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Our Macro Team is hosting an Expert Call featuring Tancred Lidderdale from the Energy Information Administration (EIA) for an in-depth discussion on the outlook for oil and natural gas.  As a Hedgeye Energy client, you are welcome to listen in.


The call titled "Oil & Natural Gas: Supply, Demand, Prices and Trends" will be held on Tuesday, November 26th at 11:00am EST


  • Oil
    • Key variables that drive the price of oil
    • Expectations for 2014 supply and demand
    • OPEC's ability to impact price
    • Why OPEC's surplus capacity is growing
    • Declining U.S. oil demand
  • Natural Gas
    • Intermediate supply outlook for natural gas
    • Current natural gas supply versus historical level
    • Drilling and drilling productivity
    • Outlook for the renaissance in U.S. natural gas
    • Current and future natural gas demand
  • Gasoline
    • Expectations heading into 2014 for demand and supply
    • Longer term trends
    • Price set versus the price of crude
    • Price implications from the spread on WTI/Brent


  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 658898#
  • Materials: CLICK HERE (Slides will download one hour prior to the start of the call.)


Tancred Lidderdale is the supervisor of the team that produces the Short-Term Energy Outlook for the Energy Information Administration (EIA). Before joining the EIA in 1991, he worked for 12 years with Atlantic Richfield Company in their petrochemical and refinery operations, and foreign crude oil trading. He received his B.S. degree in Chemical Engineering from Georgia Tech, his MBA from the University of Houston, and his Ph.D. in Economics from George Mason University.



Takeaway: The market is expensive here. But valuation is (still) not a catalyst.

This note was originally published November 20, 2013 at 15:28 in Macro. For more information on how you can subscribe to Hedgeye research click here.


I love everything about investing except maybe the fact that I’m actually in the investment industry.  If you saw how sausage was made you probably wouldn’t eat it.   


The allure of a skillfully prepared valuation narrative, however, remains one of the industry’s most enticing, sirenic delicacies. The market is expensive here but valuation is (still) not a catalyst.  Tops are processes, the price signal remains bullish currently and, up through the present, we have continued BTDB’ing (Buying the Damn Bubble) while taking down our gross and net equity exposure since the September 18th, No-Taper announcement. 





It has been hard to escape the valuation discussion the last few weeks as bubble speculation has been ubiquitous alongside higher nominal (& real) highs for domestic equities.   Reviewing a cross-section of market valuation measures (below), the summary takeaway is pretty straightforward – across the balance of metrics, equities are, indeed, moving towards overvalued on a historical basis. 


The problem, of course, is that the overbought-overvalued market narrative is a tired one as moderately elevated valuation has characterized most of 2013 and prices advancing at a premium to profits is not a new phenomenon – particularly in what could (amazingly still) be considered an “early cycle”,  liquidity supported stage of the recovery. 




We use a broad range of valuation and sentiment indicators when contemplating the direction of markets and where our view sits in the context of current prices, consensus estimates, and prevailing sentiment. From an Investment decision making perspective, valuation sits somewhere near the middle-bottom of the our consideration hierarchy. 


So, rather than claiming right to some specific valuation-in-isolation based insight on the immediate term direction for equities, below we survey a cross-section of canonical market valuation measures to provide some historical context for current multiples.    


In terms of how we are managing the current environment:  With fund flows, decent macro, rising M&A activity, bullish price momentum, near universal acknowledgement of the existent “bubbliness”, and the lack of a discrete negative catalyst all supporting equities in the immediate term, we’ll continue to ride the bull until the price signal changes.  Prune & plant within our immediate term risk ranges while holding an elevated cash balance.   


As Keith noted this morning: “This is a raging bull market, until it isn't.”


CAPE/Shiller PE:   At 24.9, the CAPE ratio (inflation-adjusted SPX price divided by the 10Y average of inflation adjusted earnings) is moving into the top decile of its historical range.   Below we’ve broken the historical CAPE ratio values into deciles and looked at average market performance over the subsequent 1Y and 3Y periods.  The mapping of the Shiller PE vs subsequent market performance suggests return expectations should move systematically lower alongside incremental increases in valuation. Historically, 1Y and 3Y returns progressively decline for each decile change in the Shiller PE.   




BUBBLE MONGERING - CAPE 12M Subsequent Performance 111913


BUBBLE MONGERING - CAPE 3Y Subsequent Performance 111913


Tobins Q-Ratio:  Longer-term valuation arguments center on the premise that returns on capital should equalize to cost of capital and  market values should normalize to economic value.  Tobin’s Q ratio is not a measure we use to tactically manage risk, but we can appreciate the intuition (why buy an asset when you can “re-create” it for less and compete away existing, excess profit) underneath its application.   


Historically, at extremes, it has served as a solid lead signal for subsequent market performance.   We are sitting just below the 1.0 level currently and approximately 1.0 standard deviation above the long-term mean value – a level that has generally not been a harbinger of positive forward returns historically.




S&P 500 Market Cap-to-GDP:  Assuming the collective output of SPX constituents credibly reflects aggregate national production (or serves as a credible proxy for it), the Market Capitalization-to-GDP ratio effectively represents a price to sales multiple for the economy.  As can be seen, on a historical basis, we are certainly entering “expensive” territory as we push towards breaching 100% to the upside.




FORWARD/TRAILING P/E:  On conventional LTM & NTM P/E metrics, the market is moderately expensive at present.  Valuing the market on 1Y of (recurrently over-optimistic) forward earnings estimates has its pitfalls and, additionally, any perceived cheapness in current multiples should be discounted to account for mean reversion downside off peak corporate profitability (more below). 




MARKET COMPS AND PEAK MARGINS:  Operating Margins remain near peak with Corporate Profitability continuing to make higher highs with after-tax corporate profits advancing to a record 11% of GDP in 2Q13 – some 85% above the long-term average at current levels .  Unless you think peak returns to capital provide a sustainable path to aggregate demand growth in the face of negative trend growth in real earnings, trough returns to labor, middling productivity growth and secularly depressed investment spending, then the mean reversion risk for margins remains asymmetrically to the downside.


Topline growth estimates for the SPX (mkt weighted) don’t look unreasonable at +4.8% for 2014.   Expectations look similar across SPX constituents on an equal weighted basis with median 2Y growth estimates reflecting modest acceleration over the next four quarters.   However, the slope on earnings growth (+10.9% for 2014) over the NTM continues to look overly aggressive given expectations for further, significant margin expansion above already peak corporate profitability.  




BUBBLE MONGERING - Corporate Profits   of GDP 111913





Christian B. Drake


CAT: Blinded by the Sun



A traditional sell side firm upgraded CAT today in a lengthy report that we suspect most longs won’t read in its entirety.  Rather than respond to a boring write-up with another boring write-up, we will mostly focus on what is missing from that report: all the bad stuff. 


Calling the bottom in CAT is a strategy that is not working.  Investors and sell siders have been making that call since before Resource Industries had even reported a down quarter (See It Hasn’t Started, So It Isn’t Over).  CAT is the 3rd worst performing Industrial YTD in the S&P 500, so arguing that the bottom is in because the shares are holding 80 as the market rips to all-time highs is a bit facile.  Why even bother trying to call a bottom when being long CAT is not working? 


CAT: Blinded by the Sun - bh1



Of course, we were not born yesterday.  Management provides special access to a sell sider and select clients.  Shortly after, said analyst upgrades the stock and writes a glowing report.  We are sure that the SOLAR/dealer visit trip was great.  We’ll leave the rest to the reader’s imagination.



Leaving Aside the Bad Stuff, CAT Is Great!



Trough Earnings


We see the $4.50 2014 EPS figure is a straw man.  We agree that CAT should produce more than $4.50 in 2014 EPS, excluding charges and any issues at CAT Financial, but why does that matter?  2014 was last interesting six months ago.  The battleground has moved to 2015 and later, where we see little hope of a rebound.  It has also moved to the CAT boardroom and CAT Financial.  The assumption that Power Systems is a stable source of profitability is deeply flawed, as is the assumption that Resource Industries cannot operate at a loss, in our view.


Multiple of Trough Not Useful For Generating Alpha


CAT underperformed the market nearly continuously from the late 1970s until 1992.  The peak/trough multiple analysis is unrelated to generating Alpha, so it is worthless.  It gives a buy signal in ’82-’83, ’84-’85, ’87, then finally successfully in ’91-’92.  Alternatively, our process – understanding the cycle, the industry structure and the valuation – has worked well and we have published real-time write-ups demonstrating it for the past year and a half (when we joined Hedgeye).


CAT: Blinded by the Sun - bh2



Cyclical Industries Can Lose Money


The Armageddon scenarios presented are really not that bad in the context of a deep cyclical like CAT.  Why exactly can’t Resource Industries operate at a loss?  Resource Industries margins are collapsing amid vast industry overcapacity.  Pricing is increasingly competitive, with the decline slow to hit the Income Statement as the company works off better priced orders in backlog.  Resource Industries revenues have only declined for three quarters, so it is still very early in the adjustment process.  What would Resource Industries profitability look like with industry capacity utilization at, say, 30%?   Mining capital spending is likely to remain at around maintenance levels, i.e. normal levels, for something like the next decade, as we see it. 


Where Is CAT Financial?


The recent credit metrics have looked questionable at CAT Financial, so we guess it was probably easier just to leave it out.  It is just the leveraged division which comprises about 40% of the firm’s assets and is a key focus for bears and short sellers.  Given the endless focus on the comparatively tiny (in terms of assets and risks) SOLAR turbine business, a few sentences might have been in order.


Mining Exposure Outside of Resource Industries


Part of the reason for weakness at Construction Industries is that larger pieces of equipment were often sold to the mining industries at high margins.  Locomotives at Power Systems are also sold to mines on occasion (see EMD website).  Mine site power is also a factor at PS.


Acquisitions & Capital Allocation


Comparing old CAT to current CAT is not exactly apples for apples.  CAT has gone through a period of terrible capital allocation, in our view, with vastly overpriced acquisitions and soon-to-be-unutilized capacity additions.  The misallocated capital is likely >$10 billion in the last few years and has yet to be recognized, by our estimates.


Management Credibility & Strategy


Given what has happened at CAT in the last year or two, some discussion of management strategy or credibility should probably have been included, right?  We expect a management change at CAT in the next year or two, with a new team coming in to lower the performance bar.  How do you write a 47 page report about a company that needs a turnaround without mentioning the name of the CEO or discussing strategy?


Competitors Missing


Komatsu, Hitachi and other competitors seem to be conspicuously absent from the discussion, which is an important omission for both Resource Industries and Construction Industries.  As mining equipment demand dries up, these competitors are refocusing on construction equipment, negatively impacting price.  In the instance where Komatsu is mentioned, it is about their coal commentary, not their competitive response to an evaporating mining equipment market.



Top Down View of Energy Capital Spending


We discussed the long-term outlook for Energy-related capital spending in our Industrials Fishfinder note this morning.  Energy-related capital spending boomed along with other resources-related capital spending and has since started to decline.  We see some risk that Power Systems is in fact the next shoe to drop.


CAT: Blinded by the Sun - BH3


Dealer Inventories


Dealer inventories should be looked at on a dollar basis, not as a % of sales.  Finning has about 2x the value of inventories of Westrac and Toromont combined, by our estimates.  Finning still has a lot of inventory to work off as we see it.  CAT provides inadequate transparency on this issue, we think.


We’ll Stop Here…


If CAT were composed exclusively of the SOLAR turbine business, the company’s outlook might be rosier.  Unfortunately, SOLAR is a small part of total CAT.  Of course, if the sell side were composed entirely of analysts actually trying to make good calls, markets might function better.


Instead, we think there is little reason to expect that this is the inflection point for CAT or that all of the bad news is priced in.  Multiple of peak/trough work would be interesting if it generated useful predictions – it just doesn’t.  We see a scenario for CAT much more like the 1980s, where the boom in resource-related capital spending drops over a long period of time amid tough competitive pressures.  We also see serious strategy and management deficits at CAT, the eventual resolution of which may result in a greater capitulation in the shares.  Maybe then we join the search for a CAT inflection….




Early Look

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$WMT's New CEO: Thumbs Up

Takeaway: This is a win-win for Wal-Mart.

Editor's note: Hedgeye Retail Sector Head Brian McGough offers a quick take on news of Wal-Mart's new CEO below.

$WMT's New CEO: Thumbs Up - dmw

  • "Wal-Mart Stores, Inc. today announced that its board of directors elected company veteran Doug McMillon, 47, to succeed Mike Duke, 63, as president and chief executive officer, effective February 1, 2014. McMillon was also elected to the company's board of directors, effective immediately."
  • "Duke will continue serving as chairman of the executive committee of the board and, in the tradition of his predecessors, stay on as an advisor to McMillon for one year. The company plans to make an announcement on McMillon's successor as CEO of Walmart International by the end of the fiscal year."

Takeaway: McMillon's profile has been growing inside WMT for a while now, so this does not come as a complete shock. But we are definitely surprised by the timing. All that said, the idea of having a 47-year old CEO with heavy International experience is extremely appetizing to us. Let's face it, there's no more unit growth in the United States; and WMT can't comp consistently better than 1%. Bottom line is this guy can't exactly do any damage to the US business, and International will have a bigger profile. It is a win-win.


Click here to learn more and subscribe to Hedgeye research.

European Banking Monitor: Winning Ways Continue

Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor".  If you'd like to receive the work of the Financials team or request a trial please email .




European Financial CDS - Europe's banks resume their winning ways, dropping an average of 8 bps W/W. Italian, Spanish and UK banks led the charge lower.


European Banking Monitor: Winning Ways Continue - zz. banks


Sovereign CDS – Sovereign swaps were mixed last week with the biggest up moves in the US (+5 bps) and Ireland (+4 bps) and the biggest down moves in Spain (-9 bps) and Portugal (-7 bps).


European Banking Monitor: Winning Ways Continue - zz.sov1


European Banking Monitor: Winning Ways Continue - zz.sov2


European Banking Monitor: Winning Ways Continue - zz.sov3


Euribor-OIS Spread – The Euribor-OIS spread tightened by 2 bps to 9 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. 


European Banking Monitor: Winning Ways Continue - zz.euribor


Matthew Hedrick


$TROW: Casteleyn Likes It

Takeaway: TROW is a prime beneficiary of the positively trending U.S. stock market.

Editor's note: What follows below is an excerpt from Hedgeye Financials Equity Analyst Jonathan Casteleyn in this weekend's Investing Ideas. Investing Ideas is for the longer-term investor looking for actionable long-only opportunities. With your subscription, you'll know immediately when one of our analysts uncovers a new idea or changes a current one. Every Saturday morning you'll receive our special newsletter full of all the important investing information of the week. Click here to subscribe.


$TROW: Casteleyn Likes It - trowe

T Rowe Price

During our recommendation of T Rowe Price as a core long position, we have solely been using industry information on equity flows from the Investment Company Institute (ICI), the trade group for the asset management industry.  However, there is a private survey of asset management performance and flows called Simfund which we don’t use that projected a very positive outlook for TROW separately from our research process using ICI data.


Last week, this private Simfund survey calculated that in October alone that T Rowe has netted over $1.8 billion in new net inflows, more than the prior 3 months combined which totaled just $1.2 billion. Thus it is safe to say that the fourth quarter has started in very strong fashion for this leading equity manager.


$TROW: Casteleyn Likes It - cast888


In addition, Simfund projected that TROW’s industry leading performance gap has widened favorably, meaning TROW’s mutual fund families have increased their lead as the best performing mutual funds of the public asset managers. According to Simfund, now 70% of TROW’s assets are 4 or 5 star Morningstar rated, the only mutual fund products that have historically generated any significant inflow (see annual 4 and 5 star inflow versus 1 to 3 star rated products below).


In a nutshell, TROW stock is a prime beneficiary of the positively trending U.S. stock market with industry leading performance and improving retail equity mutual fund flows.


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