CHART OF THE DAY: Being The Bears On Emerging Markets

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye Senior Macro analyst Darius Dale. Click here to learn more.


"... Alas, we should’ve seen broad-based EM reflation coming from a mile away. As rewarding as being the axe on the bear side of EM has been since we authored the call in early 2013 (see: Chart of the Day below) is as shameful as it has felt overstaying our welcome in the YTD."


CHART OF THE DAY: Being The Bears On Emerging Markets - 8 9 16 Chart of the Day

Where’s China?

“It does not matter how slowly you go as long as you do not stop.”



While we are all well aware of the incredibly thoughtful, oracle-esque nature of Chinese philosopher Confucius and his many proverbs, it’s a bit hair-raising to see him completely nail the current balance of Chinese economic and financial market risks some ~2,500 years after his death.


The aforementioned quote pretty much sums up how macro markets have generally priced in Chinese developments throughout much of the YTD. Specifically, one could argue that China hasn’t meant all that much to the consensus macro narrative since January. Indeed, as was the case throughout our latest rounds of client meetings, China has been conspicuously absent on both sides of the bull/bear debate.


I guess you could say that China’s ongoing structural economic deterioration doesn’t really matter as long as the yuan and/or entire mainland banking system aren’t imploding today.


Where’s China? - Blame China cartoon 08.31.2015


Back to the Global Macro Grind


Our call on China this year has been as boring as it has been accurate. Recall that at the height of CNY devaluation fears in January/early-February, we fervently remained the other side of the then-consensus view that China was careening towards a currency crisis and banking collapse.


From our 1/13 note titled, “Inverse Myopia: Checking In With Asia and Latin America”:


As we’ve previously stated, the CNY needs to depreciate by as much as 10-15% vs. the USD, but any such devaluation will come at a measured pace. Beijing has no interest in AFC-style rapid devaluations and will continue to use their wide arsenal of tools – including coercion and capital controls – to achieve this objective, which effectively implies the bearish CNY overhang is here to stay. All told, we reiterate our bearish bias on Chinese capital markets and the yuan.”


From our 2/9 note titled, “Looking for Investment Ideas Across Asia, LatAm or EEMEA?”:


“[Chinese] officials continue to push back on a material devaluation of the CNY while concomitantly defending the currency with near-peak FX reserve deployment and incremental capital controls. While we remain explicitly bearish on China’s intermediate-to-long-term growth outlook, as well as the nation’s capital and currency markets, we continue to believe the path lower will remain piecemeal in nature, rather than sharp and/or sudden."


Indeed, it is appropriate to suggest that China has stabilized – certainly on a relative basis to über-bearish consensus expectations early in the year. This stabilization has been somewhere between a stealth driver and key catalyst of broad-based reflation across EM assets in the YTD:


  • iShares MSCI Emerging Markets ETF (EEM): +14.6%
  • WisdomTree Emerging Currency Fund (CEW): +7.9%
  • iShares JP Morgan Emerging Markets USD Bond ETF (EMB): +9.9%
  • Market Vectors Emerging Markets Local Currency Bond ETF (EMLC): +12.1%
  • WisdomTree Emerging Markets Corporate Bond Fund (EMCB): +7.2%
  • iShares MSCI Brazil Capped ETF (EWZ): +64.9%
  • Market Vectors Russia ETF (RSX): +25.8%
  • Global X FTSE Argentina 20 ETF (ARGT): +27.2%
  • iShares MSCI All Peru Capped ETF (EPU): +72.7%


In the context of knowing what we knew then about the most likely path for the Chinese economy and CNY (i.e. lower but not all at once), our general bearish bias on EM throughout the YTD has been a terrible call. In the context of our #LateCycle Slowdown view of the U.S. economy and labor market (and how the Fed is likely to react to that – i.e. dovishly), our call on EM this year has been downright horrific.


Our specific long/short recommendations haven’t been quite as dreadful, but they certainly have not generated alpha this year given our preference for defensive, commodity insensitive countries and regions. But [jokingly] who cares? As has become the case with the SPY, riding the beta wave seems increasingly more important to investors than generating alpha.


Alas, we should’ve seen broad-based EM reflation coming from a mile away. As rewarding as being the axe on the bear side of EM has been since we authored the call in early 2013 (see: Chart of the Day below) is as shameful as it has felt overstaying our welcome in the YTD.


Fortuitously, this industry doesn’t leave a lot of time and space for apologies and excuse-making. Moreover, most thoughtful investors tend to focus more on what’s coming down the pike rather than what’s already occurred.


So what’s next for EM from here? Specifically with respect to China and its outsized influence on sentiment for this asset class, fundamentals for EM are decidedly mixed. That said, however, they are unlikely to be as supportive throughout 2H16 as they were in 1H16 when the Chinese economy as we know it seemingly escaped from the abyss. Specifically:



Speaking of the Fed and U.S. monetary policy – the key driver of capital flows to and from EM assets – we don’t see the Fed being able to perpetuate lower-highs in the U.S. dollar from here. They’ve already done all they can to completely root out policy normalization expectations from the market, which implies the impact of dovish rhetoric upon the currency market will be muted on a go-forward basis; they need to outright ease policy (e.g. QE or a rate cut) if they want to drive the dollar lower from here.


That the aforementioned setup is occurring in the context of both the Eurozone and Japanese economies slowing concomitantly with the U.S. would seem to imply that incremental easing out of the ECB and/or BoJ is likely to have a greater impact on currency markets than yet another dovish pivot by the Fed.


All that being said, however, I don’t know that the DXY is poised to breakout to new cycle-highs in the context of our dour view on domestic employment growth and Yellen’s sensitivity to the labor market. For now at least, the balance of risks point to slight bullish bias in the USD, though still very much range-bound. And until something material changes, I don’t know that it’s appropriate to have a ton of risk on in EM in either direction.


As such, we’re keen to book the aforementioned gains and losses in order to retreat to the sidelines until further notice. Sometimes just wiping the slate clean and getting stuff off your screens is the most effective thing an investor can do to ensure future success.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.45-1.61% (bearish)

SPX 2155-2186 (bullish)
VIX 11.13-14.98 (bullish)
USD 94.75-97.25 (bullish)
Oil (WTI) 39.29-43.78 (bearish)

Gold 1 (bullish)


Keep your head on a swivel,




Darius Dale



Where’s China? - 8 9 16 Chart of the Day

August 9, 2016

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  • Bullish Trend
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  • Neutral

10-Year U.S. Treasury Yield
1.61 1.45 1.59
S&P 500
2,155 2,186 2,181
Russell 2000
1,199 1,235 1,230
NASDAQ Composite
5,110 5,227 5,213
Nikkei 225 Index
16,068 16,856 16,651
German DAX Composite
10,119 10,566 10,432
Volatility Index
11.13 14.98 11.41
U.S. Dollar Index
94.75 97.25 96.34
1.09 1.12 1.11
Japanese Yen
99.42 103.99 102.45
Light Crude Oil Spot Price
39.29 43.78 43.02
Natural Gas Spot Price
2.53 2.93 2.75
Gold Spot Price
1,315 1,380 1,341
Copper Spot Price
2.13 2.23 2.17
Apple Inc.
101.60 108.96 108.37
734 778 767
Netflix Inc.
89.85 96.90 95.11
J.P. Morgan Chase & Co.
62.54 66.72 66.10
Priceline Group
1338 1425 1405
Ford Motor Co.
11.28 12.57 12.18
SPDR S&P Oil & Gas Explore
32.10 36.21 35.77

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#ProductionFreeze, Eurozone & Oil

Client Talking Points


New stories of a crude production freeze are again surfacing ahead of the International Energy Forum in Algeria September 26-28 where OPEC meets informally. The major OPEC influences (Saudi Arabia, Iran, Iraq) show no signs of pushing for a production cut. The trend in official selling prices from the big three middle eastern producers has been to cut further and further below benchmark prices to consumers all over the world. Saudi Arabian, Iranian, and Iraqi production is flat, +29%, and +3% respectively while production comes offline elsewhere. Petro states concede their influence on the global marketplace by throwing in the towel at this stage of the game. 


Political risk remains front and center:  the latest poll indicates that a third Spanish election would do nothing to resolve the political impasse. Separately, Italy’s high court has approved a constitutional referendum, setting in motion a vote from Italians on whether to strip the Senate of most of its powers in order to streamline legislation; if defeated, PM Renzi has vowed to resign. Uncertainty breeds contempt and contempt breeds investors heading for the exits. We remain bearish on the EUR/USD and reiterate our Q3 Macro theme of #EuropeImploding. 


This morning’s Productivity and Unit Labor Cost data for 2Q will confirm that labor growth continues to grow at a premium to output growth and that input costs continue to rise faster than output prices.  So long as the price to produce something is growing faster than the selling price, corporate margin pressure will persist.   

Asset Allocation

8/8/16 66% 3% 3% 8% 12% 8%
8/9/16 64% 3% 3% 9% 13% 8%

Asset Allocation as a % of Max Preferred Exposure

8/8/16 66% 9% 9% 24% 36% 24%
8/9/16 64% 9% 9% 27% 39% 24%
The maximum preferred exposure for cash is 100%. The maximum preferred exposure for each of the other assets classes is 33%.

Top Long Ideas

Company Ticker Sector Duration

See update on TLT/UUP.


Back to growth ... we’ll refrain from commenting on Friday’s headline non-farm payrolls number in isolation, and rather offer some perspective on the cyclical nature of the non-farm payroll data series (you’ve heard it before):

  • On a Y/Y rate of change basis, Non-Farm Payrolls peaked in February of 2015;
  • Once growth in this series peaks and rolls over, it doesn’t return and we move toward economic contraction on the margin. Read: Bullish for Long Bonds (TLT);

A print of +282K jobs was needed for July to avoid another Y/Y sequential deceleration in the series. NFP additions were +255K. While this beat expectations of +180K (which was cheered by just about every mainstream media outlet), the TREND in this series remains slow-moving, predictable, and most importantly past peak.


Our team’s macro process is both fundamental and top-down, and we get the top-down signals in real-time. The bottom-line is that both the CRB Commodities Index and crude oil have recently broken down from a quantitative risk management perspective. While this is a key factor contributing to our recent addition of the PowerShares DB US Dollar Index Bullish Fund (UUP), it also signals that TIP does not have as much upside as we thought. As Keith McCullough wrote to subscribers this week:


“Changing my mind on longer-term longs has happened infrequently this year, but it should happen. That’s how the game goes.”

Three for the Road


"My competition isn't resting!'" 

-Kim Rhode


There was a 32% drop in Olympics viewership from the 2012 to 2016 Summer Games, it is estimated that 19.5 million people watched prime time Saturday, compared with 28.7 million in 2012.

The Macro Show with Darius Dale Replay | August 9, 2016

CLICK HERE to access the associated slides.



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

Freeze September Sequel Will Have Similar Ending: No Agreement

Takeaway: Target of Freeze Talk is Sentiment Not Production. Saudi Arabia and Iran will not agree because the September timing is too soon.

We’ve seen this movie before: in response to low oil prices, a few producers propose a production freeze designed to talk up crude prices but has no real impact on fundamentals.


According to recent press reports, Venezuela, Kuwait and Ecuador are again pushing a production freeze in response to the recent dip in oil prices. Since OPEC meets informally at the upcoming International Energy Forum (IEF) in Algeria on September 26-28, some market participants believe the Production Freeze 2 has real legs pushing prices higher on Monday.


However, we believe the sequel to the production freeze will end the same with no agreement in September. We remain highly skeptical that any meaningful agreement will be reached or that it changes the outlook for oil markets.


First, the production freeze is not a serious proposal but designed only as a public relations tool to effect sentiment and try to establish an artificial price floor. The first freeze proposal was unveiled by Venezuela on February 11 when oil prices were sub-$30. Since that time, the freeze has been talked up by various OPEC members and Russia resulting in a subsequent price bounce. The invitation letter to OPEC members for the April freeze meeting specifically acknowledged that the freeze proposal “has changed the sentiment of the oil market” and “has put a floor under the oil price.”


The same script is being used again after prices dipped into bearish territory in July. But the freeze proposal is again not serious because OPEC is producing at record levels. Ironically, OPEC’s record July production of 33.41 million barrels a day is a major contributing factor in the current weakness in crude prices.


Second, Saudi Arabia and Iran will not agree to a production freeze because the September timing is too soon.


For Saudi Arabia, it's still too soon to take any action now that would raise prices and throw a lifeline to US shale and other non-OPEC producers. In the Saudi view, continued low prices this year are needed to displace non-OPEC production and bring the market into balance.  That means continued cap-ex cuts, delayed mega-projects and further declines in non-OPEC production throughout all of 2016. The Saudi’s may once again publicly express a willingness to consider a freeze if other producers, specifically Iran, also agree but we believe that is highly unlikely.


For Iran, the freeze is too soon because it is just eight months into regaining its’ market share after the lifting of nuclear sanctions. Iranian crude exports are now about 900,000 barrels a day, and a key official at the National Iranian Oil Company said that Iran has regained about 80 percent of its market share before sanctions were imposed. Iran is still aggressively pursuing production targets, and therefore, we think it will not and cannot agree to any premature limits.


Finally, with OPEC members Libya and Nigeria struggling to re-establish higher production levels after disruptions and outages, we believe a production freeze will face its own challenges in gaining support and momentum with second tier OPEC members over the coming weeks.


After leading the charge for a freeze in April, Russia’s energy minister on Monday sought to downplay the need for a production freeze saying “prices are still at a more or less normal level.” But the Russian minister said he was open to negotiations. We believe Russia will once again be a strong proponent of a freeze and will time its support to boost sentiment ahead of the September IEF meeting.

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