December 15, 2014

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Deflation's Nemesis

This note was originally published at 8am on December 01, 2014 for Hedgeye subscribers.

“Deflation is every central bank’s nemesis…”

-James G. Rickards


After a wonderful Thanksgiving weekend, I know that’s what some of you are thinking about this morning – some deflation of that inflating waist-line. I sure am! Everything related to a perpetual inflation expectation of commodity prices is too.


The aforementioned quote from Jim Rickards has critical follow on thoughts to consider about #deflation: “… because it is difficult to reverse, impossible to tax, and makes sovereign debt unpayable by increasing the value of real debt.” (The Death of Money, pg 214)


Think about that from a levered upstream-Energy MLP’s perspective (Linn Energy, LINE), and you’ll get the risk management point. Deflating the oil price is difficult to reverse, impossible to “dividend”, and makes the value of their financial leverage a major concern.

Deflation's Nemesis - Deflation cartoon 10.02.2014


Back to the Global Macro Grind


With MLP’s (Master Limited Partnerships) down -3.4% on the week (Alerian MLP ETF), the #OldWall will yawn, and say something like “it’s already priced in” and it “outperformed”, uh, Russia (RSX), last week.


Roger that.


And the biggest currency crisis since 1998 (Russian Rubles -6% since Friday’s close, crashing -40% YTD) and its interconnected crashing of the Russian stock market (down another -3.4% this morning after dropping -8% last week to -32.5% YTD) is #NoWorries too…


Admittedly, the perma-bull case for global growth and inflation expectations is getting more entertaining at this point. The worse real-economic data and #deflationary realities get, the higher the Weimar Nikkei goes! (Japanese auto sales -13.5% y/y in NOV)


Away from the “Dow” being +0.1% last week, there was a lot of money to be made on the bear side of it all:


  1. West Texas Crude Oil continued to crash, -13.5% on the week to -28.1% YTD
  2. Energy Stocks (XLE) dropped -9.8% on the week to -9.8% YTD
  3. Basic Materials (XLB) deflated -3.0% on the week to +6.4% YTD
  4. Greek stocks (Athens Index) lost another -3.1% to -17.2% YTD
  5. CRB Commodities Index got tattooed for a -5.5% weekly loss to -9.2% YTD
  6. Silver moved into crash mode, dropping -5.5% on the week to -20.4% YTD


I know. No one has any exposure to any of this. Diversified 401ks have an 80% allocation to SPY and 20% to Apple (AAPL).


On the bullish side of wacky wide asset class performance #divergences last week:


  1. Consumer Discretionary (XLY) stocks, mean reverted to the upside, and led gainers +2.5% to +7.5% YTD
  2. Consumer Staples (XLP) stocks continued their fantastic year, +1.8% on the week to +14.7% YTD
  3. Oh, and our #fav Macro Long for 2015 (Long Bonds) ripped to fresh 6 week highs, in TLT, EDV, etc. terms


As you can see in the Chart of The Day (slide 53 of our Q4 Macro Themes Deck) we have Consumer Staples (XLP) and the Long Bond (TLT) on the long side and nothing on the short side of Consumer Discretionary, so we were cool with that.


After $107 oil not being a headwind to their thesis in Q2, the perma-bull thesis drift expectation has quickly moved to “Oil Down is good for the consumer” and we get that (so we’re not short XLY), but that doesn’t mean the bull thesis is going to play out.


BREAKING: “Black Friday Fizzles – Retail Sales Down -11%” –Bloomberg


Spending tumbled an estimated 11 percent over the weekend, the Washington-based National Retail Federation said yesterday. And more than 6 million shoppers who had been expected to hit stores never showed up.”


In what seems like a rarity these days, Bloomberg is running something bearish as their #1 US “Economy” story today (mid-terms are over). But is it true? How can it be? I thought the all-time high in cost of living in America for 2014 was going to vanish instantaneously?


What if it doesn’t?


And what happens when the nasty side of commodity #deflation results in ramping job losses in two of the best hiring States in the last year (Texas and North Dakota). Is that why US jobless claims have been accelerating for 3 straight weeks alongside crashing oil?


Or is that why the Russell #Bubble (Russell 2000) has been literally FLAT, for 4 consecutive weeks? Pardon? I thought Bloomberg/CNBC was saying “stocks are up, everything is fine”? Here are the last 4 weekly closing prints for the Russell:


  1. 1173
  2. 1173
  3. 1172
  4. 1173


Big time bull market there, for the “folks.”


We’re going to have to see some bigger time reversals in both jobless claims and consumer spending in the next 4 weeks to reverse what bond yields (10yr crashing -28% YTD to 2.16%) have been to Russell “growth” investors all year long – their storytelling nemesis.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.16-2.28%

SPX 2038-2090

RUT 1153-1190

VIX 11.98-15.53

Yen 116.45-119.12
WTI Oil 63.86-71.12

Copper 2.80-2.98


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


Deflation's Nemesis - chart1

Investing Ideas Newsletter

Takeaway: Current Investing Ideas: EDV, HCA, MUB, RH, TLT, XLP and YUM.

Below are Hedgeye analysts’ latest updates on our seven current high-conviction long investing ideas and CEO Keith McCullough’s updated levels for each.


*We also feature two pieces of content from our research team at the bottom.

Investing Ideas Newsletter      - InvestingIdeas12.12 

Trade :: Trend :: Tail Process - These are three durations over which we analyze investment ideas and themes. Hedgeye has created a process as a way of characterizing our investment ideas and their risk profiles, to fit the investing strategies and preferences of our subscribers.

  • "Trade" is a duration of 3 weeks or less
  • "Trend" is a duration of 3 months or more
  • "Tail" is a duration of 3 years or less


Investing Ideas Newsletter      - Oil cartoon 12.09.2014




Update from macro analyst Darius Dale:


Tales of the Long Bond Pain Trade


Consider the following return figures:


  • iShares 20+ Year Treasury Bond ETF (TLT): +2.9% WTD, +3.1% MTD, +8.6% QTD and +24% YTD
  • Vanguard Extended Duration Treasury ETF (EDV): +3.9% WTD, +5.1% MTD, +14.2% QTD and +40.8% YTD
  • iShares National AMT-Free Muni Bond ETF (MUB): +0.3% WTD, +0.3% MTD, +0.5% QTD and +6.3% YTD


Now consider the most recently reported net speculative position of -214.8k futures and options contracts on 10Y Treasury notes. On a TTM Z-Score basis, that’s the most net SHORT the buy-side has been of the long bond since the week ended March 23rd, 2012.


Investing Ideas Newsletter      - d1

Source: Bloomberg L.P.


It’s worth mentioning that the long bond rallied hard on that signal; from late-March of 2012 through late-July of that same year, the 10Y Treasury yield plunged -86bps to its all-time closing low of 1.38%.


Investing Ideas Newsletter      - d2

Source: Bloomberg L.P.


That current setup in the bond market rhymes with investors broadly continuing to anticipate “escape velocity” and a rate “lift-off” over the NTM – even if only a modest tightening: DEC ’15 Fed Funds Futures are pricing in a mere +25bps rate hike by the end of next year.


Investing Ideas Newsletter      - d3

Source: Bloomberg L.P.


All told, the buy-side hasn’t capitulated on the short side of bonds yet.


They most likely will.


And when they do, you’ll be able to book some nice gains by selling into their mass short-covering – that is, of course, to the extent you’ve been following our recommendation to be long of long-term Treasuries and munis [and defensive equities that resemble this long duration exposure].


Update from Healthcare sector head Tom Tobin:


I have been watching the sudden and precipitous decline in LINE/LNCO, a favorite short of my energy sector colleague Kevin Kaiser, decline at an accelerating rate in recent months.  It’s been a great call and he’s been stating it clearly for well over a year as the stock has declined from the $30s to $12.50 today.  Part of the “sudden” decline in LINE/LNCO stock price has been due to the recent ~50% decline in crude oil prices.  While it’s great for Kevin’s subscribers (and now admirers) who got out of the way, the current state of affairs was years in the making and the drop in crude oil prices wasn’t the only thing that has gone wrong.  


Compliments aside for Kevin’s great work, I am sitting here looking at the companies in my  Healthcare universe and feeling alert and scanning for potential problems.  My experience has been that when big stuff is happening like a 50% decline across whole categories of market prices, the ripples can be felt in unexpected places.  I am wondering what could possibly go wrong, and entertaining (in very small portions) the potential upside.  After all, falling crude oil means lower gas prices at the pump and more consumer spending, or at least that is the prevailing wisdom. 


The impact of lower gas prices on Hospital consumption looks as it should, but the overall impact is weak, unfortunately.  In the chart below, falling gas prices in one quarter appears to lead to positive growth on Hospital consumption in the next quarter. This is one of many small positives we are considering while we continue to  recommend the HCA long position.


On the downside, however, we can see what the market downturn in crude oil and broadly weakening economic growth has had on the cost of corporate borrowing, particularly in the high yield market where HCA borrows it’s significant amount of debt.  Borrowing costs in high yield corporate bonds have been creeping higher for several months likely due to concerns of slowing economic growth.  While it is not apparent in HCA’s stock price, we can see the impact clearly filtering through to HCA’s bond yields.  The relationship is more direct and much stronger than what we are seeing with the gas price chart.  We’re not ready to change our positive view on HCA, but this could be the first ripple we are seeing radiate out from the performance problems we are seeing in crude oil and LINE/LNCO.


Investing Ideas Newsletter      - gas vs hospital

Investing Ideas Newsletter      - tt2


(Editor's note: In last week's update Retail Sector Head Brian McGough wrote ahead of Restoration Hardware's earnings report released this past week, "This one should be a winner." Well, a winner it was as RH blew past estimates sending shares up approximately 14% for the week. Shares are up 30% since it was added to Investing Ideas, well ahead of the return for the S&P 500. McGough's latest thoughts appear below.)


This RH quarter was almost exactly what we wanted, and was precisely what the stock needed.  We said on this week’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.  


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.

This story is far from over.



Both Wall Street and the media have been focused on McDonald’s as the next target of activism in the restaurant space.  While it certainly could be, we believe the often overlooked Yum Brands is the more sensible target.  Unlike McDonald’s, YUM’s multiple brands and new operating structure can, and should, be altered in a way to create significant shareholder value.


Investing Ideas Newsletter      - y5


For the better part of the past two years, management has been asked about a potential spinoff of the struggling China business.  This could 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 that direction.


CEO Greg Creed told investors and analysts yesterday that, although he has no current plans to make any structural changes, he would not rule anything out.  We believe the intrinsic value of the stock is $90-110/share.


* * * * * * * * * * 


Housing: moving from bad to decent

Purchase apps have been on the rise for a month now. Evidence continues to emerge that housing is inflecting from bad to decent.

Investing Ideas Newsletter      - HouseInHands

lulu: long (but on a short leash)

We’ll take the market reaction, but this was actually a really lousy quarter – especially considering the pain it is lapping vs last year. 

Investing Ideas Newsletter      - LULU WEB 2012Q3 WinterCB1 13603

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Commodities: Weekly Quant

Commodities: Weekly Quant - chart1 deltas

Commodities: Weekly Quant - chart2 deltas2

Commodities: Weekly Quant - chart3 usd correls

Commodities: Weekly Quant - chart4 volume

Commodities: Weekly Quant - chart5 open interest

Commodities: Weekly Quant - chart6 vol

Commodities: Weekly Quant - chart7 sentiment


Ben Ryan


The Week Ahead

The Economic Data calendar for the week of the 15th of December through the 19th of November is full of critical releases and events.  Attached below is a snapshot of some of the headline numbers that we will be focused on.


The Week Ahead - 12.08.14 Week Ahead


The Best of This Week From Hedgeye

Here's a quick look at some of the top videos, cartoons, market insights and more from Hedgeye this past week.


Contributor Call: Get Long $CTO Says Harvard Financial Analysts Club "Stock Pitch" Winners

Hedgeye CEO Keith McCullough talks with two members of the Harvard Financial Analysts Club (HFAC) who had the winning idea in a Stock Pitch Contest co-hosted by Harvard University and Seeking Alpha.

Hedgeye CEO Keith McCullough talks with two members of the Harvard Financial Analysts Club (HFAC) who had the winning idea in a Stock Pitch Contest co-hosted by Harvard University and Seeking Alpha. Kevin Li and David Reading walk through their long thesis on Consolidated-Tomoka Land Co. (CTO) and field questions from Keith.

Contributor Call is a video partnership between Hedgeye and Seeking Alpha.

Subscribe to Hedgeye TV on YouTube for more exclusive video content.

This is the opinion of Kevin Li, David Reading, Carlos Xu and Elaine Dai (HFAC team) and does not necessarily reflect the opinion of Hedgeye Risk Management. Investors should always form their own opinions as to the credibility of any company's forward financial guidance. The contributors make no representation or warranties that their forward-looking statements or opinions on forward earnings is correct, and their view should not be deemed more reliable than CTO's own guidance.


Hedgeye's Morning Macro Call with CEO Keith McCullough 12/8

CEO Keith McCullough takes a look at global markets and the economy and explains why he remains concerned.

***This is a complimentary peek behind-the-macro-scenes of our daily Morning Macro Call for institutional subscribers.***



 McCullough on Fox Business: U.S. Becoming a "Gigantic Centrally Planned Project"


Hedgeye CEO Keith McCullough appeared on Opening Bell with Maria Bartiromo Thursday morning.


In the segment below, he talks about the better than expected retail sales numbers, where the economy is now, and what to expect from the Fed moving into 2015. 

Regarding cost of living, Keith reiterates that despite some savings at the gas pump, two thirds of the U.S. is not feeling the economic recovery thanks to central planning.

Speaking of central planning, Keith talks about the impact of ECB President Mario Draghi's behavior on U.S. equities and what's next for European markets.

Lastly, Keith discusses the regulation of the financials sector, and why it's important to stay long the long bond:


(Not So) Happy Meal

The Best of This Week From Hedgeye - MCD sad 12.8.14

McDonald's takes it on the chin as the fast-food giant posts its biggest domestic same-store sales drop in over a decade.



The Best of This Week From Hedgeye - Oil fallen 12.7.14

The epic crash in oil continues with crude down over -40% since June.



The Best of This Week From Hedgeye - COD 12.10.14


Tizzle In The System

The Best of This Week From Hedgeye - COD 12.11.14


 Poll of the Day: Will Oil Prices Fall Below $50 in 2015?

Oil prices have plunged 40% in the last six months. Is the steep decline over or will the sell-off continue? We wanted to know what you think.



investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.