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INVESTING IDEAS NEWSLETTER

Takeaway: Current Investing Ideas: CCL, FDX, FXB, GHL, HCA, MD, RH, TROW and WWW

We are pleased to highlight three market research notes below from Hedgeye analysts which shed light on current market dynamics, as well as two deep dives into two stocks which have received considerable investor attention recently.  In addition, this week's Macro Note by Hedgeye Managing Director Moshe Silver offers a distilled look back over the past year and what we might anticipate in 2014. Finally, at the conclusion of this week's Investing Ideas, we offer a replay of our analysts' latest takes on their respective high-conviction stock ideas. 

 

Please click on the titles below to unlock the institutional research notes.

 

Worst Bond Outflow in Over 3 Months

The Hedgeye Financials team highlights the ramifications of the latest ICI Fund Flow Survey which showed the worst bond market outflow since August. Fixed income mutual funds continued persistent outflows with $8.1B withdrawn from bond funds last week, while the combination of equity ETFs and funds had strong inflow. At the peak of Bernanke's Bond Bubble in 2012, average weekly flows were +$5.8B average inflow per week. Last week's -$8.1B outflow from bonds takes the year-to-date weekly average outflow to -$1.4B per week. Unsurprisingly, the yield on the 10-Year Treasury finished the week north of 3%.

 

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Darden Restaurants (DRI): A Half-Baked Plan

The writing has been on the wall for quite some time that DRI needs to make significant changes to the operating structure of the company.  We didn’t believe its CEO would pull the trigger this quarter.  In fact, we didn’t think he would ever do it.  We were wrong.  However, the plan stops well short of what really needs to be done. 

 

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Caterpillar (CAT): Party Likes It's 1979?

If you are long CAT looking for a long-term bottom, history suggests that 2017 or later might be a better time to check back.  Commodity prices have stalled, we think, for the foreseeable future, and the resources capital equipment cycle has turned down.  If you are long CAT shares for a trade based on seasonality, a restructuring plan or 4Q results, it might work but we would be careful not to overstay.  If history rhymes, long-term holders will not be able to wait the down-cycle out.

 

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Macro Highlights (and Lowlights) of 2013

 

January Hedgeye ushered in the new year with our Q1 Macro Themes call.  Our Big Three themes for the start of the year were

 

#GrowthStabilizing,

#HousingsHammer, and

#QuadrillYen

 

A strengthening dollar, combined with improving labor market trends, signaled that Bernanke’s target – 6% unemployment – could be within reach.  At the same time, Financials sector head Josh Steiner said the housing market could “go parabolic” – which, in fact, it proceeded to do in the following months. 

 

On the other side of the globe, Japan’s “Abenomics” opened the floodgate on the Yen, sending Japan’s equities markets up, up, and away in their own version of Bernank-o-mania.  With central bankers across the globe rushing to burn their currencies at the stake, it was going to be one heck of a year.

 

February

 

Financials sector head Josh Steiner reported that home prices were hitting levels not seen since 2004-2006 (before the financial crisis – we offer this clarification as a service for Wall Street professionals and Washington policy makers, who can’t remember that far back.)  Housing sector stock prices had yet to catch up to Steiner’s “parabolic” call, meaning there remained room for growth – and profits.

 

Like Washington policy makers, Wall Street analysts look at broad housing market statistics, where the distressed segment exerts a powerful drag on growth figures.  If you measure the wrong thing, you come to the wrong conclusion.  We leave it to our readers to decide whether this is worse when it happens on Wall Street, or in Washington, where measuring the wrong things leads to disastrous policy decisions.  Steiner said the effect of the distressed segment had largely been flushed out of the sector, but stock prices were still waiting for investors to wake up and smell the housing recovery coffee.  

 

March

 

We got to brag a little, as two of our Q1 Macro Themes played out well on schedule.  Before the quarter drew to a close, the rest of the investing world started catching up to #HousingsHammer and #GrowthStabilizing

 

March also saw three key data points:

 

Sequester Madness – The Sequester forced fiscal responsibility on Congress, something no one in Washington had the guts to push for.  

 

Jobs – Speaking of Measuring The Wrong Thing, the government and most of Wall Street follow seasonally adjusted employment / unemployment data.  And note that em-ployment data and un-employment data do not measure the same thing to begin with.  Financial sector head Josh Steiner tracks Non-Seasonally Adjusted (NSA) numbers – the raw data is a more accurate representation of actual strength in the labor market.  By March, unemployment continued trending lower at an accelerating rate, signaling growing strength in the labor markets.  Meanwhile the government’s Seasonally Adjust figures were lining up to make year-over-year comparisons look far worse than the actual employment picture.  From this you make economic policy?!

 

Commodities – Gold started the year around $1,700 and was trending down by March.  (By Christmas it was around $1,200.)  In March oil was trending lower too.  Off a national average high price of $3.74 a gallon, gas prices made a series of lower highs and averaged around $3.26 by Christmas.  It is estimated that a one-cent decline in the price of gasoline literally “pumps” one billion dollars into the US economy.  Nearly half a dollar decline from the year’s high – that’s what we call a tax cut!

 

April

 

Hedgeye’s Q2 2013 Macro Themes call featured:

#StrongDollar,

#GrowthAccelerating, and

#EmeregingOutflows.

 

The Dollar continued reversing a generational slide, giving us the opportunity to rag on the gold bugs.  Hedgeye had bragging rights, having been bearish on the yellow metal for over a year.

 

Growth showed up in a number of key sectors, including declining unemployment and strength in the housing market.  Health Care sector head Tom Tobin produced a proprietary survey indicating the US could be on the verge of a statistically significant upturn in the birth rate, reversing a forty-year decline and leading to a boost in new household formation.  This looked potentially long-term massive for anything consumer related.

 

Meanwhile, global economies were weakening.  In particular, the BRICs were BROKEN, and even “stable” countries like Turkey were feeling a frisson of unrest (fast forward to Christmas week if you want to see how that call played out.)  The US, for all the uncertainty in its markets, remained the safe haven.

 

This was particularly damaging for gold, which had become so popular that it lost its “Haven Asset” status.  Haven Assets don’t behave like other assets.  In Wall Street jargon, they are “uncorrelated.”  Investors afraid of the stock and bond markets traditionally fled to the shelter of gold and silver.  In the past decade, so many investors bought so much gold – and so much more was sucked directly into the stock market in the form of various gold ETFs – that the “Haven Asset” now trades like a stock.  Not only is gold no longer a Haven Asset, it’s not clear what it is.

 

May

 

This was the May the earth stood still, as Washington tweaked America’s economic calculations. 

 

US Macro analyst Christian Drake unpacked the Bureau of Labor Statistics’ switch to “Chained CPI” calculation for consumer inflation.  “Chaining” assumes consumers rationally substitute goods in response to rising prices.  If beef prices rise, Chained CPI assumes consumers will buy chicken, soy, and canned tuna fish.  The trade-off between a fixed amount of money and an equivalent caloric and protein intake is economically efficient, and the transition takes place smoothly and predictably within an identified population group and provides an acceptable substitute.

 

That’s if you believe human beings are Rational, Efficient Decision Makers (classical economic theory).  But maybe you believe human beings make decisions based on partial information, driven by fear and by the desire to avoid pain in the moment, without reflecting on future consequences (the way real people actually operate).  The AARP wrote that the effect would be, not a shift from filet mignon to chicken Kiev, but to tins of cat food.

 

Chained CPI also tends to report slightly lower inflation than current measures, meaning cost of living adjustments for retirees could decline each year by about $3 for every $1000.  Three dollars makes a difference if that $1000 is all you have to live on.  After a few years, the cat food scenario looks frighteningly believable. 

 

Meanwhile, the Bureau of Economic Analysis was “essentially rewriting economic history,” in the words of national accounts manager Brent Moulton.  It was not reported whether he said that with a sense of shock, or of pride.  The BEA, just added some new components to the measure of GDP – the value of goods and services produced in the US – which now includes R&D expenditures, and motion pictures, books and recordings, as well as certain “long-lasting” television programs. 

 

This revision was estimated to add around half a trillion dollars to the US economy the equivalent of Belgium, as the Financial Times wonderingly wrote.  The BEA said they would restate the national accounts going back to 1929.  It was not clear whether this meant that, in retrospect, the Great Depression never actually happened.

 

Said Drake, “any metric in which GDP is the denominator (Debt/GDP, etc) goes down” which has policy implications.  With the stroke of a No. 2 pencil the nation got oodles richer, magically mitigating the impact of excess debt.

 

June

 

So why didn’t things get better?  By June, legendary investor Bill Gross of PIMCO said the global central bank mania couldn’t last and told investors to get out.  Out of bonds, out of stocks.  Out of everything. 

 

Fed chairman Bernanke murmured that it may be time to consider letting a little air out of the balloon, and all hell broke loose across the financial markets as people contemplated having to get out of their bond portfolios – including PIMCO’s own $300 billion. 

 

Acting in its role as lender of last resort, the Fed’s balance sheet had grown.  The Fed’s own website reported “Total assets of the Federal Reserve have increased significantly from $869 billion on August 8, 2001, to well over $2 trillion.”  That was June.  Today the number stands at $4 trillion.

 

Market volatility went on a tear, with pundits expecting the turbulence to run into Q1 of 2014 in the face of Fed uncertainty. 

 

Across the financial media, the shrieking heads were jabbering that “risk is on!”  To which Hedgeye CEO McCullough responded “Risk is always on.” 

 

Hedgeye remained firmly bullish on US economic growth.  This is not the same as being bullish on the stock market – it’s easy to miss the distinction with the indexes at all-time highs.  The Fear Factor is so overpowering that people lose sight of the longer term.  Highs are made in the markets when Greed overpowers Fear.  When Fear is in the ascendant, markets make lows.

 

And when the Market Manipulator of Last Resort enters the game, the most predictable effect is to increase volatility by accelerating economic cycles and trying to stave off the inevitable effect of interest rate moves on prices.  In other words, Bernanke’s interventions mess with Time, and the Force of Gravity.  We wonder what Einstein would say…?

 

Responding to Fed Chairman Bernanke’s calm professorial demeanor as he sought to assuage the global financial community, PIMCO’s Gross observed “Perhaps financial markets and real economic growth are more at risk than your calm demeanor would convey.”

 

Touche, Mr. Gross – for all the good it did you.

 

July

 

Hedgeye’s Q3 2013 Macro Themes call featured:

#RatesRising,

#DebtDeflation, and

#AsianContagion

The dollar continued to strengthen, while US housing, employment and consumption all surprised to the upside.  The slope of the line was definitely confirming Hedgeye’s #GrowthAccelerating theme.  On top of this, interest rates were on the rise, making the dreaded Fed taper look like an ineffectual policy tool. 

 

Interest rates were starting to reverse a long, slow decline that had prevailed for over a generation.  Imperceptible as individual data points, the slope of the line was definitely moving higher.  Like the Queen Mary, interest rates were turning ponderously, almost imperceptibly.  But the trend was, in fact, reversing course.

 

Keith went out on a Macro limb and said we are not likely to see the 2012 lows on ten-year bond yields – not soon, and maybe not ever.  (As we head into 2014, the ten-year Treasury yield traded over 3%, a two-year high.)  Longer-term historical rates average over 6%; that’s over four full percentage points for rates to reflate as the 40-year bonds bubble pops without entering the historical Danger Zone for inflation.  As we come into year-end, Hedgeye still expects the bond bubble to continue to melt, and Financials sector analyst Jonathan Casteleyn reports the generational rotation out of bond funds and into equities marches on apace.

 

August

 

Hedgeye announced: “Fed Chairman Bernanke will begin the process of tapering the Fed’s $85 billion a month bond buying program next month.  Or he won’t.”

 

In the event, we were right. 

 

Director of Research Daryl Jones wrote “there is rarely One Thing that dominates, but the seismic shift in interest rates will certainly be one of the most critical factors over the coming quarters and years.”  Hedgeye’s #RatesRising theme and our #DebtDeflation call were working their way through a major supply / demand imbalance in the investment markets.  The world was sitting atop a historically wide divergence between investments in stocks (about 1/3 of global investment dollars) versus bonds (the rest).  The ratio was further skewed by the attractiveness of the US equities markets – which is where everyone still wants to be.

 

Playing that equities market, particularly in times of uncertainty created by government policy meddling, requires a risk management process.  Rather than deal with the moment-to-moment nature of the market, traders had adopted a simplified model called “Risk On / Risk Off.”  As we wrote, it was so simple that even a major news network anchor can understand it. 

 

Risk is “On” when investors are bullish on the direction of the market and want to go along for the ride.  They trade instruments that are correlated to broad market averages, such as call options on the SPY (S&P 500 index).  This would be a “Risk On” trade, where the buyer expects to sell the option for a profit, after the market rises.  In the global currencies markets, the concept applies to more volatile currencies.  When Risk is “Off” in the global markets, investors move to more staid currencies, notably the US dollar, the Swiss franc and the Japanese yen.  They used to flee to Haven Assets like Gold and commodities – but those havens aren’t so safe any more.

 

Sounds simple: you like the prospects of the overall market, get your Risk On.  Don’t like it?  Get Risk Off – like going to 100% cash, perhaps the ultimate Risk Off trade.

 

The problem with this binary model is, not only does it not work all the time, it may not really work ever.  Or: it generally works right up to the moment when you really need it to work.  And when it fails, it fails big time.  As Hedgeye CEO Keith McCullough observes, “risk is always on.” 

 

As Jones pointed out, by June the bond market looked set to deliver a painful second blow to a large number of investors, for all their risk management tools.  (June, unanticipated and painful, was the “one” of the “one-two punch.”)   To give you an idea of just how fast extremes are reached in the financial markets, bond volatility had doubled in the second quarter alone and was reaching two-year highs.  Hedgeye senior Financials sector analyst Jonathan Casteleyn reviewed current bond duration measures and found that a one-percent rise in interest rates in mid-August would result in a nearly 9% drop in the price of the 10-year Treasury bond – a world of hurt for fixed income investors.

 

September

 

It was Back To School for Hedgeye as we had to take our #AsianContagion theme into the shop for a tune-up. 

 

Senior Macro analyst and China watcher Darius Dale said significant new political news developments indicated “we should not be short China right now.”  We admit that we had to change course on China – as Keynes famously said, “When the facts change, I change my mind.”  Of course, the lift in the Chinese markets brought out a sudden emergence of China bulls – or perhaps better put, an emergence of sudden China bulls.  Nothing like a short-term market reversal to have people switching hats and sneering “I told you so!”

 

Amidst market spikes and cash inflows, Dale called the political news “the only positive data point that actually matters” as the Politburo signaled meaningful financial reform measures with global implications.  Dale wrote that the Politburo announcement signals a take-the-Chinese-bull-by-the-horns approach that could wrench the economy to its feet.  “Unlike Western politicians,” noted Dale, “the Chinese do not speak very often.  And when they do, they invariably carry through on what they say they’re going to do.”

 

October

 

Just when we were getting used to Congress doing nothing at all, they decided to Do Nothing in a really big way.  By Doing Nothing about the nation’s debt issuance, the brought the US, if not to the brink of actual default, at least to a place where the fetid hot breath of the specter of default burned in our nostrils and caught nauseously in our throats.  Hedgeye’s McCullough renewed his call to hold Washington nincompoops of all political stripes to account for the rank fear-mongering that is the order of the day across the spectrum.  But Fed-Fed jaw-jaw notwithstanding, the growth style factors in Hedgeye’s Macro model barely corrected.  Measured year-to-date, growth stock were up over 32%; the top 25% EPS growth companies in the S&P 500 were up 28%; the top sales revenues growth stocks were up 27%, and high short interest stocks, high beta stocks, and the small cap group were all up over 25%.

 

Clearly, the Fear Mongers still had work to do.  Testifying before Congress, Treasury Secretary Jack Lew, used the words “default,” “catastrophic,” “very dangerous,” and the “real risk of a financial crisis and recession that could echo the events of 2008 or worse,” all within the space of about three minutes.

 

But wait a minute, said McCullough: politicians don’t tell us when there’s a crisis in the markets.  The markets tell us when there’s a crisis in the markets.  And as of mid-October, market risk indicators were not signaling a crisis.

 

Spreads on the US CDS widened a bit, but were nowhere near what market wags call the “Lehman Line” and, in fact, remained low compared to the past few years.  The real risk associated with the October 17th “Drop Dead” date turned out to be reputational.  No one, it seems, understood this better than Florida congressman Alan Grayson who angered House Speaker pro tem by reading into the record a national survey that found Congress was less popular than hemorrhoids, toenail fungus, and dog poop.

 

You can’t make this stuff up.

 

November

 

The Federal Reserve turns one hundred years old next month and looks set to mark its anniversary by delivering much, much more of the same.  Congress rants about the politicization of the Fed, but it’s equally clear that Washington has abdicated its responsibilities, leaving a void that permits – nay, forces – the Fed to take control.  Legislators and presidents alike have been happy to hand off the hot potato of economic policy to unelected academics, freeing themselves to get back to the basic business of sucking up to powerful constituents, while in turn encouraging wealthy lobbyists to suck up to them.

 

November brought two articles by recent Fed insiders.  In Foreign Affairs magazine, Alan Greenspan explained “Why I Didn’t See the Crisis Coming.”  Though he recognized that human decision making is driven by irrational factors, Greenspan said “For decades, most economists, including me, had concluded that irrational factors could not fit into any reliable method of forecasting.”  Translation: The world’s most powerful central banker knew that he was missing a huge body of data that impacts economic decision making, but didn’t incorporate it in his calculations because (a) it’s really hard to measure, and (b) no one else measures it anyway.

 

In retrospect, Mr. Greenspan believes that “people, especially during periods of severe economic stress, act in ways that are more predictable than economists have traditionally understood.”  In other words: “If I had it to do over again, I would do things really differently.”  This is actually to Greenspan’s credit.  King Solomon the Wise had it right: most people never learn from their mistakes.  Much good may Greenspan’s after-the-fact enlightenment do us now…

 

More widely read was a Wall Street Journal Opinion piece by Andrew Huszar, the executive at the New York Fed who was placed in charge of the “a wild attempt to buy $1.25 trillion in mortgage bonds in 12 months.”

 

In December, Huszar joined Hedgeye’s McCullough in an exclusive and extended Hedgeye TV dialogue.  Spoiler alert: both Huszar and McCullough predict that Bernanke will not taper before year end.  Even smart people can be wrong on an individual data point. 

 

That’s why we follow trends: one data point does not a long-term trend shift make, and there will be plenty of time to determine the effects of reduced bond buying by the Fed – assuming, that is, it stays reduced. 

 

December

 

All right, so he did taper.  If you call that a “taper.”

 

“I was dead wrong on the no-taper call yesterday,” wrote McCullough on the Morning After.  Still, as we wind down 2013, McCullough’s Real-Time Alerts virtual positions are ending the year positioned right, overwhelmingly long the surging market.  “Where I was brought up,” wrote Keith, “being right for the wrong reasons is called luck.”

 

The mini-Taper doesn’t change our fundamental process.  Our Macro process basically takes us back to where we were positioned from December 2012 through September of this year: Long Growth (Equities) and Short Gold, Bonds, and Equities that look like Bonds, such as MLPs, Utilities, and other high-dividend payers.

 

The Taper points – or perhaps cries “uncle!” – to an environment of rising interest rates and indicates that the Dollar is not likely to go down in flames.  This mix is bad for Gold, and bad for Bonds.  Hedgeye’s Macro work indicates fund flows out of Gold and out of fixed income – and into US growth stocks – should dominate well into the new year, especially if there’s any follow-through in Fed hawkishness.

 

We thank our subscribers for a great year.  We thank our Twitter followers for your follows, your praise – and for your criticism.  You may not realize it, but we really do go home at the end of every long day and try to figure out how we got so many things wrong.  We like to think that’s the mechanism that helps us get so many things right.

 

Wishing you a happy holiday season and a prosperous 2014.

 

Onward and upward!

 

 

- By Moshe Silver

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

 

Investing Ideas Updates

Editor's note: We are giving our sector heads the holiday off. Here's a replay of their latest takes on their respective high-conviction stock ideas from 12/20.

 

CCL – We are happy to report that it was a wonderful week for Carnival shareholders. The stock surged 8%. 

 

We have increased our 2014 FY EPS from $1.65 to a likely Street high $1.90 on the back of significant cost cutting.  Not surprisingly, our net yield (constant-currency) projection declines from +1.4% to +0.3%, due to continued Caribbean uncertainty and adverse FX impact.

 

Lower yield guidance was expected but the cost outlook was indeed a pleasant and major surprise.  The management reorganization paid dividends much sooner than expected.  Already, new management is driving cost synergies and efficiencies in the fuel, operations, and procurement areas under new CEO Arnold Donald. 

 

 

FXB – Being bullish on the British Pound versus the US Dollar remains one of Hedgeye’s favored macro themes in Q4. The position is supported over the intermediate term TREND by prudent management of interest rate policy from Mark Carney at the BOE (oriented towards hiking rather than cutting as conditions improve) and the Bank maintaining its existing asset purchase program (QE).

 

Meanwhile, data out this week confirms the underlying performance of the economy which we believe will translate to currency strength: Q3 Final GDP was revised up to 1.9% Y/Y vs an initial estimate of 1.5%; CPI dropped to 2.1% Nov. Y/Y vs 2.2% Oct. (reducing the consumption tax); and Retail Sales were up 2% in Nov. Y/Y vs 1.8% Oct. Over the immediate term TRADE we expect the USD to strengthen on Bernanke’s “unexpected” decision to taper this week, and an above-consensus Q3 U.S. GDP print, however over the medium term we expect the uber dove Yellen to issue weak USD policy.  

 


FDX – FedEx reported its fiscal second quarter results, missing expectations because of a late start to the Christmas shopping season. Management raised full year guidance, showing confidence that it will recoup that volume in FY3Q. Critically, FedEx Express generated solid YoY margin expansion, a likely reason the shares have remained strong following the report. We continue to see upside for FDX shares as the company shows investors the profit potential of the Express segment. 

 

We added FDX to Investing Ideas on 3/29/13. Our thesis centered on the potential for the Express division to be made significantly more profitable.  At the time, FedEx Express was 'free' in our valuation, presenting an attractive risk/reward. After a 45% rally in FDX shares since then (compared to 16% for the S&P 500), we still think FedEx Express has some additional value to be recognized by the market.  Importantly, we now have some evidence that they are making progress - albeit slow.

 


GHL Greenhill & Company announced a good sized advisory mandate during the week, winning a $2 billion mandate to advise AT&T in the sale of its wireless assets in the state of Connecticut.  This was the largest advisory win for GHL since October.  The company also put up two other additional mandate wins during the most recent 5 day period for a total of 3 new deals won this week, the most active week of new deal mandates for the firm since September. 

 

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GHL shares are Senior Financials sector analyst Jonathan Casteleyn’s favorite way to invest in a cyclical uptick in the mergers and acquisition market (M&A) which has been dormant for the past 3 years. Says Casteleyn, “M&A activity has historically benefited in an environment with higher interest rates – which may have started with the Fed now starting to back off of the fixed income curve – as corporations focus less on dividends and buybacks, and more on strategic M&A activity to reward shareholders.”

 

HCA – Holy $#&*@! Admissions stink! Or so says Citi's Hospital analyst quoting a recent survey of hospitals.  Apparently volumes are the "weakest ever." Not to poo-poo Citi's survey, but there are a few things to consider before flushing HCA.  Q412 has some very difficult comparisons for volumes including the one of the "worst ever" flu seasons and the only quarter of the last 6 years to see a positive year over year change in maternity volume.  Both of these cases come with extremely low margins, and possibly negative margins in some cases.  We recently did an analysis of what is an important driver of hospital profitability, names US Orthopedic surgery, the largest revenue driver for hospitals, a trend that looks likely to continue accelerating. 

 


MD – MD finally got around to making another acquisition today.  While they won't meet their guidance for deal flow with the deal in Q413, we continue to expect more deal announced in the coming weeks, offering some catch up in revenues in the next few quarters.   

 

RH and WWW

 

Below we take a detailed look at sentiment for our two retail investing ideas. The primary tool we use is our Hedgeye Sentiment Monitor. What it does is uses a quantitative scale to combine Sell-Side Ratings, Buy Side Short Interest, and Insider Trading activity. We pretty much catch all angles.

 

We use this tool in two different ways; 1) First, we look at directional changes in sentiment for each stock. 2) Second, we analyze the absolute level for each security. A reading above 90 has statistically proven to signal that the market is overly bearish on a name, and that it’s often advantageous to go the other way. Conversely, a reading below 10 suggests that the market is overly bearish, at which time it is usually prudent to go long. 

 

RH – For Restoration Hardware, even though we only have only 14 months worth of data, we see that the sentiment reading is near its all-time low. No doubt the recent management shake-up contributed, but even before then, people were finding every reason they could to be bearish. We continue to view RH as the name in retail with the greatest upside. Currently at $67, we thing that RH will touch $200 over 3-years.

 

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WWW – With Wolverine World Wide, the sentiment chart is much more clear cut. Simply put, everyone hates it! Sentiment has been drifting lower and lower, and occasionally touches the 10x mark (that’s when people are way too bearish – no Buy ratings, high short interest). While not the same expected percent gain as RH, we’re still looking for WWW to go from $32 to $55. Not half bad.

 

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TROW T. Rowe Price shares had a strong week with the Fed’s tapering and acknowledgement of an incrementally improving U.S. economy.  Senior Financials sector analyst Jonathan Casteleyn says “with the U.S. central bank now signaling that it will be adding less liquidity to fixed income markets, which could eventually lead to short term interest rates rising over time, it is valuable to understand that equities have drastically outperformed bonds in past rate raising cycles.”  (See chart below).  As the country’s leading equity asset management firm, Casteleyn says TROW shares will start to discount this potential forward opportunity for equities versus bonds in the United States with the new Fed signaling of smaller subsidies for fixed income. This positively disposes TROW shares for a good start to 2014.  Separately, Casteleyn spoke to TROW management this week and says “all our checks for a solid 4th quarter earnings print are in line in late January.”

 

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No E-Cigs For You!

Takeaway: Despite increasing regulatory headwinds, we remain quite bullish on e-cigs.

This note was originally published December 20, 2013 at 11:59 in Consumer Staples

Editor's note: This is an unlocked research note from Hedgeye analyst Matt Hedrick. For more information on how you can join the Hedgeye Revolution and become a subscriber click here.

No E-Cigs For You! - ecig

Yesterday, New York City’s city council voted overwhelmingly (43 to 8) to prohibit the use of e-cigs in indoor public areas where regular cigarettes are already banned. The Big Apple now joins New Jersey, North Dakota, Utah, and Arkansas which have already enacted similar bans in bars and restaurants. In recent weeks, we’ve also witnessed initial considerations on e-cig policy percolating in Chicago and Los Angeles.

 

NYC’s ban is set to take effect in four months, and follows the city’s recent decision to raise the age to buy traditional tobacco and e-cigs to 21 from 18, and raise the minimum price per pack of traditional cigs to $10.50 (set to take effect in APR/MAY 2014).

 

We view the vote as a marginal headwind to the industry.

 

In particular, the council’s focus was on fears that e-cigs could be a “gateway” to traditional cigarettes, outweighing “harm reduction” arguments. While we think that consumers intuitively understand that e-cigs offer a healthier alternative to traditional cigarettes (it’s the tar that kills you; the nicotine is simply an addictive agent), we think the industry stands to benefit as more science reveals the health benefits of an e-cig over a traditional cig.

 

Despite this obvious hit to the convenience of indoor smoking, we still see health considerations and a lower price point advantage driving the category as Big Tobacco’s focus on the category drives awareness, innovation and growth.

 

Just today, Philip Morris (PM) and Altria (MO) announced e-cig synergies across the two companies, effectively licensing and supplying (perhaps also manufacturing) each other’s brands across the globe. Note that both MO and PM have aspirations for nationwide e-cig distributions by mid-2014, MO under the brand MarkTen and PM with its yet to be disclosed brand.   

 

As we approach year-end, there remains an industry wide expectation that the FDA is set to imminently announce regulatory restrictions on electronic cigarettes. The exact timing? It’s still anyone’s guess. We believe the industry is bracing for regulation that could include:  

 

1) A ban of online commerce

2) Age verification standards at retail

3) Flavor limitations (beyond tobacco and menthol)

4) Health/safety certifications

5) Labeling and marketing requirements

 

We think regulation of e-cigs is positive for the industry so long as it does not, in particular, stifle innovation or price/tax as traditional cigarettes.

 

For a more comprehensive overview of the industry and regulation please see our recent report: “E-Cigs at the Thanksgiving Table”.

 

Bottom line: Despite increasing regulatory headwinds, we remain quite bullish on e-cigs.

 

Matthew Hedrick

Associate


LV: TABLES SHOULD LEAD THE WAY IN NOVEMBER

We're forecasting Las Vegas Strip revenues to increase 8-12% in November but no growth in December

 

  • A strong rebound in NV taxi trips (+10% YoY) suggests higher Vegas visitation and growth in table volume in November
    • NV taxi trips has a 0.86 correlation with LV visitation and a 0.60 correlation with non-baccarat table volume
  • Non-baccarat table volume also had a below average win rate of 10% last November (2-yr average:  12.3%)
  • McCarran airport passenger traffic was flat in November
  • Strong Vegas table business should offset continued weakness in slots in November
  • We're currently predicting a flat December for Vegas revenues.

LV: TABLES SHOULD LEAD THE WAY IN NOVEMBER - STR


the macro show

what smart investors watch to win

Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.

The Macro Market Stage

Client Talking Points

BONDS

Bear market in bonds just beginning... ICI just reported the worst bond market outflow since August. Fixed income mutual funds continued persistent outflows with $8.1B withdrawn from bond funds last week. At the peak of Bernanke's Bond Bubble (2012) average weekly flows were +$5.8B average inflow per week. Last week's -$8.1B outflow from bonds takes the year-to-date weekly average outflow to -$1.4B per week. Boom ... 3.01% on the 10-year this morning. What was immediate-term trade resistance of 2.91% is now support.

EUROPE

Stocks are ripping across the pond as the Euro rips a new high with #Eurobulls (Hedgeye Q4 Macro theme #1) featured front-and-center on the macro market stage this morning. #StrongEuro = #StrongGermany. The DAX? It's up +25.7% year-to-date as the Euro rips. What's that? Even Greece is joining in the party up +4.2% this morning. End of World? Currencies matter.

Asset Allocation

CASH 46% US EQUITIES 12%
INTL EQUITIES 12% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 30%

Top Long Ideas

Company Ticker Sector Duration
FXB

Our bullish call on the British Pound was borne out of our Q4 Macro themes call. We believe the health of a nation’s economy is reflected in its currency. We remain bullish on the regime change at the BOE, replacing Governor Mervyn King with Mark Carney. In its October meeting, the Bank of England voted unanimously (9-0) to keep rates on hold and the asset purchase program unchanged.  If we look at the GBP/USD cross, we believe the UK’s hawkish monetary and fiscal policy should appreciate the GBP, as Bernanke/Yellen continue to burn the USD via delaying the call to taper.

WWW

WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.

TROW

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

Three for the Road

TWEET OF THE DAY

Fear, as blogging ad strategy, continues to crash, -31.6% VIX for 2013 YTD @KeithMcCullough

QUOTE OF THE DAY

"Self-trust is the first secret of success." - Ralph Waldo Emerson

STAT OF THE DAY

The 2013 holiday season was the best ever for Amazon, with more than 36.8 million items ordered worldwide on Cyber Monday -- a record-breaking 426 items per second. (Amazon press release)



Endurance

“Difficulties are just things to overcome, after all.”

 -Ernest Shackleton

 

Even though many of us thoroughly enjoy our jobs, most work years are still typically a bit of an endurance test.  Luckily, as I wrote yesterday, the U.S. stock markets had a very healthy year and returns were up and to the proverbial right.  So, for stock market operators, 2013 wasn’t all that much of an endurance test.

 

I recently finished reading a book called, “Endurance: Shackleton’s Incredible Voyage”, which tells the story of Ernest Shackleton and his failed attempt at being the first person to cross Antarctica from sea-to-sea via the pole.   Shackleton’s ship was named the Endurance and endure is exactly what he and his shipmates did.

 

The Endurance departed from South Georgia for the Weddell Sea on December 5th, 1914.  Two months later the Endurance was frozen in an ice flow and Shackleton ordered the abandonment of the ship and her conversion into an ice station.  For the next 8 months, the crew lived on the ice floe in the middle of the Antarctic Sea until the ship was finally broken in half by ice pressure.

 

At that point, Shackleton order his crew to another ice floe and for the next six month, until March 1916, he and his crew shifted between various floes.  By April, their current flow was becoming too small and Shackleton and his crew jumped into the remaining life boats to make a five day harrowing trip to Elephant Island. 

 

After a couple weeks on the deserted Elephant Island, Shackleton selected a crew of six to sail with him across the Drake Passage back to South Georgia Island, the nearest point of civilization more than 600 miles away.

 

The Drake passage is widely considered the most challenging water to sail on the planet. According to Wikipedia:

 

“There is no significant land anywhere around the world at the latitudes of the Drake Passage, which is important to the unimpeded flow of the Antarctic Circumpolar Current which carries a huge volume of water (about 600 times the flow of the Amazon River) through the Passage and around Antarctica.”

 

Shackleton and his crew sailed the Drake Passage in a 20-foot wooden sail boat in the middle of a hurricane and eventually made it to a whaling station on South Georgia Island (only after crossing the Island on foot, something no man or men had done to that point).  So, after almost 20 months of being stranded in the Antarctic, Shackleton and his crew made it to civilization.  And that, my friends, is endurance!

 

Back to the Global Macro Grind...

 

After a relative tame investing year in 2013, the question for all of us is: what will we have to endure in 2014 to generate outperformance? There are a few things that potentially come to mind, specifically:

 

1)      Debt Ceiling – The debt ceiling is set to expire on February 7th, though the Treasury Department has the ability to extend this via the use of extraordinary measures for about another month.  Treasury Secretary Jack Lew, and thus the Obama administration, has already sent the opening volley in a letter to Congress last week.  As Lew wrote in the letter:

 

“The creditworthiness of the United States is an essential underpinning of our strength as a nation; it is not a bargaining chip to be used for partisan political ends.”

 

In part he is of course correct, the debt ceiling shouldn’t be used as a bargaining chip, but in reality 2014 is an election year and it is a very good bargaining chip for the Republicans. In particular the Tea Party, who need a win to go back to their constituents with after the recent budget compromise.

 

In the Chart of the Day, we show the return of the SP500 in the summer and early fall of 2011.  As you may recall, while it wasn’t as difficult as sailing the Drake Passage in a wooden row boat, the last major debt ceiling debate was a difficult and volatile period for U.S. equities.

 

2)      Interest rates – As we’ve noted, the U.S. interest rate market has basically already front run the beginning of tapering.  The 10-year yield has close to doubled from the lows of May of this year to the recent high of around 3.0%.  Certainly increasing rates has its positive implications, especially as it relates to supporting U.S. dollar strength, the challenge of course is controlling the speed at which rates normalize.   An accelerated increase in interest rates will undoubtedly serve to stymy economic growth.

 

In the short run, the most significant impact that rising rates will have is on the housing market.  In part, the impact on the mortgage market is already being seen.   According to the Mortgage Bankers Association, mortgage applications fell 6.3% on a seasonally adjusted basis last week to their lowest level in 13-years.  National home prices are unlikely to continue climbing if mortgage demand and affordability are falling.

 

3)      Chinese growth – The Shanghai Composite is having a positive morning up more than 1.4% as Chinese Interbank rates fell for the fourth day in a row.  While the spike in Chinese interbank rates has garnered headlines over the last few weeks, our Asia Analyst Darius Dale has been quick to note that much of this recent spike relates to a liquidity crunch going into year-end and is likely to be short lived. The broader question for Chine relates to economic growth.

 

Certainly, managing growth lower will be important for Beijing in reigning in domestic credit growth and rebalancing the economy, but what of the implications globally?  A Chinese growth rate potentially slowing from 7.5% to 6-7% will definitely have implications on global economic activity.  Some may be positive, such as a decline in demand, and thus price, for certain commodities.  Conversely, a lower than expected Chinese growth rate may be a shock to barely recovering Western countries and companies that depend on Chinese demand.

 

In aggregate, the three points above may actually not provide an endurance test for stock market operators in 2014, but merely be “icebergs” that we easily sail around.  Only time will tell on that front.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.91-3.02%

SPX 1

DAX 9

VIX 11.35-13.94

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

Endurance - Chart of the Day

 

Endurance - Virtual Portfolio

 


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