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THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP – February 10, 2014


As we look at today's setup for the S&P 500, the range is 75 points or 3.45% downside to 1735 and 0.72% upside to 1810.                                  

                                                                                             

SECTOR PERFORMANCE

 

THE HEDGEYE DAILY OUTLOOK - 1

 

THE HEDGEYE DAILY OUTLOOK - 2

 

EQUITY SENTIMENT:

 

THE HEDGEYE DAILY OUTLOOK - 10                                                                                                                                                                  

 

CREDIT/ECONOMIC MARKET LOOK:

  • YIELD CURVE: 2.37 from 2.38
  • VIX  closed at 15.29 1 day percent change of -11.26%

MACRO DATA POINTS (Bloomberg Estimates):

  • 12pm: Wasde commodities reports
  • U.S. Rates Weekly Agenda
  • FX Weekly Agenda

GOVERNMENT:

    • President Obama meets with French President Hollande; to discuss U.S.-French business ties, proposed U.S.-EU free-trade agreement
    • House Transportation and Infrastructure Cmte holds field hearing in Charlestown, W.Va., on Elk River chemical spill
    • 10am: CFTC’s Technology Advisory Cmte holds public meeting focused on swap data reporting; CFTC’s concept release on automated trading; swap execution facilities
    • 2pm: House Energy and Commerce panel holds hearing on drug shortages, with GAO Healthcare Director Marcia Crosse
    • 2:30pm: House Transportation and Infrastructure panel holds roundtable discussion on public-private partnerships
    • Geneva II peace talks and negotiations continue after the Jan 22 Conference; members of President Bashar al-Assad’s government and rebels are expected to resume talks in Geneva

WHAT TO WATCH:

  • L’Oreal jumps as Nestle said to seek ways to reduce 29% stake
  • James River Coal hires Perella Weinberg, may sell itself
  • PBOC signals money-mkt volatility; China seeks to tame debt
  • Hudbay makes offer to acquire Augusta Resources
  • Intl Forest Products to acquire Tolleson Lumber for $180m
  • Japan’s Dec. current-account deficit widens to record
  • Forbes sale nears; Spice Grp, Fosun said to plan final bids
  • Mandel tops best-earning hedge funds for second year
  • AIG eyes acquisitions in Asia, Latin America: Figaro
  • Barclays examining possible data theft from 27,000 customers
  • China regulator said to order smaller banks to set aside funds
  • Chinese regulator said to seek JPMorgan job for friend: NYT
  • Swiss brace for sour EU relations on anti-immigration vote

AM EARNS:

    • Boardwalk Pipeline (BWP) 6am, $0.31
    • CNA Financial (CNA) 6am, $0.85
    • Emera (EMA CN) Bef-mkt, C$0.42
    • Hasbro (HAS) 6:30am, $1.22 - Preview
    • Mercury General (MCY) 8:30am, $0.53

PM EARNS:

    • Albany International (AIN) 5pm, $0.35
    • American Capital (ACAS) 4pm, $0.24
    • Amkor Technology (AMKR) 4:07pm, $0.14
    • Compass Minerals International (CMP) 4:15pm, $1.77
    • CYS Investments (CYS) 4:01pm, $0.35
    • Flotek Industries (FTK) 4:15pm, $0.17
    • Forward Air (FWRD) 4:05pm, $0.56
    • Highwoods Properties (HIW) Aft-mkt, $0.73
    • KapStone Paper and Packaging (KS) 4:15pm, $0.48
    • Loews (L) 4:15pm, $0.70
    • Masco (MAS) 5:09pm, $0.16
    • Molina Healthcare (MOH) 4pm, $(0.19)
    • Nuance Communications (NUAN) 4pm, $0.23
    • Owens & Minor (OMI) 5pm, $0.50
    • Pioneer Natural Resources (PXD) 4:01pm, $0.98
    • Primerica (PRI) 4:02pm, $0.79
    • Rackspace Hosting (RAX) 4pm, $0.14
    • Regal-Beloit (RBC) 5:17pm, $0.84
    • Sensient Technologies (SXT) 4:24pm, $0.63
    • Toromont Industries (TIH CN) Aft-mkt, C$0.52
    • Waste Connections (WCN) 4:05pm, $0.43

 

COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)

  • Gold Demand in China Surges to Record as Bear Market Spurs Sales
  • Rubber Inventories in Producing Countries to Drop on Drought
  • Coffee to Soybean Wagers Climb on Brazilian Drought: Commodities
  • Aluminum Faces Deficit in 2015 on Cutbacks, Sumitomo Says
  • Brent Slips After Biggest Gain in Three Months Amid Libya Return
  • Nickel Climbs Amid Speculation Ore-Export Ban Will Lift Prices
  • Gold Gains to Two-Week High on U.S. Jobs as China Resumes Buying
  • Wheat Falls Third Day Before USDA Report as Supply Seen Ample
  • Sugar Drops 3rd Day in New York Before Possible India Decision
  • Hedge Funds Boost Diesel Bets With Supply at Decade Low: Energy
  • Rebar Declines for Second Day as Demand Weakens After Holiday
  • California Ranchers Missing Beef Rally in Bid to Survive Drought
  • Cheap Shale Gas Allows U.S. Refiners to Displace EU in LatAm
  • Tin Exports From Indonesia Slump to Three-Month Low in January

THE HEDGEYE DAILY OUTLOOK - 5

 

CURRENCIES

 

THE HEDGEYE DAILY OUTLOOK - 6

 

GLOBAL PERFORMANCE

 

THE HEDGEYE DAILY OUTLOOK - 3

 

THE HEDGEYE DAILY OUTLOOK - 4

 

EUROPEAN MARKETS

 

THE HEDGEYE DAILY OUTLOOK - 7

 

ASIAN MARKETS

 

THE HEDGEYE DAILY OUTLOOK - 8

 

MIDDLE EAST

 

THE HEDGEYE DAILY OUTLOOK - 9

 

 

The Hedgeye Macro Team

 

 

 

 

 

 

 

 

 

 

 

 

 


Dog or Wolf?

This note was originally published at 8am on January 27, 2014 for Hedgeye subscribers.

“The hour between dog and wolf, that is, dusk.”

-Jean Genet

 

Customer questions on Friday went something like this: ‘Keith, was that a bull or bear? Dog or wolf? What do you think?’ I don’t know. But I’m not in the business of walking up to a bear in the dark without a real-time gun! So let’s stay on our toes here and react accordingly. The best market calls are made by Mr. Macro Market, not me.

 

Ironically enough, last week I started reading the latest behavioral psych book to bubble up to the top of my pile, The Hour Between Dog and WolfRisk Taking, Gut Feelings and the Biology of Boom and Bust, by former Goldman/Deutsche trader, John Coates.

 

In his introduction, “it has been said of war that is consists of long stretches of boredom punctuated by brief periods of terror, and much the same can be said of trading” (Coates, pg 5). I’d say that if you were buying-the-damn-bubble #BTDB on Wednesday and Thursday of last week, Friday’s move, punctuated by a +45.8% VIX rip on the week, felt like terror.

 

Back to the Global Macro Grind

 

First, instead of screaming bloody murder this morning, let’s contextualize where Friday’s -2.09% drop in the SP500 came from. In an intraday note (11:45 AM on Thursday January 23rd) I wrote a risk management note titled “Not #BTDB Today” and outlined 3 main issues that were signaling in our model:

  1. US Consumption #GrowthSlowing (rate of change vs. Q313’s sequential top)
  2. SP500 broke our immediate-term TRADE line of 1837 support
  3. US stocks making lower-highs (vs. all-time highs) and down YTD perpetuates performance chasing

In other words, this was very much a playbook 3-factor (History, Math, and Behavioral) line of reasoning that seems sound, after the fall:

  1. HISTORY: our Q114 Macro Theme of #InflationAccelerating has historically slowed consumption growth
  2. MATH: immediate-term TRADE signals matter in either confirming existing TRENDs or signaling new ones
  3. BEHAVIORAL: consensus is still in the business of chasing (buying) high and freaking out (selling) low

Got #InflationAccelerating?

  1. The US Dollar (index) was down a full -0.9% last week (down -2.2% now in the last 6 months)
  2. The CRB Index (19 commodities) was +1.5% last week vs the SP500 -2.6%
  3. US Consumer Discretionary Stocks (XLY) are already down -4.98% YTD (vs SPX -3.1%)

And while, Janet Yellen’s new Fed will see no inflation this week (on a lag, after comping the all-time highs in food/commodity inflation of 2011-2012), real-time men and women trying to decide between dog and wolf see breakevens (inflation expectations rising) and Natural Gas +19.8% last week for what it is, on the margin, #inflationary.

 

Interestingly, but not surprisingly, so does Mr. Macro Market. Remember that down days for US stocks in 2014 have been #timestamped frequently by the following pattern: Down Dollar + Down Rates = Down Stocks.

 

That’s why the immediate-term TRADE correlations between the US Dollar and the SP500 are as follows:

  1. 15-day = +0.66
  2. 30-day = +0.43

In other words, if economic gravity still matters (it does), and the Dollar and Rates are signaling bear (on the slope of US economic growth), it’s probably a bear.

 

While everyone in the Barron’s Roundtable said it’s all about the Fed (you have to quantify less in making general groupthink statements), we continue to think that getting market beta right for the last few years has been more about getting the slope (rate of change) of GROWTH and INFLATION right.

 

On the GROWTH front, this week’s Macro Calendar will show you more #GrowthSlowing (on the margin):

  1. TUESDAY: Durable Goods should slow in December versus November’s +3.4%
  2. THURSDAY: Q413 US GDP should slow to 3-something percent vs Q313’s +4.12% sequential peak
  3. FRIDAY: PMI for January could easily slow form December’s frothy 60.2

Oh, and your illustrious open market committee of forecasting the weather (on a lag) at the Federal Reserve may well taper again on Wednesday into #GrowthSlowing too. Never mind dog or wolf – that’s just dumb.

 

Our immediate-term Global Macro Risk Ranges are now:

 

*= new TREND change (in brackets)

 

*UST 10yr Yield 2.72-2.79% (bearish)

SPX 1779-1825 (bullish)

*Nikkei 14678-15169 (bearish)

*VIX 14.91-20.41 (bullish)

*USD 80.19-80.79 (bearish)

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Dog or Wolf? - Chart of the Day

 

Dog or Wolf? - Virtual Portfolio


A TALE OF TWO SURVEYS: SEQUENTIAL SOFTNESS & JANUARY EMPLOYMENT

Takeaway: The January employment data was soft on balance but again offered a bevy of talking points for the bull & bear contingents.

Editor's note: This complimentary research note was written by Macro Analyst Christian Drake and originally published on February 07, 2014 at 13:36 in Macro. For more information on how you can subscribe to Hedgeye click here

A TALE OF TWO SURVEYS: SEQUENTIAL SOFTNESS & JANUARY EMPLOYMENT  - job99

This morning’s Employment data for January confirmed the slowdown observed in December and, on balance, was a disappointment versus Nonfarm Payrolls consensus at +180,000. 

 

For the record, we highlighted (in detail) the emergent deceleration in the domestic, fundamental macro data in our "Flash Call" on Wednesday. We would direct you to that for a fuller discussion of the data and how to be positioned for (on the margin) #InflationAccelerating and#GrowthDeceleratingFor a link to the presentation and replay ping sales@hedgeye.com. 

 

A TALE OF TWO SURVEYS: SEQUENTIAL SOFTNESS & JANUARY EMPLOYMENT  - drake

 

BULL/BEAR:  The January employment data was soft on balance but again offered a bevy of talking points for the bull & bear contingents.

 

On the BEAR side, the Establishment Survey was weaker for a second month with Non-farm and Private payrolls increasing +113K (vs. +180K exp.) and +142K (vs. +185K exp), respectively. 

 

Further, there was no meaningful, positive revision to the December figures which were revised +1K to +75K. 

 

With the NFP numbers now beginning to decelerate on a Trend (3M/6M) basis the implications for prospective policy adjustments become more substantive.   

 

On the BULL side, the incremental improvement in the unemployment rate to 6.6% was a function of positive dynamics, specifically higher employment and higher labor force participation.  

 

The Household Survey showed a strong gain in employment with an estimated +638K jobs added in January with Total Unemployed dropping -115K sequentially. 

 

The labor force participation rate increased to 63% from 62.8% as the net change in the labor force (+523K), driven by the positive change in employment, increased at a premium to the +170K increase in the Civilian Population. 

 

Overall, despite the ongoing decline in the U-3 rate, the preponderance of labor market metrics remains largely middling – expect the Fed to highlight that reality and increase discussion around an inflation floor or similar as we move toward breaching the unemployment ‘target’ on the downside.  

 

A TALE OF TWO SURVEYS: SEQUENTIAL SOFTNESS & JANUARY EMPLOYMENT  - NFP Revision

 

SEASONALITY:  The marked deceleration in the reported, seasonally adjusted payroll numbers is, perhaps, even more remarkable given that seasonality should be serving to buttress the numbers as we build towards the positive peak in seasonality in February. 

 

A TALE OF TWO SURVEYS: SEQUENTIAL SOFTNESS & JANUARY EMPLOYMENT  - NFP Seasonality 2

 

INDUSTRY EMPLOYMENT: Construction and Manufacturing were the notables, reversing last month’s weakness, gaining +48K and +21K, respectively

 

The laggards were Retail (-13K) and Education and Health Services (-6K).  In fact, Healthcare saw a net decline in employment MoM for the first time since July 2003!

 

A TALE OF TWO SURVEYS: SEQUENTIAL SOFTNESS & JANUARY EMPLOYMENT  - HC EMp Jan

 

GOVERNMENT EMPLOYMENT:  Federal Gov’t Employment Declined -12K MoM  (-4K ex-Postal Service).  State & local Government lost -17K jobs in December, but on a year-over-year basis growth remains positive at +0.17%. 

 

HOURS & WAGES:  Hours and wages, which shouldn’t show material distortion from weather, were largely flat sequentially.  Weekly hours worked held at 34.4 while hourly earnings grew +1.9% YoY – note that the longer-term trend in wage growth is ~ +3% and with PCE growth running at +3.6% as of the latest December reading, wage growth has some heavier lifting to do to maintain the current pace of household spending.

 

WEATHER:  Unlike last month, employees out of work due to bad weather wasn’t an upside outlier in January.  BLS reported that 262K individuals missed work due to inclement weather in January, which compares to the longer-term January average of ~250K. 

 

A TALE OF TWO SURVEYS: SEQUENTIAL SOFTNESS & JANUARY EMPLOYMENT  - Weather Emp Jan

 

CES Benchmark Revision: The BLS revised the total nonfarm employment level for March 2013 upward by 369K with the total level of NFP employment for year-end 2013 revised from 136.9M to 137.4M, or a positive revision of ~500K. 

 

A TALE OF TWO SURVEYS: SEQUENTIAL SOFTNESS & JANUARY EMPLOYMENT  - CES Revision

 

Employment By Age:  Employment growth by age accelerating sequentially for all age cohorts except 20-24 year olds.   Despite the sequential improvement from -0.9% YoY to -0.5%, 45-54 Yr. olds remain the lone age demographic still mired in negative employment growth.  With the exception of a few months in mid-2012, 45-54 years olds have yet to see positive job growth in any post-recession month according to BLS data.

 

A TALE OF TWO SURVEYS: SEQUENTIAL SOFTNESS & JANUARY EMPLOYMENT  - Employment by Age

 

 

Christian B. Drake

cdrake@hedeye.com

@HedgeyeUSA

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INVESTING IDEAS - LEVELS

Takeaway: Here are Hedgeye CEO Keith McCullough's refreshed levels for our high-conviction stock ideas.

INVESTING IDEAS - LEVELS - sun

 

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

Anything longer than 3 years is unpredictable


INVESTING IDEAS NEWSLETTER

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

Please see below Hedgeye analysts' latest updates on our high-conviction stock ideas.

 

In this week's edition of Investing Ideas, we also feature a special market commentary based on our institutional client macro "Flash Call" earlier this week. In it, we highlight specific areas of economic vulnerability and why investors are rightfully nervous right now.

 

Finally, we are excited to announce the recent launch of Hedgeye's Internet & Media Sector spearheaded by analyst Hesham Shaaban. At the conclusion of this note, we highlight Hesham's latest research on the stock market's current "darling" and explain why we think "Icarus" is a far more appropriate name.

 

(Please note CEO Keith McCullough's refreshed "Trend" levels for each stock will be sent out later this weekend.)

 

IDEAS UPDATES

The latest on Hedgeye's high-conviction stock ideas.

 

CCL — Record bookings in January bode very well for Carnival Cruise Lines with the lowest expectations on the Street. The cruise operator said it took net bookings (new reservations minus cancellations) for more than 565,000 guests last month. That’s a 17% increase from January of 2013.

INVESTING IDEAS NEWSLETTER - ccl

Meanwhile, Carnival's website had 13 million visits during January, another record. It remains to be seen whether heavy discounting was the catalyst behind the strong bookings. Unseasonably cold weather likely played a positive role. It is critical for prices to hold steady during mid-Wave. We’ll be updating our proprietary cruise pricing database next week.

 

 

DRI — Veteran Restaurants Analyst Howard Penny has nothing material to add to his bullish long-term thesis on Darden this week.  We are eagerly awaiting the release of Starboard Value’s plan for value creation with respect to Red Lobster, Olive Garden, etc. We expect that to happen sometime within the next couple of weeks.

INVESTING IDEAS NEWSLETTER - redl

In the meantime, the company has been making headlines for offering "free babysitting" for parents while they eat at Olive Garden on Friday, Feb. 7th.  To be frank, this “Parent’s Night Out” special is another feeble (laughable?) attempt to drive customer traffic. 

 

A large part of Penney’s bullish thesis revolves around the resurrection of the Olive Garden brand.  It is becoming clearer by the day that a new management team or structure is needed for this to happen. In other words, Chairman and CEO Clarence Otis needs to go.

 

 

FXB — Hedgeye remains bullish on the British Pound versus the US Dollar (etf FXB), a position supported over the intermediate term TREND by prudent management of interest rate policy from the Bank of England. The BOE continues to be oriented towards hiking, rather than cutting as economic conditions improve. In its interest rate decision on Thursday it kept the main interest rate on hold at 0.50% and its Asset Purchase Target on hold at £375B.

INVESTING IDEAS NEWSLETTER - uk1 

Economic data out during the week continues to confirm our bullish outlook on the economy which we believe should influence the currency higher. While the PMI Services and Manufacturing figures for January slightly underperformed expectations and were slightly below December figures, they remain the highest across Western European countries. We see strong through-put in PMI Construction figures that rose to 64.6 in January versus 62.1 in December (an all-time high since the series was recorded in July 2008).  Additionally, the housing market remains elevated – according to the Halifax House Price Index prices rose +7.3% in January year-over-year versus +7.5% in December, and though a bit stale, on a year-over-year basis Industrial Production remains elevated despite a slight decline to +1.8% in December versus a recent high of +2.9% in October. 

 

 

HCA —  We've commented frequently in the last few weeks about what appears to be a re-acceleration on surgical case volume across the Orthopedic and Cardiovascular practice areas. These two practice areas, with their high reimbursements and contribution to overall hospital revenue and profits, is critical to the success of any hospital company. For HCA in Q413, it only took a very small recovery in surgical case volume to drive a massive acceleration in their average reimbursement per admission.  Staying long HCA or any other hospital is still a difficult decision every day, though. From their Q413 report, which HCA had preannounced, we heard a few new items which on balance we liked. The guidance for 2014 was set reasonably (and low by our estimate) and the incremental profit from the Affordable Care Act was also guided to a very low number at an additional 1-2% of EBITDA for the year, and also likely below what they will realize.

 

Fundamentals and stock prices can and are often two different things though. But as the charts below suggest, we think the risk from a market move lower is reasonably low from here. Hospitals and HCA typically trade at a discounted multiple to the S&P 500.  We've charted the EV/EBITDA ratio for both. With a range of 73% to 89% of the market multiple, HCA's current reading of 80% is right in the middle of the range. Combined with our view that HCA can perform better fundamentally and report better than expected EBITDA numbers, we won't say there isn't any risk, but we're likely in a pretty comfortable position.

 

We should have the next round of our OB/GYN in the next day or so. We're looking forward to seeing the update on patient traffic and maternity trends. We'll also be sending out a survey to Orthopedic surgeons to ask them about case volume.  We were surprised to hear, despite 2 quarters of acceleration and one of the best quarters in the last 5 years, many of the implant manufacturers caution the street heading into 2014 not to expect the trend to continue. Our survey should give us the answer we need.

INVESTING IDEAS NEWSLETTER - HCA price vs surg

 

INVESTING IDEAS NEWSLETTER - HCA Relative Multiple

 

LVS — Hedgeye Gaming, Lodging & Leisure Sector Head Todd Jordan remains the bull on Las Vegas Sands. While he acknowledges that January gross gaming revenues in Macau were disappointing, he says it could have been due to bad luck in the last couple of weeks of the month. Jordan is much more optimistic on February, given positive anecdotal evidence that we are hearing surrounding the Chinese New Year.  For starters, mass traffic has been strong and Las Vegas Sands has several mass-centric properties.

 

 

RH — Restoration Hardware is in a particularly dark period now. Not with its business, which we think is still quite healthy, but with its communication with the Street. The company has ended its fourth quarter, but has not yet finalized the books. That process – for some reason we do not understand – takes a particularly long time for RH. The company won’t release earnings for another 1-2 months, which might very well mark the longest ‘quiet period’ for any company in retail. Unfortunately, that lack of information is not RH’s friend. Investors like to speculate about the business, particularly given the horrible results retailers posted in January due to bad weather. Generally speaking, no one speculates that ‘things are going great’. It’s simply not how Wall Street thinks. The good news is that for people who believe in the company’s opportunity, strategy, and execution, weakness in the name based on said factors prove to be a buying opportunity – like we think we have with RH today. 

 

 

TROW — Shares of T Rowe Price are the second best performing stock in the asset management group year-to-date (behind defensive institutional bond fund manager Legg Mason). With the bulk of substantial outflows from institutional sovereign wealth clients out of the way from the back half of 2013, TROW is now at a positive inflection point to book solid inflows backed by its industry leading performance. TROW’s leading 401k business is still growing above the industry average and with industry-wide retail equity flows having turned up substantially in the middle part of last year, the environment is still incrementally positive for this leading stock fund manager.

INVESTING IDEAS NEWSLETTER - trow

We are however getting cautious on the margin that the environment is getting more challenging for U.S. stocks to maintain their upward trajectory but with a solid rebound towards the end of the week in U.S. equities, the environment has stabilized a bit. We are traveling with TROW management at the end of this month and should then get a better idea of if the retail investor is incrementally adding to TROW funds. Until then, TROW shares should rebound with the market after a tough start to the year for equities.

 

 

WWW — Wolverine Worldwide is slated to report fourth quarter earnings on Tuesday February 18th before the market opens. While our call on WWW is much more long-term in nature, the reality is that we happen to like it into the print. The stock has gone from $34 to $27 in a month’s time on virtually no news. The company notes that sales were a bit light in quarter relative to expectations, but then it took up its EPS guidance. That’s the kind of company we like – one that offset weakness in the macro climate with its own initiatives to hit financial objectives.

 

This remains one of the most hated stocks in retail – not quite as much as JCP, but close. We like that – we’d be concerned if it was over-loved. We think that WWW will print upside to earnings, and ultimately will beat every quarter this year (based on current Street estimates).

 

 

ZQK — Quiksilver’s female brand, Roxy, was center stage on the first night of Olympic competition in the Women’s Slope Style qualifying run as Roxy endorsed, Torah Bright, kicked off her pursuit to bring home the snowboard triple crown for her home country of Australia.  We talked a few weeks back about ZQK’s new endorsement/marketing strategy. In summary – ZQK made the right move to downsize their athlete roster and event sponsorships. Our survey work indicated - ZQK should focus only on the Rockstars to drive brand awareness.

INVESTING IDEAS NEWSLETTER - 22 

That’s why this Torah Bright development is kind of  a double edged sword. On one hand, Roxy has the best female snowboard athlete in the world -- one that could be argued is the female equivalent of Shawn White. We know most people will argue with us on that one. We're huge White fans ourselves. But he is supremely dominant in one event -- the pipe. Torah consistently wins in the halfpipe, snowboardcross, and now slopestyle.

 

The flip side of this is that Roxy fails to promote her as a top athlete (she’s nowhere to be found on the brands website – check out the image below) -- even though she has a full line of snowboard clothing, and appeals to women and men alike. This just goes to show that ZQK still has underutilized assets at Roxy that could ultimately promote revenue growth.  

 

*  *  *  *  *  *  *

Mr. Market Is Getting a Little Queasy  

A Special Economic & Market Update 

 

CEO Keith McCullough led the Macro team earlier this week in a Hedgeye Flash Call, updating our subscribers on our Q1 themes of #InflationAccelerating and #GrowthDivergences.  Together with US Macro analyst Christian Drake, Keith walked through the quantitative set-up that has emerged since the beginning of the year. 

 

With the S&P index down roughly 3% year to date, if you own equities, it’s not pretty.  As Keith observed in his opening remarks, “Risk has happened pretty fast” since the beginning of the year – just one month, which once again demonstrates that the one certain effect of government attempts to manipulate the economy is to shorten economic cycles, and to increase volatility.  From that perspective, the near-universal efforts of the world’s central bankers seem to be having their predicted effect – if not their intended ones.

 

 

So Much Inflation, So Early in the Year

 

The individual investor who finally threw in the towel and bought stocks late last year may be feeling a little bit abandoned right now as they watch the value of their holdings decline almost daily, with nary a pundit in sight to tell them why.  Very few of the major Wall Street gurus are talking about the inflation that our macro work sees very clearly.  Instead, they are almost uniformly fixated on how much higher the S&P 500 will be at the end of this year – a recent review of top stock market forecasters found the average projection for the S&P this year was 1,955, more than 200 points higher than it was trading as Keith spoke.

 

Many of these same forecasters underestimated the strength of the market last year, coming in short by more than 15%.  We are not sure what continues to qualify them as “top forecasters.”  There must by some mystical process at work here to which we are not privy.

 

Hedgeye’s macro work indicates that commodity prices have begun to break out as other inflationary pressures continue to build.  If Fed chair Yellen decides to rescue the equities markets by going back to Quantitative Easing, the impact could re-ignite what has become a Pavlovian response from investors: QE Up, triggering Dollar Down, triggering Yield Chase/Inflation Hedge Assets Up.  This would likely spark another round of growth-slowing commodity inflation.  

 

After peaking in 2011-2012, commodity prices subsequently cratered in 2013 as the dollar strengthened and expectations rose for incremental Fed tightening.  In that environment pro-growth equities became the asset allocation of choice for both retail and institutional investors.   

 

Notably, the slope of broader inflation – as measured by the CPI – follows the slope of commodity inflation closely.  In other words, if commodity inflation accelerates or decelerates sequentially, so does the CPI.  So, generally, we can expect broader measures of consumer price inflation to track the move in commodity prices. 

 

Given last year’s price declines, the comps (period-to-period comparisons) are especially easy; thus even a moderate price increase in the commodity complex will look inflationary year over year.  This is more an optical effect than an economic reality, but policy is made in response to how things appear, not how things actually are.  Even with Princeton PhDs, Washington policy makers generally have no clue how things actually are, while the few people who actually do know how things are can never convince others until it’s too late.

 

Says McCullough, we are not likely to see 2011-2012 style actual inflation (which by the way the Fed did not see at the time) but as people start to perceive the rise in commodity prices alongside decelerating growth and declining stock prices, there will be speculation that the Fed will again loosen policy in an attempt to help support flagging growth.  If Yellen stays the course on the taper, new stock investments could be temporarily good money after bad.  If she reverses, then your dollars in the stock market will be the near-term Good Money, while the Dollar in the global context will be Bad and inflation will rise faster.  Damned if we do, damned if we don’t.

 

 

A Rising Tide of Inflation


We were seeing wage inflation even before President Obama decided to push wage increases through executive order, which is obviously bullish for further wage increases in general.  Perhaps more significant, savings rates are declining back towards historic lows as consumption is again displacing saving.  Note that, in 3Q13, aggregate household debt growth turned positive for the first time in eighteen calendar quarters (latest data), signaling that credit-driven consumption growth is now back after 5 years of household balance sheet deleveraging.  The trend to consumer over-spending is likely to be exacerbated as consumers start to worry about inflation: the propensity to chase rising prices will exert pressure on consumer spending.

 

On the market side, inflationary pressure is more likely to lead to multiple compression, the very opposite of the expansion most Wall Street strategists are calling for.  In Hedgeye’s proprietary four-quadrant model, last year saw Growth Accelerating / Inflation Accelerating.  In this scenario, optimism about the economy and enthusiasm about growth lead investors to assign higher P/E multiples to stocks – multiple expansion – and prices rise.  But we are rolling out of that scenario – Quadrant 2 in our model.  As commodity inflation rises, we risk moving into Quadrant 3: Growth Slowing / Inflation Accelerating.  This is the “in-a-box” policy scenario: Damned if you do, damned if you don’t.  This stagflationary scenario is not a good place to be, and not an easy one to work out of.  There is practically no good policy option except the one that no politician wants to hear: sit tight and wait it out.  Meanwhile, consensus is looking for continued multiple expansion this year.  Says McCullough, the pundits whose S&P targets fell short by 300 points last year may be on target to overestimate this year’s levels by the same margin.

 

Investors are not positioned for slower growth and stock price multiple compression.  But inflation metrics continue moving forward steadily and quietly.  Keith says this could in effect be commodity prices front-running policy; if the Yellen Fed yields to pressure and reverses the tapering process, inflation will charge ahead, as will “the inflation trade.”  Already, says McCullough, broad measures of inflation are moving ahead.  CRB prices continue to make higher lows. Inflation hedge assets are outperforming, even as stock prices decline – utilities are practically the only equity sector that is working, and gold is regaining its luster.  Other inflation indicators are advancing, such as the Prices Paid component in both the ISM Manufacturing and ISM Services Surveys.  ISM services new orders – the best lead indicator of future activity in the survey – are back down to the level they were in July 2009, and ISM manufacturing new orders just had its biggest month-over-month decline since December 1980, the eve of a recession that battered the nation for two years.

 

Durable goods orders, retail sales, consumer trends, housing demand and home prices are all slowing, consumer stock prices are underperforming, and the Treasurys yield spread is compressing, indicating a worsening growth outlook.

 

Fed Up?


The market appears to be set up for a reversal of the Taper.  The minute Yellen hints a return to Quantitative Easing, says McCullough, the full impact of that reversal “will roll right into the CRB.”  The markets are already pricing in slower growth and rising inflation and Hedgeye’s macro work indicates the slope of the rate of change in prices continues its upward trend, making the inflationary scenario worse for investors.

 

Globally, most central banks are engaged in a global bonfire, all rushing to burn their currency faster than their neighbor.  Notable standouts include India and the UK, whose central bankers have pushed back on the widespread religion of post-Keynesianism and held the line on their currencies. 

 

Central planners and regulators are busy assuring their citizens that things are under control, but the reality is that regulators don’t know what forces will cause the next crisis.  All they can do is make sure the abuses that precipitated the last crisis don’t get out of control again.  Meanwhile, we may already be in the midst of the next crisis, as central bankers trash their currencies to stoke price inflation and stimulate exports.  The lasting impact of these policies is not economic strength, but greater inequality, with an increasing likelihood of social unrest.  Even though pundits here have been discussing the decline in the emerging markets, the US marketplace is not insulated against the possibility of a broad EM collapse.

 

In this scenario of limited options, the only solid hope on the US policy front would be an unequivocal statement from Yellen that the Fed will continue to taper and continue to tighten.  That would strengthen the dollar and help set the US economy back on a growth track.  Of course Hope, as McCullough points out, is not an investment process. 

 

Once again the individual investor has been left high and dry.  Everyone has been pushing the bull case.  Now that it’s not working, no one is trying to unpack the reasons behind the market decline.  Keeping their eye on their lofty year-end targets for the S&P, the pundits have taken their eye off the ball: a lot can happen in the coming eleven months. 

 

If the history of market behavior is any guide, by the time the rest of Wall Street wakes up to #InflationAccelerating, it will already be behind us.

 

*  *  *  *  *  *  *

(Click on the title below to unlock our latest research note on Twitter)

 

TWTR: Staying Short, But...

Our original short thesis on Twitter centered around emerging headwinds to two of its core growth drivers 1) Reach (User Growth) and 2) Monetization (Ad Revenue per timeline view). While TWTR is down 33% from its highs, it still trades at a premium to social media comps Facebook and LinkedIn.  As soon as the Street realizes that the company can’t grow +50% in perpetuity, the stock will lose further momentum.
INVESTING IDEAS NEWSLETTER - twtr

 


TWTR: Staying Short, But...

Takeaway: See SUMMARY BULLETS and SUMMARY CHARTS at the end of the note for main takeaways

SUMMARY BULLETS

  1. 4Q13 Earnings Exposes Holes in Business Model: Both Membership Growth and Engagement decelerated meaningfully in 4Q.  Street is now questioning the runway for both growth drivers.  We believe User Growth is the bigger issue.
  2. Biggest Hole Yet to Emerge: Monetization has been a considerable growth driver, but running out of runway.  Growth likely to decelerate beginning 2H14/2015.
  3. Consensus Estimates Rising: Estimates are up with the 4Q13 earnings and 2014 guidance beat; the mistake is increasing already-lofty 2015-2016 estimates as well
  4. But Continue to See Near-Term Upside: We see consensus estimates for 1H14 as more than achievable.  Since the stock has already taken a hit, a near-term beat could refuel optimism.

 

TWTR 4Q13 EARNINGS SUMMARY

  • Revenues: 4Q13 Revenue of $245M, beating both our estimate of $218.9M and consensus of $218.1M
  • Membership (Reach): Monthly Active User (MAU) growth came in lower than we expected at 30% y/y vs. our estimate of 38%.  US Growth decelerated to 20% y/y, vs. 33% in the prior quarter
  • Timeline Views/User (Engagement): Declined -3% y/y, decelerating from the 8% growth in prior quarter. 
  • Ad revenue/timeline view (Monetization): accelerated sharply, up 76% y/y vs. 49% in prior quarter. 
  • 2014 Guidance: $1.15-$1.20B vs. consensus of 1.13B and our estimate of $1.08B.  1Q14 revenue guidance of $230M-$240M is ahead of our original estimate of $230, and well ahead of prior consensus of $214. 

 

SHORT THESIS SUMMARY

Our original short thesis centered around emerging headwinds to two of TWTR’s core growth drivers 1) Reach (User Growth) and 2) Monetization (Ad Revenue per timeline view). 

  1. Reach (Membership Growth): Our major concern was understated penetration; particularly in the US.  We have seen studies suggesting that as many as 50% of twitter’s total users are no longer active; meaning TWTR already penetrated a larger portion of the US population than its Monthly Active Users (MAUs) metrics suggest.  Average Revenue per User (ARPU) in the US is considerably higher than the international market (8x greater), so if US slows, international can’t compensate
  2. Monetization (Ad Revenue per timeline view): This has been an accelerating source of growth for TWTR over the LTM.  However, we believe this has a limited runway because it was largely driven by what we call the “Mobile Migration”, which we see as a non-recurring/waning benefit.  The “Mobile Migration” is the combination of TWTR introducing its main ad products to its mobile platform (where the company has had greater success with monetization) while users were steadily adopting the mobile app.  The former can’t be repeated; the latter is near full penetration.  The only other options from here is to introduce new ad products, or the ad load itself; both will test the loyalty of its users.

 

SHORT THESIS UPDATE

  1. Reach: TWTR only picked up an additional 1M users sequentially in 4Q13 ( up 2% q/q).  For perspective, FB picked up 2M users despite US Monthly Active User (MAU) penetration that is over 3x that of TWTR (73% vs. 22%, respectively).  We continue to believe the upside to TWTR’s user growth is limited since total US penetration is higher than its MAU metrics suggest. The emerging question is whether TWTR's addressable market is as large as FB’s, and if it can achieve comparable penetration down the road.
  2. Engagement: the 4Q deceleration in timeline views/MAU is concerning.  Management suggested that user interface improvements limited the need to refresh the site as often, which is how it measures timeline views.  While plausible, we believe that users gravitating over to TweetDeck, where the company can’t measure timeline views, may also be partly to blame.  The latter would be concerning since we do not believe the company is effectively monetizing the TweetDeck platform.
  3. Monetization: the 4Q acceleration in ARPU suggests the Mobile Migration may have more near-term upside than we originally thought; although we suspect some of that acceleration is due seasonal spike in 4Q ad spending (holiday shopping season).  Regardless, our thesis hasn’t changed.  Mobile drove substantially all of TWTR’s 4Q13 ad revenue growth.  With mobile now representing over 75% of all ad revenue (vs. 55% in 4Q13), the runway gets shorter from here.  The comp setup switches from mobile representing the minority to majority of revenue moving forward.   

 

CONSENSUS ESTIMATES LOFTY, BUT MORE REASONABLE NEAR-TERM

Following the beat on both 4Q13 Estimates and 2014 Guidance, Consensus estimates have risen substantially.  Where we take issue is 2H14 and 2015; more so on the latter.  While it may be premature to look that far out, TWTR’s stock will ultimately trade on growth expectations.  While TWTR is down 33% from its highs, it still trades at a premium to social media comps FB and LNKD.  As soon as the street realizes that company can’t grow +50% in perpetuity, the stock will lose further momentum. 

 

Timing that catalyst is the challenge; especially since we see upside to 1H14 estimates.  TWTR’s 4Q13 results have rebased expectations for the Reach and Engagement operating metrics, so we expect revenue growth will become the more important driver for the stock near-term.

 

 

SUMMARY CHARTS

 

User Growth: Significant Slowdown in US User growth.  We suspect TWTR's US penetration is much higher than its MAU metrics suggest given that some users have joined and are no longer inactive.  Runway is shorter than many expect.

 

TWTR: Staying Short, But... - TWTR   MAU Growth 4Q13

TWTR: Staying Short, But... - TWTR   US penetration scenario 4Q13

 

Engagement: Decelerated Considerably, which management suggest is partly due to Twitter interface improvements, but we believe users migrating to TweetDeck is also to blame.  We suspect this could a secular theme, which would pressure ARPU.

 

TWTR: Staying Short, But... - TWTR    Timeline Views 4Q13

TWTR: Staying Short, But... - Google Trend   Tweetdeck

 

Monetization: the Mobile Migration may have more immediate upside than we originally thought, although we suspect some of the 4Q13 acceleration is due the holiday shopping season.  

 

TWTR: Staying Short, But... - TWTR   ARPU 4Q13

 

Hedgeye vs. Consensus: We see upside in the near term to consensus estimates, but we expect ARPU growth to slow beginning 2H14 as the mobile tailwind begins to subside.  With mobile now representing over 75% of all ad revenue, the comp setup switches from mobile representing the minority to the majority of revenue moving forward.    

 

TWTR: Staying Short, But... - TWTR   Hedgey vs. Consensus 1Q14 4Q15

 

Valuation: This is just for perspective.  TWTR trades at a much higher multiple than its peers, but that can be explained by the lofty growth estimates assumed by consensus.  As soon as the street realizes that company can’t grow +50% in perpetuity, the stock will should trade more inline with its peers. 

 

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Let us know if you have any questions, or would like to discuss in more detail.

 

 

Hesham Shaaban, CFA

@HedgeyeHC2


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