THE HEDGEYE MACRO PLAYBOOK

Takeaway: We know we're a little late today (post Hedgeye holiday party edition), but you DO NOT want to miss what we have to say about energy below.

INVESTMENT CONCLUSIONS

Long Ideas/Overweight Recommendations

  1. iShares National AMT-Free Muni Bond ETF (MUB)
  2. iShares 20+ Year Treasury Bond ETF (TLT)
  3. Vanguard Extended Duration Treasury ETF (EDV)
  4. Consumer Staples Select Sector SPDR Fund (XLP)
  5. Health Care Select Sector SPDR Fund (XLV)

Short Ideas/Underweight Recommendations

  1. iShares Russell 2000 ETF (IWM)
  2. iShares MSCI European Monetary Union ETF (EZU)
  3. iShares MSCI France ETF (EWQ)
  4. SPDR S&P Regional Banking ETF (KRE)
  5. SPDR S&P Oil & Gas Exploration & Production ETF (XOP)

 

QUANT SIGNALS & RESEARCH CONTEXT

#Quad4 Asset Price Deflation in Energy Continues: As my colleague Brian McGough suggested in today’s Early Look, we aren’t perfect and we certainly don’t nail every call that we make. We often miss things, but one of the things we have fortuitously not missed this year is the pervasive deflation across the energy complex.

 

Even with tools as powerful as our GIP Model, Keith’s TRADE/TREND/TAIL model and TACRM, our asset allocation process remains far from perfect. We do, however, take solace in the fact that perfection does not exist on an ex ante basis in markets. Well, that and the fact that our process is pretty darn good.

 

Using a combination of quant signals and fundamental data to predict what “Quadrant” we’re in or headed into gives us the best probability to get our asset allocation and sector/style factor rotations right. It is truly the equivalent of perpetually stepping into the batter’s box with 3-and-0 count in hand.

 

When we started pounding the table on #Quad4 back in early August, reacting to the “3-and-0” count then was to get long of U.S. dollars and [very] short of commodities and commodity-linked equities – energy in particular. That’s probably the best macro call anyone could’ve made in 2H14. Either that or buying the mid-October lows in the stock market.

 

THE HEDGEYE MACRO PLAYBOOK - UNITED STATES

 

THE HEDGEYE MACRO PLAYBOOK - DXY GIP

 

THE HEDGEYE MACRO PLAYBOOK - BRENT CRUDE OIL

 

THE HEDGEYE MACRO PLAYBOOK - XLE

 

While we missed making the latter call, we certainly did not miss making the call for asset price deflation in energy. In fact, my colleague and rock star commodities analyst Ben Ryan has been all over this move. Please review the following notes to learn more about why we think crude oil, E&Ps and upstream MLPs have further downside from here:

 

 

After yesterday’s -3.3% plunge, domestic E&Ps (XOP) are now down -15.6% WoW and -41.3% from their YTD peak in late June. OAS on high-yield energy bonds have backed up from a YTD low of 402bps to 845bps as of this morning. As we highlighted in our #Bubbles theme, illiquidity and spread risk were the two key factors that perpetuated and continue to perpetuate our negative bias on the broader junk debt market.

 

THE HEDGEYE MACRO PLAYBOOK - energy OAS

 

THE HEDGEYE MACRO PLAYBOOK - HY Spread Risk

 

One of the hardest things to do as investors is having the guts to stick with a call like this. It’s obviously now extremely consensus; even StreetAccount appears to be bearish on the energy complex per the content of their summary note this morning at ~8:00am:

 

  • “Oil drop gives US drillers argument to end export ban: Bloomberg noted that the fall in oil prices has given oil producers a new argument for ending the US ban on exports. The article said with US output at a 31-year high and imports at the lowest level since 1995, producers seeking the best possible price for crude are stuck having to keep sales at home. Removing the ban could erase an imbalance between US and foreign crude prices. It pointed out that lawmakers are set to hold a hearing next week on dropping the ban.”
  • “Oil reserves at highest since 1975: The FT reported that US proven oil reserves rose to their highest level since 1975 last year. The article noted that proven reserves were in decline up until 2009. According to the EIA, last year US companies produced about 2.7B barrels from their reserves, but added 5.5B in new discoveries. As a result, the US ended 2013 with about 36.5B barrels of proven oil reserves, a 9.3% y/y rise. The peak remains 1970, when proven reserves were reported at 39B barrels.”
  • “Energy debt may be experiencing 'Minsky Moment': The FT said we may be seeing a "Minsky Moment" with energy and junk bonds, as investors begin to price in the potential end of the boom that funded the US shale revolution. The article said the chase for yield has begun to reverse in the energy debt market. It said currently, nearly a third of speculative-grade debt issuance by energy companies trades so poorly it qualifies as being classed as distressed.”

 

Sometimes consensus is right and that appears to be the case here. Per our Tactical Asset Class Rotation Model (TACRM), energy related sectors and subsectors continue to head up the rear among the 47 sectors and style factors we track across the U.S. equity market from a Volatility-Adjusted Multi-Duration Momentum indictor (VAMDMI) perspective. Adjusting for volume and volatility affords us the conviction needed to interpret this signal as continued pressure for investors to rotate out of these exposures.

 

THE HEDGEYE MACRO PLAYBOOK - TACRM U.S. Equity Style Factors

 

Multi-factor. Multi-duration. With conviction. That is truly the Hedgeye Macro “playbook”.

 

***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.

 

Early Look: Golden Headfakes (12/2)

 

#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.

 

Draghi Didn’t Deliver the “Drugs”! (12/4)

 

#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.

 

#Bubbles: S&P500 Levels, Refreshed (11/18)

 

Best of luck out there,

 

DD

 

Darius Dale

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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