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The 4% Economy?

This note was originally published at 8am on February 18, 2014 for Hedgeye subscribers.

“Most successful pundits are selected for being opinionated, because it’s interesting, and the penalties for incorrect predictions are negligible.  You can make predictions and a year later people won’t remember them.” 

-Daniel Kahneman

 

Last night I gave the keynote presentation at the Trader’s Expo at the Marriot Marquis in Times Square.   Prior to giving the speech, I walked around the conference floor and heard a lot of stories of trading systems that would generate ten bagger returns, some that had triple digit positive performance last year, and so on.  Clearly, the exhibitors needed to grab people’s attention in order to engage in a sales discussion.

 

Frankly, compared to some of the presentations, I’m guessing my presentation on the U.S. economy was a tad boring.  In my presentation, I gave a quick update on our Q1 Themes and the view that economic growth in the U.S. may be slower than consensus expectations in 2014.   Rightfully so, my prognostication, if you want to call it that, raised some questions.

 

The 4% Economy? - dj

 

The first question related to the cover of Barron’s this weekend which heralded the potential return of 4% growth in an article titled, “Why the Economy Could Grow by 4%”.  The article was, in effect, an interview with a group called Applied Global Macro Research (AGMR), and to be fair they sounded like thoughtful guys, who are clearly an outlier with a 4% growth projection for the U.S. economy.

 

The question poised to me related to how the Hedgeye view differed from the view on the cover of Barron’s.  My response was simple: housing.  The economists from AGMR expect housing to be a massive tailwind.  In the long run, we get their thesis, but in the short run we see headwinds to housing and this more tepid view on the U.S. economy may, sadly, keep us off the cover of Barron’s this year.

 

Back to the Global Macro Grind . . .

 

Speaking of housing, I wanted to touch on a few points that make us incrementally more cautious:

  • Mortgage Purchase Applications - This point is highlighted in the Chart of the Day, but at a reading of 171.5 in the MBA purchase index, we are now -22% below the May 2013 peak.  Mortgage applications are a direct leading indicator of home purchases and this implies that home purchase are likely to fall a commensurate amount from the peak;
  • Pending Home Sales – We view housing as a giffen good and our demand driven model was fairly accurate in modeling the acceleration in housing activity.  Alongside the decline in purchase apps, pending home sales are down ~9% year-over-year, which is decidedly negative for forward home price appreciation if price continues to follow the slope of demand;
  • Home Price Deceleration - Corelogic home price data show that after last year’s parabolic rise, home price growth has now decelerated for 3 consecutive months; and
  • Qualified Mortgages - The new “QM” (Qualified Mortgage) rules that went into effect in January tighten standards and increase culpability for both lenders and servicers.   Tighter lending standards will be a drag on aggregate housing activity on the margin – particularly for 1st time home buyers and others with irregular incomes.  First time home buyers are ~35% of the market.  

In the long run, the housing recovery likely does have legs given the nature of the massive over build and then years of inventory drawdown, but in the short run the headwinds noted above will be important to monitor.  The caveat to any view of housing, either negative or positive, is that interest rates will be the biggest driver and if interest rates head meaningfully lower from here (hard to believe that will happen  if the taper is in) then our cautious view on housing would likely become more positive.

 

Speaking of becoming more positive, and I’m not saying we are just yet, but Merrill’s Global Fund Manager Survey came out this weekend and had some interesting contrarian data points.  First, cash levels have risen from 4.5% to 4.8%, the highest since July 2012.  Second, emerging markets and global energy allocations are at record lows, while global bank allocations are at record highs.  Finally, global staples allocations are at the lowest levels since September 2003 (ahead of CAGNY). 

 

It is difficult to put too much credence in a set of data we didn’t create or collect ourselves, but it is certainly worth noting the extremes in the Merrill survey.   Much easier to discern is the market based indicators of inflation, which continue to percolate.   An extreme example of commodity based inflation domestically is natural gas, which is up almost 30% for the year-to-date.

 

Less extreme is the pervasive use of natural gas in the domestic U.S. economy.  According to the Energy Information Administration, there is almost 25 million MMcf used domestically on an annual basis.  If my math is correct that is an almost ~$125 billion input cost into the U.S. economy every year, which is split broadly between heating, residential use and industrial use. 

 

The bottom line is that if one of the key commodity input costs into the U.S. economy is up almost 30% in the year-to-date that, my friends, is inflationary.  Although perhaps not quite as bad to the economy, even worse is that a coffee addict like myself has to endure Arabica coffee bean prices up 10% this morning!

 

Our immediate-term Risk Ranges are now:

 

SPX 1805-1848 

VIX 11.89-15.95

USD 80.02-80.76 

Brent 107.99-110.51 

Gold 1279-1322 

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

The 4% Economy? - Chart of the Day

 

The 4% Economy? - Virtual Portfolio


Stock Report: United States Brent Oil Fund (BNO)

Stock Report: United States Brent Oil Fund (BNO) - HE II BNO table 3 3 14

THE HEDGEYE EDGE

Brief background: Brent Oil is a major trading classification of crude oil and is a benchmark for oil traders globally.  Brent is sourced from the North Sea, where it was originally produced in a Shell oilfield named after the Brent Goose (at one time Shell Oil had a policy of naming all of its fields after birds).  Brent is classified as sweet crude and contains approximately 0.37% sulphur, but is not as sweet at West Texas Intermediate (WTI).

 

Historically, Brent has traded at plus or minus $3 versus WTI.  Since 2010, that spread has expanded dramatically and Brent has traded at more than a $10 premium to WTI.  This widening of the spread between Brent and WTI is attributed to an increase in oil production in North America which has led to a surplus of oil in Cushing, Oklahoma.

 

Our long thesis for Brent is based on three key factors: expected decline of the U.S. dollar, tightening global oil supply and demand, and a break out in our quant models.

 

In the past decade, the U.S. dollar has had a consistently negative correlation to those global commodities that are priced in U.S. dollars.  Intuitively, this makes sense because as the dollar, or any currency for that matter, is devalued it can buy less of any fixed price physical asset, such as a commodity, that is priced in that currency.

 

Our interpretation of Chairperson Yellen’s most recent monetary policy comments last week is that the Federal Reserve is likely to continue to debauch the dollar and generate commodity inflation.

 

Specifically while speaking to the Senate on Thursday, Yellen outlined that the Fed will continue with accommodative policy and in fact halt tapering, making it incrementally dovish, if conditions warrant.  On Friday, real GDP for Q4 2013 was revised lower by 80 basis points to 2.4%, which only strengthens Yellen’s dovish case.

 

On the supply front, the IEA recently indicated that global supplies slid by 290,000 barrels in January. In as much as oil is highly inversely correlated to the U.S. dollar, its price is also driven by supply and demand. Domestically, as stated above, oil production has been accelerating, but the story is very different globally. 

 

On the demand side, primarily due to accelerating economic growth in Europe, the International Energy Administration (IEA) recently raised its global daily demand expectations by 125,000 barrels a day. 

 

As a result of this accelerating demand and declining supply, commercial stocks in OECD countries are at a six year low and saw their steepest quarterly decline in Q4 2013 since 1999.  Clearly, the global market for oil is tight and likely to get tighter through 2014 as OECD economic growth maintains its trajectory.

 

We added Brent Crude Oil (Brent) via the etf BNO to Investing Ideas on February 27th.  

 

TIMESPAN

INTERMEDIATE TERM (TREND) (the next 3 months or more)

As a result of the dynamics outlined above, Brent Oil broke out above our TREND (three months or more) line of $108.02.  Currently, on the same duration, the correlation between the U.S. dollar and Brent is -0.75, so highly inversely correlated.

 

 

LONG-TERM (TAIL) (the next 3 years or less)

In our analysis, a tight supply and demand story combined with a dovish Fed make future prices gains in Brent likely. As a result of this accelerating demand and declining supply, commercial stocks in OECD countries are at a six year low and the global market for oil is likely to get tighter through 2014.


ONE-YEAR TRAILING CHART

Stock Report: United States Brent Oil Fund (BNO) - HE II BNO chart 3 3 14


KURODA VS. YELLEN: WHO BLINKS FIRST?

Takeaway: Our conviction in the direction of the JPY and Nikkei over the next 3-6M lags far behind our understanding of the [mixed] fundamentals.

Editor's note: This research note was originally published February 12, 2014 at 12:52 in Macro. For more information on how you can subscribe to Hedgeye click here.

CONCLUSIONS:

  1. Our long-term view on Japan and the “Abenomics Trade” (short yen/long Nikkei) isn’t materially different from our previous strategy update; as such, long-term investors should remain involved in the trade.
  2. With respect to the intermediate-term (3-6M), however, we think any investors who have to meet performance targets on that duration should strongly consider the eight factors we outline below – the net of which leaves us uncomfortably neutral on the yen and Japanese equities with respect to that duration.
  3. Refer to the bullets and charts below for a comprehensive analysis of the aforementioned critical factors, which we think will drive the “Abenomics Trade” over the intermediate term.

KURODA VS. YELLEN: WHO BLINKS FIRST? - 555 

The curse of the sell-side: feeling pressure to make a call when your conviction level would suggest otherwise. We don’t run money at Hedgeye, so our stress levels are likely consistently far lower than yours; when I do get stressed out, however, 9 times out of 10 it’s because of the aforementioned curse.

 

That pretty much sums up our view on Japan.

 

Right now our research and risk management processes are scoring the odds of a +5% correction on the USD/JPY cross vs. a +5% appreciation at about 50/50 on a 3-6M forward basis. I know, that’s super helpful… probably about as helpful as having a “hold” call on a stock or publishing a strategy note that says, “we’re cautious on the market”.

 

All told, our long-term view on Japan and the “Abenomics Trade” (short yen/long Nikkei) isn’t materially different from our previous strategy update; as such, long-term investors should remain involved in the trade.

 

With respect to the intermediate-term (3-6M), however, we think any investors who have to meet performance targets on that duration should strongly consider the following factors – the net of which leaves us uncomfortably neutral on the yen and Japanese equities with respect to that duration (please share any feedback if you disagree with our neutral bias).

 

RED = bearish for the JPY; GREEN = bullish for the JPY; BLACK = toss-up:

 

  1. Sentiment: The market is still net short the yen to the tune of 82k contracts (futures + options), but bearish sentiment has receded dramatically in recent weeks as evidenced by the trailing 1Y Z-Score moving from -3.4x in early DEC to +0.2x currently.
  2. Inflation Expectations: Breakeven rates continue to march higher across the curve, with the 2Y and 5Y tenors up +91bps MoM and +46bps MoM, respectively. In the context of the JPY strengthening +1.6% MoM vs. the USD, this signals to us that Kuroda has convinced the market that either the BoJ’s existing QQE program is large enough to meet its strategic economic objectives or that the bank will respond with enough incremental easing to accomplish its goals. Either outcome is bearish for the yen.
  3. “5% Monetary Math”: Lost in the context of the day-to-day news flow are the aforementioned strategic economic objectives the LDP has tasked the BoJ with achieving. In our view, which has been consistent since NOV ’12, such lofty targets all but ensure the BoJ will remain aggressively easy over the long term.
  4. GIP Fundamentals: Not new news, but we continue to think Japanese growth will slow throughout the balance of 1H14. To the extent that weighs on inflation expectations in Japan – which they haven’t yet – we would anticipate broad JPY strength as the market attempts to force the BoJ’s hand. Thus far, JAN data (e.g. slowing Services PMI, slowing Consumer Confidence, slowing Economy Watchers Surveys) suggests Japanese economic growth is, at best, flat sequentially in the YTD. Sequentially flat growth plus sequentially tough compares tend to equate to slowing YoY growth more often than not.
  5. Correlation Analysis: We are the lonely inflation hawks in the YTD and continue to trumpet our non-consensus expectation of continued commodity reflation. Our multi-duration, cross-asset correlation analysis suggests our #InflationAccelerating theme is explicitly bullish for the Japanese yen, provided historical relationships hold.
  6. US Dollar Index Quant Factoring: The DXY is bearish on our TREND and TAIL durations and Janet Yellen’s testimony yesterday did absolutely nothing to assuage our fears that the FOMC will eventually cease tapering and begin to lay the groundwork for incremental easing at some point over the intermediate term. In fact, the only things she said that could be remotely considered positive for the USD is that the bar is set high in terms of deviating from the existing strategy (i.e. they need to see a few months of #GrowthSlowing first) and that the recent EM-related market turmoil wasn’t material enough to alter their expectations for the US economy. Their models have US real GDP growth accelerating from +1.9% in 2013 to +3% in 2014. We are currently down at +2.3% for CY14 (and falling, depending on the timing and magnitude of incremental Policies to Inflate out of the Fed). We have little doubt that the Fed will stop tapering and contemplate easing in 2014; it’s just a matter of when.
  7. USD/JPY Quant Factoring: The dollar-yen cross is now below our TREND line; this is very new. It needs to hold, but if it does, mean reversion support is all the way down at 97.27. Again, we don’t have a strong level of conviction on it holding or not holding below the TREND line. As such, we are content to let the market determine our level of conviction here.
  8. Nikkei 225 Quant Factoring: The Japanese equity market is also now below our TREND line; this is somewhat of a recent phenomenon. The longer this quantitative setup holds as is, the more foreign selling pressure we think will be applied to the index. Since equity volatility tends to be inversely correlated to sentiment, we think domestic Japanese investors are likely to repatriate their foreign assets, at the margins, which is particularly bullish for the JPY. It’s worth reiterating that Japan has a net international investment/GDP ratio of +63%, which compares -24% for the US; Japanese investors have been financing global growth for decades via persistent current account surpluses.

KURODA VS. YELLEN: WHO BLINKS FIRST? - 556

 

KURODA VS. YELLEN: WHO BLINKS FIRST? - Breakevens

 

KURODA VS. YELLEN: WHO BLINKS FIRST? - 5  Monetary Math

 

KURODA VS. YELLEN: WHO BLINKS FIRST? - JAPAN

 

KURODA VS. YELLEN: WHO BLINKS FIRST? - Correlations

 

KURODA VS. YELLEN: WHO BLINKS FIRST? - DXY

 

KURODA VS. YELLEN: WHO BLINKS FIRST? - JPY

 

KURODA VS. YELLEN: WHO BLINKS FIRST? - Nikkei

 

The ability to function amid elevated levels of cognitive dissonance remains one of the keys to effective risk management. Best of luck out there!

 

DD

 

Darius Dale

Associate: Macro Team


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$WMT: Sam's Club Makes Online Move

Takeaway: You could flip a coin on how this idea will turn out.

WMT - Sam's Club tests online subscription service

  • "Sam's Club is testing a new online service called 'My Subscriptions' which allows shoppers to have repeat-purchase items delivered to their homes automatically. The goal of the program is to save customers time by renewing their stash of household and personal care items on an ongoing cycle."

$WMT: Sam's Club Makes Online Move - sams

TAKEAWAY FROM HEDGEYE'S BRIAN MCGOUGH:

This is a tough one.

 

On one hand, we see why Sam's is doing this, and it makes sense -- minimize the time between purchases of essential items.

 

But on the flip side, the comp at warehouse clubs is driven not just by regular purchases of consumer staples, but by all the discretionary items that consumers buy that they didn't otherwise plan to buy -- simply because they see something interesting at a good price on the shelves.

 

Simply put, they've got to get people in the stores.

 

We were similarly perplexed when Wal-Mart started beta-testing its 'curbside pickup' program. You'll recall that's where people order online and pickup at the front of the store. Again, WMT needs to boost traffic and therefore discretionary purchases. 

 

Join the Hedgeye Revolution.


HIGH END IN RETREAT? January Personal Income & Spending

SUMMARY: 

  • At current levels, the ability for incremental savings reductions to drive further improvement in consumption growth remains very much constrained.  
  • Rising profligacy on luxury durables by the top income levels – which supported consumption growth in 2013 - occurred alongside peak gains in both housing and equities and is now collapsing as those same measures weaken.  
  • Given last years distortions, we’d argue that the 2Y comps still offer the cleanest read on the Trend in personal income growth – and on that basis, income growth continues to decelerate.  
  • With Inflation accelerating and growth slowing (which are reflexive, non-mutually exclusive dynamics) and geopolitical risk percolating, we’ll cover opportunistically on red, but will remain better sellers/shorters of domestic equity strength in the immediate term.   

 

 

SPENDING & INCOME

 

Spending grew at a premium to income for a fourth consecutive month as Services expenditures led the gains, accelerating on a MoM, 1Y and 2Y while spending growth on Durables and NonDurables declined MoM and decelerated on both a 1Y and 2Y basis.    

 

The savings rate held at 12 month lows and remains near the low end of the historical range.  

 

At current levels, the ability for incremental savings reductions to drive further improvement in consumption growth remains very much constrained. 

 

HIGH END IN RETREAT?  January Personal Income & Spending - Savings Rate 2

 

HIGH END IN RETREAT? 

The acceleration in Durable Goods expenditures led the strength in household spending last year.  Demand for durables is generally more elastic than that for NonDurables and rising, broad based demand for durable goods can offer insight into emergent strength in household consumerism.    

 

What’s notable, however, is that last year’s acceleration in durable goods spending was driven largely by demand for luxury and high-end items. 

 

In fact, as can be seen in the chart below, demand for luxury durables (Pleasure Boats/Aircraft and Watches/Jewelry) accelerated in 2H13, supporting headline durables growth even as broader durables demand began to slow.   

 

Spending on the same luxury items has collapsed since hitting peak growth in October.   

 

Coincidently (or not), rising profligacy on luxury durables by the top income levels occurred alongside peak gains in both housing and equities and is now tracking the same measures lower. 

 

With home price gains decelerating since October and domestic equities down YTD, it appears increasingly unlikely that the rich provide an incremental boost to consumption growth – at least not at the magnitude of last year’s contribution.   

 

HIGH END IN RETREAT?  January Personal Income & Spending - PCE   Luxury Goods

 

HIGH END IN RETREAT?  January Personal Income & Spending - PCE   Durable Goods Luxury Contribution

 

HIGH END IN RETREAT?  January Personal Income & Spending - Corelogic HPI Jan

 

 

INCOME:  Use the 1Y or 2Y comps?

Optically,  personal income growth improved sequentially as Disposable Income (DPI), Real Per Capita DPI, Private Sector Salaries and Government Salaries and Wages all accelerated YoY in January. 

 

Recall, however, that personal income figures over the peri-fiscal cliff period from Nov-12 to Jan-13 were distorted as individuals pulled forward compensation and companies ramped special dividend payments ahead of the impending tax law changes.

 

Given the noisy comp dynamics we’d argue that the 2Y comps still offer a cleaner read on the Trend in personal income growth currently. 

 

Growth on a 2Y average basis showed a second consecutive month of deceleration across all the aforementioned income measures and stands in direct contrast to the positive income dynamics suggested by the YoY figures.   

 

HIGH END IN RETREAT?  January Personal Income & Spending - Personal Income

 

HIGH END IN RETREAT?  January Personal Income & Spending - Income spending Table jan

 

2014 TAILWIND: 

While hourly earnings growth and weekly hours continue to track sideways, at the margin, the spending friendly budget deal and positive employment growth at the State and Local Government level should support salary and wage growth for the 17% of the labor force that is government workers. 

 

Indeed, aggregate, government sourced wage and salary income showed positive YoY growth for the first time in 11 months in January.   

 

Further, from a comp perspective, the annualization of the (higher-earner) tax increases and the end of the payroll tax holiday that occurred in January of last year both setup as positive dynamics supporting consumer spending for 2014.

 

HIGH END IN RETREAT?  January Personal Income & Spending - Salary   Wage  2Y jan

 

So, similar to the February ISM report this morning, the January income and spending data extended the broader Trend towards decelerating growth. 

 

With Inflation accelerating and growth slowing (which are reflexive, non-mutually exclusive dynamics) and geopolitical risk percolating we’ll cover opportunistically on red, but will remain better sellers/shorters of domestic equity strength in the immediate term.   

 

HIGH END IN RETREAT?  January Personal Income & Spending - ISM

 

HIGH END IN RETREAT?  January Personal Income & Spending - ISM Prices

 

HIGH END IN RETREAT?  January Personal Income & Spending - ISM Table Feb

 

Christian B. Drake

@HedgeyeUSA



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