Complex Games

“Thanks to their ability to invent fiction, sapiens create more and more complex games.”



That’s a big bridge between biology and human history. It’s both #behavioral and a summary point at the end of a chapter in Sapiens (by Yuval Noah Harari) titled The Tree of Knowledge. Good thinkers book. I’m enjoying it.


I’ve also enjoyed spending the week in the great state of Texas (my crystal ball had me book dates in Austin, Dallas, and Houston for the epic short squeeze in US listed Oil & Gas stocks).


West Texas Crude Oil is not only +10% in the last week, it’s +37% in the last month! No, I didn’t nail that. But, thankfully, I didn’t get nailed by it either. There is going to be a fantastic short-selling opportunity in levered Oil names again, hopefully a little higher.


Complex Games - fossil fuel cartoon 01.27.2016


Back to the Global Macro Grind


Fortuitously we took both Oil and Oil related indexes (XOP, XLE) off our Best Ideas in the Macro Themes deck on January 5th and replaced them with Utilities (XLU) on the long side and Financials (XLF) on the short side.


While plenty of our best SELL ideas (bottom up stock picks from my analysts) have been squeezed here in the 1st week of March, our best Macro Equity Sector Ideas have acted just fine:


  1. Utilities (XLU) were up another +0.5% yesterday to +11.0% YTD
  2. Financials (XLF) were down another -0.1% (in an up tape) to -7.9% YTD


That said, in Real-Time Alerts (shorter term signaling product) yesterday, I signaled that I wanted to cover some Financials and Housing related short ideas with me really having no idea what the market could do on today’s central-market-planning (ECB) event.


This morning I don’t want to get into the complexity of the Game of Slowing and how central planners (ECB this morning – BOJ and Fed next week) fundamentally believe that they can bend and/or smooth economic and profit cycles. I’d rather just wait and watch.


By the time this Early Look hits your inbox I may very well have an entirely different “market call” as we’ll have “new news” (or not) that the #BeliefSystem is or isn’t breaking down. How much longer will players in this complex game believe fiction?


Embrace uncertainty.


Even though many publicly traded US companies do not report earnings on a GAAP (Generally Accepted Accounting Principles) basis anymore, one thing I can tell you with certainty this morning is that Draghi and Yellen cannot Ctrl+PRINT Sales & Earnings growth.


With 494 out of 500 companies in the S&P 500 having reported their recent quarter (many non-GAAP):


  1. Aggregate SALES growth slowed to -4.0% year-over-year
  2. Aggregate EARNINGS growth slowed to -7.5% year-over-year
  3. With Consumer Staples squeaking out a +0.8% y/y EPS gain, only 4 of 10 Sectors have positive EPS growth
  4. Yes, Energy and Materials have y/y EPS declines of -73% and -18%, respectively
  5. But our favorite Sector on the short side (Financials) had a -9.4% year-over-year decline


Sure, you can dial-a-sell-side-strategist who’s been “backing out Energy” for the last 6-9 months, but how many of these characters proactively predicted that during a “rate hike” that Financials would be the biggest rate of change loser in their narrative?


Reminder: there are 90 companies in the S&P 500 that are categorized as “Financials”, whereas there are only 40 companies that are currently classified as “Energy.”


Oh, and by the way, “Financials” earnings got slammed BEFORE A) the recent crash in rates and B) the commensurate compression in one of the core leading indicators for “Bank Earnings” – The Yield Spread.


The spread between the 10yr US Treasury Yield and the 2yr is testing new cycle lows at 98 basis points wide. It’s a leading indicator for bank stocks because it’s a proxy for what they call Net Interest Margin (NIM).


The wider the Yield Spread, the wider bank profit margins. The narrower the spread, the faster bank earnings slow.


This brings us all the way back to the #BeliefSystem. What can the ECB’s Mario Draghi or the Fed’s Janet Yellen do other than “cut rates” and, in doing so, impose further pressure on long-term rates and bank earnings?


We’ll have to see, won’t we…


But it appears that this complex game of storytelling is reaching the beginning of the end more so than the end of the beginning.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.69-1.95%



VIX 15.88-22.66
EUR/USD 1.08-1.11
Oil (WTI) 30.89-38.99


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Complex Games - Yield Spread CoD

Oil, Euro and the DAX

Client Talking Points


There is nothing quiet about this short-squeeze in oil (up another +4.6% yesterday and +37% in the last month alone for WTI; still -24% year-over-year). The immediate-term risk range for WTI has widened out to $30.89-38.99 with @Hedgeye TAIL risk resistance = $46.11.


Down small to $1.09 EUR/USD ahead of ECB President Mario Draghi’s attempt to walk on water. The immediate-term risk range is $1.08-1.11; hedge fund bets are all over the place on what happens here today – we say embrace the uncertainty and read & react.


The DAX is doing nothing into the event, but don’t forget that it’s still in crash mode (-22% from last year’s high) so any Japanese style break-down in the belief system that central planning can ramp asset prices higher is a real risk.


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

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

If you were long energy over utilities last week, nice trade! We'd remind you that Utilities (XLU) are outperforming the S&P 500 by +10% year-to-date. And that’s with the bounce. By contrast, Energy (XLE) was up 6.5% on the week but is up only 1% year-to-date.


General Mills (GIS) faces some headwinds across their portfolio, and although the 1H of FY16 was a challenge, the company has robust merchandising and consumer plans in the 2H that should improve results.


GIS has embarked on a mission to drive their top 450 SKUs, which represent 75-85% of their volume. Calling it their ‘Power 450’, surprisingly these 450 SKUs aren’t even in all retail locations and formats, broadening the distribution footprint of these top SKUs is priority number one for GIS’s sales team. The organization is also looking at the bottom 450, representing 1-2% of volume and making critical decisions on what products can be discontinued.


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.


We can’t emphasize enough the bigger picture from both a data and top-down market signaling perspective. To contextualize the relief rallies and short squeezes in asset classes and instruments that are counter to our more longer-term view. Here’s what how we think the macro environment plays out from here:

  1. The market is positioned for more rate hikes into 2016
  2. The data continues to deteriorate, and market volatility ensues
  3. The expectation that “all is good” comes off the table and the market increasingly pivots to the view that, throughout 2016, the Fed is going to hike rates in methodical fashion straight into an economic slowdown
  4. The market takes in the growth slowing pivot in real-time (Treasury rates and the dollar both move lower, and inflation-leveraged assets like gold catch a bid)


Once the policy catalysts are out of the way in the next few weeks, our expectation is a return to outperformance in growth slowing asset classes (TLT and XLU). If you’re in for the TAIL and the TREND call, focus on the data, not the desperate attempts of central planners to arrest economic gravity. A brief reminder: ECB chief Mario Draghi will attempt to walk on water today.

Three for the Road


NEW VIDEO | The Very Real Possibility Of A Contested #GOP Convention… @KeithMcCullough



When you win, nothing hurts.

Joe Namath


The cost of companies losing valuable people can be as high as $188 billion per year.  

The Macro Show Replay | March 10, 2016

CLICK HERE to access the associated slides.


An audio-only replay is available here.



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ICI Fund Flow Survey | Comping the Tantrum

Takeaway: High yield bond funds took in $3.6 billion in new funds last week, the best 5 days since the Taper Tantrum of '13.

Investment Company Institute Mutual Fund Data and ETF Money Flow:

In the 5-day period ending March 2nd, high yield bond funds took in $3.6 billion, the second consecutive week of subscriptions after a 10 week drawdown where over -$28 billion was redeemed from the category. The substantial high yield subscription last week was the best 5 day period for high yield bond funds since July 24th, 2013 where in the middle of the Taper Tantrum, investors drew the line and stepped in to buy $5.1 billion in non-investment grade credit in the 29th week of that year. We caution for optimism however as an across cycle view, using a 5 week moving average, continues to relay the down trend for non-investment grade bonds. Below we outline the 5-week moving average of ICI's new high yield bond category against the price of crude oil which is still driving consternation for investors despite a slight bear market rally in oil.


ICI Fund Flow Survey | Comping the Tantrum - taper


Muni bonds and bond ETFs continue to be the real story in fixed income land with tax free issues taking in +$934 million, their 22nd consecutive week of subscriptions now totaling over $20 billion. Passive fixed income ETFs are also seeing substantial demand with another +$2.7 billion take this week, their 11th consecutive weekly inflow aggregating to +$24.3 billion.


Lastly, cash is king again according to ICI with money funds taking in +$26 billion in the past 5 days, a combination of risk aversion and tax season receipts. Year-over-year however, 2016 has now aggregated to a running total of +$44.8 billion having moved into money funds versus the -$60.1 billion drawdown that money funds experienced in the first 9 weeks of 2015. This cash moving back to the sidelines supports our Best Ideas long rating on Federated Investors (FII).

ICI Fund Flow Survey | Comping the Tantrum - ICI1


In the most recent 5-day period ending March 2nd, total equity mutual funds put up net inflows of +$45 million, outpacing the year-to-date weekly average outflow of -$301 million and the 2015 average outflow of -$1.6 billion.


Fixed income mutual funds put up net inflows of +$4.1 billion, outpacing the year-to-date weekly average outflow of -$238 million and the 2015 average outflow of -$475 million.


Equity ETFs had net redemptions of -$44 million, outpacing the year-to-date weekly average outflow of -$4.0 billion but trailing the 2015 average inflow of +$2.8 billion. Fixed income ETFs had net inflows of +$2.7 billion, outpacing the year-to-date weekly average inflow of +$2.4 billion and the 2015 average inflow of +$1.0 billion.


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 | Comping the Tantrum - ICI2


ICI Fund Flow Survey | Comping the Tantrum - ICI3


ICI Fund Flow Survey | Comping the Tantrum - ICI4


ICI Fund Flow Survey | Comping the Tantrum - ICI5


ICI Fund Flow Survey | Comping the Tantrum - 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 | Comping the Tantrum - ICI12


ICI Fund Flow Survey | Comping the Tantrum - ICI13


ICI Fund Flow Survey | Comping the Tantrum - ICI14


ICI Fund Flow Survey | Comping the Tantrum - ICI15


ICI Fund Flow Survey | Comping the Tantrum - 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 | Comping the Tantrum - ICI7


ICI Fund Flow Survey | Comping the Tantrum - ICI8

Sector and Asset Class Weekly ETF and Year-to-Date Results: In sector SPDR callouts, investors contributed +$1.1 billion or +4% to the SPDR Gold ETF and +$283 million or +5% to the industrials XLI ETF.


ICI Fund Flow Survey | Comping the Tantrum - 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 | Comping the Tantrum - ICI17


ICI Fund Flow Survey | Comping the Tantrum - ICI18

Net Results:

The net of total equity mutual fund and ETF flows against total bond mutual fund and ETF flows totaled a negative -$6.8 billion spread for the week (+$1 million of total equity inflow net of the +$6.8 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 +$130 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 | Comping the Tantrum - 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 | Comping the Tantrum - ICI11 

Jonathan Casteleyn, CFA, CMT 




Joshua Steiner, CFA

CREDIT RISK: Yes, Still A Risk

Takeaway: The squeeze in commodities since mid-February hasn’t changed our view in the downside to the credit cycle.

Our takeaway with respect to the relief in credit spreads, especially in the resource space, is that we believe the tightening is temporary, driven by a shift in policy expectations, and the result of a heavy squeeze in deep cyclicals.

To borrow a line from Drake’s Early Look Tuesday recapping January’s consumer credit data, “with household debt still very much elevated and no rope left on lowering debt service costs, the capacity for debt to support consumption growth over the intermediate and longer term remains constrained.”

We would also echo the “lack of rope” on the corporate investment and financing side of the equation, particularly as it relates to forward looking earnings expectations in the space.


Below we offer a series of charts and tables to support the argument that there is less room for "more rope" from a policy-induced financing perspective. Here are our main conclusions:

  • The leverage thrown on at elevated commodity prices and the lower bound in rates has decidedly started moving the other way since 2014, and the recent squeeze in resource-driven sectors, and the move in spreads won’t help cushion the necessary balance sheet flush
  • EBIT estimates for the balance of 2016 and 2017 remain optimistic, and we expect the contraction of capital on balance sheet to be an earnings headwind in the resource space for a longer period of time
  • There has been a healthy consolidation in consensus short commodity/long USD positioning  and rate hike expectations heading into the year, and this consensus expectation has now shifted the other way into the policy catalysts, starting with the ECB this morning  


  • The most heavily shorted, larger cap cyclicals in the Resource and Materials related space are also the top equity performers on a 1-mth window. When deep cyclicals in oversupplied, mature industries double in less than 2 months, we call that a squeeze:

CREDIT RISK: Yes, Still A Risk - Short Interest


CREDIT RISK: Yes, Still A Risk - Relative Performance


  • With a breather in the USD ascension YTD, The short-term move in iron ore, gold, WTI etc. has helped their respective equities, the equity indices of resource leveraged countries, and the sovereign and corporate resource-leveraged sovereigns: 

CREDIT RISK: Yes, Still A Risk - EM CDS


The takeaway as it relates to credit extension and contraction is that credit has already meaningfully tightened on top of peak leverage in commodity space, and we expect the capital flush will continue to be an earnings headwind in Q2. Spreads in the resource heavy space are meaningfully higher Y/Y despite the temporary pullback:

  • Spreads remain +~200-250bps wider Y/Y after widening in 2015 for the balance of the year
  • A cyclical trough in rates followed by a meaningful breakout in spreads hasn’t historically reversed in the same cycle
  • Resource-related credit (largely mature industries ex. U.S. shale) jumped from 5% to 14% of aggregate corporate credit outstanding in the 10-year period from 2004-2014 (sample of 34 producers)
  • Reported interest expense jumped 2.5x for this same group over that 10-year period despite the access to increasingly cheaper financing to the 2014 low in corporate credit spreads. This financing ability has already moved the opposite way for a long time
  • EBIT estimates remain too optimistic in our opinion for 2016, and much of the growth is expected in the resource space (the last two charts exemplify the Materials space)  

CREDIT RISK: Yes, Still A Risk - HY Spreads


CREDIT RISK: Yes, Still A Risk - IG and HY Spreads vs. Recessions


CREDIT RISK: Yes, Still A Risk - Commodity Producer Debt   Corporate Credit Oustanding


CREDIT RISK: Yes, Still A Risk - Gold Miner Debt vs. Real Rates


CREDIT RISK: Yes, Still A Risk - Commodity Producer Interest Expense


CREDIT RISK: Yes, Still A Risk - S P Materials Operating EPS Estimates


CREDIT RISK: Yes, Still A Risk - EBIT Divergences


EARNINGS: The backside of cheap leverage at high commodity prices is an extended capital flush that lasts for a long period of time. In reality there is too much capital chasing production that can’t be absorbed

  • This balance sheet deleveraging manifests in D&A, write-downs, impairments and even haircuts for some over a long period of time which we expect to offset the lapping of difficult comps (a bull case scenario to the awful Q4 earnings season which is winding down). Judging by Q4 earnings many companies made the choice to avoid the necessary charges for a future time in the hopes of a price rebound
  • Capital in play per oz. of production has only began inflecting off historic highs despite production efficiency gains (the backside of an industry-wide capital spending boom)

CREDIT RISK: Yes, Still A Risk - S P Rev.   Earnings Comps


CREDIT RISK: Yes, Still A Risk - Net PP E Per Oz. Gold


CREDIT RISK: Yes, Still A Risk - PP E Per Oz. in XOP


This balance sheet deleveraging is slowly on the move, but we argue it will get worse throughout the balance of the year as the cycle gets longer in the tooth.

Below we re-worked two slides in our Q1 themes macro deck to paint the cyclical picture of a breakout in credit spreads (credit’s share of GDP) within the longer-term debt cycle of which little policy “rope” remains for another cycle to commence.


CREDIT RISK: Yes, Still A Risk - Corporate Credit   GDP


CREDIT RISK: Yes, Still A Risk - Corporate Debt   GDP


Excluding the increasingly limited financing availability on the corporate investment, a number of other metrics suggest a tighter credit environment broadly (which helps elongate consumption and investment).

As our financials team outlined in its re-cap of the Q1 2016 Senior Loan Officer Survey, a tightening in commercial & industrial (C&I) loan standards continued for the second consecutive quarter. And not only did the net percentages of lenders tightening standards for those categories increase, but demand for C&I loans declined. Additionally, the Fed's survey this quarter included special questions regarding forward expectations, and loan officers indicated that they expected a further tightening of standards, increasing of spreads, decreasing volumes, and deteriorating credit quality over the course of 2016.

The risk to being long a deflationary credit unwinding is that the Fed has more RELATIVE room to fight a deflationary burden with easier policy (weaker USD, measures to lower rates, and money printing to help cushion the debt burden) when compared to other central banks, which is why the “Fed Put” still has more credibility with deteriorating data (and the expectation that the dot plot will be revised lower next week). However, the current cushion is non-existent compared to previous peaks in Fed Funds:


CREDIT RISK: Yes, Still A Risk - Corporate Debt   GDP


Concluding with behavioral, market-based expectations, the pull-back in Fed Funds expectations YTD, and a healthy rebalancing in net USD long, commodity short positioning (net futures and options positioning), the market is now leaning the other way into the March policy catalysts (long Euros, treasuries, and gold, and short dollars on the other side). This set-up suggests Draghi can’t do enough to outweigh consensus expectations this morning. Overall, both the longer-term fundamental and quantitatively bullish set-up for the USD remains intact. For a walk through in how we see this playing out, we’ve pre-coined the “BIG BANG”  


CREDIT RISK: Yes, Still A Risk - Fed Funds Cushion


CREDIT RISK: Yes, Still A Risk - Strong USD Chart


CREDIT RISK: Yes, Still A Risk - USD Trend Chart


Ben Ryan






Cartoon of the Day: Out Of Ammo

Cartoon of the Day: Out Of Ammo - Draghi cartoon 03.09.2016


ECB head Mario Draghi will attempt to quell uneasy macro markets tomorrow. Will he pull the trigger on more easing? Will it matter?

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