• run with the bulls

    get your first month

    of hedgeye free


A Look At Wall Street's Ex-Energy Earnings Fallacy

Takeaway: Well into earnings season, six of ten S&P 500 sectors have negative earnings growth.

A Look At Wall Street's Ex-Energy Earnings Fallacy - earnings cartoon 04.12.2016


It's earnings season.


Permabulls on Wall Street are terribly fond of the narrative that "Ex-Energy" earnings look great! We understand this proclivity, Energy earnings are terrible (down -132% so far). Just look at the chart below.


Click to enlarge

A Look At Wall Street's Ex-Energy Earnings Fallacy - earnings q1


But what this narrative lacks is cohesiveness. In fact, six of ten S&P 500 sectors have negative earnings growth so far, with Financials (-14.1%) and Materials (-14.8%) companies putting up double-digit earnings losses.


In other words, Energy has company.


Here's a thought... Since permabulls are more than happy to strip battered sectors out of earnings, why not (for the sake of consistency) just go ahead and strip out the performance of Energy, Financials and Materials companies from the recent market rally as well? Oh yea, because those sectors have led the pack. 


Bottom Line: Stripping out sectors of the S&P 500 to fit some permabull narrative is as nonsensical, as it is wrong. 

Do Earnings Matter?

We threw up a note for Materials subs earlier this week with a Q1 earnings update and feel it is important to continue pounding the table on earnings and current multiples from a broader market perspective.


Now that the S&P 500 is going on 3 consecutive quarters of negative Y/Y earnings growth, forward looking - earnings expectations have been taken down – no surprise…


Given the fact that the market is trading at peak forward multiples again, is an earnings beat a positive in a declining earnings, peak multiple environment? The degree of late-cycle corporate gamery (buybacks and M&A) and unprecedented earnings manufacturing is widely discussed and understood, and we assume it gets factored into analyst models.


So far this earnings season:

  • S&P 500 Earnings are down -5.6% Y/Y
  • 6/10 sectors have comped down bottom line
  • 7/10 have comped down top line

Looking at expectations, 6/10 sectors have missed top-line expectations, but every sector has blown out bottom line expectations (see chart below). Despite that fact that everyone knows earnings metrics are being manufactured aggressively, actual prints are far exceeding expectations. 


Do Earnings Matter? - Comps   Beat.Miss


We find it hard to entertain “forward expectations have undershot to the downside” arguments when earnings growth is down -5.6% Y/Y, 6/10 sectors have missed top line, and every sector has exceeded bottom-line expectations to get to that -5.6% number. S&P earnings have beat estimates by 4.2% in aggregate.


AND, with the shift in financial reporting leeway, we can assume that today’s current peak multiple could be higher than it already is from a normalized historical standpoint. So, the most important question to ask is Can you find a catalyst to buy at peak multiples into what could be a fourth consecutive quarter of negative Y/Y earnings growth in Q2?.


The broader market has been trending higher as of late, but as DD outlined in Reflation Reversal Risk , the policy catalyst will be less muted than it was in January/February if that's what you're looking for – It’s mostly a matter of psychology and positioning, outlined in the note. Below we show two slides from our macro deck that outline the easiness/difficulty of Q1 and Q2 comps. The takeaway is that easy comps won’t be in front of the market until Q3/Q4 if you're looking for a reason to buy on earnings:


Do Earnings Matter? - Q2 2016 Comps


Do Earnings Matter? - Corporate Profit Peak


To sum up the cycle view, corporate profits and operating margins peaked in 2H 14 are now poised for what could be 4 quarters of negative Y/Y earnings growth, so despite a psychological boost from a “beat” the rate of change in corporate profitability is meaningful (visual below) and continues to decelerate with the market buying at peak multiples.


Do Earnings Matter? - S P 500 NTM Multiples



CME: We Are Removing CME Group From Investing Ideas

Takeaway: Please note we are removing CME Group from Investing Ideas (long side) today.

"I thought there was going to be more upside to the numbers than there was," Hedgeye CEO Keith McCullough wrote today. "The market reaction looks right on that (companies that beat big go up big – see FB). So I’ll remove it today, as I think the U.S. stock market broadly has a ton of risk pending May-July." 


CME: We Are Removing CME Group From Investing Ideas - cme group


Earnings analysis via Financials analyst Jonathan Casteleyn:


"CME Group had solid earnings results this week with revenue up +11% and earnings up +18% year-over-year. Investors will be hard pressed to find similar growth in the Financials sector with interest rates that continue to compress and very low banking and trading activity. In contrast, the average result for Financial companies in the S&P 500 thus far in earnings season has been top line revenue declines of -3.3% with earnings decay of -14.5%. With 2Q16 trading volumes up +4% year-over-year to start the new quarter, CME will likely put up another solid quarter and out comp the rest of the sector again."


Click to enlarge

CME: We Are Removing CME Group From Investing Ideas - s p earnings

Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

Finally, Some Differentiated Thoughts on Q1 GDP…

Takeaway: Despite today's weak print, U.S. GDP growth is very unlikely to rebound here in Q2. Don't get caught up in residual seasonality hopium.

Our Q1 GDP Summary Sans Sell-Side Hopium

Obviously the slowdown in growth that occurred in Q1 had been well telegraphed, but that doesn’t negate the reality of it or the implications of the prevailing trend which has seen headline GDP growth slow (year-over-year) for 4 consecutive quarters. Outside of government spending, each expenditure bucket continued to decelerate in the latest quarter.


Finally, Some Differentiated Thoughts on Q1 GDP… - GDP Summary Table  


We expect the trend of deceleration to continue for at least another quarter as growth faces its toughest comp of the cycle in 2Q16 and employment growth, consumption growth, income growth, investment, confidence and profitability all continue to decelerate off their 2H14/1H15 peaks.


1Q16 continued the pattern of soft first quarter growth observed in recent years. There probably still exists some element of residual seasonality in the data but its presence (or not) only marginally impacts the broader conclusion.   


If there is indeed still residual seasonality in the numbers and the balance of the year shows relative improvement then we're still a 1.5% to 2% +/- economy and slower-and-lower-for-longer continues to anchor our intermediate-term research conclusions. If, on the other hand, the BEA has effectively corrected for the distortion and 0.5% accurately reflects the organic, underlying reality then the data supports our late-cycle slowdown view. (more on residual seasonality in the next section)


We fully profiled #TheCycle in our 2Q16 Macro Themes presentation and the chart below sequences the temporal progression of the important cycle indicators. While the present cycle still has some modest runway, the recent domestic macro data continues to point to a cycle that is past peak and now traversing its downslope. 


Finally, Some Differentiated Thoughts on Q1 GDP… - A Cycle  Not A Mystery


In a macro-scape where marginal changes are what matter, “less good” continues to characterize the ongoing data trend.


-Christian Drake, Director


If You Thought Q1 GDP Was Bad, Wait Until Q2 Is Reported

In addition to Christian’s always-helpful synopsis of the many puts and takes in the GDP report, I have a few additional thoughts that may help investors better understand why they shouldn’t expect a meaningful rebound in coming quarter:


  • Per the BEA’s July 2015 annual revision and methodology changes, residual seasonality has allegedly been corrected for and studies show little evidence of residual seasonality once weather is accounted for.
  • Even if the BEA failed to for residual seasonality, 1Q16 was the third warmest first quarter in the last 50 years.
  • Moreover, residual seasonality doesn’t explain away the fact that the -5.9% QoQ SAAR decline in nonresidential fixed investment was sharpest pace of retrenchment of domestic capex since 2Q09, or why spending on wells and shafts contracted -86% on a QoQ SAAR basis – the steepest decline on record.
  • It also doesn’t explain why inventories continue to be a drag on growth, subtracting -33bps from headline GDP (vs. -22bps in Q4) as companies trim stockpiles to realign their inventories with the reality of slowing sales growth.
  • On that final note, it’s worth noting that real final sales to private domestic purchasers slowed to a +1.2% QoQ SAAR growth rate – the slowest pace since 3Q12. This paltry growth rate for 2016-to-date compares to full-year averages of +2.4%, +2.6%, 3.7% and +2.8% for 2012, 2013, 2014 and 2015, respectively.


Finally, Some Differentiated Thoughts on Q1 GDP… - Real Final Sales to PDP


Before we conclude, we think it’s important to help investors fully understand residual seasonality discussion – if only because it may become a likely source of misguided hopium over the next couple of weeks (at least until we start getting reported Q2 data).


Recall that the Federal Reserve Bank of San Francisco came out with a white paper last May confirming evidence of residual seasonality after they applied the BEA/Census Bureau’s X12-ARIMA model to the already-adjusted GDP data.


Finally, Some Differentiated Thoughts on Q1 GDP… - FRBSF  1

 Source: Federal Reserve Bank of San Francisco


Finally, Some Differentiated Thoughts on Q1 GDP… - FRBSF  2

Source: Federal Reserve Bank of San Francisco


Finally, Some Differentiated Thoughts on Q1 GDP… - FRBSF  3

Source: Federal Reserve Bank of San Francisco


The irony here is that the aforementioned paper was released four days after independent researchers at the FOMC determined there was little evidence of residential seasonality after their bootstrap analysis did not reject their null hypothesis to a statistically significant degree. That was in addition to their analysis finding rather muted evidence of residual seasonality after removing outlier data points from recent years. They did, however, find evidence of residual seasonality in the GDP components (but not at the aggregate level).


Finally, Some Differentiated Thoughts on Q1 GDP… - FOMC  1

 Source: Federal Reserve


Finally, Some Differentiated Thoughts on Q1 GDP… - FOMC  2

Source: Federal Reserve


Our analysis shows evidence of residual seasonality in the Q1 data, which explains why Q2 GDP growth is consistently well above the growth rate recorded in Q1 (black line below). That being said, however, there is scant evidence of residual seasonality after removing outlier readings from the quarterly growth rates and discarding the corresponding spreads from the moving averages (grey line below).


Finally, Some Differentiated Thoughts on Q1 GDP… - Residual Seasonality Analysis


Removing outlier data points would seem to suggest no evidence residual seasonality, but rather a couple of weak Q1’s (i.e. 2011 and 2014) that contributed to somewhat misguided residual seasonality fears. Looking at the national climate data, we see that 2011 and 2014 were indeed the two coldest first quarters over the trailing 10 years. Also note that 1Q16 is the third warmest Q1 over the previous 50 years, so the hope that sequential growth in Q2 is gangbusters is just that – hope.


Finally, Some Differentiated Thoughts on Q1 GDP… - 1Q16 National Average Temperature


All told, the confluence of steepening base effects (to cycle-highs I might add) amid the trending deterioration in economic momentum support our GIP Model forecast of a continued deceleration in the YoY growth rate of real GDP from +1.9% in 1Q16 to +1% in 2Q16E. The latter growth rate translates to +0.3% on a QoQ SAAR basis, which is up from our previous forecast of -0.5% (a lower base rate implies a smaller delta to get to the same numbers, all things being equal).


Finally, Some Differentiated Thoughts on Q1 GDP… - GDP COMPS


Finally, Some Differentiated Thoughts on Q1 GDP… - U.S. Economic Summary Table


Finally, Some Differentiated Thoughts on Q1 GDP… - GDP Estimates


Finally, Some Differentiated Thoughts on Q1 GDP… - UNITED STATES


Assuming Q1 isn’t revised in any material way, our forecast for 1H16E is represents the slowest pace of domestic economic growth on a multi-quarter basis since 2H12. Any downside surprises from there will surely translate to renewed recession fears.


Best of luck out there risk managing the pending slowdown from the existing slowdown.


-Darius Dale, Director

About Everything | The Surge in Mental Health Services


In this complimentary edition of About Everything, renowned demographer and Hedgeye Sector Head Neil Howe discusses why "mental health services spending is riding a long-term attitudinal shift that has brought mental health issues out into the open." Howe explains why it's happening and explores the broader societal and investing implications.


Click here to read Howe’s associated About Everything piece.

Who Do You Believe? Consensus GDP Estimates or Hedgeye?

Takeaway: Wall Street consensus has been consistently out to lunch on U.S. growth slowing, as our bearish expectations continue to play out.

Who Do You Believe? Consensus GDP Estimates or Hedgeye? - growth  cartoon 04.05.2016


The Hedgeye Macro team has been predicting dour U.S. economic growth for over a year. Our contrarian economic call has been pretty close to spot on. Meanwhile, this #GrowthSlowing reality has consistently confounded Wall Street consensus.


As you can see in the chart below, Wall Street economists were predicting almost 3% growth for Q1 2016 last April. 


To be clear, Old Wall consensus was forced to ratchet back its inflated estimate to 2.5% in February 2016 ... all the way down to 1.1% most recently. Of course, the initial Q1 GDP reading today came in at 0.5%. That surprised even us to the downside, as we have been predicting 1%. 


Who Do You Believe? Consensus GDP Estimates or Hedgeye? - Q1 Wall Street GDP


Will this slowdown persist?


Wall Street doesn't think so. The consensus estimate for Q2 2016 is a (drum roll please)...



Meanwhile, here at Hedgeye we're predicting 0.3%


Who do you believe?


Watch Hedgeye Senior Macro analyst Darius Dale explain why we're so bearish in the video below:


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.