Each Fed chair rises to the occasion.
Takeaway: New Hampshire and Iowa are very different animals.
Below is a brief excerpt from Potomac Research Group Senior Analyst JT Taylor's Morning Bullets sent to institutional clients each morning.
"NEW HAMPSHIRE IS A VERY DIFFERENT ANIMAL, BUT SOME TAKEAWAYS FROM THE IOWA CAUCUS GIVE US CLUES FOR HOW THE NATION'S FIRST PRIMARY MAY PLAY OUT:
The Trump spectacle draws large crowds, but he was hurt by an inability to transfer that into committed voters. Cruz by contrast won "the Iowa way" with a new twist, marrying a heavy emphasis on door-to-door campaigning with cutting-edge digital targeting and demographic modeling. Evangelicals made up 64% of Iowa Republicans, and a large portion of the remaining voters classified themselves as very conservative. NH is one of the least religious states in the country and has a large block of libertarian and moderate voters. Fertile ground for Trump and Rubio -- or one of the governors. Not Cruz.
Entrance and exit polls from Iowa indicated that higher turnout, especially among new voters, didn't translate into a big Trump boost -- it seems his presence in the race brought out an even share of fans and detractors. This may be indicative of a Trump ceiling among Republican primary voters -- a notion that would be cemented with a similar result in the Granite state. Trump needs a ground game to complement his message in order to win here and beyond.
His campaign and Super PAC spent a combined $14.1 million in Iowa on ads alone -- that works out to more than $2,800 per vote for a dismal sixth-place finish. In NH, he'll be hard-pressed to convince voters that he's a better establishment standard-bearer than Rubio, who he just lost to by 20 points...
His campaign announced this week that it had pulled in $20 million in donations in January alone, averaging $27 apiece -- something he repeatedly highlighted in his not-quite-concession speech Monday night. Did we mention that he raised an additional $3 million after that speech? He's vowed to take the fight to Hillary "all the way to the convention."
Takeaway: Wait a second... Didn't the Fed hike interest rates?
A lot of people are scratching their heads wondering what the heck is going on with the 10-year Treasury. We're not. In case you missed it, the 10-year yield hit 1.83% earlier today. This ... after declining from 2.27% when the Fed hiked interest rates in December.
Here's analysis from Hedgeye CEO Keith McCullough in a note sent to subscribers earlier this morning:
"I don’t want you getting piggy with the 10yr UST at 1.83% - it’s been a great start to the year (long the Long Bond), so book some gains after this epic move towards the all-time lows (in yields) – “expensive” Long Bond gets more expensive as A) Deflation persists B) Growth Slows and C) German 10yr 0.29%, JGB 10yr 0.06%, and Swiss 10yr -0.33%."
Our Macro call on this has been spot on. That's why we've been bullish on Long Bonds since we added it to Investing Ideas in August of 2014. Here's how it's performed since then:
We're sticking with Long Bonds. It's been the best contrarian Macro call around especially based on where we think the U.S. economy is headed: #Recession.
Takeaway: Red remains the primary color in U.S. equity markets.
Here's a quick look at the year-to-date market scorecard for all the chest-pumping permabulls calling a bottom last week.
For the record, the only sector that we've liked all year on the equity side continues to work out:
Here's why, from a note Hedgeye CEO Keith McCullough sent to subscribers this morning:
"From a S&P Sector Style perspective, the Best Idea in our Q1 Macro Themes deck remains playing our rates call via long Utilities (XLU +0.4% yest to +6.4% YTD) and short Financials (XLF -2.8% yest to -11.8% YTD)"
More confirmation of our XLU long call today. In a tough tape for the equity markets today, it's the only sector (other than Materials) that's up. XLU is +1.2% versus S&P 500 down -1.2%.
Oh and did we mention that we're predicting a 20% or more stock market correction?
Stick with us. We're just getting started.
Takeaway: The soap opera continues at LULU as Chip reasserts himself. We're not betting on management.
LULU - Chip Reasserts Himself. We're not betting on management.
The soap opera continues at LULU.
First Chip traded his chairman title/power for the appointment of new CEO Laurent Potdevin. That led to Wilson being effectively neutered on the Board and to him selling half his stock to Advent in August of '14.
Then Chip announced that he would be stepping down from the BOD in February and put the processes in motion to sell his remaining stake in June of 2015.
Rather than walk away into the sunset, sell his stake now worth $1.25bn and focus on his family's new project Kit & Ace, which Chip talked about in an appearance on Bloomberg in mid-December. He is now asserting his right (per the 2014 agreement with Advent) to appoint a new member to the BOD. He chose LULU's former CIO (2010-2014), Kathryn Henry, to be his advocate. And couldn’t help but deliver a few pot shots about the company's current corporate governance.
So what would we do with the stock?
This company has at a lot of levers to pull especially on the GM side, and has lost 600bps in product margin over the past 4 years (see chart below). The top line looks relatively healthy, accelerating on a 2yr basis throughout 2015 against easy compares last year. But, now LULU starts to comp that in 2016. The US market is all but tapped out in terms of unit growth, with the company focusing on expanding existing footprint. International results have varied, with winners in Asia mixed with unenthusiastic 'on track' remarks on Europe.
At 28x next year's number we'd argue that the GM improvement is all but priced in and we have to assume that the company continues to comp in the mid to high single digits in perpetuity. That leaves little room for an operational hiccup from an unproven management team. A bet we're not willing to make. We like it as a short.
Our only concern is that with 27% of the float held short, so do a lot of other people. Still, that doesn't change the mismatch between the long-term growth trajectory and elevated valuation.
AMZN - Amazon to open up to 400 bookstores.
LOW - Lowe's will acquire RONA for $2.3bn to accelerate growth strategy in Canada
COLM - Columbia it will realign Montrail as a sub-brand of Columbia -- beginning 2017, Columbia's trail running apparel, footwear and accessories will be badged Columbia Montrail
COH - Coach to open 20,000 Sq. Ft. flagship store at 685 Fifth Avenue in NYC -- Stuart Weitzman will also open a store at this location
WMT - Walmart Canada expands online grocery pickup service to 12 greater Toronto stores
AdiBok - Mark King, President of Adidas North America, debuted his own podcast this week
Hooker Furniture Completes Acquisition of Home Meridian International -- company will double its sales volume and positions it to become one of the top 5 U.S. furniture market sources
TGT - Brad Maiorino, Target senior VP and chief information security officer, joins cybersecurity board
Toys “R” Us looking to big banks for restructuring as finances improve
TGT - CVS Health opens first pharmacy locations within Target stores and will will convert 1,672 Target pharmacies in next 6-8 months
Hancock Fabrics files for bankruptcy, considers putting 250 retail sewing and crafting stores up for sale
Takeaway: The consensus bull case for U.S. capital markets hinges on omitting commodity-linked industries (namely energy) from important economic and financial market indicators. While we continue to think such omission is off base because it misses the point of proactively positioning one’s portfolio for interconnected risks, we’re happy to entertain such discussions. Even if we were to concede the conclusion(s) of such studies, we’re not so sure they are being conducted in the most appropriate manner – i.e. in rate-of-change terms.
One common line of pushback Keith and I have been getting on the road visiting clients and prospective clients lately has centered on energy’s impact on the broader economy. The U.S. remains a net importer of crude oil, so, naturally, one would think energy price deflation has a net positive impact on U.S. economic growth.
Moreover, since energy is an essential input to the vast majority of production and consumption activity, there is an assumed net positive impact from a corporate and consumer PnL perspective as well. We don’t disagree with the assumption; it makes sense intuitively.
But does it make sense empirically?
Consider the following analysis which shows the cumulative change in the mining sector’s contribution to nominal GDP (which is as targeted as the data allows) from its 2Q14 peak juxtaposed with the cumulative change in personal outlays on gasoline, fuel oil and other energy goods. The assumption here is that to the extent a positive spread exists, the tailwind to PCE from falling energy prices is greater than the headwind to GDP from declining mining sector activity. Thus far, the spread has been negative, implying a cumulative net headwind to economic activity.
Another way to show this relationship is on a QoQ basis. In any given quarter, if the spread between these two nominal rates of change is positive, then it could be said the economy experienced a net tailwind from the perspective of energy price inflation or deflation; the opposite holds true as well. After a period of a mostly-sustained net tailwind from 4Q12 to 3Q14, the U.S. economy has experienced a persistent net headwind from the change in energy prices.
There are two key assumptions in the aforementioned analysis: 1) that mining sector GDP is predominately driven by energy prices; and 2) that U.S. consumers have a marginal propensity to consume any savings from declining energy prices, rather than pocketing the change.
Empirical evidence proves our first assumption correct, in that there exists an extremely tight positive correlation between crude oil prices and mining sector GDP.
Regarding the latter assumption, there exists an observable inverse correlation between national gasoline prices and real PCE growth for much of the past ~10yrs. The key outliers are during the 2H08-2011 crash and recovery in energy prices and during the 2H15-present fuel price deflation.
When gas prices collapse nationwide (alongside the NAV of 401(k) and IRA portfolios broadly), does the U.S. consumer get spooked and cut back spending? Probably not, but maybe. At least the following chart seems to think so:
Jumping ship, we find it important to consider multiplier effects as well. While it’s impossible to accurately quantify the multiplier effect of the domestic energy economy, we can at least assume one exists given the capital-intensive nature of the industry. The following two charts highlight this relationship by showing that growth in both employment and income in key energy-producing states contributed an outsized share of cumulative employment and income growth from their respective cycle-lows.
Specifically, at its peak share of 12.9% in OCT ’14, employment growth in key energy-producing states accounted for 18% of the cumulative growth in total nonfarm payrolls from its FEB ’10 trough and remains at a still-disproportionate 15.1% per the latest data. Moreover, at its peak share of 12.7% in 1Q15, personal income growth in key energy-producing states accounted for 16.5% of the cumulative growth in total personal income from its 3Q09 trough and remains at a still-disproportionate 15.3% per the latest data.
While there are some key assumptions here as well – namely the somewhat arbitrary level of production at which we have decided to label a given state as a key energy producer – the aforementioned relationships hold true in terms of explicit exposure to commodity production in both GDP and CapEx terms. Specifically, at its peak share of 3.2% in 3Q13, the mining sector accounted for an outsized 8.2% of the cumulative growth in nominal GDP from its 2Q09 trough. Moreover, at its peak share of 5.7% in 2Q12, the mining sector accounted for an outsized 14% of the cumulative growth in nominal private nonresidential fixed investment from its 1Q10 trough.
As the charts highlight, the mining sector’s contribution to the cumulative growth of GDP and CapEx has since dwindled to 0.5% and -1%, respectively. Not surprisingly, it is at these levels where peak mitigation or outright exclusion of energy from just about every relevant economic and financial market indicator occurs. Perhaps there’s a bee in our bonnet, but we can’t help but point out the lack of mitigation and/or exclusion on the way up.
To add some ethos to our rant, the current peak-to-trough decline in the mining sector’s contribution to cumulative GDP and CapEx growth is not unlike the decline witnessed by the housing sector in the mid-to-late 2000s. Specifically, at its peak share of 6.7% in 4Q05, nominal private residential construction accounted for an outsized 13.7% of the cumulative growth in nominal GDP from its 4Q01 trough; that share had declined to a mere 2.4% by the end of 2007. We know of no investor that would dare “ex” housing from the last economic cycle.
As with leverage, multiplier effects work both ways. This more than likely why you continue to see carnage in rate-of-change (i.e. deceleration) and/or absolute (i.e. outright contraction) terms across the broader domestic manufacturing and export sectors:
In terms of staving off an outright #USRecession, the key question investors should be asking themselves is whether or not the U.S. consumer can continue its Sisyphean struggle to hold up the U.S. economy until the aforementioned indicators begin to lap easy comps at various intervals throughout 2016.
Based on the preponderance of data, our answer is increasingly “NO”. For those of you looking for more details on why that is the case, we encourage you to review the following research reports:
Q: If industrial activity is going from “horrific” to “just bad” while consumption growth that went from “great” (in 1H15) to “good” (in 2H15) is on its way to “bad” (by mid-2016) at the same time, what are you left with?
A: The most obvious slow-moving #LateCycle slowdown we’ve seen since the early-2000s.
And even if the U.S. economy avoids recording a technical recession, we could just have an 2000-02-style corporate deleveraging cycle that drags down equity market cap alongside it. After all, it's EPS that matters most to stocks, not GDP. Recall that the 2001 downturn was the shallowest recession in U.S. history; that didn't preclude the stock market (SPX) from getting cut in half.
Oh and by the way, it’s not just energy. With 263 of 500 SPX companies having announced results throughout the 4Q15 reporting season to-date, the Energy (-65%), Materials (-18.8%), Industrials (-4.1%), Financials (-3.4%) and Tech (-2.7%) sectors are all reporting YoY declines in EPS.
If you’re bullish, best of luck in your attempt to: A) “ex” all of that out; and B) avoid making eye contact with your credit team in the elevator or restroom.
If you’re bearish, best of luck out there preserving capital amid the continued pricing in of the aforementioned business cycle risks.
Start receiving Hedgeye's Cartoon of the Day, an exclusive and humourous take on the market and the economy, delivered every morning to your inbox
By joining our email marketing list you agree to receive marketing emails from Hedgeye. You may unsubscribe at any time by clicking the unsubscribe link in one of the emails.