Editor's note: Here is a complimentary look at Hedgeye's Daily Trading Ranges product for 10/11. These are CEO Keith McCullough's proprietary buy and sell levels on major markets, commodities and currencies. To learn more and to sign up, click here.
This note was originally published at 8am on September 27, 2013 for Hedgeye subscribers.
“What people fail to realize is that we spend ~70% of the time at record highs in the equity market.”
-Anonymous Seasoned Investor
Keith and I picked up that gem in a recent meeting with a client out in San Francisco. Truly a savvy investor, this gentleman belongs to the increasingly rare camp of investors that has managed market risk across multiple decades and economic cycles.
Regarding the aforementioned quote, he dropped that line in a discussion about the pervasive lack of enthusiasm for 2013’s non-consensus equity market rally, specifically in response to our conjecture that baggage from the hard times of 2008-09 is broadly preventing investors from buying into the sustainability of said rally.
While I believe he was merely throwing a number out there to make a [wise] point, the reality is that he’s actually not that far off as it relates to the assertion he was trying to make:
- Being worried about allocating capital to the equity market at/near its all-time high is hardly as big of a deal as the average investor – fully loaded with 2000-02 and 2008-09 baggage – would have you believe.
- Over the past 30Y, the S&P 500 has traded within 5% of its [then] all-time high 43.8% of the time.
- Over that same duration, only 26% of the time has the index traded 20% below its [then] all-time high.
Oddly enough, when looking at aggregated fund flow and securities market allocation trends, it seems that investors are still positioned for yet another blow-up in the equity market, when, in reality, it’s the inevitable unwinding of Bernanke’s bond bubble they should be most concerned about.
Per Jonathan Casteleyn, the newest member of our highly-regarded financials team:
- Per the most recent data (2008-11 period), pension fund allocations to stocks is at an all-time low of 44%, while their allocations to bonds is at an all-time high of 37%. That ratio was 52% to 33% in the 1984-94 period, 64% to 27% in the 1995-00 period and 60% to 28% in the 2001-07 period.
- From the start of 2008 through the most recent data (JUL ’13), bond mutual funds have seen a cumulative $1.09T of inflows, or 17% of starting AUM. This compares to a -$441B outflow from equity mutual funds, or -7% of starting AUM.
- At $38T outstanding across the various categories, bonds represent 68% of the total US securities market (equities and debt). That compares to a 20Y average of 64% and a balanced ratio of 50/50 in 1999. Reversion to the mean implies a greater than $2T outflow from bonds into stocks over the long term.
Regarding that last point, we get a lot of pushback from fixed income managers that bonds funds don’t necessarily need to see outflows for the equity funds to receive inflows, citing record “cash on the sidelines”.
Indeed, un-invested cash in money market mutual funds, credit balances in margin accounts and deposit and currency assets on household balance sheets currently totals ~$12.4T, which is just off of all-time highs. As a percentage of the securities market, however, it hovers just above all-time lows (23% vs. a record low of 22% in 1999 and a record high of 32% in 2009).
If in 1999 someone thought the aggregate investment community was going to take its liquidity ratio down to new all-time lows in order to continue financing a bubble in stocks or even to take up its gross exposure by simply increasing its allocations to bonds, boy, were they sorely mistaken. Making that argument in defense of fixed income right now is equally off base, in our opinion.
In summary, we continue to believe there is a compelling, long-term fund flow case to be made in favor of the equity market in lieu of the bond market.
Not from every price, however…
We need to see the US Dollar Index recapture its TREND line of $81.35 for us to believe that tapering is an intermediate-term event, rather than one that is far off in the distant realm of “potentially never”.
Simply put, as long as a collection of fear-mongering doves dominate the domestic monetary policy debate, the probability of a Japan-like, no-growth economic scenario will remain heightened.
Besides a natural monetary policy response to economic gravity, what else would get investors excited about investing for growth in lieu of safety?
Corporate America would be a good place to start. My, how they have been conspicuously absent from this recovery!
- Record cash on their balance sheets ($1.8T per the latest data);
- A near-record ratio of liquid assets to short-term liabilities (47.3%; 1.8 standard deviations above the 30Y mean);
- An effective tax rate of 19.9% that is near all-time lows (-1.6 standard deviations below the 30Y mean);
- An estimated $700B in interest savings since 2009 that can be specifically attributed to QE*; and
- Profits that have grown +34.7% since 2007…
… Corporations have reduced employee headcount by -2.9% since 2007 and grown nominal CapEx by a measly +0.6% on a trailing 5Y CAGR basis – a growth rate that is just above a generational low.
Regarding the former point on corporate, QE-derived interest savings, $700B is enough to employ 9.6M workers for 1Y, assuming a $51k median income (per the Census Bureau) that represents 70% of all-in employee compensation costs (per the BLS), effectively taking up the median annual comp to $72.9k. To put that in context, there have been only 6.8M net hires since 2009 per the seasonally-adjusted nonfarm payrolls numbers.
Obviously that’s nothing more than a hypothetical analysis meant to draw attention to the fact that QE to-date has been little more than an overt transfer of wealth to Corporate America and the rest of the top-10% that owns the lion’s share of financial wealth in the this country.
It’s time both parties said, “thank you” by putting capital to work (corporations) and allocating capital back to pro-growth assets (investors).
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.57-2.74%
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“Boom, crush. Night, losers. Winning, duh.”
Yesterday was one of those days that people absolutely loved or hated. Watching my Twitter #ContraStream was quite comical actually. Some of the “intellectual” types just couldn’t believe what was happening. Some of the bros were tweet-panting.
I think most of you know that I’m not the smartest player in this game. I think that helps me. I think less when I change my mind and/or position. That’s by design. After making almost every mistake you can make in this game with live ammo (multiple times), I’ve built in blinders (machines) for my emotions. They stop me from over-thinking.
To each their own. Like you, I have my style biases. One of the big ones is approaching this game of globally interconnected-risk from an athlete’s perspective. I know we can’t win unless I grind alongside my teammates. I also know we’ll lose if we don’t respect Mr. Market’s signals.
Back to the Global Macro Grind…
VIX snaps @Hedgeye TREND support of 18.98; SP500 rips through 1663 @Hedgeye TREND resistance. “#Boom, Crush!” The Signal within the manic media’s noise made it so simple that even a hockey player could do it.
And what did we learn?
- Respect the setup (the signal was screaming into event risk that government could save us from themselves)
- Stay with the confirmation (the signal said stay with the early part of the move; don’t sell)
- Let it ride (9 LONGS, 3 SHORTS @Hedgeye – with 2 of the 3 SHORTS being bond shorts)
Do you know how many times in the last 15 years that I have violated not one, but all 3, parts of that risk management process? I don’t. And that’s primarily because 5 and 10 years ago, I didn’t have this dynamic signaling model. It evolves.
What you’ll quickly note in steps 1-3 of the decision making tree is that there are no points for intellectual IQ. Mr. Market doesn’t care how smart you are. He couldn’t care less what your position is either. The only thing that matters is how well you listen to him.
For me at least, just getting to step 1 was tough – and that’s primarily because I think the Fed leaning on the long-end of the curve, suppressing rates, and devaluing the Dollar, is a textbook #GrowthSlowing signal. But that fundamental signal should never be confused with a quantitative risk management signal. In the immediate-term they can be 2 very different things.
Once I accepted the VIX/SPY signal for what it was, what did I do next?
- Stayed with the confirmation – that means I got longer on green (covered a short, bought a long)
- Then I let it ride throughout the day despite every bone in my body telling me to sell
What do my bones have to do with it? Listen to them and prepare to be crushed. “Night, losers.” Letting a winning move ride is easily the hardest thing for me to do. Why? Because I love booking gains. And for that very reason, I tend to book them too early.
So, I need to be better than that and let the signal tell me when/where it’s the right time to sell. I’m nowhere near as bad as I used to be on this front. But I have a lot of room to improve.
Let’s use SP500 levels as an example of why I’d let that ride yesterday and drop our Cash position to 42% (we started the week net short in #RealTimeAlerts and had a 55% Cash position in the Hedgeye Asset Allocation model):
- SP500 intermediate-term TREND resistance became support at 1663; that’s a big line
- SP500 immediate-term TRADE breakout line = 1681; layered on top of the TREND, that’s even bigger
- SP500 immediate-term TRADE resistance = 1708; that’s up another +0.9% from the 1692 close
All the while, I’m considering the emotion and intensity of the move (this is where the Twitter #Contra-Stream I built is priceless) within the context of the prior 2013 US stock market “corrections.”
As you can see from Darius Dale’s Chart of The Day, each of the last 3 corrections has:
A) been to higher-lows
B) been less of a % move than the prior correction
C) been on less volume than the prior correction
Markets that people hate are the best ones to be long; particularly when corrections are confirmed by weak volume and lower-high volatility signals. Again, to contextualize this recent SP500 correction:
- SEP 18 to OCT 8 correction = -4.1%
- AUG 2 to AUG 27 correction = -4.6%
- MAY 21 to JUN 24 correction = -5.8%
And I get it. For the last 3 weeks I wrote to you every day that I wasn’t buying this correction like I did the AUG and JUN corrections. But I also get when and why I changed my mind. There are no rules against doing that. “Winning, duh!”
Our immediate-term Risk Ranges are now:
UST 10yr 2.65-2.71%
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
TODAY’S S&P 500 SET-UP – October 11, 2013
As we look at today's setup for the S&P 500, the range is 26 points or 0.62% downside to 1682 and 0.91% upside to 1708.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 2.34 from 2.34
- VIX closed at 16.48 1 day percent change of -15.92%
MACRO DATA POINTS (Bloomberg Estimates):
- 9:55am: U Mich. Confidence, Oct. prelim, est. 75.9 (pr 77.5)
- 11am: Fed’s Powell speaks on monetary policy in Washington
- 11am: Fed to purchase $1.25b-$1.75b in 2036-2043 sector
- 1pm: Fed’s Rosengren at Council of Foreign Relations in N.Y.
- 1pm: Baker Hughes rig count
- 9am: Natural Resources Defense Council, Sierra Club, Canadian scientists and activists briefing on Canadian govt, climate policies, tar sands expansion, Keystone XL
- 10am: Joint Economic Cmte hearing on fiscal sustainability, economic growth
- 1:30pm: G-20 members hold IMF/World Bank press conferences
WHAT TO WATCH:
- House Republicans enter talks with Obama on debt-ceiling deal
- Default doubters repudiated by Republican economists citing harm
- Energy Future said near bankruptcy loan exceeding $3b
- Pimco said to raise $3.5b for Bravo II credit fund
- Del Monte Pacific to buy U.S. food brands for $1.68b
- Twitter said to pay 3.25% bankers’ fee in IPO topping $1b
- Potash Corp. cuts profit forecast amid market uncertainty
- Device sales delays possible as shutdown halts FCC reviews
- Brevan Howard said to start fund run by ex-Deutsche Bank team
- China Greenland to invest in $5b New York property deal
- Google moved EU8.8b in royalty payments to Bermuda in 2012: FT
- ESM’s Regling says Greece widely expected to need new bailout
- Royal Mail surges on opening following oversubscribed IPO
- U.S. Debt Deadline, China GDP, Google, GE: Wk Ahead Oct. 12-19
- JPMorgan Chase (JPM) 7am, $1.29 - Preview
- Webster Financial (WBS) 8am, $0.49
- Wells Fargo (WFC) 8am, $0.97 - Preview
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Corn Tumbles to Three-Year Low on U.S. Harvest, Ethanol Mandate
- Gold Analysts Bearish on Signs of U.S. Compromise: Commodities
- IEA Sees Oil Output From Outside OPEC Rising Most Since 1970s
- Cocoa Jumps to Highest in Almost Two Years as Supply Falls Short
- Copper Rises for Second Day on Strengthening Chinese Car Sales
- WTI Crude Set for Weekly Decline; IEA Sees Non-OPEC Supply Boom
- Gold Heads for Second Weekly Loss as U.S. Impasse Seen Ending
- Rebar Gains for Second Week on China Restocking, Iron Ore Prices
- Falling Copper Grades Show Super Cycle Intact: Chart of the Day
- Coal 4-Year Low Lures Utilities Ignoring Climate: Energy Markets
- U.S. Oil Boom Races Against Red Queen as Shale Wells Fade Fast
- Shale Ascendancy in Europe Displaces Pipeline Gas: Bear Case
- Lukashenko Calls for Potash ‘Cartel’ Revival to Boost Price
- Sugar Climbs in New York as Brazil May Slow Sales for Now
The Hedgeye Macro Team