“Girls only like guys who have sweet skills”
- Napoleon Dynamite

“You know, like Nunchuck skills, bow hunting skills, computer hacking skills” … full-cycle investing skills! 

Q: Quick, and without overthinking it, name the following returns:

  • +44%
  • +42%
  • -1.1%

A: Performance for the following since the Full-Cycle Investing turn at the peak of the U.S. macro cycle in 3Q18

  1. Gold
  2. TLT (Bonds)
  3. S&P500

Thank you brotha’, may I have anotha’!? 

Certainly, …  Q: What do the following have in common?

  1. This magnitude of pervasive $USD strength
  2. This magnitude of oil/energy price decline
  3. This magnitude of inter and intra-country travel restrictions

A:  At any other time any of those dynamics, individually, would likely be enough to push the economy into recession … particularly one that was already traversing the wrong side of the growth curve.

In discussing the Fed’s re-commitment to backstop markets last week – and as it relates to commonality question above - I was asked a number of times to expand on the Sophie’s choice dynamic confronting policy makers.  

So, while accepting that not acting in present circumstances was not a viable option, consider the following feedback loop cultivated by the current intersection of policy and global macro conditions.   

To the extent the global macro-scape is a quasi-closed system (outside of mattress stuffing, money has to go somewhere), investment decisions and capitals flows remains a game of relatives which, given the current macro condition set, sets up an interesting paradox for market observers and a confounding circularity for policy makers.  

The following is oversimplified but some version of it has characterized domestic dynamics over the past month:  

Home of the worlds reserve currency + central bank to the world + the largest Fiscal/Monetary response in the world + best (relative) DM macro conditions headed into the crisis + market structure idiosyncracies have fomented a unique and acute flow-based US FOMO phenomenon

Now, if relative attractiveness/growth is driving capital flows to U.S. assets, it is also (directly or indirectly) supporting the dollar and (directly) driving a disinflationary impulse and an associated rise in real yields.  Absent an organic and durable acceleration in domestic growth, the only way out for the Fed is to loosen policy, which is a precarious tightrope walk … which is also probably redundant since a tightrope walk can’t, pretty much by definition, be anything other than precarious.

Anyway, If that loosening is just sufficient enough to support activity & assets domestically then it will lead to more relative attractiveness ... the same relative attractiveness that drove dollar strength, disinflation and a tightening of dollar liquidity & global financial conditions that (at least partially) necessitated the loosening in the first place. 

In other words, the Fed needs to go big enough to drive a reflationary impulse globally such that the policy and growth divergence can compress, ROW can take the handoff and a protracted run of global Quad1/Quad2 capable of driving durable $USD pressure works to extricate the fed from the perversity cycle above.

The market began pricing in negative policy rates domestically for the first time ever yesterday. 

Sweet Skills - 04.03.2020 unemployment line cartoon  1

Back to the Global Macro Grind ….

Contemplating the scale of domestic job loss is a lot like trying to ponder the number of atoms in the universe ... the numbers are so large relative to our individual experience that it escapes our capacity to really process and internalize them. 

As the shock value associated with the weekly claims numbers has slowly degraded, we have been left to further (negatively) rescale our y-axes and impassively marvel at the cumulative labor market dislocation.  

Indeed, yesterday’s Initial Jobless Claims data showed an additional 3.7M lost jobs, taking the cumulative 7-week total north of 33.5 million and effectively wiping out more than 2 decades of employment gains.

This morning’s April Employment data will show job loss more then 2X greater than that observed over the entirety of the GFC and roughly equivalent to the cumulative total of the last 8-9 recessions. 

Again, I know the coverage around this has been desensitizing but please take a moment to let that sink in.  Reconnect with the reality that real people and livelihoods are associated with those statistics.

Fundamentally, the labor data is really the only data of consequence today so let’s take a quick contextual tour of what matters:

Jobless Claims:

  • Given the large-scale changes in UI eligibility requirements and the inability of antiquated state unemployment processing systems to integrate those changes, many Initial Claims applications have been rejected with the applicant forced to reapply.  This dynamic would serve to inflate the Initial Claims numbers and, thus, overstate the magnitude of underlying job loss.  To be clear, I’m just making a technical point here.  Catastrophic job loss is the underlying reality.  
  • A fulcrum factor in determining the flow through of Initial Claims to Continuing Claims is the rejection rate.  A higher rejection rate means more people are not receiving benefits … and the flow through drag to consumption will be that much more pronounced.
  • PUA:  For the first time yesterday, the weekly data included Pandemic Unemployment Assistance claims numbers. PUAs are part of the CARES Act and cover workers ineligible for traditional state UI assistance, including independent contractors, self-employed individuals, and others as detailed in the CARES Act.  PUA claims totaled 583,699 in the latest week. In other words, the real initial claims number last week is actually 3,169,000 + 583,699 = 3,752,699.
  • For context, PUA numbers alone are roughly equivalent to the peak level of state claims seen during the GFC.
  • Continued Claims rose to 22.65 million and are currently ~3.4x the previous high-water mark of ~6.6 million set during the financial crisis.
  • As we trudge towards re-normalization it will be increasing important to monitor continuing claims as they will offer the highest frequency read on any developing improvement… 
  • As furloughed and temporarily laid off workers are re-onboarded, it should first manifest in the continuing claims numbers
  • Notably, in a recent clarification around the PPP and UI benefit rules, the Treasury Department indicated (Here) that if an employer offers to re-hire the worker and the worker rejects the offer, they forfeit eligibility for Unemployment benefits.  In other words, workers can’t simply opt not to work in order to collect (more than they would working) to do nothing.   Our Macro Policy team in D.C. has noted, however, that the appetite for actively monitoring and enforcing this is essentially zero.

NFP: 

  • As it relates to Unemployment “accounting”:  Furloughed workers may or may not be counted as unemployed. Technically, BLS classifies someone as unemployed if they do not have a job and are actively looking for work.  If an individual is furloughed and expecting to be brought back on (so are not actively looking for another job) then they would not be counted as unemployed. 
  • In its March Employment Survey, BLS asked individuals who were not working (due to COVID-19) but expected to be recalled to classify themselves as “unemployed on temporary layoff”.  Last month, the number of unemployed persons who reported being on temporary layoff more than doubled to 1.8 million. The number of permanent job losers increased by 177,000 to 1.5 million … In other words, roughly 85% of the increase in unemployment in March was classified at “temporary”.  That data will again be key this month.  
  • The preponderance of realized job loss thus far has been among younger workers with lower education (HS diploma or less) in lower-wage service sectors and for many in those industries the enhanced Unemployment Benefits (normal benefit + $600/wk) is more than they would typically make working full-time.  Again, monitoring the extent to which job loss metastasizes up the income and white-collar hierarchy will be key in defining both the consumption outlook and the trajectory of the recovery.
  • Monitor the U-6 Rate (underemployment rate) and the average weekly hours numbers. The U-6 rate captures Underemployment and offers a better reflection of total lost consumption capacity (i.e. the impact of actual job loss + reduced hours on aggregate private sector income).  
  • The direct effects of the crisis will be profound but it will be the derivative effects that matter with respect to the market outlook.  As small examples, companies have already begun suspending 401K contributions and to the extent hours worked are toggled back, it may mean lost eligibility with respect to health care … which would mean less discretionary consumption (in addition to the already lower consumption stemming from declining weekly earnings) as workers increase precautionary savings or purchase coverage independently. 
  • As tragi-dramatic as this month’s figures will be, more than 11.5 million layoffs have occurred subsequent to the April Survey period.  This promises further acute labor market contraction in the reported May data ….
  • …. and the May data should offer further, early insight into the emerging shift from “temporary” to permanent job loss (see: Bloomberg and WSJ, for example).  A dour reality whose prospects increase the longer containment measures persist and particularly as we move past the timelines associated with PPP/Small business and enhanced UI benefits.   

However unsurprising, this morning’s data will be staggering. Collectively, direct impacts, derivative effects and hysteresis promise a broad based retrenchment and protracted suppression in both business investment & household consumption relative to already fragile, pre-outbreak levels, regardless of the policy response.

As we’ve highlighted recurrently, the real economic recovery will be painfully longer than both the expedited drawdown and bounce in domestic financial markets. Macro awareness and full cycle risk management will remain exigent to navigating the chop that will invariable define the intermediate term investment future scape.

Immediate-term @Hedgeye Risk Range with TREND signal in brackets:

UST 10yr Yield 0.57-0.72% (bearish)
SPX 2 (bearish)
RUT 1 (bearish)
NASDAQ 8 (bullish)
Healthcare (XLV) 96.67-101.92 (bullish)
Consumer Staples (XLP) 56.07-58.64 (bearish)
Utilities (XLU) 53.02-59.54 (bearish)
Tech (XLK) 87.44-94.33 (bullish)
Financials (XLF) 20.29-23.49 (bearish)
Shanghai Comp 2 (bearish)
Nikkei 189 (bearish)
VIX 30.06-40.69 (bullish)
USD 98.90-100.84 (bullish)
Nat Gas 1.76-2.08 (bearish)
Gold 1684--1745 (bullish)

Best of luck out there today and have a safe and enjoyable weekend.

Christian B. Drake

Sweet Skills - CoD Negative Rates