Below are Hedgeye analysts’ latest updates on our five current high-conviction long investing ideas and CEO Keith McCullough’s updated levels for each.
*Please note that we added MUB (iShares Muni Bond ETF) to our Investing Ideas list this week.
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
You can thank your unelected central planners for zero interest rate policy for the foreseeable future.
TLT | EDV | XLP | MUB
MOVE DOVISH DATA: STAY LONG OF TLT, EDV, MUB & XLP
The week ending October 24th, 2014 equities bounced slightly as investors fearing a year-end rally nervously jumped in to buy the pullback.
Mixed economic data continues to bolster our anticipation of a reactionary dovish policy response from the Federal Reserve in the coming months:
- U.S. CPI came in flat at +1.7% YoY in SEP, which matched the below-target pace of Core CPI.
- US Markit flash Manufacturing PMI numbers slowed to 56.2 in OCT compared to a final reading of 57.5 in SEP.
In addition to a mixed week of economic data in the U.S. (versus notable strength in the 2nd quarter), we continue to receive confirmation of middling growth abroad:
- OCT flash PMI numbers showed optical strength for both the Eurozone and China. However expansive, Markit noted that new orders and inflows both slowed in the Eurozone, while “backlog of work” fell across both manufacturing and services.
- France manufacturing numbers slowed posting 47.3 vs. a prior reading of 48.8 and a services number of 54.8 vs. a prior reading of 55.7.
- In China, new orders, new export orders and output all slowed sequentially, calling into question the efficacy of the headline “beat”.
With growth in both Europe and China continuing to decelerate on a trend basis, we continue to expect slowing global growth to weigh on both business and investor confidence and reflexively perpetuate a negative feedback loop in the domestic economy over the intermediate term.
In brief, you want to be long/overweight the asset classes and style factors that have weathered recent financial market volatility (i.e. Treasuries, munis, cash, and large-cap/high-yield/liquid equities), while remaining short/underweight its inverse (high beta, small cap illiquidity and early cycle leverage). That means remaining long of TLT, EDV, MUB, and XLP.
Gold has grinded higher on the back of Janet Yellen's summary of the minutes from the committee's September 16-17th meeting.
Since her commentary on October 8th that the global economy was weaker than expected and that policy members were worried that "FURTHER GAINS IN THE DOLLAR COULD HURT EXPORTS AND DAMP INFLATION," gold is up +2.3% vs. a commodity complex getting beaten down with #QUAD4 deflation (CRB -2.1% over the same period).
Gold will continue to trade in front of the USD, and a CPI print this week below the Fed’s target is bullish for gold, especially when real full year real domestic GDP growth is tracking near 0%:
CPI m/m +0.1% Sep. vs. -0.2% prior
CPI y/y +1.7% Sep. vs. +1.7% prior
As has been the case throughout the year, the major global economies are all slowing at the same time, and we expect the monetary policy members governing the major currencies to undertake similar measures.
With TLTRO underway, and loan growth underwhelming, the ECB reported Friday that 25 banks were set to fail the Asset Quality Review Stress Test with 10 of the 25 banks expected to face capital shortfalls that will “need to be addressed.”
The banks that failed will have a short time to make adjustments before the final results are released on October 26th, but the headlines will support the implementation of additional Euro-weakening measures from Mario Draghi. With the currency war heating up, we feel comfortable with the gold allocation for FX diversification.
RH took two steps forward in redeveloping its real estate strategy this week.
1) Opening a new 33,000 sq. ft. (23,000 selling, 10,000 outdoor) store on Melrose Avenue in Los Angeles. The new store will replace the existing 17,200 square foot Design Gallery that opened in June of 2011. At nearly 2x the size, the company will show about 2.5x the assortment.
2) Substantiated rumors hit the wire this week reporting that RH had signed a new lease in the Meatpacking district of New York City. The new store will span over 70,000 square feet – time of opening TBD.
The company is still in phase 1 of its retail build out. Its Design Gallery count is now up 6 and that will grow at an accelerated pace over the next 5 years – adding an incremental 1.2mm square feet to the company’s footprint.
With the buildout comes additional exposure for the company’s newer categories. Since 2011, the company has added eight categories to the mix, and in 2015 we will see the first iteration of the Kitchen business.
Those categories have virtually zero presence in the company’s physical retail stores to date. Hence the larger stores. A legacy store can show about 10% of the existing SKUs, first generation Design galleries 20%/25%, and a Full Line Design Gallery closer to 70%.
The reason behind the additional presentation at retail is the fact that when a new item is introduced at retail in a marketplace it receives a 50%-150% lift in sales across channels (both in-stores and online). That helps explain the production levels we’ve seen from the company’s first 6 big stores to date.
Our math suggests that there are 85 markets in the United States that could support a Full Line Design Gallery. Will the company tap all of those markets, no probably not, but the runway is still wide open.
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China’s 3Q/SEP economic data confirms our view that global growth is slowing and will likely continue to slow through at least year-end.
The model is broken. Moving forward, it’s going to get tougher for management and the sell-side to make up stories to the contrary.