Is the Bear Market Priced In?

From NYC/CT to California to Chicago, Keith and I have been on the road facilitating discussions with clients and prospective clients for much of the ~3 weeks since our Q4 Macro Themes Call. As always, the discussions were candid and brimming with thoughtful analysis on both sides of the bull-bear debate. In terms of aggregating sentiment, I find that gauging buyside consensus is substantially easier now than it has been at any point over the past few years:


  • Equity and fixed income investors alike are fairly bearish – at least rhetorically. Much of that bearishness is a function of the now-obvious global industrial recession and domestic earnings recession we’ve been calling for at Hedgeye.
  • Relative to the amount of pushback we received 3-6 months ago, investors are at least willing to entertain the thought that we may be proven right in our assertion that the U.S. economy is indeed #LateCycle.
  • Still, most investors ultimately disagree with the aforementioned conclusion and don’t view the U.S. economy has having enough “speculative excesses” to support recessionary-like declines in economic and capital markets activity. Moreover, there exists a near-universal degree of consensus regarding the [overwhelmingly positive] outlook for the U.S. consumer.
  • With respect to the Fed, many investors place higher odds on QE4 than they do on eventual “liftoff”, which ultimately supports a generally sanguine outlook for “risk assets”.


Hopefully this synopsis is helpful, but to the extent you view these summaries as known-knowns, you may find additional value in our responses to what our team viewed as the key points of contention to our existing views:


  1. Great call nailing the domestic and global growth slowdown, but with the S&P 500 now down only a few percent from its all-time high, was everything you called for priced in at the August lows?
  2. Why won’t bad news continue to be good news for risk assets?
  3. In the U.S. household balance sheets are healthy, house prices are accelerating and gas prices are falling. Why won’t the U.S. economy and the domestic equity market weather the storm of international growth and earnings headwinds – much like they did in 1998?
  4. When citing your economic cycle timing indicators, how do you know that current signals aren’t false positives, rather than soundly in support of your view that the probability of a U.S. recession commencing by mid-2016 is high and rising?


See below for our detailed responses to each question. As always, feel free to reach out with any follow-up questions.


Best of luck out there,




Darius Dale





Q: Great call nailing the domestic and global growth slowdown, but with the S&P 500 now down only a few percent from its all-time high, was everything you called for priced in at the August lows?


A: Fair question, but we continue to think we are in the early innings of a series of lower-highs for the U.S. equity market.


Moreover, it’s a mischaracterization to cite the S&P 500’s minimal draw-down as indicative of the pain being felt by the preponderance of investors. For example, the HFRX Equity Hedge Fund Index is down nearly -6% from its YTD high in April. Moreover, 62% of stocks in the Russell 3000 Index (~98% of investable public equity market cap) are below their 200-day moving average (CHART). Worse, the mean and median YTD-peak-to-present drawdown of these 3,015 tickers is -25.2% and -20.2%, respectively (CHART). Recall that we initially warned of the dour implications of declining breadth in our 7/20 note titled, “Dangerous New Highs for the Market?”.


All told, we think it’s risky for investors to assume the coast is clear as a result of navel-gazing at the S&P 500, DOW or NASDAQ when the preponderance of single names are resoundingly signaling incremental deterioration of both top-down and bottom-up fundamentals.


Like Rome, this bear [market] wasn’t built in a [trading] day…





Q: Why won’t bad news continue to be good news for risk assets?


A: Given the pervasive level of bearishness I mentioned at the onset of this note (largely perpetuated by the terrible SEP Jobs Report), “risk assets” are once again trading inversely to policy rate expectations after a lengthy hiatus (CHART). Investors are clearly betting that their returns will be spared by a continuation of dovish policy and/or guidance out of the Federal Reserve.


But is the “don’t-fight-the-Fed” mantra an appropriate risk management overlay in every scenario? Historically speaking, the Fed has proven to be impotent at arresting #Quad4 deflationary pressures and/or the general credit risk associated with slowing economic growth (CHART, CHART). Moreover, the ECB and BoJ’s entry into the global currency war has made it much harder for the Fed to sustain #DownDollar asset price reflation (CHART, CHART). Lastly, the Fed has yet to prove it can suspend gravity during an actual economic downturn (CHART, CHART).


Importantly, our work continues to point to a rising, not falling, probability of the aforementioned bearish catalysts materializing:


  1. After moving to neutral from a ~15 month-long short/underweight bias on reflation assets, we now think another bout of #GlobalDeflation is just around the corner. Click on the following links to review the supporting analysis: “Risk Managing the Shift to #Quad3 – Especially in Energy” (10/8) and “Are You Prepared for a Deepening of the Global Earnings and Industrial Recessions?” (10/22).
  2. We think there is a greater than two-thirds probability the U.S. economy enters recession over the NTM. This compares the preponderance of investors pegging those odds at only 22% per a recent CNBC survey. Click on the following link to review the supporting analysis:


All told, we think the economic cycle ultimately wins out. While betting on QE to carry “risk assets” to new highs has proven to be a profoundly profitable exercise for investors during an economic expansion, we don’t recommend holding the bag when the growth music stops during what are now precariously illiquid securities markets (CHART). Most investors failed to forsee the 2000 and 2007 market tops and we expect most investors will continue to miss their opportunity to risk manage the 2015 vintage.


Tops are processes, not points. It’s never obvious to the crowd until it’s far too late…




Q: In the U.S. household balance sheets are healthy, house prices are accelerating and gas prices are falling. Why won’t the U.S. economy and the domestic equity market weather the storm of international growth and earnings headwinds – much like they did in 1998?


A: First and foremost, we would be remiss to do anything other than concede the aforementioned premises:


  1. Household balance sheets are indeed healthy (CHART);
  2. Home prices are indeed accelerating (CHART); and
  3. Gas prices are indeed falling (CHART).


That said, however, the U.S. economy had something working for it in 1998 that is now decidedly a headwind to consumption growth surmounting a demonstrable acceleration to cycle-peak base effects in the four quarters ending in 2Q16 (CHART) – demographics.


Specifically, U.S. consumption growth (and ultimately the U.S. economy) was able to remain resilient in 1998 largely due to rising demand from baby boomers “graduating” up the life-cycle consumption and income curves (CHART, CHART). Now the U.S. consumer at large is decidedly scaling down the backside of that curve with no reprieve from the millennial generation until 2019.


Perpetual 2.0-3.5% population growth in the 35-54 year-old cohort during the 1980s and 1990s might just be the greatest demographic dividend ever experienced in the western hemisphere. From the longest of long-term perspectives, “comping” that “comp” might just be the most damning component to Consensus Macro’s perpetual expectations of 3-4% U.S. GDP growth.


Now with employment growth slowing on a trending basis (CHART), investors have no choice but to wonder how where incremental [sub-prime] auto loan demand is going to come from. The risk to investors is that many failed to realize just how good the current cycle has been amid perpetually misguided expectations of a return to prior peaks.


All told, real household consumption growth has already negatively inflected (CHART) from its cycle-peak growth rate and growth in the [much-larger] services side of the U.S. economy appears likely to follow the manufacturing and export sectors lower in the coming months (CHART, CHART, CHART, CHART, CHART, CHART).


Lastly, let us not forget the inconvenient truth this is the S&P 500 experiencing a near -20% crash during 1998 (CHART). The SPY would have to drop roughly -17% from today’s closing price for the “it’s 1998, not 2000 or 2007” bullish narrative to get fully priced in…





Q: When citing your economic cycle timing indicators, how do you know that current signals aren’t false positives, rather than soundly in support of your view that the probability of a U.S. recession commencing by mid-2016 is high and rising?


A: We don’t. The entire point of investing would appear to be betting on what one’s analysis labels as a probable outcome becoming increasingly probable and ultimately getting priced into the market by other investors who subsequently arrive at a similar conclusion(s). It would seem silly for a bottom-up analyst to do a ton of work on a name only to take the other side of his/her own analysis. Macro investing isn’t any different…


This we do know:


  1. Most investors and the Fed do not expect a recession next summer.
  2. Most investors and the Fed are beyond terrible at forecasting GDP. Review our 9/2 note titled, “Early Look: Do You QoQ?” for more details.
  3. The signals suggest the probability of recession commencing at some point over the NTM is rising, not falling.
  4. The preponderance of high-frequency economic data continues to slow on a trending basis (CHART), as well as consistently surprise consensus expectations to the downside (CHART) – thereby increasing the aforementioned probability at every interval.
  5. Various read-throughs from capital markets activity – including peak M&A and buyback announcements, widening credit spreads (CHART), etc. – are confirming the rising probability of recession as well.


The confluence of the factors listed above support maintaining our current defensive posture with respect to our active Macro Themes and preferred factor exposures on the long and short side. When the fundamental, quantitative and behavioral inputs are no longer supportive, we will adjust accordingly.




  • Long-term Treasury Bonds (TLT*, EDV, ZROZ)
  • Municipal Bonds (MUB*)
  • Utilities (XLU*)




  • High Yield Credit (HYG, JNK)
  • Financials (XLF*)
  • Retailers (XRT*)
  • Small Caps (IWM)

***An asterisk denotes current Macro Playbook exposure. Long Housing (ITB), Short S&P 500 (SPY) and Short Spain (EWP) round out the list.*** 


All told, we aren’t raging bears. We aren’t calling for Lehman-style a collapse in asset markets. We are simply calling for a run-of-the-mill #LateCycle Slowdown in which inflation and capital expenditures peak and roll first, followed by employment growth and ultimately by consumer spending.


Textbook macroeconomics…

Cartoon of the Day: Fed Fortune-Telling

Cartoon of the Day: Fed Fortune-Telling - Fed cartoon 10.27.2015

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.  

U.S. Economic Data Flashes Trouble Ahead

Takeaway: The economic data continues to disappoint and signal recession ahead.

U.S. Economic Data Flashes Trouble Ahead - 10 27 2015 miss twitter


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."


U.S. Economic Data Flashes Trouble Ahead - 10 27 2015 durable goods


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. 


U.S. Economic Data Flashes Trouble Ahead - 10 27 2015 consumer confidence


Next up, new home sales... they were off 11.5% from the previous month, August, which was also downwardly revised.


U.S. Economic Data Flashes Trouble Ahead - 10 27 2015 new home sales wsj


And then there's Industrial Production... which also appears to have peaked.


 U.S. Economic Data Flashes Trouble Ahead - 10 27 2015 industrial recession


(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.


U.S. Economic Data Flashes Trouble Ahead - TLT cartoon 10.12.2015

Slow and steady wins the race.

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YELP | Thoughts into the Print (3Q15)

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.


  1. 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.
  2. 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).
  3. 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. 


YELP | Thoughts into the Print (3Q15) - YELP   Scenario Slide



Let us know if you have any questions, or would like to discuss further.  


Hesham Shaaban, CFA




YELP: The New Major Red Flag (1Q15)
04/30/15 08:53 AM EDT
[click here]

SPECIAL EDITION: McCullough Answers 4 Macro Questions From Elmo


During a special, surprise visit to The Macro Show this morning, Hedgeye CEO Keith McCullough fields some tough macro questions from “Elmo.” Top of mind for the Sesame Street character? Will the Fed hike interest rates and where should Elmo be putting his money right now.


Subscribe to The Macro Show today for access to this and all other episodes. 


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COH | Absolutely Uninvestable

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.


COH  |  Absolutely Uninvestable - COH   Kate Slide 10 27


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.

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