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Dr. House-ing

“There’s no ‘I’ in team. There’s a ‘me’ though, if you jumble it up.”

-Dr. Gregory House 


Sometimes pretending you’re a cynical, misanthropic drug-addict doctor with deific deductive dexterity is what it takes to stay excited about staring at your screen for 14 hours a day. 


The Dr. House metaphor is both apt and easy as it relates to the Hedgeye Housing teams (@HedgeyeFIG & me) inquisition for industry research alpha. 


Distilling the convoluted milieu of domestic housing data in the attempt to diagnose and front-run positive and negative dispersions from industry homeostasis holds obvious parallels to the challenges inherent to diagnosing physiological pathology in the attempt to front-run … death.   


Plus..you know..it illustrates our marginal cleverness with the whole “House” reference.

Dr. House-ing - CoD

Anyway, after being on the right side of the acute housing demand infarction in 2014, we reversed our diagnosis for 2015 in November of last year alongside our expectation for a recession and reversal in many of the industries underlying maladies.  


Since much of what we like about 2015 is what we didn’t like about 2014, juxtaposing the two years across a selection of key factors should sufficiently capture the core of our call.


HPI | 2nd Derivative Trends Matter:  Housing demand leads home price growth and housing stocks follow the slope of price growth.  Since 2008 the correlation between housing equities and the year-over-year rate of change in HPI has been 0.90. 

  • 2014:   Home price growth decelerated sharply in 2014, slowing from ~12% YoY in February to ~5% in October according to CoreLogic data.  The housing complex (XHB/ITB) underperformed the market by ~15% alongside that expedited deceleration in HPI.
  • 2015:  Home price growth stabilized in Oct/Nov across all three of the primary price series (CoreLogic, Case-Shiller, FHFA) and have, in fact, shown modest re-acceleration in December.   Performance has again followed suit with the XHB and ITB outperforming the SPX by +12% and +10%, respectively, since the 2nd derivative HPI stabilization began in November.  Ongoing inventory tightness, with months of supply on the existing market holding below 5 months, remains supportive of stable to improving price growth trends over the immediate/intermediate term.  

Net: In the Chart of the Day below we show the inflection in housing equity performance following the 2nd derivative inflection in HPI. 



Credit:  Discrete tightening in 2014 gives way to marginal easing in 2015

  • 2014 Contraction:  The implementation of QM regulations, FHA loan limit reductions and the expiration of the Mortgage Forgiveness Debt Relief Act collectively served to constrict the credit box and capsize housing demand in 2014. 
  • 2015 Credit Box Re-Expansion:  Recognizing the discrete drag on the housing recovery, regulatory policy momentum is shifting away from the over-pricing risk for the current wave of would-be borrowers and towards policy adjustments aimed at improving affordability and modest credit box expansion. 
    • FHA & Fannie/Freddie:  FHA premium cost reductions (from 1.35% to 0.85%) implemented in January along with the re-introduction of 3% down payment loan options from the GSEs for 1st time buyers could boost purchase demand by ~3% over the intermediate term. 
    • Vantage Scoring:  The FHFA is currently considering adoption of Vantage Scoring – a credit scoring system which provides a more comprehensive risk scoring framework than conventional FICO models and is capable of scoring thin file consumers previously locked out by FICO and other conventional models.  Vantage Score 3.0 is estimated to score approximately 30-35mm more consumers than conventional models and could bring ~500K more borrowers into the fold in the coming years under conservative assumptions. 

Net: Growth by the stacking of marginal easings in 2015, while likely to be modest-to-moderate, stands in sharp contrast to the restrictive QM/Loan limit reductions that headlined the regulatory environment in 2014. 


Ball Under Water:  The Illusion and the Inflection  

  • 2012-2014 | False Perceptions:  Since the start of 2011 there have been ~5.3mn net, new households formed which, using a historically consistent scalar, require 7.2mn new housing units.  However, there have been just 2.97mn housing units started, resulting in a cumulative supply-demand gap of approx 4.2mn units.  This math has underpinned the bullish ball-under-water housing demand/construction thesis for the better part of last two years.  The misunderstanding has been rooted in the reality that the imbalance has been largely illusory as the number of shared households have increased by over 3.4mn over the same period.
  • 2015:  Bear Market in Basement Dwelling:  The increase in shared households slowed markedly in 2014 and the bottom in “basement dwelling” and headship rates now appears to be in.    The implication of an inflection in shared household growth is that what has here-to been a perceived ball underwater becomes, in fact, a real ball underwater and a true support to new housing unit construction.    


Rates:  Rates are currently running ~40bps below their 2014 average, providing an approximate 4% boost to affordability.  With global growth slowing, disinflation/deflation predominating and DM yields anchoring the long-end, we don’t see acute upside risks to bond yields in the immediate/intermediate term.


Elsewhere Across Housing Macro:  Residential Construction Employment in January saw its largest sequential gain since November of 2005, employment growth across the key 20-35 YOA demographic continues to accelerate and  Consumer Sentiment around housing – as measured by the University of Michigan’s “Good Time to Buy a Home” index – continues to advance alongside the broader rise in Consumer Confidence and ongoing improvement in the domestic labor market.  Further, the latest CPS/HVS survey estimated that the total number of households grew by 2.0MM in December vs a year earlier, the largest yearly change since July 2005 and the first material acceleration in year-over-year growth in 8 years. 


The 2015 Score | RoC Solid:  Mortgage Purchase Applications were up +9.8% in the latest week marking the fastest rate of growth since June of 2013, Pending Home Sales accelerated to their fastest rate of growth in 18 months in December (we’ll get the January data this morning), New Home Sales in January held at 7 year highs, single-family housing starts were up 16% YoY in the latest January data and home price growth is reflecting a fledgling re-acceleration. 


In short, our expectation for improving rates of change across the preponderance of housing metrics in 2015 is finding positive confirmation in the early year data.  Of course, cheerleading a call that’s already worked is generally a great way to top tick yourself, but we still like the intermediate term fundamental outlook.  We’ll continue to let Keith risk manage the exposure in RTA. 


Was any of the above analytically ingenious?  Probably not, but having a process for effectively capturing, curating and contextualizing the monthly torrent of shifting housing dynamics in real-time is more than trivial for resource and time-constrained investors.   


As Sherlock Holmes (the figure on which Dr. House was based) characterized his investigatory process: 


“You know my method. It is founded upon the observation of trifles.” ….”It’s quite exciting, he said with a yawn”


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.84-2.08%

SPX 2091-2120

VIX 13.08-16.65

USD 94.01-95.45

Oil (WTI) 47.61-50.97 


The risk of heart attack rises by 20% on Mondays, Enjoy the weekend. 


Christian B. Drake   

U.S. Macro Analyst


Dr. House-ing - CoD2

KSS – Why We Think Guidance Is Too Bullish

Takeaway: We’re not making any changes to our model, which assumes that last year’s EPS proves in hindsight to be the highest number KSS ever earned.

There was an unusually large number of statements from KSS management during the conference call that stood out to us as being in stark contrast to the bullish financial guidance provided. Despite guidance, we’re not making any changes to our model, which assumes that last year’s EPS proves in hindsight to be the highest number KSS ever earned.


KSS – Why We Think Guidance Is Too Bullish - kss financials


Here Are Some Of The Standouts From Where We Sit

  • Wage Increases. In commenting on KSS stance on the impact of WMT’s 25% wage increase, Kevin Mansell noted that employees at KSS are not monetarily driven. We understand the sensitivity of making comments about wages to anyone other than the employees themselves – especially the financial community. But he averted the fact that KSS faces the biggest wage risk out of any major retailer (even more than Target) . The fact is that KSS pays its floor associates and cashiers about 6% less than the TGT/WMT average. It even characterizes itself as ‘best in class’ when it comes to payroll optimization, i.e. not paying its employees. We aren’t making a moral judgment, simply following the laws of supply and demand. When we extrapolated the wage increases from WMT ($1850 per employee) to the 106,000 part time employees at KSS, we get to 104bps in margin pressure and $0.62 in earnings. Are we modeling all of that? No. But when the 900 pound gorilla in the US employment market makes sweeping changes to its hiring and payment practices, it’s hard to imagine that KSS won’t feel the impact. No doubt that the company will try to hold off as long as it can, but eventually it will be forced to follow suit.


KSS – Why We Think Guidance Is Too Bullish - 2 23 chart3


  • Shipping Costs.  Kohl’s currently has a $50 threshold for free shipping. In answer to a question about Target’s reduction of its shipping minimum to $25, management said “…free shipping at $25 – that’s something that I don’t think will work for us long-term from a profitability perspective.” They’re right. The irony is that even $50 doesn’t work for Kohl’s either as DTC margins are already 1000bps below B&M sales. The reality is, KSS was forced to drop the free shipping minimum because it needed to incentive shoppers to protect its market share. As KSS commoditizes its merchandise (more National brands) it will have to fight tooth and nail for every point share. TGT’s move is the first domino to fall on the shipping size, but the bottom is not $25, it’s $0 – which is where we think all the major retailers, including KSS, will be within 24 months.



Gross Margin

  • The company admitted to the fact that it will face a 30bps-40bps head wind per year from e-commerce. 10bps-15bps come from mix alone, and the other 20-25bps is due to shipping expenses.
  • That’s not new to us, and it’s something we already have factored into our model. For the year we are modeling GM down 40bps. How we get there…
    • For 2014 we estimate that the -9bps move in gross margin was a function of B&M margins up 45bps and DTC down 50bps. Store level margins are now at 37.9%, 100bps off 2011 peaks. We don’t see it going any higher from there as the company mix moves towards National brands and the Yes2You rewards increases as a % of sales giving consumers who previously didn’t qualify for a 5% rebate.
    • In 2015 - we’re modeling B&M margins down 25bps due to the aforementioned headwinds, and DTC margins up 100bps as ship from store helps offset some of the negative shipping impact. DTC moving from 11% of sales to 13.5% equates to GM down 40bps for the year

KSS – Why We Think Guidance Is Too Bullish - kss dtc gm



  • Rewards Members – Since the analyst day in late Oct. Kohl’s has added 10mm new members to its Yes2You platform. That’s positive momentum in the program for sure, but the most troubling aspect of the increase is that almost 60% of the newest additions are existing credit card holders. Those credit card holders already account for about ~60% of sales and the fees generated from those sales account for about 25% of operating profit.
  • Of the 30mm credit users, 40% are now enrolled in the Yes2You program.


KSS – Why We Think Guidance Is Too Bullish - y2y table


  • Credit Income. On the call McDonald guided to credit income being up for the year. We’re highly skeptical on that front for a couple of reasons.
    • We think that KSS was playing defense when it rolled out the Yes2You program. The company is already tops in the industry in terms of credit penetration at 60% (M is only at 47%), and it got the last bps by switching its partner to COF from JPM. COF has a much lower credit threshold and allowed KSS to scrape the bottom of the credit eligibility barrel.
    • Now COF is pulling back the reins – so reaching new consumers is extremely difficult for KSS. Hence the Y2Y. The problem is that you now have 40% of a consumer group who accounted for 25% of operating profit enrolled in a program that lets consumers get double points. Once at KSS and once on a national credit program.
    • The manifestation of that will most likely flatten out the curve in penetration (and SG&A offset) until it rolls all together. By our math, $62mm in operating profit is at stake.

Important Truths

This note was originally published at 8am on February 13, 2015 for Hedgeye subscribers.

“What important truth do very few people agree with you on?”

-Peter Thiel


When Thiel interviews people, he asks them that question. It’s a good one. And while he doesn’t think everyone has good answers to it, if he asked me I’d go into something he knows nothing about (like being a lifelong Toronto Maple Leafs fan!)


This question sounds easy because it’s straightforward. Actually, it’s very hard to answer. It’s intellectually difficult because the knowledge that everyone is taught in school is by definition agreed upon…


“… and it’s psychologically difficult because anyone trying to answer must say something she knows to be unpopular. Brilliant thinking is rare, but courage is in even shorter supply than genius.” (Zero To One)


Important Truths - th5


Back to the Global Macro Grind


BREAKING: US Retail Sales and Jobless Claims miss, US Stocks Rip To All-Time Highs


How many people agree with that summary of yesterday’s no-volume (Total US Equity Market Volume, including dark pool, -17% vs. its 1yr avg yesterday) ramp to 2088 in the SP500?


Follow the knuckle-puck (Peter, see the intellectual masterpiece that is Mighty Ducks 3 #brilliance):


  1. US Retail Sales slowed -0.8% month-over-month in JAN (after slowing -0.9% in DEC)
  2. US Jobless Claims popped back up over the important 300k line to 304,000
  3. US Treasury Yields dropped -5bps (on the 10yr from 2.03% to 1.98%) on the news
  4. US Dollar went straight down, -0.9%
  5. Oil (WTI) went straight up, +5%, and Energy Stocks (XLE) had a +1.3% day
  6. CRB Commodities Index (-0.95 correlation to USD) popped +1.9% on the day


Then, the counter-TREND knuckler weaved its way into the Global Macro Correlation trade:


  1. Australia’s stock market loved the commodity bounce, closing +2.3% leading everything in the East
  2. Russia’s stock market ramped another +3.3% on the Down Dollar, Up Oil news
  3. And the bloodied Euro is testing 3-week highs up at $1.14 vs USD


Is this the truth? Or is it a version of that which very few people were positioned for? If you nailed this iteration of the counter-TREND move, I sincerely salute you. Going top-shelf from the other team’s end, Mighty Ducks style, isn’t easy!


That last point on the Euro going up has another whole set of truths to consider this morning. There’s a boat load of European growth and inflation data on the tape:


  1. Germany’s Q4 GDP accelerated to +1.6% year-over-year
  2. Italy’s Q4 GDP slowed to -0.3% year-over-year #recesssion
  3. France’s Q4 GDP slowed to +0.2% y/y vs +0.4% last
  4. Swiss PPI (producer prices) deflated to new lows of -2.7% y/y in JAN
  5. Spain CPI (consumer prices) deflated -1.3% year-over-year


So mainstream media will focus on Germany today (the bullish news). They should because the divergence between good and bad balance sheet countries in Europe is glaring, but that doesn’t mean that Global #Deflation forces now cease to exist.


By the way, the truth is that if you are long the DAX you are killing it at +12% YTD. If I had to rank order which of the 3 major global equity indexes I’d buy on pullbacks from here, Germany would be in my Top 3 (so pullback already!):


  1. Nikkei
  2. DAX
  3. Russell 2000


Who, me? Buy stocks? Of course I like to buy stocks A) on pullbacks to the low-end of my immediate-term risk ranges and B) in the sub-sector style exposures of the markets that I like from a Macro Theme perspective.


Rank ordering the majors like that isn’t what I’m talking about – buying something that’s in our Top 3 Macro Themes for Q1 like #HousingAccelerating is. Both Housing (ITB) and Consumer Discretionary (XLY) are in our Top 5 Macro Ideas (last slide of our Macro Deck). We’ve been consistent in reiterating that.


My net asset allocation to US Equities bottomed on February 3rd at +2% (damn hedgie, I think of everything on a net longs minus shorts basis) and today it’s +9%. My max net asset allocation to any asset class is 1/3 of the total pie, and I’m close to max in Fixed Income at +31% (see pie chart).


My biggest mistake on the long side in February was staying with my biggest win from January (being long Long-term Bonds). And my biggest mistake on the short side was staying with the Financials (XLF).


Whether or not staying with my lower interest rate call (Long long-term Treasuries, Short Banks) is working in the moment or not, I am accountable to every day’s mistakes. That’s the truth that I built this firm on. And I think most people can agree with me on that.


Our immediate-term Global Macro Risk Ranges are:


UST 10yr Yield 1.65-2.09%
SPX 2054-2094

Nikkei 17608-17985
DAX 10803-11008

EUR/USD 1.12-1.15
Oil (WTI) 47.42-53.45


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Important Truths - 99

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Macro Minute: What’s Causing the Dollar Melt Up?


Senior Macro Analyst Darius Dales gets granular on why the U.S. dollar is up so much today (hint: #deflation).

Cartoon of the Day: Missing the Mark

Cartoon of the Day: Missing the Mark - Inflation cartoon 02.26.2015

And the award for the worst forecasting record out there goes to...

(REVISED) MDSO: Removing Medidata Solutions from Investing Ideas

Takeaway: MDSO: Removing Medidata Solutions from Investing Ideas

Editor's note: An earlier email listed an incorrect return for the S&P 500.


We are removing Medidata Solutions (MDSO) from Investing Ideas today. Shares have risen +4% since it was added on January 5th.


According to Hedgeye CEO Keith McCullough:


My market view is getting less bullish and this one is tapping the top-end of my intermediate-term range, so I’d like to come back and signal buy again, lower  - like we did on the last short-term scare.


(REVISED) MDSO: Removing Medidata Solutions from Investing Ideas - mds1

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