Raoul Pal GMI July2015 Monthly

8/20/2019 Raoul Pal GMI July2015 Monthly

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Monthly Publication No.132 July 2015 __________________________________________________________________________

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© The Global Macro Investor 2015 2

In this edition:

Housekeeping

Introduction – Groupthink... Again…

Trade Recommendations – Buy December 2016Eurodollar Calls

The Business Cycle

Charts to make you go ‘Hmmm…’

o Dow Transports

o European Energy Stocks

o MSCI Emerging Markets

o Currency Volatility

o Wheat

o Sugar

o Bitcoin

Positions (both open and closed out)

The GMI iPad App is available to members. All you have to do is go to the Apple Store,search for The Global Macro Investor and download it.

Please remember to allow your iPad to FULLY load all of the documents before using theApplication. This may initially take some time. It is a great way to read GMI, I hope youlike it.

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Housekeeping

I will be in London on 7 th and 8th July and am available for meetings should you wish to discussthe many important developments that are happening, from the dollar bull market to the risk ofrecession and also the global commodity super cycle bust.

I’ve just completed a group of meetings with GMI members in NYC and there is plenty to discusswith regards to how everyone is thinking or is positioned.

Please let me know if you would like to set up a meeting.

I look forward to seeing you.

Introduction

Groupthink… Again…

As mentioned above, I have recently held a series of meetings in New York with GMI membersand I think these will provide a good start for this Monthly ’s discussion.

All together now

From a very top-down perspective, I find it interesting that most macro funds tend to alignthemselves in groups that share ideas, however I find the uniformity of views amongst thesegroups somewhat troubling. That is not to say that everyone is wrong but that too many firmshave the same views and same positions.

The three groups tend to be: the newer New York macro and credit community, the older NewYork macro funds and the London and Geneva crowd. All three tend to be somewhat distinctfrom each other but the views held within each group are similar.

This is the groupthink effect.

However, it is not totally ubiquitous as there are many who hold very different views. The verymacro-orientated tend to be broader in their opinions than those who are crossing over intomacro from credit, multi-strat or event driven.

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Summary of views

The first group (and the majority with whom I met in NYC) have extremely similar viewsgenerally. These are as follows:

The US economy is fine and the lagged effect of lower oil prices on consumption isabout to kick in along with real wage growth.

Inflation is going to rise with wage growth.

The European equity market is a better investment that the US market.

Chinese equities are a trade worth having on.

Japanese stocks are still an opportunity.

The Euro is going lower and the dollar higher.

Energy prices are going to rise.

Global growth is fine and EM is not much of a risk.

Positioning

In terms of positions, people were very light on dollar positioning, had zero bond exposure atbest or were short, were long Chinese equities, long oil names, long German equities, longJapanese equities and generally long US equities. Many had on specific EM trades such as

Argentina or Venezuela, Puerto Rico or Greece (yeah, it’s an EM now).

I’m a tad different…

Just to be clear, my views are startlingly out of consensus. My view is that shorting the Euro isthe best risk reward trade in macro, US bonds are setting up to be a stunning opportunity on thelong side, oil carries significant downside risk, the US and elsewhere are potentially heading intorecession, equity volatility is highly likely, EM is a major risk and Germany is at the risk ofleading Europe into a recession.

Pure macro heaven (or hell)

My over arching belief is that this is the most “pure macro” environment we have been in for overa decade, probably since the Asian Crisis in the late 1990s, and I just don’t think peopleunderstand what is going on.

My entire thesis rests neatly on the US Dollar. Nothing else matters and if my view is wrong onthat, then it is likely wrong on many things. What is really weird to me is that most people agreewith my views on the dollar but don’t have the trade on , and were less versed on the macroknock-on effects of a strong dollar. Groupthink has tended to isolate particular parts of the US orglobal economy and ignore the bigger picture.

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A Discussion Of Views

This is not going to be a confrontational discussion of who is right or wrong; the markets willdeliver that in due course. But I want to debate the core beliefs of many, the risks to the widely

held views and highlight why I think my view may well need to be given more credence.

1. Oil – the lagged consumption effect

I find the arguments for a consumption-based pick-up one of the weaker arguments and itseems to be based more on hope than reality. It is also very widely held as a view.

Models have flaws too

There are just too many assumptions made based on economic models and not enough of anunderstanding of the overall picture or indeed of the behavioural aspects of economics.

Strict economic models basically suggest that a fall in input costs always equals a rise inconsumption due to extra disposable income. This makes the dangerous assumption thatpeople are “econo-people” and not real life people. It also makes dangerous assumptions aboutglobal supply and demand being a zero sum game.

So, let’s jump to it, the f ollowing chart is the chart of Oil YoY versus Real PersonalConsumption…

The chart makes one immediately assume that Consumption is increasing as oil falls but weneed to dig in a bit to see what is really happening…

Having an eye for this stuff, as soon as I looked at the chart of Consumption I could see clearlythat it was nothing but a 6-Month lag to ISM...

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This clearly suggests that Consumption will moderate going forwards. So why is this? Well theanswer is pretty clear to me…

Firstly, the Oil Patch hit economic growth as revenues disappeared from the oil industry. Thatbrought down ISM, obviously…

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Secondly, consumption patterns persist until job losses mount, which takes a toll onConsumption…

Thirdly, job losses just lag the ISM…

Thus, this whole argument about consumption boosting the economy is backwards looking and

muddled thinking.

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The fall in oil prices does not lead to a boost in overall GDP, as any pick-up in finished goods isoffset by the fall in gas sales and other energy products. At best, it is GDP neutral.

However, once you understand that the loss of oil revenues and oil production are drags onGDP, especially considering the US’s new-found oil renaissance (due to the double hit of loss ofenergy sales revenues plus the compounded effect of loss of economic production due toclosing of rigs etc.), then you can see that people are looking at the oil price cut in EXACTLY theopposite way to reality.

The fall in the oil price will kill consumption and will not give it an overall boost. I see it no otherway.

Europe just lags the US

In countries that are not big oil producers, there is no loss of economic growth from the loss of oilproduction. Thus Europe saw a pick-up in overall consumption, but this again is misleadingbecause as US growth slows, then so will EU growth in due course and that consumption spikewill be short-lasting.

We also must then throw in the behavioural economics element, and that is the changingconsumption patterns of the US.

Changing consumption patterns

The two biggest cohorts of the demographics of consumers are the Baby Boomers and theMillennials.

The Baby Boomers have suffered two busts in recent years and are thus less amenable tospend any increase in disposable income – hence the pick-up in savings over the period oflower oil prices (and the falling in the savings rate as oil bounced). Their marginal propensity toconsume has fallen versus their marginal propensity to save. This makes complete sense.

Baby Boomers have changed their behaviour at the margin and economists, with rigid models,don’t capture this.

The Millennials on the other hand, just do not spend. They need any extra income they have topay off student debts. Their marginal propensity to save is higher than their marginal propensityto consume.

Debt damage

In a nutshell, there is too much debt and too much psychological damage from the last twocrises and that has changed consumption patterns.

So, with a change in consumption patterns and the shift in the US from oil consumer to oilproducer, there is almost zero chance that a consumption spike is coming.

Job losses and a fall in consumption is likely

In fact, the most likely economic impact from the fall in the oil price is the lagged loss ofconsumption and the lagged loss of jobs. Those numbers are going to start to appear in thecoming months and add to my view that the economic event on the horizon is a recession andnot an expansion.

I think the whole consumption-is-going-to-increase argument is groupthink and is not borne outby evidence or rigorous analysis. It sounds appealing at first hearing, but that is it. I’m still verybearish on oil and that is going to have an even bigger effect if it starts to fall again. More on this

later…

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2. Inflation is going to pick up, led by wage growth

Firstly, we have to test the assumption in this statement. It assumes there is wage growth…

This is the chart of Average Hourly Earnings…

Looking at the last five years, we can see there is now very limited wage growth and it has, infact, collapsed since the last recession (and has stayed low).

Hearsay is no substitute for facts

Hearsay would tell you that there are wage rises in some companies and an increase inminimum wage in some states, but there is no data that shows the potential pick-up in averagehourly earnings.

So, let’s just assume for now that the pick-up in earnings from Wal-Mart etc., is offset by a lossin EPS, which is clearly happening. Let’s also assume that the loss of earnings from the oilsector more than compensates for the wishful thinking headlines of some low paid sectors.

The point being that anecdotal evidence is no basis for economic analysis. There is no evidencethat earnings are on the rise via the corporate sector as a whole.

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Also, the new increased minimum wage argument is again a failure of model-based economicsover behavioural economics. If you are a restaurant or service business, you will not increaseyour wages if you can avoid it. You will take it out of total compensation (i.e. tips) or you will hireless people, e.g. cut the servers from the restaurants and just have the waiters take the food outthemselves.

Studies have shown time and again that increasing the minimum wage has very little benefit interms of total wages paid out. Wages only rise in a growing economy.

So, I think the assumption of higher wage growth is false.

Secondly, I also note that the correction between wages and CPI is in fact lagged by threemonths. Falls in CPI follow through to a fall in wages, and not the other way around…

The evidence from CPI would suggest that the fall in CPI is due to a fall in overall business

activity (the oil sector) and that will lead to a fall in unit labour costs.

This is more than fully supported by the chart of Unit Labour Costs (overleaf) versus the ISM.ULC lag the ISM by one year (CPI lags ISM by three quarters)…

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I like to use a probabilistic framework for my economic analysis as opposed to a model-basedapproach. Using the evidence above, the balance of probabilities would suggest that wagegrowth is in the process of topping out.

I see absolutely zero evidence that wage growth is going higher and will lead inflation higher.

The entire basis for the bond market sell-off is wrong. The entire basis for the Fed’sfuture increase in rates is wrong too.

This is a big concern. This is groupthink at its worst.

3. Europe is the best place to invest

Let us first address the elephant in the room: Greece.

The Greek situation is evolving quickly, but I simply refuse to accept that a second EU stateforced to close its stock market and banks in order to bail-in to pay the creditors, is anything butnegative for the EU as a whole.

Hello? Draghi?

Whatever happened to Draghi’s, “W hatever it takes…” ? It was a lie. So far, Cyprus and Greecehave been sacrificed for the sake of the German creditors and the troika . How can that be thebackstop to a harmonious and creditworthy EU?

There is no backstop. Draghi and the entire ECB/EU/IMF are a sham.

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Wrong price

CDS prices in Europe are WILDLY wrong. I am long CDS on Spain and expect them to continueto rise. It makes absolutely zero sense for CDS to be priced at 90bps. The basing pattern isclear and a breakout is occurring. I think they should be at least at 200bps to 300bpsconsidering Podemos and the elections and the Greek/Cypriot precedent…

Eye on the horizon…

But let’s not get wrapped up in the Greek tragedy, our job is to look forwards.

Germany and the DAX

I am more worried about the groupthink that the DAX is the best investment right now. Peopleare massively overweight Europe and Germany in particular. The idea is that the weaker Euro isexcellent for Germany.

So, let’s test that assumption first. If we look at the DAX in US Dollars (i.e. after you’ve hedgedthe currency) you can see that we have a large failed rally at play and the potential for the breakof the trend-line…

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The DAX is just not that strong and everyone is long.

Weaker Euro does not equal higher earnings

Let us now test the assumption that the weak Euro is going to help German corporate earnings.

Overleaf is the chart of German EPS growth and the Euro. Firstly, German earnings aregenerally inverse to the Euro, i.e. Euro down is earnings down, but let’s assume that correlationhas changed, then we can see that the fall in the Euro has had zero impact on Germancompanies…

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If we look at German Exports then there is a false assumption there too. Exports have not risenwith the weaker Euro…

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In fact, German Exports are just a lag of ISM…

So, as I have pointed out many times over the years, the EU is just a lagged US business cycleand nothing more.

The risk to German equities is weakness in the US, which I think is coming…

The Yen is eating Germany’s lunch

I also think one of the biggest macro shifts in the world is misunderstood and is going to be themain reason that Germany does less well than expected.

We live in a relative world and Germany’s biggest competitor, Japan, has had a massive terms-of-trade shock in its favour. Japan is going to eat Germany’s lunch at these exchange rates…

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Assumptions, assumptions

So, if you are long the DAX based on the Euro, you are making a false assumption. If you arelong the DAX hedged against FX risk then you are seeing the risk of a larger top.

And then there is the other elephant in the room…

If you want to know the risk of having the supposed best balance sheet in Europe then just lookat the derivative exposure of Deutsche Bank. Their derivative book is 100% of world GDP.

Just take that in for a moment. One bank has more derivatives on its balance sheet than

all of the world’s sovereign debts added together. Sure, most are netted off, until theyaren’t.

I stand by my view that DB will likely go bust in the next down-cycle and the Germans will haveegg all over their faces when they have to bail out their own, and see their own debts to GDPexplode…

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So keeping all that in mind, I think you better closely assess how long the market is of the DAXand the recent technical breakdown.

Everyone is now hoping that the next round of EU QE will push prices higher. I am not so

convinced…

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Finally, with regards to Germany, I’ll leave you with the chart of German PMI. This economy isabout to go into recession.

You have been warned.

4. Chinese Equities

I have no really strong view on Chinese equities. We know they are a bubble. We know that itlooks strikingly like the late 1920s US. We know that the debt situation is a mess. We know thatgrowth is imploding. We know that the PBOC have had to cut rates to prop up the banks.

So why the hell does everyone own Chinese equities?

Because Louis Gave from Gavekal told them to.

Louis’ story of the institutional underweight of Chinese equities bein g the biggest risk toportfolios in the world is compelling and, based on a potential inclusion in MSCI indices – whichis in turn based on the potential SDR inclusion – was just the story everyone needed to buyChinese stocks. It justified getting involved in a bubble to tack on a bit of performance.

I really like Louis and I think he is a smart guy but he is peddling China funds and a Chineseresearch service. I like the story but I think it is based on too many “ifs”.

I sincerely doubt that MSCI would add China to anywhere near full weight anytime soon. A-shares just don’t qualify. And I also think that the most popular future series from MSCI will likelybe MSCI Asia ex-China, much like it was MSCI ex-Japan for the last two decades. China isreally untradeable for most and speculative at best. I think the whole underweight story does notstack up.

Now, could Louis be right? Sure. Should we be involved considering everything we know aboutChina? No. Definitely not.

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Excuses, excuses…

Some of you have found a separate excuse to buy China and that is based on Chinese Internetplays. Again, anyone thinking that this is the justification of buying into the large speculativebubble in history is being naïve.

No country has ever had this much of their market cap based on margin accounts. No countryhas ever had this much margin debt as a percentage of GDP. No country has ever had thismuch retail money piling in. No country has ever seen their stock market cap rise by $4trn in ayear.

The baseline groupthink assumption is that the government won ’t let the market fall. The faith inthe Chinese Government is extraordinary.

I’ll stick to what I know. This is a bubble and bubbles burst. This is not a market to be long of,regardless of the reason.

This is what a crash looks like…

Can it recover and bounce? Sure. I’d leave this trade well alone. There are much higher qualitytrades out there.

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5. Japanese Equities

I don’t have too much to say about this trade. I like the story. I think if Japanese companiesmanaged to make money when the Yen was at 80 then they can make plenty of money with theyen at 124.

The only reason I don’t currently have this trade on is based on two observations: everyone elsehas it on and Japanese companies are not immune to the global business cycle, which I fear isclose to contracting, and that is not the time to be long anything but the most beaten up sectorsor markets (Uranium, Greece, Cyprus, etc.) which still have to be approached cautiously.

I’d rather take profits if you’ve got the trade on and re-buy into a bigger sell-off. It’s a small exit ifeveryone has to get out.

Simply put, Japanese earnings will not rise if global demand falls. If that is the case theneveryone is long and wrong, for now at least.

6. The Dollar is going higher

Clearly, I love this trade. But the most interesting thing from the visit to New York is that whenasked how people were positioned, almost no one had the trade on and if they had it on, it wasonly small. The average position size was 20% of full risk, for those who actually had a position.

I love a market that is implicitly short gamma. Basically if the dollar starts to move then everyonehas to chase it.

I’ll cover this more fully when I discuss my own views…

7. Energy Prices are going to rise

I’ve covered this very fully in my last few publications so I’ll spare you the full debate and sum itup in two sentences and two charts.

1. Production is still increasing globally and is at all-time highs.

2. It is all about the dollar.

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And here are the charts…

It’s the dollar, stupid…

And positioning has exploded again…

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Summary point:

You cannot be long the dollar and long oil .

One of those legs is going to negate the other. It is not a consistent macro bet.

I remain concerned that the stronger dollar will negatively impact energy prices going forwardand that people are positioned too early for a recovery.

8. Global growth is fine, as is EM

The argument goes that the fall in the oil price is beneficial to the global economy and that willsupport global growth, and that EM governments don’t carry much debt so the region is relativelysafe.

Firstly, when you look at the chart of World PMI, you can only draw the conclusion that worldgrowth is slow and the trend is firmly lower. It is only a matter of months before the world stalls

entirely…

Triple shock – China, Commodities and the Dollar

As I have mentioned many times over the last few months, the combination of the collapse ofChinese demand and the rise in the dollar has wiped out something like $5trn of commodityrevenues from the global system and maybe the same again in knock-on effects. Much of thishas yet to filter in but commodity bear markets and dollar bull markets change the balance sheetof countries and corporations all over the world.

Sure, there are some benefits to consumers, but this is more than wiped off by the devastationthis commodity collapse reaps on entire countries.

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On my travels, I heard a few people proffer the argument that the fall in commodity prices is azero sum game and that the loss of revenue is compensated for by the pick-up in consumption.This is model-based thinking at its most concerning. If this were the case then there would neverbe a recession!

The same argument is/was brought out when interest cuts were made. It proved to be a falseargument then too. When people see bad things happening they change their spendingpatterns. When companies see bad things happening, they change their production plans andtheir hiring plans. That kind of analysis is what behavioural economics brings to the table – realism.

Bad economic events are not positive events. Leave that kind of commentary to CNBC.

So let’s assess the damage in EM world… you can see that the EM PMI is in recessionterritory…

Again, all we need to know to better understand what is going on is to realise that commodity

prices have collapsed and that badly effects EM, and global demand is slow, which also effectsEM, and finally we know that almost the entire global private sector increase in debt since 2009has come from EM corporates.

When the dollar goes higher, those firms (which are almost always funded in US$) find it hard topay back debts and, when their output prices collapse too, then it’s a house of cards…

Commodity producers and exporters

We can look at this in two ways:

If we take a commodity-producing nation like Brazil, we can see that the economy is cratering…

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There is no rosy picture for a commodity producing nations. Even Canada is seeing thebeginnings of a recession.

If we flip across to a non-commodity producing nation with high debts, such as South Korea we

can see that the economy is slowing…

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Business Conditions are falling off a cliff…

As are Exports…

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And that will drag down GDP sharply into a recession…

I think the situation in emerging markets is dire and people are not realising the extent of it yet.

Personally, when I look at the chart of the KRW I think that it is going to trade at new all-time

lows in due course (new highs on the chart)…

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When I look at the short-term chart, we are about to test a very key level indeed. The necklinefor the inverse head-and-shoulders comes in at around 1135. Next stop 1300…

And I have been pointing out for a long time that the chart of the KOSPI is an accident waiting to

happen. It is the biggest failed rally I have ever witnessed…

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Total debt to GDP in South Korea is the highest of the emerging markets, outside of China.

If there is a black swan out there, it is South Korea.

But EM in general is in very bad shape indeed. It is a US recession away from a full collapse anda renewed dollar rally away from the tipping point.

In a nutshell

So, as you can see from all of the points above, I fear that many people may well be backing thewrong horses.

Clearly I can be wrong, and for me to be proven wrong is pretty simple: if the dollar does not rallyfurther then the status quo can be maintained and we can continue with this lacklustre globalexpansion for a while longer.

If the dollar rallies again from here then it is game over and the exit doors are small.

My views

In New York I presented a very different spin on the world to almost anyone else. I am wildly andcomfortably out of consensus.

I think that the dollar is the only thing that matters. My view remains that we are in the earlystages of what will prove to be one of the biggest dollar bull markets in history, and it is going toreap devastation on the global economy…

The Chart Of Truth

If you care about one chart and one chart only that sums up the entire risk to the world it is this:the DXY is forming a perfect wedge. It is going to break during the summer and the dollar isgoing to explode higher …

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If this wedge breaks then I think the dollar will finish the year around 110 to 115, which would beconsistent with the pattern of other dollar bull markets with an annual gain of over 20%. I think itdoes the same in 2016 too…

The trade I presented in NYC as the best and easiest risk reward trade in the world is shortingthe Euro. Sadly the trade has moved a little in my favour so the risk reward is less good today,but it is still compelling.

I think the Euro is about the break the head-and-shoulders top and head down to parity againstthe dollar…

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Why the risk reward is so good is that the chart could well be an inverse head-and-shoulderswith the neckline at 1.15. It is possible but it’s my least likely outcome…

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Easy stop-loss

If the dollar were to break that upside level versus the Euro then I would be forced todramatically reassess my view on the world.

Thus we have a stop-loss at 1.15 (4 points away) and the target would be 1.00. That is a clean3:1 risk reward (it was a 5:1 when I presented it!).

I’d also add in that no one has the trade on , and that everyone wants it on, and that gives it thechance of dramatic acceleration to the downside if the trend-line breaks.

If you don’t have this trade on then I urge you to do so.

Also, I like to keep an eye on the knock-on effects. If the Euro goes then…

… the Aussie goes…

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The CAD goes…

And the whole ADXY goes…

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And if they go, then Oil goes… along with the rest of the commodity markets (the chart is of theCRB Index)…

Bonds – I love ‘em, no one else does…

The next trade I discussed in NYC is that of buying US bonds. Bonds are almost universallyreviled. The structural underweight by asset managers is almost the largest in history and hedgefunds are either short or flat.

No one owns bonds.

What we do know is that the risk reward is stacking up nicely. If the Fed raises rates (which Idon’t think they do) the yield curve will flatten and the long end will rally. If I am right and globalgrowth slows further in Q3/Q4 then bonds will fly.

A rising dollar also leads to falling bond yields (as it lowers inflations and slows growth). Thefollowing chart is US 10 Years versus the DXY (inverted)…

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The risk reward of buying bonds is looking very good. The massive trend-line comes in at2.70%, giving an upside risk of 40bps and the downside target is 1.00% or lower, giving aminimum of 3:1 risk reward on buying the most under-owned major asset in the world…

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Volatility trades

The other trade idea I presented was buying VIX calendar spreads, i.e. buy front month and sellsix months out.

Even with the spike in vol over the last few days you can buy July futures for 17.8 and sell Jan2016 for 18.85. If nothing happens you’ll get the roll down and thus positive carry, but if themarket sells off (remember we have had FX vol, commodity vol and bond vol and that onlyleaves equity vol to come) then the short-dated futures will spike and the longer-dated will riseless.

Although the curve has steepened, this is still the cheapest way to hedge.

I’m going to wait for the recent spike to calm down before adding this trade. I like it a lot.

Eurodollar calls

Finally, the other trade I presented was buying the December 2016 Eurodollar 99.75 calls for 1tick.

This trade is an absolute bargain if my view is right and will cost you 0.5 ticks if I am wrong. Ithink the Fed will go to negative rates in the next recession.

By looking at past history of the lengths of business cycles there is something like an 80%chance of a recession by the end of 2016.

If that is the case then December 2016 Eurodollars will trade at 100 or even above (See Euribor

for details).

Thus the upside is a stunning 50:1 risk reward, if you assume you can always sell this back forhalf a tick if we are wrong.

To be clear, you risk half a tick to make 25.

I’ll take that bet all day.

This is the best single hedge against a recession or worse. You HAVE to have this tradeon. You can risk 1% of your NAV over the next eighteen months and the potential gain is50%.

Wow.

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Trade Recommendation:

Buy December 2016 Eurodollar Calls for 1 Tick

So, as ever, let’s see how my views pan out. I am very comfortable with where I am wrong andwhere I am right. That makes it a rather good opportunity.

It might be a busy summer.

An Update on Recession

In the last Monthly, I showed you the long list of indicators that were suggestive of a recession.

To update you:

The indicators that are in full recession territory are as follows:

US Industrial Production

US Manufacturing New OrdersDurable Goods OrdersDallas FedKansas FedUS Retail Sales 3MMACPISPC Adjusted Earnings Per Share

The indicators that are near recession:

AA Carloadings

CASS Freight Shipments IndexMilwaukee ISM

The big surprise, as ever, was the ISM, which ignored every single other Fed index andbounced. Personally, I don’t get it. I know the seasonal adjustment facts were large last monthbut it is still a mystery as to why the ISM rose.

So, now we are at the point where the CESI up-cycle should come into effect. My view remainsthat the CESI is going to rally on the bringing down of US data and not the beating of existingforecasts.

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The entire rally in the CESI from March has been based on the collapse of Q2 estimates of GDPfrom 3.5% to 2% and, with marginally less misses in the economic data, the CESI has risen.

The entire economic game is now about Q3. The estimates for this quarter remain at 3%. I thinkthose estimates are too high and Q3 will come in lower, thus the only way for CESI to continueto rise is for forecasts to come down again first. Note that GS just lowered its entire year forecastto 2.5% from 3%. I think there is more of that to come.

If that set-up occurs, where the CESI up-cycle shows a fall in GDP forecasts (and we’ll know inthe next month or so) then that would set us up for a very lacklustre GDP ahead of the nextCESI down-cycle and thus the risk of a full recession will rise significantly.

It is a tough call from the data so far, but I think that a recession is still likely in 2015.

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The Business Cycle

Well, that was an unexpected bounce in ISM… again. ISM is trying its best to make me look likean idiot…

With the big Boeing orders at the Paris Air Show, we should see the ISM continue up for a few

months now, but the bounce should be subdued…

The orders were less than last summer or the summer before so the seasonal bounce in ISMNew Orders should also be subdued…

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And that should bring GDP to around 2%...

But the point is that if this ISM up-cycle is not a large one (as was the case in 2007 and 2008)then when things roll over again in Q4 things could get ugly quickly.

Just look, for example, at AAR Carloadings…

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Or Durable Goods Ex-Transports…

The oil bust is really spreading across the economy and Non-Residential Fixed Investment iscollapsing and should keep ISM lower…

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The Milwaukee Fed is still falling…

The Chicago PMI is still not bouncing…

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Cass Freight is diverging…

Over in Asia, the CESI is expecting to rise there soon…

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Probably led by huge pessimism in China…

Electricity Production in China is picking up a tad…

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But the PMI is still going nowhere…

Japan is not seeing much of a pick-up from the weaker Yen… it looks to me that it is going to gointo recession…

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Japanese Exports to the US are slowing again…

But the trade balance has shot up and that might well start to put a floor under Yen weakness fornow…

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But inflation has failed to take hold…

I discussed Korea earlier in the Monthly … growth is close to full recession territory…

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And IP is too…

Australia is getting into real trouble… Exports are very weak…

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And Exports to China have utterly collapsed…

Ditto for Hong Kong Exports…

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And Singapore Exports…

Also in Indonesia…

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In Europe, Italy is bizarrely seeing the strongest PMI…

But the LEI has turned over again…

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Spain is seeing a meaningful pick-up in mortgages, which is helping a lot…

But the LEI has rolled over there too…

All in all, it’s still not a great picture. The US is slow, Europe is slowing (led by Germany) and Asia is slow or actually in a recession…

[email protected]


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Charts to make you go‘ H mmm…’

Chart 1

Dow Transports

This is an ominous divergence… truly spectacular…

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Chart 2European Energy StocksThe SXEP has broken a head-and-shoulders top…

And that is part of the biggest top pattern in probably all of stock market history…

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Chart 3

MSCI Emerging Markets

This is going to break soon…

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Chart 4

Currency Volatility

The CVIX looks like it’s ready to explode higher again…

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Chart 5

Wheat

Wheat prices have caught on to the El Niño risk. El Niño is usually a negative for grains, so let ’ssee…

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Chart 6

Sugar

One of the crops that really might see upside from El Niño is sugar. This is a great place to ownit…

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Chart 7

Bitcoin

Bitcoin is starting to look like it has based and can move higher… finally…

[email protected]


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Positions

Tail Risk

Trade Recommendations Entry Date Entry Price YTD

Buy 3-Yr Spanish CDS Feb 2nd 2015 60 30.00%

Core Trades


US 30-Yr Bonds Nov 3rd

2014 3.06% -6bps+1.48%

US 10-Yr Bonds Feb 2nd

2015 0.0166 -69bps+0.68%

Sell Credit Suisse Feb 2nd 2015 19.72 -23.27%

Sell UBS Feb 2nd 2015 15.45 -22.17%

Gold Feb 2nd

2015 1274.46 -8.01%

Bitcoin Feb 2nd 2015 227.29 15.56%

Aussie 2-Yr Bonds Feb 2nd

2015 1.98 -4bps+0.81%

Buy Mar 2016 Eurodollar Futures Mar 2nd 2015 98.97 31 ticks

Closed Out Trades 2015Inception

DateClosing Date ITD%

Buy Apr 2015 WTI /Sell Mar 2016 Mar 2nd

2015 $1.74 $10.10

Short Term Risk


Sell ADXY Dec 1st 2014 113.69 1.79%

Sell AUD Dec 1st 2014 0.8491 9.29%

Sell EEM Dec 1st 2014 40.79 2.87%

Sell SPX Feb 2nd 2015 2020.85 -2.05%

Buy JPY Mar 2nd

2015 120.13 1.89%

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Long Term Risk

Trade Recommendations Entry Date Entry Price% Since

Inception

Bombed Out Markets

Bank of Cyprus Feb 8th 2013 0.091 -17.13%

Other Long Term Investment

Bitcoin Nov 1st 2013 212 23.89%

Buy 6.5 Strike USD/RMB Call Dec 1st 2014 0.65% 0%

Buy ASE Index (Greece) Feb 2nd

2015 755.42 -0.99%

Buy URA Feb 2nd 2015 11.65 -13.10%

[email protected]


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Background

Raoul Pal has been publishing The Global Macro Investor since January 2004to provide original, high quality, quantifiable and easily readable research for theglobal macro investment community. It draws on his considerable experience inrunning a hedge fund and advising many more.

The Global Macro Investor has one of the very best, proven track records of anynewsletter in the industry, producing extremely positive returns in 7 out of thelast 10 years.

Raoul Pal retired from managing client money at the age of 36 in 2004 and nowlives in the tiny Caribbean island of Little Cayman in the Cayman Islands.

He is also the founder of Real Vision Television, the world’s first on-demand TVchannel for finance: www.realvisiontv.com.

Previously he co-managed the GLG Global Macro Fund in London for GLGPartners, one of the largest hedge fund groups in the world.

Raoul moved to GLG from Goldman Sachs where he co-managed the hedgefund sales business in Equities and Equity Derivatives in Europe. In this role,Raoul established strong relationships with many of the world’s pre-eminenthedge funds, learning from their styles and experiences.

Other stop-off points on the way were NatWest Markets and HSBC, although hebegan his career by training traders in technical analysis.

Should you wish to receive information about membership please email us [email protected]. The number of members is STRICTLYlimited, with only a few free spaces coming up each year, as the membership isfull. If there are no free spaces available, a waiting list will apply.

Except for use granted to the named subscriber, this publication may only bereproduced, stored or transmitted in any form or by any means, with priorpermission in writing from the publishers.
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Documents

Raoul Pal GMI July2015 Monthly