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The Velveteen Bear

This note was originally published at 8am on September 08, 2014 for Hedgeye subscribers.

“You become. It takes a long time.”

-Margery Williams


That’s a quote from one of the best children’s books I have ever read to my kids, The Velveteen Rabbit. It was also cited in Brene Brown’s recent #behavioral book, Daring Greatly (pages 110).


“Real isn’t how you are made… it’s a thing that happens to you.”

“Does it hurt?” asked the Rabbit. “Does it happen all at once, like being wound up – or bit by bit?”

“It doesn’t happen all at once,”  said the Skin Horse. “You become. It takes a long time.”


While that resonates with me as a husband, Dad, hockey coach, etc., it really hits the nail on the head in becoming a Velveteen Bear on the US stock market. I haven’t been this bearish since the fall of 2007. Getting really bearish is a process. It takes time.

The Velveteen Bear - v7


Back to the Global Macro Grind


After Europe moved back into crisis mode (easing, printing, praying) and we received the worst US jobs report in 7 months, you just have to buy the all-time-bubble high in SPY on that, right? Right. Maybe with other people’s money.


After almost (I reiterate, almost!) having its first-four-down-days in a row of 2014 on Friday, the SP500 rallied from down to up on the day, to close up a whopping +0.2% on the week. That’s 5 consecutive “up” weeks. #hooray


In other news, the Russell 2000 (which derives 80% of its revenues from the US) flashed yet another bearish divergence, closing down -0.4% on the week to pretty much flat for 2014 YTD.


To give US equity bulls credit, this is what I liked about last week:


  1. After the ECB torched the Euro, the US Dollar (vs. the Euro) was up another +1.4% on the week
  2. The US 10yr Treasury Yield rose +12 basis points on the week to 2.46%
  3. The Yield Spread (10yr minus 2yr) widened +10bps on the week to +195bps


Not only was that something to like last week, it was something I loved all of last year. Dollar Up, Rates Up – that’s what should drive a US growth bear insane.


Other than the Russell 2000, what I don’t like in 2014 is that a key component of the Dollar Up, Rates Up storyline is missing - rates are down, hard, in 2014:


  1. Inclusive of last week’s bounce to lower-highs, the 10yr yield is -19% (or -57bps) YTD
  2. For 2014 YTD the Yield Spread (10yr minus 2yr) is still crashing (-26%) or down -70bps


In conjunction with these classic early cycle slow-down macro signals (which most European growth bulls said weren’t growth slowing signals until the ECB reminded them how fast things were slowing), you’ve seen:


  1. Early Cycle Stocks (Housing, Consumer Cyclicals, Regional Banks, the Russell, etc.) underperform
  2. Slow-growth #YieldChasing Stocks (Utilities, REITS, Big Cap Dividend Stocks, etc.) outperform


In case you aren’t long something like Argentina (stock market up another +6.1% last week to +93.2% YTD) whose economy still sucks, and you’ve stayed with the long #YieldChasing thing:


  1. Utilities (XLU) were up another +0.8% last week to +14.9% YTD
  2. REITS (MSCI index) were up another +1.0% last week to +19.6% YTD


Seriously. Who needs to be long the spoos when you can be long the good stuff!


While Ocham’s Razor (boil it down, simplify) is a really sexy concept, you can’t over-simplify. While a stronger Dollar (burning Euro) has toned down some of the commodity #InflationAccelerating that we saw in the first half of 2014, at some point you have to ask yourself if it’s going to be incremental enough to stop an early cycle US slowdown that’s already in motion?


To contextualize that key risk management question, don’t forget that the US is 63 months into this economic expansion. And the jobs market (both ADP slowing for 2 consecutive months and last week’s jobs report), which is a classic late-cycle indicator that strengthened, well, at the end of the cycle… is starting to hint that the bond market has #Q3Slowing nailed.


If US jobs and housing data slows, at the same time, what do you think Janet is going to do next? That’s right. She’ll do A) what Draghi just did and B) the Japanese are going to keep trying – moarrr incremental easing… That’s bullish for bonds and anything stocks that looks like a bond. And that’s all your cuddly Velveteen US Growth Bear has to say about that.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr yield 2.32-2.46%

SPX 1994-2009

RUT 1151-1181

VIX 11.34-12.92

EUR/USD 1.29-1.32

Gold 1257-1298


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


The Velveteen Bear - Chart of the Day

CHART OF THE DAY: Behold the IPO Bubble $BABA

Takeaway: Friday's Ali-Bubble IPO was "one of the most epic US stock market days I’ve witnessed in my career" said Hedgeye CEO Keith McCullough.

CHART OF THE DAY: Behold the IPO Bubble  $BABA - Chart of the Day

Friday's Frenzy

“Where  is the lightning to lick you with its tongue?”



That’s another great quote from the latest #behavioral book I have been cranking through – The Rise of Superman, by Stephen Kotler. It’s also the perfect aphorism for one of the most epic US stock market days I’ve witnessed in my career.


Did the thunder and lightning of the Ali-Bubble lick you on Friday? Rising like a phoenix to market caps greater than General Electric (GE) and WalMart (WMT), the BABA licked someone, big time, at $99.70 (top tick of the day).


But what’s dropping $25 billion dollars or so in a few hours of trading amongst friends? Never mind it dropping to $90 intraday. As long as you owned it at $68, you crushed it. “Behold” the IPO bubble. “He is the lightning; he is the frenzy.” –Nietzsche


Friday's Frenzy - 79


Back to the Global Macro Grind


All the while, amidst Friday’s frenzy, the rest of the global macro market did not cease to exist. After the SP500 had herself an epic outside reversal, the Long Bond (TLT) rallied and the Russell 2000 got licked for a -1.4% drop on the day.


In one of the more peculiar “secular bull” markets (or whatever they’ve been calling a market that’s gone up for 5 years), the Russell 2000 is now down for 3 consecutive weeks and -1.4% for 2014 YTD (vs. the slow-growth Long Bond TLT = +12.9% YTD).


“So”, now the question is, has the licking in illiquidity already begun?


Illiquidity, as in small caps that trade by appointment – but usually on big volume, on down days (when everyone has to get out at the same time)… if you have been long 1 of the 41% (stocks in the Russell that have had greater than 20% declines), you get what I mean.


Perhaps this is Mr. Macro Market’s message: if you’re going to get long of the frenzy, you should just buck up and go big cap like the BABA and the Facebook (FB). If you’re going to pay 18-28x revenues for something, you might as well be able to get out!


We call this small cap vs. large cap performance gap a Style Factor Divergence. When I worked at Magnetar Capital, our “book” would be characterized this way. If you were long “size” as a style factor, you’d be long big caps. I would definitely have that on right now.


In terms of protecting my personal net wealth, the biggest “size” bets I tend to gravitate to are:


  1. Cash
  2. Long-Term Treasuries
  3. Equity Short Sales


Not everyone rolls that way. Call me conservative, but when I hear the thunder rolling in, I don’t wait around for the performance-chasing lightning!


Here’s another big cap “size” bet that was working last week:


  1. US Healthcare Stocks (XLV) +1.7% on the week to +17% YTD
  2. Vs. MSCI REITS Index -0.3% on the week to +12.9% YTD


As many a big cap Portfolio Manager has reminded us this year, they love our Long Bond (TLT, EDV, etc.) call but can’t get really long of stocks-that-look-like-slow-growth bonds (Utilities and REITS) because they aren’t big cap stocks in their benchmark.


As a Global Macro Risk Manager, my benchmark is not losing money. You can dial up plenty a broker/banker to tell you what to chase on the long side. I’m the one you pay while they are sleeping. I’m the one who surveys the land before dawn.


Another interesting macro divergence last week was:


  1. European Stocks (EuroStoxx 600) +1.2% on the week to +6.2% YTD
  2. Emerging Market Stocks (MSCI Index) -0.5% on the week to +5.4% YTD


I call it interesting because I think you fade the fear on that trade too. In other words, you buy EM on the dip and sell European Equities on the bounce. My research team and I will explain why on our Q4 Macro Themes call, which we’ll host on October 2nd.


The upshot of our current call has mostly to do with phase transitions in both growth and inflation. We think that both the Russell 2000 and the 10yr bond yield (down 3bps last week and -45bps for 2014 YTD) look a lot like Europe and US inflation – slowing.


And while you may have never experienced thunder and lightning when everyone is tilted to the levered long side of a performance chasing boat, you have seen both growth and inflation slowing (at the same time) before. It was Q3 of 2008. Now that was a frenzy!


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.42-2.62%


RUT 1140-1158

VIX 11.66-14.12

Pound 1.62-1.64


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Friday's Frenzy - Chart of the Day

Attention Students...

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September 22, 2014

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TODAY’S S&P 500 SET-UP – September 22, 2014

As we look at today's setup for the S&P 500, the range is 19 points or 0.67% downside to 1997 and 0.28% upside to 2016.                                                      













  • YIELD CURVE: 2.01 from 2.01
  • VIX closed at 12.11 1 day percent change of 0.67%


MACRO DATA POINTS (Bloomberg Estimates):

  • 8:30am: Chicago Fed Natl Activity, Aug. est. 0.33 (pr 0.39)
  • 9am: ECB’s Draghi speaks in Brussels
  • 10am: Existing Home Sales, Aug., est. 5.20m (prior 5.15m)
  • 10:05am: Fed’s Dudley speaks in New York
  • 11am: U.S. to announce plans for auction of 4W bills
  • 11:30am: U.S. to sell $24b 3M bills, $23b 6M bills
  • 7:30pm: Fed’s Kocherlakota speaks in Marquette, Mich.



    • Senate, House out of session
    • 8:15am: FDIC Chairman Martin Gruenberg speaks at American Banker Regulatory Symposium in Arlington, Va.
    • 4pm: Treasury Sec. Jack Lew gives speech on economics of climate change at Hamilton Project-hosted event, followed by roundtable discussion with former Treasury Sec. Robert Rubin
    • 4:15pm: Comptroller of the Currency Thomas Curry speaks at American Banker Regulatory Symposium in Arlington, Va.



  • Siemens buys Dresser-Rand for $7.6b to expand in oil equipment
  • Tesco starts probe after overstating profit guidance by ~$408m
  • Alibaba’s bankers said to increase shr sale size to record $25b
  • Apple iPhone 6 Plus outselling smaller model: Piper survey
  • Apple iPhone weekend sales preview
  • Deutsche Bank says currency trader dismissed on misreporting
  • U.S. Treasury seeking to close tax address loophole, Lew says
  • Blackstone halting efforts to find deals in Russia: FT
  • Google selects HTC to make 9-inch Nexus tablet: WSJ
  • Emirates airline plans U.S. expansion as widebody fleet grows
  • Insider buying dries up defying $275b of buybacks
  • Clorox said to reject takeover offer with 20% premium: NYPost
  • Mitsubishi Corp. offers to buy Norway’s Cermaq for $1.4b
  • Total to cut costs, sell assets after lowering output forecast
  • SK buys shale gas asset from Continental Resources: MoneyToday
  • German union calls strikes at Amazon warehouses: Reuters
  • China Finance Chief Lou say eco growth faces downward pressure
  • UN’s Ban joins 310,000-strong march for climate action



    • AutoZone (AZO) 7am, $11.26
    • Neogen (NEOG) 8:45am, $0.23


  • Nickel Leads Industrial Metals Lower on Outlook for Slower China
  • Commodities Extend Declines to Five-Year Low in ‘Capitulation’
  • Hedge Funds Make Record Bet on Lower U.S. Diesel Prices: Energy
  • Gold Is Little Changed Near Eight-Month Low as Silver Declines
  • Corn Declines With Soybeans to 2010 Lows on Increasing Supplies
  • Brent Crude Declines on Concern China Growth Slowing; WTI Drops
  • Indonesian Police Probe Clears 82 Tin Containers for Exports
  • Iron Ore Futures Decline Below $80/MT to Record Low in Singapore
  • Rubber Production Seen Declining by Consortium of Top Exporters
  • Merkel’s Taste for Coal to Upset $130 Billion Green Drive
  • Al-Amoudi to Invest $500 Million in Ethiopian Coffee, Oranges
  • U.K. Royal Mint Starts Online Trading Site for Gold Coins
  • Libya Crude Oil Production at 700k B/D, NOC Spokesman Says
  • Gasoline Pump Prices Seen Falling After Slump to 7-Month Low
  • Gold Bulls Extend Longest 2014 Exit as Prices Drop: Commodities


























The Hedgeye Macro Team

















Investing Ideas Newsletter

Takeaway: Current Investing Ideas: EDV, FXB, GLD, HCA, OC, OZM, RH, TLT and XLU.

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.

Investing Ideas Newsletter    - lev5


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


Investing Ideas Newsletter    - Apocalypse Fed 09.18.2014




Be prepared to get positioned defensively in the U.S. Quad #4 includes both economic growth and reported inflation slowing domestically. Based on negative reflections into Q3, i.e. slowdown of actual economic activity into 2H14, we notably caution investors that:


  • Headline inflation: CPI is now averaging +1.85% on a YoY basis, down from average of 2.1% in Q2
  • #ConsumerSlowing: Contrasting positive trends in both consumer credit and survey data, domestic consumption trend data shows ~70% of actual GDP that is Real PCE slowed to a +2% YoY in JUL
  • Recent survey data from the Fed, shows Median US consumers are severely impacted by all-time highs in key expenditure buckets and #HousingSlowing due to slowing home price appreciation
  • Labor market deterioration in recent months: the seasonally adjusted MoM nominal growth rate of Nonfarm Payrolls slowed sequentially to +141k in AUG

With both economic growth and reported inflation slowing domestically, we are now in a markedly different economic environment than what we saw in the second quarter. For the Q314 in particular, we see Real GDP growth in a range of +1.6% YoY to +1.8% YoY (that would translate to +1.3% on a QoQ SAAR basis) – i.e. less than half the rate of the Bloomberg consensus forecast of +3%.


We continue to expect a marginally dovish response from the Federal Reserve – particularly relative to near-consensus expectations of a tightening cycle commencing in 2H15. According to this week’s FOMC statement, a dovish Fed has revised their 2014 and 2015 Real GDP growth projections down +2.0% to 2.2% and 2.6 %to 3.0% respectively, narrowed their forecast for 2015 PCE Core Price Inflation to +1.6% to +1.9%, and failed to the remove the “considerable time” language in their Fed Fund Rate post the end of their large scale asset purchase programs.


From a tactical asset allocation perspective, our GIP model would suggest Quad #4 requires a defensive allocation. We think investors should be in bonds and defensive, bond-like equity exposure and out of both the domestic growth style factor(s) and inflation hedges. Note: Quad #4 is not a good place to buy REIT securities.


This is why we continue to favor TLT, EDV and XLU on the long side.


The voting results are in: the Scots squashed independence 55% NO to 45% YES, and with it we witnessed a relief bounce in the GBP/USD. As the chart below depicts, we fortuitously bought the bottom. 

Investing Ideas Newsletter    - hed

Over the medium term, we continue to like the cross based on what we see as relatively healthy underlying fundamentals for the country in 2H (to propel 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 Mario Draghi and Janet Yellen.


This week we got encouraging high frequency data:


  • UK Retail Sales rose 3.9% in August Y/Y vs 2.5% in the month prior
  • UK ILO Unemployment Rate dropped 20bps to 6.2%


Recent BOE Minutes showed that for a second straight meeting there were 2 votes to increase interest rates (by 25 basis points). 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.


Gold was for sale Wednesday from Janet Yellen’s 2:00p.m. statement, but the follow through was less confirmatory:

  • Gold fell from $1236 to $1216 from the time she took the stage until after the close of U.S. markets at 4:00p.m.
  • The U.S. 10-year yield ticked up ~7 bps over the same time period (continued higher Thursday)
  • The U.S. dollar caught a solid bid finishing Wednesday +79bps

Investing Ideas Newsletter    - 890


The gold market bounced slightly on the week off the Wednesday afternoon lows and the dollar pulled back on Thursday. The immediate reaction from the market suggests she used a more hawkish tone, but U.S. economic data this week certainly didn’t support this assumption:


  • Building Permits m/m -5.6% August vs. -1.6% est.
  • Housing Starts m/m -14.4% August vs. -5.2% est.
  • CPI y/y +1.7% Aug. vs +1.9% est.
  • Industrial Production m/m -0.1% Aug. vs. +0.3% est.


With central planners abroad forcing a weaker EURO YEN combating the Federal Reserve’s reaction to growth slowing and inflation missing, does the USD run vs. Gold sell-off have room to run into the end of the year? Our takeaway from Yellen’s commentary leads us to believe the non-consensus outlook for a marginally weaker dollar into Q4 remains intact:


  • The conveyance of the timing for a rate hike did not change (the “considerable time” language remained)
  • Growth expectations were cut as we expected (Full-year 2014 expectations are still below our internal forecasts)
  • We are sticking with what has been a consistent and straightforward asset allocation in 2014:
    • Long growth-slowing (Utilities and Long-term treasuries with an exhaustion of rates on the back end of the curve)
    • Long gold from here on an easier fed/weaker USD vs. expectations


As we’ve been writing in recent weeks, the job from here is to keep our head on a swivel, monitor trends closely, and tread carefully as we approach the question of selling the stock.  Incremental this week was a meeting with a very large holder of the stock (who remains very positive), a consumer survey, model review, and macro update.


Google Consumer Survey:  We initiated a survey using Google’s Consumer Survey and have linked the results here.  Initially, the survey is designed to capture a baseline value for future samples, but what we found was interesting.  The results appear to explain one of the more confounding data relationships we have seen over the last 6 years, the inverse relationship between consumer confidence and medical spending.   What has happened historically is that when consumer confidence is rising, medical spending is falling, and vice versa.  In presenting this to institutional subscribers I often get raised eyebrows and in one case a laugh. 


Investing Ideas Newsletter    - tobin


The survey shows why this strange relationship exists.  The top ranked response to If you have put off seeing a doctor, what is the main reason?”  is “I can’t take time off of work” and was cited at 2X the rate over high co-pays and deductibles.  The values in the table are for the entire sample population including Medicare beneficiaries, but for working age people, the difference is even greater.  It would follow, as employment grows as it has, employees are busier and have less time to make doctor appointments.  Consumer confidence becomes not the cause of slower medical spending, but a coincident indicator. 


On the other items, we continue to see upside to 2015 consensus numbers in our model and massive cash flow generation while the macro updates for factors that drive their admissions and pricing continue to trend positively.  


The Architecture Billings Index (ABI) is sitting at a post-financial crisis high of 55.8.  The index is supposed to lead nonresidential construction activity by approximately 11 months. Nonresidential construction activity is still growing year-over-year per the latest U.S. Census Bureau data, but the residential side is diverging from nonresidential construction activity. While the NAHB Market Demand Index is sitting at a post-financial crisis high like the ABI, the divergence between sentiment and market conditions is noteworthy. Single family building permits actually decreased for August, while the Bureau’s residential data has been slowing since February 2013.  

Investing Ideas Newsletter    - van


We view multi-strategy hedge fund products as more likely to generate positive returns moving into the later stages of this current bull market versus plain vanilla equity or fixed income portfolios.As the bull run in both bonds and stocks (fueled by an accommodating U.S. central bank) ages, the ability to reduce volatility in a portfolio by adding non-correlated assets and also short exposure should once again bring leading hedge fund products to the top of the table from a performance standpoint.


While hedge fund strategies have lagged broader benchmark returns including the S&P 500 over the past several years, across cycle over the past 20 years, leading hedge funds have produced much higher returns and lower volatility than benchmarks.


For example, since its inception in 1994, Och Ziff has had a compound annual growth rate in its investment performance of 13.4%. That's nearly 400 basis points better than the S&P 500 with compounded returns of 9.6%.

Investing Ideas Newsletter    - ozm

Furthermore, returns have been more stable at OZM over this 20-year period with a standard deviation of just 5.3%, almost 1/3 of the variation of returns in the equity market with standard deviation of 15.2% over the same time period.


Simply put, leading hedge fund strategies over a measurable time period create higher returns with less potential variation and thus are extremely valuable vehicles. OZM shares with this positive historical track record remain on our Investing Ideas list as a beneficiary of more volatile markets which we see going forward.  


In the week following Restoration Hardware's 2Q14 earnings release, the key questions we’re getting from investors focus around the possibility of a revenue ramp in 2H.  It’s important to note that we’re looking at an 800 p ramp in ‘deferred revenue’ on the company’s balance sheet, which also synchs with a 35% increase in inventory headed into the third quarter. That’s not to mention a delay in the company’s marketing efforts that should push sales into 3Q.


All in, we’re comfortable with our 24% 3Q top line growth rate, versus the Street at 22%. We remain meaningfully higher for the year.


Let’s also keep this in context with our view that revenue will ramp through 2018 to about $5bn, vs. a sub-$2bn level today. That’s something that should put a 1-2% shift in revenue between quarters into perspective. 


* * * * * * * * * * 


Click on each title below to unlock the content.


Fund Flows: Trending, Not Mending

Our research shows that despite substantial losses in the U.S. equity fund category over the past 5 months which total $48 billion, the average draw down in U.S. stock funds since 2007 has averaged 40 weeks with over $113 billion lost. In other words, trends could continue on their downward slope. 

Investing Ideas Newsletter    - 889


Are You Positioned Defensively Enough (For Quad #4)?

The slowdown in both growth and inflation domestically requires investors to adopt a particularly defensive asset allocation.

Investing Ideas Newsletter    - defense


FDX: Moving to Roughly Indifferent

We have ‘liked’ FedEx shares since late 2012, gradually reducing our affinity as the shares have moved higher (although a bit too quickly).  With recent gains, we will move to ‘roughly indifferent’. 

Investing Ideas Newsletter    - fedex

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