Japan's Nikkei is down -23% from its 2015 high. Meanwhile, in European equities, drawdowns from last year's peak range from -13% to -28%.
In this one-minute excerpt from The Macro Show, Hedgeye Financials analyst Jonathan Casteleyn highlights the key short catalyst for shares of Lazard and explains why the company is a compelling short.
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Takeaway: The industrial economy’s struggles reflect a perfect storm of trends— all pointing toward less interest in things.
Editor's Note: In this complimentary edition of About Everything, Hedgeye Demography Sector Head Neil Howe discusses why manufacturers and retailers should prepare for the possibility that “goods” aren’t coming back anytime soon. And, even when (and if) the industrial sector emerges from its long-term atrophy, the underlying framework of the “old economy” will look entirely different than what we see today.
Worldwide, the goods-producing sector is in trouble.
Ever since the Great Recession, global trade has struggled to keep up with GDP—something it used to beat easily. Over the last two years, the global manufacturing PMI has been steadily sinking.
The U.S. PMI has been under 50.0 for five of the last six months. Globally, both output and new orders are decelerating—for example in China, where manufacturing has been contracting for 13 straight months.
And what about commodity and producer prices? They’ve been tanking. Amazingly, the PPI in just about every major economy has been stuck in deflation since the summer of 2014.
Goods are being lapped by services. The services sector—encompassing activities like media, software, health care, and finance—has posted just one month of contraction over the past two years.
The decline of goods and the rise of services, of course, is a long-term trend that began many decades ago in the high-income world. U.S manufacturing employment peaked in 1979 and has mostly been declining ever since. Yet there was a brief respite following the Great Recession, especially here in the United States. Now, however, the goods sector is once again under assault.
Let’s take a look at some of the new forces that may be driving it down.
Up until 2014, China’s voracious appetite for more industrial capacity, housing, and infrastructure was propping up raw material prices and goods production worldwide. In its heyday, China was consuming roughly half of the world’s supply of just about every industrial input—from steel and copper to cement trucks and construction cranes. No longer.
Over the last decade, U.S. rural counties have been depopulating and core urban areas have been growing much faster than historical trend. A rising share of Millennials are ditching their cars, flocking to cities, and starting out their careers in cramped apartments with limited space. More than a quarter of 18- to 34-year-olds live in their parents’ homes and don’t need to buy their own household goods.
Old computers and furniture no longer get thrown in the trash, but now enjoy a second life thanks to services like Craigslist and eBay. Platforms like Uber and NeighborGoods allow people to find and use items they want without buying them.
In the old days, we bought expensive things to affirm their social status. Nowadays, we can buy expensive experiences and curate them on social media. We can thereby define ourselves more by what we do than by what we own. This trend has taken on new meaning with Millennials, who would much rather go out to dinner or attend a music festival than purchase the latest handbag or golf club.
Thanks to monumental advances in IT capabilities and infinite returns to scale, entrepreneurs can now start a profitable company without spending much at all on physical capital (or even on employees). Think Google, Uber, and Amazon. The whole concept of “book value” assets is becoming antiquated.
Aging societies (I’m looking at you, Europe and East Asia) no longer require capital-widening investment. A contracting working-age population no longer needs new factories—or even new houses. Moreover, the retired elderly are the least likely to spend on things and the most likely to spend on services (starting with health care and personal care). What’s more, they receive their benefits from taxes on young people—who historically are the most likely to want to buy things.
Falling commodity prices are hammering developing countries. Major players in Latin America and Sub-Saharan Africa have entered a “tailspin.” If this decline is indeed the new normal, poor commodity-exporting countries will have to turn to human capital—like India and the Philippines, which are turning their fluency in English to open up new service opportunities for the working class.
U.S. retailers are updating their playbooks. Companies from Urban Outfitters to REI are turning their stores into “experiences” with fun diversions and top-notch customer service. Others, like Home Depot and Lowe’s, are expanding into new markets (home services, in this case). And e-tailers like eBay and Bonobos are going high-touch with new brick-and-mortar outlets.
The U.S. economy is encountering an imbalance between the buying of private things (which is weakening) and the backlog of demand for public things like infrastructure (which is growing). It was the G.I. Generation’s commitment to building a new public infrastructure in the 1930s, ‘40s, and early ‘50s, which enabled the booming “affluent society” in subsequent decades. America may be ready for a reboot.
Manufacturers and retailers should prepare for the possibility that “goods” aren’t coming back anytime soon. Even when (and if) the industrial sector emerges from its long-term atrophy, the underlying framework of the “old economy” will look entirely different than what we see today.
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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.
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“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:
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:
*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):
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
Takeaway: The central planning #BeliefSystem is breaking down.
Following the worst U.S. stock market decline to start a year (ever), manic market myopia has set in among investors overweight advice of domestic permabull storytellers. They're missing criticial context in addition to a significant risk developing with respect to wavering faith in the global central bankers.
For the record, outside the recent Fed-stoked rally in U.S. equities, European and Asian markets remain deeply troubled as the central planning #BeliefSystem (in the ECB and BOJ) continues to break down.
Here's Asian market analysis via Hedgeye CEO Keith McCullough in a note sent to subscribers this morning:
"The yen up small +0.2% vs USD was enough to keep the Nikkei from bouncing overnight; Nikkei 225 closed down another -0.3% taking its crash from the July 2015 high to -22.8% and -15.4% YTD (China and Hong Kong closed today)"
"Post a dreadful producer price report of -4.2% y/y for the Eurozone this am the ECB’s Praet is saying they’ll “continue to act forcefully” (to try to tone down Euro Up vs Yellen’s Dollar Down move) so let’s see how European stocks react to this as they were down (again) last week with Italy’s MIB Index -2.1% w/w to -17.0% YTD."
So ... what happens when the Fed (like its central-planning brethren abroad) loses all macro market credibility and the U.S. economy continues to deteriorate? If Europe and Japan are any indication, the outlook isn't good.
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