“A good rule of thumb is that if you’ve made it to thirty-five and your job still requires you to wear a name tag, you’ve made a serious vocational error.”
As many of you may have noticed, our research team has been busy so far this quarter adding new names to our Best Ideas list. In fact, later today we will be doing a conference outlining our short case on Yelp (ticker also YELP). No surprise, at more than 10x market cap / revenue the short call on YELP has garnered some interest because clearly if we are correct, there is valuation downside.
Tomorrow we will be going over our short case on Annie’s (ticker BNNY) and this one has also garnered a lot of interest. In fact, one prospect responded to our marketing email suggesting it was somewhat irrational to short a stock with 20% short interest. In part, he’s right as there is increased risk of a short squeeze, but more broadly his email begs the question: is it an appropriate rule of thumb to not short highly shorted stocks?
Interestingly, based on the market factors we track, highly shorted stocks definitely do not consistently outperform lower shorted ones. In fact, over the last six months, the lowest quartile of short interest stocks are up 14.4% and highest quartile of short interest stocks are only up 12.5%. Now to be fair, over other time frames, high short interest stocks have outperformed, although rarely meaningfully so.
There are also a number of studies highlighting that over time highly shorted stocks underperform. Specifically, a paper from a group of MIT professors titled, “Short interest, institutional ownership, and stock returns”, concludes:
“Stocks are short-sale constrained when there is a strong demand to sell short and limited supply of shares to borrow. Using data on both short interest (a proxy for demand) and institutional ownership (a proxy for supply) we find that constrained stocks underperform during the period 1988 – 2002 by significant 215 basis points per month on an equally weighted basis . . .”
So, the moral of the story is that you shouldn’t let “tough to short stocks” get in the way of a good short idea.
Back to the Global Macro Grind . . .
Yesterday, we held our quarterly themes call and touched upon our three key macro themes heading into Q2. These themes are #ConsumerSlowing, #HousingSlowdown, and #StructuralInflation. Rather than give you my complete rehash (you can actually listen to the replay here), I wanted to highlight a key slide and point from each section.
Clearly, with consumer discretionary stocks relatively underperforming in the year-to-date (-5% on the YTD versus utilities +9%), the #ConsumerSlowing is not new news. In this presentation, though, we truly tried to quantify the impact of commodity inflation on the median consumer by rebuilding their income statement. As it turns out, the average American consumer spends more than 20% of after tax income on food and utilities. When gas and motor oil are added to the mix, the combined total of direct commodity exposure of after tax expenditures is closer to 27%.
The average consumer also primarily generates 95% of his or her income from wages, self employment, and/or government income. In aggregate, less than 1.5% is currently sourced from interest and dividends. So, perversely, as interest rates are kept low, it constrains the average consumer from earning more income and also leads to dollar devaluation. This dollar devaluation then inflates commodity prices and squeezes the consumer from the cost side.
The second key theme of #Structuralnflation gets away slightly from the concept of commodity inflation via dollar debauchery and looks at the potential for a labor market that tightens quickly. A key reason this may happen is because businesses have been consistently under investing in both capital expenditures and employees.
The Chart of the Day compares the year-over-year change of capital investment by businesses, compensation of employees, and corporate profits after taxes going back to 1983, so more than thirty years. As this chart shows, over time investment in infrastructure and employees largely maps with corporate profits. The exception of this is the last five years in which corporate profit growth has CAGRed at near 20%, while capital expenditures have CAGRed at +1.3% and employee compensation at +0.9%. The point being if hiring reverts to the mean it will likely be good for economic growth, but also accelerate inflation meaningfully.
The last theme for Q2 is #HousingSlowdown. This is obviously a reversal of our view for most of 2012/2013 where we were calling for acceleration in home prices. That parabolic move off the bottom is now decidedly in the rear view mirror based on our models. The most compelling support for a decline in housing demand and commensurately home prices is mortgage applications.
From the peak in April of 2013, purchase applications are down by -20%.
Further, the combination of both purchase applications and re-fi is now trending at a growth rate of -55% versus the same month a year ago. A key culprit behind this dramatic decline is the new Qualified Mortgage (QM) rules that were implemented as of January 10th.
While on one hand, more stringent underwriting rules will prevent excesses from developing, the new QM rules are also basically taking new and young home buyers out of the market. So be forewarned, the #HousingSlowdown is no illusion!
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.64-2.75%
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
This note was originally published at 8am on March 26, 2014 for Hedgeye subscribers.
“I wonder how much it would take to buy a soap bubble, if there were only one in the world.”
Imagine that – if there were only one bubble, tulip, or social media stock left in the world – what on earth would we pay for it? Someone at Morgan Stanley can surely answer that with a comp table.
I have to give it to the folks @Facebook. They’re nailing it on “scarcity value.” I didn’t know that either of their last two acquisitions existed. After spending $21 billion on WhatsApp and Oculus, FB’s stock has broken my mo-bro line of $67.52 support too.
Imagine there was only one bro left in the marketplace? How much would he pay for the all-time-bubble-high in the last social media stock that stops going up? It’s all fun and games until someone gets popped.
Back to the Global Macro Grind…
Never mind trying to figure out what Oculus is (an “immersive virtual reality company”) or that it was “valued” at $30M in June. These guys just got $400M large (in cash) and another $1.6B in Facebook’s (FB) bubbled up stock. #cool
Until it’s not…
In FB inflated currency terms, Oculus is “cheap” though. Ask the bankers. When you slap it on a sheet of paper next to Candy Crush (coming public today with at least a $7B valuation), it’s probably relatively “cheap” too.
I know. Fourteen years ago (Q2 of 2000), while I was leaving the big bubble house that Frank Quatrone built (Credit Suisse First Boston), calling a bubble what it was back then was subject to some really smart “it’s different this time” analysis.
But it wasn’t. This time won’t be different either.
Moving along, why don’t they just jam the US stock market right back to the all-time-bubble closing highs (SPX 1878) again in the next few trading days?
- It’s quarter-end…
- There’s no-volume out there anyway,
- And squeezing hedgies who keep shorting low and buying high is easy to do
On that last point, at least from a Style Factoring perspective, being long High Short Interest stocks is back!
Now tracking +2.8% YTD, that beats being long either Low Short Interest (as a style factor in the SP500) which is only +0.8% or, god forbid, the Dow (which is still down -1.2% YTD).
Alternatively, you can triple bypass the stress associated with buying the high short-interest bubble and:
- Buy #InflationAccelerating
- Buy #GrowthSlowing
- Short the US Consumer
How do you buy #InflationAccelerating?
- CRB Food Index +18.1% YTD
- Gold +9.5% YTD
- CRB Commodities Index +7.5% YTD
What about #GrowthSlowing?
- Utilities (XLU) +7.4% YTD
- REITS (MSCI Index) +8.1% YTD
- Bonds (yep, long-term Treasury Yields are down 30 bps YTD)
Oh, and the Short US Consumer Discretionary (XLY) position acts fantastic with the sub-sector -3.3% YTD. That’s horrendous on both an absolute and a relative basis. If you’re into that sort of thing…
You might be into buying former bubbles that blew up too. After all, isn’t that what being long of Gold and as many homes as you can get your hands on from A&E’s house flippers is all about?
Or is the show called Flip This House? Who cares what these $2, $7, or $19 billion dollar companies or shows are called. Fully loaded, listening to #OldWall bankers and mortgage brokers pitch us on why it all makes sense is just getting fun to watch.
Our immediate-term Macro Risk Ranges are now:
UST 10yr Yield 2.62-2.81%
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Daily Trading Ranges
20 Proprietary Risk Ranges
Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.
TODAY’S S&P 500 SET-UP – April 9, 2014
As we look at today's setup for the S&P 500, the range is 37 points or 1.19% downside to 1830 and 0.81% upside to 1867.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 2.29 from 2.29
- VIX closed at 14.89 1 day percent change of -4.37%
MACRO DATA POINTS (Bloomberg Estimates)
- 7am: MBA Mortgage Applications, April 4 (prior -1.2%)
- 10am: Wholesale Inventories, Feb, est 0.5% (pr 0.6%, rev 0.7%)
- Wholesale Sales m/m, Feb., est. 1% (pr -1.9%, rev -1.8%)
- 10:30am: DOE Energy Inventories
- 2pm: Fed issues March 18-19 FOMC minutes
- 3:30pm: Fed’s Evans speaks in Washington
- 7:30pm: Fed’s Tarullo speaks in Washington
- President Obama speaks at Fort Hood memorial service, then attends DCCC, DSCC fundraisers in Houston
- House Financial Services Cmte panel holds hearing on capital formation for growth cos, 10am
- Senate Judiciary Cmte hears from Comcast exec. VP David Cohen on proposed $45b purchase of Time Warner Cable, 10am
- House Armed Services Cmte holds hearing on natl defense priorities, 10am
- House Ways and Means trade subcmte holds hearing on trade implications of U.S energy policy, LNG exports; 1:15pm
- Budget (Senate Appropriations):
- EPA Administrator Gina McCarthy testifies, 9:15am
- Labor Sec. Thomas Perez, 10am
- Clinton says no imminent decision on presidential run
WHAT TO WATCH:
- Toyota recalls more than 6m vehicles globally
- Alcoa sees almost decade-long aluminum surplus ending on cuts
- La Quinta raises $650m pricing IPO below marketed range
- GM fined by U.S. safety agency for incomplete recall answers
- Comcast to pitch its Time Warner deal as boost to innovation
- Tougher leverage limits for U.S. banks approved by regulators
- Tesla plans to find more financing for new Model S leasing unit
- Weather Channel returns with less reality after DirecTV blackout
- SAC Capital judge seeks profit info before approving plea
- Greece said to plan opening book for 5-yr note sale tomorrow
- Goldman Sachs considers closing Sigma X dark pool, WSJ reports
- Goldman, Warburg in next round for Huarong stake: Reuters
- Zayo explores IPO that values co. at $7b: Reuters
- Detroit said near deal with some bond insurers: WSJ
- Microsoft issues final security update for XP: Reuters
- AngioDynamics (ANGO) 4:01 pm, $0.09
- Apogee Enterprises (APOG) 4:30 pm, $0.29
- Bed Bath & Beyond (BBBY) 4:15 pm, $1.60 - Preview
- Cogeco Cable (CCA CN) Aft-Mkt, C$1.11 - Preview
- Constellation Brands (STZ) 7:30 am, $0.76 - Preview
- Dollarama (DOL CN) 7:30 am, C$1.10
- MSC Industrial (MSM) 7:30 am, $0.85
- PriceSmart (PSMT) 4:10 pm, $0.87
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- WTI Retreats From Month-High as Crude Supplies Gain; Brent Slips
- World’s $8.9 Billion Banana Trade Threatened by Deadly Fungus
- Texas Cotton Desert Boosts Cost for Clothing Makers: Commodities
- Gold Trades Near Two-Week High as Investors Await Fed Minutes
- Raw Sugar Rises as Brazil Seen Delaying Sales; Coffee Declines
- Soybeans Climb to 10-Month High as U.S. Reserves Seen Declining
- Grandfather’s Utility Threatened by Renewable Islands of Profits
- Codelco Sees Copper Glut Imperiled by Project Lags: Commodities
- OPEC Plans to Make Room for Extra Oil From Iran, Iraq, Libya
- MORE: Iraq to Soon Reach Oil-Export Deal With Kurds, Luaibi Says
- Copper Falls Amid Concern About Potential China Debt Defaults
- Morgan Stanley Raises 2014 Brent Crude Forecast to $105/Barrel
- Aluminum Surplus Seen Ending by Alcoa as Producers Pare Supplies
- Renewables Replace Declining Nuclear, Coal in Northwest Europe
The Hedgeye Macro Team
Quick Update Note...
After the close, Permian Basin pure-play E&P Athlon Energy (ATHL) announced a significant asset acquisition in the Permian, and it looks to be the best comp transaction to the assets that LINN Energy (LINE, LNCO) is trying to swap/sell to date.
- 5 privately-negotiated transactions
- Combined cash purchase price: $873MM
- 23,500 net acres in Martin, Upton, Glasscock, and Andrews County (Hz. Wolfcamp play)
- 4,800 boe/d of current production, 67% oil
- 1P reserves: 31 MMboe; PD reserves: 12.1 MMboe (39%)
- 100% operated, 97% WI, 73% NRI
As far as we can tell, none of the acreage was acquired from LINN, though much of the acquired acreage looks very proximate to LINN and legacy ATHL’s positions (maps below). That’s somewhat strange to us – LINN is actively marketing acreage in ATHL’s backyard, but ATHL acquires acreage from 5 other private parties instead… One would’ve thought that ATHL would be in the running for some or all of LINN’s acreage. Maybe ATHL has an appetite for more acreage, maybe not... Or maybe LINN’s price was too high... ATHL hosts a conference call tomorrow AM to discuss the transaction, perhaps we get more color then.
At $75,000/boe/d or $30/proved developed boe (reasonable metrics for the production/PDPs), the acreage goes for ~$21,800/net acre.
Putting LINN’s entire Permian package on these same metrics values the production (17,000 boe/d) at $1.3B, the acreage (55,000 net acres) at $1.3B, and $2.6B in total.
We think those numbers are in-line with the whispers out there - the rumor we heard today is that LINN management thinks they can sell/swap the entire package for $2B - $4B. Still, this ATHL deal will likely be bullish for LINE/LNCO in the immediate term, as this deal gives some credence to the bull case, flawed as it may be.
ATHL Permian Acreage:
Source: ATHL Presentation
LINN Permian Acreage:
Source: LINN Presentation
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Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.