“The Road goes ever on and on… down from the door where it began.”
No, that is not from Janet Yellen’s testimony yesterday. It’s from J.R.R. Tolkien’s Lord of The Rings. It’s also the theme for a walking song that my favorite Tolkien character (Bilbo Baggins) cites in Chapter 19 of The Hobbit:
“Roads go ever ever on
Under cloud and under star,
Yet feet that wandering have gone
Turn at last to home afar.”
While Janet may have been pulled and pushed toward the path of “rate liftoff”, now she’s back to where she, Ben, and their fantasy novel has always been – back to the Shire of money printings and lower-rates-for longer, that is…
Back to the Global Macro Grind…
To be clear, The Fed’s Road doesn’t end with green meadows that rest under shining stars. Policies to Inflate, ultimately end in #deflation. And that gets the Long Bond Bulls paid.
Long Bonds? Yes, as in the things that are at all-time highs in Europe and Japan (10yr German Bund and Japanese Government Bond Yields are trading at 0.36% and 0.33%, respectively) as long-term economic expectations there = #deflation.
While the USA’s 10yr Yield has dropped -14 basis points to 1.96% in the last 24 hours, it’s still trading at a +160-163 basis point premium to German/Japanese Long-term Bond Yields. Unless you think US inflation is pending, you’re long the Long Bond (TLT).
So, thank you Janet – for pseudo telling the truth yesterday. My world needed that! What did she say?
- She kept the key-word “patient” in the Fed’s current policy vernacular
- She acknowledged inflation expectations being nowhere near the Fed’s “target”
- She reminded her fans that she is, allegedly, “data dependent”…
Why do these 3 things matter (in the same order)?
- Plenty of funds were pushing the idea that the “patient” language was going to be dropped
- Plenty of funds were trying to pull me into the narrative that the Fed “doesn’t care about inflation”
- Plenty of funds now realize that the next “data” points are really going to matter!
On the “data”, you need both a calendar and a forecast – here’s mine:
- Thursday’s CPI (consumer price inflation) report is going to slow (again) both sequentially and year-over-year
- Friday’s GDP report (for Q4 2014) is going to slow (again) both sequentially and year-over-year
- Next week’s US Jobs Report (for FEB) is going to do something that I have no edge on
While this game of front-running expectations isn’t easy, if I have 3 data points pending and I’m relatively certain about 2/3, I’d much rather see those 2 face cards first! I think both the bond and stock market see them the way I see them too.
In that regard, yesterday’s real-time market reaction to the Fed taking you right back down the road that they’ve always been on made complete sense to me:
- Bond Yields fell, and accelerated to the downside into the close (TLT +1.4% on the day)
- The US Dollar stopped going up – Burning Yens and Euros stopped going down
- Housing (ITB) and Consumer Discretionary (XLY) stocks led a stock market rally to all-time closing highs
Yes, all-time is a long-time – and that’s why I’ve been saying that it was more obvious to buy longer-term Bonds on the recent pullback than it was to buy the SP500. The 10yr US Treasury bond isn’t back to its all-time high yet = more upside!
But, for those of us who like to buy both stocks and bonds (I wouldn’t have an Independent Research business if I marketed one asset class over another, sorry), we want to be buying the parts of the US stock market that will go up the most.
We call these Sector Style Exposures. In Equities, the 2015 outperformance of the following sectors remains obvious:
- US Housing Stocks (ITB) were +2.5% yesterday to +8.8% YTD
- Healthcare Stocks (XLV) were -0.1% yesterday to +5.9% YTD
- Consumer Discretionary (XLY) stocks were +0.5% yesterday to +5.0% YTD
Whereas the Sector Styles we’d want to be net short (hedge funds) or underweight (mutual funds) like Energy (XLE) and Financials (XLF) are +1.6% and -0.9% YTD, respectively, are underperforming the SP500 (which is +2.7% YTD).
Don’t get me wrong, in a world facing both Global #GrowthSlowing and #Deflation headwinds, a +2.7% YTD gain is nothing to complain about. Being positioned on The Hedgeye Road of Long TLT, ITB, XLV, and XLY has simply been more fruitful.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 1.84-2.07%
ITB (Housing) 27.01-28.36
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer