US GDP hit the 0.7% Hedgeye forecast. We maintained our forecast of between 0.5% to 1.7% Q-o-Q for fourth quarter 2015 GDP all year, even while Wall Street consensus consistently ratcheted their forecast back from 3% in July.
“I would guess we're going to see more Chinese investment in the United States in all kinds of things… But it wouldn't surprise me to see some of that, yeah. I expect that's probably a strategy. If I were sitting over there in China, I'd be looking at some of this also.”
- CAT CEO Doug Oberhelman on Zoomlion TEX 1/28/2016
Takeaway: As we see it, MTW offers favorable idiosyncratic exposure in a deteriorating macroeconomic environment, with the less cyclical Foodservice equipment unit dominating the value picture. The Street’s approach to the Crane segment is inconsistent, as the fixation on the unit’s cyclicality stops at valuation. While we plan to keep our view on a short leash in anticipation of a weakening operating environment, the new management team performed extremely well on today’s call and looks to be executing well.
We will let others summarize the quarter, and really only want to highlight a few items. Our key work on MTW is in our December Black Book and Model/EQM – ping us if you would find them helpful.
Cranes Segment Is Cyclically Depressed: It is odd how analysts bemoan the Crane business as too cyclical for debt, but fail to treat the business as cyclical for valuation purposes. Cyclicals look expensive near a trough, and cheap near a peak. It is a real challenge and a real alpha opportunity. An investor that uses a multiple of an income metric to invest in cyclicals will bias toward purchasing value traps and passing on real value. Crane segment margins are already below GFC levels on a TTM basis. Part of that is mismanagement, but crane demand also tanked last year as used resource-related cranes displaced new sales. Note that Crane segment margins did fine during the strong dollar period of the 1990s, to the extent comparable.
Crane Valuation: We would instead choose a sales based multiple for the Crane segment. Historically, TEX and Tadano have both traded between 0.5 and 1.5 EV to sales. The Zoomlion bid for TEX comes out to roughly 0.71. If one uses that bid as reference point the Crane segment would be worth ~$1.3 billion. We can take it out, say, $200 million in separation and other one-time costs and still be left with a Crane EV of $1.1 billion. There is significant room for operating improvements, too.
Foodservice Availability Bias: Shares of MIDD have sold-off, which has reduced the valuation on the most ‘available’ comparison. Comparable transactions, like Marmon’s buy of IMI’s beverage segment, haven’t changed; shares of Rational AG, a European comp, have increased. We still think its worth as much or more than MTW’s current EV, say, >$3.5 billion.
Upshot: As we see it, MTW offers favorable idiosyncratic exposure in a deteriorating macroeconomic environment, with the less cyclical Foodservice equipment unit dominating the value picture. The Street’s approach to the Crane segment is inconsistent, as the fixation on the unit’s cyclicality stops at valuation. While we plan to keep our view on a short leash in anticipation of a weakening operating environment, the new management team performed extremely well on today’s call and looks to be executing well.
Takeaway: We reiterate our #USRecession and #CreditCycle themes in the context of the latest data -- namely Q4 GDP.
Earlier today, we received the following question from a very thoughtful [and successful] investor:
"So what are your quarterly GDP estimates for this year, and will we see a negative print and/or two quarters of negative growth? I appreciate that it is somewhat irrelevant if we have a technical recession by definition, but you guys are making the recession call, no?"
Given it's obvious relevance and our interest in continuing to broadly own the U.S. economic debate, we thought we'd share our response with a broader audience:
Regarding your question on when, where and how a recession will occur in our U.S. GDP model, it’s important to note that it’s impossible to model in negative GDP prints from where U.S. economic growth is tracking currently – either econometrically or quantitatively.
Our #LateCycle view that has since morphed into our #USRecession and #CreditCycle themes has always been centered on the high and, most importantly, rising probability of a recession commencing in/around mid-2016. It’s not about ascribing a round (or not-so-round) probability estimate to that [broadly undesired] outcome. It’s actually about whether investor, business and/or consumer expectations for an outright recession are rising or falling.
And much like expansions on the way up, a rising probably of recession is reflexive on the way down from the peak in economic growth. Recall that those peaks occurred in 2H14 for manufacturing and capex growth and in 1H15 for consumption and employment growth, respectively.
Modeling in a U.S. recession would be like modeling in +1% revenue growth for AAPL at this time last year – which would’ve obviously been too far out of the band of probable outcomes for even the most ardent bear. The point of our Bayesian inference modeling process is to constantly shock our GDP and CPI models with relevant Bayes factors (i.e. high-frequency economic and financial market data) in order to appropriately adjust our estimate from the reported base rate as implied by the base effects themselves, as well as per trends in high-frequency economic data.
What we’ve learned from Dr. Daniel Kahneman’s work on Prospect Theory is that the market prices in those adjustments (i.e. rates of change) from the base rate, rather than the final outcomes (i.e. absolute states). As such, we don’t start with a desired outcome (i.e. “GDP feels like it’s going to be 3-4%”); we let the data guide our forecasts higher or lower – purely in differential terms.
It sounds overly complicated, but we can assure you it really isn’t; it’s just overly differentiated from competing GDP and CPI models. How we model the economy is not at all unlike how any good bottom-up investor would model a company.
So to answer your question(s) specifically:
All told, we reiterate our #USRecession theme in the context of the latest data. Our refreshed U.S. GIP model, GDP and economic summary tables are below. Feel free to email with any follow-up questions."
Have a great weekend,
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Takeaway: The exchanges are just in-line performers when vol is low but act as shock absorbers in high volatility environments.
The exchange stocks historically have acted as shock absorbers in high volatility environments kicking off relative outperformance against the broader financial sector. The calm of 2012 through mid-2014, put the exchanges at just inline performers versus the XLF as both baskets of financial stocks rose in lock-step. However the high VIX environment of 2009-2011 displayed the worth of these techology driven, agency mechanisms, as the Dow Jones Exchange Index (DJGEX) consistently outperformed the Financials sector SPDR. With the VIX (magenta line, left scale) again breaking out of its base with higher highs and higher lows entering 2016, we expect the start of a divergence between the DJGEX and the XLF to continue. Only at very high levels of VIX (north of 40) do exchange equities also get shaken out to lower levels historically.
Weekly Activity Wrap Up
With volatility easing, exchange traded volume slacked off this week, although the week's average daily volumes (ADVs) in cash equities and futures still exceeded their year-over-year comps. Cash equity volume came in at 8.6 billion shares traded per day this week, bringing the 1Q16TD ADV to 9.3 billion, up +34% Y/Y. Futures activity at CME and ICE came in at 21.5 million contracts traded per day this week, bringing the 1Q16TD ADV to 24.0 million, up +20% Y/Y. CME in particular is setting an all-time trading volume high with 18.1 million contracts per day on average this month, taking out the former high of 17.5 million in ADV in October 2014 on the potential for a Greek exit from the European Union. Options did not have as strong a week, coming in with 15.3 million contracts traded per day, but that still brings the 1Q16TD ADV to 19.1 million, up +23% Y/Y.
U.S. Cash Equity Detail
U.S. cash equities trading came in at 8.6 billion shares per day this week, bringing the 1Q16 average so far to 9.3 billion shares per day. That marks +34% Y/Y and +31% Q/Q growth. The market share battle for volume is mixed. The New York Stock Exchange/ICE is taking a 24% share of first-quarter volume, which is consistent with the prior quarter and year-ago quarter, while NASDAQ is taking a 19% share, +62 bps higher Q/Q but -86 bps lower than one year ago.
U.S. Options Detail
U.S. options activity came in at a 15.3 million ADV this week, bringing the 1Q16TD average to 19.1 million, a +23% Y/Y and +20% Q/Q expansion. In the market share battle amongst venues, NYSE/ICE has been trending downward at a moderate pace, but at an 18% share it is +135 bps higher than the year-ago quarter. Meanwhile, NASDAQ's recent declines bring it -445 bps lower than 1Q15. CBOE's market share is down -131 bps Y/Y but has improved recently; its 27% share of 1Q16TD volume is up +147 bps from 4Q15. BATS and ISE/Deutsche have been taking share from the competing exchanges, with BATS up to a 10% share from 9% a year ago and ISE/Deutsche taking 16%, up from 13% a year ago.
U.S. Futures Detail
15.5 million futures contracts traded through CME Group this week, bringing the 1Q16TD average to 18.1 million, a +21% Y/Y and +37% Q/Q expansion. CME open interest, the most important beacon of forward activity, currently tallies 107.2 million CME contracts pending, good for +17% growth over the 91.3 million pending at the end of 4Q15, an improvement from last week's +14%.
Contracts traded through ICE came in at 6.0 million per day this week, bringing the 1Q16TD ADV to 5.8 million, +17% Y/Y and +22% Q/Q growth. ICE open interest this week tallied 66.7 million contracts, a +5% expansion versus the 63.7 million contracts open at the end of 4Q15, consistent with last week.
Monthly Historical View
Monthly activity levels give a broader perspective of exchange based trends. As volatility levels, measured by the VIX, MOVE, and FX Vol should rise to normal levels after the drastic compression this cycle, we expect all marketplaces to experience higher activity levels.
Sector Revenue Exposure
The exchange sector has broadly diversified its revenue exposure over 10 years as public entities with varying top line sensitivity to the enclosed trading volume data. The table below highlights how trading volumes will flow through the various operating models at NASDAQ, CME Group, ICE, and Virtu:
Please let us know of any questions,
Jonathan Casteleyn, CFA, CMT
Joshua Steiner, CFA
Takeaway: Central planners at the Fed, BOJ & ECB have consistently underestimated the challenges they face and overestimated tools in their arsenal.
This past Wednesday's Fed's FOMC announcement amounted to little more than a shoulder shrug. Apparently, the members will be...
"... monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook."
Thanks for coming out.
To be clear, today's U.S. GDP report was unequivocally awful. We're holding our breath in anticipation wondering what Yellen & Co. will have to say about it. Unfortunately, we'll likely have to wait until at least February 10th when Yellen testifies on Capitol Hill.
Meanwhile... outside these fifty states, central planners abroad are doing their best to screw things up too. Here's analysis from our Macro team on Japan in a note sent to subscribers this morning on the BOJ's decision to pursue a negative interest rate policy.
"News of the morning = Japan goes NIRP – and the Yen goes >120, 10Y JGB’s trade down to 0.09% (as in “nine” basis points) and along with the balance of global yields, U.S. 10Y treasury yields followed suite and are trading down -6bps to 1.91% as the yield curve (10’s-2’s) compresses to another new low.
Together with yesterday’s durable goods disaster, this morning’s slowing GDP report and more rumors of stimulus out of China the global #GrowthSlowing data remains conspicuous. Resurgent central bank interventionism is not a function of improving macro fundamentals. "
"The ECB’s Jens Weidmann (also President of the Bundesbank) warned fellow policy makers that the ECB should not go too far with the QE program, but will President Mario Draghi listen? We doubt it! Weidmann rightly points out that the ECB needs to lower its inflation forecast for 2016. A 2% target is after all a pipedream!"
... So back to our original question, "Do central planners have any credibility?"
In this excerpt from The Macro Show, Hedgeye Gaming Lodging & Leisure analyst Todd Jordan explains why you don’t want to be long his sector heading into a recession. Meanwhile, Hedgeye CEO Keith McCullough explains how investors should play our dour economic outlook.
Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.