“Making the simple complicated is commonplace; making the complicated simple, awesomely simple, that’s creativity.”
Canadians are somewhat simple people. As a Canadian, I think I can get away with saying that, even if most of you can’t. But let’s be honest, after hockey, beavers, and Tim Horton’s coffee, what else is there?
Certainly, there is also the vast beauty of the majestic country. Keith and I took a few of our colleagues to an offsite to Lake Nipigon, which is the largest freshwater lake solely in the province of Ontario, early this year. There is a picture from our trip in the middle graphic below and we experienced this beauty first hand.
There is also the kind soul of the nation. A soul that was very much on display after the recent tragic terrorist attack in Ottawa. Sir Winston Churchill may have said it best when he stated:
“There are no limits to the majestic future which lies before the mighty expanse of Canada with its virile, aspiring, cultured and generous-hearted people.”
That is likely as true today as it was back then, even if falling oil prices throw a curve ball to the Canadian economy in the short term.
But, back to coffee and simplicity for a second, when Canadians order coffee they keep it simple. The typical Canadian strolls into Tim Horton’s, usually at some ungodly hour, and simply orders a Double Double, which is Canadian speak for coffee with two sugars and two creams.
Last night before our men’s league hockey (we are Canadians remember!), Keith and I were chatting about the market and it dawned on us that, “Double Double Top”, may actually be the most apropos description of the current stock market action.
Back to the Global Macro Grind…
The most recent top can appropriately be called the Alibaba ($BABA) top as the top of the U.S. stock market, not unsurprisingly, coincided very closely with the IPO of the Chinese internet juggernaut. In fact, Alibaba (or whatever you want to call the Cayman Islands entity that U.S. investors own an interest in) started trading on Friday, September 19th and the SP500’s recent top was, you guessed it, also on Friday September 19th.
On some level, it should be no surprise that the biggest IPO in history signaled the market top. It is obviously an event that signals “things” can’t get much better from “here”. The question of course is what will signal the end of the most recent rally? Perhaps the social media bubble popping?
Our Internet and Media Analyst Hesham Shaaban has been admittedly vocal on the headwinds facing some of the social media business models. In fact, for a long time he was the lone bear on both Twitter ($TWTR) and Yelp ($YELP) and was recently validated by recent results from both companies. He has been less vocal on Facebook ($FB) and somewhat rightfully so as the company has performed admirably, well until last night’s earnings report . . .
Certainly, Facebook’s numbers weren’t terrible. The company has 864 million daily users and is growing revenue at 40%+ y-o-y. But even the stalwart of the social media group has to at some point show a path to real profitability and with total GAAP costs expected to increase between 50 – 70% in 2015, outpacing revenue growth by a wide margin, meaningful profitability is unlikely to happen anytime soon.
So is this then the Facebook top? Due to a dearth in crystal balls in the Hedgeye office this morning, I’m not sure I can definitively say it, but to the extent that social media stocks were leading some of the recent market froth, that ship has now sailed.
As well, there is no doubt that many consensus investors have gone from selling the recent bottom to leaning very long again. According to the most recent U.S Investor’s Intelligence poll, bullish sentiment shifted to 47.0% from 35.2%, bearish sentiment decreased to 16.3% from 18.2%, and those expecting a market correct decreased to 36.7% from 46.5%. So, if you are getting long at the Facebook top, just be forewarned that isn’t a contrarian call!
Also, some bulls may still be holding out for the Pollyanna-ish view of U.S. GDP growth of 3% in perpetuity, but as my colleague Darius Dale noted yesterday:
“Unfortunately, the data is becoming increasingly unsupportive of that narrative. Specifically, the two drivers of any U.S. economic expansion (i.e. household consumption and CapEx) appear to have lost considerable amount of steam of late.
Let’s ignore the horrible SEP Retail Sales print (falling gas prices, anyone?) and focus specifically on today’s SEP Durable Goods and OCT Conference Board Consumer Confidence numbers.
Brutal Durable Goods and CapEx Demand
Core Capital Goods dropped the most in 8M (-1.7% MoM) and Durables ex-Defense & Aircraft – i.e. the stuff the average household purchases – was down for a second consecutive month at -0.3% MoM; this was the 1st such instance of back-to-back contraction since the weather-induced weakness we saw in the first quarter.
MAJOR Consumer Confidence Head-Fake
At face value, the OCT Consumer Confidence print was a huge win for anyone who doesn’t really do macro. Specifically, the headline figure inflated to 94.5, which was the highest reading since a 95.2 reading back in OCT ’07.”
Take it from a simpleton Canadian, buying U.S. equities at the peak in Consumer Confidence is a recipe for underperformance.
Now of course with that all said, perhaps the FOMC will provide a boost to the markets with the rate announcement today at 2pm. In our Chart of the Day below, which is appropriately a cartoon created in house, I provide a summary of our thoughts on that . . .
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.14-2.33%
WTI Oil 79.91-83.67
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
This note was originally published at 8am on October 15, 2014 for Hedgeye subscribers.
“Pretend inferiority and encourage his arrogance.”
On this day in 1815, Napoleon Bonaparte began his exile on the island of St. Helena. For the next six years, mostly in isolation, Napoleon would write his memoirs before eventually succumbing to what most physicians now believe was stomach cancer. Despite an ending that was less than triumphant, Napoleon had a pretty stellar career for a short guy.
At the age of 29, when most of us were just finishing with our MBA studies, or just finishing the third level of the CFA if we were really contrarian and didn’t get an MBA, Napoleon took control of France via a coup d’etat and named himself First Consul. Four short (no pun intended) years later, Napoleon named himself Napoleon I, Emperor of the French.
Over the next decade he would lead France in the Napoleonic wars and eventually conquer most of continental Europe. It is believed that Napoleon fought 60 battles and lost only seven, a record of conquest that is almost unprecedented. So much so that the great English General Wellington, when asked who the greatest general of the time was, he responded:
“In this age, in past ages, in any age, Napoleon.”
But, alas, even the great Napoleon eventually had an off day of performance. While he was eventually and finally defeated at the famous battle of Waterloo, his off performance actually came a few years earlier in the Invasion of Russia. Although French troops were able to beat back the Russians past Moscow, by the time Napoleon’s army returned to France its numbers had dwindled down to some 40,000, despite starting at more than 400,000.
Speaking of performance, Blackrock recently published a report that showed in aggregate the hedge fund industry has produced negative alpha for the first half of the year. Similar to this, a recent report by eVestment showed “in the first seven months of the year, 79.58% of the overall portfolio volatility within the 30 largest hedge funds in its data universe could be explained by systemic or market risk.” Levered beta anyone?
If there is a moral of the story it is that even the best generals have off days. So if this year has been challenging from a performance perspective . . . channel your inner inferiority complex, go back to your contrarian roots, and fight on!
Back to the Global Macro Grind…
We’ve obviously been tooting our revolutionary horns fairly loudly on the concept that the economy is, or has, entered #Quad4, which is characterized by slowing growth and decelerating inflation. For those that are holding out that the economic growth may be better than expected, they point to the U.S. employment picture, which, admittedly, has been strong.
In the Chart of the Day, which is titled “Payroll Growth That Would Even Make Napoleon Proud”, we highlight the dramatic improvement in the labor market, but the caveat of course is that the labor market is unlikely to get much better from here. As my colleague Christian Drake (@HedgeyeUSA ) wrote when posting the note with this chart in it:
“At +1.93% YoY, Nonfarm payrolls in September recorded their fastest rate of improvement since April 2006. The current pace of improvement is inline with peak growth in the last cycle and may be as good as it gets given the demographic and labor supply headwinds and the secular slowdown in employment growth over the last 30 years.”
In terms of global growth, the Bank of Korea this morning lowered their domestic growth forecast for 2015 and cut rates to a four year low. While Korea certainly doesn’t yield the economic power of the U.S., it is still one of the largest 15 economies on the planet and this is just another sign that growth expectations are being lowered globally.
With global growth continuing to decelerate and U.S. growth and employment likely peaking at best, the only risk to the Fed not getting incremental dovish is inflation. Unfortunately, signs of inflation are benign at best. One of the best commodity proxies for inflation, oil, is down more than 10% in a straight line over the past two weeks (making our MLP Short thesis even juicier!). As well, 10-year break evens shrank to 1.9%, the narrowest spread since June 2013. #Quad4 anyone?
The question, as always, of course is where to find the alpha even if we are right on the economy. One area that we believe continues to be ripe with short ideas, as noted above, is the Upstream MLP Sector. Our Energy Sector head Kevin Kaiser will be doing a conference call this coming Wednesday to provide his updated thoughts on the sector. With oil in free fall and likely to decline further due to U.S. production growing and global demand at five year lows, cash flow coverage will be very, very tight for MLPs. If you’d like to join the call, please ping email@example.com.
The other area we’ve been pounding the table on in terms of finding shorts is the small cap space in general. Interestingly, according to a Bloomberg article this morning the most shorted stocks in the Russell 2000 have fallen 15% in the last month, which is almost three times the underling gauge.
Even as the Russell 2000 has underperformed dramatically in the year-to-date, it is important to note that stocks in the Russell are trading at 24.8x P/E versus 15.6x for the SP500. Given that valuation dichotomy, the Russell may well still be the Waterloo of small cap growth investors this year who try to buy the dip.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.19-2.36%
WTI Oil 80.07-86.20
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
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TODAY’S S&P 500 SET-UP – October 29, 2014
As we look at today's setup for the S&P 500, the range is 151 points or 6.50% downside to 1856 and 1.11% upside to 2007.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 1.86 from 1.90
- VIX closed at 14.39 1 day percent change of -10.29%
MACRO DATA POINTS (Bloomberg Estimates):
- 7am: MBA Mortgage Applications, Oct. 24 (prior 11.6%)
- 10:30am: DOE Energy Inventories
- 1pm: U.S. to sell $35b 5Y notes
- 2pm: Fed seen maintaining overnight bank lending rate 0%-0.25%; seen ending QE program
- Senate, House out of session
- Deadline for replies to FCC on $45.2b Comcast-Time Warner Cable deal
- 9am: Iraqi Ambassador to U.S. Luqman Abd al-Rahim Fayli delivers remarks on “Iraq-U.S. Relations: A View from Baghdad” at Arab-U.S. Policymakers Conf.
- U.S. ELECTION WRAP: Senate Races; Alaska Polls; McConnell Humor
WHAT TO WATCH:
- Fed Decision Day Guide: FOMC Seen Focusing on Too-Low Inflation
- Sanofi Chief Ousted After Tensions With Board Members
- Facebook Projects ‘More Difficult’ Quarter as CEO Spends
- Gilead Misses Profit Est. on Obamacare Fee, Lower Drug Sales
- Aflac Profit Climbs on Japan Bets in Dollar-Denominated Assets
- Tesla Owners Get $12,000 License Plates in Shanghai for Free
- Deutsche Bank Sinks to 3Q Loss on Provisions for Legal Costs
- Ares-Backed Floor & Decor Outlets Said to Plan $100 Million IPO
- Pimco Is Replaced by BlackRock at $6.16 Billion Prudential Fund
- Prudential Takes Stake in AFP Habitat After MetLife’s Chile Bet
- NASA Vows to Continue Commercial Rocket Program After Explosion
- Medicare Agency Said Focus of Insider Trading Probe: WSJ
- Obama Warns of Fear Hindering Ebola Fight as Quarantines Stick
- Alkermes (ALKS) 7am, $0.02
- Arrow Electronics (ARW) 8am, $1.31
- Automatic Data Processing (ADP) 7:30am, $0.60
- Booz Allen Hamilton (BAH) 7am, $0.41
- Cameco (CCO CN) 8:30am, C$0.21 - Preview
- Capitol Federal Finl (CFFN) 9am, $0.14
- Carlyle (CG) 6:30am, $0.52
- Commercial Metals (CMC) 7am, $0.25
- Dentsply Intl (XRAY) 7am, $0.60
- Eaton (ETN) 6:30am, $1.24
- Exelon (EXC) 7am, $0.72
- Garmin (GRMN) 7am, $0.71
- Goodyear Tire & Rubber (GT) 8:30am, $0.70
- Hershey (HSY) 7am, $1.08
- Hess (HES) 7:30am, $1.07 - Preview
- Hyatt Hotels (H) 7:30am, $0.26
- IAC (IACI) 7:30am, $0.66
- McGraw Hill (MHFI) 7:15am, $0.94
- Phillips 66 (PSX) 8am, $1.75 - Preview
- Praxair (PX) 6:02am, $1.62
- Prosperity Bancshares (PB) 6:04am, $1.07
- Ralph Lauren (RL) 8am, $2.05 - Preview
- Revlon (REV) 7:30am, $0.45
- Sealed Air (SEE) 7am, $0.45
- Sherritt (S CN) 7am, (C$0.07) - Preview
- SodaStream (SODA) 7:30am, $0.35
- Southern Co (SO) 7:30am, $1.07
- SPX (SPW) 6:30am, $1.38
- TE Connectivity (TEL) 6am, $1.00
- Valley National (VLY) 7:30am, $0.14
- Waste Management (WM) 7:30am, $0.68
- WellPoint (WLP) 6am, $2.26 - Preview
- Wisconsin Energy (WEC) 7am, $0.52
- Agnico Eagle Mines (AEM CN) 5:15pm, $0.15
- Akamai Technologies (AKAM) 4:01pm, $0.57
- Allstate (ALL) 4:05pm, $1.34
- Arch Capital (ACGL) 4:11pm, $0.98
- Arris (ARRS) 4:01pm, $0.72
- Assurant (AIZ) 4:05pm, $1.61 - Preview
- Atmel (ATML) 4:05pm, $0.12
- Avis Budget (CAR) 4:30pm, $1.80
- Axis Capital (AXS) 4:32pm, $1.21
- Baidu (BIDU) 4:30pm, $10.37
- Barrick Gold (ABX CN) 5pm, $0.17
- CBRE (CBG) 4:05pm, $0.35
- Cirrus Logic (CRUS) 4pm, $0.56
- Cloud Peak Energy (CLD) 4:10pm, $0.03
- DreamWorks Animation (DWA) 4:02pm, $0.05
- Duke Realty (DRE) 4:07pm, ($0.02)
- Equinix (EQIX) 4:01pm, $0.90
- F5 Networks (FFIV) 4:05pm, $1.48
- Flextronics Intl (FLEX) 4:01pm, $0.24
- FMC (FMC) 4:30pm, $0.96
- FNF (FNF) 4:04pm, $0.54
- Fortune Brands (FBHS) 4:01pm, $0.56
- Hanesbrands (HBI) 4:01pm, $1.68
- HudBay Minerals (HBM CN) 5:11pm, C$0.06
- Intersil (ISIL) 4:05pm, $0.20
- JDS Uniphase (JDSU) 4:05pm, $0.10
- KapStone Paper (KS) 4:15pm, $0.66
- Kraft Foods (KRFT) 4pm, $0.74 - Preview
- LifeLock (LOCK) 4:05pm, $0.15
- Lincoln National (LNC) 4:10pm, $1.43 - Preview
- Lundin Mining (LUN CN) 5:30pm, $0.07 - Preview
- MetLife (MET) 4:05pm, $1.38 - Preview
- Moelis (MC) 4:05pm, $0.39
- Murphy Oil (MUR) 5:32pm, $0.99
- Noble (NE) 5pm, $0.55
- Norwegian Cruise Line (NCLH) 4pm, $1.08
- Oceaneering Intl (OII) 5:02pm, $1.13
- Penn Virginia (PVA) 4:10pm, ($0.09)
- Pilgrim’s Pride (PPC) 4:45pm, $0.79
- Qiagen (QGEN) 4pm, $0.27
- Questar (STR) 4:14pm, $0.18
- Range Resources (RRC) 5:01pm, $0.33
- Raymond James Finl (RJF) 4:16pm, $0.85
- Realty Income (O) Aft-mkt, $0.23
- RF Micro Devices (RFMD) 4pm, $0.27
- Service Intl (SCI) 4:05pm, $0.24
- Suncor Energy (SU CN) 10pm, C$0.77 - Preview
- SunPower (SPWR) 4:05pm, $0.23 - Preview
- Superior Energy Services (SPN) 4:15pm, $0.54
- Take-Two Interactive (TTWO) 4:05pm, ($0.59)
- Terex (TEX) 5:17pm, $0.61
- Trulia (TRLA) 4:01pm, ($0.09)
- Unum (UNM) 4:05pm, $0.90 - Preview
- US Silica (SLCA) 5:31pm, $0.69
- Validus (VR) 4:15pm, $1.12
- Visa (V) 4:05pm, $2.10 - Preview
- Weight Watchers (WTW) 4:05pm, $0.48
- Whiting Petroleum (WLL) 4pm, $1.21
- Williams Cos (WMB) 4:15pm, $0.19
- Yamana Gold (YRI CN) 4:20pm, $0.06
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Pirates Target Oil Tankers in Asia Trade Route as Attacks Climb
- OPEC Says Shale Producers First to Suffer From Oil-Price Plunge
- Mistry Predicts Palm Oil Rally as ‘Worst Over’ on Falling Output
- ADM Investing $3 Billion to Make Food Taste Better: Commodities
- Russia Adds Gold to Reserves in Sept. as Mexico Cuts: IMF Data
- MORE: Indonesia Seeks to Mediate Freeport, Labor Union Meeting
- Palm Area in Indonesia Seen Jumping 18% to 11m Hectares by 2020
- Soybeans Gain on Brazil Drought as Wheat Rises on Russia Concern
- OPEC Discounts Shunned by Algeria as Crude Goes to Venezuela
- China Oil Trader in Record Mideast Crude Haul as Prices Drop
- Breathing Cleaner Air Has Cost as Utility Bills to Surge in U.S.
- Shanghai Rebar Rises as Mills Seen Cutting Output During APEC
- Freeport Copper Output Falls at Grasberg After Workers Protest
- WTI Crude Rises to Four-Day High as Fuel Demand Seen Expanding
The Hedgeye Macro Team
We hosted a call with Dr. Leonardo Maugeri , former executive of Eni S.p.A., Italy's largest energy company. Dr. Maugeri is currently an associate with the Geopolitics of Energy Project and the Environment and Natural Resources Program at the Harvard Kennedy School's Belfer Center for Science and International Affairs. He is also executive director of the board of Vitale&Associati, an Italian investment bank, and chairman of Ironbark Investments, a U.S. based investment fund.
On a high level, Leonardo covered two major topics which are broadly misunderstood yet heated topics in the energy space currently:
- The underestimated technological advancement in oil and gas extraction from shale resources and its impact on the marginal cost of tight oil and shale gas production
- The opportunities and obstacles for U.S. participation in global LNG trade
1. Technological Advancement of Extraction From Shale Resources
- Most analysis has underestimated technological advancement in production and recovery efficiency
- Model-driven analysis in this space anchors on old information, holding rapidly changing variables static, rather than leaning on real-time, data-driven facts
The biggest mistake in consensus analysis is that it does not accurately weigh each production area within a formation. It uses a gross average for each area within a formation with each area equally weighted.
At the end of the day the lowest cost areas are by far the largest producers. For example McKenzie County, ND in Bakken makes up almost 1/3rd of the formation's production and is by far the lowest cost area with a break-even price in the $20-$30 per barrel range.
Current break-even costs (full-cycle) calculated as capital cost + operating cost + 10% hurdle rate (IRR) yielded the following breakeven prices:
- Lowest cost plays in Bakken (46% of total) have a break-even cost of less than $29/barrel
- 80% of Bakken plays have a break-even below $42/barrel
- Just 7% have a break-even price higher than $70/barrel
2. U.S. Position in Global LNG Trade
- There are many LNG projects underway globally that will bring an excess of supply online
- LNG additions that are expected to materialize have assumed much higher global LNG prices at the onset of the projects
- Australian, Canadian, and Mozambique production costs range between $15-$18/MMbtu, and this is higher than the market prices for LNG in Japan and China which are the highest priced regions in the world ($14-$16/MMbtu on average)
- The only LNG export additions that will contribute to the liquidity in the LNG global trade arena will be in the United States
- U.S. plays are the lowest cost opportunities. However, current new projects even seem uneconomical at current European and domestic prices:
- For example, the marginal cost of the Cheniere Energy LNG export terminal (first one to be approved) is approximately $3.5/MBTU
- Russia and Nigeria are still more economic and they will be able to wage a price war on the U.S., hindering our ability to tap traditional European markets.
What is OPEC’s likely reaction in the near future?
In short, formal production cuts from OPEC and/or individual production cuts from OPEC members next month at the November 27th meeting (or prior) are highly unlikely.
- OPEC countries at large underestimate the technological advancement and longevity of the non-traditional, North American plays (which would relieve incremental stress for a production cut near-term).
- The issue of overcapacity both currently and moving forward in a global slowdown has at least sparked the conversation of production cuts within OPEC negotiations, but collective agreement near-term (and at these non-threatening price levels) among member countries as to who will cut production.
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