“Quiet is no certain pledge of permanence and safety.”
-James A. Garfield
From the innovation that flowed from the US Centennial Exhibition Fair in Philadelphia in 1876 to the uncertainty associated with the Republican Convention in Chicago in 1880, Destiny of The Republic (by Candice Millard) ranks at the top of my #history reading list YTD.
Garfield may be one of the lesser known US Presidents, but the prescience and leadership embedded in some of his quotes are quintessentially free-market American. #timeless
He embraced uncertainty; he encouraged winning and losing. He didn’t prey on the ignorance of The People; he encouraged its education. He was as progressive as any President before him. He was nothing like the politicians you have to endure today.
Back to the Global Macro Grind…
Today you have to deal with a US government (both Republicans and Democrats) that is either lying to you about real-world economics (inflation) or isn’t market-literate enough to be able to tell you the truth if it tried. I’m not sure what’s worse.
However, I am sure that whatever is left of free-markets will front-run the government’s proactively predictable behavior. While they may not be acknowledged in D.C., Burning The Buck and never calling a devalued currency inflationary are core market beliefs.
For a few days last week (actually for a day and a half), the market suspended this belief and:
- Bought US Dollars
- Sold Gold
- Sold Bonds
That’s what you should have done for literally all of Q1 of 2013 though. It’s Q1 of 2014, and the 2013 @Hedgeye TREND is over.
On Friday, everything reverted to the mean (towards the 3 month TREND):
- Dollar made another lower-YTD-high and went back down
- Gold made another higher-YTD-low and went back up
- Bonds had another great day, after v-bottoming from their Wednesday #RatesRising headfake
All the while, with the Dow Jones Industrials Index banging its head against the #OldWall to try to get itself to “up” for 2014 YTD (it’s -1.7%), food #InflationAccelerating continued with the CRB Foodstuffs Index up another +1.8% to +18.1% YTD.
Sure, oil remained under pressure (Brent Oil -1.2% last week) and that remains a bearish TREND signal @Hedgeye this morning (don’t be long oil with +406,967 net long futures/options contracts outstanding!), but that didn’t offset more of the same in terms of what components of the US equity market are delivering you the absolute return bacon YTD.
Mmm, #bacon (lean hog prices +31% YTD)…
From a sub-sector perspective in the SP500 YTD, this is what I mean by that:
- US Consumer Discretionary Stocks (XLY) -0.3% last wk (with the SP500 +1.4%) to -1.7% YTD
- Slow-growth-yield-chasing Utilities (XLU) +0.1% last wk to +6.7% YTD
In other words, whether your government calls it inflation or not, inflation slows real-consumption growth in America. So don’t get frustrated by it – just own it. #InflationAccelerating is a position that at least 10-20% of Americans can profit from.
No, that’s not a US political leadership message. It’s the winning market message – and, sadly, that is a losing one for at least 80% of America. The quiet and safety of the world buying US Dollars last year is ending. The 1-year average net long position in the USD (CFTC futures and options contracts) is +16,540 contracts, but:
- 3 months ago, the net long position went to flat
- 2 weeks ago, it moved to modestly net short
- Last week it dropped to a 1yr low of -12,167 net short
Yep, as Hemingway would say, at first the risk of your currency losing credibility happens slowly, then it happens all at once. The pledge of permanence of a #StrongCurrency advocated by Presidents like Garfield may be as worn out as (pre-1913 Fed Act days) free-market capitalism itself.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.62-2.82%
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
TODAY’S S&P 500 SET-UP – March 24, 2014
As we look at today's setup for the S&P 500, the range is 27 points or 0.83% downside to 1851 and 0.62% upside to 1878.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 2.31 from 2.32
- VIX closed at 15 1 day percent change of 3.31%
MACRO DATA POINTS (Bloomberg Estimates):
- 8:30am: Chicago Fed Natl Activity, Feb., est. 0.10 (pr. -0.39)
- 9am: Fed’s Stein speaks in Washington
- 9:45am: Markit U.S. PMI Prelim., March, est. 56.5 (prior 57.1)
- President Obama attends Nuclear Security Summit in The Hague, meets with G-7 leaders to discuss Ukraine
- Senate meets to consider S.2124, its Ukraine aid bill, at 2pm, votes expected 5:30pm
- 9:30am: Supreme Court lists cases it plans to consider
- U.S. ELECTION WRAP: Chemical Group Is Third-Biggest in 2014 Ads
WHAT TO WATCH:
- Advent, Bain to buy Nordic payment firm Nets for $3.1b
- Apple said in talks with Comcast on streaming-TV service: WSJ
- Nokia says completion of Microsoft deal is delayed until April
- China manufacturing gauge unexpectedly falls in March
- Chinese jet spots objects in search area as weather worsens
- JPMorgan’s China investment banking CEO Fang Fang to leave
- CFTC issues warning of possible legal action in swaps probe: FT
- U.S., EU free trade deal to limit investor protection: FAZ
- Euro-area March PMI falls to 53.2 vs 53.3, matches est.
- Obama in Europe, Stress Tests, Microsoft: Wk Ahead March 22-29
- Sonic (SONC) 4:01pm, $0.06
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Gold Declines on Fed as Palladium Reaches Highest Since 2011
- Korea Seeks Cut of $3 Billion Illegal Gold Trade With New Market
- Hedge Funds Defy Goldman as Gold Bears Thank Yellen: Commodities
- China to Restart Copper Recycling Tax Rebate, Metals Group Says
- Copper Drops in London as China’s Slowdown Seen Curbing Demand
- Brent Oil Slips for First Time in Three Days on China; WTI Holds
- Silver Vault for 600 Tons Starting in Singapore as Demand Climbs
- Rubber Drops to 2-Week Low as China’s Slowdown May Weaken Demand
- Corn Climbs as Demand Growing for U.S. Supplies; Soybeans Drop
- Japan’s Copper-Alloy Demand Seen Little Changed as Tax Increases
- Houston Channel Closed to Contain 4,000-Barrel Oil Spill
- Ukraine Billionaire Sought by U.S. Has Key to Putin Gas Cash
- Indonesia Commando Turns Rancher in Would-Be Path to Leader
- Tin at $24,000 Is Seen as ‘Ideal Level’ for Indonesia’s ICDX
The Hedgeye Macro Team
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Takeaway: *Reminder - We will be hosting a call titled LULU: Our Thesis vs. Consumer Opinion - Round 2 today at 11:00 am ET
We will be releasing our new BLACKBOOK and hosting a call detailing our latest work on Lululemon (LULU) today at 11:00am ET.
We turned bearish on LULU in the Fall and conducted a consumer survey on key issues impacting demand in December. The results flashed major warning signals. So we pressed our short the week before the company preannounced and guided down.
We are currently re-running our survey to reassess the health of the brand from the consumers' vantage point. We will be asking many of the same questions that we did a quarter ago, which will allow us to look at the incremental change over the past few months. Rate of change matters to us more than anything with this name. The company is set to report earnings three days later on Thursday March 27th.
We'll explore in detail the following topics:
- Does LULU need to begin a more aggressive discounting strategy?
- New brands are encroaching on LULU's turf, is that rate slowing or accelerating?
- What is LULU's perceived price/value equation relative to other brandsand how is that changing?
- Growth in points of distribution for Yoga product - a key competitive threat for LULU.
- Insight into our store overlap analysis between Athleta and Lululemon
- UnderArmour scored so close to Nike in our last survey - which was a big surprise. Nike has been fighting back. Is it working?
- Is the 'I hate LULU Management!' factor (present in 58% of people responding last time) - still as severe? Any improvement?
- Toll Free Number:
- Direct Dial Number:
- Conference Code: 154675#
- Materials: CLICK HERE
Takeaway: We became incrementally more bearish on growth at the beginning of 1Q alongside the breakdown in the USD & 10Y Yields and the VIX breakout.
Editor's note: This research note was originally published March 20, 2014 at 11:24 in Macro. For more information on how you can subscribe to Hedgeye click here.
"If I see an ending, I can work backwards."
- Arthur Miller
Hedgeye CEO Keith McCullough outlined the thought process behind our view of yesterday’s Fed announcement and the how/why of our subsequent positioning in this morning’s strategy note (Early Look: Fade The Fed's Forecast).
Below we summarily recapitulate that thought process in the context of both our research and risk management views.
1Q14 Macro View Redux: We became incrementally more bearish on growth at the beginning of 1Q alongside the breakdown in the $USD and 10Y Yields and the breakout in the VIX.
From a positioning perspective, we increased our cash allocation and shifted away from pro-growth consumer leverage towards slower-growth (bonds, gold, slower growth equities, inflation hedge commodities) exposure.
The subsequent and significant deceleration in the preponderance of fundamental macro data served to confirm the price signals.
Recall, we love the pro-growth, factor constellation of #StrongDollar + #RatesRising that characterized most of 2013,
A return to the Dollar Up/Rates Up/Stocks Up regime, confirmed by both the price and research signals, would certainly shift our intermediate term growth outlook upward but the data doesn't support that shift in view here (yet).
THE RISK MANAGEMENT: Inclusive of yesterday’s price action, the $USD and 10Y Yields remain broken Trend while the VIX and Gold remain bullish on a Trend basis.
In the context of our view of the Risk Management Signal as a leading indicator of fundamentals, from a quantitative perspective, we’d need to see the following occur for us to get back behind the growth trade
- US Dollar Index breaks out > $81.14 TREND resistance
- US 10yr Yield breaks out > 2.81% TREND resistance
- Gold snaps $1278 TREND support
THE FUNDAMENTAL: The fundamental data decelerated materially in 1Q14. We saw some multi-decade/record sequential drops in various ISM sub-indices (for example) and while the weather did have some impact, we’d argue the slope of growth was negative vs 2H13 levels even if you discount for the weather distortion.
Indeed, it’s likely we get a post-weather distortion bounce in the reported data over the next couple months – the question, however, will be whether we can recover to a positive slope of growth from a trend perspective.
Growth math, after all, is geometric – you have to go up more than you went down on a percentage basis to get back to breakeven.
In the context of the summary table below, we expect the “latest data” column to improve from the homogenous sea of “Worse” that existed in February to a more heterogenous mix of “Better”/”Worse” as we comp exaggerated Jan/Feb declines.
From a fundamental perspective, we’ll be looking for the TREND data (3M/6M/TTM Ave) to reflect a re-acceleration.
THE COMPS: In short, the comp setup gets progressively tougher for two more quarters as Growth Comps get increasingly difficult while inflation comps ease into 3Q14.
At the least, progressively harder top line comparisons alongside increasingly harder margin comparisons is a comp dynamic to be wary of on the long side – particularly when both the quant and fundamental data aren’t yet confirming the pro-growth call.
THE PLAN IS THE PLAN WILL CHANGE: The above highlights the summary output of our integrated research-risk management process post the hawkish lean out of Yellen et al.
The process isn’t perfect, but it’s dynamic, quantified and repeatable and its happened to work a good deal more than not over the last 6 years.
Of course, the process also dictates we change our view/positioning alongside the collective change in the price signals and fundamental data. The above outlines the primary metrics and levels we’ll be using to manage our exposure from here.
Fascinating and frustrating, but definitely not boring.
Current Positioning: 15 Longs, 5 Shorts
Christian B. Drake
Takeaway: Current Investing Ideas: CCL, DRI, FXB, HCA, LO, OC, RH, TROW and ZQK
Below are Hedgeye analysts' latest updates on our NINE current high-conviction investing ideas and CEO Keith McCullough's updated levels for each.
We also feature three research notes from earlier this week which offer valuable insight into the market and economy.
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
HEDGEYE CARTOON OF THE WEEK
CCL – Carnival traded up 4.1% this week vs. +1.4% for the S&P 500 Index. Optimism regarding improving European economies and stronger European consumer spending helped cruise sentiment. Our March 2014 cruise line pricing survey indicated the Carnival brand showed the greatest positive pricing momentum in sequential pricing among the big 3 cruise line operators in March 2014.
Europe’s biggest cruise event, the London Cruise Show is March 22-23 and we look forward to commentary from London, last week’s Miami convention and Wave season bookings on Tuesday, March 25th – when CCL reports fiscal 1Q14 earnings. The Ukraine/Russia conflict is of some concern because of Baltic Sea exposure. While the Baltic Sea itineraries account for <10% of Carnival’s European itineraries, it will still sting if CCL is forced to cancel/reroute some of the itineraries.
Bottom line? Keep calm, Carnival will carry on.
DRI – Earlier this week, Darden urged shareholders to reject Starboard’s proposed special meeting, calling the event unnecessary and expensive. Starboard followed up the next day by releasing a definitive solicitation statement calling for a special meeting and containing an important message to shareholders.
In this letter to shareholders, Starboard highlights their concerns with the proposed separation and Darden’s current management team. Starboard cited Hedgeye research several times throughout the letter, which can be accessed here.
We encourage you to read it for additional insight.
FXB – We remain 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 Mark Carney at the BOE (oriented towards hiking rather than cutting as conditions improve), and strong underlying economic fundamentals.
In follow-up BOE minutes, the asset purchase program was held flat by a vote of 9-0 and the interest rate was held unchanged by a vote of 9-0.
This week the UK’s Office for Budget Responsibility updated its forecasts and sees 2014 GDP at +2.7% versus forecasts of +1.8% a year ago and +2.4% in December. It also increased the 2015 growth forecast to +2.3% from +2.2% previously. The OBR sees budget deficit at -6.6% of GDP in 2013-14 from -6.8% previously forecast, and sees debt peaking at 78.7% of GDP in 2015-16, and falling to 74.2% of GDP in 2018-2019.
News out this week discussed Chancellor Osborne closing in on a deal that would see the City of London become an offshore center for trading the Chinese currency.
The British Pound is holding its Bullish Formation, trading above its intermediate term TREND and long term TAIL levels of support.
HCA – Shares of HCA Holdings have risen over 24% compared to a 14% return on the S&P 500 since being added back in June.
Importantly, Healthcare Sector Head Tom Tobin noted in a research piece this week that that there may be as many as 300,000 patients who have deferred having a total knee replacement (TKR) over the last few years through the end of 2013. If these deferred cases returned in a single year, it would represent roughly +44% of incremental case volume.
Ortho is the largest revenue driver for hospitals at 17% nationally.The implication of a recovery in orthopedic case volume is a significant tailwind for hospitals and HCA.
LO – We expect Lorillard’s price to be supported by recent news that NJOY (a private e-cig maker) received a capital injection of $70MM and an enterprise valuation of $1B – a signal of confidence in the broader e-cig category. We expect blu to lead market share despite increased domestic competition with RAI and MO bringing to market their own e-cig offerings.
OC – With recent residential construction names such as Lennar beating recent analyst expectations, despite the weather, benefits Owens Corning, which is considered an upstream name to the residential construction companies. We like OC due to its exposure to both residential ~56% and commercial construction ~22%. So looking at the big picture, construction for both nonresidential and residential is just getting under way – needing to double to just reach the 1 average. OC was added to Investing Ideas last week.
RH – Restoration Hardware should report earnings after the close on Thursday March 27th. Generally speaking, we’re expecting a good quarter. Just a few weeks ago, consensus was scared into thinking that we would see a meaningful revenue and gross margin miss – or about $0.62-$0.65 per share based on our math. While those fears have abated to a degree, we still think that the company will come in ahead of expectations by way of a same store sales comp in the 20-25% range with improved inventory position and slightly positive gross margin.
When all is said and done, we’re expecting EPS in the low-mid 80 cent range.
Importantly, the RH finally has some things to get people excited about in the next 12 months. Keep in mind that it has gone a year without opening a new store. But by May it will have two new major design galleries – one in Greenwich, Connecticut and the other in the FlatIron district of NYC.
In the Fall, there’s another in Atlanta followed by Los Angeles to close out the year.
Most importantly, there’s a completely redesigned floorset which hits this spring – again, something RH has not had in a while. Along with that will be a major sourcebook, which RH has not had in the better part of a year. Could there be things to poke holes at this quarter? Yes, there always are – with every company. But there’s a lot of positive change coming down the pike this year for RH.
TROW – T Rowe Price (TROW) had another good month of net client inflow according to Strategic Insight (SI), a private mutual fund survey released this week that estimates fund flow at the manager specific level (versus our weekly ICI exercise which looks at general fund flow from a top down industry standpoint). According to SI, TROW pulled in another $2 billion in February, a follow through on the $3 billion the firm netted in January, the first month of 2014.
To scale these new wins, TROW was averaging just $1 billion per month in October, November, and December to finish out 2013, so the pace of money being added to the manager has quickened into ’14. This production is assisted by the continued outperformance of TROW funds, with an industry leading 62% of TROW funds rated 4 or 5 stars by Morningstar versus 40% at Janus and 20% at Waddell and Reed for example.
We continue to expect a very strong first quarter earnings report from TROW (much better than the rest of the asset management group) and for shares to react favorably.
ZQK – The key to Quiksilver is in top line growth -- but where will the growth come from? We get this question often, as the common perception out there is that the three brands are mature and therefore cannot grow. We look at the following.
1) Geography: This business has historically been managed as three major geographies. That might have worked when it was a $300mm company, but not as a company clocking in $2bn revenue. Look at other successful global consumer non-durables…they all have a country President, who ultimately reports into both the head of Global Sales and have a dotted line to Marketing and Product. Two brands that come to mind; Ralph Lauren and Nike. We mention Ralph Lauren in that they had a ‘President of International’ and after only 2 years, they cut him loose. The structure does not work. They’re moving to the model that’s worked so successfully for Nike (hint: CEO Mooney is from Nike). UnderArmour still has an antiquated ‘Head of International’ structure. It’s sales outside the US have perennially been below 6% of total. #fail. We think that ZQK has built a winning formula.
2) Emerging Markets: According to the 10K, 81% of ZQK’s sales come from developed markets. So naturally, 19% of sales come from Emerging Markets. Anybody want to guess how many countries comprise that 81%? 10? 20? 30? How about 82. That’s an average of $4.5mm in sales annually to each of those countries. That’s embarrassing, and Mooney will be the first to admit it. Obviously, there’s some kind of bell curve at work, and some of the countries are $40mm and others are $1mm. That’s no less of an opportunity. If anything it’s more.
3) China: China is Not an Emerging Market, Right? Ok…one of those countries in the ’82 Developing markets’ is China. Yes, that country with 4.5x the population of the US. The per capita spend on ZQK product in China (the very place where most of it is manufactured)? About $0.29 per capita. If we use a level mid-way between where it is and where the US is (about $4.00), then we’re looking at nearly a $300mm business in China, or a $260mm revenue opportunity. Our sense is that Mooney would say that the opportunity is greater than that.
4) Footwear: This is the single greatest opportunity at ZQK. Mooney highlighted in the last conference call that there are 120mm pairs of vulcanized shoes sold in the US alone – and DC Shoes accounts for only 4mm of them. Our survey work shows that brand awareness of DC is pushing 90% -- and yet that translates to only 3% market share? That’s just not right. The brand’s current problem is that the price points are too high, and the product is simply off. Not a good mix. The new Footwear Head (from Nike) is fixing this, and fixing it fast. We expect the order book to start to kick up around the April/May timeframe, which should benefit 2H revenue.
5) But It’s Not Just DC: Quiksilver and Roxy are simply not playing in the footwear market right now. It has the distribution, it has the brand. But it simply lacks the product. We’re not saying that the product is there, but simply is not right. No…the product just is non-existent. Again, expect to see a change in 2H.
6) Yoga: Not as big of a revenue driver, but this market is on fire, and there’s no reason Roxy should be absent. You can find Roxy yoga mats and other low-margin accessories out there, but not authentic Yoga gear. Our recent survey work says consumers are willing to give it a shot. Watch out for an update to our recent Yoga Survey/Black book in a couple weeks. When all is said and done, we think that this is about a $50mm opportunity.
7) Company retail: Check out the company’s Boardrider’s stores. They’re redefining retail in this space. The stores are multi-brand, and have nearly every amenity to draw every relevant consumer in (some stores have bars). First in Europe, but it is a concept that is on its way to the US. Granted – a single concept has to reach considerable unit scale before impacting the top line. But this is both a slow build to the top line while (more importantly) building brand image.
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Hedgeye CEO Keith McCullough outlined the thought process behind our view of this week's Fed announcement and the how/why of our subsequent positioning in a morning strategy note earlier this week (see "Morning Newsletter" Fade The Fed's Forecast). In the following note, we summarize that thought process in the context of both our research and risk management views.
Food prices have surged in 2014, with the CRB Foodstuffs Index up +16.5% YTD and +4.8% YoY (as of 3/20). While rapid advances in coffee, beef, cheese and milk have largely fueled the overall basket, all of the commodities we track are in the green YTD.
We don’t have any major changes to our thesis in the wake of Nike’s 3Q14 print – we don’t think it’s an outright short, but we simply can’t get comfortable with the risk/reward here.
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