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Shelter From The Storm: A Winning Hedgeye Call In The Market Bloodbath

Takeaway: Once again, it has paid to stick with Hedgeye's non-consensus process.

Shelter From The Storm: A Winning Hedgeye Call In The Market Bloodbath - z re dd

 

Amidst the sea of red across global markets this morning, precious few investments are offering investors shelter from the storm. Moreover, ever fewer are actually up for the year. One of those just happens to be our macro team's favorite contrarian idea. It is paying off big.

Long Bonds (TLT)

 

For the record, the S&P 500 is down 8% year-to-date, while TLT is up 4%. 

 

Shelter From The Storm: A Winning Hedgeye Call In The Market Bloodbath - TLT cartoon 01.26.2015

 

Here's analysis from Hedgeye CEO Keith McCullough this morning:

 

"The UST 10YR is punching in at 1.96% this am, doing its job for us (favorite idea is Long the Long Bond) as both #Deflation and #Recession expectations continue to get priced in – Yield Spread (10s/2s) at 114bps hits new cycle lows; staying short the Financials (XLF) as JPM, BAC guidance sounded like the Fed’s (lala land) relative to economic reality."

 

 

 


Lazard (LAZ) | Hiring in Restructuring with Vice Chairman Bullish from Davos

Takeaway: Lazard made the first hiring in U.S. restructuring since December '08 and its Vice Chairman struck a positive tone on reorgs from Davos.

Lazard made a hire in domestic restructuring, the first one in over 7 years putting up a press release of the hiring of a Managing Director (MD) in its reorg business overnight. With only 141 MDs in total at the firm, the hire is not inconsequential in our view and signals that growth in M&A is waning. While the firm hired a new restructuring head in Germany in 2013, the announcement of a U.S. restructuring MD is the first since December 2008. 

 

The firm's Vice Chairman also made an address from Davos this morning, referencing volatility shaking out industry M&A activity and striking a positive tone broadly on restructuring and reorgs. Our research echoes that sentiment and we think that corporate credit spreads having increased over 100 basis points since mid-2015 will impact merger announcements in 2016 and that higher volatility (VIX) is shaking out deal activity which will create the first negative comp for M&A activity in 4 years.

 

SEE DAVOS INTERVIEW HERE

 

 A bull market in restructuring is not good for Lazard and its shareholders as the stock declines when M&A percentages of advisory drop:

 

Lazard (LAZ) | Hiring in Restructuring with Vice Chairman Bullish from Davos - chart1 final

 

The restructuring cycle of 2009 boosted restructuring revenues by $100 million year-over-year but M&A revenues dropped by $150 million and LAZ stock fell:

 

Lazard (LAZ) | Hiring in Restructuring with Vice Chairman Bullish from Davos - chart2

 

Our main contention is that the rise of corporate credit spreads will take activity out of the M&A market as funding costs rise. Moody's BAA spreads have risen 100 basis points since 2015:

 

Lazard (LAZ) | Hiring in Restructuring with Vice Chairman Bullish from Davos - chart3

 

A negative inflection in credit has always portended a reversal in M&A and we expect higher funding costs to impact merger activity as we get into 2016:

 

Lazard (LAZ) | Hiring in Restructuring with Vice Chairman Bullish from Davos - chart4

 

In 14 years of data, a +100 basis point rise in corporate credit has impacted M&A activity by -20%:

 

Lazard (LAZ) | Hiring in Restructuring with Vice Chairman Bullish from Davos - chart5

 

A spiking VIX or the volatility index has historically halved M&A activity when crossing over the 20 threshold:

 

Lazard (LAZ) | Hiring in Restructuring with Vice Chairman Bullish from Davos - chart11

 

We are also concerned that investors underestimate the firm's exposure to emerging markets (EM) and that the stated 30% of assets-under-management in EM is actually over 50% when adding strategies in Global and Multi-Regional:

 

Lazard (LAZ) | Hiring in Restructuring with Vice Chairman Bullish from Davos - chart6

 

The firm has never historically escaped an EM melt-down in the past and we don't expect it to this time. The EM downcycle of 2002-2005 created negative organic growth and market losses for Lazard Asset Management.

 

Lazard (LAZ) | Hiring in Restructuring with Vice Chairman Bullish from Davos - chart7

 

Street estimates are completely unrealistic assuming a best case scenario for the out years of 2017 and 2018:

 

Lazard (LAZ) | Hiring in Restructuring with Vice Chairman Bullish from Davos - chart8

 

Even near term assumptions are way too high and we don't have Lazard earning $3.00 this year which is -20% below the Street:

 

Lazard (LAZ) | Hiring in Restructuring with Vice Chairman Bullish from Davos - chart9

 

We think the deceleration of the firm's earnings will continue to compress the stock's multiple. In addition, we expect some reactionary downgrades of the stock with no Sell recommendations on the Street and estimates too high. Our base case valuation is $30 per share or 10x our '16 estimate with a Bear case at $22 per share on $2.20 in EPS. The stock remains on our Best Ideas list as a Short:

 

Lazard (LAZ) | Hiring in Restructuring with Vice Chairman Bullish from Davos - chart10

 

LAZ - Value Trap - Best Ideas BlackBook

LAZ - As Good As It Gets

 

Please let us know of questions,

 

Jonathan Casteleyn, CFA, CMT 

 

 

 

Joshua Steiner, CFA

 

 

 

 


POTOMAC INSIGHT | A Defense Budget Preview with PRG Senior Defense Advisor “Emo” Gardner

Editor's Note: Below is a special, in-depth conversation between Potomac Research Group Senior Defense Advisor LtGen Emerson “Emo” Gardner USMC Ret and Hedgeye Industrials and Materials analyst Jay Van Sciver. With the defense budget due out February 9th, Gardner previews what investors should expect ahead of its release with Van Sciver helping to distill the key takeaways for Lockheed Martin Corporation (LMT)General Dynamics Corporation (GD), and Huntington Ingalls Industries Inc (HII).

 

Gardner brings unparalleled insight to the defense spending process with 37 years of distinguished service as a Marine officer and as the former acting Director of Defense Secretary Gate’s Cost Assessment & Program Evaluation (please see Gardner's complete bio below the video).  

 

Hedgeye recently acquired the Washington D.C.-based policy research firm Potomac Research Group. This is one example of the research depth and granularity we look forward to bringing to our subscribers. More to come.

 

 

About Lieutenant General Emerson “Emo” Gardner, USMC, (ret.)

Lieutenant General Emerson N. Gardner, USMC, (ret.) is a recognized expert on the Department of Defense programming and budgeting process and assists defense and non-defense companies in strategy development as an independent consultant.

 

From 2007 to 2010 Gardner was the Principal Deputy Director and then acting Director of Cost Assessment and Program Evaluation within the Office of the Secretary of Defense.  In this billet he led independent evaluations of all major defense programs and managed the development of the Pentagon's $3 Trillion, six year Future Year Defense Plan for Secretary of Defense Robert Gates.  He had previously been the Deputy Commandant of the Marine Corps for Programs and Resources where he was directly responsible for the development and execution of all aspects of the Corps’ $33 Billion annual budget.

 

Gardner completed 37 years of distinguished service as a Marine officer in 2010.  As an aviator with 4300 hours of flight experience, his career highlights included tours as a Presidential Helicopter Command Pilot in HMX-1, operational deployments to the Middle East, Europe and Japan, and command in combat in Kuwait and expeditionary operations in Africa.  As a flag officer, he was Assistant Deputy Commandant for Marine Aviation, managed the US Central Command's joint operations center during operations in Afghanistan after 9/11, and was the Director for Operations at US Pacific Command, which is responsible for US military activities in 42 countries.

 

Gardner is a cum laude graduate of Duke University and was an Olmsted Scholar for two years in Göttingen, Germany.  He is a graduate of the Norwegian Defense College and the National Security Seminar at the Maxwell School of International Relations at Syracuse University.


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The Macro Show Replay | January 20, 2016

 


Equity Market Crashes

Client Talking Points

RUSSELL 2000

If you were just navel gazing at the “Dow” (in points) yesterday, it was “up”, meanwhile the Russell 2000 closed down (again), taking its crash to -23.2% from the July high. The average peak/trough decline in the Russell 3000 (98% of U.S. stocks) is almost 35%.

JAPAN

Nikkei’s -3.7% smack-down overnight puts it in crash mode now too (down -21.2% from its July high – peaked when SPX did) as the Yen Bears take it on the chin again this morning. Singapore’s crash continues -27% and the DAX crash is not far behind at -24% (from peaks).

UST 10YR

The UST 10YR is punching in at 1.96% this morning, doing its job for us (our favorite idea is Long the Long Bond) as both #Deflation and #Recession expectations continue to get priced in. The Yield Spread (10s/2s) at 114 basis points hits new cycle lows; staying short the Financials (XLF) as JPM, BAC guidance sounded like the Fed’s (lala land) relative to economic reality.

 

*Tune into The Macro Show with Ben Ryan live in the studio at 9:00AM ET - CLICK HERE

Asset Allocation

CASH 66% US EQUITIES 0%
INTL EQUITIES 0% COMMODITIES 0%
FIXED INCOME 22% INTL CURRENCIES 12%

Top Long Ideas

Company Ticker Sector Duration
XLU

We added Utilities (XLU) on the long-side last Friday as the market continued to pummel everything we haven’t liked (high debt, high beta, and small-cap stocks leveraged to inflation expectations) – Utility stocks are low-beta, slow-growth bond proxies which is why they are by far the best relative performer year-to-date.

 

XLU is outperforming the S&P 500 by +7% and remains flat on the year. Friday’s large swath of data echoed what we have been saying for a while now on the deflationary risk of an industrial recession.

GIS

GIS led a $3 million funding round for kale chip maker Rhythm Superfoods. Although this is not a big deal and will most likely never make a strong impact to top or bottom line, it marks a changing in the tide for management thinking. They are making a distinct effort to delve deeper into the natural and organic category which will help them a lot in the long run.

 

Although the overall market has been atrocious year to date, down roughly -8%, GIS with its low beta, big cap, style factors has held in, down just -5%. We continue to like General Mills as a LONG, especially during the tumultuous times in the market.

TLT

With growth continuing to slow and volatility breaking out to the upside across asset classes, we expect the unwinding of a record amount of corporate credit leverage to continue. We’d put that deleveraging in the third or fourth inning currently. Credit spreads will continue to widen. That's why you're long TLT (and short JNK).   

Three for the Road

TWEET OF THE DAY

VIDEO: China Is Lying https://app.hedgeye.com/insights/48632-mccullough-china-is-lying?type=video… via @hedgeye

@KeithMcCullough

QUOTE OF THE DAY

The talent of success is nothing more than doing what you can do, well.

Henry W. Longfellow

STAT OF THE DAY

Adidas’s market share in China is 13.8% and Nike’s is 14.3%.


CHART OF THE DAY: A Roundup Of This Morning's (Crashing) Global Equity Markets

CHART OF THE DAY: A Roundup Of This Morning's (Crashing) Global Equity Markets - 01.20.16 EL chart

 

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.

 

"... Here’s what’s going on this morning in global equity markets:

 

  1. Russell 2000 closed down another -1.2% yesterday, taking its crash to -23.2% vs. its July 2015 peak
  2. Russell 3000 (98% of US listed stocks) now has an average peak/trough crash (per stock) of -35%
  3. Japan’s Nikkei moved into crash mode overnight, dropping -3.7% (deflation of -21.2% vs. its July 2015 peak)
  4. Singapore’s stock market dropped another -3% overnight, taking its crash to -27.4% since its April 2015 peak
  5. Germany’s DAX is down another -2.7% this am, taking its crash to -24.2% since its April 2015 peak" 

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