As our outspoken CEO Keith McCullough has repeatedly warned subscribers in the last few months, "The #1 risk to macro markets remains The Fed’s Forecast."
Takeaway: Although comps are tough this quarter, rising volume is making for improving Y/Y growth rates.
Weekly Activity Wrap Up
Options and futures volumes continued to come in above their 4Q15TD averages this week in a bid to leg out positive Y/Y comps by the end of the quarter. Options volume averaged 16.7 million contracts per day, raising the 4Q15TD ADV to 16.5 million. Y/Y change remains negative at -4%, but that marks an improvement from last week's -5% comp. Futures volume averaged 19.3 million contracts per day this week, raising the 4Q15TD ADV to 18.1 million, still a -6% Y/Y contraction but an improvement from last week's -7% comparison. Cash equities came in at 7.1 billion shares per day, bringing the 4Q15TD ADV to 7.1 billion, good enough for +2% Y/Y growth. In October of last year, the potential Greek exit from the European Union drove outsized activity, making for difficult comps this quarter in '15. However, with recently rising volumes, Y/Y growth rates are grinding into more positive territory.
Additionally, with a Fed rate hike on the table again near term, the following chart shows that historical Fed adjustments have been positive for CME volumes (mainly in Eurodollar futures and options). In the last rate hiking campaign, which lasted from June 2004 through June 2006, CME Eurodollar ADV experienced a clearly positive upward trend with baseline activity accelerating throughout the program. If the Fed raises rates (even marginally), we expect a similar positive impact on CME fixed income activity.
U.S. Cash Equity Detail
U.S. cash equity trading came in at 7.1 billion shares traded per day this week. That brings the fourth quarter average to 7.1 billion shares traded per day, a +2% Y/Y expansion but -2% Q/Q contraction. The market share battle for volume is mixed. The New York Stock Exchange/ICE is taking a 24% share of fourth-quarter volume, a +2% year-over-year increase, while NASDAQ is taking an 18% share, a -9% year-over-year decline.
U.S. Options Detail
U.S. options activity came in at a 16.7 million ADV this week, bringing the 4Q15TD average to 16.5 million, a -4% Y/Y and -9% Q/Q contraction. The market share battle amongst venues continues to be one of losses at the NYSE/ICE, which has lost -7% of its share year-over-year settling at just 19% of options trading currently. Additionally, CBOE's market share sits at 26%, -16% lower than 4Q14. NASDAQ, on the other hand, has increased its market share by +15% compared to 3Q15, bringing itself only -1% lower than the 24% share it held a year ago. Additionally, BATS' 8% share of 4Q15TD volume is +29% higher than in 4Q14. Finally ISE/Deutsche's 15% share in 4Q15TD remains consistent with 3Q15, which brings it to +8% Y/Y growth.
U.S. Futures Detail
CME Group had its best week all quarter with 14.2 million contracts traded per day, bringing the 4Q15TD average to 13.2 million, a -11% Y/Y and -8% Q/Q contraction. CME open interest, the most important beacon of forward activity, currently tallies 106.6 million CME contracts pending, good for +14% growth over the 93.7 million pending at the end of 4Q14, an expansion from the prior week's +12%.
ICE saw volume of 5.2 million contracts traded per day this week, bringing 4Q15TD ADV to 4.9 million, +12% Y/Y and +15% Q/Q growth. ICE open interest this week tallied 68.2 million contracts, a +15% expansion versus the 59.4 million contracts open at the end of 4Q14, consistent with last week's +15%.
Monthly Historical View
Monthly activity levels give a broader perspective of exchange based trends. As volatility levels, measured by the VIX, MOVE, and FX Vol should rise to normal levels after the drastic compression this cycle, we expect all marketplaces to experience higher activity levels.
Sector Revenue Exposure
The exchange sector has broadly diversified its revenue exposure over 10 years as public entities with varying top line sensitivity to the enclosed trading volume data. The table below highlights how trading volumes will flow through the various operating models at NASDAQ, CME Group, ICE, and Virtu:
Please let us know of any questions,
Jonathan Casteleyn, CFA, CMT
Joshua Steiner, CFA
Takeaway: Today's disappointing data confirms a number of our non-consensus calls and risk of first Fed Hike (into a slowdown) since the early 80s.
STILL DON'T BELIEVE GROWTH IS SLOWING? WE DON'T KNOW WHAT TO SAY.
While the latest round of lackluster economic data continues to confound Old Wall expectations, we're not surprised. Our Macro team continues to reiterate its #GrowthSlowing and #SuperLateCycle calls even while many on Wall Street cherry-pick last month's "Where's Waldo" jobs report number as the latest "evidence" to remain ebullient.
Oh well. The data continues to be on our side.
Look no further than today's retail sales and producer price numbers. Hedgeye CEO Keith McCullough had this to say:
"Both US Retail Sales and PPI slowed (again) this month. If you missed the Macy’s and Nordstrom blowups this week, just wait until US Retailers comp the toughest comp in 5 yrs (in November). Oh, and the Fed is going to hike into this slowdown. That should be fantastic for the [producer prices] which is crashing to new lows like Copper did this week. USD #Deflation Risk = On."
Today's PPI reading confirmed our concerns about #Deflation (one of our calls for over a year now). Here's a five year look at PPI including the latest number. To be sure, the slope of the line is unambiguously negative:
We nailed retail sales too. This past July, Hedgeye Macro analyst Darius Dale warned subscribers about #ConsumerSlowing...
Again, here are the latest numbers and the increasingly tough comps for retail sales in November.
And this beauty...
Need more proof? Anecdotal evidence of the consumer spending crash is sprinkled all over equity markets.
"We believe that the retail industry is going through a tough period that we seem to experience something like this every five to seven years or so, and this one feels familiar in that regard."
... And a look at Macy's stock chart:
“It appears that there has been a slowdown in the overall demand for the customer that is purchasing what we sell.”
... And the resulting stock plunge:
Not to alarm you further... but even after Kohl's (KSS) posted seemingly positive earnings, its shares are getting shellacked too on #ConsumerSlowing woes. (Note: our Retail analyst Brian McGough reiterated his short call yesterday.)
Bottom Line: None of this is reassuring. Economic Pollyannas be advised.
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Takeaway: Expectations suggest sequential pickup in sales w/o margin pressure. That's extremely aggressive given the circumstances.
Here's a look at key financial metrics for the four department stores that reported earnings this week. There are some really interesting takeaways. We all know sales are weak and inventories are high. By our math those two metrics are about 500bp out of whack. Our sense is that if retail CEOs could pick any two-week period of the entire year where the industry does not have excess inventories, they'd universally pick the two leading up to Thanksgiving/Black Friday. Unfortunately, the ball is not in their court.
Expectations for 4Q, as outlined below, still look too high. For the most part, expectations are for better-trending comps, without a meaningful hit to margins. There's very little chance that this comes to fruition. Base case is that we see a slowdown in sales OR in margins (negative earnings event). Worst case is erosion in comps AND margins.
The point is that there's a better chance than not that we see another round of downward earnings revisions. Either way it's reason for the group to test lower multiples.
This chart is not pretty -- showing that inventories are growing faster than sales by about 5% for the group headed into holiday. We need to see a huge surge in underlying demand to have margins positive for the group. Our sense is that the department stores end up in Quadrant3 -- right where they started.
In this excerpt of The Macro Show earlier today, Hedgeye Materials & Commodities analyst Ben Ryan calls gold a short-term "macro trading vehicle" and lays out the longer-term thesis for why gold can "go a lot lower."
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Nu Skin (NUS) was recently added to our Hedgeye Consumer Staples Best Ideas list as a SHORT.
NUS released (click HERE for the release) detailed information surrounding VitaMeal sales and profitability. The new information they provided conflicted with the information they gave shareholders on the 3Q15 earnings call.
Clearly, by putting out this new information, management is trying to calm the skeptics about the issues surrounding VitaMeal. Unfortunately, the new information sheet provided by the company only raised more questions about VitaMeal than it answered.
Now one of the biggest concerns we see coming out of this new information is where did all the money go? Which is arguably a bigger issue than we saw rising out of the VitaMeal controversy originally. Now, the original concerns are still there, they are just further compounded by this additional question.
In the new document it clearly says that VitaMeal is “1.5% of sales and less than 1.5% of operating profits.” Which contradicts what they said on the 3Q15 earnings call, Truman Hunt, CEO, said “Yeah, it's a product just like priced and sort of positioned just like any other product we would sell.”
Breaking down what they said in the new document, some things just don’t add up.
WHERE DID ALL THAT MONEY GO?
Looking at what the company recently disclosed the numbers just don’t add up.
In 3Q15, the company disclosed that there were 15.34 million meals donated or 510 thousands bags sold. Based on 1.6% (management 3Q15 guidance) of company sales ($571.3 million), VitaMeal sales in 3Q15 VitaMeal were $9.1 million. That implies that the ASP for VitaMeal was $17.87 per bag, significantly below the retail price of $25.50.
On the 3Q15 call CEO Hunt said “distributors purchase it for $20 to $25 depending on the market.” While the newly disclosed document specifically states that VitaMeal is sold for $25.50 per bag in the United States.
What accounts for the difference in the ASP? In 3Q15, where did the $7.59 per bag or $3.89 million dollars go? For the nine months of 2015 (according to the company’s numbers) the average VitaMeal bag sold for $14.45, implying that there is $19.1 million dollars unaccounted for.
Given these discrepancies in their own reporting what happened to the $19.1 million that is unaccounted for over just the last nine months?
MARGIN STORY ON VITAMEAL DOES NOT SEEM RIGHT
The company also said that VitaMeal contributes just under 1.5% of operating margins. It's incomprehensible in our eyes that VitaMeal has similar input costs to high end creams and nutritional supplements. Additionally, there are no distribution costs for Nu Skin given the charities take care of delivery. We strongly believe that VitaMeal holds a much larger percentage of operating profit than it does of sales.
Managements inconsistencies continue, below is an excerpt from the recently disclosed document stating that the margins on VitaMeal are “lower than its typical margin.” Directly contradicting what CFO Ritch Wood said during the 3Q15 earnings call when asked about VitaMeal margins, “it’s a product just liked priced and sort of positioned just like any other product we would sell.”
In 3Q15 we have VitaMeal sales representing 2.28% of total revenue via their Smile reports, which is 68bps above managements commentary of 1.6%. Accounting for distributor commission of 19% and COGS of 4% that would equate to roughly 39.7% of GAAP EPS or roughly 14.5%% of adjusted EPS.
One thing we would also like to point out, SAFI or Napoleon Dzombe are not mentioned once in this document. A troubling fact given only just two years ago SAFI was the largest recipient of funds from Force for Good, instead they mention Feed the Children.
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