Reflation Reversal Risk Is Growing

Takeaway: Short interest in the S&P 500 is the lowest its been since mid-December.

Reflation Reversal Risk Is Growing - caution tape


Investor sentiment is one of the key indicators we track. 


Unsurprisingly, what happens over the course of the market cycle is that most investors are:


  1. Most bearish at the market lows
  2. Most bullish at the top


As Hedgeye Senior Macro analyst Darius Dale and CEO Keith McCullough discussed on The Macro Show this morning, that's exactly what we're witnessing right now in non-commercial S&P 500 futures and options positioning. As you can see in the chart below, short interest in the S&P 500 is the lowest its been since mid-December.


Remember what happened next?


Click to enlarge


 Keep your head up out there.

MONDAY MORNING RISK MONITOR | 1.21 Gigawatts from China

Takeaway: Running out of plutonium, China managed to channel lightning into its flux capacitor to get it (and the world) through the first quarter.

Key Takeaway:

Chinese stimulus has reflated the world, for now. The FT reported this weekend (HERE) that Chinese debt grew by 6.2 Trillion CNY in the first quarter of 2016 (~$930 billion USD). This brought total Chinese debt to ~$25 Trillion USD and marked the fastest pace of quarterly debt growth on record. In fact, in the ~8yrs since 2007, China has grown its debt from 148% of GDP to 237%. While that level of debt puts China roughly in line with the EU & US on a debt/GDP basis, the pace of debt accumulation is the issue. 

Consider this. The US saw staggering growth in credit from 2000 to 2008. Total US Single family mortgage debt outstanding grew from $4.8 trillion at the start of 2000 to $11.3 trillion at the start of 2008, an increase of $6.5 trillion (+137%) over eight years. China, by comparison, has seen total private credit grow from ~$3 trillion (USD) at the end of 2007 to ~$25 trillion as of 1Q16. That's $22 trillion in growth (USD), or roughly +633% over eight years. What's even more remarkable is that the pace of growth - on a much larger denominator - has accelerated of late. Even George Soros is concerned (HERE). 

If we think back to the low watermark in US equities, it was set on Feb 11, 2016. What's now clear in hindsight is that it was this torrid growth in Chinese credit that arrested the fall. The chart below of Chinese Steel prices provides an illustration of just how sharp the bounce has been since mid-February.

MONDAY MORNING RISK MONITOR | 1.21 Gigawatts from China - RM12 


Current Ideas:

MONDAY MORNING RISK MONITOR | 1.21 Gigawatts from China - RM19


Financial Risk Monitor Summary

• Short-term(WoW): Positive / 4 of 13 improved / 3 out of 13 worsened / 6 of 13 unchanged
• Intermediate-term(WoW): Positive / 6 of 13 improved / 3 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 | 1.21 Gigawatts from China - RM15


1. U.S. Financial CDS – Swaps tightened for 10 out of 27 domestic financial institutions and the median CDS tightened by -11 bps to 86 as investors continued to reach for optimism.

Tightened the most WoW: GS, BAC, C
Widened the most WoW: HIG, AIG, AXP
Tightened the most WoW: GS, MS, BAC
Widened the most MoM: UNM, XL, AGO

MONDAY MORNING RISK MONITOR | 1.21 Gigawatts from China - RM1


2. European Financial CDS – Financial swaps mostly tightened in Europe last week. Greek bank swaps stood out, tightening between -78 and -258 bps as the country made progress in its bailout discussions with creditors, agreeing that it would implement extra austerity measures if it failed to reach budget targets. 

MONDAY MORNING RISK MONITOR | 1.21 Gigawatts from China - RM2


3. Asian Financial CDS – Aside from in China, financial swaps tightened in Asia last week. In particular, Japanese bank swaps tightened on hopes for further stimulus from the BoJ.

MONDAY MORNING RISK MONITOR | 1.21 Gigawatts from China - RM17


4. Sovereign CDS – Sovereign swaps were mixed last week. Portuguese sovereign swaps stood out, tightening by -11 bps to 261 as the country announced plans to cut its budget deficit in 2017.

MONDAY MORNING RISK MONITOR | 1.21 Gigawatts from China - RM18


MONDAY MORNING RISK MONITOR | 1.21 Gigawatts from China - RM3

5. Emerging Market Sovereign CDS – Emerging market swaps mostly tightened last week. However, with the politically volatile situation in Brazil, Brazilian sovereign swaps widened by 17 bps to 359. Russian swaps tightened by -25 bps to 248 as investors brushed off the non-decision out of Doha.

MONDAY MORNING RISK MONITOR | 1.21 Gigawatts from China - RM16

MONDAY MORNING RISK MONITOR | 1.21 Gigawatts from China - RM20

6. High Yield (YTM) Monitor – High Yield rates fell 9 bps last week, ending the week at 7.51% versus 7.60% the prior week.

MONDAY MORNING RISK MONITOR | 1.21 Gigawatts from China - RM5

7. Leveraged Loan Index Monitor  – The Leveraged Loan Index rose 14.0 points last week, ending at 1885.

MONDAY MORNING RISK MONITOR | 1.21 Gigawatts from China - RM6

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

MONDAY MORNING RISK MONITOR | 1.21 Gigawatts from China - RM7

9. CRB Commodity Price Index – The CRB index rose 2.3%, ending the week at 180 versus 176 the prior week. As compared with the prior month, commodity prices have increased 4.3%. We generally regard changes in commodity prices on the margin as having meaningful consumption implications.

MONDAY MORNING RISK MONITOR | 1.21 Gigawatts from China - 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 | 1.21 Gigawatts from China - RM9

11. Chinese Interbank Rate (Shifon Index) – The Shifon Index rose 4 basis points last week, ending the week at 2.04% versus last week’s print of 2.00%. 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 | 1.21 Gigawatts from China - RM10

12. Chinese Steel – Steel prices in China rose 10.3% last week, or 295 yuan/ton, to 3147 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 | 1.21 Gigawatts from China - RM12

13. Chinese Non-Performing Loans Chinese non-performing loans amount to 1,274 billion Yuan as of Dec 31, 2015, which is up +51.2% year over year. Given the growing focus on China's debt growth and the potential fallout, we've decided to begin tracking loan quality. Note: this data is only updated quarterly.

MONDAY MORNING RISK MONITOR | 1.21 Gigawatts from China - RM4

14. 2-10 Spread – Last week the 2-10 spread widened to 107 bps, 5 bps wider than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.

MONDAY MORNING RISK MONITOR | 1.21 Gigawatts from China - 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 widened by 1 bps to 42 bps.

MONDAY MORNING RISK MONITOR | 1.21 Gigawatts from China - RM14

Joshua Steiner, CFA

Jonathan Casteleyn, CFA, CMT

6 Macro Market 'Reality Check' Charts

Takeaway: Ignore what's going on around you at your own peril.

6 Macro Market 'Reality Check' Charts - bubble cartoon 11.02.2015


QUESTION FOR YOU ... What's changed?


That may be the most important question to ask yourself right now. Here's the answer. Nothing. Nothing has changed. And that's why we're holding the line on our bearish thesis. 


It was our non-consensus call heading into 2016 ... and we continue to flag the risk that U.S. economic growth continues its slide from 3% to 2% to 1%. Meanwhile, corporate profits continue to contract and are on pace for the third consecutive quarter of declines. (Click here for an update on Q1 earnings.)


More on macro markets this morning via Hedgeye CEO Keith McCullough in a note sent to subscribers. Take a look at Copper:


"One of the many proxies to pay attention to right now on the “reflation” hope vs. the #Deflation TREND - -0.25% this am after failing to breakout above its MAR high; $2.31/lb Copper and $46 WTI are big resistance levels for me."



meanwhile, over to Europe...


After a reading of German business sentiment failed to meet expectations, Euro-zone permabulls continue to be battered by these ugly economic realities: 



That's why countries like Italy remain in crash mode. 



heading over to Asia...


Here's the Shanghai Comp Casino today:



... And Japan:



So, what should you own? As McCullough noted on The Macro Show today, Long Bonds (TLT, ZROZ, EDV) are "the most obvious position you should have" on U.S. growth slowing. Here's McCullough's incremental Monday morning update: 


"Was it a bad week for Long Bond Bulls or the last big buying opportunity of Q2? I say buyem (again) – and buy anything that looks like a safe yield (XLU, EDV, ZROZ) with the 10yr tapping the top-end of a 1.70-1.90% immediate-term risk range."



Back to reality this Monday morning.

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LB | Adding to Top of Retail Vetting List

Takeaway: We’re adding LB to the top of our Vetting List. Weighing the puts and takes.

We’re adding LB to our Vetting List. We think that it’s very likely to turn out to be a solid idea – it’s just not clear to us at this point if it will be a long or a short.  As the company comes off a year with virtually no earnings growth, there’s far too much speculation that FY2017 will be yet another.  It’s at peak productivity, peak margins, cycle-peak multiples on almost every metric, with only 3.7% of the float held short.  Add on questions surrounding changes in distribution of the Victoria’s Secret catalog – which is potentially disruptive – and we may very well see numbers come down again when LB reports earnings on May 18th.  On the flip side, brands matter in this space, and VS is arguably one of the top 3 brands in all of retail. Its product is extremely stable, steady, and almost always relevant to any consumer (in every gender) globally. Management has also earned the benefit of the doubt given its track record. 


But with all that said, in order to make a real call on LB, we need a real edge on some of the key value drivers, which we think will come in part with a detailed consumer survey of brand perception, and consumer buying patterns.  We plan to have this complete by the time we come out with our LB Vetting Book in the days before earnings. This book will, as the name suggests, Vet all the relevant puts and takes of the LB investment case. If we come away with a particularly strong opinion, what starts as a Vetting Book may evolve into a Black Book.  Stay tuned.


Details to come.


LB | Adding to Top of Retail Vetting List - 4 25 2016 Idea List

P | Thoughts into the Print (1Q16)

Takeaway: P is either dead money or a call option depending on where mgmt steers the model. We're on the sidelines; below is what we're keying in on.


  1. LOCAL TRAJECTORY? 4Q15 Local Adverting revenue growth decelerated from 52% y/y to 34%, which is more than just a red flag since that's lower than the rate that P onboarded Local sales reps in any of the last 5 quarters (as far back as we can calculate).  Maybe that was just a hiccup, but if not, the Local Radio Ad opportunity may be concentrated in the major markets that P has already entered, and the runway is likely a lot shorter than P believes.  That said, the Ad-Supported model may be fizzling out since P’s growth will become even more dependent on sell-through (i.e. ad load), which we estimate has historically pushed its users away (see second note below).
  2. INTERACTIVE TIMING? P expects to finalize interactive agreements with the labels by 4Q16 and go to market by 1Q17.  However, P is trying to negotiate additional terms beyond the interactive agreements.  That will ultimately slow negotiations down since both sides have to be careful not to set dangerous precedent for the Webcaster proceedings, which is very tough to achieve, and why there is a dearth of direct license agreements in the field today.  The above timing may prove ambitious; we’ll be keying in on any updates.
  3. NON-INTERACTIVE PRODUCT(S)? P suggested that it’s expecting “maybe 5% y/y” in sub revenue growth in 2016, which basically means the sub product is an afterthought until it hammers out new terms with the labels.  But P has the ability to create a new market overnight if it started tiering its non-interactive subscription offering today.  It's a considerable opportunity (first note below), but more importantly, would be a strategic defensive move (retention) that could actually help drive conversion for the pending interactive product (up-sell).  But the longer P waits to try and lock its users into some form of a subscription contract, the more potential subs it will cede to its competition, which are currently deploying aggressive promotional tactics (e.g. discounting).  We’re hoping for some indication that P plans to aggressively pursue the sub market today vs. whenever it's done jockeying over terms with the labels (see point 2).  For now, we remain on the sidelines.


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


Hesham Shaaban, CFA
Managing Director



P | Fixing the Story
04/06/16 08:47 AM EDT
[click here]


P: New Best Idea (Short)
12/22/14 03:56 PM EST
[click here]

The Macro Show with Keith McCullough Replay | April 25, 2016

CLICK HERE to access the associated slides.

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

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