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Right Said the TED Spread

Takeaway: While not yet at alarming levels, interbank lending rates are increasing - a negative, on the margin, for liquidity and counter party risk.

We’ve used this play on words before when referring to the Ted Spread.  “Right Said Fred” is an English based band formed by the brothers Richard and Fred Fairbrass in the last 1980s that is most well known for the hit single, “I’m Too Sexy.”  While following interbank lending rates isn’t exactly sexy, we’d be remiss if we didn’t highlight the recent acceleration in the Ted Spread domestically and the Euribor-OIS spread overseas.

 

Just as a refresher, the TED Spread is the difference between interest rates on interbank loans and short-term U.S. government debt (effectively the risk free rate).   Overtime, the TED Spread usually ranges between 10 and 50 basis points.   In the financial crisis of 2008, the TED Spread eclipsed 450 basis points.   This exceeded the previous record of 300 basis points after the Black Market crash of 1987.

 

An expanding TED Spread implies that liquidity is being withdrawn from the system and is therefore seen as a precursor to equity market declines.  More broadly, it is seen as an indicator of perceived risk in the general economy.  In effect, as the spread increases it is a sign that lenders believe the risk of default on interbank loans, or counterparty risk, is increasing.

 

In the chart below we highlight the recent movements in the TED spread and the Eurbor-OIS spread, which is the daily reference rate at which Eurozone banks offer to lend unsecured funds to other banks in the European interbank market.  Clearly, we are not yet in a danger zone for either, but both have been accelerating on a percentage basis over the past weeks.  The Eurobor-OIS spread widened by 5 basis points to 16 bps last week and the TED Spread rose 2.7 basis points to 21.4.

 

In part, these spreads widening have led our Financials team to turn bearish on their sector this morning.  As Sector Head Josh Steiner wrote in his Monday Morning Risk Monitor today:

 

“Last week's risk monitor argued for being cautiously opportunistic on the long side as the interbank risk measures remained benign, Euribor-OIS & TED Spread, in spite of the growing concern around EM market and currency risks. This week is a different story. On Friday of last week we saw the Euribor-OIS spread hockey stick higher. We also saw a notable upward move in the TED Spread. These have historically been two of the most accurate risk gauges in signaling when to move from an aggressive to a defensive posture. They're indicating fairly clearly now that the situation is deteriorating. Couple that with our quantitative line of intermediate-term support (TREND: $21.36) in the XLF being broken, and there are clear, bright-red warning signals flashing. We'll heed them until they tell a different story.”

 

Our Macro Team will be doing an update call on the U.S. economy on Wednesday at 11am, at which point we will dig deeper into the implications of the emergent expansions in the TED and Eurobor-OIS Spreads.  Dial in instructions will be circulated head of the call.

 

Right Said the TED Spread - TED Spread

 

 

Daryl G. Jones

Director of Research

 


$WTW: Short the Barron's Bounce

Takeaway: This is a great opportunity to short WeightWatchers (WTW) following the expected ‘Barron’s Bounce.'

Mr. Market is offering investors a great opportunity to short WeightWatchers (WTW) following the expected ‘Barron’s Bounce’ this morning.

 

Shares of WTW were flashing green amid a sea of market red after the financial publication posted a bullish note over the weekend on the heels of our secular short call.

 

Hedgeye analysts Tom Tobin and Hesham Shaaban released a distilled dive video on Friday laying out our secular short thesis. We believe a game-changing technological paradigm shift is underway which is prompting new entrants into the space and undercutting WTW's price and value proposition. 

 

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Our Google Trackers suggest that interest in WTW services is decelerating meaningfully. Our estimates suggest that 1Q14 could experience the slowest sequential member increase in the last 7 years

 

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MONDAY MORNING RISK MONITOR: SWITCHING FROM BULLISH TO BEARISH

Takeaway: We're moving from Bullish to Bearish on the Financials as systemic interbank risk is rising and quantitative support on the XLF is broken.

Summary:

Last week's risk monitor argued for being cautiously opportunistic on the long side as the interbank risk measures remained benign, Euribor-OIS & TED Spread, in spite of the growing concern around EM market and currency risks. This week is a different story. On Friday of last week we saw the Euribor-OIS spread hockey stick higher. We also saw a notable upward move in the TED Spread. These have historically been two of the most accurate risk gauges in signaling when to move from an aggressive to a defensive posture. They're indicating fairly clearly now that the situation is deteriorating. Couple that with our quantitative line of intermediate-term support (TREND: $21.36) in the XLF being broken, and there are clear, bright-red warning signals flashing. We'll heed them until they tell a different story.

 

Key Points:

* The Euribor-OIS Spread widened by 5 bps to 16 bps. 

 

* The TED Spread rose 2.7 basis points last week, ending the week at 21.4 bps 

 

* U.S. Financial CDS -  Citi continues to lead the charge among the large cap banks as north of 40% of its revenue comes from Emerging Markets. Its swaps widened 6 bps vs last week and are now 23 bps wider month-over-month. Mortgage insurers, MTG & RDN, both saw sizeable upticks in their swaps week-over-week as well. The insurance complex is also buckling amid falling rates. 

 

Financial Risk Monitor Summary

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

 • Intermediate-term(WoW): Negative / 1 of 13 improved / 10 out of 13 worsened / 2 of 13 unchanged

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

 

MONDAY MORNING RISK MONITOR: SWITCHING FROM BULLISH TO BEARISH - 15

 

1. U.S. Financial CDS -  Swaps widened for 23 out of 27 domestic financial institutions. Citi continues to lead the charge among the large cap banks as north of 40% of its revenue comes from Emerging Markets. Its swaps widened 6 bps vs last week and are now 23 bps wider month-over-month. Mortgage insurers, MTG & RDN, both saw sizeable upticks in their swaps week-over-week as well. The insurance complex is also buckling amid falling rates. 

 

Tightened the most WoW: TRV, JPM, SLM

Widened the most WoW: AIG, MET, HIG

Tightened the most WoW: AGO, MBI, MTG

Widened the most MoM: C, AXP, GNW

 

MONDAY MORNING RISK MONITOR: SWITCHING FROM BULLISH TO BEARISH - 1

 

2. European Financial CDS - Swaps were slightly wider, on average, across European banks last week, but, looked at on a month-over-month basis, continue to push higher. Italian banks are showing some of the worst performance on a month-over-month basis.

 

MONDAY MORNING RISK MONITOR: SWITCHING FROM BULLISH TO BEARISH - 2

 

3. Asian Financial CDS - It was a mixed week for Asian Financial CDS as swaps were mostly wider across China, Japan and India, but a few banks posted substantial tightening.

 

MONDAY MORNING RISK MONITOR: SWITCHING FROM BULLISH TO BEARISH - 17

 

4. Sovereign CDS – Sovereign swaps were modestly wider last week, outside of Japan and Portugal. 

 

MONDAY MORNING RISK MONITOR: SWITCHING FROM BULLISH TO BEARISH - 18

 

MONDAY MORNING RISK MONITOR: SWITCHING FROM BULLISH TO BEARISH - 3

 

MONDAY MORNING RISK MONITOR: SWITCHING FROM BULLISH TO BEARISH - 4

 

5. High Yield (YTM) Monitor – High Yield rates rose 6.7 bps last week, ending the week at 6.02% versus 5.95% the prior week.

 

MONDAY MORNING RISK MONITOR: SWITCHING FROM BULLISH TO BEARISH - 5

 

6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 1.0 points last week, ending at 1849.

 

MONDAY MORNING RISK MONITOR: SWITCHING FROM BULLISH TO BEARISH - 6

 

7. TED Spread Monitor – The TED spread rose 2.7 basis points last week, ending the week at 21.4 bps this week versus last week’s print of 18.74 bps.

 

MONDAY MORNING RISK MONITOR: SWITCHING FROM BULLISH TO BEARISH - 7

 

8. CRB Commodity Price Index – The CRB index rose 1.0%, ending the week at 283 versus 281 the prior week. As compared with the prior month, commodity prices have increased 2.1% We generally regard changes in commodity prices on the margin as having meaningful consumption implications.

 

MONDAY MORNING RISK MONITOR: SWITCHING FROM BULLISH TO BEARISH - 8

 

9. Euribor-OIS Spread – The Euribor-OIS spread widened by 5 bps to 16 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: SWITCHING FROM BULLISH TO BEARISH - 9

 

10. Chinese Interbank Rate (Shifon Index) –  The Shifon Index rose 72 basis points last week, ending the week at 4.44% versus last week’s print of 3.72%. 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: SWITCHING FROM BULLISH TO BEARISH - 10

 

11. Markit MCDX Index Monitor – Last week spreads widened 13 bps, ending the week at 90 bps versus 77 bps the prior week. 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: SWITCHING FROM BULLISH TO BEARISH - 11

 

12. Chinese Steel – Steel prices in China were unchanged last week but remain down 2.7% month-over-month at 3,404 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.

 

MONDAY MORNING RISK MONITOR: SWITCHING FROM BULLISH TO BEARISH - 12

 

13. 2-10 Spread – Last week the 2-10 spread tightened to 232 bps, -6 bps tighter than a week ago. The yield spread is now 29 bps tighter month-over-month. We track the 2-10 spread as an indicator of bank margin pressure.

 

MONDAY MORNING RISK MONITOR: SWITCHING FROM BULLISH TO BEARISH - 13

 

14. XLF Macro Quantitative Setup – Quantitative lines of support in the XLF are now broken on both a TRADE (short-term) and TREND (intermediate-term) basis. Our Macro team’s quantitative setup in the XLF shows 3.0% upside to TRADE resistance and 2.1% downside to TRADE support.

 

MONDAY MORNING RISK MONITOR: SWITCHING FROM BULLISH TO BEARISH - 14

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.64%
  • SHORT SIGNALS 78.61%

FLASHBACK: Dinero Caliente

Editor's note: This prescient "Morning Newsletter" was originally published July 19, 2013. It was written by Macro analyst Christan Drake who was filling in for CEO Keith McCullough. It's another nice Hedgeye #timestamp on the early side of this bearish emerging market story. Click here to subscribe.

“Never memorize something that you can look up.” Albert Einstein

The big picture

I used to have something of a photographic memory.  Lately, however, a plot of my capacity for short-term recall and a YTD chart of Gold would probably be hard to distinguish. 

 

I’d proffer that my bout with Cognitive Deflation is only transient and simply the byproduct of late nights with infants, serial overconsumption of caffeine, and serial under-consumption of exercise.  At least that’s what I tell myself. 

 

Either way, I’ve come to more closely relate to the aphoristic wisdom embedded in Einstein’s quote above.

 

With some beach time on the August calendar, I’m holding out hope the downtime catalyzes some needed cerebral exfoliation. 

Macro grind

We have been negative on emerging market debt and equities for most of 2013 with #EmergingOutflows & #AsianContagion headlining our 2Q13 and 3Q13 Macro Investments themes calls, respectively. 

 

The story of emerging market pain is one birthed from emergent strength in the U.S. dollar, acceleration in U.S. growth and the associated reversal in unprecedented Fed policy driving an expedited reversal in Hot Money & Yield Chase Flows out of developing economies.   

 

We’ve presented the principal conclusions of our research and suggested positioning in recent presentations, but it’s probably worthwhile to take an illustrative, didactic tour of capital flows to understand how the cycling of capital into and out of emerging economies can work to propagate negative economic and market impacts in an archetypical scenario.

 

Capital Flows to Emerging Economies for 3 Principle Reasons:

 

1.   External:  “Push” flows occur for reasons external to the capital-importing economy and generally relate to relative investment attractiveness.  Perhaps the simplest way to understand it is in the context of U.S. interest rates.  If growth slows, policy turns easy and interest rates in the U.S. decline, investment yields available in emerging economies become relatively more attractive and capital flows accordingly. Historically, this has been the largest driver of rich-to-poor capital flows.  It’s also generally the most volatile.   

 

2.   Internal:  “Pull” flows are catalyzed by improving economic fundamentals, sound policy and/or trade & capital market liberalization initiatives.  Pull flows provide firmer bedrock for sustained inflows. 

 

3.   Financial Globalization:  Here we’d highlight the ongoing, global trend towards Financial & Capital market integration and the proliferation of conduit investment vehicles allowing broad institutional and retail access to developing economies.   A secular shift in portfolio allocations towards international diversification holds positive longer term opportunity for developing economies.  However, in compressed periods in which flows chase performance, it can work to amplify volatility in market prices.     

 

It’s the potential transience of “push” and portfolio (i.e. equity & debt) flows that are of most concern to capital-importing countries, particularly given the reality of hyper-fast capital mobility.

 

So, what happens when the Hot Money starts to flow?

 

In a generalized model, the body of empirical evidence points to a number of discrete macroeconomic impacts:

 

1.   Currency Appreciation:  Absent Central Bank intervention the demand for foreign currency drives the exchange rate higher.

 

2.   Consumption Growth:   The influx of foreign capital provides for a higher level of domestic investment.  This higher level of investment is generally accompanied by a decline in the domestic savings rate.  Consumption rises as consumerism displaces saving.  

 

3.   Rise in the Money Supply & Inflationary Pressure: Stemming from a rise in economic activity along with any attempts by the central bank to quell the currency appreciation.

 

4.   Widening of the Current Account Deficit:  Don’t worry if you don’t remember the details about what the Current Account is.  Here, it’s sufficient to understand that imports rise relative to exports generally due to an appreciating currency and rising consumption. 

 

It’s not difficult to understand how the confluence of the above dynamics can work to drive recurrent boom and bust cycles for emerging and formerly, capital-rationed, economies.  Consider how the interaction of the above factors, which initiates with a large influx of foreign capital, can work to drive a self-reinforcing cycle in both directions:

 

U.S. growth slows, Bernanke cuts to 0%, institutes financial repression and forces capital to search out yield. Capital flows into the EM economy causing increased investment, falling domestic savings and rising domestic consumption.  Incomes rise alongside accelerating growth, driving a further increase in consumption in a positive, reflexive cycle.  Further, foreign capital inflows along with diverted domestic savings provide a bid for real (i.e. housing) and speculative financial assets.  Net wealth increases alongside inflating asset values.  Faster growth, higher incomes, and rising net wealth all serve to increase capacity for credit. Credit expansion then serves to amplify the cycle.  Everything is great, until…….

 

U.S growth starts to inflect to the upside, #StrongDollar starts to sniff out a Fed Policy reversal, and “push” flows begin to reverse.  

 

When portfolio capital starts to exit, asset prices deflate and credit gets tighter, investment and consumption both decline.  The currency depreciates, driving local inflation higher at the same time that aggregate demand accelerates to the downside. If demand is local and the debt is denominated in foreign currency, the debt burden on business is amplified.  Declining demand in the face of a crashing currency and elevated inflation can leave policy makers handcuffed. 

 

Thus, capital flows, this time the expedited exportation of foreign capital, catalyze a reversal of the boom cycle described above with some version of a self-reinforcing, contractionary cycle playing itself out.   

 

Of course, country specific fundamentals, policy decisions, and monetary systems matter and understanding the prevailing risk for a particular country is more nuanced, but the generalized model described above captures the broader dynamics that tend to drive the cycle. 

 

Further, given the large-scale proliferation of EM related investment vehicles whereby investors indiscriminately bought ‘international diversification’ without a real understanding of the underlying exposures, it’s unlikely they will be overly discriminate in their selling.  Historical precedent suggests #StrongDollar driven outflows from emerging markets are protracted. 

 

In short, we don’t think #EmergingOutflows have bottomed yet. 

 

Hopefully the decline in my recollective ability has.

  • CASH: 51
  • US EQUITIES: 18
  • INTL EQUITIES: 9
  • COMMODITIES: 0
  • FIXED INCOME: 0
  • INTL CURRENCIES: 22

Our levels

Our immediate-term Risk Ranges are now:

 

UST 10yr yield 2.49-2.74%
SPX 1670-1701
VIX 13.23-14.78

USD 82.61-83.48

Brent 106.99-109.27

Gold 1216-1306 

 

Enjoy the weekend.  

 

Christian B. Drake

Senior Analyst

 

FLASHBACK: Dinero Caliente - vv. EL


$LULU Sheer Pants Redux

Takeaway: The yoga retailer's customers are complaining about sheerness again, this time after an online warehouse sale.

LULU - Lululemon 'Inadvertently' Sold A Bunch Of Sheer Pants Again

 

$LULU Sheer Pants Redux - lu

  • "Once again, the yoga retailer's customers are complaining about sheerness, this time after an online warehouse sale in Canada."
  • "While the items came with a tag saying 'things don't always go as planned, this garment has fit, function, or visual imperfections,' the defects apparently weren't disclosed at the point of sale online."
  • "A Lululemon spokesperson confirmed to us that some defective pants were sold to customers without proper disclosure. 'This is the first time we’ve had an online warehouse sale, which included a variety of items. Some items with a 'things don’t always go as planned' tag inadvertently ended up in our inventory,' the spokeswoman said."

Quick Take from Hedgeye Retail Analyst Brian McGough: Is this really the way to rebuild customer loyalty LULU? Unfortunately for the company, it is in a fishbowl right now. Everyone is watching its every move and is criticizing them accordingly. Is it fair? Nope. But life isn't fair and Lululemon made its own bed. Now it has to sleep in it. 

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