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Credit Risk, Jobs and Deflation

Client Talking Points

CREDIT RISK RISING

Moody’s noted that the speculative grade default rate increased 40 basis points to 2.5% in Q3. While the 4.8% default rate of speculative grade energy sector bonds is the highest since 1999, the more damning takeaways of the broader corporate credit cycle are twofold:  1) defaults in the year-to-date are up 1,800% YoY (38 vs. 2) and the energy sector accounted for ONLY 37% of the 2015’s defaulted issues. In the context of our #SuperLateCycle call, we continue to anticipate a structural widening of credit spreads – as we have each interval since calling the bottom 3Q14.

JOBS

Looking ahead to Friday, we don’t pretend to have a convicted point estimate on the monthly NFP figure.  While the net gain in OCT could be better or worse sequentially, the Trend remains one of conspicuous deceleration. Indeed, with 3M Ave < 6M Ave < 2015 Ave < 2014 Ave, net monthly payroll gains have been slowing all year. And from a 2nd derivative perspective, payroll growth should continue to slow off the FEB peak of +2.34% YoY  – note: NFP in Oct would have to be +745K to re-breach that FEB RoC peak to the upside.  Moreover, given the outsized gains at the end of last year, payroll comparisons are the toughest they’ve been in 5-years into year-end.  Be patient; let the late-cycle breathe.   

DEFLATION’S DOMINOES

Chevron followed other majors BP, Shell, Total to round out last week in reporting steep YoY earnings declines for Q3 against difficult comparisons (summer 2014 triple digit crude prices). Like the others, Chevron is reducing headcount and capital spending out to 2018. Lower for longer in growth, inflation and subsequent prices is turning out to be more than a short, bad dream for those leveraged to commodity prices.    

 

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Asset Allocation

CASH 61% US EQUITIES 6%
INTL EQUITIES 0% COMMODITIES 0%
FIXED INCOME 33% INTL CURRENCIES 0%

Top Long Ideas

Company Ticker Sector Duration
MCD

Last week was a big week for McDonald’s (MCD), as they reached the inflection point we were predicting. Post earnings, the next catalyst for the stock is going to be the November 10th analyst meeting.

 

The meeting will be an opportunity for management to shed more light on the progress of all day breakfast, additional G&A cuts and the potential of doing a REIT. Our Restaurants team remains bullish on the name, and they look forward to giving you some material updates after the meeting.

RH

Restoration Hardware (RH) shares gained 5.8% this past week. The margin story here is explosive. Margins were sitting below 10% on Friday, and we think they will be above 16% in 3 years. The key reason is that expense leverage on these new properties is like nothing we’ve ever seen (i.e. RH pays only 10% more for square footage that’s 300% larger).

 

In addition, the company does not have to proportionately grow its sourcing organization with the growth in its store base OR its category expansion.

 

Our estimate is that the company will add $3 billion in sales over 3-years and climb to $11 in EPS. The earnings growth and cash flow characteristics to get to that kind of number would support a 30+ multiple. In the end, we’re getting to a stock in excess of $300.

TLT

Our forecasts for domestic economic growth continue to be more accurate than the consensus. We anticipate economic growth will get a lot worse from here. That is why you want to own long-term bonds (TLT, EDV).

  • Real GDP growth slowed to 1.5% on a quarter-over-quarter seasonally adjusted basis. That was actually right at the top end of our range going into it (remember that the mainstream Q/Q annualized number is unpredictable)
  • On the Y/Y numbers, growth decelerated for a 2nd straight quarter to 2.0% from +2.7%
  • Consumption growth was a huge contributor to the number vs. the manufacturing side of the economy which continues to slow. However, take a look at the important chart below. We’re already past peak consumption growth. Consumption growth was positive on an absolute basis but remained rate of change negative with Q3 representing the 2nd quarter of deceleration off of the Q1 2015 peak
  • Both residential and nonresidential Investment decelerated sequentially and inventories contributed almost -1.5% bps to the headline number
  • Personal Income decelerated to +0.1% for Sep vs. +0.3% in August. The expectation was for a +0.2% print
  • Personal spending decelerated to +0.1% from +0.4%. The expectation was also for +0.2% print.
  • Core PCE printed flat at +1.3% Y/Y for Sep. vs. Aug. on a Y/Y basis. That number missed expectations for a +1.4% print

Three for the Road

TWEET OF THE DAY

Recession Coming? McCullough and Hilsenrath Square Off https://app.hedgeye.com/insights/47282-recession-coming-mccullough-and-hilsenrath-square-off-on-fox-business… @KeithMcCullough @FoxBusiness

@Hedgeye

QUOTE OF THE DAY

Life is about making an impact, not making an income.

Kevin Kruse

STAT OF THE DAY

In 1991, Sennheiser unveiled the Orpheus HE90, a combination headphone amplifier and pair of headphones meant for the most rabid audiophiles. Only 300 sets were made and they sold for $16,000 each, currently an Orpheus HE90 could cost you around $50,000.


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CHART OF THE DAY: We're Heading Into the Eye of the #LateCycle Storm

Editor's Note: Below is an excerpt and chart from today's Early Look written by Hedgeye CEO Keith McCullough. Click here to subscribe.

 

CHART OF THE DAY: We're Heading Into the Eye of the #LateCycle Storm - 11.03.15 EL chart1

 

... While the “mid-cycle” theory has been dead wrong, I’ve been hearing about wages and jobs “accelerating” for 6 months… but, as you can see in today’s Chart of The Day, we’re heading right into the eye of the storm (toughest compares) of this slowing US Labor Cycle.


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The Wreck of November

“The legend lives on from the Chippewa on down
Of the big lake they call Gitche Gumee
The lake, it is said, never gives up her dead
When the skies of November turn gloomy”

-Gordon Lightfoot

 

While I hope none of you are ever subject to listening to me sing, “The Wreck of the Edmund Fitzgerald” by Gordon Lightfoot is a tune I’ll often hum, especially when I’m getting bearish.

 

It’s a local (and mortal) hymn for those of us who grew up on the big lake they call Gitche Gumme (Lake Superior). The skies of US economic data haven’t turned this gloomy since early 2007. So I’m really humming this morning.

 

And, as a friendly reminder to those of you who didn’t know, I also got fired for being “too bearish” on November 2nd, 2007. By the end of that month, the almighty SP500 was down over 6%, on the way to an almost 60% peak-to-trough crash.

 

Back to the Global Macro Grind

 

I’m not making the 2008 call we made. I’m reiterating the 2015 one we’ve been making. While time flies and Wall Street’s memory about cycles slowing are short, they always seem to miss that each cycle slow-down isn’t the last one they missed.  

The Wreck of November - macro consensus train

 

Never ever forget that it’s cycles (not central market planners) that make the world go-round. They are natural. They base (2009), recover (2010), stall (2011-12), accelerate (2013-14). They peak (2015). They get long in the tooth (Late Cycle 1H 2015). Then they slow (2H 2015).

 

That’s probably why the Atlanta Fed’s “GDP Now” cut its GDP forecast from 2.5% to 1.9% last night. Yesterday morning’s ISM reading for the US was a 50.1 for OCT. In rate of change terms, that’s -7.8% year-over-year (the slowest of the year) as we head into the gales of November.

 

But, but… the “jobs number could be good”, right?

 

Right. Right. While the “mid-cycle” theory has been dead wrong, I’ve been hearing about wages and jobs “accelerating” for 6 months… but, as you can see in today’s Chart of The Day, we’re heading right into the eye of the storm (toughest compares) of this slowing US Labor Cycle.

 

“So”, if the non-farm payroll number is 194,000 or 206,000, the Fed should “hike” into a slow-down, right?

 

Wrong.

 

Forget for a second what happens on Friday if the more probable scenario at this stage of the cycle plays out (that we get another slowing labor report), if the Federal Reserve raises rates into this gale I think they could easily be the catalyst for the next US stock market wreck.

 

“The ship was the pride of the American side
Coming back from some mill in Wisconsin
As the big freighters go, it was bigger than most
With a crew and good captain well seasoned
Concluding some terms with a couple of steel firms
When they left fully loaded for Cleveland
Then later that night when the ship's bell rang
Could it be the north wind they'd been feelin'?”

 

Yes, I get it. US investors have great pride in the American side. But the wreck of expectations happens when everything you’ve been feelin’ since the US economic data really started to slow in July hasn’t gone away.

 

With both the Europeans (ECB) and Chinese “easing” at the end of October, there’s been plenty of monetary tightening on those positions levered to both A) inflation expectations (Commodities, Levered Energy Companies, Russia, etc.) and B) US Dollar denominated debt.

 

Raising rates “just because it feels like it’s time” into a slowdown could easily rip the US Dollar Index through 100.0. And if you’re mathematically aware of how that “flows” through to SP500 Earnings, you’ll note that’ll sink 1H 2016 revenues/earnings, big time.

 

On that score, as of last night’s close, 360 of 500 companies in the SP500 have reported the following:

 

  1. Revenues down -5.1%
  2. Earnings down -4.2%

 

It took me about 3 seconds to review what 2015 US stock market bull predicted that:

 

  1. GDP growth would get cut in half in 2015
  2. And Earnings would be down 4-5%

 

That’s because none of them did.

 

So have some patience with the bear case (like we did in July). Wall Street knows a #LateCycle slowdown morphing into a recession when it sees it. Give it time. And, in the meantime, I’ll keep humming:

 

The wind in the wires made a tattle-tale sound

When the wave broke over the railing

And every man knew, as the captain did too

Twas the witch of November come stealin’

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.98-2.21%

SPX 2025-2117
RUT 1135--1189
VIX 13.54-19.30
USD 95.99-98.41
EUR/USD 1.08-1.11

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

The Wreck of November - 11.03.15 EL chart1


The Macro Show Replay | November 3, 2015

 


SJM 3Q 2015 CONFERENCE CALL NOTES

MGMT COMMENTS

  • GGR -37.9% YoY in Q3, -39.6% for the first nine months 
  • Adj EBITDA, -49.5% YoY in Q3 - HK$884M
  • Adj EBITDA margin = 7.8% in Q3, down from 9.6% in Q3 2014
  • GGR Share 22%
  • Grand Lisboa
    • GGR = -48.5% YoY, HK$3,450
    • Adj EBITDA -49.2% YoY, HK$507M
  • Challenging factors still persist, hurting opportunity for profitability 
  • Market may be stabilizing but they are not forecasting an upturn just yet
  • Still remain optimistic on the long term prospects of Macau 
  • EBIITDA margin squeezed due to labor costs and lower volumes
  • Corporate overhead hurt their satelite casinos EBITDA margins, and additionally cash rebates hurt EBITDA margins  
  • VIP remains unstable, currently have 454 VIP tables vs. 557 at beginning of the year 
  • VIP Tables at Grand Lisboa - 152 currently vs 177 at beginning of the year 
  • First Q in SJM's history where Mass revenue exceeded VIP revenue 
  • Occ up to 85% in the Q, visitation slightly up at most properties. 
  • Visitation at Grand Lisboa +7% in the Q, trends in October have been promising  
  • Cost savings associated with labor remains very difficult to attain in Macau 
  • Lisboa Palace on schedule for 2017 and in line with budget expectations 
  • CapEX HK$1.8 billion YTD, big CapEx year will be 2016 at roughly HK$17 billion 

Q&A 

  • Grand Lisboa VIP revenue -58% YoY 
  • Grand Lisboa Mass QoQ = -8%, YoY -21%
  • Cost cutting efforts slowly begin to show some positive signs, but they have just been implemented so it will take time. Expect more cost savings to kick in the future. 
  • On the revenue side, it is difficult to guide because of the new supply that is coming on line
  • Premium mass is growing, targeting a mid tier premium customer and opening a new premium mass pit in early 2016 
  • Total VIP Hold rate = 3.4% for the Q, normalized roughly 2.9% 
  • Financing for Lisboa Palace, expect to have more details in the future on bank financing
  • Reasons for EBITDA decline despite stable revenues - mostly due to older properties and satelite casinos. Older properties cost of revenue is higher 
  • Junket color - difficult environment and tough to predict 
  • Do satelite casinos have chance to survive? Yes, customers are sticky at those properties, they will survive 
  • MSC - no comments on cannibilization but consider it a nice property
  • Not aware of any changes in transit visa policies
  • Comp room ratio, roughly 70% of the rooms go to casino players
  • No update on Macau Theme Park land 
  • VIP Hold Rate at Grand Lisboa Q3 2014 2.88%, Q3 2015 3.24%
  • Hold rates at all casinos were not the reason for weaker EBITDA margins, cash rebates were likely the driver of that. 
  • Confident in their abilities to remain competitive despite the new supply that has come online in Macau

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