Takeaway: Asian risk continues to rise while the U.S. looks to be on stabler footing vis-a-vis Friday's jobs report. #RatesRising
Asia continues to be a rising source of risk with both China and India showing growing pressure in their respective banking systems. Chinese banks posted another week of sharp increases in their default swaps. Here are Keith's morning comments on Asia:
CHINA – ugly start to the week for Asian Equities, led lower by Indonesia -3.2% and China -2.4% (Hang Seng -1.3%); Shanghai Comp = -11.7% YTD and every Asian country is bearish TREND @Hedgeye other than Japan right now (Nikkei TREND = 13,668)
Domestically, things looked somewhat better for everything outside of the Treasury and gold market. One of our primary risk gauges, junk bonds, finally took a breather last week, cooling off by a modest 4 bps to 6.58%. 30-Yr conforming mortgage rates, however, climbed higher by 24 bps on Friday alone to 4.64% (Bankrate National Daily Average).
Financial Risk Monitor Summary
• Short-term(WoW): Negative / 2 of 13 improved / 3 out of 13 worsened / 8 of 13 unchanged
• Intermediate-term(WoW): Negative / 2 of 13 improved / 7 out of 13 worsened / 4 of 13 unchanged
• Long-term(WoW): Positive / 4 of 13 improved / 1 out of 13 worsened / 8 of 13 unchanged
1. U.S. Financial CDS - Swaps tightened for 24 out of 27 domestic financial institutions. While there weren't many large moves, it is worth noting that Citi led the pack among the large caps with a 7 bps narrowing to 124 bps.
Tightened the most WoW: C, ALL, HIG
Widened the most WoW: UNM, COF, MMC
Widened the least/ tightened the most WoW: SLM, AON, MMC
Widened the most MoM: GS, MS, C
2. European Financial CDS - Bank swaps were narrowly tighter across Europe last week with negative divergences in Italy and Greece.
3. Asian Financial CDS - Chinese banks post another week of widening. All three major banks we track posted WoW increases of 15-17 bps.
4. Sovereign CDS – Sovereign swaps were mostly uneventful last week with two exceptions. Portugal widened by 73 bps to 474 bps, while Japan tightened by 5 bps to 73 bps. All other major markets were unchanged.
5. High Yield (YTM) Monitor – High Yield rates fell 4.1 bps last week, ending the week at 6.58% versus 6.62% the prior week.
6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 1.5 points last week, ending at 1784.86.
7. TED Spread Monitor – The TED spread fell 0.8 basis points last week, ending the week at 23.19 bps this week versus last week’s print of 24.01 bps.
8. Journal of Commerce Commodity Price Index – The JOC index rose 1.4 points, ending the week at -2.59 versus -4.0 the prior week.
9. Euribor-OIS Spread – The Euribor-OIS spread widened by 1 bps to 12 bps. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States. Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal. By contrast, the Euribor rate is the rate offered for unsecured interbank lending. Thus, the spread between the two isolates counterparty risk.
10. ECB Liquidity Recourse to the Deposit Facility – Deposits rose by 11.5 billion Euros last week. The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB. Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system. An increase in this metric shows that banks are borrowing from the ECB. In other words, the deposit facility measures one element of the ECB response to the crisis.
11. Markit MCDX Index Monitor – Last week spreads widened 2 bps, ending the week at 96 bps versus 94.3 bps the prior week. The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 16-V1.
12. Chinese Steel – Steel prices in China rose 1.4% last week, or 48 yuan/ton, to 3406 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.
13. 2-10 Spread – Last week the 2-10 spread widened to 234 bps, 14 bps wider than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.
14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 1.2% upside to TRADE resistance and 2.1% downside to TRADE support.
Joshua Steiner, CFA
Jonathan Casteleyn, CFA, CMT
This note was originally published at 8am on June 24, 2013 for Hedgeye subscribers.
“It was not the common people who were to blame for these failures…”
“Rather, it is the great ones among you who have committed these sins. If you had not committed great sins, God would not have sent a punishment like me upon you.”
Don’t worry, I’m not going to go all religious on you this morning. That’s just what Genghis Kahn told the elite of Bukhara after conquering their centrally planned city. “He then gave each rich man into the control of one of his Mongol warriors who would go with him and collect his treasure.” (Genghis Kahn and The Making of The Modern World, pg 7)
Maybe Bernanke and his central planning ideologues around the world should do a little summer reading on my man Genghis and reflect upon how plundering the purchasing power of free peoples ends…
Back to the Global Macro Grind…
And over the #Waterfall bonds go. No matter where you think we were last week, here we are – lots of Global Macro tourists who didn’t respect the VELOCITY + VOLUME of the water approaching our bifurcation point (2.41% = the dam) = soaking wet.
So, to start, Hedgeye Risk Management will, in #OldWall style, “reiterate” the following Global Macro positions:
- 0% asset allocation to Commodities
- 0% asset allocation to Fixed Income
- 0% asset allocation to Emerging Market Debt and Equity
As the US Treasury 10yr Yield rips through our critical intermediate-term breakout line of 2.41% to 2.60% this morning, everything starts to happen a lot faster. The aforementioned 0% asset allocations were already in motion. We affectionately called Commodities, Bonds, and Emerging Markets #BernankeBubbles for a reason. When they pop, there’s no more flow!
If you’ve ever tried suspending yourself in mid-air after living in a bubble that’s popped, it doesn’t end well. Neither does living a centrally planned life where everyone in a so called “free-market” is at the beck and call of an un-elected man named Bernanke.
That’s all history now. If you didn’t know that the anti-gravity “smoothing” experiment using the most debt leverage in world history has another side of the trade (deflating debt, commodities, emerging markets, etc.), now you know.
There are two big potential drivers of asset deflation:
- #StrongDollar (US Dollar Index) from her 40yr low (in 2011 when Commodities and Gold peaked)
- #RatesRising at an accelerating rate from the 0% bound
No, it’s not the common people who are to blame for deflation. It’s the conflicted and compromised politicians who have been cheered on by those who get paid by Commodity, Fixed Income, and Emerging Market inflations whose bar tab is up.
Deflation? If you inflate a bubble to its max, there will eventually be deflation. And, yes, there will be blood. Deflation is only a bad word if you are long the thing that is deflating.
But can our institutionalized world of short-term price performance chasing handle a stronger currency and rising interest rates? Can we handle this thing call a long-term cycle turning?
And what would more of the same do to our insecure world?
- #StrongDollar (+3.2% YTD) = #CommodityDeflation (CRB Index -5.7% YTD), so more of that would be cool #Consumption
- #RisingRates (+48% YTD move in UST 10yr Yield) = bad for anything bonds, and good for my hard earned Savings Account
- A massively asymmetric shift in the way we have all been paid to invest and allocate capital for the last decade
In chaos theory, we call a big macro cycle turning a Phase Transition. Leading towards this current point of entropy, there were a series of what we call Emergent Properties warning us of a pending phase transition.
Some investors get hurt during phase transitions; some prosper. I have a great deal of respect for Bill Gross and what he has built at @PIMCO, but if you read his last 3 tweets, you can get a sense of who doesn’t win if this keeps happening.
It’s time to start winning. The USA has never achieved what all these vaunted elites of economics peddle to you as the desired outcome of all this central planning (real inflation-adjusted economic growth) without a #StrongDollar and #RisingRates.
To be clear, there will be pain before we all prosper (that’s why we have been cutting our US Equity exposure for 3 weeks). In the early 1980s and the early 1990s, Great Failures in asset allocation became as readily evident as they are this morning:
- Emerging Markets (MSCI EM Index) = -5.6% last week and are now -14.7% YTD
- Latin America (LATAM EM Index) = -8.1% last week and is now -20.5% YTD
- Silver = -9.1% last week and is now -34.2% YTD
Whether it’s the commodity bubble or the emerging market debt bubble, it’s all the same thing. US Central planners committed the great sin of devaluing the hard earned currency of the American people – and now some have to pay the price for that. The punishment happens the faster rates rise. And I don’t think The People want to go back to the zero bound all over again.
Our immediate-term Risk Ranges are now (new format!):
UST 10yr Yield 2.41-2.61%
US Dollar Index 81.21-82.69
USD/YEN Yen 96.54-98.76
Oil (Brent) 100.23-103.73
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
“Idleness is the enemy of the soul.”
There were some major contradictions in Benedict of Nursia’s “rules.” Monks not being able to openly debate what they were being told to read was one of them. I started reading Stephen Greenblatt’s Pulitzer Prize Winner, The Swerve – How The World Became Modern, this weekend. That’s what has me thinking about that.
Benedictine Rule provided the foundations for western monasticism. “Let there be complete silence. No whispering, no speaking – only the reader’s voice should be heard there… no one should presume to ask a question about the reading or about anything else, lest occasion be given.” (The Swerve, pg 27)
Reading and writing makes me think. Thinking requires what Einstein called for – constant questioning of premise. Some people don’t question either Keynesian Economics or the US Federal Reserve’s policies whatsoever. Markets, on the other hand, take occasion to debate policy makers all of the time. They front-run the next decision that will be imposed on us from upon high.
Back to the Global Macro Grind…
From the holy heights of Chaos Theory the globally interconnected ecosystem gives us this thing called economic gravity. As US employment #GrowthAccelerating continues to surprise on the upside, expectations for Fed tapering get pulled forward.
Last week’s market pricing of gravitational-risk was as closely aligned with what has been happening for 6 months as any week in 2013. Here were the big week-over-week moves, bundled within our core Hedgeye Global Macro Themes:
- #StrongDollar – US Dollar Index +1.6% on the week; up for 3 weeks in a row, and +5.9% for 2013 YTD
- #RatesRising – UST 10yr Yield +25 basis points on the week to a fresh weekly closing YTD high of 2.74%
- #EmergingOutflows – MSCI Emerging Markets and Latam Equity indexes -2.4% and -4.3% on the week, respectively
Yes, our Macro call for the last 6 months still has some serious flow to it:
- Dollar Up = Commodities Down
- Commodities Down = Commodity Linked Emerging Markets Down
- Emerging Markets Down = Emerging Outflows Up
Follow the flow. All that moulah has to, eventually, flow somewhere; especially as money’s prior flows start going the other way (at an accelerating rate).
So, you can either be long US Dollars and US Consumption Equities on the following fundamentals:
- Employment #GrowthAccelerating
- #HousingsHammer ripping a +12.2% y/y gain in US Home Prices (wealth effect)
- Consumption #GrowthAccelerating from 1.0-1.2% to 2.0-2.4% in the last 6 months
And/or, you can being long US Dollars and US Consumption Equities because you can’t be long anything else!
Lots of clients are asking us what we’re going to do with Gold, Treasuries, and Emerging Markets from here. And our answer is more of the same. We update our dynamic asset allocation model daily. Here’s the latest on that:
- Commodities = 0%
- Fixed Income = 0%
- Int’l Equities = 0%
Zero percent is about as clear a statement as we can make. And while we’ve had 0% in Commodities and Fixed Income for some time now, I don’t think last week’s combination of #StrongDollar + #RatesRising gets us less confident in that positioning.
Why would it? In macro there is this thing called momentum that trumps valuation. When negative PRICE MOMENTUM meets VOLATILITY and OUTFLOWS (all at once), that’s uber bearish.
Having 0% asset allocation to International Equities is probably the position we’ll hold for the least amount of time. But, with Emerging Markets (MSCI EM) -13% and Latin American Equities (MSCI Index) -19.7% YTD, respectively, we’re in no rush.
For now, with both the Russell 2000 (IWM) and US Consumer Discretionary (XLY) US Equity market indexes hitting fresh all-time highs at +18.4% and +21.8%, respectively, occasion has been granted by the gods of our meritocracy to keep questioning consensus and reading more books.
Our immediate-term Risk Ranges are now:
UST 10yr 2.55-2.74%
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
Client Talking Points
What an ugly start to the week in Asia. Asian Equities were led lower by Indonesia which fell -3.2%. Meanwhile, China was down -2.4% and Hang Seng down -1.3%. Get this: the Shanghai Compositie is down -11.7% year-to-date. No, that's not pretty. With the exception of Japan, every single Asian country is bearish TREND right now. (Nikkei TREND = 13,668)
Yes, European stocks are having an aggressive bounce. However, this is happening on A) no volume and B) not one of these markets is above any of my TREND lines of resistance. The most important TREND line to watch is DAX 8062. That is key. Meanwhile, EUR/USD couldn’t care less about the Troika “news.”
What's the biggest threat to the US Consumption investment theme? That would be Brent Oil closing and holding above the long-term TAIL risk line of $108.36. We're backing off -0.6% this morning toward $107. That is a good thing. We are watching this one very closely.
|FIXED INCOME||0%||INTL CURRENCIES||28%|
Top Long Ideas
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.
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.
Health Care sector head Tom Tobin has identified a number of tailwinds in the near and longer term that act as tailwinds to the hospital industry, and HCA in particular. This includes: Utilization, Maternity Trends as well as Pent-Up Demand and Acuity. The demographic shift towards more health care – driven by a gradually improving economy, improving employment trends, and accelerating new household formation and births – is a meaningful Macro factor and likely to lead to improving revenue and volume trends moving forward. Near-term market mayhem should not hamper this trend, even if it means slightly higher borrowing costs for hospitals down the road.
Three for the Road
QUOTE OF THE DAY
"People who lose money always need someone to blame."
- Jim Chanos
STAT OF THE DAY
On this day (July 8) in 1932 – The Dow Jones Industrial Average reaches its lowest level of the Great Depression, closing at 41.22.
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