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A Man Larger Than The Sun

“At rest, however, in the middle of everything is the sun.”

-Nicolaus Copernicus

 

On this day of in 1616, the Catholic Church banned Copernicus’ book. The establishment’s main issue with the man’s independent research (which correctly implied that the sun was at the center of the universe) was that it didn’t sync with their ideologies and politics.

 

Today will go down as one more day in central planning history where an unelected man of the mainstream will boil the oceans and part the heavens, raising stock markets to heights the world has never seen before.

 

That man, who sees himself residing in the middle of everything, is Mario Draghi…

A Man Larger Than The Sun - Draghi balloon cartoon 01.23.2015

 

Back to the Global Macro Grind

 

You go, Mr. Central Planning man. You go. You are the power and the light – you are the only one who can keep the Italian stock market up while its economy is in recession. Only you, the great Draghi, can see 0% improvement in Greek unemployment as Italian stocks move to +16.5% YTD.

 

While this is turning into a joke, the actual data fits what I just wrote:

 

  1. Italy’s GDP for Q4 of 2014 was -0.5% y/y (revised lower vs. the prior -0.3%)
  2. Greek Unemployment rose to 26.0% in DEC from 25.9% in NOV

 

Oh, right - the latest central planning of European stock markets didn’t really ramp until JAN, so I’m sure Greek government work is booming now and these structural debt, deflation, and unemployment problems all went away as a result…

 

And then there was moarrr #Deflation

 

Remember that, perversely, moarrr cowbell from Draghi = moarrr #StrongDollar driven #Deflation:

 

  1. Cowbell = Centrally Planned Currency Devaluation
  2. EUR/USD is getting smoked to -8% YTD and multi-yr lows of $1.10 ahead of Draghi’s latest (830AM EST)
  3. US Dollar Index is rocketing to $96.21 on that, +6% YTD and +21% from its 2014 lows!
  4. Commodities (CRB) Index (19 Commodities which largely trade in Dollars) continues to crash -28% y/y
  5. Oh, and WTI Oil, which you could have chased at $105 at this time last year, has crashed > 50% since

 

So we definitely need to have Bloomberg and CNBC cheer on more of this. Access to these Sun-smoothers drives ad revs. #clicks

 

Put another way, until either the Europeans and/or Japanese fail outright (i.e. when their people figure out this does jack for the economy, but keeps getting the bureaucrats and Eurocrats (and their all-access media) paid), this #StrongDollar + Down Rates #Deflation will continue.

 

Not to be confused with #StrongDollar + #RatesRising (our call on the US in 2013), the Down Rates (both locally and globally) part is critical to contextualize, in global growth expectations terms.

 

It’s obviously one thing to obfuscate Policies To Inflate with real-economic growth – but it’s entirely another to have neither inflation, nor growth. Japan (for the last decade), and Europe currently, that is …

 

At least in the USA we get to get paid owning all of the asset allocations and sector style exposures to this 17th century gong show of the vanities. We signaled doing more of the pure play on US domestic consumption #accelerating yesterday in Real-Time Alerts (buy Housing, ITB, on red!).

 

To review what we like during Global #Deflation:

 

  1. US Dollars (that’s our entire FX allocation, and it’s beating both US stocks and bonds YTD by a factor of 3)
  2. Long-duration-low-volatility Bonds
  3. US Housing (ITB), Consumer Discretionary (XLY), and Healthcare Stocks (XLV)

 

And what we really don’t like:

 

  1. Burning Euros and Yens
  2. Commodities
  3. Stocks and bonds that have the most #Deflation risk (energy and the financials)

 

Our Global Macro view is not that complicated. It is how you play Global #Deflation and #GrowthSlowing, while the US economy gets it’s “easy compare” Q1 sequential growth bounce (see Theme #2 @Hedgeye called #Quad414 for details).

 

And while it has been fun to be bullish on the Weimar Nikkei (in Burning Yen terms), which is handily beating US stocks and bonds YTD at +7.5%, that’s really just a rolling of the bones that can go bust whenever this epic human experiment in trying to bend gravity and the sun does.

 

Our immediate-term Global Macro Risk Ranges are now (intermediate-term TREND view in brackets):

 

UST 10yr Yield 1.89-2.17% (bearish)
SPX 2083-2117 (bullish)
Nikkei 188 (bullish)
USD 95.01-96.28 (bullish)
EUR/USD 1.10-1.12 (bearish)
YEN 118.67-120.66 (bearish)
Oil (WTI) 48.22-52.16 (bearish)

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

A Man Larger Than The Sun - 03.05.15 chart


March 5, 2015

March 5, 2015 - re do

 

BULLISH TRENDS

March 5, 2015 - Slide2

March 5, 2015 - Slide3

March 5, 2015 - Slide4

March 5, 2015 - Slide5

March 5, 2015 - Slide6

 

BEARISH TRENDS

March 5, 2015 - Slide7

March 5, 2015 - Slide8

March 5, 2015 - Slide9

March 5, 2015 - Slide10

March 5, 2015 - Slide11
March 5, 2015 - Slide12

March 5, 2015 - Slide13

 


Investor Patience

This note was originally published at 8am on February 19, 2015 for Hedgeye subscribers.

“He that can have patience, will have what he will.”

-Benjamin Franklin

 

That’s a great fishing strategy inasmuch as it is a macro risk management one. While I don’t think Benjamin Franklin was talking about either, we can always learn something from a thought leader’s timeless quotes.

 

The Fed wants you to focus on being “patient” too…

 

And while it may be intellectually stimulating to consider the removal of that wording, yesterday the Fed’s Jay Powell (voting member of the FOMC) cautioned against rising expectations of “dropping the patient language” at the March 18th Fed meeting.

 

Back to the Global Macro Grind

 

Powell’s comment was a real-time one yesterday, whereas the Fed’s “Minutes” from their January meeting were not. That said, both helped drop the 10yr US Treasury Yield in a straight line from 2.16% 24 hours ago, to 2.05% this morning.

 

The key to the Fed Minutes was the FOMC acknowledging what I’ve been very concerned about – a policy mistake – i.e. raising rates as both the global economy is slowing and #deflationary headwinds continue to manifest.

Investor Patience - Yellen dove 09.17.2014 

“So”, I think our almighty overlords on the central planning committee did the right thing in suggesting that a “premature hike might dampen the recovery.” That is indeed, the truth.

 

Or is it?

 

I’m on the road seeing Institutional Investors in California this week, and THE question in every meeting surrounds this basic, but critical, question on rates rising or falling from here. What is going to be the truth?

 

  1. That all of the “data” drives rates? (PPI slowed -0.8% in JAN, CPI will slow again next week)
  2. That the only data that matters is the employment data? (FEB jobs report 1st wk of March)
  3. Or that none of the data really matters at this point, because raising rates is a political move?

 

I like to measure the truth with what the market does on data and  events:

 

  1. So far, all of the growth and inflation data has mattered to the rate of change in long-term bond yields
  2. As both #deflation data and US growth slowing data for DEC was reported in JAN, the 10yr hit new lows
  3. On the 1 major economic surprise (strong JAN jobs report) rates reversed, and ripped higher for 2 weeks

 

And obviously the politics, wording, and timing of all Fed comments have mattered along the way. Don’t forget that Powell’s comments were plugged into the marketplace to offset a non-voting Fed member’s comments about removing the “patient.”

 

So I’d say the truth is that it all matters – and that markets are reflexively reacting to price action which, in turn, is driving Fed rhetoric, as the Fed reacts (on a lag) to data that the market is already discounting.

 

If you don’t want to deal with all of the data, noise, etc., and want to take a longer-term and more patient view of this gong show of gaming un-elected-political-policy-expectations, this gets a lot easier:

 

A)     You have to decide if year-over-year GROWTH is going to accelerate or decelerate

B)      You have to decide if INFLATION is going to continue to #deflate or start to reflate

C)      Then you have to take a view on how to front-run the Fed’s behavior depending on answers to A) and B)

 

And/or you can just let Mr. Macro Market hold your hand along the way, signaling in real-time where the probabilities on A) and B) are rising or falling. He tends to do a better job than most on that.

 

I don’t get to take the easy path. I have to write to you every day and attempt to explain every little data wiggle and watch word. But I’m cool with that. It’s what makes this game of expectations the one that I love.  

 

To review how we’d answer A, B, and C:

 

A)     Global Growth will continue to surprise on the downside as US Growth has a solid Q1, then slows Q2/Q3

B)      Global #Deflation remains our Top Global Macro Theme for Q1/Q2

C)      Even if the Fed does a token 25bps hike, they’ll have to say no more of that by Q3 anyway

 

The patient investor has bought every pullback in the Long Bond (TLT) for the last 8 months and made plenty of money doing so.

 

That’s because they understood that the best way to play global #GrowthSlowing and #Deflation was to buy low-volatility duration as the manic had to unload commodity and energy related equity beta as Oil Volatility (OVX) went from 15 to 60.

 

Never mind Oil Vol 60 – that’s epic, 2008 style volatility! Can you imagine if US Equity Volatility (VIX) went from 15 (closed at 15.45 yesterday) to 20, 25, or 30 again? I can. And a lot of #patient equity investors will be happy to buy lower (again) on that.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.74-2.16%
SPX 2075-2115
Nikkei 17804-18302
VIX 14.26-18.96
USD 93.64-95.39
EUR/USD 1.12-1.15

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Investor Patience - cod TLT


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FL - Why We Think FL Is A Short

Takeaway: Our FL Short Call has a lot of layers that we expect to play out systematically throughout ’15. $20 down/$6 upside.

Conclusion: The biggest pushback, by a long shot, on our FL short call is timing, and how long we have to wait for it to play out. While FL is unlikely to completely melt down this week on the print, especially 2-weeks ahead of an analyst meeting, we definitely think that the building blocks of our thesis will be incrementally evident in the quarter to be reported on Friday (as well as in the meeting on 3/16). But this is a complex call with many layers that will peel off one at a time systematically as 2015 progresses, resulting in downward revisions and revealing a down year in 2016.  Ultimately we think it will result in consensus estimates coming down meaningfully for the first time in six years, and we’ll see both lower estimates and multiple compression. We get to $20 downside, and $6 upside.

 

FL - Why We Think FL Is A Short - FL E Table

 

FL remains one of our top short ideas, but it is also perhaps the most complex. It’s not just about Nike, or about Ken Hick’s leaving, or about e-commerce threats. It’s about this company just having come off a six-year run that was driven by a ‘perfect storm’ (the good kind) of …

 

a) Margins: economic expansion and margin tailwind,

b) The Hicks Era: a new stellar CEO taking capital out of the model while simultaneously taking productivity and margins to new peaks, and adding 2,000bp to RNOA (RNOA to 25% from 5% pre-Hicks),

c) Nike Penetration: FL taking NKE to 70% of its inventory purchases from 56% – which has meaningful positive implications for gross margin,

d) ASP Cycle: Nike driving a 12-year ASP cycle which accrued to the retailers (like FL) just as much as it did NKE.

e)e-Commerce: Growth in e-commerce without meaningful brand competition.

 

But today, those factors have changed for the worse... (Here’s the links to our recent Black Book deck and audio presentation where we outline these factors in more detail.)

Call Replay: CLICK HERE 

Materials: CLICK HERE

 

a) Margins: The post-recession margin tailwind is over. We need raw top line growth and productivity improvements to boost margins.

FL - Why We Think FL Is A Short - FL Margin Upcyle

 

b) The Hicks Era:

1. Ken Hicks is gone. His team is still there. But we think that one of the highlights of the analyst meeting on March 16 will be how the company will be spending to grow. That’s fine, but keep in mind, it has just come off a period where it grew without spending and boosted returns by 2,000bps.  Big difference – especially when it’s still sitting at a peak 15x p/e. 

FL - Why We Think FL Is A Short - FL HIcks Era

2. Also, there’s no more capital to pull away from this model. We outlined in our Black Book how the fleet is largely optimized, and perhaps with the exception of some Lady Foot Locker stores, there’s little left to close or ‘rebanner’.

FL - Why We Think FL Is A Short - FL Store concept

 

c) Nike Penetration: Is the next move in Nike as a percent of total higher, or lower? It’s lower. And, quite frankly, it’s HEALTHY for Nike to be a smaller percentage. It’s just probably less profitable. We actually have people tell us “I called Nike and they said the Foot Locker is a really important customer – and that your thesis is wrong’. That’s what Nike HAS TO say. They fight their battles in private, and win where it matters -- on the P&L and the balance sheet. At a minimum, Nike not going higher as a percent of total sales is a negative, as the tailwind that’s existed for half a decade has been underappreciated.

FL - Why We Think FL Is A Short - FL NKE Penetration

 

d)ASP Cycle: We’re in a 12-year ASP cycle. Chances are, there will be a year 13. And probably a year 14. This is a space where the tail wags the dog. As the brands spend up in R&D, they drive prices higher. But the difference is that we’re at a point where the higher prices will start to accrue disproportionately to the brands. They (especially Nike) finally have the infrastructure and the product tiers in place to grow their DTC businesses aggressively.

FL - Why We Think FL Is A Short - ASP cycle

 

e)e-Commerce: And we’re already seeing this part of the story play out. The charts below show the yy change in reach for FL vs NKE (reach spread is defined as the percent of people using the internet that are using Footlocker.com/Nike.com today versus last year). This will accelerate. What this does is maintains the mid-upper price business for the retailers, but allows Nike to dominate the $160-$225 business on its own site. That’s a problem for FL as its ASP increase has not been broad based. It has been because the retailer added a better mix of shoes at extreme price points.

 FL - Why We Think FL Is A Short - FL Reacsh spread 90

FL - Why We Think FL Is A Short - FL Reach spread 30

 

The biggest pushback we get on any of this is “yeah that’s great guys, but am I going to have to wait another three years before seeing this? Show me the near-term catalyst and roadmap.” Fair question (and trust us, it comes from 80% of the people we talk to). When all is said and done, though FL is unlikely to melt down this week, we definitely think that parts of our thesis will be evident in the quarter to be reported on Friday. But this call has many layers that will peel off (usually) one at a time systematically as 2015 progresses, and ultimately result in consensus estimates coming down meaningfully for the first time in six years.

 

We’re about in line for the quarter at $0.91 and 6% comp, but are 5% below the consensus for 2015. And by the time we look toward 2016, we’re at $3.46, 17% below the Street.  

 

So what’s this worth? Not 15x earnings, we’d argue. But we’re not going to make a multiple contraction call. But the call we will make is one for lower earnings and growth, and once that is apparent to the Street, the multiple will follow. We think that 12-13x $3.60 in EPS by year end 2015 is realistic as the story plays out, or a $45 stock (20% downside). Looking into 2016, and the likelihood of a down year ($3.46 despite the Street's $4.17) we think we're looking at 11-12x $3.46, or a stock in the high $30s. All in, we're looking at about $20 downside over the next two years, with about $10 per year.

 

That's about 4.9x EBITDA and a 8% FCF yield, which seem fair for a zero square footage growth retailer with earnings that are shrinking. If we're wrong, we're looking at about $4.25 in EPS power. Keeping today's peak 15x p/e, that suggests a $64 stock.  That's about $6 upside versus $20 downside. We think the path of least resistance is on the downside.

  

FL - Why We Think FL Is A Short - FL Sent

 

FL - Why We Think FL Is A Short - FL Sigma

 

 

 


OC: Adding Owens Corning to Investing Ideas

Takeaway: We are adding Owens Corning to Investing Ideas.

Please note that we are adding Owens Corning to Investing Ideas today. Our Industrials team spearheaded by Jay Van Sciver will provide a full report in this weekend's edition.

OC: Adding Owens Corning to Investing Ideas - o9


YUM: Removing Yum! Brands from Investing Ideas

Takeaway: We are removing Yum! Brands (YUM) from Investing Ideas.

We are removing Yum! Brands from Investing Ideas today. As CEO Keith McCullough wrote, "We're booking the gain, so that we can come back to it again."

 

YUM is up 9% since it was added on 2/9/15, compared to a 2.5% return for the S&P 500.

 

Click image to enlarge.

YUM: Removing Yum! Brands from Investing Ideas - y7


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