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Takeaway: We highlight the ongoing deterioration in global growth and how that is perpetuating a continued rally in [safe] USD-denominated assets.

INVESTMENT CONCLUSIONS

Long Ideas/Overweight Recommendations

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

Short Ideas/Underweight Recommendations

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

QUANT SIGNALS & RESEARCH CONTEXT

Global #GrowthSlowing Continues: As you are probably well aware, we’re not huge proponents of survey data; often times surveys can be incongruent with actually recorded rate-of-change data for key economic indicators like real GDP. That said, there is some merit to following monthly PMI data – to the critical extent it is done so appropriately.

What we mean by “appropriately” is accounting for variations (read: “noise”) in the monthly PMI readings. A simple 3MMA to transform the data into a smoothed trend dramatically tightens the correlation between both ISM Manufacturing PMI and ISM Non-Manufacturing PMI and the YoY growth rate of real GDP.

Specifically, when smoothed, the change in ISM Manufacturing PMI can be said to explain 60% of the delta in real GDP growth vs. only 37% on a raw basis (trailing 15Y). Those figures are 83% and 70%, respectively, for ISM Non-Manufacturing PMI.

THE HEDGEYE MACRO PLAYBOOK - ISM MANUFACTURING vs. GDP

Source: Bloomberg L.P.

THE HEDGEYE MACRO PLAYBOOK - ISM NON MANUFACTURING vs. GDP

Source: Bloomberg L.P.

You’ll note the dramatically tighter correlation for the non-manufacturing data. This is simply because the services sector is a much, much larger component of GDP in most mature economies. In fact, given manufacturing’s relatively miniscule share of U.S. GDP (~10-12%) we remain perplexed as to why the ISM Manufacturing PMI data is so widely followed and anchored upon as a barometer of U.S. economic health. It’s impact as an indicator is hideously overstated relative to the strength of its signal. But I digress…

Amalgamating the two readings on a smoothed, economy-weighted basis is ultimately the most appropriate way to extract a meaningful signal from PMI survey data.

As you can see in the chart below, this measure is over three times more statistically significant in determining the marginal rate of change in real GDP. The r² of 0.83 compares to an r² of 0.37 for the raw Manufacturing PMI data – which is ironically the one the Consensus Macro community anchors on the most!

THE HEDGEYE MACRO PLAYBOOK - ISM vs. GDP

Source: Bloomberg L.P.

In the charts below, we show economy-weighted Markit PMI data for the world and its eight largest economies, opting for the Markit PMI series over the ISM series because it is:

  1. Comparable across economies (same survey format for every country);
  2. More robust in the sense that is anchors more heavily on actual operating results vs. confidence/expectations; and
  3. Consistently released 1-2 weeks earlier than the ISM data.

What you’ll quickly note is that global growth continues to slow on both sequential and trending basis. The only exceptions are sequential (i.e. NOT trending) accelerations in India (which is now on the other side of a tightening cycle), Japan (which is crawling from the depths of [but still in] recession) and the U.K.

THE HEDGEYE MACRO PLAYBOOK - WORLD PMI

THE HEDGEYE MACRO PLAYBOOK - COMPOSITE PMI

THE HEDGEYE MACRO PLAYBOOK - EUROZONE PMI

THE HEDGEYE MACRO PLAYBOOK - U.K. PMI

THE HEDGEYE MACRO PLAYBOOK - CHINA PMI

THE HEDGEYE MACRO PLAYBOOK - JAPAN PMI

THE HEDGEYE MACRO PLAYBOOK - INDIA PMI

THE HEDGEYE MACRO PLAYBOOK - BRAZIL PMI

THE HEDGEYE MACRO PLAYBOOK - RUSSIA PMI

Perhaps more shocking to anyone naval gazing at the performance of large-cap U.S. equities is the fact that these trends continue to be appropriately priced across the global macro universe.

Looking to our Tactical Asset Class Rotation Model (TACRM), we see that on a trailing 3M average basis 37% of asset class, country, sector and/or style factor ETF exposures have a Volatility-Adjusted Multi-Duration Momentum Indicator (VAMDMI) reading of < -1x, which implies a clear trend of negative VWAP momentum across multiple durations. That’s roughly the highest reading since July of 2012 and actually the highest reading since November of 2011.

Moving along, at the primary asset class level we see that only DM Equities and Cash – which is comprised simply of U.S. dollars and the VIX – currently have more ETFs exhibiting a clear trend of positive VWAP momentum across multiple durations (i.e. VAMDMI reading > +1x) than those exhibiting a clear trend of negative VWAP momentum across multiple durations.

THE HEDGEYE MACRO PLAYBOOK - TACRM GMRS

In fact, DM Equities is currently the only primary only asset class with more positive VAMDMI readings than negative ones, thanks mostly to the strong performance of large-cap U.S. equities and Japan. European equities remain an obvious drag.

THE HEDGEYE MACRO PLAYBOOK - TACRM GMRS N

THE HEDGEYE MACRO PLAYBOOK - TACRM Heat Map

Given that both the fundamental data and quantitative signals suggest global capital allocators in search of positive absolute returns can really only buy U.S. dollar-denominated assets and Japanese equities (on a hedged basis), we totally understand why the S&P 500 keeps making higher-highs in the context of our #Quad4 theme.

That’s certainly not to say #Quad4 hasn’t worked! In fact, we’d argue what’s driving the top quartile of performance in the active management space in 2H15 is, in fact, our #Quad4 theme, which calls for an allocation to slow-growth, yield-chasing in lieu of commodity producers and servicers in the domestic equity market and for an allocation to relative safety over high yield/junk in the domestic fixed income market.

THE HEDGEYE MACRO PLAYBOOK - 1

Source: Bloomberg L.P. (indexed to our 8/5 presentation titled, “ARE YOU PREPARED FOR QUAD #4?”)

THE HEDGEYE MACRO PLAYBOOK - 2

Source: Bloomberg L.P. (indexed to our 8/5 presentation titled, “ARE YOU PREPARED FOR QUAD #4?”)

If all you do is buy the SPY with leverage, then clearly you have little need for our global macro overlay. But to the extent you are actually looking to both outperform and preserve capital, we hope you have found and continue to find our investment ideas helpful.

***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: Party Hard? (12/8)

 

#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: “Hedge Fund Hotel” Edition (Part II) (12/8)

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 – keeping in mind that we have equal conviction in each security from an intermediate-term absolute return perspective.