All Koch'd Up!

“Going negative is daring but appropriate monetary policy”

-Narayana Kocherlakota


We don’t operate in a silo @Hedegeye and we don’t claim to have a monopoly on good ideas. 


As proof, sometime circa 2010, we introduced our proprietary Hedgeye Orb rating scale. 


Back then – and before we got all stuffy and corporate - the blue orb was our calling card of sorts and we used the scale to infrequently rate non-Hedgeye generated analysis, central banker prowess, effective use of South Park and 90’s hip hop references, cheesy Canada jokes and so on.


If you’re unfamiliar, a 1-orb rating conveys inaccuracy, unoriginality, negative alpha and/or overall  lameness. In contrast, the coveted & rarified 4-orb rating is issued for the conveyance of thoughtfulness, originality, &/or general non-consensus ballsiness.


With central bankers back-tracking, equities on the brink and credit & Fx markets balking, let’s bring back the truth serum orb for a guest appearance: 


  • $7T in negatively yielding debt globally: 1-orb, totally lame
  • Central Banks, globally, announcing (again) more or what hasn’t worked ….. on groundhog day:  1.5 orbs (+0.5 orbs for amusingly ironic timing)
  • Gundlach’s use of the “mission accomplished” banner as a metaphor for the fed rate hike (the allusion being to George W. Bush on the Aircraft carrier and the pre-mature and retrospectively misguided victory lap): Original & Accurate: 3-orbs  

All Koch'd Up! - Abenomics cartoon 02.10.2016


Back to the Global Negative Rate Grind …..


Kocherlakota – outgoing Minneapolis Fed President/FOMC member and widely suspected owner of the infamous negative blue dot in the Fed’s September Dot Plot – has been chirping Team Janet from the bleachers from the minute he left the field. 


Now with …


  • Inflation expectations making lower lows (5Y Breakevens = 0.94% last, lowest since May 2009) … and the trend similar across the major sovereigns
  • 10Y Yields:  Down another -5pbs this morning to  1.61% (lowest since the 2012 all-time lows)
  • Yield Spread (10’s-2’s):  98bps last and breaching 1.0% to the downside for the 1st time since 2007
  • U.S. High Yield Yields and Spreads making higher highs
  • Investment grade spreads making higher highs
  • High Yield Energy Debt making higher highs (yielding 20.21% as of yesterday’s higher high)
  • Lending Standards tightening and domestic Loan Demand falling  (latest Senior Loan Officer Survey)
  • Eurodollar futures are now pricing the probability of negative rates in the U.S. by 2017 at 17% (up from 2% at the start of the year)


And with futures red and global equity & energy commodity markets continuing in crash mode overnight, the carnage score is currently (% chg off of 52wk high):


  • Brazil: -31.1%
  • China: -46.6%
  • France: -25.5%
  • Germany: -28.9%
  • Greece: -54.9%
  • India: -23.6%
  • Italy: -33.9%
  • Japan: -25%
  • Russia: -38.6%
  • Spain: -33.7%
  • USA (Russell 2k): -25.7%


…. Collectively, the active policy maker contingent, is now getting Koch’d up: 


  • Fischer:  “[Negative Rates] its been better than we thought … working more than I can say I expected”
  • Bernanke:  “it’s a go to” …“I think negative rates are something the Fed will and probably should consider if the situation arises,”
  • Dudley: “if the economy were to unexpectedly weaken dramatically, and we decided that we needed to use a full array of monetary policy tools to provide stimulus, it’s something that we would contemplate as a potential action,"
  • Fed (2016 Bank Stress test):  “include negative yields on short-term rates in your stress test” (1st time including this) and  …. "This scenario does not represent a forecast of the Federal Reserve,"  
  • Yellen (yesterday):  “We will look at it, and should look at it”


Conventional thinking has held that 0% on nominal rates represented the lower bound, mostly because nominal returns on cash aren’t <0%.  Theoretically true …. until you add the costs to store institutional sized levels of cash, insure it, protect it ,etc.  


You don’t have $7T in negative yielding debt because everything is awesome and you don’t field a chorus of “will you go negative?” questions when the data is conspicuously supporting a hawkish lean. 


Janet held the policy normalization line in her testimony yesterday but for a Fed pre-occupied with ‘communication tooling’ and pro-actively leading markets via carefully crafted rhetorical gradualism, that seems like a lot of verbal table setting  


Switching gears, Initial Jobless Claims and Retail Sales (Jan data) will round out this week’s domestic macro data flow. 


Jobless Claims:  At 285K, rolling initial claims are at their highest point since April of last year and we’re coming up on the anniversary of the trough level in claims recorded last year - meaning that the best they can do going forward is not get any worse.   Think of it as if it was a company at full earnings power/potential and the best it could do is not see earnings decline going forward.  What would that be worth … or what macro multiple would you put on that setup?


Retail Sales:  The further decline in gas prices in January will weigh on the headline (recall, Retail Sales represents spending on Goods and are reported in nominal dollars) while the +1.4% MoM rise in auto sales (autos = ~21% of total) will serve as a positive offset.  Further, base effects (i.e. a positive comp setup) stemming from the severe weather in the Dec-Feb period last year will provide a modest support to reported growth.  More broadly, the trend in Retail Sales growth remains one of deceleration.  In fact, growth has been slowing steadily since 2011 as demographics, urbanization, “collaborative” and “conspicuous” consumption and the end of the LT interest rate cycle have all driven spending towards services and experience (a topic for another Early Look).


In short, this week’s fundamental data will not be the #GrowthSlowing foil the Fed is stalking. 


Yesterday, my 5-yr old son won a jiu-jitsu tournament as the youngest kid in his class - then, an hour later, his 3-yr old sister made him tear-up and tap out:  4-orbs


Economic gravity has markets and policy makers in an arm-bar.  With volatility in bullish formation, risk ranges open on the downside and confidence in central planning breaking down, the capitulatory tap-out probably hasn’t been realized yet. 


As the saying goes, “Everyone has a plan until they get punched in the face...” 


Our (7-month old) plan = Don’t get punched in the face ... Long Bonds and bond proxies remains the rope-a-dope strategy


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.57-1.85%

RUT 940-995

Nikkei 159

VIX 23.02-28.98

EUR/USD 1.07-1.14
Oil (WTI) 25.83-30.27


Good luck out there today.


Christian B. Drake

U.S. Macro Analyst


All Koch'd Up! - inflation expectations

WAB | Anxious, Are We?

Takeaway:  Wabtec’s repurchase seems to reflect anxiety about its sagging share price.  Perhaps the Faiveley family is getting antsy about their discount to public holders. For long-term holders who liked the old Wabtec strategy, we do not see how a change in capital allocation is a positive signal. 



Choking on Good Burgundy


There are a few odd and noteworthy aspects of the buyback announced today.  First, it is utterly uncharacteristic for WAB.  Wabtec has had an acquisition driven growth strategy, and the 4Q15 buyback is much larger than the cumulative net buybacks over the last decade.  It is a major change in capital allocation, and one may limit post-Faiveley acquisition flexibility.  


Second, with the Faiveley deal closing expected at some point in 2016, cash is precious.  As we see it, WAB will need to come up with about $1 billion to close, with about $200 million of that currently in escrow.  The $365 million spent on the repurchase might have been put to better use, limiting the amount of debt that would be needed to fund the transaction. 


Finally, Faiveley’s public holders can elect Euro 100 per share, while the family is stuck taking 75% of their compensation in a fixed 1.125 ratio of WAB equity that has devalued since the deal was announced.  The family would be selling shares at – depending where one marks a WAB three-year mandatory convertible preferred of dubious liquidity – a 25% to 30% discount to public holders.  Is the Faiveley family finding that a bit hard to swallow, and perhaps pushing for revised terms?



Some Other Questions

  • Why change the capital allocation strategy?  The share price was at 4Q15 average levels through most of 2014 without a large buyback, so it is unlikely that management was attracted to the exceptional value.
  • Is the buyback a signal that business is great, and management wants to demonstrate confidence?  That seems a pretty clear, ‘no’.  We know that US Freight Rail equipment is going into storage, orders for new equipment are down, and that the international freight market is not robust. Backlogged orders may support activity in early 2016, but we do not believe that Wabtec management is highly optimistic about their market outlook.
  • Does WAB just want to add additional leverage, not recognizing that this is likely the peak of the rail capital spending cycle?  We hope so.  In fairness, Wabtec has probably been underleveraged; that will change with the buyback & Faiveley merger.
  • Did the company want a lower share count to improve headline EPS guidance? Perhaps, but the market has not responded well to simplistic financial engineering of late.
  • Did the Faiveley family press the company to do something about its sagging share price?  That doesn’t seem out of the question.  If you were the Faiveley family, would you want to receive less than the public holders?


We may be asking the wrong question, but Wabtec management seemed to want a higher share price in the fourth quarter.  For long-term holders who liked the old Wabtec strategy, we do not see how a change in capital allocation strategy is a good signal.

REPLAY: Healthcare Updates You Can’t Afford To Miss & Live Q&A

Our Healthcare team, Tom Tobin and Andrew Freedman, was back in the studio today at 12:15pm ET for another Healthcare Q&A with an opportunity for you to ask your questions live.


They had key updates on a wide range of companies they cover, including HCA Holdings (HCA), AMN Healthcare Services (AHS), Athenahealth (ATHN), Mednax (MD), Medidata Solutions (MDSO), Zimmer Biomet (ZBH), and Hologic (HOLX).



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Cartoon of the Day: Rising Or Setting?

Cartoon of the Day: Rising Or Setting? - Abenomics cartoon 02.10.2016


"What happens when they move to infinity-bailout (Bank of Japan) and the market no longer trusts them?" Hedgeye CEO Keith McCullough wrote earlier today in a note to subscribers. "Japan's Prime Minister Shinzo Abe was forced to say 'I trust BOJ Governor Kuroda' overnight as neither the FX nor Nikkei does (the Yen hit new year-to-date high = Nikkei down another -2.3%)."

JT Taylor: Trump Trounces, Kasich & Bush Surge & Clinton Flounders

Takeaway: Key takeaways from the New Hampshire primary.

Editor's Note: Below is a brief excerpt from Potomac Research Group Senior Analyst JT Taylor's Morning Bullets sent to institutional clients each morning. 


JT Taylor: Trump Trounces, Kasich & Bush Surge & Clinton Flounders - trump 55


On the heels of criticism that his lack of campaign infrastructure in Iowa led to his loss to Ted Cruz, Donald Trump didn't take any chances in NH. He ramped up his organization in just a 10-day stretch to augment his strong polling numbers -- with volunteers making over 30,000 calls a day and maximizing GOTV efforts. Just think if he'd had all this in place before Iowa... Expect Trump to bring in more ground forces into South Carolina where he faces a well-organized Jeb Bush and an electorate that's partial to Cruz.  


JT Taylor: Trump Trounces, Kasich & Bush Surge & Clinton Flounders - jeb


Seems like just yesterday (ahem) that media pundits were speculating that some of the top-tier candidates would have to consider dropping out after NH. Not so fast. John Kasich's strong second place finish will infuse badly needed resources into his campaign, and Bush's resurgence will inject much-needed confidence into his. Kasich will need to quickly capitalize on his momentum and improve his 1% standing in SC, but we don't see a path forward for him.  Bush needs to place big in both SC and Nevada in his renewed fight to win the establishment lane.


JT Taylor: Trump Trounces, Kasich & Bush Surge & Clinton Flounders - sanders


There was never a doubt that the Bern would win NH, he's been leading Hillary Clinton by 15-20 points since last fall. We're not even that surprised by the margin, but by the fact that she couldn't close the gap despite winning the state in 2008, a full court press this past week, and inability to make inroads in any of the key demographics. Sanders' numbers across the board were stunning and one stands out more than the others -- he won over women by 11% and commanded 83% of 18-29 years olds.


Clinton will do what stumbling campaigns almost always do -- call for an overhaul.  But we don't think her campaign needs to hit the reset button. She does. It's her lack of a clear message and conviction -- and as a result Sanders is tapping into the constituencies that should naturally be hers. The demographics in the next two states and Super Tuesday favor her with a more diverse electorate and a ground game that has been in the place since early 2015. But Sanders isn't going away any time soon. More money will flow his way and he will look to dent her March strategy, where 56% of delegates are up for grabs.


Takeaway: Today we're flagging Toll Brothers (TOL) on the short side due its extremely bullish sentiment (Score: 90).

Our top-down view on the US Housing market changed from bullish to bearish at the start of the year and we think the high end is likely to soften materially in 1H16. At the other end of the housing spectrum is KB Home (KBH) at a bombed out sentiment score of 10. Though left for dead, we think the news will continue to get worse over the intermediate term so we'd hold off for now. That said, given the score, it's not a name where we'd be pressing the short right here. 


We are publishing our updated Hedgeye Financials Sentiment Scoreboard in conjunction with the release of the latest short interest data last night. Our Scoreboard now evaluates over 300 companies across the Financials complex.


The Scoreboard combines buyside and sell-side sentiment measures. It standardizes those measures to an index of 0-100, where 100 is the best possible sentiment ranking and 0 is the worst. Our analysis shows that a contrarian strategy can be employed successfully by taking the other side of stocks with extreme readings in sentiment, either bullish or bearish. Once sentiment reaches these extreme levels, it becomes a very asymmetric setup wherein expectations become too high or too low.  


We’ve quantified the tipping points for high and low sentiment. Specifically, we've found that scores of 20 or lower have a positive, average expected return while scores of 90 or greater are more likely to underperform.


Specifically, our backtest of 10,400 observations over a 10-year period found that stocks with scores of 0-10 went on to produce an average absolute return of +23.9% over the following 12-month period. Scores of 10-20 produced an average absolute return of +11.9%. At the other end of the spectrum, stocks with sentiment scores of 90-100 produced average negative absolute returns of -10.3% over the following 12-months.


The first table below breaks the 300 companies into a few major categories and ranks all the components on a relative basis. The second table breaks the group into smaller subsectors and again gives them relative rankings within those subsectors. 








The following is an excerpt from our 90 page black book entitled “Betting Against the Herd: Generating Alpha From Sentiment Extremes Across Financials.”


Let us know if you would like to receive a copy of our black book, which explains this system and its applications.


BUYS / LONGS: Financials with extremely low sentiment readings of 20 and below on our index (0-100) show strong average outperformance in absolute and relative terms across 3, 6 and 12 month subsequent durations.  Stocks with sentiment ratings of 20 or lower rise an average of +15.1% over the next 12 months in absolute terms.   


SELLS / SHORTS: Financials with extremely high sentiment readings of 90 and above on our proprietary sentiment index (0-100) demonstrate a marked tendency to underperform in absolute and relative terms across 3, 6 and 12 month subsequent durations.  Stocks with sentiment ratings of 90 or greater fall in value an average of -10.3% over the next 12 months in absolute terms. 






Joshua Steiner, CFA


Jonathan Casteleyn, CFA, CMT

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