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'We're In A Position Of Extreme Vulnerability' says Neil Howe

Takeaway: America is in a "position of extreme vulnerability."

Conventional wisdom suggests economic and related tensions wrought by The Great Recession are in the rearview. All is good. Sunny skies for miles.

 

Not so says Hedgeye Managing Director and Demography Sector Head Neil Howe, who kicked off John Mauldin's Strategic Investment Conference in Dallas with a bang. "Our first presentation from Neil Howe on the First Turning was the perfect set-up... and truly was a show stopper," Mauldin wrote following Howe's presentation.

 

In the wide-ranging interview below following his speech, Howe explains why America is in a "position of extreme vulnerability" based on "the mood of the electorate" and "widening generational inequity." He discusses everything from the rise of polarizing political figures like Donald Trump and Bernie Sanders to the Fed's "destructive monetary policy."  

Click to watch


3 Nasty Looking China Charts

Takeaway: All clear in China? Not by a long shot.

Editor's Note: As our Financials analyst Josh Steiner remarked on The Macro Show today, "Markets were in free-fall earlier this year and pundits were saying a recession was imminent. Then, in mid-February, it all stopped. One of the reasons is that China started pushing credit like crazy, reflating commodities, emerging markets and the U.S. stock market. But China cannot keep rapidly growing credit like it has been. China is now an enormous systemic risk to the global economy."

 

3 Nasty Looking China Charts - China cartoon 05.09.2016

(STEEL) free fallin'

"Chinese Steel – Risk measures were subdued last week. However, the price for Chinese steel continued to drop, falling by another 5% last week, bringing the month-over-month change to -21% as the mid-February to mid-April artificial reflation trade unwinds. We use Chinese steel rebar prices to gauge Chinese construction activity and, by extension, the health of the Chinese economy." 

 

3 Nasty Looking China Charts - steiner3 5 25

GOT nON-PERFORMING LOANS?

"Chinese Non-Performing Loans – Chinese non-performing loans amount to 1,392 billion Yuan as of March 31, 2016, which is up +41.7% year over year. Given the growing focus on China's debt growth and the potential fallout, we've decided to begin tracking loan quality. Note: this data is only updated quarterly."

 

3 Nasty Looking China Charts - steiner2 5 25

Debt, Debt & More Debt...

"Chinese Credit Outstanding – Chinese credit outstanding amounts to 148.7 trillion RMB as of April 30, 2016, which is up +11.9% year over year. Note: this data is only updated monthly."

 

3 Nasty Looking China Charts - steiner1 5 25

 

*This is an excerpt from an institutional research note. To access our research email sales@hedgeye.com.


Liquidation Risk, Durable Goods, #UKSlowing

Client Talking Points

Liquidation Risk

Bloomberg this AM: hedge funds have lost 1.8 percent this year, according to Hedge Fund Research's global index, the poorest performance since 2008.  The industry had net outflows of $16.6 billion in the past two quarters, the most since 2009, according to HFR.  In 2015, 979 funds closed, more than any year since 2009, according to the research firm.  To the extent redemptions and closures accelerate, expect to see crowded names and sectors like Kraft, Time Warner, Consumer Discretionary and Tech take a hit, while under-owned names and sectors like Utilities, Energy and Materials continue to thrive.

Durable Goods

Headline Durable Goods orders jumped +3.4% MoM and improved to +1.9% YoY but the internals were less sanguine with the bulk of gain stemming from the +65% MoM increase in commercial aircraft & parts, which is most aligned with what actual households buy - rose +0.6% MoM but remains down -.4% YoY.  Meanwhile, Core Capital Goods fell MoM for a 3rd consecutive month, dropping -0.8 sequentially and holding at -5% YoY -  continuing the epic run of declining capital spending with negative year-over-year growth in 15 of the last 16 months.   

 

#UKSlowing

The Financial Times was out w/ a piece this morning citing the risk to the FTSE All-Shares Index due to the downturn in the U.K. economy, which we’ve been forecasting since late last year and is being corroborate by every key category of high-frequency data slowing on a trending basis. This mainstream media’s first mention of economic risk to U.K. assets that doesn’t have anything to do with Brexit. Expect such headlines to accelerate even beyond next month’s likely “remain” vote.

Asset Allocation

CASH US EQUITIES INTL EQUITIES COMMODITIES FIXED INCOME INTL CURRENCIES
5/25/16 58% 2% 0% 10% 28% 2%
5/26/16 58% 2% 0% 10% 28% 2%

Asset Allocation as a % of Max Preferred Exposure

CASH US EQUITIES INTL EQUITIES COMMODITIES FIXED INCOME INTL CURRENCIES
5/25/16 58% 6% 0% 30% 85% 6%
5/26/16 58% 6% 0% 30% 85% 6%
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
GLD

When Janet does have to acknowledge the deterioration in U.S. growth, we expect the policy shift to be dollar bearish on the margin. And, to the contrary, if the Fed RAISES RATES (June) into this slow-down, they’ll be the catalyst for DEFLATION (down yields) again anyway. And there’s nothing Gold (GLD) likes more than a falling dollar and falling interest rates which is why we added it to the long-side of Investing Ideas this week. Remember, this is the same week various Fed members were in public calling for a rate hike with the worst jobless claims print since 2012. #GoodLuck.

MCD

McDonald's (MCD) continues to evolve. The company's latest step is testing never frozen burgers at 14 units in the Dallas, TX area. This initiative could give them the ability to compete with better burger concepts such as Shake Shack, In-N-Out and Five Guys.

 

Meanwhile, there has been chatter about the lack of identity for their value platform in 2Q16. MCD is truly still in the testing phase as to what their national value message will be. We can appreciate the fact that they are testing multiple formats before fully committing.

 

In the meantime, the tailwind from all-day breakfast will continue to propel growth going forward, until lapping this initiative in 4Q16. We continue to favor MCD as one of the best LONGs in the market right now, due to actual growth and style factors that are friendly in volatile markets.

TLT

If you haven’t yet, you got another chance to buy long-term Treasuries at lower highs this week. If you’re already long of Long Bonds (TLT, ZROZ), stick with it. None of the relevant data released this past week suggests that growth could inflect and trend positive:

  • Thursday’s Jobless Claims Report was the worst print, in Y/Y rate of change terms, since 2012, and it was the fourth consecutive week of increasing jobless claims
  • Industrial Production declined -1.1% Y/Y for April, marking the 8th consecutive month of Y/Y contraction: #IndustrialRecession

Tying together a continued deceleration in growth with policy expectations, the most important callout is that our expectation for growth in Q2 is well below consensus and Fed expectations (which have been horribly inaccurate). 

Three for the Road

TWEET OF THE DAY

Had an interesting discussion on The Macro Show with @KeithMcCullough!

@HoweGeneration

QUOTE OF THE DAY

"There are three types of baseball players: those who make it happen, those who watch it happen, and those who wonder what happens."

-Tommy Lasorda

STAT OF THE DAY

John Kruk batted exactly .300 over his 10 year MLB career. In his rookie season, he batted .309


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Daily Market Data Dump: Thursday

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: Thursday - equity markets 5 26

 

Daily Market Data Dump: Thursday - sector performance 5 26

 

Daily Market Data Dump: Thursday - volume 5 26

 

Daily Market Data Dump: Thursday - rates and spreads 5 26


CHART OF THE DAY: A Look At S&P 500 Multiple Expansion Off February Lows

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

 

"... Valuation is Not A Catalyst: Valuation isn’t an anchor in our decision making process over shorter-to-medium-term durations but it is a prime factor for others so the influence on prices can’t be dismissed outright. With SPX forward earnings estimates up just +1.5% off the lows, multiple expansion has driven most of the rebound in prices off the February lows. Upside to cycle peak valuation (recorded in 1H15) implies +68 SPX handles or +≈3.3% from current levels. In other words, unless the thesis is for accelerating earnings, that’s the upside you’re playing for under an assumption for a return to peak multiples."

 

CHART OF THE DAY: A Look At S&P 500 Multiple Expansion Off February Lows - SPX PE CoD


Common Sense Mongering

“He’s been dying from the same heart attack for the last 20 years… he thinks he’s going to live forever.”

-Michael Corleone on rival Hyman Roth, The Godfather

 

Yesterday’s Markit PMI for May printed 50.8 – dropping -1.6 pts sequentially (to 50.8, marking the 2nd lowest reading of the current downcycle) and to a level consistent with 128K in payroll adds for the month.  

 

PMI activity has been experiencing the same “bottom” for the last 20 months … the expansion is going to last forever. 

 

Common Sense Mongering - z gfat

 

Back to the Global Macro Grind...

 

To be fair, 50 represents the expansion-contraction Mendoza line in diffusion indices like the PMI’s, so 50.8 still represents expansion, but only barely. 

 

Economies are path dependent, so initial conditions matter and flirting with 50 with a faux hawkish Fed and no fundamental catalyst for a 50 => 54 => 60 type progression is not a position of strength.

 

This is the part of the missive where the conventional strategist playbook calls for narrative strong-arming with sophisticated sounding analytics and technical jargon to raise the perceived scarcity value.

 

I’m smart. Not like everybody says ... like dumb … I’m smart and I want respect! – Fredo

 

I’ll get to contextualizing the recent and upcoming domestic macro data, but first some Common Sense mongering.

 

This isn’t the kind of sophistication that gets you paid "2 and 20" but it is a bit of sleep-well-at-night sensibility that probably makes you 2 while others are losing 20.

 

The layman’s, passive strategy frame-up goes something like this: 

 

We are 7 years and +200% into the current expansion. That is not a surprise, the Reinhart & Rogoff facts are well circulated. 

 

Balance Sheet recessions are characterized by a protracted slump in employment, consumption, and credit growth. And expansions following financial crises are typically longer in period and lower in amplitude with the average & median time to reach pre-crisis levels of income being 8 and 6.5 years, respectively.

 

Real per capita income in the U.S. reached pre-crisis levels at the beginning of 2014, so just about 6 years from the onset of the recession. 

 

So, even with unprecedented intervention and global policy coordination we still fell basically right on the average. This time, in fact, was not particularly different.

 

Now, 2.5 years out from reaching income break-even, this is where we are:  

 

  • At 85 months, the current expansion is late relative to any historical reference (the mean & median over the last century are 59-months and 50-months, respectively).
  • Global and domestic growth are slow and/or slowing and slower for longer will remain the prevailing reality given global leverage and demographic dynamics
  • The central banking #BeliefSystem has begun breaking down alongside discretely diminishing returns to monetary policy initiatives.
  • China increased credit by $1T in 1Q16 (as in (Dr. Evil Face) 1 Trillion Dollars). Perhaps – alongside a rhetorically dovish Fed - that helped quell the commodity contagion but that debt bender got them … another lower low in GDP.  
  • Employment Growth, Consumption Growth, Income Growth, Confidence and Corporate Profitability are all past peak and SPX sales and earnings growth have been negative for each of the last 6 quarters. 

 

Does passing those simple realities through your common-sense-filter suggest you should be ramping your high-beta, cyclical exposure or risk-managing the same defensive and style factor exposures that have been working for the last year?

 

To frame it up slightly differently:

 

So Nice, It’s Like I Hit My (late-cycle) Prime Twice: Let’s suppose the expansion lasts two more years and base effects help drive negative sales and earnings growth nominally positive. How much runway does that give in terms of price reflation in underperforming cyclicals before a re-rotation back into more defensive, late-cycling positioning. 3, 6, 9-months? 

 

Valuation is Not A Catalyst: Valuation isn’t an anchor in our decision making process over shorter-to-medium-term durations but it is a prime factor for others so the influence on prices can’t be dismissed outright. With SPX forward earnings estimates up just +1.5% off the lows, multiple expansion has driven most of the rebound in prices off the February lows. Upside to cycle peak valuation (recorded in 1H15) implies +68 SPX handles or +≈3.3% from current levels. In other words, unless the thesis is for accelerating earnings, that’s the upside you’re playing for under an assumption for a return to peak multiples.

 

To quickly round out the rest of domestic Macro: 

 

Housing: Headline New Home Sales in April were strong, rising +16.6% sequentially and marking the fastest pace of MoM growth since January of 1992. In our note to clients on Monday we highlighted two cautionary points: 

  • The Headline was distorted by a seemingly outlier increase in sales in the Northeast. Sales in the Northeast were up +52.7% MoM and a remarkable +323% YoY, driving roughly 40% of the reported increase in total sales.
  • NHS are the most volatile and highly revised housing data series there is and we don’t take an overly convicted view of any single month in isolation – regardless if the data are good or bad. The imprecision is captured explicitly in the standard error of the estimate - for example, the +23.8% YoY increase recorded in April carries a 23% margin of error. In other words, if we were to anchor on a single series in shaping our high frequency view on housing, NHS would be the last series we’d use. 

 

Pending Home Sales: We’ll get Pending Home Sales data for April this morning which represent signed contract activity in the 90% of the Housing Market that is existing sales. PHS have been decelerating for the last 11 months and face peak comps in April & May. For context, sales need to be up +0.6% sequentially just for year-over-year growth to be 0%. As we highlighted last week, -2%-to-+2% is your fundamental demand backdrop in the existing market for the next quarter+.

 

1Q GDP: The final Construction Spending, Trade Balance and Factory Order data for March – all of which saw positive revisions - will support a upward revision to 1Q GDP tomorrow morning.  Consensus at 0.9% (up from +0.5%) is about right.  

 

Income & Spending | Sequential ↑, Trend ↓: We’ll get the official income and spending data for April on Tuesday. The sum of aggregate hours and hourly earnings growth from the NFP report implies a modest sequential acceleration in aggregate income growth. The savings rate will remain the swing factor but if it’s flat with last April at 5.1% - and in combination with the acceleration in revolving credit growth - then it’s likely we get a modest sequential acceleration in consumption growth. That sequential improvement will come inside a larger trend of deceleration that will remain ongoing.   

 

So, that’s both the passive macro strategy playbook and the short-term fundamental setup. 

 

We plan to both tactically trade the immediate-term risk range while staying strategically positioned for the late-cycle Trend … but that’s just Hedgeye Cosa Nostra …. no Omerta, just real-time and transparent.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.69-1.90%

SPX 2031-2096

VIX 13.63-17.58

USD 94.01-95.95
YEN 108.45-110.79
Oil (WTI) 46.99-50.16

Gold 1

  

To Stand-Up (macro) Guys trying not to fall,

 

Christian B. Drake

U.S. Macro Analyst

 

Common Sense Mongering - SPX PE CoD


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