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"Not Loving It" | Why Tepper is Right

"[I’m] not loving it …I have problems with earnings growth [and] problems with multiples, …So I can't really call myself a bull "

- David Tepper, 9/10/15

 

Earlier today David Tepper made headlines (HERE) in advocating for higher cash allocations and defensive positioning amidst increasingly challenged fundamentals, concerns over current multiples and pervasive over-optimism around forward growth prospects.   

 

Having authored the 2015 Global #GrowthSlowing thesis, we’d agree. 

 

Tepper’s fundamental and valuation concerns are really just manifestations of our current late-cycle reality.  Given that his comments were largely a re-capitulation of our call from July and our 2Q15 Macro theme #LateCycleUSA (Here), today offers an opportune time to update the charts and re-highlight a selection of canonical late-cycle metrics. 

 

Below is a visual tour of the data.  The larger fundamental takeaway is not different than the one we’ve been voicing YTD.  Slower for longer remains the call, lower gross and net equity exposure continues to make sense and dynamically trading the risk of the immediate-term range remains the best means of tactically risk managing late-cycle market volatility.   

 

"Not Loving It" | Why Tepper is Right - Century of Cycles

   

 

Labor: Best Before the Crest | The employment data always looks best before the crest and the current labor cycle is certainly cresting.  As we highlighted in our review of initial jobless claims this morning we are now 19-months into the sub-330K environment  (ave over the last 3 cycles = 33months) and within ~a month the year-over-year rate of change will be ~0% as we beginning lapping the floor in the claims data. 

 

With the convergence to zero complete, any trending positive growth in claims activity will offer a low-intensity means of monitoring deterioration in the labor market.   There is still some modest runway for ongoing labor strength but the clock tick is getting louder.   

 

"Not Loving It" | Why Tepper is Right - Updated LT Recession Chart

 

Valuation:  Stocks Still Hoping It’s the 1990’s | The simple fact that we’re not at peak tech-bubble valuation is not particularly sweet solace.   

 

Below is an updated look at our valuation composite which represents an equal weighted composite of three of the most widely used conventional valuation metrics: Shiller PE, SPX Market Cap-to-GDP and Tobin’s Q.  

  • Shiller PE:  Inclusive of the hundred’s of billions of market cap lost in the recent correction, the Shiller PE remains above 24x and sits just south of the top decile of its historical range.  Mapping the Shiller PE by decile vs subsequent market performance suggests return expectations should move systematically lower alongside incremental increases in valuation. Historically, 1Y and 3Y returns progressively decline for each decile change in the Shiller PE.
  • Tobin’s Q:  Longer-term valuation arguments center on the premise that returns on capital should equalize to cost of capital and market values should normalize to economic value.  Tobin’s Q ratio is not a measure we use to tactically manage risk, but we can appreciate the intuition underneath its application – why buy an asset when you can “re-create” it for less and compete away existing, excess profit.   Currently, the q-ratio sits at ~1.06 and greater than 1.0 standard deviation above the long-term mean value – a level that has generally not been a harbinger of positive forward returns historically.
  • S&P 500 Market Cap-to-GDP:  Assuming the collective output of SPX constituents credibly reflects aggregate national production (or serves as a credible proxy for it), the Market Capitalization-to-GDP ratio effectively represents a price-to-sales multiple for the economy.  At current levels we are well above both the LT average and the 2007 highs.  

"Not Loving It" | Why Tepper is Right - Valuation Composite

 

 

PEAK PROFITABILITY: Earnings, Corporate Margins and collective SPX profitability all peak late-cycle and all three appear to be moving past peak in recent quarters.  Unless you think peak returns to capital provide a sustainable path to aggregate demand growth in the face of negative trend growth in real earnings, trough returns to labor, middling productivity growth and secularly depressed investment spending, then the mean reversion risk for operating margins remains asymmetrically to the downside. 

  • 2Q15:  With 2Q earning largely rearview for SPX constituents, the final score shows revenues and earnings down -3.5% and -2.2% year-over-year, respectively.  Yes, the commodity rout was an outsized impact to energy/industrial’s profitability and that collapse becomes next year’s comp but still, negative top & bottom line growth is not the stuff escape velocity, private-sector handoffs are made of or multi-year tightening cycles anchored on.   

"Not Loving It" | Why Tepper is Right - SPX Real Earnings

 

"Not Loving It" | Why Tepper is Right - SPX Operating Margin

 

"Not Loving It" | Why Tepper is Right - Corporate Profits    of GDP

 

Policy = Lost in Transmission |  The Phillips Curve and output-inflation cycle on which conventional monetary policy is based looks broken.  Meanwhile, the empirics on Janet’s hope for policy flow through to Main Street remain dismal.  Labor’s Share of National Income only rises at the tail end of an expansion and after growth and profits have been strong for a protracted period. The cratering in the latest cycle looks like some measure of a structural break and even if we follow the pattern of gains in the late innings of expansion it won’t close the gap.  Lower highs & lower lows remains the trend.  

 

"Not Loving It" | Why Tepper is Right - Labor share of income

 

Slower for Longer:  Underneath the current business cycle oscillation remain the secular realities of over-indebtedness and negative demographics.  The combination of voluntary and involuntary deleveraging in the post-crisis period has improved the aggregate household balance sheet, but certainly not enough to jumpstart another credit cycle or drive sustained debt supported consumption growth.  And while the Millennials sit as an emergent demographic force, the core consumption demographic of 35-34 year-olds will remain in retreat for the balance of the decade – across all the major DM economies.   

 

"Not Loving It" | Why Tepper is Right - HH Debt to GDP

 

"Not Loving It" | Why Tepper is Right - Demographics CC

 

 

Christian B. Drake

@HedgeyeUSA

 


Investing Ideas | New Macro Insight from Keith McCullough

Dear Investing Ideas Subscriber,

 

We are excited to present to you the inaugural edition of our new Macro Overlay video series. This new addition is exclusively for Investing Ideas subscribers. When conditions warrant, Hedgeye CEO Keith McCullough will distill and contextualize current global macro and market developments and the key takeaways you can apply to the names on our Investing Ideas list.  

 

 

In today’s Macro Overlay, Keith ranks the current names on our list from a broader, macro perspective, explains what “style factors” are,  and walks through specific, risk management tactics he employed as a hedge fund manager.

 

We hope you enjoy this new feature. If you have a minute, let us know what you think!

 

Finally, always feel free to contact with any questions or feedback you might have.

 

Thank you for your business.

 

All Best,

Team Hedgeye

 

 


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LULU | In Search of TAIL

Takeaway: This qtr was a mess due to factors far beyond financials. LULU isn’t articulating a cogent plan – bc it probably doesn’t have one.

There’s one major reason why we think this LULU quarter was a huge let down -- and it’s not that inventories were up 23 days while Gross Margins missed by 200bps. Nor is it that LULU added $62mm in revenue year over year, but generated $1mm less in EBIT.  It’s the reality that this company does not know what it wants to be. Virtually every statement out of management on the call had to do with near-term tactical branding, marketing and product plans. All that is fine. It matters on some level – and definitely matters to small scale moves in the stock in the coming quarters. But that’s what we call TREND (in HedgeyeSpeak that translates to 2-3 quarters out – the near-term modeling horizon). This is where LULU lives, unfortunately.

 

But LULU needs a change of address. This is an extremely powerful brand in a solid, yet increasingly competitive, space. LULU needs to not only be a great brand, but a great company. Then and only then will it be a great stock. We think management is coasting on the power of the brand, by tweaking a legacy operating plan, blindly opening stores, and hoping that nothing else goes wrong. Hope, however, is not a profitable growth process.

 

LULU needs to live in the TAIL (which we define as 1-3 years). What we need for real wealth creation with this stock is for a clear, concise strategy that insiders rally around and are paid handsomely to implement. People need to look to $4.00 in earnings power, and believe in it. It’s that same strategy that would result in its CEO standing up and saying things that will make Nike, UnderArmour and Athleta quake in their boots (which used to be the case) – not that they are using ‘Sports Psychology on the Pant wall’.  Unfortunately, we truly think that LULU does not have a proactive process to grow its business.

 

Does The Company Have A Long Term Plan?

Somebody, please, ask virtually anyone in the company if they know their market share in stores and online within an hour’s drive of each store. [Note: our math shows it ranges from 2.5% (Long Island) to 26.7% (Burlington Vt) -- ping us if you want the data]. We don’t think they’ll tell you – because they probably don’t know.

 

How can a CEO stand up and give credible growth and profitability targets without knowing these basic building blocks?  How can they articulate why they don’t have a wholesale model – something that could be a home run for LULU (i.e. sell where the consumer shops)?  Even the CFO, who we have/had high hopes for, hasn’t created his own identity with the Street – as he’s following the same script of his predecessor who was pushed out.

 

All we get from the company as it relates to strategic initiatives are 1) Brand, 2) Community, 3) Innovation, and 4) Guest Experience.  The only quantified metric is that LULU will return to a 55% gross margin – something that we don’t think is realistic without meaningful backing by the balance sheet (i.e. more capex to boost profitability). But more importantly, the market is highly unlikely to pay for a passive goal to return to peak profitability when LULU is in a different stage of its growth cycle.

 

This is a great Brand, for the time being. We really want to get behind this story due to the potential that can be unlocked. But without the backing of a great company – we think this stock is going anywhere but up. We’re glad we pulled the plug in March.

 

LULU | In Search of TAIL - SIGMA LULU


REPLAY | Healthcare Q&A | #ACATaper, Jobs Report & Top Stock Ideas

Takeaway: Join us at 12:00PM for a live presentation on #ACATaper, the most recent Jobs Report, updates on our Top Ideas & an anonymous Q&A session.

Watch the replay

 

Our healthcare team presented on #ACATaper, the most recent Jobs Report and updates on our Top Ideas. As always, our analysts Tom Tobin and Andrew Freedman answered questions from viewers live.


INITIAL JOBLESS CLAIMS | LATE CYCLE IS AS LATE CYCLE DOES

Takeaway: Claims remain steady but the cycle grows longer in the tooth by the week.

Below is the breakdown of this morning's labor data from Joshua Steiner and the Hedgeye Financials team. If you would like to setup a call with Josh or Jonathan or trial their research, please contact 

 

3, 2, 1 ... Countdown

Claims remain on a countdown ...  We're now 19 months into the sub-330k environment. For reference, the last three cycles saw claims stay below 330k for 24, 45 and 31 months, respectively before the cycle gave way to recession. The average of those three cycles is 33 months. This implies ~14mos of track to the average of the last three cycles. Obviously, this is simply a reference point and the duration could more closely resemble that of the late 1980s (24mos), which would imply ~5mos of track remaining, or that of the late 1990s (45mos) implying ~26mos of track. 

 

One thing that's more certain and more imminent is the re-convergence toward zero in the rate of change Y/Y. This week that rate of change compressed to -6.6%, down from -9.1% in the prior week. We're finally lapping the floor in claims and within a month the Y/Y rate of change will be ~0%. From that point on, flagging early stage deterioration in the labor market will be a function of noticing any persistent and/or trending rise in Y/Y claims activity.

 

INITIAL JOBLESS CLAIMS | LATE CYCLE IS AS LATE CYCLE DOES - Updated LT Recession Chart

 

 

The Data

Prior to revision, initial jobless claims fell 7k to 275k from 282k WoW, as the prior week's number was revised down by -1k to 281k. The headline (unrevised) number shows claims were lower by 6k WoW.

 

Meanwhile, the 4-week rolling average of seasonally-adjusted claims rose 0.5k WoW to 275.75k. The 4-week rolling average of NSA claims, another way of evaluating the data, was -6.6% lower YoY, which is a sequential deterioration versus the previous week's YoY change of -9.1%.

 

INITIAL JOBLESS CLAIMS | LATE CYCLE IS AS LATE CYCLE DOES - Claims2 normal  4

 

INITIAL JOBLESS CLAIMS | LATE CYCLE IS AS LATE CYCLE DOES - Claims3 normal  4

 

INITIAL JOBLESS CLAIMS | LATE CYCLE IS AS LATE CYCLE DOES - Claims4 normal  4

 

INITIAL JOBLESS CLAIMS | LATE CYCLE IS AS LATE CYCLE DOES - Claims5 normal  4

 

INITIAL JOBLESS CLAIMS | LATE CYCLE IS AS LATE CYCLE DOES - Claims6 normal  4

 

INITIAL JOBLESS CLAIMS | LATE CYCLE IS AS LATE CYCLE DOES - Claims7 normal  4

 

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.28%
  • SHORT SIGNALS 78.51%
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