prev

Europe, Oil and Corporate Profits

Client Talking Points

#EUROPESLOWING

Spain’s economy Minister De Guindos lowered the country’s 2016 GDP forecast o 2.7% vs 3.0% and the 2017 forecast to 2.4% vs 2.7%.  This follows last week’s reduced growth forecast by the IMF for Spain for the first time since 2013, to 2.6% from 2.7% for 2016. Yet the forecasts pale to our own, which according to our GIP (growth, inflation, policy) model, show the Spanish economy tracking into Quad 3 (equating to growth slowing as inflation accelerates) in the back half of the year with a mere 1.0% GDP forecast for 2016.

#CRUDESTORY

Our view throughout the deflationary backside of the cheap-debt fueled, commodity sector capital spending boom has been that producers will produce until they can’t anymore – bankruptcy or per unit cash loss. The resiliency of U.S. shale production throughout the commodity downturn surprised most. WTI is down over 4% this morning as the Doha meeting over the weekend was a disappointment for the bulls. We continue to take the stance that collective production cuts from ex. U.S. producers will be nothing more than a newsy topic, including at OPEC’s June 2nd meeting.

CORPORATE PROFITS

With 39 S&P 500 companies having reported Q1 earnings to-date, sales growth is down -1.1% YoY and earnings growth has slowed to -11.8% YoY – which would be the worst annual growth rate of the cycle if it holds through the rest of reporting season. Declines are being led by Materials (-34%), Tech (-20%) and Financials (-17%). Compounding matters is the 25-30% spread between pro forma and GAAP, which continues to be reflected in a rising economy-wide debt-to-free-cash-flow ratio. Specifically, that ratio just reached 4x in 4Q15, which is the threshold it breached in 3Q07 on its way to peaking at 4.6x in mid-2008. We reiterate our view that neither the corporate profit nor credit cycles have seen their respective depths.

 

*Catch the replay to The Macro Show with Potomac Research Group Senior Energy analyst Joe McMonigle - CLICK HERE

Asset Allocation

CASH 64% US EQUITIES 0%
INTL EQUITIES 0% COMMODITIES 6%
FIXED INCOME 26% INTL CURRENCIES 4%

Top Long Ideas

Company Ticker Sector Duration
MCD

McDonald's (MCD) is reporting 1Q16 results on Friday, and we will have a more thorough update following the release. Current consensus estimates are projecting system-wide same-store sales (SSS) growth to be +4.6%, and +4.6% in the United States. Given another full quarter of All Day Breakfast, and ever evolving value proposition that MCD is providing, we feel confident in their ability to perform at or above expectations.

 

MCD continues to be a great LONG stock to hold during turbulent times in the market given their attributes of being large-cap, low beta, and aligns with our macro teams view of going LONG lower to middle income food providers.

CME

With the largest Capital Markets operation reporting results last week, JP Morgan's numbers continue to relay the business-to-business (B2B) shift in both bond and equity markets. With capital hamstrung by Financial Crisis era regulation, and fixed income desks running tight as a drum, brokerage activity continues to shift over into the exchange traded derivative markets. JPM's FICC, or fixed income trading, results hit $3.5 billion in revenue in 1Q16, down 13% year-over-year.

 

Conversely, the daily reporting of CME Group's (CME) bond volumes finished at 8.2 million contracts per day in 1Q, up +9% from last year. On a revenue basis, CME's results are actually a little stronger, with fixed income rate per contract up +2% year-over-year. The shift in equities is more balanced, with JPM's equity trading revenues up +6% y-o-y according to their latest report.

 

CME's stock volumes, however, still outflank the big brokerage desk with futures and options volume up +9% y-o-y for the forthcoming quarterly report on April 28th. This activity shift is secular in our view and CME Group has a strong upward bias in earnings power which makes its stock one of the few to own in Financial Services.

TLT

We remain the bears on the U.S. economy and the corporate profit and credit cycles - we’re long growth slowing via Long Bonds (TLT) and Pimco 25+ Year Zero Coupon U.S. Treasury ETF (ZROZ) and short risky corporate credit via Junk Bonds (JNK) as the profit cycle rolls over.

 

High yield bonds have experienced meaningful relief in price terms with the move in reflationary assets. Again, we reiterate that once credit spreads move off their cycle lows, they don’t typically revert in the same cycle, which is why we are sticking with our sell recommendation on junk bonds (JNK).

 

Any time corporate profits decline for two consecutive quarters, the S&P drawdown has had a peak to trough decline of at least 20%. Dissecting the likely direction of earnings in Q1 and Q2 of this year, we could be facing 4 consecutive quarters of declining corporate profits, and we question the market's ability to slap higher earnings multiples on the S&P 500.

Three for the Road

TWEET OF THE DAY

The current short squeeze in EM stocks is right within the +20% gain which has happened 8 times since '11

@HedgeyeJC

QUOTE OF THE DAY

You’ll never get ahead of anyone as long as you try to get even with them.

Lou Holtz                    

STAT OF THE DAY

There are 1.17 billion unique Google searches each month, over 50% of searches come from mobile devices.


An Earnings Season Scorecard Update

Takeaway: When corporate profits decline for two consecutive quarters or more the S&P 500 declines by at least 20%.

An Earnings Season Scorecard Update - corp profits cartoon 03.28.2016

 

Its that time of year again.

 

Earnings season is upon us and, by just about every estimation, companies are due to report lackluster results on the top and bottom line.

 

Here's what you need to know via our Macro team in a note sent to subscribers earlier this morning:

 

"With 39 S&P 500 companies having reported Q1 earnings to date, sales growth is down -1.1% year-over-year and earnings growth has slowed to -11.8% year-over-year -- which would be the worst annual growth rate of the cycle if it holds through the rest of reporting season. Declines are being led by Materials (-34%), Tech (-20%) and Financials (-17%).

 

Compounding matters is the 25-30% spread between pro forma and GAAP, which continues to be reflected in a rising economy-wide debt-to-free-cash-flow ratio. Specifically, that ratio just reached 4x in 4Q15, which is the threshold it breached in 3Q07 on its way to peaking at 4.6x in mid-2008. We reiterate our view that neither the corporate profit nor credit cycles have seen their respective depths."

 

REMINDER

If the current earnings data holds, this would be the third quarter of contracting corporate profits.

 

WHY IT MATTERS

Our Macro team continues to highlight that when corporate profits decline for two consecutive quarters or more the S&P 500 declines by at least 20%. 

 

Click chart below to enlarge

An Earnings Season Scorecard Update - EL profits

 

Performance? Where We're at...

 

In spite of truly ugly S&P 500 earnings in the last couple quarters, equities have rallied significantly off the February lows. However, this doesn't change our market views. We remain steadfastly bearish. Even with the recent pop, our favorite sector longs (Utilities, XLU) & shorts (Financials, XLF) continue to outperform. Here's the year-to-date scorecard:

 

An Earnings Season Scorecard Update - sector performance ytd

 


MONDAY MORNING RISK MONITOR | REACHING FOR OPTIMISM

Takeaway: Even with poor U.S. economic data and profits sliding at domestic moneycenter banks, investors remained an optimistic bunch last week.

 MONDAY MORNING RISK MONITOR | REACHING FOR OPTIMISM - RM11

 

Key Takeaway:

The reflationary bounce that took hold February 12th persists, in spite of generally weak economic data from the U.S. and profit pressures at J.P. Morgan, Bank of America, and Wells. Bank CDS tightened globally, while the YTM on high yield fell -33 bps to 7.60%.

 

Our heatmap below is positive on the short term, negative on the intermediate, and mixed on long-term readings.

Current Ideas:


MONDAY MORNING RISK MONITOR | REACHING FOR OPTIMISM - Best Ideas Table 2

 

Financial Risk Monitor Summary

• Short-term(WoW): Positive / 5 of 13 improved / 1 out of 13 worsened / 7 of 13 unchanged
• Intermediate-term(WoW): Negative / 4 of 13 improved / 5 out of 13 worsened / 4 of 13 unchanged
• Long-term(WoW): Negative / 2 of 13 improved / 2 out of 13 worsened / 9 of 13 unchanged

MONDAY MORNING RISK MONITOR | REACHING FOR OPTIMISM - RM15

 

1. U.S. Financial CDS – Swaps tightened for 12 out of 27 domestic financial institutions. Even with JPM, BAC, and WFC reporting sliding profits last week, their CDS tightened by -7 bps to 69, -8 bps to 98, and -5 bps to 58 respectively.

Tightened the most WoW: MS, MTG, JPM
Widened the most WoW: PRU, MET, LNC
Tightened the most WoW: LNC, JPM, GS
Widened the most MoM: MET, PRU, AIG

MONDAY MORNING RISK MONITOR | REACHING FOR OPTIMISM - RM1

 

2. European Financial CDS – Swaps mostly tightened in Europe as investors clung to optimism last week. The median spread tightened by -14 bps to 121.

MONDAY MORNING RISK MONITOR | REACHING FOR OPTIMISM - RM2

 

3. Asian Financial CDS – Swaps tightened nearly across the board in Asia last week. IDB Bank of India was the only one to widen, by 4 bps to 229. Even Chinese swaps tightened, where data released last week showed 1Q16 economic growth slowing to 6.7%, the slowest quarterly growth since 2009.

MONDAY MORNING RISK MONITOR | REACHING FOR OPTIMISM - RM17

 

4. Sovereign CDS – Sovereign swaps mostly tightened over last week. Italian and Spanish swaps tightened the most, by -7 bps to 129 and by -7 bps to 93 respectively.

MONDAY MORNING RISK MONITOR | REACHING FOR OPTIMISM - RM18

 

MONDAY MORNING RISK MONITOR | REACHING FOR OPTIMISM - RM3


5. Emerging Market Sovereign CDS – Emerging market swaps mostly tightened last week. In Brazil, where a congressional committee recommended that President Dilma Rousseff be impeached, swaps tightened by -48 bps to 342.

MONDAY MORNING RISK MONITOR | REACHING FOR OPTIMISM - RM16

MONDAY MORNING RISK MONITOR | REACHING FOR OPTIMISM - RM20

6. High Yield (YTM) Monitor – High Yield rates fell 33 bps last week, ending the week at 7.60% versus 7.93% the prior week.

MONDAY MORNING RISK MONITOR | REACHING FOR OPTIMISM - RM5

7. Leveraged Loan Index Monitor  – The Leveraged Loan Index rose 13.0 points last week, ending at 1871.

MONDAY MORNING RISK MONITOR | REACHING FOR OPTIMISM - RM6

8. TED Spread Monitor  – The TED spread rose 1 basis points last week, ending the week at 41 bps this week versus last week’s print of 40 bps.

MONDAY MORNING RISK MONITOR | REACHING FOR OPTIMISM - RM7

9. CRB Commodity Price Index – The CRB index rose 3.6%, ending the week at 174 versus 168 the prior week. As compared with the prior month, commodity prices have decreased -1.5%. We generally regard changes in commodity prices on the margin as having meaningful consumption implications.

MONDAY MORNING RISK MONITOR | REACHING FOR OPTIMISM - RM8

10. Euribor-OIS Spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread was unchanged at 10 bps.

MONDAY MORNING RISK MONITOR | REACHING FOR OPTIMISM - RM9

11. Chinese Interbank Rate (Shifon Index) – The Shifon Index rose 2 basis points last week, ending the week at 2.00% versus last week’s print of 1.98%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.

MONDAY MORNING RISK MONITOR | REACHING FOR OPTIMISM - RM10

12. Chinese Steel – Steel prices in China rose 8.7% last week, or 229 yuan/ton, to 2,852 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity and, by extension, the health of the Chinese economy.

MONDAY MORNING RISK MONITOR | REACHING FOR OPTIMISM - RM12

13. Chinese Non-Performing Loans Chinese non-performing loans amount to 1,274 billion Yuan as of Dec 31, 2015, 51.2% higher year-over-year.

MONDAY MORNING RISK MONITOR | REACHING FOR OPTIMISM - RM4

14. 2-10 Spread – Last week the 2-10 spread was unchanged at 102 bps. We track the 2-10 spread as an indicator of bank margin pressure.

MONDAY MORNING RISK MONITOR | REACHING FOR OPTIMISM - RM13

15. CDOR-OIS Spread – The CDOR-OIS spread is the Canadian equivalent of the Euribor-OIS spread. It is the difference between the Canadian interbank lending rate and overnight indexed swaps, and it measures bank counterparty risk in Canada. The CDOR-OIS spread was unchanged at 41 bps.

MONDAY MORNING RISK MONITOR | REACHING FOR OPTIMISM - RM14


Joshua Steiner, CFA



Jonathan Casteleyn, CFA, CMT


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.43%
  • SHORT SIGNALS 78.37%

CHART OF THE DAY: A Look At U.S. Oil Production Since 1861

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye Director of Research Daryl Jones. Click here to learn more.

 

"... In the Chart of the Day today, we look at U.S. oil production going back to 1861. As the chart shows, 1970 has been, so far, the peak in domestic oil production at ~9.6 million barrels per day. Interestingly, 2015 was a close second with a production rate of some ~9.4 million barrels per day. Clearly, if prices had not started to decline in 2015, drilling and investment would have stayed at high levels and production grown beyond Hubbert’s peak in 2016."

 

CHART OF THE DAY: A Look At U.S. Oil Production Since 1861 - 04.18.16 chart


From Peak to Peak

“Our ignorance is not so vast as our failure to use what we know.”

-M. King Hubbert

 

Just ask anybody, there is no shortage of the oil in the world. Or at least that’s the consensus view these days. In the short run, this is clearly correct. But what about in the longer term, say 5 or 10 years down the road?

 

We’ve been recently reacquainting ourselves with the work of M. King Hubbert and are in the middle of reading, “The Oracle of Oil”, by Mason Inman. Hubbert, as many of you know, is the geologist known for popularizing the idea of peak oil in the United States. He predicted that for any given geographical area, the rate of petroleum production of the reserve over time would resemble a bell curve.

 

Based on this theory, Hubbert presented a paper to the 1956 meeting of the American Petroleum Institute in San Antonio, Texas, which predicted that overall petroleum production would peak in the United States between 1965, which he considered most likely, and 1970, which he considered an upper-bound case. While his analysis was originally widely discredited, when domestic oil production actually peaked in 1970 Hubbert was very much validated.

 

In the Chart of the Day today, we look at U.S. oil production going back to 1861. As the chart shows, 1970 has been, so far, the peak in domestic oil production at ~9.6 million barrels per day. Interestingly, 2015 was a closed second with a production rate of some ~9.4 million barrels per day. Clearly, if prices had not started to decline in 2015, drilling and investment would have stayed at high levels and production grown beyond Hubbert’s peak in 2016.

 

But as it is, production in the United States is on the decline and, as of the most recent weekly data from the EIA, is down about 4.0% year-over-year. Despite this decline, which is largely due to somewhat tepid demand, inventory in the U.S. remains at record levels and is up 10.9%+ year-over-year. Eventually, though, declining production will begin to draw down this inventory.

 

At that point, investors in energy will likely get all bulled up on the price of oil. In reality, if the last couple of years have taught investors anything, it’s that there is no shortage of supply. And as for Hubbert’s Peak, at least on a strictly linear basis, the peak will likely be blown through in the next cycle of investment in domestic oil production with just a little bit of “Drill baby, drill!”

 

From Peak to Peak - OPEC cartoon 02.16.2016

 

Back to the Global Macro Grind 

 

In the shorter term, oil, and really markets globally, are being roiled this morning because OPEC could not agree on production cuts. This fact seems to have shocked almost everyone except our policy team led by former Secretary of Energy Spencer Abraham and former Vice Chairman of the IEA Joe McMonigle who wrote the following last night:

 

“Since the production freeze proposal was first introduced in February, we have repeated our view in subsequent client notes that "a freeze is not a freeze without Iran." It now seems our mantra is also the official Saudi position from Doha.

 

Over a dozen oil producers from OPEC and Russia met in Qatar on Sunday to discuss a potential agreement to freeze production at January levels. While Iran made it clear it would not participate in the freeze as it ramps up post-sanctions production, many freeze proponents pushed for an agreement that excluded Iran as a way to support a "positive trend" in oil prices.

 

But as we pointed out in our Friday preview note on the freeze meeting, "the Saudi's would only support a freeze if all other producers agreed to participate, including and most especially Iran." Based on our analysis, we concluded in our Friday note that "there is no chance Saudi Arabia reverses its position and agrees to freeze production on Sunday."

 

The deal was dead Saturday morning Riyadh time when Saudi Deputy Crown Prince Mohammad Bin Salman reiterated his position in an interview from King Salman's private desert ranch that the Kingdom would not freeze production without Iran. 

 

So oil ministers left Doha without reaching any agreement creating almost certain downward pressure on oil prices when the market opens on Monday. Oil was already down last Friday as pessimism grew about achieving an agreement in Doha. Any sell off Monday is now about the realization that there will be no agreement at the June 2 OPEC meeting either. The freeze is not a bridge to any future agreement.”

 

According to the CFTC, longs were adding to their positions into this weekend and long positions were peaking near a 9-month high. As a result, the sell off this morning is not entirely shocking.

 

Speaking of peaks, or lack thereof, there are a few more to highlight this morning:

  • Chinese housing prices clearly have NOT peaked with new home prices up +4.9% year-over-year and increasing in 62 cities;
  • U.S. corporate profit margins may have peaked, according to a report from Bloomberg this morning, which shows corporate profits their highest levels in 2014, at 9.7%, and are now closer to 9.0%;
  • The NABE highlighted a similar peak this morning with its survey that showed for the first time since the Great Recession more business owners are highlighting declining profits than expanding profits;
  • Spanish growth rates may have peaked, as both the IMF and Spanish cut government growth rate forecasts for the first time since 2013; and
  • In the global currency markets, the Japanese Yen clearly has not peaked breaking to new 19 month highs this morning as the Nikkei suffers its second -3% daily loss.

 

The bigger question of course is whether U.S. equities have peaked. In our models, U.S. equities remain in a bearish formation and, all else being equal, we have a hard time seeing them make a move towards a new peak with profit margins in decline. After all, there has only been one time since 1973 when profit margins narrowing by 60 or more basis points didn’t precede a recession. 

 

So . . . Peaking late cycle anyone?

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.67-1.81%

SPX 2041-2091

Nikkei 15160-17065

VIX 13.03-18.72
USD 93.90-95.45

Gold 1210--1266

 

Keep your head up and stick to the ice,

 

Daryl G. Jones

Director of Research

 

From Peak to Peak - 04.18.16 chart


The Macro Show Replay with Energy Analyst Joe McMonigle | April 18, 2016

CLICK HERE to access the associated slides.

An audio-only replay of today's show is available here.


the macro show

what smart investors watch to win

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.

next