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MONDAY MORNING RISK MONITOR: U.S. LOOKS GOOD, PORTUGAL NOT SO MUCH

Takeaway: The risk genie remains in the bottle for now. Potential problem areas include Portuguese sovereign/bank swaps and Indian bank swaps.

Key Takeaways:

 

* U.S. Financial CDS -  Domestic financial swaps were notably tighter last week, with some of the largest improvements coming from the mortgage insurers (MTG: -21 bps, RDN: -20 bps) as well as AXP (-4 bps), MS (-7 bps) and GS (-4 bps). Both AGO and MBI saw swaps widen, adding to the trend we've seen M/M.  Overall, swaps tightened for 20 out of 27 domestic financial institutions.

 

* Sovereign CDS – Portuguese sovereign swaps should be monitored closely as they have risen 95 bps in the past month, to 533 bps. In the last week, Italian, Spanish and Portuguese sovereign swaps widened by 6, 2 and 22 bps, respectively. Meanwhile, French, Irish and Japanese swaps tightened 1, 3 and 3 bps, respectively. The US and Germany were unchanged. All the countries we track now have swaps higher on a M/M basis.

 

* Asian Financial CDS - Indian banks finally cool off. We've been flagging the rising risk in the Indian banking system for several weeks now. This past week, Indian banks finally saw their swaps decline, albeit nominally relative to the magnitude of increase over the intermediate term. Swaps were also notably tighter in China with two out of three banks seeing their swaps decline by more than 10 bps. Japanese financials were largely unchanged on the week. 

 

 

Financial Risk Monitor Summary

 • Short-term(WoW): Positive / 4 of 13 improved / 1 out of 13 worsened / 8 of 13 unchanged

 • Intermediate-term(WoW): Negative / 5 of 13 improved / 5 out of 13 worsened / 3 of 13 unchanged

 • Long-term(WoW): Negative / 3 of 13 improved / 3 out of 13 worsened / 7 of 13 unchanged

 

MONDAY MORNING RISK MONITOR: U.S. LOOKS GOOD, PORTUGAL NOT SO MUCH - 15

 

1. U.S. Financial CDS -  Domestic financial swaps were notably tighter last week, with some of the largest improvements coming from the mortgage insurers (MTG: -21 bps, RDN: -20 bps) as well as AXP (-4 bps), MS (-7 bps) and GS (-4 bps). Both AGO and MBI saw swaps widen, adding to the trend we've seen M/M.  Swaps tightened for 20 out of 27 domestic financial institutions.

 

Tightened the most WoW: AXP, RDN, MS

Widened the most WoW: MBI, AGO, ACE

Tightened the most WoW: AXP, RDN, MET

Widened the most MoM: MBI, JPM, AGO

 

MONDAY MORNING RISK MONITOR: U.S. LOOKS GOOD, PORTUGAL NOT SO MUCH - 1

 

2. European Financial CDS - European bank swaps were broadly tighter again last week, declining by an average and median of 5 bps. One of the few outliers was Banco Espirito Santo of Portugal where swaps rose 10 bps W/W and are up 69 bps M/M, currently at 569 bps. This reflects the overall deterioration in the Portuguese sovereign market. 

 

MONDAY MORNING RISK MONITOR: U.S. LOOKS GOOD, PORTUGAL NOT SO MUCH - 2

 

3. Asian Financial CDS - Indian banks finally cool off. We've been flagging the rising risk in the Indian banking system for several weeks now. This past week, Indian banks finally saw their swaps decline, albeit nominally relative to the magnitude of increase over the intermediate term. Swaps were also notably tighter in China with two out of three banks seeing their swaps decline by more than 10 bps. Japanese financials were largely unchanged on the week. 

 

MONDAY MORNING RISK MONITOR: U.S. LOOKS GOOD, PORTUGAL NOT SO MUCH - 17

 

4. Sovereign CDS – Portuguese sovereign swaps should be monitored closely as they have risen 95 bps in the past month, to 533 bps. In the last week, Italian, Spanish and Portuguese sovereign swaps widened by 6, 2 and 22 bps, respectively. Meanwhile, French, Irish and Japanese swaps tightened 1, 3 and 3 bps, respectively. The US and Germany were unchanged. All the countries we track now have swaps higher on a M/M basis.

 

MONDAY MORNING RISK MONITOR: U.S. LOOKS GOOD, PORTUGAL NOT SO MUCH - 18

 

MONDAY MORNING RISK MONITOR: U.S. LOOKS GOOD, PORTUGAL NOT SO MUCH - 3

 

MONDAY MORNING RISK MONITOR: U.S. LOOKS GOOD, PORTUGAL NOT SO MUCH - 4

 

5. High Yield (YTM) Monitor – High Yield rates rose 8.7 bps last week, ending the week at 6.57% versus 6.48% the prior week.

 

MONDAY MORNING RISK MONITOR: U.S. LOOKS GOOD, PORTUGAL NOT SO MUCH - 5

 

6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 2.0 points last week, ending at 1804.

 

MONDAY MORNING RISK MONITOR: U.S. LOOKS GOOD, PORTUGAL NOT SO MUCH - 6

 

7. TED Spread Monitor – The TED spread rose 0.2 basis points last week, ending the week at 23.8 bps this week versus last week’s print of 23.65 bps.

 

MONDAY MORNING RISK MONITOR: U.S. LOOKS GOOD, PORTUGAL NOT SO MUCH - 7

 

8. CRB Commodity Price Index – The CRB index fell -0.8%, ending the week at 293 versus 296 the prior week. As compared with the prior month, commodity prices have increased 3.5% We generally regard changes in commodity prices on the margin as having meaningful consumption implications.

 

MONDAY MORNING RISK MONITOR: U.S. LOOKS GOOD, PORTUGAL NOT SO MUCH - 8

 

9. Euribor-OIS Spread – The Euribor-OIS spread was unchanged last week at 13 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. 

 

MONDAY MORNING RISK MONITOR: U.S. LOOKS GOOD, PORTUGAL NOT SO MUCH - 9

 

10. Chinese Interbank Rate (Shifon Index) –  The Shifon Index fell 14 basis points last week, ending the week at 2.89% versus last week’s print of 3.03%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.

 

MONDAY MORNING RISK MONITOR: U.S. LOOKS GOOD, PORTUGAL NOT SO MUCH - 10

 

11. Markit MCDX Index Monitor – Last week spreads widened 2 bps, ending the week at 104 bps versus 106 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.

 

MONDAY MORNING RISK MONITOR: U.S. LOOKS GOOD, PORTUGAL NOT SO MUCH - 11

 

12. Chinese Steel – Steel prices in China fell 0.1% last week, or 4 yuan/ton, to 3594 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.

 

MONDAY MORNING RISK MONITOR: U.S. LOOKS GOOD, PORTUGAL NOT SO MUCH - 12

 

13. 2-10 Spread – Last week the 2-10 spread widened to 248 bps, 9 bps wider than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.

 

MONDAY MORNING RISK MONITOR: U.S. LOOKS GOOD, PORTUGAL NOT SO MUCH - 13

 

14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 1.0% upside to TRADE resistance and 0.8% downside to TRADE support.

 

MONDAY MORNING RISK MONITOR: U.S. LOOKS GOOD, PORTUGAL NOT SO MUCH - 14

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 


Asian Markets Strengthen

Client Talking Points

China Calling

China’s economy finally flexes some muscle, with exports up 7.2% and inflation benign at 2.6% year-on-year. That was good enough to drive the Shanghai Composite 3.4% higher, crossing our TREND line of resistance of 2123.

Japan’s Economy Grows. Really.

Japan reports that GDP rose 3.8% in the most recent quarter, and the market loves chasing sequential growth. The Nikkei rose 2.5% for the sessions, and is already up 6% in September. This must be a bear market.

Gold Bulls Are Still Out There

Gold prices are down this morning, following a 0.5% down week where the net long position in futures/options contracts hit its highest level since January. That’s a great contra-indicator, and we still don’t like Gold though lots of others do.

Asset Allocation

CASH 26% US EQUITIES 26%
INTL EQUITIES 23% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 25%

Top Long Ideas

Company Ticker Sector Duration
WWW

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.

HCA

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.

TROW

Financials sector senior analyst Jonathan Casteleyn continues to carry T. Rowe Price as his highest-conviction long call, based on the long-range reallocation out of bonds with investors continuing to move into stocks.  T Rowe is one of the fastest growing equity asset managers and has consistently had the best performing stock funds over the past ten years.

Three for the Road

TWEET OF THE DAY

“I have never witnessed more whining about markets in my life”

--@KeithMcCullough

QUOTE OF THE DAY

“The secret of life is honesty and fair dealing. If you can fake that, you’ve got it made.” – Groucho Marx

STAT OF THE DAY

3, The number of NFL games Sunday where the first score in the game was a safety.


Information Surprise

This note was originally published at 8am on August 26, 2013 for Hedgeye subscribers.

“Information itself is best defined as surprise.”

-George Gilder

 

The first four chapters of George Gilder’s Knowledge and Power are right up my alley: “The Signal In The Noise”, “The Science of Information”, “Entropy Economics” – yes, someone else is talking “entropy” in the same sentence as markets! #beauty

 

On #OldWall, Gilder nails it: “The war between the centrifuge of knowledge and the centripetal pull of power remains the prime conflict in all economics.” And on risk management: “It is an economics of surprise that distributes power as it extends knowledge.” (page 5)

 

Think that through. In our profession, new information is surprise. If it wasn’t, why did so many risk going to jail? There is no easier way to generate returns than having inside information. Perversely, the road less travelled is the legal one. That’s why the 2.0 processes are taking mind share. We win and lose in an open forum of transparent information flow. We thrive by Embracing Uncertainty.

 

Back to the Global Macro Grind

 

If many pieces of information aren’t surprising you throughout your risk management day, you probably don’t have enough factors in your model. Price is surprise. So is data. Information surprise is everywhere.

 

So how do you absorb it all and remain sober? The answer is it’s a grind. Multiple-factors, multiple-durations – the market waits for no one. Being proactively prepared to contextualize the most immediate-term of surprises is only the beginning.

 

Bucketing the big stuff into intermediate-term TREND macro themes helps, provided that your process is flexible enough to acknowledge that TRENDs can change. But what is change? In Chaos Theory speak, can a major macro phase transition be undone?

 

Of course, in the intermediate-term, everything and anything can be undone – this is the fulcrum principle of central planning! In the long-run, gravity takes hold of anti-dog-eat-dog-cycle-smoothing though. So you want to be on the lookout for that!

 

There is a massive phase transition that is being baked into market expectations right now. The causal driver of that expectation shift is whether or not the US Federal Reserve is done with its anti-gravity policy to devalue the US Dollar and monetize the USA’s debt.

 

The main regime changes in a #RatesRising environment (versus one discounting 0% rates in perpetuity) are as follows: 

  1. Growth (as an investing style) outperforms slow-growth Yield Chasing
  2. Strong Currency countries outperform Currency Crisis countries 

That’s basically what happened again last week:

  1. Nasdaq and Russell2000 (growth indices) were +1.5% and +1.4%, respectively
  2. US Consumer Staples Stocks (XLP) were -0.2% on the wk (-2.85% for the AUG to-date)
  3. Asian (ex-Japan) Equities were -3.3% (down -8% for the YTD)

Parts 1 and 2 of that are pretty straightforward – unlevered US domestic innovation (growth stocks) are absolutely ripping this year versus a basket of pretty much anything slow-growth. That’s not new as of last week either. That’s been the TREND since June.

 

In June, #RatesRising ripped a massive amount of entropy into markets. Most people get that by now. What less people have realized is how powerful a combination A) #RatesRising  and B) #StrongDollar can be versus Emerging Markets (both equity and debt).

 

USD didn’t go down for the 2nd week in a row last week, here’s how that new information flowed to Indonesia, Chile, etc.:

  1. Emerging Markets (MSCI Index) = -2.6% on the wk to -11.6% YTD
  2. Emerging Markets Latin American Index (MSCI) = -1.5% on the wk to -17.2% YTD

Now, to be fair to the Chileans, they are also right levered to another major macro risk factor that comes into play during #StrongDollar and #RatesRising regimes – we call it #CommodityDeflation (the CRB Commodities Index = -0.6% last wk = -1.4% YTD).

 

Since #StrongDollar was more of a 1st six months of 2013 story doesn’t mean that the #CommodityDeflation risk ceases to exist (Coffee prices were -5.3% last wk to -25.2% YTD). Again, looking at the YTD scoreboard:

  1. Peru (metals/mining represents over 1/3 of the index) is the worst country in Global Equities at -19% YTD
  2. Chile and Brazil (both resource heavy indices) are 3rd and 4th worst in the world at -15% and -14% YTD, respectively
  3. Gold: despite its +4.5% month-over-month bounce off the lows, it is still -17.2% YTD

Ostensibly, there is new immediate-term TRADE information here to consider. If the US Dollar continues to weaken like it has from its July 2013 YTD highs, why can’t commodities and their related country stock market indices continue to re-flate?

 

Alternatively, the USD could be doing more of the same (building a gigantic base of higher-40yr-lows that were caused by the US cutting rates to zero), and this bullish Consumption (Growth) vs. bearish Commodities (Absolute Return Yield Chasing) theme remains intact.

 

The beauty of modeling macro the way that we do is that we don’t have to be certain about any of the answers to these questions. We simply have to absorb all of the information surprises we receive within the context of multiple durations, factors, and cycles – and make the highest probability call we can from there.

 

Our immediate-term Macro Risk Ranges are now as follows:

 

UST 10yr Yield 2.72-2.95%

SPX 1642-1671

VIX 12.17-14.98

USD 80.89-81.76

Euro 1.32-1.34

Gold 1337-1406

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Information Surprise - chart

Information Surprise - positions


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September 9, 2013

September 9, 2013 - dtr

 

BULLISH TRENDS

September 9, 2013 - 10yr

September 9, 2013 - spx

September 9, 2013 - nik

September 9, 2013 - dax

September 9, 2013 - dxy

September 9, 2013 - oil

 

BEARISH TRENDS

September 9, 2013 - VIX

September 9, 2013 - yen

September 9, 2013 - natgas

September 9, 2013 - gold
September 9, 2013 - copper

 



Congress, Save Us!

“For God’s sake declare the colonies independent at once, and save us from ruin.”

-John Page

 

That’s what Page said to Thomas Jefferson in the Spring of 1776. By September (on this day in fact), the Continental Congress officially named its union of independent states, the Unites States.

 

And the rest is history (sort of). We’re a long way from Patrick Henry’s “give me liberty, or give me death” speech from Virginia (March of 1775).  At this point, Congress is the butt of most jokes. But in these Unites States, anything can happen – there’s always a chance!

 

Imagine Congress saves us from seeing $6 at the pump? My simpleton read-through of Obama’s QA from St Petersburg last week is that he’ll respect Congress’ wishes if he can’t sell action in Syria. A no-action vote could save the American Consumer from ruin.

 

Back to the Global Macro Grind

 

There is no greater threat to this country than empowering both the almighty petro-dollar and/or the conflicted and compromised overlords who get paid by it. One of the most misunderstood realities of the 2008 crisis was $150 oil. Never forget that.

 

Since they are now front-running Obama with weapons of manic media, do you think Putin or Assad (or any of these whack jobs in Latin America or the Middle East) would stand a chance if the President of the United States started pulverizing them with a Weapon of Mass Currency Appreciation?

 

Both Reagan and Clinton seemed a lot stronger versus the Ruskies than Bush or Obama have been. Have you ever thought to yourself whether or not $20 oil had anything to do with that? How about the +4% US GDP growth rips of 1983-89 and 1993-99? Both were #StrongDollar, Strong America periods for both our Presidents and people.

 

“Our” – I keep saying our – and I am Canadian! For God’s sake Americans, stand up to this.

 

While both the US Dollar and US stock market seem to be sniffing out a no-action vote on Syria, they haven’t gone after the price of oil, yet. Check out last week’s most speculative lines on Middle Eastern conflict (commodities):

  1. Crude Oil’s net long position (futures and options contracts) just off its all-time high to +386,982 contracts
  2. Gold’s net long position was up another +3.6% w/w to +101,396 contracts = highest since January

That’s right Sons of Washington, when Wall Street wants to roll the bones on geo-political risk, they opt for the asset class with the highest beta, and then lever up those bets with options contracts. That’s why they’re great contra-indicators as they peak.

 

Gold peaked when speculation peaked that the USA would use the only other weapon of mass currency destruction that’s more dangerous than the Taliban – The Federal Reserve’s Dollar Debauchery campaign.  That was 2011-2012.

 

So when will oil peak? (*hint, it already did in 2008)

 

If we don’t do Syria, oil prices have plenty of intermediate-term downside – and, as a result, the US Consumer has plenty of intermediate-term upside.

 

Across our core risk management durations, here are the lines of support for WTI and Brent Oil that matter to me most:

  1. BRENT: immediate-term TRADE resistance = $117.98; intermediate-term TREND support = $108.35
  2. WTI: immediate-term TRADE resistance = $110.86; intermediate-term TREND support = $102.89

In other words, the opportunity for Obama here is to back off Syria and give Americans a 7-8% back-to-school tax cut (to TREND support) at the pump.

 

God forbid he drives a #StrongDollar move above and beyond a no-action call on Syria (i.e. hires Summers to taper and tighten). Oil prices could crash.

 

That’s what I’m talking about! Oh yeah – a little more red, white, and blue pin action for the only community of investors who are killing it in 2013 YTD – Growth Investors.

 

Last week’s Hedgeye Risk Management Style Factors were screaming growth:

  1. Top 25% (SP500 Quartile data) EPS Growers = +24% YTD (vs +15.5% YTD for the bottom 25% quartile)
  2. Low Yield (i.e. higher growth) Stocks = +26.4% YTD (vs +11.0% for High Dividend Yielding stocks)
  3. Consumer Discretionary (XLY) = +1.7% SEP and +23.6% YTD vs Utilities (XLU) -0.9% SEP and +5.9% YTD

“Screaming” – yes, Patrick Henry style - keep screaming at the government to strengthen the Dollar. That includes cutting defense spending from the all-time USA high Obama established in 2011.

 

Never, ever, forget that the government of these United States works for you – not the other way around.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.83-3.01%

SPX 1

VIX 15.07-17.49

USD 82.02-82.91

Brent 114.66-117.89

Gold 1

 

Best of luck out there this week,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Congress, Save Us! - Chart of the Day

 

Congress, Save Us! - Virtual Portfolio


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