“The dramatic modernization of the Asian economies ranks alongside the Renaissance and the Industrial revolution as one of the most important developments in economic history.”
Candidly, over time I have found myself disagreeing with a lot of what Larry Summers has said publicly. That said, the above quote definitely resonates with me. As I touched on earlier this week, the story of development in Asia over the last twenty years, and in particular in China, is really unprecedented in economic history.
In North America over the last few decades the Renaissance Men, for lack of a better word, have been the private equity firms and hedge funds partners that have generated outsized returns and been paid handsomely. Like any Renaissance, though, this one too will end. This end is evidenced by some recent studies that highlight hedge funds returns are correlated to the SP500 with a more than 0.9 r-squared. If true, this renaissance may be ending sooner than many expect.
With such a tight R-squared, an emerging risk is actually how much each hedge fund owns of a particular stock. Many quantitative managers have actually gone on to categorize this as “hedge fund risk”. In effect, this equates to the amount of stock outstanding that is in the hands of a series of hedge fund managers. So if a lot of the stock is held with hedge fund managers, then the hedge fund risk is high.
So speaking of Renaissance men, Hedgeye has a few, but perhaps the most legitimate one is our own Matt Hedrick, who covers European equities. Matt hits our internal team with an update on Europe every morning and today his key points were limited. This is actually positive because what it means is there is a not a lot going on in European and her sovereign debt crisis.
In fact, in the Chart of the Day we highlight this by showing Spanish 2 and 10 year yields over the last year. The fact is that credit risk in Europe has been steadily declining. As the chart shows, Spanish yields are well of their peak, but not only that, they are also below the levels of a year ago. The key take-away from this is that while Europe sill matters, it only matters to a point as European credit risk, broadly, has improved.
With peripheral yields improving, we are also seeing an improvement in capital flowing back to certain countries.
Specifically, in Italy private sector deposits were up 7.7% year-over-year in the last month. While this is not a number that is going gangbusters per se, what it does show is that capital is coming back to the certain at-risk sovereigns in the Euro-zone. This ultimately is a positive for broader credit risk in the EU.
On the flip side, some of the European data was less than positive night-over-night. For instance, German industrial production declined -1.5% from last year. This is an acceleration from December, which declined -0.5%. Are these freak out type numbers? No, but they are indicative of a European economy that continues to struggle in its recovery.
I often quote my colleague and Hedgeye Financials Sector Head Josh Steiner in the Early Look. Once again I want to highlight a big call he made yesterday in a note titled, “BAC, C, MS - LONG THE BIG CAP BETA RENORMALIZATION TRADE”. As Josh wrote:
“There’s a paradox in global U.S. banks right now, and that is that they hold more capital today than they’ve held in a very long time. We show this in a chart below, which looks at Bank of America. The red line shows BofA’s tangible equity ratio going back ten years. You can see on the right hand y-axis that capital fell steadily from the high fives in 2003 to a low of 3% in the belly of the crisis and has since risen to around 7%. Capital ratios are much higher on a regulatory basis, but we like tangible equity for its simplicity – in other words, unlike risk-weighted capital measures, it’s more difficult for banks to manipulate this ratio in their favor. The point is that capital levels are very high today and, in fact, are still headed still higher for the foreseeable future (we'll know how much more after the close). The second line on this chart shows Bank of America’s rolling one year beta going back ten years. The takeaway here is that it has risen from its tight range around 0.8 from 2003 through 2007 to around 2 today (1.93 as of this morning). Capital is the inverse of leverage, and leverage is risk. High capital equates to low risk. Now let’s use beta as our proxy for cost of capital, and by the transitive property we find that the the market is charging the highest cost of capital at a time when the risk is, in fact, lowest. This is clearly paradoxical, and a dynamic we don’t think will last.”
So to summarize: capital ratios for large U.S. banks are improving and these stocks are poised to continue to lead the U.S. equity rally. While I enjoy having a few drinks with my colleague Josh, I’m not sure he (or me for that matter) is a Renaissance man, but what he is definitely is very accurate in terms of his view of the U.S. banking system. If you’d like more of his thoughts, please email .
As you all head into the weekend, I wanted to leave you with one last quote, which is related to a quote from the Early Look earlier this week:
“Marxism is like a classical building that followed the Renaissance; beautiful in its way, but incapable of growth.”
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1, $109.07-111.73, $81.98-82.54, 92.11-95.81, 1.94-2.04%, 11.67-14.91, and 1, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
This note was originally published at 8am on February 22, 2013 for Hedgeye subscribers.
“In the taiga there are no witnesses.”
-Dersu The Trapper
That’s the opening volley from a book I just cracked open, The Tiger – A True Story of Vengeance and Survival (by John Vaillant). The “taiga” is not to be confused with the Amur Tiger. Both are to be feared, in different ways.
The taiga is where these killers prowl, in “the mixed broad leaf and conifer forests of Siberia.” As for the Siberian tiger itself, people “fear it, revere it, tolerate it, and sometimes hunt it.” (pg 19)
If you want something to scare the hell out of you, I’m betting that one of these hungry cats does it better than this market can.
Back to the Global Macro Grind…
If I take you out back into the black bear bushes of Thunder Bay, Ontario (in the dark, with no crackberry or gun) I bet I can scare the hell out of you too. To be clear, there are times to fear – and yesterday wasn’t one of them.
After banging the top-end of our immediate-term risk range (immediate-term TRADE overbought on Tuesday, where we sold at 1530 SPX), the US stock market corrected for 2-days (from the all-time high in the Russell2000) and people were freaking out.
Or are they freaking out because they missed a +177 point move in the SP500 from the November lows, chased the February high, then got snow plowed? People have baggage, I get it. But let’s get real here – nothing about our bull case has changed.
- We are bullish on global #GrowthStabilizing (especially in Asia and the USA, not France)
- We are bullish on both US Housing and US Employment (Existing Homes Inventory reported -25% y/y yesterday!)
- We are bearish on Commodities, particularly Gold, Silver, and Food
So, if you want to get bearish on something, get bearish on something that’s actually gone down for more than 48 hours. Commodities and their related equities have been a relative train wreck for not only February, but since Bernanke’s Top.
Since Bernanke’s money printing top (September 14, 2012 - #timestamp it):
- The CRB Commodities Index (19 commodities composite) is down -8.7%
- And in the last 3 months, Gold and Silver are down -8.7% and -13.9%, respectively
- Wheat, Cocoa, and Corn are down -14.7%, -15.3%, and -6.8% in the last 3 months too
And if you don’t care on Cocoa (I don’t) and are a little shorter-term than that with a US stock market focus:
- For FEB to-date, Basic Materials (XLB) is down -3.3%
- The SP500 is +0.3% for the month-to-date
Wanna get nuts? I can get nuts. I can rip into a 40yr US Dollar Debauchery cycle rant like you have never seen. I can throw more historical data at you on what perpetuated the all-time highs in Commodities (2011) than you can shake a stick at. I can yell. I can scream. I can probably even win a butt-kicking contest versus a one-legged commodity bull on this, dammit!
(interviewing for Santelli’s job, so thanks for reading that)
Back to reality – I keep getting asked “well, Keith what about your call on US Dollar Correlation Risk from 2010-2012.” A: correlations in markets are never perpetual, and it’s 2013.
What do I mean by that? It’s just math. Here’s what’s happening in our immediate-term TRADE correlation model (vs USD):
- CRB Commodities Index vs USD correlation = -0.98! (uber negative correlation)
- Eurostoxx600 vs USD correlation = -0.68
- SP500 and MSCI Asia (Equities) vs USD correlations = +0.13 and +0.55 (note, they are positive)
So stop freaking out. Like the Reagan (1983-1989) and Clinton (1993-1999) US #GrowthStabilizing (then eventually accelerating) periods, Strong Dollar can become a pro-growth signal. Oh, and China likes Strong Dollar, down food prices too. Don’t you?
If you want to get scared, fear the biggest thing of all that can screw this all up - the government.
Out immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, EUR/USD, USD/YEN, UST10yr Yield, and the SP500 are now $1554-1617, $112.59-117.02, $80.63-81.53, $1.31-1.33, 92.87-94.39, 1.97-2.05%, and 1501-1530, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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Takeaway: NAV surprised to the upside, but lost 5 points of US and Canada class 8 share in its orders relative to the industry’s. Positive for PCAR.
NAV: Share Loss Implied By Orders Positive for PCAR, Volvo, Daimler
- Five Points of “Order Share” Loss YoY: Navistar reported class 8 orders down 36% in the U.S. and Canada in their fiscal first quarter vs. an ~14% decline for the industry, by our estimates. Relative to last year’s “order share”, Navistar was down about five percentage points to 14.1%.
- ISX Intro Saps 13L: The small sequential improvement (~50 bps) may relate to the introduction of the Cummins 15L ISX Engine. Roughly 40% of NAV's class 8 orders in the quarter used the newly introduced Cummins 15L engine, so MaxxForce 13L orders were weak. That may benefit competitors’ 13L offerings.
- Major Rally in NAV Shares: Navistar’s management change, improved operating performance and better than expected liquidity position helped drive its share price higher today. The stock is heavily shorted, a position we have not advocated because of numerous uncertainties (including a potential takeout).
- Long Paccar Easier Position: Navistar’s emissions problems helped it to gain market share in early 2012, since many customers initially preferred the simpler, less clean EGR engine, in our view. As Navistar introduces compliant products, pays non-conformance penalties and suffers from poor product perceptions, it may continue to lose significant market share. NAV's loss in class 8 is PCAR, Daimler and Volvo's gain. We see NAV’s expectation of improved market share through the year as unlikely, with further market share erosion during 2013 probable.
- SCR + EGR 13L a Hard Sell: We expect Navistar to struggle with the introduction of its new 13L engine. While the 15L ISX is a well-established platform, the previous 13L MaxxForce has experienced serious perception issues. The new 13L, with two emissions technologies in the same engine, may be a non-starter with some customers, in our view.
- Focus on PCAR: Our discussion of NAV’s results focuses on the competitive dynamic with PCAR, one of our long ideas. Please ping us if you have any questions on the specifics of NAV’s earnings report or 10-Q from today.
Today we bought Nationstar Mortgage Holdings (NSM) at $38.96 a share at 1:10 PM EDT in our Real-Time Alerts. Steiner books the gain in Morgan Stanley (MS) and flips it into NSM. Quarter was solid and the company’s positive outlook/guidance remains unchanged, but the analyst community is souring so we’ll take advantage.
Hedgeye Retail Sector Head Brian McGough appeared on CNBC this afternoon to discuss JCPenney's (JCP) current financial woes and whether or not the company should fire current CEO Ron Johnson. McGough argues that firing Johnson will put the company on the fast track to Chapter 11 bankruptcy.
Go to 6:48 into the video to watch Brian’s interview.
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