This note was originally published at 8am on February 05, 2015 for Hedgeye subscribers.

“60% of the time it works….everytime”

-Brian Fantana, Anchorman (Clip)


Over the 2001-Present period (n = 160 months), the sequential, directional change in Nonfarm payrolls is the same as that of the ADP Employment series 64% of the time.


The ADP report for January released yesterday showed the sequential change in net payroll adds declined by -40K to +213K from an upwardly revised December total of +253K.


The current Bloomberg estimate for January Nonfarm payrolls is +230K, down sequentially from the +252K reported in November.  By the numbers, the sequential decline in net payroll gains reported by ADP suggests consensus is sitting on the right side of the 2:1 asymmetry into the print tomorrow.


What do you do with that? 


Not much really - it’s more analytical anecdote than investible projection.  Convictedly forecasting the NFP numbers on a month-to-month basis with precision is a quixotic endeavor.  We can generally handicap the balance of risk as it relates to consensus expectations but we haven’t found a method for reliably forecasting a point estimate – so we don’t.    


The current price/quant signals and our TREND view on domestic fundamentals generally drives our positioning into the number and we simply take what BLS gives us on jobs day and respond accordingly. 


We Get What We Get…& Don't Get Upset


Anchorman - EL Chart 1


Alongside its inveterate interest in wage inflation, the prospect for shale state employment pressure to derail the labor market recovery – and the current expansion more broadly - sits as an acute and rising investor focus into the January Employment report. 


We’ve discussed the energy economy and the developing macroeconomic impacts associated with the strong dollar driven commodity price cratering in scattershot over the last couple months but it’s worth compiling and recapitulating. 


Starting broadly and narrowing: 


Evolution of US Oil intensity:  U.S. Oil intensity - oil consumption per unit of (real) GDP – has declined by some 56% over the last 3 decades.  Summarily, as the economy has moved away from industrial production and towards ICT and Services production growth’s dependence on energy has declined.  The implication is that while the energy renaissance and the concomitant growth (& potential over-investment) in related industry makes it particularly vulnerable to an acute price shock, the transmission/amplification of that shock through the broader economy should be more muted relative to prior instances of heightened oil-price volatility. 


Oil Sector Employment:  The BLS catalogues oil & gas related employment within four major subsectors:  Oil and Gas Extraction, Oil & Gas Pipeline Construction, Support Activities for Oil & Gas Operation and Mining/Oil/Gas field Machinery. 

  • Share of Total:  Collectively, BLS estimates these industries employed 780K people as of November 2014.   Relative to Total Nonfarm employment of 140MM, those most directly employed in Oil and Gas extraction represent 0.6% of the NFP labor force.   
  • Growth From Trough:  Relative to the NFP employment trough in February 2010, Oil and Gas related employment is up +274K – a remarkable 54%.  This compares to growth of +8.1% for total NFP employment over the same period.  Further, Oil related employment gains represent 2.6% of the total increase in employment since trough (274K of 10.4MM total increase in employment) – certainly an outsized contribution relative to its share of total employment.  

Energy State Employment:  An alternate measure of the energy sectors impact on employment is to look at total employment gains in “energy” states relative to the rest of the country.   Analyzing employment changes at the state level provides an indirect (albeit largely imprecise) measure of the multiplier effects stemming from relative strength in the energy economy.  We have been using a basket of eight energy states  (AK, LA, NM, ND, OK, TX, WV, WY) in analyzing the initial jobless claims data for negative divergences in recent months.  We use the same basket here in analyzing state level employment changes

  • Share of total:  Collective Energy State employment is currently 12.9% of total.  This is roughly in-line with the baskets share of the economy with collective energy state GDP at 13.2% of total as of 2013.  
  • Growth From Trough:  Energy state employment has increased 1.998MM since the February 2010 employment trough with its share of total employment rising from 12.5% to 12.9% over the same period.  In other words, by this ‘crude’ measure, energy states have accounted for a moderately outsized 18.7% of the total gain in employment.     

Initial Claims:  We’ve been monitoring the trend in initial jobless claims for the basket of 8 energy state highlighted above for negative divergences from the National Trend.   

  • Energy State Decoupling:  We’ve indexed both the National and Energy State series back to May of last year and have monitored the spread between the two indices in the wake of the oil price collapse.  As can be seen in the Chart of the Day below the spread between the two series has held at around 15 points the last couple weeks.  In short, the accelerating decline in oil prices since late September has coincided with a moderate acceleration in energy state initial jobless claims relative to the US as a whole.  We’ll get the incremental update this morning at 8:30am.    

So, energy state labor market trends do appear to be deteriorating on the margin and (at least partially) corroborating anecdotes of energy companies reducing headcount and scaling back capex.  At the same time, the U.S. is significantly less oil intensive than it once was, employment directly tied to oil and gas extraction is a relatively small fraction of the total, and there are the oft-highlighted consumption benefits of lower energy prices – although these are likely to play out on a decidedly different timeline than oil sector employment adjustments. 


Practically, is a moderate retreat in energy employment clearly discernible above the seasonality and month-to-month noise in the monthly employment data?  Perhaps, but it would have to be a large percentage change if those losses are, indeed, concentrated in the narrow set of BLS classified oil & gas extraction industries.


Remember also that the standard error on the NFP estimate is approximately +/- 90K at the 90% confidence interval.  In other words, if we happen to get a print of +90K on Friday, that means the BLS is 90% sure we gained between 0 and 180K jobs. 


Further, with USD correlations as strong as they are, a weak dollar move could augur sizeable, expedited upside for stuff priced in those dollars.   According to the University of Michigan Consumer Sentiment report for January, American consumers aren’t convinced of the sustainability of the oil price retreat either.  In fact, the prevailing expectation is that gas prices rise 20 cents over the next year and ~$1 over the next few.


#MeanReversion: 100% of the time it works….everytime. 


Ultimately, the net impact of many of the oil price shock dynamics are equivocal and forecasting whether the collective impact will catalyze a negative, self-reinforcing inflection in the labor market is not one we’re comfortable making.  However, with the data context above and our weekly tracking of the high frequency labor data, we do feel comfortable in our ability to monitor incremental changes and dynamically update our view.


Plus….there’s bits of real panther in our risk management model  - so you know it’s good. 


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.65-1.87%

SPX 1987-2066

VIX 16.06-21.78
YEN 116.09-118.87

Oil (WTI) 42.24-51.97
Gold 1251-1301


Prepare. Perform. Prevail.


Christian B. Drake

U.S. Macro Analyst


Anchorman - EL Chart 2

VIDEO | Why Oil Prices Are Set To Go Lower


In today's Macro Minute, Hedgeye Director of Research Daryl Jones outlines three reasons why oil prices are likely to take a spill despite a recent rally.

Cartoon of the Day: Kuroda and the Inflation Killer

Cartoon of the Day: Kuroda and the Inflation Killer - Kuroda cartoon 02.18.2015

The Bank of Japan's Haruhiko Kuroda says he "will act" if crashing oil prices kill his Policy To Inflate. This is bound to get interesting.

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12 Reasons Why Oil Prices Could Get Cut in Half Again

Oil prices have shot up around 10% over the last month.  Of course, this spike occurred following a crash of epic proportions (oil has fallen over 50% from its $107 high in June 2014 to just over $52 today).  The question now is what’s next? 

12 Reasons Why Oil Prices Could Get Cut in Half Again - Oil cartoon 12.09.2014 

Here at Hedgeye, we would suggest that the next move may be lower based on the reasons outlined below.


1)      U.S. Production At 32-Year High - As measured by the Energy Information Administration, U.S. energy weekly production is at an almost 32+ year high at 9.2 million barrels per day (bbl/d).


2)      U.S. Weekly Production Growing Over 10% - Not only is production at a multi-decade high, it is also growing double digits year-on-year.  Specifically, in the week of February 6th 2015, production was at 9.2 million bbl/d versus 8.1 in the week of February 6th 2014. That’s 13.4% y-o-y. 


3)      U.S. Production Is Likely To Grow Into 2016 - The EIA estimates that in 2016 U.S. oil production will eclipse 9.6 million b/d.  This would result in the highest U.S. production since 1970, or more than 45 years.

12 Reasons Why Oil Prices Could Get Cut in Half Again - 04 

4)      Global Growth Is Muted (At Best) – Oil consumption is obviously closely correlated to economic growth.  Globally, economic growth is faltering – it is slowing in China, negative in Japan, flattish in Europe, and likely to slow in the United States this year.


5)      Saudi Arabia Can Withstand Sustained Lower Prices – The world’s largest oil producer in theory needs $90 oil to fund its budget, but has more than $726 billion in foreign reserves it can use to fund its budget during periods of sustained lower prices.


6)      Field Economics May Be Lower Than Many Think – According to a recent report by Wood Mackenzie, a survey of 2,222 oil fields globally found that only 1.6% would have negative cash flow at $40 per barrel.

12 Reasons Why Oil Prices Could Get Cut in Half Again - o3 

7)      Oil Dependent Nations Have No Choice But To Produce – In major oil producing and dependent countries like Russia, the government may have no choice but to produce at lower prices.  Roughly 42% of Russian government outlays are financed by oil exports. In other words, to cut production in an environment where prices have collapsed would be economic suicide for the Russian government.


8)      Global Demand Outlook Continues To Fall – OPEC’s most recent forecast for demand outlook suggested that global oil demand will hit a 12-year low in in 2017.  This is more than 600,000 barrels less than it forecast a year ago for 2017 demand.


9)      IEA Follows OPEC- Consistent with point above, the International Energy Agency has also dropped its oil outlook consistently over the last year.  The IEA has dropped its forecast four times in the last year. It now sees a surplus of approximately 400,000 barrels in 2015.

12 Reasons Why Oil Prices Could Get Cut in Half Again - 02 

10)   U.S. Storage Is At A Tipping Point – It is expected that Cushing and other U.S. repositories will be completely full by the April /May 2015 timeframe.   In aggregate, U.S. storage is at an 80-year high of 417.9 million barrels, which is up 15% y-o-y.


11)   OECD Storage Also Highest On Record - OECD commercial inventories totaled 2,741 million barrels at the end of 2014, which was the highest level on record and equivalent to roughly 58 days of consumption.  The EIA projects these inventories to rise in 2015.


12)   OPEC Spare Capacity Expected To Increase – According to the EIA, OPEC surplus crude oil production capacity, which is concentrated in Saudi Arabia, is expected to increase to an annual average of 2.3 million bbl/d in 2015 and 2.7 million bbl/d in 2016, after averaging about 2.0 million bbl/d in 2014.


So, what’s the bull case on the price of oil? Email your thesis to


CAT 10-K Review: SARL, Goodwill, and Slow Disclosure Hunting



We had expected CAT’s 2014 10-K to be interesting, and we were not disappointed.  Our review of CAT and CAT Financial’s 10-Ks leaves us feeling as though we missed as much as we saw, with the subpoenas/investigations sticking out most clearly.  CAT seems to be experiencing ‘investigation creep’ from the SEC, and a pretty unhappy IRS, too.  For starters, CAT should probably impair the BUCY goodwill just to get it over with.  Warranty challenges, material weakness in controls at CAT Financial, and the impact of completing distributorship divestitures also seem noteworthy. 


In next year’s 10-K, we would look for Caterpillar Financial to take the stage with mining and oil & gas exposures as sources of possible losses, since, “receivables from customers in construction-related industries made up approximately one-third of [their] total portfolio.”  Mining, as a category, is generally only top-tier miners, with smaller mining operations categorized in their respective regions.  While we took Short CAT off of the Best Ideas list, we would look to add it back if the shares continue to bounce. 



Key Items


Grand Jury Subpoena on U.S./Non-U.S. Subsidiary Profits, Cash:  This can’t really be a positive.  There has been significant speculation by shorts in CAT on the role of advance purchase transactions, tax reduction strategies, and earnings/inventory management.  We will be interested to see how it turns out.  The SEC correspondences linked below provide clues, but the lack of clear disclosure seems troubling.  What, exactly, is the allegation here?


On January 8, 2015, the Company received a grand jury subpoena from the U.S. District Court for the Central District of Illinois. The subpoena requests documents and information from the Company relating to, among other things, financial information concerning U.S. and non-U.S. Caterpillar subsidiaries (including undistributed profits of non-U.S. subsidiaries and the movement of cash among U.S. and non-U.S. subsidiaries). The Company is cooperating with this investigation. The Company is unable to predict the outcome or reasonably estimate any potential loss; however, we currently believe that this matter will not have a material adverse effect on the Company’s consolidated results of operations, financial position or liquidity.”



SEC Investigations: It seems that the SEC investigation has expanded beyond BUCY goodwill, which we previously discussed in 2013 here, to include the SARL (a non-U.S. subsidiary discussed in earlier SEC correspondences, such as here:


“On September 12, 2014, the SEC notified the Company that it was conducting an informal investigation relating to Caterpillar SARL and related structures. The SEC asked the Company to preserve relevant documents and, on a voluntary basis, the Company made a presentation to the staff of the SEC on these topics. The Company is cooperating with the SEC regarding this investigation. The Company is unable to predict the outcome or reasonably estimate any potential loss; however, we currently believe that this matter will not have a material adverse effect on the Company’s consolidated results of operations, financial position or liquidity.”


“On September 10, 2014, the SEC issued to Caterpillar a subpoena seeking information concerning the Company’s accounting for the goodwill relating to its acquisition of Bucyrus International Inc. in 2011 and related matters. The Company is cooperating with the SEC regarding this subpoena and its ongoing investigation. The Company is unable to predict the outcome or reasonably estimate any potential loss; however, we currently believe that this matter will not have a material adverse effect on the Company's consolidated results of operations, financial position or liquidity.”



IRS Tax Issue, SARL A ~$1 Billion Ask:  There is new tax language in many places in the 10-K.  After not much disclosure on the SARL issues in the 10-Q, the 10-K expands on prior disclosure and an earlier correspondence with the S.E.C. here: It would also seem that there would be substantially more exposure for the period after 2009 if CAT fails in its challenge.  This seems likely to linger, since these processes are typically slow.


“On January 30, 2015, we received a Revenue Agent's Report (RAR) from the Internal Revenue Service (IRS) indicating the end of the field examination of our U.S. tax returns for 2007 to 2009 including the impact of a loss carryback to 2005. The RAR proposed tax increases and penalties for these years of approximately $1 billion primarily related to two significant areas that we intend to vigorously contest through the IRS Appeals process. In the first area, the IRS has proposed to tax in the United States profits earned from certain parts transactions by one of our non-U.S. subsidiaries, Caterpillar SARL (CSARL), based on the IRS examination team’s application of the “substance-over-form” or “assignment-of-income” judicial doctrines. We believe that the relevant transactions complied with applicable tax laws and did not violate judicial doctrines. We have filed U.S. tax returns on this same basis for years after 2009. In the second area, the IRS disallowed approximately $125 million of foreign tax credits that arose as a result of certain financings unrelated to CSARL. Based on the information currently available, we do not anticipate a significant increase or decrease to our recognized tax benefits for these matters within the next 12 months. We currently believe the ultimate disposition of these matters will not have a material adverse effect on our consolidated financial position, liquidity or results of operations. We expect the IRS field examination of our U.S. tax returns for 2010 to 2012 to begin in 2015. In our major non-U.S. jurisdictions, tax years are typically subject to examination for three to eight years.”



Progress Rail: Update on that subpoena.  It sounds like they are planning to pay their way out.


“On October 24, 2013, Progress Rail received a grand jury subpoena from the U.S. District Court for the Central District of California. The subpoena requests documents and information from Progress Rail, United Industries Corporation, a wholly-owned subsidiary of Progress Rail, and Caterpillar Inc. relating to allegations that Progress Rail conducted improper or unnecessary railcar inspections and repairs and improperly disposed of parts, equipment, tools and other items. In connection with this subpoena, Progress Rail was informed by the U.S. Attorney for the Central District of California that it is a target of a criminal investigation into potential violations of environmental laws and alleged improper business practices. The Company is cooperating with the authorities and is currently in discussions regarding a potential resolution of the matter. Although the Company believes a loss is probable, we currently believe that this matter will not have a material adverse effect on the Company's consolidated results of operations, financial position or liquidity.”



Pre-Existing Warranty Adjustment: Warranty reserve increased despite lower sales.  It was apparently due to issues with prior period warranties, which is not usually a positive disclosure, as we see it.  In such situations, prior earnings were likely too high because of artificially low accruals, and it is difficult to tell if the further adjustments will be needed.


“The increase in liability includes approximately $170 million for changes in estimates for pre-existing warranties due to higher than expected actual warranty claim experience.”


CAT 10-K Review: SARL, Goodwill, and Slow Disclosure Hunting - bq1



Change In Residual Value Definition?  This looks like a change in definition for the calculation of residual values. The elimination of the word ‘careful’ seems odd, too.  If so, it might point to possible issues at CAT Financial.  For instance, have used mining equipment values deteriorated?  Of course, CAT Financial has already stated that “we have also concluded that our disclosure controls and procedures were not effective as of December 31, 2013” in its revised 10-K after 3Q 2014.  


CAT 10-K Review: SARL, Goodwill, and Slow Disclosure Hunting - bq2



CAT Financial Controls Still Not Effective:  Of course, CAT Financial has already stated that “we have also concluded that our disclosure controls and procedures were not effective as of December 31, 2013” in its revised 10-K after 3Q 2014.  Its only half of the balance sheet.


 “…we are still in the process of implementing and testing these processes and procedures and additional time is required to complete implementation and to assess and ensure the sustainability of these procedures and we have therefore concluded that our internal controls over financial reporting and our disclosure controls and procedures were not effective as of December 31, 2014.” And: “the material weakness relating to our Allowance for credit losses still exists as of December 31, 2014


CAT 10-K Review: SARL, Goodwill, and Slow Disclosure Hunting - bq3



Allowances Still Low?  While they may lack effective controls, as well as some interesting counterparties in mining/oil & gas, he allowance for losses remains low by historical standards.


CAT 10-K Review: SARL, Goodwill, and Slow Disclosure Hunting - bq4



Other Notable Items:


Japan Dealer: “While the large majority of our worldwide dealers are independently owned and operated, we own and operate a dealership in Japan: that covers approximately 85% of the Japanese market: Nippon Caterpillar Division. We are currently operating this Japanese dealer directly and its results are reported in the All Other operating segments. There are also three independent dealers in the Southern Region of Japan.”

Odd to Delete This Language: “We build and maintain a productive, motivated workforce by striving to treat all employees fairly and equitably”  appears in last year’s 10-K, but was removed for 2014.


Restructuring Costs Identification Helped Construction Industries?  We wonder if some of the improved performance at CI was related to ‘aggressive’ restructuring cost identification?  $227 of CI’s costs were in 1H, when the segment posted the strongest adjusted margins.


CAT 10-K Review: SARL, Goodwill, and Slow Disclosure Hunting - bq5



Finished with BUCY Distributorships Divestitures:  The BUCY distributorship divestitures are somewhat unusual since dealers are closely tied to CAT, and CAT has often provided deal financing to dealers.  Apparently, they are largely complete.   


CAT 10-K Review: SARL, Goodwill, and Slow Disclosure Hunting - bq6




Upshot:  As though CAT didn't have enough business challenges, regulatory, financial, and legal issues should provide significant additional distraction. Management has dug themselves a hole, getting paid quite well for the shoveling...







  • Executing on asset recycling program
  • Sold $1.6b of assets in 2014 at 13x EBITDA
  • Accelerated plan to sell almost all of limited service hotels in Q4 due to favorable conditions
  • Grown market share in limited service - grown number of properties by 50% since IPO
  • Owned portfolio continues to evolve to stronger, higher quality, and more strategic hotels
  • Pulled 4 more hotels off the market
  • Return of capital - in Q4 repurchased $215m in stock, most were class A purchased in the open market
  • $69m more repurchased in Q1 through last Friday
  • Q4 earnings came in below expectations due to: 1) $22m in non-recurring stock comp expense, 2) transactions - $8m negative impact for Q4 adjusted EBITDA, 3) $3m negative Fx impact, 4) some weakness in international hotels
  • Stock comp should run $2-3m per year going forward
  • Occupancies are at record level in United States
  • Group revenue would've been up 3% if you exclude 3 problem markets - don't see the Q4 problems persisting
  • Group should continue to recover in 2015 and beyond in US
  • Eurozone underperforming except UK
  • Middle East saw drop in inbound from Russia
  • Eastern Europe not good
  • Weak market conditions in HK and Seoul
  • Margins in Americas higher than elsewhere:  up 50bps vs down 240bps
  • Excluding Seoul, margins would've been flat YoY on owned
  • F&B revs were flat despite higher occupancy driven by a handful of hotels - should track RevPAR over time
  • NYC - 2 Hyatt hotels in the comp base
  • NYC represents 9% of adjusted EBITDA
  • 9 hotels in total in NYC
  • Big supply growth will continue to negatively impact those hotels
  • Hyatt Centric - full service lifestyle brand. First ones will open in Chicago and Miami in Q2. Should have 15 by year end.
  • 2015 - 1/3rd of business is outside of the USA. 2015 EBITDA could be impacted by $20m of Fx versus in 2014
  • $70m negative EBITDA impact on 2015 due to H being a net seller in 2014 - $25m in Q1 and Q2 and $20m in Q3
  • By year end, 20% of hotels will have been open less than 3 years



  • Q4 timeshare is a good run rate since sale was early in Q4
  • NYC is primary destination for inbound traffic from Europe - started the year weak but compare is tough (Superbowl last year)
  • Centric will have 3 ownership structures - Hyatt owned, Hyatt managed, and franchised
  • Will continue to use balance sheet to fund growth
  • No time pressure on redeploying asset sale proceeds for 1031 purposes
  • No CFO update
  • Sees active transactions market continuing - Hyatt will be active on the buy and sell side
  • 2015 should be as active as 2014 on the transactions front - while H was a net seller in 2014, they don't know on which side they will come out
  • Will look at property purchases, management deals, and brand acquisitions
  • Tax rate for 2015 mid to high 30s%
  • Most of the capital for new Centric's will be more related to signage and promotions
  • Owned and lease margin decline of 50bps is a comparable so asset transactions did not have an impact
  • RevPAR and profits will be positive in Seoul sometime this year
  • 4 deals pulled off the market - price, contract structure, capital commitments into the hotels, other development opportunity are the 4 criteria looked at
  • India has been under pressure for 3 years but negative progression is slowing - new government and lower oil prices are helping
  • Slowdown in development in India
  • China - no real slowdown in hotel development
  • NYC down 20% in RevPAR to start the year - outlook for the year is still positive though
  • Franchise fees up 35% in 2015 - conversions, new franchise hotels, same store growth

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