“Are we human, or are we dancer?”
As many of you likely know, “Human” is a song by American Indie rock band The Killers. Keith referenced it in Hedgeye’s last company meeting to note the infallibility of us all. Sometimes we are right, sometimes we are wrong, but we are always human. As well, sometimes things just aren’t as complicated as humans like to make them.
While I am prone to typos, the typo, or rather grammatical error, is not my doing in this instance. The Killers actually wrote the song with dancer, and not dancers. In fact, the song was motivated by a derogatory comment by Hunter S. Thompson, when he stated that America was raising a “generation of dancers”. According to Wikipedia, in an interview in Rolling Stone, the lead singer of The Killers, Brandon Flowers, was asked about confusion over the lyric and responded:
“It’s supposed to be a dance song, the beat goes with the chorus . . . if you can’t put that together, you’re an idiot. I just don’t get why there’s confusion.”
Certainly, Brandon Flowers and his band mates are human, but grammatical error and all, their song, “Human”, was voted the top song of 2008 by Rolling Stone Magazine.
The investment business is perhaps one of the most humbling of all professions and reminds its participants every day that they are human. In the Chart of the Day, we show the SP500 versus 10-year Treasuries over the last six months. Certainly, there were very few investors on the right side of both trades six months ago.
This morning I went back to our Early Look strategy note from exactly six months ago and on February 23rd, Keith wrote:
“And this is really where I can look myself in the mirror and say, despite the fierce lobbying for me to chase US stock market fund “flows” into their mid-February crescendo, I stayed true to the best top-down risk management process I know – when Global Inflation Is Accelerating, and Global Growth Is Slowing, it’s time to build up a large asset allocation to Cash.”
At that point, the SP500 had been chugging upwards since the start of the year and was up roughly 4% year-to-date and on trajectory for a more than 25% annualized return. Back then, it was hard to be bearish, now it is pretty easy.
Akin to The Killers song, we aren’t bears, we aren’t bulls, we are only human. While Keith, myself, and our team are happy that our research process helped us alert our clients early to the confluence of global economic issues that has led to the dramatic decline in global equities year-to-date, the next challenge is to have the correct view of the next major move in global equity markets.
For us to turn more positive on U.S. economic growth we would likely need to see a positive change on the margin in three key areas: housing, employment, and debt. It is really that simple. The first two relate to the largest portion of the U.S. economy, which is consumer spending. Stable house prices provide consumers the confidence to spend, and fuller employment broadens U.S. consumption. The third factor, debt, relates to the U.S. government balance sheet. Just like any corporate or individual balance sheet, the federal balance sheet has become constrained by debt, which will impede future organic growth.
Underscoring all of this, as it relates to securities prices, is, of course, the perspective of expectations. That is, what is priced in? With the SP500 now down more than 10% in the year-to-date, there is certainly a reasonable amount of bad news priced in. Often, though, securities prices tend to be a leading indicator versus a lagging indicator and a key question to consider now is what the dramatic decline in equity prices we have seen in the last month means for confidence and economic growth over the coming quarters.
A couple of days ago, President Obama stated that he doesn’t expect a recession in the next twelve months. This was supported this morning by a survey from the Associated Press that indicated that a majority of economists believe that another recession is unlikely in the next twelve months. This is, of course, the same group of economists whose group GDP growth estimate for 2011 was +3.2% on February 23rd. . .
Flagging our competitors on their errors in groupthink only gets us so far, but looking at the consensus view does provide us some insight into what is priced into the market. That said, we certainly understand, as former Yale President and Commissioner of Major League Baseball Bartlett Giamatti famously said:
“No one man is superior to the game.”
Isn’t that the truth . . .
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
This note was originally published at 8am on August 18, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“I can forecast confidently that it will vary.”
-Lord John Browne
That was a quote from the former CEO of British Petroleum on forecasting the price of oil. It’s the opening line in Chapter 2 of a must-read book that’s in my summer pile titled “Babble – Why Expert Predictions Fail and Why We Believe Them Anyway.” Good thing our Keynesian overlords in Washington and the manic media that fawns on them don’t consider me an “expert”…
I was on what we affectionately refer to as a Hedgeye Client Roady in New York City with our all-star European analyst Matt Hedrick yesterday. It was hot. We were sweaty. And, oh, were we all beared up (to be “beared up” means to be Bearish Enough).
Is the Sell-Side Bearish Enough?
Given that most of the Bullish Babble I have been reading from Wall Street’s “Sell-Side” (investment banks and brokers who market the Perma-Bull) in 2011 has not yet turned bearish (never mind Bearish Enough), the answer to that question is unequivocally no.
Is the Buy Side Bearish Enough?
The “Buy-Side” (asset managers) is definitely not bullish like the Sell-Side. But I don’t think they are Bearish Enough yet either. There’s certainly a qualitative element to that conclusion (my gut), but there’s also quantitative evidence (S&P Futures down -23 handles this morning and yesterday’s Institutional Investor Sentiment survey showed only 23.7% of people admitting they are bearish.
Back to the Global Macro Grind…
Wall Street/Washington “blue chip” forecasts on US GDP Growth continue to be so far away from the area code of reality that S&P actually looks accurate (S&P cut its Q4 US GDP estimate to 1.8% yesterday – Hedgeye’s Q4 GDP range is 0.6%-1.3% for Q4).
From a risk management modeling process perspective, we use a range because we aren’t yet dumb enough to take the government’s word for it when they can revise the GDP number down by 81% in 3 months (Q1 2011).
In terms of Global GDP Growth, Morgan Stanley is snagging the #1 “Most Read” headline on Bloomberg Economic News this morning by “Lowering Global Growth Forecast” by a whole 30 basis points to 3.9%. Oooh, lah, lah… the bearishness of it all.
Meanwhile, the Global Macro Economic Data continues to confirm our baseline case for Global Equities – that stocks will be assigned a lower multiple because A) the Street is using the wrong GDP and earnings numbers and B) The Stagflation earns a much lower multiple.
Around the world this morning, Gentlemen and Ladies of Hedgeye, here are your real-time economic taps:
- SINGAPORE (ASIA) EXPORT SLOWDOWN – exports down -2.8% in July (that’s a year-over-year number!) and if you didn’t know that the Singaporeans A) advise the Chinese and B) were dead serious about what they said on growth when I signaled it last week… now you know.
- BRITISH STAGFLATION – after reporting a whopper of a Consumer Price Inflation (CPI) number for July on Tuesday (+4.4% y/y), the Brits printed a 0.00% Retail Sales growth number for July this morning. ZERO growth + inflation = The Stagflation.
- AMERICAN STAGFLATION – yesterday’s Producer Price Index (PPI) for July came in at +7.2% year-over-year growth and this morning’s Consumer Price Inflation (CPI) print should be close to +3.5% y/y. ZERO point 36 percent Q1 GDP Growth + 1.3% Q2 GDP Growth + Inflation readings that are orders of magnitude higher than real-growth = Le Stagflation, Monsieur Bernank.
So what do you do with that this morning? Hopefully the answer to that question resides in what you’ve already done to preserve and protect your family’s capital. We’ve already made the “call” to go to ZERO percent asset allocation to both US and European Equities and on Monday we cut our asset allocation to Chinese Equities in half (from 6% to 3%) in the Hedgeye Asset Allocation Model.
Q (on yesterday’s Client Roady): “what would change your mind?”
- Global Macro Economic Data
- Market Prices
While plenty of Fed Heads have changed their tunes to a more passive-aggressive Rick Perry sounding country song in the last 24 hours (Bullard, Fisher, Plosser, etc), I have not changed mine.
I am forecasting, confidently, that market prices will vary – and that managing risk starts with accepting uncertainty.
My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1755-1834, $80.07-89.87, and 1172-1207, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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THE HEDGEYE DAILY OUTLOOK
TODAY’S S&P 500 SET-UP - August 23, 2011
Bottoms are processes, not points – and, globally, that’s going to take some time as long as the economic data and market prices continue to lean bearish. As we look at today’s set up for the S&P 500, the range is 64 points or -2.39% downside to 1097 and 3.31% upside to 1161.
SECTOR AND GLOBAL PERFORMANCE
- ADVANCE/DECLINE LINE: -356 (+1217)
- VOLUME: NYSE 1191.57 (-21.03%)
- VIX: 42.44 -1.42% YTD PERFORMANCE: +139.10%
- SPX PUT/CALL RATIO: 2.01 from 1.67 +20.01%
CREDIT/ECONOMIC MARKET LOOK:
UST YIELDS – The Hedgeye downside target in the 10-year was hit right on the nose on Friday (2.06%) and now you’re seeing the proactively predictable bounce in bond yields that is inversely correlated with Gold/Silver; remember Gold/Silver really outperforms when real-rates-of return on bonds are negative; the immediate-term TRADE range for 10s is now 2.01%-2.19%; manage risk around that range.
- TED SPREAD: 30.84
- 3-MONTH T-BILL YIELD: 0.01% -0.01%
- 10-Year: 2.10 from 2.07
- YIELD CURVE: 1.88 from 1.87
MACRO DATA POINTS (Bloomberg Estimates):
- 7:45 a.m.: ICSC weekly sales
- 8:45 a.m.: Alan Greenspan Q&A at Washington Convention Center
- 8:55 a.m.: Johnson/Redbook weekly sales
- 10 a.m.: July new home sales, est. 310k, prior 312k
- 10 a.m.: Aug. Richmond Fed manufacturing, est. -5, prior -1
- 11:30 a.m.: U.S. to auction $35b 4-wk bills, $25b 52-wk bills
- 1 p.m.: U.S. to auction $35b 2-year notes
- 4:30 p.m.: API inventories, prior crude build 1.75m bbl
WHAT TO WATCH:
- New homes sales in the US due out this morning should be another bearish data point for both Americans and the financial stocks.
- Newmont Mining (NEM); Plans new underground exploration in New Zealand, may extend gold, silver mining to 2020 and beyond
- Hurricane Irene strengthens to category 2 storm, threatening U.S. coast
- McGraw-Hill has “underperformed its potential” and should break into 4 parts, shareholders Jana Partners, Ontario Teachers’ Pension Plan proposed
- STAGFLATION – begging for the Bernank to QE3 us is keeping a lid on any USD recovery and that’s a problem for Sticky Stagflation – yesterday the CRB Index was up 2pts on the day and this morning commodities are in many cases outpacing equity market gains. We will get less bearish on Equities, globally, when Oil is at $72.
MOST POPULAR COMMODITY HEADLINES FROM BLOOMBERG:
- Gold Tops $1,910 for First Time as Platinum Reaches 3-Year High
- Silver `Neckline' Break May Signal 15% Rally: Technical Analysis
- Oil Gains a Second Day on U.S. Fuel Demand, Libya Supply Outlook
- Australia May Ship Most Wheat Since 2004: Freight Markets
- Oil Supplies Gain in Survey on Reserve Release: Energy Markets
- Copper Rises on Improving Chinese Demand, U.S. Stimulus Outlook
- Shanghai Gold Exchange Raises Margin Requirement to 12%
- Irene Strengthens to Category 2 Storm, Threatening U.S. Coast
- ‘Saudi Arabia’ of Copper Fails to Lift Output: Chart of the Day
- Corn Advances to 10-Week High as U.S. Crop Condition Worsens
- King Says Commodity Price Drop to Ease Income Squeeze Sooner
- Palm Oil Gains as Dry Weather Threatens Soybean Crop Prospects
- Gold Extends Rally Above $1,900 as Economic Concerns Lift Demand
- EUROPE – PMI numbers across the board for August are plain bearish, but markets have been pricing that in so we’re seeing another low-volume, low-conviction, rally in everything that’s been going down (other than Greece, which is down again this morn and down -45% since FEB); most interesting number was France dropping below the 50 line on PMI; GDP expectations in France (and their AAA rating) need to come down.
- EuroZone Aug preliminary Manufacturing PMI 49.7 vs consensus 49.5 and prior 50.4
- EuroZone Aug preliminary Services PMI 51.5 vs consensus 50.9 and prior 51.6
- EuroZone Aug preliminary Composite PMI 51.1 vs consensus 50.1 and prior 51.1
- German Aug ZEW current conditions 53.5 vs consensus 87.0; economic sentiment (37.6) vs con (25.0)
- ASIA: China put up a better than bad number last night and stocks stopped going down +1.5% overnight; Korea stopped crashing, which is nice.
- HSBC Flash Manufacturing PMI for China beat expectations and came in higher m/m, still indicated a contraction.
Growth continues to slow in Latin America while recent and future policy actions are creating some obvious warnings signs in the system – particularly as it relates to the FX exposure of investors and corporations alike.
Last week was rough week for Latin American equity markets, closing down -2.2% wk/wk on average. We did see the larger markets like Brazil’s Bovespa Index and Mexico’s IPC Index outperform the smaller, more illiquid markets like Argentina’s Merval Index and Colombia’s IGBC General Index, with the notable exception of Venezuela’s Stock Market Index (up +51.4% YTD). In Latin American FX markets, currencies broadly appreciated vs. the USD wk/wk, with the exception of the Argentinean peso (ARS) who’s -0.5% wk/wk decline echoes a developing trend of capital flight from the country.
The big callout in Latin American fixed income markets is the -50bps wk/wk decline in Brazilian 2yr sovereign debt yields as expectations for future interest rate cuts continue to get priced into Brazil’s interest rate market (1yr on-shore swap rates declined -37bps wk/wk and -95bps MoM). Interestingly, Friday’s closing yield of 11.54% is a full 96bps below the Brazilian central bank’s benchmark interest rate (the Selic), currently at 12.5%. In Latin American CDS markets, the key callout is the +10bps backup in Argentina’s 5yr swaps amid broad-based declines throughout the region.
Brazil: Last week was a busy week for Latin America’s largest economy. Early in the week, it was reported by O Globo that the external debt for large Brazilian corporations had increased +74% from 3Q08 levels. We continue to flag the external debt buildup of many emerging-market economies over the last ~2 years as an incremental risk for some emerging market equities heading into an environment of slower global growth – particularly if the dollar continues to strengthen against EM currencies (a lower exchange rate increases their nominal debt burden). The Brazilian real in particular is down -2.3% vs. the USD over the last month, in part due to the latest 1% tax on FX derivatives (imposed on July 27). Anecdotally, the latest measure has been said to have increased volatility in Brazil’s on-shore FX derivatives market as well as reduced corporate incentive to hedge the FX risk.
Elsewhere in the Brazilian economy, we see signs that Brazil is headed in the wrong direction from a fiscal policy/regulatory perspective per the roadmap we outlined in our recent deep dive on the Brazilian economy (email us if you’d like a copy). First, it was reported by Miriam Leitao that president Rousseff vetoed proposed legislation that contained a balanced budget proposal, as well as other legislation that would have added transparency to the Treasury’s dealings with BNDES – both supportive of higher rates of inflation over the long-term TAIL as the government rejects fiscal discipline on the margin. Secondly, the government added yet another layer to the Brazilian bureaucracy by creating the National Commission of Airport Authorities – a move we see as negative on the margin for the expediency of getting the country’s airport infrastructure up to speed in time for the 2014 World Cup. Lastly, it was leaked to Brazilian newspaper Valor Economico that the government was considering reducing its primary surplus in 2012 – a negative development for the necessary positive adjustment to Brazil’s gross national savings rate in light of the country’s infrastructure initiatives over the next 2-3 years.
From an economic data perspective, Brazilian growth continued to slow with registered job creation slowing to +140.6k MoM in July and the Economic Activity Index (proxy for GDP) slowing in June to +2.9% YoY and -0.26% MoM – the first MoM decline since December 2008! We remain bearish on Brazilian equities for the intermediate-term TREND as growth continues to slow and inflation remains sticky.
Mexico: The key callout as it relates to Mexico last week was a slowing 2Q GDP print of +3.3% YoY (vs. a prior reading of +4.6%). Moreover, the Global Economic Indicator Index (a proxy for GDP) slowed in June to +3.6% YoY (vs. a prior reading of +4.6%). The late-quarter slowdown highlights a key point we’ve been aggressively making since March – the slowdown in global growth is not merely a function of Japan’s earthquake/tsunami.
Mexico’s Ministry of Finance believes the country is likely to expand +4% YoY in 2011 and, while accelerating same store sales growth (+6.4% YoY in July) remains supportive of Mexico’s consumer story, our models continue to point to a full-year GDP growth rate roughly 100bps shy of those expectations. Net-net, we remain the bears on Mexican equities for the intermediate-term TREND as growth slows and the bears on the Mexican peso (MXN) over the same duration as said economic slowdown causes Banco de Mexico president Ron Carstens to continue with Indefinitely Dovish policy well into 2012 as TIIE futures are indicating.
Chile: Another country, another growth slowdown; 2Q GDP growth slowed from +9.9% YoY to +6.8% YoY. Our models point to Chilean economic growth continuing to slow in 2H (though to rates just shy of current levels), and, apparently, so do the central bank’s. Last week they held their benchmark interest rate flat at 5.25%, marking their third pause YTD. In the monetary policy announcement, board members dropped previous mention of possibly raising borrowing costs in the future, citing “the implications of internal and external macroeconomic conditions”.
Like us and the Chilean central bank, the country’s Ministry of Finance is also modeling in a continuation of the current slowdown in Chilean economic growth in 2H. Finance Minster Felipe Larrain is on record saying, “Chile’s economic growth, as well as consumption and investment levels will decelerate in the second half of the year after a solid first-half expansion.” We remain the bears on Chilean equities for the intermediate-term TREND.
Colombia: Like Brazil, Colombia screened poorly in our (growing) external debt monitor. In fact, it was reported last week that Colombian corporations have borrowed externally at a record pace YTD, growing the stock of external debt by a +$1.1B YoY in just the first seven months alone! For a sense of the magnitude, this is on top of a mere -$184M decline in full-year 2010. As with most emerging markets, the gaping interest rate differentials between on-shore paper (4.5% benchmark lending rate) and US dollar/euro/yen denominated paper is driving Colombian debtors abroad.
Both Colombia’s central bank and Ministry of Finance are griping about the “rising dollar inflows” putting upward pressure on Colombia’s exchange rate and we believe interventionist measures, like the deposit scheme of 2007, are on the policy debate table in the coming weeks. Colombian President Juan Manuel Santos explicitly agrees, saying last week that, “Latin American governments must intervene in [FX] markets to correct any failures… authorities can’t take a passive approach to currency appreciation that diminishes the competitiveness of exporters.” Holders of the Colombian peso, peso-denominate assets, and highly-levered Colombian equities beware.
Argentina: The key callouts out of Argentina last week centered on President Fernandez’s sweeping victory in the Argentinean primary election and capital flight/currency devaluation. To the first point, Christina Fernandez garnered just over 50% of the votes while the closest opposition candidate came away with just over 12% apiece – all but ensuring she’ll win a second term as president in upcoming election on the 23rd of October. Her victory is leading some to believe that she’ll purse a more expedient form of currency devaluation upon re-taking office. This is due to the likelihood that Argentina’s “free and available reserves” (FX reserves less monetary base/M0) shrinks to ~$4.7B by year-end (down -65.6% YoY). This is important because Argentina, like Venezuela, favors using FX reserves to fund government expenditures, like the repayment of external debt, for instance.
A currency devaluation would increase the convertible value of Argentina’s “free and available reserves” and give the Argentinean government some wiggle room to continue servicing restructured debt and potentially pursuing expansionary fiscal policy in 2012. The central bank is held hostage from lowering interest rates to support the economy (in the event it becomes necessary) due to the record pace of capital flight (-$9.8B YTD vs. -$11.4B in all of 2010) and elevated rates of consumer price inflation, which Argentinean consumers and private economists believe to be around +25% YoY (vs. the government’s officially-tainted report of +9.7% YoY).
Venezuela: The major news out Venezuela last week that is relevant on a Global Macro basis is ailing president Hugo Chavez’s decision to nationalize Venezuela’s gold mining industry. He also announced that Venezuela plans to repatriate $11B of gold assets held abroad in a scheme designed to shift Venezuela’s liquid reserves to “allied countries” (including itself, China, Russia, and Brazil). The key callout here is that you typically see aggressive maneuvers like this near the peak of bubbles – something gold investors must become increasingly cognizant of.
Continuing on a theme I wrote about last week… Some of the differences between 2008 and today are more problematic than the similarities: joblessness is higher, more people are reliant on food stamps for sustenance, and the financial crisis threatening to wreak havoc on our economy is not here in the US and therefore less within our government’s control.
I’m going to add two more differences:
First, in 2008 Bernanke had not yet shown his hand and had not started the printing presses; we now we have negative real rates, with more to come, and people actually know how ineffective the Fed’s tools are. In 2008, we didn't really know.
The second comes from today’s Hedgeye Healthcaster. The cost of funding healthcare premiums is being transferred from the employers to the individuals, further limiting the consumer’s discretionary spending.
The following is taken from the today’s Hedgeye Healthcaster.
Employer Cost Shifting/Discretionary Healthcare: In the latest Large Employer Survey on Expected 2012 benefit offerings, the National Business Group on Health (Here) found that some 53% of Employers would increase the amount workers pay toward their premiums next year while 40% said they would increase deductibles for in-network care.
The music on this cost shifting dance has been playing for the better part of the last decade as benefit expense continues to grow at healthy premium to GDP.
Employers have responded by attempting to transfer costs back to the individual – a move which has resulted in the accelerated growth in high deductible/co-pay health plans; which inhibits health consumption for many individuals, and is a meaningful contributor to the growing population classified as ‘underinsured’.
The net effect of this ongoing cost shift has been an to push healthcare spending increasingly into the discretionary camp; especially into a downturn. The correlation between Healthcare Spending and Discretionary Spending has been making higher highs over the last decade, reaching a peak TTM correlation of 0.97 into the March 2009 trough. Looking back over prior recessionary periods, the most recent downturn showed the strongest correlation between healthcare & discretionary spending by a large margin.
We’ve been highlighting the increasingly discretionary nature of healthcare spending for some time, but it’s probably worth another callout here as growth slows and employers continue to cost shift health expenses back on an employee base now mired in negative real wage growth.
The similarities, given that we are comparing the present situation to crisis of 2008, are inherently negative. Energy prices and the VIX are elevated, stocks have fallen off a cliff, and consumer confidence is depressed.
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