“Forces might make it easy for group-based processes to turn collaborations into cheating opportunities.”
There’s some serious irony that I’m finishing up my behavioral economics review of Dan Ariely’s The (Honest) Truth About Dishonesty while our profession gets its reputation tarred and feathered by the fun cops.
I call it our profession, because it is. We are all responsible for self-policing this Street. For too long we have allowed our compensation structures to cloud our definition of grey. Leadership principles are black and white. It’s time to champion transparency and accountability.
No, it’s not easy to write about this. I think we all have former friends who have lied to us. Accepting that isn’t easy either. Social groups affect us in many ways that we are too human to understand.
Ariely reminds us that “when cheaters are part of our social group, we identify with that person and, as a consequence, feel that cheating is more socially acceptable. But when the person cheating is an outsider, it is harder to justify the misbehavior, and we become more ethical in our desire to distance ourselves from that immoral person and from that other out-group.”
“… results show how crucial other people are in defining acceptable boundaries for our own behavior, including cheating. As long as we see other members of our own social groups behaving in ways that are outside the acceptable range, it’s likely that we too will recalibrate our own internal moral compass and adopt their behavior…” (pages 206-207).
Leadership isn’t how much money you make; it’s your opportunity to make a difference.
Back to the Global Macro Grind…
The Russell 2000 clocked another all-time closing high yesterday of 1054 (+24.1% YTD) as mostly every growth stock that beats toned down expectations rips to new YTD highs. Slow growth investor T-Bonds were down (again). This remains a growth investor’s market.
Growth, growth, growth – if you can find it, buy it – that’s not just a progressive message that stands in stark contrast to the fear-mongering one that is getting pummeled (VIX -29% YTD), it’s a good way to live your life. In order to grow, you need to embrace change.
What’s interesting about being long growth is that not all “growth” investors have actually agreed with it, yet. That said, it’s important to remember that we’re all storytellers – and the market doesn’t care about our own individual versions of the story.
Here’s the non-fictional account of what we call growth “Style Factors” for 2013 YTD:
- Top 25% EPS Growth Stocks (SP500) = +23.8% YTD
- Low Dividend Yield (growth) Stocks = +26.4% YTD
- High Short Interest Stocks = +22.6% YTD
In other words, if you are long high-beta stocks that A) look “expensive” B) have high short interest and C) deliver better than “expected” growth results – boom! Non-cheater alpha is yours to keep.
Not only are non-obvious growth Style Factors beating the SP500’s YTD return of +18.5%, so is growth as a sector-style within the SP500:
- Consumer Discretionary Sector ETF (XLY) = +25.1% YTD
- Utilities Sector ETF (XLU) = +12.3% YTD
That’s a massive (and widening) performance spread that looks a lot like being long US Stocks vs US Treasury Bonds.
And there’s more alpha where that came from. Whether it was Visa (V), Facebook (FB), or long-time Hedgeye favorite Starbucks (SBUX) this week, Mr. Market is telling you that you don’t need to cheat to win in this business. You need to pay up for the growth that you can find.
While this doesn’t always make sense to people until they make the amount of mistakes I have, the other side of being long this growth rip is shorting “value” stocks that look “cheap” (if you use the wrong numbers).
So all in, what we have here is an opportunity to separate the pretenders from the pros. This is the new old school - roll up your sleeves and do your own work. No need for insider information. Just have the confidence and humility to let Mr. Market tell you all you need to know.
Math is our edge. It’s black and white. The opportunity to capitalize on leadership principles and a repeatable process has never been so bright.
Our immediate-term Risk Ranges are now:
10yr Yield 2.47-2.65%
Best of luck out there today and enjoy your weekend,
Keith R. McCullough
Chief Executive Officer
THE MACAU METRO MONITOR, JULY 26, 2013
FERRY TERMINAL REVAMP TO START THIS MONTH MACAU BUSINESS
According to the Marine and Water Bureau, the revamp of the Outer Harbour Ferry Terminal aimed at improving its passenger facilities will begin as soon as July 29. The project, which will cost the government 80 million patacas (US$10 million), will add a baggage carousel on the east wing of the ground floor, and more counters on the second floor for tourism agencies and banks, as well as ferry ticketing counters and check-in counters for Hong Kong airport ferries. The one-year Outer Harbour revamp will proceed in five phases, said Sam Ip Va Hung, chief of the bureau’s Port Control Department.
EMPLOYMENT SURVEY FOR APRIL-JUNE 2013 DSEC
Macau's unemployment rate for April-June 2013 held stable at 1.8%. Hmm, I wonder in what part of the underground economy the 1.8% work?
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Colgate reported a top-line miss, but met EPS expectations of $0.70, for 2Q13 this morning and revised earnings guidance lower by 1% to 4.5-5.5% for the year. There were some reservations ahead of the quarter, on our part, about the difficult sales growth compare but strong volume growth, offset by FX headwinds, impressed versus expectations. Despite strong organic growth and operational performance, we would not own the stock at 21x forward earnings. Importantly, #RatesRising, one of Hedgeye’s 3Q Macro Theme, is a key risk for the broader Staples sector and we believe that the associated strength in the USD would be a negative for CL.
North America: The North America division delivered 5% organic sales growth (6% volume, -1% price) as Colgate continues to grow its dominant share of the oral care category. A strong new product pipeline is continuing to support robust revenue growth in this division, which represents roughly 18% of company sales. EBIT margins in North America grew 2.8% year-over-year to 29.8%. This may be unsustainable, but a “benign cost environment” and continuing sales growth implies additional strong EBIT margin results going forward.
Europe South Pacific: Management cited sluggish economic growth as a headwind to sales growth after announcing organic sales declines of -2% versus 2Q12 (1% volume, -3% price). Despite the slowing environment, the company is growing its share in toothpaste, toothbrushes, mouthwash, and fabric softener.
LatAm: The Company’s largest region, by revenue, delivered 7% organic growth in the second quarter (2.5% volume, 4.5% price) and grew market share in many categories and markets. FX was an 8% drag on the top line, driving the entire -1.5% decline in net sales growth. EBIT margins contracted in Latin America for the third successive quarter although, again in 2Q if the impact of Venezuela’s currency devaluation were excluded, LatAm margins would have been up year-over-year.
Greater Asia/Africa: GAA delivered 9.5% organic sales growth (0% price) as toothpaste market share increases in India, China, Russia, and other markets. China and India are growing at double-digit organic growth rates. Growth potential remains promising in this segment as the company improves its distribution into new cities and rural areas.
Hill’s Pet Nutrition: Hill’s net sales surprised to the upside, with unit volume of 2.5% and pricing of 3% resulting in 5.5% of organic sales growth. While the volume growth was unexpected, “one quarter ahead of schedule”, according to management, it seems to have come at the expense of some margin. In 2Q, Hill’s EBIT margin contracted by 250 basis points to 24.8%.
- Management revised FY13 EPS guidance to +4.5-5.5% growth versus +5.5-6.5% prior. This downward revision was entirely due to
- Reaffirmed organic growth rate guidance of 6-7% for FY13
- Reaffirmed gross margin expansion guidance of 30-70 bps
What we liked
- EPS met consensus expectations
- Consolidated organic sales growth came in at 5.5% vs. a difficult comp (comps ease over 2H13)
- Gross margin expansion accelerated in 2Q13 despite sequentially tougher comparison (chart below)
- EBIT margin year-over-year growth was 3.1% versus sales growth of 1.9%
- FCF flat vs. year ago despite 57% ramp in capex
- Easing comparisons in 2H12
- FY13 gross margin guidance likely to be met
What we didn’t like
- FX continues to be a big drag
- Earnings multiple implied by the stock price seems full at 21x
- Margin weakness in Latin America
(Editor's note: Earlier this morning, Hedgeye CEO Keith McCullough was asked what his estimate was for when the Bernanke Central Planners Fed will finally begin increasing the Fed Funds rate. Here's his response.)
KM: Well, my estimate and when the Fed will actually do what I would estimate they should do are two completely different things. The difference between the two is that one is math and the other is politics. That’s unfortunate.
I would never dare say that I have a forecast on when the Fed’s going to do anything. Because the best forecast you can have is having Bernanke, or one of the boys in his Crony Network, telling you. That’s why people pay so much money for that—the people that are still willing to pay for that kind of information. That’s the real answer.
When should he taper? He should be tapering right now. I mean, he should have tapered at the last meeting. He should be tapering through September. But that doesn’t mean that he will. So it’s kind of a tough one to answer.
Because what he should do, and what he will do, are two very different things.
Look, this is the first Federal Reserve chief in U.S. history to never raise interest rates. Never. He won’t even taper! Never mind raise interest rates. It’s sad, and it’s pathetic. But we just have to deal with the game that’s in front of us.
Takeaway: On balance, equity investors should be increasing their exposure to US companies that have a large domestic footprint.
- We are buyers of US equities here provided that the US Dollar Index holds its intermediate-term TREND line of support and subsequently recaptures its immediate-term TRADE line of resistance. This, of course, assumes the broader equity market remains bullish TRADE and TREND in the process. For now, there is little fundamental reason to suspect that it won’t.
- We ran a equity screen for publically-traded, domestically-domiciled corporations that break out their revenue by geographic segment. In the large cap bucket, our screen returned 270 names; in the small-to-mid cap bucket, our screen returned 1,684 names. The charts below show that, on balance, companies with a low degree of foreign currency exposure have been demonstrably outperforming those that have a high degree of foreign currency exposure.
- All told, whether you’re a large-cap stock-picker or small-cap investor, you should be demonstrably increasing your exposure to US companies that have a large domestic footprint, on balance. Needless to say, continued underperformance awaits those funds whose managers fail to do so.
- But don’t just take our word for it. Pull up the 2Q earnings releases from MCD, KMB or CAT. Those management teams will tell you all you need to know about our #StrongDollar call and its impact on various segments of the domestic equity market. Please email us if you’d like to dialogue with Howard Penney, Rory Green or Jay Van Sciver regarding their bearish theses on each of those three names, respectively.
FOLLOW THE BOUNCING BALL
We’ve often remarked that front-running inflections and/or sustained trends in the US dollar is integral to staying afloat in today’s increasingly policy-driven, globally-interconnected web of financial markets.
As the USD has appreciated in the YTD (up +4.1% on a trade-weighted basis), this rhetorically-simple, yet analytically-complex strategy has continued to work like a charm for us and our clients:
Moreover, it’s not enough to simply know what direction the US dollar is likely headed in; rather, the “why” is important as well. To recap:
- We think this latest USD rally has legs with respect to the intermediate-term TREND and long-term TAIL largely due to a positive resetting of structural growth expectations in the US, which itself is being driven by a reflexive recovery in the housing and labor markets, as well as accelerating household formation and birth trends.
- Additionally, we continue hold a demonstrably-bearish outlook for the JPY in the context of the BoJ’s monetary policy outlook and we also hold a structurally-subdued outlook for EUR appreciation in the context of the two-speed European economy.
- Lastly, we think the confluence of #StrongDollar and #RatesRising will create a reflexive feedback loop whereby global capital allocators continue to flow out of EM local currency exposure and back into USD exposure, at the margins.
As an aside, one of the ways we determine if the USD is appreciating because of rising growth expectations vs. international investors de-risking their portfolios is through cross-asset class regression analysis. In the event of the latter scenario, one would expect to see the USD hold positive correlations to various measures of financial market volatility and credit spreads, while registering inverse correlations to growth assets, such as equities.
That has certainly not been the case over the past year, which is consistent with our view that the USD is appreciating for growth reasons and not due to investor fear/economic uncertainty (TTM correlations to the DXY):
- S&P 500: +0.75
- Russell 2000: +0.70
- CBOE SPX Volatility Index (VIX): -0.25
- US Corporate BBB/Baa vs. US Treasury 10Y (bps Spread): -0.61
What is not consistent with our view, however, is the past three weeks of consensus anti-growth, anti-tapering speculation (trailing 3W correlations to the DXY):
- S&P 500: -0.81
- Russell 2000: -0.80
- CBOE SPX Volatility Index (VIX): +0.59
- US Corporate BBB/Baa vs. US Treasury 10Y (bps Spread): +0.80
We’ll continue to monitor these most recently developing price signals in real-time; for now, we hold the view that this is an immediate-term head-fake within the construct of an intermediate-term fundamental story. See the forest, not the trees…
HOW TO PLAY THIS
So what does this all mean for US equities? Simply put, we are buyers of US equities here provided that the US Dollar Index holds its intermediate-term TREND line of support and subsequently recaptures its immediate-term TRADE line of resistance.
This, of course, assumes the broader equity market remains bullish TRADE and TREND in the process. For now, there is little fundamental reason to suspect that it won’t.
MACRO MEETS MICRO
For those of you who have been following our macro calls since the start of the year, you’ll quickly note that this strategy directive isn’t anything new. What is new, however, is the analysis below, which supports our view that equity market participants have been doing just that (i.e. taking up their gross exposure to the US dollar).
We ran a equity screen for publically-traded, domestically-domiciled corporations that break out their revenue by geographic segment. In the large cap bucket, our screen returned 270 names; in the small-to-mid cap bucket, our screen returned 1,684 names. The charts below show that, on balance, companies with a low degree of foreign currency exposure have been demonstrably outperforming those that have a high degree of foreign currency exposure.
(NOTE: The first two columns on each chart show the average performance of securities in excess of -1x and +1x standard deviations of the average percentage of revenues derived from the US for all companies less than 100%; the far right column captures the rest (i.e. those companies with 100% of their revenues sourced domestically). Per this calculation method, the average, -1x STDEV and +1x STDEV domestic revenue exposure for the large cap sample was 58.3%, 31.3% and 85.2%, respectively. For the small-to-mid cap sample, those figures were 61.9%, 36.6% and 87.2%, respectively.)
All told, whether you’re a large-cap stock-picker or small-cap investor, you should be demonstrably increasing your exposure to US companies that have a large domestic footprint, on balance. Needless to say, continued underperformance awaits those funds whose managers fail to do so.
But don’t just take our word for it. Pull up the 2Q earnings releases from MCD, KMB or CAT. Those management teams will tell you all you need to know about our #StrongDollar call and its impact on various segments of the domestic equity market. Please email us if you’d like to dialogue with Howard Penney, Rory Green or Jay Van Sciver regarding their bearish theses on each of those three names, respectively.
In a world were consistent alpha generation is increasingly hard to find the legal way, we continue to sing the praises of marrying top-down macro analysis with bottom-up fundamental analysis. Long live Wall St. 2.0!