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Risky Business

This note was originally published at 8am on November 24, 2014 for Hedgeye subscribers.

“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.


Risky Business - z. EL 11.24 Mid pic


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 sales@hedgeye.com, because we have a plethora.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.28-2.38%

SPX 2011-2066

RUT 1153-1188

USD 87.45-88.51

EUR/USD 1.23-1.25

WTI Oil 73.90-78.11


Keep our head up and stick on the ice,


Daryl G. Jones

Director of Research 


Risky Business - 11.24.14 Chart

Commodities: Weekly Quant

Commodities: Weekly Quant - chart 1 divergences

Commodities: Weekly Quant - chart2 deltas

Commodities: Weekly Quant - chart3 USD correls

Commodities: Weekly Quant - chart4 S P correls

Commodities: Weekly Quant - chart5 volume

Commodities: Weekly Quant - chart6 open interest

Commodities: Weekly Quant - chart7 volatility

Commodities: Weekly Quant - chart8 sentiment



Ben Ryan


The Week Ahead

The Week Ahead - 12.05.14 Week Ahead


the macro show

what smart investors watch to win

Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.

Investing Ideas Newsletter

Takeaway: Current Investing Ideas: EDV, HCA, MUB, RH, TLT and XLP.

Below are Hedgeye analysts’ latest updates on our six current high-conviction long investing ideas and CEO Keith McCullough’s updated levels for each.


*We also feature two pieces of content from our research team at the bottom.

Investing Ideas Newsletter - InvestingIdeas12.5 

Trade :: Trend :: Tail Process - These are three durations over which we analyze investment ideas and themes. Hedgeye has created a process as a way of characterizing our investment ideas and their risk profiles, to fit the investing strategies and preferences of our subscribers.

  • "Trade" is a duration of 3 weeks or less
  • "Trend" is a duration of 3 months or more
  • "Tail" is a duration of 3 years or less


Investing Ideas Newsletter - Card house cartoon 12.03.2014




Labor Market, Is That All You Got?


Today was nothing shy of a historic day in the domestic labor market. November’s +321k MoM gain in Non-Farm Payrolls represented the fastest sequential pace of net job growth since January 2012. Underneath the hood, the report was solid as well:


  • Growth in Average Hourly Earnings accelerated +10bps to +2.1% YoY.
  • Average Weekly Hours edged up to 34.6 from 34.5 prior; per Bloomberg economists: “…a one-tenth increase in the workweek is the worker-hour equivalent of about 250k additional jobs. In other words, if the workweek was unchanged, to have the same income-effect the payroll number would have had to be 571k”.
  • Growth in Total US Employees on Nonfarm Payrolls accelerated to a new cycle-high of +1.99% YoY from +1.96% prior.


Clearly the November Jobs Report was very strong and the fixed income market reacted as such, with the 10Y Treasury bond yield shooting up from 2.24% to 2.33% immediately following the release. It closed the day at 2.30%. 2Y Treasury note yields also shot up around ~10bps immediately following the release of the employment figures, closing just shy of its highs of the day at 0.64%.


The movement in the 10Y yield coincided with a -0.58% DoD return for the TLT and -0.38% return for the EDV. Considering today’s massive rip in employment growth, these moves seem quite a bit muted.


In fact, these returns are only in the 22nd and 34th percentiles of daily returns on a trailing 3Y basis, respectively; one would think they’d be in the bottom-10 percent given this major step forward in the domestic labor market. The fact that both ETFs closed UP on the week (+0.2% and +0.4%, respectively) is actually quite stunning in the context of the aforementioned labor data.


So what gives?


We think this golf clap of a return for Consensus Macro bond bears is the market effectively trying to communicate that the Fed isn’t going to hike interest rates anytime soon – or quite possibly ever under the tenure of Janet Yellen!


That’s certainly what our proprietary G3 Monetary Policy Model is suggesting. In fact, this model actually suggests there’s a fairly high probability that the Fed gets easier over the next 3-6 months, given that its score is similar to the ECB’s, which continues to set the table for open-ended LSAP.


Investing Ideas Newsletter - s6


At a bare minimum, this implies ZIRP is likely to remain in place for longer than most investors currently expect. And the longer we hang out at 0-25bps on the Fed Funds Rate, the higher the likelihood that we enter a economic downturn. As this late-cycle labor market strength ominously implies, the clock is ticking on this economic recovery, which is slightly long in the tooth by historical standards. Moreover, the labor market actually tends to peak about ~7 months prior to the start of the recession, effectively forestalling an easier Fed along the path towards economic gravity.


Investing Ideas Newsletter - s7


All told, while we do not think it’s appropriate to make the “recession” call just yet, we still think the path of least resistance for interest rates remains lower over the intermediate-term. That’s a favorable setup for long-term Treasuries, munis and for investors seeking yield pickup in the equity market (healthcare, consumer staples, utilities and REITs).


Hospital Corporation of America hit a new 52-week high this week and is up approximately +12% since we added it to Investing Ideas on 11/7.


We track 25+ data series that drive the fundamentals of HCA in our Hospital Monitor (see below). Three of those series were updated today with the release of the November Jobs report. Women Employment Age 25-34 continues to trend positively y/y, despite slowing in rate of change terms from the October release. This series is important because it has a high correlation with births, as an increase in employment corresponds to greater insured population (more women can afford to have a child).


Meanwhile, Hospital Employment was strong and continues to accelerate y/y, which correlates well to same store metrics. Results of our November OB/GYN survey will be in next week and provide us with an update in utilization trends.


Investing Ideas Newsletter - 2014 12 05 HRM Hospital Monitor


Investing Ideas Newsletter - Women Employment


Investing Ideas Newsletter - Hospital Employment


Restoration Hardware is set to report earnings on Wednesday December 10. We’re comfortable with our above-consensus estimate of $0.52 versus the Street at $0.46.


We think that the top line will be particularly important this quarter given the miss we saw in 2Q when sales only grew at 13.5%, due to problems that RH had with consolidating its 13 Sourcebooks (catalogs) into one colossal 3300 page shrink-wrapped mailing. We’re looking for an acceleration of about 1,000bp in sales growth in this quarter alone.


The company will be switching it up this quarter in a way that we think is a positive. Once its 8K is filed, they’ll post a video presentation highlighting the Company’s ‘continued evolution and recent performance’ on the RH Investor Relations website (approximately 1:30 pm Pacific/4:30 pm Eastern). Then they’ll host a live Q&A session at 2:30 pm Pacific/5:30 pm Eastern.


This one should be a winner.


* * * * * * * * * * 


the clock is ticking for bob evans (bobe)

We continue to believe BOBE represents an under-the-radar special situation story.

Investing Ideas Newsletter - b

ici fund flow survey: a closer eye on etfs

Mutual fund activity during the past 5 days continued to be subdued, giving way to more robust trends in exchange traded funds.

Investing Ideas Newsletter - et

The Best of This Week From Hedgeye

Here's a quick look at some of the top videos, cartoons, market insights and more from Hedgeye this past week.


McCullough on Fox Business: Reading the Market Signals

Hedgeye CEO Keith McCullough on Wednesday discussed his outlook for the markets, economy and Fed with Fox Business "Opening Bell" host Maria Bartiromo.


McCullough: Devaluation Gong Show 'Ends In Tears' 

In this brief excerpt from Tuesday’s Institutional Morning Macro Call, Hedgeye CEO Keith McCullough discusses current economic pressures in Japan and the U.S., as well as the exaggerated impact of falling oil prices on consumers.


Hedgeye's Morning Macro Call with CEO Keith McCullough

We are pleased to present this complimentary peek behind-the-macro-scenes of Hedgeye's daily Morning Macro Call for institutional subscribers. This is from last Monday.


Macro Notebook 12/3: Nikkei | Euro | UST 10YR

Hedgeye Director of Research Daryl Jones shares the top three things in Keith's macro notebook Wednesday morning.



 The (Real) House of Cards

The Best of This Week From Hedgeye - Fed house of cards 12.3.14

This central planning game will not end well.


A Christmas Wish...

The Best of This Week From Hedgeye - Retail Xmas wish 12.1.14

The initial data points from Black Friday weekend? Not good. 



 The 3 and 0 Count

The Best of This Week From Hedgeye - COD 12.5.14


Glacial Cascades: Are You Prepared?

The Best of This Week From Hedgeye - COD 12.3.14

Editor's note: The excerpt below is from CEO Keith McCullough's introduction in Wednesday's Morning Newsletter.


If you’ve proactively prepared your portfolio for the phase transition of market expectations from inflation to #deflation, congrats. Not being long cascading things like Oil, Energy stocks, and Russian Rubles has been key to your wealth preservation in the last 3 months.


But how many people really think about their net wealth this way? How many people start with Warren Buffett’s 1st Rule of Investing: “Don’t Lose Money?” How many services that you pay for are equipped to monitor complex systems in a dynamic way so that your expectations of risk are constantly changing alongside analyzable factors?


I spent some time discussing these questions at the annual Hedgeye Company Meeting yesterday in Stamford, CT. In order to illustrate how risk manifests slowly, then all at once, I showed what I think was a fantastic 4 minute video onGlacial Calving (https://www.youtube.com/watch?v=hC3VTgIPoGU). I’d love to see how Draghi and Yellen would centrally plan smoothing that.



Poll of the Day: Will Oil Prices Fall Below $60 by January 1?

"#Quad4 deflation continues," Hedgeye CEO Keith McCullough tweeted on Monday. West Texas Crude Oil continued its crash last week falling another -13.5% to -28.1% YTD.


Cartoon of the Day: Wages Still Weak

Cartoon of the Day: Wages Still Weak - wages cartoon 12.05.2014

Average hourly earnings were up just 2.1% annually in November. That's historically quite weak. In other words, wages have a long way to go.

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