prev

The Smell of Incremental Easing

Client Talking Points

USD

Plenty of foreign currency volatility out there now that the USD has had its biggest move since 1997, but we’re right where it stopped going up in July of 2013. So, for a trade we would sell that. Pound vs. USD at 2 week highs into the Scottish vote.

UST 10YR

We heard more talking about the “dots” yesterday than we saw analysis of what Janet Yellen was actually saying – she’s saying she’ll go with the data, so watch-out below on yields if we’re right and Q3 GDP misses (and/or a jobs report does).

GOLD

Gold is annoying people (as it tends to on massive USD ramps), but unless the USD Index can shoot towards 86-87 and hold up there, Gold has plenty of support here (its +2% from where it started the year); the risk range is now 1216-1266.

Asset Allocation

CASH 34% US EQUITIES 6%
INTL EQUITIES 20% COMMODITIES 4%
FIXED INCOME 32% INTL CURRENCIES 4%

Top Long Ideas

Company Ticker Sector Duration
EDV

The Vanguard Extended Duration Treasury (EDV) is an extended duration ETF (20-30yr). Now that we have our first set of late-cycle economic indicators slowing in rate of change terms (ADP numbers and the NFP number), it's time to really think through the upcoming moves of this bond market. We are doubling down on our biggest macro call of 2014 - that U.S. growth would slow and bond yields fall in kind.

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.

RH

Restoration Hardware remains our Retail Team’s highest-conviction long idea. We think that most parts of the thesis are at least acknowledged by the market (category growth, real estate expansion), but people are absolutely missing how all the pieces are coming together to drive such outsized earnings growth over an extremely long duration. The punchline of our real estate analysis is that a) RH stores could get far bigger than even the RH bulls seem to think, b) Aside from reconfiguring 66 existing markets, there’s another 19 markets we identified where the spending rate on home furnishings by people making over $100k in income suggests that RH should expand to these markets with Design Galleries, and c) the availability and economics on large properties for all these markets are far better than people think. The consensus is looking for long-term earnings growth of 28% -- we’re looking for 45%.  

Three for the Road

TWEET OF THE DAY

INDIA: +1.7% move for BSE Sensex to +29.7% YTD (where the real perf is at)

@KeithMcCullough

QUOTE OF THE DAY

You don't get to choose how you're going to die, or when. You can decide how you're going to live now.

-Joan Baez

STAT OF THE DAY

The Russell 2000 (small cap Style Factor) is still down -0.9% for 2014 year-to-date versus a proxy for the #GrowthSlowing Long Bond (TLT) which is +11.1% year-to-date.


CHART OF THE DAY: Has Central Planning Reached Its Crescendo?

CHART OF THE DAY: Has Central Planning Reached Its Crescendo? - Chart of the Day


Managing Dovish Paradox

“The tools for managing paradox are still undeveloped.”

-Kevin Kelly

 

That’s the opening volley in the latest #behavioral book I have cracked open, The Rise of Superman, by Steven Kotler. It’s a book about flow, as in athletic flow – where world class athletes “completely redefine the limits of the possible.”

 

Managing Dovish Paradox - s2

 

When it comes to central planning limits, there are none (yet). And that’s making your job as a Risk Manager all the more challenging. No matter what you think the Fed, ECB, and BOJ should do, you have to operate within the paradox of what they will do.

 

When you’re forced to operate within a paradox, life gets tougher. By definition, a paradox is a “statement that apparently contradicts itself and yet might be true” (Wikipedia). But what happens when the promised output of the policy within the paradox isn’t true?

 

Back to the Global Macro Grind

 

The good news on the truth is that Janet Yellen actually rolled with it yesterday. When former WSJ reporter (now of The Economist fame) Greg Ip asked her why the Fed continues to cut its growth estimates, this is what Janet said:

 

So, there’s been a little bit of downgrading… you are certainly right, there has been a pattern of forecasting errors.”

 

“So”, what we have within the Policy To Inflate America’s cost of living to all-time highs, is a pattern within the paradox. And it’s that very pattern (forecasting errors) that the entire edifice of consensus clings to like a free-climber to the mother of all centrally planned cliffs.

 

#cool

 

Oh, and to make matters worse, now every Mickey Mouse macro journo in America has figured out what the “dots” are…

 

That’s not good. Because the only thing worse than the buy-side trading on the Fed’s first “rate hike” expectations (which have been wrong all year), is the manic media agreeing that both the Fed and Wall Street consensus growth forecast is going to be accurate.

 

Forget this time – if all of consensus nails US GDP growth being +3% for the next 6 quarters, that would be different!

 

In other news:

 

  1. Fed Keeps ‘Considerable Time’ Pledge As Growth Moderates” –Bloomberg
  2. Asset bubbles absolutely love incremental easing
  3. Ali-bubble (BABA) will be the biggest IPO in US history

 

Fortuitously, we aren’t yet brain-dead from trying to front-run the proactively predictable behavior of the Fed, and we got longer of asset price inflation on red (Monday and Tuesday, we moved to 12 LONGS, 4 SHORTS in Real-Time Alerts and cut our Cash position to 34% in the Hedgeye Asset Allocation Model).

 

But, on the damn dip, we didn’t buy into momentum bubbles or illiquid small cap US equity exposures. We went with:

 

  1. Moarrr #GrowthSlowing Bonds
  2. Stocks that look like Bonds (Utilities)
  3. International Growth Equity exposure (China, India, etc.)

 

Inclusive of the centrally planned pop, the Russell 2000 (small cap Style Factor) is still down -0.9% for 2014 YTD versus a proxy for the #GrowthSlowing Long Bond (TLT) which is +11.1% YTD.

 

No, long-term interest rates haven’t re-tested their YTD lows (they just hit those 3 weeks ago, so now you have the bounce in rates to lower-highs). And, no, the US Dollar hasn’t backed off its multi-standard deviation overbought highs (yet), but give these things time.

 

With time you get more data. And Janet made it very clear yesterday that she doesn’t want to be put in the dot-box; she wants to be “data dependent.”

 

Which, to me, means that if we are right and US GDP slows in Q3 and/or we have one more bad jobs report, market expectations will push those dots out (again). The Fed’s paradox is that the lofty growth expectations embedded in the dots just aren’t true.

 

Our immediate-term Global Macro Risk Ranges are now (we have 12 big macro ranges in our Daily Trading Range product, which includes our bullish/bearish intermediate-term TREND signals for each asset allocation):

 

UST 10yr Yield 2.39-2.62%

RUT 1143-1161

BSE Sensex 261

USD 83.79-84.83

Pound 1.61-1.64

Gold 1

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Managing Dovish Paradox - Chart of the Day


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.32%
  • SHORT SIGNALS 78.48%

ICI Fund Flow Survey - Trending not Mending - U.S. Stock Funds Continue in Redemption

Takeaway: U.S. stock funds continue to be redeemed by investors with equity managers T Rowe and Janus putting up outflows in August

Investment Company Institute Mutual Fund Data and ETF Money Flow:

 

In the most recent 5 day period ending September 10th, U.S. equity fund flow continued dire intermediate term trends with another $1.3 billion redeemed by investors. This now makes 19 of 20 weeks of outflow heading into the seasonally soft 4th quarter which could exacerbate the ongoing trend. Our research shows that despite these already substantial losses in the U.S. equity fund category over the past 5 months which total $48 billion, that the average draw down in U.S. stock funds since 2007 has averaged 40 weeks with over $113 billion lost, so trends could continue on their downward slope. Furthermore, while this weekly report focuses solely on industry related ICI fund data, the more discreet survey by Strategic Insight which actually distills fund flow by specific manager shows that both T Rowe Price (TROW) and Janus Capital (JNS) booked outflows in the most recent survey last week. The trends specifically for T Rowe are softening with inflows of $1.2 billion for May; inflows of $734 million for June; and inflows of $267 million for July; turning to an outflow of $212 million in the latest survey for August which was disseminated last week (Strategic Insight monthly tables directly below). T Rowe Price shares continue on our Best Ideas Short list currently. 

 

ICI Fund Flow Survey - Trending not Mending - U.S. Stock Funds Continue in Redemption - SI chart 1

ICI Fund Flow Survey - Trending not Mending - U.S. Stock Funds Continue in Redemption - SI chart 2

 

Hedgeye Best Ideas TROW Research 

 

Total equity mutual funds had inflow in the most recent 5 day period ending September 10th with a $1.2 billion subscription into all stock funds as reported by the Investment Company Institute. The composition of flow trends continued to be weighted towards International stock funds with a $2.5 billion inflow buffering a $1.3 billion redemption in U.S. stock funds. The inflow in International funds makes it a perfect 36 for 36, i.e. inflows in all 36 weeks of 2014. Conversely however, domestic trends are very dour with now 19 of 20 weeks of outflow now totaling over $48 billion lost. The running year-to-date weekly average for all equity fund flow continues to decline and now settles at a $1.3 billion inflow, now well below the $3.0 billion weekly average inflow from 2013. 

 

Fixed income mutual fund flow continues to be stable with $1.5 billion coming into the asset class. The inflow into taxable products of $704 million made it 29 of 31 weeks with positive flow. Municipal or tax-free bond funds put up a $841 million inflow, making it 34 of 35 weeks with positive subscriptions. The 2014 weekly average for fixed income mutual funds now stands at a $1.9 billion weekly inflow, an improvement from 2013's weekly average outflow of $1.5 billion, but still a far cry from the $5.8 billion weekly average inflow from 2012 (our view of the blow off top in bond fund inflow). 

 

ETF results were mixed during the week with inflows into equity funds but redemptions in passive fixed income products. Equity ETFs put up a $1.1 billion subscription while fixed income ETFs put up a $272 million outflow. The 2014 weekly averages are now a $1.7 billion weekly inflow for equity ETFs and a $862 million weekly inflow for fixed income ETFs. 

 

The net of total equity mutual fund and ETF trends against total bond mutual fund and ETF flows totaled a positive $1.0 billion spread for the week ($2.3 billion of total equity inflow versus the $1.2 billion inflow within fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52 week moving average has been $4.0 billion (more positive money flow to equities), with a 52 week high of $31.0 billion (more positive money flow to equities) and a 52 week low of -$37.5 billion (negative numbers imply more positive money flow to bonds for the week). The 52 week moving average chart displays the declining demand for all equity products (funds and ETFs) for the safety and security of fixed income. 

 

Mutual fund flow data is collected weekly from the Investment Company Institute (ICI) and represents a survey of 95% of the investment management industry's mutual fund assets. Mutual fund data largely reflects the actions of retail investors. Exchange traded fund (ETF) information is extracted from Bloomberg and is matched to the same weekly reporting schedule as the ICI mutual fund data. According to industry leader Blackrock (BLK), U.S. ETF participation is 60% institutional investors and 40% retail investors.   

 

ICI Fund Flow Survey - Trending not Mending - U.S. Stock Funds Continue in Redemption - SI chart 3

ICI Fund Flow Survey - Trending not Mending - U.S. Stock Funds Continue in Redemption - SI chart 4

 

 

 

Most Recent 12 Week Flow in Millions by Mutual Fund Product:

 

ICI Fund Flow Survey - Trending not Mending - U.S. Stock Funds Continue in Redemption - SI chart 5

 

ICI Fund Flow Survey - Trending not Mending - U.S. Stock Funds Continue in Redemption - SI chart 6

 

ICI Fund Flow Survey - Trending not Mending - U.S. Stock Funds Continue in Redemption - SI chart 7

 

ICI Fund Flow Survey - Trending not Mending - U.S. Stock Funds Continue in Redemption - SI chart 8

 

ICI Fund Flow Survey - Trending not Mending - U.S. Stock Funds Continue in Redemption - SI chart 9

 

 

Most Recent 12 Week Flow Within Equity and Fixed Income Exchange Traded Funds:

 

ICI Fund Flow Survey - Trending not Mending - U.S. Stock Funds Continue in Redemption - SI chart 10

 

ICI Fund Flow Survey - Trending not Mending - U.S. Stock Funds Continue in Redemption - SI chart 11

 

 

Net Results:

 

The net of total equity mutual fund and ETF trends against total bond mutual fund and ETF flows totaled a positive $1.0 billion spread for the week ($2.3 billion of total equity inflow versus the $1.2 billion inflow within fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52 week moving average has been $4.0 billion (more positive money flow to equities), with a 52 week high of $31.0 billion (more positive money flow to equities) and a 52 week low of -$37.5 billion (negative numbers imply more positive money flow to bonds for the week). The 52 week moving average chart displays the declining demand for all equity products (funds and ETFs) for the safety and security of fixed income. 

 

 

ICI Fund Flow Survey - Trending not Mending - U.S. Stock Funds Continue in Redemption - SI chart 12 

 

 

 

Jonathan Casteleyn, CFA, CMT 

 

 

 

Joshua Steiner, CFA


BAC - Removing From Best Ideas List on the Long Side

Takeaway: Valuation is no longer compelling, macro is no longer a tailwind and we're tired of waiting for Godot on normalized earnings.

We are removing Bank of America (BAC) from our Best Ideas list on the long side.

 

Prologue

After being bearish on Bank of America throughout 2011, we first turned bullish on January 19, 2012 in a research note entitled "We're Getting Bullish on Bank of America". At that time the stock was trading at $6.96. Not quite the low of $5 set a few weeks earlier, but still pretty good.

 

We formally added BofA to our "Best Ideas" list on the long side when we first launched our Best Ideas list, on February 27, 2013. By then the stock was trading at $11.30. We've had it on the Best Ideas list since then and the stock is up roughly 48% since (and 140% since our early 2012 call). Meanwhile, the S&P 500 is up ~32% since 2/27/13 and ~52% since 1/19/12. On both an absolute and relative basis BAC has been a solid long-term performer. Normally we don't leave ideas on for a year and a half, but since the thesis was steadily playing out we saw no reason to change our view.

 

Waiting for Godot

So why now, after all this time, pull the plug? There a few reasons.

 

1. Earnings. Normalized earnings remain elusive years after the term first floated circa 2011/12. Recall that in 2011 the company earned one cent per share for the whole year. In 2012 BofA earned 25 cents per share. In 2013 things started looking better with 90 cents in full year earnings, but in the first half of this year the company stumbled, earning just 14 cents on a GAAP basis (28 cents, annualized). The bigger picture, however, is that most of the core metrics at BofA have been negatively trending for the last year and a half and seem to show no signs of inflection.

 

We profile these trends in the charts below for NIM, NII, non-interest income, non-interest expense, pre-tax pre-provision net income, pre-tax income, and EPS. The punchline is that revenue, both NII and non-interest income, have been in steady decline while operating expenses have been rising. The only bright spot has been provision expense trending lower, but with reserve release compressing, this too will reverse from tailwind to no-wind and then headwind even in a benign credit environment. In other words, it's hard to see how earnings power advances from the recent run rate of  ~24 cents per quarter (average of last six quarters, excluding 1Q14 in which EPS was -$0.05) to the expected NTM rate of $0.34 when all the metrics are going the wrong way.

 

BAC - Removing From Best Ideas List on the Long Side - 1   NIM

 

BAC - Removing From Best Ideas List on the Long Side - 2   NII

 

BAC - Removing From Best Ideas List on the Long Side - 3   NON INT INC

 

BAC - Removing From Best Ideas List on the Long Side - 4   NON INT EXP

 

BAC - Removing From Best Ideas List on the Long Side - 5   PT PP NI

 

BAC - Removing From Best Ideas List on the Long Side - 6   PROV EXP

 

BAC - Removing From Best Ideas List on the Long Side - 7   RR

 

BAC - Removing From Best Ideas List on the Long Side - 8   PTI

 

BAC - Removing From Best Ideas List on the Long Side - 9   EPS

 

BAC - Removing From Best Ideas List on the Long Side - 10   EPS FWD   BACK

 

 

 

2. Macro. When we first turned bullish on BofA back in January, 2012 it was largely because we thought that (a) the company had ringfenced its mortgage liability and (b) the ECB's LTRO program would succeed in preventing Europe from sliding into the ocean. We were right on both accords as Article 77 kept the $8.5 billion settlement in place and Euribor-OIS receded back to the mid-teens bps. Several months later, it was rising home prices that became the new rallying call - a tailwind that persisted right through this Spring. 

 

Today, however, housing is a receding tailwind as the rate of home price change has been decelerating for 4 straight months now and we expect that trend to continue. Further, while there are many "hotspots" of eco/geo risk around the world (China, Ukraine, etc) the global, US banks have priced in very little discount/risk. #Asymmetric.  

 

 

3. Beta Renormalization. We added a new chapter to our bullish thesis on BAC back on March 7, 2013 when we published a note entitled "Long the Big Cap Beta Renormalization Trade". We argued that BAC, MS and C were undervalued on the basis of their capital position relative to their beta. We revisited the thesis on November 4, 2013 in our note "Banks: Capital & Volatility - A Look at the US & EU Banks With the Most Upside". At the time of the first note, BofA's 1-yr beta was just under 2. This compared with a Beta below 1 prior to the crisis, in spite of having materially increased its capital position over the ensuing time period. Our argument was simple: we though that beta would come down as the market realized risk was lower due to the permanently higher capital position. As beta came down, we argued, EVA would rise since beta is a key input in cost of capital. Finally, we have shown that EVA is very strongly correlated with price/tangible book multiples (stronger than ROE or ROTE alone). So we argued that as beta came down, the multiple to tangible book value would rise. That's exactly what happened.

 

Since our March 2013 note, BofA's beta has fallen to around 1.25 from just under 2. During that same period, the price/tangible book value multiple increased from 92% to 118%. This is a slightly smaller increase than we had originally postulated, but we think the framework worked well, overall.

 

The reason it's relevant today is that with beta back down to 1.25, this idea has largely run its course. Yes, there is likely some further reduction possible, but much of the move has already happened, as we show in the beta chart below. We also show the relative upside/downside to fair value for several of the larger banks based on our EVA fair value model. On that basis, we find that BofA is currently just about fairly valued.

 

BAC - Removing From Best Ideas List on the Long Side - bac   rolling 1yr beta for the group

 

BAC - Removing From Best Ideas List on the Long Side - bac   fair value snapshot

 

Based on this, we think it makes sense to remove Bank of America from our Best Ideas list on the long side. Please bear with us as we look for a suitable candidate to replace it.

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA


September 18, 2014

September 18, 2014 - Slide1

 

BULLISH TRENDS

September 18, 2014 - Slide2

September 18, 2014 - Slide3

September 18, 2014 - Slide4

September 18, 2014 - Slide5

 

 

BEARISH TRENDS

September 18, 2014 - Slide6 

September 18, 2014 - Slide7

September 18, 2014 - Slide8

September 18, 2014 - Slide9

September 18, 2014 - Slide10


Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

next