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Japan, Europe and U.S. Small Caps

Client Talking Points

JAPAN

The Nikkei is +1.5% to -3.1% year-to-date and signals immediate-term TRADE overbought – we’ve been waiting to add this and more European equity shorts to Real Time Alerts and we’re going to see those selling opportunities now.

EUROPE

The DAX is +0.6%, but Italy, Spain, and Russia have all turned red, which is weird, because we thought ECB President Mario Draghi said he has banned deflation. As Europe’s economy slows, we think gravity wins this time – sell European Equities.

RUSSELL 2000

Big bounce in the Russell 2000 to immediate-term TRADE overbought within its bearish TREND. The Russell 2000 would have to close > 1181 to recapture intermediate-term TREND support; still -5% from her all-time #bubble high and no support to 1067.

Asset Allocation

CASH 65% US EQUITIES 0%
INTL EQUITIES 0% COMMODITIES 4%
FIXED INCOME 27% INTL CURRENCIES 4%

Top Long Ideas

Company Ticker Sector Duration
EDV

The Vanguard Extended Duration Treasury (EDV) is an extended duration ETF (20-30yr). U.S. real GDP growth is unlikely to come in anywhere in the area code of consensus projections of 3-plus percent. And it is becoming clear to us that market participants are interpreting the Fed’s dovish shift as signaling cause for concern with respect to the growth outlook. We remain on other side of Consensus Macro positions (bearish on Oil, bullish on Treasuries, bearish on SPX) and still have high conviction in our biggest macro call of 2014 - that U.S. growth would slow and bond yields fall in kind.

TLT

We continue to think long-term interest rates are headed in the direction of both reported growth and growth expectations – i.e. lower. In light of that, we encourage you to remain long of the long bond. The performance divergence between Treasuries, stocks and commodities should continue to widen over the next two to three months. As it’s done for multiple generations, the 10Y Treasury Yield continues to track the slope of domestic economic growth like a glove. We certainly hope you had the Long Bond (TLT) on versus the Russell 2000 (short side) as the performance divergence in being long #GrowthSlowing hit its widest for 2014 YTD (ex-reinvesting interest).

RH

Restoration Hardware remains our Retail Team’s highest-conviction long idea. We think that most parts of the thesis are at least acknowledged by the market (category growth, real estate expansion), but people are absolutely missing how all the pieces are coming together to drive such outsized earnings growth over an extremely long duration. The punchline of our real estate analysis is that a) RH stores could get far bigger than even the RH bulls seem to think, b) Aside from reconfiguring 66 existing markets, there’s another 19 markets we identified where the spending rate on home furnishings by people making over $100k in income suggests that RH should expand to these markets with Design Galleries, and c) the availability and economics on large properties for all these markets are far better than people think. The consensus is looking for long-term earnings growth of 28% -- we’re looking for 45%.  

Three for the Road

TWEET OF THE DAY

COPPER: bangs the top-end of her 2.95-3.10 immediate-term risk range #sell

@KeithMcCullough

QUOTE OF THE DAY

Are you gonna bark all day, little doggy, or are you gonna bite?

-Reservoir Dogs

STAT OF THE DAY

864 million,  the number of daily active Facebook users as reported by the company Tuesday night. That represents a 19% increase compared to the prior year.


THE HEDGEYE MARO PLAYBOOK

Takeaway: Our Macro Playbook is a daily 1-page summary of our core ETF recommendations, investment themes and proprietary quantitative market context

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

 

  1. The continued breakdown in Commodities as a primary asset class and what we view as the directional drivers from here
  2. Sell the news on Ebola? That's certainly what the cocoa market is telling us; this crowded trade (i.e. net long of cocoa) is screening as a short across our compendium of quant signals

 

Best of luck out there,

 

Darius Dale

Associate: Macro Team



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Double Double Top

“Making the simple complicated is commonplace; making the complicated simple, awesomely simple, that’s creativity.”

-Charles Mingus

 

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.

Double Double Top - z. lake

 

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%

SPX 1

RUT 1067-1151

VIX 12.61-25.56

USD 84.89-86.12

WTI Oil 79.91-83.67

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

Double Double Top - z. cartoon


Napoleon Complex

This note was originally published at 8am on October 15, 2014 for Hedgeye subscribers.

“Pretend inferiority and encourage his arrogance.”

-Sun Tzu

 

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.”

 

Indeed.

 

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 sales@hedgeye.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%

SPX 1860-1928

RUT 1037-1077

VIX 18.33-25.44

USD 85.03-86.64

WTI Oil 80.07-86.20

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

Napoleon Complex - NFP NB


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