“Difficulties are just things to overcome, after all.”
Sir Ernest Shackleton was one of the principal figures of a period known as the Heroic Age of Antarctic Exploration. Initially, this period was most identified by Roald Amundsen reaching the South Pole in December 1911. Shackleton decided to try to one up Amundsen and launched an expedition to cross Antarctica from sea-to-sea over the pole.
In 1914, Shackleton began fundraising for this “Imperial Trans-Antarctic Expedition”, which was eventually launched in September 1914 despite the outbreak of World War I. Misfortune struck Shackleton and his crew early in the trip when their ship, the Endurance, was frozen into an ice flow in the Weddell Sea. The ship eventually had to be abandoned.
For the next almost 500 days, Shackleton and his men were stranded in Antarctica. They had no contact to the outside world and routinely faced temperatures that dipped below -50 degrees Celsius. Eventually after an almost impossible trip to a nearby whaling station, the entire crew was rescued. While the expedition fell short of its goal, Shackleton and his colleagues certainly gained some polar perspective.
Back to the global macro grind...
Similarly, for many hedge fund managers this has been a year to gain perspective, if not outperformance. As an example, as of the end of October 2013 the Hennessee Hedge Fund Index was up 9.9%, which paled in comparison to the return of the SP500 of north of 23%. Now to be fair, returning close to 10% on 2 and 20 money isn’t the worst thing in the world, but undoubtedly for many underperforming a passive strategy by more than 1,000 basis points is frustrating.
Keith touched on this yesterday, but a key reason for the underperformance of hedge funds is the outperformance of heavily shorted stocks. Specifically, heavily shorted stocks are outperforming the SP500 by some 570 basis points this year. That’s enough to make any great short seller bi-polar!
Long / short equity managers likely aren’t the only investment managers going a little bi-polar this year. As an example, the PIMCO Total Return Fund has returned a capital eroding -0.87% in the year-to-date. Clearly, the big bond boys at PIMCO are having some performance issues (not to say that it would at all be easy to steward that much capital!).
The broader issue with bond managers of course is how far afield they eventually have to search for yield. Just like Shackleton and his crew in Antarctica, who eventually found land, the question for bond managers is ultimately: what is the cost of this search for yield?
As it relates to the PIMCO Total Return Fund, prospective underperformance may even be more concerning given the fund’s holdings and where the managers have gone to find yield. According to analysis by our Financials Team, almost 34% of PIMCO Total Returns holdings are in agency mortgage backed securities. In the Chart of the Day, we highlight the spread of agency MBS to the 10-year Treasury Yield. As the chart highlights, prior to the financial crisis this spread was ~126 basis points, but has now narrowed to ~68 basis points.
The almighty chase for yield has effectively priced mortgage backed securities to one of the lowest levels of risk that we’ve seen in the asset class. Even if the spread for Agency MBS just normalized by 50 basis points to pre-crisis levels, it would have a meaningful impact on the market. By our estimation, allowing for modified duration, a 50 basis increase (reversal of tapering for instance) in yield would lead to 5% downside in the Agency MBS market.
The issue for firms like PIMCO is that a 5% correction in one of its more significant asset class exposures is likely to lead to continued underperformance and accelerated outflows. Outflows and decreased liquidity, of course, are only likely to exacerbate any move in price in the MBS market.
The Financial Times this morning emphasized this point even further in an article looking at managers of collateralized loan obligations. According to the article, managers of CLOs have increased the proportion of risky loans that their investment vehicles are allowed to buy to the highest level on record. Currently, 55% of new leveraged loans come in the covenant lite form, which eclipses the 29% reached shortly before the financial crisis.
Covenant lite loans are fine, in theory, if the economy is stable, but if there is volatility in economic activity, these loans get much more difficult to repay for many corporates. A good analogy is probably Shackleton and his crew in -50 degrees Celsius weather in Antarctica. You know weather that cold is dangerous but it is survivable, until the wind starts to blow and wind chill sets in . . .
To dig further into the topics of asset allocation, our Financials Team will be hosting a call his Thursday November 21st at 11am with Carl Hess who is the global head of Towers Watson’s investment advisory services that provides asset allocation recommendations to more than $2 trillion in assets under advisement. We think this call will provide an interesting perspective on asset allocation and active management, and if you’d like details on how to get access to the call, please email .
Given the challenges faced by large asset allocation funds that rely heavily on yield for performance, going forward it might be prudent that managers of these funds search for analysts for their investment teams with a similar advertisement to what Shackleton used to find his crew:
“Men wanted for hazardous journey. Small wages. Bitter cold. Long months of complete darkness. Constant danger. Safe return doubtful. Honour and recognition in case of success.”
Keep your head up and stick on the polar ice,
Daryl G. Jones
Director of Research
Client Talking Points
The impact of Janet "Mother of All Doves" Yellen was precisely what it should have been on both currencies and interest rates. See Dollar Down, Rates Down with no plan to taper anytime soon. The US Dollar Index failed at our Hedgeye TREND of $81.39 which makes the EUR/USD look stronger now even though the ECB cut rates.
Treasury yields sold off into and out of the Yellen Dove-Fest. Now it gets interesting as my TREND line of support is 2.63%. Resistance is 2.81%. For now, I’m looking for 2.63% to hold. So shorting Treasuries is back in my head again.
It's been just a disaster of a year for Commodities. The CRB Index hit a fresh year-to-date low yesterday down -7.8%, in spite of US Dollar weakness. After selling Gold into that Thursday Yellen bounce, my asset allocation to Commodities is back at 0%. We are short Oil too in #RealTimeAlerts.
|FIXED INCOME||4%||INTL CURRENCIES||20%|
Top Long Ideas
Our bullish call on the British Pound was borne out of our Q4 Macro themes call. We believe the health of a nation’s economy is reflected in its currency. We remain bullish on the regime change at the BOE, replacing Governor Mervyn King with Mark Carney. In its October meeting, the Bank of England voted unanimously (9-0) to keep rates on hold and the asset purchase program unchanged. If we look at the GBP/USD cross, we believe the UK’s hawkish monetary and fiscal policy should appreciate the GBP, as Bernanke/Yellen continue to burn the USD via delaying the call to taper.
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.
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
Yellen is so scary for American Purchasing Power (USD) that even the Euro hangs in post rate cut @KeithMcCullough
QUOTE OF THE DAY
Realize that if you have time to whine and complain about something then you have time to do something about it. - Anthony D'Angelo
STAT OF THE DAY
$13,000,000,000: The Justice Department and JPMorgan Chase are nearing completion of a $13 billion settlement related to the bank's past mortgage practices. A final deal is expected as soon as today.
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TODAY’S S&P 500 SET-UP – November 19, 2013
As we look at today's setup for the S&P 500, the range is 30 points or 0.87% downside to 1776 and 0.81% upside to 1806.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 2.40 from 2.39
- VIX closed at 13.1 1 day percent change of 7.47%
MACRO DATA POINTS (Bloomberg Estimates):
- 8:30am: Employment Cost Index, 3Q, est. 0.5% (prior 0.5%)
- 9:am: Chicago Fed’s annual agriculture conference
- 11am: Fed to purchase $2.75b-$3.5b in 2021-2023 sector
- 11:30am: U.S. to sell 4W bills
- 2:15pm: Fed’s Evans speaks in Chicago
- 4:30pm: API weekly oil inventories
- 7pm: Fed’s Bernanke speaks to Economists Club in Washington
- 8:40am Institute of Medicine holds workshop on impact of Affordable Care Act on preparedness resources, programs. Asst HHS Sec. Nicole Lurie to speak. National Academy of Sciences
- 1:30pm: Vice President Joe Biden travels to Houston to speak on infrastructure, economy; Transportation Sec. Anthony Foxx attends.
- 1pm: Media briefing by Press Sec. Jay Carney.
- 1pm:U.S. Department of the Interior Bureau of Reclamation holds a public meeting and technical workshop on cost allocation study for the Central Valley Project
- 3pm: Senate Cmte on Homeland Security and Governmental Affairs holds hearing on risks of virtual currencies, with Bitcoin Foundation General Counsel Patrick Murck. 342 Dirksen
- 2pm: Office of the Comptroller of the Currency’s Mutual Savings Association Advisory Cmte holds a public meeting on current condition, regulatory changes of mutual savings
WHAT TO WATCH:
- JPMorgan said to agree to final details of $13b settlement
- JPMorgan said in talks to sell $4b private-equity stakes
- U.S. opens probe of fires in Tesla’s Model S electric sedan
- OECD cuts global growth forecasts on emerging-market slowdown
- Apple can pursue U.S. block of Samsung smartphones, court says
- Apple said to be in talks to Buy Israel’s PrimeSense
- Sony said hiring Bain to find $100m in entertainment cuts
- Dropbox said to be seeking more than $8b value in funding
- Yellen nomination for Fed chairman to get panel vote this wk
- NLRB accuses Wal-Mart of illegally firing workers who protested
- Cepsa to Buy Coastal Energy for $2.2b to raise Asian Output
- CLP agrees to pay $1.8b for stakes in two Exxon units
- European car sales rise second straight month on Spain surge
- Camp aide said to tell groups tax proposal possible by January
- U.K. said to investigate traders’ personal currency dealing
- Spain sells 1-yr bills to yield 0.678%, lowest on record
- Best Buy Co (BBY) 7am, $0.12 - Preview
- Campbell Soup Co (CPB) 7:30am, $0.86
- Diana Shipping (DSX) 7:45am, $(0.06)
- Dick’s Sporting Goods (DKS) 7:30am, $0.39 - Preview
- George Weston (WN CN) 8am, $1.44
- Home Depot (HD) 6am, $0.90 - Preview
- La-Z-Boy (LZB) 4pm, $0.26
- Medtronic (MDT) 7:15am, $0.90 - Preview
- Saks (SKS) 8am, $0.11
- TJX Cos. (TJX) 8:28am, $0.74 - Preview
- Trina Solar (TSL) 6:30am, $(0.21)
- Valspar (VAL) 7:30am, $0.92
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Indonesia Weighs Ore Ban as Citigroup Increases Nickel Forecast
- Gold No Slam-Dunk Sell in China as Aunties Pounce: Commodities
- WTI-Brent Nears Widest Since March Amid Stimulus Taper Talk
- Copper Declines to Three-Month Low on U.S. Builder Sentiment
- Cocoa Halts Rally as Ghana May Accelerate Sales From Next Crop
- Rubber Declines for Second Day as Yen’s Rebound Weakens Appeal
- Gold Swings as Investors Weigh Stimulus After Rally in Equities
- Wall Street Pushes Back on CFTC’s Advisory for Overseas Swaps
- Egypt’s Thirst for Cheap Gas Threatens Export Prospects: Energy
- Japan Seeks to Buy Most Milling Wheat in Three Months in Tender
- Zinc Premium Said to Be Steady in Past Month During Supply Talks
- Onions Bring Tears to RBI’s Rajan as Prices Surge: India Credit
- Rio Tinto, Paladin Uranium Mines in Namibia Face Water Shortage
- Rebar Advances in Shanghai on Lower Stockpiles, Demand Outlook
The Hedgeye Macro Team
This note was originally published at 8am on November 05, 2013 for Hedgeye subscribers.
“The mechanization of ginning, spinning, and weaving the cotton launched the industrial revolution.”
The cotton gin was 1793. Twitter was 2006. Eli Whitney and Jack Dorsey had more than a few things in common. One was their age (Whitney was a 28 yr old teacher and Dorsey was a 29 yr old web developer/failed shoe salesman). That’s where revolutions come from, baby. As my man Brandon Flowers wrote in “Only The Young” (great tune):
“Look back in silence; the cradle of your whole life. There in the distance, losing its greatest prize. Nothing is easy, nothing is sacred. Why? Where did the bough break? It happened before your time. Only the young can break away, break away…“
And so it continues to begin – the unearthing of every single Western academic dogma about economics and markets ever spun. The unraveling of a weave of storytellers that only my God can be smiling down upon as stronger currencies lead new peoples to the promise land of purchasing power. Behold, the Information Revolution in financial markets is here!
Back to the Global Macro Grind…
Tomorrow at 11AM EST, Hedgeye veteran blue-liner, Daryl Jones, and Hesham Shaaban will host a Black Book conference call on the Twitter IPO (if you’d like information on how to access the call, ping Sales@Hedgeye.com). It’s a fascinating story within the history we are building here @Hedgeye. I see it as our Trojan Horse in taking down the #OldWall of aforementioned dogmas.
Mr. Market, take down that #OldWall!
How is that going to work? Let’s just look at what we did using Twitter yesterday in order to front-run a ridiculous #OldWall financial media meme that the Fed being on taper-hold is a “good” thing for growth:
- All research starts with asking the right question – our clients often ask, “Isn’t #RatesRising Bad for Growth?”
- So we created a video answering that simple question with a simple answer @HedgeyeTV: http://www.youtube.com/watch?v=BthNo_F6yvQ
- And we went on to answer two more big client questions we have been getting, then tweeted it (and re-tweeted it)
In the stone age of perceived financial market and economic wisdoms, you didn’t have Twitter, Videostreaming, YouTube, etc. So you actually had to take the government’s (and the banks they bail out) word for it on these economic history matters.
Ginning, spinning, and weaving, these academic dudes (and dudettes) who have never risk managed markets can get really creative. So was Karl Marx in introducing the adored Obama concept of #ClassWarfare in the first sentence of the Communist Manifesto.
And who the heck am I to call these people out? Sometimes I feel like a modern day version of some Iroquois or Creek Indian who is sitting here creating things (like cotton and rubber - you know, the stuff all the white dudes actually started to use). But what do I know?
What do you know?
The more I read, the less I know. So, admittedly, I do get a little frustrated to see central planning bureaucrats like Jim Bullard @FederalReserve on Big Government Intervention TV spewing economic forecasts that are rarely right, but never in doubt.
At one point yesterday @CNBC, Bullard actually said that it’s time Americans see QE (money printing, Dollar Devaluation, and 0% rates of return on your hard earned savings accounts) as a “normal policy position.”
Go back to that Iroquois style @HedgeyeTV video Darius Dale and I did and see the next popular client question: “How Concerned Are You About A Major Dislocation in the Credit Markets?”
Bullard, dude, there is nothing normal about credit markets that go no-bid when a bond ticks down half a point. Wake up man. You and your boy Bernanke have a “new normal” alright. It’s called a MBS bond bubble that people can’t get out of!
In other counter-Keynesian-consensus-dogma-economic-news this morning:
BREAKING: UK Services PMI for OCT hits a 16yr high at 62.5
Huh? With austerity and a #StrongerCurrency (we’re long the British Pound) the United Kingdom is seeing #GrowthAccelerating? You bet your Danny Blanchflower (Dartmouth Dogma professor of Currency Devaluation and Big Government Spending) it’s accelerating.
This morning, to be sure on my historical account, I went back to the time period I reviewed with my kids this weekend in the movie “Free-Birds” (where turkeys try to turn back the clocks on being slaughtered for Thanksgiving), and the replay still shows that there has never been a country that has devalued its way to long-term economic prosperity. Danny, you can’t turn back the clock. Gobble, gobble.
#StrongCurrency = Deflates The Inflation and real (inflation adjusted) consumption #GrowthAccelerating.
On the margin, that’s Europe now (not the USA –it was the USA 10 months ago):
- Swiss Consumer Prices (CPI) drop to -0.3% y/y in OCT = consumption tax cut for consumers
- Eurozone PPI (producer prices) drop -0.9% y/y in SEP = cost of goods tax cut for producers (good for margins)
And on what planet are Old World pundits allowed to fear-monger you that Deflating The Inflation is a bad thing? I guess maybe Pluto, Dartmouth (sorry guys, I’m picking on Blanchflower), or one that doesn’t have Twitter. Good luck keeping that one alive. As another revered American revolutionary, Martin Luther King Jr. reminded us, “a lie cannot live” forever.
Our immediate-term Risk Ranges are now:
Swiss Market Index 8159-8232
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
the macro show
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