This note was originally published at 8am on June 18, 2014 for Hedgeye subscribers.
“Measure what is measurable, and make measurable what is not.”
According to legendary theoretical physicist Stephen Hawking, Galileo likely bears more responsibility for the birth and development of modern science than anyone. This is a heady compliment from one of the most prominent physicists of the modern era. In terms of measuring accomplishments, Hawking is probably right.
While he was well versed in physics and mathematics, Galileo (like the artist Banksy, Galileo was known mononymously) was best known for his work in astronomy. Among other things, he confirmed the phases of Venus, discovered the four largest satellites of Jupiter, and discovered sunspots. Galileo could literally see in the stars things that his contemporaries could not.
As insinuated in the quote at the beginning of this note, Galileo was truly one of the first modern thinkers to establish and vigorously defend the idea that laws of nature are governed by mathematics. In other words, if it could be measured, Galileo measured it. And if it could be counted, Galileo counted it.
This lesson of measuring and counting can also be applied very directly to a less scientific profession, that of investing. The more we can quantify any investment, the better decisions makers we become. Anecdotes are convenient shortcut for the less informed. Math doesn’t lie, people do. As Galileo also advised:
“If I were again beginning my studies, I would follow the advice of Plato and start with mathematics.”
Wise advice, indeed
Back to the Global Macro Grind...
Speaking of outer space, an increasing macro risk we see, especially heading into the summer driving season, is that oil prices are potentially “going to the moon” due to the heightened conflict in Iraq. Iraq currently produces about 3.3 million barrels per day, but it is the second largest exporter after Saudi Arabia in OPEC.
On a percentage basis, over the next five years Iraqi is projected to see the most production growth globally. Net-net, Iraq is the key global swing producer and also has the fifth largest reserves. In the world of commodities, what happens on the margin matters and the Iraq oil industry plays squarely on that margin.
Of course, to the punditry that is arguing commodity inflation is temporary in nature, this adds fuel to the fire. The heightened tensions in Iraq are clearly “temporary” in nature. Currently, the CRB index is up +10.5% in the year-to-date and 16 of 19 of its key components are up as well. For those of us that, like Galileo, like to count things, that means that 84% of componentry of the CRB index is up on a “temporary” basis this year.
As well, for those of us that work in the hallowed halls of Wall Street, or for those that eat iPhones, this might not matter much. But for the median American consumer who has pre-tax income of $47,000, you can be damn skippy it does matter. Assuming those consumers also drive, then accelerating oil prices are only going to accelerate the vise like grip that commodity inflation has on their pocket books.
Coincident with accelerating commodity prices domestically is the fact that real weekly earnings, released yesterday morning, turned back to negative in May. At down -0.10% year-over, this is the worst reading, assuming you believe negative earnings growth is bad, since January of 2013. Food, energy and shelter prices are inflating and real income is turning negative. Clearly, this is an elixir for a strong economy (#SarcasmAlert).
Luckily enough, given the high correlation between many commodities and the U.S. dollar, our policy makers do have a choice, which is to implement strong dollar policy. Seemingly, this has worked for the United Kingdom, where its rational, and Canadian, central banker Mark Carney has protected the currency and the pound is now up 8% year-over-year versus the U.S. dollar. Subsequently, the U.K. economy has outperformed.
Sadly, about the only meaningful move we can expect out of the Federal Reserve later today is that they will once again have to take down their U.S. GDP estimates. Nothing new there though as the Federal Reserve’s economic projection have been about the best lagging, or some instances just wrong, economic projections that devalued U.S. dollars can buy.
Clearly, though, any concerns we may have are misplaced. In fact, this morning, Portugal is selling 12-month t-bills at 0.364% versus the prior level of 0.617% and 3-month t-bills at an average yield of 0.18% versus the prior yield of 0.432%. The Spanish government even got a better deal, selling five year paper at a yield of 1.402% with a bid-to-cover of, are you ready for this, 2.32x! Aye carumba!
Meanwhile, in the most recent U.S. Investor’s Intelligence poll, a mere 22.3% of respondents expect a correction in U.S. equity markets . . . but, hey, the Utility subsector of the SP500 is up +12.7% on the year-to-date, that must be healthy for the U.S. economy. Right? Or maybe the hockey heads at Hedgeye are just seeing stars.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.44-2.66%
Brent Oil 110.23-113.98
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research