McCullough: 'The Data Is Unequivocally Bearish'

In a spirited debate on Fox Business' Mornings With Maria today, Hedgeye CEO Keith McCullough and Recon Capital’s Kevin Kelly square off on Fed policy, McDonald’s and whether the U.S. is headed for a recession in 2016. 


ICI Fund Flow Survey | Barbelling

Takeaway: Investors allocated +$5.9B more to equity than bonds last week and also defensively shored up +$12B in cash.

Investment Company Institute Mutual Fund Data and ETF Money Flow:

In the 5-day period ending November 11th, investors tip toed out into equities and shored up cash, contributing +$3.1 billion to total equity products (mutual funds and ETFs) while withdrawing -$2.8 billion from total bond proxies (mutual funds and ETFs). Within equities, investors continued to pull capital from active domestic mutual funds, withdrawing -$2.4 billion last week which have now amounted to a total drawdown of -$139.9 billion so far in 2015 (the worst start to a year for domestic equity funds in all ICI data). Meanwhile, investors also shored up +$12 billion of cash in money market funds, continuing the trend of inflows in the second half of 2015. This brings cumulative 4Q15TD money market flows to +$45 billion, following the 3Q15 inflow of +$54 billion. We continue to like the cash management space and out of favor Federated Investors (see our FII report) on a combination of positive balance builds and profitability improvements in the business for '16/'17.


ICI Fund Flow Survey | Barbelling - ICI1 2


In the most recent 5-day period ending November 11th, total equity mutual funds put up net outflows of -$1.3 billion, trailing the year-to-date weekly average outflow of -$701 million and the 2014 average inflow of +$620 million. The outflow was composed of international stock fund contributions of +$1.1 billion and domestic stock fund withdrawals of -$2.4 billion. International equity funds have had positive flows in 45 of the last 52 weeks while domestic equity funds have had only 8 weeks of positive flows over the same time period.


Fixed income mutual funds put up net outflows of -$686 million, trailing the year-to-date weekly average inflow of +$230 million and the 2014 average inflow of +$926 million. The outflow was composed of tax-free or municipal bond funds contributions of +$314 million and taxable bond funds withdrawals of -$1.0 billion.


Equity ETFs had net subscriptions of +$4.4 billion, outpacing the year-to-date weekly average inflow of +$2.2 billion and the 2014 average inflow of +$3.2 billion. Fixed income ETFs had net outflows of -$2.1 billion, trailing the year-to-date weekly average inflow of +$1.1 billion and the 2014 average inflow of +$1.0 billion.


Mutual fund flow data is collected weekly from the Investment Company Institute (ICI) and represents a survey of 95% of the investment management industry's mutual fund assets. Mutual fund data largely reflects the actions of retail investors. Exchange traded fund (ETF) information is extracted from Bloomberg and is matched to the same weekly reporting schedule as the ICI mutual fund data. According to industry leader Blackrock (BLK), U.S. ETF participation is 60% institutional investors and 40% retail investors.

Most Recent 12 Week Flow in Millions by Mutual Fund Product: Chart data is the most recent 12 weeks from the ICI mutual fund survey and includes the weekly average for 2014 and the weekly year-to-date average for 2015:


ICI Fund Flow Survey | Barbelling - ICI2


ICI Fund Flow Survey | Barbelling - ICI3


ICI Fund Flow Survey | Barbelling - ICI4


ICI Fund Flow Survey | Barbelling - ICI5


ICI Fund Flow Survey | Barbelling - ICI6

Cumulative Annual Flow in Millions by Mutual Fund Product: Chart data is the cumulative fund flow from the ICI mutual fund survey for each year starting with 2008.


ICI Fund Flow Survey | Barbelling - ICI12


ICI Fund Flow Survey | Barbelling - ICI13


ICI Fund Flow Survey | Barbelling - ICI14


ICI Fund Flow Survey | Barbelling - ICI15


ICI Fund Flow Survey | Barbelling - ICI16

Most Recent 12 Week Flow within Equity and Fixed Income Exchange Traded Funds: Chart data is the most recent 12 weeks from Bloomberg's ETF database (matched to the Wednesday to Wednesday reporting format of the ICI), the weekly average for 2014, and the weekly year-to-date average for 2015. In the third table are the results of the weekly flows into and out of the major market and sector SPDRs:


ICI Fund Flow Survey | Barbelling - eq


ICI Fund Flow Survey | Barbelling - 2 ICI8

Sector and Asset Class Weekly ETF and Year-to-Date Results: In sector SPDR callouts, the industrials XLI and utilities XLU ETFs experienced significant outflows of -$707 million or -10% and -$514 million or -8%, respectively.


ICI Fund Flow Survey | Barbelling - ICI9 2

Cumulative Annual Flow in Millions within Equity and Fixed Income Exchange Traded Funds: Chart data is the cumulative fund flow from Bloomberg's ETF database for each year starting with 2013.


ICI Fund Flow Survey | Barbelling - 2 ICI17


ICI Fund Flow Survey | Barbelling - 2 ICI18

Net Results:

The net of total equity mutual fund and ETF flows against total bond mutual fund and ETF flows totaled a positive +$5.9 billion spread for the week (+$3.1 billion of total equity inflow net of the -$2.8 billion outflow from fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52-week moving average is +$922 million (more positive money flow to equities) with a 52-week high of +$27.9 billion (more positive money flow to equities) and a 52-week low of -$19.0 billion (negative numbers imply more positive money flow to bonds for the week.)


ICI Fund Flow Survey | Barbelling - 2 ICI10


The weekly data herein is important for the public asset managers with trends in mutual funds and ETFs impacting the companies with the following estimated revenue impact:


ICI Fund Flow Survey | Barbelling - ICI11 

Jonathan Casteleyn, CFA, CMT 




Joshua Steiner, CFA

How Bad Is It?

Client Talking Points


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.


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..


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.


**Watch The Macro Show replay - CLICK HERE

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

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.


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.


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


Rubio Versus The Fed… via @hedgeye cc @KeithMcCullough #MarcoRubio #economy #Fed #Yellen



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



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.

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FL | High Water Mark

Takeaway: This might not be the quarter to bet big on FL to miss. But estimates for the next 3 years need to come down – a lot.

Conclusion: We remain confident that Foot Locker will prove to be one of the best multi-year shorts in retail. The company is likely to earn about $4.20 this year, which we think will prove to be the high water mark in this economic cycle. We think that emerging competition from its top vendor, Nike (≈80% of sales), will stifle growth, and leave the company with an earnings annuity somewhere around $3.50-$3.75 per share. Is that worth $61? Not a chance. Not for a company that is Nike’s best off-balance sheet asset. And definitely not when the Street is in the stratosphere approaching $6.00 in EPS (#NoWay).


But as we know, multi-year stories are not linear. We’ve been asked many times this week what we’d do ahead of the print. First and foremost, we’re confident enough in our long term short call that we’d definitely have at least a partial position into the event. Keeping in mind, however, that the stock is off 27% since the Sept peak. Short interest has climbed to 10%, Nike got public about its DTC goals (i.e. compete with its wholesalers), SKX, DKS, FINL have blown up, and it’s pretty clear that inventories are high in the channel.  The P&L will have to show meaningful signs of stress in order to get paid tomorrow. Betting on that does not seem like good risk management to us.


But despite this quarter probably being a push, it’s really important to remember that consensus estimates in years one through three are high by $1-$2 per share. That ties into historical context. How many times did people say “damn, I missed my shot” as FL went from $5 to $10. Missed it. Then again when it went to $25. Missed it. $25 to $50. Missed. $50 to $75. Same…


We’re confident that people will be inversely ‘Missing It’ on the way down.


So our positioning into the numbers: We’re short it. On a good print, which is very possible, we get much heavier. On a bad print, we also get heavier.




Revenue: Comp expectations for the quarter sit at 6.3% which assumes a 170bps sequential deceleration in the underlying trend. Because FL reports a constant currency comp, Fx isn’t an issue. Category softness during 3Q earnings season to date has been focused primarily in sports apparel which is more levered to weather patterns and mid-tier athletic footwear (i.e. Skechers and Merrell). Apparel and accessories represent just 20% of FL’s mix (compared to DKS at 36%). And, the likes of SKX and Merrell don’t have shelf space at FL. Top line strength is directly dependent on the strength of the basketball and to a lesser extent running categories which have been running in the double digits for each of the past eight quarters for basketball, and five for running. We think this trend slows -- and not because we’re making ‘the tough comp’ or ‘top of the sneaker cycle’ call. The crux of it is that FL has taken NKE as a percent of sales from 50% to nearly 80% over the past 8 years, and we think that Nike is going to add $10bn in e-commerce sales in five years (blowing away it’s $7bn goal). And, we’ve started to see an inflection in the e-comm trends with NKE showing considerable strength over the past quarter as FL and DKS weakened considerably. We saw that reflected in the 3Q print out of DKS earlier this week when the company posted the lowest e-comm growth rate at 18% since 3Q11. Based on what we see, FL looks just as bad.

FL |  High Water Mark - FL DKS NKE


Gross Margin: FL is sitting a peak gross margins, as the company has been able to offset Fx dilution with better markdowns and leverage on the occupancy line due to mid-to-high single digit comps. At 33.4% on a TTM basis FL sits just 10bps shy from the low end of its 2020 guidance which called for GM to be in a range of 33.5%-34%. In contextualizing this across the broader space, here are a few things to keep in mind. a) On its last call NKE cited high inventories in the US channel that would persist for at least another two quarters, something we haven’t heard out of the company in over a decade. b) UA is sitting on elevated footwear inventories that are one of the biggest drivers of the -100bps GM guidance for the 4th quarter. c) SKX called out a stuffed wholesale channel and as a result saw the sales to inventory spread fall to -11% from +6% in the third quarter. d) That’s evidenced by the -8% sales to inventory at FINL and -6% sales to inventory spread at DKS, add to that the fact that DSW just bit the bullet and took down 4Q numbers by 67% due in part to weak sell throughs and the need to balance on-hand inventories. Each data point alone isn’t a smoking gun, but the broader context paints a bearish picture for #FootwearRetail1.0 -- where FL is the biggest player.


SG&A: Fx has been a considerable tailwind for the past four quarters as the SG&A benefit from Fx exposure has more than offset the gross margin pressure. We’ve seen the spread between reported and constant currency SG&A widen as far as eight percentage points. The company starts to lap that benefit in 3Q15, and then in a big way in starting in 4Q15. FL needs low single digit comps to leverage on the expense line. That equates to a lot of leverage when the company is comping in the HSD range, but on the margin as comps slow to the mid to low single digits the flow through doesn’t look as appealing. The company is within spitting distance of its long-term SG&A targets of 18%-19% and sits at the low end of any specialty retailer we can find. For a name just off peak multiples with comps slowing as it turns from a square footage consolidator into a square footage grower, that doesn’t add up to an accelerating EPS growth rate.

FL |  High Water Mark - 11 19 FL SG A


Expectations: Sentiment for FL is at 5 year lows with short interest as a % of the float marching from 7% to 10% since mid-October. Since the company reported earnings in mid-August the stock is off 15% vs. the RTH at -1%. But, that hasn’t been reflected in the consensus numbers where comps and earnings estimates have marched up by 20 bps and $0.01, respectively. There has been a lot of bad news in athletic/footwear land from the likes of SKX, DKS, FINL, BGFV, etc. when coupled with the price action in FL leads us to believe that expectations for tomorrow’s print are well in check on the comp side of the equation (a number FL has beat in 19 of the last 20 quarters).

FL |  High Water Mark - 11 19 FL Sent


Nu Skin (NUS) is on our Hedgeye Consumer Staples Best Ideas list as a SHORT.


Next Tuesday, November 24th, at 11:00AM ET we will be hosting a thought leader call with Jarrel Price of The Capital Forum.  Jarrel has been deeply engrained in the controversy surrounding Nu Skin and he has some differentiated views that will shed additional light on the issues at hand.


The Justice Department, along with federal partners brought the hammer down on the dietary supplement industry in a news conference on November 17th (link to the release can be found HERE).  As part of a year-long process, government agencies pursued civil and criminal cases against more than 100 makers and marketers of dietary supplements. “In each case, the department or one of its federal partners allege the sale of supplements that contain ingredients other than those listed on the product label or the sale of the products that make health or disease claims that are unsupported by adequate scientific evidence.”


The primary case that the DOJ announced was a criminal case charging USPlabs LLC and several of its corporate officers. The report went on to say, “the USPlabs case and others brought as part of this sweep illustrate alarming practices the department found – practices that must be brought to the public’s attention so consumers know the serious health risks of untested products.” In addition to the allegations against USPlabs, there were a number of civil cases that are going after different companies for their attempts to defraud the consumer, making false claims about products and deceptive advertising, among others. 


Given the DOJ’s actions, NUS is on notice about potentially deceptive advertising practices.  Jarrell has uncovered incremental evidence that Nu Skin distributors may have marketed VitaMeal in a way to deceive consumers. This would be in violation of the Unfair Deceptive Acts and Practices (UDAAP) act, which is exactly what these governmental agencies are attempting to prevent.


The walls are clearly closing in on Nu Skin. Now, on top of the current SEC investigation looking into their charitable giving’s in China; multiple governmental agencies are poking around the nutritional supplement category for deception and misrepresentation. We believe that it is only a matter of time until their name comes across one of these agencies desks and it catches their eye.


Jarrel "JP" Price helps lead The Capitol Forum's coverage of consumer finance and consumer protection issues. Prior to The Capitol Forum, Mr. Price led a team of analysts at the U.S. Department of Defense’s Task Force for Business and Stability Operations (TFBSO), focused on facilitating foreign direct investment in Afghanistan’s energy sector. Prior to TFBSO, Mr. Price was a Partner at Height Analytics, a Washington, DC-based investment research firm, where he covered a variety of consumer protection issues.

Mr. Price is a Founding Partner of The Park Advisors Group, which helps public and private sector clients manage investment risks in frontier and post-conflict markets. Mr. Price also serves as the President of the Young Professionals in Foreign Policy (YPFP). Mr. Price is a frequent contributor to a variety of national media outlets including CNBC, The Wall Street Journal, Bloomberg News, and NPR. 


Toll Free:


Confirmation Number: 13625346

Materials: To be provided in a follow up invite


Please call or e-mail with any questions.


Howard Penney

Managing Director


Shayne Laidlaw





Hedgeye's Early Look | #EXTRACHEESE

Takeaway: “You better cut the pizza in four pieces because I'm not hungry enough to eat six.” -Yogi Berra

We’re late in the cycle. So late. Do we trust our Macro analytical process to tell us so? Damn straight we do. But we also look for external validation from the hundreds of companies we analyze on a day to day basis at Hedgeye.


Sometimes they flip us the occasional third standard-deviation move in a given operating metric. Sometimes deviations from the mean are less significant, but vary massively from expectations. And sometimes…just once in a blue moon, a management team’s sheer unadulterated stupidity gives us all the ammo we need to remain confident that we are, in fact, #LateCycle.


Welcome to the playground we call Retail.


Back to the Global Macro Grind



Let’s look at some of the more painfully obvious datapoints handed to us by the US Retail Supply Chain this earnings season.

  • ICON - Pre-announed $0.09 vs $0.33 and restates historicals, driving the stock down 57% in a day.
  • JWN – Comp sales slowed 400bps with gross margin down 160bps.  "It appears that there has been a slowdown in overall demand from the customer who is purchasing what we sell."
  • M – 2015 EPS Guidance is now 23% below the original guide (excluding asset sales). "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."
  • SKX - The 2nd largest athletic shoe brand in the US saw its domestic wholesale business slow by 20 points sequentially. The stock subsequently lost $1.8bn in market value.
  • URBN - Missed revenue estimates for a 3rd straight quarter, this time by 5%.
  • WMT - At October Investor Day gave number that suggests last year’s EPS results won't be matched again until 2020.
  • MW – Jos. A Bank (Just acquired in a late-cycle transaction in itself) puts up a negative 15% comp, MW guided EPS in the upcoming quarter 50% below the street, and the stock dropped 40%.
  • Estimate Revisions - In the retail sector we have had 75 companies report 3Q.  20% saw 4Q estimates rise by avg of 5%. 80% saw estimates cut by average of 12%.



It’s not all bad, though. Keep in mind that many of the ugly datapoints outlined above are in the apparel, footwear and accessories space. While a very important component of retail, it accounts for only $500bn. That’s 11% of total retail sales and 30% of discretionary retail.


A part of the retail economy that’s offered up much better results is the Home category. In fact, with few exceptions, anything related to home-related durables and softlines has shown extremely solid trends in the quarter.

  • LZB - "With sales trends accelerating throughout the period, we are pleased to enter Q3 with momentum.”
  • Macy’s - "Our furniture and mattress business also continued very strong. And soft home -- categories like textiles, tabletop, et cetera -- strengthened in the third quarter."
  • Anthropologie (URBN) -  "I mentioned the home category in Anthropologie, which has been really off the charts."
  • HD / LOW - Home Depot and Lowe's both put up bullet-proof quarters this week, beating on every line of the P&L. HD was the particular standout.
  • TJX – Its HomeGoods division comped +6%.
  • RH – we won’t hear from RH for another few weeks. But we’re highly confident that the business is at or above plan. Yet the stock is off 15% in 18 days. We’d buy ahead of the quarter – and after the quarter. We think it’s going to $300.

Hedgeye's Early Look  |  #EXTRACHEESE - Home Furn Sales EL



Sometimes it’s not what a company reports that gives a #LateCycle signal, but rather what it does with shareholders’ hard-earned capital. Consider the following.

  • FOSL – Bought Misfit (wearable tech) for $260mm. This is a category where FitBit has 85% marketshare, and Apple, Nike and UnderArmour are making a push. If you can’t get the best, or make the best…buy the 5th best?? Management on the call said that it didn’t have tech capabilities and was particular headwind to the category. Huge admission of missing the ball on a major trend. Stock off 40% in a day.
  • M Backstage – Starts Off-Price Concept ‘because TJX makes it work’.  "First of all, I will tell you it is still early days in the evaluation process for Backstage. But our belief is that the model has certainly been proven by others…. So, it is more of a bet on the fact that the category has been proven, mostly by others.
  • KSS Off Aisle – Ditto. But at least Macy’s has access to high quality brands. What’s KSS gonna do, sell Juicy Couture, Dockers and Candies at discounted prices? It already does and no one wants them. #fail
  • But the biggest callout here belongs to URBN. In what we view to be one of the most ridiculous “strategic” moves by a retailer in over 20 years, Urban Outfitters acquired the Vetri Family group. Yes, a Pizza chain. This company missed on the top line three quarters in a row, and simply can’t grow. The CEO thinks that Casual Dining is a growth business – even though it is in a secular decline – so he bought a Pizza business. Not just any Pizza business, but a local Philly company who’s CEO he’s known personally, as best we can tell, for about a decade. This is a tiny investment that should have been made out of his pocket…not shareholders’.


We all know that investors tend to shoot first and think second, and with the XRT (S&P Retail ETF) down 15.4% since last earnings season, compared to just a 2.6% decline for everything that is not Retail, it’s clear that the market has spoken. When we’re late in an economic cycle, that’s probably what should happen.


But we’d argue that some names have not been punished nearly enough, and should be shorted accordingly. We’d point to KSS, FL, M, TGT, LULU, TIF, GPS, W, HBI, COLM. Others have been thrown out with the bathwater, and should be bought outright - RH, KATE, NKE, PIR, RL.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.18-2.30%

SPX 2020-2110
RUT 1135--1190

VIX 14.11-20.83
USD 98.47-100.08

Copper 2.05-2.17


Keep Calm and Win,


Brian McGough

& Hedgeye Retail Team