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The Scoundrels of Consensus

This note was originally published at 8am on September 07, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Historically, the claim of consensus has been the first refuge of scoundrels; it is a way to avoid debate by claiming that the matter is already settled.”

-Michael Crichton


In financial markets, consensus is typically what astute stock market operators invest against.  That is, if the crowd has a similar view of an asset or asset class, that asset or asset class will typically be priced to perfection.   Therefore, savvy analysts and portfolio managers strive to find the nugget of non-insider information that will prove that consensus is wrong, which inevitably leads to a re-pricing of the asset and profits for those that appropriately determined where consensus views were wrong.


Obviously, the key variant macroeconomic view that Hedgeye held coming into 2011 versus consensus was that growth was slowing and would continue to slow.   We won’t rehash the thesis, but our view was for sub 1.5% growth in the first two quarters of 2011, while sell side consensus GDP estimates were, based on Bloomberg data, at +3.4% as of early February. 


As always, though, the job is to play the game in front of us and while rehashing old victories can be fun, we’ll save those opportunities after the inevitable victories of Yale over Harvard at the Yale / Harvard hockey and football games this year.  So two questions to ask into the remainder of the trading year are:


1)      What is consensus?


2)      What are your best variant views versus consensus?


Yesterday, I noticed a nugget of information that at first suggested to me that market consensus was leaning too far to the negative.  Specifically, negative bets on the SP500, as measured by a net outstanding 107,913 futures contract in the week August 30th, were at their highest level since September 2007.  My knee jerk reaction, as it relates to determining consensus, was to look at this statistic as a contrarian indicator. History, of course, suggests a different byline.


In fact, as noted above, the last time negative options bets were at this level was September 2007.  The next month, October 2007, marked the all time high in the SP500.  There are number of studies that provide an explanation as to why this seemingly contrarian indicator is actually not one, but the primary reason is that short sellers, in aggregate, typically invest with better information than market participants broadly.  One recent study by Morningstar CMPS on Canadian stocks from 2003 to 2011 showed the following:


“CPMS looked back to 2003 (when it started to record short interest data) and found that a portfolio of the most heavily shorted stocks indeed did poorly and underperformed the S&P/TSX composite total return index by about six percentage points annually, assuming an equal weighting of each of the 15 names and reselecting new names each month.”


Thus, while consensus views are important to determine when contemplating the risk / reward of positions, always be aware of The Scoundrels of Consensus.  These critters come in many forms, such as in the form of those who practice the dark art of short selling or even, gasp, in the form of statements from senior executives or government officials.


Typically, of course, I would give little credence to the idea that either government officials or senior company executives have much insight into the global macro environment, or that they would truthfully share their views.  At times, though, I do recommend taking the words of The Scoundrels of Consensus at fair value.  Some recent statements from European “leaders”, which I’ve outlined below, exemplify this point.  To wit:


1.   “Under the current structure and with the current membership, the euro does not work.  Either the current structure will have to change, or the current membership will have to change.”

-          Stephanie Deo, Paul Donovan, and Jacek Rostowski of UBS Bank


2.   “The Euro has never had the infrastructure it requires.”

-          Herman Van Rompuy, EU President


3.   “I regard the huge buy-up of bonds of individual states of the ECB as legally and politically questionable.”

-          Christian Wulff, German President


4.   “All this reminds one of the autumn of 2008.”

-          Josef Ackerman, Deutsche Bank CEO


5.   “Dealing with a banking crisis was difficult enough, but at least there were public sector balance sheets on to which the problems could be moved.  Once you move into sovereign debt, there is no answer; there’s no backstop.”

-          Mervyn King, Governor of the Bank of England


6.   “The euro is in danger . . . if we can’t deal with this danger, then the consequences for us in Europe are incalculable.”

-          Angela Merkel, Chancellor of Germany


The intention this morning is not to fear monger our subscribers into getting overly negative in the short term.  In fact, our most recent moves in the Virtual Portfolio yesterday morning were to cover two shorts : United Kingdom Equities (EWU) and Capital One Financial (COF).


Instead the advice this morning is simply this: be aware and wary of The Scoundrels of Consensus.


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


The Scoundrels of Consensus - Chart of the Day


The Scoundrels of Consensus - Virtual Portfolio

Fiat Fool Monday

“Any fool can know. The point is to understand.”

-Albert Einstein


After spending some much needed time with my beautiful wife on a non-Greek island in the middle of nowhere last week, I’m feeling good this morning. I’m re-charged and ready to go after some Fiat Fools in France.


Actually, I’m not ready for that. That would be boring. Playing yesterday’s game all over again usually is. Being short European or US Equities is yesterday’s news. Today we are tasked with playing the game that’s in front of us.


Whether yesterday was 2008 in the US or 2011 in Europe is really for history to decide. Crashing market prices are what they are and I highly doubt blowing up other people’s money a second time around is going to be tolerated by at least that one core constituency – those other people. Equity market fund “outflows” and “sentiment” will be the final stage for the 2011 Equities bears to navigate.


Back to the Global Macro Grind


Even for a central planner of modern day money printing, arresting gravity is difficult. With that risk management thought in mind, here are the Top 3 things I am looking at this morning:

  1. GERMANY – the German DAX continues to tell us all we need to know about not being long anything Europe (stocks, bonds, or currency). With the healthiest fiscal situation and balance sheet of a bad Western European bunch, if Germany can’t stop going down, I don’t see why France or Italy can; DAX, CAC, and MIB Index crashes are now -33%, -30%, -39% since the end of April.
  2. EURO/USD – from The Correlation Risk perspective, this remains the most important relationship in all of Global Macro. We like to say, “get the EUR/USD pair right and you’ll get a lot of other things right.” Both the TAIL ($1.39) and TREND ($1.43) for the Euro have broken expeditiously here in September.
  3. SEPTEMBER – after going net short for the 1st time since June 23rd  at the end of August (more SHORTS than LONGS in the Hedgeye Portfolio), we showed the “Month-End Markup” factor (last 6 days of the month vs first 6 in the new month for US Equities). The average 6 day drawdown since April = -4.5%. For September to-date the SP500 is down -5.3%.

Of course, any fool can know most of these things after they have occurred. Yesterday’s score is the score. Since the 2007 and 2011 highs, the SP500 is down -26.3% and -15.3%, respectively. The point now is to understand what to do next.


On today’s down move, this is what I’m going to do:

  1. COVER shorts that have gone down
  2. BUY Asian Equities where the rate cycle is about to become accommodative (no more rate hikes)
  3. BUY US Equities (Utilities and Healthcare first) as we SELL more of our US Fixed Income exposure

Now before I get accused of being all horned up like a bull here, we’re in a very good position to take our time. After all, rotating your assets from one asset class to another should be a proactive process, not an emotional point.


Last week, on US Bond market strength and US Equity market weakness, I sold Fixed Income Exposure (TLT) and started buying some US stock market exposure (XLU and XLV). As a reminder, I moved to ZERO percent US and European Equity exposure before this morning’s episode of the Fiat Fool Monday gong show began.


Here’s the Hedgeye Asset Allocation Model as of Friday’s market close:

  1. CASH = 55% (down from 64% last week and down from 70% at my peak Cash position for 2011)
  2. FIXED INCOME = 18% (US Treasury Flattener, Long-term US Treasuries, and Treasury Bond ETF – FLAT, TLT, and BWX)
  3. INTERNATIONAL EQUITIES = 12% (Philippines, China, and S&P International Dividend ETF- EPHE, CAF, and DWX)
  4. US EQUITIES = 9% (Utilities and Healthcare – XLU and XLV)
  5. COMMODITIES = 6% (Silver and Corn – SLV and CORN)

Cutting an exposure to ZERO percent can be considered “aggressive” by someone who doesn’t understand what we do. Most recently, I’ve opted to cut my International Currency exposure to ZERO percent. The #1 reason for that has been my being bullish on the US Dollar for the first time in a long time.


With Global Growth Slowing being priced in and Americans leaning more conservatively in the polls than they have in years on both fiscal and monetary policy (Fiat Fools are politicians and, yes, they follow the polls), the US Dollar has put on one heck of a move “off the lows.” Last week alone, the US Dollar Index was +3.3%. That’s very good for Americans.


Yes, Americans. As in the other 90% of Americans who don’t really own stocks anymore. Either by liquidation, capitulation, or californication (housing bust), that’s your New Reality of a financial system that people don’t trust. The top 10% of America’s wealthy own 98.5% of the US stock market (source: G. William Domhoff, UC Santa Cruz). And 10% of America isn’t America.


If I’ve said this 100x in the last 3 years, I’ve said it 1000x – the best path to American prosperity is through a strong US Dollar. This isn’t a political point. Both Reagan and Clinton got this as right in America as Bush II and Obama have had it wrong. Strong Dollar reduces inflation at the pump and creates more spending power in this brave, new, globally-interconnected world.


The Monday morning Fiat Fool quarterbacks of the Keynesian Kingdom don’t get that, yet. But markets have always had a not so funny way of helping them eventually understand.


My immediate-term TRADE ranges of support for Gold, Oil, and the SP500 are now $1, $85.81-88.09, and 1126-1177, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Fiat Fool Monday - Chart of the Day


Fiat Fool Monday - Virtual Portfolio

The Week Ahead

The Economic Data calendar for the week of the 12th of September through the 16th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - 1. z

The Week Ahead - 1. z2

Weekly Asia Risk Monitor


We’re starting to see some noteworthy bifurcations in the direction of monetary and fiscal policy across the region.



Asian equity markets were largely mixed last week, headed by Vietnam (+5.7% wk/wk) and Indonesia (+4.1% wk/wk) and trailed by Japan (-2.4% wk/wk) and Korea (-2.9%). Asian FX markets declined broadly across the board, with the Kiwi dollar underperforming (-3.3% wk/wk) on the heels of dovish commentary out of the country’s Treasury department.


Speculation around interest rate cuts continues to broadly drag down yields throughout the maturity curve across Asia’s sovereign debt markets. China remains a key outlier with its 2yr yields increasing +4bps wk/wk. This expectation of future hawkishness was, however, not reciprocated in China’s interest rate swaps market (1yr tenor falling -9bps wk/wk).


From a yield curve perspective, it’s worth highlighting the +31bps expansion of the Filipino sovereign 10yr-2yr spread – a leading indicator for accelerating growth in our model. On the flip side, China’s 15bps-wide 10yr-2yr spread has compressed to a record low. Though we continue like the long-term mean reversion opportunity, the current setup is decidedly negative for the net interest margins of Chinese banks and their collective ability to generate internal capital ahead of what many expect to be a broad decline in credit quality throughout the Chinese banking system over the next 2-3 years.


Sovereign CDS widened broadly across the region with China’s +12bps wk/wk expansion leading the way. Interestingly, Fitch warned Thursday that it might downgrade the country’s credit rating (currently the lowest of the big three at A+) within two years should it become evident that China’s banks will indeed struggle with a broad-based decline in asset quality. Interconnectivity remains the dominant theme in global macro markets.


Weekly Asia Risk Monitor - 1


Weekly Asia Risk Monitor - 2


Weekly Asia Risk Monitor - 3


Weekly Asia Risk Monitor - 4


Weekly Asia Risk Monitor - 5


Weekly Asia Risk Monitor - 6


Weekly Asia Risk Monitor - 7



China: China had a busy week of economic data, which largely came in as we expected and continue to expect: growth slowed at a slower rate; inflation peaking/has peaked. Services PMI ticked down in Aug to 57.6 (vs. 59.6 prior); industrial production growth slowed in Aug to +13.5% YoY (vs. +14% prior); retail sales growth slowed in Aug to +17% YoY (vs. +17.2% prior); fixed asset investment growth slowed in Aug to +25% YoY (vs. +25.4% prior); CPI slowed in Aug to +6.2% YoY (vs. +6.5% prior); and PPI slowed in Aug to +7.3% YoY (vs. +7.5% prior). Net-net, we continue to believe slowing inflation will give the PBOC cover to remain neutral over the intermediate term, though outright dovishness is unlikely to be seen absent a further 100-200bps decline in China’s headline inflation rate. Still, China remains far and away the best positioned of all the major economies to stimulate on a large scale if deemed necessary. We demonstrate this quantitatively in our recent note titled, “Chinese Cowboys Intact”.


Hong Kong: There’s not much to flag beyond the territory’s manufacturing PMI plunging -3.6 points in Aug to 47.8. Much like Singapore, we view Hong Kong status as one of the most open, trade-heavy economies in the world (exports = 204.8% of GDP on a trailing 3yr average basis), and this nasty PMI reading is an explicitly negative signal for the near-term slope of global growth. We remain the bears on Hong Kong equities until our models suggest otherwise.


Japan: One of the more aggressive calls we made recently was that the slope of Japan’s YoY and MoM economic growth data was going to turn decidedly negative in the 2H – a call that is particularly contrary to consensus expectations for reconstruction-fueled accelerating “growth”. Though our call is only just over five weeks old, it the data continues to play out in spades: machine orders growth slowed in Jul to +4% YoY and -8.2% MoM (vs. +17.9% YoY and +7.7% MoM prior); both components of Japan’s Economy Watchers Survey ticked down in Aug: the current situation component fell to 47.3 (vs. 52.6 prior) while the outlook component fell to 47.5 (vs. 48.5 prior). We continue to expect more downside to Japanese economic data over the intermediate term.


An interesting callout we wanted to flag was the revision to Japan’s 2Q GDP, which was revised down nearly 62% to -2.1% QoQ SAAR. It appears the U.S. isn’t the only major economy that has significant trouble reporting key statistics – likely because it’s politically easier to report healthier figures while leaving nasty revisions like these to sneak in just beyond the consensus radar.


Regarding Japan’s currency, the yen, former Vice Finance Minster Rintaro Tamaki confirmed a belief that has allowed us to maintain a bullish bias on the yen over the last few months (with the exception of a one-off short position in our Virtual Portfolio ahead of the latest intervention). Specifically, he said that “members of the G7 have indicated that intervention should be done in agreement with the G7, as opposed to unilaterally.” As we anticipated, the G7 is coming across as less willing to tolerate currency devaluation strategies than they were when they assisted Japan in selling the yen after the March catastrophes – particularly as they each come to grips with slowing growth in their own economies.


India: We continue to stress that accurately predicting the slope of economic growth allows one to correctly predict outcomes across economies (both individual and global) and their financial markets. India has been a poster child for this YTD. Slowing domestic and global growth has been a major factor in various developments throughout the Indian economy.


Specifically, the -17.3% YTD decline in India’s benchmark equity market (SENSEX) has been very unkind to Indian capital markets. For example, share sales in India have declined -53% YoY on a YTD basis and the 338 billion rupees of equity capital raised happens to be the lowest amount since 2006! This is complicating the government’s efforts to monetize 400 billion rupees worth of state-owned assets through share sales, with only 11% of the target amount completed over five months into the fiscal year. As we pointed out very early in the year, this was one of many factors which would ultimately cause India to miss its aggressive and celebrated deficit reduction target.


Furthermore, the inability for Indian companies to finance growth through equity capital has driven up Indian corporate foreign currency borrowing +8% YoY on a YTD basis, which, in turn, has widened spreads on Indian dollar-denominated bond yields +164bps YTD to 489bps more than U.S. Treasuries. Elsewhere, increased provisions for defaults to the tune of +30-80% (depending on the bank) has driven Indian bank CDS to noteworthy levels, closing the week at 276bps, 303bps, and 343bps for State Bank of India, IDB of India, and ICICI Bank, respectively. Though still well below the highs of the Lehman aftermath, we will continue to monitor these swaps closely for evidence of further alarm.


Amid the realization of slowing economic growth, Indian policymakers dropped three separate hints regarding the potential for near-term stimulus. First, RBI Governor Duvvuri Subbarao explicitly stated that the central bank intends reduce India’s “high” reserve requirements “gradually” to “enable banks to boost lending”. Currently, Indian lenders are required to set aside 6% of their deposits to meet the mandatory cash reserve ratio and another 24% must be invested in approved securities to comply with the country’s statutory liquidity ratio. Elsewhere, RBI Deputy Governor Subir Gokarn said that currency intervention is not completely off the table should the central bank deem it necessary to weaken the currency to aid exports. Lastly, India’s commerce ministry is came out today with an official statement claiming that they are preparing proactive and preemptive measures to stimulate exports – which is indeed aggressive, given that export growth is currently at +44.2% YoY.


Australia: Glenn Stevens and his RBA board members continue to fight the market, holding Australia’s benchmark interest rate flat at 4.75%. For reference they’ve been on hold since November – their longest such pause since ‘05/’06. Meanwhile, Aussie economic data continues to come in soft: the unemployment rate backed up another +20bps to 5.3% in Aug; payrolls growth slowed in Aug to -9.7k MoM (vs. -4.1k prior); and while accelerating +10bps to +1.1% YoY in 2Q, the 1.05% YTD run-rate of real GDP remains substantially below the RBA’s already-reduced target of +2% GDP in 2011 (down from a May ’11 estimate of +3.25%).


Though we maintain our respect for his central banking prowess, Steven’s models have been flat-out wrong YTD – much like Bernanke’s and the sell-side’s. We continue to side with the Aussie sovereign bond market, its interest rate swaps market, and the country’s dried up corporate credit market and foresee a continuation of the recent trend of slow economic growth Down Under. Whether or not Stevens finally cracks will ultimately have a large effect on Australia’s currency market (AUD/USD down -1.9% wk/wk).


Korea: South Korea took a step backwards this week from a policy perspective. First, policymakers imposed a 14% tax on interest income from kim-chi bonds (foreign currency-denominated Korean sovereign debt) to slow currency-pressuring capital inflows. We remain negative on governments that aggressively pursue interventionist strategy – such as Korea’s. Secondly, President Lee Myung Bak failed to sell a tax cut plan that would have pumped 2.8 trillion won ($2.6 billion) of fiscal stimulus into the $1 trillion economy. The plan, which was scrapped due to populist claims that it would’ve only benefitted “a few rich people”, underscores President Lee’s drive to spur economic growth and balance the budget by 2013 through a variety of tax cuts, tax deductions for facilities investment, and tax break incentives to hire new employees. If he is ultimately successful in these initiatives, we could see the Korean economy take a huge step forward in the longer term.


Indonesia: The key callout from Indonesia this week was the central bank’s noteworthy decision to favor supporting economic growth over combating inflation. Though CPI accelerated on a both a headline and core basis in Aug (to +4.8% YoY and +5.2% YoY, respectively, vs. +4.6% and +4.6% prior) the central bank decided to keep its benchmark interest rate flat at 6.75% (on hold since Feb). Their choice came amid sour economic data, which highlighted declining consumer confidence (88.2 in Aug vs. 89.6 prior), slowing export growth (+39.5% YoY in Aug vs. +49.1% prior), and slowing trade balance growth (+$1.5 billion YoY in Aug vs. +$2.7 billion prior). Sticky Stagflation continues to keep central banks from Asia to Latin America in a box from a policy perspective.


Philippines: In a shameless pump of our own book, CPI slowed on both a headline and core basis in Aug to +4.7% YoY and +3.4% YoY, respectively. Our models point to further downside over the intermediate term, which should allow the Filipino central bank to start to ease monetary policy if deemed necessary. Their most recent decision (maintaining the hold on their benchmark interest rate at 4.5%) came earlier this week.


Darius Dale


JCP: Shorting Again


Keith just re-shorted JCP again in the virtual portfolio managing near-term risk around a very high conviction TREND and TAIL short idea. There is no change to our thesis on the name.


At $1.60 for the year, we remain 10% below consensus and bearish on the stock over the intermediate-term.


For more info on our thesis, see our Black Book, “JCP: What Ackmanists Are Missing.”


JCP: Shorting Again - JCP levels 9 9 11



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