Insight on equities, bonds and inflation, with Scott Sperling, Thomas H. Lee Partners, and Keith McCullough, Hedgeye Risk Mgmt.
Insight on equities, bonds and inflation, with Scott Sperling, Thomas H. Lee Partners, and Keith McCullough, Hedgeye Risk Mgmt.
TODAY’S S&P 500 SET-UP - December 13, 2010
As we look at today’s set up for the S&P 500, the range is 33 points or -1.64% downside to 1220 and 1.02% upside to 1253. Equity futures are trading above fair value following a strong start to the week across Asian and Europe where China's decision to not to raise its benchmark interest rate has prompted further risk appetite. On the data front this week, the passage of the newly-proposed fiscal stimulus package through both Houses of Congress will be the main focus today. For the rest of the week, data highlights include tomorrow's FOMC rate decision plus November Retail Sales, November CPI and Empire Manufacturing on Wednesday. In addition, weekly Jobless claims plus the Philly Fed Index on Thursday.
CREDIT/ECONOMIC MARKET LOOK:
Financial Risk Monitor Summary (Across 3 Durations):
1. US Financials CDS Monitor – Swaps continued to tighten across domestic financials last week, widening for just 5 of the 28 reference entities and tightening for the other 23.
Tightened the most vs last week: C, SLM, PRU
Widened the most vs last week: ALL, CB, TRV
Tightened the most vs last month: JPM, C, PRU
Widened the most vs last month: CB, TRV, MBI
2. European Financials CDS Monitor – In Europe, banks swaps reversed course and widened out. Swaps widened for 32 of the 39 reference entities.
3. Sovereign CDS – Sovereign CDS rose 27 bps on average last week.
4. High Yield (YTM) Monitor – High Yield rates rose slightly last week, closing at 8.31 on Friday.
5. Leveraged Loan Index Monitor – The Leveraged Loan Index came close to new highs, closing at 1556.
6. TED Spread Monitor – The TED spread backed up on Friday to close the week at 18.5.
7. Journal of Commerce Commodity Price Index – Last week, the index rose 3.8 points, closing at 25.7 on Friday.
8. Greek Bond Yields Monitor – We chart the 10-year yield on Greek bonds. Last week yields rose slightly, ending the week 12 bps above the prior week’s close.
9. Markit MCDX Index Monitor – The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on four 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. Our index is the average of their four indices. Spreads increased sharply last week, closing at 208 bps, 35 bps higher than last week.
10. Baltic Dry Index – The Baltic Dry Index measures international shipping rates of dry bulk cargo, mostly commodities used for industrial production. Higher demand for such goods, as manifested in higher shipping rates, indicates economic expansion. Last week the index fell 7.3 points to close at 209.5.
11. XLF Macro Quantitative Setup – Our Macro team sees the setup in the XLF as follows: 1.2% upside to TRADE resistance, 3.6% downside to TRADE support. Typically, when downside to upside is greater than 2:1, we believe caution is warranted.
Joshua Steiner, CFA
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“Knowing others is intelligence, knowing yourself is true wisdom.”
The closing of the year elicits contemplation and self-reflection. No, I’m not going to head down the road of providing a list of 10 surprises. These lists are generally interesting to read, but – ironically – many of the forecasted “surprises” become consensus and are not particularly useful from an investment idea perspective.
At Hedgeye, we like to think about what is going to happen in the next three month as opposed to where we are going to be 12 month from now. As we like to say, “You’ve got to play the game that is in front of you.” Playing the game requires discipline and some self reflection to stay grounded.
Of course, as with anything, it is easiest if you have a process or methodology. On a personal level, yoga is one thing that helps me to enjoy introspection. In India, the method of self-reflection is called svadhyaya: Sva means “self” and adhyaya means “investigation, inquiry, or education”. If you practice, svadhyaya it helps you observe moment-to-moment changes in your mind and pose important introspective questions. How are you feeling in your body? Is your mind present? What subject matter draws your mind away?
When it comes to Hedgeye, we try to have a method for observing moment-to-moment changes in the market and also in our current stances on different themes and investment ideas we generate for our clients. As we’ve said time and again, clients are a key part of this process and their feedback aids us immeasurably in our efforts to better serve them.
Heading into the New Year, it’s an appropriate time to reflect upon (1) What has transpired? (2) Where are we headed? and (3) What is left undone? Svadhyaya is what we aspire to at Hedgeye; the ability to investigate, inquire, and educate ourselves and our processes. Knowing oneself and obtaining true wisdom is likely a goal to be chased but never quite achieved. If the pursuit of this goal enriches our perspective on markets and processes then that, in and of itself, makes us better on the margin. And, as we always say, what matters happens on the margin.
Hedgeye’s take on the intermediate-term global macro outlook is three-pronged:
It has been our view for some time that interest rates are going higher. In terms of timing this call, it is extremely difficult given the scale of government interference in capital markets in recent times. This call is, quite simply, anchored on our view that global risk is compounding. Last week the US 10-year Treasury yield reached 3.33%, 28% higher than a month ago, compared with Germany’s borrowing costs rising +27% to 3.03%. The trend continues today with the US Treasuries getting smoked again this morning as the world continues to see the inflation that Ben Bernanke is not allowed to see.
Yes, inflation is accelerating globally. People are paying higher prices for what they use to feed themselves, clothe their children, and drive their cars than one year ago. CPI in China accelerated to a 28-week high of 5.1% year-over-year in November. Food inflation accelerated to 11.7% year-over-year.
The price of oil recently hit $90 for the first time in two years, gas prices at the pump are at $3.00 and according to Bloomberg, consumers of food made from wheat and corn should brace for higher prices, if history is any guide, after bad weather and a shortage of farmland threaten to create supply “shock waves”.
In keeping with the idea that we must play the game that is in front of us, the “growth is slowing” theme is being challenged by the “fiscal lunacy” of the politicians in Washington who will be adding another $900 billion to the deficit over the next five years. Now the latest projections are that the USA 2011 budget deficit will hit $1.5 trillion after it was just $1.1 trillion a few months back.
On the heels of the tax plan, consensus expects that the tax reductions will add 1% to GDP growth in 2011 (one time boost). Side-effects of Bernanke’s monetary policy will, in my view, go some way towards offsetting this boost. As the Federal Reserve stokes inflation through Quantitative Guessing, a run up in rates, coupled with a 15-20% decline in home prices in 2011, will mitigate the benefit of lower taxes.
The combination of inflation and ever-increasing debt levels does not encourage growth, it inhibits it! Jobless Stagflation is a theme we’ve been highlighting for months and it will become clearer to many as 2011 proceeds.
I believe it would be beneficial for the administration to consider svadhyaya as a New Year Resolution. The government today is an active participant in the markets. To what end this participation? Is there an end to this participation? If government’s role is to protect employment levels and maintain price stability, I think the scoreboard speaks for itself on both counts.
Projections offered by the administration in 2009 as to where unemployment would peak during this crisis have been far surpassed. If government’s role is to somehow protect and enhance the life that its citizens lead, the almost 43 million people surviving on food stamps may have something to say about the administration’s success on that score. It’s not that the administration it not trying; it is relentless in its pursuit of what it thinks is needed to bolster the obviously fragile economy.
I do not believe it would take an otherworldly bout of introspection for the administration to realize that these efforts are not working and, more pointedly, they are expensive. The public sector furor defined by massive government balance sheets has taken hold in Europe and you can bank on it coming into the fold in the U.S. in the not-too-distant future.
David Einhorn of Greenlight Capital was interviewed by Charlie Rose on December 6th and highlighted some “unfinished business” that was left unresolved from the last crisis. Einhorn is a thoughtful person and offered a metaphor for the economy at present of being “between two storms”. The private sector storm was first but the public sector crisis is coming. I don’t know David Einhorn and he may not be a yoga aficionado, but I would hazard a guess that svadhyaya would not be a completely foreign concept to him.
Function is disaster; finish in style
Looking at the recent short interest moves in the restaurant space, one can see confirmation of what we already knew; red meat costs are going to pressure earnings over the next few quarters. Casual dining concepts with said exposure are first choice on the menu for short sellers of late (MRT, RUTH, TXRH, CHUX).
Some other thoughts:
For now, if the stock market is your gauge, Bernanke is seeing some success. There are many other real time markets (commodities, global growth) that show a disconnect from U.S. equities. The most recent consumer data point indicates that the consumer is feeling better. I’m less-than-convinced that this will be sustainable or that Ben Bernanke has discovered any lasting solution to the problems facing the U.S. economy.
The following are some current positives in consumerland:
1. Income growth is getting better
2. Job growth is still stagnating but trends are better that they were in January
3. Retail sales are hanging in
4. Consumer sentiment improved 5.7% and 3.6% sequentially in November and December, respectively.
5. The Consumer discretionary index (XLY) is up 25% YTD
6. The S&P 500 up 8.76% and 3.69% September and October, respectively and is up 4.4% so far in December.
The University of Michigan consumer confidence reading rose to the highest level in six months, but is still registering a lower high; index of consumer sentiment rose to 74.2 from 71.6 at the end of November. The Bloomberg consensus was for a reading of 72.5.
The bullish consumer sentiment is not being confirmed by the more weekly ABC consumer comfort index which is at a -45, up from the low of -54 set on 12/01/08. Year-to-date the consumer sentiment index is only up 2.3%, with the expectations component down 3%, while the current conditions is up 10%.
The consumer is clearly responding to diminishing levels of uncertainty as corporate profits have improved to the best level since 2007. We are reminded that not every this is turning up roses and part of the improvement increased profits is due to better efficiencies thru lower labor costs. Just today TJX closing down the A.J. Wright division and cutting 4,400 jobs; other notable companies recently announcing layoffs in the past 30 days are the Washington Post, Express Scripts, State Street VF Corp and Apollo Group Inc.
The current trends in consumer sentiment as measured by the University Michigan are critical and continued improvements are needed to sustain the bullish sentiment running thru the market.
1. The Bullish to Bearish spread for the AAII sentiment index is approaching the danger zone again at 30.5.
2. The VIX is down 48.9% over the past six months and is now down 20.99% year-to-date; another shoe dropping could see the VIX busting a serious move to the upside.
If the politicians in Washington come to some sort of compromise from the expiring Bush income tax cuts, it’s net neutral for the economy and will not likely benefit consumption. At some time austerity will need to become a part of the conversation and a cursory glance at the television and how that is going down in Europe shows you what the consumer is going to think about that. The continuation of the unemployment benefits helps buttress consumption. I have described this before in the context of extended and emergency benefits. Allowing them to expire would essentially sweep the legs from under a large portion of consumers and, whether or not one believes that this is good policy, it would initially be a negative for consumer spending and the broader U.S. economy.
On the plus-side for consumers, the one year's elimination of two percentage points in the Social Security withholding tax will directly boost disposable income of individuals currently paying those taxes. As a result, there should be some consumption pick-up, but it is “one time” in nature and, just like the stimulus package, the impact will only be short lived.
As the facts change, we can adapt to the new trends. For now we are sticking to our Consumer Cannonball theme (albeit on a different duration), as some of the major pillars of that thesis have not changed; primarily the outlook for housing and the labor market in 2011. I will expound upon this point in a post next week.
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