This note was originally published at 8am on December 17, 2014 for Hedgeye subscribers.
“Narrative is linear, but Action... having breadth and depth, as well as length - is solid.”
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.
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 email@example.com.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.03-2.19%
Oil WTI 52.83-60.73
Keep your head up and stick to your narratives,
Daryl G. Jones
Director of Research