TODAY’S S&P 500 SET-UP – December 5, 2013
As we look at today's setup for the S&P 500, the range is 23 points or 0.27% downside to 1788 and 1.01% upside to 1811.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS (Bloomberg Estimates):
WHAT TO WATCH:
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
The Hedgeye Macro Team
This note was originally published at 8am on November 21, 2013 for Hedgeye subscribers.
“I love everything about investing except maybe the fact that I’m actually in the investment industry. If you see how sausage is made you probably wouldn’t eat it.” - Yours Truly, ~10 hours ago
One day back in high school my friend Michael decided to start referring to himself as “Mike Nice.” Quoting yourself to jumpstart an investment missive is about as cool as trying to give yourself your own nickname....but the message fits the theme today, I can’t think of anything else and at 4am, questionable ideas have a sneaking ability to cloak themselves as appealing.
Anyway, back to the Global Macro Grind….
It has been difficult to escape the valuation discussion the last few weeks as bubble speculation has been ubiquitous alongside higher nominal, and real, highs for domestic equities. We added our own speculative cogitations to the already teeming cauldron of valuation commentary yesterday (see BUBBLE MONGERING for more) in a note surveying a current cross-section of market valuation measures. We reprise those below, but the takeaway was fairly straightforward - across the balance of metrics, equities are, indeed, moving towards overvalued.
To recapitulate the selection of metrics we considered yesterday:
Shiller PE: The Shiller PE ratio attempts to normalize the price to earnings ratio by adjusting for economic cyclicality. It does so by dividing the price of the S&P500 by the 10Y average of inflation adjusted earnings. At its current reading of 24.9X, the CAPE ratio is moving into the top decile of its historical range. Mapping the Shiller PE by decile 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 (ie. average forward returns by decile decline as multiples move higher).
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 underneath its application – after all, why buy an asset when you can “re-create” it for less and compete away existing, excess profit. Currently, the q-ratio sits just below the 1.0 level 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. On a historical basis, we are certainly entering “expensive” territory as we push towards breaching 100% to the upside. At current levels we are approximately equal to the 2007 highs and well above the long-term average.
FORWARD/TRAILING P/E: On conventional P/E metrics, the market is moderately expensive currently at 17X trailing earnings and 15X forward earnings. Valuing the market on a single year of (recurrently over-optimistic) forward earnings estimates has its myopic trappings and, additionally, any perceived cheapness in current multiples should be discounted to account for mean reversion downside off peak corporate profitability (more below).
PEAK MARGINS: In the Chart of the Day below we show after-tax corporate profits as a percentage of GDP. The latest 2Q13 data marked another higher high in corporate profitability at 11% of GDP – this is some 85% above the long-term average. 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 operating margins remains asymmetrically to the downside.
ESTIMATES: Topline growth estimates for the SPX (market weighted) don’t look unreasonable at +4.8% YoY for 2014. 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 (+100 to +250bps in incremental expansion over 2014) above already peak corporate profitability. Of course, iteratively ratcheting down expectations and subsequently beating deflated growth estimates over the course of the year remains the prevailing (and hereto successful) playbook strategy for higher equity prices.
So, generally speaking, we are overvalued. Practically, what do you do with that?
A chief problem for the bear camp is that that the overbought-overvalued market narrative has become 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.
Valuation-in-isolation narratives are some of the sell-sides finest sausage and sirenic when expertly crafted. But Valuation isn’t a catalyst.
At Hedgeye, 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.
We get that valuation matters in anchoring return expectations over the longer term. Underneath the technicals, acute policy catalysts, and reflexivity that drives immediate and intermediate term price trends sits the steady drumbeat of fundamentals and an accordion-like tether to ‘fair value’.
However, Price, not deviation from estimated intrinsic value, together with our view on marginal changes in macro fundamentals are the signals we use to risk manage immediate and intermediate term exposure.
With the Price signal bullish (SPX and all nine S&P sectors in Bullish Formation) and fund flows, decent domestic and global macro data, rising M&A activity, near universal acknowledgement of the existent ‘bubbliness’ (can you really be in the terminal stage of a bubble if everyone agrees it’s a bubble?), and the lack of a discrete negative catalyst all supporting equities in the immediate term, we’ll continue to lean long until the price signal changes.
Tops are process and we have continued to Buy The Bubble on shallow corrections within our published risk ranges while taking down our gross and net equity exposure since the No-Taper announcement in September. We’ll probably continue to run tight and #RemainActive as yesterday’s FOMC Minutes only extended the confused communication policy out of the Fed.
Raise some cash. Embrace the uncertainty and volatility of it all. Don’t eat the sausage. Eat a snickers… Don't invest like a Diva.
Our immediate-term Risk Ranges are now as follows:
UST 10yr Yield 2.67-2.83%
Christian B. Drake
Holiday discounting, recovery, and Royal Caribbean outperformance.
Apparently, CCL/ NCLH engaged in some aggressive promotional discounting through Thanksgiving weekend. However, at least CCL recovered post weekend in the slow bookings period before Wave. The Royal Caribbean brand was the standout in our latest survey but the picture is mixed for RCL’s other major brand, Celebrity. In Europe, Summer 2014 looks encouraging. Please read on for details.
Below are some observations from our proprietary pricing survey (>12,000 itineraries) for CCL, RCL, and NCLH. We analyze YoY pricing, as well as sequential trends which is determined by comparing pricing relative to the last earnings/guidance date for a cruise operator i.e. CCL: 9/24; RCL: 10/24; NCLH: 10/28. For a more in-depth and quantitative analysis, please contact sales at .
MAJOR TAKEAWAYS FROM LATEST SURVEY:
CCL North American Brands - FQ1 sequential chart:
F1Q sequential pricing remained higher relative to late September. We saw a bearish pricing trend (red circle) in mid-July as pricing deteriorated significantly relative to pricing seen in late June. A bullish pricing trend (green circle) emerged in mid-October as pricing broke the downtrend seen in the past few months and was actually slightly positive relative to pricing seen in late September.
CCL North American Brands - FQ2/FQ3 sequential chart:
For very early Summer 2014 itineraries, we saw weak sequential pricing in mid-October, which continued into Thanksgiving weekend. Pricing strongly recovered immediately after Cyber Monday. It remains to be seen whether the higher pricing is sustainable heading into Wave Season. We look for the next pricing survey for bullish confirmation.
Carnival Brand (Caribbean) - F1Q/2Q/3Q YoY change chart:
On a YoY basis, mainly due to difficult comps, F1Q pricing continued to be lower for the Carnival brand in the Caribbean. However, in early December, F2Q/F3Q showed the strongest YoY pricing performance yet.
Royal Caribbean Brand (Caribbean) - F1Q/F2Q/F3Q YoY pricing chart
F1Q pricing is now modestly higher while F2Q/F3Q pricing has flatlined.
Our Top Q413 Global Macro Theme remains #EuroBulls. Long both the British Pound (which has broken out to new highs) and European Growth Equities is almost the same call we had on the US Dollar and US Growth a year ago.
It’s all born out of the same process.
On a related note, Lucerne’s Pieter Taselaar is one of the sharpest (and top performing) bottom-up European long/short equity managers we know. The video below augments some of our current views here at Hedgeye. The only downside to the video is that I’m in it.
Have a great evening.
Keith R. McCullough
Chief Executive Officer
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YUM reported November comps for its China Division earlier this week. Total China comps (+1%) beat expectations (-1%) as Pizza Hut comps (+7) and KFC comps (+0%) showed strength during the month. KFC comps were largely driven by a half-price bucket promotion during the first 10 days of the month which saw comps run +16%. Even though this implies comps were down -8% for the rest of the month, this successful promotion indicates that Chinese consumers are warming back up to chicken.
Overall, total comps improved 600 bps sequentially from October and turned positive for the first time since February. As we mentioned in our last note, we expect China comps to be positive in December and throughout 2014, as the business stabilizes, sales momentum builds, and YUM rolls over easy comparisons from a year ago. On the domestic front, management announced a 2014 national breakfast launch at Taco Bell which is expected to drive incremental sales in the U.S.
While today’s analyst meeting didn’t necessarily provide us with any new news, it did give us further confidence in our bull case. Management expects at least 20% EPS growth in 2014, approximately 40% operating profit growth in China, and impressive unit growth of 1,850 new international restaurants, including 700 new units in China, and 150 new units in India. Management believes that the fair value of its stock is $90 based on a SOTP and DCF analysis. We believe YUM has tremendous opportunities for potential growth through various channels, particularly in China where it is well positioned long-term to take advantage of a growing consumer class that is expected to double from 300mm+ in 2012 to 600mm+ by 2020.
YUM is our favorite LONG in the big cap QSR landscape one of the best positioned stocks heading into 2014. The main risk to our thesis continues to be persistent volatility in China, although we believe this is largely played out. In our view, easy comparisons, new unit growth, and positive earnings momentum will lead to margin and multiple expansion over the next several quarters.
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