“I have a feeling that the bark is worse than its bite.”
That’s what Churchill said about Joseph Stalin in 1944.
“For their part, Churchill and Roosevelt never entirely trusted Stalin… they weighed every decision against the possibility that Russia might quit the war, as the Bolsheviks had done in 1917.” (The Last Lion, pg 445).
While I don’t make market calls based on “feeling”, how people feel about markets matters. America’s historical risk management lesson with Russia feels very familiar. Now that the shorts have been squeezed, do I entirely trust being long stocks right now? Of course not.
Back to the Global Macro Grind…
The SP500 and Russell2000 finally delivered the Canadian Bacon yesterday, making higher-highs versus their September 2012 and all-time closing highs, respectively.
With the Financials (XLF) leading the charge on the day (+1.3%) and already up +4.6% for the YTD (the SP500 is +3.2%), those who stayed short this market definitely feel more than a little barking out there – these newfound fund flows to equities are like dogs panting.
To review our recent bullish call on Global Equities, there are 3 big parts:
- Global #GrowthStabilizing as Hedge Fund Short Interest was rising (NOV-DEC)
- Treasury Bonds and Gold breaking down (NOV-JAN)
- Fund Flows shifting from bonds to equities (DEC-JAN)
Since Global Macro markets are reflexive, it’s been nice to see these 3 things happen in order:
- US Equity Short Interest peaked (sequentially) in the last week of November at 3.98%
- Gold stopped going up at another lower all-time high in the 3rd wk of November ($1753)
- Global Equity Fund flows just had one of their biggest weeks since 1992 (see Merrill data this morn)
That, of course, is bearish for Treasury Bonds (we are short TLT) – and why we re-shorted Gold (GLD) on green yesterday (see our #RealTimeAlerts product for intraday signaling if you can stand watching me day-trade).
So, with all of this new “news” becoming rear-view mirror events, you don’t want to be getting piggy here; you want to be booking some gains. Depending on how hot these Financials Earnings Reports are for Q412, you can determine how leisurely you can take your time. Wells Fargo (WFC) reports first this morning and the belly of the money-center banks will be out next week.
Why would you make some sales on green?
- Global #GrowthStabilizing won’t last forever (remember, Keynesian economic cycles are short and volatile)
- #EarningsSlowing will be more readily apparent in late January to early February (Financials as good as it gets)
- It’s just generally cool to sell high after you bought low
That last one-liner might annoy some people, but it was pretty annoying seeing people short every up move for the last month as the economic data was improving too.
It’s one thing to be bearish on government; it’s entirely another to be a perma-bear of all things, all of the time.
In an over-supplied industry (asset management), this is why getting the Behavioral side of the market right matters more than it has ever mattered before. Sentiment is a factor that you fade. But it’s also one of the toughest market factors to quantify.
I’m constantly trying to find new channels and data to quantify sentiment. Currently, my Top 3 Sentiment Checks are:
- My research team’s proprietary data
- My Institutional Client base (our team collaborates best data with theirs)
- My Twitter stream
That last one is the one that fascinates me the most. I have built a “contrarian stream” of market pundits that are getting really good at chiming in, almost like an orchestra, on market direction (intraday). They have been trying to sell every down-move to lower-highs since the Fiscal Cliff low of 1400 SPX in the last week of December. #wrong
More on that later. For now, it’s important to realize that Institutional Short Sellers (Short Interest as a % of the total float for stocks listed in the SP500), just dropped from 3.98% in the last week of November to 3.74% into the 1st week of January. At the same time, the Institutional Investor Bull/Bear Spread just went from +950 basis points wide (wk of Nov19) to +2,770 bps wide this week.
Sentiment is a dog to follow, and it bites.
Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, USD/YEN, UST 10yr Yield, and the SP500 are now $1, $110.33-111.48, $3.64-3.75, $79.48-80.11, $1.30-1.32, $87.41-89.10, 1.86-1.96%, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
This note was originally published at 8am on December 28, 2012 for Hedgeye subscribers.
“An intelligent man is sometimes forced to be drunk to spend time with his fools.”
In my homeland of the vast plains of Alberta, the drink of choice for many is Rye Whiskey and Coke. Now normally, I wouldn’t start the Early Look discussing beverages of choices, but given what has been going on in Washington, D.C. over the last few months, what choice do any of us really have but to have a few cocktails to make ourselves feel better? Or, to Hemingway’s point, to enable us to at least suffer this political foolishness.
Now on one hand, I do give President Obama some credit for leaving the golf links early and coming back to work. In reality, though, does anyone really believe that a last minute meeting tonight with Congressional leaders is going to solve either the fiscal cliff or the coming debt ceiling violation? Personally, I hate to be consensus on this, but I sure don’t. Currently InTrade has the probability of the debt ceiling being raised before December 31st, 2012 at 17%.
The issue currently in Washington is that Democrats and Republicans don’t agree with each other. Ok, that’s not really a new issue, but heading into the deadline of December 31st neither side is acting like they want to work together and get a deal done. This excerpt from a news article quoting House Minority Whip Steny Hoyer about sums up how divisive things are in the nation’s capital:
“In a sign of just how charged and hyperbolic this year-end debate has become, House Minority Whip Steny H. Hoyer, D-Md., used an unfortunately timed comparison that likened Republicans trying to use the debt limit for leverage on spending cuts to people threatening to shoot their own children.
It is somewhat like taking your child hostage and saying to somebody else, ‘I’m going to shoot my child unless you do what I want done.’ You don’t want to shoot your child,” Hoyer said at a press conference following a brief 10-minute pro forma session for the House.”
Obviously the timing of this quip was bad on many levels, but the reality is that this is obviously no way to set the table for some sort of grand bargain in today’s meeting with President Obama and the Congressional leadership.
So unfortunately heading into 2013, I hate to report but it is likely that politicians and policy continue to inform much of our investment decision making. That is not to say that everything is negative of course. In fact, in the Chart of the Day today I’ve borrowed a chart from our Financials Sector Head on the recently released Case-Schiller Housing Price Index. As the chart shows, the last five months (ending with October 2012) have seen consistent year-over-year national home price increases. In the last couple of Early Looks I’ve been beating this like a dead horse, but this is a real positive for the U.S. economy and consumer.
Unfortunately, a home price recovery will only get us so far as yesterday’s consumer confidence number tells us. This reading for December came in at 65.1 versus the 70.0 that was expected and the 71.5 reading in November. So it seems that the uncertainty relating to the fiscal outlook in the United States has likely had an impact, as expected, on consumer confidence.
Given that, the looming Longshoreman strike that looks likely to occur could not be happening at a more inopportune time. This looming strike will impact 14 major East Coast and Gulf Coast ports. In aggregate, these ports move more than 100 million tones of goods every year, which is about 40% of the nation’s containerized cargo. So even a shut down of a few days is likely to have a meaningful effect on the economy.
In cheerier news, it is starting to look like the bottoming process in China is taking place. In terms of commodities, both rebar and iron ore have had very strong quarters of price appreciation. On the back of this, the Shanghai composite was up more than 1% over night to close at its highest level since the summer. Once again, this plays into our theme of global growth stabilizing.
In lieu of regularly scheduled macro call this morning, we are going to have our Financials, Industrials and Consumer Staples Sector Heads join the morning call and discuss their top ideas and themes heading into 2013 (if you are not subscribing to receive the morning call service, email firstname.lastname@example.org for details on how to gain access). Since I’m the Director of Research at Hedgeye, I’ll take some liberty and highlight what I think are each sector’s top idea long ideas. In my view, they are as follows:
1. Financials – TCF Financial (ticker: TCB) is a play on housing which is improving, is growing both loans and deposits at a healthy clip, and has a CEO who is older than average which may make it ripe for a takeout. On a reasonable multiple of price-to-tangible-book, we think the stock has 25% upside over the next twelve months.
2. Industrials – Paccar (ticker: PCAR) has been one of our key names since launching Industrials coverage earlier this year. A key tenet of the thesis is struggles at key competitor Navistar, which were reaffirmed to us this week (over the last year Navistar’s class 8 market share has been cut in half).
3. Consumer Staples – Archer Daniels Midland (ticker: ADM) is a name that we highlighted in our Consumers Staples launch a few weeks back. High corn price negatively impacted ADM in 2012, but an increase in corn plantings in 2013 should be a beneficial tailwind to ADM. At just around 1.0x price-to-tangible-book, ADM is trading at a serious discount to its 1.2 average on this metric.
On a closing note, please enjoy the New Year with your friends and loved ones.
Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1636-1671, $109.42-111.48, $3.51-3.61, $79.21-79.99, $1.31-1.33, 1.70-1.78%, and 1408-1430, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
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McDonald’s shares have recovered well since the November lows and are outperforming the S&P 500 year-to-date but management has plenty of work to do to ensure EPS growth in 2013.
McDonald’s same-restaurants sales in November were sequentially stronger than October’s, albeit aided by the calendar shift, but December will offer a more meaningful indication of the health of the company’s business heading into 2013.
Latent Issues Remain
We’ve had concerns about the operational complexities that have manifested themselves over the past 5-6 years. Like Yum! Brands, McDonald’s has difficult top-line comparisons, from a same-restaurant sales perspective, over the next three months. Even if our concerns over the operational side of the business are unfounded, we believe that staying on the sidelines for the next three months is worth considering.
Consensus is expecting sales to recover in 2Q13 but, if our contention about over-complexity in the operational setup is even half-accurate, consensus could be early on the turn. Street expectations of 5% revenue growth and 9% EPS growth are overly optimistic, in our view, with food inflation running in the low-to-mid single digits. This, along with ongoing pressure in Europe, represents a risk to earnings growth expectations.
- We believe that 5% revenue growth could prove to be aggressive by 150-200 bps, in our view
- The margin recovery story, that the street buys into, seems less and less likely to materialize
Move to Value Has Failed Before
In 2003/2004, McDonald’s made an aggressive move to value that failed to gain traction with consumers and we struggle to understand how value will put sales trends on the right track in 2013. The company needs to take price or shift mix in order to mitigate margin erosion due to beef price inflation.
Increasing complexity in the back of the house can present challenges to restaurant companies. Management has disagreed with our view that this is happening at McDonald’s but we think three areas need to be addressed to help sales and margins recover:
- Menu Optimization: A typical McDonald’s in the United States carries out more than 1,000 transactions per day with many items carrying 10-30 transactions, daily. At a point, the complexity in the menu hampers efficiency to the degree that some of the less popular items need to be taken off the menu.
- Espresso-Based Beverages: The biggest loser on the menu is the line of espresso-based McCafé drinks. Given that the Chief Executive Office was the primary champion, internally, of placing these items on the menu, we see little chance that management will change course. More and more advertising dollars need to be pulled away from the McCafé line as, over time, pressure will build on management to invest less and less in an under-performing business
- Removing the Angus Burger: The Angus Burger has failed to meet expectations. With promotions, restaurants tend to sell roughly 70 per day in US markets. Without promotions, that number falls to less than 40. While the $4 price tag helps average check, that the company had to go to the McRib for December implies that Angus burgers are failing to meet expectations. Removing the Angus could prove to be an operational improvement given the additional features of the Angus versus other burger offerings (extra patty, extra bun)
What is the Company Focusing On?
The company’s global priorities are:
- Optimizing the menu
- Modernizing the customer experience
- Broadening accessibility to our Brand
The menu has not, as of now, been optimized to the degree that it needs to be. The pricing structure was changed but that strategy has not been positive. The modernizing of the customer experience is a given, in 2013, and remains an ongoing process. Broadening accessibility to the brand seems to be an exhausted approach for McDonald’s; increasing accessibility at this point could involve lower returns.
The McRib has always, since 1983, been a three-to-four week promotion, which began this year in November. While many markets began selling McRib in November, the advertising started in mid-December and it appears that a number of markets are still selling it in January.
Other than the aggressive global value message, details are few and far between on 2013. The company plans to “relaunch” the Big Mac this year, with the commissioning of a 10-ad special campaign, reintroducing the Big Mac to America.
The US economy continues to pump out positive data points with the latest coming from the labor market. Year-over-year NSA claims improved to -9.8%, a sizable improvement than the -6.0% and -5.9% readings over the last two weeks. Remember that a smaller number (i.e. more negative) is better in this instance. With labor conditions accelerating since December, the overall improvement is a welcome addition to our theme of #GrowthStabilizing.
It’s worth noting that seasonally-adjusted claims "rose" 4k to 371k after last week's print was revised from 372k to 367k. Overall, the seasonally-adjusted series continues to bounce along the 365-375k range it has occupied post Hurricane Sandy renormalization.
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