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Five Charts That May Make You Feel Uneasy About 2016

Takeaway: Various capital markets indicators confirm the U.S. economy is undoubtedly mired in a #LateCycle slowdown. Recession pending…

Most of you are aware that a multi-quarter acceleration into peak capital markets activity has historically been a harbinger of economic downturn. In light of that, we found yesterday’s headline news on that front quite interesting: multiple reports claimed DD and DOW are in advanced talks to merge, with the combination to then split into three separate companies; both stocks finished ~12% higher on the day. This is exactly the kind of frothy, head-scratching headline you’d like to see to confirm the forward outlook for global economic growth is as bad as we think it is.

 

The WSJ recently noted that worldwide M&A, excluding buyouts, has totaled $3.7T this year, beating the previous record set in 2007. M&A peaks when sellers agree to sell and that’s exactly what you’re seeing amid insider transaction reports. At $7.6B, November 2015 was the fourth-highest month of insider selling on record. This comes amid record share buyback activity, which has averaged $3.9B/day since the beginning of earnings season in October. Data firm Trim Tabs notes that this is the highest pace since the current bull market began in March 2009 (coincidentally when we turned bullish). Hooray for Santa Claus!

 

Five Charts That May Make You Feel Uneasy About 2016 - M A Recession Indicator

 

Companies both domestic and global are doing everything they can to arrest the gravity weighing on peak margins in order to protect earnings amid #GlobalDeflation – which has perpetuated the ongoing global industrial recession, including right here in the U.S. All told, there is a ton of risk to forward estimates for GDP and EPS growth if we’re right on the economic cycle.

 

With respect to the U.S. equity market itself, we continue to highlight the dour signal for the S&P 500 and U.S. economy that is the current trending deterioration in market breadth.

 

Specifically, market breath as measured by the percentage of stocks that are technically broken is almost as bad now as it was in early November 2007, which is when the broad U.S. equity market (i.e. Russell 3000 Index which accounts for ~98% of investable market cap) had declined a commensurate level from its then all-time high as it has now (roughly -5%). Currently 60.2% and 62.4% of Russell 3000 constituent stocks below their 50-day and 2000-day moving averages, respectively. This compares to 68.2% and 64%, respectively, on 11/7/07.

 

Five Charts That May Make You Feel Uneasy About 2016 - BMBI Current

 

Looking to the S&P 500 – which is essentially flat for the YTD and off a mere -4% from its all-time high – one could make the case that Hedgeye has been wrong for being so bearish. That would certainly be the case if our clients were allowed to charge 2&20 simply to invest in the SPY on behalf of their investors. That’s obviously not the case, which is why I’m not aware of a single client that has chosen to cite the performance of the S&P 500 as proof that we are off base or as a reason to be bullish.

 

If anything, the fact that so many investors are forced to use the S&P 500 as their bogey actually amplifies our point: irrespective of what the SPX does, the carnage out there is real and it’s incredibly hard to post good return numbers when so many stocks are crashing in accordance with the bearish fundamental narratives Hedgeye has authored while “the market” itself won’t go down.

 

Five Charts That May Make You Feel Uneasy About 2016 - R3k Constituent Draw down Analysis

 

All told, we continue to see exceptional risk in searching for an investable bottom in equities at this stage in the economic cycle. Perhaps the ongoing deterioration within the high-yield credit market is as much of a warning signal about the business cycle as it was back in 2007 – and this has occurred prior to any rate hikes out of the FOMC.

 

Five Charts That May Make You Feel Uneasy About 2016 - HY Spread Risk

 

Our competition continues to be surprised to the downside by key high-frequency economic data and we expect that to continue. It’s not unlike 1H07 in that regard. The same cast of characters who failed to help you proactively prepare for the 2008-09 downturn are likely to fail you this time around too.

 

Five Charts That May Make You Feel Uneasy About 2016 - Econ Surprise Index

 

Best of luck out there as you continue to “high-grade” your portfolios in order to shield your investors from incremental economic weakness.

 

DD

 

Darius Dale

Director


NEW VIDEO | McCullough Continues To Be Bearish On The US Economy

In a spirited debate on Fox Business' Mornings with Maria today, Hedgeye CEO Keith McCullough and Federated Investors CIO Stephen Auth squared off on the outlook for the U.S. economy. Joining the discussion was Wall Street Journal Chief Economics Correspondent Jon Hilsenrath. 


FINANCIALS SENTIMENT SCOREBOARD - JPMorgan (JPM) AND FEDERATED INVESTORS (FII)

Takeaway: We are flagging JPMorgan (JPM - Score: 93) (short) and Federated Investors (FII - Score: 20) (long) on sentiment and short interest.

This morning we are publishing our updated Hedgeye Financials Sentiment Scoreboard in conjunction with the release of the latest short interest data last night. Our Scoreboard now evaluates over 300 companies across the Financials complex.

 

The Scoreboard combines buyside and sell-side sentiment measures. It standardizes those measures to an index of 0-100, where 100 is the best possible sentiment ranking and 0 is the worst. Our analysis shows that a contrarian strategy can be employed successfully by taking the other side of stocks with extreme readings in sentiment, either bullish or bearish. Once sentiment reaches these extreme levels, it becomes a very asymmetric setup wherein expectations become too high or too low.  

 

We’ve quantified the tipping points for high and low sentiment. Specifically, we've found that scores of 20 or lower have a positive, average expected return while scores of 90 or greater are more likely to underperform.

 

Specifically, our backtest of 10,400 observations over a 10-year period found that stocks with scores of 0-10 went on to produce an average absolute return of +23.9% over the following 12-month period. Scores of 10-20 produced an average absolute return of +11.9%. At the other end of the spectrum, stocks with sentiment scores of 90-100 produced average negative absolute returns of -10.3% over the following 12-months.

 

The first table below breaks the 300 companies into a few major categories and ranks all the components on a relative basis. The second table breaks the group into smaller subsectors and again gives them relative rankings within those subsectors. 

 

FINANCIALS SENTIMENT SCOREBOARD - JPMorgan (JPM) AND FEDERATED INVESTORS (FII) - SI1 2

 

FINANCIALS SENTIMENT SCOREBOARD - JPMorgan (JPM) AND FEDERATED INVESTORS (FII) - SI2

 

FINANCIALS SENTIMENT SCOREBOARD - JPMorgan (JPM) AND FEDERATED INVESTORS (FII) - SI3

 

The following is an excerpt from our 90 page black book entitled “Betting Against the Herd: Generating Alpha From Sentiment Extremes Across Financials.”

 

Let us know if you would like to receive a copy of our black book, which explains this system and its applications.

 

BUYS / LONGS: Financials with extremely low sentiment readings of 20 and below on our index (0-100) show strong average outperformance in absolute and relative terms across 3, 6 and 12 month subsequent durations.  Stocks with sentiment ratings of 20 or lower rise an average of +15.1% over the next 12 months in absolute terms.   

 

SELLS / SHORTS: Financials with extremely high sentiment readings of 90 and above on our proprietary sentiment index (0-100) demonstrate a marked tendency to underperform in absolute and relative terms across 3, 6 and 12 month subsequent durations.  Stocks with sentiment ratings of 90 or greater fall in value an average of -10.3% over the next 12 months in absolute terms. 

 

 

FINANCIALS SENTIMENT SCOREBOARD - JPMorgan (JPM) AND FEDERATED INVESTORS (FII) - Absolute 12 mo

 

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT


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Retail Callouts (12/10) | Our Take On RH Friends & Family, AMZN Nov Comps

Takeaway: Our take on RH Friends and Family Sale. The story is absolutely on track.

RH – Our Take on RH F&F

 

There has been a lot of buzz over the past 24hrs about the change up in RH's promotional posture with the addition of a 5-day Friends and Family event that ran from 12/4-12/8. While the company didn't run a Friends and Family event last year, our sense is that RH moved a January event earlier in the quarter. They have plenty of events to play with as most of the month of January in the 4th quarter of 2014 ran a 20% off deal. See table below.

RH's guidance for the balance of the year implies a meaningful acceleration in top line trends from 10% growth this quarter to 20% in 4Q15. That's driven in large part by the addition of 740 new pages of new product, 540 of which are RH modern. That's the main driver of the top line reacceleration and we don't think that a change up in the timing of one sale will move the needle dramatically. It's not as if RH has a bunch of seasonal merchandise to work through like many of the other retailers that could be considered comps. If anything, this helps RH pull sales into 4Q by incentivizing consumers to place orders earlier. Because of the shipping window and the fact that RH doesn't recognize sales until an order is delivered means that an order placed in January = a 1Q sale. But, we don't think that's at the expense of 1Q topline as the new product shift to 2H has shifted the demand curve this year. And, it doesn't have the GM impact that many would suspect especially if the company pulls a January sale.

 

Here’s our conclusions from our call on Tuesday:

1) The story is absolutely on track. We’re as close as we can get to being 100% confident that nothing will come from this print that will rattle our long-term call. Rather, we think that the commentary around value drivers like large format Design Gallery performance, and initial orders of Modern and Teen will be upbeat.

2) RH hasn’t missed yet, and shouldn’t start now. That said, this will be the most uninspiring quarter of the year due to the timing of store openings and new business launches. But let’s clarify ‘uninspiring’. RH is likely to grow EPS 30-35%, which compares to US Retail combined EPS growth of…4%.

3) We really like the stock here. Despite the business outperforming everything in Retail, the stock has underperformed virtually every Consumer stock index, including high-beta stocks in other Sectors. We think that the worst case here is that the comp is mid/high-single digits (we’re at 11% -- Street at 10%). But even then, after a few ugly days we think that the stock would get a temporary reprieve given that the company has so vocally telegraphed that 3Q would be soft. But would put extra focus to deliver in 4Q.

 

For our full thoughts headed into the quarter see our Black Book. RH | Black Book Before the Print. Replay Link CLICK HERE. Materials CLICK HERE

Retail Callouts (12/10) | Our Take On RH Friends & Family, AMZN Nov Comps - 12 10 2015 chart1

 

AMZN - November ChannelAdvisor Comps

A nice re-acceleration on 1 and 2 year basis for AMZN in November via ChannelAdvisor.  This metric tracks same store sales for ChannelAdvisor customers that are Amazon 3rd party sellers.  The results been a good directional indicator of underlying North American EGM growth at AMZN.

Retail Callouts (12/10) | Our Take On RH Friends & Family, AMZN Nov Comps - 12 10 2015 chart2

Retail Callouts (12/10) | Our Take On RH Friends & Family, AMZN Nov Comps - 12 10 2015 chart3

 

WMT - Wal-Mart enters mobile payment with launch of Walmart Pay, all but deserting the MCX CurrentC system.

(http://www.reuters.com/article/us-wal-mart-mobilepayment-idUSKBN0TT0E620151210)

 

AdiBok - Adidas CEO plans to stay until end of contract in March 2017

(http://uk.reuters.com/article/uk-adidas-ceo-idUKKBN0TS0RS20151209)

 

AdiBok - Adidas giving a preview of its first Speedfactory In Germany

(http://news.adidas.com/us/Latest-News/-From-Robots-To-Your-Home--adidas--First-Speedfactory-Lands-In-Germany/s/f4d890b6-e38d-4a32-b20d-ebc9683972ec)

 

NKE, RL - Nike Suing Former Designer and Ralph Lauren Corp Over Non-Compete

(http://fashionista.com/2015/12/nike-ralph-lauren-lawsuit)

 

WWW - Sperry Partners with the America's Cup 

(http://www.sportsonesource.com/news/article_home.asp?Prod=1&section=8&id=58650)

 

Nine Consecutive Billion-Dollar Days of Online Desktop Spending Mark the Longest Streak Ever

(http://www.comscore.com/Insights/Blog/Nine-Consecutive-Billion-Dollar-Days-of-Online-Desktop-Spending-Mark-the-Longest-Streak-Ever)

 

PGA Tour Superstore continues expansion

(http://www.retailingtoday.com/article/pga-tour-superstore-continues-expansion)

 

AMZN - Amazon Raises FBA Seller Fees for 2016

(http://www.ecommercebytes.com/cab/abn/y15/m12/i10/s01)

 


CHART OF THE DAY: When Will Deflation Bottom?

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye Macro analyst Ben Ryan. Click here to subscribe.

 

"... Even the firm with the non-consensus 18-month deflation view, wrestles with the location of a bottom. The truth is that in addition to quantitative behavioral factors that have been good indicators, the fundamental supply-demand picture will probably play a role. A supply-side backstop is proving to be an elusive, slippery floor in commodity-intensive cyclicals because the floor itself deflates with deflation (chart of the day at the bottom):

  • PPI Industrial Chemicals peaked on a Y/Y NSA rate of change basis in September 2014 and has been negative since September 2013
  • PPI Iron and Steel peaked on a Y/Y NSA rate of change basis in October 2014
  • PPI Commodities Construction & Machinery has been declining on a Y/Y NSA rate of change basis since June 2014, and it’s been tracking negative since October 2013
  • PPI Mfg. tires has been tracking negative on that same Y/Y NSA % change basis since October 2012" 

 

CHART OF THE DAY: When Will Deflation Bottom? - El Chart 12.10.15

 

 


Slippery Floors at the Bottom of Slippery Slopes

“It’s hard to get a man to understand something when his salary depends on his not understanding it.”

-Upton Sinclair

 

Lucky for the Hedgeye crew, our advancement as a new age financial research and media firm depends on our “understanding it.” That’s a promising model for me. I’m not a dramatic storyteller.  

 

Unlike when we originally introduced our deflation theme ~18 months ago, a much larger camp has come around to our house view. The pushback really isn’t that surprising when you step back and think about the number of people who are paid by inflation.    

 

Informational advantage is continuously becoming harder and harder to monetize. There are few industries where this advantage has been more lucrative in the past than financial services. Everyone now has the technology and systems to absorb and contextualize information and its implications. New information is now immediately new knowledge within seconds. This game is harder than ever.

 

So with all of the technology to absorb, contextualize, and execute on information why was $71 WTI in the fall of 2014 a marginal cost floor and a price for an OPEC cut (a consensus “buy”) that took WTI down 10% after the day a “no cut” happened, but with $41 in front of WTI, net futures and options positioning is shortest since we introduced our deflation theme, no cut from OPEC was consensus, and WTI is a falling knife?

 

To borrow the three stages of a market cycle from Howard Marks (this is a bull market description, but the psychological pendulum swings both ways):

  1. A few forward looking people begin to believe things will get better
  2. Most investors realize improvement is underway
  3. Everyone’s sure things will get better forever   

If you flip this cycle around (the pendulum), we’re somewhere between 2) investors coming around to the fact that deterioration is underway; and 3) "blood in the streets."

 

Technological advancement plotted against time may look like an exponential function, but human nature looks just about the same. Investor psychology is a slippery slope and “value” is a slippery floor.

 

Slippery Floors at the Bottom of Slippery Slopes - Oil cartoon 12.08.2015

 

Back to the Global Macro Grind…

          

The question we continue to debate with clients is whether or not the carnage in cyclical sectors is over (Energy (XLE -21% YTD), Materials (XLB -6% YTD), and Industrials (XLI -6% YTD) lead S&P 500 sectors to the downside in 2015 after relative weakness in 2014). You can call XLE a definitive crash.  

 

Put another way, can cyclicals go much lower even though we haven’t entered a technical recession? Absolutely, if the cycle cycles. We still think a recession commencing by mid-2016 is becoming increasingly probable.

 

We wrote a note last week on the "Unlikeliness of an OPEC Cut." We were right on the no cut, but admittedly, some of the behavioral expectations we outlined that have suggested crude could trade higher have not manifest over the last several trading days: contract positioning, volatility skew, volatility expectations, and a crowded rate hike trade. The Fed meeting next week is undoubtedly a catalyst.

 

Even the firm with the non-consensus 18-month deflation view, wrestles with the location of a bottom. The truth is that in addition to quantitative behavioral factors that have been good indicators, the fundamental supply-demand picture will probably play a role. A supply-side backstop is proving to be an elusive, slippery floor in commodity-intensive cyclicals because the floor itself deflates with deflation (chart of the day at the bottom):

  • PPI Industrial Chemicals peaked on a Y/Y NSA rate of change basis in September 2014 and has been negative since September 2013
  • PPI Iron and Steel peaked on a Y/Y NSA rate of change basis in October 2014
  • PPI Commodities Construction & Machinery has been declining on a Y/Y NSA rate of change basis since June 2014, and it’s been tracking negative since October 2013
  • PPI Mfg. tires has been tracking negative on that same Y/Y NSA % change basis since October 2012

Slippery Floors at the Bottom of Slippery Slopes - El Chart 12.10.15

 

Cost input inflation peaked right around the time the Fed-fueled capital spending boom peaked. The number of projects with attractive hurdle rates multiplies in a bull market. Commodity producer debt (large miners, oil majors, oil and gas equipment services, and coal miners) has skyrocketed:

  • 2005: $200Bn
  • 2010: $550Bn
  • 2014: $1.1 Trillion with a “T”

And taking an example from the gold miners, Net PP&E per Oz. of production is near pinned at the highs:

 

2003: 0.5 (ratio)

2010: 2.5

2015: 3.2

 

Policy fueled inflation expectations helped propel a surplus of mediocre investment decisions at the highs in commodity prices, and once the capital spending wheel is turning, producers will produce.

 

It’s not just hedges, long-term contracts, and private capital that prolong a bottom. It’s the technological advancement of operational efficiency and deflation on the cost side. The relationship between gold prices and Newmont Mining’s cash cost since 1985 has an r-squared correlation of 0.95.  

  

The slippery slope of deflation's feedback loop could stay slippery for a little longer. And don’t forget that the cycle cycles.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.13-2.31%

SPX 2039-2075

VIX 16.32-20.58
EUR/USD 1.05-1.09
Oil (WTI) 36.08-39.91

 

Good luck out there today,

 

Ben Ryan

Analyst 


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