“Well, I understand that you are to beat me in this contest.”
That, of course, is what Adams told Thomas Jefferson when it became clear to him in 1800 that Jefferson was going to replace him and become the 3rd President of the United States.
“Mr. Adams, this is no personal contest between you and me… Two systems of principles on the subject of government divide our fellow-citizens into two parties. With one of these you concur, and I with the other.” –Thomas Jefferson (The Art of Power, page 327-328)
In all great contests, there are two competitors, teams, and/or ideas. In all great contests, someone wins and someone loses. In the greatest of contests, the winner is gracious in victory – and the loser learns from defeat.
Back to the Global Macro Grind…
“Let us, then, fellow-citizens, unite with one heart and one mind” (Jefferson during his inaugural address of 1801), and become Yale Hockey fans as they head to the Frozen Four, for the first time since 1952!
(I had to find a way to slip that in there)
In other news, crisis-mongering remains in crisis and US stocks hit an all-time high last week.
As we like to say here at Hedgeye Risk Management – all-time is a long time, and this all-time high was driven by the fulcrum point of our bull case for US (and Chinese) Consumption Growth – a Strong US Dollar.
With the US Dollar up for the 7th week in the last 8 (+0.74% to 83.14 on the US Dollar Index):
- Down -3% in the last 2 months, Brent Oil Prices stopped going down last wk (+2.2% to close the wk at $110.02/barrel)
- Food Prices continued to get pulverized week-over-week (Wheat -5.8%, Corn -4.3%, and Soy -2.5%, last wk alone)
And the net long positions in commodities (futures and options contracts) continue to go squirrely:
- Gold – net long positions fell another -14% on the wk after Gold’s price fell -0.7% (net long position -41% YTD)
- Silver – net long position continued to crash (-77% on the wk!) to its lowest level since 2007
- Copper – built a record net short position of -30,036 contracts
The thing about shiny metals is that (after Gold went up for 12 years in a row) a lot of people own them now in lieu of what were Burning Bernanke Bucks. That (and all those Gold commercials you still hear on the radio) is a rear-view looking thesis. So is the end of the world.
As the great USA Olympic Hockey Coach, Herb Brooks, might say about this morning’s metals update – “Again!”:
- Gold is flattish around $1598/oz (down -4.6% YTD)
- Silver is down another -0.9% to $28.04/oz (down -13% from its early 2013 high)
- Copper leads losers in Global Macro trading this morning, down another -1.3% to $3.35/lb
All the while, The Great Contest between #PTCs (professional top callers) and those of us who change as the game does rages on. Are Food, Energy, and Metals prices deflating a good or a bad thing for the global consumption economy?
What do we know, but the last time our models were this bullish on US economic growth prospects relative to consensus was in 2009 when many of these same factors rhymed. The Dollar rose from its ashes and Commodity prices kept crashing well into Q209.
But if you sold in May of 2009 and went away, was that a good decision or a bad one? What if you sold in April of 2009? My keen sense from my latest institutional client meetings is that a lot of people are still looking for a big Q2 correction. What if it doesn’t come?
Risk obviously happens fast, so we’ll be sure to let you know if anything changes in terms of our intermediate-term TREND view (bullish on Asian and US stocks; bearish on Commodities, Yens, Treasuries). In the meantime, may the great contest between bulls and bears continue!
Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, USD/YEN, UST 10yr Yield, VIX, Russell2000, and the SP500 are now $1, $106.75-110.39, $3.34-3.44, $82.61-83.49, 93.44-96.35, 1.84-1.95%, 12.13-14.26, 947-955, and 1, respectively.
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
TODAY’S S&P 500 SET-UP – April 1, 2013
As we look at today's setup for the S&P 500, the range is 16 points or 0.84% downside to 1556 and 0.18% upside to 1572.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 1.62 from 1.61
- VIX closed at 12.7 1 day percent change of -3.42%
MACRO DATA POINTS (Bloomberg Estimates):
- 8:58am: Markit US PMI Final, March, est. 55.2
- 10am: Construction Spending M/m, Feb., est. 0.8% (prior -2.1%)
- 10am: ISM Manufacturing, March, est. 54.2 (prior 54.2)
- 10am: ISM Prices Paid, March, est. 59.5 (prior 61.5)
- 11am: Fed to buy $2.75b-$3.5b in 2020-2023 sector
- 11:30am: US to sell $35b 3-mo., $30b 6-mo. bills
- U.S. Rates Weekly Agenda
- Washington Week Ahead
- Rule governing high-risk loans takes effect; may change how FDIC-insured banks invest in CLOs
- USTR releases annual assessments of global trade barriers, incl study on technical, health, safety trade restrictions
- Homeland Security to begin cutting staffing hours
- FAA will begin furloughing staff, closing more than 230 control towers at smaller and midsize airports
WHAT TO WATCH
- Federal court judge dismisses civil claims against U.S. banks over Libor manipulation; rules some commodities-related suits may proceed
- Verizon sued for $2.85b in debt, interest from Idearc spinoff
- Dell said to consider Blackstone LBO with CEO guarantee
- Proxy statement has PC sales falling by $10b over 4 years
- Chesapeake names Dixon acting CEO, to hold conf. call on ops
- Beijing, Shanghai boost home curbs as China acts to cool mkt
- Wal-Mart to spend 500m yuan ungrading Chinese stores, China National Radio says
- All Nippon Airways plans for June restart of Dreamliner flights
- Boeing canceled test flight of 787, Seattle Times says
- Cerberus may begin more formal steps in Freedom Group sale
- Exxon to excavate Pegasus oil pipeline to find cause of leak
- Google is biggest threat to TripAdvisor, CEO Steve Kaufer says in FT
- Panasonic said to be under U.S. probe over bribery: WSJ
- Apple iRadio may be introduced in summer 2013, AppleInsider says
- Tesla turned profitable in 1Q; Model S sales exceeded forecast
- Amazon buying Goodreads book-review site irks author group
- U.S. Weekly Agendas: Finance, Industrials, Energy, Health, Consumer, Tech, Media/Ent, Real Estate, Transports
- North American M&A Agenda
- Canada Weekly Agendas: Energy, Mining
- BOJ Meeting, U.S. Jobs, China Index: Wk Ahead April 1-April 6
- Cal-Maine Foods (CALM) 6:30am, $1.40
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Corn Heads for Bear Market After U.S. Stockpiles Beat Estimates
- Bullish Bets Rebound at Fastest Pace in Four Years: Commodities
- Rubber Falls Into Bear Market as Stockpiles Swell, Demand Eases
- Indonesia to Review Rubber Exports After Prices Tumble in Tokyo
- Brent-WTI Crude Spread Widens as Exxon Shuts Pipe to Texas
- Spot Gold Little Changed as Silver Nears Bear-Market Threshold
- Copper Drops to 8-Month Low in Shanghai on China Manufacturing
- Hedge Funds Backing $100 Crude Lift Bullish Bets: Energy Markets
- Asia Gasoil Contango Narrows; Fuel Oil Crack Drops: Oil Products
- Mitsubishi Materials to Cut First-Half Copper Output by 6.8%
- Palm Oil Drops to Two-Month Low as Europe Crisis to Curb Demand
- Russia Sets Minimum Prices for Grain Purchases for Stockpiles
- China Manufacturing Rises at Faster Pace in March, Gauges Show
- Coffee Exports From Indonesia’s Sumatra Fall as Inventories Drop
The Hedgeye Macro Team
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"May you live in interesting times."
-Reputed Chinese curse
It has been an interesting start to the year, to say the least, for the consumer staples sector. The sector's leadership status in a strong tape is certainly an unfamiliar and perhaps uncomfortable position for many investors.
In review, another month in the books and another month of out-performance for our coverage. On average, consumer staples stocks rose 4.8% in March, with only the household and personal care sector and the tobacco sector lagging the S&P's +3.6% rise during the month.
Packaged food continued its strong performance (+7.0% in March) in the wake of the Heinz transaction, lagging only the protein sector (+9.0%) in terms of monthly performance.
We continue to struggle (based on our conversations with clients it seems many dedicated staples investors share the sentiment) with valuation. However, we recognize that valuation in and of itself is not a catalyst and that valuation may not matter for periods of time, perhaps extended periods of time. The simple fact is that a number of staples names have outstripped the multiple that we are comfortable paying for the cash flow stream, even considering earnings upside from potential margin improvement driven by lower commodity costs and improvements in business momentum driven by improved consumption trends. That doesn't mean that we are in a hurry to run out and short everything, but we caution investors to recognize that at some point, valuation will matter.
This month we have added a look at several quantitative factors in relation to the staples sector. Keep in mind that all these factors are relative within staples (i.e. smaller capitalization does not meet the technical definition of small cap, but rather represents a name within the lower half of the cap spectrum within staples).
Based on the above analysis, we can develop several themes in terms of what has worked within the staples sector:
- In March, lower beta (lower growth, perhaps 2012 laggard) outperformed higher beta names
- Higher short interest has been a consistent out-performer in 2013
- Smaller capitalization names had a very good month in March
- Dividend yield doesn't tell us much of a story - lower yield had a period of out-performance that has since reversed
- Higher debt to EBITDA has been a consistent outperformer, likely representing outperformance of lower "quality" names
Bear in mind, the performance of the staples sector has largely been absent any significant, positive EPS revisions. Further, absent any material change in business momentum or margins, consensus estimates should head lower on the strength of the dollar to the extent a company has businesses outside the U.S. While we acknowledge the impact of translating a set of results from one currency to the next is largely irrelevant to the value of a business, optics do matter.
Revisiting an analysis from last month, we see that performance was balanced across PE quartiles, with the modest relative under-performance in higher multiple names largely caused by BNNY's monthly performance (-9.5%). In fact, it was nearly impossible to find a consumer staples stock that didn't go up in the month of March.
Similar to last month, multiples expanded across all quartiles.
In keeping with a familiar theme, the yield spread between the 10 year treasury and the XLP has widened in recent days, making the XLP marginally more attractive to investors seeking yield. Further, we think it is possible that yield bearing assets in the U.S. (XLP and consumer staples stocks included) might see inflows to the extent that confidence in the European banks has taken a hit in the wake of the Cyprus situation.
Finally, taking a look at the performance of the XLP in relation to a basket of economic indicators and the performance versus consensus shows us that the broader economy continues to surprise to the upside (consistent with Hedgeye's macro call) driving performance of the XLP.
Where does that leave us?
Valuations suggest that we should stick to the sidelines, but it is difficult to ignore/fight improvements in the economy and money flows. Therefore, we are going to stick with value where we can find it and our preferred list remains unchanged:
Our least preferred list could be much longer based solely upon our concerns surrounding valuations in the sector, but for the moment we will add two names as we approach Q1 EPS:
- CL (new)
- K (new)
Enjoy the rest of your weekend.
HEDGEYE RISK MANAGEMENT, LLC
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.
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