Did you buy the all-time highs in U.S. equity markets?
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Did you buy the all-time highs in U.S. equity markets?
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Takeaway: Here's our take on some of today's top financial stories.
The Fed kicked off an action packed week of central planning with the release of its minutes and the regional Fed presidents trotted out any number of strange narratives. Here are a few.
"Let's imagine that the third quarter has very very strong productivity growth, accompanied by weak gains in payroll and employment... Well then you probably would not put much weight at all on the strength of GDP. At the end of the day, how the GDP growth translates in terms of employment gains is probably the more important element."
OUR TAKE: So Dudley wants us pay attention to the jobs market. Well, jobs growth put in its year-over-year peak in February 2015. It's been declining ever since.
In a presentation entitled “Normalization: A New Approach” today during the Wealth and Asset Management Research Conference at Washington University in St. Louis, Bullard said rates should remain flat over the next two and a half years. “If there are no major shocks to the economy, this situation could be sustained over a forecasting horizon of two and a half years," he said. "These facts suggest that it may be time to quit using the old narrative.”
OUR TAKE: LOL
“I’m not locked in to any policy position at this stage, but if my confidence in the economy proves to be justified, I think at least one increase of the policy rate could be appropriate later this year,” Lockhart said. "Early indications of third-quarter GDP growth suggest a rebound. I don't believe momentum has stalled. I remain confident about prospects in the second half of 2016 and 2017."
OUR TAKE: U.S. growth has slowed from 3-2-1%. What makes him so sure growth will accelerate.
"There is simply not enough room for central banks to cut interest rates in response to an economic downturn when both natural rates and inflation are very low," Williams said in the latest issue of his regional Fed bank's Economic Letter on Monday. There are “limits to what monetary policy can and indeed, should do... the burden must also fall on fiscal policy do to its part."
OUR TAKE: Williams was calling for up to 5 rate hikes in 2016. Now he says we need fiscal policy because U.S. economic growth is sluggish. Thanks for coming out.
Takeaway: US market short-interest has been cut 13% since February and net long positioning is near a multi-year high pointing to investor exuberance.
Editor's Note: Below is a brief excerpt from an institutional research note written by Hedgeye Macro analyst Ben Ryan. For more information about our institutional research contact email@example.com.
We speak of S&P 500 net non-commercial futures and options positioning regularly. Index + e-mini positioning has been cut the last couple of weeks, but it’s still pinned near a multi-year high.
Along with futures and options positioning, total U.S. market short-interest has been cut 13% since February and the CBOE skew index indicates a market that is positioned much less cautiously than it was in the summer of 2014, at least in volatility terms.
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In response to this morning’s Early Look in which we detailed our latest thoughts on country-picking in emerging markets, we received a number of replies asking for our thoughts on Brazil, which itself failed to make the cut in our most overvalued/undervalued analysis. Given the level of interest, we thought we’d share our revised outlook for the Brazilian economy and its financial markets more broadly.
It’s easy to recap where we’ve been on Brazil lately: wrong (at least until we closed all of our positions in EM last Tuesday). Specifically, as part of the thematic investment conclusions outlined on slide 94 in our 3/16 presentation titled, “Is This a Generational Buying Opportunity in Emerging Markets?”, we were explicitly negative on LatAm equities and FX, which we expressed through the currency un-hedged SPDR S&P Emerging Latin America ETF (GML). That instrument moved -18.4% against us throughout the course of our bearish bias.
Mitigating this disaster is the fact that we’ve been the axe on the bear side of Brazil since mid-July ’14. Inclusive of its +65.9% YTD return, the iShares MSCI Brazil Capped ETF (EWZ) still declined -30.8% from 7/14/14 through last Tuesday. For reference, the MSCI All-Country World Index declined only -2.6% over that timeframe. I’ll take +2820bps of long-term alpha generation any day.
With all that baggage and glory now squarely in the rearview mirror, we can now focus on our call on Brazil from here: patience. Specifically, we think it’s best that uninvolved investors remain neutral for now. To the extent an investor is currently involved on the long side, we believe the best course of action is to book gains and look to redeploy capital upon further notice.
In GIP Model terms, Brazil has definitely earned its outperformance in the YTD; in fact, it’s one of the best GIP setups I’ve ever seen (more on this below). Moreover, the confluence of a material rally in commodities and the Rousseff impeachment saga have proven particularly positive for a sharp reversal of what had been pervasively bearish sentiment.
Supporting Brazil’s sexy GIP Model setup are:
But are Brazilian financial markets priced to perfection? No one knows the answer to that, but my inclination is to side with the “yes” camp. I do know one thing’s for sure, however: I don’t bet on “open-the-envelope risk”, which is effectively what you’d have to do to put a positon on today given the uncertainty surrounding the outcome of Rousseff’s impeachment trial (which will be held across four sessions spanning AUG 25-26 and AUG 29-30). A two-thirds majority (i.e. 54 out of 81 senators) is needed to fully remove her from office, which would allow interim president Michel Temer to remain in power through 2018.
Indeed, the confluence of the market-friendly leadership style of Temer, the bold fiscal reform drive of his acting finance minister Henrique Meirelles and the steady hand of CBR governor Ilan Goldfajn has been a boon to Brazilian capital and currency markets in the YTD. Key reform initiatives include:
The major issue we see with each of these reforms is that Rousseff’s Workers Party (PT) may not acquiesce to the fiscal reform demands of Temer, who hails from the Brazilian Democratic Movement Party (PMDB). Recall that her own fiscal reform drive fizzled out amid PT infighting over what were widely viewed as draconian fiscal consolidation measures despite near-peak sovereign indebtedness and a slew of ratings downgrades.
Moreover, the tax hike freeze isn’t set to be decided upon until the end of this month; a failure to implement the proposed changes would go a long way towards resetting Brazil’s economic recovery expectations structurally lower given its existing status as one of the world’s most over-taxed economies; the World Economic Forum’s 2016 Doing Business Report ranks Brazil’s tax efficiency 178th out of 189 countries.
Source: World Economic Forum 2016 Doing Business Report
All told, there is a strong fundamental case to be made to back up the truck on the long side of Brazil. That being said, however, a slew of policy pitfalls remain. As such, we’d only sign off on getting long Brazil to the extent the Rousseff impeachment process goes as consensus expects it will; we would be buyers of a “sell the news” event in the face of a positive outcome.
Best of luck out there,
In this brief excerpt from The Macro Show, Hedgeye CEO Keith McCullough and Demography Sector Head Neil Howe respond to a subscriber’s question about whether the healthcare sector is a bubble that’s about to pop.
Takeaway: WMT investing as TGT sits on the sidelines. Competitive dynamics continue to intensify, TGT the clear loser.
This evolving TGT/WMT relationship has all the makings of a backyard brawl. The only problem is…it’s not a fair fight. Don’t get us wrong – it could be, but as highlighted in our note following the TGT print (full note: TGT | Losing at Defense), we think the management team at Target is playing defense – badly. Think the ‘rope-a-dope’ without the Ali endurance or uppercut. That’s at the same time that the competitive dynamics around the retailer are evolving faster than at any point we can remember in large-cap retail.
In one corner you have AMZN scooping up 25% of the incremental dollars up for grabs in US retail – that’s 2x the rate we saw at the same time in 2015. In another corner is WMT, who saw a meaningful traffic inflection starting in 1Q14 and has been able to hold the upward trajectory for 2+ years as it invests its way to a flat earnings CAGR over the next 4 years. And in the 3rd corner there’s TGT, who has effectively managed expenses to hit near term expectations at the expense of long-term share, with no clearly articulated plan to win in any environment and a stunning lack of insight as to why the business is struggling in the face of otherwise solid prints by its two closest competitors.
In the series of charts below, we walk through what we think are the key callouts from the evolving TGT/WMT relationship and why we think TGT is the ultimate loser in this royal rumble. That will ultimately manifest itself in either a) lost market share and pressured margins taking earnings into the mid-$4s, or b) a meaningful reset in expectations as the company doubles down on the investment line to compete with its peer group.
WMT Out-Trafficking TGT
We positioned this chart first in the queue because we think it clearly demonstrates that WMT is winning what we coined the ‘backyard brawl’. To be clear, this is the effect and not the cause of the broader strategic decisions each team is making in order to ultimately drive traffic and win market share. There has been a clear deviation in the trend, with the spread between the two opening up to 1.2% in 1Q and 3.4% in 2Q, both in favor of Walmart. The most recent metric is good for the biggest spread we’ve seen since the TGT data breach in 4Q13, and the widest gap over the past 5 years in a normal environment. Most importantly, we don’t think this a near term statistical aberration, as WMT is putting the dollars behind the up-tick in traffic which will continue to propel outperformance while TGT sits on the sidelines.
Two Different Investment Cycles
This is the cause we referred to earlier, as we’ve seen a huge investment spread open up between TGT and WMT. It started back in mid-2014 around the same time Cornell started his tenure in Minneapolis, and has held steady at nine-points over the past two quarters. That’s important given that Cornell is now two years into his tenure at TGT, and now has his team and strategy in place. Based on what we’ve seen to date, it can be characterized by prudent decision making when it comes to cutting Canada/Rx biz and a reluctance to spend in order to keep pace with the competition. Ultimately, we think the spread between the two needs to change dramatically – and that’s not going to be gifted to TGT from WMT as the latter company has a free pass to invest after it lowered expectations 10 months ago. That means either TGT needs to open its pockets or be content with taking what comes its way.
WMT Lean, TGT Bloated
The SIGMA trajectory for each company couldn’t be more different. For WMT: we are looking at a sales/inventory spread of 5% in the US which is a positive set-up for GM going forward and this leverage should continue to offset some of the SG&A pressure felt from investments. For TGT: inventories are building into a slowing sales guide, which we think could add additional pressure on GM in addition to the e-commerce headwind and promotional pressure already being felt.
Win For TGT
This is the one metric where we will declare victory for TGT in 2Q. Though at 16% growth it’s not going to win a medal. There have been flashes of brilliance over the past 18 months for TGT, but not the sustained growth at a 40% CAGR that management thought was achievable 18 months ago. The key here is that while TGT continues to pull back on capital outlays to fund its e-commerce growth both on the P&L and the balance sheet, WMT went out and spent $3.3bn to acquire talent and technology in the form of Jet.com. The ante chip to compete for brick and mortar retail just went up tremendously.
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