“I have long understood that losing always comes with the territory when you wander into the gambling business, just as getting crippled for life is an acceptable risk in the line backer business. They both are extremely violent sports, and pain is part of the bargain. Buy the ticket, take the ride.”
-Hunter S. Thompson
The stock market business isn’t nearly as risky as being a NFL linebacker or, at least in some jurisdictions, being involved in the gambling business. Nonetheless, being a stock market operator does not come without its risks. Ironically, the most significant risk to being invested in the stock market currently is likely mismanaging the actions of central banks.
The most recent and significant action of course comes from the People’s Bank of China (PBOC) which cut the 1-year deposit rate by 25 basis points and 1-year lending rate by 40 basis points. This was China’s first interest rate cut since June 2012. For those that were long Chinese equities, this is a short term positive, but for those that were caught offside, not so much.
Recent history shows rallies related to Chinese rate cuts have been very, very short lived. In fact, six of the past seven cuts to interest rates and reserve requirements have been followed by declines in stock prices over the next two months. Perhaps this is why according to Reuters this morning, “the Chinese leadership and PBoC are ready to cut interest rates again and also loosen lending restriction.”
The longer term challenge with seemingly arbitrary moves in central banking policy is the creation of excesses. As Professor John Taylor from Stanford wrote in a recent paper, the biggest issue with abnormally dovish policy specifically (read: low rates) is the increased appetite for risk. According to Taylor:
“Anther effect of extra low policy rates is on risk aversion. Using time series techniques Bekaert, Hoerova, and Duca (2012) found that this effect is empirically significant. They decompose the VIX into a risk aversion component and an uncertainty component. They then look at the cross autocorrelations between policy rates and these two components. Their empirical results show that “Lax monetary policy [below policy rule rates] increases risk appetite (decreases risk aversion) in the future, with the effect lasting for about two years and starting to be significant after five months.” These results provide a reason why a change in monetary policy might actually shift the tradeoff curve in Figure 2 back up—a channel to poor economic performance which is quite different than the risk aversion channel of Elliot and Baily (2009) or King (2012) and with much different policy implications.”
Net-net, non-rules based and extra low policy rate rates may actually have the unintended consequence of increasing risk and eventual economic underperformance.
Back to the Global Macro Grind…
This morning’s monetary policy rumor of the day is that the EU is set to announce a new fund this week that will use “financial engineering” in an effort to create at least €300B of additional investment. The question, of course, is what is the point of more “financial engineering”? In the chart of the day, we take a look at the yields on 10-year sovereign debt for Spain, Italy and Portugal, that highlights that cost of sovereign capital of all three are down meaningfully year-to-date and over the last three years.
Interestingly, at 2.04% and 2.25% for Spain and Italy respectively, their 10-year yields are both lower than the United States. Clearly, then, the government lending market is not the issue, so perhaps a magical €300B in incremental investment in the private sector will be what it takes to lift Europe out of its economic malaise? Perhaps, and maybe Santa Claus does actually exist!
Speaking of unlikely global macro scenarios, how about the scenario that OPEC finally agrees on production targets and sticks to them? Currently, according to reports, OPEC is over producing by about 500 – 600K barrels per day over its 30 million barrel per day target. Already, Libya, Iran, Ecuador, and Venezuela have called on the cartel to cut production, but Saudi Arabia, the key swing producer, has little ability to measure whether other members of the cartel have cut production and the four aforementioned countries are hardly the most transparent.
While OPEC in theory can control supply (although in practice we aren’t so sure), the reality remains that the biggest issue is demand from the world’s largest consumer – the United States. Currently, the U.S.’s oil imports from OPEC are the lowest they have been in 30 years. Specifically, in August, OPEC’s share of U.S. oil imports dropped to 40% versus the 1976 peak of 88%.
With Brent Crude down over -27% in the YTD and WTI down over -22%, it is no surprise that OPEC is a bit rattled. In the long run, this has the potential to be a decent tail wind for the U.S. economy, although in the short run, this quick and decisive move in oil may have some negative derivative impacts.
Currently, the gap between U.S. corporate bonds and Treasuries is at 124 basis points, near the widest level of the year. Conversely, European corporate spreads are near their tightest levels. Not surprisingly, the likely culprit is the price of oil as energy bonds are the largest industry grouping in the high yield market domestically. Speaking of which, if you want any over levered short ideas in the Energy and MLP sector, definitely email us at , because we have a plethora.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.28-2.38%
WTI Oil 73.90-78.11
Keep our head up and stick on the ice,
Daryl G. Jones
Director of Research
Takeaway: In today's Macro Playbook, we chart the domestic growth slowdown across a variety of indicators. Defensives > cyclicals in the stock market.
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
- iShares Russell 2000 ETF (IWM)
- SPDR S&P Regional Banking ETF (KRE)
- 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
- Global Growth Slowdown Continues: With Japan in a deep recession and both the ECB (Eurozone) and PBoC (China) confirming what the recent economic data has been suggesting (i.e. marked slowing), it’s a trivial matter to proclaim that global growth is slowing. What is less trivial to anyone who anchors on [outrageously incongruent] Consensus Macro and/or regional Fed surveys is that growth is slowing fairly markedly in the U.S. as well. In the spirit of not cherry-picking #GrowthSlowing data, we thought we’d take this opportunity to highlight a broad swath of U.S. economic data below. As it is plain to see, the vast majority of the key economic indicators are slowing quite ardently.
- In Equities, We Still Like Defensives > Cyclicals: In the spirit of our #Quad4 theme – which is continues to be confirmed by both the data and the market [leadership] – we continue to favor the slow-growth, yield-chasing sectors and style factors that have worked for us all year in conjunction with our call for lower long-term interest rates. Such defensive equity exposures continue to sit atop the YTD performance table, trouncing the cyclical exposure which continues to be favored by the Consensus Macro community by a wide margin. One could drive the proverbial “truck” through the 1835bps spread between the YTD performance of Healthcare (XLV) and Consumer Discretionary (XLY)!
***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.
#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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Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.
TODAY’S S&P 500 SET-UP – November 24, 2014
As we look at today's setup for the S&P 500, the range is 55 points or 2.54% downside to 2011 and 0.12% upside to 2066.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 1.81 from 1.81
- VIX closed at 12.9 1 day percent change of -5.01%
MACRO DATA POINTS (Bloomberg Estimates):
- 8:30am: Chicago Fed Nat Activity, Oct., est. 0.40 (prior 0.47)
- 9:45am: Markit US Services PMI, Nov. prelim, est 57.3 (pr 57.1)
- 10:30am: Dallas Fed Mfg Activity, Nov., est. 9 (prior 10.5)
- 11am: U.S. to announce plans for auction of 4W bills
- 11:30am: U.S. to sell $24b 3M bills, $28b 6M bills
- 1pm: U.S. to sell $28b 2Y notes
- Deadline for pact limiting Iran’s nuclear program in exchange for relief from economic sanctions
- House, Senate out of session
- USTR Michael Froman delivers speech at Federation of Indian Chmabers of Commerce and Industry
WHAT TO WATCH:
- Onex to Acquire Packaging Maker SIG for Maximum $4.7b
- Iran Nuclear Talks May Be Extended If Final Push Falls Short
- Carlyle Said to Seek $5b for Buyout Fund With Longer Life
- German Business Confidence Unexpectedly Rises 1st Time in 7 Mos.
- Iran May Seek OPEC Cut of 1 Million Barrels in Saudi Talks
- Aviva Falls on 5.4 Billion-Pound Friends Life Takeover Offer
- ‘Hunger Games’ Debut Trails Predecessors Amid Tepid Reviews
- U.S. Gasoline Falls to $2.8416 a Gallon in Lundberg Survey
- Yik Yak Said to Get $62m Investment Led by Sequoia Capital: WSJ
- Navios Maritime (NM) 7am, ($0.15)
- Brocade Communications (BRCD) 4pm, $0.23
- Nuance Communications (NUAN) 4:01pm, $0.28
- Workday (WDAY) 4:02pm, ($0.10)
- Palo Alto Networks (PANW) 4:03pm, $0.12
- Aegean Marine Petroleum (ANW) 4:15pm, $0.21
- Qihoo 360 (QIHU) 5pm, $0.62
- Post (POST) 5pm, $0.07
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- OPEC Easy-Decision Days Seen Over by Former Qatari Minister
- Iran May Propose 1 Million-Barrel OPEC Cut in Talks With Saudis
- Brent Crude Trades Near Highest in Seven Days as Iran Seeks Cut
- Soybeans Drop Amid Outlook for Record U.S. Crop and Brazil Rains
- World’s Oldest Spice Bears Vietnam Modern Riches: Southeast Asia
- Copper Falls on Concern China Rate Cut Signals Economic Slowdown
- Barclays Survey Shows 30% Investors See Gold Below $1,150 By 1Q
- CME Will Lower Rates for Wheat Storage as Futures Spread Narrows
- Enterprise Said to Offer U.S. Condensate to Asia Buyers for 2015
- Gold May Drop 5% in First Three Months of Lower Oil, SocGen Says
- CME Group to Start New Iron-Ore Futures Contract From December
- U.K. Gas Rises in Longest Streak in Year on Cold, Norway Outages
- Robusta Coffee Futures Climb on Vietnam Outlook; Sugar Declines
- Iran Won’t Cede Market Share by One Barrel: OPEC Reality Check
The Hedgeye Macro Team
This note was originally published at 8am on November 10, 2014 for Hedgeye subscribers.
“The system was blinking red.”
That’s what the 9/11 Commission Report told us, after the fact. That’s what I’ll tell you after the next “risk on” move happens in markets like it did in early October. It’s all part of a signaling process I use to identify phase transitions in markets.
This is also the #process that my friend Jim Rickards applied to tracking terror related events in markets. As Rickards writes in The Death Of Money, “no one trades in isolation.” And there is plenty of market wisdom in that.
Jim says he’s “careful to document and time-stamp the signals and analysis in real-time… it would not be credible to look at the tape in hindsight… we wanted to see things in advance.” (Rickards, pg 36). That’s what I do, every market day.
Back to the Global Macro Grind…
But, but… the “market won’t go down on that anymore. What is the next catalyst? How do we know it’s going to go down?” I get some version of those questions all of the time. The answer is that the “market” isn’t just some naval gazing US equity index.
To review the #process:
- I write down and document (#notebook) every timestamp and market signal that matters to the “market” every morning
- I contextualize time/price within a multi-factor (global equities, FX, etc.) and multi-duration picture (TRADE, TREND, TAIL)
- I always assume market dynamism, duration mismatch, and non-linearity – the macro market is a complex ecosystem
Within a dynamic ecosystem of colliding, non-linear factors, I’ll almost always register #divergences. In your natural ecosystem of life, a divergence would be that it’s snowing 10 miles from where you see no precipitation.
Here are some of last week’s most notable equity market #divergences in my notebook:
- Hong Kong’s Hang Seng Index down -1.9% vs. Japan’s Nikkei stock market index +2.8%
- The Dow +1.1% vs. Italy’s MIB Index down -3.5% week-over-week
- Brazil’s Bovespa Index down -2.8% vs. the Russell 2000 flat on the wk
Meanwhile you saw big time bearish divergences in Emerging Market Equities versus something like the SP500 which closed +0.7% on the week at its all-time high:
- MSCI Emerging Markets Index down -2.4% on the week to -1.1% YTD
- MSCI Latin American Index -4.5% on the week to -5.8% YTD
Emerging Markets have looked a lot like the Russell 2000 (a US growth index) and the 10yr Treasury Yield (another US economic #GrowthSlowing proxy) as of late – and that shouldn’t surprise anyone who realizes that global growth continues to slow.
But but, if your “market” is simply what the SP500 is doing, I can show you #GrowthSlowing divergences there too:
- Consumer Discretionary (XLY) stocks were down -0.1% in an “up SP500 market” last week
- Slower growth, Consumer Staples (XLP) stocks beat “the market”, closing up another +2.2% on the week
Since our #Quad4 deflation playbook says you buy Consumer Staples (XLP) and Healthcare (XLV), last week’s divergences at the sector level certainly made a lot more sense to us than the consensus “gas prices are down, so buy the consumer” meme.
Growth and inflation expectations are obviously causal to market prices. But so are central planners burning their respective currencies at the stake.
While many US only “market” people think the US Dollar’s rise is a sign of their savior, it’s not (if you had #RatesRising it might be, but they fell again last week to 2.30% on the UST 10yr Yield). It’s a sign of global economic duress.
Last week had both the Japanese and European central planners devaluing their currencies, at the same time:
- Euro (vs USD) down another -0.6% on the week to -9.4% YTD
- Yen (vs USD) down another -2.0% on the week to -8.1% YTD
By any long-term measure, these are massive annualized currency moves.
And since the market I look at is coming off all-time lows in cross asset class volatility (FX, Equities, Commodities, Fixed Income – see our #VolatilityAssymetry slide deck from July of 2014), I see the FX market as the biggest blinking red light of all.
It’s warning the world that this grand central planning experiment is failing where it matters most, in economic growth terms.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.26-2.38%
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
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