“Financial price series have a ‘memory’ of sorts. Today does, in fact, influence tomorrow.”
-Benoit Mandelbrot
First off, happy 4th of July weekend to our growing client base. I’m confident I speak for all of the team at Hedgeye, we’re grateful to have a chance to learn from so many unique and thoughtful investors. It’s been a challenging but rewarding experience.
It might be surprising that I’m just now getting to The (Mis)Behavior of Markets considering Keith has been referencing it regularly over the last 6 months. The stack of books on my list grows perpetually no matter how fast I try to chase it, but I can attest, this is a good one.
There are armies of analysts, authors, and professors who have poked holes the principles Modern Portfolio Theory, EMT, etc.
I get the sense that most people generally agree with the theoretical limitations to some of those frameworks but still subscribe for lack of alternative knowledge (full disclosure: my practical alternative knowledge is limited right now but hopefully that can change in time).
If you want a convincing rebuttal to traditional probability theory with a quantitative framework, this is one of the few books I’ve come across.
Back to the Global Macro Grind…
#EuropeSlowing was one of our big 3 macro themes for Q3 which we rolled out this past Friday in our Quarterly Themes call. To summarize, our perception of the set-up halfway through 2017 is as follows:
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“Contrary to our positive outlook in the U.S., our model is prospectively signaling a concomitant deceleration in both economic growth and inflation across the Eurozone economy. This view is very counter to consensus that remains extremely complacent on the long side of the euro and European equities.” |
This deceleration in both economic growth and inflation across the Eurozone looks probable within our framework. (With that being said, I think we all know that market timing and behavioral catalysts are harder to pinpoint.)
We are most wary about missing the second derivative turns in any given economy. Trends tend to be pervasive, and we generally require a robust swath of data to convince us a trending macro condition is at risk of changing. This is a daily data grind, but more or less we also believe that ‘today does in fact influence tomorrow.’ Here are a few of many bits of information to consider that are central to our #EuropeSlowing theme moving into Q3:
- Growth: Reported Y/Y GDP growth in the Eurozone has flat-lined at +1.8% to +2.0% Y/Y for 9 consecutive quarters.
- Base Effects: The 2Yr comp stack in our GIP model tends to have the best batting average for predicting accelerations and decelerations. After an acceleration and flat-lining of Y/Y growth for 9 consecutive quarters, the two-year comp for the next 4 quarters is as difficult as 1Q-3Q of 2012 after which Y/Y GDP growth decelerated -0.5%, -0.8%, -1.0% over that 3 quarter period.
- Currencies: In 3Q of 2017 (data will be reported well into October/November), we have the Eurozone tracking squarely in a QUAD 4 environment in which growth and inflation are decelerating. We expect relatively easier monetary policy from Draghi, who has echoed hawkish rhetoric of late.
- Sentiment: With Brexit fresh in the minds of investors globally, the threat of continued dislocation in the Eurozone experiment was a real risk priced by the market right through French elections. Across a number of market based signals that are vital to our risk management process including volatility expectations (skew, term structures, implied volatility premiums) and momentum in futures and options contract positioning, consensus appears much more constructive on the Euro currency. We believe this growing consensus camp may have overstayed its welcome.
In our opinion, one of the most glaring long-term structural headwinds in the Eurozone is of a demographic-nature. The outlook for Southern Europe in particular looks grim to say the least. Much of this debate was hashed out in our Q3 themes presentation:
- In most developed nations, a person spends the most money when they are in the 35-54 year old age bracket. In Spain, Portugal, Greece and Italy this peak spending demographic cohort will be decelerating through 2030.
- To get more specific, the estimated growth rates in this peak spending cohort for these four economies are -2.5%, -2.3%, -1.8%, and -1.6% Y/Y, respectively – a complete disaster on the surface.
- For the Eurozone as a whole, the growth rate by 2030 will be an estimated -0.7% Y/Y which compares to +1.0% Y/Y in the U.S.
- While the Southern European countries will experience the largest declines in the peak spending cohort, they will also have the highest “Old-Age Dependency Ratios” which measures the 65+ year old population as a % of the total population. The old age dependency population in Spain, Portugal, and Italy is roughly 21%, 24%, and 24%, respectively. For context this 65+ population is 18% in the U.S. (see Chart of the Day)
- The World Bank has created an “Ease of Doing Business Index” (for more color: DoingBusiness.org) which ranks countries based on categories like “starting a business” and
acquiring a “construction permit” among many other factors. Italy, Spain, and the rest of the Eurozone as a whole rank among the lowest globally on the Ease of Doing Business Index. - A growing tourism industry (as a % of GDP) has been a bright spot in many of these nations. Everyone has confronted the narratives on technology and millennial preferences - this will probably continue to be a debate. Travel & Tourism contributes an estimated 19%, 16%, 16%, and 10% to the total GDP of Greece, Spain, Portugal and Italy, respectively. While there are wildly varying statistics and definitions of what constitutes “tourism”, just a little research will reveal these contributions have been trending higher over the long-term. A thriving tourism industry is a boon in good times, but the deep cyclicality of this current crutch is a real risk when looking at the resiliency of the rest of the economy.
Of course, now in hindsight, the real acceleration in European economic growth and the waning of political risk was a real and non-consensus catalyst for the currency in the first couple of months of 2017. With the potential deceleration in growth and inflation coupled with the seemingly constructive consensus momentum behind the Euro currency in reaction to these positive developments, #EuropeSlowing is one of the more interesting set-ups in global macro. We look forward to the coming debate.
Thank you again for your support. Have a great 4th of July holiday and happy hunting in 2H.
Our immediate-term Global Macro Risk Ranges (intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.12-2.32% (bearish)
SPX 2 (bullish)
RUT 1 (bullish)
NASDAQ 6112-6298 (bullish)
Nikkei 195 (bullish)
DAX 120 (bullish)
VIX 9.60-11.83 (bearish)
USD 95.25-97.16 (neutral)
EUR/USD 1.11-1.14 (bearish)
YEN 110.52-112.93 (bearish)
GBP/USD 1.27-1.30 (bullish)
Oil (WTI) 41.90-46.37 (bearish)
Nat Gas 2.84-3.14 (bearish)
Gold 1 (bullish)
Copper 2.59-2.74 (neutral)
Good Luck Out There,
Ben Ryan
Macro Analyst
