We don't place a great deal of faith in the Fed's forecasting abilities here at Hedgeye. Actually, we don't place any faith whatsoever in the Fed's forecasting abilities.
Takeaway: The economic data continues to disappoint and signal recession ahead.
On The Macro Show this morning, Hedgeye CEO Keith McCullough and Macro analyst Darius Dale discussed why we're likely headed for a recession. Here's McCullough on the sequence of events typical of most economic cycles:
"This is what happens when the Deflation Dominos start to fall. First inflation falls off, then capex, industrials and cyclicals, then the consumer and, at the end of that, employment."
Look no further than September's soggy durable goods orders report released this morning. While the media focused on the dismal month-over-month decline of 1.2%, after being down 3% in August, McCullough honed in on the year-over-year data which "went recessionary in February."
Other indicators are similarly flashing red...
Like today's Consumer Confidence reading... it came in at 97.6 for October versus September's 102.6. According to Dale, consumer confidence may have reached an inflection point that has preceded a recession in the last three economic cycles.
Next up, new home sales... they were off 11.5% from the previous month, August, which was also downwardly revised.
And then there's Industrial Production... which also appears to have peaked.
(Anecdotal evidence of this industrial recession continues to roll-in as companies report earnings. Shares of engine manufacturer Cummins are down 9% today after lowering its full-year revenue and earnings guidance. In a statement, the company noted "weak demand" and a "slowdown in global markets.")
So what does all this mean for investors? Only those who have been patient on #Deflation and #GrowthSlowing have been winning in 2015. In other words, we will stick with "the most bullish call on Wall Street." Long TLT.
Slow and steady wins the race.
Takeaway: We're expecting soft 4Q guidance unless mgmt cried wolf on Display, but that would just raise the bar on already-lofty 2016 estimates.
- CORE WEAKNESS: 2H15 Local Ad revenue estimates will be a stretch unless YELP can curb attrition rates below 1H15 levels. We’re expecting YELP to miss 3Q Local Ad Revenues, and guide light for 4Q15 revenue; that is unless it can sneak in some upside from its ancillary businesses. However, it appears that consensus is already assuming a 2H15 acceleration in Eat24 revenue growth, and is also modeling sequential improvement in Other revenues as well. It’s possible that YELP could sneak in some upside in Display revenues after guiding to $10M in 2H revenue (-56% y/y decline vs. -9% in 1H). Granted, mgmt is shuttering Display by year-end; but the question is whether we’ll see that impact so suddenly in 2H, especially in a seasonally stronger 4Q.
- 2016 IS AROUND THE CORNER: If YELP does guide high for 4Q, we really won’t know why until it actually reports 4Q results since YELP doesn’t typically guide by segment. That means consensus will likely raise the bar for 2016 estimates across the board (including Local), which is already a tall order. Remember that YELP’s core business is Local Advertising, and that will become a greater percentage of revenues if YELP is indeed shuttering the Display segment by 2016. That said, the only way YELP can hit Local Ad Revenue estimates through 2016 is if it can sustain its 2Q15 new account growth rate every quarter from 3Q15 through 4Q16, and that will also require historically low attrition (see slide below from our Best Idea update call).
- WHAT WE’RE KEYING IN ON: Its Salesforce, primarily its size, secondarily its productivity. Both speak to the size of YELP’s TAM and the viability of its model. Remember YELP's model is predicated on hiring enough new sales reps to drive new account growth in excess of its rampant attrition (the majority of its customers). If YELP can’t consistently grow its salesforce to plan (net of churn), then its model is unraveling, and it's basically game over (see note below). Note that YELP already cut it sales rep growth target for 2015 from 40% to 30% on its last call, but if it can't deliver on that in 2H15, 2016 will be that much more challenging.
Let us know if you have any questions, or would like to discuss further.
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Takeaway: COH could be a TRADE to the upside as negative leverage swings in its favor. People will look to $2.50+ EPS power. But real number is $1.50.
Coach might be a good TRADE at any given point it time based on its business trending at varying degrees of ‘terrible’. But for anyone that has a duration of anything more than a year, we think that the name is absolutely positively uninvestable. Can COH earn $2.00 this year? Perhaps. It’s definitely on a ‘really bad’ as opposed to ‘horrible’ earnings trajectory – with sales ex Weitzman down 9% and EBIT down 31% as opposed to sales -15% and EBIT -50% three months ago. So yes, $2.00 in EPS is possible as we see operational leverage swing the other way. But that would be the last time annual earnings start with a 2-handle again – at least until someone takes the company private at a lower price than where it is today, incubates it, and finds the right market (and new investor base) for another IPO.
There are so many things we could point to that are problematic here, and most of them don’t represent any unique thought. A $32 stock knows about the following; a) Coach’s exodus of talent, b) that the brand simply does not resonate outside the US like other brands such as Kors, Kate Spade, and European higher-end luxury brands like Gucci and LV, c) that man-purses are not the answer, and d) what it means that the company had to resort to an acquisition in accessories (Stuart Weitzman footwear) – because unlike other brands it could not do it on its own.
[Two quickies on the SW deal: 1) buying a company like SW is a huge admission that the Core can no longer grow at the desired margin structure, and 2) one of the Cardinal rules of Retail is “Never Buy a Business from Jones Apparel Group”. JNY finalized its purchase of SW in 2012 for $430mm. Then as Sycamore Partners carved up JNY after the buyout, it sold SW to Coach for $574mm. JNY was the undisputed king of buying companies and stripping them of growth capital in order to improve margins. Coach is likely going to pony-up some deferred capex and SG&A on that one (upwards of $100mm).]
Ultimately, the problem is what most people know at some level – the brand simply does not resonate anymore with the consumer it needs to drive $1-$2bn in sales at an industry leading margin. The reality is that there’s nothing in the company’s strategy that we think allows it to shed its fate as a Department Store/Outlet brand for a style-conscious, but aging consumer. The slide below – which compares the KATE, KORS, and COH consumer -- says it all. Only 12% of KATE’s customers shop COH – that’s 9% for KORS. COH skews older (than the brand admits) and less affluent. KATE skews younger and wealthier. KORS is somewhere in between – but skews toward KATE.
The key point is that last year Coach sold about 25mm handbags to 16mm people (our math) – them’s big numbers. The best marketer in the world can’t just snap her fingers and change-up the underlying consumer group for a Brand. If Coach wants to accelerate growth, it probably has to fire some older, less affluent customers first. If it wants to drive margin, it should stop talking about the top line. Some brands/companies can have both. But that ship has long sailed for Coach. Unfortunately the company does not know it.
Bottom Line: The real earnings power for Coach – the one that allows it to sustain a low-single digit revenue growth rate over the long term, is about $1.50. That’s where we are 1 and 2-years out. But over the next two quarters, we think that the bounce in the sales/margin trajectory will make people believe in a much higher number. Unfortunately, COH management set expectations for a positive comp in 4Q – which is bold to say the least. We’ll look to get aggressive on the short side on the big green days.
A Quick Point On The Category – We’re Still Buying KATE
Category growth – in the North American premium and women’s men’s market was estimated to be in the LSD range during the quarter in line with what the company reported during it’s 4th quarter call back in August and off the high-single digit pace in 1H15 and mid-single digit pace in 3Q15. That’s not alarming to us given that two of the biggest competitors in the space, COH and KORS with market share collectively in excess of 40%, (using the $13bil market COH has cited) have been comping negative in North America at a negative HSD to LDD clip. KATE on the other hand has ~5% share in that market place and a lot of runway for growth. If COH’s numbers are right and the category is still growing at a LSD in spite of that, the dollars have to be going somewhere and we think that’s KATE.
Takeaway: Case-Shiller confirms HPI Acceleration. Meanwhile, 3Q15 HVS data shows the beginning of the long awaited rebound in 18-34 YOA homeowership.
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: August Case-Shiller HPI & 3Q15 HVS
HVS: Housing Vacancy Survey, 3Q15
We received the Census Bureau's HVS survey data for 3Q15 this morning.
The HVS survey is timely and widely cited, but it’s volatile and doesn’t always comport cleanly with the more comprehensive annual Census/CPS housing surveys or a common sense reading of reality.
We take the data with a grain of salt and, while we view the magnitude of change as a distorted reflection of the underlying reality, we view directional changes in the data as a largely accurate depiction of the underlying trend.
Household Formation: The yearly net change in Households in 3Q15 was 1.45MM, down modestly sequentially but marking a 4th straight quarter of breakout following a half-decade hibernation in household formation following the great recession.
The gains were again concentrated on the rental side with 92% of the increase stemming from an increase in renter households. Notably, however, 3Q15 marked the first time in 6-quarters in which Owner Occupied Households saw positive gains on both a QoQ and YoY basis. The quarterly HH formation trends along with the cumulative HH formation changes by type are shown in the charts below.
Homeownership: The National Homeownership Rate bounced off the 48-year low recorded in 2Q, rising to 63.7% in 3Q from 63.4% prior. The seasonally adjusted Homeownership Rate was flat sequentially at 63.5%.
The one callout is probably the notable increase in the Homeownership Rate among 18-34 year-olds which increased to 35.8% in 3Q from 34.8% prior.
Given that the employment recovery for that age cohort - which lagged the broader employment inflection - is now maturing towards the 3-year mark and has been growing at a premium to the broader average over the TTM, it's not particularly surprising to see upward pressure on ownership rates. Ongoing improvement in employment/income trends should continue to support rising headship rates with emergent rental demand slowly tricking through to the SF purchase market.
Again, we don't put significant stock in the precision of the HVS estimates but the data has begun to move directionally.
Case-Shiller HPI: August Godot Arrives (kinda)
The Case-Shiller 20-City HPI for August released this morning – which represents average price data over the June-August period – showed home prices rose +0.11% MoM while accelerating +20bps sequentially to +5.1% year-over-year. On an NSA basis, 18 of 20 cities reported sequential increases (down from 20 last month) while, on an SA basis, 11-cities reported increases (up from 10 prior). Notably, the Case-Shiller National HPI (which covers all U.S. Census divisions) accelerated for the 6th consecutive month, accelerating +10bps sequentially to +4.68% YoY.
Improving second derivative price trends have augured outperformance in the housing complex historically as rising prices are margin supportive and help perpetuate the Giffen Good dynamic that characterizes housing demand.
The National Case-Shiller HPI has been in accord with the improving price trend observed in the CoreLogic and FHFA series since late 1Q. The 2nd month of improvement in the 20-City Index in the latest August data provides more solid evidence that the most lagging of the HPI series is (finally) beginning to comport with the broader trend in prices.
About Case Shiller:
The S&P/Case-Shiller Home Price Index measures the changes in value of residential real estate by tracking single-family home re-sales in 20 metropolitan areas across the US. The index uses purchase price information obtained from county assessor and recorder offices. The Case-Shiller indexes are value-weighted, meaning price trends for more expensive homes have greater influence on estimated price changes than other homes. It is vital to note that the index’s printed number is a 3-month rolling average released on a two month delay.
Frequency and Release Date:
The S&P/Case-Shiller HPI is released on the last Tuesday of every month. The index is on a two month lag and therefore does not reflect the most recent month’s home prices.
Joshua Steiner, CFA
Christian B. Drake
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