[UNLOCKED] Early Look: Gentlemanly Bears

Editor's Note: The Early Look below was written by Hedgeye CEO Keith McCullough one week ago. It discusses how "large components of the US economy already in a recession" and why "the US economic and profit cycle won’t even have a chance of putting in a rate of change (cycle) bottom until Q2 which, candidly, won’t be reported until Q3." Click here to get the Early Look delivered in your inbox weekday mornings.


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“It meant being reasonable, tolerant, honest, virtuous, and candid.”

-Gordon Wood


As I push into my early 40s, I’d like to think a Gentlemanly Bear can be thought of that way inasmuch as a Gentlemanly Bull can be. After all, sometimes (when GDP growth is slowing) gentlemen prefer being bullish on long-term bonds!


In the latest history book I’ve cracked open, Revolutionary Characters, Gordon Wood used the aforementioned characteristics to describe America’s Founding Fathers. How well do you think they describe your economic, profit, or credit cycle resources?


Or are we all partisan now? Rate of change isn’t partisan. It’s honest math. And I think being candid about it accelerating or decelerating is, as Wood wrote, “an important 18th century characteristic that connoted being unbiased and just as well frank.” (pg 15)


[UNLOCKED] Early Look: Gentlemanly Bears - GDP cartoon 10.29.2015


Back to the Global Macro Grind


Yesterday we received more intermediate-term TREND (not to be confused with monthly or sequential immediate-term TRADE head-fakes) confirmation that the US economy is indeed well past the peak of the cycle:


  1. Having peaked at +3.8% y/y in JAN 2015, Real Consumer Spending was revised down -30bps to +2.6% growth for JAN 2016
  2. Having peaked at +13.1% y/y in APR 2015, US Pending Home Sales slowed to 0.7% year-over-year (y/y) in FEB of 2016


Sure, a growth bull might say “but, the consumer and housing are still strong parts of the US economy”… but a gentlemanly rate of change person like me would correct them by reminding them that rates of change continue to slow from their respective cycle peaks.


On economic cycle matters, saying things are “good” or “bad” means absolutely nothing to us; measuring and mapping whether things are getting better or worse is what matters most. We’re very reasonable and tolerant about all 2nd derivative debates.


While Real Consumer Spending isn’t crashing into a #Recession (that was never our call), there are large components of the US economy already in a recession (no you can’t “back out” Energy, Industrials, Cyclicals, Financials, etc.). That’s why:


  1. US Long-term Treasury Yields have dropped from 2.27% at the start of 2016 to 1.87% this morning
  2. The Yield Spread (10yr minus 2yr Yield) is right around cycle lows at 100 basis points wide
  3. High Yield Spreads remain elevated and rising (above the recessionary signal of its historical mean)


Yes, the commercial and industrial (C&I) side of the economy matters inasmuch as the consumption and real estate cycle will if these rates of change in both consumer spending and housing demand continue to slow.


By the time it’s all slowed to cycle lows, you start buying again.


Let me say that differently. If you’ve been positioned properly for the last 3-6 months (instead of last 3-6 weeks), once the entire cycle has slowed to its slowest rate of change, you’ll actually start selling what you already own:


  1. Long-term Treasuries (TLT) = +7.8% YTD
  2. Utilities (XLU) = +12.6% YTD
  3. Gold (GLD) = +15.1% YTD


And then you’ll probably start buying the classic #LateCycle things (lower) that you shouldn’t have owned from last year’s cycle peak (note: all 3 of these US Equity Style Factors have underperformed Energy YTD – so you definitely don’t want to “back out” Energy):


  1. Consumer Discretionary (XLY) = -0.3% YTD
  2. Financials (XLF) = -6.1% YTD
  3. Healthcare (XLV) = -6.7% YTD


I know. I know. The YTD performance isn’t “as bad” as this Gentlemanly Bear sounds. But, as you know, staring at a month-end markup performance snapshot can be very risky. Remember “stocks” ramped +6% from the FEB low to MAR 2008 high too…


Again, not that things being “bad” matter as much as things getting better or worse do. But wow is this Atlanta Fed “GDP Now” model getting ugly. How a GDP “forecast” goes from +2.7% GDP only a month ago to +0.6% today is beyond me, to be quite frank!


We’re sticking with what was the Street’s low Q1 US GDP forecast of 1% (our predictive tracking algorithm and mapping/measurement #process has been accurate, within 25-50 basis points, on GDP for the last 5 quarters – without the 200bps intra-quarter swings!).


And, more importantly, we’re reiterating that the US economic and profit cycle won’t even have a chance of putting in a rate of change (cycle) bottom until Q2 which, candidly, won’t be reported until Q3.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.84-1.97%

SPX 1984-2059
RUT 1060-1107

NASDAQ 4699-4828
EUR/USD 1.10-1.13

Gold 1205-1275


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


[UNLOCKED] Early Look: Gentlemanly Bears - 03.29.16 chart

Eurozone, Earnings and Japan

Client Talking Points


Got inflation?  #Nope!  Eurozone CPI picked up 1.2% in March M/M but remains grounded at 0.0% Y/Y. We continue to pound the table via our Q2 2016 Macro Theme #BeliefSystem that ECB President Mario Draghi can’t bend economic gravity and a 2.0% inflation target over the intermediate term is pipe dream.  #FadingHope.


It’s early in earnings season, but we got an early look at tough comps in commodity land (Monsanto and Agrium have both comped down double digits top and bottom line). Alcoa fired 1,000 people globally in the process. One of the key call-outs in our macro deck was that S&P 500 companies face tough comps for Q1 and Q2 (8 of 10 sectors comped higher in Q1 2015), with the flow through sparking the big question: with forward-looking earnings being taken down, what multiple will the market slap on declining forward looking expectations?  


The Japanese yen’s -1% decline to the mid-109’s on the USD cross in the WTD has been good for a major squeeze higher in the Nikkei this week. Today’s massive +3.2% rally puts the index up +6.9% WTD with one more day of trading to go. In a speech at Colombia University yesterday, BoJ Governor Haruhiko Kuroda doubled down on NIRP by highlighting how it “boosts the effects of existing policy measures by directly pushing down the short-end of the yield curve”. Despite this week’s spectacular gains, the Nikkei more-or-less remains in crash mode down -19.3% from its peak last June and we think it’ll take more than jawboning to perpetuate a series of lower-highs in the yen and higher-lows in the Nikkei from here. We expect the pressure of decelerating trends across headline, core and producer price inflation – as well as long-term breakeven rates – to cause the BoJ to add to its easing measures at its April 27-28 meeting. Will additional easing in Japan be met with additional repudiation of the central planning #BeliefSystem, or will Japan simply export this growing lack of faith to U.S. markets via a stronger dollar?

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

McDonald's (MCD) hit another all-time high last week. As we continue to reiterate, the company has all the style-factors that we like – high market cap, low beta and liquidity. Stick with it.


We are going to be looking at a much different company 1-3 years from now. Urgency has been instilled from the top down by new CEO Steve Easterbrook. He wants more speed and is encouraging people to get things done faster. The food and experience provided to the customer will greatly improve over the coming months as “Experience the Future” is implemented across the system. It won’t be instantaneous though, as MCD has a lot of work to do around changing the perception to bring back customers it may have lost.


Things like All Day Breakfast, responsibly sourced ingredients, and bringing back the value proposition will lead to increased sales and customer satisfaction. While this company is too big to be completely fixed overnight, management has the right plans in place. We are confident in where they are headed.


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.


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.


We outlined our expectation and outlook moving into Q2 last Thursday in our quarterly macro themes presentation for institutional clients. The first of the three themes was labeled #TheCycle:


With the recessionary industrial data ongoing, employment, income and consumption growth decelerating, corporate profits facing a 3rd quarter of negative growth and Commercial and Industrial credit tightening, the domestic economic, profit and credit cycles are all past peak and continue to traverse their downslope. With this cyclical backdrop, the U.S. economy faces its toughest GDP comp of the cycle in 2Q16”….


The takeaway is that the economy faces a difficult GDP comp (growth rate) in Q2 within the continued late-cycle slowdown. 

Three for the Road


VIDEO: A great discussion about the decline of material culture in my new @Hedgeye segment "About Everything"



To pay attention, this is our endless and proper work.

Mary Oliver   


The White House will redirect $589 million (predominantly from funds allocated to fight Ebola) toward fighting the Zika virus, with additional funding requested from Congress.

CHART OF THE DAY: More Evidence Of Investors Losing Faith In Central Planners

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye U.S. Macro analyst Christian Drake. Click here to learn more.


"... As the Chart of the Day below illustrates, with swap rates, inflation expectations and growth estimates falling, currencies appreciating and European and Asian equities still in crash mode off their respective highs in the face of the latest quantitative and qualitative easing announcements, investors are believing that conditions are as bad as policy makers suggest but are in increasing disbelief of their ability to do anything about it."


CHART OF THE DAY: More Evidence Of Investors Losing Faith In Central Planners - CoD inflation Expectations


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“And, for your information, you Lorax, I’m figgering  …. on biggering and Biggering and BIGGERING and BIGGERING.”

- The Once-ler, from The Lorax by Dr. Seuss


“Look”,  said the Ease-ler, “There’s no cause for alarm

I bought just one bond. I am doing no harm

I’m being quite useful.  This thing is called Easing.

An Easing’s a Fine-Something-The-1%-Finds-Pleasing.

It’s a Bill.  It’s a Bond.  It drives global flows.

But it has other uses. Yes, far beyond those. 

It can boost inequality and the suppression of risk

Or financial repression and bear markets in VIX ….


… I meant no harm. I most truly did not

But it had to grow bigger.  So bigger it got. 

I biggered my balance sheet, I biggered my ZIRP

I biggered my QE, I biggered my NIRP.

I biggered the yield chase, I biggered the need

To bigger the #BeliefSystem on which it all feeds.” 


I’m quite enjoying macro remixing this Dr. Seuss classic this morning but I’ll leave it there. 


Indeed, while I switched out the nouns, I left the spirit of the Once-ler’s original message fully intact.


After all, it’s really only once(-ler) that one gets the chance to take yields from 20% to sub-zero – alongside peak demographics, peak growth in labor participation and peak leverage – in a 30 year run of consumption pull-forward’ing.


Then, my poor Bar-ba-loots, as the multi-decade policy to inflate reaches its terminal end:  


economies start getting the crummies

because they have deflation, and no growth, in their tummies! 


THE EASE-LER - the lorax


Back to the Global Macro Grind


Q: The currency of a country with a balance-of-trade surplus and relative deflation should do what?

A: Appreciate. 


That’s Fx 101 but the dynamics around it are part and parcel of the #BeliefSystem Central Bank’s helped cultivate and are now hostage to.   


Policy makers can bend economic gravity only to the extent the investing populous believes policy prowess is enough to overcome the gravity embedded in the underlying fundamental drivers.   


As the Chart of the Day below illustrates, with swap rates, inflation expectations and growth estimates falling, currencies appreciating and European and Asian equities still in crash mode off their respective highs in the face of the latest quantitative and qualitative easing announcements, investors are believing that conditions are as bad as policy makers suggest but are in increasing disbelief of their ability to do anything about it.


Moving on ….


Not too many people know this but I can #PredictThePresent. 


That’s right, I can NowCast the Cycle.  It’s both gift and curse.  Let me Illustrate:


In about 45 minutes from now we will get a continuation of the Trend acceleration in inflation.


Core CPI inflation accelerated for a 5th consecutive month in February, making a new 4-year high at +2.3% YoY.  With easier comps and the negative impacts of Strong-Dollar on core goods pricing slowly burning off, Headline CPI has shown a similar trajectory. 


Core Inflation may be +2.4% or +2.2% on the actual print this morning, it doesn’t really matter for contextualizing the prevailing reality which = Inflation is Rising. 


Pocket that positive slope on inflation for moment, we’ll come back to it.


Yesterday we got Retail Sales data to cap-off 1Q.  It was conspicuously underwhelming. 


While we knew the headline would be soft given the steep -5.6% MoM drop in unit auto sales (we get that figure at the beginning of the month) the balance of the sub-aggregates were similarly uninspiring.


Indeed, Retail Sales ex-Autos, ex-Autos & Gas and the “Control Group” all decelerated on both a year-over-year and 2Y average growth basis.


The Control Group (Retail Sales less Food, Auto’s, Gas & Building Materials), which feeds the GDP calculation, decelerated -60bps sequentially to +2.7% YoY.  Moreover, growth on a quarter-over-quarter annualized basis – which comports with how GDP is calculated/reported - was only +1.9%. 


Layer on the fact that Retail Sales are reported in nominal dollars (i.e. not adjusted for inflation) and that +1.9% deflates to something even less impressive in real terms.


Sure, Retail Sales only represents spending on Goods (~1/3 of total Household Spending) and Services consumption (~2/3 of total household spending) has captured a growing share of consumer spending in recent years but the two are strongly correlated and total consumption in Jan/Feb has matched the softness observed in Retail Sales.    


So to put this week’s data in context, we have:  Inflation Rising + Growth Slowing


I won’t say what that equals but it rhymes with “Magflation”  …. Not a policy or equity multiple friendly environment if it persists.  


Elsewhere in domestic data flow, we got inventory data for February yesterday which showed Business Inventories declining -0.1% sequentially with January revised to -0.1% (from +0.1%). 


It was really a lose-lose setup. 


In terms of GDP accounting, rising inventories adds to Investment so, superficially, it’s a positive for reported growth.  The converse obviously holds as well.


On the other hand, inventories have been growing at a premium to sales across the supply chain for over a year now and, in the absence of accelerating demand, that cumulating inventory = lower future profitability for businesses as they have to carry/management that burgeoning supply and discount to move it. 


Add the inventory drag on investment spending to the aforementioned growth and inflation realities and you get 1Q growth that is flirting with contraction …. And comps that only get tougher in 2Q.


I guess the larger takeaway here is this:  Central Bank omnipotence and late-cycle equity markets can go out like Kobe. 


60-point grand finale heroics are great but it doesn’t negate the fact that it is, indeed, the finale (and 20-years of greatness finished with a 17-win season).


To Trades, Trends and the wisdom to know the difference.  #MambaOut


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.68-1.81%

SPX 2035-2087

VIX 13.01-19.25
USD 93.94-95.42
YEN 106.94-111.07
Oil (WTI) 38.56-44.03


Best of luck out there today, 


Christian B. Drake

U.S. Macro Analyst


THE EASE-LER - CoD inflation Expectations

The Macro Show with Darius Dale Replay | April 14, 2016

CLICK HERE to access the associated slides.


 An audio-only replay of today's show is available here.

Cartoon of the Day: The Central Bank Of Neverland

Cartoon of the Day: The Central Bank Of Neverland - Draghi Peter Pan cartoon 04.13.2016


Central planners are increasingly pushing on a string as macro markets continue to move in direct opposition to the best efforts of policymakers at the ECB and BOJ.

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