• It's Coming...

    Etf Pro

    Get the big financial market moves right, bullish or bearish with Hedgeye’s ETF Pro.

IN-DEPTH: #RATESRISING

Last week Hedgeye presented its Q3 2013 Macro Themes call for institutional clients, introducing the three major themes our Macro team has identified as significant drivers of investment strategy for the current quarter.

As a review, our Q2 Macro themes were:

  • #StrongDollar – The Dollar continues to reverse what has been a forty-year slide.  Renewed strength in the currency keeps pushing ahead despite Bernanke’s policy statements designed to weaken the Buck.
  • #GrowthAccelerating – Hedgeye has tracked significant growth in a number of key sectors, including declining unemployment, strength in the housing market, and an upturn in the birth rate, reversing a forty-year decline and leading to a boost in new household formation.
  • #EmergingOutflows – The BRICs are BROKEN, even “stable” countries like Turkey are in the grip of unrest.  The US is once again the safe haven.

The Macro View


Macro trends are sensitive to government policy.  When governments meddle in the financial markets, they compress natural market and economic cycles.  This causes volatility to spike – free money for short-term high-frequency traders (especially those who get economic news a few seconds early), and a trigger for waves of nausea for the individual investor.

But while high-frequency traders focus on specific economic numbers, scalping a few pennies on a short-term lift in Financial stocks when the Fed looks dovish, Hedgeye’s broad Macro work focuses on rates of change in the economy.  A public statement from Ben Bernanke may provide shot term profits for algorithmic traders, but it’s not a signpost to America’s economic future.  Nor is it anything the individual investor can rely on. 

Our analysis focuses on rates of change – we look at theslope of the line, the cumulative rate of change over time in key economic indicators.  If you track rates of change, you will see where the growth comes from – or fails to come from.  If you know where the growth is in the economy, you can position yourself to succeed as a long-term investor.

Hedgeye’s  Macro Themes for Q3 2013:

  • #RatesRising
  • #DebtDeflation
  • #AsianContagion

Our themes are simple.  The dollar has been strengthening.  Meanwhile housing, employment and consumption have all been surprising to the upside – not major blow-out numbers, but the slope of the line is definitely in the direction of Growth.  In this environment, Fed “tapering” is a pathetically weak dog wagged by a potent tail: interest rates are rising, the Dollar doesn’t want to go down, and growth has taken root in key areas of the economy.

Throughout the Middle Ages, the most educated people in Europe were convinced the sun rotated around the earth.  Today we chuckle derisively at how they could reject proofs from the likes of Copernicus and Galileo.  In the face of real signs of accelerating growth, Bernanke is behaving like the Defender of the Faith, as though he had the authority to direct gravity.  He needs to have his King Canute moment and publicly allow the sea to wash over him.  We’re convinced the waves are about to break.

Here we offer the first of our three Macro Themes, Rates Rising.  

#RatesRising


‘POP!’ goes the bubble as interest rates start to rise, reversing the most asymmetrical set of relationships on our Macro screen.  The gradual decline in rates that has prevailed for forty years is turning.  Like the Queen Mary, it turns ponderously – so slowly that at times you can’t tell it’s reversing course.  As the slope for interest rates turns up, so much that has been tied to declining rates will unravel.  Hedgeye continues to emphasize this on our bearish call on commodities.

Keith went out on a Macro limb and said we are not likely to see the 2012 lows on ten-year bond yields again.  Not soon, and maybe not ever.  With longer-term historical rates averaging over 6%, there’s more than four hundred basis points – over four full percentage points – for rates to reflate as the 40-year bonds bubble pops without entering the historical Danger Zone for inflation.  Hedgeye expects the bond bubble to melt over the coming 3-5 years.

What’s an Investor to Do?


Keith digs into the historical record and shows that rising interest rates are not the enemy of economic growth.  To the contrary, historically there is a high coincidence of rising bond yields during periods of high economic growth.  Mr. Bernanke’s fear mongering notwithstanding, there’s no reason to believe it has to be any different today.

In a growth environment, as characterized by rising 10-year bond yields and a strengthening Dollar, Consumer Discretionary and Financial stocks tend to perform well, along with Industrials and, to a lesser extent, Energy.  Yield plays – notably Utilities – are at a disadvantage, as increases in current yields are offset by declines in the price of the stocks.

But Growth isn’t Good News yet, as too many major investors have large portfolios based on declining rates – and short-term traders are enamored of the volatility created by Fed uncertainty.

To us, the problem continues to be political.  Wall Street boasts many of Washington’s biggest donors, money managers and bankers whose largesse in recent years has come from the built-in guaranteed profits of declining rates, as they repeatedly locked in the spread between 10-year Treasurys and 2-years.  Like the Fed, a lot of these folks hold an awful lot of fixed income paper – Treasurys, but also corporate, and even mortgages – all of which will decline in price as rates climb.  Unlike the Fed, they can’t print their own money to remain liquid.  Write-downs on these bond portfolios could get ugly.  Even if managed right, it won’t be easy to get out of billions of dollars’ worth of bonds without getting spanked.

So Bernanke keeps the myth alive, the sun continues to revolve around the earth, and the house of cards stands firm as the Inchcape Rock.  Until it doesn’t.  Meanwhile, volatility in your portfolio will likely be the order of the day.  That, and uncertainty about the future.

You weren’t planning on retiring any time soon…?