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Morning Reads on Our Radar Screen

Takeaway: A quick look at some stories on Hedgeye's radar screen.

Keith McCullough – CEO

No deal in sight as shutdown approaches third week (via CNN)

U.S. May Join Germany of 1933 in Pantheon of Defaults (KM note: “Ridiculous” > via Bloomberg)

Israel Finds Tunnel Dug Under Gaza-Israel Border  (via AP)

Visa rules for Chinese coming to the UK to be relaxed (via BBC)

 

Morning Reads on Our Radar Screen - car5


Daryl Jones – Macro

Hedge Fund Bears at Year High as Equities Focus on Budget (via Bloomberg)

U.S. May Join Germany of 1933 in Pantheon of Defaults (via Bloomberg)

 

Kevin Kaiser – Energy

'Dark side' of nat gas boom, according to Chanos (via CNBC)

FLASHBACK: T. Boone Pickens Is Down, But He Swears He Isn't Out (via BusinessWeek)

 

Josh Steiner – Financials

US investment balances skyrocketing to historic highs (via NY Post)

Fannie Mae, Freddie Mac to go after more strategic defaulters (via LA Times)

 

Jonathan Casteleyn – Financials

Hedge Fund Bears at Year High as Equities Focus on Budget (via Bloomberg)

 

Brian McGough – Retail

Accenture study forecasts 11% hike in US holiday spending (via Fibre2fasion)

Google Is Going to Include Your Face in Its New Ads (via BusinessWeek)

Jos. A. Bank keeps Men's Wearhouse door open (via The Deal)

Tumi Signs Outerwear License (via WWD)

Staples launches new price match policy (via Retailing Today)


MONDAY MORNING RISK MONITOR: INTERBANK RISK MEASURES SHOW RISING CONFIDENCE

Takeaway: The interbank markets of the US and Europe suggest a rising confidence in the outcome of the DC dynamic.

 

*************** Mergers and Acquisition Black Book Conference Call Today at 2PM ***************

 

Please join the Hedgeye Financials Team, Jonathan Casteleyn and Josh Steiner, for a deep dive Black Book presentation on the mergers and acquisition environment (M&A) with implications for companies including Greenhill & Co (GHL), Lazard (LAZ), and Evercore (EVR). The call will be held on Monday, October 14th at 2:00pm EDT.

 

The M&A environment continues to have a positive setup with:

 

1.)    High cash balances on corporate balance sheets

2.)    Low corporate borrowing costs

3.)    Relatively high stock currency values

4.)    Rising CEO confidence

 

Thus the market has the potential to break out of a 3 year flat environment. Every quarter removed from the Financial Crisis without substantial volatility is a quarter closer to a more robust M&A environment which has positive implications for this group of small and mid-cap Financial stocks.   

 

CALL DETAILS

  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 893653#
  • Materials: CLICK HERE

 

For more information please email .

 

 

Risk Monitor / Key Takeaways:

Last week we indicated that the key measures we were watching for signs of risk rising are the interbank overnight rates. On that front, the news was resoundingly positive. The TED spread compressed by 3 bps to 19 bps (-16% W/W), while Euribor-OIS tightened by 2 bps to 12 bps (-13.5% W/W). This suggests that the Financials are setting up for another rally.

 

The other news on the week was, of course, JPMorgan's 3Q earnings. On that front, we were impressed with the resilience of the top line, particularly the positive trend in the NIM. Credit quality remains another key driver and we expect these two dynamics will be the principal themes of this quarter's earnings season.

 

* TED Spread Monitor – The TED spread fell 3.4 basis points last week, ending the week at 18.6 bps this week versus last week’s print of 21.99 bps.

 

* Euribor-OIS Spread – The Euribor-OIS spread tightened by 2 bps to 12 bps.  

 

* Sovereign CDS – Sovereign swaps tightened around the world last week on rising expectations that the US will find a solution and avert default. US swaps tightened 7 bps, falling to 34 bps.  

 

* European Financial CDS - Europe's banking system continues its winning ways. Swaps across European financials tightened another 14 bps, on average, last week, bringing the median EU bank to 140 bps, as compared with 101 bps for the US Financials.

 

Financial Risk Monitor Summary

 • Short-term(WoW): Positive / 4 of 13 improved / 3 out of 13 worsened / 6 of 13 unchanged

 • Intermediate-term(WoW): Positive / 6 of 13 improved / 5 out of 13 worsened / 2 of 13 unchanged

 • Long-term(WoW): Negative / 1 of 13 improved / 4 out of 13 worsened / 8 of 13 unchanged

 

MONDAY MORNING RISK MONITOR: INTERBANK RISK MEASURES SHOW RISING CONFIDENCE - 15v2

 

1. U.S. Financial CDS -  Big banks saw their swaps largely unchanged last week, trading in a range of +2 to -2 bps. JPMorgan posted the best results with the -2 bps. GS the worst, at +2 bps. Mortgage insurers widened by 22 bps, on average. Overall, swaps widened for 14 out of 27 domestic financial institutions.

 

Tightened the most WoW: SLM, AIG, COF

Widened the most WoW: AGO, MBI, RDN

Tightened the most WoW: AXP, WFC, COF

Widened the most MoM: MBI, RDN, MTG

 

MONDAY MORNING RISK MONITOR: INTERBANK RISK MEASURES SHOW RISING CONFIDENCE - 1

 

2. European Financial CDS - Europe's banking system continues its winning ways. Swaps across European financials tightened another 14 bps, on average, last week, bringing the median EU bank to 140 bps, as compared with 101 bps for the US Financials.

 

MONDAY MORNING RISK MONITOR: INTERBANK RISK MEASURES SHOW RISING CONFIDENCE - 2

 

3. Asian Financial CDS - Bank swaps in Asia were mostly lower last week with teh one exception of IDB Bank of India, where swaps rose 10 bps. Chinese banks were 2-3 bps tighter while Japanese financials tightened 3-6 bps.

 

MONDAY MORNING RISK MONITOR: INTERBANK RISK MEASURES SHOW RISING CONFIDENCE - 17

 

4. Sovereign CDS – Sovereign swaps tightened around the world last week on rising expectations that the US will find a solution and avert default. US swaps tightened 7 bps, falling to 34 bps. Portugal, Italy and Spain saw their swaps tighten by 48, 20 and 8 bps, respectively. 

 

MONDAY MORNING RISK MONITOR: INTERBANK RISK MEASURES SHOW RISING CONFIDENCE - 18

 

MONDAY MORNING RISK MONITOR: INTERBANK RISK MEASURES SHOW RISING CONFIDENCE - 3

 

MONDAY MORNING RISK MONITOR: INTERBANK RISK MEASURES SHOW RISING CONFIDENCE - 4

 

5. High Yield (YTM) Monitor – High Yield rates fell 5.1 bps last week, ending the week at 6.24% versus 6.29% the prior week.

 

MONDAY MORNING RISK MONITOR: INTERBANK RISK MEASURES SHOW RISING CONFIDENCE - 5

 

6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 1.0 point last week, ending at 1808.

 

MONDAY MORNING RISK MONITOR: INTERBANK RISK MEASURES SHOW RISING CONFIDENCE - 6

 

7. TED Spread Monitor – The TED spread fell 3.4 basis points last week, ending the week at 18.6 bps this week versus last week’s print of 21.99 bps.

 

MONDAY MORNING RISK MONITOR: INTERBANK RISK MEASURES SHOW RISING CONFIDENCE - 7

 

8. CRB Commodity Price Index – The CRB index rose 0.1%, ending the week at 287 versus 286 the prior week. As compared with the prior month, commodity prices have decreased -1.9%. We generally regard changes in commodity prices on the margin as having meaningful consumption implications.

 

MONDAY MORNING RISK MONITOR: INTERBANK RISK MEASURES SHOW RISING CONFIDENCE - 8

 

9. Euribor-OIS Spread – The Euribor-OIS spread tightened by 2 bps to 12 bps. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. 

 

MONDAY MORNING RISK MONITOR: INTERBANK RISK MEASURES SHOW RISING CONFIDENCE - 9

 

10. Chinese Interbank Rate (Shifon Index) –  The Shifon Index rose 20 basis points last week, ending the week at 3.33% versus last week’s print of 3.13%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.

 

MONDAY MORNING RISK MONITOR: INTERBANK RISK MEASURES SHOW RISING CONFIDENCE - 10

 

11. Markit MCDX Index Monitor – Last week spreads widened 12 bps, ending the week at 101 bps versus 89 bps the prior week. The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 16-V1.

 

MONDAY MORNING RISK MONITOR: INTERBANK RISK MEASURES SHOW RISING CONFIDENCE - 11

 

12. Chinese Steel – Steel prices in China rose 0.5% last week, or 18 yuan/ton, to 3506 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.

 

MONDAY MORNING RISK MONITOR: INTERBANK RISK MEASURES SHOW RISING CONFIDENCE - 12

 

13. 2-10 Spread – Last week the 2-10 spread widened 2 bps to 234 bps. We track the 2-10 spread as an indicator of bank margin pressure.

 

MONDAY MORNING RISK MONITOR: INTERBANK RISK MEASURES SHOW RISING CONFIDENCE - 13

 

14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.9% upside to TRADE resistance and 1.4% downside to TRADE support.

 

MONDAY MORNING RISK MONITOR: INTERBANK RISK MEASURES SHOW RISING CONFIDENCE - 14

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 


What's New Today in Retail (10/14)

Takeaway: Kate on AMZN/EBAY. We’re not liking that one. TIF dumped by Swatch. Tumi Outerwear…Huh? SPLS price matches AMZN – good luck w/ that.

EVENTS TO WATCH OVER THE NEXT 24 HOURS

              

WMT - Analyst Meeting: Tuesday 10/15 8:45 am

WWW - Investor Day: Tuesday 10/15 9:00 am

 

Hedgeye Retail Events

 

RH Black Book - Wednesday 10/16 11:00 am

 

COMPANY NEWS

 

FNP - Kate Spade

 

What's New Today in Retail (10/14) - chart1 10 14

 

Takeaway: Over the weekend, Kate Space got major exposure on Amazon, and also had promotions on eBay. AMZN maybe we understand…but eBay? Not exactly the place to be for an aspirational luxury brand. We're not thrilled with this development.

 

WWW - Blake Krueger Sounds Off on WWW's Q3 Hits

(http://www.wwd.com/footwear-news/business/blake-krueger-sounds-off-on-wwws-q3-hits-7220222?module=Footwear%20News-Business-main)

 

  • "'The acquisition has turned out better financially — from a team standpoint and from an integration standpoint — than I could have predicted,' the president, chairman and CEO of Wolverine World Wide Inc. told Footwear News in a phone interview.
  • "Overall, Sperry Top-Sider proved to be a big winner, posting double-digit increases for the 16th consecutive quarter. Krueger said that while the brand’s U.S. growth could slow, international opportunities — including a recent agreement with E-Land Group to distribute both Sperry and Keds in China — will fuel expansion. 'There’s a lot of runway in front of us yet,' the CEO said. 'It’s an opportunity that will sustain itself and grow every year.'"
  • "Addressing overall industry challenges, Krueger admitted the retail climate could weigh on the company in the fourth quarter, but he affirmed that Wolverine is prepped."

 

Takeaway: Despite his positive stance, he's still sandbagging on accretion. Analyst meeting in NYC tomorrow.

 

VFC - Vans to Relaunch Juniors as Young Contemporary Brand

(http://www.wwd.com/markets-news/juniors/vans-to-relaunch-juniors-as-young-contemporary-brand-7219614?module=hp-markets)

 

  • "As VF sets an ambitious goal for Vans to reach $2.9 billion in sales within the next four years — a 70 percent spike from the $1.7 billion in sales it expects to make this year — the unit is relaunching its juniors apparel division as a young contemporary brand for next spring."
  • "Under the leadership of a new vice president of apparel, Vicki Redding, and an influx of new women’s designers and merchandisers, Vans is moving past its previous 14-year-old customer to an older crowd between the ages of 16 and 24."
  • "Vans still has a way to go with its women’s business, as well as apparel overall. Clothing made up 20 percent of Vans’ business last year. Of that share, women’s claimed only 20 percent. Bailey said the target is to double the apparel business by 2017."

 

Takeaway: VFC is sticking behind its lofty goals for Vans. Not sure we love the idea of a juniors line to fuel the growth. But in the end, it can probably run a $200-$300mm juniors line at a respectable margin.

 

TIF, UHR - Tiffany Looking at Swatch Alternatives

(http://www.wwd.com/accessories-news/watches/tiffany-looking-at-swatch-alternatives-7219060?module=hp-business)

 

  • Tiffany, in a filing with the Securities and Exchange Commission, said it had 'received numerous communications' indicating that Swatch views their watch agreement as 'terminated as of October 1, 2013.'”
  • "Accordingly, the luxe jeweler said it is 'proceeding on that basis with plans to design, produce, market and distribute Tiffany & Co. brand watches through alternative arrangements.'”
  • "The two companies formed a 20-year strategic alliance in 2007 that created a new Swiss-based firm to produce, design and market luxury watches under the Tiffany name."

 

Takeaway: If this is not a kick in the gut to Tiffany, I don't know what is. It's used to being the prom queen. But it just got dumped.

 

TUMI - Tumi Signs Outerwear License

(http://www.wwd.com/markets-news/intimates-activewear/tumi-signs-outerwear-license-7220587?module=hp-mens)

 

  • "The premium brand, best known for its travel, business and lifestyle accessories, has signed a licensing deal with David Peyser Sportswear Inc. to design, develop and distribute Tumi outerwear for men and women."
  • "...the collection, which will launch for fall 2014...will range from $295 to $695."
  • "Tumi will open a 6,000-square-foot showroom to showcase the outerwear at 463 Seventh Avenue. It is scheduled to open by the end of the year, when the first pieces from the collection will be launched."

 

Takeaway: Seriously??? Are they going to make apparel out of the same kevlar-like material that they use to make those bullet-proof briefcases?

 

SPLS - Staples launches new price match policy

(http://www.retailingtoday.com/article/staples-launches-new-price-match-policy)

 

  • "Starting Nov. 3, the retailer will match prices on items sold and shipped by Amazon.com or any retailer that sells products in retail stores and online under the same brand."

 

Takeaway: While this is partially necessary to drive volume, we don't see how in the world it could be margin accretive.

 

DKS - Dick’s grand-opens three new stores

(http://www.chainstoreage.com/article/dick%E2%80%99s-grand-opens-three-new-stores)

 

  • "Dick’s Sporting Goods grand-opened three new stores on Friday, bringing the total store count to 541 in the U.S."
  • "The chain opened a store in Redding, Wash., at the Redding Hilltop Center, its 30th store in the state of Washington. A new opening in Victorville, Calif., at The Mall of Victor Valley, marks the 31st Dick’s store in California. And in Kansas, at the Midstate Plaza in Salina, Dick’s opened its eighth store in the state."

 

Takeaway: The last thing that DKS should be doing is adding more stores. It should be figuring out why it can't comp.

 

JOSB , MW - Jos. A. Bank keeps Men's Wearhouse door open

(http://www.thedeal.com/content/consumer-retail/jos-a-bank-keeps-mens-wearhouse-door-open.php)

 

  • "Despite Men's Wearhouse Inc.'s rejection of a $2.3 billion unsolicited bid, Jos. A. Bank Clothiers Inc. and its private equity partner Golden Gate Capital will continue to seek a friendly, negotiated agreement, according to a source familiar with the situation."
  • "The source would not rule out a scenario of Jos. A. Bank sweetening its offer to entice the target to the negotiating table, but added that Jos. A. Bank and Golden Gate are not interested in bidding against themselves."

 

SCC - Sears to hold first-ever Canadian Thanksgiving Black Friday sale

(http://www.retailingtoday.com/article/sears-hold-first-ever-canadian-thanksgiving-black-friday-sale)

 

  • "Sears Canada is getting ready to introduce the first-ever Black Friday sale in Canada to accompany Canadian Thanksgiving in October."
  • "'Our customers already participate in our Black Friday sale in November so we wanted to give them one that, in a similar style to the U.S., would accompany our own Thanksgiving Holiday,' said Doug Campbell, president and CEO, Sears Canada. 'With the variety of sales being offered in stores and online they can pick up new home essentials or even get a head start on their Holiday shopping.'"

 

GOOG - Google Is Going to Include Your Face in Its New Ads

(http://www.businessweek.com/articles/2013-10-11/google-plans-to-include-users-faces-in-ads)

  • "On Friday the company said it would begin including recommendations that Google+ users make in advertisements. The new policy kicks in on Nov. 11."
  • "Here’s how it works: You use Google+ to rate some product or service. It turns out the company behind that product wants to advertise on Google. When the company purchases an ad, your friends will see a version that includes your photo along with what you said about the product."

 

INDUSTRY NEWS

 

Accenture study forecasts 11% hike in US holiday spending

(http://www.fibre2fashion.com/news/apparel-news/newsdetails.aspx?news_id=153863)

 

  • "U.S. consumers intend to spend an average of $646 on gifts this holiday season, which would represent an 11 percent increase over the $582 they planned to spend, on average, in 2012, according to Accenture’s annual holiday shopping survey."
  • "The Accenture Holiday Shopping Survey found that one in five consumers (20 percent) plans to spend more on gifts this year, compared to 14 percent who planned to increase their holiday spending in 2012. They also are more likely to overspend their holiday budget this year (46 percent, compared to 34 percent in 2012)."

 

Takeaway: One in five consumers intend to spend more this year, but they forecast an 11% rise in total spending (which would be one of the biggest holiday's on record)??? There's some flawed logic here. We'd love to know who funded the survey.

 

Bangladeshi Garment Executive Held Captive by Workers

(http://online.wsj.com/article/SB10001424052702304330904579133573505195610.html?mod=WSJ_business_whatsNews)

 

  • The managing director of a Bangladeshi apparel company where 112 employees died in a November factory fire was held captive by workers for 12 hours over the weekend in a pay dispute.
  • "Police said workers demanding salaries and severance payments locked Delwar Hossain of Tuba Group in his office for much of the day Saturday. Mr. Hossain was later released, police said. But workers on Sunday were still holding his brother-in-law as well as a Tuba factory manager, according to police."
  • "Workers said Tuba, a garment manufacturer that owns 12 Bangladeshi clothing factories, had closed one of its factories Friday without notifying them or providing back pay and severance. With the Muslim Eid al-Adha festival just two days away, they said they couldn't afford to go home empty-handed."

 

Takeaway: And who says labor costs are not going up.

 

Automated Ad Buying Surges Online

(http://online.wsj.com/news/articles/SB10001424052702304500404579131770474789490?mod=WSJ_business_whatsNews)

 

  • "Automated ad buying, in which marketers use computerized systems to target users based on consumer data and Web-browsing histories, is expected to increase 56% this year in the U.S. to $7.4 billion, according to a study scheduled for release Monday by Magna Global, the research and ad-buying arm of Interpublic Group of Cos."
  • "Such 'programmatic buying' would represent about 53% of the $14 billion U.S. market for display-related ad businesses, the company said."
  • "About $3.9 billion of the expected automated ad spending this year, Magna said, will be through real-time bidding, in which advertisers, through machines, automatically bid for inventory that meets their ad specifications within milliseconds of it becoming available."

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.

Just Another Manic (Media) Monday

Client Talking Points

CHINA

The UK relaxing some Chinese visa rules and the world marches forward despite USA Sunday talk show fear-mongering. Chinese stocks could not care less about the US media’s noise. It was up another +0.43% overnight. It's back in black for the year-to-date at +1.6%.

EUROPE

Do European stock and bond markets care about the “default risk” yip-yap overseas? Nope. Italy’s stock market is punching another year-to-date high this morning. Meanwhile, Germany’s DAX is correcting a whopping -0.18% after gaining another +1.2% last week. Take a look at Hedgeye's Q413 Macro Themesdeck on why we like Germany (DAX) more than the U.S. (S&P 500) right now. Incidentally, the SPX risk range is 1683-1708. We sold into Friday’s rip and moved back to 5 LONGS, 5 SHORTS (versus 9 LONGS, 3 SHORTS on Friday’s open). There will be plenty to do today on red if they try to freak out again.

GOLD

You’d think that if #EOW (End of the World) Republicans and Democrats were credible that Gold would be ripping higher right? Nope. It's still crashing. Gold was down -3.2% last week, and barely has a 30 basis point bid this morning. Don’t make the mistake of confusing the real risk of US #GrowthSlowing with “default risk.” They are two very different things.

Asset Allocation

CASH 50% US EQUITIES 15%
INTL EQUITIES 20% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 15%

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.

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.

TROW

Financials sector senior analyst Jonathan Casteleyn continues to carry T. Rowe Price as his highest-conviction long call, based on the long-range reallocation out of bonds with investors continuing to move into stocks.  T Rowe is one of the fastest growing equity asset managers and has consistently had the best performing stock funds over the past ten years.

Three for the Road

TWEET OF THE DAY

If the USA was going to "default", I doubt Gold would still be crashing (-25% YTD)

QUOTE OF THE DAY

“If you just set out to be liked, you would be prepared to compromise on anything at any time, and you would achieve nothing.” -Margaret Thatcher

STAT OF THE DAY

At the end of July 2013, foreign holders of U.S. Treasury securities totaled close to $5.6 trillion. China is the largest holder of U.S. debt with $1.28T, followed by Japan with $1.14T.



David and Goliath

“Even when you have three strikes, you’re still not out.  There is always something else you can do.”

-Tony La Russa

 

This weekend I read Malcolm Gladwell's most recent book, "David and Goliath - Underdogs, Misfits and the Art of Battling Giants." Now many of my academic friends are critical of Gladwell suggesting he cherry picks studies, but I sort of take his books for what they are: a compendium of interesting studies. Ultimately, it is up to the reader to accept or not accept his conclusions.  

 

As the title denotes, his most recent book is about perceived underdogs overcoming serious odds. He discusses why certain learning disorders may actually improve the chances of success of individuals (causes them to focus more intently), discusses the long term impact of California's three strikes laws (not positive for communities), analyzes how unconventional tactics in basketball can lead to outsized success (more full court pressing!), and a number of other interesting topics. 

 

One of the topics I found most interesting was the long run analysis of success in military conflicts.  As Gladwell writes, suppose you were to look at the conflicts that happened between very large countries and much smaller countries over the past 200 years.  In fact, let’s assume the size difference was 10x. How often would you assume the larger country wins?

 

Logically, and intuitively, it would seem likely that with that type of size advantage the larger country would dominate and likely win the conflicts close to 100% of the time. The reality is much different as the weaker countries have won almost 29% of the time. 

 

Even more insightful is the fact that the weaker side wins 64% of the time when employing unconventional, or guerrilla attacks.  Put another way, if the United States were to go to war with my home country of Canada (about 1/10 the population of the United States), you should put your money on Canada to win if the Canadians employed guerrilla tactics

 

Back to the global macro grind ...

 

We've had our own David and Goliath battle this year at Hedgeye as our Senior Energy Analyst Kevin Kaiser has taken on a couple of billionaire CEOs by making short calls on Linn Energy and the Kinder Morgan companies. As always, even though we believe our research supports a revaluation lower of both companies, time and Mr. Market will determine whether this call, versus the views of the energy Goliaths, is the right one. (Ping us at sales@hedgeye.com if you’d like to learn more about subscribing to the energy vertical.)

 

More practically, in investing, a bet against Goliath is often a bet against consensus.  Internally we run a number of screens to assess whether we are with or against consensus on any of our Best Ideas. As an example, is if company has 30 ratings from Wall Street and 29 of them are Buys that is likely more supportive of a short thesis, and conversely make us question whether we have differentiated enough insight to justify it as a stock to own.  Thinking unconventionally in investing is just as important as it is in warfare. 

 

The conventional thought according to the global macro pundits this morning is that some form of U.S. default is imminent.  This chatter has reached such an extreme that this morning Bloomberg was actually comparing the U.S. to the last major nation to completely stop paying back its debt – Nazi Germany.  Certainly, we have a good degree of respect for Bloomberg (in fact we all use their terminals), but a comparison like that seems erroneous, at best. 

 

In the Chart of the Day, we once again look at credit default swaps for 5-year U.S government debt.  Not only are CDS not at the same heightened levels of 2011 when they peaked at near 65 basis points, they are actually well off recently levels and currently trading at 34 basis points.  Given all of the fear mongering this weekend and headlines of discord in Washington D.C. perhaps they will spike again, but, certainly there is literally no chance that the U.S. government turns her back on the U.S. government debt obligations according to this market tell.

 

That all said, just because the probability of debt default is unlikely doesn’t mean you should be aggressively long of risk assets.  We trimmed the exposure in our real-time alerts products late last week going from a 3:1 long/ short ratio to 1:1.  Now most money managers can’t move this fast for reasons of scale, but the fact remains this is a market that will reward those who trade around positions. 

 

This is especially relevant broadly to the hedge fund industry this year.  According to Cambiar Investors LLC, shares that have been the most shorted are up 38% since the start of the year.  This is almost double the return of the SP500 in the same period.  Furthermore, according to the HFRI Equity Hedge Fund Index, hedge funds are up only 9.2% in the year-to-date. So far anyway, this has been a tough year for hedge funds to earn their 2 and 20.

 

In part it has been challenging for hedge funds and other active managers to out-perform because the variance between sectors has been abnormally low.  In our Q4 themes deck we show this graphically and the data indicated that this year is the second lowest year going back to 1990 for variance between sector returns at 0.50%.  The lowest was 2006 at 0.27%.  The historical mean since 1990 is 2.25%. So if there is one asset allocation bet you might want to consider, it is to #GetActive as sector variance is likely to only increase from these abnormally low levels.

 

Good luck out there today and feel free to ping us if you want to discuss how this week might play out from a catalyst perspective down in the nation’s capital.

 

Our immediate-term Risk Ranges are now:

 

UST 10yr Yield 2.61-2.71%

SPX 1

ShangHai Comp 2191-2247

VIX 15.19-18.98

USD 80.11-80.69

Brent 110.04-111.99

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

David and Goliath - U.S. CDS

 

David and Goliath - z. vp 10 14


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