This note was originally published at 8am on July 03, 2014 for Hedgeye subscribers.
"Show me a hero and I'll write you a tragedy."
- F. Scott Fitzgerald
Along with the likes of T.S. Elliott and Ernest Hemingway, F. Scott Fitzgerald is widely regarded as one of the most recognized young American writers of the “Lost Generation” of young Americans who fought in and emerged disillusioned out of WWI.
With the time-tested truths of human nature, we are forced to accept the unconscious anchoring biases and contextual frame of references shaped by our experiences. We then observe and perceive through this ever-changing lens.
Consequently, Fitzgerald’s frame of reference stems out of some epic undulations in popularity and wealth:
- Two world wars
- Jazz Age (a term he coined)
- Currency and Wealth Destruction:
- Great Depression
- Weimer Republic Collapse; followed by
- Ascension and destruction of Hitler’s rule
Without searching for self-proclaimed similarities between the two of us, I can say without a doubt Fitzgerald and I have one thing in common:
We spent a large part of our early years in a cold climate.
Walking across Notre Dame's campus during my junior year for a morning Econometrics class (the subject matter of the class reserved for a future "Early Look"), making a stop for breakfast and coffee was a ritual. Unfortunately, in the dead of winter in South Bend, Indiana, this stop required a small detour, and it was cold!
Now I've heard it was even colder this winter. Even so, convincing me I would not have taken a detour this past winter for a little breakfast and coffee given the colder weather is highly unlikely.
Back to the Global Macro Grind…
Here we are at the midpoint of 2014, a year that has been full of surprises relative to consensus expectations moving into the year.
- Growth (miss): -2.9% Q1 final GDP revision (miss and seventh consecutive year of downward revision from the Fed)
- Inflation (surprise): Headline CPI +0.4% vs. +0.2% expected for May
- Yield Spread: -50 bps (Net Short contracts in the ten-year down to 2.4K from 175K in the first week of January)
- Commodities: CRB (+9.6%); CRB Food (+23.3%)
- VIX: 10-handle; Hovering at all-time lows
So where do we go from here?
The Financial Times published an article yesterday on Hedge Fund beta tracking at all-time highs. Hedge Funds are levered long and yield chasing. Our team consumes and analyzes high-frequency data points across the globe to generate alpha. Alluding to the risks inherent in the market does not mean we are preparing for an epic crash. Sure it could happen, but front-running the sector variances that manifest as growth slows and inflation accelerates is the goal.
- XLU (+13%); CRB (+9%); GLD (+10%) YTD
- XLY (+1.08%); IWM (+3.2%) YTD
- SPX (+7%)
Rather than predicting third and fourth quarter consequences, we absorb the ever-changing landscape and re-adjust the inherent risk across durations in real-time. As 2H growth comps indicate a consensus miss to the downside, we believe the following sequence of events is a probable in today’s centrally-planned environment:
- 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 (hint: not weather-related)
- The Fed gets more dovish with the data
- The bond market adjusts for growth expectations and the prospect for future dollar devaluation perpetuates the yield spread compression
- Commodities as a complex, which are priced in U.S. dollars globally, face continued pressure to the upside net of unpredictable external factors
As the outlook changes, we will contextualize the data and be forced to change. After all, we are paid to be right on both sides of the tape.
With growth DECELERATING and inflation ACCELERATING central planners will try to convince you there’s no inflation in our everyday consumption habits. That coffee and breakfast would have been more expensive this year, but we all have to eat (bad weather or not). Just last year, the central bank adjusted its model for allowing a longer grace period for wage growth to catch up with commodity inflation. Now this seems like a rather convenient way to keep the accommodative power at the expense of the middle class.
F. Scott Fitzgerald could probably pencil quite a symbolic ending to this story. Give Janet Yellen a break for her nervousness. She is new to the scene. However, as you can see in today’s Chart of the Day below, the ECB's Mario Draghi has mastered that red carpet stoicism.
Our immediate-term Global Macro Risk Ranges are now:
SPX 1948-1977
RUT 1170-1208
VIX 10.61-12.81
USD 79.71-80.27
WTI Oil 104.01-107.12
Gold 1310-1330
Good luck out there today and Happy 4th!
Ben Ryan
Analyst
