Takeaway: We’ve identified 17 stocks that each face significant draw-down risk to the extent our macro themes continue to play out as anticipated.
How Did These Stocks Make the Cut?
As you are likely well aware, we continue to be the bears on domestic equities – particularly the illiquid small-to-mid cap style factor (#Bubbles), consumer discretionary stocks (#ConsumerSlowing), homebuilders (#HousingSlowdown), regional banks (#Quad4 and #HousingSlowdown), as well as commodity-linked equities (#Quad4).
And with domestic high-frequency economic data confirming our views, at the margins, we are inclined to think the market has not yet made an investable bottom – especially given that the overwhelming majority of our interactions with customers over the past week or so have centered on “where to buy” as opposed to “where to sell”.
While our gauge of buy-side consensus is obviously limited to our large (and growing) sample of clients, we think the fact that hedge funds’ correlation to beta is in excess of +90% on a traling-5Y basis speaks volumes to the fact that there isn’t a ton of differentiation out there from either a sentiment or exposure perspective.
The five key takeaways from our discussions are:
Our Screening Methodology
Understanding all of that, we took it upon ourselves to screen for names that fit our bearish macro themes on the short side; the criteria of our screen is as follows:
The 17 names highlighted in the chart below are those from the list of 38 that have at least 20% downside to their respective trailing 52-week lows. Obviously that’s an arbitrary point to anchor on in the context of the market going straight up for two straight years, but it’s at least a consistent frame of reference to gauge further downside (many of the 38 stocks in our screen have already corrected or crashed from their 52-week highs). The trailing 3M average daily turnover in these names is a “whopping” $53M.
Now that the top-down work is complete, let us know if you’d like one of our senior industry analysts to do the bottom-up work on any one of these names for you (for a fee, of course).
Associate: Macro Team
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The consumer, a main driver of the US economy, isn’t showing many signs of strength these days.
#Bubbles or Bottom? Join the Hedgeye Macro Team, led by CEO Keith McCullough, for a 15 minute flash call tomorrow, October 17th at 1:00pm EDT. We remain bearish on both domestic and international equities. On the call we will highlight the best places to "hide out in" in order to weather the market volatility.
Our industry-leading fundamental macro research and proprietary quantitative risk management systems suggest a heightened probability of a market crash over the intermediate term. When juxtaposed against the consensus narrative of, "where do I buy the dip?", we think this is a call no one can afford to miss.
Takeaway: The expectation for a supply/demand floor is not a catalyst for volatility-induced real-time market moves
The daily narrative these last few weeks following the sell-off in energy markets has anchored on the fundamental supply/demand dynamic in the energy space, and it’s been pretty simple:
There’s tons of supply hitting the market, and global growth appears to be slowing.
As a precursor to reading this note, the following is an over-simplified view of our risk management process (the sequence of relevant events is of importance in understanding how we contextualize the daily news flow in global macro):
1 We quantitatively model global macro to front-run inflection points in the slope of growth and inflation which gives us the expectation for the current environment (#QUAD4: GROWTH SLOWING, INFLATION DECELERATING)
2 With this expectation, we lean on our research team for sector-specific alpha (which companies are better longs in a macro set-up where we would want to be long that sector?). In other words we look for the fundamentals to follow and confirm.
3 With an intermediate to long-term BULLISH view on a ticker (delta positive), we will use our immediate-term TRADE ranges to BUY on RED and SELL on GREEN
NOTE: A fundamental supply/demand dynamic in global energy markets follows the quant and market-based signals to confirm our view (market-based meaning PRICE, VOLUME, AND VOLATILITY signals):
Every mainstream financial news and media source this week supplied a myriad of quotes and one-off statistical arguments as to why prices can only go so low:
The supply-side of the equation is definitive. There’s tons of supply from newly developed sources flooding the market:
Global growth is slowing and demand expectations have been downwardly revised..
Many of the statistics are self-explanatory in suggesting that production cuts are inevitable to reach equilibrium. We will be the first one to tell you that fundamentals will play-out over the long-term (and they may, but it could be at much lower prices).
With that being said, we completely disagree with the argument that an expectation for fundamental equilibrium can somehow back-stop the real-time relative changes in price, volume, and volatility. The quant signals give us indications, and we look to the fundamental set-up to confirm.
Fed-fueled easy-money policy and low periods of volatility create a few big risks:
Managed money is forced to chase outperformance. Longer periods of time in a low volatility environment force leveraged beta-chasing. It also creates the behavioral assumption as to what volatility is, based on how it’s been, and how it’s expected to be.
In a recent note before Janet Yellen’s September speech, we outlined the correlation risk embedded in the assumption of continued tapering and the outlook for a stronger USD…. Oil Getting Whacked
In the note we highlighted the correlation inherent in a non-consensus policy response:
1. When Fed heads use communication tools to talk up rate hikes (like Bernanke just did) USD and rates rise
2. When USD and rates are rising, at the same time, commodities, oil, Gold, etc. go down
3. The machines (quants) then chase macro correlations, and macro markets get overbought/oversold”
Point three addresses the immediate, real-time risk that can smack you in the face. When those looking to minimize large currency and rate exposure anchor on macro correlations for hedge-sizing considerations one-way, large positions create the execution risk block traders love to hate:
Yellen kicked the can in Jackson Hole, but just last week she reverted in her commentary on the minutes from the September 16-17th meeting:
“FURTHER GAINS IN THE DOLLAR COULD HURT EXPORTS AND DAMP INFLATION.”
A.K.A we are not hawks, and we’re not reverting on the ingrained beliefs for how monetary policy should intervene in the marketplace.
We have reiterated our expectation for this policy response all year in an environment with growth slowing and expectations for growth too high as it is an input into our macro modeling.
A +160% move in VIX from the July lows is the follow-through from Fed-induced leverage in the system. How many of the market participants in oil markets (or any derivative of oil markets, which is a much larger pool of investors) have any interest in the physical commodity over financial speculation anyway? What percentage of average daily trading volume?
Both BRENT and WTI are currently BEARISH from both an intermediate-term TREND duration. Our quantitative signals front-ran the fundamental supply/demand story which is taking shape. As always, we will continue to look to these quantitative signals and back-fill into the story.
BEARISH TREND (Intermediate-Term) : $94.63
BEARISH TAIL (Long-Term): $97.95
Please feel free to ping us with comments or questions on our current position here.
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