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CONCLUSION: We see further weakness in the Australian economy over the intermediate-term TREND as well as a growing number of key questions regarding Australia’s long-term TAIL growth potential. As such, we are reiterating our TREND-duration bearish fundamental call on Australian equities and the Aussie dollar – barring incremental accommodation out of the Fed over the immediate term.


In lowering its Benchmark Cash Rate -25bps (to 3.5%) overnight, RBA Governor Glenn Stevens reminded the world that the intermediate-term outlook for Australian economic growth leaves much to be desired. In fact, reported growth down under is poised to slow here in 2Q12E and, assuming no incremental headwinds, should start to flatten out in 3Q12E. On the inflation front, our models have the slope of Australian CPI slowing at a slower rate here in 2Q12E and flattening out in the following quarter.




The net result of this analysis is that the RBA’s current monetary easing cycle, which has amassed 100bps since NOV ’11, may in fact be nearing its end. Glenn Stevens, who has proven to a both data dependent and cautious on both sides of the policy spectrum over the past 3-4yrs, may need to see an incremental deterioration in Aussie economic growth and an incremental bout of disinflation from here to  warrant cutting rates further.


This speculation is consistent with our own research view and gives us the confidence to reiterate our TREND-duration bearish fundamental call on Australian equities (initially published MAR 26). Moreover, a wait-and-see approach out of the RBA is not currently priced in at the current juncture; even after today’s cut, various rate markets are still pricing in 50-100bps of cuts over the NTM – far more aggressive action than what we expect Stevens to signal as necessary over the intermediate term.




That’s bad news for the Aussie consumers, who boast an > 60% homeownership rate with 90% of mortgages being of the variable rate variety; banks had already been lowering mortgage rates less than the central bank has cut the benchmark rate in this cycle (-70bps vs. -100bps), due to NIM pressure from rising wholesale funding costs and heightened competition for domestic deposits.




Looking to the risk management setup, Australia’s benchmark All Ordinaries Index is firmly broken on our TRADE and TREND durations.




We would caution against shorting them in the immediate term, however, given the preponderance of many market participants to speculate on additional accommodation out of the Federal Reserve. Key TRADE-duration catalysts on this front include: JUN 7 – Bernanke testifies to Congress on the US economic outlook and JUN 20 – FOMC Rate Decision.


If the Fed disappoints growing expectations for further monetary easing in the immediate term (our base-case scenario), you’re likely to see another leg down in Australian equities. For US-based investors who chose to go short, that return is likely to be supplemented by further weakness in the Aussie dollar relative to the USD over the intermediate term – a core fundamental view we’ve [generally] held in the currency market since APR ’11.


Two other key catalysts that give us incremental confidence in reiterating our bearish fundamentals bias on Australian equities here are an incremental deterioration in China’s TREND-duration economic outlook and Deflating the Inflation of Bernanke’s Bubbles. Refer to the following research notes as well as our APR 16 2Q12 Macro Themes presentation for more details here: 

 To access the replay podcast and the presentation materials, please copy/paste the following two links into the URL of your browser: 

As it relates to China, we are of the view that increased bearish sentiment in/around the Chinese economy will act as a wet blanket over Australian equities and the AUD/USD exchange rate over the intermediate term. China is Australia’s largest trading partner at 25.1% of total shipments, per the CIA Factbook.


But the story isn’t simply about China; slower Chinese demand for Australia’s exports merely alludes to a broader trend taking place within Australia's economy. Further declines across key commodities markets pose a material risk to Australian exports (raw materials account for ~60% of the total; Australia produces ~20% of the world’s iron ore, ~7% of its liquefied natural gas and ~6 percent of its gold), which, then, pose a material risk to Australian job growth – which has become increasingly driven by CapEx and other operations stemming from Australia's natural resources industries.




For additional color, it would be an understatement to say that Australia has become a two-speed economy, with growth increasingly hampered by what economic historians refer to as “Dutch Disease”. If Australia’s A$456B mineral resources projects come under risk of being delayed or canceled on the margin, we would expect Aussie GDP growth to slow incrementally.




We’d be remiss to not point out the fact that Gillard’s government expects to reap A$6.5B from its mining tax in its latest budget, which was designed to return the nation to a slight surplus in spite of increased social spending. The nation also expects to rake in A$25.7B from the carbon tax coming into effect JUL 1 – a large component of which to come from heavy polluters like the mining, petroleum and gas industries.


The main takeaway here is that both the Aussie central government and central bank are anchoring on continued rapid expansion of Australia’s resource industry to deliver on promises of fiscal tightness (a key political issue down under) and continued employment growth, respectively, with 2012-13 GDP growth estimates in the range of 2.5-3.5% each.


To the aforementioned point regarding lower commodity prices, BHP Billiton Ltd., the world’s largest miner and Australia’s largest company, recently stated that it would fall short of its $80B CapEx guidance over the next five years due to declining commodity prices. Rio Tinto, Australia’s largest iron-ore producer,  has made similar statement(s) over the past few weeks as well.




Net-net-net, Deflating the Inflation is bad for the Australian economy – particular given some core assumptions being baked into growth estimates at the highest levels.


From a TAIL-duration perspective, our TREND-duration fundamental view of the Aussie economy poses a fair amount of key questions – particularly on the housing front due to what has the potential to morph into a structural decline in Aussie employment growth. With Aussie housing prices up +89.2% since comparable data began in 1Q03, there’s a lot of dispute on both the buy and sell sides as to whether or not this market is A) a bubble and B) poised to enter a structural decline. While we prefer to let the market decide for us, a few noteworthy metrics lend a fair amount credence to both sides of the debate: 

    • Per the central government’s annual State of Supply report, Australia has a 178.4k unit shortage of homes on a population of 22.3M (Bloomberg);
    • Per an independent study by tax-reform advocate David Collyer, commentator Kris Sayce and academic Steve Keen, Australia actually has an excess of 256.3k homes, having built new homes at a rate of 2.32 per person over the past 15yrs (Prosper Australia);
    • Home ownership rate of 60% vs. a US peak of 69.2% in ’04 and 65.4% currently (RP Data);
    • Household debt-to-disposable income of 184% vs. 141% in Spain, 118% in the US and 98% in Greece… Australia’s current ratio is > than the ’07 peaks in those countries’ ratios and that of the UK (OECD);
    • Owner-occupied home loan growth holding at an all-time low growth rate of +5.3% YoY in MAY (Bloomberg);
    • Prime mortgages default rate of 0.61% vs. 5.32% for the US (Fitch);
    • Mortgages account for 59.4% of all bank credit in Australia (Bloomberg; Hedgeye calculations);
    • An Unemployment Rate that has declined -630bps over the past ~10yrs to 4.9% (90bps above an FEB ’08 all-time low);
    • The existence of a first-time homeowner grant introduced in JUL ’00 and doubled in OCT ’08, which caused Aussie home prices to jump in the year following each implementation by +10% and +13.6%, respectively;
  • PRICE:
    • Direct and indirect taxes account for ~42% of the cost of new home in Sydney – Australia’s largest city (Australia Housing Industry Association); and
    • Australia has the second-least affordable homes in the developed world (behind Hong Kong) with metropolitan dwellings costing 6.7x median income on average (Demographia). 



All told, we see further weakness in the Australian economy over the intermediate-term TREND as well as a growing number of key questions regarding Australia’s long-term TAIL growth potential. As such, we are reiterating our TREND-duration bearish fundamental call on Australian equities and the Aussie dollar – barring incremental accommodation out of the Fed over the immediate term.


Darius Dale

Senior Analyst


  • Based on seasonality and normal hold, June could be up YoY in the high teens
  • The sequential YoY acceleration from May’s disappointing +7% growth could be a positive catalyst
  • Weekly comparisons are more consistent in June than May with no major calendar shifts


Hedgeye Does Dallas

If you’re in Dallas Wednesday through Friday of this week, stop by The Traders’ EXPO conference at the Hyatt Regency Reunion. We have a booth there – Booth 615 – where you can meet a few of our top team members. If you sign up for one of our great subscription products like Weekly Hot Ideas when you’re at the trade show, you’ll even get a free Hedgeye hat. Click here to learn more about the Traders EXPO.


Also, on Thursday at 2:45pm, Keith is speaking at Traders EXPO where he’ll continue on his barnstorming tour across the United States and tell you why America should fire Ben Bernanke. He’ll also talk through his top global macro themes, and answer all of your questions. He’ll even be at our booth from 4pm to 5pm on Thursday to meet and greet you in person.


For those of you who can’t make it to see us in Dallas in person person, Tweet us @Hedgeye or @KeithMcCullough with questions, and Keith will answer the three best ones during his presentation there. Don’t have a Twitter handle? Email us at info@hedgeye.com and please put Dallas in the subject line of your email.

Early Look

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Thoughts Ahead of ECB Meeting

Positions in Europe: Short EUR/USD (FXE)


The ECB meets tomorrow. We think there’s a high probability the ECB stays on hold to wait and watch the economic and political developments for another month ahead of Greek elections on 17. June.


Some observers have suggested a 25bps cut. We think it’s more probable that the ECB could signal a willingness to ease, but won’t cut. To this end, we wouldn’t be surprised if the ECB resumed some of its non-standard measures, including the Securities Market Program (SMP), which has been dormant for the last 12 straight weeks, but has purchased €212B of bonds on the secondary market since May 2010. However, we don’t expect yet another long term LTRO to be announced tomorrow.


One main issue at hand is that a rate cut alone won’t solve Europe’s sovereign and banking problems. The ECB, under Trichet and now Draghi, has stressed the need of governments to reduce their fiscal imbalances. And unlike the developing Hollande-Monti handshake in support of Eurobonds and the ECB doing more, Draghi has taken a very Bundesbank approach that fears unneeded ECB intervention, in particular measures that may spur inflation.


Further, we think the ECB wants to evaluate the outcome of the Greek elections on 17. June, and monitor the discussion around a fiscal union, Eurobonds, and a Pan-European deposit insurance, all of which are programs many months out if they are ever realized. These programs should be central to the Summits and meetings approaching later in the month, and should be critical for market sentiment.


Since the ECB’s last meeting on 3. May, data continues to contract and/or disappoint. The notable highlights are the declines in Manufacturing and Services PMI surveys for the month of May, the Eurozone unemployment rate that ticked up to 11% (a 17 year high), and Eurozone confidence figures that largely deteriorated month-over-month in May.


The EMU remains a compromised Union of states. However, we still believe that Eurocrats have a tremendous resolve to keep the Union alive with the existing member states.  For specific questions on anything Europe, please contact me at .


Thoughts Ahead of ECB Meeting - 11. SMP


Matthew Hedrick

Senior Analyst

Prospects of Survival

This note was originally published at 8am on May 22, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Organisms that treat threats as more urgent than opportunities have a better chance to survive.”

-Daniel Kahneman


If you only have time to read one chapter of Dan Kahneman’s Thinking, Fast and Slow this summer, I’d go with Chapter 26, Prospect Theory. It helped me bridge some gaps between the fractal dimensions in our models (math) and behavorial factors.


Prospect Theory is a behavioral economic framework that will be much more relevant to the next generation of economists than this one. It will take time to pound the Keynesianism out of our system. Sadly, seeing centrally planned economic systems in Europe and Japan (maybe at some point in the USA) fail, will be the only way to expedite this evolution.


On pages 282-283 of Kahneman’s latest book, you’ll get Prospect Theory both with a simple picture and three bullet points of prose:


1.       “Evaluation is relative to a neutral reference point.”

2.       “A principle of diminishing sensitivity applies to both sensory dimensions and the evaluation of changes in wealth.”

3.       “The third principle is loss aversion… losses loom larger than gains.”


And that brings me right back to the top of this morning’s Early Look quote, to the bottom of your gut feeling at Friday’s lows, and back again to yesterday’s biggest market rip in 2 months. Your Prospects of Survival in this business depend on your process.


Back to the Global Macro Grind


Losing other people’s money isn’t cool. Losing your own money is even less cool. If you are doing both at the same time, my sense about the matter doesn’t really matter – where your emotions fit on the slope of the loss aversion curve does.


That’s why we bought red on Friday and sold green into yesterday’s close. When it comes to your decisions to buy or sell something, there really are no rules about reversing everything you did in the prior day. I am not Warren Buffett. I am your Risk Manager. The only rules in our profession are self imposed by the institutions who think they are managing our risk.


But what is risk? What are these institutional investing styles? Why are either measures relevant to what’s happening in your portfolio today as opposed to risk measurements and style factors you may have used in 2005-2007?


There are many more questions here than answers. My goal, at the top of every risk management morning, is to Embrace Uncertainty and have markets pick me. The more I try to pick markets, the more risk I impose on myself. What is supposed to work, rarely works. And what shouldn’t happen, usually happens. Either accept that, or whine about it – it’s reality.


I sold my SP500 (SPY) long position yesterday – here’s why:

  1. Immediate-term TRADE upside resistance into the close = 1329 (so I only had 1% upside left)
  2. Immediate-term TRADE downside support into the close = 1288 (2% downside makes my risk vs reward 2:1)
  3. Immediate-term RANGE of risk (3 day probability model) = 89 S&P points (that means volatility will be real)
  4. US Equity Volatility (VIX) was down -12.3% on the day but holding my TRADE and TREND lines of support
  5. US Equity Volume was down -17% versus the average volume of last week’s down days
  6. US Equity Correlation Risk to the US Dollar Index remains wacky elevated at -0.96 (USD vs SPY)

Multi-factor, Multi-duration Risk Management – that’s how I roll. On the immediate-term TRADE duration (3 weeks or less), those were the 6 glaringly obvious reasons to be at least a lot less net long. Catalyst wise, I gave you my calendar ones in yesterday’s note.


In the Hedgeye Portfolio, we opened the day with 16 LONGS, 4 SHORTS and closed the day with 10 LONGS, 8 SHORTS. That’s easily the most aggressive 1-day swing in what can be considered a proxy for my “net” exposure in 2012.


But was it aggressive? Or wasn’t it aggressive enough? Maybe I should have sold everything and gone to 100% Cash. Maybe I should have shifted to net short. Maybe I shouldn’t have done anything at all.


Maybe I should just stick with the process and take the high probability cut at the ball, and live with it.


And I will.


With the US Dollar Index down for the 2ndday in a row, we bought that long position back yesterday on red. That position is one we have been pounding the pavement on with clients as the most asymmetric long-term long idea in Global Macro (email Sales@Hedgeye.com for Theme #3 in our Q2 Macro Themes called “Asymmetric Risks” and you’ll see the long-term mean reversion case for Strong Dollar).


In addition to the aforementioned Correlation Risk of staying long the SP500 (SPY) in the face of a -0.96 USD/SPY correlation this morning, here’s a refresh of the other big immediate-term USD correlations jumping off the page:

  1. Commodities (CRB Index) = -0.92
  2. Euro Stoxx600 = -0.97
  3. Gold = -0.89

That’s why I re-shorted Gold (GLD) yesterday too.


There’s rain in Connecticut, but Prospects of Survival out there this morning look better than bad.


My immediate-term support and resistance ranges for Gold, Oil (WTIC), US Dollar, EUR/USD, and the SP500 are now $1573-1618, $90.57-94.12, $80.82-81.97, $1.26-1.28, and 1288-1330, respectively.


Best of luck out there today,




Keith R. McCullough
Chief Executive Officer


Prospects of Survival - Chart of the Day


Prospects of Survival - Virtual Portfolio

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