What’s Next for Europe?

Takeaway: Key takeaways from Hedgeye's European economic update conference call.

Senior Macro sector analyst Matt Hedrick presented a European economic update conference call for our institutional clients.  Hedrick discussed the current climate and headwinds impeding growth; how current European Central Bank (ECB) policies affect the markets; the continuing disparity of policy choices, and of economic inputs – and especially outcomes – across the Eurozone; and risks and opportunities at the Eurozone’s periphery.


What’s Next for Europe? - ECB

Europe Who???


Henry Kissinger famously said – or maybe didn’t say, according to people who claim to know – “Who do I call if I want to call Europe?” 


The comment referred to the disorganized entity known as “Europe.”  Decades later, the EU has 27 members, while the currency club – “union” would be too strong a word – known as the Eurozone has 17 members with a common currency, a single central bank… and seventeen different economic policies.  That’s not seventeen different economic policies – it’s 17 different nations, each of which is internally arguing over what their economic policy should be, to say nothing of what happens when all seventeen sit down together at the same table.


The Eurozone history indicates there will not be any startling changes that will all of a sudden harmonize policy across the membership.  That would require a common willingness to make sacrifices, and the monetary “union,” as it insists on calling itself, remains beset by multi-lingual finger-pointing where the rich nations (read: Germany) blame economic weakness on the profligate habits of poorer nations; meanwhile the poor nations blame the rich (again, Germany) for being stingy.


The Eurozone policy debate remains a major stumbling block to making any economic progress.  The inability of the members to reach consensus continues to drag on, all the moreso when many members feel badly handled by their more flush fellows.


One negative outcome of this logjam has been an inability to effectively confront inflation – or deflation – both of which periodically threaten to break through ECB target levels.


And in general, economic policy is sclerotic.  Like a wounded limb, the Eurozone will only heal when healthy fresh blood pumps freely through the affected parts, and under the present political stalemate, that is simply not happening.  The “periphery” – the weaker economies more likely to need bailouts – can not heal before the core economies, principally Germany.  Eurozone output has declined for 6 consecutive quarters, and the ECB and the IMF have both revised their outlook downward.  Hedrick says these new forecasts may not be pessimistic enough and he expects Eurozone GDP to remain weak for a protracted period.


Unemployment should “remain staggeringly high,” with the very real risk of a “lost generation.”  The easy jobs in construction and unskilled manual labor (remember the “Polish plumber”?) vanished with the evaporation of easy credit and the real estate implosion.  Administrative jobs have been drastically reduced through austerity, and cross-border labor migration suffers from quotas, and linguistic barriers and cultural difference that can pose real problems.  Germany, for example, has a longstanding cultural tradition of robust training in the trades.  Workers from other countries who were not raised in this environment don’t do well in the apprenticeship system that has been so successful in Germany.  The disdain for skilled manual labor felt by youths from other cultures has proven to be a stumbling block to employment immigration.


We hasten to point out that large numbers of unemployed young people also becomes a recipe for major social unrest in the longer term.  The discontent that sparked such movements as the Arab Spring, Spain’s “Indignados” (credited as the impetus for Occupy Wall Street) – and that is now bubbling over in Istanbul – can easily provide the spark for a generation sullen over the failures of their elders.


Hedrick says high debt levels and deficits will persist, and the lack of availability of credit will hamper small and mid-sized business growth for a very long time to come.  Since most new jobs are created by start-up small and mid-sized businesses, the employment and business formation end of this dreary cycle looks set to continue.   


“Super” Mario?


Eurozone central banker Mario Draghi has had a certain degree of success “jawboning” the markets.  One might say that, compared to his US counterpart Ben Bernanke, his record is astounding.


Like Bernanke, Draghi has increased the flow of cash into his system.  And like the US, the increased liquidity has not translated into massive new lending.  But Draghi remains with an ace up his sleeve, in the form of a massive quantitative easing program called the “Outright Monetary Transactions” bond-buying program (OMT).  Just this week Draghi called the OMT “the most successful monetary policy measure” of recent times.  Last week he boasted that the OMT has made the Eurozone “a more stable and resilient place” by removing “unwarranted fears of a systemic collapse” of the monetary union.


The truly impressive bit about the OMT is that it has never been used.  In fact, this week a German is hearing arguments on whether the OMT would violate the German constitution.  We expect the approval to be forthcoming – probably in September or October.  But the mere fact of Draghi announcing the OMT in September 2012 was enough to pop European markets – bond yields retreated, and most European equity markets rose, with the effect that the “fear trade” no longer dominates.


There remains some way to go before stability returns to the Euro area.  Central bankers have not been helpful, saying little or nothing to give a sense of direction to the markets.  Rate manipulation is of limited effect – risk spreads on European CDS are down, but there’s not enough oomph in a negative return on consumer savings accounts to drive to a full recovery.

In the absence of anything resembling policy agreement across the Eurozone, Draghi looks to retain his ability to lift the markets by occasionally referring to the – as yet untried – OMT. 


Tighten das Belten


In “The Great Dictator,” Charlie Chaplin mocked (among other things) notions of Austerity, particularly as it relates to a Greater Cause.  With the bloom fading from the Great Cause that was European unity, austerity is becoming less popular with ruling politicians.  European Commission president Barroso recently said austerity policies have reached their limits of both social and political acceptance.  Translation: if we push one more inch, they’ll vote us out.

This may lead to more moderate policies – the German finance minister is already muttering that France and Spain may be granted “certain flexibility” in meeting deficit targets.


The move against austerity is becoming a tailwind, as planners start prognosticating “a very gradual recovery,” “export growth caused by growing foreign demand,” and a willingness to promote government-bolstered private-sector investment.


Countries and Opportunities –

Germany and France… er… France and Germany… er… Germany and…


It is all too rarely acknowledged that, so far, the Common Market and its descendants – including the EC and the Eurozone – have accomplished their primary objective, which was to remove incentives for France and Germany to go to war with each other.  With the ascent of French president Hollande the détente is nowhere near so close as during the days of “Merk-ozy.”  Nonetheless, the two nations combine to represent half the Eurozone’s economic output, and their joint – or conflicting – interests should continue to dominate the sclerotic policy scene. 



We see this as a net positive for Germany, where we are bullish.  German culture is work-oriented – French youths turn up their noses at the notion of becoming apprentices to German machine-shop operators, with the consequence that more Germans have jobs, while more Frenchmen continue to feel superior.

Germany’s export economy benefits from current weakness in the Euro, and it has one of the lowest unemployment rates in the Euro area.


Germany is a particularly bright spot, and one of the few countries where expectations are on the rise.  It will remain the European “safe haven.”  If, as we strongly anticipate, Merkel is re-elected this fall and if, as we strongly anticipate, the German court gives the go-ahead for the OMT, Germany should continue very much in the ascendant.


Investment idea: Long Germany through iShares Germany (EWG) and Short German government bonds through PowerShares DB German Bund Futures (BUNL)

… but France…

We are bearish on France where President Hollande appears decidedly “anti-business.”  He currently enjoys a mere 24% approval rating – the country slid back into recession in the first quarter and only 5% of the French think things will improve.  “Fifty million Frenchmen can’t be wrong,” they say.  We agree with their dour outlook and would be short this economy.  C’est la vie.


Investment idea: Short France through iShares France (EWQ)


Rule, Britannia  

The first economy to impose austerity, we think the UK will be the first to emerge.  Bullish elements – aside from an actual pick-up in growth in the first quarter – include new central banker Mark Carney, who has expressed his desire for greater transparency, and the pro-business stance of the Cameron government.  Its distance from the Eurozone – both political and monetary – give it great flexibility, and its import-heavy economy stands to benefit as the prices of commodities continue to deteriorate.


Recent increases in retail sales figures and industrial production, together with a dip in the savings rate, signal greater bullishness – or should we say “John Bullishness”? – in the UK, and the housing market has turned up as well.

Investment idea: Long the UK through iShares United Kingdom (EWU).  


Over the Edge: the “Periphery”


It can’t be nice being called “the Periphery.”  Just ask Portugal, Spain and Italy. 


Broad risks remain in these countries, one hold-up to the ECB launching new policy initiatives.  These governments may prove incapable of honoring commitments to Brussels under the variety of austerity and bail-out packages they have taken on.  Incurable mass unemployment may lead to severe social unrest – half of Italian youth are ready to leave the country to look for a better life.  And sovereign bank risk is not out of the question – Spain’s bank system remains opaque even after significant high-profile corruption cases that even touched the prime minister.


At the other end of the periphery, Slovenia looks like a relatively stable newcomer – its risks appear self-contained, and if it does need assistance, it is likely to be small and highly manageable.  Slovenia, in short, is not Cyprus.

Indeed, even Cyprus is no longer Cyprus.  Hedrick says the risk of another Cyprus-style crisis is minimal.  Cyprus has confirmed that, once they get in, no one wants to leave the Eurozone – and for all their complaining and chastising of weaker members, Germany can’t afford to have anyone flee the currency union.


On the negative side, these countries suffer from dreadful sentiment, crushing youth unemployment, and broad economic underperformance.  Their governments range from unappealing, to unstable.  Still, Hedgeye’s Macro readings have not yet flashed a definite Long or Short signal.  Hedrick doesn’t rule out the possibility that negative trends in the Periphery could stabilize.  If Germany recovers fast enough – and if France doesn’t lose more ground – there could be a positive contagion effect.


Investment ideas: For Spain, we would use the iShares Spain (EWP); for Italy, the iShares Italy (EWI).  It’s too soon to call a Short or Long in these markets.  We continue to monitor these economies to see which way the Macro cookie will crumble.


Conclusion: Portugal?


To everyone’s surprise – and to the relief of many – Portugal just successfully sold a 10-year government note issue.  This, in a country that was for a time viewed as the basket case of the Eurozone.


Portugal still has government debt at around 122% of GDP – the third highest in Europe.  Their bond issues are still costing them, though not so much as in the past.  Coupons are in the 5%-6% range, which is a meaningful improvement.  Hedrick says Portugal will want to join the OMT mechanism.  While it is too early to make a decisive call, the government is showing real initiative, taking steps to cut government spending and still considering austerity measures. 


We leave you with this analogy: in 1999 Portugal adopted a national strategy to fight drug addiction.  Drug users were no longer treated criminally, but as clinically sick persons requiring a range of treatments.  While it has by no means “cured” drug use, Portugal’s program is widely considered a viable alternative to the War on Drugs.  The expansion of harm reduction efforts, coupled with aggressive after-care and social reintegration programs, have dramatically reduced the social impact of drug abuse, including HIV infection. 


Like widespread drug addiction, the global financial malaise is not going to be “fixed” – not overnight, and maybe not ever.  But there are surely more effective ways to contain the addicts and to limit the harm they do to society.  After all, where there’s a will, there’s a way.


We are still waiting for Europe to show some willpower.  

Morning Reads on Our Radar Screen

Takeaway: A quick look at some stories we're reading this morning.

Morning Reads on Our Radar Screen - radar


Brian McGough – Retail

Macy's Terry Lundgren: 'We Will Try Everything' (via WWD)


Josh Steiner - Financials

US regulator gives big banks two years to push out swaps trading (via Reuters)

Bond Buffer Seen in Demand for Swaps Collateral: Credit Markets (via Bloomberg)


Daryl Jones – Macro

Can Bernanke Avoid a Meltdown in the Bond Market? (via Bloomberg)

Greece First Developed Market Cut to Emerging at MSCI (via Bloomberg)

Edward Snowden: how the spy story of the age leaked out (via The Guardian)


Kevin Kaiser - Energy

Start Your Engines: NatGas Revs for Transportation (via Breaking Energy)

New Worst Place in Manhattan Coming Soon (via Gawker)


Keith McCullough – CEO

Greece First Developed Market Cut to Emerging at MSCI (via Bloomberg)

US General Dunford: 'Fight for Afghan rights not over' (via BBC)

It's Getting Dicey...

Client Talking Points


The most important correlation risk in my entire Global Macro matrix would be a sustained breakdown in the USD/YEN cross below 95.85. The market is testing those waters now, so I’d just as soon as get out of the way and let the market tell me what’s next. The flow to up/down Weimar Nikkei, then translation to S&P Futures is getting gnarly too.


La Belle Province? It doesn’t look so pretty anymore. Next to Russia, France is now the 1st major European Equity market to snap my intermediate-term TREND line of 3889. We did a 90-slide presentation on European Risks yesterday. Ping us if you missed it. Our research view is quite bearish on France, and now the signal confirms.


I spend most of the time talking about the breakout in the long-end of the curve, but the short-end (which Bernanke has marked to model) is starting to move now. At 0.32% this morning 2s are A) above my 0.27% TAIL risk line and B) Up +9bps in the last month. Yes, that’s a monster 39% move and while low nominally, in my model it's more about slope and the rate of change.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

Financials sector head Josh Steiner is the Street’s head bull on residential mortgage originator/servicer Nationstar, projecting $9 in earnings for the company in 2014.  This is well above the company’s own guidance range, which tops out at around $7.50. NSM had a successful start to the year as it won servicing bids on substantial mortgage portfolios.  They also reported significant increases in their profit margins on those portfolios, and double-digit increases in their own originations.  Housing prices are ramping significantly higher, as Steiner predicted, as demand continues to exceed supply in both new and existing homes.  Steiner says this quality mortgage company could ride the crest of a sustained wave of sector improvement.


Gaming, Leisure & Lodging sector head Todd Jordan says Melco International Entertainment stands to benefit from a major new European casino rollout.  An MPEL controlling entity, Melco International Development, is eyeing participation in a US$1 billion gaming project in Barcelona.  The new project, to be called “BCN World,” will start with a single resort with 1,100 hotel beds, a casino, and a theater.  Longer term, the objective is for BCN World to have six resorts.  The first property is scheduled to open for business in 2016.  


WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.

Three for the Road


I really do think @KeithMcCullough has some inside info on how thousands of other traders trade. No way he can call $SPY the way he does w/o



"I am not remotely interested in just being good."

- Vince Lombardi


According to the latest data published by Amazon, sales of George Orwell's '1984' have spiked 3,100% over the past 24 hours, following fresh reports about the NSA's surveillance programs and the 29-year-old Booz Allen Hamilton employee, Edward Snowden, who leaked them. (The Atlantic)

Early Look

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Materials & Dial-In: ARE YOU SHORT CHINA [AND OTHER EMERGING MARKETS] YET? - shortchinadial 06.12.13


REMINDER: Today, June 12th at 11AM EDT, we will be hosting a flash call titled Are You Short China [and Other Emerging Markets] Yet? The call will include 25 minutes of prepared remarks and 10-15 minutes of live Q&A.




  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 663556#
  • Materials: CLICK HERE


The recent volatility across Global Macro markets has provided us with a strategic opportunity to expand upon our #EmergingOutflows theme. To that tune, the $5.5B in EM equity fund outflows per the most recent week of data was the largest weekly withdrawal since AUG '11!




Analyze the current set-up in China and other Emerging Markets and discuss the best opportunities on the short side.    



In accordance with the call, we will add Short CHIX (Global X China Financials ETF) to our Best Ideas list and discuss in detail why on the call. HINT: it's a play on policy tightening, rising NPL exposure and a pending property market inflection in China.


In addition to CHIX, we'll also add the following securities to our "Watch List" and will look to add them on the short side of our Best Ideas list on any meaningful bounce(s); we'll outline the bear case for each on the call as well:

  • Short: FRN (Guggenheim Frontier Markets ETF) - A high beta play on LatAm and African commodity producers (FX un-hedged)
  • Short: EMLC (Market Vectors Emerging Markets Local Currency Bond ETF) - A non-consensus way to play on our #StrongDollar theme
  • Short: EMB (iShares Emerging Markets USD Bond ETF) - A high beta way to express our view that duration risk is accelerating globally


If you would like more details about this call please email .

Illuminating The Past

This note was originally published at 8am on May 29, 2013 for Hedgeye subscribers.

“This story illuminates, as only great history can, not only the past but also the present.”

-Richard Holbrooke


That’s how the late Richard Holbrooke (1941-2010) ended his foreword to the latest macro strategy book I started reading this weekend – Paris 1919: Six Months That Changed The World, by Margaret Macmillan (winner of the Samuel Johnson Prize).


With the US launching its first drone attack on Pakistan since the US election, I am certain that the likes of Holbrooke (former United States Special Envoy to Afghanistan and Pakistan) could illuminate the history of this US engagement for us. Maybe his sons will tell his stories. Maybe they won’t. Someone always knows something in this world. History teaches us that the herd tends to get the truth on delay.


Markets teach us different versions of the truth. They also reflect upon history. Market prices build upon stories told. Whether those stories are fact or fiction is of less concern to me than what people will expect happens next. Holbrooke said his only regret about the 1919 Peace Conference story was that “it was not available a decade ago.” The book was published in 2003. The truth was now 86 years old.


Back to the Global Macro Grind


“What is the truth?” That’s the most important question to one of the best macro risk managers of our generation (Ray Dalio), so it’s definitely one of the most important ones to me. From a behavior economics perspective, I really care about the truth of expectations.


Is it true that rising US Treasury bond yields are a pro-growth signal? Is it true that rising yields (combined with a #StrongDollar) predicted the truth about both the 1982 and 1993 US economic growth recoveries? How do you know the truth if you haven’t studied history?


I started on Wall Street during an internship in 1997. The people have changed. But the game of expectations hasn’t. Some people try to game the game by front-running inside information. Apart from potentially going to jail and having history write about you as a cheater, what’s the downside in that? Inside information is, after all, the truth.


Then there’s the knucklehead hockey player approach to mapping expectations about the truth (I don’t like orange jump suit risk):

  1. First, have a quantitative process that signals what the truth about expectations are, across multiple-durations
  2. Then, overlay a multi-factor model of research that helps contextualize those market expectations (correlation and/or causality)
  3. And finally, either move – or choose to do nothing

With a multi-duration, multi-factor model contextualized by history in hand each morning, you can:

  1. Do nothing
  2. Do more of what you have been doing
  3. Unwind everything you were doing and do the opposite of that

Contextualizing yesterday’s newsy “breakout” in bond yields is a good working example of how people get whipped around:

  1. US Treasury yields have been breaking out on our TREND duration for almost 3 weeks (1.82% breakout signal)
  2. The causal factor in driving Treasury yields higher, faster, continues to be economic data (jobs, housing, confidence)
  3. Most who are clinging to getting inside info from Bernanke on when the Yield Chasing thing is over, are getting run-over

Again, as I wrote 3 weeks ago, Front-running The Fed is a legal and profitable business. All you have to do is have an accurate process that signals how wrong Bernanke’s forecasts on growth are going to be and then act accordingly. By the time he tells his boys and/or his boys tell their Washington “consultants” that he’s going to “taper”, Mr. Market will have already moved.

So, if you still think both Old Wall and Bernanke are too bearish on growth, how do you front-run the herd’s expectations changing?

  1. You don’t do nothing (especially if you are long Yield Chasing securities like Utilities, Treasuries, MLPs, etc.)
  2. You do more of what’s working – buy growth, which includes US Dollars, Consumer, Healthcare, and Financials

At a capitulation point (like yesterday) people who are still bearish on #GrowthSlowing (like we were until late November 2012) have to go with option #3 (unwind everything they were doing and do the opposite of that). That’s when you really get paid. #Flows!


When people said “sell in May and go away”, they must have meant selling the end of the world #GrowthSlowing trades and buying the living daylights out of #GrowthAccelerating. That’s not me pushing a progressive agenda; this is just the score May 2013 will record:

  1. Utilities (XLU) down -7.4% for May 2013 to-date
  2. Financials (XLF) up +6.6% for May 2013 to-date

That’s about as eye opening an equity sector level divergence (one the key risk factors in our multi-factor risk management model) as you will ever see on a 1-month duration. So is a +31% one-month rip (+52 basis points) in 10yr US Treasury yields in Bernanke’s face.


Unfortunately (for Bernanke’s legacy), I can’t tell you what history will tell you about all the unintended consequences associated with the US Federal Reserve and Bank of Japan seeing rates rip off of the zero-bound.


All I can tell you is that the present is already reflecting asymmetrically on the past – and May 2013 has been illuminating.


Our immediate-term Risk Range for Gold, Oil (Brent), Corn, US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1351-1404, $101.74-105.28, $6.36-6.71, $83.92-84.58, 101.23-103.67, 1.98-2.18%, 12.29-14.82, and 1644-1674, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Illuminating The Past - yy. the breakout


Illuminating The Past - Virtual Portfolio

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