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Mom Test

“So, what should I be doing [investment-wise] now?”

-Barbara Drake (my mom) - passive/unsophisticated investor, 9/13/15

 

The Mom Test is great.

 

First of all, everyone has one or, at the least, a reasonable mother-figure proxy. 

 

Second, our capacity for intentionally misleading Mom to probable personal and/or financial harm is, generally, diminishingly low. 

 

From an investment management perspective, answering the inquiry has a sneaking ability to distill out the willful blindness and fuzzy narrative framing, laying bare your true inner conviction. 

 

Take the Mom Test – it’s a refreshing and surprisingly simple exercise in noise reduction and thesis clarity .… unless you’re Robbie Akerlof (go ahead, look it up!)

 

Back to the Central Planning Grind …..

 

The FOMC coverage today will be manic and ubiquitous.  Having raised cash for Mom, we’ll stay long of waiting and watching into the open-the-envelope risk, then respond accordingly.

Mom Test - Fed in a box cartoon 09.16.2015

We can, however, provide some context around the current dynamics: 

 

First, remember the basic goal and mechanics of policy.  The core conceptual underpinning is straightforward but that simplicity tends to get lost in the endless nuance and theoreticals.

  

  1. Expansionary policy aims to lower the real interest (widening the spread between the real rate and the marginal product of capital) in an attempt to support growth via investment and consumption (interest rate effects) and net exports (currency effects).  *Mom, c’mon, don’t you know the model says you’re supposed to be a rational, intelligent agent who actually knows what the real rate is and makes decisions on what you expect that real rate to be in the future!
  2. Contractionary policy aims to tighten financial conditions in order to quell emergent inflationary pressures. The mechanism is the obverse of expansionary policy with higher rates lowering investment, debt financed consumption and net exports.

 

Macro markets are a moving target and, at times, market events can serve as a substitute for policy in both directions.  Given that current discussion centers on policy tightening, consider the impact of recent events on financial conditions:  

 

  1. $USD:  ↑ U.S. Dollar = ↓ Inflation = ↑ Real Rates:  Remember, policy is focused on the real rate (real rate = nominal rate – inflation) with declining inflation driving real rates higher.  Strong Dollar deflation serves as de facto tightening.
  2. Equities:  Equities have benefitted from ZIRP via the Present Value effect:  ↓ Rates = ↓ discount factor = ↑ present value = ↑ equities.  Fundamentally the conclusion is the same: ↓ Rates = ↑ investment/consumption = ↑ Spending = ↑ Profits.  Higher rates, in theory, should have the opposite effect.  Further, with hundreds of billions of market value lost in the last month, valuations and “financial imbalances” have seen a modest correction.
  3. Credit:  Global Turmoil + attempted policy front-running have driven credit and risk spreads higher and pushed rates on the front-end up.   

 

Translating those tightening financial conditions into rate hike equivalents (i.e. does it equate to a 25 bps hike, 50 bps hike, etc) is tricky but, collectively, conditions have tightened in recent months. 

 

A few other pre-FOMC considerations:

 

  • $USD:  As can be seen in the Chart of the Day below, in prior cycles, most of the gains in the dollar have come in anticipation of policy tightening with the currency typically weakening once rates hikes actually commence. #Frontrunning
  • Fed Fund Futures:  As has been well highlighted, Fed Fund futures are only pricing in a 23% chance of a rate hike as of this morning and, given the Feds unprecedented predilection for managing market expectations, an unanticipated rate hike could propagate unwanted volatility.  The hawkish rejoinder is that the fed fund futures market can be thin and the front end of the curve (3M-2Y treasuries) is positioning for a policy shift.
  • Lags:   The outside lag on policy – the Feds view of how long it takes enacted policy to flow through the real economy – is something like 6-18 months. Broadly, this (loosely) argues for pre-emptive policy followed by a lot of wait-and-see.

 

Janet’s Jinx:  The majority of policy maker consternation centers on the Sisyphean fight for above target inflation.  Yesterday’s CPI data for August which showed headline inflation declining -0.1% MoM only reinforces that reality.

 

While deflation will, indeed, be transient in the sense that we will lap the energy price collapse and strong dollar/slowing global growth drag on import prices, September will mark the 41st month of sub-2% price growth in the Fed’s preferred Core PCE inflation reading. 

 

Further, and unfortunately, price growth problems also carry real consequences for the populace.

 

The Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) is the series used for adjusting payments made to Social Security and Supplemental Security Income (SSI) benefits.  The Cost-of-Living Adjustment (COLA) is the government’s attempt at maintaining the purchasing power of social security and SSI payments.   

 

The COLA adjustment calculation methodology is as follows:

  • Reference Period:  The reference period =  the 3rd quarter of the calendar year (July-Sept)
  • Calculation:  Adjustment Calculation = ave 3Q15/ave 3Q14 -1 (in words:  growth in the average price level in 3Q15 relative to the average price level recorded in 3Q14)
  • Caveats:  If growth in the cost of living is greater than 0.10%, then an adjustment is applied (i.e. social security benefits go up).  If growth is less than 0.10% or negative, there is no adjustment.

 

With one month left to go in the quarter, 3Q15 is tracking down -0.3%.  In other words, price growth in the CPI-W would have to be +1.2% month-over-month to reach the +0.01% threshold for the quarter and trigger any increase at all. 

 

Q:  How many times in the last 10 years have we seen a +1.2% MoM increase in the CPI-W?

A:  0 (as in zero)

 

So, while you’re explaining to Mom how bank assets re-price faster than liabilities (i.e. return on savings will probably stay at 0% even if Janet pulls the normalization trigger) also tell her that the price of living is not rising.  In fact, it’s in outright decline and, with prices falling and Social security payments flat, her real income (i.e. the amount of goods & services she can buy) is actually up +0.30%. 

 

It’s true, BLS says!

 

How about the Census Bureau … that paragon of positive macro data flow …. What say you about the household income statement seven years into this expansion?

 

Yesterday, the Census Bureau released its 2014 report on Income and Poverty in the United States – the annual report that provides the official household income numbers.  The result was not unexpected but it’s still disheartening:

 

Median household income in the United States in 2014 was $53,657, not statistically different in real terms from the 2013 median income. This is the third consecutive year that the annual change was not statistically significant, following two consecutive annual declines.

 

LIFE ALPHA:  Mom-ing (to make it a verb) isn’t measured in monthly P&L but in quantum’s of caring and selflessness.  No opening or closing bell, no holidays, no headlines or accolades.

 

Fortunately, however, and unlike the luck and accidental billionaires of market randomness, “parenting alpha” is largely just a choice and reachable by anyone committed to it.    

 

Congratulations to Keith and Laura – proud Mom and Dad to a healthy new baby girl and a beautiful growing famille. 

 

Our immediate-term Global Macro Risk Ranges are now:

 

SPX 1
Spain’s IBEX 9

VIX 21.67-29.77
Oil (WTI) 43.51-48.95 

Gold 1097-1140

 

To family and real (non-monetary) wealth,

 

Christian B. Drake

U.S. Macro Analyst

 

Mom Test - z z Dollar CoD


The Macro Show Replay | September 17, 2015

 


September 17, 2015

September 17, 2015 - Slide1

 

BULLISH TRENDS

September 17, 2015 - Slide2

September 17, 2015 - Slide3

September 17, 2015 - Slide4

 

BEARISH TRENDS

September 17, 2015 - Slide5

September 17, 2015 - Slide6 

September 17, 2015 - seven

September 17, 2015 - Slide8

September 17, 2015 - Slide9

September 17, 2015 - Slide10

September 17, 2015 - Slide11


Attention Students...

Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.

ICI Fund Flow Survey | The Best Offense is a Good Defense

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.)


ICI Fund Flow Survey | The Best Offense is a Good Defense - ICI1


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:


ICI Fund Flow Survey | The Best Offense is a Good Defense - ICI2


ICI Fund Flow Survey | The Best Offense is a Good Defense - ICI3


ICI Fund Flow Survey | The Best Offense is a Good Defense - ICI4


ICI Fund Flow Survey | The Best Offense is a Good Defense - ICI5


ICI Fund Flow Survey | The Best Offense is a Good Defense - ICI6



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.

 

ICI Fund Flow Survey | The Best Offense is a Good Defense - ICI12


ICI Fund Flow Survey | The Best Offense is a Good Defense - ICI13


ICI Fund Flow Survey | The Best Offense is a Good Defense - ICI14


ICI Fund Flow Survey | The Best Offense is a Good Defense - ICI15


ICI Fund Flow Survey | The Best Offense is a Good Defense - ICI16



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:


ICI Fund Flow Survey | The Best Offense is a Good Defense - ICI7


ICI Fund Flow Survey | The Best Offense is a Good Defense - ICI8



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.


ICI Fund Flow Survey | The Best Offense is a Good Defense - ICI9



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.


ICI Fund Flow Survey | The Best Offense is a Good Defense - ICI17


ICI Fund Flow Survey | The Best Offense is a Good Defense - ICI18



Net Results:

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.)

  

ICI Fund Flow Survey | The Best Offense is a Good Defense - ICI10



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:


ICI Fund Flow Survey | The Best Offense is a Good Defense - ICI11 



Jonathan Casteleyn, CFA, CMT 

 

 


Joshua Steiner, CFA







Cartoon of the Day: Ready Or Not?

Cartoon of the Day: Ready Or Not? - Fed in a box cartoon 09.16.2015

 

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.

 


SHORT SMALL-CAP BURGER CHAINS | QUICK SERVICE CAN’T AFFORD $15 MINIMUM WAGE

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.

 

SHORT SMALL-CAP BURGER CHAINS | QUICK SERVICE CAN’T AFFORD $15 MINIMUM WAGE  - CHART 1 15 min

 

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.

 

SHORT SMALL-CAP BURGER CHAINS | QUICK SERVICE CAN’T AFFORD $15 MINIMUM WAGE  - CHART 2 15 min

 

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.

 

SHORT SMALL-CAP BURGER CHAINS | QUICK SERVICE CAN’T AFFORD $15 MINIMUM WAGE  - CHART 3 15 min

 

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.

 

Howard Penney

Managing Director

 

Shayne Laidlaw

Analyst

 

 


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