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#Deflation Risk

Client Talking Points


Burning Yen = Strong Dollar (2x is a charm for U.S. as consumption and investment growth slows- both Europe and Japan torched their currencies); so now you have an extremely overbought USD with falling interest rates (classic #Quad4 setup = deflation).


WTIC is down -0.6% to $80.06 this morning and doesn’t like Down Yen = Down Oil; correlation risk here continues to be very high and the translation risk to energy related countries, stocks, and bonds remains very obvious. MLPs closed down -1% last week with equities melting up.


Russia is one of our preferred country shorts on Oil Deflation, down another -0.8% this morning to -22% year-to-date; we’re doing a lot of work on whether or not Japan and Europe opting to devalue will result in a Russian economic collapse

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

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.


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).


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


GOLD: smashed by Japanese Money Printing Culture Day - risk range = 1167-1220/oz $GLD



Float like a butterfly, sting like a bee.

-Muhammad Ali


According to a report from the advocacy group Opportunity Nation, around 15% of Americans aged 16-to-24 are considered "idle youth" — they aren't in school and aren't employed.

CHART OF THE DAY: Got Inequality? Labor Share of U.S. Income vs. Congressional Disapproval

CHART OF THE DAY: Got Inequality? Labor Share of U.S. Income vs. Congressional Disapproval  - Inequality EL

Bootlegging & Banking

“I don’t mind going back to daylight saving time.  With inflation, the hour will be the only thing I’ve saved all year.”

-Victor Borge


During daylight savings time, in the fall and winter months, the U.S. Virgin Islands are one hour ahead of East Coast time. 


Instead of getting up at 4am everyday, I could get up at 5am…and, you know…..be on an island. 


Keith’s in Cali this week.  When he gets back, I’ll try to leverage the jet-lag + daylight savings  brain fog combo and float the “Hedgeye Caribbean” proposal, again….


“you miss 100% of the shots you don’t take”


Bootlegging & Banking - st1


Back to the Global Macro Grind...


In our 4Q Macro Investment themes call we profiled a series of bubbles which, among others, included:


  • Complacency Bubble: Daily moves of >1% vs. Average VIX level (by year)
  • Inequality Bubble: Labors Share of National Income vs. Congressional Disapproval vs. Gini Coefficient
  • Hedge Fund Correlation To Beta Bubble:  Hedge fund trailing correlation to the SPX vs. Average Relative Monthly Performance
  • Leverage Performance Chase Bubble:  Margin Debt (inflation Adjusted), % of SPX Mkt Cap
  • Expensive Small Cap Illiquidity Bubble:  Russell 2000 Trailing PE vs Average Market Cap Traded (by year)
  • Basement Dwelling Bubble: Real Median Household Income vs. 18-34YOA Homeownership Rate vs. Housing Expense as % of Median Income
  • Spread Risk Bubble:  IG & High Yield Spreads over Treasuries vs. Bond Volatility vs. Total Corporate Debt Outstanding


Our timing on the complacency bubble proved particularly prescient (substitute “lucky” if you’d like).  Prior to our themes call, the VIX was trading at its lowest average level in a decade and just 11% of trading days saw moves in excess of 1% in either direction.  Subsequent to our call, the VIX has been higher by ~33% on average and the SPX has had daily moves greater than +/- 1% over 50% of the time.    


We expect the Dramamine ride to continue. 


Taking a broader view, each of the aforementioned bubbles are, in some magnitude, outcroppings of the larger bubble that is Central Banking. 


With the explicit goal of QE initiatives being financial asset price inflation - and the hope for the ultimate trickle down and around effect - asymmetries and inequalities have become more pronounced in recent years.  Such policy manifestations, however, are more an extension of secular trends than neoteric phenomenon. 


The financial sector and those tied to it have benefited disproportionately since the turn of the interest rate cycle circa 1980.  From 1980 to its peak in 2006,  the finance industry grew from less than 5% of the economy to ~8.3%, taking share at a rate of ~13bps per annum while the financial sector weight in the S&P500 rose from less than 10% to greater than 20% over the same period. 


Industry and activity chase price/profit and the broader reality of the great moderation – which, instead of promoting natural economic cycling, effectively propagated the accumulation of latent risk – is that 30+ years of lower highs and lower lows in interest rates supported a multi-decade run in financial asset price appreciation - a phenomenon exaggerated further by the twin peaks in both demographics and household & corporate leverage. 


Alongside that financialization, the gini coefficient in the U.S. increased almost a full decile and the share of total income earned by the top 1% of families more than doubled from less than 10% to greater than 20%.


The minority with financial assets and those tasked with managing them - which, coincidentally, became increasingly less mutually exclusive - benefited as bond prices had a historic bull run while the ongoing, incremental lowering of discount rates provided for a perma-juicing of asset values via the Present Value effect.  


Q: How much would the median home be worth today if rates were at 10% instead of 4%?

A:  About -45%, or -$110K, less. 


Quasi-relatedly, the policy perpetuated asset bubble rotation into housing destroyed a perfectly predictive housing model. 


Over the pre-1995 historical period, New Home Sales could be modeled as an almost perfect periodic function.  For the aspirant, part-time quants like myself, who would like to plot the function, here’s what I got on a 1st pass…..


f(x) = 241*sin(2Pi/82*x-20.5)+614   ….#CoolButUseless


Perhaps as the last of the cumulative displacement from trend burns off in the next few years we can return to a similarly predictable oscillation in new housing demand.     


Anyhow, a couple weeks back, Janet Yellen expressed concern over the ongoing rise in inequality that team FOMC itself helped perpetuate. 


Janet failed to explicitly address the role of central bank policy in that burgeoning divide but the Fed does hold an appreciation for the lag between Wall Street’s discounting of policy via prices and actual Main Street effects.  And with the normal policy transmission channel left mostly prostrate by the zero bound in rates,  the less potent and longer lagged trickle through of Wall Street wealth to the real Main Street economy has become the hoped for transmission channel detour route. 


Ironically, or unfortunately, the problem with that ideology is that the prescription for ineffectual QE becomes more dovishness in the belief that it’s the bottlenecked transmission of policy and not the policy itself that’s core to the problem.  From that perspective, more and/or longer ‘easiness’ remains the most favorable conduit for the (eventual) leak through of policy to the populace.   


“You keep going until you can’t turn back. That’s where there isn’t any choice. You don’t know where that is. You don’t know until you pass it. And then it’s too late.”


Nucky Thompson epitaphed the bubble in 1920’s Prohibition barbarism and capped the series finale of Boardwalk Empire with that quote.  


I suspect there’s some transferable insight in that Boardwalk epiphany. 


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.16-2.35%


VIX 13.31-17.79

USD 84.99-87.11

Yen 108.99-112.98

WTIC Oil 79.47-81.43 


To Bootlegging, Central Banking….and kindred spirits...


Christian B. Drake

U.S. Macro Analyst


Bootlegging & Banking - Inequality EL


investing ideas

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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.

November 3, 2014

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TODAY’S S&P 500 SET-UP – November 3, 2014

As we look at today's setup for the S&P 500, the range is 56 points or 2.53% downside to 1967 and 0.25% upside to 2023.                                      













  • YIELD CURVE: 1.83 from 1.84
  • VIX closed at 14.03 1 day percent change of -3.37%


MACRO DATA POINTS (Bloomberg Estimates):

  • 9:30am: Fed’s Evans speaks in Chicago
  • 9:45am: Markit US Mfg PMI, Oct, final, est. 56.2 (prior 56.2)
  • 10am: ISM Manufacturing, Oct., est. 56.2 (prior 56.6)
  • 10am: Construction Spending, Sept., est. 0.7% (prior -0.8%)
  • 11am: U.S. to announce plans for auction of 4W bills
  • 11:30am: U.S. to sell $24b 3M bills, $30b 6M bills
  • 12:40pm: Fed’s Fisher speaks in New York



    • President Obama meets with Fed Chair Janet Yellen to discuss long-term outlook for U.S. economy, global recovery
    • Senate, House out of session
    • FSOC holds meeting on MetLife’s objection to proposed designation as “systemically important” financial firm
    • 9am: NATO Supreme Allied Commander, Europe, and Commander of U.S. European Command Air Force Gen. Philip Breedlove holds media briefing
    • 10am: Supreme Court hears arguments in case involving designation of “Israel” as place of birth for U.S. citizens born in Jerusalem
    • 10:30am: CFTC reviews rules to make sure they don’t have unintended consequences for non-financial cos.
    • 2pm: Greece’s energy minister, Yiannis Maniatis, speaks at the Center for Strategic and International Studies on energy trends in the eastern Mediterranean region
    • Washington Week Ahead
    • U.S. ELECTION WRAP: The Magic Senate Number; Googling ‘Nunn’



  • Publicis to Buy Sapient for $3.7b to Extend Digital Reach
  • Diageo Gets Full Control of Don Julio in Swap for Bushmills
  • Gold Extends Decline Toward 4-Year Low as Silver Tumbles
  • MetLife to Appear Before FSOC to Appeal Prelim. SIFI Designation
  • Altice Offers Oi $8.8b for Portugal Telecom Assets
  • NY Doctor With Ebola Now in ‘Stable’ Condition at Bellevue
  • Omega Healthcare to Acquire Aviv REIT in $1.65B Deal
  • Net Neutrality Groups Praise Using FCC Phone Rules on Web
  • Verizon, AT&T Cut Mobile Prices While Boosting Data Allotments
  • American Realty Capital Said to Face Accounting Errors Probe
  • Einhorn’s Greenlight Rose 2.2% in Oct. as Volatility Surged
  • Final Election Push: GOP Has the Edge; Will It Be Enough?
  • Billionaire Malone Got Double Tax Break in Liberty Inversion
  • Virgin Spacecraft’s Rocket Motor Intact After Breakup: NTSB
  • Gyllenhaal’s ‘Nightcrawler’ Movie Creeps to Tie With ‘Ouija’
  • Herbalife to Pay $15m to End ‘Pyramid Scheme’ Lawsuit
  • Obama Ends Midterm Campaigning With Eye on Governors’ Races
  • Auto Sales Preview: Oct. SAAR May Be 16.4m



    • Affiliated Managers (AMG) 7:30am, $2.71
    • Allete (ALE) 8:30am, $0.72
    • Arena Pharmaceuticals (ARNA) 6:45am, ($0.12)
    • Church & Dwight (CHD) 7am, $0.82
    • CNA Financial (CNA) 6am, $0.78
    • Enbridge Energy Partners (EEP) 8am, $0.26
    • Kosmos Energy (KOS) 7am, ($0.02)
    • Loews (L) 6am, $0.68
    • Sysco (SYY) 8am, $0.51



    • Acxiom (ACXM) 4:05pm, $0.17
    • Agrium (AGU CN) 6:13pm, $0.50
    • Alleghany (Y) 4:07pm, $7.66
    • American Intl Group (AIG) 4:03pm, $1.09
    • Community Health Systems (CYH) 4:30pm, $0.76 - Preview
    • Corrections of America (CXW) 4:15pm, $0.47
    • Covance (CVD) 4pm, $0.98
    • Detour Gold (DGC CN) 5:35pm, ($0.10)
    • Frontier Communications (FTR) 4:01pm, $0.04
    • Herbalife (HLF) 4:30pm, $1.51
    • Lannett (LCI) 4:04pm, $0.92
    • MannKind (MNKD) 4pm, ($0.02)
    • Marathon Oil (MRO) Aft-mkt, $0.59
    • MDU Resources (MDU) 5:30pm, $0.44
    • Mindray Medical (MR) 5pm, $0.46
    • Neurocrine Biosciences (NBIX) 4:02pm, ($0.21)
    • Protective Life (PL) 4:14pm, $1.22
    • Regency Centers (REG) 4:05pm, $0.18
    • RetailMeNot (SALE) 4:01pm, $0.13
    • Rock-Tenn Co (RKT) 5pm, $1.06
    • Rosetta Resources (ROSE) 5:15pm, $0.74
    • Ruckus Wireless (RKUS) 4:05pm, $0.11
    • Sprint (S) 4pm, ($0.06)
    • Stone Energy (SGY) 4:03pm, $0.07
    • Tenet Healthcare (THC) 4:15pm, $0.09
    • Veresen (VSN CN) 5pm, $0.02
    • Vornado Realty Trust (VNO) Aft-mkt, $0.43



  • Gold Extends Decline Toward Lowest Since 2010 as Silver Drops
  • Gold Wagers Drop as $1.3 Billion Pulled From Funds: Commodities
  • Brent Crude Trades Near 4-Day Low as China Manufacturing Slows
  • Palm Enters Bull Market as Soybeans Rally, Biofuels Drive Demand
  • Nickel Drops as Chinese Manufacturing Growth Misses Estimates
  • Hedge Funds Cut Bullish Oil Bets as Global Glut Expands: Energy
  • ICE Brent Money Managers Net-Longs Rose to 54,715 Last Week
  • White Sugar Falls for Third Day on Ample Supply; Cocoa Declines
  • Natural Gas Rises for Fifth Day as Cold Forecast for U.S. East
  • Lehman Antidote Hits Nordic Power Exchange With Another Problem
  • Steel Rebar Falls on Signs of China Slowdown, Iron Ore Price
  • Hurricane Vance in Pacific Will Weaken From Tonight, NHC Says
  • Tomato Demand Spurs Record California Crop as Drought Worsens
  • Zimbabwe Needs to Clarify its Black Ownership Laws, IMF Says
  • Corn Drops With Soybeans as U.S. Weather Seen Boosting Harvest

























The Hedgeye Macro Team



















Seeing Red

This note was originally published at 8am on October 20, 2014 for Hedgeye subscribers.

“We will have to send soldiers into this party seeing red.”

-Bernard Montgomery


World War II #history rarely accuses British Army General Bernard Montgomery of having a confidence problem. He was often decisive and ruthless. In the end, he was also a winner.


On the eve of landing on the beaches of Normandy, Monty’s bravado reminded Churchill’s Chief of Staff (Lieutenant Hastings Ismay) of the eve of Agincourt (as depicted in Henry V):


“He which hath no stomach to this fight – let him depart.” (The Guns At Last Light, pg 11)


Seeing Red - EL Chart 2


Back to the Global Macro Grind


Seeing red, in single-factor price momentum terms, is not what everyone saw on Friday’s US stock market bounce. That’s because not everyone looks at risk on a multi-factor, multi-duration basis. But that doesn’t mean it ceases to exist.


Actually, the Russell 2000 was down on Friday, so even in single-factor terms, many saw red. Don’t forget that even though the Russell was up for the 1st week in 7, over 60% of stocks in the Russell 2000 are currently crashing (-20% from their 12-month highs).


Back to the multi-factor thing, we highly suggest you consider Mr. Macro’s market message on a baseline 3-factor basis – PRICE, VOLUME, and VOLATILITY. In those terms, this is what we saw on Friday’s “bounce”:


  1. PRICE – both the SPX and Russell failed at all 3 core levels of @Hedgeye resistance (TRADE, TREND, TAIL)
  2. VOLUME – Total US Equity Market Volume was -11% and -4% vs. its 1 and 3 month averages, respectively
  3. VOLATILITY – VIX was down on the day but +3.5% and +60.3% for the week and YTD, respectively


Price momentum is an easy concept for people to understand (it goes up or down – look at the chart, bro!). That’s why many still use what I affectionately refer to as Moving Monkeys (50 and 200 day) in order to contextualize price. Unfortunately, that is not a risk management process.


The direction of price obviously matters, but so does multi-factor context. Here’s what I mean by that:


  1. BULLISH – Price Up, Volume Up, Volatility Down
  2. BEARISH – Price Down, Volume Up, Volatility Up


Within the context of a bearish intermediate-term TREND @Hedgeye, Price UP, Volume DOWN, and trending (implied) Volatility UP is bearish too.


Setting aside our research view of US #GrowthSlowing, to get bullish and “buy-the-damn-dip” in US Equity beta, what I would need to see is the SP500 close above my immediate-term TRADE line of 1949 on accelerating VOLUME and a break-down in the VIX below my TRADE line of 15.03.


Those of you paying attention to my immediate-term risk ranges will note that these levels aren’t in the area code of today’s ranges. And, to a degree, that’s the point. If I look beyond 1-3 days in duration (to 3 weeks), I’m seeing a heightening probability of more red.


Across asset classes (multi-factor), here are the other big #Quad4 deflationary forces at work across multiple-durations (TRADE and TREND):


  1. European Equity deflation of -0.9% last week (-2.9% YTD EuroStoxx600) is bearish TRADE and TREND
  2. Emerging Market Equity deflation of -1.9% last week (-3.2% YTD MSCI) is bearish TRADE and TREND
  3. CRB Index deflation of -1.1% last week (-2.7% YTD) is bearish TRADE and TREND
  4. Oil (WTI) deflation of -3.3% last week (-11.1% YTD) is bearish TRADE and TREND
  5. Energy Equity (XLE) deflation of -1.1% last week (-6.6% YTD) is bearish TRADE and TREND


Then, of course, you have trivial risk signals like:


  1. US 10yr Treasury Yield crashing (-27% YTD) to 2.19% (bearish TRADE, TREND, and TAIL)
  2. US Treasury Yield Spread crashing (-31% YTD) to +182bps wide (10yr minus 2yr)
  3. And Credit Spreads starting to move off of their all-time lows as equity and commodity volatilities breakout


“So”, yes, I do see more red pending in US, European, and Emerging Market Equities in the coming weeks and months. And, no, I don’t think last week’s immediate-term capitulation was the bottom.


But consensus does! Here’s the updated net positioning of hedge funds in non-commercial CFTC futures/options terms:


  1. SP500 (Index + E-mini) got longer by +5,537 contracts to a net LONG position of +54,153 last week
  2. 10yr Treasury Bond saw shorts get -6,976 contracts shorter last week to a net SHORT position of -58,930
  3. Crude Oil bulls only gave up -14,225 contracts last week, keeping the net LONG position at +285,500 contracts!


In other words, consensus got longer of the US stock market, shorter of the Long Bond, and not nearly less-long enough of a crashing Oil price.


I know that some are frustrated out there with their performance. I can assure you that I’ve been there and had to deal with that. But there comes a time where you have to choose between being consensus and not seeing any more red in your P&L.


Our Immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.09-2.28%

SPX 1830-1900

RUT 1040-1101

VIX 20.46-28.92

WTI Oil 79.96-84.58

Gold 1211-1251


Best of luck out there this week,


Seeing Red - CoD seeing red

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