“Prepare. Perform. Prevail.”
-Dave Tate, EliteFTS
In what feels like a lifetime ago now, I owned a human performance and nutritional consultation company. The work was rewarding, but not from a pecuniary perspective.
Designing transformative programs for dedicated collegiate athletes and prospective professional athletes, bodybuilders and Olympians was certainly gratifying. Rep counting for middle-aged housewives (in what invariably devolved into pseudo-therapy sessions)…not so much.
Unfortunately, only one of those demographics generally had the discretionary dollars to spend to keep us a going concern.
Because broke college kids don’t have much in the way of a food or supplement budget and certainly can’t afford high frequency, hormonal profiling, we had to resort to a little empirical “bro-science” to gauge recovery and the subsequent prescription of workout intensity.
Q: How do you know if cortisol levels are muted, the central nervous system is piqued, and the overall hormonal milieu is primed for hardcore training and positive physiological adaptation…in ~5s and at no cost?
A: Wake up and pick up something heavy.
If your grip strength is there right out of bed, it’s almost assured the body is recovered and ready for positive stress.
Another underused training technique effective at jumpstarting progress in advanced lifters is targeted use of eccentric training. The eccentric part of a lift can generally be thought of as the “down” part of the lift (think lowering the bar when bench pressing)
Muscle contraction during the eccentric portion is stronger, allowing you to use more weight – resulting in greater muscle soreness and, if employed correctly, faster strength & hypertrophy gains.
The majority of lifters and coaches only focus on the concentric portion of the lift – which, in investment speak, is analogous to simply being long beta. Learning when and how to manage the eccentric (down) part of the lift cycle is where training alpha is generated.
Back to the Global Macro Grind...
In our 3Q Macro Themes call tomorrow we’ll lay out the detailed case under our expectation for a sequential slowdown in consumption growth in 3Q. The punditry of the Early Look prose typically carries a tendency towards intentional overstatement, so it’s worth emphasizing that we’re not making a recession call or even a call for an overly protracted deceleration (yet).
As the current expansion matures, however, occasional detachment from the myopia of every market moment and consideration of where we are in the longer cycle can be a useful exercise.
Because we have a self-imposed 900 word limit on the morning missive and alliteration has yet to steer me wrong, we’ll use the 3-D’s of Duration, Demographics, & Deleveraging as the conceptual framework for contextualizing the prospects for the present cycle:
Duration (of Expansion): The mean duration of expansions over the last century is 59 months. Inclusive of July, the current expansion stands at 62 months. We continue to think the reality of the ticking expansion clock weighs into the Fed’s current policy calculus – they need to get out of QE if only to give themselves the opportunity to (credibly) get back in if need be. Stopping QE while the fundamental data is supportive implies that QE was (at least in part) effective in its objective. Perma-QE, however, is a de facto admission to the market of its ineffectivenss, leaving it largely impotent as a forward policy tool.
Demographics: Growth in the working age population peaked circa 2000 and won’t turn again for another ~10 years and the aged dependency ratio (the >65YOA population in relation to the 16-64YOA population) will continue to rise well beyond that. With labor supply in secular deceleration, productivity gains will have to shoulder an increasing share of the load to support trend growth in real gdp/potential gdp. Real Wage Growth may benefit from tighter labor supply and productivity driven demand for labor - but that remains an “if” and, either way, higher entitlement spending and debt service costs will likely sit as an offset to gains in real income.
Deleveraging: Household debt-to-GDP currently sits at 77.2%, down from the March 2009 peak of 95.6% according to the latest Fed Flow of Funds data. Rates remain pinned at historic lows, for now, and debt growth remains below income growth so (assuming borrowers want to borrow and creditors lend) credit could support consumption growth over intermediate term. However, given the initial debt position and zero bound rates, we certainly aren’t in position to jumpstart a repeat of the prior credit based consumption cycle.
The simple reality of the last 30+ years is that, with the Baby Boomers (born 1) entering prime working age (24 – 54) alongside the secular increase in female labor force participation, we had the largest bolus of people ‘ever’ matriculating through their peak years of discretionary income with peak leverage on that (peak) income – all of which also happened to occur on the right side of a multi-decade interest rate cycle which provided a steady tailwind to asset values (via lower discounting) and offered self-reinforcing support to the credit cycle as rising collateral values supported capacity for incremental debt.
No central bank liquidity deluge can effectively replicate that.
So, is it time to start managing the eccentric part of the macro cycle?
Probably not quite yet. Viewing economic cycles as periodic functions, balance sheet recessions are generally characterized by longer periods (slower recoveries) with lower amplitude. So, it’s probable the muddle continues for a while longer with recurrent, short-cycle oscillations in growth for the Macro Marauders of Hedgeye to continue to attempt to front run.
The “3D” style thinking above isn’t particularly new or novel, but there’s a lot of economic gravity embedded in those realities. Their recapitulation also provides an effective counterbalance to the latest Fed projections which call for GDP to grow in excess of potential output for the next 2.5 years – which is effectively a call for an accelerating recovery over the next 30 months and an implicit expectation for the 3rd longest expansionary period in a century.
Do you take their word for it or are we #PastPeak in the current cycle?
We don’t know, exactly, but our model is dynamic and data dependent… and our 4Q Macro themes are still up for grabs.
In the meantime, we’ll continue to work to evolve and fortify our process for risk managing the eccentric.
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND signal in brackets) are now:
UST 10yr Yield 2.49-2.59% (bearish = bullish for bonds)
RUT 1165-1189 (bearish)
USD 79.64-80.19 (bearish)
Pound 1.70-1.72 (bullish)
Brent Oil 107.23-111.37 (bullish)
Gold 1 (bullish)
Winter is Coming! Prepare. Perform. Prevail.
This note was originally published at 8am on June 26, 2014 for Hedgeye subscribers.
“Creativity is allowing yourself to make mistakes. Art is knowing which ones to keep.”
As you may already know, Scott Adams is the creator of the cartoon "Dilbert." The cartoon makes light of the corporate world and was originally created in the early 1990's as Adams was being "downsized" from a major corporation. Even though Adams isn’t a professional investor like most of you reading this, his quote above is remains rather apropos to the investing world.
Most great portfolio managers and analysts are also incredibly creative. They are creative in the types of analysis they employ and they are creative in their questions for management. But perhaps most importantly, they are creative in idea selection. The true skill, of course, then comes in knowing which creative ideas to keep. Some call this risk management.
We hired a cartoonist recently here at Hedgeye. Cartoons are a great way to communicate our often contrarian investing ideas and themes. Take for example the cartoon posted below that we included in our 100-page deep dive short call on United Airlines (UAL) earlier this week.
The cartoon emphasizes the craziness (at least from our perspective), of UAL’s accounting policies. Not unlike our short calls on certain stocks in the Master Limited Partnership (MLP) sector, we have a difficult time reconciling the valuation with UAL with its underlying cash flows. That said, we also know, to paraphrase Keynes, that the market can remain irrational longer than many investors can stay solvent.
As it relates to airlines, and specifically UAL, longer term we much prefer Warren Buffet’s maxim on the industry. That is, the best way to become a millionaire is to start a billionaire and buy an airline!
Back to the Global Macro Grind...
Our research team has been busy generating some very contrarian and well researched investment ideas lately. This morning I wanted to highlight a few. (As always, if you want more details on the idea and would like to review the more detailed work, please email email@example.com for details on how to subscribe.)
First up on the runway is naturally United Airlines (UAL). The core of thesis per our industrials sector head Jay Van Sciver is as follows:
“By our estimates, the underlying UAL operations have generated a cumulative loss over the past two years. Further, UAL has burned over $1.4 billion in free cash flow, defined as Cash Flows from Operating Activities - Net Capital Expenditures, in the last two calendar years. As the high cost U.S. major since AMR's bankruptcy-related cost cuts, we expect UAL to struggle to improve its operations relative to competitors. In our view, it is relative costs that matter. We expect UAL to continue to underperform lower cost airlines.
This is just the tip of the proverbial iceberg.”
In our Chart of the Day below, we highlight this free cash flow deficit versus its peer group. As the chart shows, UAL appears to have severely disadvantaged economics as compared to its peers.
The second idea I wanted to highlight is Lululemon (LULU), a contrarian long idea. For many a thoughtful short seller, LULU has been one of the better short plays in retail of late. Rightfully so. Management appears to be making one misstep after another and doing virtually everything in its power to ruin what is actually a solid brand and product. The core of our long thesis according to our Retail sector head Brian McGough is as follows:
“There’s a massive bifurcation between the growth potential at this company, and the lack of a plan to execute on it. If management continues to execute in a sub-par way, we see downside to about $31 (stress testing our model at 10x EBITDA). Not pleasant (18% downside), but not the end of the world from its current price ($37.61). If the company/Board adds the operational depth that is necessary, then the discussion returns to this company doubling or tripling its top line, and realizing $3.00-$4.00 in earnings power. Pick whatever multiple you want, but the stock price on $3.50 in earnings will push it through its all-time high of $82.”
Finally, the last idea (and probably most controversial idea I wanted to highlight) is our short call on YELP. From a stock price perspective, on the short call we’ve been early, but we are getting increasing confidence in our thesis the more work we do. Our Internet sector head Hesham Shabaan actually had a call recently with the chief financial officer of YELP to discuss, which is at the core of our short thesis. This was his takeaway from that call:
“Where we didn’t get a tremendous amount of detail was when we delved into its customer repeat rate, which is how we are backing into its attrition rate. We did spend some time discussing this topic, and while he wouldn’t explicitly verify or refute our attrition thesis, he did say that YELP has never said that they are not losing customers after we delved into its reported numbers.
The question he wouldn’t answer, which is a spin off of its customer repeat rate metric: “How many of your current customers have been generating revenue for YELP for over a year?”
This is the most important question because it drives at the heart of the retention issue we have been highlighting. We estimate that in any given period that the overwhelming majority of YELP’s reported Local Business Accounts are accounts the company has signed within the LTM (meaning YELP is losing the majority of its accounts after the first year).”
Clearly, Hesham didn’t get a lot of clarity on attrition in his discussion.
As always, let us know if you have any questions on these or any other creative investment ideas you may be working on.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.46-2.64%
India’s Sensex 24873-25617
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
Risk Managed Long Term Investing for Pros
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.
There shouldn’t be much to cheer about this earnings season but the stocks probably reflect lackluster results. We’re not sure decelerating Mass is priced in yet.
THE CALL TO ACTION
Sure, Street estimates have come down but so have the stocks. Thus, the Q2 earnings season doesn’t look like much of a catalyst, positive or negative, for the group. On an individual company basis, LVS looks like it could disappoint, particularly on a hold adjusted basis since Sands China generally played lucky during Q2. MPEL should come in light as well but we would caution would be shorts: a big share buyback announcement could (and should) be in the works. On the positive side, Galaxy looks most interesting to us. In the face of a difficult junket environment, Galaxy seems to have found the special VIP sauce and we project a slight Q2 beat.
But don’t forget about the upcoming mass deceleration…
Q2 VIP disappointment is well known and mostly reflected in the sell side estimates. The comparison between Hedgeye and the Street is detailed in the chart below. Note also that we’ve included our hold adjusted EBITDA estimates for Q2 as well. Since we mostly know property level hold percentage before the companies report, we adjust our estimates for good/bad hold.
Galaxy: Earnings Beat and VIP Strength
Galaxy looks like the only stock that could pop with earnings (maybe also MPEL if it announces a big buyback). We’ve been very impressed with that company’s performance on the VIP side despite the well-publicized headwinds. As can be seen in the following chart, the company’s portfolio of properties (mostly Starworld and Galaxy Macau) have performed very well on this metric to go along with the market mass strength. While some of the share gain in Q2 could've come from the 2 Wynn VIP rooms facing construction disruption, the trend was already under way.
The bigger issue is the likely mass deceleration in 2H – not just Q3. We think the 30-40% mass revenue growth enjoyed by the casinos could dissipate to the high teens by the end of the year. As we pointed out in our 06/13/14 note “MACAU: HANDICAPPING MASS DECELERATION” – not only are comparisons difficult but July 2013 marks the month when casinos began jacking up table minimums on the mass floor. Lapping that and keeping 1H Mass growth rates will be a challenge.
The trade set up for Q2 earnings doesn’t look as it has in prior quarters. However, over the intermediate term, we remain negative on the stocks overall. We’re not sure sentiment has fully captured decelerating mass growth.
TODAY’S S&P 500 SET-UP – July 10, 2014
As we look at today's setup for the S&P 500, the range is 36 points or 0.75% downside to 1949 and 1.08% upside to 1985.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 2.06 from 2.05
- VIX closed at 11.98 1 day percent change of 5.74%
MACRO DATA POINTS (Bloomberg Estimates):
- 8:30am: Initial Jobless Claims, July 5 est. 315k (prior 315k)
- Continuing Claims, June 28 est. 2.565m (prior 2.579m)
- 8:30am: Bloomberg July U.S. Economic Survey
- 9:45am: Bloomberg Consumer Comfort, July 6 (prior 36.4)
- 10am: Wholesale Inventories m/m, May, est. 0.6% (prior 1.1%)
- Wholesale Trade Sales m/m, May (prior 1.3%)
- 10am: Freddie Mac mortgage rates
- 10:30am: EIA natural-gas storage change
- 1:15pm: Fed’s George speaks in Shawnee, Okla.
- House, Senate in session
- Obama attends DNC event in Austin before delivering a speech on the economy
- 6:30am: Sec. of State John Kerry, Treasury Sec. Jack Lew hold press conf. after meeting Chinese President Xi Jinping
- 10am: SEC’s Investor Advisory Cmte public meeting; topics incl. market structure
- 10am: House Finl Svcs Cmte hearing on Fed accountability
- 10am: House Ways and Means markup incl. highway transportation H.R. 5021
- 2:30pm Homeland Security Sec. Johnson, HHS Sec. Mathews Burwell at Senate Appros. Cmmte on Obama border spending request
- U.S. ELECTION WRAP: Senate Avoids Gun Debate; Immigration
WHAT TO WATCH:
- Bullard says unemployment drop to push inflation above 2%
- IBM invests $3b in chips amid talks to sell division
- China exports trail estimates as global demand limited
- Prime money funds to float price in plan said headed to SEC
- American Apparel strikes $25m rescue deal with investor
- Apple bid for Samsung sales ban pitched as more modest
- McDonald’s Puerto Rican franchisees say co. broke FTC rule
- Mohegan Sun chases new mkts as Connecticut casino sales slide
- Slim plots Peru to Brazil spending as Mexico unit splinters
- Aereo can operate like cable TV after Supreme Court case
- Burberry sales to Chinese ease concern of fading luxury luster
- June U.S. comp. sales seen inline, helped by weather
- Gtech to make offer for Intl Game Technology soon: Repubblica
- Google to create $100m European venture capital fund: FT
- Bank of England signals skepticism over lenders’ risk modeling
- China said to probe alleged money laundering by Bank of China
- Israel calls up 20,000 troops for possible Gaza ground invasion
- Barracuda Networks (CUDA) 4:15pm, $0.03
- Corus Entertainment (CJR/B CN) 7am, C$0.51
- Family Dollar Stores (FDO) 7am, $0.89
- PriceSmart (PSMT) 4pm, $0.70
- Progressive (PGR) 8:40am, $0.49
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- WTI Crude Heads for Record-Long Slump on Supplies; Brent Slides
- Standard Bank Starts Legal Proceedings in China as Aluminum Held
- Shale Seen Shifting Flows at America’s Biggest Oil Port: Energy
- Gold’s ‘Mr. Fixit’ Using Low-Cost Model on Platinum: Commodities
- OPEC Sees Lowest Demand for Its Crude Since 2009 Amid U.S. Boom
- Sugar Output in India Climbing as Dams Counter Rain Shortage
- Gold Climbs to 3-Month High as Palladium at Highest Since 2001
- Aluminum Premiums Seen Dropping in Reprieve for Beer Makers
- Citigroup Sees More Copper Held Out of China in Financing Shift
- Tin Shipments From Indonesia Hold Near Five-Month High in June
- Corn Holds Below $4 as Soybeans Set for Longest Slump Since 1981
- China Copper Imports to Weaken in July Amid Qingdao Probe: ANZ
- No End in Sight for German Power-Price Volatility at 10-Year Low
- Gold in India Jumps Most Since September as Jaitley Keeps Curbs
The Hedgeye Macro Team
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