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CHART OF THE DAY: A Look At The Fed's Serial Over-Optimism In The Last Half Decade

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.


"Policy makers have serially overestimated growth by ~100bps (i.e. by ~50% with growth only averaging ~2%) every year over the last half-decade (see Chart of the Day below).


Conspicuous forecast error is the post-crisis norm but how can policy be successfully normal-ized or calibrated with normal, conventional models that fail to fit the new, less Panglossian empirical normal?"


CHART OF THE DAY: A Look At The Fed's Serial Over-Optimism In The Last Half Decade - CoD Fed Optimism

Optical Mischief

“I believe the fundamentals of our economy are strong. Very Strong”

-John McCain during his run for President, 6/5/2008 (please enjoy the epic #timestamp on that assertion)


I once got beat up in a parking lot in Iowa on the 4th of July by a bunch of racist white kids … for being white. 


I was the only white kid on our AAU basketball team and, apparently, in an acute bout of misguided ideology, beating up the lone Caucasian for his chosen associations probably seemed like a better option than taking on a whole team.


Misguided … and miscalculated. #RealTeams don’t divide across racial, socio-economic or any other lines and “lone white kid” ≠ alone.  


The Iowan boys got a bigger fight than they were looking for. It didn’t end well for them.


Cross-walking that experience to a metaphor around misguided policy ideology and a potential end game for markets as the belief system around it crumbles is almost too obvious so I’ll just let it hang there in pregnant pause for a moment…


Optical Mischief - Stocks crash test dummies cartoon 02.18.2016


Back to the Global Macro Grind …


Interpretation and contextualization of macro data is duration specific and very much sensitive to the level of zoom. 


Some argue that smaller-scale, short-term distortions in the reported data don’t matter. 


Others argue that perception = reality, so “optics” are relevant and to the extent some meaningful percentage of market participants are unaware of existent underlying distortions, that collective ignorance – right or wrong – carries real consequences for market prices.


The reality is that both camps are probably right. And, again, it’s largely a matter of duration specificity. 


To make this more tangible, consider the most significant recent example of pervasive, recurrent distortions in the reported domestic econ data. A phenomenon we previously termed “Lehman’s Ghost” that permeated through the fundamental data from 2009-14.


To review: Seasonal distortions became ubiquitous across the reported domestic macro data following the Great Recession as accelerated employment loss and the collapse in economic activity were, at least in part, captured as seasonal variation rather than as a bonafide shock.


Because many government statistical models use a 5-year look back to calibrate seasonal adjustments, that distortion echoed forward. The net effect was that seasonal adjustments acted as a tailwind augmenting the underlying data from September – February while reversing to a headwind depressing the reported, seasonally-adjusted data over the March-August period.


That shifting seasonality was perhaps most visible in the initial claims and NFP numbers but the impacts were pervasive with the reported macro data, equity market performance, investor sentiment and analyst estimates all following a similar annual, temporal pattern. 


Neither were policy makers immune to the optical mischief of the distortion. Was it completely incidental that every QE initiative was announced in the Sept-Nov period in the wake of the peak negative impact of that distortion?


Back to the present: Due to severe weather in February of each of the last two years and the BEA’s attempt to resolve “residual seasonality” problems in the 1st-quarter data (recall: GDP was negative in the 1st quarter in 3 of the last 5 years), there’s a good chance seasonal adjustments serve to upwardly bias the reported macro data for February. Any prospective distortion will be nothing like the magnitude of “Lehman’s Ghost” but it’s worth a highlight. 


At the same time, easier comps beginning in February will also act as a support to reported growth. Recall, Durable Goods, Capital Goods Orders and PPI growth (to name a few) all went negative in February of last year and have languished since. On CPI, where we’ll get the January update this morning, the energy price collapse saw its largest acceleration to the downside in Jan/Feb of last year, driving the easiest rate of change comps in both headline and core consumer inflation.


So, the hereto recessionary macro data looks set to collide with some interesting statistical/comp dynamics in the coming month(s). What do you do with that?


Rocks & Hard Places: Fortunately, the medium-term investment implications are largely the same under the competing scenarios.

  1.  If the data continues to deteriorate, in spite of favorable seasonal and comp dynamics, lower-and-slower-for-longer and its associated allocations continue to work.
  2. If the data gets an optical boost – edifying policy makers conviction around their hawkish lean - we’d expect the further attempts at policy normalization to perpetuate the same deflationary and growth prohibitive forces that have characterized the last 8-months.  


While the ultimate destination is the same under either scenario, the shorter-term investment path would probably be variant. Specifically, in the 2nd scenario, you’d likely see us get more active in risk managing the markets attempt at front-running the policy implications of the reported data for a data reliant Fed. 


I was hoping to update our bearish view on housing a bit this morning but the macro musing above surreptitiously hijacked my time allotment.


I’ll probably provide that update next time but the punchline on the recent data is this: Less good is bad and the data flow across housing continues to weaken on the margin. 


To close, I’ll leave you with our new colleague, former Fed Vice Chairman and Potomac Research Group Senior Economic Strategist Don Kohn’s, insider contextualization of the “increasing downside risks” reported in the latest Fed Minutes:


“In Fedspeak, downside risks often mean "I think I probably should lower my forecast."”


Policy makers have serially overestimated growth by ~100bps (i.e. by ~50% with growth only averaging ~2%) every year over the last half-decade (see Chart of the Day below).   


Conspicuous forecast error is the post-crisis norm but how can policy be successfully normal-ized or calibrated with normal, conventional models that fail to fit the new, less Panglossian empirical normal?


Policy makers are smart and well intentioned and villainizing them is partly a literary tool. After all, to invoke emotion and elevate myself to macro protagonist one needs a ready and capable antagonist … but that doesn’t change the realities highlighted above.  


For now, proactively front-running Fed forecast error, its policy implications and flow through impact to prices remains alpha’s new normal. 


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.61-1.86%

SPX 1811-1937

VIX 21.06-29.01
Oil (WTI) 26.01-33.02


Good luck out there today.


Christian B. Drake

U.S. Macro Analyst


Optical Mischief - CoD Fed Optimism

The Macro Show Replay | February 19, 2016


Early Look

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WAB | Nonsense

Upshot:  The internals of today’s report from WAB continue to point to 2016 EPS well below $4.00.  While we need the 10-K for a proper analysis given WAB’s skimpy disclosure, the implied orders, aftermarket sales, and PTC trends look pretty negative to us.  The big picture of rail equipment capital spending rolling over from a significant long-term up cycle remains intact.




We don’t think that the 2016 guide from WAB makes sense, beyond what we expect is management’s desire to see a higher share price to appease a no doubt disgruntled Faiveley family.  The internals in the 4Q 2015 report are poor, with deterioration in non-PTC aftermarket sales, a book-to-bill below 1, and a sizeable drop in Freight segment backlog.  With NAFTA freight rail traffic down 5% so far this year, 2016 guidance based on “flat” 2016 rail traffic is likely both back end loaded and not credible.  The expectation of flat revenue in the Freight segment is also not particularly reasonable given a book-to-bill at around 0.80, peaking PTC sales, weak international markets, and sizeable expected declines in rail car & locomotive deliveries.  While it is possible that further draws on backlogged orders, large share repurchases, and incremental acquisitions might get WAB to guidance, markets are unlikely to care. The freight rail market is entering a long downcycle, in our view, and WAB’s changed behavior serves as confirmation for us.  Given the skimpy disclosure WAB provides, we will need the 10-K to really understand the results.


Ping us back if you would like to see our updated EQM model/data sets, or recent Black Book. 


Backlogs & Book-to-Bill


Freight Segment:  The Freight book-to-bill came in just under 0.80, as backlog dropped meaningfully.  That is not a positive indicator for forward revenue growth, and suggests that guidance for flat revenue in 2016 is likely to be too optimistic.  That low book-to-bill is for 4Q 2015, before the anticipated 25% decline in freight car deliveries and 5% decline in locomotive deliveries.  The next 12 month Freight backlog dropped 31% year-over-year, which also makes the expectation of flat 2016 Freight revenue unrealistic – at least on an organic basis.


WAB | Nonsense - WAB 1 2 18



Transit Segment:  While the Transit book-to-bill was a healthy 1.21, it is much less relevant given the lower profitability of the segment.  The Transit backlog is also getting further out, with both sequential and year-on-year declines in next 12 month backlogs.  With some very long-term orders potentially skewing the Transit total backlog, we would view the next 12 month reading as more indicative of demand trends.  With U.S. and Canada ridership down ~1% in 4Q 2015 despite peaking employment (lower gas prices?), usage trends do not seem robust.


WAB | Nonsense - WAB 2 2 18



Total Backlog:  Total backlog for delivery in the next 12 months was down 19.6%, which also doesn’t point to a great topline for 2016.


WAB | Nonsense - WAB 3 2 18



Aftermarket & PTC:  Aftermarket sales were only specified for the year, but we calculate a 16% decline in fourth quarter aftermarket revenue ex-PTC sales (PTC is lumped in with aftermarket).  In a very interesting disclosure on the call, management suggested that 75% of PTC revenue was to North American Freight, while only 15% was to Transit and 10% international.  If accurate, that would spell big trouble for ultra-high margin PTC revenues as the 2018 deadline approaches…unless you believe the defensive speculation about PTC aftermarket opportunities.   Further, management is guiding to “slight growth” for PTC sales in 2016.  We estimate that PTC revenues are currently right around peak levels, and “slight growth” would represent a dramatic deceleration in PTC sales growth.


WAB | Nonsense - WAB 4 2 18



PTC has been a significant profit driver for WAB, and “slight growth” sounds like “peaking” to us.


WAB | Nonsense - WAB 5 2 18



Mix Negative: With the Transit segment taking the lead heading into 2016, we would expect negative mix to pressure margins.  We see this as another reason to be skeptical of the 2016 EPS guidance.


WAB | Nonsense - WAB 6 2 18



Secular Change, Growth Holders In Trouble:  From our perspective, this is the second earnings call with a negative tone; even when management was ‘excited’, they didn’t sound very excited.  Management implied that the market was “on the way down”.  Most importantly for growth holders, management said in prepared commentary that “headwinds could represent secular changes in our markets….”  If you look at what WAB is doing - shifting capital allocation towards buybacks and larger public deals, for example – it would certainly seem that they are signaling that their market is past peak.  If we had to guess, the large number of growth holders stuck in a deeply cyclical railroad equipment value trap will have a very difficult time finding the liquidity to sell.  In the end, we’d bet they end up grateful for the elevated short interest.


WAB | Nonsense - WAB 7 2 18


Cartoon of the Day: Crash Test Dummies

Cartoon of the Day: Crash Test Dummies - Stocks crash test dummies cartoon 02.18.2016


The stock market is headed for a crash.

JT Taylor: A Controlled Bern & The Hawks In South Carolina

Takeaway: Sanders faces a pivotal moment in Nevada. Republicans get hawkish on national defense.

Editor's Note: Below is a brief excerpt from Potomac Research Group Senior Analyst JT Taylor's Morning Bullets sent to institutional clients each morning. 



JT Taylor: A Controlled Bern & The Hawks In South Carolina - bernie


The next two weeks of the Democratic primary are pivotal, determining whether Clinton can contain Sanders' momentum.  Her "firewall" will face its first test in Nevada, where the state's diversity mirrors the U.S. as a whole.  With the contest now a dead heat, a Sanders victory in Nevada could give him enough momentum to knock a hole in Clinton's double-digit lead in SC, calling into question the integrity of her wall across the other Southern states. Someone had better tell the Clinton campaign that fire does sometimes jump firewalls...  



JT Taylor: A Controlled Bern & The Hawks In South Carolina - cruz


Republican candidates in veteran-heavy SC have been competing for the title of most-hawkish. Marco Rubio has been hitting Ted Cruz as "weak on national security," for his votes on defense reauthorization bills. Meanwhile Cruz pledged to expand the military by 100,000 active-duty troops and "unleash the holy wrath" of America on its enemies. Bush is on tour this week with venerable hawk Senator Lindsey Graham, and even John Kasich has toughened his rhetoric.


Excluding Bernie Sanders, every candidate in this race would be more interventionist than President Obama -- there's a growing consensus on Capitol Hill as well as the campaign trail that current policies and spending on defense are inadequate. To reiterate our colleague LtGen Gardner's point, it's hard to see how the current environment doesn't result in increased defense spending.

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