This note was originally published at 8am on August 08, 2014 for Hedgeye subscribers.
“It is the theory that decides what can be observed.”
I have a theory about performance that I developed running my own fund: it’s the score in your P&L that counts. I also have a theory about market theories: your positions reflect your theories.
We can theorize about the relationship between inflation and growth. We can highlight immediate-term market observations within their longer-term trends. We can write and rant too – but, at the end of the day, taking your position in macro is what matters.
In 2014, we’ve had a contrarian theory that as US growth expectations slow, US interest rates will fall, and both Gold and Long-term Treasury Bonds will rise. We’re not changing that theory this morning. We’d like you to keep that position.
Back to the Global Macro Grind…
But, but… you said that if the Dollar goes up and inflation expectations fall, the consumer gets a tax cut and consumption growth can accelerate. Yep, but I said that before we were 62 months into an economic expansion (in 2009 and again in 2013), not at the end of it.
Year-over-year, the US Dollar is down -0.4%. With US cost of living barely coming off her all-time highs, that isn’t going to make me tell you to run on out there and buy-the-damn-bubble in US stocks. Sorry.
If the US Dollar were to breakout from here, and crude oil were to drop to $80/barrel – now that might get me interested. But there’s this thing called #timing that we need to consider when we theorize about getting long.
In the meantime (we’re net short in Real-Time Alerts terms) and here’s the score:
- US Dollar Index stopped going up this morning (because the Euro stopped going down)
- US 10yr Yield of 2.36% is hitting a fresh YTD low of 2.36% (crashing -22% YTD)
- US Equities (SPX) have only had 1 up day in the last 11 (dip buyers #underwater)
Bull market, baby (in the Long Bond)! 2014 Score: Long Bond (in TLT terms) +15.1% vs Gold +9.6% vs Russell 2000 -3.9%.
Digging into the Sector Style performance of the SP00:
- Consumer Discretionary (XLY) leads losers at -2.2% YTD
- Industrials (XLI) aren’t far behind at -1.6% YTD
- Financials (XLF) are 3rd worst (of 9 Sectors) at +1.4% YTD
Digging deeper, you can see the real wins and losses (sub-sectors within the S&P’s major sectors):
- Housing (ITB) is -10.6% YTD
- Regional Banks (KRE) are -7.4% YTD
- REITS (VNQ) are up +15.3%
REITS are a way to be long A) slow-growth #YieldChasing and B) US Rents hitting all-time highs. Yep, we have a theory that you can check with your landlord on that too: he’s not reducing your rent tomorrow due to Russia or ebola.
You see, in theoretical-land, as our #InflationAccelerating theme from Q114 stops going straight up into the right (Coffee prices dropped -3.6% yesterday, but are still +66.2% YTD), real-world inflation still sticks. Starbucks (SBUX) isn’t cutting prices today.
Inflation (especially the cyclical stuff like wage inflation and rent), is a late-cycle economic indicator. So is unemployment. Got early cycle? That’s easy. Consumer, Housing, some Industrials, and Regional Banks.
The reason on Regional Banks is really simple. As the bond market prices in slower growth, the long-end of the bond yield curve falls, and net interest margins (i.e. how banks make money off your deposits - long-term rates minus shorter-term ones) compress.
This is called Yield Spread Compression. And it’s part of this fancy theory called gravity. I have a perverse theory that as the Q3 US Growth data slows, the Fed will get easier (on the margin), and that the long-end of the curve will perpetuate moarrr compression.
As growth slows, not only do net interest margins at banks compress, but equity market multiples do. All the while, you’ll see multiple expansion on long-term Treasury bonds.
Since there’s no long-term support to 1.70% on the 10yr, maybe we should all start theorizing about that. The observable score says that’s more likely than seeing the consensus theory of 3.25% anytime soon.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.35-2.51%
Best of luck out there today and have a great weekend,
Keith R. McCullough
Chief Executive Officer