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CHART OF THE DAY: What Happens To S&P 500 When VIX Is Below 13

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye U.S. Macro analyst Christian Drake. Click here to learn more.


"... 1 Factor Model:  In the Chart of the Day below we simply show VIX vs S&P500 (S&P500 is inverted on right axis). 


What you’ll simply notice is how simply effective it is to take down gross exposure and tighten net exposure when VIX goes <13.   


Global risks haven’t “greatly moderated” so building exposure into VIX 10/11/12 embeds the assumption that those risks cumulate latently with no impact on risk premiums or prices.  That seems like a pretty heroic assumption."


CHART OF THE DAY: What Happens To S&P 500 When VIX Is Below 13 - 7 22 16 CoD2

Like A Glove

“How in the world can earnings go up if nominal GDP is rising by less than wages?”

-Jeffrey Gundlach


A few years ago @Hedgeye we took the Briggs-Myers Personality test (BMTI). 


I scored as a  “Thinking Introvert” which probably explains why I'm comparatively better at generating  written analysis than delivering extemporaneous verbal content on Hedgeye TV. 


I’m okay with that.  It’s also why we have a team … and a psychologically diverse one according to the intra company dispersion in test results. 


The BMTI is cool but there’s a simpler and arguably better Street version.  #Broscience, conceived by the bro’s, for the bro’s.  


Here it is:  Watch how someone parks their car. 


Style and manner of parking offers a fairly clean insight into a person’s personality.  Think about it.


Like A Glove - like a glove


Back to the Global Macro Grind


You can get a fairly clean insight into how a person’s positioned by the nature of the questions they ask. 


We ask and receive a lot of questions daily.  


Because our business model carries no conflicts of interest, we’ve gradually become a kind of cogitation hub and a nexus for feedback, interaction and idea generation.   


That was an objective, not a byproduct of the Hedgeye operational vision.  We’ll always get things wrong, but “failing fast” and the cultivation of passionate players in perpetual pursuit of collective and personal evolution is our cultural hedge against staying wrong. 


Anyway, I chose the Gundlach quote for a few reasons.


  1. It relates directly to our 3Q16 #ProfitCycle Macro theme.
  2. We have the same suspect opinion of consensus expectations for high-teens S&P500 earning growth in 2017. 
  3. It’s great when name guys make pithy, off the cuff comments like the underlying basis for the assertion is obvious even to non-institution/non-macro investors.  
  4. It captures the collective angst and questioning that currently pervades our inbox. 


On point #4 – while the phraseology varies, most of the more recent questions and discussion distill down to “now what?”


Multiple Expansion – with forward earnings multiples making new highs - has driven most of the post-Brexit retrace in prices. 


And with Utilities PE’s at their highest ever, performance spreads between cyclical and noncyclicals at peak, small caps trading at a discount to large caps and yields near all-time lows, late-cycle, slow growth positioning has (rightly) become as crowded as it’s ever been. 


And because growth is not accelerating, the chief market purveyors of Panglossianism and serial thesis drift have coalesced around the hope for a further collapse in equity risk premiums as the justification and catalyst to drive further price appreciation.  


Recall, the equity risk premium (ERP) represents the extra return required for holding equities over “risk-free” government bonds.  Thus, most risk premium based models are relative valuation models that value stocks relative to bonds. 


So, conceptually, what’s embedded in the call for a falling ERP?


Equity risk premiums have already come in a bit so any further decline will be the result of a move toward historic lows.  A move to all-time low spreads for equity risk premiums relative to bonds that are, themselves, already in unchartered valuation water basically equates to an expectation for peak & sustained complacency.


In other words, the hope that NIRP drives ERP towards NERP in some kind of clean, linear fashion is a flimsy conceptual framework on which to anchor an investment strategy and stocks need a tangible fundamental development to help them grow into those multiples and drive prices higher.


Which brings us back to earnings expectations.


Let’s break Gundlach’s comment down into discrete parts to get a better feel for the intuition and implications:


First, why do we care about nominal GDP?


Nominal GDP, by definition = aggregate national income. 


Subtract out personal income, depreciation, business taxes and add back government transfers/subsidies and net factor income from abroad and you have corporate profits.


The easier way to think about it is this:  National income can either go to labor or capital (i.e. businesses) and while accounting measures of profits and GDP can vary from quarter to quarter the larger trend in Profits is invariably tethered to Income – and particularly so when productivity growth is weak like it is now and unable support margin improvements.   


Indeed, since the interest rate cycle turned in 1980, Nominal GDP growth has averaged 5.5% while Corporate Profit growth has averaged 6.6%.


The trend in profitability is also cyclical and that’s important. 


  1. Profits rise faster than costs in the early-to-mid part of the cycle as businesses continue to economize on labor and growth in sales/output rises faster than payroll growth.   
  2. Historically, labor’s share of national income rises at the tail end of an expansion when the labor market tightens and after growth and profits have been strong for a protracted period.

As the chart below illustrates, Corporate Profits rarely grow above 15% on an annual basis and even more rarely at this point in the cycle. 


Like A Glove - 7 22 16 CoD1


This cycle is not proving different, which takes us to the 2nd part of Gundlach’s comment about nominal GDP rising less than wages.


  1. With productivity declining and employment growing at a premium to output, unit labor costs are rising as is labor’s share of nation income.
  2. Input costs are rising faster than output prices - a point we’ve made before but one that’s worth re-highlighting.   If the price to produce something (unit labor costs) is growing faster than the price at which that something can be sold (implied by the GDP deflator) then margin pressure will remain ongoing….
  3. …. This is Gundlach’s point – if aggregate wages are rising faster than aggregate income (i.e. Nominal GDP), any earnings growth becomes a challenge, let alone an expectation of earnings growth to sustainably run 5X nominal GDP.  Sure, record repo activity and an overindexing to the goods/industrial economy could provide relative support to S&P500 earnings but that doesn’t negate the underlying fundamental reality.  
  4. Further, in a situation of slack demand and waning productivity, employment gains become bittersweet.  A rising employment-to-population ratio is paid for via corporate margin compression.


If you’re finding this discussion too tedious for a sunny, summer (Friday) morning, I’ll leave you with this:


1 Factor Model:  In the Chart of the Day below we simply show VIX vs S&P500 (S&P500 is inverted on right axis). 


What you’ll simply notice is how simply effective it is to take down gross exposure and tighten net exposure when VIX goes <13.   


Global risks haven’t “greatly moderated” so building exposure into VIX 10/11/12 embeds the assumption that those risks cumulate latently with no impact on risk premiums or prices.  That seems like a pretty heroic assumption. 


Yes, the current expansion still has some runway but the cycle will continue its interminable negative 2nd derivative march and it won’t waive curfew just because you want to stroll home late from the pro-cyclical party. 


Risk manage as best you can by understanding the prevailing, underlying macro reality within the context of consensus’s expectations for it.   


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.38-1.65%

SPX 2129-2180

VIX 11.55-16.93 
USD 95.87-97.52

Gold 1311-1365


Have a great weekend,


Christian B. Drake

U.S. Macro analyst


Like A Glove - 7 22 16 CoD2

July 22, 2016

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10-Year U.S. Treasury Yield
1.65 1.38 1.57
S&P 500
2,129 2,180 2,165
Russell 2000
1,175 1,214 1,203
NASDAQ Composite
4,938 5,098 5,073
Nikkei 225 Index
15,110 16,911 16,810
German DAX Composite
9,806 10,220 10,156
Volatility Index
11.55 16.93 12.74
U.S. Dollar Index
95.87 97.52 97.05
1.09 1.11 1.10
Japanese Yen
101.95 107.72 105.77
Light Crude Oil Spot Price
43.96 46.73 44.75
Natural Gas Spot Price
2.44 2.83 2.66
Gold Spot Price
1,311 1,365 1,331
Copper Spot Price
2.13 2.28 2.25
Apple Inc.
95.98 101.01 99.43
Amazon.com Inc.
727 759 744
Netflix Inc.
83.24 93.12 85.99
Starbucks Corp.
56.07 57.98 57.60
J.P. Morgan Chase & Co.
60.78 64.96 63.69
Kinder Morgan Inc.
18.53 22.07 20.95

Hedgeye's Daily Trading Ranges are twenty immediate-term (TRADE) buy and sell levels, along with our intermediate-term (TREND) view.  Click HERE for a video from Hedgeye CEO Keith McCullough on how to use these risk ranges.

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P | Call Option? (2Q16)

Takeaway: 2Q16 exposed limitations of P's core model. But rebased stock/expectations + potential deal flow + favorable timing = potential call option


  1. 2Q16 = LOCAL PRESSURE: The 2Q print was worse than we expected.  P missed 2Q revenues, issued 3Q guidance with the top end below consensus, and cut 2016 vs. our expectation of a 2Q beat, 3Q guide below the mid-point, FY raised inline with the 2Q beat.  The weakness was largely concentrated in Advertising Revenue across both National and Local; the latter decelerated 16 percentage-points to 26% y/y growth in 1Q16 from 42% in 4Q15.  While we did see a healthy inflection in local salesforce productivity, it wasn’t enough to compensate for mgmt curbing its major local growth driver, which is headcount.  P didn't hire any Local reps in 2Q16, which suggests that Local growth may continue to wane from here.  The positive is that growth of its national salesforce reaccelerated to 21% y/y (from 17% in 1Q16).  Btw, ignore mgmt’s q/q leverage comments; they're illogical comps given P's ad revenue seasonality (see RPM chart below).
  2. INTERACTIVE = PRIORITY: P reiterated its expected interactive launch timing multiple times during the call.  But once again, we doubt the labels are in any rush to finalize a deal unless it is decidedly in their best interest.  Mgmt offered an interesting perspective during the call, suggesting some interactive players are not monetizing at their $10 ASP given various promotions.  Between that and the industry's gripe with Spotify’s free tier, we suspect that the labels will not offer P current market terms when the benefit of granting P interactive licenses is debatable at best, if not potentially dillutive.  That said, we’re not sure P will have all the necessary deals in place to go live by 1Q17, at least on its preferred terms.  But we do believe mgmt knows it needs to get at least some of these deals done before year end to appease the street, especially given softness within its core business and growing pressure to sell the company.      
  3. P = CALL OPTION? The next time P reports will be in late October.  Between now and then, it’s essentially headline season regarding the interactive launch, especially in the absence of any real fundamental catalysts.  If P strikes a deal with any of the major labels, it will likely come with a press release, which should naturally drive the stock higher.  P really only needs to announce one deal with any of the majors to fuel sentiment since the street would likely assume that the rest of the labels will follow suit.  Between now and its next earnings release, P is effectively either a free warrant or a call option (depending on whether the stock trends up or down, respectively).  On the other hand, if there isn’t any deal-related news flow heading into the release, we could always bail ahead of the print and sidestep the risk that P pushes out the timing of its interactive launch.  P remains on our Long Bench for now, but we’re going to mull this one over during the weekend.


Let us know if you have any questions, or would like to discuss further.


Hesham Shaaban, CFA
Managing Director



P | Call Option? (2Q16) - P   Local Sales Prod 2Q16

P | Call Option? (2Q16) - P   National Sales Prod 2Q16

P | Call Option? (2Q16) - P   Ad RPM seasonality

JT TAYLOR: Capital Brief

JT TAYLOR: Capital Brief - JT   Potomac banner 2


"With me it is exceptionally true that the Presidency is no bed of roses."

-        James Knox Polk


LET’S GET READY TO RUUUUMBLE: Even for a master showman like Donald Trump, last night’s primetime acceptance speech was the biggest test of his life and his campaign, and he did what Donald needed to do. After three days of convention chaos, a very poised and polished Ivanka Trump introduced the softer side of her father and made the strongest appeal of the week to women while portraying her father as a fighter. The pleasantries stopped there as Trump launched into an hour-long dialogue doubling-down on ideals he’s pushed for over a year, and presented himself as the leader who will bring law and order to a country victimized by corruption, illegal immigrants and terrorism. The night was Trump’s and he closed the convention the way he wanted to close it, leaving no prisoners and highlighting what he’ll do to put America first again. His rockstar performance brought the Quicken crowd to their feet - and solidified his most fervent supporters viewing from their living rooms - but will it be enough to appeal to undecideds, independents and estranged Democrats?


BOOS CRUZ: Trump’s campaign tried to focus the Republican convention on party unity, but it’s apparent that Senator Ted Cruz didn’t get the memo. Most Republicans eyeing future runs for 1600 Pennsylvania Ave have already made peace with Trump, or at least ignored him altogether, and worry a failure to fall in line could backfire if the outspoken and mercurial candidate ends up placing the blame of his defeat - at their feet. But for over a year now, Cruz and like-minded conservatives have made the case that Republicans will lose again if they nominate an insufficiently conservative candidate, and they’re betting that a Trump loss would prove their point. Cruz is only 45 years old and could have a long political career ahead of him – that is, if his arrogance doesn’t come back to haunt him.


TRUMP-NATO: It’s been said that foreign policy is not Trump’s strong suit, and his previous quip that he “watches the shows” to gather geopolitical information further cements that view. So we weren’t surprised when Trump stepped into it again by stating that the US would not necessarily defend new NATO members in the Baltics in the event of Russian attack. Hmmm...that contradicts everything his newly-minted veep has said, not to mention that it rattles the very foundation of NATO itself, further digging himself into a deeper hole. His lack of foreign policy cred and unorthodox declarations will be on full display throughout the election, especially as his counterpart continually references her experience and steady hand.


SUNSHINE STATE SCHEME: Florida is looming as a potential danger for Trump and the Republican party now that President Barack Obama has stepped into the picture by endorsing Congressman Patrick Murphy in his race to unseat Senator Marco Rubio. Also joining the Murphy cause on the trail next week will be veep Joe Biden. National Democrats are investing heavily in the state by injecting themselves in a party primary, but doing so at a critical time where they see an opportunity to not only carry a state that Obama won in ‘08 and ‘12, but also build on their quest to takeover the Senate this year. Did we mention that Clinton will be in the Sunshine State this weekend making a special announcement?


CALL INVITE | BREXIT IMPLICATIONS – A 360° ANALYSIS: Please join us today at 11:00 AM EST as we begin a series of calls on post-Brexit implications. Our first call, in conjunction with the international law firm of Squire Patton Boggs, will examine Brexit’s legal and procedural implications. You can find call details here.


The Macro Show with Ben Ryan Replay | July 22, 2016

CLICK HERE to access the associated slides.



An audio-only replay of today's show is available here.

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