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Powerball Believers

“A leader must be a true believer in the mission.”

-Jocko Willink


I didn’t win Powerball last night, so I’m back at it, peddling non-fiction to Obama’s “folks” at the Fed this morning.


In all seriousness, like many of you, Laura and I had a Powerball discussion with our kids at the dinner table last night. Laura told them that “if we won”, we’d keep it anonymous and donate a large part of it to charity. The kids liked that.


Yes, I know. A certain type on the Old Wall is all about the money. And a mother’s moral lessons to her children can sound idealistic. But the reality is that a lucky ticket wouldn’t have changed the mission we’re on this morning. As parents, we’re already winning.


Back to the Global Macro Grind


As a parent, coach, or professional (or anyone in any position of leadership) our goal should always be to be on a mission – one that we can feel in our bones – one that we truly believe in. As Navy SEAL Jocko Willink went on to write in Extreme Ownership:


“Leaders must always operate with the understanding that they are part of something greater than themselves and their own personal interests. They must impart this understanding to their teams.” (pg 76)


I realize I am as flawed and fragile as any other human being. Without the blessing of good health, everything I’ve ever “wanted” can be disrupted. That’s why, every day, I re-commit to being part of something that’s a lot bigger than I’ll ever be.


Back to the belief system of a Powerballer…


Powerball Believers - Bubble bear cartoon 09.26.2014  1


A lot of people played who have never played. Why? If you’re not in it, you can’t win it. But it was also a cultural craze that transcends the bubble in “wealth.” From “internet stocks” to housing, we’ve had plenty of bubbles pop in the last two decades. This one will too.


Some people play Powerball because they want a short-cut. They’ll gamble their kids meal money away for the hope of a better life. I don’t judge that. People have wants and needs. But we also have a culture that is fixated on cheap leverage.


“Cheap” leverage has a ton of downside if the principal investment goes to zero. When I think about all the mistakes I could have made in the last 6 months, the biggest one would have been getting sucked into “missing the move” in a lottery stock.


Fortunately, saying no to gambling, drugs, and leverage is a choice. Together, many of us made that choice.


To review the biggest catalyst for a US stock market crash:


  1. The perception that “0% rates” = 0% risk is a centrally planned fraud
  2. Real risk is measured in terms of both volatility and credit spreads
  3. As #Deflation becomes pervasive instead of “transitory”, both volatility and credit spreads breakout


As you can see in the Chart of The Day, the volatility of levered investments is starting to move up and into the right of this 3-factor SPREAD RISK chart:


  1. High Yield Spread (over 10yr Treasury) = y-axis
  2. Bond Market Volatility (MOVE Index) = x-axis
  3. Total Corporate Credit Outstanding = Bubble Size


History shows that once High Yield Spreads have widened meaningfully off the cycle-lows (as they have for the last 7 months), they do not tighten again in the same economic cycle.


Moreover, we’ve never seen a Credit Cycle with this much debt outstanding. This is the biggest corporate credit bubble in human history and leverage, as we all very well know, can amplify returns in both directions.


So, if you’re looking for reasons why the German stock market (DAX) and Russell 2000 (IWM) are in crash mode (down -21-22% from their cycle peaks in April-July of 2015), the combination of:


A)     LEVERAGE (most equity hedge funds run 150-250% gross invested to lever up low nominal returns)

B)      LIQUIDITY (lots of hedgies own the same small-mid cap stocks; when they go down fast, they can’t get out)


I’ve never been a fan of levered-long strategies – especially at economic cycle peaks. Personally, I don’t believe in levering myself up with assets I can’t afford either. But that’s just me – the guy who spent $5 on Powerball, just for fun.


It’ll be fun putting those tickets in the garbage this morning. My mission is not to have you chase charts, buy high, and hope that stocks never go down. Like bonds, they go up and they go down. I’m a big believer in a risk management process that goes both ways.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.04-2.18%


VIX 21.19-29.21
Oil (WTI) 28.61-33.52


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Powerball Believers - pg 43 macro deck HY spreads

DAX, Russell 2000 and Yield Spread

Client Talking Points


Right back into crash mode goes the over-owned “this time is different” in Europe theme. The DAX is down -2% this morning and down -21.1% since the April 2015 top. ECB President Mario Draghi is going to have to defend this with Down Euro = Up Dollar = #Deflation.


Isn’t it ironic, but not surprising, that the “U.S. is the best house in a bad hood” thesis has crashed too? The Russell 2000 is now down -22% (crash mode) from its July 2015 #Bubble high as U.S. domestic growth expectations move toward a #Recession.


At 116 basis points the yield spread (10yr – 2yr) is both at a year-to-date low and cycle low. This always happens as the cycle is slowing toward recession and don’t forget you’ll get Industrial Production and PPI recession prints in the U.S. tomorrow morning. 


*Tune into The Macro Show with Hedgeye CEO Keith McCullough live in the studio at 9:00AM ET - CLICK HERE

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

McDonald's boasts style factors that are best in class for turbulent times in the market, big cap and low beta and it has handily been outperforming the market and its competitors as of late. One of the biggest aspects of competing in their space is value offering.


McDonald’s has ceded share in the value category primarily to Burger King over the last two years. Now that they are launching a national value platform with a full slate of media support, MCD will recover the value customer.


General Mills' business seems to be starting to pick up steam, as the company is working to improve merchandising and advertising on core business.


In addition they have executed a few small, but meaningful M&A deals showcasing the change in managements thinking. The divestiture of Green Giant to B&G Foods, for instance, although a profitable business, was a good move for them given their lack of focus/investment in the brand (they have more opportunities like this throughout their portfolio, in addition to SKU rationalization).


GIS continues to look for more sizeable acquisitions in emerging markets, but the string of pearls approach may remain most effective domestically.


After the worst start to a year literally EVER for U.S. equity markets, TLT caught a bid in the first week of trading as the centrally-planned Chinese stock markets traded limit down earlier in the week. It was the largest central bank liquidity injection from Beijing since Chinese markets crashed in September.


TLT remains one of our strongest long idea calls heading into 2016 as junk bond markets begin to crack.   

Three for the Road


Wait for it... Fed officials have recently cautioned that headwinds from China may upend the FOMC's planned interest rate hike path.



Success is more a function of consistent common sense than it is of genius.

An Wang


On Tuesday, crude oil briefly dropped below $30 per barrel for the first time in 12 years.

ICI Fund Flow Survey | Gentlemen Prefer Bonds

Takeaway: Last week, investors sought safety in bonds, contributing a net $12.9 billion more to fixed income than equities

Investment Company Institute Mutual Fund Data and ETF Money Flow:

In the first week of 2016, investors reacted to the market turmoil by favoring bonds over stocks as measured by the -$12.9 billion spread between total equity flows and total bond flows (incorporating both mutual funds and ETFs). Positive numbers imply greater money flow to stocks with negative numbers imply greater money flow to bonds. With volatility on the rise in early 2016, we expect the aversion to stocks to continue.


Importantly, active domestic equity funds continued their losing streak, which we define as a string of outflows unbroken by four consecutive weeks of inflows. The following chart shows that domestic equity has been in outflow for 45 consecutive weeks with the current streak running at the fastest pace on record with a redemption average of -$4.0 billion per week. With the domestic equity exodus showing no sign of stopping, we continue to recommend a short position in shares of T. Rowe Price (see our TROW reports).

ICI Fund Flow Survey | Gentlemen Prefer Bonds - ICI19


In the most recent 5-day period ending January 6th, total equity mutual funds put up net outflows of -$2.4 billion, trailing the 2015 average outflow of -$1.5 billion. The outflow was composed of international stock fund contributions of +$1.6 billion and domestic stock fund withdrawals of -$4.0 billion. International equity funds have had positive flows in 41 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 inflows of +$67 million, outpacing the 2015 average outflow of -$462 million. The inflow was composed of tax-free or municipal bond funds contributions of +$1.4 billion and taxable bond funds withdrawals of -$1.3 billion.


Equity ETFs had net redemptions of -$9.1 billion, trailing the 2015 average inflow of +$2.8 billion. Fixed income ETFs had net inflows of +$1.3 billion, surpassing the 2015 average inflow of +$1.0 billion.


ICI Fund Flow Survey | Gentlemen Prefer Bonds - 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 2015 and the weekly year-to-date average for 2016:


ICI Fund Flow Survey | Gentlemen Prefer Bonds - ICI2


ICI Fund Flow Survey | Gentlemen Prefer Bonds - ICI3


ICI Fund Flow Survey | Gentlemen Prefer Bonds - ICI4


ICI Fund Flow Survey | Gentlemen Prefer Bonds - ICI5


ICI Fund Flow Survey | Gentlemen Prefer Bonds - 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 | Gentlemen Prefer Bonds - ICI12


ICI Fund Flow Survey | Gentlemen Prefer Bonds - ICI13


ICI Fund Flow Survey | Gentlemen Prefer Bonds - ICI14


ICI Fund Flow Survey | Gentlemen Prefer Bonds - ICI15


ICI Fund Flow Survey | Gentlemen Prefer Bonds - 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 2015, and the weekly year-to-date average for 2016. 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 | Gentlemen Prefer Bonds - ICI7


ICI Fund Flow Survey | Gentlemen Prefer Bonds - ICI8


Sector and Asset Class Weekly ETF and Year-to-Date Results: In sector SPDR callouts, investors shunned technology stocks, redeeming -$506 million or -4% from the technology XLK ETF.


ICI Fund Flow Survey | Gentlemen Prefer Bonds - 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 | Gentlemen Prefer Bonds - ICI17


ICI Fund Flow Survey | Gentlemen Prefer Bonds - ICI18


Net Results:

The net of total equity mutual fund and ETF flows against total bond mutual fund and ETF flows totaled a negative -$12.9 billion spread for the week (-$11.5 billion of total equity outflow net of the +$1.4 billion inflow to fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52-week moving average is +$691 million (more positive money flow to equities) with a 52-week high of +$20.5 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 | Gentlemen Prefer Bonds - ICI10


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 | Gentlemen Prefer Bonds - ICI11 


Jonathan Casteleyn, CFA, CMT 




Joshua Steiner, CFA


Early Look

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Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

REPLAY | Healthcare Updates You Can’t Afford To Miss Plus Interactive Q&A

New format - more details!  


Our All-Star Healthcare team was back in the studio today with a new and improved segment for you.



In this replay, Healthcare Analysts Tom Tobin and Andrew Freedman review the current names in their position monitor which includes their best ideas on the LONG and SHORT side as well as ideas on the bench. 


The team hosted an interactive Q&A session after reviewing the following:

  • MD Maternity Tracker: looks weak
  • JPM Healthcare Conference: key takeaways from companies in attendance 
  • JOLTS Model: strong for November and points to a solid Q415 earnings season
  • Allscripts Healthcare Solutions Inc (MDRX): best idea short, will discuss recent preannouncement 
  • AMN Healthcare Services (AHS): update to our thesis, calling for a slight beat for 4Q15, but are looking for weak guidance for 1Q16
  • Hospital Corporation of America (HCA): preannounced positive at the EBITDA line, but we have concerns about 2016 growth
  • Zimmer Biomet (ZMH): made some positive comments, but our outlook for 2016 and beyond remains bearish

Inverse Myopia: Checking In With Asia and Latin America

***While it’s easy to get myopic about domestic trends heading into earnings season with the VIX > 20, that doesn’t mean the rest of the world suddenly ceases to exist. International growth, inflation and policy developments have been and will continue to have an outsized impact on asset class returns broadly. As such, we thought the following country-level summaries of recent noteworthy economic developments would be helpful to quickly contextualize such risks. Please email us to the extent you’d like to dig into a specific economy further or if you’d like to see a similar write-up on an economy not mentioned below due to a lack of material incremental news flow or data releases.***




In China, while accelerating export, import and trade balance growth juxtaposed sharply with decelerating auto sales growth in December, it coincided with a sharp acceleration in the growth rate of Chinese exports to Hong Kong (evidence of fake invoicing). Also in December, headline inflation ticked up sequentially, while PPI remained at its deflationary lows. All of this is contributing to what we’ve previously identified as a nascent and tepid trend of economic stabilization in China. We describe it as such because our work would suggest that said stabilization is not at all sustainable on a multi-quarter basis. Elsewhere in China, SAFE continues enacting various measures to limit yuan outflows and reduce offshore yuan positions and liquidity. As we’ve previously stated, the CNY needs to depreciate by as much as 10-15% vs. the USD, but any such devaluation will come at a measured pace. Beijing has no interest in AFC-style rapid devaluations and will continue to use their wide arsenal of tools – including coercion and capital controls – to achieve this objective, which effectively implies the bearish CNY overhang is here to stay. All told, we reiterate our bearish bias on Chinese capital markets and the yuan.


Inverse Myopia: Checking In With Asia and Latin America - China Econ Summary

In Japan, minutes from the BoJ’s December 17-18th meeting confirm more of the same with respect to guidance on Japanese monetary policy: QQE expansion is unlikely to be a near-term event due to the board’s sanguine guidance on Japanese growth and inflation. While the December economy watcher’s survey and consumer confidence index readings were supportive of their bullish outlook, on the margin, trends across the preponderance of Japan’s high-frequency growth indicators continue to paint a decidedly mixed picture. Moreover, core CPI remains well shy of their official +2% target and long-term breakeven rates continue to collapse to new Abenomics-cycle lows. Given these dynamics, we continue to think QQE expansion is an inevitability due to a variety of reasons. That said, however, a delay should perpetuate additional covering of consensus yen shorts, which bodes poorly for the Japanese equity market at large. As such, we reiterate our neutral bias on Japanese capital markets and the yen for the time being. For more details, please refer to our 1/6 note titled, “The #CurrencyWar Is a War On Your PnL; Engage Appropriately”.


Inverse Myopia: Checking In With Asia and Latin America - Japan Econ Summary

In India, the advent of decelerating industrial production growth in November coincided with the release of accelerating CPI data for the month of December – the both of which are confirmatory of our #Quad3 outlook for the Indian economy. Indian financial markets are responding appropriately: short rates and the INR are pricing in a dovish RBI, while stocks and long rates are falling victim to capital outflow pressures. While the latter signals are justified, we do not think the RBI has much, if any, scope to ease monetary policy – which is likely why you’re seeing Modi enact what little policies he can implement on the fiscal policy front (see: crop insurance program) in the face of political gridlock that has stalled more meaningful economic reforms such as the long-awaited GST. All told, we reiterate our bearish bias on Indian capital markets and the rupee.


Inverse Myopia: Checking In With Asia and Latin America - India Econ Summary


In Taiwan, sequentially accelerating export growth in the month of December is in line with our #Quad1 outlook for the Taiwanese economy. While we remain fundamentally bullish on Taiwanese capital markets, the fact neither has responded well to the dramatic surge in cross-asset volatility we’ve experienced in recent weeks would seem to paint a dour picture for global equities broadly. If you can’t buy Taiwan, what can you buy?


Inverse Myopia: Checking In With Asia and Latin America - Taiwan Econ Summary

In Brazil, the advent of slowing retail sales growth in November coincided with the release of accelerating CPI data for the month of December – the both of which are confirmatory of our #Quad3 outlook for the Brazilian economy. Brazil just can’t seem to escape its deep, stagflationary recession in spite of receding base effects and dramatically loosening fiscal policy – both in relative and absolute terms. Elsewhere in Brazil, the country’s longstanding practice of indexing for wages, as well as various key goods and services are once again perpetuating fears of incredibly sticky stagflation, which is being priced into long-term breakeven rates. Also, with $7.9B of foreign currency bonds coming due in 2016 as at a time when at least a [record] third of all Brazilian companies are spending half their earnings to service debt, we can’t help but call out the risk of further sovereign downgrades and incremental capital outflows. All told, we reiterate our bearish bias on Brazilian capital markets and the real.


Inverse Myopia: Checking In With Asia and Latin America - Brazil Econ Summary

In Mexico, consumer confidence ticked up marginally in December while industrial production growth decelerated, also by a marginal degree. This divergence highlights the decidedly mixed nature of trends across Mexican high-frequency growth data. That, plus structurally depressed and decelerating CPI gives Banxico all the cover it needs to be as rhetorically dovish as it is inclined to be. Banxico Governor Agustin Carstens had previously been guiding Mexican monetary policy to be in line with that of the Federal Reserve (recall they hiked when the Fed hiked), but his latest comments suggest something on the order of Fed-style QE may be in the works if capital outflows continue to exert pressure on Mexican capital markets and those of emerging markets broadly. That would be incredibly and inappropriately dovish and both short rates and the MXN have picked up on this rhetorical shift. All told, we reiterate our bearish bias on Mexican capital markets and the peso. Mexico is one of many emerging market economies that have not adequately shielded their currencies from capital outflows that have been perpetuated by USD strength resulting from the now-G5 monetary policy divergence. For more details, please refer to our 12/16 note titled, “Macro Playbook Update: Keep Betting On #StrongDollar #GlobalDeflation” as well as our #CurrencyWar theme as detailed on slides 46-71 of our Q1 2016 Macro Themes presentation.


Inverse Myopia: Checking In With Asia and Latin America - Mexico Econ Summary

In Russia, the advent of decelerating CPI data for the month of December is in line with our #Quad1 outlook for the Russian economy. What is not in line are crude oil prices plunging to new lows and pending fiscal tightening measures – the confluence of which may send Russia back into #Quad4 indefinitely; Russian capital and currency markets have been and continue to aggressively price in this risk. Regarding the aforementioned fiscal tightening measures, Finance Minister Anton Siluanov recently stated that measures totaling 1.5T rubles ($2B), including a -10% cut in spending that spares outlays on the military and social services, are needed to avoid a shortfall of more than 6% of GDP this year: “If we consider today’s oil price and the ruble exchange rate and don’t take any measures, the deficit could more than double compared with the budget we have passed… We have enough reserves, resources for 2016, but we need to make decisions this year that would allow to balance state finances in 2017, 2018, 2019 and beyond.” It’s worth noting that Russia’s Reserve Fund – which is drawn on to plug gaps in the budget – has fallen -35% since its August 2014 peak of $91.7B. Additionally, Russia’s budget itself is based on Brent crude oil averaging $50 per barrel – which is +64% higher than where it closed today. All told, we reiterate our bearish bias on Russian capital markets and the ruble. As long as #StrongDollar deflation persists, any bounce(s) in Russian economic growth due to receding base effects is likely to be short-lived.


Inverse Myopia: Checking In With Asia and Latin America - Russia Econ Summary


In South Africa, industrial production growth accelerated sequentially in November, but it didn’t matter to global capital allocators. All that matters to investors is the slumping ZAR, which has fallen another -6.7% vs. the USD in the YTD to lead all emerging market currencies to the downside; this is on top of last year’s -25% decline. Its accelerated plunge to new all-time lows underscores a loss of faith in the Zuma administration’s willingness to enact the appropriate tightening measures – both monetary and fiscal – that can help protect international capital from further declines. Moreover, a sovereign downgrade to junk status is now a meaningful near-term risk in the context of the aforementioned deteriorating policy outlook. While credit ratings downgrades aren’t exactly meaningful leading indicators, a change in classification to junk may instigate incremental capital outflows. All told, we reiterate our bearish bias on South African capital markets and the rand.


Inverse Myopia: Checking In With Asia and Latin America - South Africa Econ Summary


Jumping ship, what does the following chart suggest about the outlook for global growth in 1H16 (and potentially beyond)?


Inverse Myopia: Checking In With Asia and Latin America - G20 Exports


Enjoy your respective evenings and best of luck out there managing the aforementioned risks. 




Darius Dale



Cartoon of the Day: REPENT!

Cartoon of the Day: REPENT! - RussHELL cartoon 01.13.2016


"Russell 2000 #Crash continues today at -22% vs. July Old Wall #Bubble high," Hedgeye CEO Keith McCullough wrote earlier today

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