Cartoon of the Day: What Correction?

Cartoon of the Day: What Correction? - buy the dip cartoon 02.24.2017


If you bought the stock market dip, congratulations. The S&P 500 closed at another all-time high this week.



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The Devil Is In The Details: Trump Trade Cracks Emerge

This special guest commentary was written by our friend Mike O'Rourke of JonesTrading


The Devil Is In The Details: Trump Trade Cracks Emerge - Trump drunk bull 11.30.2016


Yesterday the first legitimate signs of the execution risks related to “Trump Trades” emerged in the market.  Some risks were associated with policies that may not come to pass, and some were associated with policies investors were fearful would come to pass. Republican Senators have begun to revolt against the Border Adjustment Tax (BAT).


In turn, political analysts are modifying their models to try to find a way to find the revenue to finance corporate income tax cuts. The stark reality is that it is essentially impossible to get to the Congressional Republican’s 20% rate. There is no doubt the President’s 15% rate is a near impossibility. These rising doubts may have resulted in pushing President Trump closer to the Congressional Republicans. 


Although it was lukewarm, in an exclusive Reuters interview today, for the first time, the President expressed approval of a Border Adjustment Tax. The headline hit late in the day and sent a number of retailers and apparel related companies lower because they are the largest importers in the country (chart below).


The Devil Is In The Details: Trump Trade Cracks Emerge - bat importers


The market also responded to reports that the President’s aggressive infrastructure agenda will likely be delayed until next year.  It was exactly a week ago that JonesTrading hosted a call with Washington Lobbying firm Williams & Jensen. 


On the call, W&J noted that the legislator on Capitol Hill most closely aligned with President Trump is Democratic Senate leader Chuck Schumer. That gives an indication of how far down the priority list infrastructure is. We summarized the W&J comments from last week,


Another key area of note is the plan for infrastructure spending.  While it is an issue high on the President’s priority list, many of the Republicans in Congress view it as simply another form of spending and shirking fiscal responsibility.”


We noted earlier in the week that with the exception of steel companies, many of these names have begun to pull back. There was widespread weakness among these shares with our infrastructure basket losing 4.2% on average today (chart below).


Interestingly, while these policy problems influenced performance in their defined spaces, they did not manifest in the broad market today as another round of new highs were registered. That being said, the developing trend appears to be that as more details emerge, so do more challenges. There’s a reason they say “the devil is in the details.”


The Devil Is In The Details: Trump Trade Cracks Emerge - infrastructure intra


This is a Hedgeye Guest Contributor research note written by Michael O'Rourke, Chief Market Strategist of JonesTrading, where he advises institutional investors on market developments. He publishes "The Closing Print" on a daily basis in which his primary focus is identifying short term catalysts that drive daily trading activity while addressing how they fit into the “big picture.” This piece does not necessarily reflect the opinion of Hedgeye.


The Devil Is In The Details: Trump Trade Cracks Emerge - disclaimer

Get Happy! An Update on Earnings Season

Get Happy! An Update on Earnings Season - smiley money


The stock market bulls are clearly winning in 2017. As the U.S. economy heats up, the bottom line of S&P 500 companies is swelling once again.

Earnings Season

As you all know, we’re still finishing up the 4Q16 Earnings Season. Here's the score so far:


  1. 452 of 500 S&P 500 companies have reported results
  2. Aggregate year-over-year SALES growth = +4.6%
  3. Aggregate year-over-year EPS growth = +4.9%
  4. Information Technology (61 of 66 reported): 7.0% and 10.3% sales and earnings growth
  5. Financials (61 of 63 reported): 4.4% and 7.9% sales and earnings growth


Those are a few of the winners. The key callout on the losing side is Energy (XLE) which has had an unequivocally bad Earning Season:


  1. 31 of 35 “Energy” companies in the S&P500 have reported results
  2. Aggregate year-over-year SALES growth = +2.6%
  3. Aggregate year-over-year EPS growth = -10.1% 


Get Happy! An Update on Earnings Season - earnings season 2 24 17

Sector Performance

Earnings exuberance (outside of the Energy patch) is clearly being priced into markets. That's why Tech, Healthcare, Consumer Discretionary and Financials are leading year-to-date. Unsurprisingly, the Energy sector is the laggard after posting underwhelming earnings growth.


Here's the sector performance update:


  • S&P 500: +5.6%
  • Technology (XLK): +8.6%
  • Energy (XLE): -4.9%


Get Happy! An Update on Earnings Season - sector perf 2 24 17

Bottom Line

We remain bullish on the U.S. stock market as earnings growth mirrors the broader acceleration of the American economy. 

AT&T-Time Warner Deal: Some Turbulence But Should Land Safely

Takeaway: Deal opponents are looking for leverage but we continue to think FCC review is avoided and DOJ ultimately gives the OK.

AT&T-Time Warner Deal: Some Turbulence But Should Land Safely - time warner


We continue to believe the AT&T/Time Warner deal is on track for ultimate approval but opponents and critics of the transaction are escalating their attacks in an effort to gain leverage for conditions and other mandates that could be imposed on the combined entity.


Earlier this week, the sole Democrat on the FCC, Commissioner Mignon Clyburn, suggested the FCC could assert review power over the transaction under the Clayton Act, the primary antitrust enforcement statute governing mergers.  In addition, several Democratic senators on Capitol Hill demanded and received AT&T's public interest/consumer benefit justification for the merger.  


Deal critics wanted some kind of substitute for the typical public interest filing that would have been made had the companies submitted the deal to the FCC for approval. Thus far, AT&T has determined that it will not seek the transfer of any FCC-regulated licenses from Time Warner, obviating the need for FCC review and approval.


Regulatory bottom line:  We don't believe Clayton Act review is available to the FCC and it would not make a difference in any event to the final regulatory outcome.  Capitol Hill input can, at times, offer insight regarding regulatory momentum for or against a particular transaction, but we do not expect criticism and opposition from Democratic lawmakers will make a material difference in this case.


The key takeaway -- greater operational and cost uncertainty for edge players:   Edge content providers (DISH, NFLX, AMZN, GOOGL) are nervous that the shift to Republican control at The White House and the FCC, along with continuing GOP majorities in both houses of Congress, will mean the inevitable retreat from strict net neutrality enforcement and -- eventually -- the formal abandonment of the current rules.


The recent FCC decision to terminate the prior FCC's investigation into zero-rating (exempting certain content from monthly data allowances) underscores that the regulatory trend is to allow broadband providers greater operational flexibility to explore new revenue and business models, including monetizing relationships with upstream content providers.


This is good news for ISPs but it creates operational and cost uncertainty for unaffiliated bandwidth-intensive services on the network edge.  While it's possible that Congress will work out a bipartisan consensus to protect net neutrality concepts without reliance on Title II common carrier regulation (to ensure content is not blocked, throttled or otherwise subject to unreasonable discrimination), the legislative process is a big unknown.


Moreover, recent indications suggest Republicans are less interested in outright bans on paid prioritization, the big policy concern that drove the Obama FCC to adopt rigorous net neurality restrictions enforced under common carrier rules and doctrines.


The upcoming legislative battle over the next chapter in net neutrality could get nasty.  Stay tuned for that drama.


With uncertain prospects on Capitol Hill and a likely FCC reversal of Obama era net neutrality policies, the merger review process offers the best opportunity for edge providers to lock in some level of net neutrality protection.  Without the FCC asserting its typical "public interest" review power, the mechanism for winning regulatory concessions is sketchy at best.


It is up to the Justice Department to build a plausible case against the merger and pressure AT&T to accept some conditions to get the deal done within a reasonable time frame.


Against this backdrop, edge players must push sympathetic lawmakers and all other possible allies to raise the temperature level, hoping the FCC could be pressured to intervene (somehow) or DOJ will feel compelled to demand meaningful conduct remedies in a consent decree.


Clayton Act Authority:  Generally, Commissioner Clyburn is correct when she says the FCC has merger review authority under the Clayton Act, the primary merger review statute.  But the FCC never relies on the Clayton Act when it reviews deals because the FCC's authority is far more constrained than FCC reviews under the Commission's license transfer power. 


Under the Clayton Act, the FCC would have the burden of demonstrating to a federal court that the deal should be rejected under the same antitrust standard applicable to the DOJ's review.  Does the merger substantially lessen competition in any relevant market?


We do not expect the FCC to assert Clayton Act review power, ensuring the deal avoids FCC scrutiny.  As a substantive matter, duplicating DOJ review -- with the same statutory standards and evidentiary burdens of the DOJ -- makes little practical sense.  It also exposes the FCC to more criticism that it performs redundant functions and should have its authority curtailed, a notion advanced by members of the Trump Transition team.


And technically, it is doubtful the Clayton Act applies in this particular case.  The statute says the FCC can assert review power under the Clayton Act for acquisitions of common carriers.  Time Warner, the content company AT&T is acquiring, is not a common carrier.  We think AT&T would have a good case to seek a judicial declaration that the FCC has no power under the Clayton act for this transaction.


We suspect the prior FCC under Democratic Chairman Tom Wheeler was exploring theories for asserting review power over the T/TWX transaction given AT&T's decision to avoid license transfers that would normally trigger FCC merger review.  Perhaps a novel reading of the Clayton Act represented the favored approach.  But the current Republican Chairman's DNA is not amenable to creative readings of statutory authority to assert power over this deal in a way never before attempted by any FCC. 


DOJ Review:  In its response to Democratic senators, including the usual suspects like Senators Elizabeth Warren, Al Franken and Ed Markey, AT&T asserted that various foreclosure concerns made little economic sense for the company after the deal is done.  Withholding TWX content from other distributors, for example, would devalue the subscription/advertising revenues built into the purchase price of these content assets.  Essentially, the company repeated the various arguments that the CEOs of AT&T and Time Warner made in a Senate Commerce hearing back in December.


The Justice Department's review will move ahead, including conducting confidential interviews and gathering data from industry participants that have concerns with the deal.  AT&T has signaled a willingness to accept reasonable conditions and its written assertions that it has no interest in violating basic net neutrality protections or withholding TWX content could open the door for conditions that would be embodied in a Justice Department consent decree.  But the underlying antitrust case to block this deal is not strong and we suspect a government overreach would force litigation with doubtful upside for DOJ.


AT&T is acquiring a leading, established set of content assets in the Time Warner deal, but the expanding availability of polished, high quality scripted content (including from emerging original content players like Netflix and Amazon) may dilute the long term impact of the purchase.


The next generation of viewers spends more time engaged with social media on smartphones than sitting in front of the TV.  These market trends are relevant to the assessment of vertical foreclosure risk, suggesting both a diminshed competitive threat from this deal and uncertainty about the sustainable value of the assets being acquired.

Cartoon of the Day: No Más!

Cartoon of the Day: No Más! - bull   Toro and pinata cartoon 02.23.2017


Forgive US Equity Bears for feeling like a punching bag since Election Day. The S&P 500 is up over up 10%.


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Why the M&A Peak Is In: Sell These Two Stocks

Why the M&A Peak Is In: Sell These Two Stocks - merger acq


"Pretty ugly."


That's how Hedgeye Financials analyst Jonathan Casteleyn sums up the current global mergers and acquisitions market. “We think people are being complacent," he says. "This is a counter-trend that’s not widely watched.” It doesn't bodel well for boutique M&A-focused investment banks like Greenhill & Co. (GHL) and Lazard (LZD).


Here’s why.


Worldwide M&A by deal value amounts to $292.7 billion so far in the first quarter of 2017. That's down -9.9% year-over-year. The problem is exacerbated by North America, where M&A is down -16.9% at $142.4 billion. The picture looks pretty bleak. 


Why the M&A Peak Is In: Sell These Two Stocks - global m a


The peak may be in. A look across cycles shows just how “fully valued” M&A is right now, Casteleyn says.


In the past three cycles 1999, 2007, 2015-2016, M&A deal announcements to U.S. GDP spike above the long-term average of 9.9%. Last year, that number crested at 16.4%, which is “a very, very healthy level.” Casteleyn says. That should start to drop off as we head into 2017 and 2018.


Why the M&A Peak Is In: Sell These Two Stocks - depressed activ


A few looming risks will exacerbate the past-peak trend in M&A. Super low interest rates have fueled the market for some time now. That’s obviously beginning to change. “Since mid-2016 and the Trump election borrowing costs are going up,” Casteleyn says in the video below. “That means affordability goes down on a go-forward basis.”


Moreover, Fed rate hikes will essentially "pull the rug" out from under M&A advisory shops. Going back to 1987, previous Fed tightening cycles have caused corporate credit spreads over Treasuries to rise between 20 and 2,000 basis points. Our research shows that for every 100 basis point increase in credit costs historically, year-over-year M&A activity decreases by -20%.


Meanwhile, private equity buyers are beginning to pull back. That matters because private equity shops are typically the last incremental buyers before the air comes out of the M&A market. As you can see in the chart below, private equity purchasing spiked in 2007, to 30% of all M&A deals, and again in 2015, to 25%.


The average of private equity to total M&A deals over the last 13 years is 18%. “Private equity remains at elevated levels and that is a warning sign that as we move into 2017 and 2018,” Casteleyn says. “The incremental buyer is coming out of the market.”


Why the M&A Peak Is In: Sell These Two Stocks - private equity marks top


How do you play the coming tumble in M&A? “You want to look at the boutique, undiversified names,” Casteleyn says, M&A advisory companies like Lazard (LAZ) and Greenhill & Co. (GHL). Mergers and acquisitions make up roughly 80% of Greenhill’s top-line revenue and 55% of Lazard’s.  This compares to 10% for a more diversified bank like Goldman Sachs (GS). (Casteleyn recently added Lazard as a short to his Best Ideas list.)


Bottom line? “The big deals have been done,” in the M&A space Casteleyn says. As the air comes out of the market, stay away from Lazard and Greenhill.


Watch Casteleyn make his case in the video below.