CHART OF THE DAY | How To Play Defense In A Recession and Rising Rate Environment

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye U.S. Macro analyst Christian Drake. Click here to join Hedgeye CEO Keith McCullough and Senior Macro analyst Darius Dale on today's The Macro Show. It's FREE!


"... Within the housing related equity complex, REITs provide the best relative returns during recession and rate risk environments.  As can be seen in the Chart of the Day below, REIT’s are essentially the Utilities of the Housing industry. While the r-square isn’t exceedingly high, the relative return distribution plots as you would expect and want in a growth slowing environment."  


CHART OF THE DAY | How To Play Defense In A Recession and Rising Rate Environment - CoD 2



“A calorie is a calorie is a calorie”


My grad school Bionutrition professors peddled that perceived wisdom about caloric intake and its flow through to body composition every semester.


I think they truly believed it.


The math behind the conventional thinking ran like this:  1 lb of fat = 395g (~87% lipids) … 395g X 9 calories per gram  = ~3500 calories. 


So, create a caloric deficit of 3500 and the muffin-top melts to memory. 


Intuitively compelling, expositionally convenient …. and (mostly) empirically false. 


You don’t need an advanced degree to poke common sense holes in that orthodoxy. 


At the time, my simple pushback was something like this:  “If I eat 2K calories of butter, 2K calories of chicken, or 2K calories of lettuce everyday, do you think I’ll look and perform the same after 3-months?”


Empirically, physiology and physique transformation are nonlinear processes and simple calorie reduction works … until it doesn’t.   


The further someone progresses beyond the “honeymoon” dieting period, the more progress gets choppy and less predictable. 


Most people have experienced a form of diet nonlinearity.  Diet, Diet, Diet and nothing happens for days/weeks then wake up one morning and you lost 5 lbs overnight and look noticeably different. 


Having trained hundreds of high-level, competitive athletes and bodybuilders, you learn what works with live ammo.  It’s called Bro-Science. 


Bro-Science has had a sneaking tendency to become ivory tower doctrine … on a lag. 


Relatedly, this week I put on a pair of spandex and looked in the mirror.  It’s called #TruthSerum.  


Bro-Science - CoD 1

Click here to join Hedgeye CEO Keith McCullough and Senior Macro analyst Darius Dale on today's The Macro Show.


Back to the Global Macro Grind ….


On Wednesday, we strapped the research spandex on Housing and delivered our outlook for 2016.  The conclusion, in rate-of-change bro-science empiricist terms is:  Less Good is Bad (ping if you’re interested in reviewing the 150-pg deck detailing our view) 


Without giving away the full institutional research alpha thunder, here’s a select summary of some of the issues facing the industry: 


  • WALL OF WORRY OR SLOPE OF HOPE?  The long-term bull case for Housing is still alive, but the short and intermediate term outlooks are dominated by negatives.  At the macro level, the manufacturing-industrial data is conspicuously contractionary, income and consumption growth are both past peak, birth trends are rolling over and recession risk is rising.  Housing related equities (Builders, Building Products, Home Improvement, Title Insurers, etc) underperform in both recessionary and rising rate periods.   Rather than climbing the wall of worry, we think the first 6-9 months of 2016 will be spent riding the slope of hope lower.
  • FUNDAMENTAL DECELERATION | VOLUME & PRICE:   Rate of change in both volume and price are set to decelerate in 2016. The short-term will be pressured by a late-4Q15 pull forward of demand ahead of the Fed’s rate hike. Beyond this, however, tough comps through 3Q16 will push Y/Y growth down sharply and home price trends will begin to play catch up (i.e. decelerate) to 2015’s back half volume slowdown.  Decelerating fundamentals are rarely a catalyst. 
  • HOUSTON, WE HAVE A PROBLEM:   While Houston is small relative to the country as a whole, it’s not small for builders.  The Houston Metro population is the fifth largest in the US with ~6.5 million residents and was the fastest growing metro from 2010-2014.  Builders ramped exposure to Houston and benefited over the last half-decade+ as demand and construction accelerated but conditions have reversed and activity is now spiraling south.  Job growth in the region slowed from +4.4% last year to just +0.8% in November, existing home inventory is up +28% YoY, demand is down -11% YoY, new orders at LEN were down -20.4% in 4Q and home prices and permitting activity have just begun to roll over.  Further, oil hedges for major E&P employers in the region will decline by -23% in 1H16 and further headcount “adjustments” will follow.  In short, don’t try to catch the falling knife in Houston – it’s going to get worse.
  • LABOR SUPPLY:  Builders have complained about the dearth in specialty trade contractors in recent quarters as the peri-crisis retreat in immigration, a lack of hiring of younger workers, and residual post-crisis industry level labor issues have reduced the supply of skilled workers to the industry.  A tight resi labor market is indicative of rising demand (i.e. a high quality problem from a longer-term perspective) but the associated cost and margin pressure will not resolve in 1H16 as the pace of new construction activity continues to outpace the growth in industry employment. 
  • HIGH END:  Growth in New Home Purchases at the high end (>$500K) has slowed to -10% YoY in 4Q and demand is unlikely to materially re-accelerate over the shorter-term.  As can be seen in the Chart above, High ticket discretionary consumption is (unsurprisingly) sensitive to asset market volatility and with the VIX in Bullish Formation and global equities in hard-hat mode, the high end probably won’t carry the consumption curve higher here in early 2016. 
  • PLAYING DEFENSE:  Within the housing related equity complex, REITs provide the best relative returns during recession and rate risk environments.  As can be seen in the Chart of the Day below, REIT’s are essentially the Utilities of the Housing industry. While the r-square isn’t exceedingly high, the relative return distribution plots as you would expect and want in a growth slowing environment. 


With the future’s red this morning, today’s domestic macro data is unlikely to fuel an appetite for holding risk over the long weekend. 


The PPI data will remain deflationary, Industrial Production growth should remain negative for 2nd month (and – outside of a prospective cold weather bounce in utilities production in January – it’s unlikely to reverse in the coming months with both backlogs and new orders holding <50 across the ISM/PMI surveys) and with savings rates elevated and durable goods orders and consumer credit growth flagging in recent months, Retail Sales are unlikely to surprise to the upside.  


God was in a good mood the day he created the intelligent bro-scientist gene. 


At some point we’ll be very publically wrong, but in the meantime …


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.03-2.16%


VIX 22.17-28.98
USD 98.66-100.12


To the bro’s continuing to front-run the (macro) flows,


Christian B. Drake

U.S. Macro Analyst 


Bro-Science - CoD 2

Stock Report: Allscripts Healthcare Solutions (MDRX)

Takeaway: We added MDRX to Investing Ideas on the short side on 1/12.

Stock Report: Allscripts Healthcare Solutions (MDRX) - HE MDRX table 1 14 16


Allscripts Healthcare is a legacy provider of Electronic Medical Record and Practice Management software and solutions to physician offices (ambulatory) and hospitals (inpatient). The market for ambulatory EHRs (50% of MDRX Sales) is highly fragmented, with over 400 different vendors claiming some stake to the market. The large number of vendors is the result of government subsidies issued to purchase software under the HITECH Act (2009), which mandated their purchase or face penalties longer term.


However, the stimulus spending has now ended and going forward, we believe market share will naturally accrue to the top vendors in the market. Our view is that Allscripts is NOT a top vendor.


Allscripts has a difficult past and questionable future. The company made a series of acquisitions in the 2005-2010 period and failed to integrate them properly. As HITECH requirements began, also called "Meaningful Use" attestation, in 2011 Allscripts was unable to keep up.


What resulted was a 30% drop in bookings in 2012, 50% drop in stock price, a board shakeup and ultimately a new CEO and management team. The new CEO, Paul Black, has made great strides to turn Allscripts around. Unfortunately, we believe the damage is already done and the most optimistic version of the turn-around story is reflected in the current stock price.


We have done a lot of work in the Health IT space as a derivative of our Best Idea Long call on athenahealth (ATHN), building proprietary tracking tools and analyzing large datasets to track share gain/loss over time. We also conduct a great deal of primary research, mainly in the form of speaking with those in charge of making purchasing decisions at large Health Systems and system users. The results of this research suggest that Allscripts will continue to be a share donor for the foreseeable future.


Stock Report: Allscripts Healthcare Solutions (MDRX) - 20150106 MDRX EHR GainLoss





Based on our assessment of the market, we believe bookings growth will slow over the course of 2016, and expect the multiple to compress as a result. Historically, there has been a 0.85 correlation between bookings growth YoY and the change in forward multiple. This results in a stock price closer to $10 on a trend duration.


We expect our thesis to play out on both a trend and tail duration. Our key thesis points are as follows:

    Data continues to show ambulatory and inpatient share losses. We expect this trend to continue as large health systems consolidate and value-based reimbursement drives the need for a single inpatient EHR. On the ambulatory side (~50% sales), Allscripts will continue to lose business (prospective and current) to peers athenahealth and eClinicalWorks, both of whom surpass Allscripts in interoperability and outsourcing capabilities. We will be receiving quarterly market share updates to monitor our thesis, and will continue to update our proprietary trackers.
    While Allscripts reputation has markedly improved since the dark days of 2012-2013, the reality is that the damage is already done. Many Hospital Executives refuse to include Allscripts in RFPs and estimates of mind share vs. market share do not bode well for bookings growth. Based on industry ratings and anecdotes, the probability of Allscripts unseating the current acute care EMR vendor at any large IDN is low. We will continue to collect anecdotes from industry participants, including current Allscripts customers. 
    Current valuation appears to be supported by accelerating sales growth in 2018-2019 from low single digits to mid-teens. In order for this to occur, bookings would need to sustain +25% growth and backlog conversion would need to accelerate. With system sales in secular decline, new contract lengths ranging from 5-10 years and for the reasons outlined above, we find this unlikely.

Stock Report: Allscripts Healthcare Solutions (MDRX) - 2015 01 06 EHR SHare Losers Gainers




Allscripts has amassed a large install base, and currently ranks 3rd in Ambulatory EHR market share. Share losses at Allscripts will come at both ends:

  1. Competitive displacement from the likes of athenahealth and eClinicalWorks and
  2. Health system consolidation resulting in the rip and replace of the legacy system.

On the last point, the shift to value-based reimbursement will likely accelerate health system consolidation in the coming years. The vendors that survive will be the ones who invest in the usability and interoperability of their products, and whose incentives are aligned with that of the physician. Allscripts does not rank favorable in either of these categories.


While there will certainly be volatility along the way, on a tail duration we believe the stock can reach the $5-7 level. 


Click here to watch a video of Healthcare analysts Tom Tobin and Andrew Freedman laying out their MDRX short thesis.


Stock Report: Allscripts Healthcare Solutions (MDRX) - HE MDRX chart 1 14 16


Cartoon of the Day: Bullard Befuddled

Cartoon of the Day: Bullard Befuddled - Fed grasping cartoon 01.14.2015


"Earlier today, St. Louis Fed James Bullard said market-based inflation expectations were becoming 'worrisome' after he was so hawkish a month ago," Hedgeye CEO Keith McCullough noted today.


We'll say it again. One of the biggest risks to financial markets right now is believing the Fed's economic forecast.

RH | Our Thoughts on Price Action

Takeaway: We think risk is isolated to the multiple, not earnings, and that’s what matters most at a trough 16x p/e and 33% short interest.

We’ve been flooded with calls today on the RH price move – and we should be. We’re the big Bulls on the name, and lately it wants to do nothing but go down.


The stock is moving on no news, no sell-side calls, no conference presentations, etc… We don’t think that the 1010 Data Read-Thru is relevant in this instance.


We’re as confident as ever that NEAR-TERM earnings expectations are completely in check, and that long-term earnings are too low. And we’re as sure as we can be that we’re not about to be blindsided by any kind of press release from the company about management, business trends, or promotions.


We’re now looking at short interest at historical PEAK (33% of float), and the multiple setting a new historical trough (16x).  Put another way, we’re talking a 16x multiple for a 40% EPS grower.


Obviously, the market thinks we’re wrong in our earnings math.  We’re absolutely not ignoring a material slowdown in the economy or Hedgeye’s bearish Macro view. We simply think that RH should still do better than the consensus in that environment, and that’s what we’re focused on given the massive 40% correction since November, and 20% month-to-date in Jan. 


In the end, we think the risk is isolated to the multiple, not the consensus earnings, and that’s what matters most at a 16x p/e and 33% short interest


The key concerns we hear when talking to investors is centered on the 4Q print which won’t be out until late March, and what guidance for 2016 will look like. That’s centered on a few key issues that the CEO brought to the table on the last earnings call; notably Macro headwinds (particularly in oil affected markets like Houston) and Promotional pressure in the home furnishings space.   The ‘wall of silence’ is definitely a concern, as eight-weeks of no info won’t help anyone except the shorts. But our sense is that the company will make some kind of statement about business trends, growth plans, or earnings near quarter-end.


Numbers for the upcoming quarter look to be in check. Due to the following…

1) RH issued guidance on 12/10 with only 6 weeks left in the quarter and most purchase orders in the company’s hands given that the delivery window is 8-12 weeks and RH doesn’t recognize revenue until an order has been delivered.

2) As of 12/10, RH was tracking ahead of its guidance on the top-line which calls for revenue growth of 21-23%. Other than the verbiage, RH hasn’t changed up its promotional posture materially since the added event in mid-December. If, RH needed to make up ground on the top line in a quarter where it absolutely can’t miss we think the company would have pulled another promotional lever.

3) Gross margin guidance calls for 100bps of deleverage, giving the company plenty of room to promote if needed to drive the top line and market share. Coupled with meaningful SG&A leverage we still get to 150bps of EBIT margin expansion in the quarter.


Full thoughts on our outlook over a Trend duration see note below.



RH | It’s Us vs Them


Takeaway: Here’s a detailed overview of where we’re different from the Street, by line item, in each quarter in 2016. RH needs to deliver. It will.


More than any other company/issue we've had questions on since 2016 kicked into high gear,  RH takes the cake – and more specifically, its near-term earnings trajectory. We’d peg it at roughly a dozen queries in just two days, which is very big for us. We’re not surprised, and we agree 100% with the impetus for the concern. We believe fully in the long-term call, and believe now as much as ever that there’s $11 in earnings power, and that people will actually start to believe it within a year.  But the cold hard fact remains that the tactical game changed in December due to promotional activity, perceived economic sensitivity, and timing issues around concept and new store launches.


We can talk all day about the 2-3 year economics of new categories ramping up sales into bigger stores at lower rents. But the fact is that if RH misses revenue and/or earnings in either of the upcoming two quarters, $11/ps in future earnings won’t mean squat, and this multiple will deflate faster than a game ball in Foxboro (sorry Patriots fans).


As such, in the tables and charts below, we compare where we shake out in each of the next four quarters versus consensus, with particular focus on Sales, Gross Margins, SG&A, and EPS in 1H16.  The punchline is that we’re ahead of the Street every quarter on EPS, and are coming in at $4.48 for the year vs the Street at $3.94. The good news is that this is almost entirely top line driven throughout the year, with SG&A leverage to go with it. The downside is that we’re more conservative in both 1Q and 2Q than the Street on Gross Margin.  When all is said and done, however, we think that a better comp and higher EPS will trump lower GM, given that weakness in the latter is so well telegraphed.


[As a point of reference, we’re going to vet every single part of the RH Bear Case across durations in a Black Book to be released on January 25th (1pm EST presentation). We won’t necessarily disprove all of it, but we will fully analyze it. Stay tuned for details.]


EXHIBIT 1: Hedgeye P&L Variance vs Consensus

RH | Our Thoughts on Price Action - RH Trend 1   Summary Table 



EXHIBIT 2: RH Revenue, Hedgeye vs Consensus

4Q15: To get to the streets #’s for 4Q (mid-point of guidance) need to assume a big ramp in the 2yr trend from 16% to 23%. That reacceleration = $79mm in sales. If we attribute all of that to Modern/Teen we have to make modest assumption that M/Teen books run a productivity rate of just 45% of Spring mailings. That would be what we’d consider an obscenely low performance. Plus RH guided down margins appropriately to win market share. It appears to be working. Top line should not be an issue.

1Q16: Modern/Teen not a 1-quarter event – this builds sequentially. Look at big Source Book revamp in 2Q/3Q14 for proof. Plus, vendor network is the M/T revenue bottleneck, not consumer demand. That’s not a bad position to be in.

2Q16: Continued benefit from Modern & Teen, plus newest design galleries (Chicago, Denver, Tampa, Austin + LA Modern) will have more material impact to topline. Increased marketing spend in the form of source book pages.

RH | Our Thoughts on Price Action - RH Trend 2   Rev Chart 



EXHIBIT 3: RH EBIT Margins, Hedgeye vs Consensus

4Q15: Promotional environment pressure takes margins down in 4Q. Guide for -100bps on GM likely overshot to the downside. SG&A leverage from Source Book savings and scale in the model.

1Q16: Assume that promotional pressure persists, coupled with DC occupancy deleverage, and higher shipping cost – offset by one more quarter of SG&A leverage as Source Books savings amortized over 12 month window. Strong top line flows through.

2Q16: Promotional pressure eases, product flow normalizes and retail occupancy starts to kick in. Take spending up on marketing to drive top line.

RH | Our Thoughts on Price Action - RH Trend 3   GM Chart



EXHIBIT 4: RH EPS, Hedgeye vs Consensus

4Q15: Expectations in check for 4th quarter, and RH has to deliver. Sales expectations assume a big acceleration, but product pipe, new galleries, and market share efforts will drive 35% earnings growth even with GM pressure.

1Q16: Street underestimating how long tail is on Modern/Teen product. RH will push envelope to take market share. Enough SG&A levers left to offset any GM pressure.

2Q16: New galleries + Modern/Teen + increased marketing dollars = strong top line. Modest EBIT margin leverage. Street too low by $0.10.

RH | Our Thoughts on Price Action - RH Trend 4   EPS Chart



EXHIBIT 5: RH Peak, Mid, Trough Valuation and Sentiment Summary

Any way you cut it, RH is sitting near a trough valuation on all metrics, and within 200bps of peak short interest (currently 29%). In fairness, RH has trading history for only half of the current economic cycle – but for the stock to be anything other than egregiously cheap at $78, we need to be more wrong on the fundamentals than we’ve been on any name in a very long time.

RH | Our Thoughts on Price Action - RH Trend 5   Valuation 2

REPLAY of The Macro Show: Why Markets Are Crashing



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REPLAY of The Macro Show: Why Markets Are Crashing  - TMS replay final

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