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Investing Ideas Newsletter

Takeaway: Current Investing Ideas: WAB, ZBH, GLD, MCD, RH, LNKD, ZOES, FNGN, FL, PENN, GIS, EDV & TLT

Investing Ideas Newsletter       - central bankers cartoon 09.08.2015

 

Below are our analysts’ updates on our thirteen current high conviction long and short investing ideas. Please note that we added Wabtec (WAB) to the short bench this week. In addition, we removed Utilities (XLU) from the long side. We feature CEO Keith McCullough’s updated levels for each ticker below.  

LEVELS

Investing Ideas Newsletter       - z levs

Trade :: Trend :: Tail Process - These are three durations over which we analyze investment ideas and themes. Hedgeye has created a process as a way of characterizing our investment ideas and their risk profiles, to fit the investing strategies and preferences of our subscribers.

  • "Trade" is a duration of 3 weeks or less
  • "Trend" is a duration of 3 months or more
  • "Tail" is a duration of 3 years or les

IDEAS UPDATES

RH

To view our analyst's original note on Restoration Hardware: CLICK HERE

 

This was a textbook print from Restoration Hardware – or for any company, for that matter. In case you missed it, shares finished Friday's trading up over +9%.

 

RH put up the best comp in all of US retail this quarter with 16% brand comp and 19% store comp. That drove 26% EBIT growth and 27% EPS growth.  RH beat by a penny, but took up the lower end of the year by $0.03 more than the 2Q beat. That upside is coming entirely in the fourth quarter, and as we suspected this all allowed RH to set the bar low for 3Q as revenue from new businesses will not be booked until 3Q closes in October.

 

We think all of this sets up for a beat in another 90 days, at the same time square footage growth is accelerating to 29% vs 7% in 2Q, new concepts (RH Modern/RH Teen) are in full swing, and EPS is growing 40%+. This is going to be a rough time for the bears – especially with 25% of the float short.

 

Transformational stories like Restoration Hardware are not linear, and this one certainly has not been. The stock chart over three years certainly proves that. But it also proves that the people who bought on quarterly noise have made money almost without fail.

 

If the market decides to sell off based on lower guidance in 3Q (i.e. if the after-market gains reverse), then consider it a gift.  Fundamentally and financially, we’re about to see growth at RH go on a multi-year tear. We think this stock is headed to $300 over the next 2-3 years. We’ve been patient for the catalyst calendar to begin, and the waiting is finally over.

ZBH

Our Healthcare Sector Head Tom Tobin published a stock report on Zimmer Biomet for Investing Ideas subscribers on Friday. Click here to access.

wab

We added Wabtec to the short bench on Friday. Our Industrials Sector Head Jay Van Sciver will send out a full stock report in the upcoming week.

FNGN

The report below was written by Financials Co-Sector Head Jonathan Casteleyn.

 

Financial Engines' fundamentals are solid as we expect strong 3Q15 net fund raising, a continuation from solid 2Q results, sourced by ongoing marketing campaigns in the quarter.

 

While market depreciation will be a drag (depending on exactly where beta returns shake out), we remind investors that the company is still in the seasonally strongest part of the year for AUM wins as marketing campaigns are most active in the middle two quarters historically.

 

Our research shows that the stock's return has been positive every 4th quarter calendar period since coming public with an average return of 22.6%. This stronger performance should carry through to the beginning of 2016 as the company prepares for the Wells Fargo catalyst (we calculate a $0.11 per share earnings opportunity as WFC starts to provide the firm's advisory services).

 

With a recent 2 standard deviation move in the company's valuation, but no fundamental change in our estimated $1.3 trillion in assets-under-contract (AUC) opportunity, we highlight mean reversion providing a rebound in the stock price.

 

Investing Ideas Newsletter       - z jc

LNKD

To view our analyst Hesham Shaaban's original note on LinkedIn: CLICK HERE

 

We just received our first 3Q15 update to our LinkedIn tracker. This tool gauges the strength of the selling environment for LNKD’s salesforce.  Our tracker is suggesting that the selling environment is not only improving, but doing so at an accelerating rate into 3Q15; suggesting that the organic guidance cut on LNKD’s last earnings release was not the result of any negative inflection in LNKD’s fundamental prospects.

 

We remain long LNKD into its next earnings release. 

 

We’re expecting a clean beat and raise, which we expect will be a positive catalyst for the stock, especially given the current dearth of good Internet longs. 

PENN

The update below was written by our Gaming, Lodging & Leisure team.

 

 Investing Ideas Newsletter       - z sena

 

Bottom Line here?

 

September regional gaming revenue growth should accelerate meaningfully from August and provide a catalyst for the stock. Our bull thesis on PENN appears very much intact.

GIS

Our Consumer Staples team has no material update on General Mills this week. They reiterate their bullish long-term thesis on GIS shares.

ZOES

Shares of Zoës Kitchen were up +5.4% this week, compared to a +1.7% rise for the S&P 500.

 

Our Restaurants team has no material update on ZOES. The company remains on their Best Ideas list as a long. In our team's eyes, ZOES represents the best growth story in the restaurants sector.

 

Sector Head Howard Penney believes the recent downturn in the stock represents an excellent buying opportunity for longer term investors. 

MCD 

To view our original note on McDonald's: CLICK HERE

 

McDonald’s remains on the Hedgeye Restaurants Best Ideas list as a long.

 

The company is one of Sector Head Howard Penney's favorite names. He thinks McDonald's is finally emerging from the doldrums and is doing everything they need to do to fix the company domestically.

 

Penney believes there is not only a huge inflection point coming for the profitability of the company, but also for their sales. He thinks this means Wendy’s, Jack In the Box, Sonic will suffer a bit as MCD begins to take its market share back. 

FL

The best characterization of our short Foot Locker call is that the company has done everything right over this economic cycle, such that it took net margins from -2% to +7%, and drove RNOA from 5% to 28%. As such, FL is sitting today at a peak multiple on what we believe to be peak earnings (and almost certainly peak earnings growth).

 

The problem is the lack of runway in key earnings drivers, like  changing up store banners, closing underperforming assets, and taking Nike up to 80% (from 60%). They were all tremendous profitability and margin enhancers. Unfortunately, they are irreplicable.

 

There are almost no more stores left to close outside of the normal course of business, asset swapping opportunities between banners (Locker, Lady, Champs…) are few and far between, and Nike shifting above 80% of sales – already an exceedingly unhealthy level – is very slim. In fact, one could argue that FL is Nike’s best off-balance sheet asset.

TLT | EDV | GLD

This week we rolled out 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.  If you didn’t have a chance to view it, please click here.

 

In a higher volatility, growth-slowing environment, you want low-beta exposure (stocks that move less than the market) and a larger allocation to long-term Treasuries.

 

In the video above, Keith rank-orders our top investing ideas positions from a fundamental macro and style factor perspective (low-beta, big cap liquidity, slower growth):

 

  1. Treasuries (TLT)
  2. “Something that looks like Treasuries” (EDV)
  3. Gold (GLD)
  4. Low-Beta, Big-Cap liquidity: McDonalds
  5. Low-Beta, Big Cap Liquidity: General Mills

 

To be clear, we have no idea what the Fed will say or do next week.

 

We do know that:

 

  1. They should have started raising rates in September 2013
  2. Tightening into a slowdown isn’t within the framework of modern day central policy

 

We can only stick to what the top-down market signals and ebb and flow of economic data suggests. We have a high amount of conviction that global growth continues to slow. We like long-duration bonds (TLT, EDV), and Gold (GLD) exposure if the Fed takes a dovish policy turn next week.

 

That said, our net exposure to any asset class would be next to nothing until the event is digested. For longer term investors, we remain long of the three aforementioned tickers (TLT, EDV, GLD).

 

If you are a shorter-term investor, please see here for the Real-Time Alert in TLT that we sent to subscribers on Friday (which precipitated our removal of Utilities (XLU) from Investing Ideas). We hope that it helps to bridge the gap between the two products (Real-Time Alerts being shorter-term and more tactical vs. Investing Ideas which caters to the intermediate or longer-term investor).

 

We recognize and appreciate that our current allocation may put some people to sleep. But, as we have mentioned repeatedly, our job in this tumultuous environment is to not lose money.

 

Our macro team circulated some content over different airwaves this week to highlight just how extended stock market valuations currently sit, even with the recent drawdown. Please note that we don’t anchor on valuation to manage everyday risk, but the interpretation of this data points to one of our key macro themes: #LATECYCLE

 

  • Shiller PE:  Remains above 24x (price to avg. trailing 10-year earnings ratio for S&P 500 stocks as a whole) 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
  • Tobin’s Q:  Historically, at extremes, Tobin’s Q has served as a solid lead signal for subsequent market performance.  Currently, the q-ratio sits at ~1.06 which is 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.  

Please see the chart below which is an aggregation of Shiller P/E, Tobin’s Q, and S&P 500 Market Cap-to-GDP.

 

Investing Ideas Newsletter       - z m m

 

 


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

 

THE HEDGEYE EDGE

 

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.  

TIMESPAN

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. 

ONE-YEAR TRAILING CHART

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

 

 

 

 


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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.

 


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.

KEY POINTS

  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


@HedgeyeInternet 

 

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

POLICY = LOST IN TRANSMISSION

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 = AN ANCHOR, NOT A CATALYST

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. 

 

PEAK PROFITABILITY

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


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

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