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THE “GREAT INFLATION”: FROM WHERE?

Takeaway: Global CPI readings should trend higher in the short-term, but to low absolute levels before resuming their current disinflationary trend.

This note was originally published January 25, 2013 at 16:41 in Macro

THE “GREAT INFLATION”: FROM WHERE? - INFLO

SUMMARY BULLETS:

  • After several meetings on the road with clients and prospective clients this week, it became clear to our team that a noteworthy competitor of ours is making noise about a demonstrable pickup in inflationary pressures that will slow inflation-adjusted GDP growth across the globe.
  • While we would agree that CPI readings are going to, on balance, trend higher here in 1Q and perhaps through 2Q as well, we completely disagree with the premise and conclusion of the aforementioned view.
  • Broadly speaking, we think reported CPI readings are poised to continue their rocky path lower over the next several quarters, fully equipped with a transient bounce(s) to demonstrably lower cycle peaks relative to their 2008 and 2011 highs.
  • Our call for reported inflation to broadly continue making a series of lower-highs is backed by our call for the DXY continue making a series of higher-lows while the global commodities basket (via CRB Index) continues to make a series of lower-highs.

 

At Hedgeye, we have developed a proprietary modeling process that allows us to front-run both consensus estimates of and the actual reported growth and inflation readings of any country, region or economic bloc (such as the world, on a GDP-weighted basis). In the note below, we walk through what this rigorous analytical process is signaling to us right now.

 

STEP #1: QUANTITATIVE SIGNAL(S)

Unlike many researchers who impose their theses and theories upon the market – usually the “smartest guys in the room” types – our research process remains grounded in uncertainty. We use a proven, three-factor quantitative overlay to consistently guide us to the most appropriate places to “fish”.

 

Right now, those signals are suggesting the US Dollar Index is poised to continue making a series of higher-lows over the intermediate-to-long term. That view is underpinned by our uber-bullish bias on US housing, our street-leading expectations for US employment growth and our call for a currency crisis in Japan.

 

THE “GREAT INFLATION”: FROM WHERE? - BOOM1

 

We have been vocal about our call for the domestic housing market and the yen in recent weeks/months, as culminated in our 1Q13 Macro Themes of #HousingsHammer and #Quadrill-yen. Our updated thoughts on the domestic labor market can be found in the notes below:

 

 

Moving along, we anticipate that the confluence of the domestic factors highlighted above will result in the FX market pulling forward its expectations of the culmination of QE (which, on the margin, would likely be functionally equivalent to a rate hike).

 

That’s explicitly bullish for America’s currency and bearish for commodities and international inflation hedges – which are broadly priced in and settled in US dollars internationally.

 

THE “GREAT INFLATION”: FROM WHERE? - 2

 

THE “GREAT INFLATION”: FROM WHERE? - 3

 

At least for now, domestic interest rates are confirming this view:

 

THE “GREAT INFLATION”: FROM WHERE? - 4

 

STEP #2: GIP MODEL

Now that we know where to look from a quantitative perspective, we turn to our predictive tracking algorithms to guide us to hard numbers on the economic data front. With respect to Bloomberg’s GDP-weighted world CPI YoY index specifically, our algorithm backtests with an r² of 0.76 on the median estimate.

 

For background, the model is purposefully designed to produce a high, mid and low estimate and we use the respective market-based quantitative signals to guide our expectations to the higher or lower of the two economic data risk ranges.

 

Applying the same algorithm to a particular country, region or economic bloc’s GDP growth figures allows us to triangulate the associated sequential deltas and monetary/fiscal policy implications on our GIP chart. Currently, the world is entering Quad #2 on this analysis (i.e. Growth Accelerates as Inflation Accelerates).

 

THE “GREAT INFLATION”: FROM WHERE? - WORLD

 

Taking a broader perspective of what the model is signaling to us, we can rest assured that any near-term pickup in reported inflation across the world (again, generally speaking) will be both transient and to absolute levels that we would consider not threatening to economic growth.

 

THE “GREAT INFLATION”: FROM WHERE? - 6

 

As the chart above highlights, our model has been better than bad at calling for major inflection points and trends in global inflation readings for the past 4-5 years, so we feel comfortable with its summary outputs in the absence of disconfirming evidence.

 

STEP #3 THE SEARCH FOR CONFIRMING OR DISCONFIRMING EVIDENCE

It would be intellectually lazy to rest our call on the confluence of quantitative signals and the output of our modeling of economic data. Rather, the appropriate exercise – which is what we spend all day doing when not publishing research or engaging with clients – is to constantly vet confirming or disconfirming evidence.

 

With respect to commodities specifically – which we think holds a slightly leading relationship with reported CPI readings globally (varies by country based on index weights) – we are coming up with some particularly muted YoY gains when you streamline current prices throughout the year, which is in and of itself a generous assumption.

 

In fact, the current estimate of a JUN ’13 peak of +10% is well off the peak YoY growth rates of we saw in the summer of 2008 (+45.4%) and the summer of 2011 (+37.2%).

 

THE “GREAT INFLATION”: FROM WHERE? - 7

 

Our Global Macro team continues to hold the view that commodities – particularly food and energy price inflation/deflation - have become the largest contributors to the direction and magnitude of global inflation readings in the post-crisis era of muted/nonexistent labor and income growth across the key developed markets. Slack capacity utilization also remains a headwind for the economic growth-driven inflation policymakers have been desperately searching for across much of the developed world.

 

You can see the obvious aforementioned relationship in the following chart of median YoY CPI readings of the US, Eurozone and China overlaid with our commodity price sample:

 

THE “GREAT INFLATION”: FROM WHERE? - 8

 

Net-net-net, it’s really tough to get to anything more than +3% inflation in the world’s three largest economies on a median basis by mid-summer without some meaningful degree of commodity price inflation from here – which is precisely what we do not expect to happen. If anything, further weakness across key commodity markets should augment our call for lower-highs in global reported inflation readings throughout the year.

 

Looking to the previous chart, we don't find it at all ironic that the universal view of "price stability" across developed central banks anchors on +2% YoY CPI when considering that the same +2% happens to align with neither inflation nor deflation in international commodity markets. The deep simplicity of chaos theory strikes again...

 

On the disconfirming evidence side, both Oil and the EUR are outliers here; each looks good quantitatively at the current juncture and both stand completely counter to our call for strength in the DXY and weakness across the commodity complex (energy prices are a key driver) over the intermediate term.

 

THE “GREAT INFLATION”: FROM WHERE? - 9

 

THE “GREAT INFLATION”: FROM WHERE? - 10

 

While it’s rather difficult for us to endorse a rock-solid fundamental call on either asset class at the current juncture, we think our non-consensus fundamental thesis regarding the USD and international commodities prices will ultimately prevail. For now, however, both crude oil and the EUR remain the two largest financial market-based risks to this view.

 

CONCLUSION

All told, our models, signals and the data all suggest global inflation readings should trend higher in the short-term, but to low absolute levels relative to their prior peaks. As such, the current disinflationary trend across the world economy is very much intact.

 

Have a wonderful weekend,

 

Darius Dale

Senior Analyst


GROWTH & INFLATION: WHAT NEXT?

Takeaway: We continue to hold a directionally positive outlook for global growth and a dovish outlook for global inflation (TREND duration).

This note was originally published May 20, 2013 at 15:23 in Macro

 GROWTH & INFLATION: WHAT NEXT? - yum

SUMMARY BULLETS:

  • Our proprietary GIP (short for “Growth, Inflation and Policy”) model continues to signal further nirvana for global economy. Specifically, the world is projected to remain in Quad #1 – which is a state denoted by real GDP growth accelerating as CPI decelerates – for the second-straight quarter here in 2Q13E.
  • Incorrectly interpreting YTD commodity price declines – which we have repeatedly identified as a stimulus to the global economy, rather than harbinger of souring economic trends – the bears missed the turn from Quad #3 in 4Q12 to Quad #1 in 1Q13 and we think they are missing the staying power we see at the current juncture as well.
  • A counter-consensus acceleration in global growth is something we think super-sovereign bond markets are starting to focus on. If US Treasuries, German Bunds and JGBs all have one thing in common, it’s that they are allergic to economic growth (review HERE and HERE for more details).
  • Jumping over to our outlook for global inflation, we continue to view the inverse relationship between the USD and the prices of international commodities as a casual factor for the slope of reported inflation readings across the globe (on various lags, due to cross-country variance in CPI basket weightings). That relationship continues to underpin our dovish outlook for global inflation – which is perhaps the most counter-consensus economic call we have [correctly] made all year (review HERE and HERE for more details).
  • We continue to sing the praises of #StrongDollar and the associated leeway incremental commodity deflation is creating for economic growth to surprise to the upside over the intermediate term. Insomuch as #StrongDollar has been a bearish signal for regressive assets like Gold, it has become a bullish signal for pro-growth assets like equities.
  • To that tune, the US Dollar Index holds positive correlations of +0.90 and +0.80 with the S&P 500 and MSCI World Equity Index, respectively, on our immediate-term duration. That contrasts with the -0.86 and -0.61 inverse correlations it holds with Gold and the VIX, respectively, on that same duration. While these statistical relationships are more intense in recent weeks, those directional signals are consistent across the trailing six months of our cross-asset class regression analyses.

 

THE MODEL

A decade-plus of research and remodeling has helped our macro team develop a predictive tracking algorithm that keeps us 1-2 quarters ahead of the Street on any country or region’s growth and inflation trends. The model isn’t designed with the intent of playing “pin-the-tail-on-the-sell-side-donkey” from a forecasting perspective, but rather designed to proactively signal accelerations, decelerations and inflections in the rates of change (i.e. 2nd derivative) for both growth and inflation. Using the US as an example, the model backtests with an r² of 0.82 for growth and an r² of 0.69 for inflation.

 

Our macro forecasting model, which is as differentiated as anything you’ll find on the Street, has been [accurately] modeling “countries like companies” for a past ~5 years. As an aside, this practitioner’s approach to macro investing was most recently made popular by Dan Loeb at this year’s SALT conference.

 

Jumping back into it, our proprietary GIP (short for “Growth, Inflation and Policy”) model continues to signal further nirvana for global economy. Specifically, the world is projected to remain in Quad #1 – which is a state denoted by real GDP growth accelerating as CPI decelerates – for the second-straight quarter here in 2Q13E.

 

 GROWTH & INFLATION: WHAT NEXT? - dale1

 

Incorrectly interpreting YTD commodity price declines – which we have repeatedly identified as a stimulus to the global economy, rather than harbinger of souring economic trends – the bears missed the turn from Quad #3 in 4Q12 to Quad #1 in 1Q13 and we think they are missing the staying power we see at the current juncture as well.

 

 GROWTH & INFLATION: WHAT NEXT? - CRB

 

THE SEARCH FOR CONFIRMING AND DISCONFIRMING EVIDENCE

At Hedgeye, we don’t think it’s enough to just rest on the conclusions of any model(s); rather, it ultimately pays to vet any research assumptions with confirming and/or disconfirming evidence. In this vein, the evidence continues to affirm the conclusions laid out above.

 

Looking to global growth, APR PMI data continues to signal positive sequential growth – albeit at a slightly slower rate. Specifically, the median of our 39-index sample of PMI data from all of the key countries and economic blocks was essentially flat MoM, dropping a mere -10bps to 50.8.


 GROWTH & INFLATION: WHAT NEXT? - PMI Scatter

 

Sequential gains (i.e. positive 1st derivative growth) from larger numbers bodes well for continued acceleration in the YoY real GDP growth figures (i.e. positive 2nd derivate growth), which our model is currently predicting – especially in the context of easier 1Y comps as highlighted in the aforementioned GIP chart and in the chart below. Students of Bayesian statistics understand full well that the base rate is just as important to determining the direction and magnitude of growth figures as the most recent sequential deltas.

 

 GROWTH & INFLATION: WHAT NEXT? - JPM PMI

 

A counter-consensus acceleration in global growth is something we think super-sovereign bond markets are starting to focus on. If US Treasuries, German Bunds and JGBs all have one thing in common, it’s that they are allergic to economic growth (review HERE and HERE for more details).

 

 GROWTH & INFLATION: WHAT NEXT? - 10 2

 

Jumping over to our outlook for global inflation, we continue to view the inverse relationship between the USD and the prices of international commodities as a casual factor for the slope of reported inflation readings across the globe (on various lags, due to cross-country variance in CPI basket weightings). That relationship continues to underpin our dovish outlook for global inflation – which is perhaps the most counter-consensus economic call we have [correctly] made all year (review HERE and HERE for more details).

 

 GROWTH & INFLATION: WHAT NEXT? - DXY YoY vs. CRB YoY

 

 GROWTH & INFLATION: WHAT NEXT? - CRB YoY vs. CPI YoY

 

Our dovish outlook for global inflation continues to be both perpetuated and confirmed by our quantitative risk management signals:

 

 GROWTH & INFLATION: WHAT NEXT? - DXY

 

 GROWTH & INFLATION: WHAT NEXT? - OIL

 

 GROWTH & INFLATION: WHAT NEXT? - GOLD

 

THE INVESTMENT CONCLUSIONS

All told, 2013 has been quite a year for top-calling and anchoring on mini-crises of non-epic proportions, which tells us one thing: there are large pockets of the investment community that continue to stare at the tree(s) in lieu of the forest. This is inclusive of this latest global growth scare of the past 4-6 weeks, as indicated by plummeting economic surprise indices.

 

 GROWTH & INFLATION: WHAT NEXT? - Econ Surprise

 

That being said, however, we continue to sing the praises of #StrongDollar and the associated leeway incremental commodity deflation is creating for economic growth to surprise to the upside over the intermediate term. Insomuch as #StrongDollar has been a bearish signal for regressive assets like Gold, it has become a bullish signal for pro-growth assets like equities.

 

 GROWTH & INFLATION: WHAT NEXT? - Oil 3M

 

To that tune, the US Dollar Index holds positive correlations of +0.90 and +0.80 with the S&P 500 and MSCI World Equity Index, respectively, on our immediate-term duration. That contrasts with the -0.86 and -0.61 inverse correlations it holds with Gold and the VIX, respectively, on that same duration. While these statistical relationships are more intense in recent weeks, those directional signals are consistent across the trailing six months of our cross-asset class regression analyses.

 

Focus on the forest, not the trees.

 

Darius Dale

Senior Analyst


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XRAY MEETS #EUROBULLS

Takeaway: XRAY likely to continue working on improving European trends and sentiment cycling higher.

Editor's note: Below is a brief excerpt from a report issued earlier this morning by Hedgeye Healthcare Sector Head Tom Tobin. For more information on how you can subscribe to Hedgeye research click here.

 

XRAY MEETS #EUROBULLS - dent1

Conclusion: Q313 Inline, Staying Long

Q313 came in as we expected for DENTSPLY International Inc. (XRAY), although management threw up a few warning signs for Q413, but nothing that will generate a miss. Despite closing the relative performance gap since our initial position,and a rapidly expanding multiple, we'll stick with the long here.

Thesis:  Revision Cycle

Our original thesis on XRAY shares came from confidence in our outlook for the US Dental Market.  At the time, XRAY shares were under-performing, sellside sentiment was on a multi-year low, short interest was falling, and European trends appeared to be stabilizing. 

 

Our view was that as the European region recovered economically, so to should the internal growth rates for XRAY's EU business, driving a significant part of XRAY's revenue, and subsequently, sentiment higher.  Similar to the US, growth for XRAY overseas business is driven by the changes in employment and GDP related factors.  Unlike most names in HC, sellside ratings and short interest matter to XRAY's price performance.

 

>>> CLICK HERE to watch Hedgeye's #1 Q4 Macro Theme: #EuroBulls <<<


XRAY MEETS #EUROBULLS - tobin1


Toppy? SP500 Levels, Refreshed

Takeaway: If The USD and rates fail here, this market has plenty of downside risks.

POSITION: 8 LONGS, 6 SHORTS @Hedgeye

 

I’m buying Gold and Treasuries for the 1st time in a year (today) as the SP500 signals lower-highs and the VIX signals higher-lows. If The USD and rates fail here, this market has plenty of downside risks.

 

Across our core risk management durations, here are the lines that matter to me most:

 

  1. Immediate-term TRADE resistance = 1771
  2. Immediate-term TRADE support = 1744
  3. Intermediate-term TREND support = 1683

 

In other words, with the all-time closing high (1771) registering as resistance, there’s plenty of mean reversion downside. If the market stops me out of these thoughts, so be it. But sentiment (II Bull/Bear Spread) is tracking at its YTD high now too.

 

KM

 

Keith McCullough

Chief Executive Officer

 

Toppy? SP500 Levels, Refreshed - SPX


INDIA’S “TURNAROUND STORY” CONTINUES

Takeaway: With its recent rate hike, India continues down the path towards much-needed monetary and fiscal policy reform. That’s a good thing.

This note was originally published October 29, 2013 at 15:26 in Macro

INDIA’S “TURNAROUND STORY” CONTINUES - tiger2

SUMMARY BULLETS:

  • A continued pursuit of demonstrably tighter monetary policy in India would be positive for the country’s structural GIP outlook in three ways:
    1. Inflation decelerating to levels consistent with its regional/global peers (benchmark WPI has averaged +7.6% since the Congress Party took the helm in mid-2009 vs. a GDP-weighted average of +5.1% YoY for “BRIC” economies since then);
    2. Fiscal policy stability amid lower inflation (i.e. the #1 political issue in India) and a reduction in the fiscal deficit/GDP ratio (5.8% in 2Q13) via lower subsidy expenditures (13.7% of total expenditures); and
    3. Lower domestic demand and higher real interest rates contributing to an improved domestic savings/investment ratio would tighten up the bloated current account deficit (the latest current account deficit/GDP ratio came in at 5.3% for 2Q13).
  • Additionally, India is also developing some noteworthy tailwinds with respect to its intermediate-to-long-term fiscal policy outlook that are likely to make the country’s equity and debt capital markets look increasingly attractive on the long side at the current juncture (CLICK HERE for more details).

 

In conjunction with its newfound hawkish bias, the RBI hiked its benchmark policy rates today by +25bps, taking the repo rate and reverse repo rate up to 7.75% and 6.75%, respectively. The bank, led by its new governor Raghuram Rajan, also lowered its marginal standing facility rate -25bps to 8.75% (a continued unwind of former governor Subbarao’s INR crisis measures) and held its cash reserve ratio flat at 4%.

 

INDIA’S “TURNAROUND STORY” CONTINUES - dale1

 

Today’s hike was predicted by 32 of 42 analysts surveyed by Bloomberg, a marked shift from Rajan’s first hike roughly 1M ago when we were the only firm on the Street calling for this demonstrable shift to tighter monetary policy in India. Indeed, the Indian rupee has appreciated +2.2% vs. the USD since we began to call for the currency to strengthen amid this drive to combat inflation back on SEP 20. That is the largest gain across the 21 currency markets we actively cover across Asia and Latin America over that time frame.

 

INDIA’S “TURNAROUND STORY” CONTINUES - 2

 

At the time, we thought investors would penalize India’s equity and debt capital markets for what appeared to be the start of a prolonged series of rate hikes, but with the SENSEX Index up +3.3%, 10Y INR Yields flat and 2Y INR Yields down -44bps since then, it appears investors feel very comfortable looking through this obvious near-term headwind to economic growth with an eye towards an improving structural outlook – a scenario we discussed then, but ultimately failed to sign off on at the time.

 

INDIA’S “TURNAROUND STORY” CONTINUES - 3

 

INDIA’S “TURNAROUND STORY” CONTINUES - 4

 

INDIA’S “TURNAROUND STORY” CONTINUES - 5

 

Going back to the aforementioned rate hike, accompanying commentary from the Dr. Rajan-led RBI board was undeniably hawkish:

 

  • “We can’t live with close to double-digit CPI for an extended period of time.”
  • “It is important to break the spiral of rising price pressures in order to curb the erosion of financial saving and strengthen the foundations of growth.”
  • “Wholesale-price inflation is expected to remain higher than current levels through most of the remaining part of the year, with consumer inflation probably remaining around or above 9 percent.”

 

Indeed, a continued pursuit of demonstrably tighter monetary policy in India would be positive for the country’s structural GIP outlook in three ways:

 

  1. Inflation decelerating to levels consistent with its regional/global peers (CPI has averaged +9.9% YoY since over the past 3Y vs. a GDP-weighted average of +5.3% YoY for “BRIC” economies over that same duration);
  2. Fiscal policy stability amid lower inflation (i.e. the #1 political issue in India) and a reduction in the fiscal deficit/GDP ratio (5.8% in 2Q13) via lower subsidy expenditures (13.7% of total expenditures); and
  3. Lower domestic demand and higher real interest rates contributing to an improved domestic savings/investment ratio would tighten up the bloated current account deficit (the latest current account deficit/GDP ratio came in at 5.3% for 2Q13).

 

It’s worth noting that the +90bps premium to the benchmark repo rate is a signal that participants in India’s on-shore swaps market are pricing in the equivalent of 3-4 more +25bps rate hikes over the NTM.

 

INDIA’S “TURNAROUND STORY” CONTINUES - 6

 

INDIA’S “TURNAROUND STORY” CONTINUES - 7

 

INDIA’S “TURNAROUND STORY” CONTINUES - 8

 

Indeed, this is the three-pronged “turnaround story” we think investors have begun to speculate on recently and, with Global Macro entropy at levels not seen since early 2Q, we continue to think it pays to play the long and short side of EM assets on idiosyncratic country fundamentals in the absence of a clear, co-directional trend in the USD and US interest rates.

 

On that front, India is also developing some noteworthy tailwinds with respect to its intermediate-to-long-term fiscal policy outlook that are likely to make the country’s equity and debt capital markets look increasingly attractive on the long side at the current juncture (CLICK HERE for more details).

 

Of course, a confirmed quantitative breakdown in the DXY through its long-term TAIL line of support in conjunction with a breakdown in the UST 10Y Yield through its intermediate-term TREND line of support would make us broadly bullish on emerging market assets, amongst other asset classes (CLICK HERE for more details).

 

INDIA’S “TURNAROUND STORY” CONTINUES - DXY

 

INDIA’S “TURNAROUND STORY” CONTINUES - UST 10Y

 

Our central planning overlords at the Fed convene today and tomorrow to determine which asset classes we are allowed to speculate in; we await their commands with baited breath. If the most recent fundamental and quantitative signals (CLICK HERE for more details) are correct, investors will continue getting paid to speculate in emerging market assets with respect to the intermediate-term TREND. In the context of India’s real GDP growth basing here in the fourth quarter, that bodes well for INR denominated assets.

 

INDIA’S “TURNAROUND STORY” CONTINUES - INDIA

 

Lastly, the SENSEX Index is within a half-a-percent from its all-time high; we would interpret a close above that price as a quantitative signal that India’s well-documented policy blunders (email us for “the list”) are likely/finally in the rear-view mirror. That would be HUGE for helping India finally tap into its vast growth potential. It’s worth noting that real GDP growth has decelerated to a decade-low of +5% in the most recent fiscal year and even further to +4.4% YoY in 2Q13 (-1.1x standard deviations below the trailing 3Y mean); additionally, today the RBI reduced its FY14 GDP forecast to +5%, which is -50bps below the previous estimate of +5.5%.

 

INDIA’S “TURNAROUND STORY” CONTINUES - 12

 

Please feel free to ping us with any follow-up questions.

 

Darius Dale

Associate: Macro Team


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.64%
  • SHORT SIGNALS 78.61%
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