“For every promise, there is a price to pay.”
Paying The Price is what hard working Americans do every morning. They take responsibility for their families. They are accountable for their actions. They’ll also be paying for their government’s promises at the pump this morning.
If you didn’t know that The Inflation is what you get when your government promises the entire world to devalue its currency, now you know. In order to calculate the price of The Petro-Dollars look no further than the price of The Petro and the price of The Dollar.
Here’s what those two prices did last week:
Now someone who is in the business of obfuscating the facts will tell you that the price of The Petro-Dollars raging to the upside has to do with something other than the debauchery of the dollar. Of course it does – everything that adversely affects the marketing message of Washington, DC must have to do with someone else – that’s the un-American way.
Pointing the finger at some nut-job wearing shades in Libya just makes the marketing message easier. Since speaking at the American public on economic matters has turned into a world class game of politics, we should expect nothing less. On NBC’s Meet The Press yesterday, President Obama’s newly minted Chief of Storytelling, Bill Daley, reminded the world how Washington’s finest think about risk management plainly:
“Most people don’t know what they are talking about… The President knows…”
OK. Thanks Chief.
We will un-humbly submit that, on Global Macro economic matters, US Presidents and their crony economic advisors haven’t known what they don’t know for at least a decade. That’s a long time. That’s a problem.
Back to those stubborn little critters called real-time market prices that we use to illustrate the problem, here’s what else happened in the US as a result of the US Dollar being devalued last week:
Altogether what this means is that since the US stock market stopped making higher intermediate-term highs on February 18th, the market has started to price in Slowing US Growth assumptions as US Inflation Accelerates.
For readers of our work, this shouldn’t be a new theme. Our 3 core Macro Themes at Hedgeye have been calling for Global Growth Slowing as Global Inflation Accelerates since October of 2010.
Our call on Accelerating Global Inflation’s impact on both Emerging Markets and Bonds is best captured by the #1 Economics headline on Bloomberg this morning: “Global Bond Rout Resembling 1994 As Inflation Exceeds Rates” – so, globally, people get it. The question is what will it take for US stock-centric consensus to finally get it?
Don’t fool yourself by letting some of the Fed’s Fiats fool the media most of the time, whether you look at the stock market performance divergences in US Equities or abroad, Mr. Macro Market is pricing in Global Inflation Accelerating, big time.
US S&P Sector Performance divergences for 2011 YTD:
Global Equity Market Performance divergences for 2011 YTD:
Obviously when presented with these prices on a real-time basis, the fundamental takeaways are crystal clear:
If this continues, the global economic risk management scenario starts to look a lot more like the 1970s than it does anything that most investors have had to wrestle with for the last 30 years. Stocks aren’t in the area code of “cheap” if inflation finds its way into margin and multiple compression.
The best way to fight this is by breaking the gigantic promise that America has made to the world – cheap moneys forever. If we start promising the world more hawkish monetary policy, the US Dollar will stop being debauched. That, in turn, will deflate The Inflation. And I’ll be the first in line to start investing more of my 49% position in Cash (versus 58% on Monday of last week). Paying the lower price works for me.
My immediate-term support and resistance levels for the SP500 are now 1315 and 1333, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
This note was originally published at 8am on March 02, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“Demographics is destiny.”
Undoubtedly, there is a lot I disagree with Arthur Kemp on. He is the Foreign Affairs Spokesperson for the British National Party, and is a self-avowed white separatist and critic of miscegenation. Yup, definitely not that kind of cat I would spend much time socializing with or supporting. Despite this, his quote above regarding demographics rang very true with me.
We employ demographics across many of our research verticals, and in fact use it from a macro perspective when analyzing countries and demand patterns. The inevitability of demographic trends is difficult to deny. In some instances, it may merely be getting old, which is what my mother likes to tell me I’m doing as a 37-year old bachelor. In other situations, demographics, and the related outcomes, relate more to youth and birthrates.
In an intraday note yesterday titled, “Could the Kingdom Fall?”, I highlighted the importance of age to social unrest in the Middle East and North Africa. Simply put, MENA has a young population that is severely under-employed. If there is an elixir for social unrest, this is it - young people with too much time on their hands, and not enough money in their pockets.
As a frame of reference, the median age in the United States is 36.9 years. Globally, the median age is 28.4 years. So, the population of the United States is meaningfully older than the rest of the world. The global median age is driven down by the Middle East and North Africa. In the Chart of the Day, we’ve highlighted this global discrepancy broadly, but the median age in Iran is 26.8, in Iraq 20.9, in Egypt 24.3, in Libya 24.5, and in Pakistan 21.6. The lower average and median ages in MENA have been driven by vastly improving health care over the last decade, which have driven up birthrates.
In Japan, the key demographic trend is the exact opposite. In contrast to many MENA countries, and really the world, Japan is old. Not getting old, but already there. In fact, the median age in Japan is 44.8 years. According to the CIA World Fact Book, this makes Japan the second oldest nation based on median age after Germany, whose median age is 44.9. Not surprisingly then, demographics is one the key tenets in our bearish thesis on Japan’s equity and currency; or as we like to call it: Japan’s Jugular.
While Japan’s median age is slightly lower than Germany’s, it has by far the world’s most elderly population. Currently, as of 2009, 22.7% of Japan’s population is above 65 years of age. The Japanese government has modeled this ratio to grow to 29.2% by 2020 and to 39.6% thirty years after that. The implications are that in ten years the ratio of retirees to working age will be ~48% in Japan.
The aging Japanese population has dire implications related to the future fiscal and monetary health of the country. The Japanese Government Pension Investment Fund, the world’s largest pension fund with ~$1.4 trillion in assets, has consistently been one of the largest buyers of Japanese government debt. This fiscal year, ending March 2011, the fund will be for the first time a net seller of Japanese government bonds. According to Takahiro Mitani, the President of GPIF, “We certainly have to come up with an adequate amount” to pay pensions. With these bond sales, the impact of demographic headwinds has likely reached an inflection point in the Japanese economy. These sales will only accelerate in the coming decades and with them the associated risks to the Japanese economy (higher interests rates as one) will also accelerate.
In the United States, there is some clear destiny embedded in demographic trends as well, specifically related to healthcare and healthcare investors. The Baby Boomer wave, which Healthcare investors commonly, and mistakenly, place as the core driver of a long-term Healthcare growth thesis, remains the most consequential domestic demographic trend.
Boomer Employment (45-64 yr olds) reached its crescendo in the 1993-2002 timeframe with peak earnings and peak disposable income occurring alongside historic lows in unemployment. Now, with this segment of the working population in deceleration mode, the U.S. workforce nearing a peak in average age, and the echo boomers (30-39 yr. olds) years away from peak consumption growth, the healthcare and broader economy face significant longer-term demographic headwinds.
This last point is also embedded in long-term projections for healthcare and social security entitlements in the United States. In the Congressional Budget Office’s long-term baseline scenario, due to these aging demographic trends, social security spending accelerates from 4.8% of GDP in 2010 to 6.2% in 2035 and healthcare spending accelerates from 5.5% of GDP to 9.7% over the same time period, which will lead to a huge ramp in mandatory government spending over the coming decades with no reform.
While there is inevitability embedded in many of the demographic trends outlined above, from a risk manager’s perspective we just have to manage the tail and headwinds accordingly. And as Chuck Jones, the inventor of Wile E. Coyote, said about inevitability:
“There is absolutely no inevitability as long as there is a willingness to think.”
Keep your head up and stick on the ice,
Daryl G. Jones
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Notable news items from the past few days and price action from Friday’s trading session.
TODAY’S S&P 500 SET-UP - March 7, 2011
Equity futures are holding slightly above fair value. The price of oil is again likely to drive sentiment this week as Libya looks to be sliding into civil war and the regional civil unrest threatens to spill into Saudi Arabia. On Saturday, the Saudi authorities said they would ban all protests and marches after activists called for "a day of rage" this coming Friday. As we look at today’s set up for the S&P 500, the range is 18 points or -0.47% downside to 1315 and 0.90% upside to 1333.
MACRO DATA POINTS:
WHAT TO WATCH:
We have 5 of 9 sectors positive on TRADE and 9 of 9 sectors positive on TREND.
CREDIT/ECONOMIC MARKET LOOK:
Treasuries were stronger with the belly of the curve outperforming. 2s10s wider by nearly 2 bps
For the week ending March 4, 2011.
TEAM MEMBER COMMENTARY
Keith McCullough – Strategy
CALLOUT OF THE WEEK: The bull/bear battle between what’s more impactful on US Consumption – unemployment or oil – is on. Since one is a leading (oil) and the other is a lagging (unemployment) indicator, I say oil. That’s not to say that I won’t get more constructive on US Equities at lower prices, especially if high-frequency and concurrent indicators (jobless claims, consumer confidence, mortgage applications) improve in unison. I highly doubt they will if oil prices stay pinned up here.
CONTRARIAN CALLOUT: I still don’t think consensus realizes what a US Dollar crisis will do to the American Consumer’s buying power and corporate margins. The correlation risk to just about every asset class that trades in (or relative to) US Dollars is reaching levels that I would call surreal. The Bernank is perpetuating price volatility. If he doesn’t start changing as the facts have (like virtually every other central banker in the world has), he’ll become a modern day Arthur Burns.
Daryl Jones – Geopolitics; Commodities
CALLOUT OF THE WEEK: Regardless of the grade of oil you looking at, the commodity is melting up. The key drivers are a weakening U.S. dollar, continued uncertainty in the Middle East, and, as well, decent demand for gasoline in the United States. We think the U.S. dollar weakness will continue to be a key driver; look for an acceleration in the increase of the price of crude oil if the ECB starts raising rates.
CONTRARIAN CALLOUT: While focus has shifted to the unrest in the Middle East, unrest across the United States relating to State level budget cuts is accelerating. This unrest could create an incremental headwind to GDP that currently isn’t in consensus numbers. This will come from both layoffs and a decline in State and local level budget spending year-over-year.
Matt Hedrick – Europe
CALLOUT OF THE WEEK: ECB President Trichet said on Thursday that an “increase of interest rates in the next meeting is possible… but not certain.” Trichet’s tone sets him apart from Bernanke, who chooses to turn a blind eye to inflation. European markets and the EUR vs. most major currencies rose vs. the USD this week alongside a more hawkish tone. We contend that the ECB and BoE should hike rates within the next 1-3 months to address pressing inflation risk.
CONTRARIAN CALLOUT: The March 24-25 EU Summit promises to devise a “comprehensive” package to end the region’s crisis and stabilize the Euro, however we contend that the “sailing” may not be so smooth as leaders will struggle to tie an all encompassing policy bow around the region -- increasing country competitiveness and stronger fiscal standing can be easy in theory, harder in practice. The interconnectedness of the EUR means that the instability of just one country, and Portugal looks most imminent, can severely weigh on the common currency. Gains in the EUR this week could very well pull back in the coming weeks. We’ll be monitoring political rhetoric and policy moves acutely.
Darius Dale – Asia; Latin America; State & Local Governments
CALLOUT OF THE WEEK: Both Brazil and India unveiled new fiscal policy measures this week and both failed to adequately address the key issue facing both economies – rising inflation. India’s lack of fiscal resolve (particularly relative to Brazil) contributed to the SENSEX closing up +4.5% on the week (vs. +1.9% for the Bovespa) as the market cheers on more loose policy. As we called out back in early November, Brazil’s proactive monetary policy (relative to India) will keep it outperforming in this two-legged stagflationary race: Bovespa down (-1.7%) YTD vs. SENSEX down (-9.8%) YTD.
CONTRARIAN CALLOUT: It’s clear now that consensus understands that the melt-up in commodity prices since Jackson Hole (Aug. 27) has contributed to accelerating headline inflation readings on a global basis. What consensus may fail to miss going forward is the likelihood that inflation starts to show up in “Core” CPI readings globally. The confluence of companies passing through cost pressures to end-consumers and a global acceleration in wage growth and government subsidies (particularly in key emerging economies) perpetuates this possibility.
MORNING MACRO CALL HIGHLIGHTS
Every morning at 8:30AM EST, we host a live conference call with clients whereby Keith’s 15 mins of prepared global macro commentary is followed by 5 mins of Q&A (if you need a live dial-in, please emails us a ; the call is also podcasted on our website each morning by 9:00AM). Below is a sample of some of the better questions we received this week (answers paraphrased).
Q: Why are you so negative on fund flows; wouldn’t it have been prudent in December to recognize that the flows would trump fundamentals for the intermediate-term TREND, rather than shorting the market? Could one argue that it’s the job of the risk manager to contextualize both fundamentals AND flows, as both have the ability to influence price?
A: We aren’t negative on fund flows per se; where we see risk is that talk of the “flows” is highly speculative in nature. You can’t quantify the dollar amounts ahead of time or even on a concurrent basis. Also, market history tells us that it’s a contrarian signal when the “flows” become consensus’ main catalyst.
Q: What would get you to put the SPY short back on; it rallied up to just under your TRADE line of support on Friday. Is there a specific level that would get you to test the waters again on the short side?
A: Waiting and watching. I’m learning from my mistakes of trading the SPY 1-3 days too early over the last decade.
Q: Much of the weakness in the US dollar has been generated by weak US monetary and fiscal policy. As we saw yesterday with Trichet’s commentary, could further US dollar weakness actually be driven now by hawkishness in the currencies in the US dollar basket? i.e. Could central bank hawkishness relative to Bernanke push the dollar down in addition to the downward pressure being applied by the Fed and D.C. politics?
A: Outstanding multi-factor question; the answer is “yes” (currencies are priced in baskets relative to each other). As the rest of the world respects the cost of capital and their citizenry (by not infusing them with inflation), their currencies will go higher. This will have a structural negative effect for the US dollar. Don’t get carried away, however. The US Dollar Index will be immediate-term TRADE oversold in the low-$76 range and we expect to see a snap-back rally to another lower-high prior to it resuming its bearish TREND.
ASSET ALLOCATION MANEUVERS
SELECT RESEARCH SUMMARIES & UPDATES TO SELECT QUARTERLY THEMES
3/1: Early Look: The Flows
-Our view of The Fundamentals is often 3-6 months ahead of Wall Street/Washington consensus is what it is – since October, our Global Macro view of the fundamentals remains Global Growth Slowing as Global Inflation Accelerates.
-What happens on the margin in Global Macro matters most. And on the margin, The Flows into the stock markets of Developed Economies have been huge. The most important risk management part of that last sentence is “have been.”
-There is no but in The Flows. They are what they are until they stop. All the while, I’m most certainly not going to freeze with a strategy to short-and-hold…Not in a market where professional politicians are sponsoring a Burning Buck, The Inflation, and Price Volatility.
3/1: Could the Kingdom Fall?
-Though once unthinkable, the fall of the Saudi kingdom now seems at least in the realm of reality. That is, popular unrest in Saudi Arabia and the Middle East could lead to a shift away from the autocratic rule in Saudi Arabia. Keep March 11th on your calendars as Saudi youths have organized a day of protests against the monarchy called the Day of Rage.
-The Saudi stock market has been flashing some amber lights…there has been a severe correction in the Saudi stock market of more than 10% and an expansion by more than 20% in CDS spreads.
-The International Labor Organization (ILO) has put the unemployment rate for those between the ages of 20 – 25 at close to 30%. This is particularly important given the population is young with median age of 23.4 years old.
3/3: Trichet Boosts Rate Hike Expectations, Markets Cheer
-ECB President Jean-Claude Trichet said that an “increase of interest rates in the next meeting is possible… but not certain.” Despite all attempts by Trichet to be close-lipped on future actions by the governing council, the sentence was largely interpreted by the market as proof that the ECB will hike in the near-term.
-Our position remains that both the ECB and BOE will act to address their respective inflation pressures well before Ben Bernanke does, as The Bernank chooses to ignore the looming pressures of domestic and global inflation.
-Confirming the rising tide of inflation: CPI rose 2.4% in February year-over-year versus 2.4% in January; and PPI increased 6.1% in January Y/Y versus 5.3% in December. The PPI report showed that energy prices jumped 13% from a year earlier.
3/4: Crude Oil In The US: Is the Price $103/bbl or $115/bbl?
-Refined products (gasoline and diesel) in the U.S. are tracking Brent crude oil, and not WTI. If you are using WTI as your marker for oil’s impact on consumers in your macro model, you should reconsider.
-Interestingly, the prices of refined products in the U.S. are no longer tracking WTI. When WTI began lagging other oils, gasoline and diesel did not hang back with it.
-Since November 15, the correlations between a barrel of WTI crude oil and refined products since November 15th, 2010 are: Gasoline +0.83; Diesel +0.69. Over the same duration, the correlations between a barrel of Brent crude oil and refined products are: Gasoline +0.98; Diesel +0.98.
3/4: State & Local Government Finances Not Just a Problem for Muni Bonds
-Recent developments in the FY12 State & municipal government budget season reveal to us several trends that are incrementally bearish for US GDP growth and the US Dollar over the intermediate-term.
-One could make a compelling argument that the public employee protests currently impacting the Midwest region will spread throughout the country like wildfire, especially considering the relative health of Wisconsin, which just recently issued arrest warrants for its fugitive legislators.
-46 States have to balance their budgets by July 1 or risk delays in payments to vendors and creditors alike. If the US Dollar and the protests in Wisconsin et al are indicating anything, it is that this catalyst is closer on the horizon than a resolution of the budgetary debates.
Have a great weekend,
The Hedgeye Macro Team
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