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Forcing 0%

This note was originally published at 8am on June 17, 2014 for Hedgeye subscribers.

“The Fundamental Force for Divergence: r > g”

-Thomas Piketty

 

I’m about a third of the way through Piketty’s 685 page NYT “Best Seller,” Capital In The 21st Century, and I have to admit that I don’t think I’m going to make it to the end. Like most Keynesian and/or Marxist economic diatribes written from a loft in Europe, there’s a lot more text than teeth.

 

That said, if Piketty had any experience risk managing markets, he’d have been able to hammer home why one of his core arguments is accurate. The aforementioned quote points to a simple relationship between growth (g) and returns (r). It explains the widening divergence between rich and poor.

 

True or False? “When the rate of return on capital significantly exceeds the growth rate of the economy, then it logically follows that inherited wealth grows faster than output and income” (Piketty, pg 26). True; especially when real growth is 0%. That’s when only those long inflation and/or #YieldChasing get paid.

Forcing 0% - 567


Back to the Global Macro Grind

 

The main issue most mainstream “economists” educated in the West tend to have is taking the government’s word for it on inflation. If you don’t know what real world inflation is, there’s absolutely no way you can have a real forecast for real (inflation adjusted) consumption g (growth).

 

It took Piketty to page 102 to address “The Question of Inflation”, but using multi-century government data sets he was still able to discern a very basic trend in made-up government inflation data: “the first crucial fact to bear in mind is that inflation is largely a twentieth-century phenomenon.

 

“More precisely, if we look at average price increases over the periods 1700-1820 and 1820-1913, we find that inflation was insignificant in France, Britain, the United States, and Germany: at most 0.2-0.3% per year. We even find periods of slightly negative price movements.” (Piketty, pg 103)

 

Negative price movements?

 

Oh the horror. Commonly fear mongered in 3-card Keynesian Monte as the great threat of “deflation”, most humans have got along just fine when the prices of primitive things like food and shelter have fallen in price.

 

Forget getting lost in the weeds on why there’s no way the 0.2-0.3% inflation reading is precise. It’s the forest (i.e. long-term and secular slope of the line in general prices and/or cost of living) that has been straight up into the right since 1913.

 

What happened in 1913?

 

Oh, right. That was the Federal Reserve Act of 1913 – when the US allowed an un-elected body of central planners begin with their Policies to Inflate via destruction of the purchasing power of The People (i.e. the value of their hard earned currency and savings).

 

Back to the relationship between real growth (g) and returns (r):

 

  1. If real-growth is +3-4% (1983-1989, or 1993-1999), lots of people are getting paid (savers too!)
  2. If real growth is 1.7% (Bush and Obama decade), less people are getting paid (not the savers though)
  3. If real growth is -1% (US GDP growth in Q1 of 2014), people who are long inflation and/or #YieldChasing get paid

 

If you have nothing, you can’t make a return on nothing. That’s a simple concept. What’s less obvious is that if you have something, and save it  (during this Federal Reserve Regime) you still get nothing, minus inflation.

 

“So”, when growth slows, you’re forced to buy asset price inflation (commodities, REITS, etc.) so that you can earn what you need (something greater than 0%) just to keep up with the cost of living.

 

When growth accelerates and the central planning agency RAISES rates, you get paid to both save and invest. (hint: you can’t grow unless you have savings to invest, unless you start levering yourself up).

 

Two real-time examples of countries going opposite way on this right now are the USA and the UK:

 

  1. The British Pound is +4.2% in the last 6 months vs the US Dollar
  2. As the Pound strengthens, UK inflation has weakened to its lowest level since 2009 (+1.5%)
  3. As US inflation accelerates (vs. decelerating at this time last year when the USD was strengthening), real-growth is slowing

 

What the US and UK bond markets are expecting are two different policy paths:

 

  1. US rates are falling again as the world anticipates Yellen gets less hawkish (less tapering, more dovish)
  2. UK rates are rising as the world expects the Bank of England to get more hawkish and get off 0%

 

I could ground myself in an academic hole and write a doctoral thesis on how the divergence between rich and poor is being perpetuated by Fed Policies to Inflate. But I won’t. Too expensive. The inflation of a Western Economics Education is hitting all-time highs too.

 

Our immediate-term Global Macro Risk Ranges are now:

 

SPX 1916-1951

RUT 1136-1175

VIX 10.73-13.29

Pound 1.68-1.70
Brent Oil 110.13-113.78

Gold 1259-1286

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Forcing 0% - Chart of the Day


July 1, 2014

July 1, 2014 - Slide1

 

BULLISH TRENDS

July 1, 2014 - Slide2

July 1, 2014 - Slide3

July 1, 2014 - Slide4

July 1, 2014 - Slide5

July 1, 2014 - Slide6

July 1, 2014 - Slide7

July 1, 2014 - Slide8

 

 

BEARISH TRENDS

 

July 1, 2014 - Slide9

July 1, 2014 - Slide10

July 1, 2014 - Slide11


THE HEDGEYE DAILY OUTLOOK

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.                                             

                                                                                  

SECTOR PERFORMANCE

 

THE HEDGEYE DAILY OUTLOOK - 1

 

THE HEDGEYE DAILY OUTLOOK - 2

 

EQUITY SENTIMENT:

 

THE HEDGEYE DAILY OUTLOOK - 10

 

CREDIT/ECONOMIC MARKET LOOK:

  • YIELD CURVE: 2.09 from 2.07
  • VIX closed at 11.57 1 day percent change of 2.75%

 

MACRO DATA POINTS (Bloomberg Estimates)               

  • 7:45am: ICSC weekly sales
  • 8:55am: Redbook weekly sales
  • 9:45am: Markit US Manufacturing PMI, June final, est. 57.5 (prior 57.5)
  • 10am: ISM Manufacturing, June., est. 55.9 (prior 55.4)
  • 10am: Construction Spending m/m, May, est. 0.5% (prior 0.2%)
  • 10am: IBD/TIPP Economic Optimism, July, est. 48.0 (prior 47.7)
  • 4:30pm: API weekly oil inventories

 

GOVERNMENT:

    • House, Senate on recess until July 8
    • President Obama holds cabinet meeting, speaks on economy
    • 8:30am: Treasury Sec. Jack Lew speaks at U.S.-China Business Council event ahead of his trip
    • *U.S. ELECTION WRAP: McAllister to Seek Re-Election; Obamacare

               

WHAT TO WATCH:

  • U.S. June vehicle sales starting ~8:30am - Preview
  • Iraqi lawmakers meet amid rifts on Maliki’s political future
  • China June Purchasing Mgrs at 51.0, matching estimates
  • BNP agrees to pay $8.97b to End U.S. sanctions probe
  • BNP Paribas seen rerouting dollar clearing to retain customers
  • Macau casino revenue falls 3.7%, first drop in 5yrs
  • Job gains fail to lower U.S. office-vacancy rate stuck at 16.8%
  • Global equities may rise 8-9% in 12 months, UBS’s Haefele says
  • Russell offers final member lists for Russell 1000, Russell 2000
  • U.K. manufacturing unexpectedly strengthens on demand surge
  • German joblessness unexpectedly increases for second month
  • Poroshenko says Ukraine ends cease fire in Eastern regions
  • U.S. foreign account tax compliance act takes effect

 

EARNINGS:

    • A Schulman (SHLM) 4:30pm, $0.66
    • Acuity Brands (AYI) 9:15am, $1.12
    • Paychex (PAYX) 4:01pm, $0.40

 

COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)

  • Iraq’s Kurds Vow to Keep Kirkuk Oil Fields Until Referendum
  • Gold Rally Obscures Fund Outflow as Investors Target Shares
  • Raw Materials’ Resurgence Follows Record Fund Exit: Commodities
  • Zinc Drops From 16-Month High as Rally Is Judged to Be Excessive
  • Soybeans Extend Slump on USDA Data as Corn Drops to 5-Month Low
  • Cocoa Drops as Supplies From Ivory Coast Increase; Sugar Falls
  • Gold Investor Index Falls to 4-Year Low as Rally Spurs Selling
  • Steel Rebar Extends Quarterly Slump as China Steel Output Climbs
  • Europe’s Seven Months of Warm Weather Set to Finish in July
  • South Africa Close to Starting Yellow-Corn Exports to China
  • Fuel Oil Shipments to Asia for July Arrival Increase to 3.3M Mt
  • Uganda Seen Boosting Sugar Production 32% With New Factories
  • Shutdown Threatening to Cost U.S. Ports $2 Billion Spurs Talks
  • Gold Trades Near Three-Month High as Holdings to Economy Weighed

 

THE HEDGEYE DAILY OUTLOOK - 5

 

CURRENCIES


THE HEDGEYE DAILY OUTLOOK - 6

 

GLOBAL PERFORMANCE

 

THE HEDGEYE DAILY OUTLOOK - 3

 

THE HEDGEYE DAILY OUTLOOK - 4

 

EUROPEAN MARKETS

 

THE HEDGEYE DAILY OUTLOOK - 7

 

ASIAN MARKETS

 

THE HEDGEYE DAILY OUTLOOK - 8

 

MIDDLE EAST

 

THE HEDGEYE DAILY OUTLOOK - 9

 

 

The Hedgeye Macro Team

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


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Expert Call: Geopolitical Outlook in The Energy Space -- Summary and Replay

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:

 

Link to Replay

 

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:

  • Special Assistant to George W. Bush and National Security Adviser
  • Senior Director for Strategic Planning and Southwest Asia at the National Security Council
  • Political Adviser to the Coalition Provisional Authority Administrator and Deputy Director for governance in Baghdad.

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:

  1. Iraq – The current situation with the ISIL advancement and implications for Middle-Eastern energy security moving forward
  2. Russia – Details and events that have unfolded in the last week
  3. Unconventional Oil & Gas- Geopolitical impact of North American capacity

IRAQ:

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:

  1. 25% - A new government, new Prime Minister, more robust military, and involvement of Kurdish forces in the fight.
  2. 35% - A continued political stalemate with an extensive civil war in Iraq and close involvement from neighboring countries.
  3. 40% - Something in between these two.

These three scenarios will be easier to forecast depending on several events concluding in the near future:

  1. What happens in parliament over the following weeks
  2. What religious leaders convey about political change
  3. How the U.S. intervenes
  4. ISIS exacerbation of their rule
  5. Iranian political stance

Energy implications:

  • Unlikely any production interruptions as most of Iraq’s exports move out of the Persian Gulf
  • Possibly an increase in exports near-term due to the Kurds exporting their own oil for the first time
  • Medium-term production expectations could be an issue; 45% of future OPEC production expected to come from Iraq (IEA estimates)

RUSSIA:

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:

  1. He’s provided encouragement and support for the Eastern separatists in a way that allows him plausible deniability when faced with scrutiny from the international community, mainly the West and EU;
  2. He then takes conciliatory measures to signal cooperation and his desire to end the violence.

 

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:

  • GDP increase
  • More employment opportunities
  • Trade deficit reduction
  • Lower prices

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.

 

 


Sticky Wages, Pricey Meat

Sticky Wages, Pricey Meat - USD vs. LH and LC Chart YTD

 

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%

 

Sticky Wages, Pricey Meat - chart 2 Performance Table

 

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:

 

  1. A Fed revision for 2014 full-year GDP from 3.0% to 2.1 - 2.3% at the last FOMC meeting will likely face a further downward revision after a -2.9% Final Q1 print last week
  2. The Fed gets more dovish with the data
  3. The bond market adjusts for growth expectations and the prospect for future dollar devaluation perpetuates the yield spread compression
  4. Commodities, which are priced in U.S. dollars, face continued pressure to the upside

 

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.

 

Full Article 

 

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…

 

Sticky Wages, Pricey Meat - chart 3 wage growth vs. livestock and USD

 

Income earners save less and spend more with an increase in cost-of-living:

 

Sticky Wages, Pricey Meat - chart 4 savings rate vs. USD and CRB

 

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. 

 

 

Ben Ryan

Analyst

  

 

 

 

 

 


Poll of the Day Recap: 51% Are Bullish on U.S. Equities

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:

  • Hard to be bearish on the equity market as a whole. There are certain sectors that are significantly outperforming. Record amount of assets under management, easing Fed, life is good when investing with other people's money. I'll buy all the stocks with VIX at 10, as long as I get paid. Greed is good.
  • Consumer spending compares get easier in 2H (the second half of the year). The worst performing stocks in the market through six months have almost all been consumer discretionary. If this group simply ceases to be putrid, it should be positive on the margin for the broader market.
  • Until the Fed stops propping up the market, I can't bet against it. I don’t want to fight the Fed.

 

Voters who are BEARISH on U.S. Equities for 3Q reasoned:

  • Bearish for a 10% reversion to mean without hurting major uptrend.  Reasons: XLY:XLU ratio trending sideways to downward on 1 month, 4-6 month and 1 yr period, all while JNK:TLT outperformance has slowed on those same periods.
  • Too much complacency out there, no volume, inflation cutting into consumer spending, growth forecasts being revised downward with room for consensus to continue to chase growth to the downside with future revisions...
  • Inflation creeping up, economy slowing down, jobs being created are not permanent, increasing disconnection between stock prices and economic reality... see and increasing movement of funds to commodities.
  • The third quarter contains September which historically is the worst month for the markets - so sideways trading in light volume until the tick down in Sept.


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

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