Takeaway: Slightly smaller bond outflows for the week ending Sept 4th but still over $6 billion left fixed income funds. Equity ETFs got hit hard.
Investment Company Institute Mutual Fund Data and ETF Money Flow:
Equity mutual fund inflow accelerated week-to-week to $903 million for the 5 day period ending September 4th, up from the $300 million inflow the week prior
Fixed income mutual fund outflows also improved but still resulted in a $6.7 billion withdrawal by investors, an improvement from the $9.1 billion draw down last week
Within ETFs, passive equity products experienced an outsized redemption of $11.3 billion, the second week in three weeks with over a $10 billion withdrawal. Bond ETF flows snapped into positive territory week-to-week with a $2.4 billion inflow this week compared to the $935 million outflow last week
For the week ending September 4th, the Investment Company Institute reported improvements in both equity and fixed income mutual fund flows however with bond trends simply booking a smaller outflow. Total equity fund flow totaled a $903 million inflow which broke out to a $1.5 billion inflow into international equity products and a $694 million outflow in domestic stock funds. These trends were an improvement from the prior week's total equity fund inflow of $300 million. Including this acceleration in stock fund flows, the year-to-date weekly average for 2013 now sits at a $2.6 billion inflow for total equity mutual funds, a substantial improvement from the $3.0 billion outflow averaged per week in 2012.
On the fixed income side, outflow trends continued for the week ending September 4th with the aggregate of taxable and tax-free bond funds combining to lose $6.7 billion in fund flow. The taxable bond category specifically shed $4.7 billion in the most recent period versus the $6.3 billion loss last week. Tax-free or municipal bonds continued their sharp outflow trends losing another $2.0 billion in the week ending September 4th, continuing its trend from last week which experienced a $2.9 billion outflow. Franklin Resources (BEN) continues to have the most exposure in our coverage group to declining Municipal bond trends with over 10% of its assets-under-management in the tax-free category. The 2013 weekly average for fixed income fund flow has now drastically declined from 2012, now averaging a $324 million weekly outflow 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 $263 million in the most recent weekly period although dipping below the $1 billion weekly inflow level for the first time in 8 weeks. The year-to-date weekly average inflow for hybrid products is now $1.6 billion for '13, almost a 100% increase from 2012's $911 million weekly average.
Passive Products - A Big Equity ETF Outflow versus a Stable Fixed Income Inflow:
Exchange traded funds experienced mixed trends for the week ending September 4th with a massive equity outflow and a stable fixed income inflow. Equity ETFs lost $11.3 billion, the second biggest equity ETF outflow in 5 years next to the $12.9 billion outflow two weeks ago and only the 11th negative week in the 36 weeks of 2013. Despite this week's outflow, 2013 weekly average equity ETF trends are averaging a $2.6 billion weekly inflow, an improvement from last year's $2.2 billion weekly inflow average.
Bond ETFs conversely had an improvement week-to-week with a strong $2.4 billion inflow, the biggest fixed income ETF inflow in 8 weeks, which compared to last week's $900 million outflow. Despite this improvement in the most recent period the 2013 weekly bond ETF average is now just a $345 million inflow for bond ETFs, much lower than the $1.0 billion average weekly inflow from 2012.
HEDGEYE Asset Management Thought of the Week - The Bigger Base of Numbers:
Despite the $116 billion fixed income fund outflow that has occurred since the end of May, the largest absolute bond outflow in history, we point out that on a percentage of beginning fixed income assets-under-management that the current 2013 draw down is the smallest in history on a percentage basis. The 2013 running outflow has been just 2.9% of outstanding bond funds, well below the past outflows in 2003-2004 where 5.0% of outstanding bond funds were redeemed and the 14% of bond funds that were drawn down in the 1 outflow. 1 experienced a similar 5.0% redemption of outstanding bond funds, inline with the 2003-2004 fixed income sequence.
In our recent initiation of the asset management sector, we forecasted that a $1 trillion shift out of bonds and into equities could occur (this would include ETFs and single holdings of individual bonds in addition to bond funds) taking in consideration that bond outstandings in the U.S. are at new record highs and that modified duration, the return of volatility in fixed income, and the lack of liquidity in the bond markets would dislodge the asset class. The enclosed links present this initiation again:
Jonathan Casteleyn, CFA, CMT
Joshua Steiner, CFA
TODAY’S S&P 500 SET-UP – September 12, 2013
As we look at today's setup for the S&P 500, the range is 33 points or 1.61% downside to 1662 and 0.35% upside to 1695.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 2.45 from 2.47
- VIX closed at 13.82 1 day percent change of -4.89%
MACRO DATA POINTS (Bloomberg Estimates):
- 8:30am: Initial Jobless Claims, Sept. 7, est. 330k
- 8:30am: Cont. Claims, Aug. 31, est. 2.968m (prior 2.95m)
- 8:30am: Import Price Index M/m, Aug., est. 0.5% (prior 0.2%)
- 8:45am: Bloomberg Sept. U.S. Economic Survey
- 9am: Fed’s Dudley speaks on panel on OTC derivatives
- 9:45am: Bloomberg Consumer Comfort, Sept. 8
- 10am: Freddie Mac mortgage rates
- 10:30am: EIA natural-gas storage change
- 11am: Fed to purchase $2.75b-$3.5b in 2020-2023 sector
- 12pm: Wasde agricultural report
- 1pm: U.S. to sell $13b 30Y bonds in re-opening
- 2pm: Monthly Budget Statement, Aug., est. -$147b
- Sec. of State John Kerry meets with Russian Foreign Minister Sergei Lavrov in Geneva to discuss Syria
- SEC holds private meeting with heads of exchanges, other self-regulatory organizations to discuss market-data dissemination systems, 3-hour trading halt on Aug. 22
- CFTC holds meeting of technology advisory cmte that may discuss concept release for regulating high-speed trading, issues related to swaps trading and record-keeping; approval would trigger a public-comment period, 10am
- Medicare Payment Advisory Commission begins 2-day mtg, 9:30am
- House, Senate in session
- Senate Banking Cmte hears from SunTrust Mortgage CEO Jerome Lienhard on housing finance revisions, 10am
WHAT TO WATCH:
- Michael Dell, Silver Lake poised to clinch $24.9b buyout
- SEC’s White to push exchange execs for better data backups
- Umpqua to buy Sterling Financial for about $30.52/shr
- Vertex, Ametek to replace AMD, SAIC in S&P 500 on Sept. 20
- Qualcomm plans $5b share buyback to placate investors
- Gabrielle weakens to tropical depression, Humberto moves north
- Indonesia unexpectedly raises key rate to stem currency slide
- Putin appeals to U.S. public before Kerry-Lavrov Syria talks
- Italy industrial output unexpectedly falls as slump persists
- Euro-area industrial output drops more than estimated
- Josef Ackermann said to plan resignation from Siemens board
- Analogic (ALOG) 4:15pm, $1.35
- Brady (BRC) 8am, $0.52
- BRP (DOO CN) 6am, C$0.05
- Empire (EMP/A CN) 7:03am, C$1.55
- Hudson’s Bay (HBC CN) 7am, C$0.12
- Kroger (KR) 8:30am, $0.60
- Lululemon Athletica (LULU) 7:15am, $0.35
- Transcontinental (TCL/A CN) 8:52am, C$0.38
- Ulta Salon (ULTA) 4pm, $0.67
- United Natural Foods (UNFI) 4:05pm, $0.60
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Goldman Sees Commodity Demand in China Rebounding to December
- Deere Lures Africa’s First-Time Buyers of Tractors: Commodities
- Gold Sinks to Four-Week Low as Silver Declines on Taper Bets
- Copper Reaches One-Week Low on Concern About Outlook for Demand
- Cocoa Falls in New York on Prospects Rain Will Benefit New Crops
- Soybeans Climb for Second Day as USDA Seen Cutting Crop Outlook
- Mistry Sees Palm Weakening as Prices Set for Worst Run Since ’96
- IEA Sees Less Need for OPEC Crude in 2014 as U.S. Supply Booms
- Rebar Drops to Five-Week Low as Property Curbs Weaken Outlook
- Cocoa Shortage Expanding as Chocolate Sales Climb to Record
- Vietnam’s Rice Output Faces Slide on Crop Switch: Southeast Asia
- Polar Sea Lane Finds Favor as Suez Security Doubts Grow: Freight
- Gold May Fall to $1,270 on Head and Shoulder: Technical Analysis
- Tropical Depression Gabrielle Keeps Speed, Humberto Moves North
The Hedgeye Macro Team
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“In faith there is profit.”
In blind faith (in government and/or your research process), there are also losses. So make sure you keep moving out there. The history of your money in public markets is that politicians and/or Mr. Market are always looking to take it away.
The aforementioned quote comes from an epic chapter in the late Jack Weatherford’s The History of Money titled “Knights of Commerce”, where he chronicles the history of The Knights Templars who, at one point, “became businessmen who ran the world’s greatest national banking corporation.” (pg 65)
Then along came a French plunderer (King Philip IV) and that was about it for the Knights. “Phillip took the management of his finances out of the hands of the Templars and established the Royal Treasury at the Louvre… Philips desperate need for money arose after he tried a trick that Nero had pulled a thousand years earlier: he debased the silver currency of his realm.” (pg 68)
Back to the Global Macro Grind…
Both Gold (-1.6% to -20% YTD) and Silver (-2% to -26% YTD) are being debased (again) this morning. So you have to be careful in defining what you think “money” is. In the intermediate-term, the value of all moneys is cyclical. And you have to risk manage that.
Or at least that’s how I roll. I don’t really trust that the value of anything that trades on anything that is attempted to be centrally planned has a super secret biblical “value.” Every morning we wake up to politicians trying to mess with our profit plan.
The plan remains that the plan is going to change – and with that, let’s get on with our day. Here’s this morning’s setup:
- US Equities = immediate-term TRADE overbought within a bullish intermediate-term TREND
- Japanese, German, and British Equities = immediate-term TRADE overbought within bullish TRENDs
- Government Bonds (Treasuries, JGBs, Bunds, and Gillts) = immediate-term TRADE oversold within bearish TRENDs
In other words, being long stocks (and short bonds) for the last few weeks has been fantastic – so take some profits.
While it’s a pretty straight forward communication process to tell you when I am buying things while people are freaking out on red, sometimes I confuse people when I then turnaround and sell some of what I bought.
I don’t take offense to that as I am often confusing myself! That’s where embracing the uncertainty (signals) in my process leaves me at this stage of my career. I listen to the risk management signals before I listen to the little squirrels in my head.
To boil this process down to the bare Mucker bones:
- When a stock, bond, currency, or commodity is immediate-term TRADE overbought, I sell some
- When a stock, bond, currency, or commodity is immediate-term TRADE oversold, I buy some
That’s it. So easy a hockey player can do it.
And by making every mistake I make out loud for the last 5 years (over 2,000 long/short positions #timestamped on a spreadsheet in the public domain), it’s helped me learn how to make less mistakes faster.
No, that doesn’t mean I won’t make a big mistake like I did yesterday (I should have sold Restoration Hardware (RH) on the immediate-term TRADE overbought signal into the print, and bought it back on the red reaction).
It just means that I usually understand what I did wrong and why.
What makes this whole “taking profits” exercise all the more confusing is this un-cooperative little critter called research. I’ve built my entire research team (27 analysts) on a platform that is looking to make intermediate to long-term calls on stocks, bonds, currencies, and commodities. That means (sometimes) the immediate-term signal conflicts with the longer-term picture.
You bet it does. I don’t care if you are a day trader or someone who has bought and held since Nero. What is happening right here, right now, affects you in some way, shape, or form. If it doesn’t, you aren’t reading this anyway.
Back to the RH example. Brian McGough’s long-term view on Restoration Hardware (RH) is that the company will earn $8.00/share. So, even if the signal said it was immediate-term TRADE overbought at $80, why would I sell some of that? Well, that’s pretty straightforward too. Because it just had a 12% down day after signaling immediate-term TRADE overbought!
The risk management lesson here is that there is only a chance to take profits if you have faith that your process is repeatable. You have to understand why you make every move. Otherwise you’re just guessing. And one day, Mr. Market will take all those profits away.
Our immediate-term Risk Ranges are now as follows (we have 12 Big Macro ranges in our Daily Risk Range product too):
UST 10yr Yield 2.86-3.03%
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Darden is being mismanaged, plain and simple.
DRI is scheduled to report 1QFY14 earnings on 9/20 and expectations across the board have been reduced significantly for the quarter. The only question that remains is: how bad is bad? The current FY14 EPS consensus estimate is $2.99 on Bloomberg. We could easily get our model down to $2.50. And, unfortunately, the company needs to pay a $2.25 dividend, which makes earning anywhere near $2.50 a real problem.
We continue to believe the sum of the parts is greater than the whole, at Darden, and we believe there is a striking opportunity for an activist to enter the fray, unlock value, and benefit holders of the company’s stock.
There have been four times in my career when I have seen a company in desperate need of a major overhaul. In all four cases, I wrote extensively about the issues, much to the ire of management. Darden and its problems are no different!
The following companies have undergone major corporate overhauls that have led to significant improvements in shareholder value:
- McDonald’s (2002): MCD formulated the “Plan to Win” in 2002, which later became a template for success at Brinker.
- Wendy’s (2004): The sum-of-the-parts were greater than the whole!
- Starbuck’s (2008): With Schultz back at the helm, SBUX focused on attacking the middle of the P&L and improving the guest experience.
- Brinker (2010): Facing an industry in the midst of a secular decline, senior management formulated a plan to win, which entailed attacking the middle of the P&L and driving traffic.
- Darden (2013): Will the current management team recognize the need for a major restructuring?
We are of the view that DRI is in a secular decline and, until management makes significant changes, we will continue to see erosion in the earnings power of the company. We believe it is best to wait for these significant changes to occur before we get more aggressive on the LONG side.
Low-Hanging, Bountiful, Fruit
Looking at the four prior examples of past significant corporate action, it is clear that these companies had similar traits. Specifically, each company had low-hanging fruit and the potential to create significant value for shareholders. Many of these are similar to the opportunities we currently see in Darden:
- Tremendous cash flow potential
- Huge real estate value
- Non-core, under-utilized assets that can be sold at rich valuation
- Core assets represent a classic reorganization opportunity
- Market’s valuation of the whole is far below what we believe the sum-of-the-parts would represent in a reorganization or breakup
- G&A rationalization opportunities
DRI’s Biggest Problem – It’s Too Big, Too Complex, To Perform
- This company has over 2,000 restaurants spread out among 8 separate concepts
- Olive Garden and Red Lobster account for roughly 75% of total revenues
The Complexity Has Led To A Bloated Cost Structure
DRI management has contended for years that its multi-concept structure creates operational efficiencies. But, a closer look at the numbers suggests the exact opposite. The average unit volume of DRI’s big three brands is $3.68, which is 23% larger than the average unit volume of EAT’s core brand, Chili’s.
- Restaurant level margins for DRI are 32% larger than EAT’s and 17% larger than the average of its casual dining peers
The math is quite simple. If DRI generates more revenues per store and has higher margins per store than its competitors, then it should generate higher operating profit margins as well. But, this isn’t the case. The only real explanation we can find for DRI’s lower operating margins is a bloated G&A cost structure.
- DRI’s operating margins over the TTM are 7.5%, which is 27.2% below EAT’s and 3.7% below the average of its casual dining peers
- If DRI were to cut G&A by 200 bps, and achieve 9.5% in operating margins, the company would generate an additional $1.10 in earnings per share
Our Vision Of The New DRI
Below we offer our view of what the new Darden should look like. We believe the company should be broken up into three segments – Seafood, Steak and Italian. Yard House should be spun off and taken public and Bahama Breeze should be sold. This would leave each of DRI’s three operating segments with a large brand, in addition to a smaller one in order to help, over time, improve the growth profile of the company. Additionally, each company would finally be able to focus and zero in on their operations, which, we believe, would allow for a more streamlined operating structure.
It’s Only A Matter Of Time – Restaurants Are An Attractive Sector For Activists
- McDonald’s (2006): Real estate was the fulcrum of Bill Ackman’s thesis, but better operating performance, including new management, and capital allocations decisions were the real drivers of returns. The company sold off non-core assets.
- Wendy’s (2008): Real estate was, once again, the anchor of the thesis here, but the business was also undervalued. The company, under the influence of Trian Fund Management’s Nelson Peltz, sold off non-core assets.
- Applebee’s (2006): Breeden Capital Management threatened a proxy contest at the 2007 Annual Meeting of Stockholders, which ultimately was settled with two board seats being opened up for the activist entity. The company was sold following a period of lackluster returns.
- Cracker Barrel (2005): Nelson Peltz, again, held real estate central in his thinking on taking the company private. In 1Q06, the company’s board authorized the use of proceeds from a sale of Logan’s Roadhouse to fund a modified “Dutch Auction” tender offer for $250mm of the company’s common stock (roughly 35% of common shares outstanding).
- Cracker Barrel (2011): Biglari Holdings contested two proxy battles, but has failed to secure any board seats. Pressure from Sardar Biglari led to the replacement of CBRL’s CEO and the stock price has appreciated significantly since BH first took a stake in October 2011, rising from $45 to over $100 a share today.
- DineEquity (2012): Marcato Capital Management suggested a dividend payment in order to maximize its equity value. The company announced a $0.75 quarterly dividend and a $100mm share repurchase, which amounted to 8% of equity value. Richard “Mick” McGuire of Marcato was previously an analyst at Bill Ackman’s Pershing Square Capital Management.
Piecing It All Together
- The current outlook for DRI is dire and we suspect that 1Q14 results will be a disaster
- There is no cohesive plan to fix the asset base and address significant inefficiencies
- As we have seen many times before, continuing deterioration will lead ultimately lead to intervention, in one form or the other
- Given the current trends, the dividend, which was once an asset, could become a liability
- We know how this is going to end, the only question is when?
Risk Managed Long Term Investing for Pros
Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.