CLICK HERE to view the document.
Best of luck out there,
Associate: Macro Team
Takeaway: The Hedgeye Macro Playbook is a daily 1-page summary of our core ETF recommendations, investment themes and noteworthy quantitative signals.
CLICK HERE to view the document.
Best of luck out there,
Associate: Macro Team
This note was originally published at 8am on September 10, 2014 for Hedgeye subscribers.
“Mr. Bohannon, Do you want to build this railroad?”
-Senator Grant in the AMC T.V. show, “Hell on Wheels”
Similar to our office, I’m sure most of you don’t have much time to watch T.V., but every once in a while a great show comes around that is really hard to turn off. A popular one at Hedgeye as of late is AMC’s, “Hell on Wheels.”
The show is about the epic struggle to build a trans-continental railroad. Setting aside the obvious struggles of weather, dealing with Native tribes (who felt their treaties were being violated), and limited technology, the building of the transcontinental railroad also occurred at a time when the nation was healing itself from the Civil War. As a result many former Union and Confederate soldiers worked side-by-side on the railroad.
As Wikipedia describes it:
“The First Transcontinental Railroad (known originally as the "Pacific Railroad" and later as the "Overland Route") was a 1,907-mile (3,069 km) contiguous railroad line constructed between 1863 and 1869 across the western United States to connect the Pacific coast at San Francisco Bay with the existing Eastern U.S. rail network at Council Bluffs, Iowa, on the Missouri River.”
The epic struggle to connect the two sides of the continent took more than six years, but once it was completed dramatically changed the face of commerce in the United States.
Who knows, perhaps the iWatch will do the same?
Back to the Global Macro Grind...
In the global macro world, the epic struggle du jour seems to be related to Scottish independence. Simply, 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.
So, will the Scots vote for independence on September 18th? If we rely strictly on the YouGov.com poll, it would seem there is a real chance of this occurring. Practically speaking, though, as we have written often in the past it is very unwise to rely strictly on one poll. In fact, there are a couple of key quantitative points that speak in contrast to the YouGov.com poll:
In the Chart of the Day below, we show the impact that the series of YouGov.com polls have had on the British Pound. While certainly there are other factors at play, the increasingly pro-Independence polls have been a defined catalyst for aggressive selling of British Pounds.
Setting aside the polls and betting markets, the most notable reasons for Scotland to stay a part of Great Britain are related to the Scottish economy itself. Hedgeye’s European Analyst Matt Hedrick highlighted a number of major risks to the Scottish economy should the Scots pursue independence, including:
It is certainly possible, even if unlikely, that the most recent YouGov.com poll is the harbinger of Scottish Independence. But for this to be accurate it would fly in the face of all other polls, the betting markets, and really any semblance of rational analysis by the Scots related to their own economy. So our view continues to be that the No vote will prevail and the British Pound will rally accordingly.
That said, given the weak nature of the Scottish economy and the fact that 2 out of every 3 Scots are on some form of social welfare, over the long run a Great Britain without Scotland might actually be a stronger economy and certainly more healthy from a fiscal perspective. So on some level, perhaps the British Pound is in a win-win situation given its recent sell off. A No vote leads to a relief rally and a Yes votes leads currency traders to asses s United Kingdom’s much improved fiscal health without Scotland, which leads to a long term tail wind for the Pound.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.31-2.52%
Shanghai Comp 2261-2362
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
TODAY’S S&P 500 SET-UP – September 24, 2014
As we look at today's setup for the S&P 500, the range is 21 points or 0.39% downside to 1975 and 0.67% upside to 1996.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS (Bloomberg Estimates):
WHAT TO WATCH:
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
The Hedgeye Macro Team
Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.
Takeaway: Consistent with recent quantitative developments and our fundamental GIP process, we now think the risk is to the downside for EM Equities.
On September 8th, we published a note titled: “SHOULD YOU REMAIN OVERWEIGHT EMERGING MARKETS?”; the conclusion of that note was as follows:
“We expect EM assets to continue outperforming their DM counterparts over the intermediate term.”
Our call which effectively bottom-ticked EM assets back in 1Q14 notwithstanding, this most recent assertion was obviously the wrong call to make from that particular time and price. In the note below, we walk through precisely why we are no longer bullish on EM assets.
Quant Signals: EM Equities Are Now Broken
The rapid decline in the prices of EM financial assets over the past couple of weeks has been broad based across both countries and asset classes. In light of that, our Tactical Asset Class Rotation Model (TACRM) is now generating a “high-conviction SELL” signal for EM Equities – the first of its kind since the week ended February 28th. For specific details on how this signal may impact your performance, please refer to today’s installment of the Macro Playbook, our daily one-page summary of core ETF recommendations, investment themes and noteworthy quantitative signals.
Moreover, the Vanguard FTSE Emerging Markets ETF (VWO) has fallen -6.3% in nearly a straight line from its September 8th closing price of $45.95 and is now broken from our intermediate-term TREND perspective:
GIP Process: Quad #4 in the US Is Bad for Emerging Markets
Obviously we don’t just anchor on quant signals to make investment recommendations; rather, we rely on a dynamic combination of top-down market analysis and bottom-up fundamental analysis when generating investment ideas and themes. Additionally, our conviction in any call is always greatest when those factors are working in unison as they are now to the bearish side of the ledger for emerging markets.
The key fundamental factor that portends a dour outlook for EM asset prices is an increasingly probable, multi-quarter trip to Quad #4 for the US economy:
Simply put, Quad #4 means that the rate of change in both real GDP growth and inflation are decelerating (i.e. the 2nd derivative is negative) and, of the four quadrants (i.e. economic scenarios) in our GIP model, Quad #4 tends to be the most unfavorable for the prices of financial assets – including EM equities and currencies:
The defensive nature of Quad #4 makes sense to us, given that the confluence of both growth and inflation slowing roughly equates to a macro headwind for any asset with either supply & demand dynamics or a cash flow profile that’s a function of the economic cycle.
Our Conviction In A Domestic Quad #4 Setup Is High And Rising
So why is the US likely to remain in Quad #4 for the time being? Regarding the slowdown in domestic economic growth specifically, the following three notes highlight our latest deep-dive thoughts on this topic:
Inflation is a more difficult time series to forecast at the current moment.
On one hand, 4Q14 presents us with the easiest CPI compare we’ve seen since 4Q11 on an absolute basis and the easiest CPI compare we’ve seen since 3Q10 on a relative (i.e. z-score) basis:
On the other hand, reported inflation actually decelerated in each of the aforementioned periods due to marginal USD strength (DXY up +2.1% QoQ and +6.1% QoQ, respectively), which dramatically reduced the inflationary impact of YoY commodity price appreciation in both periods. As the following charts show, that phenomenon is occurring once again and perpetuating a nascent trend of negative sequential momentum in reported inflation:
All told, as right as we ultimately were on our highly controversial #InflationAccelerating theme from the start of the year, we think our early-August call for reported inflation to decelerate from its mid-summer highs will continue to prove equally as prescient.
In the meantime, continue to ignore calls from the Consensus Macro community that wages are the primary driver of inflation; wage growth has literally done nothing since the recovery began back in mid-2009. On a highly subjective government calculation that can only really go from +1% YoY to +4% YoY (barring the financial crisis), it’s all about identifying what’s occurring on the margin within that band of probable outcomes. And what’s occurring on the margin now is decidedly disinflationary.
This continues to support our long-held assertion that: “If you get the US dollar right, you’ll get a lot of other things right in macro”.
Investment Conclusions: Sell Sell/Short/Underweight EM Equities
As you are likely well aware, we had been trumpeting a number of long ideas in the EM space in recent months and quarters. As of today, however, we are effectively removing these ideas from our active ETF recommendations. In the bullets below, we walk through our risk management thoughts around these positions:
We’ll be back in the coming weeks with more country-specific EM short ideas as well. At first glance, both China and Brazil jump off the top of our heads as obvious places to begin the search.
Best of luck out there,
Associate: Macro Team
Takeaway: After sending the "Reduce EM Exposure" message via the “MACRO PLAYBOOK,” fundamental headwinds pressuring copper prices have a catalyst.
Earlier today, we sent out the EM sell signals in our MACRO PLAYBOOK one pager with the following conclusions:
With regards to our copper position, the bearish fundamental thesis now has a catalyst:
Copper has gone through a BULLISH TO BEARISH TREND REVERSAL, and the fundamental supply/demand outlook over the longer-term supports the short copper thesis.
While a slowdown in the commodity fueled credit financing bubble in China and the expectation for a steady increase in global supply coming onto the market over the next two years have suggested lower prices for quite some time now, a 1) A BULLISH Quant set-up in Chinese equities fueled by the positive effects of monetary stimulus at the regional and local government level from Beijing; AND 2) a BULLISH quant set-up in copper, likely fueled by the Chinese catalyst (SEE BELOW), helped to support prices over the summer.
BOTH OF THESE TRENDS HAVE NOW REVERSED:
With market activity working with the downside price move to confirm the bearish set-up, market activity and current sentiment suggest perception of the next catalyst has the ability to induce outsized moves in either direction.
Data showing the net positions from money managers reveals open interest is at a 7-week high:
The market as a whole is shorter as evidenced by the commitments of traders reports released Friday by the CFTC, but the speculative positions by large money managers is increasing. At the same time, volatility is being sold for less than its trailing averages. When this occurs, the probability increases for price movements that test critical capitulation levels compresses. The expectation for less volatility with larger, speculative size behind a market is the perfect set-up for more volatility on a catalyst.
While copper is down -10% on the year, we believe a cyclical downtrend has much farther to run over the next few years.
Please see the links below for two previous notes outlining the fundamental headwinds that will continue pressuring copper prices over the intermediate to long-term. We’ll follow-up with additional data supporting the call in the coming weeks. At the time of publication of these two notes, copper was in a BULLISH TREND set-up making the fundamental picture look obsolete.
The first note outlines China’s share of global base metals demand and proceeds to outline how the expectation for over-extended demand growth looks unsustainable from here.
Highlights from the Note:
- Nickel: 47.4%
- Aluminum: 46.1%
- Zinc: 45.6%
- Copper: 42.4%
In the following update at the end of August, copper was on the verge of breaking down. We highlighted Jakarta’s reversal to its copper bauxite export ban put in place in January. While Indonesia isn’t near the top of copper producing countries, China’s move to diversify supply lines elsewhere, and Indonesia’s mid-year lift on the ban will add to what we see as an excess amount of supply coming on over the next few years.
The following quote from the note highlights our conclusions:
“We will be watching the following factors in the coming weeks for a read-through on the supply outlook:
1) Chinese economic outlook takes a more definitive turn positive or negative
2) The Indonesian copper bauxite export picture reaches a long-term resolution
3) Continued confirmation in a late-cycle mining cap-ex push from the largest miners
4) A continued positive Trend for the USD
With these fundamental factors in play, copper may be interesting on the short-side if our @Hedgeye $3.16 TREND line breaks and confirms.”
This TREND Line of support did in fact break, and to re-iterate, copper is now BEARISH from an intermediate-term TREND perspective with $3.16 now a RESISTANCE level. With the quant now agreeing with the fundamental picture, we will look to short copper on the oversold risk management signals.
Please reach out with any comments or questions.