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Prepare For the Worst

“Efficiency is doing better what is already being done.”

-Peter Drucker


Prepare For the Worst - Peter Drucker


While Peter Drucker has been referred to as the “founder of modern management,” Peter Thiel might say that running in circles trying to do better than what is “already being done” is at the top of the list of societal inefficiencies. In his book Zero to One, Thiel gives one simple rule to prospective entrepreneurs:


If you want to create and capture lasting value, don’t build an undifferentiated commodity business.

In reality, 1) we’re not all entrepreneurs, 2) Many of us exist in highly-competitive, commoditized businesses; and 3) a majority of us aren’t operating with a monopolistic shield (although this is arguably the goal).


To merge two varying ideologies of optimal advancement that scream generational mismatch, if you are in fact selling what many others are selling, hopefully you’re the leanest, most flexible operator. Accepting that the future is unpredictable and that prior plans will undoubtedly change is the first step to survival.    


Over-investment at peak margins is an ever-occurring historical phenomenon.  For recent examples take a look at iron ore or potash capacity additions circa 2004 through the financial crisis commodity-bubble highs:

  • Cap-ex less D&A for the largest miners increased nearly 6x from 2004-2012 (see a chart of iron ore on how that story ends)
  • Iron ore production increased nearly 170% from 2000-2012
  • Potash production capacity has increased 60% since 2000 on double digit Y/Y cap-ex spend growth from the largest producers from 2004-2013. Until the “emerging market demand for better food” story actually manifests, we consider this a slow to no growth, elastic demand story. Canpotex monopoly cartel or not, margins are still high which pulls the cost curve lower with the potential for prices to follow.     

Whatever your view on the reasons for a capital spending boom the implications are straightforward:


1) Over-Production

2) Lower price floor


Bottom line: people are just get better at producing commodities.


Back to the Global Macro Grind...

After a 2-step FX devaluation out of China this week and a parliamentary approval for a third Greek bailout package (shocker) ahead of Mario Draghi’s main event in Jackson Hole, the market is sniffing out what has been a de facto tightening from the relative central policy abroad.


We consider Beijing’s move on Tuesday and Wednesday a quasi-acknowledgement of economic reality which is warranted after an awful month of July data if you contextualize top-down macro on a rate-of-change basis:

  • Industrial production missed estimates, printing +6.0% Y/Y in Jul. vs. +6.6% est. (+6.8% prior)
  • Fixed asset investment hit a 15-year low
  • Property investment growth slowed to +4.3% Y/Y which was the lowest reading since March 2009
  • Factory output slowed Y/Y sequentially
  • Exports declined -8.6% Y/Y vs. -1.5% est. (+2.8% in June) à Chinese crude steel output -4.6% Y/Y (-1.8% Y/Y through first 7-months of 2015)

The devaluation pushed bets on the probability of a September lift-off back below 50% and tagged the dollar -1.1% on Wednesday. 


The ensuing reflation trade (XLE led sector performers at +1.8%) is the biggest risk to those positioned for deflation via commodities and related derivatives. Consensus remains positioned for deflation. We reiterate our view but remain cautious and weary of a snap-back reflation trade:


TTM Z-scores of non-commercial net-long futures and options positioning from the CFTC:

  • USD (Consensus LONG) : 0.64X
  • GOLD (Consensus SHORT): -1.88X
  • EURO (Consensus LONG): 1.37X
  • CRUDE OIL (Consensus SHORT): -1.17X
  • 10-YEAR Treasuries (Consensus LONG): 1.5X

Reflation trade aside, central bankers remain in a box on the harsh reality that they can’t print growth, and the rotation to growth-slowing asset classes remains persistent with one of our top long sector ideas in utilities (XLU) leading S&P sectors month-to-date (+3.7%).


The set-up for the September meeting is as follows:


1) The Fed runs the risk of tightening into a late-cycle slowdown which could ultimately flatten the yield curve.


2) Slower growth and deflationary headwinds are acknowledged and the can is kicked on a rate hike which should also be good for bonds. Until growth inflects positively, you’ll see TLT in our investment conclusions.

The largest discrepancy in our Growth, Inflation, Policy model vs. consensus and central bank estimates is our full-year inflation forecast.


Full-year 2015 CPI Forecasts:

  • Hedgeye Predictive Tracking Algorithm: +0.2%
  • Bloomberg Consensus Forecasts: +0.3%
  • Central Bank Forecasts: +1.4%

As is often the case, the Fed overshoots on its inflation forecasts. Their forecasts may have lost some credibility, but the point is that they’ll have to acknowledge overstated forecasts. Whether it comes at the September meeting or after Q3 data is released, we expect them to ultimately talk down the currency, and judging by consensus positioning, this is NOT consensus.     


With growth slowing, an FX catalyst, and secular headwinds globally coming to fruition at the same time, our expectation is that we will continue to see who  in commodity-leveraged industries is “swimming naked” as Warren Buffett likes to say. It’s only a matter of time before the carnage in the energy space flows through to the real economy (see Chart of the Day below).


The over-investment in commodity related industries from ~2004-2010 is unraveling. If you have to be invested 2H 2015 is probably the time to find the most conservative management teams and the lowest cost producers with the best asset base over rolling the bones on those riskier names most levered to a reflation trade.


One of the big surprises for those not in the weeds on a daily basis has been the resiliency in U.S. shale production. Hedging, long-term drilling contracts, etc. aside, the best producers have made rapid advancements from a cost-perspective. The forward curve reflects this psychological shift that was met by skepticism during the first leg down to the March lows.


“Our after-tax rate of return at $65 oil were better than at $95 oil three years ago. We are pleased to report that we have further improved these well economics, even as oil prices have declined. Through improved well productivity and lower cost, our key oil plays now earn a 30% after-tax rate of return with a flat $50 oil price.” - EOG Q2 2015 Conference Call


Unless you have a crystal ball, keep evolving and stay lean.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.14-2.25%

SPX 2072 - 2111
RUT 1196 - 1244
Nikkei 205
EUR/USD 1.08 – 1.12
Oil (WTI) 41.59 – 46.65


Good luck out there today,


Ben Ryan



Prepare For the Worst - z bizness 08.14.15 chart

The Macro Show Replay | August 14, 2015


LEISURE LETTER (08/14/2015) - G13.SI, RCL



August 28: 10:00am: PENN - Meeting with Management at Plainridge Park 


G13.SI - Genting Singapore resumed their buyback program today, buying back 9.2 million shares. 


Travellers International Hotel Group - Philippines casino developer and operator Travellers,  reported a 46.4-percent decline year-on-year in net profit for the three months to June 30. Such profit was PHP622.32 million (US$13.47 million) in the second quarter of 2015, compared to PHP1.16 billion in the year prior.  GGR for the period was down 10.4% YoY to PHP5.71 billion. Promotional allowances – which include revenue share with junket operators – jumped to PHP1.07 billion in the second quarter of 2015, compared to PHP304.27 million a year earlier.



RCL - Royal Caribbean is revamping its shore excursion program to appeal to passengers' special interests from adventure to family and food to animals.

As part of the new program, the line's 2,800-plus shore excursions have been grouped into seven special interest categories: Active Adventures, Family Connections, Royal Tour Challenge, Culture and Sights, Culinary Delights, Caring Discoveries and the Royal Premium Tour Collection. 



RMB Devaluation - The devaluation of the renminbi should do Macau little harm in the long run because the city still functions as an attraction for tourists from around the world and is trying to make its economy more diverse, the Monetary Authority of Macau says.  But a written statement issued by the authority emphasizes what may happen in the more distant future, saying Macau’s efforts to get more visitors from other places and to make its economy less dependent on gaming would continue.



Regional Gaming Revenues:


Connecticut - July GGR: -0.89% YoY 

Early Look

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August 14, 2015

August 14, 2015 - Screen Shot 2015 08 14 at 6.56.02 AM

RH | Catalyst Calendar Begins

Takeaway: RH Teen is a plus, but its importance will be dwarfed by how well RH is likely to execute this growth plan over the next four months.

This announcement about the launch of RH Teen is not groundbreaking by any means, but it is a positive one nonetheless, and is absolutely consistent with the path that RH needs to take in order to double its revenue by 2018 and reach $11 in earnings – a number that is $5, or ~80% above the consensus. If we’re right on our numbers – which we think we are – then that suggests a long-term CAGR in earnings and cash flow better than 40%. If that’s the case, then the current 28x forward multiple looks flat-out cheap given the growth profile.  Higher multiple on higher earnings = $140 in six months, $200 by the end of next year, and then $300 in 2017.  We detailed our math recently in our latest RH Black Book “RH | Road To $300” which outlines the longer-term, but what we think is interesting is how RH’s catalyst calendar is shaping up.  


RH | Road to $300 Black Book

Video Link: CLICK HERE

Materials: CLICK HERE


RH | Catalyst Calendar Begins - RH fin table c 


Importantly, we think that the catalyst calendar is just starting to pick up, and should be the best that RH has seen – perhaps ever. Here’s the roadmap…

1) Earnings on September 10. We’re looking for a strong, consistent quarter out of RH, with 18% revenue leveraging to 25% EPS growth. Our number is only a penny ahead of consensus, keeping in mind that management was on its convert roadshow in the final month of the quarter. It already disclosed and telegraphed everything about this quarter that we need. If there’s any surprise, it should be on the plus side. But all-in, this quarter should have the lowest volatility out of any we’ve seen in a while.

2) RH Teen -- launch on September 18, with subsequent mailing of 200-page sourcebook and dedicated space inside future design galleries.

3) RH Modern – launches within a week of RH Teen. This will have a 370-page sourcebook with a simultaneous opening of a stand-alone store on Beverly Blvd.

4) Starting Late Sept/Early Oct, Successive Design Gallery Openings In

  • Chicago (62,000 feet in the most elite part of Chicago’s Gold Coast  -- but at a non-elite cost).
  • Denver (another anchor property -- using 53,000 feet of the 90,000 left vacant by Saks at Cherry Creek).
  • Tampa (47,000 feet, which is spot on with what our real estate analysis suggests is appropriate for 10% market share and $1,200/ft).
  • Austin (47,000 feet at The Domain – likely to replace one of the two small-format stores in the area, one is just 4-miles away. That makes sense given that our math suggests that Austin could support 50-60k feet for RH).

5) Square Footage Growth Returns. Add up the four stores in the point above and we’re looking at about 210k square feet. That alone represents about 25% growth in square footage (and that’s not counting Atlanta). Keep in mind that this company went from over 100 stores pre-recession (and before having a defendable merchandise, real estate strategy, and actual management team) to 67 in the latest quarter as it culled bad locations. Square footage grew on occasion over that period in a given quarter, but has settled in around 850k. Starting in 3Q, we should see square footage growth ramp from a mid-single digit rate in 2Q to a number ~20%, then steadily march towards 35%+ in FY16. Then we’ve got 20%+ square footage growth every year thereafter for at least five years based on our real estate analysis.


So all in, there’s two new and significant merchandising initiatives, which are solid on their own. But to pair them with the square footage growth acceleration seems almost like a fantastic coincidence. But it’s not. This has been in the plan all along. There’ll be many more new concepts and classifications – though we’d argue that the company can go deep and add $2bn in revenue with what it has.


To be clear, there’s much more to this story than just square footage growth – like the ability to consistently merchandise product people want in quantities they need.  Without the ability to deliver on that requirement, a retailer could have the greatest store in the hottest location with the best demographics, and it will still be nothing but a liability (regardless of how low the rent might be). That’s why square footage growth is grinding to a halt for other US retailers. That’s also why the growth profile at RH is so powerful, and unmatchable by anyone we see in Retail today.

RH | Catalyst Calendar Begins - RH Chicago then now

Cartoon of the Day: Lonely George...

Cartoon of the Day: Lonely George... - Dollar cartoon 08.13.2015


Excerpt from a recent Hedgeye Investing Ideas newsletter:


From the perspective of foreign exchange market participants, the U.S. remains the “best house in a bad neighborhood” and we remain bullish on the U.S. dollar (UUP) as a result.

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