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What We Don't Know

This note was originally published at 8am on May 28, 2014 for Hedgeye subscribers.

“Only when we admit what we don’t know can we ever hope to learn it.”

-Ed Catmull

 

That’s another fantastic leadership quote from a new book I introduced in yesterday’s Early Look – Creativity Inc. Overcoming The Unseen Forces That Stand In The Way of True Inspiration.

 

“The best managers acknowledge and make room for what they do not know – not just because humility is a virtue but because until one adopts that mindset, the more striking breakthroughs cannot occur… They must accept risk… and engage with anything that creates fear.” –Ed Catmull

 

I can tell you that I wake up every morning living in fear of one simple thing – losing. I hate losing. And I refuse to allow my team to lose for extended periods of time. If and when we are wrong, we either double down or change our mind. We get paid to take a line and be held accountable to it.

 

Back to the Global Macro Grind…

 

Being long slow-growth and #YieldChasing in 2014 (i.e. being long bonds and/or anything equities that looks like a bond) has not only been the winning position YTD, but it was yesterday too.

 

With SP500 busting out (on no volume – US Equity Volume -29% vs the 3mth avg) to all-time-bubble highs intraday, bonds reversed from opening down to closing at their highs of the day. The 10yr UST Yield has ticked down yet again this morning to re-test a fresh 2014 low of 2.49%. Bond bears are losing.

 

But, but, Biotech (IBB) +2.5% yesterday was winning. Yep, nice trade. I just hope you didn’t own it the whole way down, because that “growth” sub-sector of the SP500 has been a certified train wreck this year. Most things high-multiple, high-beta have been.

 

“So” do we buyem because they were up?

 

Let’s get real here folks. I left Career Risk Management Inc. in 2007 so that on days like this I could double-down on my team’s hard work and process. If you want to beat a monthly bogey, great – chase the wabbit. If you want to win a championship in 2014, stay with the fundamental trends.

 

In the US, here are the big intermediate-term TRENDs that have been winning for the last 5-6 months:

 

1. US #InflationAcclerating

2. US #ConsumerSlowing

3. US #HousingSlowdown

 

Winning being defined as the score:

 

1. CRB Commodities Index, Food, and Oil +8-22% YTD #InflationAcclerating

2. US Consumer Discretionary Stocks (XLY) = DOWN -2.1% YTD #ConsumerSlowing

3. US Housing Stocks (ITB)= DOWN -3.0% YTD #HousingSlowdown

 

That’s not to say that I didn’t feel like the NY Rangers last night. However magical a playoff run they’ve had, getting lit up for 7 goals in Montreal feels like I did at yesterday’s market close. Kreider went to de penalty box in the first minute of the game. Canadiens scored. He felt shame.

 

“So” why shouldn’t I change our entire Macro Theme Deck (6-12 month view) and positioning this morning?

 

1. Why isn’t it “different this time” (i.e. bond yields going down aren’t an explicit sign of US growth slowing)?

2. Why isn’t it time to giddy up and buy stocks like Facebook, Twitter, and Yelp that blew up into the thralls of April?

3. Why isn’t it time to pretend that no-volume and an 11 VIX doesn’t matter as a risk management signal anymore?

 

Why Mucker? Why can’t you just change everything you and your team have done YTD and join a crowded consensus long-growth US Equity Multiple Expansion (and bearish on inflation and bonds) view that almost everyone else on the sell-side has?

 

What would change my mind? That’s easy. Going back to what we loved about our US #GrowthAccelerating call in 2013:

 

1. #StrongDollar

2. #RatesRising

3. #DeflatingTheInflation

 

In fact the Swiss have some of that this morning. As the Swiss Franc ripped to new highs, Swiss Exports ramped +2% year-over-year and so did Switzerland’s GDP growth rate. Sound familiar, Mr. Krugman? Same thing happened this year in the UK. #StrongCurrency tax cuts for The People.

 

“So”, other than a lot, what else don’t we know that could be driving spooos higher with the Russell 2000 -1.9% YTD?

 

1. How many hedge funds came into 2014 levered long growth, got smoked, then shorted the April lows?

2. How many people have Yellen and Bernanke whispered to that if growth continues to slow, that they go Qe6?

3. How many one-legged ducks can avoid swimming in a circle?

 

What we do know is that with the VIX at 11.51 (testing YTD lows) and the II Bull/Bear sentiment spread at its YTD highs (58.3% Bullish, 17.3% Bearish = +4100bps wide to the Bull side) that the buy in May, chase performance, and pray thing is alive and well.

 

Our immediate-term risk ranges are now (12 Global Macro Ranges are in our Daily Trading Range product):

 

UST 10yr Yield 2.48-2.60%

SPX 1888-1924

RUT 1089-1144

VIX 11.09-13.79

WTIC Oil 102.99-105.27

Gold 1261-1315

 

Best of luck out there today,

KM

 

Keith R. McCullough

Chief Executive Officer

 

What We Don't Know - Chart of the Day


STRONG CURRENCIES ACROSS THE POND

Client Talking Points

UK

FTSE down -0.5% on good news (UK unemployment 6.6% vs 6.8% last as Keynesians crawl into caves with #StrongPound perpetuating the recovery); Pound holding all lines of @Hedgeye support – upside to $1.69 vs USD.

EURO

Re-testing our long-term TAIL line of $1.35 support vs USD this morning and we think that will hold as the next Big Central Planning event is the Fed meeting next week where we believe they’ll be dovish, on the margin (Dollar bearish).

OIL

European bureaucrats want moarr cowbell (inflation) and they’re going to get it; Brent up another +0.5% to $110.46 this morning and continues to signal a bullish TREND breakout in our model #InflationAccelerating.

Asset Allocation

CASH 15% US EQUITIES 0%
INTL EQUITIES 10% COMMODITIES 20%
FIXED INCOME 30% INTL CURRENCIES 25%

Top Long Ideas

Company Ticker Sector Duration
HOLX

Hologic is emerging from an extremely tough period which has left investors wary of further missteps. In our view, Hologic and its new management are set to show solid growth over the next several years. We have built two survey tools to track and forecast the two critical elements that will drive this acceleration.  The first survey tool measures 3-D Mammography placements every month.  Recently we have detected acceleration in month over month placements.  When Hologic finally receives a reimbursement code from Medicare, placements will accelerate further, perhaps even sooner.  With our survey, we'll see it real time. In addition to our mammography survey. We've been running a monthly survey of OB/GYNs asking them questions to help us forecast the rest of Hologic's businesses, some of which have been faced with significant headwinds. Based on our survey, we think those headwinds are fading. If the Affordable Care Act actually manages to reduce the number of uninsured, Hologic is one of the best positioned companies.

OC

Construction activity remains cyclically depressed, but has likely begun the long process of recovery.  A large multi-year rebound in construction should provide a tailwind to OC shares that the market appears to be underestimating.  Both residential and nonresidential construction in the U.S. would need to roughly double to reach post-war demographic norms.  As credit returns to the market and government funded construction begins to rebound, construction markets should make steady gains in coming years, quarterly weather aside, supporting OC’s revenue and capacity utilization.

LM

Legg Mason reported its month ending asset-under-management for April at the beginning of the week with a very positive result in its fixed income segment. The firm cited “significant” bond inflows for the month which we calculated to be over $2.3 billion. To contextualize this inflow amount we note that the entire U.S. mutual fund industry had total bond fund inflows of just $8.4 billion in April according to the Investment Company Institute, which provides an indication of the strong win rate for Legg alone last month. We also point out on a forward looking basis that the emerging trends in the mutual fund marketplace are starting to favor fixed income which should translate into accelerating positive trends at leading bond fund managers. Fixed income inflow is outpacing equities thus far in the second quarter of 2014 for the first time in 9 months which reflects the emerging defensive nature of global markets which is a good environment for leading fixed income houses including Legg Mason.

Three for the Road

TWEET OF THE DAY

UAE (Dubai kind) stock market -1.9% and -10% in June #interesting

@KeithMcCullough

QUOTE OF THE DAY

“Most of the important things in the world have been accomplished by people who have kept on trying when there seemed to be no hope at all.”

-Dale Carnegie

STAT OF THE DAY

Wells Fargo study showed 4 in 10 millennials are overwhelmed by debt and almost half spend at least 50% of their paychecks paying off debt.


CHART OF THE DAY: Consensus Macro Coming Our Way on GDP

 

CHART OF THE DAY: Consensus Macro Coming Our Way on GDP - Chart of the Day


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Self-Evident Brats

“We hold these truths to be self-evident: that all men are created equal.”

-Thomas Jefferson

 

A big government central planning bureaucrat got his butt whipped down in the heartland of American Constitutionalism last night. Not unlike in the 1970s, when Nixonian Republicans and Cartering Democrats all started to sound the same on economic matters, Americans voted for change.

 

If Eric Cantor doesn’t make your skin crawl, you and I probably won’t be having beers at the Rangers/Kings Stanley Cup tilt tonight in NYC. This guy isn’t a free-market-liberal-conservative like me. On economic matters, he is a raging Keynesian.

 

Bring on the self-evidence that is the Policy To Inflate crushing at least 80% of Americans via cost of living and The Dave Brat. The winner of the 7th District of Virginia is a free-market economics professor! How cool is that? On days like this, even this proud Canadian wants to be American.

 

Self-Evident Brats - brat

 

Back to the Global Macro Grind

 

This is not a political statement. I don’t support the Tea Party inasmuch as I don’t support either the Republican or Democrat parties. This is an economic statement that is ringing as true in the United Kingdom today as it did in the Unites States of America in 2013. Strong Currency; Stronger Country.

 

If you have a Policy To Inflate (weaken your currency via both monetary and fiscal policy), you get what Harvard’s Marty Feldstein finally explained (WSJ Op-Ed yesterday) to the central planning wonks at the Fed: #InflationAccelerating.

 

And when you get inflation accelerating the cost of living in America to all-time highs, you aren’t going to get re-elected by lying to people and telling them otherwise. The truth is self-evident.

 

BREAKING: World Bank Cuts US GDP Growth Forecast

 

#nice

 

Finally someone, somewhere, in the land of officialdom-nod took their US GDP forecast closer to Hedgeye Risk Management’s. While the World Bank didn’t cut its GDP outlook by enough, the point is they had the spine to do what Consensus Macro research won’t, until it’s too late.

 

To review our call on US GDP Growth slowing into Q3 of 2014 – it’s math:

 

  1. Top line (GDP) acceleration in US GDP growth peaked in Q3 of 2013
  2. Inflation (the Deflator, which you subtract from nominal GDP) bottomed in Q2/Q3 of 2013

 

In other words, the year-over-year comparisons put Q3’s probability of inflation slowing US consumption growth at its highest level since Q1 of 2008.

 

“So”, don’t ask a linear-economist who missed calling either the Q1 of 2008 or Q1 of 2011 US #InflationAccelerating calls for their Top 10 reasons why they are still using the same models that haven’t proactively predicted real-world consumption slowdowns. Ask the bond market.

 

At 2.64% on the 10yr US Treasury Yield (down hard from 3.03% on January 1st, 2014), the entire construct of #OldWall consensus still thinks “it’s different this time” (i.e. that they were only wrong on both rates and GDP rising in Q1 because of the weather).

 

Every time the bond market sells off to higher-lows, you buy it. Every time US domestic consumption growth gets bid up to no-volume-lower-highs, you sell it. That is the Hedgeye Macro Playbook for US stocks vs bonds investing in 2014, and we are sticking to it.

 

Another way to position for what I just wrote is as follows:

 

  1. Buy Bonds via TLT, BND, or anything equities that looks like a bond (XLU, VNQ, etc.)
  2. Sell US Domestic Growth like Consumer Discretionary (XLY) and Housing (ITB)

 

If you didn’t buy puts on Cantor’s political message, you could have bought #InflationAccelerating via Oil and Gold futures too.

 

In other news, the SP500 had its 38th day of not moving more (+/-) 1% yesterday. That’s the 2nd longest streak of compressed complacency in 15 years. No worries though, everyone will be able to get out, at the same time, because “this time is different.”

 

In case you aren’t yet convinced that it is different this time:

 

  1. Fear (VIX) has never held below 10, ever (it’s at 10.99 this morning)
  2. II’s Bull/Bear Spread (survey) just hit fresh YTD highs at +4540 basis points wide to the Bull side
  3. One legged ducks still swim in a circle

 

Whether you are a bond bull, US growth bear, or a Brat from Virginia this morning, we stand together fighting the tyranny of mediocre minds trying to centrally plan us into thinking we need their inflation policies to live freely. We hold these free-market truths to be self-evident. They always have been.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.44-2.65%

SPX 1

RUT 1136-1184

VIX 10.78-13.34

Pound 1.67-1.69

Brent Oil 109.10-110.96

Gold 1

 

Best of luck out there today,

KM

 

Self-Evident Brats - Chart of the Day


June 11, 2014

June 11, 2014 - Slide1

BULLISH TRENDS

June 11, 2014 - Slide2

June 11, 2014 - Slide3

June 11, 2014 - Slide4

June 11, 2014 - Slide5

June 11, 2014 - Slide6

June 11, 2014 - Slide7 

BEARISH TRENDS

 

June 11, 2014 - Slide8

June 11, 2014 - Slide9

June 11, 2014 - Slide10

June 11, 2014 - Slide11
June 11, 2014 - Slide12

June 11, 2014 - Slide13


Getting 'Tipsy' Ranting About Inflation

Takeaway: Inflation is accelerating and we continue to think investors should proactively prepare their portfolios for this economic phase change.

This unlocked research note was originally published June 06, 2014 at 16:58 in Macro

The Perils of Falling Inflation.” Like clockwork, that phrase was on the cover of the November 9th – 15th issue of The Economist right after headline CPI bottomed at +1% YoY in OCT ’13. Fast forward to today, domestic consumer price inflation – on the government’s conflicted and compromised metric – is running +100% higher at +2% YoY (APR ’14).

 

Getting 'Tipsy' Ranting About Inflation - 10

 

Inflation doubled, lol!

 

Ok, that’s probably not very funny – especially if you’re a consumer that is feeling the pinch of rising inflation. Growth in real incomes in America has slowed from its cycle-peak of +1.3% YoY in OCT ’13 to +0.3% YoY as of APR ’14.

 

As a late-20s working professional living in Manhattan, I can say honestly that just about everything I buy – from rent, to clothes, to food, even down to the occasional Bud Light – has gone up in price on a YoY basis at rates well north of +2%. Some things, like taxis and train tickets, are tracking up mid-to-high single digits from a YoY rate-of-change perspective. Obviously this is all specific to my consumption basket, but when I speak to people all across the country – be it the cab driver in San Francisco or the Midwestern woman on the plane ride next to me – all everyone wants to talk about these days is how expensive everything has gotten.

 

Again, anecdotal data is what it is, but I challenge you to find me someone who genuinely believes inflation is running at or below +2% or decelerating. Moving along, here are a few non-anecdotal data points that have hit my inbox in recent weeks (copy/pasted directly from StreetAccount):

 

  • The WSJ reported that the Organization for Economic Cooperation and Development (OECD) said the annual inflation rate in its 34-member states rose to 2% in April, from 1.6% in March. It noted that in the Group of 20 leading industrial and developing nations, inflation rose for a second month to 2.8% from 2.5%.
  • The WSJ reported that rents rose at shopping centers and malls for the 12th consecutive quarter in a sign that landlords are getting a boost from the improving economy and low level of commercial real-estate construction. Data from Reis showed asking rents at strip centers rose 0.4% q/q in Q1, to $19.42 per square foot, the highest level since late 2008. Asking rents at large regional malls rose 0.5% to $40.15 per square foot, also the highest since the end of 2008.
  • Bloomberg cited a report from Trulia, which showed none of the 100 largest metro areas had increases of more than 20% in residential asking prices last month - the first time in almost two years. It compares with seven metro areas that had such y/y gains in May 2013. The report said national asking prices gained 8% y/y in May, the slowest pace in 13 months, amid slumping demand from both traditional buyers and investors. Meanwhile, rent growth is accelerating. Rents are up 5.1% nationally, with apartments climbed 5.8% and single-family homes gaining 2.1%... #InflationAccelerating AND #HousingSlowdown in the same data point(s)… #awesome!

 

Perhaps I’m not alone…

 

INTERMEDIATE-TERM TREND VIEW

Luckily you, unlike the vast majority of Americans, can do something about it. In line with our #InflationAccelerating macro theme (introduced in JAN ‘14), we continue to anticipate that reported inflation will accelerate throughout 2014. There are three primary reasons we hold this view:

 

One: Holding current prices flat, the US dollar on a trade-weighted basis will dip into negative YoY territory in 2Q14E and will remain negative through 3Q14E, only returning to marginally positive by 4Q14E. This is a sharp deterioration from the +3-4% trend we’ve seen since the start of 1Q13. That should provide a material shock to the rate of change in import price inflation, which, at -0.3% YoY, is currently accelerating off the lows of late-2013 (-1.8% YoY in NOV).

 

Getting 'Tipsy' Ranting About Inflation - dale

 

Two: We do not, however, think it’s prudent to hold current market prices flat. While most of Wall St. continues to anticipate higher rates amid tighter policy out of the Federal Reserve, we believe rising inflation will continue to slow consumption growth at the margins – which is ~70% of US GDP. That, coupled with the precipitous decline in both activity and price appreciation in the housing market, should eventually force the Fed to pare back their guidance on eventual monetary tightening. A cessation of their existing policy to taper is not out of the question by the third quarter. Commodities, which hold a -0.70 correlation to the USD (CRB Index vs. US Dollar Index; trailing 6M), should continue to grind higher. It’s worth noting that the CRB Index is up +9% YTD, besting the sub-6% return for the S&P 500. 

 

Getting 'Tipsy' Ranting About Inflation - 2

 

Getting 'Tipsy' Ranting About Inflation - Median CPI   US  Eurozone and China

 

Three: If none of our market-based forecasts come to fruition, we still have confidence in CPI accelerating over the intermediate term – if for no other reason than base effects. Without getting too geeked out on differential calculus, “simple” math would suggest that as comparative base rates decline sequentially – which they do throughout the balance of the year – the probability that the rate of change accelerates from the base rate (i.e. t₀) increases substantially.

 

Getting 'Tipsy' Ranting About Inflation - CPI COMPS

 

LONG-TERM TAIL VIEW

In line with our #StructuralInflation macro theme (introduced in APR ’14), we continue to think structural inflationary pressures are building up across the US economy. While we cede the point that considerable slack remains in the labor market, we do not think investors are paying nearly enough attention to the following supply-side pressures that are likely to perpetuate cost-push inflation over the long term:

 

  1. S = I. Savings equals investment. That’s the most basic, underappreciated formula in all of the borderline useless economic theory we’ve all had the “great privilege” of learning at some of the world's best (i.e. overpriced) collegiate institutions. With rates being held at zero for such a long time, it should come as no surprise that real nonresidential fixed investment is up only +3.3% on a trailing 5Y CAGR basis. That’s the slowest rate of growth this far into an economic expansion over at least the last 30Y.
  2. Again, when the central bank cuts rates to zero and leaves them there for the better part of six years, savings are naturally pulled from traditional investment vehicles that encourage investment (e.g. growth stocks) and into investment vehicles that actually encourage disinvestment – such as MLPs – in search of higher yields. Duh. Moreover, corporations – which have been increasingly rewarded by investors to buy back stock and ramp dividends – have largely done so in lieu of investing in their businesses. Now, as we approach what may be the end of economic cycle, many corporations streamlining trailing peak GDP growth rates and are scrambling to ramp up production into the inevitable result of seven years worth of broad SG&A deleveraging: relatively depressed production, transportation and storage capacity.
  3. Q: What happens when company A acquires company B in industry C? A: There are fewer companies operating in industry C, effectively creating marginal headroom for company A to hike prices on its customers. This phenomenon has been happening all throughout the post-crisis era and is now accelerating to a hilt here in 2014. The total number of domestic enterprises has declined -6% since the pre-crisis peak, with larger firms leading the decline at -10%. For example, Airlines and Hotels are two obvious industries in which consumers are feeling the pricing pinch of decreased competition. Newsflash to whomever just bought the all-time high in the US equity market at 10-VIX: You can’t be long the Airlines on a tired industry consolidation thesis and say that there’s [going to be] no inflation. That’s disingenuous at best… Another newsflash: With the retail sales control group measure declining -0.1% in APR, it’s interesting to see that revolving consumer credit grew at a +12.3% SAAR pace in APR. It is likely that consumers are feeling the pinch of rising, underreported inflation and levering themselves up to keep pace!

 

Getting 'Tipsy' Ranting About Inflation - 3

 

Getting 'Tipsy' Ranting About Inflation - 4

 

Getting 'Tipsy' Ranting About Inflation - 5

 

Getting 'Tipsy' Ranting About Inflation - 6

 

CONCLUSION

Buy TIPS. Protect yourself and/or your clients from a likely acceleration in CPI. Please note that we are not making a hysterical call for hyperinflation born out of serial money printing. That’s not our style. Rather, our style is to call it like it is: the US economy is likely to experience a run-of-the-mill pickup in reported inflation. A 3-handle on headline CPI – which remains a conflicted and compromised calculation – is probable over the intermediate term.

 

Inflation tripling, lol!

 

Have a great weekend. If you get hungry at the beach, grill an iPad!

 

Darius Dale

Associate: Macro Team

 

Getting 'Tipsy' Ranting About Inflation - 7


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