Jack & Jill: “Jack fell down and broke his crown & Jill came tumbling after”
Rock a bye baby: “When the bough breaks, The cradle will fall, And down will fall baby, Cradle and all.”
Rub-A-Dub-Dub: “Rub-a-dub-dub, three men in a tub”
Have you ever actually listened to the lyrics of the traditional nursery rhymes?
I honestly don’t even remember how the last one ends, but I imagine 3 men in a bath together could go downhill quickly. Some pretty morbid content for young minds at their peak of neuroplasticity.
Back to the Global Macro Grind…..
It’s been serene slumbering for the better part of the last 6 months as our macro model front-ran the inflection in domestic #growthstabilizing in late November. TREND Macro moves are generally self-reinforcing and catching the positive or negative inflection in the slope of growth represents the REM period of actively managed alpha.
But, alas, Rip Van Winkle and real-time, globally interconnected risk rarely make sustainable bedfellows. After riding the expedited 300-handle advance in the SPX, we went net short yesterday for the first time since November 2012.
Does that mean we’re abandoning the #StrongDollar-Strong Domestic Consumption mantra we’ve been captaining for the last 5 months?
Here is where it’s important to understand how the Risk Management & Fundamental Research sides of the Hedgeye model co-integrate to drive invested positioning.
As Keith highlighted yesterday, “I am getting my first coordinated overbought (SP500) and oversold (Gold) signal of 2013. Both signals are explicitly linked to an overbought one in the US Dollar Index”
What does that mean in the context of our constructive fundamental views on the Dollar, Domestic Consumption, and Housing? In short, it means that so long as our research view on that trinity of factors remains positive, we’ll cover shorts, buy back the same exposures we sold yesterday and get net long again when the signal indicates we’re no longer overbought or if/when we move towards the oversold 1636 line on weakness.
Since our bull case was largely predicated on Strong-Dollar, Housing, Employment & Consumption, let’s summarily review the latest across those metrics.
$USD: Mother Nature likes redundant systems and so do we. With federal deficit spending declining dramatically, domestic monetary policy turning incrementally hawkish, and explicitly dovish commentary out of Japan & the EU unlikely to ebb, we think the dollar can continue to appreciate via numerous routes. Ongoing dollar strength, perpetuated by a continuation of the above dynamics, would augur more of the same for commodity and gold price deflation.
Employment: We consider the 4-week rolling average in y/y, Non-seasonally Adjusted Claims to be the most accurate reflection of underlying labor market trends. On that metric, yesterday’s update showed a 20bps deceleration WoW with rolling NSA claims going to -8.9% YoY vs. -9.1% YoY the week prior. Despite that sequential deceleration, -8.9% YoY improvement represents a very good rate of decline. Moreover, organic 2Q trends to date have overwhelmed any negative seasonal distortion or sequestration associated drag. On balance, we’d still view labor market trends as positive.
Housing: We continue to maintain a positive view on housing broadly, but in light of yesterday’s weak headline print in housing starts, let’s narrow the focus to our expectations for starts specifically. In short we would view a multi-year doubling of housing starts to 2M annualized units as a high probability scenario.
Consider this basic imbalance. Since the start of 2011, new household formation has been running at an annual rate of 1.38 million. Historically, due to factors such as Vacant Unit demand and Demolitions, the ratio of new housing demand to new household formation has run at approximately 135%-139% (see here & here for the supporting research). At the current rate of household formation, this equates to demand for 1.89M housing units. Instead we've begun construction on 0.845 million, or just 46% of the level needed.
Note also, against demand implied by household formation, we’ve incurred a cumulative deficit of 3M new housing units since the start of 2010. Some percentage of this deferred demand should materialize as the economy improves, exaggerating organic demand trends over the next few years.
One month does not a trend make. Clearly, there remains a significant delta between new housing units needed and units being created.
Credit: The Fed’s 2Q13 Senior Loan officer survey showed bank credit standards continued to ease while business and consumer loan demand, particularly for real estate, showed further sequential improvement. Household debt burdens are making lower 30Y lows and household debt and debt ratios have retraced most of the exponential move in debt growth that occurred over the 2000-2008 period.
Ongoing labor market improvement (higher income) alongside rising household net worth (primarily via housing and financial asset re-flation), should continue to support incremental debt capacity while the flow of net new credit looks favorable for credit catalyzed private consumption over the intermediate term.
So, legitimate upside for the dollar still exists, labor markets trends remain positive, housing remains in the middle innings of a secular upswing, and the household income statement and balance sheet recovery remains ongoing alongside favorable consumer and commercial credit trends.
Obviously, we could conjure up some bearish data points to counter some of the bullish dynamics we outlined, but employment/housing/consumption/credit have been key items of focus and key drivers capable of catalyzing positive reflexivity in the economic cycle.
At present, trends across those metric remain positive and supportive of a bullish tilt towards consumption oriented domestic exposure….at a price.
To clumsily bring this missive full-circle, conventional lullabies did little to placate my teething 6-month old last night. What finally put her sleep?...Chewbacca and a 2:30am Star Wars re-run that came on accidentally when she knocked the remote onto the floor.
Lesson? Embrace Uncertainty - today’s market teething births tomorrow’s Chewbacca P&L opportunity. Life, risk, and opportunity happen fast. If fast isn’t your thing….
I hear Hedgeye made the Kessel Run in less than 12 parsecs.
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, EUR/USD, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1, $101.14-105.44, $83.04-84.43, $1.28-1.30, 100.65-103.78, 1.83-1.99%, 12.33-13.86, and 1, respectively.
Christian B. Drake
TODAY’S S&P 500 SET-UP – May 17, 2013
As we look at today's setup for the S&P 500, the range is 26 points or 0.88% downside to 1636 and 0.70% upside to 1662.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 1.65 from 1.65
- VIX closed at 13.07 1 day percent change of 2.03%
MACRO DATA POINTS (Bloomberg Estimates):
- 9:55am: U. of Mich. Conf, May prelim., est. 78.0 (prior 76.4)
- 10am: Annual revisions to factory orders data
- 10am: Leading Indicators, April, est. 0.2% (prior -0.1%)
- 11am: Fed to purchase $4.75b-$5.75b notes in 2018-2019 sector
- 1pm: Baker Hughes rig count
- 1:45pm: Fed’s Kocherlakota, Riksbank’s Ingves speak in Chicago
- 9am: House Ways and Means Cmte holds hearing on IRS screening of nonprofits applying for tax-exempt status
- 9am: Energy Dept holds mtg of Natl Coal Council
- 9:30am: Sec. of State John Kerry, Attorney Gen. Eric Holder, HHS Sec. Kathleen Sebelius, Transportation Sec. Ray LaHood attend mtg of President’s Interagency Task Force to Monitor and Combat Trafficking in Persons
- 1:20pm: President Obama speaks at “Middle Class Jobs & Opportunity Tour” event
WHAT TO WATCH
- Wall Street wins rollback in Dodd-Frank swap-trading rules
- Dell profit misses ests. on PC slump amid buyout flight
- Northrop to buy back $4b more shrs, to retire 25% of shrs
- Kansas City Southern to replace Dean Foods in S&P 500
- Caterpillar obligations cut by $135m in ERA settlement
- Europe car sales climb after 19-month drop, Germany rebounds
- Computer Sciences Corp. reaches $97.5m investor accord
- Knight discussing SEC settlement on trading error: Reuters
- Tableau raises $254.2m in biggest technology IPO of 2013
- Tesla prices 2.7m shrs at $92.24 each: WSJ
- McDonald’s seen overhauling U.S. menu from 145 choices
- Foxconn faces challenge reducing working hours
- Maersk says container rates recovered, cuts demand forecast
- China encourages foreign auto investment in policy reversal
- Bernanke, BOJ, Dimon, Goldman, IRS: Wk Ahead May 18-25
EARNINGS: (all times ET, times are approximate)
- Stage Stores (SSI) 6am, $0.09
- Donaldson Co. (DCI) 7am, $0.49
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Gold Heads for Worst Slump Since March 2009 as Holdings Contract
- Gold Bears Revived as Rout Resumes After Coin Rush: Commodities
- Soybeans Set for Biggest Weekly Gain Since January as China Buys
- Copper Advances as Shanghai Inventories Reach a Seven-Month Low
- Lead Shines on Asymmetric Chinese Base Metal Capacity Cuts
- Metal Prices May Catch Up With Equities in 2016, Forecasts Show
- Natural Gas to Remain Below $4, Energy Executives Say in Survey
- Rebar Pares Weekly Decline as China’s Stock Market Rallies
- Robusta Coffee Swings on Inventory, Vietnam Exports; Sugar Rises
- Crude May Fall as Weaker Growth Reduces Demand, Survey Shows
- Trafigura Sells Forties at Higher Price; Angola Exports to Rise
- Gold in India to Tumble to Lowest Since 2011: Technical Analysis
- SHFE Copper Stockpiles Fall to Seven-Month Low as Aluminum Drops
- Iran Pays High Premium for Staples From India on Sanctions
The Hedgeye Macro Team
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Takeaway: Keith shorted Japanese government bonds today via JGBL, an investment vehicle that tracks JGB futures.
Keith shorted JGBL at 11:42am at $20.68. Keith writes, “I've never shorted Japanese Government Bonds before. Pray for us as we enter the mother of all widow maker positions.”
Here’s an excerpt from Keith’s Early Look note that he published on Tuesday at 7:41am where he writes about his take on JGBs.
“…Something just jumped off my page as new – JGB Yields.
JGB, yeah you know me – as in the most asymmetrically depressed live market quote in all of Global Macro – as in Japanese Government Bond Yields:
1. 10yr JGB Yields +10bps day-over-day to 0.84%
2. 10yr JGB Yields are now +23bps month-over-month
3. 10yr JGB Yields just jumped above my long-term TAIL risk line of 0.82%
Oh yes, darkness my old friend, I have been waiting for you. But for how long will you stay? I have never shorted you before. Are you toying with my emotions this morning, or are you for real? If you are for real, what will central planners in Japan do to tone you down?
Consensus has spent most of the last 6 months looking for a crisis that never happened. If and when this one happens, it will matter. And the if part isn’t the question in my mind. It’s the when that really matters – when will Japanese and US Government Bond Yields stop baking in that they’ll never go up?
Now that the Greenspan/Bernanke Top 3 (major bubbles) have popped (Tech, Housing, and Commodities), this is really the last of the mega bubbles left – the Bubble in Super Sovereign Debt.
I don’t like shorting a bubble until that bubble starts:
1. Making lower all-time highs
2. Confirming those lower-highs at what I define as my bifurcation point (my TREND line)
In terms of signaling Sovereign Yield Risk, measuring and monitoring the bubble happens upside down. Which is kind of cool; especially versus the alternative (i.e. being levered long US and Japanese Sovereign Debt for May 2013 to date).
In terms of big bang risk, the 2 most important live quotes on my risk management screens next to the US Dollar Index are:
1. US Treasury 10yr Yield of 1.82%
2. Japanese 10yr Government Bond Yield of 0.82%
These are what I call my long-term TAIL risk lines. And they matter – big time; especially when A) they continue to confirm (becoming less random) and B) have causal research (deterministic) factors explaining their confirmations.
What’s causal in driving our call for a continued #StrongDollar and higher-lows in UST bond yields? That’s easy – employment, housing, and consumption #GrowthAcellerating as the Fed is forced to tone down bond purchases.
What’s causal in driving higher JGB Yields? That’s less easy – credit risk is as likely as a growth scare. Since one or the other can really get bond yields to move, which one will it be? The only thing we know is that there has never been a country with its debt and deficit positions (as a % of GDP) that has burned its currency and not ended up in crisis.
So we’ll see. These Japanese risks can happen fast, or slow. They may not happen at all. But, on my risk signaling scorecard, the improbable risk of rising Yield Risk in both US and Japanese Sovereign Debt just went up in the last 2 weeks, not down.
- Multiples are rising but valuations remain largely benign at current levels while holding a number of key risks. We’re going to continue to risk manage the range with a bullish bias as our TREND research & risk management views on domestic consumption remain constructive. Stick with what’s been working.
- PEAK MARGINS: Operating Margins & Corporate Profitability remain at peak. Unless you think peak returns to capital are sustainable alongside negative trend growth in real earnings and trough returns to labor, then the mean reversion risk for margins remains asymmetrically to the downside
- CAPE Valuation: At 24.6, the CAPE ratio is moving towards the high end of the range. Expensive could get more expensive over the immediate/intermediate term, but historical precedent suggests return expectations should move systematically lower alongside concomitant increases in valuation from here.
- Estimates: Topline growth for the SPX doesn’t look out of bounds under a scenario of accelerating housing/employment/consumption growth. However, the slope on earnings growth over the NTM continues to look aggressive given the expectations for further margin expansion embedded in those estimates.
- P/E: On conventional LTM & NTM P/E metrics, the market isn’t particularly expensive at present. However, investors should contextualize any superficial market ‘cheapness’ within the construct of corporate profitability levels that are roughly 80% above the historical average.
HEDEGYE PROCESS REDUX: Contextualizing Our Current Positioning
If you’ve followed Hedgeye for any significant period of time it has likely been clear that, from an Investment decision making perspective, valuation sits somewhere near the middle-bottom of the our consideration hierarchy. In fact, you’d probably find the “valuation is not a catalyst” mantra somewhere in our Risk Management Manifesto if such a document existed.
However, if valuation is, indeed, compelling and there is a discrete catalyst on the timeline, then it gets more interesting. Layer on a positive quantitative signal from our risk management model such that the risk management (price signal) and the research view are aligned and an idea gets actionable.
The prices rule and duration agnostic (TRADE/TREND/TAIL) structure anchoring the Hedgeye model is our evolving attempt to develop an investment research process that successfully functions outside of the legacy construct of management one-on-one’s, recycled expert opinion, and valuation-in-isolation and intuition driven decision making. This basic investment approach allows us to operate within the empirically obvious reality that cheap can get cheaper and expensive can get expensive-er from a valuation perspective.
Yesterday served as an illustrative case-study in how the model works in practice. From a TREND perspective, we’ve have been outspokenly bullish on #StrongDollar. With a strong $USD (driven by positive domestic macro data and incrementally hawkish fiscal & monetary policy) as a primary causal factor – we’ve have been bearish on gold & commodities and bullish on domestic, consumer facing equity exposure.
Do we still hold that view? Yes, but from a price.
Yesterday our risk management model was signaling the $USD and SPX overbought, gold oversold, and a relatively high probability that the jobless claims numbers would fail to comp the outsized acceleration (improvement) observed in each of the last two weeks - so we reduced our gross exposure and tightened up our net exposure a bit.
So, in brief, our prices-based Risk Management process drives our allocation and invested positioning while complimentarily functioning within the construct of our TREND research view.
From here, so long as our constructive views on the dollar/housing/consumption remain positive, we can cover shorts and buy back the same exposures we sold yesterday as we move towards the Hedgeye 1633 line on the S&P500 on any sell-off.
That protracted preamble aside, where do we sit currently on market valuation and expectations?
VALUATION: CAPE P/E
We use a broad range of valuation and sentiment indicators when contemplating the direction of markets and where our view sits in the context of current prices, consensus estimates, and prevailing sentiment. Taking a TREND/TAIL view of valuation, Yale Professor Robert Shiller’s methodology serves as a reasonable method for contextualizing current market valuation.
By way of background, Professor Shiller uses what is called CAPE, or Cyclically Adjusted Price to Earnings. In terms of the numerator, or price, Shiller uses the monthly average of daily closes for the SP500. To derive the earnings data, in this instance the denominator, Professor Shiller uses the quarterly earnings data from the SP500’s website and utilizes an interpolation to provide earnings data by month. He then adjusts both the numerator and denominator for inflation using CPI from the Bureau of Labor Statistics. Finally, the inflation adjusted price is divided by an average of ten years of real monthly earnings to determine the CAPE.
Below we’ve broken the historical CAPE ratio values into deciles and looked at subsequent, average market performance across various durations. We would highlight a few takeaways:
- Currently: At the latest value of 24.6, we are currently at the top end of the 8th decile. In other words, over the last 113 years, the CAPE has been lower ~90% of the time. We would note however that the current value is near average for the past 30Y’s inclusive of peak, tech bubble valuation.
- Near-term Performance: If the idea that expensive can get more expensive and vice versa is valid, we would expect to see a more diffuse, random distribution in subsequent performance over shorter-term durations and an increasingly less random distribution over longer term durations. Put differently, the distribution should reflect a more equal tendency of going both higher or lower in the short-term regardless of the CAPE value. This is, in fact, what we observe when looking at subsequent 3M performance relative to subsequent 1Y & 3Y performance. This is reflected in both the trend in average performance by decile (bar charts) as well as the slope of the line in the respective scatter plots below.
- Longer-term Performance: Over the longer-term, CAPE valuation is inversely related to subsequent longer-term performance. As can be seen, for each decreasing decile change in CAPE, subsequent 1Y and 3Y performance generally shows a discrete step function lower in average return.
In short, with the current CAPE ratio in the middle-high range on a historical basis, we could certainly go higher (or lower) in the more immediate term. However, from a longer-term perspective, historical precedent suggests return expectations should move systematically lower alongside concomitant increases in valuation from here.
PEAK MARGINS, PANGLOSSIAN ESTIMATES & IMMEDIATE-TERM INDIFFERENCE
On a conventional trailing or forward P/E basis, the market isn’t particularly expensive at current levels. With global fund flows out of EU and EM markets continuing to target U.S. assets and equities benefiting from downside asymmetry in fixed income and strong dollar driven rotation out of metals and commodities broadly, multiples could certainly absorb another turn or two. As equity prices inflate, we continue to see two key risks:
Peak Margins & Corporate Profitability: We remain at peak operating margins and peak profitability with after-tax corporate profits as a % of GDP at an all-time high. Unless we’ve entered a sustained new normal in terms of corporate profitability and returns to capital (which also implies a new normal trough for returns to labor), the mean reversion risk for margins should remain asymmetrically to the downside with earnings negatively levered to any deceleration in topline trends – a dynamic that is likely to remain in place over the intermediate term. So, investors should contextualize any superficial market ‘cheapness’ within the construct of corporate profitability levels that are roughly 80% above the historical average.
Estimates: While multiples, on a historical basis, aren’t overly stretched here despite the expedited advance over the last six months, as always, valuation based panglossian market narratives are only as good as the growth expectations embedded in the denominator.
Consensus expectations for the S&P500 over the next four quarters look mixed across operating metrics. Topline comps ease through the balance of the year and growth estimates in the low to mid single digits for the SPX appear reasonable under a scenario of accelerating housing/employment/consumption growth. However, the slope on earnings growth over the NTM continues to look aggressive, despite easy comparisons, given the expectations for further margin expansion embedded in those estimates.
Christian B. Drake
VIP per table stagnant over last few years but signs of an upturn emerging
- Unlike the Mass chart we posted yesterday, VIP table productivity has been nonexistent
- However, April showed promising YoY growth. May started strong, and we’re projecting accelerating growth for most of the rest of the year
- Not surprisingly, the two primary Cotai operators – MPEL and LVS – trail the others on the VIP side but perform well on the Mass side
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