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Client Talking Points

FX

Post another nasty #Deflation print out of the Eurozone (PPI -3.1% year-over-year vs. -2.6% last), the EUR/USD is down -0.4% and is finally signaling immediate-term TRADE oversold vs. an overbought U.S. Dollar Index into the U.S. jobs report.

OIL

WTI went squirrel yesterday vs. the correlation machines (up with the USD up), but it is also signaling immediate-term TRADE overbought alongside Energy Equity Beta (XOP and XLE).

RATES

For the umpteenth time this year, the UST 2YR Yield is in this 0.75-0.80 zone and signals overbought on “they’re gonna raise rates” – you’re one more bad jobs report away from 0.59% 2YR and 1.98% 10YR. FYI – we are staying with that call.

 

**Tune into The Macro Show at 9:00AM ET - CLICK HERE

Asset Allocation

CASH 61% US EQUITIES 6%
INTL EQUITIES 0% COMMODITIES 0%
FIXED INCOME 33% INTL CURRENCIES 0%

Top Long Ideas

Company Ticker Sector Duration
MCD

Last week was a big week for McDonald’s (MCD), as they reached the inflection point we were predicting. Post earnings, the next catalyst for the stock is going to be the November 10th analyst meeting.

 

The meeting will be an opportunity for management to shed more light on the progress of all day breakfast, additional G&A cuts and the potential of doing a REIT. Our Restaurants team remains bullish on the name, and they look forward to giving you some material updates after the meeting.

RH

Restoration Hardware (RH) shares gained 5.8% this past week. The margin story here is explosive. Margins were sitting below 10% on Friday, and we think they will be above 16% in 3 years. The key reason is that expense leverage on these new properties is like nothing we’ve ever seen (i.e. RH pays only 10% more for square footage that’s 300% larger).

 

In addition, the company does not have to proportionately grow its sourcing organization with the growth in its store base OR its category expansion.

 

Our estimate is that the company will add $3 billion in sales over 3-years and climb to $11 in EPS. The earnings growth and cash flow characteristics to get to that kind of number would support a 30+ multiple. In the end, we’re getting to a stock in excess of $300.

TLT

Our forecasts for domestic economic growth continue to be more accurate than the consensus. We anticipate economic growth will get a lot worse from here. That is why you want to own long-term bonds (TLT, EDV).

  • Real GDP growth slowed to 1.5% on a quarter-over-quarter seasonally adjusted basis. That was actually right at the top end of our range going into it (remember that the mainstream Q/Q annualized number is unpredictable)
  • On the Y/Y numbers, growth decelerated for a 2nd straight quarter to 2.0% from +2.7%
  • Consumption growth was a huge contributor to the number vs. the manufacturing side of the economy which continues to slow. However, take a look at the important chart below. We’re already past peak consumption growth. Consumption growth was positive on an absolute basis but remained rate of change negative with Q3 representing the 2nd quarter of deceleration off of the Q1 2015 peak
  • Both residential and nonresidential Investment decelerated sequentially and inventories contributed almost -1.5% bps to the headline number
  • Personal Income decelerated to +0.1% for Sep vs. +0.3% in August. The expectation was for a +0.2% print
  • Personal spending decelerated to +0.1% from +0.4%. The expectation was also for +0.2% print.
  • Core PCE printed flat at +1.3% Y/Y for Sep. vs. Aug. on a Y/Y basis. That number missed expectations for a +1.4% print

Three for the Road

TWEET OF THE DAY

Bad food sells. I get it.  Bad food layered with years of price increases doesn’t, kind of like.......  (fill in the blank)

@HedgeyeHWP

QUOTE OF THE DAY

There is more to life than increasing its speed.

Mahatma Gandhi

STAT OF THE DAY

The national average for a gallon of gasoline dropped 1.1 cents during the past week to $2.18 a gallon, according to GasBuddy. That’s about 11 cents lower than one month ago and 79 cents less than one year ago. AAA puts the national average at $2.19.


CHART OF THE DAY: Every Closed Signal @KeithMcCullough Issued in October | #RealTimeAlerts

Editor's Note: Below is a chart and brief excerpt from today's Early Look written by Hedgeye CEO Keith McCullough. Click here to subscribe.

 

CHART OF THE DAY: Every Closed Signal @KeithMcCullough Issued in October | #RealTimeAlerts - RTA CoD

 

"... While our competition may have the illusion that we “got killed” in October, we’re big on the whole transparency thing and would like to submit today’s Chart of The Day, in #timestamped terms – every closed signal [in Real Time Alerts] that I issued in OCT.

 

Back to what’s really been killed:

  1. Inflation Expectations (see our #Deflation Theme from last year)
  2. Growth Expectations
  3. Earnings Expectations"

Bullish Illusions

“Illusion is the first of all pleasures.”

-Oscar Wilde

 

Chinese stocks “ripped” +4.3% overnight on “speculation of opening a north-south link” that were tied to a PBOC’s “Governor comments” published on their website yesterday… but the comments ended up being from May 27th.

 

Lol

 

That headline was easily more entertaining than my favorite US domestic-equity-navel-gazer of the night: “Tesla posts its biggest loss in 10 quarters… but strong delivery guidance has the stock up +9%.”

 

Back to the Global Macro Grind

 

Into “earnings”, if you didn’t know that Tesla (TSLA) had crashed -25% from its 2014-2015 US Stock Market #Bubble top (see Hedgeye’s Macro Theme from Q4 of 2014 called #Bubbles for timing details), you’d have the illusion that whoever chased it at $280 is back to break-even.

 

It’s all about being driver-less and earnings-less, baby!

 

Bullish Illusions - Earnings cartoon 11.03.2015

 

To be fair, the SP500 OCT #HPAD (Hedgie-Perf-Anxiety-Disorder) Squeeze story wasn’t part of the earning-less one we outlined in calling the US Stock Market #Bubble what we called it before 62% of stocks in the Russell 3000 (which is 98% of stocks you could have bought) broke their 200-day Moving Monkey.

 

That epic OCT squeeze of +8.3% for the SPY was the best OCT since, well, Global Growth Slowed fastest last time (2011).

 

While our competition may have the illusion that we “got killed” in October, we’re big on the whole transparency thing and would like to submit today’s Chart of The Day, in #timestamped terms – every closed signal I issued in OCT.

 

Back to what’s really been killed:

 

  1. Inflation Expectations (see our #Deflation Theme from last year)
  2. Growth Expectations
  3. Earnings Expectations

 

Here’s an update on what I am sure every 2015 US GDP and “Earnings” bull nailed:

 

  1. Of the 500 companies in the SPY, 383 have reported Q3 Earnings (100% of them should have nailed that, so far)
  2. SP500 Sales Growth is currently down -5.2%
  3. SP500 Earnings Growth is currently down -4.3%
  4. Industrials Sector Sales Growth of -5.7% is worse than the SP500’s
  5. Financials Sector Earnings Growth of -6.2% is worse than the SP500’s

 

So, if you “back out Energy”, and stayed long the Industrials and Financials (which are both DOWN YTD in absolute return terms), you’re the strategist (or PM) who actually got nailed this year.

 

Are we competitive? Are you?

 

Obviously the score in this game matters. And while I do risk manage the immediate-term as aggressively and proactively as any strategist you’ll find (in Real-Time Alerts, which is where all my #timestamps live), the main reason for that is the obvious one – only someone who has never run money in their life wouldn’t buy/cover low and short/sell high, as Macro Themes get priced in.

 

Is both Global and US #GrowthSlowing further (in both Q415 and 1H16) from here priced in?

 

I don’t think so. And you can be damn sure that I’ll be held accountable to that view.

 

What’s most amazing to me at this stage of the game isn’t that we’re still doing what we do. It’s that the consensus that missed both #GrowthAccelerating in 2013 and #GrowthSlowing in 2015 is still doing what they do.

 

I guess the illusion in many people’s minds is that they never had any of this wrong, all along.

 

Our immediate-term Global Macro Risk Ranges (with intermediate-term research TREND views in brackets) are now:

 

UST 10yr Yield 1.98-2.26% (bearish)

SPX 2027-2116 (bearish)
RUT 1140--1198 (bearish)

NASDAQ 4 (bullish)

Nikkei 181 (neutral)

DAX 108 (neutral)

VIX 13.85-19.21 (bullish)
USD 96.31-98.02 (bullish)
EUR/USD 1.08-1.11 (bearish)
YEN 120.10-121.60 (bearish)
Oil (WTI) 42.98-48.23 (bearish)

Nat Gas 2.08-2.38 (bearish)

Gold 1110-1150 (neutral)
Copper 2.29-2.39 (bearish)

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Bullish Illusions - RTA CoD


Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

The Macro Show Replay | November 4, 2015

 


November 4, 2015

November 4, 2015 - Slide1

 

BULLISH TRENDS

November 4, 2015 - Slide2

November 4, 2015 - Slide3

November 4, 2015 - Slide4

 

BEARISH TRENDS

November 4, 2015 - Slide5

November 4, 2015 - Slide6

November 4, 2015 - Slide7

November 4, 2015 - Slide8

November 4, 2015 - Slide9

November 4, 2015 - Slide10

November 4, 2015 - Slide11

November 4, 2015 - Slide12


KATE | Critical Inflection Point

Takeaway: We think that 3Q is fine, and that after 7 yrs, EPS will inflect and begin to lend valuation support. One of the best risk/rewards in retail

Though few sane people would argue this by looking at how the stock trades, we think that the quarter looks solid for KATE, and the long-term investment thesis is fully on track. We think timing here is absolutely critical, and that timing finally favors the long side. Keep in mind that this company has been a serial restructurer, having traded under three different tickers in five years, and the only constant during that time period has been a lot of red at the bottom of the P&L. Even though KATE has been executing extremely well on its plan, the fact is that the stock has looked extremely expensive to the average investor who cared about nothing but current year earnings. This is why the stock got annihilated when the category (Kors) hit a wall. It simply had no valuation support. That’s why we think that the quarter we’re currently in (4Q), will be critical, in that the company should earn 30% more than it did in all of 2014. In fact, we’re a few short months away from people focusing on $1.00+ in earnings power for next year – a level it hasn’t seen since 2007. People will be looking at a name trading at 18x an earnings rate that should grow 50%+ for 3-5 years.

 

So why has the stock been acting like death?  For starters, it’s perfectly fair to be worried about what management will say on the call. Even though we think the trends look good, the fact is that KATE’s track record with communication is not good. We think it’s getting better, but wounds take time to heal.  In addition, it’s extremely tough to dispute that tax-loss selling was an issue here. Last week was fund year-end, and KATE was down 44% YTD through Friday. The double whammy of tax-loss selling and the “what will they say on the call next week” served as a vicious cocktail for the stock, we think. There was virtually no fundamental news out – even out of COH last Tues – that should have rocked this name like it did.

 

Watch what KATE does, not what it says. Ultimately, ‘what it does’ will create the value we know is about to be unlocked. Do we need better disclosure? Yes. Enough financial information to build a basic retail/multi channel model (like RL, KORS, COH, and pretty much every other real company that sells product in this space)? Yes. Management to put it’s money where its mouth is and buy stock when real believers in the story are sweating it out on the down days? Yes. A CFO who is on the conference calls (like every other company in the S&P)? Yes, please. But these are factors that can all be fixed – quite easily, actually. The thing that KATE has down pat is execution on the Brand growth and profitability strategy. We’ll take that.

 

Ultimately, we think we’ve got between $2.50-$3.00 in EPS power in three years. The CAGR it takes to get there gets us to $62 on the low end (25x $2.50) to $90 on the high end (30x $3.00). Either way, we’re talking around a 3-4-bagger from where the stock is today. This is one of the best risk rewards out there from where we sit.

 

Here’s a Few Considerations Regarding the Quarter

The ‘Space’ – COH indicated on its call last week that the premium North American women’s and men’s handbag category grew at a LSD rate in the most recently completed quarter (no change from 3 months ago). That’s not a big surprise to us considering that two of the biggest competitors in the space, COH and KORS with market share in excess of 40% have comped negative in North America at a HSD to LDD clip. But, if we do some quick math on that and assume that a) COH and KORS market share = 40%, b) the category is growing at 3%, and c) the absolute dollar growth rate for COH and KORS is ~ -5%. Then that means that the rest of the space is growing in the high single digit range. For a company like KATE, with only 5% share of the US handbag market and significant market share available to capture as the company builds out its US distribution network, that’s not as ‘toxic’ an environment as commentary would otherwise suggest.

 

Flash Sales/Promotions – this might be the first quarter in recent memory that there has not been excessive chatter about the space being overly promotional. That’s particularly the case with KATE, as the company continues to step off the Flash Sale accelerator in the DTC channel while working with wholesale partners to remove the brand from promotional events (in other words, when you see online promos at retailers like Lord & Taylor, it includes Coach, Kors, but not Kate). At DTC in NA specifically, KATE ran 4 sales in 3Q15 compared with 5 in 3Q14. 75% off Flash Sales were pared down from 3 to 1 in the quarter the company will report on Thursday. In 2Q (reported 90 days ago) the pull back in Flash Sales cost the company $6mm in revenue or three percentage points of growth on the adjusted consolidated revenue line, and 400-500bps on the comp line (reported comp of 10% vs. mid-teens adjusted for change in Flash Sale strategy). Due to timing KATE had 3 days of its mid-year Friends and Family sale pushed into the 3rd quarter vs. only one day last year, and the company added an additional 25% of Sale Items event in early September. The bottom line is that on an underlying basis, KATE is absolutely, positively less promotional than a year ago, as well as on a sequential basis.

 

E-commerce trends – sequentially e-comm growth ended the quarter right in line with where the company ended the 2nd quarter with the index traffic rank up 7% YY based on our analysis. Traffic rank is a 90-day moving average that takes into account both unique visitation and page visits per user and ranks each URL relative to the internet in aggregate. Since late August, when KATE bottomed it has outperformed the rest of the space (COH, KORS, & Tory Burch) by a wide margin (see chart 2). Comparisons at the e-comm level ease up in the 3rd quarter as KATE comps against a 23% growth rate vs. a 26% growth rate in 2Q (assuming a 20% e-comm weight). That’s not as marked as the sequential step down in Brick and Mortar compares where the company reported a 32% comp in 2Q14 and a 13% in 3Q14, but on the margin compares in this channel ease up in the 3rd quarter as KATE continues to pull back on its Flash Sale posture. The bottom line is that recent trends, which will presumably be implicit in the company’s guidance, are directionally encouraging.

 

KATE | Critical Inflection Point - KATE ecomm 1

KATE | Critical Inflection Point - KATE ecomm 2

 

GM guidance – KATE is guiding to a 60.4% gross margin rate for the year, which is flat to LY after adjusting for the $8mm inventory right down hit the company took in the 4th quarter from Jack/Saturday. YTD the company has leveraged Gross Margin by 190bps (65bps if we adjust for the $6m hit in 2Q14 from the Kate Spade Saturday inventory liquidation) and current guidance would imply that gross margins need to be down in excess of 125bps in 2H. The company has a tough compare in the 3rd quarter, but we have a hard time reconciling the delta between the 1H and 2H performance. Especially when you consider that the factors cited as headwinds (Fx, increased outlet penetration) should be annualized by 4Q15 when the company comps the Juicy outlet pull forward and Fx pressure from 4Q14. On the positive side, KATE will see the benefit of the JV conversion, the elimination of Jack Spade and Kate Spade Saturday retail doors, and increased licensing penetration. We don’t have KATE getting back the full 210bps of GM it lost in FY14, but given that there is 130bps from inventory right downs alone, and the current trends we’ve seen in the business it only makes sense that the company gets the majority of it back.

 

KATE | Critical Inflection Point - KATE earnings 2


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