"With the Russell 2000 down YTD and both inflation expectations and 10yr bond yields #crashing," Hedgeye CEO Keith McCullough wrote in today's Morning Newsletter, "initial 2014 consensus beliefs of worldwide growth accelerating and rates rising are no longer believed."
“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.”
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.
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
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.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS (Bloomberg Estimates):
WHAT TO WATCH:
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
The Hedgeye Macro Team
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.
HERE’S THE LINK TO OUR PRESENTATION
Presentation: CLICK HERE
Materials: CLICK HERE
The company set the record straight this quarter in many ways.
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).
Some Things We Didn’t Like
Still our favorite name in retail. As outlined below, we get to $150 and $230 in 1 and 2 years, respectively.
HERE'S OUR NOTE FROM MONDAY NIGHT, AHEAD OF THE PRINT
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.
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.
Some More Detailed Modeling Considerations
Combined Brand Comp:
CALL TO ACTION
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
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