This note was originally published
at 8am on June 07, 2013 for Hedgeye subscribers.
“And when it rains on your parade, look up rather than down. Without the rain, there would be no rainbow.”
-Gilbert K. Chesterton
It is a rainy day in the Northeast. And rain can be depressing if we let it get to us. The point that Chesterton makes above though is spot on. Without the disruption of rain, there would ultimately be no rainbow and subsequently the hope of a pot of gold.
The idea that we have to suffer through bad times to get to good times is of course a bit of a paradox. To Chesterton, who is often referred to as the “prince of paradox” this was fine. After all, he was an orthodox Christian who had friendly enemies. (He was also 6’4, wore a cape, and carried around a swordstick in his hand.)
In mathematical terms, we would probably characterize this concept of bad weather becoming good as reversion to the mean. Due to mathematical impossibilities, no price goes up forever and no price goes down forever. In the same vein, rain doesn’t last forever and when it stops the weather is typically very nice. Unfortunately for those hoping for good weather, the forecast is for showers through Tuesday of next week. But as Longfellow said:
“The best thing one can do when it’s raining is to let it rain.”
For the last week or so, the U.S. equity market has been raining on our growth is accelerating parade. So is this a temporary rainy spell and will the sunshine of a positive economic growth return shortly? Well, we certainly still believe this to be the case.
We had a good email discussion with one of our subscribers yesterday who asked us about an assertion Keith made that employment is continuing to improve. The distinction between our view and the view of much of consensus is that we believe that seasonally adjusting the employment number distorts the data series. Unfortunately for us, the market continues to cue off the seasonally adjusted number and those appear to be stagnating.
The impact over the last four years is that the seasonal adjustments have created a tailwind from September to February and a headwind from March through August. This is highlighted in the first chart below. This “seasonally adjusted” slowdown in employment has also been a headwind for the equity market for the last few years. Nonetheless, even on a seasonally adjusted basis, as highlighted by the purple line in the first chart, employment is decelerating at a slower pace than in the prior four years.
More instructive though is the second chart below, which highlights rolling initial unemployment claims that are non-seasonally adjusted. The trend here is clear, which is that employment is improving and somewhat decisively so. To the extent that the market continues to focus on the seasonally adjusted series, though, we are likely to have a few more months of employment rain. On that front, the May employment report is at 830am, so be wary as we are in the season of employment rain!
We would be remiss if we didn’t touch on Asia this morning where the storm clouds are creating a down pour on the global macro markets. For those that chased Japan into its Abenomic highs, they are now quite literally having a mother of a time. Specifically, the MOTHERS index closed down -11.5% over night and is now down -38% from its highs. (This index holds smaller companies so is naturally more volatile.)
The driver of this mother of a correction in Japan was the strength in the Yen versus the dollar. From our purview, the break through the 99 barrier seemingly triggered a massive stop loss program and, as they say, when it rains, it pours. As a result, the Yen / Dollar went from 99 to 96 in a straight line yesterday. (Some have speculated that one catalyst may have been a leaking of today’s jobs number, but who are we to distrust the government . . .!)
As it relates to the Yen, which remains one of our Best Ideas on the short side, we still think that relative monetary policy will inform the direction of the currency. As my colleague Darius Dale emphasized yesterday in a note to subscribers, the BOJ is already committed to monetizing ¥132 trillion through EOY ’14 (27.7% of 2012 nominal GDP) vs. the Fed’s $2.04 trillion (13% of 2012 nominal GDP) over the same time period – assuming the Fed continues at the current pace of $85 billion per month through EOY ’14 (an unlikely scenario in our opinion). So despite yesterday’s correction in the Yen, we think the structural bear case remains.
One important highlight in the recent action in U.S. equities is that our risk range on the SP500 has widened to 1,607 – 1,669. This isn’t terribly surprising given that volatility, as measured by the VIX, is up about 30% in the last month. For those that actively hedge or trade their portfolio, all this really means is that you need a bigger umbrella in the short term! Or as the popular band Blind Melon sings, “No Rain.”
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1361-1424, $100.58-104.73, $81.34-82.46, 95.66-103.34, 2.02-2.22%, 13.37-17.91, and 1607-1669, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones