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Macro Playbook Update: Don’t Mind the Data

Key Takeaway: While easy to lose track of trends across domestic macroeconomic data during earnings season, one thing’s for sure and two things are for certain: U.S. economic growth continues to slow and the economic expansion itself is now well past-peak. The risk to “risk asset” prices embedded in 2016E nominal GDP and earnings growth forecasts remains great. 

 

It’s earnings season and we know you’re busy, but that doesn’t mean macro catalysts cease to exist. That being said, it’s neat when the top-down and bottom-up signals are implying the same conclusion: the domestic economy is mired in industrial and earnings recessions.

 

A quick update on the latter recession:

 

  • Though Q3 earnings season to-date, 387 of 500 S&P 500 companies have reported.
  • Sales growth decelerated to -5.3% YoY from -3.4% YoY in Q2.
  • EPS growth decelerated to -4.3% YoY from -1.9% YoY in Q2.

 

A quick update on the former recession:

 

  • We received three key data points regarding the broad health of the domestic manufacturing and production economy over the past three trading days: OCT Markit Manufacturing PMI, OCT ISM Manufacturing PMI and OCT Factory Orders. No, we do not consider the ISM Milwaukee PMI, MNI Chicago PMI or ISM New York PMI as indicative of the health of the broader economy. Each represents little more than opportunities to cherry pick data to form-fit an existing narrative and we do not believe in cherry picking data.
  • The former key data point (Markit Manufacturing PMI) registered a sequential acceleration in OCT and is now accelerating ever-so-slightly on a trending basis.
  • The latter two key data points (ISM Manufacturing PMI and Factory Orders) registered sequential decelerations in OCT and SEP, respectively, and both continue to decelerate on a trending basis.

 

Macro Playbook Update: Don’t Mind the Data - MARKIT MANUFACTURING PMI

 

Macro Playbook Update: Don’t Mind the Data - ISM MANUFACTURING PMI

 

Macro Playbook Update: Don’t Mind the Data - FACTORY ORDERS

 

Aside from the fact that Real GDP growth slowed on queue against steepening base effects in Q3, the [other] critical risk to broader economic growth remains the likelihood that the aforementioned recessions spillover into an eventual consumer-led downturn. That would be in line with how a typical business cycle works:

 

  1. Inflation peaks, then slows;
  2. CapEx and Manufacturing growth peaks, then slows;
  3. Employment and Wage growth peaks, then slows; and finally
  4. Consumption and Services growth peaks, then slows.

 

Given that those catalysts have all played out in order since the start of 2014, we retain confidence in reiterating our view that domestic economic growth is likely to slow into a full-blown recession by mid-2016. For those of you who remain skeptical of this view, we encourage you to review the following presentations – each refreshed as of today:

 

  1. U.S. GIP Model Summary (45 slides): http://docs3.hedgeye.com/macroria/Hedgeye_U.S._GIP_Model_Summary.pdf
  2. U.S. Economic Cycle Indicators (10 slides): http://docs3.hedgeye.com/macroria/Hedgeye_U.S._Economic_Cycle_Indicators.pdf
  3. Global Demographic Analysis (17 slides): http://docs3.hedgeye.com/macroria/Hedgeye_Global_Demographic_Analysis.pdf

 

Going back to the most recently reported data, a quick update on the fourth business cycle catalyst highlighted above:

 

  • In the past three trading days we received three key data points regarding the broad health of the domestic consumption economy: SEP Real PCE, OCT University of Michigan Consumer Sentiment and OCT Passenger Vehicle Sales.
  • The former key data point (Real PCE) recorded a modest sequential acceleration in SEP to its trend line (i.e. 3MMA), but the aforementioned trend has now decidedly stagnated.
  • Consumer Sentiment recorded a decent sequential acceleration in OCT, but is still decelerating on a trending basis; meanwhile, Passenger Vehicle Sales growth continued its trend of acceleration with a sequential uptick in OCT.

 

Macro Playbook Update: Don’t Mind the Data - REAL PCE

 

Macro Playbook Update: Don’t Mind the Data - CONSUMER CONFIDENCE

 

Macro Playbook Update: Don’t Mind the Data - LIGHT VEHICLE SALES

 

The key takeaway here is that broad consumption growth remains overwhelmingly positive from an absolute perspective (e.g. the current 3MMA of Real PCE growth is in the 91st percentile of all readings on a trailing 10Y basis). Given that Real PCE represents over two-thirds of U.S. GDP, the real risk to the economy is that the consumer slows alongside the trend in employment growth. Friday’s OCT Jobs Report will be telling in that regard.

 

Also telling is the fact that growth in the 77.7% of the U.S. economy that falls within the Services Sector has negatively inflected and is now driving broader measures of economic momentum lower as of OCT:

 

Macro Playbook Update: Don’t Mind the Data - MARKIT SERVICES PMI

 

Macro Playbook Update: Don’t Mind the Data - MARKIT COMPOSITE PMI

 

Macro Playbook Update: Don’t Mind the Data - GDP vs. Composite PMI Value

Source: Bloomberg L.P.

 

Macro Playbook Update: Don’t Mind the Data - GDP vs. Composite PMI RoC

Source: Bloomberg L.P.

 

One key risk to our bearish call on the economic cycle is that credit remains a-plentiful and keeps consumption growth elevated as it traverses a series of difficult growth compares through 2Q16. If, however, the Fed’s 4Q15 Senior Loan Officer Survey results are telling, credit too is now moving past-peak with respect to this economic expansion:

 

 

Sticking with the theme of threes, the critical risk to domestic “risk asset” prices are threefold as well:

 

  1. Bad news becomes bad news again (as implied by the now-positive 1M correlation between the S&P 500 and the Implied Yield on the Fed Funds Futures Contract 1Y Out) – just as it had been during the previous two economic downturns;
  2. Equity sentiment is likely now pervasively bullish, insomuch as it had been pervasively bearish at the AUG/SEP lows (we currently have data though 10/27; on Friday we will receive data through today's close); and
  3. At this new “all-time high” (for all intents and purposes), market breadth continues to confirm the now-obvious degradation of recent micro trends, as well as the dour nature of our macro outlook.

 

Macro Playbook Update: Don’t Mind the Data - 1Y Out Fed Funds Future Implied Yield vs. S P 500

 

Macro Playbook Update: Don’t Mind the Data - SPX 2000 02

Source: Bloomberg L.P.

 

Macro Playbook Update: Don’t Mind the Data - SPX 2007 09

Source: Bloomberg L.P.

 

Current Hedgeye Extreme Sentiment Monitor:

Macro Playbook Update: Don’t Mind the Data - EXTREME SENTIMENT MONITOR

 

End-of-September ESM Refresh:

Macro Playbook Update: Don’t Mind the Data - EXTREME SENTIMENT MONITOR 10 6 15

 

Macro Playbook Update: Don’t Mind the Data - BMBI Current

 

Macro Playbook Update: Don’t Mind the Data - BMBI Draw down Chart

 

All told, while easy to lose track of trends across domestic macroeconomic data during earnings season, one thing’s for sure and two things are for certain: U.S. economic growth continues to slow and the economic expansion itself is now well past-peak. The risk to “risk asset” prices embedded in 2016E nominal GDP and earnings growth forecasts remains great:

 

Macro Playbook Update: Don’t Mind the Data - U.S. Economic Summary

 

Furthermore, another round of Deflation’s Dominoes remains a critical risk to manage over the NTM: “Are You Prepared for a Deepening of the Global Earnings and Industrial Recessions?” (10/22)

 

When will asset markets start to broadly discount investor consensus being wrong on the domestic economic cycle again? We don’t know. The best thing we can do in the interim is continue to remain grounded in the data.

 

Enjoy your respective evenings,

 

DD

 

Darius Dale

Director


Cartoon of the Day: Watch Your Step!

Cartoon of the Day: Watch Your Step! - Earnings cartoon 11.03.2015

Below is an excerpt from today's Early Look by Hedgeye CEO Keith McCullough:

 

...[A]s a friendly reminder to those of you who didn’t know, I 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.

 

...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% 

Encore! Another World Class Short Call Brought to You By Hedgeye | $ECPG

Our Financials team led by Josh Steiner and Jonathan Casteleyn nailed the Short Call on Encore Capital Group (ECPG). Shares are down 12.5% amid speculation that the debt financing company will face increasing FTC scrutiny. They added ECPG to their Best Ideas Short list on 11/19/2014. Since then shares are down 19%. 

 

Encore! Another World Class Short Call Brought to You By Hedgeye | $ECPG - 11 3 2015 ECPG chart

 

In their ECPG Black Book, they cite “regulatory risk,” among others factors, as catalysts that could send the stock lower. See the slide from their Black Book below.

 

Encore! Another World Class Short Call Brought to You By Hedgeye | $ECPG - 11 3 2015 encore

 

In September, the Consumer Financial Protection Bureau forced Encore to pay up to $42 million in consumer refunds, a $10 million penalty and stop collection on over $125 million worth of debts. In a press release the CFPB noted that Encore:

 

“… bought debts that were potentially inaccurate, lacking documentation, or unenforceable. Without verifying the debt, the companies collected payments by pressuring consumers with false statements and churning out lawsuits using robo-signed court documents.”

 

As today’s selloff clearly illustrates, investors think the regulatory woes are only going get worse before they get any better. In a press release, the FTC said it would be announcing “a major law enforcement initiative involving the debt collection industry.”

 

Encore! Another World Class Short Call Brought to You By Hedgeye | $ECPG - 11 3 2015 ECPG

 

***An FTC press conference is scheduled for tomorrow at 12:30 so stay tuned for an update. In the meantime, read Steiner and Castelyn’s Black Book on ECPG by pinging sales@hedgeye.com

 

 

 


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McCullough: ‘This Epicenter of Risk Has Not Gone Away’

 

During this brief excerpt from RTA Live today, Hedgeye CEO Keith McCullough discusses the “certified disaster” that is junk bonds and what may lie ahead in the months to come.

 

Subscribe to Real-Time Alerts today for access to this and all other episodes. 

 

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A Cautionary Tale: Energy Analyst Kevin Kaiser's MLP Warning and 8 Short Calls

Takeaway: What a difference a year or two makes.

Last week, the Associated Press ran a feature story chronicling recent woes of small investors burned by the implosion of master limited partnerships (MLPs). As the AP reported, brokers steered “Mom and Pops” to MLPs promising them “fat payouts.” As many of you already know, this story doesn’t end well.

 

While the AP misses the mark on many MLP nuances, it does get a few things right. In particular, that these energy partnerships “borrowed heavily” and were “running big risks even when oil was twice as high.”

 

For the record, Hedgeye Energy analyst Kevin Kaiser was among the first (and certainly most vocal) analysts warning about the dangers of MLPs. His non-consensus research has been unrelenting in questioning the dubious accounting practices of many MLPs. He held his ground and stuck with his conclusions, even in the face of the overwhelming majority of Wall Street analysts – on both the buy and sell sides – who didn’t even bother to dig for facts, but assiduously retold managements’ version of the numbers.

 

A Cautionary Tale: Energy Analyst Kevin Kaiser's MLP Warning and 8 Short Calls - z mlp

 

In a research note, written in May 2014 well before the MLP blowup, Kaiser recalled laying out his short case during a meeting with seasoned money managers who knew little about MLPs beyond their tax-exempt status and high current yields:

 

“I traveled to Omaha, Nebraska two weeks ago to pitch the bear case on Master Limited Partnerships to a group of value investors.  Buffett couldn’t fit me into his schedule, but I was lucky enough to meet with seasoned money managers cut from the same cloth… So I walked through a few of the more surreptitious aspects of the [MLP] story: the enormous “incentive” fees that many MLPs pay to their General Partners; the conflicts of interest and limited fiduciary duties; the gimmicky accounting; the serial capital raising; and the valuations.”  

 

Another excerpt:

 

“It’s been said that there are no new eras, only new errors – most things in finance are cyclical.  We look at the fees that some of the largest MLPs are paying to their GPs today and wonder if this time will be different.  How long can a business that pays two-thirds of its income to its manager survive?”

 

Click here to read Kaiser’s entire note on MLPs.

 

At one point during his presentation, an audience member chimed in, “The whole thing seems like a big Ponzi scheme to me.” Kaiser didn’t disagree, simply replying that his compliance officer preferred that he not use that language.

 

Take a look below at Kaiser’s short calls on MLPs (and the company's performance versus the Alerian MLP index):

 

A Cautionary Tale: Energy Analyst Kevin Kaiser's MLP Warning and 8 Short Calls - 11 3 2015 kaiser MLPs

*Data through 11/02/2015. Price only, does not account for distributions.

 

Clearly, being long MLPs has been a costly bet for investors. According to the AP’s story, in the past year, investors have lost $20 billion in publicly-traded drilling partnerships, or $8 of every $10 they had invested. It gets worse. Add in the bonds sold by these partnerships to investors since 2010 and the losses total $57 billion.

 

YTD PERFORMANCE UNEQUIVOCALLY RED FOR MLPS

 

A Cautionary Tale: Energy Analyst Kevin Kaiser's MLP Warning and 8 Short Calls - 11 3 2015 MLP down 

 

Sadly, many of these misinformed investors will never recoup those losses before retirement.

 

For the record, when Kaiser was warning investors and making these calls, many people were defending MLPs in earnest. One in particular was Kaiser’s short call on Linn Energy (LINE) which may ring a bell for anyone who has been following this unfolding train wreck.

 

Kaiser’s well-reasoned short case on LINE drew a lot of attention, especially from CNBC’s equity market mouthpiece Jim Cramer and hedge fund manager Leon Cooperman, a Linn shareholder who came to the stock’s defense in a letter published in Barron’s.

 

There was also Business Insider, which as you can see in this article here, clearly missed the mark, siding with Cramer and LINE bulls. Incidentally, we were actually forced to write a piece defending our firm after Jim Cramer accused us of orchestrating a bear raid on the company.  

 

*Sigh*

 

What a difference a year or two makes.

 

Take another look at the table above. The relevant tickers for Linn are LINE and LNCO. You can make up your own mind about who got the call right.

 

A Cautionary Tale: Energy Analyst Kevin Kaiser's MLP Warning and 8 Short Calls - 11 2 2015 LINN dump

 

* * *

Editor’s Note: Kaiser’s most recent short call is Genesis Energy (GEL). A full listing of Kaiser’s energy research is available upon request.  If you’d like to learn more about how you can subscribe to his research as well as our other institutional research, please email sales@hedgeye.com.


4Q15 SENIOR LOAN OFFICER SURVEY | SIGNS OF A SLOWDOWN

Takeaway: The Fed's Senior Loan Officer Survey is a useful tool for gauging where we are in the credit cycle and it just inflected negatively.

C&I and CRE Results Turn Negative

The Fed released its 4Q15 Senior Loan Officer Survey yesterday afternoon. The survey was conducted between September 29 and October 13 and covers lending standards and loan demand across business and consumer loan categories.

 

The survey results turned negative for both C&I and CRE lending. Residential mortgage lending standards were mixed. Consumer lending showed the most positive results; a net positive percentage of banks continued to report easing consumer lending standards, and demand for those loans increased.

  

Here are the two main takeaways this quarter:

 

1. The net % of banks tightening C&I lending standards turned positive in 4Q15. Just to be clear, this is a bad thing. 7.3% of banks, net, tightened C&I credit standards for large and medium firms in 4Q15. This is only the second time since the last recession that a net positive percentage of banks tightened standards; the last time banks tightened was 1Q12, when 5.4% tightened C&I standards for large and medium sized firms. Moreover, 1.4% of banks, net, tightened C&I credit standards for small firms in 4Q15. As the chart below shows, tighening standards have preceeded and arguably been a proximate cause of the last two recessions. That being said, there have also been a few false positives, such as 1Q12, 1Q96 and it's debatable whether the surge in tightening that accompanied the late-1990s Asian Financial Crisis and LTCM was in fact a false positive or not.

 

At a minimum, the takeaway is fairly clear: lending standards tend to autocorrelate across the cycle and when they roll from net easing to net tightening it's something investors must take note of. 

 

4Q15 SENIOR LOAN OFFICER SURVEY | SIGNS OF A SLOWDOWN - main chart   new one

 

While somewhat obvious, it's nevertheless worth stating that this could be the inflection point signaling that Financial equity prices are at or near their peak. Unlike the prior positive tick in 1Q12, this time the economic cycle is showing many signs of being late stage.

 

The chart below looks at the historical C&I lending standards (LHS) juxtaposed against the S&P 500 Financials Index (RHS). C&I lending standards have historically begun tightening coincident with or ahead of peaks in Financial equity prices. We've highlighted in green the periods during which Financials stocks have risen. In the 1990s it was clear that lending standards were tightening by late 1999, suggesting the roll was near. In the 2003-2007 period standards began to tighten in 2007.

 

4Q15 SENIOR LOAN OFFICER SURVEY | SIGNS OF A SLOWDOWN - main chart v2 

 

2. CRE Tightening. Commercial real estate lending also saw standards tighten in the quarter. The tightening was across all three categories: C&D, Nonfarm Nonresidential and Multifamily. Unfortunately, the survey format changed with the 4Q13 survey when they replaced the single category of CRE loans with the three aforementioned subcategories. As such, it's not possible to compare apples to apples historically. That said,  in the 9 quarters since the new format began, this marks only the second (and second consecutive) quarter in which standards have tightened on C&D loans. It marks the first quarter in which Nonfarm Nonresidential loans have seen standards tighten. The Multifamly category has been bouncing between easing and tightening over the last two years so we take this quarter's net tightening with a grain of salt.

 

 

A Quick Review of the Senior Loan Officer Survey by Category:

 

C&I: The Canary In the Coal Mine

Two quarters ago, we called out C&I as a potential canary in the coal mine. That's because the net percentage of lenders tightening standards was almost back to the zero line. That percentage then eased back in 3Q15. However, 4Q15 appears to be the confirmation; the net percentage of banks tightening standards for loans to large firms moved past zero to +7.3%. Additionally, +1.4% of banks tightened standards for C&I loans to small firms. This could mark the end of the 6-year bull market for Financials equities. 

 

4Q15 SENIOR LOAN OFFICER SURVEY | SIGNS OF A SLOWDOWN - SLOOS2

 

4Q15 SENIOR LOAN OFFICER SURVEY | SIGNS OF A SLOWDOWN - SLOOS3

 

4Q15 SENIOR LOAN OFFICER SURVEY | SIGNS OF A SLOWDOWN - SLOOS4

 

CRE: Tightening Across the Board

After C&D lending saw a moderate 1.4% of lenders tightening standards in 3Q15, banks are now tightening standards for all three CRE categories in 4Q15. This inflection in CRE standards adds to our concern over the inflection in C&I standards.

 

Meanwhile, demand for all three categories of CRE loans increased in the fourth quarter.

 

4Q15 SENIOR LOAN OFFICER SURVEY | SIGNS OF A SLOWDOWN - SLOOS6

 

4Q15 SENIOR LOAN OFFICER SURVEY | SIGNS OF A SLOWDOWN - SLOOS5

 

Residential Mortgage: Mixed

Starting in 1Q15, the Federal Reserve broke the survey's residential Prime and Nontraditional categories into six new categories and kept the Subprime category for a total of seven different categories. The six new categories include: (GSE-Eligible, Government, QM non-jumbo/non-GSE eligible, QM jumbo, Non-QM jumbo, and Non-QM/non-jumbo). The categories we're most interested in are the GSE-Eligible (Fannie/Freddie) and Government categories (FHA/VA) since these two categories account for ~90% of all origination volume. The GSE-Eligible category showed 13.8% of banks, net, eased standards Q/Q in 4Q15. However, Government showed a 5.5% net tightening. 20% of banks also tightened standards for Subprime loans. Three of the other four categories eased while one was unchanged.

 

We pay little attention to the demand component of the Fed's Survey because it reflects shifting refi demand and isn't a good barometer for purchase activity. Nevertheless, we include both charts below.

 

4Q15 SENIOR LOAN OFFICER SURVEY | SIGNS OF A SLOWDOWN - SLOOS7

 

4Q15 SENIOR LOAN OFFICER SURVEY | SIGNS OF A SLOWDOWN - SLOOS8

 

Consumer Loans: Easing

Standards for credit cards, auto loans, and consumer loans ex-cards and autos all eased in the third quarter.

 

4Q15 SENIOR LOAN OFFICER SURVEY | SIGNS OF A SLOWDOWN - SLOOS9

 

4Q15 SENIOR LOAN OFFICER SURVEY | SIGNS OF A SLOWDOWN - SLOOS10

 

4Q15 SENIOR LOAN OFFICER SURVEY | SIGNS OF A SLOWDOWN - SLOOS11

 

 

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 

 

 

 


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