“I’m the fellow who takes away the punch bowl just when the party is getting good.”
-William McChesney Martin
Economic #history fans will remember McChesney Martin as the Chairman of the Federal Reserve when central planners didn’t decide the fate of every market day (1). Sadly, Richard Nixon and Arthur Burns changed that by Burning The Buck in 1971.
Today, if you want to light up your country’s currency and party hard, you need a Ph.D. in economic storytelling. Devaluation has plenty of stock market pop, but “the trouble is...” according to Ken Rogoff, “a lot of people have not had any punch yet.”
In contrast, the two aforementioned quotes are what Jim Rickards used to introduce Chapter 10 (pg 243 in The Death of Money) – “Crossroads.” And, oh are we at a crossroad for both growth and inflation expectations, globally, this morning.
Back to the Global Macro Grind…
Before I replay what happened last week, here’s what the Japanese just restated (revised lower) about the results of burning their currency – Q3 GDP dropped -1.9% (year-over-year) in 2014. “So”, they definitely need to triple down on that!
I know, that is so Q3. How about China’s November trade data? Imports dropped -7% year-over-year (from +5% in October, which was a bad number to begin with); exports slowed to +5% NOV vs. +12% in OCT. #TrainWreck = Chinese stocks straight up.
In other central planning news, here’s what the world’s Big 3 (currencies) did last week:
With the exception of a counter-TREND move in US jobs data (the 1st pseudo good rate of change report in months), most of the strength in the US Dollar can be attributed to the currency war (i.e. where the BOJ and ECB burn theirs).
To review, why does an un-elected central planner burn the currency?
A) In response to #GrowthSlowing and/or
B) In reaction to #deflation
In Hedgeye-speak (i.e. in Bayesian rate of change terms), when both of these core factors (GROWTH and INFLATION) are slowing, we call that the 4th Quadrant. That’s why our Q4 Macro Theme is called #Quad4 Deflation. That’s where we think the USA is too.
But, but… “it’s different this time” (says the cover of Barron’s, who will be charging 2 & 20 for that investment thesis starting in 2015 due to #deflationary forces in Old Wall media print advertising).
And… at the end of a cycle (66 consecutive months of US economic expansion), the other 2/3 of Americans who have only been punched (negative real wages for the last 5 years) are going to magically get wage growth and a capex cycle…
Simple Global Macro risk manager question: with global #GrowthSlowing and #Quad4 Deflation, how are global capex cycles and wages going to inflate? A: I don’t know.
While the fanfare surrounding Nikkei and “Dow 18,000 Bro” has been fantastic, the following stock markets have not been:
These stock markets have been undergoing what we call a phase transition in inflation expectations becoming deflationary ones. You can see that in the following real-time read-throughs:
Even the strongest commodities in 2014 (Coffee and Cattle) were down -3.9% and -2.6% last week, respectively.
From here, I think the debate really boils down to what’s more important: A) the impact of #deflation on stocks, bonds, and workers who have been compensated (in size) by the last 5 years of inflation expectations, or B) Ph.D. hopes for US wage growth?
Rather than partying hard with the planners, I’ll take B). Yep, call me names – I’m the fellow who doesn’t get paid to navel gaze at the Weimar Nikkei Dow and think that 55x earnings for the Russell 2000 in 2014 wasn’t a #bubble.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.16-2.34%
WTI Oil 62.21-69.40
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.
TODAY’S S&P 500 SET-UP – December 8, 2014
As we look at today's setup for the S&P 500, the range is 41 points or 1.70% downside to 2040 and 0.27% upside to 2081.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS (Bloomberg Estimates):
WHAT TO WATCH:
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
The Hedgeye Macro Team
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.
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 firstname.lastname@example.org, 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