Deflation's Good Fortune

“See your disappointments as good fortune – one plan’s deflation is another’s inflation.”

-Jean Cocteau


After another tough week of #bubbles popping in the US stock market, there was some good fortune in being long bonds!

Deflation's Good Fortune - Super TLT cartoon 10 01 2014


Back to the Global Macro Grind…


Golf clap for the no-volume bounce to lower-highs in US Equities on Friday. Is it just me, or was there some irony in the US government printing a rosy picture of jobs in America on the last employment report before the mid-term elections?


The thing about conspiracy theories is that sometimes they are true. Regardless, the lagging of lagging economic indicators (the US unemployment rate) can now only go one way from here – up. That’s a good thing, if you are long the long end of the bond market.


With mostly everything Global Equities and Commodities deflating last week, here’s what long-term Treasuries looked like:


1. US Treasury 10yr yield down another -9 basis points week-over-week

2. US Treasury 10yr yield now down -59 basis points, or -19.5%, for 2014 YTD

3. Total Return of the iShares 20yr Bond Fund (TLT) +18% (vs. Russell 2000 -5.1% YTD)


The other disappointing thing that happens when the long-end of the curve (bond yields) falls is that this thing called the Yield Spread compresses. Yield Spread is the long end of the curve (10yr yield) minus the short-end (2yr yield). That compressed another 8 basis points to +188bps wide (-77 basis points YTD).


Both Yield Spread and the Long-end of The Curve are leading indicators for the rate of change in US economic growth. Whereas things like non-farm payrolls and the unemployment rate are what we call lagging indicators.


“So”, if you’re a cyclical investor like me, you want to be shorting what we call “early cycle slowdown” (and/or #bubble) stocks and commodities at the end of an economic cycle (i.e. when the lagging indicators look good). And you want to be re-allocating your capital to cash and bonds all the while.


Back to the deflations in stocks last week – it was a global affair:


1. Russell 2000 deflated for the 5th week in a row, -1.3% to -5.1% YTD

2. SP500 deflated for the 2nd week in a row, -0.8% to +6.5% YTD

3. European stocks (EuroStoxx600) were down another -2.1% to +2.1% YTD

4. Emerging Market Equities (MSCI) were -2.6% to down -0.5% YTD

5. Russian stocks continued to crash, -5.5% on the week to -24.3% YTD


I know – what could possibly go wrong…


If we look one layer underneath the crust of the US equity market selloff, in S&P Sector Style terms here’s what happened:


1. Energy stocks (XLE) got slammed another -4.1% on the week to DOWN now for the YTD (-0.4%)

2. Basic Material stocks (XLB) deflated -3.9% on the week to +4.8% YTD

3. Consumer Staples stocks (XLP) outperformed, closing +0.8% on the week to +5.7% YTD


Unlike the first half of 2014 (when the Hedgeye GIP Model had us in #Quad3, where inflation was accelerating and growth slowing), the 2nd half has us in #Quad4 where both growth and inflation are slowing. That’s bad for commodities and their commodity linked equities and good for Consumer Staples.


With the US Dollar up another +1.2% last week, here’s what happened to commodities:


1. CRB Commodities Index -1.4% on the week to down that much now for the YTD

2. Oil (WTI crude) was down -4.1% on the week to -3.9% YTD

3. Gold dropped another -1.9% on the week to -1.1% YTD


No, being long Gold isn’t as bad as being long the small cap US equity #bubble. But it was deflating nevertheless.


The thing about the deflation becoming a good thing for the consumer spirit inflating is that it comes on a lag too. Coffee and cattle prices were up +11% and +4%, respectively, last week (they’re +72% and +43% YTD, respectively!) so don’t expect to get a price cut at Starbucks or Chipotle any time soon.


Fully loaded with rent at all time highs (anyone get a rent reduction due to REIT deflation last week?) and real wages sucking wind (oh, that was in the jobs report too), that’s the real problem with US GDP – almost 2/3 of the country is already in an early cycle recession.


But both the Russell and the 10yr UST yield already signaled that to you, so you don’t have to be disappointed. This is our market life. It’s cyclical too. And our good fortunes are best inflated by allowing markets to help us looking forward, not in the rear-view.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.39-2.50%


RUT 1081-1132

DAX 9181-9489

VIX 13.34-17.31

USD 84.71-86.89

EUR/USD 1.25-1.28

Pound 1.59-1.62

WTIC Oil 89.13-93.14

NatGas 3.81-4.19

Gold 1185-1235

Copper 2.98-3.06


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


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