Who's next? Grexit? Spexit? Frexit?
Below is a collection of interesting links and insights from today's news with analysis filtered through our macro lens. This installment discusses St. Louis Fed head James Bullard's poor forecasting abilities, Bernanke's Brexit blog post, sorry hedge fund European equity bets and the bubble in mergers and acquisitions.
Interesting reads from the St. Louis Post-Dispatch and the Wall Street Journal on St. Louis Fed head James Bullard's forecasting abilities (or lack thereof). Here's the St. Louis Post-Dispatch, "For someone who has called himself “the North Pole of inflation hawks,” James Bullard sounds dovish these days." And here's WSJ:
"The president of the Federal Reserve Bank of St. Louis has developed an unrivaled reputation for changing his mind on the central question of whether the Fed should raise interest rates. He surprised markets again by declaring on June 17 that he now favors raising the Fed’s benchmark interest rate just once this year, by a quarter of a percentage point, then holding it steady through 2018."
Bottom Line: The biggest risk to investors is believing in the Fed's serially-overoptimistic and incorrect forecasts.
Former Fed head Ben Bernanke weighed in on Brexit today and the effects on the global economy via the Brookings blog:
"Among the hardest hit countries is Japan, whose battle against deflation could be set back by the strengthening of the yen and the decline in Japanese equity prices. In the United States, the economic recovery is unlikely to be derailed by the market turmoil, so long as conditions in financial markets don’t get significantly worse: The strengthening of the dollar and the declines in U.S. equities are relatively moderate so far."
Bottom Line: Bernanke's modus operandi has been to devalue the dollar (the US Dollar hit a 40-year low during his reign as Fed head). What makes him so sure the Fed has that power now? The central planning #BeliefSystem is breaking down.
"While some hedge funds have profited from the pain crippling global markets since Britons voted to exit the European Union, more funds may be facing potentially heavy losses," WSJ's Gregory Zuckerman writes. Apparently, a lot of hedge funds were buying European equities ahead of the vote.
Bottom Line: "2016 might go down as the worst year for hedge funds ever; so many of the 10,000 lack a repeatable macro process," Hedgeye Senior Macro analyst Darius Dale writes. That's a tough pill to swallow especially after last year's showing. In 2015, hedge funds lost more than 3%, on average, according to early estimates from hedge-fund-research firm HFR Inc., while the S&P 500 returned 1.4%, including dividends.
Here's the headline from Nikkei: "Brexit survey: Japanese firms see weaker European economy." "Nearly 88% of respondents think the U.K.'s exit from the EU will harm their operations: 34.1% expect a negative impact while 53.7% predict the effect will be mildly negative. None of the 123 chiefs expects a positive outcome for their business."
Meanwhile, a survey of 1,000 U.K. business executives conducted by the Institute of Directors, found "about a quarter of respondents are planning to freeze recruitment, with 5% saying they would cut jobs. One in five executives said they were looking to move operations outside the U.K."
Bottom Line: The Brexit fallout continues.
According to Bloomberg, "Companies paid a median of 11.07 times their target’s earnings before interest, taxes, depreciation and amortization through June 27 to make acquistions, the data show. That’s the most since at least 2007." The story also notes a drop in deal value. "About 18,000 deals with a total value of about $1.5 trillion dollars were announced so far in 2016, compared to $1.7 trillion in the same period last year."
Bottom Line: "This is one of the top M&A Bubbles in world history," Hedgeye CEO Keith McCullough writes. The pricking of the bubble will be undoubtedly painful as the #LateCycle U.S. economy rolls over.
Takeaway: We've warned on this 3,748 times ... #GrowthSlowing.
The market is now signaling a 15% chance of a rate cut this September.
(That's no typo - rate CUT ... not hike)
Take a look at this shocking about-face in the chart below. In fairly short order, the hatchet was taken to rate hike probabilities. The market now sees a 0% chance for each of the July, September and November Fed meetings. That's down from an over 50% chance of a July hike just a few weeks ago.
So the pendulum has swung to cuts.
Basically, markets are pricing in our Macro team's warnings about global #GrowthSlowing. Sure, the U.K.'s vote to leave the European Union was the catalyst but, then again, it was effectively a voter referendum on lackluster growth. Post-Brexit voter analysis shows that a preponderance of the "Leave" contingent came from lower income areas and regions that derived most of their trade from the European Union.
Essentially, the promise of growth from European bureaucrats didn't live up to reality for a majority of U.K. voters.
Look no further than the 10yr/2yr Treasury yield spread. At 84bps wide this afternoon, the 10s/2s yield spread hasn't been this compressed since the Great Recession.
It's a government manufactured mirage...
As Hedgeye CEO Keith McCullough points out, the US government effectively overstated GDP (again) today by cutting its inflation measure. Here's how that works:
To calculate real GDP, the government subtracts the "GDP deflator" (a measure of inflation) from the nominal GDP number. The GDP deflator used this go-round was 0.4%, an artificially low number by our estimation. "It should be more like 1.6%," McCullough writes. "In other words, into an Election, they understated inflation (the deflator) by 75%!"
We'll say it again, U.S. #GrowthSlowing.
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In this brief excerpt from The Macro Show this morning, Hedgeye CEO Keith McCullough rips apart the government’s latest GDP calculation. “You couldn’t make this up if you tried,” said McCullough. “And you wonder why people are getting upset with the establishment and the making up of numbers.”
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“It doesn't matter how smart you are unless you stop and think.”
― Thomas Sowell
So far, so good for Donald Trump 3.0, who has maintained a relatively low profile while his campaign continues to improve on all fronts (except his poll numbers). His newfound path forward continues to drive donations and improve its advertising capabilities, focusing on digital media outside of his well-worn Twitter account. The Republican nominee has rolled out websites and attack ads, as he continues to pitch his agenda to supporters and reshape his demeanor.
These factors signal that the Trump campaign is finally gaining some footing and it couldn’t come at a better time - with less than three weeks until the convention Trump still hasn’t nailed down key party endorsements or even solidified speakers for the convention.
Hillary Clinton and MA Senator Elizabeth Warren teamed up to trash Trump, knocking him for his self-promotional trip to Scotland and for his celebratory musings amidst Brexit global turmoil. Clinton and Warren highlighted their blue-collar upbringings, promoted the importance of strong union values, and called for the need to rebuild the middle class.
While many progressive tongues were wagging at the prospect of the two women on the ticket, we feel Warren’s appearance is more of an affirmation of Clinton’s commitment to winning over the progressive wing of the party. Further, Clinton’s increasingly robust surrogate list continues to cast a large shadow over Trump, who seems to have very few major allies by comparison.
Freedom Partners Action Fund, a super PAC financed by the network of billionaire brothers Charles and David Koch, has pledged $2.7 million in television and digital ad buys in the OH Senate race where incumbent Senator Rob Portman faces a tough battle with former Governor Ted Strickland. News of the spending spree comes just days after the group announced it will spend $1.2 million on advertising in the NV Senate race where Senate Minority Leader Harry Reid’s open seat is up for grabs.
Republicans are stepping up their fundraising efforts ahead of what will be a dogfight for the House and Senate (perhaps at the expense of the White House) - and we expect no changes to this strategy for the foreseeable future.
Takeaway: Delinquencies are rising and credit conditions are tightening as the U.S. economy heads into the 9th inning of economic expansion.
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:
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