Duration Neglect

This note was originally published at 8am on August 31, 2012 for Hedgeye subscribers.

“Duration neglect is normal in a story, and the ending often defines its character.”

-Daniel Kahneman


That’s one of my favorite risk management quotes from Kahneman’s Thinking, Fast and Slow. It comes from Chapter 36 titled “Life As a Story.” After this morning’s central planning event, take some time to think this weekend. Re-read the last 30 pages of one of the most important books of the year. If there ever was a time to embrace the uncertainty of Behavioral Economics, it’s now.


Storytelling is at the core of everything we do. Storytelling can be personal and political. Storytelling can be short or long-term. But no matter what your confirmation bias or duration, storytelling, at some point, meets a fork in the road between fact and fiction. Whether or not you are proactively prepared for that moment is purely up to you.


Two weeks ago, the Bailout Bull Storytelling was that “Bernanke and Draghi are going to provide a one-two punch in Jackson Hole.” Stock were higher and bonds were lower. Since then: 1. Draghi bagged the meeting, 2. Bernanke’s boys are waffling with “it’s too close to call”, and 3. US Equity Volatility (VIX) is up +34%.


As Ray Dalio likes to say, look in the mirror and ask yourself, “what is true?”


Back to the Global Macro Grind


The other thing Ray Dalio reminds us (from the Introduction of Ray Dalio’s Principles) is to “above all else, think for yourself.” That’s pretty important when considering what sources are credible in this profession. Many of them have not evolved since 2007.


Duration Neglect is one thing, but being unable to tell the difference between fact and fiction can bankrupt you at the poker table as fast as it can in your personal and professional life. From a Global Macro perspective, no matter what these broken sources tell you this weekend as they live large on your dime in Jackson Hole, Growth Is Slowing.


When I say Growth, I mean Global Growth Data – here it is in the last 48 hours:

  1. US Jobless Claims rose wk-over-wk to 374,000 vs 366,000 two weeks ago
  2. US Consumer Confidence fell -8% month-over-month in AUG to 60.6 vs 65.9 in JUL
  3. Japanese Retail Sales fell -0.8% year-over-year
  4. Hong Kong Retail Sales volumes dropped from +8.3% year-over-year to +1.3%
  5. Brazil cut interest rates as inflation ramped +100bps month-over-month to +7.7%
  6. Spain’s Retail Sales fell -7.3% in JULY (year-over-year) vs -5.2% JUN
  7. Italy’s unemployment rate ramped to 10.6% in Q2 vs 9.8% in Q1
  8. Italy’s inflation rate remains at +3.5% in AUG vs +3.6% in JULY (stagflation)
  9. US GDP Growth for Q212 slowed to 1.73% vs +1.97% in Q112

So, even if you’re still in the “growth is back and earnings are great camp” (Tom Lee, Ed Hyman, Laszlo Birinyi, etc.) from March of 2012 – at this point, if your storytelling is based on the USA alone – you’ve just gotta change your story to begging for bailouts.


To review, the call we made in March of 2012 was that Global Growth Slows As Inflation Accelerates. That, on the margin, is precisely what’s happened here in August versus July – primarily because of the inflation part of that statement. Food and Oil prices matter.


Now if you turn around and tell me that inflation fell in May versus where it was in March, I’ll agree with you. It did. That’s why we bought the SP500 at its long-term TAIL support line of 1283. But, to be consistent, don’t forget what central planning does: A) It Shortens Economic Cycles and B) Amplifies Market Volatility. So you have to keep moving.


Back to that US GDP Growth print this week of 1.73%:

  1. It implied a “Deflator” of 1.59% in Q2 versus +2.16% in Q1; therefore GDP, inflation adjusted, was overstated in Q2
  2. Assuming inflation is the same as the government says it was in Q1 here in Q3 (it’s higher), #GrowthSlowing continues
  3. Irrespective of the storytelling on what inflation rate you use, US GDP is down -57.8% from Q411 to Q2 of 2012

In this No Trust; No Volume market, one of the most neglected long-term issues remains confidence. Small business owners in America like me aren’t morons. We aren’t going to ramp Fixed Investment growth, Inventories, and Hiring into a central planning event.


That’s not me telling my own story – the only inventory I have in oversupply are tweets. That’s the story within the latest US GDP report:

  1. US Fixed Investment Growth was basically cut in half, sequentially, from Q1 to Q2 (+0.63% vs +1.18%)
  2. US Inventory Growth went from +2.53% in Q411 (when Growth was solid) to -0.23% in Q212
  3. US Export-Import Growth (+0.3% in Q212) remains nowhere to be found as an offset to 1 and 2

Keynesian Quacks will tell you that if you debauch the currency of a nation, “exports will ramp” and a bunch of other stuff will multiply upon that as Ben Bernanke and Larry Summers raise the oceans to escape velocity.


Not true.


Not this time. No dear Sirs; this time is not different. This story will have an ending - and your Duration Neglect will be the cross of the families bearing your name for many years to come.


My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, 10yr UST Yield, and the SP500 are now $1627-1679, $111.12-113.74, $81.11-82.18, $1.23-1.26, 1.56-1.65%, and 1397-1409, respectively.


Enjoy your long weekend,



Keith R. McCullough
Chief Executive Officer


Duration Neglect - Chart of the Day


Duration Neglect - Virtual Portfolio


Takeaway: Coffee prices have taken a turn higher this week but favorable outlook remains for $SBUX, $GMCR, $DNKN, $THI, $CBOU

Corn dropped over the last week but beef retained the limelight as prices gained another 1.2%.  Coffee prices snapped higher as speculation grew that Columbia’s Arabica harvest is likely to come up short versus growers’ expectations.  We do not view this as overly material for the coffee retailer stocks given that prices are still down 33% versus last year.  Chicken wings moved slightly lower to +103% year-over-year.


The last week has been mixed for commodity prices but today’s Fed announcement is likely to sustain the volatility in commodity markets that have made life difficult for investors, analysts, and company executives alike.  As the chart below indicates, the CRB Foodstuffs Index turned sharply higher during the implementation of both prior rounds of quantitative easing.  While there are different schools of thought on the relationship, or lack thereof, between monetary policy and commodity prices, and other factors such as drought clearly have an impact.  As long as interest rates are artificially pushed lower, and QE3 seems likely to have that effect, investors will speculatively seek yield in alternative asset classes such as commodities.  Joe Sanderson, CEO of SAFM, and others have noted Federal Reserve intervention have had an impact on commodity markets.





Summary View


The USDA World Agricultural Supply & Demand (WASDE) report was released yesterday and there were some surprises.

  • Corn declined yesterday as the USDA unexpectedly raised its corn ending stock forecast to 733 million bushels from 650 million prior.  Lower production and yield were offset by higher beginning stocks.  We believe that a slowing in consumption, as well as the market anticipating more drought damage to the crop than seems to have materialized, was behind the move lower
  • Wheat supply and consumption estimates were unchanged for the current U.S. marketing year. 
  • The 2011/2012 marketing year estimate of U.S. exports of soybeans was increased by 10 million bushels

Coffee prices gained 13.1% week-over-week as speculation grew that Columbia’s Arabica harvest is likely to come up short versus growers’ expectations.  Coffee prices are still down 33% from year-ago levels and the outlook remains favorable for PEET, SBUX, GMCR and other coffee retailers from a cost of sales perspective.


Beef prices gained over the last week and U.S. Meat Export Federation President and CEO Philip Seng had the following to say: “With higher operating costs, the beef sector is facing serious economic challenges.  Tight beef supplies have pushed prices higher and strong demand from our international customers is helping support higher beef cutout values. With these factors in mind, it is absolutely critical that we remain aggressive with our international promotions and continue to capture the highest return possible on the products we export.”  Beef price gaining is a negative for WEN (20% of spend), BLMN (30%), and JACK (20%).


Drought is undoubtedly still an issue in several areas of the world, including the U.S., but the USDA’s -1% corn output revision was much less dramatic than feared.  That said, the drought is nearing its fourth month





Macro Callout


Gasoline prices continue to head higher.  As Hedgeye CEO Keith McCullough has been pointing out – particularly in light of QE3 today – gas prices north of $4 have had a destructive impact on consumption (71% of U.S. GDP) in 2008, 2011, and in 1Q12.












COMMODITY CHARTBOOK - crb foodstuffs












COMMODITY CHARTBOOK - chicken whole breast


COMMODITY CHARTBOOK - chicken broilers











Howard Penney

Managing Director


Rory Green




Takeaway: Rate of growth in core demographic falling and will soon go negative

  • The core age group for domestic gaming visitors has been 50 to 59 years old. The baby boomer generation caused this group to grow rapidly until 2003. 
  • The rate of growth was consistent between 2007 and 2010 but began a sharp downward trend.  The absolute population in this segment may actually fall in 2016.
  • Compounding the demographic issue is the fact that younger generations are not embracing the slot machine



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Bernanke's Market


With the Federal Reserve announcing today that it would extend Operation Twist by purchasing agency mortgage-backed securities each month and extending 0% rates into 2015, the market rallied in full force and volume picked up. With the extension of QE3 out of the way, the question on everyone's mind is: what's next?

Hedgeye CEO Keith McCullough appeared on CNBC's Fast Money to discuss how the Fed's actions affect economic growth, stocks and bonds and the US dollar. Also discussed was our bullish thesis on Nike and President Obama's chances of being reelected.

QE3? Yah You Know Me

Takeaway: The Fed pulling the trigger on QE3 is bullish for gasoline and, historically, prices north of $4 per gallon have led to equity sell-offs.

It seems 99% of Wall Street was correct as QE3 was extended.  Usually fading consensus is a great strategy, although perhaps not as it relates to the Fed, at least yet.  But for starters, let’s look at the Fed’s statement from earlier today, the key points are as follows:


“Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.”


That’s actually not a key point, although it does emphasize, as we will touch on shortly, the mandate that the Fed has struggled to fulfill.


First on QE, the Fed effectively, as Keith would say, extended QE to infinity and beyond with this statement:


“If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.”


On a basic level, this will start with increasing purchases of longer-term securities by about $85 billion each month through the end of the year, included in this will be $40 billion of mortgage paper.  As it relates to interest rates, the Fed indicated that a zero to 0.25% federal fund rate is likely to be warranted at least through mid-2015.


In the chart below, we show the aggregate growth of the Federal Reserve balance sheet.  The first chart shows the massive growth in the Fed balance sheet since 2008 with close to $3 trillion dollars being printed over the course of that period.  As a ratio of nominal GDP (just shy of 20%), this is a meaningful quantity as the following chart highlights.  Unfortunately, we have not seen a corresponding increase in economic activity.


QE3? Yah You Know Me - 2


The broader issue with extending QE is that it has been largely ineffective at fulfilling the Fed’s dual mandate.  Ironically, or not, the key economic data out this morning before the Fed’s statement enforced this.  On price stability, August’s producer price index came in at +1.7%, versus last month’s +0.3%.  This is near a three year high in terms of MoM acceleration.  Jobless claims also came in higher than expected at +382K versus +370K consensus, and +367K in the prior month.


QE3? Yah You Know Me -


While the employment data is only marginally bearish, the PPI data point is far more critical.  At +1.7% MoM growth in producer prices, this is the largest increase in PPI since June of 2009.  Our key issue with QE / money printing is that it is bearish for the dollar, which conversely inflates key commodities that are priced in dollars.  As Keith noted in the Early Look today, the CRB index currently has a -0.94 correlation to the dollar over the past month.


Obviously, the most relevant commodity to the U.S. consumer is crude oil and the derivative price of gasoline.  Given that there are 254 million registered vehicles in the U.S., the relevance of gasoline costs to consumer spending and growth should not surprise anyone.  That question, as always, though, is when does increasing commodity inflation start to matter? 


In the chart below, we show that prices at/north of $4 per gallon at that the pump have had a definitively negative impact on growth and the stock market over the last few years. Gasoline exceeded $4 per gallon in mid-2008, mid-2011, early 2012, and now.  In each instance there was a corresponding sell off in equities.  Perhaps this time is different, though we have our doubts.


QE3? Yah You Know Me - 1


Daryl G. Jones

Director of Research

What's Next For The Manheim Index?

Takeaway: With the Manheim Index continuing to fall, it's likely the S&P 500 will follow in its footsteps based on past data.

Last month, we examined the relationship between the S&P 500 and the Manheim Index of Used Car Values. The Manheim Index is the de facto standard for determining the prices of used cars and is closely correlated with the S&P 500, meaning it can be viewed as a barometer of where the market is headed (to an extent of course). 



What's Next For The Manheim Index? - Manheim   SPX growth



Today, the Manheim Index posted its fifty consecutive month-over-month decline in August, falling 0.4% vs. July. On a year-over-year basis, the index is down 2.4%, which is an improvement vs. the July year-over-year decline of 3.7%. Suffice to say, the consecutive declines in the Manheim Index indicate that the S&P 500 will continue to fall as growth slows and the economy struggles to recover. We expect that the index will continue to decline going forward, albeit at a slower rate. 



What's Next For The Manheim Index? - Manheim   SPX



Of course, today’s announcement of QE3 by the Federal Reserve may change things in the short-term, but we’re confident that the rally will be short lived and that the market will post a correction soon enough.

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