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Takeaway: Recent commentary out of Federal Reserve policymakers solidifies our expectations that the Fed will surprise investors to the dovish side.

When I started as a junior analyst in this business, I had the fortunate experience from learning from one of the best Retail & Apparel analysts in the world, Hedgeye Sector Head Brian McGough. One of my primary responsibilities on Brian’s team was to update models during earnings season and take notes on conference calls. 


It didn’t take long for me to realize that “management” knew little more about the future than even I did. In fact, listening to how bearish many of those executives sounded during what was a generational opportunity to buy domestic consumer discretionary stocks (i.e. mid-2009) sounded increasingly at odds with the Hedgeye Macro Team’s almost-giddy bullish view on the US consumer.


I learned three valuable lessons from that experience that have shaped, if not defined my analytical career:


  1. No one knows anything about the future. We’re all getting paid handsomely to bet on what we view as the most probable outcome (i.e. “guess”).
  2. While relative levels of compensation would indicate otherwise, corporate executives are not any better than you or I at predicting the future state of their own operating performance – let alone the broader economy. The best they can do for you in a 1x1 meeting is provide you with details that may border on material nonpublic information – something we vehemently shun at Hedgeye. 
  3. There is no “management” to call in macro.


Regarding that last point, we often joke in meetings with prospective customers that “God called us” whenever we’re asked to describe the research process that has allowed us to stay on the opposite side of both buy-side and sell-side consensus on the direction of interest rates in both 2013 and 2014 (i.e. accurate).


In reality, our process is a combination of rigorous quantitative methods, meticulous study of economic history and a willingness to incorporate relatively newer disciplines such as behavioral finance and complexity theory into our analysis. We’re certainly not always right, but over the years we’ve found that combination to be the most successful at generating a high probability of accuracy on a consistent basis.


If, however, there was a management team to call in macro, it would most likely be the Federal Reserve. Their incessant and growing interference with financial markets has certainly amplified their role in both the price discovery process and the pace of economic activity. 


While we don’t have Janet Yellen’s phone number, or the numbers of any of her minions among the Federal Reserve Board of Governors, or their minions at CNBC or the WSJ, we can at least pretend to engage in a 1x1 dialogue with them by asking and responding to commentary from their recent statements.  We do this below with a satirical interview that incorporates sound bites from Federal Reserve Vice Chairman Stanley Fischer’s 8/11 speech at the Swedish Ministry of Finance:


  • Q: Hedgeye: Tell us about the Fed’s track record on growth.
  • A: Fischer: “Year after year we have had to explain from mid-year on why the global growth rate has been lower than predicted as little as two quarters back. Indeed, research done by my colleagues at the Federal Reserve comparing previous cases of severe recessions suggests that, even conditional on the depth and duration of the Great Recession and its association with a banking and financial crisis, the recoveries in the advanced economies have been well below average... These disappointments in output performance have not only led to repeated downward revisions of forecasts for short-term growth, but also to a general reassessment of longer-run growth. From the perspective of the FOMC, even in the heart of the crisis, in January 2009, the central tendency of the Committee members' projections for longer-run U.S. growth was between 2-1/2and 3 percent. At our June meeting this year, these projections had fallen to between roughly 2 and 2-1/4 percent.”


  • Q: Hedgeye: Interesting. Why do you think growth has been so slow in the post-crisis era?
  • A: Fischer: “As Cerra and Saxena and Reinhart and Rogoff, among others, have documented, it takes a long time for output in the wake of banking and financial crises to return to pre-crisis levels. Possibly we are simply seeing a prolonged Reinhart-Rogoff cyclical episode, typical of the aftermath of deep financial crises, and compounded by other temporary headwinds. But it is also possible that the underperformance reflects a more structural, longer-term, shift in the global economy, with less growth in underlying supply factors… In the United States, three major aggregate demand headwinds appear to have kept a more vigorous recovery from taking hold. The unusual weakness of the housing sector during the recovery period, the significant drag--now waning--from fiscal policy, and the negative impact from the growth slowdown abroad--particularly in Europe--are all prominent factors that have constrained the pace of economic activity.”


  • Q: Hedgeye: So, to be clear, you do not think your Policies To Inflate have had anything to do with the fits and starts in growth we’ve seen over the past several years?
  • A: Fischer: [no comment]


  • Q: Hedgeye: Moving along, what do you make of claims that ZIRP and quantitative easing after quantitative easing are effectively holding back the recovery by depressing the “animal spirits” needed for a true economic cycle?
  • A: Fischer: “… turning to the aggregate supply side, we are also seeing important signs of a slowdown of growth in the productive capacity of the economy--in the growth in labor supply, capital investment, and productivity. This may well reflect factors related to or predating the recession that are also holding down growth. How much of this weakness on the supply side will turn out to be structural--perhaps contributing to a secular slowdown--and how much is temporary but longer-than-usual-lasting remains a crucial and open question.”


  • Q: Hedgeye: Interesting that you mention labor supply. Can you talk a little bit about “slack”, which has been a hot topic amongst monetary policymakers in recent weeks?
  • A: Fischer: “There has been a steady decrease in the labor force participation rate since 2000. Although this reduction in labor supply largely reflects demographic factors--such as the aging of the population--participation has fallen more than many observers expected and the interpretation of these movements remains subject to considerable uncertainty. For instance, there are good reasons to believe that some of the surprising weakness in labor force participation reflects still poor cyclical conditions. Many of those who dropped out of the labor force may be discouraged workers.”


  • Q: Hedgeye: Lastly, can you share with us any insights you guys may have that we may not yet be aware of as it relates to your “data dependent” guidance on policy normalization?
  • A: Fischer: “At the end of the day, it remains difficult to disentangle the cyclical from the structural slowdowns in labor force, investment, and productivity. Adding to this uncertainty, as research done at the Fed and elsewhere highlights, the distinction between cyclical and structural is not always clear cut and there are real risks that cyclical slumps can become structural; it may also be possible to reverse or prevent declines from becoming permanent through expansive macroeconomic policies.”


  • Q: Hedgeye: So basically what you’re saying is, “We really have no clue what we’re doing or where we’re headed, but we’re going to attack every problem as if it were a nail and we’re the hammer.” Is that more-or-less accurate?
  • A: Fischer: [no comment]


Moving along, if you aren’t yet familiar with the debate surrounding the outlook for US monetary policy we’ve been attempting to prepare investors for since JAN, we highly encourage you to review the following Reuters article: "Yellen Resolved to Avoid Raising Rates Too Soon; Fearing Downturn" (7/12).


All told, we remain the bears on US interest rates/bulls on long-term Treasuries as growth is likely to slow throughout 2H14.




Meanwhile, Consensus Macro remains out to lunch with their expectations of perpetually compounding +3% QoQ SAAR GDP growth – expectations that don’t even align with their full year view of +1.7%. Specifically, if GDP compounds at +3.1% in Q3 and Q4, full year GDP will equate to +2.1%, not the +1.7% currently expected by Bloomberg Consensus. I know it’s August, but c’mon, that’s just analytically lazy. Update those forecasts!




For those of you who are still grinding away with us, we wish you a restful night’s sleep and a very productive morning.




Darius Dale

Associate: Macro Team


Takeaway: The untimely death of PSB candidate Eduardo Campos throws major wrench in Brazil’s presidential race that investors need to factor in.

First and foremost we offer our condolences to the family, friends and supporters of Brazilian presidential candidate Eduardo Campos, who died earlier today in a plane crash, along with six other victims. We also offer our condolences to the many victims of geopolitical violence around the world, be it in Iraq, Ukraine or in/around Gaza.


Risk happens fast; just like that, Brazilian stocks (using the iShares MSCI Brazil Capped ETF or “EWZ” as a proxy) closed down -1.5% on the day. This is a negative divergence versus the sample average of 24 country-level ETFs we track across the EM space (+0.6%) and versus the S&P 500 SPDR ETF Trust (SPY), which closed up +0.7%.


We think the market is continuing to price in the likelihood of a Rousseff reelection, which equates to:


  • Continued heavy-handed interference in Brazil’s SOEs;
  • A general unwillingness to take a back seat to the private sector; and
  • Unrelenting fiscal and capital account policy mismanagement.


We say “continuing to price in” because, much like we predicted back in early-JUN, the EWZ is now demonstrably underperforming on a 3M basis. It’s -2% decline over that duration compares to sample mean of +6% for the 24 country-level ETFs we track across the EM space and a gain of +2.6% for the SPY. In full disclosure, the EWZ is up +4% since our 6/3 note, but that’s lagging the aforementioned sample by -30bps; we don’t get paid to recommend crowded beta...




The call from here is simple, yet somewhat complex:


  • Campos’ death paves the way for his vice presidential candidate Marina Silva to head the Brazilian Socialist Party’s ticket, which is not her original party (i.e. Rede Sustentabilidade). PSB leadership have 10 days to officially submit another name for the party’s presidential ticket.
  • Should Silva decide to run, there is fair risk that she uses her popularity to steal votes from both Rousseff and current runner-up Aécio Neves of the Brazilian Social Democracy Party in the primaries, though likely mostly from Rousseff. Recall that she finished third in the 2010 election with 19% of the vote.
  • If she is unable to do so, or if another named candidate is unsuccessful at steering public opinion (highly unlikely at this state of the process), it is likely that Rousseff emerges victorious in a runoff election. She is currently outpacing Neves in head-to-head polls.
  • If Rousseff wins, the “vote-Rousseff-off-the-island” trade we authored back in FEB gets unwound – likely in a major hurry if investors add to positions on what may develop into widespread electoral uncertainty in the wake of Campos’ untimely death. For more details, please review our 7/14 note titled, “SELL BRAZIL?”.


Stay tuned, this could get dicey.




Darius Dale

Associate: Macro Team


Takeaway: We remain comfortably neutral on the “Abenomics Trade” here as domestic factors conflict with globally interconnected risks.

Gee, what a boring year it has been for the bulk of investors with capital allocated to Japan. The Nikkei 225 is trading at roughly the same level it did back in the last week of JAN – as is the USD/JPY cross. Truly, Japanese financial markets have been as boring in the YTD as BoJ monetary policy statements have been since Governor Haruhiko Kuroda got his term started with a bang in APR of last year.


Judging by speculative net length in the futures and options markets, it remains our view that many international investors dog-piled into the “Abenomics Trade” (i.e. long Japanese equities/short the JPY) at the end of last year – likely in an attempt to chase what had been one of our 2013 “moneymaker” trades alongside our #RatesRising and #GrowthAccelerating (i.e. the outperformance of the domestic growth style factors) themes.




What hasn’t been so fortunate for investors is the -6.6% YTD decline in the Nikkei 225 or the +2.8% appreciation of the Japanese yen versus the US dollar. Moreover, the outlook from here remains undecided as ever as domestic factors conflict with globally interconnected risks.


This high-conviction directionless view is something we have been wrestling with since the end of JUN, when we detailed the economic puts and takes contributing to what we continue to see as a fiscal and, more importantly, monetary policy vacuum in Japan:


  • JAPAN POLICY VACUUM PART II? (6/30): We lack conviction on the intermediate-term direction of the Abenomics Trade and we think investors should remain on the sidelines for now.
  • REITERATING OUR RESEARCH VIEW ON JAPAN (7/15): We reiterate our call of not having a high-conviction call on Japan here amid a convoluted globally-interconnected monetary policy outlook.


In full disclosure, this view comes after recommending investors short and subsequently cover Japanese equities back in mid-FEB and late-MAY.



It’s worth noting that from MAY 28 through JUN 30 the Nikkei 225 appreciated +3.3% in the face of a +0.5% advance in the JPY/USD cross. Since then, however, the Nikkei 225 has traded flat (i.e. +0.3%) in the face of a -1.1% decline in the JPY/USD cross. That’s a good cover followed by an even better call to move to the sidelines amid a breakdown in the well-known inverse correlation supporting the Abenomics Trade.


If you ask us, we think that inverse correlation is breaking down due to one primary factor: market participants trying to decipher whether or not the recent strength in the US Dollar Index is a harbinger of good news (i.e. a Quad #1 or Quad #2 setup in the US) or a bad news (i.e. a Quad #3 setup in the Eurozone that facilitates a Quad #4 setup in the US as our domestic #Q3Slowing theme remains in play).


For those of you who would like more details regarding the aforementioned scenario analysis, please refer to the following presentations: REPLAY: 3Q14 MACRO INVESTMENT THEMES CALL (7/9) and VIDEO & SLIDE DECK: ARE YOU PREPARED FOR QUAD #4? (8/5).


Looking to factors specific to Japan, the 2Q GDP report was yet another nonevent in the context of forcing the BoJ’s hand. The release was in line with consensus expectations and those of the Japanese government, as confirmed by Economy Minister Akira Amari following the release, which had a muted impact on the otherwise-volatile Japanese equity market (it closed up +0.4% on the day).


  • 2Q Real GDP: -6.8% QoQ SAAR from 6.1% prior
  • YoY: -0.1% from 3% prior
    • C: -2.7% YoY from 3.5% prior
    • I-Residential: -1.9% YoY from 12.1% prior
    • I-Commercial: 7.1% YoY from 11.6% prior
    • G: 0.6% YoY from 0.7% prior
    • X-M: 2.3% YoY from -38.6% prior
  • 2Q GDP Deflator: 2% YoY from -0.1% prior


Importantly, LDP officials expect GDP to rebound in the third quarter (as do we), so there would appear to limited need for either fiscal or monetary policymakers to step in here to aid Japan’s recovery from the tax hike-induced weakness. It’s worth noting that the 3M trend in the preponderance of Japanese growth data is decidedly positive.




This is especially true for the BoJ; recall that while acting president of the Asian Development Bank, Kuroda was very critical of the piecemeal easing measures oft-implemented by his predecessor Masaaki Shirakawa. Rather, the current BoJ chief prefers the “big bang” stimulus – something that may not be necessary until reported inflation slows throughout 2H14, which is something our models are forecasting. That puts the timeline for an expansion of the BoJ’s QQE program in the 1H15 range.




All told, be it Yellen & Co. potentially preparing to devalue the USD (and thereby inflating the JPY) or #GrowthSlowing in the US and EU that perpetuates a meaningful reversal of #VolatilityAsymmetry, we think it’s best for investors to remain on the sidelines (i.e. not involved or a combination of low gross and tight net exposures) with respect to the Abenomics Trade.  


Lastly, if you aren’t yet familiar with the debate surrounding the outlook for US monetary policy we’ve been trying to prepare investors for since JAN, we highly encourage you to review the following Reuters article: "Yellen Resolved to Avoid Raising Rates Too Soon; Fearing Downturn" (7/12).


Have a wonderful evening,




Darius Dale

Associate: Macro Team

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Takeaway: Recent economic data is supportive of our bullish bias on Chinese equities.

A meaningful helping of China’s JUL high-frequency economic data was reported overnight/over the past few days. The key takeaways are highlighted in the bullets and tables below.


First the bad news:


  • A continued deceleration in capital flows fueled a pullback in deposit growth that caused both traditional (i.e. CNY bank loans) and nontraditional (i.e. “shadow” credit) financing to slow meaningfully. Specifically, new CNY bank loans decelerated to 385.2B MoM from 1.08T prior, while shadow credit decelerated to -309.9B MoM from 535B prior. These deltas caused the total social financing figure of 273.1B CNY MoM to come in at the slowest pace of credit expansion since OCT ’08.
  • Key headline indicators such as fixed asset investment, industrial production and retail sales all slowed MoM, in addition to generally exhibiting negative deviations vs. their respective 3M, 6M and 12M trends.
  • On a rolling monthly basis, the PBoC has now drained a net 20B CNY from the money market, which is a dramatic reversal from inputting a net 105B into the financial system in the previous 1M period and the trailing 3M average of 87.3B in net liquidity provision.


And now the good news:


  • China’s manufacturing PMI data showed considerable strength in JUL, accelerating to 51.7, which was the strongest print since APR ’12. Every sub-index accelerated MoM except gauges for supplier delivery times and employment.
  • On the heels of waning commodity price pressures (click HERE and HERE for more details), CPI came in flat MoM, with headline, food and non-food inflation measures exhibiting negative deviations vs. their respective 3M and 12M trends.
  • Amid a broad-based rollback of macroprudential measures at the local government level, property market stabilization continued for a second month in JUL, highlighted by the sequential acceleration in credit availability and the sequential and trend-based improvement in both land speculation and housing starts – the two key leading indicators for construction activity.


KEEP BUYING “OLD CHINA” - CHINA High Frequency GIP Data Monitor


On the flip side of the aforementioned positive developments in China’s property market, we continue to see slowing growth in both current construction and completions, contracting and slowing growth in demand, slowing home price appreciation and waning readings of general market conditions.


KEEP BUYING “OLD CHINA” - CHINA Property Market Monitor


In light of these dour trends, it remains our view that until China’s property market has regained sound footing, Chinese policymakers will continue to ease, at the margins. From a timing perspective, that’s at least 2-3M of continued loosening which should provide a boon to 3Q GDP growth alongside decelerating inflation.




On balance, this outlook for a continued 1-2 punch of “proactive” fiscal policy and “relatively loose” monetary policy should provide a meaningful tailwind to the high-beta Chinese equity market – particularly those industries exposed to fixed asset investment (i.e. “Old China”).


Simply put, in order for the Communist Party to implement its targeted structural reforms, we think it must first show face on the low-hanging fruit (i.e. the State Council’s GDP, CPI and M2 targets). While said guidance clearly does not represent “hard” targets, any material downside deviations in the context of a widespread perception of financial instability would risk undermining the party’s credibility, in our opinion.


In that light, we continue to like the iShares China Large-Cap ETF (FXI) on the long side, which has appreciated +3.4% since our 7/24 note recommending it on the long side. This compares to a sample mean of -0.7% across the 24 country-level ETFs we track across the EM space and is demonstrably outpacing the -2.7% decline for the S&P 500 SPDR ETF Trust (SPY). Looking to our Tactical Asset Class Rotation Model (details HERE), the China style factor remains the best looking secondary asset class in the global macro universe, accounting for 11 of the top 20 VAMDMI readings.


KEEP BUYING “OLD CHINA” - TACRM 20 20 Vision Thermodynnmic Monitor Bar Chart




All that being said, China has by no means turned the corner from a longer-term perspective, so we are reticent to make this a best idea until we can get the first signs of confirmation that perceived tail risk is receding. Specifically, neither valuation nor sentiment are in “layup” territory, so it’s tough to “back the truck up” on Chinese shares here:


  • We look at EV/TTM EBITDA ratios at the index level to account for varying levels of private sector indebtednesses across the various economies; on this metric the MSCI China Index is more-or-less fairly valued versus the MSCI US Index, while being slightly overvalued vs. the MSCI Europe Index and fairly overvalued versus the MSCI EM and MSCI Japan indices.
  • In a JUL ’14 Bloomberg poll of 550+ global investors, 19% of respondents saw China as being the economy offering the best returns over the NTM. That was fourth-highest total among the eight specific economies listed.




KEEP BUYING “OLD CHINA” - Bloomberg China Sentiment


Don’t be shy with questions if you want to dig into anything highlighted above. Have a great evening,




Darius Dale

Associate: Macro Team

FXB: Adding the British Pound to Investing Ideas

Takeaway: We are adding FXB to Investing Ideas.

Our macro team is adding the British Pound to Investing Ideas. Stay tuned for a full report detailing our bullish case.


FXB: Adding the British Pound to Investing Ideas - pound sterling today

Cartoon of the Day: Pied Piper

Takeaway: What happens when everyone stops believing?

Cartoon of the Day: Pied Piper - Bubbles pied piper 08.13.2014