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Earnings Deluge

This note was originally published at 8am on October 23, 2012 for Hedgeye subscribers.

“This tends to leave us less prepared when the deluge hits.”

-Nate Silver

 

If you think about all of the corrections (2-8%), draw-downs (9-19%), and crashes (20-30%) stocks and commodities have had in the last 5 years, how many of your favorite economists nailed calling all of them?

 

Almost anyone who is overpaid on the sell-side can tell you a story about why something is going up – but why do they have such are hard time articulating real-time risk on the way down?

 

Forecasting growth (slowing in Q1/Q2 of 2012) and earnings (slowing Q3/Q4) in 2012 wasn’t easy. But it’s even more difficult to comprehend how people who missed calling both are now telling you this is the “trough” and stocks are “cheap.”

 

Back to the Global Macro Grind

 

“Forecasting something as large and complex as the American economy is a very challenging task. The gap between how well these forecasts actually do and how well they are perceived to do is substantial. Some economic forecasters wouldn’t want you to know that.” (The Signal And The Noise, page 177)

 

How $50-100 Billion in market cap companies like Caterpillar (CAT) and Intel (INTC) miss these very obvious turns in both the global growth and the corporate earnings cycle at this point shocks me.

 

Does anyone get paid to have learned anything from the cycle turning in late 2007? The Fed can’t smooth the corporate EPS cycle.

 

In our top Global Macro Theme for Q4 (#EarningsSlowing – ask sales@Hedgeye.com for the slide deck if you haven’t reviewed it), we contextualize the following:

  1. What coming off the last 5 peaks in corporate margins in the last 100 years looks like (stocks look “cheap” at the peaks)
  2. Why the risk to expectations is more in Q4 and 2013 than what’s staring CFO’s in the face in Q312
  3. Why stocks aren’t cheap if you’re using the right growth, margin, and earnings assumptions

That’s just the long-cycle data. It’s not “tail risk.” Corporate margins peaking as sales growth slows is a very high probability situation that you are seeing come across the tape with each and every Q312 earnings report. This should not be surprising you.

 

What surprises me is how disconnected the reality of this moment in the cycle has been relative to where the stock market has levitated. If you want to talk legitimate TAIL risk, that spread risk is it.

 

I often get asked what would change my view. My answer is usually a question – on what, the economy or the stock market? These have been two very different things in 2012 and all of a sudden they are colliding.

 

“Apres moi, le deluge”

 

That’s what King Louis the XV said to his mistress, meaning, en francais – ‘after me, the flood.’ And oh did he nail that one! And that’s the point of hitting the end of a long-standing narrative – everything bullish about stocks, oil, and gold at 14 VIX tends to end, fast.

 

Are the perma-bulls still serious about what they were saying in March (right as #GrowthSlowing took hold)?

  1. US GDP Growth +3-4% (US GDP = down 69% from Q411’s 4.10% to 1.26% reported most recently)
  2. Earnings are “great” (they were at the Q1 2012 top; but Q312 has been the worst in 3 years)
  3. Stocks are “cheap” (sure, if you use the wrong numbers)

Given the data, I doubt it. That would be a joke. And clients aren’t laughing. From Denver to Kansas City, Boston, Maine, and San Francisco (this morning), I have been on the road speaking with clients for the last month. They are getting very concerned about Q4 of 2012 through Q2 of 2013 – and they should be. They’ve seen this movie before.

 

The real reason stocks and commodities were straight up since June was the Fed. Since the Bernanke Top (September 14, 2012), the SP500 has had a 3% correction. What would make it a 9-19% draw-down from that “buy everything high”? Re-read the last 600 words, then factor in an Obama win, and then add a US Debt Ceiling being bonked in January, right before we hit the #FiscalCliff.

 

And remember, after stocks were up “double-digits YTD” in October of 2007, le “deluge” had a heck of a time finding its trough.

 

My immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1699-1741, $108.22-110.84, $79.06-80.16, $1.29-1.31, 1.71-1.82%, and 1419-1442, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Earnings Deluge - Chart of the Day

 

Earnings Deluge - Virtual Portfolio


The President's Chance Of Reelection

With the election taking place tomorrow, we're proud to deliver the final results of the Hedgeye Election Indicator for the week ending November 5. President Obama's chances of being reelected ticked up 10 basis points week-over-week to put his chances at 62.5%. Much better than a coin flip and some of the recent polls out there that put Romney ahead, but certainly not a landslide.

 

Hedgeye developed the HEI to understand the relationship between key market and economic data and the US Presidential Election. After rigorous back testing, Hedgeye has determined that there are a short list of real time market-based indicators, that move ahead of President Obama’s position in conventional polls or other measures of sentiment.

 

Based on our analysis, market prices will adjust in real-time ahead of economic conditions, which will ultimately shape voters’ perception of the Obama Presidency, the Republican candidates and influence the probability of an Obama reelection.  The model assumes that the Presidential election would be held today against any Republican candidate. Our model is indifferent toward who the Republican candidate is as the sentiment for Obama and for any Republican opponent is imputed in the market prices that determine the HEI. The HEI is based on a scale of 0 – 200, with 100 equating to a 50% probability that President Obama would win or lose if the election were held today.

 

President Obama’s reelection chances reached a peak of 64.5% on September 24, according to the HEI. Hedgeye will release the HEI every Tuesday at 7am ET until election day November 6.

 

The President's Chance Of Reelection - HEI

 


EXPERT CALL: GAMING EXPANSION IN SOUTH KOREA?

What's Next For Gaming Legislation in South Korea?    

 

 

Date: Thursday, November 8th 

Time: 8:30am EST  

To gain access email  

 

 

Steve Park, Senior Consultant of Gaming Asia-Pacific Company

 

The Hedgeye Gaming, Lodging and Leisure Team lead by, Todd Jordan will be hosting an Expert Conference Call with Steve Park, Senior Consultant of Gaming Asia-Pacific Company. The call will be held Thursday, November 8th at 8:30am EST and will discuss potential gaming expansion in South Korea.

 

Key Topics Will Include:    

  • Current state of the gaming industry in S. Korea  
  • Draft legislation for further gaming liberalization
  • Timeline & process 
  • Potential players  
  • Scope of the market
  • Touch on surrounding marketing looking at gaming legislation 

The dial-in information will be sent in a forthcoming note.

 

About Steve Park

  • Partner and senior consultant at Gaming Asia-Pacific, a firm providing business and regulatory consulting for international clients wishing to enter the South Korean and Japanese markets
  • Serves as a consultant to the Korea Tourism Organization Advisory Board, advises the integrated resorts committee on political and media affairs
  • Provides advice and assistance to the New Frontier Party to develop the government partys legislative agenda and strategies
  • Previously as a policy advisor in the National Assembly, Park served in the Public Administration & Security Committee reviewing tourism projects by all 16 regional governments   
  • Also served as a campaign consultant and reporter in the U.S for the Republican Party and the Washington Times

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

A QUICK PEAK UNDERNEATH THE HOOD OF THE US EQUITY MARKET

Takeaway: While the current earnings season has been cause for worry, pollyannaish estimates remain the key headwind to the stock market from here.

SUMMARY BULLETS:

 

  • Roughly 80% though earnings season, it’s clear to see that 3Q12 has shaped up exactly as we had laid out in our #EarningsSlowing theme: very bad.
  • Consensus remains out to lunch with their forward revenue, operating margin and EPS growth estimates. When you combine the negative trend in corporate guidance with the potentially-precarious Global Macro setup (potential US recession; no Chinese stimulus; Europe continues to contract), it’s easy to anticipate a scenario whereby those estimates have to be revised down hard and fast at some point over the intermediate term.
  • Aggressive estimates for operating margin expansion puts a great deal of pressure on corporate management teams to accelerate material cost-cutting initiatives like we’ve seen at UBS, DOW, AMD, RIO, FDX and CMI (to name a few). While that may appear good for a single company’s earnings outlook in the short term, the reality is that when corporations are engaged in cost-cutting en masse, GDP growth tends to slow materially; this perpetuates top line weakness across the corporate sector in a reflexive manner.

 

For the 3Q12 earnings season to-date, 59.8% of S&P 500 companies have missed on the top line and 28.7% have missed on the bottom line (388 total). That compares with 57.8% and 26.8%, respectively, in 2Q12. Average SPX constituent EPS growth is flat on a YoY basis and average sales growth is down -1.4% YoY. We have not seen weakness like this since mid-to-late 2009.

 

From a forward-looking perspective, 74 companies have issued 4Q12 EPS guidance and 56 of those cases have been below the mean EPS estimate (vs. 18 above). Per Factset, the 76% negative guidance ratio is well above the long-term average of 61%, though roughly in-line with the 78% recorded at this time during the previous quarter.

 

We know consensus is typically poor at forecasting inflections in macro, but it’s shocking to us that consensus continues to aggressively ignore the warnings issued at the micro level. As the chart below highlights, the sell-side continues to expect a v-bottom and a demonstrable acceleration of revenue and EPS growth over the NTM.

 

A QUICK PEAK UNDERNEATH THE HOOD OF THE US EQUITY MARKET - EARNINGS SEASON 2.0

 

When you combine the negative trend in corporate guidance with the potentially-precarious Global Macro setup (potential US recession; no Chinese stimulus; Europe continues to contract), it’s easy to anticipate a scenario whereby those estimates have to be revised down hard and fast at some point over the intermediate term. We can’t see how that is a positive catalyst for the stock market, but we’ve been surprised before.

 

Digging into the weeds a bit, we see that consensus continues to burden corporate management teams with incredibly aggressive margin expansion assumptions. Over the NTM, SPX constituent operating margins are projected to expand by an average of +101bps YoY per quarter on a median basis. That compares with +5bps of median YoY expansion in 3Q12 and an average of -2bps YoY over the LTM.

 

A QUICK PEAK UNDERNEATH THE HOOD OF THE US EQUITY MARKET - SPX Margins

 

Judging by the latter trend, it would appear that much of the earnings “juice” has been squeezed from corporate operations. Moreover, consensus forecasts NTM median SPX constituent revenue growth of +3.8% YoY on average, per quarter, which does not bode well for meeting their aggressive operating margin assumptions.

 

A QUICK PEAK UNDERNEATH THE HOOD OF THE US EQUITY MARKET - SPX Revenues

 

That setup puts a great deal of pressure on corporate management teams to accelerate material cost-cutting initiatives like we’ve seen at UBS, DOW, AMD, RIO, FDX and CMI (to name a few). While that may appear good for a single company’s earnings outlook in the short term, the reality is that when corporations are engaged in cost-cutting en masse, GDP growth tends to slow materially; this perpetuates top line weakness across the corporate sector in a reflexive manner. Refer to our OCT 10 note titled, “#EARNINGS SLOWING UPDATE: IS CORPORATE COST-CUTTING COMING BACK WITH A VENGEANCE?” for more details.

 

Broadly speaking, praying for stock buybacks is not a risk management process.

 

Darius Dale

Senior Analyst


MCD FEELING $ STRENGTH

Takeaway: If tomorrow's election serves as a catalyst for the US Dollar, the impact on MCD's earnings could be meaningful.

A stronger dollar may be better for the long-term health of the US economy but the immediate impact of dollar strength on McDonald’s, a multinational corporation with significant exposure to FX, has historically been negative from an earnings perspective.

 

We turned cautious on McDonald’s in May as the extent of the impact of macroeconomic trends and difficult summer months’ compares became clearer.  We believe that MCD is now closer to bottoming but will have a firmer view following October sales being released on November 8th.  We’d still avoid the stock on the long side, for now, but the company’s cash flow strength and the stock’s dividend yield provide support.  We see 2013 bringing more issues for MCD; consensus is expecting a snap back to +10% and +11% EPS growth in 2013 and 2014, respectively.  As yet, we see no evidence that MCD has taken the right steps to correct issues within its control.  Macro headwinds are persisting, for now, and amplifying the impact of self-inflicted wounds.  Foreign exchange is one such factor that can impact MCD’s earnings growth.  

 

There are plenty of opinions available today, as there have been for months now, regarding the myriad consequences of tomorrow’s election for markets and the economy more broadly.  Judging by the rhetoric, for what it’s worth, of each candidate, it seems that one asset that could be greatly impacted by the outcome of the election, over time, is the U.S. Dollar.  Any catalyst such as tomorrow’s election, that leads the United States to economic policies supportive of the value of its currency, could meaningfully impact McDonald’s earnings power.

 

The chart below shows, on a trailing-twelve-month basis, the impact of foreign currency translation on EPS versus the year-over-year change in the US Dollar Index, also on a trailing-twelve-month basis.    

 

MCD FEELING $ STRENGTH - mcd usd index impact

 

MCD FEELING $ STRENGTH - usd index level

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 


Are The Experts Wrong On The Election?

Takeaway: Historically, polls in aggregate have accurately predicted the Presidential election. This year voter ID is a true wildcard.

This note was originally published November 05, 2012 at 11:57 in Macro

As usual, we had a vigorous discussion in a recent research meeting on the state of the election.  I provided the update to the team that all of the indicators appear to be moving more towards President Obama over the last ten days. Specifically, in the national poll average Obama is now up +0.4, Intrade has reached a three week high with a probability of 68% that Obama gets re-elected, and Obama appears to be expanding his lead in Ohio from +0.8 three weeks ago to +2.9 today.  According to the expert pollsters, Obama is on the path to re-election.  Is it possible that the experts are wrong?

 

To start let’s look at Gallup, the longest running Presidential pollster, going back to 1936.  In the nineteen elections going back to 1936 that Gallup has polled, the organization has correctly picked the winner 16 of 19 times, so it has been correct 84% of the time.  The three elections that they missed were as follows:

  • 2004 – In their last poll leading into this election, Gallup had Bush and Kerry tied at 49.0%.  Bush won the popular vote with an edge of 50.7% to 48.3%;
  • 1976 – In their final poll prior to the election, Gallup had Ford at 49% and Carter at 48%.  Carter won 50.1% to 48.1%; and
  • 1948 – In the classic miscalled election, Gallup had Dewey at 49.5% and Truman at 44.5%.  Truman won 49.5% to 45.1%.

If we can use Gallup as a proxy for the professional polling industry, then you would have been correct betting on the experts 84% of the time for the popular vote.  The professional pollsters, in aggregate, are currently predicting an Obama win, primarily based on the President’s stronger polling in the battleground states and his edge in the national polls, albeit slight. With a 68% probability on Intrade that President Obama is re-elected, this polling data is all but priced into the market.

 

The probability on Intrade of course assumes that the polls are accurate.  In this election, more so than many prior elections, the validity of polls is being increasingly questioned, despite their long term track record of being accurate.  The key doubt related to polls this year is whether the samples accurately reflect the voters who will actually turn out.

 

In its most recent poll, the National Journal critiqued its own methodology in “The United Technologies / National Journal Congressional Connection Poll”.  They wrote:

 

“The poll’s finding of a 50-45 Obama advantage in the presidential race highlights the central uncertainty surrounding the blizzard of late campaign polling: What will the partisan and racial composition of the actual electorate look like?

 

In its likely-voter model, the Congressional Connection Poll projected that the 2012 electorate will be virtually unchanged from 2008, with Democrats holding an 8 percentage-point advantage among voters (compared with 7 points last time) and whites representing 73 percent of voters (compared to 74 percent last time).”

 

In the table below, we’ve looked at the voter ID breakdowns for the most recent polls that provide voter ID from national polls, Ohio polls, Nevada polls, and Virginia polls.  In this analysis, we’ve used those three states as they are considered by many to potentially be the deciding states in the Electoral College vote.  In fact, Nate Silver from the New York Times put the probability of these three states being the deciding votes at 71% collectively. 

 

Are The Experts Wrong On The Election? - 1

 

The high level takeaway is that across the board the polls have meaningfully higher voter IDs projected for Democrats. Based on the national polls it is a +7 advantage, in Ohio it is +6.3, in Nevada it is +8.3, and in Virginia it is +6.7.  If there is in fact more Democrats than Republicans and nationally in these key states, and they turn out in comparable numbers to the Republicans, then President Obama likely has the election won, even with an overwhelming swing of independents to Romney.  Conversely, if these voter IDs are incorrect, then Governor Romney remains very much in contention.   The prior two elections provide some insight into this voter ID question.

 

In 2008, there is no question that more Democrats turned out and more Americans identified as being Democrats.  In 2004, with Bush’s victory, this was most definitely not the case.  The key question is whether this election looks more like 2004 or 2008.  In the table below, we look at average voter IDs in the polls above and actual voter IDs from exits polls in 2004 and 2008.

 

Are The Experts Wrong On The Election? - 2

 

As the table above shows, the voter ID by party in the 2012 polls looks much more similar to 2008 than 2004.  This is surprising given that on a national level the race looks much more like 2004 than 2008.  Intuitively, it doesn’t make sense for the race to be effectively tied on a national basis but for state level polls to reflect voter turnout comparable to 2008, a year when the Democratic candidate won the popular vote. To be fair, we are comparing apples to oranges on some level as the table above looks at exit polls versus pre-election polls.  Regardless, all measures suggest that Democrats are less enthusiastic in 2012 than in 2008.

 

In the last table below, we return to the nation’s longest running polling firm, Gallup.  In this table Gallup compares the demographics of likely voters in 2004, 2008 and 2012.  They find the following:

  • In 2004, 37% were Democrats, 24% were Independents and 39% were Republicans;
  • In 2008, 39% were Democrats, 31% were Independents and 29% were Republicans; and
  • In 2012 they estimate, 35% are Democrats, 29% are Independents and 36% are Republicans.

So in contrast to much of the polling industry, Gallup is expecting more Republicans than Democrats to vote in 2012.  It is no surprise then that Gallup has Romney up 5% in its latest poll, which was given on October 29th before Hurricane Sandy hit.  If Gallup is accurate, Romney will be the next President.  But if Gallup is accurate, then the crowd of experts is wrong and the state polls, in particular, will be proven profoundly inaccurate.

 

We say profoundly inaccurate because historically state level polls have been spot on in predicting the winner of the Electoral College.  Nate Silver from the New York Times runs a probability model on the election based on state level polls and he currently has an 86% probability that Obama wins re-election.  This is due to the fact that the key battleground state polls currently lean towards Obama on average and going back to 1988 the state poll averages have been accurate in calling the winner of the state 96% of the time.

 

So in summary, the experts, via their opinion polls, currently show a high likelihood that Obama gets re-elected.  For them to be wrong, it is likely because of broad sampling errors based on party affiliation, which as we outline above there is some evidence to support.  This also jives with many of the economic predictive models that point towards a Romney victory, such as the recent call we did with Dr. Ken Bickers from the University of Colorado.

 

We can assure you of one thing: this is going to be one of the closest races in Presidential history and pollsters won’t decide the outcome.  As former Congressman from Minnesota Walter Judd famously said:

 

“People often say that, in a democracy, decisions are made by a majority of the people. Of course, that is not true. Decisions are made by a majority of those who make themselves heard and who vote - a very different thing.”

 

 

Get out there and vote!

 

Daryl G. Jones

Director of Research

 

Are The Experts Wrong On The Election? - 3

 

 

 


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