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FLASHBACK: 'Central Bankers Have Lost Control, Setting Stage For Market Crash'

In this brief excerpt from last February, Hedgeye CEO Keith McCullough discusses how global central bankers have "certifiably lost control" and reveals what he’s seeing which could ignite a significant market correction. 

 

In other words, our subscribers were spared the market crash in August. And to be clear, we're not changing our tune from here. Proceed with great caution.  


ICI Fund Flow Survey | Year-End Active Shakedown

Takeaway: All active categories except muni bonds saw outflows in the 5 days ending Dec 30th while investors favored passive products and money funds.

Investment Company Institute Mutual Fund Data and ETF Money Flow:

Most active products finished 2015 with a dull thud in the 5 days ending December 30th. All categories but tax-free bonds saw outflows during the last week of the year. Domestic equity funds again bled out another $2.9 billion in the final week of the year, ending 2015 with their worst annual outflows on record, losing -$172.2 billion. This compares to the +$144 billion subscription for equity ETFs as the shift from active to passive continued last year. In fixed income, taxable bond funds lost -$6.8 billion in the last week as investors digested the new more active Fed policy. Taxable bonds in aggregate had a rare annual redemption in '15 losing $40 billion last year. Since 2007, only 2013 resulted in an annual redemption in the taxable bond category.

 

Finally, with markets shuddering, investors seeking safety shored up +$16 billion in money market funds, bringing the 4th quarter money market inflow to +$90.1 billion following the +$54.4 billion in subscriptions during the 3rd quarter. 2015 finished with the first annual money fund inflow since 2008 with an annual tally of +$26 billion in cash being moved to the sidelines. The first annual cash increase this cycle is reminiscent to the cash builds of 1999 and 2006 with investors having overallocated to risk assets and then reversing to safety. Overall there is a $1 trillion opportunity for leading cash managers to collect lost funds that have been allocated to stocks and bonds over the past 7 years.


ICI Fund Flow Survey | Year-End Active Shakedown - ICI1

 

In the most recent 5-day period ending December 30th, total equity mutual funds put up net outflows of -$6.0 billion, trailing the year-to-date weekly average outflow of -$1.5 billion and the 2014 average inflow of +$620 million. The outflow was composed of international stock fund withdrawals of -$3.1 billion and domestic stock fund withdrawals of -$2.9 billion. International equity funds have had positive flows in 41 of the last 52 weeks while domestic equity funds have had only 8 weeks of positive flows over the same time period.

 

Fixed income mutual funds put up net outflows of -$4.6 billion, trailing the year-to-date weekly average outflow of -$462 million and the 2014 average inflow of +$926 million. The outflow was composed of tax-free or municipal bond funds contributions of +$2.2 billion and taxable bond funds withdrawals of -$6.8 billion.

 

Equity ETFs had net subscriptions of +$5.5 billion, outpacing the year-to-date weekly average inflow of +$2.8 billion and the 2014 average inflow of +$3.2 billion. Fixed income ETFs had net inflows of +$1.9 billion, outpacing the year-to-date weekly average inflow of +$1.0 billion and the 2014 average inflow of +$1.0 billion.

 

Mutual fund flow data is collected weekly from the Investment Company Institute (ICI) and represents a survey of 95% of the investment management industry's mutual fund assets. Mutual fund data largely reflects the actions of retail investors. Exchange traded fund (ETF) information is extracted from Bloomberg and is matched to the same weekly reporting schedule as the ICI mutual fund data. According to industry leader Blackrock (BLK), U.S. ETF participation is 60% institutional investors and 40% retail investors.



Most Recent 12 Week Flow in Millions by Mutual Fund Product: Chart data is the most recent 12 weeks from the ICI mutual fund survey and includes the weekly average for 2014 and the weekly year-to-date average for 2015:

 

ICI Fund Flow Survey | Year-End Active Shakedown - ICI2

 

ICI Fund Flow Survey | Year-End Active Shakedown - ICI3

 

ICI Fund Flow Survey | Year-End Active Shakedown - ICI4

 

ICI Fund Flow Survey | Year-End Active Shakedown - ICI5

 

ICI Fund Flow Survey | Year-End Active Shakedown - ICI6



Cumulative Annual Flow in Millions by Mutual Fund Product: Chart data is the cumulative fund flow from the ICI mutual fund survey for each year starting with 2008.

 

ICI Fund Flow Survey | Year-End Active Shakedown - ICI12

 

ICI Fund Flow Survey | Year-End Active Shakedown - ICI13

 

ICI Fund Flow Survey | Year-End Active Shakedown - ICI14

 

ICI Fund Flow Survey | Year-End Active Shakedown - ICI15

 

ICI Fund Flow Survey | Year-End Active Shakedown - ICI16



Most Recent 12 Week Flow within Equity and Fixed Income Exchange Traded Funds: Chart data is the most recent 12 weeks from Bloomberg's ETF database (matched to the Wednesday to Wednesday reporting format of the ICI), the weekly average for 2014, and the weekly year-to-date average for 2015. In the third table are the results of the weekly flows into and out of the major market and sector SPDRs:

 

ICI Fund Flow Survey | Year-End Active Shakedown - ICI7

 

ICI Fund Flow Survey | Year-End Active Shakedown - ICI8



Sector and Asset Class Weekly ETF and Year-to-Date Results: In sector SPDR callouts, investors seeking safety contributed +3% or +$171 million to the long treasury TLT ETF.

 

ICI Fund Flow Survey | Year-End Active Shakedown - ICI9



Cumulative Annual Flow in Millions within Equity and Fixed Income Exchange Traded Funds: Chart data is the cumulative fund flow from Bloomberg's ETF database for each year starting with 2013.

 

ICI Fund Flow Survey | Year-End Active Shakedown - ICI17

 

ICI Fund Flow Survey | Year-End Active Shakedown - ICI18



Net Results:

The net of total equity mutual fund and ETF flows against total bond mutual fund and ETF flows totaled a positive +$2.2 billion spread for the week (-$520 million of total equity outflow net of the -$2.7 billion outflow from fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52-week moving average is +$741 million (more positive money flow to equities) with a 52-week high of +$20.5 billion (more positive money flow to equities) and a 52-week low of -$19.0 billion (negative numbers imply more positive money flow to bonds for the week.)

  

ICI Fund Flow Survey | Year-End Active Shakedown - ICI10

 


Exposures:
The weekly data herein is important for the public asset managers with trends in mutual funds and ETFs impacting the companies with the following estimated revenue impact:

 

ICI Fund Flow Survey | Year-End Active Shakedown - ICI11 



Jonathan Casteleyn, CFA, CMT 

 

 

 

Joshua Steiner, CFA







PRODUCER LEVERAGE | Non-GAAP Splurge to Get Worse?

Takeaway: The excessive amount of capital in play in commodity industries is only beginning to decelerate and inflect.

Below we offer three different conclusions to supplement the credit-cycle section in our Q1 themes deck:

  • Planned capital spending cuts are only the first leg of the capital flush needed in commodity related sectors.
  • There is a gross excess of capital chasing current production levels, and this excess greatly overshadows the near-term effect of planned capital spending cuts – The market needs an extended period of underinvestment to reduce the excess capital deployed.
  • The non-GAAP reporting splurge should get worse with impairments and write-downs as the back side of the cycle plays out.

 

----------

 

We outlined the risk that is beginning surface in credit markets in the themes presentation. Coming off the summer 2014 lows in spreads and volatility, credit spreads are now widening on an unprecedented amount of corporate credit outstanding.

 

Moreover, commodity producers in mature industries have chased inflation expectations with free money to gain a much larger share of this expanding ‘debt pie’. One rhetorical question that we’ll ask with regards to monetary policy’s attempt to create inflation post-crisis:

 

Has monetary policy, in its attempt to create inflation, actually perpetuated deflation? Or, taking the policy discussion off the table, have inflation

expectations from producers created deflation?  

 

The answer is elusive, but we can probably make at least one conclusion: Free-money policy harvested a credit binge from commodity producers anchoring on higher prices:

 

Investment banker A says “don’t bother predicting commodity prices. Assume today’s prices (at the highs) and model the economics of digging a hole, pulling something out of it, and selling it. Then we can pitch this free money capital raise to Company X” - Leverage yourself up, and undertake projects at peak margins while everyone else is doing it.

 

Using a sample of 34 different producers in 4 different subsectors, commodity producer debt as a % of corporate credit outstanding has multiplied ~2.5x in 10 years. This group’s aggregate debt level is up ~5x in 10 years. The chart below shows the jump in commodity producer debt as a share of aggregate corporate debt levels.  

 

PRODUCER LEVERAGE | Non-GAAP Splurge to Get Worse? - Commodity Producer Debt   total corporate credit

 

PRODUCER LEVERAGE | Non-GAAP Splurge to Get Worse? - Real Rates Vs. Gold Miner Debt

 

To help illustrate the height of the leverage problem as rates move wider, the chart below shows interest expense charges for that same group of 34 producers. Every interest rate cycle since coming out of the early 1980s has led to lower lows in rates, and near the lower bound in rates commodity producers splurged.

Even though a bulk of the financing happened near this lower bound, interest expense has gone straight up over the last 10 years.  

 

PRODUCER LEVERAGE | Non-GAAP Splurge to Get Worse? - Interest Expense vs. Commodity Credit

 

Looking at three completely different markets (Energy, Gold Mining, and Potash), these price chasing charts paint the same picture. Projects look attractive to all of the same people at the same time at peak margins:

 

PRODUCER LEVERAGE | Non-GAAP Splurge to Get Worse? - Real Gold Price vs. Gold Miner Capex

 

PRODUCER LEVERAGE | Non-GAAP Splurge to Get Worse? - Potash Capex

 

PRODUCER LEVERAGE | Non-GAAP Splurge to Get Worse? - Capex less D A in energy

 

With one of the conclusions in the deck yesterday being that the deflation sewing investment splurge has taken credit markets to peak leverage, the cyclical bubble charts below show that the move off the low in rates and volatility of mid-2014 is in transit.

 

PRODUCER LEVERAGE | Non-GAAP Splurge to Get Worse? - pg 43 macro deck HY spreads

 

PRODUCER LEVERAGE | Non-GAAP Splurge to Get Worse? - Pg 44 IG Spreads

 

And now that spreads are widening, the leverage problem worsens. Once credit spreads begin to widen for an extended period of time, they don’t revert within the same cycle without the commencement of a recession. 

 

PRODUCER LEVERAGE | Non-GAAP Splurge to Get Worse? - Credit Spreads and Recessions

 

PRODUCER LEVERAGE | Non-GAAP Splurge to Get Worse? - PG 41 macro deck credit outstanding

 

A key call-out to monitor with regards to balance sheet trouble with spreads now moving is that a large amount of credit in the commodity space is on the edge of high yield even though much of it still trades like investment grade credit. Looking at a number of large producers in our sample of 34 companies above:

  • 9 of the larger producers have $211Bn in credit outstanding that could be tiptoeing the high yield line by late 2016 (arguably longer for BHP and Rio Tinto, but our macro view is not in their favor). That $211B is nearly 3% of corporate credit outstanding
  • Several IG credits trade like high yield is inevitable
  • 5 of the 9 listed below are on negative watch by Moody’s

PRODUCER LEVERAGE | Non-GAAP Splurge to Get Worse? - IG to HY Table Image

 

To conclude with the most important point of the note, the capital in play chasing each unit of production is excessive and is just beginning to inflect. As mentioned at the top, the market needs an extended period of underinvestment to flush at the excess capital deployed per unit of production across the space, with energy and gold mining exemplified below:

 

PRODUCER LEVERAGE | Non-GAAP Splurge to Get Worse? - Gold MIner Net PPE per Oz.

 

PRODUCER LEVERAGE | Non-GAAP Splurge to Get Worse? - Production vs. Net PPE 2003

 

PRODUCER LEVERAGE | Non-GAAP Splurge to Get Worse? - Production vs. Net PPE 1998

 

While we look at the delta in aggregate capex as an indicator of capacity coming online, on the unwind, looking at capital in play or capital on balance sheet for every unit produced may be the best metric to gauge the flush.

 

There is still way too much capital chasing every unit produced, especially when considering the empirical evidence to support that, in general, producers have gotten better and more efficient at producing commodities over the long haul. The supply-side backstop that builds the foundation for a favorable long-term outlook for these businesses takes time to surface.

 

 

 


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CHART OF THE DAY: This Indicator (Always) Signals 20%+ Stock Market Crash

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye U.S. Macro analyst Christian Drake. Click here to learn more. 

 

"... In the Chart of the Day below we show corporate profit growth vs forward year returns in the S&P500. 

 

The takeaway is straightforward:  While 2+ consecutive quarters of declining corporate profits haven’t always signaled recession, such occurrences have always signaled stock market crashes in the subsequent year."

 

CHART OF THE DAY: This Indicator (Always) Signals 20%+ Stock Market Crash - EL profits


Lion's Den

“Lions Don’t Lose Sleep Over the Opinions of Sheep”

-Anonymous

 

Some version of that mantra must maintain residence in the non-consensus psyche of a contrarian – even if it’s not said aloud. 

 

We’ve been making and defending the late-cycle, growth-slowing call and selling rallies since July.

 

While commodities, currencies, EM and domestic small caps have been crashing and confirming that view for months, with the Dow and SPX now flirting with double digit drawdowns from their respective highs, our panglossian pushback stream has finally ebbed to a trickle.    

 

Chinese traders getting multiple days off as the market trades limit down within minutes of the open is remarkable but not remarkably surprising.

 

The path by which being on the wrong side of the global growth curve manifests in interconnected market risk is always uncertain … the net result on prices, less so. 

 

We’ll announce the details of our 1st major acquisition in the coming weeks but even if we never scale headcount beyond our core team from here, I won’t lose sleep.

 

I’d rather go to (macro alpha) war with 10 lions than a 100 sheep. 

 

Lion's Den - bull riding cartoon 08.26.2015 large

 

Back to the Global Macro Grind …

 

The capacity for information absorption is inversely related to density.

 

Drowning this missive with deep analytics may sound impressive and read well in the moment but a week from now most of it will be forgotten. 

 

Instead,  I’d like to focus on one salient point from our 1Q16 Macro Themes call from Tuesday (ping for the replay/details if you missed it). 

 

We are past peak in corporate profitability. 

 

That’s not our contention, that’s simply the data. 

 

The peak in both SPX operating margins and aggregate corporate profits is now rearview – and with growth estimates declining, income and consumption growth slowing, capex plans falling and inventories continuing to grow at a premium to sales, the retreat in margins looks set to persist over the nearer-term.   

 

Earnings growth and corporate profits have been negative QoQ for two consecutive quarters as of 3Q15 and should be negative YoY in back-to-back quarters once 4Q15 is reported.   

 

Earnings recessions have preceded actual recessions in each of the last three cycles and margin contractions greater than -60-70bps have almost always coincided with economic contractions. 

 

The ‘almost’ modifier sits as the battleground point currently. 

 

The last time we saw a significant earnings and margin contraction without a subsequent economic recession was in 1985-86 when oil prices dropped ~60% and profitability in the energy sector cratered, dragging broader EPS growth and profitability down as well.

 

Superficially, that sounds very much like the current setup  – although global macro dynamics and the capacity for policy to cushion a decline are decidedly different. 

 

So, could we again avoid a recession amidst an energy/industrial-centric profit recession?

 

Perhaps, but that may or may not be the right question.

 

In the Chart of the Day below we show corporate profit growth vs forward year returns in the S&P500. 

 

The takeaway is straightforward:  While 2+ consecutive quarters of declining corporate profits haven’t always signaled recession, such occurrences have always signaled stock market crashes in the subsequent year. 

 

Limit down with no liquidity is the lion’s den for complacently long PnL.  Last refuge currency devaluations and the limiting of shareholder sales to 1% of shares outstanding within a 3-month period (the CSRC response to today’s action in China) is a sheepish, reactionary policy response to market gravity. 

 

Complacently long of Gravity is usually the better allocation.  

 

To borrow the poker phrase:  If you look around the lion’s den and can’t tell who the sheep is  ….

 

… It’s okay, both sheepishness and asset allocation are (reversible) choices - keep moving. 

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.09-2.25%

SPX 1

VIX 17.93-24.48
USD 97.91-100.12

Oil (WTI) 32.06-36.88  

 

To long bonds and long sleeps,

 

Christian B. Drake

U.S. Macro Analyst 

 

Lion's Den - EL profits


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