“By knowing more about what we don’t know, we may get a few more predictions right.”
First, my prayers go out to the 2 million Americans who are still without heat this morning on the East Coast. I am part of the 14% without power in Westport, CT. It’s getting colder. If you have the means to help others, please do.
Predictions, about the weather, politics, and markets, can get you in trouble; especially if your own money is behind your opinion. I guess the upside to being a partisan political pundit is that you’ll probably be gainfully employed regardless of your predicted outcomes. Right or wrong, someone will probably send you a sticker for effort; particularly if you drove ad revs.
From my model’s vantage point, markets have been predicting a closer election than the “expert” polls have been predicting for months. The recent strength in the US Dollar reflects Romney narrowing the gap. Whether or not he can beat Nate Silver’s Obama odds is something neither of us know. After all, that’s the conclusion of Silver’s book (The Signal and The Noise) – don’t trust the polls.
Back to the Global Macro Grind…
Last week, the US Dollar Index was up another +0.65%. It has only had 1 down week in the last 7 and is now breaking out from an immediate-term TRADE duration perspective (after holding its long-term TAIL line of $78.11 support).
Nate Silver’s model doesn’t account for this, but those of you who trade markets do. The causality behind a Debauched Dollar has been weak fiscal and monetary policy. Heightening probabilities of Romney not getting crushed raises the probability that Ben Bernanke and Tim Geithner will be employed by Citigroup by 2014. That’s been Dollar Bullish, on the margin.
The Known Unknown here is that we don’t know who will win this election, but:
- If Obama wins, the US Dollar probably goes down from here
- If Romney wins, the US Dollar probably goes up from here
The key word in those Bayesian (conditional probability) statements is probably. Probably doesn’t mean certainly. If neither holds true (what if they tie?) markets could have a tough time digesting what to do next. Like it or not, all the quant machines are trading Correlation Risk, in size.
Causality doesn’t always drive correlation; sometimes it does – and big time. For the last 3 months (90 day Correlation Risk model), here are the inverse correlations between the US Dollar Index and the Big Beta driving your portfolio performance:
- SP500 = -0.91
- Eurostoxx600 Index = -0.97
- MSCI World (Equities) = -0.94
- CRB Commodities Index = -0.62
- Copper = -0.88
- Gold = -0.97
Yes, these intermediate-term TREND correlations are surreal. Which makes it likely that if Obama wins, you want to buy the living daylights out of Gold and European Stocks. If Romney wins, you want to respect the likelihood of known knowns (correlations) continuing.
Like my not having power for 6 days, legitimate TAIL risk is defined by the unknown unknowns. I didn’t know that was a known unknown until maybe 2 weeks ago. Risk happens fast.
Known knowns: for the last month, here’s what Strong Dollar has been doing to Bernanke’s Bubble (Commodities):
- Coffee = -15.8% (down -1.9% last week)
- Silver = -10.8% (down -3.6% last week)
- Copper = -8.4% (down -1.9% last week)
- Oil (WTIC) = -7.6% (down -1.6% last week)
- Gold = -5.3% (down -1.9% last week)
Sometimes Strong Dollar deflates commodity prices faster than a Debauched Dollar inflates them. That’s been the key risk management lesson of front-running Bernanke’s multiple QE experiments. What goes up, can come down in a hurry.
Bernanke has been at the helm of the Federal Reserve for 6 years. He has never raised interest rates. Never is a long time. So, that’s another Known Unknown to consider here that the market doesn’t yet consider a legitimate risk – what it means for the bond market.
If Romney wins but:
A) He appoints Glenn Hubbard as his Fed Chief
B) He appoints John Taylor as his Fed Chief
There are 2 very different possible outcomes for the US Bond market overall. Don’t forget, Hubbard is a hard core Keynesian - he could very well make Romney look like Bush, fast. Taylor would raise rates – and could scare the bond market, faster!
On the economy, it’s not a secret that I don’t think Obama is a good President. I didn’t think Bush was either. From a US fiscal and monetary policy perspective, those are known knowns in my model. Whether Romney can be any worse is an unknown.
My immediate-term risk range for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1, $105.17-108.26, $3.44-3.54, $79.86-80.79, $1.27-1.29, 1.67-1.75%, and 1, respectively.
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
This note was originally published at 8am on October 22, 2012 for Hedgeye subscribers.
“Success is to be measured not so much by the position that one has reached in life as by the obstacles which he has overcome.”
-Booker T. Washington
This weekend one of my colleagues circulated an article written by Malcolm Gladwell in The New Yorker titled, “How David Beats Goliath”. The gist of the article is that there are actually advantages to being the “David”, or the underdog, in an industry, game, or confrontation. On a basic level, this often occurs because the underdog does not subscribe to the same norms as his or her opponent. In fact, to succeed “David” has to be quicker, more tireless, and, most importantly, more innovative.
In the article, Gladwell uses basketball as a case study to highlight his point. He cites example after example of basketball teams that have beaten more talented teams by aggressively utilizing the full court press. In effect, instead of letting more talented opponents bring the ball down the court and set up their plays, the teams Gladwell highlights aggressively went after their opponents in their own end.
In top level basketball such as the NCAA or NBA, the full-court press is rarely used despite the evidence that it enables those teams with lower talent levels to be much more competitive. One of the more successful basketball coaches to use the full court press is Rick Pitino. Despite struggling as a coach in the NBA, Pitino has had a steller NCAA record of 616 wins and 227 losses, in part due to his use of the full-court press.
So, why don’t more coaches adopt Pitino’s strategy? Well, many actually do reach out to Pitino to come watch his practices and learn from him, but as Gladwell writes:
“The coaches who came to Louisville sat in the stands and watched that ceaseless activity and despaired. The prospect of playing by David’s rules was too daunting. They would rather lose.”
Being an underdog is not easy work.
On Friday the SP500 closed down -1.7% and no doubt many stock market operators felt like underdogs. The last time we had a sell-off in that area code was June 25th when the SP500 was down -1.6%. At a VIX of 15-ish, which is where Friday started, no one was expecting an almost two percent declining in equities, especially when the market is so “cheap”.
One of the key negative catalysts on Friday was #EarningsSlowing – one of our key Q4 investment themes. As is usual when complacency sets in, negative events occur when they are least expected to happen. On Thursday this occurred with Google’s (GOOG) earnings being released earlier than expected and being worse than expected. Although, to be fair, revenue was still up 45% year-over-year, but in the investment business expectations, as always, are the root of all heartache.
Earnings from Google on Thursday were then compounded on Friday with news from Asia that some of Apple’s (AAPL) supply chain was looking to take some margin back from the Cupertino giant. As reported in the Korea Times this morning, Samsung Display has now said that they will terminate its contract with Apple as Samsung is unable to supply its flat-screens at “high discounts”.
On the earnings front this morning one of our Industrials team’s favorite short ideas, Caterpillar (CAT), has come out with disappointing numbers and guidance. According to CAT:
“Cat dealers have lowered order rates to well below end-user demand … Production across much of the company has been lowered, resulting in temporary shutdowns and layoffs.”
The simple thesis for CAT is that next year’s earnings will be lower than this year’s earnings. While many companies may continue to grow earnings in 2013, even if CAT isn’t one of them, a bigger issue goes back to the point of expectations. In the Chart of the Day we highlight the view of margin expansion that is baked into consensus expectations headed into 2013. Needless to say, we do not see an acceleration in margin expansion in an environment where revenue is barely growing at 2% year-over-year in aggregate for the SP500.
Interestingly, CAT also plays into our second key quarterly theme, which we have called Bubble #3. A key tenet of this thesis is that the decade long boom we have seen in commodities driven by loose monetary policy is getting close to the last inning. This is most directly supported by slowing economic growth in China, which just printed one of its worse GDP numbers since the Great Recession.
Coincident with this commodity boom has been mining companies investing well beyond depreciation and amortization for more than a decade. This, too, will mean revert as we are seeing with CAT’s guidance this morning. We are expecting to see more follow through on this theme as more of the mining complex reports in the coming weeks.
Stepping away from earnings, the most significant global macro catalyst in the short term is clearly the November 6th election in the United States. Currently, the race has no underdog. The two candidates are virtually tied in national polls, they are virtually tied in the elector college, and in terms of favorability ratings they are, as well, virtually tied. Intrade still has Obama with a slight edge, but that too may well be fleeting.
In terms of insight into the election outcome, we will be joined this Wednesday at 1pm for a call with Professor Ken Bickers from the University of Colorado. He has crafted an interesting analysis based on state-by-state election economic situations that, according to his analysis, suggest that Romney may win in a run-away. Clearly, this is a non-consensus view. We hope you can join us for the call and will circulate the dial-in to institutional subscribers later this week.
Our immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1699-1748, $108.67-112.61, $79.15-80.24, $1.29-1.30, 1.73-1.82%, and 1419-1442, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
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Takeaway: PMI Manufacturing and confidence figures from the Eurozone confirm a continued downturn.
Positions in Europe: Long German Bonds (BUNL)
Asset Class Performance:
- Equities: The STOXX Europe 600 closed up +1.6% week-over-week vs -1.3% last week. Top performers: Ukraine +6.3%; Austria +3.8%; Spain +2.5%; Netherlands +2.5%; Finland +2.5%; Ireland +2.2%; Hungary +2.2%; Germany +1.8%. Bottom performers: Cyprus -8.6%; Greece -8.3%; Slovakia -1.4%. [Other: France +1.7%; UK +1.1%].
- FX: The EUR/USD is down -0.80% week-over-week. W/W Divergences:NOK/EUR +1.45%; TRY/EUR +1.25%; SEK/EUR +0.74%; GBP/EUR +0.25%; CHF/EUR +0.16%; HUF/EUR +0.04%; DKK/EUR 0.00%; CZK/EUR -1.24%.
- Fixed Income: The 10YR yield for sovereigns were mixed week-on-week. Greece rose the most at +100bps to 18.21%, followed by Portugal +31bps to 8.35%. Spain and Germany both declined by -7bps to 5.60% and 1.45%, respectively. France fell -2bps to 2.22% and Italy declined -1bp to 4.92%.
This week it’s worth noting that despite signals from some analysts of “green shoots” and optimism that the Eurozone will find a path forward, the data continues to indicate that the Eurozone has not found a bottom. A look at the PMI Manufacturing figures out this week (Services come out next week and may be slightly higher) indicate levels that are both comfortably below the 50 line indicating contraction and sequentially lower (especially) for the core countries in OCT versus SEPT.
Eurozone Confidence figures showed a similar negative trend, namely declining for a seventh straight month in the October figures. Given that the largest business and trade partners for European countries are their fellow neighbors, we do not expect one country to sustain a positive growth inflection until the entire region starts to see improvement. That said, Germany remains the “best of the rest” and we currently have a Real-Time position in BUNL to take advantage of this relative strength.
The European Week Ahead:
Monday: Nov. Eurozone Sentix Investor Confidence; Oct. UK PMI Services, Official Reserves, BRC Sales Like-For-Like; Oct. Spain Unemployment
Tuesday: Oct. Eurozone PMI Composite and Services - Final; Sep. Eurozone PPI; Oct. Germany PMI Services - Final; Sep. Germany Factory Orders; Oct. UK NIESR GDP, BRC Shop Price Index, New Car Registration; Sep. Germany Industrial Production, Manufacturing Production; Oct. France PMI Services – Final; Spain Services PMI; Oct. Italy PMI Services
Wednesday: Sep. Eurozone Retail Sales; Oct. Germany Wholesale Price Index (Nov. 7-12); Sep. Germany Industrial Production; Sep. Spain Industrial Output
Thursday: ECB Governing Council Meeting; ECB Announces Interest Rates; AFME 7th Annual European Bond Conference in Brussels; Nov. Eurzone Asset Purchase Target; Sep. Germany Exports, Imports, Current Account, Trade Balance; BoE Announces Rates; UK Asset Purchase Target; Nov. UK Bloomberg Economic Survey; Sep. France Trade Balance; Aug. Greece Unemployment Rate
Friday: Oct. Germany Consumer Price Index – Final; Sep. UK Total Trade Balance; Oct. BoF Business Sentiment; Sep. France Industrial Production, Central Government Balance, Manufacturing Production; Sep. Italy Industrial Production; Oct. Greece Consumer Price Index; Sep. Greece Industrial Production
NOV 12 – Eurogroup Meeting in Brussels
NOV 15 – Catalonia regional election in Spain
NOV 22 – ECB Governing Council Meeting
NOV 27 – AFME 4th Annual Spanish Funding Conference in Madrid
DEC 1 – Beginning of the Russian Presidency of G20
DEC 3 – Eurogroup Meeting in Brussels
DEC 6 – ECB Governing Council Meeting
DEC 12-13 – First public consultation between the Russian government, B20 Coalition and international civil society representatives on G20 agenda for 2013 (in Moscow)
DEC 20 – ECB Governing and General Council Meeting
APR 2013 – Parliamentary elections in Italy
MAY 2013 – Presidential elections in Italy
Greece - Kathimerini discussed how Greece's ruling coalition faces an extremely tense next few days ahead of two key votes in parliament next week. The article highlighted concerns about the rising dissent in the Pasok party that could leave the coalition without sufficient support to pass the austerity and reform measures demanded by the troika. It noted that Prime Minister Samaras is due to meet with his 127 deputies on Monday, ahead of the vote on structural reforms on Wednesday and the vote on the 2013 budget, which will be held at midnight on Sunday, 11-Nov (just ahead of the 12-Nov Eurogroup meeting during which a final decision on Greece is expected).
Italy – Over the weekend former Prime Minister Berlusconi threatened to bring down the technocratic government led by Prime Minister Monti via a no-confidence vote from his People of Liberty party (PDL), the biggest in parliament. Berlusconi noted that, "We have to recognize the fact that the initiative of this government is a continuation of a spiral of recession for our economy. Together with my collaborators we will decide in the next few days whether it is better to immediately withdraw our confidence in this government or keep it, given the elections that are scheduled." While a no-confidence vote would likely force early actions, there were also thoughts that Berlusconi may no longer have enough support within the PDL to bring down the government.
Ireland - Germany has signaled that it is open to a restructuring of the €30B Anglo Irish Bank promissory note to improve the sustainability of Ireland’s adjustment program (rather than tapping the ESM).
Spain - Spain's northern region of Cantabria on Monday became the ninth region to request a credit line, recently established by the central government to cover liquidity needs. It said it would tap the €18B fund for €137M. Recall that other regions have already tapped the credit line for close to €17B.
Greece - Greek 2013 Govt Debt/GDP at 189.1% vs 175.6% in 2012, according to revised Greek Budget.
Netherlands - The incoming Dutch finance minister said on Thursday that “We have agreed to a tight budget and together we are going to implement it. It is a tough package that is going to require sacrifices from everyone in the Netherlands. I see it as my job to keep the finances on the right path.” The government has already agreed to nearly 16 billion euros ($21 billion) in budget cuts.
Slovakia - Prime Minister Robert Fico said on Wednesday that the state will return to having a single, state-run health insurance system and nationalize two private insurers.. "The government that I head rejects the notion of private health insurers making profits from taking public money and then using those profits to realize their ideas of a luxurious lifestyle," Mr. Fico told reporters, saying the newly unified insurance system would be in place by 2014.
Eurozone CPI Est 2.5% OCT Y/Y vs 2.6% September
Eurozone Unemployment Rate 11.6% SEPT vs 11.5% AUG
Germany Retail Sales -3.1% SEPT Y/Y (exp. -1.1%) vs -1.1% AUG
Germany CPI 2.1% OCT Prelim Y/Y (exp. 2.0%) vs 2.1% SEPT
Germany Unemployment Chg 20K OCT vs 12K SEPT
Germany Unemployment Rate 6.9% OCT vs 6.9% SEPT
UK GfK Consumer Confidence -30 OCT (exp. -28) vs -28 SEPT
UK Nationwide House Prices -0.9% OCT Y/Y vs -1.4% September
UK Construction PMI 50.9 OCT vs 49.5 September
UK M4 Money Supply -3.5% SEPT Y/Y vs -4.0% AUG
France Producer Prices 2.9% SEPT Y/Y vs 2.8% AUG
France Consumer Spending -0.3% SEPT Y/Y vs -0.6% AUG
Italy CPI 2.8% OCT Prelim Y/Y vs 3.4% SEPT
Italy Unemployment Rate 10.8% SEPT Prelim vs 10.6% AUG
Spain Total Housing Permits -31.7% AUG Y/Y vs -37.1% JUL
Spain Q3 GDP Prelim -0.3% Q/Q (exp. -0.4%) vs -0.4% [-1.6% Y/Y (exp. -1.7%) vs -1.3%]
Spain CPI 3.5% OCT Y/Y Prelim vs 3.5% SEPT
Spain Retail Sales -12.6% SEPT Y/Y vs -2.0% AUG
Norway Unemployment Rate 3.1% AUG vs 3.0% JUL
Finland Business Confidence -11 OCT vs -8 September
Finland Consumer Confidence -1.6 OCT vs 3.4 September
Sweden Retail Sales 4.6% SEPT Y/Y vs 1.6% AUG
Belgium Unemployment Rate 7.4% SEPT vs 7.4% AUG
Belgium CPI 2.79% OCT vs 2.76% SEPT
Switzerland Retail Sales 5.4% SEPT Y/Y vs 6.0%
Switzerland UBS Consumption Indicator 1.07 SEPT vs 1.02 AUG
Austria PPI 0.7% SEPT Y/Y vs 1.0% AUG
Iceland Unemployment Rate 5.0% in Q3 vs 7.2% in Q2
Ireland Unemployment Rate 14.8% OCT vs 14.8% SEPT
Portugal Consumer Confidence -55.3 OCT vs -51.4 September
Portugal Economic Climate -4.6 OCT vs -4.2 SEPT
Portugal Retail Sales -5.7% SEPT Y/Y vs -6.1% AUG
Portugal Industrial Production -9.2% SEPT Y/Y vs -2.1% AUG
Greece Retail Sales -7.2% AUG Y/Y vs -8.0% JUL
Hungary Unemployment Rate 10.4% SEPT vs 10.4% AUG
Hungary Producer Prices 2.5% SEPT Y/Y vs 5.1% AUG
Romania PPI 6.6% SEPT Y/Y vs 7.2% AUG
Interest Rate Decisions:
(11/1) Czech Repo Rate Announcement CUT from 0.25% to 0.05%
(11/2) Romania Interest Rate Announcement UNCH at 5.25%
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