"Chinese GDP growth hit a 24-year low in 2014," Daryl Jones, Hedgeye Director of Research tweeted earlier today. "And you're worried about Greece?"
The biggest risk to the market right now isn’t fundamental – it’s technical. Not technical as in chart analysis (e.g. "The technicals look bad), but rather the structural nature of the U.S. equity market.
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Specifically, one of the least discussed risks to the U.S. equity market is the $2.6 trillion in assets under management (AUM) in the ETF industry, which is now more-or-less tied with the AUM of the entire hedge fund industry. The proliferation of passive investing has accelerated demonstrably in recent years amid the confluence of three key factors:
- The secular trend of underperformance among active managers
- A trend of minimal variance in returns at the sector and style factor levels
- A trend of subdued volatility at the index level
ETFs provide their investors – which are increasingly institutional – a cheap way to passively allocate to systematic risk. That’s great for investors, but in doing so, it severely disrupts market functionality (e.g. all-time lows volume and turnover) and distorts the price discovery mechanisms at the security level (e.g. tight, but spurious correlations in “risk on” or “risk off” episodes).
When the market goes up, no one cares. But when investors panic – as previewed in early-to-mid October – the market goes down hard and fast because investors are likely de-risking their portfolios of entire factor exposures (e.g. “U.S. equity risk”), rather than of individual names.
In summary, the proliferation of passive exposure to market beta likely means the buying power of investors who are prepared to defend individual names/stories is getting dwarfed, at the margins, by the selling power of those that will just want out when the tide turns.
It took nearly 74 weeks for the U.S. equity market to trough during the last major downturn (10/9/07 – 3/9/09). If the October 2014 draw-down was any indication of the current dire state of market pricing dynamics, a similar decline is likely to have substantially more velocity absent outright central bank intervention.
“Velocity” * “Volatility” = “Mass Panic”, whereby “Mass Panic” heightens the risk that investors make decisions that lead to permanent or semi-permanent capital impairment.
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Editor's note: This a brief sample of Hedgeye research. For more information on how you can subscribe to our services click here.
Takeaway: This week we consider a few different ways of evaluating the labor market's current state.
Below is the detailed breakdown of this morning's initial claims data from Joshua Steiner and the Hedgeye Financials team. If you would like to setup a call with Josh or Jonathan or trial their research, please contact
In psychology, cognitive dissonance is the mental stress or discomfort experienced by an individual who holds two or more contradictory beliefs, ideas, or values at the same time, or is confronted by new information that conflicts with existing beliefs, ideas, or values. - Wikipedia
The initial jobless claims data is beginning to give me some cognitive dissonance.
CD 1) 50,000 Feet - Claims are simultaneously at their best and worst level. They're at their best in that they're trending around 300k, which is the historical average of the trough level of claims over the last seven economic cycles. See the first table below for details (courtesy of our Macro team's Christian Drake).
However, they're also at their worst, in that the nature of the trough is that .... it's the trough. It can't get any better. We illustrate this in the second chart below. We've tried to help investors frame up this risk/reward scenario by looking to history for guidance. Specifically, we've compiled data on how long markets have risen after claims have fallen to a specific level.
As the third chart below shows, the claims data has now been sub-330k for 10 months. Looking back historically at the last three cycles, rolling SA claims ran at sub-330k for 24, 45, and 31 months, respectively, before the corresponding market peaks in late 1991, March, 2000 and October, 2007.
CD2) The Energy Paradox - We've written a fair amount recently about the deteriorating labor conditions for energy sector workers brought on by the collapse in crude oil prices since the Fall of last year. Last week's note on the subject can be found here: Concentrated Harm Meets Diffuse Benefit. This week's data shows a further decoupling in initial jobless claims for the US as a whole vs those states with higher energy exposures. We shows this in the two charts below, where we break the 8 energy-heavy states into a basket and index them vs the US since May last year.
However, as we pointed out in last week's note, oil and gas jobs make up just 0.6% of nonfarm employment in the US; if that were cut in half (along the lines of what's happened to the price of oil), it would have only modest repercussions on the labor force at the national level. That said, energy jobs tend to pay better than non-energy jobs, so that needs to be taken into account.
CD3) 50 Feet - This week's print wasn't good. Seasonally adjusted 1-week initial claims rose 25k to 304k, a large jump in absolute terms and a rise that was beyond what consensus expected. We're not aware of any distortions in the data for the most recent week. However, if we look at the rolling data (4-wk rolling averages) then we see a different story. 4-wk rolling SA claims dropped 3k to 290k vs the prior week. Meanwhile, 4-wk rolling NSA claims were lower on a YoY basis by 13.2% this week vs 9.9% in the previous week - the third consecutive week of accelerating improvement in that series.
Our firm places a lot of emphasis on the importance of Rate of Change (RoC). Our overarching gestalt is that what happens on the margin matters most since it determines the next price. The challenge in that approach, however, is which data point to key off of, as the most recent week's number is clearly a miss while the rolling 4-wk average shows ongoing improvement.
When dealing with something as large as the US labor market, we're not going to make an inflection call based on a single week's worth of data, especially not based on a data series as routinely volatile as the weekly jobless claims. That said, anytime a high frequency data series signals potential trouble, our caution flags go up and we place added significance on the next data as we look to see whether the beginning of a new trend is taking hold. For now the trend remains positive, but we've got the caution flag up with this morning's claims number.
CD4) Convergence & Mice - One of the challenges of watching RoC is that you have to have proper context for what you're observing. In Science, mice are often used for experimentation. We'll use them for our purposes as well.
Consider the following thought experiment (again, h/t Christian). Let's say that I have 10 mice in my house in 2012, 5 mice in my house in 2013, no mice in my house in 2014 and no mice in my house in 2015. Here's how RoC looks on that: 2013: 50% improvement, 2014: 100% improvement, 2015: 0% improvement.
No mice is the obvious objective here, the analog is maximum potential employment. RoC would have you believe that 2013 was good (50%) , 2014 was better (100%) and 2015 was bad (0%), but obviously 2014 represented the achievement of the goal (no more mice) so no change to 2015 was as good as could be hoped for since you can't have negative mice in your house.
Claims reach their frictional lower bound around 300k. As a reminder, 300k is the trough average over the last seven economic cycles. As we are now at that trough we should expect that as we begin to lap the 300k level the YoY rate of change will converge towards zero, just as no mice YoY equals 0% RoC improvement. This isn't a bad thing. This simply means we've reached the trough in claims. At this point, the important exercise becomes watching for signs of new mice (a rise in claims).
Prior to revision, initial jobless claims rose 26k to 304k from 278k WoW, as the prior week's number was revised up by 1k to 279k.
The headline (unrevised) number shows claims were higher by 25k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -3.25k WoW to 289.75k.
The 4-week rolling average of NSA claims, another way of evaluating the data, was -13.2% lower YoY, which is a sequential improvement versus the previous week's YoY change of -9.9%
Joshua Steiner, CFA
Jonathan Casteleyn, CFA, CMT
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Takeaway: Another good quarter by a regional gamer and estimates going higher for the first time in years
- Revenues up ~11% in January, with positive trends that continuing into February
- Pleased with financial performance in 4Q
- Seeing improvement in consumer confidence
- Based on Jan/Feb numbers, consumer seems to have wind behind its back across all geographical areas
- Sees improving spend per visit and visitation
- Q4 tables game volumes grew 10% at ASCA properties. Expect them to grow in 2015.
- Have seen solid improvement in REVPAR at East Chicago (+10%) and St. Charles (+7%). 15% increase in hotel cash revenues in Q4.
- myChoice program: 9% increase in play and 6% spend per visit
- Market share:
- Grew 60bps and expanded EBITDA margins
- River City - record market share
- St. Charles: highest since 2010
- East Chicago- highest since 2008
- L'Auberge Lake Charles: Q4 and 2014 record EBITDA and performance.
- December: revenues lower but volumes increased
- January: both revenues and volume both increased
- Belterra Park: seeing larger % of play from VIP players; have launched expanded advertising campaign in the next 30 days
- 1st time in 10 years, SS revenue growth
- Q4 SS EBITDA $152m increased $11.6m (excluding integration costs and Lake Charles costs)
- Belterra Park posted positive EBITDA in January
- Lake Charles retention program costs: halfway through program. Expect $1m per quarter in Q1 and Q2 2015.
- Boomtown New Orleans hotel: have improved results
- Will make final payment for Belterra Park license in 2Q 2015
- So far in 2015, have repaid $25m in debt
- Will issue equity to de-lever. $1bn prelim estimate lowered to $700m and potentially less. Reduction due to strong operating performance broad base which has a multiplier effect on leverage and cash flow and other company refinements
- Not have added risk to profile of company through this change.
- The issuance of up to 20% of REIT could be large portion of the $700m
- REIT spin-off: (issue shares up to 20% of REIT pre-spin without tax consequences), straight equity, equity-linked securities options
- Submitted Private letter ruling to IRS in December.
- Expect REIT in 2016
Q & A
- 1Q so far, revenues continue to build
- Lake Charles:
- Golden Nugget attracting a different and new customer
- Optimistic on market expansion
- Seeing myChoice customers grow as well
- L'Auberge hotel doing well
- Not changed marketing strategy
- Lower G&A: expect 2015 to be south of $80m (mid 70s or so)
- How much has PNK spent on REIT transaction? $1m in quarter. $2-3m overall.
- REIT: Need approval from IRS and gaming regulators. Will be diversified REIT.
- New Orleans smoking ban: sees upside from that
- Some discussion of smoking ban in other Louisiana markets but see no progress there
- Table game initiative: still early
- National casino advertising
- Expansion of table games
- East Chicago: putting in a restaurant called Stadium (will be there in April). And doing some gaming changes as well. Construction starting on Cline Avenue Bridge is a positive
- Maintenance capex: close to $80m run rate but $100m in 2015
- Term Loan B outstanding: $782m ; should see it go lower as you go forward
Editor's note: This is a complimentary research excerpt written by Hedgeye U.S. macro analyst Christian Drake. For more information on how you can subscribe to the fastest-growing independent financial research firm in America click here.
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Bottom Line: It was an “okay” report for January with the Headline less flattering than the under the hood.
- Headline sliding a big -0.8% while holding flat on a year-over-year basis.
- Gas Stations: Sales at gas stations (which reflects the gasoline price drop) are obviously everyone’s key focus item and the biggest driver in the headline change – Nominal dollar sales at gas stations were down -9.3% month-over-month and -23.5% year-over-year.
- Sales ex-Autos & Gas were up +0.2% month-over-month and accelerated to +5.7% year-over-year from +4.7% in December
- Control Group: Retail Sales control Group (which feeds the GDP calculation) were +0.1% month-over-month and accelerated to +4.3% year-over-year from +3.3% last month
- Industry: Positive on balance - Sales growth was positive in 8 of 13 industries on a month-over-month basis. On a year-over-year basis 8 of 13 industries saw sales growth accelerate relative to December
*Remember – advance retail sales are notably volatile and subject to big revision. They are also reported in nominal dollars, so price vs. volume effects have to be inferred.
Takeaway: New Nike App is another demonstration of DTC commitment. Bad for FL, HIBB, etc
EVENTS TO WATCH
SKX - 4Q14 Earnings
Takeaway: In line quarter with a solid algorithm on the P&L -- revs up 26%, EPS +53%. The mid-point of 1Q guide was 8% and 18% above consensus for revs and EPS respectively. But, keep in mind that SKX has never made it more than 8-quarters with out an earnings surprise on the down side. This quarter marks the 5th quarter in a row where the company beat but that has slowed dramatically from the big blowouts we saw at the start of the year. Sales are slowing sequentially on both a 1yr and 2yr basis. We're 3-6 months away from a tough margin comparison, and the company will lap the memory foam benefit from 2014 this year. Overall AUR trends for the year were a big benefit for SKX, the trend looks like this: -3.1% in 4Q13, +5.1% in 1Q14, +4% in 2Q14, +1.2% in 3Q14, and +7.4% in 3Q14. Gross margins ended the year about 40bps off all time highs and EBIT margins are creeping in the same direction. Though we have a negative bias on this name, we have to respect what the company has done over the past two years. The question for us is whether there is something structurally that has changed for the better at this company, or is it due for another Skecher-esque blow up. If we see the inventory/sales trend continue to drift lower in 1Q, this will make it to our Short bench for sure.
NKE - Nike SNKRS App
Takeaway: There is a lot going on with this new Nike SNKRS app. The takeaway right up front is that it makes buying shoes easier on a mobile device. That's bad for retailers like FL, HIBB, FINL, etc. We haven't seen this type of technology before but it makes sense given Nike's push into the direct business. A few more nuances worth mentioning…
- Everything purchased on the app ships for free. The free shipping threshold on nike.com sits at $75. As we were typing this it made sense to us because this is a sneaker-head app which will probably not feature any styles under the current hurdle rate, but it’s a solid piece that the marketing department can use. We think that Nike moving to free shipping across the board is a 12-18 month development.
- The app will curate specific styles that fit the consumers taste. That's cool, but we think the more important feature is the limited/new release notifications. Limited releases are a big driver for the likes of FL. Nike now has a way of communicating with its target consumers directly about these releases.
Work at West Coast ports to scale back for 4 days
WMT - Walmart Canada announces expansion plans
TGT - Target Cuts 550 Jobs With More to Follow
GOOG, AAPL - Google Testing Payment Service
JCP - J.C. Penney expanding Disney shops to additional 116 stores
ZU - Zulily CFO Out
Scott Kessler Named Belk's Chief Information Officer
ASNA - Ascena Retail Group, Inc. Appoints Robb Giammatteo as Chief Financial Officer
Plac to Enter U.S. Retail Market
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