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THE HEDGEYE MACRO PLAYBOOK

Takeaway: The Hedgeye Macro Playbook is a daily 1-page summary of our core ETF recommendations, investment themes & noteworthy quantitative signals.

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Enjoy!

 

Darius Dale

Associate: Macro Team


Failing Successfully

This note was originally published at 8am on September 04, 2014 for Hedgeye subscribers.

“If you try to fail, and succeed, which have you done?”

-George Carlin

 

In theory, investing is very straightforward.  You buy stocks in great companies and the stock prices goes up.  You short stock in bad companies and the stock prices go down.  Practically, of course, that’s never really how it happens, except in fundraising power point presentations. 

 

A real paradox of investing is that there are periods in which the stock prices of “weaker” companies actually dramatically outperform “stronger” companies. Over the last three months, stocks in the highest quartile of short interest have outperformed low short interest stocks by 240 basis points over the last three months - +5.5% vs +3.1%.  In part, this is facilitated by so called short covering.

  

Our lives are, of course, replete with paradoxes, so a little paradoxical market action should on some level be easy to stomach, right?

 

 Some notable paradoxes of different genres include:

  • Paradox of voting - For a rational, self-interested voter the costs of voting will normally exceed the expected benefits, so why do people keep voting?
  • Fenno's paradox  - This is the belief that people generally disapprove of the United States Congress as a whole, but support the Congressman from their own Congressional district.
  • Hedgehog's dilemma – This is the paradox that human intimacy cannot occur without substantial mutual harm (This is maybe the best philosophical defense for long term bachelors like myself!)
  • Archimedes paradox – The paradox that a massive battleship can float in a few litres of water

Lastly is one of my personal favorites - the St. Petersburg paradox.

 

According to the St. Petersburg paradox, a casino offers a game of chance for a single player in which a fair coin is tossed at each stage. The pot starts at $2 and is doubled every time a head appears. The first time a tail appears, the game ends and the player wins the pot.

 

Thus the player wins $2 dollars if a tail appears on the first toss, $4 if a head appears on the first toss and a tail on the second, $8 if a head appears on the first two tosses and a tail on the third, $16 if a head appears on the first three tosses and a tail on the fourth, and so on.

 

What would be a fair price to pay the casino for entering the game?

 

Back to the Global Macro Grind...

Failing Successfully - Putin 09.03.2014

 

As it relates to recent events in Russia, the term circus comes more to mind than paradox.  Yesterday Russian President Putin introduced a hastily patched together seven point peace plan at a press conference.  This came shortly after President Obama upped the rhetoric in terms of the U.S.’s willingness to support Ukraine (and also NATO countries in the region) and ahead of a two day NATO summit that begins today.   

 

By some pundits, this “ceasefire” was perceived positively.  But the ever thoughtful George Friedman from Stratfor (the largest non-government intelligence agency) had a more paradoxical take and wrote the following:

 

“This rapid turnaround on the battlefield (in reference to the recent thwarting of a Ukrainian offensive) had two main purposes. The first was to assert Russian military power and convince the West that Moscow would not be afraid to use it in spite of the economic consequences. The second was for Moscow to use its military gains to make it appear that the West was utterly irresponsible in trying to wrest Ukraine out from Moscow's shadow. Now, by dangling an ambiguous cease-fire before the Americans, Russia is essentially telling the United States that to defeat Russia it must fight Russia directly, knowing that NATO is loath to engage directly with the Russian military.

 

That deal goes well beyond a cease-fire. Russia wants its buffer in Ukraine recognized and respected, along with sanctions lifted so it can get on with repairing its economy. And with winter approaching, Russia also has the means to turn the screws on Europe's natural gas supply at the same time it holds a clear military advantage on the Ukrainian battlefield.”

 

Indeed.

 

Of course, the real news in Europe this morning are the monetary moves from the ECB and not that geo-political move from Russia yesterday.  In an announcement that was a surprise to most, the ECB cut interest rates from 0.20% to 0.05%, cut the deposit rate by 10 basis points to -20 basis points, and also cut the re-fi rate and marginal lending rate by 10 basis points. 

 

Although this isn’t necessarily monetary shock and awe, with the Euro trading down about 80 basis points, Draghi was seemingly able to get his point across with this move on some level.  Practically speaking though, it is not clear that this will necessarily be a catalyst to ignite European economic activity.

 

Certainly a negative deposit rate incentivizes banks to lend out their money and sovereigns such as France, with a negative short term borrowing rates, have benefitted.   That said, at least based on the initial foray into a negative deposit rate early this summer, this policy move has not lead to increased lending to businesses that are willing to invest in and grow the European economy.

 

All eyes will now be on Draghi’s press conference where he is likely to now introduce a QE type plan that also surprises to the dovish side.  But the paradox of these surprises moves from such low levels is related to the answer to the St. Petersburg paradox, which is: infinity.   Unfortunately infinite monetary policy moves from zero do not grow an economy.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.33-2.43%

SPX 1988-2007

Shanghai Comp 2232-2316

VIX 11.34-12.95 (bullish)

WTI Oil 92.51-96.53 (bearish)

Gold 1264-1296 (neutral)

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

Failing Successfully - Chart of the Day


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.


Early Look

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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


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


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 80.64%
  • SHORT SIGNALS 78.58%
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