The Path Forward

“Does the walker choose the path, or the path the walker?”

-Garth Nix


Not that everyone cares about how personal this journey building Hedgeye has been, but I just wanted to say that it’s been both a pleasure and a privilege to walk down this path of seeking economic and market truths for the last 8 years.


One of the best parts about the trip has been all of the people I’ve met along the way. Before we started the firm, I really didn’t get what other investors did. I didn’t have the time (or get paid) to care. Now I’m overly compensated to learn. That is a blessing.


I couldn’t believe the feedback I had yesterday for simply saying that it was time for me to “take a knee.” So I wanted to thank all of you who reached out to me on that. The path forward will not be easy, but it’ll be less hard knowing that I’m not alone.


The Path Forward - woods


Back to the Global Macro Grind


Understanding where you are on the path matters inasmuch as what it took to get you there does. Did you truly understand the causal factors? Did you overcome the obstacles using the right reasoning? Were you lucky? Or are you still making excuses?


After spending the entire day meeting with Institutional Investors in New York City yesterday (we’ll do Boston today and tomorrow), one obvious observation is that every investor is in a different place on the path.


At the risk of exhausting the metaphor, think of this as a long multi-year race to the top of a performance mountain called Alpha. The path narrows. It steepens. It widens. We’ll all make mistakes traversing it. How long we stay with mistakes keeps us behind.


From my perspective, here are the big macro mistakes I am not willing to make:


  1. Believe that 0% rates = 0% risk
  2. Believe that #Deflation Risk is “transitory”
  3. Believe that US #GrowthSlowing isn’t as big a risk as #Deflation


The most basic reason why I don’t believe these things is because neither the economic data nor real-time market prices do.


Again, think about being on a mountain of colliding non-linear risks (wind, rain, animals, grrrr!). If your belief system (or marketing pitch) assumes perpetual sun and compensation fun, you’re definitely going to get wet – and you might get eaten.


Let’s get back to the path that we are on in Global Equities (as opposed to the one many would like to be on):


  1. JAPAN: Nikkei down another -2.4% overnight, taking its #crash from its July 2015 peak to 23.1%
  2. CHINA: Shanghai Comp Casino ran out of peddled fictions, making lower-lows, -3.2% overnight
  3. SINGAPORE: former “read-through” market, -1.1% overnight taking its crash to -28.4% since April 2015
  4. GERMANY: trying to “bounce” (small), but still in crash mode, -24.1% since peaking in April 2015
  5. RUSSIA: no bounce, down another -2%, crashing within its crash (down -20% in the last month alone)
  6. USA: Russell 2000 and SP500 -22.9% and -12.7% from their all-time #Bubble highs (July of 2015)


For 2016 YTD alone (worst start to a US stock market year ever – and ever remains a long time), the Financials (XLF) are already down -11.9% and that’s primarily because Mr. Macro Market reads crashing long-term interest rate expectations as bearish for growth.


When GDP growth slows from 3% to 2% to less than 1%, #Recession expectations ramp. You’re seeing that now and that’s a big part of climbing the mountain – calibrating and risk managing expectations.


Markets don’t trade on where ideologues or perma bull marketers think they “should be” (from a “multiple” perspective, for example). They rise and fall as the rates of change in future growth and inflation expectations do.


As opposed to thinking about this qualitatively, here are two very basic mathematical considerations:


  1. SPREAD RISK – when it’s widening, that is bad; when it’s compressing, that is good
  2. VOLATILITY – when it’s breaking out, that is bad; when it’s in a bearish TREND, that is good


Bad and good, from the underlying asset price’s perspective, that is.


Forget about those wild #Deflation animals (China and Oil) that have attacked you in your sleeping bags (and eaten some of your friends) for a minute and tell me what the path looks like in the US economy from a Spread Risk and Volatility perspective.


Until either (or neither) of those two things change, I’ll just take a knee and keep watching our macro call that is cascading down the mountain side play out. We’re going to need to be rested for the final ascent.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.95-2.08%



VIX 22.34-29.56
USD 98.35-99.88
Oil (WTI) 27.01-30.80


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


The Path Forward - 01.21.15 EL chart

The Macro Show Replay | January 21, 2016


Sentiment Update: Three Things I Learned Today (and Three Weeks From Now)

Takeaway: Don't blame China (or energy); the U.S. consumer is slowing markedly; and QE4 likely won't form an investable bottom in equities or credit.

Today, Keith and I dove head first into the usual gauntlet of marketing that follows our Quarterly Macro Themes presentation. Having started with a full slate of meetings NYC, he and I will then be visiting clients and prospective clients in Boston, San Francisco, LA, Chicago, Dallas, Austin, Houston and ultimately back in NYC and southern Connecticut over the next ~3 weeks.


Besides the opportunity to build lasting relationships, my favorite part about meeting face-to-face with clients is learning where our economic and market views are generally most differentiated from buyside sentiment. This is where Keith and I learn what calls to press, what themes to do more work on and what topics we need to start doing work on if we are to stay 1-2 steps ahead of macro consensus. To everyone we have met or will soon meet with, we are truly grateful to have such open and honest dialogues. We are hopeful that each of you finds value in this reflexive feedback loop.


Aggregating buyside consensus is a far more difficult task. It’s nearly impossible to disassociate the macro views we hear from how a particular investor(s) might be positioned – either out of desire or mandate. Moreover, since not every buyside shop has a institutionalized process to contextualize meaningful trends and inflections across the macroeconomic and policy landscape, we’ve been known to spend a decent amount of time just agreeing on a platform upon which to have such debates.


That is most certainly not to say we are smarter; we have and continue to learn a great deal from the collective knowledge and experience of our client base. We thank each of you for that as well. It’s humbling to consistently learn what you didn’t know you did not know.


Having said all that, when we hear the same premises or similar lines of questioning meeting-after-meeting, it is easy to interpolate that sentiment upon a much larger collection of investors.


In meetings today, I consistently heard three conclusions that we [very respectfully] disagree with:


  1. The narrative fallacy that China and/or energy deflation is the root cause of the economic and financial market malaise we are experiencing domestically.
  2. The narrative fallacy that the U.S. consumption economy is good.
  3. The narrative fallacy the U.S. equity market will form an investable (read: not short-lived) bottom if/when the Fed announces QE4.


Regarding #1: We put out a research note back in mid-November titled, “Can Beijing Maintain Exchange Rate Stability Or Is the Chinese Yuan the Next Thai Baht?” in which we detailed why a rising U.S. dollar is the root cause of the aforementioned problems. China’s economic downturn and subsequent currency debasement are merely symptoms of a broader disease. To the extent you disagree with our view, we encourage you to review the second half of that note starting with the following passage:


“All told, while we are comfortable reiterating our explicitly dour outlook for Chinese economic growth, it bears repeating that we continue to view the Chanos “economic collapse” view as misguided given that the “Beijing Put” continues to largely offset that outcome. China’s trending GDP growth deceleration just feels like a collapse to the rest of world given China’s outsized contribution to global growth.”


Regarding #2: We put out an extensive chart book on the state of the U.S. consumer last night [appropriately] titled, “U.S. #ConsumerSlowing”. It’s worth reviewing if you, like many investors, hold a sanguine outlook for domestic consumption growth and consumption-oriented assets.


Regarding #3: While ZIRP and LSAP have proven to be powerful tools in perpetuating income-inequality generating asset price inflation throughout this economic and corporate profit expansion, the Federal Reserve has yet to demonstrate the effectiveness of monetary easing during concomittant recessions in economic activity and corporate profit growth. If our bearish call on the domestic business cycle continues to resonate with the data, investors will have to adjust their expectations for a pending market bailout accordingly. Assuming QE4 is, in fact, introduced (the presidential election cycle is big risk in terms of popping the bubble in U.S. monetary policy), we think it will only work to produce a lasting bull market to the extent it is introduced at/near the depths of what we view as a likely #USRecession and bearish #CreditCycle.


Sentiment Update: Three Things I Learned Today (and Three Weeks From Now) - SPX Early 90s Recession

Source: Bloomberg; Hedgeye Risk Management


Sentiment Update: Three Things I Learned Today (and Three Weeks From Now) - SPX Early 2000s Recession

Source: Bloomberg; Hedgeye Risk Management


Sentiment Update: Three Things I Learned Today (and Three Weeks From Now) - SPX The Great Recession

Source: Bloomberg; Hedgeye Risk Management


Sentiment Update: Three Things I Learned Today (and Three Weeks From Now) - U.S. Household Net Worth as a   of DPI


***To the extent either of the hyperlinks above do not work, please email and they’ll get the referenced materials over to you.***


Enjoy the rest of your respective evenings and best of luck out there tomorrow.




Darius Dale


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.45%
  • SHORT SIGNALS 78.38%

Cartoon of the Day: Meanwhile At Disneyland... *ahem* Davos

Cartoon of the Day: Meanwhile At Disneyland... *ahem* Davos - Davos cartoon 01.20.2016


"All of these people (especially the financial media) at Davos are just completely full of themselves and out of touch with Main Street," Hedgeye CEO Keith McCullough wrote earlier today.

UAL | Adding UAL Equity Short To Best Ideas List



We have not previously added short UAL Equity to our firm’s Best Ideas list, despite numerous issues with UAL’s “adjusted” financial reporting and the broader airline renaissance thesis.  We have had the CDS on the list, which were very tight in mid-2014 and we believed offered an attractive asymmetric return potential.  However, with employment at or very near a peak for this cycle, we expect demand growth to slow and potentially turn negative in 2016.  At the same time, lower fuel prices have allowed the industry to rapidly grow capacity.  Weaker demand and rapid capacity growth are likely to prove a toxic combination...particularly for UAL. 


This isn’t a call on UAL’s report tomorrow, which should be roughly in line with the Investor Update.  UAL’s outlook may well be just as rosy as DAL’s, even though we have observed some modest pressure on UAL’s fares in recent readings.  The equity market could also bounce, taking shares of UAL higher.  However, this is a longer-term view, informed by capacity growth amid changing fleet dynamics, an expected softening of demand, and our firm’s Macro process.  Ping us for our prior Black Books and EQM/data sets for additional background.





Fade Ideal Environment:  Following a 70%+ drop in the price of oil and a halving of the unemployment rate, it would be hard for the airline environment to be better.  Our firm’s Macro team makes a strong argument for a recession, or at least a recessionary environment, in 2016.  The data are compelling.  For example, credit losses are coming from resource-related industries from coal mining to oil & gas to metals.  Credit losses typically bring broadly tighter credit.  For airlines, as we show below, the economy need not experience a downturn on the scale of the Financial Crisis for the shares to sell off sharply.  Airlines typically perform horribly on both an absolute and relative basis in periods of economic slowing.  Even the 2H 2012 slowdown took a third off shares of UAL from a much lower level.  In a recession, even “high-quality industrials” would continue to sell-off sharply.


UAL | Adding UAL Equity Short To Best Ideas List - UAL 1 1 20

h/t Hedgeye Macro



Airlines Still Beloved:  Amazingly, 100% of analysts rate Delta Airlines a Buy.  Perhaps more amazingly, 88% rate UAL a Buy.  Yet, if the recession/significant slowdown call is correct, airline shares face a disproportionately large downside.  Higher cost airlines often fail in recessions; there is little historical precedent to expect airline shares to perform defensively through a downturn.  



UAL As Tide Goes Out:  We have detailed what we view as series of accounting gimmicks that have served to boost UAL’s adjusted numbers.  We won’t rehash all of them, but here are a few:

  • Writing-up frequent flier deferred revenue on emergence and in CAL purchase accounting allocations, only to drain it through later changes to FFP assumptions at ~100% margin (we estimate this at well over $1 billion)
  • Categorizing cash paid to employees as a one-time expense; GAAP allows it, but doesn’t require exclusion from adjusted results
  • Special charges for uniforms, aircraft painting which seem fairly operating to us

UAL | Adding UAL Equity Short To Best Ideas List - UAL 2 1 20


UAL | Adding UAL Equity Short To Best Ideas List - UAL 3 1 20



In recent years, UAL has only generated free cash flow on the firm’s own metric with employment trends peaking and jet fuel prices cratering.  We see the mismatch between cash and adjusted profits as noteworthy.


UAL | Adding UAL Equity Short To Best Ideas List - UAL 4 1 20



It is not as though capacity additions have been driving the cash drain.  Domestic capacity has generally contracted and UAL has steadily dribbled away market share.


UAL | Adding UAL Equity Short To Best Ideas List - UAL 5 1 20



Domestic Capacity No Longer Disciplined:  Domestic airline capacity growth is outpacing its typical relationship to economic growth amid lower fuel costs.  This is shown below as a residual from the regression of Industrial Production to ASM growth. 


UAL | Adding UAL Equity Short To Best Ideas List - UAL 6 1 20



Which tends to be explained by fuel prices….


UAL | Adding UAL Equity Short To Best Ideas List - UAL 7 1 20



So far, demand has kept pace as lower airfares and higher employment generated adequate traffic.  In a recessionary environment, however, we expect capacity trends to prove troublesome.  Capex is up, and capacity is coming on rapidly into a deteriorating macroeconomic environment.  We have generally explained accelerated capacity growth as resulting from flattening of the incremental capacity cost curve in a lower fuel price environment (e.g. economics of older planes work better at lower fuel prices).


UAL | Adding UAL Equity Short To Best Ideas List - UAL 8 1 20


UAL | Adding UAL Equity Short To Best Ideas List - UAL 9 1 20


UAL | Adding UAL Equity Short To Best Ideas List - UAL 10 1 20


UAL | Adding UAL Equity Short To Best Ideas List - UAL 11 1 20



AAL is still roughly playing the game, but this is partly company specific. 


UAL | Adding UAL Equity Short To Best Ideas List - UAL 12 1 20



And capital spending has ramped higher.


UAL | Adding UAL Equity Short To Best Ideas List - UAL 13 1 20



UAL Cost Challenges:  For a company which has twice promised billions in cost reductions (Project Quality & Merger Synergies), UAL’s cost efforts may have limited how quickly costs have grown, although it is hard to tell if that is the case. At a November conference appearance, UAL claimed to have cut “$800 million” in 2015 non-fuel operating expenses in November, which is odd since non-fuel expenses are generally higher vs. 2014.


UAL | Adding UAL Equity Short To Best Ideas List - UAL 14 1 20



Liquidity & Net Debt:  In the best airline operating environment in a generation, UAL did not make much progress on net debt or liquidity.  The relatively small buyback activity (net of converted debt, that is) may be viewed as an error in a recessionary environment.


UAL | Adding UAL Equity Short To Best Ideas List - UAL 15 1 20


UAL | Adding UAL Equity Short To Best Ideas List - UAL 16 1 20



Senior Management Uncertainty:  We very much hope that UAL’s CEO Oscar Munoz makes a speedy recovery.  As unfortunate as it is, senior management has been lacking at the firm since Jeff Smisek was pushed out following the Port Authority scandal.  That may prove an additional challenge.


UAL | Adding UAL Equity Short To Best Ideas List - UAL 17 1 20



2015 Fuel Profits: UAL has benefited enormously from the decline in fuel prices.  We expect airfares to compete away lower fuel on a lag.  Since airfares are readily tracked daily, investors may need to move well ahead of actual changes.


UAL | Adding UAL Equity Short To Best Ideas List - UAL 18 1 20



Upshot:  We see UAL as a high cost airline with dubious financial reporting, a combination that seems a straightforward short in a recessionary environment.  Airlines are historically among the most cyclical groups, but UAL is still very much “up” and investor sentiment remains very positive despite signs of an inflection in economic activity.  We expect the shares to trade lower before airfares fully reflect the changed environment.  While this does not represent a view on UAL’s soon-to-be reported quarter, the tide appears to be moving out amid a loss of capacity discipline.  

THANK YOU | A Thoughtful Note From A Subscriber

Takeaway: Notes like the one below are precisely why we launched our firm back in 2008.

Editor's Note: Below is a note we received this past Friday from a Hedgeye subscriber. Amidst all the tumult in financial markets, it is extremely rewarding and gratifying to receive messages like this validating why we do, what we do. At its core, our firm was designed to help investors protect, preserve, and grow their wealth through treacherous market environments just like today.

*  *  *  *  *  *  *


THANK YOU | A Thoughtful Note From A Subscriber - note from subscriber


Here's the video mentioned in the note above where Hedgeye CEO Keith McCullough explains how Hedgeye was founded. It all started with a personal conversation he had with his mother.



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