“The World Must Unite”

-President Obama, 3/22/16


My son’s elementary school is one street over from my office. As updates on the Brussels attack flooded yesterday’s newsflow, a 5 minute chorus of gunshots came from the direction of the school.   


I grabbed my gun and headed over. Thankfully, the shots were coming from somewhere behind the playground. 


A false alarm close to home isn’t comparable to yesterday’s real-life tragedy. The incident, however, left me further despondent about our new actuality of risk but heartened that I wasn’t the only one who showed up at the school.


Someone was going to walk out of that building and it wasn’t going to be the wrong person.   


The ‘heightened risk’ message has been ubiquitous over the last year+ – to the point where it’s easy to tune out. 


But verbal posturing chased by indifference or inaction can’t be our model or legacy.  


Now is truly a time, not for passive or fearful “insouciance”, but for hardened acceptance of a new exigent reality.  


That’s not a political point and I’m talking less about the official government response or bureaucratic action than about the personal metamorphosis required for effectively operating within that new reality and its contingencies.


Less superficial manic reactionism, more durable proactivity. Empathy substituted for apathy, humanism for self-absorption. 


Back to the Global Macro Grind ….


40% of Fortune 500 companies in the United States were founded by immigrants or their children (The Economist (Here)).


From an economic perspective, “unity” and the efficient flow of capital (human and physical) remains the right recipe for innovation – particularly as the domestic economy becomes increasingly reliant on productivity improvements and immigration trends to drive growth.


Remember, at a most basic level, real GDP per person is a function of: “how much stuff each person can make” * “how many people are making stuff”


… and with the Boomer population bolus having made its way through the working age population and female entre into the workforce now a rearview phenomenon we’ve already cashed in our golden ticket with respect to growth in “how many people are making stuff”.


I wouldn’t call it a love-hate relationship necessarily, but I have mixed feelings about demographics.


On the one hand they are crawlingly glacial and incapable of backstopping a thesis over most investible durations. 


On the other hand, it’s hard to argue that knowing whether a particular industry’s demand demographic over the next decade is going to be +5% or -5% doesn’t matter or that the secular drivers of slower (growth) and lower (rates/inflation) for longer are practically inconsequential. 


In talking with clients – even macro-centric ones – it’s clear that immigration is a vastly underappreciated dynamic. 


Indeed, over the last four decades, net immigration has accounted for 30% of total population growth in the U.S. And because 2nd generation immigrants are counted as native born (and immigrants tend to have higher fertility rates, foreign born contribution to population growth is generally understated.


On the Housing side of Macro, we recently hosted a call with our new sector head of Demography, Neil Howe, titled: Get Ready For the Demographic “New Normal” In Housing. 


U-N-I-T-Y - housing cartoon 03.02.2016


Below is a selection of key takeaways (ping if you’d like access to the call or are interested in Neil’s research):

  • Big Picture | Fertility & Immigration: Fertility rates in both North and South America (a key driver of domestic immigration trends) are falling with significant consequences for domestic population growth. As the Chart of the Day below illustrates, Natural population growth is expected to trend toward 0% over the next 30 years with net immigration becoming an increasingly important growth driver. Declining fertility rates across Mexico and key source countries in Central/South American broadly suggest the past will not be prologue for the long-term forward trend in immigration.  
  • Gen X | The Lost (Housing) Generation: Homeownership and net wealth among Gen X’ers suffered the most during the Great Recession. A large number never formed households or became homeowners and many that did ended up in negative or near negative equity positions. Their disadvantaged position limits their capacity for “trading up” and will continue to weigh on housing turnover broadly. Whether this generation eventually transitions to ownership to the same extent as previous generations remains an open question.  
  • The Demand Sweet Spot | The millennial wave is currently driving rental demand and will support starter home demand over the next half decade+ and trade-up home demand in the following decade. Demand for “mid-life luxury” homes will see a drought as the baby bust generation reaches 50-64YOA. Boomers and the emergent trend towards aging in place will continue to drive a boon in remodeling over the next decade and accelerating demand for senior and assisted living units after that as the boomer bulge moves into their mid-80’s.


Elsewhere on the housing front, the WSJ reported yesterday (HERE) that the GSE’s (Fannie Mae and Freddie Mac) – after years of back & forth on the issue - are set to announce a principal forgiveness program for a select group of ~50K underwater homeowner’s. 


There were few details on the proposal but the program, as it was described, carries a couple of notables:

  • There are still 4.3 million borrowers with negative equity positions. No matter how theoretically justified the programs parameters, forgiving principal balances on just 50K of those will carry an air of arbitrariness/unfairness. 
  • Only forgiving balances for borrowers who have been delinquent is a slippery slope and probably sends the wrong message to the balance of underwater borrowers. 
  • In the unlikely scenario that every single one of these 50k homes came onto the market as a result, it would only increase inventory by 2-3% and do little to resolve the prevailing supply problem. 


On the fundamental side, we got the brick of a print we’ve been warning you about out of Existing Home Sales on Monday as closed transaction volume made a new 13-month low. 


Looking forward, we’re more interested in the Pending Homes Sales (PHS) data for February next Monday as it will give us the lead read on March Existing Home Sales. 


As it stands, PHS have decelerated for 9-months off the April 2015 rate-of-change peak and we continue to expect sales in the existing market to decelerate through 1H16 with a strong possibility for negative mid-single digit volume growth against peak PHS comps in April/May. 


Given the lagged relationship of home prices to volume (rate-of-change in home prices lag the rate-of-change in demand by 9-12 months) we expect HPI trends to flat-line and begin to roll as we move through 1H16, representing an addition fundamental headwind for housing related equities. 


Your analytics need not have gone through puberty to understand that slowing price + slowing volume is not a bullish fundamental factor set. 


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.85-2.01%


Nikkei 168

VIX 13.57-20.39
USD 94.59-96.69 
Oil (WTI) 35.40-42.90


Best of luck out there today, 


Christian B. Drake

U.S. Macro Analyst


U-N-I-T-Y - CoD Pop Growth

NKE | 52% Gross Margin… Anyone?

Takeaway: If there’s one callout from this Q, it’s the speed at which online is eclipsing traditional wholesale. Margin & EPS implications are massive

This Nike quarter was fairly predictable. EPS was spot on with our model, and the company’s guidance was consistantly bullish. The top line miss, however, is not something any 30x multiple stock can afford. We actually thought the weakness would come on the futures line, but that metric remains bullet proof for now. Keep in mind that historically, futures orders almost never roll over a quarter in advance of shipping product for the Olympics.  Importantly, the evolution – and acceleration – of the company’s Direct-to-Consumer model served as a punch in the jaw to bulls of the traditional athletic brick & mortar model. We outline these points below – seemingly ignoring some of the astounding call outs we’re seeing in Nike’s Global model. But this one is a game-changer if there ever was one.  We’re actually taking up our Gross Margin estimate to 52% by May20 – mind you that is leagues above what this company has ever tested before (on an apples-to-apples accounting basis to peers, this is closer to 58%). Our resulting EPS number is $4.73, which is nearly 30% above the consensus. Again, that’s huge for a company with the dominance, size, scale, cap and stability of Nike. What’s that worth? We hate picking multiples out of the air – so we won’t. Let’s simply use a 1.0 PEG, which is below what it’s trading at today. That’s a 25x p/e, a $120 stock – or $90 in 12-18 months.  Nike remains one of our top picks.   


NKE | 52% Gross Margin… Anyone? - 3 23 2016 NKE Earn Table


1) Lower Lows at Wholesale, Higher Highs for DTC. NKE NA biz grew 13% during the quarter. The incremental $429mm in revenue was essential evenly split between wholesale and retail, with DTC growing 25% fueled by e-comm  and wholesale up 9% against the easiest comp in the past 5 years (3% wholesale growth in 3Q15). If we look at it on a 2yr basis, eliminating all of the quarterly noise, we’ve seen a meaningful bifurcation in the underlying growth trend – not over the past three quarters, but past three years. If we hold the 2yr growth rate constant into 4Q16 we’re looking at negative growth for NA wholesale at -2%. A far cry from the 12% average we’ve seen over the past 20 quarters. But, that came at a time when Nike was taking its penetration inside its key wholesale partners to all-time highs – Nike sales inside of Foot Locker went from 60%-80% over that time period.

NKE | 52% Gross Margin… Anyone? - 3 23 NKE decelerating wholesale


2) Channel Growth Spread at New Peak. The growth spread (calculated by taking DTC growth minus Wholesale growth) accelerated to 16% in the quarter Nike reported last night. The chart itself paints a pretty clear picture on how Nike is turning the distribution paradigm on its head, but what we think is most important to point out is that we are seeing higher highs in the DTC growth rates as the business approaches $4bn in sales. Over the course of the next five years we expect Nike to blow away its $7bn e-commerce target with the majority of that growth coming in its home market. That means an incremental $5bn-$6bn in NA e-commerce off a base of ~$750mm today. That translates to a continued widening in the growth spread over the near and long term.

NKE | 52% Gross Margin… Anyone? - 3 23 NKE DTC growth spread


3) DTC Penetration is Accelerating – Off a Higher Base. DTC Penetration as a % of total sales accelerated meaningfully in the quarter on a TTM basis, up 75bps representing the largest growth rate we’ve ever seen sequentially at Nike NA. To add a little context, over the past five years NKE NA DTC has grown its penetration by 450bps. This one quarter amounted for nearly 20% of that growth. If we look at where Nike direct competes online, its at the top end of the distribution chain. Put another way its at the product level which drives ASP and traffic to the likes of Foot Locker, Finish Line, and Dick’s Sporting Goods. As Nike continues to push its DTC agenda, those dollars come directly from that tier of the market, while the mid-tier channel stays more or less isolated.

NKE | 52% Gross Margin… Anyone? - 3 23 NKE dtc penetration





Here’s our note from yesterday, specifically outlining some of the reasons why we like NKE long-term.



Takeaway: NKE might be the best long-term idea we can find, but there are some serious short-term factors that will cause big buying opportunities


Conclusion: We think that Nike is perhaps the best idea in retail as EPS more than doubles to nearly $5/shr, which is huge for a large cap name that is already operating at peak margins. The company should add $10bn in revenue over 4-years from e-commerce alone, which should take gross margins at least 5-points higher, past the 50% mark (a level most never thought achievable). But this transformation will also make its Futures model obsolete, and we think it’s a matter of time before it’s no longer reported to the Street. That won’t happen today. But we’ll inch closer as each quarter passes and earnings surprises on the upside, while the order book goes the other way. That’s going to create some fantastic buying opportunities. Though the Olympics and slightly better FX should help order levels and the company’s outlook, we’d rather wait for a point where there is some critical misunderstanding of the company’s growth and financials to make a ‘step in and buy before the event’ call. That does not exist today.



We like a lot more about Nike than we don’t, and the story is arguably more investable than ever. This company and story have become extremely complex, but the basic building blocks of what we like can be placed in the following buckets

a) Investing at a greater rate than ever in its product engine resulting in an arsenal that even its strongest competitors can’t replicate

b) Changing up the manufacturing paradigm for the first time in 40 years (initially what most of us know as FlyKnit – but this will change soon), which not only creates margin and working capital opportunities, but also gets Nike even closer to market (i.e. it will get 2-3 months out in an industry that is locked into a 5-6 month order window).

c) Dropping its attitude of deference and respect for the traditional footwear retailing channel, and getting the right product into the hands of the right consumers regardless of the poor growth and real estate decisions made by Nike’s traditional wholesale channel over the past 20 years.


Put these together, and we think that you’re looking at an incremental $10bn in sales at a 70% gross margin (vs $31bn in sales at a 47% margin today). When all is said and done, we think that gets you to almost $5 in EPS in four years versus the $1.85 it earned last year. Yes, earnings should more than double in 4-years for a large cap name with stable growth, a bullet proof balance sheet ($3/sh in cash), 75%+ share in some of its core businesses, dominant positioning in a global duopoly, and a structural advantage that could potentially never be overcome (i.e. what Google has over Yahoo).  Does it make sense to us that Nike is trading at an all time high price and multiple? Of course it does. But that doesn’t mean it’s expensive – at least for someone that follows our train of thought.


Now, please allow me to talk out of the risk management side of my mouth. This name might look ridiculously expensive for a person with a very short (TRADE) duration, who is only looking in the rear-view. They’ll see peak margins, a peak 30x multiple, and a futures growth rate (THE key stock driver) that has been running at a double digit rate for the past 10 quarters with a risk to reversion to a longer-term mean of 7-9%. Tack on short interest that is running at just 1.1% of the float (basically nonexistent), and the simplest roll in futures could send this name tumbling.


Two considerations

  • The first is that the Olympics this summer will definitely boost Nike’s order book. Now…if the futures rate STILL rolls over despite the Olympics, then Houston has a problem. Unlikely. But a strong consideration.
  • Second is that if we’re right, which we obviously think we are, then we’re going to see more than half of growth come from DTC channels – as we saw last quarter when Nike proved to be its own biggest growth engine for the first time in history. But think about it…If we see a $50 wholesale order that used to show up on the order book (futures) all of a sudden turn into a $100 fully consolidated sale through Nike DTC (online, retail), then we’ll have sales, margins and earnings going higher, but futures going lower. This is critical, as when this trend hits critical mass, we’re likely to see Nike start to consistently beat earnings and cash flow, but miss on an increasingly arbitrary statistic known as Futures.


The question then is when will PWC recommend to Nike that they stop reporting futures altogether. We think that is a near mathematical certainty. But, will Nike do so during a quarter when they are crushing it on every metric – including futures? Or will it happen in response to an otherwise ugly futures number that is the result of the wholesalers (like FL) tapping out on their ability to order more product because that part of the business is in a decline?  Nike always talks about playing offense. Let’s see if they do it right this time. We’re not worried about a change happening with tonight’s print. But a change should definitely be in the works.


Until then, this is a name for long term investors to buy on red as futures numbers revert. 

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

Cartoon of the Day: American Gothic II

Cartoon of the Day: American Gothic II - Fed Up cartoon 03.22.2016


As Hedgeye CEO Keith McCullough has repeatedly reiterated, what the Fed's quantitative easing actually did was "pay the few and crushed the many."

Trump's Presidential Pivot & An Early Look At Tonight's Voting

Below is a brief excerpt from Potomac Research Group Chief Political Strategist JT Taylor's Morning Bullets sent to institutional clients each morning.



Trump's Presidential Pivot & An Early Look At Tonight's Voting - bernie hillary


Republicans are voting today in both AZ and UT, with divergent results expected in the two neighboring states. Politically polarized AZ should be considered safe ground for Donald Trump, where his hard-line stance on immigration is bread and butter to the state's conservative crowd, but Ted Cruz has a superior organization and it's a closed primary which work to his favor. The real test is whether Cruz can capture over 50% of the vote in UT -- winning over Mormons who loathe Trump as well as all 40 delegates -- and not ceding too much ground to the frontrunner. 


Bernie Sanders and Hillary Clinton will also be competing in AZ and UT, as well as in ID. Sanders' best shots are in UT and ID, where a whiter demographic and caucus-style primaries have been working in his favor, but Sanders has spent much more time and money trying to overcome Clinton's advantage in much more diverse AZ. In a sign of confidence (or arrogance?) Clinton detoured to Washington to address the AIPAC conference and continues her focus on the general election.



Trump's Presidential Pivot & An Early Look At Tonight's Voting - trump pic


All eyes were back on Trump at yesterday's AIPAC conference as he shared the stage with Clinton, Cruz and John Kasich. Trump ditched his off-script speaking style and shifted to a prepared -- and more substantive -- speech reading from a teleprompter for the first time since his announcement last June and refuting Clinton's claims of indecision when it comes to his views on Israel. The softer-toned speech by Trump as well as an editorial board meeting at the Washington Post, a press conference at the Trump Hotel and a meeting with the a number of key Republican Senators and Congressmen have all the makings of pivot with the intent of quelling the concerns of the establishment in its backyard.  Or maybe he came down with Potomac fever. Let's see how long this lasts... 



Majority Leader McConnell ruled out consideration and confirmation of Judge Garland under a President-elect Clinton scenario during a lame duck session of Congress this fall, but we still believe that his hand may be forced. Democrats are looking to keep the spotlight on the vacancy at every turn -- with Veep Biden set to deliver a speech calling out Republicans later this week. We're hearing that Trump also plans to weigh in with his list of potential SCOTUS nominees soon -- potentially capping off a week where the frontrunner looks to shed his bombastic rhetoric and display a more even-keeled, disciplined and...presidential tone.

[UNLOCKED] Fund Flow Survey | Something Has To Give

Takeaway: Re-risking continued in high yield this week with a +$1.6 billion subscription, the third straight week of rebound.

Editor's Note: This is a complimentary research note originally published March 17, 2016 by our Financials team. If you would like more info on how you can access our institutional research please email

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Investment Company Institute Mutual Fund Data and ETF Money Flow:


Re-risking continued in high yield this week with a +$1.6 billion subscription, the third straight week of rebound which has tallied +$6.6 billion. Either U.S. high yield is a great buy currently still sitting at depressed levels or U.S. equities should be put out for sale. Historically there is a close directional relationship between stocks and non-investment grade bonds and with the substantial divergence which has unfolded since 2013, something has to give. Below we plot, U.S. high yield fund flows (orange line) which are still in a downtrend within a 5 week moving average, the high yield ETF, the JNK (in green), and the S&P 500 in magenta.


[UNLOCKED] Fund Flow Survey | Something Has To Give - Some thing has to give large



In the 5-day period ending March 9th, total equity ETFs and mutual funds experienced a +$5.1 billion inflow, the equity category's largest inflow so far in 2016. The total equity subscription was mostly comprised of +$3.6 billion to equity ETFs with investors depositing +$1.7 billion to international equity mutual funds. Domestic equity funds continue to bleed out however with -$235 million reigned in by investors.


[UNLOCKED] Fund Flow Survey | Something Has To Give - ICI19


In the most recent 5-day period ending March 9th, total equity mutual funds put up net inflows of +$1.5 billion, outpacing the year-to-date weekly average outflow of -$123 million and the 2015 average outflow of -$1.6 billion.


Fixed income mutual funds put up net inflows of +$5.9 billion, outpacing the year-to-date weekly average inflow of +$380 million and the 2015 average outflow of -$475 million.


Equity ETFs had net subscriptions of +$3.6 billion, outpacing the year-to-date weekly average outflow of -$3.2 billion and the 2015 average inflow of +$2.8 billion. Fixed income ETFs had net inflows of +$1.7 billion, trailing the year-to-date weekly average inflow of +$2.3 billion but outpacing 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:


[UNLOCKED] Fund Flow Survey | Something Has To Give - ICI2


[UNLOCKED] Fund Flow Survey | Something Has To Give - ICI3


[UNLOCKED] Fund Flow Survey | Something Has To Give - ICI4


[UNLOCKED] Fund Flow Survey | Something Has To Give - ICI5


[UNLOCKED] Fund Flow Survey | Something Has To Give - 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.


[UNLOCKED] Fund Flow Survey | Something Has To Give - ICI12


[UNLOCKED] Fund Flow Survey | Something Has To Give - ICI13


[UNLOCKED] Fund Flow Survey | Something Has To Give - ICI14


[UNLOCKED] Fund Flow Survey | Something Has To Give - ICI15


[UNLOCKED] Fund Flow Survey | Something Has To Give - 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:


[UNLOCKED] Fund Flow Survey | Something Has To Give - ICI7


[UNLOCKED] Fund Flow Survey | Something Has To Give - ICI8

Sector and Asset Class Weekly ETF and Year-to-Date Results: In sector SPDR callouts, investors contributed +4% or +$396 million to the consumer staples XLP ETF.


[UNLOCKED] Fund Flow Survey | Something Has To Give - 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.


[UNLOCKED] Fund Flow Survey | Something Has To Give - ICI17


[UNLOCKED] Fund Flow Survey | Something Has To Give - ICI18

Net Results:

The net of total equity mutual fund and ETF flows against total bond mutual fund and ETF flows totaled a negative -$2.5 billion spread for the week (+$5.1 billion of total equity inflow net of the +$7.6 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 -$34 million (negative numbers imply more positive money flow to bonds for the week) 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.)


[UNLOCKED] Fund Flow Survey | Something Has To Give - ICI10


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:


[UNLOCKED] Fund Flow Survey | Something Has To Give - ICI11 


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