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The End of the Beginning

“This is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.”

-Winston Churchill


The quote above is one of my favorite quotes from Churchill. After all, what exactly is the end? What is the beginning? Certainly for many of us, the start of the year signifies a beginning. In the investment management business, it really is a new beginning in that performance numbers are again set at zero and the race for outperformance begins anew.


We used this same Churchill quote in the conclusion of a recent video we put together on the history of Hedgeye. We showed that video to a new group of analysts that we are onboarding this week. We are officially announcing the combination on Tuesday next week, but suffice it to say we think the group we acquired will dramatically improve our research with their domain expertise in studying government policy. Stay tuned for the official announcement early next week.


There is no question that the next twelve months will be critical in Washington, DC. We will definitely have a new President, we will certainly have a slew of new legislators, and generally speaking the election outcomes at this point are still unknown. It seems likely that Hillary Clinton will get the Democratic nomination and, much to the chagrin of many, Donald Trump seems poised to capture the Republican nomination.


But even these nominations are far from done deals at this point, especially in the broader context of how unhappy Americans are with the government, which is obvious in a few areas:

  • President Obama’s approval ratings are dismal at around 44% and disapproval being above 50%;
  • In the most recent “Direction of the Country” poll, those believing the country is going in the wrong direction came in at 59%, versus those believing the country is going in the right direction at 27%; and...
  • Finally, the worst approval rating is Congressional job approval, with 73% disapproving and a mere 13% approving of the job Congress is doing.

Whoever is elected President is going to have the challenge of winning the country back and the objective is likely to come with a slew of legislative activity. So, as it relates to the governments impact on the economy and markets, we are likely only at the end of the beginning.


The End of the Beginning - Bull SCREAM 01.06.2015


Back to the Global Macro Grind …


This has been a busy week at Hedgeye and the month is only going to get busier as our Sector Heads ramp up their idea production. We have a couple of key events to highlight in the coming weeks, but most importantly this past week was our Q1 Macro Themes Conference call. The first theme, front and center, was US #Recession. We were the first to call out the likelihood of U.S. growth slowing more than expected and now we are #TimeStamped making the recession call.


In the Chart of the Day, we highlight ISM Manufacturing data, which contracted for the first back-to-back month since 2009. As the chart highlights going back to the 1980s, this type of contraction typically precedes or coincides with a recession. The same scenario could be said for a slew of data including industrial production, capital investment, durable goods, exports, and the list goes on. In fact, of the 34 key economic data points we track for the U.S., 24 have gotten worse sequentially.


All this is not to say that a recession is a forgone conclusion, but as our colleague and Senior Macro analyst Darius Dale wrote in response to a client question earlier this week:


“Per the preponderance of indicators we track, the U.S. economy has the highest probability of entering into recession somewhere around Q2/Q3 of this year. Recall that a technical recession requires two consecutive quarters of QoQ SAAR contraction, though the NBER’s actual dating of recessions is a bit more nuanced.


Our +1.5% estimate for 2016E is calculated as the average of the four quarterly YoY estimates; this is the same calculus the BEA uses to calculate annual growth rates. Given that distinction, you don’t have to have a full-year number be negative to experience an intra-year recession (or one that spans multiple calendar years). Recall that U.S. Real GDP grew +1.9% during CY1990 in spite of the July ’90 - March ’91 recession and +1% during CY2001 in spite of the March ’01 – November ’01 recession.


Beyond that, the +1.5% estimate doesn’t actually include an outright technical recession. Recall that we run a predictive tracking algorithm that feeds high and low-frequency data into the model to generate a probable forecast range for any given quarter in conjunction with the directional adjustment implied by the base effects. Obviously the C&I data has been recessionary, but given its outsized weight in the GDP calculus, we actually do need to observe further slowing of consumption data to open up the downside in the quarterly forecast ranges throughout 2016E.”


So from a timing perspective, we think Q2 going into Q3 is when growth likely slows the most, but it will require a slowdown in consumption to fully push the economy into a recession. One catalyst for this slowdown in consumption may be the housing market being worse than expected.


In that vein, our Housing team is introducing their view of the U.S. housing market on Wednesday January 13th and are shifting to a negative bias. The call is titled, Less Good is Bad, and they are making the call that key metrics for housing will likely slow in 2016. Housing, of course, has a very high correlation to consumption, so in the world of interconnected research, housing will be a critical determinant in how much the economy slows.


So, is a U.S. recession and housing slowdown the end? No, but it is also not likely the beginning of outsized equity returns.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.09-2.24%

RUT 1051-1090

VIX 18.74-27.49
USD 97.44-100.12
Oil (WTI) 32.28-36.26


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


The End of the Beginning - CoD 01.08.16  

Don't Blame China

Client Talking Points


Thinking like consensus does is the biggest risk, but they will stare at the absolute number this morning instead of the rate-of-change; don’t forget that the U.S. employment cycle peak was a NFP growth rate of 2.3% in Q1 of 2015 – it’s also the latest of late cycle indicators (put another way, there’s nothing this number can be to change our bearish TREND view).



We remain bullish on this breakout in volatility (new range = 18-26) – if all the Chinese could do having the government buy stocks overnight is get a +0.6% bounce in Hong Kong, London, and Germany, that’s not what stock market bulls need here. We believe the bulls are sellers on rallies for the 1st time – hedge funds have to get a lot shorter too; performance out there is bad.

S&P 500

The U.S. stock market has never NOT crashed (20% or more decline from peak – that would get you 1704 SPX from the 2130 #bubble high) when corporate profits go negative for 2 consecutive quarters – we’ll have that in earnings season that starts next week – JPM’s earnings are way more important to me than this jobs report.


*Tune into The Macro Show at 9:00AM ET - CLICK HERE

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

With the Fed's 25 basis point hike in interest rates, in the financial sector, FII stands to benefit most from even this marginal change.


In essence, Federated Investors (FII) has a stable business for what we think will be a volatile 2016. 2015 finished with slight positive inflows into the firm's main business line, money market or cash products. This is reminiscent of the start of cash builds in 1999 and 2006 ahead of the negative returns in risk assets in 2000 and 2007.


RH is our top long idea in all of retail, and we view the recent weakness in the stock as a buying opportunity. All in we think the company will build to $5bn in sales at mid-teens operating margin which equates to $11 in earnings power. This growth and profitability comes from...

  •  ~30% Square footage growth with new full line design galleries.
  • New businesses, like Modern and Teen, that can be easily layered over its low cost infrastructure.
  • Leveraging occupancy from the "sweet heart" real estate deals the company is getting as a high end traffic driving 

The yield spread (10Y’s -2Y’s) compressed to a 52-week low of 120 basis points last week.  AGAIN, that’s a 52-week low in growth expectations right after “lift-off”. Into year-end, the bond market continues to price in what it has all year long: #Slower-and-lower-for-longer.


We continue to believe deflation will pressure the policy-fueled leverage embedded in junk and high yield bond markets. The cheap money, corporate credit boom inflated asset prices and it has more room to deflate. This deflationary run started in the second half of 2014, with the introduction of our #Deflation theme. Back then, was also the low in cross-asset volatility and the high in outstanding corporate credit (commodity producers chasing inflation expectations were the largest contributor).

Three for the Road


LIVE Healthcare Q&A Friday @ 11AM - A Special Jobs Report Edition & Best Ideas Recap https://app.hedgeye.com/insights/48445-live-healthcare-q-a-friday-11am-a-special-jobs-report-edition-be… via @hedgeye



Keep steadily before you the fact that all true success depends at last upon yourself.

Theodore T. Hunger


Star Wars: The Force Awakens is now the highest-grossing film ever in North America, pulling in $758.2 million and beating out Avatar.

The Macro Show Replay | January 8, 2015


WisdomTree (WETF) - More Questions Than Answers - We Remain Short

Takeaway: WETF announced a suite of dynamically hedged international products. Our research shows the FX hedge provides the bulk of returns however.

WisdomTree announced a suite of dynamically hedged ETFs yesterday. In concert with its main currency hedged Japanese fund the DXJ, and the Euro-zone ex. Euro ETF, the HEDJ, the firm has launched 4 new products. The firm is now adjusting an "always on" FX hedge (on the HEDJ and DXJ) to a rules based approach that will dynamically apply and remove the FX hedge depending on market conditions. These latest products have been launched on European equities, Japanese equities, small cap foreign equities, and a broader international equity fund (see WETF info HERE). The latest information on the firm's website outlines the following new rules based approach for the new "dynamic" FX hedge:


WisdomTree (WETF) - More Questions Than Answers - We Remain Short - chart 1

WisdomTree (WETF) - More Questions Than Answers - We Remain Short - chart 2


While dynamically hedged products allay some of our concerns that historically, local currency exposure has been beneficial for foreign investors (and thus the FX hedge nullifies important returns), we remind investors that the HEDJ and DXJ underperform in local currency outside of the FX hedge because of a beta construction issue. Both DXJ and HEDJ construction is weighted by dividend paying stocks, with also favorable weightings for export driven companies. This benchmark construction thus far has proven to underperform standardized benchmarks in local currency.


The main issue with the new dynamically hedged products is that the WisdomTree products underperform in local currency outside of the FX hedge (in both Japan and Europe).


WisdomTree (WETF) - More Questions Than Answers - We Remain Short - chart7

WisdomTree (WETF) - More Questions Than Answers - We Remain Short - chart8


Thus it's a double edged sword with the WisdomTree's hedged FX products as the FX hedge has been the source of most of the ETF's returns recently for both the DXJ and the HEDJ:


WisdomTree (WETF) - More Questions Than Answers - We Remain Short - chart3

WisdomTree (WETF) - More Questions Than Answers - We Remain Short - chart4


But there are plenty of historical references that foreign investors would have benefited from having local currency exposure (see first grayed boxes versus the second grayed periods). 


WisdomTree (WETF) - More Questions Than Answers - We Remain Short - chart5

WisdomTree (WETF) - More Questions Than Answers - We Remain Short - chart6


The last question on the new dynamically hedged products is will overall fund returns suffer when the hedge comes off. Currently the hedge ADDS credits or returns to fund holders out of the gate as overnight interest rate differentials and liquidity pay the manager to undergo the FX hedge:


WisdomTree (WETF) - More Questions Than Answers - We Remain Short - chart12

WisdomTree (WETF) - More Questions Than Answers - We Remain Short - chart11


Dynamically hedged ETFs could be signaling our view that the U.S. dollar move higher has already experienced the bulk of its move. Our main basis for this stance is that the dollar has already made a 3 standard deviation move over a 10 year period and is also bumping up against its historical 20% year-over-year rate of change ceiling.


WisdomTree (WETF) - More Questions Than Answers - We Remain Short - chart13

WisdomTree (WETF) - More Questions Than Answers - We Remain Short - chart14


WisdomTree trends are inflecting negatively with the firm just having put up its worst quarter from an asset raising standpoint in 4Q15 with a $2.6 billion redemption (and an unprecedented second consecutive quarter of outflows in the firm's now 9 year history). Prior to 3Q and 4Q '15, the firm only had redemptions in 3Q 2008 and 1Q 2014. Trends accelerated to the downside to finish 4Q15 to boot with the HEDJ and DXJ losing $3 billion and $2 billion respectively in the last 10 business days of 2015.


WisdomTree (WETF) - More Questions Than Answers - We Remain Short - chart9



We think 2017 estimates (the best way to value this growth stock) are implying an unacheivable ramp in the firm's AUM to over $80 billion from the current tally of ~$50 billion. This assumption supports the Street's estimate of $0.97 per share. Our estimate of $0.79 per share is supported by a slower ramp to just over $70 billion.


WisdomTree shares continue to trade ahead of median takeout multiples implying further downside. We think shares start to look attractive at $10 pending no substantial degradation of recent trends. We hosted our best ideas Short call on December 17th with the stock at $17.30.


WisdomTree (WETF) - More Questions Than Answers - We Remain Short - chart10


WisdomTree Best Ideas Short - Not So Smart Beta

Video Replay of Best Ideas


Please let us know of any questions,


Jonathan Casteleyn, CFA, CMT 




Joshua Steiner, CFA


MUST SEE | Healthcare Q&A - A Special Jobs Report Edition & Best Ideas Recap

did you miss it?

Watch the replay below.



Healthcare analysts Tom Tobin and Andrew Freedman were in the Hedgeye studio today discussing the key takeaways from the latest U.S. jobs report and implications for their current top ideas.


The team also highlighted what's new on their radar.


Cartoon of the Day: Knot Good

Cartoon of the Day: Knot Good - China cartoon 01.07.2016


The People's Bank of China devalued the yuan another 0.5% overnight. The Shanghai and Shenzhen Composite indices closed down -7% and -8.3% respectively and Chinese regulators announced that significant shareholders were not allowed to sell stock equivalent to more than 1% of a company's shares outstanding.


Not good. We reiterate our bearish bias on the Chinese economy, its capital and currency markets.

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