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The Herd Goes Astray

Client Talking Points

JAPAN

Consensus is (was) long Nikkei and short Yen. Why? Because it was working last year. Big time. Now it’s not as the Yen moves to +3% YTD versus the US Dollar and the Nikkei drops another -2.5% overnight to -7.9% YTD. I finally shorted the Yen on Friday on an overbought signal. The Nikkei should bounce tonight off the oversold signal, but its dicey. We have no position there as we think Japanese growth slows.

COMMODITIES

With global growth expectations getting rocked last week, the CRB Index (19 commodities) closed up +1.5% on the week. #InflationAccelerating perpetuates #GrowthSlowing in our model. That’s why we do not like Consumer stocks, especially US restaurants. There are plenty of ways to play our Q1 Macro Theme. 

UST 10YR

For the last few years, the 10-year yield has tracked the rate of change of US growth as well as anything we model. Now, with US consumption #GrowthSlowing, the 10-year yield is snapping the Hedgeye TREND support of 2.79% last week makes sense to me. So does Gold going up on that (GLD loves rates down).

Asset Allocation

CASH 39% US EQUITIES 12%
INTL EQUITIES 15% COMMODITIES 10%
FIXED INCOME 0% INTL CURRENCIES 24%

Top Long Ideas

Company Ticker Sector Duration
JPM

JPMorgan shares are currently trading with the most implied upside to fair value in our fair value model for money-center, super-regional and regional bank stocks. By our estimates, JPM shares have upside of 33% based on our regression of EVA (economic value added) – which looks at the spread between return on capital and cost of capital – and the current multiple to tangible book value. Over time, we have found that sizeable discounts and premiums mean revert toward fair value giving JPMorgan an embedded tailwind in 2014.

FXB

We remain bullish on the British Pound versus the US Dollar, a position supported over the intermediate term TREND by prudent management of interest rate policy from Mark Carney at the BOE (oriented towards hiking rather than cutting as conditions improve) and the Bank maintaining its existing asset purchase program (QE). UK high frequency data continues to offer evidence of emergent strength in the economy, and in many cases the data is outperforming that of its western European peers, which should provide further strength to the currency. In short, we believe a strengthening UK economy coupled with the comparative hawkishness of the BOE (vs. Yellen et al.) will further perpetuate #StrongPound over the intermediate term.

DRI

Darden is the world’s largest full service restaurant company. The company operates +2000 restaurants in the U.S. and Canada, including Olive Garden, Red Lobster, LongHorn and Capital Grille. Management has been under a firestorm of criticism for poor performance. Hedgeye's Howard Penney has been at the forefront of this activist movement since early 2013, when he first identified the potential for unleashing significant value creation for Darden shareholders. Less than a year later, it looks like Penney’s plan is coming to fruition. Penney (who thinks DRI is grossly mismanaged and in need of a major overhaul) believes activists will drive material change at Darden. This would obviously be extremely bullish for shareholders and could happen fairly soon driving shares materially higher.

Three for the Road

TWEET OF THE DAY

TREASURIES: 2.74% 10yr yield is currently below @Hedgeye TREND support - that's new (good for Gold) @KeithMcCullough

QUOTE OF THE DAY

"The stock market is never obvious. It is designed to fool most of the people, most of the time." - Jesse Livermore

STAT OF THE DAY

The dollar has shed nearly 2% in the past three sessions as investors saw currencies like the yen and the Swiss franc as relatively safe while a sell off in emerging markets assets picked up pace late last week. (Reuters)


MONDAY MORNING RISK MONITOR: IS IT TIME TO PANIC?

Takeaway: Anything with tentacles into emerging markets is getting hit. Citi is the bullseye among large cap US, although GS & MS are not far behind.

Summary:

While the bonfire that is emerging market currencies keeps burning, the systemic interbank risk measures in the US, Europe and China remain benign (for now). TED Spread, Euribor-OIS and Shifon are all less impressed with what's happened thus far in Argentina, Turkey and elsewhere. Fundamentally speaking, history has shown that when these interbank measures show little sign of alarm it has historically indicated a good time to take advantage of fear/weakness. Tactically speaking, however, be mindful that the Hedgeye TREND line of support on the XLF is $21.01 and we'd be cautious about buying weakness in a broken TRADE/TREND environment. 

 

Key Points:

* XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 2.7% upside to TRADE resistance and 0.5% downside to TREND support. The important line in the sand here is the TREND line of support at $21.01. 

 

* U.S. Financial CDS -  Large cap US banks saw their credit default swap spreads widen sharply last week on the growing concerns around emerging market risk and potential for contagion. Citi saw the biggest move, rising 17 bps to 89 bps. GS and MS were close behind, up 15 bps apiece. While spreads widened almost across the board, the domestic-focused banks were predictably less impacted.

 

* 2-10 Spread – Last week the 2-10 spread tightened a further 7 bps to 238 bps. In the past month it has compresed 20 bps. 

 

* Euribor-OIS Spread – The Euribor-OIS spread tightened by 1 bps to 11 bps. 

 

* TED Spread – The TED spread fell 1.7 basis points last week, ending the week at 18.7 bps this week versus last week’s print of 20.36 bps.

 

* High Yield (YTM) Monitor – High Yield rates rose 11.7 bps last week, ending the week at 5.95% versus 5.83% the prior week.

 

Financial Risk Monitor Summary

 • Short-term(WoW): Positive / 7 of 13 improved / 1 out of 13 worsened / 5 of 13 unchanged

 • Intermediate-term(WoW): Negative / 4 of 13 improved / 5 out of 13 worsened / 4 of 13 unchanged

 • Long-term(WoW): Positive / 5 of 13 improved / 0 out of 13 worsened / 8 of 13 unchanged

 

MONDAY MORNING RISK MONITOR: IS IT TIME TO PANIC? - 15

 

1. U.S. Financial CDS -  Large cap US banks saw their credit default swap spreads widen sharply last week on the growing concerns around emerging market risk and potential for contagion. Citi saw the biggest move, rising 17 bps to 89 bps. GS and MS were close behind, up 15 bps apiece. While spreads widened almost across the board, the domestic-focused banks were predictably less impacted.

 

Tightened the most WoW: MBI, AGO, MTG

Widened the most WoW: C, GNW, SLM

Tightened the most WoW: AGO, MBI, MTG

Widened the most MoM: C, AXP, GNW

 

MONDAY MORNING RISK MONITOR: IS IT TIME TO PANIC? - 1

 

2. European Financial CDS - Swaps were sharply higher across Europe's banks last week. UK banks fared equally poorly alongside their French, German, Spanish and Italian counterparts.

 

MONDAY MORNING RISK MONITOR: IS IT TIME TO PANIC? - 2

 

3. Asian Financial CDS - Chinese bank swaps were up sharply last week, extending the month-over-month trend. 

 

MONDAY MORNING RISK MONITOR: IS IT TIME TO PANIC? - 17

 

4. Sovereign CDS – Sovereign swaps widened almost across the board last week with the biggest moves occurring in Portugal and Italy (+25 and +19 bps). Meanwhile, the US and Germany were unchanged at 28 and 23 bps, respectively. 

 

MONDAY MORNING RISK MONITOR: IS IT TIME TO PANIC? - 18

 

MONDAY MORNING RISK MONITOR: IS IT TIME TO PANIC? - 3

 

MONDAY MORNING RISK MONITOR: IS IT TIME TO PANIC? - 4

 

5. High Yield (YTM) Monitor – High Yield rates rose 11.7 bps last week, ending the week at 5.95% versus 5.83% the prior week.

 

MONDAY MORNING RISK MONITOR: IS IT TIME TO PANIC? - 5

 

6. Leveraged Loan Index Monitor – The Leveraged Loan Index was unchanged last week at 1850.

 

MONDAY MORNING RISK MONITOR: IS IT TIME TO PANIC? - 6

 

7. TED Spread – The TED spread fell 1.7 basis points last week, ending the week at 18.7 bps this week versus last week’s print of 20.36 bps.

 

MONDAY MORNING RISK MONITOR: IS IT TIME TO PANIC? - 7

 

8. CRB Commodity Price Index – The CRB index rose 1.7%, ending the week at 283 versus 278 the prior week. As compared with the prior month, commodity prices have decreased -0.1% We generally regard changes in commodity prices on the margin as having meaningful consumption implications.

 

MONDAY MORNING RISK MONITOR: IS IT TIME TO PANIC? - 8

 

9. Euribor-OIS Spread – The Euribor-OIS spread tightened by 1 bps to 11 bps. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. 

 

MONDAY MORNING RISK MONITOR: IS IT TIME TO PANIC? - 9

 

10. Chinese Interbank Rate (Shifon Index) –  The Shifon Index rose an impressive 88 basis points last week, ending the week at 3.7% versus last week’s print of 2.82%. That said, the index remains down on a month-over-month basis and is still nowhere near its mid-2013 high of over 13%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.

 

MONDAY MORNING RISK MONITOR: IS IT TIME TO PANIC? - 10

 

11. Markit MCDX Index Monitor – The muni market seems relatively unfazed by what's going on in emerging markets. Last week, MCDX spreads were unchanged at 77 bps. The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 16-V1.

 

MONDAY MORNING RISK MONITOR: IS IT TIME TO PANIC? - 11

 

12. Chinese Steel – Steel prices in China fell 0.5% last week, or 16 yuan/ton, to 3,403 yuan/ton, but have fallen 1.9% in the past month and as the chart below shows the trend is down and rather linear. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.

 

MONDAY MORNING RISK MONITOR: IS IT TIME TO PANIC? - 12

 

13. 2-10 Spread – Last week the 2-10 spread tightened a further 7 bps to 238 bps. In the past month it has compresed 20 bps. We track the 2-10 spread as an indicator of bank margin pressure.

 

MONDAY MORNING RISK MONITOR: IS IT TIME TO PANIC? - 13

 

14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 2.7% upside to TRADE resistance and 0.5% downside to TREND support. The important line in the sand here is the TREND line of support at $21.01.

 

MONDAY MORNING RISK MONITOR: IS IT TIME TO PANIC? - 14

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 


THE WEEK AHEAD

The Economic Data calendar for the week of the 27th of January through the 31st is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.

 

THE WEEK AHEAD - week


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

January 27, 2014

January 27, 2014 - Slide1

 

BULLISH TRENDS

January 27, 2014 - Slide2

January 27, 2014 - Slide3

January 27, 2014 - Slide4

January 27, 2014 - Slide5

January 27, 2014 - Slide6

 January 27, 2014 - Slide7

BEARISH TRENDS

January 27, 2014 - Slide8

January 27, 2014 - Slide9

January 27, 2014 - Slide10

January 27, 2014 - Slide11
January 27, 2014 - Slide12

 



Dog or Wolf?

“The hour between dog and wolf, that is, dusk.”

-Jean Genet

 

Customer questions on Friday went something like this: ‘Keith, was that a bull or bear? Dog or wolf? What do you think?’ I don’t know. But I’m not in the business of walking up to a bear in the dark without a real-time gun! So let’s stay on our toes here and react accordingly. The best market calls are made by Mr. Macro Market, not me.

 

Ironically enough, last week I started reading the latest behavioral psych book to bubble up to the top of my pile, The Hour Between Dog and WolfRisk Taking, Gut Feelings and the Biology of Boom and Bust, by former Goldman/Deutsche trader, John Coates.

 

In his introduction, “it has been said of war that is consists of long stretches of boredom punctuated by brief periods of terror, and much the same can be said of trading” (Coates, pg 5). I’d say that if you were buying-the-damn-bubble #BTDB on Wednesday and Thursday of last week, Friday’s move, punctuated by a +45.8% VIX rip on the week, felt like terror.

 

Back to the Global Macro Grind

 

First, instead of screaming bloody murder this morning, let’s contextualize where Friday’s -2.09% drop in the SP500 came from. In an intraday note (11:45 AM on Thursday January 23rd) I wrote a risk management note titled “Not #BTDB Today” and outlined 3 main issues that were signaling in our model:

  1. US Consumption #GrowthSlowing (rate of change vs. Q313’s sequential top)
  2. SP500 broke our immediate-term TRADE line of 1837 support
  3. US stocks making lower-highs (vs. all-time highs) and down YTD perpetuates performance chasing

In other words, this was very much a playbook 3-factor (History, Math, and Behavioral) line of reasoning that seems sound, after the fall:

  1. HISTORY: our Q114 Macro Theme of #InflationAccelerating has historically slowed consumption growth
  2. MATH: immediate-term TRADE signals matter in either confirming existing TRENDs or signaling new ones
  3. BEHAVIORAL: consensus is still in the business of chasing (buying) high and freaking out (selling) low

Got #InflationAccelerating?

  1. The US Dollar (index) was down a full -0.9% last week (down -2.2% now in the last 6 months)
  2. The CRB Index (19 commodities) was +1.5% last week vs the SP500 -2.6%
  3. US Consumer Discretionary Stocks (XLY) are already down -4.98% YTD (vs SPX -3.1%)

And while, Janet Yellen’s new Fed will see no inflation this week (on a lag, after comping the all-time highs in food/commodity inflation of 2011-2012), real-time men and women trying to decide between dog and wolf see breakevens (inflation expectations rising) and Natural Gas +19.8% last week for what it is, on the margin, #inflationary.

 

Interestingly, but not surprisingly, so does Mr. Macro Market. Remember that down days for US stocks in 2014 have been #timestamped frequently by the following pattern: Down Dollar + Down Rates = Down Stocks.

 

That’s why the immediate-term TRADE correlations between the US Dollar and the SP500 are as follows:

  1. 15-day = +0.66
  2. 30-day = +0.43

In other words, if economic gravity still matters (it does), and the Dollar and Rates are signaling bear (on the slope of US economic growth), it’s probably a bear.

 

While everyone in the Barron’s Roundtable said it’s all about the Fed (you have to quantify less in making general groupthink statements), we continue to think that getting market beta right for the last few years has been more about getting the slope (rate of change) of GROWTH and INFLATION right.

 

On the GROWTH front, this week’s Macro Calendar will show you more #GrowthSlowing (on the margin):

  1. TUESDAY: Durable Goods should slow in December versus November’s +3.4%
  2. THURSDAY: Q413 US GDP should slow to 3-something percent vs Q313’s +4.12% sequential peak
  3. FRIDAY: PMI for January could easily slow form December’s frothy 60.2

Oh, and your illustrious open market committee of forecasting the weather (on a lag) at the Federal Reserve may well taper again on Wednesday into #GrowthSlowing too. Never mind dog or wolf – that’s just dumb.

 

Our immediate-term Global Macro Risk Ranges are now:

 

*= new TREND change (in brackets)

 

*UST 10yr Yield 2.72-2.79% (bearish)

SPX 1 (bullish)

*Nikkei 149 (bearish)

*VIX 14.91-20.41 (bullish)

*USD 80.19-80.79 (bearish)

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Dog or Wolf? - Chart of the Day

 

Dog or Wolf? - Virtual Portfolio


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