Hedgeye Guest Contributor | Cliggott: A Tired, Fragile Stock Market

Takeaway: The footings now supporting US equity prices are looking pretty tired and fragile.

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. While this column does not necessarily reflect the opinion of Hedgeye, suffice to say, more often than not we concur with our contributors. In the piece below, Cliggott writes, "The footings now supporting US equity prices are looking pretty tired and fragile."


Hedgeye Guest Contributor | Cliggott: A Tired, Fragile Stock Market - corp profits cartoon 03.28.2016


Total income has expanded at a slow, but steady pace in the U.S. during the past several quarters – national income grew by 3.1 percent during 2015 and 2.9 percent in Q1.2016. Not much change there. What has changed in an important way is the composition of overall income – labor compensation grew by 4.5 percent in 2015 and accelerated a bit to 5.0 percent in the first quarter.


The flip side of the pick up in labor compensation is a weakening of corporate profits. They contracted by 3.1% in 2015 and by 5.8% in the first quarter. So what we are seeing is a clear weakening of profit margins – a very natural outcome 7 to 8 years into a profit cycle.


The dismal trend in U.S. labor productivity and OECD data on leading economic indicators of the most relevant markets for large US corporations – the US, Europe, China – strongly suggest a further intensification of “profit problems”.


Corporate America has reacted to weakening profitability in traditional fashion. They have scaled back capital spending (down about 2% versus a year ago in the first quarter) and they have slowed their pace of new hiring, from about 200,000 jobs a month this time last year to about 100,000 per month during the past three months.


We know what usually happens next – weaker capex and slower job creation slows demand growth, this weakens profitability further, and down we go in a negative, re-enforcing cycle. The normal “end game” – outright declines in total income and employment – may now be just months away in the U.S.


What corporate America has not done – yet – is slow their accumulation of new debt. Non-financial corporations increased their borrowing in the first quarter by $180 billion, to $8.28 trillion. The last time U.S. corporations borrowed this much in a 3-month period was the last quarter of 2007. And it looks like their primary motivation for borrowing in 2016 is exactly the same as it was back then – to support their stock prices by ratcheting up the amount of cash they give back to shareholders even as their profits and cash flows weaken.


The shrinkage in equity outstanding through both mergers and share buybacks added together with dividend payments totaled $1.27 trillion (at an annual rate) in the first quarter, up about 10 percent from the $1.15 trillion pace during 2015. These shareholder payments represented 59 percent of the after-tax cash flow of non-financial corporations in Q1 2016, up from 53 percent in 2015 and 43 percent in 2014. By contrast, capital spending as a share of cash flow declined modestly, to 80 percent in Q1.2016 versus 83 percent in 2015. 


Looking back at seventy years of US financial history, the only time corporate America devoted a similar amount of their cash flows to dividend payments and share buybacks was in 2006 (56 percent) and 2007 (70 percent). And then when corporate borrowing slowed, total shareholder payments were cut hard – to 46 percent of cash flow in 2008, and 25 percent of cash flow in 2009. 


The key lesson from this time, I think, is that while corporate cash flow declined by less than 5 percent between 2007 to 2009, shareholder payments were cut by two thirds – from $1.20 trillion to $400 billion.


Since it is commonly acknowledged that shareholder payments are now the primary, and in some months, the sole, source of demand for US equities, the pace of corporate borrowing may be our best guide to the direction stock prices in America. With profits declining and cash flow stalling it wouldn’t be too surprising to see borrowing slowdown real soon.


So here’s the punch line: The footings now supporting US equity prices are looking pretty tired and fragile.

Stormy U.S. Economic Data

Takeaway: U.S. Consumer Confidence and Jobless Claims data paint an ugly economic picture.

Stormy U.S. Economic Data - S P 500 cartoon 06.08.2016


"If you're bullish on a US economic recovery in 2H, I've got a couple of charts for you to be willfully ignorant of," writes Hedgeye Senior Macro analyst Darius Dale.


Consumer Confidence


Stormy U.S. Economic Data - consumer confidence 6 13


Jobless Claims


Stormy U.S. Economic Data - jobless claims 6 13


...Not to mention May's U.S. jobs report, which just so happened to be the worst report in almost six years.


So, what do you do with that? 


Here's Darius:

Meanwhile ... our non-consensus call on long bonds (via TLT) continues to serve Hedgeye subscribers rather well too. It's up 12% YTD vs a 2.5% return for the S&P 500.

In the States: A Primer on Drug Price Ballot Initiatives in CA and OH - GILD, JNJ, ABBV, AMGN

Takeaway: Although opposition to high drug prices polls well, these efforts do not appear to be much of a threat to Pharma at this point.

As we discussed in a recent note on the Medicare Part B Drug Demo, the political environment for the pharmaceutical industry is less than perfect these days. Taking advantage of recent trends are drug price activists in two states, Ohio and California. Californians for Lower Drug Prices (funded mostly through the AIDS Healthcare Foundation) and Ohioans for Fair Drug Prices have initiated ballot measures that would require their respective states to pay no more than what the Department of Veterans Affairs pays for prescription drugs.


As we also noted in the context of a discussion on the Medicare Part B Drug Demo, controlling drug prices just isn't that simple. The ballot initiatives further prove that point. Below is a brief explanation of each initiative and our thoughts on likely outcomes.


California. California has a reputation for being the hot house for citizen driven initiatives that spread east. Certainly, it was in California in 1978 that the "no new taxes" fervor kicked off with the passage of Proposition 13 limiting property tax increases. The "tough on crime" period of the 1990s began in earnest with California's adoption of the "three strikes" ballot initiative. When it comes to health care issues, Californians are not nearly as cutting edge. A 2005 ballot measure would have created a prescription drug discount program for people earning 300 percent or less of the federal poverty threshold. The effort had the support of the pharmaceutical industry but failed miserably, 58.5 percent to 41.5 percent. More recently, Proposition 45 on the November 2014 ballot would have imposed health insurance rate regulation. It was defeated soundly with almost 60 percent casting "no" votes.


On the November 2016 ballot will be another citizen driven effort called the "Drug Price Relief Act." According to the ballot summary provided by the California Attorney General the measure:


Prohibits state agencies from paying more for a prescription drug than the lowest price paid for the same drug by the United States Department of Veterans Affairs. Applies to any program where the state is the ultimate payer for a drug, even if the state does not purchase the drug directly. Exempts certain purchases of prescription drugs funded through Medi-Cal.


The petition drive to get the measure on the ballot was spearheaded by the AIDS Healthcare Foundation which provides care and advocacy for AIDS patients in 36 countries. The object of AHF's ire appears to be Gilead whose Hepatitis C drug, Sovaldi has contributed to increased drug spending in state Medicaid programs. AHF has also been critical of GILD's development of other AIDS therapies. AHF's advocacy style tends toward the inflammatory and theatrical. A recent protest at the Goldman Sachs Global Healthcare Conference featured "a hearse, a double-deck bus and 25+ cars outfitted with ‘Gilead Greed Kills’ banners and placards as well as a small plane towing a Gilead Greed Kills banner" according to the organization's website.


There a number of problems with Drug Price Relief Act. Chief among those is that no one knows exactly what the "lowest price paid" by the VA is. There are two caps set in legislation that limit the maximum price the VA pays for a drug. They pay either the best commercial price net of certain discounts and rebates or the average price paid by pharmacies minus a large statutory discount, whichever is lower. VA receives additional discounts if drug prices rise faster than general inflation (which they have generally done). The VA negotiates further discounts with drug makers for the drugs included on its formulary (or list of preferred drugs), and in return steers its enrollees to use those drugs. According to some reports, the VA pays about half the commercial rate for some drugs.


Other than those restrictions, we know little about what the VA pays for which drugs. The California Legislative Analyst's Office which is responsible for estimating the fiscal impact of the effort could not do so due to lack of price data from both the VA and the State of California. The California Medicaid Agency, Medi-Cal has publicly asserted that they believe they pay as little as or less than the VA for drugs already.


Another problem with the ballot proposal is that it applies to any program that gets state aid to purchase drugs which would include certain grant-funded entities but not all. A number of health care providers - rural clinics and Ryan White clinics, for example, receive funding from federal rather than state sources. This provision would somehow - and no one knows how - insert the state into the price of drugs to be administered by private non-profit providers to which it supplies grant support.


AHF's ballot measure has been met with stiff resistance from the pharmaceutical industry, to no one's surprise. Interestingly enough, the measure has also failed to garner much in the way of support from the highly organized, very effective AIDS/HIV organizations in California whose constituencies have been hard hit by the cost of specialty drugs used to treat HIV and associated conditions. In fact, Peter Staley, the legendary AIDS/HIV activists and former leader of ACT-UP has taken to Facebook to criticize AHF and its leader Michael Weinstein regarding the ballot measure. Anne Donnelly of the San Francisco-based Project Inform which advocates for HIV and Hepatitis C patients was quoted in April as saying "there is a possibility for some unintended, very harmful consequences.”


Opponents to the effort have raised about $60 million - most of it from the pharmaceutical industry. Proponents have raised about $5 million and hit the airwaves Tuesday, June 7, with two TV ads. The Stop Pharma Greed Facebook page appears oftentimes to almost be a proxy for the Bernie Sanders for President campaign suggesting less than enthusiastic support from Clinton supporters in the future. Poorly researched and drafted, the Drug Price Relief Act has a lot of opposition and little organized support from the groups that, at least in theory, would most benefit. Although opposition to high drug prices polls well, at this point we believe the chances this ballot measure is successful are around 40 percent.


Ohio. Ohio is an indirect initiative state. Proponents of a ballot measure submit signatures to petition the Ohio General Assembly to consider a change to law. The General Assembly can approve, reject or revise the measure. If they reject or revise in a manner unacceptable to proponents and a sufficient number of signatures are gathered, the matter can be put to the voters in November. On Feb. 5, 2016, the Secretary of State sent the proposed law to the Ohio General Assembly. The legislature chose not to act thus triggering another petition drive last Friday. The proponents will need to gather about 91,000 signatures before July 6, 2016 to qualify for the November ballot.


The Ohio Drug Price Relief Act is essentially identical to the California measure and so the same problems identified above apply here. Unlike the California effort, the Ohio initiative does not appear to be as well organized or funded. In Ohioans for Fair Drug Prices' last election campaign finance report filed at the end of January, they reported $815,000 raised, $700,000 spent and about $15,000 cash on hand. This is a paltry amount compared to the $4 million raised by AHF and the $60 million the pharmaceutical industry plans to spend in California. We have not been able to identify either a Facebook page or a Twitter account for Ohioans for Fair Drug Prices. Most of the campaign effort appears to be directed out of Los Angeles by AHF.


With little organization, less time and almost no money, we estimate the probability for voter approval of the Ohio Drug Price Relief Act to be about 40 percent, assuming it is approved for the ballot. We are very skeptical Ohioans for Fair Drug Prices will be able to meet the July deadline for submission.

It is early in the game so we will keep you up to date on changes to the landscape for both these efforts.

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LNKD | CRM Wars (MSFT acquisition)

Takeaway: Timing/price is a big surprise, but we understand the rationale. LNKD’s content creates big competitive advantage in CRM space.


  1. MSFT TO ACQUIRE LNKD: MSFT announced this morning that it will be acquiring LNKD at $196/share.  The price is somewhat of a surprise since the takeout price is below where LNKD was trading at the beginning of the year.  Timing is the bigger surprise since LNKD theoretically could have potentially fetched a higher price if it could have revived its stock by proving to the street that its long-term prospects weren’t nearly as bad its initial 2016 guide.  The fact that LNKD is willing to sell now essentially suggests the opposite, or maybe mgmt didn’t want to risk remaining a stand-alone public company into a potential hiring slowdown and/or recession; the latter we haven't seen its public history.
  2. CRM WARS: MSFT may seem like an odd fit as a suitor, but we suspect the motivation comes down the CRM space (Client Relationship Management), where MSFT, CRM, ORCL & SAP are competing head on.  What LNKD provides to the CRM space is its database of user-generated professional profiles, which likely can't be replicated at comparable scale.  The key differentiator is that LNKD’s content is created/maintained by the professionals themselves rather than the other CRM tools that require the client to create/maintain the record themselves.  From that perspective, what LNKD provides is a CRM user database that is likely more current and requires much less manual labor on the part of the CRM client.  
  3. ACQUISITION CALL AT 11:45ET: More details to follow after the event.  


Let us know if you have any questions or would like to discuss further.  


Hesham Shaaban, CFA
Managing Director


RTA Live: June 13, 2016

[Crash]: A Look At Global Stocks

Takeaway: "The Old Wall will blame Brexit, but stocks in London are only -0.39% - blame #GrowthSlowing."

[Crash]: A Look At Global Stocks - World Market No 12.16.14


Global Equity markets are getting crushed this morning.


  1. Japan, Nikkei (-3.5%)
  2. China, Shanghai Comp (-3.2%)
  3. Germany, DAX (-1.3%)
  4. Italy, FTSE MIB (-2.3%)


The common refrain cited by mainstream media this morning is Brexit risk ... but that's a mirage. "The Old Wall will blame Brexit, but stocks in London are only -0.39% - blame #GrowthSlowing," Hedgeye CEO Keith McCullough wrote this morning.


Here's more analysis from McCullough in a note sent to subscribers this morning:


"... Not that this would matter, but Japan, China, Germany, Italy, etc. are all in crash mode from 2015 cycle highs – Nikkei hammered -3.5% last night (-23% from July 2015); Shanghai -3.2% overnight (-45% y/y); Italy -2.4% (-30% from July 2015) #GrowthSlowing."


Take a look at Japan...



... And China



Meanwhile, over in Europe...


Italian equities lead the losers:




... German equities are still crashing:



While global equity markets get eviserated, our favorite Macro positions like Long Bonds (TLT) and Gold (GLD) are winning. McCullough continues:


"Our call for an all-time low this year in the UST 10yr is playing out and the Long Bond remains our Best (Long) Macro Idea – 1.62% 10yr in the USA, taking it to -65bps YTD; Germany 10yr testing negative at 0.01%, Swiss 10s new lows at -0.51%."





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