In this excerpt from The Macro Show this morning, Hedgeye CEO Keith McCullough cautions subscribers and advises what investors should consider as U.S. equities hit an all-time high.
Takeaway: At the current default rate, 2016 is on track to surpass the 2009 all-time corporate bankruptcy high.
As U.S. equity markets hit all-time highs, subtly simmering beneath the surface, the bond market is telling an entirely different story about the state of the U.S. economy.
According to the Financial Times:
"Global defaults hit the milestone century mark last week, a 50% jump from the number of delinquencies at the same point last year and the highest level since the US emerged from recession in 2009.
The number rose by four to 100 in the first full week of July, as defaults in the US oil and gas sector ratcheted higher, according to Diane Vazza of S&P Global Ratings.
That brings the amount that has been defaulted on to $154 billion."
(**S&P Global Ratings now predicts the default rate by junk-rated companies in the U.S. will climb to 5.3% by March 2017, up from 3.8% a year earlier.)
More disconcerting still, at the current default rate, 2016 is on track to surpass the 2009 all-time corporate bankruptcy high.
"The asymmetry between Rising Stars (potential for upgrade) & Fallen Angels (downgraded to Junk) in U.S. Credit continues," Hedgeye Financials analyst Jonathan Casteleyn wrote earlier today.
More to be revealed.
**To read more of our #CreditCycle work check out:
Takeaway: This is just a short-term trade on what we believe to be a bullish setup into the 2Q16 print. Bearish thesis remains the same.
We published a note last night discussing our thoughts into NFLX’s 2Q16 earnings release (same bullets below in case you missed it). In short, we expect that strength in int’l net sub adds on the 2Q print/3Q guide to alleviate growing concerns around the longer-term NFLX story; most of which were introduced by the 2Q16 guidance release. Granted, we expect the 3Q guide for US net subs to disappoint, but we don’t see that as a major headwind given the heightened level negative sentiment around the US story today. We suspect the street would look past a miss on the 3Q US net subs guide as long as it isn’t worse than the 2Q guide; especially if NFLX produces upside to its 2Q US net adds metric as we expect, and more importantly shows progress with the int’l story. In short, the Int'l story is now the new battleground in the name since it's the barometer to NFLX's longer-term viability given perceived pressures in the US. That said, given the growing wave of negative sentiment around the story, we suspect the stock works as long as int'l works.
nflx | THOUGHTS INTO THE PRINT (2q16)
- THESIS RECAP: We doubt NFLX will be able to sustain its model and/or the breadth of its content offering, and that's it 2016 ROW launch will put that into context over 2016/2017. We see NFLX’s contractual obligations as a considerably understated proxy for the ongoing cost of running its business rather than a distinct set of milestones; especially since its content outlays profile more as recurring quarterly expenses rather than asset purchases. That said, the viability of its model is dependent on its ability to realize its user TAM. However, our analysis of the US market suggests it may only have limited near-term runway, making the int’l expansion story crucial. NFLX has essentially accelerated the test case for whether that story will work into 2016/2017 with its ROW launch, so we suspect the story may be coming to a head this year. If Int'l starts sputtering out, we suspect the hype around the longer-term story fizzles out, and the multiple gets sucked out of the stock.
- US DOES APPEAR TO BE UNDER PRESSURE: Consensus is expecting net subscriber adds to decline -41% y/y to 532K in 2Q (vs. guidance of 500K), followed by a -12% decline in 3Q. Our trackers are suggesting that the US did decline at a decelerating rate in 2Q, but not quite at the pace implied by guidance/consensus. The 3Q guide may be a different story though since consensus is expecting a considerable moderation in the y/y decline in US net adds, and our tracker suggests only marginal improvement in the y/y trend in 3Q vs. 2Q. Granted it’s still early in 3Q, but given that NFLX reports so early in the quarter, we suspect mgmt would need to take a big leap of faith in order to guide consensus domestic 3Q net adds. We’re expecting 2Q net adds to come in at roughly 650K, with the 3Q guide slightly below that (vs. consensus of 774K).
- BUT INT’L LOOKS MUCH BETTER: Consensus is expecting net adds to decline -11% y/y to 2.1M in 2Q (vs. guidance of 2.0M), followed by a 4% increase in 3Q. Remember that NFLX hasn’t annualized past all of its 2015 country launches yet, so a y/y decline in 2Q seems overdone, especially considering its 2016 ROW launch. While our trackers are pointing to decelerating 2Q growth, we’re not seeing declines outside of a few notable countries (UK, CA, AU), but that is being largely offset by elevated growth throughout Latin America. Our trackers also suggest that those two themes are largely extending early into 3Q as well, however the decline in those countries mentioned above is moderating, while Latin American growth remains elevated, if not accelerating in certain countries on a y/y basis QTD. Collectively, we’re expecting int’l net adds to approach 3M in 2Q, with the 3Q guide coming in around 3.5M (vs. consensus of 2.85M)
- 2Q16 = BULLISH SETUP? We suspect that sentiment around the US story is fairly muted at this point, so attention has shifted toward the int’l markets as the proxy for whether the longer-term NFLX story has any legs. In turn, we suspect if int’l works then than the stock could work as well. We know we’re not alone in expecting upside to 2Q int’l net sub adds, but the 3Q guide hasn’t gotten as much attention. If NFLX guides to a 3-handle for 3Q int’l net sub adds, we suspect the int’l story will find rekindled optimism following the shell shock from the 2Q guide, which would likely appear as a hiccup and/or sandbag in retrospect. Regarding the US story, it’s tougher to gauge how sentiment tracks from here since we’re expecting a miss on the 3Q net sub adds guide, which could propel the bear case around potential churn from NFLX’s planned price increases. But we suspect the street could look past a miss on US net sub adds as long as the 3Q guide isn’t worse than the 2Q guide, especially if NFLX produces upside to its 2Q net adds metric as we expect, and more importantly shows promise around the int’l story.
See the notes below for supporting detail around our thesis. Let us know if you have any questions, or would like to discuss further.
NFLX | Good vs. Bad (US User Survey)
06/09/16 10:41 AM EDT
NFLX | Breaking Down Content Costs
05/26/16 08:14 AM EDT
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Takeaway: A closer look at global macro market developments.
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Takeaway: Japanese trends are being "lifted" by rumors of Helicopter QE but Brexit is still pushing AUM out the door.
- Trends have marginally improved in Japan with rumors of a new bout of QE and a potential last ditch effort to "Helicopter" credit to consumers and spur the moribund Japanese economy. With that speculation running through the market early last week, the firm's hedged Japanese product took in over +$400 MM in new AUM in the past 5 days, as the Yen sold off -5%. The respite to the consistent uptrend in the currency and the slough off in AUM is allowing the DXJ to put in its best running month in 9 months and has boosted the stock out of a consistent downtrend for now.
- Europe is still a slippery slope with Brexit adding a layer of complexity to the already weak economic landscape with fears of an Italian banking crisis now being intermixed with the unknown of how the U.K. will divorce itself from existing agreements with the E.U. The firm's hedged European product lost over -$250 million alone on Friday, with the tally from Brexit over the past 15 trading days now at -$1.2 billion in AUM (outflows and depreciation).
- The wiggle higher in DXJ AUM has helped the stock on a short term basis but we remain bearish on the concentration risk to the firm on these 2 products which total 45% of AUM (especially with the ongoing weakness and concern in Europe which is impacting HEDJ). Other fundamental issues include the consistent underperformance of the firm's smart beta products compared to local benchmarks and also that over a broader cycle that long currency exposure tends to stabilize returns for foreign investors and the currency hedges at DXJ and HEDJ have done nothing but nullify Euro and Yen gains all year. The stock still trades well over 30x earnings and will report quarterly results next Friday with a likely $0.06 per share earnings print. With an $0.08 quarterly dividend currently, management will need to either cost cuts, restrike the dividend policy, or grow out of the current weak trends in its main products. We see fair value at $5-$7 per share or ~20x a $0.28 estimate for 2017 (under a scenario where DXJ and HEDJ stabilize but the firm doesn't grow). Our bear case scenario is that the firm breaks even at $20 billion in AUM and the stock is worth $2 per share.
The rumors of a "Helicopter" bout of QE in Japan finally took the rally out of the Yen last week with the Japanese currency depreciating -5%. This helped DXJ AUM by over +$400 MM with the product working on its best month in 9. The downtrend in DXJ AUM is still substantially lower however:
The European hedged product is now discounting another unknown with Brexit fears running through the product the past 3 weeks. The HEDJ lost over $250 MM on Friday (July 15th) alone with the total tally on the fund's AUM at -$1.2 billion since the U.K. referendum to leave the E.U.
Both funds are highly responsive to the direction of their respective foreign currencies and the Yen's rally this year has been dramatic with a stubbornly high Euro also problematic for the firm's currency hedges:
One of our main contentions with the story is that outside of near term currency weakness (the past 3 years), that there are significant periods of time where long currency exposure significantly benefits foreign investors:
In addition, the firm's "smart beta" methodology or fundamentally indexing via dividend payouts has yet to prove that it can "outperform" established market cap weighted benchmarks:
Shares remain wildly expensive and still have very high embedded growth despite AUM in decline. The firm also has a capital management issue at hand, currently paying an $0.08 per share common dividend while currently at a $0.06-0.07 per share earnings run rate. WETF stock sits as a Best Idea Short with fair value at $5-7 (and a $2 valuation in a breakeven scenario).
Please let us know of any questions,
Jonathan Casteleyn, CFA, CMT
Joshua Steiner, CFA
Patrick Staudt, CFA
Takeaway: The reality of slowing growth and a likely British recession gave way to elation over future BoE stimulus and positive U.S. and Chinese data
Extreme optimism took hold last week, especially with Bank of England officials advising that they expect to launch fresh stimulus next month, J.P. Morgan and Citigroup beating earnings expectations, U.S. retail sales coming in higher than expected, and Chinese economic growth coming in higher than expected at 6.7%. Almost all of our risk measures in the heatmap below eased week over week, most of them significantly. The heatmap is also positive on the intermediate and long term.
Financial Risk Monitor Summary
• Short-term(WoW): Positive / 8 of 13 improved / 0 out of 13 worsened / 5 of 13 unchanged
• Intermediate-term(WoW): Positive / 9 of 13 improved / 0 out of 13 worsened / 4 of 13 unchanged
• Long-term(WoW): Positive / 3 of 13 improved / 2 out of 13 worsened / 8 of 13 unchanged
1. U.S. Financial CDS – Swaps tightened for 13 out of 13 domestic financial institutions. With J.P. Morgan and Citigroup beating earnings expectations, retail sales coming in higher than expected, and Brexit fears giving way to elation over future BoE stimulus, the median domestic financials CDS tightened by -8 bps to 78.
Tightened the most WoW: AIG, MS, PRU
Widened the most WoW: ACE, CB, MTG
Tightened the most WoW: JPM, BAC, C
Widened the most MoM: AGO, ACE, SLM
2. European Financial CDS – Financials swaps mostly tightened in Europe last week as the reality of slowing growth and a likely British recession gave way to elation over future BoE stimulus.
3. Asian Financial CDS – With relief provided by a weakening Yen and Chinese economic growth coming in higher than expected at 6.7%, all financials swaps in Asia tightened last week, with the exception of Japanese Mizuho CDS, which did not trade.
4. Sovereign CDS – Sovereign swaps mostly tightened over last week. Portuguese swaps tightened the most, by -26 bps to 288.
5. Emerging Market Sovereign CDS – Emerging market swaps were propelled tightener last week by better-than-expected Chinese economic growth. The average CDS change was -13 bps.
6. High Yield (YTM) Monitor – High Yield rates fell 24 bps last week, ending the week at 6.42% versus 6.66% the prior week.
7. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 15.0 points last week, ending at 1925.
8. TED Spread Monitor – The TED spread fell 1 bps last week, ending the week at 38 bps this week versus last week’s print of 39 bps.
9. CRB Commodity Price Index – The CRB index fell -0.6%, ending the week at 189 versus 190 the prior week. As compared with the prior month, commodity prices have decreased -1.8%. We generally regard changes in commodity prices on the margin as having meaningful consumption implications.
10. Euribor-OIS Spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States. Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal. By contrast, the Euribor rate is the rate offered for unsecured interbank lending. Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread tightened by 2 bps to 5 bps.
11. Chinese Interbank Rate (Shifon Index) – The Shifon Index fell 0 basis points last week, ending the week at 2.00% versus last week’s print of 2.00%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.
12. Chinese Steel – Steel prices in China rose 3.8% last week, or 95 yuan/ton, to 2610 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity and, by extension, the health of the Chinese economy.
13. Chinese Non-Performing Loans – Chinese non-performing loans amount to 1,392 billion Yuan as of March 31, 2016, which is up +41.7% year over year. Given the growing focus on China's debt growth and the potential fallout, we've decided to begin tracking loan quality. Note: this data is only updated quarterly.
14. Chinese Credit Outstanding – Chinese credit outstanding amounts to 151.0 trillion RMB as of June 30, 2016 (data released 7/14/2016), which is up +15.3 trillion RMB or +11.3% year over year. Month-over-month, credit is up +1,514 billion RMB or +1.0%. Note: this data is only updated monthly.
15. 2-10 Spread – Last week the 2-10 spread widened to 88 bps, 13 bps wider than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.
16. CDOR-OIS Spread – The CDOR-OIS spread is the Canadian equivalent of the Euribor-OIS spread. It is the difference between the Canadian interbank lending rate and overnight indexed swaps, and it measures bank counterparty risk in Canada. The CDOR-OIS spread tightened by 1 bps to 39 bps.
Joshua Steiner, CFA
Jonathan Casteleyn, CFA, CMT
Patrick Staudt, CFA
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