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TACRM SAYS STICK W/ THE GAME PLAN... ARE YOU LISTENING?

Takeaway: HF investors may be increasingly forced to flip-flop their L/S book by selling 2014’s losers in order to fund a chase in 2014’s winners.

38.5% through CY14, hedge funds have found themselves broadly underwater remaining long our preferred exposures in the Hedgeye 2013 Macro Playbook and short our least-liked ones. The key issue with that is that it’s 2014, not 2013. Macro markets have been front-running a cessation of our #StrongDollar + #RatesRising = #StrongAmerica view since JAN.

 

To recap hedge fund performance:

 

  • HFRX Equity Hedge Fund Index: -166bps MTD, -306bps QTD and -185bps YTD
  • HFRX Macro/CTA Index: -57bps MTD, -113bps QTD and -216bps YTD

 

TACRM SAYS STICK W/ THE GAME PLAN... ARE YOU LISTENING? - 1

 

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 capital outflows as a key tail risk.

 

With the exception of a handful of very astute investors (and an independent research firm domiciled in CT), it’s become increasingly clear through monitoring performance and collecting anecdotes that the majority of the hedge fund space came into 2014 with basically the same exposures:

 

  • LONG BOOK: US equities – particularly the growth style factor(s) and Japanese equities.
  • SHORT BOOK: US Treasury bonds, long-duration credit, everything-EM, commodities and the Japanese yen.

 

A subtle, but important callout here is that with the exception of a handful of very astute investors (and an independent research firm domiciled in CT), not everyone nailed front-running all of these major macro moves in 2013 (e.g. HFRX Macro/CTA Index down -1.8% in 2013 vs. S&P 500 Index up +29.6%). That means there’s likely a fair amount of funds that jammed into the 2013 playbook at precisely the wrong time (i.e. just in time for CY13 “window dressing”).  

 

The key risk here for investors to manage is that the longer 2013’s losers (i.e. the aforementioned SHORT BOOK) continue to exhibit higher degrees of relative momentum on a trending basis, the greater risk there is to the upside, given the crowded nature of these trades and the propensity for investors to unwind such underwater exposures at roughly same time – likely on the same catalyst(s).

 

Our TACRM All-Weather System continues to signal rotation-based flows into Fixed Income & Yield Chasing and EM Equities as primary asset classes, in lieu of DM Equities, at the margins:

 

TACRM SAYS STICK W/ THE GAME PLAN... ARE YOU LISTENING? - TACRM Global Macro Weathervane

 

TACRM SAYS STICK W/ THE GAME PLAN... ARE YOU LISTENING? - TACRM Global Macro Barometer

 

This is a direct function of the relative momentum taking place at the secondary asset class level – which is more-or-less a 180° flip from 2013:

 

TACRM SAYS STICK W/ THE GAME PLAN... ARE YOU LISTENING? - TACRM Global Macro Thermodynamic Monitor

 

TACRM SAYS STICK W/ THE GAME PLAN... ARE YOU LISTENING? - TACRM Heat Map

 

TACRM SAYS STICK W/ THE GAME PLAN... ARE YOU LISTENING? - TACRM 20 20 Vision Thermodynnmic Monitor

 

For more details on how to interpret these charts, please review the following presentation: http://docs.hedgeye.com/HE_TACRM_2014.pdf. Email us if you’re interested in how TACRM can beef up your research and risk management processes; we are happy to customize it to your watch list.

 

Going back to the aforementioned point regarding the rotation in Fixed Income & Yield Chasing and EM Equities, we encourage you to review the following two research notes:

 

 

If a trip to Quad #3 on our GIP model is not “the catalyst” mentioned above, then we too are still searching for that “ah ha” moment.

 

TACRM SAYS STICK W/ THE GAME PLAN... ARE YOU LISTENING? - UNITED STATES

 

TACRM SAYS STICK W/ THE GAME PLAN... ARE YOU LISTENING? - 7

 

TACRM SAYS STICK W/ THE GAME PLAN... ARE YOU LISTENING? - 8

 

Even without a catalyst, the risk that fund managers are broadly forced to sell 2013’s winners in order to finance an industry-wide performance chase in 2014’s winners is not inconsequential. That would roughly equate to investors broadly flipping their entire exposures (and thesis) on its head, so we’re comfortable with our anecdotal evidence that most people have yet to do so.

 

In fact, our conversations with some customers and prospective customers have gone a lot like this:

 

  • Hedgeye Macro Team: “We continue to like bonds, slow-growth/yield chasing stocks like Utes and REITs, commodities and emerging markets in lieu of things like US and Japanese equities and the US dollar.”
  • Investor: “Nice call. I hear ya, but I can’t justify buying Utilities up here. They are so expensive now. I feel like the money has already been made.”
  • Hedgeye Macro Team: “Ok, that’s fair. You know how we feel about valuation not being a catalyst, but, at a bare minimum, don’t be short these markets. The risk in these asset classes is up, not down, given the consensus lean in the hedge fund community.”
  • Investor: “Got it; thanks.”

 

If we had this conversation 10 times in the past week, we’ve had it 1,000 times since FEB. Make this the 1,001th  time.

 

Have a great evening,

 

DD

 

Darius Dale

Associate: Macro Team


Poll of the Day Recap: 76% Are Pessimistic About US Housing Market

Takeaway: 76% PESSIMISTIC; 24% OPTIMISTIC.

Earlier this week, Charles Plosser, president of the Federal Reserve Bank of Philadelphia, said the housing market’s fundamentals “remain sound,” with faster hiring supporting the economy, while William Dudley, president of the Federal Reserve Bank of New York, argued that he expects a slow pace for the housing market’s recovery as headwinds take some time to abate.

 

Meanwhile, despite mortgage rates at their lowest levels since November, applications to buy a home fell 3% week to week and are now nearly 12% lower than a year ago.

 

We wanted to know what you thought, so today’s poll question was: Are you optimistic or pessimistic on the growth of the US housing market?

 

Poll of the Day Recap: 76% Are Pessimistic About US Housing Market - 1


At the time of this post, 76% said they were PESSIMISTIC; 24% were OPTIMISTIC.


(Voters sharply swung so much in one way, that we didn’t receive any comments on why people voted NO.)

 

Here’s what those who are PESSIMISTIC had to say:

 

  • “The middle class is so squeezed by inflation on one side, taxes on the other. The lower class has been cut off from credit and is pushed toward renting (at all time high levels). The upper class isn’t numerous enough to make a difference. No growth in aggregate demand.”
     
  • “Low interests asset bubbles is the most dangerous type of bubble in real estate. Bidding wars in hot markets (CA), stagnate inventories in cold markets (OH), rents rising in all markets and nothing left in the Fed's bag of tricks short of covering one's down payment.”
     
  • “The near-term price trend for housing appears to be down, with rental properties rising, but home buyers declining. I believe this will persist into next year and will be highlighted by a stock market correction.”
     
  • “Housing supply/demand/price trends tend to be auto correlated -- i.e. the tide turn (up or down), the trend tends to last for a while.”
     
  • “Buying in 1-2 years... need prices to drop some.”

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Hedgeye Energy: Why $BPT Is A One Dollar Bill Selling for Two

Takeaway: We still think that BPT is a solid short.

Editor's Note: This research note was originally sent to subscribers on May 20, 2014 by Hedgeye Energy analyst Kevin Kaiser. Follow Kevin on Twitter @HedgeyeENERGY.

 

Hedgeye Energy: Why $BPT Is A One Dollar Bill Selling for Two - 424 10 slick operators

 

I'll pay you $1 per year for the next 8 years.  The payments are not guaranteed, they have equity-like risk.  How much would you pay me today for this deal?  A BPT long would give me $10.

 

BP Prudhoe Bay Royalty Trust (BPT) lives in the obscure world of high-yielding energy equities where retail investors value securities as if the current distribution is a perpetuity – the ultimate Efficient Markets Hypothesis refutation...

 

We added Short BPT to our Best Ideas list on 1/15/2014 at $77.24/unit. We've been wrong on the scoreboard, but don't believe that the fundamental analysis is off.  In our view, BPT is still a $1 bill selling for $2. And sure, this $1 bill could trade at $2.50 or $3.00, but that only makes it more of a short.  

 

In hindsight, we underestimated just how inefficient the market for BPT is. With virtually no institutional holders and limited units available to borrow, it's uncertain when (not if) BPT will move to intrinsic value, which we calculate to be $49.70/unit, 47% below the current price of $94.40.

 

Perhaps we are too early, as the true distribution-destroying function of this trust – the automatic increases to the trust's chargeable costs – do not begin to increase drastically until 2018. By that point, the writing on the wall should be more obvious. However, BPT collapsed ~50% in the second half of 2012, and the same thing could have been said back then.  

 

In the short-term, seasonality is now on our side, as the next two distributions payments should be below the $3.01/unit distribution paid in the second quarter of 2014 given summer field maintenance.

 

Provided the borrow cost is reasonable, we still think that BPT is a solid short.  If you hedge out the WTI price risk, you're short negative carry and playing for ~50% downside to net asset value (NAV). Pair a quality, reliable oil producer like an EOG Resources, Anadarko, Denbury Resources, Suncor Energy, Canadian Natural Resource, or Imperial Oil against it.

 

We've updated our BPT NAV model for the recent increase in the WTI strip, the changes to the production tax regime, and a lower discount rate.  Our base case NAV assumes: production declines at 2% per annum; future oil prices equal the current WTI strip; the current tax regime (35% base + a production credit); 1.5% annual CPI; and a 7.75% discount rate. We calculate the discount rate (BPT's cost of equity) using the capital asset pricing model and the following assumptions: R-free = 2.50%, R-market = 10.0%, Beta = 0.70.

 

The result is a NAV of $49.70, 47% below BPT's current price. And the undiscounted sum of future distribution payments is only $66.20.

 

Hedgeye Energy: Why $BPT Is A One Dollar Bill Selling for Two - bpt1a

 

Hedgeye Energy: Why $BPT Is A One Dollar Bill Selling for Two - bpt2

 

Hedgeye Energy: Why $BPT Is A One Dollar Bill Selling for Two - bpt3

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Mortgage Demand Falls Again This Week

Takeaway: This morning's MBA mortgage purchase application data shows housing demand dropped for a second week in a row in spite of falling rates.

Mortgage Demand Falls Again This Week - alg mortgage refinancing jpg

MBA Mortgage Applications

The Mortgage Bankers Association today released its weekly mortgage applications survey data for the week ending May 16. The interesting takeaway is that while mortgage refinancing volume has shown a modestly positive response to falling rates (+4% week-over-week this week and +7% w/w in the previous week, but still down -66% year-over-year), mortgage purchase application volume continues to slide (-3% w/w this week and -1% w/w in the previous week and down -12.3% y/y). 

 

Essentially, demand continues to slow and, remember, price growth follows the slope of demand.

 

In fact, the Corelogic early read on April showed home prices decelerated to +9.2% year-over-year versus their March reading of +11.1% year-over-year. This marked one of the steepest sequential decelerations (-190 bps) in years.

 

Mortgage Demand Falls Again This Week - Purchase   Refi YoY

 

About MBA Mortgage Applications

The Mortgage Bankers’ Association’s mortgage applications index covers more than 75% of mortgage applications originated through retail and consumer direct channels. It does not include loans delivered through wholesale broker and correspondent channels. The MBA mortgage purchase applications index is considered a leading indicator of single-family home sales and construction. Moreover, it is the only housing index that is released on a weekly basis. 

 

The MBA Purchase Apps index is released every Wednesday morning at 7 a.m. EST.

 

*     *     *     *     *     *

 

Editor's Note: This is a brief excerpt of a research note that was originally sent to subscribers on May 21, 2014 at 8:14 a.m. EST by by Josh Steiner and Christian Drake from Hedgeye's Financials and Macro teams. Follow Josh & Christian on Twitter @HedgeyeFIG and @HedgeyeUSA.

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TGT – This Narrative Will Change Dramatically

Takeaway: Less talk about tactical patches. More action about expensive strategic solutions to 5-years worth of poor decisions. Flat EPS for 3-yrs?

Conclusion: Though the fundamental call is playing out as expected, we still think TGT is a ‘Best Idea’ short. The reality is that the narrative on this name will change dramatically over the next 12 months after a real CEO is hired, major strategic decisions are made and we get away from the tactical discussion about whether traffic is up or down by 50bps or how many Frozen DVDs Target sold.  We’ll be talking about a new CEO’s vision to both transform the company, and fix all the mistakes made over the past 5 years. That might sound like great news, but it will be expensive news. You don’t build a world-class e-commerce platform without investing a few billion on the balance sheet and P&L. You also don’t change the make-up of your customers and product offerings and brand image without some painful organizational changes and operational expenses that hurt over a multi-year time period before they ultimately help grow market share, margins, and returns. Our point is that the bar has been reset for this FY closer to a level that we think is doable. But this company might not earn anything higher than $4.00 for another 3-years. We won’t wait a day for mediocrity – nevermind 3 years.  This stock should have a 4-handle.

 

DETAILS

 

We added TGT to our Best Ideas list as a Short on 4/24, and there it will stay. The quarter played out exactly as planned; the company traded margin for comp (which was still negative) in the US, and meaningfully underperformed in Canada. But our call went far beyond the quarter. It is based on the premise that five years ago Target set out on a path to dramatically alter its persona. Mind you, in the mid-2000s Target was the anti-Wal-Mart, and was viewed as a fashion leader for a younger demographic (i.e. Tar-Jay). At that point, it was clearly worth a higher multiple, which it consistently commanded.  But then three things happened that would ultimately cost Sheinhafel his job – and No, one of them was NOT the data breach.

 

1) TGT converted 65% of stores to P-Fresh – which mirrored WMT’s supercenters (ie sell people milk and eggs so they stick around and buy diapers, sweaters and lipstick).

2) TGT pushed the Red Card, which offered 5% off on all purchases. This went from 6.5% of sales to 20% of sales over 5 years.

3) The company was spending on the above initiatives while the rest of retail was investing in e-commerce, something TGT is severely deficient in.

 

Maybe all these things seemed a good idea to TGT at the time. But it fundamentally changed the makeup of the company.

 

1) That old cool Tar-Jay is not just dormant, but it is officially dead. Now TGT competes in the US more closely with WMT than it ever has before. So it’s got WMT on one end, supermarkets on another, department stores on another, and even dollar stores to a certain extent. This is one of the least appealing competitive sets we can think of. And that’s not even mentioning AMZN, which is emerging as one of its biggest competitors whether Target likes it or not.

 

TGT – This Narrative Will Change Dramatically - TGT chart1

 

2) The Red Card might have seemed like a good idea as well. After all, some retailers have had great success with similar reward cards. It’s not the 100bps in margin that TGT gives back to consumers that we have a problem with. But rather, we think that the mix of customers changes meaningfully when you start incentivizing them with price.  To be clear, we understand the nature of US retail, and price discounting can be a great weapon. But when TGT was more of a cool-ish fashion-leading department store, it did not have to incentivize people with a Red Card to be loyal. Now it is a different animal altogether. Our point is that we encounter many people who think that historical peak margins could someday be doable. We think it’s close to impossible.

 

TGT – This Narrative Will Change Dramatically - TGT chart2

 

3) Lastly, the dot.com element is pathetic. Every statistic we track shows that target.com is near the bottom of the pack when compared to other retailers’ online business. We hear Mulligan say on the conference call that they are ‘channel agnostic’, and that they don’t care if a person buys online or in the store. Seriously? 46% of what your store sells is Food and Home Essentials – these are things that you need people to come into the store to buy repeatedly at lower margin so they buy high margin seasonal goods. This company needs people in its stores, period.

 

TGT – This Narrative Will Change Dramatically - chart3 tgt

 

SO WHAT HAPPEN’S NOW

 

We think that today’s conference call was so bad yet so enlightening. We walked away with the firm view that both the company and the Street are hyperfocused on issues that are impacting the next 2-3 quarters of earnings. Those things are important as it relates to near-term trading. We respect that. But the reality is that there were some people who are interviewing for the CEO job who were listening in to the call. Others will read the transcript. Those people could care less about a couple points in traffic growth, or weakness in gross margin, or whether Target sold a million Frozen DVDs (still in disbelief that they talked about this). They’re going to have to make a handful of strategic decisions when they start their new job if they want to get paid 3-5 years down the road -- because status-quo is not acceptable. If it is, then the Board will be hiring the wrong person, and they should probably hand in their own resignations while they’re at it.

 

Our point here is that what we heard on today’s call is a narrative that will be a distant memory in 9-12 months’ time. We’ll be talking about a new CEO’s vision to both transform the company, and fix all the mistakes made over the past 5 years. That might sound like great news, but it will be expensive news. You don’t build a world-class e-commerce platform without investing a few billion on the balance sheet and P&L. You also don’t change the make-up of your customers and product offerings and brand image without some painful organizational changes and operational expenses that hurt over a multi-year time period before they ultimately help grow market share, margins, and returns.

 

The bar has been reset for this FY closer to a level that we think is doable. But this company might not earn anything higher than $4.00 for another 3-years. We won’t wait a day for mediocrity – nevermind 3 years.  

 

TGT – This Narrative Will Change Dramatically - tgt financials 1



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