This note was originally published at 8am on March 28, 2014 for Hedgeye subscribers.
“Beware of false knowledge; it is more dangerous than ignorance.”
-George Bernard Shaw
Every effective stock market operator knows that investment analysis is at best an imperfect science. The mosaic theory is an apt description because with the absence of a silver bullet (knowing the results of a drug test before everyone else as an example), an investment analyst’s best tool is his or her ability to collect more data than his or her peers and to then use that data to reach a more informed conclusion.
Even then, in the absence of perfect information, many outcomes are flawed. In fact, many analysts are guilty of making what is called a Type 1 error, or a false positive. False positives lead analysts to conclude that a relationship exists when in fact it does not. In medicine, this might occur when a test shows a patient has a disease, when they don’t.
As Europe contemplates another round of extreme monetary policy to offset perceived deflationary pressures, it does beg the question of whether there is a relationship between a monetary policy and a tightening economy. Certainly, many supporters of former Fed Chairman Bernanke point to the fact that the economy recovered under him as evidence that his implementation of the most extreme monetary policy in the history of central banking was the reason for this recovery.
Conversely, though, the question remains whether the economy has recovered at all because of QE or even commensurately with the QE that has been implemented. As former Dallas Fed President Bob McTeer recently wrote in Forbes:
“The hoarding of excess reserves limited the money creation or “printing” that took place despite the Fed’s massive purchases of securities and expansion of its balance sheet. That’s why the dire consequences predicted never came to pass. However, it is also the reason that the Fed’s purchases never stimulated the economy as much as hoped.”
In reality if you print dollars and don’t allow them to be spent, then you are really only debauching the currency by increasing the denominator. Certainly this a policy that is good for the inflation trade, especially relating to those commodities priced in U.S. dollars
Back to the Global Macro Grind...
As Portugal’s bonds fall below the 4% yield for the first time in almost ever, one has to wonder if there isn’t a bit of a false positive emerging in the European peripheral sovereign debt markers. Currently the 10-year yields of Portugal, Italy and Spain stand at 3.99%, 3.27%, and 3.20%, respectively. Certainly these yields are still wide versus German bunds, but are these yields, on absolute basis, truly reflective of the underlying creditworthiness of those economies?
Take Spain as an example. This morning the Spanish central bank is projecting the Spanish economy will grow by 1.2%. Given that this is below par economic growth, it is likely that Spanish unemployment stays above 25%. This morning consumer prices were also reported to have fallen at an annual rate of -0.2%, which is the first decline in consumer prices in four years in Spain and indicative that consumers in Spain aren’t really spending (recent retail sales data show the same).
Clearly, on the margin, the economies in the periphery in Europe have improved, but if you are a buyer of Italian or Spanish 10-year bonds at 3.2%-ish, you need to put on the big boy analytical pants and decide if for that yield, the risk is commensurate. At a 10% dividend yield, Linn Energy ($LINE) might be a good relative bet . . . actually I take that back, we’d continue to stay the heck away from LINE and much of the MLP complex !!!
My colleague Christian Drake, our U.S. focused economic analyst, wrote a note yesterday that he titled, “INFLECTIONS OR FALSE POSITIVES? CLAIMS, CONSUMPTION & CAPEX” where he addressed some of the myriad of U.S. economic data out recently:
- #ItsNot2013: Growth estimates globally continue to get marked down. Slowing topline (GDP) and compressing margins (rising inflation) is not the stuff of market multiple expansion or macro P&L dynamics to remain lazy long of.
- RISING INEQUALITY: Corporate Profits - measured as the % of National Income or GDP - made another new high in 4Q13. The other side of that, of course, is a lower low in labor’s share of income. Latent risks can remain latent, however.
- CAPEX RESURGENCE? General acknowledgement that assets are aging and businesses have under-invested isn’t a catalyst.
- PAY-ME-NOW: Productively continues to grow at a positive spread to unit costs and investors continue to reward the ‘pay-me-now’ corporate capital strategy.
- DURABLE DISAPPOINTMENT: New Orders for Capital Goods non-Defense Ex-Air have been negative on a month-over-month basis for four of the last six months.
- INITIAL JOBLESS CLAIMS: A positive week of data…finally. The next few weeks of data should be important
His conclusion, which is highlighted in the Chart of the Day below, is that although the U.S. economic data is part positive and part negative, GDP estimates continue to fall. Ultimately the direction of GDP change is what matters.
But that all said, as you head into the weekend I would leave you with words of Mark Twain:
“All generalizations are false, including this one.”
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.64-2.75%
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research