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Keith's Daily Trading Ranges [Unlocked]

This is a complimentary look at Daily Trading Ranges - our proprietary buy and sell levels on major markets, commodities and currencies sent to subscribers weekday mornings by CEO Keith McCullough. It was originally published March 26, 2015 at 07:56. Click here to learn more and subscribe.

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BULLISH TRENDS

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BEARISH TRENDS

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Sound Reasoning

This note was originally published at 8am on March 12, 2015 for Hedgeye subscribers.

“You are right not because others agree with you, but because your facts and reasoning are sound.”

-Benjamin Graham

 

That’s one of the concluding quotes in a great book I’ve been citing for the last few weeks, The Outsiders, by William Thorndike. It comes from the final chapter, “Radical Rationality – The Outsider’s Mindset” (pg 197). I love that mentality.

 

I also love getting big Macro Themes right. After beating myself up daily in this forum throughout February as inflation was having a counter-TREND bounce, I’m happy that March looks a lot more like January – Global #Deflation continues to dominate.

 

Was our early January reasoning on an intermediate-term TREND target for the Euro of $1.05 sound? Yes. In stark contrast to how many are describing US Dollar strength today, we started with the most basic premise of all – that Draghi would burn the Euro at the stake.

Sound Reasoning - bruning euro 08.25.2014

 

Back to the Global Macro Grind…

 

Burn baby burn. And now what? Now that they have centrally planned both their stock and bond markets to all-time highs (German DAX +20.2% YTD; German 10yr Bund Yield 0.21%), what’s next?

 

Our reasoning is mathematical, so bear with me:

 

1. European growth and inflation data will continue to slow well into Q3…

2. Draghi’s growth and inflation targets will be missed… and… drum-roll…

3. Then he’ll need to provide more #Cowbell, burning the Euro further

 

That’s been our intermediate-term TREND call. In the very immediate-term (i.e. this morning) the US Dollar is finally signaling overbought at 99.99 on the US Dollar Index (which is what implies our $1.05 EUR/USD target).

 

Meanwhile, the European “inflation” data remains deflationary:

 

1. Spain’s Consumer Price Index (CPI) for FEB was still -1.1% year-over-year

2. Germany’s CPI bounced to a whopping +0.1% year-over-year

 

That’s right. After the counter-TREND bounce in things like commodities in FEB, that’s all the Germans got out of Draghi in reported economic terms, a 0.1% inflation reading which isn’t in the area code of the 2% “target” most central planners are hoping for.

 

Hope, as we like to say @Hedgeye, is still not a risk management process. And with March’s reversion to the mean of #deflationary forces firmly intact, the Federal Reserve’s hope that #deflation in Oil and Energy markets is “transitory” is going to look wrong (again).

 

Being right with sound reasoning is one thing. Being wrong, over and over again, on both your growth and inflation forecasts – but representing yourself as right (using stock markets as your validation) is entirely another.

 

NEWSFLASH: centrally planned stock markets should not be confused with economic realities

 

That is, of course, how this gigantic and ideological experiment ends. With central planners attempting to bend and twist economic gravity and ending up right where they started – with both Global growth and inflation slowing.

 

“So”, with European equity and sovereign bond prices pinned up here this should be fun to watch.

 

It’s also been a hoot to watch the Weimar Nikkei, which took it’s inverse-correlation queue from Burning Yens and ramped another +1.4% overnight (+8.9% YTD) to a 15 year high. Yep, that’s crushing the SP500 (which is -0.9% YTD).

 

Oh, you don’t like when I contextualize the almighty US stock market that way? You mean you didn’t tell your clients you were buying the living daylights out of failed Abenomics and shorting the US stock market on the other side of that?

 

What is wrong with you? You definitely don’t deserve 2 and 20 unless you had that reasoning! #kidding

 

But I’m not kidding in telling you that I have my US equity asset allocation (see our dynamic and daily Hedgeye Asset Allocation model in the bottom of this note for how I’d be allocating capital or raising cash after macro moves) at YTD highs, on red.

 

From this time and price, I like US Consumer Discretionary (XLY), Housing (ITB), and the Russell 2000 (IWM) – in that order. I also like Healthcare (XLV) stocks, but in looking for a beta bounce on accelerating US consumption (US Retail Sales are going to be reported this morning), I think there’s more upside in the aforementioned order.

 

If everything that punishes those levered to commodity and/or debt #Deflation doesn’t pay the people in America who have been pulverized by US cost of living, my reasoning will prove to be wrong. Oh, and so will any US GDP forecast that doesn’t look recessionary.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.98-2.24%

RUT 1194-1235

Nikkei 18715-19009

USD 96.98-99.99

EUR/USD 1.05-1.08

YEN 119.35-121.91

Oil (WTI) 48.01-50.22

 

Best of luck out there today,

KM

 

Keith R. McCullough

Chief Executive Officer

 

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March 26, 2015

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BULLISH TRENDS

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BEARISH TRENDS

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CHART OF THE DAY: Homebuilder Seasonality (Ave Performance by Month, 1996-2014)

CHART OF THE DAY: Homebuilder Seasonality (Ave Performance by Month, 1996-2014) - HB Seasonality

 

Editor's Note: Below is an excerpt from today's Morning Newsletter written by Hedgeye U.S. Macro Analyst Christian Drake. Click here to learn more and subscribe.

 

  • March:  Seasonality | Performance in Housing related equities shows marked seasonality. In short, the housing complex outperforms from Nov-Feb ahead of the Spring selling season and subsequently underperforms modestly in March as (presumably) some of that cumulated optimism comes off and again in mid-year as the heart of the selling season concludes (see 1st and 2nd charts below).  We show the seasonal pattern that has typified the last 20 years in the Chart of the Day

 


Gizmo or Gremlin?

“No matter how much it cries or begs, NEVER feed it after midnight”

-Gremlins, 1984

 

According to 1980’s legend, feeding a mogwai after midnight catalyzes the transformation from cutesy, wellmeant Gizmo to mischievous, malevolent Gremlin.   Hijinks, hilarity, and the creation of the first PG-13 rating ensue. 

 

The spat of soft early March housing demand data had many wondering whether we’d already reached midnight on the current housing inflection and if the fund flows and improving sentiment feeding the multi-month run of outperformance were set to spawn a reversal in the related equity complex. 

 

We think the hour is nearer twilight than midnight… and Gizmo has more to give as it relates to housing. 

Gizmo or Gremlin? - 15

 

Back to the Global Macro Grind….

 

We reviewed our bullish thesis on Housing in a late-February Early Look – see: Dr. House-ing.  The subsequent ping-pong match in housing data over the last month has, at the least, been interesting.

 

In a recent note to institutional clients we compared and contextualized the competing realities promulgated by the March to-date data. 

 

Consider the following juxtaposition: 

 

(False) Reality:   

  • 3/13:  Mortgage Purchase Applications | Purchase demand declined -1.5% sequentially with year-over-year growth sliding back towards the zero line at +0.7%.
  • 3/16:  NAHB HMI | Builder Confidence declined -2pts month-over-month in March, marking the 3rd consecutive month of decline and the lowest reading since July of last year.
  • 3/17: Housing Starts | New Home Starts in February dropped -17% sequentially, posting their biggest month-over-month decline since January 2007
  • March:  Seasonality | Performance in Housing related equities shows marked seasonality. In short, the housing complex outperforms from Nov-Feb ahead of the Spring selling season and subsequently underperforms modestly in March as (presumably) some of that cumulated optimism comes off and again in mid-year as the heart of the selling season concludes (see 1st and 2nd charts below).  We show the seasonal pattern that has typified the last 20 years in the Chart of the Day below.

So, certainly not the numbers accelerating recoveries and sustainable outperformance are made of. 

 

We think the underlying reality is more sanguine with the preponderance of the weakness in the reported February data largely attributable to weather. 

 

As it relates to builder confidence, the Current Traffic component of the index led the weakness in the composite reading, which is consistent with a severe weather related drop in the flow of active buyers.  The NAHB also cited supply chain concerns, particularly in terms of labor supply.   Residential construction employment saw its largest monthly increase in employment in nearly 10 years in January and employment at the industry level continues to run in the high-single digits.  

 

There is clearly strong demand for labor in the sector, however, wage growth has yet to really accelerate according to BLS data so it remains equivocal whether rising labor demand is, in fact, driving accelerating builder cost pressure and/or labor supply shortages at the aggregate level.  Further, while labor supply constraints may serve as a drag to builder confidence, presumably it is rising demand trends that are driving tighter conditions in the resi employment market.  All else equal, we’d view improving demand as a net positive. 

 

On the New Construction side, while the sharp drop in Housing Starts captured most of the headlines, we believe the real story was in the 3% gain in permits. The 57% collapse in starts in the Northeast drove the bulk of the headline decline, again consistent with unusually cold/severe weather weighing on activity.  

 

Sure, seasonality and weather are not new phenomenon but resolving the volatility and vagaries inherent in month-to-month changes in activity in seasonal industries remains challenging despite the best efforts of evolving seasonal adjustment methodologies.   

 

Further, staring at industry numbers from the aseptic environment of a spreadsheet has the sneaking ability to, at times, drive a wedge between expectations conceived in an analytical echo chamber and the practical realities of the underlying business.  Having been in the construction industry, digging a foundation or auguring down to below the frost line to pour piers in frozen terrain is a largely quixotic pursuit. 

 

Anyhow, we expect to see a big rebound in the next two months in housing starts as the data plays catch-up to the thaw.

 

Reported Reality:  

  • 3/19-20:  Builder Earnings | Reported results for 1Q15 out of the Builders LEN and KBH had both companies beating sales and earnings estimates while reporting strong pricing and accelerating orders growth.  Further, they talked down the weakness in reported Starts in February and guided to incremental margin improvement over the balance of the year with the expectations for continued, ongoing improvement in the demand environment.  We’re not inclined to take management’s word for it but in this particular case, we’d agree on the intermediate term outlook. 
  • 3/23:  Existing Home Sales | Sales of Existing Homes accelerated to +4.7% YoY, marking the fastest rate of growth in 17-months. 
  • 3/24: New Home Sales | New Home sales in February hit their highest level since February 2008 rising +7.8% MoM to 539K vs an upwardly revised January estimate.  More notably, sales were up a remarkable +25% year-over-year and should continue to look strong from a second derivative perspective as we traverse a 5-month period of easy comparisons.  
  • 3/25:  Purchase Applications | Purchase application saw some positive mojo in the latest week, rising +4.9% sequentially and accelerating +200bps to +2.7% on a year-over-year basis.

 

What’s our suggested interpretation of this Tale of Two Housing Realities?

 

We’d argue that much of the weakness in the reported February data was weather related and, in effect, created a mini-ball underwater dynamic.  Over the next 6-8 weeks, we expect a modest backlog of deferred housing consumption in conjunction with healthy organic demand trends to manifest in accelerating improvement in reported activity.   

 

Indeed, behind the data volatility in March, the crux of our underlying thesis remains largely unchanged.   Labor market strength + credit box expansion + (very) easy compares should continue to support improving rates of change in housing demand over the intermediate term.  

 

We’ll be hosting our 2Q Housing Themes call next Thursday, April 2nd at 11am to update our outlook for the industry and the related equity complex.  Please contact if you are interested in attending. 

 

No matter how much it [your position] cries or begs, NEVER capitulate at a manic, short-term bottom.

 

Our immediate-term Global Macro Risk Ranges are now 

 

UST 10yr Yield 1.81-1.98%
SPX 2046-2084

DAX 113
VIX 14.03-16.97
EUR/USD 1.04-1.11
Oil (WTI) 42.37-52.28 

 

To hair bands, Hungry Hippos and Volker-style policy sobriety,

 

Christian B. Drake

U.S. Macro Analyst

 

Gizmo or Gremlin? - HB Seasonality


The Changing Food Landscape is Just Beginning

With this note we are announcing the addition of Shayne Laidlaw to the Hedgeye Consumer Staples team.  Shayne has spent the past three years working at General Mills and brings a differentiated view of the food industry to the Hedgeye team. 

 

Deal Overview

  • H.J. Heinz and Kraft Foods announced that they have entered into a definitive merger agreement to create the Kraft Heinz Company, forming the third largest food and beverage company in North America
  • Kraft shareholders to own 49% and Heinz shareholders to own 51% of the combined entity
  • Kraft shareholders to receive a one-time cash payment of $16.50 per share ($10 billion aggregate value), fully funded by $10 billion of new common equity contributed by Berkshire Hathaway and 3G Capital
  • The cash dividend represents 27% of Kraft’s closing price on 3/24/2015
  • Board of Directors to be composed of 5 members of current Kraft Board and 6 members of current Heinz Board (3 from 3G and 3 from Berkshire Hathaway)

 

Strategic Rationale

  • With combined sales of $29.1 billion, of which $22.2 billion are generated in North America, the Kraft Heinz Company will be the third largest food company in North America and the fifth largest in the world
  • Improved scale in key North America retail and foodservice markets
    • Foodservice platform raises brand awareness with iconic portfolio of center-of-store brands
    • Significant cost efficiency and synergy opportunities
      • Expected to achieve $1.5 billion in run-rate annual cost savings across COGS and SG&A by 2017
        • Implement zero-based budgeting
        • Integrate distribution networks and rationalize manufacturing footprints
        • Improve productivity and optimize procurement expenditures
        • Streamline organizational structure
        • Optimize advertising and marketing spending
  • Significant revenue synergy opportunity, with strong platform for international growth
  • International expansion from Kraft brands through Heinz platform
    • Heinz currently generates 61% of sales internationally
    • It is anticipated that the new company will use this manufacturing footprint to expand Kraft brands globally (currently only 2% of sales outside North America)
    • Kraft has many international brands currently licensed to Mondelēz that are due to revert back to Kraft in the near future
    • Investment grade company with sustainable capital structure built for long-term growth

 

Industry Implications

  • The food industry has seen a steady amount of M&A over the recent years involving acquisitions of small to mid-sized companies by larger food manufactures
  • But now, with this merger it will leave the big players; General Mills, Kellogg’s, Mondelēz, Campbell’s and J.M. Smuckers thinking, could we be next?
  • With this merger and Berkshire Hathaway’s backing we expect increased competitive pressure forcing other industry players to respond before their hand is forced
  • Kraft has had lackluster performance lately leading management to really think, can we return to growth? Or would it maximize shareholder value to sell now?
    • Obviously they chose to sell, most likely led by their newly appoint CEO John Cahill, known as a deal maker
    • When you look across the major competitors listed above, it will be interesting to see if current management is willing to rock-the-boat and make a move, or will an ousting or “retirement” be required for change to occur
    • Either way, I believe we will begin to see large transformational acquisitions or mergers in the space in order for companies to stay competitive. There is just no way all five of these companies will stand still, when starring down the barrel of Mr. Buffett’s elephant gun

 

Getting 3G’ed                 

  • 3G Capital has become synonymous across the Restaurant, food and beverage industries with cost cutting and creating efficiencies
  • Over the last two years since 3G and Berkshire Hathaway took Heinz private, they have turned it into a lean mean fighting machine and one of the most profitable food companies globally
    • In the process, realizing $1 billion in operating improvements by:
      • Implementing zero-based budgeting and management by objectives
      • Simplified corporate structure; and
      • Rationalization of the manufacturing footprint
  • Through these cost cutting efforts and operational improvements the new leadership has brought EBITDA margins from 18% to 26%

 

Words from an Insider

  • Warren Buffett when asked if he would continue to work on deals in this space, declined to comment, but said that Kraft Heinz will be a company with ‘ambitions for a long time’ and did imply that there is no ‘finish line’ with respect to the partnership with 3G

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