Tizzle In The System

“Each time the system is recalculated, the posterior becomes the prior.”

-Sharon Bertsch McGrayne


Simple is as simple does, within a non-linear and dynamic system like the Global Macro market, that is…


“Conceptually, Bayes’ system was simple. We modify our opinions with objective information. Initial Beliefs (our guess where the cue ball landed) + Recent Objective Data (most recent ball left or right of the prior) = A New and Improved Belief.”

-The Theory That Would Not Die, pg 8


What do you believe? Is what you believed in late September consistent with what you believe after the October and December corrections? How about from January to June (when late-cycle inflation was accelerating) vs. today’s global #deflation? The best way to manage risk is by constantly recalculating your system.

Tizzle In The System - Falling cartoon 12.10.2014


Back to the Global Macro Grind


What does the system say this morning?


With the Russell 2000 down YTD and both inflation expectations and 10yr bond yields #crashing, initial 2014 consensus beliefs of worldwide growth accelerating and rates rising are no longer believed.


Since so many Old Wall dudes still use the “Dow” as some sort of proxy for the global economy, here’s what the broader global equity system is saying:


1. Weimar Nikkei (Japan) only goes up when the economy is so bad that they need to hit the CTRL+Panic (print) button

2. The liquid side of the “China” trade (Hang Seng) continued to signal bearish TREND @Hedgeye overnight (-0.9%)

3. The former Global Growth “signal” (known as Dr. KOSPI in South Korea) -1.5% overnight to -4.7% YTD #bearish

4. The UK’s FTSE failed @Hedgeye TREND resistance and is back to DOWN for 2014 YTD

5. Germany’s DAX is holding on to TREND support of 9688 at +3.2% YTD

6. Greece, Portugal, and Russia continue to crash (down more than 20% respectively, YTD)


Oh, and Argentina dropped -14% in the last 2 trading days… but #NoWorries there – centrally planned currency devaluation has had fantastic economic results for the Argentines! Watch the LEGO movie this weekend with your kids – “everything is awesome.”


Yep, everything other than this other Big Macro thing that is correlating with #CommoditiesCrashing called 10yr Bond Yields:


1. Japan 10yr = 0.40%

2. Germany = 0.67%

3. France = 0.94%


“So” I guess my growth-and-inflation-slowing bull case for the USA Long Bond (TLT) with the US 10yr Treasury Yield crashing (-28% YTD) to 2.16% has plenty of room to run.


The only thing that is awesome (i.e. you don’t have to make things up about global growth accelerating and #deflation not being a globally interconnected risk) is actually being long something, in size, with very low-volatility (Long-Term Treasuries).


One of our hard core customers called it “TLT tizzling” at our Hedgeye NYC Holiday Party on Tuesday… so I looked that up in the Urban Dictionary: “A fat party. This word is derived from the word partizzle, shortened to tizzle…”




Yes, it’s ok to laugh at this game. If you don’t, it might just make you cry. And so will what’s most causal to the pain you are seeing in inflation expectations globally right now – central planners losing Mr. Macro Market’s confidence that they can re-flate asset prices.


In case you didn’t know, that’s how this central planning game of expectations ends – in #deflation.


It’s one thing to run around telling yourself that the Dow and DAX are up because you just knew that markets can’t go down. It’s entirely another to be doing that over and over again when the global macro system starts to signal that the party’s music is stopping.


Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets, which you can find in our Daily Trading Range product) are as follows:


UST 10yr Yield 2.14-2.24% (bearish)

SPX 2018-2042 (bullish)

RUT 1151-1172 (bearish)

KOSPI 1 (bearish)

VIX 14.43-19.59 (bullish)

USD 87.67-88.79 (bullish)

EUR/USD 1.22-1.25 (bearish)

Yen 116.79-121.65 (bearish)

Oil (WTI) 60.48-65.38 (bearish)

NatGas 3.49-3.81 (bearish)

Gold 1 (neutral)

Copper 2.84-2.95 (bearish)


Best of luck out there today,



Keith R. McCullough

Chief Executive Officer


Tizzle In The System - 12.11.14 TLT vs. CRB


TODAY’S S&P 500 SET-UP – December 11, 2014

As we look at today's setup for the S&P 500, the range is 24 points or 0.40% downside to 2018 and 0.78% upside to 2042.                                        













  • YIELD CURVE: 1.58 from 1.60
  • VIX closed at 18.53 1 day percent change of 24.45%


MACRO DATA POINTS (Bloomberg Estimates):

  • 8:30am: Retail Sales Advance, Nov., est. 0.4% (prior 0.3%)
  • 8:30am: Import Price Index, m/m, Nov., est. -1.8% (pr -1.3%)
  • 8:30am: Initial Jobless Claims, Dec. 6, est. 297k (pr 297k)
  • 8:45am: Bloomberg U.S. Economic Survey, Dec.
  • 9:45am: Bloomberg Consumer Comfort, Dec. 7 (prior 39.8)
  • 10am: Business Inventories, Oct., est. 0.2% (prior 0.3%)
  • 10am: Freddie Mac mortgage rates
  • 10:30am: EIA natural-gas storage change
  • 12:pm: Household Change in Net Worth, 3Q (prior $1.390t)
  • 1pm: U.S. to sell $13b 30Y bonds in reopening



    • Deadline day for govt funding bill
    • 9:10am: SEC Chair Mary Jo White speaks at New York Times Dealbook conference
    • 9:30am: House Energy and Commerce subcmte holds hearing on crude oil export ban
    • 12:15pm: IRS Commissioner John Koskinen delivers luncheon keynote address at GWU, IRS International Tax Conf.



  • New York Regulator Said to Probe Barclays, Deutsche Bank Forex Algorithms
  • Oil Trades Near 5-Yr Low as Saudis Question Need to Cut Output
  • Cargill Weighs Stand-Alone Bid for Animal-Feed Supplier Nutreco
  • Wal-Mart Report Found Inflated Profit in China
  • KKR Is Looking at Mexico Investment Opportunities, Petraeus Says
  • House Passes Bill to Ease Dodd-Frank Capital Rules for Insurers
  • PBOC Said to Inject 400b Yuan as Targeted Move Preferred
  • Google Shutting Down Spain News Website After Copyright Ruling
  • Walgreen CEO Is Out as Top Shareholder Pessina Takes Over
  • United Technologies Fills CFO Post Ahead of Investor Day
  • Fiat Chrysler Sells Stock at 4% Discount After Slump on NYSE
  • Starboard Takes 6% Staples Stake, Boosts Office Depot Shrs: WSJ
  • Ebay Said to Mull Cutting Thousands of Jobs Next Year: WSJ
  • SNB Sees Higher Deflation Risk, Keeps Franc Limit at EU1.20
  • Hong Kong Police Tear Down Tents as Democracy Protesters Make Last Stand
  • Danone Said to Discuss Two Offers Topping $3.7b for Nutrition Unit
  • ECB Says Banks Take EU130b in 2nd Targeted Long-Term Loan Offer



    • Adobe Systems (ADBE) 4:02pm, $0.30
    • Ciena (CIEN) 7am, $0.13
    • Dominion Diamond (DDC CN) 5pm, $0.25
    • Esterline Technologies (ESL) 4:05pm, $1.84
    • Lululemon (LULU) 5:30am, $0.38 preview
    • Methode Electronices (MEI) 6:30am, $0.55
    • Nordson (NDSN) 4:30pm, $1.13
    • North West (NWC CN) 10:45am, C$0.38
    • Quiksilver (ZQK) 4:04pm, ($0.12)
    • RadioShack (RSH) 7am, ($1.04)



  • Oil Trades Near 5-Year Low as Saudis Question Need to Cut Output
  • Roubini Global Predicts Sub-$60 Iron Ore Amid ‘Massive Surplus’
  • Milk Glut Spurs Slump in Win for U.S. Butter Eaters: Commodities
  • Gold Declines With Silver for Second Day as Dollar Strengthens
  • Robusta Coffee Falls for 6th Day on Vietnam Harvest; Cocoa Drops
  • HSBC Sees Silver Market Moving Into Supply Deficit Next Year
  • Copper Advances Amid Speculation China Will Move to Stoke Growth
  • Ore Ship-Charter Cost Has Longest Retreat in More Than a Year
  • Putin Pledges Oil, Weapons and Nuclear Power for Modi in India
  • Traders Hedge Oil ETF While Energy Stocks Lure Buyers: Options
  • Brent Crude May Fall to $60 a Barrel in Coming Weeks: Natixis
  • Wheat Extends Drop as Supply Outlook Improves; Soybeans Climb
  • ICE Gasoil Flips to Front-Month Contango for 1st Time Since Oct.
  • Iraq Says Its Oil Pricing Gives ‘No Basis’ for Price War Claims
  • Gold ETF Buyers Return as Investors Take Cover From Equities


























The Hedgeye Macro Team



















RH - The Plan = The Plan Will Change

Takeaway: RH delivered on the numbers, but also showed its intent to adapt and change – a trait that is critical for a category killer like RH.

This RH quarter was almost exactly what we wanted, and was precisely what the stock needed.  We said on yesterday’s RH Flash Call that this is a Binary Quarter, and that when all is said and done there is really only one line that matters – revenue (and we were above consensus by 200bps with an 18% comp). RH has never missed an earnings number, but it missed 2 of the past 3 quarters on the top line. It’d be tough to argue that this is a transformational, ‘once in a generation’ retail story if it consistently misses on the top line.  



Presentation: CLICK HERE 

Materials: CLICK HERE


The company set the record straight this quarter in many ways.

  1. As it relates to the top line, RH put up a crusher 22% comp vs our 18% estimate. This was a huge ramp from 21% on a 2-year basis in 2Q to 30% in 3Q.
  2. That includes 31% growth online – a 1,800bp sequential acceleration
  3. RH threw in an extra 100bp in gross margin expansion above our estimate for +164bps in total. This supports our view that one of the key underappreciated elements of the story is the occupancy leverage from new stores.
  4. RH also gave more clarity on the long-term margin equation, with a goal of 15-16% vs. 7.8% last year. (Note: we’ve been at 16% for a year). RH had previously alluded to ‘mid teens’ margins, but this time Karen Boone formally and confidently walked through the Gross Margin and SG&A levers that will get there.
  5. As we outlined in our RH Real Estate deck, Houston was one of the markets where RH needed a much bigger store. The company's decision to make the new Houston store 3x bigger makes 100% economic sense. See our deck for details.


Some Notes On Management

It’s tough to talk about RH and not comment on management -- because the reality is that this story is entirely about the people (probably more so than most retail companies).

  1. Earnings Format: First off, the company hosted a 16 minute video presentation, and then took Q&A in a more traditional teleconference. That format will rub a lot of people the wrong way. But like it or not, it was extremely effective. RH is a very visual company and concept. So much gets lost in translation when limited to a phone call. Management was able to craft its message, stay on point, and be in its element along the way. We’d be shocked if a handful of other companies don’t follow suit in 12-months’ time.
  2. Gary: This is a classic email I got mid-video presentation from one of the best investors I know (who gave me permission to publish this). “Brian, Gary is nuts. But he is creating the Apple, Nike, Chipotle of home furnishings.” Is he nuts? Dunno. But people always call visionaries crazy. There are not a lot of category killer models out there (the three mentioned are good examples). But we definitely think that RH is emerging as one for the back half of this decade (and the next). People will argue vehemently about valuation until the model’s dominance is obvious.
  3. “The Plan Is That The Plan Will Change”:  This is a phrase we use a lot internally at Hedgeye. It means that we’ll be fluid and will change our plan as business opportunities present themselves. That’s how Nike operates – and it’s worked for them. RH operates precisely the same way. I noted this on our Flash call yesterday after someone asked why this story always seems like it is different/changing. It’s always different because the people at RH are tasked to consistently find ways to make it better. We’re pretty sure that we’ll be talking about drivers for RH in another 12 months that we don’t know exist today. We welcome that – so long as they’re accretive to our model.


Some Things We Didn’t Like

  1. The comp was so strong at +22%, and yet revenue only grew at +22%. With ending square footage up 10% (3% weighted) that suggests a meaningful hit to new store productivity. There are a lot of moving parts there (see our comments below) as it relates to the timing of stores added and removed from the comp base for various reasons. But we need to get some answers as to the specifics.
  2. SG&A was a little above our estimate – about $4mm (3%). Not really a big deal given the stellar growth algorithm – sales 22%, Gross Profit +28%, EBIT +54%. But this is the first time in three years that RH did not leverage SG&A.
  3. Not much leverage below the line, as EPS grew in line with EBIT.


Still our favorite name in retail. As outlined below, we get to $150 and $230 in 1 and 2 years, respectively.





Conclusion: This is a binary set-up for RH and the market knows it. The company needs to put up a significant reacceleration in its top line. With 31% of the stock held short, there are plenty of people betting it won't. But we think the unit growth, category expansion, comp, and margin opportunities are coming together for RH, and will be apparent this quarter. RH remains our favorite name in Retail. 



We feel good about the RH earnings event on Wednesday after the close.Revenue should accelerate meaningfully as RH has finally hit the inflection point (after 7+ years) where square footage starts to enhance as opposed to shrink the top-line algorithm.  We’re also seeing great strength in the brand’s online momentum, and should see a catch up from revenue that was delayed by problems with the sourcebook in 2Q. All-in, we’re looking for 24% growth, which is over 1,000bp better than the (unacceptable) 13.5% we saw in 2Q.  The Street is straddling guidance at about 20-21%.  On the EPS line, we’re at $0.52, which compares to the Street at $0.47 ($0.46-$0.48 guidance).


While the EPS beat should be nice, we think that there’s a binary nature to this quarter. Why? RH has never missed EPS, and it’s not going to start now. But it missed 2 of the last three quarters on the top line by an average of 4%. Even though the trendline growth rate (2-yr) remains well above 20%, the fact is that we’re arguing that RH will add $700mm in revenue next year alone (31% growth) and another $2.4bn over the following 3-years. We’re the first to call out that while the company undergoes its real estate build-out, there will be ongoing volatility in its’ top line on a quarter to quarter basis – that should last another 2-3 years. But weakness in 2Q needs to manifest itself in the 3Q revenue line. To be clear, we think that will happen. But if it doesn’t – timing or not – it will be very tough to argue a big multiple for RH over the near-term. 


Details of Our Thesis. The way we see it, we think that RH will ramp from $2.50 in EPS this year to $11 in 2018. It’s an ambitious model, but completely achievable. The biggest barrier to getting there is RH itself. We think a few factors remain misunderstood – 1) The degree to which the high-end home furnishings market can be consolidated – not unlike what Ralph Lauren did to high-end apparel in the 1980s. 2) Our view that there are over 20 markets that could sustain a 50,000+ foot Design Gallery at a productivity rate of $1,200/foot. 3) The impact that occupancy leverage will have on Gross Margins, ultimately pushing GM% to 40%.  Our key modeling assumptions are in the table below. 


RH - The Plan = The Plan Will Change - rh 1


With Growth Comes The Multiple. If our model is right, then the company will be growing EPS at a CAGR of over 40% for the next four years. What kind of multiple is fair for a high-end category leader with a low-cost advantage that’s growing EPS at over 40%? We hate to just make-up multiples. But there are businesses growing at lower rates that carry a much higher multiple.  UnderArmour grows at 25-30%, and yet it trades at near 70x earnings. Perhaps UA is grossly overvalued, and perhaps the market likes that someone came first and paved the way (Nike) showing what UA could look like when it grows up. With RH, people will have to use their imagination. But using 40x 2015 and 2016, we get to $150 and $230, respectively.



Why Revenue Should Accelerate In 3Q

Here’s a few supporting points for why we think revenue will accelerate.

  1. Square Footage Turns Decidedly Positive. We’re looking for 3.5% growth in square footage this quarter. That might seem like it falls into the ‘who cares’ category. But this is a company that has largely been shrinking its store base since before the last recession. This quarter it turns positive, and should be up roughly 30% by the end of next year. Note that the Atlanta Design Gallery that opened on November 20 falls into 4Q, and should account for about a 6% pop in consolidated square footage.
  2. RH Online Presence Has Strong Momentum. There are several tools that we use to track the online momentum for consumer brands, including RH. The chart below shows the spread in ‘reach’ versus last year. The percentages are irrelevant – as they show the percent of all internet users that visited What we care about is the direction of the line. Up is good, and RH has been increasingly up. 
    RH - The Plan = The Plan Will Change - rh 2
  3. Deferred Revenue Buildup. Every quarter, RH books deferred revenue, which represents product that has been ordered but is not yet delivered (RH gets paid when the consumer takes final delivery). There’s an exceptionally strong relationship between deferred revenue, and the upcoming quarter’s realized revenue. That is, except for 2Q. That’s when revenue stalled due to timing associated with a Friends and Family promotion, as well as what we think are miscues in its Sourcebook (ie 3,300 pages at once was a mistake). The deferred revenue alone synchs with our 24% revenue growth forecast.
    RH - The Plan = The Plan Will Change - rh 3
  4. Inventory Supports Revenue Growth. One of the only times that deferred revenue will not accurately accrue to the upcoming quarter would be when there is not enough inventory on hand to fulfill orders. Then RH has a problem. That is absolutely not the case this time around, as RH ended 2Q with inventories up 35% -- and ready to ship to fulfill 3Q deliveries.


Some More Detailed Modeling Considerations

Square Footage:

  • RH added one new store during the quarter on Melrose Ave. in Los Angeles. That equates to 10% growth in selling sq. ft. year-over-year and the addition of 9K sq. sequentially as the new 23,000 sq. ft. Design Gallery replaced the now idle 13,800 sq. ft. Beverly Boulevard location.
  • With the opening of the first 2nd Generation Design Gallery in Atlanta during the opening weeks of 4Q, square footage growth is now done for the year.
  • For the year the square footage growth algorithm looks like this: Design Gallery square footage +77%, Legacy Store square footage -6%, total selling square footage growth +9%, and total average selling sq. ft. growth +8%. *Note we model NYC store as a Full Line Design Gallery.
  • Initial guidance for 2015 implies 4 to 6 openings and 30%-40% sq. ft. growth. Those will be heavily weighted towards the back half of next year.


Retail Comp:

  • This may be the hardest line on the entire P&L to model as the store additions/subtractions and remodels make for a lot of moving pieces. For the quarter we are at 18%.
  • Additional details
    • Boston and Indy entered the comp base during June of this year. This will be the first full quarter where those two properties show up in the consolidated comp number.
    • New York was removed from the comp base after the 17,000 sq. ft. remodel during the 2nd quarter. This is the most productive store in the entire fleet.
    • The 13,800 sq. ft. store on Beverly Boulevard exited the comp base once Melrose opened at the tail end of the quarter. This store was operating in excess of $2,000/sq. ft.

DTC comp:

  • On the last call, management indicated that DTC growth would outpace Retail growth until the real estate transformation catches up to fit the expanded product assortment. For the quarter we’re at 25% growth in the DTC channel. Up 700bps sequentially on the 1yr trend line and 1000bps on the 2yr.
  • Visitation statistics were solid for the quarter. Up over 65% in every month during the quarter and 77% for the quarter in aggregate (+48% on the 2yr). The company was comping against a visitation suppressed 3Q13 when the company eliminated the fall source book. That coupled with the late shipment of the Source Book this year and prospecting efforts are the main drivers of the growth.
    RH - The Plan = The Plan Will Change - rh 4
    RH - The Plan = The Plan Will Change - rh 5
    RH - The Plan = The Plan Will Change - rh 6


Combined Brand Comp:

  • Putting the two pieces together, 25% DTC growth and 18% Retail comp, equates to a 22% combined brand comp for the quarter.



  • Guidance of $475-$485 implies 20%-23% growth. An acceleration of 1000bps sequentially on both the 1 and 2yr trend line.
  • The Source Book timing issue caused books to arrive in homes about a month later on average compared to last year. Some of those sales were lost forever especially in seasonal categories like outdoor. But, given the company’s extended shipping window and strong traffic trends in the DTC channel we believe there was a healthy backlog headed into 3Q.
  • Stores in Greenwich and New York were open for the entirety of the quarter. And, there was very little interruption caused by the shift from Beverly Boulevard to Melrose Ave. in Los Angeles with the late October opening.


Gross Margin:

  • We’re modeling 100bps of Gross Margin expansion in the quarter. Here’s a quick look at the headwinds and tailwinds for the quarter…
  • Headwinds
    • Promotions: Margins were up 230bps in 2Q. Part of that was due to reduced promotional selling during the company’s Friends & Family event in July. Some of that may have been pushed into the early October Friends & Family sale. Which we should note was the exact same timing as last year.
    • Dead rent: The company started to feel a drag from new properties scheduled to open in ’15  in the quarter. That will be more pronounced in 4Q due to the back-half weighting in the opening schedule next fiscal year and the companies 6-12 month buildout schedule. But, it’s something that we are aware of.


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.43%
  • SHORT SIGNALS 78.34%




Granted, the cruise stocks will probably not go down as long as oil is falling 3% per day. However, we believe investors are baking in 2015/2016 estimates that are too high, certainly higher than current sell-side estimates.  Adverse foreign currency moves will eat into the fuel related EPS tailwind that appears to be already discounted into the stocks.  


In this note, we analyze the assumptions necessary for RCL to meet its Double-Double target on a ship-by-ship basis. Meeting or beating that target seems to be factored into the stock and while Double-Double is certainly achievable, cannibalization and a stronger dollar may be significant hurdles.


Please see more details in our note: CLICK HERE

Beware Big Divergences In Asia

Big divergences continue manifesting across Asian Equity markets.


Editor's note: This is a brief excerpt from Hedgeye research from this morning.

*  *  *  *  *  *  *

Beware Big Divergences In Asia - boog


In South Korea, the KOSPI was down another -1.3% overnight to -3.3% year-to-date. It remains bearish TREND (a duration of 3 months or more) here @Hedgeye. Meanwhile, the bounces in India and the Hang Seng were quite weak. As far as Thailand is concerned (straight down in December), it was down another full 1%.


We call this #GlobalGrowthSlowing.

Cartoon of the Day: Falling

Cartoon of the Day: Falling - Falling cartoon 12.10.2014

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