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Rules & Tools

"You can’t expect the Fed to spell out what it’s going to do...because it doesn’t know."

-Stanley Fischer, Fed vice chair


The economy is like a pendulum.   It oscillates above and below productivity growth but never really falls exactly on center. 


“Potential Output” and “NAIRU” (non-accelerating inflation rate of unemployment) are nice theoretical constructs and are helpful in conceptualizing a tractable macroeconomic framework but they can’t actually be measured with precision and can only be approximated after the fact. 


Fascinatingly, despite the abject amorphousness and immeasurability of those concepts, the perceived real-time state of the macroeconomy relative to them remains central to the Fed’s policy calculus.    

Rules & Tools - dollar cartoon 07.02.2014

Policy makers often play the role of antagonist in our daily strategy narratives but, in truth, we don’t particularly envy their challenge. 


Consider the following middle school riddle:

Q: How far can you walk into a forest?

A: Halfway – after that you are walking out of the forest.


Macro policy making can be similarly enigmatic.  Policy makers generally know the correct direction to take (easing/tightening) but don’t necessarily know how big the forest is (the output gap) and the mapping tools (models) used for orienting oneself inside the forest to understand where you are and how far you’ve actually gone are underdeveloped…oh, and the forest isn’t static – it’s dynamic (subject to global/exogenous shocks), reflexive (policy action itself perturbs the system) and changes shape and size as you try to walk through it.


A perennial problem faced by policy makers is determining whether short-run deviations from potential (remember: the macro pendulum is always above/below potential & we don’t actually know the value of “potential”) represent a transient dislocation amenable to policy action and transition dynamics or if potential output/growth itself has changed.  Discerning which scenario correctly reflects the underlying reality is critical as the appropriate policy prescriptions can be antithetic. 


The post-crisis period has only added an exclamatory emphasis to Fischer’s characterization of the Fed’s limited capacity to convictedly forecast macrofundamental changes over any extended period.  Indeed, in the wake of the Great Recession, what were once decreed macroeconomic “Laws” were downgraded to “Guidelines” and then further decremented to something akin to “conceptual guideposts”.


To review some of the notables: 


Curve-balls ….


Phillips Curve: The Phillips Curve – which can also be viewed as the aggregate supply curve in the vaunted AD/AS macro model - relates the change in the inflation rate to the level of short-run economic activity.   Here, a negative output gap drives a negative change in the rate of inflation and a positive output gap drives a positive increase in the rate of inflation.  The idea is compelling, intuitively appealing, and holds up fairly well historically.  However, as Larry Summers has been apt to highlight, the relationship has failed to hold more recently: “inflation did not decelerate by much even a few years ago when unemployment was in the range of 10 percent. Nor was there much evidence of accelerating inflation in the 1990s, when the unemployment rate fell below 4 percent. “ 


This breakdown in the output-inflation link is important.   The conventional view is that the level of output drives inflation which, in turn, drives the policy response.  A structural break in the output-inflation connection leaves policy without its proverbial North Star.


Law & (Dis)order ….


Okun’s Law:  Okun’s Law – named for Kennedy economic advisor Arthur Okun -  links the growth rate of output to changes in the unemployment rate and says that short-run output needs to grow ~2.25% above trend to reduce unemployment by 1%. Historically, the relationship has been strong with ~70% of the annual change in unemployment explained by the change in GDP growth.  In the Chart of the Day below we show Okun’s Law on an annual basis over the 1 period.  We’ve highlighted the large dispersion/break from trend in the peri and post-crises period with unemployment spiking higher than predicted by the model in 2009/10 and subsequently falling faster than predicted over the 2011-14 period. 


Secular and structural changes in the economy and labor market have certainly shifted the relationship over the last 65 years and the Great Recession served to bring those changes further into focus.   But that’s also largely the point.  If the forecast error in a workhouse macro model such as Okun’s Law rises to such an extent that its practical utility is lost when it’s needed most, the conventionalist forecaster’s tackle box gets increasingly bare.    


Rules & Tools ….


Conventional expansionary policy works to increase investment (& export) demand by expanding the spread between the marginal product of capital and the real interest rate.  This works well over “normal” cycles and particularly well on the right side of an interest rate cycle (think 1) when decades of lower highs and lower lows in both real and nominal rates support recurrent layering of debt augmented demand and asset price inflation. 


Conventional policy breaks down in a demand vacuum perpetuated by the long-term rate cycle reaching its terminal end.  In short, no one cares if the real interest rate is below the marginal product of capital if there is no demand for the output you produce using that newly purchased “cheap” capital.   


Mo’ Money, Mo’…. Inflation? 


But #StrongDollar is sweet, right?... Lower gas prices, higher share of wallet for other discretionary purchases, cheaper imports, stronger intermediate-term domestic consumption.  Rising domestic demand, tightening capacity, and a taut labor market should support incremental wage and demand-pull inflation.  Viva la Phillips Curve!  True, but the inflationary impacts are more likely to manifest over the medium term and provided the domestic labor market remains something of an insular island of strength.    


Duration Mismatch ….


In the more immediate term, an expedited appreciation of the dollar, the associated cratering in energy/commodity prices and decline in import prices drives disinflation domestically.  Global deflationary pressures only exaggerate that impact. 


Keepin’ it Real ….


The other side of lower inflation (besides the simple fact that it’s running at <50% of the 2% target) is rising real interest rates and the goal of expansionary policy is lower – and preferably negative - real rates.  That disinflation is predominating globally and fixed investment (still) flagging with most central banks sitting on 0% six years post-crisis is not particularly comforting.  Again, there are no good analogues for the current global dynamics and conventional policy efforts have been Sisyphean. 


Wet Noodles & Rented Alpha ….


What do you do with this quasi-random redux of post-crisis creative destruction in conventional macro modeling?  


Mostly it’s just an incremental noodle to noodle over as you noodle over the Fed’s latest noodling over lagging macro data. 


More tangibly, I think it edifies Fischer’s quote above.  Effective policy action, even in “normal” times is challenged by the realities of imperfect information, incomplete understanding and structural shifts unamenable to the coarse tools of monetary policy. 


Those challenges have only been amplified in the post-crisis period and have only heightened the magnitude of uncertainty facing policy makers and, by extension, market participants. 


Uncertainty breeds volatility and volatility breeds market dislocations.  Market dislocations, however, are (still) alpha’s breeding ground.  We expect the already rampant cross-asset class volatility to persist.   


When I was in coaching/bodybuilding, the running punchline for steroid users with no process and marginal work ethic was that they had a “rented physique”.  Great moderations, secularly depressed volatility and leverage is like rented alpha. 


Our immediate-term Global Macro Risk Ranges are now: 


UST 10yr Yield 1.79-2.15

SPX 2078-2120

VIX 13.99-18.88

USD 93.70-95.32
YEN 118.16-120.26

Oil (WTI) 49.09-53.99

Gold 1   


To not being “that guy”,


Christian B. Drake

U.S. Macro Analyst 


Rules & Tools - Okuns Law

Alternative Market Medicine

This note was originally published at 8am on February 06, 2015 for Hedgeye subscribers.

“The traditional point of view doesn’t explain everything.”

-Deepak Chopra


Need some alternative Macro Market Medicine to get you through your risk management day? With the help of my man Deepak’s evolving professional experience, oh does the Mucker have something non-centrally-planned, for you!


“Deepak Chopra used to be firmly entrenched in a very traditional field of medicine: endocrinology. During the 1980s he worked as the Chief of Staff at New England Memorial Hospital… back then Chopra chugged coffee in the morning, smoked cigarettes, and drank whiskey in the evening to relax.” (The Medici Effect, pg 155)


No, I don’t drink whiskey to relax – neither am I recommending it as a medicine for the 100 point Dow swings you now have to deal with every day. I’m simply asking you to realize what Chopra did before he wrote 3 dozen books and decided to change his #process. He “started to notice things that could not be explained by theory.” In our profession’s case, those things are Old Wall theories.


Alternative Market Medicine - a. deepak


Back to the Global Macro Grind


Some of the Old Wall types still operate on a theory that if the stock market is going up, the economy must be going up. Then you have this other camp of quacks like me who’d remind you that if the bond market (Long Bond) is going up, the economy is slowing.


You also have all the poor bastards out there just chasing charts, who wouldn’t know the 2nd derivative of growth and inflation cycles from their next shot of Fireball. And, of course, you have mainstream media, who is left-leaning about everything economic anyway.


But that’s what makes a market. Mr. Macro Market doesn’t care about any of our individual strategies or stimulus preferences. He is naturally setting it up to provide the most amount of people, the most pain, at the most inopportune time.


Is today one of those days? Simple question – with a not so simple answer. Here’s the setup:


  1. STOCKS: One week ago today, after a bad US GDP report for Q4, the SP500 closed at 1995
  2. BONDS: as GDP growth slowed, the 10yr US Treasury Yield hit fresh new lows at 1.65%
  3. Then, zoom… stocks rallied +3.3% off those lows and the 10yr has popped back up to 1.81%


But what was it that drove the “stocks” up – and what kind of stocks really went up?


  1. US Dollar Down has driven a massive counter-TREND move in all of the Correlation Risk trades
  2. Both Oil and Energy stocks related to Oil’s counter-TREND move led the zoom…
  3. And crazy macro guys like me just day-traded my way around the pylons, trying to stay in the black


Soh-rry. In Canadian hockey speak we call them pylons. In USA Hockey, they call them “cones.”


However you play the game, you do need to zig and zag when macro markets move like this. After all, inclusive of this week’s no-volume ramp (total US Equity market volume was -22% vs. its 1yr avg yesterday) the SP500 summary for the YTD = 0.19%.


Yeah, I know you know. But just a friendly reminder to your friends that don’t (please forward this to them) if you’re long the Long Bond (TLT, EDV, ZROZ, etc.) you’re already up +7-8% YTD by just staying the global #GrowthSlowing course.


“So”, what will today’s US jobs report bring?


  1. Rocketing wage growth, booming capex hiring cycles in Oil & Gas, puppy dogs & rainbows?
  2. Or, blah…


Blah. As in what always happens in the latest of late-cycle economic indicators (employment)… what if there’s just nothing, blah?


I don’t predict stock and bond markets will do nothing on that. Fully loaded with Dollar Down, Rising Gas Prices, and 2014 #Bubbles (GPRO, YELP and Pandora) Imploding, I predict #fun!


And if you can’t have fun playing this game, I don’t have any alternative medicine for that anyway.


Our immediate-term Global Macro Risk Ranges are now (giving you all 12 Big Macros today with our intermediate-term TREND view in brackets):


UST 10yr Yield 1.64-1.89% (bearish)
SPX 1987-2075 (neutral)

Nikkei 17395-17879 (bullish)

DAX 10599-10962 (bullish)

VIX 16.06-21.76 (bullish)

USD 93.05-94.52 (bullish)
EUR/USD 1.11-1.14 (bearish)
YEN 116.27-117.99 (bearish)
Oil (WTI) 42.48-53.09 (bearish)
Natural Gas 2.54-2.74 (bearish)
Gold 1250-1275 (bullish)
Copper 2.40-2.63 (bearish)


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Alternative Market Medicine - 02.06.15 chart


Takeaway: Little-to-no comp momentum, margin pressure, and accelerated expansion into new markets makes 20% EPS growth unlikely in ’15.

Key Takeaway

NDLS delivered a disappointing 4Q14 print and offered up a similarly disappointing outlook for 2015.  While we expected both, the fundamentals of the business are worse than we’d initially thought.  We reiterate our $14-16 fair value and anticipate another leg down in the stock.



No momentum heading into ’15.  NDLS reported system-wide SSS of +1.3%, well short of the consensus estimate of +1.8%.  As a result, revenues and EPS missed estimates by $1.5 million and $0.01, respectively.  The bigger disappointment, however, is the anemic 1.1% comp growth NDLS is seeing to-date in 1Q15 – consensus is expecting +3.9% for the quarter.  To put this number into context, Black Box reported January 2015 comp sales of +6.1%.  An emerging, fast casual growth concept should not be lagging its peers to this extent.  With little momentum so far in ’15, management guided to full-year EPS growth of 20% (below consensus at 27%) on the back of 2.5-4% comp growth.  These scaled back estimates are aggressive and will put a lot of pressure on the business to perform in 2H15.




Margin deterioration will be difficult to reverse.  NDLS is having a difficult time managing its P&L as it pursues its aggressive expansion agenda and, although they are scaling back new unit development slightly (from 16% to 12-13%) in ‘15, this will continue to be the case.  The truth is, this company needs to see mid-single digit comps to even think about driving margin expansion.  With pressure on the cost of sales (durum wheat) and labor lines (ACA, claims activity), in addition to increased marketing, ’15 could be another year of flat-to-down margins.




Expansion outside of the core will not be easy.  We’ve been through this before with CHUY.  Investors that expect these regional companies to rapidly, and successfully, expand outside their core markets are in for a rude awakening.  It doesn’t help that NDLS, in our view, is a rather narrow concept that largely unproven outside of the Midwest (little presence in New England, the Southeast, Pacific Coast, etc.).  Management appears to be finding this out the hard way and is struggling to drive brand awareness in these markets.  The current media strategy is such a disaster that they decided to suspend advertising in 1H15, with plans to accelerate it in 2H15.  New unit development this year will be skewed more toward new and developing markets than in ’14, with new units coming on in Oklahoma, California, upstate New York, Arizona, Florida, and Toronto, CA.  A rapid growth plan is never easy to execute, particularly when venturing into new markets.  We don’t see how NDLS will be able to deliver 20% EPS growth in 2015.

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Real Conversations: How Firefly Founder Tom Markusic Is Changing the New Space Paradigm


In this edition of Real Conversations, Firefly Founder and CEO Tom Markusic talks with Hedgeye's Keith McCullough about the growing demand for efficient & inexpensive small satellite launches, his experiences working with entrepreneur Elon Musk, and why Firefly is poised to disrupt the new space landscape.

This Is the Biggest Risk in the Industrial Sector Right Now

This Is the Biggest Risk in the Industrial Sector Right Now - mm


In the industrials sector, significant debt financed capital investment has been directed toward feeding the commodity bubble – from iron ore, copper mines and rail networks, to oil well service and agriculture equipment. 


Losses on project financing and equipment backed lending may prove to be a big surprise later in 2015 and beyond, particularly at captive finance companies like Caterpillar Financial.


The cessation of credit available for commodity-related equipment sales and remarketing of used equipment may also lengthen and deepen the downturn.  We have estimated that approximately 10% of sector sales go to commodity-related capital equipment, with many highly visible companies facing much more significant exposure.


The bottom line here is the commodity correction should drive a prolonged blow back into several segments of Industrial equipment and finance.


This Is the Biggest Risk in the Industrial Sector Right Now - 779

Initial Claims | Still Strong

Takeaway: This morning's labor market report was good, and the energy state complex got less bad in the most recent week.

Below is the detailed breakdown of this morning's initial claims data from Joshua Steiner and the Hedgeye Financials team. If you would like to setup a call with Josh or Jonathan or trial their research, please contact 


Last week's note (Initial Claims: Cognitive Dissonance & Mice) ran through both a high level and ground level overview of the labor market data. This week we'll keep it tight. After bouncing notably higher last week, claims retreated this week, dropping 21k to 283k. The four week moving average declined by a further 6k to 283k. The Y/Y rate of improvement in rolling NSA claims also accelerated. This week's numbers correspond to the sample period for the February jobs report and the M/M dynamic (4wk rolling) is lower by ~23k jobs vs the prior sampling period. 


On the energy side, job losses eased slightly as the gap between our energy state basket and the US as a whole tightened in the most recent data. The gap between the two closed by 4 pts to 26 from 30. 


Net net, the labor market data continues to hang in there, for now. 


Initial Claims | Still Strong - Claims18 normal  1


Initial Claims | Still Strong - Claims20 normal  1


The Data

Prior to revision, initial jobless claims fell 21k to 283k from 304k WoW, as the prior week's number was unrevised.  Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -6.5k WoW to 283.25k.


The 4-week rolling average of NSA claims, another way of evaluating the data, was -14.8% lower YoY, which is a sequential improvement versus the previous week's YoY change of -13.1%


Initial Claims | Still Strong - Claims2


Initial Claims | Still Strong - Claims3 normal  1


Initial Claims | Still Strong - Claims6



Joshua Steiner, CFA


Jonathan Casteleyn, CFA, CMT


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