“See your disappointments as good fortune – one plan’s deflation is another’s inflation.”
After another tough week of #bubbles popping in the US stock market, there was some good fortune in being long bonds!
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%
WTIC Oil 89.13-93.14
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
This note was originally published at 8am on September 22, 2014 for Hedgeye subscribers.
“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
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:
- Long-Term Treasuries
- 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:
- US Healthcare Stocks (XLV) +1.7% on the week to +17% YTD
- 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:
- European Stocks (EuroStoxx 600) +1.2% on the week to +6.2% YTD
- 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%
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
the macro show
what smart investors watch to win
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: 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. In today’s edition, we highlight:
- Why investors should be raising cash
- For those investors who must remain fully invested, we highlight the rotation within Fixed Income & Yield Chasing to demonstrate how an investor may tilt their book in a defensive manner in preparation for continued #Quad4 deflation
Best of luck out there,
Associate: Macro Team
Takeaway: The intermediate term trends remain mostly red (2 to 1) across the host of systemic risk factors we track.
Current Best Ideas:
Last week we flagged a broader trend of rising risk across the Financials complex. There were 3 things that caught our eye. The first was high yield rates rising 36 bps w/w. The second was EU financial CDS widening sharply, especially in Russia. The third was the increase in domestic financial CDS, where 27 of 27 reference entities we track were higher w/w. This week, high yield has calmed down (-28 bps w/w), but remains higher on the month by 34 bps. EU financial CDS was unchanged on the week, but remains higher on the month. US financial CDS was actually better on the week (-3 bps), but remains +6 bps on the month.
Financial Risk Monitor Summary
• Short-term(WoW): Positive / 5 of 12 improved / 1 out of 12 worsened / 6 of 12 unchanged
• Intermediate-term(WoW): Negative / 3 of 12 improved / 6 out of 12 worsened / 3 of 12 unchanged
• Long-term(WoW): Negative / 2 of 12 improved / 3 out of 12 worsened / 7 of 12 unchanged
1. U.S. Financial CDS - Swaps tightened for 25 out of 27 domestic financial institutions. The US global banks were tighter by an average of 3 bps with JPM leading the way at -5 bps. In the consumer finance space, MTG & RDN were lower by 19 and 26 bps, respectively.
Tightened the most WoW: ALL, RDN, AXP
Widened the most/ tightened the least WoW: CB, TRV, AON
Widened the least/ tightened the most WoW: MMC, LNC, HIG
Widened the most MoM: AGO, SLM, COF
2. European Financial CDS - Swaps were mixed in Europe last week, but little changed overall. We've been keeping a close eye on Sberbank as our proxy for overall geopolitical risk. After rising steadily for several weeks, it cooled off notably this past week dropping 65 bps w/w to 315 bps.
3. Asian Financial CDS - Indian bank swaps tightened notably, while Japan and China were little changed.
4. Sovereign CDS – Sovereign swaps were little changed on the week with most countries moving 0-1 bps. Portugal and Japan were the outliers at +3 bps each.
5. High Yield (YTM) Monitor – High Yield rates fell 27.6 bps last week, ending the week at 5.95% versus 6.23% the prior week.
6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 2.0 points last week, ending at 1866.
7. TED Spread Monitor – The TED spread rose 0.3 basis points last week, ending the week at 22.3 bps this week versus last week’s print of 22.0 bps.
8. CRB Commodity Price Index – The CRB index fell -1.4%, ending the week at 276 versus 280 the prior week. As compared with the prior month, commodity prices have decreased -4.3% We generally regard changes in commodity prices on the margin as having meaningful consumption implications.
9. Euribor-OIS Spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States. Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal. By contrast, the Euribor rate is the rate offered for unsecured interbank lending. Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread tightened by 2 bps to 11 bps.
10. Chinese Interbank Rate (Shifon Index) – The Shifon Index fell 15 basis points last week, ending the week at 2.53% versus last week’s print of 2.68%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.
11. Chinese Steel – Steel prices in China rose 0.2% last week, or 7 yuan/ton, to 2917 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.
12. 2-10 Spread – Last week the 2-10 spread tightened to 188 bps, -8 bps tighter than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.
13. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 1.5% upside to TRADE resistance and 0.4% downside to TRADE support.
Joshua Steiner, CFA
Jonathan Casteleyn, CFA, CMT
Takeaway: Current Investing Ideas: EDV, FXB, GLD, LM, OC, OZM, RH, TLT and XLP.
Below are Hedgeye analysts’ latest updates on our nine current high-conviction long investing ideas and CEO Keith McCullough’s updated levels for each.
*Please note that we removed HCA Holdings (HCA) this week after a 72% gain.
We also feature two institutional research notes which offer valuable insight into the markets and economy.
Trade :: Trend :: Tail Process - These are three durations over which we analyze investment ideas and themes. Hedgeye has created a process as a way of characterizing our investment ideas and their risk profiles, to fit the investing strategies and preferences of our subscribers.
- "Trade" is a duration of 3 weeks or less
- "Trend" is a duration of 3 months or more
- "Tail" is a duration of 3 years or less
CARTOON OF THE WEEK
TLT | EDV | XLP
Yet another solid week for our recommended non-consensus slow-growth, yield-chasing trade (WoW performance):
- TLT +1.4%
- EDV +2.4%
- XLP +0.6%
With the Russell 2000 down a full percent on the week, the market is clearly having a vote of no-confidence for consensus GDP estimates of +3%, per quarter, as far as the eye can see.
Perhaps that’s because growth slowed, on the margin. Again. In fact, the Bloomberg US Economic Surprise Index actually dropped -45% WoW.
While the actual rate-of-change in the economic data was not nearly as dour, there were a number of key #GrowthSlowing data points that were supportive of our fundamental view:
- Pending Home Sales: -4.1% YoY in AUG from -2.8% in JUL
- Case-Shiller Home Price Index: 6.8% YoY in JUL from 8.1% in JUN
- ISM Manufacturing PMI: 56.6 in SEP from 59 in AUG
- Markit Manufacturing PMI: 57.5 in SEP from 57.9 in AUG
- Construction Spending: 5% YoY in AUG from 6.9% in JUL
- ISM Non-Manufacturing PMI: 58.6 in SEP from 59.6 in AUG
- Markit US Services PMI: 58.9 in SEP from 59.5 in AUG
Now to be fair, PCE (AUG), Initial Jobless Claims and the Jobs Report (SEP) were quite good. In fact, the data was actually really good (per our US macro analyst Christian Drake):
- “Consumer Spending accelerates as income growth remains strong and savings rate declines modestly from 18-month high. This month we saw income growth hold just under last month’s highs but the savings rate ticked down, allowing consumption growth to accelerate. Spending improved across services, non-durables and durables, with durables again leading the pack.”
- “Solid Report overall with private payrolls leading the gains (236k of the 248k). Growth accelerated in September on both a 1Y and 2Y basis across NFP & Private payrolls. The net two-month revision was +69k, which was not surprising. Looking back at historical revision trends August is almost always revised higher & generally with one of the largest magnitudes of any month. The unemployment rate gets a 5-handle as the LFPR ticks down again to another new multi-decade low.”
- “The initial jobless claims data this morning is reasonably strong. SA rolling claims continue to trend lower, coming in just under 295k this week. The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -6.5% lower YoY, which is a sequential improvement versus the previous week's YoY change of -5.9%We're 7 months into the sub-330k claims environment. The last 2 cycles lasted 31 (2007) and 45 (2000) months before the market top.”
So net-net, there’s some good data and there’s some bad data. The problem with the good data is that the market appears to effectively pricing in its inevitable crescendo. And as long as it’s doing that, we’ll stick with what’s worked all year: long-duration paper and stocks that look like bonds.
We’ve been offsides on our position in recent weeks, however resilient fundamentals continue to support our positioning and we view BOE policy (expectations around a rate hike) as hawkish compared to dovish intentions of the Fed and ECB. For the week the GDP/USD was down -1.2%.
That said, the GBP/USD intermediate term TREND of $1.62 has been under attack, and the British have done little to support it. We’re sticking with the position (strong UK = strong Pound) and watching to see if/how the Fed acts to devalues the USD. We expect any shift in stance could show a strong mean reversion in the cross.
This week we got a mix of data out of the UK that weighed on the cross:
- Q2 Final GDP Q/Q revised up 10bps to 0.9%
- UK Construction PMI 64.2 SEPT (exp. 63.5) vs 64.0 AUG
- Lloyds Business Barometer 57 SEPT vs 47 AUG
- UK Services PMI 58.7 SEPT (exp. 59.0) vs 60.5 AUG
- UK Composite PMI 57.4 SEPT (exp. 58.2) vs 59.3 AUG
- UK GfK Consumer Confidence -1 SEPT (exp. 0) vs 1 AUG
BOE Minutes continue to show 2 votes (out of 9) to increase interest rates (by 25bps) from the Governing Council. We expect this marginally more hawkish tone taken together with the outperformance of UK growth over the US and Eurozone in 2014 to push the GBP/USD higher over the intermediate term.
We bought Gold on the oversold signal Friday morning after a pop in the ten-year yield and a big move in the dollar. Is the economy back after a slight beat from the jobless claims report (post-revision) as seen from the lens of the fed regime? We don’t believe so. Nor do we believe it makes for a material data point supporting the committee’s decision to taper.
Draghi has successfully induced a -10% devaluation in the Euro since his first round of rate cutting in the middle of Q2. With growth in the U.S. and European economies slowing at the same time, his relative dovishness has been a tailwind for the dollar (and thus bearish for Gold). A flattening in the yield curve confirms the disbelief around a sustainable growth outlook domestically (10-year yield -7bps week-over-week).
With that being said, our gold position has held strong to the negative correlations inherent in the expectation for the USD. With this summer’s FX move being the largest since 1997, gold in and of itself has been a losing trade.
The ECB’s implementation of rate cut on two separate occasions and the herd mentality increasingly positioning for a fed taper into the end of the year have perpetuated the USD strength. Tactical currency exposure in front of centrally-planned policy decisions makes this game more difficult than ever:
Since the May 6th highs in the Euro:
- EUR/USD: -10.2%
- Gold: -9.0%
- USD: +9.6%
Embedded in this move is correlation risk. It is our view that Draghi in a smaller box at this point whereas Yellen has more flexibility in moving incrementally dovish from here. When she does, we want to have an allocation to Gold.
Shares of Legg Mason continue to perform well up over 18% in 2014 however the story has received a shot in the arm as of late. With last week’s news that leading bond fund manager Bill Gross has left PIMCO, reports of substantial redemptions at Gross’ former shop have been reported with the rest of the large bond fund platform’s likely large beneficiaries.
While PIMCO had already been struggling with over $60 billion in redemptions over the past 18 months, a reported additional $23 billion has been pulled from the platform just this week according to various media outlets. While it is not completely a zero sum game (with PIMCO’s loss someone else’s gain), there is reason to believe that the other major fixed income platforms on the Street will mop up these outflows.
Legg Mason (LM), Blackrock (BLK), and the private Doubleline funds all have strong existing franchises with strong performance that would be a natural destination for these PIMCO funds in dislocation. While LM and BLK have not commented on the environment over the past 10 days, the private Doubleline has mentioned collecting over $500 million in a single day last week as investors exited PIMCO.
This was not a situation we had modeled for in our recommendation of LM shares, however the company will be a beneficiary of a PIMCO in donor mode.
This week U.S. construction spending came in for August with both Nonresidential and Residential spending easing. Private construction spending for residential home improvement disappointed again. Lack of significant storm activity such as hailstorms and hurricanes are helping keep improvement spending levels depressed.
Next week, our industrial’s team will host an update call on pricing in the asphalt roof shingle market, on Tuesday October 7. If recent price increases in this market hold, we believe it would remove a key overhang from OC shares.
Och-Ziff remains on our Investing Ideas list as shares are currently trading at a negative multiple of its incentive fee earnings, a situation that last came about in 2011 when shares were just $7. We arrive at this negative multiple when we apply a traditional asset management earnings multiple of 15.9x to the firm's core asset management earnings of near $0.76 per share which would imply a stock value of $12 per share.
Thus with the current stock value at $11, or $1 per share below its "traditional" implied value, the running incentive fees per share earnings of $0.24 implies a new all time low multiple on this earnings stream.
The average incentive fee multiple for OZM shares since 2009 has been +3.7x providing solid upside when valuation improves. Thus if the firm can hang on to its running year-to-date positive performance, without additional negative regulatory news flow, that the stock should rally off of these depressed levels.
OZM shareholders are getting paid to wait for this situation to rectify itself with a dividend year of 7.3%, well above the average for the S&P 500’s yield of 2.1%.
Please click here to read Hedgeye retail sector head Brian McGough's note released on Friday "RH - Stealth revenue Driver."
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We believe the market is finally calling ECB President Mario Draghi’s bluff.
We believe prospects are rising for another leg down in consensus expectations for Chinese growth.
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