Stock Report: Zimmer Biomet (ZBH)

Takeaway: We added Zimmer Biomet to Investing Ideas on the short side on 9/4.

Stock Report: Zimmer Biomet (ZBH) - z 1 ZBH table 9 11 15




Zimmer Biomet (ZBH) is in the crosshairs of a number of our Healthcare themes. 


The first, and specific to ZBH, is our view that the demographic drivers of knee joint replacement are well past peak and in a secular decline.  We did what we believe is a thorough analysis of the contribution of aging and obesity to the population of people with severe osteoarthritis of the knee.  What we found was a market that peaked in 1990s and has likely drawn down the majority of eligible patients as implant rates per capita rose faster than the underlying patient population growth. 


Second, affordability of medical spending has peaked in the United States with deflationary pressures mounting and being expressed through policy changes alongside the broadening adoption of IT systems.  Better information systems and price transparency are likely to have an increasingly negative impact on device costs with orthopedic devices sitting at the top of the spending list.  


On a related note, Medicare recently initiated an aggressive global payment policy (CCRJ) which we expect to create a strong incentive for providers to pressure device costs. 


We believe the #ACATaper is emerging over the coming months as the newly insured revert to spending levels similar levels as seen with typical insured populations.  We’ve documented several instances where the newly insured consumed medical care at elevated rates during the initial rollout of this historic program, with evidence that knee replacement volume saw a dramatic increase.


Lastly, the Biomet merger (while accretive) is not the solution for ZBH shares.  Cost synergies are rarely a positive when organic growth is slowing.  


INTERMEDIATE TERM (TREND) (the next 3 months or more)


We do not expect fundamental misses of dramatic size in the intermediate term.  However, employment growth slowing and fears of a recession will certainly dampen investor appetite for what is viewed as an elective procedure.  



LONG-TERM (TAIL) (the next 3 years or less)


Our team's long-term view calls for slowing/declining unit volume and deteriorating pricing.  The impact to gross margins should be significant with very little spending flexibility within the organization. 


Stock Report: Zimmer Biomet (ZBH) - z 2 ZBH chart 9 11 15

HEDGEYE Exchange Tracker | Futures Rising From Their Summer Lull

Takeaway: Futures maintained their recently strong activity levels bringing QTD activity to +7% y/y growth, breaking out of a summer lull.

Weekly Activity Wrap Up

The Labor Day holiday couldn't pause futures activity (the combination of CME Group and ICE Futures U.S. activity) which came in strongly this week at an average 18.9 million contracts per day, exceeding the third-quarter-to-date average of 18.7 million. That brings the third quarter to a +7% year-over-year and +6% quarter-over-quarter expansion. Our Best Idea in the sector continues to be the CME Group (CME). As the chart below shows, volatility tends to be seasonally high as we move into the "back to work" months of September and October and CME Group exchange volumes have already begun to benefit from this trend. See our recent note on the company which highlights the back-end-loaded nature of the stock's returns given historical Fall volatility and a year-end special dividend.


HEDGEYE Exchange Tracker | Futures Rising From Their Summer Lull - XMon18


U.S. cash equity and options activity for the week were both lower than their 3QTD averages in light of the holiday. However, both categories continue to show impressive year-over-year and quarter-over-quarter growth. U.S. cash equity volume averaged 6.8 billion shares this week, bringing the third quarter to a 7.3 billion ADV, an expansion of +29% Y/Y and +15% Q/Q. U.S. equity options activity averaged 15.7 million contracts this week. Year-over-year growth in U.S. options is tracking at +17%.


HEDGEYE Exchange Tracker | Futures Rising From Their Summer Lull - XMon1


U.S. Cash Equity Detail

U.S. cash equity trading finished the week at 6.8 billion shares traded which is blending to a 7.3 billion daily average thus far for the 3rd quarter of 2015. This is +29% 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 remains at 24%. NASDAQ's share also remained unchanged week over week at 19%, 100 bps lower than last year, a -4% decline.


HEDGEYE Exchange Tracker | Futures Rising From Their Summer Lull - XMon2


HEDGEYE Exchange Tracker | Futures Rising From Their Summer Lull - XMon3


U.S. Options Detail

U.S. options activity came in at a 15.7 million ADV this week which is blending 3Q15 activity to 18.4 million contracts per day, up +22% quarter-over-quarter and +17% 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.


HEDGEYE Exchange Tracker | Futures Rising From Their Summer Lull - XMon4


HEDGEYE Exchange Tracker | Futures Rising From Their Summer Lull - XMon5


U.S. Futures Detail

CME Group volume came in this week at 15.0 million contracts. That blends 3Q15 volume to a 14.6 million average level, a +8% year-over-year expansion. Additionally, CME open interest, the most important beacon of forward activity, continues in strong fashion. 104.8 million CME contracts are pending, good for +25% growth over the 84.1 million pending at the beginning of 2014, an expansion from the prior week's +23%.


Activity levels on the futures side at ICE hit 3.9 million contracts this week, with 3Q15 blending to a 4.1 million daily average, a +2% year-over-year expansion. ICE open interest this week tallied 64.9 million contracts, a -6% contraction versus the 69.2 million contracts open at the beginning of 2014, an improvement from the prior week's -8%.


HEDGEYE Exchange Tracker | Futures Rising From Their Summer Lull - XMon6


HEDGEYE Exchange Tracker | Futures Rising From Their Summer Lull - XMon8


HEDGEYE Exchange Tracker | Futures Rising From Their Summer Lull - XMon7


HEDGEYE Exchange Tracker | Futures Rising From Their Summer Lull - XMon9


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.


HEDGEYE Exchange Tracker | Futures Rising From Their Summer Lull - XMon10


HEDGEYE Exchange Tracker | Futures Rising From Their Summer Lull - XMon11


HEDGEYE Exchange Tracker | Futures Rising From Their Summer Lull - XMon12


HEDGEYE Exchange Tracker | Futures Rising From Their Summer Lull - XMon13


HEDGEYE Exchange Tracker | Futures Rising From Their Summer Lull - XMon14

 HEDGEYE Exchange Tracker | Futures Rising From Their Summer Lull - XMon15


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:


HEDGEYE Exchange Tracker | Futures Rising From Their Summer Lull - XMon19 3




 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


HEDGEYE Exchange Tracker | Futures Rising From Their Summer Lull - XMon20


 Please let us know of any questions,


Jonathan Casteleyn, CFA, CMT 




 Joshua Steiner, CFA





Cartoon of the Day: Slow Growth Gorilla!

Cartoon of the Day: Slow Growth Gorilla! - Slow growth cartoon 09.11.2015 copy


Below is an abridged excerpt from today's Early Look:


A little bit of a #TepperTantrum yesterday from the Appaloosa Management founder and stalwart bull. 


Advocating higher cash allocations, highlighting higher volatility and increasingly challenged corporate fundamentals, voicing concerns over current multiples and pervasive over-optimism around forward growth prospects.   


Sound familiar?


Tepper’s fundamental and valuation concerns are really just manifestations of our current late-cycle reality and a recapitulation of our 2Q15 #LateCycle Macro Theme.   


We don’t always agree with Tepper but, when we do, we like to do it 3-months and 150 SPX handles ago.


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LNKD: Tracker Update (Talent Solutions)

Takeaway: Our tracker suggests an improving selling environment into 3Q15, reinforcing our view that mgmt was crying wolf with its organic guide down.


  1. TRACKER SUGGESTS IMPROVING SELLING ENVIRONMENT: Our LNKD JOLTS tracker is accelerating early into 3Q15, suggesting an improving selling environment.  Our tracker has produced a relatively tight correlation with LNKD's Talent Solutions ARPA dating back to 1Q11 (~0.75).  As a reminder, our LNKD Talent Solutions TAM analysis suggest the bulk of that TAM is in the upsell opportunity (ARPA) vs. new account volume.  See 2nd note below for detail.  
  2. GUIDANCE = WORST-CASE SCENARIO: Our conversation with IR and our review of the 10-Q solidified our view that LNKD all but removed Display Advertising revenue from its guidance (see 1st note below).  That said, we see Talent Solutions as the swing factor moving forward, and LNKD doesn't need much to handily beat rebased 2H15 consensus revenue estimates (see scenario analysis below).  The improving selling environment mentioned above further reinforces our view that mgmt cried wolf (again) when it cut organic guidance on its last print.  


See the notes below for supporting detail/analysis on our Long thesis.  Let us know if you have any questions or would like to discuss further.


Hesham Shaaban, CFA



LNKD: Tracker Update (Talent Solutions) - LNKD   ARPA vs. JOLTS 3Q15

LNKD: Tracker Update (Talent Solutions) - LNKD   TS Scen 2015 3Q15 


LNKD: Notes from 10-Q & IR
08/26/15 10:35 AM EDT
[click here


LNKD: New Best Idea (Long)
07/14/15 08:00 AM EDT
[click here]

[UNLOCKED Early Look] Problems

***This is a complimentary look at the Hedgeye Early Look. While typically written by CEO Keith McCullough, today's note was written by U.S. Macro analyst Christian Drake. We encourage you to consider subscribing and leaving tired consensus research behind.

"[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

The big picture

A little bit of a #TepperTantrum yesterday from the Appaloosa Management founder and stalwart bull. 


Advocating higher cash allocations, highlighting higher volatility and increasingly challenged corporate fundamentals, voicing concerns over current multiples and pervasive over-optimism around forward growth prospects.   


Sound familiar?


Tepper’s fundamental and valuation concerns are really just manifestations of our current late-cycle reality and a recapitulation of our 2Q15 #LateCycle Macro Theme.   


We don’t always agree with Tepper but, when we do, we like to do it 3-months and 150 SPX handles ago.

[UNLOCKED Early Look] Problems - buzz the tower NEW 09.05.2014

(The prescient cartoon above was published one year ago this month.)

Macro grind

Since 2 & 20 sourced soundbites still grab more headlines than Hedgeye’s #BlueCollarMacro mouthpiece, Tepper’s comments yesterday offer a worthwhile opportunity to review some of the fundamental market data and contextualize the current expansion within the historical late-cycle experience. 


First, The Cycle:  Let’s take a quick step back to re-remember the archetypical economic cycle – from the perspective of the current cadre of policy makers. 


Macro cycles, left to themselves, follow a pattern that largely resembles the circular, counter-clockwise flow captured in the inflation-output loop depicted in the 1st Chart of the Day below.    


The conventional view is that the level of output drives inflation which, in turn, drives the policy response. These output-inflation cycles were the prevailing macro reality when the present global policy making oligopoly was coming of age and conventional monetary policy is designed to function within the context of this naturally evolving cycle.  


The broader goal of current policy efforts is to both jump-start and subsequently smooth such a cycle in the face of persistent cyclical challenges and glacial secular shiftings.  

[UNLOCKED Early Look] Problems - z CoD1


The Phillips Curve and the aforementioned output-inflation cycle on which conventional monetary policy is based has been so loose over the last 2 cycles (& the present one) as to be non-existent.


Meanwhile, the empirics on Janet’s hoped for policy flow through to Main Street remain dismal.  Labor’s Share of National Income – which, historically, only rises at the tail end of an expansion and after growth and profits have been strong for a protracted period – remains at a multi-decade trough.   Even if we follow the pattern of gains in the late innings of expansion it won’t close the gap – and, if it does, it will likely come alongside a step function move lower in corporate profitability and EPS growth.  


The other side of rising inequality and top-heavy income distributions is lower highs and lower lows for labor income.    



Valuation is not a catalyst and from a short-to-medium term risk management perspective, it sits somewhere near the middle-bottom of our consideration hierarchy.


That said, over the longer-term, valuation certainly matters in anchoring return expectations and we don’t discount it as a factor completely, particularly as it moves towards extremes in either direction. Underneath the technicals, acute policy catalysts, and reflexivity that drives immediate and intermediate term price trends sits the steady drumbeat of fundamentals and an accordion-like tether to ‘fair value’. 


Because investor’s maintain varying proclivities for particular multiples and conceptual valuation frameworks, one measure we track is a 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.  


We review each in turn below but the broader conclusion is straightforward:  current valuations are richer than at any point except the nose-bleed tech bubble highs.  As we’ve highlighted, lower neutral policy rates and perma central bank interventionism may indeed be supportive of higher mean valuations but that only modestly dilutes the conclusion.  When valuations are in the top decile of LT historical averages, subsequent returns over medium and longer-term periods are just not that compelling.   

  • 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.   Historically, at extremes, it has served as a solid lead signal for subsequent market performance.  Currently, the q-ratio sits at ~1.06 and greater than 1.3 standard deviations 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.  


The Chart of the Day below shows the valuation composite using the most recent data for the respective metrics. 



Earnings, Corporate Margins and collective SPX profitability all peak mid-to-late-cycle and the last few quarters of data suggest we’re probably past peak in the current cycle (ping sales@hedgeye if you’d like to review our 2Q/3Q Macro Themes decks). 


In a low-to-no growth environment where the pie size stays the same, peak margins are good until they aren’t and are probably a symptom of policy ineffectiveness (in terms of flow thought to Main St.) more than not.  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:  As Keith highlighted yesterday, 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 this year’s 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.   

[UNLOCKED Early Look] Problems - zxx

Our levels

Our immediate-term Global Macro Risk Ranges (with our intermediate-term TREND call in brackets)


UST 10yr Yield 2.12-2.24% (bearish)

SPX 1903-1997 (bearish)

VIX 21.70-30.93 (bullish)
Oil (WTI) 42.43-48.17 (bearish)

Gold 1101-1147 (bullish)


Turning away from the market myopia for a moment before closing. 


Today is Patriot Day.  To those who serve(d) in the military and those, more broadly, who go underpaid and underappreciated in service of our greater good, your selflessness does not go unnoticed and your sacrifice will not be forgotten.  We are sincerely grateful for your effort.


To hope & humanism, doing the right thing when no one is looking and blue collar alpha,


Christian B. Drake

U.S. Macro Analyst


[UNLOCKED Early Look] Problems - z CoD 2

XLU: We Are Removing Utilities From Investing Ideas

Takeaway: We are removing Utilities from Investing Ideas today.

Please be advised that we are removing Utilities (XLU) from Investing Ideas today.


The note below from CEO Keith McCullough recently issued in Real-Time Alerts provides some contextual analysis behind the decision on everything yield-based.


XLU: We Are Removing Utilities From Investing Ideas - z xlu


*  *  *  *  *


With TLT doing it's job (again) +1% on the day in another down US stock market tape, this is not an easy signal for me to send out - and maybe that is precisely the point...


I spend a lot of time thinking about what our GIP Model (Growth, Inflation, Policy) is signaling. When we have heightening convictions on what we call a Phase Transition (going from bearish to bullish TREND or vice versa), we make that call.


Updated examples of that are as follows:


1. GROWTH - signaled bullish (growth accelerating) coming out of 2012, then bearish (slowing) here in 2015

2. INFLATION - signaled #Deflation in Q3 of 2014 and have not yet signaled any Phase Transition from that TREND


The problem with making a call on POLICY (from here into the Fed meeting next week) is that I have no idea what the Fed is going to do. My confusion on POLICY risk should not to be confused with:


A) What they should have done - started raising rates in SEP 2013, so that they'd have room to cut, eventually and/or

B) What they should do now - nothing as tightening into a slowdown isn't modern day monetary policy rules 


What scares the hell out of me is that they still don't know what they want to do - and they have to decide within a week.


Will that decision be based on what the US Equity Futures do in the next 3 hours or 3 days of trading? Or will it be based on "proving they can" despite Fund Fund Futures saying they shouldn't? 


Consensus Macro may not, but we know growth (globally and locally) is slowing. We don't know what Janet Yellen is going to do with that. So I'd rather take down some Treasury Bond market exposure to an open-the-envelope event, then revisit on the event.


I've never gone broke getting out of the way when I wasn't highly convicted in the next move. This SELL (some) signal is consistent with both my track record in markets and life in general.



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