Editor's Note: The Early Look below was written by Hedgeye CEO Keith McCullough one week ago. It crystallizes many of our current thoughts about the precarious macro setup and why we think U.S. equities are in trouble. Click here to get it delivered in your inbox weekday mornings.
* * * *
“No profit grows where no pleasure is taken.”
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.
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:
- The Euro (vs. USD) fell -0.9% on the week to +2.8% YTD
- The Yen (vs. USD) fell -1.4% on the week to +6.3% YTD
- The Canadian Dollar (vs. USD) fell -2.0% on the week to +4.3% YTD
- Commodities (CRB Index) fell -2.4% on the week to -2.3% YTD
- Oil (WTI) fell -4.1% on the week to -1.3% YTD
- 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:
- High Beta stocks were -2.0% on the week
- High Leverage (Debt/EBITDA) stocks were -1.9% on the week
- 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):
- Net LONG position in USD (CFTC futures/options contracts) was -2.16x standard deviations vs. its TTM average
- 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:
Oil (WTI) 36.06-42.91
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer