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Takeaway: A formal production cut from OPEC (which we see as highly unlikely) will have no bearing on how much member countries produce anyway.

While we can’t deny a formal production cut tomorrow will induce a short-term pop to oil prices, the follow-through will be short-lived.


Consensus was more one-sided on expecting a production cut when we circulated our first note on OPEC’s waning influence toward the end of October:




While the market has priced in this clear shift in sentiment even though WTI is -10.4% since the October note, consensus is still divided on the outcome of the meeting. We expect any decision to induce an active Friday in markets. Volatility buyers feel the same.


Note: Without reading about this volatility set-up know that options markets are pricing in the uncertainty embedded in the market’s expectation for the outcome of the meeting. The market is pricing-in the expectation for much higher volatility (assumed annualized 1-standard deviation price movement) near-term than it has realized over the last 1/3/6-months….

  • Rolling realized volatility in front month WTI Crude is 24%/23%/19% going back 1/3/6-months




  • At-the-money put- implied volatility for Jan 15’ is trading near 38%, which is +24%/+41%/+74% above trailing averages over the last 1-6 months
  • Looking at the skew of the chain going back every week in November reveals the heightened levels of uncertainty into the event.  The shape of the surface has remained proportionally the same while volatility across the whole chain has been bid up significantly

OPEC CUT? NOPE. - WTI volatility surface


We don’t gamble by positioning ourselves in front of events, but we can certainly study consensus positioning and the expectations for volatility vs. what it has realized over going back in time and tell you that any decision is going to warrant a volatile Friday.



Before dethroning OPEC as a powerful cartel that pushes and pulls oil markets, let’s look at those parties who are perfectly comfortable with the overstated hora of OPEC as an organization:


1.       OPEC members themselves which is self-explanatory from a political standpoint


2.       Financial market participants who live off volatility


3.       Oil companies who like higher oil prices and can use OPEC as a scapegoat for pushing prices higher


4.       The media because they need something to report


Our expectation is simple…


WE DON’T EXPECT A FORMAL PRODUCTION CUT FROM OPEC OUT OF THE MEETING AND THIS WILL PUT MORE PRESSURE ON OIL PRICES (in addition to the quant set-up and #QUAD4 deflation which we have continuously outlined).


As mentioned above, we do not doubt any decision will provide a short-term move in spot markets, but from an intermediate to longer-term perspective, the decision is irrelevant:




OPEC member representatives underestimate the longevity of other non-traditional plays, especially U.S. shale. We have no reason to believe OPEC officials know much about the technological advancements in shale extraction have brought down the break-even costs of U.S. shale plays. We hosted a call with Leonardo Maugeri who has consulted with the Sec. Gen. of OPEC, and he provided support to this reality. 


Replay Link


In 2013, OPEC referenced an average per unit cost of production of $90/barrel for U.S. shale plays and this year they’ve said $70/barrel. On a longer -term horizon, OPEC members anchor on the idea of peak oil in the global marketplace, meaning their influence only has upside from here.

Remember that OPEC currently produces 40% of the world’s oil, but they hold an estimated 60-70% of proven reserves. They are more focused on near-term market share and long-term relative positioning against one another supporting prices.

Do we think that Saudi Arabia is ready and willing to come to Venezuela’s rescue when Venezuela has the second highest (behind Saudi Arabia) level of crude reserves on earth? No, we do not.

OPEC total production levels are below the 2012-13 period and we expect the inflection to higher levels to continue from here barring geopolitical discontent. The biggest perceived risk near-term is that they will continue to lose market share.

With some of the Gulf States having the lowest production costs on earth, they are fine with lower prices (especially if they carry the perception of squeezing non-traditional plays). 


OPEC CUT? NOPE. - Total OPEC Production Ratio


OPEC CUT? NOPE. - OPEC to U.S. Production Ratio


Saudi Arabia holds almost all of OPEC’s spare capacity and we do not think they will be willing to further production cuts.


OPEC CUT? NOPE. - OPEC surplus


As outlined in section 11.C. of OPEC’s statute, a formal production cut from OPEC technically requires a unanimous decision from the one representative member of each nation (unlikely considering the near-term incentives outlined above).

Now, assuming OPEC members band together and agree to a production cut, let’s take a look at how irrelevant these quotas have been throughout history…


Jeff Colgan of Brown University performed an extensive study of OPEC from its founding in 1982 and found that OPEC countries cheated (out-produced) their quotas 96% of the time.

  • OPEC ANNOUNCEMENTS have an ability to move spot prices for about 15-20 days, but there is no evidence that production levels are at all influenced
  • The correlation between OPEC quotas and oil prices is non-existent (r^2 =.15 since inception in 1982)
  • During this period all OPEC nations except Iran and Venezuela over-produced 80% of the time based on monthly observations
  • The nine principal OPEC members produced on average 10% above their respective quotas in this period.
  • From 1 there were 22 OPEC meetings where quotas were increased, and in 21 cases, the increase in quotas were still below what each country had produced the month before quotas were raised



If OPEC is irrelevant, what happened in 1973?

While the chain of events leading to the embargo in 1973 is the one precedent that refutes our claim that OPEC as an organization is irrelevant:


1. We think the dynamic in the energy market was different; and,


2. The notion that OPEC curbed production by cutting quotas to jack-up oil prices in protest to the Arab-Israeli war is over exaggerated.


OPEC’s crude output in 1973 (embargo year) was 30.9MM B/D on average vs. 27.3MM B/D in 1972 (large increase), and OPEC maintained these price levels through 1974.


OPEC’s actions in that year were as follows:

  1. They increased posted prices (no longer in existence) which set the nominal price that international oil companies paid to extract oil from foreign fields. It was essentially a tax and royalty hike that followed what became a big spread in these royalty payments vs. market price per unit of oil. This did in fact lower oil company margins, and in 1973 OPEC raised posted prices from $2.90/barrel to $11.65 barrel
  2. OPEC made a push to encourage its members to nationalize their oil industries
  3. SOME OPEC members implemented a very short-term embargo against the U.S. and a few others. The embargo started in October 1973 and lasted for five months

Now posted prices are no longer a reality, the nationalization in the larger OPEC members is already complete, and the oil market is much more diverse, robust, and prepared to handle supply disruptions:

  • More sources
  • Higher stockpile levels in the major consuming countries
  • More short-termism in contracting

Although the market has seen continued selling into the meeting tomorrow, volatility expectations, market sentiment, and OPEC’s decreasing influence are creating a set-up that will disappoint to support a move off of the multi-year lows.


If there is a cut, it will provide a short-term pop at the most holding all big macro constant.


Please ping us with any comments or questions.


Enjoy your Thanksgivings.


Ben Ryan


COLD TURKEY: 4Q Starts With a Dud

IN SHORT: Initial Claims deteriorated for a 3rd week, Durable and Capital Goods spending softened (again), and Household Spending and Income did a whole ‘lotta not much (with a notable negative revision).  We parse each of the releases below. 


COLD TURKEY:  4Q Starts With a Dud - Eco Summary 112614png



INCOME & SPENDING (Oct.):  And like that, it was gone…..  


Spending:  Another middling month for domestic consumerism with real spending rising +0.2% sequentially against a +0.0% comp.  Total Spending growth decelerated -10bps sequentially to +2.2% YoY and accelerated +10bps on a 2Y ave growth basis.


Spending on Services was flat sequentially while NonDurables spending growth accelerated on a MoM/1Y/2Y.  Notably, spending on Durables was negative MoM for a 2nd month and decelerated further on a YoY basis. 


Revolving consumer credit growth broke out of its 3Y slumber in 2Q alongside accelerated spending on durables and the two have moved in lockstep the last 6 months.  It’s likely card spending moderates alongside the moderation in higher ticket discretionary consumption. 


COLD TURKEY:  4Q Starts With a Dud - Consumer Spending TTM YoY   2Y Oct


COLD TURKEY:  4Q Starts With a Dud - Durables vs Revolving Credit


Income:  Estimates for personal income were revised for the April-to-September period and the PCE figures were revised for the July-to-September period.   The adjustments were noteworthy as total disposable income gains were revised down significantly with the net impact being downward revisions to both wage and income growth and the savings rate. 


As can be seen in the 1st chart below, while aggregate private sector wage growth ticked up sequentially and remains near post-recession highs, the slope of wage growth in 2Q/3Q goes from one of acceleration to one of flat-to-modest deceleration after the revision.    


A holiday Salute to Simplicity:  Growth in Disposable Income and the change in the Savings Rate explains ~95% of the change in household spending (i.e the multiple regression b/w DPI growth & the chg in the savings rate vs. Chg in PCE has an R-square of 0.95). 


 If ya ain’t got it (wages), and ya ain’t borrowing it (credit)…ya can’t spend it (PCE). 


And in a modern, Keynesian consumption economy, it’s the “spendin it” that counts. 


Macro can be as made as nuanced and complex as one wishes and the alpha, of course, is in correctly forecasting that change in growth/income, but it’s worth re-remembering that the trajectory of an economy boils down to some simple realities.  


COLD TURKEY:  4Q Starts With a Dud - Private Wage Income Growth Revision


COLD TURKEY:  4Q Starts With a Dud - DPI Revision


COLD TURKEY:  4Q Starts With a Dud - Income   Spending Table Oct





SA:  Headline claims rose +21K sequentially to +313K, marking the first week above the +300K level in 11 weeks.  Seasonally adjusted rolling claims increased +6K WoW to +294K, marking a 3rd week of deterioration (not overly unexpected given the comp setup) and the highest level in 2 months.


NSA:  The rate of improvement in non-seasonally adjusted claims deteriorated to -3.6% YoY (vs -12.53% prior) while the 4-week rolling average, which we consider a more accurate representation of the underlying labor market trend, slowed for the 5th straight week, decelerating -330bps to -12.7% YoY.


CYCLE ACCOUNTING: As we’ve highlighted, historical cycle precedents suggest peak improvement in initial claims (3Mo rolling ave basis) consistently occurs ~7months before the peak in the economic cycle. 


It’s been our contention, from a fundamental view of the labor market data, that while an economic peak isn’t immediately imminent, the trough is currently being put in and once the inflection occurs the ticking of the clock gets increasingly louder – particularly when the ~330K level gets re-breached to the upside.   


Its also worth re-highlighting that while peak improvement in claims has been a consistently good lead indicator for the economic cycle, using it to time the market cycle has proven more dubious – particularly in recent cycles where market peaks have occurred quasi- coincident with the trough in claims.  


COLD TURKEY:  4Q Starts With a Dud - Claims SA 112614


COLD TURKEY:  4Q Starts With a Dud - Claims NSA 112614


COLD TURKEY:  4Q Starts With a Dud - Claims Cycle



DURABLE GOODS: A Second Month of Softness


The Headline was a bit more flattering than the core with total new durable goods orders rising +0.4% MoM (against a -0.9% comp) and accelerating on a YoY basis.   However, for a 2nd month, almost every sub-aggregate reported negative MoM growth with most decelerating on a year-over-year and 2Y ave basis as well.


Durables Ex Defense & Aircraft - the goods the ave household buys – declined -0.7% MoM and decelerated on both a 1Y and 2Y.  On the business demand side, Core Capital Goods declined a sizeable -1.3% MoM for a second consecutive month and has now been negative for 7 of the last 12 months. 


COLD TURKEY:  4Q Starts With a Dud - Capital Goods Orders MoM Oct


COLD TURKEY:  4Q Starts With a Dud - Druables Goods Ex Defense   Aircraft Oct


COLD TURKEY:  4Q Starts With a Dud - Durable Goods table Oct 



A Quick Look Globally:  For the last couple quarters we’ve suggested both fundamental trends and market prices were heralding slowing growth, disinflation and a move into what we refer to as Quad #4.  


Domestically, the inflation, spending and manufacturing data is slowing from a second derivative perspective into 4Q but the convergence to slower growth and transition into Quad 4 has been global. 


Below is our “Global Macro for Dummies” table which consolidates global estimate trends for growth and inflation.  One need only observe the ubiquitous red (i.e. negative growth/inflation estimate revisions) to see the Quad 4 reality manifesting in real-time. 


Until we see the slope of growth inflect and market prices confirm, we’ll remain better sellers of strength in equities and buyers of the long bond on weakness.  


COLD TURKEY:  4Q Starts With a Dud - GPL


Christian B. Drake





QE Conundrums – Draghi’s Misguided Intervention?

Key Takeaways:

  • Eurozone equities are Bullish TRADE and TREND (see levels below). Tactically we are recommending shorting France’s underperformance via the etf EWQ.  (See France GIP model below)
  • Draghi’s latest comments (last Friday) have accelerated the prospect of sovereign QE  – Draghi said the ECB must drive inflation higher “as fast as possible,” and the Bank will broaden its asset-purchase program if needed to achieve that
  • The market’s expectations on timing of potential sovereign QE have also accelerated – the Bank has targeted the Q1 2015 horizon, and we do not think the ECB will be ready to act at its next meeting on DEC 4th. In addition, we would caution that legal and political (German in particular) hurdles are still plainly apparent. QE may in fact NOT be a snap of the fingers
  •  On balance over the shorter term, we expect EUR/USD (etf FXE) weakness (broken on its TREND and TAIL durations – chart directly below),  and equity strength
  • We do not expect that the ECB can will growth through financial engineering, and the rate of change of the quarterly “comp” will remain difficult for at least the next 3 quarters (see Eurozone GIP chart below)
  • Our intermediate-term bearish bias on the economic region remains grounded in our Q4 2014 Macro theme #EuropeSlowing

QE Conundrums – Draghi’s Misguided Intervention? - vv. eur usd broken


Economies are not financial markets – this point is not to be confused.

The Hedgeye macro team continues to tout that central planning will not fix the economies across the globe; the interventions have everything to do with trying to resuscitate drowning inflation expectations, and in the short run may inflate stock markets.


Specifically, ECB President Mario Draghi’s speech in Frankfurt last Friday once again tilted expectations. He said the ECB must drive inflation higher “as fast as possible,” and the Bank will broaden its asset-purchase program if needed to achieve that.


Read: Open the sovereign QE buying flood gates!


QE Conundrums – Draghi’s Misguided Intervention? - z. EL 11.24 Mid pic


But, but, if expectations are the root of all heartache, massive amounts of hospital beds will be needed given the indecision of both the ability and impact of issuing QE. Here’s select commentary over recent days:

  • Victor Constancio (ECB VP) said that the ECB will consider buying government bonds in the secondary market if the current measures prove insufficient. He went on to say that the ECB would wait until Q1 2015 to gauge the impact of current programs.
  • Jens Weidmann (Bundesbank President) said there are high legal hurdles for ECB to buy government bonds and that monetary policy alone cannot lead to growth.
  • Ewald Nowotny (Austria Central Bank President) said that Q1 2015 was too early for taking further measures to boost the Eurozone economy and does not see a point of time where that could happen. He pointed out that the ECB has taken a series of measures and should observe the impact of these.
  • Benoit Coeure (Member of the Executive Board of the ECB) said the ECB won't make a hasty decision to add more stimulus and will hinge any measures on incoming economic data. He added that there is unanimous agreement on the Governing Council that situations may arise where it has to do more.
  • Victor Constancio (ECB VP) said that Europe is not at risk of sliding into full deflation but the current rate of inflation is dangerously low. He said that living with inflation so close to zero is dangerous because it makes it harder to repay public and private debt, and impedes economic growth.
  • Klaas Knot (Dutch Central Bank President) said that the ECB could move to take additional easing steps, including purchases of government bonds, but it is uncertain whether this would be effective to fight low inflation. He was skeptical on a sovereign debt-targeted QE program because many governments were already borrowing at historically low rates. In addition, he said that the prior measures would take time to feed through.

Despite heightened expectations that the Bank may act when it next meets on December 4th, we doubt that the council will be ready to act. Specifically, it only just started to purchase ABS (November 21) and the 2nd tranche of the TLTROs will only be allocated a few days following the ECB meeting. Further, we do think VP Constancio’s reiteration of Draghi’s dovish remarks and Q1 2015 timetable offer clear evidence that the bank will wait until 2015 to act. 



Q) What’s Fallen?  A) the Data

Growth & Expectations Down – while a classic lagging indicator, the OECD in its latest Economic Outlook warned that the biggest worry for the global economy is the Eurozone falling into a persistent stagnation trap. The OECD’s downward growth revision brings it close to Hedgeye’s forecast (see GIP model below), however we are not of the camp that a sovereign QE program (like the ABS, covered bond, or TLTROs) will in and of itself lift growth. Here’s a look at the revised forecasts:

  • Eurozone GDP Forecast:
    • 2014: +0.8% vs prior +1.2%
    • 2015:  +1.1% vs prior +1.7%
    • 2016:  +1.7%

QE Conundrums – Draghi’s Misguided Intervention? - vv. EUROZONE


Inflation Expectations Down – 2014 is the year that Draghi has attempted to resuscitate drowning inflation expectations, but so far, he continues to fail miserably. Even with the prospect of QE, we don’t see much of a shift upwards (the ECB target is below but close to 2%). As our GIP chart shows, we expect CPI for 2015 at 0.7% versus Bloomberg consensus at 0.8% and its current level of 0.4%.

QE Conundrums – Draghi’s Misguided Intervention? - vv. cpi draghi


Sovereign Bond Yields Down – with growth and inflation expectations lowered and the heightened prospect for the ECB to buy sovereign bonds, it comes as no surprise that sovereign bond yields are approaching all-time lows. Below we want to flash a chart that shows in particular the periphery dramatic declines in the cost of capital and interestingly, that at 1.98% and 2.16% for Spain and Italy respectively, their 10-year yields are both lower than the 10-year for the United States at 2.24%. 


QE Conundrums – Draghi’s Misguided Intervention? - vv. sov yields



Short France (EWQ)

On 11/24 Keith added short France (via the etf EWQ) in our Real-Time Alerts. We presented this investment idea in our Q4 2014 theme of #EuropeSlowing, expressed as short “Socialism”.  As we show in the GIP chart directly below, there’s a giant delta between our growth expectations and those of consensus.  We therefore expect the economy and its equity market to underperform the region and fortuitously shorted EWQ at the top of its immediate-term risk range.  The CAC remains broken TREND @ 4388 as we show in the second chart below.


QE Conundrums – Draghi’s Misguided Intervention? - vv. FRANCE

QE Conundrums – Draghi’s Misguided Intervention? - vv.  cac


Long European equities as long as TRADE and TREND hold (etf EZU as potential investment vehicle).


As we show in the chart below, the STOXX Europe 600 is bullish TRADE and TREND. We’ll be managing this position closely, as again, we see little prospect of Draghi’s QE halting a continuation of decelerating inflation and growth, which we expect to be reflected in the equity market over the intermediate term.

QE Conundrums – Draghi’s Misguided Intervention? - vv. stoxx600


A wonderful Thanksgiving to you and yours!


Matthew Hedrick


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Between "ROC's" & Hard Places

Takeaway: In light of the holiday and the crush of data we've decided to keep the format on today's housing note short & sweet.

“After all is said and done, more is said than done.”

-   Aesop



Aesop probably wasn't referring to analyzing new home starts and purchase activity in 2014, but that quote pretty well characterizes the monthly deluge of commentary and conjecture around dead flat TTM volume trends.  


Anyhow, we’ll can the verbosity ahead of the holiday and summarily review today’s trifecta of housing data below.   


In short:  The balance of recent data has come in slightly north of middling on an absolute basis but housing remains in a tough spot and industry escape velocity remains very much a phantasm.  However, from a Rate of Change perspective - given the comp dynamics - most of the data is inflecting positively, a trend which should extend as we traverse volume compares that continue to ease into 2H15. 


Purchase Apps:  Purchase Demand declined -4.8% sequentially after last week’s notable 11.7% rise (the largest weekly increase in 20 months) but held above the 170 level on the index for a second week.  From here, compares ease further into the last weeks of the year and take a second dive into the end of 1Q15


Pending Home Sales:  Pending home sales declined -1.1% but, to our point above, accelerated on a YoY basis to +2.2% - the second month of positive YoY growth after an eleven month run of negative sales growth.  The soft’ish PHS data the last couple months has diverged from the strength reported in EHS.  The two series are invariably tethered so we expect to see a re-coupling in favor of one or the other in the next few months. 


New Home Sales:  New Home Sales increased for a 3rd month, rising +0.7% sequentially and +2% YoY.   Sales were up +14% in 3Q against trough comps but are up just 1.4% YoY for the Jan-to-Oct period.  Both Sales and SF starts have been virtually flat over the last year but with NHS above the TTM trend for each of the last 3 months, the slope has shifted from slightly negative to slightly positive.   


Our Hedgeye Housing Compendium table (below) aspires to present the state of the housing market in a visually-friendly format that takes about 30 seconds to consume. 


*Note - to maintain cross-metric comparability, the purchase applications index shown in the table below represents the monthly average as opposed to the most recent weekly data point.


Between "ROC's" & Hard Places - Compendium 112614


Between "ROC's" & Hard Places - EHS vs PHS


Between "ROC's" & Hard Places - NHS Existing to New Ratio


Between "ROC's" & Hard Places - NHS LT w Summary Stats


Between "ROC's" & Hard Places - NHS Total   YoY


Between "ROC's" & Hard Places - PHS Index   YoY TTM


Between "ROC's" & Hard Places - NHS Sales vs SF Starts TTM


Between "ROC's" & Hard Places - NHS Regional


Between "ROC's" & Hard Places - NHS Mean   Median Price


Between "ROC's" & Hard Places - PHS LT w Summary Stats


Between "ROC's" & Hard Places - PHS Regional


Between "ROC's" & Hard Places - PHS Regional YoY


Between "ROC's" & Hard Places - Purchase 2013 v 2014


Between "ROC's" & Hard Places - Purchase   Refi YoY


Between "ROC's" & Hard Places - Purchase LT w Summary Stats


Between "ROC's" & Hard Places - Composite LT w Summary Stats


Joshua Steiner, CFA


Christian B. Drake


Cartoon of the Day: Gobble, Gobble!

Cartoon of the Day: Gobble, Gobble! - Yen turkey cartoon 11.27.2014

Happy Thanksgiving from Hedgeye. Be sure to count your blessings.

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