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Takeaway: Current Investing Ideas: TIF, JNK, NUS, W, WAB, ZBH, FII, MCD, RH, ZOES, GIS & TLT
Below are our analysts’ updates on our twelve current high conviction long and short ideas. As a reminder, if nothing material has changed in the past week which would affect a particular idea, our analyst has noted this. Hedgeye CEO Keith McCullough’s updated levels for each ticker are below. Please note that we removed LinkedIn (LNKD) this week.
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
TLT | JNK
To view our analyst's original report on Junk Bonds click here. Below is an update on our Long TLT and Short Junk positioning written by Senior Macro analyst Darius Dale:
Is the Spread Widening Trade a Win-Win From Here?
Implicit in our long TLT/short JNK bias is an expectation for high-yield spreads to continue along their recent trend of widening throughout the YTD. As we penned in our 12/10 note titled, “Five Charts That May Make You Feel Uneasy About 2016”:
“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.”
Inclusive of Friday’s retails sales, PPI, consumer confidence and wholesale inventories data, we remain appropriately bearish (see charts and tables below) on the domestic (and global) economic cycle. Our dour intermediate-term outlook was most recently highlighted in the aforementioned note, as well as in our 12/9 Early Look titled, “Conviction Sells”:
“The U.S. economy is #LateCycle and the probability of a recession commencing by mid-2016 is extremely elevated – both in absolute terms and relative to the belief held by the overwhelming majority of investors and policymakers. Moreover, the risk of a global recession is also great in this scenario.”
Click the images below to enlarge.
The economic cycle doing what it always does (i.e. decelerate into a recession before bottoming and then reaccelerating) is reason enough to be bullish on the long bond and bearish on junk bonds, which are accelerating into full-blown crisis mode (the JNK ETF declined another -2% on Friday and is down -4.1% WoW, -5.8% MoM and -12.7% YTD).
Is the Third Avenue Credit Fund blow-up a canary in the coal mine for a substantial deepening of the junk bond illiquidity crisis? While we can’t know for sure, our research would suggest there are quite a few more cockroaches to be uncovered by the time it’s all said and done. Thus, developments such as these are definitely worth keeping on your screens:
(WSJ article HERE)
Enjoy the rest of your weekend, risk managers – you deserve it.
To view our analyst's original report on Nu Skin click here.
The success of the Nu Skin (NUS) short, in large part, is dependent on government action. As we have stated, the SEC is currently investigating NUS for charitable contributions in China, which could easily expand once they are under the hood.
In the 2015 Investor Day press release, NUS added additional language to their risks and uncertainties disclaimer. It reads, “risk that litigation, investigations or other legal matters could result in settlements, assessments or damages that significantly affect financial results.”
Conveniently tucked away about three-quarters of the way into the paragraph this language signals to us that the SEC investigation is very real and could pose a threat to them. Although it would be pure speculation to think what the meaning of this is, we believe that the SEC investigation is coming to a head, and could have grown larger than its original scope.
click the image below to enlarge.
To view our analyst's original report on Federated Investors click here.
During the week, leading money fund manager Federated Investors (FII) closed on the small lift out of the money market assets of Huntington Asset Advisors, rolling in an additional $930 million in assets-under-management.
While the deal adds just +0.5% to FII’s existing money fund AUM of over $200 billion, lift out deals are immediately accretive as they come with little incremental operating infrastructure and represent a sub-scale manager ceding assets to a bigger more capable player.
Exiting the Financial Crisis in 2008, there were over 125 money market fund managers. Now, that number has been whittled down to just 75 providers. We foresee less than 30 providers over the next several years giving FII plenty of other accretive roll up deal opportunities.
This reduction in industry capacity is another way that Federated can increase its AUM along with late cycle flows out of risk assets and back into cash on the sidelines.
FII is a top 5 money fund manager behind Fidelity, JP Morgan, and BlackRock.
To view our analyst's original note on Wabtec click here.
Following the congestion driven surge in demand / Tier 4 pre-buy, locomotives are being stored even while the total equipment fleet is young. Equipment heading to storage hurts Wabtec (W) in two ways:
- As equipment heads to storage, why would new equipment demand increase?
- Second, WAB’s aftermarket business is hit as their customers choose to either delay maintenance and/or scavenge for parts off of stored equipment.
As we see it, equipment coming out of storage helped boost aftermarket activity, while equipment returning to storage may depress it. This is particularly problematic with slowing freight rail capital spending on equipment likely to decline for 2016.
To view our analyst's original report on Tiffany click here.
In regards to our Tiffany (TIF) short thesis, the key question we ask is why do earnings NEED to grow next year. If TIF is going to have a flat year in FY15 in an otherwise decent US and Global economy, what kind of consumer climate do we need to assume in 2016 to get earnings higher?
That’s an especially interesting question given the following…
- Sales productivity is at a historical peak of ≈$3,450
- A Brand that might be "Great" to the person typing this note, but one that is simply ‘Very Good’ to Millennials.
- Minimal square footage opportunity (2% long term)
- A business that structurally does not lend itself to online (only 6% of sales)
- Gross Margins currently at peak levels of 60%
- EBIT margins still at 19% this year despite the company’s challenges – with 2-3 points of potential downside.
We'll stick with our short call.
To view our analyst's original report on Wayfair click here.
On Thursday's Q/A call, RH management had some clear comments about the promotional environment in the mid-tier furnishings channel. They indicated that this holiday season was the most promotional they had ever seen by a meaningful margin. Many of the players in the furnishings space are accelerating email campaigns and increasing discounts. This is not a positive sign for Wayfair's (W) fourth quarter margins, especially when you consider that its cost structure is not fixed and predicated on ad-spend and price to attract customers to its platform.
It is undeniable that Wayfair is taking share while growing revenue at an industry leading rate. However, the bottom line is that this company is spending – and spending big – around penetrating what management believes to be the company’s TAM. Unfortunately, we think they are overestimating it by a country mile, and are building an infrastructure for growth that will not materialize – at least not profitably.
To view our analyst's original report on Restoration Hardware click here. Below is an excerpt from from our Retail team's note ("RH - Lost in Translation") sent to institutional clients earlier this week.
"This Restoration Hardware (RH) quarter is going to draw a Mason Dixon line between the Bulls and the Bears. On one hand, the key factors that the Bulls (including us) need to see were profoundly present – giving us confidence that revenue will double, that we’ll see a 16% operating margin, and $11 in earnings power. In addition, RH beat the quarter, delivered 33% EPS growth in what should be the slowest growth quarter of the year, and it took up 4Q revenue guidance based on what it’s seeing so far this quarter (to 20%+).
On the flip side, the Bears got a nice little gift in the form of weaker Gross Margins due to promotional activity, and renewed concerns about management. The reality is that this is a transformational growth story that will change on the margin more often than it doesn’t.
Even though the 30% short interest already captures a whole lot of bad news, this print won’t make people cover – and probably validates the pressure the stock came under earlier this week. We’ll respect it for what it is, but based on our confidence in the earnings power at play here, we’d use any weakness as an opportunity to buy.
The market combined with noise around the evolution of this story gives you a shot at buying it on the cheap every six months or so. We’re thinking that this is one of those times."
To view our original note on McDonald's click here.
McDonald's (MCD) remains one of our top LONG ideas in the restaurants space. All indications are that all day breakfast is working, bringing back old customers and driving growth of new customers. Customers are pairing both breakfast and lunch items together in the lunch and dinner day, part which is helping drive additional sales.
McDonald’s Canada opened its first standalone McCafe this month. The much simplified concept intends to appeal to customers by offering both speed of service and low cost. They intend to be faster than their main competitor Tim Hortons and cheaper than Starbucks, carving out their own niche in the market.
To view our analyst's original report on Zimmer Biomet click here.
Healthcare analyst Tom Tobin has no material update on Zimmer Biomet's (ZBH) but his bearish thesis on the company is firmly in tact. Here are some key highlights from Tobin's original call on ZBH that are well worth a second look:
- "The demographic drivers of knee joint replacement are well past peak and in a secular decline."
- "Affordability of medical spending has peaked in the United States with deflationary pressures mounting and being expressed through policy changes alongside the broadening adoption of IT systems."
- "Medicare recently initiated an aggressive global payment policy (CCRJ) which we expect to create a strong incentive for providers to pressure device costs."
- "We believe the #ACATaper is emerging over the coming months as the newly insured revert to spending levels similar levels as seen with typical insured populations."
- "The Biomet merger (while accretive) is not the solution for ZBH shares. Cost synergies are rarely a positive when organic growth is slowing."
General Mills (GIS) reports 2Q16 earnings next Thursday, the 17th before the market opens. GIS remains one of our core LONG ideas in the consumer staples sector and in the market overall because of its strong brands and style factors that are in favor. GIS boasts high-cap, low-beta and high liquidity, all good things to have in a volatile market.
Zoës Kitchen (ZOES) is a company with style factors that are out of favor currently, high beta and low-cap. But this is a long-term story and you must remember that during these volatile trading days. Furthermore, we suggest that you buy big on the dips, but don’t expect to get out of the position clean in the near-term.
Now that Chipotle (CMG) customers aren’t going within 100 ft. of one of their restaurants, we thought about who would benefit most. From the standpoint of stealing the most share from CMG, it’s probably not ZOES just due to their comparitively small size. But ZOES looks to have the best opportunity to draw in new customers that they hadn’t been able to attract before.
Their concepts although dissimilar in type of cuisine, are similar in that they both offer a premium, better for you option, at a fair price, and with fast service. ZOES’ restaurants are conveniently and strategically located to take advantage of the opportunity, 80.1% of ZOES restaurants are within five miles of a Chipotle. This only represents roughly 15.3% of Chipotle’s restaurants but that amount will be under significant threat from a very capable competitor.
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The carnage you’re seeing across emerging market capital and currency markets is exactly what we anticipated when we first went broadly negative on this investment space back in early 2013 – a view that received a fair amount of pushback at the time.
While the path to get here was anything but linear – i.e. full of intermittent reflation rallies that we had to risk manage or take advantage of select opportunities on the long side for a trade(s) – we’ve maintained a bearish bias on EM with respect to our intermediate-term TREND and long-term TAIL durations throughout the entirety of the move and many of our clients have benefitted tremendously from this research view over the past few years.
Given that EM is now a consensus short, we don’t necessary have much more to add to the discussion at the current juncture. That said, however, it’s important to contextualize how we got here so that we can better position ourselves for either incremental carnage or an investable bottom. As such, we think the following sampling of our work on EM/global dollar tightening from the past few years is a good place to start:
- Emerging Market Crises: Identifying, Contextualizing and Navigating Key Risks in the Next Cycle (4/23/13)
- Are You Prepared for #Quad4? (8/5/14)
- #EmergingOutflows Round II: This Time Is Actually Different (12/16/14)
- Are You Prepared for a Deepening of the Global Earnings and Industrial Recessions? (10/22/15)
- Can Beijing Maintain Exchange Rate Stability Or Is the Chinese Yuan the Next Thai Baht? (11/19/15)
Source: Bloomberg L.P.
In terms of evaluating incremental data, we complied the following country capsules to: A) provide an update on the individual economies listed below, as well as B) provide our overarching thoughts on the space at this historic moment in time. Remember, the Fed has never hiked rates into an obvious #LateCycle Slowdown. The next few months could be very interesting…
Best of luck out there! Email us if we can expound upon anything; always happy to help.
In China, the month of November registered a sequential pickup in CPI, but headline inflation is still decelerating on a trending basis. Moreover, the persistent and deeply negative PPI in conjunction with the sequential deceleration in FDI speaks volumes to the ongoing deflationary pressures emanating throughout the Chinese economy. The NOV credit and money supply data was positive, on the margin, and confirms the Chinese economy is not “rolling down the hill” (as we’ve previously termed), but rather continuing to be “walked down the stairs” by policymakers. Economic data aside, the most impactful headline out of China this week has to be the PBoC’s decision to set the CNY reference rate to 6.4385 – which is the lowest value per USD since August 2011. Following this maneuver was the headline of the week in the PBoC signaling that it intends to change the way it manages the yuan’s value by potentially loosening its peg to the U.S. dollar. Specifically, the PBoC said it makes more sense to measure the yuan’s exchange rate against a basket of currencies rather than the USD alone, and that referencing the yuan against a basket of currencies would help keep its value at a reasonable equilibrium. This confirms our view that the PBoC fully intends to materially devalue the CNY vs. the USD and likely speeds up the process by which said devaluation will occur – something we did not see coming. That said, however, we still don’t think the CNY will suffer a major one-off devaluation(s) in line with what we saw in August, but rather a multi-year revaluation lower vs. the USD to improve its competitiveness against peer currencies (namely the JPY, KRW, MXN, TWD and THB). Unrelated, we find it interesting that this headline leaked just days before the FOMC meeting begins; this is not unlike the August devaluation ahead of the September 17th FOMC statement. Will China force the Fed’s hand on liftoff (or the lack thereof) for the second time in 2015? Investment conclusion: We previously held a neutral bias on China, but today’s news of the pending change to the CNY policy has us thinking more volatility is ahead over the immediate-to-intermediate term. As such, we are downshifting to underweight.
In India, capital and currency markets are under pressure as they look through the sequentially strong OCT industrial production report and focusing on two policy catalysts – one domestic (i.e. Modi’s inability to push through GST legislation amid opposition protests to recent corruption charges) and one foreign (the December 16th FOMC statement). The INR is threatening to record a new all-time low as the country’s twin deficits in the current and fiscal accounts perpetuate capital outflows, at the margins. Investment conclusion: We reiterate our underweight bias on India.
In South Korea, the BoK held its Benchmark 7-Day Repo rate flat at 1.5%, which marks the sixth straight month of being on hold after -50bps of cuts in 1H15. While their statement was dovish in terms of them highlighting external risks to their 2016 GDP growth and headline inflation forecasts of +3.2% and +1.7%, respectively, the South Korean economy is clearly developing a hawkish #Quad2 setup heading into 1Q16. Like many EM currencies, the KRW is getting smoked ahead of the Fed statement, but we would expect the won to outperform on a longer duration once the dust settles. Investment conclusion: We reiterate our neutral bias on South Korea.
In Brazil, the country’s stagflationary recession and political crisis deepened again this week, with headline inflation accelerating to new highs in NOV and tensions heating up between Finance Minster Joaquim Levy (a fiscal hawk) and Planning Minister Nelson Barbosa (left of Levy) over next year’s primary budget surplus target. The BRL – which may break to a new all-time low soon – is getting blown out alongside rates amid these negative developments. Investment conclusion: We reiterate our underweight bias on Brazil. Twin deficits? Check.
In Mexico, both headline and core inflation ticked down in NOV, which perpetuated a sequential improvement in real wage growth. Despite that, same-store sales growth decelerated sharply in the same month, which is indicative of the loss of purchasing power associated with the MXN’s -6.4% plunge over the past three weeks to new all-time lows. The Mexican economy is currently in an obvious #Quad4 state and short rates are pricing in the risk is that it slides over into stagflationary #Quad3 in fairly short order – an outcome that would inhibit Banxico from responding with easier monetary policy. Investment conclusion: We reiterate our underweight bias on Mexico. Twin deficits? Check.
In Russia, it was an uneventful week in terms of reported sequential deltas, with 3Q real GDP coming in unchanged vs. 2Q at -4.1% YoY and with the Central Bank of Russia holding its Benchmark Key Rate steady at 11%. The Russian economy had completed its transition from stagflationary #Quad3 to deflationary #Quad4, but the -8% plunge in the RUB over the past three weeks (threatening a new all-time low vs. the USD) threatens to perpetuate a hawkish inflection in headline inflation over the near term, which would keep CBoR in its box (it hasn’t cut rates since July after cutting them -600bps in the YTD. Investment conclusion: We reiterate our underweight bias on Russia.
In South Africa, recent economic data has come in in fairly mixed – which is a good thing, on the margin – as accelerating headline CPI in NOV and decelerating consumer confidence in 4Q contrasts with decelerating core inflation (NOV) and accelerating retail sales in OCT. From a trending perspective, the South African economy is still mired in stagflationary #Quad3, which is being perpetuated at the margins by the flaming ZAR (down -11.9% over the past three weeks to new all-time lows). Also weighing on the ZAR is a sharp increase in political consternation, as President Zuma’s recent decision to fire Finance Minister Nhlanhla Nene (a fiscal hawk) comes after a very public disagreement between the two regarding the path for government spending. Nene was replaced by little-known David van Rooyen, who is unlikely to oppose the president’s plans to move forward with proposals to build a nuclear-power industry, bailout the state-owned airline and push other spending before local government elections next year. Investment conclusion: We reiterate our underweight bias on South Africa. Twin deficits? Check.
In Turkey, real GDP accelerated in +20bps in 3Q to +4% YoY in line with the recent and material positive inflections registered across the preponderance of Turkey’s key high-frequency growth indicators. With various measures of Turkish inflation also accelerating on both a sequential and trending basis, the Turkish economy has clearly moved into #Quad2. So why are the Borsa Istanbul 100 Index (down -14% MoM) and the TRY (down -5% vs. the USD over the past three weeks) getting tattooed ahead of next week’s FOMC statement? The answer is simple: twin deficits have a tendency to perpetuate capital outflows amid global dollar tightening episodes. Turkey’s equity and rates markets are signaling that CBT will have to get serious about defending the currency – which is threating a new all-time low – in short order. Unfortunately for global capital allocators and Turkish consumers, the political situation may prevent them from implementing meaningful measures. Investment conclusion: We reiterate our underweight bias on Turkey.
Japan is obviously not an Emerging Market, but our long-held structural bearish bias on the Japanese yen (yes, we authored the Japan reflation thesis too) is partially why we are so bullish on the USD and bearish on EM. As such, Japan deserves an update as well… The latest batch of NOV/4Q growth data came in soft, with machine orders and PPI ticking up but remaining in negative territory and the 4Q MoF Survey declining sharply QoQ. Additionally, a Japan Center for Economic Research survey that showed economists’ estimates for CPI over the long run (i.e. FY17-FY21) ticking down -10bps vs. the prior survey (1.3% vs. 1.4%) – the first such decline since the BoJ launched its QQE program in April 2013. We still think QQE expansion is months away largely based on the BoJ’s guidance, but, on the margin, these latest developments pull that catalyst forward to a noteworthy extent. Investment conclusion: We reiterate our overweight bias on Japan.
"Forget what people who are in the business of marketing 'the market is flat' are telling you," Hedgeye CEO Keith McCullough wrote in today's Early Look. "Across asset classes we are in the midst of the 3rd major crash I’ve seen in my Wall Street career."
Editor's Note: We are pleased to present this brief Hedgeye Contributor View written by Doug Cliggott. Cliggott is a former U.S. equity strategist at Credit Suisse and chief investment strategist at J.P. Morgan. He is currently a lecturer in the Economics Department at UMass Amherst. Incidentally, he recently sat down with us here at Hedgeye for a Real Conversations interview. Click here to watch.
* * *
By Doug Cliggott
The Fed released the Q3 2015 flow of funds data yesterday. Now we have a good picture of the third quarter.
Profits of non-financial corporations were down 5% vs. Q3.2014, and their debt was up 7% vs. Q3.2014. This 1200 bps gap between debt growth and profit growth is the widest we have seen since 2007. As we talked about in September — watch "An Uncomfortably High Probability of a Significant Correction" — bad things tend to happen when debt growth a lot faster than earnings.
The Fed data also show a violent (75%) slowdown in Q3 net share buybacks. That no doubt played a central role in the equity downdraft during Q3 ... a huge buyer went away.
My guess is this is a central theme for 2016 — contracting corporate profits and much weaker cash flows mean very low share buyback volumes compared with the past four or five years. So U.S. equities will be "missing" a big buyer with no obvious, or less-than-obvious, cast of characters standing in the wings to step in and take their place.
And, on the earnings front, the OECD released new LEI data on December 8th. This data — VERY WEAK — plus wages & salaries growing at 5% point to further weakness in profits.
On that cheery note ... Have a good weekend!
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