“I still eat a burger at a counter with ketchup dripping down my face.”
Like being long #InflationAccelerating and slow-growth #YieldChasing in 2014, that sounds #tasty.
My Mom makes yummy burgers on the barbee too. Today we’ll be pounding those back (amongst other things) as we celebrate Canada Day out here on the Big Lake they call Gitchee Gumee in Thunder Bay, Ontario.
Back in Connecticut, it’s going to be Berger Time as well. The Craig Berger, that is – our long-awaited head of Technology Research @HedgeyeBerger who will be launching his Best Semiconductor Ideas today at 11AM EST (Dial-in: ; Conference Code: 859426#).
Back to the Global Macro Grind…
We surprised some of our Institutional Subscribers when we added Semiconductors (SMH = +16.6% YTD) to the long side of our Global Macro Themes deck in Q2. With Berger on board, we’ll really be able to augment our top-down macro call. It goes something like this:
- As US growth slows (and European + Emerging Market + Asian demand stabilizes/strengthens), we like global instead of local demand
- With the US Federal Reserve fear-mongering disinvestment (0% rates), US capex and inventory growth will continue to disappoint
- With tight inventory and low-capex, obvious ways for companies to grow faster are through A) pricing and B) M&A
Yep, just one more way you can be long a slowing US domestic consumption cycle.
There’s a solid article in the FT today reminding you that those who were bullish on the “US capex cycle” have been direly disappointed in 2014 YTD. Newsflash: you aren’t going to get a real mid-1990s capex cycle until you let interest rates rise.
Ideological central-planners don’t get the career-risk adjusted decision making process of execs inasmuch as their Keynesian textbooks don’t get how a country like the UK can see manufacturing demand accelerate (PMI for June 57.5) as the value of the UK currency does (Pound $1.71 vs USD today).
Why on earth would a public CFO sign off on his or her CEO ramping capex (and hurting peak margins, because that’s what happens in the short-term when you invest) when he or she can just fire people (cut costs), take price, and/or buy someone and do the same all over again?
Back to Berger time…
He and I are going to have some fun together creatively destructing some of the old ways of #OldWall research. You see, our edge isn’t what some of NYC and CT’s finest hedgies went to jail for. It’s working as a team, using a differentiated top-down and bottom-up research process.
If you’re still reading my rants, you probably have a feel for what I do. What Berger does is born partly out of his industry experience (worked at Intel, INTC) and partly from doing his time working for firms that also loved doing banking and brokering (we don’t plan on doing either).
We do un-conflicted, un-compromised, independent research. If we don’t have Research Edge that helps investors generate alpha, we don’t get paid. We’re really looking forward to marrying the top-down signaling process of Global Macro with Craig’s detailed financial models and industry analysis.
Here’s a looksy at slide 10 of Berger’s 52 slide Global Semis deck:
1. Chip Sector now a Dividend + Cash Return Story: Div yield leaders include STM (4.2%), INTC (3.0%), MXIM (3.0%), MCHP (2.9%), ADI (2.7%)
2. Large Dividend Hikes (and/or share buybacks) Possible: from SNDK, QCOM, BRCM, NVDA, MRVL, ALTR, AVGO, POWI, VSH, SWKS
3. Acquisitions in Chip Sector Heating Up: Consolidation trends should continue with CAVM, ISIL, SLAB, POWI, MLNX, AMCC, IPHI, EZCH our top acquisition targets
In other words, if you’re into slow-growth #YieldChasing + M&A, you should still be into semis.
If you’d like to throw some more inflation ketchup on that tasty Hedgeye-Style factored burger, stay with long inflation via my homeland too. Largely a play on commodity #InflationAccelerating, Canadian Stocks (TSX) are +12.9% YTD. Beats banging your head against that Old Wall Dow, doesn’t it?
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.49-2.59%
WTIC Oil 104.76-106.94
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
This note was originally published at 8am on June 17, 2014 for Hedgeye subscribers.
“The Fundamental Force for Divergence: r > g”
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.
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):
- If real-growth is +3-4% (1983-1989, or 1993-1999), lots of people are getting paid (savers too!)
- If real growth is 1.7% (Bush and Obama decade), less people are getting paid (not the savers though)
- 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:
- The British Pound is +4.2% in the last 6 months vs the US Dollar
- As the Pound strengthens, UK inflation has weakened to its lowest level since 2009 (+1.5%)
- 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:
- US rates are falling again as the world anticipates Yellen gets less hawkish (less tapering, more dovish)
- 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:
Brent Oil 110.13-113.78
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Risk Managed Long Term Investing for Pros
Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.
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:
- 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
- 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
- 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 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:
- 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:
- Iraq – The current situation with the ISIL advancement and implications for Middle-Eastern energy security moving forward
- Russia – Details and events that have unfolded in the last week
- Unconventional Oil & Gas- Geopolitical impact of North American capacity
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:
- 25% - A new government, new Prime Minister, more robust military, and involvement of Kurdish forces in the fight.
- 35% - A continued political stalemate with an extensive civil war in Iraq and close involvement from neighboring countries.
- 40% - Something in between these two.
These three scenarios will be easier to forecast depending on several events concluding in the near future:
- What happens in parliament over the following weeks
- What religious leaders convey about political change
- How the U.S. intervenes
- ISIS exacerbation of their rule
- Iranian political stance
- 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)
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:
- 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;
- 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.
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