“A great number of people think they are thinking when they are merely rearranging their prejudices.”
In investing, there is no hiding from your prejudices. If your prejudices trump your intellectual honesty, then you probably won’t be in this business for long, regardless of whether you are on the sell side, buy side, or the dark side.
Since it is political season in the United States, prejudices are as heightened as they have ever been. Unfortunately, the nature of the two-party system in the United States has evolved to a state where supporting the party trumps rational analysis. The political overlords speak and those who are politicized vote according to party lines. But I digress . . .
In reference to the title of this note, the Oracle of Delphi was an ancient Greek figure that was at the height of power around 1600 B.C. She supposedly spoke for Apollo and answered questions for the Greeks, and foreigners, about many topics including: colonization, religion, war, and power. The Oracle purportedly knew all and people listened.
For a period of time, the Oracle exerted disproportionate influence over the Greek world and was consulted before every major decision. Obviously, most of us do not run our organizations or investment teams based on the proclamations of an oracle. And thank goodness for that.
Ironically, one of the most effective decision making methods is called the Delphi technique, which involves assembling viable options that are then voted on independently until a quorum is reached. As Michael O’Malley wrote in a recent blog for the Harvard Business Review:
“As the Marquis de Condorcet (http://en.wikipedia.org/wiki/Marquis_de_Condorcet) showed (in the collective wisdom proof), good, unbiased decisions are made if a solution space is well sampled and the final judgment is determined by independent decision-makers. One of the attributes that determines the range of options that bees ultimately consider is genetic diversity. The greater the diversity in the bees' DNA, the more sensitive they are to different conditions and circumstances, and the more options the hive is able to gather. More diverse hives are better at everything and more productive than less diverse ones.”
Thus, the key to effective decision making is to assemble a group of diverse individuals with independent voices.
The Federal Reserve does not exactly fit this mode as highlighted by the backgrounds of the current board members:
- Chairman Ben Bernanke – formerly a professor at Princeton and a Ph.D in economics;
- Vice Chair Janet Yellen – formerly a professor at Berkeley and a Ph.D in economics;
- Elizabeth Duke – formerly a senior banking executive at various regional banks;
- Daniel Turollo – formerly a professor at Georgetown and a law degree from Michigan;
- Sarah Raskin – formerly Commissioner of Financial Regulation for the State of Maryland and law degree from Harvard;
- Jeremy Stein – formerly professor at Harvard with a Ph.D in economics; and
- Jerome Powell – formerly Assistant Secretary of the Treasury and law degree from Georgetown.
Clearly, the nature of the Federal Reserve board is more akin to a group of oracles than a manifestation of the Delphi technique. The key error we’ve made in assessing the Fed’s willingness to continue to ease is that we believed they were “in a box” due to the data and the political cycle. Groupthink, of course, is not always rational.
Regardless of whether we agree or disagree with the Fed, we are back to playing the game in front of us. Printing money is inherently an inflationary action and will ultimately slow growth. As we have seen this year, printing money will also inflate equities until the printing presses stop or they get trumped by growth and inflationary concerns.
On the growth front, yesterday the durable goods report dropped -13.2% in August from the prior month. Largely, this was driven by a drop in aircraft orders, so there is probably a one-time negative and likely non-reoccurring factor here, but still it is what it is . . . pretty negative.
As it relates to currency, the Chinese yuan hit a new record versus the dollar this morning at 6.2856. The pundits are speculating that this is due to strong corporate demand and financial institutions getting out of short positions ahead of the week long Chinese holiday. While Hedgeye won’t be taking a holiday next week, our man on China, Darius Dale, will be writing the Early Look next week to give an update on China.
Needless to say, we are still on the sidelines as it relates to the world’s second largest economy. We are also on the sidelines as it relates to the idea that we will see meaningful stimulus from the Chinese in the short term. Despite this, the Shanghai Composite was up another +1.4% today on the back of being up +2.6% yesterday. Up +4% in two days is solid, but the anecdotes from China continue to be negative. On the back of Caterpillar saying construction demand was down -40%, we have Nike saying this morning that demand is worse than expected.
Anemic demand from Chinese is crushing the U.S. coal market. Currently, metallurgical coal from the Appalachian region is trading hands at $52 or so, while it costs $65 - $75 to produce. Given these economics it is no surprise that we have recently seen a bankruptcy in the sector with Patriot Coal recently filing for Chapter 11. In our Q4 themes call next week, we will be discussing more companies that have bagel (bankruptcy) risk.
Regardless of potential bagels, we have plenty of long idea and I’ll send you into the weekend with a couple of our top ones:
- Las Vegas Sands (LVS)
- Urban Outfitters (URBN)
- Paccar (PCAR)
Our immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, 10yr UST Yield, and the SP500 are now $1, $111.44-113.17, $79.36-80.36, $1.27-1.29, 1.61-1.71%, and 1, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Head of Sales and Research
TODAY’S S&P 500 SET-UP – September 28, 2012
As we look at today’s set up for the S&P 500, the range is 19 points or -0.91% downside to 1434 and 0.40% upside to 1453.
SECTOR AND GLOBAL PERFORMANCE
- ADVANCE/DECLINE LINE: on 09/27 NYSE 1479
- Increase versus the prior day’s trading of -678
- VOLUME: on 09/27 NYSE 634.05
- Decrease versus prior day’s trading of -14.15%
- VIX: as of 09/27 was at 14.84
- Decrease versus most recent day’s trading of -11.72%
- Year-to-date decrease of -36.58%
- SPX PUT/CALL RATIO: as of 09/27 closed at 1.82
- Down from the day prior at 1.84
CREDIT/ECONOMIC MARKET LOOK:
- TED SPREAD: as of this morning 27.40
- 3-MONTH T-BILL YIELD: as of this morning 0.09%
- 10-Year: as of this morning 1.62%
- Decrease from prior day’s trading of 1.65%
- YIELD CURVE: as of this morning 1.38
- Down from prior day’s trading at 1.40
MACRO DATA POINTS (Bloomberg Estimates)
- 8:30am: Personal Income, Aug., est. 0.2% (prior 0.3%)
- 8:30am: Personal Spending, Aug., est. 0.5% (prior 0.4%)
- 8:30am: PCE Core (Y/y), Aug., est. 1.6% (prior 1.6%)
- 9am: NAPM-Milwaukee, Sept., est. 45.0 (prior 42.9)
- 9:45am: Chicago Purchasing Manager, Sept., est. 53 (prior 53)
- 9:55am: UMich Confidence, Sept. F, est. 79 (prior 79.2)
- 11am: Fed to buy $1.5b-$2b notes due 2/15/2036 to 8/15/2042
- 1pm: Fed’s Fisher speaks in Dallas on economy
- 1pm: Baker Hughes rig count
- Obama leads in latest swing-state polls as first debate nears
- Financial Stability Oversight Council meets to choose first nonbank companies likely to be branded potential risks to financial system
- FDIC holds Consumer Research Symposium; panelists include Fed officials, 8am
- CFTC holds closed meeting on enforcement matters, 10am
- SEC holds meeting of Dodd-Frank Investor Advisory Cmte, 10am
- WTO sets up panel to decide whether U.S. broke global commerce rules with anti-subsidy duties affecting $7.3b of Chinese products
- Acting Commerce Secretary Rebecca Blank speaks at Council on Foreign Relations on policies to promote manufacturing, 12pm
- FCC open meeting on licensing, operating rules for satellite services; economic, innovation opportunities of spectrum through incentive auctions; mobile spectrum holdings, 10:30am
- Homeland Security Secretary Janet Napolitano speaks at cybersecurity summit, 8am
WHAT TO WATCH:
- Spanish banks scheduled to release results of stress tests today
- Monti says ECB conditions, IMF role hinder bond-buying requests
- Yuan climbs to strongest level since 1993 on China stimulus
- Euro-region inflation unexpectedly accelerated in September
- Xstrata split with Glencore on terms as deadline nears
- FSA to oversee Libor in streamlining of tarnished benchmark
- U.S. criminal Libor probe said to seek London trader interviews
- Sony to invest $645m in Olympus
- Hartford to sell life-insurance unit to Prudential Financial
- U.S. Debate, ECB Bond Buying, Spain: Week Ahead Sept. 29-Oct. 6
- Finish Line (FINL) 7am, $0.44
- Walgreen (WAG) 7:30am, $0.56 - Preview
- American Greetings (AM) 7:30am, $0.14
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Sumitomo Sees Higher Copper Fees in 2013 as Supplies Increase
- Copper Bulls Retreat on Concern Stimulus Not Enough: Commodities
- Crude Oil Poised for Quarterly Gain Before U.S. Spending Report
- Gold Seen Extending Best Quarterly Gain Since 2010 on Stimulus
- Copper Heads for Quarterly Gain on Reduced Euro-Crisis Concern
- Corn Slides to an 11-Week Low Before USDA Report; Wheat Declines
- Cocoa Advances Most in Three Weeks in London; Coffee Declines
- Domestic Cuts May Make India a Net Importer of Iron Ore by 2015
- Brazil Has 24.8 Million Tons of Sugar for Export, Datagro Says
- Oil May Fall on Weaker Economy and Higher Output, Survey Shows
- Airlines Threatened by Costliest Fuel Since 2008: Energy Markets
- Shale Takeovers Loom as Texas Discounted in Australia: Real M&A
- Xstrata Split With Glencore on Terms as Deadline Nears: Energy
- India’s Goa Iron Ore Ban Likely to Have Minimal Effect on Market
The Hedgeye Macro Team
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This note was originally published at 8am on September 14, 2012 for Hedgeye subscribers.
“Two things are infinite: the universe and human stupidity. And I’m not sure about the universe.”
As much as we and other market prognosticators (and even trained economists) have criticized Chairman Bernanke’s monetary policies, he went ahead yesterday and put on the big boy gloves of monetary policy. In the Fed’s statement yesterday, quantitative easing was, as Buzz Light Year would say, extended to infinity and beyond.
In using the Einstein quote above I’m not suggesting anyone on the Federal Reserve board is stupid. In fact, they are obviously all very intelligent. While I would give myself the odds in a game of hockey, I’m pretty sure anyone on the Fed could beat me in a game of one-on-one Sudoku (if that even exists). Of course, what they may be missing is the impact of their policies on the real economy.
After Keith got off CNBC’s Fast Money last night, he and I had a long discussion about the quarter. Let’s be honest, we’ve been leaning too bearishly this quarter. Coming into the quarter, we actually believed that the Fed would be in a box because the data didn’t currently support incremental easing and that the Fed wouldn’t ease ahead of the election. Obviously, we were wrong on both those points.
Conversely, we’ve been spot on in terms of our view on general economic growth this quarter and this year. Ultimately, economic activity will drive both company fundamentals and the broader stock market. In the shorter term, of course, other factors can override these fundamentals.
So while we weren’t levered long in to this new market high (in fact, we are actually short the SP500), our risk management process has also enabled us to not have major blow ups. Step #1 for us is always to minimize our losses. Start by not losing money, and you will get your shot to generate returns.
A popular refrain yesterday in the media and around some areas of Wall Street was that Bernanke and the Fed are the only ones focused on doing anything about the abysmal jobs market. I have to admit, I find this view a little nonsensical. From a practical sense, printing money does very little to encourage companies to hire. Further, it has actually done very little to encourage banks to lend more broadly.
On the last point, and I will admit this is anecdotal, I ran into a friend who is one of the larger real estate developers and condo owners in a small New England city. I assumed that extending the duration that rates will be held at 0% and further monetizing of MBS would be beneficial for those in real estate. His response was that I was right, for those that can get a loan this is a very good thing. But, according to him, for the large percentage of the population who doesn’t have a 20% down payment or stellar credit rating, it is far less relevant. On some level, this likely explains why mortgage applications have not accelerated with rates at all-time lows.
The most critical economic issue with printing dollars to infinity and beyond is the inflationary impact. Ironically, shortly before the Fed released its statement yesterday, PPI hit a three year high in terms of month-over-month growth. But forget that spurious government data, what about the real economy you say? Well, in the Chart of the Day today we actually looked more closely at the impact of commodity inflation on the real economy.
As the chart shows, going back to 2008 gasoline has exceeded $4 in mid-2008, in mid-2011, in early 2012, and now. The corresponding result, as the chart shows very vividly, is that economic growth slowed and we then saw a corresponding correction in equities, despite infinitely loose monetary policy.
Not to scare you this morning, but inflation from these levels shifts our growth slowing scenario squarely into potential recession territory. We don’t use the R word frivolously. In fact, the last time we emphasized recession as a probable scenario was back in March of this year.
Whether we get aggressive on the recession call will be data dependent, but we are comfortable continuing with the idea that global growth is slowing. In this vein, later this morning we will be doing a 15-minute call on Caterpillar Inc. (CAT) outlining our long-term bearish thesis. Our Industrials Sector Head Jay Van Sciver is relatively new to Hedgeye, but hasn’t been afraid to make a bold call. This one will be no different. The key tenets of his thesis on CAT are as follows:
- Resource company investment is near cyclical highs and set to decline. Other end markets do not appear poised to replace this tailwind;
- CAT has been adding capacity and building inventory into what we believe will be a peak in demand; and
- Our cyclically adjusted valuation for CAT implies a stock price range of $50 – 70.
This is going to be a quick call with a lot of data, so grab a coffee and join us at 11am. If you are an institutional subscriber and don’t have the dial in, please email firstname.lastname@example.org and we will get it to you.
Before I let you head into this weekend, the other point related to extending QE to flag is that if equity markets continue to inflate, it will likely be positive for President Obama’s re-election chances. To wit, our Hedgeye Election Indicator has his chances of re-election at an all-time high at 61.9% and this corresponds closely with InTrade at 64.5% odds.
Incidentally, if you are confused by the global economy, you are in good company. In his most recent letter to investors, legendary investor Howard Mark writes that the “world seems more uncertain than any other time in my life.”
Our immediate-term support and resistance risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1721-1779, $114.49-118.01, $79.04-80.67, $1.27-1.30, 1.70-1.80%, and 1427-1463, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
Takeaway: You'd be a fool to short URBN, even at its current levels which are deemed expensive. The stock is performing well and has room to go higher
The Street has been pretty bullish on Urban Outfitters (URBN) and rightfully so with the stock up +50% since May. Keith added URBN to our Real-Time Positions this week as a long and our Retail team supports URBN, albeit with reservations.
Revenues and comps are trending upward and have been since Q1 of fiscal year 2013. The company revised comp guidance (to a positive tune) earlier this month, pleasing sell-side analysts yet again. What URBN seems to “get” is that it needs to execute and run its business in a tight, efficient matter. Three notes that Retail Sector Head Brian McGough pointed out in a note back in May say it all:
The message is simple:
-Hire all the right talent.
-Empower each of them to come up with a concise plan, to which they will be held accountable.
-Give them the financial and human resources to achieve the plan.
And that’s what you have with URBN. The stock is now more expensive than it was back in May, but we still like it and believe betting against URBN is simply the wrong choice at this point in time.
Takeaway: We're shorting the Japanese yen here as risk heightens across the Japanese economy and Japanese capital markets.
- We are now short the Japanese yen (via the CurrencyShares Japanese Yen Trust etf “FXY”) in our Real-Time Positions product as a way to communicate our bearish TRADE and TREND thesis on the JPY relative to the USD.
- The key catalyst in support of our bearish bias is a likely acceleration of the BOJ’s balance sheet expansion, which may include a potential implementation of a foreign asset purchase program as Japan’s economic outlook deteriorates on the margin due to slowing commerce with China and recent yen strength.
- From a TAIL duration perspective, any sustained weakness in the yen risks Japanese banks and asset managers clearing out of the JGB market en masse in search of higher yields abroad (which they couldn’t do previously due to structural yen appreciation), as well as imposing the threat of structurally higher rates of inflation – a risk the JGB market hasn’t had to price in for over a decade.
Overnight, recent BOJ board appointee Takehiro Sato (former Morgan Stanley economist) attempted his best Chuck Evans impersonation by publically stating that the Japanese central bank is ready to ease monetary policy further – just one week after the BOJ increased its Asset Purchase Program by ¥10 trillion to ¥55 trillion (¥5 trillion for purchases of JGBs; another ¥5 trillion for purchases of Japanese Treasury discount bills) and removed its price ceiling/yield floor for JGB purchases! More importantly, he reiterated his call for the board to consider new measures, such as taking on additional balance sheet risk via purchases of riskier securities and/or outright purchases of foreign currency assets.
Sato, a known dove from his days on the sell side, has been a big supporter of altering the BOJ’s mandate to include the purchasing of foreign currency assets, with the explicit goal of devaluing the JPY vs. competitor currencies to promote Japanese exports. It’s worth noting that its +7.1% gain vs. the USD makes the JPY the world’s strongest currency over the last six months. We’ve written extensively on how this is the ultimate fool’s game with respect to the JGB market, as any sustained weakness in the yen risks Japanese banks and asset managers clearing out of the JGB market en masse in search of higher yields abroad (which they couldn’t do previously due to structural yen appreciation), as well as imposing the threat of structurally higher rates of inflation – a risk the JGB market hasn’t had to price in for over a decade. For our detailed thoughts on this topic, refer to the following notes: ARE JAPANESE GOVERNMENT BONDS POSED TO MAKE SOME NOISE? (7/27) and THE RAMIFICATIONS OF JAPAN’S LOOMING GOVERNMENT SHUTDOWN (8/28).
A new catalyst that looks poised to accelerate yen deprecation over the intermediate term are Shinzo Abe’s recent election to head up the Liberal Democratic Party in Japan, the ruling DPJ’s main opposition group. He’s long been in favor of the BOJ accelerating their balance sheet expansion as they seek to achieve a +3% inflation target, which Abe prefers over the BOJ’s current +1% target. A broader parliamentary election must be called by AUG ’13 at the latest and a Yomiuri newspaper poll published SEP 18 showed 31% of respondents planned to vote for the LDP in the proportional representation section of the next election vs. 14% for the DPJ and 16% for a new party formed by Osaka Mayor Toru Hashimoto – meaning Abe and the LDP could once again reestablish themselves atop the Japanese political hierarchy. As a result, we could see even more pressure placed upon the BOJ to acquiesce to political demands for monetary easing, though to some extent, that is already very much a non-partisan agenda among Japanese bureaucrats.
Another way Abe’s victory contributes to our intermediate-term bear case on the JPY is via the current Sino-Japanese tensions over the Diaoyu-Senkaku islands. Abe has been outspoken in recent years about revising Japan’s pacifist constitution to loosen military restrictions and he also supports building on the islands, which would be a “gross violation of China's territorial integrity and sovereignty" per China’s foreign minister Yang Jiechi. “We want to show our intention to firmly protect the islands and our territorial waters,” Abe said at a post-election press conference. At a bare minimum, Abe’s hawkish stance and rhetoric on the matter is likely to push current Japanese prime minister Yoshiko Noda in that direction as he seeks to strike a chord with the Japanese populace (75% of Japanese voters approve of the government’s intentions to seize and develop the islands). In that vein, Noda stated today that “Japan will never budge” on its ownership over the Senkaku islands.
As we detailed in a research note last week titled, “ARE CHINA AND JAPAN HEADED FOR WAR?”, the economic consequences of escalating tensions between the two countries are both great in magnitude and poised to continue accelerating over the intermediate term. To recap recent events occurring in just the week-to-date:
- Bloomberg news reported that reservations for more than 40,000 seats on All Nippon Airways flights were canceled from SEP to NOV as of yesterday, and Japan Airlines Co. had 15,500 cancellations as of Sept. 24.
- Kyodo news says over 60 Japanese companies were told to leave a China trade show earlier this week.
- Nikkei news reported that Nissan, Honda and Toyota are scaling back China production as anti-Japanese consumer sentiment is expected to impact sales.
It’s no surprise that corporate CDS in Japan are approaching 52-week wides, as indicated in the following chart:
The key risk here as it relates to our bearish thesis on the yen is that incremental economic weakness may force the BOJ to accelerate balance sheet expansion over the immediate-to-intermediate term via conventional or potentially non-conventional measures. The BOJ monetary policy meeting calendar is listed below; to the extent Sino-Japan tensions remain status quo or even deteriorate over this duration, we expect the JPY to weaken vs. the USD into and through these catalysts. The global Currency War remains in full force and Japan looks to take the baton over the next few months as the Fed is likely to be on a temporary hold with regards to pursing incremental “stimulus”.
- OCT 4-5 (NOTE: A bleak Tankan Survey, which is due out 9/30, may actually set the stage for the BOJ to ease in back-to-back meetings here)
- OCT 30
- NOV 19-20
- DEC 19-20
Our quantitative risk management levels on the yen are included in the chart below.
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