This note was originally published at 8am on December 29, 2014 for Hedgeye subscribers.
“Our interdisciplinary approach sets us apart and gives us a chance to lead new discovery.”
While he won’t lead you to where the latest Air Asia flight went this morning, 84 year old Nobel Prize winning physics professor Leon Cooper has had his fair share of discovery in his lifetime. From synaptic plasticity to superconductivity, being first (and right) is how you get that done.
This weekend I learned about Cooper’s interdisciplinary research while reading about one of my favorite topics (#monkeys) in a book called The Medici Effect, by Frans Johansson: “Tiny implanted electrodes read signals from the monkey’s brain cells… data from the brain could now be translated into what the monkey was thinking… turning thoughts into action in real time.” (pg 12)
Now if only Cooper’s team at Brown University could send us a real-time feed on what 50,000 fund managers were thinking during 5-10% corrections in stocks (in December) that are followed by sharp v-bottoms and epic no-volume ramps to new highs… oh, while commodities and global bond yields crash…
Back to the Global Macro Grind…
Thankfully, I learned a long time ago that making a living trying to call what SPYs are going to do next is no way to live. That’s why I built our Global Macro Risk Management #Process to be both multi-factor and multi-duration, across asset classes.
If you do macro the way we do, you don’t have to be one-dimensional. You don’t have to have as many blind spots as I used to have either. From a research perspective, there’s always a new discovery to be made on both the bullish and bearish sides of markets.
In our research process, new discoveries are driven by what many probability theorists would call Bayesian Inference. That basically means that what we learned yesterday might change what we think about today.
Discoveries don’t always have to be progressive or regressive – sometimes they should just stop you from doing anything at all. While you may think you know your “companies” better than anyone on earth (and I genuinely hope you do), it’s next to impossible to have that kind of conviction on global macro risks.
If you had to pick one major new discovery (if you’re long Energy stocks, Emerging Markets, Junk Bonds, etc., it’s probably in your “diversified portfolio”!) in global macro risk that you should have proactively prepared for in the last 3-6 months, would it be?
A) Global #GrowthSlowing
B) Global #Deflation
Since the dogmatic +3-4% US growth forever bulls are still staring at non-year-over-year GDP growth data for Q3 (newsflash: it’s the end of Q4, and Q314 was +2.7% y/y, not +5.0), and inflation expectations continue to get hammered, I’ll take B).
While the causal factor for #deflation may be global #GrowthSlowing (think demand), for the last 3 days of the compensation calendar, who actually gets paid to care? What most of you really care about is the score, and here’s how that risk looked last week:
For those of you who don’t know that breakevens are a leading indicator for the rate of change in inflation expectations, now you know. For all of you who know that falling bond yields and flattening yield curves are leading indicators for #GrowthSlowing, well, you still know that… but need to ignore it on low-volume SPY ramps into your year-end!
In the last 6 months, what we (and physicists like Cooper) call a phase transition (from bullish to bearish) in #deflation has been much more pronounced than the macro market acknowledging it as a #deflation risk in the 1st 2 weeks of December. To put that in time/price context, check out these 6 month moves:
And 5yr breakevens were actually down a lot more in the last 6 months (-90bps, or -43%) than they’ve been for the YTD (remember when late-cycle inflation accelerated in the first half of 2014 and the perma growth bulls just called that bullish for consumers too?).
While the growth bulls finding a new narrative at all rates of change in prices doesn’t surprise me, what will definitely surprise me when the macro market’s volume comes back next week is if #deflation isn’t a marked to market risk for high yield debt.
On the bullish side, with the macro market marking up everything US consumer assets (Consumer Discretionary, XLY +1.9% last week vs Energy, XLE -0.6%) on the “down gas prices” theme, it wouldn’t surprise me if the Russell (domestic pure play) continued to outperform Emerging Equity Markets linked to #deflation either. With new discoveries come new positions in the new year.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.05-2.31%
Oil (WTI) 54.01-57.43
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
Dear Investing Ideas Subscriber,
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ICI FUND FLOW SURVEY: 2014 WAS THE YEAR FOR FOREIGN STOCKS AND DOMESTIC EQUITY ETFS
JUST CHARTS: EYE-CATCHING INDUSTRIALS DATA
The Hedgeye Team
Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.
Takeaway: Current Investing Ideas: EDV, HOLX, MDSO, MUB, RH, TLT, XLP and YUM.
Below are Hedgeye analysts’ latest updates on our eight current high-conviction long investing ideas and CEO Keith McCullough’s updated levels for each.
Please note we added Medidata Solutions MDSO earlier this week. Our Healthcare sector team presents a granular, deep-dive distillation into our bullish thesis below.
We also feature two additional pieces of content at the bottom.
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.
Down from its peak in March 2014 when all things cloud were working, MDSO's stock price has been cut in half and the short interest has doubled. When they report in early February we think they beat numbers and the shorts get squeezed.
Click to enlarge.
Business Model: Cloud-based clinical trial software
History: Rise and Fall
Consensus: Sellside bullish, shorts tend to be wrong
1. Currently the stock screens long based on performance, earnings revisions and short interest. 50% peak-to-trough stock price decline driven by missed expectations (deal timing), guidance adjustment and fraudulent wire transfer*. We view recent weakness as buying opportunity given strength in leading indicators.
2. Macro Monitor identified the following series as two quarter leading indicators of y/y ROC in Application Services Revenue:
3. $1.5 bill annual revenue opportunity based on current product mix ($409 mill ’15 Consensus Sales). Long-term model utilizing s-curve methodology tracking 50% market share based on 4,000 potential customers. Significant cross-sell opportunity with 12 products available, average product per customer (intensity) 2.4.
Combined, these key drivers point to a material acceleration in application services revenue through 1Q15 at a time when consensus sales and earnings estimates have been reduced.
*Fraud targeted certain mid-level employees in their finance department resulting in the transfer of $4.8 mill to a rogue overseas account. No customer data was involved in the matter and the company’s systems were not impacted or compromised. Management has reviewed internal controls and processes and implemented additional procedures to prevent future incidents. (Source: Q3 Prepared Remarks)
Figure 1: NTM EV/Sales Valuation Table
Bonds, Bonds, Bonds, Bonds, Bonds!
Amid a mixed week of domestic economic data, our slow-growth, yield-chasing trade of long TLT, EDV, MUB and XLP latched on the trend of #GrowthSlowing data throughout the fourth quarter:
If the DEC Markit and ISM Composite PMI data are any indication, the preponderance of DEC high-frequency growth data will continue to slow as we progress throughout the month of January:
If the DEC Average Hourly Earnings data from Friday’s Jobs Report is any indication, the trend of reported disinflation will continue when we get the DEC CPI data next Friday:
When the 2nd derivatives of real GDP and headline CPI are concurrently negative, the marginal investor is predisposed to allocate assets to the long bond and to equities with defensive, bond-like characteristics.
Fortuitously for you, you’re already positioned that way!
Here’s a look at the growth algorithm for Restoration Hardware going forward.
1) Square Footage Growth: The company is in the beginning stages of transforming its existing 10,000 square foot Legacy Store portfolio to the 45,000+ square foot Design Gallery concepts. Currently the company has 7 of these properties in LA, Houston, Scottsdale, Indianapolis, Boston, Atlanta, and Greenwich. Over the next 5 years an incremental 20+ locations will be added and square footage will grow from 550K at the end of FY2013 to 1550K at the end on 2018.
2) Revenue: Our model calls for mid-20’s sales growth over the next 4 years as the company finally has the real estate to showcase its diversified category portfolio. The current Legacy stores show about 10%, but the new Full Line Design Galleries (Atlanta) houses closer to 70%. The proof of concept from the existing 7 design gallery doors have shown that new categories when presented at retail experience a 50%-150% lift across channels (both retail and DTC). That’s a big opportunity for RH as it builds out its real estate portfolio.
3) Margins: Over the duration of our model we have operating margins going from high single digits to mid-teens. The main driver of that is occupancy leverage. As the company builds these new bigger stores it is taking square footage up in each market by 6x to 8x, but rent expense only increases by 30%-50%. Meaning that on average new square footage comes in at about 25% of the cost of Legacy Store square footage. Perhaps the best example of that is the Denver market where selling square footage will go from 7,500 sq. ft. to 45,500, with rent expense going from $1.3mm to $2.0mm. And this deal isn’t a one off. Over time occupancy will come down from low double digits to mid-single digits. That will be a big tailwind to margins.
YUM is a stock that continues to trade at a significant discount to its intrinsic value, making it one of our favorite long-term buys in the restaurant space. The China recovery may be slightly slower than anticipated as management works hard to regain consumer trust there, but the recent industry-wide acceleration in U.S. sales should be enough to offset any concerns. If the recovery fails to materialize at all, management will be pressured to de-risk the business by spinning off a piece of China.
We wouldn’t be surprised to wake up one day to news of a prominent activist buying up shares of YUM. There’s too much value here to ignore and the stock’s multi-year underperformance is not going unnoticed. Sell-side sentiment is bombed out enough to provoke several upgrades on the slightest hint of good news, and the buy-side knows better than to short a company with such upside. Learn to ignore the day-to-day volatility and prepare yourselves to own this stock for the long haul.
3D TRACKER UPDATE DECEMBER 21, 2014
Our Healthcare team updated our count (proprietary process) of US facilities currently offering 3D Tomosynthesis. December placements are signalling a break-outquarter after a sharp acceleration in October and slight correction to a still very high rate in November. We believe we are seeing a sustained acceleration in placements that will likely drive upside to Breast Health throughout FY2015.
The number of new facilities is accelerating and coming up against an easy comparison (December 2013). The key data in the table below is the 146 new facilities during F1Q15 versus 49 a year ago, or a ~+300% increase. Consensus is modelling 4.7% growth for Breast Health in F1Q15 while our model is producing segment growth well into the teens.
Results of our December OB/GYN show rate of decline in PAP volume continues to moderate. 48% of survey respondents indicate pap testing on a 3-year basis, with an annual expected rate of decline of -12% to reach 100% compliance. This rate of decline translates into 2.6 years before total compliance is reached.
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ADDITIONAL RESEARCH CONTENT BELOW
A rig today isn’t quite the same as a rig in the late 1970s, but the trend should be clear.
2014 was best for international stock funds and domestic equity ETFs. Money funds also rallied late with +$124 billion in the last 11 weeks
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