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CHART OF THE DAY: When Will Deflation Bottom?

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye Macro analyst Ben Ryan. Click here to subscribe.

 

"... Even the firm with the non-consensus 18-month deflation view, wrestles with the location of a bottom. The truth is that in addition to quantitative behavioral factors that have been good indicators, the fundamental supply-demand picture will probably play a role. A supply-side backstop is proving to be an elusive, slippery floor in commodity-intensive cyclicals because the floor itself deflates with deflation (chart of the day at the bottom):

  • PPI Industrial Chemicals peaked on a Y/Y NSA rate of change basis in September 2014 and has been negative since September 2013
  • PPI Iron and Steel peaked on a Y/Y NSA rate of change basis in October 2014
  • PPI Commodities Construction & Machinery has been declining on a Y/Y NSA rate of change basis since June 2014, and it’s been tracking negative since October 2013
  • PPI Mfg. tires has been tracking negative on that same Y/Y NSA % change basis since October 2012" 

 

CHART OF THE DAY: When Will Deflation Bottom? - El Chart 12.10.15

 

 


Slippery Floors at the Bottom of Slippery Slopes

“It’s hard to get a man to understand something when his salary depends on his not understanding it.”

-Upton Sinclair

 

Lucky for the Hedgeye crew, our advancement as a new age financial research and media firm depends on our “understanding it.” That’s a promising model for me. I’m not a dramatic storyteller.  

 

Unlike when we originally introduced our deflation theme ~18 months ago, a much larger camp has come around to our house view. The pushback really isn’t that surprising when you step back and think about the number of people who are paid by inflation.    

 

Informational advantage is continuously becoming harder and harder to monetize. There are few industries where this advantage has been more lucrative in the past than financial services. Everyone now has the technology and systems to absorb and contextualize information and its implications. New information is now immediately new knowledge within seconds. This game is harder than ever.

 

So with all of the technology to absorb, contextualize, and execute on information why was $71 WTI in the fall of 2014 a marginal cost floor and a price for an OPEC cut (a consensus “buy”) that took WTI down 10% after the day a “no cut” happened, but with $41 in front of WTI, net futures and options positioning is shortest since we introduced our deflation theme, no cut from OPEC was consensus, and WTI is a falling knife?

 

To borrow the three stages of a market cycle from Howard Marks (this is a bull market description, but the psychological pendulum swings both ways):

  1. A few forward looking people begin to believe things will get better
  2. Most investors realize improvement is underway
  3. Everyone’s sure things will get better forever   

If you flip this cycle around (the pendulum), we’re somewhere between 2) investors coming around to the fact that deterioration is underway; and 3) "blood in the streets."

 

Technological advancement plotted against time may look like an exponential function, but human nature looks just about the same. Investor psychology is a slippery slope and “value” is a slippery floor.

 

Slippery Floors at the Bottom of Slippery Slopes - Oil cartoon 12.08.2015

 

Back to the Global Macro Grind…

          

The question we continue to debate with clients is whether or not the carnage in cyclical sectors is over (Energy (XLE -21% YTD), Materials (XLB -6% YTD), and Industrials (XLI -6% YTD) lead S&P 500 sectors to the downside in 2015 after relative weakness in 2014). You can call XLE a definitive crash.  

 

Put another way, can cyclicals go much lower even though we haven’t entered a technical recession? Absolutely, if the cycle cycles. We still think a recession commencing by mid-2016 is becoming increasingly probable.

 

We wrote a note last week on the "Unlikeliness of an OPEC Cut." We were right on the no cut, but admittedly, some of the behavioral expectations we outlined that have suggested crude could trade higher have not manifest over the last several trading days: contract positioning, volatility skew, volatility expectations, and a crowded rate hike trade. The Fed meeting next week is undoubtedly a catalyst.

 

Even the firm with the non-consensus 18-month deflation view, wrestles with the location of a bottom. The truth is that in addition to quantitative behavioral factors that have been good indicators, the fundamental supply-demand picture will probably play a role. A supply-side backstop is proving to be an elusive, slippery floor in commodity-intensive cyclicals because the floor itself deflates with deflation (chart of the day at the bottom):

  • PPI Industrial Chemicals peaked on a Y/Y NSA rate of change basis in September 2014 and has been negative since September 2013
  • PPI Iron and Steel peaked on a Y/Y NSA rate of change basis in October 2014
  • PPI Commodities Construction & Machinery has been declining on a Y/Y NSA rate of change basis since June 2014, and it’s been tracking negative since October 2013
  • PPI Mfg. tires has been tracking negative on that same Y/Y NSA % change basis since October 2012

Slippery Floors at the Bottom of Slippery Slopes - El Chart 12.10.15

 

Cost input inflation peaked right around the time the Fed-fueled capital spending boom peaked. The number of projects with attractive hurdle rates multiplies in a bull market. Commodity producer debt (large miners, oil majors, oil and gas equipment services, and coal miners) has skyrocketed:

  • 2005: $200Bn
  • 2010: $550Bn
  • 2014: $1.1 Trillion with a “T”

And taking an example from the gold miners, Net PP&E per Oz. of production is near pinned at the highs:

 

2003: 0.5 (ratio)

2010: 2.5

2015: 3.2

 

Policy fueled inflation expectations helped propel a surplus of mediocre investment decisions at the highs in commodity prices, and once the capital spending wheel is turning, producers will produce.

 

It’s not just hedges, long-term contracts, and private capital that prolong a bottom. It’s the technological advancement of operational efficiency and deflation on the cost side. The relationship between gold prices and Newmont Mining’s cash cost since 1985 has an r-squared correlation of 0.95.  

  

The slippery slope of deflation's feedback loop could stay slippery for a little longer. And don’t forget that the cycle cycles.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.13-2.31%

SPX 2039-2075

VIX 16.32-20.58
EUR/USD 1.05-1.09
Oil (WTI) 36.08-39.91

 

Good luck out there today,

 

Ben Ryan

Analyst 


ICI Fund Flow Survey | 40 Weeks and Counting

Takeaway: The domestic equity outflow streak has maintained the fastest pace on record and is now the third longest running.

Investment Company Institute Mutual Fund Data and ETF Money Flow:

In the 5-day period ending December 2nd, investors withdrew another -$8.0 billion from domestic equity mutual funds, bringing the year-to-date total outflow to -$155.0 billion. Additionally, the table below shows that the current streak of redemptions is running at -$3.9 billion per week, the fastest pace on record which has now aggregated to -$157.8 billion in total drawdown, the second largest in history (we define a streak as being intact unless broken by 4 consecutive weeks of subscriptions). Meanwhile, equity ETFs continue to mop up flows with +$6.6 billion in subscriptions in the most recent 5 days as investors favor passive exposure. We continue to recommend a short position in shares of T. Rowe Price as a way to express this ongoing shift out of active products (see our TROW reports).

 

In other asset classes, total fixed income flows (including mutual funds and ETFs) were moderately weak at -$206 million following Fed Chair Yellen's hawkish testimony. Additionally, investors displayed some risk aversion by shoring up +$18 billion in money market funds last week.

 

ICI Fund Flow Survey | 40 Weeks and Counting - ICI19

 

 

In the most recent 5-day period ending December 2nd, total equity mutual funds put up net outflows of -$8.9 billion, trailing the year-to-date weekly average outflow of -$1.0 billion and the 2014 average inflow of +$620 million. The outflow was composed of international stock fund withdrawals of -$890 million and domestic stock fund withdrawals of -$8.0 billion. International equity funds have had positive flows in 42 of the last 52 weeks while domestic equity funds have had only 8 weeks of positive flows over the same time period.

 

Fixed income mutual funds put up net outflows of -$1.0 billion, trailing the year-to-date weekly average inflow of +$75 million and the 2014 average inflow of +$926 million. The outflow was composed of tax-free or municipal bond funds contributions of +$918 million and taxable bond funds withdrawals of -$2.0 billion.

 

Equity ETFs had net subscriptions of +$6.6 billion, outpacing the year-to-date weekly average inflow of +$2.4 billion and the 2014 average inflow of +$3.2 billion. Fixed income ETFs had net inflows of +$829 million, trailing the year-to-date weekly average inflow of +$1.1 billion and the 2014 average inflow of +$1.0 billion.

 

ICI Fund Flow Survey | 40 Weeks and Counting - ICI1

 

Mutual fund flow data is collected weekly from the Investment Company Institute (ICI) and represents a survey of 95% of the investment management industry's mutual fund assets. Mutual fund data largely reflects the actions of retail investors. Exchange traded fund (ETF) information is extracted from Bloomberg and is matched to the same weekly reporting schedule as the ICI mutual fund data. According to industry leader Blackrock (BLK), U.S. ETF participation is 60% institutional investors and 40% retail investors.



Most Recent 12 Week Flow in Millions by Mutual Fund Product: Chart data is the most recent 12 weeks from the ICI mutual fund survey and includes the weekly average for 2014 and the weekly year-to-date average for 2015:

 

ICI Fund Flow Survey | 40 Weeks and Counting - ICI2

 

ICI Fund Flow Survey | 40 Weeks and Counting - ICI3

 

ICI Fund Flow Survey | 40 Weeks and Counting - ICI4

 

ICI Fund Flow Survey | 40 Weeks and Counting - ICI5

 

ICI Fund Flow Survey | 40 Weeks and Counting - ICI6



Cumulative Annual Flow in Millions by Mutual Fund Product: Chart data is the cumulative fund flow from the ICI mutual fund survey for each year starting with 2008.

 

ICI Fund Flow Survey | 40 Weeks and Counting - ICI12

 

ICI Fund Flow Survey | 40 Weeks and Counting - ICI13

 

ICI Fund Flow Survey | 40 Weeks and Counting - ICI14

 

ICI Fund Flow Survey | 40 Weeks and Counting - ICI15

 

ICI Fund Flow Survey | 40 Weeks and Counting - ICI16



Most Recent 12 Week Flow within Equity and Fixed Income Exchange Traded Funds: Chart data is the most recent 12 weeks from Bloomberg's ETF database (matched to the Wednesday to Wednesday reporting format of the ICI), the weekly average for 2014, and the weekly year-to-date average for 2015. In the third table are the results of the weekly flows into and out of the major market and sector SPDRs:

 

ICI Fund Flow Survey | 40 Weeks and Counting - ICI7

 

ICI Fund Flow Survey | 40 Weeks and Counting - ICI8



Sector and Asset Class Weekly ETF and Year-to-Date Results: In sector SPDR callouts, investors withdrew -$367 million or -6% from the long treasury TLT ETF following Fed Chairwoman Yellen's testimony that signaled a high probability of a rate hike later this month.

 

ICI Fund Flow Survey | 40 Weeks and Counting - ICI9



Cumulative Annual Flow in Millions within Equity and Fixed Income Exchange Traded Funds: Chart data is the cumulative fund flow from Bloomberg's ETF database for each year starting with 2013.

 

ICI Fund Flow Survey | 40 Weeks and Counting - ICI17

 

ICI Fund Flow Survey | 40 Weeks and Counting - ICI18



Net Results:

The net of total equity mutual fund and ETF flows against total bond mutual fund and ETF flows totaled a negative -$2.0 billion spread for the week (-$2.2 billion of total equity outflow net of the -$206 million outflow from fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52-week moving average is +$857 million (more positive money flow to equities) with a 52-week high of +$27.9 billion (more positive money flow to equities) and a 52-week low of -$19.0 billion (negative numbers imply more positive money flow to bonds for the week.)

  

ICI Fund Flow Survey | 40 Weeks and Counting - ICI10

 


Exposures:
The weekly data herein is important for the public asset managers with trends in mutual funds and ETFs impacting the companies with the following estimated revenue impact:

 

ICI Fund Flow Survey | 40 Weeks and Counting - ICI11 



Jonathan Casteleyn, CFA, CMT 

 

 

 

Joshua Steiner, CFA







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The Macro Show Replay | December 10, 2015

 


December 10, 2015

Hedgeye's Daily Trading Ranges are twenty immediate-term (TRADE) buy and sell levels, with our intermediate-term (TREND) view and the previous day's closing price for each name.  Click HERE for a video from Hedgeye CEO Keith McCullough on how to use these risk ranges.

 

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INDEX BUY TRADE SELL TRADE PREV. CLOSE
UST10Y
10-Year U.S. Treasury Yield
2.31 2.13 2.22
SPX
S&P 500
2,039 2,075 2,047
RUT
Russell 2000
1,138 1,173 1,145
COMPQ
NASDAQ Composite
4,987 5,103 5,022
NIKK
Nikkei 225 Index
19,221 19,840 19,301
DAX
German DAX Composite
10,402 10,876 10,554
VIX
Volatility Index
16.32 20.58 19.61
DXY
U.S. Dollar Index
96.67 99.31 97.33
EURUSD
Euro
1.05 1.09 1.08
USDJPY
Japanese Yen
121.23 122.55 121.40
WTIC
Light Crude Oil Spot Price
36.08 39.91 37.21
NATGAS
Natural Gas Spot Price
2.01 2.17 2.07
GOLD
Gold Spot Price
1,046 1,089 1,072
COPPER
Copper Spot Price
1.99 2.10 2.06
AAPL
Apple Inc.
113 119 115
AMZN
Amazon.com Inc.
653 681 664
PCLN
Priceline.com Inc.
1,231 1,318 1,294
COST
Costco Wholesale Corp.
156 164 159
NFLX
Netflix, Inc.
119 130 124
KMI
Kinder Morgan Inc.
13.23 19.50 16.81

 

 


FLASHBACK: Hedgeye Energy Analyst Kevin Kaiser Lays Out Short $KMI Thesis (9/11/13)

Here's a video from deep in the Hedgeye vault (check out the old studio). Energy analyst Kevin Kaiser first lays out his short thesis on Kinder Morgan (KMI) with Managing Director Todd Jordan. While Kaiser's short KMI call was clearly a success, we think his hair was the real winner that day. Seriously, check out that flow.


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