On Fox Business' Mornings with Maria, Hedgeye CEO Keith McCullough discussed the recent reverberations rocking junk bonds and why the Fed is "culpable" for investors chasing high yield. The outlook, according to McCullough, doesn't look much better from here.
On The Macro Show this morning, Hedgeye CEO Keith McCullough observed that during last week's market rout — the S&P was down -3.8% — volume spiked as equity markets continued to make lower highs. That's a tenuous setup, at best, for equity market perma-bulls as we head into 2016:
"There was a very obvious breakout in volatility on Friday as deflation risk continues to manifest itself in the face of growth slowing.
Interestingly, but not surprisingly, volume spiked on Friday. I’ve been waiting for a big flush, down move because we’ve only had three big up moves in the past 26 days of trading. In fact, there have been just eight up days in the last 26. Those up days came after terrorist events and with relatively low volume.
What this visual tells you [see chart below] is that volatility was up 19% versus the 1-month average. So here was the huge spike in volume on the down move.
In other news, small caps continue to be an absolutely atrocious thing to hold long. The Russell was down 5.1% last week and is down 7% year-to-date. That’s not a good year. So don’t believe anybody that is looking for a Santa Claus rally because the S&P 500, for December, is not saying ‘Ho Ho Ho.’ It's down 3.5% for the month to date.
Now, talking about sectors, Consumer Staples is the only one that looks good from a trade and trend perspective. Meanwhile, just one of the many, many, many signals that confirms growth is slowing, consumer discretionary broke down pretty hard last week, alongside the financials. For any of your friends who were long financials in advance of a Fed rate hike, Merry Christmas. The sector is down 5.2% for the year to date.
And yet there are still people out there looking for Santa Claus and PMIs to bottom. This will be fun to watch. For anyone on top of economic reality, you know you don’t have to just sit back and buy stocks into year end. There are plenty of better ways to spend your holiday."
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Takeaway: Addition of a Flash Sale may cause some near-term noise. But revenue drivers are in place as we turn the calendar forward to 2016.
KATE ran a one day Flash Sale over the weekend offering up to 75% off items. It's not a huge change in promotional posture -- the company ran a Theme Sale Gifts $99 and Under last year, and a Flash Sale at this same time in 2013. But it tells us a few things…
1) KATE has been in 'Flash Sale pruning mode' now for the better part of 1-year. At the end of 3Q the company had run 5 Flash Sales vs. 8 in 2014. Quarter to date the count is now up to 3 vs. 2 in 4Q14, and 3 in 4Q13. To date the company has stuck to plan in an effort to promote quality of sale events, but it makes us wonder if KATE management is staring at the 28% comp it put up in 4Q14 and promoting to drive the top line.
2) Flash Sales for KATE are gross margin accretive. That's counterintuitive, we know, but because the products are specially made for this channel it's actually a positive gross margin event, assuming of course that there isn't a whole lot of full price merchandise being discounted in order to clear up the balance sheet, which we don’t think is the case.
3) We think that KATE has done an exceptional job year to date cleaning up its distribution and sales posture in both the company owned and wholesale channel. The company is starting to lap those changes now, and 2016 should see a similar amount of events when compared to 2015, i.e. no more top line headwind. That coupled with the two handfuls of licenses launched in 2015/launching in 2016 and International distribution/JV agreements equals a lot of tailwinds in 2016.
4) If there is any red flag for us from the addition of this Flash Sale it is the quarter to date e-commerce trends. Last year the company put up a mid-40's e-comm comp (assuming a 20% e-comm weighting). We saw the YY change in Traffic Rank, which takes into account page visits per user and unique visits vs. the internet in aggregate, inflect negative in late November. There are still plenty of drivers on the comp side (especially with the addition of the Juicy outlet door conversions which are worth a couple hundred bps to comp) that we are not overly concerned with the quarter that will close at the end of December.
Takeaway: The credit markets are getting very shaky as evidenced by high yield and leveraged loans while EM and commodities continue to get torched.
Our risk monitor is now tilted toward the negative across all 3 durations.
High yield backed up another 63 bps to 8.57% last week. Leveraged loans, meanwhile, shed 19 points to 1807 (-1.1%) and are down 30 points on the month (-1.7%). In spite of the emergent carnage in the high yield and leveraged loan markets, the Fed is poised to move forward this week with its first rate hike in almost a decade.
The confluence of a stronger US dollar and both a supply glut and demand uncertainty have crushed oil and the commodities complex generalyl. CRB shed another 3.3% on the week and is down 5.4% on the month. Chinese steel, our proxy for the health of China, is down 2.3% on the week and 9.0% on the month. Beyond this, the TED spread widened by +4 bps on the week to 28 bps.
We've been discussing the risk posed by energy hedges rolling off in the coming weeks. Here's an interesting Reuters article discussing the coming hedge expirations with none other than John Arnold himself being quoted saying (Article HERE):
"Come Jan. 1, revenues will experience a pronounced decline for many companies, coinciding with a time of severe stress for balance sheets across the industry." - John Arnold, Founder Centaurus Partners
Our Canadian bank short thesis should benefit from this coming expiration. Our favorite small cap plays remain CWB (Canadian Western Bank) and MIC (Genworth MI). Our preferred large cap plays remain Royal Bank (RY) and CIBC (CM).
Our heatmap below is more negative than positive across all time horizons.
Financial Risk Monitor Summary
• Short-term(WoW): Negative / 1 of 12 improved / 7 out of 12 worsened / 4 of 12 unchanged
• Intermediate-term(WoW): Negative / 3 of 12 improved / 8 out of 12 worsened / 1 of 12 unchanged
• Long-term(WoW): Negative / 1 of 12 improved / 3 out of 12 worsened / 8 of 12 unchanged
1. U.S. Financial CDS – Swaps widened for 14 out of 27 domestic financial institutions. The median spread increased by +4bps from 74 to 78 as investors worried about the effects of a Fed rate hike. Notably, Genworth saw its CDS blow out by +87 bps to 712 bps.
Tightened the most WoW: MMC, LNC, AIG
Widened the most WoW: GNW, CB, WFC
Tightened the most WoW: LNC, ACE, MMC
Widened the most MoM: CB, GNW, JPM
2. European Financial CDS – Swaps mostly widened among European banks last week as global markets were roiled over a likely U.S. Fed rate hike and oil prices falling to new lows.
3. Asian Financial CDS – Swaps on Asia banks mostly widened amid global market volatility. The Export-Import Bank of China's CDS widened the most, by +13 bps to 121, followed by the IDB bank of India, which widened by +10 bps to 210.
4. Sovereign CDS – Sovereign swaps were little changed last week. The real takeaway here is the contrast between DM and EM sovereign swaps. Compare the table below with the same table for EM further down.
5. Emerging Market Sovereign CDS – Emerging market swaps widened across the board last week from the negative effects of rising dollar / rising U.S. interest rates and falling oil. Indonesian sovereign swaps widened the most, by +35 bps to 263, followed by Brazilian and Russian swaps, which widened by +34 bps to 479 and +27 bps to 307 bps.
6. High Yield (YTM) Monitor – High Yield rates rose 63 bps last week, ending the week at 8.57% versus 7.95% the prior week.
7. Leveraged Loan Index Monitor – The Leveraged Loan Index fell 19.0 points last week, ending at 1807.
8. TED Spread Monitor – The TED spread rose 4 basis points last week, ending the week at 28 bps this week versus last week’s print of 25 bps.
9. CRB Commodity Price Index – The CRB index fell -3.3%, ending the week at 175 versus 181 the prior week. As compared with the prior month, commodity prices have decreased -5.4%. We generally regard changes in commodity prices on the margin as having meaningful consumption implications.
10. Euribor-OIS Spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States. Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal. By contrast, the Euribor rate is the rate offered for unsecured interbank lending. Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread was unchanged at 11 bps.
11. Chinese Interbank Rate (Shifon Index) – The Shifon Index was unchanged over last week, ending the week at 1.79%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.
12. Chinese Steel – Steel prices in China fell 2.3% last week, or 46 yuan/ton, to 1917 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity and, by extension, the health of the Chinese economy.
13. 2-10 Spread – Last week the 2-10 spread tightened to 125 bps, -8 bps tighter than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.
Joshua Steiner, CFA
Jonathan Casteleyn, CFA, CMT
CALL TO ACTION
A much needed shot in the arm, Macau table revenues jumped sequentially last week, causing us to raise our December forecast. However, while any improvement is welcome, let’s put things into perspective. It’s only one data point, table revenues still fell double digits YoY, and the comparison was easier than week 1. Looking ahead, more government constraints may be on the way in the form of real-time Union Pay monitoring and sell side estimates are already not bearish enough for 2016. While maintaining our negative view of the Macau stocks, we didn’t feel that December GGR was necessarily a negative catalyst and we still feel that way. We do, however, remain on the bearish side and are looking for re-entry points on the short side.
See our detailed note: CLICK HERE
Client Talking Points
The Euro finally backs off -0.3% to $1.09 and European Equities are catching a bid on that. Don’t forget that the FTSE and EuroStoxx600 were down -4.6% and -4.0% last week vs. the S&P 500 -3.8% week-over-week.
After crashing another -11.6% to -41.1% year-to-date last week, Oil starts the week down -0.5%. Down Euro = Up Dollar, don’t forget – and if you think ECB President Mario Draghi is going to take the Euro back to $1.05 + Fed hikes, it’s #Deflation, in Dollars.
The S&P 500 has been down 18 of the last 26 trading days (top 3 up days came post terrorist attacks) and volume ripped (higher) +19% vs. Total U.S. Equity Volumes 1 month average on Friday; liquidity is there, on the down moves.
*Tune into The Macro Show with Hedgeye CEO Keith McCullough at 9:00AM ET - CLICK HERE.
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Top Long Ideas
MCD remains one of our top LONG ideas in the restaurants space. All indications are that all day breakfast is working, bringing back old customers and driving growth of new customers. Customers are pairing both breakfast and lunch items together in the lunch and dinner day, part which is helping drive additional sales.
McDonald’s Canada opened its first standalone McCafe this month. The much simplified concept intends to appeal to customers by offering both speed of service and low cost. They intend to be faster than their main competitor Tim Hortons and cheaper than Starbucks, carving out their own niche in the market.
This RH quarter is going to draw a Mason Dixon line between the Bulls and the Bears. The key factors that the Bulls (including us) need to see were profoundly present – giving us confidence that revenue will double, that we’ll see a 16% operating margin, and $11 in earnings power. In addition, RH beat the quarter, delivered 33% EPS growth in what should be the slowest growth quarter of the year, and it took up 4Q revenue guidance based on what it’s seeing so far this quarter (to 20%+).
The Bears got a nice little gift in the form of weaker Gross Margins due to promotional activity, and renewed concerns about management. The reality is that this is a transformational growth story that will change on the margin more often than it doesn’t. Based on our confidence in the earnings power at play here, we’d use any weakness as an opportunity to buy.
Implicit in our long TLT/short JNK bias is an expectation for high-yield spreads to continue along their recent trend of widening throughout the YTD.
“The U.S. economy is #LateCycle and the probability of a recession commencing by mid-2016 is extremely elevated – both in absolute terms and relative to the belief held by the overwhelming majority of investors and policymakers. Moreover, the risk of a global recession is also great in this scenario.”
The economic cycle doing what it always does (i.e. decelerate into a recession before bottoming and then reaccelerating) is reason enough to be bullish on the long bond and bearish on junk bonds, which are accelerating into full-blown crisis mode (the JNK ETF declined another -2% on Friday and is down -4.1% WoW, -5.8% MoM and -12.7% YTD).
Three for the Road
TWEET OF THE DAY
Hedgeye Guest Contributor | Cliggott: 'Bad, Bad Data This Week' https://app.hedgeye.com/insights/48045-hedgeye-guest-contributor-cliggott-bad-bad-data-this-week… via @hedgeye
QUOTE OF THE DAY
A good archer is known not by his arrows but by his aim.
STAT OF THE DAY
61% of the U.S. public was middle class in 1971 now that figure has dropped to 50%.
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