THEMATIC INVESTMENT CONCLUSIONS
Long Ideas/Overweight Recommendations
- iShares U.S. Home Construction ETF (ITB)
- Health Care Select Sector SPDR Fund (XLV)
- Consumer Staples Select Sector SPDR Fund (XLP)
- PowerShares DB U.S. Dollar Index Bullish Fund (UUP)
- iShares 20+ Year Treasury Bond ETF (TLT)
- LONG BENCH: Vanguard REIT ETF (VNQ), Utilities Select Sector SPDR Fund (XLU), Vanguard Extended Duration Treasury ETF (EDV)
Short Ideas/Underweight Recommendations
- iShares TIPS Bond ETF (TIP)
- CurrencyShares Japanese Yen Trust (FXY)
- iShares MSCI Emerging Markets ETF (EEM)
- SPDR Barclays High Yield Bond ETF (JNK)
- Industrial Select Sector SPDR Fund (XLI)
- SHORT BENCH: SPDR Oil & Gas Exploration & Production ETF (XOP), CurrencyShares Euro Trust (FXE), WisdomTree Emerging Currency Fund (CEW)
QUANT SIGNALS & RESEARCH CONTEXT
Q&A w/ the Hedgeye Macro Team: Yesterday, Keith and I enjoyed a solid start to two full days of client and prospect meetings; as always, the discussions were lively, entertaining and, most importantly, thoughtful. Per usual, we received a fair amount of questions pertaining to our macro themes, which are hyperlinked daily at the bottom of this note.
Below we share our responses to some of the most frequently asked questions from yesterday’s meetings. Please note that we are deliberately keeping these thoughts brief (we’ve already done the work, so please email us if you’d like additional color, charts, etc.).
With the VIX up +85.4% since we called the bottom in our #VolatilityAsymmetry presentation back on July 11th, we’re sure you’re plenty busy these days and don’t want to take up too much of your time. Enjoy:
Q: Will we see a rate hike by the Fed at some point over the next 6-12 months?
A: According to both the preponderance of data most central to their monetary policy decision-making tree and our outlook for employment growth, the FOMC will not be able to justify a rate hike over the intermediate term. In fact, we’d consider a rate hike at this stage in the economic cycle to be a deflationary policy mistake – a la Jean-Claude Trichet in 2008 or 2011 – that threatens to tip the U.S. and global economy into recession.
Q: What gets employment growth to roll over?
A: Reduced energy-related capital expenditures and business services would precipitate the first wave of not hiring and then firings. The knock-on effects are both unquantifiable and very real given that oil and gas E&P has a high multiplier effect because it is a capital intensive industry and because energy-related jobs are typically higher earning than the preponderance of other jobs created during the recovery. And remember, it’s not just energy companies that are reeling from the wave of commodity deflation ripping through their income statements; ask CAT about its mining businesses or BAC, JPM or C about their FICC business...
(see: "Schlumberger to axe 9,000 jobs amid oil rout" or "Big Oil Companies Get Serious With Cost Cuts on Worst Slump Since 1986")
Q: How can housing work alongside your call for a negative inflection in the rate of change of employment growth?
A: The simple answer is that housing did not work in 2014 with employment growth breaking out to the upside. That alone should tell you not to isolate employment as the driver of housing equities. What’s occurring in housing is a lot more nuanced and we have a 100-slide presentation walking through all of those critical puts and takes. The summary is threefold: 1) macroprudential regulation is being unwound, at the margins, which should perpetuate a positive inflection in mortgage demand growth; 2) demand growth leads home prices by ~1yr and demand growth troughed in early 2014, which means home price appreciation is poised to positively inflect as well; and 3) the comparative base effect for home price appreciation – which carries a +0.90 correlation to housing equities since 2008 – gets incrementally supportive throughout 2015. Lower interest rates are a nice kicker as well as it relates to stimulating incremental demand. The 30yr fixed rate mortgage is now 3.8%; it was 4.42% one year ago. Many headwinds still exist in the U.S. housing market (e.g. low household formation; student debt bubble), but more are shifting into the tailwind category, at the margins.
Q: Are falling oil prices a net positive or a net negative for the U.S. economy?
A: It depends on what part of the cycle you’re referring to. Falling oil prices are very positive for early-cycle Consumer Cyclical and very negative for late-cycle Industrials (via slowing CapEx) and Financials (via slowing employment growth and asset price deflation). On a net-net-net basis after it’s all said and done, falling oil prices probably wind up doing more harm than good – particularly if asset price deflation continues. Remember, gasoline only accounts for 6.4% of median consumer PCE, so the consumer has only experienced a -279bps effective tax cut on the -44% peak-to-present decline in crude oil. Meanwhile, the SPY is down -482bps from its all-time high; MLPs – which are a favorite among retail investors – are down -1437bps from their all-time high. Robbing Peter to pay Paul is not a recipe for sustained economic growth – especially the +3-5% variety bandied about by consensus.
Q: Isn’t this setup – i.e. U.S. dollar breakout, mid-cycle economy and the Fed getting tighter – just like the 1990s?
A: First and foremost, anyone who thinks it’s the 1990s from an economic standpoint clearly has not yet done the work on domestic debt and demographic trends. Those two factors alone will most certainly ensure that the U.S. economy will never again experience a period like 1990s for very long time.
Q: If so, why can’t stocks keep working?
A: It doesn’t have to be the 1990s for stocks to keep working - #Quad4 stocks that is. As highlighted daily in our thematic investment conclusions above, there are plenty of sectors and style factors you can buy with our bearish thesis. Nevermind that healthcare, staples, utilities and REITs are “expensive” on both a relative and absolute basis. The fact of the matter is that ~80-90 of active managers underperformed their benchmarks last year, so the majority of the buy-side clearly isn’t long what we were telling them to be long of most of the year. That means they will eventually have to sell what isn’t’ working (i.e. the U.S. “escape velocity” narrative) in order to chase what is working or even just to avoid becoming increasingly underweight the aforementioned sectors as a function of relative performance. This is how macro fund flows work. Moreover, this is why you need a competent macro view either internally or outsourced.
Q: How low can rates go?
A: Lower and lower and lower – until Consensus Macro strategists and the investors who either don’t do macro or overpay for the wrong macro research capitulate on the short side of Treasury bonds. Both camps remain far from having done just that.
Q: Will Draghi disappoint next Thursday?
A: From these levels in the EUR/USD, most likely. The probability that he disappoints is particularly high given the speculative net length in the futures and options markets and yesterday’s SNB revaluation, which prompted speculation that the ECB would pursue substantially more divergent monetary policy over the intermediate-to-long term. It remains to be seen whether or not Draghi has secured enough of a mandate to achieve the degree of balance sheet expansion believed needed to appropriately combat deflation and economic stagnation in the Eurozone.
Q: Are Japanese stocks a short?
A: Not here, but certainly if the USD/JPY breaks our intermediate-term TREND line of 114.26. That would be a clean-cut signal to us that either QQE expansion will not happen on our expected horizon (i.e. within 2-3 months) or that any QQE expansion will be overshadowed by a continued breakout in cross-asset volatility, which has historically been positive for the Japanese yen. Either of those events would make us very wrong on the bearish side of the JPY and bullish side of the Nikkei.
Q: Is gold a buy?
A: Right now, gold is trading right at our long-term TAIL line of resistance, which is $1,262/ozt. When securities or asset classes break out above or break down below our TAIL line, we don’t ask questions – we look for answers. Sometimes our fundamental analysis front-runs these TAIL risk events, like our call on bond yields in 2013 (i.e. domestic #GrowthAccelerating) and in 2014 (i.e. domestic #GrowthSlowing). Other times – like today’s setup in gold – we don’t yet know what the answer is so we simply make one up because that’s what the market is telling us to do. Could a breakout in gold be front-running a marginally dovish policy shift by the Fed that perpetuates a more material pullback in the DXY? We don’t know yet, but that’s a story that not only makes sense, but would also be easy for the preponderance of market participants to substantiate with data. Moreover, we’d look to confirm gold’s breakout across other dollar-sensitive asset classes like emerging markets and upstream MLPs.
***CLICK HERE to download the full TACRM presentation.***
TRACKING OUR ACTIVE MACRO THEMES
Global #Deflation: Amidst a backdrop of secular stagnation across developed economies, we continue to think cyclical forces (namely #StrongDollar driven commodity price deflation) will drag down reported inflation readings globally over the intermediate term. That is likely to weigh heavily upon long-term interest rates in the developed world, underpinning our bullish outlook for U.S. Treasury bonds.
The Hedgeye Macro Playbook (1/12)
#Quad414: After DEC and Q4 (2014) data slows, in Q1 of 2015 we think growth in the US is likely to accelerate from 4Q, aided by base effects and a broad-based pickup in real discretionary income. We do not, however, think such a pickup is sustainable, as we foresee another #Quad4 setup for the 2nd quarter. Risk managing these turns at the sector and style factor level will be the key to generating alpha in the U.S. equity market in 1H15.
EARLY LOOK: Macro Stars (1/15)
Long #Housing?: The collective impact of rising rates, severe weather, waning investor interest, decelerating HPI, and tighter credit capsized housing in 2014. 2015 is setting up as the obverse with demand improving, the credit box opening and 2nd derivative price and volume trends beginning to inflect positively against progressively easier comps. We'll review the current dynamics and discuss whether the stage is set for a transition from under to outperformance for the complex.
HOUSING: Purchase Demand | Post-Holiday Deluge (1/14)
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.