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Howe: A ‘Foreboding’ Election And Its Implications

 

Hedgeye's Demography Sector Head Neil Howe discusses the GOP and Democratic presidential candidates, how Donald Trump could “destroy the traditional Republican party,” and what it means for markets.  


REPLAY | Keith McCullough, Darius Dale and Neil Howe on The Macro Show

Did you miss Keith, Darius and Neil on The Macro Show today? Catch the replay HERE.

REPLAY | Keith McCullough, Darius Dale and Neil Howe on The Macro Show - TMS 3.24

 

This dynamic trio hit on a wide-ranging number of topics in a very thoughtful discussion including:

  • Being The Bear in commodities
  • Another Fed policy mistake
  • What the next Bull Market will look like
  • How much pain (both economically and institutionally) we'll have to undergo to get there
  • Why it's time to be positioned short "rich people"/long "poor people"
  • and much more...

 Don't forget you can watch The Macro Show week-day mornings at 9:00AM ET HERE.


Macro Playbook: Helping Bears Maintain Our Collective Conviction

Yesterday, were asked by a very sharp, longtime client of Hedgeye if we still had conviction in our #USRecession theme after the recent sharp rally in risk assets, which came amid a number of positive surprises across various economic data throughout the YTD. For those economic cycle junkies among you, we expand upon our answer to his question in great detail below:

 

Yes, we still do believe the U.S. economy may experience a shallow recession over the intermediate term and that it has the highest likelihood of commencing in/around 3Q16. Specifically, our top-three U.S. recession indicators (i.e. the Jobless Claims, Consumer Confidence and Corporate Profit cycles) are all continuing to progress according to our previously defined expectations:

 

Macro Playbook: Helping Bears Maintain Our Collective Conviction - Recession Watch Jobless Claims

 

Macro Playbook: Helping Bears Maintain Our Collective Conviction - Recession Watch Consumer Confidence

 

Macro Playbook: Helping Bears Maintain Our Collective Conviction - Recession Watch TTM EPS

 

Additionally, the domestic #CreditCycle continues to deteriorate in kind with the trends we identified at the onset of the year:

 

Macro Playbook: Helping Bears Maintain Our Collective Conviction - Hedgeye Macro U.S. Bank Credit Cycle Indicator

 

Macro Playbook: Helping Bears Maintain Our Collective Conviction -  CreditCycle Delinquencies Slide 35

 

That being said, however, the meaningful retreat in HY OAS is new and noteworthy, so we must be cognizant of the extent to which the market is pricing in all of the above fundamental signals as head fakes. On that note, HY spreads would have to get back below their long-term historical mean of ~500bps on an index basis for us to consider that to be true. Right now, they’ve currently retreated back to just above 600bps, which implies a considerable amount of tightening from here for the credit markets to shake us off our recession view.

 

Macro Playbook: Helping Bears Maintain Our Collective Conviction - HY OAS by Sector

 

Commensurate with this decline in spreads, Standard & Poor’s notes that the U.S. distressed ratio – a gauge of the proportion of speculative-grade bonds with a spread over Treasuries of more than 10 percentage points – had fallen to 24.8% as of March 15 from 33.9% at the end of February. That’s the first bi-weekly decline since last May. Per S&P via the Financial Times, there were 279 borrowers with bonds trading in the distressed range, affecting total debt of $214B in March, compared with 353 issuers affecting $327B in debt the month prior.

 

Time will tell whether or not the aforementioned sequential improvement is a short-term, reflation-based market head fake. Credit spreads can widen just as quickly as they’ve tightened since mid-February…

 

But above all else, as we’ve stressed repeatedly throughout the year, a U.S. recession is actually the least pressing of what we consider to be the biggest risks to asset markets. Those risks are as follows (in order):

 

  1. Corporate profit recession (ongoing)
  2. Deteriorating credit cycle (ongoing)
  3. #BigBangTheory – i.e. market participants broadly losing faith in central bank Policies To Reflate (TBD domestically)
  4. A technical recession in the U.S. (progressing according to plan, but likely to be shallow like the 2000-02 C&I lending led downturn)

 

Macro Playbook: Helping Bears Maintain Our Collective Conviction - Profits Down  Stocks Down Slide 39

 

Macro Playbook: Helping Bears Maintain Our Collective Conviction - Spread Risk HY Slide 43

 

Obviously risks #1 and #2 are intricately linked, as is #3 – specifically because that would be proof of the Fed losing its perceived ability to counteract microeconomic gravity with shell games of ZIRP and debt-financed buybacks.

 

We discuss risk #4 in great detail at the conclusion of our 2/3 note titled, “Ex-Energy?”:

 

“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 [DESPITE the Fed cutting rates by a cumulative -525bps during the decline].”

 

Like Rome, economic contractions aren’t built in a day. Domestic high-frequency economic data needs to continue decelerating from here in order to become equally as reflexive on the downside as it is during an expansion.

 

And much like with bear markets that are historically rife with massive short squeezes to lower-highs, there will be “green shoots” (i.e. sequential upticks) across several key data sets that lead perma-bulls to believe the bottom is in with respect to growth. The TREND remains your friend on that front, however.

 

As the following chart highlights, every major category of high-frequency economic growth data continue to decelerate on a TRENDing basis in spite of whatever recently released, sequentially positive data points the bulls want to anchor on; meanwhile, every major category of high-frequency inflation data is accelerating on a trending basis. This confluence is a double-negative for TREND real GDP growth expectations for both investors (think: flows) and corporations (think: capex) alike.

 

Macro Playbook: Helping Bears Maintain Our Collective Conviction - U.S. Economic Summary

 

Sure, select indicators such as last week’s Retail Sales report or today’s Service and Composite PMI readings have ticked up in the February/March timeframe, but does cheerleading that on A) account for the fact that they are all still making a series of lower-highs on a trending basis; or B) account for the sharp deterioration across the housing sector (CLICK HERE and HERE for more details) or nascent cracks across the commercial real estate sector?

 

Macro Playbook: Helping Bears Maintain Our Collective Conviction - RETAIL SALES CONTROL GROUP

 

Macro Playbook: Helping Bears Maintain Our Collective Conviction - MARKIT SERVICES PMI

 

Macro Playbook: Helping Bears Maintain Our Collective Conviction - MARKIT COMPOSITE PMI

 

Of course they don’t. Anyone who thinks they do likely lacks a repeatable process for contextualizing macro data, which we dissected at length in our recent Early Look titled, “Bull Market Marketing”.

 

It does, however, call attention to the analytically weak nature of the nascent bull thesis for U.S. stocks and credit. As the following table highlights, there’s a lot of green (i.e. accelerating) in the “Sequential Data” column to the right, while the “Trending” and “Quarterly Average” data columns are as red (i.e. decelerating) as ever:

 

Macro Playbook: Helping Bears Maintain Our Collective Conviction - U.S. Economic Summary Table

 

Let’s ignore the ongoing, trending slowdown in Industrial Production growth in order to play devil’s advocate for a second. Can the nascent recovery in domestic manufacturing activity get back to healthy enough levels in time to offset ongoing degradation in the growth rate(s) of consumer spending?

 

Macro Playbook: Helping Bears Maintain Our Collective Conviction - INDUSTRIAL PRODUCTION

 

Macro Playbook: Helping Bears Maintain Our Collective Conviction - DURABLE GOODS

 

Macro Playbook: Helping Bears Maintain Our Collective Conviction - CAPITAL GOODS

 

Macro Playbook: Helping Bears Maintain Our Collective Conviction - ISM MANUFACTURING PMI

 

To answer the question, base effects support some version of the soft bigotry of low expectations that is “muddle-along nirvana” for a quarter (i.e. Q1) while compares for both “C” and “I” are easier on a sequential basis – but not for much longer than that:

 

Macro Playbook: Helping Bears Maintain Our Collective Conviction - PCE COMPS

 

Macro Playbook: Helping Bears Maintain Our Collective Conviction - Industrial Production Comps

 

As an aside, base effects for Real PCE in the four quarters ended in 3Q16 remain as tough as anything the U.S. consumer has experienced since the four quarters ended in 3Q08. Recall that Real PCE growth decelerated sharply from +2.7% YoY in AUG ’07 to -1.2% in SEP ’08. As such, we continue to anticipate real consumption growth as having downside risk to +1% YoY in a moderate scenario. As one very astute client accurately pointed out in a recent meeting:

 

“While that may not produce an actual technical recession, it may certainly feel like one – especially relative to consensus expectations of a “resilient” U.S. consumer.”

 

Indeed.

 

As Keith remarked during a client meeting on Tuesday, it’s actually easier to make the bearish economic cycle call today than it was [at the top] in early July, as most economic data series weren’t broadly slowing then. Now we can simply sit back and watch market prices [hopefully] continue to come our way on a trending basis. Sounds simple enough.

 

And by the way, #Quad4 starts next Friday…

 

Macro Playbook: Helping Bears Maintain Our Collective Conviction - Brent Crude Oil

 

Happy Easter,

 

DD

 

Darius Dale

Director


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Cartoon of the Day: Permabull Storytelling

Cartoon of the Day: Permabull Storytelling - Bull market 03.24.2016

 

Reality check: The S&P 500 is back to flat for the year after its worst start ever. Meanwhile, the Russell 2000 is down -5% year-to-date.


CME: Adding CME Group to Investing Ideas (Long Side)

Takeaway: We are adding CME Group to Investing Ideas today.

Editor's Note: Please note that our Financials analyst Jonathan Casteleyn will send out a full report outlining our high-conviction long thesis next week. In the meantime, below is a brief summary of our thesis sent today by Hedgeye CEO Keith McCullough in Real-Time Alerts.

 

CME: Adding CME Group to Investing Ideas (Long Side) - trading floor

 

With long-term bond yields signaling immediate-term TRADE oversold (within bearish yield TREND view), I'm going to signal buy here on red on one of the few Financials (XLF down another -1.2% today, crushing the bulls) our Jonathan Casteleyn likes right now: CME Group (CME).

 

"CME Group (CME), one of the few stocks that sits on our Best Ideas list as a long, put up a decent fourth quarter earnings print with a slight revenue and earnings beat. Not that we put much weight on what happened last quarter but trends into the new operating period are looking even better. The exchange guided to just a +1% operating expense increase for 2016, guided to slightly lower annual taxes for '16 (with more activity coming from abroad), and again announced that open interest was setting a new record, at over 111 million contracts.

 

Even assuming some mean reversion to just over 16.5 million contracts (depending on product group), 1Q is running at ~$1.20 per share in earnings, which means the Street will need to perk up its current $1.06 estimate. Simply put, this is one of the few growth stories in the current macro environment within Financials."


DRI: We Are Removing Darden Restaurants From Investing Ideas

Takeaway: Please note we are removing Darden Restaurants from Investing Ideas (short side) today.

"The stock has corrected hard post the squeeze," says Hedgeye CEO Keith McCullough. "I want to take it off, for now, and put on some other short ideas."

 

Please note Hedgeye Restaurants analyst Howard Penney remains bearish on Darden. Here's a distillation of his bearish case from his original stock report on the company:

  • Having pulled all the levers to create shareholder value, it’s now down to the facts about how Darden's core business is performing. 
  • Under the new business model the company is posting peak margins. In addition to significant capital investment, the company will need to invest in incremental food and labor costs to drive positive traffic across the enterprise.
  • Olive Garden has been in need of a major remodel since FY2007. Olive Garden has about 400 older RevItalia restaurant models that are in dire need of remodeling... To date, Olive Garden has done 32 remodels, and is far behind schedule. Olive Garden makes up roughly 56% of sales and is in need of cash just to prevent declines. 
  • The company is in desperate need of a large capital investment to turn around their negative trends. Until management realizes, this the business will continue to decline and the stock will go with it. 

 

DRI: We Are Removing Darden Restaurants From Investing Ideas - darden


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