“I follow the lightning, And draw near to the place that it strikes.”
Now I know that a lot of our clients want to talk about what consensus versus contrarian thinking is, in this no-volume marketplace, but I’m thinking they’d have a tough time advising their kids to go hard core contrarian like the early 19th century Navajos did.
Admittedly, I am developing a Darwinian confirmation bias in my reading list this summer as I delve into more Native American history with a book I started reading this week titled Blood and Thunder – “The epic story of Kit Carson and the Conquest of the American West.”
Whether it was the ability of the Navajo and Comanche tribes to adapt and survive the late 18th and early 19th centuries, or it’s what you are staring at on your screen this performance chasing morning, our goals remain common in human nature; evolve or die.
Back to the Global Macro Grind…
Buy stocks or bonds?
Rarely can I time that question as critically as I’ll timestamp it this morning. Yes, these are the thralls of August. But Mr Macro Market couldn’t care less about our summer vacations. Timing matters right here and now, big time.
Timing was especially important in answering this same basic asset allocation question in the middle of March 2012 (see Darius Dale’s Chart of the Day):
- Stocks wouldn’t go down
- Bonds wouldn’t go up
- Volatility went away
In fact, by the time the VIX hit 14.26 on March 26th (the Russell2000 topped for 2012 on the same day at 846, +5.2% higher than where it is today), there was a massive consensus (both buy and sell side) that “growth was back” and “earnings are great.”
Fast forward to June… and US stocks were gasping for air in the middle of a double-digit drawdown (Russell2000 and SP500 down -13% and -10% from their late March highs) as US Treasuries put on a massive move to the upside (10yr yield dropped -42%, from 2.4% to 1.4%).
What drove the correct answer to the stocks vs bonds question?
Global #GrowthSlowing. Period.
What will get you to the correct answer for the next 1-3 months, from here?
Follow The Lightning.
The most abysmal volume and volatility readings I have ever recorded in my US Equity model aside, there are 2 basic realities that both bulls and bears have to deal with this morning:
- US stocks are making both intermediate and long-term lower-highs
- US bonds are making both intermediate and long-term higher-lows
In other words, if you believe Growth is going to improve from here, you buy stocks. If you’re more confident (like we and the data are) on #GrowthSlowing, you buy bonds.
Our predictive tracking algorithm (the one that called for #GrowthSlowing when few did in March), which is a multi-factor, multi-duration model, is telling us that this is a fairly straightforward call to make because:
A) Oil prices are up +32% (Brent) from the June low (that slows growth)
B) Corporate Revenue growth’s slope is as weak as it has been, globally, since Q308
C) Chinese Growth continues to surprise on the downside
Chinese what? Yes, while I suppose you could say that China’s Foreign Direct Investment (FDI) print this morning of -9% year-over-year was better than India’s Export growth tanking to -15% year-over-year earlier this week, we highly suggest you take China’s word for it:
“In the second half, China’s foreign trade and export situation will be more grim, there will be more difficulties, harder tasks, and the pressure of achieving the full-year target will be bigger…” –China Ministry of Commerce (this morning)
Now, before you zap me with the bull counterpoint (for stocks) to this (rate cuts, stimuli, bailouts, etc.), just remember that doing more of the same will only keep food/energy prices higher (and growth slower) for longer. That’s bullish for bonds, longer term. And our long-term TAIL risk line for growth (bond yields) remains intact at 1.94% on the US Treasury 10yr.
My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, 10yr UST Yield, and the SP500 are now $1, $111.69-116.21, $82.34-82.97, $1.22-1.24, 1.56-1.82%, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
TODAY’S S&P 500 SET-UP – August 16, 2012
As we look at today’s set up for the S&P 500, the range is 19 points or -1.03% downside to 1391 and 0.32% upside to 1410.
SECTOR AND GLOBAL PERFORMANCE
- ADVANCE/DECLINE LINE: on 08/15 NYSE 799
- Increase versus the prior day’s trading of -41
- VOLUME: on 08/15 NYSE 497.83
- Decrease versus prior day’s trading of -12.15%
- VIX: as of 08/15 was at 14.63
- Decrease versus most recent day’s trading of -1.48%
- Year-to-date decrease of -37.48%
- SPX PUT/CALL RATIO: as of 08/15 closed at 1.12
- Down from the day prior at 1.52
CREDIT/ECONOMIC MARKET LOOK:
10YR – talk about ripping; massive short-term rip in bond yields this week looks almost identical to the pace of gains in stocks vs bonds at the March highs; at 14-15 VIX, that was not the buy stocks signal; higher lows in bonds now as stocks make lower highs.
- TED SPREAD: as of this morning 35
- 3-MONTH T-BILL YIELD: as of this morning 0.08%
- 10-Year: as of this morning 1.81%
- Decrease from prior day’s trading of 1.82%
- YIELD CURVE: as of this morning 1.52
- Down from prior day’s trading of 1.53
MACRO DATA POINTS (Bloomberg Estimates)
- 8:30am: Jobless Claims, Aug. 11, est. 365k (prior 361k)
- 8:30am: Housing Starts, July, est. 756k (prior 760k)
- 8:30am: Building Permits, July, est. 769k (prior 760k)
- 9:45am: Bloomberg Consumer Comfort, Aug. 12 (prior -41.9)
- 10am: Philadelphia Fed., Aug., est. -5 (prior -12.9)
- 10am: Freddie Mac mortgage
- 10:30am: EIA Natural Gas
- 8pm: Fed’s Kocherlakota speaks on the Fed in Williston, N.D.
- House, Senate not in session
- Paul Ryan attends campaign event in North Canton, Ohio. 9:55am
WHAT TO WATCH:
- Lock-up on insider sales of Facebook expires
- U.S. home construction probably held near 4-yr high
- Verizon-cable agreement is said to win antitrust approval today
- Apollo is said to seek up to $12b for flagship LBO fund
- Spain said to speed EU bank bailout after collateral limits
- U.K. retail sales unexpectedly rise as discounts boost fuel
- Apple said to talk with cable industry about set-top TV devices
- Dish is said to plan nationwide satellite broadband service
- JPMorgan, Barclays said among banks to get N.Y. Libor subpoenas
- Morgan Stanley unit fined over junior trader’s $1.3b bet
- AMR’s American denied court approval to cancel pilot contract
- Foreign direct investment in China fell to lowest level in 2 yrs in July
- PepsiCo Gatorade Chief O’Hagan said to leave after sales revamp
- Spotify, Pandora spur U.S. digital music sales past CD purchases
- Pfizer’s experimental arthritis drug works in Ulcerative Colitis
- Cisco 4Q adj. EPS, rev. top ests.; Applied Materials’ 4Q sales may miss est.
- Soufun (SFUN) 5:45am, $0.41
- Sears Holdings (SHLD) 6am, $(0.86)
- Children’s Place (PLCE) 6:30am, $(0.66)
- Buckle (BKE) 7am, $0.49
- Cato (CATO) 7am, $0.57
- Wal-Mart Stores (WMT) 7am, $1.17
- Dollar Tree (DLTR) 7:30am, $0.47
- Perrigo (PRGO) 8am, $1.27
- GameStop (GME) 8:30am, $0.16
- Ross Stores (ROST) 8:30am, $0.81
- Gap (GPS) 4pm, $0.48
- Aeropostale (ARO) 4:01pm, $0.01
- Marvell Technology (MRVL) 4:02pm, $0.27
- Brocade Communications Systems (BRCD) 4:05pm, $0.12
- Avago (AVGO) 4:05pm, $0.66
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
OIL – ripping humanity a new one here w/ Brent Oil charging to $116/barrel; Oil is up +32% since June, but that’s not inflationary – take the government’s word for it while it continues to slow real (inflation adjusted) GDP growth.
CHINA – If you thought this week’s India Export reports (-15% y/y) was bad, take a peek at the Foreign Direct Investment (FDI) print out of China at -9% y/y #awful; Chinese stocks down for 3rd day out of 4 on that this wk; media begs for stimuli.
The Hedgeye Macro Team
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Takeaway: The bull case for #oil is bailouts and bombs - not growth. $USO $OIL
The price drivers of crude oil are difficult to impute because there are many, with some mattering more than others one day, and others the next. That said, we offer the following series of charts for your consideration in risk management as it pertains to your oil exposure, whether it be via the commodity itself or oil-levered equities.
Conclusion: The Brent crude spot (the global benchmark) is +5% YTD and +29% higher from the 6/21/12 low of $88.99. The fundamentals (read: supply and demand) warrant lower oil prices, but expectations for easier monetary policy and fears of supply disruptions (geopolitical risk) have lifted prices recently. Note that the oil market has shrugged off actual data in favor of events that may or may not occur – the Fed has not gone to QE3, Europe has yet to implement a comprehensive solution to its debt crisis (if there is one), and there has been little aside from increased rhetoric out of Iran and Israel – yet oil continues to trade higher in expectation of some or all of those events. Given, the risk-reward setup in crude is skewed to the downside. If the Fed or ECB appeases the market – how much of that is already priced-in? And if they don’t – does the market’s focus turn to the weak growth data? On the geopolitical risk front, tensions in Israel, Iran, Syria, Egypt, etc are all serious tail risks; and the only thing that we can say for certain is that that's not going away anytime soon. A war-inspired oil price spike would have a dire impact on the global economy given its already fragile state; not even oil-levered equities would perform well in that environment, as has been the case in past instances of Mid-East strife.
Brent crude is trading in a bullish formation on our quantitative model. Long-term TAIL support for Brent is at $110.36/bbl. It is +5% YTD and +29% higher than the most recent low of $88.99/bbl, made on 6/21/12.
Volume traded was strong in July, +46% Y/Y, confirming the rally. But that euphoria has eroded quickly – the most recent volume studies are nasty at -34% Y/Y for the first 9 trading days of August. That is the largest monthly Y/Y decline in Brent volume since the financial crisis.
Volatility and price tend to be inversely correlated. We often speak to the relationship between the VIX index and the S&P500: since 2007 a VIX near 15 has been an excellent time to sell US equities. Oil and oil volatility (OVIX) act similarly: the mid-20’s on the OVIX seems to indicate complacency (bullishness), and a good exit signal. The OVIX currently sits at 29.90, down from early-June high of 42.
Demand (Global Growth): Bearish
The concurrent indicators of global growth are flashing negative. From Indian exports down 15% Y/Y, to the Manheim used car value index putting in its worst reading in 42 months, we have not seen a confluence of global growth data this poor since 2007. We offer two charts below that highlight this point: Brent vs. Chinese steel rebar and Brent vs. the Baltic Dry Index. (Note: the Baltic Dry Index over a long duration is not a good representation of global demand given the glut of shipping capacity that weighs on the index relative to pre-crisis levels. But changes on the margin are still telling, and the BDI has moved sharply lower since mid-July.)
The oil market is well-supplied. Real-time data on global oil production is not readily available, though the two most important producing regions – North America (as the marginal cost producer) and OPEC (as the largest producer by volume) – keep relatively current numbers. On the former, US oil production was +11% Y/Y in May near 6.3MM bbls/d; and US imports from Canada were +19% Y/Y to 2.4MM bbls/d. While North America is still a significant net importer of crude, shale and oil sands production has lifted production to the highest level in more than a decade.
OPEC production has been on a similar upward trajectory since the 2011 Arab Spring took Libya’s production from 1.6MM bbls/d to 0 in six months; Saudi Arabia stepped up to fill that gap, increasing production from 8.2MM bbls/d in late 2010 to 9.8 MMbbls/d as of July 2012. But now that Libya is back producing 1.5MM bbls/d, the increased output from Saudi serves to fill the Iranian void. Iran’s oil production has been in steady decline since the financial crisis, though output has fallen more rapidly in 2012 due to sanctions. Output has slipped from 3.6MM bbls/d in Dec 2011 to 2.9MM bbls/d in July 2012. Aside from Iran most OPEC nations have increased production Y/Y, including Kuwait, the UAE, and Venezuela. In aggregate, production from the OPEC 12 (OPEC + Iraq) is just off its post-2007 high and +4% Y/Y.
Other supply data points:
- The Buzzard oilfield, the largest in the UK North Sea will be down for several weeks of maintenance in September. That will take ~200 Mbbl/d of Forties crude (sets the price of Brent) off the market. With that outage, as well as planned maintenance at other North Sea fields (Norway’s Troll) and natural declines, supply from the North Sea could shrink by as much as 300 Mbbl/d in September – though the decline is planned and transitory. The expectation of this output loss could have much to do with Brent’s rise in the last 2 months. On the other hand, the return of the production (mid-October) should be an equal headwind.
- Russia – the world’s top oil producer in 2011 – pumped 10.3MM bbls/d in 2011, the highest level since 1990. Putin and Co. aim to increase production 1% in 2012 after a 1.2% rise in 2011, and indeed, the Energy Ministry said that production for 1H12 was +1.1% Y/Y. But June production slipped slightly from May, and fears are that growth has hit a capacity wall.
- Syria and South Sudan are struggling with civil and political unrest, putting ~500 Mbbl/d at risk.
We chart a scatter of the monthly mean price for the US Dollar Index versus the monthly mean Brent crude spot price below. We assert that the strength or weakness of the world’s reserve currency, driven by US monetary policy, has a major impact on commodities priced in dollars, particular ones that are liquid and global, like crude oil. In effect, oil prices have become a proxy for interest rates in the developed world. Higher oil prices slow growth (as discretionary spending falls) forcing central banks to stop printing; those countries that actually have interest rates (emerging markets mostly) cut them – which many mistakenly consider bullish for risk assets in the immediate-term. Then as oil prices drop, global growth eventually bounces, EM countries raise rates, and central planners are emboldened to print more. (It is a perverse cycle, right?)
But with Brent already back at $115/bbl, global growth slowing, and market expectations for another round of QE – something has to give. We argue that we are in the point in the cycle detailed above where the Fed is stuck on hold. The price of gold – which is bearish TREND and TAIL on our quantitative model – agrees, as does the USD Index, which is also bullish TREND and TAIL (+3.2% YTD):
Geopolitical Risk: Mixed
Looking at the divergence in the prices of Brent crude, copper, and gold can help shed some light on the key factors driving each. We argue that, generally speaking, gold is a proxy for inflation expectations; copper is a proxy for inflation + growth expectations; and that oil is a proxy for inflation + growth + geopolitical risk expectations. The chart below shows the price performance of each since Brent crude put in its YTD low on 6/21/12: Brent is +28.9%, gold is +2.3%, and copper is +0.5%. Brent’s sharp divergence from gold and copper highlights the geopolitical risk premium currently baked into crude (and to a certain extent, energy equities); while copper underperforming gold is a growth slowing signal.
Mid-East strife has returned to the front pages recently, with anti-Iran rhetoric picking up from Israel’s PM Benjamin Netanyahu and Defence Minister Ehub Barak. “We are determined to prevent Iran from becoming nuclear (armed), and all the options are on the table. When we say it, we mean it,” Barak said on Israeli radio last week. An Iranian official fired back: “[Israel] definitely doesn’t have what it takes to endure Iran’s might and will,” and he called the Israeli threats “a sign of weakness” by “brainless leaders.”
The mainstream attention that the ever-present Israel/Iran conflict gets tends to ebb and flow; whether increased rhetoric will precede serious action, we just don’t know. But consider this: at 4.05 the Israeli shekel is near its strongest versus the US dollar since 2009; the Tel-Aviv 25 Index is +3% over the last month and +0.6% YTD; and CDS on the 5Y government bond is at 153 bps (just off the YTD low of 140). Curiously, the price of oil is the only one that suggests action is imminent in the Mid-East.
From a long-term perspective, investors are bullish on crude oil (given the cyclical nature of crude prices, we consider overly bullish sentiment a contrarian indicator). We argue that, “Over the long-term, oil prices are heading higher” is one of the most consensus views in global macro – we hear it all the time. It’s an easy side to stand on after oil prices have gone up 15% per annum (nominal) since 2001. To the point, non-commercial (hedge funds, etc) net length (longs minus shorts) in NYMEX crude is currently at +248k. Between 1995 and 2000 the average net length was +15k contracts; between 2000 and 2010 it was +61k contracts; and the market has not been net short crude oil since 2003.
Looking at the more immediate-term, net length in NYMEX oil increased 13% w/w to +248k contracts for the week ended 8/7; that is the largest one-week gain since Feb ’12 and hedge funds are the most bullish they’ve been on crude oil in 3 months.
CONCLUSION: As we’ve previously stated, political headwinds, especially from Romney and Ryan, will serve to inhibit further monetary easing out of the Fed between now and election day.
America’s currency (via the DXY), which is bullish TREND and TAIL on our quantitative factoring, loves how the political winds are blowing of late. More specifically, international FX investors continue to see what we see – Bernanke being forced into a tighter and tighter box as we head into the heart of election season.
On our APR 13th 2Q Macro Themes Conference Call, we identified the intermediate-term political calendar as a headwind to further iterations of QE out of the Federal Reserve and continue to view it as such. As part of our Asymmetric Risks theme, we walked through the logic and reasoning behind our conclusion in slides 38-41 of that presentation. To access the replay podcast and the presentation materials, please copy/paste the following two links into the URL of your browser:
- PODCAST: https://app.hedgeye.com/feed_items/19596-q2-macro-themes
- SLIDES: http://docs.hedgeye.com/Q22012.pdf
Jumping ahead, we encourage you to check out the following Bloomberg article titled, “Romney-Ryan See Fed QE As Inflation Risk Amid Low Prices”. While the article, written by Jeff Kearns and Joshua Zumbrun, demonstrates a clear bias that attempts to make Romney and Ryan look like economic donkeys for being worried about the inflationary impact of incremental QE on US consumers and businesses “amid low prices”, we were able to glean few key quotes from Republican presidential candidate Mitt Romney that we don’t think the #BailoutBull crowd is currently factoring into their immediate-to-intermediate term expectations for Fed policy:
- Romney said on June 17 the second round of quantitative easing was ineffective while potentially causing inflation and undermining the dollar. A third round would pose the same risks, he said. (Bloomberg)
- “QE2, as it’s called, which was a monetary stimulus, did not have the desired effect,” the former Massachusetts governor said in an interview on CBS’s “Face the Nation.” “It was not extraordinarily harmful, but it does put in question the future value of the dollar, and will, obviously, encourage some inflation.” (Bloomberg)
- “A QE3 would do the same thing,” Romney said. “But the potential threat down the road in inflation is something which we have to be aware of, and the last QE2, the last monetary stimulus, did not put Americans back to work, did not raise our home values, did not bring jobs back to this country or encourage small businesses to open their doors.” (Bloomberg)
Romney’s new running mate, Paul Ryan, has been even more outspoken and negative on the Fed’s expansionary monetary policy and we think his influence can force the Fed’s policies into the mainstream focus and do one of two things:
- Significantly raise the bar for further QE due to Bernanke feeling increased political heat; or
- Force Obama to either defend or reject the quantitative easing policy in a very public forum – either of which is prohibitive for a new round of QE. The former because A) he knows Bernanke would look incrementally politicized by pursing action amid such heightened political rhetoric; and B) members of the Federal Reserve would have to talk down their assessment of the economy in conjunction with announcing a new LSAP. The last thing the Obama campaign needs right now are bureaucrats that he appointed talking negatively about the economy.
Jumping back to Ryan specifically, in a 2H10 piece co-authored by renowned Stanford economist John Taylor, Ryan remarked (with Taylor):
- “Quantitative easing is part of a recent Fed trend toward discretionary and away from rules-based monetary actions. The consequences of this trend are clear: The Fed's decision to hold interest rates too low for too long from 2002 to 2004 exacerbated the formation of the housing bubble. And while the Fed did help to arrest the ensuing panic in the fall of 2008, its subsequent interventions have done more long-run harm than good.”
- “QE1 failed to strengthen the economy, which has remained in a high-unemployment, low-growth slump, and there is no convincing evidence that QE2 will help either. On the contrary, QE2 will create more economic uncertainty, stemming mainly from reasonable doubts over whether the Fed will know exactly when and how to contract its balance sheet after such an unprecedented expansion.”
- “While consistent with the "sugar-high economics" practiced in Washington of late, quantitative easing marks a further departure from the foundations for prosperity and another step toward an increasingly politicized central bank.”
- “For all of these reasons, Congress should reform the Federal Reserve Act, particularly the section of the act that establishes the Fed's dual mandate. The Fed should be tasked with the single goal of long-run price stability within a clear framework of overall economic stability. Such a reform would not prevent the Fed from providing liquidity, serving as lender of last resort, or cutting interest rates in a financial crisis or a recession.”
- “Experience shows that a focus on price stability is the surest way for monetary policy to lay the groundwork for strong economic growth. The 1980s and 1990s had better economic performance than the stagflationary 1970s in part because the Fed did not waver from its primary goal of checking inflation.”
- “In particular, the Fed should explicitly publish and follow a monetary rule as its means to achieve price stability. Such a rule should include, among other things: greater simplicity; a description of interest-rate responses to economic developments including how the Fed will achieve those responses through money growth; and greater attention to commodity prices, including food and energy, as opposed to a myopic overemphasis on core inflation.”
All told, we continue to anticipate growing political headwinds to further iterations of monetary easing out of the Fed, with the general election and preceding debates serving as a much-needed forum to publically discuss the course of US monetary policy. We think that is likely to keep Bernanke in his box until at least after the election. And while Romney may be getting crushed by Obama on our proprietary Election Indicator and in various polls across the country, we think a narrowing of that spread is in the cards and that this is the key political risk to manage over the TRADE and TREND durations.
Takeaway: Darden is burning cash trying to grow Red Lobster and Olive Garden. If the stock breaks its support level of $51.56, expect a free fall.
Hedgeye Restaurants Sector Head Howard Penney has been bearish on Olive Garden owner Darden Restaurants (DRI) for months now. But sometimes you have to wait until quantitative and qualitative metrics fall into place. Time and price matter in these markets and today, we’ve decided to short Darden in the Hedgeye Virtual Portfolio.
The case for Darden is that in the immediate term TRADE duration, the stock is overbought. Right now, the stock has TREND duration support (3 months or more) at $51.56. This is the line in the sand. Snap $51.56 and Darden is headed into the low $40s in rapid fashion.
Our bearish thesis on Darden focuses on its two largest chains and revenue drivers: Olive Garden and Red Lobster. Traffic at both restaurants is on the decline and are having difficulties growing their respective brands. Penney has outlined his concerns on Darden below:
• Anemic sales trends at Olive Garden, Red Lobster
• Focusing on growth rather than remedying issues at OG & RL
• Capex growth outstripping sales growth
• The company is burning cash
• Maintaining the dividend, growth profile, and operating margins not possible with current fundamentals
• Difficult macro outlook is not encouraging
• Absent a resurrection in sales trends, we believe downside in stock is significant (to $43)
The fact that this company is busy burning cash in an effort to grow two mediocre, stagnant brands is an easy-to-spot red flag. Add in a slowdown in sales growth and same store sales and the picture becomes bleak for Darden. Again, should the stock fall through the $51.56 level, it’s going to be a messy free fall into the low $40 range very quickly.
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