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Pricing in An Easier Fed

Client Talking Points


New 7-year high - epic ramp continues with the Shanghai Composite up another +3% overnight = +40% year-to-date and +96% since OCT 2014 as speculation runs rampant about precisely what at this point, we do not know!


EUR/USD backs off -0.3% this morning after rallying to the top-end of its immediate-term risk range (now 1.06-1.09), the Euro is +1.3% in the last month vs. USD as the world prices in an easier Fed at the Wednesday meeting.

S&P 500

The U.S. stock market (and its volatility) likes the expectation of the Fed being easier, on the margin – at +1.8% for the week with Tech and Consumer Discretionary leading the rally (+3.2-4.0% week-over-week) the obvious question is what is priced in now that we’re back at the all-time highs?

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

The Dodge Construction Starts Index accelerated at its highest rate since 1982. The index was driven largely by non-building projects, which was 74% higher for the first three months compared to last year. The Architecture Billings Index (ABI), a survey of architects, increased ~3% month-over-month and ~5% year-over-year for March. The ABI Index typically leads nonresidential and residential construction spending by 9-12 months. More importantly, the ABI Index leads Manitowoc Crane Orders by 2 quarters. This suggests MTW’s crane sales should see a pickup in the first half of the year. MTW reports April 29th after the close. Earnings Call will be held at 10:00am eastern time the following day.


iShares U.S. Home Construction ETF (ITB) is a great way to play our long housing call. Housing went 4 for 4 in a data heavy calendar for the sector this week with demand improving across both the new and existing markets and the fledgling acceleration in price growth finding some positive confirmation. The builder stocks had a choppy week of performance as investors held mixed opinions of earnings reports and management commentary out of DHI and PHM but, from a fundamental data perspective, the Trend remains one of discrete improvement.


Ten-year rates dipped 12bps on the week (forward-looking growth expectations) and the USD got crushed for a 1.5% loss. Growth and inflation expectations get priced in AHEAD of the more dovish policy tone resulting from any sign of deterioration in the labor market. Wednesday’s Fed meeting will be the next catalyst that will steer the market’s expectation on forward-looking growth and inflation. We expect the dots (forward-looking federal fund rate expectations) to be pushed out….again.

Three for the Road


TREASURIES: 1.91% 10yr (after starting the yr at 2.17%) as Lower-For-Longer gets priced into Fed expectations



Treat a person as he is, and he will remain as he is. Treat him as what he could be, and he will become what he should be.

Jimmy Johnson 


Branded-drug prices have increased 127% since 2008, compared to an 11% rise in the consumer price index (according to Express Scripts Co.).

CHART OF THE DAY: To Raise, Or Not To Raise (That Is The Question)

CHART OF THE DAY: To Raise, Or Not To Raise (That Is The Question) - z chart


Editor's Note: This is a brief excerpt and chart from today's Morning Newsletter written by Hedgeye CEO Keith McCullough. If you'd like to get ahead of consensus, we encourage you to take a look and subscribe today.


Since the last Fed meeting (March 18th) I’ve been fixated on whether or not the Fed is for real on raising interest rates into both #Late-Cycle (see our Q2 Macro Themes deck) employment gains and Global #GrowthSlowing.


While it may have sounded a little over the top, our “buy everything” call on that March 18th Fed decision to go dovish, since then (from Chinese to Japanese stocks and/or US stocks and bonds), that was the right asset allocation decision to have made...



Are You Fixated?

“The real issue is not whether you have a mental model, but whether you’re fixated.”

-Gary Klein


That’s an excellent risk management #process quote from a conversation Ed Hess had with Dr. Gary Klein (senior scientist with Macro Cognition) in chapter 8 of Learn Or DieUsing Science To Build A Leading-Edge Learning Organization.


Klein made an astute point about expectations in reminding me that “so much of decision making is taught and treated as if you can pre-define the options” (pg 90). My experience with markets is that the options are both non-linear and constantly changing.


Sometimes expectations change fast; sometimes slow. It isn’t my job to tell the market which catalyst or correlation to fixate on. It’s my job to try my best to accept change.


Back to the Global Macro Grind


Since the last Fed meeting (March 18th) I’ve been fixated on whether or not the Fed is for real on raising interest rates into both #Late-Cycle (see our Q2 Macro Themes deck) employment gains and Global #GrowthSlowing.

Are You Fixated? - FED cartoon 12.18.2014

While it may have sounded a little over the top, our “buy everything” call on that March 18th Fed decision to go dovish, since then (from Chinese to Japanese stocks and/or US stocks and bonds), that was the right asset allocation decision to have made.


Front-running central planning expectations (especially when they are changing, on the margin, from hawkish to dovish – or dovish to uber dovish) will remain a major macro market fixation, until this epic experiment has nothing left to give.


In US Dollar devaluation terms, here’s what macro markets saw last week:


  1. US Dollar Index down another -0.6% week-over-week, taking its 1-month correction to -1.5% (+7.4% YTD)
  2. Euro (vs. USD) up another +0.6% in kind, taking its 1-month counter-TREND bounce to +1.3% (-10.1% YTD)
  3. Canadian Dollar up +0.5% vs. USD last week, taking its 1-month counter-TREND bounce to +4.1% (-4.6% YTD)


In other words, the closer you got to being long anything that looked like a Commodity Correlation trade (for the last month) – from oil itself, to energy stocks and junk bonds, to a resource driven currency – you crushed it.


With the Dollar off its highs, Rates #LowerForLonger, and the SP500 closing at her all-time highs on Friday, could all of this dovishness be priced in? I’m not so sure it is, yet. Chinese stocks closed up another +3% overnight to a 7yr high, +40% YTD!


With USD Down, the other big obvious last week in Global Equities was the outperformance of inflation oriented markets:


  1. Brazil’s Bovespa was +4.9% on the week to +13.2% YTD
  2. MSCI Latin American Equity Index bounced back to break-even YTD with a +4.5% wk-over-wk move
  3. Emerging Markets Equities (MSCI Index) had another big week, +1.7% to +10.9% YTD


If you boil all of this down in growth vs. inflation terms (using a 1-2 month duration), this is all one massive macro re-rating of inflation expectations (to the upside) within the context of what was a nasty 6 month #deflation scare.


On a reported basis (from governments) #deflation or disinflation (or whatever you want to call it) is going to be reality through the summer time. Government data is reported on a year-over-year basis, don’t forget.


But what if the Fed not only backs off on rate hikes, but starts to talk about incremental easing again? I don’t think they’ll do that. But being fixated on what the Fed should do vs. what they will do has proven to be quite costly for the past 6 years.


In the meantime (as in this week), this is where US stock and bond investors are at:


  1. SP500 was +1.8% week to an all-time closing high of 2117 = +2.9% YTD
  2. Tech Stocks (XLK) led the charge at +4.0% wk-over-wk = +4.3% YTD
  3. Consumer Discretionary (XLY) stocks squeezed the shorts +3.2% last wk = +7.6% YTD


Especially when I look at moves in big cap Tech names like Amazon (AMZN) and Microsoft (MSFT) of +14% and +10% (on the day!) on Friday, last week’s beta chasing move in the US stock market tells me that:


  1. Hedge funds are getting squeezed again (forced to cover shorts high and get net longer)
  2. Long-Only funds are being forced to chase performance again into month-end
  3. It’s going to be really hard to be bearish into the Fed meeting on Wednesday


To accentuate this view, the net SHORT position (CFTC non-commercial futures/options contracts) in SP500 Index (+ E-minis) hit a new monthly high of -45,673 contracts last week. To put that in context (when consensus didn’t respect the risk of #deflation) the trailing 6 month average net LONG position in SP500 futures/options contracts is +32,687.


In this game, the real issue is not whether or not you’re “smart”; it’s whether or not you can be mentally flexible enough to fixate on the right things, at the right time.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.85-1.99%
SPX 2103-2124
USD 96.71-99.01
EUR/USD 1.06-1.09

Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Are You Fixated? - z chart

Idealistic Innovation

This note was originally published at 8am on April 13, 2015 for Hedgeye subscribers.

“Innovation has nothing to do with how many dollars you have.  When Apple came up with the Mac, IBM was spending at least 100 times more money on R&D.  It’s not about money.  It’s about the people you have, how you’re led, and how much you get it.”

-Steve Jobs


Innovation is a tricky concept.  No doubt, we all struggle with it in our businesses.  The key question often is how much to stick with what is tried and trusted versus creating brand new processes in an attempt to meet future and unplanned needs.


Harvard Professor Clayton Christensen addressed this very issue in his thoughtful book, “The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail.”  His point in the book is that successful companies can put too much emphasis on customer’s current needs, and fail to adopt new technology or models that will meet their customer’s future needs.


This weekend I was a judge at Stamford Start-Up Weekend and the role made me consider both Jobs’ quote at the top and Christensen’s book.    Over the weekend, the teams in Stamford had to come up with an idea and then deliver a five minute pitch to the judges. The pitch was followed by five minutes of Q&A from the judges and audience.


Interestingly, all four judges picked the same winning company – Slip Share.  The company was “founded” by an avid recreational boater that had determined it was very difficult to find slips to rent or use when he was away from his home marina.  In effect, he was proposing an AirBNB for the boating industry.  


Even if Slip Share doesn’t ever become a billion dollar company, or a real company at all, we all liked it for the same reasons – the management team was passionate, there was a defined problem they were trying to solve for consumers, competition was limited and unorganized, and there was an intuitive business model. 


Certainly, Slip Share isn’t developing the type of innovation that Christensen is alluding to in his book or that Peter Thiel alludes to in his recent book, “Zero to One”.   But just because it may not be a billion dollar disruptive idea, doesn’t mean Slip Share won’t succeed.  As I noted in a recent critique of Thiel’s book, sometimes the most important part of becoming an entrepreneur is just to get going.


Back to the Global Macro Grind . . .


Speaking of innovation, or lack thereof, data from the CFTC this weekend shows that hedge funds boosted net-long positions in WTI oil by 30% in the seven days ended April 7th.  In terms of context, this is the biggest jump in net long exposure since October 2010.  It is also the most significant long bet in more than nine months. (Note to reader: CFTC data is often a contrarian indicator.)


In as far as we can tell, the bulls are on some level anchored on U.S. rig count and interpreting the precipitous decline in active drilling rigs in the U.S. as sign of future slowdown in U.S. production.  Certainly this thesis may be true to a point, but the reality remains that innovation in the drilling industry means the most productive rigs are still active.


In the Chart of the Day below, we highlight a table from a recent note by our commodities analyst Ben Ryan that shows oil production by each major field in the U.S., productivity by the active rigs in that play, and rig count.  In the case of the bears, they are correct that rig count is down, and meaningfully so.  In fact, Baker Hughes rig count in the U.S. in aggregate is down 47% y-o-y.


Conversely, oil production in each major field and on a per rig basis is still up dramatically.  Even if on the margin production growth is slowing, and trust us we get that changes on the margin do matter, the more notable challenge, or looming catalyst, is that storage capacity in the U.S. is nearing capacity.  In fact by our math, the hub at Cushing, Oklahoma will be completely full in 6 or 7 weeks.


While there is some merit in the oil bulls focusing on U.S. production, that focus shouldn’t be myopic in the context of the global demand picture.  On that note, this morning’s data out of China shows that crude imports into China slowed dramatically in March at 26.1M metric tons. This is down 5.2% month-over-month and the slowest pace since November.


The broader context out of China this morning was the trade data, which was in one word: dismal.  Exports were down -15% year-over-year versus the consensus estimates of being up +11.7%.  Imports were also disappointed coming in at -12.9% year-over-year.  


Certainly, there were some 1-time impacts in the Chinese trade numbers, but the fact remains it’s hard to be excited about global growth, let alone global oil demand, when the world’s second largest economy is reporting those sorts of trade numbers. 


That said, we aren’t bearish on all economies and all asset classes.  In fact, we still are quite favorably disposed to German Equities.  Even as the DAX has had a major run over the past six months, over the past five years it has dramatically underperformed its U.S. counterparts.  Tomorrow at 11am, our European Analyst Matt Hedrick will be presenting a 50-page deck that outlines that continued case to be long of German equities.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.85-1.99

SPX 2079-2116

RUT 1249-1266

DAX 12075-12395

VIX 12.48-16.01
WTI Oil 47.09-53.74


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Idealistic Innovation - zj

CAT: Annoying Set-up, Cracks At Cat Financial?

(note: delayed because of an earnings season bout of stomach flu.)




The mining downturn showed CAT’s executives the importance of managing Street expectations.  CAT stands a good shot of earning between $4.50 and $5.25 this year, and those odds increased with 1Q15 results.  Estimates for 2016 EPS are now slightly below those for 2015, even with an aggressive buyback program.  Despite an achievable bar, management commentary was decidedly downbeat.  The delusional optimism is now gone.  Bummer.  Comments like this were more fun:


“That’s the reason back in 2010 we said that we were going to invest heavily in mining, and yes we did, in terms of our acquisitions and our R&D and our capital we invested over $15 billion and everybody will see over the long term that that was an outstanding investment.” – Steve Wunning 3/4/14



We have three takeaways from the quarter:

  1. Cat Financial Showing Cracks?  Cat Financial had performance issues in its Latin American and Mining portfolios.  Mining and Oil & Gas credit trouble is our next potential downside catalyst.  Remarketing equipment would be no picnic in either industry.  For background on our concerns, see here, and we expect to have more detail on Cat Financial in the next couple of weeks.
  2. Implied Orders Weak, But Biased by Cancellations:  End-market demand was much weaker than either reported sales or full year revenue estimates.  However, book-to-bill type metrics may be artificially depressed due to oil & gas order cancellations.
  3. CI, E&T Margins Quite Good:  CAT performed well with what it had, and that, along with a low 2Q15 bar, may keep us sidelined for now.  We had anticipated placing short CAT back on our Best Ideas List, after having removed following a weak 4Q14 earnings report in January.


Frustrating Set-up, Waiting Until Closer to 2Q 2015:  CAT may be able to meet or beat 2Q15 estimates, and again inch guidance higher.  We would guess that management didn’t raise guidance by the full beat because they wanted to keep expectations low heading into a far weaker 2H 2015 environment.  We’d also bet that the company’s “actual” internal forecast has them crushing their “publically discussed” internal forecast.  We have been expecting to re-enter a CAT short view, as discussed in our 1Q15 earnings preview note, but will now likely wait until either just before or just after 2Q15 results.



CAT Not Out of the Woods

Cat Financial Showing First Cracks:  CAT noted that “At the end of the first quarter of 2015, past dues were 3.08 percent, compared with 2.17 percent at the end of 2014. The increase in past dues compared to year-end 2014 was primarily due to the performance of the Latin American and Mining portfolios and seasonality impacts.”  We think this might be the next key downside catalyst for Caterpillar, and one that could represent ‘the bottom’ – that, or perhaps a management changeWe will have more to say about Caterpillar Financial in coming weeks.  .


CAT: Annoying Set-up, Cracks At Cat Financial? - mn1



Implied Orders Below Revenue, Estimates:  The mining downturn is now better appreciated, including expectations for price competition and negative RI operating margins.  CAT’s exposure to Oil & Gas is also well recognized now, even though it won’t really hit results until 2H 2015. Still, if we look at the end-market order rates implied by quarterly sales, adjusted for backlog and dealer inventory changes, CAT reported a book-to-bill like metric well below 1.00 (~0.86 in 1Q 2015 vs. ~0.98 in 1Q 2014).  Does this suggest downside risk to revenue in the longer-term?  Maybe, but we would bet that cancellations had a non-recurring and disproportionate impact.


CAT: Annoying Set-up, Cracks At Cat Financial? - mn22





Construction Industries (CI):  CI benefitted from a larger inventory build at the dealer level than the company has seen in recent years, but only about $100-$200 million more than last year by our rough estimates.  Pricing and currency were also benefits.  Regardless, it is hard to spin 220bps of margin improvement on a 7% revenue decline as some sort of negative.  Of course, we expect margins to decline during next three quarters of 2015, much as they did last year following strong 1Q results and dealer inventory builds.


CAT: Annoying Set-up, Cracks At Cat Financial? - mn3



Energy & Transportation:   E&T should run through its high margin, at risk oil and gas backlog by the end of 2Q15, and back half 2015 margins should suffer as a result.  Still, an operating margin in the 15%-16% seems reasonable in 2H.  We suspect, although the company has not indicated as much, that deposits for cancelled orders may have boosted results somewhat.  Also, close in orders (inside 90 days, or so) are typically unable to be cancelled.  Those two factors suggest margin slippage in 2Q 2015, ahead of the 2H 2016 profitability stepdown.


CAT: Annoying Set-up, Cracks At Cat Financial? - mn4



Resource Industries:  Earnings call commentary indicated that segment operating losses would like;y come later this year.  The industry is capital intensive industry and has excess capacity, and we have been expecting price competition to heat up. 


CAT: Annoying Set-up, Cracks At Cat Financial? - mn5




We learned last year, quite painfully, to be careful of CAT management’s plans to guide low and ratchet expectations higher.  With 2015 and 2016 estimates already fairly low, we need to build our case for meaningful credit losses at Cat Financial.   We will stay on the sidelines until we get closer to the 2Q 2015 results, which could again provide CAT with the scope to nudge guidance higher.  




Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.