Earnings season... hawkish or dovish?
With the advent of the JUN Retail Sales, JUN Industrial Production and JUN CPI data, Friday was an important day for U.S. macroeconomic data and, more importantly, the predictive tracking algorithm we employ to forecast Real GDP growth on an intra-quarter basis.
The key read-through from these data points is that YoY consumption and investment growth are both tracking higher on a quarterly average basis (i.e. Q2 vs. Q1). With key metrics of inflation flat QoQ and the net export matrix largely unchanged as well, the probability that Real GDP growth decelerates in Q2 is extremely low. The more likely outcome is that growth accelerates modestly; our model is now anticipating a sequential bump up to +2.3% YoY in Q2.
On a headline (i.e. QoQ SAAR) basis this figure translates to +4.8%; no that is not a typo. Recall that our latest update had been calling for Real GDP to decelerate from Q1’s +2.1% YoY growth rate to +1.8% YoY, which translates to +2.7% on a QoQ SAAR basis. That +50bps of positive revision to the YoY growth rate equates to nearly a doubling of the headline growth rate.
For a variety of reasons detailed in our 9/2 Early Look titled, “Do You QoQ?”, we don’t lend too much credence to the headline growth rate – which itself is more “noise” than “signal” – but it’s important to track nonetheless – if only because Macro Consensus queues off of it when formulating opinions about the state of the macroeconomy. Indeed, formulating differentiated [and profitable] opinions about growth and inflation requires a differentiated modeling process, which we detail below:
To the extent that +4.8% headline growth rate is proven in the area code of accurate when Q2 GDP is reported next Friday morning, there are three key considerations for investors to consider:
1) After starting the quarter with Wall Street’s lowest estimate for Q2 GDP growth (+1% YoY; +0.3% QoQ SAAR), we are now the Street high estimate. For comparison’s sake, the Atlanta Fed and Bloomberg Consensus are currently at +2.4% and +2.5%, respectively, on a QoQ SAAR basis.
We pride ourselves on the accuracy of growth and inflation forecasts; our predictive tracking algorithm has an intra-quarter standard error of 28bps vs. 252bps for the Atlanta Fed’s tracker. As such, an intra-quarter revision of that magnitude is embarrassing to say the least and represents one of the few major mistakes we’ve made in recent years. While unachievable, perfection remains our goal and we’ll continue to evolve our models as needed in pursuit of that objective.
2) On their own, absolute growth and inflation numbers mean nothing to our investment process. Rather, our analysis has shown that analyzing such figures on a second derivative basis leads to more impactful conclusions from the perspective of predicting the performance of key factor exposures across asset classes.
We triangulate second derivative trends across Real GDP growth and Headline CPI in our four-quadrant GIP analysis (shown below) and the positive revision to our Q2 GDP estimate suggests the U.S. economy likely moved into #Quad1 last quarter; this represents a delta from our initial forecast of #Quad4 and can explain why the equity and credit markets were so resilient heading into and throughout last quarter.
3) Even if we’re too high by ~100bps on the headline GDP print next Friday, a growth rate in the mid-to-high +3% range will be interpreted very positively throughout the investment community. By reinforcing what we’ve shown to be misguided expectations of residual seasonality, it will also impact the views of policymakers as well.
Recall that the FOMC effectively shrugged off the initially weak Q1 GDP print as largely a function of poor seasonal adjustment techniques. A trend growth rate of +2.5% to +3% is likely to allow Yellen to look past trending weakness in her proprietary Labor Market Conditions Index and adjust policy guidance in the hawkish direction.
This means the time between the FOMC’s July 27th meeting and its September 21st meeting is likely to contain a meaningful degree of hawkish rhetoric out of the various Fed Heads. That may serve to catalyze incremental convergence in the factor exposures we’ve been bullish and bearish on in the YTD; last week may have been a preview to the extent all of this wasn’t immediately priced in. Conversely, toned-down expectations of fiscal stimulus might prove to be rather bearish for risk assets for a TRADE.
Looking ahead, there are three very important factors to consider as we progress throughout the back half of 2016 and into 2017:
Source: Bloomberg L.P.
All told, next Friday’s Q2 GDP report is likely to come in better than expected – perhaps by a significant degree. While backward-looking in nature, any such “beat” will likely affirm the recent optimism in the domestic equity and credit markets – optimism that we’ve admittedly been on the wrong side of.
That being said, however, we’re inclined to fade such optimism given our expressly dour outlook for domestic economic growth from here. As we detail on slides 43-45 in our Q3 Macro Themes presentation, the biggest downside surprise risk remaining in the economy is a pending pickup in the pace of labor market deterioration that should commence within the next 2-3 quarters.
Best of luck out there risk-managing this whiplash in U.S. growth expectations. As always, feel free to email or call with questions.
Takeaway: Here's our take on some of today's top financial stories.
"Anyone claiming that America's economy is in decline is peddling fiction," President Obama said in his final State of the Union address this January. Sadly, it appears, President Obama is peddling his own brand of fiction these days. On Friday, the White House published its "Mid-Session Review," with updated forecasts on the U.S. economy. Not good. The White House now expects GDP will rise 1.9% down from its 2.6% prediction in February.
OUR TAKE: "Ironically, our GDP forecast for Q2 is now higher than both White House and Consensus but lower for Q3," Hedgeye CEO Keith McCullough wrote today.
"Ministers are aiming to secure ground-breaking free trade deals with zones ten times the size of the EU before Britain leaves in 2019," the Daily Mail reports. Britain is aiming "to secure free trade deals with 12 countries before leaving the EU in 2019 as Australia and the US emerge at the front of the queue for deal worth billions to UK economy."
OUR TAKE: "This is the liberty vote in motion," Hedgeye CEO Keith McCullough writes. Britain might just benefit from Brexit. Time will tell.
OUR TAKE: Enough said...
According to a paper written by economists at the central bank watchdog the Bank for International Settlements:
"Unconventional monetary policy measures, in our view, are likely to be subject to diminishing returns. The balance between benefits and costs tends to worsen the longer they stay in place. Exit difficulties and political economy problems loom large. Short-term gain may well give way to longer-term pain.
As the central bank’s policy room for manoeuvre narrows, so does its ability to deal with the next recession, which will inevitably come. The overall pressure to rely on increasingly experimental, at best highly unpredictable, at worst dangerous, measures may at some point become too strong. Ultimately, central banks’ credibility and legitimacy could come into question."
OUR TAKE: Well said...
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Editor's Note: In this complimentary edition of About Everything, Hedgeye Demography Sector Head Neil Howe discusses why the movie industry is in decline and breaks down the broader implications for investors.
The film industry is struggling. Ticket sales have been on a downward tilt since 2002, and this year U.S. theaters are on pace to sell the fewest tickets per capita of any year since before the 1920s.
If it were just a matter of disappointing ticket sales, that would be bad enough. But other important metrics also paint a picture of an industry in decline.
For one, an ever-smaller share of movies accounts for an ever-larger portion of box office sales. Plus, films make up a shrinking share of sales for most top media companies. Walt Disney (DIS) now earns just 13% of its revenue from movies, down from roughly a quarter in 2005. Viacom (VIAB), which owns Paramount Pictures, gets 22% of its revenue from movies, down from 36% as recently as 2010. That share could decline even further if the company’s talks to offload a 49% stake in Paramount go through.
Meanwhile, sales have stagnated over the past three years for 20th Century Fox (FOXA), Columbia Pictures (SNE), and Warner Bros. Pictures (TWX). Smaller players that specialize in film like Lionsgate Films (LGF) and DreamWorks Animation (DWA) have seen their sales slide as well.
All told, forecasters and media outlets are bearish on the industry, saying that 2016 may end up being the worst year ever for movies. Yikes.
Better competition from TV. Back in 1961 when TV programming was considered a “vast wasteland” (in the famous words of FCC Chairman Newton Minow), there was a vast quality gap between television and movies. But that gap has narrowed dramatically in recent decades. Some might even say the gap has reversed.
Additionally, high-end networks now upload an entire season’s worth of shows all at once. Which means that these shows are meant to be binge-watched—and thus are even designed more like movies. In 40 continuous hours, a TV show can boast more complex plotting and deeper subtext than would be possible in any single movie.
More competition from other media. The slate of players vying for people’s attention is constantly expanding. Movies have got mobile apps, video games, and the vast universe of screened entertainment as a whole to contend with. (Video game industry sales overtook box office sales roughly a decade ago. Today, the margin is more than 2 to 1.)
Paid subscription services like Netflix and Hulu have created a whole new world where would-be theatergoers can find the same high-quality entertainment at a low price from the comfort of their bedrooms. Not to mention the countless free options—think YouTube and Snapchat (yes, Snapchat has its own scripted programming)—that provide hours of entertainment for just the price of an Internet connection.
Generational change. Call it the great age divide: Theatergoing has been falling most among younger age brackets. Indeed, over the last few years, more than the entire decline has occurred among the younger age brackets that have historically fueled box office sales. From 2012 to 2015, the total number of “frequent” moviegoers (those who attend once a month or more) decreased among 12- to 17-year-olds, 18- to 24-year-olds, and 25- to 39-year-olds. Attendance among older audiences, meanwhile, is up: Over the same period, the number of frequent moviegoers grew among 50- to 59-year olds and the 60+.
Aftermarket cannibalizing of the box office. Originally, filmmakers used video sales to grab an extra slice of revenue from consumers who weren’t willing to pay to see a movie in theaters. But now, this strategy works against the film industry. Today’s consumers expect to see a movie on store shelves (or in their Netflix queues) within weeks of it leaving theaters. With the exception of the very biggest blockbuster hits, most big-screen releases now register a resounding “meh, I’ll just wait” from consumers.
Going old. Many moviemakers are catering to graying audiences by producing high-quality, thoughtful, and often transgressive films—usually about older people. Boomers have been avid media consumers their entire lives. As they moved into middle age, they fueled a golden age of G-rated cartoons for their kids. Today, these aging film connoisseurs are buying tickets to see grittier, introspective films starring older actors whose characters’ lives are in shambles (à la Youth, featuring Michael Caine). According to GfK MRI, the number of 65+ movie-goers is up 67% since 1995. And you wonder why richly meaningful films that might have been directed by Coppola, Altman, Lumet, or Polanski are still box office draws?
Going young: reboots and sequels. While many Boomers consider remakes uncreative and formulaic, plenty of Millennials don’t mind the lack of originality. Over the past decade, series like Transformers have dominated the top box office spots. And with studios creating fewer, more expensive films (with more explosions than intellectual content), these crowd-pleasers with built-in audiences reduce some of filmmaking’s risks.
But beware: Even sequels are not a guaranteed proposition. Over the past six months, high-profile titles like X-Men: Apocalypse and Allegiant have tanked at the box office.
Going young: whiz-bang technology at the theater. Some film giants are using cutting-edge tech to draw Millennials to the movies. Paramount is reportedly in talks with IMAX to create VR movies. (Care to watch the action from any angle?) Meanwhile, Lions Gate Entertainment and 21st Century Fox have agreed to sell movies via Oculus’s online store.
However, it’s too early to tell whether VR moviemaking is a promising growth strategy or a passing fad. Remember 3-D movies? Plenty once picked that as the “next big thing.”
Going abroad. This may be the safest bet for today’s moviemakers. From 2010 to 2015, the U.S./Canadian share of global box office revenues slid from 33% to 28%. While this may not seem like much of a decline, it leaves China in line to become the largest movie market in the world by 2017.
Walt Disney Pictures is leading the way in overseas markets. The film giant accounts for four of the five highest-grossing films imported to China in 2016. This accomplishment puts Disney on track to be the first Hollywood studio to make $1 billion in one year at the (highly regulated) Chinese box office. Disney even plans to have a branded film in production in China by the end of the year.
Meanwhile, India’s movie audience is also growing at a breakneck pace. In 2015, the top 10 Hollywood releases in India collected about $98 million at the box office—a single-year jump of 34%.
To be sure, even this strategy has its ceiling. High-speed Internet is already beginning to reach these foreign moviegoers. Over time, films will have to compete with the same low-priced, high-quality alternatives that have been hurting the U.S. box office. Netflix is now available in 190 countries worldwide. As the company stocks up on foreign-language movies—and as competitors follow suit—it will mean trouble for the movie industry.
Go long on companies that can synergize many media. Once upon a time, a successful movie stood on its own. Today, it is only one avenue by which a branded character or story is delivered to audiences: Along with the movie, there is the book, the song, the videogame, the theme park, the clothing, the toy merchandise, and so on. In the movie industry, the biggest players own the most successful movie franchises. Universal has Harry Potter. Disney has Pixar, Lucasfilm, and Marvel Comics. Warner Bros. has DC Comics. And Lionsgate has The Hunger Games and Divergent series.
Major players like Universal and Disney thus have the edge over smaller players like Columbia and 20th Century Fox that don’t have successful franchises or theme parks. And in a world where standalone films aren’t selling, the biggest losers will be independent filmmakers. Inevitably, these smaller shops will have to transition to TV production and on-line branded entertainment—taking a hit on their market value as they go. And some will be gobbled up, leading to more concentration in the industry. NBCUniversal, for example, plans to acquire DreamWorks Animation by the end of the year.
Expect movie theater operators to be hit hardest. While studios are still able to profit when movies hit pay-per-view, movie theater operators miss out entirely. To stay afloat, many of the larger ones are buying up smaller competitors to enhance economies of scale.
These companies are also doubling down on amenities. Regal has invested in 4DX technology, which gives younger audiences an immersive experience complete with bumps, wind, and fog.
But at this point, there’s probably more money to be made chasing older audiences. Many theater chains are trying to woo Boomers with a deluxe high-margin, high-touch theatergoing experience. In 2014, AMC Theaters announced that it would be spending $600 million to install reclining leather seats in some of its theaters. Others are offering dine-in services for a lavish (hors d’oeuvres and vintage wine) “dinner and a movie” experience.
Takeaway: Friday, July 22nd at 11:00AM EST
Hedgeye Potomac, in conjunction with the international law firm of Squire Patton Boggs, will be hosting a series of calls on Brexit and will first examine the legal and procedural implications.
With Prime Minister Theresa May now formally installed at 10 Downing Street, we will discuss with Squire’s Brexit Task Force the events following the UK’s exit vote from the EU and what the outcome of the vote spells for the UK and the rest of the world.
The call will take place on July 22nd at 11:00AM EST with prepared remarks followed by Q&A.
KEY TOPICS ON THE CALL WILL INCLUDE
ABOUT SQUIRE PATTON BOGGS
Squire Patton Boggs is a full service global law firm that provides insight at the point where law, business and government meet. Squire Patton Boggs consists of over 1,500 lawyers in 45 offices across 21 countries.
Squire Patton Boggs’ Brexit Task Force is a multi-disciplinary team of lawyers and policy advisers who are uniquely placed to support clients from across the globe on the effects Brexit will have on business.
The Public Policy teams, particularly in Brussels and Washington, D.C., consist of top tier lawyers with considerable public policy experience - which helps them provide seamless and coordinated discussions with the relevant authorities.
Confirmation Number: 13641782
Editor's Note: Below is a complimentary research note written over the weekend by Hedgeye Potomac National Security analyst LTG Dan Christman USA Ret.
The coup attempt to oust President Erdogan has clearly failed; clashes evidently are still occurring at some naval bases, but plotters and insurgents have either been arrested, died in the attempt, or are fleeing to nearby countries (Greece) and are seeking asylum.
The White House, Secretary Kerry, Chancellor Merkel, and the EU's leadership all aligned reasonably early in the crisis to signal support for Erdogan; and the Turkish president also quickly won the support of "Turks in the street." As much as some U.S. analysts last evening were breathlessly hoping for the coup to succeed, it seemed poorly planned and lacked substantial support even within the military; it also failed to reckon with the fact that, despite the increasingly authoritarian behavior of Erdogan, his muzzling of the press and key opponents, and his creeping Islamization, he was (in the words of Fareed Zakharia) the most popular Turkish politician since Ataturk.
First and most obviously, US support for the government in terms of foreign military sales (FMS) and broader security and economic assistance will continue; Turkish bases are simply too important for the US in its fight against ISIS to be put at risk.
Second, however, the coup will play into Erdogan's increasing paranoia will do nothing to arrest the Putin-like moves of the Turkish president to assert even greater executive authority, at the fringes of constitutionality. Initial statements from the president and his AK party highlight this; they blame the entire episode last night on the "Pocono imam," Fethullah Gulen, a former ally of Erdogan who is now a vocal critic and living in Pennsylvania.
Finally, and related, expect a harsh crackdown, not just on the military, but on domestic critics as well, as order is restored.
All of this complicates the anti-ISIS coalition and the war against Islamic extremism; it may however, give the US and the EU an opportunity to encourage Erdogan to bridge his differences with the Kurds. Their separatist party, the PKK, was, ironically, amongst the first of the opposition parties to voice their support for the embattled president last night. Hard to figure.
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