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[UNLOCKED] What’s More Important: the Short Squeeze in the Market or the Data?

Takeaway: Investors would do well to appropriately contextualize and actively risk manage head fakes in domestic economic data.

Editor's Note: Earlier today, the Atlanta Fed's GDPNow estimate (which forecasts U.S. GDP growth) hit 1.4% for Q1 2016 versus 2.6% just a month ago. Last month, Hedgeye Senior Macro analyst Darius Dale wrote:

 

"Don’t get caught up in the current strength of the Atlanta Fed’s GDPNowcast or what may actually turn out to be a decent Q1 GDP report on a headline basis. We strongly consider both of those catalysts to be head fakes in the context of the underlying sine curve of U.S. economic and capital markets activity."

 

Below is his prescient research note in its entirety explaining why our own GDP estimate is substantially below Wall Street consensus and Atlanta Fed estimates. For more information on how you can subscribe to our institutional research email sales@hedgeye.com.

 

[UNLOCKED] What’s More Important: the Short Squeeze in the Market or the Data? - bear gdp

 

If I’ve heard Keith reference PTJ’s quote about the last third of the move being “the toughest to risk manage” in a meeting once, I’ve heard it a thousand times. In bear markets, those who mismanage “the last third of the move” are short sellers that cover too early (in fear of the policy response) and bulls that cite “valuation” as a reason to purchase securities – quite often far too early. Both are buy orders, FYI.

 

Did the shorts cover too early?

 

No, well at least not from the perspective of our short-term trading signals. Last Wednesday morning, we published an immediate-term risk range of 1835-1899 for the S&P 500, which was an explicit signal for investors to cover shorts well into last Thursday’s low (1810 to be exact).

 

That’s not to suggest that we’ve nailed it by any stretch of the imagination, but rather to reiterate the omnipotence of actively  managing risk in bear markets. We’ve been vocal in stressing that bear-market bounces are typically more sharp than their bull-market counterparts. The +645bps rally in the SPX from Thursday’s intra-day low to today’s closing price is allegedly the sharpest three-day rally since the thralls of our last bear market in late-2008.

 

Indeed, high short interest stocks are the 2nd best-performing style factor on a WoW basis, just behind high beta stocks. We consider that to be ample enough evidence of aggressive covering of crowded momentum shorts. I’m sure there will be plenty of research notes from prime brokers highlighting this very point tomorrow morning – if there haven’t been already. Obvious is as obvious does.

 

[UNLOCKED] What’s More Important: the Short Squeeze in the Market or the Data? - WoW Style Factor Performance large  1

 

In light of the aforementioned strength in the U.S. equity market, has anything materially changed, quantitatively speaking?

 

No, certainly not from the perspective of our Tactical Asset Class Rotation Model (TACRM), which shows that:

 

  1. Realized volatility continues to accelerate on a trending basis across asset classes.
  2. TACRM continues to generate a [bearish] “DECREASE Exposure” signal for U.S. Equities at the primary asset class level.
  3. Across the 47 sector and style factor exposures TACRM tracks within U.S. Equites, only two are signaling bullishly from the perspective of TACRM’s multi-duration, volatility-adjusted view of volume-weighted average price momentum.

 

***CLICK HERE to download the latest refresh of our TACRM presentation.***

 

[UNLOCKED] What’s More Important: the Short Squeeze in the Market or the Data? - TACRM U.S. Equities 10 10

 

A much more difficult question to answer at the current juncture is, “Has anything materially changed, fundamentally speaking?”

 

On a trending basis, the answer to that question is a resounding “no” – especially with respect to: 1) the corporate profit cycle, 2) the C&I credit cycle, and 3) the monetary policy cycle. As we’ve detailed extensively in recent notes, the confluence of the likely progression of each will be the determining factor for ultimate downside in risk asset prices:

 

  1. The Domestic #CreditCycle Is About to Get A Lot Worse (1/26): “As the ongoing corporate profit recession deepens, we highlight the obvious risk of companies allocating earnings to buybacks and dividends, rather than preserving cash and paying down debt. If our explicitly negative view on the domestic economic cycle continues to be corroborated by the data, then the growth rate of such payouts will likely have to slow dramatically – if not decline outright. That is an obvious headwind to the broader equity market in terms of removing key cogs from the post-crisis secular bull case.”
  2. Ex-Energy? (2/3): “And even if the U.S. economy avoids recording a technical recession, we could just have an 2000-02-style corporate deleveraging cycle that drags down equity market cap alongside it. After all, it's EPS that matters most to stocks, not GDP. Recall that the 2001 downturn was the shallowest recession in U.S. history; that didn't preclude the stock market (SPX) from getting cut in half.”
  3. Sentiment Update: Three Things I Learned Today (and Three Weeks From Now) (1/20): “While ZIRP and LSAP have proven to be powerful tools in perpetuating income-inequality generating asset price inflation throughout this economic and corporate profit expansion, the Federal Reserve has yet to demonstrate the effectiveness of monetary easing during concomitant recessions in economic activity and corporate profit growth.”

 

[UNLOCKED] What’s More Important: the Short Squeeze in the Market or the Data? - CORPORATE PROFITS VS. SPX

 

[UNLOCKED] What’s More Important: the Short Squeeze in the Market or the Data? - U.S.  CreditCycle Bubble Chart

 

[UNLOCKED] What’s More Important: the Short Squeeze in the Market or the Data? - Hedgeye Bank Credit Cycle Indicator

 

[UNLOCKED] What’s More Important: the Short Squeeze in the Market or the Data? - U.S. Household Wealth as a   of Disposable Personal Income vs. Shadow FFR

 

On a shorter-term basis, astute investors have been asking us the right questions about sequentially improving high-frequency economic data. In the 1Q16 to-date, we’ve seen three releases that lend some pause to our bearish outlook for the domestic economy – if only for a brief moment:

 

  1. First, the ISM Manufacturing PMI ticked up ever-so-slightly to 48.2 in JAN from a reading of 48.0 in DEC. The New Orders index rose back above 50 for the first time since OCT; its 51.5 reading for the month of JAN is the highest since AUG.
  2. Then, the growth rate of Retail Sales – specifically the omnipotent “Control Group” therein – accelerated meaningfully to +3.1% YoY in JAN from +2.2% in DEC. Per the JAN release, the growth rate of Retail Sales – which accounts for a third of consumer spending and a fourth of GDP – is now accelerating on a trending basis.
  3. Lastly, the growth rate of Industrial Production accelerated to -0.7% YoY in JAN from a downwardly revised -1.9% in DEC. Sequential strength was recorded across all key product categories as Capacity Utilization arrested what had been five consecutive months of MoM contraction and YoY deceleration.

 

[UNLOCKED] What’s More Important: the Short Squeeze in the Market or the Data? - ISM MANUFACTURING PMI

 

[UNLOCKED] What’s More Important: the Short Squeeze in the Market or the Data? - RETAIL SALES CONTROL GROUP  2

 

[UNLOCKED] What’s More Important: the Short Squeeze in the Market or the Data? - INDUSTRIAL PRODUCTION

 

While it would be easy to poke holes in each of the aforementioned releases (for example, the Employment index of the JAN ISM report crashed to a new cycle low of 45.9), it’s not clear to me that that would be a valuable use of your time; nor would it be a valuable endeavor on which to expend analytical credibility. The risk of being perceived as arguing with the data for too long for a research outfit that doesn’t have banking, trading or asset management to support its revenues is arguably just as punitive as the risk of a money manager fighting the market for too long.

 

A better use of our collective time is attempting to determine the sustainability of the aforementioned positive deltas in economic data:

 

  1. With respect to a sustained recovery in domestic manufacturing activity, we flag sequentially declining U.S. dollar comps throughout the balance of the year as positive and consider the high likelihood that we tip back into #Quad4 – which has historically been positive for the USD – in the upcoming quarter to be a potential negative shock.
  2. With respect to a sustained recovery in consumer spending, we still believe the sharp acceleration in base effects through the third quarter of this year will continue to be a material negative catalyst for reported growth rates of household consumption. Specifically, base effects for Real PCE growth in the four-quarters ended 3Q16 are far and away the toughest since the four-quarters ending in 3Q08. Recall that Real PCE growth decelerated sharply from +2.7% YoY in AUG ’07 to -1.2% in SEP ’08.
  3. With respect to a sustained recovery in the industrial sector, we highlight generally receding base effects throughout the balance of the year as a positive catalyst. This is juxtaposed with the negative cocktail of rising credit costs, peak inventories and GDP-negative capital allocation decisions from major U.S. corporations (e.g. AAPL, IBM buybacks).

 

[UNLOCKED] What’s More Important: the Short Squeeze in the Market or the Data? - Trade Weighted U.S. Dollar Index

 

[UNLOCKED] What’s More Important: the Short Squeeze in the Market or the Data? - UNITED STATES

 

[UNLOCKED] What’s More Important: the Short Squeeze in the Market or the Data? - Real PCE Comps

 

[UNLOCKED] What’s More Important: the Short Squeeze in the Market or the Data? - Industrial Production Comps

 

[UNLOCKED] What’s More Important: the Short Squeeze in the Market or the Data? - Barclays Agg Credit YTW

 

[UNLOCKED] What’s More Important: the Short Squeeze in the Market or the Data? - Inventory to Sales Ratio

 

All that having been discussed, let us turn our attention to the Atlanta Fed’s recent revision of their “GDPNowcast” for Q1 to 2.6% per the latest release. That forecast is up from a trough of +0.6% as recently as mid-January and has the attention of many concerned short-sellers and confident bulls alike.

 

[UNLOCKED] What’s More Important: the Short Squeeze in the Market or the Data? - Atlanta Fed GDPNow Tracker

 

How important is the aforementioned estimate within the context of the Atlanta Fed’s ~4.5 year-old track record at forecasting U.S. GDP growth? Not very.

 

The following chart shows us the Atlanta Fed’s peak (green line) and trough (red line) estimates 47 days into any given quarter as we are currently. These figures are juxtaposed with the actual recorded QoQ SAAR growth rate of U.S. GDP (blue line) and the maximum tracking error of the Atlanta Fed’s GDPNowcast (black line). The average maximum intra-quarter-to-date tracking error is a startling 248bps over the duration of this study. That is a whopping 113% of average growth rate of GDP over that same time frame (i.e. 2.2%)!

 

[UNLOCKED] What’s More Important: the Short Squeeze in the Market or the Data? - Atlanta Fed Tracking Error

 

PLEASE NOTE: We are not showing this analysis with the intention of undermining the Atlanta Fed. Their GDPNowcast estimates are a good barometer of what consensus thinks about near-term growth prospects and their work in charting the “Shadow” Fed Funds Rate has been equally additive to the Macro discussion. We simply highlight the elevated risk of their current forecast for Q1 2016 being revised materially lower (or higher) as the quarter progresses. It’s worth noting that we’ve hardly received much in the way of January data – let alone enough data points to have statistical validity in any regression model.

 

As we highlighted in our 9/2 Early Look titled, “Do You QoQ?”:

 

“In the context of modeling the economy, the more we learn about sequential momentum, the less we are able to know about the underlying growth rate of the economy. Recall that headline GDP growth accelerated +660bps to +7.8% in the 2nd quarter of 2000 and that it accelerated +470bps to +2% in the 2nd quarter of 2008. If you were prescient in forecasting these second-derivative deltas, you could’ve bought all the stocks you wanted en route to peak-to-trough declines on the order of -49.1% and -56.8%, respectively (S&P 500)… Going back to the aforementioned head-fakes, it’s clear that those read-throughs on sequential momentum failed to signal pending material changes to the underlying growth rate of the economy.”

 

In the aforementioned note, we also highlighted the poor track records of both Bloomberg Consensus and the Fed in forecasting quarterly and annual GDP growth rates in the post-crisis era:

 

  • “Over the past five years, Bloomberg consensus forecasts for headline GDP just one quarter out have demonstrated a quarterly average [maximum] tracking error of 145bps. This means that at some point within 3-6 months of any given quarter-end, Wall St. economists’ estimates for QoQ SAAR real GDP growth were off by an average of 145bps. That’s flat-out terrible in the context of actual reported QoQ SAAR growth rates averaging just 2.1% over this period."
  • “Over the past five years, the FOMC’s intra-year U.S. GDP forecasts have demonstrated an annual average [maximum] tracking error of 100bps. Worse, the maximum deviation of their intra-year forecasts from the actual reported annual real GDP growth rate was an upside deviation in every single year, meaning that the Fed’s growth forecasts are consistently far too optimistic.”

 

As the following charts demonstrate, the aforementioned updated quarterly and annual average maximum tracking errors are now 164bps and 91bps, respectively (data through EOY ‘15). These updated figures continue to reflect the fact that investors should remain highly skeptical of even the nearest-term growth forecasts from economists and/or policymakers. At best they’re playing a game of Marco Polo; at worst, they are feeding potentially hazardous information to market participants.

 

[UNLOCKED] What’s More Important: the Short Squeeze in the Market or the Data? - Bloomberg Consesus Real GDPTracking Error

 

[UNLOCKED] What’s More Important: the Short Squeeze in the Market or the Data? - FOMC GDP Tracking Error

 

All told, as we discussed at length in our 1/29 note tilted, “What Recession?!”, predicting headline (i.e. QoQ SAAR) GDP is a fool’s errand. Don’t get caught up in the current strength of the Atlanta Fed’s GDPNowcast or what may actually turn out to be a decent Q1 GDP report on a headline basis. We strongly consider both of those catalysts to be head fakes in the context of the underlying sine curve of U.S. economic and capital markets activity.

 

Best of luck out there,

 

DD

 

 

Darius Dale

Director


5 Ugly Markets Around The Globe

5 Ugly Markets Around The Globe - Global economy cartoon 12.16.2014

 

Sure, there's always a bull market somewhere... but you won't find one in the five markets below. Each one looks especially ugly when you peel back the onion. 

1. JAPAN

 

2. Australia

 

3. Germany

 

4. Russell 2000

 

5. CRB Index (commodities)

 

 

You'll note that each one of these markets have been consistently making lower highs. The lesson here? Fairly simple. Don't blindly fish for bottoms in falling markets.


RTA Live: March 24, 2016


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We Are Unafraid To Be The Bears

Takeaway: The Fed raising rates into a slowdown could be the catalyst for dollar strength. Not good for commodities and stocks.

 

In the famous scene above from the 1980s classic "Caddyshack," ace golfer Ty Webb (Chevy Chase) blindfolds himself before making a string of tremendous shots, advising his young confused-about-life caddy Danny Noonan to "be the ball."

 

Ty's point? Relax. Take a deep breath. Trust in your skill and hard work.

 

On a related note, the recent stock market "rally" doesn't mitigate our major concerns about market risk. To the contrary. As many of you already know, we're unafraid to "Be the Bears" on stocks. In light of the precarious setup in U.S. equity markets, here's what Hedgeye CEO Keith McCullough wrote in a note to subscribers earlier today.

 

"Dollar Up, Reflation Down – it’s not that complicated to understand unless you are the Fed, trying to maintain “credibility” going for another policy mistake, raising rates into a slowdown. We’ll see if they’re S&P 500 (instead of data) dependent, the 15-day correlation (machines chase it) between USD and SPX is -0.84."

 

And some related thoughts from Hedgeye Macro analyst Darius Dale. (Click to enlarge the chart.)

 

The other market tethered to moves in the U.S. dollar? Commodities.

 

As McCullough points out in today's Early Look, the two week inverse correlation between U.S. and CRB commodities index is -0.96. "Where do you think the Commodity “Bull” and/or reflation trade will be if the US Dollar Index ramps another +3% from here?" 

 

Here's a hint. Look at the chart of the CRB index below, inclusive of the recent "rally" and yesterday's drawdown on dollar strength:

 

 

Remember... Fed heads have been trumpeting U.S. economic fundamentals that look "really quite good" and lauding modest improvements in inflation and the manufacturing sector. In fact, the chorus of Fed officials getting hawkish on further interest rate increases gets stronger every day. Some are calling for rate hikes as soon as April. We think the likely outcome from here is further dollar strength (i.e. not good for commodities or stocks).

 

More data...

 

With the S&P 500 back to flat for the year, permabull pundits and financial journalists have been praising the recent "rally." Rally? Meanwhile, small cap stocks reveal an entirely different story. 

 

"We are The Bears on U.S. stocks," McCullough writes. "And we can’t understand how the Russell dropping a full -1.9% yesterday back to -5.3% year-to-date (and -17% since July) is bullish. Apparently, if no one talks about it and quotes the S&P 500, everything is fine."

 

 

No matter. We'll keep crunching the numbers.

 

What the data tells us is that U.S. growth is slowing and the Fed is hell-bent on raising rates into this slowdown. 


PVH | Added to Short Bench. Now or in 6 Months?

Takeaway: Up 36% ahead of bad quality EPS. Buy into mgmt’s pitch if you want. But we think PVH is a short. NT timing is all that matters to us now.

We’re adding PVH to our short bench – not because this quarter was horrible at face value (EPS -14% yet Manny ‘beat expectations’), or because it’s up 36% since January. But because we think the poor quality of earnings is validation that this business is seriously growth-constrained going forward. It arguably has only one highly defendable piece of the business, and that’s CK fragrances, and even that’s been losing share in recent years. How we’re doing the math, fragrances’ $1.4bn in retail revenue accounts for about 18% of EBIT.  That leaves over 80% of earnings and cash flow that we have a tough time arguing will grow or improve margins without a meaningful capital investment. Could PVH simply do another deal? Yes, it’s possible. But to see a company with a $10bn EV and $3bn in debt do a sizable transaction so late in the economic cycle would be downright frightening. It would also validate that it’s got no game in its core business.  The key thing for us today is to drill down whether it is a short right now, or in another six months based on a) the puts and takes of the near-term model and b) how management ‘works the street’ (or at least tries to – it’s getting old) as it relates to expectations.  Regardless, there’s nothing we could hear on the call that is likely to change our long term view on this business, or the limited prospects for its brands.

 

Much more to come on this one.

 

PVH | Added to Short Bench. Now or in 6 Months? - 3 24 2016 chart1

 

PVH | Added to Short Bench. Now or in 6 Months? - 3 24 2016 chart2

 

PVH | Added to Short Bench. Now or in 6 Months? - 3 24 qcomp chart3


ICI Fund Flow Survey | DOL To Put Active Strategies DOA

Takeaway: Active equity strategies continued to struggle in the most recent survey and the forming DOL rules won't help.

Investment Company Institute Mutual Fund Data and ETF Money Flow:

In the 5-day period ending March 16th, three of five active equity mutual fund categories lost funds with large cap equity and emerging market funds seeing the biggest redemptions losing  -$1.3 billion and -$1.0 billion respectively. Meanwhile equity ETFs continued their market share advance during the week with +$3.5 billion in contributions. Fixed income allocations snapped back with total bond mutual funds and ETFs collecting +$7.3 billion as investors rebalanced from the 5 week long stock rally.

As if the active business didn't have enough challenges competing with passive ETFs to begin with, the forming Department of Labor Fiduciary rule is decidedly skewed to driving incremental growth into index products. The DOL outlines "conflicted advice" as an active mutual fund distributed by a third party (a broker dealer for example not associated with the fund family) and if those 3rd party funds underperform their benchmark then the new rule gives retail investors (in the retirement channel) the ability to pursue class action law suits against the distributors. Thus, passive ETFs or index funds stand to benefit as a way to circumvent the guidelines, as by definition they can't "underperform." Our Speaker Series call this week with Bob Litan laid out a framework for understanding this policy (see Speaker Series replay HERE). 

 


ICI Fund Flow Survey | DOL To Put Active Strategies DOA - ICI1

 

In the most recent 5-day period ending March 16th, total equity mutual funds put up net outflows of -$2.1 billion, trailing the year-to-date weekly average outflow of -$302 million and the 2015 average outflow of -$1.6 billion.

 

Fixed income mutual funds put up net inflows of +$4.9 billion, outpacing the year-to-date weekly average inflow of +$793 million and the 2015 average outflow of -$475 million.

 

Equity ETFs had net subscriptions of +$3.5 billion, outpacing the year-to-date weekly average outflow of -$2.6 billion and the 2015 average inflow of +$2.8 billion. Fixed income ETFs had net inflows of +$2.4 billion, outpacing the year-to-date weekly average inflow of +$2.3 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 | DOL To Put Active Strategies DOA - ICI2

 

ICI Fund Flow Survey | DOL To Put Active Strategies DOA - ICI3

 

ICI Fund Flow Survey | DOL To Put Active Strategies DOA - ICI4

 

ICI Fund Flow Survey | DOL To Put Active Strategies DOA - ICI5

 

ICI Fund Flow Survey | DOL To Put Active Strategies DOA - 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 | DOL To Put Active Strategies DOA - ICI12

 

ICI Fund Flow Survey | DOL To Put Active Strategies DOA - ICI13

 

ICI Fund Flow Survey | DOL To Put Active Strategies DOA - ICI14

 

ICI Fund Flow Survey | DOL To Put Active Strategies DOA - ICI15

 

ICI Fund Flow Survey | DOL To Put Active Strategies DOA - 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 | DOL To Put Active Strategies DOA - ICI7

 

ICI Fund Flow Survey | DOL To Put Active Strategies DOA - ICI8



Sector and Asset Class Weekly ETF and Year-to-Date Results: In sector SPDR callouts, investors withdrew -$411 million or -5% from the utilities XLU ETF last week.

 

ICI Fund Flow Survey | DOL To Put Active Strategies DOA - 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 | DOL To Put Active Strategies DOA - ICI17

 

ICI Fund Flow Survey | DOL To Put Active Strategies DOA - ICI18



Net Results:

The net of total equity mutual fund and ETF flows against total bond mutual fund and ETF flows totaled a negative -$5.9 billion spread for the week (+$1.4 billion of total equity inflow net of the +$7.3 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 -$541 million (negative numbers imply more positive money flow to bonds for the week) with a 52-week high of +$20.2 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 | DOL To Put Active Strategies DOA - ICI10

 


Exposures:
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 | DOL To Put Active Strategies DOA - ICI11 



Jonathan Casteleyn, CFA, CMT 

 

 

 

Joshua Steiner, CFA







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