TODAY’S S&P 500 SET-UP – April 11, 2014
As we look at today's setup for the S&P 500, the range is 32 points or 0.33% downside to 1827 and 1.41% upside to 1859.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 2.73 from 2.30
- VIX closed at 15.89 1 day percent change of 14.98%
MACRO DATA POINTS (Bloomberg Estimates):
- 8:30am: PPI Final Demand m/m, March, est. 0.1% (prior -0.1%)
- PPI Ex Food and Energy m/m, March, est. 0.2% (prior -0.2%)
- PPI Final Demand y/y, March, est. 1.1% (prior 0.9%)
- PPI Ex Food and Energy y/y, March, est. 1.1% (prior 1.1%)
- 9:55am: UofMich. Confidence, April preliminary, est. 81 (prior 80)
- 1pm: Baker Hughes rig count
- President Obama addresses National Action Network in New York
- 8:30am: World Bank, IMF hold annual Spring Meetings
- 11:30am: Senate Env. Chairwoman Barbara Boxer, D-Calif., Sen. Sheldon Whitehouse, D-R.I. hold Keystone XL pipeline media call
- U.S. ELECTION WRAP: Poll Shows Obamacare Motivates GOP Voters
WHAT TO WATCH:
- Coldwater Creek files bankruptcy after clothing sales decline
- Sebelius resignation may give successor more room on Obamacare
- H&R Block shrs jump as tax preparer agrees to sell bank
- U.S. warns Russia of more sanctions as G-7 studies Ukraine aid
- China’s inflation stays below target as producer prices drop
- Wall Street bond trading, allocation draws scrutiny from Finra
- Samsung adds $600 of S5 freebies to fend off Apple, Xiaomi
- Citadel fund said to quadruple with high-frequency trading gains
- Gallagher priced at $43.25 in sale to fund Wesfarmers deal
- Heartbleed flaw found in Cisco, Juniper networking equipment
- Li & Fung said to work with Citigroup on brands unit spinoff
- Citi said investigated by DOJ on suspicious transactions: WSJ
- Vista Equity may seek to raise $5b for newest fund: NYT
- Fastenal Co (FAST) 6:50am, $0.38 - Preview
- JPMorgan Chase & Co (JPM) 6:58am, $1.46 - Preview
- Wells Fargo & Co (WFC) 8am, $0.96 - Preview
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Australia Braces for Strongest Storm Since 2011 in Queensland
- Nickel Favored by UBS on Supply Shocks, Macquarie Sees Deficit
- China’s Li Swaps Steel Production for Cleaner Air: Commodities
- WTI Heads for Weekly Gain as Discount to Brent Shrinks on Libya
- Gas Loses Decades-Old Link to Crude Oil in Landmark Contract
- Nickel Heads for Second Weekly Gain on Mounting Supply Concerns
- Shanghai Gold Exchange to Start Leasing Platform by End of June
- Westinghouse Says EU States’ Uranium Interest Gains on Ukraine
- Cotton Shipments From India Jumping as Harvest Climbs to Record
- Shanghai to Introduce Gold Leasing Platform in 1H, Exchange Says
- Gas Carousel Making Spain Europe’s Biggest LNG Exporter: Energy
- Soybean Traders Bullish First Time in 6 Weeks on Tight Supplies
- Platinum Favored Over Gold on Supply Shortage: Chart of the Day
- Drought Seen Hurting Thai Farm Output as El Nino Risk Climbs
The Hedgeye Macro Team
This note was originally published at 8am on March 28, 2014 for Hedgeye subscribers.
“Beware of false knowledge; it is more dangerous than ignorance.”
-George Bernard Shaw
Every effective stock market operator knows that investment analysis is at best an imperfect science. The mosaic theory is an apt description because with the absence of a silver bullet (knowing the results of a drug test before everyone else as an example), an investment analyst’s best tool is his or her ability to collect more data than his or her peers and to then use that data to reach a more informed conclusion.
Even then, in the absence of perfect information, many outcomes are flawed. In fact, many analysts are guilty of making what is called a Type 1 error, or a false positive. False positives lead analysts to conclude that a relationship exists when in fact it does not. In medicine, this might occur when a test shows a patient has a disease, when they don’t.
As Europe contemplates another round of extreme monetary policy to offset perceived deflationary pressures, it does beg the question of whether there is a relationship between a monetary policy and a tightening economy. Certainly, many supporters of former Fed Chairman Bernanke point to the fact that the economy recovered under him as evidence that his implementation of the most extreme monetary policy in the history of central banking was the reason for this recovery.
Conversely, though, the question remains whether the economy has recovered at all because of QE or even commensurately with the QE that has been implemented. As former Dallas Fed President Bob McTeer recently wrote in Forbes:
“The hoarding of excess reserves limited the money creation or “printing” that took place despite the Fed’s massive purchases of securities and expansion of its balance sheet. That’s why the dire consequences predicted never came to pass. However, it is also the reason that the Fed’s purchases never stimulated the economy as much as hoped.”
In reality if you print dollars and don’t allow them to be spent, then you are really only debauching the currency by increasing the denominator. Certainly this a policy that is good for the inflation trade, especially relating to those commodities priced in U.S. dollars
Back to the Global Macro Grind...
As Portugal’s bonds fall below the 4% yield for the first time in almost ever, one has to wonder if there isn’t a bit of a false positive emerging in the European peripheral sovereign debt markers. Currently the 10-year yields of Portugal, Italy and Spain stand at 3.99%, 3.27%, and 3.20%, respectively. Certainly these yields are still wide versus German bunds, but are these yields, on absolute basis, truly reflective of the underlying creditworthiness of those economies?
Take Spain as an example. This morning the Spanish central bank is projecting the Spanish economy will grow by 1.2%. Given that this is below par economic growth, it is likely that Spanish unemployment stays above 25%. This morning consumer prices were also reported to have fallen at an annual rate of -0.2%, which is the first decline in consumer prices in four years in Spain and indicative that consumers in Spain aren’t really spending (recent retail sales data show the same).
Clearly, on the margin, the economies in the periphery in Europe have improved, but if you are a buyer of Italian or Spanish 10-year bonds at 3.2%-ish, you need to put on the big boy analytical pants and decide if for that yield, the risk is commensurate. At a 10% dividend yield, Linn Energy ($LINE) might be a good relative bet . . . actually I take that back, we’d continue to stay the heck away from LINE and much of the MLP complex !!!
My colleague Christian Drake, our U.S. focused economic analyst, wrote a note yesterday that he titled, “INFLECTIONS OR FALSE POSITIVES? CLAIMS, CONSUMPTION & CAPEX” where he addressed some of the myriad of U.S. economic data out recently:
- #ItsNot2013: Growth estimates globally continue to get marked down. Slowing topline (GDP) and compressing margins (rising inflation) is not the stuff of market multiple expansion or macro P&L dynamics to remain lazy long of.
- RISING INEQUALITY: Corporate Profits - measured as the % of National Income or GDP - made another new high in 4Q13. The other side of that, of course, is a lower low in labor’s share of income. Latent risks can remain latent, however.
- CAPEX RESURGENCE? General acknowledgement that assets are aging and businesses have under-invested isn’t a catalyst.
- PAY-ME-NOW: Productively continues to grow at a positive spread to unit costs and investors continue to reward the ‘pay-me-now’ corporate capital strategy.
- DURABLE DISAPPOINTMENT: New Orders for Capital Goods non-Defense Ex-Air have been negative on a month-over-month basis for four of the last six months.
- INITIAL JOBLESS CLAIMS: A positive week of data…finally. The next few weeks of data should be important
His conclusion, which is highlighted in the Chart of the Day below, is that although the U.S. economic data is part positive and part negative, GDP estimates continue to fall. Ultimately the direction of GDP change is what matters.
But that all said, as you head into the weekend I would leave you with words of Mark Twain:
“All generalizations are false, including this one.”
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
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“They complain that I’m robotic, abrupt, I’m not cheerful and smiley, and you know what? That’s not my problem,”
- Arthur Chu
On the back end of a 14-hour work day yesterday, after dinner time, bath time, story time, bed time and the host of other daily, toddler parenting “times,” I swilled back some late night espresso and fired up the DVR to watch something I’ve been itching to review for a while now - Jeopardy!.
Jeopardy is still on? The White House Petition to deport Justin Bieber only got 275K signatures? ….that fat guy is the kid from The Sixth Sense?
The story is a bit stale now, but if you didn’t follow its procession last month, controversial Jeopardy contestant, Arthur Chu, emerged out of the arithmetic ether like some sort of sagely, evil game-show probabilist savant.
Using math and a game theory based playing strategy, he managed an 11-game win streak and ultimate winnings of $298K – good for 3rd all-time (Wikipedia).
Alongside terseness and less than conventional congeniality, Chu’s most noteworthy exploit was his innovative use of the “Forrest Bounce” - whereby you jump quickly from category to category – across the bottom three rows of the board in an attempt to locate the “daily doubles”.
The daily double sits as the singularly largest source of uncertainty in the early rounds of the game. If that uncertainty can be systematically eliminated, the odds of winning increase provided one’s knowledge of the other trivia is marginally better than that of the other two contestants.
Here's the clip of Chu ferreting out a daily double, dismissively betting $5, answering “I dunno” after 1 second and summarily continuing on.
Chu’s challenge of conventional contestant etiquette inspired the ire of Jeopardy ‘purists’ nationally who took to social media en masse to voice their discontent and defend the game’s storied, 3-decade tradition from the emergent nihilist.
Applied mathematical innovation challenging preconceived wisdoms and conventional orthodoxy…..sound familiar?
Fortunately, in the end, #Evolution has a sneaking ability to overcome both antiquated conventionalism and institutional (ivory tower) obstructionism.
Back to the Global Macro Grind….
When hearing economists discuss markets in terms of rational agents, benevolent dictators, and other nonsensical simplifying assumptions, the economy becomes something largely abstract and intangible.
Certainly, the dynamic, complex system that is globally interconnected macro is difficult to comprehend (let alone forecast) in full, but a coherent understanding of the drivers of significant parts of the economy over defined periods isn’t inaccessible.
Consider the largest part of the domestic economy – consumption, in the short run.
Broadly speaking, the drivers of Consumption aren’t overly complicated. In short, consumer spending growth is a function of the growth in income, the marginal propensity to consume or save that income, and the net change in household credit.
Asset appreciation and credit growth matter, but they are somewhat indirect drivers. We discuss the wealth effect further below and leave the discussion and analysis of credit for another missive.
So, what do income and savings trends tell us about the slope of consumption growth?
Together, growth in disposable income and the change in the savings rate explain most of the change in nominal consumption (PCE) growth. Indeed, over the last 30 years, the multiple regression between PCE growth vs. nominal Disposable Income growth and the change in the Savings Rate produces an R-squared of 0.99. #tight
While that ultra-strong correlation doesn’t provide much insight into how to actually go about fostering significant, sustainable real income growth, it does provide a means of reasonably nowcasting the 68% of the economy that is consumption.
For instance, under a baseline assumption that the 3 primary input variables (Disposable Income growth, the Savings Rate and PCE inflation) come in at their respective QTD averages in March, the regression model suggests year-over-year real consumption growth of 2.2% in 1Q14 – down 10bps sequentially from 4Q13, but +20bps ahead of the TTM average
Nothing revolutionary or proprietary there - just the gravity of a few numbers to which consumption growth remains inextricably hostage.
What about the Wealth Effect?
The wealth effect ‘theory’ posits that when real wealth increases, consumer spending permanently increases by some fraction of that wealth increase in every subsequent year.
Consumers, on balance, don’t immediately convert 100% of a wealth increase into current consumption. Instead, in annuity like fashion, they tend to spread that ability for increased consumption out over their lifetime.
In general, studies examining the marginal propensity to consume show that consumer spending increases between 2 and 7 cents for each dollar of wealth increase.
It makes intuitive sense that an increase in real wealth, be it from housing or financial asset appreciation, lends itself to increased consumption.
Again, when hearing analysts and pundits discuss it in the media, one is left feeling that the wealth effect occurs via some mystical monetary transubstantiation whereby higher net wealth is somehow cleanly and instantaneously transformed into higher consumption.
In reality, a number of key, very mechanical conditions must be satisfied for increased housing/financial asset wealth to translate into higher consumer spending on non-housing related goods and services
Practically, increased real wealth needs to drive a behavior shift such that households decrease savings or other investments, increase home equity/other collateralized borrowing, or downsize to a cheaper residence (liquidity event freeing up cash for spending), for that wealth increase to be effective in driving higher consumption growth.
With the value of corporate equities and the aggregate housing stock up $3.52T and 2.0T, respectively, in 2013, the case for wealth effect spending has some residual legs. However, with equities down YTD and housing in the midst of a discrete deceleration, we expect wealth effect support to consumption to continue to ebb.
While consensus continues to make the pro-growth, pro-consumption call that should have been made last year, we think the consumer slows sequentially in 1H14. We layed out ‘the why’ in our 2Q Macro themes call on Tuesday. Ping if you’d like the replay/presentation.
Like Alex Trebek’s facial hair, the forward slope of consumption growth remains the subject of ongoing conjecture and speculation. Both continue to fascinate and confound consensus onlookers on a regular basis. Understanding both will remain central to generating global macro alpha in 2014.
Be the mustache, don’t be consensus…..or something like that.
Our immediate-term Global Macro Risk Ranges are now as follows:
UST 10yr Yield 2.61-2.73%
Enjoy the weekend.
Christian B. Drake
We recently added BNNY to the Hedgeye Best Ideas list as a SHORT.
BNNY’s core business is the marketing and distribution of natural and organic food products under the Annie’s brand name. BNNY has the number one natural and organic market position in four product lines: macaroni and cheese, snack crackers, fruit snacks and graham crackers. The natural and organic segment of the food industry is the fastest and most dynamic part of the industry – and BNNY is a key player.
BNNY operates three main business segments: meals; snacks; and dressings, condiments and other. While the company has shown admirable topline growth, the growing pains of managing this growth as a publicly traded company are beginning to take their toll on the margin composition of the company.
The company has faced numerous issues since coming public in April 2012, including executive departures, product recalls and balance sheet issues (excess inventory growth, inventory write-downs, accounts receivable). In addition, a viable competitor, WhiteWave (WWAV) has emerged and is going after both BNNY’s core macaroni & cheese and cracker businesses. On top of all this, significant commodity inflation in organic wheat has recently emerged as another notable headwind facing the business.
The company has not provided guidance for FY15, but will do so when they report earnings on June 10th. We think the current EPS estimate of $1.13, or 22% growth, is very aggressive. Although estimates were revised down significantly following 3QF14 earnings, we believe they have not come down nearly enough.
Great Brand in the Right Category – As advertised, the Annie’s brand authentically honors social responsibility and environmental sustainability by selling products with clean ingredients and giving mom a healthy alternative to mainstream packaged foods.
Strong Volume Growth – The company has reported significant volume growth in its grocery and mass distribution segments since coming public, driven by deeper penetration in the main aisle of the grocery store. Additional volume growth is being driven by innovation and expansion into new categories.
Broader Popularity – A big shift for Annie’s is the pivot to selling more products in the main aisle of the grocery store. Historically, natural and organic foods were primarily only available at independent organic retailers or natural and organic retail chains. Mainstream grocery stores and mass merchandisers have expanded their natural and organic food offerings to meet the increasing consumer demand for natural and organic products, which generally command a higher margin for the retailer.
New Products – FY14 marks a year of accelerated innovation for Annie’s, as the company launched two new products. On the 4QF13 earnings call, management announced a “highly incremental” platform extension to the mac & cheese business – the entry into the single serve microwaveable cup segment. This segment represents approximately 20% of the total mac & cheese category and is growing at twice the rate of the overall category in conventional distribution channels. On the 1QF14 earnings call, management said they’d secured over 15,000 points of distribution for microwaveable cups, adding that sales so far have been incremental to the base mac & cheese business.
During the same call, management also announced BNNY’s entry into the Family Size segment of the Frozen Entrée category with the launch of four items: Lasagna with Meat Sauce, Classic Mac & Cheese, Shells & White Cheddar with Chicken and Butternut Squash Mac & Cheese. This segment is nearly a $3.5 billion category that’s dominated by large, conventional brands and lacks an established, authentic natural organic offering.
The Pivot to an Asset-Based Model – Since becoming a publicly traded company, BNNY has had a difficult time meeting earnings guidance. Clearly, managing a rapidly growing business is a challenge for management. In FY15, the company is taking on incremental operational risk by acquiring hard assets. Historically, the company utilized contract manufacturers or co-packers to manufacture the company’s entire product line. In FY13, BNNY’s four largest contract manufacturers accounted for 75% of the company’s sales.
Last week, the company announced the closing of its acquisition of the Safeway snack factory in Joplin, Missouri. We believe both the company and the street have inadequately accounted for this acquisition. In our opinion, it is prudent to assume the pivot to an asset-based model will present operational issues in FY15.
Our first concern is regarding the geographical location of the plant – Joplin, MO is a considerable distance from Berkley, CA. Second, and more importantly, BNNY is currently an asset-light business model. Given that the company uses all contract manufacturers to source its product, owning a manufacturing plant could present new, unexpected operational issues. Third, any inefficiencies stemming from the plant will be significantly dilutive to EPS in FY15. On the positive side, the plant already produces close to 100% of Annie’s product and the company has signed a three-year supply deal with Safeway to help ensure consistent demand.
Commodity Inflation – According to management, FY15 is going to be “a tale of two halves.” The inflation headwinds that pressured margins in FY14 will persist, particularly with regards to organic wheat and cheese prices. For the time being, commodity inflation is expected to moderate over the course of FY15, with overall pressure being more modest on a year-over-year basis.
Decelerating Sales Trends – Two-year sales trends are set to slow in FY15, as the company rolls over the introduction of two new product launches in FY14.
Margin Pressure – We expect increased complexity, new products and food inflation to all lead to a significant decline in gross margins. With 4QF14 yet to be reported, we estimate gross margins will be down 200 bps for the full fiscal year. While some of this can be labeled as “one time” in nature, it is likely that the company will be operating at a lower gross margin for a significant period of time. In FY14, the majority of gross margin pressure came from inflation, sales mix and inventory management. More recently, there has been material commodity inflation due in large part to a surge in organic wheat and cheese prices. We don’t expect this to ease until sometime in 2HF15.
While inflation pressures may lessen in the back half of FY15, channel issues and a sales mix shift due to new products will likely persist for the balance of the year and potentially longer. We also see “aged inventory” as a troubling sign and believe this signals weak internal controls.
Operating margins only declined 150 bps in 3QF14 due to aggressive expense management. For a growth company, this decline in SG&A is not a net positive and can be labeled as “one time” in nature as well. The company remains on a very aggressive growth curve and is transitioning its business to an asset-based model. We question how much wiggle room they have left on the SG&A line.
Balance Sheet Issues – For a company such as BNNY, which is seeing tremendous volume growth, we find it very odd that it needs to write down old inventory and has trouble converting sales into cash.
Employee Turnover – Former CFO Kelly Kennedy announced her resignation back in November 2013. Former EVP and Chief Supply Chain and People Officer Amanda Martinez tendered her resignation at the end of March 2014. We suspect Ms. Martinez may be taking the fall for the companies issues to-date in 2014. It’s an odd move, considering she was only promoted to the position a few months ago.
Increased Competition – WhiteWave, through its Horizon brand, has recently introduced a new mac & cheese business as well as a snacks & crackers business to compete directly with Annie's products. While this is not new news to the market, it continues to be an overhang on BNNY. Annie’s FY14 results thus far have not shown a significant slowdown in Mac & Cheese sales trends, but the pressure will not be going away any time soon.
Generally, the street is rather cautious on the name, with 80% of analysts rating the stock a hold and short interest comprising 23% of the float. However, with the street looking for 22% EPS growth in FY15, we believe this is a prudent call.
At 34x NTM EPS, the stock trades at a substantial premium to the group, which is trading closer to 22x. To its credit, BNNY is showing significantly stronger top line growth than its peers; however, we have legitimate concerns with the company’s ability to manage EPS.
We believe BNNY represents an attractive risk/reward setup for short sellers, offering notable downside in the intermediate-term.
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