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The U.S. Economy Is Growing: Sell Long-Term Bonds & Gold

The U.S. Economy Is Growing: Sell Long-Term Bonds & Gold - growth info

Sell Gold and Long-Term Bonds

 

Simply put, the U.S. economy is accelerating and that's not good for either Long Bonds or Gold. Case in point, yesterday's ISM Manufacturing release hit a 2-year high. This follows recently reported economic data from GDP to Retail Sales to Durable Goods orders that's been better than expected.

 

If you've been following Hedgeye for a while you might be shocked to see the aforementioned investment conclusions. We had been bullish on Long-Term Treasury Bonds (TLT) since late 2014 and liked Gold (GLD) for much of 2016. But we also told subscribers to sell it all shortly after Donald Trump's Election Day victory. Why this seemingly radical change? It's actually not radical at all but consistent with a fundamental aspect of our research process. 

 

Let's back up a bit. It was our contention in 2014 that the U.S. economy was slowing. It did. U.S. growth peaked in March of 2015 at 3.3% (on a year-over-year basis) and declined to 1.3% in June 2016. Over that period, Gold, Long-Term Treasury bonds, and the Utilities sector (XLU) posted double-digit gains. These typically outperform in a slow growth environment.

 

Shortly thereafter, the market began betting that the U.S. economy bottomed. The traditional U.S. growth slowing leaders turned into laggards and sectors tethered to an accelerating U.S. economy, like Industrials (XLI) and Financials (XLF), came roaring back. (See our detailed explanation in "Why Trump Didn't Kick-Start the U.S. Economy.")

U.S. Economic Data Hadn't Confirmed Recovery (Yet)

#Economy #GDP #Recession

 

The market was front-running the U.S. economic data. As the numbers rolled in (just before Trump's victory in early November), however, the data started to rubber-stamp investor's bets:

 

  • Durable goods and Retail Sales data for the month of October began improving.
  • Then previously recessionary Industrial Production data started to look up.
  • U.S. GDP for the third quarter stopped slowing, rising to 1.7% after five quarters of deceleration from 3.3% year-over-year growth in March 2015 all the way to 1.3% in June 2016.

 

The ISM Manufacturing report from yesterday is further confirmation. As you can see in the Chart of the Day below, the ISM numbers started to signal that we were lapping the recessionary lows of the Industrial economy back in August.

 

Take a look at the breakdown of data below:

 

  1. August 2016 ISM = 49.4
  2. October 2016 ISM = 51.5
  3. September 2016 ISM = 51.9
  4. November 2016 ISM = 53.2
  5. December 2016 ISM = 54.7

 

"In other words, in addition to ISM, Industrial Production, Durable Goods, etc., there’s now plenty of evidence to suggest that the Industrial & Manufacturing #Recession that the US experienced bottomed in August-September 2016," Hedgeye CEO Keith McCullough wrote in today's Early Look. In the fourth quarter of 2016, as the U.S. economy was bottoming, Gold and Long-Term Bonds lost -13.1% and -14.1% respectively.

 

The U.S. Economy Is Growing: Sell Long-Term Bonds & Gold - 01.04.17 EL Chart

the U.S. Economy Will continue to Grow...

#GrowthAccelerating (tickers: TLT, GLD)

 

All of this supports our current research call on U.S. growth accelerating. It's also why investors should now short Long-term bonds (TLT) and Gold (GLD).

 

Our predictive tracking algorithm suggests U.S. GDP will come in at 1.9% growth in the fourth quarter of 2016 (the Federal government's first estimate will be released on January 27th). Add all this together and we'd expect more carnage for investors in Long Bonds and Gold.

 

Sell it.


Why Trump Didn't Kick-Start the U.S. Economy

Why Trump Didn't Kick-Start the U.S. Economy - trump hat making

 

Wall Street is betting that Donald Trump can kick-start the U.S. economy. The story goes that tax cuts and infrastructure spending will unleash a boom of pent-up economic activity. But let's not give the President-elect too much undue credit. Before he even takes office on January 20th, Trump will inherit an accelerating U.S. economy. Consider the evidence.

The market already sniffed out An Accelerating U.S. Economy

 

Sure, since Election Day, investors have been betting on Trump by buying the Russell 2000. It's up 14.8% since then, as a pure play, domestic-oriented stock index. But the market started to front-run U.S. growth accelerating back mid-2016. 

 

Check out the sector performance from June 30th until just before Trump's victory in the chart below. Utilities (XLU), the classic outperformer when U.S. growth is slowing, was lagging while sectors tied to U.S. growth accelerating, like Industrials (XLI), Financials (XLF) and Materials (XLB), started to lead the pack. Note: This was a complete reversal of the trend in which Utilities led the sectors and Financials lagged.

 

Treasury bond yields, another important barometer of economic activity, also bottomed around this time. (Falling bond yields generally portend slower growth and conversely yields often rise during acceleration.) On July 6th, the 10-year Treasury yield hit 1.32% and have backed-up to 2.5% today.

 

Why Trump Didn't Kick-Start the U.S. Economy - S P 500 Sector Performance

U.S. Growth Expectations Were Confirmed by Economic Data

 

Data collected just prior to Trump's win, rubber stamped the market's prediction that the U.S. economy had bottomed.

 

  • Durable goods and Retail Sales data for the month of October began improving.
  • Then previously recessionary Industrial Production data started to look up.
  • U.S. GDP for the third quarter stopped slowing, after five quarters of deceleration from 3.3% year-over-year growth in March 2015 to 1.3% in June 2016, .

 

Now that U.S. growth is so clearly accelerating, the U.S. dollar is ripping to the upside. As you can see in the Chart of the Day below, in the fourth quarter alone, the dollar was up +8.5%.

 

(Note: When U.S. growth and inflation are accelerating, we call this Quad 2 in our proprietary GIP model [Growth, Inflation, Policy]. To learn more check out, "A Closer Look At How We Actually Model The U.S. Economy.")

 

Why Trump Didn't Kick-Start the U.S. Economy - 01.03.17 EL Chart

 

Now, to be fair, Trump can be credited with instilling a countrywide euphoria (i.e. Trumphoria) that has been spilling into recently reported November economic data. Time will tell whether it's justified but for the time being the data corrobates Wall Street's #TrumpTrade.

Bottom Line

 

To be sure, we're in for an interesting 2017 under President Trump. This morning's mainstream media freakout is over Trump's tweets related to the ongoing tit-for-tat trade battles with China, the nuclear armament of North Korea, a border tax on General Motors and the wholesale repeal of Obamacare.

 

But a lot can happen in between Trump's 140 character tweet storms and the signing of actual legislation. In terms of market implications, we'll have to wait and see how this all shakes out. (Hedgeye's Washington Policy research team offered up their Trump policy predictions in a recent HedgeyeTV special, "Our Top Five Trump Administration Investing Themes.")

 

For now, we remain bullish on U.S. stocks as the economy continues to accelerate, at least until Inauguration Day.


Stronger Dollar = Emerging Market Carnage: A Brief History of Emerging Market Debt Crises

Stronger Dollar = Emerging Market Carnage: A Brief History of Emerging Market Debt Crises - em debt crises

 

The U.S. dollar just hit a 14-year high against the Euro. So, as the world's reserve currency, dollar strength will have implications for investments around the globe, particularly for emerging markets.

 

Here's what you need to know.

What the Media Missed

A stronger dollar has caused a mainstream media freakout that's been largely misdirected. The focus has been on the impact to the U.S. The story goes that corporate profits particularly in the manufacturing sector could take a hit and this weakness may spill over into the broader economy.

 

(**Note: In theory, a stronger curency does make purchasing U.S. exports less attractive to foreigners whose currency and buying power weakens versus the dollar. But U.S. exports aren't the primary driver of our economy, consumption is. We've outlined before, in more detail, why we think the media's attention is misguided, here and here.)

 

Establishment media is missing the more important implication of the dollar, Emerging Markets. In the fourth quarter-to-date, the U.S. dollar index is up almost +8%. Emerging Markets (EEM), meanwhile, have taken it on the chin, -5.9% over that same period.

 

The U.S. Dollar/Emerging Market relationship is fairly simple to understand. The problem is two-fold. Most Emerging Markets are commodity exporters. Since commodities are priced in dollars, prices typically take a hit when the dollar strengthens. Also, developing countries account for one-third of the $9.7 trillion dollar debt held outside the U.S. as of the end of 2015. As the dollar strengthens against these developing country currencies, it becomes harder to service that debt which is priced in dollars.

Here's a brief recap of Emerging Market crises

As you can see in the Chart of the Day below, a decade of Emerging Market crises are typically preceded by a decade of easy money from the U.S. federal government which seeks to perpetuate a weaker dollar for one reason or another.

 

The developing crisis typically follows these stages:

 

  1. Flooding the world with dollars sends cash-flush investors in search of opportunities abroad.
  2. Developing economies pig out on the money pouring in. 
  3. New debt is then issued but becomes increasingly difficult to pay back as the cycle turns and dollar heads higher.

 

Below is a timeline of the U.S. Dollar index with Analysis...

 

Stronger Dollar = Emerging Market Carnage: A Brief History of Emerging Market Debt Crises - StrongDollar vs.  WeakDollar Cycles EM Crises

Click image to enlarge.

1960 – 1979

The Federal Reserve and U.S. government tag team to weaken the U.S. Dollar through abandoning the Gold Standard and Fed easy money policies. Latin America goes on dollar-denominated debt binge.

1982 – 1989

  • Mexico Default (1982)
  • Latin American Debt Crisis (and IMF imposed austerity, 1982 – 1989)

1980 – 1989

The Plaza Accord (1985): The governments of France, Germany, U.S., U.K. and Japan agree to manipulate foreign exchange markets by depreciating the U.S. dollar relative to the Yen and Deutsche mark. The U.S.’s resulting easy money policies caused money to flow into emerging markets.

1990 – 1999

  • Mexico’s Tequila Crisis (1994)
  • Contagion in Argentina and Brazil (1994 – 1995)
  • Asian Financial Crisis (1997 – 1998)
  • Russian Default (1998)
  • Brazil Currency Crisis and devaluation (1999)
  • Turkish Financial Crisis (2001)
  • Argentina Debt Default (2001 – 2002)
  • Uruguay Banking Crisis (2002)

2000 – 2009

A secular growth slowdown and two recessions in the U.S. (Dot Com bust and the Great Recession) cause Presidents Bush and Obama and Fed chairmen Alan Greenspan and Ben Bernanke to implement a variety of fiscal and monetary easing policies. The U.S. Dollar hits all-time lows in April 2011.

 

Money flows into Emerging Markets once again, in search of higher growth and higher interest rates. At the same time, the invention of ETFs greatly reduces barriers to investing in Emerging Markets. Chinese demand for raw materials quintuples bolstering these commodity export-driven economies.

2010 – Present

  • India and Indonesia Currency Crises (2013)
  • China Mini Banking Crisis (2013)
  • Argentine Currency Crisis (2014)
  • Russian Currency Crisis (2014)
  • Turkey and Brazil Currency Crises (2015)
  • Mexican Currency Crisis (2016)

Why This Matters Today

The post-financial crisis trend of dollar weakness is clearly over. The dollar has been strengthening for the better part of three years now. The Federal Reserve is tightening monetary policy, which will cause further dollar strength. Simply put, expect further carnage in Emerging Markets as this trend sets off a deleveraging of the $9.7 trillion in dollar-denominated debt held outside the U.S. 


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Will Trump Ignite A Full-Blown Trade War With China?

Will Trump Ignite A Full-Blown Trade War With China? - Boxing Gloves 2

 

Donald Trump has repeatedly accused China of manipulating global financial markets to gain a trade advantage over U.S. industries.

 

The President-elect says China is intentionally weakening its currency, the yuan, thereby making U.S. dollars relatively stronger and Chinese goods appear artificially cheaper. This illusion of cheap Chinese goods hurts U.S. industries, so the theory goes, and American jobs suffer as a result.

 

Here's a tiny taste of Trump's China theory:

 

"Look at what China is doing to our country ... They are devaluing their currency and we have nobody in our government to fight them ... They are using our country as a piggy bank to rebuild China."

 

It's a neat theory that plays well in the Rust Belt (i.e. Trump's core constituency) but upon closer inspection of the facts reveals a more complicated truth.

Not Just China: America's Trade Issues Run much Deeper

 

First, the facts. As Hedgeye Senior Macro analyst Darius Dale writes in today's Early Look, China is the U.S.'s third largest export market, following Canada and Mexico. In 2015, the U.S. and China exchanged a total of $599 billion goods and services, with China netting a $367 billion surplus advantage (in other words, China exported $483 billion to the U.S.; U.S. exported $116 billion to China).

 

So far so good for Trump's theory.

 

But here's where it gets a little murky. The U.S. ran trade deficits with 100 other countries last year, Dale points out, so it's odd to single out China as the bad actor on global trade. 

 

"To the naked eye of a less-informed populist like Trump, the U.S.’s disadvantage comes across as the result of bad trade deals and unfair trade policies on the behalf of the Chinese government. From our vantage point, that’s only half true at best.

 

Specifically, the U.S. doesn’t have a series of bilateral issues with China and other key trading partners; in 2015 it ran trade deficits with 101 countries. One hundred and one. The broad-based nature of our bilateral trade deficits is not likely to be the result of “bad deals” or “unfair practices” as Trump and his national trade team have repeatedly suggested."

THE U.S. HAS A CONSUMPTION PROBLEM, NOT A CHINA PROBLEM

 

So what are we missing here? The U.S. consistently consumes more than it saves. Plain and simple. As you can see in the Chart of the Day below, U.S. Gross National Savings less Investments as a percentage of GDP (in short, the amount of money Americans save each year) has been negative for the past 35 years. This mirrors the U.S.'s Current Account Balance as a percentage of GDP (essentially the net trade balance, or exports minus imports, versus the broader U.S. economy).

 

There you have it. 

 

Will Trump Ignite A Full-Blown Trade War With China? - Chart of the Day 12 29 16

Why Trump's Misconceptions Matter

 

Facts don't always filter into policy. That's the risk. Trump's rhetoric plays well among his core constituency so there's a considerable amount of risk to investors who blindly dismiss the possibilities of a full-blown U.S.-China trade war. Trump's pick for director of the National Trade Council, Peter Navarro, is no salve. He literally wrote the book on combating Chinese trade and the country's increasing militarism. (see "Death by China" and "The Coming China Wars.") In other words, this is a risk worth watching.

 

More to come.

 


Our Retail Analyst's 'Killer Chart' of the Day

"Risk happens slowly at first, then all at once."

 

Those are the words our firm's Founder and CEO Keith McCullough is fond of reminding our subscribers. It's in that spirit of risk management that we highlight a complimentary, extended excerpt of our Early Look market newsletter. While written most mornings by McCullough, today's is by veteran retail analyst Brian McGough. He shines a light on an important issue global investors should be keeping a close eye on.

 

FROM THIS MORNING'S EARLY LOOK:

 

...People are talking about Trump’s anti-China move in naming Dr. Peter Navarro as Assistant to the President, and a new role of Director of Trade and Industrial Policy. Seriously, the dude wrote a book called Death by China, describing the risk that China's form of capitalism and militarism poses to the future of the US. 

 

Yeh…I get it, protectionism is bad for Retail margins without a corresponding offset in the form of higher wages and stimulated consumer spending. In other words, a pair of Air Jordans may cost $50 more, but the consumer can afford it so it does not matter (well, not really, but that’s the Trump argument).

 

But what I think people are missing is that this would – quite rapidly – undo the biggest consumption trend most of us have seen – in any industry – in our careers. Consider the following.

 

1) Before 1994 there was a protectionist measure in place (simply referred to as Import Quotas) that limited quantities of apparel that we could import from non-WTO countries. Yes, that meant that we could only import fixed quantities of goods from these countries (let’s simply call all of those countries ‘China’ for arguments sake).

  1. That meant that we could only import about 1mm pairs of denim, a few million pair of socks, and maybe 200k ugly holiday sweaters, etc…
  2. This measure was lobbied by Warren Buffett and others who had acquired a nice little portfolio of North Carolina-based apparel manufacturing plants, and were threatened by Chinese labor.
  3. At that point in time, the consumption norm in the US was about 30 units per capita. Plainly put, each of the 270mm Americans alive at that time purchased an average of 30 garments per year. Yes..some bought 100, and some bought 3, but you get the drift.

 

2) HERE’s the key..Starting in the late 1990s, we started to see apparel import quotas phased out. It took the better part of 7 years – though the factories starting jockeying in price wars to secure a customer base in a post-quota environment. That, my Macro-Loving friends, was the beginning of tsunami of apparel deflation that lasts through today.  Consider the numbers…

  1. From the 1990s, we saw the cost of apparel come down by 5-10% per year – every year for two decades.
  2. Yet the CPI for apparel only came down by only 2-4% annually. So that means that the brands, retailers and virtually everyone in the supply chain had a multi-billion dollar kitty to boost margins every year (by about 700-1,000bps in total).
  3. That allowed the industry at large to both boost margins AND pass lower costs through to consumers in order to boost per capita unit consumption.
  4. That is anomalous in every way. Most of the time, when this happens we see either consumption OR margins take off. Not both. But in this instance, we saw both.
  5. The punchline is that this trend boosted per capita unit consumption to 84 units!
  6. I’ll say that again, the average number of units purchases by US consumers on a per capita basis more than doubled over 25 years.
  7. This is a paradigm change. People bought lower quality stuff at far lower prices, and simply cycled those every 3-4 years instead of every seven years (remember the 7-year fashion cycle? That was effect, not cause).

 

3) This ultimately took the barriers to entry down to the point where lousy brands (by our standards) could fill the shelves at the Kohl’s and JC Pennys of the world, and actually allow the bottom of the barrel retailers to earn money, while also allowing short-sighted investors to say ‘but they’re so cheap on cash flow’.

 

Here’s the killer chart folks.

 

Our Retail Analyst's 'Killer Chart' of the Day - mcgough chart


"The World Was Gloomy Before I Won," Trump Says. Exactly!

"The World Was Gloomy Before I Won," Trump Says. Exactly! - trump sunshine

 

President-elect Donald Trump took a victory lap Monday night on Twitter writing, "The world was gloomy before I won - there was no hope." Trump cited stock market returns since his election and Christmas-time spending as proof that this shroud of economic anxiety has finally lifted. It would appear, he is already "Making America Great Again."

 

The U.S. Economic Outlook Strengthened After Trump's Win

 

It's true. Since Trump's Election Day victory, U.S. equity markets, bond yields and the U.S. Dollar have rallied. Consumer, Homebuilder and Business Confidence are all rising. U.S. economic growth is strengthening (though recently reported, this had nothing to with Trump since the data was recorded well before Election Day). Third quarter GDP came in at +1.7% year-over-year growth, an acceleration of 0.4 basis points versus the prior quarter.

 

This stands in stark contrast to a nasty slowing U.S. economy that slowed for five consecutive quarters, from the peak of 3.3% in March 2015 to the bottom of 1.3% in June 2016.

 

Recent macro market moves are characteristic of what we call QUAD 2 (when both economic growth and inflation are accelerating). In this environment, sector exposures like Financials, Industrials, and Tech outperform.

 

That's exactly what's been happening:

 

  • Russell 2000 (the small cap, domestic play on the U.S. economy): +0.5% last week; fourth quarter to-date gain +10.8%
  • US Dollar Index: +0.1% last week; fourth quarter to-date gain +7.9% 
  • Financials (XLF): +0.9% last week; fourth quarter to-date gain +23.8%
  • Tech (XLK): +0.8% last week; fourth quarter to-date gain +3.0%
  • Industrials (XLI) were up another +0.7% on the week; fourth quarter to-date gain +8.9% 

 

Stocks highly correlated to the market (otherwise known as "high beta") continue to outperform. High beta stocks are up 21% year-to-date versus 9.6% for equities less tethered to market performance (otherwise known as "low beta").

Strong Dollar Lifts U.S. Equities (Hammers Gold, Emerging Markets)

 

As you can see in the Chart of the Day below, the U.S. Dollar has a 90-day correlation to the S&P 500 of 0.7, which means, over the last 3 months, when the dollar rises or falls so too does the broader equity market. Conversely, Gold doesn't like #StrongDollar so much (with a correlation of -0.96 over the same period). The barbarous relic is -13.4% so far this quarter.

 

Meanwhile, Emerging Markets stocks have been getting shellacked. The MSCI Emerging Markets Index was down another -1.7% last week, taking its Q4 loss to -6.8%.

 

"The World Was Gloomy Before I Won," Trump Says. Exactly! - Strong Quad2 CoD 2

The Silver Lining For Japanese equities

 

The fourth quarter to-date has been especially kind to investors in Japanese equities. The Nikkei is up a monstrous +18.1% in the quarter, putting it back in the “green” at +2.1% year-to-date. The playbook is pretty simple there: Dollar Up = Yen Down = Nikkei Up. Take a look: The Japanese Yen is down -13.6% versus the dollar for the fourth quarter.

 

A quick recap...

 

It's pretty simple what you do from here: As U.S. growth continues to accelerate, expect the U.S. Dollar to rise, U.S. stocks to go up (Financials, Technology, Industrials), Japanese equities up and Emerging Markets and Gold down. 

 

Thanks Donald.


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