What's Been Driving Macro Markets?

Takeaway: Bulls are begging for a dovish Fed and as the Down Dollar trade reversed yesterday Metals & Mining stocks and Russian equities took a hit.

 What's Been Driving Macro Markets? - dollar crumbled


What's been driving macro markets?


Look no further than the U.S. Dollar, Hedgeye CEO Keith McCullough writes. Bulls are begging for a dovish Fed, as the dollar's inverse correlation to the S&P 500 (-0.72, 90-day correlation). 


That's why it was so interesting to read the knock on effects yesterday, as the Down Dollar trade reversed even marginally. Here's analysis via McCullough in a note sent to subscribers this morning:


"Get the Dollar right and you’re still getting most things macro right – USD hammered #Reflation yesterday (Metals & Mining ETF -7.8% on the day!) and should signal immediate-term TRADE overbought on this bounce up at 94.65 USD Index."



On The Strong Dollar, Russia took a hit...



Meanwhile in Japan...


"Japan loves Up Dollar, Down Yen – Nikkei +2.2% overnight got US Equity Futures excited, but I’d fade that – Nikkei will signal overbought on the bounce around 16,667 inasmuch as Yen will signal oversold vs. USD around 110."



More to be revealed.


Takeaway: We knew PRA's results would deteriorate over time, but even we were surprised by how quickly things unraveled.

PRA Group (PRAA) reported 1Q 2016 earnings after the close last night. The company missed revenue expectations by -6%, reporting $225 million versus expectations for $240 million, and adjusted EPS of $0.85 fell -11% short of expectations for $0.96. GAAP EPS, meanwhile, was $0.69, 28% below expectations.


Not only did 1Q16 fall short of expectations, but the company is faced with challenges on a number of fronts, which we detail in the note below:

  • Across the Board Deterioration — Most of the company’s major metrics are deteriorating year-over-year.
  • The Rising Cost of Doing Business — Management pointed out on the conference call that due to new regulation and scrutiny of legal representation in debt collection cases, the amount of documentation PRA’s lawyers require before they will sign off on and pursue litigation is driving up the cost and decreasing the efficiency of legal collections.
  • Wishful Thinking — Allowance charges, which management previously dismissed as a non-issue, continue to occur.
  • It’s Always Something — GAAP Earnings are consistently worse than the Non-GAAP numbers management wants investors to focus on. The company consistently adjusts earnings upward for “one time” items. The catch is that the adjustment for nonrecurring items consistently reccurs. Interestingly, in the last 9 quarters, not once have Non-GAAP numbers been lower than GAAP numbers.
  • Tax Troubles Swept Under the Rug — Although the matter is little discussed, PRAA will stand trial on September 19, 2016 for a $252 million tax payment deficiency plus $91 million in interest. A ruling against PRA could significantly affect the firm’s liquidity
  • TCPA — A recent catalyst to PRAA stock’s downward movement was the FCC’s notice of proposed rulemaking (“NPR”) to formally amend the TCPA for restrictions on autodialers. While the FCC proceeded with its exemption of government debt collectors, the NPR did not include a similar provision for non-government debt collectors, as the industry had hoped.


Across the Board Deterioration

  • Cash collections of $384 million are -4% lower than 1Q15’s $400 million.
  • $225 million in 1Q16 revenue is -8% lower than $245 million in 1Q15.
  • Operating expenses of $154 million are up +3% from $149 million in 1Q15.
  • Net income was nearly cut in half. 1Q16 came in at $32 million, -45% lower than $58 million in 1Q15.

The following chart shows that PRA built up a good deal of operating leverage from 2009 to 2014; its revenues were growing, and its operating margins were expanding. However, now that revenues are falling, the company’s fixed costs are not unwinding so easily. In fact, operating expenses have risen (+$5mn Y/Y), and operating margin has fallen by a massive -770 bps from 39.2% in 1Q15 to 31.5% in 1Q16. We expect this deterioration to continue as limited supply continues to impede the company’s ability to replace liquidations, newer, lower-performing vintages increasingly dominate the portfolio, cash collections continue to fall, and revenue follows suit while fixed costs remain.




Meanwhile, the company continues to lever up. As of 1Q16, PRAA holds $1,817 in net debt, $165 million higher than 4Q15 and $378 million higher than 1Q15. Additionally, debt to equity now sits at 2.09x, up from 2.05x as of 4Q15 and 1.81x as of 1Q15. Bear in mind that most of that equity is from intangible assets (Goodwill).


The Rising Cost of Doing Business

In our February note, Encore Capital (ECPG) | The Pressures Are Both Cyclical and Secular, we pointed out the case of Psaros v. Green Tree which exemplifies the heightened liability placed on law firms litigating to collect debts. Lawyers are now responsible for verifying the legality, accuracy and legitimacy of the debts they attempt to collect on behalf of clients, and they can be sued for damages caused by attempting to collect illegitimate debts. In February, we predicted that this development in the legal collection environment would increase the amount of time collectors spend checking the accuracy of information before proceeding in the legal channel and may also decrease the amount of ECPG’s and PRAA’s collectible debt as legal representation refuses to litigate on debt that the collectors previously thought  to be collectible. Sure enough, PRA management directly commented on this issue during the 1Q16 conference call, making the following statement


"The changes that are of note, if there are any, are the lawyers and them desperately wanting to be perfectly comfortable with how these tweaks and changes in practices have affected the paperwork that they're signing off on each and every day, and they're not going to do it until they have perfect clarity and confidence, so the amount of angst around all of that, that's been different."




"Legal collection performance has suffered delays and some loss of inventory related to regulatory and legislative events including state law changes, jurisdictional rule changes, and our consent order, all of which are directing us to obtain different or incremental documents than were required historically."


While management also attempted to ease concerns by pointing out that legal representation is getting to a place where they’re comfortable with the changes PRAA has made, we caution that while the lawyers may now be comfortable and willing to process cases, the elevated legal costs are here to stay. Specifically, management indicated that legal collection costs would be flat sequentially in 2Q16 ($17mn), but would be higher by 20% in the back half of 2016. To put that in context, that works out to +$3.4mn in legal costs/quarter, or roughly 7% of pre-tax income this quarter.

Wishful Thinking

The future is not as bright as management would have us think. PRAA management has argued in recent quarters that, per GAAP, it is being unjustly forced to record allowance charges due to short-term changes in collection patterns while they are increasing longer term collection projections. They claim that the net present value of the upward revision to expected remaining collections (“ERC”) for better performing vintages outweighs the shortfall of the vintages taking the allowances. However, we see this commentary as a distraction from the fact that significant allowances continue to occur. While management may be increasing projections, the shortfalls that force them to book losses continued in 1Q16 to the tune of a $9.9 million revenue hit, roughly in-line with the trend over the last few quarters.




Furthermore, management highlighted a $7 million Italian portfolio that it is performing so poorly that it is not even booking revenue anymore. In other words, any collections that the company makes on that portfolio incur a cost to collect, reducing earnings, but accruing no revenue. This is not a good sign for the overall health of the debt collection business.


It’s Always Something

To make a quick point about the usefulness of the information that PRA’s management feeds investors, there always seems to be different “one-time” items that they use to adjust earnings. The problem is that when one-time occurrences occur every time, they’re not so “one-timeish”, are they? Our point is that PRAA earnings truly are lower than what management attempts to dangle in front of investors. In fact, since 1Q14, one-time adjustments have averaged $7 million per quarter. Even excluding 3Q15, when PRAA booked most of its CFPB expense, the average is $4.7 million. To put this in better perspective, add-backs of one-time items averaged just six cents per quarter from 1Q14 through 2Q15, but in the last three quarters they've averaged $0.32/quarter. The last 9 months have seen GAAP earnings of $1.91, while non-GAAP earnings have been $2.87 (50% higher!). We think the buyside and sell-side may be slowly waking up to the fact that GAAP numbers are the better gauge of how PRA is performing. It's also remarkable how in the last 9 quarters, not once have Non-GAAP earnings been lower than GAAP earnings.




Tax Trouble Swept Under the Rug

Although it’s seldom discussed, hidden away in the 10-k is a disclosure that the IRS reviewed the company’s tax revenue recognition methods and determined that PRA is alleged to have shorted the tax man by $252 million. Also, as of 12/31/15, that tax bill carried an estimated $91 million in interest. PRA is set to stand trial for this tax liability on September 19, 2016. If it loses the case, the $300+ million tax charge would likely significantly affect PRAA’s liquidity.





Since July 2015, the FCC’s ruling to ban the use of autodialers to contact debtors on their cell phones has been a hot issue. The Association of Credit and Collection Professionals appealed the FCC’s ruling shortly after it was issued. However, on January 15, 2016 the FCC released a defense of its original decision and showed no sign of budging. Even still, there remained hope that the FCC’s formal notice of proposed rulemaking (“NPR”) might provide some exemptions to non-government debt collectors. However, last Friday, May 6, the FCC released its NPR without guiding towards such provisions. As it stands, private debt collectors will continue to experience higher cost to collect due to the decreased efficiency of manually dialing cell phones to make collection calls.



Plenty of Downside

Given the numerous aforementioned headwinds, we believe this quarter’s broad deterioration in PRAA’s metrics is only the beginning of the company’s downturn. We continue to see significant downside to PRAA’s stock price.



One Final Note

We normally analyze PRAs' individual vintages to track performance and look for any changes in quality, but we need the 10-Q to do this. Once the Q is out, we'll provide an update with the latest look at vintage performance.



Joshua Steiner, CFA


Jonathan Casteleyn, CFA, CMT

Daily Market Data Dump: Tuesday

Takeaway: A closer look at global macro market developments.

Editor's Note: Below are complimentary charts highlighting global equity market developments, S&P 500 sector performance, volume on U.S. stock exchanges, and rates and bond spreads. It's on the house. For more information on how Hedgeye can help you better understand the markets and economy (and stay ahead of consensus) check out our array of investing products




Daily Market Data Dump: Tuesday - equity markets 5 10


Daily Market Data Dump: Tuesday - sector performance 5 10


Daily Market Data Dump: Tuesday - volume 5 10


Daily Market Data Dump: Tuesday - rates and spreads 5 10

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

Morning Bullets 5/10/16

Trump's Troubling Numbers, Sanders' Other Math Problem; Will Carried Interest be the New Inversions?


TRUMP'S TROUBLING NUMBERS:   Donald Trump is under fire for waffling on the pillars of his economic plans. We think he has a bigger numbers problem - and his difficult task of winning over key demographics (particularly Hispanics) may have just gotten harder. Yes, his unfavorables are at a historic high for a major party nominee; and yes, his misguided attempts to win over those groups (think: TacoGate 2016) have not done him any favors. But that may be nothing compared to the impending "Hispanic backlash."  Trump is backed up against a big border wall for a number of reasons: he has a net favorability among Latinos of negative 78% (while Hillary Clinton is at +29%).  Since 1980, no Republican has won the White House without locking down at least 30% of the Hispanic vote, and Hispanic registration is up in a number of key states - CA, CO, NV and FL - to name a few. 

BERNIE SANDERS' WAR ON MATH: The Democratic underdog is fighting over big numbers again, and this time they're coming at him from the left. The left-leaning Urban Institute did the math on Sanders' "Medicare for all" program estimating it would increase federal spending by $32 trillion over 10 years - yes, that's trillion with a T.  Sanders had previously estimated the cost to be closer to a measly $13.8 trillion. But West Virginians don't seem too concerned. Despite Sanders' long list of policy proposals with no clear way to pay for them, he is likely to pick off another win in WVA today and the Democratic contest will just keep dragging on. 

CARRIED INTEREST, THE NEW INVERSIONS?  Tax Notes recently suggested the Obama Administration could use the regulatory process to close the so-called "carried interest loophole." Treasury officials responded in an eerily similar tone it used during the run-up to recently-released inversion guidance, saying closing the loophole was a top priority and that Treasury is "continuing to explore its existing authority...but the department cannot eliminate the carried interest tax benefit by itself."  Given the heat they are taking on their unilateral action on inversions, we would be surprised to see Treasury take on another battle.  But given Clinton, Sanders and Trump have all criticized the carried interest provision, the rhetoric on this issue will likely heat up just in time for the summer.

ANYTHING BUT REGULAR ORDER: When he became Senate Majority Leader in 2015, Mitch McConnell promised a return to "regular order" when considering legislation.  He specifically wanted to avoid more short-term government funding patches by passing all 12 appropriations bills that fund government programs and agencies - something that has not happened since 1994.  Fast forward to present - the Senate has failed to pass a budget for 2017 and is now stuck on the first funding bill out of the gate, the Energy and Water Appropriations bill, over an issue related to Iran.  Despite McConnell's worthwhile goal, we fear short-term funding patches and looming shutdowns are destined to be the new normal.  Driving off these cliffs are predictably avoided, but in ever-decreasing dramatic fashion. A new Administration could change this - but not as long as Congress remains as polarized as it is.       

CHART OF THE DAY: How To Play US #GrowthSlowing

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye CEO Keith McCullough. Click here to learn more.


"... Back to REITS, in stark contrast to what they did vs. Utilities when #Deflation dominated in JAN-FEB 2016 (REITS got crushed), they’ve really started to rip higher post the ugly 0.5% GDP report and another rate-of-change slow-down in non-farm payroll (NFP) growth:

  1. The Vanguard REIT ETF is pulverizing the Financials (XLF -1% in May) and is now +8.5% YTD
  2. Vs. Utilities (XLU) which continues its impressive, but steady, march higher to +13.5% YTD"


CHART OF THE DAY: How To Play US #GrowthSlowing - 05.10.16 EL Chart

Making America Weak Again

“The cheap dollar tactic started a currency war that has been playing out ever since.”

-Jim Rickards


In The New Case For Gold, Rickards reviews a critical period in American history that Ben Bernanke refuses to have the courage to admit. “Though it seems like an extraordinary policy to adopt, since 2010 the US government has effectively abandoned the sound dollar.”


“In January of that year, the United States ended the sound dollar policy that prevailed since 1980. An intentional policy of cheapening the dollar to encourage inflation and nominal growth was commenced.” (pg 120)


This Weak Dollar Policy, of course, has been tried before. If you want to see Trump make America weak again, you should vote for him so that he can triple down on what Nixon/Carter did in the 1970s inasmuch as Bush/Obama did in the most recent decade. It’ll be you-ge!


Making America Weak Again - trump point


Back to the Global Macro Grind


As any bi-partisan and/or objective student of Economic History can teach you, weakening a currency weakens the purchasing power of The People who earn their living (and have to pay to live) in that currency.


Given that you have two deteriorating Boomer Brands (Republican and Democrat parties) fighting over how much their political and corporate leaders should get paid in devalued Dollars, I’m surprised that someone isn’t running on the basic principle of sound money.


Instead of sounding creepy like Cruz, I’d bet my entire net wealth that I could lay a beat-down on Trump in a US Dollar debate. But, who knows, maybe I’ll just get to beat on Mr. Big Time for the next 4-5 years on Twitter instead.


In the meantime, despite the Fed’s renewed Dovish Down Dollar policy in 2016, what’s really getting beaten up are America’s profits:


  1. 441 of 500 S&P 500 companies have reported their Q1 2016 numbers
  2. Aggregate SALES growth is DOWN -2.4% year-over-year
  3. Aggregate EARNINGS growth is DOWN -8.9% year-over-year
  4. Ex-Energy (EPS -109% y/y), Financials have EARNINGS DOWN -14.3% year-over-year
  5. Ex-Energy, Technology has EARNINGS DOWN -8.4% year-over-year


Yeah, I know. Everyone nailed calling #TheCycle and this is all going to be fine. But when? Are Financials (banks, brokers, asset managers, etc.) going to crush it under a Down Dollar Trump and/or Hillary currency policy?


Maybe that’s why REITs have gone parabolic in the last few weeks. Have you seen my boy Big Time’s comments on how to protect his Dad’s original rental/real estate holdings? “I love debt!” And, ‘believe me, the US can never default because we can print money.’


I’m not yet dumb (or is it numb?) enough yet to believe everything Big Time says, but I can believe that he’d print money in order to try to protect his own interests above The People’s.


Don’t forget that RENT remains the largest component of the median US consumer’s cost of living (24% of total expenditures vs. something like gas at 4%) … and it remains at all-time highs.


Back to REITS, in stark contrast to what they did vs. Utilities when #Deflation dominated in JAN-FEB 2016 (REITS got crushed), they’ve really started to rip higher post the ugly 0.5% GDP report and another rate-of-change slow-down in non-farm payroll (NFP) growth:


  1. The Vanguard REIT ETF is pulverizing the Financials (XLF -1% in May) and is now +8.5% YTD
  2. Vs. Utilities (XLU) which continues its impressive, but steady, march higher to +13.5% YTD


Since I do believe that Big Time’s chances at becoming President are higher than Wall St. consensus, shouldn’t I consider adding REITS to our Best Macro Ideas list alongside the Long Bond (TLT), Munis (MUB), Extended Duration Treasuries (EDV), Utilities (XLU) and Gold (GLD)?


Heck, why not? Low Beta and Safe Yield is just one gargantuan bet that US growth continues to slow and that both Republicans and Democrats race to devalue the Dollar to try to show Americans the illusion of growth (asset inflation) again, isn’t it?


Of course it is, but it also runs its course when bad economic data becomes bad (again) for 90-100% of Americans who don’t get paid by Clinton Foundation speeches or owning their own apartment towers and oil wells.


What’s interesting is that the overall US Equity market traded deflationary yesterday, but REITS did not:


  1. US Dollar Up (small) on the day
  2. Oil (WTI) and Gold DOWN -2.9% and -2.3%, respectively
  3. Metals & Mining Equity ETF DOWN -7.8% on the day


So they jammed everyone back into what has not been working since the April 2016 lower-bubble-highs in the SP500 and chased US Retailers, Restaurants, etc. (you know, the stuff that does well when America is actually great, economically) and that was that.


But now what?


What happens when the entire equity market goes to Quad4 (#Deflation), including REITS? Well, I guess that might be my buying opportunity. Unlike Trump, I don’t love debt. But like many Americans (and Canadians), I love buying things on sale.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.71-1.82%

SPX 2030-2070
RUT 1096-1128


VIX 13.61-17.78
USD 92.49-94.65
Oil (WTI) 42.51-46.34

Gold 1255--1310


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Making America Weak Again - 05.10.16 EL Chart

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.