The most consensus macro position right now is long the S&P 500.
Takeaway: Clinton Courts Millennials; Trump Turnaround Part Four; Warren Warnings
Editor's Note: Below is a brief excerpt from Hedgeye Potomac Chief Political Strategist JT Taylor's Capital Brief sent to institutional clients each morning. For more information on how you can access our institutional research please email firstname.lastname@example.org.
“Divide and rule, a sound motto. Unite and lead, a better one.”
― Johann Wolfgang von Goethe
Now that Hillary Clinton has sidelined Bernie Sanders, she’s making a play for some of his most diehard supporters - millennials. The first of many Sanders staffers joined Clinton’s camp with the main objective of corralling and converting college students. More importantly, though, are the ongoing talks between both campaigns regarding how to best deploy Sanders as a Clinton surrogate later this year.
Millennials rallied behind Sanders because they were inspired by his vision for change and political revolution. Clinton must determine where she too can foster change and promote those policies. For Clinton, targeting young voters is a critical element in unifying the part of the party’s base that turned out in record numbers to put Obama into the White House in ’08 and then again in ’12. Keep snapping those selfies, H.
One of Donald Trump’s first campaign hires, Corey Lewandowski, has departed amidst chaos in the Trump campaign following two particularly bad weeks. Firing your campaign manager five months out from Election Day is usually not the sign of a winning campaign. Trump needs to use this moment to change course and pivot away from the missteps and the resulting criticism his campaign has endured. He’ll likely pin the blame on Lewandowski and move on – hopefully for the Republican party - with a fresh approach.
With his recent decline in national polls, and Hillary Clinton’s barrage of attack ads, change is a must – but whether it will actually occur is the real question. Trump now finds himself in an even bigger rut, lacking staff, organization and most importantly money - he has less cash-on-hand than Ted Cruz - and he dropped out of the race six weeks ago.
Wall Street has a clear message for Clinton – don’t pick Senator Elizabeth Warren (MA) as your veep if you want our money. Harsh, but true. Warren’s war on Wall Street has been one of the largest political battles any sector has withstood in recent years. She was the driving force behind the CFPB and wants to break up big banks - even the mere mention of her name draws groans from the pinstriped crowd. Clinton is flirting with the left in her courtship of Bernie Sanders’ supporters – which Wall Street can stomach – but if she goes at it with Warren, she can kiss those checks goodbye.
With Spain heading to the general election voting booth (again!) this Sunday, below we offer special commentary from a Hedgeye contributor, Daniel Lacalle, to contextualize the vote.
Daniel is an economist, CIO of Tressis Gestion and author of Life In The Financial Markets and The Energy World Is Flat. He presented Sell Spain conference call for Hedgeye customers back on 10/21/15 (Audio Replay and Materials) and was a contributor at Macrocosm 2015.
As Daniel points out, the political climate has shifted very little since the country’s last vote in December 2015 (research). The hung parliament that resulted from the last vote has carried through to present day with no clear movement towards coalition building across the various parties. What does this spell? The high likelihood of a repeat of December’s results, or the lack of a new government with a strong majority, and a fragile economy weighing in the balance.
Daniel will join us LIVE on Friday’s Macro Show. Tune in and feel free to lob him questions about the Spanish vote and the UK's Brexit vote.
"Here I go Again, On My Own"
Here we go again. Spain has spent almost six months without a new government, and elections are again on our doorstep. The 26th of June, unfortunately, is unlikely to deliver a major change and uncertainty remains.
The economy in the meantime hasn´t done so badly. GDP growth has been revised up to 2.7% for 2016, and unemployment continues to fall. However, investments and consumer confidence have fallen and the path of job creation is somewhat slower than last year.
Polls show that the likely outcome of the elections will show a rise of the Conservative Popular Party (PP), but without a clear majority, and of the populist radical left (and anti-austerity) Podemos party. This move to the left of the voter shows that Spain seems polarized between those who will vote against the rise of communist-radicals and those who will vote for anything, even if it´s populist, to get the conservatives out of power.
So the marginal vote seems to be "against" not in favor of an option.
The major risks and likely outcome of these elections are:
– Vast majority of Spanish citizens vote for moderate, center parties [PP, PSOE (socialists) and Ciudadanos (liberals)]
– Neither PP+Ciudadanos nor PSOE+Podemos reach clear majority for government
– Key to stability and growth will be to find a coalition between Conservative PP and Ciudadanos and maybe PSOE
– Biggest risk is a coalition of populist radicals Podemos with PSOE and other radical and nationalist parties looking for constitutional changes and anti-EU measures
The push to unwind all the reforms that have helped Spain recover from the recession is quite relevant. Most parties seem to have forgotten budget stability and are aiming at more public spending in a country with 5% deficit and 100% debt to GDP.
In Spain, the main economists behind the opposition parties believe in the inexistent "growth multiplier" of public spending and in the positive effect of large deficits. This poses a huge threat to the economy just at the time when corporate profits seem to be slowing down and tax intake is very fragile and dependent on the recovery.
However, most parties - except the conservatives - promise large tax increases and huge public spending. In Spain it seems that the voter believes that somehow all this will be paid by someone else, not him or her.
If a left-wing coalition unwinds all reforms made by the PP and starts a constitutional change it could mean 0.7% to 1.0% impact on GDP and zero job creation.
In a country where non-financial sectors debt to EBITDA is at 5x (versus 3.3x in EU27) and where budget deficits have been in excess of 5% since 2008, large tax increases and public spending plans are likely to lead the economy to another shock once low rates and ECB stimulus fade.
The challenges of the economy remain, and the uncertainty might last well beyond the election day as coalitions will likely be fragile and with parties that have different agendas.
Key elements to watch:
– A high unemployment rate, despite the large reduction and the evidence that many jobs are hidden in the underground economy and counted as unemployed.
– A large fiscal deficit. Despite the massive adjustment, Spain´s deficit is well above the EU stability pact target.
– External debt remains at 100% of GDP and public debt at 97%.
In any combination, the new government will probably not have a strong majority, and most of the likely agreements may only come with parties who promise more spending.
The risk of Spain falling under the QE trap, putting all the bets on the European Central Bank, as it did in 2008, and going back to the same mistakes of deficit spending and public sector white elephants to “boost growth” is not small. Halting reforms and going back to past failed measures will likely give the same results. Less growth, less jobs, more debt.
With world growth slowing and keynesian measures failing from Japan to the Eurozone, there is a risk that if Spain votes against the Conservative Party and in favor of anti-austerity measures, the country could suffer another setback similar to 2010´s.
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Takeaway: Medicare Trustees report expected tomorrow probably won't trigger IPAB. Action for Medicare cost reduction at CMMI anyway
Rumor has it that the annual report of the Boards of Trustees for the Federal Hospital Insurance and Federal Supplementary Hospital Insurance Funds (a.k.a the Medicare Trustees) will be released on Wednesday this week. The release - earlier than the July 2014 and 2015 publication dates - has had tongues wagging for months about the possibility that the Independent Payment Advisory Board (IPAB) will be deployed as a result of the Trustees estimates of growth of per capita Medicare spending. If IPAB is implemented, the express targets of their efforts must be Medicare Advantage and the Part D perscription drug plans.
We believe that triggering IPAB is politically impossible for a number of reasons discussed below. Even if we are wrong, the result will be pretty muted and we think you can almost count on a complete nullification of the IPAB provisions in the ACA early next year. For 2017 and beyond, the action for bending the Medicare spending curve won't be at IPAB but at the Center for Medicare and Medicaid Innovation and to that we direct our attention.
Independent Payment Advisory Board. IPAB was created by the Affordable Care Act as a way to reduce Medicare spending. The Board would consist of 15 members - all appointed by the President and confirmed by the Senate - and charged with developing proposals to reduce the growth in per capital Medicare spending. IPAB's proposals are, at least theoretically, designed to take the form of legislation and follow the usual course of House and Senate approval. However, the Secretary of Health and Human Services has the authority to implement if Congress fails to act. IPAB, through a joint resolution of Congress introduced no earlier than February 2017, can be discontinued effective January 2018.
Deployment of IPAB. Each year with the release of the Medicare Trustees report, the Office of the Actuary at Health and Human Services sends a letter to the head of the Centers for Medicare and Medicaid with a determination - based on the Trustees' report - as to whether or not anticipated five-year per capita Medicare spending growth exceeded the estimated target growth rate. The per capita spending growth rate is specified as the sum of the average per capita spending for each of Medicare Parts A, B and D in the prior two years, the current year and the following two years. This per capita growth rate shall take into account "any delivery system reforms or other payment changes that have been enacted or published in final rules but not yet implemented as of the making of such calculation." When the Office of the Actuary sends its letter to Andy Slavitt at CMS this week, they will be using data for years 2014 to 2018. The target growth rate is equal to the average of the projected 5-year average growth, ending in 2018, in the Consumer Price Index for All Urban Consumers (all items; United States city average) and the medical care expenditure category of the Consumer Price Index for All Urban Consumers (United States city average).
If the Medicare per capita spending growth rate does not exceed the target growth rate, as was the case in 2013, 2014, 2015 and likely 2016, the Office of the Actuary will advise CMS of that determination and IPAB is not deployed. If, however, the Actuary determines that the Medicare per capita spending growth did exceed the target, they must also provide CMS with a savings target - a reduction in Medicare spending - for the final year of the five years included in the analysis, which for this year's analysis would be 2018. The savings target in 2018 must be the lesser of 1.5 percent or the excess of the average Medicare per capita spending growth rate over the target growth rate.
Once this savings rate is established, the President will appoint the 15 member IPAB board subject to confirmation by the Senate. Members must then develop a proposal or proposals by January 15, 2017. If IPAB fails to submit a proposal, the Secretary of Health and Human Services can submit one that satisfies all the requirements of the law. Neither the Secretary or IPAB can submit a proposal that would reduce Medicare reimbursement to providers of services (acute care hospitals, home health agencies, dialysis providers, etc.) or supplies (durable medical equipment, prosthetics and other supplies) prior to December 31, 2019. Any proposal shall include reduction in Medicare payments under Part C - Medicare Advantage - and Part D - Medicare Prescription Drugs benefit. Suggestions offered in the ACA regarding reductions in spending under Parts C and D include:
IPAB, assuming they convene, will submit a draft proposal for review to the Secretary by September 1, 2016. The Secretary has until March 1, 2018 to report to Congress the results of that review. If the Secretary is responsible for submitting the proposal, then this review and report is not required. IPAB is also not required to submit a proposal of the Office of the Actuary detemines that in 2018 CPI-U for medical care will be less than CPI-U for all items.
For better or worse, IPAB is highly politicized. For better or worse 2016 is a highly - and very unusual - political year. For that reason, any analysis of whether or not IPAB (or the Secretary) will submit and implement a proposal to reduce Medicare spending growth must start with the politics.
Medicare spending in general and IPAB in particular have become a political hot spot for Democrats. Republicans successful connected ACA-mandated reductions in Medicare spending to their Democratic rivals and took control of the House of Representatives in 2010. In 2012, more spectactularly but less effectively, Vice Presidential candidate Sarah Palin dubbed IPAB the "death panel" and raised the specter of rationed care. Since then, IPAB has become one of the few things in the ACA that both parties agree should disappear. A few weeks ago, the Senate Appropriations Committee approved, on a bipartisan vote, the FFY 2017 Health and Human Services' budget which included a defunding of IPAB with the following explanation:
Funding for IPAB is eliminated. IPAB is a 15 member board of unelected bureaucrats created by the ACA to achieve a reduction in Medicare spending through the only means they have – rationing care.
Given the manner in which IPAB was successfully leveraged - at least in part - by Republicans in 2010 to 2012, a trigger of this section of the ACA presents a lot of downside risk for Democrats. With the the possibility they will retain the presidency and potentially regain majority of the Senate, a replay of 2010's broadcast, cable and social media ads accusing Democrats of rationing care and cutting Medicare benefits is clearly something to be avoided. Donald Trump, whose base consists largely of older voters who may well remember Hillary Clinton's own health care proposal of 1993, will find the implementation of the IPAB provisions to be good ammunition against an opponent that openly supports the ACA.
The implications of IPAB implementation on presidential and congressional races would be magnified by the inevitably contentious nomination and confirmation process of IPAB board members. We wonder who that is qualified to serve on the IPAB board would also be willing political canon fire. More likely, President Obama would not want to nominate anyone thus avoiding risking the confirmation process that would thrust IPAB and its mission into the spotlight right when the 2016 elections were hitting full stride this summer. The Senate would likely not hold hearings but instead would repeat the strategy deployed around President Obama's Supreme Court nominee and use the opportunity to explain why America should vote Republican in November.
Complicating things tremendously is the fact that the ACA explicitly places in IPAB's crosshairs two extremely popular programs - Medicare Advantage and Medicare Part D. When the ACA was drafted and passed, Medicare Advantage was still a go-to source of spending reductions for Democrats who had a long held distaste for the Republican-originated program. Between then and now, Medicare Advantage reached an inflection point whereby its popularity is now firmly bipartisan and significant reductions unpopular. The specifics IPAB's authority to make spending reductions in these areas and the protections the law attempts to provide beneficiaries will no doubt get lost in the shuffle. All a good video ad or direct mail piece needs to say is that these programs are being threatened - something to be avoided in an election year.
The inability to seat an IPAB board presents the Obama Administration with a particularly thorny problem. The ACA directs that if the board cannot submit a proposal for any reason then President Obama's Secretary of Health and Human Services will do so. That contingency plan, incorporated into the ACA, drops the IPAB spending reduction mandate firmly into the lap of the President and his party.
In short, if the Office of the Actuary determines that the IPAB provisions of the ACA are to be implemented, the result is one big political headache for Democrats on the cusp of a major election.
With politics driving the agenda but a law that clearly defines the process, what happens next turns on how much discretion the Office of the Actuary has in determining if estimated five year average Medicare per capita spending growth exceeds the target growth rate. The good news is that the ACA included a provision that permits the Actuary to consider "any delivery system reforms or other payment changes that have been enacted or published in final rules but not yet implemented as of the making of such calculation." Given the startling pace of payment delivery reform in the form of CMS driven pilots like the Comprehensive Care for Joint Replacement and Congressional mandates of physician payment reform and changes to the clinical lab fee schedule, the Actuary has a lot to work with this year in estimating Medicare per capita spending growth on the low side.
A determination by the Actuary that IPAB is not triggered in 2016 would also be consistent with their 2015 forecast which estimated that Medicare per capita spending growth would modestly overtake the target spending in 2017 and then fall below it until 2022. Table 1 provides the Office of the Actuary's 2015 IPAB related forecasts as presented in the Medicare Trustees' Report.
Table 1. Key Rates of Percentage Growth for IPAB Determination
Source: 2015 Report of the Medicare Trustees
If, for the sake of argument, the political environment shifts dramatically in the next few weeks and IPAB is implemented, the consequences are very likely not dire. Had the IPAB provisions been triggered last year, the savings target rate for the year of implementation, 2017, would have been 0.12 percent or about $735 million. In the context of the $170 billion Medicare Advantage program and the $ 67 billion Medicare Part D program, that is not a lot of money. The reason for the modest impact is that IPAB's implementation is triggered by a difference between Medicare per capita spending growth and target spending growth. The target spending growth rate is established by CPI-U and CPI-U for Medical Care over which Medicare spending has a good deal of influence. In other words, the IPAB provision in the ACA is really designed to limit Medicare spending growth that was anomalous relative to general and medical care price increases.
What Happens in 2017. This time next year, the political conditions will be very different. A new president will be elected and control of the Senate will be determined. None of those things will make IPAB any more popular than it is today, however. Thankfully, the IPAB provisions of the ACA will be eligible for what is essentially nullification via a joint resolution of both houses next year. We expect that there will be a large bipartisan crowd wanting to slay this beast. Republicans can claim a blow to a law they tried to repeal 50 times. Democrats can rid themselves of an albatross that appears every election cycle. For health care investors, an element of uncertainty will be removed.
The irony of this drama is that CMS can and is accomplishing more effectively and more prudently the goals of IPAB through another provision of the ACA which created the Center for Medicare and Medicaid Innovation. The ACA conveyed to CMMI broad powers to test payment and delivery reforms and expand them nationally without the benefit of Congressional action. With the launch of the Comprehensive Care for Joint Replacement model in April, CMS began in earnest its efforts to significantly alter how Medicare pays for services. It is to CMMI not IPAB to which investors attention should be turned in 2017 and beyond.
Takeaway: Another negative data point on Consumer Credit this morning. Retail's credit risk is much greater than the last cycle.
Retailers are more exposed to credit risk today at the tail end this economic cycle, than ever before in history. That’s a long time. And, it’s not just about slowing consumer demand as the credit quality wanes. We think there are at least 8 companies with underappreciated risk to the credit cycle because of the earnings power associated with private label credit cards (which is recognized as an offset to SG&A). The doomsday scenario happens if we see consumer spending dry up (sales weaken – down 5-10%), gross profit margins are down 3-5 points due to excess inventory, SG&A grows in the high single digits due to credit income (which is booked as an offset to SG&A) eroding. But, in the interim even a reversion from all-time lows (which a number of sources have indicated) dries up the credit tailwind stretching the leverage points on the P&L for a group of companies who are already facing demand constraints on the top line.
The most to lose: Macy’s with 38% of EBIT coming from credit card income. The most at risk: KSS – slightly lower than KSS in EBIT generated from credit card income ~30%, but without the real estate kicker. These two alone have seen EBIT growth of over an 8 year time period (’07-’15) of 12% and -14%, respectively. If we eliminate the credit benefit, the EBIT growth rate for comes down to -8% and -32%, respectively. That’s a 15-20 percentage point benefit from credit expansion alone.
This morning CarMax reported a 7.7% decline in financing income despite an increase in loan receivables year over year. The decline was driven largely by an increased provision for loan losses, which is yet another data point in a string of signals that the consumer credit cycle is inflecting negatively. We highlighted Retail credit in Friday's The Macro Show. For a Replay: CLICK HERE
Trough Credit Risk
We hit all-time lows in charge off rates in 2015, and have seen a gradual increase in charge off rates since. Recent events and commentary have indicated that this is not likely just near term turbulance, but seemingly the end of an expansionary consumer credit cycle. As Hedgeye Financials Co-Sector Head Josh Steiner likes to say, "when the credit cycle turns, it’s like a battleship – once it starts, it doesn’t stop."
Recent Events Signal Inflection
1) In November the Fed's Senior Loan Officer Survey showed that Commercial and Industrial lending inflected to net tightening. Why does this matter? Because ultimately credit easing = economic expansion and credit tightening = economic contraction. The 1Q survey showed an inflection in Commercial Real Estate lending to net tightening. Consumer lending had stayed net easing, but continues to trend towards net tightening, as it has since 2011.
2) On the 4Q15 call in February Macy's CFO warned that delinquencies were rising within its credit portfolio.
3) And, most recently, last week Synchrony removed all doubt when management revised guidance to include a higher charge-off rate than previously expected and included commentary suggesting that they are not alone, as the lending industry is over extending itself in credit card, auto finance, and student loan vehicles. And oh by the way, SYF has 22 private label credit cards in its portfolio.
Retailer Credit Exposure - Its Different This Time
The risks associated with an inflection in the credit cycle we believe are still underappreciated because of the exposure that more than a handful of retailers have to the private label credit card business. That leverage looks a lot different than it did 8 years ago at the end of the last economic cycle.
For example, in 2007 credit made up 22% of Macy's EBIT – today it’s 38%. For Kohl's we estimate credit income made up 11% of EBIT in ’07 – today it’s up to 30%. That happened at the same time that the Kohl's credit card sales a percent of total sales increased 1700bps, which also leads to topline risk. That translates to serious negative pressure on comps and margins when the retailer who has been driving comp sales through the extension of credit (and to a lesser extent promotion) no longer has that luxury.
Below we have highlighted retailers with high or unique credit exposure. There are undoubtedly others that we will uncover as we continue to get in the weeds.
A few notable callouts:
During testimony before Congress today, Fed head Janet Yellen said she saw a "loss of momentum, not a deterioration" in the jobs market. That's funny because the Fed chair's favorite economic indicator (the "Change in Labor Market Conditions Index") registered its lowest readings since June 2009 and has deteriorated now for the past five months.
We've written before that employment growth is past peak and slowing. Nothing Janet Yellen said changes that today.
For additional analysis, watch Hedgeye U.S. macro analyst Christian Drake in the video below:
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