TODAY’S S&P 500 SET-UP – January 28, 2014
As we look at today's setup for the S&P 500, the range is 64 points or 1.32% downside to 1758 and 2.27% upside to 1822.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS (Bloomberg Estimates):
WHAT TO WATCH:
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
The Hedgeye Macro Team
This note was originally published at 8am on January 14, 2014 for Hedgeye subscribers.
“A vigilant and well-informed press, setting forth the truth…”
-Doris Kearns Goodwin, The Bully Pulpit
But what, precisely, is the truth? The truth is that Ray Dalio asks the same question in order to explain his investment process (minus the words ‘but’ and ‘precisely’). It’s the same question you need to be asking yourself every market day.
The 20th President of the United States, James A. Garfield, wasn’t talking about markets when he said that “the truth will set you free, but first it will make you miserable.” But for this morning, let’s lie to ourselves and pretend he did. For me at least, it’s the truth!
The truth is that for the 1st day of 2014, US stocks down (yesterday) has captured the top (most read) headline on Bloomberg.com: “SP500 Falls Most Since November Amid Valuation Concern.” Only one part of that headline story is true. The “valuation” part is just an #OldMedia editorial. Well-informed market practitioners can do better than that.
Back to the Global Macro Grind…
Fresh off a feeding of our new born baby Lucy Taylor McCullough yesterday (she’s a beauty!), I walked upstairs to my post and bought-the-damn-bubble #BTDB into the US stock market close. Whether I was right or wrong in doing so isn’t the point. #Timestamps are truth.
Before I get into the why, I’ll just rehash the step by step process in terms of what I actually did:
1. After coming into the open with my first net neutral position of 2014 (8 LONGS, 8 SHORTS), I covered shorts
2. I didn’t cover any of these shorts on “valuation” (RRGB, MCD, LINE, F); I covered them because they were oversold
3. Then I waited, watched, and finally bought SPY on my signal at 3:38PM EST at $181.60
Having made every single mistake you can make in this game in buying things too early (which is typically followed up with excuses like, “but it’s cheap”), this time I actually took my time. Getting net longer on red should be a process, not an emotional episode in your life.
At Hedgeye there are 3 big parts to how we try to probability weight where Mr. Macro Market might move next:
On the #history front, contextualizing the emotion of yesterday’s final selling moments is easy – that was only the 3rd one-day decline of over 1% for the SP500 in the last 3 months:
1. November 7th, 2013 = -1.32%
2. January 14th, 2014 = -1.26%
3. December 11th, 2013 = -1.13%
In other words, that’s why the first part of this morning’s Bloomberg headline is true. It was the biggest US stock market down day since November 7th, 2013 when the SP500 closed at 1747. If you bought SPY there, you could have sold it 101 handles higher (+6%) at the US stock market’s all-time closing high of 1848 on December 31, 2012. #truth
#History reminds us that past performance doesn’t predict future results. I have no illusions about that. Neither should you. So let’s dig into some of the math (levels, correlations, etc.) that got me to hit that SPY buy button yesterday:
1. PRICE: the SP500’s immediate-term TRADE oversold line of support = 1817 with TREND support well below that at 1771
2. VOLUME: my composite volume signal was in line with my TREND based average yesterday; nothing to freak out about
3. VOLATILITY: front-month VIX was obviously up on the day, but still well below @Hedgeye TREND resistance of 14.91
So that’s that. The #history and #math parts had nothing to do with “valuation” obviously.
How about the #behavioral side of the decision to buy SPY? I think about that in 2-big parts, levels and catalysts:
1. LEVELS: for a year now, performance chasers have been selling red and buying green; fade that consensus on the signal
2. CATALYSTS: A) Japanese Yen was signaling overbought and B) JPM was signaling immediate-term TRADE oversold
These are, of course, very immediate-term catalysts. But when making buy or sell decisions, what else would you use? Whether people admit it or not, without a tested and tried, real-time, decision making process, they’ll use emotion instead of high probability signal levels and catalysts - or at least I used to.
on A) and B):
A) The Global Macro Correlation Risk that is the YEN vs Nikkei relationship is crystal clear (Yen Down = Nikkei Up)
B) JP Morgan (JPM) beating earnings in this environment (fat Yield Spread) is research edge you either had or did not
On A) the Yen is -0.6% vs USD this morning and on B), thankfully I have a great Financials analyst in Josh Steiner (who has been The Bear on NSM as of late). But even if I didn’t have Steiner, I’d have had that JPM oversold signal alongside the Yen’s overbought one. Now the manic media can run headlines that “JPM Beat, Alleviating Valuation Concerns.”
You either have research and risk management signals that you trust, or you do not. They help keep me well informed.
Our immediate-term Macro Risk Ranges are now:
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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Takeaway: Did Nike deliberately inflate the price Puma paid?
Puma to Outfit Arsenal Football Club
Takeaway from Hedgeye Retail analyst Brian McGough: Puma beat out Nike for the right to spend $50 million to put their logo on Arsenal's jersey. Nike is currently in the midst of negotiations with Manchester United, and most likely bowed out of the Arsenal talks after Puma inflated the price. Either that, or in typical Nike fashion, it knew how badly its competitor wanted the deal, so it bid up the price knowing that it would ultimately walk away.
Takeaway: We see heightened risk of a material devaluation of the Venezuelan bolivar (VEF) over the intermediate term.
In the wake of Argentina’s currency devaluation last week, we’ve gotten a couple of questions from subscribers asking, “who’s next?”.
While it’s tough to get inside the head of foreign (or domestic) policymakers with regard to timing, we think Venezuela is definitely on what appears to be a growing list for prospective material currency debasement. Please note that we don’t care if it’s an intentional devaluation or unintentional debasement; monetary and fiscal policymakers always have a choice with respect to protecting the purchasing power of their citizenry from both internal and external forces.
Venezuela remains the certified gong show we’ve identified it as in our published work over the years – most recently in our proprietary EM Crisis Risk Model, which shows that Venezuela is overly exposed to BoP/Currency Crisis risk (i.e. Pillar I) and Political & Regulatory (i.e. Pillar IV) risk:
This, of course, comes as a surprise to no one, given the country’s history of devaluations, expropriations etc. (CLICK HERE for our most recent work on these topics). It’s fitting that the country is rated B-, Caa1 and B+ by S&P, Moody’s and Fitch, respectively, and all three agencies maintain a negative outlook on their ratings.
Looking to actual conditions on the ground, credit investors have been increasingly worried of late. 5Y CDS has ramped +271bps in the YTD to 1,419bps wide. The move on the 1Y tenor has been even more dramatic since then (+316bps to 1,486bps wide – i.e. wider than the longer 5Y tenor).
That is worrisome. Perhaps creditors are anticipating that President Maduro does something equally as dramatic over the intermediate term (i.e. yet another material devaluation of the VEF – or worse). Bloomberg Consensus currently anticipates a VEF devaluation from the current official rate of 6.3 per USD to 10.3 per USD (-39%) by the end of 1Q14.
Maduro’s recent activity (as well as the recent activities of his gov’t) would certainly support that view:
Meanwhile, here are five key macroeconomic statistics that are currently pressuring Venezuelan policymakers to act:
The first statistic is supportive of a devaluation in the context of President Maduro’s recent promise to “create a unified exchange system next year which will provide foreign currency at a fair price for the functioning of the economy.” Under the current regime the government provides ~95% of the USD in the economy to selected companies and individuals at 6.3 VEF per USD. The remaining 5% is sold through weekly auctions at a higher floating rate, which currently stands at 11.3 VEF per USD.
The last statistic supports a currency devaluation because the country may seek a devaluation to shore up its illusion of creditworthiness (via artificially inflating FX reserves like Argentina does). The timing of which is anyone’s guess, but we’re guessing last week’s move in the ARS has investors pulling forward expectations, at the margins.
In spite of the aggressive price controls, we can’t see how another devaluation does not promote further rampant inflation – which we’d argue has played a critical role in perpetuating the well-documented social unrest in the country in the wake of Chavez’s death.
Net-net-net-net-net, the bond market’s got this one right, folks; Venezuela’s benchmark 10Y USD bonds have dropped -8.72 points in the YTD to 66 cents on the dollar and are now yielding a world-beating 16.12%. Remember, a weaker currency makes it harder to service USD debt (in the absence of pillaging central bank FX reserves, of course).
All told, we see heightened risk of a material devaluation of the Venezuelan bolivar (VEF) over the intermediate term. In normal times, that catalyst might come-and-go without any meaningful degree of broad capital markets impact. In today’s increasingly scrutinized emerging market investment landscape, however, we can’t see how another gap down in an EM currency bodes well for broader sentiment towards EM assets and a reversal of #EmergingOutflows.
Aye, aye, aye…
Associate: Macro Team
Takeaway: We remain broadly bearish on EM assets and continue to think that absolute returns for EM assets will be negative over the intermediate term
Needless to say, last week was a brutal week if you were running a EM FX carry-trading strategy(ies) or, if you’ve been conditioned by the past ~10Y to be permanently bullish on emerging market assets.
As of Friday’s close, the JPM EM Currency Index had fallen -1.8% WoW; LatAm – which remains our favorite region on the short side of EM capital and currency markets – led decliners with the Bloomberg/JPM LatAm Currency Index falling -3.2% WoW. The iShares MSCI Emerging Markets Index ETF (EEM) declined nearly -4% last week and is now down -8.5% for the YTD.
*As of Friday's close.
*As of Friday's close.
The Argentine peso was undoubtedly the life of the party, declining over -15% last week. If you missed our note from last Thursday titled: “ARGENTINE DEFAULT 2.0?”, we encourage you to review it whenever you have a few minutes to spare; it’s a must-read for any investor attempting to understand the myriad of idiosyncratic risks that one must consider when allocating capital to emerging markets at this stage in the cycle.
We continue to think it’s of utmost importance for investors to proactively prepare their portfolios for what we continue to see as the next cycle of emerging market crises. Contrast the following preparation with the hyperbolic and emotional research that you’ve likely been spammed with from the sell-side over the past ~72 hours:
All told, we remain broadly bearish on EM assets and continue to see them for what they are: overpriced relative to a long-term TAIL investment cycle that has clearly turned in favor of DM assets, at the margins. For some long ideas in the DM space, look no further than our #EuroBulls theme, which continues to augur well for appreciation across the UK and German capital and currency markets.
When we last left off, we had a number of ways to play this view within the construct of EM assets; below is a review of that strategy:
Obviously if we were running a fund, we would not have these positions on in equal weights; we’ve obviously been the loudest EM bears on the street since last APR, so it would only make sense to size the shorts appropriately larger than the longs.
From here, we continue to think that absolute returns for EM assets will be negative over the intermediate term. In fact, we continue to believe that EM assets lose in two out of the three most probable intermediate-term global macro scenarios. As such, we don’t think discretion is overly warranted until investors drill down into the country level.
In that vein, the only change we would make there would be to remove Russia (RSX) and Mexico (EWW) from the overweight ideas. Crude oil is now bearish TREND and TAIL on our quant factoring and we no longer wish to seek out that exposure on the long side. Indonesia (EIDO) is nowhere near as compelling on the short side as it once was, given the recent acceleration in hawkish rhetoric out of Bank Indonesia; still, we’d like to see them put their money where their mouth is in that regard (i.e. hike rates again) before we can get behind a turnaround story here.
Here are three more important things to highlight: 1) the US Dollar Index remains broken TREND and TAIL (old news); 2) the 10Y Treasury Yield is now below its TREND line (new news); and 3) the CRB Index is now trading above its TREND line (new news). If this setup continues to manifest in the face of declining risk aversion, then we could get behind EM assets on the long side for trade.
For now, however, we’re comfortable with our current positioning. The SPX is now testing its TREND line of support (1779); a confirmed breakdown below that level in conjunction with the VIX remaining above its TREND line does not augur well for declining risk aversion with respect to the intermediate term.
For more details about our multi-factor, multi-duration quantitative overlay, please refer to slide #5 of our 1Q14 Macro Themes presentation. It remains unclear to us how so many strategists make calls on markets without a proven process to contextualize critical inflection points in global markets in real-time, but to each his/her own.
At any rate, we’ll stick with our process for marrying bottom-up macro fundamentals (e.g. our proprietary EM Crisis Risk Index and our deep-dive research on the previous two EM crisis cycles) with a top-down overlay (e.g. our quantitative market timing signals).
Don’t fix it if it ain’t broken!
Associate: Macro Team