Last week, hedge fund titan George Soros grabbed headlines after it was announced he had come out of semi-retirement and placed bearish bets, shorting the S&P 500 and buying gold.
Takeaway: Misguided? Out to lunch? Delusional? You decide.
That was San Francisco Fed head John Williams' call in January of this year.
Now that the Fed has turned dovish (again), with poor economic data continuing its past peak cliffdive, markets are discounting the probability of any rate hike in 2016 at all. Currently, the market's probability of a hike isn't above 50% until February 2017.
Going out on a limb here ... but five hikes look like a stretch (given that there are just five meetings left in 2016).
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Here's an illuminating excerpt from the interview with CNBC's Steve Liesman back in January, in which John Williams discussed his rate hike outlook.
LIESMAN: So let's talk about the path for Fed rate hikes this year. The median seems to suggest four this year. Is that also your forecast?
WILLIAMS: Well, I think that given the forecast they have for where the economy's going, what's happening with inflation – and inflation is the one thing that we're still struggling to get back to our 2% goal. That to me is the main focus. You know, I think something in that 3 to 5 rate hike range makes sense, at least at this time. But we're data dependent. We continue to be data dependent so the data's suggesting that gradual pace of rate hikes makes sense. But we'll have to re-evaluate that, reassess that, based on where we see inflation and other indicators that kind of are factors in inflation and how we see economic growth over the next year." (Emphasis added)
Williams continued saying that, by his estimation, U.S. GDP is headed toward 2% at the end of this year.
(**If you'd like to read more Fed nonsense, here's the full transcript of the interview with links to the video.)
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."
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.
Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.
Takeaway: U.S. Consumer Confidence and Jobless Claims data paint an ugly economic picture.
"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.
...Not to mention May's U.S. jobs report, which just so happened to be the worst report in almost six years.
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.
Takeaway: "The Old Wall will blame Brexit, but stocks in London are only -0.39% - blame #GrowthSlowing."
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."
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%."
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.
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