Investing Ideas Updates:
- CAG: With consumer staples earnings season all but finished, Consumer Staples sector head Rob Campagnino continues to like Con Agra (CAG) as a longer-duration idea. While the company didn’t post the most impressive quarter of the names that we follow, we believe that the mosaic of earnings season points to CAG as a solid, longer-term play. Themes such as lower commodity costs, consumer frugality and concerns over stretched valuations in consumer staples continue to suggest to us that CAG is a preferred name in the space. (Please click here to see the latest Stock Report on CAG.)
- HOLX: Hologic CFO Glen Muir presented at the Bank of America Healthcare Conference this week and had some helpful commentary regarding their weak quarterly results and the outlook for some key items.
On a pricing code for 3D Tomo systems from CMS, Muir said, “We don't feel we need reimbursement” but “we are hopeful. (Holgogic CEO) Rob (Cascella) stated on our call that we believe that by the end of this calendar year we could have a G code in place. Hedgeye Health Care Sector Head Tom Tobin says, “The code from CMS will make financing a purchase of a 3D system viable for the customer. Management seems to continually push out getting a code and now have introduced the idea that they may not need one. Being hopeful is not a good place to be and we are reaching out to our clinical network to find out more.”
On a weak Breast Health result despite strong MQSA data: “And I know when you and I spoke after the call you said that a lot of those conversions now are going to FUJI because they have kind of a lower-tech machine that those accounts are interested in.” Hedgeye says, “Share loss explains the miss against our forecast and puts more burden on 3D ramp.” (Please click here to see the latest Stock Report on HOLX.)
- MPEL: The news from Macau continues to impress as growth appears to be actually accelerating even from April’s strong 13% market growth. Following our Asia trip, we expect more of the same in the ensuing months. Melco Crown Entertainment (MPEL) remains our favorite way to play the rosy Macau thesis due to a still discounted valuation, expanding market share, and new project pipeline. (Please click here to see the latest Stock Report on MPEL.)
Macro Theme of the Week: The Buck’s the Trend
Folks looking for a Sure Thing in the investment markets would like nothing more than the ability to read tomorrow’s newspapers today. If you’re really paying attention, it might be enough to just read today’s papers.
This week Hedgeye CEO Keith McCullough said, If you get the dollar right, you get a lot of other things right too. Last week Keith said, If you get the dollar right, you get a lot of other things right too. The week before that Keith said, If you get the dollar right… well, you get it.
The dollar is the driver of so many other critical pieces of the global economy. Reading the dollar is a bit like driving. If you see a driver several cars ahead of you signal a turn, you realize that the driver behind that car is highly likely to slow down very soon. Which will cause the next car in line to slow down, causing the next one to slow, et cetera. If you are a cautious driver you may slow down even before the brake lights come on on the car ahead of you. If you are an aggressive driver, you may speed up to catch that last few yards before the row of cars ahead of you cause you to slow down. But however you play it, your driving in the space of the next few seconds is governed by your awareness of the chain reaction that is highly likely to take place in front of you.
Says McCullough, “So much more of what’s been working will happen is the US Dollar keeps ripping.”
Consumption: A Strong dollar is a Spendable dollar, and the Strong Consumption growth trend remains in place. Financials sector head Josh Steiner wrote this week that recent data from the Fed and from Harvard’s Joint Center for Housing Studies indicate “housing construction is likely to double from current levels.” (We give more detail on Steiner’s work in the next section.) If you are either a long-term investor, or a person who spends dollars to buy things, this is a positive scenario.
If your investment horizon is shorter term, or if you manage your portfolio risk on a daily basis, McCullough says this week’s breakout of the dollar to fresh Year To Date highs takes the currency to an immediate-term overbought level. As in the example of the driver signaling a turn, this could mean a short-term rise in the price of things that tend to trade against our currency. Right now two of the most sensitive counterweights to the dollar are Gold, and just about anything Japanese.
The End of the “End of the World”: The so-called “end of the world trade” – we would give credit if we knew who coined the term – describes the massive flow of investment capital out of “normal” instruments like blue chip stocks, investment-grade corporate bonds and government bonds of developed economies like US Treasuries or British Gilts, and into commodity investments. Commodity investors generally buy things like gold and silver, either in ingots or in the form of a variety of ETFs, commodity contracts, or mining stocks.
This week McCullough points to persistent weakness in the price of gold, saying a little more Dollar strength could continue to perpetuate the crash in the physical gold market.
But End of the World investors also piled lots of cash into things like bottles of wine, fine art and other collectibles.
Tremendous amounts of money have also been invested in stocks in economies that revolve around the commodity complex. This has long been a key to the BRICS thesis, which may now be unraveling. As noted by Hedgeye Macro analyst Darius Dale (there are vast sinkholes of vulnerability in these commodity-based markets, most of which are so-called “emerging markets” characterized by economies that ride up and down on the back of the commodities they produce.
Dale quotes a 2010 IMF report that says market crises are not guaranteed to follow when commodity prices turn down. Says the IMF, “Crises require some triggering event.” But Dale cautions that crises tend to start when investors apply developed market rigor to analyzing emerging markets. When the yield on US Treasury bonds went into the toilet, the “Hot Money” scoured the world for yield and came to rest on the shoulders of such nations as Russia and Brazil, with vast commodity wealth, but with underdeveloped capital markets.
Hedgeye’s Macro team also writes that the Japanese markets may be “signaling an end to the ‘end of the world’ trade.” Japanese Government Bonds (JGBs) continue to decline and the Yen is positively crashing. The Macro team reads the Japanese tea leaves in the crashing yen and tumbling JGB markets as a signal that this end of the world scenario may be done, at least for this cycle.
Ultimately, McCullough writes that this could lead to “a 1994-style or 2003-style backup in super-sovereign interest rates over the next 12-18 months.” In other words, first the JGB market dives. Lower bond prices cause Japanese interest rates to shoot to the upside – McCullough notes that Japanese market indices are signaling widespread fears of higher inflation. This could be the start of a trend that washes back from Japan’s shores and flows over the major developed markets, causing interest rates to rise throughout the OECD nations and ultimately in the US.
This could get particularly sticky in the US if global upward pressure on interest rates pushes on the Treasury market while US unemployment is still above 7%, which would require (well, at least according to what he said) Bernanke to maintain an aggressive Quantitative Easing program to hold rates down. At a certain point, Bernanke would have to yield to the yield, or risk seeing a massive outflow of global money from the Treasury market in flight to higher yields in other developed markets.
Hedgeye’s Macro bullish thesis for the US economy continues to crystallize as our work confirms Strong Dollar, Rising Consumption, Accelerating Household Formation, Rising Birth Rates, Labor Market Improvement, and Parabolic Recovery in Housing.
Sector Spotlight: Housing – Dodging the Wrecking Ball
The last 4 housing cycles have exceeded two million starts at their peak. Will this one?
Financials sector head Josh Steiner cautions that we should not be tripped up by this week’s reported 16.5% decline in housing starts. Like every other statistic reported by the government, housing is broken up into a number of components. It would be too simple to just say “more houses were built” or “fewer houses were built” during the month.
Steiner tears apart this week’s report and concludes it is not a significantly negative number. Indeed, while Housing Starts declined, Housing Permits were strong. Steiner quotes work by the Census Bureau that indicates Permits may be the better indicator on a short-term basis than Starts, though in either case, a single report does not constitute a trend – nor even a reversal of a trend.
Last month the Census Bureau reported that March housing starts shot through the magic “one million” number for the first time since June 2008. Steiner says this was about twice the low reading of 500,000 in early 2009 and continues and confirms an upward trend in place since mid-2011. The combination of immigration with rising birth trends continue to point to increasing household formation, a primary driver of housing. And a significant kicker is analysis from the Federal Reserve that indicates a two-pronged stimulus effect on housing. In the long term – a decade or more – demographic trends affect household formation, with a direct influence on housing. But in the shorter term – one to three years – household formation appears to be driven almost exclusively by macroeconomic factors, especially by unemployment. In other words, as more people get jobs, more families will form in the near term.
Can Bernanke hit his 6% unemployment target? We have been saying it could happen a lot sooner than he planned. Can you imagine the double-whammy impact on the housing market if we get lower unemployment and rising birth rates in the near term, coupled with the longer-term impact of immigration reform? We can.
Investing Term of the Week: CPI
Like any other economic measure, Inflation is tracked on many different scales. The CPI – the Consumer Price Index – is supposed to measure inflation as it affects you, the individual participant in the economy.
Also like any other statistic, the CPI is based on averaging lots of numbers. The Bureau of Labor Statistics, the government agency that calculates the CPI, defines the Index as “a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.” There are a number of ways in which the BLS formula strives to make the CPI a truly representative index.
The CPI reflects the spending patterns of all urban consumers, representing about 87% of the US population, and including all economic classes, as well as the unemployed. Excluded from the CPI calculation are farmers, people living in rural nonmetropolitan areas, people in the military, and people in prisons and mental hospitals.
The CPI is a policy tool. It models broad categories of consumer behavior as a guide to measuring overall rates of inflation. One thing the CPI is not, it is not a Cost Of Living Index. A cost of living index would measure changes in how much you would have to spend to maintain your style and standard of living. The CPI tells you how much you spend regardless of its impact on your lifestyle, not how much you have to spend to stay at the same level.
Consider also, that inflation can be very individual and life-stage specific. An individual over age 65 consumes a far different mix of goods and services than someone aged 25. For example, medical cost inflation has generally run at a sizeable premium to reported CPI inflation and an individual over age 65 consumers healthcare services in amounts multiplies higher than an individual age 25. The difference in personal inflation levels and the resulting capacity for other consumption between these two individuals can turn out to be more stark than the single, Headline CPI figure might suggest.
The BLS comes in for criticism – some would say, “from the usual quarters” – for the way it sets parameters in the CPI. The CPI is part of the toolkit that helps government economic policy makers maintain the American Way of Life. We’ll attempt to describe one of the tools our government uses to describe your behavior, as a guide to finding out what it is you really want.
If you find the following confusing, don’t worry. It’s difficult for non-practitioners to make any sense of economic statistics.
As critics of our government’s policies might observe: for practitioners, it’s impossible.
Hedonic Adjustments – You may have gone into a verbiage-induced coma just from reading the term, but as they say in the used car business, “Work with me here.”
The BLS recognizes that products change. A common example would be the substitution of lower (or higher) qualities of beef in burgers in a region, owing to weather conditions that had a negative (or positive) impact on the corn crop, and consequently on cattle feed. The word “hedonic” – related to “hedonism” – describes the pleasure you get from biting into that juicy burger at your favorite chain. The BLS has used hedonic adjustment for many years and says that the International Labor Office acknowledges that hedonic adjustment is a “powerful, objective and scientific” way to approach the flowing changes in consumer goods.
To describe it simply, imagine that your hamburger has lower quality beef in it because there has been a drought. Or imagine that it has lower quality beef because management of your favorite chain has decided they need to beef up profits (pun totally intended) and have wantonly substituted cheaper ingredients to save expenses. The hedonic modeling is one of the methods used to determine what percentage of a change in price is perceived by consumers as also reflecting a change in quality.
Do you get it?
Critics (and there are plenty) point out a few issues with this approach.
One is that often the price doesn’t change. A burger can sell for the same, but contain cheaper ingredients. Indeed, the consumer may not even be aware of the change, which may not require disclosure. Proponents of “right” economic practice insist the only way to make a true hedonic comparison is for the new and the old product to both be on the market at the same time, and for a decent period of time to elapse so that consumer preferences can be determined.
That will not happen if a burger chain increases the soy content of all their burgers, while cutting the beef content.
If you are of a certain age, you may recall a product called “New Coke.” In the new product introduction, Coca Cola did a pure hedonic experiment, offering both products side by side and allowing consumers to establish the market levels for both. In the event, the “market clearing price” for New Coke was nothing. Zip. Nada. It is still a mystery to us why the product came on the market in the first place. We were told it was an attempt by Coke to become its own primary competition, thereby capturing both the Number One and Number Two spots worldwide. In the event, New Coke got slammed and has since been ignominiously retired. (It may be in belated recognition of this product failure that there recent introducti0on is called “Coke Zero.”)
The BLS rarely gets to grapple with such a clear-cut example of hedonic adjustment in action.
Another criticism is that most “improvements” in most products are driven by marketing, not by any meaningful technological or quality advance. Marginal improvements in computer hardware mean little to most consumers, and many individuals buy new hardware not because they desperately need the improvement, but because they are “upgrade junkies.” You know, the people who stood on line for 72 hours for that New New New New New smart phone.
But hedonics is not just about how much benefit a consumer receives from a product. If that were the case, the measure would have to be based on medical testing. Instead, it attempts to measure how much a consumer enjoys a change in a product, and what price the consumer is willing to pay for that enjoyment.
The CPI attempts to model buying habits of the consumer, who represents over 70% of the US economy. That makes it a really important metric. And to scoffers who say it doesn’t fairly represent the value of a hamburger that is made cheaper, but priced the same, we might point out that the psychological / emotional satisfaction derived from eating is much more important to us than nutritional content. Many more Americans now suffer from obesity than malnutrition.
It’s where it’s at.
Hedonic adjustment attempts to capture sentiment around consumer perceptions of whether they enjoy a new product. The impact of marketing-driven consumption has introduced such critical notions as Planned Obsolescence, which had consumers buying new cars and new major appliances every three years. Which we believe spilled over into real estate finance, where the average American homeowner sold or refinanced after about seven years.
Where thousands of people worldwide will stand in line overnight to be the first to own a “new” product consisting of a redesigned housing, a larger screen, and a few software upgrades.
Now that’s what we call a really smart phone!