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Deflation Risks Remain

“Hurting was nothing new to him.”

-Daniel James Brown


That was a formative character quote about 1936 Olympic Gold medal winner, Joe Rantz, in an epic story I’ve been reading called The Boys In The Boat. His parents packed up and left him with the family farm when he was only 15 years old. He had no choice but to fend for himself.


“Each evening (eating by himself at the head of a table in an empty house) Rantz noted with mounting satisfaction that there were fewer boys making the climb. And he noted something else. The first to drop out had been the boys with impeccably creased trousers…” (pg 51)


While I didn’t live during the depression, I did leave home when I was 16 years old. My teammates and I have a DNA that will not fade when we have conviction in something we see that others don’t. Both #Deflation and #GrowthSlowing risks remain. Tell the Establishment we said so.

Deflation Risks Remain - Deflation cartoon 12.29.2014


Back to the Global Macro Grind


Got, hashtag, #Deflation?


Yep, ask the authors of that call when we think the risk doesn’t remain. We’ve been making this call for over 15 months now. Whether it’s signaling an immediate-term TRADE overbought signal within a long-term bearish TAIL risk or updating the data itself, we’ve had your back.


Away from China’s Imports (one of the few #s they can’t make up) crashing -20.4% y/y in SEP:


  1. Swiss Producer Price (PPI) #Deflation was -6.8% y/y in SEP (yes, that’s why they have negative bond yields)
  2. German Econ Sentiment (ZEW index) slowed to 1.9 in OCT vs 12.1 last (= fresh #SuperLateCycle lows)
  3. UK Producer Prices dropped -1.8% y/y and CPI showed only its 2nd NEGATIVE reading (y/y) since 1960


I know. I know. My Canadian buddy, Francois – who has been saying “don’t pay so much attention to the data” (after telling clients to chase “reflation” and global demand “bottoming” in July) reiterates not to be so data driven. Great.


How about being market driven? After yet another “reflation” rally to lower-highs last week:


  1. Oil (WTI) got smoked for a -5% loss yesterday and, despite last week’s +9% gain, is -15% in the last 3 months
  2. Energy Stocks (XOP) were down -4% at one point in the day and remain the worst sector to have been long in 2015
  3. Emerging Markets (still in crash mode) are leading on the downside (again) this morning with Indonesia -3.2% overnight


But, if we don’t pay attention to the data or market prices, we can pretty much tell ourselves whatever we want, eh? Not @Hedgeye. We aren’t the boys with the creased trousers trying to sell the perma bull.


What’s really interesting about the perma bull on growth and inflation “bottoming” isn’t so much that the growth bulls didn’t call for a slowdown to begin with, it’s that they’re way more bullish than the slow-moving-economists at the Fed, ECB, BOJ, etc.


Check out these comments from linear economists in the last 24 hours (even they get it at this point!):


  1. "I view the risks to the economic outlook as tilted to the downside.” –Lael Brainard, Federal Reserve
  2. “We see the possibility of inflation turning negative.” –BOJ Bureucrat
  3. “It will take longer than expected to reach stable inflation.” –Yves Mersch, ECB


In other words, forget the perma bulls who are still calling for 3.5-4.0% GDP growth (Nancy Lazar). They aren’t even in the debate at this point. The market’s debate (marked-to-market, every day) is purely about the risks of long-term #Deflation vs. immediate-term #Reflation trades.


On US growth, the much more appropriate debate right now is between the Hedgeye low-end scenario of 0.1% Q3 GDP and high-end scenario of 1.5% (SAAR) GDP vs. the Atlanta Fed Tracking model of 1.0%. We’ll get that river card report at the end of the month.


In the meantime, we’ll spend our time this week observing the data we’ve already predicted as slowing (10 months ago) like US CPI, PPI, Retail Sales, and Industrial Production (all due to be reported this week).


Darius Dale and I will also spend plenty of time debating Institutional Investors on the real-time call they need to make (from here) into the end of 2015 – perversely, will the #SuperLateCycle call itself be the catalyst for Down Dollar asset price reflation?


Or will consensus eventually just come to terms with the simple reality that central planners and their cheer-leading economists/strategists cannot CTRL+Print demand?


Deflation risks remain because Global #GrowthSlowing does. The hurt remains on those expecting both higher-growth and higher bond yields.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.97-2.12%

SPX 1 (bearish)
EUR/USD 1.11-1.14
Oil (WTI) 46.07-50.60

Gold 1135-1171


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Deflation Risks Remain - z 10.13.15 chart

October 13, 2015

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The Macro Show Replay | October 13, 2015


Attention Students...

Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.

Special Guest Contributor View: End Game?

Editor's Note: We are pleased to present this special Contributor View written by Doug Cliggott. Mr. Cliggott is a former U.S. equity strategist at Credit Suisse and chief investment strategist at J.P. Morgan. He is currently a lecturer in the Economics Department at UMass Amherst. Incidentally, he recently sat down with us here at Hedgeye for a Real Conversations interview. Click here to watch.

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Special Guest Contributor View: End Game? - z doug cliggott

By Doug Cliggott


Business cycles in America follow a distinct pattern.   At the beginning of the cycle, as the economy climbs out of recession, corporate profits begin to grow.  The behavior of both bankers and their corporate clients remains cautious, because memories of recent declines in financial asset prices and business activity are still vivid memories.


As the economic recovery continues, realized profits continue to beat still-subdued expectations, and slowly but surely optimism builds.  It takes some time, usually a few years, but eventually “animal spirits” are ignited, to steal a phrase from John Maynard Keynes.  Corporations become more willing – even eager -- to invest and to borrow.  Bankers become more willing to lend, and investors become more enthusiastic about buying equity shares of “seasoned” public companies as well as shares of newer ventures making their initial public offerings.


This process becomes self-reinforcing as higher stock market values encourage firms to borrow more and bankers to lend more.  But this process doesn’t go on forever. Economic expansions in America are measured in years, not decades.  The reason is simple.  Bankers, investors and managers of non-financial companies are just like you and me – they are human. They make mistakes.


We all have a strong tendency to extrapolate the present into the future. When things are going well – when sales and profits are beating expectations and stock prices and corporate bond prices are climbing – we expect these trends to continue and we make decisions about the future based on these expectations.


But inevitably, some of these more optimistic expectations prove to be misguided.  Some of the new investments by businesses earn less than expected, maybe because sales disappoint or a new product fails to catch on.  In the stock and bond markets, some prices start to fall.  The price declines are few at first, almost imperceptible, since the broader market indices usually continue to climb in this phase of the credit cycle.


As time moves on, the weight of our collective errors in judgment multiply and the declines in corporate earnings become increasingly widespread.  As do the decline in the prices of financial assets linked to those earnings


Tracking our location


One clear way to track the “status” of American credit cycles is to compare the growth rate of corporate profits with that of corporate borrowing.  Profit growth in excess of borrowing growth is a powerful signal of a sturdy economy since it indicates that the fruits of new investments are – in a very broad sense – exceeding expectations.  Or put another way, we have collectively not yet become overly optimistic about the near future.


Conversely, when these growth patterns trade places, when the pace of borrowing by non-financial corporations accelerates to the point that it exceeds the growth rate of profits, that tends to be a signal of trouble ahead since it indicates that optimism may have become excessive and that it will become difficult for an increasing number of borrowers to pay back their loans if they continue to increase borrowing at a rapid rate.


This part of the business cycle also takes time, often years, to play out.  One way to think about it may be what happens on a commercial aircraft when the pilot informs us that we are leaving our cruising altitude.  The “fasten seat belt” sign may not be illuminated right away, and the ride is typically still nice and smooth.  But in a very real sense, the flight path we are on has changed.  The decent has begun – we are in the final phases of our flight.


Changes in the American economy’s flight path – to an environment where corporate borrowing growth exceeds profit growth -- happened in 1998, it happened in 2007, and it happened again in 2013.  What follows – sometimes immediately, but typically in a year or two – is an increase in financial market volatility, then a decline in corporate profits and stock prices followed by a contraction of business investment and employment, and increases in business failures and loan defaults.


To repeat, this sequence of events occurs repeatedly because borrows, lenders and investors of all stripes make errors in judgment.  And we tend to make mistakes that involve borrowing too much money, or paying too high a price for a corporate bond or shares of equity in a corporation, when we are over-confident and budding with optimism.  And these types of mistakes tend to dominate when a cycle is comfortably mature, not at the beginning of the cycle when we are usually too pessimistic and often outright skittish.


Keeping score


Looking back at the past six decades, we see a neat symmetry. There is an even split between years when profits of nonfinancial companies grew at a faster rate than their liabilities (31 years) and years when the opposite was the case (31 years).  {See Table 1.}


Special Guest Contributor View: End Game? - z doug clig chart


The performance of U.S. equities is not nearly as symmetric.  Equity prices declined during just sixteen of these sixty-two years, or roughly twenty five percent of the time.  More to the point -- eleven of these sixteen negative years occurred during periods when debt growth exceeded profit growth, and three more (1962, 1981, 2002) happened in the first year of a period when profits grew faster than liabilities.  


So not surprisingly, observed equity price declines are a recurring feature of the phase of the credit cycle when excitement and optimism turn to disappointment and pessimism.  Sadly … that appears to be exactly where we are right now.

FNGN: We Are Removing Financial Engines From Investing Ideas

Takeaway: We are removing Financial Engines from Investing Ideas today.

***Please note that we are removing Financial Engines (FNGN) from Investing Ideas today.


Hedgeye Financials co-sector head Jonathan Casteleyn doesn’t think the company is going to have a good quarter. In addition, Hedgeye CEO Keith McCullough does not like Financials or Small Caps from a style factor perspective enough to put Investing Ideas subscribers through the long-term "patience" exercise with respect to shares of FNGN. In other words, the embedded market risk doesn't match up favorably for investors right now. 


FNGN: We Are Removing Financial Engines From Investing Ideas - z yellow

Cartoon of the Day: Slow and Steady (Wins the Race) | $TLT

Cartoon of the Day: Slow and Steady (Wins the Race) | $TLT - TLT cartoon 10.12.2015

Hedgeye's macro team reiterates its contrarian bullish call on the Long Bond.