This note was originally published at 8am on September 16, 2013 for Hedgeye subscribers.
“Ah, summer, what power you have to make us suffer and like it.”
In more ways than one, summer ends this week. And, oh, what a summer it was. My wife, kids, and I spent our last summer Saturday up at West Point watching the Army vs Stanford football game. By Sunday morning I was back on the ice, coaching the kids.
With summer’s end I get football, hockey, and another US stock market rip. The SP500 is already +3.4% for September. We’ll test the 2013 YTD highs again this morning, right as consensus got too bearish (again).
Indeed. With American growth prospects trading at their highest premium to #EOW (end of the world) in half a decade, Larry Summer’s chances to run the Fed are over this morning too.
Back to the Global Macro Grind…
While I was surprised to see Summer’s prospects end so quickly, I was more shocked to see Gold go down on that. In anticipation of ultra-dove, Janet Yellen, getting the nod as un-elected central-market-planner-in-Chief, we’re going to have a Dollar Down day.
Dollar Down equates to what? Well, that depends on what risk management duration you are using. If you are using a longer-term duration (say our TREND duration, 180 days) here’s what the US Dollar’s correlation matrix looks like:
- SP500 = +0.49
- Gold = -0.54
- Oil = -0.60
In other words, from an intermediate-term TREND perspective, Summer’s End should = Dollar Down, Stocks Down, Gold/Oil Up. But the exact opposite of that is happening this morning. Why?
Well, let’s get all wild and multi-duration here, and see what USD correlations look like on a shorter term duration (30 days):
- SP500 = -0.16
- Gold = +0.26
- Oil = +0.63
In other words, from an immediate-term TRADE perspective, Summer’s End = Dollar Down, Stocks Up, Gold/Oil Down.
We call this Duration Mismatch – and I absolutely love it, because it drives the machines right squirrel. You see, nothing in Global Macro risk management happens in a linear 1-factor, 1-duration, box. That’s because markets are non-linear.
While what we call Correlation Risks can (and have) “blown out” across durations from time to time, assuming that’s going to trend as a constant is a really bad assumption. Correlations aren’t perpetual.
#OldWall’s media doesn’t completely get the Chaos Theory of it all, so they tend to write about markets that are correlating across durations as “risk on or off.” Whereas the only risk that’s really on here is assuming that risk trades that way.
Back to Yellen over Summers… I have more questions than answers this morning:
- What if Janet Yellen completely loses control of the bond market in 2014?
- What if Gold’s #bff (Bernanke) being gone for good is the point that matters most?
- What if Yellen doesn’t get the job altogether?
While the answer to that last question is improbable, with the US Dollar trading higher for 4 of the last 5 weeks I think the market would have considered Summer’s End improbable this morning too. Embrace the improbable.
While some apologists who have missed the entire rally in US growth stocks in 2013 would have you believe that the entire Global Macro market moves as a monolith, what Mr. Market is reminding you this morning is that that’s a dumb belief.
Alongside the Fed, there are plenty of major Global Macro risks moving Equities, Gold and Oil this morning - not the least of which are expectations in the Middle East being recalibrated.
Looking at last week’s drops in commodity prices, it’s also instructive to look at expectations in the futures and options market on a week over week basis:
- The total net long position in CFTC futures and options contracts declined -4.1% wk-over-wk
- Gold’s net long position dropped -16% wk-over-wk to +84,929 net longs (after hitting its highest net long position since JAN)
- Crude Oil’s net long position dropped another -5% wk-over-wk to +290,058 net longs after hitting an all-time high in AUG
All-time is a long time, and don’t forget to contextualize that point for the price of Oil as it’s making a lower-high versus one of the many Bernanke Bubble highs in asset classes (Oil’s all-time high = 2008).
Don’t get me wrong, Down Dollar probably gets me to take down our US Equity exposure again into this tidal wave of performance chasing this morning. But that would probably just mean selling more of what we bought when consensus pundits were telling you “this is it” for the umpteenth time in August as they were selling stocks 4% lower.
I say probably because I am not sure yet. I rarely am. How could you be if the President of the United States isn’t in the area code of certain on big decisions like Syria and Summers? As a result, my baseline strategy is to keep moving out there, because risk does.
Our immediate-term Risk Ranges are now:
UST 10yr Yield 2.80-2.99%
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
Takeaway: US sovereign swaps blew out 38% last week while high yield reversed its intermediate-term yield decline. JPMorgan was the large cap laggard.
* Sovereign CDS – U.S. sovereign swaps rose 9 bps last week, rising from 22 bps to 31 bps (a 38% increase). This week will be an interesting one. We think the dual probabilities of a protracted impasse coupled with a better than expected Friday employment report could reverse the recent QE-led downdraft in long-term yields.
* 2-10 Spread – Last week the 2-10 spread tightened to 229 bps, -11 bps tighter than a week ago. Spreads have come in notably since their mid/late August highs of 252 bps.
* Chinese Steel – Steel prices in China fell 1.0% last week, or 34 yuan/ton, to 3494 yuan/ton. Chinese steel prices have been in steady retreat since August.
* High Yield – High Yield rates rose 10.9 bps last week, ending the week at 6.30% versus 6.19% the prior week. This marks a reversal of the trend in place since mid/late August.
Financial Risk Monitor Summary
• Short-term(WoW): Negative / 1 of 13 improved / 6 out of 13 worsened / 6 of 13 unchanged
• Intermediate-term(WoW): Positive / 6 of 13 improved / 3 out of 13 worsened / 4 of 13 unchanged
• Long-term(WoW): Positive / 3 of 13 improved / 2 out of 13 worsened / 8 of 13 unchanged
1. U.S. Financial CDS - JPMorgan led large caps higher, rising by 10 bps as reports of a settlement amount ballooned. BAC and C rose by approximately half as much. Mortgage Insurers saw 27 and 24 bps increases last week, casting a bit of a pall over the housing outlook. Overall, swaps widened for 23 out of 27 domestic financial institutions.
Tightened the most WoW: TRV, CB, XL
Widened the most WoW: MBI, JPM, COF
Tightened the most WoW: AXP, TRV, GS
Widened the most MoM: MBI, AGO, SLM
2. European Financial CDS - Swaps were wider throughout Europe's banking system last week with the exception of Spanish banks. Interestingly, Euribor-OIS was unchanged suggesting perceptions of systemic risk have not moved.
3. Asian Financial CDS - Indian banks resumed their losing ways with State Bank of India posting a 47 bps W/W increase to 309 bps. The other two major Indian banks were up 25 and 19 bps as well. Chinese banks were wider by 8-10 bps, while Japan's banks were flat to tighter by single digit bps.
4. Sovereign CDS – U.S. sovereign swaps rose 9 bps last week, rising from 22 bps to 31 bps (a 38% increase). This week will be an interesting one. We think the dual probabilities of a protracted impasse coupled with a better than expected Friday employment report could reverse the recent QE-led downdraft in long-term yields. Elsewhere, Italian spreads rose by 19 bps while Portuguese spreads fell by 32 bps.
5. High Yield (YTM) Monitor – High Yield rates rose 10.9 bps last week, ending the week at 6.30% versus 6.19% the prior week.
6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 6.0 points last week, ending at 1806.
7. TED Spread Monitor – The TED spread fell 0.4 basis points last week, ending the week at 23.3 bps this week versus last week’s print of 23.7 bps.
8. CRB Commodity Price Index – The CRB index fell -0.9%, ending the week at 287 versus 290 the prior week. As compared with the prior month, commodity prices have decreased -2.3% We generally regard changes in commodity prices on the margin as having meaningful consumption implications.
9. Euribor-OIS Spread – The Euribor-OIS spread was again unchanged at 12 bps. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States. Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal. By contrast, the Euribor rate is the rate offered for unsecured interbank lending. Thus, the spread between the two isolates counterparty risk.
10. Chinese Interbank Rate (Shifon Index) – The Shifon Index fell 45 basis points last week, ending the week at 3.112% versus last week’s print of 3.557%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.
11. Markit MCDX Index Monitor – Last week spreads widened 3 bps, ending the week at 86 bps versus 83 bps the prior week. The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 16-V1.
12. Chinese Steel – Steel prices in China fell 1.0% last week, or 34 yuan/ton, to 3494 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.
13. 2-10 Spread – Last week the 2-10 spread tightened to 229 bps, -11 bps tighter than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.
14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.3% upside to TRADE resistance and 0.6% downside to TREND support.
Joshua Steiner, CFA
Jonathan Casteleyn, CFA, CMT
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Client Talking Points
Pay close attention tho this relationship. Versus the Burning Buck, a breakout in the Yen from here would matter to global correlation risk. Big time. Our intermediate-term TREND line for the YEN vs US Dollar is 97.88. The market is trading right at it here. As I have said many time before, the Nikkei "no likey" the #StrongYen. The Nikkei was down -2.1% overnight. It broke my immediate-term TRADE support line of 14,616. Blame Bernanke and Congress for my not buying this dip.
From Rome to Washington D.C., the political class is raging, globally, this morning. Don’t you just love it? A "no confidence" vote is now scheduled in Italy for Wednesday and the Italian MIB Index leads European losers. It's down -1.6% to start the week after breaking TRADE support of 17,493. Congress clearly has major problems, but we're keeping a close eye on this one too.
Phew. A bright spot. One of the few positives in global macro markets this morning is of course the price of Brent Oil. It snapped our long-term TAIL risk line of $108.57. It's down -0.8% last to $107.72. Guess what? A strong US employment report later this week could wreak total havoc on Oil bulls (and the bond market).
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Top Long Ideas
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.
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.
Financials sector senior analyst Jonathan Casteleyn continues to carry T. Rowe Price as his highest-conviction long call, based on the long-range reallocation out of bonds with investors continuing to move into stocks. T Rowe is one of the fastest growing equity asset managers and has consistently had the best performing stock funds over the past ten years.
Three for the Road
TWEET OF THE DAY
Yield Spread (and US growth expectations embedded therein) continues to compress thanks to Bernanke + Congress
QUOTE OF THE DAY
STAT OF THE DAY
800,000: The number of federal workers who would be sent home tomorrow if Congress fails to pass a stopgap spending bill before funding expires tonight.
THE MACAU METRO MONITOR, SEPTEMBER 30, 2013
PUBLIC SERVANTS WHO FREQUENT S'PORE CASINOS MUST DECLARE VISITS WITHIN SEVEN DAYS Strait Times
From Tuesday, all public servants will have to declare their visits to local casinos if they go more than four times a month or if they purchase an annual pass. The declaration must be made within seven days, said Singapore's Public Service Division (PSD) on Monday.
For officers "whose misconduct will have significant reputational risk to the Public Service," every visit to a casino must be declared to their superiors, it added, but did not specify who would be subject to this more stringent rule. The new regulations come in the wake of several high-profile cases of misconduct by top public servants.
HO SEEKS JAPAN CASINO AS DEVELOPMENT LIMITS LOOM IN MACAU Bloomberg
Lawrence Ho plans to invest more than $5 billion in Japan if MPEL receives permission to build a casino there as he sees constraints on development at home. “We still have the most eggs in the Macau basket. Given the Macau government and the Chinese government want to control the growth rate, the company is seeking other opportunities outside the city. Macau is a small place. As much as I want to build a theme park, we just don’t have the land to do it....The potential is huge. If Japan opens up and allows integrated resorts in Tokyo, Osaka, the market could easily be in excess of $10 billion to $15 billion or more,” said Ho. Ho adds that he has been lobbying multiple cabinet members in Japan for the legalization of casinos. He sees “significant” non-gaming revenue for the country because “there’s so much to do, so much to see. Japan has a rich culture,” the executive said.
Ho plans to build Japan casino resorts, preferably in Tokyo and Osaka, through Melco Crown. WYNN, MGM, LVS, and CZR are also seeking expansion opportunities in Japan as Tokyo’s selection to host the 2020 Olympics boosts confidence the government will legalize casinos.
Ho expects casino revenues in Macau will grow at least 10% in 2014 as the global economy improves.
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