"Not Loving It" | Why Tepper is Right

"[I’m] not loving it …I have problems with earnings growth [and] problems with multiples, …So I can't really call myself a bull "

- David Tepper, 9/10/15

 

Earlier today David Tepper made headlines (HERE) in advocating for higher cash allocations and defensive positioning amidst increasingly challenged fundamentals, concerns over current multiples and pervasive over-optimism around forward growth prospects.   

 

Having authored the 2015 Global #GrowthSlowing thesis, we’d agree. 

 

Tepper’s fundamental and valuation concerns are really just manifestations of our current late-cycle reality.  Given that his comments were largely a re-capitulation of our call from July and our 2Q15 Macro theme #LateCycleUSA (Here), today offers an opportune time to update the charts and re-highlight a selection of canonical late-cycle metrics. 

 

Below is a visual tour of the data.  The larger fundamental takeaway is not different than the one we’ve been voicing YTD.  Slower for longer remains the call, lower gross and net equity exposure continues to make sense and dynamically trading the risk of the immediate-term range remains the best means of tactically risk managing late-cycle market volatility.   

 

"Not Loving It" | Why Tepper is Right - Century of Cycles

   

 

Labor: Best Before the Crest | The employment data always looks best before the crest and the current labor cycle is certainly cresting.  As we highlighted in our review of initial jobless claims this morning we are now 19-months into the sub-330K environment  (ave over the last 3 cycles = 33months) and within ~a month the year-over-year rate of change will be ~0% as we beginning lapping the floor in the claims data. 

 

With the convergence to zero complete, any trending positive growth in claims activity will offer a low-intensity means of monitoring deterioration in the labor market.   There is still some modest runway for ongoing labor strength but the clock tick is getting louder.   

 

"Not Loving It" | Why Tepper is Right - Updated LT Recession Chart

 

Valuation:  Stocks Still Hoping It’s the 1990’s | The simple fact that we’re not at peak tech-bubble valuation is not particularly sweet solace.   

 

Below is an updated look at our valuation composite which represents an equal weighted composite of three of the most widely used conventional valuation metrics: Shiller PE, SPX Market Cap-to-GDP and Tobin’s Q.  

  • Shiller PE:  Inclusive of the hundred’s of billions of market cap lost in the recent correction, the Shiller PE remains above 24x and sits just south of the top decile of its historical range.  Mapping the Shiller PE by decile vs subsequent market performance suggests return expectations should move systematically lower alongside incremental increases in valuation. Historically, 1Y and 3Y returns progressively decline for each decile change in the Shiller PE.
  • Tobin’s Q:  Longer-term valuation arguments center on the premise that returns on capital should equalize to cost of capital and market values should normalize to economic value.  Tobin’s Q ratio is not a measure we use to tactically manage risk, but we can appreciate the intuition underneath its application – why buy an asset when you can “re-create” it for less and compete away existing, excess profit.   Currently, the q-ratio sits at ~1.06 and greater than 1.0 standard deviation above the long-term mean value – a level that has generally not been a harbinger of positive forward returns historically.
  • S&P 500 Market Cap-to-GDP:  Assuming the collective output of SPX constituents credibly reflects aggregate national production (or serves as a credible proxy for it), the Market Capitalization-to-GDP ratio effectively represents a price-to-sales multiple for the economy.  At current levels we are well above both the LT average and the 2007 highs.  

"Not Loving It" | Why Tepper is Right - Valuation Composite

 

 

PEAK PROFITABILITY: Earnings, Corporate Margins and collective SPX profitability all peak late-cycle and all three appear to be moving past peak in recent quarters.  Unless you think peak returns to capital provide a sustainable path to aggregate demand growth in the face of negative trend growth in real earnings, trough returns to labor, middling productivity growth and secularly depressed investment spending, then the mean reversion risk for operating margins remains asymmetrically to the downside. 

  • 2Q15:  With 2Q earning largely rearview for SPX constituents, the final score shows revenues and earnings down -3.5% and -2.2% year-over-year, respectively.  Yes, the commodity rout was an outsized impact to energy/industrial’s profitability and that collapse becomes next year’s comp but still, negative top & bottom line growth is not the stuff escape velocity, private-sector handoffs are made of or multi-year tightening cycles anchored on.   

"Not Loving It" | Why Tepper is Right - SPX Real Earnings

 

"Not Loving It" | Why Tepper is Right - SPX Operating Margin

 

"Not Loving It" | Why Tepper is Right - Corporate Profits    of GDP

 

Policy = Lost in Transmission |  The Phillips Curve and output-inflation cycle on which conventional monetary policy is based looks broken.  Meanwhile, the empirics on Janet’s hope for policy flow through to Main Street remain dismal.  Labor’s Share of National Income only rises at the tail end of an expansion and after growth and profits have been strong for a protracted period. The cratering in the latest cycle looks like some measure of a structural break and even if we follow the pattern of gains in the late innings of expansion it won’t close the gap.  Lower highs & lower lows remains the trend.  

 

"Not Loving It" | Why Tepper is Right - Labor share of income

 

Slower for Longer:  Underneath the current business cycle oscillation remain the secular realities of over-indebtedness and negative demographics.  The combination of voluntary and involuntary deleveraging in the post-crisis period has improved the aggregate household balance sheet, but certainly not enough to jumpstart another credit cycle or drive sustained debt supported consumption growth.  And while the Millennials sit as an emergent demographic force, the core consumption demographic of 35-34 year-olds will remain in retreat for the balance of the decade – across all the major DM economies.   

 

"Not Loving It" | Why Tepper is Right - HH Debt to GDP

 

"Not Loving It" | Why Tepper is Right - Demographics CC

 

 

Christian B. Drake

@HedgeyeUSA

 


Cartoon of the Day: Acrophobia

"Most people who are making a ton of money right now are focused on growth companies seeing accelerations," Hedgeye CEO Keith McCullough wrote in today's Early Look. "That’s what happens in Quad 1."

read more

People's Bank of China Spins China’s Bad-Loan Data

PBoC Deputy Governor Yi says China's non-performing loan problem has “pretty much stabilized." "Yi is spinning. China’s bad-debt problem remains serious," write Benn Steil and Emma Smith, Council on Foreign Relations.

read more

UnderArmour: 'I Am Much More Bearish Than I Was 3 Hours Ago'

“The consumer has a short memory.” Yes, Plank actually said this," writes Hedgeye Retail analyst Brian McGough. "Last time I heard such arrogance was Ron Johnson."

read more

Buffalo Wild Wings: Complacency & Lack of Leadership (by Howard Penney)

"Buffalo Wild Wings has been plagued by complacency and a continued lack of adequate leadership," writes Hedgeye Restaurants analyst Howard Penney.

read more

Todd Jordan on Las Vegas Sands Earnings

"The quarter actually beat lowered expectations. Overall, the mass segment performed well although base mass lagging is a concern," writes Hedgeye Gaming, Lodging & Leisure analyst Todd Jordan on Las Vegas Sands.

read more

An Update on Defense Spending by Lt. Gen Emo Gardner

"Congress' FY17 omnibus appropriation will fully fund the Pentagon's original budget request plus $15B of its $30B supplemental request," writes Hedgeye Potomac Defense Policy analyst Lt. Gen Emerson "Emo" Gardner USMC Ret.

read more

Got Process? Zero Hedge Sells Fear, Not Truth

Fear sells. Always has. Look no further than Zero Hedge.

read more

REPLAY: Review of $EXAS Earnings Call (A Hedgeye Best Idea Long)

Our Healthcare Team made a monster call to be long EXAS - hear their updated thoughts.

read more

Capital Brief: 5 Things to Watch Right Now In Washington

Here's a quick look at some key issues investors should keep an eye on from Hedgeye's JT Taylor and our team of Washington Policy analysts in D.C.

read more

Premium insight

[UNLOCKED] Today's Daily Trading Ranges

“If I could only have one thing of the many things we have it would be my daily ranges." Hedgeye CEO Keith McCullough said recently.

read more

We'll Say It Again: Leave Your Politics Out of Your Portfolio

If your politics dictates your portfolio positioning, the Democrats and #NeverTrump crowd out there have had a hell of a week.

read more

Cartoon of the Day: 'Biggest Tax Cut Ever'

President Donald Trump's economic team unveiled what he called last week, "the biggest tax cut we’ve ever had.” Before you get too excited about that hang on a sec. "Trump Tax Reform ain’t gettin’ done anytime soon," Hedgeye CEO Keith McCullough wrote in today's Early Look.

read more