“To achieve an extraordinary result you must choose what matters most and give it all the time it demands. This requires getting extremely out of balance in relation to all other work issues, with only infrequent counterbalancing to address them.”
-Gary Keller, “The One Thing”
Yesterday, I presented to the global finance team of a Fortune 100 company. Don’t worry, they weren’t paying us and we don’t do research on the company. In fact, the presentation came at the request of a friend who is the number two person in their finance department. He wanted to provide his direct reports some insights into how Wall Street research works.
The presenter that went before me was a former bulge bracket analyst covering their company. He was a thoughtful guy and talked about the importance of setting guidance that could consistently be beat. His view was that that investors don’t like to be surprised, and in part of course he is right. The perception of predictable returns gives comfort to investors that don’t really do the work (think LINN energy).
He went on to talk about the fact that sell side analysts compete for commissions to get paid and try to make a lot of noise so as to garner “II votes”. This description of traditional sell side analysts obviously gave me the opening to discuss how our model is different. As I explained to the group, we get paid for two reasons: a) two have investment ideas that work and b) to make our clients think.
If we are not succeeding at those two objectives, then our business likely would not be sustainable as we have no asset management, trading, investment banking, or prop desk to cover the overhead. In his recent book, Gary Keller calls this pursuing the One Thing and explains that the pursuit of this One Thing will ultimately determine your personal or professional success. Hedgeye’s One Thing is research, what is yours?
Back to the global macro grind . . .
Every quarter we try to boil down the global macro markets to three key themes. But in the spirit of this note, I’m going to distill this down to One key theme: #RatesRising. Especially in light of the Wall Street Journal headline that emerging market growth is trailing the developed world, and thus indicative of our view of slowing emerging market growth being reflected in consensus, it seems likely that the direction of interest rates are likely to be the One Thing (as always subject to change as the facts change). But consider the following:
1. The Queen Mary of macro trends has inflected– We often use the analogy of the Queen Mary turning to describe the long term trend in interest rates. The Queen Mary, of course, is the massive ocean super liner that dominated transatlantic voyage before the jet age. Like any vehicle that is more than 300 meters in length, turning the Queen Mary was no easy task and not without its implications.
This analogy is appropriate for interest rates as they have literally been in decline for the last 30 years since peaking in the early 1980s. This long term decline has enabled any business that depends on borrowing money to fund its business to have a steadily declining cost of capital. In addition, this has made bonds a compelling asset class with a long term underlying bid to price.
In our models in Q2, yields inflected notably and broke out above our TRADE, TREND and TAIL levels. In fact, as shown in the Chart of the Day, 10-year yields had their largest percentage increase quarter-over-quarter in more than a decade. Even though 10-year yields have broken out, they remain well below the mean yield since 1989 of 5.21%.
2. The market is chalk full of debt – Given the generational trend in interest rates going lower and thus providing a tail wind for bonds, it should be no surprise that investors’ portfolios are chalk full of fixed income. According to the most recent data, there is $38 trillion of bonds outstanding across all subsectors of the bond market. Further, bonds outstanding have increased every single year since 1990.
The more critical data point from an asset flow perspective is that the notional value of bonds outstanding is currently at 68/32 versus the market capitalization of equities. This, too, is an extreme ratio based on history and is literally the highest we’ve seen. For comparative purposes, this ratio was at 50/50 as recently as 1999.
3. Volatility and duration across the bond market are in a set up that could lead to meaningful losses – As volatility in an asset class increases, so too does the expected loss and/or return. According to Merrill Lynch’s MOVE index, bond volatility has almost doubled in the last quarter and is at two year highs. Meanwhile duration is at close to all-time highs. My colleague Jonathan Casteleyn of our financials team highlighted this in his recent presentation on asset managers (ping if you haven’t seen it yet), but based on current duration a roughly 100 basis point move in yields equates to a 8.9% loss on the 10-year treasury.
In part we are already starting to see the sort of generational losses in bonds that we should expect from the dynamics outlined above. Specifically, the Barclay’s Aggregate Bond Index is set for its first loss in 14-years and only third loss since 1990. While gentleman may prefer bonds, they don’t prefer losses.
The reality in markets is that there is rarely One Thing that dominates, but the seismic shift in interest rates will certainly be one of the most critical factors over the coming quarters and years. As money flows from the bond market to avoid losses, equities will be awaiting with open arms.
Our immediate-term Risk Ranges are now as follows:
UST 10yr 2.57-2.74%
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
This note was originally published at 8am on July 30, 2013 for Hedgeye subscribers.
“There are lies, damned lies and statistics."
I’ve been spending the last few weeks reading up on advanced statistical analysis of hockey. Based on my initial research, hockey is very much behind the other major sports in the use of statistics to analyze and value players. Much of professional hockey is still ruled by the old boys club who make player acquisitions based on “gut feel”.
To be fair, hockey is a difficult sport to analyze, unlike baseball which has repeatable interactions, such as at bats, that can be counted, hockey is more of a chaotic game. I asked my good friend Theo Epstein from the Chicago Cubs, an early and successful user of Sabermetrics in baseball, about his thoughts related to the analysis of hockey. He directed me towards what he called a plus / minus on steroids – Corsi.
This statistic was developed by former Buffalo Sabres goaltending coach and measures, or counts, the number of shot attempts on the opposition’s net (including blocked and missed shots) for which the player receives a plus and subtracts it versus the number of shots on his own net. The theory is that shots are a proxy for possession and over the long run possession leads to goals and a positive goal differential to wins.
This stat can then be adjusted according to the relative quality of competition via a statistic called Corsi Rel QoC, which attempts to normalize Corsi for the quality of opponent. There are also addendums to this stat that look at where a player typically starts on the ice. For instance, if a player, due to his defensive proficiency is more often started by the coach in face-offs in his own zone, he is likely to have a lower Corsi rating. So, this too needs to be normalized over time and relative to other players.
But enough about hockey statistics and back to the global macro grind . . .
Yesterday the newest member of our Financials Team, Jonathan Casteleyn, launched on asset management coverage in a very thoughtful 90+ page presentation titled, “Fixing Your Income: The Danger of the Bond Market.” Akin to all of Hedgeye’s research, this launch presentation was replete with statistics (and hopefully very few damned lies!) From the macro perspective, Casteleyn raised a number of key points that I wanted to re-emphasize.
First, the U.S. bond market has $38 trillion outstanding across munis, treasuries, mortgages, corporate debt, agency debt, money markets and asset backed. This is up more than 15% over the last five years and has been dually driven by the increase in corporate bonds, up 50% in that period, and treasuries, which are up roughly 100% in five years. The ratio of stocks to bonds is now at 68/32%, which is one of the highest ratios we’ve ever seen. Reversion to the mean anyone?
Second, 10-year treasury duration is literally at an all-time high of 8.9. The implication of this is that a 100 basis point move in the 10-year equates to an 8.9% loss in value. In other words, interest rate risk is literally as high as it has ever been, so any further normalization of rates (remember we remain well below historical levels) has the potential to lead to substantial losses in the bond market. Given this, broker dealers are reducing trading exposure to interest rate products, which has the potential of exacerbating moves in the fixed income market. As we highlight in the Chart of the Day, this is already leading to accelerating bond volatility (or as Taleb would say, more fragility).
Finally, Casteleyn corroborated our macro team’s bullish view of U.S. equities on likelihood of reversion to the mean on asset flows, as alluded to above. He also pointed out that current all in yield of the SP500 is 6% (2.0% dividend yield plus 4.1% earnings yield), which compares favorably to the 2.5% yield-to-maturity on 10-year treasuries. So not only do you get a better yield on equities, but equities typically outperform when the first hike in rates occurs.
That was a Cliff’s Notes version, at best, of the presentation yesterday, but if you have institutional research access please email firstname.lastname@example.org to receive a copy. This idea of continued and sustained outflows from fixed income is in the early innings and may have profound implications for asset returns in the coming quarters and years.
Speaking of interest rate volatility, the FOMC’s 2-day meeting begins today with a rate decision, or lack thereof, scheduled for Wednesday. This is to be followed by the ECB on Thursday. We actually would be lying, or at least have inside information, if we attempted to make a call on what either the ECB or Fed will say, but we can say this with some certainty, the potential for them to create market volatility is a real risk, so keep these events front and center on your risk management monitor this week.
Our immediate-term Risk Ranges are now as follows:
UST 10yr Yield 2.47-2.66%
I’ll sign off with one of my very favorite statistics quotes from George Bernard Shaw:
“Statistics show that of those that contract the habit of eating, very few survive.”
Stats don’t lie, my friends.
Keep your head up and stick on the ice,
Daryl G. Jones
Risk Managed Long Term Investing for Pros
Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.
THE MACAU METRO MONITOR, AUGUST 13, 2013
REVAMP FOR SJM GAMING CONTRACT; KEEPS HARBOUR DREDGING Macau Business
SJM will have its gaming concession revised but the company will still be in charge of dredging the harbour and get the associated tax break, worth about MOP806 million (US$100 million) last year. Secretary Tam will review the contract’s provisions on dredging and the location of SJM’s casinos.
Dredging work will be transferred to SJM from parent company Sociedade de Turismo e Diversões de Macau SA, director Ambrose So said. The Gaming Inspection and Coordination Bureau said SJM would keep its tax break: a discount of 1% point on the urban development, tourism promotion and social security levy, now 2.4% of gross gaming revenue.
TODAY’S S&P 500 SET-UP – August 13, 2013
As we look at today's setup for the S&P 500, the range is 34 points or 0.56% downside to 1680 and 1.45% upside to 1714.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 2.35 from 2.32
- VIX closed at 12.81 1 day percent change of -4.47%
MACRO DATA POINTS (Bloomberg Estimates):
- 7:30am: NFIB Small Bus. Optim, July, est. 94.5 (prior 93.5)
- 7:45am: ICSC retail sales
- 8:30am: Import Price Index, July, est. 0.8% (prior -0.2%)
- 8:30am: Retail Sales Advance M/m, July, est. 0.3% (pr 0.4%)
- 8:30am: Retail Sales Ex-Auto M/m, July, est. 0.4% (pr 0.0%)
- 8:55am: Redbook weekly retail sales
- 10am: Business Inventories, June, est. 0.2% (prior 0.1%)
- 11am: Fed to purchase $1b-$1.5b TIPS in 2018-2043 sector
- 11:30am: U.S. to sell 4W bills, 21-day cash mgmt bills
- 12:45pm: Fed’s Lockhart speaks on economy in Atlanta
- 4:30pm: API crude, oil product inventories
- U.S. Senate primary elections in N.J.; Newark Mayor Cory Booker is considered leading candidate
- American Institute of Certified Public Accountants holds National Governmental Accounting and Auditing Update, w/ remarks from GAO Director Jim Dalkin, 9:05am
WHAT TO WATCH:
- Apple said to ready thinner iPad model for release this yr
- Soros said to support J.C. Penney CEO in Ackman feud
- Goldman subpoenaed by CFTC on waits at aluminum warehouses
- Facebook to buy Mobile Tech for speech recognition
- London Whale resurfaces to help U.S. with JPMorgan trading probe
- Blackstone said to purchase GE U.S. apartments for $2.7b
- U.S. watchdog to propose greater disclosure in auditor reports
- Sina 3Q rev. view, 2Q adj. EPS, 2Q non-GAAP rev. beat ests.
- German Aug. ZEW current situation, expectations beat ests.
- U.K. inflation slows from 14-mo. high on airfares, clothes
- Li & Fung profit misses ests. on weaker U.S. retail demand
- Amazon, Microsoft may be interested in buying Blackberry: NYPost
- Argonaut Gold (AR CN) 7:30am, $0.08
- Brocade Communications Systems (BRCD) 4:04pm, $0.12
- Cree (CREE) 4pm, $0.38
- CST Brands (CST) Bef-mkt, $0.65
- Flowers Foods (FLO) 6:30am, $0.23
- Jack Henry & Associates (JKHY) 4:05pm, $0.51
- JDS Uniphase (JDSU) 4:05pm, $0.13
- Millennial Media (MM) 4:01pm, ($0.01)
- Myriad Genetics (MYGN) 4:05pm, $0.44
- SeaWorld Entertainment (SEAS) 4:01pm, $0.41
- Taylor Morrison Home (TMHC) 4:01pm, $0.32
- Valspar (VAL) 7:30am, $1.09
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Soybeans Extend Biggest Gain in 13 Months on U.S. Crop Outlook
- Iron Ore Gluts Seen Through 2017 on Record Supply: Commodities
- U.S. Regulator Subpoenas Banks Over Long Queues at Warehouses
- WTI Rises a Second Day on U.S. Supply Forecast, Mideast Unrest
- Copper Heads for Highest Close Since June Amid Rebound Signals
- Gold Trades Below Highest Price in Almost 3 Weeks; Silver Gains
- Sugar Rises to Six-Week High on Brazil Cold Scare; Cocoa Falls
- India Increases Gold Tax for Third Time This Year to Cut Deficit
- Freeport’s Grasberg Mine May Reach Full Production by Month-End
- Crude Supply Falls Sixth Week in Seven in Survey: Energy Markets
- North Dakota Oil Boom Seen Adding Costs to Ease Rail Safety Risk
- Freeport Expects Grasberg Reach Full Output Capacity End of Aug.
- India May Import More Iran Oil Within UN Rules, Chidambaram Says
- China Copper Production Plummets, Imports Increase: BI Chart
The Hedgeye Macro Team
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