This note was originally published at 8am on March 25, 2014 for Hedgeye subscribers.
"Kings are not born, they are made by general hallucination."
-George Bernard Shaw
On this day more than 700 years ago, Robert the Bruce became the King of Scotland. Robert was one of the most well known warriors of his generation and led the Scots in their wars of independence against Britain.
Prior to successfully defeating the British, according to legend, Bruce was hiding in a cave on Rathlin Island off the north coast of Ireland. While in the cave Bruce purportedly watched a spider spinning a web in an attempt to connect one area of the cave's roof to another area. (Clearly, Robert the Bruce had some spare time on his hands.)
The spider repeatedly failed but after each failed attempt kept turning back to the task at hand. Eventually the spider succeeded. According to legend, Bruce is said to have used this as inspiration to continue his war against Britain where he eventually inflicted on them a number of critical defeats on the path to Scottish independence.
This story also supposedly inspired the maxim: "If at first you don't succeed, try try try again."
Back to the Global Macro Grind ...
As the story of Robert the Bruce teaches us, becoming king is not an easy task. As it relates to asset class performance this year, there aren't a lot of kings in the year-to-date. On a country basis, the top three decliners are as follows:
- Russia -19.5%
- Venezuela -14.8%
- Czech Republic -12.6%
Japan is a close runner up to the top three and comes in fourth with a -11.5% decline on the Nikkei in the year-to-date. Incidentally, the Japanese Mothers Index (more small cap focused) is down a staggering -5.7% today.
As the reigning King of Russia, Vladimir Putin is certainly learning the pain of trying to broaden his kingdom. On the back of Russia's literal annexation of Crimea, Russian equities are getting clobbered as noted above.
This morning the West is implementing more actions to further alienate Russia. The big symbolic one is that the G-8 summit, which was originally scheduled for Sochi this summer, has now been moved to Brussels and Russia has been uninvited.
In part, this and the myriad of sanctions that have been implemented against Russia are largely symbolic. No doubt the most significant sanction is the one that has been implemented by the markets themselves as noted above by the almost -20% decline for Russian equities in the year-to-date. To the extent Russian equities continue to decline and Russian companies are challenged to tap the public markets to raise capital, Putin will certainly be wondering whether it is all worth it to become king.
The King of Fed watching, Jon Hilsenrath from the Wall Street Journal, wrote an interesting article yesterday highlighting the odd (for lack of a better word) nature of economic target setting by the Federal Reserve. According to Hilsenrath, even though the Fed expects a 5.4% jobless rate in 2016, a normalized level, they are still likely to keep interest rates at a level that is well below normal (typically considered 4%-ish on the Fed funds rate).
To the extent this turns out to be accurate, it is likely that we continue to see inflationary assets (Gold) continue to front run this long term dovish policy. The broader concern, of course, is the arbitrary nature of employment targets such as the jobless rate. In the Chart of the Day, we highlight a chart we have shown many times in the past which is the labor force participation rate.
As the chart shows, the U.S. is literally at generational lows in terms of participation in the labor market. In fact, labor force participation peaked at just under 67.5% in 2000 and has been in relatively steady decline ever since. Currently, the labor force participation rate is just over 62.5% and at an almost 35-year low.
This emphasizes the oddity of the Federal Reserve using an arbitrary data point such as the jobless rate to highlight the health, or lack of health of the economy, since the jobless rate doesn’t take in to account the people simply dropping out of the labor force. For today, we’ll leave a discussion of whether the Fed’s extreme dovishness has helped the economy to the side, but certainly the arbitrariness of their targets has and continues to confuse the markets. This is likely why the 10-year treasury rates are down almost 10% on the year and down again this morning. Simply put: investors don’t believe what the Fed is saying.
To add to the confusion, this morning Philadelphia Fed chief Charles Plosser is indicating he believes that Fed Fund rates will hit “2-something” by the end of 2015 and 3% by the end of 2016. This is more than a 300 basis point move in the next couple of years. Plosser also indicated he finds the market’s reaction to Yellen’s press conference last week confusing. Well, Mr. Plosser, confusion breeds contempt, as they say.
Conversely, the United Kingdom, despite losing Scotland to Robert the Bruce many years ago, appears to have a central bank that is at a minimum providing some confidence to the markets and allocators of capital. The U.K. reported CPI this morning at +1.7%, which suggests an inflationary environment in the U.K. that is relatively benign.
Certainly, we’d be somewhat hypocritical if we assumed the CPI was the best gauge of inflation in the U.K. (it is a government constructed number after all), but nonetheless the key economic indicators in the U.K. continue to trend the right way as evidenced by CPI coming in lower versus the +1.9% reading in January.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.62-2.81%
Best of luck out there today and long live the king!
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research