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A Brief History Of The US #CreditCycle From Past To Present

Takeaway: Delinquencies are rising and credit conditions are tightening as the U.S. economy heads into the 9th inning of economic expansion.

A Brief History Of The US #CreditCycle From Past To Present - The Cycle cartoon 03.04.2016

 

As is typical in any #LateCycle economy, U.S. companies are resorting to all manner of corporate chickanery to mask financial deterioration. In response to a Wall Street Journal article about companies inflating their financial results by obscuring generally-accepted accounting principles (GAAP), Hedgeye Senior Macro analyst Darius Dale wrote, "The U.S. #CreditCycle continues to deteriorate and no amount of non-GAAP accounting will stop it."

 

A key callout for our Macro team has been the rollover in the credit cycle. Essentially, the natural progression of any economy in the final stages of expansion is for a protracted breakout in corporate credit spreads. (Hence our short Junk Bonds call.)

 

As proof of deteriorating fundamentals in the credit cycle, Dale offered the following charts with key takeaways for investors:

 

Click to enlarge

A Brief History Of The US #CreditCycle From Past To Present - credit darius 2

 

A Brief History Of The US #CreditCycle From Past To Present - credit darius 3 


Europe's Got 99 Problems (And Brexit's Just One)

Takeaway: Despite today's pop, European equity markets like Italy and Germany are crashing.

Europe's Got 99 Problems (And Brexit's Just One) - Growthslowing europe

 

If you think Brexit fallout and uncertainty are the only catalysts for further European equity declines, think again.

 

As Hedgeye CEO Keith McCullough writes in a note sent to subscribers earlier this morning:

 

"As we’ve outlined since the beginning of the year, #EuropeSlowing will become more obvious when Germany, France, Italy, Spain, etc. lap peak cycle GDP comps in Q2/Q3 - #Brexit was just a preview to what Europe will look like as the causal factor (#GrowthSlowing) becomes obvious; watch out below if EUR/USD $1.05 breaks."

 

Here's what that damn #EuropeSlowing data looks like this morning... a sea of red:

 

 

This is what #EuropeSlowing looks like in equity market terms...

 

Take a look at Germany's DAX... just terrible:

 

 

And Italian equities:

 

 

And here's the European equity market drawdown map with the pop today versus the crash from 2015 highs for context:

 

Europe's Got 99 Problems (And Brexit's Just One) - european equities 6 28

 

In essence, bear markets bounce but peel back the charts a little bit further to reveal the underlying reality.

 

And now for a bit of math:

 

Using the 35% drawdown in Italian equity markets as an example...

 

 

Don't do that to your portfolio. We've told our subscribers to have a 0% allocation to International Equities for some time now. Here's why:

#EuropeSlowing


Daily Market Data Dump: Tuesday

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

 

CLICK TO ENLARGE

 

Daily Market Data Dump: Tuesday - equity markets 6 28

 

Daily Market Data Dump: Tuesday - sector performance 6 28

 

Daily Market Data Dump: Tuesday - volume 6 28

 

Daily Market Data Dump: Tuesday - rates and spreads 6 28

 

Daily Market Data Dump: Tuesday - currencies 6 28


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.43%
  • SHORT SIGNALS 78.35%

CHART OF THE DAY | Japan: "Every Key Growth & Inflation Measure Is Slowing"

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye Senior Macro analyst Darius Dale. Click here to learn more.

 

"... As the Chart of the Day below details, EVERY key category of Japanese high-frequency growth and inflation data is slowing on a trending basis, with every growth metric experiencing some form of contraction and headline CPI and PPI in deflation territory as well."

 

CHART OF THE DAY | Japan: "Every Key Growth & Inflation Measure Is Slowing" - 06 28 16 Chart of the Day


Japan’s Referendum

“I was instructed by the prime minister to take various, aggressive responses to ensure stability in financial and currency markets.”

-Taro Aso, Finance Minister of Japan

 

While unilateral intervention in foreign exchange markets by Japan’s Ministry of Finance appears unlikely in the context of staunch opposition from key G7/G20 allies – the United States in particular – we can only hope that any such measures have a better, more lasting impact than Abenomics, which itself has seen its various “arrows” come under tremendous fire of late.

 

Specifically:

 

  • A Nikkei poll published 6/6 showed that 81% of respondents said the recent consumption tax hike delay will not affect their spending, with 57.6% citing the inevitability of a tax increase at some point in the future and another 20.7% citing an increase in economic uncertainty. That’s not good in the context of real consumer spending tracking at -0.4% YoY and slowing on a trending basis as of the latest reported data (April).
  • A Eurekahedge poll published 6/9 showed that only 5% of respondents expect the Nikkei 225 Index to end the year at/near 20,000, down from 85% in last year’s survey. Only 16% of respondents deemed Abenomics as a success – a figure that is down from 72% last year. Despite their disproval of the program, a whopping 90% of respondents expect the BoJ to double-down on what allegedly hasn’t worked – i.e. incremental QQE and NIRP – by year-end.
  • A Yomiuri poll published 6/20 showed Prime Minister Shinzo Abe’s approval rating slipping to 49% from 53% previously amid rising discontent with economic policy.
  • That same day, a Mainichi poll showed Abe’s approval rating declining to 42% in June from 49% in May. 61% of respondents supported changes to the Abenomics agenda.
  • A Yomiuri poll published 6/21 showed that 89 of 117 Japanese firms characterized the domestic economy as “stalling”, with the majority of firms citing sluggish consumer demand.
  • An Asahi poll published that same day showed that majority of Japanese firms (51% of respondents) believed that Abe would fail on his goal to expand Nominal GDP to ¥600T by the end of FY20 – a goal that requires a CAGR of +4.6% from FY15, which is a whopping 3.4x the CAGR in the five years ending in FY15.
  • A Kyodo poll of Japanese households published one day later showed 62.2% of respondents expressed doubts about the effectiveness of Abenomics.

 

Tough crowd.

 

Japan’s Referendum - Abenomics cartoon 02.25.2016

 

Back to the Global Macro Grind

 

In order to understand the drivers of the aforementioned shifts in popular sentiment, it’s worth reviewing the myriad of economic and financial market factors that have each contributed to the marginal demise of Abenomics.

 

Starting with markets:

 

  • The easiest place to start seeking evidence of failure is within the Japanese equity market. The benchmark Nikkei 225 Index is down -26.6% since peaking in late-June of 2015. Perhaps even more damning, the TOPIX Banks Index is down -27.5% since the BoJ introduced its NIRP back on January 29th of this year.
  • The confluence of NIRP, QQE worth ¥80T annually and forward guidance (Japan’s 2Y OIS Rate has collapsed -35bps YTD to -0.30%) have been unable to stem the rise in the Japanese yen, which is up +17.5% YTD vs. the U.S. dollar and +22.8% since the USD/JPY cross hit its Abenomics era peak of 125.63 on June 5th of last year.
  • It’s worth noting that both the Nikkei 255 Index and the USD/JPY cross are back trading at levels last seen just prior to the BoJ’s surprise expansion of QQE in late-October of 2014.
  • This dramatic appreciation has led to a collapse in long-term inflation expectations in Japan, with 5Y5Y Forward Breakeven Rates -119bps narrower YoY to 0.2%. Yes, that’s -180bps shy of the BoJ’s +2% “price stability” mandate – the same mandate that remains in a perpetual state of “we’ll accomplish our goal in two years’ time”.

 

Turning to the Japanese economy:

 

  • As the Chart of the Day below details, EVERY key category of Japanese high-frequency growth and inflation data is slowing on a trending basis, with every growth metric experiencing some form of contraction and headline CPI and PPI in deflation territory as well.
  • In the 10 quarters since Abenomics began in late-2012/early-2013, the Japanese economy has experienced a sequential contraction in Real GDP 50% of the time!
  • One of the lone bright spots of the Japanese economy during Abenomics has been CapEx growth, which bottomed at -7.2% YoY in 4Q12 and subsequently accelerated to its post-crisis peak growth rate of +11.5% in 3Q15. That has since slowed to +4.3% YoY as of 1Q16. The confluence of cycling peak base effects, the aforementioned melt-up in the JPY (the two series have been co-integrated for the past 10-12 years) and serious doubts about the efficacy of Abenomics among Japanese corporations portends a deep recession in CapEx in the near future.

 

Alas, it would seem the aforementioned repudiation of Abenomics, at the margins, is well deserved. More importantly, however, this shift in sentiment comes ahead of very critical upper house elections, which are scheduled to take place on July 10th.

 

Abe’s Liberal Democratic Party (LDP) is hoping to win 57 of the 121 seats in play (1/2 of the total are up for election every three years); pairing that with the 65 seats it already has would give the party a standalone majority in the upper house for the first time since 1989. In order to win the two-thirds majority Abe is seeking in order to ratify Japan’s postwar constitution, the LDP/NKP coalition needs to win a combined 86 seats – which is nothing shy of a tall order.

 

Some in the LDP consider that an achievable goal, but we’re not so sure. The same 6/20 Yomiuri poll referenced above showed that 35% of respondents said they would vote for the LDP in the proportional representation ballot, down from 42% in the previous poll. Given that the other parties did not notch a noticeable increase in support, we are keen to note that the growing displeasure with Abenomics is occurring in the absence of viable alternatives.

 

While perhaps unlikely, the magic number on the downside for the ruling coalition is a combined 46 seats; anything less would represent a loss of their mandate in Japan’s House of Councillors in just three short years.

 

Regardless of outcome, the results of Japan’s upper house elections will have lasting implications for global financial markets – mostly via USD appreciation or depreciation pressure.

 

Unfortunately, I’m not willing to speculate on the outcome of said elections. Be it Brexit or Donald Trump’s presumed ascendency to the GOP nomination, I think investors the world over have probably learned their collective lesson with regards to betting on political outcomes.

 

If Abe wins a strengthened mandate for his Abenomics agenda, expect a confluence of aggressive fiscal and monetary stimulus (e.g. ¥10T supplementary budget, helicopter money, etc.) that is reminiscent of his initial splash. If, however, the LDP and NKP coalition falter in their goal to win a majority of seats up for election, expect a confluence of aggressive fiscal and monetary stimulus that reeks of desperation.

 

Specifically, next month’s upper house elections are unlikely to have a material influence on the likely path of policy given the state of the Japan’s economy and its financial markets, but the market may interpret said policies as either a renewed and sustainable push towards [very investable] reflation or a continued breakdown of the central planning #BeliefSystem amid woeful demographic trends.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.44-1.62% (bearish)

SPX 1 (bearish)

Nikkei 149 (bearish)

YEN 101.15-105.19 (bullish)

EUR/USD 1.09-1.12 (bearish)

Oil (WTI) 44.91-48.62 (bullish)

Gold 1 (bullish)

 

Keep your head on a swivel,

 

DD

 

Darius Dale

Director

 

Japan’s Referendum - 06 28 16 Chart of the Day


EXPE | “It’s Largely a Cost Story”

Takeaway: Consensus appears cautious on EXPE’s EBITDA target, but mgmt can get there largely on the cost side alone, while AWAY may provide the upside

KEY POINTS

  1. EBITDA GUIDANCE BREAKDOWN: EXPE is guiding to 2016 Adjusted EBITDA growth of 35%-45%, which is predominately driven by its OWW+AWAY EBITDA target of $300M (both metrics at the midpoint).  Both acquisitions closed in 2H15, but the inorganic tailwind from each effectively extends through 2016 given 2015 purchase accounting headwinds.  We estimate EXPE needs about 27% incremental EBITDA growth from OWW+AWAY to hit its $300M target.  On the remaining legacy EXPE business, EXPE's organic EBITDA guidance calls for 15% growth.
  2. “IT’S LARGELY A COST STORY”: Consensus is calling for 2016 EBITDA growth at the low-end of EXPE’s target (37%), suggesting some doubt around EXPE’s ability to hit the mid-point of its target.  Management has two big levers it can pull aside from cutting redundant/duplicate costs.  The first is curbing OWW’s marketing spend (3x its EBITDA) since growing brand awareness for OWW’s is largely counterproductive.  The other is how EXPE chooses to categorize certain expenses since EXPE can shift some expenses out of its non-GAAP figures, in turn inflating its reported Adjusted EBITDA.
  3. AWAY USER FEE = KICKER: The takeaway from the prior two bullets is that EXPE could possibly hit its inorganic EBITDA target largely on the cost side alone, even without revenue growth.  On the other end, AWAY could provide the upside from its model transition (see note below).  For context, AWAY could drive the 27% EBITDA growth mentioned above from the new user fee alone if it can capture ~$1B of its estimated $15B in annual bookings online.  Timing issues will limit the total 2016 opportunity, but very small progress with the user fee will go a long way toward EXPE's EBITDA target.

 

EBITDA GUIDANCE BREAKDOWN

EXPE is guiding to 2016 Adjusted EBITDA growth of 35%-45%, which translates to roughly $483M in incremental EBITDA, of which OWW and AWAY are expected to contribute $300M (both metrics at the midpoint).  The OWW & AWAY acquisitions closed late in 3Q15 and 4Q15, respectively, but EXPE didn’t recognize any material OWW EBITDA contribution in 2015 because of a 4Q purchasing accounting headwind.  That said, the inorganic tailwind from each effectively extends throughout 2016.  OWW & EXPE produced $236M in combined TTM EBITDA in 2Q15, which is the most recent comparable period that we can calculate for both companies.  Using that figure as a proxy (albeit dated), EXPE needs about 27% incremental EBITDA growth from OWW+AWAY to hit its $300M target.  On the remaining legacy business, EXPE's organic EBITDA guidance calls for 15% growth. 

 

EXPE | “It’s Largely a Cost Story” - EXPE   2016 Guidance Walk up 1 

 

"IT'S LARGELY A COST STORY"

The CFO’s comments on EXPE's ability to hit its 2016 EBITDA target on its 1Q16 call.  Consensus is currently expecting 2016 EBITDA growth at the low-end of EXPE’s target (37%), suggesting some doubt around EXPE’s ability to hit the mid-point of its target.  However, management has two big levers it can pull, aside from cutting redundant/duplicate costs. 

 

The first is OWW’s marketing spend since growing brand awareness for OWW’s properties is no longer a priority, if not counterproductive since OWW’s brands are still competing with EXPE’s legacy brands.  For the TTM period ending 2Q15, OWW’s marketing spend was $326M, which was over 3x OWW’s GAAP EBITDA and 35% of its revenue.  For illustrative purposes, if EXPE cuts OWW’s entire marketing budget and OWW revenues do not decline by more than 35%, it’s incrementally positive to EBITDA (that also conservatively assumes no variable costs attached to that revenue).

 

The other lever is how EXPE chooses to categorize certain expenses since we’re all indexing off of Adjusted EBITDA.  EXPE can pretty much tag any expense it wants as restructuring and/or reorganization, which would effectively shift the cost out of its non-GAAP expenses, in turn inflating reported EBITDA. 

 

EXPE’s organic EBITDA assumption calls for 15% y/y growth, which would be a concern vs. 1Q16 results (-4% y/y), but we suspect that was due to a combination of seasonality and certain OWW employees migrated into open legacy EXPE positions.  Only 10% of EBITDA in any given year is earned in 1Q, so it’s not surprising that we saw pressure from the migrated hires.  Naturally, EXPE's leverage off those migrated hires should improves as it moves into seasonally strongest quarters, but we suspect some of those new hires may not be with the company by then.  

 

EXPE | “It’s Largely a Cost Story” - EXPE   OWW Financials

EXPE | “It’s Largely a Cost Story” - EXPE   Adjusted EBITDA calc 2

 

AWAY USER FEE = KICKER 

The main takeaway from the prior two bullets is that EXPE could conceivably hit its inorganic EBITDA target largely on the cost side alone, even without revenue growth.  On the other end, AWAY could provide the upside to EXPE's target. 

 

We recently published a note discussing the AWAY model transition (link below), which presents a considerable opportunity since it’s largely based on capturing a take on the estimated $15B in bookings that AWAY’s subs are already earning from the service today.  Since the new user fee is an agency transaction, there’s no COGS attached to it, which it should mostly fall to EBITDA.  EXPE expects the user fee to average 6% of its online transaction value.  For context, AWAY could hit its $300M OWW+AWAY EBITDA target if it captures a 1/3 of AWAY’s current bookings volume online.  

 

Granted, we won't see the full ramp in AWAY's online bookings this year since the search algorithm will not favor online bookable listings until early July.  But in a far more achievable scenario, AWAY could fill the $63M delta between EXPE's 2016 OWW+AWAY EBITDA guidance and their combined TTM EBITDA (2Q15) from the user fee alone on roughly $1B in online bookings.  In short, very small progress with the user fee this year will go a very long way toward EXPE's 2016 EBITDA target, even under fairly restrictive assumptions (see scenario analysis below).  

 

EXPE | “It’s Largely a Cost Story” - EXPE   AWAY scen analysis vs. EBITDA 

 

 

EXPE | Pay to Play (HomeAway)

06/17/16 09:28 AM EDT
[click here]

 

 

Let us know if you have questions, or would like to discuss in more detail.  

 

Hesham Shaaban, CFA
Managing Director


@HedgeyeInternet 

 

Todd Jordan
Managing Director


@HedgeyeSnakeye


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