“Very simple. It’s going to be a big letdown for everyone. It was process and spot.”
I don’t know about yours, but my multi-factor, multi-duration analysis this summer has revealed that my golf game needs some serious work. The hottest hand on the Hedgeye Research Tour, Howard Penney, reminded me that I need to get Rory’s #process.
After his British Open win, Mcilroy explained “with my long shots, I just wanted to stick to my process and stick to making good decisions… I just wanted to roll that ball over that spot. If it went in, then great. If it didn’t, then I’d try it the next hole.”
Process & Spot - #love that. If we can execute it, consistently, on the Global Macro course of interconnected risk, we’ll make less double bogeys. Remember, it’s those of you who don’t have a lot of blow-up holes that have the best performance track records.
Back to the Global Macro Grind…
In Hedgeye-speak, making our tee-to-fairway swing (process) repeatable means embracing the uncertainty of Mr. Macro Market’s intermediate-term TREND signals:
- If something like Chinese Stocks or Copper signal a bearish to bullish TREND reversal, we buy/cover
- If something like the Russell 2000 or Bond Yields signal a bullish to bearish TREND reversal, we sell/short
In long-bond speak, when we sell bond yields, we buy bonds. And we like it.
When it comes to our shorter-term duration game (putting), we try to manage what we call the immediate-term TRADE risk of the range. In other words, we respect the breaks and try to take the highest probability line of the proverbial putt by:
- Selling if the price is at the high end of the range
- Buying if the price is at the low-end of the range
Yep. So easy a Mucker can do it. What’s differentiated in this process is that I’m consistent in being inconsistent:
- My long shots are playing with the wind (bullish or bearish TREND)
- My putts are playing the breaks (fading last price)
Consensus Macro tends to do the opposite:
- Longer-term – consensus tends to be late in acknowledging bullish and bearish TREND reversals
- Shorter-term – consensus tends to chase, rather than fade, last price
Across both short and longer-term durations, you can see this on the most emotional strokes the Consensus Macro takes (net long or short futures and options bets in Big Macro positioning):
- LONG BOND (10r Treasury) saw a +26,023 wk/wk swing to a net LONG position in bonds now of +5,282 contracts last wk
- SPX (Index + Emini) saw a +37,728 wk/wk swing to a net LONG position in SP500 of +614 contracts last wk
Now, if you only look at these putts in isolation, you’d say that week over week, these were the right lines to take. But if you look at all the swings it took to get to the green, this was the score:
- LONG BOND – consensus net SHORT bet on average of -21,204 and -43,289 contracts for the last 3 and 6 months, respectively
- SPX – consensus net SHORT bet on average of -65,318 and -44,327 contracts for the last 3 and 6 months, respectively
In other words, for the last 3-6 months, Consensus Macro was A) shorting 10yr Treasuries and B) shorting SPY (and C) making double bogeys). You don’t want to be doing that.
And now you don’t want to be getting net long US Equity beta A) after consensus hedge funds have covered SPX shorts, B) Russell 2000 continues to signal bearish TREND, and C) front-month VIX is testing an intermediate-term TREND bearish to bullish reversal.
Or at least my process says you wouldn’t…
With the CRB Food Index and Energy Stocks (XLE) both up another +0.9% last week to +19.7% and +12.8%, respectively (Coffee and Cattle prices are +52.9% and +28.2% YTD), you probably want to stay net LONG our 2014 #InflationAccelerating Theme and short US Consumers (discretionary and housing stocks) too.
In golf sometimes it’s the shots you don’t take that make all the difference. #Process, spot, #process. Rinse and repeat.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.44-2.54%
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
TODAY’S S&P 500 SET-UP – July 28, 2014
As we look at today's setup for the S&P 500, the range is 21 points or 0.62% downside to 1966 and 0.44% upside to 1987.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 1.99 from 1.98
- VIX closed at 12.69 1 day percent change of 7.18%
MACRO DATA POINTS (Bloomberg Estimates):
- 9:45am: Markit U.S. Services, July prelim., est. 59.8 (prior 61.0)
- 9:45am: Markit U.S. Composite PMI, July prelim. (prior 61)
- 10am: Pending Home Sales m/m, Jun, est. 0.5% (prior 6.1%)
- 10:30am: Dallas Fed Mfg Activity, July, est. 12 (prior 11.4)
- 11am: Fed purchases $1b-$1.25b notes in 2036-2044 sector
- 11am: U.S. announce plans for auction of 4W bills
- 11:30am: U.S. to sell $27b 3M, $24b 6M bills
- 1pm: U.S. to sell $29b 2Y notes
- EPA to hold public hearings this week in Atlanta, Denver, Pittsburgh, Washington on proposed carbon dioxide emissions standards for existing, modified, reconstructed power plants
- EU representatives to discuss curbs on trade, investment with Crimea, penalites for business allies of Russian President Vladimir Putin
- 9:30am: Rep. Scott Garrett, R-N.J., holds roundtable on equity market structure with KCG CEO Daniel B. Coleman, SIFMA CEO Ken Bentsen, Nasdaq OMX CEO Robert Greifeld, BATS Global Markets CEO Joe Ratterman, TD Ameritrade CEO Fred Tomczyk among participants; Library of Congress
- 12:15pm: Treasury Secretary Jack Lew releases annual Social Security and Medicare trustees reports
WHAT TO WATCH:
- Danone said to be in talks to sell medical unit to Hospira
- JPMorgan to sell $1.3b of assets to Sankaty Advisors
- Yukos owners win $50b award against Russia
- Global pressure mounts on Israel to halt Gaza offensive
- Goldman said in talks to settle mortgage case for $800m-$1.25b
- Reckitt Benckiser confirms plans to spin off suboxone unit
- China H-shares rise 20% from March low, enter bull market
- Big Mac banished in Shanghai after meat scare prompts recall
- U.S. says satellite photos show Russia shelling into Ukraine
- Fox said open to giving board seats to Time Warner investors
- Microsoft taps Tencent, JD.com for first Xbox sales in China
- Deutsche Bank, HSBC sued for alleged silver fix manipulation
- Armstrong World (AWI) 7am, $0.65
- Capitol Federal Financial (CFFN) 8am, $0.14
- Compass Minerals Intl (CMP) 7am, $0.26
- Cummins (CMI) 7:30am, $2.39
- Old National Bancorp (ONB) 9am, $0.26
- Roper (ROP) 7am, $1.50
- RPM Intl (RPM) 7:30am, $0.78
- Tenneco (TEN) 7am, $1.26
- Tyson Foods (TSN) 7:30am, $0.78
- American Capital Agency (AGNC) 4:01pm, $0.68
- American Financial (AFG) 5pm, $0.94
- Amkor Technology (AMKR) 4:08pm, $0.15
- CNO Financial (CNO) 4:03pm, $0.31
- Cognex (CGNX) 4:06pm, $0.22
- Crane (CR) 4:15pm, $1.16
- Eastman Chemical (EMN) 5pm, $1.84
- General Growth Properties (GGP) 4:01pm, $0.10
- HealthSouth (HLS) 4:30pm, $0.47
- Herbalife (HLF) 4:30pm, $1.57
- Integrated Device Technology (IDTI) 4:01pm, $0.16
- Jacobs Engineering (JEC) 9:30pm, $0.86
- Masco (MAS) 5:15pm, $0.28
- Norwegian Cruise Line (NCLH) 4pm, $0.57
- Owens & Minor (OMI) 5:17pm, $0.46
- PartnerRe (PRE) 4:30pm, $2.62
- Plum Creek Timber (PCL) 4:04pm, $0.30
- Range Resources (RRC) 5:02pm, $0.40
- WR Berkley (WRB) 4:05pm, $0.76
- XL (XL) 5pm, $0.84
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- WTI Crude Drops Before U.S. Economic Data; Brent Falls
- Gold Bulls Boost Bet on Rally as Prices Extend Drop: Commodities
- World Weather Seen Abnormal as El Nino Poised to Develop: Lerner
- Gold Declines in London as Stronger Dollar Curbs Investor Demand
- Lead Reaches 17-Month High on Supply Outlook as Aluminum Gains
- Wheat Production in Parts of Australia Seen Hurt by Dry Weather
- Big Mac Banished in Shanghai as Meat Scare Prompts Probe
- Morgan Stanley Sees Weaker Aluminum Premiums as Contango Shrinks
- China Takes on Hitachi as 17-Year-Old Rare Earth Patent Ends
- Rubber Reaches Three-Week High as Thai Price Drop Lures Buyers
- Steel Rebar Rises Most in One-Month as China Outlook Improves
- Bulls Fleeing Natural Gas as Goldman Sees Further Drop: Energy
- Corn, Wheat Supply Outlook Fully Priced In, ANZ Says in Report
- China’s State Stockpiler Said to Miss Cobalt Purchase Target
The Hedgeye Macro Team
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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.
Outspoken free market economist and TV personality Larry Kudlow explains why America is suffering from the "worst recovery since World War II" and offers solutions on how the U.S. can regain its economic footing once again.
Here’s the question-and-answer portion from Keith’s daily Morning Call with Hedgeye’s institutional subscribers.
Real Americans are about to get eaten.
HARBINGER? CHINA'S BEARISH-TO-BULLISH REVERSAL
Chinese Stocks (Shanghai Composite) closed up another +1.3% last night after China’s best PMI in 18 months.
LEADING VS. LAGGING INDICATORS: YOU CHOOSE
Risk managing macro rarely has anything to do with “valuation” or even reported supply and demand metrics. Most of the big moves in macro happen on the margin when there is a phase transition in price momentum, volume, and volatility.
Measures of volatility suggest investors remain complacent about a variety of risks, including rising global turmoil which could disrupt the calm over the coming months.
The our poll on Wednesday we asked: Which global conflict is a bigger market threat Israel/Gaza or Russia/Ukraine?
At the time of this post, 69% voted that Russia/Ukraine posted the bigger market threat vs 31% that voted for Israel/Gaza.
Takeaway: Current Investing Ideas: BOBE, GLD, HCA, HOLX, LM, OC, OZM, RH, and TIP
Below are Hedgeye analysts' latest updates on our NINE current high-conviction investing ideas and CEO Keith McCullough's updated levels for each.
We also feature three recent institutional research notes which offer valuable insight into the markets 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
BOBE – We continue to like Bob Evans as a long and part of this thesis revolves around a potential value creating transition to an asset light business.
Bob Evans’ significant real estate holdings give management the ability to convert to an asset light model in order to significantly enhance shareholder value. In the restaurant industry, there have been a number of public companies that have pioneered such a transition. We point to Jack in the Box (JACK) as the most recent success story, but numerous others have successfully sold restaurant assets as well.
Two direct competitors in the family dining segment, Denny’s (DENN) and IHOP (DIN), are nearly 100% franchised. Burger King (BKW) has also made an aggressive push to an asset light model in order to generate substantial value for shareholders.
In the restaurant space, franchisees have been known to run restaurants better than the franchisors running the brand. We don’t see why this would be different in the case of BOBE and believe there would be a significant appetite to sell off large blocks of stores.
In an asset light model, we believe BOBE would be able to collect as much as 10-12% of revenues in rent and royalty on a per-store basis. This compares favorably to the current 7% operating margin. In addition, we estimate the company could generate $300-600 million pre-tax in asset sales. The cash generated would allow the company to reduce its current outstanding share count by 20-30%.
Changes of this magnitude will undoubtedly take time, but the numbers suggest the stock would see meaningful upside.
GLD – With a slight bounce in the dollar week-over-week, the 10-year yield and and gold remained relatively flat in advance of the first Q2 GDP print and FOMC statement on Wednesday next week. The bond market needs more evidence of any sustainable dollar strength with the likely catalyst coming with September’s Jackson Hole meeting, We expect a sequential increase off of a very weak -2.9% Q1 print (Note: The Fed expects +2.1-2.3% for the full year, so we would need to see a significant acceleration).
Albeit relatively small this week, the sector variances that ensue when our economy is slowing with cost of living accelerating continue to grind wider:
Week-over-Week % Change:
- XLE: +0.9% Energy Sector that lives on production cost/energy price inflation margin
- TLT: +0.8% We remain long one of our key, non-consensus macro calls moving into this year (10-year yield down from 3.028% on December 31st to 2.47% ... -18.5%)
- December 31st was both the highest point for the 10-year and largest consensus short 10-year position (-175K contracts since). Not only was consensus short in front of a -18.5% move down; It was the largest short position since
- CRB Food: +0.9% Headline inflation crushes everyone; while, unfortunately not all Americans can hedge their cost of living squeeze with Gold or a Treasury bond
- S&P 500: Flat
- Russell 2000: -0.6% Small companies need a strong consumer to justify the growth assumptions baked into valuations
- Consumer Discretionary: -1.10% Stagnating real wage growth with cost of living increases means less real disposable income chasing consumer products
Despite the headline inflation this year, real wage growth declined -0.1% in June on a year-over year basis. If you are one of the minority with the ability to hedge your real earnings power, we continue to recommend an allocation to gold, treasuries, and sectors that do not depend on the disposable income of the consumer.
HCA – The question of what to do with HCA at this price is beginning to become harder to answer. Within our framework, there appears to be adequate upside from here as consensus moves their numbers higher for 2015 and HCA and its peers report solid quarterly results. Zimmer Holdings (ZMH) reported sequentially weaker results in their hip and knee businesses, which is becoming a concern as the aggregate category sales appear to be slowing. If this trend continues, we’ll get more cautious on HCA and hospitals.
On the other hand, we updated our maternity model today with the most recent data from June 2014. The forecast continues to show considerable acceleration into the second half of 2014. With unemployment claims continuing to trend below 300,000 per week, employment trends should continue to be supportive of HCA as well. When it starts to feel like we are playing for just a small amount of upside, we’ll rethink our long position. As of now, there are some cracks, but nothing (yet) that has changed our view.
HOLX – Hologic reports this Tuesday. We think they will report modest upside to their numbers, but we expect some concern about the strength of the Breast Health growth rate. Fiscal 3Q last year is a very difficult comparison based on their disclosures regarding contributions to Breast Health revenue growth. On a year over year basis, the growth rate may look challenged particularly as we have seen placements of 3D systems run slightly lower than the previous quarter. HOLX reacted positively to the upside last quarter in Breast Health revenue.
Given that there remains plenty of bears on the name that we continue to speak with, a disappointing Breast Health revenue print may drive the stock lower on Tuesday. While we still like the name, there is some risk heading into the quarter that we want you to be aware of, and depending on your horizon, trade around.
LM – Legg Mason announced the acquisition of Martin Currie (MC), an Edinburgh-based equity asset manager at the end of the week filling a large hole in their product offering. Martin Currie is a 100% institutional manager that delivers both traditional and alternative equity management and importantly has been in inflow over the past 2 years.
Legg will look to assist MC with their distribution as LM has substantially deeper penetration into U.S. brokerage networks as well as other international relationships.
We calculate the deal will be accretive by at least 2% within the first 12 months and up to 3-4% over a longer period of time. We like the fact that Legg is using its excess capital to enhance its business and not just engineer higher earnings per share solely by reducing its share count.
We think fair value on Legg stock resides closer to $60 per share.
OC – At first, the Owens Corning earnings release did not read well. However, there are encouraging signs masked by weaker Roofing results. Margins in Insulation and Composites (ex-rebuilds) expanded at a healthy rate. Corporate expenses were lower. Much of the report was reasonably positive.
As indicated in OC’s pre-announcement, the Roof segment was weaker than expected. This is a topic of great interest, since it is challenging to pinpoint what is driving the margin pressure. Our understanding is that the change is not structural. Rather, we believe an input price drop early in the year stimulated production during a period of weather-curtailed demand. The resultant excess inventory pressured pricing in a second quarter demand environment that was well below longer-term ‘normalized’ levels. We expect an eventual return to replacement levels of roof shingle demand to resolve these shorter-term challenges. However, this is an understanding we continue to challenge, and we are scheduling another call on roof shingle competition, this time with a focus on distribution.
We are sticking with OC because the Insulation and Composites businesses are tracking well and have significant value creation potential. While we expected margin pressure in Roofing, recent margin pressure has exceeded our expectations. The Roofing pressure does not appear to be structural, but we will continue to try to verify that it is not. However, we expect Insulation and Composites segment margins to expand, with this quarter’s results again lending credibility to that view. Revenues in the Insulation and Composites segments are roughly as large as that of Roofing. We expect the Insulation margin to nearly match that of the Roofing business and Composites margin to reach double digit levels by 2016. In that scenario, OC would generate $5 to $6 per share in EPS, including tax expense, assuming our construction rebound scenario plays out roughly as expected (leaving aside the rough $5/share NOL). That well exceeds current consensus estimates. Our reasonable range of assumptions yield valuation range extending from the mid-40s to the high 60s.
OZM – Market rumors swirled at the beginning of the week that the Department of Justice (DOJ) was softening its stance against Och Ziff on its potential violation of the Foreign Corrupt Practices Act (FCPA). We have always estimated that this issue was well discounted in the stock with an $800 million decline in OZM’s market cap having come about on this FCPA issue based on a $200 million loan, which is part of the reason the stock is on our Best Ideas list as a long.
Despite, the strong move up this week, longer term there is still upside in the stock.
OZM is now trading at 3.5x its incentive fees, right at the midpoint of its 0-7x historical incentive fee multiple. If we assume that the pension tailwind can force this incentive multiple back to new highs, there would be another 15% upside to over $16 per share (stock is at $14) plus investors would clip a 10% dividend yield, so a few ways to get paid here.
RH – Here’s an interesting Macro nugget about Restoration Hardware. It makes sense that it puts its stores in the wealthier areas of the US. If we map out a 60 minute driving radius around each of its existing stores, we see that the average household income is $81,000, versus $65,000 for the average US city. That 25% bump is nice.
But what’s even more interesting is that when we look at how much money households spend each year on home furnishings, it’s $857 on average throughout the US. But in RH territories, the average household spends $1,779/yr – more than double the US average.
We’ve done extensive analysis showing how increasing the size of the existing store fleet will result in meaningful market share growth for RH, at an increasingly higher ROI.
RH remains our top retail idea, even after its recent run.
TIP – Keeping up with the U.S. inflationary data released last week, things are continuing to pick up on the domestic inflation front as another high frequency data point was released.
CPI advanced another +0.3% MoM while holding flat YoY at 2.1%. Moving through the second half of 2014, we should see this accelerate as annual comparisons continue to get easier. This data adds to our conviction in staying long of the iShares Tips Bond ETF (TIP) as a way of profiting from accelerating rates of reported inflation over the intermediate term.
Next week, the ISM Input Prices and GDP Deflator numbers are scheduled to be reported. It is likely these relevant data points add to the U.S. cyclical inflation story should continue to support our long idea in TIPS.
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Well that was short-lived. Last month's NHS report suggested a return to positive momentum. Nothing could have been further from the truth.
Until proven wrong, we continue to believe some of MCD's wounds are self-inflicted and stem from the company's attempt to be all things to all people while over-indexing the business toward beverages.
U.S. stock funds put up their 12th consecutive week of outflow with bond fund inflows holding steady.
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.