CLICK HERE for the associated slides.
Client Talking Points
CREDIT & CONFIDENCE
While tightening standards and declining demand currently characterize the corporate credit environment, Consumer Credit growth decelerated to its slowest pace in 23-months in January according to Fed data released yesterday. Small Business Confidence, meanwhile, retreated for a 4th straight month in February according to NFIB data released this morning. Notably, the Hiring Plans, Current Compensation and Compensation Plans Indices all declined sequentially to new 9-month lows. Small Businesses represent over 99% of total U.S. Employer firms and > 60% of net private sector hiring on a monthly basis – sentiment around the current and forward prospects for business activity are discretely related to hiring activity and labor compensation trends for small businesses and the data has now shown a multi-month trend towards softening.
Trade the Range: buy it $1.08, sell it at $1.12. As we’ve noted in our Big Bang Theory, we think any “easing” policy announcement at Thursday’s ECB meeting from Mario Draghi could send the EUR/USD to the top end of its range.
We’re pretty confident calling a reflation trade a “squeeze” in a week where high debt, high short-interest, high beta stocks (everything that has gotten crushed) greatly diverge to the upside vs. the rest of the market. That continued yesterday with a +6% move in WTI. Most importantly with regards to the move in commodities, we highlight that a reflation TRADE doesn’t help spark another credit cycle. Corporate credit has gotten some relief in spread and fair value terms, but with lending standards tightening, a return to 2014-15 financing levels is unlikely at best. Looking at high yield energy spreads, credit is still trading at a level +400-500bps over March 2015 spreads. As we highlight in our Q1 themes deck, once the credit cycle begins to roll, any relief has historically been temporary.
*Tune into The Macro Show with Retail Analyst Alec Richards live in the studio at 9:00AM ET - CLICK HERE.
|FIXED INCOME||29%||INTL CURRENCIES||6%|
Top Long Ideas
If you were long energy over utilities last week, nice trade! We'd remind you that Utilities (XLU) are outperforming the S&P 500 by +10% year-to-date. And that’s with the bounce. By contrast, Energy (XLE) was up 6.5% on the week but is up only 1% year-to-date.
General Mills (GIS) faces some headwinds across their portfolio, and although the 1H of FY16 was a challenge, the company has robust merchandising and consumer plans in the 2H that should improve results.
GIS has embarked on a mission to drive their top 450 SKUs, which represent 75-85% of their volume. Calling it their ‘Power 450’, surprisingly these 450 SKUs aren’t even in all retail locations and formats, broadening the distribution footprint of these top SKUs is priority number one for GIS’s sales team. The organization is also looking at the bottom 450, representing 1-2% of volume and making critical decisions on what products can be discontinued.
We continue to believe GIS is one of the best positioned consumer packaged foods companies due to its strong brands and best-in-class people and organization.
We can’t emphasize enough the bigger picture from both a data and top-down market signaling perspective. To contextualize the relief rallies and short squeezes in asset classes and instruments that are counter to our more longer-term view. Here’s what how we think the macro environment plays out from here:
Once the policy catalysts are out of the way in the next few weeks, our expectation is a return to outperformance in growth slowing asset classes (TLT and XLU). If you’re in for the TAIL and the TREND call, focus on the data, not the desperate attempts of central planners to arrest economic gravity. A brief reminder: ECB chief Mario Draghi will attempt to walk on water Thursday.
Three for the Road
TWEET OF THE DAY
Hedgeye CEO @KeithMcCullough on #ECB & "Is this time different"
[UNLOCKED] Big Bang Theory https://app.hedgeye.com/insights/49593-unlocked-big-bang-theory… @Hedgeye
QUOTE OF THE DAY
The best evaluation I can make of a player is to look in their eyes and see how scared they are.
STAT OF THE DAY
Today in 1817, the New York Stock Exchange was founded.
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.
"... The Data | Ruh-roh? The February data showed the Hiring Plans Index decline -1 pt, the Compensation Index decline -5pts and the Compensation Plans Index decline -3pts; all marking 9 month lows and multiple months of sequential decline (See Chart of the Day above).
The decline off the recent peak and the failure for hourly earnings to accelerate as labor slack has diminished continues as a lead source of consternation for late-cycle labor and Phillips curve economists."
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“What kind of cookies do they sell at the airport? Plain.”
Rene Descartes - famed mathematician, creator of the Cartesian plane and bane of 7th grade math classes - enjoyed getting up late, preferring to spend the morning lying in bed thinking.
The story goes that he invented the coordinate plane while lying in bed watching a fly crawl on the ceiling, reasoning that he could describe the exact location of the fly by knowing its distance from two perpendicular walls.
Descartes laid in bed. Socrates engendered philosophical insight strolling the gardens. Einstein intuited and fully conceptualized his theory of relativity “during long walks on the beach” and while “lying down and gazing at the ceiling” before any math entered the equation.
When I was in construction, I had everyone take a week off every six weeks. The path to improved morale and elevated productivity was, ironically, not working.
In athletics (and life in general), an exceedingly effective way to hinder long-term progress and physical/mental adaptation is through over-work.
Workout 2-3 times a day for a couple weeks and your progress will be great. Try to do that for a year straight and performance will invariably go downhill.
A small minority of people have the genetics to sustain 12-14 hr days of focused attention. The vast majority don’t and performance, creativity and mental plasticity start to deteriorate over time under that kind of regimen.
This is basically fact, and it’s interesting that even people who know this (myself included) still succumb to the prevailing Wall Street culture that more hours = more & better productivity.
There is a trade-off to be sure.
Work wins high-frequency battles and grinders generate ideas but #BigIdeas, it seems, are the product of restless but rested minds.
Back to the Global Macro Grind…
A notable takeaway from last Friday’s jobs reports is that with hourly earnings growth decelerating and average hours worked per week declining, aggregate income growth will show further deceleration when the official income and spending data are released for February later this month.
Further, unless credit growth accelerates meaningfully and/or the savings rates declines materially, consumption growth for February should follow income growth lower.
This week is light in terms domestic fundamental data flow but we did receive some incremental updates related to both wage and credit trends.
Credit | Consumption’s Wild-Card: With household debt still very much elevated and no rope left on lowering debt service costs, the capacity for debt to support consumption growth over the intermediate and longer term remains constrained.
In the shorter-term, however, there exists some runway for accelerating credit growth to help offset slowing income growth in support of consumption.
Yesterday’s consumer credit data for January showed total borrowing rose $10.5B, marking the slowest gain in 27-months.
Non-revolving credit (i.e. auto’s and student loans) rose $11.6B sequentially while decelerating to +6.9% YoY – the slowest pace of growth since July 2012. Revolving credit (i.e. credit cards) dropped for the first time in a year, declining at an annualized rate of -1.4%. On a year-over-year basis, however, growth in credit card debt made a new cycle high at +5.27% YoY.
So, credit growth appears to be moderating but remains a modest, positive support to consumption growth. Not enough to fully compensate for the deceleration in income growth but a positive offset to buttress a slowdown in aggregate consumer spending.
Compensation Plans | Hurry Up & Wait: Keeping with the theme of wage and income growth, we got the NFIB small business confidence data for February this morning and, with it, the sub-indices tracking both actual Compensation trends and Compensation Plans.
Economists and strategists focus on the Small Business Compensation Plans index because, historically, it has presaged actual compensation increases pretty well – typically leading growth in the ECI and reported hourly earnings by ~3 quarters.
Indeed, and as we’ve highlighted, the strong advance in NFIB Compensation Plans over the last 39 months along with more recent strength in the Employment Cost Index (ECI) have backstopped consensus expectations for accelerating wage inflation for the better part of the past two years.
The Data | Ruh-roh? The February data showed the Hiring Plans Index decline -1 pt, the Compensation Index decline -5pts and the Compensation Plans Index decline -3pts; all marking 9 month lows and multiple months of sequential decline (See Chart of the Day above).
The decline off the recent peak and the failure for hourly earnings to accelerate as labor slack has diminished continues as a lead source of consternation for late-cycle labor and Phillips curve economists.
Why has the conventional relationship between unemployment and wages failed to materialize?
Mix Matters: Yesterday, the San Francisco Fed put some quant around a dynamic we’ve known was impacting the wage growth data but had yet to study intensively.
Specifically, they explored the impacts exerted by labor composition and the flow of workers into and out of the labor force on reported wage inflation.
You can read the note HERE but it’s worth reviewing the key takeaways.
Some of the underlying methodology is complex, but the conceptual crux of the analysis is pretty straightforward.
The analysis centers on the premise that income is generally an increasing function of age and tenure. That is, wage and salary income typically rises with experience and duration of full-time employment.
Commonsense and empirics side with that presumption.
This logic implies that older, continuously employed full-time workers, on balance, make more than part-time or recently employed, younger full-time workers.
Now, what would the impact to average wage growth be if labor turnover evolved in an exaggerated barbell type of way that saw older, more highly compensated workers retire and be predominately replaced by new lower-wage entrants?
Suppose further that at the same time, and in addition to this secular reality, labor slack and underemployment remain a cyclical overhang on compensation growth – and disproportionately so for new, younger entrants into the labor force.
Hidden In Plain Sight: Does the entry of younger, comparably lower-wage workers to full-time time employment and the exit of a large bolus of higher-wage retirees sound like any (Millennial-Boomer) developed market economy you know?
In other words, mix matters and when taking a composition-centric view of the labor force the protracted stagnation in reported average wage growth isn’t particularly surprising.
The implications are a few fold.
Labor composition shifts give leash to businesses, in the aggregate, to help manage and minimize labor cost pressure. However, if new entrants are less productive then unit labor costs may actually be rising (even though it wouldn’t be showing up in the headline inflation data, to the Fed’s continued chagrin).
Rising unit labor costs in combination with decelerating demand = incremental margin pressure for a corporate sector collectively past peak in profitability and now on the wrong side of the global growth curve.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 1.67-1.92%
Oil (WTI) 29.86-36.98
Best of luck out there today,
Christian B. Drake
U.S. Macro Analyst
Editor's Note: Below is a complimentary Early Look (our daily morning market newsletter) written by Hedgeye CEO Keith McCullough. In it, McCullough explains why stocks crash when earnings roll over. "Is this time different?," he asks. "Unlikely." Click here to subscribe.
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“There were humans long before there was history.”
-Yuval Noah Harari
The big picture
I think there were lots of bears before there was a Wall St. bull too. If you go all the way back, you’ll find that there was physics before humans. A new book on #evolution called Sapiens, by Yuval Noah Harari, got me thinking about this last night.
As Harari reminded me, “about 13.5 billion years ago matter, energy, time and space came into being in what is known as the Big Bang…” After physics, came biology (3.8 billion years ago) … then human history (70,000 years ago)…
And now, post a 500 year long scientific revolution, we have a social “science” experiment (or ideology) called central-market-planning (or QE)… which could easily implode if the #BeliefSystem that humans can bend and smooth economic gravity crashes.
Wow. In terms of a time-series, that’s a little deeper than staring at a 50-day moving monkey, isn’t it? While our understanding of physical, biological, and human histories continue to evolve at an accelerating rate, how did the Old Wall’s thinking get left behind?
Over the course of the last 30 years, Japan’s “growth” story has been left for dead. Instead of asking yourself when you should be “buying Japanese stocks”, why not ask yourself if this is the beginning of the end – of the grand central-market-plan, that is?
My Big Bang Theory for the #CurrencyWar (one of the Top 3 Themes in our Macro deck right now) is as follows:
- Japan is no longer able to convince markets that it can burn its currency at the stake on command
- Japan’s Yen starts to rise, and Japanese stocks start to crash
- Europe then fails to convince consensus of the same
- Euro goes up (instead of down) on Draghi’s next central-market-planning day (March 10)
- European and US stocks resume their current crashes and go straight down
I know, I know. It’s just a theory. But it’s what I would call one that has a probability that is rising, not falling, in rate-of-change terms. Not only is my intermediate-term TREND signal research suggesting rising probability, but super long-term history has always sided with gravity. So why would economic reality vs. perma-asset-inflation-hope be any different?
On a much shorter-term basis (because that’s where the next ECB and Fed meetings reside):
- Realize that the inverse correlation between the USD and Commodities remains pervasive (not transitory)
- But there is a developing POSITIVE correlation (15-30 day = +0.5-0.7) between USD and US stocks
What that tells me is that if we’re right on both the US economic and profit cycle continuing to slow in 1H 2016, Dollar Down => Rates Down => Stocks Down, could easily be perpetuated by the #BeliefSystem in both Japan and Europe breaking down.
Anyway – just a theory. Moving along…
As you know, irrespective of any longer-term Big Bang Theories that have a short-term catalyst, the easiest call for me to stick with is the intimate relationship PROFITS have with CREDITS at this stage of the cycle.
While they’ve “rallied” US stocks “off the lows” on slow-volume (Total US Equity Volume -15% vs. 1-month avg yesterday), the SP500 and Russell 2000 are still -8.7% and -21.1% (crashing), respectively, from their all-time #Bubble highs established in July.
Meanwhile, here’s the update on corporate profits:
- 435 of 500 S&P 500 companies have reported their respective quarters
- Aggregate SALES growth is -4.2% year-over-year and EPS down -6.5% year-over-year
- Only 3 of 10 S&P Sectors have POSITIVE year-over-year EPS growth
- ENERGY (31 of 41 companies reported) has SALES -34%, EPS -74%
- FINANCIALS (85 of 89 companies reported) has SALES -1%, EPS -8.8%
In other words, if your friends are still “backing out energy” and levered long US Equity beta, they’re a lot more exposed to rates crashing, Yield Spread compressing, and the Financials (XLF -11% YTD) than they’ve ever been!
Unless it’s different this time, US stocks always crash (greater than 20% decline from peak) once corporate profits go negative (on a year-over-year basis) for two consecutive quarters.
I’m certain that physics and biology have played a part in all economic cycles. But given that there was history before there were “stocks”, I have no idea how slowly or quickly the beginning of the end turns into a new beginning for a more credible belief system.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 1.62-1.84%
Oil (WTI) 25.77-33.61
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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