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)
- iShares MSCI Emerging Markets ETF (EEM)
- Industrial Select Sector SPDR Fund (XLI)
- SPDR Barclays High Yield Bond ETF (JNK)
- CurrencyShares Japanese Yen Trust (FXY)
- SHORT BENCH: SPDR Oil & Gas Exploration & Production ETF (XOP), CurrencyShares Euro Trust (FXE), WisdomTree Emerging Currency Fund (CEW)
QUANT SIGNALS & RESEARCH CONTEXT
Barring a Positive ECB Surprise, Expect a Pickup in Cross-Asset Volatility Following Today’s Disappointing BoJ Announcement: Overnight, the Bank of Japan concluded its two-day monetary policy meeting. The takeaways were unspectacular – for Japanese yen bears, that is:
- No change to the existing QQE program, which targets an ¥80T annual increase in JGBs, a ¥3T annual increase in ETFs, a ¥90B annual increase in J-REITs, a ¥2.2T annual increase in commercial paper and a ¥3.2 annual increase in corporate bonds.
- Marginal adjustments to their Stimulating Bank Lending Facility (i.e. increasing individual allotments to ¥2T from ¥1T; increasing the total allotment to ¥10T from ¥7T) and their Growth-Supporting Funding Facility (i.e. expanding the base of institutions that can access the program). Both programs were extended by one year.
- The key incremental data point is the BoJ’s sharp revisions to its growth and inflation forecasts, which were set back in October. Like the FOMC, the BoJ updates its economic outlook 2x annually (in April and October) and revised them 2x annually as well (in January and July). The net result of today’s revisions is a dramatically lowered probability for QQE expansion in the near term (i.e. ~2-3 months).
- On Real GDP growth, the BoJ revised up its FY15 and FY16 forecasts by +60bps and +40bps, respectively, to +2.1% and +1.6%. The board cited a large tailwind from energy price deflation as the primary reason for the material shift higher. Clearly they are not paying attention to U.S. retail sales data…
- On Core CPI – which excludes both the prices of fresh food and the effects of the consumption tax hike – the BoJ revised down its FY15 forecast by -70bps to +1%. It nudged up its forecast for FY16 by +10bps to +2.2%, citing a reflationary tailwind of [assumed] higher wage growth on the strength of what they anticipate as the start of a self-perpetuating cycle of consumption and wage growth.
It’s worth noting that we [continue to] strongly disagree with just about every assumption they make in their economic forecasts.
On growth, the base effect alone will prevent Japan from even sniffing its GDP target for FY15. In our Bayesian prior/posterior forecasting process, a probable draw-down in 1Q15 GDP growth will likely set the Japanese economy back in a material way ahead of a likely 2H15 recovery:
On inflation, #StrongDollar commodity price deflation and a brutal demographic outlook continues to weigh on both reported CPI and structural inflation expectations in Japan:
Net-net, the BoJ will remain well shy of its “+5% Monetary Math” mandate over the intermediate term (i.e. the ~NTM):
So what happens next? We think the both the USD/JPY cross and the Japanese equity market are at risk of consolidating meaningfully over the next ~2-3 months as investors are forced to delay their expectations for QQE expansion – which we now see April as the most likely timeframe:
This is especially true in the context of the crowded net lean in the latter index throughout the buy-side; it won’t take much JPY appreciation to smoke the Nikkei down 5-10%:
All told, market participants – ourselves included – who are stuck on the wrong side of the Abenomics trade here should strongly consider hedging a probable pickup in volatility over the near-term. Our intermediate-to-long-term call for 135-147 on the USD/JPY cross and ~25k on the Nikkei remains intact, however.
Beyond that, the knock-on effects of a potential ~2-3 month consolidation phase on the USD/JPY cross would be many:
EM equities up?
EM FX and EM USD debt up? Or down if JPY appreciation perpetuates cross-asset volatility as it has been known to do (per the most immediate-term correlation):
Commodity prices up? Or down if JPY appreciation perpetuates cross-asset volatility as it has been known to do (per the most immediate-term correlation):
U.S. equities down?
With the VIX smack dab in the middle of our 16.66 to 23.06 immediate-term risk range, it’s tough to have a concrete call on the spillover effects today. That being said, however, we’re definitely inclined to expect a pullback in cross-asset beta on further consolidation in the USD/JPY cross as the TREND in volatility remains bullish:
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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.