Takeaway: Widespread withdrawals in the 5 days ending September 9th erased last week's inflow into equity funds with stock ETFs also losing.
Investment Company Institute Mutual Fund Data and ETF Money Flow:
China's downward revised GDP and consternation over the upcoming FOMC meeting contributed to defensive reallocations in the 5-day period ending September 9th. Investors allocated +$3.3 billion to fixed income ETFs while withdrawing funds from all other asset classes. The spread between total fixed income products and total equity products was highly defensive with an $18.7 billion skew to fixed income, well below the average +$1.6 billion 52-week average benefiting equities. In specific ETF callouts, the S&P 500 SPDR SPY lost -$10.1 billion or a -5% net redemption while the long Treasury TLT gained +$255 million or +4% NAV gain.
Finally, defensive posturing continues to hurt domestic equity funds. The asset class lost -$3.0 billion to redemptions last week, erasing the prior week's inflow and bringing the year-to-date outflow to -$109.2 billion. T. Rowe Price (TROW) stock continues to be our Short/Avoid proxy on these trends. (See our TROW report HERE.)
In the most recent 5-day period ending September 9th, total equity mutual funds put up net outflows of -$3.2 billion, trailing the year-to-date weekly average outflow of -$273 million and the 2014 average inflow of +$620 million. The outflow was composed of international stock fund withdrawals of -$237 million and domestic stock fund withdrawals of -$3.0 billion. International equity funds have had positive flows in 46 of the last 52 weeks while domestic equity funds have had only 10 weeks of positive flows over the same time period.
Fixed income mutual funds put up net outflows of -$2.4 billion, trailing the year-to-date weekly average inflow of +$551 million and the 2014 average inflow of +$926 million. The outflow was composed of tax-free or municipal bond funds withdrawals of -$191 million and taxable bond funds withdrawals of -$2.2 billion.
Equity ETFs had net redemptions of -$14.7 billion, trailing the year-to-date weekly average inflow of +$1.5 billion and the 2014 average inflow of +$3.2 billion. Fixed income ETFs had net inflows of +$3.3 billion, outpacing the year-to-date weekly average inflow of +$1.1 billion and the 2014 average inflow of +$1.0 billion.
Mutual fund flow data is collected weekly from the Investment Company Institute (ICI) and represents a survey of 95% of the investment management industry's mutual fund assets. Mutual fund data largely reflects the actions of retail investors. Exchange traded fund (ETF) information is extracted from Bloomberg and is matched to the same weekly reporting schedule as the ICI mutual fund data. According to industry leader Blackrock (BLK), U.S. ETF participation is 60% institutional investors and 40% retail investors.
Most Recent 12 Week Flow in Millions by Mutual Fund Product: Chart data is the most recent 12 weeks from the ICI mutual fund survey and includes the weekly average for 2014 and the weekly year-to-date average for 2015:
Cumulative Annual Flow in Millions by Mutual Fund Product: Chart data is the cumulative fund flow from the ICI mutual fund survey for each year starting with 2008.
Most Recent 12 Week Flow within Equity and Fixed Income Exchange Traded Funds: Chart data is the most recent 12 weeks from Bloomberg's ETF database (matched to the Wednesday to Wednesday reporting format of the ICI), the weekly average for 2014, and the weekly year-to-date average for 2015. In the third table are the results of the weekly flows into and out of the major market and sector SPDRs:
Sector and Asset Class Weekly ETF and Year-to-Date Results: In a defensive move, investors withdrew -$10.1 billion or -5% from the S&P 500 SPY ETF and contributed +$255 million or +4% to the long treasury TLT.
Cumulative Annual Flow in Millions within Equity and Fixed Income Exchange Traded Funds: Chart data is the cumulative fund flow from Bloomberg's ETF database for each year starting with 2013.
The net of total equity mutual fund and ETF flows against total bond mutual fund and ETF flows totaled a negative -$18.7 billion spread for the week (-$17.9 billion of total equity outflow net of the +$854 million inflow to fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52-week moving average is +$1.6 billion (more positive money flow to equities) with a 52-week high of +$27.9 billion (more positive money flow to equities) and a 52-week low of -$18.7 billion (negative numbers imply more positive money flow to bonds for the week.)
Exposures: The weekly data herein is important for the public asset managers with trends in mutual funds and ETFs impacting the companies with the following estimated revenue impact:
Jonathan Casteleyn, CFA, CMT
Joshua Steiner, CFA
Excerpt from a Real-Time Alert signal issued last week by Keith McCullough:
...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.
Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.
We remain SHORT small-cap hamburger chains SONC, WEN and JACK. Expectations (and valuations) for those companies are not aligned with reality. SONC gave us a look at what happens to high-expectation stocks with even a slight miss and guidance that suggest 2-year sales trends will slow significantly. (Click HERE for our recent note on SONC)
Part of our LONG thesis on MCD, includes that the company will not be ceding anymore market share, especially with the “value” based customer. It’s our belief that all three domestic chains have benefited from MCD being a poorly managed company.
We specifically did not mention Restaurant Brands International (QSR) on this list because of the global nature of the Burger King business and the strong Tim Hortons brand. That being said the Burger King’s business in the U.S. will also be negatively impacted by a stronger McDonald’s. We also see the Burger King system having a very difficult time adjusting to higher minimum wage. The combination of low average unit volumes, excessive discounting and significantly higher debt levels at the franchisee level are all significant impediments to future profitability.
We are now adding QSR to the short bench, with an eye on taking it to the next level.
WHAT $15 MINIMUM WAGE MEANS FOR QUICK SERVICE RESTAURANTS
The move to $15 minimum wage will be a crushing blow to small independent Quick Service Restaurant (from this point forward, QSR will pertain to Quick Service Restaurant) operators and will be a negative for “asset light” franchisor stocks.
This note is not a political statement about what a “fair wage” is, it’s just math. And math is simple. To be blunt, without major structural changes, most small independent QSR operators will go bankrupt at $15 minimum wage. To avoid bankruptcy, the options are limited. Operators can raise prices and risk a decline in traffic and or the more likely scenario is to cut labor too drastically to maintain profitability.
The bottom line is that the QSR industry already operates on low margins and can’t afford to see labor costs increase by 50% or more.
As the CEO of CKE Restaurant, Andy Puzder's, says “if you increase wages in such a ‘draconian fashion,’ it takes away from the ability of businesses to absorb the increase in pricing and forces them to use labor more efficiently or resort to automation, resulting in the loss of jobs.”
You can read Mr. Puzder’s WSJ op-ed piece HERE
In the table below we run thru a hypothetical (but close to reality) scenario analysis of a typical QSR restaurant doing average unit volumes of $1.2 million, $1.4 million and $1.6 million. As you can see in the table on the left, the industry already operates under very thin margins.
On the right side of the slide, is the impact on profitability of taking minimum wage up to $15 per hour. What this analysis does not contemplate is the Andy Puzder scenario of pricing a significant reduction in the number of jobs and the impact of new technology (automation) on profitability.
We did a separate analysis for MCD since it has average unit volumes significantly higher than other competitors. Even MCD is not immune from a significant decline in profitability and franchisees only cover the royalties by a modest amount.
While this is devastating personally for crew workers and franchisees, the franchisors are not immune to the impact. Given significantly higher labor costs, a store averaging $1.4 million would need to increase volumes by 55% to $2.175MM in order to return the labor margin back to where it started. Since this is impossible to do, operators will be required to seek alternative strategies to run the restaurant.
As we see it the impact is twofold. First, marginally profitable stores will be closed, and second, even the profitable stores will not be able to pay the required royalties.
Bottom line, at $15 minimum wage, the TAIL thesis for being short the high multiple, highly leveraged, “asset light” darling restaurant stock becomes very clear. First, the recurring cash flows (royalty payments) begin to dry up. Then, over time massive leverage on the balance sheet of these companies becomes the noose around the neck and they will probably have to deal with franchisees going bankrupt. If $15 minimum wage becomes a reality, the descent is just beginning for these stocks, and it will be an ugly landing.
Please call or e-mail with any questions.
There have only been a few buying opportunities for Class 1 Railroad shares over the last decade, and we think the current sell-off will be another. Rails have underperformed significantly since late 2014, with Norfolk Southern giving back nearly a decade of relative outperformance.
Takeaway: Builder confidence in September records a new post-crisis high of 62, but remains well below the prior cycle highs of 71, 78 and 72.
Our Hedgeye Housing Compendium table (below) aspires to present the state of the housing market in a visually-friendly format that takes about 30 seconds to consume.
Today's Focus: September NAHB HMI (Builder Confidence Survey) & Mortgage Apps
Builder Confidence: New Highs | Builder Confidence made another post-crisis high in September with the HMI rising +1pt to 62, marking the strongest reading since October 2005.
Across the Sub-indices, 6M Expectations dipped -2 pts sequentially while Current Sales and Current Traffic both rose +2pts. Geographically, builder optimism in the West was flat MoM while the South, Midwest and Northeast all recorded gains sequentially.
Builder vs Consumer Confidence: Given the low base of new construction activity, continued low rates, ongoing labor market improvement and the steady gains observed across Pending, Existing and New Homes sales YTD, the sustained build of positive sentiment is not particularly surprising. Under the hood, the decline in 6M Expectations in September accords with the steep drop observed across the same category in the University of Michigan’s preliminary September reading (see confidence table below) although the headline HMI doesn’t appear to be impacted by the global turmoil and equity market correction that seemingly weighed on the broader measure of consumer confidence.
The divergence is interesting given the tendency for builder confidence to lead both Consumer Confidence and broader macro inflections over recent cycles. Any emergent bifurcation between the two confidence measures could also be reflecting the divergent short-to-medium term paths being tread by housing and the larger economic cycle. As we’ve highlighted (see: Resi Construction & the Cycle), while we’re late or mid-late cycle more broadly, we’re probably somewhere closer to early-mid or mid cycle in housing itself given the significantly lagged recovery in the sector.
With respect to NAHB commentary around the September data:
NAHB Chairman Tom Woods commented:
"The HMI shows that single-family housing is making solid progress ….However, our members continue to tell us that they are concerned about the availability of lots and labor.”
NAHB Chief Economist David Crowe added:
"NAHB is projecting about 1.1 million total housing starts this year ..Today's report is consistent with our forecast, and barring any unexpected jolts, we expect housing to keep moving forward at a steady, modest rate through the end of the year.”
Purchase Applications: Mostly Noise | Purchase application demand fell -4.2% in the latest week while decelerating to +15.9% YoY. Given that it was a holiday shortened week and the holiday was shifted relative to last year, the noise level in this week’s data is substantial. The prevailing read-though on the trend in the data remains largely unchanged, however. Purchase demand remains lower by ~1% QoQ in 3Q while reported year-over-year growth remains (& should remain) solid as compares remain easy through the balance of 2H.
Monetary policy and the flow through impact to rates will likely remain the largest externality for housing in the nearer-term. Beyond any nearer-term volatility associated with the attempt at policy normalization, our macro call on both growth and inflation remains slower-and-lower-for-longer and would view a flattening of the curve and flat-to-lower long-term rates as an increasingly likely by-product of a sustained attempt at tightening.
(h/t to Brian Collins for today's note title inspiration)
About the NAHB HMI:
The Housing Market Index (HMI) is based on a monthly survey of NAHB members designed to take the pulse of the single-family housing market. The monthly survey has been conducted for 30 years. The survey asks respondents to rate market conditions for the sale of new homes at the present time and in the next 6 months as well as the traffic of prospective buyers of new homes. The HMI is a weighted average of separate diffusion indices for these three key single-family series. The HMI can range from 0 to 100, where a value over 50 implies conditions are, on average, improving, a value below 50 implies conditions are worsening, and an index value of 50 indicates that the housing market is neither improving nor worsening.
About MBA Mortgage Applications:
The Mortgage Bankers’ Association’s mortgage applications index covers more than 75% of mortgage applications originated through retail and consumer direct channels. It does not include loans delivered through wholesale broker and correspondent channels. The MBA mortgage purchase applications index is considered a leading indicator of single-family home sales and construction. Moreover, it is the only housing index that is released on a weekly basis.
The MBA Purchase Apps index is released every Wednesday morning at 7 am EST.
Joshua Steiner, CFA
Christian B. Drake
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