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"When you have afforded yourself and your family’s hard-earned capital the long-term Full Investing Cycle gift of #patience, these 3-6 week Counter @Hedgeye TREND moves are so silly."
-CEO Keith McCullough, Early Look, 2/21/2023

Market Edges: #Patience - 02.13.2023 I like the dove better cartoon

The Cleveland Fed just released a new paper entitled, "Post-COVID Inflation Dynamics: Higher for Longer," in which they suggest "A deep recession would be necessary to achieve the September projected inflation path" forecasted by the Fed.

LOL.

Meanwhile, as Hedgeye Macro analyst Christian Drake notes in key takeaways taken from a premium Macro research note...

  • Consumer Credit Card Balances are at 20-year highs
  • The cost of that debt is at multi-decade highs
  • The Consumer Savings Rate hits multi-decade lows
  • There's a 22-month streak of negative income growth

So "the Consumer is in great shape"? No. Just no.

BOTTOM LINE: Bear market bounces require patience. Make no mistake. #Quad4 conditions remain.

Below is what's inside this week's edition of Market Edges:

  • Client Talking Points: Our Macro team breaks down long China, the precarious nature of sticky CPI versus negative real wage growth and the rock-and-a-hard-place for central bank policymakers.
  • Chart of the Week: U.S. Macro analyst Christian Drake describes a worrisome scenario for U.S. consumers: rising credit card debt, higher debt costs and falling wage growth.
  • Sector Spotlight: Our Industrials team is hosting their 1Q 2023 Mid-Quarter Themes Update. Here's a preview.
  • What the Media Missed: Macro and Financials analyst Josh Steiner explains the Macro implications of the 2-year Treasury, Capital One/Synchrony/JPMorgan data, and Mortgage Purchase App data series.
  • Around the World: A think piece from Demography analyst Neil Howe on "the global succession crisis."

Good luck out there!

ASSET ALLOCATION

Below is our 'GIP Model Risk Management Overlay' to better guide your asset allocation decisions. CLICK HERE to watch a brief video about our GIP model.

Click to enlarge

Market Edges: #Patience - high low

CLIENT TALKING POINTS

Long China, CPI VS. Real Earnings & Self-Defeating Policy Conundrum

1. Long China

The next large trend in the international market is China’s reopening. When China reopened, the country’s most reliant on China as a trade partner also saw a significant price increase based on the belief that the China opening will increase international demand.

What we have been using to track this are the January export numbers for individual countries to China. In the chart below, you can see the only countries with an acceleration in exports are Singapore $EWS and Indonesia $IDX. While South Korea $EWY (-31% YoY), Japan $EWJ (-17% YoY), Taiwan $EWT (-34% YoY), and Vietnam $VNM (-21% YoY) all saw significant decelerations in trade exports.

This is only one data point but will continue to be important going into February as expectations for GDP in these countries continues to accelerate (as are quarterly earnings expectations).

Market Edges: #Patience - FRIDAYCOD

2. CPI & Real Earnings

Headline and core inflation both ticked down -10 bps sequentially to 6.4% and 5.6%, respectively. Corroborating the small business account of rising inventories and falling output prices, core goods-based inflation led the charge lower, falling to 1.4% from a local peak of 6.8% in March. Meanwhile, core services inflation accelerated +20 bps to 7.2%, powered by accelerating shelter (+7.9%), utilities (+5.0%), and sticky double-digit inflation in transportation services (+14.6%). Nine quarters of double-digit food inflation and a reacceleration in energy inflation, both on the goods and services side, gave additional pause to any disinflationary excitement.

Meanwhile, real earnings declined -1.8% y/y in January, the 22nd consecutive negative monthly print. Recall, disinflation is not deflation and does nothing to lower the household burden of higher equilibrium price levels – as we like to say, initial conditions matter.

The implications of the CPI print were clear: higher for longer.

3. Self-Defeating Policy Conundrum

“Small business owners remain cynical (and negative) about future business conditions”
-NFIB Chief Economist Bill Dunkelberg, 2/14/23

We featured the graphic below in last quarters Macro Themes deck. It doesn’t capture all the nuance at play but it satisfies with respect to embodying the core conundrum. The labor imbalance-inflation angst remains a lead protagonist in driving macro-policy narrative. And the cameos in the high-frequency macro soap opera occur daily.    

Market Edges: #Patience - CoD1 RoCs   Hard Places

CHART OF THE WEEK

The RoC Report | Consumer Squeeze (Update)

Below is a premium note written by U.S. Macro analyst Christian Drake to Hedgeye Risk Manager subscribers last week:

It remains all RoC ATHs and Cost-of-Living Hard Places as credit card balance growth accelerated in the latest 4Q22 data released this morning. 

If you harbor a closet phobia of visuals depicting large growth numbers or angstful hues of red … the chart below shows growth in the balance of credit card debt accelerating to multi-decade highs while the cost of that debt similarly summits fresh multi-decade RoC highs …. while the savings rate plumbs multi-decade lows and the consecutive monthly streak of negative real income growth hit 22-months in the latest January data.  

Surrendering to the sirenic soft-landing call is compelling for the unaware but the macro mosaic wrt the underlying dynamics of the consumption economy is now littered with different variants of the chart below.   

Again,  Macro resilience on display domestically? Yes.  Progressive hollowing out under that surface strength?  Also Yes. 

…. Just a quick update on a ‘chart favorite’ from the 4Q22/1Q23 themes deck.

Market Edges: #Patience - credit

SECTOR SPOTLIGHT

1Q 2023 Industrials Themes Mid-Quarter Update | Bear Despair Or Hope Springs Eternal?

Our Industrials team (led by Jay Van Sciver) is hosting their 1Q23 Industrials Themes & our earnings season takeaways this Thursday, February 23rd @ 2PM EST.

While many investors seemed to celebrate not-so-bad 4Q22 earnings reports for the sector, estimates for the out year continue to ratchet lower. 

Market Edges: #Patience - 1 21923

The ‘higher for longer’ dynamic is, for the most part, short-term positive for cyclical relative outperformance. On a market relative performance basis, cyclicals follow Fed tightening up and follow Fed easing back down.

Market Edges: #Patience - 2 21923

Each part of the cycle has its own character, with this one driven by heightened geopolitical tensions (long Defense names), the consequences of supply chain shortages (extended order backlogs), and anticipated effects of the Inflation Reduction Act. 

We continue to expect higher interest rates for equipment financing, lower asset/used values, and declining order backlogs to define the coming quarter or two of 2023.  While that outlook generally would reward more defensive positioning, that view has not worked in profitless growth names year-to-date.  We’ll look at how we plan to adapt to the evolving macro-market investment environment, update out takeaways on earning reports, and identify what we expect to be the key catalysts for the group into 1Q23 reports. 

Market Edges: #Patience - 3 21923

WHAT THE MEDIA MISSED

Josh Steiner on 2-Year Treasury, Delinquencies & Housing

Below is an excerpt from a recent edition of "The Call @ Hedgeye" featuring commentary from Macro and Financials analyst Josh Steiner. In this video, Josh dissects the rapid run-up in the 2-year Treasury, Capital One/Synchrony/JPMorgan data, and the implications for Housing buried inside the Mortgage Purchase App data series. (Watch here.)

Video Highlights:

  • Housing (MBA): Seen move in activity up off the base level; in the MBA Mortgage Purchase App Series we are in a sideways pattern of a new level of activity at 180
  • Capital One/Synchrony/JPMorgan: After reporting results Josh Steiner breaks down the implications for credit card delinquencies
  • Macro (2yr): After yesterday’s CPI print there was a significant move higher in 2yr Treasury yields; within 6-7 basis points of its high late last year; 90 basis points inverted on 2-10 yield curve spread

Market Edges: #Patience - js

AROUND THE WORLD

Trendspotting: The Global Succession Crisis

Below is a Demography Unplugged research note written by Demography analyst Neil Howe:

Aging business owners in Japan are struggling to find successors. While this issue may be particularly severe in the world’s oldest nation, it’s a growing problem for businesses around the globe. (The New York Times)

Neil Howe: In Japan, hundreds of thousands of business owners are on the verge of retirement. The single biggest cohort of business owners is 69-year-olds. Many of these companies have operated for decades, if not centuries, with ownership often passed down within families. Many are also vital to local industries. Yet an estimated 630K will close down by 2025 because there is no successor to take the reins.

The difficulty of finding a successor is particularly acute in Japan given that its population is rapidly aging and shrinking. Companies located in small towns and cities have a hard time attracting employees, let alone eager would-be owners. But a shortage of young people is not the only challenge. Business owners from Asia to North America to Europe are also facing a generational values shift: Millennials are increasingly opting for different careers and are not interested in taking over the family business. As a result, business owners are increasingly faced with one of two options: sell to a third party, or close. Both come at a serious cost to the economy and risk leaving consumers with fewer options and higher prices.  

The lack of a successor is a problem affecting all kinds of small and mid-sized businesses: car dealerships, insurance agencies, doctors’ offices, convenience stores, law firms. Global surveys show that most business owners are not confident about their succession plans--if they even have them at all. In a 2018 survey of 276K Japanese companies, 66% of them said that they had no successor to take over the business.

Those who had chosen a successor most commonly said that a family member would be taking over (36%), but this share has been steadily declining. Conversely, the share changing ownership via internal promotions, outside hires, or other reasons like a company merger has been climbing.

Similarly, in a 2019 survey by Step Research that polled business owners from 33 countries, 70% said that they did not have a succession plan. Only 37% said there was a high likelihood that their next CEO would be a family member. In some countries, especially Japan and other East Asian nations, the problem is numbers-driven. There are simply fewer young adults who are viable successors. But an even bigger issue across the board is lack of interest. Surveys of family businesses in China have shown that around 6 in 10 children of business owners are not interested in succeeding their parents.

Running a company requires long hours, hard decisions, and lots of stress. Millennials are seeking more work-life balance and don’t want to sell their souls to their jobs. (See “Goodbye, Dr. Welby.”) And those who do become entrepreneurs tend to want to pursue their own dreams, which are often in newer fields like IT and are located in cities. Many family businesses are in old-economy industries in smaller towns. Even larger, well-established firms are struggling to raise kids in the business tradition. Because they focus on giving their children the best education, they often end up raising super-credentialed doctors or lawyers (who want to work in big firms) rather than experienced leaders who "know the ropes" of managing an entire company.

Surveys show that young business owners are less emotionally attached to their work than older owners. In the Step Research survey, Silent and Boomer CEOs were more likely than Gen-X and Millennial CEOs to believe that their next leader will come from their family. Most Millennial CEOs also said they plan to retire before age 60, while most Boomer CEOs plan to work past 70.

If no one steps up, these businesses will close when the current leadership retires. One might wonder: Is this necessarily a bad thing? Maybe this means that the next generation is more economically mobile. Or perhaps more efficient businesses will replace them.

But successful family businesses play a vital role in the market economy. They keep the big chains honest and ensure competitive vitality across hundreds of industries. Long-established small businesses also demonstrate a persistent productivity advantage over large businesses, in part because generational continuity allows them to plan over the long term more effectively. What’s more, they serve a civic function. Not only do small business owners spend money locally, they are more likely to be engaged members of their communities.

The other option--selling to a third party--generates instant cash but also longer-term economic costs. Private-equity firms that are better known for multibillion-dollar deals, including the Carlyle Group (CG) and Bain Capital (BCSF), are increasingly turning their attention to rolling up small businesses in specific industries. (Recent acquisitions include a bean sprout company and a family-run restaurant chain.) These deals often come at the expense of the consumer welfare and productivity growth, since they are often followed by higher prices, poorer service, and ramped-up market concentration. (See “Shhh! The Markets Are Concentrating.”)

Another tailwind behind PE buyouts is that the fact that they allow companies to avoid hefty tax bills. According to a 2019 government report, more than 84% of mid-sized firms in South Korea don’t intend on passing the business to the next generation, largely because the country has one of the highest inheritance taxes in the world (up to 50%). The tax is levied on the total value of the estate, but of course much of that wealth is tied up in the company and is not actually accessible as cash, so families are often left scrambling to pay for it. In 2021, South Korea's inheritance tax made headlines when the children of late Samsung chairman Lee Kun-hee were hit with a $10.7B bill. 

Looking ahead, is there any chance that this situation could ease? IMO, yes. We may find more late-wave Millennials embracing the idea of becoming successors for two reasons. A growing share of young people are close to their families, and many are discovering how difficult it is to outearn their parents. Closer bonds combined with economic precarity makes the family business look like a safe harbor.