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August 26, 2014

August 26, 2014 - 1

 

BULLISH TRENDS

August 26, 2014 - Slide2

August 26, 2014 - Slide3

August 26, 2014 - Slide4

August 26, 2014 - Slide5

August 26, 2014 - Slide6

 

BEARISH TRENDS

August 26, 2014 - Slide7

August 26, 2014 - Slide8

August 26, 2014 - Slide9

August 26, 2014 - Slide10

August 26, 2014 - Slide11
August 26, 2014 - Slide12


LOOKING FOR ANSWERS? LET THE QUANT GUIDE YOU

Takeaway: Use our quantitative signals below to help guide your thought process on what are currently macro’s most challenging questions.

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:

 

  1. 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?
  2. 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?
  3. 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?
  4. 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?
  5. 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.

 

LOOKING FOR ANSWERS? LET THE QUANT GUIDE YOU - S P 500 Industry Divergence Monitor 1

LOOKING FOR ANSWERS? LET THE QUANT GUIDE YOU - S P 500 Industry Divergence Monitor 2

LOOKING FOR ANSWERS? LET THE QUANT GUIDE YOU - S P 500 Industry Divergence Monitor 3

LOOKING FOR ANSWERS? LET THE QUANT GUIDE YOU - S P 500 Industry Divergence Monitor 4

 

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:

 

 

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,

 

DD

 

Darius Dale

Associate: Macro Team


Expert Call: Coffee Outlook in 2015 and Beyond

On Thursday, August 21st, we hosted a call with Judith Ganes-Chase, founder and president of J. Ganes Consulting, an independent agricultural softs commodities research and consultancy firm. Judy worked on the sell-side for 20 years before founding J. Ganes Consulting in 2001. A replay link to the call is included below with a brief summary:

 

Call Replay

 

Judy acknowledged that Brazil has a cyclical pattern of coffee production (one year up, one year down). However the scale of Brazil’s shortfall in the coming years will be unprecedented: She emphasized that this is the first time we are looking at a two-year production deficit.

Judy proceeded to outline three unusual weather scenarios that occurred earlier this year:

  1. Late Winter Frost: Brazilian winter (November-December) mild frost lowered crop quality
  2. Severe Drought: Drought and lack of moisture in tree root system from January-March during the vegetative period
  3. Heavy Rainfall: Late timing of heavy rainfall knocked flowers off trees, reducing the available volume for harvest
  • In her prediction prices could easily move much higher: Brazil will not produce enough volume in 2015-2016 to meet the global market demand for Arabica coffee.
  • Consensus expected 53-64 million bags of Arabica to be produced, but less than 46 million bags will come out of Brazil this year.  
  • Dire outlook into next year: Next year aggregate demand is expected to be around 34 million bags. However due to a current stock deficit and severe crop damage, Brazil’s production yield will be just 27 million bags in 2015.
  • Nobody to pick-up the slack: Not enough capacity from other countries to cover the expected crop shortage of Arabica coffee in Brazil.
  • How High Can Prices Go?: $2.75 to above $4.00/kg. There will likely be a spike in prices for Arabica, and a higher basis for other grades of coffee. We can expect some read-through after the assessment of the third or fourth bloom in the coming weeks.

Please feel free to reach out with additional questions.

 

Ben Ryan

Analyst 


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Commodities Weekly Sentiment Tracker

Note: Using the z-score in the tables below as a coefficient of variation for standard error helps us flag the relative positioning of the commodities in the CRB Index. It is not intended as a predictive signal for the reversion to trailing twelve month historical averages. For week-end price data, please refer to “Commodities: Weekly Quant”  published at the end of the previous week. Feel free to ping us for additional color.    

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1.       CFTC Net Futures and Options Positioning For Commodities in the CRB Index: The U.S. Commodity Futures Trading Commission (CFTC) releases “Commitments of Traders Reports” at 3:30 p.m. Eastern Time on Friday afternoons. The release usually includes data from the previous Tuesday (Net Positions as of Tuesday Close). The table below includes the net positions of “non-commercial” futures and options participants. A “Non-Commercial” market participant is defined as a “large speculator.” We observe the weekly marginal changes in the overall positioning of “non-commercial” futures and options positions to assess the directionally-biased capitulation risk among those with large positions.

  • The copper, sugar, and soybean markets are positioned shorter through Friday’s release. The market took comments from Yellen and Draghi at last week’s symposium as USD bullish and bearish for Gold which is currently testing its @Hedgeye $1271 Trend line of support. Gold has sold off ~-1.5% over the last week and we anticipate a market that is relatively shorter week-over-week when new contract data is published on Friday.
  • The coffee, cocoa, and orange juice markets were positioned relatively more bullish according to Friday’s report. The net-commercial length of both cocoa and coffee futures and options positions are sitting much longer than their trailing 1-year averages. we anticipate more producers have come to hedge cash market exposure with the uncertainty of the future crop in Brazil. Coffee is +65% YTD.

Commodities Weekly Sentiment Tracker - chart 1 CFTC w.w change

2.       Spot – Second Month Basis: Measures the market expectation for forward looking prices in the near-term.

  • The sugar, coffee, and corn markets are positioned for higher prices near-term. 
  • The soybean, lean hogs, and RBOB Gasoline markets are expecting lower prices near-term.

Commodities Weekly Sentiment Tracker - chart 2 spot 2nd basis

3.       Spot – 1 Year Basis: Measures the market expectation for forward-looking prices between spot and the respective contract expiring 1-year later.

  • The sugar, corn, and wheat markets reflect the expectation for higher prices 1-year in the future. 
  • The lean hogs, soybeans, and live cattle markets reflect the expectation for lower prices 1-year in the future. 

Lean hogs spot prices have already retreated ~-27% over the last month and are expected ~-18% lower in 1-year. We highlighted the recent developments of a potential game-changing vaccine to the PEDv virus that affected an estimated 5,000 farms in 30 states across the country. A link to that article from July 31st is included below:

All Time Highs in July: Hogs and Cattle

Commodities Weekly Sentiment Tracker - chart 3 Spot 1 Yr Basis

4.       Open Interest: Aggregate open interest measures the amount of opened positions in all actively traded futures contract months. Open interest can be thought of as the total sum of “naked” or “directionally-biased” contracts as opposed to hedgers scalping and providing liquidity. A majority of the open interest is created from large speculators or participants who are either: 1) producers/sellers of the physical commodity hedging their cash market exposure or 2) large speculators who are directionally-biased on price.

Commodities Weekly Sentiment Tracker - chart 4 Open Interest     

 

Ben Ryan

Analyst    



Cartoon of the Day: Burning Euro

Takeaway: ECB chief Mario Draghi is evidently a bigger fan of monetary cowbell than previously imagined.

Cartoon of the Day: Burning Euro - bruning euro 08.25.2014


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