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THE HEDGEYE MACRO PLAYBOOK

Takeaway: Our Macro Playbook is a daily 1-page summary of our core ETF recommendations, investment themes and proprietary quantitative market context.

CLICK HERE to view the document. In today’s edition, we highlight:

 

  1. The persistence of #Quad4 deflationary pressures in the commodity complex and China's impact on this trend
  2. Why this is a GREAT spot to short U.S. equities 

 

Best of luck out there,

 

Darius Dale

Associate: Macro Team


Conflations and Incongruencies

This note was originally published at 8am on October 08, 2014 for Hedgeye subscribers.

“History is just one thing after another.”

 

I’m not sure who the attribution for the above quote goes to, but it does offer a nice little existential change of pace for the early AM global macro hombres.

 

The macro practitioners’ grind is just one data point and price tick after another.

 

If we’ve successfully employed our “communication tool” over the last six years, you’re gainfully aware that, at its core, our macro process operates as a hybrid model with our fundamental macroeconomic research dynamically informing our quantitative view of markets.

 

Reciprocally, as my colleague Darius Dale highlighted yesterday, we apply those top-down quantitative signals – which often front-run reported fundamental inflections - in a reflexive manner to our bottom-up qualitative analysis (e.g. our Growth/Inflation/Policy framework) in order to generate actionable investment ideas and themes.

 

Most of the time the fundamental and the quantitative are in accord, or harmonize on a small lag.

 

More rarely, the incongruency persists for an extended period. In those instances we default to the price/quantitative signal – in recognition that market prices are real-time leading indicators and that the market and the economy are not the same thing, particularly over shorter durations.

 

Theoretically, corporate earnings should reflect economic growth with the high end of sustainable earnings growth capped at potential GDP and the value of the stock market reflecting GDP, corporate earnings as % of that GDP, and the multiple investor’s put on those earnings. But that certainly doesn’t hold in the short run and it’s only approximately true over the long-term.

 

It’s the conflation of perceived fundamental trends into a convicted market call where economists turned strategists most often go awry.

 

Conflations and Incongruencies - 15

 

Back to the Global Macro Grind

 

In covering the domestic macro economy, the quasi-persistent discontinuity between the research (fundamental) and the risk management (quantitative) signals has been my reality for the last couple months.

 

Juxtaposing the current domestic labor market data (positive) against the prevailing price signals (bearish) provides a timely and tangible case study:

 

INITIAL CLAIMS: Rolling Initial Jobless Claims were just under 295K in the latest week, matching the best levels of the post-recession period. As we’ve highlighted, over the last two cycles rolling SA claims have run sub-330k for 45 and 31 months, respectively, before the corresponding market peaks in March, 2000 and October, 2007. We are currently in month seven at the sub-330K level in the present cycle. Further, over the last half century, the trough in initial claims has led the peak in equities and the peak in the economic cycle by 3 and 7 months, respectively. At present, we are still putting in the trough – with cycle precedents suggesting the economic peak is not yet imminent.

 

NFP: Monthly NFP gains have been solid on balance and, due to seasonal artifacts, even sequential slowdowns in net monthly payroll gains have been characterized by flat to rising employment growth on a year-over-year and 2Y average growth basis. At +1.93% YoY in September, Nonfarm Payrolls recorded their fastest rate of improvement since April 2006 and are in-line with peak growth in the last cycle. Similar to initial claims, peak monthly NFP gains lead the economic cycle by ~7 months. Whether the May-July NFP gains represented peak improvement remains to be seen.

 

JOLTS: Total Job Openings made a new 13 year high and the quits rate held at cycle highs in the August report released yesterday. Total hires moderated sequentially alongside the dip in NFP gains reported for August but is likely to re-accelerate to new highs in the September release. Historically, the Job Openings data leads accelerations in wage growth by about a year. The relationship has been muted vs previous cycles but with the NFIB’s compensation index making new highs, the share of short-term unemployed continuing to rise and labor supply (total available workers per job opening) tightening to pre-recession averages, wage inflationary pressures are percolating.

 

INCOME: The confluence of an accelerating employment base and flattish wage growth has driven an acceleration in disposable personal income growth over the last 5 months. Indeed, aggregate private sector salary & wage growth is currently running at +5.8% and holding at its best levels of the recovery outside of the peri-fiscal cliff period.

 

CREDIT: Consumer revolving credit declined at a -0.3% annualized pace in August according to Federal Reserve data released yesterday. The sequential decline wasn’t particularly surprising given the comps (the increase in July was the 2nd largest in 6.5 years) and the already reported retreat in spending on durable goods ex-defense and aircraft (ie. the stuff the average household buys). On a year-over-year basis, growth in credit card spending decelerated just -5bps from the 6 year high recorded in July.

 

In a Keynesian economy, total spending is cardinal, and income and credit is predominate. You can spend what you make (income) and you can spend what you don’t make (credit) and, with both income and credit accelerating presently, the underlying trends in both are positive.

 

The caveat has been that while the capacity for consumption growth has improved alongside accelerating income growth, actual household spending has not because the savings rate has shown a commensurate increase.

 

So, while reported consumption growth remains middling, it’s hard to characterize accelerating income growth, a rising savings rate and moderate credit growth alongside increased investment as fundamentally negative.

 

Transitioning to the price signals, which paint a contrasting picture for the prospects of forward growth. Keith has hit the boards hard in highlighting these, but to briefly review:

 

10Y Yields: 10Y bond Yields are down -69 bps YTD (-23%), the yield spread (10’s-2’s) continue to compress and inflation expectations are collapsing – all of which are discretely bearish growth signals.

 

Russell 2K: The Russell is down -7.5% YTD with the rotation out of growth style factors and small Cap Illiquidity accelerating over the last month+ - again, not a growth-accelerating signal . The Russell 2000 is immediate-term TRADE oversold around 1076, but remains in a Bearish Formation.

 

Consumer: The XLY is the worst performing sector YTD (-1.84%), underperforming the S&P500 by 6% as real median income growth continues to trend negative and the bottom 60% remain very much income constrained. Also in Bearish Formation.

 

Housing: The ITB is down -9.1% YTD with housing sitting as one of the worst performing asset classes globally. We have been bearish on housing since the end of 2013 and continue to believe housing related equities underperform, trading sideways-to-down, alongside ongoing deceleration in HPI trends.

 

ROW: The EU and Japan are in discrete deceleration, China is not an upside catalyst, EM markets are flagging alongside dollar strength and the US is already past the mean duration of expansions over the last century. The IMF marked its (still too optimistic) global growth forecast lower yesterday and growth estimate revision trends over the last quarter across both developed and EM markets have been almost universally negative. Further, the disinflationary trends prevailing globally only add to the Feds Sisyphean fight towards sustained, above target CPI and core PCE inflation.

 

From a Hedgeye modeling perspective we are entering Quad #4 which is characterized by both growth and inflation slowing from a 2nd derivative perspective and a generally dovish policy response. A sequential slowdown in GDP in 3Q14 from the near 5% in 2Q14 is almost as inevitable as the sequential acceleration from the worst post-war expansionary period GDP print ever in 1Q14. Whether that manifests into a protracted slowdown domestically remains TBD.

 

Markets are discounting an increasing probability of a more enduring deceleration and are, at the least, refuting consensus’ laughably linear straight-lining of 3% growth into perpetuity.

 

May the wind be always at your back.

May the sun shine warm upon your face.

May your fundamental and quantitative signals always be in accord.

 

Our immediate-term Global Macro Risk Ranges are now: 

 

UST 10yr Yield 2.35-2.46%

RUT 1072-1100

DAX 9026-9367

VIX 15.67-17.58

USD 85.05-86.64
WTI Oil 86.92-91.39

 

To cognitive dissonance, its ubiquity and successful management,

 

Christian B. Drake

Macro Analyst

 

Conflations and Incongruencies - Complacency


No Bullish Signals

Client Talking Points

EUROPE

European equities showing 0% follow through to the latest “communication tool” (read: hope); Portugal -1.1% leads losers this morning (-19.9% year-to-date) as liquidity traps remain obvious; Russian collapse remains a credible threat as the stock market continues to crash -23.7% year-to-date.

VIX

The front-month volatility went from 10.32 (July 7th when the Russell #Bubble topped) to 26.25 on Oct 15th, then back to 16.08 – yeah, that’s normal! But what is born out of that is an immediate-term risk range of 15.09-28.26 – enjoy.

S&P 500

Since implied volatility’s range is wicked wide now, so is the risk range for SPX at 1830-1947 (i.e. -4.6% downside vs +0.3% up); my dynamic (non-linear) model hasn’t seen risk ranges widen like this since NOV 2007 (when the SPX closed -6.6% on the month).

Asset Allocation

CASH 67% US EQUITIES 0%
INTL EQUITIES 0% COMMODITIES 4%
FIXED INCOME 25% INTL CURRENCIES 4%

Top Long Ideas

Company Ticker Sector Duration
EDV

The Vanguard Extended Duration Treasury (EDV) is an extended duration ETF (20-30yr). U.S. real GDP growth is unlikely to come in anywhere in the area code of consensus projections of 3-plus percent. And it is becoming clear to us that market participants are interpreting the Fed’s dovish shift as signaling cause for concern with respect to the growth outlook. We remain on other side of Consensus Macro positions (bearish on Oil, bullish on Treasuries, bearish on SPX) and still have high conviction in our biggest macro call of 2014 - that U.S. growth would slow and bond yields fall in kind.

TLT

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. The performance divergence between Treasuries, stocks and commodities should continue to widen over the next two to three months. As it’s done for multiple generations, the 10Y Treasury Yield continues to track the slope of domestic economic growth like a glove. 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).

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

OIL: wti up small; trending weakness remains pervasive as #Quad4 deflation dominates

@KeithMcCullough

 

QUOTE OF THE DAY

“Each of us has a fire in our hearts for something. It’s our goal in life to find it and keep it lit.”

-Mary Lou Retton, winner of gold medal at 1984 Los Angeles Summer Olympic Games

STAT OF THE DAY

The share of first time homebuyers remains anemic, coming in at 29% in September. First time homebuyers have been sub-30% now for 17 of the last 18 months. The share of first time homebuyers was generally above 40% from 2001-2008 and briefly hit 50% in 2010 in response to the government's homebuyer tax credit programs.


investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.


All Boxed In

“The Italian people are tired of this corruption. Because we have too many people that steal, too many people that put the money in his pocket. We have 40% of people who don’t pay tax. Can you imagine? 40%. It’s unbelievable.”

-Renzo Rosso

 

Renzo Rosso is an Italian and founder of the Diesel jeans brand. He appeared in a 60 Minutes segment on Sunday titled “Saving Italy’s History Becomes Fashionable” that showed how he along with a number of other prominent Italian fashion houses (Tod’s, Fendi, Bulgari) were donating millions to repair and improve the country’s historical landmarks, from the Colosseum and the Spanish Steps in Rome to the 400 year old Rialto Bridge over the Grand Canal in Venice.

 

Why? Because the government is too broke to allocate funds to maintain the country’s historic treasures.

 

While the issues of deep corruption and oversized bureaucracy in Italy remain nothing new, it’s both telling and remarkable to see these individuals and companies take a stand (now), rather than pointing fingers or pushing the problem on to somebody else further down the road.

All Boxed In - z. colosseum

 

Back to the Global Macro Grind

 

If only the Italian government could take a similar stand and unilaterally agree to reform itself… NOW.

 

As we’ve noted in previous work, Italy recently joined France as a standout in the camp of “Austerity Is Dead” in submitting 2015 budget plans that extend out its initial fiscal consolidation targets.

 

Specifically, Italian PM Matteo Renzi presented a budget last week that included cuts to labor taxes and personal income taxes worth €18 Billion, however some €11 Billion of it will be funded with extra borrowing that will raise the country’s deficit-to-GDP to 3% this year versus its previous target of 2.6% (with 2015 forecast as 2.9%).

 

And so for the first time in history, the European Commission may exercise its power to reject both Italy’s and France’s budgets and ask for new ones.  A formal resolution is expected to come on October 29th.

 

What’s clear is that the 39 year old young-gun and reform-minded Renzi has inherited a challenged position and the country is looking for leadership to pull itself out of what will be three years of negative growth:

  • He filled a power vacuum in February 2014 composed of splintered and diverse parties (that legacy continues and challenges reform)
  • Italy has a record high youth unemployment rate at 43% (3rd highest in the Eurozone behind Spain and Greece at 50%+) and an aggregate unemployment rate of 12.3% vs Eurozone 11.5%
  • Italy has put little dent in its record high debt of 133% (2nd highest to Greece’s in the Eurozone and 3rd highest of all countries in the developed world) vs Eurozone at 92% (that remains a persistent threat to raising debt/increasing interest rate costs)

Yet as we described in an Early Look note on 10/10 titled #EuropeSlowing – Austerity Is Dead? the main “rub” throughout the Eurozone is a leadership one. 

 

On one hand, we have the ECB and European Commission pointing its finger at the member states to do more country-level reforms. On the other hand, we have member states (like Italy and France) saying they’ve already done a significant level of reform and collectively pointing the finger back at the ECB for not doing more to inflect the lack of growth and deflation they’re experiencing.

 

To fuel the fire, tack on the indecision created by the fiscally conservative Germans calling into question the potential negative consequences that could result for the ECB’s newest policy toolkit, including the TLTROs, ABS and covered bond buying programs. Just in the last few days we’ve heard whispers (because the information is private) that the ECB bought French, Italian, and Spanish covered bonds, ahead of ABS purchases and the second round of the TLTRO program that are slated to begin/issued in December.

 

We’ve been clear in our research, including in our Q4 Macro theme of #EuropeSlowing, that we do not see Draghi’s Drugs arresting the low levels of inflation in the Eurozone (CPI currently is at 0.3% Y/Y) nor producing sustainable economic growth (recent programs baked in and with record low interest rates).

 

As we show in The Chart of the Day below, not only do we think that Draghi’s inflation policies will not work, but we expect deflation to hit Italy (CPI at -0.1% Y/Y) and the other countries across the periphery harder, which should only further push out growth expectations and limit business and consumer confidence. 

 

If Renzi’s Reform is to ever become a success, it will be counted in many years, not many months, and our opinion is that regaining competitiveness within the confines of the Eurozone structure is a sisyphean task.

 

Our bottom-up, qualitative analysis (e.g. our Growth/Inflation/Policy framework) indicates that the Eurozone is setting up to enter the ugly Quad4 in Q4 (equating to growth decelerates and inflation decelerates).

 

From an investment position we continue to recommend shorting Italian (EWI) and French (EWQ) equities (down -7.6% M/M and -8.1% M/M, respectively) and shorting the EUR/USD (FXE) (down -1.2% M/M).

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.09-2.24%

SPX 1

RUT 1037-1115

DAX 8

USD 84.84-86.16

EUR/USD 1.26-1.28

 

Matthew Hedrick

Associate

All Boxed In - z. neu CPI


October 22, 2014

October 22, 2014 - 1

 

BULLISH TRENDS

October 22, 2014 - Slide2

October 22, 2014 - Slide3

October 22, 2014 - Slide4

 

BEARISH TRENDS

October 22, 2014 - Slide5

October 22, 2014 - Slide6

October 22, 2014 - Slide7

October 22, 2014 - Slide8

October 22, 2014 - Slide9

October 22, 2014 - Slide10

October 22, 2014 - Slide11
October 22, 2014 - Slide12


Early Look

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