THEMATIC INVESTMENT CONCLUSIONS
Long Ideas/Overweight Recommendations
- iShares U.S. Home Construction ETF (ITB)
- Consumer Staples Select Sector SPDR Fund (XLP)
- Health Care Select Sector SPDR Fund (XLV)
- 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)
- Industrial Select Sector SPDR Fund (XLI)
- SPDR Barclays High Yield Bond ETF (JNK)
- SHORT BENCH: SPDR Oil & Gas Exploration & Production ETF (XOP), CurrencyShares Euro Trust (FXE), WisdomTree Emerging Currency Fund (CEW)
QUANT SIGNALS & RESEARCH CONTEXT
Checking In With TACRM: With the recent bout of cross-asset volatility – e.g. the VIX increased +19.4% WoW to close up +9.1% YTD – we’re sure many investors are incrementally confused about the macro environment. Fortuitously for our subscribers, we have built effective quantitative tools to help investors contextualize what’s happening, why it’s happening and how to take advantage of it in one’s portfolio.
One of those tools is our Tactical Asset Class Rotation Model (TACRM), which is designed to systematically measure momentum across a variety of asset classes in order to transform those signals into actionable investment themes. TACRM does this by generating a normalized view of price momentum for every liquid market in the world. That momentum score is derived from a multi-factor, multi-duration approach, which we have termed a “Volatility-Adjusted Multi-Duration Momentum Indicator” reading, or “VAMDMI” for short.
Recall that this VAMDMI metric is simply the arithmetic mean of three independent z-scores of volume-weighted average price data, in which the three sample sizes (i.e. short-term, intermediate-term and long-term) accordion inversely to the trend in global financial market volatility. The metric is designed to standardize recorded momentum across securities and asset classes with variant betas, effectively normalizing the degree to which marginal investors might have a propensity to buy or sell a given market.
That is definitely a mouthful. What isn’t a mouthful is the analytical color TACRM provides investors. Below, we frame up the current state of macro markets through TACRM’s various analytical lenses, flagging what we deem to be noteworthy (i.e. investable) signals.
At the primary asset class level:
- Only DM Equities has a bullish “INCREASE Exposure” signal. On a cumulative one-week forward basis since the start of 2008, the MSCI World Index has returned +32.4% when TACRM is generating the aforementioned signal for DM Equities. That compares to a buy-and-hold return of +5.9% over that same time frame.
- Cash – which is comprised simply of volatility (VXX) and U.S. dollars (UUP) – continues to have the largest Passive Trend Follower Asset Allocation at 36%, which is in the 100th percentile of readings on a TTM basis and in the 95th percentile of readings since the start of 2008. Its “DECREASE Exposure” signal implies one (or both) of these markets will continue to experience a second derivate slowing of VWAP momentum over the intermediate term. A pullback in volatility would obviously auger well for the signal discussed in the previous bullet.
- Fixed Income & Yield Chasing currently has a “DECREASE Exposure” signal which it has maintained since late-September due to the ongoing break down in foreign-currency denominated debt, domestic high yield debt, curve steepeners and MLPs – which were all in line with our #Quad4 theme.
- The strength in the other secondary asset classes that make up the Fixed Income & Yield Chasing primary asset class – i.e. Treasuries, munis, Utilities and REITs – is becoming so pervasive that we’d expect it to the push the entire asset class back into “INCREASE Exposure” territory in the coming weeks. Specifically, 47% of the 30 ETFs that comprise this asset class have a VAMDMI reading greater than +1x, which implies a clear trend of positive VWAP momentum across multiple durations.
- That being said, we don’t need to see an “INCREASE Exposure” signal to be bullish on the appropriate pockets of this (or any other) asset class and we remain bullish on Treasuries (TLT, EDV), munis (MUB), Utilities (XLU) and REITs (VNQ) as outlined above in our thematic investment conclusions.
At the secondary asset class level:
- We consistently analyze extreme VAMDMI readings to determine if there is a trend developing “underneath the hood” that may be front-running a broader phase transition at the primary asset class level. On this metric, #Quad4 continues to get incrementally priced into global financial markets. Of the top-20 VAMDMI readings, only three of the exposures – i.e. Philippines (EPHE), Indian small-caps (SMIN) and Gold (GLD) – are not consistent outperformers during historical periods of #Quad4. Only one of the bottom-20 VAMDMI readings – i.e. Finland (EFNL) – is not a consistent underperformer during historical periods of #Quad4.
- In an attempt to take advantage of changing sector and style factor leadership, we consistently analyze extreme VAMDMI readings within the U.S. equity market as well, often looking for a pattern of leadership and/or laggardship that rhymes with one of our GIP Model quadrants. On this metric, #Quad4 continues to dominate as well.
- Specifically, across the 47 sectors and style factors we track in the domestic equity market, #Quad4 outperformers account for 8 of the highest 10 VAMDMI readings: REITs (VNQ), Utilities (XLU), Healthcare (IHE, IBB, XLV IHI), Consumer Staples (XLP) and mega caps (USMV). Additionally, #Quad4 underperformers account for 9 of the lowest 10 VAMDMI readings: Financials (KRE, IAI, KIE, XLF), Energy (XLE, AMLP, IEZ, XOP) and Basic Materials (XLB).
- All told, our patience in sticking with our #Quad4 trade continues to pay off amid incessant calls to adopt a more offensive asset allocation strategy heading into a likely #Quad1 setup in 1Q15. It’s a great long/short market for discretionary macro investors that possess a repeatable process to take advantage of!
- Lastly, TACRM is generating a “BUY” signal for both Gold (GLD) and Silver (SLV). As we highlighted in last Friday’s Macro Playbook, we haven’t yet found a fundamental reason to like the precious metals complex, but we’re happy to make one up because that’s what the market is telling us to do. Gold is resoundingly bullish on our price/volume/volatility quantitative factoring as well, meaning we are looking to buy the metal on pullbacks – irrespective of our view on the U.S. dollar, which may change as the rate of change in the domestic labor market negatively inflects. Stay tuned.
Net-net-net-net-net, with the exception of the breakout in the precious metals, nothing has really changed. That being said, however, the precious metals complex is definitely the most important thing to watch, on the margin, as it relates to its signaling capability regarding G-3 monetary policy, which itself continues to be the primary driver of dispersion among asset class returns.
Please click on the following link to review the various explanations associated with the aforementioned analyses; the model is refreshed daily to the extent you find the aforementioned signals helpful. Send us an email if you’d like to dig in further. Best of luck out there this week!
***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.
#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.
The Hedgeye Macro Playbook (1/16)
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.
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.