“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?
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%
Oil (WTI) 39.97-44.25
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research