TODAY’S S&P 500 SET-UP – May 12, 2014
As we look at today's setup for the S&P 500, the range is 20 points or 0.50% downside to 1869 and 0.56% upside to 1889.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS (Bloomberg Estimates):
WHAT TO WATCH:
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
The Hedgeye Macro Team
Takeaway: Pollyannaish, back-end loaded estimates for growth and poor hedge fund performance are meaningful risks to the equity market.
First and foremost, Happy Mother’s Day to all the mothers out there and to the husbands, daughters and sons who support them.
Secondly, please go outside and add something to 2Q14 GDP if you haven’t already. The weather is amazing!
I’m sure every consensus economist, journalist and corporate executive will give 100% of the credit to awesome weather for what should be a marked acceleration in economic and operational performance this quarter. For what it’s worth, the top of our range for 2Q14E GDP is +3.1% on QoQ SAAR basis, so we’ll side with consensus in expecting a short-term recovery for now. If you blamed the weather on the way down, it’s only fair that you caveat any and all good data with better weather on the way up, right? Right.
At any rate, where we continue to be divergent from both consensus and the Fed (have been all year, btw) is that we expect accelerating inflation to slow growth, at the margins, through the balance of the year.
Be it sector variance (XLU +9.7% YTD vs. XLY -6.1% YTD) or style factor variance, the market definitely agrees with our call. The rotation out of the growth style factor(s) is now trending and, at least in macro, the trend is your friend.
The key issue here is that market participants are increasingly back-end loading growth estimates. Not only is equity volatility protection being priced cheaply on an absolute basis across the curve relative to recent years, the spread between VIX futures ~3 quarters out and front-month contracts is rather narrow – effectively implying considerable confidence that conditions for investors will remain more-or-less fine for the foreseaale future.
Source: Bloomberg LP
This move has caught a lot of investors offsides in the YTD. Per StreetAccount:
Obviously, we have number of hedge fund customers, so we don’t write this to be trite or disrespectful. We only call this to your attention because if this trend of poor performance continues, there will likely be an industry-wide lowering of gross exposures and tightening of net exposures, with outflows as a key tail risk. Don’t forget how correlated equity hedge funds are to market beta (+0.75 on a DoD % change basis and +0.96 on an index value basis over the TTM).
Source: Bloomberg LP
What’s even worse is that our TACRM™ global macro weathervane is signaling a breakdown in hedged equity exposure. This is likely because many funds are still long of growth (which is also breaking down) and short things like bonds and emerging markets (which happen to be among the best looking asset classes, along with inflation proxies and REITs).
We’ll explain these signals in far greater detail and how to apply TACRM™ to your investment process in the coming days and weeks. For now, just accept the simple conclusion that there are thousands of hedge funds suffering from the ol’ “Texas Hedge” right now and that is a meaningful risk to the stock market if prevailing market trends continue to do just that (i.e. trend).
Enjoy the rest of your weekend,
Associate: Macro Team
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Takeaway: Current Investing Ideas: DRI, HCA, HOLX, LM, LO, OC, RH, and ZQK
Below are Hedgeye analysts' latest updates on our EIGHT current high-conviction investing ideas and CEO Keith McCullough's updated levels for each.
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DRI – Managing director Howard Penney doesn’t have any updates on Darden this week, but he still considers the company stock a "generational buying opportunity" as he explains in this exclusive HedgeyeTV video.
HCA – There are comments in the press about HCA Holdings' intent to purchase an Australian hospital system. Frankly, we don’t know too much about analyzing Australian hospitals, but we’ll cross that bridge when we get there. We’d rather HCA focus more on the opportunity in the United States. We believe the US hospital industry is on an accelerating pace of consolidation which will lead to increase pricing and purchasing power.
We spoke recently to an orthopedic surgeon who recently started receiving an income statement for his procedures and for the department. This kind of transparency, in his view and ours, will lead to better pricing from medical supply and equipment manufacturers. A long time ago we calculated the total raw material cost for a prosthetic knee at roughly $200. This is a shockingly low number compared to the $12,000 a hospital may pay for the device implies there is plenty of margin to go and get, assuming you had the right data, that is.
Expanding overseas is an interesting move for HCA, but we feel there is plenty of opportunity here at home too.
HOLX – We continue to like the set up for Hologic. One of potential pools of upside is located within their sentiment metrics, i.e. short interest and sellside ratings. For HOLX both of these metrics sit at multi-year highs (short interest) and lows (sellside rating). For Hologic, this is positive for returns typically.
When short interest has been at this level in the past, the forward returns on a 3-month, 6-month, and 12-month duration are 14%, 27%, and 69%, respectively. The sellside rating history would suggest 13%, 20%, and 41% returns over the same time periods. If we are right on adoption for Digital Breast Tomosynthesis adoption, the shorts will cover and the sellside will upgrade their ratings.
LM – In a quiet week of news flow after asset manager earnings season last week, the price action in the market spoke volumes. For the week ending May 9th, the defensive, fixed income related asset managers all had positive performance in their stocks versus the more equity related managers subcombing to fears that the strong run in stocks is stalling out which will affect their assets under management. Franklin Resources (BEN) and Legg Mason had strongly positive moves in their stocks in the most recent week ending May 9th which appreciated by 3.7% and 2.0% respectively. BlackRock (BLK), with its leading legacy fixed income business also eked out a gain this week as the market became more defensive. On a year-to-date basis, second place is first loser, with Legg Mason the only asset management stock in positive territory. The gain of 9.9% for LM is nothing to bat an eye at either considering current LM performance is over 10% ahead of the next best performer in the group and also well ahead of the S&P 500 with just a 1.5% gain this year. We are sticking with the LM story and still think it is worth in the neighborhood of the high $50 per share range on a revival in fixed income inflows from pensions and the fact that the stock has high short interest and very low Wall Street sentiment.
LO – Lorillard was relatively flat on the week, yet followed the prior week’s monster +8.5% move which we commented was mostly fueled by rumors that RAI is interested in acquiring the company. Clearly the rumors subsided this week, which is in-line with our opinion that a hypothetical deal (especially an imminent one) is challenged.
We maintain our bullish stance on LO (originally released in our Best Idea call on 3/4/2014, and before any takeout rumors) supported by 1.) Its leading share and profitability of its core menthol business, 2.) Our belief in the limited menthol regulatory risk over the longer term (substantiated by a Washington, D.C. tobacco expert), and 3.) The upside growth in its blu e-cigarette business that commands leading share in the U.S.
OC – Owens Corning’s weakest business in Q1 2014 should benefit as we head towards warmer weather. The Roofing & Asphalt segment exited Q1 with -18% in sales YoY with an operating margin of 16%. Historically, its operating margin is impacted by the colder quarters as seen in the graph below. The U.S. roofing market is still 20% below its 15 year average as noted in an OC investor presentation this past Thursday. Furthermore, the roofing industry has consolidated to 4 companies (including OC) with 90% of the U.S. market compared to 10 companies owning 90% of the market in the 1990s. This implies as roofing activity picks up in the summer – impacted by the weather and an increase in demand – the four largest players should capture the majority of the gains.
RH – This week, Restoration Hardware released its new Source Book showcasing a redesigned product assortment. This ‘Source Book’ is actually 13 books in one, and is made up of over 3,300 pages (Yes, RH is keeping Dunn & Bradstreet in business). Clearly too big to mail, the books will be sent out to customers via UPS. While it will be more expensive, it’s worth noting that this will give RH certainty that the books will actually be delivered to the customer instead of being thrown near the mailbox on the street, and will also give RH better data usage. We should note that the mere existence of a Source Book does not get us excited, but the fact that there is a full assortment of product around 13 different categories ultimately helps the in-store business (53% of sales) in addition to catalog/e-commerce. In addition to the catalog launch, the company will also host a Grand Opening Gala (and make no mistake, it is a Gala) at the new Greenwich store next Thursday, May 15. Knowing how ‘Hollywood’ RH makes these events, it’s likely to be a positive experience for anyone in attendance.
ZQK – Sector head Brian McGough has no new updates on Quiksilver this week, but in this flashback HedgeyeTV video from December 2013, he explains why he sees top-line growth for Quiksilver and, ultimately, a higher stock price for the action retailer.
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