THEMATIC INVESTMENT CONCLUSIONS
Long Ideas/Overweight Recommendations
- Consumer Staples Select Sector SPDR Fund (XLP)
- SPDR Gold Shares (GLD)
- iShares 20+ Year Treasury Bond ETF (TLT)
- PowerShares DB U.S. Dollar Index Bullish Fund (UUP)
- iShares U.S. Home Construction ETF (ITB)
- LONG BENCH: Vanguard REIT ETF (VNQ), Utilities Select Sector SPDR Fund (XLU), Vanguard Extended Duration Treasury ETF (EDV), Healthcare Select Sector SPDR Fund (XLV)
Short Ideas/Underweight Recommendations
- iShares MSCI Emerging Markets ETF (EEM)
- SPDR Barclays High Yield Bond ETF (JNK)
- Industrial Select Sector SPDR Fund (XLI)
- SPDR S&P Regional Banking ETF (KRE)
- iPath S&P GSCI Crude Oil Total Return ETN (OIL)
- SHORT BENCH: SPDR Oil & Gas Exploration & Production ETF (XOP), CurrencyShares Euro Trust (FXE), WisdomTree Emerging Currency Fund (CEW)
QUANT SIGNALS & RESEARCH CONTEXT
Reviewing Our Bullish Bias on the U.S. Dollar From a Calendar Catalyst Perspective: With the DXY trading near the low end of our immediate-term risk range, we thought we’d review our bullish thesis from the perspective of navigating the macro calendar.
Over the next month or so, we would agree that further consolidation on the DXY is both healthy and justified in the context of the speculative net length in the futures and options markets. The net long position of 70,456 contracts is the widest net long position in the history of the U.S. Dollar Index (data since March 1995) and is nearly two standard deviations above its TTM mean, which indicates the presence of investors crowding into the trade.
Connect the dots on potential incremental consolidation in the U.S. dollar vis-à-vis peer currencies over the next 4-6 weeks:
- Draghi remains in wait-and-see mode amid positive 2nd derivative inflections across the preponderance of Eurozone growth data.
- The Fed openly acknowledges the marginal deterioration in the U.S. economy – largely citing lagging DEC/Q4 data – at its March 18th meeting.
- Tomorrow’s jobs report will be critical to monitor in the context of this development.
- Potential BoJ easing at the end of April as Q1 data is likely to negatively inflect from the recent trend of recovery.
- The ECB revisiting the pace of its QE program sometime in 2H15 as much lower Eurozone CPI readings effectively quash any remaining opposition from the Bundesbank.
- The U.S. economy looking optically better through at least the end of April when all the MAR/Q1 data is reported.
- The noise surrounding the Consensus Macro “lower gas prices” narrative will likely peak around then.
Beyond April/May, we view the following scenarios as the three most likely paths for the U.S. dollar to traverse:
- Straight the heck up as investors freak out and go to cash once the “lower gas prices” narrative completely morphs into “late-cycle slowdown” or “potential recession” in the U.S.:
- The U.S. dollar probably rips higher on any U.S. recession freak-out (see: 2001, 2008) considering the current low levels of financial market volatility – which implies tons of dollar-denominated financial leverage that has yet to be [forcibly] unwound.
- For example, emerging market corporations and banks have raised well over $2 trillion in dollar-denominated debt since 2010. Both debt redemptions and the FX-adjusted cost of financing are rising at accelerating rates for these borrowers.
- Based on the trend in initial jobless claims, a U.S. recession is likely within ~12 months of commencing, so the terminal downside in the DXY on any Eurozone and/or Japanese recovery narrative is somewhat limited from that perspective.
- It’s tough to bet the house on that catalyst if George Bush or Mitt Romney were any indication of the GOP’s official stance on the Federal Reserve.
- This we know, however: the next election most definitely won’t be dollar bearish… you physically can’t get any more dollar bearish than Bush/Obama + Bernanke/Yellen… well, maybe with the exception of Nixon/Carter + Arthur Burns.
- Meanwhile open-ended QE has just begun in the Eurozone; it likely won’t produce the desired economic outcome(s), but that definitely keeps the ECB’s main refinancing rate unchanged for at least 1-2yrs.
- Additionally, the Japanese populous just voted for round two of Abenomics; like the Europeans, they likely won’t hit their politicized economic targets, but that won’t stop the BoJ from getting creative every 6-12 months for the next 3-4yrs.
- The U.S. has the best demographic curve of the G-3 economies, so the probability that the ECB and BoJ remain at ZIRP longer than the Fed (from here) is likely well north of 50/50.
If scenarios #1 or #3 are put in play, inflation expectations are likely to continue to decline and the current concept of “deep value” in commodities and high yield credit will come under severe pressure – especially the latter as the outlook for cash flow generation wanes:
If scenario #2 is put in play, then both emerging markets and commodity prices are likely to experience sharp relief rallies. We currently view that scenario as the least likely of the three so we are content to maintain our bearish biases on these asset classes with respect to the intermediate- term TREND and long-term TAIL.
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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.
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.