TODAY’S S&P 500 SET-UP – July 1, 2014
As we look at today's setup for the S&P 500, the range is 29 points or 1.13% downside to 1938 and 0.35% upside to 1967.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS (Bloomberg Estimates)
WHAT TO WATCH:
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
The Hedgeye Macro Team
Takeaway: Dr. O'Sullivan outlined three geopolitical pressure points in the global energy space along with potential scenarios that could manifest.
Last Friday we hosted a call featuring Dr. Meghan O’Sullivan, Kirkpatrick Professor of the Practice of International Affairs and Director of the Geopolitics of Energy Project at Harvard University’s Kennedy School. A replay link is included below along with a brief summary:
Prior to her current position as professor of the Practice of International Affairs and Director of the Geopolitics of Energy Project, Dr. O’Sullivan has held a number of posts including but not limited to the following:
On a high-level, Dr. O’Sullivan outlined three major geopolitical pressure areas in the energy space. She provided potential implications and forward-looking points of interest in her discussion:
ISIS has made a substantial advance in Iraq and currently controls more than a third of Iraqi territory. Most of the Western and Northern Provinces outside of Kurdish control have fallen. Mosul and Iraq’s largest oil refinery, Baiji, have been overtaken. ISIS’ goal is to continue diminishing the border between Syria and Iraq. For all practical purposes, the border between Syria and Iraq has already merged in the northwest part of the country.
Iran has initiated support and advice, with the unconfirmed existence of special forces within Iraqi borders. Syria has conducted air raids within Iraqi airspace against ISIS. Finally, Russia has sold Iraq jet fighters. Throughout escalation of the conflict the US has been hesitant to provide support militarily, but rather has called for political reform.
The current Iraqi government has failed to maintain Sunni support. Many Sunni-based groups have sided with ISIS because of their growing disillusionment with the current regime. Pressure is now being applied for Iraq to form a new government that would be more inclusive to the Sunnis, Kurds, and Shiites. All parties remain hopeful that steps will be taken within the coming weeks to form a new government.
O’Sullivan provided probability-weighted scenarios moving forward:
These three scenarios will be easier to forecast depending on several events concluding in the near future:
Over the last weeks and months we have seen this constant ebb and flow of confrontation between Russia and the West. The world is waiting to see if a new round of sanctions will be imposed on Russia. Despite a cease-fire proposal from Kiev, Russian backdoor involvement is likely fueling the violence.
Putin’s strategy when dealing with the EU and U.S. seems to be twofold:
His strategy points to the likely goal from Moscow: keep Ukraine weak and vulnerable without being directly involved in a war in the global spotlight.
For the first time, the US and EU have been more specific about what they want to see. These measures would target the exploration and production of natural gas. These sanctions however, would not be a tough as people think; Global leaders are cognizant of the situation in Iraq and the corresponding global price impact of short-term supply disruptions.
UNCONVENTIONAL NORTH AMERICAN ENERGY:
Dramatic changes in North American production capacity have shifted the domestic landscape. The U.S. has gone from importing tens of billions of dollars of LNG to self-sustainability.
Possible economic benefits of self-sustainability:
Prior to the boom, every time an intelligence assessment was made of the US, it was recognized that America’s dependence on external energy was one of its prime vulnerabilities. This movement from energy as an Achilles’ heel to energy as an asset relative to other countries globally is a monumental benefit moving forward.
A sign notifying customers of “conventionally raised” steak has been up for two months. Chipotle is either seeing outright supply scarcity or experiencing supply shortages at a price it’s willing to pay. Granted this is only one location, prices have recently increased +8.3% for steak and 11.1% for guacamole at New York locations… And for “conventionally raised!”
With the exception of a -3 bps correction in front-month live cattle futures during the week ending June 20th, Livestock prices closed in positive territory every week this month:
June 6th: Live Cattle: +1.7%; Lean Hogs: +1.1%
June 13th: Live Cattle: +5.3%; Lean Hogs: +1.2%
June 20th: Live Cattle: -0.3%; Lean Hogs: +10.3%
June 27th: Live Cattle: +3.2%; Lean Hogs: +2.4%
Rather than making a call on the direction of agricultural and soft commodity prices on a daily basis, we accept that the speculation of supply shortages can whip prices for a number of reasons outside our control. What we choose to dissect is the consumer and outlook for the U.S. dollar. For the first half of 2014, the consumer slowed and will continue to face similar headwinds in 2H:
Unfortunately this headline commodity inflation is not considered the kind of inflation that concerns the Federal Reserve formula. Forgive us on the repetitive call-out, but the Hedgeye Macro team felt the following article from Reuters last week was an epic interview with Yellen on the linearity of the Fed’s model.
Every FOMC meeting in the last several years precedes an abundance of financial media punditry that dissects the sequential change in the language of each statement. Although rare, we enjoy this direct commentary in the Reuters article for insight into the assumptions made by the fed machine:
"My own expectation is that, as the labor market begins to tighten, we will see wage growth pick up some to the point where ... nominal wages are rising more rapidly than inflation, so households are getting a real increase in their take home pay," she said last week, adding: "If we were to fail to see that, frankly, I would worry about downside risk to consumer spending."
Janet Yellen is, in this quote, referring to her belief in what is called “money neutrality” which is basically the idea that prices and wages move together without harm over the intermediate to long-term. In our opinion, she sounds rather nervous in her assessment of this “reality".
To further quote the Reuters reporter in this article:
“Over the last year Fed staff changed their main model for forecasting wage and price inflation to reflect evidence that companies were adjusting prices more slowly than in prior years. That implies the Fed has more time to allow wages to rise and employment to expand before having to be concerned about inflation accelerating.”
This seems like a convenient way to make room for an extension of accommodative policy as wage growth has stagnated against a flat dollar and skyrocketing cost of living…
Income earners save less and spend more with an increase in cost-of-living:
Our process points to Fed and consensus full-year growth and inflation estimates that are still too optimistic. Yellen’s comments point to the predictable FOMC policy response that we have continuously highlighted as a catalyst for further dollar devaluation. With the CRB Index up 10% in 2014, both the dollar and ten-year treasury yield remain in @Hedgeye bearish formations.
Takeaway: 51% voted BULLISH, 49% voted BEARISH
In today’s Morning Newsletter Keith McCullough wrote, “While it might work in disruptive technologies, devaluing history, time, and cycles rarely works in Macro… ‘so’, let’s embrace the uncertainty born out of these measurable risk factors and get on with Q3.”
As Q2 month-end markups end today and as June stands as one of the lowest equity volume months in U.S. we wanted to know what your thoughts were heading into the third quarter.
Today’s Poll Question Asked: Are you bullish or bearish on U.S. equities for the third quarter?
In the video below Director of Research Daryl Jones highlights the top three reasons why he is decidedly BEARISH on U.S. Equities for the third quarter.
At the time of this post, 51% voted BULLISH, 49% voted for BEARISH.
Those who would are optimistic about what the third quarter holds and are BULLISH on U.S. Equities had this to say:
Voters who are BEARISH on U.S. Equities for 3Q reasoned:
Takeaway: We lack conviction on the intermediate-term direction of the Abenomics Trade and we think investors should remain on the sidelines for now.
I know. The only thing worse than an offensive lineman who can’t block is a sell-side strategy note that lacks conviction. But don’t take our lack of conviction as the absence of conviction altogether; rather, we have conviction in the view that it makes little sense for investors to have conviction in either direction of the Abenomics Trade (SHORT Japanese yen + LONG Japanese equities) with respect to the intermediate term.
Consider the following arguments that are in favor of this investment strategy:
Now, consider the following two arguments that are particularly unsupportive of the aforementioned investment strategy:
Net-net, we do not think it’s appropriate for investors to gross up their exposures here in either direction. Our call for investors to cover Abenomics shorts ~1M ago was highly appropriate, but the outlook from here is less than clear.
As such, we think it makes sense to hold tight through 3Q so that we can finally be 1-2M striking distance of a likely expansion of the BoJ’s QQE program. Again, that is the approximate timing of the next major pro-Abenomics Trade catalyst according to our Hedgeyes, as the resiliency of the Japanese economy post the consumption tax hike should continue to keep Kuroda and Co. at bay for at least the next 3-4M.
Specifically, given the large amount of “hay” that the LDP has promised to bale on the growth and inflation front, we continue to see no reason why long-term investors should bail on the Abenomics Trade (i.e. they should remain involved on the long side of Japanese equities). Policies to Inflate out of Tokyo aren’t going anywhere anytime soon; that’s more than we can say for the Japanese consumer, however.
Email us if you have any further questions and we’d be more than happy to follow up. Best of luck out there!
Associate: Macro Team
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