Albert's Folly?

“Insanity: doing the same thing over and over again and expecting different results.”

-Albert Einstein


Was Einstein complexity deficient and wrong?


His well-worn colloquial definition of insanity may carry the caveat of scale dependence. 


In describing complex systems, Jim Rickards uses the example of snowflakes accumulating on the mountainside:  ….for long periods of time the same thing can happen with no discernible change in result - the snow just keeps accumulating and growing higher. 


This happens until some critical threshold is breached and the incremental snowflake catalyzes the avalanche or what is termed a “phase transition” in the local environment. 


There was nothing particularly special about that last, individual snowflake.   It’s the inherent complexity of “the system” that drives the dynamism and end result.


In biochemistry, many times you need “X” amount of substrate to hit an enzymatic trigger point.  You can keep adding “chemical ingredients” but you won’t catalyze the desired reaction until enough of the necessary compounds are present.   


In many experimental situations doing the same thing over and over and expecting (at some point) a different outcome may, in fact, be the most rational course of action. 


An inherent and principal problem is that repeated trial & error approaches are generally employed in situations of uncertainty and with outcomes that can be binary … you don’t know if you’re “insane” or not until you hit the level of system criticality and see a positive or negative phase transition. 


If that phase transition is negative, too late.  Kind of like a bank run…gradually, then suddenly…and completely nonlinear. 


When does the incremental QE snowflake catalyze a financial market phase transition and is unconventional monetary policy action heading towards a binary phase transition outcome catalyzed by a change in market confidence, unintended consequences, accumulation of latest risks, etc.?


Are global central banks insane in their repeated easing initiatives and failures to print real sustainable growth or have they simply not yet done enough?


If the former and if the rationale for prevailing policy is flawed, the likelihood that the phase transition is negative goes up. 


Here, increasing the scale (more debt/devaluation/etc.) on a (monetary policy) system built on a misguided ideology is doomed to fail – while the incremental easing initiative may be the negative trigger, the actual, absolute level of the debt/QE/etc. would largely be a random variable -  it’s the construct and scale of the system itself that ensures the implosion.


If the latter – with the BOJ announcing negative interest rates overnight (response: YEN >120, 10Y JGB’s dropping as low as 0.09% ... as in “nine” basis points) and China floating more stimulus rumors - we remain on the path to finding out.   


In the secular fight against overleverage, oversupply and negative demographics, Abe’s quiver is getting light and the remaining tools in the global central bank policy chest are few and duller. 


The probability that the developed market NIRP train continues to onboard central bankers is rising, not falling. 


Albert's Folly? - einstein


Back to the Global Macro Grind ….


Yesterday’s Durables Goods data (-5.1% MoM, -0.6% YoY) was a train wreck as the headline and all the sub-aggregates declined both sequentially and year-over-year. 


The mini implosion in December capped off a year which saw orders decline -3.5% and post the largest annual decline outside of a recession in 24 years.   


Notably, Durables Goods Ex-Defense and Aircraft – which is the aggregate most closely associated with what actual households buy – declined -1.2% MoM and accelerated to -2.8% YoY, marking an 8th consecutive month of negative YoY growth.


Core Capital Goods Orders (i.e. business capex), meanwhile, declined -4.3% MoM and accelerated to -7.5% YoY – marking an 11th consecutive month of negative year-over-year growth and the worst growth print since November 2009.


But bad is good because 11 straight months of negative growth now = easy comps …. Right?


Here’s the current score on recessionary domestic data:   


  1. Industrial Production: -1.8% YoY in Dec following a -1.3% YoY reading in Nov = 1st negative readings since 2009.  This series also carries the distinction of throwing off almost zero false positive vis-à-vis recession signaling over the last half-century
  2. ISM/PMI:  Contractionary prints (<50) in each of the last two months.  With inventories still elevated and both backlogs and new orders in contraction, the headline Index reading should stay sub-50 in the near-term.
  3. Exports:  Export growth has been negative in 6 of the last 7 months. The -4.0% growth recorded in the latest month = worst since 2009.
  4. Durable Goods: Negative growth in 9 of the last 11 months and down -3.5% YoY for 2015.
  5. Capex:  11th consecutive months of negative year-over-year growth and worst since 2009.
  6. Capex Plans:  Forward Capex plans as measured by the Fed Regional Surveys made another new low in January, suggesting the negative trend in investment spending is unlikely to ebb in the coming quarter(s).
  7. Producer Prices:  Headline PPI inflation negative for 11-straight months with Core PPI at just 0.30% and falling. Another step function move lower in energy prices in Jan and one of the worst import price growth #’s (-3.7% YoY, ex-petroleum) since 2009 in the latest month say the trend will continue.   
  8. Corporate Profits: Earnings growth and corporate profits across S&P500 companies have been negative QoQ for two consecutive quarters as of 3Q15 and are tracking at -3% with ~37% of constituents having reported for 4Q15. 
  9. Stocks: Russell 2000 is down -22.6% off the July 2015 highs.  In other words, the majority of publically listed equites have already crashed.   


And just to make it a Macro (Not) Top 10 list:


  1. Slowing:  Employment Growth, Income Growth, Consumption Growth and Credit growth are all slowing currently.  Yes – many of those measure remain good on an absolute basis but … & I feel like I say this 100X a week … it’s about better/worse, not good/bad and less good is bad when adopting a slope-of-the-line perspective of the data. 


This morning we’ll probably get a 0-handle on GDP for 4Q15 (QoQ, SAAR).  


On a year-over-year basis – which is how we model it, how companies are modeled, and the lens through which almost all other data is interpreted -  4Q15 will mark a 3rd consecutive quarter of slowing (& comps get tougher in 1Q16).


Whether we fall into technical economic recession from here may be largely beside the point (although that risk is rising, not falling)


  1. Earnings and Profit recessions are followed by significant, subsequent drawdowns in equities regardless of whether we actually go into economic recession.
  2. Common sense:  Is slowing growth, falling inflation, rising volatility, expanding credit spreads and rising uncertainty and reactionary central bank interventionism a fundamental factor set you want to be over-exposed to?   


Nature manages physiological complexity via redundant systems and controls. 


Slowing growth puts us in Quad #3 (slowing growth & Inflation) or Quad #4 (stagflation) in our GIP model. $USD’s, Bonds and Utilities win under either scenario. #Redundancy


We’ll side with Mother Nature … she’s traversed a global cycle or two.  


Christian B. Drake

U.S. Macro Analyst


Albert's Folly? - CoD Cap Goods Orders

The Macro Show Replay | January 29, 2016




Takeaway: We're flagging Toll Brothers (TOL) as having extremely bullish sentiment (Score: 90). This pairs well with our short top-down housing call.

We're flagging Toll Brothers (TOL - Score: 90) as a short on sentiment. This pairs well with our short top-down housing call.


This morning we are publishing our updated Hedgeye Financials Sentiment Scoreboard in conjunction with the release of the latest short interest data last night. Our Scoreboard now evaluates over 300 companies across the Financials complex.


The Scoreboard combines buyside and sell-side sentiment measures. It standardizes those measures to an index of 0-100, where 100 is the best possible sentiment ranking and 0 is the worst. Our analysis shows that a contrarian strategy can be employed successfully by taking the other side of stocks with extreme readings in sentiment, either bullish or bearish. Once sentiment reaches these extreme levels, it becomes a very asymmetric setup wherein expectations become too high or too low.  


We’ve quantified the tipping points for high and low sentiment. Specifically, we've found that scores of 20 or lower have a positive, average expected return while scores of 90 or greater are more likely to underperform.


Specifically, our backtest of 10,400 observations over a 10-year period found that stocks with scores of 0-10 went on to produce an average absolute return of +23.9% over the following 12-month period. Scores of 10-20 produced an average absolute return of +11.9%. At the other end of the spectrum, stocks with sentiment scores of 90-100 produced average negative absolute returns of -10.3% over the following 12-months.


The first table below breaks the 300 companies into a few major categories and ranks all the components on a relative basis. The second table breaks the group into smaller subsectors and again gives them relative rankings within those subsectors. 








The following is an excerpt from our 90 page black book entitled “Betting Against the Herd: Generating Alpha From Sentiment Extremes Across Financials.”


Let us know if you would like to receive a copy of our black book, which explains this system and its applications.


BUYS / LONGS: Financials with extremely low sentiment readings of 20 and below on our index (0-100) show strong average outperformance in absolute and relative terms across 3, 6 and 12 month subsequent durations.  Stocks with sentiment ratings of 20 or lower rise an average of +15.1% over the next 12 months in absolute terms.   


SELLS / SHORTS: Financials with extremely high sentiment readings of 90 and above on our proprietary sentiment index (0-100) demonstrate a marked tendency to underperform in absolute and relative terms across 3, 6 and 12 month subsequent durations.  Stocks with sentiment ratings of 90 or greater fall in value an average of -10.3% over the next 12 months in absolute terms. 






Joshua Steiner, CFA


Jonathan Casteleyn, CFA, CMT

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.46%
  • SHORT SIGNALS 78.35%

Cartoon of the Day: Unhinged?

Cartoon of the Day: Unhinged? - paranoid bull 01.28.2016


Old Wall perma-bulls are justifiably paranoid. That's because a preponderance of U.S. economic data is already in #Recession. To name a few: Industrial Production, Exports, Durable Goods, Capex, Producer Prices.

CAT | Lighting Their Pants On Fire

“It is difficult to get a man to understand something, when his salary depends on his not understanding it.” – Upton Sinclair



Takeaway:  In the short-run, spin and accounting maneuvers can keep results elevated.  In the long-run, it could impair CAT’s reporting credibility.





CAT management lit their proverbial pants on fire with today’s report.  We had expected them to blur the lines, but elements of the 2016 guide risk the company’s broader credibility.  When managements enter the surreal world of accounting changes and restructuring charges, both shorts and longs want to be careful not to get burned.  Long-term, investors usually punish gimmicks, and getting reporting credibility back is a serious challenge… Just ask GE (Is CAT the New GE?).


Beyond noting that order activity remains below sales, we’ll leave it to others to summarize the quarter.  We highlight key items and charts below.  Ping us for our CAT Black Books (most recent focuses on Cat Financial and midstream) and our updated EQM (data sets, model) for more background.


CAT | Lighting Their Pants On Fire - CAT 1 1 28 16



$3.50 Is A Magic Number:  Changing CAT’s pension & OPEB accounting helps keep 2016 EPS above $3.50.  Who cares? CAT management…just insert “bonus” instead of “salary” in the quote above. 


“The 2014 ESTIP design provided that a bonus pool would only be funded if the Company achieved a minimum profit per share-diluted (PPS) performance “trigger” of $3.50." – 2015 CAT Proxy Materials*


In a negative “Say on Pay” solicitation, CtW wrote:


“We are troubled, not only by the return to an EPS focus – and the jettisoning of ROA -- but also by the decision to base a majority of the award on EPS. The change gives outsized influence to EPS which investors increasingly view as a problematic compensation performance measure given its susceptibility to large-scale buybacks and earnings management.” – CtW Investment Strategy Group**



Pension & OPEB Accounting Change:  On the call, Mr. DeWalt “explained” the “elected” change in accounting principal.  Comments like “… I think the market has done a decent job of, ah, you know, understanding what’s going on and that it is, uh, what it is for what it is” are really clarifying.  So is “…it’s taking out losses from prior years that were masking operating results in the current year. That’s our view, anyway.”


See?  It is entirely straightforward. 


There is, you know, fixed income in the plan, too. 



Congress-Level Creativity:  Joking aside, why not have changed the principal last year if it was so good, or wait until next year in case markets soften?  Our unkind take is that the higher profitability was needed to secure 2016 comp. The way we read it, they are retrospectively lowering prior years for the boost to 2016…but they will provide more on that later. 


“The benefit primarily represents prior period actuarial losses that would have been amortized to earnings under the previous accounting policy. This change will be applied retrospectively to prior years. We are currently determining the impact on prior years and will provide that information later in 2016. Our current estimate of the impact on 2015 earnings is a benefit of about $575 million or about $0.65 per share.” – CAT 4Q15 Earnings Release



“Realistic” Forecast For Bucyrus Impairment:  If past is prologue, Bucyrus is in for a very, very long period of weak results.  That seems pretty “realistic” to us. The SEC is already looking into this, of course, and impairment testing is perhaps subjective…like pension accounting.  At this point, it is hard to take the lack of impairment seriously.


CAT | Lighting Their Pants On Fire - CAT 2 1 28 16



CAT Financial: Write-offs jumped nearly 50% year-over-year on a smaller asset base.  Yet the allowance for credit losses ticked down, despite obvious stress in CAT’s customer base.  Management emphasized the decline in past dues, which is partly a product of the write-offs. We will need the 10-Ks to understand more, but the trends we track, like used equipment quantities and prices, do not look favorable.


CAT | Lighting Their Pants On Fire - CAT 3 1 28 16



Cost Reduction Composition: For a year with so many restructuring charges, we would have hoped for more manufacturing oriented cost reductions.  Of course, we also would have hoped for an itemization of the restructuring costs when backing $585 million out of the quarter. We got neither.


CAT | Lighting Their Pants On Fire - CAT 4 1 28 16



Other Items:  The tax rate was low, pricing was weak, and a reduced incentive comp (down $265 mil YoY) helped support headline EPS. 



Upshot:  In the short-run, spin and accounting maneuvers can keep results elevated.  In the long-run, it could impair CAT’s reporting credibility. Today’s report doesn’t change the reasons to remain bearish on CAT. 








Denial To Acceptance: The Fed Stumbles Through The 5 Stages Of Grief

Takeaway: Despite the Fed's rosy economic narrative, the preponderance of economic data is rolling over.

We're not psychologists here at Hedgeye. But one thing seems increasingly clear to us following yesterday's FOMC statement. It appears the Fed is grieving the loss of economic momentum, but denying the reality of unfolding economic data. 


Denial To Acceptance: The Fed Stumbles Through The 5 Stages Of Grief - fed five stages of grief


The likelihood is rising that we enter a full-blown recession in Q2 or Q3 of this year. That's been our Macro call and we're sticking with it.



Back to Kübler-Ross...


First, the Fed will be forced to reconcile that everything they have predicted in the past year is wrong. It's a tough pill to swallow. As Hedgeye CEO Keith McCullough writes in today's Early Look:


"... the Reputational Bubble that is popping is that of an un-elected and un-accountable bureaucracy called The Federal Reserve. Until Bernanke’s legacy of linear forecasters embrace the non-linearity of it all, one of the most obvious risks remains their forecast."


It will take some time for the Fed to accept economic reality. But they'll eventually have to. We've got the charts below to help nudge them along the road to Acceptance.


Five economic data series that are already in #Recession:


1. industrial production

Following the industrial production print a few weeks ago, McCullough wrote: "Industrial Production down -1.8% y/y accelerating to downside and 1st negative prints since 2009."

Denial To Acceptance: The Fed Stumbles Through The 5 Stages Of Grief - industrial production keith


2. exports

The latest exports reading was the worst since November 2009...

Denial To Acceptance: The Fed Stumbles Through The 5 Stages Of Grief - export growth


3. Durable goods

"Durable Goods Slowing like this = one of the many predictors of recession risk rising (grey bar coming)," McCullough wrote earlier today.

Denial To Acceptance: The Fed Stumbles Through The 5 Stages Of Grief - durable goods


4. Capex

"Please ignore all red dots and grey (recession) bars," McCullough wrote today.

Denial To Acceptance: The Fed Stumbles Through The 5 Stages Of Grief - capital goods


5. producer prices


Analysis from a recent Investing Ideas newsletter:


"More on the depressed state of the producer. Deflationary PPI continued its march downhill with December reported numbers:

  • Headline PPI declined -1.0% Y/Y
  • PPI Final Demand declined -3.9% Y/Y
  • PPI Final Demand Services increased +0.4% Y/Y
  • PPI Energy declined -3.4% Y/Y"

Denial To Acceptance: The Fed Stumbles Through The 5 Stages Of Grief - PPI



Do you still agree with the Fed's economic forecast?


We don't.


Denial To Acceptance: The Fed Stumbles Through The 5 Stages Of Grief - bull psych fed

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