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Household Wealth Up, Income...Not So Much

Takeaway: Higher Highs in Household Net Wealth. Personal income and spending improved in august but growth should remain constrained near-term.

We’re not big into “maintenance” research at Hedgeye but, at the same time, contextualizing marginal macro changes (i.e. the ones that matter) requires continually grinding through the incremental big picture data points. 

 

This morning’s Consumer Spending and Income data and Tuesday’s 2Q13 Flow of Funds data from the Fed aren’t  particularly actionable from an investment perspective, but they are worth a quick highlight. 

 

Below is an updated snapshot of the U.S. Household Balance Sheet from the latest Flow of Funds report from the Federal Reserve.   The continued improvement in Household Net wealth shouldn’t come as a surprise given the lack of aggregate household credit growth and the ongoing re-flation in real estate and financial asset prices. 

 

As of the end of 2Q13, Household Net Wealth is well above the prior 2007 peak on a nominal basis, flat on an inflation adjusted basis and -3.4% vs prior highs after adjusting for both inflation and the number of households (ie. inflation adjusted net worth per household).   

 

Household real estate values, currently at $18.6T (21% of total assets), grew at a rate of +11.9% YoY and remained a primary driver of net wealth gains in 2Q13.  We continue to expect positive growth in property values, albeit a slower rate of improvement than we’ve observed over the TTM,  to support further balance sheet improvement over the intermediate and longer-term. 

 

Putting aside the disproportionate benefit and wealth equality implications stemming from financial asset price inflation, ongoing strengthening in the aggregate household balance sheet remains an obvious positive as we continue to emerge on the other side of a long-term, domestic credit cycle.    

 

Household Wealth Up, Income...Not So Much - HH BS 2Q13

 

 

Consumer Income & Spending:  Upside Still Constrained

 

Today’s preliminary estimates from the BEA showed Personal Income grew 0.4% MoM  in August while Consumer Spending advanced +0.3% alongside a tick higher in the Savings Rate to 4.6% from 4.5% in July.   

 

On the income side, personal and disposable income growth accelerated on both a MoM and YoY basis while Government sourced income (~17% of the Workforce) remained a discrete drag on DPI growth.    

 

On the spending side, consumption of Non-durables decelerated on both a MoM and YoY basis (after accelerating last month) while spending on Services and Durables both accelerated sequentially (after decelerating last month).

 

From a multi-month Trend perspective, accelerating spending on goods has helped offset a modest deceleration in consumption of services. (see table below for a detailed breakdown).   

 

Inflation remained muted with core PCE – the key measure for the Fed – mired at 1.2% growth. 

 

Summarily, Personal Income accelerated sequentially but with the savings rate rising and compensation of government employees still growing negatively (due to ongoing job loss and the negative income effects from furloughs – see Here for a fuller discussion) consumer spending growth remained middling. 

 

The confluence of smallish credit growth, a static savings rate and a fiscal policy related drag on (already muted) income growth should serve to constrain the upside in consumption growth nearer term.  

 

Enjoy the weekend.  

 

Household Wealth Up, Income...Not So Much - Income   Spending 092613 

 

Christian B. Drake

Senior Analyst


NSM: GETTING OUT OF THE WAY OF 3Q13 RESULTS & REMOVING FROM BEST IDEAS LIST

Takeaway: We are removing NSM from the Hedgeye Best Ideas list as a long.

We Think It Makes Sense to Step Aside For Now

We have been consistently bullish on Nationstar Mortgage since adding it to Hedgeye's Best Ideas list back on February 27, 2013 at a price of $38-39. The stock has had a good run since then, recently trading in the $56-57 range, but today many of the themes and catalysts we thought were misunderstood earlier in the year have either come to pass or are now far better understood and priced in. Consequently, we think most of the good news is now reflected in the valuation. Consider that in just the last few weeks there have been at least two positive initiation reports and one upgrade of the stock from the sell side. In fact, there are currently 8 buy ratings on the stock, more than at any other point in the company's history.

 

We expect there will likely be near-term positive catalysts in the form of deal announcements. Inside Mortgage Finance has written that sizeable MSR transactions are to be expected in the near-term from Wells Fargo ($40 Bn), JPMorgan ($70 Bn) and, most recently, Citi ($61 Bn). Recall that in their second quarter earnings release, Nationstar bumped up its guided pipeline for bulk deals by $100bn, or roughly in line with the sum of the reported WFC & JPM deals. Clearly, there is high probability, but also high expectations, that NSM will win a large share of those big deals. We wouldn't be surprised to see the stock rally further on such announcements. Historically, deal announcements have been a catalyst for upside as they often led to upward guidance/estimate revisions, not just for NSM but for peer companies OCN and WAC as well.

 

So, Why the Change?

We have always regarded three dynamics as paramount for NSM shares to move higher: Growing UPB, Improving Servicing Margins and Maintaining GOS. We think the company has delivered on all three fronts to date, and we are not concerned with the progress being made toward the first two dynamics. It's the third one that worries us.  

 

Our primary concern, and the reason for our change in view, is our expectation that Nationstar will struggle to beat estimates going forward due to pressure on both volume and gain-on-sale margins in the mortgage origination business. After spending considerable time working with our model, we are now currently expecting $1.14 in 3Q13 earnings, which is down from our prior expectation of $1.72 and is now below Street expectations for $1.27. Further, we have baked 15 bp sequential quarterly increases into our expectations for long term interest rates throughout 2014 and this has had a profoundly negative effect on our outlook for next year's earnings power. Based on that bump up in rate expectations, we're now expecting NSM to earn $5.37 in 2014, down from our previous expectation for $8.30-9.35. You may find yourself at odds with our assumption of rising rates throughout 2014, particularly in light of the Fed's recent pronouncements and Summers' withdrawal from consideration. Our basis rests upon the strengthening labor market data we track in the initial jobless claims series, which we think will exert growing pressure on prices and, in turn, should pressure the Fed to begin to constrict credit.

 

HARP & Non-HARP 

We've assumed that HARP volumes are relatively unaffected by the rate change. The guidance is for half of 2013's core production target of $23 billion to be HARP, or roughly $11.5 billion. In the first half of the year, we estimate the company originated $4.5 billion in HARP loans, leaving $7 billion in production for the back half of the year. We've split this evenly at $3.5 billion per quarter. However, the remaining non-HARP origination business we have haircut by 40% vs. our prior baseline forecast. Multiple datapoints support the appropriateness of such a haircut. Cardinal Financial recently pre-announced the quarter citing a 40% drop in Q/Q mortgage origination volume (both purchase & refi) coupled with material compression in gain-on-sale margins. MBA volumes 3QTD are down Q/Q by 47% for refi and purchase volumes are down 9% 3QTD vs 2Q13. Given that most of NSM's volume is refi-based, we think a 40% haircut outside of the HARP channel is reasonable. 

 

NSM: GETTING OUT OF THE WAY OF 3Q13 RESULTS & REMOVING FROM BEST IDEAS LIST - mba vols for nsm note

 

Gain-On-Sale 

We've also assumed gain-on-sale margin pressure. Here's the comment management made on the 2Q13 earnings call, hosted in early August: "With the recent rise in interest rates, we've seen some pressure on market pricing, mainly in the premiums on HARP originations." Generally speaking, HARP loans fetch a 250-500 bps GOS premium to non-HARP loans based on a December 2012 Fed study, which can be found here: Fed Study. Taking the mid-point of the 250-500 bps premium, we estimate that last quarter HARP GOS revenue accounted for roughly 60% of total GOS revenue while only accounting for 38% of volume. The average 30-Year FRM rose to 4.45% thus far in the third quarter, up from the 2Q13 average of 3.67%. That 75-80 bps Q/Q increase in rates is likely to weigh heavily on HARP premiums. Remember, HARP loans fetch a smaller premium in a rising rate environment as traditional loans become more valuable. We've nevertheless been conservative in our treatment and assumed roughly a 25 bps decline in Q/Q total GOS margins.  

 

Based on the combination of these factors, reduced volume vs. prior baseline and lower GOS margins, we've lowered our expectation for GOS revenue to $288mn in 3Q down from our prior thinking of $365mn. While management has indicated that they can and likely will bring some further efficiency to the cost side of this business, we doubt it will be enough to offset the compressed volumes and spreads especially considering the magnitude of efficiency improvement seen in 2Q13. #ToughComps

 

In short, while we think the long-term opportunity in the servicing business remains attractive, we think expectations are already high on that front without sufficient deference being paid to the pressure on the originations business. We would sell Nationstar at these levels and consider an alternative without heavy origination exposure, like Ocwen.

 

Ocwen (OCN) as an Alternative

We think it makes sense to roll out of Nationstar and into Ocwen, ticker OCN, where investors can still benefit from the secular trend in servicing but without the significant risk to the GOS business. 

 

Our expectation is that 3Q13 earnings from NSM will disappoint and likely will serve as a catalyst for a rotation out of NSM and into OCN.

 

NSM: GETTING OUT OF THE WAY OF 3Q13 RESULTS & REMOVING FROM BEST IDEAS LIST - IS

 

NSM: GETTING OUT OF THE WAY OF 3Q13 RESULTS & REMOVING FROM BEST IDEAS LIST - 2

 

NSM: GETTING OUT OF THE WAY OF 3Q13 RESULTS & REMOVING FROM BEST IDEAS LIST - 3

 

NSM: GETTING OUT OF THE WAY OF 3Q13 RESULTS & REMOVING FROM BEST IDEAS LIST - 4

 

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 


THINKING LIKE A FED HEAD

Takeaway: A strong quantitative argument can be made for the FOMC board to remain on hold throughout the balance of 2013 and throughout 2014 as well.

This note was originally published September 23, 2013 at 18:01 in Macro

THINKING LIKE A FED HEAD - bb1

SUMMARY BULLETS:

  • A strong quantitative argument can be made for the FOMC board to remain on hold throughout the balance of 2013 and throughout 2014 as well. This debate is likely to become increasingly mainstream in the coming weeks and months and will have meaningful implications for the US dollar, US interest rates and global capital and currency markets at large.
  • Investors attempting to get inside of Bernanke's head and/or view the economy as the FOMC board does should arrive at the following three conclusions based on the most recent data:
    • Reported US economic growth is sluggish at best;
    • The labor market has cooled off substantially; and
    • Benign reported inflation will give policymakers ample headroom to continue easing even if the labor market starts to accelerate meaningfully.
  • Regarding the latter point, both St. Louis Fed President James Bullard and Chicago Fed President Chuck Evans (the both of whom are voting members on the FOMC board) have been calling out low inflation as their chief economic concern in recent weeks/months.
  • Our analysis suggests the US economy may have to sustainably record Real GDP growth in the +3% to +3.6% range in order to generate the kind of job creation necessary for the Unemployment Rate to breach the Fed’s 6.5% threshold over the intermediate term (holding flat other factors like the Labor Force Participation Rate).

 

Like most market participants, we were surprised by the Fed’s decision not to taper its asset purchase program last week.

 

In our view, both the pace and slope of economic growth has been solid enough to justify commencing a process of weaning the economy and its capital markets off of  large-scale asset purchases (LSAP).

 

The critical takeaway from the aforementioned statement is not the part about the pace and slope of economic growth; rather, the key element of that declaration was indeed the phrase, “in our view”.  

 

Specifically, “our view” of the pace and slope of economic growth is wholly shaped by leading and concurrent indicators, such as market prices, survey data (such as New Orders PMI readings) and our proprietary analysis of that data (e.g. modeling market prices with Keith’s quantitative risk management levels or something like tracking the YoY % change in Rolling NSA Jobless Claims).

 

Moreover, our process is designed to front-run inflection points in the market(s) and/or policy. Thus, an overt focus on concurrent-to-leading indicators is a prerequisite for any repeatable success in doing so.  

 

The Fed, on the other hand, primarily focuses on lagging economic indicators, like Unemployment, Core PCE and Real GDP. Their primary responsibility is to set monetary policy based on actual – not guesstimated – economic conditions. Thus, an overt focus on lagging indicators is appropriate for their task as it is defined.

 

While we’d certainly prefer they apply more modern-day analytical techniques (i.e. chaos theory, behavioral economics, etc.) to their policy-setting agenda, for the purposes of keeping this note tight, we will temporarily concede to the consensus view among the academic economist community that the Fed should be more measured (i.e. less dynamic) with respect to setting monetary policy.

 

All told, understanding this distinction between what market participants are focused on and what the FOMC board is focused on is critical to appropriately preparing your portfolio for the Fed’s next policy move and, more importantly, the timing therein.

 

Looking at the economy from the Fed’s perspective, it should not have come as a surprise to see them back away from tapering at last week’s FOMC meeting. If anything, their only fault was allowing tapering speculation to percolate throughout the global financial community in the first place!

 

  • In the 12M through 2Q13 (the latest reported figure), the US economy has grown only +1.6% on real basis; that rate of change represents a full standard deviation below the trailing 3Y trend.
  • In the QTD, Nonfarm Payrolls have averaged +136k MoM; that’s nearly one full standard deviation below the trailing 3Y trend (-0.9x) and down sharply from an average pace of +207.3k MoM in 1Q13.
  • In the 12M through JUL ’13 (the latest reported figure), underlying inflation – as measured by the Fed’s preferred measure of Core PCE – has tracked +1.2% YoY; that’s nearly one full standard deviation below the trailing 3Y trend (-0.9x).

 

Investors attempting to get inside of Bernanke's head and/or view the economy as the FOMC board does should arrive at the following three conclusions based on that sequence of data:

 

  1. Reported US economic growth is sluggish at best;
  2. The labor market has cooled off substantially;
  3. Benign reported inflation will give policymakers ample headroom to continue easing even if the labor market starts to accelerate meaningfully.

 

Regarding the latter point, both St. Louis Fed President James Bullard and Chicago Fed President Chuck Evans (the both of whom are voting members on the FOMC board) have been calling out low inflation as their chief economic concern in recent weeks/months.

 

THINKING LIKE A FED HEAD - dale1

 

Absent a dramatic near-term acceleration in core inflation – which is all but impossible given the neutering of consumer price indices in recent decades – the Fed is unlikely to find it appropriate to tighten monetary policy [via tapering… tapering is tightening, FYI] over the next few months.

 

Looking ahead to next year, one really has to see a dramatic acceleration of momentum in the labor market in order for the FOMC board to justify tapering LSAP – irrespective of whomever winds up in charge (no disrespect to Janet Yellen).

 

By our math which looks at the historical relationship between the deviation from trend in MoM Nonfarm Payrolls SA and deltas in the Unemployment Rate SA, the former series would have to average somewhere between +218.1k and +260k for five quarters in order for the latter series to reach the Fed’s 6.5% “target” (FYI, 6.5% is NOT a target for the initiation of tapering, as Bernanke has repeatedly stated in his recent commentary).

 

THINKING LIKE A FED HEAD - dale2

 

Regarding the study, please note that we purposefully decided to cap our study at a 10Y look-back; similar results hold over a trailing 30Y period as well, but we decided to front-run consensus pushback about how the labor market is structurally different today vs. 20Y or 30Y ago. We get it…

 

Moving along, it’s worth stressing that five quarters from now is the end of next year; not ironically, that is exactly when the FOMC board expects Unemployment Rate to hit that level.

 

Of course, maintaining the aforementioned pace of job creation for such an extended period of time would no doubt drag up the average and dampen any future deviations from trend. We understand that and would still expect to see continued improvement in the Unemployment Rate in spite of that – the purpose of this study is simply to gauge what level of economic performance we need to see in order to appropriately front-run the Fed from here.

 

Looking at the historical relationship between the deviation from trend in YoY Real GDP growth and the deviation from trend in MoM Nonfarm Payrolls SA, the former series would have to average somewhere between +3% and +3.6% produce readings in the latter series that are +1x to +2x standard deviations from the trailing 3Y trend. Using the most recent data set to reverse engineer those deviations produces the aforementioned range of +218.1k and +260k.

 

THINKING LIKE A FED HEAD - 2

 

Of course, the pace of job creation isn’t the only factor in determining deltas in the Unemployment Rate; rather, there other key indicators, such as the structurally challenged Labor Force Participation Rate, that are integral components of the calculus.

 

Still, for anyone looking to correlate economic growth to a pace of job creation that is appropriate for the FOMC board to authorize a reduction in its LSAP program, we’d advise anchoring on anything north of +3% YoY. That’s nearly a double from the latest reported rate.

 

We consider it noteworthy that the Fed’s full-year 2014 GDP growth projection is right in line with that rate, effectively confirming that their economic growth expectations are on track for a 6.5% Unemployment Rate target by EOY ’14.

 

Right now, our model can get as high as +2.7% for 2014E Real GDP growth, but that’s not an estimate we would advise lending any credence to at the current juncture. As mentioned our previous works, our predictive tracking algorithm is designed to capture deltas and inflection points on a rolling 1-2 quarter basis. It’s worth nothing that trying to predict anything much further out than that tends to negatively skew the balance between facts and assumptions in any economic model.

 

THINKING LIKE A FED HEAD - USA   ALTERNATIVE SCENARIO

 

Even if the economy can get up to and sustain a +3% rate of growth over the intermediate term, investors must continue to be cognizant of the fact that subdued core inflation will continue to keep the doves on the FOMC board uneasy about the mere thought of tapering – let alone hiking the Fed Funds Rate (which is what they likely intend to do when the Unemployment Rate reaches 6.5%, assuming both reported inflation and inflation expectations are in line with the committee’s +2% objective at that time).

 

Not surprisingly, those market participants closest to the pin-action are already starting to bake this scenario in. The implied probability of the Fed Funds Rate being 0.0% at the DEC ’14 FOMC meeting has increased from 7.7% in early SEP to 25.5% currently. Conversely, the implied probability of the Fed Funds Rate being hiked to 0.75% or 1% at the DEC ’14 meeting has dropped to 7.8% and 1.5%, respectively, from 23.2% and 10.4%, respectively, in early SEP.

 

THINKING LIKE A FED HEAD - 5

 

All told, a strong quantitative argument can be made for the FOMC board to remain on hold throughout the balance of 2013 and throughout 2014 as well. This debate is likely to become increasingly mainstream in the coming weeks and months and will have meaningful implications for the US dollar, US interest rates and global capital and currency markets at large.

 

Have a wonderful evening,

 

Darius Dale

Senior Analyst

 

THINKING LIKE A FED HEAD - 6


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CHART OF THE DAY: CHINESE #GROWTHSTABILIZING

Takeaway: On the margin, key initiatives in the Shanghai FTZ reform package are positive for China’s structural economic outlook.

TAKEAWAY: On the margin, key initiatives in the Shanghai FTZ reform package are positive for China’s structural economic outlook.

 

Today, China announced general guidelines for economic and financial market reform within the Shanghai FTZ. On balance, the outline was met with mixed-to-slightly-disappointed reviews from the analyst and financial media community.

 

While regrettably and conspicuously devoid of specific rates, quotas and other metrics that would allow analysts to quantitatively extrapolate the zone’s impact upon the broader Chinese economy, the guidelines were indeed full of key initiatives that we continue to think are positive for China’s TAIL-duration growth outlook via an infusion of capital and liquidity into the nation’s increasingly cash-strapped financial sector.

 

  • Key positives:
    • 18 service sectors will be granted access to private and foreign capital, with financial services being the most important as it relates to Chinese economic growth.
    • “On the condition of effective oversight”, China will allow Chinese banks in the zone to conduct offshore business – essentially allowing them to provide banking services to foreign depositors.
    • “China will push for a full-scale opening of the financial services sector to eligible private capital and foreign financial institutions.” Essentially, this will allow foreign-funded financial institutions to set up banks and team up with private Chinese banks to form joint ventures. Both initiatives will undoubtedly be supportive of increasing the supply of credit to China’s SMEs, which tend to be significantly more productive than their SOE counterparts.
    • Foreign-funded mutual funds will be granted access to operate in China via the Shanghai FTZ. With the securitization of financial assets also being promoted, the presence of foreign-funded mutual funds helps address the elephant in the room surrounding China’s still-developing ABS market (i.e. “who’s going to hit the bid on the bulk of China’s pending ABS sales?”), given that Chinese banks themselves will inevitably find it difficult to broadly offload assets unto one another.
    • While not specific to banking, another pro-growth reform initiative is the implementation of favorable tax policies that seek to boost investment and trade. An example of this is the Chinese government’s plan to make imported capital equipment exempt from taxes within the FTZ.
  • Key negatives:
    • Aside from the fact that it was light on specifics, the fact that the zone “aims to get up to international standards of convenient investment and trade, as well as full capital account conversion in 2-3 years” is disappointing. Why such a long delay? It’s not like this is China’s first rodeo with special economic zones (think: Deng Xiaoping’s Shenzhen success story).
    • Moreover, “creating conditions” to “test” capital account conversion, interest rate liberalization and cross-border use of the CNY is not the same as “proceeding with” any/all of those reforms right off the bat.

 

All told, while not necessarily a game-changer for the broader Chinese economy, we stand counter to the consensus interpretation that today’s announcement of the specific reforms earmarked for the Shanghai FTZ amounts to little more than a policy non-event.

 

Rather, we continue to believe Chinese officials are embarking  on a grand-strategy to [methodically] import foreign capital to offset the structural liquidity headwinds weighing on the country’s financial sector and its economic growth potential.

 

That, on the margin, is positive for China’s structural economic outlook (CLICK HERE for more details).

 

Have a great weekend,

 

Darius Dale

Senior Analyst

 

CHART OF THE DAY: CHINESE #GROWTHSTABILIZING - 1



JCP Flash Call Invite. Today at 1pm EDT.

Takeaway: Please join us for a flash call on JCP today at 1:00pm. We'll take an in-depth look at why we'd play the other side of the JCP = zero call.

Please join us for a flash call on J.C. Penney (JCP) today, September 27th at 1:00pm EDT. The call will take an in-depth look at JCP and why we would play the other side of the 'going to zero' trade.

 

 

CALL DETAILS

  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 798797#
  • Materials: CLICK HERE (slides will download one hour prior to the start of the call)

 

 

We'll Take The Other Side of The 'Going To Zero'  Trade

This is not for the faint of heart, as earnings are non-existent, there's a lame duck CEO, no square footage growth, and the average American probably could care less if JCP exists or not.  But everything has a price - even JCP. 

 

Almost All of Its Problems Are Fixable

Apparel retail might not be the best business in the world, but it is one that allows you to shake the etch-a-sketch clean every 13 weeks.  Our work shows that JCP's problems have been largely due to pricing, lack of promotions, and the omission of product that the consumer had otherwise grown to rely upon.

 

There's a Steep Gross Margin Opportunity

Johnson took away $2.5bn in revenue at a 48% GM, and substituted with less than $1bn of 33% GM product. There's over 500bp in GM recovery right there.

 

This Equity Offering Solved More Problems Than It Caused

As tight as cash seemed to be, JCP did not need this deal now. It was poorly managed/telegraphed. But the reality is that liquidity is no longer a near-term risk.  This makes the 'going to zero' call really tough to play for. It also takes risk of factoring companies limiting goods  out of the equation.  Lastly, it accelerates the quality and quantity  of CEO candidates.

 

Another Way To Play the JCP Recovery is to Short KSS

Our work suggests that KSS stole $800mm from JCP, and there's nothing permanent about that share shift. JCP is gunning for the business, and whether it succeeds or not, it will hurt KSS while it tries.

 

 

CONTACT 

Please email for further details (please note that email will be the best way contact the team).


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