W | Lightning Rod

Takeaway: W turned out to be the unintentional lightning rod of our Home Furnishings Black Book presentation yesterday. Here's the summary and links.


Slide Deck: CLICK HERE

Video Replay: CLICK HERE


W turned out to be the unintentional lightning rod of our Home Furnishings Black Book presentation yesterday. Here's the summary and links.


Full Text (in larger font) is below.

W  |  Lightning Rod - W chart1


This chart show the percent of people within each income bracket that are comfortable buying furniture without first touching it. 

W  |  Lightning Rod - W chart2


This chart shows that Wayfair's price points are meaningfully above what people are willing to pay. The company needs a high-end consumer, and even that might not be enough.

W  |  Lightning Rod - W chart3


CONCLUSION: We think Wayfair is a structural short. It might have RH’s sales base and market cap, but it’s unlikely to ever have RH profitability. Actually, it is very unlikely to earn a penny -- ever.  Here’s why…

1) Mono Channel does not work. Restricting sales to just the internet in this category, is just as bad as a retailer who focuses 100% on physical stores. Both are highly likely to fail over time.

2) TAM is limited. The categories that W needs to grow its business profitably skew to the higher-end consumer who is focused on aesthetic and assortment. W’s consumer is focused on Price. The competitive set there is not pretty. Of the $323bn home furnishings market, we think that just $20bn is relevant for W.  In other words, it currently has 12% share of its market. RH has 3%, IKEA 4%, WSM 6%, and PIR 1.5%.

3) The financial model does not work. Could W build from $2bn in revenue to $5bn over 3-4 years? Yes, it could. Given its solid balance sheet and lack of working capital, there’s no reason why that can’t happen. BUT, the whole time it will likely continue to lose something in the vicinity of $100mm/yr.

There will be ebbs and flows in this model when people will temporarily believe that it could make money. But let’s be clear, this is not like AMZN, who simply has to stop investing in drones and smart phones in order to make EBIT margins pop. Given Wayfair’s lack of capital intensity on the balance sheet, it has to continually invest in the P&L (SG&A) in order to grow.




CHART OF THE DAY: "It's The [CYCLE], Stupid

Editor's Note: The chart and excerpt below are from today's Early Look which was written by Hedgeye Senior Macro Analyst Darius Dale. Click here if you would like to leave lousy, consensus research behind and up your market game with the fastest-growing Independent Research platform on 2.0.

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CHART OF THE DAY: "It's The [CYCLE], Stupid - Chart of the Day


  • Bayes factor (i.e. the base effect): Roughly two-thirds of the time, the second derivative of GDP in the forecast period carries the opposite sign of the second derivative of GDP in the comparative base period. Moreover, as the Chart of the Day below shows, there is exists a considerable degree of negative cointegration between the comparative base effect and the subsequent YoY growth rate. Translation: we have a reasonable basis for knowing which direction (up or down) to adjust the base rate.


Do You QoQ?

"Prediction is very difficult, especially if it's about the future."

-Niels Bohr


Most (if not all) of you are at least somewhat familiar with Nobel Laureate Niels Bohr and his contributions to the field of physics – namely developing a working model of the atom and laying the groundwork for modern-day quantum theory.


The study of various quantitative disciplines was never really my strong suit as an undergraduate, but I did manage to sneak in a physics course during my time at Yale. Thankfully as a result, I am able to at least hazily recall learning about Bohr’s Principle of Complementarity, which states that the more accurately one property is measured, the less accurately the complimentary property is measured. Some eight or nine years later, I now wish I took better notes during that lecture(s)…


Back to the Global Macro Grind


One debate Keith and I often find ourselves engaged in with clients is the merit of reacting to headline (i.e. QoQ SAAR) GDP prints versus the merit of focusing on the underlying growth rate of the economy (i.e. YoY % change). For the purposes of retroactively explaining financial market returns and, ultimately, factor exposure selection, both growth rates are important to contextualize.


Specifically, when you backtest our GIP Model quadrants using historical return data across key asset classes and factor exposures, the key takeaways are overwhelmingly similar regardless if the second derivative of real GDP (i.e. the rate of change of the growth rate in this instance) is a function of the aforementioned tangent or secant.


For better or for worse, however, we are firmly entrenched in our preference for the latter (i.e. YoY % change) and have built a proprietary asset allocation process that responds appropriately to meaningful deviations in this key economic variable, among others. Like most frameworks, our asset allocation process remains ever-expanding alongside the cumulative intelligence, experience and bandwidth of our now six-person macro team, but one thing is for sure according to Bohr’s Principle of Complementarity: the more you are able to learn about an object’s momentum, the less you are able to discern about its position – and vice versa.


In the context of modeling the economy, the more we learn about sequential momentum, the less we are able to know about the underlying growth rate of the economy. Recall that headline GDP growth accelerated +660bps to +7.8% in the 2nd quarter of 2000 and that it accelerated +470bps to +2% in the 2nd quarter of 2008. If you were prescient in forecasting these second-derivative deltas, you could’ve bought all the stocks you wanted en route to peak-to-trough declines on the order of -49.1% and -56.8%, respectively (S&P 500).


Oh, and by the way for all the QE4 bulls out there: the Fed cut rates by -525bps during the former downturn and by -500bps (in addition to introducing QE1) during the latter downturn. If our #LateCycle Slowdown view proves prescient, investors would do well to keep that in mind as the Consensus Macro bull case for U.S. stocks shifts from “we really like them despite $100-120 crude oil” to “we love them because of falling gas prices” to “growth missed our expectations, but that’s OK because the Fed is likely to ease monetary policy again”…


Going back to the aforementioned head-fakes, it’s clear that those read-throughs on sequential momentum failed to signal pending material changes to the underlying growth rate of the economy. To cite a lesson from macroeconomics 101: the annual growth rate of real GDP is calculated by averaging the YoY growth rate recorded in each quarter. In light of this, what does 2Q15’s revised growth rate of +3.7% QoQ SAAR signal to you about the forward outlook for the underlying growth rate of the U.S. economy?


Another reason we like to focus on the secant rather than the tangent is because the former is simply easier to predict on an out-quarter basis. Intra-quarter forecasting is fairly straightforward if, like us and the Atlanta Fed’s GDPNow Tracker, you apply a predictive tracking algorithm to record and coagulate trends across key high-frequency economic data. Out-quarter forecasting is a far more difficult task.


But don’t take my whining for it; just look at our competitors’ track records:


  • Over the past five years, Bloomberg consensus forecasts for headline GDP just one quarter out have demonstrated a quarterly average tracking error of 145bps. This means that at some point within 3-6 months of any given quarter-end, Wall St. economists’ estimates for QoQ SAAR real GDP growth were off by an average of 145bps. That’s flat-out terrible in the context of actual reported QoQ SAAR growth rates averaging just 2.1% over this period.
  • Over the past five years, the FOMC’s intra-year U.S. GDP forecasts have demonstrated an annual average tracking error of 100bps. Worse, the maximum deviation of their intra-year forecasts from the actual reported annual real GDP growth rate was an upside deviation in every single year, meaning that the Fed’s growth forecasts are consistently far too optimistic.


Moving along, as the guy on our team responsible for generating our GDP estimates, how am I going have a reasonable basis for predicting the sequential growth rate in 4Q15 if I do not yet know what GDP is in 3Q15? What if my 3Q15 estimate is wrong? In the context of tens of basis points making all the difference between noteworthy accelerations or decelerations, multiplying a mistake by four for the purposes of annualizing the growth rate can lead to costly errors.


At least in attempting to calculate out-quarter YoY estimates, we are equipped with a base rate that is far more useful than the prior QoQ SAAR reading and a Bayes factor that is substantially more robust:


  • Base rate (i.e. the prior reported growth rate): Over the trailing 10Y, the standard deviation of the YoY growth rate of real GDP is 30% less than that of the headline growth rate (186bps vs. 267bps). Translation: YoY readings are considerably less volatile, which implies the most recently reported growth rate is a far better starting point for the purposes of forecasting YoY % changes than it is for forecasting QoQ SAAR % changes.
  • Bayes factor (i.e. the base effect): Roughly two-thirds of the time, the second derivative of GDP in the forecast period carries the opposite sign of the second derivative of GDP in the comparative base period. Moreover, as the Chart of the Day below shows, there is exists a considerable degree of negative cointegration between the comparative base effect and the subsequent YoY growth rate. Translation: we have a reasonable basis for knowing which direction (up or down) to adjust the base rate.


Going back to Bohr’s Principle of Complementarity one last time, what buy-side analyst in their right mind would analyze a cyclical on a sequential growth rate basis? If that made even a lick of sense, we’d all be buying retailer stocks hand-over-fist into every fourth quarter of every year, in which this thing called “the holiday season” occurs. Sure, you could probably apply a seasonal adjustment overlay to smooth obvious calendar-related deviations, but who’s to know what duration is appropriate for the historical observation period? Do you minimize it to keep current with changing dynamics within the industry or do you elongate it to account for key mean reversion thresholds across cycles? I, for one, have no idea what the right answer is and this dilemma is at least part of the reason why the BEA – i.e. the government organization responsible for reporting GDP – struggles mightily with its own seasonal adjustment process (CLICK HERE to learn more).


Do You QoQ? - Residual Seasonality


Again, I don’t purport to know a ton about analyzing individual companies – certainly not on a relative basis to anyone reading this note – and I’m sure there are industries where the aforementioned practices might make sense, but, on the whole, analyzing corporate operating metrics on a QoQ SAAR basis doesn’t really tell you a whole heck of a lot about the underlying health of the business on either a retroactive or prospective basis. But don’t take my word for it; try it at home for yourself.


So why the long rant about modeling principles? Because the U.S. economy is one giant cyclical – especially its most meaningful component, personal consumption (~70% of GDP), which we highlight in the chart below. As said chart emphasizes, when cyclicals bump up against a series of outright tough or incrementally tougher compares, recorded growth rates tend to slow on a trending basis; the opposite is true of recorded growth rates when encountering outright easy or incrementally easier compares.


Given that the strength of the U.S. consumer is one of the remaining catalysts (if not the only remaining catalyst) underpinning largely sanguine expectations for domestic economic growth among sell-side and Federal Reserve economists, market participants must hope that the underlying growth rate of the U.S. economy is not poised to inflect and decelerate on a trending basis as our forecasts imply it likely to do for the foreseeable future. Hope, however, is not an investment process.


But then again, the science of prediction is very difficult – especially when said predictions are about the future…


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.99-2.21% (bearish)

SPX 1 (bearish)
VIX 21.69-42.27 (bullish)
EUR/USD 1.09-1.15 (neutral)
YEN 117.71-124.89 (neutral)
Oil (WTI) 35.84-48.42 (bearish)

Gold 1115-1165 (bullish)


Keep your head on a swivel,



Darius Dale



Do You QoQ? - Chart of the Day


Client Talking Points


As the central planning panic moves into its scary stage, we expect ECB President Mario Draghi to try to devalue again tomorrow at the ECB meeting; if he does, don’t forget that Down Euro (Up Dollar) = Down Oil – lots of beta in that trade.


WTI was down -10% yesterday and down another -2% this morning – that shouldn’t surprise anyone who thinks Draghi has cowbell coming. There is no support for WTI in our risk range model to $35.84.


Tons of questions on why the UST 10YR wasn’t “down more” yesterday, and not one focused on the move higher in Global Yields! Plenty of conspiracy theories out there from Bond Bears, but Spanish 10YR is as close to UST as its been – is this a sovereign credit trade developing as our #EuropeSlowing Macro Theme plays out? Eurozone #deflation of -2.1% PPI this morning.


**Tune into The Macro Show with Hedgeye CEO Keith McCullough at 9:00AM ET - CLICK HERE

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

We recently tried out the "Create Your Taste" experience at the newly remodeled McDonald’s location in Midtown East on the corner of 58th street and 3rd Ave. Walking into the newly remodeled MCD, we were greeted by the brand new self-order kiosks with attentive staff there to assist you. Customers were very interested in using the kiosks, and everyone using them seemed to be having an easy time with it.


For it being only two weeks into the process we were very impressed by the efficiency and mastery the staff is already displaying. We plan to head back to the same McDonalds location and check on their progress.



Our Gaming, Lodging & Leisure team is going to furnish a new update following their recent meeting with Penn National Gaming's management. They note that the stock has held up quite well despite increased market volatility. The bullish thesis on shares of PENN remains intact. Regional revenues remain strong in addition to the 2-year growth story, etc. Stay tuned.



As we outlined through various channels, we expect that high levels of volatility are here to stay for the foreseeable future. The biggest shift last week that we’ll call out is a bullish to more neutral intermediate-term view on the U.S. dollar which is why we added GLD to investing ideas in replace of UUP. To be clear, if growth continues to slow we want to be long of bonds (that view hasn’t changed in a year and a half).


From an asset allocation perspective here is the set-up:

  • Growth slowing: Long bonds and low-beta yield chasing sectors (TLT, EDV, XLU)
  • Shift to more dovish policy: long of GOLD as the shift weakens the value of the USD

We re-iterate the same view we’ve had since the beginning of 2014: Growth is slowing, and deflation remains a real risk (central bankers can’t solve this by talking down the currency). The fed will continue to push out the dots on “policy normalization.”

Three for the Road


VIDEO (3mins): I Am Unnerved  via @YouTube



The best way to have a good idea is to have a lot of ideas.

Dr. Linus Pauling


Total retail sales are 15% higher than they were in mid 2008, yet furniture store sales are 10% below their mid 2006 peak.

The Macro Show Replay | September 2, 2015


September 2, 2015

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