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Guest Contributor: Current Market Psychology Reminiscent of 2005 Housing Bubble

Takeaway: An easy money Fed encouraged investors to blindly buy stocks. Passive index funds benefited. Active funds lost. That may be changing.

by Mike O'RourkeJonesTrading


Guest Contributor: Current Market Psychology Reminiscent of 2005 Housing Bubble - blindfolded man


We started highlighting the trend towards “Blind Buying” back in 2013 and over the course of 2016, the trend reached new heights. In general, we are referencing behavior in which individual stock analysis plays little or no role in the investment process. In short, equities are purchased for exposure to the asset class as opposed to purchasing a company’s shares based upon the individual growth and value prospects of its business.


While the strategies come in many forms – asset allocation, automated, correlation driven, factor driven, social media driven – none has been more influential than the shift away from active investing towards passive investing. That has become one of the key themes of the market over the past year.


Guest Contributor: Current Market Psychology Reminiscent of 2005 Housing Bubble - orourke callout 1 5


It was three decades ago when the seminal research by Brinson, Hood and Beebower was published indicating that asset allocation is the overwhelming determinant of returns in comparison to market timing and stock selection. Over the past three decades, this point has been debated countless times. 


Subsequent research has noted that the high correlation reported is the result of “aggregate market movement,” i.e. they are all invested in stocks. This is often referred to as the "rising tide lifts all boats" argument.

The 9-Year Bull Market: Active vs. Passive Funds

Regardless, there are numerous arguments and examples of passive funds outperforming active funds. One can understand how those arguments have reached a fever pitch as we head into the ninth year of a bull market, a bull market that has been fostered by unconventional accommodative policy.


This is a policy that has included 9+ years of one or more major central banks always buying assets and concurrent zero or near zero interest rate policies. In such an environment, it becomes very easy to outsource the decision making and let the market (and the central banks) do all of the work.


It is a one size fits all approach. The leading rationalization behind riding the rising tide has been the fact that equities are “relatively” inexpensive in comparison to Treasuries (which are very expensive), even after the bond market selloff over the past 6 months.


Interestingly, that Fed Model relationship moved dramatically during the Treasury selloff and equities are now the most expensive they have been versus Treasuries since 2010 (chart below), which is the year earnings began to recover.


Guest Contributor: Current Market Psychology Reminiscent of 2005 Housing Bubble - fed model


Considering both stocks and bonds are very expensive, comparing them to one another is a dangerous proposition. A more realistic approach is to measure how expensive stocks and bonds are together - relative to history. One can add the S&P 500 earnings yield and the 10 year Treasury yield, essentially inverting the Fed Model.


One can go one step further and multiply the S&P 500 earnings yield by 60% and the Treasury yield by 40% to create the theoretical historic valuation for a 60% equity/40% fixed income portfolio mix (chart below). The readings for both metrics over the past year, especially the past 6 months, rank in the most expensive percentile of readings dating back to 1962.

Why do active managers exist?

They exist so investors can differentiate their returns. In different environments, different stocks, industries, sectors and assets perform better than others. When the two main assets reach their most expensive levels in 56 years, one can understand why investors are not looking to differentiate.


Furthermore, the static monetary policy environment that is almost a decade old has accentuated and elongated this trend. When policy is static, investors don’t need to worry about how policy will influence their holdings and “one size fits all” appears to work.


When monetary and fiscal policy change and the static environment comes to an end, investors will once again need to look to differentiate. Apparently, this is not happening overnight, but as each gradual shift occurs, the gradual pressure will grow into an unsustainable weight.


Since inflation has been rising for over a year and it’s on pace to continue, now is not the time to argue that low inflation justifies a higher multiple. Many will be caught off guard because it has been way too easy to “set it and forget it” in recent years.

Bottom Line

The psychology associated with simply being invested in the “market” has become so pervasive that it is reminiscent of the 2005-2006 housing bubble arguments that “US Home prices have never declined year over year” - until they did. One size fits all makes sure you are wearing something, but it may not be the right thing.


Guest Contributor: Current Market Psychology Reminiscent of 2005 Housing Bubble - 60 40 model


Guest Contributor: Current Market Psychology Reminiscent of 2005 Housing Bubble - disclaimer


This is a Hedgeye Guest Contributor research note written by Michael O'Rourke, Chief Market Strategist of JonesTrading, where he advises institutional investors on market developments. He publishes "The Closing Print" on a daily basis in which his primary focus is identifying short term catalysts that drive daily trading activity while addressing how they fit into the “big picture.” This piece does not necessarily reflect the opinion of Hedgeye.

Can Stocks Hit Fresh All-Time Highs? Yup. Volume Is Accelerating

Can Stocks Hit Fresh All-Time Highs? Yup. Volume Is Accelerating - volume accel

The U.S. stock market is within spitting distance of all-time highs


Which begs the question: Can the market go higher? You bet.


As you can see in the Chart of the Day below (from today's Early Look), equity market volume (the number of shares traded on U.S. stock exchanges) yesterday was up +11% versus its 1-month average and up 8% versus the 3-month average. The S&P 500 was up +0.6% yesterday. This follows increasing volume in Tuesday trading as well, when the market was up 0.85%. Here's the volume scorecard on that move higher:


  • Trading volume (1/3) vs. 1-month average: +30%
  • Trading volume (1/3) vs. 3-month average: +26%

What Accelerating Volume Means For Stocks

Think of accelerating volume (on up days) as a vote of confidence that the market can head higher. It's simple. If more investors are buying as the stock market heads higher that's bullish. Conversely, if volume accelerates on down days that means investors are selling in droves. That is very bad and very bearish signal.


Consider what happened during a two particularly trying weeks at the end of October and early November in which stocks fell -3%. Volume was consistently accelerating as investors headed for the door. On November 1st and 2nd, volume was up almost 20% versus the one-month average as stocks dropped -0.6% on both days. 

Bottom Line

We're a far cry from those dismal days today. The U.S. economy is growing, stocks are heading higher and volume is accelerating. All of this bodes well for equities. We don't see an end to the 9-year bull market just yet.


Can Stocks Hit Fresh All-Time Highs? Yup. Volume Is Accelerating - 01.05.17 EL Chart  2

The Most Disruptive Change In the Restaurant Industry In This Generation

The Most Disruptive Change In the Restaurant Industry In This Generation - food delivery cartoon 01.05.2017


Veteran restaurant industry analyst Howard Penney is calling it "the most disruptive change in the restaurant industry in this generation." He's referring to restaurant DELIVERY and his analyst team is hosting a special call featuring in-depth analysis of this development Thursday at 1pm ET.


Penney will discuss how the consumer's need for convenience is paramount. Access to food is no exception. With the likes of Domino's and other pizza players having had a lock on meal delivery for some time, it is now time for others to join the party.


Here's a brief look at some key discussion points.



The Most Disruptive Change In the Restaurant Industry In This Generation - Z POST


There has been a spread of third party delivery services such as DoorDash and Postmates which have received considerable venture funding, and partnered with many independents and large national chains.



The Most Disruptive Change In the Restaurant Industry In This Generation - z grub


Historically, GrubHub has merely been an aggregator of orders. But now it has begun to delve into the delivery space. Both organically and through acquisitions.


GRUB's business model is under severe pressure. We see considerable downside to management's lofty top line and margin goals given competitive actions and company initiatives around delivery. The commission model is also going to be under pressure and is unsustainable at the current rates.



The Most Disruptive Change In the Restaurant Industry In This Generation - z panera


The chain of bakery-café fast casual restaurants has been investing immense amounts of capital to push out their Panera 2.0 initiative, which is nearly completed in company-owned stores. Panera Bread's next frontier is delivery, which they anticipate will be in 15% of units by the end of 2016, and ramping to 35% - 40% of the system by the end of 2017.


We are looking at 2017 as being another investment year for PNRA and 2018 will be a much cleaner year from a profitability standpoint. We believe PNRA's ownership of delivery will allow them to maximize the profitability while having complete control of the process, yielding top of class results.



The Most Disruptive Change In the Restaurant Industry In This Generation - z dominos


Founded back in 1960, when Dwight D. Eisenhower was President, Domino's Pizza remains the darling of the restaurant industry from a technology and convenience standpoint. It trades at a premium valuation accordingly. We have not talked about DPZ much, but we now believe there is line of sight to their domination in the delivery business ending.




If you are an institutional investor interested in accessing this call email sales@hedgeye.com.

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Cartoon of the Day: Belly Up?

Cartoon of the Day: Belly Up? - GOLDfish cartoon 01.04.2016


Gold prices are down -16% since peaking in early July. We say sell it.



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ICYMI: How to Trade Gold Right Now

Takeaway: The U.S. economy is growing. Interest rates and the U.S. Dollar are rising. That’s an explicit signal to do what? Sell gold.


“If you want to get Gold right, you have to get rates and the U.S. Dollar right.”

—Hedgeye CEO Keith McCullough


As you can see in the video above, the U.S. Dollar has a negative correlation of -0.97 to Gold over the past 90 days, meaning their prices move in direct opposition to each other. Pay attention to the 10-year Treasury yield and direction of the U.S. dollar — both are expressions of future growth expectations.


Recently reported economic data including U.S. GDPISM Manufacturing and Durable Goods orders all suggest that U.S. economic growth is accelerating.


We agree.


And at the right level, you sell gold.


Our proprietary model signals gold is overbought. It suggests Gold has almost 4% downside at current prices to $1121 per ounce. However, an even better spot to sell, McCullough says, is when the 10-year Treasury yield hits 2.41%. That would imply Treasuries (and hence other asset classes that benefit from slower U.S. economic growth) are also overbought.


Guest Contributor: The End Of Currency Wars?

by Daniel Lacalle

Guest Contributor: The End Of Currency Wars? - currency wars


“From its creation in 1913, the most important Fed mandate has been to maintain the purchasing power of the dollar; however, since 1913 the dollar has lost over 95 percent of its value” -James Rickards


One of the least talked about proposals of the future Trump administration is the one that aims to penalize with economic sanctions those countries that manipulate their currency … even the US.


The proposal is not entirely new, and has been defended by Republicans since 2014, but the novelty is to penalize monetary manipulation.


On the one hand, Republicans have two proposals, one in the House of Representatives Financial Services Committee -of 2014- and another, of 2015, in the Senate Banking Committee by which the Federal Reserve would be prevented from making decisions on interest rates and balance sheet expansion if they deviate by more than two percentage points from a predetermined Taylor Rule. Let’s explain.


If the Federal Reserve targets a level of inflation and employment for a level of rates and monetary policies, it would have to explain to Congress or the Senate why it changes or deflects the normalization when these targets are met.


Why? Very few representatives of the Republican party deny that the dramatic cut in interest rates led to a huge bubble that generated the 2008 crisis, and that prolonging the so-called expansive policies in recent years has generated another bubble in bonds and an excess of euphoria in financial assets with no discernible impact on the real economy ( read the results here )

Guest Contributor: The End Of Currency Wars? - d lac 2

The indiscriminate creation of money not supported by savings is always behind the greatest crises, and there is always someone willing to justify it as both a problem and its solution.


Add to this that the economists of the Federal Reserve and its chairpersons were all unable to alert or even recognize the risk of such bubbles (from Greenspan to Bernanke or Yellen) and you will understand why there is a growing body of politicians concerned about monetary policies that are always launched as if they had no risk and then justified with the lame argument of “it would have been worse.”


Of course, the Federal Reserve rejects such limitations. When the central bank becomes the largest hedge fund in the world under the premise that there is “no inflation” despite a massive bubble in financial assets, it is difficult to change the methodology of the entity. But after consistently erring on estimates, impact and consequences, it is normal that the Republican Party and many Democrats put the mandate of the central bank in question .


Carl Icahn, one of the world’s top investors and Trump’s newly appointed regulation adviser, still holds the napkin where he took note of the Federal Reserve chairman’s response to his question on whether they had gauged the negative consequences of the Fed´s monetary policy. ” We don’t know “, was the answer.


But I am especially interested in the idea of penalizing countries that implement devaluation policies of ” beggar thy neighbor ” after the currency war seen in recent years. Read here.


Several years ago, in 2009, I had the opportunity to chat at a meeting with the incoming US Secretary of State, Rex Tillerson, and he was already saying that the greatest threat to the world was the spread of currency wars.


Now, only a few days away from getting a clear picture of the entire US government team and advisors, Rex Tillerson, Mick Mulvaney and Carl Icahn are clearly against the policies of financial repression. Even Steve Mnuchin himself has often commented on the risk of inflationary policies.


But the US cannot prevent central banks from other countries from continuing to impoverish their citizens through devaluations and brutal increases in money supply … Unless they are fined for doing so. And that penalty can have dissuasive effects and, in addition, prevent the generation of larger bubbles that lead us to another financial crisis. It is no coincidence that Mick Mulvaney applauds initiatives like Bitcoin  and the depoliticization of currencies.


It is not about returning to the gold standard or anything like that. In fact, what this group of representatives of the Republican party demands – and in that they are absolutely right – is the end of uncontrolled monetary excess without any responsibility on its consequences. Rejecting a system that encourages bubbles and over-indebtedness under the excuse that “it could be worse.”

Guest Contributor: The End Of Currency Wars? - dla z 

We do not know if these measures will be implemented, but I think it is important and healthy that the debate over the excesses of central banks is raised at government level in the world’s leading economy. Trump himself, who once said that “America can print all the money it needs,” has abandoned that ridiculous comment.


In any case, just as the crisis of 2008 ended the open bar excesses of some financial operators, it is time to alert that central banks´balance sheet cannot be used indiscriminately as if they were high risk funds to perpetuate the bubble , when the result has been more than disappointing. Recovering a little sanity, even modestly, will not hurt anyone.


We shall see.


This is a Hedgeye Guest Contributor research note written by economist Dr. Daniel Lacalle. He is the author of Life In The Financial Markets and The Energy World Is Flat. This piece does not necessarily reflect the opinion of Hedgeye.



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