“Some questions have no answers to find.”
This weekend I changed things up a bit and started re-reading a play called Copenhagen which is based on a meeting of the physics minds of Niels Bohr and Werner Heisenberg in 1941.
The timing of the play opening on Broadway (April of 2000 at the top in the US stock market) is interesting. I was a newbie on Wall Street back then. I didn’t know much more than I know now about why this time the bubble is “different.”
Copenhagen’s opening scene starts with four questions exchanged between Bohr and his wife, Margrethe:
Margrethe: “But why?”
Bohr: “You’re still thinking about it?”
Margarethe: “Why did he come to Copenhagen?”
Bohr: “Does it matter, my love? Now we’re all three of us dead and gone”
Back to the Global Macro Grind…
But why do bond yields keep going down? Why is Old Wall consensus still expecting 3.32% for the 10yr US Treasury yield for 2014 when it’s currently trading at 2.51? Why did consensus come into 2014 expecting US Growth to accelerate, and inflation to fall? Does it matter, my friends?
These questions obviously have obvious answers – unless you are paid to anchor on estimates that are dead wrong, that is. As #InflationAccelerating slows real US growth expectations for 2014, some serious questions remain as to why Wall Street and Washington have not yet come to agree with gravity.
This is, of course, the upshot of Copenhagen – Heisenberg (not the Breaking Bad dude, but Walter White was named after him):
“No one understands my trip to Copenhagen. Time and time again I’ve explained it. To interrogators and intelligence officers, to journalists and historians. The more I’ve explained, the deeper the uncertainty has become…”
“So” embrace the uncertainty associated with how an unprecedented level of un-elected central planning is affecting the rate of change in both growth and inflation in the US economy. There is nothing linear about this.
In addition to US Bond Yields getting hammered last week, here’s what Mr. Macro Market had to say about US growth:
- Growth Stocks (Russell 2000) down another -0.4% last week to -5.2% for 2014 YTD (down -8.8% since March)
- Yield Spread (10yr yield of 2.51% minus the 2yr yield of 0.36%) compressed another 8 basis points on the week (-48 basis points YTD)
- Financials (XLF) were the worst performing sub-sector of the SP500 at -0.8% on the week to -0.5% YTD
In other words, as the long-end of the curve (10yr yield) dropped -10 basis points on the week (-51 basis points YTD), not only is that a leading indicator for US #GrowthSlowing, but it’s as good a proxy as any for bank earnings (net interest margin tracks the Yield Spread).
Everyone who has followed market history knows why. There isn’t a person in this profession who can tell you with a straight face that growth stocks, financials, and bond yields all declining at the same time is a bullish growth signal.
Neither can they tell you that food and oil prices accelerating is a consumer tax cut. Here’s the update on that:
- Oil price up another +2.3% last week (breaking out above @Hedgeye TAIL risk lines of resistance)
- Cattle prices up another +1% last week to +13.5% YTD
- REITS up another +0.4% last week to +14.6% YTD
Oh, you mean you don’t eat REITS? But you’re still thinking about chasing some slow-growth yield? Obviously cost of living is ripping in this country, and since 1/3 of Americans rent, they can eat that inflation – and like it, because as Heseinberg explained in Breaking Bad, “I say so.”
The only good news I can give you on the US stock market is that buy-side consensus is starting to figure out the #InflationAccelerating slows US consumption growth theme. Here’s the updated CFTC Non-Commercial net long/short positions in the Big Macro stuff that matters:
- SPX (Index + Emini) closed the wk with a net short position of -40,901 contracts (vs. an avg NET LONG position of +16,256 contracts over the last 6 months)
- 10YR Treasury has a net long position now of +23,948 contracts (vs an avg NET SHORT position of -81,337 contracts over the last 6 months)
Put another way:
- If you were long growth equities and short bonds 6 months ago, you were killing it (but about to get killed)
- If you made the turn (out of growth stocks into slow-growth bonds) in the last 6 months, you are still killing it
Just because consensus is moving the way of economic gravity doesn’t mean the move is done. In Breaking Bad, Walter White explained this reality quite effectively to Saul too: “We’re done when I say we’re done.” And that’s all Mr. Macro Market is going to have to explain about that.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.48-2.61%
WTIC Oil 101.05-102.97
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
TODAY’S S&P 500 SET-UP – May 19, 2014
As we look at today's setup for the S&P 500, the range is 21 points or 0.90% downside to 1861 and 0.22% upside to 1882.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 2.16 from 2.16
- VIX closed at 12.44 1 day percent change of -5.54%
MACRO DATA POINTS (Bloomberg Estimates):
- 11:30am: U.S. to sell $25b 3M, $23b 6M bills
- 12:10pm: Fed’s Williams and Fisher speak in Dallas
- 12:50pm: Former Fed Chair Bernanke speaks in Dallas
- House in session; Senate returns Tue.
- President Obama attends evening fundraiser at private home in Potomac, Md.
- 10am: Supreme Court may release opinions
- 11:45am: Former Treasury Sec. Tim Geithner speaks at Politico lunch
- 1pm: Energy Sec. Ernest Moniz, EPA Admin. Gina McCarthy participate in Google+ Hangout
- Financial Stability Oversight Council hosts conf. on risks to financial system; includes Citadel’s Ken Griffin
WHAT TO WATCH:
- AstraZeneca rejects Pfizer’s sweetened $117b takeover proposal
- AT&T agrees to buy DirecTV for $95/shr as TMT deals continue
- Deutsche Bank to raise $11b as Qatar taking stake
- GE said to seek partners on Alstom assets for French approval
- Johnson Controls to spin off Automotive Interiors into JV
- Credit Suisse guilty plea looms as U.S. said to reassure banks
- Blackstone sells five Boston towers for $2.1b: WSJ
- Walgreen considering GBP10.5b Boots buyout: Sunday Times
- Cisco CEO calls on Obama to rein in surveillance: FT
- Google’s YouTube said to buy Twitch for $1b: Variety
- Yahoo Japan cancels plan to buy EAccess from SoftBank
- ’Godzilla’ wins N.A. box office with est.-beating $93.2m
- Gasoline prices fall to $3.6876/gal. in Lundberg survey
- Gunmen storm Libya parliament as violence grip oil producers
- Marriott offers EU130m for Madrid Ritz Hotel, Expansion says
- Ryanair targets profit growth by flying 3m more travelers
- Ousted NYT Editor Abramson to speak at Wake Forest commencement
- Campbell Soup Co (CPB) 6:30am, $0.59
- Urban Outfitters (URBN) 4pm, $0.27
- Valspar (VAL) 7:30am, $1.04
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Brent Extends Weekly Gain as Libya Fighting Worsens; WTI Rises
- Hedge Funds Cut Bullish Gold Wagers Most in a Month: Commodities
- Thai Gold Imports Plunge Amid Political Deadlock: Southeast Asia
- European Central Banks Make Gold Agreement Without Sales Limit
- Gold Climbs on Speculation of India Relaxing Import Restrictions
- Cocoa Drops on Outlook for West African Crops; Arabica Declines
- Wheat Set for Longest Slump in 15 Years as Rain Aids U.S. Crops
- Nickel Advances as Norilsk Forecasts Move to Deficit Next Year
- Norilsk Sees Nickel Surplus Shrinking to Smallest in Four Years
- Natural Gas Bets Drop to Five-Month Low on U.S. Supply: Energy
- Biggest 10 Banks’ Commodities Revenue Rises 26% Amid Pullback
- Iron Ore Futures on SGX Below $100 for First Time Since 2013
- Global Grain Production Records Show No Signs of Peak: Bull Case
- Russia Gas Supply Fears Spur Record Trading on ICE Exchange
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Takeaway: Here's a quick look at some of the top videos, cartoons, market insights and more from Hedgeye this past week.
Hedgeye CEO Keith McCullough talks markets on Fox Business' Opening Bell with host Sandra Smith, filling in for Maria Bartiromo.
In this excerpt from the Retail team’s conference call this morning for institutional investors, Brian McGough explains one key point in his bearish thesis on Kohl’s. Hint: it has to do with JC Penney.
Hedgeye CEO Keith McCullough takes a look underneath the economic hood and explains why stocks and bonds both have it right.
Stay with what’s been working all year – #InflationAccelerating and slow-growth #YieldChasing assets.
Food prices have surged in the US as Americans suffer sticker shock.
Could the data be more clear? #InflationAccelerating slows growth.
The PPI report on Wednesday showed (shocker!) that inflation is soaring – thanks in large part to food prices. Click here to view the poll and results.
Sell Growth: SP500 Levels, Refreshed
In a research note CEO Keith McCullough originally wrote for subscribers he said, "But whatever you do, don’t call falling bond yields (do not sell bonds here!) on today’s #ConsumerSlowing (Retail Sales +0.1%) print a US growth slowing confirmation. The weather turned, but the consumption data that matters most didn’t." Click here to read more.
Retail: Wal-Mart Plays Right Into #GrowthSlowing | $WMT
Sure, Wal-Mart's comp miss is obvious, but the earnings per share miss is startling given historical context. As Hedgeye Retail analyst Brian McGough explains, this plays right into Hedgeye's #GrowthSlowing theme. Click here for more.
Fund Flows, Refreshed
Last week's data reveals significant deceleration in equity fund flows, capping off a week of less-than-stellar performance. Click here to continue reading.
LEARN MORE ABOUT BECOMING A HEDGEYE SUBSCRIBER.
Takeaway: Current Investing Ideas: HCA, HOLX, LM, LO, OC, RH, and ZQK
Below are Hedgeye analysts' latest updates on our SEVEN current high-conviction investing ideas and CEO Keith McCullough's updated levels for each.
*Please note we removed DRI from Investing Ideas this week.
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
HCA – We published an article with an update to our birth model with April 2014 data which was updated earlier this week. You can read that note here. Births account for 25% of all hospital admissions nationally, so a recovery could be a significant tailwind for HCA Holdings.
HOLX – We heard from an institutional customer this week that Washington DC consultants to Wall Street are suggesting 3D Tomosynthesis will not be receiving any incremental reimbursement. This would be a major blow to our thesis. While we don’t discredit the source entirely, we do think we’ve covered the scenarios if this actually happens. So far our work suggests a reasonable increase in price for 3D over 2D Digital mammography.
LM – Legg Mason reported its month ending asset-under-management for April at the beginning of the week with a very positive result in its fixed income segment. The firm cited “significant” bond inflows for the month which we calculated to be over $2.3 billion. To contextualize this inflow amount we note that the entire U.S. mutual fund industry had total bond fund inflows of just $8.4 billion in April according to the Investment Company Institute, which provides an indication of the strong win rate for Legg alone last month. We also point out on a forward looking basis that the emerging trends in the mutual fund marketplace are starting to favor fixed income which should translate into accelerating positive trends at leading bond fund managers. Fixed income inflow is outpacing equities thus far in the second quarter of 2014 for the first time in 9 months which reflects the emerging defensive nature of global markets which is a good environment for leading fixed income houses including Legg Mason.
LO – Lorillard pulled back in the week over -2% and underperformed its peers, yet the slight drawdown comes after weeks of outperformance (up ~ +19% in the last 3 months), on a mix of take-out rumors from RAI/BAT and what continues to be a strong menthol portfolio. We maintain that we have no merger knowledge from any party within the tobacco space, however we view a hypothetical deal (especially an imminent one) of RAI acquiring LO as challenged, given:
- Our main flag is that a combined RAI + LO would own ~ 67% of U.S. menthol market, which we believe should trigger anti-trust flags.
- Big tobacco is already a highly concentrated industry in the U.S. across the big three – MO has a leading ~51% of market share; a combined RAI + LO would equate to ~ 42% share.
We expect the tobacco group to continue to trade around category shifts in e-cigarettes: recently we’ve heard increased color that cig-alike e-cigs (or those primarily being manufactured by Big Tobacco) are losing out to larger, tank, open, and e-vapor products based on their lower price points and superior vapor quality. We expect Big Tobacco’s cig-alike e-cig technology to improve, and to also begin to see portfolio mix shifts away from cig-alike e-cigs products. We do expect increased competition as RAI and MO bring their own e-cig versions (VUSE and MarkTen) to market nationwide in the coming months, however we expect blu to maintain its market share leadership.
Our intermediate term TREND to longer term TAIL bullish outlook on LO remains intact.
OC – We found some interesting results after collecting historical data from the Census Bureau and the Bureau of Labor Statistics. We noticed both residential and non-residential floor space per worker was hovering around post-WWII lows. This suggests the market is very depressed by post-war standards on a per capital basis. Owens Corning has more exposure to the non-residential side through its insulation and composites segments. The roofing segment is driven more from damage/ repairs and does not correlate with housing related metrics. For example, roofing sales were up nearly 36% in 2008.
RH – Restoration Hardware opened its newest design gallery this past Friday, May 26th, in Greenwich, CT. The store has 14,000 selling square feet, nearly 3x the legacy Greenwich store located down the block. The new Greenwich location is on the small side of new Design Galleries, but it marks an important turning point for the company as it begins to grow square footage after 6+ years of decline. More importantly – the new space will allow the company to display a much larger percentage of the company’s growing category portfolio including Baby&Child, Tableware, as well as Outdoor. The company has stated that when an item is displayed at retail for the first time in a new market it typically sees a 50%-150% boost in sales, one of many justifications for the real estate transformation.
An issue we rarely address when talking about the real estate transformation is the significant operating leverage opportunity associated with these new Design Gallery spaces. Not many retailers are looking to expand into 30,40, or 50,000 square foot boxes - giving RH significant leverage when negotiating lease terms. Greenwich is a great example of this leverage opportunity. The company was paying $900,000 in rent for the Legacy 5,000 square foot space, but will only pay $1,000,000 per year for the new 14,000 sq. ft. store. That equals just $11.11 for each incremental square foot of selling space. This is one of the key drivers behind our forecasted gross margin expansion, which we have going from 35.9% in 2013 to nearly 39% in FY18.
ZQK – INTERMEDIATE TERM (TREND) (the next 3 months or more)
This is the only part of the story we’re not thrilled with. Why? 2014 will be all about cost cuts and modest (2%-ish) top line growth. As such, our estimates for 2014 are not too far off of consensus. This is all a logical progression. The management team started in early 2013. The first and easiest thing to do is reorganize Quiksilver, cut redundant functions and ensure that the team is filled with ‘A’ players. Earnings in 2014 should be slightly positive mostly a function of restructuring, but with some revenue growth weighted toward the back half of the year.
LONG-TERM (TAIL) (the next 3 years or less)
2015 and beyond is a much different story. Our long-term model has Quiksilver adding $600mm in revenue on top of a $1.9bn base. As a frame of reference, our top line growth forecast is over 1,000 basis points ahead of consensus.
Ultimately, we’re at over $1.00 per share in 2017, which is 40% ahead of the consensus. In the end, this is a 40%+ EPS grower that’s a double if we use a 20x p/e, which we think is more than fair based on the soon-to-be-realized growth profile.
* * * * * * *
Click on each title below to unlock the institutional content.
Retail sector head Brian McGough explains why Macy’s is at a critical point in its decision tree and where the company goes from here.
Energy analyst Kevin Kaiser recounts a recent trip he took to pitch the bear case on Master Limited Partnerships to a group of value investors.
Financials analyst Jonathan Casteleyn takes a granular look at the most recent data which showed that last week the combination of taxable and tax-free bond fund flow had the best week all year.
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