“To see, and to show, is the mission now undertaken.”
Born in China to missionary parents, Henry Luce went on to graduate from Yale in 1920 and become one of the most influential multi-media content generators in world history.
In June of 1944 in Life magazine, Luce declared the following about America: “With the establishment of a firm lodgment on the continent, we are now the most powerful nation on earth.” (The Last Lion, page 847)
That’s one way to get Americans to like you. Another is calling it like it is. Now that central planners of the world have saved us from themselves (again), I wonder how Luce would characterize the new world order today.
Back to the Global Macro Grind…
If there was another Luce born in China in the 21st century, she probably wouldn’t be able to publish what she really thinks about China’s role as a burgeoning super-power anyway. Power and influence have some ugly disclosures.
This morning China’s power-center is ticked-off (expressing it in their state controlled media) because the Japanese are adding 287 people to their military. That’s not a typo, 287. Since Japan’s armed forces number north of 225,000, what’s the point?
The point is that we are in a Currency War, and the Japanese continue to tick just about everyone from South Korea to China off. This isn’t going to end any time soon. Neither will the longstanding cultural differences between Japan and China. If we are right on how it ends for the currency debaucherers in Japan, the Chinese won’t be there to bail them out like they did Europe.
Last week, in what was nothing short of another fantastic one for US Equities (SP500 and Russell2000 up another +1.1% and +1.5% to fresh YTD highs, respectively), there were 3 major divergences in Global Equities:
- South Korea = KOSPI -2.1% (breaking TRADE and TREND support)
- Brazil = Bovespa -1.3% (holding TRADE and TREND support)
- China = Shanghai Composite -1.1% (holding TRADE and TREND support)
Now, when a market price snaps TRADE and TREND support in our model, we don’t buy-the-the-damn-dip. We wait and watch. When a market price holds TRADE/TREND support, we like buying those instead.
If you bought China on Friday (we’re long Taiwan via EWT), nice job. This morning, Chinese stocks ripped a fresh new YTD high, closing up another +2.4% at 2364 in Shanghai. That’s what bull markets do – they correct and climb.
South Korea’s stock market didn’t do that however. The KOSPI saw follow through selling overnight, down another -0.36% to immediate-term TRADE oversold within its freshly established bearish intermediate-term TREND (1961 = resistance).
Since the KOSPI is an important leading indicator in our multi-factor Global Macro model, what is this signal telling us?
In any risk management model with Chaos Theory at its core, the 1st answer to an early signal is ‘I don’t know.’ That might not sound as smart as someone who allegedly knows something about everything, but over the years the limits of my thick hockey skull remain readily apparent – so I’ll stick with Embracing Uncertainty.
The other big question you should be asking yourself is could we see a 6% handle on the US unemployment rate in 2013?
Remember, expectations of the Fed getting out of the way matter more than them actually doing so. Looking at this week’s Macro Catalyst Calendar, there will be plenty of data to consider on that front:
- Monday – Pending Home Sales and Durable Goods are both released for the USA
- Tuesday – Case Shiller Home Prices and US Consumer Confidence
- Wednesday – PMI (JAN), Q412 GDP, and the Fed’s decision/commentary on rates
- Thursday – US weekly Jobless Claims (and month end)
- Friday – US Employment Report (JAN) and the ISM report for January
And, as usual, the market has already front-run some of these considerations via its own expectations:
- US Treasury Bonds (10yr Yield) continued lower again last week, with the 10yr rising to 1.95% from 1.84%
- Gold continued lower last week, closing down another -1.7% in a broadly bullish Global Equity tape
- CRB Commodities Index continued to make a series of lower-highs, closing down -0.6% last week
Now I know some people are calling for both epic levels of inflation and the end of the world – but the good news is that we have neither of those two things, yet. Nor do we expect them before you have to report results to your investors at month-end.
What we have so far (and for the last 2 months really) is a Growth Scare, and it’s to the upside. How else can you explain another all-time high in the Russell2000 of 905 (all-time is a long time) and confirmed 5-yr lows in US Equity Volatility (VIX)?
To see and show our Top 3 Global Macro Themes (#GrowthStabilizing, #HousingsHammer, and #QuadrillYen) as they are happening helps illustrate that Global Macro A) works both ways and B) is interconnected. This is our mission, undertaken.
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, EUR/USD, USD/YEN, UST 10yr Yield, and the SP500 are now $1, $111.75-114.28, $79.62-80.14, $1.32-1.34, 89.55-91.11, 1.88-1.98%, and 1, respectively.
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
This note was originally published at 8am on January 14, 2013 for Hedgeye subscribers.
“Our affairs are not conducted entirely by simpletons and dunderheads.”
Per the Urban Dictionary, a “dunderhead” is, amongst other things, an idiot, dunce, numskull, or bonehead. With public opinion of him falling in early 1942, Churchill was irritated. Losing the war was one thing; being chastised by Ivory Tower academics was entirely another.
“Singapore fell on February 15 (1942). It was death foretold – too few defenses, a weak commanding general, a demoralized garrison, and too savvy an enemy … Churchill had no need to resort to hyperbole… he informed Roosevelt that the fall of Singapore was the greatest disaster in our history.” (The Last Lion, page 484-485)
While the 113th United States Congress has yet to prove that it is the worst in free-market history (the 112th is a tough compare), it still has time. I’m just elated that these economic dunderheads of the #PoliticalClass have been out of this market’s way for the last few weeks. Geithner leaving and Congress being out of the way definitely helped the Russell2000 close last week at an all-time high.
Back to the Global Macro Grind…
This is the first Global Macro morning that I can remember where the names Boehner and Reid aren’t in the Bloomberg’s “Most Read.” Today it’s all about Chinese growth (acceleration) and Japanese currency (debauchery).
Neither of those macro stories are new. That’s the point about consensus macro – by the time it becomes this newsy, the big moves in the related markets have already occurred.
From their intermediate-term troughs/peaks in November 2012 (as global growth stopped slowing):
- Chinese stocks (Shanghai Composite) are up +18%
- Japanese Yen (vs the US Dollar) is down -11%
Especially in the context of the SP500 and US Dollar Index being +8.7% and -2.1% from their respective November 2012 lows/highs, respectively, those are massive moves in Asian markets.
The move in Japanese Equities has been even more powerful than China’s. Since November 13th, the Nikkei225 is +25%! Krugman/Bernanke Playbook 101: burn your currency at the stake, admit nothing about it publicly, and point at the daily closing price of stocks.
How will what Jim Rickards coined the Currency War end? I don’t know. But it probably won’t end well. So, as you ride the bull of higher-lows and higher-highs in stocks out there, just keep that in mind. Remember, in Chaos Theory, our daily objective is to embrace uncertainty.
CONSENSUS WATCH: On Friday I highlighted the massive shift from bearish to bullish we have seen in US Equity market sentiment in the last two months. Today, it’s worth reminding you that the sentiment in Commodities has done almost the exact opposite.
Last week’s CFTC (futures and options) net long commodities figures revealed the following realities:
- Total net long positions down another -5.4% wk-over-wk to 654,443 contracts (down -51% from all-time highs in SEP 2012)
- Gold’s net long position dropped another -13% wk-over-wk to 92,115 (lowest level since August 2012)
- Corn’s net long positioned dropped another -15% wk-over-wk to 115,113 (lowest since June 2012)
In other words, when it comes to risk managing the Commodities Bubble, you are best served doing the exact opposite of what the hedge fund community is doing. This may be the most glaring intermediate-term example of BUY HIGH, SELL LOW I have seen in a decade.
Both Gold and Corn prices went up on that last week. What better bull case do you need other than consensus dunderheads who call themselves “smart” getting bearish? While we have deflated the inflation in commodity prices (CRB Index -8% from its SEP 2012 lower long-term high) for the last 3 months, that certainly doesn’t mean they can’t re-flate.
With the US Dollar Down hard last week (-1.2%), here’s where the beta-juice was to Down Dollar:
- Platinum +4.8%
- Corn +4.2%
- Coffee +4.1%
At the same time, we saw some of the widest global equity market divergences (by geographic region) that we have seen in some time. Europe saw Germany down -0.8% on the week, but Italy was +3.2%. In Asia, Vietnam was +8.6% versus Indonesia -2.4%.
What do we simpletons do with all of this? We stay with the research and risk management process; we do our best to incorporate all of the real-time economic data and price changes (across multiple factors and durations) in our models; and we keep moving.
Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST10yr Yield, and the SP500 are now $1642-1671, $109.98-111.48, 3.64-3.75, $79.39-79.98, $1.31-1.33, 1.84-1.97%, and 1459-1485, respectively.
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
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Our experience is that consumer staples generally lag a "risk on" market such as we have seen since January 1st. This has not been the case to start 2013 - staples have outperformed the broader market (+6.5% including agricultural services and protein, +5.5% core staples vs. the S&P +5.4%) since January 1st. Admittedly, the world doesn't change when the calendar rolls over, but let's run with it.
Outside of the agricultural service names and protein - likely investors getting positioned for the new crop year, which is consistent with our views - the best performing sectors have been household and personal care (+7.5%, 2.4% of which came from PG's performance on Friday) and packaged food (+6.4% to start the year). We are a bit surprised by packaged food's performance - a highly defensive sector. Part of it may be that people are looking at 2012 laggards and part of it may be investors looking at the possibility of lower input costs (again, consistent with our initiation call back in December).
Also somewhat surprisingly, investors have broken the pattern of the last two years and not put risk on within the staples sector to start the year. Generally, we see higher beta names outperform lower beta within consumer staples when the calendar turns. That has not been the case thus far in 2013.
This year to date performance, accomplished absent any significant upward EPS revisions, has left the valuation of the consumer staples sector somewhat stretched versus recent history.
The consumer staples sector performance has been somewhat confounding for another reason - the sector has become increasingly sensitive to changes in yields on government securities in recent years, a theme we discussed at length on our initiation.
In fact, the spread between the yield on the 10 year and the yield of the XLP has decreased 44 bps (from -139 to -95 bps) in just a few weeks. This represents a combination of the price performance of the XLP and the fact that yields have crept higher.
We are left with the relative out-performance of the sector in the face of two potential headwinds - a "risk on" market and a relatively less attractive yield profile. So, we went searching for an answer and tested a few possibilities.
Our first though was short covering. Short covering has been a powerful theme to start the year - just ask the shorts in NFLX. We looked at the short interest ratio for individual stocks as of December 31st and the associated absolute performance to start the year. No dice - R2 of 0.0052.
Next, we looked at names that lagged in 2012, anticipating investors positioning for some regression to the mean in the sector. Again, no luck, as you can see below.
We then asked the question "what if investors simply don't believe this move up in the market?" In that case, the go to move would be to try and participate in as safe a way as possible, with limited downside should the economy stall or negative news flow surrounding the debt ceiling debate increase in intensity. The consumer staples sector makes sense in that context. In fact, we have heard some investors suggest that they were waiting for a better entry point, anticipating broad weakness as the debt ceiling debate looms.
We examined this possibility by looking at the performance of the XLP versus the performance of the Citi Economic Surprise Index (an index that purports to measure the gap between expectations and reality with respect to multiple economic data points). When the index is rising, data is better than expectations, and consumer staples generally lag. When the index is falling (as it is currently), the XLP tends to perform well as expectations are not being met by the reported data. Imperfect, indeed, but directionally and intuitively compelling.
Where does that leave us? A quick summary:
Very good performance to start the year across consumer staples
- The trend of risk on within staples to start the year has been broken
- Valuations have become somewhat stretched
- Not seeing short-covering or chasing laggards
- Investors may be playing "offensive defense" by buying staples in the face of a rising market they might not necessarily believe in
If this move up in the market is "real", and to the extent that more investors start to believe that, money should flow from staples. Alternatively, if those investors that are on the sideline are correct, staples will decline, albeit not as significantly as the broader market. So, it follows that we are getting more cautious across the sector. Our preferred shorts remain TAP, KMB, PM and either GIS or CPB in packaged food. We are sticking with our preferred longs:
- STZ - event stock with near-term catalyst
- CAG - valuation remains compelling
- PG - positive bias to EPS estimates (versus KMB short)
- ADM - most compelling way to play new crop year (though no clear view on upcoming EPS)
One more thought - for those investors that can, options are broadly inexpensive and stock replacement strategies might make sense particularly as we are getting more and more cautious on the group given the dynamics outlined in this note. Finally, the upcoming earnings season will be revealing in terms of business momentum and the likely direction of EPS revisions. We prefer to pick our spots (like we did with PG) where we either see risk or opportunity in single stock ideas.
Have a good week,
HEDGEYE RISK MANAGEMENT, LLC
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