The Taming of Profits

“No profit grows where no pleasure is taken.”

-William Shakespeare


And, generally speaking, no multiple expansion grows when there’s no corporate profit growth. Rather than The Taming of the Shrew (i.e. where that Shakespeare quote comes from), USA is seeing The Taming of Profits.


No, I’m not talking about the taming of US stock market profits and/or returns (i.e. the ones that were negative in 2015 and mostly negative for 2016 YTD) – I’m simply talking about US Corporate Profits, which were reported to have remained in #Recession on Friday.


No worries. We’ll probably be the only ones on Wall St. writing about it this morning. If only the bulls of the 2015 peak warned you that Q415 corporate profits would slow another -540 basis points sequentially (vs. Q3 when they first went negative) to -10.5% year-over-year.


The Taming of Profits - recession cartoon 02.22.2016


Back to the Global Macro Grind


As Darius Dale wrote to our Institutional clients on Friday, you have to go all the way back to the depths of the 2008 Financial Crisis (Q408) to find a worse year-over-year decline in US Corporate Profits.


“More importantly, Q4 marked the 2nd consecutive quarter of declining corporate profit growth… such occurrences have been proceeded by stock market crashes in the subsequent year for at least the past 30 years (5 occurrences).”


Since Q4 ended on December 31st (they haven’t been able to centrally plan a change in the calendar dates yet), has anyone considered why we just saw the worst 6 week start to a stock market year ever? Yep, it’s the Profit vs. Credit Cycle (within the Economic Cycle), stupid.


Ok. If you’re not stupid, but really super smart and still blaming “the algos and risk parity funds” for the AUG-SEP and DEC-FEB US stock market declines, but giving them 0% credit for the JUL, OCT, and MAR decelerating volume bounces… all good, Old Wall broheem, all good.


Many who missed the economic cycle slowing from its peak (and the commensurate profit #slowing and credit cycles that always come along with such a rate of change move) will blame the US Dollar for that.


They, of course, wouldn’t have blamed Ben Bernanke devaluing the US Dollar to a 40 year low for the all-time high in SP500 Earnings (2015) though. That would be as ridiculous as blaming the machines and corporate buy-backs for market up days.


Last week the US Dollar came back, and the “reflation” trade didn’t like that. With the US Dollar Index +1.2% on the week:


  1. The Euro (vs. USD) fell -0.9% on the week to +2.8% YTD
  2. The Yen (vs. USD) fell -1.4% on the week to +6.3% YTD
  3. The Canadian Dollar (vs. USD) fell -2.0% on the week to +4.3% YTD
  4. Commodities (CRB Index) fell -2.4% on the week to -2.3% YTD
  5. Oil (WTI) fell -4.1% on the week to -1.3% YTD
  6. Gold fell -2.5% on the week to +15.3% YTD


Yeah, I know. Those 5 things are just the things that have immediate-term inverse correlations of 79-99% vs. the US Dollar, but there’s this other big thing called the SP500 that now has an immediate-term (3-week) inverse correlation of -0.80 vs. USD too.


Imagine that. Imagine the machines stopped chasing the hope that the Fed fades on their rate hike plan, the US dollar gets devalued (again), and all of America keeps arguing about the “inequality” gap having nothing to do with Fed Dollar Policy?


You see, when you devalue the purchasing power of a human being:


A) Almost everything they need to buy to survive goes up in price as the value of their currency falls

B) A small % of human beings (i.e. us) get paid if they own the asset prices we are “reflating”


And if you’re not a human being (i.e. you’re a US corporation) and your profits are falling, all you have to do is lever the company up with “cheap” US debt, buy back the stock with other people’s money, lower the share count, and pay yourself on non-GAAP earnings per share.




While small/mid cap US Equities reverted to their bear market mean last week (Russell 2000 down -2.0% on the week and -16.7% since US Corporate Profits peaked in Q2 of 2015), so did a few other US Equity Market Style Factors that had had a big 1-month bounce:


  1. High Beta stocks were -2.0% on the week
  2. High Leverage (Debt/EBITDA) stocks were -1.9% on the week
  3. High Short Interest stocks were -1.7% on the week

*Mean performance of Top Quintile vs. Bottom Quintile (SP500 companies)


At the same time, Consensus Macro positioning remained what most US stock market bulls would have to admit they want/need from here (Down Dollar => Up Gold, Commodities, and Oil):


  1. Net LONG position in USD (CFTC futures/options contracts) was -2.16x standard deviations vs. its TTM average
  2. Net LONG positions in Gold and Oil held 1yr z-scores of +2.45x and +1.33x, respectively


In other words, in the face of both the economy and profits slowing, Wall St. wants to go back to that ole story of Burning The Buck, I guess. It’s sad and it probably won’t work… but, as Shakespeare went on to say about profits and pleasures, “study what you most affect.”


Our immediate-term Global Macro Risk Ranges are now:


RUT 1060-1107
USD 94.68-97.01
Oil (WTI) 36.06-42.91

Gold 1


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


The Taming of Profits - 3 28 Profits Down  Stocks Down Slide 39

Retail Idea List: Major Growth Spurt This Week

Takeaway: We’re shaking up the Retail Idea list by adding 12 names to our vetting bench. Shorts outnumber longs 2-to-1.

Lots of changes (12 to be exact) to our Idea List this morning.

First off, we broke both longs and shorts into three categories 1) Best Ideas, 2) Other Active Longs, and 3) Bench. All three labels speak for themselves. Best Ideas are our highest conviction names, Active Ideas includes names where we’re officially on the clock – but lack the conviction at this point to make the ‘Big’ call, and the Bench indicates that either Research is still in progress, or the price is not yet appropriate.


A second observation…we’re looking at 3 Longs and 8 Shorts, with roughly 10 names on the Vetting Bench. Definitely lopsided, but the latest rally took away the ‘cheap’ factor for a lot of these names.


Here’s a 1-liner on all additions this week.


COH: Near the higher range of where we’re comfortable, but the space continues to look good to us. COH likely to test higher than people think.

TLRD: When a name loses 75% of its value after botching up a deal, we’ve got to at least scrub it for some value – maybe.

FLEX: Flextronics. Not a retail name – but we don’t care. It’s got razor thin (3%) margins, and signed a major deal with Nike. We know that Nike is thinking VERY big on this one. We need to quantify the difference it could make. At FLEX’s margin structure, it could be material.

TJX: We’re more convinced that there will be excess inventory in the department store channel this year, which helps TJX. Also, Home Goods might only be 11% of the company, but it’s bigger than RH and Wayfair. Can’t overlook that. Yes, the chart and valuation are both scary. But you could have said that a year ago. And a year before that, and so on.

FRAN: We’re not sure if we ‘get’ the concept, but we also did not ‘get it’ when the stock was 2x where it is today. Not a lot of unit growth out there in retail today, and this name’s got it. This is worth a look (at a minimum to see if it should or should not be growing – either way, there’s a call).



HBI: We don’t like the Brands, the Company, positioning in the Category, the Management team, or the Stock. This is kind of like LULU (as it relates to those characteristics) but with less desirable product.



PVH: The company is being celebrated for putting up horrible quality numbers.  We think it’s seriously growth-constrained. Looks like a short is two quarters early given expectations – but we’ll be patient.

SHOO: Over exposed to two segments we don’t like – Department Stores and non-athletic/fashion footwear. Core business rolling over, growth from acquisitions drying up, new peakish margins, at a 17.7x earnings and 10.6x EBITDA screens like a short to us.

OLLI: A rare square footage growth story, but currently overpriced with underappreciated capital needs and long term risks to the model. When the company anniversaries its private equity IPO in July, we could start to see some fireworks. If so, we’ll have a front row seat.

DKS: No Sports Authority won’t be a big help to DKS, and not making up any of the margin dollars lost in Golf/Hunt. In fact, let’s look at the reason WHY TSA went under in the first place. Those factors are bearish for DKS. We’d previously been bullish on DKS – but that ship has sailed.

WSM: Just listen to that last conference call. This management team is perfectly appropriate for a $1bn company. Unfortunately, WSM is $5bn.

FINL: The same factors that will hurt FL (NKE aggressively shifting around traditional wholesalers) could destroy FINL, which trips over its own kicks when everything else is going just great in the land of shoe retail.


Retail Idea List: Major Growth Spurt This Week - 3 28 2016 Chart1

REPLAY! This Week On HedgeyeTV

Our deep bench of analysts take to HedgeyeTV every weekday to update subscribers on Hedgeye's high conviction stock ideas and evolving macro trends. Whether it's on The Macro ShowReal-Time Alerts Live or other exclusive live events, HedgeyeTV is always chock full of insight.


Below is a taste of the most recent week in HedgeyeTV. (Like what you see? Click here to subscribe for free to our YouTube channel.)




1. Washington on Wall Street: A ‘Foreboding’ Election And Its Implications (3/24/2016)



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.



2. McCullough: Give Me Liberty! (3/23/2016)



In this excerpt from The Macro Show this morning, Hedgeye CEO Keith McCullough takes a page out of American patriot Patrick Henry’s playbook on the anniversary of his "Give me liberty, or give me death!" speech. He also addresses critics of his current bearish stance on equities.


3. McCullough: Joke of the Year? Fed Data Dependence (3/22/2016)



In this animated excerpt from The Macro Show this morning, Hedgeye CEO Keith McCullough pulls no punches on San Francisco Fed President John Williams’ head-scratching contention that he’s data dependent. If you like this excerpt, you’ll love The Macro Show.

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Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.

The Week Ahead

The Economic Data calendar for the week of the 28th of March through the 1st of April is full of critical releases and events. Here is a snapshot of some of the headline numbers that we will be focused on.



The Week Ahead - 03.25.16 Week Ahead

This Week In Hedgeye Cartoons

Our cartoonist Bob Rich captures the tenor on Wall Street every weekday in Hedgeye's widely-acclaimed Cartoon of the Day. Below are his five latest cartoons. We hope you enjoy his humor and wit as filtered through Hedgeye's market insights. (Click here to receive our daily cartoon for free.)


1. Permabull Storytelling (3/24/2016)

This Week In Hedgeye Cartoons - 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. 


2. The Fourth Turning (3/23/2016)

This Week In Hedgeye Cartoons - demographics cartoon 03.23.2016


Demographic trends are radically reshaping the U.S. economy.


3. American Gothic II (3/22/2016)

This Week In Hedgeye Cartoons - Fed Up cartoon 03.22.2016


As Hedgeye CEO Keith McCullough has repeatedly reiterated, what the Fed's quantitative easing actually did was "pay the few and crushed the many."


4. Nuclear Decay (3/21/2016)

This Week In Hedgeye Cartoons - radio activist cartoon 03.21.2016


Shares of embattled Valeant Pharmaceuticals (VRX) are down 89% since July much to the chagrin of (radio)activist investor Bill Ackman, whose firm Pershing Square Capital owns a 9% stake.

U.S. Corporate Profits Plunge Into the Abyss... What Are the Implications?

Conclusion: The ongoing recession in domestic corporate profits just took a decided turn for the worse; this has dramatic forward-looking implications for both the S&P 500 and the labor market.


Aggregate domestic corporate profits are released commensurately with the third and final GDP report of any given quarter. With this morning’s release of the 4Q15 statistics, we learned that the ongoing recession in domestic corporate profits just took a decided turn for the worse.


The -10.5% YoY rate of contraction was slower by -540bps sequentially and represents a new low for the cycle. You have to go all the way back to the depths of the financial crisis (4Q08) to find a worse YoY growth rate. More importantly, Q4 marked the second-consecutive quarter of declining corporate profit growth; as we were keen to highlight on our 1Q16 Quarterly Macro Themes Conference Call, such occurrences have been proceeded by stock market crashes in the subsequent year for at least the past 30 years (five occurrences).


U.S. Corporate Profits Plunge Into the Abyss... What Are the Implications? - Profits Down  Stocks Down Slide 39


Recall that we also showed that, over the past 30 years, anytime the TTM EPS reading of the S&P 500 breaks down below its 12MMA, a recession has ensued in short order. With respect to the current business cycle, the breakdown occurred in June 2015 and we’ve been trending below the 12MMA ever since.


U.S. Corporate Profits Plunge Into the Abyss... What Are the Implications? - Recession Watch TTM EPS


Recall that we also highlighted the headwind to the labor market that is declining corporate profits. Don’t for one second think that the scars of 2008-09 haven’t perpetuated a broad-based “CYA” attitude among executives of large U.S. enterprises. When it comes to protecting their “buyback babies” and their own personal (read: stock based) compensation, we believe they are most likely to eschew labor costs, at the margins. Whether or not they do it fast enough to prevent further declines in corporate profits remains to be seen.


U.S. Corporate Profits Plunge Into the Abyss... What Are the Implications? - Profits Down  Employment Headwind Slide 37


Unfortunately for this economic cycle, we are in a fairly precarious position with respect to the domestic labor cycle. It literally doesn’t get much better than it has been trending on a trailing 6-12 month basis. That doesn’t mean the U.S. consumer is facing imminent risk of a plunge into the depths of an employment crisis. What it does mean, however, is that if you roll the clock forward by ~6 months, investor consensus could be using a decidedly more sour tone to describe the health of the domestic labor market. As the following chart highlights, once initial jobless claims roll off the lows, there’s no turning back.


U.S. Corporate Profits Plunge Into the Abyss... What Are the Implications? - Profits Down  Unemployment Up Slide 38


There’s a credible case to be made that we hang out at the aforementioned lows for much longer than previous cycles given the depth and nature of the previous downturn (i.e. a financial crisis). That said, however, we aren’t of the view to bet on such perma-bull hopium. Anything could happen, but we’re not smart enough to side with storytelling over data; our firm has too much at risk for us to miss calling the next big draw-down in U.S. equities. Recall that being a raging bear is how Keith got fired from Carlyle in late-2007, which afforded him the opportunity to start Hedgeye in 2008.


Luck matters in this business. So does having repeatable research and risk management processes. And a core tenet of our repeatable risk management process is monitoring the relationship between volatility and price.


One way to do this over short-to-intermediate-term durations is by charting the relationship between the VIX futures curve and the SPX. As the following chart highlights, the stock market is in a fairly precarious position with respect to the steepness of the 6 month/1 month VIX curve – specifically in that we’ve yet to sustainably breach 4 points wide since we called for cross-asset volatility to start trending bullishly in mid-to-late-2014. Coincidentally, the aforementioned curve hit 4 points wide just prior to Monday’s highs in the SPX.


U.S. Corporate Profits Plunge Into the Abyss... What Are the Implications? - VIX Curve vs. SPX

Source: Bloomberg L.P.


While this is one of a myriad of factors we incorporate into our risk management process, this specific factor would seem to suggest another leg down in risk assets is upon us. And given how generally bearish our client base is, I’m not so sure that’s a bad thing.


Wishing you and your family a Happy Easter,




Darius Dale



P.S. In case you missed our latest Macro Playbook update from yesterday afternoon, we’re including the link HERE. Feel free to email with questions.

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