Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye CEO Keith McCullough. Click here to learn more.
"... After this 1-day bounce off the Russell 2000’s crash (20% decline from July) intraday low yesterday, and commodities “bouncing” off 5-13 year lows (CRB Commodities Index down -20% in the last 3 months alone – see 5-year non-“transitory” deflation chart for details), I’m looking forward to swimming with both Potomac and the non-peddled-rate-of-change data. I won’t drown our clients that way."
“President Can’t Swim.”
That’s what President Johnson said “if one morning I walked on top of the water across the Potomac River.”
For those of you still trying to decipher fact from fiction from Obama’s State of The Union address last night, there is a long history of US Presidents being straight up with people on certain matters.
Sometimes to a fault, I’m going to tell you like it is. We built our firm on the principles of transparency, accountability, and trust. And we’re super excited to have announced that we acquired another truth-telling firm, in D.C. based Potomac Research Group yesterday.
Click here to read more about our PRG acquisition.
Back to the Global Macro Grind…
When the President of the United States feels compelled to use a mainstream media stage like #SOTU to suggest his economic critics are “peddling fiction”, you know we’re telling the truth about #Deflation and #GrowthSlowing into the end of his reign.
One of the main reasons why I’m so excited to partner with Potomac’s thought-leader in chief, Suzanne Clark, is that she calls it like it is too. She’s built a culture of truth-seekers at Potomac. And, together, we’re going to open Pandora’s box on people who get paid to lie to you.
“What’s the truth?”
It’s such a basic but differentiating question in this age of people from Wall Street to Washington doing “whatever it takes” to get themselves paid. It’s also the #1 question one of the world’s best macro investors (Ray Dalio) wakes up to every morning.
For anyone who has a 10th or 11th grade education in math (the new baseline for Americans being able to understand who is telling the truth), whether the US economy is accelerating or slowing, in rate of change terms, is a trivial matter.
Commonly called calculus, or the mathematical study of change, “in the same way that geometry is the study of a shape” (Wikipedia). Unlike political ideologies, rate-of-change is very easy to see on these things we call charts.
Whether it’s #Deflation or US #Recession data, you’ll see on Friday that both:
- US Producer Prices (PPI) continue to TREND (rate of change slowing) bearish
- US Industrial Production (IP) growth continues to TREND recessionary
To boil this down for who Obama calls the “folks” (are they people who don’t do math? or can only “rich” people do math?), there is a difference between:
A) Growth Slowing from its cycle peak (these are called #LateCycle factors like employment, consumption, auto sales, etc.)
B) And Recessionary Data – i.e. when the rate of change goes from slowing to negative year-over-year growth
Corporate profits, for example, are not only #LateCycle (they peak at the end of an economic cycle like they just did in Q2 of 2015), but critical to understand when they become recessionary.
CSX Corporation (CSX) is a $24B railroad company that, right before The Big O called me a peddler, said “with negative global growth and industrial market trends… our earnings are going to be lower in 2016 versus 2015.”
Sounds like some truth-telling to me.
A railroad is called an “industrial cyclical.” And I’ll be damned if the truth about a stock like CSX is that it peaked when the US Industrial growth cycle did in 2014.
An auto company (like Ford) is called a “consumer cyclical.” And they typically outperform industrial cyclicals at the end of an economic cycle. That’s why they’re called #LateCycle stocks.
If you bought CSX when Hedgeye went bullish on US #GrowthAccelerating (end of 2012) and sold it when the Industrial Cycle peaked, you made +105%. If you bought CSX “on valuation” (using the wrong #s) when the cycle peaked, you’re down -34%.
If you don’t do the macro truth about cycles, the cycle is going to do you.
What’s next? Earnings season:
- It started with an industrial cyclical, Alcoa (AA), hitting a fresh cycle low this week (down -60% from cycle peak in 2014)
- And continues with a #LateCycle financial (JPM) reporting tomorrow (still only -15% from its cycle peak in 2015)
After this 1-day bounce off the Russell 2000’s crash (20% decline from July) intraday low yesterday, and commodities “bouncing” off 5-13 year lows (CRB Commodities Index down -20% in the last 3 months alone – see 5-year non-“transitory” deflation chart for details), I’m looking forward to swimming with both Potomac and the non-peddled-rate-of-change data. I won’t drown our clients that way.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.06-2.20%
Oil (WTI) 29.45-34.21
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
daily macro intelligence
Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.
Client Talking Points
The key to our quantitative signal is price/volume/volatility, so we’ll be watching those volatility components (both Equities and OVX) very closely this morning. Front month VIX would need to break-down below 15.52 to turn the bearish SPX/Russell tide.
With the CRB Index closing at 162 yesterday (Oil sub $30, Copper $1.94, Nickel -5.7% on the day!, etc) macro markets are bouncing on those crashes bouncing, not Chinese trade data (Shanghai was -2.4%). #Deflation/Recession reports pending on Friday with USA’s PPI and Industrial Production reports.
Not much of a bounce in UST 10YR Yield terms this morning, the UST 10YR is at 2.14% with immediate-term downside to 2.06% this week if we continue to be right on that #Deflation data. We looking for the JPM report tomorrow to be bearish on the margin too.
*Tune into The Macro Show with Hedgeye CEO Keith McCullough live in the studio at 9:00AM ET - CLICK HERE.
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Top Long Ideas
McDonald's boasts style factors that are best in class for turbulent times in the market, big cap and low beta and it has handily been outperforming the market and its competitors as of late. One of the biggest aspects of competing in their space is value offering.
McDonald’s has ceded share in the value category primarily to Burger King over the last two years. Now that they are launching a national value platform with a full slate of media support, MCD will recover the value customer.
General Mills' business seems to be starting to pick up steam, as the company is working to improve merchandising and advertising on core business.
In addition they have executed a few small, but meaningful M&A deals showcasing the change in managements thinking. The divestiture of Green Giant to B&G Foods, for instance, although a profitable business, was a good move for them given their lack of focus/investment in the brand (they have more opportunities like this throughout their portfolio, in addition to SKU rationalization).
GIS continues to look for more sizeable acquisitions in emerging markets, but the string of pearls approach may remain most effective domestically.
After the worst start to a year literally EVER for U.S. equity markets, TLT caught a bid in the first week of trading as the centrally-planned Chinese stock markets traded limit down earlier in the week. It was the largest central bank liquidity injection from Beijing since Chinese markets crashed in September.
TLT remains one of our strongest long idea calls heading into 2016 as junk bond markets begin to crack.
Three for the Road
TWEET OF THE DAY
Keith McCullough @KeithMcCullough 1h1 hour ago
VIDEO (3mins) Why Hedgeye Acquired Potomac Research https://www.youtube.com/watch?v=-kYtVLJc_y0 via @YouTube #SOTU
QUOTE OF THE DAY
The surest way not to fail is to determine to succeed.
Richard Brinsley Sheridan
STAT OF THE DAY
Christmas sales in the UK "disappointing", growing just 1% in December, after a 0.7% increase in November.
Takeaway: WETF assets-under-management finished '15 on a slippery slope and January '16 hasn't started much better.
WisdomTree assets-under-management (AUM) finished last year in fluid fashion with -$3.0 billion flowing out of the asset manager in December alone. This was the worst month in the history of the firm and January 2016 hasn't started in any better fashion. In the first five business days of the New Year, WisdomTree has shed another $686 million, essentially on par with the -$3 billion monthly run rate exiting '15. We can't exactly chalk up year end loses to seasonality, as December 2014 put up a +$1.0 billion inflow for WETF. Monthly inflows are now a pittance of their highs of over $6.0 billion from March '15. Over 90% of the losses in both December and January occurred in the firm's international hedged equity products.
The Tale of Two Products
We are chalking the exodus in the international hedged products to separate catalysts as firstly the firm's Japanese hedged product has fallen victim to a substantial rally in the Yen which has taken demand for the hedged FX fund off of the boil. We warned of a slack in demand should the U.S. dollar not continue to strengthen which has proven accurate over the very near term.
The firm's European product can't be painted with the same brush however as the Euro has maintained its price range against the U.S. currency.
It looks however that European woes are the result of new demand for the copy cat iShares hedged product (which is 5 basis points cheaper). The following chart shows how the HEDJ moved from a 91% share of the market’s three major hedged Euro products (WisdomTree’s HEDJ, BlackRock’s HEZU, and Deutsche’s DBEZ) at the beginning of December to 86% share through yesterday. This has increased the HEZU iShares Currency Hedged MSCI Europe share from 8% to 14% over the same period on net positive inflows respectively.
Additionally, DXJ’s share of the market’s three major hedged Japan products (WisdomTree’s DXJ, BlackRock’s HEWJ, and Deutsche’s DBJP) ceded another point of market share over the past month. The Deutsche and BlackRock products both gained incrementally in December finishing at just over 9% and 4% share respectively.
PRICING NOW IN QUESTION and Forward outlook
It looks like pricing is becoming a factor with the emergence of investor interest in the iShares hedged European product (or it was just a catch up trade to share that the Japanese product had already ceded to competitors). While the delta's of price decreases per basis point are quite small, we don't think Street estimates incorporate a lot, if any, pricing compression for WisdomTree. At a 1 basis point decline for HEDJ pricing on an annual basis, we calculate a -0.6% top line revenue impact, but with AUM in decline the impact could be worse. We calculate for every $1 billion in AUM lost for the hedged European fund that annual WisdomTree revenues decline by -3.2%. The impact on pricing and AUM are not as severe for the Japanese DXJ product.
The ongoing fundamental issue from our vantage point is Street consensus is way too high (which is increasing by the month with the development of net outflows). We calculate that 2017 consensus estimates of $0.97 per share (the out year numbers this growth stock is valued on) to be based on over $80 billion in AUM. With assets-under-management at $47 billion currently, this is a stretch at best. Even our $0.79 estimate for '17 based on $70 billion in AUM looks ambitious at this point. WisdomTree continues to trade at a substantial premium to the asset management group at over 20.0x next 12 month estimates versus the group at just over 13.0x '16 numbers which make estimate cuts problematic. The stock remains on our Best Ideas list as a Short.
Please let us know of questions,
Jonathan Casteleyn, CFA, CMT
Joshua Steiner, CFA
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