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Global Slowdown or Outright Recession? A Special Guest Commentary By Daniel Lacalle

Editor's Note: We are pleased to present this special Hedgeye Guest Contributor column by Daniel Lacalle. Mr. Lacalle is CIO of Tressis Gestion and professor of Global Economics at the Instituto de Empresa, UNED and IEB. His books include Life In The Financial Markets (Wiley) and The Energy World Is Flat (Wiley). You can follow him on Twitter at @dlacalle

 

Global Slowdown or Outright Recession? A Special Guest Commentary By Daniel Lacalle - recession cartoon 12.22.2015

 

By Daniel Lacalle

 

One of the most dangerous statements we usually hear is that “fundamentals have not changed.” They change. A lot.

 

If we analyze the global growth expectations of international organizations, the first thing that should concern us is the speed and intensity of downward revisions. In the US, for example, we had an expectation of growth of 3.5% revised to 2% in less than six months. If we look at the revision of the estimates for the fourth quarter of 2015 of the major economies of the world, they were downgraded by 40% in less than twenty days.

 

Not surprisingly, the IMF and the OECD have cut their expectations for 2016 and 2017 growth already in January. Can they be wrong? Yes, but if we look at history, they have mostly been optimistic, not cautious.

 

This downgrade process is not over.

 

China is one of the key reasons. The global economy has geared itself to justify huge investments to serve the expected Chinese growth, ignoring its fragility. China, with an overcapacity of nearly 60% and total debt already exceeding 300% of GDP, has a financial problem that will only be dealt with a large devaluation, many investors expect 40% vs the US dollar over three years, and lower growth . That landing will not be short. An excess of more than a decade is not resolved in a year. This exports deflation to the world, as China devalues and tries to export more, and when the “engine of the world” slows down because it ends an unsustainable model, we are left with the excess in global installed capacity created for that growth mirage. Commodities fall and mining and energy dependent countries suffer.

 

Consensus economists have overestimated the positive effects of monetary policy and expansionary fiscal measures and ignored the risks. Emergency measures have become perpetual, and the global economy, after eight years of expansionary policies shows three signs which increase fragility.

 

First, excess liquidity and low interest rates have led to increase total debt by more than $ 57 trillion, led by growth in public debt of 9% per annum, according to the World Bank.

 

Second, industrial overcapacity has been perpetuated by the refinancing of inefficient and indebted sectors. Governments do not understand the cumulative effect of this overcapacity because they always attribute it to lack of demand, not misallocation of capital. In 2008, there was a problem mainly in developed countries. With the huge expansion plans in emerging markets, overcapacity has accumulated and been transferred to two-thirds of the global economy. Brazil, China, the OPEC countries, and Southeast Asia in 2015 join the developed nations in suffering the consequences of investment in huge white elephant projects of questionable profitability “to boost GDP.”

 

Third, financial repression has not led to the acceleration of activity from economic agents. Currency wars and manipulation of the amount and price of currencies makes the velocity of money slow down. Because the perception of risk is higher, and solvent credit does not grow, as the average cost of capital is still greater than expected returns, causing debt repayment capacity to shrink in emerging and cyclical sectors below 2007 levels, according to Fitch and Moody’s.

 

Since 2008, the G7 countries have added almost $ 20 trillion of debt, with nearly seven trillion from expansion of central bank balance sheets to generate only a little over a trillion dollars of nominal GDP, increasing the total consolidated debt of the system to 440% of GDP.

 

A balance-sheet recession is not solved with more liquidity and incentives to borrow. And it will not be solved with large infrastructure spending and wider deficits spending, as Larry Summers requests.

 

Offsetting the slowdown from China and emerging markets with public spending is fiscally impossible. We have exceeded the threshold of debt saturation, when an additional unit of debt does not generate a nominal GDP increase. Global needs for infrastructure and education are about 855 billion dollars annually, according to the World Bank. All that extra expense, if carried out, does not make up for even half of the impact of China, even if we assume multipliers that are more than discredited by reality, as seen in studies by Angus Deaton and others.

 

China is about 16% of global GDP, its slowdown to sustainable growth cannot be compensated with white elephants. It is not pessimism, it is mathematics.

 

The monetary “laughing gas” only buys time and gives the illusion of growth, but ignores the imbalances it generates. Financial repression encourages reckless short-term borrowing, attacks disposable income and is accompanied by tax increases that affect consumption.

 

In the United States, following a monetary and fiscal expansion of over $24 trillion, the economy is growing at its slowest pace in three decades, real wages are below 2008 figures and labour force participation is at levels of 1978. Its total debt is nearly 340% of GDP. The economy´s fragility is such that the impact of an insignificant rate hike -from 0% to 0.25% – is phenomenal.

 

The odds of a recession in the US have tripled in six months. Although I find more plausible a scenario of poor growth, indicators of consumer and industrial activity show a clear weakening.

 

The capital misallocation created by excess liquidity and zero rates have led to a credit bubble in high yield that issued at the lowest rates in 38 years, masking their true ability to repay. Looking at the figure globally, maturities of corporate and sovereign bonds to 2020 are nearly $20 trillion. Up to 14% of those are considered “non performing”.

 

With all these elements of fragility, it is normal to assume we face an environment of low growth, but there is reason to doubt a global recession.

 

The Chinese problem is mostly in local currency and within its financial sector, reducing the risk of contagion to the global financial system.

 

Dollar reserves in emerging countries have only fallen by 2% in 2015 and remain at record levels.

 

Although default risks in emerging markets, mining and commodities has risen recently, the total combined fails to reach a fraction of the extent of the real estate bubble risk in 2008.

 

Additionally, it is unlikely that a global financial meltdown effect will happen when it did not occur in 2015, with the perfect storm of devaluations, falling commodity prices, terrorism, Greece and growing geopolitical risk.

 

Consumption continues to grow due to the growth in the global middle class and the effect of technology, which provides efficiency and good disinflation.

 

This is a slowdown from oversupply, not a credit crunch led by financial risk, and as such it puts in question the possibility a global recession. But increased consumption will not compensate for the saturation of the obsolete indebted industrial growth model.

 

For more than a year I have warned of a long period of weak growth, but we should not confuse it with a global recession. Repeating the mistakes of these past years will not change the landscape. It will perpetuate it.

 

Negative real rates do not stimulate investment. They slow lending to the real economy and encourage short-term speculation.

 

The exit from a balance-sheet recession is not going to come from the same mistake of increasing public spending and adding debt. It will only be solved when we recover as main policy objective to increase disposable income of households, not attacking it with financial repression.


IN THE NEWS: Hedgeye Energy Analyst Kevin Kaiser In Barron's "Worst Isn't Over For MLPs"

Editor's Note: In case you missed it... over the weekend Barron's Andrew Bary wrote an excellent profile about maverick Hedgeye Energy analyst Kevin Kaiser. It's the #1 story on Barron's right now and chronicles Kaiser's bearish calls on companies including Kinder Morgan, Linn Energy, and Chesapeake Energy. Kaiser reiterates his view that "the worst may not be over for investors in battered master limited partnerships."

 

Below is a brief excerpt.

 

IN THE NEWS: Hedgeye Energy Analyst Kevin Kaiser In Barron's "Worst Isn't Over For MLPs" - kaiser hedgeye image

 

"The brash young energy analyst who has scored with bearish calls on such companies as Kinder Morgan , Linn Energy , and Chesapeake Energy , says the worst may not be over for investors in battered master limited partnerships. “We’re in the early innings of the MLP down-cycle,” says Kevin Kaiser, a managing director at Hedgeye Risk Management, a research boutique based in Stamford, Conn. “We had a 15-year up-cycle, and now we’re a year and a half into the downturn.”

 

It’s hard to name another equity analyst who has caused as much of a stir and bagged as many big targets in recent years as Kaiser, 29, who graduated in 2010 from Princeton University, where he was a co-captain of the hockey team. Kaiser’s views run counter to those of MLP bulls—mostly Wall Street analysts and dedicated MLP investors—who argue the sector is deeply undervalued now that the benchmark Alerian MLP index is down 45% in the past year and yielding 10%."

 

Click here to read the rest of the story on Barrons.com.


INSTANT INSIGHT | Rate Hikes, Long Bonds, & Financials

Takeaway: Our Macro team loves Long bonds (TLT). TLT up +8.6% versus the S&P 500 down -9.6%.

INSTANT INSIGHT | Rate Hikes, Long Bonds, & Financials - TLT safewaters 10.15.14

 

Hedgeye CEO Keith McCullough is fond of saying that he is "the most bullish guy on Wall Street... on Long Bonds (TLT)."

 

Here's analysis from McCullough in a note to subscribers earlier this morning on TLT and why 10yr Treasury yields continue to fall:

 

"One of the few places to stay long and liquid remains the Long Bond – 10yr UST Yield was -8bps last week and is down another 2bps this morning to 1.82% - this is flattening the Yield Spread to a new cycle low of 110bps (10yr minus 2yr) and that’s one of the main reasons why the Financials (XLF) remain my fav S&P Sector short."

 

Below is a chart of the 10yr yield post-rate hike...

INSTANT INSIGHT | Rate Hikes, Long Bonds, & Financials - 10 yr treasury down today

 

... And here's how TLT has done year-to-date vs. the S&P 500

INSTANT INSIGHT | Rate Hikes, Long Bonds, & Financials - tlt v s p

 

Stick with the firm that got it right. We're just getting started.


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Shaking Up Idea List

Takeaway: Major changes to our Retail Idea List. Long: NKE, RH, KATE. Short: FL, KSS, HIBB, W, TIF, TGT, LULU

Shaking Up Idea List - 2 8 2016 chart1B

 

We made some major changes to our Retail Idea List today. Here goes…

Thematically, our longs have meaningful, yet underappreciated, growth drivers (NKE) and have been punished/annihilated by the market (KATE, RH). Our bench is mainly composed of quality companies that have had a meaningful earnings/price reset, and it is only a matter of time before we think the ideas work again (PVH, RL, ULTA, AMZN, WWW, PIR).

Our shorts are composed largely of zero-square footage-growth retailers that are either overly exposed to deflationary pressures and/or have meaningful margin risk and are significantly overearning relative to consensus. This includes FL, KSS, HIBB, GPS, TIF, TGT, M, JCP, JWN, LULU, COLM and W.

 

Changes in Order of Top Longs

NKE: We moved this to #1 (from #3) on our list. It won’t make you rich here, but the earnings upside is very much underappreciated.

RH: Not our top name for first time since back when the stock was at $32. Still a core name for us. Earnings defendability in a recession is misunderstood, as is leverage as square footage growth kicks in and new store productivity improves. Only uncertainty is that RH does not report EPS until late March, a long time to wait. We think we’ll see a press release by the end of Feb, which should ease concerns.

KATE: No change. Sentiment in ‘space’ finally improved, and KATE should earn more $ this quarter than it has cumulatively in seven years. Then people should start to look at $0.70-$1.00 in EPS power for the year. Then it’s finally got valuation support – especially with the stock at $17.

 

 

Removed from Long Bench

DKS: The more we consider how bad the changes at Nike will be for Foot Locker, we’re now of the mindset that DKS will be hurt on the margin as well. Plus, we’ve been disappointed by the lack of margin-recapture in golf/hunt business. Sports Authority should hurt, not help (as many wrongly think).

COH: We think it’s rangebound between $30-$40. The stock’s currently at $35. When upside/downside is 1/1 we throw in the towel.

DLTR: We weren’t fast enough on this one. It was like a balloon underwater in the low $60s in Oct, then over the course of a week it rightfully popped to $75. Still likely upside from here in earnings, but we don’t think we have a real edge today. Revisit.

KORS: The model has proven to be far more resilient than the market expected. But the upside from here gets a little tougher. We’d stick with KATE – as ‘the space’ is bifurcating.

BBBY: Will this company ever stop disappointing?

CROX: As hard as we try, we can’t go the final mile on this idea. Cheap? Yes. Cash flow? Yes. Core Idea for us? No.

TLRD: After one of the most spectacular blowups of last year after the closing of the MW/JOSB merger, this name is trading at just 7x EARNINGS. The problem is, we still can’t get comfortable that the earnings number is real. We’d rather own DLTR if we had to own a recent retail merger where execution is paramount.

 

Removed from Short Bench

WSM: Though we think the company has issues long-term, the stock is arguably cheap down here. Not shortable anymore.

AEO: Vetted it, and don’t have a great edge on EPS downside. Need to bet on brand heat easing, which isn’t our game.

COST: Stock looked expensive – so we vetted it. Comps missed, and stock still looks expensive. But it’s a great company – and there are plenty of junkier ones to bet against.

 

Added to Long Bench

RL: This was on our Long Idea list, and yes, last week was a disaster. This company has so many issues it’s almost impossible to count. That said, this stock looks very close to a bottom. It might take a while to get paid (12-18 months) as it likely embarks on yet another restructuring, but this is one to keep a close eye on – and we DEFINITELY would not short it here.

PVH: Stock bottoming from a valuation perspective and easy compares on the top line, margins, and capital intensity over a trend and tail duration. Sentiment improving on the margin, as we enter year 3 of Warnaco acquisition. We have to assume that the worst of Warnaco’s skeletons are cleaned from the closet (regardless of what management says). Once we get past that, then we’re in business.

WWW: It’s tough to find names with a 20-year chart like this, and when the stock drops by 55% in under a year, we need to start giving its solid management team, deleveraging trend, and global diversification a lot more credit at just 11x earnings.

 

 


MONDAY MORNING RISK MONITOR | THE GRAVITY OF THE EMPLOYMENT SITUATION

Takeaway: More evidence of the US labor market slowing triggered a global selloff in credit, as CDS for banks and sovereigns worldwide spiked.

MONDAY MORNING RISK MONITOR | THE GRAVITY OF THE EMPLOYMENT SITUATION - RM11

 

Key Takeaway:

The drumbeat of recession grows louder seemingly with each new eco data point. Last Friday's NFP was but the latest link in a growing chain of a getting-harder-to-dismiss negative data mosaic. We've been flagging emergent weakness in the labor data since late last year (Here's our late December initial jobless claims note: Raise Shields!), and our overarching bearish tone is unchanged as we enter the second week of February.

While the datapoints worth flagging in our Risk Monitor have waxed and waned from week to week YTD, what hasn't is the heavy skew towards negative trend. Right now the ratio of positive to negative on a short-term basis is 6 to 1, while on an intermediate term basis that ratio is 6 to 3. The long term ratio is 5 to 1. 

 

Last week the big theme was sovereign and corporate default risk rising seemingly across the board globally, partly in reaction to the weakening U.S. labor market. European banks CDS widened significantly with DB rising 56 bps and Barclays rising 40 bps. In the US, GS and MS each rose 20 bps, while BofA and Citi were +14 and +18, respectively.

 

Our heatmap below is more negative than positive across all durations.


Current Ideas:


MONDAY MORNING RISK MONITOR | THE GRAVITY OF THE EMPLOYMENT SITUATION - RM19

 

Financial Risk Monitor Summary

• Short-term(WoW): Negative / 1 of 13 improved / 6 out of 13 worsened / 6 of 13 unchanged
• Intermediate-term(WoW): Negative / 3 of 13 improved / 6 out of 13 worsened / 4 of 13 unchanged
• Long-term(WoW): Negative / 1 of 13 improved / 5 out of 13 worsened / 7 of 13 unchanged

MONDAY MORNING RISK MONITOR | THE GRAVITY OF THE EMPLOYMENT SITUATION - RM15

 

1. U.S. Financial CDS – Swaps widened across the board for domestic financial institutions. GS & MS both widened by +20 bps to 115 and 118 bps, respectively. Meanwhile, Citi and BofA were +18 and +14 to 120 and 109 bps. Insurers PRU and MET also had a rough go of it, widening by +31 and +23 bps.  

Widened the least/ tightened the most WoW: ALL, CB, AGO
Widened the most WoW: PRU, MET, GS
Widened the least/ tightened the most WoW: CB, ALL, MTG
Widened the most MoM: AIG, AXP, PRU

MONDAY MORNING RISK MONITOR | THE GRAVITY OF THE EMPLOYMENT SITUATION - RM1

 

2. European Financial CDS – Swaps widened notably across European financials last week. The median spread widened by a significant +24 bps to 123. Deutsche Bank saw swaps widen by +56 bps to 201 bps, while Barclays widened by +40 bps to 121 bps.

 

MONDAY MORNING RISK MONITOR | THE GRAVITY OF THE EMPLOYMENT SITUATION - RM2

 

3. Asian Financial CDS – Asian financial swaps widened last week as the perceived risk of default rose globally. The Bank of China saw the largest increase, widening by +24 bps to 180.

MONDAY MORNING RISK MONITOR | THE GRAVITY OF THE EMPLOYMENT SITUATION - RM17

 

4. Sovereign CDS – Sovereign Swaps mostly widened over last week. Portuguese sovereign swaps widened the most, rising by +34 bps to 252.

MONDAY MORNING RISK MONITOR | THE GRAVITY OF THE EMPLOYMENT SITUATION - RM18

 

MONDAY MORNING RISK MONITOR | THE GRAVITY OF THE EMPLOYMENT SITUATION - RM3

 

MONDAY MORNING RISK MONITOR | THE GRAVITY OF THE EMPLOYMENT SITUATION - RM4


5. Emerging Market Sovereign CDS – Emerging market swaps mostly widened last week. Chinese sovereign swaps widened the most, rising by +14 bps to 138. 

MONDAY MORNING RISK MONITOR | THE GRAVITY OF THE EMPLOYMENT SITUATION - RM16

MONDAY MORNING RISK MONITOR | THE GRAVITY OF THE EMPLOYMENT SITUATION - RM20

6. High Yield (YTM) Monitor – High Yield rates rose 11 bps last week, ending the week at 8.84% versus 8.73% the prior week.

MONDAY MORNING RISK MONITOR | THE GRAVITY OF THE EMPLOYMENT SITUATION - RM5

7. Leveraged Loan Index Monitor  – The Leveraged Loan Index rose 2.0 points last week, ending at 1798.

MONDAY MORNING RISK MONITOR | THE GRAVITY OF THE EMPLOYMENT SITUATION - RM6

8. TED Spread Monitor  – The TED spread rose 3 basis points last week, ending the week at 33 bps this week versus last week’s print of 30 bps.

MONDAY MORNING RISK MONITOR | THE GRAVITY OF THE EMPLOYMENT SITUATION - RM7

9. CRB Commodity Price Index – The CRB index fell -1.4%, ending the week at 162 versus 164 the prior week. As compared with the prior month, commodity prices have decreased -3.9%. We generally regard changes in commodity prices on the margin as having meaningful consumption implications.

MONDAY MORNING RISK MONITOR | THE GRAVITY OF THE EMPLOYMENT SITUATION - RM8

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 14 bps.

MONDAY MORNING RISK MONITOR | THE GRAVITY OF THE EMPLOYMENT SITUATION - RM9

11. Chinese Interbank Rate (Shifon Index) – The Shifon Index fell 1 basis point last week, ending the week at 1.98% versus last week’s print of 1.99%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.

MONDAY MORNING RISK MONITOR | THE GRAVITY OF THE EMPLOYMENT SITUATION - RM10

12. Chinese Steel – Steel prices in China were unchanged last week at 2,028 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity and, by extension, the health of the Chinese economy.

MONDAY MORNING RISK MONITOR | THE GRAVITY OF THE EMPLOYMENT SITUATION - RM12

13. 2-10 Spread – Last week the 2-10 spread tightened to 111 bps, -3 bps tighter than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.

MONDAY MORNING RISK MONITOR | THE GRAVITY OF THE EMPLOYMENT SITUATION - RM13

14. CDOR-OIS Spread – The CDOR-OIS spread is the Canadian equivalent of the Euribor-OIS spread. It is the difference between the Canadian interbank lending rate and overnight indexed swaps, and it measures bank counterparty risk in Canada. The CDOR-OIS spread was unchanged at 39 bps.

MONDAY MORNING RISK MONITOR | THE GRAVITY OF THE EMPLOYMENT SITUATION - RM14


Joshua Steiner, CFA



Jonathan Casteleyn, CFA, CMT


SECTOR SENTIMENT RUN

Our monthly sentiment run is a behavioral, market-based gauge of investor sentiment in the Basic Materials Sector. Any relative performance measure is tied to the benchmark S&P 500 Materials Sector INDEX (GICS). Further screening methodologies are included in the link to the tracker below.

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CLICK HERE to access the February Sentiment Tracker presentation.

 

Key Call-Outs:

 

Positive Sentiment

Negative Sentiment

 

  • Looking at short-interest, 6 of the top 12 least shorted names are in the Gold Mining space with large-cap Diversified Metals and Miners being the most heavily shorted (FCX, AA, TCK, AWC, FMG).
  • Combining consensus “buy” ratings and short-interest, Diversified Chemicals & Specialty Chemicals have the most positive relative sentiment when combining both metrics. Diversified Metals and Mining, Aluminum, & Commodity Chemicals have the most negative sentiment.
  • With the outperformance in precious metals YTD, relative outperformance, declines in volatility premiums, and a cutting in short positioning all suggest the market views Gold Miners much more favorably vs. the beginning of 2016. 5 of top 12 declines in volatility expectations are in Gold Mining names. The largest 2016 YTD spikes in implied vol. come in the chemicals space (9 of top 12), but we believe this is due to broader market volatility.
  • The largest sector divergences in growth metrics (TOP-LINE, OPERATING, BOTTOM LINE) exist in the mining space. We expect a downward revision in sell-side estimates in the space as many mining company expectations still need to be taken down while some are already discounted with declining operating leverage.  

 


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 80.33%
  • SHORT SIGNALS 78.51%
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