A Brief History Of The #CreditCycle via Hedgeye's Darius Dale

Takeaway: "We are loudly reiterating our call that the unwind of ZIRP and QE will continue to deflate the easy money credit boom it fabricated..."

A Brief History Of The #CreditCycle via Hedgeye's Darius Dale - Fed cartoon 10.24.2014


Below is an essential risk management chart via Hedgeye Senior Macro analyst Darius Dale. Here's the key callout on the #CreditCycle from our quarterly Macro Themes deck:


"We are loudly reiterating our call that the unwind of ZIRP and QE will continue to deflate the easy money credit boom it fabricated in the form of continued recessionary earnings growth as the business cycle gets dangerously long in the tooth."


Click image to enlarge. 

A Brief History Of The #CreditCycle via Hedgeye's Darius Dale - delinquencies rising

NFLX | Good vs. Bad (US User Survey)

Takeaway: Account sharing could actually be a funnel, but NFLX is struggling to drum up interest elsewhere. US runway may be shorter than most assume

INTRODUCTION: We’re in the process of running a larger survey to segment NFLX’s US user base and prospects.  This is the first batch (n=2,037), but this note focuses only on those respondents where we have demographic data (n=1,637), which is a key component to this analysis.  We have married our survey results to 2013 US Census Broadband metrics by Householder age, which we then grossed up to approximate SNL Kagan's more recent US Household Broadband estimates of 101M (via NFLX).  The Key Points below are our summary findings, the bulk of the supporting analysis is in the charts below.  



  1. THE GOOD: Our survey results suggest ~20% of NFLX’s accounts are being shared, which may be a concern at face value, but account sharing could actually be a funnel to new suscriptions.  Roughly half (48%) of those freeloaders are considering signing up for their own Netflix account, which is 4x the rate of those not using the service at all.  In short, freeloaders are effectively trialing the service.  Further, the ratio of account shares to freeloaders is less than 2 (1.6), which suggests a freeloader has access to no more than one account on average.  That said, NFLX churn risk is somewhat mitigated by the prospect of new sign-ups amongst freeloaders in the event the host subscriber cancels their account.
  2. THE BAD: The overwhelming majority (84%) of NFLX’s unpenetrated TAM currently has no interest in signing up.  It’s important to note that we asked the question with an affirmative bias (i.e. may be interested vs. not at all), and that this is an internet-based survey, so we don’t believe there is a negative selection bias.  Granted this is a subjective question; some of those that aren’t interested today may eventually change their mind over time.  But what remains of its TAM is decidedly older (~65% are 45+), which is historically a tougher group to penetrate given their below-average usage levels to date (both paid and free).  Once again, things could change, but it will likely cost a lot more in per-sub acquisition costs (marketing expense/net adds), which is currently over 55% of NFLX's annual ARPU in the US (TTM basis).
  3. NET-NET: NFLX’s recent softness in domestic net adds could persist in the near-term given that only 16% of NFLX's unpenetrated TAM may be interested in signing up; only a 1/3 of which are currently trialing (freeloading) the service today.  Assuming a maximum TAM of 101M US Broadband households (SNL Kagan), NFLX may only have a near-term runway of 9M US accounts vs. the 47M it has today, meaning NFLX may struggle to reach the lower end of its 60M-90M US user TAM estimate.  This is a much bigger concern regarding the longer-term prospects of its current operating model, which is essentially dependent on NFLX's ability to grow into its user TAM (see note below).  That said, international will become an increasingly important part of this story (note to follow).


See note and charts below for supporting detail.  Let us know if you have any questions, or would like to discuss further.


Hesham Shaaban, CFA
Managing Director



NFLX | Breaking Down Content Costs
05/26/16 08:14 AM EDT
[click here


NFLX | Good vs. Bad (US User Survey) - NFLX   Survey Responses 2

NFLX | Good vs. Bad (US User Survey) - NFLX   Survey Freeloader Interest 2

NFLX | Good vs. Bad (US User Survey) - NFLX   Survey Non User Interest

NFLX | Good vs. Bad (US User Survey) - NFLX   Survey Penetration 2

NFLX | Good vs. Bad (US User Survey) - NFLX   Survey Interested

NFLX | Good vs. Bad (US User Survey) - NFLX   Survey Not Interested

NFLX | Good vs. Bad (US User Survey) - NFLX   TAM segmentation 3

Dispelling Another Wall Street Fairy Tale: "Global Demand Has Bottomed"

Takeaway: Evidence of #GrowthSlowing? Japanese and German equity markets are tumbling and the 10yr/2yr Treasury yield spread is pancaking.

Dispelling Another Wall Street Fairy Tale: "Global Demand Has Bottomed" - growth escalator cartoon 04.29.2016


We've been hearing for a while now, from various pundits and prognosticators, that "global demand has bottomed." The problem with that argument is that it just isn't born out by the facts. 


Setting aside that economic indicators around the world are rolling over, simply looking at the massive drawdowns in global equity markets could satisfy even a casual observer's curiousity that all is not well.


Here's analysis from Hedgeye CEO Keith McCullough in a note sent to subscribers earlier this morning:


"I know. When trying weave the “global demand has bottomed” narrative about US stocks, you have to ex-out things like Japanese and German Equities (and their bond yields hitting all time lows) – small details I’m sure, but both Nikkei and DAX down another -1% today and down -20% and -19%, respectively, from last year’s highs."


Take a look at the Nikkei...



And Germany's DAX...



Clearly, global demand has not bottomed...


Here's the most obvious #GrowthSlowing indicator. The 10yr to 2yr Treasury yield spread is pancaking, with the yield on the 10yr at 1.669% this morning.


Dispelling Another Wall Street Fairy Tale: "Global Demand Has Bottomed" - yield spread 6 9 16


More to be revealed.


(FYI: Our biggest Macro call, Long Bonds (TLT) is breaking out to new highs today.)

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.

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




Daily Market Data Dump: Thursday - equity markets 6 9


Daily Market Data Dump: Thursday - sector performance 6 9


Daily Market Data Dump: Thursday - volume 6 9


Daily Market Data Dump: Thursday - rates and spreads 6 9


Daily Market Data Dump: Thursday - currencies 6 9

CHART OF THE DAY: When US Corporate Profit Growth Is Negative S&P 500 Does This...

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.


"... As you know, 100% of the time that US corporate profits slow to negative (year-over-year), the SP500 has had a draw-down (crash) of 20% or more. We’re about to see the 3rd consecutive quarter of a US #ProfitRecession. And Q3 of 2016 will probably be the 4th."


CHART OF THE DAY: When US Corporate Profit Growth Is Negative S&P 500 Does This... - 06.09.16 EL Chart

Reflation's Shadow

“You see a shadow moving in the long grass – should you worry about lions?”

-Phil Tetlock


I guess it depends if you are in Thunder Bay, Ontario (it could be a wolf or a bear), NYC, or Africa…


In an excellent excerpt from Superforecasting titled Probability For The Stone Age, Phil Tetlock reminds us that “it was remarkably late in history, arguably as late as the 1713 publication of Bernoulli’s Ars Conjectandi, before the best minds started to think seriously about probability. Before that, people had no choice but to rely on the tip-of-your-nose perspective.” (pg 137)


Sadly, over 300 years later, I wouldn’t say the Old Wall’s “blue chip” forecasters have evolved much. I hear a lot about how GDP “feels like it could be 2.5%.” Then again, this comes from people who were “feeling” like it was 4% only six months ago. I can assure you that I feel absolutely nothing about the numbers that run through our predictive tracking algos.


Reflation's Shadow - 4  growth cartoon 03.02.2016


Back to the Global Macro Grind


Let’s start with some questions I asked the CFA Society at a lunch in Pittsburgh yesterday (Go Pens!):


  1. JOBS: given that the rate of change in US Non-Farm Payroll growth TRENDS toward negative 100% of the time after putting in its cycle-peak, is the probability rising or falling that the US labor market is doing what it always does at the end of a cycle?
  2. RATE HIKES? With US #EmploymentSlowing, does the Federal Reserve have it in its non-SP500-dependent mandate to be raising rates as that slowing labor and consumption data is reported?
  3. USD: If both the US Dollar and US Interest Rates go DOWN, every day, pricing in that the answer to question #1 Is YES and the answer to question #2 Is NO, can all assets priced in Dollars ramp to infinity and beyond?


Answer to question #3: possibly.


But in probability speak, possible is not the same word as probable. This isn’t my first bubble reflation chasing rodeo. Every 5-7 years of my 17 year career on Wall Street, I’ve been told that the US stock market just cannot go down, for real, ever again.


If both US and Global Growth continues to slow, it’s much more probable that US Equities crash from here (greater than 20% draw-down from its cycle-peak) than they go to infinity because “this time is different.”


As you know, 100% of the time that US corporate profits slow to negative (year-over-year), the SP500 has had a draw-down (crash) of 20% or more. We’re about to see the 3rd consecutive quarter of a US #ProfitRecession. And Q3 of 2016 will probably be the 4th.


During stagflation (Quad3) in Q3, can the US equity market see multiple expansion?


  1. Anything is possible
  2. But the probable answer is no


Why? Because the probable answer starts with what probability theorists call Frequency Theory. Most of the time when nominal growth slows while inflation is accelerating, profits get squeezed and multiples compress on that.


Now if you’re long Bernanke’s Bubbles again (i.e. Reflating the mother of all Commodity and Cost of Living Inflations), the market is telling you that you can (once again) get paid on that. How?


  1. Late cycle employment and consumption growth slows
  2. The Fed hurries to protect asset inflation via Dollar Devaluation
  3. In Dollars, you get paid by Reflation’s Shadow


I know. If you’re just looking at a 50-day moving monkey, most things Reflation (Commodities, Energy Stocks, Emerging Markets, etc.) look like they can outrun any lion right now. The 3 month performance (price) charts are breaking out the bananas. It’s a party, baby!


But, god forbid you are a longer-term investor, you pull back those same charts to 5, 15, and 30 year charts, and you’ll see that you might be the monkey hanging out by the tall grass line somewhere in Africa.


This, of course, has happened 100% of the time in my carreer. And the non-fiction bubble reflation story goes something like this:


  1. 1 #TheCycle peaks and there was one mother of a Q1-Q2 rally to lower-highs in Tech Stocks
  2. 2007-2008 #TheCycle peaks there was one mother of a Q1-Q2 rally in everything levered to Consumer/Housing
  3. 2015-2016 #TheCycle peaks and there’s been one mother of a rally in Commodity Inflation


Is it demand or is it the Fed? (i.e. the Dollar)


I realize that some big EM like Brazil has its own political story, but does Russia? Both China and Europe continue to slow as Japan falls somewhere inside its own economic abyss (Nikkei and DAX -1% this a.m. and -19-20% from last year’s cycle peak).


How about the divergence between 2 big 2011-2012 Bernanke Bubbles that imploded – Oil vs. Copper?


  1. Oil (WTI) is up +41% in the last 3 months, but is still down -12% year-over-year
  2. Copper is down -7% in the last 3 months, and remains in crash mode -23% year-over-year


Ok. So Energy stocks (XLE +15.0% YTD) look almost as awesome as Utilities (XLU +16.2% YTD), but is that because Oil’s volatility (OVX) has crashed from 80 in FEB to 35 in JUN? Or is that because everything demand is awesome again and suppy will never come back?


I’ve been much more vocal on the Long Utilities (XLU) vs. Short Financials (XLF) view than I have been on being long Reflation and that’s basically because it was an easier call to make that growth would slow than it was that being right on #GrowthSlowing would get people to chase Reflation Charts that have been blowing investors up for 3 years.


I don’t think of this as a mistake yet (this “bull” only started in MAR/APR). I’m actually thinking of it as an opportunity. While I haven’t been short Energy this year (we were last year with our #StrongDollar Deflation call), I haven’t been long it either.


Do I buy something that I’ve initially missed (that’s already had a huge move) that doesn’t have global demand behind it?




I have no problem buying or selling anything, don’t forget. If Energy stocks (XLE, XOP, OIH, etc.) are about to put on a 6-12 month move (higher) from here, it’s my job not to miss that inasmuch as it’s my job not to get sucked into the allure of its momentum.


Maybe it’s a bull. Maybe it’s a bear. Maybe it’s a lion.


I just don’t want to end up becoming the monkey in Reflation’s Shadow.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.64-1.78%

SPX 2082-2121

RUT 1139-1195
USD 93.15-94.87
Oil (WTI) 47.78-51.37

Gold 1
Copper 2.02-2.11


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Reflation's Shadow - 06.09.16 EL Chart

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