Takeaway: In the note below, we respond to two very important questions in the context of our dour outlook for global growth.
Q: PMI’s in both Europe and China don’t seem to be trending as bad as in the U.S. In fact Europe seems to be growing and China stabilized. As such, why is the call for them to get worse from here if some leading indicators are better and they’ve been cutting [rates] already?
Due to a variety of fiscal and monetary policy support measures, economic growth in China has indeed stabilized – for now at least. We discuss these dynamics in great detail on slides 38-57 of our 9/15 presentation titled, “Our Latest Thoughts On C-H-I-N-A”.
We do not, however, think it would be wise for investors to bet on a material acceleration from here – especially considering that Chinese growth continues to slow on a trending basis across a variety of key metrics, specifically: industrial production, exports, composite PMI, consumer confidence, business confidence and PPI.
We think the structural headwinds to Chinese fixed asset investment growth and household consumption are incredibly dour and wildly misunderstood by consensus. Refer to slides 7-19 of the aforementioned presentation for more details.
Looking to Europe, we continue to cite steepening base effects as the primary driver of our dour outlook for European economic growth. All else being equal, difficult GDP compares in 1H16 represent a meaningful headwind to the trend in various European high-frequency growth data. The Eurozone and U.K. are not unlike the U.S. in this regard.
In terms of cratering a narrative around the aforementioned mathematical reality of steepening base effects in the Eurozone, industrial production, exports, consumer confidence, business confidence and PPI are all slowing on both a sequential and trending basis throughout the region. Its composite PMI is still slowing on a trending basis and household consumption growth is trending at an unsustainably elevated rate in the context of our outlook for ECB monetary policy and it’s likely [negative] impact on the EUR.
In terms of cratering a narrative around the aforementioned mathematical reality of steepening base effects in the U.K., global headwinds have caused U.K. export growth to slow on both a sequential and trending basis, which is negatively impacting business confidence (also slowing on both a sequential and trending basis) and perpetuating a negative inflection in industrial production growth per the most recent data. Additionally, consumer confidence is slowing on both a sequential and trending basis, which may cause the unsustainably elevated trend in household consumption growth to subsequently inflect. The trend of deceleration in the U.K. composite PMI would seem to imply as much.
Q: Why do you not seem to heavily weight PMI’s [in your growth forecasts]? These seem to have a pretty good record as predictive indicators [of growth], at least for industrial stocks.
We tend to weight any given high-frequency indicator on a country-by-country basis relative to that sector’s contribution to the economy. For example, our expectations for U.S. economic growth will never deviate too far from the trend and/or our outlook for household consumption or the services sector, which account for 68.7% and 77.7% of U.S. GDP, respectively. That compares 13.4% and 20.7%, respectively, for exports and the manufacturing sector.
We run a predictive tracking algorithm that pulls a number of core indicators into our growth and inflation forecasts and analyzing them from a rate-of-change perspective allows to make forward-looking inferences that many investors tend to rely on mere conjecture for.
With respect to PMIs specifically, we do place a decent amount of weight on them as a directional indicator of domestic economic growth. For reasons alluded to above, the ISM GDP-Weighted Composite PMI series has a tighter correlation to YoY U.S. real GDP growth than the ISM Manufacturing PMI series. Both indicators carry the same weight in terms of being a directional indicator for QoQ SAAR real GDP growth.
That PMI readings continue to slow on a trending basis across both the domestic manufacturing and services sectors should lend a significant degree of pause to any bullish narrative surrounding domestic economic growth. We continue be among the most accurate firms (if not the most accurate) on the Street with respect to forecasting both trends and inflections in U.S. and global GDP growth and our forecasts for both remain well below consensus with respect to the intermediate-term.
All told, we continue to view the “global growth has bottomed” claim as reckless at best and we detail precisely why that is the case in our 11/5 note titled, “Global Growth Has Not Bottomed”.
Best of luck out there,
Takeaway: Increasing awareness of the overhang of used equipment is a big deal for Caterpillar Financial. We are very excited to hear how Caterpillar explains away falling collateral values in key equipment categories at its November 17th Caterpillar Financial investor meeting.
Feeling Used? CAT Black Book (latest of many)
Officially Denied: We are excited to see what CAT comes up with on Caterpillar Financial in the November 17th investor meeting. We think that segment is a bigger risk than investors appreciate, and our Black Book above illustrates why.
Press Coverage: While we have been tracking building used equipment pressure in resources-related capital equipment for quite some time, we saw news coverage for the first time today from an auction in Australia.
Why This Matters: Caterpillar Financial relies on used equipment as collateral for its lending activities. While the article focuses on mobile mining equipment, we expect the issues to impact a broader array of categories. Gensets look likely to become problematic, for instance. We do not expect this to go away, and it should eventually result in a painful 2016 at Caterpillar Financial. Investors typically hate problems at captive finance subsidiaries.
Feel free to ping us back for additional background.
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In Greek mythology, Icarus, on wings made of feathers and wax, defies his father's warning and flies too close to the sun. The wax in his wings melts and Icarus falls to his death. In other words, hubris was Icarus' downfall.
Uber-combative hedge fund investor Bill Ackman has been similarly burned. Not by the sun, but by Valeant Pharmaceuticals (VRX). Since Ackman's Pershing Square Capital disclosed it's stake in VRX shares are down almost 60%.
It’s shaping up to be a good week for our Gaming, Lodging and Leisure team. Our analysts went long after calling the bottom in Macau casino stocks back in September. Last week, they called the top. Stocks have fallen as much as 10% today.
In a note to institutional clients back in September, Gaming analysts Todd Jordan and Felix Wang wrote that the outlook for casino operators in Macau was looking up. Stocks like Wynn Resorts (WYNN), Melco Crown (MPEL), Las Vegas Sands (LVS), MGM Resorts (MGM), and Galaxy Entertainment had been hammered by a preponderance of bad “junket” news. Our Gaming team correctly noted that the casino operators would soon be lapping last year's easy comps for its “mass” business."
The first week in October was aided by a better than expected "Golden Week." But the rest of the month didn't come in nearly as strong. and our team thinks November will be back to what the longstanding trend. More to be revealed.
*From 9/30 until closing out their long call on 11/4 the stocks noted above were up between 27% and 40%.
That rosy outlook reversed last week.
In their report, titled “October Not So Golden,” Jordan and Wang wrote “We’ve had a long Macau call on since late September but we fear the end of that trade is near.” After a good run, it was “a good time to book profits.”
They got the timing right. Among their chief concerns was gross gaming revenue (GGR) that would revert to the norm, i.e. bad news for gaming revenues. Wall Street remained bullish. But the data confirmed their thinking. Today alone, the casino operators are down between 2% and 10%.
Where do we go from here? Well, the outlook isn’t good.
“We think November has started with a dud and fear is GGR could disappoint over the near-term. Moreover, our 2016 estimates remain well below the Street.”
Below is a key slide from Jordan and Wang's presentation to institutional subscribers last week laying out their thesis.
(If you'd like to read our Gaming team's comprehensive research on Macau please ping firstname.lastname@example.org.)
Below is a brief excerpt from The Macro Show earlier this morning. In it, Hedgeye CEO Keith McCullough explains a key risk embedded in financial markets today following Friday’s jobs report, and what to expect if the Fed raises rates:
“Notwithstanding people’s visceral reaction to last week’s "Waldo" jobs number, the Federal Reserve’s potential to make a policy mistake, which is that it raises interest rates into worldwide deflation and growth slowing, is a big risk.
In particular, I am concerned that our forecast for GDP is right and the Fed’s forecast is wrong. Their forecast is that the jobs market is rainbows and puppy dogs and that GDP is going to be 3% to 4%.
We have Q4 GDP between 0.4% and 1.7% so anything in between is way slower than what the Fed thought. God help them if its 0.4%, on the lower end of the range, and they’re raising rates into that.
What does that mean for investors?
McCullough says that should the Fed tighten into a slowdown that would "blow up oil, China, Emerging Markets and anything tied to the aforementioned.”
In other words ... watch out.
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