CREDIT RISK: Yes, Still A Risk

Takeaway: The squeeze in commodities since mid-February hasn’t changed our view in the downside to the credit cycle.

Our takeaway with respect to the relief in credit spreads, especially in the resource space, is that we believe the tightening is temporary, driven by a shift in policy expectations, and the result of a heavy squeeze in deep cyclicals.

To borrow a line from Drake’s Early Look Tuesday recapping January’s consumer credit data, “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.”

We would also echo the “lack of rope” on the corporate investment and financing side of the equation, particularly as it relates to forward looking earnings expectations in the space.


Below we offer a series of charts and tables to support the argument that there is less room for "more rope" from a policy-induced financing perspective. Here are our main conclusions:

  • The leverage thrown on at elevated commodity prices and the lower bound in rates has decidedly started moving the other way since 2014, and the recent squeeze in resource-driven sectors, and the move in spreads won’t help cushion the necessary balance sheet flush
  • EBIT estimates for the balance of 2016 and 2017 remain optimistic, and we expect the contraction of capital on balance sheet to be an earnings headwind in the resource space for a longer period of time
  • There has been a healthy consolidation in consensus short commodity/long USD positioning  and rate hike expectations heading into the year, and this consensus expectation has now shifted the other way into the policy catalysts, starting with the ECB this morning  


  • The most heavily shorted, larger cap cyclicals in the Resource and Materials related space are also the top equity performers on a 1-mth window. When deep cyclicals in oversupplied, mature industries double in less than 2 months, we call that a squeeze:

CREDIT RISK: Yes, Still A Risk - Short Interest


CREDIT RISK: Yes, Still A Risk - Relative Performance


  • With a breather in the USD ascension YTD, The short-term move in iron ore, gold, WTI etc. has helped their respective equities, the equity indices of resource leveraged countries, and the sovereign and corporate resource-leveraged sovereigns: 

CREDIT RISK: Yes, Still A Risk - EM CDS


The takeaway as it relates to credit extension and contraction is that credit has already meaningfully tightened on top of peak leverage in commodity space, and we expect the capital flush will continue to be an earnings headwind in Q2. Spreads in the resource heavy space are meaningfully higher Y/Y despite the temporary pullback:

  • Spreads remain +~200-250bps wider Y/Y after widening in 2015 for the balance of the year
  • A cyclical trough in rates followed by a meaningful breakout in spreads hasn’t historically reversed in the same cycle
  • Resource-related credit (largely mature industries ex. U.S. shale) jumped from 5% to 14% of aggregate corporate credit outstanding in the 10-year period from 2004-2014 (sample of 34 producers)
  • Reported interest expense jumped 2.5x for this same group over that 10-year period despite the access to increasingly cheaper financing to the 2014 low in corporate credit spreads. This financing ability has already moved the opposite way for a long time
  • EBIT estimates remain too optimistic in our opinion for 2016, and much of the growth is expected in the resource space (the last two charts exemplify the Materials space)  

CREDIT RISK: Yes, Still A Risk - HY Spreads


CREDIT RISK: Yes, Still A Risk - IG and HY Spreads vs. Recessions


CREDIT RISK: Yes, Still A Risk - Commodity Producer Debt   Corporate Credit Oustanding


CREDIT RISK: Yes, Still A Risk - Gold Miner Debt vs. Real Rates


CREDIT RISK: Yes, Still A Risk - Commodity Producer Interest Expense


CREDIT RISK: Yes, Still A Risk - S P Materials Operating EPS Estimates


CREDIT RISK: Yes, Still A Risk - EBIT Divergences


EARNINGS: The backside of cheap leverage at high commodity prices is an extended capital flush that lasts for a long period of time. In reality there is too much capital chasing production that can’t be absorbed

  • This balance sheet deleveraging manifests in D&A, write-downs, impairments and even haircuts for some over a long period of time which we expect to offset the lapping of difficult comps (a bull case scenario to the awful Q4 earnings season which is winding down). Judging by Q4 earnings many companies made the choice to avoid the necessary charges for a future time in the hopes of a price rebound
  • Capital in play per oz. of production has only began inflecting off historic highs despite production efficiency gains (the backside of an industry-wide capital spending boom)

CREDIT RISK: Yes, Still A Risk - S P Rev.   Earnings Comps


CREDIT RISK: Yes, Still A Risk - Net PP E Per Oz. Gold


CREDIT RISK: Yes, Still A Risk - PP E Per Oz. in XOP


This balance sheet deleveraging is slowly on the move, but we argue it will get worse throughout the balance of the year as the cycle gets longer in the tooth.

Below we re-worked two slides in our Q1 themes macro deck to paint the cyclical picture of a breakout in credit spreads (credit’s share of GDP) within the longer-term debt cycle of which little policy “rope” remains for another cycle to commence.


CREDIT RISK: Yes, Still A Risk - Corporate Credit   GDP


CREDIT RISK: Yes, Still A Risk - Corporate Debt   GDP


Excluding the increasingly limited financing availability on the corporate investment, a number of other metrics suggest a tighter credit environment broadly (which helps elongate consumption and investment).

As our financials team outlined in its re-cap of the Q1 2016 Senior Loan Officer Survey, a tightening in commercial & industrial (C&I) loan standards continued for the second consecutive quarter. And not only did the net percentages of lenders tightening standards for those categories increase, but demand for C&I loans declined. Additionally, the Fed's survey this quarter included special questions regarding forward expectations, and loan officers indicated that they expected a further tightening of standards, increasing of spreads, decreasing volumes, and deteriorating credit quality over the course of 2016.

The risk to being long a deflationary credit unwinding is that the Fed has more RELATIVE room to fight a deflationary burden with easier policy (weaker USD, measures to lower rates, and money printing to help cushion the debt burden) when compared to other central banks, which is why the “Fed Put” still has more credibility with deteriorating data (and the expectation that the dot plot will be revised lower next week). However, the current cushion is non-existent compared to previous peaks in Fed Funds:


CREDIT RISK: Yes, Still A Risk - Corporate Debt   GDP


Concluding with behavioral, market-based expectations, the pull-back in Fed Funds expectations YTD, and a healthy rebalancing in net USD long, commodity short positioning (net futures and options positioning), the market is now leaning the other way into the March policy catalysts (long Euros, treasuries, and gold, and short dollars on the other side). This set-up suggests Draghi can’t do enough to outweigh consensus expectations this morning. Overall, both the longer-term fundamental and quantitatively bullish set-up for the USD remains intact. For a walk through in how we see this playing out, we’ve pre-coined the “BIG BANG”  


CREDIT RISK: Yes, Still A Risk - Fed Funds Cushion


CREDIT RISK: Yes, Still A Risk - Strong USD Chart


CREDIT RISK: Yes, Still A Risk - USD Trend Chart


Ben Ryan






Cartoon of the Day: Out Of Ammo

Cartoon of the Day: Out Of Ammo - Draghi cartoon 03.09.2016


ECB head Mario Draghi will attempt to quell uneasy macro markets tomorrow. Will he pull the trigger on more easing? Will it matter?

Washington on Wall Street: The Very Real Possibility Of A Contested GOP Convention


Following Tuesday’s presidential primary contests, Hedgeye Director of Research Daryl Jones walks through the key takeaways, including the historical context around previous contested conventions and potential stock market implications.

Early Look

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NEW VIDEO | The Bear Case On Foot Locker (FL)

We thought you would appreciate this brief 2-minute video.


Hedgeye Retail analyst Alec Richards explains why the expansion of Nike’s (NKE) direct-to-consumer business is bearish for footwear retailer Foot Locker.


If you have any questions or comments, please email Matt Moran at .


Best Regards,

The Hedgeye Team


Why Clinton Lost Michigan... & Cruz's Big Gamble

Takeaway: What to watch on the election 2016 campaign trail.

Below is a brief excerpt from Potomac Research Group Chief Political Strategist JT Taylor's Morning Bullets sent to institutional clients each morning.



Why Clinton Lost Michigan... & Cruz's Big Gamble - trump face


Whatever rattled Donald Trump last weekend is already old news. His double-digit takedown of his rivals in MI coupled with his wins in MS and HI last night netted 71 delegates and significantly shifted momentum back his way. Now heading into the winner-take-all states, Ted Cruz is back on defense despite winning Idaho, Marco Rubio is limping (he picked up no delegates) and after playing big in MI, John Kasich may have lost momentum going into his neighboring OH.


Trump's focus now turns to tomorrow night's debate in Miami (another QVC-esque infomercial for Trump products anyone?) and holding his ground while his rivals frantically attack him.



Why Clinton Lost Michigan... & Cruz's Big Gamble - ted cruz photo


Ted Cruz continues to invest serious resources into FL, despite having no chance of winning the state. Cruz's strategy to intercept the anti-Trump vote from Marco Rubio has two prongs:

  1. Denying him a home-state victory and likely sinking his candidacy for good;
  2. Keeping Rubio pinned down while he presses ahead in other March 15th states.

It's a big gamble -- if Trump wins the state along with NC and IL, his delegate lead will be all but insurmountable. While Rubio and John Kasich are pinning their hopes on prevailing at an open convention, Cruz is reaching for an outright win in the delegate count -- even at the risk of ending the contest next week.



Why Clinton Lost Michigan... & Cruz's Big Gamble - bern


Throughout Hillary Clinton's campaign, she has raked in local endorsements from Democratic mayors, state leaders, and even governors across the nation. Her tactical focus on local issues like water, minimum wage fights, and her calculated attacks against Republican governors at local rallies have so far won her broad support.


Then what happened in Michigan last night? One word -- trade. In exit polling, MI Democrats overwhelmingly expressed that trade with other countries "takes away U.S. jobs" -- and it didn't help that Bernie Sanders outspent Clinton in the state and exposed her support for trade pacts during the Flint debate, in speeches, and negative ads for the past month. With Clinton's overwhelming win in MS, she still wins the day and more delegates.

A Look At The MLP Boom & Bust With Hedgeye Energy Analyst Kevin Kaiser

Editor's Note: Earlier today, Hedgeye Energy analyst Kevin Kaiser published a 55-page "Midstream MLP Chart Book" institutional research deck highlighting key metrics and developments. As a reminder, Kaiser has been the lone MLP bear since the beginning on companies including Kinder Morgan and Linn Energy. He was recently featured in Barron's (MLPs: Is the Worst Over?). 


The chart below compares the narratives floated about the MLP industry during the boom years (2000-2014) to the bust of 2015.


Click to enlarge 

A Look At The MLP Boom & Bust With Hedgeye Energy Analyst Kevin Kaiser - mlp kaiser chart

To access Kaiser's research email

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