McCullough: The Beginning of the End


In this brief excerpt from The Macro Show this morning, Hedgeye CEO Keith McCullough discusses the latest “Viagra” monetary policy moment and why central planners’ days are numbered.


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Behold The Impotent ECB Viagra

Takeaway: The Central Market Planning #BeliefSystem is breaking down.


The ECB popped its latest Viagra pill this morning in a desperate attempt to stimulate Europe's flacid economy. Markets didn't buy it and did the exact opposite of what central planners intended.


In other words...


The euro soared and equity markets are falling.


A brief recap of the ECB announcement:

  • The ECB cut its main interest rate to 0% from 0.05%
  • The deposit rate was trimmed from -0.3% to -0.4%
  • Quantitative easing purchases increased to €80 billion per month, from €60 billion, and was expanded to include corporate bonds
  • Marginal lending rate is now 0.25% from 0.3%

What happened in macro markets following the policy announcement is even more important. European equities rallied, at first, with Italy up as much as 2%, following ECB head Draghi's press conference.


Then, it all came apart and equities fell. 


Here's European equities before (10 am ET): 

Behold The Impotent ECB Viagra - europe viagra moment


... And after (11:30 AM):

Behold The Impotent ECB Viagra - wei equities


Meanwhile, as Draghi was laying out the ECB stimulus measures, the Euro tumbled 1.4% versus the U.S. dollar (i.e. Draghi's intent) but then completely reversed. As of now, the Euro/USD is up 1.3%.


Here's what that looked like this morning:

Behold The Impotent ECB Viagra - eurusd chart draghi


Macro markets are wising up and clearly questioning the potency of central-planning policy tools. Note: The ECB cut its outlook for growth and inflation:



Key takeaways? 


"Why not ask yourself if this is the beginning of the end – of the grand central-market-plan," Hedgeye CEO Keith McCullough wrote on 2/23 in a recent Early Look entitled "Big Bank Theory." McCullough continues:


"My Big Bang Theory for the #CurrencyWar (one of the Top 3 Themes in our Macro deck right now) is as follows:

  1. Japan is no longer able to convince markets that it can burn its currency at the stake on command
  2. Japan’s Yen starts to rise, and Japanese stocks start to crash
  3. Europe then fails to convince consensus of the same
  4. Euro goes up (instead of down) on Draghi’s next central-market-planning day (March 10)
  5. European and US stocks resume their current crashes and go straight down

I know, I know. It’s just a theory. But it’s what I would call one that has a probability that is rising, not falling, in rate-of-change terms."



So here's what you really need to know:


ECB Delivers!

Draghi to the rescue?!  The ECB cut the Main Refinancing Rate 5bps to 0.00%, cut the Deposit Rate 10bps to -0.40%, and cut the Marginal Lending Facility by 5bps to 0.30%. It also increased the “drugs” through its asset purchasing program (QE), now delivering €80 billion/month of purchases (from €60 billion prior) and expanding its purchasing mandate to bonds of non-bank corporations (specifically investment grade financial companies).


And the markets rejoiced!  European indices bounced +2 to +3% and the EUR/USD first fell (~ -1.5%) on the annoucement but has currently rallied +1.1% in line with our Big Bang Theory call that today’s ECB QE announcement would perversely strengthen the common currency.


Is all good under the Eurozone hood?  Far from! Our call of #EuropeSlowing remains firmly planted. Below we show our proprietary Eurozone GIP (growth, inflation, policy) model, charting our outlook for the coming quarters –the Eurozone finds itself in the ugly Quad 4 equating to growth slowing as inflation decelerates.


It therefore came as no surprise that the ECB’s staff downgraded the region’s growth and inflation projections vs its prior projections in December of last year:

  • Eurozone GDP Projections at 1.4% Y/Y in 2016 (vs December projection of 1.7%), 1.7% in 2017 (vs 1.9% prior) and 1.8% in 2018
  • Eurozone CPI Projections at 0.1% Y/Y in 2016 (vs December projection of 1.0% in Sept), 1.3% in 2017 (vs 1.6% prior) and 1.6% in 2018.

ECB Delivers! - EUROZONE


As we discussed in Friday’s note titled Top 7 Reasons Why the ECB Will Act on March 10th, we do not see Draghi (nor other global central bankers) arresting Economic Gravity with policy like QE and rates at and below the zero bound. To us, Draghi’s belief that his policy tool kit is a “transmission mechanisms” to the real economy is a pipe dream.


In this light, Keith coined the term Big Bang Theory, to underline that after 600 rate cuts globally, there’s a new regime of investors that has given up on the belief that central bankers can artificially produce stimulus and weaken their currency for economic benefit.  This policy hasn’t worked in Japan, and it isn’t going to work in the Eurozone.


Euro strength!  Specifically heading into today’s meeting we signaled that Draghi’s “simulative measures” would strengthen the EUR/USD rather than weaken the common currency, and suggested trading the band of $1.08 to $1.12. #PlayBook


How long will Draghi’s policy QE juice last?  All we know is that we don’t want to be on the merry-go-round when the music stops, and will continue to outline our risk tolerance and risk ranges across European securities. Feel free to email us if there are specific tickers you’d like levels for. 


ECB Delivers! - neu. EUR

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 80.46%
  • SHORT SIGNALS 78.35%

Initial Claims | Pushing the Limit

Takeaway: Claims have held steady recently, but there is a time limit on the labor cycle.

Initial Claims | Pushing the Limit - deflation cartoon 03.07.2016


The labor market continues to hang in there. Last week, seasonally adjusted initial claims came in at 259k, a 19k week-over-week decrease, prior to revision. This brings the 4-wk moving average to 267.5k (a 2.5k w/w decline), which is low by any objective measure. While labor conditions in Energy states have shown notable deterioration, the country as a whole has offset those pockets of discreet weakness.


While we may sound a bit like a broken record on this point, we still think it bears worth repeating that the cycle is late stage. The chart below shows that there has historically been a time limit on how long the labor market can run this hot. The chart shows that in the last three cycles, claims have run below 330k for 24, 45, and 31 months before recession set in. The current sub-330k run just entered month 25. That puts us one month past the minimum, 8 months from the 33-month average, and 20 months from the 1990s record-setting expansion.


Initial Claims | Pushing the Limit - Claims17 2


The following three charts show that the labor market in energy states has been deteriorating versus the rest of the country due to protracted weakness in energy prices.


Initial Claims | Pushing the Limit - Claims12


Initial Claims | Pushing the Limit - Claims13


Initial Claims | Pushing the Limit - Claims14

The Data

Prior to revision, initial jobless claims fell 19k to 259k from 278k WoW, as the prior week's number was revised down by -1k to 277k.


The headline (unrevised) number shows claims were lower by 18k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -2.5k WoW to 267.5k.


The 4-week rolling average of NSA claims, another way of evaluating the data, was -11.4% lower YoY, which is a sequential improvement versus the previous week's YoY change of -11.2%


Initial Claims | Pushing the Limit - Claims2


Initial Claims | Pushing the Limit - Claims3


Initial Claims | Pushing the Limit - Claims4


Initial Claims | Pushing the Limit - Claims5


Initial Claims | Pushing the Limit - Claims6


Initial Claims | Pushing the Limit - Claims7


Initial Claims | Pushing the Limit - Claims8


Initial Claims | Pushing the Limit - Claims9


Initial Claims | Pushing the Limit - Claims10


Initial Claims | Pushing the Limit - Claims11


Initial Claims | Pushing the Limit - Claims19

Yield Spreads

The 2-10 spread rose 1 basis points WoW to 99 bps. 1Q16TD, the 2-10 spread is averaging 109 bps, which is lower by -27 bps relative to 4Q15.


Initial Claims | Pushing the Limit - Claims15


Initial Claims | Pushing the Limit - Claims16



Joshua Steiner, CFA


Jonathan Casteleyn, CFA, CMT



Takeaway: Lazard (LAZ) still has extremely bullish sentiment according to our quantitative screen of Financials.

This morning we're flagging Lazard (LAZ - 91) as a short on sentiment. It is the highest ranked stock in the broker/asset manager category. Additionally, we hosted a best ideas black book call on January 12 on why the M&A environment and LAZ's AUM exposure to emerging markets makes the stock an interesting short. Please refer to our LAZ call replay and presentation materials for more information.


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

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.

Daily Trading Ranges

20 Proprietary Risk Ranges

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