“We live by emotion, prejudice, and pride.”
-Dwight D. Eisenhower
That’s what President Eisenhower wrote in a letter to Winston Churchill in the early 1950s after the Korean War. He added: “It is remarkable how little concern men seem to have for logic, statistics, and even, indeed, survival.” (Ike’s Bluff, pg 105)
Sounds a lot like risk managing the 2013 Global Macro market to me. So far, with the underpinnings of real (inflation adjusted) global economic growth stabilizing (instead of slowing), the best way to survive the game has been to be long growth, not gold.
We all have our investment-style prejudices. We all have plenty of emotion too. The hardest thing to do is keep that all checked at the door before we turn on our screens every morning. The Behavioral side of this game has never been so important.
Back to the Global Macro Grind…
Admittedly, I was all fired-up covering shorts and getting longer (equities) during last week’s 2-day correction. Was I being emotional? Or were the sellers? Now I’m questioning whether I got Bullish Enough?
At Augusta in 1954 the legendary Sam Sneed told Ike, “you’ve got to stick your butt out more, Mr. President” (Ike’s Bluff, pg 115). While Eisenhower didn’t like having other people tell him what to do, he listened. Sneed’s advice wasn’t from some local pro.
When I stick my old hockey bubble-butt out and make a market call, I don’t ask a local pundit for permission. It’s always based on two very important things that we are trying to hammer home with clients – they are both critical to our process:
1. The Risk Management Signal
2. The Team’s Research Views
Note which one of the two comes first. Indeed, it is the signal I prioritize over what can often become research noise. All that said, when both are aligned, I’m learning to get over how I look - and I just do it (stick out my butt).
When you boil down the difference between our bullish Research View on growth versus competitor views, it’s quite simple:
- Our view is Dollar centric: Strong Dollar = Down Commodities (deflation) = Stronger Consumption
- Their view is Commodity centric: they are either calling for inflation OR thinking deflation is a bearish leading indicator
Irrespective of your research team’s view, this is what Mr. Market’s signals think:
- Strong Dollar = up another +1.1% last week; up for 3 consecutive weeks on a +3% run
- Commodity Deflation = down another -1.7% last week; down for 3 consecutive weeks (-3.9% all in)
No, the world’s economies and stock markets didn’t end on that. In fact, despite Oil prices reacting late relative to Gold (Brent Oil finally down -2.9% last wk), the two key US consumption demand points we care on (US employment growth and housing) held up quite well. The question now is how well do they react to prices at the pump falling, instead of rising?
If you Embrace Uncertainty at the core of your process, the simple answer is usually going to be ‘I don’t know.’ You’ll know when market prices and high-frequency economic data either refute or support your thesis. Advice: don’t marry your thesis.
If you were buying commodities futures and options contracts since the Bernanke Top (September 2012), the CRB Commodities Index is one of the worst places you could have been invested (down -9% from there to here). And finally, in the last few weeks of Commodity Deflation, the net long (CFTC futures/options position) has capitulated to its lowest level since DEC 2011:
- Copper contracts crashed last week, down -51%! to +11,413 (lowest since NOV 2012)
- Gold contracts crashed (again) last week, down another -40% to 42,318 (lowest since JUL 2007)
- Farm Goods contracts capitulated too, down -44% last week to 190,892 (lowest since March 2009)
Farm Goods still has the biggest net long position because food prices were the last of the commodities to put in their all-time tops. Corn’s all-time high was in August of 2012. Corn prices are now on the verge of crashing (greater than 20% peak-to-trough decline) from that all-time top and net long contracts in corn were down -48% last week to +65,303.
Are falling food prices good for you? Do you eat? If you don’t (or someone in Washington buys all your meals with our tax “revenues”), you can safely assume, with no emotion or prejudice, that the rest of the world does.
Hedgeye reiterates our 0% asset allocations to both Commodities and Fixed Income this morning. Sure, we will take down these equity asset allocations when the signals tell us too. But we didn’t get those signals at Thursday’s lows. Emotional sellers did.
Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, USD/YEN, UST 10yr Yield, and the SP500 are now $1, $112.61-115.15 (Oil is bearish TRADE now), $3.51-3.65 (Copper is back in a Bearish Formation), $80.57-81.71 (USD = Bullish Formation), 92.72-94.41 (we re-shorted Yen last wk), 1.96-2.05% (Bond Yields = Bullish Formation), and 1, respectively.
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
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This note was originally published at 8am on February 11, 2013 for Hedgeye subscribers.
“For a theory is a very dangerous thing to have.”
I just got back from an island in the Bahamas and I’m flying to London this morning. As a result, February will be a very productive month of reading. I just finished grinding though both The Last Lion and Antifragility. I’m digging into Ike’s Bluff next.
The problem with self-education is that the more you read, the less you know. This helps contextualize how clueless the people who are trying to centrally plan your life actually are. Particularly when it comes to economic policies, I agree with Taleb that their “theories are superfragile.”
He also goes on (and on and on) to differentiate between social and hard sciences: “Physics is privileged; it is the exception, which makes its imitation by other disciplines similar to attempts to make a whale fly like an eagle.” (Antifragility, pg 116)
Back to the Global Macro Grind…
After closing up for the 6th consecutive week, the US stock market is flying like something – and it’s not the London Whale. On almost no volume on Friday (down -21% from my YTD average for market up days), the Russell2000 made yet another all-time high.
As we like to say at Hedgeye, all-time is a long time… but now we’ve been writing about all-time for a pretty long time too. For perma-bears, this has to be leaving a mark. Last week’s II Bull/Bear Sentiment Survey saw Bears capitulate to a fresh new YTD low of 21.1%.
Other than playing with my kids in the Bahamian sun, what did I like about last week?
- STRONG DOLLAR – the US Dollar moved back into a Bullish Formation, closing up +1.4% wk-over-wk at $80.25
- DEFLATING THE INFLATION – the CRB Index (19 commodities) closed down another -1.3% on the week at 301
- I discovered a tasty new beach beer, Kalik Light
I know some of our competitors keep talking about the risk of raging inflation – but that’s a Dangerous Theory to have if the US Dollar continues to make a series of long-term (40 year) higher-lows.
We’re not theorizing that Bernanke’s Bubbles (Commodities) will continue to pop from their all-time highs (2008-2012). They are already popping. Oil topped in 2008; Gold and the CRB Index stopped going up in 2011; and Food Prices put in their all-time highs in 2012.
If your theory was that the Fed would print to infinity and beyond and you bought Gold, Silver, etc. on that in 2008-2009, great call. But what happens to your theory if employment and housing #GrowthStabilizes in 2012-2013 and the Fed gets out of the way?
What didn’t I like about last week?
- TREASURIES – US Treasury Yields stopped rising (10yr yield down 6bps wk-over-wk to 1.95%)
- YIELD SPREAD – 10yr yield minus 2yr yield stopped expanding (down 5bps wk-over-wk to +170bps wide)
- GLOBAL EQUITIES – both European and Emerging Market stocks closed down on the week
Since everything that matters in our macro model happens on the margin, what we call negative divergences (they do bad things when the US stock market headlines are doing good things) really matter.
Some clean-cut negative divergences vs the SP500 closing at its YTD high (1517) were as follows:
- Friday’s highs came on down volume (you want expanding volume on the way up, not flailing volume)
- Friday’s highs came on an immediate-term TRADE signal in the VIX for a higher YTD low of 12.42 (you want lower-lows)
- Global Equities were down wk-over-wk = Emerging Markets -1.1%, MSCI World Index -0.4%, EuroStoxx600 -0.3%
Then, in terms of positive divergences (US Equities), some of the Bullish Style Factors we have been bulled up about got as extended as they have been versus the SP500’s +6.4% YTD return:
- High Short Interest Stocks = +9.2% YTD
- High Beta Stocks = +9.2% YTD
- Top Earnings Growth Stocks (top 25%) = +9.1% YTD
Since A) I have extension (immediate-term TRADE overbought) in our most bullish factors and B) I’ve finally been issued some fairly broad based negative divergences across asset classes, my decision late last week was to take down Global Equity exposure and raise Cash.
That’s not theorizing. That’s doing it in real-time and holding ourselves accountable to explaining the decisions we make. I guess that probably makes us dangerous too. But that’s just a theory.
Our immediate-term Risk Ranges for Gold, Oil (Brent), CRB Index, US Dollar, USD/YEN, UST 10yr Yield, and the SP500 are now $1659-1683, $116.38-118.83, 299-303, $79.79-80.39, 92.67-94.41, 1.93-2.01%, and 1507-1521, respectively.
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
Worse Start to Year versus 2012
Current moisture conditions in crop regions (in particular west of the Mississippi) are no doubt much worse than a year ago (see progression below). However, conditions have improved since the start of the year and with some projected moisture events coming up, we continue to think the bias is downward in terms of corn prices. The futures curve would seem to agree with us. Further, the set-up on the futures curve appears identical to this year versus 2012.
We think it’s very difficult to be long corn at this point (as supported by recent CFTC data that shows non-commercial buyers becoming less long corn), with significant time (and weather) remaining until the crop goes in the ground. As it currently stands, we would not be surprised to see 97 million acres of corn planted in the U.S this year – the USDA’s current estimate stands at 96.5 million acres. The incentive certainly exists for farmers to plant as much corn as possible.
We aren't in the habit of making bets on Mother Nature, but we do try to estimate what is currently priced in with respect to various assets and it appears to us that ADM at current levels remains a reasonably priced option with respect to the quantity and cost of the upcoming corn crop.
After a very nice run post EPS and with the news that Berkshire Hathaway is an investor, ADM has traded off its highs as the balance of the agricultural complex (fertilizer stocks) have languished in the face of broadly weaker commodity prices. To be clear, ADM is not a play on higher corn prices – lower corn prices benefit ethanol margins and a larger crop benefits merchandise and handling margins – think big crop with no price spikes, and ADM can continue to work from its current level.
Lower corn prices would also be constructive for protein stocks (SFD, TSN, PPC, SAFM) - though at current levels, only SFD interests us on the long side.
Have a good week,
HEDGEYE RISK MANAGEMENT, LLC
We would characterize CAGNY 2013 as largely uneventful and in some cases downright boring. We didn’t hear much that changed our thinking relative to how we came into the year or how we left Q1 earnings season. Briefly, the key themes running through the presentations were:
- Innovation – it’s the cost of doing business in the “new normal”. Consumers will pay a premium for value, perceived or real. Given the prominence of this topic, we wonder if companies are finding it necessary to spend more to stay in place?
- Advertising – companies have to communicate the benefits and differences of product offerings, old and new, to both consumers and retail partners
- Emerging markets – characterized as a “once in a generation” opportunity, the potential represented by an expanding global middle class was consistently referenced
- Productivity – doing more with less is necessary in a world where pricing is elusive, consumers are fickle, private label is growing and commodities are a wild card
- M&A – not a presentation topic, but certainly a topic of cocktail conversation – who’s next? We don’t see the Heinz deal as a catalyst for wide spread M&A across staples. However, some names make sense as potential targets – HSH, for one.
Where did our thinking change?
We won’t rehash the presentations, but as a quick summary:
CPB – less likely to want to short as core soup business potentially stabilizes
KRFT – one of our favorite presentations, would be a buyer lower – upside to low $50s
HSH – again, one of our favorite presentations, more constructive
BG – doing more work here on the long side after an awful quarter, good long-term theme
PG – less impressed with potential progress on top-line, but cost-savings likely preserve EPS
CLX – can’t abide by the multiple, but with good visibility on margins and innovation, tougher short
MDLZ – feels earlier, but risk/reward profile strikes us as very favorable over longer duration
NWL – we liked the story going in, presentation reinforced our belief that the stock can continue to rerate.
KO – interesting commentary on incremental bottler consolidation. Does Iberia represent a new potential acquirer for German assets?
We are, of course, happy to discuss any and all names in greater detail.
Enjoy your Sunday,
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