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RH | What We Don't See That Matters

Takeaway: Last 'Brand Destructive' promo email sent 2/16 @ RH. Changing m.o. to set up next leg of growth from $2bn to $4bn.

There’s a lot happening this morning in the markets, but what interests us is what’s NOT happening.  Specifically, we’re witnessing (often without seeing) the change in RH’s promotional cadence play out.

 

The company noted with its 2/24 preannouncement that it would be moving away from promotions towards a membership model – which we think will be formally rolled out  within two weeks. But what happened just prior to the 2/24 announcement was the elimination of any and all promotional emails.

 

In fact, the last one was sent out on 2/16, and was arguably just as ‘Brand Destructive’ as the ones that came before it. In 3-years covering RH (the RH as it exists today) we’ve grown used to investors routinely talk about the latest promotional email from the company, and question why they exist for a brand that is supposedly so much higher-end.  Those emails were sent not only every day, but multiple times each day to tens of millions of consumers – most of whom will likely never spend a dime at RH.

 

RH | What We Don't See That Matters - 3 10 2016  RH promo email chg2

 

Three things have changed, however.

1) The first is size. Having an aggressive strategy where you need to blanket new consumers with spam on a) new products, and b) old products that need to be sold – might be appropriate when a company is maybe $500mm in sales (as RH once was). But it’s certainly not appropriate for a company that is $2bn in revenue looking to double in size through a higher end consumer base.

 

2) The second thing that changed is that selling online in this space stopped being as big of a competitive advantage about two years ago – at least how we look at it. Think about it…even Pier 1 went from 4% of sales online to about 20% in that time. Even aside from Home Furnishings competitors, most consumers’ in-boxes are absolutely riddled with product and promotional emails from every retailer/site they had the misfortune of registering with online…as well as the obscure retailers who paid-up for those (and your) email. The punchline is that the average consumer received about 10 emails per day three years ago from companies marketing products and services, but they receive 30 today.

 

3) Mobile has become a deterrent. About 90% of marketers now say that email is their primary channel for ‘lead generation’. But five years ago, mobile accounted for only 8% of marketing email opens. Today that number is 55%. Think about it…there’s a better than 50% chance that you’re reading this on a mobile device. I may be typing this on a mac with a 30” monitor, but it almost certainly looks less appealing when being consumed. Furniture takes this a step further. Why do you think that RH started presenting its quarterly earnings in a video format? Because it is an extremely visual part of retail, and they can appropriately show the vision on a big screen.  That might look good on a large desktop or a smart TV. But it looks ‘above average’ on a regular laptop, and downright horrible on a 4” mobile device.

 

The punchline is that RH is changing the way it markets its product not just because business is weak and it had a problem delivering on Modern. But because it’s what the company needs to do in order to double the size of the company. The m.o. of the past economic cycle will certainly not take it through the next one. In fairness, RH was ready to roll this new strategy out roughly 18 months ago, but our sense is that it had such great momentum that it did not want to risk disrupting. Now, the time is right. It might be painful. In fact, it will almost certainly be painful. But do you think that just maybe a $38 stock and 25% downward earnings revision already knows this?

 

We can’t stand the uncertainty around another gap downwardward if numbers come down again with the guide later this month. But we maintain that our recession-case EPS estimate is $2.50, which we think puts the stock near $30. On the upside, we definitely, positively, absolutely think $10 in earnings is in play. Pick any multiple you want – the stock is many times where it is today.


CHART OF THE DAY: The Leading Indicator For Bank Stocks Is Falling

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.

 

"... Oh, and by the way, “Financials” earnings got slammed BEFORE A) the recent crash in rates and B) the commensurate compression in one of the core leading indicators for “Bank Earnings” – The Yield Spread.

 

The spread between the 10yr US Treasury Yield and the 2yr is testing new cycle lows at 98 basis points wide. It’s a leading indicator for bank stocks because it’s a proxy for what they call Net Interest Margin (NIM)."

 

CHART OF THE DAY: The Leading Indicator For Bank Stocks Is Falling - Yield Spread CoD


Complex Games

“Thanks to their ability to invent fiction, sapiens create more and more complex games.”

-Harari

 

That’s a big bridge between biology and human history. It’s both #behavioral and a summary point at the end of a chapter in Sapiens (by Yuval Noah Harari) titled The Tree of Knowledge. Good thinkers book. I’m enjoying it.

 

I’ve also enjoyed spending the week in the great state of Texas (my crystal ball had me book dates in Austin, Dallas, and Houston for the epic short squeeze in US listed Oil & Gas stocks).

 

West Texas Crude Oil is not only +10% in the last week, it’s +37% in the last month! No, I didn’t nail that. But, thankfully, I didn’t get nailed by it either. There is going to be a fantastic short-selling opportunity in levered Oil names again, hopefully a little higher.

 

Complex Games - fossil fuel cartoon 01.27.2016

 

Back to the Global Macro Grind

 

Fortuitously we took both Oil and Oil related indexes (XOP, XLE) off our Best Ideas in the Macro Themes deck on January 5th and replaced them with Utilities (XLU) on the long side and Financials (XLF) on the short side.

 

While plenty of our best SELL ideas (bottom up stock picks from my analysts) have been squeezed here in the 1st week of March, our best Macro Equity Sector Ideas have acted just fine:

 

  1. Utilities (XLU) were up another +0.5% yesterday to +11.0% YTD
  2. Financials (XLF) were down another -0.1% (in an up tape) to -7.9% YTD

 

That said, in Real-Time Alerts (shorter term signaling product) yesterday, I signaled that I wanted to cover some Financials and Housing related short ideas with me really having no idea what the market could do on today’s central-market-planning (ECB) event.

 

This morning I don’t want to get into the complexity of the Game of Slowing and how central planners (ECB this morning – BOJ and Fed next week) fundamentally believe that they can bend and/or smooth economic and profit cycles. I’d rather just wait and watch.

 

By the time this Early Look hits your inbox I may very well have an entirely different “market call” as we’ll have “new news” (or not) that the #BeliefSystem is or isn’t breaking down. How much longer will players in this complex game believe fiction?

 

Embrace uncertainty.

 

Even though many publicly traded US companies do not report earnings on a GAAP (Generally Accepted Accounting Principles) basis anymore, one thing I can tell you with certainty this morning is that Draghi and Yellen cannot Ctrl+PRINT Sales & Earnings growth.

 

With 494 out of 500 companies in the S&P 500 having reported their recent quarter (many non-GAAP):

 

  1. Aggregate SALES growth slowed to -4.0% year-over-year
  2. Aggregate EARNINGS growth slowed to -7.5% year-over-year
  3. With Consumer Staples squeaking out a +0.8% y/y EPS gain, only 4 of 10 Sectors have positive EPS growth
  4. Yes, Energy and Materials have y/y EPS declines of -73% and -18%, respectively
  5. But our favorite Sector on the short side (Financials) had a -9.4% year-over-year decline

 

Sure, you can dial-a-sell-side-strategist who’s been “backing out Energy” for the last 6-9 months, but how many of these characters proactively predicted that during a “rate hike” that Financials would be the biggest rate of change loser in their narrative?

 

Reminder: there are 90 companies in the S&P 500 that are categorized as “Financials”, whereas there are only 40 companies that are currently classified as “Energy.”

 

Oh, and by the way, “Financials” earnings got slammed BEFORE A) the recent crash in rates and B) the commensurate compression in one of the core leading indicators for “Bank Earnings” – The Yield Spread.

 

The spread between the 10yr US Treasury Yield and the 2yr is testing new cycle lows at 98 basis points wide. It’s a leading indicator for bank stocks because it’s a proxy for what they call Net Interest Margin (NIM).

 

The wider the Yield Spread, the wider bank profit margins. The narrower the spread, the faster bank earnings slow.

 

This brings us all the way back to the #BeliefSystem. What can the ECB’s Mario Draghi or the Fed’s Janet Yellen do other than “cut rates” and, in doing so, impose further pressure on long-term rates and bank earnings?

 

We’ll have to see, won’t we…

 

But it appears that this complex game of storytelling is reaching the beginning of the end more so than the end of the beginning.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.69-1.95%

SPX 1

DAX 9

VIX 15.88-22.66
EUR/USD 1.08-1.11
Oil (WTI) 30.89-38.99

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Complex Games - Yield Spread CoD


Early Look

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Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

Oil, Euro and the DAX

Client Talking Points

OIL

There is nothing quiet about this short-squeeze in oil (up another +4.6% yesterday and +37% in the last month alone for WTI; still -24% year-over-year). The immediate-term risk range for WTI has widened out to $30.89-38.99 with @Hedgeye TAIL risk resistance = $46.11.

EURO

Down small to $1.09 EUR/USD ahead of ECB President Mario Draghi’s attempt to walk on water. The immediate-term risk range is $1.08-1.11; hedge fund bets are all over the place on what happens here today – we say embrace the uncertainty and read & react.

DAX

The DAX is doing nothing into the event, but don’t forget that it’s still in crash mode (-22% from last year’s high) so any Japanese style break-down in the belief system that central planning can ramp asset prices higher is a real risk.

 

*Tune into The Macro Show with Hedgeye CEO Keith McCullough at 9:00AM ET - CLICK HERE

Asset Allocation

CASH 67% US EQUITIES 0%
INTL EQUITIES 0% COMMODITIES 4%
FIXED INCOME 25% INTL CURRENCIES 4%

Top Long Ideas

Company Ticker Sector Duration
XLU

If you were long energy over utilities last week, nice trade! We'd remind you that Utilities (XLU) are outperforming the S&P 500 by +10% year-to-date. And that’s with the bounce. By contrast, Energy (XLE) was up 6.5% on the week but is up only 1% year-to-date.

GIS

General Mills (GIS) faces some headwinds across their portfolio, and although the 1H of FY16 was a challenge, the company has robust merchandising and consumer plans in the 2H that should improve results.

 

GIS has embarked on a mission to drive their top 450 SKUs, which represent 75-85% of their volume. Calling it their ‘Power 450’, surprisingly these 450 SKUs aren’t even in all retail locations and formats, broadening the distribution footprint of these top SKUs is priority number one for GIS’s sales team. The organization is also looking at the bottom 450, representing 1-2% of volume and making critical decisions on what products can be discontinued.

 

We continue to believe GIS is one of the best positioned consumer packaged foods companies due to its strong brands and best-in-class people and organization.

TLT

We can’t emphasize enough the bigger picture from both a data and top-down market signaling perspective. To contextualize the relief rallies and short squeezes in asset classes and instruments that are counter to our more longer-term view. Here’s what how we think the macro environment plays out from here:

  1. The market is positioned for more rate hikes into 2016
  2. The data continues to deteriorate, and market volatility ensues
  3. The expectation that “all is good” comes off the table and the market increasingly pivots to the view that, throughout 2016, the Fed is going to hike rates in methodical fashion straight into an economic slowdown
  4. The market takes in the growth slowing pivot in real-time (Treasury rates and the dollar both move lower, and inflation-leveraged assets like gold catch a bid)

 

Once the policy catalysts are out of the way in the next few weeks, our expectation is a return to outperformance in growth slowing asset classes (TLT and XLU). If you’re in for the TAIL and the TREND call, focus on the data, not the desperate attempts of central planners to arrest economic gravity. A brief reminder: ECB chief Mario Draghi will attempt to walk on water today.

Three for the Road

TWEET OF THE DAY

NEW VIDEO | The Very Real Possibility Of A Contested #GOP Convention https://app.hedgeye.com/insights/49638-washington-on-wall-street-the-very-real-possibility-of-a-contested-go… @KeithMcCullough

@Hedgeye

QUOTE OF THE DAY

When you win, nothing hurts.

Joe Namath

STAT OF THE DAY

The cost of companies losing valuable people can be as high as $188 billion per year.  


The Macro Show Replay | March 10, 2016

CLICK HERE to access the associated slides.

 

An audio-only replay is available here.

 


ICI Fund Flow Survey | Comping the Tantrum

Takeaway: High yield bond funds took in $3.6 billion in new funds last week, the best 5 days since the Taper Tantrum of '13.

Investment Company Institute Mutual Fund Data and ETF Money Flow:

In the 5-day period ending March 2nd, high yield bond funds took in $3.6 billion, the second consecutive week of subscriptions after a 10 week drawdown where over -$28 billion was redeemed from the category. The substantial high yield subscription last week was the best 5 day period for high yield bond funds since July 24th, 2013 where in the middle of the Taper Tantrum, investors drew the line and stepped in to buy $5.1 billion in non-investment grade credit in the 29th week of that year. We caution for optimism however as an across cycle view, using a 5 week moving average, continues to relay the down trend for non-investment grade bonds. Below we outline the 5-week moving average of ICI's new high yield bond category against the price of crude oil which is still driving consternation for investors despite a slight bear market rally in oil.

 

ICI Fund Flow Survey | Comping the Tantrum - taper

 

Muni bonds and bond ETFs continue to be the real story in fixed income land with tax free issues taking in +$934 million, their 22nd consecutive week of subscriptions now totaling over $20 billion. Passive fixed income ETFs are also seeing substantial demand with another +$2.7 billion take this week, their 11th consecutive weekly inflow aggregating to +$24.3 billion.

 

Lastly, cash is king again according to ICI with money funds taking in +$26 billion in the past 5 days, a combination of risk aversion and tax season receipts. Year-over-year however, 2016 has now aggregated to a running total of +$44.8 billion having moved into money funds versus the -$60.1 billion drawdown that money funds experienced in the first 9 weeks of 2015. This cash moving back to the sidelines supports our Best Ideas long rating on Federated Investors (FII).


ICI Fund Flow Survey | Comping the Tantrum - ICI1

 

In the most recent 5-day period ending March 2nd, total equity mutual funds put up net inflows of +$45 million, outpacing the year-to-date weekly average outflow of -$301 million and the 2015 average outflow of -$1.6 billion.

 

Fixed income mutual funds put up net inflows of +$4.1 billion, outpacing the year-to-date weekly average outflow of -$238 million and the 2015 average outflow of -$475 million.

 

Equity ETFs had net redemptions of -$44 million, outpacing the year-to-date weekly average outflow of -$4.0 billion but trailing the 2015 average inflow of +$2.8 billion. Fixed income ETFs had net inflows of +$2.7 billion, outpacing the year-to-date weekly average inflow of +$2.4 billion and the 2015 average inflow of +$1.0 billion.

 

Mutual fund flow data is collected weekly from the Investment Company Institute (ICI) and represents a survey of 95% of the investment management industry's mutual fund assets. Mutual fund data largely reflects the actions of retail investors. Exchange traded fund (ETF) information is extracted from Bloomberg and is matched to the same weekly reporting schedule as the ICI mutual fund data. According to industry leader Blackrock (BLK), U.S. ETF participation is 60% institutional investors and 40% retail investors.



Most Recent 12 Week Flow in Millions by Mutual Fund Product: Chart data is the most recent 12 weeks from the ICI mutual fund survey and includes the weekly average for 2015 and the weekly year-to-date average for 2016:

 

ICI Fund Flow Survey | Comping the Tantrum - ICI2

 

ICI Fund Flow Survey | Comping the Tantrum - ICI3

 

ICI Fund Flow Survey | Comping the Tantrum - ICI4

 

ICI Fund Flow Survey | Comping the Tantrum - ICI5

 

ICI Fund Flow Survey | Comping the Tantrum - ICI6



Cumulative Annual Flow in Millions by Mutual Fund Product: Chart data is the cumulative fund flow from the ICI mutual fund survey for each year starting with 2008.

 

ICI Fund Flow Survey | Comping the Tantrum - ICI12

 

ICI Fund Flow Survey | Comping the Tantrum - ICI13

 

ICI Fund Flow Survey | Comping the Tantrum - ICI14

 

ICI Fund Flow Survey | Comping the Tantrum - ICI15

 

ICI Fund Flow Survey | Comping the Tantrum - ICI16



Most Recent 12 Week Flow within Equity and Fixed Income Exchange Traded Funds: Chart data is the most recent 12 weeks from Bloomberg's ETF database (matched to the Wednesday to Wednesday reporting format of the ICI), the weekly average for 2015, and the weekly year-to-date average for 2016. In the third table are the results of the weekly flows into and out of the major market and sector SPDRs:

 

ICI Fund Flow Survey | Comping the Tantrum - ICI7

 

ICI Fund Flow Survey | Comping the Tantrum - ICI8



Sector and Asset Class Weekly ETF and Year-to-Date Results: In sector SPDR callouts, investors contributed +$1.1 billion or +4% to the SPDR Gold ETF and +$283 million or +5% to the industrials XLI ETF.

 

ICI Fund Flow Survey | Comping the Tantrum - ICI9



Cumulative Annual Flow in Millions within Equity and Fixed Income Exchange Traded Funds: Chart data is the cumulative fund flow from Bloomberg's ETF database for each year starting with 2013.

 

ICI Fund Flow Survey | Comping the Tantrum - ICI17

 

ICI Fund Flow Survey | Comping the Tantrum - ICI18



Net Results:

The net of total equity mutual fund and ETF flows against total bond mutual fund and ETF flows totaled a negative -$6.8 billion spread for the week (+$1 million of total equity inflow net of the +$6.8 billion inflow to fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52-week moving average is +$130 million (more positive money flow to equities) with a 52-week high of +$20.5 billion (more positive money flow to equities) and a 52-week low of -$19.0 billion (negative numbers imply more positive money flow to bonds for the week.)

  

ICI Fund Flow Survey | Comping the Tantrum - ICI10

 


Exposures:
The weekly data herein is important for the public asset managers with trends in mutual funds and ETFs impacting the companies with the following estimated revenue impact:

 

ICI Fund Flow Survey | Comping the Tantrum - ICI11 



Jonathan Casteleyn, CFA, CMT 

 

 

 

Joshua Steiner, CFA







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