This note was originally published at 8am on December 19, 2014 for Hedgeye subscribers.
“From the elevation of retrospect we can see it all coming together more clearly and sooner than those who were there and running.” - Norman Maclean, Young Men and Fire
On August 5, 1949 fifteen young men parachuted out of a C-47 transport plane to fight a wildfire in the remote forests of central Montana.
It was the dead of summer in the middle of an extreme heat wave. On the day of the jump it was 97 degrees, then the hottest day on record in Helena, Montana. The fire danger rating was 74 out of 100, which meant “explosive potential.” It was so windy that the turbulence onboard the plane caused one of the men not to jump, return to the base, and immediately resign. The men that did jump landed on a steep slope in Mann Gulch that was covered in dry, knee-high grass…
Within two hours of landing all but three of the “smokejumpers” were dead.
What happened in Mann Gulch that day was one of the greatest disasters in US forest-fire fighting history. The lessons learned from the tragedy had a significant effect on how the US Forest Service fought wildfires for years to come.
I think of wildfires a lot like I do investment research, in that the identification and understanding of an unstable system is the primary goal. A wildfire occurs because existing conditions allow it to: the forest is dry, it’s hot, it’s windy, and there hasn’t been a fire in a long time. As conditions become more extreme, the probability of fire increases. So, as a fundamental analyst, I try to figure out where the hot, dry forests are before everyone else does, and before they go up in flames.
The instantaneous cause of the wildfire – the “catalyst” – is a secondary concern, and often, unpredictable. If the forest is dry and hot enough, any small spark can set it ablaze, at any moment. Will it be an irresponsible campfire? A bolt of lightning to a dead tree? A cigarette butt thrown from a car window? It doesn’t really matter because the result is the same, the forest burns down.
Didier Sornette, an expert on financial crises, summarizes the point:
“...a crash occurs because the market has entered an unstable phase and any small disturbance or process may have triggered the instability. The collapse is fundamentally due to the unstable position; the instantaneous cause of the collapse is secondary. Essentially, anything would work once the system is ripe… a crash has fundamentally endogenous, or internal origin.”
I don’t spend a lot of time trying to forecast what I’m ill-equipped to forecast with a high degree of confidence. I don’t know when lightning will strike. But I can put forth investment ideas that are based on sound data and reasoning, and are likely to work under various assumptions and scenarios. And when the spark is set, I am prepared and well-positioned.
I’ve written about no company more than LINN Energy (LINE, LNCO) over the past two years because I thought that the system was extremely unstable. The basic story has always been the same – the company makes no real profit, but dividends out $1 billion per year, which it pays for via serial debt and equity issuance. As I saw it, it was highly likely to end disastrously. The pushback was consistent, “There’s no catalyst.” This was not a good idea, I was told, because there wasn’t a lightning storm in sight…
…And then the price of crude oil tumbled from $100 to $55 per barrel, prompting more investors to doubt the sustainability of LINN’s business model, and sell. The prices of LINN’s stocks and bonds plummeted quickly; in just three months LINE and LNCO fell 60%, and the unsecured bonds lost 25 points. The “catalyst” is now clear, as it always is in retrospect. It was the oil price collapse, though it easily could have been something else: a failed acquisition, an SEC enforcement action, a rise in interest rates, another leg down in the natural gas price, or something else I never even considered.… It doesn’t matter – we were well positioned for any small disturbance to trigger the instability.
Our latest energy investment idea is an unstable situation of a different kind – and this one we like on the long side. Natural gas pipeline MLP Boardwalk Pipeline Partners LP (BWP) trades at a 50% discount to its peer group because it doesn’t dividend out all of its cash flows. Investors are still sour from the February 2014 distribution cut – which we called for in advance – and have not recognized the positive turn that BWP’s business took this year. In our view, this is an unstable system waiting for a trigger to re-rate the stock higher... (Ping us if you’re interested in learning more about our work on BWP.)
What else in the financial world is at risk of going up in flames? Like the Mann Gulch disaster of 1949, it’s not always easy to recognize an unstable system for what it is… Are you prepared and well positioned for the lightning strikes and errant campfires that will invariably come?
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.03-2.23%
Oil (WTI) 52.02-58.32
This note was originally published December 30, 2014 at 08:08 in Early Look
“You only have a full-year target if someone pays you a lot to have a full-year target”
-Keith McCullough on market dynamism & quixotic sell-side pursuits
We start every morning missive with a quote. Sometimes it’s inspirational, sometimes it’s intentionally flippant but, hopefully, it always carries real-time relevance and helps distill some signal from the global macro noise.
Alpha is Early Look modus operandi number one, but if it makes you laugh or re-think or get angry, it’s served its purpose.
Anyhow, with the 2015 market prognostications piling up into year end, we thought we’d lighten the tenor in today’s note and look back a bit as we look forward to the new year.
Neils Bohr famously quipped that, “Prediction is very difficult, especially if it’s about the future”.
The short selection of some of our favorite misadventures in #TimeStamping below bears witness to that reality and provides a potent reminder that imagination remains a scarce resource, conventionalisms box can be hermetic and humility oft follows hubris.
If you have favorites of your own, feel free to pass them along. They will, at the least, be tweeted.
“We see no serious broader spillover to banks or thrift institutions from the problems in the subprime market…We believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.” - Ben Bernanke, May 17, 2007
“We don’t know what we’ll be doing a year from now. It’s a mistake to try and get too precise…you can’t expect the Fed to spell out what it’s going to do...because it doesn’t know…Year after year we have had to explain why the global growth rate has been lower than predicted.” - Stanley Fischer providing a little 2014 FOMC truth serum
“In all likelihood world inflation is over” - Per Jacobbson, IMF, 1959
“I believe the fundamentals of our economy are strong. Very Strong” - John McCain during run for President, 6/5/2008
“The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. It is a sign that the U.S. Government can’t pay its own bills. It is a sign that we now depend on ongoing financial assistance from foreign countries to finance our Government’s reckless fiscal policies” - Senator Barack Obama, 3/16/2006
“There is no doubt that the regime of Saddam Hussein possesses weapons of mass destruction. As this operation continues, those weapons will be identified, found, along with the people who have produced them and who guard them.” - General Tommy Franks
“Everything that can be invented has been invented” - Charles H. Duell, US patent office, 1899
“Who would want to use it anyway?” - President Rutherford B Hayes on the telephone, 1876
"The world only needs five computers" - Thomas J. Watson Sr, President of IBM
“They couldn’t hit an elephant at this distance” - General John Sedgwick moments before being killed by enemy fire.
"I will say that I cannot imagine any condition which could cause a ship to founder. I cannot conceive of any vital disaster happening to this vessel. Modern shipbuilding has gone beyond that." - Capt. E. J. Smith of the Titanic, a few days before it sank.
“If I had asked people what they wanted, they would have said faster horses.” - Henry Ford
And, of course, perhaps the pithiest prediction from one of the Great Moderation’s foremost prognosticator’s…..
My Prediction?...PAIN! - Mr. T, 1982
We’ve #TimeStamped 2,969 signals in Real-Time Alerts since 2008. The historical data is there to see and download on our website and in the Chart of the Day below we show the return distribution across RTA’s 6+ year history. In our attempt to further the evolution towards an investing meritocracy, we feel we’ve built a better Risk Management mousetrap.
As always, you are free to disagree. We happily accept and consider all (thoughtful) criticism as we work to continually evolve the process.
”You have two ears and one mouth, use them in that proportion”. I’m not sure to whom that’s attributable, but Hedgeye would sign off on its sageness.
Our immediate-term Global Macro Risk Ranges are now :
UST 10yr Yield 2.06-2.23%
Oil (WTI) 52.56-55.79
Happy Birthday Lebron James & Tiger Woods and Happy Tuesday - the humpday between Monday and humpday
Christian B. Drake
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This note was originally published at 8am on December 18, 2014 for Hedgeye subscribers.
“The two most powerful warriors are patience and time.”
In case you didn’t know that I’m not a fan of centrally planned markets and economies, now you know. My long-term risk management call remains that any asset price inflation that is based on perma-planning will end in some form of a deflationary shock.
And while I know everything is rainbows and puppy dogs these days in the US economy (it’s going to “de-couple” from all of Global Macro markets, but bounce when they do!)… even the most avid perma bull on global growth should note that the Top 5 Stories on Bloomberg this morning have everything to do with central planners bailing markets out of the “everything is awesome” narrative.
Janet Yellen leads headlines this morning, followed by Mario Draghi (Europe), Shinzo Abe (Japan), a Swiss dude you probably don’t know (Switzerland cut interest rates to negative), and, of course, Vlad – as in Putin. Other than what went violently wrong in markets in the 1st two weeks of both October and December, what could possibly go wrong? #Patience, Risk Managers. Patience.
Back to the Global Macro Grind…
Away from her ridiculous comment that the crash in Oil is “transitory” (she can’t call bubbles, but she can call crashes… boil the oceans, part the heavens, etc.), I must give Janet Yellen props for having the #patience to wait until year-end to cut her forecasts (again).
This is big news for Hedgeye as the Fed, once again, effectively agrees with our core macro call that:
- Growth is slowing
- Inflation is slowing
I recapped the sell-side forecasts for you on Tuesday. Here are the Fed’s for 2015:
- GDP Growth cut from 3.5% to 3.0%, lowering the range to 2.6-3.0%
- Inflation cut from 2.2% to 1.9%, lowering the range to 1.0-1.6%
Notwithstanding that the Fed’s forecasts on growth and inflation have been wrong 60-70% of the time since Bernanke/Yellen took over the central planning bureau, the point here isn’t about good or bad – it’s about better or worse.
One of my Partners here @Hedgeye (Josh Steiner) coined that one-liner… and since I’m a rate of change guy, I like it. It’s simply another way to say the same thing. I don’t care much about absolutes – I care about the slope of the line. Is it slowing or accelerating?
Clearly, both locally and globally, the rate of change in both growth and inflation expectations are slowing. That’s why US, German, and Japanese bond yields continue to fall. That’s also why FX, High Yield, Commodity, and Equity Volatilities continue to accelerate.
“So” (Janet said that every other sentence yesterday, proving she’s in the tank with #OldWall groupthink), now that most things Global Macro have corrected (and bounced) again, what do we do next?
- As Long-term Risk Managers (Long-term Investors, I know you like that term!) we want to have #patience
- From Oil to Energy stocks, to EM and High Yield, we want you to recognize that #Deflation’s Dominoes take time
What we don’t want you to do is very straightforward:
- Don’t chase high, and freak out low
- Don’t believe the Fed’s forecasts (front-run them)
That’s it – just #FadeBeta (when the non-consensus view on growth and/or inflation is the most probable one).
Don’t be a Consensus Macro perf chaser who gets stimulated above the 50-day moving monkey and depressed below it. That is not going to make you a warrior of the alpha generating gridiron. No Sirs and Madames. That is going to make you mentally weak.
I don’t do weak. And I don’t do drawdown risk either. If I can proactively prepare you for it, that is…
If you nailed every 50 handle whip-around in spooz perfectly for the last 2 weeks, congratulations. We had a great year here, so send me your docs and I might give you some of my money to manage. If you did not, and stayed the course of patient, dynamic asset allocation:
- You sold some of your long duration bonds at 2.03% on the 10yr
- You bought some #Quad4 US Equity Exposure (Healthcare or Utilities were 1-2 for us this week)
- You shorted more Burning Yens and Euros high, against a net long US Dollar FX asset allocation
I didn’t have to nail every US stock market move to get that right in our asset allocation model. I just had to have the patience to not buy the November highs in US stocks and/or get shaken out of my Long Bond and US Dollar allocations on the recent November pullbacks.
Patience and time. They work in risk management as well as your best long term ideas do. Be a powerful warrior versus the tyranny of centrally planned momentum chasing consensus.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.03-2.19%
WTI Oil 52.49-59.91
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Takeaway: Investors have favored passive over active this year. Passive equity put up its largest inflow in the 52-week period.
Investment Company Institute Mutual Fund Data and ETF Money Flow:
With a $25.3 billion inflow to the SPY, we again highlight investors' favoring passive over active this year, especially in equity. In the first chart below, the spread between cumulative flows in equity ETFs versus equity mutual funds drastically widened in the five days ending December 22nd. Equity ETFs have taken in $157 billion in 2014 versus equity mutual funds' $32.7 billion inflow. As outlined in our sector exposure table at the bottom of this note, BlackRock (BLK) and Invesco (IVZ) house the most substantial ETF exposure on a revenue basis at 44% and 19% respectively. Both stocks year-to-date have outflanked the S&P asset management index on a total return basis with BLK returning +15.4% and IVZ up +11.3%. The asset management group is up 9.4% thus far in 2014.
In the most recent 5 day period ending December 22nd, total equity mutual funds put up net outflows of $2.4 billion according to the Investment Company Institute. The outflow was composed of domestic stock fund withdrawals of $1.1 billion and international stock fund withdrawals of $1.4 billion. The international and domestic equity categories have been polarized this year with international stock funds having inflows in 48 of the past 51 weeks, versus domestic trends which have been very soft with inflow in just 16 of the past 51 weeks. The running year-to-date weekly average for all equity fund flow continues to decline and now settles at a $641 million inflow, well below the $3.1 billion weekly average inflow from 2013.
Fixed income mutual funds put up outflows of $3.0 billion with $3.3 billion of outflows from taxable funds and $329 million of inflows into tax-free funds. Munis have had a solid year with subscriptions in 49 of the past 51 weeks. The 2014 weekly average for fixed income mutual funds now stands at a $729 million weekly inflow, an improvement from 2013's weekly average outflow of $1.3 billion, but still a pittance of the weekly average of +$5.8 billion in 2012 (our view of the blow off top in bond fund inflow).
ETF results were markedly strong; equity ETFs put up their largest inflow in the past 52 weeks: $29.3 billion, well above the the 2014 weekly average of a $3.1 billion inflow. Fixed income ETFs, put up a $2.0 billion inflow, above the year-to-date average of a $1.1 billion inflow.
Mutual fund flow data is collected weekly from the Investment Company Institute (ICI) and represents a survey of 95% of the investment management industry's mutual fund assets. Mutual fund data largely reflects the actions of retail investors. Exchange traded fund (ETF) information is extracted from Bloomberg and is matched to the same weekly reporting schedule as the ICI mutual fund data. According to industry leader Blackrock (BLK), U.S. ETF participation is 60% institutional investors and 40% retail investors.
Most Recent 12 Week Flow in Millions by Mutual Fund Product: Chart data is the most recent 12 weeks from the ICI mutual fund survey and includes the running weekly year-to-date average for 2014 and the weekly quarter-to-date average for 4Q 2014:
Most Recent 12 Week Flow Within Equity and Fixed Income Exchange Traded Funds: Chart data is the most recent 12 weeks from Bloomberg's ETF database (matched to the Wednesday to Wednesday reporting format of the ICI) and the running weekly year-to-date average for 2014 and the weekly quarter-to-date average for 4Q 2014. The third table are the results of the weekly flows into and out of the major market and sector SPDRs:
Sector and Asset Class Weekly ETF and Year-to-Date Results: In sector SPDR callouts, the SPY took the majority of inflows with $25.3 billion (13%) in net contributions. The Energy XLE experienced the second biggest gain, taking in $1.4 billion (13%).
The net of total equity mutual fund and ETF trends against total bond mutual fund and ETF flows totaled a positive $27.9 billion spread for the week ($26.9 billion of total equity inflow versus the $990 million outflow from fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52 week moving average has been $2.1 billion (more positive money flow to equities), with a 52 week high of $27.9 billion (more positive money flow to equities) and a 52 week low of -$37.5 billion (negative numbers imply more positive money flow to bonds for the week).
Exposures: The weekly data herein is important for the public asset managers with trends in mutual funds and ETFs impacting the companies with the following estimated revenue impact:
Jonathan Casteleyn, CFA, CMT
Joshua Steiner, CFA
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