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.”
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:
- What coming off the last 5 peaks in corporate margins in the last 100 years looks like (stocks look “cheap” at the peaks)
- Why the risk to expectations is more in Q4 and 2013 than what’s staring CFO’s in the face in Q312
- 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)?
- US GDP Growth +3-4% (US GDP = down 69% from Q411’s 4.10% to 1.26% reported most recently)
- Earnings are “great” (they were at the Q1 2012 top; but Q312 has been the worst in 3 years)
- 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,
Keith R. McCullough
Chief Executive Officer
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.
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What's Next For Gaming Legislation in South Korea?
Date: Thursday, November 8th
Time: 8:30am EST
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
Takeaway: While the current earnings season has been cause for worry, pollyannaish estimates remain the key headwind to the stock market from here.
- 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.
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.
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.
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.
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.
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