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Stock Report: CME Group (CME)

Takeaway: We added CME to Investing Ideas on the long side on 3/24.

Stock Report: CME Group (CME) - HE CME table 4 1 16

THE HEDGEYE EDGE

 

We recently completed a granular, deep dive study demonstrating that all classes of volatility including equity, fixed income, and FX have been managed lower by a U.S. Central Bank engineering a historically abnormal quantitative easing policy over the past 7 years.

 

What does this mean and what are the implications? Well, with Quantitative Easing over (for now) and the Federal Reserve on a rate hiking policy path (for now), for the first time in a long time there is a reason to hedge bond and equity exposure. CME is one of the few venues that allows both institutional and retail investors to do exactly that. The company manages the entire Treasury futures curve and also most of the equity index futures in the U.S.

 

INTERMEDIATE TERM (TREND)

 

In this late cycle economic environment, CME Group (CME) has a solid earnings trajectory. The exchange continues to benefit from all 3 legs of the exchange stool including incremental volatility; incremental participants coming into its markets; and also new product introduction. Over the course of the next 12 months, we think the earnings opportunity will jump and the path to more than $5 per share in earnings will become more obvious. (Note: Our earnings target is over +15% ahead of the Street.)

 

Along the way, CME should continue to issue its variable year-end dividend of up to $1 billion (near $3 per share or a 3.1% yield on this distribution alone). In an environment that has entered into an earnings recession (2 consecutive quarters of negative Y/Y earnings results for the S&P 500), the exchange's results are accelerating to the upside. This large cap company currently sits on our Best Ideas list as a Long with solid earnings growth and a defensive business that thrives on incremental volatility across asset classes.

 

LONG TERM (TAIL)

 

There looks to be a forming secular case that energy hedging from a commercial standpoint is receding as, historically, E&P enterprises have not hedged at low commodity prices. This is showing up in lower energy trader counts in the CFTC bi-monthly data. Conversely, financial traders counts are growing and what was a “lost decade” in financial activity (from 2000-2010 during the Financial Crisis) should be a boon for fixed income and equity hedging, which benefits CME. Thus, from a secular standpoint the more financially oriented CME will outflank the more energy dependent Intercontinental Exchange from an activity and trader growth stand point.

ONE-YEAR TRAILING CHART

Stock Report: CME Group (CME) - HE CME chart 4 1 16


It's Happening: The Belief System Is Breaking Down

Takeaway: The only thing crashing more than markets in Japan and Europe is faith in central planners. Is the U.S. next?

It's Happening: The Belief System Is Breaking Down - central banker cartoon 02.02.2016

 

The #BeliefSystem that central-market-planners in Japan and Europe can levitate stock markets continues to crash…

 

According to Reuters, "Bank of Japan Governor Haruhiko Kuroda stressed on Tuesday his readiness to expand monetary policy still further, saying that market moves would be key factors the central bank would examine in deciding when and how it might next expand stimulus."

 

So... how about those "market moves?"

 

Some analysis via Hedgeye CEO Keith McCullough in a note sent to subscribers this morning:

 

"Japan big rip higher in the Yen to immediate-term overbought at 110 (vs USD) smoked Japanese stocks again, -2.4% Nikkei taking the crash from the July US Equity market high of 2015 to -24.6% - negative yields is not working in Japan or Europe (DAX down -2.4% and -22.6% since last year’s top)"

 

 

Take a look at the strength of the Yen versus the Dollar, a move in direct opposition to the BOJ's intent:

 

It's Happening: The Belief System Is Breaking Down - jpy strenght

 

 

Meanwhile, in Europe, Germany is crashing...

 

 

... Italian stocks? plummeting...

 

 

The latest "jig is up" moment for central planners came in India. The Reserve Bank of India cut interest rates to a five year low... and (surprise!) the Bombay Stock exchange fell.

 

 

The evidence is piling up. Global central bankers around the world can't fight economic gravity. But how about the U.S. and the Fed?

 

On that front, Hedgeye CEO Keith McCullough has been pretty candid about what he thinks. Watch the video below:

 


[UNLOCKED] Fund Flow Survey | Active Equity Bleeding

Takeaway: Passive equity ETFs took in +$5.4B while all active equity categories lost funds. Additionally, HY bond subscriptions slowed.

Editor's Note: This is a complimentary research note originally published March 31, 2016 by our Financials team. If you would like more info on how you can access our institutional research please email sales@hedgeye.com.

*  *  *  *

Investment Company Institute Mutual Fund Data and ETF Money Flow:

The migration from active equity funds to passive ETFs was especially pronounced in the 5-day period ending March 23rd. All five active equity mutual fund categories experienced net redemptions, summing to a -$2.1 billion loss. Meanwhile, equity ETFs drew +$5.4 billion in subscriptions. This ongoing migration is one of the main reasons TROW, which is committed to active only strategies, should underperform going forward. We are hosting a call today at 11 AM to detail the TROW short case (invite here). The best grossing passive products year-to-date have been defensive in nature including the SPDR Gold Trust and the iShares Aggregate Bond and long dated 20 Year+ Treasury ETF. Conversely, net redemptions are being led by WisdomTree's two largest funds, the Hedged Japan (DXJ) and the Hedged Europe (HEDJ) product, as the newest rounds of QE in each geography is resulting in risk aversion and not risk taking (see our latest WETF note here).

 

[UNLOCKED] Fund Flow Survey | Active Equity Bleeding - ETF flow YTD

 

Fixed income had another week of big inflows. Total fixed income mutual funds and ETFs took in +$5.8 billion, slightly less than the previous week due in part to high yield subscriptions slacking down to +$420 million from +$1.5 billion in the previous week. We believe the recent inflows into high yield are a temporary phenomenon.


[UNLOCKED] Fund Flow Survey | Active Equity Bleeding - ICI1

 

In the most recent 5-day period ending March 23rd, total equity mutual funds put up net outflows of -$2.1 billion, trailing the year-to-date weekly average outflow of -$455 million and the 2015 average outflow of -$1.6 billion.

 

Fixed income mutual funds put up net inflows of +$4.7 billion, outpacing the year-to-date weekly average inflow of +$1.1 billion and the 2015 average outflow of -$475 million.

 

Equity ETFs had net subscriptions of +$5.4 billion, outpacing the year-to-date weekly average outflow of -$1.9 billion and the 2015 average inflow of +$2.8 billion. Fixed income ETFs had net inflows of +$1.2 billion, trailing the year-to-date weekly average inflow of +$2.2 billion but outpacing 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:

 

[UNLOCKED] Fund Flow Survey | Active Equity Bleeding - ICI2

 

[UNLOCKED] Fund Flow Survey | Active Equity Bleeding - ICI3

 

[UNLOCKED] Fund Flow Survey | Active Equity Bleeding - ICI4

 

[UNLOCKED] Fund Flow Survey | Active Equity Bleeding - ICI5

 

[UNLOCKED] Fund Flow Survey | Active Equity Bleeding - 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.

 

[UNLOCKED] Fund Flow Survey | Active Equity Bleeding - ICI12

 

[UNLOCKED] Fund Flow Survey | Active Equity Bleeding - ICI13

 

[UNLOCKED] Fund Flow Survey | Active Equity Bleeding - ICI14

 

[UNLOCKED] Fund Flow Survey | Active Equity Bleeding - ICI15

 

[UNLOCKED] Fund Flow Survey | Active Equity Bleeding - 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:

 

[UNLOCKED] Fund Flow Survey | Active Equity Bleeding - ICI7

 

[UNLOCKED] Fund Flow Survey | Active Equity Bleeding - ICI8



Sector and Asset Class Weekly ETF and Year-to-Date Results: In sector SPDR callouts, investors contributed +$160 million or +7% to the materials XLB ETF this week.

 

[UNLOCKED] Fund Flow Survey | Active Equity Bleeding - 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.

 

[UNLOCKED] Fund Flow Survey | Active Equity Bleeding - ICI17

 

[UNLOCKED] Fund Flow Survey | Active Equity Bleeding - ICI18



Net Results:

The net of total equity mutual fund and ETF flows against total bond mutual fund and ETF flows totaled a negative -$2.6 billion spread for the week (+$3.2 billion of total equity inflow net of the +$5.8 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 -$485 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.)

  

[UNLOCKED] Fund Flow Survey | Active Equity Bleeding - 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:

 

[UNLOCKED] Fund Flow Survey | Active Equity Bleeding - ICI11 


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CHART OF THE DAY: What's The Catalyst For A Stock Crash?

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye CEO Keith McCullough. Click here to learn more. 

 

"... How the heck could that ever happen? It’s impossible that the #BeliefSystem could ever break down, isn’t it? Other than US corporate profits being negative for 2 consecutive quarters (which has always equated to a > 20% decline), what is your catalyst, Keith??”

 

A: The Cycle"

 

CHART OF THE DAY: What's The Catalyst For A Stock Crash? - 04.05.16 Chart


Disease Of Expectations

“Because I and my companions suffer from a disease of the heart which can be cured only with gold.”

-Hernan Cortes

 

Not to be confused with the disease of begging central-market-planners for more currency devaluation (punishes the many) in exchange for short-term asset inflation (pays the few), that’s how the boys back in the day used to think about pillaging populations for Gold.

 

“In 1519, Hernan Cortes and his conquistadors invaded Mexico, hitherto an isolated human world. The Aztecs, as the people who lived there called themselves, quickly noticed that the aliens showed an extraordinary interest in a certain yellow metal.”

 

Since the Aztecs were used to paying for things with cocoa beans and cloth, “the Spanish obsession with gold thus seemed inexplicable” (Sapiens, pg 173). Ah, what idiots those Aztecs must have been. They totally wouldn’t have understood QE either.

 

Disease Of Expectations - Fed Up cartoon 03.22.2016

 

Back to the Global Macro Grind

 

I believe that our profession is fighting a serious mental disease. I spent all of yesterday going from meeting to meeting in NYC and eventually, most meetings devolved into why stocks can’t go down because the Fed has an extraordinary interest in keeping them up.

 

‘Yeah Keith, we hear you Brofessor… you say it’s The Cycle… but if you’re right then the Fed is definitely going to bail out markets and go to Qe4, aren’t they? Why not? Seriously, think about everything the Fed can still do – they’re already going dovish…’

 

Sadly, at that point in the conversation (trust me, I have a lot of reps when it goes that way!), I immediately agree with the client and say, “absolutely – they can do anything they want to do – they can make it really big and super you-ge.”

 

That is core to the #BeliefSystem.

 

And, by the way, in going to “negative yields” (after 90-100 TRILLION Yen in money printing, per year, AND buying stocks) in Japan, and QE + buying corporate bonds in Europe, you know what their hoped-for stock market inflations are doing this morning?

 

  1. Japanese Stocks (Nikkei) down another -2.4%, taking their #crash since July’s (2015) high to -24.6%
  2. German Stocks (DAX) down another -2.4% this morning, taking their #crash since April’s high to -22.6%
  3. Italian Stocks (MIB Index) no bid, -1.8% this morning, taking their #crash from last year’s high to -28.1%

 

Q: Do you know what the range on the SP500 would be on a -23% to -28% #crash?

A: SPX 1

 

So, I’m “reducing my price target” (since everyone asks me for one!) to that range, down from a prior target of 1704 (which would be a -20% decline from the all-time closing #Bubble high of July = 2130).

 

How the heck could that ever happen? It’s impossible that the #BeliefSystem could ever break down, isn’t it? Other than US corporate profits being negative for 2 consecutive quarters (which has always equated to a > 20% decline), what is your catalyst, Keith??”

 

A: The Cycle

 

Oh, am I teasing you? Not on the probability of 1704 then 1640 then 1533 rising (SP500). Just a little tickler for you ahead of our Q2 Macro Themes Call that we’ll host at 11AM EST on Thursday (ping for access).

 

In other news this morning, here’s how our Q1 Macro Ideas are doing (hint: I’m doubling down on them in Q2):

 

  1. Long-term US Treasury Yields dropping to 1.73% on the 10yr, only 5 basis points away from the Q1 low
  2. Utilities (XLU) are +14.6% YTD and primed to outperform Financials (XLF) -5.6% today with rates crashing
  3. Gold is +1.4% this morning to +16.2% YTD

 

Why didn’t the masters of the super smart alpha generating universe go all 16th century on their investors and ramp up their Gold holdings? “Believe me”, the spread on GLD vs. Valeant is super huge and really really smart. You need a really big brain for it.

 

According to the FT, Q1 report cards weren’t as good as yours was. Apparently 19% of mutual funds beat their benchmark in Q1. That was their worst quarter since 1998. Only 6% of “Growth” fund managers beat their bench (worst performance since 1991).

 

Many are suffering from a disease of expectations (either they’re too bullish on growth and/or always too bullish because they think the Fed can do something to replicate growth via asset inflation when they’re wrong) which can only be cured by performance.

 

So, instead of whining about where the SP500 is (which you don’t need an active manager to buy for you), I say they better get on board with our Best Long Ideas, Macro Exposures, and Style Factors, before it’s too late.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.71-1.85%

SPX 2018-2077
RUT 1069-1130

Nikkei 151

DAX 9

VIX 13.01-19.45
USD 94.11-96.06
Gold 1

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Disease Of Expectations - 04.05.16 Chart


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