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Investors Have Begun to Smell a Rat In the Bond Market

This guest commentary was written by "Fed Up" author Danielle DiMartino Booth. Make sure to watch her recent conversation with Hedgeye CEO Keith McCullough.

 

Of all virtues to which we must ultimately aspire, forgiveness demands the most of our souls. In our naivety, we may fancy ourselves man or woman enough to absolve those who have wronged us. But far too often, we find our pool of grace has run dry. So deeply burdened are we by our emotions that grace to us is lost.

 

How many of us have the strength of resolve to let bygones be gone for good? Those of the cloth recognize the damage self-inflicted scars sear into our souls as they seek to guide us through life’s most difficult journeys. They pray for our deliverance from a painful inner turmoil and with it the peace only forgiveness can convey.

 

None who have ever heard Don Henley’s "The Heart of the Matter" could be blamed for thinking divine inspiration itself came down from the heavens to spawn those longing lyrics. But it isn’t just the words that scorch their way into your memory, it’s Henley’s tone, the raw pain that pierces every time you’re caught off guard by the mournful ballad released in 1989.

 

 

Henley sings of our feeble struggle as no other, grasping for our collective release in humility. “The more I know, the less I understand. All the things I thought I’d figured out, I have to learn again.” In the end, Henley hands down the cruelest of convictions: If you truly want to vanquish your demons, you must find the strength within to forgive.

 

Astute policymakers might be saying a few prayers of their own on fixed income investors’ behalves. The explosion in corporate bond issuance since credit markets unfroze in the aftermath of the financial crisis is nothing short of epic. Some issuers have been emboldened by the cheap cost of credit associated with their sturdy credit ratings.

 

Those with less than stellar credit have been prodded by equally emboldened investors gasping for yield as they would an oasis in a desert. Forgiveness, it would seem, will be required of bond holders, possibly sooner than most of us imagine.

 

Investors Have Begun to Smell a Rat In the Bond Market - dimartino banks

 

For whatever reason, we remain in a world acutely focused on credit ratings. It’s as if the mortgage market never ballooned to massive proportions and imploded under its own weight. In eerie echoes of the subprime mania, investors indulge on the comfort food of pristine credit ratings despite what’s staring them in the face – a credit market that’s become so obese as to threaten its own cardiac moment.

 

It may take you by surprise, but the U.S. corporate bond market has more than doubled in the space of eight years. Consider that at year end 2008, high yield and investment grade bonds plus leveraged loans equaled $3.5 trillion. Today we’re staring down the barrel of an $8.1 trillion market.

The age-old question is, and remains:  Does size matter?

 

Ask yourself, did size matter as it pertained to the mortgage market way back in 2006, when it peaked in size at $13 trillion? (That was rhetorical in the event you weren’t on Planet Earth at the advent of all modern times’ meltdowns.) Still, it’s the why behind the growth of any given market that matters most. In the case of both markets, the credit rating agencies have helped investors sleep at night, a fact that might now keep you up at night.

 

First, a disclaimer. Of course, speculative grade debt is riskier than its investment grade brethren. The vast majority of investors in the go-go junk market know this and are hopefully buckled up as such, especially if a true rate-hiking cycle is about to test their mettle – more on this later.

 

Still, it’s the blind abandon with which issuance has risen among investment grade (IG) issuers that should, but has yet to, give supposedly conservative investors pause. Consider that in 2011, a (then) record $741 billion was sold into the IG market. As an endless encore, in every single year that followed, issuance has shattered the prior 12-month record. 

 

Last year alone witnessed $1.28 trillion in issuance. As for all the rate hike anxiety permeating the airwaves, 2017 also appears to be in it to win it — $254 billion was sold in the first two months of the year, $20 billion more than the same period in 2016. Investors might soon have to call upon Archimedes’ concept of exponentiation to sufficiently capture how very large the numbers have become.

 

You might wonder how the health of the corporate bond market is faring as it bulks up. As Bloomberg reported last week, you’d have to time travel back to 2002 to get back to the last time IG issuers were carrying more debt vis-à-vis their profits. The sticking point is leverage ratios tend to peak as an economy is just emerging from recession, as companies’ revenue streams hit their nadir.

 

Today, though, as we’ve been told in tsk-tsk fashion, the economy is at the precipice of an accelerating trend. That’s a good thing as companies have sold a heck of a lot more debt than their profit growth justifies, leaving their rainy-day cash to cover their massive, mounting obligations at the lowest levels since 2009.

Debt: The Good, the Bad and the Ugly

The good news is that on the surface, the chances of a hiccup appear to have diminished. According to credit rating agency Standard & Poor’s (S&P), 2016 ended on a relatively better low note: Some 68 global IG issuers were at risk of being downgraded speculative grade, five fewer than the last time the data were compiled at the end of the third quarter.

 

S&P refers to these envelope-pushing issuers as ‘potential fallen angels,’ with ratings at the cusp of crossing over into junk-land. Though you might be thinking one notch on a ratings scale is just that – one measly notch – crossing that line in the sand makes a huge difference for borrowing costs. The yield ‘spread’ above Treasuries paid by junk issuers is typically about double that of what IG issuers pay.

 

The not so good news is that the universe of potential fallen angels remains at historically high levels. The latest read of 68 potential fallen angels is identical to what it was last summer and appreciably higher than as recently as 2015’s first quarter when 42 issuers were at risk of downgrade to spec grade. Moreover, the divide that began to open between potential rising stars – those with the potential to be upgraded into the IG sphere – and potential fallen angels remains at the current cycle’s wides.

 

Perhaps most worrisome is the sector at the greatest risk of downgrades — that is, financials. Years ago, a high yield strategist remarked that declining commodities prices would take their toll in two waves – first, the actual commodities producers, and second, the financials who banked them as the initial commodities cycle became super-sized in magnitude. Bank balance sheets are highly susceptible to a nasty contagion effect.

 

And yet, here we sit watching those oil prices Janet Yellen lectured us would be at ‘transitory’ lows (several years ago) decline anew. God help us if crude’s latest swoon presages a broader downturn. Precisely because leverage is rising among IG borrowers, economic growth literally has to hang in there.

 

If growth even slows, or worse, contracts, all this ballyhooed record issuance among IG issuers will devolve into unprecedented levels of potential-to-actual fallen angels. It will be as if the heavens have opened up as their wings burn and they tumble back to earth.

 

Of course, downgrades don’t necessarily denote defaults. The Start of the Matter may nevertheless require forgiveness in some form as refinancing needs are also now at record levels and must be met. If the Federal Reserve does not intervene, markets are likely to revert back to pure price discovery mechanisms; they will be brutally agnostic to the rate environment to say nothing of the economic backdrop.

Investors have begun to smell a rat

IG exchange-traded funds (ETFs) have slid more in price compared to their high yield ETF peers since the surprise U.S. election that set rates rising. But unlike junk’s magnificent rebound since then, IG has yet to stage a return rebound.

 

It all comes down to refinancing risk. According to S&P’s competition down the block, Moody’s, the refinancing needs of both IG and spec grade issuers will hit record levels over the next five years.

 

Spec grade issuers’ five-years-out refinancing needs have officially crossed the trillion-dollar threshold. Some $1.06 trillion will come due between now and 2021, up from $947 billion in last year’s refinancing risk study and double what they were ten years ago. In the event you’re concerned spec risk has been overly downplayed in this missive, rest assured, the same dynamics that propel record fallen angel levels will be the mother of all default-rate cycle accelerants. File that one away in the ‘actual forgiveness’ to come file.

 

As for the IG space, $944 billion comes due in the five years through 2021. But here’s the kicker – the need to roll over debt is going to come on much more quickly for IG. Maturities are roughly evenly distributed over the next five years as opposed to the needs in spec grade, whose rollover risk gains speed and crescendos in 2021 with a record $402 billion in refinancing coming due.

 

Is that why junk is trading more richly than IG? The yield at which spec trades vs. its Treasury equivalent has only been wider 13 percent of the time over the past 17 years (2007 should provide you comfort because…?). IG on the other hand has traded this ‘tightly’ in only 25 percent of the times records have been kept.

 

Would the start of the matter – the prospects for debt forgiveness and debilitating defaults – be threatening so were it not for central bankers’ meddling ways in markets designed to determine their own damn prices? The ashes will indeed scatter. They will let us know.

EDITOR'S NOTE

This is a Hedgeye Guest Contributor piece written by Danielle DiMartino Booth. DiMartino Booth spent nine years as a Senior Financial Analyst with the Federal Reserve of Dallas under Dallas Federal Reserve President Richard W. Fisher. Her brand new book “Fed Up” explains why the current Federal Reserve system is due for a serious revamp. DiMartino Booth currently runs Money Strong, an economic research consultancy. This piece does not necessarily reflect the opinion of Hedgeye.


Are You Bullish Enough? Inflation & Retail Sales Near 5-Year Highs

Are You Bullish Enough? Inflation & Retail Sales Near 5-Year Highs - bull or bear

 

Are you bullish enough on U.S. growth? That's a healthy question all investors should be asking themselves, especially in light of some seriously hot U.S. economic data this morning. The February Consumer Price Index (CPI) reading is just shy of a five-year high as reported this morning.

 

And despite Bloomberg suggesting Retail Sales "posted the smallest gain in six months" (on a month-over-month basis), year-over-year retail sales data hit the highest level since March 2012

 

(Click here to read a wrap of recently reported U.S. economic data.)

 

Hedgeye vs. Wall Street: U.S. Growth

#Economy #GDP 

 

So what's our current U.S. economic outlook? As you can see in the Chart of the Day below from today's Early Look, we're significantly more bullish than Wall Street consensus. Here are the numbers...

 

  • Hedgeye U.S. Real GDP estimates (year-over-year): Q1 = +2.28%; Q2 = +2.59%; Q3 = +2.89%; Q4 = +3.09%.
  • Wall Street Consensus Real GDP estimates (year-over-year): Q1 = +2.20%; Q2 = +2.45%; Q3 = +2.20%; Q4 = +2.30%.

 

Does your portfolio reflect the bullishness to come?

 

Are You Bullish Enough? Inflation & Retail Sales Near 5-Year Highs - Chart of the Day 3 15 17


OPEC Still Optimistic Production Cuts Will Bring Market Into Balance & Stabilize Prices

Meanwhile, EIA Forecasts US Shale Production Will Rise 1 Million B/D in 2017

 

OPEC Still Optimistic Production Cuts Will Bring Market Into Balance & Stabilize Prices - opec 22

 

VIENNA, AUSTRIA -- While the US East Coast is battling a Nor’Easter storm with blizzard conditions today, oil prices are bracing for another storm on Wednesday in the form of EIA’s weekly crude inventory data.

 

Last week US crude stocks rose for the 9th straight week by 8.2 million barrels a day (b/d) to 528 million barrels. Another EIA announcement of an increase in crude stocks on Wednesday would almost certainly send oil prices further downward.

 

On Monday, EIA released its monthly drilling activity report that forecasts April 2017 US shale production will increase by 109,000 b/d to 4.96 million b/d. The Permian Basin alone is forecast to increase by 79,000 b/d to 2.29 million b/d, according to EIA. If this trend continues, US shale production would add another one million b/d in 2017.

Is OPEC Worried?

If you thought all of this bearish data for oil prices was worrying OPEC, you would be wrong. Instead OPEC remains positive and calm about its production cut agreement working as intended to bring the market into balance and stabilize prices.


OPEC maintains that it is in the optimistic camp when it comes to oil prices and market rebalancing. Saudi Arabia also shares confidence that the production cut agreement is working and cautions against pessimism less than three months into the deal. However, the Saudis also acknowledged that better compliance is needed especially from Iraq and Russia.

 

OPEC seems to have its talking points down with all key players saying that there has been no decision yet about extending the agreement in June for another six months. OPEC’s compliance monitoring committee meets next week in Kuwait and will begin to discuss the extension.

 

However, don’t expect any final decision until OPEC’s regular meeting on May 25 in Vienna. Meanwhile OPEC is considering some additional conditions regarding an any possible extension.

 

First, it was conveyed that non-OPEC participants in production cut deal will be invited to participate in the the May 25 OPEC meeting in some way. There could also be changes to exempted countries in any extension.

 

The Saudis raised the specter that Iran may need to participate if the cuts are to be extended. In addition, because of the Nigeria's successful increase in production, there is the potential that its exemption under the production cut agreement may be lifted if cuts are extended for another six months.

Bottom Line

OPEC cautions about the market being misled about rising US crude stocks and rig counts. For OPEC, OECD inventory data is the metric it will use to gauge success of the production cut deal, and OPEC expects stocks to decrease into the five-year average range. However this seems impossible without an extension of the production cut deal.

 

In addition, both EIA and IEA forecasts show OECD inventories will be well above the five-year average range even with full OPEC compliance.

EDITOR'S NOTE

This is an excerpt from an institutional research note written by Hedgeye Senior Energy Policy analyst Joseph McMonigle. For access to the entire institutional research note ping sales@hedgeye.com.


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IBM: Headcount Grower (or Headcount Lower?)

Takeaway: A weekly review of the biggest topics on our minds heading into the new week.

“At IBM alone, we have thousands of open positions at any given moment, and we intend to hire about 25,000 professionals in the next four years in the United States, 6,000 of those in 2017,” IBM CEO penned this line in an editorial published in the USA Today (12/13/16).

 

Does anyone really believe that? Let’s look at the numbers.

 

IBM: Headcount Grower (or Headcount Lower?) - ibm post1

Net of major divestitures the company’s headcount is down in the last few years.

IBM: Headcount Grower (or Headcount Lower?) - ibm post2

Including a real reduction in US headcount, as implied by the 401K chart above.

IBM: Headcount Grower (or Headcount Lower?) - ibm post3

IBM has taken annual workforce rebalancing charge in each of the last six years.

IBM: Headcount Grower (or Headcount Lower?) - ibm post4

The direction of revenue is likely the single best directional indicator of total headcount (rather than empty promises). 

IBM: Headcount Grower (or Headcount Lower?) - ibm post5

 

Who believes this stuff?

EDITOR'S NOTE

This is an institutional research note written by Hedgeye Technology analyst Ami Joseph. For access to our institutional research ping sales@hedgeye.com.



3 Charts: The Calculated Politics Behind Trump's "Fake News" Fury

3 Charts: The Calculated Politics Behind Trump's "Fake News" Fury - trump fake news tweet2

 

President Donald Trump is a product of our tumultuous times. He's tapped into a gnawing feeling of economic and political insecurity. Shouting "fake news" in a press conference or clubbing politicians on Twitter resonates for a reason. Congressional job approval and mainstream media trust (or lack thereof) are in the proverbial basement, hovering near all-time lows.

 

From politicians to the mainstream media, confidence is withering. 


As Hedgeye CEO Keith McCullough explains in the video below from The Macro Show earlier this year:

 

“If you really look at his strategy. He’s anti-mainstream media and anti-Congress. Do you know what the approval rating is for these two things are? Very, very low. Trump wakes up every day and he effectively enrages these two constituencies. But he’s got a lot of people that don’t like these things more than they don’t like him.”

 


Consider this...

1. Congressional Job Approval

Only 23% of Americans approve... 64% disapprove.

 

3 Charts: The Calculated Politics Behind Trump's "Fake News" Fury - congressional job approval

2. Mainstream Media Trust

Only 21% of Americans have “a great deal” or “quite a lot” of confidence in TV news … versus 36% ten years ago.

 

Take a look at the Gallup polling data below. People were asked "how much confidence" do you have in each of the following institutions. Respondents answering "a great deal" or "quite a lot" has been slipping across the board for two decades.

 

3 Charts: The Calculated Politics Behind Trump's "Fake News" Fury - trust in institutions

 

3 Charts: The Calculated Politics Behind Trump's "Fake News" Fury - trump post image

3. America ‘Right Direction or Wrong Track?’

Boding well for Trump, 42% of Americans say the country is on the right track today … that’s almost double the 24% at December 2015 lows.

 

3 Charts: The Calculated Politics Behind Trump's "Fake News" Fury - rasmussen chart


In light of these numbers, don’t expect the Trump administration to stop bash Congress and the media any time soon.


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