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Global Growth Has Not "Bottomed"

Earlier today Keith and I were on the road visiting clients in FL and debating some noteworthy victory laps by several of our [bullish] competitors.

 

Unlike said competitors, our process doesn’t leave a ton of room for cherry-picking data. As you may know, we run a predictive tracking algorithm on every relevant data point from every relevant economy in the world. The goal of that algorithm is three-fold:

 

  1. To contextualize sequential deltas as accelerating or decelerating;

  2. To contextualize the trend in any given data set as accelerating or decelerating; as

  3. To determine if the absolute value of the latest data point(s) is at/near a probable mean reversion level.

 

With respect to “global PMIs”, the table below compiles GDP-weighted Composite PMI data in the context of the aforementioned process:

 

Global Growth Has Not "Bottomed" - Composite PMI Summary

 

With respect to said process:

 

  1. Global PMIs did indeed broadly accelerate on a sequential basis in OCT. That is positive for the global growth outlook. Good.

  2. Global PMIs are still broadly decelerating on a trending basis as of OCT. That is negative for the global growth outlook and implies that the aforementioned uptick is not sustainable – at least not yet. Bad.

  3. Global PMIs are still far from “bottoming” given the average and median percentile readings in the far right column. In fact, economies like the Eurozone, Japan and U.S. are far from “bottoming” given where the latest data points fall within their respective cycles. Not good.

 

With respect to #2:

 

  1. According to the JPM Global Composite PMI series, global economic growth is still decelerating on a trending and quarterly average basis (1st chart below). Bad.

  2. According to the JPM Developed Market Composite PMI series, DM economic growth is still decelerating on a trending and quarterly average basis (2nd chart below). Bad.

  3. According to the JPM Emerging Market Composite PMI series, EM economic growth is still decelerating on a trending and quarterly average basis (3rd chart below). Bad.

  4. According to the ISM Composite PMI series, domestic economic growth is still decelerating on a trending basis. Bad.

  5. In fact, when analyzing each individual country’s benchmark Composite PMI series, economic growth across the balance of G20 economies continues to decelerate on a trending and quarterly average basis (5th chart below). One month of good data does not a trend make. Bad.

 

Global Growth Has Not "Bottomed" - GLOBAL COMPOSITE PMI

 

Global Growth Has Not "Bottomed" - DM COMPOSITE PMI

 

Global Growth Has Not "Bottomed" - EM COMPOSITE PMI

 

Global Growth Has Not "Bottomed" - ISM COMPOSITE PMI

 

Global Growth Has Not "Bottomed" - G20 COMPOSITE PMI

 

In short, when considering the preponderance of the data, any “bottoming” call with respect to global growth:

 

  1. Blatantly disrespects the TREND in domestic and global growth data.

  2. Blatantly disrespects the absolute level of the data – especially considering that most investors who are now calling for a “bottom” failed to identify what was an obvious top back in early 2015.

  3. Blatantly disrespects the risk of incremental #StrongDollar debt deflation – almost in cavalier fashion, especially given that the unwind of a #WeakDollar global leverage buildup is what got us in this mess in the first place.

 

After having done about 30+ meetings all over the country since we introduced our Q4 Macro Themes in early October, Keith and I remain of the view that #3 is arguably the most misunderstood and mispriced risk across asset markets today.

 

We are the authors of this view and suspect that most equity and credit investors still fail to grasp what macro investors view as a simple concept: a rising U.S. dollar tightens financial conditions globally.

 

Ten-plus years of financial repression in the U.S. created 10+ years of commensurate financial repression across the global economy (to prevent “Dutch Disease”) – especially in emerging markets (namely China). Such easy financial conditions perpetuated the world’s largest stock of USD and local currency denominated debt and, as a result, unprecedented levels of global demand. Now that cycle is in the process of coming undone, just as every cycle before it.

 

Global Growth Has Not "Bottomed" - Global Dollar Tightening

 

Required reading on this subject:

 

  • Two Schools of Thought Part II (6/8/12): We continue to view a sustained breakout in the USD as the most asymmetric and contrarian outcome facing global financial markets over the long-term TAIL.

  • Emerging Market Crises: Identifying, Contextualizing and Navigating Key Risks in the Next Cycle (4/23/13): We currently see a pervasive level of risk across the emerging market space at the country level and have quantified which countries are most vulnerable. As such, we find it prudent for investors to reduce their allocations to emerging market equity and currency risk in favor of US equity and US dollar exposure. #StrongDollar and commodity price deflation have been and should continue to be key catalysts for EM underperformance.

  • Are You Prepared for #Quad4? (8/5/14): Developing quant signals and fundamental data are supportive of investors adopting a defensive allocation w/ respect to the intermediate term.

  • #EmergingOutflows Round II: This Time Is Actually Different (12/16/14): In the context of our expectations for European and Japanese monetary policy, we think the rally in the U.S. dollar – which, now more than ever, has a profoundly negative impact on EM asset prices and economic growth – has legs.
  • 1Q15 Macro Theme: #GlobalDeflation (1/8/15): Amidst a backdrop of secular stagnation across developed economies, we continue to think cyclical forces (namely #StrongDollar driven commodity price deflation) will drag down reported inflation readings globally over the intermediate term. That is likely to weigh heavily upon long-term interest rates in the developed world, underpinning our bullish outlook for U.S. Treasury bonds (TLT, EDV, ZROZ, etc.).·

  • Are You Prepared for a Deepening of the Global Earnings and Industrial Recessions? (10/22/15): 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.

  • 4Q15 Macro Theme: #GameOfSlowing (10/8/15): With the Street, IMF, World Bank and OECD all still forecasting global growth of around 3% for 2015, we find it appropriate to reiterate our call for global growth to come in at or below half that rate. Moreover, while China's August CNY devaluation effectively made our #EmergingOutflows theme a consensus bearish cog in the global economic outlook, we do not think investors are appropriately positioned for a likely trend of negative revisions to the respective growth outlooks in the U.S., Eurozone and Japan throughout the balance of the year.

 

Moving along, the more we are right on our #EuropeSlowing view, our view that Abenomics will fail to achieve “5% Monetary Math”, or our view that the BoE is poised to shift dovish in conjunction with a rising probability of a U.K. recession, the more we will continue to be right on our structurally bullish bias on the U.S. dollar. Despite our bearish view on the U.S. economy, we believe the Yellen Fed is too far out in la-la-land with respect to its “dot plot” and GDP forecasts to implement QE4 quickly enough.

 

Global Growth Has Not "Bottomed" - Dot Plot vs. Fed Forecasts

 

Moreover, the more we continue to be right on our structurally bullish bias on the U.S. dollar, the more we will continue to be right on our structurally bearish bias on inflation expectations and the respective growth rates of global capital expenditures, global leverage and EM consumer demand associated with said inflation expectations globally.

 

In short, the global economy might’ve recorded a few “green shoots” in OCT, but the TREND in global growth is decidedly lower with respect to the intermediate term.

 

We are hopeful that this late-night rundown of the "data" helps clarify any confusion our competitors may have caused. Yes, this is the same "data" some of them told you to "ignore" and failed to identify as slowing 6-9 months ago.

 

Keeping it real,

 

DD

 

Darius Dale

Director


CAT | Naughty

Takeaway:  While we suggested covering some in late September, the recent disclosures leave us more bearish and suggest our thesis is on track.  Cat Financial apparently goosed 3Q15 results by changing model assumptions, adding an estimated 6 percentage points to the segment margin with an accounting maneuver.  Caterpillar Financial cut the Allowance for loan losses amid unfavorable changes in credit quality, which seems odd.  We can’t wait to hear CAT’s presentation on the Finance segment on November 17th, although we do not expect it to provide the data and granularity that investors want.  The various investigations appear to have expanded, and the company’s postretirement benefit underfunding should increase next year.  Overall, CAT’s 10-Q, proposed meeting on Cat Financial, and GS conference presentation continue to suggest further downside to us.

 

 

Key Earlier Publications

 

Feeling Used? CAT Black Book (latest of many)

 

In Rehab?  Would Reduce Short Exposure For Now (9/25/15)

Barron’s article response (8/8/15)

It Gets Worse From Here (7/23/15)

 

 

 

Writing On The Wall

 

“During the third quarter of 2015, as a result of management’s review, the loss emergence period and loss given default assumptions were updated and resulted in a decrease to the allowance for credit losses of $45 million. The decrease in the provision for credit losses was also due to the absence of a $14 million out-of-period adjustment in the third quarter of 2014 (included in the discussion above). These changes were partially offset by an unfavorable impact from changes in the credit quality of Cat Financial’s portfolio.”

 

Our Translation:  Credit quality deteriorated, but we changed some model assumptions so that deterioration didn’t impact earnings.

 

CAT | Naughty - CAT 11 4 15

 

 

Not Healthy:  If you come home, and a three year old says “I didn’t draw on the wall” do you bother to check, or do you just grab Mr. Clean Magic Eraser?  An unprompted denial usually doesn’t indicate anything good.  For CAT, the assertion that “our captive finance company is healthy and strong” was a similar red flag in the 3Q15 earnings release, and would have been tough to defend had margins dropped over 6 percentage points.  Write-offs were higher only in 2 quarters over the last dozen years, with both of those during the Financial Crisis.  Healthy?

 

CAT | Naughty - CAT 2 11 4 15

 

 

One Quarter Fix, Future Earnings At Risk:  Amazingly, that disclosure on the $45 million benefit from an accounting assumption change did not make the press release or earnings call, at least that we saw.  But the drop in allowance was highlighted.  To quote Josh Steiner of our Financials team “taking reserves, not just reserve coverage, down amid (sharply) rising NPLs is reckless and aggressive. Any traditional lender would face villagers/pitchforks for this.”  

 

 

Do You Know Who They Lent To?  Here is part of the list of Caterpillar Financial mining Major Accounts from our June 2015 deck.  As we understand it, these are not necessarily included in the Mining category of the portfolio in disclosures, but may be in regional buckets.  

 

CAT | Naughty - CAT 3 11 4 15

 

 

Problems Outside of Caterpillar Financial

 

Backlog Longer Than 12 Months:  It is worth noting that CAT’s order backlog is getting somewhat longer dated, which is not positive for 2016 since the total order backlog is lower.  It could also indicate that some delivery dates have been pushed out.

 

CAT | Naughty - CAT 4 11 4 15

 

 

Investigations Expanding

CAT has so many legal issues, that it can be hard to keep track of them.  The key investigations seem to be heading in the wrong direction for investors as of 3Q15.  The Federal grand jury investigation into CAT’s taxes apparently expanded, with additional subpoenas for, among other things, information on “dividend distributions of certain non-U.S. Caterpillar subsidiaries, and Caterpillar SARL and related structures.”  The pressure on this does not seem to be easing, and it could be an expensive settlement for CAT, as we understand it.  The investigation by the SEC into the accounting for the Bucyrus acquisition also generated additional subpoenas, and we think management should just restate, impair, pay a fine, or whatever is needed to get it over with, in our view.  

 

 

Pension Losses May Impact 2016 Earnings

CAT disclosed in the 10-Q that “Based on market conditions as of September 30, 2015, we would be required to recognize an increase in our underfunded status of approximately $800 million at December 31, 2015.” The driver of the pension challenges was “due to year-to-date negative plan asset returns”.  All else equal, this could increase pension expense in 2016 – a year that likely won’t need additional profit challenges. 

 

 

November 17th Cat Financial Meeting For Investors

The last one of these meetings, which was on the Across the Table dealer initiative, was not especially helpful.  We would be very surprised if this upcoming meeting on November 17th had the data and granularity that investors actually want.  We hope that CAT decides to provide more transparency on the composition and exposures in the portfolio, but our expectation is that it will be a narrative driven presentation.

 

 

Upshot:  While we suggested covering some in late September, the recent disclosures leave us more bearish and suggest our thesis is on track.  Cat Financial apparently goosed 3Q15 results by changing model assumptions, adding an estimated 6 percentage points to the segment margin with an accounting maneuver.  Caterpillar Financial cut the Allowance for loan losses amid unfavorable changes in credit quality, which seems odd.  We can’t wait to hear CAT’s presentation on the Finance segment on November 17th, although we do not expect it to provide the data and granularity that investors want.  The various investigations appear to have expanded, and the company’s postretirement benefit underfunding should increase next year.  Overall, CAT’s 10-Q, proposed meeting on Cat Financial, and GS conference presentation continue to suggest further downside to us.


Cartoon of the Day: Rate Hike Off the Table?

Cartoon of the Day: Rate Hike Off the Table? - Jobs.rate hike cartoon 11.04.2015

 

The surprise that Wall Street consensus isn't predicting? A gloomy jobs report on Friday. That would reduce the odds of a December rate hike. Here's more from Hedgeye CEO Keith McCullough on what that would mean for Treasuries:

 

"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."

 


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MACAU CALL: FRIDAY, NOVEMBER 6 @ 11AM

We will host a conference call on Friday, November 6 at 11:00AM ET to present our view on the Macau stocks, a deeper analysis of the October numbers, our updated estimates for FY 2015/2016, and a comparitive analysis of the concessionaires' performance. As always, we will entertain questions at the end of the presentation.

 

RELEVANT TICKERS INCLUDE:

LVS, WYNN, MGM, MPEL, 0027.HK, 1128.HK, 1928.HK, 2282.HK, 6883.HK, and 0880.HK

 

DISCUSSION POINTS

  • End of "The Trade": Taking profits on our long trade call 
  • Hedgeye company EBITDA estimates vs the Street for 2015, and 2016
  • Revised 2015/2016 monthly market projections
  • "True" Mass trends
  • Macau Studio City implications
  • Relative bottom line performance:
    • EBITDA share analysis
    • Who is succeeding in driving the higher margin Direct VIP business
    • Cutting the fat - how much lower can fixed costs go?
    • Promotional spending analysis
  • Q&A

CALL DETAILS

Attendance on this call is limited. Ping  for more information


The Stock Market Is Out of Breadth and Overstretched

Takeaway: We see a lot of risks in the market's recent run-up.

The Stock Market Is Out of Breadth and Overstretched - Hindenburg

 

Our Macro team continues to question whether the recent equity market run-up is getting long in the tooth.

 

It was the same question Hedgeye Macro analyst Darius Dale posed back in July. (You remember how that ended in August.) Click the image below to read Dale’s previous note.

 

The Stock Market Is Out of Breadth and Overstretched - darius dangerous highs

 

To update his previous research, Dale looked at the Russell 3000 (which is 98% of the investable public equity market) and, specifically, the percentage of stocks currently trading below their 200 day moving average to gauge the breadth of the market’s recent advance. 

 

See the chart below which shows that 53.6% of stocks are below their 200-day moving average. To put that in perspective, back in May that reading was 39.1%.

 

The Stock Market Is Out of Breadth and Overstretched - darius breadth 2

 

As Dale notes:

 

“… While not useful as a [market] timing indicator, the aforementioned deterioration does imply the duration and scope for prospective returns are substantially worse than many investors may assume given consensus expectations for the length and strength of the current economic cycle…”

 

The Stock Market Is Out of Breadth and Overstretched - darius twitter expansions


DRI | ARE OLIVE GARDEN EXPECTATIONS TOO HIGH?

Darden Restaurants (DRI) remains on the Hedgeye Restaurants SHORT bench.

 

We like it when you can keep a thesis on a stock simple and straightforward!  Expectations for a recovery at Olive Garden have gotten way ahead of reality.

 

DRI is going to report EPS in early December and the chances are high they have a good quarter.  The current street estimate for Q2 ’15 is $0.42, up 50% YoY.  Since November ’14 that estimate has moved up from $0.34, so expectations have increased 24% over the past 12 months.  In addition, since Jan ’15 the estimate for FY ’16 has gone from $2.99 to $3.68, up 23%.    

 

Over the last three quarters the company has beaten estimates by 18%, 16% and 18%, respectively.  I suspect the company can beat the number but the days of the “big beat” and raise are over.   

  

It’s been a year since Chairman Jeff Smith and his team took over Darden and what a year it’s been.  Consider the following improvements to the P&L:

  • Consolidated SSS have gone from flat to nearly 3% growth
  • SSS for the OG have gone from 0.5% to 2.7% in 1Q16
  • LTM Food Costs have improved 56 bps
  • LTM Labor Costs have improved 34bps
  • LTM Other Expenses have improve 95bps
  • LTM Restaurant Margins up 186bps
  • LTM G&A has improved 81bps
  • LTM Operating Margins have improved 310bps
  • EPS has nearly doubled to $3.17 over the last four quarters

 

Management has executed a strong recovery in financial performance over the past 12 months.  As you can see most of the gains have come from below the line cost cutting items, which are one time in nature.  Importantly, the company has announced and filed the relevant docs to create a new real estate company.  I understand there is an arbitrage that creates value by putting the OG rents in a vehicle, but what’s left is also very important.

 

As of 1Q16 this is what management is doing to post sustainable same-store sales growth at OG:

  • Value Proposition -  “Olive Garden is where people of all ages gather to enjoy the abundance of great Italian food and wine, and to be treated like family”
  • Leveraging Core Brand Equities – Breadstick nation and Tour of Italy
  • Table top tablets
  • Refresh 19 restaurant with 25 more planned for 2016

 

As you can see there is not an abundance of new innovation and management is not investing behind the brand or the assets!  As you can see from the chart below street expectation call for a significant acceleration is 2-year sales trends at Olive Garden.  As we see it the slope of the red line is way too steep given there is little investment in the OG brand and the industry trends are slowing.     

DRI | ARE OLIVE GARDEN EXPECTATIONS TOO HIGH?  - CHART 1

 

Given the current overall industry is slowing down, is it possible the trends at Olive Garden are that good? We don’t think it is logical to think that in 6 months Olive garden will be doing a 2.2% same-store sales on a 2-year basis.

 

Olive garden is the engine of growth for DRI.  Olive Garden represents 56% of sales for the company we believe accounts for roughly 42% of the total value of the company after parsing out the REIT.  Where Olive Garden goes, Darden goes.

 

Multi-concept casual dining restaurant companies struggle for the simple fact that it is difficult to allocate capital correctly. OG needs a lot of capital to reassert itself in the market while you have growth engines like Capital Grille and Yard House that need it in order to grow. The simple fact is Olive Garden is not getting the attention/capital it needs in order to return to meaningful long-term growth. This thinking coupled with a slowing casual dining industry is not good news for Olive Garden and the other concepts at Darden.

 

VALUATION

In a slowing sales environment with compressing casual dining multiples, if DRI were to trade at one of its closest competitors multiple, EAT, there is downside to the low $40’s.

DRI | ARE OLIVE GARDEN EXPECTATIONS TOO HIGH?  - CHART 2

 

Please call or e-mail with any questions.

 

Howard Penney

Managing Director

 

Shayne Laidlaw

Analyst

 

 


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.28%
  • SHORT SIGNALS 78.51%
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