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THE HEDGEYE MACRO PLAYBOOK

Takeaway: In today's edition of the Macro Playbook, we contextualize the broad-based de-risking of the HY credit asset class.

INVESTMENT CONCLUSIONS

Long Ideas/Overweight Recommendations

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

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

Illiquidity Risk Remains in the Junk Bond Market: Consistent with our #Quad4 and #Bubbles themes – which calls for an allocation to relative safety over high yield/junk in the domestic fixed income market – spreads continue to widen in the corporate bond space.

 

On a WoW basis, OAS on HY USD bonds backed up +19bps yesterday and are now +80bps WoW and +150bps MoM to cycle-wides of 603bps. Obviously, as we have detailed extensively, the energy sector continues to lead declines in the HY USD bond market. Specifically, OAS in this space backed up +23bps yesterday and are now +155bps WoW and +397bps MoM.

 

THE HEDGEYE MACRO PLAYBOOK - 1

Source: Bloomberg L.P.

 

Not surprisingly, given the dour state of secondary bond market liquidity, emerging market USD debt is selling off as well, with OAS having backed up +81bps WoW and +142bps MoM to cycle-wides of 483bps.

 

THE HEDGEYE MACRO PLAYBOOK - 2

Source: Bloomberg L.P.

 

In the following two charts, which we have sourced from our presentation on Emerging Markets yesterday (email to obtain the replay), we detail the state of secondary bond market liquidity in the U.S. and specifically as it pertains to EM debt. Needless to say, there is a pervasive lack of liquidity in these asset classes and the crowded nature of these trades amid an era of ZIRP dramatically amplifies the risk of what we have seen thus far – i.e. reflexive selling.

 

THE HEDGEYE MACRO PLAYBOOK - Secondary Bond Mkt Liquidty

 

THE HEDGEYE MACRO PLAYBOOK - EM Bond Market Liquidty

 

All told, we continue to think this negative re-rating for HY and EM USD debt is likely to have a substantial impact on broader “risk assets” to the extent the broad-base de-risking of this asset class continues.

 

***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: Money Man (12/15)

 

#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.

 

Moscow, We Have a Problem (12/16)

 

#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.


Will The Fed Centrally Plan a Bounce?

Client Talking Points

YEN

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

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.

UST 10YR

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

CASH 61% US EQUITIES 3%
INTL EQUITIES 0% COMMODITIES 0%
FIXED INCOME 30% INTL CURRENCIES 6%

Top Long Ideas

Company Ticker Sector Duration
EDV

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.

TLT

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).

XLP

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

TWEET OF THE DAY

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

@KeithMcCullough

QUOTE OF THE DAY

Leadership and learning are indispensable to each other.

- John F. Kennedy

STAT OF THE DAY

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.


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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%

SPX 1

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

 

BULLISH TRENDS

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December 17, 2014 - Slide4

 

BEARISH TRENDS

December 17, 2014 - Slide5

December 17, 2014 - Slide6 

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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,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Glacial Cascades - 12.03.14 Chart


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

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