“Any intelligent fool can make things bigger, more complex, and more violent. It takes a touch of genius —and a lot of courage —to move in the opposite direction."
-E. F. Schumacker
The most challenging thing to do as a stock market operator is to make a trade or investment against consensus. If you are wrong for any period of time, you hear about it in spades. Especially in this day and age when every Jamoke under the sun has a soapbox and/or a twitter feed. (Admittedly, though, we do applaud the democracy that Twitter has brought to the media world!)
The fact is, the harder consensus leans, the higher your probability of being right in fading that view. Conventionally speaking, one way in which this is manifested is in value investing. Now, to some, value investing is about deep dive company analysis, which we get, but on a higher level it is really about the implications of company valuation. Simply put: when a company’s valuation is high, the prospects for its future are perceived as rosier than when the valuation is low. (That is a simplification, but you get the point.)
In effect, valuation is an opinion, so when the vast majority of stock market operators give a company a low valuation, their opinion of that company is low. Ironically, or not, this consensus opinion is consistently wrong over the long run. In fact, Dreman Value Management proved this in spades in a study of “cheap” stocks:
- First, the study showed that for the period of January 1st, 1970 to December 31st, 2010, stocks in the lowest P/E quintile outperformed stocks in the highest P/E quintile by a margin of 15.4% to 8.3% in terms of annual return;
- Second, in the 52 quarters when the S&P 500 declined between 1970 – 2010, low P/E stocks outperformed the market by an average of +2.4% versus an under performance of -1.9% for high P/E stocks; and
- Finally, from 1973 to 2010 the lowest quintile P/E stocks went up +1.2% on a negative surprise versus a return of -7.4% for the highest quintile P/E stocks on a negative surprise.
Now valuation is obviously only one factor, and not always the best factor for shorter term tactical trading, but over the long run it is a great gauge of the consensus opinions of companies. And over the very long run, fading well loved “names” as based on high P/E multiples has provided enormous outperformance.
Back to the Global Macro Grind...
This morning it is not difficult to find the consensus view of U.S. equities. The II Bulll Bear Spread (bulls minus bears) is +99% to the bullish since October 12th. As well, Bears are tracking near all-time lows at 14.8%. If you are a lemming, of course, this makes sense. As markets go up you get more bullish and as markets go down you get more bearish. Practically speaking, as we highlight in the Chart of the Day, chasing this rally is fraught with risk given how unconvincing the volume has been.
Complacency seems to once again be setting into the view of European equity markets as well. We’ve seen a few notable chart followers suggest the turn is in for European equities and today they may have some fodder for the case with Eurozone Industrial production, which beat expectations.
Specifically, Eurozone September Industrial Production rose by +0.6% year-over-year versus the consensus view of -0.3%. This compared to the August reading, which was a -0.5% decline (also an upward revision from -1.9%). As well, the German economic minister was out this morning saying that the “German economy stabilized in Q3 after a Q2 contraction and now has slight upward momentum”. Now, of course, if this is the best the Eurozone can do, fading any rally is certainly worth considering.
Over at the Bank of England today, the honest Canadian, BOE Governor Mark Carney, is at least being forthright in saying, "it’s appropriate that markets now expect easier monetary conditions” based on the real-time growth and inflation data the BOE is seeing. The challenge with easier monetary conditions for many global central banks is that while they are not out of bullets, the bullets are increasingly ineffective.
Yesterday we hosted a call for our Institutional Macro subscribers with Professor John Taylor from Stanford on this very topic. Taylor is an outspoken advocate for rules based central banking (hence the eponymous Taylor Rule) and also highlighted in spades a point we’ve been harping on for some time, which is that the extreme QE monetary policy in the U.S. has became increasingly ineffective. As Taylor noted on QE3:
“When started 10-year Treasury was 1.7%, then rose and has remained higher
- Effects of QE on yield spreads
– 1-year vs 10-year US Treasury spread
– 2003-2008 non-QE period……1.3%.
– 2009-2013 QE period……………2.4%”
It obviously begs the question of whether the biggest no-brainer “Fade Trade” has become to fade the increasingly impotent global central banking regime? You likely already know our answer on that.
If you’d like to listen to the replay of our discussion with Professor Taylor, the replay and his presentation can be accessed below.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.26-2.39%
WTIC Oil 75.61-78.97
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
Takeaway: Our Macro Playbook is a daily 1-page summary of our investment themes, core ETF recommendations and proprietary quantitative market context.
Long Ideas/Overweight Recommendations
- iShares National AMT-Free Muni Bond ETF (MUB)
- iShares 20+ Year Treasury Bond ETF (TLT)
- Vanguard Extended Duration Treasury ETF (EDV)
- Health Care Select Sector SPDR Fund (XLV)
- Consumer Staples Select Sector SPDR Fund (XLP)
Short Ideas/Underweight Recommendations
- SPDR S&P Regional Banking ETF (KRE)
- iShares Russell 2000 ETF (IWM)
- iShares MSCI European Monetary Union ETF (EZU)
- iShares MSCI France ETF (EWQ)
- SPDR S&P Oil & Gas Exploration & Production ETF (XOP)
QUANT SIGNALS & RESEARCH CONTEXT
- Emerging Market Headwinds: Within the context of our #Quad4 theme, its associated USD strength/global deflationary pressures and waning Chinese demand, we have been keen to recommend being short/underweight exposure to EM equity and currency exposure since mid-to-late September. Our Tactical Asset Class Rotation Model (TACRM) continues generate “DECREASE Exposure” signals for EM Equities and Foreign Exchange as primary asset classes; their respective Passive Trend Follower Asset Allocation signals of 18% and 2% are -28% and -50% from their respective trailing 3M averages. Delving deeper into the global macro ecosystem, we see that EM equity/currency/debt exposures account for 50% of the bottom-20 Volatility-Adjusted Multi-Duration Momentum Indicator readings across the entire global macro universe. All told, we continue to anticipate further downside for such exposures – particularly in the context of #VolatilityAsymmetry remaining throughout global financial markets. From a country risk perspective, South Africa is an economy where we currently see risk being egregiously mispriced amid this dead-cat bounce in EM equities.
***CLICK HERE to download the full TACRM presentation.***
TRACKING OUR ACTIVE MACRO THEMES
#Quad4 (introduced 10/2/14): Our models are forecasting a continued slowing in the pace of domestic economic growth, as well as a further deceleration in inflation here in Q4. The confluence of these two events is likely to perpetuate a rise in volatility across asset classes as broad-based expectations for a robust economic recovery and tighter monetary policy are met with bearish data that is counter to the consensus narrative.
Oil: More Downside? (11/5)
#EuropeSlowing (introduced 10/2/14): Is ECB President Mario Draghi Europe's savior? Despite his ability to wield a QE fire hose, our view is that inflation via currency debasement does not produce sustainable economic growth. We believe select member states will struggle to implement appropriate structural reforms and fiscal management to induce real growth.
#Bubbles (introduced 10/2/14): The current economic cycle is cresting and the confluence of policy-induced yield-chasing and late-cycle speculation is inflating spread risk across asset classes. The clock is ticking on the value proposition of the latest policy to inflate as the prices many investors are paying for financial assets is significantly higher than the value they are receiving in return.
Best of luck out there,
Associate: Macro Team
About the Hedgeye Macro Playbook
The Hedgeye Macro Playbook aspires to present investors with the robust quantitative signals, well-researched investment themes and actionable ETF recommendations required to dynamically allocate assets and front-run regime changes across global financial markets. The securities highlighted above represent our top ten investment recommendations based on our active macro themes, which themselves stem from our proprietary four-quadrant Growth/Inflation/Policy (GIP) framework. The securities are ranked according to our calculus of the immediate-term risk/reward of going long or short at the prior closing price, which itself is based on our proprietary analysis of price, volume and volatility trends. Effectively, it is a dynamic ranking of the order in which we’d buy or sell the securities today.
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TODAY’S S&P 500 SET-UP – November 12, 2014
As we look at today's setup for the S&P 500, the range is 84 points or 3.66% downside to 1965 and 0.46% upside to 2049.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 1.81 from 1.83
- VIX closed at 12.92 1 day percent change of 1.97%
MACRO DATA POINTS (Bloomberg Estimates):
- 7am: MBA Mortgage Applications, Nov. 7 (prior -2.6%)
- 10am: Wholesale Inventories, Sept., est. 0.2% (prior 0.7%)
- 11:30am: U.S. to sell $25b 52W bills, TBA 4W bills
- 12pm: Fed’s Kocherlakota speaks in Eau Claire, Wis.
- 1pm: U.S. to sell $24b 10Y notes
- 4:30pm: API weekly oil inventories
- 4:30pm: Treasury Sec. Lew at World Affairs Council in Seattle
- 10am: Supreme Court hears arguments in Alabama Legislative Black Caucus vs. Alabama case
- 10am: Attorney General Eric Holder delivers remarks at 20th anniversary of Community Oriented Policing Services Office
- 2pm: Senate Appropriations Cmte hearing on White House anti-Ebola funding request
WHAT TO WATCH:
- Five Banks to Pay $3.3b in First FX-Rigging Settlements
- Barclays Says Not Ready to Settle Global FX-Rigging Probe
- OCC seen announcing more fines later today
- Yahoo to Acquire Video-Ad Service BrightRoll for $640m
- Wal-Mart to Stretch Black Friday Over 5 Days to Lure Shoppers
- Ackman’s Pershing Square Takes Stake in Drugmaker Zoetis
- Fossil Rises After 3Q Results Top Analysts’ Estimates
- U.S., China Agree on New Carbon Cuts to Fight Climate Change
- China to Overtake U.S. as World’s Biggest Oil Consumer, IEA Says
- Republican Sullivan Finally Wins Alaska Sen. Race Vs Begich
- Comcast Deal Disclosure Spurs Bid to Keep Contract Terms Secret
- Apax Joins Bain to Bid $8.8 Billion for Oi Portugal Assets
- U.K. Unemployment Stays at 6% as Wage Growth Accelerates
- Chinese Buyer of Waldorf Astoria Said to Plan $2b IPO
- Two Yahoo Shareholders Said to Ask AOL to Mull Merger: Reuters
- FCC May Move Away From Obama on Future of the Internet: WPT
- ADT (ADT) 7am, $0.48
- CAE (CAE CN) 8:30am, C$0.16
- Canadian Solar (CSIQ) 7:20am, $1.16
- Encana (ECA CN) 6am, $0.43 - Preview
- Energizer (ENR) 7am, $1.61
- EZchip Semiconductor (EZCH) 8am, $0.25
- First Majestic Silver (FR CN) 7am, ($0.02)
- Loblaw Cos (L CN) 6:30am, C$0.86
- Macy’s (M) 8am, $0.50 - Preview
- Meritor (MTOR) 7:30am, $0.15
- Pinnacle Foods (PF) 8:30am, $0.41
- Plug Power (PLUG) 7am, ($0.03)
- Rice Energy (RICE) Bef-mkt, ($0.04) - Preview
- Rockwell Automation (ROK) 7am, $1.83
- SeaWorld Entertainment (SEAS) 7:30am, $1.13
- Aimia (AIM CN) 6:15pm, C$0.20
- AmeriGas Partners (APU) 7pm, ($0.54)
- Cisco Systems (CSCO) 4:05pm, $0.53 - Preview
- Iamgold (IMG CN) 5pm, $0.04
- J.C. Penney (JCP) 4pm, ($0.80) - Preview
- NetApp (NTAP) 4:01pm, $0.69
- NetEase (NTES) 7pm, $1.49
- Silver Wheaton (SLW CN) 5pm, $0.20
- Tetra Tech (TTEK) 4:41pm, $0.35
- WGL (WGL) 5pm, ($0.26)
- WuXi PharmaTech Cayman (WX) 4:30pm, $0.50
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- UBS Precious Metals Misconduct Found by Finma in FX Probe
- Gold Stable as Investors Weigh Falling Oil, Dollar’s Strength
- Brent Oil Near 4-Year Low on Signs OPEC Will Resist Output Cuts
- Palm Oil Output in Indonesia to Rise Over Next 5-10 Yrs: Wilmar
- Oil Slide Echoes ’08 Peg Pressure for Nigeria, Saudi: Currencies
- Abu Dhabi’s Taqa Cuts Spending for 2014 After Oil Prices Decline
- CRU Group Says Bearish Copper Trend Will Extend Through 2016
- Nickel’s Waning Price Boom Leaves BHP With Unwanted Mines
- Standard Chartered Global Agriculture Sales Head Pepper Leaves
- Gold to Find Solace From Negative Lending Rate: Chart of the Day
- Shanghai Steel Rebar Swings Amid Post-APEC Production Restarts
- S. Africa Nat. Resources Bill Examination May End Soon: Minister
- Corn Price Seen Rebounding Next Year by Hightower on Less Acres
- Singapore Ship-Fuel Sellers Tighten Credit After OW’s Bankruptcy
- China to Overtake U.S. as World’s Biggest Oil Consumer, IEA Says
The Hedgeye Macro Team
This note was originally published at 8am on October 29, 2014 for Hedgeye subscribers.
“Making the simple complicated is commonplace; making the complicated simple, awesomely simple, that’s creativity.”
Canadians are somewhat simple people. As a Canadian, I think I can get away with saying that, even if most of you can’t. But let’s be honest, after hockey, beavers, and Tim Horton’s coffee, what else is there?
Certainly, there is also the vast beauty of the majestic country. Keith and I took a few of our colleagues to an offsite to Lake Nipigon, which is the largest freshwater lake solely in the province of Ontario, early this year. There is a picture from our trip in the middle graphic below and we experienced this beauty first hand.
There is also the kind soul of the nation. A soul that was very much on display after the recent tragic terrorist attack in Ottawa. Sir Winston Churchill may have said it best when he stated:
“There are no limits to the majestic future which lies before the mighty expanse of Canada with its virile, aspiring, cultured and generous-hearted people.”
That is likely as true today as it was back then, even if falling oil prices throw a curve ball to the Canadian economy in the short term.
But, back to coffee and simplicity for a second, when Canadians order coffee they keep it simple. The typical Canadian strolls into Tim Horton’s, usually at some ungodly hour, and simply orders a Double Double, which is Canadian speak for coffee with two sugars and two creams.
Last night before our men’s league hockey (we are Canadians remember!), Keith and I were chatting about the market and it dawned on us that, “Double Double Top”, may actually be the most apropos description of the current stock market action.
Back to the Global Macro Grind…
The most recent top can appropriately be called the Alibaba ($BABA) top as the top of the U.S. stock market, not unsurprisingly, coincided very closely with the IPO of the Chinese internet juggernaut. In fact, Alibaba (or whatever you want to call the Cayman Islands entity that U.S. investors own an interest in) started trading on Friday, September 19th and the SP500’s recent top was, you guessed it, also on Friday September 19th.
On some level, it should be no surprise that the biggest IPO in history signaled the market top. It is obviously an event that signals “things” can’t get much better from “here”. The question of course is what will signal the end of the most recent rally? Perhaps the social media bubble popping?
Our Internet and Media Analyst Hesham Shaaban has been admittedly vocal on the headwinds facing some of the social media business models. In fact, for a long time he was the lone bear on both Twitter ($TWTR) and Yelp ($YELP) and was recently validated by recent results from both companies. He has been less vocal on Facebook ($FB) and somewhat rightfully so as the company has performed admirably, well until last night’s earnings report . . .
Certainly, Facebook’s numbers weren’t terrible. The company has 864 million daily users and is growing revenue at 40%+ y-o-y. But even the stalwart of the social media group has to at some point show a path to real profitability and with total GAAP costs expected to increase between 50 – 70% in 2015, outpacing revenue growth by a wide margin, meaningful profitability is unlikely to happen anytime soon.
So is this then the Facebook top? Due to a dearth in crystal balls in the Hedgeye office this morning, I’m not sure I can definitively say it, but to the extent that social media stocks were leading some of the recent market froth, that ship has now sailed.
As well, there is no doubt that many consensus investors have gone from selling the recent bottom to leaning very long again. According to the most recent U.S Investor’s Intelligence poll, bullish sentiment shifted to 47.0% from 35.2%, bearish sentiment decreased to 16.3% from 18.2%, and those expecting a market correct decreased to 36.7% from 46.5%. So, if you are getting long at the Facebook top, just be forewarned that isn’t a contrarian call!
Also, some bulls may still be holding out for the Pollyanna-ish view of U.S. GDP growth of 3% in perpetuity, but as my colleague Darius Dale noted yesterday:
“Unfortunately, the data is becoming increasingly unsupportive of that narrative. Specifically, the two drivers of any U.S. economic expansion (i.e. household consumption and CapEx) appear to have lost considerable amount of steam of late.
Let’s ignore the horrible SEP Retail Sales print (falling gas prices, anyone?) and focus specifically on today’s SEP Durable Goods and OCT Conference Board Consumer Confidence numbers.
Brutal Durable Goods and CapEx Demand
Core Capital Goods dropped the most in 8M (-1.7% MoM) and Durables ex-Defense & Aircraft – i.e. the stuff the average household purchases – was down for a second consecutive month at -0.3% MoM; this was the 1st such instance of back-to-back contraction since the weather-induced weakness we saw in the first quarter.
MAJOR Consumer Confidence Head-Fake
At face value, the OCT Consumer Confidence print was a huge win for anyone who doesn’t really do macro. Specifically, the headline figure inflated to 94.5, which was the highest reading since a 95.2 reading back in OCT ’07.”
Take it from a simpleton Canadian, buying U.S. equities at the peak in Consumer Confidence is a recipe for underperformance.
Now of course with that all said, perhaps the FOMC will provide a boost to the markets with the rate announcement today at 2pm. In our Chart of the Day below, which is appropriately a cartoon created in house, I provide a summary of our thoughts on that . . .
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.14-2.33%
WTI Oil 79.91-83.67
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
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