Last week was a really interesting week for us. Specifically a number of important developments occured that were either directly counter to our existing macro themes, or generally outside the scope of those themes, including but not limited to:
- The US Dollar Index advancing +1.1% WoW to decisively above our TAIL risk line of ~81.50
- WTI and Brent Crude Oil falling -2% and -1.3%, respectively… both are decidedly broken on our immediate-term TREND and long-term TAIL durations
- Gold falling -2% WoW into a range where it is likely to test its TREND line of support at $1271/ozt.
- Financials (XLF) and Consumer Discretionary (XLY) leading the rally in domestic equities at the sector level (alongside Materials) at +2.4% and +2.3%, respectively… both sectors remain are now bullish on our immediate-term TRADE and intermediate-term TREND durations
- The S&P 500 developing a markedly positive correlation to the USD (DXY) of +0.87 on a trailing 3-week basis, up from +0.19 and -0.29 over the past 6 weeks and 3 months, respectively
- Draghi’s remarks being significantly more dovish than Yellen’s at Jackson Hole
- Pretty darn good domestic high-frequency growth data, including:
- Initial Jobless Claims ticking down to 298k
- CPI responding to deflation across key commodity markets by slowing in JUL – albeit marginally – to +2% YoY and +9bps MoM
- Markit Flash Manufacturing PMI ticking up in AUG to the level in four years
- Philly Fed Index ticking up in JUL to the highest level since MAR ‘11
- Housing Starts jumping +15.7% MoM in JUL to 1.093M SAAR, the second-fastest pace since mid-2008
- Existing Home Sales climbing +2.4% MoM in JUL to 5.15M SAAR, the fastest pace since SEP ‘13
- AIA Architecture Billings Index ticking up to 55.8 in JUL, the highest level since 2007
In the context of all that, I had an extremely thoughtful discussion with an even more thoughtful portfolio manager late in the week. The discussion centered on the following questions:
- At what point does commodity deflation become a consumption tax cut for the US consumer? Moreover, what wins out in your GDP forecasts: real-time economic tailwinds or difficult compares?
- Because the compares in the CPI model get markedly easier throughout 2H14, what would prevent the market from overacting to hawkish CPI prints and pulling forward their “dots” as opposed to pushing them out over the next 3-6M?
- With the exception of Retail Sales and Housing, the 3-6M trend across many domestic high-frequency growth indicators remains positive from a 2nd derivative perspective. Even if every single data point slowed sequentially from here, doesn’t that mean it will take at least 2-3M before one can show definitively (i.e. with the preponderance of reported data) that growth is officially slowing on a trending basis?
- If that is the case, doesn’t this rally in the USD have legs – if only in the form of a massive, but meaningful head fake?
- How worried should investors be about Europe?
Obviously these are very difficult questions and we won’t even pretend to claim we have all the answers readily available. What we do have are robust quantitative tools to guide our internal discussions and workflow. In the context of the aforementioned deluge of puts and takes, we thought we’d share some of those signals with you.
Looking to our Tactical Asset Class Rotation Model (TACRM) we see that:
- At 28% and 25%, respectively, EM Equities and Fixed Income & Yield Chasing remain the #1 and #2 weights in volatility-adjusted optimized asset allocation. This essentially means an investor would do best to allocate $0.28 and $0.25 per every $1 of incremental capital to the extent he/she is seeking the highest risk-adjusted, intermediate-term return profile across the spectrum of liquid global macro assets. (slide 4)
- Optimized per historical backtest data, current levels of relative momentum across the six primary liquid asset classes call for investors to increase their exposure to EM Equities and Fixed Income & Yield Chasing, at the margins (unchanged since early-MAY and early-DEC, respectively). This would be in lieu of DM Equities (hello Europe), FX, Commodities and Cash. (slide 4)
- TACRM averages three z-scores of volume-weighted price data across three independent durations to form its composite view of price momentum at the single security level, otherwise known as a Volatility-Adjusted Multi-Duration Momentum Indicator (VAMDMI) . Of the bottom 20 VAMDMI scores across the universe of global macro ETF exposures, there are five foreign currency ETFs and 10 commodity ETFs. Perhaps the most noteworthy extreme signal among the top 20 VAMDMI scores is the fact that the US Dollar (UUP) currently has the highest VAMDMI score in the sample of nearly 200 ETFs. (slide 11)
- The dramatic loss of momentum across European Equities, FX and Commodities has caused the pool of available investments to become increasingly constrained over the past 3-6M, effectively forcing investors to flock into EM Equities, Fixed Income & Yield Chasing and Cash. (slide 12-13; 9)
Looking to our S&P 500 Industry Divergence Monitor:
- Industries that have lagged in the YTD, including Retail, Homebuilding, Home Improvement, Home Furnishing, Construction & Engineering and Steel are among those industries leading the bounce from the AUG 7 lows.
- Only four industries have declined in price since AUG 7: Oil & Gas Drilling, Coal Miners, Gold Miners and Paper & Forest Product Producers.
- Up +14.2% from the AUG 7 lows, Airline stocks have led the rally, followed by Home Entertainment Software and Home Improvement Retail.
Again, we thought we’d share these nuggets not as conclusions, but as perspective into our evolving thought process. Signals like these will continue to guide our interpretation of the fundamental data, as well as our expectations for said fundamentals.
It’s worth noting that have not changed our fundamental views; nor are we looking to do so at the current juncture. If, however, we were to do so in the coming months, that process would undoubtedly start with a deeper understanding of the answers to the aforementioned questions.
Lastly, for those of you looking for fundamental analysis with respect to the aforementioned questions, we highly encourage you to review the following research notes:
- Draghi Trumps Yellen’s Dovishness – Sticking with the Playbook (8/25): http://app.hedgeye.com/feed_items/37594... a detailed analysis of the slowdown in Europe and what it means for European capital markets
- PATIENCE OR PENURY: The Jobless, Wage-less, Investment-less Recovery? (8/14): http://app.hedgeye.com/feed_items/37426... detailed analysis of where we are in the economic cycle
- VIDEO & SLIDE DECK: ARE YOU PREPARED FOR QUAD #4? (8/5): http://app.hedgeye.com/feed_items/37210... detailed analysis of the slowdown in Europe and what it means for global financial markets
- A MUST-READ ON THE 2Q GDP PRINT & JULY FOMC STATEMENT (7/30): http://app.hedgeye.com/feed_items/37090... detailed analysis of recent commodity deflation and its impact on domestic economic growth
As always, please feel free to reach out with any follow-up questions and we’ll be more than happy to help. Have a great evening,
Associate: Macro Team