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Christman: The Real Reason Russian Fighter Jets Flew Dangerously Close To USS Donald Cook

Takeaway: Expect more Russian "Top Gun" behavior in the months ahead.

Editor's Note: Below is a complimentary research note written by Hedgeye colleague and Potomac Research Group National Security analyst LTG Dan Christman USA Ret. In the note, Christman analyzes "what was largely overlooked" in the media's coverage of Russian fighter jets' "Tom Cruise-like antics" while recently flying "dangerously close" to a U.S. destroyer in the Baltic Sea.


Click below to watch the footage.


Russian fighter-jet antics over the last 10 days -- buzzing dangerously close to an Aegis-class US destroyer and barrel-rolling over an American high-tech reconnaissance aircraft -- begs the question, "Why?"


Ian Bremmer of the Eurasia Group wrote shortly after the events that, discounting the muscle flexing, the intent was principally intelligence gathering: the U.S. destroyer Donald Cook had recently received an upgrade to add the highly sophisticated "Aegis" phased-array radar suite, which has anti-ballistic missile as well as anti-air and anti-cruise missile capability. The Russians were hoping the destroyer would turn on at least part of its defensive radar package, to allow Russian electronic intercepts. That probably occurred, at least with some of the Cook's radars, given the flight profile of the Russian jets.


What was largely overlooked in the media's emphasis on the Tom Cruise-like antics of the Russia fighter jets, however, was the slow-flying Russian helicopter which loitered near the ship, undoubtedly taking high-resolution pictures of the Aegis weapon system for later intelligence evaluation


None of this is particularly new in terms of muscle flexing and intelligence gathering, "Soviet-style;" actions like these were very common through the '80's, despite the signing in 1972 of the U.S.-USSR "Incidents at Sea" agreement.   


In this case, Vladimir Putin's finger prints are obvious; the Russia leader has yet to meet a security cooperation agreement with the West that he likes. With his economy continuing to contract in 2016 as Russian banks close by the dozens, Putin has every incentive to provoke an incident with the U.S. It's to the credit of the Donald Cook's crew that they didn't take the bait. 


But there is more than intelligence gathering at play. The eastern reaches of the Baltic Sea and the Baltic states themselves, for Soviet-era apologists like Putin, are Russia's back yard. They have never accepted Baltic state independence, and the incorporation of the three Baltic countries into NATO's Article V guarantees grates especially. In this light, the "muscle flexing" that really matters is geo-strategic. 


For well over a year, robust Russian ground exercises, submarine activity, and aerial overflights in the Baltic region have alarmed NATO's military; SACEUR General Breedlove has been especially vocal in calling for a U.S. and NATO response. The Donald Cook's steaming by Kaliningrad is part of a long-delayed US reaction to the Russian year-long push in the north; the Russians last week told us what they thought of that.  


But there is an additional twist: NATO must decide shortly, in advance of its July summit in Warsaw, whether to follow a U.S. and Breedlove lead to plus-up its ground forces with heavy armor and then continuously rotate these into northern Poland and the Baltics. It's no surprise that opinion is sharply split within NATO on the wisdom of doing this; it's also no surprise that the Russian information campaign is working overtime to deepen these divisions. 


The Tom Cruise-like antics last week should hence also be viewed as part of this larger strategic game: a none-too-subtle reminder by Moscow to NATO, and to NATO members opposing a ground force plus-up especially, what could happen if force enhancements proceed; all this in a part of Europe where Russia insists on exercising strategic influence.


Bottom line: expect more Russian "Top Gun" behavior in the months ahead. And hope that the U.S. exercises leadership to maintain the NATO alliance unity that Putin is determined to undermine.

WAB | Release Not Very Useful, But One Thing Stands Out (First Look)

Wabtec’s earnings release is generally not helpful for understanding the quarter.  For example, the topline is not particularly helpful without the backlog numbers.  How gross margin increased on negative mix and a sales decline is also unclear – were accruals reversed, pre-production costs capitalized, unsustainable inventory builds that lowered unit costs, or the like at play?  Last quarter, traders were crushed by relying on the initial release, and this release similarly lacks critical data.


One item of note, however, is that with year-on-year declines in sales and net income, Wabtec is no longer a growth company and may fail to meet the criteria for some growth funds.  This is a key step in the growth to value transition we continue to anticipate for WAB shares. Growth investors are unlikely to rely on financial engineering like debt funded buybacks in establishing investment criteria.  If that take is right, we would look for growth holders to have shares on offer following today’s sales miss.


Unfortunately, we won’t be able to understand WAB’s results without the rapid-fire earnings call disclosures and the 10-Q.  

Earnings & Expectations - Key Call-Outs (Peak Forward Multiples)

The Materials sector, and the S&P 500 as a whole, is going on its third consecutive quarter of negative Y/Y earnings growth, and forward expectations have been taken down (obviously on a lag). With the sector now trading at peak forward multiples, below we ask the question, are forward-looking earnings expectations now too beaten-down, or is the current peak multiple a sign to be cautious of prospective returns? We would argue the latter.


*Note*: The S&P 500 GICS Materials Index only has 27 companies, so we’ll take a deeper look at expectations and different multiples for a larger sample next week in our monthly “Sector Sentiment Run” slide deck.

  • Earnings Growth: With Materials sector earnings down -18% this reporting season to date (after printing -18% in Q4 2015), Q1 2016 would mark the 3rd consecutive quarter of negative Y/Y earnings growth (see chart below).
  • Case for Peak Multiples: Without question earnings expectations have been revised materially for the obvious reasons, especially in resource-driven sectors. Every sub-sector beat bottom line expectations in Q4 despite the fact that earnings declined -18% (the same level we are currently tracking for Q1 2016). With the 2-month move in Materials stocks, does the market have it right? – The sector is trading at cycle peak forward multiples. 
  • Earnings & Expectations: Earnings growth beat estimates by 16.9% in Q4 2015 despite declining -17.9%. However, every sub-sector beat top-line estimates in Q4. This trend has continued for Q1 2016. So are earnings expectations too low, or is earnings manufacturing by corporations at unprecedented levels? Either way, the sector is trading at a peak multiple 7 years into a bull market, which in reality could be a much higher on a comparative basis, and we question the catalyst to take the market to much higher multiples without a correction. Again, we’ll look at this next week with a larger sample of companies.


Earnings & Expectations - Key Call-Outs (Peak Forward Multiples) - PE Chart


Earnings & Expectations - Key Call-Outs (Peak Forward Multiples) - Q1 COmps


Earnings & Expectations - Key Call-Outs (Peak Forward Multiples) - Q4 15 Comps



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 80.48%
  • SHORT SIGNALS 78.35%

RTA Live: April 26, 2016


Cartoon of the Day: Earnings Jack-In-The-Box

Cartoon of the Day: Earnings Jack-In-The-Box - earnings cartoon 04.25.2016


"If the economic (GDP falling to 1%) and profit cycle (SP500 Earnings currently -8.1% year-over-year with 130/500 companies reporting) data wasn’t so bad, those begging for Dovish (Fed) Dollar Devaluation wouldn’t believe in buying commodities/stocks here either," Hedgeye CEO Keith McCullough wrote in today's Early Look.

CHART OF THE DAY: What Happens When The #BeliefSystem Breaks Down In US?

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.


"... Perversely, if the #BeliefSystem starts to break down here in the USA, Gold is going to be an intermediate-term loser in that. Those who are begging Yellen to devalue will have to cover US Dollar shorts and sell both their Oil and Gold futures contracts."


CHART OF THE DAY: What Happens When The #BeliefSystem Breaks Down In US? - 04.26.16 Chart

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