Slow Global Growth Snails

Takeaway: The latest read through on U.S. and Euro-area economies isn't good and confirms both economies remain mired in this slow growth environment.

Slow Global Growth Snails - Slow growth snails cartoon 07.14.2015


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


"Eurozone April preliminary PMIs were released this morning... drum roll... both the Manufacturing and Composite (Manufacturing + Services) fell month-over-month, in-line with our theme of #EuropeSlowing. Eurozone Manufacturing recorded 51.3 vs. 51.6 prior and the Composite fell to 53.0 vs. 53.1. Services rose 10bps to 53.2. Meanwhile, coming late to the party, the ECB released the results of the Q2 2016 survey of professional forecasters, which sees the inflation forecast revised down by 0.4% to 0.3% for 2016 and growth at 1.5% in 2016 vs. a prior estimate of 1.7%."


Slow Global Growth Snails - eurozone


Meanwhile, in the U.S., more souring economic data. According to Markit, its survey of U.S. Manufacturing PMI fell to its lowest level in six-and-a-half years:


Slow Global Growth Snails - us pmi


Here's analysis from Markit: 


"US factories reported their worst month for just over six-and-a-half years in April, dashing hopes that first quarter weakness will prove temporary... With prior months’ survey data pointing to annualized GDP growth of just 0.7% in the first quarter, the deteriorating performance of manufacturing suggests that growth could weaken closer towards stagnation in the second quarter."


Then there's China. Earlier this week, we noted that the PBoC would enact more "prudent" monetary policy even as China's economy continues to slow.


Add all of this to the laundry list of dour economic news we've seen of late.

Eurozone, Commodities and Credit Cycles

Client Talking Points


Eurozone April preliminary PMIs were released this morning… drum roll…  both the Manufacturing and Composite (Manufacturing + Services) fell month-over-month, in-line with our theme of #EuropeSlowing. Eurozone Manufacturing recorded 51.3 vs 51.6 prior and the Composite fell to 53.0 vs 53.1.  Services rose 10bps to 53.2. Meanwhile coming late to the party, the ECB released the results of the Q2 2016 survey of professional forecasters, which sees the inflation forecast revised down by 0.4% to 0.3% for 2016 and growth at 1.5% in 2016 vs a prior estimate of 1.7%.


China forever the commodity sponge? Iron ore is up over +60% YTD with rebar +50% YTD on Asian exchanges. With the move in commodities comes the mainstream media stories of Chinese demand and stockpiling. We prefer to stick with the top-down signals. With the CRB up 5.5% over the last month (16/19 on CRB green) on higher trending volume in aggregate (unprecedented in some markets), we’ll soon find out if a re-pricing of QE has been met by incremental buying forcing out shorts, or if the short USD/long commodities trade is a new trend. The fresh non-consensus risk is a hike in June.   


Junk bonds have rallied +3% in the YTD, inclusive of a +6% squeeze over the past 3M alone. Option adjusted spreads continue to narrow dramatically, compressing -30bps in the past week alone to 586bps wide. This is down from a peak of 839bps on February 11th. Is the trough of the domestic credit cycle in the rear-view mirror, leaving us holding the bag on a stale thesis? Not at all. Our work has shown that once the horse leaves the barn on the domestic credit cycle, there is no recovery until HY spreads are north of 1,000bps and corporations have sufficiently delivered their balance sheets – neither of which has occurred.


*REPLAY The Macro Show with Darius Dale and Ben Ryan - CLICK HERE

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

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.


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.


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


About Everything: The Golden Age of Home Improvement…  @HoweGeneration $LOW $HD  #millennials



It's about discovery.  

Scott Jurek


Apple reported iPhone owners unlock their device, on average, 80 times a day.

Down the Path

“Everyone has their own experience. That's why we are here, to go through our experience, to learn, to go down those paths and eventually you may have gone down so many paths and learned so much that you don't have to come back again.”



The cultural icon Prince Rogers Nelson, more commonly known as Prince, passed away yesterday. Unlike many artists who veer into other worlds, Prince pretty much stuck with music and sticking to that path rewarded him and his listeners. Over the course of his career, he sold over 100 million albums and was inducted into the Rock n’ Roll Hall of Fame in his first eligible year. He also left us with some very memorable lyrics, such as:


“I never meant to cause you any sorrow / I never meant to cause you any pain / I only wanted to one time to see you laughing / I only wanted to see you / Laughing in the purple rain." 


For stock market operators, it has been a year of diverging paths and depending on which path you’ve followed you are either “laughing” or feeling “sorrow” at the moment. On February 11th, the SP500 was down about -10.5% for the year. As of the close yesterday, the SP500 is up about 2.3% for the year. In early February, it seemed the world, or at least the stock market, was going to end. Now, after the 15%+ move off the bottom, there is nary a bear in sight.


We don’t have the daily stresses of managing money like many of you, so it does allow us to take a step back to consider the larger picture. The larger picture from the macro perspective involves continuing to focus on direction of earnings growth, the direction of broad economic activity, the direction of inflation, and contemplating the role of the Fed in all of this. For stock market bears, the question remains: what gets the stock market to go down from here?


Down the Path - bear 2


Back to the Global Macro Grind


Our colleague Darius Dale wrote a note yesterday in which he discussed what would make the stock market go down from here and his answer was on simple level: the data. But, of course there is more to it than just that simple answer. As Darius wrote:


“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 its early-February lows as U.S. economic data stabilized in rate-of-change terms and perpetuated a waning of recession fears.


Now, a topping process in the latter index appears to have gotten underway over the past two weeks, as most recently highlighted by big misses in this morning's Philly Fed and Chicago NAI surveys. While our process generally underweights survey data – particularly one-off regional surveys – in lieu of doing the actual rate-of-change calculus on relevant “C” + “I” + “G” + “NX” metrics, we reiterate our view that economic deterioration from here is itself the catalyst for the stock market to reverse course in a meaningful manner.


Simply put, because macro consensus doesn’t have our economic outlook, we believe domestic economic data will start to miss by a wide margin again, as it did in the early part of this year. It’s also worth noting that economist consensus always have a natural upward-sloping bias to their growth estimates, which creates additional downside surprise risk to the extent we're right on where the data is headed over the next couple of quarters."


So to summarize, our view is that key economic statistics will begin to miss consensus estimates as the year progresses. We’ve highlighted our view on GDP growth throughout the course of the year in the Chart of the Day. Specifically, while we were in line with consensus for Q1 2016 GDP growth, we are close to 100 basis points below consensus for the remainder of 2016E. In our views it’s hard to see how disappointing data will buoy the stock market, especially when the growth rates being reported are barely above recessionary levels in the best case scenario.


That said, given the move off the February lows the stock market is clearly considering an alternative scenario than Hedgeye's for the course of 2016. Even more notable in this regard is the high yield bond market. Junk bonds in aggregate are now up almost 6% on the year and energy related junk bonds are leading the way, up about 10% in the year-to-date. Ironically, this comes at a time when the number of companies at risk of a default, according to Standard & Poors, is at 242, the highest level since 2009.


Flipping over to Asia and staying on this idea of debt defaults, we see somewhat similar trends. According to a report out by Reuters, bad debt at Asian banks is now also at the highest level since 2009. Specifically, non-performing loans at 74 major Asian banks (excluding Japan) reached $171 billion at the end of 2015, which was up 28% from 2014.


Despite our dire view on growth, deterioration of corporate balance sheets domestically and abroad, and of course the ongoing decline in corporate earnings, global central bankers may yet "save the day" if the markets sells off and more accurately reflect the deteriorating data. That said, according to Fed futures the next rate hike is now priced in for Q3/Q4 2017 versus October 2016 when we started the year. So absent explicit easing action, there is not much the Fed can do, especially in the light of inflation statistics that seems poised to increase given the recent rally in commodities.


So, how will the rest of the of the stock market year look? Well, we continue to believe it’s prudent to put on your raspberry berets, get in your red corvettes, and be prepared for deteriorating economic data and markets that react accordingly to these fundamentals.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.70-1.88%

SPX 2044-2116

VIX 13.01-18.32
USD 93.77-95.21
YEN 107.51-110.94
Oil (WTI) 39.97-44.25


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Down the Path - 4 22 16 EL

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CHART OF THE DAY | U.S. 2016 Growth Estimates: Us Versus Consensus

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.


"... So to summarize, our view is that key economic statistics will begin to miss consensus estimates as the year progresses. We’ve highlighted our view on GDP growth for 2016 in the Chart of the Day below. Specifically, while we were in line with consensus for Q1 2016 GDP growth, we are close to 100 basis points below consensus for the remainder of 2016E. In our views it’s hard to see how disappointing data will buoy the stock market, especially when the growth rates being reported are barely above recessionary levels in the best case scenario."


CHART OF THE DAY | U.S. 2016 Growth Estimates: Us Versus Consensus - 4 22 16 EL

The Macro Show with Darius Dale Replay | April 22, 2016

CLICK HERE to access the associated slides.

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

FCC Action on Special Access Next Week (T, CTL, VZ, LVLT, WIN, CMCSA, TWC, CHTR, S, TMUS)

At next week's agenda meeting (April 28), the FCC will likely consider the imposition of new special access pricing regulations, rejecting incumbent phone carrier claims that competitive conditions in the dedicated enterprise private line market justify continued deregulation.  The FCC also plans to issue an order modifying volume and term conditions in special access contracts that are deemed unreasonable under traditional common carrier standards. 

The FCC estimates that special access is a $40 billion market that will grow substantially as high capacity connections become increasingly critical to furnish backhaul to expanding wireless facilities in metro markets.  Thus, lower backhaul costs should benefit wireless carriers like Sprint and T-Mobile.  For top tier wireless players like AT&T and Verizon Wireless, lower backhaul costs could be beneficial in geographic territories outside their wireline footprint.

We previously noted the upcoming FCC action, a proceeding raising concerns for incumbents like Verizon and AT&T, and even raising concerns for cable operators (like Comcast (CMCSA), Charter (CHTR) and Time Warner Cable (TWC)) seeking to expand their enterprise service offerings (Potomac Research, FCC Tees Up Special Access, April 5, 2016).  The upcoming action is positive for competitive local exchange carriers (CLECs) like Level 3, XO Communications, Windstream (which acquired PAETEC) and others.

Tariff Investigation:  The FCC tariff modification would close an ongoing investigation of the special access contracts of Verizon (VZ), AT&T (T), CenturyLink (CTL) and Frontier (FTR).  Competitive carriers, including Level 3 (LVLT, which acquired tw telecom), have complained the incumbents impose volume and term commitments, enforced by significant penalties, that effectively shut out alternative sources of private line supply and discourage CLEC investment in private line extensions into enterprise buildings.  The FCC is expected to mandate modifications that will benefit CLECs.  Such competitors lease access to special access connections to provide service for off-net locations (buildings not served by CLEC proprietary lines).

Potential Rule Changes:  Apart from action on the tariff investigation, the FCC will commence a rulemaking to consider substantial changes to the special access regulatory regime.  Verizon and an industry association representing competitive carriers (INCOMPAS) have jointly proposed a new regulatory approach that would end tariffing and deregulate special access in markets deemed competitive.  In markets not considered competitive, rate restrictions would be imposed but would apply on a technology-neutral basis to all providers of enterprise private lines.

Defining when markets are competitive and non-competitive, and the size or granularity of markets under consideration, would be issues explored in the upcoming rulemaking proceeding.  The FCC would need to establish criteria for setting reasonable rates and develop an effective system of enforcement.

Cable operators oppose the Verizon/INCOMPAS regulatory principles, rejecting the notion that they should be subject to any type of pricing regulation as an emerging provider making new facilities-based investment in the enterprise services market.  Competitors agree that cable private line options have been expanding to serve enterprise buildings and provide backhaul from cell towers, but they contend a functional duopoly still results in supra-competitive rates, justifying regulation of both incumbent telco providers and cable operators.

The FCC is interested in the Verizon-INCOMPAS approach as it represents the potential foundation of a consensus industry solution.  But without support from AT&T, CenturyLink and cable operators, the fight over final rules will be intense.  The Commission hopes to wrap this up late in the year, recognizing that potential changes in FCC personnel next year could derail possible rule changes for the special access market.

Cable Operators at Risk:  The proceeding poses two major enterprise market risks to cable providers.  First, any regulatory mandate that drives down incumbent telco special access rates would affect the retail pricing flexibility of cable operators.  They have generated double-digit growth in enterprise services and have plans to grow more substantially in this market, particularly in the provision of backhaul for wireless services.

Second, the FCC is now considering, consistent with the Verizon proposal, the imposition of rate regulations on all special access providers, renaming the offering "business data services."  This would extend pricing rules to cable operators and other providers of enterprise private lines.  Cable operators have not been subject to federal special access regulation and direct pricing regulation would become a new and potentially substantial burden.

Although the FCC would apply Title II common carrier telecom regulation to all special access services -- even if labeled as "business data services" -- the risk to cable operators appears to be complex rate regulation, not the more ominous regime involving mandatory network unbundling.  Under existing statutes, only incumbent phone carriers (essentially the former Baby Bells) are subject to loop unbundling.  The obligation does not extend to cable operators or CLECs.

Moreover, the FCC, backed by senior telecom policy officials in the Administration, generally does not favor network unbundling mandates to promote competition.  They have an expressed preference for facilities-based competition, avoiding the regulatory and litigation burdens associated with estimating wholesale pricing and other requirements for an unbundling regime.  After years of experience with the 1996 Telecom Act local phone competition rules, the Commission seems to acknowledge that genuine competition only comes from facilities-based alternatives.

Absent such alternatives, however, the FCC appears willing to intervene in a market deemed non-competitive, ensuring prevailing special access rates are reasonable.  The upcoming proceeding will be complicated and highly adversarial, but the regulatory trend looks favorable for competitors like Level 3 and introduces new enterprise regulatory uncertainty for cable operators.

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