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Legislating Deflation?

This note was originally published at 8am on September 29, 2014 for Hedgeye subscribers.

“There are far too many great men in the world; there are too many legislators.”

-Bastiat

 

Today in 1789, the 1st United States Congress adjourned. There were no political parties in Congress back then. Members of US Congress were grouped (informally) according to their voting records. There was at least some peer review and accountability in that.

 

As far as who was a “great” man back then, I personally can’t tell you for sure. My only certainty is that the more I try to understand #history through the lenses of different perspectives (books), the less I know.

 

I can tell you with 100% certainty that, of all the great men and women I know, not one is a legislator. The thing about great leaders is that they embrace their own imperfections and rarely feel certain about anything. Find me that in today’s political media and I will happily reconsider. Sadly, the deflation of my expectations continues to accelerate on that front.

 

Legislating Deflation? - founding fathers

 

Back to the Global Macro Grind

 

Deflation and depression aren’t cool feelings. I guess that’s why the Bush/Obama politicians who perpetuated the most recent decade of US economic growth surprising on the downside call the recession a #Great one.

 

There’s always spin from political incumbents who aren’t telling you the truth about economics.  The Federal Reserve is going to be spinning its wheels with a conflicted “World Economic Think Tank” from Germany called the Kiel Institute this week.

 

Their topic: “The Labor Market After The Great Recession.” Their problem: that both the US and Germany may very well be entering their next recessions. Yep. So let’s make sure US legislators get told what to do by left-leaning German states in preparation for that…

 

Deflated yet?

 

Back to real world leading economic indicators in Global Equity markets, here’s what happened last week:

 

  1. The illiquid small-cap #bubble component of the US stock market continued to deflate
  2. The Russell 2000 was down another -2.4% on the week and is now down for 4 consecutive weeks
  3. The more liquid (and “cheaper”) Dow and SP500 were down -1.0% and -1.4%, respectively
  4. US Industrial Stocks (XLI) led losers, falling -2.1% on the week and have lagged for the last 3 months
  5. REITS (MSCI Index) corrected another -1.9% as deflation in real estate prices continues in #Quad4
  6. Emerging Markets deflated another -2.7% and -4.2% on the wk for the MSCI EM and LATAM indexes, respectively

 

In what we call FICC (Fixed Income, Currencies, and Commodities), here’s what Mr. Macro Market said last week:

 

  1. Draghi’s (un-elected) Devalued Euro move continues with the EUR/USD down another -1.1% on the week
  2. US Dollar Index added to its most deflationary move since 1997, closing up the same that the Euro was down
  3. Canadian Dollars dropped -1.7% in kind, and the Japanese Yen fell another -0.2% on the week to $109.29 vs USD
  4. Commodities (CRB) Index held the 280 line (where it started 2014), closing +0.3% on the week
  5. Gold and Copper were +0.1% and -3.7% on the week, respectively (YTD: Gold +1% vs Copper -10%)
  6. UST 10yr Bond Yield dropped another -5 bps to 2.53%, down -17% YTD (or down 50bps)

 

That last thing (10yr yield falling) is one thing that the perma-US-growth-bulls have had a very hard time explaining (especially overlayed with the Russell). Since US #history tells you that falling bond yields are never a sign of accelerating growth, that’s for good reason.

 

Much like the politically partisan, perma-growth-bulls are very good at seeking data that confirms their bullish biases. Instead of talking about early cycle-stocks like Housing (ITB), Regional Banks (KRE), and Consumer Discretionary (XLY) being down for 2014 YTD, they’re now all experts on #Strong Dollar and “falling oil prices” (even though WTI crude was +2% last week to flat on the YTD).

 

I like #StrongDollar, but only as a leading indicator of US economic #GrowthAccelerating when long-term interest rates are RISING at the same time. Let me write that one more time in these terms: Dollar Up, Rates Up = Hedgeye Bullish On Growth!

 

That, of course, was why we loved US growth stocks in 2013 and had an equal amount of joy shorting the US bond market. This year, being the only decisively bi-partisan bull/bear risk managers you pay, we have had precisely the opposite position.

 

I’ll go through the why on Dollar Up, Rates Down (it’s called #Quad4 deflation) on our Q4 Global Macro Themes call this Thursday afternoon at 1PM EST. Institutional Investors, please ping sales@Hedgeye.com for access.

 

I’d like to extend an invite to any Member of The 113th US Congress who would like to learn something about where economic risks are going (rather than where they’ve been). I don’t hang with them, so I’d appreciate it if you passed it along to your local central planner.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.48-2.58%

SPX 1962-1994

RUT 1100-1136

VIX 13.53-16.13

EUR/USD 1.26-1.29

Gold 1209-1249

 

Best of luck out there this week,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Legislating Deflation? - 09.29.15 USD vs. 10 Yr


October 13, 2014

October 13, 2014 - Slide1

 

BULLISH TRENDS

October 13, 2014 - Slide2

October 13, 2014 - Slide3

 

BEARISH TRENDS

October 13, 2014 - Slide4

October 13, 2014 - Slide5

October 13, 2014 - Slide6 

October 13, 2014 - Slide7

October 13, 2014 - Slide8

October 13, 2014 - Slide9

October 13, 2014 - Slide10

October 13, 2014 - Slide11
October 13, 2014 - Slide12


VIX, Oil and Gold

Client Talking Points

VIX

The front month fear has crashed to the upside (doubling since the Russell topped July 7th), closing +46% last week to +54.8% VIX year-to-date; immediate-term TRADE overbought within a risk range of 16.85-21.67, so U.S. stocks should bounce.

OIL

Oil is not bouncing; after ramming the rocks of #Quad4 deflation (-4.4% last week), WTI is down another -1.9% this morning and this is starting to get gnarly for both spec and low-quality small/mid cap stocks (and bonds) across the energy complex.

GOLD

Not the best place to be in #Quad4 (the Long Bond and Cash are), but definitely not the worst either – after closing +2.4% last week, Gold is +0.5% to $1230; +2% year-to-date vs. the Russell 2000 -9.5%; Dollar Down helping today.

Asset Allocation

CASH 70% US EQUITIES 0%
INTL EQUITIES 6% COMMODITIES 2%
FIXED INCOME 22% INTL CURRENCIES 0%

Top Long Ideas

Company Ticker Sector Duration
EDV

The Vanguard Extended Duration Treasury (EDV) is an extended duration ETF (20-30yr). Now that we have our first set of late-cycle economic indicators slowing in rate of change terms (ADP numbers and the NFP number), it's time to really think through the upcoming moves of this bond market. We are doubling down on our biggest macro call of 2014 - that U.S. growth would slow and bond yields fall in kind.

TLT

Fixed income continues to be our favorite asset class, so it should come as no surprise to see us rotate into the Shares 20+ Year Treasury Bond Fund (TLT) on the long side. In conjunction with our #Q3Slowing macro theme, we think the slope of domestic economic growth is poised to roll over here in the third quarter. In the context of what may be flat-to-decelerating reported inflation, we think the performance divergence between Treasuries, stocks and commodities may actually be set to widen over the next two to three months. This view remains counter to consensus expectations, which is additive to our already-high conviction level in this position.  Fade consensus on bonds – especially as growth slows. As it’s done for multiple generations, the 10Y Treasury Yield continues to track the slope of domestic economic growth like a glove.

RH

Restoration Hardware remains our Retail Team’s highest-conviction long idea. We think that most parts of the thesis are at least acknowledged by the market (category growth, real estate expansion), but people are absolutely missing how all the pieces are coming together to drive such outsized earnings growth over an extremely long duration. The punchline of our real estate analysis is that a) RH stores could get far bigger than even the RH bulls seem to think, b) Aside from reconfiguring 66 existing markets, there’s another 19 markets we identified where the spending rate on home furnishings by people making over $100k in income suggests that RH should expand to these markets with Design Galleries, and c) the availability and economics on large properties for all these markets are far better than people think. The consensus is looking for long-term earnings growth of 28% -- we’re looking for 45%.  

Three for the Road

TWEET OF THE DAY

GERMANY: DAX +0.3% to -7.8% YTD #EuropeSlowing

@KeithMcCullough

QUOTE OF THE DAY

You may have to fight a battle more than once to win it.

-Margaret Thatcher

STAT OF THE DAY

We 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 year-to-date, ex-reinvesting interest, TLT = +18.3% year-to-date vs. Russell 2000 -9.5%.

 


Early Look

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.

THE HEDGEYE MACRO PLAYBOOK

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:

 

  1. The importance of raising cash or being #antifragile (i.e. long of volatility) amid #Quad4 asset price deflation
  2. Why a dovish Fed is more likely to spook investors, rather than encourage more passive, levered-long beta chasing
  3. How the broad-based weakness across global macro did exactly what we said it would eventually do: spill over into U.S. equities, which are now broadly breaking down across sectors and style factors
  4. Why the financials – both moneycenters and regional banks – are a good short here

 

Best of luck out there,

 

Darius Dale

Associate: Macro Team


CHART OF THE DAY: Small Cap Illiquidity #Bubble $IWM

Takeaway: Peak Valuation + No Turnover = Window Down

 

CHART OF THE DAY: Small Cap Illiquidity #Bubble $IWM - Chart of the Day


Pardon The Bear

“But pardon, gentles all…”

-Shakespeare

 

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 LightThe 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.

Pardon The Bear - Bubble bear cartoon 09.26.2014

 

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:

 

  1. SP500 down -3.1% (down for the 3rd straight week) to +3.1% YTD
  2. Russell 2000 down -4.7% (down for the 6th straight week) to -9.5% YTD
  3. US Energy Stocks (XLE) down -5.2% to -5.6% YTD
  4. US Industrial Stocks (XLI) down -4.7% to -3.7% YTD
  5. 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:

 

  1. Coffee was up another +6.7% to +83.5 % YTD
  2. Palladium was +4.0% to +8.7% YTD
  3. 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:

 

  1. Crude Oil still has a net LONG position of +299,755 futures and options contracts (vs. 6 month avg of +385,000)
  2. US 10yr Treasury still has a net SHORT position of -51,954 contracts (vs. 6 month avg of -15,000)
  3. 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:

 

  1. Complacency #Bubble (slide 44)
  2. Levered Beta Chasing #Bubble (slide 45)
  3. 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:

 

SPX 1

RUT 1037-1086

VIX 16.85-21.67

USD 85.07-86.67

WTI Oil 83.99-88.64

Gold 1

 

Best of luck out there this week,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Pardon The Bear - Chart of the Day


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