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Speculative Natures

This note was originally published at 8am on December 11, 2013 for Hedgeye subscribers.

“Time destroys the speculation of men, but it confirms nature.”

-Cicero

 

Marcus Tullius Cicero was a Roman philosopher, politician, lawyer, orator, political theorist, and constitutionalist (no word on whether he played hockey).  His impact on the Latin language was so deep that the history of prose in both Latin and European languages, up until the 19th century, is said to be either a reaction against or a return to his style.   To use a sports analogy: he was an impact player.

 

Like many of you, I tend to tune out much of the main stream media, but I did catch myself watching a little bit of CNBC yesterday.  Interestingly, it actually made me realize that the buy side, sell side, and media are arguing with many of the same platitudes on the topic of tapering.  In short, no one has conviction or a strong insight.  Or certainly, unlike Cicero, their views are not having an impact. 

 

In the land of bonds, of course, Bill Gross from PIMCO is widely considered to be the impact player.  And rightfully so, as PIMCO manages over $2 trillion in assets and is the world’s largest bond investor.  Even if we don’t agree with PIMCO’s research or views, there can be no debate that the firm has the ability to impact asset prices in a meaningful reallocation.

 

So, what is the latest from the big bond boys on the taper?  Well, this is what Gross wrote in his most recent monthly letter (which is usually a fun read by the way!):

 

“The taper will lead to the elimination of QE at some point in 2014, but the 25 basis point policy rate will continue until 6.5% unemployment and 2.0% inflation at a minimum have been achieved. If so, front-end Treasury, corporate and mortgage positions should provide low but attractively defensive returns.

 

We have positioned our bond wars portfolio – heavily front-end maturity loaded along with credit, volatility and curve steepening positions, with the aim of outperforming Vanguard as well as many other active managers.”

 

In part, especially given PIMCO’s sizeable position, Gross’s job is to influence and ensure the bond market doesn’t shake, rattle, or roll in any direction that isn’t beneficial to PIMCO.   If you are Gross, you certainly want the incremental buyer to be focused on mortgage backed securities.

 

Currently, $40 billion of the Fed’s monthly purchases are in the MBS market.  In aggregate, this is more than half a trillion in annual purchases of mortgage backed securities.   The impact of multiple rounds of QE has been that the premium of Agency MBS over Treasuries has narrowed by some ~50 basis points from pre-QE to post-QE. 

 

Given that 34% of PIMCO’s Total Return Fund are in agency MBS, there is some serious interest rate risk in that position.  By our estimation, a 50 basis point move in the spread of Agency MBS has the potential to lead to 5% downside in price.  To the extent that 34% of PIMCO’s “book” has the potential to be marked down 5%, that is a big deal for PIMCO and the associated market. 

 

Reflexively, if PIMCO were to underperform, they would then be forced to liquidate MBS positions as investors exited their funds.  In turn, this would amplify any move in price.  A mass exit of PIMCO would be an “Aye Carumba” moment in the MBS market to be sure.

 

Back to the Global Macro Grind

 

On the longer end of the curve, specifically 10-year yields, tapering is getting somewhat priced in.  In the Chart of the Day, we show this graphically by comparing 10-year yields, to the Fed Funds rate, to the Federal Reserve balance sheet.  As the chart below shows, 10-year yields are now back at a level not seen since early 2011, which pre-dated QE Infinity (i.e. the open ended purchases that began in September 2012).

 

In the hypothetical world where 10-year rates actually get priced based on economic fundamentals, the current spread of 2.6% between the 10-year yield and the Fed’s discount rate may not be far off reality.  For context, the average spread between the two over the last decade was about 1.7% and since 1954 0.54%.   Certainly, the 100 basis points widening of this spread over the last year is indicative of some level of tapering being priced in. 

 

This all leads to an interesting question: will tapering be a ‘sell the news’ moment for 10-year yields?  That’s a question I’ll leave to the speculators and those that need to protect their book to answer...

 

One point that many pundits don’t seem to be talking about is that a decline in tapering will be positive for the U.S. dollar.  This is further supported by a point we have been highlighting consistently, which is that the Federal deficit has been narrowing.   In the fiscal year ending 2013, the federal deficit was below $1 trillion for the first time since 2008.

 

This improvement continued into this fiscal year as the deficit in October was -$91.6 billion, an improvement of 24% year-over-year.   The Treasury will release November’s budget numbers at 2pm and we would expect similar improvement.  In addition to this budget improvement, the fact that Congress seems to actually be functioning should also bode well for the U.S. dollar.

 

In fact, last night the House and Senate announced a two year budget deal.  Even if the deal isn’t ideal, thankfully our elected officials are at least getting out of the way and signaling to the world that they can functionally manage the country.  From a deficit perspective, there will be $63 billion in increased spending (sequester relief) over the next two years, but that shouldn’t impact the continued narrowing of federal budgets.  It’s amazing what our elected officials can accomplish when they get out of the way.

 

Just imagine what would happen if the un-elected officials at the Fed got out of the way, the strong dollar American growth story would be fully in play!

 

Our immediate-term Risk Ranges are now:

 

UST 10yr Yield 2.75-2.82% 

SPX 1785-1815 

Gold 1216-1261 

Brent 108.67-110.87 

VIX 12.85-15.28 

USD 79.67-80.49

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

Speculative Natures - 10Y Normalcy

 

Speculative Natures - virtual portfolio


28 Percent

Takeaway: Buying-The-Damn-Bubble #BTDB may not sound polite, but it's been working like a charm.

28 Percent - 881

 

The S&P 500 is up 401 points (+28%) 2013 year-to-date.

 

Gold is down $475 (-28%).

 

How's that for a macro market mirror image?

 

Buying-The-Damn-Bubble #BTDB may not sound polite, but it's been working like a charm. A stronger US Dollar and #RatesRising can perpetuate both of these moves further.

 

28 Percent - Gold vs SPX

 

Editor's note: This is an excerpt from Hedgeye CEO Keith McCullough's morning research. For more information on how you can become part of the Hedgeye Revolution click here.



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10 Bullish, 10 Bearish Trends

Takeaway: What a year it’s been.

Editor's note: This is a brief excerpt from Hedgeye CEO Keith McCullough's Morning Newsletter. Click here to learn more about how you can become a subscriber. To subscribe to Daily Trading Ranges click here.

 

10 Bullish, 10 Bearish Trends - bo9

Since my kids are giving me an opportunity to laugh and smile this morning, I’ll keep the rest of my Christmas Eve note to just levels. It’s Daddy’s day off, allegedly.

 

Most of these intermediate-term bullish and bearish TRENDs aren’t new as of this morning. With sporadic ramps in fear, they’ve been trending for the better part of a year now. What a year it’s been.

 

Top 10 Bullish TRENDS @Hedgeye (and their immediate-term TRADE risk ranges)

 

1. UST 10yr Yield 2.88-2.95% (bullish)

2. SP500 1796-1835 (bullish)

3. Nasdaq 4047-4158 (bullish)

4. Germany’s DAX 9197-9533 (bullish)

5. UK’s FTSE 6539-6719 (bullish)

6. Japan’s Nikkei 15503-15989 (bullish)

7. British Pound 1.62-1.64 (bullish)

8. Euro (EUR/USD) 1.36-1.38 (bullish)

9. Brent Oil 109.89-112.12 (bullish)

10. Natural Gas 4.36-4.51 (bullish)

 

Top 10 Bearish TRENDS @Hedgeye (and their immediate-term TRADE risk ranges)

 

1. BOND (PIMCO Total Return Fund) 104.31-105.32 (bearish)

2. Long-term Treasuries (TLT) 102.08-104.77 (bearish)

3. Short-term Treasuries (SHY) 84.09-84.57 (bearish)

4. Emerging Markets (MSCI EM Index) 977-1009 (bearish)

5. Brazil’s Bovespa 49,308-52,172 (bearish)

6. US Equity Volatility (VIX) 12.56-14.91 (bearish)

7. Gold 1179-1221 (bearish)

8. Silver 19.01-19.97 (bearish)

9. Wheat 5.89-6.38 (bearish)

10. Japanese Yen (vs USD) 102.48-104.92

 

From our family and firm to yours, we’d like to thank you for your business and wish you both a very Merry Christmas and a Happy Holiday season.

 

Click here to join the Hedgeye Revolution.

 



Laugh, Smile

“There is nothing in the world so irresistibly contagious as laughter.”

-Charles Dickens

 

Charles Dickens started writing A Christmas Carol in 1843 as a progressive economic answer to the fear-mongering of the politicians of his age. Negativity, after all, is a long-standing and regressive (but effective) political strategy.

 

Sylvia Nasar quotes Dickens in Grand Pursuit - he called his story “a tale capable of twenty times the force - twenty thousand times the force of a political pamphlet.” The narrative “argues the economic historian James Henderson, is an attack on Malthus… an England characterized by New world abundance rather than Old World scarcity.” (Nasar, pg 7)

 

New versus old. Rich versus poor. These are timeless realities of life. But they don’t always have to oppose one another. Leaders, across centuries, have found a positive alternative to perdition’s path. This time was not “different.” There was no “new normal” either. Like laughter, the truth is contagious. And the truth is that patterns of human behavior and business cycles repeat.

 

Back to the Global Macro Grind

 

The SP500 and Gold are up 401 points (+28.1%) and down $475 (-28.3%), respectively for 2013 YTD. Depending on who you are talking to, that reality will either make them laugh or cry!

 

As Dickens wrote in A Christmas Carol, “no space of regret can make amends for one life’s opportunity misused.” And oh boy was investing in growth (and shorting fear) quite the opportunity.

 

Since my kids are giving me an opportunity to laugh and smile this morning, I’ll keep the rest of my Christmas Eve note to just levels. It’s Daddy’s day off, allegedly.

 

Top 10 Bullish TRENDS @Hedgeye (and their immediate-term TRADE risk ranges)

 

1. UST 10yr Yield 2.88-2.95% (bullish)

2. SP-1835 (bullish)

3. Nasdaq 4047-4158 (bullish)

4. Germany’s DAX 9197-9533 (bullish)

5. UK’s FTSE 6 (bullish)

6. Japan’s Nikkei 159 (bullish)

7. British Pound 1.62-1.64 (bullish)

8. Euro (EUR/USD) 1.36-1.38 (bullish)

9. Brent Oil 109.89-112.12 (bullish)

10. Natural Gas 4.36-4.51 (bullish)

 

Top 10 Bearish TRENDS @Hedgeye (and their immediate-term TRADE risk ranges)

 

1. BOND (PIMCO Total Return Fund) 104.31-105.32 (bearish)

2. Long-term Treasuries (TLT) 102.08-104.77 (bearish)

3. Short-term Treasuries (SHY) 84.09-84.57 (bearish)

4. Emerging Markets (MSCI EM Index) (bearish)

5. Brazil’s Bovespa 49,308-52,172 (bearish)

6. US Equity Volatility (VIX) 12.56-14.91 (bearish)

7. Gold 1179-1221 (bearish)

8. Silver 19.01-19.97 (bearish)

9. Wheat 5.89-6.38 (bearish)

10. Japanese Yen (vs USD) 102.48-104.92

 

Most of these intermediate-term bullish and bearish TRENDs aren’t new as of this morning. With sporadic ramps in fear, they’ve been trending for the better part of a year now. What a year it’s been.

 

From our family and firm to yours, we’d like to thank you for your business and wish you both a very Merry Christmas and a Happy Holiday season,

 

KM

 

Keith R. McCullough
Chief Executive Officer

 

Laugh, Smile - Chart of the Day

 

Laugh, Smile - Virtual Portfolio


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