Takeaway: Peak Valuation + No Turnover = Window Down
“But pardon, gentles all…”
That’s from William Shakespeare’s Prologue to Henry V. It’s also the opening volley from a #history brick my wife gave me for Father’s Day (sorry, just digging into it now!) called The Guns At Last Light – The War in Western Europe 1.
While I think she sometimes thinks I’m at war with my keyboard in the early mornings, she puts up with my market life – and for that I am forever grateful. From my family to my friends at the firm, getting it done is an all-out team effort.
But whose team is The Bear on? While I received some kind emails while in London last week, I’m not sure that being right this time is a good thing. The #Quad4 Deflation is nastier than a gnarling grizzly. And I fear the war between inflated asset #Bubbles and gravity has just begun.
Back to the Global Macro Grind…
The thing about fear is that you need to accept it before you conquer it. Last week’s +46% move in the front-month fear (VIX) index to +54.8% YTD should help pave part of that path towards acceptance. But don’t forget that there’s a long way between denial (1st stage of grief), anger, bargaining, depression, and acceptance.
Maybe using the Five Stages of Grief is a little over the top for a Monday morning. Maybe not (especially if you are a NY Jets fan). Being bearish at 1208 on the Russell (all-time #Bubble high = July 7th) or during the Ali-Bubble (BABA) IPO day (September 19th) at SPX > 2011 wasn’t easy for me. The denial stage for the bulls was equally isolating for our bearish macro view.
So pardon, gentles all – isolation is often where the alpha lives. And we certainly hope you had the Long Bond (TLT) on versus the Russell 2000 (short side) as the performance divergence in being long #GrowthSlowing hit its widest for 2014 YTD (ex-reinvesting interest, TLT = +18.3% YTD vs Russell 2000 -9.5%).
In US Equity terms, here’s how the Def-#Quad4 Deflation looked last week:
- SP500 down -3.1% (down for the 3rd straight week) to +3.1% YTD
- Russell 2000 down -4.7% (down for the 6th straight week) to -9.5% YTD
- US Energy Stocks (XLE) down -5.2% to -5.6% YTD
- US Industrial Stocks (XLI) down -4.7% to -3.7% YTD
- US Consumer Staples (XLP) up +0.4% to +6.1% YTD
That’s right. In addition to the Long Bond (Treasuries), Munis, and Cash, we’ve noted in our most recent Macro Themes slide deck that Consumer Staples (XLP) is as good as any place to hide as the world clamors for low-beta-big-cap-liquidity.
Typically, when Correlation Risk (commodities trading inversely to USD) is this high, Down Dollar pays the commodity bulls. But last week, that was only true for pockets of the commodity complex (Oil was -4.4%). In addition to Gold +2.4% last week:
- Coffee was up another +6.7% to +83.5 % YTD
- Palladium was +4.0% to +8.7% YTD
- Cocoa was +3.3% to +16.4% YTD
But I am thinking there are more hedge funds who are still carry trading oil futures with a levered long bias than there are 2 and 20 alpha dogs who are long Cocoa on the #Ebola trade.
In fact, if you look at how hedge funds are positioned from a speculative net futures and options perspective:
- Crude Oil still has a net LONG position of +299,755 futures and options contracts (vs. 6 month avg of +385,000)
- US 10yr Treasury still has a net SHORT position of -51,954 contracts (vs. 6 month avg of -15,000)
- SP500 (Index +E-mini) has a net LONG position of +48,616 contracts (vs. 6 month avg of -41,000)
We’re obviously on the other side of every one of these Consensus Macro positions (bearish on Oil, bullish on Treasuries, bearish on SPX), so it was a good week. But the bigger question is where do the US equity bulls (and Treasury bears) go from here?
Within the small cap US equity #Bubble, there are a whole bunch of #bubbles we highlighted on our Q4 Macro Themes call (ping if you want the replay). And some of them play right into hedge fund consensus:
- Complacency #Bubble (slide 44)
- Levered Beta Chasing #Bubble (slide 45)
- Leveraged Speculation #Bubble (slide 46)
We can do a conference call with you to review all of these #bubbles, but the #Complacency one is really easy to show in terms of the number of days where the SP500 has had a > 1% move. After hitting an all-time YTD low, we just had 4 of those days, in a row!
Sure, markets scare people when they do that. I think I scared the hell out of some Institutional Investors in London with some of these slides too. Coming off the all-time lows in complacency, there’s never been this level of #VolatilityAsymmetry, ever.
While never-ever is a very long time – and I certainly don’t mean to be mean (or scare people) - I’d appreciate it if you took it easy on my inbox. My wife thinks of me as a cuddly Thunder Bay Bear, so be gentle with me.
Our immediate-term Global Macro Risk Ranges are now:
WTI Oil 83.99-88.64
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.
Takeaway: Current Investing Ideas: EDV, GLD, LM, OC, RH, TLT and XLP.
Below are Hedgeye analysts’ latest updates on our seven current high-conviction long investing ideas and CEO Keith McCullough’s updated levels for each.
*Please note that we removed the British Pound (via the etf FXB) and Och-Ziff Capital Management Group (OZM) this week from our Investing Ideas list.
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
Small caps. Tech stocks. IPOs. And more. There are bubbles everywhere, and it’s why #Bubbles is one of Hedgeye’s three core Macro Themes this quarter.
TLT | EDV | XLP
Per Google Translate, the title of this note means, “show me the money!” in French. Why French? Because it is the language of love. And we love helping you make money…
Indeed, the week ended October 10th, 2014 was another great week for the slow-growth, yield-chasing trade we’ve been ardently advocating all year. To recap weekly performance:
- iShares 20+ Year Treasury Bond ETF (TLT): +2.0%
- Vanguard Extended Duration Treasury Bond ETF (EDV): +2.56%
- Consumer Staples Select Sector SPDR (XLP): +0.37%
Those performance figures represent material outperformance when benchmarked against traditional equity exposures like the S&P 500 (SPY) or Russell 2000 (IWM), which were down -3.04% WoW and -4.48% WoW, respectively.
Moreover, the widening spread of relative performance over the past month is supported by our view that both domestic and global economic growth is slowing.
- iShares 20+ Year Treasury Bond ETF (TLT): +4.3% MoM
- Vanguard Extended Duration Treasury Bond ETF (EDV): +5.86% MoM
- Consumer Staples Select Sector SPDR (XLP): +0.57% MoM
- SPDR S&P 500 Trust (SPY): -4.76% MoM
- iShares Russell 2000 ETF (IWM): -9.60% MoM
There wasn’t really any meaningful domestic economic data to anchor on this week. In spite of this lack of data, global financial markets managed to go completely haywire on the Fed reminding everyone exactly what we’ve been forewarning all year:
US real GDP growth is unlikely to come in anywhere in the area code of consensus projections of 3-plus percent.
To recap the decidedly dovish minutes from the FOMC’s September 16-17th meeting:
- The minutes highlighted risks to the US economy and domestic inflation expectations from sluggish global growth and a stronger US dollar.
- The minutes suggested that the “considerable time” forward guidance and “significant underutilization of labor market resources” language may remain in the October FOMC statement.
- The minutes suggested that any changes to the board’s current guidance will present communication challenges and that caution would be required to avid an unintended tightening of financial conditions.
- Lastly, the minutes also downplayed concerns about potential risks to financial stability, which effectively means the Fed would be slow to react, if at all, to bubbly valuations in either the credit and/or equity markets with a less accommodative policy mix.
It is clear to us that market participants – many of whom have been anchoring on the Fed (which itself has a terrible track record at forecasting the economy) to guide their asset allocation all year – are interpreting the Fed’s dovish shift as signaling cause for concern with respect to the growth outlook. They should.
All told, we continue to think long-term interest rates are headed in the direction of both reported growth and growth expectations – i.e. lower. In light of that, we encourage you to remain long of the long bond.
Stick with the playbook. The USD-monetary policy hedge that is gold loves surprisingly dovish statements from FOMC members. We continue to lean on our internal model for predicting the change in the slope of 1) growth and 2) inflation, and the third part of the model is a policy input.
We’ve hammered this point all year with regard to our gold position, but the policy response from today’s central bankers has been one of the most predictable inputs into the model.
When growth and inflation are decelerating and consensus positioning suggests that growth will surprise to the downside, the monetary response will take a relatively dovish turn.
While Draghi was successful in taking down the Euro over Q2/Q3, the Federal Reserve will be dovish at the same time. Gold remains neutral from an intermediate-term TREND duration and will catch a bid on each incrementally dovish statement pressuring the outlook for the dollar.
Yellen’s commentary Wednesday on the minutes from the September 16th-17th Fed meeting indicated the global economy was weaker than expected and that policy members were worried that “FURTHER GAINS IN THE DOLLAR COULD HURT EXPORTS AND DAMP INFLATION.”
- The 10-yr yield tightened (Bonds rallied)
- The USD closed RED on the day after being in positive territory right before Yellen’s speech (-46bps)
- GOLD followed up Thursday with a +1.6% rally
Legg Mason (LM) continues to surprise to the upside with results above Street expectations. During the most recent week, the company posted its monthly assets-under-management report with the strongest results in six months. In aggregate LM posted net new asset growth of $11.4 billion in September with all 3 of its major segments posting gains. While the company posted net new inflow of $800 million within its leading bond franchise and $8.8 billion within its money fund business, most impressive was the $1.8 billion inflow within its equity franchise.
While we continue to recommend a long position in Legg Mason on its underappreciated bond business, if the high margin equity franchise starts to generate above average results, our estimates could be too conservative leading to further upside. We currently estimate fair value on LM stock at $57-58 per share but if the Legg equity segment continues its recent trend line our estimates will prove too conservative.
Earlier this week we hosted a follow-up call on the roofing market’s pricing and the current environment with Bill Carlin. Bill has over 36 years experience in the industry and previously held executive positions in OC’s roofing business.
Bill noted a more stable pricing environment for asphalt roof shingles, a significant improvement from year-on-year price declines in 2Q and most of 3Q 2014. Following OC’s poorly explained lack of pricing discipline in late 2013, prices and margins suffered.
The industry offers little fixed cost leverage, limiting the competitive benefits of seeking volume and market share over price (>80% non-variable cost). As long as competitors respect the value of oligopolistic pricing over market share, the industry should remain reasonably profitable.
The September 2014 price increase appears to be holding so far, transferring some pain to distributors. Unfortunately, high inventories across the channel may limit the 4Q benefit of better pricing. The survival of the price increase is a key issue for OC investors to track.
Sentiment around RH ticked up slightly over the last month, which is largely due to an 8% reduction in short interest for the month. That’s not a major surprise in light of CEO Gary Friedman’s $2mm open market stock purchase, which sent a powerful signal to the market.
All that said, 28.6% of the RH float is currently held short. To put that into context, JC Penney, which one might think sets the standard for ‘investor hatred’ is sitting right at 29%. By comparison, Williams-Sonoma is at 6.8%, Macy’s is 3.1%, and Nike is 0.9%.
We think the fundamental story will play out in a way that will prove today’s short interest levels to never be retested.
* * * * * * * * * *
Click on each title below to unlock the content.
The most recent ICI fund flow survey rounded out the worst quarter for equity funds since 4Q 2012 and also reflected the dislocation at PIMCO.
Semiconductor Downcycle Confirmed by MCHP; All Chip Firms to be Impacted over the course of a couple quarters.
Takeaway: Here's a quick look at some of the top videos, cartoons, market insights and more from Hedgeye this past week.
McCullough: Russell 2000 Is "Definitive Bubble"
In this brief excerpt from Friday's Morning Macro Call, Hedgeye CEO Keith McCullough reiterates his opinion that small cap stocks are in a bubble.
Semi Stocks Facing Risks?
Hedgeye semiconductor analyst Craig Berger discusses a weak pre-announcement from one company in the sector and looks at growing risks for other names in the chip space.
We caught up with Hedgeye CEO Keith McCullough in between investor meetings in London. Keith tells us what’s on the minds of those investors.
Hedgeye + $TLT = LOVE
As the 10-year yield drops back below 2.40%, we reiterate our non-consensus, best macro long idea of the year: Long the Long Bond.
Beware of #QUAD4
Hedgeye's Macro Team, led by CEO Keith McCullough recently hosted its quarterly Macro Themes conference call in which it detailed the THREE MOST IMPORTANT MACRO TRENDS it has identified for 4Q14 and the associated investment implications. At the top of the list is #Quad4. Our models are forecasting a continued slowing in the pace of domestic economic growth, as well as a further deceleration in inflation here in Q4. The confluence of these two events is likely to perpetuate a rise in volatility across asset classes as broad-based expectations for a robust economic recovery and tighter monetary policy are met with bearish data that is counter to the consensus narrative.
Deflating #BUBBLES in #QUAD4
Exorbitant Privilege (Fed Remittances to the U.S. Treasury)
Energy Price Sensitivity (Wildcatters Energy E&P Index)
As you can see in today’s chart, the Thomson Reuters Wildcatter’s Index (small and mid-cap E&Ps) has retreated -33% from its June YTD highs. If you top-ticked that move, it was the same day you shorted oil at the 2014 highs.
POLL OF THE DAY
With WTI crude oil prices trading around $90/barrel, we wanted to know what’s the likeliest next stop?
daily macro intelligence
Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.