“In the end, if you build it, they may not come.”
Whether it’s the Japanese burning their currency, a demigod named Draghi “saving” Europe, or the Fed’s perpetual Policy To Inflate asset prices, I often wonder if Rickards is right – now that markets have built these expectations, will the growth come?
So far, the long-end of the bond market says no. On growth that is… but what are markets telling you about the centrally planned illusion of growth (i.e. inflation expectations)?
And “what happens when you manipulate markets using price signals that are the output of manipulated markets?” (The Death of Money, pg 86) Never forget that the biggest risks to markets are the critical answers to the toughest questions.
Back to the Global Macro Grind…
I spent all of yesterday seeing Institutional Investors in Greenwich, CT. The meetings, as always, were tremendous learning opportunities. And there was one moment in one of the meetings that I’ll never forget.
As I was sitting across from a Portfolio Manager, the Federal Reserve’s “Minutes” (from their last meeting) were released. So, I sat there and watched Liesman @CNBC spew his interpretation of what he thought the Fed said… and the seasoned PM just giggled.
Even at the most sophisticated funds, whether they like it or not, this is modern day “macro” – where you have to not only think about what you think… but seriously consider what everyone else was told they should think…
Here’s what I think was incremental in those Fed Minutes:
Since our “Bad #Deflation” view is not yet consensus, it’s really hard for consensus to get why this is bearish for bond yields (and bullish for the Long Bond, TLT, EDV, etc.). But markets almost always front-run consensus – and that’s already in motion.
After our interlude with the English-major turned pretend macro savant (who has never traded a market in his life), the Portfolio Manager asked me a very simple question that I get asked a lot: “what things should I look at to monitor your #deflation view?”
I answered by referring him to exhibit 15 (the slide in my #Quad4 Deflation Macro deck) that shows #InflationExpectations:
Then I said:
The price of Oil ($74.20/barrel) continues to crash this morning (-31% since June); the CRB Index is trading at 267 (-4.6% YTD); and after having another horrendous day (both absolute and relative to US Equities yesterday) the Russell 2000 is DOWN (again) for 2014 YTD.
Back to real economic growth expectations, I told investors yesterday what I’ve been telling them all year long – my catalyst is the cycle. As the growth cycle data slows, whatever these “bullish surveys” are telling you will look wrong.
That’s what’s happening from China to Europe this morning (they release Producer Manufacturing and Services data for November). Literally all of the growth data slowed.
While China’s PMI print of 50.0 wasn’t as bad as France’s (47.6 NOV vs. 48.8 OCT), that’s not saying much. Bond Yields are falling because the rate of change in global growth is slowing.
When both growth and inflation data slows, expectations for asset price inflation in those things slow. So BUY slow-growth-yield-chasing assets (TLT, EDV, MUB, XLV, XLP, XLU) and keep SELLING growth and/or inflation expectations (IWM, KRE, XOP, EWQ, VWO).
And that’s all I have to say about that.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.29-2.36%
France (CAC 40) 4139-4281
WTI Oil 73.01-76.13
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
This indispensable trading tool is based on a risk management signaling process Hedgeye CEO Keith McCullough developed during his years as a hedge fund manager and continues to refine. Nearly every trading day, you’ll receive Keith’s latest signals - buy, sell, short or cover.
TODAY’S S&P 500 SET-UP – November 20, 2014
As we look at today's setup for the S&P 500, the range is 50 points or 2.13% downside to 2005 and 0.31% upside to 2055.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS (Bloomberg Estimates):
WHAT TO WATCH:
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
The Hedgeye Macro Team
This note was originally published at 8am on November 06, 2014 for Hedgeye subscribers.
“Never believe anything, until it has officially been denied.”
For those of you who didn’t know that Cockburn was a British journalist and proponent of communism, now you know. His aforementioned quote was cited by Jim Rickards at the beginning of an excellent chapter titled “Prophesy” in The Death of Money.
BREAKING: “Bundesbank investigating whether it can block sovereign QE”
Pardon? I know. I know. What is up with the London Telegraph dropping that anti-money-printing (QE) bomb on my laptop while I was sitting pretty at the epicenter of inequality’s Social #Bubble (San Francisco) after the US stock market close last night?
Back to the Global Macro Grind…
Now I’m sure that Europe’s un-elected-central-planner-in-Chief (Draghi) will officially deny anything that remotely resembles that headline being true at today’s ECB (European Central Bank) meeting… but that’s the point.
What if the Germans have legal grounds to tell the Italian jobber to #PoundSand?
Pardon my hockey-talk, but believing anything that you hear about what the Japanese, European, and American central planning agencies can do to stock markets these days is a very dangerous premise.
What happens if:
Bueller? Or is it “spoos and chartreuse” while Ed is saying that every time the “surveys” get growth wrong “QE will get the perma bulls paid” anyway?
Admittedly, as global growth slows (again), it’s getting harder and harder to keep track of what it is, precisely, that has consensus right bulled up about chasing the all-time #bubble high in the SP500.
As Rickards appropriately summarizes in the same chapter, “when it comes to betting on a sure thing, greed trumps common sense.” (The Death of Money, page 25).
In other news…
Utilities (XLU), +2.3% on the day to +22.3% YTD, led the US stock market’s no-volume charge to all-time highs yesterday. I know. Everyone nailed that and Energy (XLE) being -3.1% YTD too.
As for me… after spending most of the week in California, I am back in the saddle in Connecticut wondering what changed, fundamentally, since the Russell 2000 was -10% lower (120 points) less than a month ago…
Other than mostly every growth and inflation metric in our model being slower today than it was then, I guess the answer is that those who are permanently predisposed to be long of US stocks will believe almost anything, other than common sense.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.24-2.38%
WTI Oil 76.12-80.29
Natural Gas 3.88-4.27
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Takeaway: We’ve been dead wrong on Japan over the past month or so. With the exception of one MAJOR caveat, consensus probably has this trade right.
Where We’ve Been
On October 31st, the day of the BoJ’s surprise easing, we wrote a note titled, “WEEKEND MUST-READ: DOES THE DEATH OF JAPAN = THE DEATH OF ACTIVE MANAGEMENT?”. The key investment takeaway from that note was as follows:
”We’re inclined to maintain our SHORT bias on the DXJ and our LONG bias on the FXY for now. We think recent moves are exaggerated in both directions in the context of a highly likely dearth of incremental Policies to Inflate over at least the next few months.
That being said, however, we are actively looking for a rise in cross-asset volatility as an opportunity to exit this position in the coming weeks. In short, we are now wrong on this trade and are seeking to minimize the damage by not covering high (DXJ) and selling low (FXY).”
It’s worth noting that the Japanese yen tends to be positively correlated with cross-asset volatility due to the country’s status as the world’s largest supplier of capital. Japan’s net international investment surplus of ~$3T is equivalent to 68% of the country’s GDP and compares to a -$5.5T deficit for the US.
With the obvious lack of cross-asset volatility since 10/31, we have been made incrementally wrong on this recommendation and are now content to just get the heck out of the way. For what it’s worth, the DXJ and FXY have moved -487bps and -787bps, respectively, against us since we introduced the thesis on September 22nd.
That was obviously the right call to have made by mid-October (e.g. the DXJ and FXY moved +1045bps and +253bps, respectively, in our favor from 9/22 to 10/15), but we have clearly overstayed our welcome on the short side of the “Abenomics Trade”.
Unlike our competitors – the vast majority of whom lack a buyside practitioner’s approach to global macro risk management – we actually get things wrong here at Hedgeye. With no banking, trading or asset management revenues to help “keep the lights on”, we don’t tend to stay wrong for long, however. Moreover, we’d like to think our customers appreciate our conviction on the LONG and SHORT side of global macro risk management.
The alternative would be opining with no view…
Where We’re Headed
In the next three sections, we attempt to coagulate all of the moving parts across Japan’s macro and political economy. Hopefully we’ll adequately distill that into an investment conclusion, but as the title of the note implies, we’ll let you be the judge of that!
The Snap Election: Tricky At Best
Today Prime Minster Shinzo Abe officially announced a November 21st dissolution of the Diet, effectively paving the way for snap elections on December 21st. To the extent that he secures a second mandate, it is likely that he attempts to push through a series of potentially unpopular reforms over the next four years, including but not limited to:
Currently the LDP (Abe’s party) has 294 of 480 seats (61%) in the House of Representatives (i.e. lower house) and 114 of 242 seats (47%) in the House of Councilors (i.e. upper house). Together with partner NKP, Abe’s coalition has a 68% mandate in the lower house and a 55% mandate in the upper house.
Conclusion: there’s really nowhere to go but down from these levels. In fact, we consider it a highly risky proposition for Abe to pursue a snap election at the current juncture in light of recent Japanese economic data:
FYI, it’s worth mentioning that Japan entered its fourth recession in six years with the advent of the 3Q GDP release:
Further, the Japanese economy continues to contract here in 4Q:
To top it all off:
Good luck next month, Mr. Abe; you’re going to need it!
In fact, the only saving grace we can find in support of a positive election surprise is the fact that:
Abe has hinted at resigning if the election results point to an overwhelming majority of voters rise up against his Abenomics agenda. In that light, the “Abenomics Trade” will be facing a critical level of tail risk in the coming ~month.
Fiscal Policy: Getting Easier
With respect to Japanese fiscal policy, prepare the anchor for more stimulus. The government is currently considering a supplementary budget worth ¥2-3T full of measures aimed at “helping people cope with rising energy prices, local revitalization and reconstruction in disaster-hit areas”.
With unspent funds from FY13 and above-target fiscal revenues from FY14, the government should be able to secure about ~¥4T in funds for a supplementary budget. In terms of the anticipated economic impact, this figure compares to supplementary budgets of ¥10T and ¥5.5T in FY12 and FY13, respectively.
In the context of Abe delaying next fall’s consumption tax hike and pledging to proceed with the first iteration of cooperate tax cuts next year, Japanese fiscal policy will remain very favorable for equity investors over the next 12-18M.
On the flip side, much of the late-2013/early-2014 acceleration in real GDP growth was pull-forward ahead of April’s +300bps VAT hike. Without a similar need for consumers and businesses to accelerate expenditures, we anticipate Japan’s economic contraction will continue for at least the next two quarters as the country laps extremely difficult GDP compares.
In fact, the broad balance of Japan’s high-frequency economic data continues to lose sequential momentum on a trending basis. In the context of how we model Real GDP, this all but ensures a continued deceleration in the growth rate of the headline figure(s).
Monetary Policy: Getting Crazier
Japanese consumption be damned, we now know that the BoJ is completely comfortable with going “full Weimar [Republic]” with Japanese monetary policy, as most recently highlighted by today’s 8-1 vote in leaving monetary policy unchanged; recall that the board was split 5-4 when Governor Haruhiko Kuroda opted for additional easing last month.
What we found even more surprising is the fact that Kuroda reiterated his “upbeat” assessment of the economy. Yes, the same Japanese economy that is mired in recession and contracting -1.2% on a YoY basis!
What this tells us is that he is likely leaving room for a downside surprise to his targets, which would afford him scope to expand QQE sooner, rather than later. Per Bloomberg, sellside consensus expects a further expansion of QQE by June. Kuroda surprised us once; he won’t catch us off guard again!
Reasons for QQE expansion over the next 2-3M:
All told, the BoJ can and will “do more” to pursue the “5% Monetary Math” agenda as originally stated with the introduction of Abenomics.
It seems crazy to us allocating capital to the “Abenomics Trade” (i.e. LONG the DXJ and SHORT the FXY) at current price levels in Japan’s equity and currency markets, but perhaps that’s precisely the point: Japanese central planners are forcefully compelling us to join in on the craziness.
Investment Conclusions: Doing Nothing, For Now
If there’s anything investors should glean from the U.S. midterm elections is that the state of the economy matters big time at the ballot box. We don’t want to be in the way of a potential election surprise that could potentially render the entire Abenomics agenda a thing of the past.
While we’re likely to miss out on further upside by not joining in on the craziness of it all, we think this is the most prudent risk management decision for an investor to make at the current juncture. At a bare minimum, those that have risk managed this trade appropriately should look to book gains in the coming days/weeks.
For those of you who have a desire or mandate to keep “riding the bull”, you should take some solace in the fact that with a Z-Score of +0.2x (TTM), the JPY isn’t nearly as crowded of a short now as it has been in recent months. Perhaps there’s another leg down to ~125 vs. the USD right around the corner!
All told, if Abe strengthens his mandate to pursue his crazy economic agenda, we will happily go “all-in” on the long side of Japanese equities (DXJ) and on the SHORT side of the Japanese yen (FXY), while anticipating further economic deterioration in the process! We just find doing so ahead of the elections to be a risky proposition.
Imagine if you were forced to buy Germany’s DAX equivalent in the early 1920s?
SOURCE: The Economics of Inflation by Costantino Bresciani-Turroni, published 1937
Crazy stuff indeed…
Feel free to ping us with any follow-up questions. Have a wonderful evening,
Associate: Macro Team
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