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Old Enough To Know Better

“Old Enough to Know Better, Young Enough Not To Care”

-Billy Zane


Let me tell you a story.


Since my cold is getting worse at an accelerating rate this morning, it’ll be a short story:


The year is 1980 and interest rates in the U.S. are cresting to their stagflationary peak (Fed Funds peaked at 22.4% in 1981). 


Our early chapter protagonist – one iconoclastic central banker – Mr. Paul Volcker successfully broke the inflationary cycle and in an ironic plot twist also birthed our story’s antagonist: policy and the multi-decade accommodative interest rate cycle.  


Mysteriously (or not), #Inequality – hereto a noncharacter – is unwittingly thrust into the spotlight and begins his ascent higher alongside the progression of the interest rate cycle.


Ahh … the plot thickens.   


But before further character development, a bit of backstory.


35+ years of falling bond yields:

  1. Gets bond bulls paid (you must own bonds to benefit mind you)
  2. Increase the value of assets via the Present Value effect (again, you have to own financial assets to benefit)
  3. Serve to drive financial innovation, the “financialization” of markets and disproportionate growth in the finance economy


For those not holding financial assets, the benefits of expansionary policy and declining interest rates are more insidious as it:

  1. Spurs household demand by making credit cheaper and reducing the incentive to save, driving investment and household consumption of goods and services higher
  2. Lower highs and lower lows in interest rates in each successive cycle support onboarding of incremental debt as the costs of servicing debt are marched lower (see the beauty of a graphic by Bob Rich below). 


Old Enough To Know Better - Fed Chairmen cartoon 02.03.2016


Back to the Global Macro Grind …


Perhaps perversely, under a bureaucratic system perpetuating political short-termism and a monetary policy mandate calling for full employment, the solution to rising debt-to-income levels stemming from lower interest rates and accommodative monetary policy, is even lower interest rates, more expansionary policy, and currency devaluation.


Lower interest rates and a depreciating currency reduce the cost of servicing debt while further increases in aggregate demand and financial asset price appreciation support an ongoing rise in incomes. 


Under this story arc, policy supports a growing economic pie and the wealthy benefit directly - and can increase consumption while maintaining a static income-to-consumption ratio (…also, remember, they are the ones financing and getting paid on the cumulating debt). 


The lower income quartiles, meanwhile, can enjoy increased consumption at the cost of rising leverage. Rising Household debt can offset consumption differences created by rising income inequality and policy can support the perceived prosperity dance so long as there remains cushion for further reduction in rates.   


With our Stasis, Trigger and Conflict thus established, this leaves us with 5 points in a typical story structure:

  1. The Surprise
  2. The Critical Choice
  3. The Climax
  4. The Reversal
  5. The Resolution


The last three (or four) points are unfolding in real-time as NIRP and the currency war race-to-the-bottom crescendo and drive us towards some version of a tragi-comical catharsis. 


So let’s detail the Surprise and the Critical Choice with some relevant digression along the way.


The (Un)Surprise:   For our story here, the net of a multi-decade credit cycle are a few fold:

  1. Rising income inequality: the income distribution is increasingly top heavy with the top quintile/decile/1% taking down a larger share.
  2. Rising consumption skew: Consumption trends are increasingly hostage to what we’ll call the ‘wealth economy’ with the top 5% on the income distribution accounting for something on the order of ~40% of total consumption
  3. Credit: an outcropping of the credit cycle and financialization of the economy is that inflections in credit growth remain a primary marginal driver of aggregate spending. 


So, the expansion and contraction of credit and the ebb and flow of high end consumerism are critical to understanding and projecting the slope of consumption growth. 


Enter the (Growth) Foil: couple of developing realities:

  • High End: High End consumption shows a strong relationship to financial market volatility with new home sales and higher ticket discretionary consumption a decreasing function of volatility. Volatility is marching steadily higher and as the climax of this weaving macro narrative progresses, the plot twists will continue to manifest as bouts of rising volatility.
  • Credit: The Fed Senior Loan officer survey for 1Q16 showed a further tightening in corporate & commercial credit. Specifically, a net percentage of banks tightened C&I (commercial and Industrial) lending standards for the second quarter in a row. Moreover, demand for C&I loans inflected into negative territory this quarter. Eleven percent of banks saw C&I loan demand decrease from large and medium firms (13% saw it decrease from small firms), signaling that borrowers expect a decreased need for capital. 


This matters because, historically, when two of the three C&I questions have turned negative, it has portended a recession in the near future (see Chart of the Day below).


This isn't coincident, it's causal.


Banks tightening the screws, increasing the price of money or reporting reduced demand for money all portend a slowing of economic activity.


Credit is pro-cyclical and just as it can serve to jumpstart or amplify a virtuous cycle on the upside, it can similarly serve to catalyze a negative self-reinforcing downcycle. 


In other words, banks tighten credit => consumption/investment decline => job growth slows or workers are laid off => delinquencies rise => banks further tighten credit => and so on and so forth.


Very Dalio-esque, but it’s also how I lean towards intuiting the “economic machine”. But then again, I’m just a guy in a room with creative analytical license spinning commonsense narratives around data at 5am with minimal editing. 


If you’re an Old Wall shop, you traffic in contrived sophistication and perceived scarcity value, it’s what you do.


If you’re consensus, you forecast 3% on the 10Y and serially revise your earnings/growth forecast lower every year, it’s what you do. 


If you’re an active participant in this democratization of investment research experiment we’re conducting @Hedgeye, you try to simplify the complex. That and buy long bonds and bond proxies (Utilities, REITs, etc) when growth is slowing. 


7-months of boring allocations to long bonds isn’t the positioning fabric dazzling macro narratives are weaved on or sexy marketing campaigns based but that’s okay. We’re old enough to know better, but still young enough not to care. 


Post-Script | Recession Mongering: To be clear, our call has been that the probability of recession is rising and insufficiently discounted by markets. We don’t need an outright technical recession for our #GrowthSlowing call to manifest as recessionary price action in equities – we only need the prevailing opinion/sentiment/consensus to recouple with the more dismal underlying macro and corporate profit reality. Across a growing swath of companies (namely, smaller cap/lower liquidity/higher beta/higher leverage style factors) bear market price action has already commenced. 


…. Oh yeah, and the domestic services sector showed further slowing yesterday as the ISM Services reading slowed to its lowest reading in two years and the EU cut its growth and inflation forecasts again this morning.


To real-life page turners and harmonious Resolutions,


Christian B. Drake

U.S. Macro Analyst


Old Enough To Know Better - EL C I Spreads Demand standardsl

INVITE | 1Q16 Internet Best Ideas Call (TODAY)

Takeaway: Please join us for our today at 1:00pm EST. Dialing instructions below

We will be hosting our quarterly INTERNET BEST IDEAS Update Call today at 1pm EST.  We will be reviewing the major themes and incremental developments to our Best Idea Short theses (YELP, TWTR), and will be discussing two recently-closed Best Ideas that we have added to our Bench in the opposite direction (LNKD as a potential Short, P as a potential Long).  The emphasis of this call will be to outline our view over various durations (particularly 2016) as well as the upcoming catalyst calendar; identifying the major catalysts and risks to each company over the near-to-intermediate term.


Join us for our call today at 1:00pm EST.  Dialing instructions below




  • TWTR: Aggressive monetization tactics creating structural headwinds; why there is at least one more leg down to the short.
  • YELP: Sell-side refuses to acknowledge its attrition, so estimates still too high.  Question if mgmt will repeat 2015 mistake and guide to them
  • LNKD: Closed Long, Potential Short.  Selling environment appears to be deteriorating, could be beginning of challenging trend
  • P: Covered Short, Potential Long.  Dead money or Call Option? Depends on how mgmt chooses to proceed post Web IV


Participating Dialing Instructions

  • Toll Free:
  • Toll:
  • UK: 0-
  • Confirmation Number: 13629885
  • Materials: CLICK HERE


Hesham Shaaban, CFA


The Macro Show Replay | February 4, 2016


investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.

Why We’re Bearish On U.S. Housing


In this excerpt from The Macro Show this morning, Hedgeye analyst Josh Steiner discusses the reasons behind our decision to go from bullish to bearish on the U.S. housing market. He’s joined by U.S. Macro analyst Christian Drake.

Cartoon of the Day: Volcker To Yellen

Cartoon of the Day: Volcker To Yellen  - Fed Chairmen cartoon 02.03.2016


Each Fed chair rises to the occasion.

JT Taylor: 4 Thoughts Heading Into the New Hampshire Primary

Takeaway: New Hampshire and Iowa are very different animals.

Below is a brief excerpt from Potomac Research Group Senior Analyst JT Taylor's Morning Bullets sent to institutional clients each morning. 


JT Taylor: 4 Thoughts Heading Into the New Hampshire Primary - bernie




The Trump spectacle draws large crowds, but he was hurt by an inability to transfer that into committed voters. Cruz by contrast won "the Iowa way" with a new twist, marrying a heavy emphasis on door-to-door campaigning with cutting-edge digital targeting and demographic modeling. Evangelicals made up 64% of Iowa Republicans, and a large portion of the remaining voters classified themselves as very conservative. NH is one of the least religious states in the country and has a large block of libertarian and moderate voters. Fertile ground for Trump and Rubio -- or one of the governors. Not Cruz.

A Trump Ceiling?

Entrance and exit polls from Iowa indicated that higher turnout, especially among new voters, didn't translate into a big Trump boost -- it seems his presence in the race brought out an even share of fans and detractors. This may be indicative of a Trump ceiling among Republican primary voters -- a notion that would be cemented with a similar result in the Granite state. Trump needs a ground game to complement his message in order to win here and beyond.

Bush got burned. Badly

His campaign and Super PAC spent a combined $14.1 million in Iowa on ads alone -- that works out to more than $2,800 per vote for a dismal sixth-place finish. In NH, he'll be hard-pressed to convince voters that he's a better establishment standard-bearer than Rubio, who he just lost to by 20 points...

Sanders is in for the long haul

His campaign announced this week that it had pulled in $20 million in donations in January alone, averaging $27 apiece -- something he repeatedly highlighted in his not-quite-concession speech Monday night. Did we mention that he raised an additional $3 million after that speech? He's vowed to take the fight to Hillary "all the way to the convention."

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.46%
  • SHORT SIGNALS 78.35%