“Let your plans be dark and impenetrable as night, and when you move, fall like a thunderbolt.”
Last week I took the pen on the Early Look from Keith and talked about complacency in global markets. In that note, I highlighted both volatility (VIX) and the level of certain European peripheral yields on government debt, specifically in Spain and Italy. The simple takeaway was that there was not a lot of fear baked into market prices.
Yesterday I was forwarded a chart from the always thoughtful research firm Nautilus Capital Research. The chart looked at the trend and duration of rallies of SP500 from 1900 – Present without a 10% correction. According to their analysis, the current rally from October 2011 is greater than 97% of prior rallies over the last 114 years in duration without a correction. This is, of course, another way to say that investors are currently not very fearful.
The area of foreign policy may be one key area in which the amount of concern or fear is lower than reality warrants. From the Taliban in Pakistan, to the potential for an Iranian nuclear arsenal, to the ongoing conflict in the Ukraine, foreign policy risks remain. Certainly these global hot spots create buying opportunities more often than global calamity, but at a VIX of sub 12, not a lot of calamity is priced in.
This Friday at 10:30am EST. we will once again be joined by Yale Professor Charles Hill for a briefing on foreign affairs. Professor Hill is former Chief of Staff at the State Department, aid to U.S. Secretary of State George Schultz, and special consultant to U.N. Secretary Boutros Boutros-Ghali. He currently teaches the renowned seminar Grand Strategies at Yale.
In the briefing on Friday, Professor Hill will give us his view of the top three foreign policy risks facing both the United States and the World. The dial-in instructions will be sent to all Hedgeye Macro institutional subscribers. If you are not a subscriber, email for details.
Back to the Global Macro Grind . . .
We made a key move on the macro front on our Best Idea List as we removed the Brazilian Real (BRL) from our Best Ideas List. Since making it a key research call, the BRL posted a total return of ~+4.7% versus the U.S. dollar, which compares to a mean return of +2.7%, and is good for the sixth largest gain amongst the 24 EM Currencies tracked by Bloomberg over that time frame.
As our Asia and Latin America Analyst Darius Dale wrote late yesterday:
“Brazilian growth data is flat-out awful; as you can see in the Chart of the Day, 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 to ramp up deficit spending ahead of what is likely to be Brazil’s most contested presidential race since 1989. Recent policy initiatives include:
A +4.5% increase in income tax exemptions starting next year;
A +10% increase in Bolsa Familia cash transfers starting next year worth R$9B… this latest increase takes Bolsa Familia transfers – which benefit ~25% of the Brazilian population – up +64% in real term since the Rousseff administration took office on JAN 1st, 2011; and
Extending a $9.7B payroll tax cut for various manufacturing industries.
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 combination of flat out bad Brazilian economic data combined with murky policy outlook makes us cautious on Brazil, but not on all emerging markets. In fact two that we like, in lieu of Brazil, are Taiwan and India. Although we aren’t quite ready to pound the table and add them to our Best Ideas list, both countries screen positively on our Growth, Inflation and Policy model.
Stepping back from the emerging markets, the most interesting domestic data point that our internal research team picked up yesterday was related to Treasuries. Specifically it was that J.P. Morgan’s institutional clients haven’t been this net short of Treasuries since 2006, which occurred shortly before a major crash in yields.
I’ve been emphasizing the risk of being complacent, but there is also another key risk to consider, which is the risk of being consensus. In the Treasury market, the consensus view is that yields must go higher. Unfortunately, markets normally don’t do what the crowds want them to do.
Certainly on a reversion to the mean basis the following trades make sense:
- Long VIX;
- Long Treasury Yields;
- Short Utilities;
- Long Interest rates broadly; and
- Short European peripheral sovereign debt;
The list could go on to be sure, but if there is one truism in managing global macro risk it is simply that markets can stay irrational longer than investors can stay solvent. So if you aren’t going to wait on the Hedgeye quantitative signal on these reversion to the mean plays, at least keep some fire power dry.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.42-2.61%
WTIC Oil 102.09-104.88
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research