“It all comes back to the basics. Serve customers the best-tasting food at a good value in a clean, comfortable restaurant, and they'll keep coming back.”
We can all agree to agree that Wendy’s (WEN) makes great hamburgers and that the founder of the fast-food chain, Dave Thomas, was one of the great American capitalists of the 20th century. The fact that he didn’t graduate high school until he was 61 years old speaks volumes to the importance of simply having good principles and remaining true to your core values in business.
Back to the Global Macro Grind…
Amid a challenging ~6 weeks on our desk, we are keen to refocus on what we view as the core values of global macro risk management and for our team nothing is more basic than our framework for viewing the world on a rate-of-change basis across multiple factors and durations.
Our proprietary GIP Model – which produces growth, inflation and policy estimates for every noteworthy economy in the world – is our best attempt at commercializing the aforementioned framework. Below we refresh our GIP Model for each of the world’s five largest economies.
- G: Our model has domestic economic growth decelerating sharply here in Q2 with a probable trough by the third quarter. This forecast is corroborated by the trending tightening across all segments of domestic rates markets, as well as the sharp breakdown of the USD on a trade-weighted basis in recent months – which itself has perpetuated a massive short squeeze across nearly every facet of the global reflation trade.
- I: In line with our #Quad4 expectation for Q2, reported inflation has at least temporarily inflected from generally hawkish trends. We are projecting a resumption of trending acceleration in 2H16, but to lower-highs on a long-term basis.
- P: Domestic and global spillover effects stemming from structural USD strength have forced the Fed’s hand to the dovish side, which is being ardently reflected throughout the short end of U.S. rates markets in the YTD. There is, however, limited room for further spread compression absent outright easing.
- G: Our model has Eurozone growth decelerating on a trending basis throughout the balance of the year. This forecast is corroborated by the fact that Eurozone economic growth continues to slow on a trending basis across every key category of high-frequency data.
- I: Our model has Eurozone inflation decelerating through the balance of 1H16 before v-bottoming and trending higher through year-end. This forecast is corroborated by the trending breakdown in 5Y5Y EUR inflation swaps as well as the trend higher in the EUR on both a nominal and real basis.
- P: We expect the ECB to incrementally ease monetary policy by their June meeting in order to combat: 1) the aforementioned cyclical headwinds; 2) the trend lower in both Eurozone equities and Eurozone inflation expectations; and 3) the trend higher in the EUR/USD.
- G: Our secular bear case on China remains firmly intact as evidenced by the lackluster Q1 GDP report and the fact that growth rates within the “C” + “I” + “NX” formula continue to decelerate on a trending basis across key high-frequency metrics.
- I: Our model has Chinese inflation inflecting here in Q2 and trending lower through the balance of Q3. Corroborating this forecast is the trending deceleration in core CPI, which implies the recent trend of global commodity reflation – something we anticipate will end soon – has been artificially propping up headline inflation readings in China.
- P: Consistent with our bullish bias on the USD from here, we anticipate the PBoC will begin to revalue the CNY lower on a trending basis over the intermediate term. This will likely force them to keep policy rates tight(er) in order to offset capital outflow pressures and it appears that is already being reflected on the short end of Chinese rates markets.
- G: Our model is all over the map with respect to Japanese GDP growth, forecasting a #Quad4 setup in Q1, a #Quad1 setup in Q2, a #Quad3 setup in Q3 and a #Quad2 setup in Q4. While there are indeed nascent signs of inflection, Japanese economic growth continues to trend lower across every key category of high-frequency data – as do rates on the long end of the JGB yield curve.
- I: Our model has Japanese inflation trending lower throughout the balance of 1H16. This forecast is being corroborated by trending deceleration across headline CPI, core CPI and headline PPI, as well as the trend lower in 5Y5Y JPY inflation swaps and the trend higher in the JPY on both a nominal and real basis.
- P: Japanese policymakers in both the Cabinet and BoJ have ratcheted up verbal intervention in the JPY, which is up ~10% YTD vs. the USD. We believe verbal intervention to be unsustainable and anticipate the BoJ will expand upon QQE and/or NIRP at its April 27-28 meeting.
- G: Aside from a brief respite in Q3, our model has U.K. GDP growth decelerating on a trending basis throughout the balance of 2016. Corroborating this forecast is the trending deceleration seen across every key category of high-frequency growth data, as well as the trending narrowing of the Gilt 10Y-2Y spread.
- I: Our model has U.K. inflation accelerating throughout the balance of 2016. This forecast is corroborated by trending acceleration across headline CPI, core CPI and headline PPI, as well as the trending breakdown in the GBP on both a nominal and real basis.
- P: Naturally, we’d expect the BoE to be in a box given the aforementioned cyclical outlook for persistent #Quad3 stagflation. Complicating policy matters is the Brexit vote which is scheduled for late-June and is effectively a coin toss. The BoE is appropriately storing its ammo in the event that process weighs heavily upon consumer and business confidence in the U.K.
CLICK HERE to download the associated slide deck (13 slides).
Both our bottom-up modeling and top-down risk management systems have proven to be pretty accurate over the years, so we are effectively doubling down on our process. If we’re wrong, at least we’ll know why we’re wrong and where we need to evolve. From my vantage point, that’s a better outcome than emotionally capitulating at the top end of what we believe to be a bear-market bounce.
Consistent with that decision are our thematic investment conclusions, which won’t change until we traverse the depths of the domestic and global economic cycles:
- With respect to Equities: Simply put, we do not think Janet Yellen can authorize QE4 without another leg down in domestic credit and equity markets – which, if prescient, calls into question the sustainability of this rally. As such, we believe the late-cycle sectors (i.e. Financials, Healthcare and Consumer Retail) are in the earlier innings of pricing in the depths of the cycle, while reflation sectors have clearly priced in some version of approaching the ninth inning; it’s not at all clear that the latter sectors will make lower-lows on the next leg down. Given our bearish outlook for the domestic equity market from here, we still want to be short the opposite of our preferred style factors on the long side – i.e. low beta, high quality, capital return stories like GIS and MCD. We continue to like Utilities on the long side as well. Internationally speaking, we remain cyclically bearish on DM equities broadly as the #BeliefSystem continues to fail on a trending basis. Moreover, we remain structurally bearish on EM equities as the #CreditCycle in many emerging market economies has yet to fully materialize – let alone capitulate.
- With respect to Fixed Income: Consistent with our dour cyclical outlook for the U.S. economy, we remain the bulls on Treasury bonds. Moreover, we continue to remain negative of high-yield credit under the belief that the domestic #CreditCycle has yet to fully capitulate. We don’t have a view on international fixed income outside of continuing to shun EM hard and soft currency debt.
- With respect to Currencies: Consistent with our #Quad4 outlook for the U.S. economy, we anticipate that the USD will perversely benefit from a bout of global risk aversion amid rising cross-asset volatility as it typically has during historical episodes of #Quad4. We expect a series of higher-lows versus peer currencies and a meaningful move higher versus commodity currencies as broad-based CNY devaluation fears come back online over the next few months.
- With respect to Commodities: Consistent with the aforementioned views in the currency market, we remain bearish on reflation assets and anticipate what may be a final flush down across key commodity markets with respect to the intermediate term. Moreover, we believe the energy complex is the most likely candidate to lead any such move lower. All that being said, however, we are keen to keep any shorts in the reflation space on a short leash ahead of the Fed’s likely policy response to our economic outlook (i.e. QE4).
Best of luck out there risk managing these views to the extent you are generally in the same or similar camp. Consider this a heartfelt thank you to those among you who are holding the line on the bear case.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 1.69-1.82% (bearish)
SPX 2046-2112 (bearish)
RUT 1087-1153 (bearish)
USD 93.11-95.11 (bullish)
Oil (WTI) 38.08-43.99 (bearish)
Gold 1220--1268 (bullish)
Keep your head on a swivel,