“New knowledge is the most valuable commodity on earth – the more truth we have to work with, the richer we become.”
-Kurt Vonnegut
The truth about commodities right now is that they continue to go down. We call this trending Global Macro Theme “Reflation’s Rollover.” As a result, there’s no truthful data to support that inflation readings haven’t already put in their 2017 peak.
The other mathematical truth about real GDP growth is that (all other things held constant), if inflation rolls over, the GDP Deflator goes down, and real GDP goes up. A levered Oil & Gas company doesn’t like that; my Dad (who buys gas) does.
I spent a lot of time discussing this current economic truth (inflation slowing and real growth accelerating) with investors in California this week. It’s bullish for real growth (Tech, Consumer Discretionary, etc.) bulls and reflation bears alike.
Back to the Global Macro Grind…
Bullish for bears? Big time. If you’re short or underweight Energy (XLE) and long Tech (XLK), your investors are ragingly bullish about your returns right now. For 2017 YTD there’s a +1,530 basis point performance spread here:
- Tech (XLK) = up +13.3% YTD
- Energy (XLE) = down -12.0% YTD
Will this YTD margin of victory for REAL growth bulls continue to widen? I’m not sure. The only certainty here is that a big move has already happened. Some people crushed it with this type of positioning. Some people got crushed.
Active manager returns are back, baby!
When we had Reflation’s Peak as our Macro Theme for Q1 (Reflation’s Rollover is Q2), we showed what we use to predict the rate of change in year-over-year reported inflation: arithmetic mean of our Hedgeye year-over-year Commodity Price Sample.
As you can see in today’s Chart of The Day, that price sample is getting crushed too.
The truth is that we use the truth (real-time prices as opposed to someone’s macro opinion) because it has been a good predictor for CPI (consumer price inflation) when you consider it on a 2nd derivative basis.
In addition to the price sample itself, we’re constantly measuring and mapping the rates of change in things like:
A) Break-even Inflation rates (across durations)
B) Inflation Swap Rates (again, across durations)
The inflation swap rate is the zero coupon fixed rate necessary to build a swap against US Headline Inflation (CPI). A 5 year, 5 year inflation swap rate is found by taking the difference between the 10yr and 5yr zero coupon inflation swap rates and multiplying by 2. It’s an indication of long-term inflation expectations.
After peaking at +2.5% year-over-year inflation (headline CPI) in Q117, here’s where our predictive tracking algo is at for Q2-Q4:
- Q217 = 2.3%
- Q317 = 2.1%
- Q417 = +1.7%
Meanwhile Consensus Macro (Bloomberg Consensus Estimates) is doing pretty much what it usually does, taking the most recently reported inflation rate and calling that the forecast for the next 3 quarters at +2.4-2.5%. #Sweet.
Obviously the buy-side is going to have forecasts for inflation that converge closer to ours as leading indicators for reported inflation continue to fall. That’s probably why consensus expectations for rates to rise continue to fall.
How do I measure that expectation? I look at the market’s positioning. Non-commercial futures & options positioning on the 10yr Treasury Bond have gone from max short (-348,133 net SHORT contracts in FEB) to +221,842 net LONG contracts this past week.
The truth on that is quite simply the truth about most things macro these days – consensus sells low and chases high, after macro markets move.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.25-2.39% (bullish)
SPX 2 (bullish)
RUT 1 (bullish)
NASDAQ 5 (bullish)
XOP 33.08-35.13 (bearish)
VIX 10.03-11.29 (bearish)
EUR/USD 1.07-1.10 (bearish)
Oil (WTI) 44.90-48.52 (bearish)
Copper 2.49-2.61 (bearish)
Best of luck out there today,
KM
Keith R. McCullough
Chief Executive Officer
