Below are Hedgeye analysts’ latest updates on our nine current high-conviction long investing ideas and CEO Keith McCullough’s updated levels for each.
We also feature three recent institutional research notes that offer valuable insight into the markets and the global 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
CARTOON OF THE WEEK
IDEAS UPDATES
Staying Long TLT; Adding EDV
(We added EDV Vanguard Extended Duration ETF to Investing Ideas on Friday.)
What an awesome week it’s been for bond bears. In addition to the -2% decline for the iShares 20+ Year Treasury Bond ETF (TLT) and the -3.6% decline for the Vanguard Extended Duration Treasury ETF (EDV), a new leader emerged amongst the consensus bond bear lobby – legendary hedge fund manager David Tepper.
While Tepper’s returns since 2009 have been nothing shy of brilliant – as any levered-long equity fund’s returns should be – we don’t think it pays to get caught up in the emotion of it all and sell your bonds here.
Specifically, the data would support actually adding to safe, long-duration assets here. Looking to the brutal AUG Jobs Report – which was appropriately foreshadowed by misses in the ADP Employment Report and Initial Jobless Claims – we see that:
- Nonfarm Payrolls slowed to a pace of +142k MoM from a revised +212k pace prior
- Private Payrolls ticked down to +134k MoM from a revised +213k pace prior
- Average Hourly Earnings and Average Weekly Hours held flat at 2.1% and 34.5, respectively
Our backtest studies show long-duration Treasuries rally strongest when domestic economic growth slows – which is precisely the outlook we have for the US economy in 2H14.
Layer on economic weakness and fears of deflation in the Eurozone, and you have a potent cocktail for declining interest rates here in the US. In particular, we’ve found that long-duration German Bund yields, long-duration French OAT yields and medium-duration German breakeven rates have explained 56-75% of the rate of change in 10Y Treasury yields over the trailing intermediate-term duration.
In short, buy bonds; nothing has changed fundamentally.
FXB: The GBP/USD is down around -1.7% on the week, beat down on a couple factors:
- Increasing support for Scottish independence. A YouGov poll out on Monday showed a mere 6 point spread to “no” versus a 22 point spread in early August. The expeditious closure of the gap caught us by surprise, although our outlook remains that the populous will vote down independence.
- Marginal strength in the USD. European Central Bank President Mario Draghi cut rates and signaled that the ECB is willing to lever up its balance sheet to 2012 levels, or to the ~ €3Trillion versus the current ~€2Trillion.
Otherwise, data out this week was mostly bullish for our positioning:
- The Bank of England (BOE) kept rates unchanged at 0.50% and the asset purchase target unchanged at £375B
- UK August BOE/GfK Inflation (next 12 months) indicated higher inflationary conditions, to 2.80% versus 2.60% prior
- UK Construction PMI rose to 64.0 in August vs 62.4 prior; Services PMI rose to 60.5 in August vs 59.1 prior; and the Composite rose to 59.3 in August vs 58.6 prior
- UK Car Registrations rose to 9.4% in August Y/Y vs 6.6% prior
As a reminder, our positioning in the cross remains based on what we see as relatively healthy underlying fundamentals for the country into 2H (to drive strong UK = strong Pound), versus our forecast for decelerating growth trends in the U.S. and Eurozone, combined with dovish policy expectations from central bank heads Draghi and Fed Chief Janet Yellen.
Recent BOE Minutes showed that for the first time in more than three years there were 2 votes to increase interest rates (by 25bps). We expect this marginally more hawkish tone taken together with the outperformance of UK growth over the US and Eurozone in 2014 to push the GBP/USD higher.
GLD: Gold has been in a BULLISH set-up on an intermediate-term TREND duration for all of 2014. Draghi proved his ability to move the Euro this week and Gold broke its $1271 TREND Line of support this week on the back of the ECB’s rate cut on Thursday:
- Benchmark Rate: cut from 0.15% to 0.05% (0.15% est.)
- Marginal Lending Facility: cut from 0.40% to 0.30% (0.40% est.)
- Deposit Facility: cut from -0.10% to -0.20% (-0.10% est.)
With growth slowing in both the U.S. and Eurozone, most of the commentary into the ECB decision this week echoed speculation as to how soon the ECB would implement a quantitative easing type program. Of importance is that Draghi and the policy committee does not yet have the authority to implement a broad-based asset purchase program. The policy path to a further rate cut was largely unexpected but it was one of the tools readily available to prove Draghi would standby his “anything it takes” rhetoric.
With the ECB moving to devalue, Yellen will get her chance next to play the FED hand at the FOMC’s policy meeting in two weeks. If Friday’s non-farm payrolls (NFP) report is any indication, she certainly won’t surprise consensus macro she’ll be easing up on the QE pedal any faster than already expected.
- Change in NFP: +142K for August vs. +230K estimate (+209K prior)
Gold and bonds catch a bid on the number as growth continues to slow on the margin in the U.S. The reactionary policy response is straightforward, and Yellen will have the next formal stage chance to talk the dollar down at the FOMC policy meeting in two weeks which would be bullish for gold on the margin:
- Currently below its $1271 TREND Line (previous support)
- The move below $1271 would have to hold for confirmation: GOLD CURRENTLY NEUTRAL ON A TREND DURATION
HCA: In meetings this week at sell-side conferences, hospital executives have apparently been talking about a sequential slowdown in volume, which we’ve heard from some people who met with companies.
Universal Health Services (UHS) made headlines during a 2-day selloff in the group talking about a third of their strength in recent quarters coming from the ACA. That was taken to mean that Affordable Care Act (ACA) had led to an early 2014 bonus of patient volume, but also that 30-40% of the volume upside would fade in the second half. When we listened to UHS’s presentation at the Baird conference, we heard a more positive outlook than what the stocks were reflecting on big volume down moves. We thought Steve Filton, as usual, sounded measured and reasonably positive.
Then, moving over to the HCA presentation, we heard what can only be described as a continuation of their positive commentary from 2Q14. So are volumes soft and getting weaker? Our macro overlay work suggests that the positive environment that really began back in 3Q13 is continuing. But as always, we’re monitoring trends and looking for reasons to change our mind.
The only negative we’ve seen is in a monthly trend for US ICD volume, key for high margin cardiovascular cases and revenue trends for companies such as BSX , MDT, and STJ. But our initial take will be to look at the short side there and stay long HCA.
Our survey data is in which will give us a look at maternity and patient volume trends. More later.
HOLX: Our OB Survey data for August/September came in this morning. It shows patient volume declined in August and year-over-year pap trends were down an adjusted -17%.
In meetings with clients this week, we heard that the CEO is making some strongly positive comments about reducing their tax rate significantly near term. It's something they have commented on publicly, helps earnings, but is not part of our thesis. We just don’t think people pay a multiple for below the line upside, they pay for revenue growth.
In that light, out Tomo Tracker update was very soft for August. After converting a record 35 facilities in July, we found only 15 new facilities in August, almost a record low. What may explain the slowdown, however is the approval of GE’s 3D system. News of upcoming approvals are often previewed to customers, and telling prospects to hold off is a likely possibility.
But the better news in GE’s approval is what we’ll see when CMS releases their revised mammography codes in November. A big reason it has taken so long for CMS to revise their codes and possibly add reimbursement for 3D scans, was the absence of GE on the market. With both players approved, a major political hurdle is off the table. It's still a big uncertainty what if anything 3D scans will receive in excess of a normal mammography. We’re hopeful there is at least a modest bump for 3D which can drive significant adoption. A slow august is concerning….but more later.
OC: As we have mentioned in previous notes, a more favorable environment stemming from economic indicators may be a tailwind in the back half of 2014 for Owens Corning. We are now seeing some encouraging signs from some recent economic data.
This week the Census Bureau’s construction spending data came in favorably for July. Total construction spending increased 8.2% year-over-year, while total private spending increased 10.9%. More importantly, total nonresidential spending increased 8.6% year-over-year and sequentially 2.5% led by lodging, office, power, and manufacturing segments. Private nonresidential spending increased at 14.1% year-over-year, while private residential spending increased 7.6% year-over-year.
OZM: Financials analyst Jonathan Casteleyn has no update on Och-Ziff.
RH: Restoration Hardware is set to report earnings on Wednesday, September 10 after the close. For the quarter we are at $0.77, 20% higher than consensus.
Here are some factors that we think about as it relates to the print. To be clear, after vetting these factors we still come out positive. But let’s lay it all on the table such that there are as few surprises as possible.
- Buying shallow. When the company launches a Sourcebook, it usually does so with a redesigned product line, which is exactly what it did with its goliath 16-lb book that was distributed to customers via UPS from mid-May through early-June. But given the ever-growing breadth of RH’s product line – the company has a tendency to go very shallow with inventory around the book. The strategy is simple…let consumers tell you over the course of 2-3 months which items they like the best, and then go very heavy on inventory for those items in the subsequent three quarters. That means that growth will be more heavily weighted towards the back half of the year. For the year, it is a strategy that clearly maximizes gross profit dollars and ROIC. But there could be a shift between 2Q and 3Q.
- Deferred Revenue. The RH-haters out there love to talk about the company’s deferred revenue as customers wait 10-weeks or more for custom items (keeping in mind that RH does not get paid until the customer takes delivery). In 2Q14 we could see an uptick in deferred revenue around non-custom items due to the strategy around buying shallow that we outlined in point #1. It could provide ammo for those RH bears who want to poke holes in the company’s revenue recognition. We’re not worried about the economic reality -- but just the perception based on how some people will take it.
- Margin Weakness. With any new assortment, margins will usually be lower given that the company will not have hit its own costing hurdles to lower its COGS (cost of goods sold) on high volume. The margins will be better on the product 3-4 quarters out when RH focuses its inventory spend on key items and gets additional volume discounts. Initially, it will be buying some items that might not be as popular as it otherwise planned. That leads us to think that there’s the potential for a margin ramp throughout the year.
- Dead Rent. RH is officially in growth mode. It opened the Greenwich store successfully in May and the Flat Iron store in NYC in June. Then there’s Atlanta and Chicago in 2H followed by a meaningful acceleration in 2015. It takes between 6 to12 months to complete a store. The bigger the store, the more time it will take. And make no mistake, the stores are getting bigger. While the company is overseeing construction, it is paying rent – and a lot of it. It’s known as Dead Rent, and it has never been a part of the RH equation as it has been in store shrinking mode. But there will be a meaningful ramp in rent over the next 12-18 months, and we’ll see some of it this quarter. The company is getting great deals, which helps. For example, the Greenwich store just opened up at $1.1mm in annual rent. That seems like a lot, but it is replacing a store up the street that is one-third the size where they pay $1mm in rent. That’s only $100k extra for about 15,000 extra square feet. The ROI is astounding. But as it relates to quarterly occupancy costs, there is clearly some overlap. We think we’re accounting for all this correctly. But it is an area where we could be wrong on the near-term earnings flow.
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