Since moving into #QUAD 4 in September, we’ve tried to keep our audience on top of the deflationary headwinds that exist when growth and inflation are decelerating at the same time. Riding our shorts in the energy (and the commodity space) from both a company specific and asset class perspective was one of our bigger calls in Q4.
To be clear, we believe the side effects of this trade will continue to play-out (#QUAD4 Confirmation from Darius Dale) . Included below are links to previous notes throughout Q4 in chronological order as we navigated through the sell-off:
October 16th: OIL HAS FURTHER DOWNSIDE BEFORE THE BOTTOM
October 23rd: OPEC's NEXT MOVE
October 28th: REAL COST OF SHALE PRODUCTION
November 26th: OPEC CUT? NOPE.
With our call being what it is currently, a sharp decline in rig count, major cap-ex cuts, and a blowout in high-yield energy spreads will all have a meaningful impact on the domestic production outlook. The next big opportunity in the energy space is logically on the long-side, but it may not be until:
1) Oil prices get cut by another 10-20% under the weight of #QUAD4 deflation
2) Realized and thus the price of forward looking volatility (the two are very tightly correlated. What has happened in the recent past will certainly happen moving forward!) compresses.
Regarding the second point above, this afternoon’s weekly release of the Baker Hughes Rig count provided another incremental data point that would logically provide price support. The number was largely expected, aggregate production has not yet peaked, and global demand is showing tangible signs of slowing even with the existence of stockpiling at the commercial and government (China) level.
Inventory data from the DOE on Wednesday showed that commercial inventories reached the 400MM barrel mark for the first time since 1982:
We yield to the fact that the modern oil market may be more positioned to deal with supply demand shocks than it was in the past. An increase in storage and inventory capacity globally creates a cushion should supply begin to come off-line. This versatility implies a “U-shaped recovery” as many sell-side analysts have pinned now that prices have retreated. While this may be true, our process is top-down oriented and anchors on daily changes in market signals and economic data. As a macro team, we try to get in front of the price news with the belief that fundamental supply/demand dynamics will complement what the market and economic data is signaling.
Whether the market expected the sharp decline in rig count today or not, the behavioral, volatility-inducing ripple effects encompassing this huge move in oil pushed WTI crude oil up as much as +8% this afternoon. We reference volatility constantly in our risk management process, and getting the market’s expectation right is key to pegging real exhaustion signals on both the long and short side of intraday moves. When this input is higher when volatility is higher, today’s intraday moved needed to be higher for the “short-oil” signal.
Our key upside risk management levels in WTI remain intact post-rig report:
With that being said, the decline in rig count is meaningful for the domestic production outlook, (REAL SUPPLY/DEMAND) and the decline in rigs has been drastic in January. This is BULLISH for prices fundamentally, but as mentioned above we believe big macro has more to say about global deflation near-term.
As outlined in a note after the release, OIL RIG COUNT: EARLY LOOK AT THE DAMAGE, the timeline between oil’s rout and the ensuing rig count reduction looks very similar to 2008:
“While the world was much different in 2008, E&P companies are very sensitive to oil prices under any circumstance. WTI declined 77% from July 3rd , 2008 to December 19th 2008. The oil rig count topped almost exactly 4-months after the July highs on November 7th , 2008 before being cut in half by June of 2009 (6-months after oil bottomed in December).”
We recognize that oil prices are now pressuring producers CURRENTLY, but we will continue to yield to our-top down contextualization of daily data to front-run the big macro turns. WE REMAIN BEARISH ON THE ENERGY SPACE as an asset class.
Please reach out with any comments or questions.
Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.
Takeaway: Our #Quad414 theme is picking up steam with the deluge of this week's U.S. economic data and remains core to alpha generation in 1H15.
Per our 1Q14 Macro Themes presentation:
“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.”
Focusing on the first part of that outlook, this week we received a fair amount of data that confirmed our forecasted #Quad4 setup in the fourth quarter of 2014, none larger than today’s Q4 GDP release. Key highlights:
Second derivative trends across a variety of key high-frequency economic indicators imply much more weakness in the domestic economy than the preliminary -20bps deceleration in Real GDP growth suggests:
For example, Industrial Production growth is slowing on a sequential basis while CapEx growth is slowing on a trending basis:
Export growth slowing on both a sequential and trending basis is clearly weighing on both reported and prospective Corporate Earnings growth:
Slowing Corporate Earnings growth on both a reported and prospective basis is perpetuating a deceleration in Employment growth:
Lastly, Import growth slowing on both a sequential and trending basis and is continuing to weigh on reported and prospective Inflation:
Net-net-net, the U.S. remains a +/- 2% economy. All of the conjecture surrounding "+3-5% growth" is horribly misguided -- at least according to the data.
Moreover, everywhere you look across the compendium of high and low-frequency economic data, #Quad4 is ringing true. According to our empirical studies, this is precisely why interest rates continue to make new lows and bond proxies continue to outperform within the domestic equity market.
All it not dour, however. Specifically, the probability of a #Quad1 setup in the first quarter of 2015 is high and rising with the release of the first batch of JAN high-frequency economic data.
While late-cycle manufacturing continued to show weakness per the Markit PMI data, services sector growth posted a solid sequential acceleration, which led the composite index higher:
This dynamic is supported by meaningful sequential and trending accelerations in the Conference Board’s Consumer Confidence Index and in the NFIB Small Business Confidence Index:
It’s clear that “Main Street” America favors the trend of reported disinflation and layering their confidence and activity on top of an extremely easy base effect for Q1 GDP is likely to produce a 2-4 month trend of #GrowthAccelerating data in the U.S.
That said, however, the probability that we tip right back into #Quad4 for the Q2 and potentially for Q3 (depending on how the U.S. dollar trades from here) is equally elevated.
Worst of all, by then the domestic labor market could be showing a clear trend of deterioration that may not inflect until we’re the other side of the next U.S. recession.
Good luck risk managing this likely turn in the domestic macro narrative. We genuinely mean that – it won’t be easy! Let us know how we can help.
Enjoy your weekend and Go Hawks!
Associate: Macro Team
Here's a quick look at some of the top videos, cartoons, market insights and more from Hedgeye this past week.
McCullough: Don’t Buy Most Expensive Bubble We’ve Seen Since Beginning of Mankind | $BABA
In Thursday's edition of RTA Live, Hedgeye CEO Keith McCullough did not mince words when asked about Alibaba.
RTA Live is available exclusively to Real-Time Alerts subscribers.
McCullough: You Can Front-Run The Fed
In the Q&A segment of Monday's Morning Macro Call for institutional investors, Hedgeye CEO Keith McCullough reveals how the Fed has tipped their hand courtesy of WSJ’s Jon Hilsenrath, discusses his expectations ahead of Wednesday's FOMC meeting, and reminds us what would happen should interest rates rise.
McCullough: I Don't Give One Iota About Greece
In this excerpt from Monday's Morning Macro Call for institutional subscribers, Hedgeye CEO Keith McCullough talks Greece's "fascinating" weekend developments and the effects of oil's continuing tumble.
McCullough Phones It In to Maria: Why the Market’s Getting Spanked
As stocks were getting hit hard on Tuesday, Hedgeye CEO Keith McCullough explained to Fox Business “Opening Bell” host Maria Bartiromo what’s behind the market volatility and selloff.
If the Fed raised interest rates with the world slowing, and deflation doing what it's doing right now, well.... look out.
Very few research firms have been cautious or negative on the BABA, but at Hedgeye, we’ve been on the other side of consensus.
THE HEDGEYE "AVOID, SELL, SHORT" LIST
Editor's note: This is a brief excerpt from Thursday's Morning Newsletter by CEO Keith McCullough.
Since all 3 of these S&P Sectors remain on our “avoid, sell, short, etc.” list (they are both late-cycle and carry explicit Global #Deflation risks), I’ll just reiterate that call this morning – because it’s easy to.
Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.