Disciplined Risk Premiums

“In some places we’re picking up disciplined risk premiums.”

-Cliff Asness


While it’s easy to rib my friends at Barron’s sometimes (on cover stories about “No recession – we’re going back to 3% GDP”, for example), I try to give credit where it’s due and I applaud their headline story this weekend about one of the asset managers I respect most – AQR.


I cited a fantastic interview AQR’s founder, Cliff Asness, did in an excellent markets book I’ve been reviewing for Early Look readers titled Efficiently Inefficient, by Heje Lasse Pederson. The aforementioned quote was part of an important answer Asness gave on AQR’s strategy:


“I think in some places we’re picking up disciplined risk premiums that are not very correlated with long-only markets, which means, if someone doesn’t have those in their portfolios, they should add them. In other places I think we’re taking advantage of human biases and we’re trying to be disciplined and determined about it, taking the other side of some common psychological trait or institutional constraint…” (pg 164)


Back to the Global Macro Grind


Just to boil this down, a “risk premium” is a return that’s greater than whatever you’d call the “risk free” rate. For us, it’s what we get paid for understanding the prevailing growth and inflation environment and having the right “risk” allocations associated with that.


What most people miss is how the rate of change of growth and inflation is affecting market expectations. That’s why there is a lot of “excess return” to be made in front-running where asset allocators have to, as Asness points out, “add to their portfolios.”


Sure, a big shot endowment man might start with what he “needs” as a return, but if the risk free rate is a negative yield and illiquid assets are deflating, then the risk premium is in owning style factors like liquidity, “low-beta” and, of course, Long-Term Treasury Bonds.


Disciplined Risk Premiums - GDP cartoon 02.29.2016


In other words, as US growth slowed from 3% to 2% to 1% (from its cycle-peak of 3% in 1H of 2015):


  1. Long-term Treasury Bond exposures like TLT have earned a risk premium of +8.4% YTD
  2. Utilities (XLU) have earned a risk premium of +7.0% YTD
  3. If you ran a hedge fund that is only long Utes (XLU) and short Financials (XLF), you’re +18.5% YTD


Oh, and that would probably be called a boring hedge fund that isn’t putting “leverage” on that pristine risk premium associated with the basic understanding that rates fall (they don’t “hike”) during #GrowthSlowing (XLU +7% YTD vs XLF -11.5% YTD).


To be fair, no reasonable risk manager would put their entire fund in one LIQUID non-consensus position like XLU vs. XLF (see Ackman’s ILLIQUID consensus Valeant (VRX) “pick” for details), but there would be one heck of a story on the cover of Barron’s if someone did!


I’m obviously generalizing here. I’m well aware that the +8.4% and +7.0% (and +18.5%) returns do NOT include interest and/or dividend payments. In the hedgie format they don’t SUBTRACT fees. And, of course, I am using a “risk free rate” of 0%.




Well, we can be like every other consensus talking head and yap about Trump, China, or Oil today. Or we can just get back to work and A) protect the risk premium we’ve earned YTD (Rule #1 = Don’t Lose Money) and then B) build upon that (compounding returns is cool).


Let’s start with the TAIL risk wagging the disciplined dog here – corporate profits:


  1. Earnings Season is coming to an end – 485/500 companies in the S&P have reported
  2. Aggregate SALES are -4.5% year-over-year and EPS (non GAAP in some cases) are -8.5% year-over-year
  3. Only 3 of 10 S&P Sectors had POSITIVE year-over-year EPS growth
  4. Ex-Telecom (don’t do that Mucker!) Healthcare and Consumer Discretionary EPS growth closed the quarter on the lows
  5. Financials finished Earnings Season with NEGATIVE EPS growth of -5.9% year-over-year


Not to simplify the complex, but if 3-6 months ago the cover of the WSJ walked through that a #LateCycle rate hike would perpetuate a stock market decline via “down earnings” for non-Energy Financials via Yield Spread compression, would people have listened?


Moreover, people are starting to remember that there is what Soros calls “reflexivity” (Asness calls it a “common psychological trait”) associated with stock market declines.


For #behavioral evidence of that reality, look no further than one of our better new short selling ideas – US Housing (ITB). Signed contract activity for “Pending Home Sales” contracted another -2.5% sequentially in January. That’s a 17 month low in rate of change terms…


And, yes, like early cyclicals (Industrials, Energy, etc.) now this #LateCycle consumption and employment factor (Housing Demand is linked to both) has slowed to NEGATIVE -1.4% year-over-year. For Housing Bulls (we were The Bull on Housing for most of last year) #NotGood.


Neither is being invested on the same side as the crowd (at the turn) when the economic, profit, and credit cycles are rolling off their cycle-peaks. But you already know that. Welcome to March. Let’s get out there and compound some risk premiums!


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.65-1.81%



VIX 18.54-26.50
USD 96.43-98.63
Oil (WTI) 28.48-34.75


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Disciplined Risk Premiums - 03.01.16 Chart

China, Oil and Earnings

Client Talking Points


But if we blame China and Oil for everything, all good – after seeing the Shanghai Composite re-test its year-to-date lows, the Chinese had a slew of central-planning headlines to change that. Including “cutting 5-6M jobs from zombie enterprises” (imagine the U.S. did that?) – bullish move there vs. expectations, Shanghai Composite “off the lows” +1.7%.


Oil is prodding the top-end of its immediate-term $28.48-34.75 risk range (WTI) so we would be looking to re-load on Energy related shorts again (newsflash: at $35-45 Oil and Oil Volatility = 60-70, most credit issues remain). You simply have to be there selling the top-end of the risk range so that you can cover lower.


Imagine consensus blamed the following reality for terrible U.S. Equity returns in the last 6 months: 485/500 S&P companies have reported an aggregate Sales decline of -4.5% (and an earnings year-over-year decline of -8.5% on non-GAAP numbers); that made-up EPS decline is right inline with the year-to-date decline of the Russell 2000 of -8.7%.



*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

Our preferred growth slowing vehicle remains Utilities (XLU) in equites. Hitting on Friday’s revised GDP report (Q/Q SAAR Q4 GDP revised to +1.0% from +0.7%), a deep-dive into the number doesn’t support an incrementally stronger economy:

  • Consumption was revised down marginally but net exports were up with the negative revision to imports outweighing the negative revision to exports. That’s good for the number but lower global trade activity is not a good sign for global growth;
  • Much of the actual change in the revision was due to inventories, which contributed +0.31pts to the headline number

General Mills (GIS) hit an all-time high last week when it reached $60.18 on Thursday. Although this would not be a great entry point, it is also not a reason to get out if you have a long-term view. Nothing has changed in our fundamental story and we have no reason to lose faith in our thinking to date.


Over the course of the past few years, GIS has made strategic acquisitions within the natural & organic / wellness space (we call it the string of pearls approach). Although they are not largely meaningful to top or bottom-line right now, they are changing the way the company thinks about its broader portfolio.


We continue to believe GIS is one of the best positioned consumer packaged foods companies due to its strong brands and best-in-class people and organization.


Our preferred growth slowing vehicle remains (Long-Term Treasuries) TLT in fixed income. A flattening in the yield spread (10YR Treasury Yield – 2YR Treasury Yield) continued last week into double digit basis point territory (currently at 96 basis points). Year-to-date the yield spread has declined 44 basis points while the 10YR Treasury Yield has dropped 47 basis points. As a reminder the yield curve flattens as the economy slows with policy and/or liquidity management driving the short-end higher and defensive positioning and/or discounting of lower future growth/inflation driving the long end lower.


Three for the Road



A #SuperTuesday16 Preview with @PotomacResearch & @HedgeyeDJ… @KeithMcCullough



Your decisions reveal your priorities.

Jeff Van Gundy


Kate Spade & Co (KATE) short interest into this morning's print is the highest in 3 years.

The Macro Show Replay | March 1, 2016


Early Look

daily macro intelligence

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.

Cartoon of the Day: Blast Off!

Cartoon of the Day: Blast Off! - GDP cartoon 02.29.2016


"If the Old Wall wants you to imagine that Friday’s 1% GDP report was a “beat” (when the expectation for the past 2 years has been +3-4% growth), that’s fine," Hedgeye CEO Keith McCullough wrote in this morning's Early Look. "Your 2016 portfolio returns, however, have sided within being long asset allocations that do well when GDP growth slows from 3 to 2 to 1. So start your March off right - short the Financials (XLF) – buy more Utilities (XLU)."


must-see [INTERACTIVE] market tv


You don't want to miss this. Earlier this morning we hosted a special *FREE* edition of The Macro Show with Hedgeye CEO Keith McCullough and Senior Macro analyst Darius Dale. You'll get a front-row distillation of all the key global market and economic developments and how to position yourself accordingly. In addition ... Keith answers viewer questions during our interactive Q&A.

Don't miss out. click below for access.





Washington on Wall Street: Super Tuesday Preview with JT Taylor and Daryl Jones


Potomac Research Group's Chief Political Strategist JT Taylor joins Hedgeye Director of Research Daryl Jones for a Super Tuesday preview. The Republican establishment hopes that Rubio or Cruz can capture some delegates in the face of Donald Trump's seemingly insurmountable leads in nearly every Super Tuesday state. Meanwhile, Hillary Clinton seeks to build on her momentum from a big South Carolina win to effectively seal the deal on the Democratic side.

get free cartoon of the day!

Start receiving Hedgeye's Cartoon of the Day, an exclusive and humourous take on the market and the economy, delivered every morning to your inbox

By joining our email marketing list you agree to receive marketing emails from Hedgeye. You may unsubscribe at any time by clicking the unsubscribe link in one of the emails.