Takeaway: We remain broadly bearish on EM assets and continue to think that absolute returns for EM assets will be negative over the intermediate term
Editor's note: This complimentary, unlocked research note was originally published January 27, 2014 at 13:23 in Macro. For more information on how you can subscribe to Hedgeye click here.
- We continue to think it’s of utmost importance for investors to proactively prepare their portfolios for what we continue to see as the next cycle of emerging market crises.
- We remain broadly bearish on EM assets and continue to see them for what they are: overpriced relative to a long-term TAIL investment cycle that has clearly turned in favor of DM assets, at the margins. For some long ideas in the DM space, look no further than our #EuroBulls theme, which continues to augur well for appreciation across the UK and German capital and currency markets.
- We continue to think that absolute returns for EM assets will be negative over the intermediate term. In fact, we continue to believe that EM assets lose in two out of the three most probable intermediate-term global macro scenarios. As such, we don’t think discretion is overly warranted until investors drill down into the country level.
- Here are three more important things to highlight: 1) the US Dollar Index remains broken TREND and TAIL (old news); 2) the 10Y Treasury Yield is now below its TREND line (new news); and 3) the CRB Index is now trading above its TREND line (new news). If this setup continues to manifest in the face of declining risk aversion, then we could get behind EM assets on the long side for trade.
- For now, however, we’re comfortable with our current positioning. The SPX is now testing its TREND line of support (1779); a confirmed breakdown below that level in conjunction with the VIX remaining above its TREND line does not augur well for declining risk aversion with respect to the intermediate term.
Needless to say, last week was a brutal week if you were running a EM FX carry-trading strategy(ies) or, if you’ve been conditioned by the past ~10Y to be permanently bullish on emerging market assets.
As of Friday’s close, the JPM EM Currency Index had fallen -1.8% WoW; LatAm – which remains our favorite region on the short side of EM capital and currency markets – led decliners with the Bloomberg/JPM LatAm Currency Index falling -3.2% WoW. The iShares MSCI Emerging Markets Index ETF (EEM) declined nearly -4% last week and is now down -8.5% for the YTD.
*As of Friday's close.
*As of Friday's close.
The Argentine peso was undoubtedly the life of the party, declining over -15% last week. If you missed our note from last Thursday titled: “ARGENTINE DEFAULT 2.0?”, we encourage you to review it whenever you have a few minutes to spare; it’s a must-read for any investor attempting to understand the myriad of idiosyncratic risks that one must consider when allocating capital to emerging markets at this stage in the cycle.
We continue to think it’s of utmost importance for investors to proactively prepare their portfolios for what we continue to see as the next cycle of emerging market crises. Contrast the following preparation below with the hyperbolic and emotional research that you’ve likely been spammed with from the sell-side over the past ~72 hours:
- 4/16/13: 2Q13 Macro Theme: #EmergingOutflows
- 4/23/13: Presentation: Emerging Market Crises: Identifying, Contextualizing and Navigating Key Risks in the Next Cycle
- 4/29/13: Expert Call w/ Carl E. Walter: Will China Break?
- 6/12/13: Presentation: Are You Short China [and Other] Emerging Markets Yet?
- 7/15/13: 3Q13 Macro Theme: #AsianContagion
- 8/30/13: Presentation: Paddling Upstream?: Navigating #EmergingOutflows
- 12/20/13: Presentation: #EmergingOutflows: More Pain to Come?
All told, we remain broadly bearish on EM assets and continue to see them for what they are: overpriced relative to a long-term TAIL investment cycle that has clearly turned in favor of DM assets, at the margins. For some long ideas in the DM space, look no further than our #EuroBulls theme, which continues to augur well for appreciation across the UK and German capital and currency markets.
When we last left off, we had a number of ways to play this view within the construct of EM assets; below is a review of that strategy:
- ASSET CLASS LEVEL: a cumulative -117bps of equal-weighted performance
- Overweight EEM: -6.5%
- Underweight EMLC: -5.4%
- REGIONAL LEVEL: a cumulative +18bps of equal-weighted performance
- Overweight GUR: -7.5%
- Underweight GML: -7.7%
- COUNTRY LEVEL: a cumulative +614bps of equal-weighted performance
- Overweight EWW: -8.6%
- Overweight EPOL: -3.6%
- Overweight RSX: -9.5%
- Overweight EWY: -6.6%
- Overweight EWT: -2.4%
- Underweight EWZ: -8.6%
- Underweight ECH: -7.4%
- Underweight EIDO: +1.2%
- Underweight THD: -5.9%
- Underweight TUR: -14.7%
Obviously if we were running a fund, we would not have these positions on in equal weights; we’ve obviously been the loudest EM bears on the street since last APR, so it would only make sense to size the shorts appropriately larger than the longs.
From here, we continue to think that absolute returns for EM assets will be negative over the intermediate term. In fact, we continue to believe that EM assets lose in two out of the three most probable intermediate-term global macro scenarios. As such, we don’t think discretion is overly warranted until investors drill down into the country level.
In that vein, the only change we would make there would be to remove Russia (RSX) and Mexico (EWW) from the overweight ideas. Crude oil is now bearish TREND and TAIL on our quant factoring and we no longer wish to seek out that exposure on the long side. Indonesia (EIDO) is nowhere near as compelling on the short side as it once was, given the recent acceleration in hawkish rhetoric out of Bank Indonesia; still, we’d like to see them put their money where their mouth is in that regard (i.e. hike rates again) before we can get behind a turnaround story here.
Here are three more important things to highlight: 1) the US Dollar Index remains broken TREND and TAIL (old news); 2) the 10Y Treasury Yield is now below its TREND line (new news); and 3) the CRB Index is now trading above its TREND line (new news). If this setup continues to manifest in the face of declining risk aversion, then we could get behind EM assets on the long side for trade.
For now, however, we’re comfortable with our current positioning. The SPX is now testing its TREND line of support (1779); a confirmed breakdown below that level in conjunction with the VIX remaining above its TREND line does not augur well for declining risk aversion with respect to the intermediate term.
For more details about our multi-factor, multi-duration quantitative overlay, please refer to slide #5 of our 1Q14 Macro Themes presentation. It remains unclear to us how so many strategists make calls on markets without a proven process to contextualize critical inflection points in global markets in real-time, but to each his/her own.
At any rate, we’ll stick with our process for marrying bottom-up macro fundamentals (e.g. our proprietary EM Crisis Risk Index and our deep-dive research on the previous two EM crisis cycles) with a top-down overlay (e.g. our quantitative market timing signals).
Don’t fix it if it ain’t broken!
Associate: Macro Team
The weather, expiration of investment tax credits, exclusion of commercial aircraft orders in the advance estimate (Boeing orders that will probably show up in the Jan data) and seasonality will all be held out as potential distortions in the December figures.
With Durable Goods being one of the more volatile series, subject to significant revision, and negatively diverging from the ISM mfg data for December, we may indeed see a positive revision and sequential acceleration next month, but the reality is that the deceleration reflected in this morning’s durables data agrees with the sequential slowdown observed more broadly across the domestic macro data.
Headline Durable Goods printed its worst number in five months, accelerating to the downside sequentially with New Orders declining -4.3% MoM while decelerating meaningfully on both a YoY and 2Y basis.
Core Capex Orders growth accelerated to the downside as well, declining -1.3% MoM and >300bps on a 2Y. If there was a lone positive in the release, it’s that core capital goods orders growth did accelerate 70bps sequentially to 6.2% from +5.6% in November.
Additionally, both headline New Orders and Core Capex figures for November were revised lower by -80bps and -150bps, respectively.
No silver linings to be had in the sub-aggregates either with (perhaps) the cleanest read on household consumerism - New Durable Goods Orders Ex-Defense & non-defense Aircraft - decelerating on a MoM, 1Y and 2Y.
In short, today’s durable goods data agrees with our expectation for a sequential slowdown in domestic growth and suggests some emergent weakness in what has been a key source of macro strength over 2H13 (with wage inflation still muted and services consumption growth flagging).
As we highlighted in our 1Q14 Macro themes call (HERE), easy 1H14 inflation comps and our expectation for a deceleration in the rate of change in reported growth has us incrementally more cautious on U.S. equities than we have been over the TTM.
Now, with the risk management/price signals flashing red with a breakout in equity volatility above TREND resistance and the S&P500 flirting with a TREND breakdown (SPX Trendline = 1779), in the more immediate term, we’ll keep our net exposure to domestic equities relatively tight.
Christian B. Drake
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The good news is that the S&P 500 held our Hedgeye TREND support (1779) yesterday. The bad news is that front-month VIX is still solidly above TREND support of 14.91. So I’d sell an up open in US stocks unless volatility calms. Unlike the UK (whose Q4 GDP accelerated sequentially this morning to +2.8% year-over-year, USA’s should slow on Thursday from the Q3 peak).
If you’re long European Equities versus virtually any other region of the world year-to-date, you are less miserable and sleeping a little bit better. Europe is bouncing as Germany's DAX holds our Hedgeye TREND support of 9166. Meanwhile, Portugal was up +1.2%, Denmark +0.8%, and Austria +0.6%. All of them are still up +3-4% year-to-date versus the S&P 500 which is down -3.6% YTD. The rate of change in growth is our #GrowthDivergences theme.
It's game time again for the 10-year yield as our TREND level of 2.80% and yield just bounced 6 basis points off of Friday’s lows. Gold didn’t like that, so we’re waiting and watching for the next Gold buy signal. If the 10-year fails at 2.80% again, buying back Gold is at the top of my macro menu. We will let the market decide.
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Top Long Ideas
JPMorgan shares are currently trading with the most implied upside to fair value in our fair value model for money-center, super-regional and regional bank stocks. By our estimates, JPM shares have upside of 33% based on our regression of EVA (economic value added) – which looks at the spread between return on capital and cost of capital – and the current multiple to tangible book value. Over time, we have found that sizeable discounts and premiums mean revert toward fair value giving JPMorgan an embedded tailwind in 2014.
We remain bullish on the British Pound versus the US Dollar, a position supported over the intermediate term TREND by prudent management of interest rate policy from Mark Carney at the BOE (oriented towards hiking rather than cutting as conditions improve) and the Bank maintaining its existing asset purchase program (QE). UK high frequency data continues to offer evidence of emergent strength in the economy, and in many cases the data is outperforming that of its western European peers, which should provide further strength to the currency. In short, we believe a strengthening UK economy coupled with the comparative hawkishness of the BOE (vs. Yellen et al.) will further perpetuate #StrongPound over the intermediate term.
Darden is the world’s largest full service restaurant company. The company operates +2000 restaurants in the U.S. and Canada, including Olive Garden, Red Lobster, LongHorn and Capital Grille. Management has been under a firestorm of criticism for poor performance. Hedgeye's Howard Penney has been at the forefront of this activist movement since early 2013, when he first identified the potential for unleashing significant value creation for Darden shareholders. Less than a year later, it looks like Penney’s plan is coming to fruition. Penney (who thinks DRI is grossly mismanaged and in need of a major overhaul) believes activists will drive material change at Darden. This would obviously be extremely bullish for shareholders and could happen fairly soon driving shares materially higher.
Three for the Road
QUOTE OF THE DAY
"Oh yes, the past can hurt. But you can either run from it, or learn from it." - Rafiki, from The Lion King
STAT OF THE DAY
The U.S. retail price for regular gasoline fell to $3.279 a gallon yesterday, according to AAA, the nation’s largest motoring company. The countrywide average rose to within a cent and a half of $4 in April 2011.
“Wall St. was a street of vanished hopes, or curiously silent apprehension, and a sort of paralyzed hypnosis.”
-New York Times
Imagine that was the header for @NYT on the eve of America’s central economic planner in chief’s State of The Union. Newsflash: it’s not. That was the front page of the New York Times on the day after the 1929 US stock market crash.
John Coates cites the aforementioned headline in chapter 1 (The Biology of a Market Bubble) of The Hour Between Dog and Wolf and goes on to remind us that “research on body-brain feedback, even within physiology and neuroscience, is relatively new.” (pg 28).
So how are you feeling this morning? While you know that hope is not a risk management process, apprehension and paralysis are all part of the game. While it’s hard to sell`em on green and buy`em on red, fading your emotional state is often the precise action to take.
Back to the Global Macro Grind…
I don’t know about you, but in the heat of the decision making moment I fade how I feel about markets a lot. Through 15 years of trial and error, I’ve learned to increasingly rely on multi-factor, multi-duration, risk management signals amidst the research noise.
Since I don’t have a dog (or wolf) in the fight in marketing a perma bullish or bearish position, I use the TRADE versus the TREND in order to tone down my testosterone. Yep, I’m a dude – keeping that under control matters!
To review our process lingo:
- TRADE is 3 weeks or less in duration
- TREND is 3 months or more in duration
The reason why I use “more” or “less” is because time in my model (days) varies inversely with volatility. In other words, if front-month volatility ramps +50% in a week, the number of days in my TRADE model falls, fast – and, if implied volatility (looking out on the curve) doesn’t confirm that immediate-term information surprise, I keep an above average amount of duration (time) in the TREND model.
That may or may not make sense to you. So to put it more simply:
- When both front-month and implied volatility are signaling lower-highs and lower-lows, a monkey can buy stocks
- When both front-month and implied volatility move from bearish to bullish TRADE and TREND, monkeys get killed
Momentum monkeys, I mean.
I know, I know. Every time I call someone a monkey, I trigger an emotional response. But, please, don’t be offended. I am a monkey too – I’m just one that tends to learn from the cage door being slammed on my fingers.
Volatility, of course, is the #1 risk factor that every major fund manager who has fallen from grace has messed up. Even the world’s best messed this up in bonds last June. Many more have already messed this up in Japanese and Emerging Market Equities YTD.
This is basically why I completely disagree with the concept of being an active “long-term investor” who doesn’t use an implied volatility risk management overlay. While it would be nice to wake up to sun and bananas at the zoo every day, reality is that every once in a while a storm rips the cages open and the tigers, who have been putting up with monkey-bull chirping for a year, are hungry.
Back to the actual levels, to keep this simple, let’s just focus on the inverse relationship between the SP500 and VIX:
- TRADE – SPX 1837 momentum support broke as 13.81 VIX resistance became immediate-term support
- TREND – SPX 1779 support was tested intraday yesterday (and held), but VIX 14.91 TREND is firmly intact
And here Mucker the monkey was covering oversold shorts (and buying one long, LVS) into the close as 1779 SPX held (which would be called a high-probability gamble - dealer shows a 6 in #BlackJack)… and the minute I saw Apple (AAPL) guide down, I thought it was going to be a gamble I’d pay for today (and deserve it).
But, the US Equity Futures are up 8-10 handles and I’ll play lucky on the open today instead. I won’t, however, confuse that with the next leg up in this market ripping to fresh all-time highs. Provided that 1837 SPX TRADE resistance and 14.91 VIX TREND support remain intact, I’ll be a seller again this morning on green (like we were in #RealTimeAlerts on the open yesterday).
I know that playing the game across durations isn’t for everyone. But this is what I do. And I like it. I can assure you that the longest of “long-term” investments you can ever make is starting your own company with all of your own money. And for me at least, that investment requires absorbing 24/7 risk management, apprehension, and pain – if you want the long-term to last longer, that is.
Our immediate-term Global Macro Risk Ranges are now (12 Big Macro Ranges are in our Daily Trading Range product):
Pound 1.64-1.66 (bullish)
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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.