The Economic Data calendar for the week of the 4th of November through the 8th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.



CAT: Is "It" Spreading? (10-Q Review)





We continue to see evidence that CAT’s challenges extend beyond its Resource Industries segment.  CAT’s divisions do not form a true conglomerate, as we see it.  Construction Industries shares key competitors, components and end-markets with Resource Industries.  Similar resource-related capital spending trends drive sales at both Power Systems and Resource Industries.  CAT Financial has credit exposure across CAT’s manufacturing customers, with potential stress in mining appearing this quarter.  These businesses fall under a corporate structure that continues to show instances of poor governance.  Rather than address these structural challenges, CAT's management seems to cling to unrealistic financial targets and demand expectations.  Long-term, we expect CAT shares to continue to underperform as investors recognize that ongoing declines in resources-related capital spending are a return to normal levels, not a decline from them.  







Progress Rail Subpoena & Criminal Investigation:   Progress Rail, part of CAT’s Power Systems segment, received a grand jury subpoena “relating to allegations that Progress Rail conducted improper or unnecessary railcar inspections and repairs and improperly disposed of parts, equipment, tools and other items.”  The company was also “informed by the U.S. Attorney for the Central District of California that it is a target of a criminal investigation into potential violations of environmental laws and alleged improper business practices.”  It doesn’t sound like a favorable development.


CAT acquired Progress Rail in mid-2006 from One Equity Partners, a JPM (which has had its own Federal investigations of late) PE fund.   It was formerly the rail services business of Progress Energy and, later, helped form a rationale for CAT’s 2010 Electromotive Diesel acquisition.  Progress Rail was a big acquisition for CAT at the time (“only the second that we've done at or above $1 billion”) and we know a lot about it circa 2006 because it filed an S-1 prior to being acquired by CAT.  Progress Rail has exposure to public transportation services and short lines in addition to the Class 1 rails.  Union Pacific has been litigating a complaint regarding derailments from improper remanufacturing work, but the claims are very small.  U.S. Attorneys usually have high win rates and do not, to our knowledge, engage in frivolous investigations.  We will wait for more information, but the investigation is another possible notch against the CAT’s internal controls.


Excess Inventory Not Isolated to Mining:  It has become increasingly clear that CAT is not just facing challenges in its mining heavy Resource Industries segment.  For example, excess inventory extends to Construction Industries and Power Systems, with even “changes in dealer inventories…unfavorable for electric power applications.”  Even part of the “decline in petroleum application sales was due to the impact of changes in dealer inventory.”  The broad dealer inventory problem should raise yellow-to-red flags for investors, in our view.  How can nearly every relevant product category have excess dealer inventory?  It would seem broader than the years-old flawed implementation of the "lane strategy", since CAT is similarly facing excess company inventory. 


Mining Not Isolated to Resource Industries:  While hinted to on the earnings call, Construction Industries sales to mining applications reached the 10-Q with “The unfavorable mix of products is primarily attributable to relatively higher sales of small and mid-size machines which generally have lower margins than larger size machines which are also sold into mining applications.”  Further, competitors in mining equipment, such as Komatsu and Hitachi, are refocusing on construction equipment because of weak mining equipment demand, depressing prices and margins for construction equipment.  Mine site power and locomotives are also exposed to mining investment, and Power Systems is broadly exposed to resources-related capital spending (e.g. petroleum), in our view.


No Capacity Reduction Cure:  While management hinted that Resource Industries was not planning a major capacity overhaul, additional disclosure puts it in writing: “We are expecting lower mining sales in 2014 and are continuing our efforts to lower structural costs. In order to be well-positioned when the industry improves, we are working to reduce costs, but are not expecting to make substantial changes in physical capacity”  (emphasis added). We expect CAT to eventually undertake more significant restructuring at Resource Industries, including the removal of excess capacity.


Increased CAT Financial TDRs/Impaired Assets:  While it is a long section (has its own 10-Q) and worth a read, CAT Financial showed meaningful increases in TDRs and Impaired Loans and Finance Leases.  When combined with the issues highlighted last quarter on “incorrectly reported” impairments, the increase may be of interest.  Total Troubled Debt Restructurings (where a debtor/lessee is in financial distress and the lender has granted relief as a result of that distress) increased to $195 million vs. $159 million in the year ago period.  What is more interesting is that the “Mining” TDRs went from (apparently) zero in the year ago period to $123 million in the three months ended September 2013.    Mining equipment sales may be down, but CAT Financial Mining segment assets increased 10.4% YoY, interesting given the credit dynamics there.  Investors may start to focus on this exposure, particularly if metal/mineral prices soften.  CAT Financial was the best performing CAT segment last quarter - the only one showing revenue and profit growth.  Under the hood, it may also prove mining/resources exposed.  CAT Financial is not exactly leverage and covenant free.


CAT: Is "It" Spreading? (10-Q Review) - bvc



Warranty Language Change:  The language describing warranty accrual rate switched from “are developed for each product build month” to each “are developed for each product shipment month” (emphasis added).  While it does not appear relevant in its impact on the quarter (warranty liability was not very interesting from what we see), warranty accruals are noteworthy as an area of flexibility for manufacturing companies.


Some Good Stuff, Too:  The yen impact should start to decrease over the next few quarters and currency in the third quarter “was unfavorable $188 million primarily due to the weaker Japanese yen, as sales in yen translated into fewer U.S. dollars.”  Pension remeasurement is likely to help 2014, as the use of a quarter-end discount rate would “result in a decrease in our Liability for postemployment benefits of approximately $2.6 billion.”  We expect these impacts to be well exceeded by the ongoing headwind from declining resources-related capital spending.  Nonetheless, these items are minor positives for reported EPS.




Long-term, we expect CAT shares to continue to underperform as investors recognize that ongoing declines in resources-related capital spending are a return to normal levels, not a decline from them.  CAT’s apparent control issues may limit management’s strategic flexibility (e.g. attention, limit M&A) as it responds to these challenges.  While 2014 expectations are now at more reasonable levels relative to our expectations, we expect further weakness, not a recovery, in 2015.  



Takeaway: Current Investing Ideas: BNNY, BYD, FDX, HCA, HOLX, MD, NKE, RH, SBUX, TROW and WWW

Below are the latest comments from our Sector Heads on their high-conviction stock ideas.


BNNY – Despite some pressure on the stock following last week’s CFO shake-up at Annie’s, Consumer Staples analyst Matt Hedrick remains firmly bullish on the company’s earnings outlook over the medium term, based on the momentum of its advantaged organics portfolio. BNNY’s strategy remains one of targeted expansion, based on getting into the “right” stores over just any store.  Hedrick sees Whole Foods’ plan to continue to roll out new stores in 2014 as a bullish catalyst for BNNY.  


BYD – Boyd Gaming missed 3Q earnings due to high expectations out of the Las Vegas Locals segment and top-line pressure from the regional markets and guided way below the Street for Q4. While we’re obviously disappointed, we look out to October and see trends improving significantly based on our regional gaming model.  While revenues for October may still fall year-over-year, it might be significantly lower September’s ugly results and ahead of BYD’s internal projections.


FDX FedEx again soared to all-time highs this week as optimism surrounding the greater shareholder focus implied by the buyback continued to be priced into the shares.  Industrial sector head Jay Van Sciver expects investor attention may shift to the mid-December earnings report over the coming weeks, now that the buyback looks to be priced into the shares. 


Van Sciver continues to see FDX having significant profit improvement opportunities in its Express division and believes the share price increase better reflects the opportunity at FedEx Express.


HCA – Tobin watched as the hearings continued this week, with HHS head Sebelius testifying in front of the House Committee on Energy and Commerce.  Traffic to the site remains high, but Tobin assumes this is primarily from people continuing to try to access the site, as the site continues not to function. Tobin observes that demographics of people visiting the site appear skewed toward college-educated women.  This is different than the demographic profile of the uninsured, among whom 30% have some college education. 


For HCA Holdings and for hospitals overall, a big key to 2014 and beyond is how well the ACA does at getting people insured.  So far, the results are not so good, and on the margin policy cancellations and disenrollment are a risk. 


HOLX Hologic reports November 11th after the close.  Tobin and his team will update their proprietary Tomo Tracker this week and next – a proprietary tool Tobin uses to track system sales – as well as Tobin’s OB/GYN Survey, which has shown solid growth in patient traffic.  HOLX management has guided to a poor quarter, but Tobin believes they are presenting an unlikely disaster scenario.  Tobin’s data are showing solid trends that should help drive upside against aggressively negative guidance and sentiment. 


MD ­Mednax reported a good quarter despite the deceleration in births in the 2H13 compared to the positive trends a year ago.  Volume at their Anesthesiology segment was reasonably strong and offset the weakness in birth trends.  The company reiterated their goal of closing more than $400M in acquisitions by year-end, although some deals may slip into January 2014.   


Health Care sector head Tom Tobin says his biggest concern coming out of the conference call was the comment that private equity firms are competing for deals and paying what MD thinks are some crazy multiples.  While management suggested deal flow is still strong, Tobin says there is a big risk if MD either decides to chase prices higher, or gets boxed out of attractive deals more frequently.


NKE – This is a big product week for Nike. First, today marks the release of the Nike Fuelband SE, which is a major relaunch of Nike’s award-winning activity-monitoring Fuelband.


Second, Nike has created the Hi-Vis Collection of winter apparel, footwear and equipment enabling athletes to train and play at the same intensity throughout the season and with zero distractions.  The Hi-Vis Collection features bright and contrasting color combinations of Volt, Electro Purple, Green Glow and Electric Green on the apparel, footwear and equipment.  This is a big deal for Nike, as it has been absent in large part from cold-weather gear since it backed away from its All Conditions Gear (ACG) line.


Third, the company is launching the LeBron 11 ‘Away’, which highlights Nike Hyperposite technology. In tandem, Nike is selling its KD VI ‘AWAY’ product, which is all Kevin Durant. Let’s see which one sells better. Our bet? LeBron.


RH–  Hedgeye Retail Sector Head Brian McGough recently released the results of our comprehensive consumer survey focused on Restoration Hardware and the home furnishings space. Our findings supported our thesis that RH has one of the biggest growth runways in the Consumer space. RH is in the process of transforming its estate portfolio, as they move away from their 10,000 square foot Legacy Store to their new 45,000 square foot Design Gallery.


In its current format, RH is only able to display approximately 25% of its product offerings. Many of the company’s current product lines have virtually no retail presence. So, how did consumers feel about RH’s presence in the home furnishings space? Well, it was pretty straight forward, consumers in general don’t know what products Restoration Hardware carries. In fact, consumers indicated that the only product category, of the twelve we asked about, that they would buy at RH vs. the competition was lighting.


Now, you may be thinking this is bad right, but we see it the opposite way. There is a significant amount of opportunity for RH to grow its existing and upcoming product lines as it expands into its growing real estate portfolio. Many of these underexposed offerings will finally get a spot on the floor and that means more consumer awareness.


SBUXRestaurants sector head Howard Penney says Starbucks’ latest 4Q14 earnings report showed “a staggeringly good quarter” and the company “appears to be firing on all cylinders heading into FY14.”  The company was helped globally by highly favorable commodity prices, but international growth put in a strong showing “and management continues to find feasible, innovative ways to drive comp growth accretive to the whole SBUX system.” 


The company reported global same-store sales growth of 7%, making this 15 consecutive quarters of SSS growth in excess of 5%, an impressive feat for a mature retailer.  Total revenue growth of 13% produced a 28% increase in operating profit and a 30% increase in EPS.  As has been their pattern, management provided conservative go-forward guidance, despite a number of analysts pushing CEO Howard Schultz to shoot publicly for a more aggressive number.  Schultz is adamant that he’d rather aim at a modest target and beat it, than aim at an ambitious one and stumble.  Wall Street analysts are busy looking at the mountaintop, but Schultz recognizes you have to get there step by step. 


No matter how ambitious your plan, the reality is that Same-Store Sales comparisons start every new year at zero.  Penney says “SBUX remains the best-run company that we follow and the long-term TAIL continues to seem unlimited.”


TROW – Financials sector senior analyst Jonathan Casteleyn says US domestic equity mutual funds set an all-time record for weekly inflow this week, with over $9 billion coming into domestic equity mutual funds. This result eclipsed the prior record from the first week of 2013 of $7.7 billion in a single 5 day period and was a multiple better than the best weekly period in 2007 of $3.5 billion. The lack of retail investor participation during the rebounding equity markets of the past 4 years has been evident with consistent outflow in the stock mutual fund channel. 


However, says Casteleyn, 2013 is shaping up to being the first inflow into overall stock mutual funds in over 5 years, and trends into the fourth quarter have started strongly with this all-time record inflow. T Rowe Price benefits most from a resurgence in U.S. stock fund investing, with 59% of its revenue coming from equity mutual funds, the largest percentage exposure in the asset management group. With an industry leading percentage of 4 and 5 star mutual fund assets within its product suite, Casteleyn says TROW is set to disproportionately benefit as retail investors improve engagement within stocks.


WWW – Women’s Wear Daily published an article this week looking at athletic footwear trends across the US through the eyes of the store managers and owners. Their real time sales feedback provided valuable insight. Several things jump out on this list. First, the comment on consumers moving away from 'minimalist running' syncs nicely with trends we're otherwise seeing. Second, the fact that Nike only has 2 of the 12 shoes mentioned is shocking -- and it's no surprise that they're both from a retailer in NYC as opposed to middle-America. Third, Saucony trumps Nike with three shoes on the list. Impressive showing for WWW.



Macro Theme of the Week – The Running of the #Bulls in Europe

Hedgeye’s popular quarterly Macro Themes call features three major themes that we believe will be key macro drivers of the markets in the coming period.  The Q4 2014 call, held early last month, featured



          #EuroBulls, and



We have seen the first theme playing out in real time (though in this Kafkaesque world of economic non-policy, Time is perhaps the only element that is “real”...) laying down a bedrock of economic uncertainty.  We believe Chairman Bernanke and his partisans do not understand the market deterioration caused by his “to infinity and beyond” Quantitative Easing policy. 


A young child rides a tricycle until their balance improves and they can stay up on a bicycle.  Once they master the two-wheeled conveyance, they never look back.  But take a healthy athlete and make them travel everywhere in a wheelchair, and their muscles will atrophy.   Markets, we contend, are like that.  Bernanke’s extended “support” to the market is not acting like a set of training wheels.  It’s a restraint that is fundamentally undermining the integrity of market mechanisms meant to operate freely. 


Just as confining a world-class Marathoner to bed will weaken their muscles, providing the markets with a trillion-dollar crutch means it will take that much longer for the markets to return to their normal function, and increases the likelihood that there will be shocks and disruptions – equivalent to the runner stumbling on atrophied legs – when the support is removed.  Withdrawing QE without causing global havoc will be a delicate balancing act.  Chairman Bernanke appears to get that; so far he hasn’t budged.


But to not take a policy step is, in itself, a significant policy step.  By hinting at the Taper, then withholding it, Bernanke risks singlehandedly toppling the dollar from what had been a firming trend.  While many economists and forecasters pick the latest data points as the basis for their investment calls, we look to rates of change – the slope of the curve.  If, as hoary Wall Street lore has it, “the Trend is your friend,” then trends in new job creation, new household formation, demand for housing, medical care and consumer goods – all these and many more weave together to give us a macro picture of where the markets are likely to be headed.


This week, we see markets trending towards our #EuroBulls theme, as the slope of all things European starts to turn positive.  Our CEO, Keith McCullough, lays this out graphically in Hedgeye TV’s Halloween offering.  It should come as no surprise that the key causal factor in the resumption of European growth is renewed strength in the Euro – and in the Pound Sterling.  The strength in Europe’s currencies is attributable to two simple factors: European central bankers are planning less centrally, taking a more hands-off approach to monetary market manipulation.  The second factor – alas – is a sudden weakening of the Dollar, which we believe is directly attributable to Bernanke’s standing down from the Taper.


The Euro is in the middle of an extended up-move.  At this point on our proprietary price levels model, the Euro is no longer “recovering,” it is breaking back above trade resistance lines and in fact has posted a two-year high against the Dollar.  Surprise of surprises for Keynesians in the audience, Germany’s stock market is tracking higher on the strength of the Euro.  Right across the Channel, the Bank of England is now captained by Mark Carney, who stiffened the resolve of the City of London with last week’s “we are open for business!” speech. 


Right on cue, Keith noted “the slope of UK economic growth just clocked a 3-year high and both the British Pound and British stock market (FTSE) are breaking out to new highs as the world comes to realize that ending Mervyn King’s QE Pound Getting Pounded experiment hath ended.”


This is the direct opposite of what America’s markets are going through, where the “extend and pretend” policy of Quantitative Easing is credited with pushing the stock market higher.  How can opposite policies, on opposite sides of the ocean, have the same effect of pushing stock prices higher?


You will be relieved to hear that we have some thoughts on that.


Financials sector senior analyst, Jonathan Casteleyn, continues to see rotation out of bonds, and now strong inflows into equities.  Last week, $9.1 billion of new money flowed into US stock funds, the record for any five-day period and far above the old record of $7.7 billion from the beginning of the year.  And fixed income funds continue to have persistent outflows, consistently tracking negative, compared to a strong average inflow of $5.8 billion a week last year.


Money follows performance, says Casteleyn, so the inflows get stronger on the back of strong market moves.  Inertia can carry this forward for some time, but fundamental strength will only return to the US equities market when the props have been removed.  Only then will we have any idea of whether this tottering beast can actually stand on its own two feet.  Only then will we be able to have any notion of where market prices actually “should” trade.


The Fed’s desire to prop up bond prices notwithstanding, investors are migrating away and into equities.  Equities got an extra pop this week from the end of the mutual fund sector’s reporting year, where everyone rushed to buy the stocks that have performed best, so they can show them in their portfolios at year end.  This quarterly exercise, known as “window-dressing,” is a key example of how Wall Street consistently misrepresents its way to success and another regulatory head-scratcher: if “everyone knows” that the mutual funds do this every quarter, why are they permitted to continue to do it? 


Thus, our markets are being buoyed by follow-through momentum.  Like a car coasting along the highway at 90 MPH – totally out of gas, it will continue careening down the road until the momentum dies.  And then…


In Europe, meanwhile, a bull move has been taking shape and has been all but disregarded by American investors.  Europe is showing signs of fundamental strength.  Purchasing managers indexes (PMIs) are stabilizing and basing, indicating a turn to the upside across the Eurozone.  Autos are absolutely positive in the Eurozone, as measured by new car registrations, and confidence readings are rebounding smartly off their End Of The World lows.  Said Keith this week, if US policy doesn’t step aside and allow our markets to operate on their own, “Europe will be the better place to allocate your capital in 2014. If the USA’s said free-market leadership signs off on Burning The Buck and Japanese Rate Repression, the Euro, Pound, and Swiss Franc are going up. If that continues to happen, you’ll basically have the exact same call we made on US growth almost a year ago occur in Europe:

  1. #StrongEuro, #StrongPound, etc. = deflates European inflation
  2. Inflation slowing = real/inflation-adjusted economic growth stabilizing, then accelerating.”

Beware of scoffers.  Spain has its problems – but so does New Jersey.  Greece hasn’t yet worked through its economic issues – but neither has California, which still can’t figure out how many jobs it has lost (or gained) lately.  Meanwhile, Spain has just turned the corner to positive inflation-adjusted growth, and Italy is flashing a positive divergence after dumping the political Old Guard (Berlusconi) and cutting corporate taxes – both of which are more than can be said for the US of A.


Oh, and one more thing the Europeans have going for them right now – even Spain, and even Italy, and even Greece – a strong currency.  Which is also more than can be said of the US.


So, Ben Bernanke… che si dice?


Sector Spotlight – Tobacco: To E- Or Not To E-

Hedgeye Consumer Staples sector analyst Matt Hedrick continues to be bullish on the burgeoning market for electronic cigarettes.  You may not like the idea of tobacco, but annual tobacco sales in the US approach the $100 billion mark.  This is a huge market, and one that investors take seriously.


Hedrick posted an overview this week (“What’s Big Tobacco Saying About E-Cigs in Q3 2013?”) noting that “for a second straight quarter there was significant buzz around Big Tobacco’s electronic cigarette offerings.”  The segment leader continues to be Lorillard (LO), which acquired e-cigarette brand Blu early last year and is in some 127,000 retail outlets around the country.  But, notes Hedrick, “both MO and RAI joined the category through test market launches in individual states in Q3, and PM reaffirmed its plan to launch an e-cig in 2016/7.”


Tobacco, a $100 billion market in the US alone, ranges up to perhaps $800 billion globally, according to Craig Weiss, CEO of privately held e-cigarette manufacturer NJOY.  Hedgeye hosted a conference call with Weiss this week where he addressed the e-cigarette segment, and described his company’s approach to the product and its marketing.


Weiss says the segment is trying to determine the best mix of “lifelike” features to attempt to replicate.  The look and feel of the product ranges from futuristic aluminum tubes, to products such as NJOY’s that strive to replicate the look and feel of actual cigarettes; what Weiss calls “old technology – tobacco wrapped in paper.”  E-cigarette makers note that America’s 45 million existing smokers are not only addicted to nicotine, but also cherish the spongy feel of the paper roll, the sensation of snapping open the flip-top box, and the ceremony around lighting up, including the flickering cigarette lighter and the initial “nicotine hit” at the back of the throat.  As Weiss says, these people “will literally take this habit with them to the grave.”


On the plus side, smokers who switch to e-cigarettes will no longer have to deal with the stink of stale smoke on their clothing and hair, the nicotine stains on their fingers, messy ashtrays and fouled cocktail glasses – not to mention the unpleasant thought of kissing someone with “smoker’s mouth.”


Are e-cigarettes an “alternative” technology or a “quit aid”?  Or is this a new product category that will break down into traditional tobacco users looking to cut down or quit, and new users looking for a nicotine experience?  The jury is still out on how safe electronic cigarettes are.  It should come as no surprise that there are studies claiming to “prove” that e-cigarettes are not safe – including at least one that claims there is an electronic secondhand smoke effect – as well as studies indicating that e-cigarettes are far less harmful than traditional tobacco, some of which claim minimal negative health effects.


Our society condones products that are dangerous when used the wrong way – automobiles, firearms – as well as products that are likely to produce negative health effects if not used with care – alcohol, painkillers.  But cigarettes are perhaps the only consumer product that has negative health effects when used as intended by the manufacturer.  If electronic cigarettes were introduced today in a vacuum – with no history of tobacco use – we wonder whether there would be significant resistance to their use as a mechanism for delivering a nicotine vapor, with its demonstrated effect of increasing alertness and a feeling of general well-being.


Weiss pointed to anecdotal evidence from NJOY’s own marketing data where retailers saw e-cigarette sales outstrip sales of over-the-counter stimulant products – the various “energy in a bottle” preparations.  Again, if these products are deemed safe, we wonder whether nicotine delivered in vapor format would be questioned, if not for the history of the cigarette industry. 


“Sin” Sells


Tobacco is the original “unsafe at any speed” product.  Weiss says over 400,000 Americans die every year from tobacco-related conditions.  “It’s basically a 9/11 every three days,” he says, costing the US economy some $200 billion annually.


Tobacco is good business.  And it is a highly concentrated market.  The Centers for Disease Control website reports “more than 293 billion cigarettes were purchased in the United States in 2011, with three companies selling nearly 85% of them.  (Emphasis added.) 


The category monster remains Marlboro, which contributes massively to Philip Morris’ 46% market share.  Reynolds came in second, at just under 25%, followed by Lorillard at a mere 13.7%.  But even as third banana, LO sold 45 billion individual smokes in 2011 – and they are the notable first on the block with electronic cigarettes.  This makes more sense in light of current regulatory efforts to block the marketing of menthol cigarettes – LO’s leading brand is Newport.  There is less core business for LO to potentially cannibalize, and they may need an emergency fallback. 


In terms of how Big Tobacco’s marketing efforts stack up, it is interesting to note that, of almost $8.4 billion spent by the industry on advertising and promotion in 2011, $7 billion – nearly 84 per cent – went to price discounts.  The industry appears happy to “partner” with the consumer to continue to promote sales volume.  


LO’s market leading Blu e-cigarette’s market share gain to 49% vs 40% last quarter was also driven by severe discounting and couponing, resulting in break-even cost for the company.  LO’s avowed strategy to aggressively expand sales, while sacrificing short-term profits, has shown initial results, helping to expand sales somewhat beyond LO’s existing already massive distribution channels.


In their latest earnings call, LO’s CEO Kessler addressed some specifics of the e-cigarette segment.  Hedrick notes a few key takeaways:  LO reiterated a $1-$2 billion retail sales figure for e-cigarettes in the current year, or about a 1% total piece of the cigarette market.  Kessler believes the regulatory environment will be the ultimate determining factor to growth in the e-cigarette segment, including restrictions on advertising, as e-cigarettes have already shown significant repeat purchasing patterns.  Altogether, Kessler sees growth in both top-line revenues, and profits for the industry as e-cigarettes become an established category.


While LO remains the leader of the pack, Hedrick outlined the e-cigarette initiatives of the other major tobacco companies, all of whom seem to share an enthusiasm for the potential of this new segment.  But note that e-cigs currently represent around 1% of Big Tobacco’s business, if that.  This means that an adverse regulatory ruling (the FDA may be coming out with restrictions before year end) will not represent a massive setback for existing sales.  It also means it is likely to be some time before the full impact of the segment makes itself felt on the majors.  There are smaller companies in this space, but they tend to be really small, with low public floats – meaning likely higher volatility in their stock prices.  And they are pure e-cigarette companies, which means they will be successful only if the segment succeeds.


Big Tobacco may not be out of the woods either.  The FDA is considering banning, or adding significant restrictions to, the sale of menthol cigarettes.  Lorillard is urging smokers of its Newport brand to write to Washington asking the FDA to take a hands-off approach to menthol.  A ban on menthol, says LO, “would impact 30% of the US cigarette market,” and would affect 500,000 jobs (  So now it’s your health, versus the Free Market.  The First Amendment protects what comes out of your mouth.  Now it is being used to protect your right to put stuff in as well.


Investing Term – Consumer Staples

Who would believe that cigarettes could be considered a “staple”?  When we were in fourth grade, we learned about “staple” foods.  These included rice (in parts of the world we only saw in the pages of National Geographic), wheat, bread, and some odd vegetable thing called manioc.  If you are like us, you associate the word “staples” with the basic stuff that keeps one alive.  For investment professionals, Consumer Staples is a global industry classification sector (GICS, a registered trademark indicating the classification system used by Standard & Poors to categorize companies and industry groups). 


The Consumer Staples sector comprises food and drug retailing companies, as well as food, beverage and tobacco companies, and companies that provide household and personal goods.  The Consumer Staples sector is distinct from the Consumer Discretionary sector, which includes apparel, hotels, media and leisure and entertainment companies, as well as big ticket items such as automobiles and consumer durables.


Companies in the Consumer Staples space include such household names as Gillette, Colgate Palmolive, and P&G. 


What makes these “staples” companies is the non-cyclical nature of their sales, which makes it logical to include tobacco in the sector.  This is one addiction that tends to remain price inelastic and not vulnerable to economic cycles, at least among its core constituency.  In short, these are products that people are not able, or willing, to cut out of their budget during economic downturns.  Staples tend to be relatively stable;  people may buy a new car when the economy is doing well (Consumer Cyclical), but they are not likely to rush out and buy an extra $80,000 worth of bathroom cleaner.


Consumer Staples are considered counter-cyclical or “defensive” stocks, and the best among them tend to produce slow and steady growth.  While they produce important products, Consumer Staples stocks make up only about 10% of the S&P 500.  Investors are drawn to them for a few basic reasons:


-         They are easy businesses to understand.  A pasta manufacturing operation or a maker of paper towels and napkins   do not present major technological challenges to the investor.


-         Established brands tend to have high consumer loyalty, meaning it takes an awful lot to create a substantial shift in   demand. 


-         They are low-tech, not subject to major unexpected upheaval from “disruptive technology.”  There’s no “iToothpaste   5C” on the horizon likely to unseat Colgate Palmolive with one fell swoop.


-         Earnings tend to be broadly highly predictable, as Staples are, by definition, well established product categories with   inelastic demand.  People buy corn flakes, toilet paper and cigarettes no matter what the economy is doing.


But perhaps the single best-kept secret: Consumer Staples stocks as a group have historically a low correlation to the broad market.  The sector is only about 65% correlated to the S&P 500.  In portfolio jargon, this means it has a .65 Beta, which is a low volatility reading.  For every one per cent move in the S&P 500, the sector tends to move .65%.  This is both to the up- and downside, making the sector less exciting when stocks are charging to the upside, but less terrifying when the broad averages are plunging.  The Consumer Staples sector – through mutual funds or ETFs, or through individual stock holdings – is a favorite hedge for many investors’ portfolios.


- By Moshe Silver

Moshe is a Hedgeye Managing Director and author of the Hedgeye e-book Fixing A Broken Wall Street 


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Toppy? SP500 Levels, Refreshed

Takeaway: If the USD and rates fail here, this market has plenty of downside risks.

This note was originally published November 01, 2013 at 11:56 in Macro



I’m buying Gold and Treasuries for the first time in a year (today) as the S&P 500 signals lower-highs and the VIX signals higher-lows. If the USD and rates fail here, this market has plenty of downside risks.


Across our core risk management durations, here are the lines that matter to me most:

  1. Immediate-term TRADE resistance = 1771
  2. Immediate-term TRADE support = 1744
  3. Intermediate-term TREND support = 1683

In other words, with the all-time closing high (1771) registering as resistance, there’s plenty of mean reversion downside. If the market stops me out of these thoughts, so be it. But sentiment (II Bull/Bear Spread) is tracking at its year-to-date high now too.




Keith McCullough

Chief Executive Officer


Toppy? SP500 Levels, Refreshed - km1

Buy the EURO: #EuroBulls

That’s right, we believe now is a great opportunity to get long the EUR/USD on weakness [etf: FXE].


Draghi and some of his lieutenants (including ECB Governing Council member Ewald Nowotny) talked down the common currency mid-week, suggesting that the ECB was ready to issue liquidity measures to spur the broader economy.  We heard whispers of another round of LTRO, and then the manic media ran with headlines that the ECB is going to cut rates, all of which sent the EUR/USD correcting over 2%.


By our score, the first two LTROs that Draghi issued were complete failures – banks either quickly repaid these loans and/or capitalized playing the spread on these cheap 1% loans, but in any case, did not lend to the real economy. This time around, we believe Draghi has 1). learned his lesson and will not issue another failed LTRO program to boost liquidity, and 2). has suggested in press conferences and other commentary that the data he’s tracking shows initial positive signs of a recovery across the Eurozone, which therefore suggests to us that neither liquidity measures nor a rate cut (why waste the powder now?) would be warranted over the near term.  


Our #EuroBulls Purview:  as we discussed as one of the team’s Q4 quarterly macro themes, #EuroBulls, we’re bullish on German and UK equities (see Keith’s latest video for that update) and bullish on the EUR/USD, built on a few central factors:

  • Bernanke/Yellen continue to burn the USD via delaying the call to taper (note: we do not expect any update in the December meeting), #EuroBulls
  • EUR strength reflects country strength: recent data continues to reflect that the Eurozone economy has stabilized and is beginning to accelerate, #EuroBulls
  • The deflation of inflation across the Eurozone equates to more consumer purchasing power via lowering the consumption tax,  #EuroBulls
  • The ECB’s hawkish policy, which we believe is the decision not to cut rates or issue imminent liquidity, is #EuroBulls
  • The Data: as we show below in a number of updated charts from our #EuroBulls Q4 themes deck, from PMIs and Confidence to Auto Sales and Factory Orders, the trend in the data is positive : this supports our conviction to be overweight European equities over U.S. equities.
  • Further, we see a strong positive correlation between the EUR/USD and the DAX, encouraging us to be long the German DAX via the eft EWG.  [We’re also bullish on the UK’s FTSE, via the etf EWU]


By the Charts:

  • Our levels in the sand:

Buy the EURO: #EuroBulls  - zz. EUR LEVELS NEW


  • PMIs bouncing:  across the Eurozone, the majors have broadly held above the 50 level indicating expansion.  While we don’t expect gangbuster moves in PMIs over the intermediate term, we expect them to indicate the acceleration in growth we’re seeing from low levels.

Buy the EURO: #EuroBulls  - zz. pmis


  • Confidence Up: as we look out across Economic, Consumer, and Business Confidence, an upward trend is solidified. We expect this improvement to continue.

Buy the EURO: #EuroBulls  - zz. consumer conf


Buy the EURO: #EuroBulls  - zz. bus conf


  • Retail Sales: as a sign of the consumer’s health, and confidence, retail sales are even going up across the periphery: Italy Business Confidence 97.3 OCT vs 96.8 SEPT; Spain Retail Sales 2.2% SEPT Y/Y vs -4.4% AUG; Greece Retail Sales -8.9% AUG Y/Y vs -14.1% JUL

Buy the EURO: #EuroBulls  - zz. italy retail


  • Even Autos are getting a bounce:  New Commercial Vehicle Registrations for the EU just recorded +6.1% Y/Y in September. Any increase in big ticket items is a signal to us of confidence.

Buy the EURO: #EuroBulls  - zz. clunkers


  • Deflating the Inflation: anchoring improving retail sales and confidence is deflation of the inflation.  While Draghi has “failed” to meet his 2% CPI target (currently at 0.7% Y/Y vs 1.1% in September), deflating the inflation equates to a lower consumption tax, which will boost real inflation adjusted growth.

Buy the EURO: #EuroBulls  - zz. inflation target


  • The CPI Turn Matters: the year over year changes are huge!

Buy the EURO: #EuroBulls  - zz. inflation comp


  • German Preference: we continue to like the DAX, on a positive correlation to the EUR/USD. Fundamentals remain grounded with a low unemployment rate (6.9% vs 12.2% in the Eurozone), CPI at 1.3% Y/Y, strong PMIs and consumer and business confidence, and an inflection in factory orders to the upside. [Long German DAX via the etf EWG]

Buy the EURO: #EuroBulls  - zz. eur vs das new


Buy the EURO: #EuroBulls  - zz. germany factory



Enjoy the weekend!


Matthew Hedrick


3Q13 Earnings Scorecard: Macro Monopolization

Macro's Monopolization:  The EPS-Sales Beat-Miss spread continues to widen vs 2Q13 and the TTM average while macro, more than fundamentals, has persisted as the dominate driver of beta during earnings season.  Forecasting fundamentals has been something of an antediluvian exercise thus far with only 60% of companies that have beaten estimates subsequently outperforming the market.   


Beat-Miss:  Beat-Miss trends remained largely static over the last week as 53% and 75% of SPX constituent companies have beaten Sales and Earnings estimates, respectively.  With three-quarters of companies having reported, the Sales-EPS beat-miss spread continues to widen vs the 2Q13 (54%/71%) and TTM (51%/72%) averages. 


3Q13 Earnings Scorecard:  Macro Monopolization - ES Table 110113


Style Factor Performance:   Reported results vs expectations across style factors has flattened out in the latest week with the exception of high topline growers, where high growth equities continue to perform better vs existent estimates that their slow growth counterparts. 


3Q13 Earnings Scorecard:  Macro Monopolization - ES SFP Table 110113


Fundamental Performance:    Slight deterioration WoW with 51% and 53% of companies registering sequential acceleration in sales growth and earnings growth, respectively.  55% of companies are reporting sequential expansion in operating margins as cost initiatives, modest efficiency gains and muted wage pressures continue to drive peak returns to capital.  At the sector level, Materials, Tech, Industrials and Staples are reflecting improving trends across sales, profitability and margins.


3Q13 Earnings Scorecard:  Macro Monopolization - ES OP Table 110113 


The Post-Print Random Walk?  Below we chart company Beats & Misses vs subsequent market adjusted 3-day performance.

  • Sales: 60% of companies that beat sales estimates subsequently outperformed the market to the tune of 4.0% on average.  The other 40% of companies that beat sales estimates underperformed the market over the subsequent 3-day period by an average of -3.7%.  Subsequent performance for companies missing Sales estimates was similarly mixed.  
  • EPS:  57% of companies beating EPS estimates have subsequently outperformed the market by ~3.8% on average while 43% went on to underperform the market by an average of -3.9%. Subsequent performance for companies missing EPS estimates was similarly mixed.  

3Q13 Earnings Scorecard:  Macro Monopolization - BM Sales


3Q13 Earnings Scorecard:  Macro Monopolization - BM EPS


Christian B. Drake


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