• run with the bulls

    get your first month

    of hedgeye free


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

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 (https://www.youtube.com/watch?v=hC3VTgIPoGU). 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

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.37%
  • SHORT SIGNALS 78.32%

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 - http://thebakken.com/articles/685/generators-evolving-with-the-bakken.


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.



Moscow, We Have a Problem

When your country’s central bank raises its interest rate a monster 650bps to 17% (as the Russian Central Bank did early this morning local time) and the currency still doesn’t go up, Houston, we have a problem.


By all accounts, we saw some of the most epic swings (ever) across Russian markets today. The whipsaw moves beg the important question:  during these desperate times in Putin’s Russia, will we witness desperate measures taken? 


In today’s Hedgeye Poll of the Day we asked: “Will Vladimir Putin take major military action in 2015?” The response was 65% “YES” versus 35% “NO”.  Clearly, taking a “major” action to inflect the price of oil could be seen as desperate to some, or as a necessity to others.


Moscow, We Have a Problem  - w. putin poll


We run though the current risk set-up impacting Russia below and offer accompanying charts illustrating current risks. While it remains unclear exactly how conditions will play out from here, the risk has markedly increased to the upside (over even just the last 24 hours).


Four factors worth considering upfront:


1) OPEC may have an agenda to tighten the screws on Russia and other countries with high break-even prices;

2) Currency crashes can be expedient and self-perpetuating;

3) Russia’s economic isolation and nationalism may extend the prospect of economic recovery;

4) The heavy ties of Russia’s largest companies to the State could expedite and heighten the sovereign risk profile.


A key news item to this entire story was released yesterday: the Russian government disclosed that state-owned Rosneft needed to raise capital, with help from the Central Bank, to cover $6.9Bn in a USD-denominated bridge term-loan due early next week. Rosneft issued $10.9Bn in new bonds at Friday’s exchange rate with large, State-owned banks buying the issue. The banks then deposit the bonds with the central bank, and Rosneft is financed with the printed Rubles.  Rosneft, due to the current sanctions, is unable to roll the term loan with western banks, and so squarely looks like it desperately needed the money from the CB to foot the bill next week.  Of note is that Rosneft CEO Igor Sechin is a close ally with President Vladimir Putin. The next unsecured USD-denominated debt from Rosneft is a $7.1Bn payment due February 2015.   


While we look from the outside, on the streets the purchasing power of the Ruble is evaporating, quickly. Despite Putin’s popular approval rating still in the 80s, we’d be overweight the “YES” camp that in fact a crashing Ruble will propel him to take some form of desperate action. 


Moscow, We Have a Problem  - w. Russia cartoon 12.15.2014


We suggest you consider these risks to protect your portfolio during this downslide.

  • Crash Mode 1: The USD/RUB is down -27% W/W and -56% YTD
  • Crash Mode 2: The Russian Stock Market (RTSI) is down -28% W/W and -57% YTD
  • Russia’s 5YR Sovereign CDS rose to 551bps (+67bps D/D) (above 300bps = Lehman breakout line).
  • The Russian Central bank has spent ~ $80 - $100 Billion on FX interventions to strengthen the RUB – but yet to no avail. The FX reserve is now at a 5YR low. Their total FX and gold reserve base is at $416.2Bn as of 12/05 (-18.50% YTD) and we’ll get an updated number from the CB on Thursday.  They have already pumped dollars into the Russian banking system and bought Rubles (a move that would have been slightly reversed if there is any truth to the Rosneft debt bailout)
  • The Russian Central Bank has raised the main interest rate 6 times this year; today’s 650bp increase to 17% follows last week’s 100bp hike. Here too there’s been no inflection in the currency or stock market.
  • Brent Crude is down -46% YTD at $59.60. A close proxy for Russia’s Urals main export blend, according to Finance Minister Anton Siluanov the price needs to be at $90/barrel for the 2015 budget to balance (a level 51% above today’s price).
  • Russia derives about 50% of its budget revenue from oil and natural gas taxes and 25% of its GDP is linked to the energy industry.
  • The Russian Central Bank said today that 2015 GDP may shrink to 4.5% to 4.7%, the most since 2009, if oil averages $60 a barrel under a “stress scenario”. (We expect the 2015 GDP drag could be closer to -6% to -8%).
  • The Russian Central Bank said net capital outflow may reach $134 billion this year, more than double last year’s total.
  • Inflation is at a 3YR high at 9.1% while real wages are at a paltry 0.3%.
  • Lower purchasing power via a depreciating currency + some higher local prices given import sanctions = the perfect cocktail for massive declines in consumer spending (beyond buying goods to lock in the “value” of the Ruble – evidence we’ve received anecdotally).
  • Russian banking crisis risk is rising by the day: as a proxy, Sberbank, Russia's largest bank with 46% deposit share, has seen its CDS rise steadily since mid-year, up 50bps D/D to 576bps.
  • Further, the CEO of Sberbank said back on November 14th that if the Russian economy were to decline by more than 1.2% in 2015 Sberbank would need the State to bail it out.

Moscow, We Have a Problem  - a. 1

Moscow, We Have a Problem  - a. 4

Moscow, We Have a Problem  - a. 5

Moscow, We Have a Problem  - a. 6

Moscow, We Have a Problem  - a. 7

Moscow, We Have a Problem  - a 8

Moscow, We Have a Problem  - a.9


Matthew Hedrick



Ben Ryan


REPLAY PODCAST & SLIDES | #EmergingOutflows Round II: This Time Is Actually Different

Takeaway: In today's call, we expanded upon our negative outlook for EM asset prices with respect to the intermediate-to-long term.

Amid rapidly declining asset prices, we held a conference call today to expand upon our bearish outlook for emerging markets over the intermediate-to-long term. The presentation and its conclusions were organized as follows:


REPLAY PODCAST & SLIDES | #EmergingOutflows Round II: This Time Is Actually Different - Thesis Summary


CLICK HERE to access the replay podcast.


CLICK HERE to access the aforementioned presentation (~75 slides).


As always, we’re available to field any follow-up questions you may have and are more than happy to set up a call with you to discuss these risks live; just shoot us an email as needed.


Have a fantastic evening,




Darius Dale

Associate: Macro Team

Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.