How Bad Is It?

Client Talking Points

HOUSING

Headline Hijinks yesterday as neither the notable decline in Housing Starts nor the remarkable rise in Purchase Applications were as they appeared.  While Total Housing Starts declined -11%, single-family construction activity dipped just -2.4% off of cycle highs, single-family permits made a new 8-year high and the rise in multi-family permits suggests the decline in multi-family starts (-25% MoM) which weighed on the headline in October will reverse. The +12% week-over-week rise in Mortgage Purchase Applications, meanwhile, was the product of statistical adjustment noise in the holiday week (Veteran’s Day) and some measure of purchase pull-forward alongside rising rates.  Looking to next week, we expect a sequential decline in EHS as existing sales play catch-up to the trend in Pending Sales.

#GROWTHPROXIES

Fresh cycle lows in copper and iron ore are not a good sign for global growth… How bad is it? The China Iron & Steel Association said it expects steel output to drop -2.9% in 2016. That’s not a small inflection considering China’s mills produce half of global output. Former chief economist of Rio Tinto had this to say about continuing deflationary headwinds: “There’s about 300MM tons (~40% of Chinese production) of surplus capacity (in steel refining) that needs to not just be shut down, it needs to be bulldozed.” The deflation continues..

CHINA

Shanghai and Shenzhen closed up 1.4% and 3.1%, respectively, on the heels of a solid handoff from a strong U.S. close. Economic fundamentals continue to take a back seat in China with the unofficial MNI PMI reading slipping to 49.9 in NOVT from 55.6 in OCT. This is in line with crashing rail freight traffic growth and is also corroborated by a sequential slippage in the growth rates of industrial production, fixed assets investment, foreign direct investment, total social financing, as well as various measures of supply and demand in the Chinese property market in the month of OCT. Offsetting these “downside pressures” – which President Xi reiterated yesterday – is a sharp reversal of capital outflows that coincided with the IMF’s tacit decision to include the CNY in its vaunted SDR basket. Moreover, Beijing has taken to capital controls to help it accomplish its goal of exchange rate stability. While capital controls have rarely – if ever – been proven successful at staving off long-term currency depreciations, they can and will continue to be a short-sellers worst nightmare from the perspective of the consensus short on the Chinese yuan. Specifically, the PBoC’s verbal guidance to onshore banks to cull their offshore lending practices has made it more expensive than ever to borrow and sell short the yuan. The “Bejing Put” remains the #1 reason we aren’t in the Chanos camp on China; Chinese official can and will do what the half to do to ensure a relatively stable downshift in growth – if there even is such a thing.

 

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Asset Allocation

CASH 61% US EQUITIES 4%
INTL EQUITIES 3% COMMODITIES 0%
FIXED INCOME 28% INTL CURRENCIES 4%

Top Long Ideas

Company Ticker Sector Duration
MCD

Restaurants Sector Head Howard Penney attended MCD's investor meeting in New York City early last week. His takeaway from the meeting was that it was "very very bullish" for investors. Expectations were high, but CEO Steve Easterbrook came to NYC with big changes which have ultimately exceeded those expectations. "The big smile on Steve Easterbrook's face when talking about the current quarter was very telling," Penney writes. "He could not hide the enthusiasm." MCD increased the dollar value returned to shareholders by $10 billion. Penney and his team still see +30% upside from here.

RH

Restoration Hardware (RH) shares got caught up in the tumultuous selloff of other high-end retailers. But we're still bullish on RH. Here's why. RH Tampa has just opened. That makes 4 new Full Line Design Galleries in 90 days. And all will be open before the start of holiday shopping season and just in time to house the new product lines RH Modern and Teen. Add up the four stores and we’re looking at about 210k square feet. That alone represents about 25% growth in square footage.

 

When all is said and done, we still think this company has $11 in earnings power 4-years out, which is nearly double the consensus. We remain convinced that the debate should not be ‘if or when’ the stock hits $115, but rather is it going to $200 or $300? We’ll be looking at an earnings CAGR of 40-50% over five years. What kind of multiple does that deserve? 20x? 25x? 30x? We’d argue the higher end.

TLT

It was a nasty end to the week for the “growth is back” bulls. It was an equally nasty end to the week in equity markets. The S&P 500 was “going to all-time highs” Tuesday before retreating over 3% from Wednesday to Friday.

 

With continued data-driven confirmation that growth is slowing:

  • PPI (producer price index) printed -1.6% Y/Y for October
  • On a m/m basis, PPI declined -0.4% 
  • Declines in the energy component certainly bring the index lower, but PPI ex. Food and energy only printed +0.1% Y/Y which is ugly

Three for the Road

TWEET OF THE DAY

Rubio Versus The Fed https://app.hedgeye.com/insights/47625-rubio-versus-the-fed… via @hedgeye cc @KeithMcCullough #MarcoRubio #economy #Fed #Yellen

@Hedgeye

QUOTE OF THE DAY

The wise man should be prepared for everything that does not lie within his control.

Pythagoras

STAT OF THE DAY

North Dakota’s portion of the Bakken produced 1.11 million barrels a day in September, down 1.1% from the same month a year ago, according to state data. Drillers have been forced to idle 67% of the rigs that were in the region last year.