This is a complimentary excerpt from today's Early Look written by Hedgeye CEO Keith McCullough. Click here and subscribe if you're serious about staying ahead of the consensus herd.
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...As I look at what I call the downside of the “probable range” in Global Equity markets this morning, for the first time in my career I don’t think I want to be right.
That’s a tough thing for me to write because the goal of the game is to be right. We’ve spent the last 7-8 years trying to evolve the Global Macro risk management #process to the point where many aren’t unprepared for this. Unfortunately, many are.
Rather than depress you with words, let me just show you the numbers my models showed me:
- SP500 has immediate-term downside of -8.3% to 1822
- Russell 2000 has immediate-term downside of -6.3% to 1080
Takeaway: Defensive positioning within homebuilders has paid off in 3Q. DHI and NVR are the only two builders with positive MTD performance.
Our FMHQ (Friday Morning Housing Quant) tables present the state of the publicly traded homebuilders in a visually-friendly, quantitative format that takes about 60 seconds to consume.
Quick Quant Takeaways:
- Performance Roundup: Housing continues to outperform the market YTD as XHB (+6.0%), ITB (+6.8%) and S5HOME (+10.6%) are running +9-14% ahead of the S&P 500 (-3.5%). The Best builders YTD are DHI (+19.9%), NVR (+18.4%) and MTH (+15.6%), while the laggards are HOV (-58.1%) and BZH (-14.7%). Interestingly, in spite of a rough August all around, the strongest MTD performances have also come from DHI (+2.1%) and NVR (+1.3%), while HOV and BZH have led decliners (-14.4% and -13.9%, respectively).
- Insider Buying (Within Last 6mos): PHM (2), NVR (1) and KBH (1). That said, there's been no insider buying in the sector since April.
- Estimate Revisions: NTM earnings estimates in the last 3mos have been revised higher for NVR (+10.3%), DHI (+7.3%) and LEN (+4.7%). At the other side of the spectrum, NTM earnings estimates are down for HOV (-39%) and BZH (-5.6%). NTM revenue, meanwhile, saw the biggest positive revisions at KBH (+4.9%), LEN (+4.8% and DHI (+1.6%), while the biggest declines were at MDC (-4.6%) and HOV (-3.0%).
Housing Macro | ↑Income Growth: This morning’s Household Income and Spending figures for July showed aggregate Disposable and Salary & Wage Income growth accelerating on MoM/YoY/2Y Ave basis. The trend in the aggregate household P&L continues to be one of improvement as solid monthly labor market gains and positive mix in hiring have continued to drive rising income growth. While the rising savings rate has muted the translation to actual consumption growth, it’s hard to characterize rising incomes and rising savings as fundamentally negative developments and, for housing, that duality remains supportive of rising headship rates and housing consumption broadly (see last table below).
Joshua Steiner, CFA
Christian B. Drake
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Takeaway: With the VIX's closing level spiking as high as 40 intra-week, exchange volume across the board rocketed higher.
Weekly Activity Wrap Up
With the VIX's closing level spiking as high as 40.7 in the 5 days ending August 27th, exchange volume followed suit and rocketed higher. U.S. cash equity volume averaged 11.2 billion shares for the week, after trending at just 6.7 billion shares per day for the first 7 weeks of the third quarter. Growth in U.S. stock trading for the third quarter is now running at +28% Y/Y and +15% Q/Q respectively. U.S. equity options activity averaged an astounding 29.0 million contracts this week (with the 3Q average prior to the most recent 5 days having averaged just 17.4 million contract per day). Year-over-year growth in U.S. options is now tracking at +20%. U.S. futures activity, which had been comping negatively for much of the third quarter, is now positive after this week's volume ramp. U.S. futures activity hit 31.0 million contracts this week (the combination of CME Group and ICE Futures U.S. activity) compared the the 3Q average prior to the past 5 days of just 17.2 million contracts. Our Best Idea in the sector continues to be the CME Group (CME) with $5 per share in earnings power and a $140 per share fair value in our view.
U.S. Cash Equity Detail
U.S. cash equity trading finished the week at 11.2 billion shares traded which is blending to a 7.3 billion daily average thus far for the 3rd quarter of 2015. This is +28% year-over-year growth for U.S. stock activity. The market share battle for volume is mixed. The New York Stock Exchange/ICE's share of third-quarter volume grew to 25% from 24% in the prior week. Additionally, NASDAQ's share grew to 19% from 18% in the prior week but remains 100 bps lower than last year, a -4% decline.
U.S. Options Detail
U.S. options activity remains significantly higher, both quarter-over-quarter and year-over-year. 29.0 million contracts traded this week which is blending 3Q15 activity to 18.9 million contracts per day, up +25% quarter-over-quarter and +20% year-over-year. The market share battle amongst venues continues to be one of losses at both the NYSE/ICE and NASDAQ. NYSE has lost 400 basis points of share year-over-year settling at just 18% of options trading currently. NASDAQ has shed 300 basis points of share, good for a -15% loss from last year as ISE/Deutsche Boerse and BATS mop up volume and share.
U.S. Futures Detail
CME Group volume came in this week at 25.5 million contracts. That blends 3Q15 volume to a 14.5 million average level, a +7% year-over-year expansion. Additionally, CME open interest, the most important beacon of forward activity, continues in strong fashion. 103.3 million CME contracts are pending, good for +23% growth over the 84.1 million pending at the beginning of 2014, although a contraction from the prior week's +25%.
Activity levels on the futures side at ICE hit 5.5 million contracts this week, with 3Q15 blending to a 4.4 million daily average. Even with this week's volume ramp, 3Q15 year-over-year growth remains negative at -2%. ICE open interest this week tallied 72.8 million contracts, a -3% contraction versus the 75.2 million contracts open at the beginning of 2014. That marks a deterioration versus the prior week's -2% level.
Monthly Historical View
Monthly activity levels give a broader perspective of exchange based trends. As volatility levels, measured by the VIX, MOVE, and FX Vol should rise to normal levels after the drastic compression this cycle, we expect all marketplaces to experience higher activity levels.
Sector Revenue Exposure
The exchange sector has broadly diversified its revenue exposure over 10 years as public entities with varying top line sensitivity to the enclosed trading volume data. The table below highlights how trading volumes will flow through the various operating models at NASDAQ, CME Group, ICE, and Virtu:
We recently presented our investment thesis on the Exchanges. To summarize,
- Long CME: Financially oriented CME Group (CME) is enjoying a long awaited boom in activity, as trader counts and open interest in Treasuries, Eurodollars, and FX products are swelling. The decade long concentration on trading energy and commodities is over and with steeply shaped forward curves and more profitable opportunities, financial products are seeing rapid adoption.
- Short ICE: We see collateral damage from the ongoing rapid price decline in energy and commodity markets. As a result, these important products at ICE will be less active than the Street expects, as commercial hedging and speculative energy trading dries up.
We think CME has $5 per share in earnings power in the out year and the stock will revisit near $140. As outlined in our presentation deck and replay below, a CME long position can also be paired with a short ICE position, with favorable fundamental exposures on each side of the trade.
Separately, recent IPO Virtu (VIRT) is being valued incorrectly by the market. Our main qualm is that the company takes intraday prop risk, but has no tangible equity capital to cover any potential trading losses. Shares of VIRT are currently on our Best Ideas list as a short with a fair value in the mid-teens (30-40% downside).
Hedgeye Exchange Black Book Replay HERE
Hedgeye Exchanges Black Book Materials HERE
Please let us know of any questions,
Jonathan Casteleyn, CFA, CMT
Joshua Steiner, CFA
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