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Bond Bubble: Losing Air

Takeaway: We recommend that investors continue to reduce overall exposure to fixed income, and to incrementally add to stock portfolios on pullbacks.

Bond Bubble: Losing Air - cast1

 

One of the major risks we previously flagged in fixed income markets is contributing to the challenging results coming out of the leading investment banks this week. With Value at Risk representing an indication of liquidity in bond markets having been in dramatic decline over the past 3 years, it isn't surprising to us that the fixed income businesses of JP Morgan, Citigroup, and Goldman Sachs reported negative year over year results this week.

 

While JP Morgan’s negative 8% revenue result year-over-year in fixed income trading was manageable, the surprising 44% year-over-year decline at Goldman Sachs was shocking.

Click here to watch the HedgeyeTV video "Bond Bear Market: Just Beginning."

 

With dealers getting dinged in fixed income trading, this may cause even less capital to be committed going forward by brokers to trade bonds which can continue to exacerbate year-to-date negative returns in bonds.

 

We recommend that investors continue to reduce overall exposure to fixed income, and to incrementally add to stock portfolios on pullbacks as we outlined in prior calls.


INITIAL CLAIMS: CALIFORNICATION

Takeaway: The number of adjustments needed to get to the center of the labor market tootsie pop is growing. We try our best to get there.

With the DC drama sideshow shelved for a few months, confused monetary policy positioning out of the Fed can again return as the attendant driver of investor angst.  Alongside the market re-shift in focus today, the dollar is down, rates are down, and stocks are struggling to mount a reversal of early weakness 

 

Essentially, we are back to where we were about a week and a half ago with both the dollar & the 10Y testing their breakdown lines.  Keith will be home from London and back in the PM seat tomorrow, but the levels that matter are still:

 

  • DXY ($USD):  TAIL Support = 79.21
  • 10Y Treasury:  TREND Support = 2.58%

We are currently running fairly low gross exposure with 6 longs, 3 shorts.  From here, we need to see the $USD and 10Y Treasury support lines hold alongside some fundamental confirmation with next week’s data deluge to take our gross & net exposure to domestic equities higher again. Conversely, if the dollar and 10Y breakdown alongside marginal weakness in the macro data and an overbought signal in equities, we’ll continue to tighten up/reverse our positioning.     

 

Meanwhile, on the labor front, the ongoing distortion in the only currently available government data series –  Initial Jobless Claims - continues to perpetuate uncertainty around both the underlying strength of the domestic labor market and the read through to probable, forward monetary policy adjustments. 

 

We work through this weeks claims numbers in detail below, but the bottom line is that, after adjusting for the impacts of the government shutdown and California catch-up, the Labor Market’s trend line of improvement remains intact.

 

Below is the detailed breakdown of this morning's claims data from the Hedgeye Financials team.  If you would like to setup a call with Josh or Jonathan or trial their research, please contact 

 

-  Hedgeye Macro

 

--------------------------------------------------------------------------------------------------------

 

Lots of Needed Adjustments

The Golden State has been the source of considerable and ongoing distortion in the only currently-available government labor market data series, initial jobless claims. We thought that last week's sharp spike in claims reflected the full catch-up of California's temporary IT systems-related issues, but that was wrong. This morning's number is again distorted by California's ongoing catch-up. While we received data last week indicating that there were 33k additional claims from California due to the backlog catch-up, this week we received no such number. Comments in the media, however, have alluded to the impact being of comparable size.

 

In the first chart below we look at the distortion being created with California and then in the second chart we examine the impact this is having on the national data. The first chart shows weekly NSA initial claims for CA through 10/4. Unfortunately, state level data is only available on a 1-week lag. The blue line shows 2013 while the red line shows the corresponding period in 2012.  It's clear that the IT system effect occurred the week of Sep 6, when the spread between 2012 and 2013 jumped to -25k claims. The following week it remained wide at -21k. In the most recent week the spread reversed to +26k. However, it's the cumulative size of the distortion that now needs to be reversed. As such, we would expect next week's number to again be overstated. Thereafter, we would expect to see the series revert back to normal.

 

Separate from California's distortive effects, there is also the effect of the govt shutdown. While Federal employees file under a separate system (~70k of them filed the week of Oct 4), there are private workers who were laid off because they work in govt-related fields. These people were reported to have accounted for 15k additional claims in the week of Oct. 4. This past week no such similar disclosure was provided, but we did see reference from Reuters quoting a labor dept analyst saying "There had not been a perceptible increase in filings last week from non-federal workers furloughed because of the just-ended government shutdown."

 

The bottom line is that when making the adjustments for both California and the temporary distortions from the govt shutdown, the labor market's trend line rate of improvement remains intact.

 

INITIAL CLAIMS: CALIFORNICATION - JS 1

 

INITIAL CLAIMS: CALIFORNICATION - JS 2

 

Nuts & Bolts

Prior to revision, initial jobless claims fell 16k to 358k from 374k WoW, as the prior week's number was revised down by -1k to 373k. Meanwhile, the 4-week rolling average of seasonally-adjusted claims rose 12k WoW to 336.75k.

 

The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -7.5% lower YoY, which is a sequential deterioration versus the previous week's YoY change of -11.8%, but again this is an unadjusted number.

 

INITIAL CLAIMS: CALIFORNICATION - JS 3

 

INITIAL CLAIMS: CALIFORNICATION - JS 4

 

INITIAL CLAIMS: CALIFORNICATION - JS 5

 

INITIAL CLAIMS: CALIFORNICATION - JS 6

 

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 


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HPPC Round-up Ahead of Earnings

The HPPC earnings season kicks off next week with Kimberly Clark reporting on 10/22 before the market open. Below, we offer a recap of recent trends in sentiment and valuation for the sector as well as a reiteration of our favorite names on the long and short sides.

 

 

Current Ideas

 

ENR (short side): The Company’s exposure to unfavorable categories and lack of exposure to growing categories is a concern for us as is the macro outlook. Over the past ten years, organic sales growth has been anemic as acquisitions have been the primary driver of top-line growth. Per our recent notes, we believe ENR is still a short.  

 

HPPC Round-up Ahead of Earnings - ENR organic growth

 

HPPC Round-up Ahead of Earnings - enr snapshot

 

 

KMB (short side): Of all the companies we follow, KMB carries the greatest risk of a guide-down in 2H13 after management reiterated its FY EPS guidance range on 2Q results that were disappointing due to weak sales and FX headwinds.

 

A difficult competitive and operating environment is pressuring volume growth and margins at KMB as input costs accelerate even as pricing growth in the U.S. remains flat-to-down. The company has underperformed the S&P 500 since we suggested shorting the stock as a pair versus long EL (see note). We expect investor sentiment to turn when organic sales growth inflects although recent strength in the stock suggests that some positive news is expected in next Tuesday’s press release.

 

 

EL (long side): Estée Lauder has been our favorite name on the long side since 8/27.

 

EL has performed less-well over the past week-to-ten days versus the prior two months but we remain positive on the company’s prospects as a high-double digit earnings growth rate is supported by mid-to-high single digit revenue growth and exposure to the high-end consumer.

 

With the stock up 5% since 4QFY13 EPS on 8/15, investors will need to see impressive figures for the stock to maintain momentum. We have confidence in the long-term benefits of SMI, particularly cost savings which, unlike where ENR and KMB are concerned, we expect investors to pay up for as strong sales growth enhances the impact of efficiency gains.

 

 

CL (long side): Colgate Palmolive is another stock we have a favorable view of ahead of earnings (last quarter’s recap note). The company’s strength in the growing oral care category and resilience in emerging markets have been strong positives for the company. We expect continuing EBIT margin expansion when the company reports 3Q13 results before the market open on 10/24.

 

The company was prudent in lowering its FY EPS guidance based on FX headwinds when releasing 2Q EPS and we expect the stock to outperform over the remainder of the year.

 

 

Sentiment

 

From a sentiment perspective, CLX (downgraded this morning to Underweight from Equalweight at Morgan Stanley) is the least liked stock in the sector. Generally, the most liked names in the sector have seen a retracement in sentiment (NWL, PG, EL, REV).

 

ENR has been a standout in that it is middle-of-the-pack in terms of sentiment (below) but the most recent two week period saw sharp decline in sentiment as one sell-side downgrade and an uptick in short interest pressured the stock.

 

Per our comments, above, we remain bearish on the name. We include a sentiment table encompassing all of staples, for reference.

 

HPPC Round-up Ahead of Earnings - HPPC sentiment scorecard 10.17.13

 

HPPC Round-up Ahead of Earnings - Staples sentiment scorecard 10.17

 

 

Price Action & Valuation

 

As we can see in the table below, recently there has been plenty of variance in the price action of the sector, independent of categories/geographical exposure. Note that the starting points for the respective companies’ price and multiple changes vary depending on the date of each company’s most recent earnings release. KMB was the first of these companies to report 2QCY13 earnings, on 7/22, with COTY the latest on 9/17. Please see the table to the right of the chart for reference.

 

HPPC Round-up Ahead of Earnings - cpg multiple and stock turn since earnings 1

 

HPPC Round-up Ahead of Earnings - hppc pe multiples

 

 

 

Rory Green

Senior Analyst


INITIAL CLAIMS: CALIFORNICATION

Takeaway: The number of adjustments needed to get to the center of the labor market tootsie pop is growing. We try our best to get there.

Lots of Needed Adjustments

The Golden State has been the source of considerable and ongoing distortion in the only currently-available government labor market data series, initial jobless claims. We thought that last week's sharp spike in claims reflected the full catch-up of California's temporary IT systems-related issues, but that was wrong. This morning's number is again distorted by California's ongoing catch-up. While we received data last week indicating that there were 33k additional claims from California due to the backlog catch-up, this week we received no such number. Comments in the media, however, have alluded to the impact being of comparable size.

 

In the first chart below we look at the distortion being created with California and then in the second chart we examine the impact this is having on the national data. The first chart shows weekly NSA initial claims for CA through 10/4. Unfortunately, state level data is only available on a 1-week lag. The blue line shows 2013 while the red line shows the corresponding period in 2012.  It's clear that the IT system effect occurred the week of Sep 6, when the spread between 2012 and 2013 jumped to -25k claims. The following week it remained wide at -21k. In the most recent week the spread reversed to +26k. However, it's the cumulative size of the distortion that now needs to be reversed. As such, we would expect next week's number to again be overstated. Thereafter, we would expect to see the series revert back to normal.

 

Separate from California's distortive effects, there is also the effect of the govt shutdown. While Federal employees file under a separate system (~70k of them filed the week of Oct 4), there are private workers who were laid off because they work in govt-related fields. These people were reported to have accounted for 15k additional claims in the week of Oct. 4. This past week no such similar disclosure was provided, but we did see reference from Reuters quoting a labor dept analyst saying "There had not been a perceptible increase in filings last week from non-federal workers furloughed because of the just-ended government shutdown."

 

The bottom line is that when making the adjustments for both California and the temporary distortions from the govt shutdown, the labor market's trend line rate of improvement remains intact.

 

INITIAL CLAIMS: CALIFORNICATION - Cali Chart

 

INITIAL CLAIMS: CALIFORNICATION - 20   Gray Chart

 

Nuts & Bolts

Prior to revision, initial jobless claims fell 16k to 358k from 374k WoW, as the prior week's number was revised down by -1k to 373k. Meanwhile, the 4-week rolling average of seasonally-adjusted claims rose 12k WoW to 336.75k.

 

The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -7.5% lower YoY, which is a sequential deterioration versus the previous week's YoY change of -11.8%, but again this is an unadjusted number.

 

INITIAL CLAIMS: CALIFORNICATION - 1

 

INITIAL CLAIMS: CALIFORNICATION - 2

 

INITIAL CLAIMS: CALIFORNICATION - 3

 

INITIAL CLAIMS: CALIFORNICATION - 4

 

INITIAL CLAIMS: CALIFORNICATION - 5

 

INITIAL CLAIMS: CALIFORNICATION - 6

 

INITIAL CLAIMS: CALIFORNICATION - 7

 

INITIAL CLAIMS: CALIFORNICATION - 8

 

INITIAL CLAIMS: CALIFORNICATION - 9

 

INITIAL CLAIMS: CALIFORNICATION - 10

 

INITIAL CLAIMS: CALIFORNICATION - 11

 

INITIAL CLAIMS: CALIFORNICATION - 12

 

INITIAL CLAIMS: CALIFORNICATION - 13

 

INITIAL CLAIMS: CALIFORNICATION - 19

 

INITIAL CLAIMS: CALIFORNICATION - 14

 

Yield Spreads

The 2-10 spread rose 4 basis points WoW to 234 bps. 4Q13TD, the 2-10 spread is averaging 231 bps, which is 3 bps lower relative to 3Q13. 

 

INITIAL CLAIMS: CALIFORNICATION - 15

 

INITIAL CLAIMS: CALIFORNICATION - 16

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 


Kaiser Questions Kinder Morgan

If you‘ve been paying any attention to what’s going on in the Master Limited Partnership (MLP) space recently, you’ve undoubtedly come across Kevin Kaiser’s name. Kaiser is the Senior Energy Analyst at Hedgeye Risk Management and the guy who’s ruffling more than a few feathers questioning certain energy companies’ accounting practices. Here are some recent noteworthy headlines about his research:

  • Young analyst draws Wall Street ire taking on Kinder Morgan (via Reuters)
  • Why a 26-year-old analyst has managed to rattle Wall Street (via Quartz)
  • Research firm rebuts Kinder Morgan’s rebuttal (via MarketWatch)
  • Is Kinder Morgan Scrimping on its Pipelines? (via Wall Street Journal)

Kaiser Questions Kinder Morgan - kindm

 

Kinder Morgan, the current target of Kaiser’s attention, (finally) allowed him to ask a few questions in their quarterly conference call yesterday. One of Kaiser’s key contentions all along is that Kinder Morgan is understating it maintenance capex. As you’ll see in the transcript below, Kaiser was trying to get some color on the management team’s philosophy regarding the calculation of their distributable cash flow.

 

Analyst: Kevin Kaiser, Hedgeye Risk Management - Analyst

 

Question – Kevin Kaiser: A question on CapEx for gathering and processing. What is CapEx budget for gathering and processing on a quarterly basis including Copano?

 

Answer – Steve Kean (President and Chief Operating Officer): I don't know if we have that number broken down.

 

Answer – Rich Kinder (Chairman & CEO): We don't break it out separately. It's part of our natural gas CapEx.

 

Answer – Steve Kean: We have CapEx on Copano and Altamont and some in Texas, some in other -- in Texas as well but we don't have a break out of that.

 

Question – Kevin Kaiser: Okay so no break out for GNP by sustaining CapEx versus expansion CapEx either?

 

Answer – Steve Kean: No, I think that's just aggregated in our total Gas Group.

 

Answer – Rich Kinder: Total Natural Gas segment aggregates all of the -- whether sustaining CapEx or the expansion CapEx is all aggregated.

 

Question – Kevin Kaiser: Okay, and then on the Company wide -- so the budget for this year for sustaining CapEx will be $339 million. That's before Copano. If KMP only spent that on an annual basis, so no organic expansion CapEx, how would the segments perform over the long term? Would the Company be able to keep cash flow flat?

 

Answer – Rich Kinder: I'm sorry, I don't--

 

Answer – Kim Dang (CFO): Well, I think that we have growth -- are you asking if there's growth absent spending CapEx in KMP?

 

Question – Kevin Kaiser: The question is really if the budget was only limited to the sustaining CapEx, would the additional asset base be able to -- would it be maintained -- would the cash flows be maintained over the long term $339 million?

 

Answer – Rich Kinder: Oh, I see your question. Yes, we've said this several times and these are ballpark numbers, of course, but generally speaking that 5% or 6% this year happens to be 7% growth in distributions. We think probably 1.5% to 2% is organic growth, in other words, if you didn't spend any capital you would get that. At KMP that comes from a number of things. One is, of course, the inflation escalator that we have on our FERC-regulated products pipelines. The second is on automatic escalators that we have on some of our terminal assets. So you'd probably have we estimate 1.5% to 2% growth if you didn't spend any capital. And then the rest of that growth comes from -- primarily from new projects that come on line.

 

Answer – Steve Kean: That's obviously subject to market conditions. Market conditions determine the growth on just the existing asset base on a stand-alone basis.

 

Question – Kevin Kaiser: Right and how would 1% to 2% organic growth be possible with just $339 million if you spend about $400 million in ENP alone and that's not in the sustaining CapEx budget?

 

Answer – Rich Kinder: As I just said, I'm not following your question I guess. You ask how much organic growth you had without expansion CapEx and that's the kind of number that we use, about 1.5% to 2%. Kim?

 

Answer – Kim Dang: Kevin, is your question if CO2 production would stay flat if we weren't spending expansion capital?

 

Question – Kevin Kaiser: No, the question is really if you -- on the business, the entire KMP business how would cash flows trend over the long term if we only spend $339 million a year in Capital Expenditures.

 

Answer – Kim Dang: I think Rich just answered it.

 

Question – Kevin Kaiser: Okay and then the last question I have is do you consider distributable cash flow to be synonymous with free cash flow?

 

Answer – Kim Dang: Kevin, look, what we're looking at is how much cash flow that the MLP generates before expansion capital. Because our partnership agreement requires us to finance expansion capital, to distribute everything that we generate and to finance our expansion capital. So what we are comparing, distributable cash flow is to the cash flow that we have available for distributions to our unit holders before we factor in expansion CapEx.

 

Question – Kevin Kaiser: Okay, so you would say it's not -- you would not say that free cash flow and distributable cash flow are the same thing?

 

Answer – Kim Dang: If you're defining free cash flow as cash flow after expansion CapEx, then I would say that distributable cash flow and free cash flow are not the same thing but it depends on how you're defining free cash flow.

 

Question – Kevin Kaiser: I would define free cash flow as cash flow from operations minus the capital expenditures needed on an annual basis to maintain those cash flows from operations?

 

Answer – Kim Dang: Well that is not, unfortunately, that is nice that you would interpret it that way but that's not the way that our partnership agreement defines it and therefore, that's not the way we are allowed to segregate it.

 

(Source: AlphaSense transcripts)


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