This note was originally published at 8am on May 21, 2014 for Hedgeye subscribers.
“The people who cast the votes don’t decide an election, the people who count them do.”
A key upcoming market and economic catalyst on the horizon is the 2014 congressional midterm elections to be held on November 4th. Historically, we’ve provided extensive election analysis into the election. The next six months will be no different. Simply put, politics drive policy, which in turn drive markets.
The most famous national election surprise was probably the 1948 Dewey versus Truman presidential race. It is widely considered the greatest election upset in American history. Literally every prediction, both with and without associated polls, predicted that Dewey would defeat Truman. In fact, in late September, Gallup had Dewey with an unbelievable 17 point-lead over Truman.
Given that most pundits believed he had no chance at winning the Presidency, Truman adopted a no holds barred approach to campaigning. He attacked Dewey at every stop and “Give’em hell Harry” was consistently yelled by his supporters from the crowd. With this gusto, Truman was able to narrow the deficit, but he still lost all of Gallup’s post convention polls, was endorsed by a mere 9% of the nation’s newspapers, and 50 of 50 “experts” in Newsweek selected Dewey to win.
Many members of the mainstream media were so confident of a victory that stories were written in advance of the election that discussed the “Next President Dewey” and “The Truman Failure.” The most famous photo of the campaign was a copy of the Chicago Tribune held by President Truman that declared, “Dewey Defeats Truman,” after Truman had actually beat Dewey by a reasonable margin of 49.6% of the popular vote versus 45.1% for Dewey.
Back to the Global Macro Grind...
As of now, we certainly are not of the mind that there is going to be a massive surprise in the midterm elections, although we did get your attention with the title we’re sure! In fact, with the advent of more advanced and real-time polling, a massive surprise is quite unlikely. If there is a surprise, it may well be that the Republicans may actually do better than expected. But first let’s look at how the race stands today.
According to the RealClearPolitics 2014 Generic Congressional Vote aggregate, the race is fairly tight. In fact, the Democrats currently have a slight edge over Republicans with the Democrats at 43.4 in the poll versus the Republicans at 42.8, for a positive edge to the Democrats of +0.6, but effectively is a near tie. Back in late October of 2013, this poll favored the Democrats by a spread of+6.6, so Republicans have certainly narrowed the margin.
Interestingly, if we go back to the 2010 midterm elections, this same set of polls also showed the election basically tied at this point in time (we show this in the Chart of the Day below). Ultimately, that election turned into a Republican landslide and the Republican Party won more Congressional seats than almost any “expert” predicted. Even the much avowed Nate Silver got the election wrong.
In part, what many pundits missed in 2010 was the broad disdain for Congress. That disapproval has continued to prevail and currently the RealClearPolitics Congressional Approval Poll Aggregate shows literally the lowest approval rating for Congress in the history of political polling. Currently, the approval rating for Congress is 13.7%. Needless to say, polls that ask about the Direction of the Country very much mirror this with only 28% of respondents saying the country is going in the right direction.
The other key point that many prognosticators missed in 2010 was the Republican motivation to vote. Poll after poll showed that Republicans felt much stronger about the election in 2010. As a result of this elevated enthusiasm, Republicans came out in droves. Will that happen again this year again? It may be too early to tell, but President Obama’s low approval, which is currently at an abysmal +42, is likely to motivate Republicans and not get Democrats overly excited.
Perhaps the most interesting recent poll related to potential outcomes is a Politico poll from Monday that looked at States and races that are actually in contention. In this poll the current edge for Republicans is somewhat staggering.
According to the poll, 41% of respondents said they would vote for Republicans, 34% said they would vote for Democrats, and 25% were undecided. When asked specifically about Senate races, the Republican edge increased to 43%. Further, according to this poll, approval for Obama is just 40% and almost 50% favor an outright appeal of the Affordable Care Act. Campaigning against an unpopular brand in Obama and unpopular policy in Obama Care may make this midterm strategically easier to execute on for the Republicans.
Speaking of elections, perhaps the most noteworthy one internationally is the upcoming election in the Ukraine. Currently the front runner is Petro Poroshenko, or as he is better known for his candy empire, the Chocolate King. The Chocolate King was the lone Ukrainian oligarch to join in the popular protests that led to the ousting of President Yanukovych in February, which seems to be giving him an edge with the masses.
Regardless of who is ultimately victorious in the Ukrainian election, the results will be watched very closely by the international community, especially as it relates to Russian acceptance of the outcome. Let’s just hope a relative of Josef Stalin isn’t counting the votes.
Our immediate-term risk ranges are now as follows (we have 12 Global Macro ranges with a TREND signal overlay in our Daily Trading Ranges product):
UST 10yr Yield 2.46-2.57%
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
TODAY’S S&P 500 SET-UP – June 4, 2014
As we look at today's setup for the S&P 500, the range is 43 points or 1.57% downside to 1894 and 0.66% upside to 1937.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS (Bloomberg Estimates):
WHAT TO WATCH:
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
The Hedgeye Macro Team
This indispensable trading tool is based on a risk management signaling process Hedgeye CEO Keith McCullough developed during his years as a hedge fund manager and continues to refine. Nearly every trading day, you’ll receive Keith’s latest signals - buy, sell, short or cover.
Takeaway: We no longer consider Brazil an attractive investment destination and are content to remove the country from our Best Ideas list.
STEP ONE: SELL BRAZIL
Since our bullish conference call titled, “TIME TO BUY BRAZIL?” (2/27) the following has occurred in Brazilian capital and currency markets:
While that’s obviously a fair degree of global macro alpha, we aren’t simply content to relinquish our research view simply because the trade has worked well. Rather, we see a confluence of deteriorating GIP fundamentals supporting an exodus of investors from Brazilian capital and currency markets.
Brazilian growth data is flat-out awful; as you can see in the table below, there is a hardly a meaningful economic indicator in Brazil that isn’t rapidly decelerating on both a sequential and trending basis. That this is coming amid accelerating headline inflation means Brazilian policymakers are now forced to choose between promoting growth or combating inflation – the latter of which we still view as the country’s key political issue.
Unfortunately for investors, the Rousseff administration is resorting to the tired Keynesian playbook of fiscal stimulus ahead of the election, choosing ramp up deficit spending ahead of what is likely to be Brazil’s most contested presidential race since 1989. Recent policy initiatives include:
These promises of fiscal sweetness come amid heighted pressure to raise the minimum wage, which has increased +42.2% in real terms since 2007. Both Rousseff and her runner-up in the latest polls, Aecio Neves, are on board with another hike.
The problem with hiking the minimum wage now is that many government salaries and pension benefits are indexed to the federal minimum wage in Brazil. In fact, roughly 80% of all federal expenditures are earmarked by law. That is obviously not helpful for a government that has promised investors fiscal retrenchment in 2014. The 1.9% primary surplus target appears to be in danger and the nominal budget balance – which is what really matters to the currency – remains bloated at -3.1% of GDP.
While Rousseff continues to get tagged in the latest polls (37% support as of MAY 7-8), we view the recent retreat from promises of fiscal austerity and monetary policy tightness out of the Neves camp (20% support as of MAY 7-8) limits pressure upon the Rousseff administration to tighten policy heading into the election.
Eduardo Campos (11% support as of MAY 7-8) is a fiscal and monetary hawk and we would view any ascent by him to 2nd place in the polls as positive for our original long idea. That remains to be seen at the current juncture, however. As such, we are now content to take down our intermediate-term growth estimates and take up our intermediate-term inflation estimates for Brazil.
All told, it appears increasingly likely that the Brazilian government is choosing stimulus over prudence at the current juncture and we think international capital allocators have begun to sniff this out.
Specifically, the BRL, Bovespa and Petrobras have all recently broken their respective immediate-term TRADE lines of support and are now flirting with TREND line breakdowns on our proprietary three-factor quant model. The latter two are in the process of confirming lower-highs from technical perspective as well. We don’t recommend buying either signal, as both tend to be leading indicators for further downside.
STEP TWO: BUY TAIWAN
Let’s assume you’ve just booked your Brazil allocation for a nice profit and have some capital to put to work. You’re likely well aware of how we feel about chasing the domestic growth style factor up here in the US equity market, so naturally we are looking abroad for our preferred allocation. Taiwan passes our fundamental and quantitative screens and looks like an interesting play on the long side of global equities from current levels.
Up +5.9%, Taiwan’s benchmark TAIEX Index is on a slow-and-steady march higher in the YTD. While being up +590bps might not seem like that much, that compares to a sample mean of +4.7% across the 21 equity markets we track across Asia & Latin America and is besting the +4.4% YTD gain for the S&P 500.
While it’s hard to argue in favor of the predictability of YTD gains, Taiwan does have idiosyncratic country risk factors that support allocating capital to this market at the current juncture. Specifically, improving GIP fundamentals support chasing Taiwanese equities up here – particularly amid heightened prospects for M&A activity in the global semiconductor space. It’s worth noting that the Tech sector accounts for a whopping 46% of TAIEX market cap, with semiconductors alone accounting for 23%.
Contrary to Brazil, it’s particularly difficult to find a meaningful economic indicator in Taiwan that isn’t accelerating on both a sequential and trending basis. While headline inflation is indeed accelerating, it’s accelerating off of extremely low levels and does not warrant any attention from the central bank – especially with WPI trends being so subdued.
Both the sequential momentum and base effects embedded in our predictive tracking algorithm support our above-the-Street forecast for Taiwanese real GDP growth in 2014 and we see it accelerating through at least the third quarter.
Annualized currency weakness supports a marginally hawkish CPI outlook as we progress through the year, but as previously mentioned, this catalyst is unlikely to result in monetary tightening over the intermediate term. READ: the coast is clear for Taiwanese exporters.
Not surprisingly, the benchmark Taiwan TAIEX Index has registered a +0.83 correlation with the MSCI World Semiconductors GICS Level 3 Index in the YTD, which is up a bit from the +0.80 correlation registered over the trailing 3Y. Indeed, it would seem that getting the semis cycle right is really all investors need to have a handle on to get market beta right for Taiwanese equities.
For those of you who are not yet aware, we’ve recently hired a Global Semiconductors analyst to co-head our Information Technology vertical at Hedgeye. While it would not be compliant nor appropriate for us to discuss his incubating ideas and themes at length in this note, office chatter supports our existing view that #InflationAccelerating will continue to perpetuate a robust M&A cycle across many industries globally – including semiconductors.
Needless to say, semiconductors is in fact an industry with far too many public companies and is ripe for M&A activity over the intermediate term. Perhaps that’s why both the semiconductor stocks and the iShares MSCI Taiwan ETF (EWT) continue to make new highs. Moreover, semiconductors aren’t levered to slowing US consumer demand, as the US accounts for only 20-25% of all consumer electronic consumption globally.
Another style factor we have and continue to support across global capital markets in the YTD is a reach for yield – i.e. allocating capital to long-duration fixed income and bond-like equities. As the chart below highlights, Taiwan is outclassing many of its EM peers with respect to its highly attractive real yields.
All told, if you’re looking for places to put money to work in global equities, then we are firmly in support of any decision to allocate capital to Taiwan on the long side.
STEP THREE: BUY BACK INDIA
In our 5/12 note titled, “BOOKING RESEARCH ALPHA IN INDIA”, we advocated for booking gains in what we are now dubbing the “Modi Trade” across Indian capital and currency markets. At the time, it seemed like a good call in the context of the research alpha we generated and the likelihood that much of the good news was priced in – seemingly only leaving room for election-day disappointment. From that note:
As mentioned at the onset of this note, that was the wrong call. Specifically, the WisdomTree India Earnings Fund (EPI) has appreciated another +8.6% – on admittedly thinner volume of late. While the latter signal is cause for worry, it’s easy for investors to interpret the heavy volume amid the late-MAY melt-up as the entrance of “real money”, strategic buyers who now view a Modi-led India a core holding in an international equity portfolio. @JohnnyComeLately money aside, we do think the chase is generally warranted.
While the aforementioned storytelling has little to do with our fundamental process, we do think it’s worth considering in the context of what has been one of the most hyped capital and currency markets in the YTD.
Indeed, while Modi and his BJP Party did take care of business in last month’s elections, capturing an outright majority with 283 of 543 available seats in the lower house of Indian parliament (accounting for BJP allies, this figure jumps to an overwhelming majority of 335 seats), the BJP coalition is still on very shaking footing in the upper house where they control only 61 of 245 seats. The former ruling Congress Party, which had been in control of Indian parliament since 2004 dropped -175 seats from their 2009 election total.
The aforementioned consternation in the upper house consternation is critical in the context of some of the prospective economic reforms being bandied about the press, many of which require upper house consent – particularly on anything related to foreign direct investment, taxes and constitutional amendments. Such reforms include, but are not limited to:
While it is unlikely that any of this gets done in the near term, it’s become increasingly clear that international investors are willing to propel the hope-fueled rally in Indian capital and currency markets higher.
Moreover, while we believe that fiscal and economic reforms are likely to disappoint intermediate-to-long-term expectations of what is likely priced into the SENSEX at its all-time highs, we do think the prospect for Indian monetary policy supporting structural improvement in India’s GIP fundamentals is a meaningful enough catalyst to warrant reallocating to India on the long side.
As mentioned throughout our bullish work on India over the past few quarters, RBI governor Dr. Raghuram Rajan’s monetary policy soundness has been integral to restoring the country’s credibility amongst global inventors after last year’s fiscal and monetary policy-induced currency crash. A key indication of this is India’s current account balance improving markedly from -4.4% of GDP to -2.8% in 4Q13.
Thus far, we’ve received little-to-no indication that his job or the RBI’s monetary policy independence is at risk under the Modi regime. Recall this was a key worry of ours a few weeks back.
Digging into the most recent data, the RBI’s decision to stand mostly pat on rates today was both well telegraphed (e.g. predicted by all 38 analysts surveyed by Bloomberg) and well-received given that they maintained their previous guidance of maintaining appropriately tight monetary conditions until inflation converges to their targets (i.e. +8% YoY by JAN ’15 and +6% YoY JAN ’16).
The board did implement some targeted easing measures, such as lowering rates in both its statutory liquidity ratio (SLR) and its export credit refinance facility (ECR), but these moves appear more administrative in nature and rhyme with the marginal trend-duration improvement we’ve seen in India’s CPI and WPI readings.
As the table above highlights, India’s growth data is good, but not great. Recent sequential and [marginal] trend-based improvement in PMI data is offset to some degree by waning consumer confidence, passenger car sales and money supply data. As such, we continue to maintain a choppy intermediate-term outlook for Indian growth. If it’s any consolation for investors, our model has Indian CPI converging to the aforementioned targets by EOY ’14.
All told, we are now content to look through likely near-term economic softness (i.e. the “G” in our GIP model) with the intention of playing for likely structural improvement in India’s inflation and policy dynamics (i.e. the “I” and the “P” in our GIP model). Giddy up!
Have a wonderful evening,
Associate: Macro Team
Liz Ann Sonders, chief investment strategist at Charles Schwab, sits down with Hedgeye CEO Keith McCullough to talk markets, the economy and much more in this latest edition of HedgeyeTV's "Real Conversations."
Takeaway: 65% said YES; 35% said NO.
As bond yields crash year-to-date and the Russell delivers negative returns, the world’s most consensus short position (SPX Index + E-mini) hit another new high on no volume yesterday.
Today’s poll question was: Is the S&P 500 going to cross 2,000 this year?
At the time of this post, 65% said YES; 35% said NO.
(Voters sharply swung so much in one way, that we didn’t receive any comments on why people voted NO.)
Here’s what those who voted YES had to say:
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