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CHART OF THE DAY: Wall Street Projections Are As Bad As The Fed's

 

CHART OF THE DAY: Wall Street Projections Are As Bad As The Fed's - 11.27.15 EL chart

 

Editor's Note: Below is a brief excerpt from today's Early Look written by Hedgeye's Director of Research Daryl Jones. Click here to subscribe.

 

"... Now we certainly give money managers credit for being savvier, as it relates to the markets, than most members of the Federal Reserve, but the Chart of the Day shows that their “projections” may be almost as inaccurate as the Fed. As the chart highlights, in September 2014, the last time investors were selling Treasuries at this rate, it was basically at the peak in 10-year yield. So the moral of the story is: only turkeys sell at the lows."


Don’t Be a Turkey

“The 50-50 rule: Anytime you have a 50-50 chance of getting something right, there’s a 90% probability of getting it wrong.”

-Andy Rooney

 

Over the the Thanksgiving break, we stock market operators use only one rule of thumb. Related to Rooney's quote above, we assign a 50-50 chance of falling asleep after the second helping of turkey. In reality, that sneaky critter tryptophan turns that 50 – 50 chance into a more than 90% probability of sleep.

 

In fact though, the rule of thumb that eating turkey leads to sleep is really just a fallacy. Take it from our good friends at Wikipedia:

 

“A common assertion in the US is that heavy consumption of turkey meat results in drowsiness, due to high levels of tryptophan contained in turkey. However, the amount of tryptophan in turkey is comparable to that contained in most other meats. Furthermore, post-meal drowsiness may have more to do with what is consumed along with the turkey, carbohydrates in particular. It has been demonstrated in both animal models and humans that ingestion of a meal rich in carbohydrates triggers release of insulin. Insulin in turn stimulates the uptake of large neutral branched-chain amino acids (BCAA), but not tryptophan (an aromatic amino acid) into muscle, increasing the ratio of tryptophan to BCAA in the blood stream. The resulting increased tryptophan ratio reduces competition at the large neutral amino acid transporter (which transports both BCAA and aromatic amino acids), resulting in more uptake of tryptophan across the blood–brain barrier into the cerebrospinal fluid (CSF). Once in the CSF, tryptophan is converted into serotonin in the raphe nuclei by the normal enzymatic pathway. The resultant serotonin is further metabolised into melatonin by the pineal gland. Hence, this data suggests that "feast-induced drowsiness"— or postprandial somnolence — may be the result of a heavy meal rich in carbohydrates, which indirectly increases the production of sleep-promoting melatonin in the brain.”

 

That is a long winded way of saying: when it comes to blindly accepting conventional wisdom, don’t be a turkey!

 

Don’t Be a Turkey - FED cartoon 11.25.2015

 

Back to the Global Macro Grind...

 

In the cartoon above, from our illustrious cartoonist Bob Rich, we highlight the ongoing dilemma being contemplated by investors. Are the most recent data points hawkish or dovish? If so, what will the Fed do next? The bigger question of course is whether we are all just being turkeys with this continued myopic Fed focus.

 

It is more than a rule of thumb to suggest that any future shift in rates by the Fed should be based on their economic outlook, the problem with the economic projections of the Fed is that there isn’t a 50/50 chance they are correct. In fact, there is a more than 90% probability they are wrong.

 

The range of GDP projections from the members of the Federal Reserve started the year at 2.6 – 3.0% GDP growth. Just six months later in June, those projections were down at 1.8 – 2.0%. Now certainly we get better than most that making economic projecting is challenging in the best of times, but from the mid-point that is a more than 30% change in the projection in just six months. As my thirteen year old niece would say . . . #OMG!

 

Still despite the proven inaccuracy of Fed projections, the consensus view remains that the Fed will raise rates in December. According to a Bloomberg report out this morning, investors are selling U.S. government bond ETFs at the fastest pace in 14 months. As well, money managers withdrew $4.1 billion from U.S. fixed-income funds in November, the most since September 2014.

 

Now we certainly give money managers credit for being savvier, as it relates to the markets, than most members of the Federal Reserve, but the Chart of the Day shows that their “projections” may be almost as inaccurate as the Fed. As the chart highlights, in September 2014, the last time investors were selling Treasuries at this rate, it was basically at the peak in 10-year yield. So the moral of the story is: only turkeys sell at the lows.

 

In China this morning, the turkeys are seemingly coming home to roost with equity markets getting clobbered down almost 6% across the board. The cause du jour of this sell off is a broad, and likely overdue, crackdown on Chinese brokerages. The primary concern is CITIC Securities, which is being investigated by the Chinese version of the SEC for a supposed inflation of its derivatives business by a mere $1 trillion yuan (or $165 billion for those of you who are counting in U.S. dollars). 

 

To add a bit of fuel to the sell-off in Chinese equities, the only piece of economic data released was, not to mince words, abysmal. Specifically, industrial profits came in for September at -4.5% year-over-year. Given that data point, we probably shouldn’t be surprised that Chinese nickel producers announced today that they are reducing production in 2016 by 20%. But, hey, maybe more stimulus will help?

 

Things obviously aren’t great in China, but then there is Japan. According to recent government data, the Japanese work force could fall from 64 million in 2014 to 56 million in 2030, a decline of over 8 million people. In other news, the U.S. Federal Reserve is projecting inflation will accelerate in Japan over the next decade. (That’s a joke!).

 

Contemplating Japan and China reminds us of one of our favorite quotes from the Oracle of Omaha:

 

“Only when the tide goes out do you realize who’s been swimming naked.”

 

Indeed.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.18-2.29%

SPX 2025-2109

VIX 13.92-20.11

USD 99.11-100.21
Oil (WTI) 40.18-43.64

Gold 1060-1080

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research 

 

Don’t Be a Turkey - 11.27.15 EL chart


McCullough: How To Stay Ahead Of Consensus Right Now

 

In this brief excerpt from a recent Investing Ideas ‘Macro Overlay,’ Hedgeye CEO Keith McCullough explains how to position your portfolio ahead of the Fed’s potential December rate hike. McCullough also reflects on Wall Street’s worst macro calls of the year.

 

Subscribe to Investing Ideas today for access to our full list of longer term ideas.

 

Subscribe to Hedgeye on YouTube for all of our free video content.


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

The Macro Show Replay | November 27, 2015

 


ICI Fund Flow Survey | ~$250 Billion Dollar Divergence

Takeaway: Investors favored passive ETFs last week, continuing the trend that has brought 2015 ETF inflows to +101B versus fund redemptions of -$143 B

Investment Company Institute Mutual Fund Data and ETF Money Flow:

 

Investors pulled funds from almost all risk categories in the 5-day period ending November 18th. Total equity mutual funds lost -$4.9 billion, including another -$4.5 billion outflow from domestic stock funds. Fixed income mutual funds lost -$3.0 billion with investors continuing to flee the taxable bond category on fears of a rate hike. Meanwhile, investors favored passive ETFs, contributing +$1.5 billion and +$1.9 billion to equity and fixed income ETFs, respectively.

 

The chart below shows that the ongoing shift out of active domestic equity funds to passive U.S. equity ETFs year-to-date which has produced -$143.4 billion in outflows versus the +$101.1 billion that has been reinvested into ETFs over the same period. We recommend a short position in shares of T. Rowe Price as a way to express this ongoing shift (see our TROW reports). TROW's organic growth rate has been steadily dropping and what was once a double digit growth rate is moving to flat at best with our estimates calling for negatives growth through 2016. TROW funds still perform strongly however the shift out of the mutual fund structure is just too pervasive for the company to make the Street's still rosey expectations.


ICI Fund Flow Survey | ~$250 Billion Dollar Divergence - ICI19

 

ICI Fund Flow Survey | ~$250 Billion Dollar Divergence - TROW chart

 

In the most recent 5-day period ending November 18th, total equity mutual funds put up net outflows of -$4.9 billion, trailing the year-to-date weekly average outflow of -$773 million and the 2014 average inflow of +$620 million. The outflow was composed of international stock fund withdrawals of -$438 million and domestic stock fund withdrawals of -$4.5 billion. International equity funds have had positive flows in 44 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 -$3.0 billion, trailing the year-to-date weekly average inflow of +$161 million and the 2014 average inflow of +$926 million. The outflow was composed of tax-free or municipal bond fund contributions of +$649 million and taxable bond fund withdrawals of -$3.6 billion.

 

Equity ETFs had net subscriptions of +$1.5 billion, trailing 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 inflows of +$1.8 billion, outpacing the year-to-date weekly average inflow of +$1.1 billion and the 2014 average inflow of +$1.0 billion.

 

ICI Fund Flow Survey | ~$250 Billion Dollar Divergence - ICI1

 

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 | ~$250 Billion Dollar Divergence - ICI2

 

ICI Fund Flow Survey | ~$250 Billion Dollar Divergence - ICI3

 

ICI Fund Flow Survey | ~$250 Billion Dollar Divergence - ICI4

 

ICI Fund Flow Survey | ~$250 Billion Dollar Divergence - ICI6 2

 

ICI Fund Flow Survey | ~$250 Billion Dollar Divergence - 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 | ~$250 Billion Dollar Divergence - ICI12

 

ICI Fund Flow Survey | ~$250 Billion Dollar Divergence - ICI13

 

ICI Fund Flow Survey | ~$250 Billion Dollar Divergence - ICI14

 

ICI Fund Flow Survey | ~$250 Billion Dollar Divergence - ICI15

 

ICI Fund Flow Survey | ~$250 Billion Dollar Divergence - 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 | ~$250 Billion Dollar Divergence - ICI7

 

ICI Fund Flow Survey | ~$250 Billion Dollar Divergence - ICI8



Sector and Asset Class Weekly ETF and Year-to-Date Results: In sector SPDR callouts, the materials XLB ETF ceded -4% or -$94 million to redemptions in the 5-day period ending November 18th.

 

ICI Fund Flow Survey | ~$250 Billion Dollar Divergence - ICI9



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 | ~$250 Billion Dollar Divergence - ICI17

 

ICI Fund Flow Survey | ~$250 Billion Dollar Divergence - ICI18



Net Results:

The net of total equity mutual fund and ETF flows against total bond mutual fund and ETF flows totaled a negative -$2.3 billion spread for the week (-$3.4 billion of total equity outflow net of the -$1.1 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 +$963 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 | ~$250 Billion Dollar Divergence - ICI10 2

 


Exposures:
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 | ~$250 Billion Dollar Divergence - ICI11 



Jonathan Casteleyn, CFA, CMT 

 

 

 

Joshua Steiner, CFA







DE | Incredible Guide

 

Takeaway:  DE gave low quality guidance that exceeded consensus, a strategy we think may backfire later this fiscal year.  While the key components of the guidance look conservative at first, the outlook assumes stabilization in collapsing unit sales – a very tall order given our view of industry trends.  DE’s outlook also benefits heavily from a convenient change in pension & OPEB assumptions.  Long-term, we think DE is trapped in a less severe version of the 1980s Ag Equipment down-cycle, offering perhaps ~30% relative downside from current levels. DE is increasingly shifting to an FY17 story, as well.  Shorter-term, we expect the report to pressure bears and allow us to repeat our ‘short-a-squeeze’ strategy.

 

 

Key Earlier Notes:

 

Replay & Materials From Ag Equipment Black Book

 

Best Ideas Addition (5/22/15)

Where To From Here (9/21/15)

Removing As Best Ideas Short (11/24/15)

 

 

 

Dissecting the Outlook

 

We’ll let others summarize DE’s quarter, as only one section of the release really matters: Guidance.  We think DE’s FY2016 guidance is truly incredible in that it is difficult to believable.  Management overshot with a back-end loaded $1.4 billion net income outlook, we think, which was puffed up with a “candidly…more accurate” change in pension & OPEB assumptions.  Ag Equipment demand in DE’s key markets is in free fall; management ought to have included a larger buffer to accommodate continued deterioration.  The outlook instead appears to assume stabilization at current run-rate levels. 

 

 

Short Squeezes: For longs, the aggressive, low quality guidance risks an outlook cut later in the fiscal year.  Who wants to buy DE shares on that? For the moment, the answer is weak longs and those trying to pick an Ag Equipment cycle bottom. We plan to wait for a fairly clear squeeze to add it back as a Best Ideas short, even though that strategy risks missing the next down move in the shares.

 

 

Big Picture: Our view is that the Ag Machinery industry is in a 1980s-lite scenario, a case we laid out in our Twin Peaks & Mid-Cycle Myths black book.  In major capital equipment downswings, management and investors are typically surprised at just how far demand can fall.  The recent downturn in mining equipment is a good example - sales of new equipment pretty much evaporated.  Used equipment often competes with new equipment just as deteriorating borrower credit disrupts financing.  If our view for the Ag Equipment industry is accurate, sales levels should continue to slip from the lofty 2013 peak.

 

DE | Incredible Guide - DE 1 11 25 15

 

DE | Incredible Guide - DE 2 11 25 15

 

 

Weak Guidance Strategy:  The character of the FY2016 guidance may prove to be another hit to management credibility* following the unneeded FY2Q to FY3Q guidance fiasco.  We would have expected management to guide to consensus, and then hope to ratchet the outlook higher over time.  Fiddling with actuarial assumptions and guiding higher than needed is likely to be unhelpful.  The guidance also assumes that the free fall in equipment sales abates, which may prove optimistic. 

 

DE | Incredible Guide - DE 3 11 25 15

 

 

Implied Decrementals Not Too Aggressive:  Maintaining current FY15 decrementals should prove challenging as DE cuts production to abnormally low utilization (e.g. single shift).  However, guidance assumes a drop in decrementals excluding the benefit of the Pension/OPEB assumption change. 

 

DE | Incredible Guide - DE 4 11 25 15

 

 

Yield Expectations Also Reasonable: Sure, yields could drop a bit.  

 

DE | Incredible Guide - DE 5 11 25 15

 

 

Lowering Costs Through New Pension/OPEB Assumptions:  A driver of the higher guidance relative to expectations is Pension & OPEB expense, a huge 2016 tailwind.  In late 2014, DE’s FY2015 guidance included a far smaller $85 million headwind. It is a low quality cost decline, but it has also been a market where accounting quality has been largely ignored.  It may push out the DE short case, which is increasingly shaping up as a late FY16/FY17 story.

 

DE | Incredible Guide - DE 6 11 25 15

Source: Company Filings

 

 

Units Likely Unreasonable: DE is a short thesis that is in the process of playing out, we think, and it is easy to mistake ‘new lows’ for a ‘bottom’.  Cyclicals also tend to look “cheap” all the way down.  Guidance assumes a significant deceleration in unit sales declines, by our estimates.  Sales are in a free fall from very high productivity adjusted levels.  In the late 1990s and early 1980s, unit declines continued at a pretty severe pace without much let up.  Early order indications for 2016 have been horrific vs. 2015 levels (which were already down).  Declines from peak look large, but can readily continue.  There is no quick cure for too much industry capacity/equipment.

 

DE | Incredible Guide - DE 7 11 25 15

 

 

Too Reliant On Deere Financial, Especially Into FY17:  The 2016 profit outlook also relies heavily on Deere Financial.  Credit quality is likely to follow softening metrics like farm values, used equipment prices, and past dues.  As the portfolio shrinks into FY17, in our estimates, Deere Financial may prove an uncertain source of a high percentage of DE’s profitability.

 

DE | Incredible Guide - DE 8 11 25 15

 

DE | Incredible Guide - DE 9 11 25 15

 

 

ICYMI - Why the strong quarter?  Continuing the low quality theme, much of the beat relates to a lower tax rate. 

 

DE | Incredible Guide - DE 10 11 25 15

 

 

Upshot: DE gave low quality guidance that exceeded consensus, a strategy we think may backfire later this fiscal year.  While the key components of the guidance look conservative at first, the outlook assumes stabilization in collapsing unit sales – a very tall order given our view of industry trends.  DE’s outlook also benefits heavily from a convenient change in pension & OPEB assumptions.  Long-term, we think DE is trapped in a less severe version of the 1980s Ag Equipment down-cycle, offering perhaps ~30% relative downside from current levels. DE is increasingly shifting to an FY17 story, as well.  Shorter-term, we expect the report to pressure bears and allow us to repeat our ‘short-a-squeeze’ strategy.

 

 

DE & Segment Margins

 

DE | Incredible Guide - DE 11 11 25 15

 

DE | Incredible Guide - DE 12 11 25 15

 

DE | Incredible Guide - DE 13 11 25 15

 

DE | Incredible Guide - DE 14 11 25 15

 

 

*To clarify, we believe management is doing very well with what they have.  Unfortunately, outside of subject experts, few market participants are likely to notice as the cycle overwhelms excellent execution.

 

 


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 80.30%
  • SHORT SIGNALS 78.51%
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