This note was originally published at 8am on July 25, 2014 for Hedgeye subscribers.
“Shot everytime Janet says “Slack””.
-Hedgeye FOMC drinking game
I was trained as a research scientist, not as an economist. Given that I’m charged with front running the flow of the domestic macro economy, that could be viewed favorably or not – and is probably most dependent on one’s particular ivory tower predilection.
Truthfully, in a debate with an econ PhD scored on the use of technical jargon and unnecessarily complicated verbiage to describe largely pedestrian macro concepts – I’d probably bet on the other guy.
Generalize the contest to one scored on general cerebral alacrity and proficiency in information processing and contextualization – I bet on myself. I’m cool with that tradeoff.
The “Yin” thing about hours of toil in grad school biochem labs and research libraries is that it builds transferable analytical skills.
The “Yang” - when comparing science with investing – is that the conclusiveness of the output and the manner in which the research is applied is almost antithetical.
Generally, the goal of scientific research is to arrive at a definitive, singularly right answer. In investing, such a thing rarely exists. Even if a hard conclusion is, in fact, reachable, bandwidth and time constraints often limit the ability to fully distill the available data.
For someone trained as a scientist, big-time decision making based on imperfect information, data mosaics, and preponderances of evidence amounts to living in a kind of perma-purgatorial state of cognitive dissonance.
If the Hedgeye Macro team was a Boy Band, I would probably be “the overly analytical, loveable one.”
Back to the Global Macro Grind…
Hard hat utilization among the domestic construction bulls continues to run at peak capacity with the housing market throwing up nothing but bricks in 2014.
Wednesday’s Mortgage Application data showed housing demand to start 3Q is running -3.6% QoQ with the purchase index sitting just 6% above the 10Y lows recorded during the peak weather distortion back in February.
Yesterday’s New Home Sales data for June was equally uninspiring, declining -8.1% MoM and -12% YoY. Notably, the June decline was on top of a -12% downward revision to the May data.
To quickly review the evolution of our housing call: After being discretely bullish on housing for the better part of a year beginning in 4Q12, we turned increasingly negative at the beginning of 2014 and elevated #HousingSlowdown to a top Macro theme for 2Q14.
With demand flagging, home prices in conspicuous deceleration and the ITB down -6% YTD (vs. the SPX +7.5%), that call has played out rather well.
Does it still have legs? We think so.
THE SECRET SAUCE: There’s endless housing data available and enough moving parts across the industry to build as much nuance into a housing call as one would like. Where we can, however, we prefer to keep it simple.
Two core, empirical realities sit underneath our base contextual framework for modeling the housing market and the resultant impact on market prices
I won’t keep the sauce secret, but I will make you work for it, kinda You’ll internalize it too if you actually go through this 2 step exercise – Pop-tarts have more directions than that!
- Plot housing demand (pending home sales Index) vs. price (Case-shiller 20 City HPI Index) with demand leading price by 18-months
- Plot Home Price change vs. ITB (U.S. Home Construction ETF)
What you’ll observe is that demand leads price by 12-18 months and housing related equities track the 2nd derivative of price like a glove.
In other words, current demand trends tell you what home prices will do about a year from now and, if the model holds as it has for numerous cycles, equities will follow the slope in HPI.
“RIDING THE SHORT BUS”: The Corelogic HPI data for June showed home prices growing +7.7% YoY – a sequential -110bps deceleration in the rate of home price change vs. the +8.8% recorded in May. In fact, we have seen approximately 100bps of deceleration in HPI in each of the last four months since the February peak of +11.8% YoY growth. Housing demand trends in 2H13 suggest the home price deceleration should continue over the back half of 2014 – implying there’s still some runway left on the short side.
CAPTAIN OBVIOUS: “Everyone expects HPI to decelerate at this point, isn’t that priced in?”…we’ve heard some version of that reasoning multiple times this year and at multi-points along the recurrent housing cycle. We get that sentiment and, intuitively, it feels more right than not, but the data argues otherwise. We’re inclined to stick with the data. With more downside in HPI, demand listing alongside weak income growth and regulation dragging on credit availability, we think sideways represents the bull case for housing related equities over the intermediate term.
GOING BOTH WAYS: A flattening and inflection in the 2nd derivative on HPI will be a key signal for us in terms of shifting off our bearish view. Who knows….by then, maybe the labor data will have held positive, incomes will be growing at a multiple to HPI, comps will be easy, we will have annualized the implementation of the QM regulations and we can get back on the long side.
DRINKING GAMES: I’m on vaca with the fam next week, so I’ll miss the non-event that will be the official reporting of growth accelerating in 2Q off the easiest, non-recession comp ever.
I will, however, try to rally the beach brigade for a ‘spirit’-ed searching of the FOMC announcement for “slack” mentions.
Back in the day, the FOMC “shot” word was “dollar”, but somewhere along the way we had to switch it up...you’d think the man whose lone job was to control the supply of money would have mentioned “the dollar” or “currency” at least once in 8 years…
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.45-2.55%
Shanghai Comp 2091-2146
Christian B. Drake