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The Doppelganger Fed

This note was originally published at 8am on October 31, 2013 for Hedgeye subscribers.

“One day everything will be well, that is our hope. Everything’s fine today, that is our illusion.”

-Voltaire

 

In German folklore a doppelganger is literally a paranormal double of a living person. More contemporarily, the word doppelganger is used to identify a person that closely resembles someone else either physically or behaviorally. As an example, some people have suggested that my doppelganger is Russell Crowe.

 

As it relates to the Federal Reserve, the biggest question facing investors currently is whether Janet Yellen will be a doppelganger, in terms of policy and communication, of current Chairman Ben Bernanke (more commonly known as The Bernank).  Practically speaking, copying Bernanke’s behavior is likely to mean a continuation of QE Infinity.

 

Keith had some colorful comments on Fox Business last night as it relates this idea of QE Infinity. The video is attached in the link below and Keith’s comment begin at around the 3:00 mark. As Keith notes, the biggest issue is that the Fed is confusing the market which has dramatically heightened interest rate volatility this year.

 

Paul Singer from Elliott Management made a similar statement in his letter to investment partners yesterday where he wrote:

 

“QE Infinity” has so distorted the prices of stocks and bonds that nobody can possibly determine what the investing landscape would look like, or what the condition of the economy and financial system would be, in the absence of Fed bond-buying.”

 

This is indeed the issue, namely that the economy and investors have become so accustomed to abnormal interest rate policy, that they have an incredibly difficult time determining what normal is anymore.  Sadly, the new normal appears to be to wait for the Fed’s next whisper to the Wall Street Journal’s Jon Hilsenrath.

 

To be fair, for those that are into reading Federal Reserve tea leaves, there was communication other than whispers to Hilsenrath yesterday. Specifically, in its statement the Federal Reserve made three changes:

  • This clause was removed, “the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market”;
  • They changed ”that economic activity has been expanding at a moderate pace” to “generally suggests that economic activity has continued to expand at a moderate pace”; and
  • They removed the “some” from this statement - “Some indicators of labor market conditions have shown further improvement”.

Maybe it is just me, but I’ve been reading English for a long time now and I have no idea what the implication is of those changes.

 

The fact is that the bogey that remains out there is 6.5% unemployment and if we take their word then the Fed will:

 

“. . . keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent.”

 

Although, even there, The Bernank has been quite dodgey as he has at times alluded to 7% being the bogey for altering monetary policy and other times suggesting he would lower the bogey to 6%. But if we accept the current 6.5% target, QE Infinity is likely to continue at the rate of $85 billion, give or take, for the for seeable future. 

 

In the Chart of the Day, we’ve highlighted the growth of the Federal Reserve balance sheet since 2008 as a result of QE Infinity.  In total, the Fed is almost at $4 trillion in assets on its balance sheet.  Not to be the alarmist, but another reason that we may be in the low interest time zone for a lot longer than we realize is because of interest rate risk associated with the Fed’s balance sheet.

 

Ironically, some pundits (we won’t name names) have commended the Fed under Chairman Bernanke for being transparent and great at communicating.  Sadly, it doesn’t take much more than the last 24 hours to understand that a) the Fed is as bad at communicating as ever and b) this is why investors are so confused. Frankly, we see no reason to believe that Yellen will be anything but Bernanke’s doppelganger on the communication front . . . and so the confusion will go on.

 

Sadly for stock operators, this confusion has led to an environment in which fundamentals for companies are, at times, ignored.  As an example, let’s look at both earnings and sales results for SP500 companies:

  • Sales: 60% of companies that beat sales estimates subsequently outperformed the market to the tune of 3.7% on average.  The other 40% of companies that beat sales estimates underperformed the market over the subsequent 3-days by an average of -3.8%.   Subsequent performance for companies missing Sales estimates was similarly mixed.  
  • EPS:   56% of companies beating EPS estimates subsequently outperformed the market by ~3% on average while 44% went on to underperform the market by an average of -4.1%.  Subsequent performance for companies missing EPS estimates was similarly mixed.

In a nutshell, stock performance has had very little relation to fundamental performance in 2013.  More simply, it has been a structurally tough year to isolate Alpha.  But even there no one should be surprised, because it is a macro driven market.  And if you don’t do macro, macro will do you.

 

Our immediate-term Risk Ranges are now:

 

UST 10yr Yield 2.47-2.60%

SPX 1755-1771

VIX 12.85-14.92

USD 79.21-81.16

Brent 108.86-111.27

Gold 1327-1363

 

Keep your head up and stick on the ice,

Daryl G. Jones

 

The Doppelganger Fed - Chart of the Day

 

The Doppelganger Fed - Virtual Portfolio


ICI Fund Flow Survey: Equities Strong, Bonds Weak

Takeaway: Equity funds followed through on their prior weekly record with another strong inflow in the most recent 5 day period; Bonds were weak again

This note was originally published November 07, 2013 at 09:20 in Financials

ICI Fund Flow Survey: Equities Strong, Bonds Weak - bull4

Investment Company Institute Mutual Fund Data and ETF Money Flow:

 

Total equity mutual fund flow followed through after the record week last week with another strong inflow of $7.9 billion for the 5 day period ending October 30th, well above the 2013 weekly average inflow of $2.9 billion. Domestic equity mutual fund flow was $4.2 billion in the most recent period with world equity funds collecting $3.6 billion in new investor capital.  Total equity mutual fund trends in 2013 now tally the aforementioned $2.9 billion weekly average inflow, a total reversal from 2012's $3.0 billion weekly outflow 

 

Fixed income mutual funds continued persistent outflows during the most recent 5 day period with another $4.1 billion withdrawn from bond funds. This week's draw down worsened sequentially from the $2.3 billion outflow the week prior which has now forced the 2013 weekly average for all fixed income funds to a $798 million outflow which compares to the strong weekly inflow of $5.8 billion throughout 2012

 

ETFs experienced declining weekly subscriptions in the most recent 5 day period, with both equity and fixed income ETFs seeing smaller inflows week-to-week. Passive equity products took in $8.7 billion for the 5 day period ending October 30th, a sequential weekly decline, with bond ETFs experiencing a $551 million inflow, also a smaller inflow than the week prior. ETF products also reflect the 2013 asset allocation shift, with the weekly averages for equity products up year-over-year versus bond ETFs which are seeing weaker year-over-year results

 

ICI Fund Flow Survey: Equities Strong, Bonds Weak - ICI chart 9

ICI Fund Flow Survey: Equities Strong, Bonds Weak - ICI chart 10

 

For the week ending October 30th, the Investment Company Institute reported another strong weekly subscription within equity funds with another $7.9 billion inflow into total equity mutual funds. The breakout between domestic and world stock funds separated to a $4.2 billion inflow into domestic stock funds and a $3.6 billion inflow into international or world stock funds. Both results for the most recent 5 day period within stock funds were above the 2013 weekly averages, with the domestic stock fund 2013 weekly mean at just a $442 million inflow and world stock funds having averaged a $2.5 billion inflow during 2013. The aggregate inflow for all stock funds now sits at a $2.9 billion inflow, a complete reversal from the $3.0 billion outflow averaged per week in 2012.

 

On the fixed income side, bond funds continued their weak trends for the 5 day period ended October 30th with outflows staying persistent within the asset class. The aggregate of taxable and tax-free bond funds booked a $4.1 billion outflow, a sequential deterioration from the $2.3 billion lost in the 5 day period prior. Both categories of fixed income contributed to outflows with taxable bonds having redemptions of $3.3 billion, which joined the $789 million outflow in tax-free or municipal bonds. Taxable bonds have now had outflows in 17 of the past 22 weeks and municipal bonds having had 22 consecutive weeks of outflow. While the sharp outflows that marked most of the summer and the start of the third quarter have moderated, the appetite for bonds has hardly rebounded. The 2013 weekly average for fixed income fund flows is now a $798 million weekly outflow, a sharp reversal from the $5.8 billion weekly inflow averaged last year.

 

Hybrid mutual funds, products which combine both equity and fixed income allocations, continue to be the most stable category within the ICI survey with another $2.0 billion inflow in the most recent 5 day period. Hybrid funds have had inflow in 18 of the past 20 weeks with the 2013 weekly average inflow now at $1.6 billion, a strong advance versus the 2012 weekly average inflow of $911 million.

 

 

ICI Fund Flow Survey: Equities Strong, Bonds Weak - ICI chart 2

ICI Fund Flow Survey: Equities Strong, Bonds Weak - ICI chart 3

ICI Fund Flow Survey: Equities Strong, Bonds Weak - ICI chart 4

ICI Fund Flow Survey: Equities Strong, Bonds Weak - ICI chart 5

ICI Fund Flow Survey: Equities Strong, Bonds Weak - ICI chart 6

 

 

Passive Products:

 

Exchange traded funds booked inflows on both sides of the ledger with equity ETFs posting a $8.7 billion inflow, a sequential decline from the very strong $13.0 billion subscription the week prior. The 2013 weekly average for stock ETFs is now a $3.4 billion weekly inflow, a 50% improvement from last year's $2.2 billion weekly average inflow.

 

Bond ETFs managed an inflow for the 5 day period ending October 30th with a $551 million subscription, also a sequential decline from the week prior which netted a $1.3 billion inflow for passive bond products. Taking in consideration this most recent data, 2013 averages for bond ETFs are flagging with just a $308 million average weekly inflow for bond ETFs, much lower than the $1.0 billion average weekly inflow for 2012.

 

 

ICI Fund Flow Survey: Equities Strong, Bonds Weak - ICI chart 7

ICI Fund Flow Survey: Equities Strong, Bonds Weak - ICI chart 8

 

 

Jonathan Casteleyn, CFA, CMT

203-562-6500

jcasteleyn@hedgeye.com 

 

 

 

Joshua Steiner, CFA

203-562-6500

jsteiner@hedgeye.com


CHINESE BANKING REFORMS: SHORT OF DETAILS; LONG OF RISKS

Takeaway: Chinese policymakers appear committed to ignoring the risks embedded throughout the country’s financial system.

CONCLUSIONS:

 

  • We don’t like that Chinese policymakers appear committed to ignoring the risks embedded throughout the country’s financial system and its 3,800 banks.
  • Forging ahead with interest rate reform – as recently affirmed by the PBoC – in the absence of meaningful and accelerated banking system reform that is accompanied by broader economic reform (see: publically-perpetuated fixed asset investment bubble) is a HUGE risk, in our analytical opinion.
  • If it seems as if we’re no longer comfortable with NOT being bearish on China, then we’d say that is an accurate depiction of our fundamental bias at the current juncture.

 

How trite of me to send you a note in the late afternoon thrashing the 3rd Plenary Session of the 18th CPC Central Committee. Surely by now you’ve been pelted with sell-side notes and media headlines berating it for its lack of specificity on the reform front.

 

As such, we’ll spare you the details and a long-winded summary of our likes and dislikes; we really couldn’t put one out if we tried – the actual policies are to be designed by a hand-picked reform task force in the weeks and/or months ahead. For now, all we have are more questions than answers.

 

A short-winded summary of our likes and dislikes:

 

  • We like that Chinese policymakers appear committed to reforming municipal government financing. Per World Bank estimates, municipal level governments spend ~80% of total public expenditures in China, but take home only ~40% of total public revenues. This cash flow mismatch is financed largely by off-balance sheet debt issuance of questionable credit quality (~28% of outstanding bank loans per the latest CASS estimates), so anything to remedy the aforementioned disparity would be positive, at the margins, for reducing the risk of an NPL crisis predicated by LGFV liquidity issues.
  • We like that Chinese policymakers appear committed to restructuring property rights. While harvesting the low-hanging fruit will likely fall short of broad-based Hukou reform, we do think any progress on this front will help to alleviate the political pressure boiling up across rural China which has decidedly undermined CPC legitimacy in recent years.
  • We don’t like that Chinese policymakers appear committed to ignoring the risks embedded throughout the country’s financial system and its 3,800 banks. Forging ahead with interest rate reform – as recently affirmed by the PBoC – in the absence of meaningful and accelerated banking system reform that is accompanied by broader economic reform (see: publically-perpetuated fixed asset investment bubble) is a HUGE risk, in our analytical opinion.

 

If you’re not yet familiar with our seminal concerns surrounding the structural headwinds to Chinese (and global) economic growth embedded throughout the Chinese banking sector, we think it is important that you review the summary piece we published last Friday, “PREVIEWING CHINA’S THIRD PLENARY SESSION: CREDITHOLICS ANONYMOUS?” (11/8), as well as our 61-page slide deck titled, “ARE YOU SHORT CHINA [AND OTHER EMERGING MARKETS] YET?” (6/12).

 

CHINESE BANKING REFORMS: SHORT OF DETAILS; LONG OF RISKS - 1

 

If it seems as if we’re no longer comfortable with NOT being bearish on China, then we’d say that is an accurate depiction of our fundamental bias at the current juncture.

 

Please feel free to email us if you have follow-up questions that you’d like us to address.

 

Have a great evening,

 

DD

 

Darius Dale

Associate: Macro Team


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A 'Sell' Rating on $RH? NONSENSE.

Hedgeye Retail Sector Head Brian McGough reports that a sell-side firm just initiated coverage on Restoration Hardware (RH) today with a Sell rating. "That's a head-scratcher" he says. 

 

In an emailed note McGough writes, "It’s tough to find any logic whatsoever in a short call on RH when the company will see 30%+ acceleration in square footage growth AND outsized comp growth to boot. This is Retail 101. Our estimates across durations remain 2-3x consensus."

 

Bottom line according to McGough is "RH is a $175 stock waiting to happen."

 

Check out the HedgeyeTV video below from October 17th where McGough explains why he believes RH is a 3-bagger.

 

 

(Note: McGough recently issued a 50-page Black Book on Restoration Hardware detailing his thesis. Ping sales@hedgeye.com for more information).


INVITE - FDX: Delivering After a Year in Transit? (Call Tomorrow @ 1PM EST)

Takeaway: Please join us tomorrow @1PM for an annual check-up on our FDX thesis

INVITE - FDX: Delivering After a Year in Transit? (Call Tomorrow @ 1PM EST) - FedExDIALIN 11 14 13

 

 

We will be presenting a Flash Call titled "FDX: Delivering After a Year in Transit?" on Thursday, November 13th at 1:00pm EDT.

 

A year after our initial Black Book and long call (Replay: CLICK HERE, Black Book: CLICK HERE) on FedEx Corp. (FDX), FDX shares are significantly higher and the opportunity at FedEx Express is better recognized. On the Flash Call tomorrow we will examine how key components of our FDX thesis are tracking and evaluate several relevant risks.  We think it is increasingly important to consider shares of FedEx on different time horizons.

 

 

KEY TOPICS WILL INCLUDE:

  • Long-term cycle drivers
  • Express margin opportunity vs. execution
  • Competitive risks
  • Industry headwinds
  • FY2Q set-up
  • Valuation and margin of safety

 

CALL DETAILS

  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 969216#
  • Materials: CLICK HERE

YUM: OCTOBER CHINA COMPS BEAT EXPECTATIONS

YUM reported October comps for its China Division yesterday after the close.  Total China comps (-5%) and Pizza Hut comps (+10%) beat expectations, while KFC comps (-7%) missed expectations.  Overall, we view this as positive news.  Total comps improved 600 bps sequentially from September and the recovery appears to be on track, as October marked the first month in several that overall results have come in above expectations.  We expect China comps to be positive in November, December and throughout 2014, as the company begins building sales momentum and lapping easy comparisons.

 

YUM: OCTOBER CHINA COMPS BEAT EXPECTATIONS - 11 13 2013 11 00 22 AM

 

YUM: OCTOBER CHINA COMPS BEAT EXPECTATIONS - YUM China SSS

 

 

As it stands, YUM is our favorite LONG in the big cap QSR landscape and, despite facing significant volatility over the past year, its long-term growth story remains intact.  As China same-store sales begin to accelerate meaningfully, we believe YUM’s earnings growth will follow suit and accelerate for the next year, and potentially longer, as margins begin to regain form.  We will be looking for more details on the pace and extent of the recovery during YUM’s Investor Conference on Wednesday, December 4, 2013 and will post on anything incremental following the meeting.

 

YUM: OCTOBER CHINA COMPS BEAT EXPECTATIONS - RLMMM

 

 

 

Howard Penney

Managing Director

 


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