Trust Your Process

This note was originally published at 8am on December 30, 2013 for Hedgeye subscribers.

“Self trust is the first secret of success.”

-Ralph Waldo Emerson


With a little more downtime than usual this past week I had the opportunity to crack open a few new books. One of them is a leadership book that’s been in my pile for almost a year now titled Unusually Excellent, by golf pro John Hamm.


The aforementioned quote is the opening line from Chapter One – Being Authentic, The Courage to Be Yourself. And it’s followed up by another insightful thought by Lao Tzu: “He who knows others is wise. He who knows himself is enlightened.”


Hamm’s core leadership framework has three parts: Credibility, Competence, and Consequence. In other words, be who you are, do what you do, and be accountable for the decisions you make. Trust your process in 2014 and people will probably trust you.


Back to the Global Macro Grind


When people ask me why I seem so confident in my process, it’s relatively easy to explain. My process embraces change and uncertainty. One of the simplest truths that I trust about this game is that my process will change as my business, markets, and economies do. It’s a lot easier being confident in that than a predetermined dogma, conclusion, or ideology.


Lots of people in the media have asked me what my “highest conviction calls are for 2014?” Instead of being put in a box, I just say that I’m very confident that I have no idea what will happen across a trivial twelve month period. Then the other side of the conversation gets quiet. And I assure them that its really ok. “I don’t know” is often the answer.


What I do know is that I’ll be up and at it, grinding away alongside my teammates, at the top of every risk management morning in 2014. Every day starts with information surprise – new economic data, market risks, price moves, etc. – it’s kind of like Christmas, but every morning, for Canadian-American macro market geeks.


On that score, last week was as interesting as any other week in 2013:

  1. US interest rates ripped back up to their YTD highs
  2. US stocks ripped back to their all-time highs

Even though this wasn’t the way consensus expectations drew it up with its “2013 predictions” at this time last year, all-time, as we like to say here @Hedgeye, is a long time.


With the Fed reacting (on a 3-month lag) to what markets have been pricing in all year (US GDP #GrowthAccelerating from 0.14% Q412 to 4.12% Q313), all we have witnessed here is a run-of-the-mill rotation out of fear (slow-growth yield chasing) and into growth itself:

  1. SP500 and Russell 2000 = +1.3% each last week to +29.1% and +36.7% YTD, respectively
  2. 10-year US Treasury Yield = +11 basis points to 3.00% (+124 basis points, or +70% YTD = #RatesRising)
  3. US Equity Fear (Volatility) = VIX down another -9.6% last wk to -30.9% YTD #crashing

All the while, underneath the hood, the month-to-date performance across asset classes and investment Style Factors continues to do what it constantly does – change:

  1. SP500 = +1.97% for DEC to-date
  2. Basic Materials (XLB) = +3.81% and Utilities (XLU) = -0.58% DEC to-date, respectively
  3. CRB Commodities Index (19 commodities) = +3.4 and Copper = +5.6% DEC to-date, respectively

In other words, as US #GrowthAccelerating hits its crescendo (rate of change on a 9-12 month basis), market expectations for INFLATION are finally starting to rise again. That’s new.


And yes, inflation expectations rising will eventually slow real (inflation adjusted) economic growth. But since the entire edifice of Certainty Forecasting that is Old Wall Street and Washington DC “economics” centrally plan and predict on a lag, threading the needle on when #GrowthSlowing might matter to market expectations is going to be one of the more important things I do.


Notwithstanding it’s 1-wk up move on the taper news, it’s important to acknowledge the real-time #GrowthSlowing factor that is the USD falling for 6 of the last 7 weeks. That, in our model, is what is perpetuating the resurgence of inflation expectations. While we were bearish on Commodities for over a year, Mr. Macro Market is telling us to go neutral on that, for now.


Got respect for Mr. Macro Market? My process does. This is a short-term market reality, but looking at the 15-day inverse correlation between the CRB Commodities Index and the USD right now, it’s jumping off my screen at -0.94. And with the Euro breaking out versus USD (see our Q413 #EuroBulls Macro Theme), Down Dollar (with taper!) is to be respected by our process as well.


Our immediate-term Global Macro Risk Ranges are now (Top 12 ranges are in our Daily Trading Range product):


UST 10yr Yield 2.93-3.05%

SPX 1817-1859

VIX 11.06-13.83

USD 80.09-80.72


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Trust Your Process - 5Y Breakeven


Trust Your Process - 55


The Economic Data calendar for the week of the 13th of January through the 17th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.




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


Below are Hedgeye analysts' latest updates on our high-conviction stock ideas. Please note that we added two new names to Investing Ideas - Darden Restaurants (DRI) and Quiksilver (ZQK) this week. 

Here are CEO Keith McCullough's refreshed levels for each stock.




Trade :: Trend :: Tail Process - These are three durations over which we analyze investment ideas and themes. Hedgeye has created a process as a way of characterizing our investment ideas and their risk profiles, to fit the investing strategies and preferences of our subscribers. 

  • "Trade" is a duration of 3 weeks or less
  • "Trend" is a duration of 3 months or more
  • "Tail" is a duration of 3 years or less

Ideas Updates

The latest comments from our Sector Heads on their high-conviction stock ideas.


CCL – Got "Polar Vortex"? In case you missed it, Niagara Falls is frozen. Extreme cold temperatures have affected approximately 200 million people in the United States.


What the heck does this have to do with Carnival you're asking?




Gaming, Lodging & Leisure analyst Todd Jordan believes the ridiculously cold weather outside ought to get everyone thinking about escaping to warmer weather. That is a very good thing for cruisers, according to Jordan, and big beneficiaries include Carnival.


Shares of Carnival are up 15% since we added it to Investing Ideas. Meanwhile, the S&P 500 is up around 2.5%. 


Incidentally, "Wave Season" has just started and promotions are rolling in. Our first look into Wave pricing is on January 20. We will provide analysis as it becomes available.


DRI – Restaurant Sector Head Howard Penney added Darden Restaurants to Investing Ideas this week. Click here to read the full report.



FDX  Hedgeye Industrials Sector Head Jay Van Sciver says shares of FedEx continued to hold up well this week.  For the record, shares of FDX have risen 45% since we added it to Investing Ideas, compared to a 17% return on the S&P 500.


Van Sciver notes that recent transport data from rails to trucking to airfreight suggest reasonably good industrial activity in calendar 4Q 2013.  That positive momentum may help FDX into 2014.  


FXB – The British Pound is holding its bullish formation, which we expect will continue to be supported by prudent monetary policy from the BOE and strengthening economic fundamentals.




We believe that positive UK economic data out this week and the BOE’s decision on Thursday to keep the main interest rate unchanged at 0.50% and maintain the asset purchase target will provide further support for the GBP/USD. PMI Services of 58.8 for DEC reflected another month of healthy expansionary activity. New Car Registrations were up 23.8% in DEC Y/Y (a level not reached since 2010) and signal to us that strong underlying confidence is returning to the consumer. In addition, Industrial Production was another bright spot, rising 2.5% in NOV Y/Y, and home price remain elevated and were up 7.5% in DEC Y/Y according to Halifax House Prices.


GHL – Greenhill & Company continues to be our preferred way to invest in a recovery in the mergers and acquisition market (M&A).  Global M&A volume has been flat for the better part of three years with global executives hesitate to engage in excessive deal making because of the current uneven economic recovery, new emerging regulatory rulesets which remain largely undefined, and still a corporate depression mentality remaining from the Financial Crisis.




However, the second half of 2013 has started to show a glimmer of hope of improved M&A activity driven by a recovering Europe, new fundraising from the Private Equity sector in the U.S., and recovering global stock markets that although corporation more valuable equity currencies to do deals. Greenhill is a well diversified advisor with penetration in each of these segments to capitalize on both a rebound in Europe and improved reinvestment cycles from domestic Private Equity firms. In a mid cycle M&A environment, we calculate that GHL has the most earnings leverage versus the other independent M&A advisors Lazard and Evercore and hence is our favorite long idea in the group.


HCA – Healthcare sector head Tom Tobin says HCA Holdings was the dog that got wagged by the tail when Community Health Systems (CYH) preannounced a dreadful quarter, at least in terms of volume, and then went on to say they expect to do at least as well as consensus is expecting in 2014.  Hospitals rallied, and HCA, at least for now, is trading above $50. 


Tobin has been watching two data points – maternity and flu –which he says tell a lot about what we need to know to forecast admissions.  These two items are responsible for a huge portion of admissions, and both have been weak.  In Tobin’s proprietary survey of OB/GYNs, maternity trends continue to trend down significantly.  And flu appears to be running 20% below last year's emergency levels. 


But neither of these cases pays very well or generates a great deal of profit.  Asks Tobin, if CYH announced their volume was down 10% in Q4, should we be worried about HCA?  Yes and no, says Tobin.  The chart below suggests HCA and CYH live in similar neighborhoods, but HCA has consistently performed much better.  “At some point performance in HCA becomes a concern,” says Tobin, “and we'll try and find a good point for an exit, but for now we'll stick with it.”




RH – Retail sector head Brian McGough calls Restoration Hardware “the biggest idea in retail today.”  The stock doubled in 2013, and McGough thinks it should triple within three years.  McGough’s thesis is based on sheer market share gain in the home furnishings space -- everything from furniture, to kitchen, to artwork, to collectibles, to literally everything someone might want to put in a higher-end home.  




Almost every RH bull (and there aren’t many) will hinge their thesis on square footage growth from grossly inadequate 9,000 sq/ft boxes to 40,000 foot anchor real estate.  McGough concedes that floor space expansion is important.  But he says it’s missing the point.  What good is having bigger stores without the appropriate mix of product to meaningfully take up productivity?  That’s where it all begins with RH, and that’s where McGough thinks the company is unmatched.  


McGough thinks RH will become to the home furnishing space what Ralph Lauren is to Apparel, and Nike is to Athletics.  Ultimately, the math translates to 1) square footage tripling, 2) sales/sq/ft going from sub $1,000 to $1,600 despite significantly larger boxes, 3) the RH Direct business growing by 2-3x. 4) Revenue topping out over $5bn vs. $1.5bn today. 5) Ultimately, McGough thinks we’ll see better than $10 in EPS power, with a 50% EPS compound annual growth rate over time. 


TROW – In our most recent report this week of asset related flows into mutual funds and ETFs, all equity related products tallied a $10.5 billion total inflow ($6.0 billion into mutual funds and $4.5 billion into equity ETFs) which compared to a $3.0 billion outflow in fixed income mutual funds and ETFs. This resulted in a net spread of $13.5 billion in favor of equity products considering the positive inflow into stocks and the outflows in bonds. This result this week is significant considering it is double the 2013 weekly average of just a $7.8 billion spread to equities which highlights that the asset allocation shift from bonds and into stocks is accelerating. When looking at a 52 week moving average of this relationship, this asset allocation shift is getting more pronounced in favor of equities which leads us to estimate that this investable trend is continuing (actually its accelerating in favor of equities).


As a result of this ongoing shift by investors, our favorite asset management stock remains T Rowe Price (TROW), a predominately equity only asset manager with industry leading stock fund performance that should gather outsized net new assets because of their top performing fund family.  TROW is set to report earnings on January 28th and we expect a well received release from the company considering our recent positive conversation with management.


WWW – Retail sector head Brian McGough says he’s “keenly aware of not wanting to overstay our welcome” onWolverine World Wide, given how it worked in 2013.  But McGough says that this is the first year where the real revenue synergy should start to kick in.  That’s usually not the right time to walk away from a name unless a) estimates are too high, or the stock is overly loved.


McGough says estimates are low by 20% next year, and then tack on an incremental 10% each year thereafter. To reiterate the underlying call: the Street is grossly underestimating the revenue growth opportunity of the PLG brands (Sperry, Keds, Saucony and Stride Rite).  The simplest way to put it is that the old “legacy” WWW is the most global footwear company in the world.  It sells about 65% of its units outside the US, and has seamless and sophisticated systems (SAP). The PLG brands, which are better quality overall, sell only 5% overseas, and that’s simply because its former owner (Collective Brands) spent capital first on Sperry, then on US Payless stores, and did not have anything left in the kitty for international distribution of PLG brands.


So now WWW can scale this superior content over its existing lean/mean infrastructure. McGough thinks it will drive an incremental $2bn in revenue over 5-years and an extra 400bp of margin.  In the end, this gets to earnings power of about $4.30, which is 50% ahead of what management guided at its recent analyst meeting. 


McGough concedes “WWW probably won't make you rich here, as it will likely take a good 4-5 years to double.”  McGough says he would rather get more aggressive on a pullback. But he says “we know people who have been waiting for a pullback for the last 50%.  In the meantime you’re paying a high-teens multiple for mid-20s EPS growth -- and this company has one of the best track records of anything in Consumer.”


ZQK – Retail Sector Head Brian McGough added Quiksilver to Investing Ideas this week. Click here to read the full report.



Macro Theme of the Week – Welcome To 2014

Hedgeye’s Macro team kicked off the new year this week with our 1Q14 Macro Themes call, the first of our quarterly Macro calls for 2014.


As we do four times each year, our Macro team put up what we see as the three key themes for the coming quarter.  These themes will guide our asset allocation and investment strategy as we head into the year.


As a reminder, last quarter’s themes were 

  • #EuroBulls 
  • #BernankeVsCongress 
  • #GetActive


This year starts off with Q1 themes: 

  • #InflationAccelerating
  • #GrowthDivergences
  • #FlowShow.

(Click here for a video of CEO Keith McCullough discussing the Q1 themes.)


The Hedgeye Process


We will dive into the three themes in upcoming Investing Ideas, laying them out in detail and tracking them as they unfold during coming weeks.  First, to reiterate what sets Hedgeye apart: we have spent our careers watching the crowd behavior of Wall Street.  Whether you call it Common Knowledge, Received Wisdom, Groupthink, or Mass Hysteria, the vast majority of the “smart money” (around 96%, according to our figures) tends to do almost exactly the same thing, at almost exactly the same time, over and over. 


This “rinse and repeat” cycle moves titanic sums of cash across the globe, charging commissions and management fees everywhere it goes, but doesn’t generally make you more money than average.  Indeed, if “average” is what you are looking for in your investment portfolio, then the really bad news is that, on average, the “average” investment professional often turns in below-average returns for their clients – even while charging average fees.  Replace the word “average” with “mediocre” and you start getting closer to the average truth.


In our ongoing commitment to not be Average, we look at what makes the average professionals “average” and note a few common themes that average financial professionals embrace as Gospel.  These include: reacting to key data points; embrace of Keynesian economic principles and government policies based on them; and adherence to standard metrics such as 50-day and 200-day moving averages (for market dynamics), and seasonally-adjusted employment data (for government policy).


Hedgeye’s macro process is a three-pillar structure, each pillar built to differentiate itself from, and take advantage of the way the “average” investor looks at the market. 


Global Macro Risk Management


The first pillar combines History, Math, and Behavioral Psychology. 


History: Most investors’ processes are based on a short time horizon – we hear people talking about 50-day and 200-day moving averages all the time, but no one even remembers what the bond market was doing fifty years ago.  The failure to observe how markets have behaved over very long time periods means most market professionals are taken by surprise by big events.  Wall Street and the media have come up with all kinds of names for stuff they failed to see coming.  Perfect Storm.  Black Swan.  Tail Risk.  Outlier Events.  All describe events for which almost no one was prepared.  And events for which risk managers should have been prepared.


This inability to look to the past leads the average investor to invest recklessly, believing that “this time is different.”  When their investments don’t work out, they smack themselves on the forehead and say “this has never happened before!”  To paraphrase a famous quote: Risk managers who do not study the disasters of investment history are condemned to repeat them.  At Hedgeye, we look to history to see what happened in the past, how it unfolded, and what its consequences were.  When faced with an unfamiliar phenomenon, we try to ask “When did this happen before?” and look to the historical record for guidance.


Math:  The average investor looks at economic theory, often expressed in key data points: if unemployment is at X%, then the equities market will do Y.  Hedgeye’s Macro work recognizes that, by the time the data point has been publicly announced, the trend has already taken hold – indeed, often it has already played out and is already being replaced by a new trend.  While the rest of the world is looking for proof that things have changed, we are looking for evidence that things are starting to change.  Hedgeye’s macro work focuses on the slope of the line, looking for indications that trends are starting to shift.  These changes are small – too small to be recognized as individual data points.  But the really important changes in macro tend to happen at the margin, in almost imperceptibly small ways.  By the time the change is obvious, it has already happened.  As a mathematician might say, we look at The Rate Of Change Of The Rate Of Change.


Behavioral Psychology: The average investor works from a standard menu of concepts.  One of these is Valuation – which leads to predictable outcomes, since everyone uses the same basic tools.  Another is “gut instinct,” either their own, or that of their investment guru.  Behavioral Psychology helps us to see through short-term market movements.  Investors, like other people, routinely believe that they know something no one else knows, that they have an insight no one else has, and that they will succeed where others will not.  This completely misses one of the few fundamental truths of the way the world behaves, which is Reversion To The Mean.  


Mean Reversion is a statistical concept that most people need to understand – because most people don’t want to believe it exists.  The fact is that Mean Reversion explains an awful lot of what you thought was Free Will, not to mention the economy.


If you’ve ever gone on a diet, you probably experienced Mean Reversion.  People have what the medical profession calls a “set weight,” the long-term average weight they tend to maintain.  You can go on an eating binge and gain ten pounds, but you will likely shed most of it over the next few months and return to more or less your “set weight.”  You can go on a diet and be thrilled when the scale shows you have lost ten pounds.  But try as you might, over the next few months, your weight will likely creep back to your “set weight.”  You have just experienced Mean Reversion, the statistical principle that, over long periods of time, most things tend to get back to where they pretty much have always been.”


The deep psychological reality is that most people believe Mean Reversion applies to everyone else, but not to them.  This allows people to fool themselves into believing that “this time is different.”  Then when they lose money they take solace in the fact that “this has never happened before.”  For this you paid for an ivy-league MBA?  There has to be a better way.


The second pillar of our macro process is Fundamental Analysis.  Hedgeye’s global macro model looks at Growth, Inflation, and government Policy (the “GIP” model).  History matters: where we’ve been will tell us a lot about how we got to where we are, and what we are doing today is a guide to where we are likely to be in the future. 


Our fundamental macro process uses a four-quadrant GIP model that tracks the shifting relationships between economic growth, inflation, and economic policy.  Says Hedgeye’s McCullough, “If you get the slope of the line of both growth and inflation right, you will get a lot of other things right – particularly in your P&L.”


The third pillar is Hedgeye’s proprietary quantitative modeling process.  During nearly ten years as a successful hedge fund manager, Keith developed a 27-factor model that tracks market levels in real time.  The model breaks price trends into three major durations that we call TRADE, TREND, and TAIL, measuring price trends over periods from three weeks, to three years. 


Hedgeye’s combination of fundamental and technical tools has allowed us to spot trends early, and has helped us guide our subscribers to investment success over the past five-plus years.  We welcome you to join us as Hedgeye launches into 2014.  Our macro work indicates there are some significant shifts taking place in global market dynamics.  Stick with us as we give you the call-outs.


Happy New Year from Hedgeye.




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.


Takeaway: We are removing MEDNAX from Investing Ideas.

MEDNAX is coming up against some difficult comparisons in their Q413 report.  In fact, births face the toughest compare in the last six years when they report numbers and guide Q114.   




Our recent physician survey is telling us births are likely down in the US in Q413.  A second quarter in a row of negative year over year organic growth, and likely worse sequentially than Q3, is not a risk we want to take. 


Meanwhile, sellside sentiment is falling, which is negative for MD shares.  The sellside actually does a good job on MD, unlike most other stocks.  


Bottom line: Most of our catalysts to the upside seem played out.  We'd rather sidestep the quarter and take another crack at the name from a lower price and lower expectations.




Takeaway: Does a negative view on WFM heed caution on SBUX?

It was not too long ago that the success of Starbucks and Whole Foods Market was linked to the “higher end” consumer, particularly when compared to their counterparts McDonald’s and Walmart.  Accordingly, both SBUX and WFM have been strong performers, as the “higher end consumer” has proven to be much more resilient in a stagnant economy than others.





With another downgrade today, the street has turned decidedly negative on WFM.  We offer no opinion on the stock at this time, but a negative outlook could suggest that “higher end” consumers are starting to feel the pinch.  If this plays out and WFM sees same-store sales growth begin to slow, we have reason to believe the same could happen at SBUX.


The tepid jobs number reported earlier today is also concerning and, on the margin, bearish for SBUX.  We continue to believe street estimates are too high for SBUX and with 78% of analysts having a “buy” rating on the stock (versus only 50% for WFM), sentiment could be peaking.  After being one of the biggest fans of SBUX over the past 5 years, we see plenty of reason to be cautious on the stock in the early stages of 2014.











Feel free to call with questions.



Howard Penney

Managing Director


Reality Check on the Jobs Report

Takeaway: We wouldn't dismiss today's jobs data outright, but we wouldn't materially shift our positioning on one outlier print.

Forecasting Folly:  If you’ve followed us here at Hedgeye for any period of time, you already know that we don’t pretend to have any edge on the monthly non-farm payrolls figure. That shouldn’t come as a surprise.  While myriad market pretenders toss out their predictions, no real pro or analyst will.


Incidentally, what really matters is non-seasonally adjusted rolling US Jobless Claims.


Reality Check on the Jobs Report - 778


The BLS and ADP figures are certainly co-integrated on a multi-month basis and the trend in the initial claims and other higher frequency employment data can offer some probability weighted, directional insight and some fertile fodder for the tea leafers, but predictive value on a month to month basis is notoriously poor. 


It’s not the number itself, but the markets reaction to it that drives our subsequent allocations.


Summary Take:  In short, +74,000 was obviously a disappointment vs. prevailing expectations and an outlier verses the balance of higher frequency labor market data. We wouldn't dismiss today's data outright, but we wouldn't materially shift our positioning on one outlier print.


With 273K people out of work due to bad weather (vs. an average of 166K over the prior 5 December’s) weather is being held out as the biggest distortive factor. With our retail and restaurant analysts (who rarely cite weather as a discrete swing factor) citing weather as a drag on traffic also, we'll assume the unusually inclement weather likely did, indeed, have some impact on construction and transports/trade employment and drag on hours worked.   


Reality Check on the Jobs Report - keepcalm


Strategy:  The unsurprising price response to today’s jobs data is down dollar/down bonds as “no-taper” expectations get priced in at the margin. (We outlined how to play a breakdown in the dollar in our 1Q14 macro themes call yesterday.) While we'll monitor the dollar weakness closely, in regards to the more immediate term and today’s employment data specifically, we’ll take the other side of overbought/oversold moves in today’s price action.   


In the context of the broader labor market data, where the preponderance of evidence remains positive with ADP, initial claims, ISM manufacturing and ISM services all reflecting moderate, ongoing improvement,  the BLS data sits as a single negative outlier. 


Unless we see confirming fundamental evidence alongside a shift in risk management signals (across SPX, VIX, DXY, 10Y Treasury), we’re unlikely to pivot on our generally positive view of the domestic labor market because of today’s data in isolation – particularly given the positive revision, the weather caveat and the ongoing, significant seasonal distortion.   


Editor's note: This is an excerpt from Hedgeye research earlier this morning. If you like what you see and would like more information on how you can subscribe to our research click here.




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