This note was originally published at 8am on November 14, 2014 for Hedgeye subscribers.
“The world wants to deflate while governments want to inflate.”
Now if that isn’t one of the best quotes of the year, I don’t know what is. It’s another way of saying that, since the enemy of government debt is deflation, they’ll do anything to try to arrest economic gravity – so will Wall Street consensus.
To their credit, if only because they’re going #Gruber (Google the video) on The People and preying on their economic and market ignorance, at least government Policies To Inflate are implicit at this stage of the game.
Wall Street strategists, on the other hand, are bullish on “stocks” during both #InflationAccelerating and deflation. Yep, $100-150 Oil was no problemo muchachos… But $70? Ah, that’s why they’ve been bullish on the “economy” all along!
Back to the Global Macro Grind…
Obviously times, technologies, and mostly everything other than the Old Wall have changed. But the very basic difference between what I’ll call good vs. bad #deflation has not.
Here’s the difference:
- Good #Deflation = #StrongDollar + #RatesRising (signal that real, inflation adjusted US growth is accelerating)
- Bad #Deflation = #StrongDollar + #RatesCrashing (signal that both US and Global growth are slowing)
And trust me, I know who is out there making the call that I made on #StrongDollar, Strong America (after I did in Q4 2012). He’s the same guy who got run-over by late-cycle #InflationAccelerating from JAN-JUN 2014, and missed both early-cycle US #ConsumerSlowing and #HousingSlowdown in 2014 too. But this isn’t about me versus him. This is about understanding:
A) The difference between good and bad growth expectations
B) How to express those very different scenarios in terms of stocks versus bonds
C) How to pick the right sectors of the stock and bond markets that reflect economic reality
Good vs. Bad, Stocks vs. Bonds?
Yes. Top down, the difference in your asset allocation should have been polar opposite in 2013 and 2014:
- Good #Deflation = I said Short the Long Bond, Buy The Russell (80% of its revenues come from USA)
- Bad #Deflation = I said Buy the Long Bond (TLT), Short the Russell (until growth expectations reset)
And to be clear, only after you have the Bad #Deflation play out in all of its manifestations (down High Yield Energy Bonds, down upstream MLP Energy Stocks, etc.) will you have the catalyst to get long the Good #Deflation.
Put another way, if and when markets price in what the Long Bond and Russell 2000 have been pricing in all year (like they did in early October), you get to buy your favorite early-cycle consumption stocks, lower.
How some of these guys go from having not called for an early cycle slowdown to calling for an economic recovery (from the consumer spending and US housing slowdown) is above my pay grade, but who really cares. Macro markets are going to do what they are going to do, on their own time.
In the meantime, we want you to stay with the #Quad4 deflation playbook:
- Long the Long Bond (TLT, EDV, etc.), Munis (MUB), and Cash
- Long Healthcare (XLV), Consumer Staples (XLP), and REITS (VNQ)
- Short the Russell 2000 (IWM) and Oil & Gas E&Ps (XOP)
- Short France (EWQ), Russia (RSX) and Emerging Markets
The US economy won’t recover until government Policies To Inflates are reversed (#RatesRising, not crashing). That is not what the Old Wall wants. But I called my top contact (God) this morning (smart guy)… and he said he still wants economic cycles and gravity to exist.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.30-2.40%
WTI Oil 73.89-77.31
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer