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Time To Short The Market?

Takeaway: Keith is ready to short the S&P 500 and buy bonds. As far as Facebook goes, there's only one way to go: down. $FB $SPY

 

Hedgeye CEO Keith McCullough appeared on CNBC’s Fast Money Halftime Report today to discuss Facebook (FB) stock, which hit all time lows. Keith is bearish on the stock, noting that market momentum will continue to drag down shares. “Don’t catch a falling knife," said Keith. Wise words.

 

Also discussed was shorting the S&P 500 (SPY). We think the time is right to short stocks and buy bonds. The correlation with stocks and volatility brought the discussion back to March, when the VIX was between 14 and 15 and the time was right to short the market.. Again, with the VIX this low, a reversal in equities seems imminent. 

 


Knight: Throwing Up Shields

Takeaway: The market is largely ignoring several problems associated with the broker; we believe the stock can go as low as zero. $KCG

Knight Capital (KCG) has a long ways to go to recover from its near-death experience. We don’t think the event is priced into the stock properly and thus, we see further downside for KCG. Keith shorted KCG in the Hedgeye Virtual Portfolio yesterday at a price of $3.01 a share.

 

There are three factors affecting Knight that will push the stock down further. One risk of being short is that the company could be acquired at a premium to its current share price. Whether or not it’ll be sold off piecemeal style or just swallowed whole remains to be seen.  But for now, consider this:

 

-Knight took a $35 million loss on Facebook during the IPO. That debacle is still being sorted out with Nasdaq and other parties.

 

-Trading volumes have been insanely low.  Knight’s trading volume has declined sequentially over the last five quarters.

 

-Knight sold about 70% of the equity to a consortium of buyers in order to save itself. It got $400 million in 2% preferred stock convertible at a $1.50 strike. There is a mandatory conversion provision that says the preferred must be converted if the stock price stays above 2x the strike price for 60 consecutive days.

 

 

Knight: Throwing Up Shields - KCG levels

 

The stock is entirely capable of going to $1, then $0.50 then $0. CEO Tom Joyce better have an ace up his sleeve because the company is not putting enough effort into saving face. Even more concerning is whether the $400 million will be enough capital to hold the company over heading into the back half of 2012.


CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET

Takeaway: $XLF no longer bears any resemblance to jobless claims. This is a first. If you're a lender, you'd think borrowers having jobs would matter.

Trying to Improve Upon Boring

This week's claims print is boring so we've tried to make our weekly note on the subject a bit more interesting by looking at claims' relevance to both the market and the XLF over differing time intervals. That sounds boring too, but if you'll bear with us we think you'll find the conclusion at least somewhat interesting.

 

The first chart below shows the relationship between rolling initial jobless claims and the S&P 500 from the start of 2007. The relationship is strong with an R-squared of 0.8866 on a zero-lag basis. In other words, the level of jobless claims has explained 88 percent of the S&P 500's value each week over the last five and a half years. It's clear that claims are a good proxy for the health of the economy and that the market is a reflection of sentiment around the economy's health. As an aside, it's interesting to note that the strength of the relationship didn't improve much when we lagged claims. In other words, the common wisdom that the market is the leading indicator for the economy is not supported by the data in this particular case. While we saw very small increases in the R-squared value (an improvement from 0.8866 to 0.8974) by having the S&P 500 lead claims by 3 weeks rather than zero, we don't consider this difference significant. For reference, the market is overvalued, albeit slightly, based on the current level of jobless claims. This assumes that claims are in fact the x-variable (independent) and not the other way around. This model suggests a fair value for the S&P 500 of 1364, or roughly 3.3% below present levels.

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - CLAIMS VS SPX SCATTER

 

The next chart looks at the XLF vs. the same jobless claims series since 2007. Note the correlation breakdown vs. the relationship with the S&P 500. The R-squared value here is only 0.54, far less exciting. We suspect this owes to the substantial balance sheet restructurings that took place amid the large cap banks, Citi and Bank of America as glaring examples. This would partially explain the divergent path for the XLF relative to its historical relationship. 

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - CLAIMS VS XLF SCATTER

 

We actually find the next chart the most interesting. This is the relationship between the XLF and jobless claims over the past two years. Note the correlation: zero. In other words, the improvement in jobless claims in the past 104 weeks from roughly 488k to 355k has done nothing to move financials stocks higher. This is counterintuitive. For reference, that same move has driven a 302 point rise in the S&P 500 (+27.4%). Financials have been and should be more sensitive to changes in jobs than other sectors as their primary P&L driver is credit, which reflects frequency and severity of loss. Frequency of loss is driven by newly unemployed people, which is reflected in initial jobless claims.

 

Our suspicion is that the confluence of European counterparty fears, higher capital standards equating to lower returns, compressing top lines (NIM & Fee Income), and higher regulatory/litigation/personnel expenses are now large enough, on a combined basis, to completely negate the huge improvement in credit we've seen over the past two years. Looking ahead, the outlook for claims to improve further is small. Jobless claims rarely break below 300k on a sustained basis, a move from current levels roughly one-third the size of what we have seen over the last two years. This is another way of saying that the credit tailwind is coming to an end. This is troubling because the alternative interpretation of the below chart is that the only thing that's held the XLF flat (as opposed to breaking lower) over the past two years is the improvement in credit.  

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - CLAIMS VS XLF SCATTER 2yr

 

The Boring Details on This Week's Print 

Initial claims rose 5k to 366k last week, but only 2k after incorporating the 3k upward revision to the prior week's data. Meanwhile, rolling claims fell by 5.5k to 364k. 

 

We've been chirping lately about the slowdown in improvement in the year-over-year measure of rolling non-seasonally adjusted claims. We prefer this method as it gets around what are considerable seasonality distortions in the data. For the last several weeks this year-over-year change had been worsening, in that the rate of improvement was slowing. This most recent print marked a small reversal of that trend. The year-over-year change in rolling NSA claims was better by 7.9% this past week, which is an improvement from the 6.1% improvement YoY in the previous week's results. We wouldn't get too excited here as it's just one print and the prior trend had been in place for a few months. Nevertheless, we're keeping a close eye on it.

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - RAw

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - Rollinh

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - NSA

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - Rolling NSA

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - S P

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - Fed

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - YoY NSA

 

Yield Spreads

Spreads continue to widen for now, pushing the 2-10 spread out another 15 bps to 153 bps in the latest week. Much of this is coming from the long end of the curve, where 10yr yields have risen 17 bps to 182 bps. This recent rally in yields is driving a rotation out of REITs back into Financials. 

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - 2 10

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - 2 10 QoQ

 

Financial Subsector Performance

The table below shows the stock performance of each Financial subsector over multiple durations. 

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - Subsector Performance

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - Companies

 

Joshua Steiner, CFA

 

Robert Belsky

 

Having trouble viewing the charts in this email?  Please click the link at the bottom of the note to view in your browser.  

 

 

 


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FL: Accelerating Into 2H

 

We’re at $0.38 for FL headed into Friday’s print before the open on a +9% comp ahead of Street estimates at $0.34E and a comp of +7%.


The stock is up +18% since we published our note “FL: We Like It Here” on June 27th versus the S&P up +6% so it’s fair to say that expectations are high headed into the print, but for good reason.

  • June footwear sales in the Athletic Specialty Channel came in up +9% following +10% in May. Sales accelerated in July as expected against easing compares headed into the 2H. Given the average 400-600bps markup of weekly trends that reflect sales in aggregate (vs athletic channel), July sales appear to have come in up low-double-digits to low-teens to finish the quarter. In addition, apparel sales also picked up in July. We think this translates to comp of +9% at FL.
  • Category mix remains a key driver of outperformance and upside versus peers with strength in basketball – a trend we expect to continue following strike related disruptions last year. Take a look at the chart below, basketball has steadily improved YTD with compares getting easier through the 2H. Running also reaccelerated during the quarter. While a bigger boost for FINL (more heavily indexed to the category), these improving trends headed into the 2H are clearly favorable.
  • Europe remains an overhang. FL indicated a strong start to European sales in May with sales turning positive (up +LSD vs. –MSD in Q1), which is a stark contrast to most other retailers with exposure to Europe mitigating further weakness in a region that accounts for ~24% of sales. While we admittedly don’t have great visibility into how June is shaping up, there are two factors to consider re Europe, 1) early indications suggest trends are stable if not turning positive, and 2) compares here are also getting more favorable.
  • We’re modeling +80bps of gross margin improvement driven primarily by occupancy leverage up +90bps offset by a modest drag on merchandise margin (-10bps). We are also modeling SG&A up +3.5% reflecting 5% growth in core SG&A including $6.5mm in incremental marketing spend offset by a ~$5mm reduction in Fx.

Bottom-line is that this story in on track. The key drivers continue to be product innovation complemented by an improving apparel assortment mix, growing international store footprint (more productive that domestic base), and expanding digital platform. Given the run into earnings, we think expectation for good numbers is largely reflected in the stock here and as such don't expect a move of the same magnitude we've seen in recent quarters. But numbers are still too low for the year. We’re at $2.49 for the year above the Street at $2.38 and $2.83 for 2013 vs. $2.64E. We continue to like the earnings visibility over the intermediate-term and this name on the long side.

 

Casey Flavin

Director 


FL: Accelerating Into 2H - FL Comps

 

FL: Accelerating Into 2H - Athl Channel

 

FL: Accelerating Into 2H - Athl Cat

 


 

 


Brent Under Pressure

Takeaway: Geopolitical risk and the threat of war have people getting long oil; not fundamentals. $OIL $USO

Brent crude oil, the worldwide standard for crude, is ripping even higher today, touching $116 a barrel and not looking to stop anytime soon. Oil is up +32% since June thanks to inflation and geopolitical risk. This is great for producers of oil; bad for consumers of oil.

 

Our Energy Analyst Kevin Kaiser had a nice quote that pretty much summed up the long case for crude oil. Allow us to share:

 

Bull case for #oil is bailouts and bombs - not growth. $USO $OIL

 

 

Brent Under Pressure - sweetBRENTchart

 

 

Kaiser pretty much nails it. A lot of market participants seem to have wised up this year and noticed that supply and demand economics don’t have anything to do with oil. We’ve got plenty of oil. But the threat of Iran closing the Strait of Hormuz or unrest in the Middle East is what has everyone on the edge of their seat. With hedge funds remaining incredibly bullish on oil, fundamentals are thrown out the window. It’s a waiting game.


Brent Under Pressure

 BRENT UNDER PRESSURE

 

 

CLIENT TALKING POINTS

 

BRENT UNDER PRESSURE

Brent crude oil, the worldwide standard for crude, is ripping even higher today, touching $116 a barrel and not looking to stop anytime soon. Oil is up +32% since June thanks to inflation and geopolitical risk. This is great for producers of oil; bad for consumers of oil. Our Energy Analyst Kevin Kaiser had a nice quote that pretty much summed up the long case for crude oil. Allow us to share:

 

Bull case for #oil is bailouts and bombs - not growth. $USO $OIL

 

 

FADING AUGUST

The global macro picture at the moment is bleak and more importantly, it’s slow. What do we mean by slow? Volatility and volumes are virtually non-existent, everyone’s on vacation including the Eurocrats in the Eurozone and half of Wall Street (gotta milk that Hamptons timeshare for all it’s worth!) and no one knows what asset class they want to buy. Bonds? Stocks? Everything is essentially flat. Now that the S&P 500 is above 1400, expect it to trade in a tight range for some time.

 

Watching the market in real time is like watching an amateur ping pong game. It’s slow, uneventful and no one is keeping score.

 

 

CHINESE SLOWDOWN

Chinese growth has been slowing for the last year. People keep saying that China’s market is going to crash. Guess what – it has already crashed. Chinese equities get slaughtered on a weekly basis and the economic numbers coming out of China are painful to look at, knowing that they’re likely doctored. China’s Foreign Direct Investment (FDI) print this morning of -9% year-over-year is grim. How grim? Allow the Chinese Ministry of Commerce to lay it out for us:

 

In the second half, China’s foreign trade and export situation will be more grim, there will be more difficulties, harder tasks, and the pressure of achieving the full-year target will be bigger…”

 

_______________________________________________________

 

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

 

LAS VEGAS SANDS (LVS)

LVS finally reached and has maintained its 20% Macau gaming share, thanks to Sands Cotai Central (SCC). With SCC continuing to ramp up, we expect that level to hold and maybe, even improve. Macau sentiment has reached a yearly low but we see improvement ahead.

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

  

_______________________________________________________

 

THREE FOR THE ROAD

 

TWEET OF THE DAY

“Moral: If you're going to steal, steal big .... and know people http://dealbook.nytimes.com/2012/08/15/no-criminal-case-is-likely-in-loss-at-mf-global/” -@HuffPeter

 

 

QUOTE OF THE DAY

“Not a shred of evidence exists in favor of the idea that life is serious.” – Brendan Gill

                   

 

STAT OF THE DAY

The number of new housing permits rose by 6.8% to annualized level of 812,000 in July - highest number since August 2008.

 

 


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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