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Small Caps Struggling

Client Talking Points


The Russell 2000 sadly, closed down -1.4% on BABA day and is down that much for the year-to-date. The bubble in illiquid/small cap stocks (over 50x trailing earnings) will only be clear in hindsight, but we remain bearish of it in the meantime vs. big cap liquidity on the long side.


The biggest ramp in USD since 1997 has embedded some serious correlation risk into macro markets – on a 30-day correlation basis (which the machines chase), USD and SPX have a positive correlation of +0.68, whereas Brent Oil and Gold have negative correlations of -0.86 and -0.95, respectively. USD big time overbought signal too.


Correlation to USD remains as obvious as the round trip move the CRB Index has had during 2014 – on a 90 and 120 day basis the USD correlations to the CRB Index are -0.81-0.83. In our GIP model, this is called a Quad 4 move (when both growth and inflation are slowing, at the same time = #deflation).

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

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.


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.


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


EUROPE: stoxx start the wk red w/ Greece -1.2% and Russia -1.2% leading losers



The purpose of learning is growth, and our minds, unlike our bodies, can continue growing as long as we live.

-Mortimer Adler


U.S. Healthcare Stocks (XLV) are up +1.7% on the week to +17% year-to-date.


The Velveteen Bear

This note was originally published at 8am on September 08, 2014 for Hedgeye subscribers.

“You become. It takes a long time.”

-Margery Williams


That’s a quote from one of the best children’s books I have ever read to my kids, The Velveteen Rabbit. It was also cited in Brene Brown’s recent #behavioral book, Daring Greatly (pages 110).


“Real isn’t how you are made… it’s a thing that happens to you.”

“Does it hurt?” asked the Rabbit. “Does it happen all at once, like being wound up – or bit by bit?”

“It doesn’t happen all at once,”  said the Skin Horse. “You become. It takes a long time.”


While that resonates with me as a husband, Dad, hockey coach, etc., it really hits the nail on the head in becoming a Velveteen Bear on the US stock market. I haven’t been this bearish since the fall of 2007. Getting really bearish is a process. It takes time.

The Velveteen Bear - v7


Back to the Global Macro Grind


After Europe moved back into crisis mode (easing, printing, praying) and we received the worst US jobs report in 7 months, you just have to buy the all-time-bubble high in SPY on that, right? Right. Maybe with other people’s money.


After almost (I reiterate, almost!) having its first-four-down-days in a row of 2014 on Friday, the SP500 rallied from down to up on the day, to close up a whopping +0.2% on the week. That’s 5 consecutive “up” weeks. #hooray


In other news, the Russell 2000 (which derives 80% of its revenues from the US) flashed yet another bearish divergence, closing down -0.4% on the week to pretty much flat for 2014 YTD.


To give US equity bulls credit, this is what I liked about last week:


  1. After the ECB torched the Euro, the US Dollar (vs. the Euro) was up another +1.4% on the week
  2. The US 10yr Treasury Yield rose +12 basis points on the week to 2.46%
  3. The Yield Spread (10yr minus 2yr) widened +10bps on the week to +195bps


Not only was that something to like last week, it was something I loved all of last year. Dollar Up, Rates Up – that’s what should drive a US growth bear insane.


Other than the Russell 2000, what I don’t like in 2014 is that a key component of the Dollar Up, Rates Up storyline is missing - rates are down, hard, in 2014:


  1. Inclusive of last week’s bounce to lower-highs, the 10yr yield is -19% (or -57bps) YTD
  2. For 2014 YTD the Yield Spread (10yr minus 2yr) is still crashing (-26%) or down -70bps


In conjunction with these classic early cycle slow-down macro signals (which most European growth bulls said weren’t growth slowing signals until the ECB reminded them how fast things were slowing), you’ve seen:


  1. Early Cycle Stocks (Housing, Consumer Cyclicals, Regional Banks, the Russell, etc.) underperform
  2. Slow-growth #YieldChasing Stocks (Utilities, REITS, Big Cap Dividend Stocks, etc.) outperform


In case you aren’t long something like Argentina (stock market up another +6.1% last week to +93.2% YTD) whose economy still sucks, and you’ve stayed with the long #YieldChasing thing:


  1. Utilities (XLU) were up another +0.8% last week to +14.9% YTD
  2. REITS (MSCI index) were up another +1.0% last week to +19.6% YTD


Seriously. Who needs to be long the spoos when you can be long the good stuff!


While Ocham’s Razor (boil it down, simplify) is a really sexy concept, you can’t over-simplify. While a stronger Dollar (burning Euro) has toned down some of the commodity #InflationAccelerating that we saw in the first half of 2014, at some point you have to ask yourself if it’s going to be incremental enough to stop an early cycle US slowdown that’s already in motion?


To contextualize that key risk management question, don’t forget that the US is 63 months into this economic expansion. And the jobs market (both ADP slowing for 2 consecutive months and last week’s jobs report), which is a classic late-cycle indicator that strengthened, well, at the end of the cycle… is starting to hint that the bond market has #Q3Slowing nailed.


If US jobs and housing data slows, at the same time, what do you think Janet is going to do next? That’s right. She’ll do A) what Draghi just did and B) the Japanese are going to keep trying – moarrr incremental easing… That’s bullish for bonds and anything stocks that looks like a bond. And that’s all your cuddly Velveteen US Growth Bear has to say about that.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr yield 2.32-2.46%

SPX 1994-2009

RUT 1151-1181

VIX 11.34-12.92

EUR/USD 1.29-1.32

Gold 1257-1298


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


The Velveteen Bear - Chart of the Day

CHART OF THE DAY: Behold the IPO Bubble $BABA

Takeaway: Friday's Ali-Bubble IPO was "one of the most epic US stock market days I’ve witnessed in my career" said Hedgeye CEO Keith McCullough.

CHART OF THE DAY: Behold the IPO Bubble  $BABA - Chart of the Day

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Friday's Frenzy

“Where  is the lightning to lick you with its tongue?”



That’s another great quote from the latest #behavioral book I have been cranking through – The Rise of Superman, by Stephen Kotler. It’s also the perfect aphorism for one of the most epic US stock market days I’ve witnessed in my career.


Did the thunder and lightning of the Ali-Bubble lick you on Friday? Rising like a phoenix to market caps greater than General Electric (GE) and WalMart (WMT), the BABA licked someone, big time, at $99.70 (top tick of the day).


But what’s dropping $25 billion dollars or so in a few hours of trading amongst friends? Never mind it dropping to $90 intraday. As long as you owned it at $68, you crushed it. “Behold” the IPO bubble. “He is the lightning; he is the frenzy.” –Nietzsche


Friday's Frenzy - 79


Back to the Global Macro Grind


All the while, amidst Friday’s frenzy, the rest of the global macro market did not cease to exist. After the SP500 had herself an epic outside reversal, the Long Bond (TLT) rallied and the Russell 2000 got licked for a -1.4% drop on the day.


In one of the more peculiar “secular bull” markets (or whatever they’ve been calling a market that’s gone up for 5 years), the Russell 2000 is now down for 3 consecutive weeks and -1.4% for 2014 YTD (vs. the slow-growth Long Bond TLT = +12.9% YTD).


“So”, now the question is, has the licking in illiquidity already begun?


Illiquidity, as in small caps that trade by appointment – but usually on big volume, on down days (when everyone has to get out at the same time)… if you have been long 1 of the 41% (stocks in the Russell that have had greater than 20% declines), you get what I mean.


Perhaps this is Mr. Macro Market’s message: if you’re going to get long of the frenzy, you should just buck up and go big cap like the BABA and the Facebook (FB). If you’re going to pay 18-28x revenues for something, you might as well be able to get out!


We call this small cap vs. large cap performance gap a Style Factor Divergence. When I worked at Magnetar Capital, our “book” would be characterized this way. If you were long “size” as a style factor, you’d be long big caps. I would definitely have that on right now.


In terms of protecting my personal net wealth, the biggest “size” bets I tend to gravitate to are:


  1. Cash
  2. Long-Term Treasuries
  3. Equity Short Sales


Not everyone rolls that way. Call me conservative, but when I hear the thunder rolling in, I don’t wait around for the performance-chasing lightning!


Here’s another big cap “size” bet that was working last week:


  1. US Healthcare Stocks (XLV) +1.7% on the week to +17% YTD
  2. Vs. MSCI REITS Index -0.3% on the week to +12.9% YTD


As many a big cap Portfolio Manager has reminded us this year, they love our Long Bond (TLT, EDV, etc.) call but can’t get really long of stocks-that-look-like-slow-growth bonds (Utilities and REITS) because they aren’t big cap stocks in their benchmark.


As a Global Macro Risk Manager, my benchmark is not losing money. You can dial up plenty a broker/banker to tell you what to chase on the long side. I’m the one you pay while they are sleeping. I’m the one who surveys the land before dawn.


Another interesting macro divergence last week was:


  1. European Stocks (EuroStoxx 600) +1.2% on the week to +6.2% YTD
  2. Emerging Market Stocks (MSCI Index) -0.5% on the week to +5.4% YTD


I call it interesting because I think you fade the fear on that trade too. In other words, you buy EM on the dip and sell European Equities on the bounce. My research team and I will explain why on our Q4 Macro Themes call, which we’ll host on October 2nd.


The upshot of our current call has mostly to do with phase transitions in both growth and inflation. We think that both the Russell 2000 and the 10yr bond yield (down 3bps last week and -45bps for 2014 YTD) look a lot like Europe and US inflation – slowing.


And while you may have never experienced thunder and lightning when everyone is tilted to the levered long side of a performance chasing boat, you have seen both growth and inflation slowing (at the same time) before. It was Q3 of 2008. Now that was a frenzy!


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.42-2.62%


RUT 1140-1158

VIX 11.66-14.12

Pound 1.62-1.64


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Friday's Frenzy - Chart of the Day

September 22, 2014

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TODAY’S S&P 500 SET-UP – September 22, 2014

As we look at today's setup for the S&P 500, the range is 19 points or 0.67% downside to 1997 and 0.28% upside to 2016.                                                      













  • YIELD CURVE: 2.01 from 2.01
  • VIX closed at 12.11 1 day percent change of 0.67%


MACRO DATA POINTS (Bloomberg Estimates):

  • 8:30am: Chicago Fed Natl Activity, Aug. est. 0.33 (pr 0.39)
  • 9am: ECB’s Draghi speaks in Brussels
  • 10am: Existing Home Sales, Aug., est. 5.20m (prior 5.15m)
  • 10:05am: Fed’s Dudley speaks in New York
  • 11am: U.S. to announce plans for auction of 4W bills
  • 11:30am: U.S. to sell $24b 3M bills, $23b 6M bills
  • 7:30pm: Fed’s Kocherlakota speaks in Marquette, Mich.



    • Senate, House out of session
    • 8:15am: FDIC Chairman Martin Gruenberg speaks at American Banker Regulatory Symposium in Arlington, Va.
    • 4pm: Treasury Sec. Jack Lew gives speech on economics of climate change at Hamilton Project-hosted event, followed by roundtable discussion with former Treasury Sec. Robert Rubin
    • 4:15pm: Comptroller of the Currency Thomas Curry speaks at American Banker Regulatory Symposium in Arlington, Va.



  • Siemens buys Dresser-Rand for $7.6b to expand in oil equipment
  • Tesco starts probe after overstating profit guidance by ~$408m
  • Alibaba’s bankers said to increase shr sale size to record $25b
  • Apple iPhone 6 Plus outselling smaller model: Piper survey
  • Apple iPhone weekend sales preview
  • Deutsche Bank says currency trader dismissed on misreporting
  • U.S. Treasury seeking to close tax address loophole, Lew says
  • Blackstone halting efforts to find deals in Russia: FT
  • Google selects HTC to make 9-inch Nexus tablet: WSJ
  • Emirates airline plans U.S. expansion as widebody fleet grows
  • Insider buying dries up defying $275b of buybacks
  • Clorox said to reject takeover offer with 20% premium: NYPost
  • Mitsubishi Corp. offers to buy Norway’s Cermaq for $1.4b
  • Total to cut costs, sell assets after lowering output forecast
  • SK buys shale gas asset from Continental Resources: MoneyToday
  • German union calls strikes at Amazon warehouses: Reuters
  • China Finance Chief Lou say eco growth faces downward pressure
  • UN’s Ban joins 310,000-strong march for climate action



    • AutoZone (AZO) 7am, $11.26
    • Neogen (NEOG) 8:45am, $0.23


  • Nickel Leads Industrial Metals Lower on Outlook for Slower China
  • Commodities Extend Declines to Five-Year Low in ‘Capitulation’
  • Hedge Funds Make Record Bet on Lower U.S. Diesel Prices: Energy
  • Gold Is Little Changed Near Eight-Month Low as Silver Declines
  • Corn Declines With Soybeans to 2010 Lows on Increasing Supplies
  • Brent Crude Declines on Concern China Growth Slowing; WTI Drops
  • Indonesian Police Probe Clears 82 Tin Containers for Exports
  • Iron Ore Futures Decline Below $80/MT to Record Low in Singapore
  • Rubber Production Seen Declining by Consortium of Top Exporters
  • Merkel’s Taste for Coal to Upset $130 Billion Green Drive
  • Al-Amoudi to Invest $500 Million in Ethiopian Coffee, Oranges
  • U.K. Royal Mint Starts Online Trading Site for Gold Coins
  • Libya Crude Oil Production at 700k B/D, NOC Spokesman Says
  • Gasoline Pump Prices Seen Falling After Slump to 7-Month Low
  • Gold Bulls Extend Longest 2014 Exit as Prices Drop: Commodities


























The Hedgeye Macro Team

















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