It Gets Late Early

This note was originally published at 8am on May 22, 2015 for Hedgeye subscribers.

“It's tough to make predictions, especially about the future.”

-Yogi Berra


Yogi turned 90 last week.  Hedgeye will turn 7 in June.  From the mound to markets, deep simplicities and pithy aphorisms are still ageless. 


When Berra donned post-war pinstripes en route to 3 AL MVP’s, 18 All-Star appearances and 13 World Series championships, the U.S. was enjoying a productivity boon, the demographic tide was just beginning to come in, the middle class was ascendant, Buffett was still small enough to perform and the prospects of rising household leverage and modern central banking carried an air of secular opportunity. 


“The Future Ain’t What It Used to Be”


It Gets Late Early - Housing Signal


Back to the Global Macro Grind...


Hedgeye’s formal coverage of the Housing sector turned 1 last week and I’ve chronicled our evolving investment view of the sector recurrently in the Early Look over the last year. 


Our 2Q15 Housing Themes call, which we presented back on April 2nd, was titled “If it Ain’t Broke” … the allusion being that our reversal from bear to bull in late 2014 was working with Housing outperforming every other sector through 1Q15 and the fundamental strength looked set to continue. 


The core of the 2Q call could be sufficiently captured in the context of the following four factors:    

  • The Data:  The cocktail of easy comps, improving fundamentals, credit box expansion and rebound demand (i.e. deferred housing consumption due to weather) should conspire to drive accelerating rates of change in reported housing data in 2Q. 
  • The Dilemma:  Housing equity performance shows pronounced seasonality with 4Q/1Q being periods of marked outperformance and 2Q/3Q generally being periods of relative softness.  At the same time, the implementation of new TRID regulations on August 1st could emerge as a mild-to-large speedbump to reported activity.
  • The Distillation:  The convergence of performance seasonality and new regulation (TRID) – along with emergent issues such as the California drought and step function back-up in global bond yields - pose a collective risk to housing activity into the end of 2Q.  While we remain mindful of those quasi-latent risks, it’s likely accelerating rates of change in both demand and price dominate investor mindshare in the more immediate-term.  
  • The (tactical) Decision:  Let’s stay long accelerating improvement in the immediate-term and then look to lower exposure into the collective crescendo of concern as it builds into mid-late summer

To frame it another way:  If I told you housing would put up the best rate of change numbers in all of domestic macro – and, arguably, in all of global macro – would you want to be long or short that?


So, how has the data come in thus far in 2Q? 

  • Housing Starts:  New 7-year high in the latest month
  • Purchase Applications (existing market):  2Q15 Tracking +14% QoQ and +13% YoY, on pace for best quarter in two years. 
  • Pending Home Sales (existing market):  PHS are up an average of +11.8% year-over-year the last two months
  • New Home Sales (new market):  NHS are up an average of +22.5% year-over-year the last two months
  • HPI:  After a year of discrete deceleration in home price growth in 2014, 2nd derivative HPI has seen 3 consecutive months of acceleration through the latest March data. 

How have the stocks performed?

  • April (Rate Rise + Builder Margin Concerns):  Of the four categories we profiled in our 2Q themes call as being beneficiaries of Housing's ongoing improvement, only one, the Mortgage Insurers, beat the market in April.  The builders underperformed significantly and the Title Insurers and Home Improvement chains underperformed moderately.
  • May:  Housing got its mojo back in May, rebounding strongly over the last couples weeks alongside the moderation in rates and ongoing strength in reported price/volume data.

The somewhat confounding part is that even if I knew then, what I know now in terms of how the fundamental housing data would come in in 2Q, I would have made the same decision to lean long in April.   


What about Existing Home Sales yesterday, that missed right?


EHS in April were certainly underwhelming, missing estimates and declining -3.3% sequentially (although they were still +6.1% YoY).  Below is how we contextualized the data in our institutional note yesterday:


Here’s the primary issue at play:   Pending Home Sales and Existing Home Sales have shown recurrent bouts of divergence and re-convergence in recent quarters.   Definitionally, Pending Home Sales (PHS) represent signed contract activity while Existing Home Sales (EHS) represent actual closings.  The two measures are invariably tethered and, given the mechanical nature of the relationship, PHS serve as a strong leading indicator for EHS with the relationship strongest on ~1mo lag. 


There is some chop in the data from month-to-month but, absent some acute shock to the qualifying ratio, the two only diverge for so long and so much in magnitude before re-convergence between the two series occurs.  Practically, this can only occur in a few ways – one series can fully re-couple with the other on a lag, both see subsequent revisions in opposite directions and/or both series (for whatever reason) move in opposite directions with spread compression from both directions.  


As can be seen in the Chart of the Day  below, the recent tendency has been for EHS to re-converge with PHS.  Given the prevailing pattern, unless PHS in April (released 5/28, next Thursday) are very soft and/or March sees a significant negative revision, the path of least resistance is for upside in Existing Sales over the next couple months.  Further, the trend in the high frequency mortgage purchase application data, which is currently running +14% QoQ and +13.3% YoY, argues in favor of that expectation more so than not.   


Universality is the hallmark of acute observation.  Clever linguistics provide the effervescence and perdurability.   Ahead of the holiday weekend – and just because they’re good – I’ll leave you with a few of Berra’s best (annotated with associated investment applicability):


“It gets late early out there” (counter-cyclical investing… remember, the data always looks best before the crest)


Nobody goes there anymore because it’s too crowded” (consensus’s thinking about consensus’s positioning)


“You can observe a lot just by watching” (no annotation needed)



Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.97-2.24% 

SPX 2110-2144 
RUT 1233-1267 
USD 92.92-96.17 
EUR/USD 1.10-1.15 
Oil (WTI) 56.98-61.64 


Have a great weekend!


***Click here to watch The Macro Show live at 8:30am.


It Gets Late Early - EHS vs PHS

The Macro Show Replay | June 5, 2015



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ZOES: Cooks up Something Big

Takeaway: They continue to prove that they are some of the best operators in the industry.

ZOES in on the HEDGEYE Best Ideas list as a LONG


ZOES delivered a fantastic quarter, exceeding our already bullish expectations.  The company beat on nearly every metric, driven by same-store sales, climbing to 7.7% beating consensus by 180 basis points (traffic was up 3.7%). Coupled by top ($63mm vs. consensus $61.4mm) and bottom line beats ($0.7mm vs. consensus -$0.1mm), there was nothing to complain about in this one.


Management increased its full-year 2015 guidance, including higher 2015 revenues of ($218mm to $223mm vs. prior $215mm to $220mm) and vs. consensus $219.9mm.  The higher revenues growth is driven by high-quality 2015 comps of 4.0% to 6.0% vs. consensus +5.1%, but which now incorporates no new pricing in 2H15.  Management also guided to higher restaurant contribution margins of 20.0% to 20.5% vs. 19.7% to 20.2% and new 2015 new store development of 31 to 33 vs 30 to 33.


As shown in the table below, they are effectively growing there business, while intelligently managing cost line items, to maintain a healthy company.


ZOES: Cooks up Something Big - Chart 1 zoes


Same-Store Sales Composition

Same-store sales increased 7.7% during Q1 FY15, consisting of a 3.7% increase in traffic, a 2.8% increase in product mix and a 1.2% increase in price. Since the price increases were taken last year, that consideration will go away this July, leading to management aiming for 4-6% comp sales growth for FY15. The two biggest contributors to mix were catering and new flavors of hummus.


ZOES: Cooks up Something Big - Chart 2 zoes


Controlling Costs

We came out of this earnings report being very positive about management doing all the little things right. They continue to prove that they are some of the best operators in the industry. Importantly, many small cap restaurant companies with an undisciplined unit growth strategy experience significant labor inefficiencies as they expand. ZOES is in a different class of companies.  In a quarter where ZOES opened 12 new company-owned restaurants they managed to decrease both COGS and labor. 


COGS were down 140 basis points, primarily driven by new annual pricing agreements for produce, feta cheese and olive oil. Although some of these Q1 savings will be partially offset by rising chicken prices (which have increased in Q2 by 15% sequentially since Q1). The company is projecting full year COGS to be slightly above 32% which would be flat relative to last year. This is virtually unrelated to avian flu, per or thought leader call, only 1% of chickens used for their meat have been infected. Additionally, eggs represent roughly 1% of COGS, making those price increases insignificant.


Labor costs are obviously a growing concern around the country but ZOES has been methodical about this cost line.  They track labor on a daily basis, run labor matrices, and have become much more efficient at opening stores.  They expect this number to increase slightly as they have added an additional manager at seven high volume locations, to build out the bench of managers to enable future growth. This extra cost now will pay off greatly in the future.



ZOES was added to our Best Ideas list as a long on 4/02/15, admittedly since then the stock hasn’t moved up much, just about 3.8% but the underlying thesis is being confirmed.


LTM Stock Price Performance


ZOES: Cooks up Something Big - Chart 3 zoes


We still like ZOES on the long side for many reasons, including its:

  • Superior brand positioning
  • Management philosophy and execution
  • Unit opening geographic profile
  • Early-stage average unit volumes and returns


We want to close this note with a quote from the CEO that describes the basis for our bullish stance. “Zoës is a differentiated concept offering wholesome, freshly prepared Mediterranean dishes with Southern hospitality, appealing to guests across the country and inspiring them to live Mediterranean. We continue to bring this Mediterranean lifestyle to more guests, opening 12 new restaurants in the first quarter, and we remain on track to open 31 to 33 new restaurants in 2015. We are confident that we can successfully operate over 1,600 units in the US long term.” This is the most differentiated offering in the quick service segment, and this team knows how to take advantage of that.



Takeaway: Tops are processes & “late-cycle” is not some discrete peak on a Macro sine curve. Move while the music plays but don't be willfully blind.

A CENTURY OF CYCLES: In our 2Q15 Macro Themes presentation we profiled the historical economic cycles of the last century, catalogued a selection of late-cycle indicators and contextualized the current expansion within the historical experience.   


Canonical Macro cycles, left to themselves (i.e. with central banks following a largely passive policy reaction function), follow a pattern that largely resembles the circular, counter-clockwise flow captured in the inflation-output loop depicted in the chart below. 


Conventional monetary policy is designed to function within the context of this naturally evolving cycle.  The broader goal of current policy efforts is to both jump-start and (perhaps discordantly) smooth such a cycle in the face of persistent cyclical challenges and sectoral/secular shiftings.  






“PATIENCE” - TOPS ARE PROCESSES:  The halcyonic days of the late-cycle invariably birth discussion about whether it is, in fact, different this time, whether the economic cycle actually matters to stocks over protracted, investible periods of time and whether great central-bank catalyzed volatility moderations can matriculate into perma-profiteering opportunities.   


The “It’s different” tag-line holds credence to the extent it refers to using the temporal pattern of typical business cycle oscillations as the appropriate anolog for the current expansion.  Indeed, a defining characteristic of financial/balance sheet crises is the muted and crawling pace of the subsequent recovery.  ‘Lower in Amplitude and Longer in Period’ is the periodic function speak we’ve used to describe the likely macro path over the last 2 years. 


As it stands, we’re now 73-months into the current expansion – which compares to a mean of ~60 over both the last century and post-war era.  What’s worth re-remembering is the fact that, on average, it takes between 6.5 and 8 years to reach pre-crisis levels of income following a financial crisis.  In the current cycle - real per capita income in the U.S. reached pre-crisis levels at the end of 2013, so just about 6 years from the onset of the recession. 


So, even with unprecedented intervention and global policy coordination we still fell basically right on the average. This time, in fact, was not particularly different. 






PROFITS PAST-PEAK?  As Keith referenced in an institutional highlight yesterday - during the 2000 and 2007 economic (and profit cycle) slow-downs, Wall St ramped M&A/IPO/Buyback activity to levels never seen before. I.e. the ramp in “everything is different” was happening to offset the cyclical slowdowns. 


Corporate Profits peak mid-to-late cycle and the last few quarters of data suggest we’re probably past peak in the current cycle.  Past peak profitability in combination with companies facing prospective acceleration in wage inflation, a continued dearth in aggregate global demand and the ongoing secular retreat in the worlds core consumption demographic of 35-54 year olds is not a factor cocktail supportive of a step function rise in capex.  





Valuation is not a catalyst and investor’s maintain varying proclivities for particular multiples and conceptual valuation frameworks. There is good debate to be had regarding the superiority or shortcoming of different multiples but there is a more general point to be made about current levels of valuation. 


Looking across the selection of metrics below, broadly, current valuations are richer than pretty much at any point except the nose bleed tech bubble highs.  Lower neutral policy rates and perma central bank interventionism may indeed be supportive of higher mean valuations but that only modestly dilutes the conclusion.  When valuations are in the top decile of LT historical averages, subsequent returns over medium and longer-term periods are just not that compelling.   









Solving for what drives prices higher as profits flag is trivial.  But if you’re going to be paying near-peak multiples on peak margins as margins appear to be past peak and the expansion enters its twilight, you should at least be aware that that’s what you are doing. 


Tops are processes and “late-cycle” is not some discrete peak on a Macro sine curve.  We’re continuing to move tactically while the music plays but we won’t be willfully blind to the #LateCycle reality of it all.   


NICKELS & STEAMROLLERS | IS THE PROFIT CYCLE PAST PEAK? - Growth cartoon 05.19.2015 normal



Christian B. Drake


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