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CHART OF THE DAY: The Harbinger Of Future Defaults | $JNK

 

CHART OF THE DAY: The Harbinger Of Future Defaults | $JNK - Image 1

 

Editor's Note: Below is a brief excerpt from today's Early Look written by Hedgeye Director of Research Daryl Jones. Click here to subscribe.

 

"... In the Chart of the Day, we look at the true harbinger of future defaults, which is comparing shares of company losing money versus the default rate. Going back to 1985, these two metrics have moved basically in lockstep (until recently). This is no surprise since corporate profits are what companies use to make payments on their debt. So fewer profits, lead to a lower likelihood of re-payment.

 

The combination higher of rates in the short term, declining corporate profitability, and accelerating downgrades is not a great fundamental mix heading into 2016."


Speaking Loudly

“Who you are speaks so loudly, I can’t hear a word you’re saying.”

-Ralph Waldo Emerson

 

Seven years or so ago, during the throes of the global market crisis, I sat at my desk one morning at Kudlow & Company, a cup of coffee in hand and an Early Look a friend had forwarded me on the computer screen in front of me. It was the first market missive I had ever read from this guy “McCullough.” Who the hell is Keith McCullough? Where does he get off being so damn confident? I was blown away by its candor and authenticity during such a fearful time racked with so much uncertainty. This guy had the courage of his convictions.

 

As rattled investors were racing around like chickens with their heads cut off, this guy had the audacity to write that the “Old Wall” was coming down. He told readers if they were interested in doing things a new way, a different way, to send him their résumés. Millions of Americans were losing their jobs, and this guy was hiring?

 

Ernest Hemingway had a great line about developing a ‘built-in bullshit detector.’ Over the years, I’ve met my fair share of people, especially on Wall Street, who were full of it. But this guy passed the smell test. So I sent him my résumé. After a number of professional twists and turns, I ended up getting my place on the team years later.

 

Fast forward to last night… Well over 100 people are gathered inside a former U.S. Post Office turned top-notch restaurant in Westport, Connecticut for our firm’s holiday party. In the event you’re a Hedgeye newbie, our analysts had a phenomenal year across the board. Two of our people (Healthcare Sector Head Tom Tobin and his protégé Hesham Shaaban who now spearheads our Internet & Media research) were awarded the coveted “Hedgeye Hockey Puck” award. They made some ridiculously good contrarian calls in a number of battleground stocks. Our cartoonist Bob Rich was also awarded a puck for delivering the best market-themed cartoons you’ll find anywhere.

 

Fast forward to this morning… me, Dan Holland, is writing the introduction to the Early Look. Huh?

 

In closing, (speaking of interesting twists and turns), the irony of celebrating inside a former U.S. Post Office wasn’t lost on me last night. If you went back in time and told someone waiting in line to buy stamps inside that same building 20 years ago, that a financial research firm would be celebrating a banner year in it two decades letter, well, I doubt they’d believe you.

 

I’ll hand the pen back to our Director of Research Daryl Jones now, but as we are fond of saying around here, “Risk happens slowly at first. Then all at once.” Things happen. Change is inevitable.

 

Speaking Loudly - Rate hike Grinch 12.03.2015

 

Back to the Global Macro Grind

 

Speaking of risk, a mounting issue looming over the fixed income markets is defaults. According to the Financial Times this morning, more than $1 trillion in corporate debt has been downgraded since the start of the year. In addition, S&P has more than 300 companies on review for downgrades. This should be no surprise since the number of global companies defaulting this year has eclipsed 102, the highest level since 2009.

 

In the Chart of the Day, we look at the true harbinger of future defaults, which is comparing shares of company losing money versus the default rate. Going back to 1985, these two metrics have moved basically in lockstep (until recently). This is no surprise since corporate profits are what companies use to make payments on their debt. So fewer profits, lead to a lower likelihood of re-payment.

 

The combination higher of rates in the short term, declining corporate profitability, and accelerating downgrades is not a great fundamental mix heading into 2016. While this tightening of credit is marginal, the game of global macro continues to be played in the changes on the margin. Collectively, this combination reinforces are cautious long-term view on the junk bond market. It is called junk for a reason and, frankly, who wants to own junk at the end of a cycle.

 

In the shorter term, an asset class we think may be due for a bounce is oil.   This morning the news is that oil tanker rates are at near a 7-year high. The primary driver of this spike in tanker rates is not demand, per se, but lack of storage.The lack of storage obviously speaks to the oversupply that has driven, in combination with the strong dollar, the sustained decline in oil prices this year. 

 

But like most things, what is in the headlines is not always the most appropriate way to place your fundamentals. In particular with oil, in the short term the market is heavily tilted to the short side. As our Commodity Analyst Ben Ryan wrote yesterday:

  1. Going into today, commodities have been crushed, yet protection is most expensive NOW (OVX back over 50). The market is heavily short commodities.
  2. Volatility expectations for this year’s OPEC meeting (starting today) are grossly higher than last year – protection is near its most expensive point since summer of 2014.  As a rule, tighter stops on lower volatility expectations causes more volatility.   
  3. The Commitment of Trader’s Report from the CFTC suggests the market was heavily short commodities and long dollars into this week. That doesn't get unwound in one day. A catalyst to take commodities lower from here is hard to find with renewed rate hike expectations. 

 

Suffice it to say, it’s not going to take much a positive catalyst to create one mother of a short squeeze in the energy sector.

 

Keep your head up and sticks on the ice,

 

Daryl G. Jones

Director of Research

 

Speaking Loudly - Image 1


December 4, 2015

Hedgeye's Daily Trading Ranges are twenty immediate-term (TRADE) buy and sell levels, with our intermediate-term (TREND) view and the previous day's closing price for each name.  Click HERE for a video from Hedgeye CEO Keith McCullough on how to use these risk ranges.

 

  • Bullish Trend
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INDEX BUY TRADE SELL TRADE PREV. CLOSE
UST10Y
10-Year U.S. Treasury Yield
2.38 2.08 2.33
SPX
S&P 500
2,046 2,109 2,049
RUT
Russell 2000
1,163 1,209 1,170
COMPQ
NASDAQ Composite
5,055 5,159 5,073
NIKK
Nikkei 225 Index
19,608 20,091 19,939
DAX
German DAX Composite
10,409 11,548 10,789
VIX
Volatility Index
14.39 18.45 18.11
DXY
U.S. Dollar Index
96.52 101.02 97.63
EURUSD
Euro
1.05 1.07 1.06
USDJPY
Japanese Yen
122.36 123.86 122.53
WTIC
Light Crude Oil Spot Price
40.02 43.01 41.27
NATGAS
Natural Gas Spot Price
2.14 2.31 2.19
GOLD
Gold Spot Price
1,044 1,082 1,061
COPPER
Copper Spot Price
1.98 2.09 2.06
AAPL
Apple Inc.
115 119 115
AMZN
Amazon.com Inc.
645 684 666
PCLN
Priceline.com Inc.
1,221 1,305 1,280
VRX
Valeant Pharmaceuticals International, Inc.
75.86 100.11 93.66
MCD
McDonald's Corp.
112 116 113
P
Pandora Media, Inc.
12.16 14.85 12.63

 

 


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The Macro Show Replay | December 3, 2015

 


OPEC & EXPECTATIONS

Takeaway: OPEC cut or not, the risk is to the upside

Before reading our expectation on the likely course of action from OPEC (we expect no action), the next few charts should be more concerning for USD Longs/commodity shorts than OPEC jawboning pre-meeting:

  1. In the first chart below, going into today, commodities have been crushed, yet protection is most expensive NOW (OVX back over 50). The market is heavily short commodities
  2. Volatility expectations for this year’s meeting are grossly higher than last year – protection is near its most expensive point since summer of 2014 (tighter stops on lower volatility expectations causes more volatility (last year’s 10%+ down day post OPEC meeting)
  3. The Commitment of Trader’s Report from the CFTC suggests the market was heavily short commodities and long dollars into this week. That doesn't get unwound in one day. A catalyst to take commodities lower from here is hard to find with renewed rate hike expectations. 

OPEC & EXPECTATIONS - Commodity positioning

 

OPEC & EXPECTATIONS - Implied vol in WTI

 

OPEC & EXPECTATIONS - Dec Fed Funds

 

We’re seeing the risk to one-way consensus positioning front and center, as outlined in a note earlier today titled Is This the Beginning of the Great Unwind of USD Consensus Longs?

This story looks a lot like the end of August pre- Jackson Hole and rate “lift-off” expectations. You could see more of what you’re seeing today on a bad jobs report tomorrow, and this move would be exacerbated if the Fed decides to push a rate cut.  

----------

Last year at this time the world was contemplating whether or not OPEC would conspire together in an attempt to move global energy markets. We wrote about the unlikeliness of that happening (OPEC CUT? NOPE. ) The point of the note was to dispel the relevance of OPEC quotas. It’s worth a read as a primer.

A cut was expected by many at $73 on WTI. Now, at $41, the expectation is that OPEC quotas will remain the same at 30MM B/D. For the significance of quota levels, see the chart below which shows that:

  • Out of the 48 months over the last four years that OPEC quotas have been set at 30MM B/D, OPEC collectively has produced under that quota in just 4 months (8.3% of the time)
  • Since the beginning of 2014, production has averaged more than 1MM B/D above the collective OPEC quota level
  • Any reason for production below quota levels has not been voluntary. At the end of 2013, a civil uprising reminiscent of the Libyan Revolution in 2011 was successful in reducing Libyan production by over 1MM B/D in several months (That accounted for two of the months below official OPEC quotas)
  • Of the 9 of 12 OPEC producers in the global production table below, only 2 of them has reduced production Y/Y
  • Of the 4 largest producers in OPEC, production is up double digits in all but Saudi Arabia where production is still up significantly. That’s a market share story:
    • Saudi Arabia: +8%% Y/Y
    • Iraq: +27% Y/Y
    • U.A.E.: +10% Y/Y
    • IRAN: +14% Y/Y

 

OPEC & EXPECTATIONS - Quota to Production Price Differential

 

OPEC & EXPECTATIONS - Global Crude Production Monitor

 

If Saudi Arabia had any plans to cut production they probably wouldn’t be racing to cut official selling prices to Asia into 2016. On a spread to the Oman/Dubai benchmark, Saudi Aramco undercut that spread in both light and heavy crude for January:

 

OPEC & EXPECTATIONS - Saudi Aramco OSP

 

Keeping a grip on dwindling market share is the goal. In a commodity-producing business, a low-cost producer (Saudi Arabia) with the most reserves is not incentivized to cut production. OPEC’s global market share is about 36% currently, but they hold 60-70% of the world’s proven reserves.  

Like last year, Russia has already said it has no interest in complying with collective production cuts or even attending the meeting.   

Most of OPEC’s spare capacity is with Saudi Arabia. The way they see it, they are doing their job. Given any need to accommodate Iran post sanctions, it would be hard to envision lower targeted quotas unless it was purely a smoke and mirrors exercise to boost prices in the short-term. As outlined in last year’s note, OPEC ANNOUNCEMENTS have an ability to move spot prices for about 15-20 days, but there is no evidence that production levels are at all influenced.

 

OPEC & EXPECTATIONS - OPEC vs. Saudi Spare Capacity

 

OPEC & EXPECTATIONS - Saudi Spare Capacity

 

OPEC & EXPECTATIONS - OPEC Market Share

 

We think the argument the Saudi Arabia would cut production despite the fact that they are a low cost producer with endless reserves (and all of the spare capacity in OPEC) is just newsiness. FX Reserves are only down 12% from an August 2014 high, which is hardly a dent with oil prices declining 56% over that same time period. Prices could remain low for years, and they’d be in good shape.

 

OPEC & EXPECTATIONS - Saudi Arabia FX Reserves

 

Deflation has taken a hold of the market for the last 18 months, and the catalyst to reverse deflation’s dominoes will be behaviorally and policy-driven. Look for a real catalyst with tomorrow’s jobs report. A bad one could perpetuate the currency move seen today.

 

As always we welcome any comments or questions.

 

Ben Ryan

Analyst  


Cartoon of the Day: Look Out Whoville!

Cartoon of the Day: Look Out Whoville! - Rate hike Grinch 12.03.2015

 

"... Yellen was grasping for #LateCycle employment reasons to raise rates," Hedgeye CEO Keith McCullough wrote in today's Early Look. "Never mind the data – she really wants to hike."


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