Will The Fed Centrally Plan a Bounce?

Client Talking Points


We re-entered the dark side with a SELL signal on green yesterday (see Real Time Alerts product) and, barring Janet going completely dovish today, we think there’s immediate-term downside (vs. USD) in Burning Yens to $121.78; that would be good for the Nikkei, which held @Hedgeye TREND support of 16,441 overnight.


Oil saw another bounce (yesterday)… and another selloff this morning (-1.8% WTI to 54.93 with no support to 52.83) – this is what we call pervasive #deflation expectations being baked into one of the most epic perpetual inflation expectations in world history. Respect its longer-term ramifications.


The UST 10YR Yield touched 2.03% yesterday, then bounced to 2.10% and that puts is right in the middle of our 2.03-2.19% immediate-term risk range ahead of the Fed. We have no idea what these people are going to do, but if they did remove “considerable time” and the Long Bond got hit on that, we would buy more of our best Macro Long Idea (TLT).

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

The Vanguard Extended Duration Treasury (EDV) is an extended duration ETF (20-30yr). U.S. real GDP growth is unlikely to come in anywhere in the area code of consensus projections of 3-plus percent. And it is becoming clear to us that market participants are interpreting the Fed’s dovish shift as signaling cause for concern with respect to the growth outlook. We remain on other side of Consensus Macro positions (bearish on Oil, bullish on Treasuries, bearish on SPX) and still have high conviction in our biggest macro call of 2014 - that U.S. growth would slow and bond yields fall in kind.


We continue to think long-term interest rates are headed in the direction of both reported growth and growth expectations – i.e. lower. In light of that, we encourage you to remain long of the long bond. The performance divergence between Treasuries, stocks and commodities should continue to widen over the next two to three months. As it’s done for multiple generations, the 10Y Treasury Yield continues to track the slope of domestic economic growth like a glove. We certainly hope you had the Long Bond (TLT) on versus the Russell 2000 (short side) as the performance divergence in being long #GrowthSlowing hit its widest for 2014 YTD (ex-reinvesting interest).


The U.S. is in Quad #4 on our GIP (Growth/Inflation/Policy) model, which suggests that both economic growth and reported inflation are slowing domestically. As far as the eye can see in a falling interest rate environment, we think you should increase your exposure to slow-growth, yield-chasing trade and remain long of defensive assets like long-term treasuries and Consumer Staples (XLP) – which work decidedly better than Utilities in Quad #4. Consumer Staples is as good as any place to hide as the world clamors for low-beta-big-cap-liquidity.

Three for the Road


RUSSIA: +5.3% on the "bounce" to -52.4% YTD (math: you'd have to be +108%, from here, to get back to breakeven) #crash



Leadership and learning are indispensable to each other.

- John F. Kennedy


The Russian Central bank has spent approximately $80-$100 Billion on FX interventions to strengthen the Ruble – but yet to no avail. The FX reserve is now at a 5 year low.

CHART OF THE DAY: Emerging Markets Are More Important Than You Might Think

CHART OF THE DAY: Emerging Markets Are More Important Than You Might Think - 28


This idea of "emerging economies" is a bit of a misnomer.  According to our analysis, on a purchasing parity basis the so called emerging economies comprised 56% of global GDP share in 2013.  Moreover, in the same year emerging economies comprised 73% of global growth.  So as emerging markets go, so to goes global economic growth.

Two Words

“Narrative is linear, but Action... having breadth and depth, as well as length - is solid.”

-Thomas Carlyle


This morning, the investing world is waiting on a critical two-word pronouncement from the Fed.  Sitting in my hotel room here in London, drinking a Red Bull (it’s 4:30am and the British don’t have any coffee ready!), it's difficult not to find the idea of many of us sitting and waiting on the edge of our seats for a small word change just a bit laughable.


According to Bloomberg:


“Sixty-eight percent of 56 economists surveyed by Bloomberg late last week said the Federal Open Market Committee will drop its pledge to keep interest rates near zero for a “considerable time” and instead adopt a word such as “patient” to describe its approach to policy. Only 23 percent said the committee will keep “considerable time.”


On on hand, given how bad most economists are at predicting actual economic figures, opining on language in central bank statements might actually be a better use of their time.  But regardless there you go, if the Fed keeps “considerable time” in its policy statement, this will be perceived as dovish, and if it changes its language to “patient” this will be perceived as hawkish.

Two Words - Global economy cartoon 12.16.2014

There is also a tail scenario where the Fed does something completely different, but far be it for any traditional economists to opine on something that doesn’t fit a linear narrative.   Currently, the most popular narrative out there is that the U.S. is decoupling from the global economy. While that may be true now, and to a point, it has also become fairly consensus. 


Back to the Global Macro Grind...


On the topic of the U.S. economy, it has been out-performing many major economies this year and at up +6.7% for the year-to-date the SP500 is in part reflecting this.  In addition, if it weren’t for energy (the XLE is down over -16%) the SP500’s performance would be much stronger.  That said, it is likely a narrative fallacy to believe that if the world catches an economic cold, the U.S. won’t at a minimum sneeze.


My colleague Darius Dale did a comprehensive presentation yesterday on emerging markets and his conclusion was somewhat dire.  While he acknowledges that many emerging markets have underperformed year-to-date, he also uses history as a guide which suggests a scenario of increasing emerging market calamity due to strong U.S. dollar in combination with emerging market illiquidity (among other things). 


Certainly, the case can be made, as we have, that a strong U.S. dollar is good for the U.S. economy, but the greater global risk is that it moves too far and too quickly, which puts the squeeze on emerging economies that issue debt in U.S. dollars and pay it off in local currency. 


In fact, according to some estimates “international banks had loaned $3.1 trillion to emerging markets by the middle of this year, mainly in dollars. Such nations had also issued international debt securities totaling $2.6 trillion, of which three-quarters was in dollars.”  That, my friends, is a lot of U.S. dollar denominated debt in the hands of some potentially very weak economic hands.


So, to the extent that emerging economies have less access to capital because of a strong dollar (the data is already showing they do) or in a more extreme scenario, have challenges paying back U.S. dollar debt, there will be increasing economic headwinds globally and we’d be naïve to think that won’t impact U.S. growth.


In fact, as we show in the Chart of the Day below, this idea of emerging economies is a bit of a misnomer.  According to our analysis, on a purchasing parity basis the so called “emerging economies” comprised 56% of global GDP share in 2013.  Moreover, in the same year emerging economies comprised 73% of global growth.  So as emerging markets go, so to goes global economic growth.


Now to be fair to the bullish narrative on the U.S., in the last full year of 2013, only about 9.4% of U.S. GDP was from exports, so relative to many economies, the U.S. is much more self-sufficient.  The obvious caveat is that from 2009 to 2013, exports also grew by about 49%, so the increase in exports has been a notable tailwind to U.S. GDP. 


More critically, for those of us who are stock market operators at least, is the fact that almost a full 1/3 of SP500 corporate revenue comes from international sources.  So even if the U.S. continues to hum along alone, if the global economy does decelerate, so too will U.S. corporate profits. And while the U.S. stock market could continue to move higher in that scenario, we’d probably be hedged.


Inasmuch as we are disbelievers in a complete decoupling scenario, there are certainly positives in the U.S.:  a “tightish” labor market, meaningfully lower energy costs and a new one for our ledger... an improving housing market.  Incidentally, we will be outlining our housing narrative (albeit a narrative with facts and analysis) at 1pm eastern today.


The key components of this new thesis are as follows:

  • Progress: The same model that underpinned our long thesis in housing in 2012/13 and short position in 2014 is signaling another inflection as we head into 2015;
  • Fledgling Inflection: 2nd derivative trends matter in housing and, from a rate of change perspective, most of the data is beginning to inflect positively; and
  • Opening the Credit Box: After a discrete tightening in 2014, credit constraints should show marginal easing in 2015.

If you’d like information for the call, please email .


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.03-2.19%


VIX 17.54-25.49

YEN 116.06-121.78

Oil WTI 52.83-60.73

Gold 1180-1220 


Keep your head up and stick to your narratives,


Daryl G. Jones

Director of Research


Two Words - 28

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.

December 17, 2014

December 17, 2014 - 1



December 17, 2014 - Slide2

December 17, 2014 - Slide3

December 17, 2014 - Slide4



December 17, 2014 - Slide5

December 17, 2014 - Slide6 

December 17, 2014 - Slide7

December 17, 2014 - Slide8

December 17, 2014 - Slide9

December 17, 2014 - Slide10

December 17, 2014 - Slide11
December 17, 2014 - Slide12

Glacial Cascades

This note was originally published at 8am on December 03, 2014 for Hedgeye subscribers.

“The key to wealth preservation is to understand the complex processes and to seek shelter from the cascade.”

-James G. Rickards


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 on Glacial Calving ( I’d love to see how Draghi and Yellen would centrally plan smoothing that.


Glacial Cascades - 55


Back to the Global Macro Grind


Yesterday I used the snow-pack metaphor to discuss market risk factors that have a rising probability of cascading into asset class draw-downs. The idea was inspired by my friend Jim Rickards, who wrote an awesome chapter called “Maelstrom”:


“An avalanche is an apt metaphor of financial collapse. Indeed, it is more than a metaphor, because the systems analysis of an avalanche is identical … An avalanche starts with a snowflake that perturbs other snowflakes, which, as momentum builds, tumble out of control… The dynamics are the same, as are the recursive mathematical functions used in modeling the process.”

-The Death of Money, pg 265


Unless they are just looking at “charts”, I think almost everyone who gets paid real money to pick stocks, bonds, commodities, etc. has a bottom-up process to analyze securities. In fact, some are quite impressive. But how impressed are you with the systems of analysis our profession uses, from a top-down perspective?


Going on 16 years into this, my experience has been a learning one. The more I read, the less I know. But the more I observe how consensus thinks about top-down macro risks that are developing in this dynamic ecosystem of market expectations, the more opportunity I see in learning more of what not to do, out loud.


You see, while I certainly don’t make the same “money” I used to make on the buy-side, I am making a difference in my learning experience. When you open yourself up to the critique of the crowd (daily), you’re actually forced to learn faster.


In terms of big bang losses of wealth (draw-downs), the lessons, unfortunately, tend to be more expensive for the many, and profitable for the few. That’s why I think making money at the all-time highs in asset price inflation becomes next to impossible, without protecting for the downside risks associated with an avalanche (deflation) like the one we just saw in Energy markets.


Moving along…


Never mind snowflakes, there are two big snowballs that are going to hit you square in the forehead on Thursday and Friday:


  1. Thursday: European Central Bank (ECB) decision by Draghi
  2. Friday: US Jobs Report for November


In isolation, even for people who don’t do macro (but have a macro opinion on everything!) both of these events probably matter. From an interconnectedness perspective, fully loaded with time/price for both Euros and Yens relative to where European and Japanese equity markets are right here and now, these events matter as much as any we’ve seen in months.


Here’s the system’s setup:


  1. Japanese stocks (Nikkei) are signaling immediate-term TRADE overbought with a risk range of 16,945-17,741
  2. European Stocks (EuroStoxx 600 Index) are signaling immediate-term TRADE overbought with a risk range of 337-351
  3. Both the Euro and Yen are signaling immediate-term TRADE oversold vs. USD at $1.23 and $119.56, respectively


In other words, measuring the system’s risk within a “risk range” (where being at the top and/or bottom end of the range increases the probability of a short-term reversal), the probability is as high as it’s been of seeing a big macro reversal.


There’s that word again, probability…


If you’ve never gone heli-skiing on a mountain with identifiably risky snow-pack factors, try it and you’ll get my point. I’m not saying you are going to break your leg going down a certain path – I’m saying some paths/situations have higher probabilities of that happening than others!


Whether you are skiing, or risk managing your portfolio alongside already cascading asset class paths (like high-yield Energy stocks, Silver futures, Brazilian stocks, etc.), you should always be asking yourself a lot of questions:


  1. What if Draghi doesn’t deliver the drugs?
  2. What if Japanese election sentiment forces Abe to tone down the currency burning?
  3. What if the US Jobs reports misses, and the Dollar corrects from its overbought highs?


There are obviously a lot of questions to ask yourself, all of the time – and maybe that’s why some people don’t “do macro” the way we do. It requires a ton of rinse/repeat systems analysis, yes. But, more importantly, it always puts you at the epicenter of the uncertainty of the system… and stock picking tends to “feel” more certain than that.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.16-2.30%

SPX 2032-2078

Nikkei 16945-17741

EUR/USD 1.23-1.25

Yen 117.41-119.56

WTI Oil 64.55-70.36


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Glacial Cascades - 12.03.14 Chart

CAT: A Short Christmas Come January 26th?


“Skeptical of Oil & Gas Capital Spending…Energy-related capital spending looks like ‘mining capital spending-lite’”


Hedgeye Industrials 4/21/2014 CAT: Defining Differences & The Segment Formerly Known As Power Systems





2015 is not shaping up well for CAT.  While some other industrials offer exposure to pending declines in upstream oil capital spending, we think CAT has greater exposure than the market appreciates.  We also believe CAT provides broader positives as a short/underweight, such as exposures to other resources-related capital equipment, likely credit losses, and problematic corporate controls.  We have been bearish on CAT since Hedgeye Industrials launched in 2012, and the tail of the thesis – declining energy-related capital spending and credit issues at its captive finance subsidiary – is finally coming into view. 


Consensus estimates for CAT’s 2015 EPS have hardly budged since late October.  This is odd, since expectations for 2015 upstream oil capital spending, a key CAT end-market, have certainly declined.  CAT provided its initial 2015 top-line guidance with its 3Q 2014 earnings report, calling for, give or take, zero growth.  Consensus just assumed margin expansion in 2015, translating that flattish top-line guidance into 8% EPS growth. 


Excluding a transaction or similar rabbit-out-of-the-hat solution, we expect both sales and EPS to be lower in 2015 vs. 2014.  We think something in the $5.00 -$6.50 range is a reasonable expectation for the initial guide in January vs. current consensus of $7.00.  Our guess is that management will want to set initial expectations low to avoid a repeat of the 2013 serial guidance cuts.


We really wonder if current holders have examined to whom CAT has provided financing in its quest to sell equipment.  CAT Financial has disclosed a “material weakness” relating to “Allowance for credit losses”, although the disclosed adjustments so far have been fairly small.  Caterpillar Financial has ~$35 billion in assets (although we do not hear much about it) and lends to mining and oil/gas companies, too.  There will be credit issues, in our view.  Losses at captive finance companies are typically greeted with a mix of confusion and disdain in the Industrials sector.


Here is a brief summary of why we expect the 2015 guide to come in well below consensus, and below anticipated 2014 results:


  • Resource Industries: We expect Resource Industries to show further modest revenue declines and a segment loss in 2015, as oil sands capital spending should weaken, MATS regulations should prove an incremental negative for coal demand, and many mined mineral prices, like iron ore, have fallen further.  Mining equipment prices should continue to be under pressure, as we understand it.  Financing also is likely to be less available/attractive.  Optimism around the cessation of the dealer destock seems misplaced in a market with slackening demand.
  • Energy & Transportation:  We have long expected a decline in oil & gas capital spending to follow the decline in mining capital spending, but the recent drop in oil prices locks that in for 2015.  We think the market actually underestimates the relevance of upstream oil and gas capital spending for CAT.  Gensets, drilling engines, fire pump engines, well service engines/pressure pumps, and transmissions add to the exposure, along with the aftermarket sales on these often overworked engine platforms.  While Tier 4 Final will have a disclosed negative impact on locomotive sales, it will also impact other categories of very large engines, like gensets.  The spike in North American E&T sales growth supports the view of a broader 2014 Tier 4 Final pre-buy.
  • Construction Industries:  While Construction Industries is largely insulated from the decline in resource-related capital spending, it faces very tough comps in 2015.  Dealer inventory builds supported record 1H 2014 margins.  Improving on 2014’s strong performance may prove challenging, particularly if dealer inventory actions are less supportive.  Emerging market demand may well continue to deteriorate, too.
  • Financial:  Caterpillar Financial has lent money to a number of mining projects, as discussed here.  While oil and gas financing exposure is difficult to quantify, it has presumably been a meaningful part of the portfolio.  Asset growth has slowed, and we expect higher allowances in 2015.


Are investors missing CAT’s upstream exposure?


We think that E&T has more upstream exposure than investors realize.  First, the margins correlate reasonably well to metrics like rig count, as best we can estimate.



CAT: A Short Christmas Come January 26th? - jkq1



Second, some oil and gas sales can get miscategorized.  For example, gensets may get categorized as electric power, even if the unit is for an oil and gas application.  Remote mines, offshore platforms, and onshore drilling sites tend not to have ready electricity grid access.  Consider this article -


Consider Aggreko's end-market mix in North America, which shows about 1/3 of sales to oil & gas and mining.  Given CAT's product set and relationships, we would be surprised if it were a smaller part of the mix.


CAT: A Short Christmas Come January 26th? - adenew 2



Would You Want These Receivables?

And these are the ones that the company discloses in its mining finance pitch book…  We covered this in more detail a couple of weeks ago.


CAT: A Short Christmas Come January 26th? - jkq2



There is also likely to be credit exposure on the oil & gas side.  We do not know how big the exposure is today, but in 2009 it was expected to grow to several billion dollars.   We would guess that the growth has exceeded those earlier expectations.


CAT: A Short Christmas Come January 26th? - jkq3



In terms of exposures circa a few years ago, the drilling and well services names may be troubled, while the compression names look largely okay.


CAT: A Short Christmas Come January 26th? - jkq4


CAT is still advertising onshore financing, but we would bet credit standards have tightened just a bit this quarter.  Tighter credit is an obvious negative for new equipment sales.


CAT: A Short Christmas Come January 26th? - jkq5



Upshot & Valuation


CAT has high quality products and employees, but has become a bit ‘low quality’ from an investor perspective, we think.  There is an S.E.C. review of the company's accounting, some fantastically unfortunate acquisitions, numerous guidance gaffs, and clear strategy issues.  We suspect CAT shares will put in a bottom when management is either changed, or does a 180-turn on strategy.  If CAT earns, say, $5.00 in 2015, ex-items, and has some of the credit, accounting, management, and strategy issues that we anticipate, a 12x-15x multiple might prove generous.  To us, it doesn’t seem unreasonable that the shares could trade in the $60-$75 range (although we do not like a P/E framework), and possibly even lower if it gets messy. 


Still, the 2015 guidance we should see when CAT reports on January 26 will likely miss consensus, and we would expect the shares to underperform into that report.  It also seems like a short-run cover the news event, but that decision can wait.