“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.
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:
- Going into today, commodities have been crushed, yet protection is most expensive NOW (OVX back over 50). The market is heavily short commodities.
- 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.
- 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