The Economic Data calendar for the week of the 21st of September through the 25th of September is full of critical releases and events. Here is a snapshot of some of the headline numbers that we will be focused on.
Takeaway: Current Investing Ideas: WAB, ZBH, GLD, MCD, RH, LNKD, ZOES, FNGN, FL, PENN, GIS, EDV & TLT
Below are our analysts’ updates on our thirteen current high conviction long and short investing ideas. If nothing material has changed in the particular name, the analyst has made a note of this. Hedgeye CEO Keith McCullough’s updated levels for each ticker are below.
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.
No rate hike.
Both of our macro team's calls, "slower-for-longer" and "lower-for-longer" were acknowledged by your central planners (downwardly revised GDP expectations on Thursday). The result…Treasury yields fall and gold catches a bid.
Gold went on to finish the week +3.1% while TLT reversed its losses from earlier in the week to finish +0.2% (EDV +0.55%). As growth and inflation continue to slow, Treasuries and cash are a safer allocation than rolling the bones in the equity market over the last month.
Some perspective. Since the August 19th FOMC dovish minutes release from the July meeting, the S&P 500 Index has lost -6.2%.
Bad news is bad news? This is new.
The scary thing for equity markets is that the Federal Reserve is having less and less of a “Save the Day!” affect. Central planners lose the power to ease when rates are already 0%. Market participants are questioning the Fed’s ability to arrest the gravity embedded in late-cycle slowing (sound like a familiar narrative?) In other words, the market finishing lower post- save-the-day-dovish turn is the new.
While both the Dollar (Down) and the US Stock Market (Up) have been discounting that the Fed would be forced to punt, that doesn't change the reason WHY they punted. Growth is slowing:
This week’s data:
Slower (and Lower) For Longer remains our non-consensus call. It's nice to see that the Fed is finally starting to see what the #GrowthSlowing late-cycle data does.
In the press conference recall that Yellen said the Fed won’t raise rates until “inflation is at 2%.”
No September hike? What about December?
Our estimate for Y/Y% GDP for Q3 is a range of 0.1% to 1.5%. Even the Q/Q SAAR # that consensus hangs on will be comping against a 3.7% Q/Q SAAR GDP print (second revision). Good luck positioning for a rate hike. Prepare for the fade…. AGAIN.
Just take a look at the markets expectation for a rate cut. Here’s a chart of December federal funds futures (implied rate %):
Zoës Kitchen has been tricky from an investment standpoint. Over the last three months, the stock has been hit alongside other small-cap universe names. However, in the spirit of Investing Ideas, we believe you have to take a long term approach to this name. We still remain very bullish on the concept here, the fundamentals, and we believe the dip represents an excellent buying opportunity for longer-term focused investors.
The company's management just presented at the Stifel Consumer Conference. Their presentation added further confirmation to our LONG stance. The company is growing the way a restaurant company should, with a strong beachhead in Texas, flanking out from there.
In the chart below you can see their current footprint and (more importantly) the white space available for future expansion.
To view our analyst Tom Tobin's original report on Zimmer Biomet CLICK HERE
Our short in Zimmer Biomet is based on a number of interconnected themes and datasets. Eventually, a stock price will reflect a company’s ability to grow their revenue and profits and cash.
But a great theme or story is only that, a story about the future. And when you are in a debate about the future, the winner of the debate is the one with the stock working their way.
The wisdom of the markets is often accepted out of hand and accepted as proof of how smart you’ve been (or dumb). So, while our themes and data behind our ZBH short remain 99% identical to when we first presented the short idea six months ago, we certainly don’t think we should be raising the victory flag just because the stock went our way.
When we take a step back and ask what made our ZBH short work, the best explanantion has been the simplest one; the market went down. Because ZBH price and multiple is so highly correlated (found using Macro Monitor) with the S&P 500, we didn’t need our thesis to play out in order for us to win.
Janet Yellen explained on Thursday (what our macro team has been saying for months) that growth is slowing. Right or wrong, the market thinks this is bad news for ZBH. To what extent will be the next debate given that orthopedic demand can be driven by economic growth.
So, as our long term thesis on ZBH plays out in the coming years, we’ll be sensitive to our blind spots. But in the short term, we won’t turn away success either.
To view our analyst's original report on Restoration Hardware: CLICK HERE
One of the most significant developments with Restoration Hardware right now is the return of Square Footage Growth.
Restoration Hardware went from over 100 stores pre-recession (and before having a defendable merchandise, real estate strategy, and an actual management team) to 67 in the latest quarter as it culled bad locations.
Square footage grew on occasion over that period in a given quarter, but has settled in around 850k. Starting in 3Q, we should see square footage growth ramp from a mid-single digit rate in 2Q to a number ~20%, then steadily march towards 35%+ in FY16.
Then we’ve got 20%+ square footage growth every year thereafter for at least five years based on our real estate analysis.
Fundamentally and financially, we’re about to see growth at RH go on a multi-year tear.
Our Industrials Sector Head Jay Van Sciver sent a stock report on his bearish Wabtec thesis to subscribers Friday afternoon. Click here to read the report.
Our Financials Co-Sector Head Jonathan Casteleyn has no new, material update on Financial Engines this week. Below is his update from last week:
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.
Our Internet & Media analyst Hesham Shaaban has no new, material update this week. Below is his most recent update from last Saturday. To view his original report 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 National Gaming continues to be our favorite Regional Gaming stock.
Regional numbers for August have come in soft, but we predicted the August weakness. September revenues should rebound and serve as a catalyst for the stock going into Q3 earnings. On the research side we have not altered our views of PENN’s long term growth story. We continue to see more upside from current price levels.
Our Consumer Staples team led by Sector Head Howard Penney remains positive on General Mills heading into its critical 2Q15 earnings release and call next week.
We have been long GIS for the last six months and continue to have a favorable view of the company due to the following reasons:
We will provide a more detailed update following next week's call.
To view our original note on McDonald's: CLICK HERE
McDonald’s remains one of our Restaurant teams Best Ideas on the LONG side. We continue to believe that 3Q15 will be the inflection point for the company’s turnaround and that we are going to be looking at a much different company 1-3 years from now.
Urgency has been instilled from the top down by new CEO Steve Easterbrook. He wants more speed and is encouraging people to get things done faster. The food and experience provided to the customer will greatly improve over the coming months as “Experience the Future” is implemented across the system. It won’t be instantaneous though, as MCD has a lot of work to do around changing the perception to bring back customers it may have lost.
Things like "All Day Breakfast," responsibly sourced ingredients, and bringing back the value proposition will all lead to increased sales and customer satisfaction.
This company is too big to be completely fixed overnight. That said, management has the right plans in place. We are confident in where they are headed.
We reiterate our view that Foot Locker remains one of the top shorts in retail.
The company hosted an analyst day exactly six months ago, with a new CEO at the helm and ran through its long term growth targets. During the Ken Hicks (former CEO) era, the company was focused on taking capital out of the model, improving productivity and boosting returns. Now the model is positioned on store and comp growth with little margin leverage left to squeeze out.
Financial Plan: FL’s prior goals were all about dramatic improvements in productivity and occupancy leverage by way of pulling capital out of the model (closing stores, changing banners, and eliminating working capital). But now FL is guiding to the following…
Earlier this week, Hedgeye Macro analyst Darius Dale released a detailed Growth | Inflation | Policy (GIP) research note on China to our institutional subscribers. In this brief excerpt, Dale discusses three key things investors need to know right now including the dire secular outlook for Chinese growth and what long-term investors may have to look forward to.
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Below is an excerpt from today's Early Look written by Hedgeye CEO Keith McCullough:
...I know the establishment doesn’t want me to inspire change or give them a speech. There’s no compensation scheme for them in that. Back to what most people want – what to do with this mess of market forecasts and expectations?
No hike in DEC?
Takeaway: We added Wabtec to Investing Ideas on the short side on 9/11.
Capital equipment suppliers to a cyclical industry are usually more cyclical than their customers.
We believe Wabtec was a beneficiary of both resources-related capital spending (international freight railroads) and the congestion of the U.S. rail system in 2014. With rail speeds increasing and mining capex falling through the floor, those supports should gradually be removed from this richly-valued stock.
The end markets do not look promising for Wabtec. Freight car orders are coming off their all-time highs as backlog does the same per Railway Supply Institute data. Class 1 Railroads are curbing capex spending in the face of slowing freight volumes. U.S. railroads are now putting equipment into storage.
Wabtec’s end markets are largely driven by its Freight business (75% of Operating Income), with the remainder going to its Transit business (passenger travel by rail).
In addition, the company is acquisitive. We believe that this "acquisitiveness" has been a key factor in its being miscategorized as a ‘growth’ industrial. In our view, railroad parts was a growth industry back in the days of the robber barrons.
Wabtec’s recent acquisition of Faiveley Transport indicates to us that both companies' management teams see trouble ahead. Faiveley’s major customers are consolidating, while WAB may be looking for ways to maintain growth in a weaker Freight rail demand environment.
INTERMEDIATE TERM (TREND) (the next 3 months or more)
The lead time on major U.S. freight orders is quite short for Wabtec – well short of a full quarter. The decline in expectations should come with the U.S. Freight rail capital budget guidance, which should come with 4Q2015 railroad earnings reports.
LONG-TERM (TAIL) (the next 3 years or less)
By the time utilization has declined (amid peak equipment deliveries and stagnant traffic) it will be too late to exit/short Wabtec -- assuming we are correct. Investors should increasingly note a disconnect between weaker order rates versus expectations for continued robust earnings growth in 2016. That would be a big problem for a 'growth' name with a high valuation.
We see the set-up as analogous to Joy Global (JOY) and Caterpillar (CAT) back in 2012.
Takeaway: The VIX is settling into the sweet spot of 20-40 which historically is the best range for incremental exchange volume.
Weekly Activity Wrap Up
Futures activity continues to rise, coming in strongly this week at an average 19.8 million contracts per day, exceeding the third-quarter-to-date average of 18.8 million. That brings the third quarter to a +7% year-over-year and +7% 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.
U.S. cash equity volume averaged 6.4 billion shares this week, bringing the third quarter to a 7.2 billion ADV, an expansion of +27% Y/Y and +14% Q/Q. U.S. equity options activity averaged 16.7 million contracts this week. Year-over-year growth in U.S. options is tracking at +16%.
U.S. Cash Equity Detail
U.S. cash equity trading finished the week at 6.4 billion shares traded which is blending to a 7.2 billion daily average thus far for the 3rd quarter of 2015. This is +27% 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.
U.S. Options Detail
U.S. options activity came in at a 16.7 million ADV this week which is blending 3Q15 activity to 18.3 million contracts per day, up +21% quarter-over-quarter and +16% 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 -14% loss from last year as ISE/Deutsche Boerse and BATS mop up volume and share.
U.S. Futures Detail
CME Group volume came in this week at 14.6 million contracts. That blends 3Q15 volume to a 14.6 million average level, a +8% year-over-year expansion. CME open interest, the most important beacon of forward activity, currently tallies 97.2 million CME contracts pending, good for +15% growth over the 84.1 million pending at the beginning of 2014, a contraction from the prior week's +25%.
Activity levels on the futures side at ICE hit 5.2 million contracts this week, with 3Q15 blending to a 4.2 million daily average, a +4% year-over-year expansion. ICE open interest this week tallied 63.1 million contracts, a -9% contraction versus the 69.2 million contracts open at the beginning of 2014, a deterioration from the prior week's -6%.
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.
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:
We recently presented our investment thesis on the Exchanges. To summarize,
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
Please let us know of any questions,
Jonathan Casteleyn, CFA, CMT
Joshua Steiner, CFA
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