Editor’s Note: Welcome to the inaugural edition of the Investing Ideas weekly newsletter, which replaces our Weekly Hot Ideas newsletter. Each week, you’ll get a summary of our top Investing Ideas, a detailed Macro Update on key events that shaped the week, a Sector Spotlight, which focuses on a key industry or industries every week plus an Investing Term of the Week, where we’ll demystify the jargon and clearly explain a popular investing term.
Additionally, you will have access to Stock Reports, which are one page reports on the individual stocks that make up our top Investing Ideas. To find those, just log in to the web site, go to the Dashboard, and click on the Investing Ideas tab on the left side of your screen. Then, you’ll see a list of all Stock Reports plus a list of all the most recent Investing Ideas weekly newsletters.
Macro Update: A Refrigerator in Every Kitchen
Hedgeye’s fundamental view of accelerating economic activity in the US was bolstered this week as US Macro analyst Christian Drake called out key economic reports in Durable Goods Orders (up 5.7% month-over-month) and existing home prices (up 8.1% year-over-year).
Durable goods, or big ticket items like refrigerators, furniture or cars, and rising home sales point to a stronger economy and a potentially a stronger consumer.
February’s Durable Goods increase came on top of an upward revision of January’s figures and flipping from negative to a strong positive reading. While there may be unevenness as the Sequester disrupts such industrial goods as defense-related aircraft, Drake says positive growth trends in capital goods and consumer durables continue to look positive, providing impetus for business investment.
Meanwhile, existing home prices continue to move ahead, driven by that old economic saw The Law Of Supply And Demand. As Health Care sector head Tobin’s work on birth rates and new household formation shows, there is definite increasing demand.
And as Financials sector head Josh Steiner has reported, there is a tightening supply: builders downsized capacity in the heart of the financial crisis and will take time to ramp up. This is also because the decline in building activity reverberated downstream: building materials and supplies, and the machinery and equipment for new construction all downsized as their customers shrank their operations. It will take time to rebuild this entire supply chain.
Meanwhile, without the capacity to build new houses fast enough to satisfy current demand, the demand for existing homes should continue higher. Drake reminds us that Hedgeye views housing as a Giffen Good, the economic anomaly where higher prices cause higher demand, rather than scaring away consumers. Thus the current increases in the Case Schiller housing price index should attract still more demand – which will further tighten the supply – which will push up the price – which will drive demand still higher... so stay tuned.
Sector Spotlight: Restaurants and Consumer Staples
The upsurge in housing, combined with increased buying in consumer durables, points to accelerated household formation. This is further bolstered by ahead-of-the-curve work by our Health Care team that indicates a climb in birthrates. Recovery in buying patterns is driven as much by confidence in the future as by actual cash in the bank.
Buying patterns look set to recover as America wakes up to the reality of a recovering economy. At a certain point, consumers start buying in anticipation of their next paycheck. Increasingly positive macro data bodes well for consumer-driven companies, as highlighted by recent work from our Restaurants sector head, Howard Penney, and our Consumer Staples sector head, Rob Campagnino.
Restaurants – Penney’s latest work indicates that a strong macro picture should start to fill in the blanks at Burger King (BKW). Penney had a short call on the company until last week when the surge in macro data, combined with a strong emerging quantitative set-up for BKW stock, overshadow his bear case. Following on the heels of that switch, Penney went bullish on Darden Restaurants (DRI), which was added as a an Investing Idea on March 11.
Key to Penney’s call on DRI is his sum-of-the-parts analysis, which he says puts a much higher value on the company than reflected in the current stock price. Penney also sees indications of emerging pressure for strategic changes at the company, whether from significant outside investors, or even from within the board of directors.
Consumer Staples: Campagnino points to a number of factors in favor of his sector today. The obvious ones include all the points we referenced above – the acquisition of more refrigerators as more new households are formed is clearly good for business in the sector.
But Campagnino says the sector has not yet clearly mirrored the behavior in other sectors, where larger-capitalization companies draw more investment dollars. Campagnino interprets this as investors such as big mutual funds, who have to put their money into stocks, looking for low-beta ways to participate in a market rally they still don’t completely believe in. He believes there are key stocks in the sector that will continue to surprise to the upside, such as ConAgra Foods (CAG), which we added as an Investing Idea on February 11.
Campagnino likes CAG’s recent acquisition of Ralcorp, the leading private-label foods manufacturer. This makes the new CAG the largest private branded food company in the US, and the private label business is growing twice as fast as CAG’s basic branded business.
Campagnino says “deal stocks” tend to do better in his sector, and as more details of the Ralcorp acquisition are understood, the stock can continue higher. For example, he thinks the combined entities will generate synergies in excess of the predicted $225 million.
And while Hedgeye’s Macro work indicates the “US Dollar up / Global Commodities down” relationship may not be as direct as it once was, Campagnino says any weakness in foodstuff commodities can flow right through to CAG’s income statement.
Finally, Campagnino likes the visibility of a big stock, with a good story, making new highs. Many investors naturally shy away from buying stocks at their highs. But ask yourself, Where will selling pressure come from? After all, at an all-time high in a stock, where are the unhappy shareholders?
Investment Term: Equal-Weighted Index
We are all familiar with the concept of portfolio diversification. In its simplest form, a diversified portfolio of different companies, spread across several industry groups, provides a built-in hedge: when one sector is weak, other sectors are likely to be strong.
The likelihood of all the stocks in your portfolio dropping in price at the same time is low. And if they all drop in value, it’s likely because you are in a bear market. In which case, as your portfolio manager will tell you, “All bets are off.”
The Standard & Poor’s 500, one of the best-known market benchmarks, contains the 500 leading companies traded in the US. Moves in the S&P 500 index during the trading day reflect changes in the prices of those 500 companies, weighted to reflect their importance in the market. The bigger a company’s market capitalization, the greater its weighting in the index.
Academic research based on Modern Portfolio Theory (MPT) says the best way to achieve diversification is to own a portfolio that mirrors the broad market – and MPT argues that capitalization-weighting is the proper way to go.
Hedgeye’s domestic US Macro analyst Christian Drake provides a chart that challenges MPT and implies that weighted diversification may be measurably inefficient. If you are an index fund investor, you may be able to improve your investment performance by readjusting the weightings in your portfolio.
In addition to the standard index-tracking funds, there are also ‘equal-weight” funds and ETFs available, which invest in the same stocks as the standard index funds, but with equal weightings.
An S&P 500 index fund is structured to mirror the performance of the index. This means each stock holding in the fund will be given the same weighting as that stock represents in the index. In an equal-weight fund, each stock is weighted the same as all others. Each stock in an equal-weight S&P 500 fund represents exactly 1/500th of the portfolio, regardless of its weighting in the reported S&P index.
One study found an equal-weighted S&P 500 ETF outperformed its traditional sibling by about 1.5% annually, and did it rather consistently. While one study does not an investment philosophy make, Drake’s chart indicates that equal-weighted vehicles should behave very differently from their traditional namesakes and may provide superior performance over the longer term.