TODAY’S S&P 500 SET-UP – September 23, 2014
As we look at today's setup for the S&P 500, the range is 34 points or 0.87% downside to 1977 and 0.84% upside to 2011.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS (Bloomberg Estimates):
WHAT TO WATCH:
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
The Hedgeye Macro Team
Takeaway: We now view the Japanese equity market as a short idea amid a likely acceleration in both domestic and globally interconnected risks.
Globally Interconnected Risks Are Rising
Consistent with our growing expectation that the US economy has entered into a multi-quarter Quad #4 setup, we think recent weakness in the Japanese yen is overdone. Specifically, our GIP model backtest results indicate that the JPY has historically performed best in this economic environment, which makes sense given that Quad #4 in the US implies a dour outlook for the prices of many financial assets globally and the yen’s status as a “safe haven” among them.
Again, “risk off” usually means “risk on” (to the upside) for the Japanese yen. This is because of the yen’s status as both a global funding currency and Japan’s status as an international capital allocator. Its net international investment surplus of ~$3T is equivalent to 68% of the country’s GDP and compares to a -$5.5T deficit for the US.
Probable upside in the JPY should equate to probable downside in Japanese share prices given rising correlation risk in marketplace. Our multi-duration look at this relationship suggests the Japanese yen has become increasingly important as a directional driver of the Japanese equity market. In fact, the chart below would suggest that the USD/JPY breaking out of its 101-103 trading range to ~109 has been the primary driver of the latter ~half of the TOPIX’s +17% rally from the its mid-April lows.
Indeed, it would seem that if we get the currency right from here, we should be able to accurately forecast market beta for Japanese stocks. Again, we’re of the view that a Quad #4 outcome in the US is positive for the Japanese yen, which implies a bearish outlook for Japanese stocks.
Idiosyncratic Risks Are Rising As Well
Obviously we can’t just isolate the US in any attempt to predict the direction of the USD/JPY cross (or any exchange rate for that matter); what’s happening from GIP perspective in Japan is likely to play a key factor as well. And from the perspective of the Japanese economy, a bullish call on the JPY from these levels is actually a lot easier to make.
Our GIP model also has Japan entering into Quad #4 for the fourth quarter. While a second consecutive quarter of likely deceleration in reported inflation figures is sure to pull forward market expectations of BoJ easing as we traverse through the next few months, we do think the confluence of both growth and inflation slowing will weigh on sentiment in the interim in the context of Japan’s already muted post-tax hike recovery.
Indeed, if our GIP model proves accurate in predicting the 2nd derivative of those metrics, we’d expect to see a growing loss of faith in the Abenomics agenda among investors, at the margins. To that tune, the following six signals give us confidence in our forecast for both Japanese growth and inflation to slow in the fourth quarter:
Tougher GDP compares on the margin:
A loss of sequential growth momentum:
*As the preceding table highlights, Japan’s Economy Watcher’s Survey, Small Business Confidence, Industrial Production, Machine Tool Orders, CapEx, Housing Starts, Bank Loans, Consumer Confidence, Overall Household Spending, Real Household Incomes, Exports and Imports are all sequentially decelerating as of July/August and/or negatively diverging from their respective trailing 3M trends. The conclusion: Japan’s post-tax hike recovery has lost a considerable amount of steam.
A demonstrable loss of purchasing power among Japanese consumers:
Demonstrably tougher CPI compares on the margin:
A loss of sequential inflation momentum:
Demonstrably reduced import price pressures:
Currency Debasement Is Falling Out Of Favor With Japan Inc.
Going back to our point about the potential for steepening levels of pushback against the Abenomics agenda (i.e. using a confluence of monetary and fiscal easing to achieve “+5% monetary math” at seemingly all costs), we’re actually already starting to see increased pushback from Japan Inc. regarding the recent bout of yen depreciation, which clearly took many Japanese corporations by surprise given expectations embedded in the BoJ’s Tankan survey.
Moreover, an increasing number of key business lobbies are finding it increasingly difficult to pass through the costs of higher import prices, which is squeezing the outlook for corporate earnings growth, at the margins, and weighing on near-consensus expectations that Abenomics will help Japanese companies close the ROE gap between their DM counterparts.
Recall that amid secular yen appreciation, a large portion of Japan Inc.’s manufacturing capacity has been off-shored to places like China, Thailand and even Mexico. That Japanese exports have been slowing on a trending basis since the start of the year is very telling in the light of that.
In summary, we think the hurdle for a meaningful expansion of the BoJ’s QQE program is much higher now than it has been at any point in its ~18M of existence.
This view is in line with both our existing expectations for a monetary policy vacuum in Japan and BoJ Governor Haruhiko Kuroda’s latest guidance that the Japanese economy remains on track to hit their inflation target in the appropriate timeframe.
Of course the BoJ will adjust monetary policy if and when it is deemed necessary (also in line with his latest guidance), but it’s important to remember that Kuroda is not a supporter of piecemeal easing; he prefers “shock and awe” when it comes to influencing inflation expectations in the marketplace. That means he’ll likely react to the aforementioned fundamentals on a lag (e.g. sometime in 1H15).
Investment Conclusions: Short the DXJ; Long the FXY
All told, we are increasingly of the view that the Japanese equity market is pinned up here on a rope based purely on hopeful expectations for a US economic recovery [and subsequent monetary policy tightening] that we continue to think are grossly misguided. 1,300 on the TOPIX or 16,000 on the Nikkei 225 is rather aggressive in light of that.
As such, we now find it prudent for investors who have participated in the rally in Japanese shares to book gains. We had been comfortably watching the rally from the sidelines amid a lack of conviction in our fundamental view, which, in the context of holding ourselves to the highest analytical standards, is a miss. We don’t like missing things – especially not what could be next 10-plus percent correction the Japanese stock market.
Have a great evening,
Associate: Macro Team
Takeaway: Hedgeye reiterates our bearish call on housing that we first made early this year.
In this brief 3-minute video from earlier this summer, Hedgeye managing director Josh Steiner highlights why we are inclined to remain bearish on the U.S. housing market.
Takeaway: Existing Home sales decline for the 1st time since March w/ distressed & cash sales making multi-year lows as investor activity retreats.
Our Hedgeye Housing Compendium table (below) aspires to present the state of the housing market in a visually-friendly format that takes about 30 seconds to consume.
Today's Focus: August Existing Home Sales
As we've highlighted, there's limited usefulness in the EHS report on the sales side since the data is well-telegraphed by the Pending Home Sales report. We show this in the 1stchart below, where we've offset the EHS data by one month to show its correlation to PHS on a 1-month lag.
Interestingly, however, since the trough in transaction volume in March, the relationship has exhibited more volatility and a longer lag with Existing Home Sales re-converging to PHS in a recurrent, every other month periodicity (2nd chart below).
Despite the limited real-time utility in terms of demand trends, there is value in the data on inventory and the composition of sales (first-time buyers, cash buyers, investor share).
TOTAL EXISTING HOME SALES: Total EHS fell for the first time in five months as sales declined -1.8% MoM against downwardly revised July figures with the year-over-year rate of change deteriorating to -5.3% in August from -4.5% in July.
Pending home sales have advanced +12.4% since the trough in March vs +10% for EHS and, given the recent pattern highlighted above, its likely we see a modestly better sequential EHS print in September. From a growth perspective, comps continue to get progressively easier through the balance of the year.
REGIONAL: The South and West regions registered sequential declines in sales while the Northeast and Midwest saw modest gains. Sales across all regions remain negative on a YoY basis.
INVENTORY: On a unit basis, existing home inventory declined -1.7% MoM, marking the 1st month of sequential decline in supply since December of last year. On a months supply basis, inventory was flat sequentially at 5.49 in August and up +10.3% YoY
HOME PRICES: Median Home prices declined sequentially across all regions while continuing to rise in the mid-single digits YoY across the South, Midwest, and West.
OTHER: The decline in investor activity is tangible evident in the data now as Distressed sales declined to 8% of the market (down from 12% last year) and cash sales declined to 23% - their lowest level since December of 2009 and down from 29% in July. First-time homebuyers held at 29% of the market while median time on the market fell to 53 days from 49 and 43 days last month and last year, respectively.
About Existing Home Sales:
The National Association of Realtors’ Existing Home Sales index measures the number of closed resales of homes, townhomes, condominiums, and co-ops. Existing home sales do not take into account the sale of newly constructed homes. Existing home sales account for 85-95% of all home sales (new home sales account for the remainder). Therefore, increases in existing home sales tend to signify increasing consumer confidence in the market. Additionally, Existing Home Sales is a lagging series, as it measures the closing of homes that were pending home sales between 1 and 2 months earlier.
The NAR’s Existing Home Sales index is published between the 20th and the 22nd of each month. The index covers data from the prior month.
Joshua Steiner, CFA
Christian B. Drake
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