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2 LEGAL DISCLAIMER Hedgeye Risk Management is a registered investment advisor, registered with the State of Connecticut. Hedgeye Risk Management is not a broker dealer and does not provide investment advice for individuals. This research does not constitute an offer to sell, or a solicitation of an offer to buy any security. This research is presented without regard to individual investment preferences or risk parameters; it is general information and does not constitute specific investment advice. This presentation is based on information from sources believed to be reliable. Hedgeye Risk Management is not responsible for errors, inaccuracies or omissions of information. The opinions and conclusions contained in this report are those of Hedgeye Risk Management, and are intended solely for the use of Hedgeye Risk Management s clients and subscribers. In reaching these opinions and conclusions, Hedgeye Risk Management and its employees have relied upon research conducted by Hedgeye Risk Management s employees, which is based upon sources considered credible and reliable within the industry. Hedgeye Risk Management is not responsible for the validity or authenticity of the information upon which it has relied. TERMS OF USE This report is intended solely for the use of its recipient. Re-distribution or republication of this report and its contents are prohibited. For more detail please refer to the appropriate sections of the Hedgeye Services Agreement and the Terms of Use at HEDGEYE 2

3 PLEASE SUBMIT QUESTIONS TO TO BE ANSWERED AT THE END OF THE CALL HEDGEYE 3

4 PROCESS SLIDE #1 OLD FORMAT = $800/SQUARE FT NEW FORMAT = $1,300 SQ FT DIFFERENTIATED FROM THE HERD Macroeconomics and Global Macro Risk Management are two very different fields. We specialize in the latter. WE FOCUS ON THE SLOPES Everything that matters in Global Macro occurs on the margin. HEDGEYE 4

5 PROCESS SLIDE #2 OLD FORMAT = $800/SQUARE FT NEW FORMAT = $1,300 SQ FT OUR FUNDAMENTAL PROCESS If you get the slopes of both growth and inflation right, you ll tend to get a lot of other things right particularly in your P&L. HISTORY MATTERS BACKTEST Analyzing intermediate-term trends within the context of long-term economic and political cycles helps us consistently front-run major asset class turns. HEDGEYE 5

6 PROCESS SLIDE #3 2,150 HEDGEYE QUANTITATIVE SETUP: US EQUITIES S&P 500 BULLISH TREND = 2058 BULLISH TAIL = ,100 2,050 2,000 1,950 1,900 1,850 1,800 ALL BACKSTOPPED BY A PROVEN QUANTITATIVE OVERLAY Multi-factor: Price, Volume and Volatility Multi-duration: TRADE (3 weeks or less), TREND (3 months or more) and TAIL (3 years or less) DATA SOURCE: BLOOMBERG HEDGEYE 6

7 #LATECYCLE USA

8 A CENTURY OF CYCLES HEDGEYE 8

9 CYCLES ARE TYPICAL BUT NOT THE SAME DATA SOURCE: Bloomberg, HRM HEDGEYE 9

10 #HOPE: CYCLES & CENTRAL BANKING Spending Employment #Hope is not a Risk Management Process. Credit Confidence Income It is, however, a requisite input for embattled central bankers hoping to smooth economic gravity and catalyze a virtuous, selfreinforcing macro cycle in the face of post-peak demographics, constrained credit growth, ongoing over- indebtedness & global disinflation Data Source: Reuters, HRM HEDGEYE 10

11 THE LONGEST EXPANSION EVER? OLD FORMAT = $800/SQUARE FT NEW FORMAT = $1,300 SQ FT U.S. ECONOMIC CYCLES We are in month 71 of the current expansion. The mean and median duration of expansions over the last century has been 59 and 50 months, respectively DATA SOURCE: BLOOMBERG, HEDGEYE, FOMC FOMC: MARCH SEP With an expectation for rising rates through 2017, the Fed is implicitly forecasting one of the longest expansions ever. HEDGEYE 11

12 LABOR CYCLE ACCOUNTING HEDGEYE 12

13 INITIAL CLAIMS: AS GOOD AS IT GETS Initial Claims is a leading labor metric and it has peaked. Peak improvement in Initial Jobless Claims has occurred approx 7- mo before the economic cycle peak over the last seven cycles. 300K is as good as it gets and the clock ticks gets louder as the cycle in claims inflects. Data Source: Bloomberg, BEA, NBER, DOL, HRM HEDGEYE 13

14 BEST BEFORE THE CREST: U-3 & NFP The Unemployment Rate is a classic latecycle indicator and total employment peaks after the peak in the economic cycle. Waiting for the top to be reported is not Macro Risk Management Data Source: Bloomberg, BEA, NBER, BLS, Hedgeye HEDGEYE 14

15 INFLATION PEAKS LATE CYCLE, BUT 14.0 Recession Dates Core CPI, YoY% Hourly Earnings, YoY % (nominal) 10.0% % 8.0% 7.0% Jan-66 Jan-67 Jan-68 Jan-69 Jan-70 Jan-71 Jan-72 Jan-73 Jan-74 Jan-75 Jan-76 Jan-77 Jan-78 Jan-79 Jan-80 Jan-81 Jan-82 Jan-83 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan % 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% DATA SOURCE: BLOOMBERG HEDGEYE 15

16 THE PHILLIP S CURVE LOOKS BROKEN The outputinflation connection has been (very) weak over the last two cycles. The reasons are not fully understood and represent a fundamental headwind for CB s tasked with catalyzing higher inflation Data Source: Bloomberg, BEA, NBER, BLS, Hedgeye HEDGEYE 16

17 WAGE INFLATION REMAINS ELUSIVE? Wage Inflation is late cycle and lags payroll growth. It has yet to manifest despite being 71- months into the current expansion and payroll growth eclipsing the prior cycle peak. HEDGEYE 17

18 POLICY = LOST IN TRANSMISSION! Fed policies to inflate financial asset prices have thus far failed to drive a meaningful Main Street recovery. Labor s share of income only increases near the end of a cycle but the recent slide looks like a structural break. HEDGEYE 18

19 ZIRP = POLICY STRING PUSHING Lower Highs and Lower Lows Investment has been increasingly less sensitive to interest rates over the course of the longterm interest rate/credit cycle and liquidity trap conditions have characterized the post-crisis period. Data Source: Bloomberg, BEA, NBER, BLS, Hedgeye HEDGEYE 19

20 STOCKS STILL HOPING IT S THE 1990 S Recession Dates VALUATION COMPOSITE 100% 90% 97% 80% 70% 60% 50% 40% 66% 71% 30% 20% Methodology: The Valuation Composite represents an equal weighted composite of Tobin's Q-Ratio, SPX Mkt Cap-to-GDP and Shiller PE with each taken as a % of their peak historical value. 10% Sep-90 Sep-91 Sep-92 Sep-93 Sep-94 Sep-95 Sep-96 Sep-97 Sep-98 Sep-99 Sep-00 Sep-01 Sep-02 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 DATA SOURCE: BLOOMBERG HEDGEYE 20

21 WITH PROFITABILITY PAST PEAK 12.0% Recession Dates Corporate Profits, % of GDP LT Ave 11.0% 10.8% 10.0% 10.1% 10.4% 9.0% 8.0% 8.2% 7.0% 6.0% 7.1% 6.5% 6.4% 5.0% 4.0% 3.0% Dec-51 Dec-53 Dec-55 Dec-57 Dec-59 Dec-61 Dec-63 Dec-65 Dec-67 Dec-69 Dec-71 Dec-73 Dec-75 Dec-77 Dec-79 Dec-81 Dec-83 Dec-85 Dec-87 Dec-89 Dec-91 Dec-93 Dec-95 Dec-97 Dec-99 Dec-01 Dec-03 Dec-05 Dec-07 Dec-09 Dec-11 Dec-13 DATA SOURCE: BLOOMBERG HEDGEYE 21

22 REMINDER: EPS PEAK LATE-CYCLE TOO Recession Dates S&P Real Earnings (log Scale) Mar-52 Mar-54 Mar-56 Mar-58 Mar-60 Mar-62 Mar-64 Mar-66 Mar-68 Mar-70 Mar-72 Mar-74 Mar-76 Mar-78 Mar-80 Mar-82 Mar-84 Mar-86 Mar-88 Mar-90 Mar-92 Mar-94 Mar-96 Mar-98 Mar-00 Mar-02 Mar-04 Mar-06 Mar-08 Mar-10 Mar-12 Mar-14 DATA SOURCE: BLOOMBERG HEDGEYE 22

23 AS DO MARGINS 15.0% 14.0% Recession Dates S&P 500 OPERATING MARGIN? 13.0% 12.0% 11.0% 10.0% 9.0% 8.0% 7.0% 6.0% Mar-90 Oct-90 May-91 Dec-91 Jul-92 Feb-93 Sep-93 Apr-94 Nov-94 Jun-95 Jan-96 Aug-96 Mar-97 Oct-97 May-98 Dec-98 Jul-99 Feb-00 Sep-00 Apr-01 Nov-01 Jun-02 Jan-03 Aug-03 Mar-04 Oct-04 May-05 Dec-05 Jul-06 Feb-07 Sep-07 Apr-08 Nov-08 Jun-09 Jan-10 Aug-10 Mar-11 Oct-11 May-12 Dec-12 Jul-13 Feb-14 Sep-14 DATA SOURCE: BLOOMBERG HEDGEYE 23

24 EPS (E) INFLECTING, IN RATE OF CHANGE TERMS 120 THERE IS PERHAPS NO SUCH THING AS AN EARNINGS RECESSION WITHOUT AN ACTUAL RECESSION; THE LAST THREE RECESSIONS HAVE BEEN PRECEDED BY S&P 500 TTM EPS BREAKING DOWN BELOW ITS TTM AVERAGE AN EVENT THAT IS AT RISK OF OCCURRING FAIRLY SOON U.S. Recession S&P 500 TTM EPS TTM Average DATA SOURCE: BLOOMBERG HEDGEYE 24

25 IMPLICITLY FORECASTING A RECESSION? AS DEFLATION REARS ITS UGLY HEAD THROUGH CORPORATE INCOME STATEMENTS, THE ASSOCIATED DOUR OUTLOOK FOR SALES AND EARNINGS GROWTH COULD BECOME A MAJOR HEADWIND TO EMPLOYMENT AND CAPEX GROWTH 15% S&P 500 Constituent YoY Revenue Growth S&P 500 Constituent YoY EPS Growth 14.4% 12% 9% 6% 3% 3.4% 5.3% 4.7% 10.1% 4.1% 9.5% 1.6% 5.5% 0.8% 3.5%??? 8.3% 4.3% 1.2% 0% -3% -3.5%-3.6% -0.5% -1.5% -6% 1Q14 2Q14 3Q14 4Q14 1Q15E 2Q15E 3Q15E 4Q15E 1Q16E DATA SOURCE: BLOOMBERG HEDGEYE 25

26 DO BONDS WORK EITHER WAY? In the last period of Fed tightening, the Fed raised rates 25 bps every meeting for 17 straight meetings. The 10Y TSY and mortgage rates, however, essentially went sideways during this period. Lower for Longer or a flattening curve both support the bond bulls HEDGEYE 26

27 LOWER FOR LONGER = AFFORDABILITY Compared with the average for 2014, current rates alone support midsingle digit home price upside this year. For reference, if rates were to fall to 3.0% from the current 3.7% it would imply upside of 17%. DATA SOURCE: CENSUS BUREAU, BLOOMBERG, HRM HEDGEYE 27

28 HOUSING ACTIVITY IS MID-CYCLE Historically, housing activity has peaked mid to late mid-cycle with New Home construction reaching at least ~1.8MM units in each instance. With Starts averaging 1.01MM over the last year and just 770K since the end of the recession, the medium-run opportunity for mean reversion up to the LT average of 1.45MM remains strong. HEDGEYE 28

29 HOUSING DEMAND IS ACCELERATING Housing has lagged in the latest expansion. Improving demand, accelerating HPI, easy comps, low rates and an expanding credit box should all support the sector over the immediate/inter mediate term. HEDGEYE 29

30 XLF Relative Performance, MoM % (3M MA) RATES + YIELD SPREAD = XLF LOWER FOR LONGER AND A FLATTENING YIELD CURVE IS NOT THE FACTOR COCKTAIL FOR FINANCIALS OUTPERFORMANCE 4.00% 3.00% 2.00% 1.00% 0.00% -1.00% -2.00% -3.00% -4.00% DATA SOURCE: BLOOMBERG, HRM FINANCIALS: Relative Performance vs. Yield Spread 2010-Present, Monthly Yield Spread (10Y -2Y), MoM Chg (3M MA) HEDGEYE 30

31 FINANCIALS LATE-CYCLE PERFORMER HEDGEYE 31

32 #DEMOGRAPHICYIELDS

33 CONSISTENTLY TOO HIGH ON GDP GROWTH 4.0% 3.5% 3.0% EVERY SINGLE YEAR OF THE POST-CRISIS ERA HAS SEEN A DOWNWARD REVISION BIAS TO BLOOMBERG CONSENSUS U.S. REAL GDP GROWTH FORECASTS THROUGHOUT THE YEAR CONSENSUS IS CURRENTLY CALLING FOR +3% GROWTH Actual Linear (2010) Linear (2011) Linear (2012) Linear (2013) Linear (2014) 2.5% 2.0% 2.5% 2.3% 2.2% 2.4% 1.5% 1.6% 1.0% 0.5% 0.0% -0.5% DATA SOURCE: BLOOMBERG HEDGEYE 33

34 NEWSFLASH: POPULATION AGEING SLOWS GROWTH OLD FORMAT = $800/SQUARE FT NEW FORMAT = $1,300 SQ FT The demographic impact on aggregate real GDP is somewhat straightforward when the population is growing, declining or ageing given the direct implication on the size of labor inputs, while its impact on per capita real GDP is less so, attracting attention for analysis. For example, Chapter 3 of the 2004 World Economic Outlook by Callen et al. (2004) found that per capita GDP growth is positively correlated with changes in the working age population share, but is negatively correlated with changes in the elderly share. SOURCE: KIM, LEE AND YOON. IMPACT OF DEMOGRAPHIC CHANGES ON INFLATION AND THE MACROECONOMY. IMF WORKING PAPER 14/210. (2014). PAGES 10, 15 & 27. HEDGEYE 34

35 CONSISTENTLY TOO HIGH ON INFLATION WITH THE EXCEPTION OF 2011 (QE2 ALL-TIME LOWS IN THE USD), EVERY SINGLE YEAR OF THE POST-CRISIS ERA HAS SEEN A DOWNWARD REVISION BIAS TO BLOOMBERG CONSENSUS U.S. CPI FORECASTS THROUGHOUT THE YEAR; A FORECAST OF +2.2% IN LOOKS AGGRESSIVE 7.0% 6.0% 5.0% 4.0% Actual Linear (2010) Linear (2011) Linear (2012) Linear (2013) Linear (2014) 3.0% 3.2% 2.0% 1.0% 1.6% 2.1% 1.5% 1.6% 0.0% -1.0% -2.0% DATA SOURCE: BLOOMBERG HEDGEYE 35

36 NEWSFLASH: POPULATION AGEING SLOWS INFLATION As displayed in Column (1), population growth affects inflation positively, since a greater population implies more aggregate demand. This might be due to the fact that the aggregate supply adjustment could be slower than aggregate demand adjustment in responding to demographic shocks in the short or medium run. When the share of elderly is added as an independent variable (Column 2), population growth continues to affect inflation positively and the influence of the elderly share is significantly negative. Conditional on a given population growth, the ageing process will suppress inflation significantly. This is true when the share of is coupled with the elderly share (Columns 3 and 4) and when life expectancy is added as well (Column 5). SOURCE: KIM, LEE AND YOON. IMPACT OF DEMOGRAPHIC CHANGES ON INFLATION AND THE MACROECONOMY. IMF WORKING PAPER 14/210. (2014). PAGES 19 & 20. HEDGEYE 36

37 WHO S GETTING OLDER?: THE U.S. THE POST-CRISIS ERA HAS SEEN THE U.S. AGE AT AN UNPRECEDENTED RATE AND PEAK/NEAR-PEAK AGEING (IN RATE-OF-CHANGE TERMS) IS PROJECTED TO CONTINUE THROUGH THE BALANCE OF THE DECADE; IS IT IRONIC THAT BOND YIELDS HIT AN ALL-TIME LOW IN 2012? 90bps 80bps 70bps 60bps 50bps 40bps 30bps 20bps 10bps 0bps -10bps -20bps 25bps 23bps 17bps 19bps 18bps 19bps 15bps U.S. 65+ Year-Old Population as a % of Working-Age Population (15-64) YoY bps Change U.S. 65+ Year-Old Population as a % of Working-Age Population (15-64); (rhs) 9bps 10bps 2bps 0bps -4bps -11bps -10bps -14bps -12bps -15bps-16bps -2bps -5bps 4bps 0bps 14bps 31bps 30bps 26bps 26bps 79bps 81bps 75bps 72bps 67bps 68bps 64bps 64bps 65bps 27% 26% 25% 24% 23% 22% 21% 20% 19% 18% 17% DATA SOURCE: OECD HEDGEYE 37

38 WHO S GETTING OLDER?: EUROPE MUCH LIKE THE U.S., THE POST-CRISIS ERA HAS SEEN EUROPE AGE AT AN UNPRECEDENTED RATE AND PEAK/NEAR-PEAK AGEING (IN RATE-OF- CHANGE TERMS) IS PROJECTED TO CONTINUE THROUGH THE BALANCE OF THE DECADE; EUROPE IS ALSO STARTING FROM AN OLDER BASE 70bps E.U. (27) 65+ Year-Old Population as a % of Working-Age Population (15-64) YoY bps Change E.U. (27) 65+ Year-Old Population as a % of Working-Age Population (15-64); (rhs) 32% 60bps 60bps 61bps 61bps 59bps 57bps 57bps 58bps 61bps 30% 50bps 28% 40bps 40bps 41bps 26% 30bps 31bps 28bps 28bps 26bps 27bps 25bps 27bps 28bps 29bps 29bps 30bps 31bps 31bps 30bps 29bps 27bps 28bps 28bps 26bps 24bps 24bps 25bps 24bps 22bps 22bps 24% 20bps 22% 13bps 10bps 20% 0bps 18% DATA SOURCE: OECD HEDGEYE 38

39 WHO S GETTING OLDER?: JAPAN JAPAN IS LIKELY PAST PEAK IN RATE-OF-CHANGE TERMS, BUT A PROJECTION OF ONE ~RETIREES PER EVERY TWO WORKING AGE ADULTS BY 2020 CALLS INTO QUESTION THE EFFICACY AND SUSTAINABILITY OF THE ABENOMICS AGENDA, WHICH ITSELF CALLS FOR 5% MONETARY MATH Japan 65+ Year-Old Population as a % of Working-Age Population (15-64) YoY bps Change Japan 65+ Year-Old Population as a % of Working-Age Population (15-64); (rhs) 225bps 214bps 50% 205bps 185bps 165bps 183bps 197bps 168bps 45% 40% 145bps 125bps 105bps 85bps 65bps 45bps 49bps 47bps 39bps 39bps 33bps 87bps 88bps 89bps 83bps 78bps 67bps 64bps 70bps 72bps 74bps 110bps 103bps 102bps 90bps 77bps 131bps 131bps 127bps 126bps 120bps 48bps 51bps 139bps 117bps 97bps 75bps 73bps 35% 30% 25% 20% 25bps 15% DATA SOURCE: OECD HEDGEYE 39

40 WHO S GETTING OLDER?: CHINA WHILE NOT A MATERIAL SHARE OF THE POPULATION RELATIVE TO OTHER COHORTS, THE LATTER HALF OF THIS DECADE WILL SEE CHINA AGE RAPIDLY CALLING INTO QUESTION THE EXPEDIENCY (OR LACK THEREOF) IN FORMULATING AN APPROPRIATE SOCIAL SAFETY NET China 65+ Year-Old Population as a % of Working-Age Population (15-64) YoY bps Change China 65+ Year-Old Population as a % of Working-Age Population (15-64); (rhs) 90bps 80bps 80bps 77bps 75bps 18% 70bps 64bps 69bps 16% 60bps 50bps 51bps 14% 40bps 30bps 20bps 10bps 0bps 5bps 0bps -1bps 16bps 16bps 11bps 12bps 13bps 14bps 15bps 16bps 14bps 12bps 10bps 11bps 4bps 6bps 8bps 9bps 8bps 9bps 9bps 10bps 12bps 0bps 21bps 22bps 25bps 31bps 40bps 12% 10% -10bps 8% DATA SOURCE: OECD HEDGEYE 40

41 SECULAR STAGNATION: U.S. GIVEN THE DISAPPOINTING TREND IN U.S. GROWTH SINCE 2007, IT S NOT AT ALL IRONIC THAT GROWTH IN THE U.S. S CORE CONSUMPTION DEMOGRAPHIC WENT NEGATIVE IN 2008 AND IS PROJECTED TO CONTINUE CONTRACTING THOUGH % 3.5% 3.0% 2.5% 2.0% 1.5% 2.4% 3.2% 3.2% 3.2% 3.0% 2.8% U.S Year-Old Population YoY % Change 3.4% 3.6% 3.3% 3.1% 3.1% 2.9% 2.7% 2.0% 2.1% 1.9% 1.5% U.S Year-Old Population as a % of Total 30% 29% 28% 27% 26% 1.0% 0.5% 0.0% -0.5% -1.0% 0.4% 0.5% 0.7% 0.6% 0.2% 0.2% -0.1% -0.3% -0.4% -0.7% -0.7% -0.7% -0.6% -0.2% -0.2% -0.2% -0.4% -0.4% 0.1% 25% 24% 23% 22% DATA SOURCE: OECD HEDGEYE 41

42 WHY DO YEAR-OLDS MATTER? BECAUSE ACCORDING TO BOTH EMPIRICAL EVIDENCE AND LIFE-CYCLE ECONOMICS THEORY, THIS IS THE WORLD S CORE END CONSUMPTION DEMAND DEMOGRAPHIC $70,000 U.S. Average Annual Disposable Income by Age Bracket U.S. Average Annual Expendiutres by Age Bracket Poly. (U.S. Average Annual Disposable Income by Age Bracket) Poly. (U.S. Average Annual Expendiutres by Age Bracket) $69,152 $68,048 $65,000 $60,000 $55,000 $53,178 $58,784 $60,524 $63,312 $55,892 $50,000 $45,000 $48,087 $48,742 $46,757 $40,000 $35,000 $30,000 $25,000 $26,559 $30,373 $34,382 $32,744 $20,000 Under 25 Years-Old Years Old Years Old Years Old Years Old Years Old 75+ Years-Old DATA SOURCE: 2013 BLS CONSUMER EXPENDITURE SURVEY HEDGEYE 42

43 SECULAR STAGNATION: EUROPE EUROPE S CORE END CONSUMPTION DEMOGRAPHIC IS PROJECTED TO CONTRACT AT AN ACCELERATED RATE THROUGH THE END OF THE DECADE; CAN DRAGHI EFFECTIVELY COUNTER THAT WITH A BURNING EURO? 2.0% E.U. (27) Year-Old Population YoY % Change E.U. (27) Year-Old Population as a % of Total 30% 1.5% 1.4% 1.5% 1.4% 1.3% 29% 1.0% 0.7% 0.7% 0.9% 1.1% 1.0% 1.0% 1.1% 1.1% 1.1% 1.0% 1.0% 1.2% 1.2% 0.9% 0.9% 0.7% 0.6% 0.6% 0.6% 28% 0.5% 0.4% 0.2% 0.2% 0.3% 27% 0.0% 26% -0.1% -0.5% -0.2% -0.1% -0.1% -0.2% -0.2% -0.3% -0.5% -0.5% 25% -1.0% 24% DATA SOURCE: OECD HEDGEYE 43

44 SECULAR STAGNATION: JAPAN AFTER A BRIEF RESPITE, JAPAN S CORE END CONSUMPTION DEMOGRAPHIC RETURNS TO A TREND OF ACCELERATED CONTRACTION THROUGH AT LEAST % 1.7% Japan Year-Old Population YoY % Change Japan Year-Old Population as a % of Total 1.8% 31% 1.5% 1.0% 0.5% 0.0% -0.5% -1.0% 1.1% 0.7% 0.3% 0.1% 0.0% -0.4% -0.5% -0.3% 0.0% -0.1% -1.0% -1.1% -0.7% -0.8% 0.6% -0.1% -0.8% -0.3% 0.2% 0.7% 0.6% 0.5% 0.4% 0.3% 0.0% -0.1% -0.2% -0.3% -0.5% -0.6% -1.1% 30% 29% 28% 27% -1.5% -1.4% -1.6% -1.6% -2.0% 26% DATA SOURCE: OECD HEDGEYE 44

45 SECULAR STAGNATION: CHINA GIVEN CHINA S STATUS AS A DEVELOPING COUNTRY AND IT S SHAKY INCOME AND CONSUMPTION STATISTICS, IT S LESS CLEAR THE IMPACT LIFE-CYCLE ECONOMICS HAS ON ITS CONSUMPTION PATTERNS; THAT SAID, HOWEVER, THE OUTLOOK FOR REBALANCING IS DIFFICULT AT BEST 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% -0.5% 3.2% 3.3% 3.9% 4.1% 3.9% China Year-Old Population YoY % Change 3.5% 3.0% 2.7% 2.8% 2.7% 2.7% 3.7% 3.5% 3.5% 3.6% 3.7% 3.5% 3.5% 3.5% 3.1% China Year-Old Population as a % of Total 2.7% 2.2% 1.8% 1.5% 1.3% 1.0% 0.8% 0.6% 0.4% 0.2% 0.1% 0.0% -0.1% -0.1% 0.2% 0.0% 32% 30% 28% 26% 24% 22% 20% 18% DATA SOURCE: OECD HEDGEYE 45

46 WHY DO THESE ECONOMIES MATTER? OLD FORMAT = $800/SQUARE FT NEW FORMAT = $1,300 SQ FT On a cumulative basis, these economies represent just over half (i.e. 54%) of global GDP (PPP basis) and just over half (i.e. 53%) of global GDP growth. Given the myriad of headwinds facing emerging market economies, continued secular stagnation in the U.S., Europe, Japan and China is likely to weigh heavily upon global growth and inflation readings going forward. DATA SOURCE: BLOOMBERG HEDGEYE 46

47 LOWER-HIGHS AND LOWER-LOWS THE DIRECTIONAL TRENDS OF BOTH GLOBAL GROWTH AND GLOBAL INFLATION HAVE BEEN GENERALLY NEGATIVE FOR DECADES AND THE AFOREMENTIONED DEMOGRAPHIC DYNAMICS SHOULD PERPETUATE LOWER-LOWS FROM HERE 9.5% 9.0% 9.2% World GDP (PPP) Trailing 5Y CAGR Linear (World GDP (PPP) Trailing 5Y CAGR) World CPI Trailing 5Y CAGR Linear (World CPI Trailing 5Y CAGR) 8.5% 8.0% 7.5% 7.0% 6.5% 6.0% 5.5% 5.0% 4.5% 4.0% 3.5% 3.0% 8.2% 7.8% 6.9% 6.9% 6.8% 7.1% 6.7% 7.3% 7.0% 7.0% 7.0% 6.6% 6.4% 8.5% 7.4% 7.7% 7.3% 8.0% 7.2% 8.2% 7.7% 7.0% 7.0% 7.5% 5.5% 7.2% 5.8% 5.3% 5.2% 5.5% 4.7% 5.3% 4.2% 5.0% 3.7% 5.6% 3.4% 6.2% 3.5% 7.1% 6.4% 3.6% 3.7% 7.9% 4.1% 7.6% 5.2% 6.1% 5.1% 5.8% 4.9% 5.3% 5.1% 5.5% 4.8% 4.6% 4.5% 3.5% 3.6% DATA SOURCE: IMF; WORLD BANK HEDGEYE 47

48 NOMINAL INTEREST RATES IN A BACKDROP OF REDUCED SUPPLY (QE) AND REGULATORY-INDUCED EXCESS DEMAND (BASEL III; DODD FRANK), IT S NO SURPRISE TO SEE NOMINAL RATES ON THEIR LOWS GIVEN SUPPORTIVE GLOBAL GROWTH AND INFLATION TRENDS 14% 10Y Treasury Yield (Percentile of Latest Reading = 7%) 10Y Bund Yield (Percentile of Latest Reading = 0%) 10Y OAT Yield (Percentile of Latest Reading = 0%) 10Y BTP Yield (Percentile of Latest Reading = 0%) 10Y Gilt Yield (Percentile of Latest Reading = 2%) 10Y JGB Yield (Percentile of Latest Reading = 1%) 10Y MoF Yield (Percentile of Latest Reading = 39%) 12% 10% 8% 6% 4% 2% 0% DATA SOURCE: BLOOMBERG; MONTHLY AVERAGES HEDGEYE 48

49 REAL INTEREST RATES ON A REAL BASIS, HOWEVER, GLOBAL BOND MARKETS CONTINUE TO OFFER POCKETS OF VALUE FROM A YIELD PERSPECTIVE ESPECIALLY IN THE U.S. TREASURY AND U.K. GILT MARKETS 14% 13% 12% 11% 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% -1% -2% -3% -4% -5% Real 10Y Treasury Yield (Percentile of Latest Reading = 41%) Real 10Y Bund Yield (Percentile of Latest Reading = 11%) Real 10Y OAT Yield (Percentile of Latest Reading = 6%) Real 10Y BTP Yield (Percentile of Latest Reading = 5%) Real 10Y Gilt Yield (Percentile of Latest Reading = 26%) Real 10Y JGB Yield (Percentile of Latest Reading = 4%) Real 10Y MoF Yield (Percentile of Latest Reading = 81%) DATA SOURCE: BLOOMBERG; MONTHLY AVERAGES; DEFLATED BY RESPECTIVE MONTHLY HEADLINE CPI READING HEDGEYE 49

50 CONCLUSION: LOWER-FOR-LONGER OUR ESTIMATES SUGGEST THERE S ROUGHLY $4 TRILLION IN NEGATIVE-YIELDING G-10 SOVEREIGN DEBT OUTSTANDING AT THE CURRENT JUNCTURE; INVESTORS ARE CLEARLY BETTING ON DEFLATION TO PERPETUATE STABLE-TO-HIGHER REAL YIELDS AND/OR CAPITAL APPRECIATION AMID THIS RETURN-OF-CAPITAL STRATEGY DATA SOURCE: BLOOMBERG; IMF. DATA AS OF 4/6/14. HEDGEYE 50

51 OIL S #DEFLATIONDECK

52 EPIC MOVE IN THE ENERGY SPACE HEDGEYE QUANTITATIVE SET-UP WTI Crude Oil ($/Spot) TREND Resistance ($57.54) TAIL Resistance ($72.12) As always, we rely on our topdown, datadriven process to generate the quantitative risk management levels Our model continues to generate sell signals for crude oil, energy stocks and all assets leveraged to commodity inflation. DATA SOURCE: HRM, BLOOMBERG HEDGEYE 52

53 FUELED BY THE USD TEAR HEDGEYE QUANTITATIVE SET-UP U.S. Dollar Index TREND Support (93.02) TAIL Support (88.55) Starting last May with the inflection in the Euro, the U.S. dollar has gone on a big run, but long-term U.S. Dollar #History suggests this can last. a long time DATA SOURCE: HRM, BLOOMBERG HEDGEYE 53

54 WHAT DRIVES ENERGY PRICES LONG-TERM? BIRDS-EYE VIEW U.S. Dollar Index Historical Oil Price* ($) Sep. 69- June 80: 1970s inflation/bretton Woods Jun. 80 Dec. 84: Recession & contractionary Policy Dec. 84 Jun. 95: Decade-Long Expansion Jun. 95 Jun. 01: Clinton era tight fiscal policy, strong-dollar de-leveraging Jun. 01 Mar. 11: Greenspan deregulation, low-interest rate era Mar. 11- Present: Grt.-Rec. to present inflation of asset prices How Much Higher? *Log Scaling DATA SOURCE: BLOOMBERG (*BLOOMBERG HISTORICAL CRUDE OIL PRICE INDEX) HEDGEYE 54

55 CAN COMMODITIES MOVE LOWER? WOULDN T BE THE FIRST TIME DATA SOURCE: HRM HEDGEYE 55

56 LONGER DURATION TURNS LED BY THE USD COMMODITIES LAG USD INFLECTIONS BY AN AVERAGE OF TWO QUARTERS DATA SOURCE: HRM HEDGEYE 56

57 DON T FORGET VOLATILITY, EVEN THOUGH STOCKS HAVE CROSS-ASSET VOLATILITY MOVING OFF ALL-TIME LOWS LAST SUMMER 300 Treasury Volatility Index (MOVE Index) S&P Volatility Index (VIX) Oil Volatility Index (OVX) DATA SOURCE: HRM, BLOOMBERG HEDGEYE 57

58 LEVERAGE WAS FREE AND $50/BARREL IMPOSSIBLE, RIGHT? OLD FORMAT High = $800/SQUARE Yield Energy OAS FT Spread (BPS) NEW FORMAT High = Yield $1,300 Energy SQ FT Debt Issuance ($Bn) Oil Volatility Index (OVX) $70 $60 $50 $40 $30 $20 $10 $ ? VOLATILITY VS. HY ENERGY OAS HY ENERGY DEBT ISSUANCE ($BN) Low probability from a modeling perspective of a large drawdown in oil prices coupled with cheap cost of capital fueled the HY splurge Capital structure decisions have been massively levered to commodity inflation expectations. DATA SOURCE: HRM, SIFMA HEDGEYE 58

59 POSITIONING MORE BEARISH AFTER THE MOVE LONGER ON THE HIGHS, SHORTER ON THE LOWS NYM Crude Oil Net NCCP = x STDEV = ,000-2x STDEV = TTM Average = , , , , , , , , , Highs in WTI 2015 Highs in WTI DATA SOURCE: CFTC HEDGEYE 59

60 COMMODITY POSITIONING NOW BEARISH CRB INDEX -30% FROM JUNE 2014 HIGHS CFTC Net Futures and Options Positioning: TTM Z-Score WTI Crude Cocoa Sugar #11 Lean Hogs Natural Gas Wheat NY Harbor ULSD (HO) RBOB Gasoline Coffee Orange Juice Cotton #2 Gold Silver Copper Soybeans Live Cattle Corn DATA SOURCE: CFTC HEDGEYE 60

61 WHO STOPS THE PAIN? OPEC? YY% Change 7.0 U.S. Crude Oil Imports From OPEC Members (MM/BD) TTM Average 6.0 Trailing 3-Month Average Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 DATA SOURCE: DOE 40% 30% 20% 10% 0% -10% -20% -30% -40% A functioning cartel works if it accounts for a significant amount of production OPEC is losing this position at 35% U.S. Crude Imports from OPEC declined -26% Y/Y in March It is not in the interest of OPEC Members to cut production Whatever the price is Whether it goes down to $20, $40, $50, $60, it is irrelevant - Ali Al-Naimi Saudi Oil Minister Dec. 22, 2014 HEDGEYE 61

62 OPEC MARKET SHARE AND INFLUENCE EMBARGO YEARS IN THE DISTANT PAST Non-OPEC Production (MM/BD) OPEC Market Share (% Global Production) 42.0% 40.0% 38.0% OPEC Market Share of global production in 1970 was closer to 50% during the embargo years % % % 30 Apr-90 Apr-93 Apr-96 Apr-99 Apr-02 Apr-05 Apr-08 Apr-11 Apr % DATA SOURCE: ENERGY INTELLIGENCE GROUP HEDGEYE 62

63 HISTORY OF OPEC S INFLUENCE 50% MARKET SHARE LONG-GONE; U.S. IS THE FOCAL POINT While OPEC sits on ~80% of global crude reserves, OPEC as a cartel to be reckoned with, has had virtually no impact on how much crude its members produce OPEC sets quotas, but its member countries cheated about 96% of the time from according to a study from Jeff Colgan of Brown University: o o o o o OPEC announcements have an ability to move spot prices for days but there is exactly zero evidence that OPEC is actually restricting output during this time On average over this period, the nine principal members produced on average 10% more oil than their quotas supposedly allowed The relationship between oil prices and OPEC quotas is virtually uncorrelated (r^2=0.15) All but two members over-produced in more than 80% of the months during this period. The exceptions were Iran and Venezuela, which still cheated over 70% of the time There were 22 OPEC meetings in that same period in which quotas were increased, and in 21 cases, the new aggregate quota for the 9 principal members was lower than what those countries were producing a month prior to the change DATA SOURCE: NBER, PRINCETON.EDU HEDGEYE 63

64 10.0 AND U.S. PRODUCTION CONTINUES U.S. Crude Oil Production (MM/BD) Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Apr-13 Apr-14 DATA SOURCE: EIA, DOE HEDGEYE 64

65 BUT WHEN WILL IT MOVE DELTA NEGATIVE? PRODUCTION WEIGHTED DELTA OF MAJOR PLAYS 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% -5.0% DATA SOURCE: DOE, EIA Haynesville Marcellus Utica Niobrara Bakken Eagle Ford Permian YY % 6M % 3M % 1M % Aggregate production is hovering just over ~9MM B/D and close to moving delta negative on a shortterm duration HEDGEYE 65

66 SUPPLY ADJUSTMENTS LAG TOP-DOWN MACRO DISPELLING THE PRICE FLOOR BACKSTOP WTI ($Spot) Production From Major Shale Plays (MM/BD) First significant sequential deceleration in March and ensuing negative turn projected for April Meaningful Production Slowdown despite rangebound prices in 2015 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Dec-14 Jan-15 Feb-15 Mar-15 Apr Spot WTI prices have remained range bound for 4 months now and production has steadily declined while rigs have been idled week-after week throughout this year Key Takeaway: Top-down macro will continue to lead with physical markets reacting to prices DATA SOURCE: EIA HEDGEYE 66

67 INVESTMENT CONCLUSIONS LONGS OLD FORMAT = $800/SQUARE FT Long-term Treasuries (TLT) Ultra Long-Term Treasuries (EDV) Homebuilders (ITB) Healthcare (XLV) REITS (VNQ) LONG BENCH: U.S. Dollar (UUP) Russell 2000 (IWM) SHORTS NEW FORMAT = $1,300 SQ FT High-Yield Credit (JNK) Crude Oil (OIL) Domestic E&Ps (XOP) Financials (XLF) Industrials (XLI) SHORT BENCH: Euro (FXE) Turkey (TUR) HEDGEYE 67

68 APPENDIX

69 G.I.P. MODEL FORECAST: #QUAD4 150bps 100bps 1Q15E 50bps 2Q14 3Q14 0bps -150bps -100bps -50bps 0bps 50bps 4Q15E 100bps 150bps 4Q14 2Q15E -50bps 3Q15E -100bps 1Q14 DATA SOURCE: BLOOMBERG -150bps x-axis: sequential bps change in YoY CPI y-axis: sequential bps change in YoY Real GDP HEDGEYE 69

70 WHY DOES THE 2 ND DERIVATIVE MATTER? BECAUSE FINANCIAL ASSET RETURNS HAVE HISTORICALLY ANCHORED ON THE MARGINAL RATE OF CHANGE IN BOTH GROWTH AND INFLATION ESPECIALLY WHEN THESE DELTAS ARE COUNTER TO CONSENSUS EXPECTATIONS DATA SOURCE: BLOOMBERG HEDGEYE 70

71 U.S. ECONOMIC SUMMARY TABLE PAST PEAK IN RATE-OF-CHANGE TERMS? OUTSIDE OF THE HOUSING SECTOR, NOMINAL WAGES ARE CURRENTLY THE ONLY KEY HIGH-FREQUENCY GROWTH DATA CATEGORIES THAT IS ACCELERATING ON BOTH A SEQUENTIAL AND TRENDING BASIS DATA SOURCE: BLOOMBERG HEDGEYE 71

72 U.S. ECONOMIC SURPRISE INDEX DATA DEPENDENT = DEFINITELY DOVISH 0.80 Bloomberg U.S. Econ Surprise Index, 3MMA (Percentile of Latest Reading = 4%) DATA SOURCE: BLOOMBERG HEDGEYE 72

73 RECESSION WATCH: JOBLESS CLAIMS 650k THE TREND IN INITIAL JOBLESS CLAIMS WOULD IMPLY 4-5 MORE QUARTERS OF ECONOMIC EXPANSION U.S. Recession Initial Jobless Claims SA, SMAVG(6MO) Indicator of Late-Cycle Labor Market Strength: 300k 600k 550k 500k 450k 400k 350k 300k 250k 18MO 19MO 20MO 6MO DATA SOURCE: BLOOMBERG HEDGEYE 73

74 RECESSION WATCH: CONSUMER CONFIDENCE RECESSIONS TEND TO OCCUR WHEN THE INTERMEDIATE-TERM TREND IN CONSUMER CONFIDENCE BREAKS DOWN BELOW THE LONG-TERM TREND THAT IS UNLIKELY TO HAPPEN SOON GIVEN THE CURRENT SPREAD U.S. Recession Conference Board Consumer Confidence Index SMAVG(12MO) SMAVG(36MO) DATA SOURCE: BLOOMBERG HEDGEYE 74

75 RECESSION WATCH: LEADING/LAGGING INDICATOR RATIO THE LAST THREE RECESSIONS HAVE BEEN PRECEDED BY A TRENDING DOWNWARD SLOPE OF THE TRENDING RATIO BETWEEN LEADING AND LAGGING INDICATORS THE CURRENT SLOPE OF THIS TRENDING RATIO REMAINS POSITIVE 1.30 U.S. Recession Conference Board Leading Economic Indicators Index/Conference Board Lagging Economic Indicators Index, Ratio (TTM Average) DATA SOURCE: BLOOMBERG HEDGEYE 75

76 RECESSION WATCH: COMPOSITE PMI DATA IS SPARSE GIVEN THE RELATIVE YOUTH OF THE SERVICES PMI INDICATOR, BUT THE LAST TWO RECESSIONS HAVE BEEN PRECEDED BY A DRAMATIC BREAKDOWN IN COMPOSITE PMI TRENDS BOTH ON AN ABSOLUTE BASIS AND RELATIVE TO ITS LONG-TERM AVERAGE U.S. Recession GDP-Weighted ISM Composite PMI SMAVG(36MO) DATA SOURCE: BLOOMBERG HEDGEYE 76

77 RECESSION WATCH: CORPORATE PROFITS 120 THERE IS PERHAPS NO SUCH THING AS AN EARNINGS RECESSION WITHOUT AN ACTUAL RECESSION; THE LAST THREE RECESSIONS HAVE BEEN PRECEDED BY S&P 500 TTM EPS BREAKING DOWN BELOW ITS TTM AVERAGE AN EVENT THAT IS AT RISK OF OCCURRING FAIRLY SOON U.S. Recession S&P 500 TTM EPS TTM Average DATA SOURCE: BLOOMBERG HEDGEYE 77

78 U.S. MONETARY POLICY MODEL 100% 90% 80% TRENDS ACROSS A VARIETY OF MARKET AND ECONOMIC INDICATORS SUGGEST THE ECONOMY IS NOWHERE NEAR A LEVEL OF OVERHEATING THAT WOULD REQUIRE MONETARY TIGHTENING; IN FACT, THE DATA MAKES A COMPELLING CASE FOR MORE EASING U.S. (Federal Reserve) Neutral Policy Recommendation 70% 63% 68% 60% 54% 50% 40% 30% 38% 31% 24% 23% 34% 20% 10% 14% 9% 17% 0% 5Y-5Y Forward Breakeven Rate (1YR) Benchmark Equity Market (3MO) Nominal GDP YoY (10YR) Composite PMI (1YR) Core CPI YoY (10YR) Econ Surprise Index (3MO) REER (10YR)* Sovereign 10Y- 2Y bps Spread (1YR) Employment Cost Index YoY (10YR) Unemployment Rate (10YR)* AVERAGE Values shown are the current reading as a percentile of the indicated trailing period. An asterisk following an indicator indicates the percentile reading has been inverted to maintain directional consistency within the model. A high average value suggests a high probability of tightening and/or hawkish guidance. A low average value suggests a high probability of easing and/or dovish guidance. DATA SOURCE: BLOOMBERG. HEDGEYE 78

79 KNOW YOUR FED THE VOTING CONSTITUENCY OF THE 2015 FOMC IS MUCH MORE DOVISH THAN CONSENSUS MAY REALIZE AT THE CURRENT JUNCTURE SOURCE: BLOOMBERG HEDGEYE 79

80 KNOW YOUR TIGHTENING CYCLES THE MEDIAN LENGTH OF TIME AND CUMULATIVE INCREASE OVER THE LAST FIVE TIGHTENING CYCLES IS 47 WEEKS AND +300 BASIS POINTS, RESPECTIVELY DATA SOURCE: BLOOMBERG HEDGEYE 80

81 CASE STUDY: U.S. DOLLAR INDEX SOMEWHAT IRONICALLY, THE DOLLAR TENDS TO WEAKEN ONCE RATE HIKES COMMENCE; THIS IS LIKELY DUE TO ITS FRONT-RUNNING NATURE 15% 12/16/1986 3/29/1988 2/4/1994 6/30/1999 6/30/2004 Median 10% 8.6% 7.6% 10.6% 10.5% 5% 0% -5% -4.7% 2.5% 2.1% 2.1% 2.6% 2.3% 1.7% 1.7% 0.2% 0.4% 0.8% 0.2% 0.3% 0.2% -0.1% -1.8% 1.3% 0.3% -1.6% -1.6% -3.0% -1.6% -4.5% -4.2% -4.2% -1.0% 3.9% 0.3% 0.3% -10% -9.8% -7.0% -8.3% -9.1% -6.9% -9.3% -6.9% -8.8% -15% -20% t ₆ t ₃ t ₁ t₁ t₃ t₆ t₁₂ -18.1% DATA SOURCE: BLOOMBERG. PERFORMANCE AS OF PRECEDING 6MO, 3MO, 1MO, AND SUBSEQUENT 1MO, 3MO, 6MO AND 12MO. HEDGEYE 81

82 CASE STUDY: 10Y TREASURY YIELD 200bps LONG-TERM RATES TEND TO RISE DRAMATICALLY FOLLOWING THE FIRST RATE HIKE WITH THE NOTABLE EXCEPTION OF THE LAST TIGHTENING CYCLE; AS SUCH, THERE IS HISTORICAL PRECEDENT FOR SPREAD COMPRESSION DURING AN EPISODE OF MONETARY TIGHTENING 12/16/1986 3/29/1988 2/4/1994 6/30/1999 6/30/2004 Median 190bps 163bps 150bps 114bps 125bps 124bps 115bps 100bps 50bps 0bps -50bps -55bps 0bps 32bps 0bps 69bps 59bps 18bps 18bps -27bps -37bps 38bps 16bps 4bps 4bps -7bps -15bps 49bps 36bps 12bps 12bps -9bps -11bps 9bps 29bps 10bps -46bps 10bps 59bps 59bps 40bps -33bps 78bps 25bps -67bps 78bps -100bps -113bps -150bps t ₆ t ₃ t ₁ t₁ t₃ t₆ t₁₂ DATA SOURCE: BLOOMBERG. PERFORMANCE AS OF PRECEDING 6MO, 3MO, 1MO, AND SUBSEQUENT 1MO, 3MO, 6MO AND 12MO. HEDGEYE 82

83 CASE STUDY: S&P 500 INDEX THE STOCK MARKET TENDS TO DECLINE IMMEDIATELY AFTER THE INITIAL RATE HIKE, BUT ALMOST ALWAYS RECOVERS SIX AND 12 MONTHS LATER 25% 12/16/1986 3/29/1988 2/4/1994 6/30/1999 6/30/2004 Median 21.9% 20% 15% 11.4% 15.3% 12.4% 10% 5% 0% -5% 1.6% 4.7% 2.8% 2.8% 7.9% 6.3% 5.5% 5.5% 5.4% 2.7% 2.3% 1.2% 0.6% 1.8% 1.8% -2.9% 6.5% 0.5% -1.1% -1.1% -3.2% -3.4% 4.2% -3.9% -2.3% -2.3% 6.7% 6.4% 6.4% 4.8% -2.4% -0.8% 6.0% 4.4% 4.4% 1.9% -10% -6.6% -15% -20% -19.2% -25% t ₆ t ₃ t ₁ t₁ t₃ t₆ t₁₂ DATA SOURCE: BLOOMBERG. PERFORMANCE AS OF PRECEDING 6MO, 3MO, 1MO, AND SUBSEQUENT 1MO, 3MO, 6MO AND 12MO. HEDGEYE 83

84 CASE STUDY: CRUDE OIL THE FLIP SIDE OF THE USD FRONT-RUNNING THE FED AND THEN SUBSEQUENTLY TRADING LOWER ARE CRUDE OIL PRICES TENDING TO REBOUND AFTER TIGHTENING HAS COMMENCED 80% 12/16/1986 3/29/1988 2/4/1994 6/30/1999 6/30/2004 Median 70% 71.3% 68.5% 60% 50% 57.1% 52.5% 40% 30% 20% 10% 0% -10% -20% 5.3% -15.0% -18.9% 21.8% 5.3% -5.7% -10.2% -13.5% 2.5% -5.7% 20.0% 7.2% 6.7% 3.4% 0.0% 0.0% 0.0% 0.0% 0.0% -1.8% -0.9% -4.7% 34.0% 33.6% 32.6% 27.1% 29.2% 29.2% 27.5% 10.5% 11.3% 8.9% 11.3% -5.2% 23.4% 13.4% 21.1% 23.4% -30% t ₆ t ₃ t ₁ t₁ t₃ t₆ t₁₂ DATA SOURCE: BLOOMBERG. PERFORMANCE AS OF PRECEDING 6MO, 3MO, 1MO, AND SUBSEQUENT 1MO, 3MO, 6MO AND 12MO. HEDGEYE 84

85 CASE STUDY: GOLD THE PRICE OF GOLD TENDS TO PERFORM IN A SIMILAR MANNER AS CRUDE OIL IN/AROUND MONETARY TIGHTENING CYCLES ALSO LIKELY DUE TO THE TENDENCY OF SUBSEQUENT U.S. DOLLAR DEPRECIATION 25% 12/16/1986 3/29/1988 2/4/1994 6/30/1999 6/30/2004 Median 23.7% 20% 15% 15.9% 13.8% 15.2% 10% 5% 3.8% 6.7% 5.7% 3.5% 6.1% 3.5% 11.1% 9.7% 9.7% 10.3% 10.5% 10.3% 0% -5% -10% -1.0% -4.0% -4.0% -5.3% -8.6% -5.8% -5.5% -6.0% -6.3% -5.8% -3.7% 0.2% -1.9% -1.3% -0.8% -1.9% -1.3% -2.9% -2.4% -2.5% -2.4% -2.1% -4.7% -2.6% -15% -20% t ₆ t ₃ t ₁ t₁ t₃ t₆ t₁₂ -12.4% -15.8% DATA SOURCE: BLOOMBERG. PERFORMANCE AS OF PRECEDING 6MO, 3MO, 1MO, AND SUBSEQUENT 1MO, 3MO, 6MO AND 12MO. HEDGEYE 85

86 2Q15: IF IT AIN T BROKE, DON T FIX IT HEDGEYE 86

87 1Q15: WHY IT WORKED 1 STABILIZING HPI After decelerating through much of 2014, US home prices began to stabilize late last year and that trend continued into 1Q15. 2 IMPROVING VOLUME After declining throughout 2014 on the heels of QM s implementation, the trend in demand during 1Q15 both in the existing and new home markets was that of improvement. 3 EASING CREDIT QM implementation in early 2014 set the bar low from a comp standpoint, but the GSEs lowering down payment requirements and the FHA lowering MI premiums put housing back on the right track from a credit availability standpoint. HEDGEYE 87

88 HOUSING FROM ZERO TO HERO Housing went from being the worst performing sector through most of 2014 to the best performing sector since late last year. YTD, the XHB is up +8% vs the S&P %. DATA SOURCE: BLOOMBERG HEDGEYE 88

89 THE 5 PHASES OF HOUSING POST 2008 Today, it s clear that Phase 5 is well underway with the XHB outperforming the S&P by 1500 bps since November last year on the stabilization in HPI. HEDGEYE 89

90 1Q15: STABILIZING HPI Here s how the blended composite of the three series looks. HEDGEYE 90

91 1Q15: IMPROVING VOLUME Pending Home Sales have continued to accelerate their year-over-year growth and are now growing at their fastest rate since mid HEDGEYE 91

92 1Q15: IMPROVING VOLUME Existing Home Sales have been steadily accelerating over the last twelve months. DATA SOURCE: NAR, BLOOMBERG HEDGEYE 92

93 1Q15: IMPROVING VOLUME New Home Sales just put in the fastest growth rate in the last 18 months. HEDGEYE 93

94 2Q15: WHY IT WILL KEEP WORKING 1 IF IT AIN T BROKE, DON T FIX IT Prices have stabilized and are poised to re-accelerate. Demand is growing in the short and intermediate-term. Supply remains tight. Credit is expanding. 2 MIND THE SEASONALITY & SPEED BUMPS Seasonality is more pronounced in housing equities than in other sectors, and it s important to be mindful of the recurrent trends. Also, TRID is likely to cast an August shadow. 3 DEMOGRAPHICS DEEP DIVE Household formation and employment trends remain supportive of the bull case over the intermediate and longer term. Student loan dynamics, however, remain a real headwind. HEDGEYE 94

95 HPI ACCELERATION LOOKS LIKELY Pending Home Sales are up 12% Y/Y in the most recent data. Demand growth in the low-teens correlates to rate of change in prices in the low teens on a 1yr lag. This is well above the current rate in the mid single digits. HEDGEYE 95

96 ANOTHER LOOK AT WHY HPI SHOULD When months supply is sub-5 months, future HPI has historically accelerated into the 10-15% range. HEDGEYE 96

97 TIGHT SUPPLY ACCELERATING HPI When adjusted supply is sub-2 million units, as it is today, it has historically produced 10-15% HPI on an 11-mo lag. This compares favorably with the current midsingle digit rate. HEDGEYE 97

98 AFFORDABILITY SUMMARY Taking the average of the four main affordability measures suggest that housing is ~14% undervalued at the moment based solely on a reversion to the mean in affordability. HEDGEYE 98

99 BUILDER SEASONALITY IS REAL Everyone knows that housing is seasonal, but fewer realize that the stocks are very seasonal as well. DATA SOURCE: BLOOMBERG, HRM HEDGEYE 99

100 TRID : WHO, WHAT, WHY,... TRID disclosure requirements require a wholesale overhaul of lender loan origination and software systems. The new requirements go into effect on August 1 st, DATA SOURCE: CFPB, HRM HEDGEYE 100

101 FOR MORE INFORMATION CONTACT: