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3 Economic Charts Of Concern

Takeaway: The Fed has little or no juice left.

"This morning's data confirms our view that the economy continues to slow on a trending basis and is set up to slow fairly sharply here in Q2," Hedgeye Senior Macro analyst Darius Dale wrote earlier this morning.

3 Economic Charts Of Concern - GDP cartoon 05.29.2015


Here's more analysis from our Macro team in a note sent to subscribers earlier this morning:


"Since the late-September lows, the S&P 500 has held a reasonably tight positive 0.75 correlation with the Citi U.S. Economic Surprise Index, which itself has rallied hard off it's early-February lows as U.S. economic data stabilized in rate-of-change terms and perpetuated a waning of recession fears.


3 Economic Charts Of Concern - s p citi surprise


Now, a topping process in the latter index appears to have gotten underway over the past two weeks, as most recently highlighted by this morning's meaningful misses in the Chicago Fed National Activity Index and the Philly Fed Business Outlook Survey. We reiterate our view that [pending] dour economic data itself is the catalyst for the market to decline from here." 


Digging deeper into the data...


As you can see below in the "high-frequency" data series that we track for the U.S. economy, many of these indicators stabilized on a sequential (month-over-month) basis but are in the red versus their 3-month average:


Click image below to enlarge

3 Economic Charts Of Concern - U.S. data


As Dale points out, dovish Fed commentary can't add much more juice to the markets. The most recent read on implied yield on Fed Fund futures suggests investors don't see a rate hike until December 2017.


3 Economic Charts Of Concern - Chart of the Day 4 20


"There's no more juice left to squeeze out of rates markets w/ dovish talk," Dale writes. "She actually has to do QE4 to get rates spreads to compress further from here. QE4 before the crash?"


Yet more reasons why we're holding the line on our bearish views.


For more...


Watch Dale in the video below, "U.S. Economy Enters Most Difficult Part of Cycle":

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10-Year U.S. Treasury Yield
1.87 1.69 1.85
S&P 500
2,036 2,118 2,102
Russell 2000
1,089 1,159 1,142
NASDAQ Composite
4,845 4,999 4,948
Nikkei 225 Index
15,583 17,448 16,906
German DAX Composite
9,497 10,544 10,421
Volatility Index
12.82 18.40 13.28
U.S. Dollar Index
93.77 95.18 94.47
1.12 1.14 1.13
Japanese Yen
107.51 110.74 109.79
Light Crude Oil Spot Price
39.41 44.54 43.97
Natural Gas Spot Price
1.86 2.23 2.18
Gold Spot Price
1,225 1,269 1,245
Copper Spot Price
2.07 2.27 2.23
Apple Inc.
105 110 107
Amazon.com Inc.
586 647 633
McDonald's Inc.
126 130 128
Utilities Select Sector SPDR
47.81 49.65 47.93
Netflix Inc.
92 102 96
Kinder Morgan Inc.
17.02 19.25 19.00

CHART OF THE DAY: S&P 500, Shiller PE & Forward-Looking Returns

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye Financials analyst Josh Steiner. Click here to learn more.


"... Now consider the longstanding relationship described by Cliff Asness between current CAPE ratio levels [aka Shiller PE] and forward 10yr market returns (HERE). What he shows is that there’s a near perfect relationship between forward 10yr returns on the S&P 500 and starting CAPE ratio multiples over the last 85 years (see table below).


The market is currently trading at a CAPE ratio of 26.4x, which puts it in the 10th [the most expensive] decile. Forward 10yr real returns from this decile have averaged just +0.5% per year over the 1926-2012 period. The best period saw returns for this decile of +6.3% per year, while the worst saw losses of -6.1% per year."


CHART OF THE DAY: S&P 500, Shiller PE & Forward-Looking Returns - Cliff Asness Guide to CAPE implied future returns

Source: Cliff Asness, AQR (An Old Friend: The Stock Market’s Shiller P/E)

The Retirement Reality Check

“Everybody talks about the weather, but nobody does anything about it.”

– Mark Twain


Yesterday, I was asked to write the Early Look – the topic suggested was US Housing. To paraphrase my colleague, Christian Drake, the most remarkable feature of the recent housing data is probably the abject lack of anything remarkable. With that in mind, I chose a different topic.


The American retirement crisis has arrived, and it poses a long-term structural millstone on domestic growth for years to come.


The Washington Post ran an article yesterday entitled One of the nation’s largest pension funds could soon cut benefits for retirees.


The Retirement Reality Check - protests


Back to the Global Macro Grind


The pension fund requesting a benefits cut turns out to be the Members of the International Brotherhood of Teamsters, and counts among its members more than a quarter million truckers from Texas, Michigan, Wisconsin, Missouri, New York and Minnesota. Notwithstanding its notorious ties to organized crime in the 1960s/70s, the Central States Teamsters is not unlike many DB pension plans; in 1980 they counted 4 active participants for every retiree, today there are 5 retirees for every active participant.


While the worker/retiree pyramid inversion is the proximate cause of today’s problem, the catalyst is a law passed in late 2014 that allowed multi-employer pensions like the Central States Teamsters to request permission from Treasury to cut benefits in order to maintain longer-term solvency of the fund. For reference, over 10 million Americans have their pensions through multi-employer pension plans.


The Teamsters asked for a 23% reduction in benefit payments, but some will be more affected than others. The article describes a husband and wife – both Teamsters – whose benefits will be reduced by 57%. Without the cuts, the pension argues it will be insolvent within 10 years. With them, it has a 50% chance of surviving another 30 years.


Private Corporate Defined Benefit Pensions look better, but are they really?  Based on data from Milliman, one of the largest providers of actuarial products and services in the world, the picture isn’t pretty.


Milliman maintains an index that tracks the top 100 corporate US pension funds (HERE). Here’s where the index stood on 3/31/16: $1.37 trillion in assets and $1.76 trillion in liabilities producing a shortfall of $390 billion and a funded ratio of 78%. There’s a widely-held myth in pension accounting that plans funded at 80% are in good shape. This is simply not true – pensions need to be funded at 100% (for more on why, see HERE).


What I found surprising was that the $390 billion funding deficit is close to its all-time high even though the S&P 500 is just inside of its all-time high. 


Equally surprising are the assumptions embedded in future returns. In order to reach 100% funded status, the funds will need to earn returns of +11.2% per annum going forward. The base case, just to stay at the current ~80% funding level, would require +7.2% returns per annum, while their bear case assumes positive returns of +3.2% and would result in funding levels declining to 65%.


Now consider the longstanding relationship described by Cliff Asness between current CAPE ratio levels [aka Shiller PE] and forward 10yr market returns (HERE). What he shows is that there’s a near perfect relationship between forward 10yr returns on the S&P 500 and starting CAPE ratio multiples over the last 85 years (see table below).


The market is currently trading at a CAPE ratio of 26.4x, which puts it in the 10th [the most expensive] decile. Forward 10yr real returns from this decile have averaged just +0.5% per year over the 1 period. The best period saw returns for this decile of +6.3% per year, while the worst saw losses of -6.1% per year. In other words, the base case pension return scenario (+7.2% per year) is 1% higher than the best return ever observed in the last 85 years of market history starting from this level of market valuation, and that’s just for those plans to stay at 80% funded status!


What about the States and Local Government Pensions? Two things are clear.


First, the sacrosanctity of state and local government pension obligations has already frayed. The NY Times (HERE) describes the precedent-setting cases of Detroit, where a judge ruled that public pensions could be reduced in bankruptcy, and Stockton, where pension giant CalPERS came under judicial fire for insisting no adjustments could be made to the pension side of the liabilities in Stockton’s bankruptcy. 


Second, the current benefits promised are, in many places, simply untenable.  Let’s take NY as an example. As a NY resident, I’m always curious when I see the local town/school budget information and was genuinely shocked by a report I read a few years back on retirement spending at the NY County/Local level in 2011, 2012 and 2013. For those interested, the data can be found in this second tab of this excel file (HERE), but allow me to summarize a few of the highlights.


  • Suffolk and Nassau counties each had direct retirement expenditures of $300mn in 2011. By 2013, those same counties saw direct retirement spending balloon to $481mn and $491mn, respectively. Those are increases of 61% and 64%, respectively over just two years.
  • Westchester saw its payments increase from $275mn in 2011 to $439mn in 2013, a 60% increase.
  • Other large NY counties look similar: New York (Manhattan): +51%, Kings (Brooklyn): +52%, Erie (Buffalo): +54%, Onondaga (Syracuse): +60%, Monroe (Rochester): +57%. In fact, from 2011 to 2013, the 61 counties of New York saw an average increase in direct retirement spending of 59% (median: 60%).
  • Consider how much the growth in that one line item crowds out other areas of local budgets. When revenues and most spending categories are growing at 2-4% per year, it’s simply not possible to absorb 30% annual growth in retirement costs on an ongoing basis without either enormous tax increases or other expenditures seeing profound declines.


At the state level, things are just as bad. On paper (HERE), New York is considered a “Top-10” state for pension funding with ~93% funding vs its actuarial liability estimate. Compared with CT, which has just 55% of its actuarial liabilities funded (Bottom 10), or Illinois – the worst in the country – at just 43%, New York seems to be in good shape. The overall funding ratio for all the states is 73% based on the official reporting.  Not great, but not terrible.


Digging a bit deeper, however, the State level problem appears more serious. Once again, the culprits are the assumptions for asset returns and liability discount rates. The fiscally conservative think tank, State Budget Solutions, a non-profit out of Virginia, has run the same analysis using a market-valued liability (HERE) and found that the 73% funded status system-wide drops to 39% once a little reality is injected. Using their methodology, New York’s funding status drops from 93% funded to just 47%, leaving a funding hole of $260 billion, the fourth largest in the country behind California ($640bn), Ohio ($287.4bn) and Illinois ($287.0bn).


The Big Kahuna, of course, is Social Security. Not to be outdone, in its latest annual long-term financial outlook, the Board of Trustees for Social Security projected the fund will run out of money by 2034, at which time only 79% of benefits will be payable. This one irks me the most, as it’s the only one I’m personally eligible for. By then, I’ll be 60 and will have paid into the system for 40 years. I’m pretty sure I’ll never see a dime of money in return.


What about Private Retirement Savings? In short, there’s no reason to expect it to fill the gap for the vast majority of Americans. A few facts to consider, from the Government Accountability Office (GAO):

  • 29% of Households headed by someone 55 or older have ZERO pension or retirement savings
  • Among those with savings, Households headed by 55-64 year olds, have median savings of $104k and those 65-74 years old have median savings of $148k. This level of savings would produce an inflation-protected annuity of just $310/mo and $649/mo, respectively.
  • A TransAmerica survey done in 2015 found that 401k savers in their 20s had median balances of $16k, those in their 30s had $45k, and those in their 50s had $117k. 60 year olds had saved a median of $172k.


So, what can be done?

There’s no silver bullet here, but a partial solution will likely be that Americans will increasingly tap into their accumulated home equity, either through cash-out refinancing, reverse mortgages or downsizing.


The most recent Fed data (4Q2015) shows total US Owners’ Equity in Real Estate reached $12.54 trillion, up from $6.35 trillion in mid-2011.  For reference, a little over half that wealth (~$6.75 trillion) is held by the ~30% of homeowners who own their homes free and clear. These households are fortunate in that they have a sizeable, monetizable asset.


The median US existing home ($223k) currently sells for roughly 4.25x the median US household income ($52k). Retirement guidelines call for saving ~8x your income, meaning that around 1/3 of homeowners could in theory tap the equity in their homes to cover ~1/3-1/2 of their retirement needs – in reality, of course, they still need somewhere to live, so the offset is somewhat less. For the other 2/3 of homeowners who are still encumbered, they’ll have some cushion, but it’s no panacea.


The bottom line is that very difficult choices will need to be made by pensions, courts and politicians in the coming 10 years, and it seems unavoidable that pension promises will be broadly reworked.


Either Americans will slowly awaken to the fact that they don’t have enough saved for retirement and will choose to save more, which will suppress growth today, or they won’t, which will suppress growth down the road. Most likely, we’ll see a mix of the two. It’s hard to see American economic growth sustainably re-accelerating to 3-4% in the coming decade in the face of this.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.69-1.87%

SPX 2036-2118

Nikkei 15

VIX 12.82-18.40
USD 93.77-95.18

Gold 1225--1269


Yours in risk management,


Josh Steiner
Managing Director


The Retirement Reality Check - Cliff Asness Guide to CAPE implied future returns

Source: Cliff Asness, AQR (An Old Friend: The Stock Market’s Shiller P/E)

LNKD | Thoughts into the Print (1Q16)

Takeaway: We're expecting a beat/raise, but we suspect this release is more about what mgmt says than what it prints; a situation we'd rather avoid.


  1. TRACKER SUGGESTS GUIDANCE BLUFF: Our LNKD JOLTS tracker improved sequentially through the first two months of 2Q16, which is expected given seasonality in LNKD's selling environment.  But as we've mentioned previously, 4Q15/1Q16 is more about magnitude than direction.  The former is fairly strong QTD, which suggest mgmt wasn’t seeing the deterioration implied by its guidance when it issued it.  As a reminder, our LNKD Talent Solutions TAM analysis suggests that the bulk of that TAM is in the upsell opportunity (ARPA); our tracker is intended to monitor that selling environment.
  2. EXPECTING SOLID BEAT/SOFT RAISE: As a reminder, LNKD’s 2016 Talent Solutions guidance translates to sharply declining ARPA and net new LCS Account growth well in excess of anything it's ever reported for either of those metrics (see note/table below).  Consensus 1Q16 estimates are also implying a considerable deceleration.  For context, we estimate that LNKD could potentially hit consensus TS estimates without signing a single new LCS account in 1Q16, which would imply a massive deceleration in salesforce productivity since its S&M headcount ended 2015 up 39% y/y (est. 33% ex Lynda).  The other factor is ARPU, which we addressed in Point 1 above.  We’re expecting a solid 1Q beat, but mgmt may not raise 2016 guidance by much more than the 1Q upside.
  3. BUT WILL THE STREET CHASE IT? A 40% drawdown on the 4Q15 print on 3x the volume of any event in LNKD's post-IPO history basically suggests an exodus.  Aside from the disaster guide, mgmt introduced a series of red flags during their 4Q15 call; most notably announcing that is was pulling the LCS account metric.  We suspect mgmt has essentially lost the Street, and it will take more than one good print to regain their trust after running over its holders on largely avoidable missteps.  That said, we suspect this earnings release will be more about what mgmt says than what it prints; a setup we’d rather avoid.  We remain on the sidelines for now. 

Let us know if you have any questions or would like to discuss in more detail.


Hesham Shaaban, CFA
Managing Director



LNKD | Thoughts into the Print (1Q16) - LNKD   ARPA vs. Tracker 1Q16 v2

LNKD | Thoughts into the Print (1Q16) - LNKD   TS 2016 Guid Scen 1


LNKD | Guidance = Recession
02/05/16 09:50 AM EST
[click here]

The Macro Show with Tom Tobin Replay | April 21, 2106

CLICK HERE to access the associated slide. 


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

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