Takeaway: Pollyannaish, back-end loaded estimates for growth and poor hedge fund performance are meaningful risks to the equity market.

First and foremost, Happy Mother’s Day to all the mothers out there and to the husbands, daughters and sons who support them.


Secondly, please go outside and add something to 2Q14 GDP if you haven’t already. The weather is amazing!


I’m sure every consensus economist, journalist and corporate executive will give 100% of the credit to awesome weather for what should be a marked acceleration in economic and operational performance this quarter. For what it’s worth, the top of our range for 2Q14E GDP is +3.1% on QoQ SAAR basis, so we’ll side with consensus in expecting a short-term recovery for now. If you blamed the weather on the way down, it’s only fair that you caveat any and all good data with better weather on the way up, right? Right.


At any rate, where we continue to be divergent from both consensus and the Fed (have been all year, btw) is that we expect accelerating inflation to slow growth, at the margins, through the balance of the year.






Be it sector variance (XLU +9.7% YTD vs. XLY -6.1% YTD) or style factor variance, the market definitely agrees with our call. The rotation out of the growth style factor(s) is now trending and, at least in macro, the trend is your friend.




The key issue here is that market participants are increasingly back-end loading growth estimates. Not only is equity volatility protection being priced cheaply on an absolute basis across the curve relative to recent years, the spread between VIX futures ~3 quarters out and front-month contracts is rather narrow – effectively implying considerable confidence that conditions for investors will remain more-or-less fine for the foreseaale future.



Source: Bloomberg LP


This move has caught a lot of investors offsides in the YTD. Per StreetAccount:


  • The WSJ cited data from researcher HFR Inc, which showed hedge funds just experienced back-to-back monthly declines for the first time in two years. The firm said hedge funds on average dropped -0.17% in April, following a -0.33% decline in March – the first time funds have turned in consecutive monthly declines since April-May of 2012.
  • StreetAccount notes data from Preqin showed the average hedge fund returned 1.23% in Q1 – the worst start to the year since 2008.


Obviously, we have number of hedge fund customers, so we don’t write this to be trite or disrespectful. We only call this to your attention because if this trend of poor performance continues, there will likely be an industry-wide lowering of gross exposures and tightening of net exposures, with outflows as a key tail risk. Don’t forget how correlated equity hedge funds are to market beta (+0.75 on a DoD % change basis and +0.96 on an index value basis over the TTM).



Source: Bloomberg LP


What’s even worse is that our TACRM™ global macro weathervane is signaling a breakdown in hedged equity exposure. This is likely because many funds are still long of growth (which is also breaking down) and short things like bonds and emerging markets (which happen to be among the best looking asset classes, along with inflation proxies and REITs).




We’ll explain these signals in far greater detail and how to apply TACRM™ to your investment process in the coming days and weeks. For now, just accept the simple conclusion that there are thousands of hedge funds suffering from the ol’ “Texas Hedge” right now and that is a meaningful risk to the stock market if prevailing market trends continue to do just that (i.e. trend).


Enjoy the rest of your weekend,




Darius Dale

Associate: Macro Team

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