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Unwinding Growth

This note was originally published at 8am on August 11, 2014 for Hedgeye subscribers.

“The unwinding began at countless times, in countless ways.”

-George Packer

 

Yep. After a wonderful weekend with my family on the East Coast, I figured I’d get up early this morning and cheer you up with that quote. It comes from George Packer’s recent bestseller – The Unwinding: An Inner History of The New America.

 

Under both the Bush and Obama central-econ-planning regimes, what’s really been unwinding for the last decade is the bull case for sustainable and real (i.e. inflation adjusted) US GDP growth. But both you and the bond market probably already know that.

 

Who seems to miss this roughly all-of-the-time are America’s Old Wall “economists.” In a Wall Street Journal poll on Friday, 43 economists agreed to agree that US GDP growth will magically be 3% in the back half of 2014. In today’s USA, that looks almost impossible.

 

Unwinding Growth - unwinding

 

Back to the Global Macro Grind

 

In stark contrast to what I loved about the ole-school 1980s/1990s USA breakouts in both #StrongDollar and #RatesRising in 2013, today we have a Dollar that has done, well, absolutely nothing year-over-year, and interest rates crashing.

 

Crashing? Yep. The 10yr US Treasury Yield crashed (again) last week, falling -20.2% from where it started the year (at 3.03%). At 2.43% this morning, the 10yr couldn’t care less about the emotional roller coaster that is 80% of hedge funds trading the spoos.

 

Spoos (pronounced, spoo-z – or boo-hoo-zzz) are making grown men cry in 2014 as the net long or short position that the herd takes in these emotionally abused securities manifests into one of the best weekly contrarian market indicators in my notebook.

 

Check out this directional indicator for the last 3 weeks (SPX Index + Emini net LONG or SHORT position in CFTC non-commercial contract terms):

 

  1. AUG 11th (today) = net LONG +10,716 contracts
  2. AUG 4th = net SHORT -41,210 contracts
  3. JUL 28th = net LONG +614 contracts

 

Short low, cover high? The context of these weekly moves is critical. Don’t forget that the all-time-bubble-high for the SP500 was established on July 23-24 at 1987. As of Friday’s no-volume rally (Total US Equity Volume -18% vs. its 3-mth avg), there have only been 2 up days in the last 12 trading days.

 

While buying “dips” in anything early-cycle growth slowing has been painful in August, being long #GrowthSlowing via TLT (Long-Bond) +13.8% YTD vs Russell 2000 (US Equity Growth bogey) -2.8% YTD has been nothing short of fantastic. So let’s keep doing  more of that.

 

From a risk management (and relative performance) perspective, what you don’t do in this game is often more important than what you are doing. You don’t have to buy early-cycle stocks that are slowing just because they look “cheap.” You need to avoid that temptation before “cheap” gets cheaper.

 

If we’re right on #Q3Slowing, two major places to avoid on “valuation” are:

 

  1. US listed Industrials (which are really multi-nationals) = XLI
  2. European Equities = EZU, EWG, EWI, etc.

 

Last week in Europe was ugly:

 

  1. Greece led losers at -9.9% on the week (and is “bouncing” +2% this morning #hooray)
  2. Portugal was down another -6.7% to -17.5% YTD
  3. Germany was down another -2.2% to -5.7% YTD

 

No, Germany is not Greece. But my aunt’s sister is my Mom. And #interconnectedness matters.

 

Not only do my intermediate-term TREND signals continue to signal bearish for European Equities, but our proprietary GIP (Growth, Inflation, Policy) model is probability weighing the same for the next 1-3 quarters of European growth. #Q3Slowing

 

That’s probably why a lot of single stock setups are bearish TREND too (DEO, KO, GE, etc.). If your two main markets are USA and Europe, you want to be paying attention to this bullish-to-bearish TREND reversal @Hedgeye very closely. We haven’t had a coordinated unwinding of growth expectations since 2011.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.40-2.50%

SPX 1893-1950

RUT 1107-1143

DAX 8815-9295

VIX 13.89-18.43  

Gold 1299-1321

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Unwinding Growth - Chart of the Day


DRAGHI’S DOVISHNESS

Client Talking Points

EURO

The Euro is getting smoked down to $1.31 this morning (vs USD) after Draghi says he “stands ready” to devalue Europe’s way back to economic stagflation? Net short position in the EUR/USD (CFTC futures + options) hits a big year-to-date high of -142,738 contracts.

FRANCE

The Prime Minister resigns on the economy, so that’s gotta be good for more money printing too. The CAC is up +1.1% this morning as European economic growth slows (German IFO for AUG at 4 month low), the @Hedgeye TREND line resistance for CAC is 4364.

UST 10YR

The UST 10YR Yield drops back down to 2.39% this morning as the bond market figures this doesn’t end well from a U.S. growth perspective. Yield Spread (10yr minus 2yr) compressing to a new year-to-date low of +189bps as U.S. equity futures (SPX) test all time highs.

Asset Allocation

CASH 56% US EQUITIES 0%
INTL EQUITIES 12% COMMODITIES 4%
FIXED INCOME 24% INTL CURRENCIES 4%

Top Long Ideas

Company Ticker Sector Duration
HOLX

Hologic is emerging from an extremely tough period which has left investors wary of further missteps. In our view, Hologic and its new management are set to show solid growth over the next several years. We have built two survey tools to track and forecast the two critical elements that will drive this acceleration.  The first survey tool measures 3-D Mammography placements every month.  Recently we have detected acceleration in month over month placements.  When Hologic finally receives a reimbursement code from Medicare, placements will accelerate further, perhaps even sooner.  With our survey, we'll see it real time. In addition to our mammography survey. We've been running a monthly survey of OB/GYNs asking them questions to help us forecast the rest of Hologic's businesses, some of which have been faced with significant headwinds. Based on our survey, we think those headwinds are fading. If the Affordable Care Act actually manages to reduce the number of uninsured, Hologic is one of the best positioned companies.

BOBE

The level of activism in the restaurant industry has never been more rampant.  In the past year alone, we’ve seen CBRL, DAVE, DRI, BJRI and BOBE attract largely uninvited attention from these investors. BOBE has a long history of mismanagement, evidenced by flawed strategic rationale, an excessively bloated cost structure and severe underperformance relative to peers.  Fortunately, its poor operating performance presents a tremendous opportunity. After almost a year of pushing for change at Bob Evans, activist investor Sandell Asset Management is claiming a big victory. Activist investor Sandell won at least five seats on the board of the restaurant operator and food processor, based on preliminary results from the company’s annual shareholder meeting last week. This is precisely the sort of bullish catalyst that was central to our high conviction on BOBE.

TLT

Fixed income continues to be our favorite asset class, so it should come as no surprise to see us rotate into the Shares 20+ Year Treasury Bond Fund (TLT) on the long side. In conjunction with our #Q3Slowing macro theme, we think the slope of domestic economic growth is poised to roll over here in the third quarter. In the context of what may be flat-to-decelerating reported inflation, we think the performance divergence between Treasuries, stocks and commodities may actually be set to widen over the next two to three months. This view remains counter to consensus expectations, which is additive to our already-high conviction level in this position.  Fade consensus on bonds – especially as growth slows. As it’s done for multiple generations, the 10Y Treasury Yield continues to track the slope of domestic economic growth like a glove.

Three for the Road

TWEET OF THE DAY

OIL: after falling -2.0% last wk, WTI is down another -0.1% this morn #bearish TREND

@KeithMcCullough  

QUOTE OF THE DAY

We cannot solve our problems with the same thinking we used when we created them.

- Albert Einstein

STAT OF THE DAY

India (our favorite stock market in the East) is up +0.7%, +27.5% year-to-date.


August 25, 2014

August 25, 2014 - Slide1

 

BULLISH TRENDS

August 25, 2014 - Slide2

August 25, 2014 - Slide3

August 25, 2014 - Slide4

August 25, 2014 - Slide5

August 25, 2014 - Slide6

August 25, 2014 - Slide7

 

BEARISH TRENDS

August 25, 2014 - Slide8

August 25, 2014 - Slide9

August 25, 2014 - Slide10

August 25, 2014 - Slide11
August 25, 2014 - Slide12

August 25, 2014 - Slide13


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.


Central Planning's Curse

“Ideas have consequences.”

-Richard M. Weaver

 

That’s the introductory quote from Hamilton’s CurseHow Jefferson’s Arch Enemy Betrayed The American Revolution, by Thomas Dilorenzo. And oh isn’t that an appropriate thought now that our central planning overlords have talked down at us from upon high from the Tetons in Jackson Hole.

 

Big ideas, moreover, can have big consequences, and there are probably no ideas in American political history bigger than the ones debated by Alexander Hamilton and Thomas Jefferson at the time of the founding.” (pg 1)

 

Japan has had the same failed central economic planning ideas for decades. Now both the un-elected US and European monetary policy duo of Janet Yellen and Mario Draghi and are hell bent on executing on the same. It’s the economic curse of devalued currencies. And I don’t think it will end well.

 

Central Planning's Curse - 789

 

Back to the Global Macro Grind

 

The number one thing I have had wrong in 2014 is how dovish Draghi was going to get in the face of what was a decent European economic rate of change acceleration. Ever since he decided to devalue the Euro in May, the European economy has slowed, sequentially.

 

I thought Yellen was going to be more dovish than consensus thought at Jackson Hole (she was). But I didn’t think her headline impact was going to be trumped by Draghi. He said he “stands ready to adjust” his Euro devaluation policy stance further. Whatever that means… the currency market believes him.

 

“So”, following the bouncing macro ball:

 

  1. Euro (vs USD) is getting smoked to fresh YTD lows of $1.31 this morning
  2. US Dollar Index is now breaking out to fresh YTD highs of $82.59
  3. Commodities (CRB) index, led by oil’s decline, are retracing most of their YTD gains

 

And our macro playbook would call the alleviation of the #InflationAccelerating tax (on Americans) good, on the margin. But what’s good for the country with the consumption tax cut is bad for the economy who gets the devaluation tax.

 

The other thing that’s not good is what the US bond market thinks:

 

  1. US Treasury 10yr Yield has fallen back to 2.39% this morning (down -63bps YTD from 3.03%)
  2. US Treasury Curve Yield Spread is compressing to a fresh YTD low of +189bps (bps = basis points)
  3. US growth expectations (Russell 2000) are still down for the YTD as well

 

But, but, there are no buts…

 

I am bearish on both US and European growth, and both US equity futures and European stocks are up on whatever it is that Draghi is going to do next.

 

BREAKING: Draghi Pushes ECB Closer To QE As Deflation Risks Rise –Bloomberg

 

That’s one of the most read headlines of this morning. Alongside Germany’s IFO (business climate index) dropping to a fresh 4 month low of 106.3 (vs. 108.0 last month) and France’s Prime Minister resigning over the economy, that is…

 

“So” you just have to buyem when they are up on this, right? No thanks.

 

If the US Dollar and rates were rising alongside US growth expectations, I’d be right bullish on being long US growth right now. But that’s not happening. The #InflationAccelerating of the first half of 2014 is sticky. In other words, you aren’t getting a cheaper cup of coffee and a rent reduction this morning.

 

Over time, what we call a 4th Quadrant move in our GIP Model (Growth, Inflation, Policy = GIP) becomes a big idea. But going there (both Growth and Inflation slowing, at the same time) requires a big asset price reset. This happened in Q3/Q4 of 2008, don’t forget.

 

I don’t think it’s 2008. I think it’s Q3 of 2014. While every economic cycle rhymes with parts of others, we haven’t seen all three of the major Currency War central planners (Japan, USA, and Europe) try to devalue (print moneys, monetize debt, bend gravity, etc.) at the same time like this.

 

If US and European growth continues to slow, at the same time (and both Yellen and Draghi get easier and easier into that)… and it ends well… I’ll be wrong on that too. In the meantime, 200 years after Alexander Hamilton’s Euro style Central Planning Curse was imposed on the American people, Jefferson is rolling in his grave.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.34-2.46%

SPX 1

RUT 1130-1171

VIX 10.91-14.12

USD 81.67-82.59

EUR/USD 1.31-1.33

Gold 1

 

Best of luck out there this week,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Central Planning's Curse - Chart of the Day


MONDAY MORNING RISK MONITOR: FADING THE GEOPOLITICAL (FOR NOW)

Takeaway: The signals are now bullish in the short-term and mixed on an intermediate term basis.

Current Best Ideas:

 

MONDAY MORNING RISK MONITOR: FADING THE GEOPOLITICAL (FOR NOW) - 19

 

Key Callouts:

The XLF put in a good showing last week, rising 2.4%, but that brings the month-over-month change to just +0.4%. Not much to get excited about. Much of the geopolitical risk that was pushing risk premia out last month is now in retreat. This is evident across the EU, Sovereign and US Financials CDS complex as well as in the move in high yield (tighter by 8 bps on the week). 

 

On an intermediate term basis, there are now 5 measures that are positive while 4 are negative. One of the few areas that continues to retreat aggressively is the 2-10 spread, now tracking 10 bps tighter on the week at 191 bps.

 

Financial Risk Monitor Summary

 • Short-term(WoW): Positive / 4 of 12 improved / 0 out of 12 worsened / 8 of 12 unchanged

 • Intermediate-term(WoW): Positive / 5 of 12 improved / 4 out of 12 worsened / 3 of 12 unchanged

 • Long-term(WoW): Negative / 1 of 12 improved / 3 out of 12 worsened / 8 of 12 unchanged

 

MONDAY MORNING RISK MONITOR: FADING THE GEOPOLITICAL (FOR NOW) - 15

 

1. U.S. Financial CDS -  Swaps tightened for 25 out of 27 domestic financial institutions. Led by WFC (-6 bps) the large cap financials were tighter by an average of 4 bps. Specialty finance also saw big swings with Sallie Mae tightening by 20 bps on the week to 228 bps.

 

Tightened the most WoW: TRV, CB, ACE

Widened the most/ tightened the least WoW: AXP, GNW, GS

Tightened the most WoW: RDN, AGO, WFC

Widened the most MoM: GNW, AXP, MET

 

MONDAY MORNING RISK MONITOR: FADING THE GEOPOLITICAL (FOR NOW) - 1

 

2. European Financial CDS - Swaps mostly tightened in Europe last week, dropping by an average of 6 bps on the week. Swaps are now tighter by 5 bps on a m/m basis. Even Sberbank, a proxy for the geopolitical turmoil of the Russia/Ukraine situation, tightened by 11 bps on the week, but remains over 300 bps at 316 bps.

 

MONDAY MORNING RISK MONITOR: FADING THE GEOPOLITICAL (FOR NOW) - 2

 

3. Asian Financial CDS - Default swaps across the Asian financials complex were generally tighter with the most improvement coming from India, where they tightened by an average of 8 bps. 

 

MONDAY MORNING RISK MONITOR: FADING THE GEOPOLITICAL (FOR NOW) - 17

 

4. Sovereign CDS – Sovereign swaps tightened around the world last week, except in the US, where they widened by 1 bp to 18 bps. Portuguese sovereign swaps tightened by -10.9% (-20 bps to 161 bps).

 

MONDAY MORNING RISK MONITOR: FADING THE GEOPOLITICAL (FOR NOW) - 18

 

MONDAY MORNING RISK MONITOR: FADING THE GEOPOLITICAL (FOR NOW) - 3

 

MONDAY MORNING RISK MONITOR: FADING THE GEOPOLITICAL (FOR NOW) - 4

 

5. High Yield (YTM) Monitor – High Yield rates fell 8.3 bps last week, ending the week at 5.61% versus 5.69% the prior week.

 

MONDAY MORNING RISK MONITOR: FADING THE GEOPOLITICAL (FOR NOW) - 5

 

6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 6.0 points last week, ending at 1878.

 

MONDAY MORNING RISK MONITOR: FADING THE GEOPOLITICAL (FOR NOW) - 6

 

7. TED Spread Monitor – The TED spread rose 1.1 basis points last week, ending the week at 21.5 bps this week versus last week’s print of 20.41 bps.

 

MONDAY MORNING RISK MONITOR: FADING THE GEOPOLITICAL (FOR NOW) - 7

 

8. CRB Commodity Price Index – The CRB index fell -0.9%, ending the week at 289 versus 291 the prior week. As compared with the prior month, commodity prices have decreased -3.2% We generally regard changes in commodity prices on the margin as having meaningful consumption implications.

 

MONDAY MORNING RISK MONITOR: FADING THE GEOPOLITICAL (FOR NOW) - 8

 

9. Euribor-OIS Spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread was unchanged at 15 bps.

 

MONDAY MORNING RISK MONITOR: FADING THE GEOPOLITICAL (FOR NOW) - 9

 

10. Chinese Interbank Rate (Shifon Index) –  The Shifon Index fell 4 basis points last week, ending the week at 2.85% versus last week’s print of 2.89%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.

 

MONDAY MORNING RISK MONITOR: FADING THE GEOPOLITICAL (FOR NOW) - 10

 

11. Chinese Steel – Steel prices in China fell 0.8% last week, or 26 yuan/ton, to 3092 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.

 

MONDAY MORNING RISK MONITOR: FADING THE GEOPOLITICAL (FOR NOW) - 12

 

12. 2-10 Spread – Last week the 2-10 spread tightened to 191 bps, -2 bps tighter than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.

 

MONDAY MORNING RISK MONITOR: FADING THE GEOPOLITICAL (FOR NOW) - 13

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 


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