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“Because our process was so different… we felt it had real power.”
As I grind through the end of it, Creativity Inc. is turning out to be one of the best business books I’ve read in a long time. Chapter 4, “Establishing Pixar’s Identity”, is all about process – “trust the process.”
For my team, that’s going to sound very familiar. As real-time market prices, volumes, and volatilities change, we feel that our process is better than our #OldWall competition’s, if only because we change.
“What is the nature of honesty? If everyone agrees about its importance, why do we find it hard to be frank? How do we think about our own failures and fears? Is there a way to make our managers more comfortable with unexpected results?” (Catmull, pg 82)
Back to the Global Macro Grind…
This is going to be one of the shortest Early Looks of the year because a European Central Planner can change my decision making process by doing something drastic to the Global Currency Market in the next few hours.
While I’d only have to work 6 hours a day if I had the inside information that Mario Draghi may have whispered to his favorite cronies, I still wouldn’t know how to position until I saw the reaction to this version of “whatever it takes.”
That’s the main point about my process. I react to what Mr. Macro Market tells me to do – I don’t tell him what to do. It’s taken me a long time to embrace the reality of not only information surprises, but how the market scores them.
Just to set the manic media’s volume on this ECB decision right:
In other words, no one needs moarrr central-planning-cowbell moarrr than those trying to sell advertising. And everyone in the financial media is leading every lemming who will trade alongside the implied trend of the headline, until the market goes the other way.
That’s why contextualizing the #behavioral side of markets across multiple factors and durations is as critical as it has ever been. I’ve been doing this for almost 17 years now and I have never seen macro consensus positioning get run-over so consistently.
That’s not to say that Draghi can’t do something wacky this morning and burn the Euro through my $1.35 EUR/USD long-term TAIL risk line of support. It’s simply to remind you that everyone and their brother is worried that he will, at the same time.
“So”, deal with it. How do I deal?
On the process, I’m constantly vetting, evolving, and hopefully improving ours by stress testing it with the best buy-side minds in the world. Yesterday I was in Boston. Coming out of every meeting I was told that our “macro calls” for 2014 have been different.
Being different can also mean being wrong. “So”, what’s the plan if I am wrong this morning and the EUR/USD doesn’t hold $1.35?
In other words, the plan is that the plan could change. If I take myself out of the emotion of what will be this morning’s moment, there are other big time macro events that could then change the plan yet again:
Yes, the process of printing moneys, destroying currencies, and compromising the trust of The People who have to eat the cost of living born out of that has real power too. Our job is to help you risk manage it.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.41-2.61%
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Takeaway: We remain bullish on FXE and GLD into Thursday's ECB policy meeting.
While we don’t have a crystal ball on how the ECB will act tomorrow, we do know that the Bank has historically surprised (when the ECB last cut the benchmark interest rate in November 2013, from 0.50% to 0.25%, it was widely unexpected by consensus). Frankly, we wouldn’t be surprised if Draghi underwhelms the market’s lofty expectations this time around, and we’re setting ourselves up to buy the EUR/USD (etf FXE) on weakness as we think 1) the sell-off is largely priced in following weeks of rumors about the ECB’s intent to act, and 2) the predictable dovish monetary response by the Federal Reserve as growth surprises to the downside should continue to aid our bearish call on the USD. (Here we look forward to the FOMC statement on the 18th for confirmation.)
The headline CPI estimate in the Eurozone came in lighter than expectations yesterday, increasing at an annual rate of +0.5% for the month of May while consensus expected +0.6%. Today’s preliminary Q1 Eurozone GDP release printed in-line with expectations at +0.9% year-over-year. With the Euro coming off -2.0% from the March 18th high of $1.3934 and Gold (priced in USD) decreasing -4.5% over the last month, the market expects something from the ECB tomorrow. Draghi’s “whatever it takes rhetoric” about fighting what he has labeled a “Japanese” style deflation risk in recent weeks has successfully strengthened the market’s expectation of a dovish policy move at 7:45 a.m. EST tomorrow morning. In a survey of economists released by Bloomberg, 44 of 50 expect the ECB to implement a negative deposit rate. In a separate survey, 56 of 58 expect a cut in the benchmark interest rate. Consensus estimates expect the ECB to cut its deposit facility rate from 0.0% to -0.10% with the benchmark interest rate being cut from 0.25% to 0.10%.
We believe Gold is a hedge against future dollar devaluation and the price activity in both the Euro and Gold have legitimized this view. We added Gold (etf GLD) on the long-side to Hedgeye's investing ideas list on May 22nd:
The Euro-Gold correlations have trended much stronger relative to historical interaction since the ECB’s first mention of an asset purchase plan back in February:
Gold has historically held a meaningful negative correlation to the arithmetic mean of the U.S. Dollar and ten-year treasury yields. As growth surprises to the downside, the expectation for future dollar devaluation in response to Fed policy response increases. Judging by the move in Gold and currency markets into the meeting, anything short of a significant move from the European central bank is widely unexpected.
Also, the anticipation of even easier policy from the ECB moving forward has pushed sovereign debt yields across the Eurozone to historically low levels. Ten-year yields have come in significantly over the last year:
After receiving a $125Bn IMF aid package just two years ago, Spanish yields now hover approximately 30bps over ten-year treasuries. Portugal, which just exited its IMF bailout program in March, borrows at ~100 bps over treasuries. A Bloomberg article published yesterday noted just how drastic this shift has been:
“Bond yields in Germany and its predecessors haven’t been this low since at least the early 1800s, when French forces under Napoleon Bonaparte fought wars throughout the European continent.”
The Federal Reserve is up next on June 18th, and we expect a dovish statement after a horrendous revised Q1 GDP print last week.
We continue to play the sector variances in the market as growth slows and inflation accelerates in the U.S. by remaining long of utilities (XLU +12.6% YTD), REITs (+15% YTD), and commodities (CRB +9.0% YTD; GLD +8.7% YTD). We remain short of consumption-driven sectors that negatively diverge as the consumer is squeezed with inflation: XLY (-1.2% YTD) and IWM (-2.6% YTD). As the prospect for future dollar devaluation increases, we like leaning long of inflation in Gold terms as consensus GDP comps for 2H14 become merely impossible. Despite the slowdown, our non-consensus call into Q2 of 2014 remains just that: NON-CONSENSUS. JPMorgan recently cited that its clients have not been as short of treasuries since 2006. Bullish bets on Gold peaked in Mid-March, right before the Euro began selling off from its YTD highs.
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Takeaway: 76% said HIGHER; 24% said LOWER.
In today’s Morning Newsletter, Hedgeye Director of Research Daryl Jones questioned the lack of current market fear writing:
"…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.”
But we wanted to know what you thought, so today’s poll question was: Is the VIX heading higher or lower?
At the time of this post, 76% said HIGHER; 24% said LOWER.
Of those who voted HIGHER, they explained:
However, this voter, who said it was heading LOWER, pointed out: "Like shorting the SPX, the VIX has been the pain trade of 2014. Of course a geopolitical event could send the VIX to 20 in a millisecond, but what type of event? Until such event happens, I believe the VIX will stay within KM's risk range of 11.## to 14."
Takeaway: It's another arrow in Nike's quiver that differentiates it from its competition.
Nike leads the footwear category in innovation and the margin isn't even close. We're not as excited for a form fitting shoe as we are for the in-store FlyKnit customizer, but it's another arrow in NKE's quiver that differentiates it from its competition. It's much easier to take price when its associated with technical innovation. Even if the wholesale partners (FL, FINL, DKS, etc…) don't initially carry this technology, it is something that Nike can wave in front of them as an incentive to strengthen its leverage over these retailers.
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Editor's Note: This is a complimentary research excerpt from Hedgeye Retail sector head Brian McGough. Follow Brian on Twitter @HedgeyeRetail.
Takeaway: Despite falling rates and solid labor market indicators, the demand to buy homes keeps dropping.
The Mortgage Bankers Association today released its weekly mortgage applications survey data for the week ended May 30. Mortgage purchase application volume slid further this week dropping another -3.6% week-over-week. This brings the streak of negative sequential prints to four in a row on the purchase side. And while 2Q14 is tracking higher vs 1Q14 by 2.9%, it remains down year-over-year by just over -17%.
Activity cooled off on the refinance side as well. Despite falling rates, refinance application volume has been negative in both of the last two weeks, falling -2.9% this week and -1.4% in the prior week.
We're more interested in the mortgage purchase volume data as it's the better leading indicator of the direction of housing's momentum, while the refinance data is largely a reflection of rates on a coincident basis.
As the chart below shows, demand recently peaked in 2Q13 and has fallen significantly since. Admittedly, 2Q14 is tracking up vs 1Q14 by 2.9%, but relative to the -19% decline since mid-2013 (and the positive shift in weather) this bounce remains quite minor.
About MBA Mortgage Applications
The Mortgage Bankers’ Association’s mortgage applications index covers more than 75% of mortgage applications originated through retail and consumer direct channels. It does not include loans delivered through wholesale broker and correspondent channels. The MBA mortgage purchase applications index is considered a leading indicator of single-family home sales and construction. Moreover, it is the only housing index that is released on a weekly basis.
The MBA Purchase Apps index is released every Wednesday morning at 7 am EST.
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Editor's Note: This is a brief excerpt of a research note that was originally sent to subscribers on June 4, 2014 at 8:33 a.m. EST by by Josh Steiner and Christian Drake from Hedgeye's Financials and Macro teams. Follow Josh & Christian on Twitter @HedgeyeFIG and @HedgeyeUSA.