"I openly challenge the Federal Reserve to hike into this #LateCycle Slowdown," Hedgeye CEO Keith McCullough wrote following today's jobs report. "If perma-stock market bulls are so ready for a rate hike, have at it. See what happens."
Editor's Note: Below is a complimentary research note written earlier this week by Hedgeye Macro analyst Darius Dale. If you'd like more information on how you can subscribe to our institutional research please send an email to firstname.lastname@example.org.
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Earlier today Keith and I were on the road visiting clients in FL and debating some noteworthy victory laps by several of our [bullish] competitors.
Unlike said competitors, our process doesn’t leave a ton of room for cherry-picking data. As you may know, we run a predictive tracking algorithm on every relevant data point from every relevant economy in the world. The goal of that algorithm is three-fold:
To contextualize sequential deltas as accelerating or decelerating;
To contextualize the trend in any given data set as accelerating or decelerating; as
To determine if the absolute value of the latest data point(s) is at/near a probable mean reversion level.
With respect to “global PMIs”, the table below compiles GDP-weighted Composite PMI data in the context of the aforementioned process:
With respect to said process:
Global PMIs did indeed broadly accelerate on a sequential basis in OCT. That is positive for the global growth outlook. Good.
Global PMIs are still broadly decelerating on a trending basis as of OCT. That is negative for the global growth outlook and implies that the aforementioned uptick is not sustainable – at least not yet. Bad.
Global PMIs are still far from “bottoming” given the average and median percentile readings in the far right column. In fact, economies like the Eurozone, Japan and U.S. are far from “bottoming” given where the latest data points fall within their respective cycles. Not good.
With respect to #2:
According to the JPM Global Composite PMI series, global economic growth is still decelerating on a trending and quarterly average basis (1st chart below). Bad.
According to the JPM Developed Market Composite PMI series, DM economic growth is still decelerating on a trending and quarterly average basis (2nd chart below). Bad.
According to the JPM Emerging Market Composite PMI series, EM economic growth is still decelerating on a trending and quarterly average basis (3rd chart below). Bad.
According to the ISM Composite PMI series, domestic economic growth is still decelerating on a trending basis. Bad.
In fact, when analyzing each individual country’s benchmark Composite PMI series, economic growth across the balance of G20 economies continues to decelerate on a trending and quarterly average basis (5th chart below). One month of good data does not a trend make. Bad.
In short, when considering the preponderance of the data, any “bottoming” call with respect to global growth:
Blatantly disrespects the TREND in domestic and global growth data.
Blatantly disrespects the absolute level of the data – especially considering that most investors who are now calling for a “bottom” failed to identify what was an obvious top back in early 2015.
Blatantly disrespects the risk of incremental #StrongDollar debt deflation – almost in cavalier fashion, especially given that the unwind of a #WeakDollar global leverage buildup is what got us in this mess in the first place.
After having done about 30+ meetings all over the country since we introduced our Q4 Macro Themes in early October, Keith and I remain of the view that #3 is arguably the most misunderstood and mispriced risk across asset markets today.
We are the authors of this view and suspect that most equity and credit investors still fail to grasp what macro investors view as a simple concept: a rising U.S. dollar tightens financial conditions globally.
Ten-plus years of financial repression in the U.S. created 10+ years of commensurate financial repression across the global economy (to prevent “Dutch Disease”) – especially in emerging markets (namely China). Such easy financial conditions perpetuated the world’s largest stock of USD and local currency denominated debt and, as a result, unprecedented levels of global demand. Now that cycle is in the process of coming undone, just as every cycle before it.
Required reading on this subject:
Two Schools of Thought Part II (6/8/12): We continue to view a sustained breakout in the USD as the most asymmetric and contrarian outcome facing global financial markets over the long-term TAIL.
Emerging Market Crises: Identifying, Contextualizing and Navigating Key Risks in the Next Cycle (4/23/13): We currently see a pervasive level of risk across the emerging market space at the country level and have quantified which countries are most vulnerable. As such, we find it prudent for investors to reduce their allocations to emerging market equity and currency risk in favor of US equity and US dollar exposure. #StrongDollar and commodity price deflation have been and should continue to be key catalysts for EM underperformance.
Are You Prepared for #Quad4? (8/5/14): Developing quant signals and fundamental data are supportive of investors adopting a defensive allocation w/ respect to the intermediate term.
1Q15 Macro Theme: #GlobalDeflation (1/8/15): Amidst a backdrop of secular stagnation across developed economies, we continue to think cyclical forces (namely #StrongDollar driven commodity price deflation) will drag down reported inflation readings globally over the intermediate term. That is likely to weigh heavily upon long-term interest rates in the developed world, underpinning our bullish outlook for U.S. Treasury bonds (TLT, EDV, ZROZ, etc.).·
Are You Prepared for a Deepening of the Global Earnings and Industrial Recessions? (10/22/15): Don’t be fooled by today’s price action in the DOW (which KM shorted into the close today). To the extent the ECB and BoJ incrementally ease monetary policy as our models suggests they will at some point over the next 2-3 months, the ongoing monetary policy divergence across G3 economies is likely continue perpetuating a severe tightening of credit conditions globally via a stronger U.S. dollar. Moreover, that is likely to perpetuate a deepening of the ongoing global earnings and industrial recessions.
4Q15 Macro Theme: #GameOfSlowing (10/8/15): With the Street, IMF, World Bank and OECD all still forecasting global growth of around 3% for 2015, we find it appropriate to reiterate our call for global growth to come in at or below half that rate. Moreover, while China's August CNY devaluation effectively made our #EmergingOutflows theme a consensus bearish cog in the global economic outlook, we do not think investors are appropriately positioned for a likely trend of negative revisions to the respective growth outlooks in the U.S., Eurozone and Japan throughout the balance of the year.
Moving along, the more we are right on our #EuropeSlowing view, our view that Abenomics will fail to achieve “5% Monetary Math”, or our view that the BoE is poised to shift dovish in conjunction with a rising probability of a U.K. recession, the more we will continue to be right on our structurally bullish bias on the U.S. dollar. Despite our bearish view on the U.S. economy, we believe the Yellen Fed is too far out in la-la-land with respect to its “dot plot” and GDP forecasts to implement QE4 quickly enough.
Moreover, the more we continue to be right on our structurally bullish bias on the U.S. dollar, the more we will continue to be right on our structurally bearish bias on inflation expectations and the respective growth rates of global capital expenditures, global leverage and EM consumer demand associated with said inflation expectations globally.
In short, the global economy might’ve recorded a few “green shoots” in OCT, but the TREND in global growth is decidedly lower with respect to the intermediate term.
We are hopeful that this late-night rundown of the "data" helps clarify any confusion our competitors may have caused. Yes, this is the same "data" some of them told you to "ignore" and failed to identify as slowing 6-9 months ago.
Keeping it real,
Takeaway: Please note we are removing Gold (GLD) from Investing Ideas
Jobs report Friday was eventful to say the least.
To sum things up, the expectation for a Fed rate hike was pulled forward which is why we are removing GLD. More deflation from a stronger USD with rates moving higher in the near-term (NOTE: A stronger USD vs. potential more cowbell from Draghi) is NOT good for gold.
Bottom line? More deflation and higher rates is not a recipe for a long gold position. Even if the Fed doesn’t hike in December, the deflation risk for the next month as the world re-positions up for a rate hike could continue pressuring gold prices.
It’s best to stay out of the way.
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In this excerpt from The Macro Show this morning, Hedgeye CEO Keith McCullough and Macro analyst Darius Dale break down the October jobs report and explain what it means for investors.
Subscribe to The Macro Show today for access to this and all other episodes.
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Takeaway: Good Domestic Data Perpetuates Global Deflation Risk. The Last Domino Is Still A Domino.
I contextualized a lot of the current labor market dynamics in this morning’s Early Look (HERE), I touch on the incremental below.
The payroll data for October was strong across the board: Headline NFP & Private Payroll gains, Hourly Earnings, Unemployment/Underemployment Rate (with healthy internals), Positive Sector Hiring Breadth, Employment mix were all better sequentially.
The Fundamental Read-Through | Here’s what the prevailing narrative will be in the wake of the October data:
At 5% Unemployment, the domestic labor market is now at or flirting with full employment and, with wage growth making a new cycle high at +2.5%, has finally reached some critical threshold whereby that tightness is beginning to manifest in higher earnings growth
Conventionally, wages are viewed as a lagging indicator, with wage inflationary pressure building as the labor supply declines and the economy moves towards constrained capacity.
The intuition is straightforward: ↓ Supply + ↑/Stable demand = ↑Prices …. as the labor market tightens (supply goes down) and job openings and hires remain solid (demand), the price of labor rises.
That line of thinking is commonsensical and the core of the slack debate has centered on the magnitude of the shift in labor supply-demand dynamics and whether policy should move ahead of or behind any emergent inflationary curve in service of their dual mandate.
The problem of the last 3 decades, however, has been that, by and large, there has been no inflation curve. The conventional output-inflation loop in which rising wage growth drives demand pull inflation which drives an acceleration in broader inflation has been almost non-existent over the last 3 cycles.
Even with the inflationary cocktail of peak demographics, peak productivity growth, peaking leverage, asset price bubbles and positive interest rate cycle dynamics coming in-phase in the late 90’s and mid-2000’s core PCE inflation failed to rise much above 2%.
The bearish/dovish re-joinder to the above is that on a Trending basis payroll growth is slowing, a growing list of lead indicators have moved past peak, the preponderance of domestic and global macro data has slowed in recent months, inflation is not an emergent threat, the Aug/Sept Employment figures were more reflective of the underlying reality and October was the outlier. Time will be the arbiter.
On Wage Growth: Wage growth for production and nonsupervisory employees (~80% of the labor force) was +2.3%, below the private sector average of +2.5% so the improvement was broad based but still disproportionately going to the top quintile.
Is a return to a halcyonic 4-4.5% level of nominal wage growth of prior cycles (see chart below) in the face of persistently lower inflation, an aging workforce, top heavy demographics, lower productivity and lower credit growth a reasonable expectation?
Probably not. Could we accelerate to +3.0%? … sure, I suppose, but know that you’re (maybe) playing for something like ~50 bps and wage growth peaks at the very tail end of the expansion.
Income & Consumption Read-through: Consensus growth expectations continue to rely almost singularly on consumption expenditures and income growth anchors the capacity for consumption growth. The acceleration in aggregate hours worked + acceleration in hourly earnings will = re-acceleration in aggregate income in Oct (reported 11/25).
The slope of household spending growth will hold modestly negative (off the 1Q15 peak) but will remain “good” on an absolute basis to start 4Q, particularly if the savings rates stays static at current levels.
The Market Read-Through: #DeflationRisk
The Dollar, Yields, and Fed Fund futures which had already been discounting the rhetorically hawkish FOMC commentary all appear to be pricing-in the final price-in of a December hike. And there's a month of data and another employment report to digest before that policy trigger pull.
A correction in equities alongside an attempt at policy normalization would not be surprising. After all, if QE = ↓ Yields = ↓ Discount Rate = ↑ Present values, the converse should hold in some measure as well.
Notably, if you look at the Shadow Fed Funds Rate – which attempts to translate unconventional policy initiatives into Fed Fund equivalents – we have been in a rising rate environment since April, 2014 and the effective Fed Funds rate has risen ~225 bps to -0.75% from -3%. From a rate of change perspective, the macro data has slowed concomitantly.
Strong $USD: A policy induced strong dollar only perpetuates global deflation risk. Global Inflation expectations are priced in dollars (as are the Trillions in $USD denominated EM debt) and further dollar strength will only exacerbate the OUS growth and inflation challenges faced by foreign central banks. The U.S. will continue to import that deflation on the back end and the industrial and earnings recessions we’ve witnessed the last two quarters domestically will persist.
Sustained domestic de-coupling is a sirenic concept but deflation's dominoes follow a winding path. The last domino is still a domino.
A visual tour of the Employment data is below.
Christian B. Drake
Why? Because the U.S. labor market is even later cycle than we thought.
With the advent of today’s gangbusters jobs report – specifically the sharp accelerations in the growth rates of nonfarm payrolls and wages (see: summary table below) – this U.S. economic expansion is now closer than ever to its termination.
Click on the following link to download the presentation (13 slides): http://docs3.hedgeye.com/macroria/Hedgeye_U.S._Economic_Cycle_Indicators.pdf
From an asset allocation perspective:
Deflation’s Dominoes are coming home to roost.
Have a great weekend,
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