“I don’t mind going back to daylight saving time. With inflation, the hour will be the only thing I’ve saved all year.”
During daylight savings time, in the fall and winter months, the U.S. Virgin Islands are one hour ahead of East Coast time.
Instead of getting up at 4am everyday, I could get up at 5am…and, you know…..be on an island.
Keith’s in Cali this week. When he gets back, I’ll try to leverage the jet-lag + daylight savings brain fog combo and float the “Hedgeye Caribbean” proposal, again….
“you miss 100% of the shots you don’t take”
Back to the Global Macro Grind...
In our 4Q Macro Investment themes call we profiled a series of bubbles which, among others, included:
- Complacency Bubble: Daily moves of >1% vs. Average VIX level (by year)
- Inequality Bubble: Labors Share of National Income vs. Congressional Disapproval vs. Gini Coefficient
- Hedge Fund Correlation To Beta Bubble: Hedge fund trailing correlation to the SPX vs. Average Relative Monthly Performance
- Leverage Performance Chase Bubble: Margin Debt (inflation Adjusted), % of SPX Mkt Cap
- Expensive Small Cap Illiquidity Bubble: Russell 2000 Trailing PE vs Average Market Cap Traded (by year)
- Basement Dwelling Bubble: Real Median Household Income vs. 18-34YOA Homeownership Rate vs. Housing Expense as % of Median Income
- Spread Risk Bubble: IG & High Yield Spreads over Treasuries vs. Bond Volatility vs. Total Corporate Debt Outstanding
Our timing on the complacency bubble proved particularly prescient (substitute “lucky” if you’d like). Prior to our themes call, the VIX was trading at its lowest average level in a decade and just 11% of trading days saw moves in excess of 1% in either direction. Subsequent to our call, the VIX has been higher by ~33% on average and the SPX has had daily moves greater than +/- 1% over 50% of the time.
We expect the Dramamine ride to continue.
Taking a broader view, each of the aforementioned bubbles are, in some magnitude, outcroppings of the larger bubble that is Central Banking.
With the explicit goal of QE initiatives being financial asset price inflation - and the hope for the ultimate trickle down and around effect - asymmetries and inequalities have become more pronounced in recent years. Such policy manifestations, however, are more an extension of secular trends than neoteric phenomenon.
The financial sector and those tied to it have benefited disproportionately since the turn of the interest rate cycle circa 1980. From 1980 to its peak in 2006, the finance industry grew from less than 5% of the economy to ~8.3%, taking share at a rate of ~13bps per annum while the financial sector weight in the S&P500 rose from less than 10% to greater than 20% over the same period.
Industry and activity chase price/profit and the broader reality of the great moderation – which, instead of promoting natural economic cycling, effectively propagated the accumulation of latent risk – is that 30+ years of lower highs and lower lows in interest rates supported a multi-decade run in financial asset price appreciation - a phenomenon exaggerated further by the twin peaks in both demographics and household & corporate leverage.
Alongside that financialization, the gini coefficient in the U.S. increased almost a full decile and the share of total income earned by the top 1% of families more than doubled from less than 10% to greater than 20%.
The minority with financial assets and those tasked with managing them - which, coincidentally, became increasingly less mutually exclusive - benefited as bond prices had a historic bull run while the ongoing, incremental lowering of discount rates provided for a perma-juicing of asset values via the Present Value effect.
Q: How much would the median home be worth today if rates were at 10% instead of 4%?
A: About -45%, or -$110K, less.
Quasi-relatedly, the policy perpetuated asset bubble rotation into housing destroyed a perfectly predictive housing model.
Over the pre-1995 historical period, New Home Sales could be modeled as an almost perfect periodic function. For the aspirant, part-time quants like myself, who would like to plot the function, here’s what I got on a 1st pass…..
f(x) = 241*sin(2Pi/82*x-20.5)+614 ….#CoolButUseless
Perhaps as the last of the cumulative displacement from trend burns off in the next few years we can return to a similarly predictable oscillation in new housing demand.
Anyhow, a couple weeks back, Janet Yellen expressed concern over the ongoing rise in inequality that team FOMC itself helped perpetuate.
Janet failed to explicitly address the role of central bank policy in that burgeoning divide but the Fed does hold an appreciation for the lag between Wall Street’s discounting of policy via prices and actual Main Street effects. And with the normal policy transmission channel left mostly prostrate by the zero bound in rates, the less potent and longer lagged trickle through of Wall Street wealth to the real Main Street economy has become the hoped for transmission channel detour route.
Ironically, or unfortunately, the problem with that ideology is that the prescription for ineffectual QE becomes more dovishness in the belief that it’s the bottlenecked transmission of policy and not the policy itself that’s core to the problem. From that perspective, more and/or longer ‘easiness’ remains the most favorable conduit for the (eventual) leak through of policy to the populace.
“You keep going until you can’t turn back. That’s where there isn’t any choice. You don’t know where that is. You don’t know until you pass it. And then it’s too late.”
Nucky Thompson epitaphed the bubble in 1920’s Prohibition barbarism and capped the series finale of Boardwalk Empire with that quote.
I suspect there’s some transferable insight in that Boardwalk epiphany.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.16-2.35%
WTIC Oil 79.47-81.43
To Bootlegging, Central Banking….and kindred spirits...
Christian B. Drake
U.S. Macro Analyst
TODAY’S S&P 500 SET-UP – November 3, 2014
As we look at today's setup for the S&P 500, the range is 56 points or 2.53% downside to 1967 and 0.25% upside to 2023.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 1.83 from 1.84
- VIX closed at 14.03 1 day percent change of -3.37%
MACRO DATA POINTS (Bloomberg Estimates):
- 9:30am: Fed’s Evans speaks in Chicago
- 9:45am: Markit US Mfg PMI, Oct, final, est. 56.2 (prior 56.2)
- 10am: ISM Manufacturing, Oct., est. 56.2 (prior 56.6)
- 10am: Construction Spending, Sept., est. 0.7% (prior -0.8%)
- 11am: U.S. to announce plans for auction of 4W bills
- 11:30am: U.S. to sell $24b 3M bills, $30b 6M bills
- 12:40pm: Fed’s Fisher speaks in New York
- President Obama meets with Fed Chair Janet Yellen to discuss long-term outlook for U.S. economy, global recovery
- Senate, House out of session
- FSOC holds meeting on MetLife’s objection to proposed designation as “systemically important” financial firm
- 9am: NATO Supreme Allied Commander, Europe, and Commander of U.S. European Command Air Force Gen. Philip Breedlove holds media briefing
- 10am: Supreme Court hears arguments in case involving designation of “Israel” as place of birth for U.S. citizens born in Jerusalem
- 10:30am: CFTC reviews rules to make sure they don’t have unintended consequences for non-financial cos.
- 2pm: Greece’s energy minister, Yiannis Maniatis, speaks at the Center for Strategic and International Studies on energy trends in the eastern Mediterranean region
- Washington Week Ahead
- U.S. ELECTION WRAP: The Magic Senate Number; Googling ‘Nunn’
WHAT TO WATCH:
- Publicis to Buy Sapient for $3.7b to Extend Digital Reach
- Diageo Gets Full Control of Don Julio in Swap for Bushmills
- Gold Extends Decline Toward 4-Year Low as Silver Tumbles
- MetLife to Appear Before FSOC to Appeal Prelim. SIFI Designation
- Altice Offers Oi $8.8b for Portugal Telecom Assets
- NY Doctor With Ebola Now in ‘Stable’ Condition at Bellevue
- Omega Healthcare to Acquire Aviv REIT in $1.65B Deal
- Net Neutrality Groups Praise Using FCC Phone Rules on Web
- Verizon, AT&T Cut Mobile Prices While Boosting Data Allotments
- American Realty Capital Said to Face Accounting Errors Probe
- Einhorn’s Greenlight Rose 2.2% in Oct. as Volatility Surged
- Final Election Push: GOP Has the Edge; Will It Be Enough?
- Billionaire Malone Got Double Tax Break in Liberty Inversion
- Virgin Spacecraft’s Rocket Motor Intact After Breakup: NTSB
- Gyllenhaal’s ‘Nightcrawler’ Movie Creeps to Tie With ‘Ouija’
- Herbalife to Pay $15m to End ‘Pyramid Scheme’ Lawsuit
- Obama Ends Midterm Campaigning With Eye on Governors’ Races
- Auto Sales Preview: Oct. SAAR May Be 16.4m
- Affiliated Managers (AMG) 7:30am, $2.71
- Allete (ALE) 8:30am, $0.72
- Arena Pharmaceuticals (ARNA) 6:45am, ($0.12)
- Church & Dwight (CHD) 7am, $0.82
- CNA Financial (CNA) 6am, $0.78
- Enbridge Energy Partners (EEP) 8am, $0.26
- Kosmos Energy (KOS) 7am, ($0.02)
- Loews (L) 6am, $0.68
- Sysco (SYY) 8am, $0.51
- Acxiom (ACXM) 4:05pm, $0.17
- Agrium (AGU CN) 6:13pm, $0.50
- Alleghany (Y) 4:07pm, $7.66
- American Intl Group (AIG) 4:03pm, $1.09
- Community Health Systems (CYH) 4:30pm, $0.76 - Preview
- Corrections of America (CXW) 4:15pm, $0.47
- Covance (CVD) 4pm, $0.98
- Detour Gold (DGC CN) 5:35pm, ($0.10)
- Frontier Communications (FTR) 4:01pm, $0.04
- Herbalife (HLF) 4:30pm, $1.51
- Lannett (LCI) 4:04pm, $0.92
- MannKind (MNKD) 4pm, ($0.02)
- Marathon Oil (MRO) Aft-mkt, $0.59
- MDU Resources (MDU) 5:30pm, $0.44
- Mindray Medical (MR) 5pm, $0.46
- Neurocrine Biosciences (NBIX) 4:02pm, ($0.21)
- Protective Life (PL) 4:14pm, $1.22
- Regency Centers (REG) 4:05pm, $0.18
- RetailMeNot (SALE) 4:01pm, $0.13
- Rock-Tenn Co (RKT) 5pm, $1.06
- Rosetta Resources (ROSE) 5:15pm, $0.74
- Ruckus Wireless (RKUS) 4:05pm, $0.11
- Sprint (S) 4pm, ($0.06)
- Stone Energy (SGY) 4:03pm, $0.07
- Tenet Healthcare (THC) 4:15pm, $0.09
- Veresen (VSN CN) 5pm, $0.02
- Vornado Realty Trust (VNO) Aft-mkt, $0.43
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Gold Extends Decline Toward Lowest Since 2010 as Silver Drops
- Gold Wagers Drop as $1.3 Billion Pulled From Funds: Commodities
- Brent Crude Trades Near 4-Day Low as China Manufacturing Slows
- Palm Enters Bull Market as Soybeans Rally, Biofuels Drive Demand
- Nickel Drops as Chinese Manufacturing Growth Misses Estimates
- Hedge Funds Cut Bullish Oil Bets as Global Glut Expands: Energy
- ICE Brent Money Managers Net-Longs Rose to 54,715 Last Week
- White Sugar Falls for Third Day on Ample Supply; Cocoa Declines
- Natural Gas Rises for Fifth Day as Cold Forecast for U.S. East
- Lehman Antidote Hits Nordic Power Exchange With Another Problem
- Steel Rebar Falls on Signs of China Slowdown, Iron Ore Price
- Hurricane Vance in Pacific Will Weaken From Tonight, NHC Says
- Tomato Demand Spurs Record California Crop as Drought Worsens
- Zimbabwe Needs to Clarify its Black Ownership Laws, IMF Says
- Corn Drops With Soybeans as U.S. Weather Seen Boosting Harvest
The Hedgeye Macro Team
This note was originally published at 8am on October 20, 2014 for Hedgeye subscribers.
“We will have to send soldiers into this party seeing red.”
World War II #history rarely accuses British Army General Bernard Montgomery of having a confidence problem. He was often decisive and ruthless. In the end, he was also a winner.
On the eve of landing on the beaches of Normandy, Monty’s bravado reminded Churchill’s Chief of Staff (Lieutenant Hastings Ismay) of the eve of Agincourt (as depicted in Henry V):
“He which hath no stomach to this fight – let him depart.” (The Guns At Last Light, pg 11)
Back to the Global Macro Grind…
Seeing red, in single-factor price momentum terms, is not what everyone saw on Friday’s US stock market bounce. That’s because not everyone looks at risk on a multi-factor, multi-duration basis. But that doesn’t mean it ceases to exist.
Actually, the Russell 2000 was down on Friday, so even in single-factor terms, many saw red. Don’t forget that even though the Russell was up for the 1st week in 7, over 60% of stocks in the Russell 2000 are currently crashing (-20% from their 12-month highs).
Back to the multi-factor thing, we highly suggest you consider Mr. Macro’s market message on a baseline 3-factor basis – PRICE, VOLUME, and VOLATILITY. In those terms, this is what we saw on Friday’s “bounce”:
- PRICE – both the SPX and Russell failed at all 3 core levels of @Hedgeye resistance (TRADE, TREND, TAIL)
- VOLUME – Total US Equity Market Volume was -11% and -4% vs. its 1 and 3 month averages, respectively
- VOLATILITY – VIX was down on the day but +3.5% and +60.3% for the week and YTD, respectively
Price momentum is an easy concept for people to understand (it goes up or down – look at the chart, bro!). That’s why many still use what I affectionately refer to as Moving Monkeys (50 and 200 day) in order to contextualize price. Unfortunately, that is not a risk management process.
The direction of price obviously matters, but so does multi-factor context. Here’s what I mean by that:
- BULLISH – Price Up, Volume Up, Volatility Down
- BEARISH – Price Down, Volume Up, Volatility Up
Within the context of a bearish intermediate-term TREND @Hedgeye, Price UP, Volume DOWN, and trending (implied) Volatility UP is bearish too.
Setting aside our research view of US #GrowthSlowing, to get bullish and “buy-the-damn-dip” in US Equity beta, what I would need to see is the SP500 close above my immediate-term TRADE line of 1949 on accelerating VOLUME and a break-down in the VIX below my TRADE line of 15.03.
Those of you paying attention to my immediate-term risk ranges will note that these levels aren’t in the area code of today’s ranges. And, to a degree, that’s the point. If I look beyond 1-3 days in duration (to 3 weeks), I’m seeing a heightening probability of more red.
Across asset classes (multi-factor), here are the other big #Quad4 deflationary forces at work across multiple-durations (TRADE and TREND):
- European Equity deflation of -0.9% last week (-2.9% YTD EuroStoxx600) is bearish TRADE and TREND
- Emerging Market Equity deflation of -1.9% last week (-3.2% YTD MSCI) is bearish TRADE and TREND
- CRB Index deflation of -1.1% last week (-2.7% YTD) is bearish TRADE and TREND
- Oil (WTI) deflation of -3.3% last week (-11.1% YTD) is bearish TRADE and TREND
- Energy Equity (XLE) deflation of -1.1% last week (-6.6% YTD) is bearish TRADE and TREND
Then, of course, you have trivial risk signals like:
- US 10yr Treasury Yield crashing (-27% YTD) to 2.19% (bearish TRADE, TREND, and TAIL)
- US Treasury Yield Spread crashing (-31% YTD) to +182bps wide (10yr minus 2yr)
- And Credit Spreads starting to move off of their all-time lows as equity and commodity volatilities breakout
“So”, yes, I do see more red pending in US, European, and Emerging Market Equities in the coming weeks and months. And, no, I don’t think last week’s immediate-term capitulation was the bottom.
But consensus does! Here’s the updated net positioning of hedge funds in non-commercial CFTC futures/options terms:
- SP500 (Index + E-mini) got longer by +5,537 contracts to a net LONG position of +54,153 last week
- 10yr Treasury Bond saw shorts get -6,976 contracts shorter last week to a net SHORT position of -58,930
- Crude Oil bulls only gave up -14,225 contracts last week, keeping the net LONG position at +285,500 contracts!
In other words, consensus got longer of the US stock market, shorter of the Long Bond, and not nearly less-long enough of a crashing Oil price.
I know that some are frustrated out there with their performance. I can assure you that I’ve been there and had to deal with that. But there comes a time where you have to choose between being consensus and not seeing any more red in your P&L.
Our Immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.09-2.28%
WTI Oil 79.96-84.58
Best of luck out there this week,
Takeaway: YUM could easily be the next Restaurant company to face the scrutiny of an activists. We see 32-53% upside under such a scenario.
We are adding YUM to the Hedgeye Best Ideas list as a long.
Vulnerable to Activism
Both Wall Street and the media have been focused on McDonald’s as the next target of activism in the restaurant space. While it certainly could be, we believe the often overlooked Yum! Brands is the more sensible target. Unlike McDonald’s, YUM’s multiple brands and new operating structure can, and should, be altered in a way to create significant shareholder value.
For the better part of the past two years, management has been asked about a potential spinoff of the China business. Spinning out this business would be the first step in a series of potential transactions that would simplify the structure and improve the operating performance of the company. In fact, we find it likely that a group of influential shareholders begin to push the board in that direction.
We’ve been saying for years that multi-concept restaurant companies are structurally flawed, putting them at a distinct disadvantage to their nimble counterparts. If you recall, YUM initially got off to a rocky start as a public company, but has benefitted greatly over the last decade as growth in the China business has largely overshadowed inefficiencies and other underperforming brands. For this reason, YUM has never been lumped into the category of inefficient multi-branded restaurant companies.
Times are a changing for YUM. The company’s growth driver, China, has been under pressure and the overall performance of the enterprise has suffered, while the stock has underperformed the S&P 500 for the past three years. Underperformance is the kiss of death and typically the starting point for most activist white papers.
But mere underperformance is only the tip of the iceberg. There have been a series of transactions in the restaurant space that highlight how vulnerable YUM is to more progressive thinking. The balance sheet is underleveraged and there is ample liquidity in the marketplace to fund the type of restructuring we believe would benefit all constituents.
Activist investors have been an ambitious bunch lately, amassing war chests to support their cause. In the last two years, we’ve seen the community shift from buying up 5-10% stakes in smaller companies to buying smaller stakes in larger targets and working together to effect change. Recent examples of this include Icahn’s Apple campaign, ValueAct Capital Management’s sub-1% stake in Microsoft, Elliott Management Corp’s $1 billion investment in EMC and Jana Partners’ $1 billion investment in Apache Corp, which is approximately the same market cap as YUM.
In this day and age, YUM’s $31 billion in equity value is now in the sweet spot of the activist pool.
We’re not going to wait for an activist to come knocking; rather we’re going to lay out the activist thesis for you in an upcoming presentation. It will focus on the following key points:
- The new global reporting structure of the company allows for a clean split of the business units into multiple asset-lite business models.
- Creating a Pan-Asian KFC business listed on the Hong Kong exchange and headed by a Chinese national would limit the pressure being placed on the business by the Chinese government. A Hong Kong-listed company would go a long way in restoring consumer faith in the KFC brand in China.
- The BKW/THI deal highlight’s YUM’s underleveraged balance sheet.
- More shareholder friendly thinking would lead the board to take advantage of the liquidity in the marketplace and increase the leverage of the company to pay a special dividend or repurchase stock.
- There is significant liquidity in the franchisee community to refranchise more stores and structure the company as an asset-lite business.
- Cut excess G&A spend.
- Global asset-lite restaurant companies are trading at a 30% premium to YUM on an EV/EBITDA basis.
Importantly, YUM is already amidst a significant transition. David Novak, the charismatic CEO the company, is stepping down at the end of the year. Mr. Novak has been an incredible CEO and is the backbone of this company. With that being said, it will be extremely difficult to replace him.
The company announced last May that Greg Creed, the CEO of Taco Bell, will take on this daunting challenge as the next CEO of Yum! Brands. At the time, we believed the selection of Mr. Creed as CEO was a strange, although not illogical choice. It’s not that we don’t think Mr. Creed will make a good CEO, but rather that we expected Sam Su, the CEO of YUM China, to replace Mr. Novak. That would've, however, required Mr. Su move to the U.S., which is something we believe he didn’t want to do. Potentially for good reason; he is needed in China more now than ever before.
This leads us to believe that the leadership team, under a new operating structure, is already in place. YUM currently has several viable, and competent, CEO’s within the organization. When considering a potential split of the company, the two most important divisions (Yum! Brands China, Taco Bell) have management team’s that would ensure a smooth transition.
- Sam Su as CEO of the Pan-Asian KFC business
- Greg Creed as CEO of Taco Bell
We will work around these assumptions in our forthcoming black book on the company. With such strong assets, an opportunity for value creation is readily apparent to most investors. As a standalone business, we believe each of YUM’s brands would trade at a premium to where the conglomerate is trading today.
Under the scenario we will layout in our upcoming presentation, we believe the stock could trade between $95-110, representing approximately 32-53% upside from current levels.
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