The Economic Data calendar for the week of the 12th of October through the 16th of October 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: TIF, JNK, W, WAB, ZBH, GLD, MCD, RH, LNKD, ZOES, FNGN, PENN, GIS, EDV & TLT
Below are our analysts’ updates on our fifteen current high conviction long and short investing ideas. Please note that we added Tiffany (TIF) and Junk Bonds (JNK) to the short side this past week. As a reminder, if nothing material has changed in the past week which would afffect a particular idea, our analyst has noted 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.
Our veteran Retail Sector Head Brian McGough sent out a full stock report detailing his bearish thesis on Wayfair on Friday. Click here to read it.
In addition to his note on Wayfair, McGough also sent out a stock report outlining in granular detail his bearish case on Tiffany. Click here to read it.
Our macro team has just released its short thesis on Junk Bonds. Click here to read it.
Bottom Line: We remain 50% below Bloomberg Consensus on GDP growth. Wall Street, the IMF, World Bank and OECD are all still forecasting global growth of around 3% for 2015. We reiterate our call for growth to come in at or below half that rate.
The most recent US jobs report confirmed the top in the #LateCycle US Employment. We highlighted this in last weekend’s report, but gold likes a bad jobs report and any other data point that takes the Fed further away from hiking rates:
From labor and manufacturing markets to consumer and business confidence, leading indicators are beginning to roll as the late-cycle moves past peak.
Concentrating on the corporate profit cycle which peaks late cycle, here is a summary of some content from our Q4 2015 macro themes call with respect to S&P 500 company performance:
While most #LateCycle growth expectations in macro markets peaked in April, the US stock market peaked in July as bond yields hit the market with their last head-fake of a “breakout.” That makes this bear market in growth expectations relatively young. With that considered, sit back and relax with your TLT and EDV.
To view our analyst's original report on Restoration Hardware: CLICK HERE
We think that the catalyst calendar is just starting to pick up, and should be the best that Restoration Hardware has seen – perhaps ever. Here’s the roadmap:
So all in, there are two new and significant merchandising initiatives, which are solid on their own. But to pair them with the square footage growth acceleration seems almost like a fantastic coincidence. But it’s not. This has been in the plan all along. There’ll be many more new concepts and classifications – though we’d argue that the company can go deep and add $2bn in revenue with what it has.
To be clear, there’s much more to this story than just square footage growth – like the ability to consistently merchandise product people want in quantities they need. Without the ability to deliver on that requirement, a retailer could have the greatest store in the hottest location with the best demographics, and it will still be nothing but a liability (regardless of how low the rent might be). That’s why square footage growth is grinding to a halt for other US retailers.
That’s also why the growth profile at RH is so powerful, and unmatchable by anyone we see in Retail today.
To view Hedgeye Internet & Media analyst Hesham Shaaban's original report on LinkedIn: CLICK HERE
The disappointing Non-Farm Payrolls release for September may be viewed by some investors as weakness for LinkedIn given that much of its business centers around recruitment. However, it’s not net hiring, but rather gross hiring that is the better read into the recruitment industry.
We’ll be getting a read there when the Bureau of Labor Statistics (BLS) releases its JOLTS data next week. As of the last release, there wasn’t any cause for concern.
As mentioned here before, we remain long LNKD into its next earnings release. We’re expecting a clean beat and raise. We expect this will be a positive catalyst for the stock, especially given the current dearth of good Internet longs.
To view our analyst Tom Tobin's original report on Zimmer Biomet CLICK HERE
We had two interesting, incremental updates to our Zimmer Biomet short thesis this week. In our process, we attempt to marry the data with anecdotes. This week we managed to accomplish both.
On the anecdotal front, we interviewed an orthopedic surgeon from a major academic hospital in the Midwest. He does 800 cases per year, which is high volume by any measure, and likely means he’s a very fit guy. But more importantly, his comments match our data analysis.
Case volume has been generally very consistent yearly with a modest increase late in 2014. In the most recent months, case volume slowed dramatically. This is consistent with a penetrated market that caught a slight boost from the Affordable Care Act.
This morning we updated our population model that describes what we are expecting for total knee replacement volume. The government released data for total cases by age and payor for 2013 and the results of our mini-experiment were spot on. Growth in younger patients is slow and growth among Medicare patients is fast. That would be positive if not for the fact that Medicare is putting pressure on reimbursement which is subsequently putting intensifying pressure on device costs, and ZBH revenue.
As we heard from our surgeon, they have a “patient matching algorithm” which just means they use cheaper implants in older Medicare patients. And with Medicare rolling out a global payment system for knee replacement surgery reimbursement, the pressure and device deflation will only get worse from here.
Our Consumer Staples team has no new material update on General Mills this week. They remain positive on the company coming out of the 2Q15 earnings call. 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:
Our restaurants team has no new material update on Zoës Kitchen this week. They remain very positive on the company long-term.
To view our analyst's original note on Wabtec: CLICK HERE
Wabtec’s core US freight equipment business is a good franchise, but also a cyclical one. The investment cycle is turning down for global freight rail equipment as decreased mining capital spending and a young US freight equipment fleet constrains spending, as we see it.
WAB is trading at a high multiple on what we expect to be peak results, with estimates reflecting faith in management more than prospective customer activity. Is Wabtec a ‘growth’ industrial even though it serves a mature, static, sub-GDP product category? Is expansion outside of its traditional, structurally robust US freight franchise a solution to slowing freight rail capital investment?
We think the answer to both questions is ‘probably not’, and that investors are mistaking a long investment upcycle for secular growth…much as they did for Joy Global and Caterpillar a few years ago.
To view our original note on McDonald's: CLICK HERE
Our Restaurants team has no new material update on McDonald’s this week.
The stock continues to be well liked by our research team, and is a perfect fit into our macro team’s style factor preferences. This stock is high cap with a low-beta, coupled with a turnaround story that is well underway. We believe this stock will do well through this tumultuous time in the market.
As you may have read or seen, MCD's all day breakfast began this week. We anticipate this not only driving increased visits from existing customers but also new customers that maybe don’t wake up early enough to get breakfast by 10:30am or just people that enjoy eating breakfast items outside of the morning day-part.
New CEO, Steve Easterbrook has taken an internal activist approach to reorganizing this company and we believe we will see the strong signs of it all working during the 3Q15 call on October 22nd.
Our Financials analyst Jonathan Casteleyn has no material update on Financial Engines this week. He reiterates his long term bullish thesis on the company.
As we predicted, a rise in September regional revenues would serve as a catalyst for regional gaming stocks, and in particular, Penn National Gaming. For the record, PENN is up +12% since we added it to Investing Ideas back in May, outperforming the S&P 500 which has fallen -5% since then.
We believe shares of PENN have a lot more room to run, given its strong performance in key markets like Ohio and its successful opening in Massachusetts. A handful of states still need to report their September revenue figures, but numbers have been in line with our expectations thus far.
PENN will be reporting Q3 earnings on October 22nd.
"Definitive crashes have occurred across many global macro markets in recent months," our macro team recently wrote. "Is the U.S. equity market next in line?"
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Takeaway: In the first few days of the fourth quarter, equity volumes are white hot with options and futures burning off a tougher comp
Weekly Activity Wrap Up
U.S. cash equities are coming out of the gate strong so far in the fourth quarter. Fourth-quarter daily volume is averaging 7.9 billion, a +12% year-over-year and +8% quarter-over-quarter expansion. Meanwhile, options and futures have not started with the same gusto with tougher comps. U.S. equity options activity is averaging 17.2 million contracts per day in the new quarter, 0% growth versus the fourth quarter of 2014 and a -5% contraction versus 3Q15. Futures activity is averaging 19.0 million contracts per day in the fourth quarter, a -1% year-over-year contraction and +2% quarter-over-quarter expansion.
U.S. Cash Equity Detail
U.S. cash equity trading is running at 7.9 billion shares traded per day in the fourth quarter to date. This is +12% year-over-year growth for U.S. stock activity. The market share battle for volume is mixed. The New York Stock Exchange/ICE is taking a 25% share of fourth-quarter volume, a +3% year-over-year increase, while NASDAQ is taking a 19% share, a -7% year-over-year decline.
U.S. Options Detail
U.S. options activity came in at a 17.8 million ADV this week, bringing the 4Q15TD average to 17.2 million, 0% Y/Y growth and a -5% Q/Q contraction. The market share battle amongst venues continues to be one of losses at the NYSE/ICE, which has lost -12% its of share year-over-year settling at just 18% of options trading currently. Additionally, CBOE's market share has been falling recently and has started off the fourth quarter at 26%, -16% lower than 4Q14. NASDAQ, on the other hand, started the quarter strong, increasing its market share by +16% compared to 3Q15, bringing itself back into line with the 24% share it held a year ago. BATS' share has been falling recently but at 9% in 4Q15TD it remains +40% higher than in 4Q14. Finally ISE/Deutsche's 15% share in 4Q15TD remains consistent with 3Q15, which brings it to +67% Y/Y growth.
U.S. Futures Detail
CME Group volume came in this week at 13.9 million contracts per day and is averaging 14.1 million for the fourth quarter, a -5% year-over-year contraction. However, CME open interest, the most important beacon of forward activity, currently tallies 99.1 million CME contracts pending, good for +18% growth over the 84.1 million pending at the beginning of 2014, an expansion from the prior week's +15%.
Activity levels on the futures side at ICE hit 4.8 million contracts this week and are averaging 4.9 million contracts per day in the fourth quarter, a +13% year-over-year expansion. ICE open interest this week tallied 64.7 million contracts, a -7% contraction versus the 69.2 million contracts open at the beginning of 2014, an improvement from the prior week's -8%.
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
Takeaway: We added JNK to Investing Ideas on the short side on 10/8.
Our edge right now with High Yield Fixed Income is our macro team's continuing dissection of the cycle. Look no further than corporate activity YTD…
With a phase transition in volatility that has crushed buy-side performance and sent U.S. equities on a roller coaster ride over the last couple months, confidence in what has been a 6-year bull market is waning. Just 37% and 43% of S&P 500 companies recorded sequential acceleration in sales and earnings growth, respectively, in the latest quarter. Operating margins have already peaked.
That sounds like a slowdown.
Rather than experiencing organic growth, large companies are attempting to manufacture growth by buying back shares, sidelining capital investment projects, and acquiring other companies. 2015 will be a record year for M&A activity. The previous record? 2007...
From our perch, debt-financed buybacks at peak valuations, peak margins and new highs in corporate leverage does not equal long-term shareholder value creation. Buyback trends are a classic contra-indicator with activity peaking at the end of the cycle.
Bottom line: This kind of corporate activity in aggregate is just another late-cycle indicator.
INTERMEDIATE TERM (TREND) (the next 3 months or more)
Our proprietary Growth, Inflation, Policy (GIP) model is signaling that Q3 GDP, on a year-over-year basis, faces very difficult comparisons (this year vs. last year) in Q3 and Q4 of this year. Our estimated range for GDP for Q3 is 0.1-1.5% which is still below consensus despite estimates that have been taken down by Central Bankers and consensus Wall Street.
If GDP prints in that range, forward-looking growth expectations will be downwardly revised as evidenced in bond yields going lower and credit spreads widening.
LONG-TERM (TAIL) (the next 3 years or less)
When the economic cycle begins to roll-over, a drawdown in the equity market manifests, volatility ensues, and credit spreads widen. There is a rotation into what is considered safer fixed income (TLT and EDV for example) at the expense of riskier borrowers (worse credits). The commonalities of a cyclical slowdown and secular headwinds are matching up to give us visibility into our #superlatecycle call which happens to be one of our top Q4 2015 Macro themes.
Takeaway: We added TIF to Investing Ideas on the short side on 10/5.
If you’re looking for a U.S. Equity to play our macro team’s #LateCycle #SlowerForLonger bearish themes, here’s a name wrapped in a "Little Blue Box" just for you.
We all know Tiffany. Generally speaking, this is a structurally sound business. It is definitely not a ‘headed to zero’ short like we’d argue for a company like Wayfair (W). But stocks of good companies like Tiffany go down all the time, and we think TIF is headed lower.
Common perception seems to be that “just because TIF blew up earlier this year, it can’t blow up again.” We disagree. It actually blew up twice this year. And we think there will be another. We didn’t like TIF into the latest print, and we definitely don’t like it on the way out. The company lowered back half guidance, which we expected to see, but we’re not sure if $0.10 is enough off of 2H14’s $2.27 base. We’re inclined to think ‘no’.
The bigger tell for us will be how much consensus numbers come down for next year. They currently sit at $4.56. If the macro environment plays out like we believe, then we think we’re looking at a number closer to $4.00.
The problem here is that management is adjusting guidance based on what it sees at the time of the earnings report – not based on how the environment will likely deviate from what they see in front of them.
Also keep in mind that the company is at peak productivity of $3,500/ft (some less productive Apple stores – the highest s/sqft in retail -- do $3,500), peak Gross Margins, trough SG&A margins, peak diamond exposure (59% of units has a diamond, which is gross margin accretive), and only can grow square footage by 2-3% on its best day.
We have no doubts in the quality of the management team or brand name, but the reality is that there are no obvious margin levers to offset the declining growth profile in the business, especially amidst increased late cycle risks.
It is trading near a peak multiple (18.5x) on peak margins (21%), a peak earnings ($4.20E TTM and NTM) that isn’t growing, peak returns (18%), has the worst cash conversion cycle we’ve ever seen (490 days), while sentiment is sitting at all-time highs.
It’s feast or famine – if one of those metrics breaks, then they all do.
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.