“It has exerted its pull on the West for a thousand years.”
That’s what Scott Anderson called the “lure of the East” in a fascinating new book I just started studying about the history of the Middle East called Lawrence in Arabia (2013).
“That lure brought wave after wave of Christian Crusaders to the Near East over a three-hundred year span in the Middle Ages. More recently, it brought a conquering French general with pharaonic fantasies named Napoleon… Europe’s greatest archaeologists in the 1830s… hordes of Western oil barons… and con men to the shores of the Caspian Sea in the 1870s.” (pg 15)
While 1,000 years is a long time, the lure of central planners clipping coins and/or devaluing the currency of The People has been in motion for at least 2x that. “In 64 A.D., in a naïve attempt to deceive the populace, Nero decreased the silver content in the coins and made silver and gold coins slightly smaller” (The History of Money, pg 52). Bernanke hopes no one has read that history.
Back to the Global Macro Grind…
What is it, precisely, that gave both the Roman and Ottoman Empires the audacity to plunder the purchasing power of their people? After 200 years of operating as an independent bank, what made the British Empire so soft that it felt it had to socialize (nationalize) the Bank of England in 1946? What was the US “Free-Market” Empire and why have we empowered the Fed to change it?
My apologies in advance for thinking this morning. If you disregard the vacuum of history in which Bernanke thinks (1930s) and contextualize the moment that his Fed is in (within the construct of long-term history which will ultimately judge Bernanke when he is long gone), it’s getting scary again. But you already know that – and the sad thing is that some of his Fed heads do too.
Yesterday, Dallas Fed Head (Fisher) basically admitted two things:
- The current White House Administration has politicized the US Federal Reserve
- By not doing what they led the market to believe what they’d do (taper), the Fed is losing credibility
I think most people who aren’t paid not to “get” it understand this now. If you don’t understand the history of un-elected politicians devaluing currencies, you have some reading to do. Self-education is the best long-term path to not becoming a lemming.
I’m not that smart. I think most people who have seen my SAT scores get that too. But Mr. Market is a very smart cookie, and what I tend to get (on a lag) is what he (or she) is telling me to get. I don’t wake up every morning trying to bend economic gravity.
Bernanke thinks he can “smooth” gravity, cycles, etc. He’s telling the entire bond, currency, and stock markets they are wrong. #Wow, bro. So let’s rewind the tapes and go to the score – what have markets done since Bernanke didn’t taper?
- US Dollar went straight down (now bearish TREND after being bullish for the better part of the last 9-10 months)
- US Interest Rates went straight down (still bullish TREND, but lost the immediate-term TRADE momentum line of 2.80% 10yr)
- US Growth Stocks stopped going up; slow-growth Utilities stopped going down
Now isn’t that last part perfect. Great job Ben. Instead of US growth expectations accelerating, now they are slowing again.
This is the first 2013 US stock market “correction” that I will not buy because Bernanke has decided that the opposite of what I want is what he wants. To review, what I want is A) what was happening and B) what every American should want:
To be fair, there are a lot of people who are in the business of slow-growth (Gold, Bond, MLP, etc.) investing who have a pre-determined path as to what they want (more money to manage). But that’s not what The People want.
You don’t have to go back 2,000 years to get this either:
- 1983-89 US Growth > 4% GDP with #StrongDollar (Reagan’s avg = $115.25 USD) and Down Oil ($16.53/barrel avg)
- 1993-99 US Growth > 4% GDP with #StrongDollar (Clinton’s avg = $97.89 USD) and Down Oil ($19.69/barrel avg)
And maybe Hillary is smart enough to get what Obama doesn’t – and maybe that’s the only way out of this mess:
- Obama’s average USD (US Dollar Index) is the lowest in Presidential history at $79.52
- Obama’s average Oil price (Brent Oil) is the highest in Presidential history at $102.01/barrel
But that’s more than a few years away and sadly, at some point, someone in this country is going to realize that empowering both Putin and Middle Eastern kings via a Down Dollar, Up Oil policy is no different than doing the same via an un-elected Federal Reserve.
There is no doubt in my mind that the Fed is exerting its misplaced fear-mongering pull on the President. The lure is also to get you, The People, to fear the alternative (“if rates rise, housing will collapse”) when in reality it’s the government policy itself that is luring us away from the free-market system that gave America its empire to begin with.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.59-2.80%
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Takeaway: A strong quantitative argument can be made for the FOMC board to remain on hold throughout the balance of 2013 and throughout 2014 as well.
- A strong quantitative argument can be made for the FOMC board to remain on hold throughout the balance of 2013 and throughout 2014 as well. This debate is likely to become increasingly mainstream in the coming weeks and months and will have meaningful implications for the US dollar, US interest rates and global capital and currency markets at large.
- Investors attempting to get inside of Bernanke's head and/or view the economy as the FOMC board does should arrive at the following three conclusions based on the most recent data:
- Reported US economic growth is sluggish at best;
- The labor market has cooled off substantially; and
- Benign reported inflation will give policymakers ample headroom to continue easing even if the labor market starts to accelerate meaningfully.
- Regarding the latter point, both St. Louis Fed President James Bullard and Chicago Fed President Chuck Evans (the both of whom are voting members on the FOMC board) have been calling out low inflation as their chief economic concern in recent weeks/months.
- Our analysis suggests the US economy may have to sustainably record Real GDP growth in the +3% to +3.6% range in order to generate the kind of job creation necessary for the Unemployment Rate to breach the Fed’s 6.5% threshold over the intermediate term (holding flat other factors like the Labor Force Participation Rate).
Like most market participants, we were surprised by the Fed’s decision not to taper its asset purchase program last week.
In our view, both the pace and slope of economic growth has been solid enough to justify commencing a process of weaning the economy and its capital markets off of large-scale asset purchases (LSAP).
The critical takeaway from the aforementioned statement is not the part about the pace and slope of economic growth; rather, the key element of that declaration was indeed the phrase, “in our view”.
Specifically, “our view” of the pace and slope of economic growth is wholly shaped by leading and concurrent indicators, such as market prices, survey data (such as New Orders PMI readings) and our proprietary analysis of that data (e.g. modeling market prices with Keith’s quantitative risk management levels or something like tracking the YoY % change in Rolling NSA Jobless Claims).
Moreover, our process is designed to front-run inflection points in the market(s) and/or policy. Thus, an overt focus on concurrent-to-leading indicators is a prerequisite for any repeatable success in doing so.
The Fed, on the other hand, primarily focuses on lagging economic indicators, like Unemployment, Core PCE and Real GDP. Their primary responsibility is to set monetary policy based on actual – not guesstimated – economic conditions. Thus, an overt focus on lagging indicators is appropriate for their task as it is defined.
While we’d certainly prefer they apply more modern-day analytical techniques (i.e. chaos theory, behavioral economics, etc.) to their policy-setting agenda, for the purposes of keeping this note tight, we will temporarily concede to the consensus view among the academic economist community that the Fed should be more measured (i.e. less dynamic) with respect to setting monetary policy.
All told, understanding this distinction between what market participants are focused on and what the FOMC board is focused on is critical to appropriately preparing your portfolio for the Fed’s next policy move and, more importantly, the timing therein.
Looking at the economy from the Fed’s perspective, it should not have come as a surprise to see them back away from tapering at last week’s FOMC meeting. If anything, their only fault was allowing tapering speculation to percolate throughout the global financial community in the first place!
- In the 12M through 2Q13 (the latest reported figure), the US economy has grown only +1.6% on real basis; that rate of change represents a full standard deviation below the trailing 3Y trend.
- In the QTD, Nonfarm Payrolls have averaged +136k MoM; that’s nearly one full standard deviation below the trailing 3Y trend (-0.9x) and down sharply from an average pace of +207.3k MoM in 1Q13.
- In the 12M through JUL ’13 (the latest reported figure), underlying inflation – as measured by the Fed’s preferred measure of Core PCE – has tracked +1.2% YoY; that’s nearly one full standard deviation below the trailing 3Y trend (-0.9x).
Investors attempting to get inside of Bernanke's head and/or view the economy as the FOMC board does should arrive at the following three conclusions based on that sequence of data:
- Reported US economic growth is sluggish at best;
- The labor market has cooled off substantially;
- Benign reported inflation will give policymakers ample headroom to continue easing even if the labor market starts to accelerate meaningfully.
Regarding the latter point, both St. Louis Fed President James Bullard and Chicago Fed President Chuck Evans (the both of whom are voting members on the FOMC board) have been calling out low inflation as their chief economic concern in recent weeks/months.
Absent a dramatic near-term acceleration in core inflation – which is all but impossible given the neutering of consumer price indices in recent decades – the Fed is unlikely to find it appropriate to tighten monetary policy [via tapering… tapering is tightening, FYI] over the next few months.
Looking ahead to next year, one really has to see a dramatic acceleration of momentum in the labor market in order for the FOMC board to justify tapering LSAP – irrespective of whomever winds up in charge (no disrespect to Janet Yellen).
By our math which looks at the historical relationship between the deviation from trend in MoM Nonfarm Payrolls SA and deltas in the Unemployment Rate SA, the former series would have to average somewhere between +218.1k and +260k for five quarters in order for the latter series to reach the Fed’s 6.5% “target” (FYI, 6.5% is NOT a target for the initiation of tapering, as Bernanke has repeatedly stated in his recent commentary).
Regarding the study, please note that we purposefully decided to cap our study at a 10Y look-back; similar results hold over a trailing 30Y period as well, but we decided to front-run consensus pushback about how the labor market is structurally different today vs. 20Y or 30Y ago. We get it…
Moving along, it’s worth stressing that five quarters from now is the end of next year; not ironically, that is exactly when the FOMC board expects Unemployment Rate to hit that level.
Of course, maintaining the aforementioned pace of job creation for such an extended period of time would no doubt drag up the average and dampen any future deviations from trend. We understand that and would still expect to see continued improvement in the Unemployment Rate in spite of that – the purpose of this study is simply to gauge what level of economic performance we need to see in order to appropriately front-run the Fed from here.
Looking at the historical relationship between the deviation from trend in YoY Real GDP growth and the deviation from trend in MoM Nonfarm Payrolls SA, the former series would have to average somewhere between +3% and +3.6% produce readings in the latter series that are +1x to +2x standard deviations from the trailing 3Y trend. Using the most recent data set to reverse engineer those deviations produces the aforementioned range of +218.1k and +260k.
Of course, the pace of job creation isn’t the only factor in determining deltas in the Unemployment Rate; rather, there other key indicators, such as the structurally challenged Labor Force Participation Rate, that are integral components of the calculus.
Still, for anyone looking to correlate economic growth to a pace of job creation that is appropriate for the FOMC board to authorize a reduction in its LSAP program, we’d advise anchoring on anything north of +3% YoY. That’s nearly a double from the latest reported rate.
We consider it noteworthy that the Fed’s full-year 2014 GDP growth projection is right in line with that rate, effectively confirming that their economic growth expectations are on track for a 6.5% Unemployment Rate target by EOY ’14.
Right now, our model can get as high as +2.7% for 2014E Real GDP growth, but that’s not an estimate we would advise lending any credence to at the current juncture. As mentioned our previous works, our predictive tracking algorithm is designed to capture deltas and inflection points on a rolling 1-2 quarter basis. It’s worth nothing that trying to predict anything much further out than that tends to negatively skew the balance between facts and assumptions in any economic model.
Even if the economy can get up to and sustain a +3% rate of growth over the intermediate term, investors must continue to be cognizant of the fact that subdued core inflation will continue to keep the doves on the FOMC board uneasy about the mere thought of tapering – let alone hiking the Fed Funds Rate (which is what they likely intend to do when the Unemployment Rate reaches 6.5%, assuming both reported inflation and inflation expectations are in line with the committee’s +2% objective at that time).
Not surprisingly, those market participants closest to the pin-action are already starting to bake this scenario in. The implied probability of the Fed Funds Rate being 0.0% at the DEC ’14 FOMC meeting has increased from 7.7% in early SEP to 25.5% currently. Conversely, the implied probability of the Fed Funds Rate being hiked to 0.75% or 1% at the DEC ’14 meeting has dropped to 7.8% and 1.5%, respectively, from 23.2% and 10.4%, respectively, in early SEP.
All told, a strong quantitative argument can be made for the FOMC board to remain on hold throughout the balance of 2013 and throughout 2014 as well. This debate is likely to become increasingly mainstream in the coming weeks and months and will have meaningful implications for the US dollar, US interest rates and global capital and currency markets at large.
Have a wonderful evening,
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Editor's note: This is a brief excerpt from a note Hedgeye Retail Sector Head Brian McGough sent out this morning. For more information on how you can subscribe to Hedgeye research please click here.
What’s New Today in Retail (9/23)
JCP - J.C. Penney Said in Talks to Raise More Money for Turnaround
- "J.C. Penney...is in talks to potentially raise more cash, said people with knowledge of the matter. The chain doesn’t have immediate cash needs, and is exploring fundraising amid shareholder pressure to take advantage of cheap financing, said the people, who asked not to be named as the deliberations are private. Goldman Sachs...which arranged a $2.25 billion loan for the retailer this year, is advising J.C. Penney on funding options including borrowing against its real estate, said one of the people."
- "One option under consideration is for J.C. Penney to borrow against the real estate that it hasn’t already pledged as collateral on other debt, three people said. J.C. Penney values its owned and ground-leased real estate at $4.08 billion, according to a May investor presentation."
Takeaway: JCP does not need the cash right now, and our math suggests that it can go the next three years without tapping external sources. But a key consideration is that a new CEO would likely want to come in with zero liquidity risk. Our sense is that JCP is doing this to broaden the pool of potential CEOs.
JCP - JCPenney Cuts Off Free Wi-Fi
- "JCPenney is busy undoing the work of former CEO and ex-Apple retail head Ron Johnson, and this week the company is axing the free Wi-Fi he once dubbed 'fundamental architecture' for stores. The retailer confirmed the removal of the service to BuzzFeed after shoppers voiced their displeasure on Twitter. A JCPenney spokesperson explained that the signal wasn't used very often by customers."
- "JCPenney has already invested $12 million installing the system last year, but shutting it off for customers will save the chain about $7 million a year, according to BuzzFeed."
- "...CEO Mike Ullman, the investment hasn't been worth it. In addition to slow usage, he said the mobile checkout technology that was based on the Wi-Fi was confusing for most customers. Shoppers also don't tend to realize free Wi-Fi in a store exists, or just choose to use their own data plan instead. Mobile checkout will still be able to run on the private Wi-Fi network, but Ullman will put a new focus on making sure store associates are visible and able to assist customers."
Takeaway: This borders on ridiculous. But the reality is that people don’t go to JCP to get free Wi-Fi.
Regional markets looked better in August but that was predictable.
- Mature regional gaming market revenue declined “only” 1.0%, beating our projection slightly.
- However, the underlying trends are not good and we expect that to show through in September
- Given the results from June-August, we estimate September 2013 same-store casino revenue will fall more than 8% (down 1 Saturday)
Takeaway: Hedgeye CEO Keith McCullough offers his thoughts on this Pulitzer Prize-winning book.
American Prometheus – The Triumph and Tragedy of J. Robert Oppenheimer, by Kai Bird & Martin Sherwin (2005)
This book captures the complexity of the human mind but, at the same time, simplifies the predictable behavior of politicians. In many ways Oppenheimer’s story reminds us how fragile our freedoms can become.
- Deserving winner of a Pulitzer Prize; a true human story of science, evolution, and conscience
- Knowledge threatens political power; especially when it has a liberal mind that doesn’t pander to government
- Respect (from practitioners) vs. Reprimand (by politicians) – Oppenheimer battled bureaucrats to his grave
- “Damn it, I happen to love this country.” (pg 3) #truth, Oppenheimer wasn’t the communist his haters wanted him to be
- “He received every idea as perfectly beautiful” (pg 9) #objective research defined
- “Well, neither one of us came over on the Mayflower” (pg 25) on being Jewish, Oppie to his Scotch-Irish friend at #Harvard
- “The notion that I was travelling down a clear track would be wrong” (pg 29) #honesty about learning (1922 enrolled @Harvard)
- Proust’s “A La Recherche du Temp Perdu” (pg 51) a book that left an impression on him in college #introspection
- “Becoming a scientist, Oppenheimer later remarked, is like climbing a mountain in a tunnel” (pg 67) #Gottingen 1927 Germany
- “Quantum mechanics describes nature as absurd from the point of view of common sense” –Feynman (pg 79) #Oppie liked
- “Oppie” = title of Chapter 6 (Oppenheimer’s nickname, humanizes the man as he moved on to teach in California)
- “How far is it wise to respond to a mood?” –Oppenheimer in #1930 (pg 95), we was 26 yrs old, #mentoring brother Frank
- “In 1936 my interests began to change” –Oppie (pg 111) met his 1st love, young #communist party member, Jean Tatlock
- “FBI would never resolve the question of whether or not Robert was a CP member” (pg 142) b/c he wasn’t a #communist
- “devoted to working for social and economic justice… he chose to stand with the left” (pg152) left isn’t Russian Communist
- “By the end of 1939, Oppenheimer’s often stormy relationship with Jeadn Tatlock had disintegrated” (pg 153)
- “I’d had about enough of the Spanish cause… there were more pressing crises in the world” (pg 178) #1941 post Pearl Harbor
- “Only an atomic bomb could dislodge Hitler from Europe” –Oppenheimer to #Teller in #1942
- “Groves is a bastard but he’s a straightforward one” –Oppenheimer (pg 185) on his boss at #LosAlamos
- “He’s a genius, a real genius” –Groves on Oppenheimer (pg 185) #1942, peer #respect
- “Robert was beginning a new life. As the Director of a weapons laboratory…” (pg 205) #1942, he was 38 yrs old
- “No, no, you’re crazy… that’s nuts” –Dick Feynman (pg 217) Feynman, Bethe, Bohr + Oppenheimer = genius collaboration
- “Oppenheimer is telling the truth…” (pg 236) people may have not liked the #truth, but he was usually telling it; that’s life
- “I am disgusted with everything” –Jean Tatlock (pg 249), in #1944 Oppenheimer’s 1st love committed #suicide
- “December 1943, Niels Bohr arrived at Los Alamos” (pg 268) Oppie was his #prophet
- “If Bohr was convinced, then Oppenheimer must have realized that German physicists were in all likelihood far behind” (pg 276)
- “Everyone sensed Oppie’s presence. He drove himself around The Hill in an army jeep” (pg 277) #leader amongst peers
- “Well, Roosevelt was a great architect, perhaps Truman will be a good carpenter” –Oppenheimer (pg 290) he respected POTUS
- “I feel I have blood on my hands” –Oppenheimer (pg 323) October 16, #1946 to #Truman (and Truman didn’t like the honesty)
- “Oppenheimer arrived in Princeton in mid-July 1947” (pg 369) he was appointed Director of Einstein’s Institute #thinktank
- “After Einstein, Oppenheimer was undoubtedly the most renowned scientist in the country” (pg 390) #1948 (so he was a #threat)
- “Our atomic monopoly is like a cake of ice melting in the sun…” –Oppenheimer (cover of Time Magazine 1948) (pg 418)
- “The Administration now supported a program to build a bomb 1,000x as lethal as the Hiroshima weapon” (pg 430)
- “You probably don’t know to what extent you have become my intellectual conscience” –George Kennan to Oppie #1950 (pg 431)
- “We may be likened to 2 scorpions in a bottle, each capable of killing the other, but only at the risk of his own life” –Oppenheimer (pg 462)
- In 1953 Oppenheimer sent the new Eisenhower Administration a report “urging a policy of candor” (pg 463) #transparency
- “I must reveal its nature without revealing anything” –Oppenheimer on #nuclear weapons in 1953 #candor (pg 463)
- “The President had read Oppie’s essay and had found himself to be in general accord with its argument” (pg 468) #Strauss was enraged
- Strauss and the anti-Oppenheimer hawks went after Oppie (ultimately he “collapsed on his bathroom floor”) (pg 484) #pressure 1953
- Einstein, not impressed, thought Oppenheimer “a man who was easily hurt and intimidated” (pg 498) #fair assessment
- “The Oppenheimer hearing thus represented … the narrowing of the public forum during the early Cold War” (pg 550)
- “It achieved just what his opponents wanted to achieve; it destroyed him” –I.I. Rabi (pg 551) #1954
- “How can the independent experimental mind survive in such an atmosphere?” –The New Statesman (pg 556) #1954
- “By the early 1960s, with the return of Democrats… Oppenheimer was no longer a political pariah” (pg 574) #JFK
- “I think it is just possible Mr. President that is has taken some charity and some courage to make his award” (pg 574)
- “In 1963, Oppenheimer learned that President Kennedy gave him the prestigious Fermi Prize” (pg 575) #validation
- “In 1965, Oppie visited his doctor for a physical… 2 months later his smoker’s cough became noticeably worse” (pg 581)
- “Robert has cancer” –Kitty (pg 582) #1966
- Oppenheimer’s Memorial Service was in Princeton on February 25, 1967 (pg 588)
- “Kitty took her husband’s ashes in an urn to Hawksnest Bay... and dropped the urn overboard” (pg 588) #St.John
- “That’s where he wanted to be” –Kitty (pg 588)
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