Esteemed Authorities

“Clearly those esteemed authorities had been guessing.”

-David McCullough


One of the best parts of evolution stories is that eureka moment when someone comes to realize that the received wisdoms of the past are standing in the way of future progress.


The aforementioned quote comes from The Wright Brothers when Orville and Wilbur Wright realize “that so many of the long established, supposedly reliable calculations” (on flight from Lilienthal, Langley, etc.)… “had been proven wrong and could no longer be trusted… the accepted tables were, in a word, worthless.” (pg 63)


To be fair, I don’t consider ECB, BOJ, Federal Reserve, etc. forecasts worthless (there’s so much money to be made doing the opposite of what their anchoring-linear-forecasts imply). But their calculations do pose systemic threats to worldwide economies.


Esteemed Authorities - Central banker cartoon 03.03.2015


Back to the Global Macro Grind


For your friends who are still only staring at the “Dow” (in daily fantasy points) as a proxy for what “the market” is doing, there’s absolutely nothing to worry about. The Dow, bro, is only -0.1% YTD.


Then there are those of us who have embraced not only the non-linearity of a dynamic ecosystem like the Global Economy, but the interconnected and sometimes correlating style factors within macro markets (including Currencies, Commodities, Countries).


On that score, last week signaled more of our 18 month old call on the mother of all economic risks – #Deflation. And before I drip on why deflation morphs into a risk to the Fed’s serially overoptimistic growth forecasts, here’s what happened in Global Macro last week:


  1. US Dollar Index ramped > 100, closing up another +0.5% on the week to +10.9% YTD
  2. Euros dropped another -0.5% (vs. USD) on the week, taking its YTD devaluation to -12.4%
  3. Canadians lost another -0.2% of their currency’s purchasing power, taking the CAN$ to -13.1% YTD
  4. Commodities (CRB) remained in #crash mode, falling another -0.3% on the week to -20.1%YTD
  5. Oil’s (WTI) crash/deflation for 2015 dropped another -0.5% on the week to -30.4% YTD
  6. Dr. Copper’s crash/deflation hit new lows intraweek, then bounced to -27.3% YTD


I’ll take a breather right there as that’s just a wall of headline foreign currency and commodity market risk factors that every legitimate macro investor should be aware of. If you don’t do macro, it will eventually do you.


Moving along to the beloved US Equities side of the market:


  1. Healthcare Stocks (XLV) were +0.8% on the week, still beating “the market” (SP500) at +5.4% YTD
  2. Financials (XLF) were down -0.4% on the week, still lagging “the market” at -0.6% YTD


Now, as the Fed prepares to raise rates (into worldwide #Deflation and a #LateCycle US economic slow-down), isn’t the ongoing bearish divergence between what the Financials are doing and the Fed’s “supposedly reliable calculations” on GDP interesting?


It certainly shouldn’t surprise anyone who is paying attention to both the #GrowthSlowing and credit cycle signals of the bond market. The long-end of the curve is compressing into said “hike” expectations.


Here’s how that looks this morning, in bond market terms:


  1. Short-term (2yr) Yields spike to 0.95%
  2. Long-term (10yr) Yields don’t budge at 2.23%
  3. Yield Spread (10yr minus 2yr) compresses to +128 basis points, -23 basis points (at the lows) YTD


In other words, since the rate of change in the Yield Spread is a far better leading indicator for the expansion/contraction of the economy than some central-planning dude’s forecast, the Global Macro market continues to read the Fed’s forecast (hike) as a risk to the economy.


Oh, and on the said “data dependence” of the Federal Reserve, they’ll get both a PMI reading out of Chicago this morning and an ISM reading for November tomorrow. Last month’s super slow ISM reading of 50.5 wasn’t cited by anyone at the Fed, or our competition.


But does the data really matter? Nope. Yellen’s speech at the central-planning (economics) club of Washington on Wednesday does. And so will Mario Draghi’s central market planning event on Thursday morning (ECB meeting).


By the time we get to Yellen’s testimony in front of the “Joint Economic Committee” (JEC) in Washington on Thursday, more #StrongDollar Deflation will still have our esteemed authorities guessing.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.18-2.28%

SPX 2045-2109

NASDAQ 5034-5181
USD 99.19-100.29
Oil (WTI) 40.55-43.26
Copper 1.98-2.11


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Esteemed Authorities - 11.30.15 EL chart

The Macro Show Replay | November 30, 2015


November 30, 2015


  • Bullish Trend
  • Bearish Trend
  • Neutral

10-Year U.S. Treasury Yield
2.28 2.18 2.22
S&P 500
2,045 2,109 2,090
Russell 2000
1,143 1,209 1,202
NASDAQ Composite
5,034 5,181 5,127
Nikkei 225 Index
19,321 20,041 19,883
German DAX Composite
10,880 11,377 11,293
Volatility Index
13.99 19.01 15.12
U.S. Dollar Index
99.19 100.29 100.07
1.05 1.07 1.06
Japanese Yen
122.19 123.68 122.82
Light Crude Oil Spot Price
40.55 43.26 41.77
Natural Gas Spot Price
2.20 2.39 2.23
Gold Spot Price
1,050 1,075 1,056
Copper Spot Price
1.98 2.11 2.05
Apple Inc.
112 120 117
640 688 673
1,213 1,295 1,244
Valeant Pharmaceuticals International, Inc.
67.52 96.70 87.09
Walt Disney Co.
114 118 115
McDonald's Corp.
111 116 114




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Takeaway: Expectations imply 4Q malaise is purely weather, and that we snap back in 1Q. That’s an extremely reckless approach - one we’d short against

Conclusion: We’re happy to get into the debate about how crowded the parking lot was at the mall this weekend, but it’s nowhere near as relevant as the current profitability growth trajectory for Retail, and the consensus expectations for the group as we head into 2016. The good news is that 4Q sales estimates look only slightly high. The bad news is that margins expectations are still 50-100bps high for the group. The worse news is that the Street’s numbers are banking on a recovery in growth and margin starting in 1Q16. In other words, it’s chalking up this ‘thing’ retailers are feeling now as exactly what management teams want us all to believe – while they cross their fingers, hope and pray that the economy is not really slowing.  The group might be viewed as damaged goods in this market, but keep in mind that it’s only down 4.3% for the YTD vs a 1.5% gain for the market – not a big difference. It’s trading at 18-19x earnings, and has short interest that is disproportionately low for an economy that is #LateCycle. We’re net sellers of Retail.





We’re going to let #WallStreet1.0 debate the success of the start of the holiday season based on things like how long the lines were at the Gap, counting shopping bags and empty parking spaces, or how long it took to get a Chick-fil-A at the food court.  But I think most of us would agree that basing one’s view on a small handful of stores is a pretty useless exercise given that there are about 1,100 regional malls and 7,100 shopping centers in the US, which combined account for $5.3 trillion annually, $2.5 trillion in discretionary spending -- nearly $300bn of that falls in the month of December alone. Yes, there are always data points and anecdotes that might ultimately prove to be representative of the whole, but from our perspective, you overwhelmingly need to go big picture in looking at the next few months.  That picture, unfortunately, is not a good one.  


In contrast, management teams have been generally upbeat with Black Friday press releases (especially Kohl’s, Wal-Mart, Target). But make no mistake, the CEOs were not talking to us with their bullish statements. They were talking to consumers and more importantly, to employees. They have no choice but to be very upbeat, get their salesforce jazzed up in the process, and sit and hope that things play out in their favor. Even this week, when we inevitably get negative datapoints on sales versus last year, the press releases will contain verbiage intended to keep hope alive that business will pick up materially throughout December – the elevated levels of inventory are banking on it.


If there are any numbers we come remotely close to trusting about the weekend, they’re online sales growth numbers given by the sources below. All in, it suggests that sales growth slightly accelerated vs last year on Thanksgiving, but growth was lower on BF vs last year. The numbers are hardly consistent, but we’ve found that all four in concert have been a good directional indicator as to how things are going. If we had to believe just one of the sources, it’d be IBM, which has been closer to the mark in the past with its reporting.





But the real thing we care about is the financial trajectory in aggregate for the group, which we aggregate below. We have eight historical quarters of sales, margins, earnings, working capital and capex, along with quarterly consensus estimates through mid 2016.


Sales and Margins: The good news is that consensus is looking for just 1.2% sales growth in 4Q (ending Jan). It happens to be on top of a very solid 6.8% sales growth number last year – but at least the Street seems to have done the math right with 4Q revanue estimates.  On the flip side, the Street is looking for revenue growth to pop back up to a 3-4% rate in 1H16. That’s not eggregious, but its more aggressive than we see in 4Q.


Margins: Margin expectations look too high. While 80bp below last year, the Street’s 4Q margin target (columns in the chart below) looks too high. It represents a 100bp sequential increase, which simply does not seem plausible given the inventory overhang. Etimates also assume that we’re back to flat yy by 2Q, which also seems very aggressive. In other words, the street is treating this slowdown as a weather event – and nothing more. If the economy is actually weakning, which we think it is, then sales will come down, and margins will come off materially.




EPS: Third quarter EPS declined by 1.9% for the group. The good news is that 4Q estimates call for a similar decline. We think it will be worse than that, but perhaps not terribly. The risk, however, is that growth expectations pop back up to mid-single digits rather quickly after 4Q. As noted in the Sales/Margin discussion, we need to assume a rock solid economy for this to happen.



Capex: has been quite stable for the past two years at a fairly low rate of 3.8% of sales. That said, we’re hard pressed to find a retailer that is not increasing its planned rate next year as it invests more in e-commerce. We stress ‘planned rate’ because the dollars are in motion, but if the sales level comes in weak, which happens commonly when we’re late in a cycle, then the rate goes up materially.



SIGMA: In looking at the triangulation of sales, inventories and margins (SIGMA) the group has the unfortunate distinction of being in the lower left hand quadrant for the second consecutive quarter. That means inventories are growing faster than sales, and margins are down. The only thing we could realistically see at this point is a defensive move to clear inventories, which would mean another leg down in margins. We see that often at the company level, but it’s rare to see an entire group of companies move in concert to clear inventory. Realistically, we’re looking at a negative 2-3 quarter event.


The Week Ahead

The Economic Data calendar for the week of the 30th of November through the 4th of December is full of critical releases and events. Here is a snapshot of some of the headline numbers that we will be focused on.



The Week Ahead - 11.27.15 Week Ahead

Investing Ideas Newsletter

Takeaway: Current Investing Ideas: TIF, JNK, NUS, W, WAB, ZBH, FII, MCD, RH, LNKD, ZOES, GIS & TLT

Investing Ideas Newsletter - FED cartoon 11.25.2015


Happy Thanksgiving Investing Ideas subscribers!


We hope you are enjoying your holiday. We have much to be grateful for.


It was a big week for our Macro team, with a batch of new economic data confirming our #GrowthSlowing theme (see update on TLT and JNK below). On a related note, we thought you would appreciate the following research piece, "What's Driving Our Bearish Forecasts for Domestic and Global Growth?" It was written by our Senior Macro analyst Darius Dale and recently sent to institutional subscribers. It's an insightful read which lays out our bearish outlook for the U.S. and global economy. 


Please note that we added Federated Investors (FII) to the long side and Nu Skin (NUS) to the short side this past week. Our Financials analyst Jonathan Casteleyn and Consumer Staples analyst Howard Penney will send subscribers a full research report next week.   


Below are Hedgeye CEO Keith McCullough’s updated levels for each ticker and our analysts' updates on our high conviction ideas. 


Investing Ideas Newsletter - 11 27 2015 2 40 23 PM


Trade :: Trend :: Tail Process - These are three durations over which we analyze investment ideas and themes. Hedgeye has created a process as a way of characterizing our investment ideas and their risk profiles, to fit the investing strategies and preferences of our subscribers.

  • "Trade" is a duration of 3 weeks or less
  • "Trend" is a duration of 3 months or more
  • "Tail" is a duration of 3 years or less



To view our analyst's original report on Junk Bonds click here.


All of this week’s domestic economic data came pre-Thanksgiving. Revisions to Q3 GDP and personal consumption on Tuesday were followed by personal income, spending, and core PCE on Wednesday.


The rough state in the manufacturing sector needs no further documentation for Investing Ideas subscribers. But it’s the consumption side of the economy that is arguably most important, as its 69% of U.S. GDP. From a rate-of-change perspective, consumption growth decelerated in October, and consumer confidence is waning along-side it. (That's why Growth Slowing=Long TLT)


To be clear, the consumption side of the economy had been a point of strength over the last several months. We’re not calling for a crash in household consumption, but the comps (comparison vs. prior reporting period) are important in rate-of-change analysis.


The next four quarters of comps for Real PCE growth are the most difficult since Q3 2008 while the next four quarters of comps for CPI are the easiest since the four quarters ended in 4Q11. Simply put, both are headwinds for the consumer and we expect that the consumption component of the economic equation will continue to decelerate. 


Let’s review the pre-Thanksgiving economic data:


1) Personal Consumption Expenditures (Real PCE) decelerated to +2.7% Y/Y for October after increasing +3.1% in September


Investing Ideas Newsletter - 11.27.15 Real PCE


2) The Conference Board Consumer Confidence reading dropped to 90.4 from 99.1 in September and is now decelerating on a trending and quarterly basis in addition to this week’s sequential bomb.


Investing Ideas Newsletter - 11.27.15 Consumer Confidence


We look at every data series on a rate of change basis and then contextualize each series within longer term economic cycles. As you can see in the chart below, upon dissecting the Conference Board Reading for consumer confidence, when confidence begins to break down it happens rather quickly AND it happens at the end of the cycle when growth is slowing, not when it’s accelerating:


Investing Ideas Newsletter - 11.27.15 Consumer Confidence Chart2


That's why we think the recent round of data bolsters our 2016 recession call. But you won't hear that from anyone else on Wall Street.


Editor's note: We added LinkedIn to Investing Ideas on August 3rd. Since then shares have risen over 25% while the S&P 500 has fallen 0.15%.To view the original report on LinkedIn click here. 


Our Internet & Media Sector Head Hesham Shaaban has no new update on LinkedIn (LNKD) this week. 


Editor's note: We added McDonald's to Investing Ideas on August 11th. Since then shares of McDonald's have risen over 16% compared to a 0.2% return for the S&P 500. To view our original note click here.


As Restaurants Sector Head Howard Penney wrote right around the time we added McDonald's (MCD), "We continue to get more bullish every time we talk to the company, franchisees and/or customers which we have polled via conducting surveys. We are going to be looking at a much different company 1-3 years from now."  


"Urgency has been instilled from the top down by new CEO Steve Easterbrook," according to Penney. "This ship is in gear and headed north. 2015 will be the last time this stock is below $100."


Editor's note: We added Wabtec to Investing Ideas on the short side on September 11. Our call continues to work out very well for subscribers. Since its addition, the stock has fallen 14%. To view our analyst's original note click here.


Our Industrials analyst Jay Van Sciver maintains that Wabtec (W) was a beneficiary of both resources-related capital spending (international freight railroads) and the congestion of the U.S. rail system in 2014.  With rail speeds increasing and mining capex falling through the floor, those supports should gradually be removed from this richly-valued stock.


The end markets do not look promising for Wabtec. Freight car orders are coming off their all-time highs as backlog does the same per Railway Supply Institute data. Class 1 Railroads are curbing capex spending in the face of slowing freight volumes.  U.S. railroads are now putting equipment into storage.


To view our analyst's original report on Tiffany click here.


Hedgeye Retail Sector Head Brian McGough is staying short Tiffany (TIF) in the wake of the company’s 3Q results. While the market might be blowing off this ugly print, we’re not. TIF will miss again. Simply put, in the absence of 2016 guidance, the consensus will remain too high – likely in the range of $4.30-$4.40. We’re clocking in about $0.30 lower. Is that a huge miss? No. But...


1) we also don’t assume a material worsening in the economy in our model, which could push numbers closer to $3.50.


2) After last holiday’s blow-up, the Street was at $4.45 for FY15, and now is at $4.02. Not a huge earnings miss by our standards – yet the stock is down 28% year to date.  There’s no reason we can’t, and won’t, see that again.


Ultimately, while we have no doubts in the quality of the management team, the reality is that there are no obvious margin levers to offset the declining growth profile in the business, especially amidst increased late cycle risks. The price has come off, but so have earnings. It is trading near a peak multiple on our numbers (18x) on peak margins (21%), and peak earnings that are not likely to grow for 2-3 years. 


To view our analyst's original report on Wayfair click here.


Retail Sector Head Brian McGough reiterates his short call on Wayfair (W).


As we’ve been saying, Wayfair's total addressable market is much smaller than many investors believe. People (including management) are using numbers like $90bn as an addressable market. That’s just flat-out wrong. We’ve done extensive research on this one, and when all is said and done, we think that the end market is no more than $30bn.


To put that into context, that suggests that Wayfair has about a 10% share of its market. That’s 2-3x the share of players like RH and IKEA. There’s absolutely no reason why this should be the case. 


To view our analyst's original report on Restoration Hardware click here.


Retail Sector Head Brian McGough reiterates his bullish call on Restoration Hardware (RH).


We believe that RH is to Home Furnishings what Ralph Lauren is to Apparel and what Nike is to Athletic Shoes. That’s a meaningful statement given that RH has only 3% share of a $140 billion relevant market. 


RH is the preeminent brand in the space. We think that RH is in second inning of a game that may ultimately prove to be a double header. We believe the company will add $3 billion in sales over 3-years and climb to $11 in EPS. The earnings growth and cash flow characteristics to get to that kind of number would support a 30+ multiple. In the end, we see a stock in excess of $300.


To view our analyst's original report on Zimmer Biomet click here. 


Regardless of one's politics or what they think about Affordable Care Act (ACA) the simple reality is that the ACA massively expanded government spending on healthcare. It literally brought millions of new medical consumers into the system. Since its passage, the U.S. Medical Economy has witnessed the largest inflow of new medical consumers (35 million), from exchanges and Medicaid, in the last 30 years. These new consumers carried with them above normal per capita spending.


The result? More than $120 billion of new money pumped into the system in a mere 18 months.


Let’s put those enrollment figures into historical context. The next best year for increases in the number of insured medical consumers occurred back in 1996 when the U.S. added 3.2 million people to the insured population. In other words, the United States just added 10 times that number in just 18 months!


Nothing in history even comes close.


In other words, the Affordable Care Act was essentially a massive one-time stimulus — injected squarely into the healthcare sector’s bottom line — and its slowly drying up. Imagine 35 million newly-insured consumers rushing to take advantage of cheaper medicine. The law essentially pulled forward significantly pent-up demand for healthcare. 


As you may have already guessed, this is bad news for Zimmer Biomet (ZBH).


General Mills (GIS) continues to be one of our top ideas in the Consumer Staples sector. Sector head Howard Penney loves the name for its characteristics during this macro driven market. Big-cap, low-beta, and their line of sight at growing the top line in a meaningful way, are contributors to our LONG thesis. 


"Zoës Kitchen (ZOES) was never a one or two quarter call for us," Hedgeye Managing Director Howard Penney recently wrote.


Given the high multiple nature of the stock, it is ultra-sensitive to the volatile market. This stock does not contain style factors that the market likes right now (high-beta, low-cap), so we expected a turbulent ride, but you must stay strong and buy on the dips.


This latest quarter for instance was a perfect example. There was nothing wrong with it, besides the comp number missing slightly, and the stock fell 9% immediately in after-hours trading. People that sell on these headlines create great buying opportunities. As Penney wrote following the head-scratcher of a sell-off, "we would be buyers of ZOES on any big down day."


Case in point? Shares surged 10% this past week, while the S&P 500 was flat.

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