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THE HEDGEYE MACRO PLAYBOOK

Takeaway: The Hedgeye Macro Playbook is a daily 1-page summary of our core ETF recommendations, investment themes and noteworthy quantitative signals.

CLICK HERE to view the document. In today’s edition, we highlight:

 

  1. Why you should continue rotating out of "risky" fixed income exposure and into "non-risky" fixed income exposure, at the margins
  2. How a dovish Fed is contributing to pervasive strength in "safe" fixed income

 

Best of luck out there,

 

Darius Dale

Associate: Macro Team


Yo, FX Go!

This note was originally published at 8am on September 25, 2014 for Hedgeye subscribers.

“Listen: there’s a hell of a good universe next door; let’s go.”

-E.E. Cummings

 

With a body of work that included almost 3,000 poems, E.E. Cummings was one of the most prolific poets in America’s 20th century. If he was around today, he’d probably tell you the aforementioned quote was about centrally planned economies.

 

You got it, yo. It’s all about jamming our noses into 18th century export-models and burning the purchasing power of The People at the stake. Rip some lip. You know, bro – get those asset prices hooked and up and out of the water!

 

This is Master of The Universe type stuff. Janet, Mario, Haruhiko - God put you on earth to do this, yo. Let’s go!

 

Yo, FX Go! - 3gp

 

Back to the Global Macro Grind

 

As you can see, when left to my own 45 minutes of creative writing devices in the early morning, I get flashback moments to what my first English professor @Yale deemed “un-grade-able” work …

 

Getting back to where I have some competence - central questions about centrally planned currencies:

 

  1. Did the devalued currency model work for the Argentines or Japanese?
  2. What happens when all 3 of the major players in the FX War (Japan, Europe, USA) are at 0%?
  3. Coming off the all-time lows in FX, Fixed Income, Commodity, and Equity volatility, what could go wrong?

 

Answers:

 

  1. No
  2. They’ll tell you that 0 minus 0 is actually greater than 0
  3. Everything

 

No way. Everything?

 

Uh, yeah, yo. Let’s go there:

 

  1. When USD goes up or down, a lot, the machines chase this thing called the Correlation Trade
  2. In 2011, with Buck Burning to all-time lows, the Correlation Trade = Long Commodities, Gold, FX, etc.
  3. In 2014, with Euro and Yens Burning, the Correlation Trade = Short Commodities, Long Nikkei, etc.

 

Causality or correlation? Please. The causal factor that drives all of this are market expectations that central planners only do one thing when the economic data (always) misses their growth forecasts – they get easier…

 

Easier, as in dovish = devaluing…

 

At the first sniff of #EuropeSlowing (in May) Mario’s Italian and French bureaucrat buddies immediately focused on devaluing ze Euros. That gave the USD a surrender bid. Then, as the Abenomics experiment started to fail, the market started speculating that there were another 3-legs to the 3-legged Japanese devaluation stool.

 

That’s right – 0 minus 0 = moarrr than 0. And 3-legged central planning stools really have 6, or 10 legs. This is so ridiculous at this point that my jokes aren’t funny.

 

Moving along. If you are into the monthly performance chasing thing, here is the wood (6-week USD correlations):

 

  1. USD’s 6 week inverse correlation to Gold -0.95
  2. USD’s 6 week inverse correlation to Commodities (CRB Index) -0.93
  3. USD’s 6 week inverse correlation to Brent Crude Oil -0.92
  4. USD’s 6 week positive correlation to Japanese Stocks +0.89
  5. USD’s 6 week positive correlation to Swiss stocks +0.83
  6. USD’s 6 week positive correlation to Austrian stocks +0.82

 

In other words, as it became glaringly obvious that both Japan and Europe’s economies were slowing, you either bought the living daylights out of the Mother’s Index in Japan or something in Austria, and you crushed it.

 

“#Boom, crush. Night, losers. Winning. Duh!”

-Charlie Sheen

 

Oh, and what happens if and when my rates call plays out “fundamentally” – i.e. US #GrowthSlowing here in Q3 (then Q4) takes hold… the Fed freaks, and starts to devalue the Dollar again?

 

Bingo. This entire bongo board of Correlation Risk turns upside down and you do the opposite, fast.

 

As a result, volatility (across asset classes) is already signaling to me that we could very well see the mother of all historical volatility breakouts in FX, Commodities, and Equities. But no worries. For now, the central planners call this “price stability”, yo.

 

Out immediate-term Global Macro Risk Ranges are now:

 

SPX 1977-2011

RUT 1115-1144

VIX 12.91-14.98

USD 84.61-85.33

EUR/USD 1.27-1.30

WTI Oil 90.42-93.95

Gold 1209-1254

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Yo, FX Go! - Chart of the Day


October 9, 2014

October 9, 2014 - Slide1

 

BULLISH TRENDS

October 9, 2014 - Slide2

October 9, 2014 - Slide3

 

 

BEARISH TRENDS

October 9, 2014 - Slide4

October 9, 2014 - Slide5

October 9, 2014 - Slide6 

October 9, 2014 - Slide7

October 9, 2014 - Slide8

October 9, 2014 - Slide9


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ICI Fund Flow Survey - Worst Quarter since 4Q 2012 for Equity Fund Flows and the PIMCO Puke

Takeaway: The most recent ICI fund flow survey rounded out the worst quarter for equity funds since 4Q2012 and also reflected the dislocation at PIMCO

Investment Company Institute Mutual Fund Data and ETF Money Flow:

 

The most recent weekly ICI fund flow survey put a wrap to data for the third quarter which marked the worst underlying trends for domestic equity fund flows since the fourth quarter of 2012. In aggregate, U.S. stock funds experienced over $28 billion in redemptions in the most recent quarter, the biggest withdrawal since the $56 billion drawn down in 4Q 2012. While international equity trends cushioned the blow during the period with $24 billion of inflow, the net equity result was still the worst since the end of '12. We continue to be very cautious on the two main proxies for U.S. equity fund flow trends, shares of T Rowe Price (TROW) and Janus Capital (JNS), especially considering that seasonally the fourth quarter has historically been worse than all third quarters since 2007 (see seasonal ICI trends here). On a weekly basis, the ICI reported the biggest ever redemption in the taxable bond category, which reflects the substantial dislocation as a result of the movement of Bill Gross from PIMCO to Janus. Interestingly, fixed income ETFs put up a $4.3 billion inflow last week, well over the 52 week average of a $852 million inflow, mopping up some of the knee jerk reaction out of PIMCO taxable bond funds. As far as an update on our call that the implied inflow to Janus on the Bill Gross addition is a market overreaction, a major media outlet reported that Gross' new fund took in $66 million in the first two days of operation this week which would imply an annual net of $8 billion in new assets-under-management ($33 million per day at 250 trading days). This is still a far cry from our calculation of implied impact of over $40 billion in AUM. We continue to maintain shares of TROW and JNS on our Best Ideas short list supported by this most recent industry data (see links to our reports below). Despite the industry's best investment performance, TROW equity fund flow data has not been immune to the broader ICI industry level weakness (regression between the two data sets below), and thus the worst quarter in a year and a half with the seasonally weak fourth quarter ahead, is reason for concern.

 

ICI Fund Flow Survey - Worst Quarter since 4Q 2012 for Equity Fund Flows and the PIMCO Puke - Q3 chart 1 preview final

 

ICI Fund Flow Survey - Worst Quarter since 4Q 2012 for Equity Fund Flows and the PIMCO Puke - Q3 chart 2 preview

 

Hedgeye Best Ideas TROW Short Research 

Hedgeye Best Ideas JNS Short Research

 

Total equity mutual funds in the most recent 5 day period ending October 1st experienced $1.8 billion in redemptions according to the Investment Company Institute. The composition of flow trends continued to be weighted towards International stock funds with a $2.2 billion inflow buffering another meaningful outflow of $4.0 billion in U.S. stock funds. The inflow into International stock funds made it a perfect 39 for 39, i.e. inflows in all 39 weeks of 2014. Conversely, domestic trends continue to be very soft with now 22 of 23 weeks of outflow now totaling over $56 billion lost. The running year-to-date weekly average for all equity fund flow continues to decline and now settles at a $1.1 billion inflow, now well below the $3.0 billion weekly average inflow from 2013. 

 

Fixed income mutual fund flow had a substantial purge in the most recent ICI data, booking the biggest weekly outflow in the taxable bond category in the history of the public reporting of the data. Within the most recent survey, over $21 billion was redeemed last week in taxable bonds, just surpassing the weekly redemption of $20.4 billion during the "Tapering Tantrum" in June 2013 (see ICI press release here). The ICI specifically addressed this as "having no discernable impact on broader financial markets" without naming a driver of the outflow. In matching up industry events with this redemption, the dislocation at PIMCO with Bill Gross leaving the $200+ billion Total Return Fund was to blame. We expect there will be a trailing impact on the category for the rest of the fourth quarter as the industry adjusts to this development. Intermediate term trends are still quite positive however for taxable fixed income with 29 of the past 34 weeks having had positive subscriptions. Municipal or tax-free bond funds in the most recent survey put up a $788 million inflow, making it 33 of 34 weeks with positive subscriptions. The 2014 weekly average for fixed income mutual funds now stands at a $1.3 billion weekly inflow, an improvement from 2013's weekly average outflow of $1.5 billion, but still a far cry from the $5.8 billion weekly average inflow from 2012 (our view of the blow off top in bond fund inflow). 

 

ETF results were mixed during the week with substantial outflows into equity funds but subscriptions in passive fixed income products mopping up the substantial snap redemption in taxable bond funds. Equity ETFs suffered a $7.5 billion redemption, the biggest outflow in 2 months, while fixed income ETFs put up a $4.3 billion subscription, the biggest inflow in almost 5 months. The 2014 weekly averages are now a $1.9 billion weekly inflow for equity ETFs and a $852 million weekly inflow for fixed income ETFs. 

 

The net of total equity mutual fund and ETF trends against total bond mutual fund and ETF flows totaled a positive $6.3 billion spread for the week (-$9.4 billion of total equity outflow versus the -$15.8 billion outflow within fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52 week moving average has been $3.6 billion (more positive money flow to equities), with a 52 week high of $27.2 billion (more positive money flow to equities) and a 52 week low of -$37.5 billion (negative numbers imply more positive money flow to bonds for the week). The 52 week moving average chart displays the declining demand for all equity products (funds and ETFs) for the safety and security of fixed income. 

 

Mutual fund flow data is collected weekly from the Investment Company Institute (ICI) and represents a survey of 95% of the investment management industry's mutual fund assets. Mutual fund data largely reflects the actions of retail investors. Exchange traded fund (ETF) information is extracted from Bloomberg and is matched to the same weekly reporting schedule as the ICI mutual fund data. According to industry leader Blackrock (BLK), U.S. ETF participation is 60% institutional investors and 40% retail investors.   

 

ICI Fund Flow Survey - Worst Quarter since 4Q 2012 for Equity Fund Flows and the PIMCO Puke - ICI recap the real chart 3

 

 

 

 

Most Recent 12 Week Flow in Millions by Mutual Fund Product:

 

ICI Fund Flow Survey - Worst Quarter since 4Q 2012 for Equity Fund Flows and the PIMCO Puke - ICI chart 3

 

ICI Fund Flow Survey - Worst Quarter since 4Q 2012 for Equity Fund Flows and the PIMCO Puke - ICI chart 4

 

ICI Fund Flow Survey - Worst Quarter since 4Q 2012 for Equity Fund Flows and the PIMCO Puke - ICI chart 5

 

ICI Fund Flow Survey - Worst Quarter since 4Q 2012 for Equity Fund Flows and the PIMCO Puke - ICI chart 6

 

ICI Fund Flow Survey - Worst Quarter since 4Q 2012 for Equity Fund Flows and the PIMCO Puke - ICI chart 7

 

 

Most Recent 12 Week Flow Within Equity and Fixed Income Exchange Traded Funds:

 

ICI Fund Flow Survey - Worst Quarter since 4Q 2012 for Equity Fund Flows and the PIMCO Puke - ICI chart 8

 

ICI Fund Flow Survey - Worst Quarter since 4Q 2012 for Equity Fund Flows and the PIMCO Puke - ICI chart 9

 

 

Net Results:

 

The net of total equity mutual fund and ETF trends against total bond mutual fund and ETF flows totaled a positive $6.3 billion spread for the week (-$9.4 billion of total equity outflow versus the -$15.8 billion outflow within fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52 week moving average has been $3.6 billion (more positive money flow to equities), with a 52 week high of $27.2 billion (more positive money flow to equities) and a 52 week low of -$37.5 billion (negative numbers imply more positive money flow to bonds for the week). The 52 week moving average chart displays the declining demand for all equity products (funds and ETFs) for the safety and security of fixed income. 

 

 

ICI Fund Flow Survey - Worst Quarter since 4Q 2012 for Equity Fund Flows and the PIMCO Puke - ICI chart 10 

 

 

 

Jonathan Casteleyn, CFA, CMT 

 

 

 

Joshua Steiner, CFA


JCP – Key Conclusion From Analyst Meeting

Takeaway: We respect the fact that September was weak. But are people doing the math on the long-term plan? JCP guided up materially.

Conclusion: The weaker September trends are clearly taking center stage as it relates to the stock. But we wonder if people are internalizing that the company’s financial plan – its first believable one in at least five years – suggests that JCP will be squarely profitable in 2017. Sales productivity going from $108 to at least $135 (on the low end), and earnings between $0.44 and $1.05 -- keeping in mind that the Street is at a loss of ($0.17). One of the key things we needed to see from JCP (see comments below) was a line in the sand for when the P&L would turn a profit. While they did not spell it out explicitly, when you build up the components of the model the message is clear -- profit by '17. Tack on the fact that Ullman seemed to strengthen his posture that finding a new CEO is a top priority, and we think that the story strengthened today, not weakened (as the market suggests).  Are we enamored with the stock here? No. We’re not. It’s trading at a 23x a base-case earnings number three years out, and 22x current year EBITDA.  We have a real hard time finding any valuation support on this name, and quarterly volatility in the model is intense. But we think that JCP’s revenue and margin targets are defendable, and that it will continue to be a net share gainer on a consistent basis for the next three years (unless a new CEO derails the plan – it’s happened before). We’re comfortable enough sitting back and watching this one grow into its multiple, or getting involved if it gets any cheaper.

 

DETAILS

It’s stating the obvious that the market did not like JCP’s lower comp guidance for the quarter (low-single instead of mid-single digit comps). While we’d call the sell-off in the name today excessive given that company stuck with margin guidance and annual sales/earnings guidance, the reality is that nothing really shocks us anymore with how this name trades in reaction to near-term data points (particularly given an infinite multiple on current earnings and 30% of the float held short).

 

But we are surprised that people are not talking more about the company’s long-term financial targets.

1) First off, let’s simply acknowledge the fact that JCP finally has long-term financial targets for the first time in more than five years.

2) Second, JCP outlined $3.5bn in revenue as its internal goal by 2017. That equates to $148 per square foot, which tops the $140/ft we’ve been talking about since last year. The level that the company set with the Street was 60% of this level – that’s $2.1bn in incremental revenue, or a total of $135 per square foot.

3) JCP also gave a Gross Margin target between 36.5% and 37.0%, versus 29.5% last year and a current run rate of 34.5%. That’s on top of SG&A that should be held relatively constant, and a slight decline in interest expense as $300mm in maturities come due.

4) Add that all up, and you get to EPS of $0.44 on the low end, and $1.05 if the company hits its internal goal.

 

We’re certainly not betting on the company hitting its internal goal – not by any stretch. But let’s keep in mind that the consensus has JCP losing ($0.17) in 2017.  The company just took up expectations by anywhere between $0.61-$1.22.

 

Still a lot to digest from the day’s events. We’ll be back when warranted.

 

 

10/06/14

JCP – What JCP Needs To Say


Takeaway: There’s a gap between what JCP should say vs. what it will say on Wednesday. All it needs to say is “break even in 2016.”

 

Ullman & Co have a pretty easy job at this Wednesday’s JCP analyst meeting. Expectations are low, and this company has not articulated a long-term plan since Ron Johnson took center stage and then proceeded to destroy $8.6bn in shareholder value – or 87% of JCP’s market cap. Talk about easy comps. We don’t think it will take much to get people excited.

 

There’s sure to be information overload on Wednesday, but there’s only a few simple messages we want to hear.

  1. “Sales productivity of $140 by 2016”, up from $108 today. This includes Store productivity going from $98 to $120, and JCP adding another $500mm in e-commerce sales (much of which we think will come from Kohl’s).
  2. “Positive Earnings by 2016”. This would actually be a huge news event for JCP given that the consensus has JCP losing money…well…forever. We think that positive in 2017 is very likely, but 2016 is certainly possible.
  3. “Close 300 Stores”.  Our math suggests 300 stores that need to be closed. We identified each of them in an analysis in May, and outlined some of the salient points below. We’d peg a 25% or less chance in getting this announcement on Wednesday. But we don’t see how Ullman can stand up there with a straight face and say that the company is currently running the optimal fleet size. It’s too close to the holiday for him to send a message to 25% of his rank and file that they might not have jobs anymore. We expect some acknowledgement of a small number of store closures on Wednesday, with a far greater announcement coming in the new year.

 

POSITIVE JCP DATAPOINT FROM OUR CONSUMER SURVEY

We’re in the process of compiling one of our Deep Dive Black Books and will be hosting a call next week. We’ll be discussing several things, including…


a) What the Department Store landscape should look like (operationally and financially) when we enter the next economic cycle.

b) Detailed Revenue analysis for all the Department Stores – by category, consumer, and demographic.

c) Detailed Results of our latest Consumer Survey on the department stores.

d) Real estate deep dive – including overlap with stores that are likely to go away.

e) E-commerce – growth and profitability prospects for the companies and industry.

 

Here’s one chart as it relates to JCP that we thought was worth sharing. Each time we conduct our Consumer Surveys, one thing we ask the 1,000 department store shoppers is to rank which are their ‘go to’ stores in each product category. We don’t necessarily look at the results compared to one another, as Macy’s will obviously get more votes across the board than Lord & Taylor or Bon-Ton, for example. But we can gauge the incremental change for each company from one survey to the next (in this instance, 1Q14 to today).

 

There’s only one company that improved its ranking in every single product category – and that’s JCP.

 

JCP – Key Conclusion From Analyst Meeting - jcpgrid

 

REAL ESTATE OVERVIEW

Here are a few select highlights of the JCP Real Estate Analysis we conducted in May.   

 

1. Real Estate Approach: We did this analysis from the vantage point of a) optimizing JCP’s fleet, and b) seeing what the revenue impact would be for KSS. In order to properly assess the potential, we analyzed every JCP market to see where the most likely closures are, and whether or not they overlap with KSS. For starters, we did not simply map out store locations (a feat in itself) and draw a circle around each point on the map to gauge overlap by market. We mapped out a 15-minute driving radius around every store, which as you can see by the chart below is very different for every single store location in the country. This shows Tallahassee, FL, which has two locations where JCP and KSS overlap perfectly, and another location where JCP exists without KSS as a competitor. We did this in every market in the US.

 

JCP – Key Conclusion From Analyst Meeting - jcp2

 

2. Productivity Analysis. This next chart shows us what the implied sales per square foot range is for JCP’s 1089 stores. What we know is that in the US, JCP has 0.47% share of wallet in apparel, home furnishings and other relevant retail goods across its portfolio in aggregate – again, we’re looking at all expenditures within a 15 minute drive of its stores. If we apply that ratio to each market, we get implied sales/square foot levels ranging from $8 to nearly $1,000 (Manhattan). We know that share is likely to vary by market, so we’re not trying to say that these are the exact productivity levels of each store. But directionally, we think we’re right. And that direction tells us that 782 stores, or nearly 72% of JCP locations, are running below the system average of $98/square foot.

 

JCP – Key Conclusion From Analyst Meeting - jcp3

 

3. 300 Store Closures: We think that JCP needs to close 300 locations, at a minimum. We know that the demographic profile in the surrounding area of JCP stores in aggregate is about $66k in annual household income. We also know that JCP just identified 33 stores that it is closing. We analyzed those locations, and the demographic profile is $54k annually – that’s 18% lower than the portfolio average. So we looked throughout the system of JCP stores and looked to see how many other stores fit that profile. There are 300. If these stores are closed, the average income statistic goes up for the whole portfolio by 7% to $70k.  The 300 stores closed have implied sales/square foot of less than $38 annually. There are still almost 500 stores above $38 and yet still below the system average. 

 

JCP – Key Conclusion From Analyst Meeting - jcp4

 

4. Revenue Impact of Closures. Our math suggests that these stores would only result in about $550mm-$600mm in revenue loss to JCP. Importantly, KSS only overlaps in 42% of these markets. Our research shows that KSS took about 19% of the $5.4bn in sales JCP hemorrhaged over the past three years. If we apply a 20% share gain level to this analysis for KSS, it suggests about $73mm, or less than 0.4% to KSS in comp. If you want to get more aggressive and assume that KSS takes 100% of that revenue (which WMT won’t allow) you’re looking at about 1.9% in comp to KSS. We think something far below 1% is closer to reality. Here’s the sensitivity analysis below.

 

JCP – Key Conclusion From Analyst Meeting - jcp5


Cartoon of the Day: A Snail's Pace

Cartoon of the Day: A Snail's Pace - growth cartoon 10.08.2014

 

We’ve been telling you for months that growth is slowing. Now, we’ve entered #Quad4, too, where grow and inflation both slow.

 

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