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November Rain

“If at first you don’t succeed, then skydiving definitely isn’t for you”

- Steven Wright

 

Every November for the last decade, my high school buddies and I gather ahead of Thanksgiving to toast our respective, eclectic journeys into grown up’ness.

 

Every November for the last half-decade, domestic inflation expectations have crashed in an acute, seasonal de-crescendo.                                                                                                                                                    

Every November, Global Central Bankers meet in the collective effort to arrest economic gravity. 

 

Every December, the Macro Muchachos of Hedgeye toast to the profit opportunities borne of the unique pervasiveness of this-time-is-different’ness

 

Back to the Global Macro Grind…

 

In mid-October, Fed researchers documented Residual Seasonality in the reported Inflation data whereby in 8 of the last 10 years consumer price inflation has tended to be higher in the first half of the year than in the second half – a pattern evident even in the seasonally adjusted data. 

 

The research doesn’t really offer a supporting theory for the serial seasonality but the publication of the research suggests the Fed is, at least, aware of the seasonality and may (partially) discount the magnitude of sub-target inflation reported in the 3rd and 4th quarters. 

 

Notably, the paper also fails to identify policy itself as a contributing factor in perpetuating that phenomenon. 

 

As can be seen in the 1st Chart of the Day below, policy initiatives have, in recurrent fashion, been implemented circa November in the wake of crashing growth expectations.  

 

November Rain - EL Chart  1 QE vs BE

 

The direction of causality is (perhaps) open to debate but given that QE initiatives (generally announced in late 3Q) drove recurrent bouts of commodity price inflation & ‘escape velocity’ optimism into the New Year and that inflation expectations, in regular fashion, collapsed subsequent to cessation of QE initiatives is certainly suggestive.   

 

The 2nd chart of the day, first published by our Financials team early in the year, shows that the end of QE1 & QE2 were both followed by sharp drops in 10-year treasury yields as the bond market priced in slowing growth and the inability of the private sector to successfully take the hand-off from the Fed.   We’re inclined to interpret the current weakness in the 10Y as a protracted version of this recurrent cycle.  Essentially, it's the same selloff seen in the last two iterations, but in slow-motion, over the duration of the taper instead of all at once.

 

The Fed wants to get out of QE if only to afford themselves the opportunity to get back in and the cost-benefit balance in terms of policy spillover to financial market (in)stability has shifted in favor of policy normalization, but established patterns/habits and embedded (dovish) ideologies are hard to break…. particularly with the Quad#4 scourge of disinflation and slowing growth becoming an increasingly tangible threat.    

 

In physics, Constructive Interference describes the phenomenon of wave propagation and the propensity for two, in-phase waves to meet and produce a resultant wave larger in magnitude than either of the individual waves.  Conversely, destructive interference, describes the propensity for two, out of phase waves to cancel each other out. 

 

How does that relate to global macro risk? 

 

A host of individual economies have traversed through Quad #4 over the last 5 years.  However, the preponderance of G7/G20 economies have been at different points along the economic cycle at any given time – effectively in a state of destructive interference with the collective effect being a global economy oscillating above and below middling growth.

 

One benefit from being “out-of-phase” is that a rotate-the-QE model among DM central banks was a viable strategy and the race to the currency war bottom could proceed in a more-or-less orderly fashion.   

 

At present, however, the global Macroeconomy is experiencing a constructive interference of sorts whereby individual country cycles are converging to an in-phase wave of disinflation and decelerating growth.  The expedited collapse in major currencies and the discrete rise of $USD correlation risk is symptomatic. 

 

Growth, domestically, was almost 5% in 2Q. The first  revision to 3Q GDP will  show a negative revision down to  ~3%.  The early estimate for 4Q from the Fed’s GDPNow model is pointing to  +2.6% growth.   

 

The U.S. has been a source of relative strength but the late-cycle data is cresting alongside persistent, negative revisions to global growth and inflation estimates.  With bonds leading asset class performance YTD and the canonical defensive trio of XLV/U/P leading the 2014 rise in sector variance, the market has been discounting some measure of the current reality for some time. 

 

Personally, I’m getting bored of being long the long bond and would welcome a shift back into early-cycle, high growth/high beta exposure but neither the quant nor the fundamental data are supportive of that, yet. 

 

In other physics 101 news, Work still = Force x Distance.  

 

Here, distance actually refers to displacement, so, if your net change in position is zero you didn’t technically do any work.  On a physics score, the Russell 2000, having round-tripped in price, hasn’t done any work for two weeks….technically, with the S&P 500 up ~0% on an inflation adjusted basis since mid-2000, we haven’t done any work in nearly two decades. 

 

Yup…all the collective speculation, all the sunken search and research costs, all the spurious activity = zero work done when measured in SPX price terms.    

To Tuesday morning existentialism and bull markets in (economic) #gravity. 

 

Our immediate-term Global Macro Risk Ranges are now:  

 

UST 10yr yield 2.29-2.35%

RUT 1149-1181

CAC40 4149-4262

VIX 12.53-16.01

Yen 114.04-116.94

WTI Oil 74.05-76.99

Gold 1130-1203 

 

Christian B. Drake

U.S. Macro Analyst

 

November Rain - EL Chart  2 QE vs BS

 


THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP – November 18, 2014


As we look at today's setup for the S&P 500, the range is 49 points or 2.12% downside to 1998 and 0.28% upside to 2047.                                    

                                                                                           

SECTOR PERFORMANCE

 

THE HEDGEYE DAILY OUTLOOK - 1

 

THE HEDGEYE DAILY OUTLOOK - 2

 

EQUITY SENTIMENT:

 

THE HEDGEYE DAILY OUTLOOK - 10

 

CREDIT/ECONOMIC MARKET LOOK:

  • YIELD CURVE: 1.83 from 1.83
  • VIX closed at 13.99 1 day percent change of 5.11%

 

MACRO DATA POINTS (Bloomberg Estimates):

 

  • 7:45am: ICSC weekly sales
  • 8:30am: PPI Final Demand m/m, Oct., est. -0.1% (prior -0.1%)
  • 8:55am: Redbook weekly sales
  • 10am: NAHB Housing Market Index, Nov., est. 55 (prior 54)
  • 11:30am: U.S. to sell 4W bills
  • 1:30pm: Fed’s Kocherlakota speaks in St. Paul, Minn.
  • 4pm: Net Long-term TIC Flows, Sept. (prior $52.1b)
  • 4:30pm: API weekly oil inventories

 

GOVERNMENT:

    • Senate to vote Keystone XL pipeline after House passed bill
    • Diplomats from the U.S., U.K., France, Germany, Russia and China convene in Vienna for nuclear talks as they attempt to finalize interim deal with Iran before Nov. 24 deadline
    • 10am: Senate Foreign Relations Cmte hearing on countering Islamic State in Iraq and Syria
    • 10am: FDIC board holds open meeting to consider final rule on revisions to Deposit Insurance Assessment System
    • 10am: House Foreign Affairs subcmte hears from leaders of Doctors Without Borders and Africare on Ebola
    • 10am: House Cmte on Transportation and Infrastructure hearing on FAA reauthorization
    • 1pm: House Energy and Commerce Cmte hears from CDC Director Tom Frieden on U.S. response to Ebola
    • 6:30pm: Sen. Energy and Natural Resources Chairwoman Mary Landrieu holds news conf. on Keystone after Senate votes   

               

WHAT TO WATCH:

  • Abe Delays Tax Hike, Calls Vote to Renew Mandate: NHK
  • Wall Street to Reap $316m From Actavis, Halliburton Deals
  • Sprint CEO Claure Shuffles Top Management in Turnaround Bid
  • AT&T Cutting Shared Data Plan by 23% in Pre-Holiday Promotion
  • Intel to Merge Loss-Making Mobile Business With PC Division
  • Samsung Moves Smartphone Engineers to Internet of Things
  • Nokia Rolls Out Android Tablet in Return to Mobile Devices
  • Blackstone Said to Sell NYC Tower to Ivanhoe for $2.25b
  • SunEdison, TerraForm to Acquire First Wind for $2.4b
  • Halliburton Said to Plan $4b in Disposals for Baker Hughes
  • Halliburton, Baker Hughes May Be Cut by S&P
  • Carnival Enlists Public in Push to Tackle Cruise Image
  • China Rejection of HK Stock Icons Evident in Lopsided Link

 

EARNINGS:

    • Dick’s Sporting Goods (DKS) 7:30am, $0.41 - Preview
    • George Weston (WN CN) 7:45am, C$1.53
    • Home Depot (HD) 6am, $1.13 - Preview
    • Jack in the Box (JACK) 4:02pm, $0.53
    • La-Z-Boy (LZB) 4:10pm, $0.34
    • Ma-Com Technology (MTSI) 4:05pm, $0.33
    • Medtronic (MDT) 7:15am, $0.96 - Preview
    • PetSmart (PETM) 5:55pm, $0.94
    • Sears Canada (SCC CN) 7am, NA
    • TJX Cos (TJX) 8:28am, $0.85 - Preview
    • Vipshop (VIPS) 4:01pm, $0.07                 

                               

COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)

 

  • Shale Output Unchecked by Rig Cutback as Top Fields Become Focus
  • Gold Climbs to Two-Week High on Speculation ECB May Buy Bullion
  • Iron Ore Bear Market Deepens as China Home Data Add to Concern
  • China’s Ore Supplies Cushioning Nickel Output Amid Disruptions
  • Oil Fall Not Mirrored at Pump to Crimp Demand Growth: Julian Lee
  • Aluminum Falls to Two-Week Low on Concern Slowdown to Sap Demand
  • Goldman Says OPEC in Dilemma as Output Cut Seen Helping U.S.
  • Corn Falls for a 3rd Day as Record U.S. Harvest Nears Completion
  • MORE: Spot Gold Climbs to Highest Price This Month, Gains 0.8%
  • Sugar Rises Amid Prospects for Future Deficits; Cocoa Advances
  • Rubber Falls by Most in 2 Weeks in Tokyo Amid Japanese Recession
  • Singapore Iron Ore Futures for March Settlement Drop Below $70
  • Money Managers Raise Aluminum Bullish Bets on LME in Latest Week
  • WTI Rises Before OPEC Meeting as Dollar Weakens; Brent Stable

 

THE HEDGEYE DAILY OUTLOOK - 5

 

CURRENCIES

 

THE HEDGEYE DAILY OUTLOOK - 6

 

GLOBAL PERFORMANCE

 

THE HEDGEYE DAILY OUTLOOK - 3

 

THE HEDGEYE DAILY OUTLOOK - 4

 

EUROPEAN MARKETS

 

THE HEDGEYE DAILY OUTLOOK - 7

 

ASIAN MARKETS

 

THE HEDGEYE DAILY OUTLOOK - 8

 

MIDDLE EAST

 

THE HEDGEYE DAILY OUTLOOK - 9

 

 

The Hedgeye Macro Team

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


November 18, 2014

November 18, 2014 - Slide1

 

BULLISH TRENDS

November 18, 2014 - Slide2

November 18, 2014 - Slide3

November 18, 2014 - Slide4

November 18, 2014 - Slide5

 

BEARISH TRENDS

November 18, 2014 - Slide6 

November 18, 2014 - Slide7

November 18, 2014 - Slide8

November 18, 2014 - Slide9

November 18, 2014 - Slide10

November 18, 2014 - Slide11
November 18, 2014 - Slide12

November 18, 2014 - Slide13


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MCD: An Activist's Dream? Not So Fast.

With the news of a large activist buying into MCD, we find it prudent to ask, “Will shareholders be saved?” 

 

We think it’s going to be a long road.  The last activist that was involved in MCD was successful, but not because they had an impact on management thought process. 

 

What did Pershing see in late 2005?

  • A concept squarely in the midst of a significant turnaround that resulted in over 110 months of positive global same-store sales growth
  • MCD had a market cap of $42 billion and $20 billion in system-wide sales
  • A real estate portfolio that was undervalued by $16 billion ($30 billion versus Pershing Square’s $46 billion estimate)
  • A stock that was unnecessarily trading at a discount to its peers
  • Three different businesses: franchise operations, company-owned operations and real estate

 

What did Pershing propose?

  • Spin 65% of the McOpCo stores
  • Spin out the real estate
  • Use the proceeds and increase leverage to repurchase stock

 

What was McDonald’s response?

  • They called it a mere exercise in financial engineering
  • Claimed they had a unique business model
  • Suggested it would disrupt the relationships it had with customers, franchisees and suppliers
  • Management said friction costs would make a REIT cost prohibitive
  • Pointed to potential unintended consequences
  • Feared it would lose its “A” credit rating

 

In the end, the company never implemented any of Pershing's bold plans.  Pershing's investment in MCD was successful, not because of the their ideas, but because the business was going in the right direction. 

 

Here we are, ten years later, with another activist prepared to potentially knock on the door of MCD.  In some ways, it’s a very different McDonald’s this time around.  In others, it’s the same old story. 

 

Last week, Jana Partners took a stake in MCD by accumulating 1.042 million shares, inclusive of calls.  According to the investment manager’s website, “Jana typically applies a fundamental value discipline to identify undervalued companies that have one or more specific catalysts to unlock value.  Jana can be the instrument for value creation by becoming an actively engaged shareholder.”

 

We understand why an activist would be attracted to MCD today:

  • McDonald’s needs to undergo a significant restructuring
  • McDonald's has approximately 6,500 company-operated restaurants that could be re-franchised
  • Global same-store sales are declining and have been for quite some time
  • The stock has under-performed the SPX by 14.5% over the past year
  • Chipotle has grown from approximately 440 restaurants in 2005 to approximately 1,785 restaurants today and is leading a significant shift in consumer eating patterns. 
  • McDonald's must be pushed to aggressively adapt to the changes in the market place 

 

The activist playbook in the restaurant space is generally confined to a couple of key moves.  Get control of the board and do one, or all, of the following:

  • Sell real-estate
  • Cut SG&A
  • Sell company-owned stores
  • Sell other non-core assets
  • Increase leverage and repurchase stock

 

In the case of MCD, we believe it will be very difficult to achieve any of these moves. 

 

First, we don’t think the board is ready to give up on CEO Don Thompson (for now, at least). Second, selling real-estate will never happen at MCD; there is a chance, however, that the company sells some McOpCo stores.  All told, we believe the latter is too small of a change and would not move the needle on profitability.  Third, McDonald’s doesn’t have any non-core assets.  And, fourth, we believe it is unlikely management will increase leverage because they like their credit rating where it is.  This would likely be a unwise move, to be frank, because increasing leverage in a declining sales and margin environment is unlikely to create shareholder value.

 

Now, either Jana’s investment is just the beginning of a bigger position or they are making the call on a short-term improvement in the operating performance of the company. 

 

We’re not sure what the play is here. 

 

What we are sure of is that McDonald’s is unlikely to see a notable, short-term improvement in trends and that Jana’s position is too small to agitate for change.  The truth is, none of the typical moves in the activist playbook will generate much value in this environment. 

 

The biggest upside in MCD will come from fixing the core operations.  With no disrespect to Jana, there is likely little they can do in this regard.  If they did come up with a silver bullet it would take 12-18 months for it to be approved and executed.  Lastly, we doubt the franchisee base will look kindly upon a hedge fund telling them how to run their business.    

 

For this reason, we still think there is risk to the numbers in 2015 and remain bearish on MCD.  We normally side with activists in the restaurant space, but we don’t see how one can make money in MCD right now. 

 

Feel free to call, or email, with questions.

 

Howard Penney

Managing Director

 

Fred Masotta

Analyst


Write It Down

This note was originally published at 8am on November 04, 2014 for Hedgeye subscribers.

“Write down, therefore, what you have seen, and what is happening, and what will happen afterwards.”

-Revelation 1:19

 

No, I’m not going all religious on you this morning. That’s the opening volley from Jim Rickards in his recent book, The Death of Money. For those of you who missed it, I had a Real Conversation @HedgeyeTV with Rickards earlier in the year that you can watch here.

 

Do you write it down? What is “it”? And what do you do when something macro is happening that hasn’t happened for a very long period of time (like #deflation)? Once market expectations go through a phase transition from inflation policies to deflation, what will happen afterwards?

 

I’ve been writing down real-time market quotes, data, research, etc. in my notebook for 15 years and I have only seen versions of what I have been writing down for the last 10 months 2x: October 2007 and October 2008. Neither were bullish historical reference points and neither were the same.

 

Write It Down - 3

 

Back to the Global Macro Grind

 

To review, what is #Quad4 Deflation? In our risk management process (rate of change) it’s when the second derivatives in both growth and inflation are slowing, at the same time. These signals are both non-linear, and dynamic.

 

“There has been no episode of persistent deflation in the United States since the period from 1927-1933; as a result, Americans have practically no living memory of deflation.” (The Death of Money, pg 9)

 

I was in LA yesterday (San Francisco today) and, to a degree, I think that’s why we’ve been getting so many moments of silence in one-on-one Institutional Investor meetings as of late. It’s really hard for objective risk managers to absorb a scenario they’ve really never had to deal with.

 

“Objective”? Yes, as in this is what the market told you about #Deflation expectations yesterday:

 

  1. US Dollar up +0.3% to +8.8% YTD
  2. WTI Crude Oil down -2.8% to #crashing -20.5% YTD
  3. Energy Stocks (XLE) down -1.6% to -2.8% YTD
  4. Basic Material Stocks (XLB) -0.7% to +3.9% YTD
  5. Healthcare Stocks (XLV) +0.1% to +21.5%% YTD

 

In other words, in stark contrast to the Dollar Up, Rates Up #Quad1 signal we gave you to be long of everything big beta US growth in 2013, this Dollar Up (going to cash), Down Rates, #Deflation move is nasty for most things that lose their pricing power.

 

Healthcare (XLV) and Utilities (XLU) are two of the sectors that don’t get decimated by #deflation as fast as a levered-long-crude-oil-hedgie-dude (or an upstream E&P MLP dude who depends on the “dividend” that is decided by the price of the other dude’s oil inflation expectations).

 

I know, #dude!

 

That’s why the objective investor who has been writing down the sector returns for the SP500 in 2014 has noted the following RELATIVE YTD performance:

 

  1. Healthcare (XLV) +12.3% YTD
  2. Utilities (XLU) +11.4% YTD
  3. Technology (XLK) +4.7% YTD

Vs.

  1. Basic Materials (XLB) -5.2% YTD
  2. Consumer Discretionary (XLY) -7.3% YTD
  3. Energy (XLE) -12.0% YTD

 

Yep, if all you did was express either our early-cycle slowdown calls for #ConsumerSlowing and #HousingSlowdown from the beginning of the year and/or our #Quad4 deflation call, in your S&P Sector asset allocations, you’ve crushed it.

 

If all that mattered to the American Consumer was “gas prices” (it actually represents only 6.4% of the median consumer’s budget) all of these rosy “surveys” you’ve been reading would have been right. Instead, in relative and sector performance terms, those narrative fallacies got you killed.

 

But, but, the ISM number was great yesterday. Yep, just great, another survey!

 

In other news, Industrials (XLI) closed down on the day on that ISM manufacturing report. I wonder if that’s because the non-survey data (US Retail Sales, Consumer Spending, Durable Goods, Construction Spending, and New Home Sales), all recently SLOWED, in actual rate of change terms!

 

Moving along…

 

If only everyone who writes in this business was forced to actually write this stuff down, every single day, consensus might be as concerned about the big beta #bubble in levered-long-and-illiquid US equity inflation expectations as I am.

 

But what is your catalyst, Keith?

 

  1. What I have been writing to you all year is already happening
  2. What I have seen (on the mid-October Russell and Bond Yield Lows) has not been forgotten
  3. What is most probable to happen next is more of the same

 

If everything that was in #crash mode on October 13-14th were to crash, literally, tomorrow… I’d write it down too – and “it” would be something that should not come as a surprise to anyone.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.21-2.37%

SPX 1967-2033

RUT 1086-1181

Italy’s MIB Index 18912-20099

Yen 109.27-113.66

WTI Oil 76.41-80.94

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Write It Down - 11.04.14 Chart


RCL EXECUTIVE PRESENTATION/DINNER NOTES (11/16-11/17)

Takeaway: Lots of positive buzz on elements on Quantum, particularly the WiFi. But the 'Quantumizing' of the existing fleet will be costly.

Management commentary on board Quantum

 

 

Chairman Fain, CEO

  • Fuel:  20% better on ships pre-2006 vs post 2006 on $ per APCD
  • 85% guests using smart online registration process; boarding process on ship was less than 10 minutes.
  • O3B technology:  
    • Connectivity is 450x faster (fastest in the industry)
    • 8 orbiting satellites beaming on Quantum
    • Will be on Allure shortly and will be implemented across the fleet, particularly Caribbean-focused ships
      • Will be a very expensive investment 
      • Currently charging less on new WiFi product than older version of internet on other ships
    • RCL has exclusive contract with O3B in the cruise industry for a long period of time
  • Energy usage:  10-12% more efficient than their competition
    • Additional ~2.5% energy improvement expected in 2014
  • Advanced Emission Purification (AEP):  takes out sulfur; Mein Schiff III is the 1st cruise ship built with an AEP system already installed
  • Oasis 3 :  20% more efficient than Oasis 
  • Newer ships:  25% higher revenue, 20% lower costs, 3.5x higher EBITDA
  • ROI opportunities:  Best thing to add are staterooms; staterooms cost less to build on newer ships. 
  • Customers who book onboard activities in advance spend more onboard $ on the ship.  The pre-cruise planner has worked well.
  • Revenue breakdown:  Have gone from 20% non-US to 50% non-US

 

Jason Liberty, CFO

  • Solid liquidity
  • Net debt/EBITDA improved by ~50% over last 5 yrs
  • ROIC up 110 bps YoY
  • Moderate capacity growth:  
    • 2 Quantum Class
    • 2 Oasis Class
    • No order for 2017
    • Sold 5 ships in past 6 years
  • Continued double yield growth for Europe and China for end of 2014
  • Quantum demand exceeding expectation
  • 2015 
    • Yield growth: higher than 2014 yield growth
    • Fuel consumption down 2.5% for 2015

 

Q & A

  • Dollar strength vs lower fuel prices have neutralizing effects.  Will look into revising fuel hedging program but will also keep an eye on how much stronger the dollar gets.
  • Share buyback vs buying back debt:  
    • Being investment-grade credit is very important to RCL
    • Weighted cost of debt:  3.5%
    • Not much tax shield
  • Travel agents vs direct bookings:
    • Quantum has gotten better publicity than any other ship
    • Travel agents critical to attracting 1st time cruisers
    • More and more cruisers are buying directly thanks to internet resources
    • RCL direct bookings cost:  less than the 12-15% of revenues
  • Quantum to China
    • More significant costs
        • Marketing expenditures on grand welcome for Quantum
        • Chic will be transformed into traditional Chinese restaurant
        • Rice will be cooked in large woks -- more expensive products
        • Expanding casino
          • More table games; few slots
          • 2 private gaming rooms
        • Johnny Rockets will be converted to Kung Fu Panda noodle shop
        • Why Quantum didn't consider Southwest China on their itineraries and not just Korea/Japan?
          • For tax reasons and also less port charges.  
          • The trips are short (4-5 days), so not enough time to visit other places
        • Commissions paid to Chinese agents:  similar to US
    • Ships are almost exclusively Mainland Chinese guests  
    • A little more family/multi-generational 
    • 1/3 crew will be Chinese
    • Booking online in China is very low
  • Supply in Caribbean:  have seen stress in Q1 2015
  • Supply stress also in Australia/New Zealand
  • Not focused on macroeconomic trends in Europe
  • Ships that burn MGO fuel have lower ROIC e.g. Millennium, Meridian  
  • Double-Double targets have incorporated much of the additional capex needed to upgrade existing fleet.

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