I want someone to accuse me of looking through the sluggish numbers just to find a silver lining!
The consensus thesis on the consumer is consistent with a fundamentally-weak economy: no job growth, declining real income, Bernanke-inspired price volatility, declining stock prices, falling house prices, sticky gasoline prices, and zero confidence.
Overall, the MACRO data out today on consumer trends is consistent with the factors listed above. Yet, there are silver linings! Well, maybe…
Today, the high frequency – ICSC chain store sales index – confirms the decelerating thesis, as the index fell 0.2% last week. This is consistent with the painfully slow downward trend (the index is now down 6 of the last 8 weeks.) On a year-over-year basis, growth dipped to 2.7%, the slowest pace in three weeks, though consistent with the trends of 1H11. Is there a silver lining here?
Also bouncing along the bottom is the Richmond Fed survey, which contracted for the third consecutive month in September. The pace of decline moderated from August, as the composite index rose 4 points to -6. Looking at the details, new and unfilled orders remained on downward trends but employment growth accelerated and input cost pressures eased. The increase in employment month-over-month is the first silver lining in the overall sluggish environment
Lastly, after plunging 14 points in August, the Conference Board Confidence Index was virtually unchanged in September (rising only 0.2). Last month saw a slight 0.7-point upward revision to the August print. The improvement was led by better employment expectations, which is the second silver lining.
If the economy were to accelerate confidence should recover, but given the excessive debt burden domestically and in Europe, it’s unlikely that growth is going to accelerate. Our 3Q GDP estimate is 1.1 to 1.4% year-over-year; the risk to the downside is that the low confidence results stay on a continued downward trajectory in sales trends, and causes further economic weakness.
The third silver lining is not one from today’s data, but one that economists often cite as a reason to buy equities here: that corporate America is flush with cash. That cash waiting in the wings coupled with pent-up demand could lead to a quick improvement in the jobs picture and an acceleration of growth.
Hope springs eternal, but is not an investment process!
Conclusion: Given the historical inverse correlations, a strengthening U.S. dollar is likely to continue deflating key commodity prices, which is positive, on the margin, for the U.S. economy.
One the more bullish factors in our global macro models as of late is the strength in the U.S. dollar. In the short term, this is viewed as a flight to safety as global asset allocators get increasingly concerned about the outlook of the euro and the global economy and naturally reallocate funds into U.S. dollar-denominated assets. In both the short term and long term, a strong U.S. dollar has one key positive benefit, which is a Deflation of the Inflation.
As we’ve consistently highlighted over the course of the past three years, the key driver of many global asset prices has been and will continue be the direction of the U.S. dollar versus other major currencies. In the chart below, we’ve charted the U.S. Dollar Index versus WTI oil and copper going back three years. In fact, according to our analysis the correlation between the U.S. dollar index and both copper and oil going back three years is -0.77 and -0.68, respectively.
The immediate term impact of Deflating the Inflation is at the gas pump in the United States. As of last week’s retail pricing across the United States, gasoline was priced at $3.51 per gallon and diesel was priced at $3.79 per gallon. On year-over-year basis, as of last week, the price in gasoline is up +29.9% and the price of diesel is up +28.3%. On a year-over-year basis, this is obviously not great news, but gas prices are also now at their lowest level since March 2011 and prices have been declining for the last four weeks, so, on the margin, we are seeing some alleviation of the energy consumption tax.
In the short term, gasoline demand has been proven to be inelastic, so when prices change demand does not change meaningfully. Therefore, it is likely that these gas savings potentially get funneled back into other areas of consumer spending.
As a frame of reference for the potential impact to the economy of changing energy prices, according to the Energy Information Administration in 2009 the United States consumed roughly 19.2 MM barrels of oil per day (2/3rds in transportation alone). This equates to just over 7 billion barrels of oil per year. Thus, a $10 deflation of the price of oil on an annualized basis leads to $70 billion that can be reallocated within the economy. In aggregate terms this decrease in the price of oil has a potential positive impact of ~+0.6% on GDP growth.
As an interesting aside, the only two major commodities that have shown a positive correlation to the U.S. dollar over the last three years are natural gas and lumber with +0.49 and +0.62, respectively. On natural gas, this is somewhat understandable as natural gas, due to transportation costs, is a localized market that is priced based on local supply and demand dynamics. The lumber point is more interesting and seems to at least tangentially suggest what we’ve often theorized, which is that a strong dollar will lead to a willingness by foreign investors to purchase excess U.S. real estate assets (and thus buoy the price of housing materials).
As it relates to correlations, another key risk point we wanted to highlight is globally increasing correlations between markets and asset classes. This is occurring in fixed income markets versus equities (at a 40-year high in Europe according to reports), in components of the emerging markets versus the emerging markets index, and between subsectors in the U.S. market. To the last point, we’ve highlighted in the chart below this strengthening correlation in the U.S. of the SP500 versus its key sectors. This outcome of increased correlation is, obviously, increased directional risk, but also increased performance risk, as Alpha becomes increasingly difficult to come by.
Daryl G. Jones
Director of Research
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POSITION: Short Consumer Staples (XLP)
So far, I’m at least a day early going back to 0% US Equity exposure. Being early is also called being wrong.
After the August-September my team has had, I’m not willing to put on the crash-helmet-risk for the sake of another immediate-term TRADE breakout in the SP500.
That doesn’t mean that we aren’t seeing a breakout above my TRADE line of 1182 by the way. It just means I’m not willing to get sucked into another month-end markup.
When I moved the Hedgeye Portfolio back to net short on August 30th (first time I’d done that since June 23rd), it was because my immediate-term TRADE range had run out of price range and the end of the month had run out of time. Time and Price is what I do. There’s still room here.
Today, provided that 1182 holds, there’s still immediate-term TRADE upside to 1203. So, I wait and watch. Both the intermediate-term TREND and long-term TAIL (1266) for US Equities remain broken.
I’m in no rush to get net short, yet.
Keith R. McCullough
Chief Executive Officer
Positions: We currently have no European positions (including FX) in the Hedgeye Virtual Portfolio
We’ve taken our chips off the table in Europe in the last weeks, including EUR-USD, a good call given the downside in country indices (despite the recent bounce over the last few days) and uncertainty on the go-forward policy to address the region’s sovereign debt and banking contagion risks.
Below we refreshed some key charts we’ve had our eye over the last months that have helped us predict Germany’s economic slowdown and stock market crash.
The DAX is down -23% over the last two months. We think the +8.3% squeeze in the DAX over the last three days has a high probability of being short lived, and therefore there exists heightened downside risk from here. The key catalyst the market is anticipating is a passage vote from Germany on the EFSF on Thursday. The problem is that while this hurtle is significant in and of itself, the larger picture shows that any attempts to contain contagion risks will require additional hurdles, themselves much larger, which would need to include some form of a larger EFSF, bank recapitalization programs, and enhanced ECB debt buying programs. Further the question remains just how big the kitchen sink must be to contain the issue, and if it can be contained at all without default.
In the charts below we’ve highlighted our levels on the DAX, and include German sentiment charts and Services and Manufacturing PMI figures which began turning down around February of this year and have helped us to navigate Germany’s slowdown.
As we’ve stated before in our research, no country is immune to Europe’s growth slowdown, which has been augmented by sovereign debt imbalances across the periphery and the significant web of European banking exposures to one another, and in particular to the PIIGS. The domino effect—of countries leaving the Eurozone and the EUR collapsing—is one that Eurocrats remain intensely aware of; this point alone suggests their behavior will likely include attaching near-term band-aids in an attempt to “fix” far deeper, and structural problems. Here we're calling out that Europe's strongest player is down and out-- this bodes very poorly for the region's go-forward economic outlook.
We expect investors to buy the rumors and sell the news going into the critical decisions that Eurocrats will discuss in the coming weeks and months—that is to say that even given a positive outcome to the most near-term catalyst of Germany’s vote on the EFSF this Thursday there’s a long road ahead (which we think weighs to the downside) in the European project to stabilize the region.
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