First Time, Long Time

“I’m against picketing, but I don’t know how to show it”

-Mitch Hedberg


Suppose I told you that a certain macroeconomic phenomenon manifests as a discrete trigonometric function with a period of approximately 7 years. 


The phenomenon in question is highly autocorrelated (i.e. it goes in the same direction for extended periods), peaks and troughs at approximately the same levels in each cycle and is levered to glacial, analytically tractable drivers. 


Moreover, our mystery metric currently sits in the bottom quartile of historical observations with mean reversion upside of ~40% to its LT historical average and ~65% upside to average peak levels.  Now further suppose that in addition to this sanguine secular backdrop, in the nearer term it will probably (continue to) post the best rate-of-change numbers in all of global macro.


In abstract terms, what I’ve described  – which is probably not particularly mysterious given my ongoing Early Look chronicling of our evolving housing investment thesis - is the core argument behind the secular bull case in housing and residential construction activity. 


In today's Chart of Day we show the historical cycles in Housing Starts over the last half century.  Immediately below, we show the periodic nature of New Home Sales in the pre-bubble period.  


Click image to enlarge 

First Time, Long Time - z 2 NHS CoD1 


Back to the Housing Macro Grind...


“Yeah, but it’s a dry heat, so it’s not that bad”. 


With summer upon us and the temperature inflecting, your hopes for the future of human originality will again be tested as you’re invariably subjected to some version of that “insight”, probably repeatedly.   


You can tell when the comment is coming.  You can’t do anything to stop it.  And when the person actually says it, it feels just as trite you thought it would be.  Or maybe that’s just me…


To extend the superfluousness even further – another of my etymological pet peeves is when talk radio callers call-in and lead with “Hi..First time, long-time” (short for “first time caller, long-time listener”).


If nails and chalkboards managed copulation, those irksome platitudes would be their progeny.


Anyway, we did get a first-time, long-time moment in housing this week as 1st-time buyers, after a half-decade hibernation, showed signs of stirring.  


1st-Time Buyers | Call it a Comeback?   First-time buyers represented 32% of Existing Sales in May, up from 30% last month and 27% in May of last year.  It’s been our view that ongoing improvement in labor and income fundamentals along with maturation of the employment recovery beyond the 2-year mark for the key 20-34 YOA age demographic would support household formation growth with slow flow through to demand in the single-family market.  


It’s difficult to take a convicted view of a single month of data in isolation but with cash/investor/distressed sales declining, mortgaged purchases rising and young buyer demand percolating the slow march towards market normalization is progressing. 


Whether the mini-step function rise in 1st-time buyer demand in May represented a head-fake or an early inflection back towards the historical average of ~40% share of EHS remains to be seen but its evolution will represent a fulcrum factor for the direction of the existing market from here with transaction activity having retracted back to longer-term historical averages.


Indeed, the sequential +5.1% rise in May took aggregate existing sales up to 5.35MM units SAAR, marking the strongest level of housing demand since the artificially (tax-credit) amplified late 2009 period.


Further, the high-frequency weekly Purchase Application data from the MBA – which clocked purchase demand growth at +18% year-over-year in the latest week – suggests the strength observed across Pending and Existing Sales in March/April extended to May/June.


Trends in the New Home market have been similarly strong.


New Home Sales | 2nd Derivative Bonanza - New Home Sales in May (reported Tuesday) rose +2.2% month-over-month to +546K, the strongest level since February 2008 (88 months).  On a year-over-year basis, sales growth registered +19.5% with the positive revision to the prior month (+1.3% MoM) taking April sales growth up to a remarkable +30% year-over-year.  


Further,  given the favorable comp dynamics, it’s likely we see similar strength from a rate-of-change perspective in the coming months.  For context, if sales were to hold flat at current levels, year-over-year growth would come in at +34%, +35% and +20% over the next 3-months, respectively.    


But isn’t Housing Early-Mid Cycle?


That has been a recurrent inquiry given our late-cycle view of the broader economy. 


A somewhat obvious but seemingly underappreciated dynamic of the current cycle is that the recovery in housing lagged the broader macro inflection by more than two years.  Given that housing was the final, pre-crisis beneficiary of an epic, multi-decade (policy) game of rotate-the-asset bubble, it’s not surprising that the subsequent recovery has been slow, choppy and broadly unimpressive. 


However, Housings unique role in precipitating and propagating the financial collapse also makes historical cycle precedents (in terms of housings position in the temporal pattern of the archetypical cycle) less informative as analogs.  In short, while we’re late or mid-late cycle more broadly, we’re somewhere closer to early-mid or mid cycle in housing itself.  The housing cycle and the economic cycle are, of course, not mutually exclusive but they can tread variant short-to-medium term paths.


Teasers & Siren Songs:  The secular upside opportunity for housing is both conspicuous and sirenic.  But between here and the omni-amorphous “long-term”, however, there are/will be discrete investible periods on both sides of the trade.   


We reversed to bullish on Housing in late 2014 and with positive 2Q results out of KBH and LEN over the past week, the top down inflection in housing fundamentals we’ve been calling for is now showing up in the reported numbers and being embedded in more sanguine forward guidance from management.


The fundamental data should remain good over the nearer term.  Will good be good enough to support ongoing outperformance in the housing related equity complex?  We’ll be updating our outlook on our 3Q15 Housing Themes call on Thursday, July 9th (ping for details)


Our immediate-term Global Macro Risk Ranges are now:


SPX 2094-2130 
Nikkei 204
VIX 12.13-15.61 
USD 93.81-95.96
Oil (WTI) 59.04-61.22 

Gold 1168-1188

To long-term opportunities, tactical risk management, and who-ever invented “the teaser”.


Christian B. Drake

U.S. Macro Analyst


First Time, Long Time - z 1 Starts CoD2


Rate Hike Apologists

This note was originally published at 8am on June 11, 2015 for Hedgeye subscribers.

“It is dangerous for a bride to be apologetic about her husband.”

-Wallace Stegner


There are a lot of ways I can go with that quote this morning, but I’ll keep it above the belt. I read it as I was flying to LA from San Francisco last night. And I couldn’t stop thinking about Janet & Ben.


While Yellen isn’t married to Bernanke, she is wed to the policy expectations framework he created. While anything is possible when it comes to un-elected decision making on interest rates, I highly doubt she raises rates for the sake of the apologists.


Apologists? Yes. As in the every-other-meeting I’ve been in this week where a sophisticated Institutional Investor asks me “isn’t it just time she raises rates?” I promptly say no. Raising rates into a slowdown could easily perpetuate the next US recession.

Rate Hike Apologists - Yellen cartoon 09.17.2014NEW


Back to the Global Macro Grind


Probably the sharpest bond guy I met with yesterday (incidentally, he carries one of the biggest bats in the bond buying game) A) agreed with me on the Rate Mistake call and B) took the reason for a potential Fed mistake one step further:


“My main concern isn’t that you’re wrong on the economy  - it’s that you’re right (it’s #LateCycle slowing) and she (Yellen) takes this Global Bond Yield move as a signal that the coast is clear to get one-and-done (rate hike) on the tape.”




This is where the political and market pressures on this un-elected institution (The Fed) meets its maker – the data. I actually think Janet Yellen is much more “data dependent” than The Bernank ever was. She doesn’t need to apologize for that.


Neither do I need to apologize for all of us hanging on any tweet that leaks when the Fed is going to move. This is the centrally planned macro market America asked for. It’s our job to attempt to risk manage it.


So let’s give that a try and outline 3 baseline scenarios ahead of the Fed meeting next week:


  1. Yellen signals that after having missed their window to hike in 2013, “it’s just time” to raise
  2. Yellen signals that since the US economic data continues to slow, there’s no rate hike on the table until 2016
  3. Yellen signals that she remains “data dependent” (i.e. repeats what she said at the March 18th meeting)


While I believe scenario #3 is the most probable, Consensus Fear is that Scenario #1 is more probable than it was 10 days ago when the 10yr US Treasury Yield was 2.10%.


And, yes, since it’s all about the rate-of-change in probabilities, the proclivity for a bureaucrat to chase last price (2.49% on the US Treasury Yield) is rising right now, not falling.


What if Yellen opts for the rate hike? I think the Dollar rips and stocks, bonds, and commodities get slammed. But having watched all of these macro markets move for the last 3 weeks (all down) prior to yesterday’s bounce, you already know that.


Then what?


She’ll have to cut! Yep, raise and cut. Huh? Correct – you can’t just chase bond yield charts and their correlated moving monkey averages and dismiss what I started this rant with this morning – the policy expectations framework that Janet & Ben created.


To review the Fed’s “data dependent” framework in its simplest of terms:


  1. As the data accelerates, expectations for higher interest rates do (see 2013 for details)
  2. As the data slows, expectations for lower interest rates do (see Q4 2014 to Q1 2015)


This is the bed that Bernanke built. And from what I can see, Janet isn’t apologizing for it. As a result, until she says otherwise, my expectation is that she is going to sleep in that bed, waking up every morning to the rate-of-change in the data.


In other news, the World Bank is the latest central planning outfit to cut both its US and Global Growth Estimates for 2015. They, of course, just pushed out the estimates for 2016 – which means they’ll inevitably have to cut those (again) too.


And in terms of non-rate-spike related ideas, I signaled to short the Yen yesterday and buy more of that Weimar Nikkei. The Japanese know very well what Slower-For-Longer looks like – they won’t divorce themselves from that rate policy anytime soon.


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


UST 10yr Yield 2.09-2.55% (bearish)

SPX 2075-2125 (neutral)
RUT 1251-1269 (neutral)
Nikkei 20049-20713 (bullish)
VIX 13.02-15.42 (bullish)
USD 94.06-95.84 (neutral)
EUR/USD 1.09-1.14 (bearish)
YEN 122.49-125.46 (bearish)
Oil (WTI) 58.81-61.98 (bullish)

Nat Gas 2.56-2.92 (neutral)

Gold 1168-1198 (bullish)
Copper 2.67-2.77 (bearish)


Best of luck out there today,



Click to enlarge

Rate Hike Apologists - z Chart of the Day

The Macro Show Replay | June 25, 2015



Takeaway: The stock is fully valued.

DRI – MOVING PIECES - Chart 1 replace v2


As expected DRI put up a very strong quarter, management noting cost cutting, less discounting and an extra week as leading causes.  That being said, management is doing a great job getting the cost structure of the company and the margins to return to normalized levels.  At this point the stock currently reflects all the good news and is 10% above our sum-of-the-parts analysis.


The key points coming out of the earnings release are:

  1. Consolidated margins are benefiting from a slight sales tailwind from lower gas prices
  2. Olive Garden margins are benefiting from less discounting
  3. Cost cutting is a priority
  4. The margin structure of the company will change significantly from the REIT transaction



One of Starboard Values top priority’s when getting control of Darden was “substantially improving the value proposition and experience at Olive Garden to increase guest counts.”  Part of Olive Garden’s operational improvement plan was to return the concept to its Italian roots, enhance the guest experience all while reducing costs.  On this earnings call management provided little evidence that they were focused on returning the concept to its Italian roots.  The focus on to-go sales is not a long –term solution.  The Olive Garden team has been working on more contemporary concepts, designed to appeal to today’s consumer. And although these concepts may be resulting in improved sales, they are being implemented in a small number of stores and expanding slowly. The speed and breadth of these changes are ultimately not going to be enough to improve their very tired asset base!  


While Olive Garden had a better year in 2015 there remains few signs of life that the concept is back on track.  As we have said before, the improved profitability at the concept is due to industry tailwinds and less discounting.  Management has now set expectations that traffic will be positive in FY2H16, providing little evidence to support that claim.  As seen in the chart below traffic trends at the concept remain elusive.  The improvements in 2015 same-store sales have been driven by price and mix as traffic remains slightly below industry trends.






  • Adjusted EPS $3.05-3.20 vs FactSet $2.88 (before adjusting for the REIT transaction)
  • Same-restaurant sales growth (52-week basis) of 2.0% to 2.5%
  • Total capital spending of $230 to $255M (very little in this for remodels)
  • New unit openings of 18 to 22 restaurants
  • Does not include the impact of any fiscal 2016 real estate transactions and related cash and capital structure activities



Today, Darden announced that its Board approved a strategic real estate plan to pursue a separation of a portion of the company's real estate assets.   The separation would be achieved through a combination of selected sale leaseback transactions and the transfer of a portion of its remaining real estate assets to a new REIT that will be separated by a spin-off resulting in the REIT becoming an independent, publicly-traded company.


According to the company there is “a significant amount of work remains and there can be no assurance the company will be able to successfully complete the transaction and establish a REIT.” 


If the current plan is consummated, Darden will transfer approximately 430 of its owned restaurant properties to the REIT, with substantially all of the REIT's initial assets being leased back to Darden.  The leases are expected to have attractive rent coverage ratios, fixed rent escalations and multiple renewal options at Darden's discretion. The proposed REIT would be well positioned to grow through real estate acquisitions of other assets. 


In addition, Darden has been marketing selected properties for individual sale leasebacks.  To date, the company has listed 75 properties, and over 30 of these properties have been sold or are under contract.  The company expects an average cash capitalization rate of approximately 5.5% for all 75 properties, and expects to close most of these transactions by the end of August.  In addition, the company is seeking to sell and lease back its Orlando Restaurant Support Center property and buildings under a long-term contract with multiple renewal options at the company's discretion.


After receiving proceeds from the completion of the strategic real estate plan, the company expects to retire approximately $1B of its debt over time and maintain its investment grade credit profile.



It is clear that the new Board has DRI headed in the right direction.  With the financial engineering aspects of the turnaround nearly complete, the hard part begins, fixing Olive Garden!



DRI – MOVING PIECES - Chart 4 v3



NKE - Key Issues Into The Print

Takeaway: We usually feel great into a NKE print. But not this one. Too much has to go right. We're buyers on weakness, or after the event.

Conclusion: We remain bullish on Nike over the intermediate and long-term, but let’s be crystal clear, we don’t feel good about Thursday’s print. We actually think that the company will beat EPS estimates by a wide margin – about $0.90 vs the Street at $0.83. Gross Margins are likely to continue to defy gravity, which we think is entirely due to e-commerce. That said, promotional activity and potential ‘channel overfill’ in the mid-tier has us concerned about a reversion to the mean (+HSD) in US Futures. That’s still a respectable level – but a deceleration nonetheless. If that happens, then that’s the headline – not the EPS beat, unfortunately. We’re also concerned on the margin about this being Don Blair’s (CFO) last conference call, as it has implications for guidance. Lastly, keep an eye on increased capital costs coming down the pike as Nike spends to regain its top position in the athlete endorsement world – something it seemingly lost to UnderArmour over the past six months. 


Combine all of that with short interest at less than 1% of the float, the stock sitting at an all-time high, as well as the highest multiple in 17-years, and it’s really difficult to be overly bullish on a near-term event. If we see a pull-back on any of the issues we flagged, we’d likely get vocal to buy on weakness. Similarly, if none of these concerns play out, then we’ll be even more impressed and will want to buy it anyway – just not before the event.


Here’s a few key questions/issues we’re considering for Nike into tomorrow’s 4Q print.


1. Quality of the Order Book. For the better part of two years, Nike US wholesale sales have outgrown the reported revenue growth for virtually every athletic specialty retailer. In fact, over the past two quarters alone, Kohl’s sales of Nike product have been up about 22%. Should Nike really be up 22% in a retailer like Kohl’s? Probably not. Then a little over a week ago, we noticed extremely uniform discounting on mid-tier Nike product at Dick’s, Kohl’s, JC Penney, Finish Line, and Macy’s. It was not extremely deep (about 25%), but the breadth of the pricing actions definitely caught our eye – particularly given that they did not occur at this time last year. We want to get some clarity into what price points and channels are really driving Nike’s futures.  

NKE - Key Issues Into The Print - Nike NA vs B M Growth


NKE - Key Issues Into The Print - Nike discounts


2. Inventory Control: Kind of a boring topic – but it’s critical for several reasons. There’s one thing that you can take to the bank, when futures are strengthening, and inventory is declining, it is nearly fool-proof trigger for a significant lift in Gross Margins at Nike. Unfortunately, the opposite holds true as well – weakening futures and higher inventories = weak Gross Margin setup. While we think that e-commerce will be a meaningful boost to gross margins for the quarter, the reality is that if we had to bet on a directional change in futures, it would be on a mean reversion to the high single digit range (C$). At the same time, the chart below shows that the spread between futures and inventory has been unfavorable for the past four quarters running, and gross margins have remained bullet proof. E-commerce is buoying this…but we worry about near-term sustainability of the trend if the futures rate declines without material improvement in inventory.
NKE - Key Issues Into The Print - NKE futures GM


3. Athletic Endorsements

Just about any way you slice it, UA has stolen the spotlight from Nike on its home turf over the past six months. We think we’re going to see a meaningful tweak in Nike’s endorsement strategy – in other words, spending more money – which will be easier to push through the system with Don Blair out of the picture. 


Some will argue that Nike’s new NBA deal will help, but we’d argue that no fewer than seven out of ten people think that Nike already is the league sponsor. They’d be wrong – it’s Adidas.  League endorsements largely do not work. Consumers don't care about the logo players are required to put on their shirts. They care about the logo they proudly wear on their feet. That's why Nike walked away from these League deals over a decade ago. Now it’s a good idea again?


Adidas paid $400mm over 11 years. Nike is paying $1bn over 8-years. While this is still less than the $1.1bn/5-yrs that Nike is paying for the NFL, it is a lot of coin to pay for the 5th most watched sport in the US (NFL, MLB, CFB, NASCAR, NBA, NHL) -- yes, NBA is just a notch above hockey.


Here's where Nike can earn its keep. If they somehow figure out how to innovate the uniforms such that players notice a dramatic improvement in their ability to put points on the board and play over an extended period of time, then there's a commercial apparel opportunity for Nike. That's what it did with the NFL. But a football player's uniform weighs about 30lbs, and has not been innovated or streamlined in 30 years. That was a ripe opportunity for Nike.  Basketball is a very different story -- shorts, tank top, that's it.


NKE - Key Issues Into The Print - endorsement weight


4. E-Commerce. There are some major considerations here.

A. E-commerce was up 42% last quarter, which is a sequential slowdown from 2Q’s 66%. But looked at on a 2-year run rate, underlying growth remains at peak levels. We think that Nike has plans to set new peak levels in FY16. How we’re doing the math, e-commerce represents about 6% of Nike’s sales. That’s about $1.8bn today. We think the company will add between $1bn-$1.2bn in FY16, or 55%-65% growth. Nike will probably tell you that we’re too aggressive. But let’s put the accountability pants on. In Oct 2013, the company said that e-comm would go from $540mm in 2013 to $2bn in FY17. It appears to be hitting that goal 1-2 years ahead of plan. It didn’t purposely sandbag, but rather it’s such a dynamic growth opportunity with more and more growth opportunity by the day.

B. The margin on those sales is a big consideration. How we do the math, e-commerce sales are about 20points margin accretive. That’s outlined in the table below. But more important than the actual gross margin rate is the magnified amount of gross margin dollars as Nike captures a full retail price instead of one with a 50% wholesale discount. A 20%+ margin on a 2x price = nearly 4x the gross margin dollars.

C. Yes there are increased working capital requirements, which Nike will have to manage. There will be a learning curve there. But outright capital spending and incremental SG&A investment on e-commerce is shrinking – for now at least – given what Nike has been investing (much of it quietly) over the past three years.

D. We could actually make the argument that 100% of the e-commerce spend will be incremental – as in, not take away from its wholesale business (FL, FINL, HIBB). Not over the long term, but temporarily. The point is that Nike is going to manage its wholesale model with kid gloves. It will say and do all the right things, as will its partners. But make no mistake, it will aggressively push the envelope with its e-comm model along the way. It will only know it pushed too far when some serious channel stuffing is apparent in the wholesale channel (ie. higher inventories, lower comps at FL, or maybe even 24% growth in a sub-par outlet like KSS in the last qtr).  And at that point, the right decision will likely be to still grow e-comm aggressively.

E. In the end, we think that e-commerce growth will account for $750mm-$900mm in incremental gross profit – or about 60% of gross profit growth.  That also translates to 5-7% in EPS growth. Back to the comparison to other companies above, we think this largely explains away why Nike is growing earnings 2x the rate of sales while other non-durables brands are flat to down. 

NKE - Key Issues Into The Print - Nike ecom vs whole


5. Guidance -- WWDD

What will Don do? This is Don Blair’s last conference call as CFO. It’s also when Nike will give more definitive guidance about FY16. Does Don set a conservative plan for his successor, Andy Campion, to beat in his first year out of the box? That’s bad near-term, but good for the next few quarters. Or does he set the bar high with a bullish outlook for the year that the team might or might not hit? Keep in mind that when Don Started at the company over 15 years ago, he got a major black eye when he misread the internal budgeting process and lowered street expectations significantly – when in actuality the company ended up having a great year. Maybe Campion needs the same ‘trial by fire’? Our sense is that Campion ran the budgeting process with Don as a chaperone. There may be some noise, but it should appear relatively seamless to most observers. Nonetheless, we'll be watching this one closely.

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