Greater than the tread of mighty armies is an idea whose time has come."
I’ve spent many early mornings this year attempting to objectively contemplate the end of the world. Despite the Nasdaq (+23% YTD) closing at a fresh YTD high yesterday, on every downtick in US growth stocks everyone and their brother has been worried about it – and there have been big fear-based advertising businesses built on it. How some people get paid is serious stuff.
Our Big Macro Idea in 2013 (that the world wouldn’t end) has drawn the ire of everyone, from the old-boy financial media network, to the newbie ad-platform from parts unknown (Zero Hedge). Many of you have seen the comments they chose to flog in public – in Twitter, on TV, in the press. Only a very few of us have seen the ugliness of some of the emails some of these characters have sent me. Least said, soonest mended (word to the wise…)
We will continue to power forward with an idea whose time has come – a transparent, accountable, and trustworthy independent research platform that has zero conflicts of interest. We have no banking, trading, or advertising revenues to pander to. We aren’t banned from the securities industry either, like some of our snottier critics. We’re right where we want to be - standing in the arena of meritocratic debate.
Back to the Global Macro Grind…
Today is what we call an Event Day @Hedgeye, because we are hosting one of our Best Idea Conference Calls on what we believe is a significantly overvalued company called Kinder Morgan. For those of you who follow either our written research from Energy sector all-star Kevin Kaiser or my #RealTimeAlerts, you’ll know we’ve been bearish in both print and #timestamped KMP short sales since the beginning of August.
For the end of the world community that somehow hasn’t called the short side of things that actually go down in 2013 (like Gold, Bonds, or Linn Energy – another short idea from Kaiser), this whole event day thing drives them right squirrel. How dare a “young” and up and coming research and risk management firm interrupt their navel gazing?
Admittedly, I’ve only been making short calls for about 15 years, so I may not know as much as the clients who pay for our work. Every morning of my market life, I wake up assuming that I need to learn something. It’s not my job to assume we’re going to be right – it’s to try to prove myself wrong.
The #OldWall and its media outlets have a different model – they know everything about everything, 5 miles wide and an inch deep:
From our Wall St 2.0 friends at Seeking Alpha > Kinder Morgan Energy Partners (KMP): "There is an outfit that is trying to get this thing down. They are calling it a house of cards. Richard Kinder (the CEO), come on this show. I know they are going to (do) a massive hit job on you. If you want to be able to tell your story, Mad Money welcomes you. This is a stock I like." –Jim Cramer
Mr. Cramer got nowhere with his Sound and Fury in our last public debate – which descended into members of the Old-Boy network trying to suggest we were committing a securities violation with our research call on Linn Energy (LINN). One has to admire the conviction the man brings to the table today, on what looks like a replay of the same tape. Occasionally wrong, never in doubt.
Whether you’re a media talking head trying to drive advertising revenues, an Old Wall firm that’s banking one of Kinder’s deals, or just a portfolio manger flat out chasing dividend yield because you have to – it’s all cool with us. So is doing our own work on an idea whose time has come.
For those of you who think it’s a big positive that Rich Kinder “bought stock” in KMI here are a few research nuggets to consider as you contextualize that headline:
In other words, Kinder has more than a few billion reasons to defend both his stock’s crazy valuation and how he gets paid. The old-boy network of Old Wall Street and the media brotherhood are going to help him do that.
After Bear Stearns crashing … and all that we have gone through in the last 5 years as a profession, is this the best the said savants of the closed-network that was Wall St 1.0 can do?
Or, after missing epic declines in both Gold and Bonds (and after trying to freak people out at yet another higher-low for the US stock market at the August lows), is this just the end of their world as they knew it?
We don’t purport to know everything. But we do our own work and we’re looking forward to objective analysis that attempts to refute our well researched opinion. Dial into our call on Kinder Morgan at 11AM (ping for access) and, instead of calling just calling us “young” (Daryl Jones and Todd Jordan are getting old!), please tell us what you think.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.84-3.02%
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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TODAY’S S&P 500 SET-UP – September 10, 2013
As we look at today's setup for the S&P 500, the range is 20 points or 0.82% downside to 1658 and 0.38% upside to 1678.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS (Bloomberg Estimates):
WHAT TO WATCH:
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
The Hedgeye Macro Team
Below we highlight relatively new products and business models that are displacing the more traditional ones, as they appeal to both the Baby Boomer and Millenial generations.
Baby Boomers and Millenials Converge
Consumers are constantly making decisions regarding the choice, purchase and use of products and service. As we have seen in this new consumer landscape, a product or service that can span two generations is a game changer. I’m the father of three wonderful children, two girls and one boy, who are all in fact Millenials. It is becoming more and more common that we enjoy shopping and eating out at the same places. And, while I would say that our taste in music differs, that statement may lack validity, as the Zac Brown Band and Jimmy Buffet have recently come together to perform “Knee Deep.” The point is, this Baby Boomer and Millenial convergence is fairly widespread.
Whole Foods is an example of a company that spans multiple generations and is driving incremental visits in large part to their multifaceted approach in which they seek to attract new and old consumers. The following quote from the CEO of WFM is highly indicative of this theme, which leads us to search for companies that are leveraging new business models, while avoiding companies with traditional business models that are coming under pressure:
“We were built by boomers, we are boomers, and I think the boomer you got – you basically have, what a million people retiring every day or something now? You've got people who are coming into that time of their life where their health really matters. And that's just a statistical fact and the alternative around your healthcare, if you don't take care of yourself, it's pretty bad and it's pretty expensive. So, I think a lot of people, who have realized that this is the time to shift around diet and lifestyle and that all the noise in the world around us basically saying – pointing folks in that direction too. I think what I've seen with the millennial generation, that we have a lot of team members who obviously are Millennials is that, they are coming to Whole Foods a lot because of that, but because they also like the way the company, the decisions it makes, the values that it stands for, the change it's trying to create in the world. And increasingly, are looking for companies that they can line up with, in a way that feels right to them.”
-Walter E. Robb, CEO Whole Foods
From our perspective, we see three main themes embedded in this quote from Walter Robb:
It All Starts With Stressed Consumers
In today’s consumer environment, with a bevy of public information now available, people consistently seek to make smarter choices, leading them to purchase items with a higher perceived value. Value is not simply about price and varies from industry to industry. For example, in the restaurant industry, value is now a combination of price, quality, environment and experience, with an added emphasis to experience. This is why a $7.50 burrito from Chipotle may have a higher perceived value than a $4 Big Mac from McDonald’s.
With disposable income and confidence coming under pressure here in the U.S., the consumer base is being stretched. Between 2000 and 2009, disposable income per capita grew on average 3.8%, as opposed to the 1.1% growth we have seen year-to-date in 2013. Over the same time periods, the Bloomberg Consumer Comfort Index was on average 13.4, as opposed to -31 so far in 2013. The point is, consumers want to go out to shop and eat, but what they get from their experience is now more important than ever before. We believe this is driving consumers toward higher perceived stores and restaurants and away from lower perceived, traditional ones.
Higher Rates = Lower Multiples
Restaurant industry finance guru, John Hamburger, recently shed light on a few developing casual dining issues. Most notably, in our opinion, was his take on the private equity sector. He highlighted how a majority of the new private equity investments in the restaurant industry have been to scoop up large pools of franchised stores, rather than ponying up for the brand itself.
In the past, private equity investors were willing to pay a premium to what the same company would receive on the public market. In the late 1990’s, which marked the beginning of a decade of growth for the casual dining industry, the average cash flow multiple was 7x. Today, the average cash flow multiple is 8.1x and most of the larger, more mature names in the space have little to no growth. Specifically looking at DIN and DRI—the two largest casual dining companies—you can see that despite having limited growth opportunities, both companies trade at a premium valuation of 9.9x and 8.0x cash flow, respectively. Additionally, both companies carry a high dividend yield of 4.5%.
This leads us to one of our Macro Team’s 3Q13 themes, which is #RatesRising. We here at Hedgeye believe that the low for the 10Y treasury yield was set back in November 2012. Part of the #RatesRising theme suggests that growth is accelerating and the economy is strengthening, which likely means one thing: the Fed will begin to taper. If this happens, we believe the 10Y treasury will begin mean reverting back its 50-year average. This type of environment would be particularly challenging for both DIN and DRI. In our opinion, neither company would be able to raise its dividend fast enough to maintain its relative value in a #RatesRising environment.
New Era Growth Stocks
Restaurants – Recent IPOs in the restaurant space have come from companies that are helping to change the consumer retail landscape. The most recent IPO, and one of the most successful IPOs across all sectors year-to-date, came from Noodles & Company (NDLS). The company, which is up 152% since its June 27th IPO, offers a wide variety of high quality, cooked-to-order dishes, including noodles and pasta, soups, salads and sandwiches, all of which are served on real china – fancy!
Importantly, customization is becoming a “must” in the restaurant industry and NDLS plays into this theme very well. Because each dish is cooked-to-order, it can be customized to each customer’s personal tastes and preferences (they even have gluten free, vegan, vegetarian or low sodium items). Noodles participates in the ‘fast casual’ segment of the restaurant industry as they strive to provide a medium between quick service and casual dining restaurants. In other words, fast casual restaurants attempt to provide customers with a combination of impressive speed of service, high quality food and a quality environment.
Other notable fast casual chains include Chipotle (CMG), Smashburger (private), and Qdoba (owned by JACK). The NPD Group recently reported that the number of fast-casual restaurants grew by 7%, while traffic grew by 9% for the FY ended May.
Food Retail – Similarly, in the food retail space, recent IPOs such as Sprouts Farmers Market (SFM), Natural Grocers (NGVC) and Fairway Group Holdings (FWM) have expanded natural and organic product selections in addition to fielding extensive perishables departments. Of the group, Natural Grocers' IPO has enjoyed the largest percentage gain as the stock is up 140% since its first trading day.
On the margin, these new competitors in the Food Retail space will begin to take occasions away form traditional casual dining companies.
Below we highlight a number of relative, recent IPOs and their respective performance.
We currently like high growth stocks that should continue to benefit from the aforementioned trend, including NDLS, KKD, CMG, and OPEN.
We continue to dislike traditional quick-service and casual dining names, including MCD, DRI and RRGB.
Takeaway: Quantitative and fundamental factors no longer support being short CHIX and EEM.
***If you are not yet familiar with our firm-wide Best Ideas list, please shoot us an email and we’ll be happy to reach out to you to discuss whether or not shifting to a coverage model makes sense for you and/or your team.***
I. REMOVING CHIX & EEM FROM OUR BEST IDEAS LIST
Today, we are formally removing the CHIX ETF and the EEM ETF from our Best Ideas list; both were selected as shorts to #TimeStamp the performance of our #EmergingOutflows thesis and our bearish bias on the Chinese financial sector, respectively.
From its APR 23 addition to our firm-wide Best Ideas list through today’s closing price, the EEM ETF has declined a cumulative -2.4%, inclusive of a maximum drawdown of -12.8% during the ~2M period from APR 23 to JUN 24. With respect to our proprietary quantitative factoring, the EEM ETF closed above its intermediate-term TREND line for the first time in several months today.
From its JUN 7 addition to our firm-wide Best Ideas list through today’s closing price, the CHIX ETF has appreciated a cumulative +7.1%, inclusive of a maximum drawdown of -13% during the ~2W period from JUN 7 to JUN 20. The CHIX ETF is now decisively bullish from an intermediate-term TREND perspective on our quantitative factoring.
Obviously, we made the classic mistake of getting too greedy on the short side of both securities and it cost us in the performance category; hopefully you were able to better risk manage the aforementioned theses with respect to both security selection and market timing.
Pulling back the curtain a little broader, it’s clear that an investor(s) would’ve crushed it had they tactically allocated assets to EM equities right around the late-JUN lows, given that EM equity markets are up an average of +7.1% on a currency-adjusted basis since then. That, of course, would’ve more than likely required said fund to have been out of EM equities heading into those lows.
Needless to say, not a lot of funds were actually out of EM equities heading into those lows. While there was certainly some forced selling amid outflows which happened to commence shortly after the time of our APR 16 #EmergingOutflows presentation, we’re guessing most funds were and still are quite long of EM equities. It’s worth noting that the $7.5B YTD cumulative outflow from EM stock and bond funds represents a minuscule 2.3% of the $322B of cumulative fund inflows into said funds since 2009 (EPFR Global data through the month of AUG).
II. THE “WHY” DOES NOT ALTER OUR POSITION OF BEING THE BEARS ON EMERGING MARKETS
While we are removing the iShares MSCI Emerging Markets ETF (EEM) from our Best Ideas list on the short side, this delta does not represent a change to our broader bearish thesis on EM capital and currency markets. Rather, the geographic allocation of the index no longer makes this our preferred vehicle to express the aforementioned bearish thesis going forward.
Specifically, the index’s #1 and #2 country weights are South Korea (15.8%) and China (15%), respectively. This setup makes the EEM ETF a rather precarious vehicle to be short from here given that we recently adopted a bullish bias on South Korean equities and have recently shifted to a neutral (formerly bearish) bias on Chinese equities.
In light of the latter shift, we no longer consider it appropriate at the current juncture to wager on a negative wholesale revaluation of the Chinese banking sector in light of the structural liquidity issues we have discussed at great length over the past few months – hence the removal of the Global X China Financials ETF (CHIX) from the short side of our Best Ideas list as well.
III. SO THEN, HOW DO ONE PLAY SAID THESIS FROM HERE?
To help clients get a better grasp of all the moving parts across EM capital and currency markets, we have created two dashboards to systematically monitor performance divergences with the intent on flagging developing, existing, and dissipating trends in the marketplace. One of the dashboards is programmed to highlight divergences in excess of  standard deviation relative to their respective sample mean and the other is programmed to highlight divergences based upon the max/min values within the respective sample.
Each dashboard is symmetrically grouped into three distinct buckets (i.e. samples): Asset Classes, Regions and Countries. Realizing that we could and should do better than implementing an all-or-nothing strategy in emerging markets, this multi-tiered setup will allow us to spot the development and dissipation of said trends at the level most appropriate for any given investor.
Lastly, we thought it would be best to use actual ETFs, rather than the benchmark indices themselves to track said divergences because: A) the universe of liquid ETFs most likely accurately reflects the universe of broadly investable emerging market securities and asset classes; B) the ETFs are all both un-hedged and priced in US dollars, which means they automatically adjust for deltas in the currency markets; and C) ETFs have an underlying fund flow element to them that influences price trends – which is precisely what we’re trying to capture with our #EmergingOutflows thesis.
It’s also worth noting that whenever there was a collection of ETFs that represented a particular asset class, region and/or country, we selected the specific ETF in our sample based on a combo score of size (AUM) and liquidity (average daily trading volume).
MAX/MIN Divergence Monitor:
STDEV Divergence Monitor:
Below we analyze and interpret the signals being generated by the developing, existing and dissipating trends that are currently being highlighted by our divergence monitors:
At the asset class level: We think it pays to rotate out of being short EM equities here in favor of being short EM debt – both dollar-denominated and local currency paper. EM FX is not flashing anything meaningful in terms of developing price signals, but the mere fact that it hasn’t outperformed recently after having been such a long-term laggard (-10.8% on a 3Y duration) suggest a continuation of the slow bleed.
As always, it’s worth noting that the risk management setups per our quantitative factoring models support the aforementioned conclusions:
At the regional level: The one meaningful signal we see starting to develop is the outperformance of Latin American equities; this is likely a dead-cat bounce in the context of severe underperformance and absolute declines over longer durations, but to the extent recent outperformance starts to trend, short-covering and [perceived] value-buying could perpetuate higher-lows on an intermediate-term basis.
At the country level: Indonesia still looks like death… as does Turkey… Peru’s dead-cat bounce appears fleeting… both China and Russia have recently developed a trend of outperformance… Thailand looks like it wants to resume its secular outperformance… Mexico does not… Brazil could begin to look more interesting on the long side from fund flow front-running perspective if it can turn its WoW outperformance into something more lasting (i.e. MoM).
As an aside, we have done and continue to do a ton of work on which countries look good and which countries do not. Email us if you’re interested in discussing any country from an intermediate-term TREND GIP (i.e. GROWTH/INFLATION/POLICY) perspective – or from the perspective of our proprietary, four-pillared EM Crisis Risk Model, which is naturally better suited for managing long-term TAIL risk.
All told, while we remain bearish on emerging markets from a top-down perspective and will predominantly be engaged in hunting for shorts in this space, we think it has become decidedly less appropriate to passively short EM capital and currency markets at the asset class, regional and country levels.
As such, we’ve created proprietary divergence monitors to help aid us in rotating in an out of the best places to be on the SHORT side of emerging markets. Please email us if you’d like to see these monitors more regularly – we can obviously use these tools to help you appropriately allocate assets on the LONG side as well.
Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.