Commodity-leveraged credit, which moved on a lag to top-down commodity deflation, is now FAST on the move.


With large impairment charges and write-downs foreshadowed by many large producers, credit markets are front-running balance sheet contraction to reflect lower short and long-term commodity price assumptions:

  • BHP made a pre-earnings announcement of a $7.2 Bn pre-tax impairment charge on U.S. shale assets.
  • Australia’s Woodside Petroleum said it expects to take an ~$1 Bn pre-tax impairment hit due to lower long-term oil price assumptions when it announces its full-year 2015 results in mid-February.

As we flagged in a recent note PRODUCER LEVERAGE , much of the spread risk lies with what are current IG credits.


Two important points we would make with respect to the more recent moves in credit markets:


1) Both high-yield AND investment grade have historically moved together when spreads widen (all corporate credit is at risk), and there is a large amount of IG credit that could move high-yield in 2016 in the current price environment.


2) A good chunk of low-notch IG commodity credit trades like it’s going high yield, but there is also a large chunk that is 1-2 notches off lowest IG-Notch that has just started moving in the last couple of months – These issues are worth a look if you are behind our pending recession call. 


NOTCH RISK - Energy and Materials IG Yield




NOTCH RISK - Energy and Materials Spreads


NOTCH RISK - Energy   Materials HY Index


To consolidate concerning commentary from S&P & Moody’s on the shift in credit quality at the end of last week:

  • S&P: More companies were at risk of having their credit ratings cut at the end of December than at the close of any other year since 2009
  • S&P: The number of potential downgrades was at 655, compared with 824 reported by the finish of 2009
  • S&P: The year-end total for 2015 was "exceptionally" higher than a yearly average of 613
  • S&P: Oil-exporting countries face fresh downgrades as crude prices fall further. The agency currently has Azerbaijan, Bahrain, Kazakhstan, Oman, Russia, Saudi Arabia, Brazil, and Venezuela on negative watch.
  • Moody’s: Friday morning, Moody's disclosed it was putting the ratings of 120 Oil & Gas companies and 55 mining companies on watch.
  • S&P: Revised 2016 and 2017 metals price assumptions late Friday night, following on its recent reduction in 2017 oil price forecasts from $US65 a barrel to $US45. (expected but meaningful):

-        Iron Ore: Cut to $65/MT for 2015-16 vs. $85/MT back in October

-        Copper: $2.70/lb. for 2015 through 2017, down from its previous forecast of $3.10/lb. for 2015-2016

-        Gold: Forecasts remain flat at $1,200 per ounce for the period from 2015-2017.

-        Nickel: Lowered from $8.00/lb. in 2015-2016 to $6.50/lb. this year and $7.25/lb. in 2016

-        Zinc: Lowered from $1/lb. this year to $0.95, but maintained its $1/lb. forecast for 2016


In the table below, we have pegged a significant amount of investment grade credit from commodity producers that could get downgraded to high-yield ($227Bn) -- some credits much more at risk near-term than others.


A move to HY from IG should perpetuate spread risk with forced selling from institutional money.  As mentioned above and with regards to our short JNK position, the insurance on low-IG credit in the commodities space that hasn’t moved as much (YET) is worth a look into a potential recession as a way to play our short JNK view outlined in the Q1 Themes deck.   


NOTCH RISK - chart1 IG to HY


NOTCH RISK - chart3 credit outstanding vs. HY YTM


One of the bubbliest charts we’ve put together alongside the above slide as it relates to commodity producer balance sheet leverage is one that shows interest expense skyrocketing despite unprecedented lows in financing expense. We continue to think the deleveraging here is in the early innings.


NOTCH RISK - Interest Expense


Ben Ryan




CHART OF THE DAY: An Early Look At The Q4 Earnings Scorecard

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye CEO Keith McCullough. Click here to learn more. 


CHART OF THE DAY: An Early Look At The Q4 Earnings Scorecard - 01.26.16 chart


"... A cyclical #Recession morphing into a revenue recession is a serious catalyst (for multiple compression).


It’s early, but for Q4 Earnings Season to-date:

  1. Energy Revenues (for the 4 out of 40 Energy companies in the SP500 who have reported) are -24.4% so far
  2. Industrial Revenues (for the 20 out of 60 companies in the SP500 who have reported) are -9.1% so far
  3. Financials Revenues (for the 28 out of 88 companies in the SP500 who have reported) are 0.1% so far" 

Straight Outta Hedgeye

“Speak a little truth and people lose they mind.”

-Ice Cube


For those of you who are new to following our research rhymes, the maestro on the Hedgeye Macro Team is Darius Dale. He hails from West Seattle. And in case you’ve never been there, let me give you the “upper class” short cut – it’s not where Wall St. consensus lives.


The aforementioned quote comes from a non-peddled-fiction movie called Straight Outta Compton. For those of you “sheltered folk” who don’t do chaos theory, recessions, or rap, the movie’s title was also the name of N.W.A.’s pioneering West Coast hip-hop album in 1988.


I was in college by the time Dr. Dre and Ice Cube made it to my virgin ears. But I can assure you that I get the evolution of it all now. If we have the humility to open our eyes/ears (and the empathy to open our minds), we have the opportunity to learn something, every day.


Straight Outta Hedgeye - dre ice cube


Back to the Global Macro Grind


What we learned yesterday was that, no matter what the Establishment police has to say, the bear market in stocks isn’t over. To put closing prices in context:


  1. The SP500 was -1.6% on the day, taking it to -8.2% YTD, and -13.6% since the all-time #Bubble high in July
  2. The Russell 2000 remains in crash mode (I won’t gore you with the details) down -23.0% since July 2015


In terms of US Equity Sector Styles, here’s where the mauling was most obvious:


  1. Energy Stocks (XLE) down another -4.7% on the day and already down another -11.9% YTD
  2. Basic Materials Stocks (XLB) down another -3.2% on the day, leading YTD losers -14.1%
  3. Financial Stocks (XLF) down another -2.0% on the day, shocking “rate hike” bulls at -12.5% YTD


If you’re shocked, that’s ok. Consensus “folks” are losing their minds over these losses of capital. Life could be worse.


If you’re thinking this ends with some magical “valuation” love song, think again. We’ve busted a rhyme many times on this simple reality, but to boil it down for you one more time – valuation (during a #Deflation and #GrowthSlowing Phase Transition) is not a catalyst.


A cyclical #Recession morphing into a revenue recession is a serious catalyst (for multiple compression).


It’s early, but for Q4 Earnings Season to-date:


  1. Energy Revenues (for the 4 out of 40 Energy companies in the SP500 who have reported) are -24.4% so far
  2. Industrial Revenues (for the 20 out of 60 companies in the SP500 who have reported) are -9.1% so far
  3. Financials Revenues (for the 28 out of 88 companies in the SP500 who have reported) are 0.1% so far


But, if you back out that 10% of the SP500 and just focus on the good news, no worries. Until an $11B levered “value stock” like Hess (HES) reports what it did last night and you have to go back to the pre 2000-2002 US #Recession lows to find your “price target.”


I realize this morning’s note is a little too bearish for the average bull. But remember, it’s Straight Outta Hedgeye – that fringe firm that authored some of the things that “no one” saw coming.


If the SP500 drops to fresh closing lows this week, I’ll back off, cover some shorts, and take a knee again. But if the 2015 turned 2016 US stock market bulls want to start parading around the field disrespectfully, I’m bringing Darius out to rap some recession research rhymes.


To paraphrase Ice Cube, ‘our art (macro #process) is a reflection of (the data’s) reality.’


Our immediate-term Global Macro Risk Ranges (+ Intermediate-term TREND Research Views in brackets):


UST 10yr Yield 1.96-2.07% (bearish)

SPX 1 (bearish)
RUT (bearish)

NASDAQ 4 (bearish)

Nikkei 16001-17925 (bearish)

DAX 9 (bearish)

VIX 21.51-29.72 (bullish)
USD 98.80-99.98 (bullish)
EUR/USD 1.07-1.10 (bearish)
YEN 116.59-118.99 (bullish)
Oil (WTI) 28.09-32.51 (bearish)

Nat Gas 1.98-2.28 (bearish)

Gold 1075-1119 (neutral)
Copper 1.93-2.04 (bearish)


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Straight Outta Hedgeye - 01.26.16 chart

Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

TWTR | Thesis Refresh (2016)

Takeaway: The story has devolved from lofty consensus estimates to a structurally challenged model. Mgmt needs to decide what matters more.


  1. PICK YOUR POISON: The problem with the TWTR story in its short public history is that street demands upside on both revenues and MAUs, but those two factors have historically been working against each other. The common denominator is excessive ad load, which is driving monetization, but pushing the user away at the same time.  The problem isn't ad load per se, but the magnitude at which TWTR had been increasing it on a relatively disengaged user base (last reported DAU/MAU % <50%).  In short, TWTR generally can't beat on both revenue & MAU expectations at the same time, which is basically why the stock has sold off on 6 of 8 prints.  
  2. CROSSROADS: The dynamic above has devolved into a potentially dangerous situation where TWTR could see declining y/y users if mgmt doesn't take its foot off the gas with ad load.  For context, US MAU growth has decelerated to 5% y/y in 3Q15 from 19% as recently as 3Q14.  Further, our survey results suggest that nearly 40% of its US users are no longer using the platform, which means it longer-term revenue potential is compromised.  That said, TWTR needs to decide what matters more: chasing consensus estimates with excessive increses in ad load or prioitizing the user in hopes of getting some of them back.
  3. THOUGHTS INTO THE PRINT: We suspect mgmt realizes that it's been shooting itself in the foot by trying to appease the street, and its sandbagged 4Q guide suggests it may be changing its approach to managing expectations.  We're expecting a light 2016 guidance release vs. consensus estimates that are implying a persistent surge in per-user ad engagements since MAU growth has all but flattened out in the US, which is where the majority of its ad revenue comes from since it monetizes US at nearly 7x Int'l (on an ARPU basis).  However, if TWTR attempts to appease the street by guiding to consensus estimates, then this could turn into a negative US MAU story.  Either way, we see at least one more leg down to the short.


TWTR | Thesis Refresh (2016) - TWTR   Ad Engagement vs. MAU 3Q15

TWTR | Thesis Refresh (2016) - TWTR   Survey Churn 8 15

TWTR | Thesis Refresh (2016) - TWTR   Ad MAU vs. CPE 3Q15 v1


See notes below for supporting analysis and recent thoughts.  Let us know if you have any questions, or would like to discuss in more detail.


Hesham Shaaban, CFA




TWTR: What the Street is Missing

05/19/14 09:09 AM EDT
[click here]


TWTR: The Crossroads  (User Survey: n=7,500)
08/25/15 07:48 AM EDT
[click here


TWTR | Auto-Play Action (3Q15)
10/28/15 09:12 AM EDT
[click here]


The Macro Show Replay | January 26, 2015


The Domestic #CreditCycle Is About to Get A Lot Worse

Conclusion: Leverage among U.S. corporations is currently indicating a level of speculative excess that has historically coincided with the onset of much-needed economic purging – i.e. a recession.


As mentioned in our 1/20 note titled, “Sentiment Update: Three Things I Learned Today (and Three Weeks From Now)”, Keith and I are in the full swing of our post-Quarterly Macro Themes marketing excursion. This week we’re out west visiting with clients and prospective clients in California after having made the rounds in Boston and NYC last week.


Sticking with the theme of the aforementioned note in terms of rebutting key points of contention that were as consensus as they were critical, we thought we’d take a stab at refuting the narrative fallacy that leverage among U.S. corporations is at a healthy level.


Nothing can be further from the truth.


The following chart is a little busy, but allow us to highlight the key takeaways:


  • Despite the cost of debt financing (green line) falling to new all-time lows in the current cycle, aggregate corporate interest expense as a percentage of EBIT (white line) has marched steadily higher off of a secular higher-low and is now at 11.5%.
  • This is likely due to the sheer amount of leverage on U.S. corporate balance sheets. Specifically, U.S. corporate debt outstanding as a percentage of aggregate corporate free cash flow (red line) just eclipsed four turns (4.1x to be exact). This is up from a secular low of 2.7x in early 2011.
  • An economy-wide corporate debt/FCF ratio of ~4x meaningful because that level of leverage that has historically portended recessions in short order: 3.9x just prior to the 1990-91 recession, 4.1x just prior to the 2001 recession and 4.2x just prior to the Great Recession.
  • Among the more interesting things to note in refutation of the narrative fallacy that “low rates = little-to-no #CreditCycle risk” are the secular lower-highs in the aforementioned interest expense/EBIT ratio. Specifically, the level this ratio reached just prior to the onset of recession has declined alongside the cost of capital in each successive economic cycle (25.2%, 22.1% and 15.5%, respectively).
  • This is supportive of our view that there is no magic elevated level of interest expense that must be reached in order to see a recession commence. Moreover, this effectively implies low rates are not the panacea they are widely perceived to be in terms of staving off an economic downturn.


The Domestic #CreditCycle Is About to Get A Lot Worse - Corporate Leverage Cycle

Source: Bloomberg L.P., Hedgeye Risk Management


How to Profit From This Realization

One conclusion we can all agree upon is that many U.S. corporations have taken advantage of low rates by levering up to finance “shareholder friendly” (read: “management compensation friendly”) activities. In fact, the past couple of years have seen record buyback and dividend activity among S&P 500 constituents.


The Domestic #CreditCycle Is About to Get A Lot Worse - S P 500 Buyback Trailing 2Y Sum


The Domestic #CreditCycle Is About to Get A Lot Worse - S P 500 Dividends Trailing 2Y Sum


The Domestic #CreditCycle Is About to Get A Lot Worse - S P 500 Sector Buyback   Dividend Contribution


As the ongoing corporate profit recession deepens, we highlight the obvious risk of companies allocating earnings to buybacks and dividends, rather than preserving cash and paying down debt. If our explicitly negative view on the domestic economic cycle continues to be corroborated by the data, then the growth rate of such payouts will likely have to slow dramatically – if not decline outright.


That is an obvious headwind to the broader equity market in terms of removing key cogs from the post-crisis secular bull case. It’s also an obvious headwind to individual equities as well. In that vein, the following 12 tickers are the output of a screen of U.S. corporations that may have become over-levered in the pursuit of such “shareholder friendly” activities:


The Domestic #CreditCycle Is About to Get A Lot Worse - Buyback Payback Watch List 1 25 16

Source: Bloomberg L.P., Hedgeye Risk Management


Specifically, the aforementioned screen looks for publically listed U.S. equities with market caps north of $1B that have seen double-digit growth in total debt over the past five years and negative geometric growth in basic shares outstanding (over the past five years as well) that are also in the top quartile of trailing five-year growth in gross dividends.


While admittedly crude, we think this list of names serves as a better-than-bad starting point for alpha-generating short/underweight candidates if you have been appropriately convinced of our bearish view on the domestic #CreditCycle.


Parting Thoughts

In our 12/31 Early Look titled, “More Questions Than Answers”, we alluded to the fact that every crisis – either financial or economic – requires a broad-based refutation of a formerly widely-held belief. In light of that, we strongly posit the consensus view that zero percent interest rates equates to zero percent risk is one such widely-held belief that is being refuted almost daily by the market(s). As such, we believe investors would do well to adapt their belief system to incorporate such signals.


Best of luck out there today,




Darius Dale