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CHART OF THE DAY: What The Fed's December Rate Hike Did To High Yield Spreads

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.

 

"... How about the credit cycle? Oh right – another true but unimportant factor for weekly chart-chasers to consider until it matters again… What happened to High Yield Spreads last time (i.e. the only time in modern history) that the Fed tightened into a slow-down?"

 

CHART OF THE DAY: What The Fed's December Rate Hike Did To High Yield Spreads  - 06.02.16 EL Chart


True But Unimportant?

“It was too easy to brush aside bounded rationality as a true but unimportant concept.”

-Richard Thaler

 

“Bounded Rationality” is the term coined by one of the great non-linear minds in American history, Herbert Simon. He wrote about it “well before Kahneman and Tversky came along… saying that people lack the cognitive ability to solve complex problems.”

 

Oh don’t get your under-pants in a bunch this morning. I’m not suggesting you can’t solve complex problems. That’s your job. When Thaler says “people” aren’t that smart, he meant The People – as in the bros on Main Street don’t do efficient market hypothesis.

 

As Richard Thaler goes on to remind us in Misbehaving (The Making of Behavioral Economics), “economists are fine with the idea that their models are imprecise and that predictions contain error” (pg 23). But what happens when their mistakes affect The People?

 

True But Unimportant? - Fed cartoon 12.21.2015

 

Back to the Global Macro Grind

 

Will the Fed make another monetary policy mistake and raise rates into a classic #LateCycle slow-down? Janet’s latest answer to that question is “probably.” And I spent all of yesterday debating institutional investors in the Midwest on timing another mistake.

 

Just to set the table here for what may be true, but not yet important:

 

  1. Fed goes HAWKISH and tightens into a slow-down in December
  2. Fed then goes DOVISH and devalues the DOLLAR in March/April
  3. Fed then goes HAWKISH in May and the DOLLAR rallies for 3 straight weeks

 

Everyone agree with that? Ok. Now what?

 

  1. What if the US Jobs report for May (tomorrow) is another rate of change slow-down?
  2. What if the US Jobs report for May “beats” a headline expectation that implies continued slowing?
  3. What if both the May and June jobs reports are #LateCycle Employment slowing reports?

 

You know that Janet “probably” raising rates in July has 2 jobs reports pending in front of it, right? Oh, right – “but if you’re right on #TheCycle, Keith… and labor continues to slow, then she’ll just go dovish again and not hike.”

 

Do you agree with that? If you do, in the span of 6 months, the Federal Reserve will have gone from:

 

  1. HAWKISH to
  2. DOVISH to
  3. HAWKISH … and back to
  4. DOVISH!

 

As one Portfolio Manager (who has been very long of Utilities, which are now +13.6% YTD) said to me after this exchange yesterday, “lol – good luck landing on all four of those dots.”

 

And doesn’t that summarize the guessing game that we are in? Not only do we have to strive for excellence in our forecasting of the trending rates of change in growth and inflation, but we have to solve for what inaccurate forecasters are going to do in the meantime!

 

As a reminder, on Janet Yellen’s publicly stated preferred LABOR MARKET INDICATOR (her “Change in Labor Market Conditions Index”), including the April reading, US Employment has slowed to NEGATIVE for 4 STRAIGHT MONTHS.

 

In addition to the labor cycle, back to what is also true and important – i.e. the profit cycle:

 

  1. 493 of 500 S&P 500 companies have reported Q1 2016
  2. Aggregate SALES were -2.2% y/y and EPS -8.4% y/y
  3. 6 of 10 SECTORS were negative y/y EPS, including Financials -14.2% y/y

 

Never mind that the aggregate numbers are non-GAAP. We’re having a tough enough time trying to understand why both US GDP and Personal Consumption are being overstated by “Deflators” that are being understated by 40-60% vs. the Fed’s own calculation of inflation. Even on a non-GAAP to non-GAAP (apples to apples) basis, the USA is in a profit #Recession.

 

How about the credit cycle? Oh right – another true but unimportant factor for weekly chart-chasers to consider until it matters again… What happened to High Yield Spreads last time (i.e. the only time in modern history) that the Fed tightened into a slow-down?

 

Economic Cycle => Profit Cycle => Credit Cycle?

 

Instead of flailing like a dove pretending to be a hawk, maybe Janet should consider the causal factor in perpetuating the #Deflation risk across asset classes (Rate Hike => Dollar Up) that she completely underestimated in December. It’s a true and important concept.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.80-1.90%

SPX 2043-2110

NASDAQ 4

VIX 12.59-16.93
USD 95.01-96.02
Oil (WTI) 46.87-49.99

Gold 1

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

True But Unimportant? - 06.02.16 EL Chart


JT TAYLOR: Capital Brief (formerly Morning Bullets)

JT TAYLOR:  Capital Brief (formerly Morning Bullets) - JT   Potomac banner 2 

VEEPSTAKES: Traditionally, conventional wisdom holds that vice presidential picks are hype and for the most part don’t matter much (for the most part), but with this being a very unconventional year, the veep pick may matter – a lot. Given weaknesses and sagging favorability stats for both frontrunners, we believe the veep pick will unify the Democrats and help Hillary Clinton win over Bernie Sanders supporters and the liberal wing of the party; Donald Trump’s pick will serve to counterbalance the ticket, calming Republican nerves and and adding credibility to the ticket.

 

BIG MONEY IS BACK: Big donors are starting to break open their piggy banks as candidates lock up party nominations. Trump hit the jackpot with a backing by casino mogul Sheldon Adelson, while the Libertarian party will deposit desperately-needed funds to its first super-PAC donation - to the tune of one million dollars. Around the Capitol, you’ll find Republicans and U.S. Chamber of Commerce working to “Save the Senate” and House seats. Republicans remain scattershot on White House efforts, but stand united on a front to save Congress.

 

HEAD ON COLLISION: We’ve been lamenting the pace of the appropriations process this year, and now top Republicans leaders are heading down opposite tracks with spending bills setting up a collision course in the coming months. Speaker Paul Ryan’s pledge to give members more input in the legislative process is handicapping him and his ability to move any legislation, while Senate Majority Leader Mitch McConnell feels he has restored order to the once dysfunctional Senate passing eight approps bills out of committee - with bipartisan support. If both fail to resolve conflicting priorities, expect yet another massive late-year omnibus deal or a default to multi-month stopgaps. Did we mention funding for the government expires right before the presidential election?

 

WHEN DOES CLINTON CAVE?: Clinton has been dogged for more than a year as being too  shifty insisting she broke no rules by maintaining her own private email server while Secretary of State. If she expects to win this November, she’ll need to break that syndrome as her half-hearted attempts to explain away her email server are not reassuring. Top Clinton allies have highlighted the importance for her to engage directly on the trust issue and re-center her campaign on positive footing with a positive agenda - resorting to negative campaigning already failed miserably for Trump’s primary opponents.

 

SIGN LANGUAGE AT OPEC: Nothing like $50 oil to create a positive atmosphere at the OPEC meeting in Vienna. Our Senior Energy Analyst Joe McMonigle, who is attending the meeting, has said for months not to expect any big action at the June meeting. But Joe said he was looking for signs of potential action at the next OPEC meeting in December after continued reductions in non-OPEC production. Joe believes the Saudis offered up such a sign on Wednesday when a "senior gulf official" said the Kingdom was "open" to some action to stabilize prices. As a result, for the first time in two years, we think a policy change could be under consideration at the end of the year.

 

BREXIT: SHOULD I STAY OR SHOULD I GO?: Join us for a call next Wednesday with Alexander Nicoll, a consulting member of the UK-based International Institute for Strategic Studies, as he discusses the events leading up to the UK vote and what the outcome of the vote spells for the UK and EU.  

 

OPEC MEETING PREVIEW: In case you missed it, our Senior Energy Analyst Joe McMonigle and Former Secretary of Energy Spencer Abraham held a conference call previewing today’s OPEC meeting – “Energy Policy: OPEC Meeting Preview

 

RAISE CASH, SELL SOME BONDS – Around the world, long-term bond yields have had #TheCycle story right from a GDP #GrowthSlowing perspective. Like the Swiss 10yr yield hitting new lows of -0.40% yesterday. The question now is, with the Yellen Fed “probably” raising rates in June/July, what do we do with our market-beating positions in Long-Term Bonds, Munis, Utilities, etc? Hedgeye CEO Keith McCullough says it’s time to book some gains. Enjoy the summer – we can always buy them back (at a better price). What does that mean for your portfolio? Here’s a complimentary look at Hedgeye’s proprietary Asset Allocation — Cash: 80%; U.S. Equities: 0%; International Equities: 0%; Commodities: 4%; Fixed Income: 8%; International Currencies: 8%. In other words, we remain very cautious on stocks at home and abroad.

 

 


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ICI Fund Flow Survey | Record Earnings for a Financial Company?

Takeaway: ICI's recently published annual Factbook shows 2015 as the biggest annual inflow for money markets since 2008. FII printed record EPS in '08

Record earnings for a Financial company that is not an exchange? Survey says...only a handful...however Federated Investors (FII) is headed in that direction. With the diversification of the business into industry leading equity (and a few fixed income products) that are back stopping the challenged money fund business, the firm is a prime beneficiary of a "not too hot but not too cold" environment. That said, the firm's core business is about to get another shot in the arm and the positioning is nicely paired off. If the Fed hikes rates into the back half of the year, the $260 billion in money fund assets at FII gets more profitable. Another +25 basis point increase takes operating income up $8 million annually or +$0.08 in annual EPS. If the economy slows and investors rush back to cash, then the company increases that $260 billion cash balance substantially. If the Fed hikes into a slowdown (drum roll please), then FII increases BOTH pricing and volume. The company is a late cycle stock either way having put up record earnings in 2008 of $2.23 per share with a stock price that increased throughout both the Tech Wreck in 2000 and also the Financial crisis of 2007. The latest ICI annual FactBook outlines that 2015 was the biggest inflow into cash products (+$21 billion) since 2008.  

 

ICI Fund Flow Survey | Record Earnings for a Financial Company? - Cover chart

 

ICI Fund Flow Survey | Record Earnings for a Financial Company? - Cover II

 

Investment Company Institute Mutual Fund Data and ETF Money Flow:

International equity mutual funds missed a 3 week winning streak, with a -$1.0 billion outflow in the 5-day period ending May 25th. What has not been volatile however is domestic equity mutual funds which have been consistently soft, giving up -$5.2 billion this week alone with a -$3.0 billion weekly redemption thus far in '16. In fixed income, high yield and global mutual funds experienced -$321 million and -$1.8 billion in drawdowns while investment grade, other, and muni bonds brought in +$1.9 billion, +$2.2 billion, and +$1.5 billion respectively. Municipal bonds are leading the pack in fixed income, with the best start on record for the 21 weeks of 2016. ETF flows were fairly flat this week with equity funds bringing in +$280 million and bond funds gathering +$522 million. Finally, investors shored up a resounding +$14 billion in money funds/cash last week, the 3rd biggest weekly cash build of 2016.


ICI Fund Flow Survey | Record Earnings for a Financial Company? - ICI19

 

In the most recent 5-day period ending May 25th, total equity mutual funds put up net outflows of -$6.3 billion, trailing the year-to-date weekly average outflow of -$2.3 billion and the 2015 average outflow of -$1.6 billion.

 

Fixed income mutual funds put up net inflows of +$3.5 billion, outpacing the year-to-date weekly average inflow of +$2.4 billion and the 2015 average outflow of -$475 million.

 

Equity ETFs had net subscriptions of +$280 million, outpacing the year-to-date weekly average outflow of -$1.4 billion but trailing the 2015 average inflow of +$2.8 billion. Fixed income ETFs had net inflows of +$522 million, trailing the year-to-date weekly average inflow of +$1.5 billion and the 2015 average inflow of +$1.0 billion.

 

Mutual fund flow data is collected weekly from the Investment Company Institute (ICI) and represents a survey of 95% of the investment management industry's mutual fund assets. Mutual fund data largely reflects the actions of retail investors. Exchange traded fund (ETF) information is extracted from Bloomberg and is matched to the same weekly reporting schedule as the ICI mutual fund data. According to industry leader Blackrock (BLK), U.S. ETF participation is 60% institutional investors and 40% retail investors.



Most Recent 12 Week Flow in Millions by Mutual Fund Product: Chart data is the most recent 12 weeks from the ICI mutual fund survey and includes the weekly average for 2015 and the weekly year-to-date average for 2016:

 

ICI Fund Flow Survey | Record Earnings for a Financial Company? - ICI2

 

ICI Fund Flow Survey | Record Earnings for a Financial Company? - ICI3

 

ICI Fund Flow Survey | Record Earnings for a Financial Company? - ICI4

 

ICI Fund Flow Survey | Record Earnings for a Financial Company? - ICI5

 

ICI Fund Flow Survey | Record Earnings for a Financial Company? - ICI6



Cumulative Annual Flow in Millions by Mutual Fund Product: Chart data is the cumulative fund flow from the ICI mutual fund survey for each year starting with 2008.

 

ICI Fund Flow Survey | Record Earnings for a Financial Company? - ICI12

 

ICI Fund Flow Survey | Record Earnings for a Financial Company? - ICI13

 

ICI Fund Flow Survey | Record Earnings for a Financial Company? - ICI14

 

ICI Fund Flow Survey | Record Earnings for a Financial Company? - ICI15

 

ICI Fund Flow Survey | Record Earnings for a Financial Company? - ICI16



Most Recent 12 Week Flow within Equity and Fixed Income Exchange Traded Funds: Chart data is the most recent 12 weeks from Bloomberg's ETF database (matched to the Wednesday to Wednesday reporting format of the ICI), the weekly average for 2015, and the weekly year-to-date average for 2016. In the third table are the results of the weekly flows into and out of the major market and sector SPDRs:

 

ICI Fund Flow Survey | Record Earnings for a Financial Company? - ICI7

 

ICI Fund Flow Survey | Record Earnings for a Financial Company? - ICI8



Sector and Asset Class Weekly ETF and Year-to-Date Results: In sector SPDR callouts, investors contributed +$117 million or +5% to the materials XLB ETF last week.

 

ICI Fund Flow Survey | Record Earnings for a Financial Company? - ICI9



Cumulative Annual Flow in Millions within Equity and Fixed Income Exchange Traded Funds: Chart data is the cumulative fund flow from Bloomberg's ETF database for each year starting with 2013.

 

ICI Fund Flow Survey | Record Earnings for a Financial Company? - ICI17

 

ICI Fund Flow Survey | Record Earnings for a Financial Company? - ICI18



Net Results:

The net of total equity mutual fund and ETF flows against total bond mutual fund and ETF flows totaled a negative -$10.0 billion spread for the week (-$6.0 billion of total equity outflow net of the +$4.0 billion inflow to fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52-week moving average is -$2.0 billion (negative numbers imply more positive money flow to bonds for the week) with a 52-week high of +$20.2 billion (more positive money flow to equities) and a 52-week low of -$19.0 billion (negative numbers imply more positive money flow to bonds for the week.)

  

ICI Fund Flow Survey | Record Earnings for a Financial Company? - ICI10

 


Exposures:
The weekly data herein is important for the public asset managers with trends in mutual funds and ETFs impacting the companies with the following estimated revenue impact:

 

ICI Fund Flow Survey | Record Earnings for a Financial Company? - ICI11 



Jonathan Casteleyn, CFA, CMT 

 

 

 

Joshua Steiner, CFA







Global Manufacturing: One of These Things Is Not Like the Others (and #InflationAccelerating)

Continuing with the Sesame Street theme of this morning’s Early Look, we thought we’d highlight a conspicuous divergence that emanated from this morning’s global Manufacturing PMI data for the month of May, which is presented below with minimal commentary:

 

Per the Markit PMI surveys, World manufacturing growth is slowing on a sequential and trending basis…

 

Global Manufacturing: One of These Things Is Not Like the Others (and #InflationAccelerating)  - GLOBAL M PMI

 

… led by ongoing sequential and trending deceleration across Developed Markets and a negative inflection in China:

 

Global Manufacturing: One of These Things Is Not Like the Others (and #InflationAccelerating)  - DEVELOPED MARKETS M PMI

 

Global Manufacturing: One of These Things Is Not Like the Others (and #InflationAccelerating)  - CHINA M PMI

 

Within Developed Markets specifically, the Eurozone, Japan and U.S. all contributed to the aforementioned sequential and trending deceleration:

 

Global Manufacturing: One of These Things Is Not Like the Others (and #InflationAccelerating)  - EUROZONE M PMI

 

Global Manufacturing: One of These Things Is Not Like the Others (and #InflationAccelerating)  - JAPAN M PMI

 

Global Manufacturing: One of These Things Is Not Like the Others (and #InflationAccelerating)  - U.S. M PMI

 

Allegedly, however, U.S. manufacturing growth is accelerating on a sequential and trending basis (per the ISM) despite a stronger dollar (up +2.9% MoM on a broad, trade-weighted basis) and the aforementioned global headwinds:

 

Global Manufacturing: One of These Things Is Not Like the Others (and #InflationAccelerating)  - ISM MANUFACTURING PMI

 

The internals of the ISM report were mixed, but one key callout is that after persistent deflation since late-2014 the Prices Paid component advanced for the fourth-consecutive month to 63.5, which is the highest level since mid-2011:

 

Global Manufacturing: One of These Things Is Not Like the Others (and #InflationAccelerating)  - ISM MANUFACTURING PMI TABLE

 

While the aforementioned inflation dynamics perpetuating upside in the ISM Manufacturing PMI are inconsistent with market signals – Gold is down -6.2% MoM; 5Y5Y Forward Breakeven Rates down -20bps MoM to 1.55%, or the 2nd percentile on a trailing 10Y basis – said dynamics are consistent with our GIP Model, which is now forecasting an increasingly shallow dip into #Quad4 from a headline CPI perspective here in Q2 and still forecasting accelerating inflation for the balance of 2H16:

 

Global Manufacturing: One of These Things Is Not Like the Others (and #InflationAccelerating)  - UNITED STATES

 

Global Manufacturing: One of These Things Is Not Like the Others (and #InflationAccelerating)  - INFLATION MODEL

 

Global Manufacturing: One of These Things Is Not Like the Others (and #InflationAccelerating)  - CPI COMPS

 

This development is something to keep front and center over the next 1-2 months as you begin preparing your portfolios accordingly for the Fed’s likely reaction to #InflationAccelerating.

 

Have a wonderful evening,

 

DD


Cartoon of the Day: Blind Faith

Cartoon of the Day: Blind Faith - Fed Hike cartoon 06.01.2016

 

The Yellen Fed seems oblivious to the idea that they are considering hiking rates into an economic slowdown. 


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