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A Humbling Moment For St. Louis Fed Head James Bullard?

A Humbling Moment For St. Louis Fed Head James Bullard? - Fed cartoon 05.04.2016


Even the hawks are "cooing" these days.


St. Louis Fed head James Bullard has finally acknowledged that the U.S. economy is slowing. The eye-opening part of Bullard's Friday morning admission is this: He now says the U.S. economy's growth is so underwhelming that we may need no more than a single additional rate hike for the next 2.5 years.


As we've pointed out before, Bullard joins San Francisco Fed head John Williams in dialing back prior rate hike expectations. (Williams was perhaps the most ardent hawk, yearning for as many as five rate hikes in 2016.)


Oh how the mighty have fallen...


In a shocking mea culpa though, Bullard released a statement today about Fed forecasting and the U.S. economy saying:


"We are backing off the idea that we have dogmatic certainty about where the U.S. economy is headed in the medium and longer run. We are trying to replace that certainty with a manageable expression of the uncertainty surrounding medium- and longer-run outcomes."


A Humbling Moment For St. Louis Fed Head James Bullard? - Fed grasping cartoon 01.14.2015


Bullard now predicts that, “Output grows at a trend pace of 2%, but the unemployment rate remains quite low and inflation remains at 2%” over the next two-and-a-half years.


He even brought up the dreaded "R-word":


"We are currently in a no recession state, but it is possible that we could switch to a recession state. If such a switch occurred, all variables would be affected but most notably, the unemployment rate would rise substantially. Again, the possibility of such a switch does not enter directly into the forecast because we have no reason to forecast a recession given the data available today. The possibility of recession is instead a risk to the forecast."


And here's another interesting admission about the Fed's concern about "asset price bubble risk":


"The approach presented here also says little about asset price bubble risk, a factor that often enters the actual policy discussion."


Bullard's statement is an interesting read. Hopefully, we're moving toward a Fed that puts humility before dogma. 


Time will tell.

CHART OF THE DAY: The First Shot Fired Across The Credit Cycle Bow

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye Financial analyst Josh Steiner. Click here to learn more.


"... Synchrony fired a shot across the credit cycle bow on Tuesday by raising its guidance for expected net charge offs from a range of 4.3-4.5% to a range of 4.5-4.8%. SYF shares reacted by dropping ~14%, while the rest of the card space followed suit: Capital One (COF) was down ~5%, Discover (DFS) was down ~3% and so on...


I think Synchrony’s announcement Tuesday will prove to be one of the early timestamps used in the future to mark the end of the current credit cycle. Incidentally, many of the lender stocks peaked in mid-2015." 


CHART OF THE DAY: The First Shot Fired Across The Credit Cycle Bow - 06.17.16 EL Chart

Negligible Senescence

"I am Duncan MacLeod of the Clan MacLeod."



The Highlander film & television franchise began in the mid-1980s and ran through the late 90s. To the surprise of many critics, it spawned five movies, two television series, an animated series, an animated movie, an animated flash-movie series, ten original novels, nineteen comic book issues and various licensed merchandise (h/t Wikipedia).


My favorite film critic, the late Roger Ebert, had this to say about the 1986 film that started it all:  


“[Highlander] is sort of like a garage sale at the house of a berserk screenwriter. This movie has a little bit of everything: immortality, sword fights, ancient legends, muscular heroes, exploding automobiles, wise old men, beautiful women, bloody beheadings and lightning crackling through the sky. It has an especially lot of beheadings and lightning. In fact, occasionally people’s fingertips tingle with all of the excess electrical energy in the story.” (Ebert’s YouTube review: HERE).


Despite what seemed like a promising list of Hollywood ingredients, Ebert was left underwhelmed, and gave it a thumb down. Siskel agreed, but that didn’t stop Hollywood from firing up a reboot 5 years later: Highlander 2: The Quickening, which is now generally considered one of the worst films ever made, and about which Ebert offered this:


"This movie has to be seen to be believed. On the other hand, maybe that's too high a price to pay. "Highlander 2: The Quickening" is the most hilariously incomprehensible movie I've seen in many a long day - a movie almost awesome in its badness. Wherever science fiction fans gather, in decades and generations to come, this film will be remembered in hushed tones as one of the immortal low points of the genre." (HERE).


Negligible Senescence - highlander


Back to the Global Macro Grind


Until recently, Highlander was always the first thing I thought of whenever I thought of immortality, but then I read something really interesting on Reddit.


I’ve become a big fan of Reddit. While something like a billion and a half people around the world whittle away the hours on Facebook, I prefer Reddit. Recently, this question was posed on Reddit: What is surprisingly NOT bulls**t?  Here’s the one answer that caught my attention: Crocodiles actually have no life span. If they lived in a perfectly suited environment with no predators/diseases etc. they would live forever. It’s a process called Negligible Senescence. This was something I had never heard of before, and when you get to your 40s you start to feel as though you’ve seen or heard most of what’s out there.


In the simplest sense, Negligible Senescence means that a creature is functionally immortal. It means that certain types of plants or animals will not die from old age-related wear and tear. For instance, their metabolism doesn’t slow down as they get older, their heart doesn’t show signs of aging, they don’t become incompetent or impotent, they don’t lose strength or experience declining health. At the cellular level, this is because they have no post-mitotic cells – they continually undergo cellular division, reducing/eliminating the creation of damaging free radicals – this is also why these types of plants and animals never stop growing.


These organisms die only from external factors like disease or predation. Examples in the real world include lobsters, crocodilians (alligators, crocodiles, caymans), turtles, tortoises, sturgeon, and certain types of trees. For instance, Aspen trees live 40-150 years above ground, but the root system can live for thousands of years. There’s an Aspen root system in Utah called Pando that’s estimated to be 80,000 years old. There’s a bristlecone pine in Eastern California called Methuselah, which scientists peg at just over 4,800 years old.


It’s conceivable that as our understanding of genetics continues to improve – and all signs point to it improving at an accelerating rate – we may one day be able to incorporate the genetic properties of negligible senescence into our own DNA, negating most of the effects of aging. The implications this would have on investing are interesting and profound. Consider the power of compounding interest on a multi-century investible timescale. #YaleEndowmentTimescale


While negligible senescence seems like a distinct possibility for humans somewhere down the line, there’s little doubt that today the economic cycle ages and decays just as people still do. The latest evidence for this comes from Synchrony Financial (SYF), a private label credit card lender spun out of GE Capital two years ago. Synchrony is a big lender with over $65 billion in consumer receivables and counts WalMart, Lowe’s and Amazon among its customers. In other words, if you have a Lowe’s card, it’s a Synchrony card.


Synchrony fired a shot across the credit cycle bow on Tuesday by raising its guidance for expected net charge offs from a range of 4.3-4.5% to a range of 4.5-4.8%. SYF shares reacted by dropping ~14%, while the rest of the card space followed suit: Capital One (COF) was down ~5%, Discover (DFS) was down ~3% and so on.


Synchrony management presented at a conference that day and said that the problems likely went beyond just them. They suggested that consumers have suffered a decline in their ability to pay debts, and speculated that it was due to auto and student loan burdens having reached a tipping point. The increase in loss guidance of 20-30bps is small in absolute terms, and nowhere near enough to justify shaving 14% off the value of SYF, but it’s the inflection that spooked the market.


Credit trends are autocorrelated, meaning that they self-reinforce both on the way up and down, and the market gets this. The natural progression goes something like this: credit quality deteriorates slightly on the margin, lenders tighten credit underwriting in response, which causes less credit consumption, which causes credit quality to deteriorate further, which causes lenders to further tighten underwriting and so on.


In other words, once you see the first cockroach in the credit cycle, you should aggressively exterminate long exposures in your portfolio because the cycle has begun to turn but still has a long way to go. It won’t be obvious that it has turned for months or even quarters to come, but rest assured … it has turned.


Thinking back to the last cycle, there were many signs marking the turning of the cycle at various points leading up to Lehman’s collapse in September 2008. The early signs, for instance, came in mid-2005 when the rate of change in volume of homes sold began to slow. Coincidentally, also in mid-2005, homebuilder stocks peaked. By mid-2006 the rate of change in home prices began decelerating. By the Spring of 2007 subprime lender New Century went into a death spiral. In May 2007, the Financials ETF, XLF, peaked. In June 2007, two Bear Stearns Hedge Funds collapsed. In October 2007, the S&P 500 peaked. In March 2008, Bear Stearns collapsed. In September 2008, the Global Financial Crisis hit with its full fury.


I think Synchrony’s announcement Tuesday will prove to be one of the early timestamps used in the future to mark the end of the current credit cycle. Incidentally, many of the lender stocks peaked in mid-2015.


One thing to understand about credit cycles is that they’re like chains. The weakest link ALWAYS breaks first under pressure. The analog here is the subprime borrower – the person with the least resources to service their debt when a problem arises. Synchrony has sizeable exposure to subprime borrowers. In fact, 28% of their credit card customers have FICO scores below 660 – the cutoff point for subprime borrowers.


Synchrony has 65 million cardholders, which translates to roughly 18 million subprime borrowers. For reference, there are 185 million conventionally scoreable people in the US, so Synchrony’s subprime pool is roughly 10% of the total US borrower base and close to one third of all US subprime borrowers. Among big card lenders, only Capital One has a greater share of subprime borrowers at 35%.


Another thing to understand is what’s called the hierarchy of payments. Let’s say a borrower has three separate credit obligations: a mortgage, a car loan and a credit card balance. If that person finds that they’re unable to pay all these bills in a timely fashion, in which order will they choose to default? Notwithstanding the last cycle, which inverted the longstanding payment hierarchy pyramid, so-called normal cycles see borrowers first default on their unsecured credit card debt, then on their auto loan and finally on their mortgage.


Again, up until the last cycle, this is how it’s always gone. The last cycle was clearly anomalous as many borrowers chose to walk away from their mortgage while, in many cases, continuing to pay their car loans and credit cards. This cycle is not like the last cycle. This cycle will see a normal payment hierarchy. This is why seeing subprime borrowers defaulting on their credit cards is exactly what you would expect to see at the start of a credit cycle downturn.


A final thing to understand is a phenomenon called the denominator effect. Charge off rates have a numerator: the dollar amount of bad loans being written off, and a denominator: the average loan balance during the period. If the denominator is growing rapidly, this will cause the charge off rate to be artificially suppressed.


Here’s a simple example. Say a lender has $150 in charge offs on a $1,500 average loan balance. The charge off rate is 10%. But now assume that the lender grew that loan base by 50% over the past year, so the balance a year ago was $1,000. The reality is that bad loans take some time to season and they must be in default for 6 months (180 days) before they’re charged off. As such, the $150 in charge offs should really be divided by the $1,000 in loans to give an accurate depiction of the charge off rate, meaning the real charge off rate in this example is more like 15%. Once the loan growth slows, the credit quality will appear to worsen dramatically.


The point is that fast growth in receivables is usually enough to temporarily suppress the appearance of deteriorating credit quality, at least optically over the intermediate term. So the fact that Synchrony had to raise its charge off guidance at a time when it’s growing receivables rapidly means things are worsening in a material way.


In normal recessions, card lenders tend to see their shares cut in half. In the last recession, they lost 80-90% of their value. We wouldn’t expect this downturn to be on par with the last recession, but that’s not to say there isn’t still a lot of downside risk over the coming 12-24 months as cyclical senescence takes hold. The big card lenders include COF, DFS, AXP, ADS, SYF. The big banks with big card books include BAC, JPM, C. The big auto lenders with subprime exposure include SC, CACC and ALLY.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.54-1.65%

SPX 2055-2095

VIX 17.26-23.12
USD 93.39-95.25

Gold 1


Yours in risk management,


Joshua Steiner, CFA
Managing Director


Negligible Senescence - 06.17.16 EL Chart

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Brexit, DAX and Oil

Client Talking Points


Coin toss? We would say so. And since we don’t make calls on coin tosses, we’ll just give you both bearish intermediate-term TREND signals in FTSE (6,388 resistance) and Pound ($1.47 vs. USD) with an intermediate-term risk range of $1.39-1.47. In other words, even if they don’t exit, odds are the FTSE remains bearish TREND (because the UK economy is slowing regardless vs. last year’s cycle peak).


More definitively bearish TREND than FTSE, but that’s because the DAX remains in crash mode (-22% from last year’s cycle high). Reminder that we still have the Street low forecasts for both Eurozone and German GDP in 2H of 2016 – #GrowthSlowing is the tail wagging the political dog, and it’s not just the UK who has political risks accelerating in kind. 


Oil was down -4.2% yesterday, up +1.4% on the bounce today, down   -23% year-over-year, but up +20% in the last 3 months – which way from here? The risk range signal says lower-highs ($46.06-49.21 WTI) and Oil’s Volatility (OVX) signal (ramped back up to 44 this week) says this said bull market isn’t done chopping a bullish consensus up for the summer time.


*Tune into The Macro Show with Retail Sector Head Brian McGough live in the studio at 9:00AM ET - CLICK HERE

Asset Allocation

6/16/16 66% 2% 0% 8% 20% 4%
6/17/16 66% 2% 0% 8% 20% 4%

Asset Allocation as a % of Max Preferred Exposure

6/16/16 66% 6% 0% 24% 61% 12%
6/17/16 66% 6% 0% 24% 61% 12%
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

No matter what side of the reflation/deflation trade you’re on, the growth in global demand continues to decelerate on a trending basis. The debate is no longer whether or not growth is slowing. The real debate centers on the policy response and the market reaction to that policy response. While that question presents us with “open the envelope” risk, #GrowthSlowing will continue to be the bull catalyst for U.S. Treasuries whatever the policy response as the slow march to zero yields globally goes on. 


To sum things up, stay away from the guessing game and stick to what is empirically evident. A stronger USD over the longer term is a probable scenario in our book. We expect the Fed, and all central banks for that matter, will try to combat deflation. That said, global currencies all burning at the same time makes a compelling case for GLD, as gold knows no currency. You can sell it in local currency all over the world. Scary but true.


There have been rumblings in the news that McDonald's (MCD) 2Q comps have slowed due to the temporary replacement of the 2 for $5 value platform for Monopoly. This has clearly been reflected in the stock as of late, as MCD has underperformed the S&P 500 over the last month.


Despite this near term headwind, we still strongly believe in the long-term story for MCD and remain confident that once they get their value platform right nationally, they will be just fine. In the short to intermediate term, as we wait for a solidified value platform, this recent underperformance represents a great buying opportunity. We remain LONG MCD.

Three for the Road


**REPLAY About Everything | Q&A w/ @HoweGeneration: Demographic Warning Shots In America https://app.hedgeye.com/insights/51725-about-everything-q-a-with-neil-howe-tom-tobin-demographic-warning …



Kind words are the music of the world.

F. W. Faber


Over 50% of Canada's population has a college degree, making it the most educated country in the world.

The Macro Show with Brian McGough Replay | June 17, 2016

CLICK HERE to access the associated slides.


An audio-only replay of today's call is available here.

JT TAYLOR: Capital Brief

Takeaway: Donald in Distress, Sanders Stays and Rubio Reconsidering...


JT TAYLOR:  Capital Brief - JT   Potomac banner 2


“I'm not the smartest fellow in the world, but I can sure pick smart colleagues.”

                                - FDR


DONALD IN DISTRESS: After the IN primary six short weeks ago, Donald Trump was atop some national polls and riding a high wave of Republican endorsements on his way to unifying the party, while Hillary Clinton was left to battle an insurgent and struggling to unite her own party.  After two tumultuous weeks of picking fights with everyone in his path, Trump has found himself alone and losing momentum faster than ever. Republicans have had a knee jerk reactions to criticizing the nominee early and often in the past, but the frequency with which they’re doing it now is different and more problematic. With less than a month before the convention, he hasn’t won endorsements from many of his former primary opponents, has yet to put together a core finance team and is creating tension with the RNC - his only (and largest) organizational back up for the next five months. Does this guy really want to win?


SANDERS STAYS: Bernie Sanders still refuses to hang his hat – but that’s what a revolution is all about, right? Despite having finished more than 400 delegates behind Clinton, Sanders plans to stick around a little longer. He turns his focus to shaping the party’s platform and guaranteeing his supporters voices are heard. In his platform fight, Sanders plans to include issues like raising the minimum wage to $15 an hour, safeguarding equal pay, gay rights, enacting gun control reform, protecting social security, defeating TPP, and reforming the banking system and the role of money in politics. In the end, his main focus remains defeating Trump come November. Clinton’s camp has no choice but to work with Sanders over the next few months and focus on her goal of uniting the party ahead of the convention.


GUN JAM: Our nation’s gun laws have many Democrats up in arms and now Trump - who throughout his campaign has expressed his opposition to gun control - has been prompted to meet with the National Rifle Association over the issue in the wake of the Orlando massacre. Trump has backed a no-buy list for FBI watch list members and the NRA has opposed the measure concerned that Americans wrongfully placed on list were being stripped of their constitutional rights to due process. Tensions have emerged on Capitol Hill after a 15-hour filibuster by Senate Democrats has forced Republicans to hold votes on two separate gun measures - with PA Senator Pat Toomey being one of few Republicans willing to cross party lines on the issue.


RUBIO RECONSIDERING: When Senator Marco Rubio launched his presidential campaign, he made the bold promise of winning the White House or bust - but a lot has changed since then especially with Trump at the top of the ticket. Holding onto the Senate was always going to be a challenge for Republicans given the number of seats they had to defend and now with the political winds changing, Senate Majority Leader Mitch McConnell and his colleagues feel Rubio is their best hope to keep FL in the red column. As the Democratic frontrunner, Rep. Patrick Murphy has been the beneficiary of the party’s growth in registration and fundraising in the state making him the early favorite…if Rubio doesn’t run. Rubio has exactly one week to decide if he’ll throw his hat in the ring.


GAUGING GARLAND?: Senate Majority Leader Mitch McConnell has remained steadfast on holding hearings or a vote on President Obama’s Supreme Court nomination. Chatter is starting to pick up in the corridors of the Senate as prospects of a Clinton presidency increase and six months from now the alternative could be much different - especially if Democrats are able to take the Senate as well and narrow the gap in the House. Though Judge Merrick Garland is considered a centrist, some Republicans are coming around to the notion that he may be the best option for them going forward.


HUNTED: THE F-35 PROGRAM AT FARNBOROUGH: Today at 11:00 AM EDT, our Senior Defense Policy Advisor LtGen Emo Gardner will host a call for investors regarding the first ever appearance of the F-35 at the world’s most important aerospace show, the Farnborough International Airshow, July 11-17. You can find the dial-in information here.


ELECTION PREVIEW WITH SCOTT REED: With the fight for the White House heating up, we’ll talk with Scott Reed, one of Washington’s top political strategists, to gather his views on who will be the next President of the United States, the upcoming party conventions, and the highly competitive Senate and House races this fall. The call will take place next Tuesday, June 21st at 11:00 AM EDT. You can find the dial-in information here.


NOTE:  We're traveling on Monday and will be back on Tuesday morning.  Have a great weekend.

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