Has the historic 30-year bull run in bonds finally come to an end? Is the bear market in fixed income assets just beginning?  If the answer to these questions is “yes”, what should an investor do right now to take advantage of this generational paradigm shift?


Jonathan Casteleyn, Director of Financials Research at Hedgeye Risk Management, discusses the remarkable sea change underway in the U.S. bond market, and how this move will have a profound effect on institutional and retail investors’ portfolios across the globe.  

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This note was originally published August 16, 2013 at 08:19 in Daily Trading Ranges

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UK Bulls as Eurozone Inches Out of Recession

  • Bullish position on the UK (etf: EWU) and Germany (EWG) remains.
  • Eurozone fundamentals inching higher; investor sentiment improving on weak comps. On a relative basis the Eurozone is well below its historical growth average and churning only modestly higher as deep structural imbalances and the lack of credit drag on growth.
  • We underline the significance of Eurocrat and ECB resolve to lend support to the region and markets (at all costs), which, along with marginally better data, should continue to support Eurozone capital market performance.


UK’s Island Economics

In support of our fundamental bullish call on the UK economy since our June 11th European update presentation titled “Where Does Europe Go From Here”, yesterday the UK printed a strong Retail Sales figure of 3.0% in July year-over-year (exp. 2.4%) vs 1.9% JUN.


The print and the down move in the FTSE100 yesterday prompted us to add the UK via the etf EWU to our real-time portfolio positions on the long side.


UK Bulls as Eurozone Inches Out of Recession  - zzz. uk ftse


UK Bulls as Eurozone Inches Out of Recession  - z. uk retail and IP


Our outlook on the UK is data and price dependent and hasn’t changed: we expect to see outperformance from the UK economy versus many of its European peers due to its decision to issue austerity earlier in the fiscal consolidation cycle. We are now seeing stronger signs of improved consumer sentiment, and expect PMI readings to maintain their level above the 50 line (expansion) into year-end. Beyond retail sales, industrial production and housing figures have improved year-to-date, and while wage volatility and sticky stagflation persist, we view reductions in the saving rate as another indicator of improved sentiment.  Further, we’re bullish on the changing of the guard at the BOE to Mark Carney – while it’s up for argument on just how effective tying monetary policy to the unemployment rate is, we like the Bank’s move towards a more transparent state to better manage and guide expectations.


UK Bulls as Eurozone Inches Out of Recession  - z. uk cpi


UK Bulls as Eurozone Inches Out of Recession  - z. uk house prices


UK Bulls as Eurozone Inches Out of Recession  - z. uk savings rate



Eurozone Inching Higher


The big news this week was a better-than-expected first print of Q2 GDP out of the Eurozone, a follow-on to improving fundamental data out of the Eurozone in recent weeks.


The Eurozone’s +0.3% Q2 GDP rise marked the end of an 18 month recession (cheer!), and the figure beat our expectations for only modest improvement over Q1 (consensus was at +0.2%), especially in a quarter that was hampered by bad weather (including serious flooding throughout central Europe), continued misdirection in economic leadership from France’s Hollande (France has the second largest economy behind Germany in the Eurozone), and continued political strife in Italy, Spain, and Portugal.


UK Bulls as Eurozone Inches Out of Recession  - z. eurozone gdp


Clearly the data is looking better.  Germany and France also beat Q2 GDP expectations. Germany reported growth of +0.7% Q/Q (+10bps above expectations) versus 0.0% in Q1 and France rose +0.5% Q/Q (+30bps above expectations) vs -0.2% in Q1. Add to this performance PMI figures that have improved across the region over the last 3-5 months (reaching over the 50 line in the last 1-2 readings) and improvement in sentiment readings across the core and periphery.


UK Bulls as Eurozone Inches Out of Recession  - z. pmis


Risk Spreads are dropping to new lows. Also, 10YR Spanish and Italian bonds are trading at their tightest spreads over comparable German paper in more than two years at ~252bps and 235bps, respectively.


UK Bulls as Eurozone Inches Out of Recession  - z. 10 spreads



Not All Is Rosy

What’s our read?  While there’s optimism to be had on improving data, GDP was still down -0.7% year-over-year in Q2 and we expect a very slow churn higher in Eurozone GDP in the balance of 2013. Certainly GDP will remain well below the pre-crisis average of 2.1% (since 2000) as the region hits the reset button on standards of spending and lending as budgets are readjusted at the government and household levels.  We maintain our call for 2013 GDP between -0.8% and -0.6% year-over-year.

Beyond struggling to reset spending and lifestyles habits, here are some significant hurdles that we expect will continue to weigh on Eurozone GDP:

  • The slim availability of credit, in particular to the small and medium sized businesses, the core drivers of growth and employment (see chart below on ECB Loans to Non-Financial Corporations and Households as proxy—at or near all-time lows)
  • Diminished credit quality of banks, especially across the periphery, as they report increasing non-performing loans
  • Further bank write-downs of non-performing assets
  • Labor market reforms slow to enact or institute at all
  • A protracted unemployment overhang, especially youth unemployment across the periphery, that will limit consumer spending and confidence
  •  Political uncertainty, in Italy, Spain, and Portugal, to weigh on budget reforms and confidence

UK Bulls as Eurozone Inches Out of Recession  - z. ecb lending


To throw out a couple anecdotes from the media stories we’ve recently come across that paint a still subdued outlook, we include:

  • The WSJ reported that auto sales in Europe are so bad that less than half the factories in the region operate at the minimum 75% of capacity needed to break even. It said that those operating below that level are mostly located in Italy, France, and Spain whose economies have been hit by the crisis. The article noted that governments in Western Europe are worried about seeing more workers join the ranks of the unemployed and that unions are aggressively protecting jobs, while the courts have also been sympathetic. The paper said that because of this, auto makers are losing billions of euros a year by retaining workers and factories they no longer need.
  • A poll by ING-DiBa AG and the University of Hohenheim shows that only 17% of Germans believe that the worst of the Eurozone crisis is over, while 91% think that the crisis will still go on for a long time. Only 10% of Germans believe that politicians are being honest with citizens regarding Eurozone issues.


Concluding Thoughts


Our call remains that into Q4 we expect European PMIs to hover around the 50 line (ups and downs) but not to show a material breakout given the very weak structural issues that we do not see inflecting materially over the intermediate term, including weak credit conditions, high unemployment, alongside political uncertainty at the country level – Italy, Spain, and France in particular.  We continue to be fundamentally bullish on German and the UK equities, so should we see any outperformance from PMIs, we think it could come from these two countries.


As it relates to the capital markets, we think a much larger force versus marginal improvement in fundamental data is the political resolve of the Eurocrats and Draghi to lend fund if needed (back-pocket OMT ready) and prevent any country from leaving the Eurozone, which we think can continue to stabilize and push markets higher. Already we’re seeing domestic and international investors become increasingly confident in Draghi’s heavy hand and buying distressed asset, for example housing in Spain and bank debt across the periphery, as the EU banking system slowly continues to heal.      


Enjoy the weekend!


Matthew Hedrick

Senior Analyst

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Hedgeye CEO Keith McCullough weighs in on the state of the markets including #EOW ("End of the World" trade) and the continuing rout of US Treasuries (yes, China holds $1.3T of those ... and they're selling).


End of the World? Get Real

Client Talking Points


Treasury yields are making higher-lows and higher-highs based on strength in the only leading indicator that matters in our employment model (non-seasonally adjusted rolling jobless claims). No, the world probably will not end on the continuing positive developments going on in US employment. 2.66-2.79% is now my 10-year risk range. It's very simple: Buy growth stocks; sell Treasuries – rinse and repeat.


It looks like someone apparently forgot to tell European markets that the world ended in the good 'ole USA yesterday (i.e. the fleeting, freak out "End of World" trade). So what is Europe doing? How about absolutely nothing except holding onto their recent gains. So no, they did not freak out. We finally had our opportunity to buy British Equities on red yesterday via (EWU). We did.


If you want to freak out about a country, pick one with A) #GrowthSlowing and B) #InflationAccelerating as their currency implodes. Yes, that there would be India. And that’s the only market that really got tagged overnight. It was down -3.3% to -2.5% year-to-date.Not a pretty market picture there.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.


Gaming, Leisure & Lodging sector head Todd Jordan says Melco International Entertainment stands to benefit from a major new European casino rollout.  An MPEL controlling entity, Melco International Development, is eyeing participation in a US$1 billion gaming project in Barcelona.  The new project, to be called “BCN World,” will start with a single resort with 1,100 hotel beds, a casino, and a theater.  Longer term, the objective is for BCN World to have six resorts.  The first property is scheduled to open for business in 2016. 


Health Care sector head Tom Tobin has identified a number of tailwinds in the near and longer term that act as tailwinds to the hospital industry, and HCA in particular. This includes: Utilization, Maternity Trends as well as Pent-Up Demand and Acuity. The demographic shift towards more health care – driven by a gradually improving economy, improving employment trends, and accelerating new household formation and births – is a meaningful Macro factor and likely to lead to improving revenue and volume trends moving forward.  Near-term market mayhem should not hamper this  trend, even if it means slightly higher borrowing costs for hospitals down the road. 

Three for the Road


TREASURIES: monster move in #RatesRising remains a pro-growth signal that growth bears missed, 2.77% 10yr last @KeithMcCullough


“Fear is static that prevents me from hearing myself.” -Samuel Butler


The Yield Spread (10-year -2-year) which is a great leading indicator for US growth is up +15 basis points this week to +243 basis points wide.

August 16, 2013

August 16, 2013 - dtr



August 16, 2013 - 10yr

August 16, 2013 - spx

August 16, 2013 - nik

August 16, 2013 - ftse

August 16, 2013 - dxy

August 16, 2013 - euro

August 16, 2013 - oil



August 16, 2013 - VIX

August 16, 2013 - yen

August 16, 2013 - natgas
August 16, 2013 - gold

August 16, 2013 - copper



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