Takeaway: Here's a quick look at some of the top videos, cartoons, market insights and more from Hedgeye this past week.
Q&A | McCullough: Small and Mid Cap US Equity Bubble "Epic"
Hedgeye CEO Keith McCullough answers questions from institutional investors about small and mid cap stocks and about his current asset allocation.
Hedgeye's Berger With The Latest Intel on INTEL $INTC
Hedgeye semiconductor analyst Craig Berger gives us his key takeaways after attending this week’s Intel Developer Forum in San Francisco.
McCullough: Housing “Train Wreck Within a Train Wreck”
HEDGEYE IN THE MEDIA
McCullough on Fox Business: The Biggest Risks to the Markets and Economy Right Now
Hedgeye CEO Keith McCullough sits down with "Opening Bell" host Maria Bartiromo on Fox Business to discuss the biggest risks to investors right now.
Yes, it's a bubble.
Smells Like 2007
Will They Or Won't They?
Will the Scots decide to leave the United Kingdom, or not? A few weeks ago, no one was even considering this as a potential global macro issue, but after a recent YouGov.Com poll that showed a slight majority of Scots voting Yes (51%) to independence versus No (49%), the British pound was sold dramatically and Scottish independence became a hot topic with the manic media.
The New Fundamental Analysis: Front- Running Fed Leaks!
Bernanke allegedly (and recklessly) told a group of investors during a secret lunch Thursday that US GDP growth was going to surprise to the upside (i.e. be better than 3% consensus) and that he could not believe the 10yr was still trading under 3%. In Fed whisper speak, that’s code for Janet is going to get more hawkish (look at the intraday chart, post lunch) … but is she?
At Some Point, Consumers Just Run Out of Breathing Room
POLL OF THE DAY
Do You Agree With Bernanke's 'Secret' >3% GDP Forecast?
At a "super secret" Morgan Stanley lunch Thursday, Ben Bernanke allegedly told a group of investors that US GDP growth was going to surprise to the upside (i.e. be better than 3% consensus). Do you agree or disagree with him?
As shares of Apple hover around $100, what's the next stop? Cast your vote.
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Takeaway: Upwardly revised U.S. production levels from the EIA and USD strength meet the IEA’s expectation for a slower pace of global demand growth
A big currency move meeting a shift in forward-looking supply/demand expectations continue to put downward pressure on oil prices.
From a quantitative perspective, our intermediate-term TREND set-ups in Oil vs. the USD have reversed from their 1H14 TRENDS:
USD = BULLISH TREND
BRENT = BEARISH TREND
WTI = BEARISH TREND
Below we outline two major factors contributing to the oil and gas disinflation over the summer with a view on the potential price risk into next week’s FOMC statement….
1. DRAGHI TRUMPS YELLEN: USD MOVES STEADILY OFF 2014 LOWS:
Moving into 2014 we positioned for a slowdown in U.S. growth and acceleration in inflation perpetuating an easier Fed-putting pressure on the dollar.
Through May 6th, 2014:
- USD debauchery: -1.18%
- domestic growth DECELERATION (this view is still FIRMLY intact)
- domestic inflation ACCELERATION
- CRB Commodity Index: +9.7%
- 10-Year yield: -44 bps (-14.4%) against the largest short position in U.S. treasuries we have seen since. See below for an outline of the risk with one-way, leveraged consensus macro positions
Adding to the pressure on the USD was the sustained strength in most Eurozone economies through the first half of the year. Once this relative strength began missing expectations with inflation missing estimates, Draghi moved to talking down the Euro with every opportunity.
On May 6th he hinted at a rate cut and asset purchase program by stating, “There is consensus [among the ECB Committee] about being dissatisfied with the potential path of inflation.”
May 6th also happened to be the YTD high in the EUR/USD: +1%. Since the May 6th highs, the USD has run +5.6%.
The relationship here is self-evident. At two points over the summer, Draghi took deliberate policy steps to devalue the EURO and plant the QE seed (WHICH HE DOES NOT HAVE THE POWER TO IMPLEMENT RIGHT NOW).
While the USD continues its steady move off its 2014 lows, Oil has sold off sharply from the June highs in WTI and BRENT:
- -12% from June highs
- -6% YTD
- -2.8% WTD
- -15% From June highs
- -11.7% YTD
- -3.7% WTD
Refreshed daily, our real-time view on both Q3 and full year 2014 growth estimates remain meaningfully divergent from consensus (the Fed, sell-side/buy-side macro):
We expect incremental divergence in this view to warrant an easier Fed. With consensus leaning 1) short the Euro, 2) short of treasuries; And 3) longer of U.S. growth (THAN US)…
YTD highs in the negative correlations between gold and oil vs. the USD present the volatility and macro correlation risk Keith outlined in this morning’s Early Look:
The chart above shows the dislocation of correlation risk relative to historical averages which are more or less insignificant.
KM’s EL commentary:
“Again, this is where the Hydra-headed monster of market expectations really matters – it’s called correlation risk:
- When Fed heads use communication tools to talk up rate hikes (like Bernanke just did) USD and rates rise
- When USD and rates are rising, at the same time, commodities, oil, Gold, etc. go down
- The machines (quants) then chase macro correlations, and macro markets get overbought/oversold”
Point three addresses the immediate, real-time risk that can smack you in the face. When those looking to minimize large currency and rate exposure anchor on macro correlations for hedge-sizing considerations one-way, large positions create the execution risk block traders love to hate:
- Anchoring: Tighter the correlation requires a bigger hedge
- Volume: Larger positions create large capitulation risk
- Sentiment: The “Commitments of Traders Report” from the CFTC shows a consensus position that is short the Euro, short long-duration treasuries, and longer (Than US) on U.S. growth.
- Volatility: If a leveraged consensus trade is wrong, the volatility risk is greater in the FX, Gold, and Oil markets as robots and scalpers chase the large trades.
- Risk: What is the probability of price moving to a certain level? We model it higher with this correlation risk. From an immediate-term TRADE duration perspective the bands/levels for identifying overbought/oversold exhaustion signals widen.
2. U.S. SUPPLY FLOOD AND GENERAL GEOPOLITICAL EASE:
- On Tuesday the Energy Information Administration (EIA) increased its expectation for U.S. oil production for the full year 2014 and 2015
- On Wednesday the International Energy Agency (IEA) decreased its estimate for global oil demand for 2015
In The EIA’s monthly release of its “Short-Term Energy Outlook” on Tuesday, the administration raised its estimate of 2015 U.S. Crude Production to 9.53M/BD (highest level in 45 years)
The report included the following data points and revisions:
- Increased full year 2014 U.S. production estimate to 8.53M/BD vs. 7.45M/BD 2013
- Production levels for August reach 8.6M/BD (highest since July 1986)
- Also in the report, the EIA estimates GLOBAL oil supplies will increase by 1.3M/BD in 2015 (U.S. accounting for 91% of the increase)
The increase in expected U.S. production can be seen in a widening of the Spot-1YR basis between WTI and BRENT:
This summer’s decline in petroleum prices is finally flowing through to the pump….
The average gallon of gas in the U.S. is $3.433/gallon which is down -6% from Memorial Day. This summer’s decline is the largest since 2008.
Following the EIA’s Tuesday report, the IEA released its downward predictions for global energy demand in 2015:
- Demand to expand +1.2M/BD (+1.3% in aggregate) 2015 vs. August estimate (-165K/BD less) m/m
- Saudi Arabia exported the least in 3-years in August
As a result OPEC has now cut its estimates for the amount of petroleum it needs to produce for the full year 2014 by 200K/BD to 29.2M/BD on average.
The two reports induced selling pressure and volatility to WTI and BRENT markets. The move in BRENT is a great indication on how quickly the bid for volatility can change with a catalyst:
The move was confirmed with heavy VOLUME Tuesday and Wednesday in BRENT-WTI:
- Tuesday: BRENT-WTI +10-25% 1/3/6-month averages
- Wednesday: BRENT +56/34/48% above 1/3/6-month averages
- Wednesday: WTI +18/11/16% above 1/3/6-month averages
Also adding to the pressure is an overall ease in the geopolitical catalysts threatening supply disruptions
The U.S., Canada, and Iraq are expected to experience the largest increases in global oil production over the next five years, so protecting Iraq’s oil reserves remains a priority for production sustainability into the future. OPEC estimates Iraq will peak at 40% of OPEC’s total production in the future, a fourfold increase from ~9% currently. The ISIS advance is undoubtedly a real threat, and our involvement in the conflict is timely. We outlined the ISIS threat to Iraq’s production capacity in a recent note. So far it’s minimal.
Russia/Ukraine (add link to Note):
Energy encompasses 70% of Russia’s annual exports. Russia’s dependency on demand from the rest of Europe as a driver for the rest of Europe is outline in a recent note we published last week:
As always, please feel free to reach out with any comments or questions. Have a great weekend.
Takeaway: We continue to favor Chinese equity exposure on the long side as stimulus expectations are set to remain elevated.
Dovish Growth Data + Dovish Inflation Data = A Dovish Policy Response
Overnight, the latest batch of high-frequency economic data showed that credit growth accelerated in AUG – albeit from insanely low levels – but still came in well-shy of consensus estimates:
- Total Social Financing: 957.4B CNY MoM from 273.1B in JUL vs. a Bloomberg consensus estimate of 1.135T
- New Loans: 702.5B CNY MoM from 385.2B in JUL
- Shadow Credit: 11.7B CNY MoM form -309.9B in JUL
- M2 Money Supply: 12.8% YoY from 13.5% in JUL (in line with Premier Li’s guidance from earlier in the week)
It is our view that soft credit growth combined with yesterday’s decidedly dovish inflation data will keep the PBoC “in the game” as it relates to being a net provider of liquidity. Specifically, the PBoC has pumped a net 72B CNY into the Chinese financial system over the past month via a combination of reverse repos as well as unsterilized repo and bill expirations. While that monthly total is down -31% from the rolling 3M average of +104B CNY, it’s up substantially versus the prior month sum of only +4B CNY.
Clearly, the PBoC’s dovish lean has had a dramatic impact on the cost of capital across the Chinese banking system, which, in turn, has completely reversed what had been a trend of rising cost of capital for Chinese corporates.
The “Beijing Put”
While we don’t see broad based easing measures such as a rate cut or a RRR cut(s) as a likely occurrence, we do think targeting monetary loosening such as the aforementioned liquidity provision, sector specific RRR cuts and relaxed regulatory quotas are all within the band of probable outcomes. Coupled with continued infrastructure investment at the municipal government level and relaxed home purchase restrictions on a city-to-city basis, we think enough will be done to prevent expectations for Chinese growth from falling off of the proverbial cliff.
They are going to need it. Be it seasonality in Chinese economic activity or marginally difficult GDP compares, Chinese real GDP growth is set to slow throughout 2H14.
This prediction is in line with the recent trend in China’s high-frequency growth data:
- Our favorite leading indicator for the slope of Chinese growth (i.e. the rolling 2M average of the arithmetic mean of the YoY % change in monthly average iron ore, rebar and coal prices) continues to decelerate sequentially and is negatively diverging from its trailing 3M, 6M and 12M trends.
- The official headline Manufacturing PMI and Non-Manufacturing PMI figures are negatively diverging from their respective trailing 3M, 6M and 12M trends.
- The National Bureau of Statistics (NBS) business cycle surveys are all either unchanged or negatively diverging from their respective trailing 3M, 6M and 12M trends.
- Fixed Assets Investment, Retail Sales and Industrial Production data are all negatively diverging from their respective trailing 3M, 6M and 12M trends.
- Export and Import growth decelerated sequentially and both are negatively diverging from their respective trailing 3M trends.
- FDI and “hot money” flows decelerated sequentially and both are negatively diverging from their respective trailing 3M, 6M and 12M trends.
- The only segments in China’s property sector that look “good” on the margin (i.e. going from brutal to less bad) are credit availability and housing starts. The rest of the segments in China’s housing compendium (i.e. construction, completions, purchases, prices and sentiment) are decelerating on a sequential basis, as well as negatively diverging from their respective trailing 3M, 6M and 12M trends.
But much like what we’re observing in the Eurozone of late or in the US during parts of 2010-12, marginally bad news is currently good news in China to the extent it maintains elevated expectations for the “Beijing Put”. Obviously really bad data would not be supportive of “investor” sentiment – which we’d argue is the primary directional driver of the Chinese stock market – but we doubt policymakers would allow growth data to slip much further from here, given that the property sector is the primary culprit for China’s current growth slowdown.
Specifically, the autocorrelated nature of property markets means that once a trend develops, actors and investors respond in kind by perpetuating the trend. This would effectively reduce Chinese policymakers’ ability to counter a deeper slowdown in property investment with more stimulus.
Net-net, while we don’t see a tremendous amount of upside to Chinese growth from here, we think there is a floor at/near the current level of economic activity and any threat of breaching that level should continue to be met with expectations of incremental stimulus from the marketplace.
Elsewhere In China…
There are few other noteworthy items to discuss that fall outside of the scope of our aforementioned bull case for Chinese equities, but we think they are important to factor into your analysis nonetheless:
- Shanghai-Hong Kong Stock Connect: While certainly not new news, we think there is still scope for this to be a catalyst to the upside for Chinese shares in the near term. Specifically, the A-Shares of mainland companies that have dual listings in both Shanghai and Hong Kong are trading at a discount of roughly 7% to their H-Share counterparts. We expect that valuation gap to narrow (in a good way) as a new class of investors enters the mainland market through this reform mechanism.
- New Economic Dashboard: Per NBS, Chinese policymakers are in the process of creating an economic dashboard of over 40 indicators to measure the efficiency and quality of growth, in order to shift investor and policymaker attention away from GDP. The indicators will concentrate on measuring eight criteria, including economic stability, economic security, optimized economic structure, industrial upgrading, profits and efficiency, innovation, the environment and people’s living conditions. This effectively raises the threshold by which Chinese policymakers are likely to react with incremental stimulus. By how much? We’re not sure, but it’s something to keep an eye on as we traverse the next few months of Chinese economic data and the accompanying rhetoric out of Beijing.
- Antitrust Crackdowns: Over the past month, Beijing has taken a lot of heat from international business groups and multinational companies from both the US and Europe after what had appeared to be a series of targeted probes into the Chinese operations of several noteworthy corporations, including Microsoft Corp. and Volkswagen AG. In addition to recent fines levied upon the Chinese operations of Audi and Chrysler, it also fined 10 Japanese auto parts makers a cumulative 1.24B CNY ($202M), which was the largest antitrust fine ever issued by Chinese authorities. In a rare joint press briefing in Beijing yesterday, China’s three antitrust regulators rebuffed such claims by saying only about 10% of anti-monopoly investigations have involved foreign businesses, echoing comments made by Premier Li Keqiang earlier this week. They also rebutted allegations that companies were denied legal representation during the probes. While far south of actually enacting policies that are supportive of FDI, we think acknowledging the issue with data is the first step towards China repairing its image in the eyes of global investors.
All told, now that you’re done reading this note, get out there and buy the dip in “Old China”! Our preferred way to play this thesis is via the iShares China Large-Cap ETF (FXI), which remains one of our macro team’s core long ideas (CLICK HERE for more details).
Have a fantastic weekend,
Associate: Macro Team
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