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Europe, Oil and China

Client Talking Points

EUROPE

Got growth slowing?  Europe’s economic heavyweight does.  Today the German economic ministry cut Germany’s 2016 growth forecast to 1.7% from 1.8% previously forecast. It also cut the 2016 export growth outlook to 3.2% vs prior 4.2% and lowered its outlook for import growth to 4.8% vs 5.3%. #EuropeSlowing

#CRUDECORRELATION

When an asset class that big moves that much that fast it leaves a mark on markets.  Equities correlation to oil has been building over the last year and has been ~0.97 over the last month.  Yesterday’s rally in equities followed the bounce in crude (& rumors of production cuts) only to be reversed after hours when API reported an 11.4 mm barrel build in inventory – the largest since 1996.  Demand is slowing, supply is building and as deflation continues to define the Trend despite manic, one-day countertrend price moves. 

#INDUSTRIALRECESSION

Chinese industrial profits declined -4.9% Y/Y in December which is a sharp deceleration from -1.4% Y/Y in December. Whispers of fresh stimulus might be the only fading hope to delaying the flush of global overcapacity hanging on the “Chinese Demand” story.   

Asset Allocation

CASH 67% US EQUITIES 0%
INTL EQUITIES 0% COMMODITIES 0%
FIXED INCOME 21% INTL CURRENCIES 12%

Top Long Ideas

Company Ticker Sector Duration
XLU

Utilities (XLU) continue to be the bright spot in the equity markets for 2016. XLU is up 1% this year, having edged out all other S&P 500 subsectors by a wide margin. Last week, XLU was down marginally but was still second best among the subsectors, beating all but Healthcare (XLV). Essentially, it's paying off to own low-beta XLU in a crashing market.

GIS

General Mills (GIS) has turned on its advertising for no artificial colors and flavors in its cereal, as well as an increased effort for its gluten free campaign. Click here to view the 30 second spot TV commercial.

 

These steps taken on cereal, coupled with improved merchandise planning across their portfolio in the second half should bode well for the company’s future performance. Additionally, General Mills fits neatly into the style factors that we like from a macro point of view, large cap, low beta and liquidity.

TLT

Rating agency S&P disclosed on Thursday three concerning stats as it relates to the wellness of credit oustanding:

  • More companies were at risk of having their credit ratings cut at the end of December than at the close of any other year since 2009
  • The number of potential downgrades was at 655, compared with 824 reported by the finish of 2009
  • The year-end total for 2015 was "exceptionally" higher than a yearly average of 613

 

Then on Friday, S&P followed with additional action:

  • Disclosure that oil-exporting countries face fresh downgrades as crude prices fall further and that it could repeat last year's move when it made a big group of cuts all at once
  • S&P currently has Azerbaijan, Bahrain, Kazakhstan, Oman, Russia, and Saudi Arabia on negative outlook in its Europe, Middle East and Africa region, as well as Brazil and Venezuela in Latin America

Moody’s echoed the shaky state of credit markets by announcing it was putting the ratings of 120 oil and gas companies on watch Friday.

 

Strap on your seatbelts as we expect that credit spreads will continue to widen. If the Fed pivots on its “4 rate hikes” in 2016 as the data continues to slow, Treasury bond yields get pushed lower and high-yield spreads widen into a late cycle deleveraging. This should continue to generate alpha in a Short JNK, Long TLT trade.

Three for the Road

TWEET OF THE DAY

NEW VIDEO | Under 60 Seconds: #McDonalds Earnings Report https://app.hedgeye.com/insights/48766-under-60-seconds-mcd-s-earnings-report… @HedgeyeHWP $MCD @KeithMcCullough

@Hedgeye

QUOTE OF THE DAY

We learn wisdom from failure much more than success. We often discover what we will do, by finding out what we will not do.

Samuel Smiles

STAT OF THE DAY

In 2015 U.S. Universities raised a record $40.3 billion.


Casteleyn: M&A Has Peaked – ‘The Last Bastion Of Capital Is Gone’

In this brief excerpt from The Macro Show, Hedgeye Financials analyst Jonathan Casteleyn explains the precarious setup for any investor banking on M&A hitting another all-time high this year.


The Macro Show Replay | January 27, 2016

 

 

Here is today's asset allocation:

The Macro Show Replay | January 27, 2016 - Slide2


investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.

Cartoon of the Day: Running Scared

Cartoon of the Day: Running Scared - bear cartoon 01.26.2016

 

Tomorrow is the FOMC meeting announcement. We'll see if Yellen & Co. have anything to say about the recent stock selloff.


Under 60 Seconds: MCD’s Earnings Report

 

Hedgeye highlights the three key points from McDonald's strong quarter courtesy of our veteran Hedgeye Restaurants analyst Howard Penney in under one minute.


Stock Report: Foot Locker (FL)

Takeaway: We added FL to Investing Ideas on the short side on 1/13.

Stock Report: Foot Locker (FL) - HE FL table 1 22 16

THE HEDGEYE EDGE

We are confident Foot Locker will prove to be one of the best multi-year shorts in retail. The bulls on Foot Locker are missing a huge negative fundamental turning point, while the bears are bearish for the wrong reasons. This is going to get far worse than anyone thinks. To be clear, this is not the typical ‘Internet is taking over, so short  legacy retailers!’ call and the catalyst has been in the works for a while now.

 

This change starts with Nike. Nearly a decade ago, Nike decided to shift incremental capital to build a Direct-To-Consumer (DTC) platform, and fund that with excess growth in the wholesale channel in the US. Now, with the building part largely done and the wholesale channel very full of Swooshes, the tides are turning. None of this bodes well for Foot Locker.

 

In other words, the old industry paradigm is breaking down. This change is great if you own content that consumers want — like Nike, UnderArmour and Adidas. But if you’re stuck between the all mighty Consumer and those Jordan 23s, Nike FlyKnit AirMax 180s, Yeezys or Curry 1s, then you (i.e. Foot Locker (FL), Finish Line (FINL), Hibbett Sports (HIBB) and most other traditional “brick & mortar” distributors) are in deep trouble. 

 

INTERMEDIATE TERM (TREND)

 

In the upcoming Fiscal Year 2016, FL will be working against 2 consecutive years of around 8% comparable sales growth with the economy weakening, and an SG&A rate at an all-time low of 19% (the lowest we’ve seen in a mall-based retailer). That’s how the company can comp 5%, and leverage that into a 30%+ EPS growth rate. But unfortunately, leverage works both ways.

 

We think that emerging competition from Foot Locker’s top vendor, Nike (=80% of sales), will stifle growth, and leave the company with an earnings annuity somewhere around $3.50-$3.75 per share. Is that worth $66? Not a chance. Not for a company that is Nike’s best off-balance sheet asset. And definitely not when the street is in the stratosphere approaching $6.00 in EPS (#NoWay). The company is likely to earn about $4.20 this year, which we think will prove to be the high water mark in this economic cycle. 

 

LONG TERM (TAIL)

 

It’s no secret that Nike announced last year it would grow e-commerce to $7bn by 2020, which is a huge jump from its current $1.4bn (only 4% of sales). We think Nike is sandbagging, by the way, and that it will build its e-commerce operation to about $11bn – adding $10bn in e-comm sales in the next 4-years. Now, let’s say 60% of that is in North America…we’re talking $6bn in incremental revenue to Nike. To put this into context, the entire Athletic Footwear industry is likely to add about $6bn in retail over that time period alone.

 

Our estimates for Foot Locker three years out are 30% below the street, as we think it’s at peak earnings today. Importantly, this is not the kind of story that will play out with a simple press release.

 

This is a 40-year paradigm that is unwinding over a 5-year period. We think that three out of four earnings announcements will be negative – over and over again – at least based on current expectations. Along the way, we should see significant multiple compression, and margin erosion that will cut cash flow and torpedo that argument that we hear over and over about ‘FL throwing off so much cash.” It does until it doesn’t.

ONE-YEAR TRAILING CHART

Stock Report: Foot Locker (FL) - HE FL chart 1 22 16


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