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CHART OF THE DAY: Breaking Down The Cycle's Toughest Earnings Growth Comps

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.


"... And that’s really the point on raising Cash. I have no problem buying stocks when they are on sale. But when they are at the top-end of my current SP500 risk range (2049-2116) AND the latest bull case is one of the easiest yet to refute, I get out.


As you can see in today’s Chart of The Day (slide 35 in our Q2 Macro Themes Deck) the toughest comps (comparative period) for #LateCycle Sector Earnings Growth is the 2nd quarter. That’s because Q2 of 2015 was the peak."


CHART OF THE DAY: Breaking Down The Cycle's Toughest Earnings Growth Comps - 06.07.16 Chart

Changes vs. Levels

“People think about life in terms of changes, not levels.”

-Richard Thaler


That’s a great Behavioral Economics quote from Richard Thaler in an excellent chapter of Misbehaving that he called Value Theory. “They can be changes from the status quo or changes from what was expected, but whatever form they take it is changes that make us happy or miserable.”


In that same chapter, Thaler shows what most rate-of-change macro analysts will recognize as an S-curve. Yes, “people like gains… but they hate losses more…” and that’s a critical lesson every portfolio manager should learn earlier in his or her career than later.


“Kahneman and Tversky recognized that we had to change our focus from levels of wealth to changes in wealth. This may sound like a subtle tweak but switching the focus to changes as opposed to levels is a radical move” (pg 30).


Changes vs. Levels - Bull goes... 07.11.2014


Back to the Global Macro Grind


The further you get from academia (and the closer you get to how real money is managed), the faster you’ll realize that using linear econ/valuation models generally don’t work. If you can get ahead of a rate of change move however, you might generate alpha.


No, generating alpha (or excess returns on capital) in any industry that is oversupplied (like the money management business has become) is not easy. That’s why we have to constantly evaluate and evolve our #process. As the game changes, we should.


But at what point do we start trying to change what it is that we do for the sake of very short-term change in market prices that we were not positioned for? Do we capitulate? Do we chase?


I’m on the road in Baltimore, Pittsburgh, and Minneapolis this week and I can guarantee you that in a significant percentage of my meetings at least one person will say “but the market is back to flat.”


Then, as I’m accustomed to answering with a question, I’ll say “what market do you mean, the SP500?” Because, of course, macro markets (stocks, bonds, currencies, etc.) have been far from flat as markets started pricing in #TheCycle going back to late 2014.


Sure, you can just sit there at your desk and complain that “this market won’t go down”…


Or you can be long the things that have actually gone up. Amidst crashes and draw-downs in asset classes around the world, the 1yr return (June to June) in the Long Bond has been double digits.


So, from a rate of change perspective, with the US 10yr at 1.73%, SP500 at 2109, and CRB Index at 192, where to from here? What’s going to be the best place to avoid losses?


  1. CASH – yep, good ole fashioned world reserve currency style – I say the US Dollar


Nope, from these macro market prices (now that Gold and Utilities are +15-17% YTD), there really isn’t anything that beats raising CASH for this pending period of the employment, consumption, and #ProfitCycle slowing.


Slowing? I thought the Old Wall said the call that they didn’t make (before earnings slowed) is done slowing?


Yep, if I don’t hear that 3x per day on the road for the next 3 days, I will be shocked. You see, the way this works is that the sell-side’s perma bull strategists do the rounds too. And I spend a fair amount of time auditing their ever-changing reasons to “buy stocks.”


And that’s really the point on raising Cash. I have no problem buying stocks when they are on sale. But when they are at the top-end of my current SP500 risk range (2049-2116) AND the latest bull case is one of the easiest yet to refute, I get out.


As you can see in today’s Chart of The Day (slide 35 in our Q2 Macro Themes Deck) the toughest comps (comparative period) for #LateCycle Sector Earnings Growth is the 2nd quarter. That’s because Q2 of 2015 was the peak.


No, I’m not talking about Energy and Industrials (which, by the way, we don’t see consensus “backing out” of the “but the market is flat” comment do we?)….


I’m talking about the mainline of the US economy: Consumption, Employment, Financials, Healthcare, Tech, etc. And oh is that going to look slow, in rate of change terms, by the time late summer hits (Q2 reports).


At a level, do I care? Sure, but only if the rate of change in profit growth goes positive. No macro man worth his #timestamped t-shirt makes BUY/SELL calls based on a “valuation” model.


“Ex-Energy” (lol), we’re about to see the biggest rate of change slow-down (year-over-year) of #TheCycle. Give this macro market a few months to noodle over that and we’ll see if I was right to raise Cash in June.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.69-1.81%

SPX 2049-2116
RUT 1115-1183

VIX 12.99-16.84
USD 93.62-95.48
Oil (WTI) 47.36-49.99

Gold 1


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Changes vs. Levels - 06.07.16 Chart

JT TAYLOR: Capital Brief

Takeaway: Hillary the Historic, Bernie's California Dream; the Other Republican Agenda

JT TAYLOR:  Capital Brief - JT   Potomac banner 2

HILLARY THE HISTORIC: Hillary Clinton has secured enough delegates to claim the Democratic presidential nomination and is poised to become the first female candidate to lead a major party to the White House in U.S. history.  A handful of super delegates pushed Clinton over the finish line of 2,383 ahead of a jampacked day full of primaries. Clinton will call for the  Democrats to unify behind her candidacy as primary season comes to an end today – and she and party leaders expect Bernie Sanders to follow suit. To pad her lead, look for her to pick up a sizeable chunk of delegates in the six states voting today; her campaign hopes that being declared the presumptive nominee 24 hours before CA votes doesn’t suppress turnout and handing a victory to Sanders.


BERNIE’S CALIFORNIA DREAM: Now that Clinton has been declared the presumptive Democratic nominee, this leaves Sanders with a hard decision to make – accept it or fight until the death. Sure, a win in CA would help him pitch his future to superdelegates - but to what end? Sanders’ case is broken - Clinton won a majority of the states, pledged delegates and super delegates - not to mention tens of  thousands of more votes. We think that despite Sanders’ reputation for obstinance, he’ll turn the corner once he realizes the only thing he can do between now and the convention in late July is hobble Clinton and her ability to get a head start on outmaneuvering Donald Trump, not to mention damage the party’s increasing chances at making gains in Congress.


No matter what happens in today’s primary, with Democrats adding 2.3 million voters to their ranks in the past four months, CA has become increasingly blue and will be an insurmountable challenge for Trump come November.


THE OTHER REPUBLICAN AGENDA: Speaker Ryan will release the first installment of a six point Republican agenda – “A Better Way” – presenting different types of conservative policies the Republican party will implement if they take the White House. To make it work - Republicans need a compromise with Donald Trump. Disagreements between establishment Republicans and Trump continue to flare and so far establishment Republicans have taken a back seat – but with a plan in place – look for their voices to trump the party’s standard-bearer.


GARY’S GAINS: Libertarian presidential nominee Gary Johnson may not have solidified a serious position in the election race yet, but he’s sure on his way – he’s currently polling at 10 percent and gaining ground. Senator Ben Sasse (NE) – who was long considered as a potential third-party nominee – may be hopping on team Johnson. While Trump continues to double down on his hijinks and as Johnson begins to pick up big endorsements and earns media coverage - he’ll climb in the polls – something he needs to happen to be included in the general election debates.


FRENCH FRIED: David French stepped out of the limelight almost as fast as he came into it. Bill Kristol’s choice for an independent third party challenger confirmed he will withdraw his name from consideration for president. No surprise here as the third-party position has been filled by Johnson, the Libertarian.


FICKLE FED: Fed head Janet Yellen expressed concern about the jobs market, while reiterating that the Fed is data dependent - stocks popped on the news. In the past six months, the Fed pivoted from Hawkish (in December) to Dovish (March/April) to Hawkish (May). Market consensus now perceives Yellen and the Fed as flipping back to Dovish in June. Yellen’s favorite economic indicator (the “Labor Market Conditions Index”) just hit a 7-year low. U.S. #GrowthSlowing. So, what’s an investor to do? The Fed is perpetuating volatility in macro markets, so stick with what’s worked all year, Long Bonds (TLT). For the record, our most vocal call has been TLT – it’s up around 9% YTD versus 3% for the S&P 500.


NEUSTAR: NATIONAL SECURITY POLITICAL FIGHT: Our Telecommunications-Media Policy Analyst Paul Glenchur gave us his insight on Neustar’s continued fight to retain the lucrative local number portability contract “Neustar: National Security Political Fight


BREXIT: SHOULD I STAY OR SHOULD I GO?: Join us for a call this Wednesday with Alexander Nicoll, a consulting member of the UK-based International Institute for Strategic Studies, as he discusses the events leading up to the UK vote and what the outcome of the vote spells for the UK and EU. Please email us for dial-in information

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Checking in w/ Asia, LatAm and EEMEA

Let’s face it, with several Fed heads publically opining on U.S. monetary policy on a seemingly hourly basis, it’s easy for all of us to get caught up in naval gazing at the SPY’s reaction to said commentary. As such, we thought you’d find the following country-level summaries helpful to expanding upon your global investment motif. As always, feel free to email us to the extent you’d like to dig deeper into a specific country or topic.



In China, growth continues to slow per the advent of the MAY PMI data, while headline risk surrounding China’s increasingly clogged credit channel continues to grow with the latest batch of stories highlighting rising refinancing risk facing China’s overcapacitied sectors. As highlighted in our recent work and most recently reiterated by PBoC assistant governor Ying Yong, the PBoC is likely to remain prudent with respect to monetary policy implementation (click HERE and HERE to review). All told, we reiterate our negative bias on China.


Checking in w/ Asia, LatAm and EEMEA - China


In Japan, the composite PMI data was marginally better in MAY, but growth continues to come in decidedly mixed per the MAY vehicle sales and APR real wage data. The BoJ meets on June 15-16 and we think the probability is high that they expand monetary easing amid political and economic pressure to do so. All told, we reiterate our negative bias on Japan, which is down another -2.9% WoW (Nikkei 225 Index) amid the +3.3% rip in the JPY vis-à-vis the USD.


Checking in w/ Asia, LatAm and EEMEA - Japan


In India, the composite PMI data was sharply worse in MAY, confirming the growth slowdown we’ve been forecasting for Q2. All told, we reiterate our negative bias on India amid a likely multi-quarter trend of #Quad3 stagflation.


Checking in w/ Asia, LatAm and EEMEA - India


In Australia, both growth and inflation are moving in the right direction per the advent of the latest data highlighted by the APR retail sales print and MAY services PMI reading. The resilience of the Australian economy in the context of the China slowdown and commodity bust continues to confound many investors, including myself. Said resilience speaks volumes to the outstanding job the RBA has done managing the economy amid global economic headwinds and domestic political turmoil. That said, however, the OECD is out warning of an Australia property bubble crash, which is the inevitable other side of all the easy money Australia has seen in recent years. We don’t currently have an investment bias on Australia, but our financials team is readying a deep dive on the Aussie banks that is sure to wash out quite negative from an intermediate-to-long-term perspective. Email us for access.


Checking in w/ Asia, LatAm and EEMEA - Australia


In Thailand, growth and inflation are moving in the wrong direction per the MAY PMI and CPI data. We’ve had a positive bias on Thailand (THD +4.4% since our 3/16 EM presentation), but now consider it time to relinquish that bias in favor of other investment opportunities.


Checking in w/ Asia, LatAm and EEMEA - Thailand


In Malaysia, both growth and politics have inflected in the right direction (for now) per the advent of the APR trade data and news that opposition infighting threatens to give Prime Minister Razak’s ruling coalition UNMO an even bigger majority after two bi-elections this month. We don’t have an explicit bias on Malaysia, but are inclined to be negative given the country’s poor score on our proprietary EM Crisis Risk Index.


Checking in w/ Asia, LatAm and EEMEA - Malaysia


Singapore and Hong Kong offer stealth positive read-throughs for the global growth outlook with the advent of their MAY PMI data, which ticked up to 50.1 (from 49.8) and 47.2 (from 49.3), respectively.


Checking in w/ Asia, LatAm and EEMEA - Singapore


Checking in w/ Asia, LatAm and EEMEA - Hong Kong


In Brazil, the good news is that real GDP growth posted a sequential acceleration in Q1 for the first time since 2Q14. The bad news is that it’s still down -5.4% YoY and, worse, the MAY manufacturing and composite PMI data slowed to new lows of 37.3 and 38.3, respectively. We reiterate our negative bias on Brazil and continue to believe the economic and political situation there is likely to get worse before it gets better.


Checking in w/ Asia, LatAm and EEMEA - Brazil


In Mexico, the MAY PMI data came in rock solid across the board, but is rather inconsistent with trends across the preponderance of key high-frequency growth data. All told, we reiterate our negative bias on Mexico and see Mexican exports and employment growth at risk of a further slowdown in U.S. consumer spending growth. Perhaps the MXN (down -4.2% MoM vs. the USD) is already sniffing that out.


Checking in w/ Asia, LatAm and EEMEA - Mexico


In Colombia, real GDP slowed fairly meaningfully in Q1, while inflation ticked up across the board in MAY. This may or may not have prompted marginally dovish comments out of the central bank with respect to the outlook for the benchmark policy rate, which itself has been hiked +150bps in the YTD. Despite this shift, we continue to find it prudent to reiterate our bearish bias on Colombia and expect the COP to come under pressure amid the removal of policy support.


Checking in w/ Asia, LatAm and EEMEA - Colombia


In Peru, the presidential election has entered a state of “too-close-to-call” with former finance minister Pedro Pablo Kuczynski holding a slender lead over incumbent Keiko Fujimori 50.3% vs. 49.7% with 93% of the votes counted. Both candidates have pledged massive infrastructure initiatives, though Kuczynski’s pledge appears to be triple that of Fujimori ($6B to $2B) at face value, which would imply a more positive reaction in the markets to the extent his [slim] lead is confirmed. We do not have an investment bias on Peru at the current juncture.


Checking in w/ Asia, LatAm and EEMEA - Peru


In Russia, the MAY composite PMI data moderated slightly while inflation – particularly core inflation – continued its trend lower. The confluence of these factors should perpetuate monetary easing expectations on the margin and we’re seeing that reflected in 1Y OIS spreads (-10bps narrower WoW; -50bps MoM). Still, the RUB remains structurally depressed on a REER basis, which should keep the central bank at bay. We do not have an investment bias on Russia at the current juncture, but continue to see it as a safer way to play lasting commodity reflation relative to Brazil.


Checking in w/ Asia, LatAm and EEMEA - Russia


In Turkey, the MAY manufacturing PMI and inflation data is confirmatory of #Quad1-esque trends across the preponderance of key high-frequency data. Moreover, the sequential downtick in core CPI is perpetuating renewed expectations of monetary easing and those expectations are being aggressively priced into Turkish rates markets (1Y OIS spreads -46bps narrower WoW; 2Y yields down -21bps WoW; 10Y yields down -55bps WoW). Both the BI100 and TRY are responding favorably to these economic developments (up +2.1% and +2.5%, respectively, over the past 3W), but we don’t consider such moves sustainable in the context of political consternation, steepening base effects for GDP and receding base effects for CPI. All told, we do not have an investment bias on Turkey at the current juncture, but are inclined to be negative given the aforementioned dynamics.


Checking in w/ Asia, LatAm and EEMEA - Turkey


In South Africa, the MAY composite PMI data was at odds with the MAY manufacturing PMI data which plunged to 51.9 (from 54.9) and the MAY vehicle sales data, which plunged -10.3% YoY. This juxtaposition highlights the decisively mixed nature of key high-frequency growth data in South Africa. What is not mixed is how well the country has performed amid persistent commodity reflation (50% of South Africa’s exports are commodities, above the median ratio of 37% for our EME sample); the FTSE/JSE Top-40 Index and ZAR are up +3.4% and +5%, respectively, over the past 3W – making us incrementally wrong on our bearish bias, which we are now keen to eschew in the face of receding base effects for GDP growth.


Checking in w/ Asia, LatAm and EEMEA - South Africa


Enjoy the rest of your respective evenings,


Darius Dale


LULU | Expensive Asset With Eroding Returns

Takeaway: We don’t like LULU at all – not at 30x earnings with a declining growth and return profile. Appeasing Chip is X-factor this qtr.

Conclusion. We don’t like LULU one bit. In fact, we dislike it a lot. We’re mildly concerned that the company will pull all the stops this quarter in order to silence Chip Wilson, who recently reared his head again and more aggressive than ever about how the company is being mismanaged by both the C-Suite and the Board. But aside from near-term window dressing, we think that returns are headed squarely lower at LULU – by way of both weaker operating turns and eroding margins. Where we live, stocks don’t go up when returns are going down.


Chip Being Chip

It’s been two years since LULU CEO, Laurent Potdevin, said on a conference that “…our parents are fighting and it’s awkward.” 2yrs later there still has been no resolution. Yes, Chip has been on his best behavior – with only a few flare ups – since he sold half his stake to Advent in August 2014, but his recent public moves/statements raise a lot of question marks. A brief synopsis of the timeline: 1) 2/2/16 – Chip exercises his right to appoint an independent director to the BOD when he taps ex LULU CIO, Kathryn Henry, and 2)  6/1/16 – Chip releases a statement questioning the competency of the corporate governors/management of the company that he started.  

We largely agree with Chip’s voiced sentiments around the lack of a long term strategic plan. Though we think it’s important to keep in mind that many of the ‘managerial flaws’ Chip is attacking were set up when he held the reins. Outside of the drama, we think the company is on red-alert after Chip went public with his discontent last week. Could it be that Chip was pressed into action after catching wind of an upcoming earnings disappointment? It’s possible. But, our sense is that the company will want to rub Chip’s nose in this earnings release. In other words, it will find any way imaginable not to miss.



Since the positive holiday sales print ahead of the ICR conference in January, short interest has come off all-time highs to still elevated levels just north of 20%. Valuation is peaky at 30x P/E, and the company now trades at a premium to UA on both EV/EBITDA and EV/Sales. That’d be well and good if LULU’s presented 5yr financial targets were at all within the realm of possibility, but we have a very hard time with the idea that sales will double in 5 years at the same time op-margins recover despite the fact that LULU’s growth is coming from less profitable vehicles. We outlined this growth disconnect in our deck published on April 11th (click here to access LULU materials).

The point here is that in many of our conversations, most investors give LULU the benefit of the doubt on this Fiscal Year. Meaning that margins will begin to inflect, inventory will come back in line, and sales will continue to outperform the rest of US retail. We’d argue that at this price – those near-term benefits are more than priced in.


LULU | Expensive Asset With Eroding Returns - LULU chart1


Category Considerations

It’s been a noisy month for the athletic space. This is a loose definition including: NKE, UA, LULU, AdiBok, FL, and DKS. Each name has its own specific issues but it kicked off in the 3rd week of May with the FL earnings print, where the company was as negative on Nike as we’ve heard in 14 years. Then UA took down guidance at the end of May due to the TSA bankruptcy. Every name in the space, with the exception of AdiBok and LULU, has felt the pain ever since. And rightly so, in the case of LULU, as much of the pressure facing the rest of the brands/retailers in its competitive set is focused on footwear and the bankruptcy of a largely irrelevant competitor to LULU.

Based on the commentary during this earnings season, it appears that LULU is sitting in the sweet spot from a product standpoint, as FL noted that it’s SIX:02 concept experienced negative apparel comps as taste shifted away from athletic performance towards athletic lifestyle. That’s LULU’s core offering. But, it’s what happens below the line that’s more important with this print as the company has added and incremental $470mm in revenue over the past two years but EBIT dollars have declined by $22mm for an incremental margin of -5%. This has to matter to the ‘perennially bullish on LULU’ investment community at some point.


LULU | Expensive Asset With Eroding Returns - LULU chart2



It’s been a long time since we can remember this much attention focused on the balance sheet for a company with a growthy multiple like LULU. To be clear - at 30x earnings and 17x EBITDA – LULU has no margin of error when it comes to its inventory position. That’s largely due to the fact that much of this year’s promised inflection in profitability is hinged on increased efficiency in the supply chain.

After pushing expectations for a cleaner inventory position from the end of FY15 into the first quarter this year, current guidance promises that inventories will be in line with forward sales expectations. Compares are easy as the sales to inventory spread hit 40% through the midpoint of FY15, but we want to be explicitly clear that LULU has no margin for error as the inventory balance is one of the only benchmarks the company has pointed to in order for the street to gauge the progress in the company’s supply chain initiatives.

For a company with a big growth multiple and eroding returns, we think the emphasis on improved efficiency proves how hairy this story is. There is certainly a lot of wood this company needs to chop to improve the back of house, but will ultimately make LULU a multi-year growth story is investment across all buckets of the P&L, especially those that will drive outsized market share growth. Those aren’t a point of emphasis today in Vancouver.


LULU | Expensive Asset With Eroding Returns - LULU chart3

Cartoon of the Day: Yellen & Screamin'

Cartoon of the Day: Yellen & Screamin' - Hawk dove cartoon 06.06.2016


The mercurial Fed has pivoted from Hawkish (in December) to Dovish (March/April) to Hawkish (May). With today's speech, market consensus now perceives Yellen & Co. as flipping back to Dovish here in June. Clearly, the Fed is perpetuating a massive amount of volatility in macro markets.

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