Hedgeye - Investing Ideas Newsletter

Below are Hedgeye analysts’ latest updates on our nine current high-conviction long investing ideas and CEO Keith McCullough’s updated levels for each.

*Please note that we removed HCA Holdings (HCA) this week after a 72% gain.

We also feature two 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

CARTOON OF THE WEEK

IDEAS UPDATES

TLT | EDV | XLP

#Winning

Yet another solid week for our recommended non-consensus slow-growth, yield-chasing trade (WoW performance):

TLT +1.4%
EDV +2.4%
XLP +0.6%

With the Russell 2000 down a full percent on the week, the market is clearly having a vote of no-confidence for consensus GDP estimates of +3%, per quarter, as far as the eye can see.

Perhaps that’s because growth slowed, on the margin. Again. In fact, the Bloomberg US Economic Surprise Index actually dropped -45% WoW.

While the actual rate-of-change in the economic data was not nearly as dour, there were a number of key #GrowthSlowing data points that were supportive of our fundamental view:

Pending Home Sales: -4.1% YoY in AUG from -2.8% in JUL
Case-Shiller Home Price Index: 6.8% YoY in JUL from 8.1% in JUN
ISM Manufacturing PMI: 56.6 in SEP from 59 in AUG
Markit Manufacturing PMI: 57.5 in SEP from 57.9 in AUG
Construction Spending: 5% YoY in AUG from 6.9% in JUL
ISM Non-Manufacturing PMI: 58.6 in SEP from 59.6 in AUG
Markit US Services PMI: 58.9 in SEP from 59.5 in AUG

Now to be fair, PCE (AUG), Initial Jobless Claims and the Jobs Report (SEP) were quite good. In fact, the data was actually really good (per our US macro analyst Christian Drake):

“Consumer Spending accelerates as income growth remains strong and savings rate declines modestly from 18-month high. This month we saw income growth hold just under last month’s highs but the savings rate ticked down, allowing consumption growth to accelerate. Spending improved across services, non-durables and durables, with durables again leading the pack.”
“Solid Report overall with private payrolls leading the gains (236k of the 248k). Growth accelerated in September on both a 1Y and 2Y basis across NFP & Private payrolls. The net two-month revision was +69k, which was not surprising. Looking back at historical revision trends August is almost always revised higher & generally with one of the largest magnitudes of any month. The unemployment rate gets a 5-handle as the LFPR ticks down again to another new multi-decade low.”
“The initial jobless claims data this morning is reasonably strong. SA rolling claims continue to trend lower, coming in just under 295k this week. The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -6.5% lower YoY, which is a sequential improvement versus the previous week's YoY change of -5.9%We're 7 months into the sub-330k claims environment. The last 2 cycles lasted 31 (2007) and 45 (2000) months before the market top.”

So net-net, there’s some good data and there’s some bad data. The problem with the good data is that the market appears to effectively pricing in its inevitable crescendo. And as long as it’s doing that, we’ll stick with what’s worked all year: long-duration paper and stocks that look like bonds.

FXB

We’ve been offsides on our position in recent weeks, however resilient fundamentals continue to support our positioning and we view BOE policy (expectations around a rate hike) as hawkish compared to dovish intentions of the Fed and ECB. For the week the GDP/USD was down -1.2%.

That said, the GBP/USD intermediate term TREND of $1.62 has been under attack, and the British have done little to support it. We’re sticking with the position (strong UK = strong Pound) and watching to see if/how the Fed acts to devalues the USD. We expect any shift in stance could show a strong mean reversion in the cross.

This week we got a mix of data out of the UK that weighed on the cross:

Bullish

Q2 Final GDP Q/Q revised up 10bps to 0.9%
UK Construction PMI 64.2 SEPT (exp. 63.5) vs 64.0 AUG
Lloyds Business Barometer 57 SEPT vs 47 AUG

Bearish

UK Services PMI 58.7 SEPT (exp. 59.0) vs 60.5 AUG
UK Composite PMI 57.4 SEPT (exp. 58.2) vs 59.3 AUG
UK GfK Consumer Confidence -1 SEPT (exp. 0) vs 1 AUG

BOE Minutes continue to show 2 votes (out of 9) to increase interest rates (by 25bps) from the Governing Council. 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 over the intermediate term.

GLD

We bought Gold on the oversold signal Friday morning after a pop in the ten-year yield and a big move in the dollar. Is the economy back after a slight beat from the jobless claims report (post-revision) as seen from the lens of the fed regime? We don’t believe so. Nor do we believe it makes for a material data point supporting the committee’s decision to taper.

Draghi has successfully induced a -10% devaluation in the Euro since his first round of rate cutting in the middle of Q2. With growth in the U.S. and European economies slowing at the same time, his relative dovishness has been a tailwind for the dollar (and thus bearish for Gold). A flattening in the yield curve confirms the disbelief around a sustainable growth outlook domestically (10-year yield -7bps week-over-week).

With that being said, our gold position has held strong to the negative correlations inherent in the expectation for the USD. With this summer’s FX move being the largest since 1997, gold in and of itself has been a losing trade.

The ECB’s implementation of rate cut on two separate occasions and the herd mentality increasingly positioning for a fed taper into the end of the year have perpetuated the USD strength. Tactical currency exposure in front of centrally-planned policy decisions makes this game more difficult than ever:

Since the May 6^th highs in the Euro:

- EUR/USD: -10.2%

- Gold: -9.0%

- USD: +9.6%

Embedded in this move is correlation risk. It is our view that Draghi in a smaller box at this point whereas Yellen has more flexibility in moving incrementally dovish from here. When she does, we want to have an allocation to Gold.

Shares of Legg Mason continue to perform well up over 18% in 2014 however the story has received a shot in the arm as of late. With last week’s news that leading bond fund manager Bill Gross has left PIMCO, reports of substantial redemptions at Gross’ former shop have been reported with the rest of the large bond fund platform’s likely large beneficiaries.

While PIMCO had already been struggling with over $60 billion in redemptions over the past 18 months, a reported additional $23 billion has been pulled from the platform just this week according to various media outlets. While it is not completely a zero sum game (with PIMCO’s loss someone else’s gain), there is reason to believe that the other major fixed income platforms on the Street will mop up these outflows.

Legg Mason (LM), Blackrock (BLK), and the private Doubleline funds all have strong existing franchises with strong performance that would be a natural destination for these PIMCO funds in dislocation. While LM and BLK have not commented on the environment over the past 10 days, the private Doubleline has mentioned collecting over $500 million in a single day last week as investors exited PIMCO.

This was not a situation we had modeled for in our recommendation of LM shares, however the company will be a beneficiary of a PIMCO in donor mode.

This week U.S. construction spending came in for August with both Nonresidential and Residential spending easing. Private construction spending for residential home improvement disappointed again. Lack of significant storm activity such as hailstorms and hurricanes are helping keep improvement spending levels depressed.

Next week, our industrial’s team will host an update call on pricing in the asphalt roof shingle market, on Tuesday October 7. If recent price increases in this market hold, we believe it would remove a key overhang from OC shares.

OZM

Och-Ziff remains on our Investing Ideas list as shares are currently trading at a negative multiple of its incentive fee earnings, a situation that last came about in 2011 when shares were just $7. We arrive at this negative multiple when we apply a traditional asset management earnings multiple of 15.9x to the firm's core asset management earnings of near $0.76 per share which would imply a stock value of $12 per share.

Thus with the current stock value at $11, or $1 per share below its "traditional" implied value, the running incentive fees per share earnings of $0.24 implies a new all time low multiple on this earnings stream.

The average incentive fee multiple for OZM shares since 2009 has been +3.7x providing solid upside when valuation improves. Thus if the firm can hang on to its running year-to-date positive performance, without additional negative regulatory news flow, that the stock should rally off of these depressed levels.

OZM shareholders are getting paid to wait for this situation to rectify itself with a dividend year of 7.3%, well above the average for the S&P 500’s yield of 2.1%.

Please click here to read Hedgeye retail sector head Brian McGough's note released on Friday "RH - Stealth revenue Driver."

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