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Crash Mode: Shanghai Composite Casino Down -44% Since July

Takeaway: Just a few months ago "accelerating" economic data signaled a bottom in equities, according to Old Wall economists. Yeah, well, not so much.

Crash Mode: Shanghai Composite Casino Down -44% Since July - China cartoon 01.07.2016

 

Headfake

 

That's the most appropriate word to describe supposedly "accelerating" economic data around the globe a few months ago. The headfake is becoming more evident and is taking the hatchet to some global equity markets.

 

Below is analysis via Hedgeye CEO Keith McCullough in a note sent to subscribers earlier this morning: 

 

China evidently has not 'bottomed' – neither the made-up Chinese data nor the stock market is healthy right now; Shanghai Comp hammered for a -2.8% loss overnight and remains in #crash mode -44% since July of 2015 (Italy -26% and Nasdaq -10% since then)

 

 

Here's the Nasdaq chart...

 

 

And Italy...

 


China, UST 10YR and Gold

Client Talking Points

CHINA

China evidently has not “bottomed” – neither the made-up Chinese data nor the stock market is healthy right now. The Shanghai Composite got hammered for a -2.8% loss overnight and remains in #crash mode -44% since July of 2015 (Italy -26% and Nasdaq -10% since then).

UST 10YR

Oh boy has the Bond Market been nailing it since both #TheCycle (U.S. GDP) and stocks peaked in July 2015 – going into the jobs report 1.74% smells a slow-down as we test new lows in the 10s/2s Yield Spread at 101 basis points.

GOLD

Gold alongside the Long Bond (TLT) and Utes (XLU), remains one of our Top 3 Macro Long Ideas. Gold is up +0.3% into the jobs report with Copper down as our boy Trump trashes the Dollar – he says he wants a weak one (long real estate, in Dollars) – so does Janet! America has never been “great” with a Weak Dollar Policy.

 

*Tune into The Macro Show with Hedgeye CEO Keith McCullough live in the studio at 9:00AM ET - CLICK HERE

Asset Allocation

CASH 58% US EQUITIES 4%
INTL EQUITIES 0% COMMODITIES 6%
FIXED INCOME 28% INTL CURRENCIES 4%

Top Long Ideas

Company Ticker Sector Duration
GIS

Please note we are removed General Mills (GIS) from Investing Ideas (long side) on Monday. Hedgeye CEO Keith McCullough wrote in Real-Time Alerts: "While I like GIS from a Style Factor perspective (it did its job last week, closing up in a down tape - doing its job again this a.m. +1%), it's:

A) Signaling a series of lower-highs from a long-term perspective

B) Not as well loved by my analyst team (Penney and Laidlaw)

 

While we still like the long-term story, the stock’s performance in 2016 has been nothing short of spectacular. Year-to-date GIS is up +7.8% versus +1.3% for the S&P 500. The company’s 3Q15 performance was mixed with the company missing on revenues and beating on EPS with the benefit of cost cutting.

 

That being said, there are a number of one-time items impacting volume growth that should self-correct in 4Q16 and FY17. GIS is currently trading at 13.9x EV / NTM EBITDA an all-time high for the company. Looking past GIS, the entire Consumer Staples space feel like there is a Safety Trade/ZBB/M&A bid underneath the entire group. We maintain our long-term bullish stance on GIS, but given the rapid acceleration to all-time highs in the YTD period, a correction is inevitable.

MCD

In a recent note to Real-Time Alerts subscribers, Hedgeye CEO Keith McCullough asked rhetorically, "What to buy?" "On pull backs to the low-end of my immediate-term risk range, I'd be buying more:

1. Long-duration Bond Exposures (TLT, ZROZ, EDV, etc)

2. Low-Beta Big Cap Stocks With Safe Yields (MCD, GIS, NKE, etc.)

3. Gold (GLD)"

 

McDonald's (MCD) has all the style factors we like for these turbulent markets, which explains why it's up 27% since we added it to Investing Ideas in August. Stick with it here.

TLT

Despite the weak U.S. GDP print, growth is very unlikely to rebound here in Q2. Don't get caught up in residual seasonality hopium. The confluence of steepening base effects 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).

 

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.” Giddy up for continued #GrowthSlowing!

 

The good thing about each of our active Macro positions (i.e. TLT, ZROZ, XLU and JNK) is that each of them typically works on an absolute return basis when growth slows.

Three for the Road

TWEET OF THE DAY

**NEW VIDEO

An Animated History Of U.S. #GrowthSlowing https://app.hedgeye.com/insights/50765-an-animated-history-of-u-s-growthslowing… via @KeithMcCullough #GDP #Economy

@Hedgeye

QUOTE OF THE DAY

Everyone is a genius; you just can’t judge a fish by its ability to climb a tree.

Einstein       

STAT OF THE DAY

The NHL’s Arizona Coyotes named John Chayka the team’s General Manager, making the 26-year-old the youngest GM in the league.


100K lbs.

“I think Bigfoot is blurry, that's the problem. It's not the photographer's fault. Bigfoot is blurry, and that's extra scary to me. There's a large, out-of-focus monster roaming the countryside.”

-Mitch Hedberg

 

I took last week off to build my deck.

 

My “vacation” kicked off with the shoveling of 100,000 lbs. of fill and process in order to grade the area.

 

If you’re unfamiliar with the soil/aggregate business, it’s a great legal racket.  Here’s how it works:

 

A construction company has a piece of raw land that they want to develop but they need to do large-scale engineering and site prep work to ready the land. 

 

Typically this will involve the reshaping and removal of a ton of earth …. literally thousands of tons of dirt and rock that, for development purposes, is waste that they somehow need to get rid of.   

 

This is the good part ….

 

As they ponder how, and at what cost, to get rid of the earthen waste, people like me call them up and offer to buy it from them.    

 

So, not only do they not have to pay to dispose of it, they actually make money by selling me their developmental ‘garbage’.

 

Selling people what you don’t want anyway is a paragon of operating efficiency.  Find your industry equivalent and you have yourself a sustainable model.

 

Personally, I’ve always wanted to do something with leaves.  Collect them => emulsify => add resin or some other compositing agent => use for some building product purpose (mdf type trim, plywood, etc).

 

Have people pay you to take their leaves away and then pay you again to buy it back in its reincarnated form. Repeat annually.  Profitable, sustainable, marketable.

 

If anyone can think of a viable application and wants to partner on development, feel free to ping me.

 

Back to the Global Macro Grind …..

 

Selling someone the equity exposure you no longer want near the cycle peak is a close cousin to the golden goose of retailing refuse topsoil.    

 

Across most domestic macro metrics, those peaks occurred between 2H14 and 3Q15.  As we profiled in our 2Q Macro Themes presentation, the procession of economic fundamentals is not a mystery, it’s a cycle - our media team did a great job of simplifying the complex in this short clip on the topic (Sequencing the Cycle).  

 

100K lbs. - Sequencing The Cycle  0 01 02 11

 

On the labor side, employment growth peaked in February 2015 at +2.28% year-over-year and has slowed consistently to the +1.99% YoY growth recorded last month.

 

We’ll get the April update in about 45 minutes and despite the manic “Jobs Day” agitations of social and financial media, we already know most of what matters relative to the trend in employment.    

 

Unless we get something >256K (consensus is at 200K vs 215K prior) then employment growth will register another sequential deceleration.  And unless we get something >675K – which is not going to happen – then the peak rate of change recorded in February last year will remain safely rearview.

 

In other words, the most probable scenario is that the labor market continues to slow on both a TRADE & TREND basis.

 

The flow through implications of slowing employment growth are important and relatively straightforward: 

  • With job growth slowing, earnings growth flat and weekly hours flat-to-down, aggregate income growth is also slowing.
  • If income growth is slowing then so is the capacity for consumption growth. With external demand in the doghouse and investment and corporate capex in recession, consumption spending has buttressed aggregate expenditure. 
  • In income growth is slowing and the savings rate is flat-to-higher year-over-year as is the case presently then the drag on consumption growth is amplified- which is what we observed in the latest Household spending figures.

 

There also exists some equally relavant but less direct associations to the deceleration in employment growth.

  • As the Chart of the Day below illustrates,  while employment growth is slowing it is still rising at a premium to output growth …
  • Employment Growth > Output Growth:  Employment growing faster than output is a different way of saying that productivity is declining and unit labor costs are rising which, in turn, serves as a drag on Profitability …
  • Input Costs > Output Prices:  If the price to produce something (unit labor costs) is growing faster than the price at which that something can be sold (implied by the GDP deflator) then margin pressure will remain ongoing.  In a situation of slack demand and declining productivity, employment gains are somewhat bittersweet.  A rising employment-to-population ratio is largely paid for via margin compression … which then (unsurprisingly) manifests in the much discussed crescendo of companies reporting adjusted, non-GAAP earnings in an attempt to mask the more dour underlying reality.    
  • Productivity ↓ = Real Earnings ↓:  Over the longer-term the trend in productivity drives the trend in real earnings growth.  Recall, real earnings are earnings measured in units of goods and services and the more goods and services each person can produce (i.e. productivity) the more each person can consume.  Declining profitability and productivity can function in a negative self-reinforcing fashion.  Declining profitability disincentivizes business from both hiring and investing and protracted underinvestment will curtail gains in productivity.    

 

To balance this out a bit before closing, let me highlight some bullish developments:

  • 1Q GDP Revision:  The final Construction Spending, Trade Balance and Factory Order data for March (which saw positive revisions) will support a positive revision to 1Q GDP.  +1% is better than +0.5%, I suppose. 
  • Retail Sales Rebound:  The rebound in auto sales in April will support sequential improvement in reported April Retail Sales (reported next Friday) and help backstop durables consumption to start 2Q16

 

These revisions and month-to-month shifts represent a kind of Forest vs Tree situation, however. 

 

The current cycle is past peak and is now traversing its downslope but a continuous series of smaller cycles oscillates above and below the larger “Trend” cycle.  Dalio’s description of this (HERE) is right on.

 

We’re well aware that we sound like a broken record on the #CycleSlowing theme.  Big developed market fundamentals don’t shift measurably hour-to-hour or day-to-day.  Just because we’re charged with generating high-frequency, daily commentary doesn’t change the slower, temporal reality of the macro cycle. 

 

But while fundamentals trudge, markets and asset prices move enough on small time scales to present the profit and/or risk management opportunities that we attempt to highlight daily. 

 

Bond markets have accurately reflected the cycle slowdown and, if you think about it, equities probably have on a net basis as well.  Indeed, the S&P500 hasn’t done much (net) of anything in two years having finished 2015 down -0.73% and sitting just +0.32% in 2016 YTD. 

 

To close, as the mania around jobs Friday surrounds you, the message for this morning is #Patience. 

 

The economy is a vast interconnected and interdependent network with labor serving as a primary linchpin.  Employment remains “okay” on an absolute basis but the trend remains one towards “less good” as payroll growth, income growth and confidence all continue to slow. 

 

Breath and let the cycle play out, it takes time.  Remember that things always look best before the crest.  Aggressively risk-manage climbing the late-cycle wall of worry if you’re so inclined but don’t get caught riding the slope of hope (much) lower.  

 

Our immediate-term Global Macro Risk Ranges are now: 

 

UST 10yr Yield 1.70-1.85%

SPX 2028-2078

NASDAQ 4

VIX 13.41-17.79
USD 92.01-95.11
Oil (WTI) 42.40-46.51

Gold 1260--1314

 

Best of luck out there today, 

 

Christian B. Drake

U.S. Macro Analyst

 

100K lbs. - 5 5 cod


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CHART OF THE DAY: Why Productivity ↓ = Real Earnings ↓

Editor's note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye U.S. Macro analyst Christian Drake. Click here to learn more.

 

CHART OF THE DAY: Why Productivity ↓ = Real Earnings ↓ - 5 5 cod

 

"... There also exists some equally relavant but less direct associations to the deceleration in employment growth.

  • As the Chart of the Day below illustrates,  while employment growth is slowing it is still rising at a premium to output growth …
  • Employment Growth > Output Growth:  Employment growing faster than output is a different way of saying that productivity is declining and unit labor costs are rising which, in turn, serves as a drag on Profitability …
  • Input Costs > Output Prices:  If the price to produce something (unit labor costs) is growing faster than the price at which that something can be sold (implied by the GDP deflator) then margin pressure will remain ongoing.  In a situation of slack demand and declining productivity, employment gains are somewhat bittersweet.  A rising employment-to-population ratio is largely paid for via margin compression … which then (unsurprisingly) manifests in the much discussed crescendo of companies reporting adjusted, non-GAAP earnings in an attempt to mask the more dour underlying reality.    
  • Productivity ↓ = Real Earnings ↓:  Over the longer-term the trend in productivity drives the trend in real earnings growth.  Recall, real earnings are earnings measured in units of goods and services and the more goods and services each person can produce (i.e. productivity) the more each person can consume.  Declining profitability and productivity can function in a negative self-reinforcing fashion.  Declining profitability disincentivizes business from both hiring and investing and protracted underinvestment will curtail gains in productivity."

The Macro Show with Keith McCullough Replay | May 6, 2016

CLICK HERE to access the associated slides.

 

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


An Animated History Of U.S. #GrowthSlowing

In this animated video, Hedgeye CEO Keith McCullough walks through the recent history of the #LateCycle U.S. economy, exploring peak corporate profits in 2014 to today’s lackluster growth.


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