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“Every man desires to live long, but no man would be old.”
-Jonathan Swift 

How would you like to remain forever young? How would you like your emerging market equity, credit and/or FX exposures to remain forever at generational highs in trailing 18-to-24-month Sharpe Ratio terms like they were in late-January?

Please excuse my pathetic attempt at satire. I don’t have Swift’s natural talent for using humor and irony to convey deeper meaning. In fact, my communication style is typically far more blunt – even to a fault at times. 

Communicating with more tact and grace is something I’m working on and, in the context of Deep Work – a book Keith has been citing in recent Early Look notes – it’s important that we don’t forget to work on ourselves, as well as our relationships with our respective God, our family, our colleagues, our friends and the strangers we interact with daily. 

Back to the Global Macro Grind… 

Sell Emerging Markets - emerging markets cartoon 12.19.2016

You want to know what’s NOT working this year? Emerging Markets. Consider the following YTD Total Returns for the following sample of big, liquid EM exposures: 

  • iShares MSCI Emerging Markets Index (EEM): -1.5%
  • Bloomberg Barclays EM USD Aggregate Index: -3.7%
  • J.P. Morgan Emerging Market Currency Index: -3.6% 

Now juxtapose those figures with the YTD Total Returns for the following factor exposures we have liked all year:

  • Consumer Discretionary Select Sector SPDR Fund (XLY): +5.6%
  • Technology Select Sector SPDR Fund (XLK): +7.0%
  • Bloomberg Barclays EUR Aggregate Index: +0.3%

The relative performance of our #UnderweightEM theme – introduced on January 4th, 2018 (CLICK HERE to access the replay materials) – is even more stark on a tighter duration:

  • iShares MSCI Emerging Markets Index (EEM): -3.9% Quarter-to-Date
  • Bloomberg Barclays EM USD Aggregate Index: -2.3% QTD
  • J.P. Morgan Emerging Market Currency Index: -5.2% QTD 

Now juxtapose those figures with the QTD returns for the following factor exposures we have liked since we introduced our Q2 2018 Macro Themes at the beginning of April: 

  • Energy Select Sector SPDR Fund (XLE): +10.6%
  • CRB Foodstuffs Index: +5.3%
  • U.S. Dollar Index: +3.2% 

Aside from giving us a reason to come hang out with and learn from you every few months, the primary mission of our Quarterly Macro Themes product is to educate investors on emergent top-down risks that our repeatable, quantitatively-oriented research processes are signaling as increasingly probable that investor consensus is not yet positioned for. 

We aim to flag these risks 3-6 months early with the goal of having helped our high-turnover clients nail the quarter by being three months early OR with the goal of giving our larger, low-turnover clients enough time to do their own work and reposition accordingly over the course of the next half-year. We can’t be everything to everyone, but that 3-6 month window of lead time seems to work for the largest number of clients. 

Admittedly, that was a mouthful, so allow me to summarize: 

“The Hedgeye Quarterly Macro Themes summarize three big risks that have the potential to ruin your year [in PnL terms] to the extent you fail to position for them appropriately.” 

No, we are not fearmongers; we’re educators. It takes A LOT of man (or woman) hours to: 

  • Sequence Growth, Inflation and Policy data for every investable economy in the world;
  • Identify extremes in Positioning and Pricing for every relevant derivatives market in the world; and
  • Signal immediate-term Overbought and Oversold conditions, as well as intermediate-to-long-term Phase Transitions across hundreds of factor exposures and securities, daily. 

We have a five-person team with nearly 70 years of professional buyside and sellside experience working to achieve these objectives daily. It’s an absolute grind, but it’s also our passion and we’re here to help. 

With respect to helping you risk manage your EM exposures, I think it’s important to consider just how gnarly this could get if we’re increasingly right on the U.S. dollar from here. Consider the following YTD-peak-to-present drawdowns as a warning: 

  • iShares MSCI Emerging Markets Index (EEM): down -10.9% from its January 26th YTD high
  • Bloomberg Barclays EM USD Aggregate Index: down -4.0% from its January 8th YTD high
  • J.P. Morgan Emerging Market Currency Index: down -6.5% from its February 15th YTD high 

Fortuitously, our #UnderweightEM theme helped some of you avoid these drawdowns. Did we turn bearish on EM because we knew that Argentina would require yet another IMF bailout to alleviate its currency crisis or that Ergodan would successfully set the stage for the near-abolishment of the rule of law in Turkey? No – we don’t have “boots on the ground” in either country. 

I spent the better part of my flight home from Kansas City last night reading up on the latest Argentine and Turkish BoP crises (ARS and TRY down -17.2% and -11.3%, respectively, for the YTD), but after a couple hours of deep study, I realized that none of what I was reading about was actually predictive. You know what was predictive? Analyzing the data on the Global Macro Risk Monitor table I send to handful of our top clients each morning: 

  • After spending the better part of 2016-17 in Hedgeye GIP Model Quadrants 1 and 2, both Turkey and Argentina were transitioning to spending the better part of 2018E in Quadrants 3 and 4;
  • Argentina and Turkey have two of the deepest Twin Deficit Balances in the world, at -5.5% and -7.1% of GDP, respectively.
  • The confluence of transitioning to less favorable cyclical (i.e. GIP Model) setups and U.S. Dollar Up, U.S. Rates Up has historically hammered twin deficit emerging markets. Recall that these outcomes are precisely what we forecasted as a function of the analysis laid out on slides 62-84 of the aforementioned presentation

All told, a cursory glance at the general state of the active management industry would seem to suggest that having “boots on the ground” isn’t all it’s cracked up to be in trailing absolute and relative performance terms. Perhaps there is a better, data-driven way to manage top-down PnL risk after all. 

Our immediate-term Global Macro Risk Ranges are now: 

UST 10yr Yield 2.93-3.03% (bullish)
SPX 2 (bearish)
VIX 14.24-18.58 (bullish)
USD 91.06-93.28 (bullish)
Oil (WTI) 67.25-71.23 (bullish)
Gold 1 (bearish) 

Keep your head on a swivel,

DD 

Darius Dale
Managing Director

Sell Emerging Markets - Chart of the Day