Is the EM Relief Rally Nearing Its [Eventual] End?

Takeaway: We now believe EM assets are generally priced quite richly relative to our intermediate-to-long-term fundamental outlook for the space.

Our sincerest congrats to anyone who’s nailed this low-quality relief rally across global financial markets in which nearly everything levered to reflation, excessive leverage, and/or illiquidity risk led. While we’ve been the axe on the bear side of emerging markets since early 2013, we wrongly missed getting out in front of the aforementioned short squeeze with a tactical short covering view.


With respect to EM asset class returns specifically:


  • The MSCI Emerging Markets Equity Index has gained +20.6% from its 1/21 YTD trough;
  • The JPMorgan EM FX Index has gained +7.7% from its 1/21 YTD trough;
  • The Bloomberg EM Local Currency Sovereign Debt Index has gained +5.4% from its 1/20 YTD trough; and
  • The Bloomberg EM USD Corporate Bond Index has gained +6% from its 1/20 YTD trough.


These are the kinds of wildly impressive ~two month returns you can make your year on – especially if you don’t give it all back. We do, however, see mounting risk of investors “giving it all back” over the intermediate-term. Moreover, our long-term call on EM remains ultra-bearish for a variety of reasons, most recently highlighted on our recent conference call titled, “Is This a Generational Buying Opportunity in Emerging Markets?” (3/16).


CLICK HERE to access the video replay of the call, as well as the associated 105-page slide deck in PDF format.


The three key conclusions of the call were as follows:


  1. We see further downside at the primary asset class level, as well as elevated risk of material bankruptcy cycles in a number of key emerging market economies.
  2. While we remain explicitly and overtly bearish on the Chinese economy and RMB, we believe investor consensus is far too bearish on both. Most of the analysis we’ve seen inappropriately analyzes the Chinese financial sector from the perspective of Western economies; nor does it include the full range of potential outcomes – including a secular bull market in the Chinese currency and Chinese equities.
  3. On the long/overweight side we like Emerging Europe (i.e. Poland, Hungary and Czech Republic), South Korea and Thailand. In terms of short/underweight candidates, we think Latin America (specifically Brazil, Mexico and Colombia), Indonesia and South Africa are most at risk for #PhaseIII of our #EmergingOutflows theme – i.e. a wave of bankruptcy cycles.


As we take this opportunity to pound the table on the latter risk, there remains a large compendium of investors that believe EM assets are both “cheap” and a “crowded short”. We do, however, continue to believe that valuation and sentiment are not catalysts for sustained recoveries in asset prices or economies.


Is the EM Relief Rally Nearing Its [Eventual] End? - MSCI EM Index EV to EBITDA Ratio vs. MSCI World Index


On the contrary, we view the following as likely catalysts for ongoing economic deterioration and asset price declines across the emerging market space:


  1. Intermediate-term (2-3 quarters): a cyclical recovery in the U.S. dollar; and
  2. Long-term (2-3 years): a meaningful NPL cycle across key emerging market economies.


Regarding the former risk, we think a 2nd quarter delta into #Quad4 in the U.S. followed by what is likely to be two consecutive quarters of #Quad2 in 2H16 (assuming the U.S. economy is able to avoid an outright recession) may prove fundamentally bullish for the DXY – which has been consolidating in both market price and speculative net length terms for over a year now. Recall that quadrants two and four have historically proven most positive for the USD vs. peer currencies.


Is the EM Relief Rally Nearing Its [Eventual] End? - UNITED STATES


Is the EM Relief Rally Nearing Its [Eventual] End? - U.S. Dollar Index


Is the EM Relief Rally Nearing Its [Eventual] End? - EXTREME SENTIMENT MONITOR


Regarding the latter risk, we continue to see elevated risk in any buy-and-hold strategy in EM assets ahead of what is likely to be a material bankruptcy cycle that ripples across many EMEs. Per IIF data, outstanding debt in EM economies across all sectors reached $62 trillion (or 210% of GDP) in 2015. Roughly 40% of that stockpile of debt is in the nonfinancial corporate sector – which is especially exposed to structurally depressed commodity prices (read: perpetually lower FCF absent a material and sustained recovery in commodity prices).


Is the EM Relief Rally Nearing Its [Eventual] End? - CRB Index vs. MSCI Emerging Markets Index EPS


Per our analysis, we haven’t seen anything yet in terms of a meaningful NPL cycle across emerging markets. The median and mean NPL ratios across the 20 emerging market economies covered by our proprietary EM Crisis Risk Index are 3% and 3.6%, respectively, which compares to the 1 EM bankruptcy cycle peaks of 12.4% and 14.2% – which were both recorded in 1999, respectively. Moreover, those NPL ratios are only beginning to trend higher off all-time lows as a spread to the mean and median NPL ratios across advanced economies. This would imply a substantial degree of pain is yet to come.


Is the EM Relief Rally Nearing Its [Eventual] End? - EME NPL Ratio vs. AE NPL Ratio


Is the EM Relief Rally Nearing Its [Eventual] End? - EME NPL Ratio vs. AE NPL Ratio Spread


Don’t get piggy on the long side of emerging markets. Keep a [great] trade a trade out there.




Darius Dale


Cartoon of the Day: The Fourth Turning

Cartoon of the Day: The Fourth Turning - demographics cartoon 03.23.2016


Demographic trends are radically reshaping the U.S. economy.

QUICK TAKE: How To Risk Manage Gold | $GLD

QUICK TAKE: How To Risk Manage Gold | $GLD - gold bar

Bullish on Gold? We are.


Here's some key short-term trading advice via our Macro team:


"... Gold is up ~19% for the year, the USD going up and interest rates going up could cause gold to fall. Around 1,225 is an interesting spot to buy more gold but we are going to be a little more patient in the face of all the rate rise commentary. The immediate-term risk range for gold is 1225-1279."


Hedgeye CEO Keith McCullough sent out a key signal in Real-Time Alerts Monday warning subscribers about inherent risks to gold given current macro trading.


Check out McCullough's recent interview with bestselling author Jim Rickards, "Why Gold Is Going To $10,000."

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GOP Candidates React To Brussels Terror Attack

Takeaway: What to watch on the election 2016 campaign trail.

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



GOP Candidates React To Brussels Terror Attack - brussels


The attacks in Brussels will revive terrorism and national security as premier issues in the presidential campaign, likely displacing economic and social issues.  All of the candidates will now focus their strategies and resolve to combat terror, and will play heavily into Donald Trump's game plan. Trump called practically every major news network yesterday morning, highlighting his views on the importance of border control and echoed his previous statements regarding Muslims -- that our country should shut down our borders until we "know exactly what is going on."  Not wasting any time, Cruz trumped him with his call for the policing of Muslim neighborhoods and treating them like gang areas... hmmm



GOP Candidates React To Brussels Terror Attack - chess board


Cruz's team understands the only he can defeat Trump is to beat him on the second ballot at the convention -- when delegates are no longer bound to any one candidate. Cruz would have access to all of Marco Rubio and Jeb Bush's supporters -- while also making a play to steal Trump's and Kasich's delegates. His campaign has been stealthy in targeting Republican kingmakers and state convention delegates well before they pack their bags for Cleveland, looking to secure their support on the second ballot.

McCullough: Give Me Liberty!


In this excerpt from The Macro Show this morning, Hedgeye CEO Keith McCullough takes a page out of American patriot Patrick Henry’s playbook on the anniversary of his "Give me liberty, or give me death!" speech. He also addresses critics of his current bearish stance on equities.


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


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From Their Lips: 5 Recent (Head-Scratching) Fed Statements

Takeaway: We think the hawkish tone from policymakers sets up a potential April policy mistake. Watch out.

From Their Lips: 5 Recent (Head-Scratching) Fed Statements - Fed cartoon 12.21.2015


Are the omnipotent central planners at the Fed losing touch with economic reality?


Hedgeye CEO Keith McCullough offered his thoughts in a Real-Time Alerts note to subscribers earlier this morning:


"... I am officially concerned the Fed makes yet another Policy Mistake (either raising rates in April or signaling they're raising in June in the April statement).


The US Dollar has done nothing but go up this week post multiple Fed heads making hawkish statements, and there's obviously a lot of market risk in that (see "reflation" on Down Dollar trades for details!).


While the Fed shouldn't be raising rates into a slow-down (remember what happened to markets post the DEC hike), that doesn't mean they won't. One of the biggest markets risks has always been the Fed's forecasts."


In short... post-rate hike stocks tumbled and Long Bonds (TLT) rallied...  


From Their Lips: 5 Recent (Head-Scratching) Fed Statements - s p 500 rate hike


With the recent stock market rally and hawkish commentary from the Fed, markets are standing on the precipice of yet another precarious setup.


Here's a brief recap of (head-scratching) Fed president statements this week that (we think) raises the specter of a policy blunder:

  • Chicago Fed head Charles Evans said U.S. economic fundamentals are "really quite good," citing improving manufacturing activity. (3/22)
  • San Francisco Fed head John Williams said the U.S. economy is “looking great” and the Fed would raise rates faster were it not for global factors. “All else equal, assuming everything else is basically the same and the data flow continues the way I hope and expect, then April or June would definitely be potential times to have an increase in interest rates." (3/21)
  • St. Louis Fed head James Bullard said a case could be made for rate hike in April, sounding a hawkish tone. "The odds that we will fall somewhat behind the curve have increased modestly... We are going to get some [inflation] overshooting here in the relatively near term that might cause the committee to have to raise rates more rapidly later on." (3/23)
  • Philadelphia Fed head Patrick Harker said "I think we need to get on with... This economy is really quite resilient to a lot of the headwinds (including the strong dollar).... I am not a two (rate) rise person... I'd rather see [more hikes this year]." (3/22)
  • Atlanta Fed head Dennis Lockhart said U.S. economic growth has "sufficient momentum evidenced by the economic data to justify a further step at one of the coming meetings, possibly as early as the meeting scheduled for end of April." (3/21)



Consider our Macro team's insights from a note sent to subscribers earlier this morning:


"Federal Reserve Bank of Chicago President Charles Evans said yesterday that economic fundamentals are “really quite good.” We aren’t sure if he said this immediately after existing home sales was reported being down -7% month-over-month or what he was precisely talking about.


People who have no idea what is going on are preparing to do something that they already did that didn’t work…RAISING RATES. What has led the market higher is USD dollar down and reflation, so what happens in April if the Fed raises rates or indicates that they will raise in June?


That will be a destabilizer in markets."


Investors can choose to double-down on the Fed's wrongheaded economic projections. But two words of advice .. remember December.


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