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Lower-Highs: SP500 Levels, Refreshed

POSITIONS: Long Utilities (XLU), Short Industrials (XLI)

 

You’re not going to get the prices you sold into in early April 2012 (at least not yet), but you’re going to get the next best thing – lower long-term highs.

 

Fundamentally, it’s actually easier to make the sell call now than it was then. Back then at least #GrowthSlowing wasn’t as broad based (ask MCD, PCLN, or RL about that today). Back then, revenues/earnings on the company side were a lot better too.

 

Across our core risk management durations, here are the lines that matter to me most: 

  1. Immediate-term TRADE resistance = 1408
  2. Intermediate-term TREND support = 1381 

In other words, provided that 1381 holds – everything US Equities is fine, until it isn’t. In the meantime, I think we make lower highs as growth continues to surprise on the downside.

 

The volume signals I am registering are the most bearish I have ever measured in my career.

 

KM

 

Keith R. McCullough
Chief Executive Officer

 

Lower-Highs: SP500 Levels, Refreshed - 1


ARE US EQUITIES SUFFERING FROM COGNITIVE DISSONANCE?

CONCLUSION: We see a similar see a similar pattern in consensus storytelling and a similarly-asymmetric price setup as we did in the previous occurrences of our being bearish at cyclical tops in the US equity market and “risky assets” broadly (1Q08, 1Q10, 1Q11, 1Q12).

 

Extrapolating from anecdotes out of our institutional client base, we’d be willing to bet that the phrase: “I’m bullish because everyone is bearish,” has certainly made its way around the buyside in recent weeks.

 

Unfortunately for US equity bulls, its conceptually impossible for the majority of investors to be positioned in a contrarian manner all at once. Moreover, is it really contrarian to be bullish from here, or is that merely what many US equity investors are telling themselves to ease the broad-based feeling of cognitive dissonance shared by many domestic stock market operators?

 

Net-net-net, that is once again the key debate we feel investment teams should be having internally at yet another long-term lower-high in the US equity market, which was largely perpetuated by expectations of incremental Policies to Inflate out of the Fed/ECB.

 

WHERE WE'VE BEEN

On MAR 29, 2012 we published a timely note titled, “DEFINING ASYMMETRY: INVESTOR COMPLACENCY AT MULTI-YEAR LOWS” where the conclusion read:

 

“Measures of investor complacency are signaling to us asymmetric risk from an intermediate-term perspective. As such, we’re either at/near a cyclical top in “risky assets” or we’ve achieved “escape velocity” and are entering a new era of investing. We believe this is the key market debate to focus on.”

 

The note, which was a precursor to our 2Q Theme “Obvious Asymmetric Risks”, isolated a critical factor within our then-bearish intermediate-term view of US equities and “risky assets” broadly – broad based investor complacency. That call ultimately proved rather prescient all the way through to our JUN 1 note titled, “SHORT COVERING OPPORTUNITY: SP500 LEVELS, REFRESHED”:

 

“I think it’s safe to say that consensus now agrees with Hedgeye on Growth Slowing. Now we have to deal with cleaning up their mess. Alongside immediate-term capitulation, we’re finally seeing a Short Covering Opportunity.”

-Hedgeye CEO Keith McCullough (JUN 1, 2012)

 

To recap the score: 

  • The S&P 500 dropped -8.9% from MAR 29 to JUN 1;
  • The EuroStoxx 600 Index dropped -9.8% from MAR 29 to JUN 1;
  • The MSCI EM Equity Index dropped -13.4% from MAR 29 to JUN 1;
  • The JPMorgan EM FX Index declined -7.5% from MAR 29 to JUN 1; and
  • The CRB Commodities Index dropped -12.3% from MAR 29 to JUN 1, including a -19.6% drop in Brent crude oil and a -12.7% decline in high-grade copper. 

TODAY'S SETUP

As we turn to today, we are once again approaching critical levels in the CBOE SPX Volatility Index (~15) and our own proprietary Global Macro VIX (~18-20) that have provided clean-cut sell signals for members of our team dating back to 2007. Comparing 4Q07 to today’s setup, we spot similar patterns of broad-based cognitive dissonance among US equity investors as those ahead of the largest global recession and financial crisis since the Great Depression based upon the OCT 9th concurrent bottom in the VIX (16.12)/top in the S&P 500 (1565.15).

 

ARE US EQUITIES SUFFERING FROM COGNITIVE DISSONANCE? - 1

 

ARE US EQUITIES SUFFERING FROM COGNITIVE DISSONANCE? - 2

 

The then-consensus view at that 4Q07 top was that the US equity market was “appropriately” discounting a continuation of then-peak earnings generation was obviously incorrect and lends credence to our view that the crowd is often most wrong at critical inflection points in domestic and/or global GROWTH/INFLATION/POLICY dynamics.

 

And while we are certainly aware that consensus can remain correct longer than many individual funds can remain solvent, we remain keen to get loud ahead of what we see as pending sell-offs in US equities (1Q08, 1Q10, 1Q11, 1Q12); today we see a similar see a similar pattern in consensus storytelling: 72.5% of S&P 500 companies that have reported Q2 results have beat on the bottom line, overshadowing the 58.9% of companies that have missed top line estimates and a -548bps sequential slowdown in the YoY growth rate of aggregated SPX sales to +0.5% (per Bloomberg Professional).

 

Needless to say, we see a similarly-asymmetric price setup as we did in those previous occurrences of broad-based cognitive dissonance. Best of luck picking your spots on the short side out there.

 

Darius Dale

Senior Analyst


Idea Alert: Covering RL

Conclusion: We’re keeping a TRADE a TRADE. The company is doing everything right, but it’s not immune. Earnings power is underappreciated, but we think we have time. For now it’s rangebound.

 

Keith covered our RL short this morning on the print. We shorted it into the print as a TRADE – simply because top line expectations were high, SG&A is headed up, they just lost their CFO, the global macro climate presented a perfect opportunity for RL to guide down, and this is a consensus long.

 

After a sharp initial sell-off, the stock is hanging in there reasonably well – most notably it is holding Keith’s $144 level. Breaking (and holding) that level would put $138 in play.

 

There’s not much that really changed our thought process here. We like the name more and more the further we go out in duration, and we have the earnings in our model to prove it. But the realization of $12 in EPS will not happen in a vacuum.

 

The reality is that this is the first time in three years that RL missed to this magnitude in its own retail stores. Comps of +1% do not exactly instill the confidence we need to bank on a 2H top line acceleration. They can make it up in the (higher margin) wholesale business, but let’s face some facts… if any power brand like RL wants to find some dollars, they turn to wholesale, not retail. Retail is the best barometer of a brand’s trajectory.

 

One of the positives is that they are beginning to see the benefit from input cost relief, and that should only improve from here. Unlike brands like Carter's, Hanesbrands, and Gap we think that Ralph has the brand power to keep most of the margin upside. But we’re mindful about ‘granting’ both margin upside AND top line acceleration starting 90 days out. That’s a long time to wait with a lot of unknowns.

 

Ultimately, where the Street shakes out over the next day or two with earnings estimates will be critical.

In the interim, Keith will do what he does…manage risk around a high conviction longer-term research call by trading a range which today stands at $144-$153.

 

Based on the research we have in front of us today, we’d need to see that $138 to step up and buy right now.

 

There are two things that could change that:

 

1) Time. We think that as each day draws closer to getting past 2Q, the stock has a better shot of working as margin pressure eases relative to last year's compares.

 

2) The Research. The reality is that the volatility in the business environment has never been greater than it is today. If there’s anyone who will be left standing, it will be RL. But there’s simply limited visibility past the upcoming quarter (where RL likely sandbagged). Could comps at retail be up 10%? Yes. Down 10%? Yes. We’ve got low single digit comps in our model for the remainder of the year. If we gain confidence in them later in the quarter, then all else equal, the stock might make sense here for the intermediate-term. But we don’t see the need to rush.

 

 

We have included below our RL Idea Alert from Monday, August 6

 

Idea Alert: Covering RL - RL Levels


We shorted RL into the print for a TRADE. To be clear on this one, there’s a sharp delineation between where we like RL over each duration. In the event of a sell-off, we'd be looking for a point of entry once the dust settles to get involved with what could be $12 in earnings power. 

 

TAIL (3-Years or Less): This is one of our favorite TAIL ideas, as we think that the consensus is underestimating RL’s 3-year earnings power by  nearly a dollar. When we add up the opportunities by country, product category, and most notably – by channel (ie dot.com), we think that people are underestimating the leverage inherent to this model.  Specifically, we’re looking at nearly $10 in EPS next year, and over $11.50 the year after. A 10% premium to the market suggests a stock near $175. A 1x PEG is $200+ over 2 years.

 

TREND (3-Months or More): RL still has a full 75% of its (March) FY left to go, so the company will be guarded into the print. RL laps European category expansion (intro of Polo FW), Denim & Supply, FX, and double digit retail comps – which are tougher to bank on this year.

 

TRADE (3-Weeks or Less): The company has every reason in the world to offer up a cautious outlook – given all that’s going on in the world – especially Western Europe (it has minimal exposure to China) and the clear trend of other companies putting up weak numbers. Add in the Olympic spending, tough wholesale and store productivity comps, and our analysis that stretches to find more than 10% of CFO changes that end up being a near-term positive earnings event, and we’re more inclined to be on the negative side of this print. This is a perfect ‘buy on pullback’ stock. 


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NKE: Building An Olympian

NKE: Building An Olympian - usgym nike

 

 

The XXX Olympics have been exhilarating to watch, make no mistake about it. It is currently beating out the 2008 Beijing Olympics with ease. It’s also the premier event to put advertising dollars to work and to generate buzz around new products. At the forefront of the marketing blitz is Nike (NKE).

 

With nearly every top notch/famous athlete that’s competing using Nike, there’s room for all sorts of marketing and advertising from Nike. We believe that two specific campaigns, both from Nike, are going to make a massive impact on the public.

 

 

NKE: Building An Olympian - nike VOLTbest

 

 

The first campaign is a bit on the subliminal side. If you’ve noticed - Hedgeye Retail Sector Head Brian McGough did during the first week of the games – nearly every team are wearing bright, neon green Nike shoes. Known as the Volt line of footwear, this is the shoe uses Nike’s new FlyKnit technology and go for about $150 a pair and everybody seems to love them. It didn’t hurt that Michael Phelps chose to wear them for his interview with Bob Costas on NBC this past Sunday. With Phelps’ massive size and contrasting black pant, you couldn’t help but stare at the shoes. See below for a screenshot.

 

NKE: Building An Olympian - michael phelps and bob costas

 

Speaking of Phelps, this brings us to our second marketing campaign that Nike uses: building an organic brand around an athlete.

 

Any company can throw some clothes and a check at an athlete, hope they perform and walk away. That’s simple and doesn’t resonate as much with its consumer base. What you need is something emotional and outstanding. Per Brian McGough:

 

The best brands will take the stories that inevitably rise from performance (in this case, the Olympic Games), and craft stories around key athletes to create an emotional connection to the consumer AFTER the fact. When Liu Xiang, the Michael Phelps of China (he won the gold medal on the 100m hurdles eight years ago in Athens – an unprecedented feat for the Chinese) dropped out of the race last minute due to injury on his home turf in 2008, Nike turned the disappointment upside down, and created a marketing message that made consumers sympathize with the rigors of training at such a high level for one’s country.”

 

The result? Running revenue accelerated in China. Building brands is important for business; how you do it is everything.


You Can’t Sugarcoat It

You Can’t Sugarcoat It

 

 

CLIENT TALKING POINTS

 

REGISTER THE SENTIMENT

The bulls enjoyed their high-fiving of 1400 on the S&P 500 yesterday. That’s fine, but we’ve got two indicators that are cause for concern. Going back to the VIX, it’s about to seriously test our long-term TAIL support level of 14-15. With the VIX this low, you can expect the market to break down soon. The second indicator is the Bull/Bear Spread spiking back up to +1810bps wide to the bull side. Bears have been eviscerated from the spread, down to 25.5% vs 27.7% last week. A change is coming soon and the futures dropping well below that coveted 1400 level is key. If we drop below 1381, watch out for a bumpy ride.

 

 

THE NEXT WAVE OF REGULATION

There’s a problem going on in Britain right now – three to be exact. Standard Chartered is at risk of losing its New York banking license due to this Iranian money laundering scandal that broke this week, HSBC is dealing with a similar money laundering issue and Barclays is still wrangling with the LIBOR scandal. There’s now a rift being created between regulators and politicians in the United States and Great Britain. Expect further witch hunts down the road as we prepare to investigate one another’s banking institutions.

 

 

_______________________________________________________

 

ASSET ALLOCATION

 

 Cash:               DOWN                           U.S. Equities:    Flat

 

 Int'l Equities:   Flat                                Commodities:    Flat

                                  

 Fixed Income:  UP                                Int'l Currencies: Flat

 

 

 

_______________________________________________________

 

TOP LONG IDEAS

 

JACK IN THE BOX (JACK)

This company is transitioning from cash burn to $75mm annual free cash flow generation thanks to completion of a reimaging program and refranchising of JIB units. Qdoba is the leverage; a maturing and growing store base will bring higher margins. We see 8.5% upside over the next 6-9 months.

  • TRADE:  LONG
  • TREND:  LONG
  • TAIL:      LONG            

 

FIFTH & PACIFIC COMPANIES (FNP)

The former Liz Claiborne (LIZ) is on the path to prosperity. There’s a fantastic growth story with FNP. The Kate Spade brand is growing at an almost unprecedented clip. Save for Juicy Couture, the company has brands performing strongly throughout its entire portfolio. We’re bullish on FNP for all three durations: TRADE, TREND and TAIL.

  • TRADE:  LONG
  • TREND:  LONG
  • TAIL:      LONG  

_______________________________________________________

 

THREE FOR THE ROAD

 

TWEET OF THE DAY

“@KeithMcCullough you guys killed it short side with $mcd $coh $rl, congrats” -@lipscrl

 

 

QUOTE OF THE DAY

“A lifetime is more than sufficiently long for people to get what there is of it wrong.” – Piet Hein

 

 

STAT OF THE DAY

Market expects Chinese corn production to rise Friday to 197-200mmt vs 195mmt last month.

 

 

 


MGM: OWW AND PCLN CONTRADICTION

Priceline and Orbitz are down pre-market 16% and 9%, respectively.

 

 

We'll have more analysis on this later but PCLN and OWW are getting crushed pre-market as bookings and other leisure travel metrics are worse than expected.  Commentary from these online travel companies do not exactly corroborate MGM management's commentary that, "We've already seen an improvement in customer trends here in the third quarter."

 

MGM's stock popped yesterday on an in-line quarter and the positive forward looking commentary (post June).  That looks like some commentary that should be faded.  We remain below the Street for 2012 and 2013 MGM EBITDA - 2% and 11% lower than consensus. 


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.65%
  • SHORT SIGNALS 78.64%
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