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Dog Days of August

Client Talking Points

#RatesRising

It's late August on Wall Street. Volumes are light, ideas are sparse and the Hamptons is packed. Now's as good a time as any to reiterate Hedgeye's three core Q3 Macro Themes. At the top of the list? You guessed it. #RatesRising. 2.91% last on the 10-year. It's been a monster move. A generational shift is going on. We are not likely to see the 2012 lows on 10-year bond yields ever again. Yes, "ever" is a long time. Meanwhile, as the slope for interest rates turns up, so much that has been tied to declining rates will unravel.

#DebtDeflation

Total global debt outstanding is 3X total equity. This has created a massive Supply/Demand mismatch, as the supply of debt dwarfs the availability of equities. Nearly every major investment class is broken on Hedgeye's macro screen including Gold, 10-year Treasurys, Emerging Markets and high-yield bonds. The trends have reversed, and you should expect the outflows to be just as poorly planned as the inflows were. Indeed, the real risk is that there is a rush for the exits, leading already-crumbling asset classes to implode. 

#AsianContagion

Ex-Japan, Asian equity markets do not look good. Just pull up a chart on India's Sensex. Or Thailand. Or Indonesia. Japan is after 2% inflation, and they may get it by Burning Yens. The trade is Short Yens and Long Japanese equities. There's a lot of upside in the deep, liquid Nikkei. I know it's a tough pill to swallow. Look, Asia is not for the faint of heart. The Weimer Republic tried all this monetary madness. It didn't end too well. Bottom line is get out of the way of these highly suspect Asian currencies in a rising rate environment.

Asset Allocation

CASH 26% US EQUITIES 28%
INTL EQUITIES 24% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 22%

Top Long Ideas

Company Ticker Sector Duration
WWW

WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.

MPEL

Gaming, Leisure & Lodging sector head Todd Jordan says Melco International Entertainment stands to benefit from a major new European casino rollout.  An MPEL controlling entity, Melco International Development, is eyeing participation in a US$1 billion gaming project in Barcelona.  The new project, to be called “BCN World,” will start with a single resort with 1,100 hotel beds, a casino, and a theater.  Longer term, the objective is for BCN World to have six resorts.  The first property is scheduled to open for business in 2016.

HCA

Health Care sector head Tom Tobin has identified a number of tailwinds in the near and longer term that act as tailwinds to the hospital industry, and HCA in particular. This includes: Utilization, Maternity Trends as well as Pent-Up Demand and Acuity. The demographic shift towards more health care – driven by a gradually improving economy, improving employment trends, and accelerating new household formation and births – is a meaningful Macro factor and likely to lead to improving revenue and volume trends moving forward.  Near-term market mayhem should not hamper this  trend, even if it means slightly higher borrowing costs for hospitals down the road.

Three for the Road

TWEET OF THE DAY

Another solid European #GrowthStabilizing data pt this morning with German PMI for AUG clocking a 52 vs 50.7 last @KeithMcCullough

QUOTE OF THE DAY

"Great minds discuss ideas; average minds discuss events; small minds discuss people" -Eleanor Roosevelt

STAT OF THE DAY

Americans spent $11.8 billion on bottled water in 2012. Americans account for 15% of total world consumption of bottled water, which stands at about 61.4 billion gallons annually. At an average cost of $1.22 per gallon, US consumers are spending 300 times the cost of tap water to drink bottled water.


ICI Fund Flow Continues to be Tilted Towards Equities

Takeaway: While Equity fund flow slowed from last week it remained positive versus Fixed Income flow which continues to be decidedly negative

Investment Company Institute Mutual Fund Data and ETF Money Flow:

 

Equity Mutual Fund inflow slowed to $1.4 billion for the week ending August 14th, down from a $3.4 billion inflow the week prior but remained positive

 

Fixed Income Fund flows accelerated to a bigger draw down with a $3.9 billion outflow for the week which compared to the $2.0 billion outflow last week

 

Both Equity and Fixed Income ETF money flow was negative for the week with Equity ETFs losing $1.8 billion in fund flow and Fixed Income passive products losing $209 million in investor capital

 

ICI Fund Flow Continues to be Tilted Towards Equities - Table 1

ICI Fund Flow Continues to be Tilted Towards Equities - Table 2

 

For the week ending August 14th, the Investment Company Institute reported softening equity mutual fund flow trends albeit positive flow trends and accelerating week-over-week declines in fixed income mutual funds. Total equity fund flow totaled a $1.4 billion inflow which broke out to a $2.2 billion inflow into international equity products and a $764 million outflow in domestic stock funds. These trends compared to the week prior which experienced a much larger inflow of $3.4 billion with positive flow in both stock categories. Despite this deceleration in stock fund flows, the year-to-date weekly average for 2013 now sits at a $2.7 billion inflow for total equity products, a substantial improvement from the $3.0 billion outflow averaged per week in 2012.

 

On the fixed income side, outflow trends worsened during the week with the aggregate of taxable and tax-free bond funds combining to lose $3.9 billion in fund flow. This was almost a doubling of the $2.0 billion lost in the prior week with the taxable bond category specifically shedding $1.8 billion in the most recent period versus a slight inflow of $33 million last week. Tax-free or municipal bonds continued their sharp outflow trends losing another $2.0 billion in the week ending August 14th, in line with the outflow from the week ending August 7th. The 2013 weekly average for fixed income fund flow has now drastically declined from 2012, now averaging just a $469 million inflow this year, a far cry from the $5.8 billion weekly inflow averaged last year.

 

Hybrid funds, or products that combine both fixed income and equity allocation, continue to be the most stable category bringing in another $1.5 billion in the most recent weekly period. The year-to-date weekly average inflow for hybrid products is now $1.7 billion for '13, almost a 100% increase from 2012's $911 million weekly average.

 

ICI Fund Flow Continues to be Tilted Towards Equities - ICI 1

ICI Fund Flow Continues to be Tilted Towards Equities - ICI 2

ICI Fund Flow Continues to be Tilted Towards Equities - ICI 3

ICI Fund Flow Continues to be Tilted Towards Equities - ICI 4

ICI Fund Flow Continues to be Tilted Towards Equities - ICI 5

 

Passive Products Were in Outflow Last Week:

 

Both categories of exchange traded funds experienced redemptions by investors for the week ending August 14th. Equity ETFs lost $1.8 billion, the biggest outflow in 7 weeks and a reversal from the robust $6.2 billion which came into stock ETFs last week. Despite this week's outflow, 2013 weekly average equity ETF trends are averaging a $3.6 billion weekly inflow, a sharp improvement from last year's $2.2 billion weekly average.

 

Bond ETFs also had soft trends in the most recent weekly period losing $209 million in fund flow. This slight outflow was a vast improvement from the substantial outflow from last week of $3.8 billion however the 2013 weekly average is now just $401 million, much lower than the $1.0 billion average weekly bond ETF inflow from 2012.

 

ICI Fund Flow Continues to be Tilted Towards Equities - ETF 1

ICI Fund Flow Continues to be Tilted Towards Equities - ETF 2

 

HEDGEYE Asset Management Thought of the Week - Follow the Money Flow:

 

With exchange traded funds generally representing 60% institutional use and 40% retail investor use, we think it is valuable to look at year-to-date specific product flow trends to see where investor interest is gravitating. Looking at the ETF products with the most substantial fund flow as a percent of outstanding assets relays improving flow in domestic equity sector ETFs and also passive Japanese products. Conversely, 2013 has marked substantial selling of emerging market and bond ETF products thus far this year.

 

The biggest loss year-to-date has come from the MSCI Brazil iShare which has had over $3.0 billion withdrawn by investors or over 40% of its assets. The SPDR gold ETF has experienced a fund flow loss of similar magnitude having lost $20 billion from investor withdrawals or over 34% of its assets to end at a level of $40.1 billion. Bond products have seen accelerated loses since the beginning of the summer with the iShare TIPS fund now having seen a 29% redemption for the year and the SPDR high yield ETF, the JNK, now having lost 28% of its assets or $3.3 billion. With the passive unmanaged nature of these fixed income ETFs, we see these products as continuing to have disproportionate risk as bond fund flows continue to weaken.

 

ICI Fund Flow Continues to be Tilted Towards Equities - Bottom 10 ETFs

ICI Fund Flow Continues to be Tilted Towards Equities - Top 10 ETFs

 

Jonathan Casteleyn, CFA, CMT

 

 

Joshua Steiner, CFA

 

 

 

 

 


CHARTS DU JOUR: MACAU MASS HOLD

Still climbing but converging:  When will we know what is normal?

 

  • Luck obviously affects quarterly hold on all tables, not just VIP, but for Mass at least, it’s difficult to calculate.
  • Mass hold is impacted by the percent of chips taken out of the cage (not included in the denominator of the hold calculation) versus the table, dealer competency, player ability, and table minimums. 
  • Market hold has been on a steady climb especially for MPEL and Galaxy for all of the above reasons save luck.
  • Until we get a flattening of the rolling curve, it’s impossible to determine hold normalcy and calculate the luck impact on any given quarter.

CHARTS DU JOUR: MACAU MASS HOLD - JJ

 

CHARTS DU JOUR: MACAU MASS HOLD - HH


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

August 22, 2013

August 22, 2013 - dtr

 

BULLISH TRENDS

August 22, 2013 - 10yr

August 22, 2013 - spx

August 22, 2013 - ftse

August 22, 2013 - dax

August 22, 2013 - dxy

August 22, 2013 - euro

August 22, 2013 - oil

 

BEARISH TRENDS

August 22, 2013 - VIX

August 22, 2013 - yen

August 22, 2013 - natgas
August 22, 2013 - gold

August 22, 2013 - copper



The Desert

“What makes the desert beautiful is that somewhere it hides a well.”

-Antoine de Saint-Exupery

 

Volumes are light, ideas are sparse and the Hamptons are packed.  Welcome to summer on Wall Street!

 

The desert is the most pertinent geographical analogy to this part of the investing year.   Deserts are defined in a number of different ways, but generally the classification is based on the amount of precipitation that occurs in any year.  Below a certain level of precipitation, the region is considered a desert.  Think of precipitation as the idea generation engine of Wall Street that slows during the summer.

 

Interestingly, while most of us likely perceive a desert as a vast region of sand and limited plant growth, the reality is that only 20% of deserts have sand.  The largest desert in the world is actually the Antarctic Desert, which is, naturally, in Antarctica and covers more than 5.5 million square miles of ice and snow.  So, no, cold desert is not an oxymoron.

 

One place you don’t want to go after a long night of cavorting and over indulging is the Atacama Desert, which is the driest place on Earth and virtually devoid of life.  The average rainfall in parts of the Atacama is less than 1mm per year.  Further, evidence suggests that the Atacama may not have had any rainfall for the four hundred year period between 1570 and 1970.  Needless to say, even if you feel your portfolio is devoid of new ideas, there have been worse droughts!

 

In the Chart of the Day, I’ve attached our current Best Ideas list, which is comprised of the ideas that our research team recommends for three months and beyond (TREND) in our models.  Independent of this list I want to highlight the three ideas that I find most compelling.  They are as follows:

 

1.   International Game Technology (IGT) – IGT makes gaming machines and is, not to mince words, a free cash flow monster.  Over the course of the past three fiscal years, operating cash flow has outpaced total capital expenditures by over a $1 billion dollars in aggregate.    Compared to the current market capitalization of just under $5BN, this provides IGT ample cash to return to investors via share repurchases or debt pay down.

 

Speaking of debt pay down and cash flow, one of the more compelling reasons to own this stock is its potential interest to private equity firms and its inherent private market value.   As our Gaming, Lodging & Leisure Sector Head Todd Jordan has oft noted, four private equity firms were interested in IGT’s competitor WMS and one made it to the final round before Scientific Games ultimately won out.

 

2.   Nationstar Mortgage Holdings (NSM) – The roll up of mortgage servicing is a trillion dollar opportunity and NSM is ideally positioned.  (Translation: this is huge market.) NSM recently put up an EPS number for Q2 of $1.37, which outpaced the consensus estimate by almost 50%.  We think there is continued upside in numbers through 2014.  Currently based on the midpoint of NSM’s 2014 guidance, the stock is trading at less than 7x earnings with upward revisions and continued acquisition catalysts on the horizon.

 

3.   Fed-Ex (FDX) – FDX is just shy of a 52-week high and has outperformed the SP500 over that period, so is not necessarily a contrarian stock.  On a valuation basis, the stock is cheap trading at less than 6x TTM EV/EBITDA and has net cash on its balance sheet (excluding leases). 


Setting aside the financials, which are bullet proof, we think a key reason for owning the stock is that investors are currently ascribing little value to FedEx Express.  We think this division, once restructured, could have a similar margin to UPS or DHL’s express margin and generate an incremental $1.5BN in additional EBIT per year.   Frankly, if the Germans can make DHL Express profitable, it should be achievable for FDX.  If FDX can’t do it, there is no doubt an activist will consider stepping up.

 

Speaking of Fed-Ex, its key competitor UPS announced late yesterday that it was going to be dropping 15,000 spouses who are eligible for coverage from their own employer from its health insurance plan due to higher anticipated costs under the Affordable Care Act.  UPS expects to save up to $60MM per year on this “initiative”.

 

We’ve long extolled the benefits of limiting governments, in large part, due to unintended consequences of policy.   In the UPS instance, it may lead to less or more limited coverage for 15,000 working women.   There has also been ample evidence of workers hours being reduced so employers can avoid the punitive impact of the Affordable Care Act on their bottom line.

 

On a more macro level, there are potentially long term impacts to the labor market.  As Chicago Economist Casey Mulligan wrote in a recent blog for the New York Times:

 

“The Affordable Care Act’s explicit taxes on employers, subsidies for layoffs and implicit taxes on employees, together amount to five or six percentage point addition to the marginal tax rate on labor income.”

 

By Mulligan’s analysis, this may contract the labor pool by 3% in 2015.  At the end of the day, this shouldn’t really surprise any of us for as Milton Friedman said on the topic of government management:

 

“If you put the federal government in charge of the Sahara Desert, in 5 years there’d be a shortage of sand.”

 

Indeed.

 

Our immediate-term Risk Ranges are now:

 

UST10yr 2.74-2.96%

SPX 1

DAX 8

USD 80.91-81.81

Yen 96.21-98.56

Gold 1

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

The Desert - COD

 

The Desert - vp 8 22


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