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“LBO was still a dirty word.”
Carey & Morris, King of Capital

Key Takeaways

  • While consensus bulls might think it’s “different this time” (they’re right, USA had the most Corporate Leverage in human history, pre-virus), I’m thinking those of us who have been accurately bearish should re-consider if we’re Bearish Enough.
  • “Bear” with me… and forget the short-term “rebal trade” and whatever The Fed is doing today for a minute. Longer-term Full Cycle Investors should realize that late 2018 and all of 2019 is like late 1989 and all of 1990 was for levered long Equity and Credit investors.

The big picture

Post the 1991 US recession, Wall Street wasn’t using dirty words like that anymore – they started calling it Private Equity!

“The Junk Bond market experienced a revival in 1992-1993, as DLJ and other banks hired the best and the brightest out of Drexel Burnham after it went under in 1990…” -King of Capital, pg 136

Yep, spitem out and bring the new cycle of (distressed) investors in, bro. All we need to do is a little rebal and have the Fed fuel some charts and we might get to “the other side” without ever having to see a full credit and employment cycle play out, eh?

Sell The Rebal - 02.06.2019 volleyball bears cartoon

Macro grind

After doing 6 straight 45 minute plus Institutional Client calls yesterday, I went for a run and re-balanced my thoughts for the line of questioning I went through. As a result, I’m changing my market views this morning – I am not nearly Bearish Enough!

“You’re such a Rebal, KM.”
*In the urban dictionary that means “a guy who makes comebacks after what you exactly said to him.”

While I’m not sure why it’s just a guy (couldn’t it be a gal?), I’ll roll with it. After walking clients through our Q2 Macro Themes deck, I’m just repeating exactly what The Cycle just said. I’m not “fighting the Fed.” The Fed is fighting economic gravity.

While the majority of client questions we’ve had since making that Q2 presentation last week anchor on economic v-bottoms, “liquidity”, and how “quickly we might recover”, 2 of the 6 calls I had yesterday focused on “how much worse” it might get…

Here are some Business Cycle thoughts on that:

A) When Revenue Growth #slows into pro-cyclical (rising) operating expenses and peak debt leverage…
B) Deleveraging in Corporate P&L’s lead to faster firings, tripped covenants, and further curtailing of capex
C) Then it can take multiple quarters to get businesses (cash flows) right-sized for recessionary demand … and
D) If you’re going to “lever up further”, you’ll be even more levered during a protracted economic slow-down…
E) And that will hold you back from “getting aggressive” on wherever the “other side” ultimately is going to be

Again, I’m just spit-ballin’ on that. But I have built a company that in 2 years out of 13 saw revenue growth slow post my ramping my operating expenses (on the back of the prior year’s growth acceleration).

Not only were those the 2 years where I had to let people go. They were the 2 years where we didn’t hire anyone. Years, not months.

“Secular Grower” fans may have liked it if I “levered up” and “bought a bunch of stock” in those years. That’s cool on a spreadsheet when banks are throwing credit at you but, for most of us running medium-sized businesses (50 or more employees), that’s not reality.

For “Small Businesses” in America reality is much harsher.

As you can see in today’s Chart of The Day, in 1-3 months it can be pretty much over. At > 50% of total employment and > 80% incremental hiring, Small and Medium sized businesses fuel both late-cycle US employment and consumption growth, don’t forget.

‘Oh just send them some checks and/or lever them guys and gals up’, eh?

Again, while consensus bulls might think it’s “different this time” (they’re right, USA had the most Corporate Leverage in human history, pre-virus), I’m thinking those of us who have been accurately bearish should re-consider if we’re Bearish Enough.

So… that’s the local picture. Globally, coming into this (pre-virus) it was way worse. Here’s the latest from Quadzilla on that:

1. Premature bounce in China’s official PMI data:

a. Manufacturing PMI: +16.3pts to 52 in MAR – best print since SEP ’17 and fastest RoC since JAN ’05
b. Non-Manufacturing PMI: +22.7pts to 52.3 in MAR – fastest RoC since JAN ’07
c. Composite PMI: +24.1 to 53.0 in MAR – fastest RoC ever

2. Speaking of global disinflation:

a. Brazil FGV IGP-M Price Index: -1bps to a 4mo low of 6.81% YoY in MAR
b. Germany EU Harmonized Headline CPI: -40bps to a 4mo low of 1.3% YoY in MAR
c. France EU Harmonized Headline CPI: -90bps to 0.7% YoY in MAR – the slowest RoC since OCT ’16 and sharpest MoM deceleration since NOV ‘08
d. Italy EU Harmonized Headline CPI: -10bps to 0.1% YoY in MAR – the slowest RoC since OCT ’16
e. Eurozone Headline CPI: -50bps to 0.7% YoY in MAR – the slowest RoC since NOV ’16 and sharpest MoM deceleration since FEB ’16
f. Eurozone Core CPI: -20bps to a 7mo low of 1.0% YoY in MAR

3. Brutal leading soft data confirming the SPEED and DEPTH of the global downturn:

a. US Dallas Fed Regional Manufacturing Index: -71.2 to -70.0 in MAR – the worst print and sharpest MoM decline ever
b. South Korea BoK Manufacturing Business Sentiment Index: -15pts to 54 in APR – the worst print since MAR ’09 and sharpest MoM decline ever
c. South Korea BoK Non-Manufacturing Business Sentiment Index: -16pts to 52 in APR – the worst print and sharpest MoM decline ever
d. UK GFK Consumer Confidence Indicator: -2pts to -9 in MAR
e. UK Lloyds Business Barometer Indicator: -17pts to a 6mo low of 6 in MAR – the sharpest MoM decline since MAY ’17

If you need to or want to believe the Chinese guys (yes, they are actually all guys) on that diffusion index (it’s a survey, not hard economic data), you may as well have believed Xi’s initial coronavirus numbers too!

The sad reality is that China is even more levered than the USA is at particularly the wrong time in The Cycle. That’s the thing about cycles and why Steve Schwarzman himself said selling CNW Junk Bonds in 1989 was like “catching the last helicopter out of Vietnam.

“Bear” with me… and forget the short-term “rebal trade” and whatever The Fed is doing today for a minute. Longer-term Full Cycle Investors should realize that late 2018 and all of 2019 is like late 1989 and all of 1990 was for levered long Equity and Credit investors.

If my Bearish Enough case plays out (I also have the plain vanilla bear case, which could happen too), and a US recession were to play out for the rest of 2020, there will be very very hugely bad words that explain many super late-cycle investments of 2019 too.

Our levels

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

UST 10yr Yield 0.56-0.99% (bearish)
SPX 2199-2719 (bearish)
RUT 991-1199 (bearish)
Tech (XLK) 68.19-84.48 (bearish)
Shanghai Comp 2660-2817 (bearish)
VIX 53.64-79.27 (bullish)
USD 97.60-105.13 (bullish)
GBP/USD 1.11-1.24 (bearish)
Oil (WTI) 19.04-24.31 (bearish) 

Best of luck out there today,

KM

Keith R. McCullough
Chief Executive Officer

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