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January 6, 2015

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BULLISH TRENDS

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BEARISH TRENDS

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THE HEDGEYE MACRO PLAYBOOK

Takeaway: In today's version of the Macro Playbook, we revisit our bearish thesis on emerging markets. We do NOT see "deep value" in this asset class.

THEMATIC INVESTMENT CONCLUSIONS

Long Ideas/Overweight Recommendations

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

Short Ideas/Underweight Recommendations

  1. iShares TIPS Bond ETF (TIP)
  2. SPDR S&P Regional Banking ETF (KRE)
  3. SPDR S&P Oil & Gas Exploration & Production ETF (XOP)
  4. iShares MSCI European Monetary Union ETF (EZU)
  5. iShares MSCI France ETF (EWQ)

 

***Please note that we have removed the iShares Russell 2000 ETF (IWM) from the short side of our thematic investment conclusions as of yesterday afternoon, opting to replace it with the iShares TIPS Bond ETF (TIP). Tune in to our Q1 Macro Themes conference call this Thursday at 1pm EST for an even broader update to our core long/short asset class recommendations. Email for dial-in details.***

 

QUANT SIGNALS & RESEARCH CONTEXT

Since our 9/23 bullish-to-bearish phase transition research note titled, “EMERGING MARKETS: THE EM RELIEF RALLY IS LIKELY OVER”, EM asset prices have fallen sharply:

 

  • The MSCI Emerging Markets Equity Index is down -8.9%
  • The JPMorgan Emerging Markets Currency Index is down -8.7%
  • OAS on the Bloomberg USD Emerging Markets Corporate Bond Index has backed up +141bps to post-crisis wides of 437bps

 

Those returns compare to a +1.9% advance for the S&P 500 and a more modest widening of +104bps for U.S. HY OAS. Moreover, those returns don’t compare to the absolute bloodbath occurring at both the regional and country levels:

 

THE HEDGEYE MACRO PLAYBOOK - ETF Divergence Monitor

 

To review our bearish thesis, we see three key fundamental risks that threaten to take EM asset prices dramatically lower over the intermediate-to-long term:

 

  1. #StrongDollar translating to commodity price deflation and debt service inflation
  2. Market structure risks (i.e. illiquidity and crowding) perpetuating a broad de-risking of this asset class amid fund outflows
  3. Growth in Chinese demand slowing to levels that threaten the debt sustainability of commodity producing nations

 

To assess these risks in greater detail, please review our 12/16 presentation titled, “#EmergingOutflows Round II: This Time Is Actually Different”.

 

Ironically, hosting a conference call expanding upon our bearish thesis on emerging markets at the depths of the Russian ruble crisis on December 16th was either very fortuitous or unfortunate, depending on how one views it (i.e. generating interest via marketing vs. mark-to-market timing). Specifically, this low-volume bounce to lower-highs across the spectrum of EM asset prices has rendered our EM “short book” slightly more ineffective than we would’ve liked thus far:

 

THE HEDGEYE MACRO PLAYBOOK - 1 6 2015 7 54 08 AM

Source: Bloomberg L.P.

 

THE HEDGEYE MACRO PLAYBOOK - EM Idea Flow Monitor

 

That being said, the longs have held up quite nicely; Turkey (TUR) in particular has lead all of our ideas the bounce, suggesting we’ve likely made the correct call here. The jury is still out on whether or not Philippines (EPHE) will deliver positive absolute returns over the intermediate term (good for hedge funds) or merely outperform its peers (good for long-onlys).

 

All told, we think the U.S. dollar rally has legs as G-3 monetary policy is set to continue diverging over the intermediate term. That should continue to weigh on EM asset prices, at the margins, as well as deter capital flows into this asset class.

 

THE HEDGEYE MACRO PLAYBOOK - DXY vs. MSCI EM Index

 

THE HEDGEYE MACRO PLAYBOOK - DXY vs. JPM EM FX Index

 

THE HEDGEYE MACRO PLAYBOOK - DXY vs. EM USD Bonds

 

THE HEDGEYE MACRO PLAYBOOK - DXY vs. EM LC Bonds

 

THE HEDGEYE MACRO PLAYBOOK - DXY vs. EM OAS

 

THE HEDGEYE MACRO PLAYBOOK - DXY vs. EM OAS plot

 

***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: 2015 Predictions (1/2)

 

#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.

 

Draghi Jawboning and EURO Falling, Again (1/2)

 

#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.   


Time to Redeploy Some Capital

Client Talking Points

VIX

The VIX is +32% in the 4 straight down days in the SPX from the 2090 no-volume-year-end-markup, and now that front month VIX is signaling immediate-term TRADE overbought (within its bullish TREND), we think you buy/cover U.S. equities this morning. The risk range for the VIX risk is 16.36-20.59.

UST 10YR

Registering the 1-handle this am at 1.99% and that’s not a Long Bond (TLT) buy signal – that’s a book some gains in your Long Bond core long positions and redeploy that capital into some oversold U.S. domestic consumption exposure (XLY, XLP, etc.); still our Best Macro Long idea, but we don’t buy at every price.

RUSSELL 2000

After another fast -3.1% correction, the Russell is signaling immediate-term TRADE oversold, so we’ll take it off our Best Ideas list on the short side (and review why on our Macro Themes call on Thursday); as opposed to 1 year ago when we loved it short side, now it’s a hedge fund consensus short (-25,000 net short position in futures/options contracts).

Asset Allocation

CASH 52% US EQUITIES 10%
INTL EQUITIES 2% COMMODITIES 0%
FIXED INCOME 28% INTL CURRENCIES 8%

Top Long Ideas

Company Ticker Sector Duration
EDV

The Vanguard Extended Duration Treasury (EDV) is an extended duration ETF (20-30yr). As our declining rates thesis proved out and picked up steam over the course of the year, we see this trend continuing into Q1.  Short of a Fed rate hike, there’s no force out there with the oomph to reverse this trend, particularly with global growth decelerating and disinflationary trends pushing capital flows into the one remaining unbreakable piggy bank, which is the U.S. Treasury debt market.

TLT

As growth and inflation expectations continue to slow, stay with low-volatility Long Bonds (TLT). We believe the TLT has plenty of room to run. We strongly believe the dynamics in the currency market are likely contribute to a “reflexive deflationary spiral” whereby continued global macro asset price deflation and reported disinflation both contribute to rising investor demand for long-term Treasuries, at the margins.

XLP

Our models are forecasting a continued slowing in the pace of domestic economic growth, as well as a further deflation. 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. 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

Dr. KOSPI continues to signal global #GrowthSlowing -1.7% overnight; India tagged for a -2.9% drop

@KeithMcCullough

QUOTE OF THE DAY

In all likelihood world inflation is over

-Per Jacobbson, IMF, 1959

STAT OF THE DAY

Beijing removes tax rebate for steel-boron products which accounted for 31% of steel exports for 2014 through November.


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CHART OF THE DAY: What My Macro Crystal Ball Says About the Russell | $IWM

CHART OF THE DAY: What My Macro Crystal Ball Says About the Russell | $IWM - 01.06.15 chart

 

Editor's note: This is an excerpt from today's Morning Newsletter by CEO Keith McCullough.

 

The other thing crystal ball is telling me this AM is don’t short the Russell 2000 today. #Pardon? Yes. You heard it from whatever this transparent ball is that I am rubbing this morning first! Do not short the IWM because:

 

  1. After another swift -3.1% correction, the Russell 2000 is signaling immediate-term TRADE oversold
  2. The inverse of that beta trade (VIX) is signaling immediate-term TRADE overbought at 20.59
  3. Hedge Fund Consensus is short the Russell (IWM) vs long SPY



My Crystal Ball

“It’s far better having an approximate answer to the right question, than an exact answer to the wrong question.”

-John Tukey

 

Tukey was one of the most important mathematicians of the 20th century. The probability man died in 2000 and the only knock on him is that he went to Princeton. Yes, he was a Bayesian. He was also a Bell Labs guy. That’s where they asked the right questions.

 

The Global Macro question remains: will global #GrowthSlowing + #Deflation matter to both the US economy and its stock, bond, currency, and commodity markets? If you thought yes, then how so? Oh, and how did you position for that?

 

After rubbing it this morning, my crystal ball (my wife got me one for my birthday – no joke, a real one) says A) yes, it mattered and B) it translated into both crashing global long-term bond yields and commodity prices. “So”, let’s keep re-positioning…

 

My Crystal Ball - 78

 

Back to the Global Macro Grind

 

Re-position? Yes, as in rotate. With the UST 10yr Yield tapping the 1%-handle this morning:

 

  1. Book some gains in those Long Bond (TLT, EDV, BND, MUB, etc.) holdings
  2. Re-position some of that capital into oversold US consumption equities
  3. And send your Old Wall broker an email that says your crystal ball guy said to :)

 

In Hedgeye Asset Allocation terms (re-positioning = rotation of the allocation!), that means:

 

  1. Taking net Fixed Income down from max allocation to an asset class (1/3 of my capital) to +28%
  2. Taking net US Equity asset allocation up from +3% on December 29th, 2014 to +10%
  3. Do nothing in International Equities and/or Commodities

 

No, I don’t want to chase Gold up here. I haven’t told you to engage in amateur knife catching crude oil contests for the last 6 months either. My net asset allocation to #deflation (Commodities) = 0% because the answer to THE question mattered.

 

“Net” – what does that mean, net?

 

Net (and in rate of change terms) is how I think. Not because my crystal ball told me so (remember, I didn’t have one until today!), but because that’s how I learned, at a young age in the hedge fund business, to manage risk.

 

I know having longs and shorts isn’t for everyone. And it really shouldn’t be. On the short side in particular, at least 2/3 of hedge funds don’t do the hedging thing very well, don’t forget.

 

We are better than bad at that – and we also don’t tell our long only investors to chase tops. That’s why I referenced December 29th, specifically. If you are in the business of compounding returns and dynamically allocating assets, that day mattered because:

 

  1. The SP500 was 70 handles higher than yesterday’s 2020 close, at an all-time closing high of 2090
  2. The yield on the 10yr US Treasury was 2.25%

 

If you are a portfolio manager of anything Fixed Income or US Equities, THE question that day was:

 

  1. BUY
  2. SELL
  3. Or DO NOTHING?

 

As all of you veterans of the risk management gridiron know, sometimes doing nothing is the best answer. But, unless you are in the business of low-fee generating-passive-asset-management, sometimes you do need to BUY or SELL!

 

“So”, as the Old Wall analysts like to say, on December 29th:

 

  1. If you bought more Long Bond (TLT) exposure, the 10yr Yield just had a 12% move from there (1.98% last)
  2. If you bought more SPY (there was a big fund flow into it that week), you just lost -3.3%

 

“So”, crystal ball says you wanted to have done 1. And not 2.

 

The other thing crystal ball is telling me this AM is don’t short the Russell 2000 today. #Pardon? Yes. You heard it from whatever this transparent ball is that I am rubbing this morning first! Do not short the IWM because:

 

  1. After another swift -3.1% correction, the Russell 2000 is signaling immediate-term TRADE oversold
  2. The inverse of that beta trade (VIX) is signaling immediate-term TRADE overbought at 20.59
  3. Hedge Fund Consensus is short the Russell (IWM) vs long SPY

 

Back to the “net” concept. If you want to earn your keep in 2 and 20 land, it’s usually best to not be pressing the lows on the short side of your net exposure in a crowded macro short.

 

Rather than rant any further this morning, here’s a 2 minute video explaining why “I Would Not Do What Hedge Funds Are Doing” in what was one of our best Global Macro short ideas 1-year ago today: https://www.youtube.com/watch?v=hrl7J_HVKZw

 

Crystal Ball just told me to stop there. #Cool. I’m already starting to like this thing.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.97-2.16%

SPX 2017-2051

VIX 16.26-20.59
Oil (WTI) 48.45-54.15

Gold 1166-1217

Copper 2.73-2.84

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

My Crystal Ball - 01.06.15 chart


MACAU: EARLY JANUARY COLOR

CALL TO ACTION


Four days is not enough to call a trend but January started off better than December finished, but still down 16% YoY. With the easiest comp in some time, January should fare better than recent months, optically. However,  February could rival December as the worst month ever in terms of YoY performance.

 

Please see our detailed note:  http://docs.hedgeye.com/HE_Macau_1.6.15.pdf



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