Spurious Correlations

“Shallow men believe in luck or in circumstance.  Strong men believe in cause and effect.” 

-Ralph Waldo Emerson


If you are human, when the global macro market correlations go against your position, you undoubtedly classify them as spurious.  After all, they don’t fit your thesis, so how else can they be classified?


In reality, when we think of spurious correlations, we think of things that have no business or rationale in being correlated.  We’ll give you a few examples:


  • From 1990 to 2009, the inverse correlation between honey producing bee colonies in the U.S. was -0.93 inversely correlated to juvenile arrests for marijuana;
  • From 1990 to 2010, the positive correlation between people who drowned falling out of a fishing boat in the United States with the marriage rate in Kentucky was +0.95;
  • And last but not least . . . from 2000 to 2009, the per capita consumption of mozzarella cheese was +0.96 correlated with civil engineering doctorates awarded in the United States.


Suffice it to say, not all correlations are created equal.


In yesterday’s Early Look, Keith highlighted the fact that some of our macro views that are highly correlated have been going against us for the last week or so – dollar down, oil up, Euro up, Russia up, Greece up, Brazil up . . . and the list goes on.  Versus say mozzarella and engineering degrees, these assets, even if we disagree with their recent price direction, have a lot more business being correlated.


Certainly, almost every asset and asset class has a price, but what we have seen in February remains a counter TREND move.  In our view, the underlying fundamental circumstance of global #deflation and slowing growth remains intact.


Back to the Global Macro Grind...

Spurious Correlations - Hamlet cartoon 02.17.2015

Speaking of spurious, the most interesting central banking comments of the day award has to go to Bank of Japan Governor Kuroda, who indicated he will potentially act if the drop in the price of oil continues to hurt his outlook for inflation and general price levels (read: his inflation statistics).  Since the Bank of Japan has bought almost every other asset available globally, perhaps the next move will be to lever up and buy oil futures!


On the topic of oil and counter trend moves, oil continues to be one of the more hotly contested asset classes globally.  After a decline of epic proportions, WTI is now up about 10% in the last month and this is, admittedly, on contract volume that is up about 61% versus the 3-month average.  Certainly, declining rig count in the U.S. and some level of short covering has helped, but what of production and future supply?  Interestingly, Wood Mackezie in a recent report noted the following per a Bloomberg article:


“. . . that of 2,222 oil fields surveyed worldwide, only 1.6 percent would have negative cash flow at $40 a barrel. That suggests there won't be a lot of chickening out at $40. Keep in mind that the marginal cost for efficient U.S. shale-oil producers is about $10 to $20 a barrel in the Permian Basin in Texas and about the same for oil produced in the Persian Gulf.”


In Chart of the Day, we highlight weekly U.S. oil production in the U.S. going back to 1983 (as long as the data has been kept).  As you can see, weekly oil production in the U.S. hit its highest level in more than 32-years last week.  If Wood Mackenzie is correct, it seems we may not be done with #DrillBabyDrill just yet.


Inasmuch as oil bears want the bottom to be in for WTI, the chart is very telling.  Not only is oil production at a 32+ year high in the U.S., it is growing some 10% year-over-year.  Unfortunately, again for oil bulls, on the demand side, the outlook is not overly robust either, with U.S. oil demand at a more than 12-year low (as a % of GDP).


The nearest term catalyst for oil markets may well be in the April / May time frame in the U.S.  Based on projections of current production, it is expected that Cushing, and other U.S. repositories, may be at full capacity by then.  In theory, this may force producers to dump near term supplies on to the market at seriously discounted prices.  #Contango, anyone?


Switching commodity gears slightly, at 11am ET this morning, we will be hosting a call with Keith Barnett the Head of Fundamental Analysis from Asset Risk Management ( ) on the outlook for natural gas prices (he will also discuss oil).  If you don’t already have it and would like to get the dial in for the call, please email .  The key topics Barnett will discuss include:

  • Rapid growth in US production driven primarily by emergence of Marcellus / Utica shale play has created basis price dislocations as infrastructure and demand re-calibrate to new supply / demand regional balances;
  • Demand growth along the US Gulf Coast [industrial, LNG exports, and pipe exports to Mexico] create a “battle zone” for basis differentials to re-balance in 2016-2020, with the Haynesville waiting in the wings;
  • British Columbia / Northern Alberta shale plays will look for a home, especially if BC LNG exports continue to be delayed and lower crude prices dampen oil sands (gas demand) development; and
  • Lower crude prices will affect the supply side through reduced liquid-oriented gas, and the demand side by impacting petchem plant development, global LNG price arb, and Mexico project development.


We hope you can join the call.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.70-2.18%

SPX 2070-2110
Nikkei 176

VIX 14.35-19.33

EUR/USD 1.12-1.14

Oil (WTI) 48.37-54.02
Gold 1195-1232 



Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Spurious Correlations - COD updated 2 18


Takeaway: Higher synergy target and better Wave commentary show why NCLH may outperform in 2015


There was much to like from NCL’s 2015 guidance. We had believed that the Prestige impact was underestimated by the Street (see our note: NCL/PRESTIGE: 3 TOPICS TO CHEW ON (9/4/2014). Indeed it was on both yield growth and synergy targets as outlined by management. Management’s commentary on an improving outlook for Wave 2015 corroborates our thesis that Norwegian is the best positioned cruiser for 2015.  NCL remains our top (and only right now) long idea in the cruise space. 


Please see our detailed note:

February 18, 2015

February 18, 2015 - Slide1



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Warrior Tape!

This note was originally published at 8am on February 04, 2015 for Hedgeye subscribers.

“The two most powerful warriors are patience and time.”



I love that quote. When I think about risk managing my firm, the Global Macro tape, and what I need to improve upon – as I get older, I usually come back to patience and time.


Can I maintain opposing thoughts, across multiple durations, and still operate objectively? Can I help both my team and yours understand the difference between an immediate-term TRADE risk and an intermediate-term TREND?


To me, the words patience and time don’t have to imply “long-term investor.” To be a long-term active risk manager (someone please market their fund as doing so!) you have to be patient so that, sometimes, you can act quickly.


Warrior Tape! - hrg


Back to the Global Macro Grind


Since centrally planned markets move quickly, why wouldn’t you, sometimes, risk manage quickly? As I’ve been sitting here this morning the S&P futures have gone from down 2 to down 9, to down 2 (on a Chinese rate cut), to down 6 twenty minutes later.


Yeah, that’s about as free-market as the Nikkei being jammed +2% into the bell on a “rumor that the BOJ is going to add another dovish member.” Lol! Seriously, like Japan hasn’t been dovish for 2 decades – they are printing 90 TRILLION Yens a year!


To be a warrior of this actively managed tape, in addition to patience and time, you have to have a lot of weapons at your disposal. One of the biggest ones is historical context. Another is keeping yourself together, mentally.


If you have neither context nor emotional control, you will get wrecked.


To review this most recent 3-day counter-TREND move in macro markets:


  1. It’s all about the Dollar
  2. Reversing an epic 6 month #StrongDollar move started with a bad US GDP print on Friday
  3. Down Dollar’s counter-TREND move picked up momentum when the ISM # slowed on Monday
  4. By Tuesday, the EUR/USD was headed to the top-end of its $1.11-1.14 risk range
  5. USD had one of its biggest DOWN days in a year (yesterday)
  6. CRB Index had one of its biggest UP days in a year, closing +3.2%


Yeah, Oil ramped. I get it. If you knew what a Down Dollar move would do to both Oil and the Commodities complex, you should have absolutely got that right too. To remind you where the trending probabilities were heading into this 3-day move:


  1. USD 3-month inverse correlation to CRB Index = -0.91
  2. USD 3-month inverse correlation to Crude Oil = -0.95
  3. USD 3-month inverse correlation to SP500 = -0.29


Sure, it should have been harder to convince yourself that the SP500 could have a big up move on a Down Dollar move – but it really wasn’t that big – certainly not on an absolute or relative basis to the move in Commodities and their linked stock sectors:


  1. From the Friday closing low of 1995, SP500 = +2.7%
  2. Whereas the CRB Index ramped +6.6% from its low of last week
  3. And Oil & Gas Stocks (XOP) ramped +10.4% in 3 trading days


I know, as long as you bought Greek stocks alongside everything that has been crashing in Commodities and their linked US equity sectors for the last 6 months, you absolutely crushed it yesterday.


I am not saying this is easy. I am simply reminding you how the next crisis looks – because you are already in it. It’s called a market volatility crisis perpetuated by central planners who move into panic mode in a final effort to “smooth” the tape.


Volatility crisis?


Yes, do you know what Oil Volatility (OVX index) did in the midst of crude going from $43 to $53? It went up! And the implied volatility for the SP500 on my intermediate-term TREND duration did not change.


No, I do not profess to know how to call this, play by play, with everyone of these countries randomly coming out with made for Bloomberg ad rev headlines on what they are going to try to do to markets next…


But my longest term risk management conviction remains that this epic central planning experiment of markets will not end well. It will end the way that it is already ending – with confusion and volatility. Have patience with that.


Our immediate-term Global Macro Risk Ranges are now (12 macro ranges with TREND signal in brackets like this are in our Daily Trading Range product):


UST 10yr Yield 1.61-1.82% (bearish)
SPX 1987-2066 (neutral)

Nikkei 17292-17889 (bullish)

Greece (Athens Index) 674-849 (bearish)

VIX 16.06-21.87 (bullish)

USD 93.45-94.84 (bullish)

EUR/USD 1.11-1.14 (bearish)
YEN 116.03-118.34 (bearish)
WTI Oil 42.35-52.79 (bearish)
Natural Gas 2.60-2.81 (bearish)
Gold 1255-1291 (bullish)
Copper 2.42-2.59 (bearish)


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Warrior Tape! - 02.04.15 chart

KATE - Big Deal For KATE

Takeaway: This announcement out of KATE that it is transitioning its watch business to FOSL is bigger than the headline otherwise suggests.

This announcement out of KATE that it is transitioning its watch business to FOSL is bigger than the headline otherwise suggests. We get to a dime accretion by year three for a company that will end up earning $0.30 in 2014, with an even greater impact on cash flow.  Here are some key considerations.


1) As it stands today, KATE has about an $80-$100mm watch business, which is about 7% of KATE’s total business at retail ($1.35bn footprint – grossing up the value of wholesale and licenses). But by our estimate, the business is only marginally profitable, with EBIT of around $5mm, or around 3% of total. Accessories like watches should be 2-3x the margin rate of things like apparel, shoes and other core categories.

2) KATE was determined to develop its watch/jewelry business in house. That might work for a sub-$100mm brand, but without the scale of a larger design and sourcing operation it would likely stay a $100mm business forever. There is a reason why KORS, Tory Burch, Marc Jacobs, etc. all have deals in place with FOSL. If KATE wants to take the watch business closer to $500mm over time (no pun intended), which it does, then the deal with FOSL makes perfect sense.

3) Bye bye Adelington. We’ve been wondering for a while now why Adelington (its in-house private label jewelry design company for department stores) still exists as a part of Kate Spade. The brand itself is losing licenses left and right and is now margin dilutive. We can only think that it served some support function for Kate’s Jewelry/Watch design effort, but now that it’s moving over to FOSL we don’t see the need to keep it around. We have it coming off the P&L in our model by the end of 2016.

4) Over the past 3 years KORS watch/jewelry business has grown over 140% to $730mm as of the end of FY13. That’s huge. Let’s say KATE can grow 3x in 3 years. That means we take away about $100mm in consolidated revenue at about a 5% margin, or $5mm. Then in year 1 we take the business to $150mm at a 10% royalty – that’s $15mm at about a 60%margin (could be as high as 80%). That’s $9mm, which is about 80% growth in watch-related EBIT in year 1 – and that’s not to mention the fact that it takes working capital off the balance sheet. The net is $4mm, or about $0.02-$0.03 per share. That might not seem like a lot, but it’s actually about 10% earnings accretion in year 1. 

5) In year 2, the math works out to be something like $225mm x 10% x 60% = $14mm, or $9mm net of lost consolidated sales. There’s an extra nickel in earnings. We’ll likely build closer to a dime by year 3.

6) Not only is KATE signing up for FOSL expertise and sourcing power, it will now be able to tap into the brands global supply network. In the past KATE had been signing distribution agreements ad-hoc region by region. This helps simplify that.

7) The only real issue we can think of would be KORS ties with FOSL. The brand currently accounts for about 25% of FOSL’s revenue. That’s the equivalent of UnderArmour starting up a line at a new shoe factory in Asia only to find out that the entire building is otherwise dominated by Nike.  That said, KORS and FOSL just signed a 10yr deal which locks in the license through 2024. If KORS were going to have bargaining power it would have been a few months back. In addition, this is not FOSL’s first rodeo. It’s dealt with competition like this before. If it mismanages either of the two brands (KATE, most notably) it will shoot itself in the foot as it relates to reputational risk. FOSL management won’t let that happen. 


KATE - Big Deal For KATE - kate financials

Cartoon of the Day: Rotten

Cartoon of the Day: Rotten - Hamlet cartoon 02.17.2015

Risks are rising around the world.

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