“There are times when it’s important to invest cautiously, and there are times when it’s important to invest aggressively… A big part of the job is knowing where we are and choosing between those two.”
Howard Marks is one of the world’s top Risk Managers primarily because he doesn’t have an investment mandate that doesn’t allow him to change. If you can manifest the change you want to see in this industry into your risk management style, I think you can win.
The aforementioned quote is one of the many winner’s quotes you’ll find from Marks. It came at the end of an excellent Bloomberg article by Gillian Wee titled “Biggest Distressed Debt Investor Marks Europe After 22 years of 19% Return.”
Whether we like it or not (I personally love it), Timing Markets matters – big time. Whether it’s on the long or short side of what you think is a great research “idea”, try putting real risk capital on the line for a decade or more across cycles and you’ll quickly realize this lesson the hard way – there is a huge difference between great research and great risk managed research (timing).
Back to the Global Macro Grind…
After a massive 2-week melt-up across Global Equities, last week ended on a stinky note. By the time it was all said and done, commodity inflation was up a lot more than US stock market inflation last week; and with US style Jobless Stagflation compounding the stinky-ness of it all, the US Equity futures don’t like it this morning either.
Reviewing the week-over-week moves where it matters on this front, here’s what happened last week:
- US Dollar Index = UP +1.1% to $75.18
- Euro/USD = DOWN -2.1% to $1.42
- CRB Commodities Index = UP +2.1% to 343
- West Texas Crude Oil = UP +1.2% to $96.20
- Gold = UP +4.0% to $1541
- Copper = UP +2.6% to $4.41
- SP500 = UP +0.3% to 1343
- UST 2yr Yields = DOWN -17% to 0.39%
- UST 10yr Yields = DOWN -5% to 3.03%
- Yield Spread (10s minus 2s) = DOWN 7 basis points to +264bps wide
What’s a little squirrely about those 10 moves is that we saw Commodity Inflation in the face of a strong US Dollar. That’s a TRADE though and not the TREND. The intermediate-term TREND that we have been calling for since April has been a Deflating Of The Inflation (Q2 Hedgeye Macro Theme). That’s predominantly driven by a series of higher-lows in the US Dollar Index.
Whether it was the 2008 strengthening of the US Dollar or the May-July 2010 period, carry traders of the US Dollar inspired Inflation Trade don’t particularly like it when that happens. Why? Well that’s easy – Timing Markets gets a lot harder when you can’t bank on the Fed bailing you out with another Dollar Devaluation policy. Got an imminent catalyst for QG3?
In terms of the Debt Ceiling debate finding a July compromise and QG2 (Quantitative Guessing Part Deux) ending at the end of June, our call has been that for the first time in a long time both US monetary and fiscal policy have bullish US Dollar catalysts.
We’ll see if this holds, but the odds are that as Silvio Berlusconi shifts his focus from hot-tubbing to going after the “speculators” in Italy, the Euro should be under duress inasmuch as the US Dollar searches for Waldo. Remember, Timing Markets matters – and to get the US Dollar right, you need to get the Euro right.
If you change the duration of the thesis, I can give you a different “research” call for almost everything I am looking at right now. The tricky thing about markets is that they couldn’t care less about the duration of my thesis. I used to get upset about it – now I just deal with it.
In terms of positioning for the intermediate-term TREND, I think Deflating The Inflation and a Strong US Dollar is constructive for US, Chinese, and German equities, from a price.
Here’s how I am currently positioned from a Global Macro perspective in the Hedgeye Asset Allocation Model:
- Cash = 49% (down 3% week-over-week as I add exposure to Global Equities)
- International Equities = 21% (China, Germany, Sweden and S&P International Dividend ETF – CAF, EWG, EWD, and DWX)
- Fixed Income = 18% (US Treasury Flattener – FLAT)
- US Equities = 6% (Healthcare – XLV)
- International Currencies = 6% (Canadian Dollar – FXC)
- Commodities = 0%
From a timing perspective, I risk managed getting long both Chinese Equities (CAF) and the US Treasury Flattener (FLAT) well. Both of these positions are good examples of expressing a “research” view with solid risk management (timing).
As US growth slows, I wanted to express Growth Slowing by being long the compression of the US Treasury Yield Curve. As global growth slows, I wanted to buy the best major growth market in the world (China) while it’s on sale.
That’s not to say I haven’t made my fair share of timing mistakes. Two weeks ago I sold my Gold (GLD) position as I thought rising US Treasury Yields could deflate the gold price (historically, that’s when gold underperforms –when real-interest rates are negative). This morning, after the train wreck (9.2% US unemployment), US Treasury Yields are falling again, and Gold is rising (as it should).
No one said Timing Markets is easy. But “there are times when it’s important to invest cautiously, and there are times when it’s important to invest aggressively”, and I’ve made it my firm’s responsibility to be thought leaders on the front lines of these Global Macro debates.
My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1 (no position in GLD), $91.10-96.93 (we’re short OIL), and 1 (no position in SPY), respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Conclusion: Both prices and policy outlooks came in largely divergent on an intra-regional basis.
This is the first installment of our now-weekly recap of prices, economic data, and key policy events throughout Latin America. We’re aiming to keep our prose tight here, so if you’d like to dialogue more deeply regarding anything you see below, please reach out to us at .
From an equity market perspective, “divergence” was the name of the game this week. One could drive a figurative truck through the 670bps spread between the best performer (Peru’s Lima General Index) and the worst performer (Brazil’s Bovespa). Latin American FX rates were also divergent, with a 100bps spread between the best performer (Chilean peso) and the worst performer(s) (Argentine peso and Brazilian real) vs. the USD. Interestingly, the options market is bearishly positioned on every major Latin American currency vs. the USD over various durations (3wk, 3mo, and 1yr).
On the credit front, there was nothing spectacular to write home about other than a significant widening of yield spreads relative to US Treasuries. On the flip side, however, CDS declined broadly with Argentina being the lone holdout to the upside.
Like Asia, we’re seeing a broad-based pickup in positive correlations between Latin American equity markets and currencies and the S&P 500 over shorter durations. It remains to be seen whether or not this is something we should expect to continue over the near-to-intermediate term, however.
KEY ECONOMIC & POLICY DATA
- Brazil’s June trade data was rock solid: Export growth accelerated to +38.6% YoY and its YoY Trade Balance growth was up sequentially to +$2.2B. Still, a weak June Manufacturing PMI report (slowed to 49 vs. a prior reading of 50.8) may foreshadow a near-term pullback in Brazil’s overseas sales.
- By breaking out the composition of Brazil’s YTD dollar inflows, the central bank exposed Brazil’s recent capital controls for what they really were – attempted currency devaluation. With only 16.5% of the total dollars flowing into Brazil’s fixed income market, Finance Minister Guido Mantega certainly has some explaining to do regarding his relentless quest to “ban the speculators”. Interestingly, President Rousseff was out today saying that Brazil isn’t considering additional steps to curb real appreciation, citing inflation as her “bigger priority”. We’ve been saying that all along and have been appropriately bearish on Brazilian equities since November.
- Speaking of inflation, Brazil’s CPI accelerated in June to +6.7% YoY – a six year high. We remain bullish on the slope of Brazilian CPI through the next 2-3 months, and as such, we continue to anticipate incremental tightening out of Brazil’s central bank. Further, we continue believe structural inflation has the potential to take hold in Brazil under the current structure of monetary and fiscal policy.
- Two buy-side funds ran a story in the Financial Times warning about the potential for the Brazilian consumer to drift into a household debt “death spiral”. With consumer credit running at rates north of +20% YoY (well beyond the central bank’s +13% target) and an average debt service burden of ~24-28% of household disposable income, we certainly see reason for caution here. That said, however, hyper-bearish stories like this tend to surface after an -11.2% YTD equity market move. We’ll proceed very carefully here.
- Brazil’s Finance Ministry is preparing to issue dollar bonds abroad for the first time since September in attempt to take advantage of the falling yields (down nearly -75bps YTD). The bonds are more than likely to be of the 10Y or 30Y duration, as officials look to continue extending Brazil’s sovereign debt maturity profile.
- Both of Mexico’s key corporate surveys slowed in June: the IMEF Manufacturing Index fell to 53.3 vs. a prior reading of 53.7 and the IMEF Non-Manufacturing Index fell to 52.5 vs. 53.1. The slowdown is supportive of our bearish call on the Mexican peso (MXN) and our cautious outlook for Mexican equities.
- On the flip side, Mexican Consumer Confidence increased sequentially to 93 in June, supporting the central bank’s view that the Mexican consumer remains robust enough achieve its aggressive 2011 GDP growth estimates.
- Mexican CPI came in flat on a sequential basis at +3.3% YoY – also supportive of our bearish MXN thesis. The Mexican interest rate futures market continues to price in marginal dovishness out of Agustin Carstens and Co.
- The US and Mexican governments came to terms on an accord that will resolve a 15Y cross-border trucking dispute, with the Mexican government agreeing to suspend punitive tariffs worth about $2.4B of US goods in exchange for increased trucking safety.
- Chile had a mixed bag of data this week with its Economic Activity Index accelerating in May to +7.3% YoY vs. a prior reading of +6.3% and its Export and Trade Balance growth both slowing sequentially in June to +17.1% YoY and -$573.9M YoY, respectively.
- Finance Minister Felipe Larrain, a non-voting member of the central bank board, said that Chile is close to the end of its tightening cycle, citing “reduced priced estimates”. We are of the view that a likely 2H slowdown in Chilean economic growth is also a factor.
- The central bank kept its benchmark interest rate flat at 4.25%, citing uncertainty over new president Ollanta Humala’s economic policies. We remain bearish on socialism and Big Government Intervention over the long-term TAIL and would look to short Peruvian equities, its currencies, or its sovereign debt on any signs of either going forward. Socialism continues to be a failed experiment in Venezuela – where Humala’s mentor Hugo Chavez has presided over since 1999.
- In the latest sign that socialism is not a sound economic policy, Venezuelan CPI accelerated in June to +23.6% YoY. Not much else needs to be said here.
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Conclusion: Though the region’s economic data came in quite mixed in the last week, we continue to see Asian equity markets and currencies strengthen. We’ll find out shortly whether or not they were merely following US equities up for the ride or if a regional economic bottoming process is underway.
This is the second installment of our now-weekly recap of prices, economic data, and key policy events throughout Asia. We’re aiming to keep our prose tight here, so if you’d like to dialogue more deeply regarding anything you see below, please reach out to us at .
For the second week in a row, we’ve seen broad-based bullishness in Asian equities and currencies. Sovereign bonds were mixed across the curve. On the short end, we highlight the decline in Australian 2Y yields as indicative of a broader thesis we authored a few months back – the RBA’s next interest rate move is more likely to be a cut vs. a hike. On the long end, we highlight Hong Kong’s +15bps backup in 10Y yields as supportive of our view that the Hong Kong economy is overheating and inflation remains a serious headwind going forward because it transcends the standard commodity-based inflation we’ve been seeing throughout Asia and many other emerging markets over the last 3-4 quarters. Asian credit risk was mixed week-over-week with spreads widening broadly and CDS narrowing in most countries.
The main take away from this week’s data is that the volatility surrounding market perception of the US’s economic situation appears to be driving the direction of most Asian equity markets and currencies of late, as evidenced by the positive correlations with the S&P 500 gaining strength over shorter durations.
KEY ECONOMIC & POLICY DATA
- Services PMI slowed sequentially in June to 57 – as expected given the overstretched nature of May’s 61.9 reading.
- Moody’s was out making additional noise regarding China’s LGFV burden; as we have said and continue to say, “If you’re not buying China because you’re afraid of widely-speculated systemic risk within its banking system, then we’d recommend you go to cash. You shouldn’t own anything equity or commodity related if you’re bearish on China from here.”
- The PBOC raised its benchmark lending and deposit rates +25bps to 6.56% and 3.25%, respectively. We continue to think this will be the last of Chinese interest rate hikes for this cycle as CPI hits its 2011 peak in June (released tomorrow night).
- The divergence in China’s Businesses Confidence Index (up sequentially to 135.6) and Entrepreneur Confidence Index (down sequentially to 132.4) is exactly what we want to see as it relates to determining the severity of China’s oft-bandied about “landing”. Extracting from the results, we portend that current operations see growth on a steady-to-improving path, while new enterprises find it tough to get started as a result of higher interest rates and lower bank lending. Well done PBOC. Well done…
- Speaking of the PBOC, in a conference today, Governor Zhou Xiaochuan affirmed our call that China will begin to shift to a state of marginal dovishness as inflation slows in 2H saying, “China can’t adopt inflation as [its] only monetary policy target. The central bank also has to maintain economic growth and consider employment.”
- Manufacturing PMI slowed in June to 50.3 vs. 52.2 complicating the decision making process of Hong Kong authorities – fight [rampant] inflation or preserve growth? We remain bearish on Hong Kong’s long-term TAIL as any steps they take are likely to prove too-little-too-late.
- To the point on inflation, Hong Kong is selling its first ever inflation-linked debt as investors increasingly demand protection from rising prices in the territory. The offer totals HK$10B ($1.3B).
- Prime Minister Naoto Kan proposed a ¥2T ($25B) supplementary budget to aid Japan’s recovery from this year’s natural disasters. It won’t matter. We have shown many times quantitatively that Keynesian-style “countercyclical-government spending” does NOT produce sustainable growth beyond certain levels of sovereign debt. On the contrary, debt buildup past 90% of GDP is shown empirically to slow economic growth. For reference, Japan’s debt-to-GDP ratio will be well over 200% by the time the reported figures are released.
- Machine Orders growth came in faster in May: +3% MoM vs. -3.3% in the month prior. The +10.5% YoY increase is both a sequential acceleration from the prior month’s -0.2% rate, as well as a sign that the Japanese economy might actually be “growing” – as opposed to merely coming back online from unfortunate devastation. At Hedgeye we don’t pay for “quake reconstruction”; rather, we preserve our chips for more sustainable growth opportunities.
- Both sub-indexes of Japan’s Economy Watchers survey ticked up in June (“Current” up to 49.6 and “Outlook” up to 49) as the nation continues to recover from March’s devastating events. We continue to point out the enormous difference in an economy experiencing a Dead-Cat Bounce off the lows vs. a country achieving sustainable growth aided by some form of competitive advantage and sober fiscal and monetary policy. Japan has neither.
- The Aussie dollar continues to hang in there amid a growing slate of weak fundamentals: an unofficial gauge of CPI slowed in June to +2.9% YoY, Retail Sales growth slowed to -0.6% MoM in May, Building Approvals growth slowed in May to -14.4% YoY, both Services and Construction PMI readings fell MoM (48.5 and 36.8, respectively).
- On the positive ledger, Australia’s Trade Balance growth accelerated in May to +A$354M YoY. Moreover, the June employment data was nothing short of spectacular: +23.4k Total Payrolls were added MoM vs. a prior reduction -0.5k (revised down from +7.8k). A large acceleration in Full-time Payrolls growth was incrementally supportive as well: +59k MoM vs. a prior reduction of -29.3k (revised down from -22k). We question, however, how sustainable such gains are given that mining continues to be the lone bright spot supporting Australia’s labor market. Our Deflating the Inflation thesis is bearish on the margin for the Aussie employment picture.
- The Reserve Bank of Australia kept rates flat again (on hold at 4.75% since November) and talked down its GDP guidance without officially revising down the +4.25% full-year estimate. Both the futures and swaps market are now pricing in an RBA rate cut toward the end of the year. This is in sharp contrast to the June/July rate hike expectations of just a few months prior. We remain bearish on the Aussie dollar (AUD) over the intermediate-term TREND.
- Confirming the recent strength in Indian equities, Indian Services PMI increased in June to 56.1 vs. a prior reading of 55.
- YoY Inflation readings in food, energy, and primary articles all slowed sequentially in the week ended June 25. Still we see further upside in India’s monthly reported inflation figures through at least the next 2-3 months due to the recent crop price hikes and favorable base effects. Still we believe the Reserve Bank of India is nearing the end of its tightening cycle and have accordingly shifted our once hyper bearish view on Indian equities to a more neutral-to-positive outlook over the intermediate-term TREND.
- Corruption continues to cast a dark cloud over foreign sentiment regarding India. The latest headlines center on the resignation of now former Textiles Minister Dayanidhi Maran. Maran becomes India’s second federal minister to resign in less than a year over the widely publicized “2G Scam”. In our view, the market has appropriately paid a lower multiple for the increase in both magnitude and breadth of political vice.
- Both of Indonesia’s main Consumer Confidence Indexes increased in June, supporting our constructive view of the Indonesian economy. We continue to expect the Bank [of] Indonesia to remain on hold as inflation continues to trend down. Recent pro-growth commentary from Indonesia’s Finance Minister Agus Martowarjojo supports our bullish bias here.
- As expected the Pheu Thai won the majority in Thailand’s parliamentary elections – paving the way for populism and higher rates of inflation over the long-term tail. This is bullish for the baht (THB) and bearish for Thai short-term sovereign debt. Not ironically, Thailand is selling its first ever inflation-linked debt on July 13thto the tune of 40B baht ($1.3B).
- Bucking the general trend across the region, Taiwan’s trade data came in positive on the margin in June, with Export growth accelerating to +10.8% YoY and the YoY contraction in the Trade Balance (-$160M) was less than May’s -$1.9B.
- The NZIER Business Opinion Survey ticked up in 2Q to 27 vs. a -27 reading prior, supporting the recent strength in the Kiwi dollar.
- Though stale, May’s weak Trade data (slowing Export growth, slowing Trade Balance growth) is confirming of weak global demand that continues to stymie trade numbers across the region broadly.
- The Bank Negara of Malaysia shocked consensus forecasts by keeping its benchmark policy rate on hold at 3% and instead increased its statutory reserve requirement ratio +100bps to 4%, citing a need for further assessment of economic conditions.
- CPI came in faster in June at +4.6% YoY vs. May’s +4.5% YoY reading, underscoring a simple point we continue to stress: reported inflation is both sticky and a lagging indicator. We’ll continue to monitor market prices within the commodity complex for indication of the next leg of the global price cycle. While we don’t often take bureaucrats’ words at face value, central bank Deputy Governor Guingundo said that reported inflation is likely to peak soon, helping the bank achieve its 2011 target.
- The central bank said that its decision to cut its repurchase rate -100bps to 14% on Monday was not a “policy signal”. We’re not sure what this means, but we are sure that the Vietnamese central bank continues to showcase their general incompetence, for lack of a better phrase. Pardon our frankness, but the numbers speak for themselves here: Vietnamese CPI is currently running at +21.8% YoY and the Vietnamese dong down -5.3% YTD vs. the USD – far and away the worst performer in Asia. Down -11.2% YTD, the Ho Chi Minh Index isn’t looking too great either.
POSITION: No Position
What a train wreck that employment number was – and, at the end of the day, when markets pin their hopes on Keynesian economic resolve, that’s what you get – disappointments versus fleeting expectations.
- Immediate-term TRADE – SP500 is in no man’s land (1323 support, 1363 resistance)
- Intermediate-term TREND – SP500 is fine; TREND line support = 1314
- Long-term TAILs – 1220 support; 1377 resistance
I was too net long going into today’s market open, so I took the changed facts and tightened up my net exposure to 11 LONGS and 9 SHORTS.
Keith R. McCullough
Chief Executive Officer
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