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The Evolving Complacency In Credit Markets

Takeaway: Complacency about the credit cycle is at YTD highs, especially in commodity-related sectors.

Editor's Note: Below is #CreditCycle analysis via our Macro team in a note sent to subscribers earlier this morning. 

 

The Evolving Complacency In Credit Markets - credit cycle

With renewed expectations for Fed intervention on growth slowing and the precedent of Central Bankers buying corporate bonds in Europe, bond market volatility expectations have been smashed.

 

The MOVE index is at a level not seen since 2014. High yield spreads have nearly returned to their 2015 averages. Energy OAS is below 2015 averages after trading +600 over that level back in Febraury, and materials and industrials spreads have nearly reverted back to 2015 levels.

 

What's changed? Expectations certainly have:

 

  1. Spreads being well-off 2014 cycle lows;
  2. Consumption rolling over; and
  3. Jobless claims picking up

 

A confluence of data suggests the cycle still cycles.

 

The Evolving Complacency In Credit Markets - credit spreads 5 13

 


RL – ISSUES INTO ANALYST DAY CALL

Takeaway: On June 6th, we will host a call to review the key issues facing RL management heading into its analyst day.

RL currently sits at the top of our Long Vetting Bench. The reality is that RL is one of the few stocks we can find in retail that has arguably found a floor, and has potential catalysts to take it higher. With RL Management pushing its 2017 guidance off until the June 7th Investor day, all eyes will be on this event.

 

On June 6th, at 1PM ET we will host a call to review our thesis, as well as the key insight on the issues we think management must address in its analyst meeting. 

 

Details will be provided prior to the call.


The Macro Show Keith McCullough Replay | May 16, 2016

CLICK HERE to access the associated slides.

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


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Daily Market Data Dump: Friday

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

 

CLICK TO ENLARGE

 

Daily Market Data Dump: Friday - equity markets 5 13

 

Daily Market Data Dump: Friday - sector performance 5 13

 

Daily Market Data Dump: Friday - volume 5 13

 

Daily Market Data Dump: Friday - rates and spreads 5 13


CHART OF THE DAY: Trump Beating Clinton? Not As Challenging As Once Thought

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye Director of Research Daryl Jones. Click here to learn more.

 

"... Admittedly it is somewhat ironic to have a quote about losing from Donald Trump. To the chagrin of many, Trump has literally done nothing but win over the last year. He has won primary after primary and, if the most recent polls are any indication, beating Hillary Clinton might not be as challenging as pundits once thought either. In the Chart of the Day, we highlight this narrowing gap between the two."

 

CHART OF THE DAY: Trump Beating Clinton? Not As Challenging As Once Thought - 5 13 16 CoD


Winning the War

"Sometimes by losing a battle you find a new way to win the war."

-Donald Trump

 

Admittedly it is somewhat ironic to have a quote about losing from Donald Trump. To the chagrin of many, Trump has literally done nothing but win over the last year. He has won primary after primary and, if the most recent polls are any indication, beating Hilary Clinton might not be as challenging as pundits once thought either. In the Chart of the Day, we highlight this narrowing gap between the two.

 

On the topic of winning and losing, we've recently been reading Richard Thaler's book, "Misbehaving", which is the history and development of behavioral economics. In the not so distant past, the idea of psychology impacting economic decision making was largely ridiculed. Now, of course, the impact of human irrationality (or rationality for that matter) on decision making is broadly accepted. 

 

In the book, Thaler describes a classic article by MIT economist Paul Samuelson in which Samuelson describes a lunchtime conversation with a colleague at MIT. In the conversation, Samuelson notes to the colleague that he's heard the definition of a coward is someone that won't take a bet with 2:1 odds. To emphasize his point, Samuelson then offers the following bet (converted to today's dollars) to that same colleague: heads he wins $1,500 and tails he loses $750. 

 

Now if the colleague were acting based on economic rationality, he would accept that bet hand over first. But Samuelson’s colleague did not accept the bet. When asked to explain, the colleague simply said the negativity of losing $750 was much more significant to him than the positive impact of winning $1,500. In effect, the colleague, like many people (if not most), was loss averse.

 

In isolation, this example doesn’t mean much, but when repeated many times over and over in an economy the influence on markets and prices is staggering. As Peter Diamandis wrote:

 

“He fingers loss aversion—a tendency for people to regret a loss more than a similar gain—as the bias with the most impact on abundance. Loss aversion is often what keeps people stuck in ruts.” 

 

Indeed.

 

Winning the War - middle graphic chart

 

Back to the Global Macro Grind

 

Speaking of losing, President Obama was handed a major loss yesterday when a federal judge ruled the Obama administration has been improperly funding an Obamacare subsidy program. In effect, the ruling indicated that the Department of Health and Human Services (HHS) was spending about $180 billion that was not appropriated by Congress. 

 

While the ruling was voluntarily placed on injunction pending appeal, the impact on the health insurance industry could be substantial. As our new Managing Director for Healthcare policy Emily Evans (ping  if you want to be on her distribution) wrote:

 

“CBO projected that these cost-sharing subsidy payments to health insurers will total $180 billion over the next decade - including $3 billion in 2014, $7 billion in 2015, and $13 billion in 2016. 

 

The issue cited by the lawsuit is akin to the challenges made to the risk corridors program - i.e. that there is no legal mechanism in the bill that actually appropriates the money to the Administration to make the payments. The absence of promised payments to insurers under the risk corridor program is responsible, in part, for sinking a number of non-profit COOPs.

 

Insurers are required to reduce the out-of-pocket cost limits for eligible enrollees - regardless of whether the government reimburses them for doing so. In the absence of reimbursements, insurers would shift the cost of required out-of-pocket limits to higher premiums for silver plans.”

 

So heads and the health insurance industry loses $180 billion... yikes.

 

Also in the news yesterday was the bankruptcy of a company called Linn Energy. Our Energy Sector Head Kevin Kaiser was on this name very early and believed its equity was worth close to zero despite its high “dividend”. Kaiser was denigrated by all sides: the Company, the almighty Jim Cramer and his cabal at CNBC, and even a few billionaire hedge fund managers who owned stock in the company. 

 

In hindsight, despite all of the financial analysis Kaiser did to prove his case, the most significant red flag was probably a wedding. You read that correct: a wedding. You see at the height of the price of oil, the CFO of Linn decided to have one of the more extravagant weddings Houston has ever seen. As seen in the middle graphic above, the wedding included a performance of Cirque de Soleil with the happy couple. Oh, and there was also a Phantom Rolls Royce at the wedding . . . the “Phantom” of course representing Linn’s cash flow.

 

Another company that is currently on Kaiser’s radar screen, that he believes has the potential to lose all of its equity value, is Summit Midstream Partners, LP (ticker: SMLP). As Kaiser wrote a week ago:

 

“Our base case valuation for SMLP is $0 based on our DCF and SOTP models (see figure below). Our bull case valuation is $2 - $7/unit, an increase from March on account of the decline in SMLP’s cost of capital (unsecured bonds rallied from ~18% YTM to ~10% YTM)."

 

So if you are following, heads you win $2 - $7 / unit and tails you lose everything. But since the current unit price is $22, it is really heads you lose and tails you lose. Anyone irrational enough to take that bet?

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.69-1.78%

SPX 2039-2086

VIX 13.44-17.59
USD 92.54-95.07
Oil (WTI) 42.50-46.86

Gold 1

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research 

 

Winning the War - 5 13 16 CoD


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