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McCullough: Beware the Reflation Trade Risk

In this brief excerpt of The Macro Show earlier today, Hedgeye CEO Keith McCullough discusses this week’s Fed meeting, the recent reflation trade bounce and takes a deep dive into commodities markets.

 

Subscribe to The Macro Show today for access to this and all other episodes. 

 

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5 (Ugly) Charts To Show Your Broker

Takeaway: Despite the recent bounce in equities, a number of key equity markets are down precipitously.

5 (Ugly) Charts To Show Your Broker - Bear crossing cartoon 09.29.2015

 

The recent bounce in equities raises a number of important questions.

 

  • Is global growth slowing? (Even the IMF seems to think so.)
  • Can central planners bend or smooth economic gravity? (Nope. Just ask the BOJ or ECB...)
  • Will a sustained rally in the price of oil send stocks higher? (Iran says it's unlikely.)

 

With none of these concerns truly abating, let's put the recent "rallies" in perspective. Here are five charts of key indexes, the respective drawdowns from the 2015 and the necessary returns just to get back to breakeven. This should raise a few red flags. Bear in mind, we're not even addressing the myriad recessionary data points here.

 

Russell 2000 down -16% since July.

To get back to breakeven must be up 19%.

 

 

South Korea's Kospi Down -12% since April.

To get back to breakeven must be up 14%.

 

 

Germany's DAX down -19% since April. 

To get back to breakeven must be up 23%.

 

 

Italy's FTSE MIB index down -21.3% since July.

To get back to breakeven must be up 27%. 

 

 

CRB Index of commodities down -26% since May.

To get back to breakeven must be up 35%.

 

 

careful out there...


REPLAY: Jim Rickards and Keith McCullough on HedgeyeTV | Why Gold Is Going To $10,000

Bestselling author Jim Rickards sits down with Hedgeye CEO Keith McCullough to discuss his new book “The New Case for Gold” and why a cocktail of factors makes it more critical than ever for investors to protect their portfolios with gold. 

 

 


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RH | Membership Program Goes Live

Takeaway: New Grey Card went live Sunday. Different from AMZN Prime/Costco model, but clear value proposition & democratizes interior design services.

The company didn't put out a press release this morning, but the new RH rewards program went live to customers on Sunday. Called the Grey Card -- the key feature is 25% off all orders for a $100 annual fee. There are other benefits associated with the card: early access to sale events, preferred financing (w/ an RH Credit Card), and 10% savings on sale items. But the key benefit (outside of the discount), we think is access to RH's in-house Interior Designers at no additional cost.

RH | Membership Program Goes Live - 3 14 2016 1 

There are few examples in retail of a customer funded membership program. The two obvious corollaries are Amazon Prime and Costco, which offer benefits in the form of free shipping and low prices to encourage customer loyalty. But, the Grey Card from RH is not that. Instead, it's a democratization of the interior design services.

 

Under the old RH Trade Sales membership agreement, interior designers were offered 20% off all non-sale purchases. With the new membership model -- non-RH interior designers are offered free membership to the Grey card. For the ~60% of purchases that come from customers who do not use external interior design services, the new membership model allows for the same type of services at a steep discount to the current market rate. Not only does it up the customer service element of the equation, but it also allows RH interior designers to up-sell RH product across every room of the house.

 

Over the near term -- there is little doubt that the shift in promotional posture will make quarterly top-line results choppy as customers adjust to the new value proposition and the company laps meaningful promotional events. But, if we look at it over a slightly longer duration we think it will a) allow RH to get valuable insight on customer behavior as it analyses customer buying behavior through membership rewards data, and b) allow the company to smooth out the demand curve which will allow for greater efficiency from the vendor network and supply chain.

RH | Membership Program Goes Live - RH tradesales 2

 

There is still a ton left unanswered as it relates to the rewards program, and we expect the company to speak to the initial reads on the program when it reports numbers/provides guidance at the end of the month.

 

Additional details…

  • Value proposition: The value proposition from a $100 subscription fee is clear and up front for anyone looking at a big ticket item. That's reflected in the pricing on the company's website (and we assume in store) where the ticket price and membership price are clearly displayed on every item.
  • Small Ticket: The breakeven point on a rewards membership is $401 for the customer, so for the marginal customer only interested in bath towels and sheets there is little incentive to drive incremental purchases. But consider that a bedding set (composed of a duvet cover, sheets, and pillow cases) costs $707 at the advertised price. When we factor in the 25% discount and add back the subscription fee we get to an 11% discount. These types of transactions don't move the needle when RH is selling $4000 couches, but it may limit new customers looking to the brand at more accessible price points now without a promotional sweetner.

RH | Membership Program Goes Live - 3 14 2016 3

  • Not a secondary revenue stream: We think the customer base within the rewards segment will shift meaningfully from year to year. Furniture is an event driven purchase and due to the replacement cycle doesn’t lend itself to an Amazon prime esque annual subscription model. At checkout for the Grey Card there is a box that needs to be checked to allow RH to automatically renew the membership after the first year has expired. That all but eliminates the multi-year subscription members.

A Review Of Recent "Rallies" and What's Really Been Working

Takeaway: Did the permabulls nail this? Utilities are up 11.3% (on U.S. growth slowing) and Financials (a rate hike proxy) are down -5.6% this year.

A Review Of Recent "Rallies" and What's Really Been Working - bull riding cartoon 08.26.2015

 

Most bears are positioned bullish now - and the underwater bulls, well, they're always bullish.

 

"After 2-3 weeks of being royally squeezed, I’m doubling down on everything we’ve been saying for 8 months," Hedgeye CEO Keith McCullough wrote this morning in a note to subscribers. McCullough continues: 

 

"Everything we’ve been saying” includes not being long small caps and/or junk bonds – Russell 2000 only +0.5% last week (yes, I can take a lot more pain than that) to -4.3% YTD and -16.1% since we went broadly bearish on US stock market beta in July."

 

Permabulls can call recent bounces from the 2016 lows whatever they like. But ask them to pull the chart back a bit further and explain this uncomfortable reality.  

 

 

Another point. Investors have expressed their lack of conviction in stock rallies all year. On up days, volume is either flat or declining. That's not exactly bullish. 

 

 

To be sure, there have been some clear winners and losers in 2016. Take a look at our favorite Long/Short sectors. Long Utilities (XLU), a U.S. growth slowing proxy, is up 11.25% this year. Meanwhile, our short Financials (XLF) call, for rate hike skeptics, has also worked out nicely, down -5.6%. Neither of those are consensus or fits any bullish narrative.

 

Here's the chart:

 

A Review Of Recent "Rallies" and What's Really Been Working - year to date sectors

 

We also like Long Bonds (TLT), up 5.6% year-to-date.

 

"With the 10yr +10bps last week to 1.98%, now it’s go time (again) for the Long Bond and Utilities (XLU) bulls who are having a great year vs. “Long Financials During Rate Hike Cycle” view  (XLU +11.3% YTD vs XLF -5.6%); is the Fed going to be hawkish this week? I think so – but so does everyone else; I think rates and Financials drop on the “news” like they did post rate hike."

 

 

Don't believe all the storytelling.


MONDAY MORNING RISK MONITOR | GREEN DOESN'T MEAN GO

Takeaway: While global markets pushed higher in response to the ECB, we remain skeptical of the nature and durability of this rally.

MONDAY MORNING RISK MONITOR | GREEN DOESN'T MEAN GO - RM11

 

Key Takeaway:

Global markets reacted with broad optimism to the ECB announcing that it would cut rates and expand asset purchases last week. Our heatmap below reflects this with an overwhelming number green "risk on" signals across the short and intermediate term durations. CDS tightened globally, the high yield YTM tightened by 15 bps, the leveraged loan index rose by 20 points, and the TED spread and Euribor OIS spreads tightened by 5 bps and 4 bps respectively. Meanwhile, the price of Chinese steel jumped by 286 Yuan/ton (+13% W/W).

 

While the drumbeat in the short-term has been positive now for 3-4 weeks, we remain concerned that central planners ability to fight slowing growth is in secular decline (see Japan). We advise caution against getting over your ski tips on the bullish side.

 

Current Ideas:

MONDAY MORNING RISK MONITOR | GREEN DOESN'T MEAN GO - 3 RM19

 

Financial Risk Monitor Summary

• Short-term(WoW): Positive / 9 of 13 improved / 1 out of 13 worsened / 3 of 13 unchanged
• Intermediate-term(WoW): Positive / 9 of 13 improved / 1 out of 13 worsened / 3 of 13 unchanged
• Long-term(WoW): Negative / 1 of 13 improved / 4 out of 13 worsened / 8 of 13 unchanged

MONDAY MORNING RISK MONITOR | GREEN DOESN'T MEAN GO - 2 RM15

 

1. U.S. Financial CDS – Swaps were tighter across the board for US Financials last week. Positive US labor data coupled with the ECB's announcement for rate cuts and increased asset purchases drove the median US financial swap tighter by -8 bps to 95.

Tightened the most WoW: AIG, AXP, C
Widened the most WoW: AON, TRV, ALL
Tightened the most WoW: AIG, MET, PRU
Widened the most MoM: SLM, MBI, AGO

MONDAY MORNING RISK MONITOR | GREEN DOESN'T MEAN GO - RM1

 

2. European Financial CDS – European investors reacted with broad optimism to the ECB's announcement last week, and swaps tightened across the complex. The median swap fell by -25 bps to 104.

MONDAY MORNING RISK MONITOR | GREEN DOESN'T MEAN GO - RM2

 

3. Asian Financial CDS – Asian Bank CDS were tighter across the board last week. ICICI Bank of India saw the biggest improvement W/W at -20 bps to 182.

MONDAY MORNING RISK MONITOR | GREEN DOESN'T MEAN GO - 2 RM17

 

4. Sovereign CDS – Sovereign Swaps mostly tightened over last week. Portuguese swaps tightened the most, by 17 bps to 252.

MONDAY MORNING RISK MONITOR | GREEN DOESN'T MEAN GO - RM18

 

MONDAY MORNING RISK MONITOR | GREEN DOESN'T MEAN GO - RM3

 

MONDAY MORNING RISK MONITOR | GREEN DOESN'T MEAN GO - RM4


5. Emerging Market Sovereign CDS – Emerging market swaps mostly tightened last week. Propelled by optimism over the effects that ECB stimulus might have on global economic growth, the median swap for these producer economies tightened by 13 bps to 181.

MONDAY MORNING RISK MONITOR | GREEN DOESN'T MEAN GO - RM16

MONDAY MORNING RISK MONITOR | GREEN DOESN'T MEAN GO - RM20

6. High Yield (YTM) Monitor – High Yield rates fell 15 bps last week, ending the week at 7.84% versus 7.99% the prior week.

MONDAY MORNING RISK MONITOR | GREEN DOESN'T MEAN GO - RM5

7. Leveraged Loan Index Monitor  – The Leveraged Loan Index rose 20.0 points last week, ending at 1833.

MONDAY MORNING RISK MONITOR | GREEN DOESN'T MEAN GO - RM6

8. TED Spread Monitor  – The TED spread fell 5 basis points last week, ending the week at 31 bps this week versus last week’s print of 37 bps.

MONDAY MORNING RISK MONITOR | GREEN DOESN'T MEAN GO - RM7

9. CRB Commodity Price Index – The CRB index rose 5.4%, ending the week at 174 versus 165 the prior week. As compared with the prior month, commodity prices have increased 8.2%. We generally regard changes in commodity prices on the margin as having meaningful consumption implications.

MONDAY MORNING RISK MONITOR | GREEN DOESN'T MEAN GO - RM8

10. Euribor-OIS Spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread tightened by 4 bps to 11 bps.

MONDAY MORNING RISK MONITOR | GREEN DOESN'T MEAN GO - RM9

11. Chinese Interbank Rate (Shifon Index) – The Shifon Index was unchanged at 1.95% last week. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.

MONDAY MORNING RISK MONITOR | GREEN DOESN'T MEAN GO - RM10

12. Chinese Steel – Steel prices in China rose 13.2% last week, or 286 yuan/ton, to 2458 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity and, by extension, the health of the Chinese economy.

MONDAY MORNING RISK MONITOR | GREEN DOESN'T MEAN GO - RM12

13. 2-10 Spread – Last week the 2-10 spread widened to 103 bps, 2 bps wider than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.

MONDAY MORNING RISK MONITOR | GREEN DOESN'T MEAN GO - RM13

14. CDOR-OIS Spread – The CDOR-OIS spread is the Canadian equivalent of the Euribor-OIS spread. It is the difference between the Canadian interbank lending rate and overnight indexed swaps, and it measures bank counterparty risk in Canada. The CDOR-OIS spread was unchanged at 40 bps.

MONDAY MORNING RISK MONITOR | GREEN DOESN'T MEAN GO - RM14


Joshua Steiner, CFA



Jonathan Casteleyn, CFA, CMT


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 80.32%
  • SHORT SIGNALS 78.48%
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