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McCullough: Coo! Coo!

In this excerpt from The Macro Show earlier this morning, Hedgeye CEO Keith McCullough responds to a subscriber’s question on how markets will react if the Fed decides against raising rates in September.

 

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MCD | THE GAME CHANGER | ALL DAY BREAKFAST (ADB) SURVEY RESULTS

As we said in our recent MCD Black Book, 3Q15 will be a critical inflection point for the company.  It now looks like there is a major initiative underway that could be announced in late 2015 or early 2016 – ALL DAY BREAKFAST.  The trends MCD reported in 2Q15 now support the thesis that 3Q15 will be a key inflection point in the company’s turnaround.    

 

With clear visibility on an improved cost structure, fixing sales trends are a critical next step.  One way to get there is to serve some key breakfast items all day.  I would go so far as to say that if McDonald’s has figured a way to serve ALL DAY BREAKFAST it will be a game changer for the company and it will have significant industry implications. 

 

From the research we have done and the conversations we have had with people close to McDonald’s suggest that All Day Breakfast could be that silver bullet McDonald’s is looking for!

 

Early in his tenure as CEO, this initiative by Steve Easterbrook could define his legacy at MCD.  Does Mr. Easterbrook want to be the CEO who just couldn't make ALL DAY BREAKFAST happen, or will he be the CEO who made ALL DAY BREAKFAST work for the first time in McDonald's history. 

 

Currently, ADB is in a small test in Southern California.  I understand that the costs for changes to the kitchen will range from $10,000 - $20,000 and involve adding an egg-cooker.  As always, the cost will vary by restaurant depending on what other equipment they already have on hand.  I believe that if the costs exceed $20,000, it will be very difficult to sell it to franchisees.

 

I also believe that if McDonald’s does add some breakfast items to the menu it should be a part of a broader reduction in other menu items.  The question remains do they have the discipline to do it?  A complex menu is a complex menu whether it's beef, chicken, or breakfast egg products.  There is the possibility, that adding breakfast to the all-day menu might make ordering more confusing for the customer.

 

We went out and conducted a survey to gauge consumer interest in ADB and the outcome was pretty positive. When we asked 2,000 people whether they would go to MCD more often if they could get breakfast for lunch, 33.3% of people said yes. We weren’t expecting to see a number over 50%, we consider 33.3% to be a significant number. Not surprisingly, lower income people said yes more often as well, further confirming the need for MCD to deliver value to customers.

 

MCD | THE GAME CHANGER | ALL DAY BREAKFAST (ADB) SURVEY RESULTS - CHART ADB 


Retail Callouts (7/27): GPS, TGT, AMZN, BBY

Takeaway: GPS trying to improve turns, but can it? TGT cash from store liquidations coming in slow. AMZN drive-thru. iWatch at BBY, already?

GPS - Gap goes seamless with inventory management

(http://www.chainstoreage.com/article/gap-goes-seamless-inventory-management)

We're intrigued anytime we see GPS make moves as it relates to inventory management. GPS is perceived to be so lean in its inventories, but one could argue that it's not. The chart below shows that it is on the higher end of Specialty Retailing peers, but nearly half the levels of the department stores.  As it relates to trend, the dept store group has largely been trending higher, while the Specialty group has had inventories trending lower. GPS, on the flipside, has been pegged right at 65 days. Did it find a bottom at the start of the Glenn Murphy days? Or does it have room to operate closer to the Specialty group? Our sense is that it has found a bottom. This company has not grown sales in a decade, and has found every way imaginable to grow margins and free up cash to repo stock. If initiatives like the one discussed in this article bear any fruit, we're talking a day, maybe two -- max.

Retail Callouts (7/27): GPS, TGT, AMZN, BBY - 7 27 chart2

 

TGT - Target’s struggle to sell stores exposes Canada’s weak retail leasing market

(http://www.theglobeandmail.com/report-on-business/targets-struggle-to-sell-stores-exposes-canadas-weak-retail-leasing-market/article25715341/)

This may be simplifying a very complex set of transactions and minimizing current real estate market conditions, but the fact that TGT can't find buyers for over 50% of its stores speaks volumes for the quality of properties TGT acquired when it bought the Zellers leases back in 2011. That's under the bridge at this point.

When the company announced it's exit from Canada, management guided to $500 to $600mm in cash charges associated with the move. That doesn’t appear to be headed higher because of the weak demand for its real estate, but as Target Propco is the largest creditor with a $1.9bil claim -- it's possible that the cash expected to be recovered comes in a bit light.

 

AMZN - Amazon planning drive-through grocery stores

(http://www.telegraph.co.uk/technology/amazon/11763617/Amazon-planning-drive-through-grocery-stores.html)

The concept of 'drive through grocery stores' might be a head scratcher for many. But keep in mind that the company already operates a grocery delivery service called Amazon Fresh, as well as a service called Amazon Locker, where consumers could pick up online orders in a centralized location (see below).  Though there have been rumors that Amazon would allow people to browse physical stores, the company is likely -- at least initially -- to offer this as a pure drive-thru/pick-up service. But like everything else AMZN does, this will evolve. When you're growing sales annually by $15bn -- the size of Whole Foods -- you pretty much have a free pass to try anything -- profitable or not.

Retail Callouts (7/27): GPS, TGT, AMZN, BBY - 7 27 chart1

 

BBY - Apple Watch to Be Sold at Best Buy

(http://blogs.wsj.com/digits/2015/07/26/draft-apple-watch-to-start-selling-at-best-buy/)

So soon? We'd have thunk that the launch into mass channels like Best Buy wouldn't come so soon after the April 24th launch of the watch. We view this as bullish for companies like FOSL, who the Smart Watch trend was perceived to have in its line of sight.

 

 

OTHER NEWS

 

Weak Euro Masks Lingering Woes at LVMH, Kering

(http://www.wsj.com/articles/low-euro-masks-lingering-woes-at-lvmh-kering-1437942805)

 

Kering Names Grita Loebsack CEO of Luxury Emerging Brands

(http://wwd.com/business-news/executive-changes/kering-names-grita-loebsack-ceo-luxury-emerging-brands-10192560/)

 

WWW - Keds Launches ‘Ladies First’ Campaign With Taylor Swift

(http://vampfootwear.com/keds-launches-ladies-first-campaign-with-taylor-swift/)

 

Kmart Settles Converse Trademark Case

(http://wwd.com/business-news/government-trade/kmart-converse-trademark-settlement-10192736/)

 

JWN - Nordstrom-Madewell Partnership Advances

(http://wwd.com/retail-news/department-stores/nordstrom-brings-nordstrom-to-more-doors-10192529/)

 

WMT - Walmart hatches an exceptional partnership

(http://www.retailingtoday.com/article/walmart-hatches-exceptional-partnership)

 

LOW - Lowe’s Canada to add 14 stores

(http://www.chainstoreage.com/article/lowe%E2%80%99s-canada-add-14-stores)

 

CVS - CVS unveils new beauty lines

(http://www.retailingtoday.com/article/cvs-unveils-new-beauty-lines)

 

Morrisons buyers demanded one-off payments from suppliers

(http://www.theguardian.com/business/2015/jul/26/morrisons-buyers-demanded-one-off-payments-from-suppliers)


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FINANCIALS SENTIMENT SCOREBOARD - First American (FAF)

Takeaway: This week we're flagging First American (FAF - Score: 19) as a long. Our 3Q15 call to "hide out" in Housing favors the title insurers.

This morning we are publishing our updated Hedgeye Financials Sentiment Scoreboard in conjunction with the release of the latest short interest data last night. Our Scoreboard now evaluates over 300 companies across the Financials complex.

 

The Scoreboard combines buyside and sell-side sentiment measures. It standardizes those measures to an index of 0-100, where 100 is the best possible sentiment ranking and 0 is the worst. Our analysis shows that a contrarian strategy can be employed successfully by taking the other side of stocks with extreme readings in sentiment, either bullish or bearish. Once sentiment reaches these extreme levels, it becomes a very asymmetric setup wherein expectations become too high or too low.  

 

We’ve quantified the tipping points for high and low sentiment. Specifically, we've found that scores of 20 or lower have a positive, average expected return while scores of 90 or greater are more likely to underperform.

 

Specifically, our backtest of 10,400 observations over a 10-year period found that stocks with scores of 0-10 went on to produce an average absolute return of +23.9% over the following 12-month period. Scores of 10-20 produced an average absolute return of +11.9%. At the other end of the spectrum, stocks with sentiment scores of 90-100 produced average negative absolute returns of -10.3% over the following 12-months.

 

The first table below breaks the 300 companies into a few major categories and ranks all the components on a relative basis. The second table breaks the group into smaller subsectors and again gives them relative rankings within those subsectors. 

 

FINANCIALS SENTIMENT SCOREBOARD - First American (FAF) - Sentiment 1

 

FINANCIALS SENTIMENT SCOREBOARD - First American (FAF) - Sentiment 2

 

FINANCIALS SENTIMENT SCOREBOARD - First American (FAF) - Sentiment 3

 

The following is an excerpt from our 90 page black book entitled “Betting Against the Herd: Generating Alpha From Sentiment Extremes Across Financials.”

 

Let us know if you would like to receive a copy of our black book, which explains this system and its applications.

 

BUYS / LONGS: Financials with extremely low sentiment readings of 20 and below on our index (0-100) show strong average outperformance in absolute and relative terms across 3, 6 and 12 month subsequent durations.  Stocks with sentiment ratings of 20 or lower rise an average of +15.1% over the next 12 months in absolute terms.   

 

SELLS / SHORTS: Financials with extremely high sentiment readings of 90 and above on our proprietary sentiment index (0-100) demonstrate a marked tendency to underperform in absolute and relative terms across 3, 6 and 12 month subsequent durations.  Stocks with sentiment ratings of 90 or greater fall in value an average of -10.3% over the next 12 months in absolute terms. 

 

 

FINANCIALS SENTIMENT SCOREBOARD - First American (FAF) - Absolute 12 mo

 

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT


MONDAY MORNING RISK MONITOR | JUNK BONDS & CHINA SEEING RED

Takeaway: The Chinese rout resumes while US high yield begins to unwind.

Key Takeaway:

Risk grew on a number of fronts last week. Our heatmap is flashing mostly red in the short-term driven by widening CDS across sovereigns and financials globally. Beyond this, the high yield market is showing signs of heavy strain with yields rising 30 bps on the week and now tracking higher by +60 bps (to 6.99%) vs month-ago levels.

 

The basic challenge with high yield at this point in the cycle is that it just can't win. This may seem counterintuitive since there aren't many other ways to capture yield. The basic problem is that both rates and credit are now poised to work against you. 

 

Meanwhile, the Chinese stock market was under significant pressure earlier today. The Shanghai Composite Index fell -8.5% and the Shenzhen Composite declined -7% for the day.

 

Current Ideas:

MONDAY MORNING RISK MONITOR | JUNK BONDS & CHINA SEEING RED - RM 19

 

Financial Risk Monitor Summary

 • Short-term(WoW): Negative / 2 of 12 improved / 7 out of 12 worsened / 3 of 12 unchanged

 • Intermediate-term(WoW): Negative / 3 of 12 improved / 4 out of 12 worsened / 5 of 12 unchanged

 • Long-term(WoW): Positive / 2 of 12 improved / 1 out of 12 worsened / 9 of 12 unchanged 

 

MONDAY MORNING RISK MONITOR | JUNK BONDS & CHINA SEEING RED - RM 15 2

 

1. U.S. Financial CDS -  Swaps widened for 17 out of 27 domestic financial institutions, coinciding with the S&P 500's -2.2% slide for the week after hitting a top of 2,132 on Monday. SLM Corporation CDS widened the most, by 93 bps to 436, following the company's earnings announcement on July 23.

 

Tightened the most WoW: CB, ACE, GNW

Widened the most WoW: SLM, JPM, MET

Tightened the most WoW: CB, GNW, AIG

Widened the most MoM: SLM, MMC, MBI

 

MONDAY MORNING RISK MONITOR | JUNK BONDS & CHINA SEEING RED - RM 1

 

2. European Financial CDS - While Greek bank CDS tightened sharply, swaps were mostly wider across the EU banking system.

 

MONDAY MORNING RISK MONITOR | JUNK BONDS & CHINA SEEING RED - RM 2

 

3. Asian Financial CDS - The cost to protect against bank default continues to rise in China and India.

 

MONDAY MORNING RISK MONITOR | JUNK BONDS & CHINA SEEING RED - RM 17

 

4. Sovereign CDS – Sovereign swaps were mixed last week. CDS tightened for the U.S., Germany, France, Ireland, and Japan. Meanwhile, CDS for Italy, Spain, and Portugal widened.

 

MONDAY MORNING RISK MONITOR | JUNK BONDS & CHINA SEEING RED - RM 18

 

MONDAY MORNING RISK MONITOR | JUNK BONDS & CHINA SEEING RED - RM 3

 

MONDAY MORNING RISK MONITOR | JUNK BONDS & CHINA SEEING RED - RM 4

 

5. Emerging Market Sovereign CDS – Emerging market swaps widened last week. Brazilian sovereign swaps widened the most, by 29 bps to 294 bps, followed by Russian swaps, which widened by 23 bps to 334.

 

MONDAY MORNING RISK MONITOR | JUNK BONDS & CHINA SEEING RED - RM 16

 

MONDAY MORNING RISK MONITOR | JUNK BONDS & CHINA SEEING RED - RM 20

 

6. High Yield (YTM) Monitor – High Yield rates rose 30 bps last week, ending the week at 6.99% versus 6.68% the prior week.

 

MONDAY MORNING RISK MONITOR | JUNK BONDS & CHINA SEEING RED - RM 5

 

7. Leveraged Loan Index Monitor – The Leveraged Loan Index fell 10.0 points last week, ending at 1884.

 

MONDAY MORNING RISK MONITOR | JUNK BONDS & CHINA SEEING RED - RM 6

 

8. TED Spread Monitor – The TED spread fell 1 basis points last week, ending the week at 26 bps this week versus last week’s print of 27 bps.

 

MONDAY MORNING RISK MONITOR | JUNK BONDS & CHINA SEEING RED - RM 7

 

9. CRB Commodity Price Index – The CRB index fell -5.3%, ending the week at 205 versus 217 the prior week. As compared with the prior month, commodity prices have decreased -8.8%. We generally regard changes in commodity prices on the margin as having meaningful consumption implications.

 

MONDAY MORNING RISK MONITOR | JUNK BONDS & CHINA SEEING RED - RM 8

 

10. Euribor-OIS Spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread was unchanged at 10 bps.

 

MONDAY MORNING RISK MONITOR | JUNK BONDS & CHINA SEEING RED - RM 9

 

11. Chinese Interbank Rate (Shifon Index) –  The Shifon Index rose 5 basis points last week, ending the week at 1.34% versus last week’s print of 1.28%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.

 

MONDAY MORNING RISK MONITOR | JUNK BONDS & CHINA SEEING RED - RM 10

 

12. Chinese Steel – Steel prices in China rose 1.1% last week, or 23 yuan/ton, to 2135 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity and, by extension, the health of the Chinese economy.

 

MONDAY MORNING RISK MONITOR | JUNK BONDS & CHINA SEEING RED - RM 12

 

13. 2-10 Spread – Last week the 2-10 spread tightened to 158 bps, -10 bps tighter than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.

 

MONDAY MORNING RISK MONITOR | JUNK BONDS & CHINA SEEING RED - RM 13

 

14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.8% upside to TRADE resistance and -1.5% downside to TREND support.

 

MONDAY MORNING RISK MONITOR | JUNK BONDS & CHINA SEEING RED - RM 14

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 


Nasty Asset Price #Deflation

Client Talking Points

CHINA

They better re-halt – the Shanghai Composite Index was down -8.5% overnight (the biggest drop since the 2008 crash in global asset prices). They can halt and print, but they can’t print demand/growth (Industrial Profits move to negative -0.3% year-over-year in June – how is GDP +7.0%?). 

USD

As speculation rises that the Fed can’t raise rates into this slowdown (5YR UST breakevens are down -29 basis points in the last month as #deflation risk mounts), we should get an immediate-term oversold signal in the USD Index today (EUR/USD overbought at $1.10).

10YR YIELDS

We can’t count how many people told us the UST 10YR was going to “2.75%” (when it was at 2.50%); now it’s back down to 2.25%, German 10YR Bund yields 0.69% and Swiss 10s are back to negative -0.09% = Global growth and inflation slowing.

 

**The Macro Show - CLICK HERE to watch today's edition at 8:30AM ET.

Asset Allocation

CASH 50% US EQUITIES 6%
INTL EQUITIES 8% COMMODITIES 0%
FIXED INCOME 24% INTL CURRENCIES 12%

Top Long Ideas

Company Ticker Sector Duration
GIS

General Mills (GIS) remains on the Hedgeye Consumer Staples Best Ideas list as a LONG. Key segments across the company are turning the corner and improving performance. Specifically GIS has figured out the yogurt category, after 3 years of struggling with Greek and losing on the core business, management has turned the Yogurt division into a growth segment. Cereal has obviously been a struggle for all companies participating. Although still down, the trend is looking better, in FY16 we hope to see the switch to Gluten Free Cheerios and other improvement, turn performance around.

PENN

Penn National Gaming reported Q2 profit of $16.9 million on Thursday. The company's profit of 19 cents per share beat analysts' expectations.  PENN posted revenue of $701 million in the period, which also beat forecasts.  Shares have climbed 40% since the beginning of the year and 58% over the last 12 months, obviously much higher than the S&P 500. Gaming, Lodging and Leisure Sector Head Todd Jordan was at Penn National Gaming's investor day on July 24th. He will provide a detailed update this week.

TLT

Those long of #LowerforLonger enjoyed another solid week of 2%+ gains for TLT and EDV. VNQ followed up last week’s gains with a pullback of equal size, but we received a positive sloth of data this week that confirms our long housing theme. A positive housing outlook within a bearish rate environment should be positive for VNQ.

Three for the Road

TWEET OF THE DAY

Tom Tobin is reviewing his SELL call on Zimmer $ZBH @HedgeyeHC this morning

@KeithMcCullough

QUOTE OF THE DAY

The future belongs to those who see possibilities before they become obvious.

John Scully

STAT OF THE DAY

Tourism in Cuba has jumped, up 15% in the first 5 months of this year.


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