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The Hierarchy

This note was originally published at 8am on September 17, 2013 for Hedgeye subscribers.

“The great thing about fact based decision is that they over rule the hierarchy.”

-Jeff Bezos


Jeff Bezos knows a thing or two about making decisions.  In 1994 after making a cross country drive from New York to Seattle, he made the decision to write up a business plan.  To undertake this cross country drive, he made a decision to leave a “well-paying” job.   The little company that Bezos was developing a business plan for was Amazon.com and the rest, as they say, is history.

 

At the time, Bezos combined two facts that helped him overcome the establishment.  The first was that the internet was growing in leaps and bounds.  The second fact was that the U.S. Supreme Court had ruled (in Quill Corp V. North Dakota) that online retailers would not have to collect sales taxes in states where they lacked a physical presence.

 

This series of decisions paid off handsomely for Bezos as he is now worth an estimated $25.2 billion.   Meanwhile his company Amazon.com has a market capitalization of more than $135 billion and generates more than $65 billion in annual revenues.  Frankly, it kind of makes me want to quit my job and go for a drive!

 

Former Harvard President Larry Summers made a big decision late Sunday to withdraw his name from consideration to replace current Federal Reserve Chairman Ben Bernanke.  Now technically speaking, the fact that five Democrats intended to vote against him in committee kind of forced his hand, but nonetheless a decision was made.

 

In the short run, Mr. Market viewed this development as somewhat positive as stocks were up broadly with the SP500 up 0.57%.  (Strangely, the bell weather master limited partnership, Kinder Morgan Partner (KMP), underperformed and was down -1.50%.) President Obama then chose to come out and spoil the Wall Street party as Obama indicated he will not negotiate an extension of the U.S. debt ceiling as part of the budget fight. 

 

Slight digression, yes the debt ceiling debate is looming again.  As Yogi Berra said, this is déjà vu all over again.  You may recall, in 2011 Congress raised the debt ceiling to $16.7 trillion, an increase of over $2 trillion.  Currently, based on projections from the Treasury department, the federal government could hit the debt ceiling as soon as mid-October.

 

In the chart of the day, we highlight a chart from the Bipartisan Policy Center that shows that the debt ceiling is likely to be breached to between October 18th to November 5th.   Technically speaking, the United States hit its debt limit on May 19th, but as my colleague Christian Drake has written about, via a number of extraordinary measures, the ceiling has been extended, but these measures will run out at some point in the time frame noted above at which point the federal government will only have enough tax revenue to cover about 68% of its bills.

 

Incidentally, and for those that don’t have their calendars in front of them, the “X-date” is just over a month away.  And just think, most investors are worried about who is going to be the next Chairman / Chairperson of the Federal Reserve!  Given the uncertainty around the direction of policy, a looming fiscal crisis, and the fact that U.S. equities have performed quite well in the year-to-date, it should be no surprise that some savvy investors like Stan Druckenmiller are indicating they are largely underinvested.

 

We certainly get the risks, but one point that has and will continue to benefit equities, is bond outflows.  Since May we have seen $116 billion fixed income fund outflows, which is the largest absolute bond outflow in history.

 

Interestingly though, as our Financials team pointed out yesterday,  as a percentage of beginning fixed income assets-under-management, the current 2013 draw down is the smallest in history on a percentage basis. The 2013 running outflow has been just 2.9% of outstanding bond funds, well below the past outflows in 2003-2004 where 5.0% of outstanding bond funds were redeemed and the 14% of bond funds that were drawn down in the 1994-1995 outflow.  So while there are certainly risks looking for equities, the continuation of bond outflows will be a meaningful tailwind. 

 

Nonetheless, many of the large investors we speak with remain focused, and rightfully so, on the direction of leadership at the Fed.  Given this focus, I thought I’d highlight a few fun facts about the Fed:

 

1) The greatest long term period of economic growth in the United States was between the Civil War and 1913 when there was no Fed.

 

2) Prior to the creation of the Federal Reserve, the estimated rate of inflation in the United States was 0.5% and it is   estimated to be at 3.5% in the ensuing century.

 

3) The permanent income tax was introduced in the same year as the Federal Reserve.

 

4) In 1913, Congress promised that if the Federal Reserve Act was passed it would eliminate the business cycle.

 

5) The value of the U.S. dollar has declined, by some estimates by more than 95% since the Fed was created.

 

6) There have been 10 recessions since 1950 (arguably many Fed induced).

 

I borrowed some of these points above from a blog called End of the American dream and, as we touched up on in the past, it kind of begs the question, as Bezos would say, as to whether the best fact based decision is to overrule the Federal Reserve hierarchy in its entirety.  Based on the points above, ending the Fed wouldn’t be the worst decision the Federal Government ever made.

 

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

 

UST 10yr Yield 2.80-2.98%  

SPX 1675-1709 

VIX 13.33-14.98 

USD 80.89-81.75  

Euro 1.32-1.34 

Gold 1301-1361 

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

The Hierarchy - Chart of the Day

The Hierarchy - VP

 

 



The Biggest Loser

“Get comfortable with being uncomfortable.”

-Jillian Michaels

 

That’s a varsity quote from one of the original trainers on NBC’s “The Biggest Loser.” To a degree, Jillian Michaels typifies the attitude of my generation of entrepreneurs in America. She’s a 39 year old self-made business woman. She didn’t get anything handed to her in life. She bartended her way through college, sucked it up, and lived the American dream.

 

What is the American dream? Is it a bunch of big political and media losers getting paid to perpetuate fear and crisis on cable TV? Or is it the polar opposite of that? Bernanke, Boehner, and Obama can’t shut us down. No, no, no ladies and gentlemen. Today we are going to do what we do at the top of every risk management morning – we are going to grind.

 

Grinding in the arena of business life has been celebrated by this country for generations. In 1925, President Calvin Coolidge reminded the American Society of Newspaper Editors that “the chief business of the American people is business” (The History of Money, pg 169). So that’s the headline coming out of this 2.0 Financial Media upstart from Stamford, CT this morning. Rise Above that.

 

Back to the Global Macro Grind

 

What’s fascinating about watching both the US stock market futures and the bond market this morning is that neither of them seem to care whatsoever about Old Media’s politicized fear-mongering. Mr. Market is shutting the media’s message down.

 

That shouldn’t surprise you. As newspaper editors and television producers look backward, markets look forward. Up next is the US Employment Report for the month of September.

 

September (and the 3rd quarter in general) was one of the best quarters for US growth expectations in half a decade:

  1. US Growth Stocks hit all-time highs (for SEP Industrials (XLI) +5.4% and Consumer Discretionary (XLY) +5.1%)
  2. US (slow growth) Bonds and Utility stocks hit their YTD lows (for SEP Utilities (XLU) only +0.18%)
  3. US Equity Volatility (VIX) hit YTD lows as well

Then, mid-September, along came Bernanke, Boehner, and Obama …. and:

  1. US Growth Stocks started making a series of lower highs (down for 7 of the last 8 days)
  2. US (slow growth) Bonds and Utilities outperformed everything growth
  3. US Equity Volatility (VIX) ripped a +26% move to the upside in less than 2 weeks

Congrats to the Fed, Democrat, and Republican parties. It’s a tie – you all get a Hedgeye sticker for America’s biggest losers!

 

Looking forward to the US employment report on Friday:

  1. US Growth Stocks may very well put in yet another higher-low (SP500 = 1660 TREND support)
  2. US Treasuries appear to be making another lower-high (10yr Yield = 2.55% TREND support)
  3. And front-month fear (VIX) is making yet another lower-YTD-high as well (VIX = 18.98 TREND resistance)

What say you Mr. Market about all of that?

 

I say it’s government versus gravity!

 

That would be economic gravity of course. As in the stuff that Bernanke has been trying to bend. And while bending gravity appears to be quite innovative to the Central-Market-Planner-in-Chief-of-anti-dog-eat-dog USA, that doesn’t mean it’s going to work.

 

So play this out – the US jobs report on Friday has a binary outcome:

  1. It’s a moon-shot to the upside and bond yields rip (again) to the upside
  2. It’s in line to a “miss” and Bernanke and his old-boys from anti-gravity-smoothing headquarters say “we nailed it”

Which of the two will it be?

 

I’m proud to say that I have absolutely no idea. That’s why the Hedgeye Asset Allocation Model has a 50% Cash position and in our #RealTimeAlerts I only have 5 LONGS, and 4 SHORTS. Getting out of the way of this political gong show was a risk managed decision.

 

I’m very comfortable grinding out another business building day. I’m uncomfortable with risking what’s been a great year for us on a government report that could go either way.

 

UST 10yr Yield 2.59-2.68%

SPX 1

Nikkei 142

VIX 14.64-16.99

USD 80.02-80.77

Brent 107.08-108.98

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

The Biggest Loser - Chart of the Day

 

The Biggest Loser - Virtual Portfolio


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Is a U.S. Debt Default Imminent? A Discussion with Former Speaker of the House Newt Gingrich

Is a U.S. Debt Default Imminent? A Discussion with Former Speaker of the House Newt Gingrich - Newt.client

 

"You can't trust anybody with power."

-Newt Gingrich

 

On Thursday, October 3rd at 11:00am EDT, please join Hedgeye CEO Keith McCullough and Director of Research Daryl Jones for a discussion with former Speaker of the House Newt Gingrich, a key player in the last Federal Government shutdown, to discuss the current dysfunction in Washington, D.C. and implications for the markets.

 

Details for the call will be distributed on the morning of October 3rd.

 

 

TOPICS WILL INCLUDE:

  • What is the next strategic move for both the Democrats and Republicans?
  • How does this compare to the 1995 / 1996 government shutdowns?
  • Is Obama serious enough that he would risk a technical default? Will the Democrats in Congress support him?
  • Is the Tea Party influence on the Republican Party sustainable and, if so, what are the long term ramifications?
  • What are the implications of the current debate on the future of healthcare and the Affordable Care Act? 

 

ABOUT NEWT GINGRICH

Newt Gingrich is well-known as the architect of the "Contract with America" that led the Republican Party to victory in 1994 by capturing the majority in the U.S. House of Representatives for the first time in forty years. After he was elected Speaker, he disrupted the status quo by moving power out of Washington and back to the American people. Under his leadership, Congress passed welfare reform, the first balanced budget in a generation, and the first tax cut in sixteen years. In addition, the Congress restored funding to strengthen defense and intelligence capabilities, an action later lauded by the bipartisan 9/11 Commission.

 

Along with then President Bill Clinton, former Speaker of the House Gingrich was a key player in the United States federal government shutdowns of 1995 and 1996.  The conflicts between Democratic President Bill Clinton and the Republican Congress were over funding for Medicare, education, the environment, and public health in the 1996 federal budget. The government shut down after Clinton vetoed the spending bill the Republican Party-controlled Congress sent him. The federal government of the United States put non-essential government workers on furlough and suspended non-essential services from November 14 through November 19, 1995 and from December 16, 1995 to January 6, 1996, for a total of 28 days.

From May 2011 to May 2012, Newt Gingrich was a candidate for the Republican nomination for President of the United States, winning the South Carolina and the Georgia primaries. The campaign was especially notable for its innovative policy agenda, its effort to bring new coalitions into the Republican fold, and for Newt's debate performances. His $2.50 a gallon energy plan set off a nationwide discussion about the use of America's energy resources.

 

Newt Gingrich is also the host of CNN's political show Crossfire, which was restarted in the fall of 2013 after an eight-year hiatus. He hosts the show alongside conservative commentator S.E. Cupp, former Obama campaign spokeswoman Stephanie Cutter, and green advocate Van Jones. As an author, Newt has published twenty-four books including 14 fiction and nonfiction New York Times best-sellers.

 

Newt was first elected to Congress in 1978 where he served the Sixth District of Georgia for twenty years. In 1995, he was elected Speaker of the U.S. House of Representatives where he served until 1999. The Washington Times has called him "the indispensable leader" and Time magazine, in naming him Man of the Year for 1995, said, "Leaders make things possible. Exceptional leaders make them inevitable. Newt Gingrich belongs in the category of the exceptional."

 



Summer's End

This note was originally published at 8am on September 16, 2013 for Hedgeye subscribers.

“Ah, summer, what power you have to make us suffer and like it.”

-Russell Baker

 

In more ways than one, summer ends this week. And, oh, what a summer it was. My wife, kids, and I spent our last summer Saturday up at West Point watching the Army vs Stanford football game. By Sunday morning I was back on the ice, coaching the kids.

 

With summer’s end I get football, hockey, and another US stock market rip. The SP500 is already +3.4% for September. We’ll test the 2013 YTD highs again this morning, right as consensus got too bearish (again).

 

Indeed. With American growth prospects trading at their highest premium to #EOW (end of the world) in half a decade, Larry Summer’s chances to run the Fed are over this morning too.

 

Back to the Global Macro Grind

 

While I was surprised to see Summer’s prospects end so quickly, I was more shocked to see Gold go down on that. In anticipation of ultra-dove, Janet Yellen, getting the nod as un-elected central-market-planner-in-Chief, we’re going to have a Dollar Down day.

 

Dollar Down equates to what? Well, that depends on what risk management duration you are using. If you are using a longer-term duration (say our TREND duration, 180 days) here’s what  the US Dollar’s correlation matrix looks like:

  1. SP500 = +0.49
  2. Gold = -0.54
  3. Oil = -0.60

In other words, from an intermediate-term TREND perspective, Summer’s End should = Dollar Down, Stocks Down, Gold/Oil Up. But the exact opposite of that is happening this morning. Why?

 

Well, let’s get all wild and multi-duration here, and see what USD correlations look like on a shorter term duration (30 days):

  1. SP500 = -0.16
  2. Gold = +0.26
  3. Oil = +0.63

In other words, from an immediate-term TRADE perspective, Summer’s End = Dollar Down, Stocks Up, Gold/Oil Down.

 

#cool

 

We call this Duration Mismatch – and I absolutely love it, because it drives the machines right squirrel. You see, nothing in Global Macro risk management happens in a linear 1-factor, 1-duration, box. That’s because markets are non-linear.

 

While what we call Correlation Risks can (and have) “blown out” across durations from time to time, assuming that’s going to trend as a constant is a really bad assumption. Correlations aren’t perpetual.

 

#OldWall’s media doesn’t completely get the Chaos Theory of it all, so they tend to write about markets that are correlating across durations as “risk on or off.” Whereas the only risk that’s really on here is assuming that risk trades that way.

 

Back to Yellen over Summers… I have more questions than answers this morning:

  1. What if Janet Yellen completely loses control of the bond market in 2014?
  2. What if Gold’s #bff (Bernanke) being gone for good is the point that matters most?
  3. What if Yellen doesn’t get the job altogether?

While the answer to that last question is improbable, with the US Dollar trading higher for 4 of the last 5 weeks I think the market would have considered Summer’s End improbable this morning too. Embrace the improbable.

 

While some apologists who have missed the entire rally in US growth stocks in 2013 would have you believe that the entire Global Macro market moves as a monolith, what Mr. Market is reminding you this morning is that that’s a dumb belief.

 

Alongside the Fed, there are plenty of major Global Macro risks moving Equities, Gold and Oil this morning - not the least of which are expectations in the Middle East being recalibrated.

 

Looking at last week’s drops in commodity prices, it’s also instructive to look at expectations in the futures and options market on a week over week basis:

  1. The total net long position in CFTC futures and options contracts declined -4.1% wk-over-wk
  2. Gold’s net long position dropped -16% wk-over-wk to +84,929 net longs (after hitting its highest net long position since JAN)
  3. Crude Oil’s net long position dropped another -5% wk-over-wk to +290,058 net longs after hitting an all-time high in AUG

All-time is a long time, and don’t forget to contextualize that point for the price of Oil as it’s making a lower-high versus one of the many Bernanke Bubble highs in asset classes (Oil’s all-time high = 2008).

 

Don’t get me wrong, Down Dollar probably gets me to take down our US Equity exposure again into this tidal wave of performance chasing this morning. But that would probably just mean selling more of what we bought when consensus pundits were telling you “this is it” for the umpteenth time in August as they were selling stocks 4% lower.

 

I say probably because I am not sure yet. I rarely am. How could you be if the President of the United States isn’t in the area code of certain on big decisions like Syria and Summers? As a result, my baseline strategy is to keep moving out there, because risk does.

 

Our immediate-term Risk Ranges are now:

 

UST 10yr Yield 2.80-2.99%

SPX 1669-1704

VIX 13.33-14.88

USD 81.05-81.81

Brent 110.33-113.96

 

Best of luck out there this week,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Summer's End - Chart of the Day

 

Summer's End - Virtual Portfolio


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