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Hedgeye Guest Contributor | Cliggott: If I'm Right On Inflation, Sell Your Long Bonds

Editor's Note: Below is a Hedgeye Guest Contributor research note written by our friend Doug Cliggott. Cliggott is a former U.S. equity strategist at Credit Suisse and chief investment strategist at J.P. Morgan. He is currently a lecturer in the Economics Department at UMass Amherst. 

 

A brief note on our contributor policy. This column does not reflect the opinion of Hedgeye. In fact, in this instance we disagree with Cliggott. That's what makes a market. Cliggott has a keen eye for the markets and economy and, in the very least, is worth reading to challenge our own deeply-held views.

 

Hedgeye Guest Contributor | Cliggott: If I'm Right On Inflation, Sell Your Long Bonds - Inflation cartoon 02.26.2015

 

American consumer price inflation is running at about 1.0 percent so far in 2016. A year ago, it was zero. Six months from now, it will likely be around 3.0 percent and trending higher. Here’s why.

 

Inflation is now 1.0 percent because energy prices are lower than they were a year ago. Energy commodity prices – gasoline and heating oil – are down about 14 percent from where they were a year ago. Energy services prices – electricity and natural gas – are down about 3%.  

 

But oil prices have bounced since February, and are now right where they were in November 2015. So if oil prices don’t change much, on balance, between now and November 2016 (not a bad bet I think) then energy will shift from being a lever pushing down on inflation to one that is pushing up on inflation next winter.

 

The longer-term, more-important story is what is going on with prices of services. Rents folks are paying for a house or an apartment are rising by a bit more than 3% now, and look to be trending higher. And prices of all types of services that we buy (except for energy) – like medical care, travel, going to restaurants or the movies, using the internet – they are rising by a collective 3 percent. Maybe price increases for services slow in the next 6-12 months, but I doubt it. 

 

The reason is most of the services we buy involve quite a bit of labor. And the cost of labor is going up in America – not quickly, but at a slow and steady rate of ascent, kind of like the climb out of Keflavik Airport in Reykjavik Iceland. No need for a steep climb out of that place when there is nothing but water for hundreds of miles in all but one direction.

 

So-called “unit labor costs” moved up by 2.0 percent in 2014, by 2.1 percent in 2015, and by 2.3% in the first quarter of 2016. This soft trend higher isn’t because hourly compensation is accelerating – that has been growing at an unbelievable steady 2.8 percent per year since the end of 2013. What is happening is growth of labor productivity – the holy grail of economic activity – is grinding down towards zero.

 

No one really knows exactly how labor productivity works. We know you need good tools, good workers with the right training, good organization and management … but there also seems to be a really important role for something intangible like “chemistry” or “team spirit” in organizations that are experiencing strong growth in productivity.

 

Robert Gordon, in his excellent new book The Rise and Fall of American Growth, tells us about the amazing improvements in productivity that occurred in the Kaiser shipyards in Oregon and California in the early 1940s. When the yards began production of Liberty ships in 1942, the scheduled production time was eight months per ship. A year later, production time was down to a few weeks.

 

Hedgeye Guest Contributor | Cliggott: If I'm Right On Inflation, Sell Your Long Bonds - z xx

 

Gordon writes that the stunning productivity gains were "made possible in part by letters from more than 250 employees suggesting ways to make production more efficient".   Gordon creates an image of an amazing team spirit in these shipyards, a spirit that seems to have been shared in many factories and work places in America during the war.

 

That was then. Things are different now.

 

 

Since the end of the 1970s, we have had a well-documented divergence between productivity and a typical American worker's pay. Seventy years removed from the second World War, we now have a generation of American workers who have seen very little relationship between their collective productivity and what they are paid. And the compensation numbers really have become extreme. 

 

Think of corporate America as an American football team with twenty-two players. Twenty-one of these players earn between $15,000 and $125,000 each year, with half the team earning less $50,000 or less. But one player – the quarterback (or CEO) – earns $16,000,000 each year. Despite a pretty good won/loss record for many years, the only players' salaries that have gone up in a measurable fashion are those of the quarterback, and maybe one of his favorite receivers. 

 

In this scenario, we really shouldn't be surprised that most "team members" are now simply showing up on game day and going through the motions. And so the team’s performance (measured productivity) has deteriorated in dramatic fashion. This may be an important part of the profound slowdown in productivity – there may not be a lot of "team spirit" in many American work places these days, but there is a whole lot of selfish behavior going on in the "quarterback fraternity". 

 

We can see the unprecedented shares of cash flow being deployed to increase dividends and buy shares back, all in an effort to inflate stock prices and boost the compensation of those that are paid in stock. What we can’t see is the investments in new tools and training that are not being made, nor the dinner discussions of all those families that keep getting essentially the same pay check, no matter how profitable their company is.

 

But back to inflation – if I’m right and US inflation is on its way to about 3 percent in six months, and maybe higher than that in twelve months time, owning a 10-year US Treasury yielding 1.75% does not seem like a good idea. But perhaps owning some TIPs is a pretty good one.


RTA Live: May 18, 2016


The Hospital Lobby Making Progress on Site Neutral Payment Fix but it is Still Early

Takeaway: In addressing concerns from hospitals on site neutral payments, Congress may be paving the way for more of the same

Relevant tickers: HCA, CYH, THC, LPNT, SEM, AMSG, SCAI, SGRY, CNC

 

Last November, as part of the FFY 2016 and 2017 budget deal crafted by outgoing Speaker of the House, John Boehner, Congress imposed site neutral payments on newly built or acquired hospital outpatient departments located more than 250 feet from a hospital’s main campus. Under this site neutral payment law, new hospital outpatient departments that exceed the distance requirement will be reimbursed under the Physicians Fee Schedule or the Ambulatory Surgical Center rates instead of the higher, Hospital Outpatient Prospective Payment System (OPPS) rates. One of the primary motivations for hospital acquisition of physicians' practices has been the enhanced reimbusement available by declaring the practice an outpatient department upon closing the deal.

 

The American Hospital Association had lobbied vigorously against the provision in the budget deal, to no avail. The Federation of American Hospitals which represents the investor-owned hospital companies issued a conciliatory statement suggesting they were unconcerned about the change at the time. Since then however, both organizations have made amending the law to grandfather projects “under development” a priority.

 

According to reports, the House Ways and Means Committee is crafting a bipartisan response to the AHA and FHA’s request but not without a price. As reported, the new bill would potentially do the following:

  • Grandfather projects under development as of November 3, 2015 and that began billing Medicare under the OPPS within a certain time frame. The term “under development” and the deadline for bringing these projects online is not, as far as we can tell, defined.
  • The cost associated with the grandfather clause would be offset with a cut to the annual hospital market basket adjustment.
  • Outpatient cancer departments would be exempt from the site neutral requirement of the budget deal but would have a cancer department-specific budget offset.

Because no legislative opportunity should go unexploited, especially these days, there have been a few other provisions – in the form of filed bills - circulating that range from technical corrections to harbingers of long term trends. Those provisions being bandied about include:

  • The Medicare Crosswalk Hospital Code Development Act (H.R. 3291) -This potential addition tops our list because it is authored by House Speaker Paul Ryan (albeit before he became House Speaker) who has quietly and rather effectively made site neutral payments a priority. This bill would create uniform codes for at least ten surgical procedures that are performed on an inpatient and outpatient basis. For the uninitiated, outpatient departments bill Medicare using different codes than inpatient departments even if the procedure is the same. Billing codes are one of the major obstacles of payment reform. The merging of billing codes between outpatient and inpatient systems sets the stage for greater site neutral payment by Medicare and commercial payers.
  • Establishing Beneficiary Equity in the Hospital Readmission Program Act (H.R. 1343) – This possibility, if incldued, would adjust the hospital readmission program to account for the poor health of low income beneficiaries.
  • The Rural Community Hospital Demonstration Extension Act (S. 607) - This Senate bill would extend this CMS demonstration program from five to ten years.
  • The LTCH Technical Correction Act (H.R. 2580) - If added, this bill would make some technical corrections to how high cost patients at LTCHs are handled. Worth noting here is that LTCHs like SEM have lobbied for a change to the 25 percent rule which has an expiring implementation moratorium.  As of this writing it is not included and does not appear to be a priority.
  • Electronic Health Fairness Act of 2015 (HR. 887) –This possible provision would exempt ambulatory surgery centers like those owned by AMSG, SCAI and SGRY from meaningful use penalties. CMS and Congress have gotten out the coffin nails for Meaningful Use so this provision seems like an easy one given the rapidly changing philosophy on MU.
  • Medicare Advantage Coverage Transparency Act (H.R. 2505) - Would require CMS to release enrollment data on Medicare Parts A, B, C and D by zip code. CMS currently releases data regularly on Medicare enrollment and this provision would allow Congress and others (like us!) to compare enrollment by type.
  • Seniors Health Care Plan Protection Act (H.R. 2506) This provision would be welcome by Medicare Advantage providers with  large number of low income,. chronically ill patients like Centene (CNC). It requires CMS to revise risk adjustment calculations to account for Medicare Advantage beneficiaries’ chronic conditions like diabetes and COPD. This addition would also require changes to the risk adjustment system. Risk Adjustment for the chronically ill and low income beneficiaries has recently become a priority for CMS.

All of the provisions reportedly under consideration appear to be selected largely for their technical nature, thus carrying relatively low price tags in terms of budgetary offsets. Those factors argue for relatively smooth passage. However, this is politics in a particularly peculiar election year, so we are not going to get too excited just yet. The Senate is especially hard to predict. We assume the best hope for passage is as an accompaniment to the Health and Human Services appropriations bill.

Stay tuned.


investing ideas

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US Economy: WSJ Says "All Clear" ... Nope

Takeaway: Brighter economic data? Seriously?

US Economy: WSJ Says "All Clear" ... Nope - economic indicators cartoon 02.24.2016 

 

Head-scratcher of the day via the Wall Street Journal:

 

"Brighter economic data raises specter of Fed rate increase; yield curve is flattest since 2007."

 

Huh?

 

Here's a better explanation as to why... ugly S&P 1Q16 earnings:

 

The bond market is signaling a precarious reality... a.k.a. #GrowthSlowing. Here's analysis from Hedgeye CEO Keith McCullough in a note sent to subscribers earlier this morning:

 

"Yield spread flattening = leading indicator of economic slowing – at 94bps wide this am (10yr minus 2yr) that’s a fresh YTD low and it’s driven by the 2yr popping to 0.84% on concern the Fed will hike on a rising CPI? If the Fed raises rates in June, they will make US Equity Beta Bears happy (reminder: rising inflation takes DOWN our Street low GDP forecast for Q2)."

 

Addressing all the supposedly "brighter" data, Hedgeye Senior Macro analyst Darius Dale provides this chart of the recently reported key economic releases. Dale writes:

 

"U.S. Economic Summary: green shoots where the trend remains bearish; red shoots where the trend has likely bottomed."

 

Click image to enlarge

 

US Economy: WSJ Says "All Clear" ... Nope - us economic summary

 

Dale continues:

 

"Not much to do with those [sequential green shoots] other than trust the forward-looking components of our process, such as Mr. Market himself."

 

... A.K.A. the 10s/2s spread. Here's the yield spread.

 

US Economy: WSJ Says "All Clear" ... Nope - 10y2y spread 5 18

Click to enlarge

 

What do you do with that?

 

Dale's conclusion:

 

"This is our third or fourth short-term headfake in domestic economic data since the cycle peaked in 1H15. Elongate your memory. FYI, the TSY 10s-2s spread compressing to new cycle lows is not exactly a bullish indicator... See through the S/T headfake in the data."

 

In other words.. stick with your #GrowthSlowing positions... Long Bonds (TLT) and Utilities (XLU).


Daily Market Data Dump: Wednesday

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

 

CLICK TO ENLARGE

 

Daily Market Data Dump: Wednesday - equity markets 5 18

 

Daily Market Data Dump: Wednesday - sector performance 5 18

 

Daily Market Data Dump: Wednesday - volume 5 18

 

Daily Market Data Dump: Wednesday - rates and spreads 5 18


Asia, Nasdaq and YieldSpread

Client Talking Points

ASIA

Both China and Copper rocked again overnight with the Dr. (Copper) -1.4% after failing @Hedgeye TREND resistance in April. Global Equity Bulls aren’t talking much about the Hang Seng as its -1.5% drop today takes it’s crash from the 2015 Global Equity Bubble peak to -30% (newsflash: global growth has not bottomed).

NASDAQ

Both China and Copper rocked again overnight with the Dr. (Copper) -1.4% after failing @Hedgeye TREND resistance in April. Global Equity Bulls aren’t talking much about the Hang Seng as its -1.5% drop today takes it’s crash from the 2015 Global Equity Bubble peak to -30% (newsflash: global growth has not bottomed).

YIELDSPREAD

Flattening = leading indicator of economic slowing – at 94 basis points wide this morning (10YR minus 2YR) that’s a fresh YTD low and it’s driven by the 2YR popping to 0.84% on concern the Fed will hike on a rising CPI? If the Fed raises rates in June, they will make U.S. Equity Beta Bears happy (reminder: rising inflation takes DOWN our Street low GDP forecast for Q2).

 

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

Asset Allocation

CASH US EQUITIES INTL EQUITIES COMMODITIES FIXED INCOME INTL CURRENCIES
5/17/16 58% 2% 0% 6% 28% 6%
5/18/16 58% 2% 0% 6% 28% 6%

Asset Allocation as a % of Max Preferred Exposure

CASH US EQUITIES INTL EQUITIES COMMODITIES FIXED INCOME INTL CURRENCIES
5/17/16 58% 6% 0% 18% 85% 18%
5/18/16 58% 6% 0% 18% 85% 18%
The maximum preferred exposure for cash is 100%. The maximum preferred exposure for each of the other assets classes is 33%.

Top Long Ideas

Company Ticker Sector Duration
XLU

Utilities (XLU) remains our favorite sector on the long side as Financials (XLF) remains our favorite sector on the short side. Current global macro positioning is squarely behind a continuation in the reflation trade as evidenced by commodity leveraged credit spreads, global macro futures and options positioning, and forward-looking volatility expectations. Global macro futures and options positioning show a market that is leaning long of commodities and short of U.S. dollars. Corporate credit as a % of GDP remains at cycle highs, capital markets activity has dried up significantly, and credit extension is tightening nationwide according the most recent Fed Senior Loan Officer survey.

MCD

For some perspective on the Macro environment and why we favor companies like McDonald's (MCD), here's an excerpt from the Early Look written by Hedgeye CEO Keith McCullough:

 

Taking a step back, don’t forget where US Consumers (70% of GDP) were at this time last year:

 

  • US Employment Growth (NFP) was putting in a cycle peak
  • US Consumer Confidence was putting in a cycle peak
  • US Consumption Growth was putting in a cycle peak

 

Peak. Peak. #Peak!

 

And what happens when you start to lap the cycle peak? Well, instead of crappy Baby Boom capacity putting up mediocre (barely positive) same store sales at the peak, they look even crappier on the back side of the cycle."

 

That's why we like large-cap, low-beta, liquid companies like McDonald's in this tumultuous market environment. Case in point, earlier in the week, MCD hit an all-time high. Since we added the company to Investing Ideas, it is up almost 30%.

 

Stick with it. Restaurants analyst Howard Penney reiterates his "road to $150" call, implyling more than 15% upside from here.

TLT

Credit markets are one of the major beneficiaries (maybe the largest) of the reflation trade since February. While yield spread compression has been a positive for Long Bonds (TLT, ZROZ), a perceived monetary policy shift and a collapse in bond market volatility expectations have been a positive for Junk Bonds (JNK), but we don’t expect it to continue.

 

With growth continuing to slow alongside consensus positioning broadly, downside deflation risk is on the table. As we’ve highlighted on a daily basis, consumption growth and labor market growth peaked in Q1 2015 and both are slowing alongside a continued corporate profits slowdown. This mix:

  • Smells like incremental deflation on the margin;
  • Is a huge risk for high yield credit (JNK);

 

Did we mention TLT and ZROZ were up 4.4% and 2.1% respectively last week? Not bad with U.S. #GrowthSlowing.

Three for the Road

TWEET OF THE DAY

Huge thanks to @LincolnMotorCo for helping make our Hedgeye Cares charity golf challenge a success. @KeithMcCullough

@Hedgeye

QUOTE OF THE DAY

There is no exercise better for the heart than reaching down and lifting people up.

John Holmes

STAT OF THE DAY

A horse gallops on average 25 to 30 mph, the world record for a horse galloping over a short, sprint distance is 55 mph.


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