Rates of Change

This note was originally published at 8am on August 01, 2014 for Hedgeye subscribers.

“The future is not a point – a single scenario that we must predict. It is a range.”

-Chip & Dan Heath


In Chapter 10 of Decisive, “Prepare To Be Wrong”, the Heath boys nail it with that risk management thought. Translating it into Hedgeye-speak: market tops and bottoms are processes, not points.


Price, volume, and volatility are all dynamic but measurable beasts. You don’t have to be a rocket scientist to be able to visualize their patterns. All you need is a process to score them. It’s rarely an absolute price level that matters – it’s almost always about its rate of change.


Measuring rate of change (slope of the line) won’t help you much unless you contextualize it across multiple durations. We strongly advise that you stand outside your western academic confirmation biases and consider rates of change across multiple factors as well.


Rates of Change - 78


Back to the Global Macro Grind


Multi-factor, multi-duration macro. Yep. That’s how we roll. And after a +64% rip in front-month US stock market volatility (since July 7th) we’re not only going to stick with that process this morning, but also remind you that it’s not Q2. It’s Q3.


They can blame Argentina or my cousin’s neighbor’s brother for yesterday’s levered-long-beta-belly-flop in US Equities (worst down day of the year), but they can’t change that the USA’s PMI print got powdered (rate of change) down to 52.6 in JULY vs 62.6 in JUNE.


They may very well have built inventories into the USA growth-hope narrative in Q2, but in Q3 the PMI (purchasing manager index) looks almost identical to the Industrial Stocks (XLI). Since US Equity volatility bottomed late June, early July:


  1. Industrials (XLI) are down -7.2%
  2. And the Russell 2000 (IWM) is down, well, -7.2%


Forget our #VolatilityAsymmetry Q3 Macro Theme. How symmetric is that?


More importantly, who gets what it’s been signaling? Who is writing about an early-cycle slowdown? These rates of change didn’t start yesterday. Depending on which factor in the US economy you have been measuring, they have been in motion now for 7 months!


What are the early-cycle slowdown sectors of the US stock market?


  1. Housing (ITB)
  2. Consumer Discretionary (XLY)
  3. Industrials (XLI)


All three of these early-cycle sectors are down now for 2014.


“So”, if god called you and said ‘hey, here’s my survey of the US economy’:


  1. Long-term Bond Yields are down -15% YTD (10yr UST Yield)
  2. The Russell 2000 is down -3.7% YTD… and
  3. Housing (ITB) is down -10.5% YTD


What would you say back if you were bullish on something like +3-4% US GDP growth? I think Bill Ackman would say, “my bad.”


I’m not trying to be snarky about this. I’m actually trying to drive my Scottish-Canadian flag right into the front-line of this ongoing culture war I’ve been fighting vs. #OldWall since we started the firm in 2008. You know, and wiggle the Braveheart kilt at them.


Let’s have some bull/bear battles already. At some point, someone out there in Consensus Macro land needs to man-up and just say ‘hey, I’ve missed calling every early-cycle slowdown since 1999, and I’m tired of this Canadian-mutt doing the rate of change thing.’


Now many would argue that consensus economists and strategists in Washington and on Wall Street would rather all be wrong together than wrong all on their own (#JobSecurity). But I think our profession is better than that.


I’m betting someone who is a lot smarter than me is going to change what they are doing and fight me, Red-White-And-Blue style! In every profession in America, there’s always been a progressive rate of change in that too.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.43-2.59%

SPX 1924-1965

RUT 1111-1145

DAX 9206-9613

VIX 13.12-17.91

Brent Oil 105.54-108.79

Gold 1271-1305


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Rates of Change - Chart of the Day


"I believe in focusing on what you do best, instead of a lot of things." -Irwin Simon CEO HAIN


We recently added HAIN to the Hedgeye best Ideas list as a SHORT. 


Irwin Simon was quoted saying the above quote at the time he bought Celestial Seasonings.  Given HAIN has acquired 33 companies over the ten years I’m not sure the old management style still applies.


Yesterday we published a 70 page slide deck outlining our thesis on HAIN (if you would like a copy please email me.)  The thesis centers on three key points:


ACQUISITION FATIGUE - HAIN has been a serial acquirer over the past ten years, acquiring over 33 companies. Although the company owns 50 brands, the 80/20 rule applies. Management is compensated to grow revenues and earnings, incentivizing them to acquire complementary companies. Not all the companies they buy, however, are complementary including a few recent ones that have been margin dilutive. We believe the core-business, ex-acquisitions, is slowing – a fact that management is doing their best to mask.


INCREASING COMPETITIVE LANDSCAPE -April 10, 2014, the day WMT announced it would carry Wild Oats, was the day organic food went mainstream. This move by WMT won’t be ignored by other retailers and will likely force gross margins lower for a number of organic companies. The current pricing umbrella in the organic space will create significant demand for private label products at traditional grocery chains. Can HAIN sustain its current business model in light of the new industry headwinds?


SLOWING TRENDS, MARGIN PRESSURE - HAIN’s absolute gross margins are significantly below its peer group, making it difficult for the company to compete in a more competitive marketplace. The increased competitive headwinds will slow organic growth and keep pressure on gross margins, forcing the company to cut SG&A at a faster rate than anticipated. This increases the likelihood that street expectations are too aggressive. Under such a scenario, the company’s multiple would likely contract.


The last bullet point is critical.  At 26%, HIAN’s gross margins are below a typically strong organic company and put the company in a difficult spot to defend against increased competition.  As we said on page 55 of the slide deck the following are the characteristics of a strong organic company:

  • Notable competitive advantage; highly differentiated product giving the company a strong reason to be in the market.
  • Sustainable gross margin, typically above 40%, which allows the company to reinvest in its brands.
  • Resonates with consumers and helps engender loyalty.
  • Validation across multiple channels.





In addition, HAIN has significantly cut SG&A to levels that are also below its competitors’ making it difficult to support the business.




This has resulted in a significant improvement in operating margins.




How long can management rely on SG&A cuts to make the numbers?

Are they underinvesting in many of their brands?


We believe there will come a time when management must reinvest in their business and will be hard pressed to lever SG&A to the same degree.


If you would like to discuss HAIN further please call any time.


Howard Penney

Managing Director


Fred Masotta





TODAY’S S&P 500 SET-UP – August 15, 2014

As we look at today's setup for the S&P 500, the range is 54 points or 2.52% downside to 1906 and 0.25% upside to 1960.                     













  • YIELD CURVE: 1.98 from 1.99
  • VIX closed at 12.42 1 day percent change of -3.72%


MACRO DATA POINTS (Bloomberg Estimates):     

  • 8:30am: Empire Manufacturing, Aug., est. 20 (prior 25.6)
  • 8:30am: PPI Final Demand m/m, July, est. 0.1% (prior 0.4%)
  • 9am: Net Long-term TIC Flows, June (prior $19.4b)
  • 9:15am: Ind. Production m/m, July, est. 0.3% (prior 0.2%)
  • 9:55am: UofMich Confidence, Aug. prelim, est. 82.5 (pr 81.8)
  • 10:45am: Fed’s Kocherlakota speaks in Brainerd, Minn.
  • 1pm: Baker Hughes rig count



    • Senate, House on Aug. recess; President Obama on vacation on Martha’s Vineyard
    • 2pm: Foreign Policy Initiative conf. call on “Iraq in Turmoil,” with Michael Pregent, adjunct lecturer, Natl Defense University’s College of Intl Security Affairs
    • U.S. ELECTION WRAP: Hawaii Primary Timeline in Flux; Debates


WHAT TO WATCH:          

  • Coca-Cola to gain Monster Beverage stake in $2.15b deal
  • Berkshire redoes pay-TV bets with Charter stake, less DirecTV
  • Billionaire Paulson keeps stake in world’s biggest gold ETP
  • Icahn takes new activist position in Gannett, backs split plan
  • John Paulson bets on Allergan, takes 5.6m shr stake
  • J.C. Penney’s loss narrows as return to roots boosts sales
  • Supervalu says hackers may have stolen U.S. shoppers’ card data
  • Citigroup, JPM, others report July credit-card delinquencies
  • ZF talks to buy TRW Automotive said to hinge on Bosch JV exit
  • Chiquita sticks to Fyffes deal as Cutrale-Safra offer rejected
  • Applied Materials forecasts sales that may top analyst ests.
  • BlackBerry shipments rise from prior quarter under Chen’s watch
  • GM plans top-range Cadillac car, redesigned SRX for next year
  • Maliki resigns as Iraqi prime minister to make way for Abadi
  • U.K. keeps momentum in second quarter with 0.8% GDP growth
  • BOJ officials said to mull cutting growth forecast for 2014
  • Hong Kong cuts 2014 growth target after unexpected contraction
  • BHP eyes Billiton assets split to focus on iron ore to coal
  • Impala Platinum sees profit falling as much as 75% after strike
  • Ackman’s Pershing Square sues U.S. over Fannie, Freddie bailout
  • Samsung buys startup SmartThings to move into smart homes
  • U.S. video-game industry sales rise 16% on console spending
  • Ebola outbreak in W. Africa worse than cases suggest, WHO says
  • Jackson Hole, Yellen, Draghi, Fed Minutes: Wk Ahead Aug. 16-23



    • Estee Lauder (EL) 7:30am, $0.55



  • Billionaire Paulson Keeps Stake in Top Gold Fund as Price Climbs
  • WTI Oil Set for Weekly Loss With Brent on Weaker Demand Outlook
  • Brazil Turns Aluminum Importer as Power Costs Surge: Commodities
  • Copper Rises Before U.S. Factory Output Data as Stockpiles Drop
  • London Silver Price Set at $19.86 an Ounce on First Day
  • Soybeans Drop as Rain Seen Helping Crop; Corn Climbs With Wheat
  • ABN Amro Adds Heads of Metals, Energy to Asia Commodities Team
  • Panama Says a $5.3 Billion Canal Expansion May Not Be Big Enough
  • Libyan Gas Flows to Italy Climb as Russian Supplies Threatened
  • Traders Lured to Bet on Power Overloads Worth Billions: Energy
  • Oil Sands Profits Most at Risk From Falling Crude Price: Study
  • BHP Eyes Billiton Assets Split to Focus on Iron Ore to Coal
  • Copper Traders Bearish on Slowing Economies to Demand Weakness
  • HSBC, Mitsui, ScotiaMocatta to Participate in New Silver Price


























The Hedgeye Macro Team

















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August 15, 2014

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JCP – Dual Duration Call(s)

Takeaway: Doesn’t matter today but at some point in 12 mos the momentum call will give way to LT EPS/valuation call. Not sure if that’s good or bad.

Conclusion: Even the biggest JCP bears have to give credit to Ullman’s team for executing this quarter. That said, it’s a little scary that key P&L and balance sheet levers were so jacked this quarter and yet JCP still lost $0.75 per share. We think it’s critical to bifurcate duration on the JCP call. The near-term call that will likely take it into the first half of next year is all about revenue and margin momentum, with little valuation support. We have a tough time making that call, even though the reality is that it will probably take this stock to $12 within another two quarters. Then there’s the long-term call where the stock looks outrageously cheap (6x p/e, 3x EBITDA, and 25% FCF yield) on our $1.45 in EPS. But our confidence in those numbers is in the bottom quartile of every name we track. Discounting back by 20% suggests that JCP is trading at 13x today – which is about right for a department store on steady-state earnings. The x-factor for us is JCP stepping up its store closures. We think there’s 300 that should be shuttered. Not just bad locations, but also some good ones where the lease could be bought at a premium. In the end, we think the stock is probably headed higher given momentum, and are not averse to owning it so long as it’s on a short leash. But we’d rather hold out for when the research gives us a higher degree of confidence in the longer-term model.


JCP – Dual Duration Call(s) - JCP financials


Full Details

Even JCP bears will have to give some credit to the company for putting up a 6% comp, 640bps Gross Margin improvement, and a 10% inventory reduction. It’s pretty rare to hit that kind of trifecta in retail – especially for a department store. On the flip side of that, it’s scary to see such tremendous metrics on the P&L – growth of 5% on the top line, 28% gross profit, 6% decline in SG&A, and yet have it still result in a loss of $0.75 per share.


This quarter is the best example yet of the two distinct calls that exist here, based largely on duration.


1) There’s the near-term momentum call. That’s the one that’s playing out now. We hate this call. Not because it doesn’t have merit. The reality is that it absolutely does.  It’s the call that will likely take this stock to the low teens over the next 12 months as JCP continues to regain market share (which we firmly believe will happen based on our survey work), take margins higher, and improve its balance sheet. As it relates to market share, our work suggests that the two retailers most exposed to a revived JCP are KSS and M. Collectively they picked up over $1.5bil of the $5.9bil in sales that JCP coughed up over the past three years. That’s a lot more meaningful for KSS in percentage terms, and we don’t think KSS sees JCP coming.That said, this momentum in business recovery has so little valuation support because the company will continue to lose money for at least another two years.

JCP – Dual Duration Call(s) - JCP market share


2) That takes us to the longer-term (Tail) call. This is one that makes more sense to us, as we can model even a partial productivity rebound with a sub-peak margin, and we build up to $1.45 in EPS by the end of our model (’18). Keep in mind that all JCP needs to do is go from being ‘the worst apparel retailer’ to being just plain bad. While bad isn’t what we typically aim for in scouting out good long candidates, the math checks out. Going from trough sales per sq. ft. productivity levels in 2013 at $110 to $145 in 2018 would mean an incremental $4bil in revenue. As the chart below shows, that would put JCP’s productivity just ahead of where Dillard’s stands today, 22% below Kohl’s and its Agenda of Excellence, and 25% below JCP’s own peak – something it will likely never see again (but doesn’t have to). 

JCP – Dual Duration Call(s) - SPSQFT

One key consideration is that we can model these changes til we’re blue in the face, but if management does not have a plan to get there, then it’s a wasted exercise.  That’s been our concern over the past year with Ullman at the helm. But on today’s conference call, we heard management make the first mention of a strategic plan that we’ve heard since Johnson was given the boot last year. They didn’t say what the plan is, and we have no idea if it will be a good one until we hear it live at the October analyst meeting. But even a mediocre plan is better than no plan.

If we use $1.45 in earnings, $1.6bn in EBITDA, and $2.30 in free cash flow in 2018, the stock at $9 is flat-out cheap across the board (6.4x earnings, 3.1x EBITDA, 25% FCF yield). But the problem is that we’re talking 5-years away. There are some companies where we can build a highly quantified and extremely defendable 5-year model. But our confidence level in our JCP 5-year numbers is low relative to where we stand with other companies. If we simply take up our risk premium on $1.45 in EPS and discount it back by 20% annually, then it suggests that today JCP is trading at about 13x normalized earnings. Maybe 20% is too steep, but we’ll take a conservative stance given that we have no clue what management intends to accomplish after the next two quarters.


What will get us really excited?


If they articulate a plan to close stores – a lot of them. Our analysis shows that there’s about 300 stores that should be closed. The company has not agreed with us in the past. But we think that changing dynamics in the real estate landscape is creating opportunities for JCP to jettison its less profitable stores, and get out of malls where it simply does not belong. Here’s a hypothetical example we whipped up for the Cherry Hill Mall in NJ. Currently JCP is one of three anchor tenants in an A mall. It’s likely doing only $165/ft, which is far too low for that property. The problem is that JCP’s customers don’t shop there. The property owner is generating $10mm in income today based on the existing productivity, but if it buys out the JCP lease, and converts to higher productivity concepts (such as Restoration Hardware, Cheesecake Factory, and Whole Foods, for example) the implied REIT income goes up to $24mm per year. Clearly, there’s enough to buy out JCP at a steep premium and still have money left over to build some walls to subdivide the store. As a frame of reference, JCP has about 140 ‘A’ mall locations.


JCP – Dual Duration Call(s) - JCP 4


JCP – Dual Duration Call(s) - JCP 5


Stock Report: CurrencyShares British Pound Sterling (FXB)

Stock Report: CurrencyShares British Pound Sterling (FXB) - HE II FXB table 8 14 14


On 8/13/14 we issued a buy signal on the GBP/USD (via the etf FXB) in our Real-Time Alerts with the cross reaching our immediate-term TRADE oversold level ($1.67) within our bullish long-term TAIL view (support = $1.65).


At the time of our signal the GBP/USD had corrected -2.2% M/M and took a leg down following the BoE’s release of its August Inflation Report. We believe the weakness reflected:

  • UK wage growth that fell -0.2% in Q2 Y/Y (the first decline since 2009)
  • BoE Governor Mark Carney rhetorically pushing out expectations for a rate hike to at least late 1H 2015 (though no specific guidance was given)

Despite the near term correction, the GBP/USD is up +12% since it troughed on 7/5/13 and we expect the cross to continue to be supported higher based on healthy underlying fundamentals into 2H, especially versus what we expect to be economic weakness (below consensus) and dovish policy out of the Eurozone and U.S.


INTERMEDIATE TERM (TREND) (the next 3 months or more)

Over the intermediate term TREND, we expect strong fundamentals to drive a strong Pound:

  • Low Unemployment: the UK unemployment rate to drop below 6.0% by year end (the most recent reading fell 10bps M/M to 6.4%, the lowest level since 2008)
  • Strong Growth, especially versus peers: the BoE revised up its expectation for near-term growth to 3.5% in 2014 (vs ~1% for the Eurozone)
  • Managed Inflation: the tax of inflation has moderate and CPI (currently at 1.9% Y/Y) is near the 2.0% target

Stock Report: CurrencyShares British Pound Sterling (FXB) - chart


On central bank policy, we expect a more dovish policy response from the ECB and Fed versus the BoE that should be supportive of the Pound versus the USD and EUR:

  • Janet Yellen’s commentary suggests she remains an uber dove: (See Reuters article with current and former Fed officials indicating that Yellen and core decision-makers at the U.S. central bank are determined not to raise interest rates too early and risk hurting the fragile U.S. economy). We’ll be watching her Jackson Hole commentary beginning August 21 for a confirming dovish outlook.
  • ECB’s Mario Draghi looks poised to issue QE over intermediate term. Following the June announcement of the issuance of the TLTRO programs to unlock lending, come Fall he may begin QE-lite purchases (via ABS). A hike in rates (after cutting in June) appears highly unlikely over the next year plus given underlying weak fundamentals and inflation expectations that are likely to miss on the downside.  

Essential to our thesis on FXB is expectations around economic growth and the policy stance of central bankers. If and when these expectations shift, so will we, however under the current set-up, we expect the British Pound to be a relative winner, especially versus the USD and EUR. 


Stock Report: CurrencyShares British Pound Sterling (FXB) - HE II FXB chart 8 14 14

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