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Volatility Asymmetry (We’re In Uncharted Territory for Most Risk Managers)

 

Hedgeye CEO Keith McCullough answers a subscriber’s question on market volatility in this brief excerpt from The Macro Show earlier this morning.

 

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FLASHBACK: 2.75% or 1.75%?

This (rather prescient and contrarian) Early Look was written on June 26, 2015 by Hedgeye Risk-Manager-In-Chief and CEO Keith McCullough. If you would like to leave consensus groupthink behind and begin your subscription click here.

“Take your pick as to when the story begins.”

-Moises Naim

 

Was it when Chinese growth really started slowing? Was it when #LateCycle sectors of the US stock market (Industrials and Transports) started to break down? Or was it when secular European #deflation started to “reflate”?

 

Was it a “technical” breakout in bond yields from levels very few fund managers thought we’d ever see (don’t forget that all-time lows in Global Yields were in Q1 of 2015)? Was it a “liquidity” move? Or was it both?

 

How about the latest no-volume-ramp in both US and European stocks? Was it the more dovish Fed (which Bond Bears had dead wrong)? Was it “Greece”? Was it both? Or neither? Take your pick.

 

FLASHBACK: 2.75% or 1.75%?  - TsipuMerk

 

Back to the Global Macro Grind…

 

As my French Canadian hockey roommate in college used to say, “the thing of it is, Mucker…” that whoever the establishment was and/or is supposed to be on Global Macro matters, they just don’t seem to matter much anymore.

 

The fact of the matter is that after all the storytelling, 6 months into 2015 the Dow/SP500 are +1-2%; Oil = range-bound; bond yields have ramped from 3yr lows (in January) to +23 basis points (10yr) YTD, and US earnings have slowed, big time.

 

Sure, you can tell me a story about “liquidity and technicals” … and until something drops like Chinese stocks just did (-7.4% overnight, -14.8% month-over-month), I’ll entertain it – because the “charts look good” and I’m just a really nice guy.

 

But, to be clear, chasing the momentum associated with what already happened (charts), isn’t a research #process. On that front, the biggest top-down factor to solve for is real (inflation adjusted) growth. So what’s your pick?

  1. US and Global Growth are going to accelerate from here through 2016 and beyond
  2. US growth accelerates sequentially in Q2, then slows (again) in Q3 and beyond
  3. European growth slows sequentially in Q2/Q3; Japanese growth accelerates Q2/Q3

I’ll pick 2 and 3 (because that’s what our GIP Models are signaling as the highest probability). For those of you who are new to considering our research and risk management process, GIP model stands for:

  1. Growth
  2. Inflation
  3. Policy

In meetings with Institutional Investors, I affectionately call this our government PIG model (GIP in reverse) because, essentially A) that’s what big central-planners are and B) they believe the P (policy) solves for the G (growth).

 

In reality, what we have learned in the last 5-10 years (after almost 600 “rate cuts” globally) is that:

 

A)     When real-growth misses the perpetually optimistic government “forecast”,

B)      Central planners ease (cut rates) and devalue their currencies… then that “policy action”

C)      Reflates asset prices (cost of living in local currency terms) and slows real-purchasing power (spending)

 

If you want to retire from 2/20 and become a famous academic, spend the rest of your life telling the world a story that’s based on that (I’m too busy reading to write a book).

 

My name is Keith McCullough, and I write daily-non-fiction macro from a house on the lake in Northern Ontario (Canada).

 

Other than reading my rant right now, what do you do? Do you write? Or do you read what other people write? Can you, transparently and accountably explain, daily, what it is that you think is going to happen next and why?

 

I know. It’s hard. But so is life.

 

It’s even harder to spend your Global Macro life chasing consensus and big round “targets” like 3% GDP, Dow 20,000, and “the 10yr is definitely going to 2.75%, bro.”

 

Btw, that last one isn’t a joke. It must be making the rounds on the buy-side these days because I have heard 2.75% about two dozen times in the last 3 weeks from very sharp accounts (more when last price was at 2.54%, eh).

 

No, God doesn’t call with a level. And no, I don’t purport to know anything about nothing either.

 

All I know is that our Bayesian-inference research #process got us as bullish on real US growth (bearish on long-term Treasury Bonds) in 2013 as it’s getting me bearish on this #LateCycle (74 months in) expansion slowing into 2016.

 

Our predictive-tracking algorithm is implying a sequential acceleration in real GDP in Q2, then another big deceleration in Q3. Does that get the Bond Bears 2.75%? Maybe. But maybe not. And, more importantly, if it does, maybe it’s 1.75% after that.

 

Q2 ends in 5 days. And Mr. Macro Market will decide when the discounting of real GDP slowing in Q3/Q4 matters - not a research note that cherry picks the timing of what already happened.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.19-2.44%

SPX 2083-2130
Nikkei 20404-21015
USD 93.91-95.99
YEN 122.69-124.36
Oil (WTI) 59.06-61.14

Gold 1164-1194

 

Best of luck out there today (and enjoy your weekend),

KM

 

Keith R. McCullough
Chief Executive Officer

 

FLASHBACK: 2.75% or 1.75%?  - 06.26.15 chart2


SBUX | DO THE NEW FOOD OFFERINGS DRIVE INCREMENTAL TRAFFIC?

 “Starbucks’ new ‘tapas’ menu is totally disgusting” -NY POST August 20, 2015

 

While this headline might be a bit of sensationalism, the point is not lost on me.  Starbucks’ food initiative is not a driver of incremental traffic and makes operations more complex while having negative implication for the brand.

 

We wrote a Hedgeye SHORT SBUX Black Book in January of 2015, and the centerpiece of the short thesis was focused on the food not driving incremental traffic into the stores.  Needless to say the timing was off, but the thesis is still in play with timing being the remaining issue.    

 

In its quest for growth in its U.S. store base, Starbucks is trying to be all things to all people.  In the end this could be a bad decision for the company.  Starbucks’ aggressive move into serving more food at every day-part will ultimately be disruptive to the operations and the poor quality food will also impact the consumer perception of the brand.

 

Just like nobody went to McDonald’s for espresso based drinks, nobody is going to Starbucks to eat food wrapped in plastic and heated in a Microwave.  Starbucks’ new food it is serving goes completely against the secular trend consumers are looking for; customizable, all-natural, non-GMO and organic alternatives.  The quality of the Starbucks brands is associated with its hand crafted beverages and that does not automatically extend to the current food offerings. 

 

In our SBUX Black Book we ran a survey that asked consumers if they like the La Boulange food at Starbucks.  It was clear that consumers did not like the new food. 

 

SBUX | DO THE NEW FOOD OFFERINGS DRIVE INCREMENTAL TRAFFIC? - CHART 1

 

We recently ran a new survey that asked. Do you go to Starbucks more often because of the increased food offerings? 

 

SBUX | DO THE NEW FOOD OFFERINGS DRIVE INCREMENTAL TRAFFIC? - CHART 2

 

Time will tell where Starbucks’ new food efforts are headed, but we suspect it will not end well.

 

 

 


Early Look

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RTA LIVE: KEITH MCCULLOUGH WALKS THROUGH REAL-TIME ALERTS AT 11:00AM ET

Hedgeye CEO Keith McCullough hosted RTA Live this morning at Hedgeye TV studios. Catch the replay below: 

 

 
 

 


RTA Live: August 24, 2015

 
 


MONDAY MORNING RISK MONITOR | A SEA OF RED---CHINA WORRIES ABOUND

Takeaway: Bonfire of the risk indicators => commodities, junk bonds/leveraged loans, anything EM. US Interbank rates starting to widen: Foxhole time.

Key Takeaway:

Here are the key things to keep an eye on:

 

Front Burner Disasters:

1. Commodities torched for another -3.7% W/W drop, bringing the M/M change to -6.7%

2.  Junk Bonds rip another +19 bps W/W to 7.40% and are higher by +41 bps M/M.

3. Leveraged Loans shed 4 points to 1866 W/W and are down 18 pts M/M.

4. EM Sovereign Swaps: Russia +45 bps W/W to 420 bps. Brazil +25 bps to 330 bps. Indonesia and Thailand: +28 bps & + 22 bps, respectively.

 

Back Burner Simmers:

1. US TED Spread (US Interbank rate):  +7 bps to 31 bps - biggest 1 week move in years. 

2. Shifon Index (Chinese Interbank rate): +18 bps W/W to 185 bps. Almost a double from mid-June lows of ~100 bps.

 

Last week, global markets roasted on concerns over Chinese economic growth and concerns over a broader Asian collapse. Most notably, CDS widened broadly, the price of oil hit a new low, high yield YTM blew out by another +19 bps, the TED spread spiked by +7 bps, and the Chinese interbank rate rose by +18 bps. As we show in the heatmap below, market risk is tilted heavily negative in the short and intermediate durations, while the long-term balance remains positive (for now). 

 

Current Ideas:

We're adding BlackRock (BLK) to our Best Ideas Short Bench.

 

MONDAY MORNING RISK MONITOR | A SEA OF RED---CHINA WORRIES ABOUND - Ideas 2

 

Financial Risk Monitor Summary

 • Short-term(WoW): Negative / 2 of 12 improved / 7 out of 12 worsened / 3 of 12 unchanged

 • Intermediate-term(WoW): Negative / 3 of 12 improved / 8 out of 12 worsened / 1 of 12 unchanged

 • Long-term(WoW): Positive / 4 of 12 improved / 2 out of 12 worsened / 6 of 12 unchanged

 

MONDAY MORNING RISK MONITOR | A SEA OF RED---CHINA WORRIES ABOUND - RM15

 

1. U.S. Financial CDS -  Swaps widened for 18 out of 27 domestic financial institutions. The average change was +6 bps as concerns over Chinese growth shook global markets.

 

Tightened the most WoW: CB, ACE, ALL

Widened the most WoW: WFC, BAC, RDN

Tightened the most WoW: ACE, AXP, CB

Widened the most MoM: GNW, RDN, MET

 

MONDAY MORNING RISK MONITOR | A SEA OF RED---CHINA WORRIES ABOUND - RM1

 

2. European Financial CDS - Swaps mostly widened among European Banks last week as global worries over growth in China rose. Russia's Sberbank swaps widened by +30 bps to 479 as the price of oil fell to $40 as of Friday's close. Additionally, with the political volatility of Greece's prime minister planning to resign, that country's banks' swaps widened between +327 bps and +2,910 bps.

 

MONDAY MORNING RISK MONITOR | A SEA OF RED---CHINA WORRIES ABOUND - RM2

 

3. Asian Financial CDS - While swaps across the region were mixed, last week's focus was growth concerns in China, where financial CDS widened between 11 bps and 12 bps.

 

MONDAY MORNING RISK MONITOR | A SEA OF RED---CHINA WORRIES ABOUND - RM17

 

4. Sovereign CDS – Sovereign Swaps were largely unchanged last week. The largest moves (+/- 1 bp) came from French, Italian, and Japanese swaps. 

 

MONDAY MORNING RISK MONITOR | A SEA OF RED---CHINA WORRIES ABOUND - RM18

 

MONDAY MORNING RISK MONITOR | A SEA OF RED---CHINA WORRIES ABOUND - RM3

 

MONDAY MORNING RISK MONITOR | A SEA OF RED---CHINA WORRIES ABOUND - RM4

 

5. Emerging Market Sovereign CDS – Emerging market swaps widened sharply last week. Russian sovereign swaps widened the most, by +45 bps to 420. Brazil was close behind at +25 bps to 330 bps.

 

MONDAY MORNING RISK MONITOR | A SEA OF RED---CHINA WORRIES ABOUND - RM16

 

MONDAY MORNING RISK MONITOR | A SEA OF RED---CHINA WORRIES ABOUND - RM20

 

6. High Yield (YTM) Monitor – High Yield rates rose 19 bps last week, ending the week at 7.40% versus 7.21% the prior week.

 

MONDAY MORNING RISK MONITOR | A SEA OF RED---CHINA WORRIES ABOUND - RM5

 

7. Leveraged Loan Index Monitor – The Leveraged Loan Index fell 4.0 points last week, ending at 1866.

 

MONDAY MORNING RISK MONITOR | A SEA OF RED---CHINA WORRIES ABOUND - RM6

 

8. TED Spread Monitor – The TED spread rose 7 basis points last week, ending the week at 31 bps this week versus last week’s print of 24 bps.

 

MONDAY MORNING RISK MONITOR | A SEA OF RED---CHINA WORRIES ABOUND - RM7

 

9. CRB Commodity Price Index – The CRB index fell -3.8%, ending the week at 191 versus 199 the prior week. As compared with the prior month, commodity prices have decreased -6.7%. We generally regard changes in commodity prices on the margin as having meaningful consumption implications.

 

MONDAY MORNING RISK MONITOR | A SEA OF RED---CHINA WORRIES ABOUND - RM8

 

10. Euribor-OIS Spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread tightened by 1 bps to 10 bps.

 

MONDAY MORNING RISK MONITOR | A SEA OF RED---CHINA WORRIES ABOUND - RM9

 

11. Chinese Interbank Rate (Shifon Index) –  The Shifon Index rose 18 basis points last week, ending the week at 1.85% versus last week’s print of 1.67%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.

 

MONDAY MORNING RISK MONITOR | A SEA OF RED---CHINA WORRIES ABOUND - RM10

 

12. Chinese Steel – Steel prices in China fell 1.0% last week, or 24 yuan/ton, to 2331 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity and, by extension, the health of the Chinese economy.

 

MONDAY MORNING RISK MONITOR | A SEA OF RED---CHINA WORRIES ABOUND - RM12

 

13. 2-10 Spread – Last week the 2-10 spread tightened to 142 bps, -5 bps tighter than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.

 

MONDAY MORNING RISK MONITOR | A SEA OF RED---CHINA WORRIES ABOUND - RM13

 

14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows that Financials are now both broken TREND (intermediate term) and broken TRADE (short term). On a short term basis, there is 3.3% upside to TRADE resistance and 1.8% downside to TRADE support.

 

MONDAY MORNING RISK MONITOR | A SEA OF RED---CHINA WORRIES ABOUND - RM14

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 

 

 

 


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