Winged Pigs

“Bulls make money, bears make money, pigs get slaughtered”

What about …..  “When you know you’re going to be right, spread your wings”.

So, which is it?  Can you cleanly distinguish between getting piggy vs spreading your wings and riding something, in size, that is working?

Wall street is replete with hollow, sirenic aphorisms. 

It’s not that they don’t contain some amount of distilled truthiness, it’s just that the generalization robs it of any practical utility as the analytical alpha comes precisely in understanding the conditional dependencies and duration sensitivities of a particular exposure. 

So, is it neither? Is it some conditional and amorphous combination of both?

Pocket that question for a moment.  I’ll came back to it (with an answer) below.     

Back to the Global Macro Grind… 

I’ve exhaustively detailed the evolution of our #GlobalDivergences & #DollarBottoming themes and the attendant implications for equities, rates & Fx, globally, over the last 5 months, and the past 6 weeks, in particular. 

For new readers, the defining macro factor flow we’ve been riding has essentially been the following: 

Oil up (we’re using oil as a catch-all for energy, wage, core/headline inflation … and b/c the Trending correlation with yields & inflation expectations is essentially +1.0) = inflation expectations up = hawkish policy expectations up + nominal real/yields up = rate differentials up + Global Divergences (relative growth in the U.S. looking better as EU/China/EM growth slows broadly) + offsides FX spec positioning = $USD up = EM down (among other things)

While I don’t think its fully priced in yet, I’ve actually heard my own thesis pitched back to me over the last week+ so the narrative shift is certainly in progress.    

Yesterday was interesting because:

1. On the one hand, CPI accelerated but came in less hot than estimates which relieved some angst around the prospects for an overaggressive Fed.
2. On the other hand, the BOE punted on hiking and downgraded their forecast amidst a rash of weaker data causing forward rate hike odds to crash lower.   This underscores the re-emergent policy divergence dynamic whereby the Fed stands pat on its expected policy trajectory while the BOE, EU, China work to rhetorically or tangibly moderate or walk-back hawkish expectations.  Any widening policy divergence would work to maintain or further propagate the flow dynamic described above.  

Now, recall, our inflation acceleration call has an expiration date – we think the RoC peak occurs sometime into 3Q - and we don’t have a Jamie Dimon 4% spitball yield target so we’re not price insensitive.

Which brings us back to resolving the viability of building an investing strategy around the shallow sagacity of Wall Street aphorisms.  

Consider the last couple days as it serves an quintessential case study in applied risk management:

Here’s how we risk managed our rate/inflation exposure around the CPI catalyst:

• Research View:  Inflation growth will trend higher over the next quarter+.  Rising inflation/inflation expectations should remain supportive of yields. 
• Risk Management view:  The risk range on the 10Y Treasury coming into Wednesday was 2.93-3.02%.
• The Process & The Decision:  We covered our short TLT position on Wednesday as the 10Y Yield hit the top end of the risk range at 3.01%.  The intuition is that the top end of the range embedded the notion that inflation expectations were mostly/fully priced in ahead of reported CPI data on Thursday.
• The What Next:  = We go back to the tactical risk management.  With the research view unchanged we come back and short the same exposure at the low end of the risk range.

That’s it. 

And that, in practice, is how you spread your wings on an emerging Trend while minimizing the risk of getting slaughtered. 

Again, we’re fully cognizant of the fact that consensus is short treasuries.  We think nearer-term inflation dynamics will continue to buttress a tilt toward rising yields but we still don’t want to own them at every price.  The one-sided positioning makes the price sensitivity and risk management exercise described above all the more relevant.   

Moreover, as we traverse the rate-of-change peak in inflation in June/July and if Quad 4 (growth and inflation both slowing) still looks like the pending reality, we’ll be glad to take the other side of our current position for what has the potential to be an “entertaining” unwind.   

So that’s how we risk managed the positioning.   With respect to our research view on Inflation, here’s how the report scored:

• Headline = 3^rd month of acceleration and fastest pace of growth in 14 months
• Core = 5^th month of acceleration (taking the growth rate out to two decimal places = +2bps of acceleration: 2.14% Y/Y in April vs +2.12% Y/Y in March) and fastest pace of growth in 14 months
• Shelter = accelerated +7bps to +3.39% Y/Y
• Wireless/Cellphone Services = accelerated +170bps to -0.7% Y/Y
• Medical = accelerated +22bps sequentially to +2.21% Y/y
• Energy = accelerated +84bps sequentially to +7.87% Y/Y
• Food = accelerated +10bps sequentially to +1.39% Y/Y
• Sticky prices CPI = 2^nd month of acceleration and fastest pace of growth in over a year
• Core Sticky Prices CPI = 2^nd month of acceleration and fastest pace of growth in over a year
• Trimmed-mean CPI = 2^nd month of acceleration and fastest pace of growth in a year
• Median CPI = 2^nd month of acceleration and fastest pace of growth in over 9 years
• Underlying Inflation CPI = 11^th month of acceleration and fastest pace of growth this cycle

In other words, with the preponderance of underlying and nondiscretionary household cost centers showing accelerating price growth, the notion that the April gain was exclusively or predominately a function of energy is a mischaracterization. 

In other, other words, nothing’s changed with respect to our nearer-term outlook for accelerating inflation.

Quickly, before closing, let me briefly touch on a few housing related inflation dynamics vis-à-vis “Triple-L” (Lots, Labor, Lumber) risk. 

Lot and skilled labor shortages have been known-knowns for the industry for a few years now and Lumber emerged as a more discrete concern post the announcement and implementation of Canadian lumber tariffs last year. 

What’s incremental and notable is the continued resurgence in raw material costs.   

As of this week’s latest data:

• Concrete prices =  +6.9% Y/Y  = fastest pace of price growth in 11 years.
• Lumber & Plywood prices =  11% Y/Y and holding just off of 4Y rate-of-change highs
• CME Lumber futures = up a remarkable 70% Y/Y
• Aggegate Inputs to Resi Construction = +6.2% Y/Y = fastest pace of price growth in 7 years.

And the latest input cost crescendo is occurring with rates again backing up.  

To be sure, underlying demand remains solid, some runway exists from an affordability perspective (i.e. home prices/rates can rise further before becoming an acute constrain on affordability) and the longer-term opportunity in housing remains favorable but rising rates and unbridled input cost inflation are not a bullish factor cocktail for related equity exposures.   

From a top-down perspective, we’ll probably look to rebuild some housing exposure as cost pressures ebb and quad 4 becomes a more investible reality. 

Lastly, to all the mom’s whose day doesn’t open or end with the ringing of a bell and whose caring and selflessness go underappreciated but undeterred, we appreciate everything you do, truly, though we don’t say it nearly enough.  Thank you.

And for all the children - CPI for Flowers is only up +1.29% Y/Y …. No excuses.   Better yet, CPI for New Auto’s is down -1.62% Y/Y .… I mean, you love mom, right?

Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:

UST 10yr Yield 2.93-3.02% (bullish)
SPX 2 (bearish)
NASDAQ 6 (bearish)
Energy (XLE) 74.07-76.88 (bullish)
Industrials (XLI) 70.55-74.87 (bearish)
VIX 13.01-17.89 (bullish)
USD 91.29-93.39 (bullish)
Oil (WTI) 67.74-72.22 (bullish)

Have a great weekend,

Christian B. Drake
U.S. Macro analyst