This note was originally published at 8am on January 28, 2015 for Hedgeye subscribers.
“The media's the most powerful entity on earth. They have the power to make the innocent guilty and to make the guilty innocent, and that's power. Because they control the minds of the masses.” -Malcolm X
Since starting Hedgeye, we have had two main strategic goals in mind. The first was to reinvent how Wall Street produces, packages and sells research. On this goal, we've succeeded in spades thanks to all of you.
The second goal was perhaps more bold, and has taken more time and planning, but it was to go head-to-head with the traditional financial media outlets and take mind share.
We were early on social media and now have a prolific presence. We hired a cartoonist, which was surprising to some, but has been a great way to communicate ideas and themes. (Case in point is the cartoon below highlighting the less-than-stellar start of earnings season.). Finally, we built out a state-of-the-art TV studio in our office in Stamford.
As it relates to TV, today we are hosting our first full day of interactive programming. We are calling it the Hedgeye Market Marathon and we'll be broadcasting it live from the stock market open to the close: real players, real analysis, and all in real-time. If you'd like to watch or ask Keith, our analysts or guests a question today, you can sign up here:
Back to the Global Macro Grind...
Other than watching Hedgeye TV, most stock market operators will be taking a break from earnings season to watch the Federal Reserve this afternoon. The consensus view of the manic media, and frankly a fair bit of the buy side, continues to be that it is not if, but when as it relates to the Federal Reserve reversing policy and beginning to raise interest rates.
For most 2014, as many of you know, we were of the view that rates were going down and not up. That was a stance that led to some real out performance for those that implemented it into their portfolios. We continue to believe that this is the right stance and that, if anything, the surprise from the Fed over the next few months and quarters is that they will be surprisingly more dovish than consensus expects.
There are two key reasons for that stance from our perspective. The first is that we think growth will slow incrementally in the U.S. On Friday, we will get the preliminary Q4 2014 GDP print, which will, we believe, show a sequential slowdown from the +2.7% year-over-year growth rate in Q3.
The key reasons we believe Q4 will slow from Q3 are as follows:
1) Comps – As you know, we model economies like companies and Q4 has the toughest comparison on a 1, 2 and 3-year basis of any quarter in the last seven years
2) High Frequency Data – The majority of high frequency data we track has slowed sequentially. In particular, PMI has slowed from 59.8 in Q3 2014 to 55.6 in Q4 2014. As my colleague Darius Dale recently highlighted, the three-month moving average in economy-weighted composite PMI has a r² of 0.83 to YoY GDP, so is highlight correlated
3) Yields – The last, and perhaps most obvious, signal of slowing sequential growth is 10-year yields. Frankly, if they aren’t indicating a growth slow down, then what are they indicating?
The second reason we believe that the Fed will ultimately be more dovish than consensus expects is deflation. As is highlighted in the Chart of the Day, which shows PCE and PCE ex-energy and food going back a decade, inflation is solidly below the Fed’s target of 2%. The charts also shows, of course, that deflation is far from transitory so far with PCE and PCE ex-energy and food tracking very closely.
Certainly, we don’t expect the Fed to be ahead of the curve on seeing the challenges of growth and deflation, so there is potential that we have a “hawkish” head fake, but nonetheless we continue to believe the path is to easier policy and not tighter.
Another important point to highlight this morning is the other derivative impact of deflation, which is a negative headwind to corporate earnings in the short run. On a basic level, it is hard to take pricing power when prices are declining. More acutely, as it relates to the SP500 and the near term, it will be difficult to have much aggregate year-over-year earnings growth for the SP500 with oil down more than 50% year-over-year.
This earnings impact is not just on energy related companies (although roughly 35% of SP500 earnings can be tied back to commodities). In fact, in our real-time alerts product yesterday, we actually shorted Keith’s former employer the Carlyle Group ($CG) on the back of the derivative impact from oil. According to Bloomberg estimates, the big three private equity firms' earnings are looking as follows:
- Carlyle’s expected to lead the decline with a 73% drop, “driven by its energy holdings”
- Apollo is expected to report a 63% drop in earnings.
- Blackstone Group LP (BX) is expected to have a 32% slide.
In particular, Carlyle’s biggest energy holdings were Sandridge (-58% in Q4) and Pattern Energy (-20% in Q4) . . . Yikes !
We hope you can join us for at least part of our market marathon today.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 1.75-1.85%
Oil (WTI) 44.02-46.81
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research