Client Talking Points
The S&P 500 is getting lots of attention as it recaptures the minds of those who think the 200-day moving monkey is a risk management indicator; for us, 1967 remains bearish TREND resistance and there is no immediate-term TRADE support to 1835; volatility’s risk range is wide open too with VIX = 15.06-28.49.
Oil experienced a one-day rally, and failed, again – WTI is down -0.9% this morning to $81.33 with no immediate-term support to $79.75; even after a -5.2% move in energy stocks (XLE) for October to-date, some of the best looking shorts on our screen remains energy and MLP related equities as #Quad4 deflation risk remains.
When they bounce yields to lower-highs, you add to the winning team’s position in 2014 and buy the Long Bond (TLT, EDV, if you are looking at the ETF version); UST 10YR at 2.25% this morning with no support to 2.11% as both global and U.S. growth slows.
|FIXED INCOME||28%||INTL CURRENCIES||4%|
Top Long Ideas
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
TWEET OF THE DAY
Both the FTSE and DAX remain bearish; Portugal down another -0.8% to -19.1% YTD this morning
QUOTE OF THE DAY
The creation of a thousand forests is in one acorn.
-Ralph Waldo Emerson
STAT OF THE DAY
According to a Google 2014 Shopping Intentions Study more than 50% of consumers surveyed said they'll start their research before Thanksgiving, with 26% of shoppers starting before Halloween.
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“The problem with the big focus on making capital cheaper… is it’s akin to fighting fire with fire.”
That’s a quote from the beginning of chapter 6 of The Age of Oversupply, by Dan Alpert. The chapter was a good one titled “The Empty Toolbox” and it focuses on why central planners “can’t fix the economy.” #agreed
Whether you are looking at the US economy or global one slowing right now, it’s important to keep these v-bottom moves in equity markets in context. Where are they v-bottoming from? Oh, and why did they go down so hard so that they could v-bottom to begin with?
Our call throughout the year has been very consistent on the why – growth is slowing. And when early-cycle growth slows from multi-year highs, you short the most illiquid form of beta chasing (small cap stocks) and you buy the Long Bond.
Back to the Global Macro Grind…
I was at a dinner meeting in Maine last night and an entrepreneurial CEO asked me a question I’ve been asked by hundreds of non-Wall Street people in 2014: “What do you think I should do with my money right now?”
I’m not the beat-around-the-bush-type, so I told her exactly what I have been telling people all year:
- Sell stocks
- Buy bonds
- Raise Cash
As basic as this advice has been is as hard as it’s been for people to just execute on it. But, with the total return of the Long Bond (TLT) at almost +19% for 2014 (vs. the Russell 2000 down -4%), why is that?
A: It’s not what “everyone” is saying people should be doing.
That’s it. From New Hampshire to California and everywhere I’ve been this year in between. That pretty much sums it up. The response is always the same: “but can’t interest rates go up? Aren’t bonds expensive?”
What’s been really expensive is believing that central planners can bend gravity and deliver +3-4% economic growth. If they deliver 0-2%, “expensive” bonds are going to get more expensive, and really expensive growth stocks (think Amazon at 112x earnings) are going to continue to crash.
But, but… “Keith, this bounce is crazy – why can’t it keep going…”
If I have some iteration of that in my inbox 100x in the last 3-4 market days, I have it 1,000x. And all I do is shake my head wondering why so many refuse to take a lesson from the risk management exercise learned as the Russell was having a -15% draw-down and the 10yr broke 2% only a week ago.
To review the #Quad4 deflation case that Mr. Market is effectively yelling right now:
- Bond Yields (10-30yr) in the US are crashing
- Oil prices are crashing
- Over 60% of stocks in the Russell 2000 are crashing
To be fair, if you didn’t have a view that all of these things would go down, you blamed ebola (and Canada) and wore them the whole way down anyway. But, if you did, you are killing it YTD and in a position to re-ramp every position you’ve had throughout the last 6 weeks of macro market volatility.
We’re deep into 2014 and at this stage of the season playing this game from a position of strength is entirely different than playing it from a position of weakness. If you’ve been winning, you don’t have to spend your entire day worrying about why the stock market is bouncing and bonds correcting.
You’ve realized that the Fed, Bank of Japan, and European Central bank have all cut to zero. You’ve also reminded yourself that 0 + 0 doesn’t equal something greater than zero – and that they can’t solve for #GrowthSlowing again.
In other words, they can’t fix this. Unfortunately, only a deflationary reset can.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets – which you can get in our Daily Trading Range product as well) are now:
UST 10yr Yield 2.11-2.32% (bearish)
SPX 1 (bearish)
RUT 1040-1127 (bearish)
Nikkei 149 (bearish)
VIX 15.06-28.49 (bullish)
USD 85.01-86.20 (bullish)
EUR/USD 1.26-1.28 (bearish)
Yen 105.36-108.31 (neutral)
WTI Oil 79.75-82.62 (bearish)
Natural Gas 3.51-3.74 (bearish)
Gold 1 (bullish)
Copper 2.95-3.05 (bearish)
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Takeaway: Our Macro Playbook is a daily 1-page summary of our core ETF recommendations, investment themes and proprietary quantitative market context.
CLICK HERE to view the document. In today’s edition, we highlight:
- Why global financial market volatility is likely to ramp in the coming weeks – particularly as we progress through next week's FOMC statement and mutual fund fiscal year-end
- The bull case for bombed-out Brazilian financial assets (HINT: it has nothing to do with a Neves victory)
Best of luck out there,
Associate: Macro Team
This note was originally published at 8am on October 10, 2014 for Hedgeye subscribers.
“Some day, following the example of the United States of America, there will be a United States of Europe.”
Well, if Washington is right, “some day” is still a long ways off.
In fact, over the intermediate to longer term we expect the culture clash that is the Eurozone to continue transpiring – from the top (Brussels and the ECB) right on down to the bottom (individual member states).
Our macro playbook continues pointing to a Euro with potential downside from here (it’s down around -9% since May and is broken across TREND and TAIL durations in our quantitative models). Despite ECB President Mario’s Draghi’s pledge “to do whatever it takes” (and lever up the balance sheet by €1 Trillion) to support growth and inflation, we’re not buying the promise of Draghi’s Drugs producing sustainable economic growth.
Why? Because we expect some member states to be very slow in passing the necessary fiscal and labor market reforms to improve their competitiveness.
Back to the Global Macro Grind…
And so the culture clash took another turn this week when the French government announced that austerity is dead and that it would not meet its original deficit reduction target. This shot across the bow stands to reignite tension with the fiscally conservative member states (Germany in particular) and may influence the policy stance of other members (like Italy) that have A) long questioned the merit of austerity, B) have yet to deliver on a full package of reforms, and C) like France, are looking to push out their own deficit timetable.
Specifically, France in its 2015 budget stipulated that it would adapt a pace of deficit reduction parallel to the economic situation of the country. Therefore, instead of meeting the original target of 3% deficit by 2015, the country would push out that target by an additional two years.
And so for the first time in history, the European Commission may exercise its power to reject France’s budget and ask for a new one. A resolution could come at the end of the month.
In follow-up remarks, French Finance Minister Michel Sapin has said that the EU must shift its policy to avert the threat of prolonged low growth and low inflation (along with boosting investment), if Europe was to prevent being stuck in Japanese-style stagnation.
Here’s the rub playing out from Top to Bottom:
- The European Commission (EC) and ECB: (pointing the finger at a select group of member states): “You guys need to reform (more).”
- The Member States Being Accused: (pointing the finger back) “We just issued loads of “austerity” to minimize the public sector, reduce our borrowing costs and improve our credit rating, yet in doing so we’ve choked off growth, are saddled with record high unemployment rates, and have zero ability to manipulate policy to make ourselves more competitive than our European peers. We’re done with this course of action, so be your expectations for deficit and debt consolidation!”
- The EC and ECB: “But if you don’t reform at the state level, there’s no chance our newest programs (ABS & covered bond buying programs and TLTROs) will have any chance of success!”
The problem is that countries like France haven’t done enough. For proof of the shortfall, France’s government spending still stands at a monster 55% of GDP. And as an anecdote, the Magic Kingdom a la France (Disneyland Paris) reported this week that it needs a bailout to the tune of $1.25 Billion. The company cited French labor laws and planning regulations making it difficult to replicate the success of the other Disney enterprises, and called-out in particular the high cost of employing French workers.
Similar structural shortfalls could be identified in Italy, which just this Wednesday happened to host an EU Summit in Milan to discuss job creation.
And so as the “rub” between the Top and Bottom plays out, Eurozone growth stands to suffer as there’s no clear action plan on how to fix it. This week the IMF (a classic lagging indicator) revised down its global GDP forecast and specifically took the Eurozone GDP outlook to 0.8% in 2014 (vs a prior estimate of 1.1% July) and 1.3% in 2015 (vs prior 1.5%).
A quick look at key Eurozone data metrics over the last two weeks shows a similar trend downward:
- Eurozone PMI Services fell to 52.4 SEPT (exp. 52.8)
- Eurozone PMI Manufacturing fell to 50.3 SEPT (exp. 50.5)
- Eurozone PMI Retail Sales 44.8 SEPT vs 45.8 AUG
- Eurozone Sentix Investor Confidence -13.7 OCT (exp. -11) and -9.8 SEPT
- Eurozone Business Climate 0.07 SEPT (exp. 0.10) vs 0.16 AUG
- Eurozone Economic Confidence 99.9 SEPT (inline) vs 100.6 AUG
- Eurozone Industrial Confidence -5.5 SEPT (exp. -5.8) vs -5.3 AUG
- Eurozone Consumer Confidence -11.4 SEPT vs -10 AUG
- Eurozone Unemployment Rate UNCH at 11.5% AUG
- Eurozone CPI fell 10bps to 0.3% Y/Y in SEPT
Our bottom-up, qualitative analysis (e.g. our Growth/Inflation/Policy framework) indicates that the Eurozone is setting up to enter the ugly Quad4 in Q4 (equating to growth decelerates and inflation decelerates). We discussed this point in depth on our Q4 2014 Macro Themes Call on 10/2 (email firstname.lastname@example.org if you’d like access) in our theme #EuropeSlowing (one of three).
Our key conclusions include:
- We do not believe Draghi will be able to turn the tide of deflation (see chart below) and growth through his policy tools alone. German Finance Minister Wolfgang Schaeuble has repeatedly said the ECB has “run out of tools” and that “cheap money can’t force growth”
- We expect the recent package of “supportive” measures (ABS and covered bond purchasing program and TLTRO) to come up short of expectations. Recall as an initial read-through that demand was light for the first round of TLTRO at €83 Billion vs estimates of €150-300 Billion
- Should Sovereign QE become a reality, expect push back from member states (think uproar over OMT and hearings from the German Constitutional Court)
- We believe it’s still largely unlikely that a sovereign QE program can support sustained economic growth (witness years of shortcoming on this front from the Japanese).
- From an investment position, we are recommending shorting French (EWQ) and Italian (EWI) equities and the EUR/USD (FXE).
The former President of France Jacques Chirac once said: “The construction of Europe is an art. It is the art of the possible”. Indeed, if the Eurozone is to become a functioning United States of Europe, it’s just in the initial sketch stage.
Our immediate-term Global Macro Risk Ranges are now:
WTI Oil 84.02-89.82
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