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CALL INVITE | Brexit Implications – A 360° Analysis

Takeaway: Friday, July 22nd at 11:00AM EST

Hedgeye Potomac, in conjunction with the international law firm of Squire Patton Boggs, will be hosting a series of calls on Brexit and will first examine the legal and procedural implications.  

 

With Prime Minister Theresa May now formally installed at 10 Downing Street, we will discuss with Squire’s Brexit Task Force the events following the UK’s exit vote from the EU and what the outcome of the vote spells for the UK and the rest of the world.

 

The call will take place on July 22nd at 11:00AM EST with prepared remarks followed by Q&A.

 

KEY TOPICS ON THE CALL WILL INCLUDE

  • The timing and procedure of the withdrawal, and future negotiations between the UK and the EU
  • The consequences for UK, EU and US companies arising from the end of the application of EU Freedoms, Mutual Recognition, Passports and other privileges
  • Consequences under the domestic laws of the UK and the remaining 27 Member States
  • What happens to International Agreements entered into by the EU
  • What you need to know when entering into new contracts after June 23, 2016 and what you should do with respect to existing contracts
  • Labor, Employment and Immigration
  • What alternatives are available to the UK, including WTO, EFTA, EEA, Swiss-Style, Free Trade Agreements

 

ABOUT SQUIRE PATTON BOGGS

Squire Patton Boggs is a full service global law firm that provides insight at the point where law, business and government meet. Squire Patton Boggs consists of over 1,500 lawyers in 45 offices across 21 countries.

 

Squire Patton Boggs’ Brexit Task Force is a multi-disciplinary team of lawyers and policy advisers who are uniquely placed to support clients from across the globe on the effects Brexit will have on business.

 

The Public Policy teams, particularly in Brussels and Washington, D.C., consist of top tier lawyers with considerable public policy experience - which helps them provide seamless and coordinated discussions with the relevant authorities.

 

 

CALL DETAILS

Toll Free:

Toll:

UK: 0

Confirmation Number: 13641782

 


High, High, High

Takeaway: The guide down and beat: A new high in earnings “beats” as a bull catalyst.

With Q2 earnings season underway, headlines centering on “earnings beats” as a bull catalyst are at a new cycle high. The “beat” catalyst from the bulge brackets is a bit ironic considering financials in the S&P 500 have beat bottom line estimates by double digits on average in the current cycle (taking out the post-recession beats, the 5-yr avg. beat is +5.9% from the Financials), outpacing  every other sector.

 

In fact, every sector beats estimates, just about every quarter. This reporting season has started no differently. Earnings have come in at -5.7% Y/Y in aggregate so far with earnings exceeding expectations by nearly 4.2%:

 

High, High, High - S P 500 Earnings Beat Miss

 

High, High, High - S P Rev.   Earnings Comps

 

High, High, High - S P Beat Miss

 

Looking at more highs, the current forward multiple is at a new cycle peak on earnings expectations that assume positive S&P earnings growth by Q3 2016, 9% in Q4 2016, and +16% and +14% by Q1 and Q2 2017 respectively. Starting in Q4 of this year, positive earnings growth expectations are baked in for every sector for three quarters through Q2 of 2017. So we’re looking at a market that has been taken to an all-time high on cycle-high buyback activity with a new cycle high forward multiple with optimistic earnings expectations in the denominator as seen in the chart immediately below.

 

High, High, High - S P NTM and TTM PE Multiple

 

High, High, High - S P NTM and TTM EV EBITDA Multiple

 

High, High, High - 07.19.16 EL Chart

 

So the earnings management cycle goes on...

 

Lofty earnings expectations --> Negative guidance communicated --> estimates taken lower --> company beats estimates

 

That’s seemingly a marginal positive for now. According to factset:

  • S&P 500 earnings expectations for Q2 started the quarter at -2.1% Y/Y and were revised to -5.5% Y/Y by June 30th
  • 81 companies issued negative guidance for Q2 vs. 32 that issued positive guidance

In Q2 of 2015 only two S&P 500 sectors comped down, energy and industrials, and energy’s -56.5% Y/Y comp was in reality a very large contributor to a -1.2% S&P earnings comp in Q2 of last year. And looking at energy in isolation, spot energy commodity prices were meaningfully lower Y/Y on average in Q2 of 2016. All in all, Q2 is not an easy comp across the board which has been largely baked into in expectations in real-time:

 

High, High, High - q2 2015 comps

 

With lofty expectations, companies remain objectively laser focused on exceeding expectations, and the corporate gamery has increasingly picked up steam since margins and corporate profits peaked in 2H 2014 – buyback activity continues to make-up an increasing share of daily volume while return of capital via dividends is only showing early signs of deceleration:

 

High, High, High - profits and operating margin

 

High, High, High - Factset Buybacks

 

High, High, High - Factset dividends

 

As we've written, our expectation for Y/Y GDP for Q2 has been revised higher to +2.3%, implying the Q/Q SAAR number on which most of global macro is focused, could easily have a “4%” in front of it. The strength of last Friday’s retail sales report was a notable contributor to our revision with goods consumption contributing ~1/3 to PCE and ~1/4 to GDP – the trend in this series is meaningful. However, to re-iterate two important points with respect to the market’s potential reaction to a positive print:

  • Can good news from an economic perspective now be good for the market just as deteriorating trending data was good for the creation of a policy tailwind?
  • Is the risk of marginally hawkish policy with the data supported backdrop overpowered by good news?

Those are two questions worth asking, but a key takeaway with regard to our positive revisions for Q2 is the data supported overlay that employment and consumption is past peak with revolving credit showing mixed signs of slowing at a cycle low in delinquencies (credit growth has provided a consumption growth cushion since the consumer peaked in 1H 2015). Credit growth remains very robust, but taken as a whole, there is little room for an extension in the current consumer credit cycle and some metrics have already rolled over:

 

High, High, High - PCE growth 

 

High, High, High - Consumer Credit

 

High, High, High - consumer credit standards

 

High, High, High - Credit Quality

 

With the current “E” expectation empirically in question, we chose the title “high, high, high” instead of “peak, peak, peak” because we are constantly asked to weigh in on on the direction of the broader equity market in real-time (understandably as beta is the measuring stick for most) instead of focusing on what have been our better than bad tactical exposures within equities for most of 2016 (Long Utilities, short Financials). 

 

So can market levels, multiples, and buyback activity reach new highs? Sure, but as we wrote in this morning's early look:

 

“At this price (i.e. the all-time closing high of 2166), even if you believe the “E” (Earnings) embedded in the SP500’s multiple, this is a Top 3 most expensive stock market in US history.”

 

And to add another behavioral overlay, fund flow data indicates the cyclical gravitation to beta is at a new cycle high with fund flows out of actively managed funds averaging -$2.8Bn weekly in 2016 according to ICI and headline stories this week of actively managed outflows Financial Times.  

 

Please ping us back with comments or questions. We’re happy to look into anything mentioned above in more detail.

 

Ben Ryan

Analyst

 

 

 


U.S. GDP Whiplash

Key Takeaways:

 

  1. Next Friday’s Q2 GDP report is likely to come in better than expected – perhaps by a significant degree.
  2. While backward-looking in nature, any such “beat” will likely affirm the recent optimism in the domestic equity and credit markets – optimism that we’ve admittedly been on the wrong side of.
  3. That being said, however, we’re inclined to fade such optimism given our expressly dour outlook for domestic economic growth from here.

 

With the advent of the JUN Retail Sales, JUN Industrial Production and JUN CPI data, Friday was an important day for U.S. macroeconomic data and, more importantly, the predictive tracking algorithm we employ to forecast Real GDP growth on an intra-quarter basis.

 

U.S. GDP Whiplash - RETAIL SALES CONTROL GROUP

 

U.S. GDP Whiplash - Retail Sales Table

 

U.S. GDP Whiplash - INDUSTRIAL PRODUCTION

 

U.S. GDP Whiplash - Industrial Production and Capacity Utilization

 

U.S. GDP Whiplash - CPI

 

The key read-through from these data points is that YoY consumption and investment growth are both tracking higher on a quarterly average basis (i.e. Q2 vs. Q1). With key metrics of inflation flat QoQ and the net export matrix largely unchanged as well, the probability that Real GDP growth decelerates in Q2 is extremely low. The more likely outcome is that growth accelerates modestly; our model is now anticipating a sequential bump up to +2.3% YoY in Q2.

 

U.S. GDP Whiplash - U.S. Economic Summary Table

 

On a headline (i.e. QoQ SAAR) basis this figure translates to +4.8%; no that is not a typo. Recall that our latest update had been calling for Real GDP to decelerate from Q1’s +2.1% YoY growth rate to +1.8% YoY, which translates to +2.7% on a QoQ SAAR basis. That +50bps of positive revision to the YoY growth rate equates to nearly a doubling of the headline growth rate.

 

For a variety of reasons detailed in our 9/2 Early Look titled, “Do You QoQ?”, we don’t lend too much credence to the headline growth rate – which itself is more “noise” than “signal” – but it’s important to track nonetheless – if only because Macro Consensus queues off of it when formulating opinions about the state of the macroeconomy. Indeed, formulating differentiated [and profitable] opinions about growth and inflation requires a differentiated modeling process, which we detail below:

 

  1. Stochastic (us) vs. Econometric (them): Our GIP Model employs a top-down approach that uses trailing momentum and volatility in the GDP series itself as inputs to determine a range of probable outcomes. Contrast this with traditional econometric models that anchor on reported high-frequency data to “build” a singular GDP estimate from the bottom-up. In conjunction with the Bayesian inference process highlighted below, we are able to have reasonable estimates for GDP growth up to four quarters out, as opposed to econometric models whose accuracy is severely limited on an out-quarter basis due to a lack of reported high-frequency data. As a result, we tend to spot critical inflections in the trending momentum of the economy 3-6 months ahead of Macro Consensus.
  2. Bayesian (us) vs. Frequentist (them): Our GIP Model employs a Bayesian inference process that uses base effects as inputs to determine the direction and magnitude of adjustments from the base rate (i.e. the prior reported growth rate) with the output being a singular growth estimate that falls within the aforementioned range of probable outcomes. Our Bayes factor is the incorporation of a predictive tracking algorithm that guides our estimate to the most appropriate level within (or sometimes outside of) the aforementioned range on an intra-quarter basis. Contrast this with the Frequentist approach employed by Macro Consensus which typically defaults stock estimates of +2.5%, +3.0% or, worse, +4.0% and adjusts from there according to reported high-frequency data.

 

To the extent that +4.8% headline growth rate is proven in the area code of accurate when Q2 GDP is reported next Friday morning, there are three key considerations for investors to consider:

 

1) After starting the quarter with Wall Street’s lowest estimate for Q2 GDP growth (+1% YoY; +0.3% QoQ SAAR), we are now the Street high estimate. For comparison’s sake, the Atlanta Fed and Bloomberg Consensus are currently at +2.4% and +2.5%, respectively, on a QoQ SAAR basis.

 

U.S. GDP Whiplash - Atlanta Fed vs. Hedgeye Macro GDP Estimate Tracker

 

We pride ourselves on the accuracy of growth and inflation forecasts; our predictive tracking algorithm has an intra-quarter standard error of 28bps vs. 252bps for the Atlanta Fed’s tracker. As such, an intra-quarter revision of that magnitude is embarrassing to say the least and represents one of the few major mistakes we’ve made in recent years. While unachievable, perfection remains our goal and we’ll continue to evolve our models as needed in pursuit of that objective.

 

U.S. GDP Whiplash - Atlanta Fed GDP Tracking Error

 

2) On their own, absolute growth and inflation numbers mean nothing to our investment process. Rather, our analysis has shown that analyzing such figures on a second derivative basis leads to more impactful conclusions from the perspective of predicting the performance of key factor exposures across asset classes.

 

U.S. GDP Whiplash - Process Slide  1

 

U.S. GDP Whiplash - Process Slide  3

 

We triangulate second derivative trends across Real GDP growth and Headline CPI in our four-quadrant GIP analysis (shown below) and the positive revision to our Q2 GDP estimate suggests the U.S. economy likely moved into #Quad1 last quarter; this represents a delta from our initial forecast of #Quad4 and can explain why the equity and credit markets were so resilient heading into and throughout last quarter.

 

U.S. GDP Whiplash - UNITED STATES

 

U.S. GDP Whiplash - SPX

 

U.S. GDP Whiplash - Barclays High Yield YTW

 

3) Even if we’re too high by ~100bps on the headline GDP print next Friday, a growth rate in the mid-to-high +3% range will be interpreted very positively throughout the investment community. By reinforcing what we’ve shown to be misguided expectations of residual seasonality, it will also impact the views of policymakers as well.

 

Recall that the FOMC effectively shrugged off the initially weak Q1 GDP print as largely a function of poor seasonal adjustment techniques. A trend growth rate of +2.5% to +3% is likely to allow Yellen to look past trending weakness in her proprietary Labor Market Conditions Index and adjust policy guidance in the hawkish direction.

 

U.S. GDP Whiplash - LABOR MARKET CONDITIONS INDEX

 

This means the time between the FOMC’s July 27th meeting and its September 21st meeting is likely to contain a meaningful degree of hawkish rhetoric out of the various Fed Heads. That may serve to catalyze incremental convergence in the factor exposures we’ve been bullish and bearish on in the YTD; last week may have been a preview to the extent all of this wasn’t immediately priced in. Conversely, toned-down expectations of fiscal stimulus might prove to be rather bearish for risk assets for a TRADE.

 

U.S. GDP Whiplash - YTD PERFORMANCE

 

Looking ahead, there are three very important factors to consider as we progress throughout the back half of 2016 and into 2017:

 

  1. Relative to other key metrics of inflation, the GDP Deflator is being understated by a significant degree. Specifically, the spread between the GDP Deflator and the Fed’s preferred metric for inflation (i.e. the PCE Core Price Index) was -160bps in Q1; that 0.8th percentile reading represents a z-score of -2.2x on a trailing 30Y basis. Headline Real GDP growth would have been negative in Q1 at -0.5% had the two inflation figures been equal. #electionyearmath
  2. Our model has Headline CPI accelerating by a substantial amount throughout the balance of the year. To the extent the GDP Deflator and Core PCE Inflation remain co-integrated and the former mean reverts to where other key metrics of inflation are tracking, we could see a sizeable “accounting” hit to Real GDP growth over the next 2-3 quarters.
  3. The confluence of the aforementioned accounting drag, decelerating employment and consumer credit growth, as well as consumer confidence and bond yields concomitantly trending lower into peak base effects for consumer spending leads us to have a negative bias on Real GDP growth through at least 1Q17. Specifically, our model is calling for YoY Real GDP growth to decelerate from +2.3% in Q2 to +2.0%, +1.8% and +1.4% in Q3, Q4 and Q1, respectively. Those figures translate to +0.8%, +0.6% and -0.5%, respectively, on a headline basis.

 

U.S. GDP Whiplash - GDP Deflator Spread

Source: Bloomberg L.P.

 

U.S. GDP Whiplash - INFLATION MODEL

 

U.S. GDP Whiplash - PCE CORE PRICE INDEX

 

U.S. GDP Whiplash - CORE CPI

 

All told, next Friday’s Q2 GDP report is likely to come in better than expected – perhaps by a significant degree. While backward-looking in nature, any such “beat” will likely affirm the recent optimism in the domestic equity and credit markets – optimism that we’ve admittedly been on the wrong side of.

 

That being said, however, we’re inclined to fade such optimism given our expressly dour outlook for domestic economic growth from here. As we detail on slides 43-45 in our Q3 Macro Themes presentation, the biggest downside surprise risk remaining in the economy is a pending pickup in the pace of labor market deterioration that should commence within the next 2-3 quarters.

 

Best of luck out there risk-managing this whiplash in U.S. growth expectations. As always, feel free to email or call with questions.

 

DD

 

Darius Dale

Director


CALL INVITE | Brexit Implications – A 360° Analysis

Takeaway: Friday, July 22nd at 11:00AM EST

Hedgeye Potomac, in conjunction with the international law firm of Squire Patton Boggs, will be hosting a series of calls on Brexit and will first examine the legal and procedural implications.  

 

With Prime Minister Theresa May now formally installed at 10 Downing Street, we will discuss with Squire’s Brexit Task Force the events following the UK’s exit vote from the EU and what the outcome of the vote spells for the UK and the rest of the world.

 

The call will take place on July 22nd at 11:00AM EST with prepared remarks followed by Q&A.

 

KEY TOPICS ON THE CALL WILL INCLUDE

  • The timing and procedure of the withdrawal, and future negotiations between the UK and the EU
  • The consequences for UK, EU and US companies arising from the end of the application of EU Freedoms, Mutual Recognition, Passports and other privileges
  • Consequences under the domestic laws of the UK and the remaining 27 Member States
  • What happens to International Agreements entered into by the EU
  • What you need to know when entering into new contracts after June 23, 2016 and what you should do with respect to existing contracts
  • Labor, Employment and Immigration
  • What alternatives are available to the UK, including WTO, EFTA, EEA, Swiss-Style, Free Trade Agreements

 

ABOUT SQUIRE PATTON BOGGS

 

Squire Patton Boggs is a full service global law firm that provides insight at the point where law, business and government meet. Squire Patton Boggs consists of over 1,500 lawyers in 45 offices across 21 countries.

 

Squire Patton Boggs’ Brexit Task Force is a multi-disciplinary team of lawyers and policy advisers who are uniquely placed to support clients from across the globe on the effects Brexit will have on business.

 

The Public Policy teams, particularly in Brussels and Washington, D.C., consist of top tier lawyers with considerable public policy experience - which helps them provide seamless and coordinated discussions with the relevant authorities.

 

 

CALL DETAILS

 

Toll Free:

Toll:

UK: 0

Confirmation Number: 13641782

 


CALL INVITE | Brexit Implications – a 360° Analysis

Hedgeye Potomac, in conjunction with the international law firm of Squire Patton Boggs, will be hosting a series of calls on Brexit and will first examine the legal and procedural implications.  

 

With Prime Minister Theresa May now formally installed at 10 Downing Street, we will discuss with Squire’s Brexit Task Force the events following the UK’s exit vote from the EU and what the outcome of the vote spells for the UK and the rest of the world.

 

The call will take place on July 22nd at 11:00AM EST with prepared remarks followed by Q&A.

 

KEY TOPICS ON THE CALL WILL INCLUDE

  • The timing and procedure of the withdrawal, and future negotiations between the UK and the EU
  • The consequences for UK, EU and US companies arising from the end of the application of EU Freedoms, Mutual Recognition, Passports and other privileges
  • Consequences under the domestic laws of the UK and the remaining 27 Member States
  • What happens to International Agreements entered into by the EU
  • What you need to know when entering into new contracts after June 23, 2016 and what you should do with respect to existing contracts
  • Labor, Employment and Immigration
  • What alternatives are available to the UK, including WTO, EFTA, EEA, Swiss-Style, Free Trade Agreements

 

ABOUT SQUIRE PATTON BOGGS

 

Squire Patton Boggs is a full service global law firm that provides insight at the point where law, business and government meet. Squire Patton Boggs consists of over 1,500 lawyers in 45 offices across 21 countries.

 

Squire Patton Boggs’ Brexit Task Force is a multi-disciplinary team of lawyers and policy advisers who are uniquely placed to support clients from across the globe on the effects Brexit will have on business.

 

The Public Policy teams, particularly in Brussels and Washington, D.C., consist of top tier lawyers with considerable public policy experience - which helps them provide seamless and coordinated discussions with the relevant authorities.

 

 

CALL DETAILS

 

Toll Free:

Toll:

UK: 0

Confirmation Number: 13641782


Macrocosm 2016 | Save the Date!

We are thrilled to announce Macrocosm 2016 will be held in New York City on Monday, October 3rd. 

 

Mark your calendar now.  In the coming weeks we will release our full speaker roster and how to reserve your spot at this exclusive investor event.

 

Macrocosm 2016 | Save the Date! - macrocosm2016 banner graphic email

 

-Your Macro Team


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