Takeaway: Interest rates in two key European markets have been falling off a cliff compared to the U.S.
“Have no fear of perfection, you’ll never reach it.”
Last night I enjoyed my first major league baseball game of the summer. It couldn’t have been a more perfect night. I had cute Southern gal on my arm and the weather was almost perfect. Sadly, the hometown New York Mets lost in a 3 -2 heartbreaker.
Of course, perfect evenings, days, and stock market runs never last forever. As sad as that is, in life, business, and as stock market operators our luck and performance will always ebb and flow and perfection, should it occur, happens oh so rarely.
In baseball perfection is often epitomized by the so called “perfect game”. A perfect game occurs when the pitcher (or a combination of pitchers) retires 27 batters in a row through nine innings. The pitcher cannot allow any hits, walks, hit basemen, or any opposing player to reach base for any other reason.
Perfection in this sense is extremely rare. In fact, the feat has only been achieved 23 times in major league baseball history and only 21 times since the modern era began in 1900. The last time a perfect game was pitched occurred on August 15, 2012 by Felix Hernandez of the Seattle Mariners.
According to Wikipedia, the first known use in print of the term perfect game occurred in 1908 in the Chicago Tribune. Report I.E. Sanborn wrote the following about Addie Joss’s performance against the White Sox:
“. . . it was an absolutely perfect game without run, without hit, and without letting an opponent reach first base by hook or crook, on hit, walk, or error, in nine innings.”
As it relates to global markets, what is perfection? Is it the SP500 at all-time highs? Is it German bund yields at all-time lows? Is it corporate debt issuance at generational highs and terms at generational lows? Is it car loans at zero percent interest for a 9-year term? Or is it an all-time high in the number of uniformed market mavens appearing on T.V.?
Back to the Global Macro Grind…
Those long of European equities this morning are not dealing with perfect portfolio performance. Led by Russia down just under 200 basis points, European equities are red across the board this morning.
Even as bottoms-up stock pickers in Europe continue to have edge, the U.S. based macro asset allocators seems increasingly concerned about European growth, which was the original reason for being long Europe coming into the year. Clearly, eight months and a life time ago now!
In the Chart of the Day, we compare the interest rates of France to Germany and to the U.S. As you can see, interest rates in these two key European markets have been falling off a cliff versus the U.S. This is probably the best real time market indicator of future economic growth that we know of but, as the Europe bulls would also argue, decelerating growth leaves the door open for more
aggressive easing by the European Central Bank.
This, then, is the new, new bull thesis for European equities. Specifically, that by burning the Euro, Draghi will be able to inflate European equities. But with German 10-year yields below 1.0% and France not far behind, how much incremental easing is already priced in?
As the Wall Street Journal writes this morning, “some sell-side economists, including JPMorgan, Deutsche Bank and Nomura are now pricing in policy easing next week.” Expectations will always be the root of all heartache, won’t they?
One of our favorite sovereigns on the short side continues to be France. As my colleague Matt Hedrick noted yesterday:
“Just two weeks ago France’s government cut its GDP forecast in half (again) to 0.5% (from 1.0%) for 2014 and it will likely miss its FY deficit target of 4%. News this week of President Hollande reshuffling his government (after Economy Minister Arnaud Montebourg stepped down on Monday), is confirming evidence to us that the policies of Hollande’s government are not on track to return growth to the economy over the medium term. That Hollande himself is wildly unpopular, with a paltry approval rating of 17%, furthers the outlook that the government’s pledge that the “recovery is there” is grossly disingenuous.”
Political upheaval and growth getting cut in half are as good a reason as we know to, at a minimum, invest elsewhere if not to get outright short.
Speaking of short ideas (one of Hedgeye’s favorite investment topics) our firebrand energy analyst Kevin Kaiser is adding a new short to the firm’s Best Ideas list this morning and will be hosting a call to discuss his thesis on September 3rd. As Kaiser writes:
“VNR is a serial-acquisition / roll-up story that now sports a $2.5 billion market cap and $4.0 billion enterprise value after 22 separate acquisitions since 2008. It is owned primarily by retail investors for its outsized distribution yield (8.5%) and monthly distribution payments. VNR has actually trademarked the slogan, "The Monthly Distribution MLP.
But what unwitting investors don't realize is that VNR finances its distribution payments with capital raises - call that what you want to call it. In our view, VNR's "game" is at the beginning of its end. When VNR's distribution is ultimately cut, investors will discover that the Fair Value of VNR is substantially below the current market price.”
Vanguard is a whole lot of yield, with very minimal cash flow. Usually a toxic mix!
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.32-2.41%
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
This note was originally published at 8am on August 14, 2014 for Hedgeye subscribers.
“The odds are six to five that the light in the end of the tunnel is the headlight of an oncoming train.”
Whether it be hockey (which no doubt many of you are tired of us writing about!), card games, or chess, it's critical to put yourself in the best position possible to win. In effect, you want to play the strong hand. Most games involve some level of probability in which playing the odds can improve your chance of success meaningfully.
For example, in chess there are few basic rules of thumb that even the novice chess player should know and follow, such as:
- Use the center pawns to gain space on the opening
- Control the center of the board
- Secure your king early
- When ahead in material, force exchanges
- And perhaps the most important . . . never fight a land war in Asia.
Obviously, the last rule of thumb is not for chess, but was reputedly advice given by General MacCarthur to President Kennedy and then popularized in the 1987 movie, “The Princess Bride”. As rules of thumb go, given America's lack of success in the four Asian land wars post World War II, Korea, Vietnam, Afghanistan, and Iraq, the last point may be the most accurate rule of thumb.
As it relates to global macro investing and asset allocation, a couple of rules of thumb we have recently been reminded of are: 1) be on the right side of liquidity (It’s all about the flows, bro!) and 2) it’s the fundamental changes on the margin that matter.
Back to the Global Macro Grind...
In the Chart of the Day, we highlight a point that many asset allocators have been focused on over the past few weeks, which is that high yield bonds, even despite the recent rally, have sold off sharply from the highs of the year. As a result, the spread between high yield and comparable duration treasuries is at its widest of the year.
Some strategists have been flagging this as an opportunity to wade back into the high yield market, an entry point if you will. One point that gives us pause on this line of thinking is the risk of illiquidity in the high yield market. In some ways, this time IS different on the liquidity front.
According to Lipper, fund flows in high yield bond funds have experienced outflows of some $13 billion over the past four weeks. Rightfully, you might push back and say that is a smidgen of the size of the entire high yield market, which according to recent data from Barclay’s is north of $1.2 trillion in the U.S. alone. So based on those rough numbers, we are looking at only about 1% of the entire market in outflows, but the kicker, again, is liquidity.
Since April 2013, the New York Fed has started to break out dealer inventories of high yield bonds and they currently stand at about $8.2 billion. So even as the high yield market has ballooned from $660 billion in 2007 to almost double that now, liquidity, as facilitated by the dealers, has been shrinking. This then is the unintended consequence of government regulation and tighter capital rules: dealers have a more limited ability to facilitate an orderly rush for the exit.
The other rule of thumb we noted above is that fundamental changes on the margin matter. Europe is on the sell side in our current macro themes deck and that position is seeing the benefit of more slowing economic data from Europe this morning. A few points to highlight from this morning’s data:
- Eurozone GDP slows to +0.7% year-over-year in Q2 2014;
- German GDP contracted sequentially by -0.2%; and
- France cut their GDP forecast in half again to +0.5% for 2014.
For Germany, this is the first sequential contraction since 2012. Given this, it no surprise then that the German Bund hit a record low of 1.0% this morning and has also been front running this slow down. Clearly, low reported inflation is leaving the door open (some might say wide open!) for incremental easing in Europe (a point the German bund market is front running).
Incidentally for those that have been watching, the U.S. 10-year yield is ticking lower again this morning. The contrarian Hedgeye call that 10-year yields may touch 2.3%/2.2% may happen sooner than even we anticipate!
And conversely in a sign today that this time truly isn’t different, Reuters is reporting that mortgage lenders are again offering stated income mortgages in an attempt to facilitate mortgage activity. When combined with excesses in the auto loan market and a spike in subprime credit card issuances, perhaps there is more than just liquidity that is making the credit markets shake.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.39-2.48%
WTIC Oil 96.60-98.26
Keep your head up and pawns in the middle,
Daryl G. Jones
Director of Research
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TODAY’S S&P 500 SET-UP – August 28, 2014
As we look at today's setup for the S&P 500, the range is 28 points or 0.76% downside to 1985 and 0.64% upside to 2013.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 1.83 from 1.85
- VIX closed at 11.78 1 day percent change of 1.29%
MACRO DATA POINTS (Bloomberg Estimates)
- 8:30am: GDP Annualized, 2Q revised, est. 3.9% (prior 4%)
- 8:30am: Initial Jobless Claims, Aug. 23, est. 300k (pr 298k)
- 9:45am: Bloomberg Consumer Comfort, Aug. 24 (prior 36.6)
- 10am: Pending Home Sales m/m, July, est. 0.5% (prior -1.1%)
- 10am: Freddie Mac mortgage rates
- 10:30am: EIA natural-gas storage change
- 11am: Kansas City Fed Mfg Activity, Aug., est. 7 (prior 9)
- 11am: U.S. to announce plans for auction of 3M/6M bills
- Senate, House out on August recess
- Federal Deposit Insurance Corp releases quarterly report on bank earnings
- 12pm House Dem. Leader Nancy Pelosi press conf. call on women’s agenda, including equal pay legislation
WHAT TO WATCH:
- Russian hackers said to attack 5 banks seeking customer data
- U.S. sees Russia directing rebel counteroffensive in Ukraine
- Lagarde to explain her role in French legal case to IMF board
- Boeing, Airbus vying for $2b order from India’s Air One
- Goldman cedes NYSE post as speed traders seize stock floor
- Telefonica lifts GVT bid to $9.8b to rival Telecom Italia
- Dollar General reports earns; Family Dollar deal a focus
- Paramount said to plan $2.5b IPO in biggest REIT offering
- Google extends local advertisements on smartphones to desktops
- Ford begins production of first Mustang to be sold worldwide
- Glaxo’s Ebola vaccine set to begin tests in humans next week
- Sands sues brother of trader in Chinese probe over casino debt
- Wal-Mart’s Massmart profit plunges on weaker S. Africa spend
- CSR rejects Microchip approach; says is considering options
- Spain growth picks up as consumer prices drop most since 2009
- TripAdvisor to begin trading on Nasdaq today under TRIP
- Tel Aviv switch to Mon.-Fri. trading backed by TASE brokers
- Abercrombie & Fitch (ANF) 7:30am, $0.11 - Preview
- CIBC (CM CN) 6am, C$2.21 - Preview
- Coty (COTY) 6:30am, $0.05
- Dollar General (DG) 7am, $0.83 - Preview
- Genesco (GCO) 7:28am, $0.55
- Hanwha SolarOne (HSOL) 6am, no est.
- Laurentian Bank of Canada (LB CN) 8:33am, C$1.40 - Preview
- Pall (PLL) 7am, $1.06
- Signet Jewelers (SIG) 7am, $0.98
- Toronto-Dominion Bank (TD CN) 6:30am, C$1.09 - Preview
- Avago Technologies (AVGO) 4:05pm, $1.05
- OmniVision Technologies (OVTI) 4:18pm, $0.53
- Pacific Sunwear (PSUN) 4pm, $(0.03)
- Splunk (SPLK) 4:02pm, $(0.02)
- Veeva Systems (VEEV) 4:02pm, $0.07
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- WTI Declines as Crude Stockpiles Expand at Cushing; Brent Steady
- Gold-Price Indicator Fades as ETPs Lose $71 Billion: Commodities
- Commodity Income at Top 10 Banks Seen Climbing 21% in First Half
- New Ship Rules Come Amid Worst Barge Spills Since 2008: Freight
- Aluminum Advances for Fourth Day as LME Stockpiles Decline
- Sugar Rises in New York on Brazil Supply Outlook; Coffee Falls
- China Commodity Buyer Changhua Says Banks Resume Credit Line
- Congo Copper Shipments Halt as Botswana Bars Entry to Stem Ebola
- Rubber in Tokyo Falls on Yen as Thai Price Slumps to 5-Year Low
- Palm Oil Climbs From Five-Year Low on Chinese Demand Outlook
- Cotton Seen Dropping to Lowest Since ’09 by Gap’s Indian Partner
- Drier Sept.-Nov. Seen for Parts of Southeast Australia: Bureau
- Glencore Says Company is Preferred Proponent for Bauxite Project
- Modi’s Faster Green Permits Seen Fueling Growth: Corporate India
The Hedgeye Macro Team
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