Fresh Stimulus!

“Defeat should never be a source of discouragement but rather a fresh stimulus.”

-Robert South


Preach, brother! If wrong on both growth and inflation all year long, never, ever, give up. There’s always a sticker for everyone to win at the end of the QE rainbow. Cowbells and puppy dogs. Ring it, preacher!


Robert South was an English churchman in the 17th century who would probably do as well as the speaker of the centrally-planned market house today as he did under King Charles II and then William & Mary.


Discouraged short seller? Hopefully not. The Long Bond continued higher yesterday too. If you’re only a US stock picker type, there’s a plethora of longs and shorts for you to pick from post yesterday’s “fresh stimulus” too.


Back to the Global Macro Grind


Yep. That’s what your un-elected-central-planning-overlord Draghi called it yesterday. Nah, he didn’t have to actually do anything. He just had to call it a “fresh stimulus.” If only the people who have been bullish all year long were bullish for that reason.

Fresh Stimulus! - Draghi cartoon 10.22.2015

Bullish on either top-down GDP growth or “reflation”, that is…


If you were bullish on some of the most expensive big cap stocks in human history (like, say Amazon – AMZN) with the fundamental call that growth there would accelerate throughout a #LateCycle US (and Global) slowdown, that was dead right.


Whereas if you were bearish on some of the most expensive mid cap stocks in human history (i.e. the ones that don’t make money like, say Pandora – P) alongside Hedgeye’s Internet & Media Analyst, Hesham Shaaban, you nailed that too.


That’s why I’m refreshed and fired up this morning. How could you not be? AMZN is +10% pre-open and Pandora (P) is crashing another -23%.


Stock Pickers and Macro Minds, Unite!


As opposed to focusing on the macro data this morning (Germany’s PMI slowed again to 51.6 in OCT vs 52.3 last month), I’d be remiss (and un-objective) to not give a big Earnings Season shout-out to the likes of AMZN, GOOGL, and MSFT last night.


This is what those 3 stocks did to the Q3 Sales/EPS Scorecard vs. what I highlighted 2-days ago:


  1. SP500 Sales “growth” of -3.6% got back to down -2.4%
  2. SP500 Earnings “growth” of -7.9%  clawed back to down -5.4%


In other words, after consensus called for +8-10% Earnings Growth in 2015, the new bull case is that after AMZN, GOOGL, MSFT, we’re back to earnings season being better than horrendous.


Just to break the Sector Styles of Earnings Season down for you again, here are the numbers post 161/500 companies reporting:


  1. Energy – Sales -31%, EPS -55%
  2. Materials – Sales -18%, EPS -36%
  3. Industrials – Sales -6%, EPS -2%
  4. Financials – Sales -3%, EPS -8%
  5. Information Technology – Sales -3%, EPS -13%
  6. Consumer Staples – Sales -4%, EPS -2%
  7. Consumer Discretionary – Sales +4%, EPS +19%
  8. Healthcare – Sales +10%, EPS +4%


Yeah. Healthcare Sales and Earnings have been relatively awesome (as they tend to be alongside consumer spending at the end of an economic cycle), so Healthcare stocks (XLV) were down -0.6% on the day yesterday.


Remember, when QE Cowbell is your catalyst, bad news is good and good news is bad, baby! Unless the news (like American Express, AXP, Earnings) is really bad or really good (McDonald’s, MCD), that is.


That’s why I love where this market and all of its risks/opportunities are right now. For far too long the variance of macro, sector, and stock picking returns was generationally low. Everything either went up, or down. Now some things go up, and others straight down.


Back to Draghi’s “fresh stimulus” comment and what we think about that (see Darius Dale’s video presentation from last night):


  1. Down Euro --> Up Dollar, Down Rates is not a GDP growth accelerating signal – it’s a slowing one
  2. What’s bearish for the Euro (until the Fed gets more dovish data next week) is bearish for Commodity inflation expectations
  3. What’s bearish for growth and inflation expectations is bullish for The Long Bond (TLT) and Municipal Bonds (MUB)


Ultimately (and perversely) Down Euro Devaluation is a global TIGHTENING event because the world’s biggest asset price #deflation risk is that the world’s inflation expectations (commodities, debt, etc.) are DENOMINATED IN DOLLARS.


Yep. I’m going all CAPS on you at the top of this freshly squeezed and stimulated risk management morning! Let’s get after it.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.98-2.09%

USD 94.89-96.75
EUR/USD 1.10-1.12
Oil (WTI) 44.80-47.63


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Fresh Stimulus! - 10.23.15 EL chart

Instant Dollar Insight: #GrowthSlowing Data vs. Draghi QE

"The Bond Market doesn't give a damn about US stocks up," Hedgeye CEO Keith McCullough said yesterday, as stocks soared higher and 10-year U.S. bond yields hovered near two handle.


We're obviously keeping a close eye on the U.S. dollar (which fell in recent months on #GrowthSlowing data and bounced yesterday on Draghi ECB dovishness)...


As McCullough wrote earlier this morning:


"Draghi rang that #cowbell and macro markets absolutely ripped – gotta love that, even though people will realize it’ll perpetuate as opposed to arrest #deflation (see our research note from last night); here’s a visual on USD during #GrowthSlowing data vs. Euro QE."


Instant Dollar Insight: #GrowthSlowing Data vs. Draghi QE - 10 23 2015 usd


FootwearRetail #1.0 = Busted

Takeaway: The cross-currents here are incredibly telling. This is the beginning of the end for FL.

We’ll simply let this SKX blow up speak for itself (while we kick ourselves for missing the short) – at least, the market certainly will.  But we think that when put into context with a few other factors, it paints an extremely bearish picture for #FootwearRetail1.0 – i.e. the traditional footwear retailers like Foot Locker, Finish Line, Hibbett Sports, and to a much lesser extent, Dick’s.


In contextualizing this across the broader space, here are a few things to keep in mind.


1. Let’s keep in mind that Skechers is the second largest Athletic Footwear brand in the US behind Nike at 8-9% market share. Most people don’t realize that. It’s bigger than Adidas and UnderArmour combined. Specifically, the domestic wholesale business at Skechers decelerated by approximately 20 percentage points sequentially on both a 1 and 2-year basis. Wholesale missed expectations by 11.5% and accounted for all of the miss in the quarter, and then some. We haven’t seen any major brand miss at wholesale to this magnitude in a long time.


2. In its most recent quarter NKE reported North American growth of 8%, and 15% in revenue and constant currency futures, respectively.  The more interesting nugget is that it put up these numbers while citing high inventory levels in the US, which is something we haven't heard out of this company in nearly a decade. With almost every retailer at historical peak ratios of Nike as a percent of total (up to 80% for retailers like Foot Locker), and even retailers like KSS showing 20% growth in Nike over the past three quarters, there’s really only one option for growth – online.  Nike is looking towards e-comm, to add an incremental $6bil by FY20. We think over half of that will be in the US. To put  that in perspective, the ENTIRE footwear space in the US is likely to grow by less than $4bn over that time frame. We think Nike will beat its target handily – but are being conservative in vocalizing their plans as to not overtly upset incumbent retail partners. This is so bad for #FootwearRetail1.0.


3. SKX cited a ‘full’ (i.e. stuffed) and promotional wholesale channel in the US for the $39mm sales miss. The company had planned on an extra inventory turn in September that didn’t materialize as promotional levels were high and the company's broadening wholesale network turned off the spigot. Now the company is sitting on a bloated inventory position, and the worst sales to inventory spread we've seen at SKX in over 3 years.


4. Recall that the latest inventory reading at FINL, HIBB and DKS were all negative on the margin, with sales to inventory spread down -8%, -8%, and -6% respectively.

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Janus Capital (JNS) | Discounted Appropriately...Removing From Best Ideas Short

Takeaway: We are removing shares of JNS from our Best Ideas Short list as the stock has dropped -20% and the Street's estimates are now reasonable.

We are removing shares of Janus Capital from our Best Ideas list as a short as the stock has now:

  • Appropriately discounted minimal impact from the Bill Gross hire;
  • Out year estimates have dropped to near our $1.00 number for '16;
  • The stock has dropped -20% from the $19 range.

In addition, short interest has been rebuilt to over 17% of float as of the most current reading which means that pessimism is peaking and now there is risk to the upside in a short covering rally. We are not gone for good on finding profitable spots to short JNS as we are still concerned that Credit, one of the main sources of growth at the firm, will start to struggle again. In the meantime there are incremental positives that should reinflate shares to higher levels (especially in light of higher short interest balances) where they will have a better risk/reward as a new short position:


  • Slight market share growth - Despite the ongoing worst start in history for active equity mutual funds trends (see the latest ICI survey here), the firm is gaining market share which means it is not as exposed to broader industry trends as other equity platforms. The retooling of its PM teams at Janus 20 and 40 has worked on the margin and forward performance has improved versus benchmark which is allowing trends to be more resilient than the overall industry.
  • Delevering - The firm continues to delever its balance sheet and is ensuring that it is self funding as the investment environment becomes tougher. This is not the Janus of past cycles which walked into the Bear Market of 2000 with substantial leverage AND middling investment performance. The firm reduced long term debt by ~$50 million during the quarter and extended the duration of its long term credit from 2017 to 2025. Debt to EBITDA is now just 1.8x versus over 3.0x before the Tech Wreck in early 2000 where the firm's liquidity was called into question. Simply put, the firm is managing its balance sheet at the right time.
  • Gross discounted - The Street and even company commentary now calls Bill Gross a "contributor to brand equity" and not a real asset gatherer as was implied in the substantial stock jump that started shares moving higher from $12 to $19 upon his hiring. Street estimates quickly zoomed up over 20% assuming a substantial AUM impact of between +$20-30 billion. With Street estimates now back to the $1 per share range for '16, Gross has been appropriately discounted.
  • Performance fee seasonality - With slightly better investment performance during the course of the year and less follow through of broader industry weakness via the ICI data, 4Q is likely to bring some incremental performance fees to boost returns. Over half of the firm's separate account performance fees hit in the last quarter of the year so seasonally this treatment could help shares in the short run.

We think there is risk to the upside at this juncture and are sidestepping putting fresh money into a short position for now. When short interest has returned to lower levels and pessimism normalizes, we will revisit the Bear case. The credit book at this point is our biggest cause for concern. It has been the main driver of AUM growth over the past 5 years, but performance in this product has become volatile. High yield spreads are now at 2011 levels, and any incremental decay will be worrisome for JNS. We think the credit exposure at the firm is under appreciated and any further blood letting in the asset class is cause for concern. We are moving shares from our Best Ideas list to our short bench but are looking for a better entry point to lay out shorts if fundamentals don't turn substantially higher.


Short interest balances have been re-built to over 17% of the float which means pessimism is now peaking again:


Janus Capital (JNS) | Discounted Appropriately...Removing From Best Ideas Short - Short interest build


A downright frightening drop in fixed income (credit) performance starting in 4Q14 has corrected itself, with 75% of Janus credit products now back above benchmark this quarter. Volatility in credit performance is worrying though as this is arguably the most important segment for the firm's growth. The company's long struggle with Quant products (at least on the performance side) thawed in the quarter as well with Intech making positive strides in 3Q15 across duration for now:


Janus Capital (JNS) | Discounted Appropriately...Removing From Best Ideas Short - Performance layout


The real driver of growth at Janus has been its Credit (fixed income) strategies which is why the perk up in performance this quarter is important. With high yield markets however having backed up hard in the latter half of 2015, Janus has a less recognized reliance on the continuing performance of corporate credit. This segment of the firm is the only silo that has been consistently growing the past 5 years with fixed income AUM having grown from 5% to 19% firmwide currently:


Janus Capital (JNS) | Discounted Appropriately...Removing From Best Ideas Short - Janus AUM 


The More Things Change...The More They Stay the Same 

Maybe Gross is Fully Invested

Freshly Squeezed - Don't Confuse Beta for Alpha - 4Q Recap

Lipper Speaker Series Call - Can Janus Return to Deity Status?

Gross Over Reaction - Adding to Best Ideas Short


Jonathan Casteleyn, CFA, CMT 




Joshua Steiner, CFA

Are You Prepared for a Deepening of the Global Earnings and Industrial Recessions?

Key Takeaways: Don’t be fooled by today’s price action in the DOW (which KM shorted into the close today). To the extent the ECB and BoJ incrementally ease monetary policy as our models suggests they will at some point over the next 2-3 months, the ongoing monetary policy divergence across G3 economies is likely continue perpetuating a severe tightening of credit conditions globally via a stronger U.S. dollar. Moreover, that is likely to perpetuate a deepening of the ongoing global earnings and industrial recessions.


Today we put together a ~20min video and a 27-slide presentation detailing how we arrive at the aforementioned conclusions. 



CLICK HERE to download the associated PDF, which reads as a standalone research note.


Feel free to call or email us with questions.


Enjoy your respective evenings,




Darius Dale


CAT | Official Denial & Pending Overshoot

“Never believe anything in politics until it has been officially denied.”  - Otto von Bismarck



Upshot: We see the potential stress at CAT Financial to be a downside catalyst for CAT shares in early 2016, and see commentary to the contrary as a sign that it is an internal concern. Deteriorating order trends still suggest that 2016 sales estimates need to move lower.  If those two catalysts play out, there is the potential for CAT shares to overshoot what we would see as a long-term fair value (perhaps around 60).  This management team seems frustrated, but after that 2016 reset, a new bullish narrative may emerge focused on structural cost reductions.



Relevant Prior Notes


Black Book: Feeling Used?



Three Takeaways


CAT’s report this morning is a mixed bag; that the shares could trade higher on it is probably a sign that sentiment is a bit down on the name.  We aren’t going to provide a tedious summary of the quarter since management did that at length on the earnings call.  There are lots of potential call-outs, like Resource Industries finally posting a negative margin.  But instead we will highlight our three takeaways.


  1. Hey, CAT Financial Is Fine Because Management Said So And They Always Nail It


Just a comment on CAT Financial in our captive finance business. It's a great business model. It's been proven through several ups and downs. Key metrics are in line with long-term averages despite weakness in a few very critical markets and it's healthy, well managed and risk is very much under control.”

        -  Doug Oberhelman 10/22/15


This management team has consistently been surprised by the extent of the downturn in resources-related capital spending.  CAT Financial didn’t exist during the last major cycle in resource-related capital equipment in the early 1980s, so we are not sure what “ups and downs” they mean.  After all, management finally referred to the downturn as a “super cycle” today.  We don’t think CAT Financial will do well in a super downcycle.  Who would?


If we were way off base in our expectation that CAT Financial is likely to become a drag in early 2016 (say, around the 4Q earnings report & 10-K), it probably wouldn’t have been specifically called out in the press release and earnings call.  We have detailed the specific exposures previously. In today’s report, we are interested by the odd combination of increased write-offs with a drop in allowance.  A bit of year-end assumption updating may well relieve our cognitive dissonance.


The current level of profitability seems to us unsustainable given the likely trend in residual values and the credit prospects of customers in North American Coal/Energy, Mining, and Emerging Markets.  We will need to wait for the 10-Q for the specifics.  


CAT | Official Denial & Pending Overshoot - CAT 1 10 22 15



Shouldn’t this be going the other way?

CAT | Official Denial & Pending Overshoot - CAT 2 10 22 15



If you don’t believe us that calling out the CAT Financial “model” (odd specificity) should be a concern, here are some cherry picked quotes.  They are well worth a read.


On Mining Downturn:  “We've added production capacity around trucks. We are staged to be the mining leader for decades to come. And I know there are lots of headlines out there that said mining is dead, not one more ounce of coal will ever be mined, iron ore will never come back, the world's going to stop spinning, it's over. Well, it's not over….”  -Douglas R. Oberhelman 9/24/2012


On Bucyrus:  “The Bucyrus acquisition, we need to finish that. We're almost done. It's been almost 3 years since we bought Bucyrus. Bucyrus brought to us greater stability during the downturn, we saw that in 2009 before we bought them, and we're seeing it again in 2013, plus it gives us greater growth opportunities -- more stability, greater growth.” – 3/4/14


On Brazil’s Economy: “I'm also optimistic in Brazil, although there's an election there this weekend, but both candidates, both parties are talking about reflating the economy and Brazil has always used infrastructure as a way to do that” – 10/23/14


On Oil Capital Spending: “…sustained basis certainly will take the really agitated top off of it, but there is still plenty of room for reinvestment.” – 10/23/14



Orders, Adjusted For Dealer Inventory, Still Trending Below 2016 Estimates


While it isn’t perfect, sales rates adjusted for changes in backlog and dealer stocks gives a decent sense of the run-rate top-line.  With the backlog dropping and estimated book-to-bill solidly below 1, we think 2016 sales estimates are still vulnerable.  Could sales come in closer to $40 billion next year? That appears increasingly plausible. It would be very hard to look at the orders in the quarter and conclude that the bottom is in.


CAT | Official Denial & Pending Overshoot - CAT 3 10 22 15


CAT | Official Denial & Pending Overshoot - CAT 4 10 22 15


CAT | Official Denial & Pending Overshoot - CAT 5 10 22 15



Not Happy With His Shareholders or The Street


In addition to the dig that “you may not as investors appreciate this in terms of dollars and cents” with respect to employee safety, there seemed general desire to avoid questions from the analyst community on the call.  The initial presentation cut off Q&A, and the call was not lengthened to accommodate questions.  What does a frustrated Oberhelman mean for CAT?  Probably nothing good for a leader who is laying-off employees and making tough choices.


Still, CAT management now has a more positive story to tell.  They do seem to be executing better on costs, and that matters.  The cost view into 2016 has more credibility with the trends below.


CAT | Official Denial & Pending Overshoot - CAT 6 10 22 15


Upshot:  We see the potential stress at CAT Financial to be a downside catalyst for CAT shares in early 2016.  We see commentary to the contrary as a sign that it is a concern in the C-suite.   Deteriorating order trends still suggest to us that 2016 sales estimates need to move lower.  If those two catalysts play out, there is the potential for CAT shares to overshoot what we would see as a long-term fair value (perhaps around 60).  This management team seems frustrated, but after a 2016 reset reflecting a weaker CAT Financial and current order rates, the groundwork is being laid for a new bullish narrative in the form of structural cost reductions.







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