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The Fade Trade

This note was originally published at 8am on November 12, 2014 for Hedgeye subscribers.

“Any intelligent fool can make things bigger, more complex, and more violent. It takes a touch of genius —and a lot of courage —to move in the opposite direction."

-E. F. Schumacker


The most challenging thing to do as a stock market operator is to make a trade or investment against consensus.  If you are wrong for any period of time, you hear about it in spades.  Especially in this day and age when every  Jamoke under the sun has a soapbox and/or a twitter feed.  (Admittedly, though, we do applaud the democracy that Twitter has brought to the media world!)


The fact is, the harder consensus leans, the higher your probability of being right in fading that view.   Conventionally speaking, one way in which this is manifested is in value investing.  Now, to some, value investing is about deep dive company analysis, which we get, but on a higher level it is really about the implications of company valuation.  Simply put: when a company’s valuation is high, the prospects for its future are perceived as rosier than when the valuation is low.  (That is a simplification, but you get the point.)


The Fade Trade - fish


In effect, valuation is an opinion, so when the vast majority of stock market operators give a company a low valuation, their opinion of that company is low.  Ironically, or not, this consensus opinion is consistently wrong over the long run.  In fact, Dreman Value Management proved this in spades in a study of “cheap” stocks:

  • First, the study showed that for the period of January 1st, 1970 to December 31st, 2010, stocks in the lowest P/E quintile outperformed stocks in the highest P/E quintile by a margin of 15.4% to 8.3% in terms of annual return;
  • Second, in the 52 quarters when the S&P 500 declined between 1970 – 2010, low P/E stocks outperformed the market by an average of +2.4% versus an under performance of -1.9%  for high P/E stocks; and
  • Finally, from 1973 to 2010 the lowest quintile P/E stocks went up +1.2% on a negative surprise versus a return of -7.4% for the highest quintile P/E stocks on a negative surprise.

Now valuation is obviously only one factor, and not always the best factor for shorter term tactical trading, but over the long run it is a great gauge of the consensus opinions of companies.  And over the very long run, fading well loved “names” as based on high P/E multiples has provided enormous outperformance.


Back to the Global Macro Grind...


This morning it is not difficult to find the consensus view of U.S. equities.  The II Bulll Bear Spread (bulls minus bears) is +99% to the bullish since October 12th.  As well, Bears are tracking near all-time lows at 14.8%.  If you are a lemming, of course, this makes sense.  As markets go up you get more bullish and as markets go down you get more bearish.  Practically speaking, as we highlight in the Chart of the Day, chasing this rally is fraught with risk given how unconvincing the volume has been.


Complacency seems to once again be setting into the view of European equity markets as well.  We’ve seen a few notable chart followers suggest the turn is in for European equities and today they may have some fodder for the case with Eurozone Industrial production, which beat expectations.


Specifically, Eurozone September Industrial Production rose by +0.6% year-over-year versus the consensus view of -0.3%.  This compared to the August reading, which was a -0.5% decline (also an upward revision from -1.9%).   As well, the German economic minister was out this morning saying that the “German economy stabilized in Q3 after a Q2 contraction and now has slight upward momentum”.  Now, of course, if this is the best the Eurozone can do, fading any rally is certainly worth considering.


Over at the Bank of England today, the honest Canadian, BOE Governor Mark Carney, is at least being forthright  in saying, "it’s appropriate that markets now expect easier monetary conditions” based on the real-time growth and inflation data the BOE is seeing.  The challenge with easier monetary conditions for many global central banks is that while they are not out of bullets, the bullets are increasingly ineffective.


Yesterday we hosted a call for our Institutional Macro subscribers with Professor John Taylor from Stanford on this very topic.  Taylor is an outspoken advocate for rules based central banking (hence the eponymous Taylor Rule) and also highlighted in spades a point we’ve been harping on for some time, which is that the extreme QE monetary policy in the U.S. has became increasingly ineffective.   As Taylor noted on QE3:


“When started 10-year Treasury was 1.7%, then rose and has remained higher

  •  Effects of QE on yield spreads

– 1-year vs 10-year US Treasury spread

– 2003-2008 non-QE period……1.3%.

– 2009-2013 QE period……………2.4%”


It obviously begs the question of whether the biggest no-brainer “Fade Trade” has become to fade the increasingly impotent global central banking regime?  You likely already know our answer on that.


If you’d like to listen to the replay of our discussion with Professor Taylor, the replay and his presentation can be accessed below.


***Click here for Replay

***Click here for Presentation Materials


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.26-2.39%

SPX 1965-2049

RUT 1135-1182
VIX 12.33-16.51

Yen 111.99-117.87

WTIC Oil 75.61-78.97 


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


The Fade Trade - cod

Cartoon of the Day: A Global Currency Gong Show

Cartoon of the Day: A Global Currency Gong Show - Dollar cartoon 11.25.2014

Sure... when you compare the Dollar to its peers in this global #CurrencyBurning gong show, the greenback looks pretty good.

Best Idea Call Invite: Long YUM

We recently added YUM to our Best Ideas list as a long.


We are hosting a call next Tuesday, December 2, 2014 at 10am EST to run through our thesis and field questions. We will send out dial-in information and materials for the call next week.


Key Topics Will Include:

  1. Vulnerable to Activism – There have been a number of events over the past two years that suggest the timing is optimal for YUM to simplify its corporate structure.  While there several different avenues of value creation, one thing is clear: YUM’s new corporate structure, multiple brands and underleveraged balance sheet almost ensure that the company is vulnerable to change.  What remains to be seen, however, is if the new CEO will be proactive and effect change or be reactive to the changing marketplace.
  2. Spinoff China (and/or Pizza Hut) – For the better part of the past two years, management has been asked about a potential spinoff of the China business.  In our view, this move would be the first step in a series of potential transactions that would simplify the structure and improve the operating performance of the company.  We find it likely that a group of influential shareholders begin to push the board in this direction.  It also makes sense to consider spinning off the dilutive Pizza Hut (co-owned stores) business, which would trade at a substantially higher multiple as a standalone entity.
  3. Multiple Ways to Win – The new global reporting structure of the company allows for a clean split of YUM's business units into multiple asset-light business models.  We also believe there is an opportunity to increase leverage (to repurchase stock or pay a special dividend), cut excess SG&A, refranchise additional restaurants and command a premium valuation. 


Under the scenario we will layout in our upcoming presentation, we see approximately 30-50% upside to the stock from current levels.


Howard Penney

Managing Director


Fred Masotta


Attention Students...

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Are You (Still) Waiting for Godot on Treasury Yields?

The verdict is in. The UST 10YR Yield is reading Japanese/Chinese/European PANIC (i.e. global growth slowing) as bearish ... as it should.


Are You (Still) Waiting for Godot on Treasury Yields? - g7

It’s 2.29% for the UST 10YR this morning… That’s a 2 week-low as the total return of the Long Bond in 2014 continues to be:


A) higher than most U.S. stock market averages and

B) without all the SEP-OCT volatility


If you’re new to Hedgeye research, we’ve been making this non-consensus bearish call on Treasury yields and global growth slowing throughout 2014 despite a ton of naysayers.


Are You (Still) Waiting for Godot on Treasury Yields? - pck


Case in point was the first week of September when hedge fund manager David Tepper grabbed headlines proclaiming to Bloomberg’s Stephanie Ruhle that we were witnessing “the beginning of the end of the bond market rally."


That hasn’t worked out so well.


After beginning 2014 at 3%, the yield on the ten-year fell to less than 2.4% during the summer, and is currently trading south of 2.30%. Hedgeye CEO Keith McCullough and our macro team thinks yields go lower from here and are continuing to advise our customers to stay long TLT.

Retail Callouts (11/25): NKE, UA, WMT, ICSC, TIF, DSW, BWS

Takeaway: Odell’s ‘The Catch’ made wearing Nike gloves, big UA snub – again. WMT CMO leaves 3 days before Black Friday. TIF, DSW, BWS SIGMAs.



Takeaway: Not the type of strength we'd expect to see out of the ICSC through Nov. so far in light of the fact that disposable personal income was slightly negative during the same month last year.  Comps get easier throughout the month and December when DPI was -3.1% YY. We could talk all day about cheap gas and easy comps, but the fact is that we haven't seen any data points during this earnings season that would make us get more constructive on the US consumer.

Retail Callouts (11/25): NKE, UA, WMT, ICSC, TIF, DSW, BWS - 11 25 chart1





WMT - Wal-Mart’s Chief Merchandising Officer to Leave



Takeaway: What does this tell you when Wal-Mart loses (or fires) it's Chief Merchant three days before Black Friday?


TIF - 3Q14 Earnings

Takeaway: The US business continues to look rock solid and Europe surprised to the upside as comp trends improved by 1100bps sequentially and 400bps on the two year. The rest of the Globe underperformed expectations though each region improved sequentially on a 2yr basis. Comps get easier on the top line over the next 3 months, but over a little longer duration we don't love the set up. Gross margins are at peak and consensus has that expanding by another 100bps by 2018. SG&A is at post recession lows. Not a name that we want to put on our short bench -- yet at least -- but one we'll avoid on the long side unless an unwarranted price drop gives us an opportunity for a TRADE.  

Retail Callouts (11/25): NKE, UA, WMT, ICSC, TIF, DSW, BWS - TIF SIGMA


NKE - Odell Beckham Catch Means $2.2 Million for Nike Gloves



  • "Nike Inc.’s official football Twitter account sent a photo of the 22-year-old New York Giants rookie with the tagline 'Drop Jaws. Catch Everything Else.'"


Takeaway: That catch will be played on Sports Center's 'best catch' top ten (potentially in the #1 slot) for decades to come. Nike definitely is using that as a big authenticator for it's football gloves -- especially when the picture shows that Brandon Carr, the Cowboy cornerback who fouled Odell and still couldn't make him drop the ball -- was wearing UnderArmour gloves.

Retail Callouts (11/25): NKE, UA, WMT, ICSC, TIF, DSW, BWS - 11 25 chart5

Source: NBC Sports


BWS - 3Q14 Earnings

Takeaway:  Perennially-underperforming BWS definitely beats out DSW yet again this quarter.  Its SIGMA looks better, as margins remain strong and inventory position is right-sizing. Absolute EPS growth was 20.9% on top of 3.7% revenue growth. DSW, however, de-levered 5.8% sales growth into a -3.5% earnings decline, and inventories still look problematic.

Retail Callouts (11/25): NKE, UA, WMT, ICSC, TIF, DSW, BWS - 11 25 chart3


DSW - 3Q14 Earnings

Retail Callouts (11/25): NKE, UA, WMT, ICSC, TIF, DSW, BWS - 11 25 chart4





AMZN - Amazon to team up with Royal Mail to allow parcel collection



KSS, TGT - ‘Frozen’ Overtakes Barbie as Holiday Season’s Most Popular Toy



Chow Tai Fook’s sales hurt by China’s economic slowdown



WMT - Wal-Mart names former American Airlines CEO to board



  • "Wal-Mart Stores Inc. has appointed Tom Horton, former chairman and CEO of American Airlines, as a new member of the company’s board, effective Nov. 21."


ODP - Office Depot using new location-based marketing app Shazam In-Store



Takeaway: The rate of change in home price growth matters to prices and the 2nd derivative is stabilizing.

Our Hedgeye Housing Compendium table (below) aspires to present the state of the housing market in a visually-friendly format that takes about 30 seconds to consume. 




With the Corelogic data in hand for about a month already, we completed the HPI trinity for September with the Case-Shiller and FHFA price series releases this morning.    


THE DATA:  The Case-Shiller HPI data for September showed home prices growing +4.9% YoY, decelerating -70bps vs. +5.6% in August.  Meanwhile, the FHFA series showed home prices growing at +4.2% YoY, decelerating -60bps vs the 4.8% rate of increase reported for September. 


So, home price growth continues to decelerate.  However, its that rate of deceleration that we’re principally concerned with. 


THE DERIVATIVE:  Its worth re-highlighting our base conceptual, top-down framework for housing as its been effective across cycles and centers on HPI trends:


Housing Demand leads HPI --> Home price growth follows the slope of demand on an 12-18mo lag --> Housing related equities follow the slope of home price growth


We have anchored on the 2nd derivative move in HPI trends as a key signal because, historically, equity prices across the housing complex have followed the slope in home price growth. 


The 1st chart below illustrates the Equity Price-HPI relationship.  The 2nd chart shows the emerging 2nd derivative stabilization in HPI trends.






We’ve seen this same cycle dynamic play out again in 2014 with housing related equities significantly underperforming alongside the ~6 months of discrete deceleration since home price growth peaked in February.   


INFLECTION INSPECTION:  Our tone on housing has shifted (we were explicitly bearish from Jan-Oct) in the last month as many of the negative dynamics that we flagged earlier this year have largely or completely played out. 


While the macro environment remains a discrete risk to housing, (very) easy volume compares, the lapping of weather/QM Implementation/FHA loan limit reductions, looser regulation, and a fledgling stabilization in 2nd derivative HPI trends all sit as modest, prospective tailwinds for 2015. 


Essentially, the balance of risk from a rate of change perspective has largely shifted.   


We'll be hosting a call on December 11th to update our views on housing heading into 2015. 











About Case Shiller:

The S&P/Case-Shiller Home Price Index measures the changes in value of residential real estate by tracking single-family home re-sales in 20 metropolitan areas across the US. The index uses purchase price information obtained from county assessor and recorder offices. The Case-Shiller indexes are value-weighted, meaning price trends for more expensive homes have greater influence on estimated price changes than other homes. It is vital to note that the index’s printed number is a 3-month rolling average released on a two month delay.


Frequency and Release Date:

The S&P/Case-Shiller HPI is released on the last Tuesday of every month. The index is on a two month lag and therefore does not reflect the most recent month’s home prices.



Joshua Steiner, CFA


Christian B. Drake


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