“The problem with the big focus on making capital cheaper… is it’s akin to fighting fire with fire.”
That’s a quote from the beginning of chapter 6 of The Age of Oversupply, by Dan Alpert. The chapter was a good one titled “The Empty Toolbox” and it focuses on why central planners “can’t fix the economy.” #agreed
Whether you are looking at the US economy or global one slowing right now, it’s important to keep these v-bottom moves in equity markets in context. Where are they v-bottoming from? Oh, and why did they go down so hard so that they could v-bottom to begin with?
Our call throughout the year has been very consistent on the why – growth is slowing. And when early-cycle growth slows from multi-year highs, you short the most illiquid form of beta chasing (small cap stocks) and you buy the Long Bond.
Back to the Global Macro Grind…
I was at a dinner meeting in Maine last night and an entrepreneurial CEO asked me a question I’ve been asked by hundreds of non-Wall Street people in 2014: “What do you think I should do with my money right now?”
I’m not the beat-around-the-bush-type, so I told her exactly what I have been telling people all year:
- Sell stocks
- Buy bonds
- Raise Cash
As basic as this advice has been is as hard as it’s been for people to just execute on it. But, with the total return of the Long Bond (TLT) at almost +19% for 2014 (vs. the Russell 2000 down -4%), why is that?
A: It’s not what “everyone” is saying people should be doing.
That’s it. From New Hampshire to California and everywhere I’ve been this year in between. That pretty much sums it up. The response is always the same: “but can’t interest rates go up? Aren’t bonds expensive?”
What’s been really expensive is believing that central planners can bend gravity and deliver +3-4% economic growth. If they deliver 0-2%, “expensive” bonds are going to get more expensive, and really expensive growth stocks (think Amazon at 112x earnings) are going to continue to crash.
But, but… “Keith, this bounce is crazy – why can’t it keep going…”
If I have some iteration of that in my inbox 100x in the last 3-4 market days, I have it 1,000x. And all I do is shake my head wondering why so many refuse to take a lesson from the risk management exercise learned as the Russell was having a -15% draw-down and the 10yr broke 2% only a week ago.
To review the #Quad4 deflation case that Mr. Market is effectively yelling right now:
- Bond Yields (10-30yr) in the US are crashing
- Oil prices are crashing
- Over 60% of stocks in the Russell 2000 are crashing
To be fair, if you didn’t have a view that all of these things would go down, you blamed ebola (and Canada) and wore them the whole way down anyway. But, if you did, you are killing it YTD and in a position to re-ramp every position you’ve had throughout the last 6 weeks of macro market volatility.
We’re deep into 2014 and at this stage of the season playing this game from a position of strength is entirely different than playing it from a position of weakness. If you’ve been winning, you don’t have to spend your entire day worrying about why the stock market is bouncing and bonds correcting.
You’ve realized that the Fed, Bank of Japan, and European Central bank have all cut to zero. You’ve also reminded yourself that 0 + 0 doesn’t equal something greater than zero – and that they can’t solve for #GrowthSlowing again.
In other words, they can’t fix this. Unfortunately, only a deflationary reset can.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets – which you can get in our Daily Trading Range product as well) are now:
UST 10yr Yield 2.11-2.32% (bearish)
SPX 1 (bearish)
RUT 1040-1127 (bearish)
Nikkei 149 (bearish)
VIX 15.06-28.49 (bullish)
USD 85.01-86.20 (bullish)
EUR/USD 1.26-1.28 (bearish)
Yen 105.36-108.31 (neutral)
WTI Oil 79.75-82.62 (bearish)
Natural Gas 3.51-3.74 (bearish)
Gold 1 (bullish)
Copper 2.95-3.05 (bearish)
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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:
- Why global financial market volatility is likely to ramp in the coming weeks – particularly as we progress through next week's FOMC statement and mutual fund fiscal year-end
- The bull case for bombed-out Brazilian financial assets (HINT: it has nothing to do with a Neves victory)
Best of luck out there,
Associate: Macro Team
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This note was originally published at 8am on October 10, 2014 for Hedgeye subscribers.
“Some day, following the example of the United States of America, there will be a United States of Europe.”
Well, if Washington is right, “some day” is still a long ways off.
In fact, over the intermediate to longer term we expect the culture clash that is the Eurozone to continue transpiring – from the top (Brussels and the ECB) right on down to the bottom (individual member states).
Our macro playbook continues pointing to a Euro with potential downside from here (it’s down around -9% since May and is broken across TREND and TAIL durations in our quantitative models). Despite ECB President Mario’s Draghi’s pledge “to do whatever it takes” (and lever up the balance sheet by €1 Trillion) to support growth and inflation, we’re not buying the promise of Draghi’s Drugs producing sustainable economic growth.
Why? Because we expect some member states to be very slow in passing the necessary fiscal and labor market reforms to improve their competitiveness.
Back to the Global Macro Grind…
And so the culture clash took another turn this week when the French government announced that austerity is dead and that it would not meet its original deficit reduction target. This shot across the bow stands to reignite tension with the fiscally conservative member states (Germany in particular) and may influence the policy stance of other members (like Italy) that have A) long questioned the merit of austerity, B) have yet to deliver on a full package of reforms, and C) like France, are looking to push out their own deficit timetable.
Specifically, France in its 2015 budget stipulated that it would adapt a pace of deficit reduction parallel to the economic situation of the country. Therefore, instead of meeting the original target of 3% deficit by 2015, the country would push out that target by an additional two years.
And so for the first time in history, the European Commission may exercise its power to reject France’s budget and ask for a new one. A resolution could come at the end of the month.
In follow-up remarks, French Finance Minister Michel Sapin has said that the EU must shift its policy to avert the threat of prolonged low growth and low inflation (along with boosting investment), if Europe was to prevent being stuck in Japanese-style stagnation.
Here’s the rub playing out from Top to Bottom:
- The European Commission (EC) and ECB: (pointing the finger at a select group of member states): “You guys need to reform (more).”
- The Member States Being Accused: (pointing the finger back) “We just issued loads of “austerity” to minimize the public sector, reduce our borrowing costs and improve our credit rating, yet in doing so we’ve choked off growth, are saddled with record high unemployment rates, and have zero ability to manipulate policy to make ourselves more competitive than our European peers. We’re done with this course of action, so be your expectations for deficit and debt consolidation!”
- The EC and ECB: “But if you don’t reform at the state level, there’s no chance our newest programs (ABS & covered bond buying programs and TLTROs) will have any chance of success!”
The problem is that countries like France haven’t done enough. For proof of the shortfall, France’s government spending still stands at a monster 55% of GDP. And as an anecdote, the Magic Kingdom a la France (Disneyland Paris) reported this week that it needs a bailout to the tune of $1.25 Billion. The company cited French labor laws and planning regulations making it difficult to replicate the success of the other Disney enterprises, and called-out in particular the high cost of employing French workers.
Similar structural shortfalls could be identified in Italy, which just this Wednesday happened to host an EU Summit in Milan to discuss job creation.
And so as the “rub” between the Top and Bottom plays out, Eurozone growth stands to suffer as there’s no clear action plan on how to fix it. This week the IMF (a classic lagging indicator) revised down its global GDP forecast and specifically took the Eurozone GDP outlook to 0.8% in 2014 (vs a prior estimate of 1.1% July) and 1.3% in 2015 (vs prior 1.5%).
A quick look at key Eurozone data metrics over the last two weeks shows a similar trend downward:
- Eurozone PMI Services fell to 52.4 SEPT (exp. 52.8)
- Eurozone PMI Manufacturing fell to 50.3 SEPT (exp. 50.5)
- Eurozone PMI Retail Sales 44.8 SEPT vs 45.8 AUG
- Eurozone Sentix Investor Confidence -13.7 OCT (exp. -11) and -9.8 SEPT
- Eurozone Business Climate 0.07 SEPT (exp. 0.10) vs 0.16 AUG
- Eurozone Economic Confidence 99.9 SEPT (inline) vs 100.6 AUG
- Eurozone Industrial Confidence -5.5 SEPT (exp. -5.8) vs -5.3 AUG
- Eurozone Consumer Confidence -11.4 SEPT vs -10 AUG
- Eurozone Unemployment Rate UNCH at 11.5% AUG
- Eurozone CPI fell 10bps to 0.3% Y/Y in SEPT
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). We discussed this point in depth on our Q4 2014 Macro Themes Call on 10/2 (email email@example.com if you’d like access) in our theme #EuropeSlowing (one of three).
Our key conclusions include:
- We do not believe Draghi will be able to turn the tide of deflation (see chart below) and growth through his policy tools alone. German Finance Minister Wolfgang Schaeuble has repeatedly said the ECB has “run out of tools” and that “cheap money can’t force growth”
- We expect the recent package of “supportive” measures (ABS and covered bond purchasing program and TLTRO) to come up short of expectations. Recall as an initial read-through that demand was light for the first round of TLTRO at €83 Billion vs estimates of €150-300 Billion
- Should Sovereign QE become a reality, expect push back from member states (think uproar over OMT and hearings from the German Constitutional Court)
- We believe it’s still largely unlikely that a sovereign QE program can support sustained economic growth (witness years of shortcoming on this front from the Japanese).
- From an investment position, we are recommending shorting French (EWQ) and Italian (EWI) equities and the EUR/USD (FXE).
The former President of France Jacques Chirac once said: “The construction of Europe is an art. It is the art of the possible”. Indeed, if the Eurozone is to become a functioning United States of Europe, it’s just in the initial sketch stage.
Our immediate-term Global Macro Risk Ranges are now:
WTI Oil 84.02-89.82
TODAY’S S&P 500 SET-UP – October 24, 2014
As we look at today's setup for the S&P 500, the range is 128 points or 5.94% downside to 1835 and 0.62% upside to 1963.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 1.87 from 1.89
- VIX closed at 16.53 1 day percent change of -7.50%
MACRO DATA POINTS (Bloomberg Estimates):
- 10am: New Home Sales, Sept., est. 470k (prior 504k)
- 1pm: Baker Hughes rig count
- Senate, House out of session
- 9:30am: House Oversight hearing led by Chairman Darrell Issa, R-Calif., on U.S. response to Ebola
- 9:40am: EPA Administratior Gina McCarthy delivers keynote remarks on “The Future of Energy & Our Environment”
- U.S. ELECTION WRAP: N.C. ‘Political Hate’; Outlook in Arkansas
WHAT TO WATCH:
- New York Man Diagnosed With Ebola as Authorities Track Movements
- Amazon Faces Season of Worsts as Losses Mount Before Holidays
- Sony, Apple to Introduce Large Tablets in 1Q 2015: DigiTimes
- Google Said to Buy Six Silicon Valley Buildings for $585m
- Toyota Sells Tesla Shares as Joint Electric RAV4 Project Ending
- Lockheed, Pentagon Reach $4b Deal on F-35 Jets: Reuters
- AMC Networks Pays $200m for 49.9% BBC America Stake
- Occidental CEO Sees Lower Drilling Fees If Oil Slump Continues
- RealPage Approached by at Least 2 PE Groups, FT Says
- Amtrak Weighs Selling Land for Development in 5 U.S. Cities
- Goldman, Inner Circle Hired by NBA’s Atlanta Hawks to Sell Team
- Regulators Ramp Up Bond Fund Exams in Response to Price Swings
- Swiss Banks Urge U.S. to Amend Demands in Tax Amnesty Deals
- ECB Vies for Third Time Lucky on Stress Tests as New Role Dawns
- U.K. Economic Growth Slows as Headwinds to Recovery Increase
- Actavis CEO Saunders Has $70b in Deals From Which to Choose
- Billionaire Fredriksen to Make Mandatory Bid for Flex LNG
- BASF Cuts 2015 Goals as Delayed European Growth Hurts Demand
- Chiquita Brands holds special shareholder meeting
- Fed, ECB Tests, U.S. GDP, Facebook: Week Ahead Oct. 25-Nov. 1
- Aaron’s (AAN) 7am, $0.37
- Avery Dennison (AVY) 8:30am, $0.74
- Bristol-Myers Squibb (BMY) 7:30am, $0.42 - Preview
- Cabot Oil & Gas (COG) 7:30am, $0.21 - Preview
- Colgate-Palmolive (CL) 7am, $0.75 - Preview
- Delphi Automotive (DLPH) 7am, $1.13
- DTE Energy (DTE) 7:15am, $1.05
- First Niagara Finl (FNFG) 7:15am, $0.18
- FLIR Systems (FLIR) 7:30am, $0.35
- Ford Motor (F) 7am, $0.19 - Preview
- IDEXX Laboratories (IDXX) 7am, $0.86
- ImmunoGen (IMGN) 6:30am, ($0.15)
- Lear Corp (LEA) 7am, $1.88
- LifePoint Hospitals (LPNT) 7am, $0.74
- LyondellBasell (LYB) 6:50am, $2.30
- Moody’s Corp (MCO) 7am, $0.90
- NASDAQ OMX (NDAQ) 7am, $0.70
- National Penn Bancshares (NPBC) 6:38am, $0.18
- Omnicare (OCR) 7:30am, $0.92
- Procter & Gamble (PG) 7am, $1.07 - Preview
- State Street (STT) 7:12am, $1.21
- TCF Financial (TCB) 8am, $0.30
- United Parcel Service (UPS) 7:45am, $1.28 - Preview
- Ventas (VTR) 7:15am, $0.45 - Preview
- WABCO Holdings (WBC) 6:30am, $1.41
- Wyndham Worldwide (WYN) 6:30am, $1.63
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- WTI Set for Fourth Weekly Drop as Saudi Policy Seen Unchanged
- Iron Ore Glut Spurring Slump in China Output, Goldman Sachs Says
- Gold Trades Near One-Week Low as Investors Assess U.S. Economy
- Aluminum Leads Metals Declines as China House-Price Drop Widens
- Glasenberg’s Iron Barbs Blunted by Coal Expansion: Commodities
- Soybeans Rise on Signs of Increasing Demand for U.S. Exports
- Romania’s Farmland Costing Fraction of U.K. Attracts Investments
- Rebar Pares Weekly Loss on Bets Mills to Cut Output During APEC
- Wheat Crop Seen Falling Short in Australia on Frost, Hail Damage
- Weak El Nino Seen Evolving by Year-End as Sea Warmer Than Usual
- Don’t Assume Saudi Supply Drop Was Move to Bolster Oil Price
- Vale Coming of Age as a Nickel Heavyweight Just as Prices Plunge
- Gold Traders Bullish a Fourth Week on Physical Demand to Economy
- MORE: China’s Copper Output Climbs to Record High in September
The Hedgeye Macro Team
Daily Trading Ranges
20 Proprietary Risk Ranges
Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.