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.