THEMATIC INVESTMENT CONCLUSIONS
Long Ideas/Overweight Recommendations
- Health Care Select Sector SPDR Fund (XLV)
- Consumer Staples Select Sector SPDR Fund (XLP)
- iShares National AMT-Free Muni Bond ETF (MUB)
- iShares 20+ Year Treasury Bond ETF (TLT)
- Vanguard Extended Duration Treasury ETF (EDV)
Short Ideas/Underweight Recommendations
- SPDR S&P Regional Banking ETF (KRE)
- iShares Russell 2000 ETF (IWM)
- iShares MSCI European Monetary Union ETF (EZU)
- SPDR S&P Oil & Gas Exploration & Production ETF (XOP)
- iShares MSCI France ETF (EWQ)
QUANT SIGNALS & RESEARCH CONTEXT
China Equity Bubble 2.0?: In 2014’s “Year of the Horse” China’s benchmark A-Shares index, the Shanghai Composite, galloped all the way to a +52.9% return, handing mainland Chinese and QFII investors their best annual return from stocks since a +79.9% return in 2009.
Prior to this year’s melt-up – the bulk of which had been condensed in the final 6M of the year (the Shanghai Composite was actually down on the year through 7/24) – A-Shares had delivered a negative annual return in three of the previous four years:
- 2010: -14.3%
- 2011: -21.7%
- 2012: +3.2%
- 2013: -6.8%
Source: Bloomberg L.P.
This pattern is eerily similar to the five years preceding the 2006-07 bubble in the A-Shares:
- 2001: -21.6%
- 2002: -17.5%
- 2003: +10.3%
- 2004: -15.4%
- 2005: -8.3%
- 2006: +130.4%
- 2007: +96.7%
Source: Bloomberg L.P.
That obviously begs the question: is this the start of another bubble in mainland Chinese equities? Ultra-bullish volume and turnover signals support an outlook for continued upside, which rhymes with the pattern seen in 2006-07 (though there has been significantly more of both during this current melt-up):
Source: Bloomberg L.P.
To be crystal clear, we think the rally in the A-Shares has legs, though we continue to search for confirming evidence as it relates to forming a communicable thesis. We’re still in the early innings of this process (i.e. we’re not yet comfortable with officially going LONG of the CAF ETF), but we think the story is likely to end up as follows:
- Growth in China’s current and capital account inflows slow – already happening
- Growth in China’s banking sector liabilities slows on a trending basis – already happening
- Growth in China’s banking sector assets (e.g. loans designated for fixed assets investment) slows on a trending basis – already happening
- China’s overall economic growth slows – already happening
- As Chinese GDP growth slows, Chinese demand for commodities wanes; that, coupled with a rising dollar, weighs incrementally upon commodity prices – already happening
- As commodity prices fall, reported inflation readings in China continue to slow – already happening
- As this perpetual state of #Quad4 threatens the employment and wage growth outlook in China, the State Council and PBoC commit to a stated +7% floor in real GDP growth by easing monetary and fiscal policy, at the margins – already happening
- As Chinese officials ease, investors get excited about the prospects for stock market appreciation – already happening
- As the stock market appreciates, Chinese speculators commit incremental capital to the stock market in lieu of the property market, which causes property prices to contract – already happening
- As Chinese property prices contract, Chinese investors move incremental capital out of this sector into the stock market – already happening
Rinse and repeat?
Stay tuned as we look substantiate the aforementioned hypothesis with further analysis in the coming days and weeks. 2015’s “Year of the Sheep” could be a magical year for Chinese equities – the A-Shares in particular. It’s also worth noting that the sheep is generally considered to be a lucky animal among the Chinese, as it is the 8th animal in the 12-animial zodiac and the number 8 is generally perceived to be among the luckiest of all numbers in China…
Happy New Year and best of luck to you and your team in 2015! Many thanks for your continued patronage and interest in our research.
***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: New Discoveries (12/29)
#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,
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.