“We had invested very heavily over a very long period of time in the education of quality leaders.”
John Allison retired in 2010 after building one of the best banks in US history. “BB&T made it through the sub-prime crisis without a single quarterly loss… In Allison’s 19 years as CEO, BB&T grew from a statewide bank… to a $152B bank operating in 11 southern states and the District of Columbia.”
“We had really strong presidents … they had a much higher level of authority than our competitors… they were held responsible – they owned the process.” –Allison (Knowledge and Power, pg 172)
Sounds like our central bank, right? Ha! Especially the crony boys from mediocre-land (downtown at the New York Federal Reserve Bank). That’s where you’ll find below-average-at-best Bill Dudley and his whipping boy Simon Potter. These guys aren’t leaders. They are academic group-thinkers. And one day, all of their conflicted “smoothing” decisions will come home to roost. Mark my tweets.
Back to the Global Macro Grind…
If you want to get into the holiday anti-Fed mood, pick up a copy of the book John Allison published this year – The Financial Crisis and the Free Market Cure. It contains 0% of the Fed-access-propaganda you see paraded around with CNBC’s Keynesian peacocks every day. They are real thoughts from a real-time risk manager of banking and non-linear market risk.
“In my career, the Fed has a 100% error rate in predicting and reacting to important economic turns… because it is trying to arbitrarily set the single most important price of the economy – the price of money… setting wage and price controls from the time of Diocletian to Nixon, has proven in every case a disaster for economies and the people entrapped by them.” (Knowledge and Power, pg 175)
In other news this morning, after stuffing the New York financial media with crab cakes and vino last night, the Fed’s anti-dog-eat-dog-price-controller-of gravity, currency, and rates (Simon Potter) proclaimed his mystery of faith that “operationally, market participants generally characterize the exercise as smooth, with minimal disruptions.”
Potter, of course, is talking about what Thomas Jefferson surely had in mind - a reverse-repo-facility from the Fed that will look over Americans while they sleep. Chartreuse for everyone in NYC. This is the new America we all believe in, baby! (I’ll have a Bud Light pls)
Meanwhile, US stocks are pinned by a vacuum of Fed stimulated performance chasing all-time bubble highs, on no volume, and rising implied volatility signals.
By “minimal disruptions” what the NY Fed means is that @PIMCO doesn’t have to worry about economic information surprises being market-to-market on the long-end of the yield curve.
As evidenced by June and August spikes in US #RatesRising, there is nothing “smooth” about US currency and/or rate markets trading freely anymore. Oh, and The Fed needs to find a way to get people out of an MBS market bubble that doesn’t trade, don’t forget.
That’s why yesterday’s story within Mr. Macro Market’s score was so revealing. Follow the bouncing ball of events in the order that they appeared:
- 10:00 AM – ISM of 57.3 for NOV surprised on the upside (driven by New Orders of 63.6 and Employment at a fresh YTD high)
- 10:14 AM – US stocks put in their low of the day as the market got briefly confused about great news being bad re Fed-taper
- 12:30 PM – SP500 stops going up at an all-time high of 1810 as #RatesRising push higher, Gold lower
4:00PM EST – US stocks close on their lows of the day; US Equity Volatility (VIX) closes at the high of the day
In other words, to John Allison’s point, the Fed continues to look silly whenever it hinges policy on its forecasts. Its 2013 forecast on US consumption and employment growth were dead wrong. So now the Fed is behind the curve, making stuff up, in a Sisyphean fight for its academic dogma.
We’re going to get a 3% handle on US GDP this week (Thursday) and all the Fed’s open-market-storytelling communications will be able to do is make up more reasons why you should think this is still 2008. Fear, forever.
And guess what – if you let them, they might just perpetuate their own reality this time. The next crisis is going to be a central planning one. America hasn’t invested in Paul Volcker type leadership at the Fed. We are hostage to un-elected NYC banking group-thinkers.
10yr Yield 2.71-2.81%
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
the macro show
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TODAY’S S&P 500 SET-UP – December 3, 2013
As we look at today's setup for the S&P 500, the range is 33 points or 1.05% downside to 1782 and 0.78% upside to 1815.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 2.50 from 2.51
- VIX closed at 14.23 1 day percent change of 3.87%
MACRO DATA POINTS (Bloomberg Estimates):
- 7:45am/8:55am: ICSC/Redbook weekly retail sales
- 9:45am: ISM New York, Nov. (prior 59.3)
- 10am: IBD/TIPP Economic Optimism, Dec., est. 43, (pr 41.4)
- 1pm: Fed’s Lacker testifies on bankruptcy to House subcmte
- 2pm: Fed to buy $3b-$4b 2019-2020 notes
- 4:30pm: API weekly oil inventories
- 5pm: Total Vehicle Sales, Nov., est. 15.8m (prior 15.15m)
- Domestic Vehicle Sales, Nov., est. 12.2m (prior 11.73m)
- House in session, Senate out until Dec. 9
- 9:15am: SEC Chairwoman Mary Jo White delivers remarks at meeting of European Corporate Governance Inst.
- 10am: House Oversight and Government Reform panel holds hearing on design-build contract
- 10am: American Antitrust Inst. holds Private Antitrust Enforcement conf. National Press Club
- 11am: Obama hosts Colombian President Juan Manuel Santos at White House
- 1:25pm: U.S. Chamber of Commerce President Thomas Donohue discusses regulatory environment for business community
- VP Joe Biden meets with Japan Prime Minister Shinzo Abe, Deputy Prime Minister Taro Aso in Tokyo
WHAT TO WATCH:
- S&P says U.S. fraud lawsuit over ratings is too big to work
- Apple buys real-time access to Twitter’s feed with Topsy deal
- Wang Jianlin’s AMC Entertainment to seek $368m in IPO
- Tesla says German agency’s review clears model S after fires
- Fed doesn’t object to Goldman, JPMorgan capital plans
- Hong Kong confirms city’s first human case of H7N9 bird flu
- Google cuts prices on cloud services in Amazon, IBM challenge
- Yuan passes euro to be second-most used trade-finance currency
- Biden to stress opposition to China defense zone in Japan visit
- Rio Tinto to halve capital spending by 2015 in focus on cash
- Toshiba to acquire most OCZ assets out of bankruptcy for $35m
- Number of federally-insured U.S. banks falls to 6,891: WSJ
- Sony Playstation 4 sales top 2.1 million
- Cyber Monday sales soar to record
- Bank of Montreal (BMO CN) 6:30am, C$1.57 -- Preview
- Bob Evans Farms (BOBE) 4pm, $0.55
- Golub Capital BDC (GBDC) 4:15pm, $0.33
- Guidewire Software (GWRE) 4:01pm, $(0.16)
- OmniVision Technologies (OVTI), 4:18pm, $0.43
- United Natural Foods (UNFI) 4:05pm, $0.54
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Copper Falls as Reviving U.S. Economy Fuels Tapering Speculation
- Gold Bulls Retreat as Prices Drop to Four-Month Low: Commodities
- WTI Crude Gains a Third Day; OPEC Set to Maintain Output Limit
- Gold Pares Gains in London, Is Little-Changed at $1,219.34/Oz
- Wheat Climbs From Biggest Drop in a Month as Demand Increases
- Sugar Reaches Three-Year Low as Indian Dispute Ends; Cocoa Drops
- Rebar Rises to Seven-Week High on China Demand Growth Outlook
- China May Halt Corn Imports From U.S. on GMO Cargoes, Yigu Says
- Volcker Rule Said Set for Dec. 10 Approval by U.S. Regulators
- Wider Oil-Price Gap Seen Aiding U.S. Refiners: Chart of the Day
- Hedge Fund Bullish Gas Bets Surge on Cold Blast: Energy Markets
- Rio Tinto to Halve Capital Spending by 2015 in Focus on Cash
- West of Shetland Has Substantial Exploration Potential, BP Says
- Korea Exchange Targets Gold Trading as Park Hunts Tax Revenue
The Hedgeye Macro Team
This note was originally published at 8am on November 19, 2013 for Hedgeye subscribers.
“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 firstname.lastname@example.org.
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
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