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Are Old Wall Consenseless Earnings Expectations Out To Lunch?

Takeaway: The S&P 500 hit all-time highs on cycle-high buyback activity and a new cycle high (overly-optimistic) forward multiple.

The current S&P 500 forward multiple is at a new cycle peak on earnings expectations that assume positive earnings growth by Q3 2016, +9% in Q4 2016, and +16% and +14% by Q1 and Q2 2017 respectively. Starting in Q4 of this year, positive earnings growth expectations are baked in for every sector for three quarters through Q2 of 2017.

 

Are Old Wall Consenseless Earnings Expectations Out To Lunch? - earnings expec

 

In other words, the S&P 500 hit all-time highs on cycle-high buyback activity and a new cycle high forward multiple. Note the optimism embedded in those earnings expectations as seen in the chart above.

 

Estimates too high? You decide.

 

Emblematic of the ongoing earnings recession, here's how Q2 2016 earnings are shaking out so far. Still bullish?

 

Are Old Wall Consenseless Earnings Expectations Out To Lunch? - earnings q2 7 22


NKE/FL | The 10k Disclosure That Matters

Takeaway: Nike's 10k offered up a host of data that, when analyzed alongside others in the space, are bearish for FL.

Here's an unabridged review Richards sent me last night after going through the numbers in Nike's 10k that we think matters as it relates to the central themes (mainly share shift in distribution and pressure on legacy retailers) in the Nike ecosystem.

 

The punchline is that I'd give anything to NOT be an executive running FL, FINL, HIBB, or any other retailer that disproportionately relies on Nike as we head into calendar year-end.

 

1) DTC at NKE added an incremental $1.2bn in Fiscal 2016, that was paced by 51% e-commerce growth. The composition of that growth adds important context, we think, to the relationship with the company’s traditional wholesale partners primarily in the US. One of the key points of pushback we received when we laid out our $11bn in e-comm by 2020 thesis for Nike was that the lion’s share of direct growth was going to come in Global markets. That’s not been the case to date, and this dynamic will continue to pressure the likes of FL and FINL. For the year – NA accounted for ~50% of NKE’s DTC growth. Tack on China and that comprises ¾ of the growth for the year.

NKE/FL | The 10k Disclosure That Matters - NKE chart1

 

2) If we breakdown that Nike NA growth into channel specific segments over a longer time series it becomes strikingly evident where the next leg of growth is coming from. All in we saw an incremental $1bn in sales for the year taking Nike on this continent to $15bn with DTC accounting for 58% of the incremental dollars. Yea, the fact that NKE DTC accelerated to 17% growth in the year is notable, but what we think is  far more important to the dynamic between NKE and its traditional wholesale accounts is that the incremental wholesale dollars recognized on the P&L was about half as much as the worst year we’ve seen over the past 5 at just $431. $431 (north of $700mm at end retail) translates to 4%, again half the trough year we’d seen from 2012-2015. That’s a much smaller pie for the content distributors to fight over, and we expect it goes to something starting with a 2 in the next Fiscal year.

NKE/FL | The 10k Disclosure That Matters - NKE chart2

 

3) At retail – NKE’s NA wholesale business was up $737mm dollars. Of that $700+mm, FL captured 29%. That’s up from previous years when NKE was growing like a weed, but in line with prior two years. All in that’s an incremental $215mm to FL, good for 4% growth in its US business. That’s about half the average growth rate (8%) NKE wholesale handed to FL on a silver platter over the past 4 years.  Going forward, assuming FL still gets the same allocations from Nike (despite the fact that FL was as bearish as it’s ever been on the brand in its most recent call) we think the NKE benefit gets cut in half again in 2017. ***Methodology note: we adjusted FL’s Fiscal year to more closely match NKE’s calendar.

NKE/FL | The 10k Disclosure That Matters - nke chart3

 

4) Below is a year by year breakdown of the NKE/FL relationship. We think it’s incredibly important to understand the historical context in order to understand how the relationship evolves in the coming years. The punchline on all this is that we know the emphasis NKE is placing internally to grow it’s DTC business (mainly e-comm), and we can do the math to see what the risk is to FL. But, what are the options for the retailer? It can either a) take a larger share of NKE’s incremental wholesale business, or b) spend to grow the less relevant footwear brands like UA and AdiBok. The first ain’t going to happen as FL has hit it’s limit with Nike and the 2nd requires both additional investment and something we haven’t seen in a long time which is NKE losing market share.

 

Based on our math for FY17 (that’s 2Q-1Q for FL), using the Street’s estimates, FL needs to add an incremental $330+mm to its US business to hit numbers. We think about $130mm comes from NKE, meaning we need to see an incremental $200mm from other brands. Hint – it’s not a slam dunk. See below for a brief description of our key assumptions.

  • We assume that NKE adds $1bn in NA sales in FY 17, good for a 7% growth rate.
  • NKE DTC carries the weight accelerating to 20% bringing it to almost $5bn. The remainder goes to wholesale which sums up to a retail equivalent = $10.9bn up $440mm vs. $737mm in FY16.
  • We assume FL captures 30% of those dollars, which = $132mm vs. $213mm in FY16.
  • NKE share inside FL goes from 76% down to 74% in the US.
  • That means FL needs an incremental $200mm from the likes of UA and AdiBok to hit current Consensus Estimates.

NKE/FL | The 10k Disclosure That Matters - NKE chart4

 

5) So what does that mean for the likes of UA and AdiBok? This scenario analysis walks through the possible options FL has to get to its 2017 numbers without the NKE benefit. Essentially anything in green (one purple) works for FL. Some brief background info: current UA NA FW sales = ~$1bn, current AdiBok NA FW sales = $2bn

One example: We’ll take the $201 number  highlighted in purple. This says that: UA would need to grow FW 60% and AdiBok 20% with 50% of that growth coming from wholesale with the over arching assumption in all the calculations that FL captures 40% of the incremental share from each of the brands.

NKE/FL | The 10k Disclosure That Matters - NKE chart5

 

6) The only problem with those type of growth and channel assumptions is that Nike isn’t the only brand navigating around its wholesale partners. AdiBok is the worst offender with 70% of its incremental growth over the past 4 years coming from the direct channel. UA is at 32%, and we think FW growth for UA is more heavily weighted to the DTC channel. That means from here, the likes of AdiBok and Under Armour would need to take share from NKE, allocate over 40% of its wholesale growth to FL, and (not or) redirect a portion of its more profitable retail growth to the wholesale channel. A lot has to go right for that to happen.

NKE/FL | The 10k Disclosure That Matters - NKE chart6

 


Daily Market Data Dump: Friday

Takeaway: A closer look at global macro market developments.

Editor's Note: Below are complimentary charts highlighting global equity market developments, S&P 500 sector performance, volume on U.S. stock exchanges, rates and bond spreads, key currency crosses, and commodities. It's on the house. For more information on how Hedgeye can help you better understand the markets and economy (and stay ahead of consensus) check out our array of investing products

 

CLICK TO ENLARGE

 

Daily Market Data Dump: Friday - equity markets 7 22

 

Daily Market Data Dump: Friday - sector performance 7 22

 

Daily Market Data Dump: Friday - volume 7 22

 

Daily Market Data Dump: Friday - rates and spreads 7 22

 

Daily Market Data Dump: Friday - currencies 7 22

 

Daily Market Data Dump: Friday - commodities 7 22


the macro show

what smart investors watch to win

Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.

#Peaks

Client Talking Points

#CrudeProduction

Changes on the margin matter. The long-term fundamental crowd is squarely behind a long-energy position with U.S. crude production down nearly -3% Y/Y. Despite the fact that crude inventories are pinned near an all-time high adjusting for a seasonal summer draw, and gasoline consumption is at a high not seen since 2007 yet gasoline inventories are still up 10% Y/Y, the market is still slapping a cycle peak forward multiple with earnings expected to increase by triple digits over the next year. Hope consensus is right.

#Peaks

The current forward multiple is at a new cycle peak on earnings expectations that assume positive S&P earnings growth by Q3 2016, 9% in Q4 2016, and +16% and +14% by Q1 and Q2 2017 respectively. Starting in Q4 of this year, positive earnings growth expectations are baked in for every sector for three quarters through Q2 of 2017. So we’re looking at a market that has been taken to an all-time high on cycle-high buyback activity with a new cycle high forward multiple with optimistic earnings expectations in the denominator as seen in the chart immediately below.

#EHS

Growth in Existing Home Sales slowed to +3.0% YoY in June but the main callout was that the share of sales to 1st-time buyers rose to 33%, marking the highest percentage since July 2012 as unit sales increased to the highest level of the cycle at 1.84M.  The trend here is important because any next leg higher in transaction volumes will require resurgent 1st-time and entry level buyer demand. The past 3 years have been littered with single-month breakout headfakes and false optimism so we’re interested to see if the strength can confirm next month.  The more important housing release will be next week’s Pending Home Sales data for June – which will give us the lead read on sales in the existing market for July.  

Asset Allocation

CASH US EQUITIES INTL EQUITIES COMMODITIES FIXED INCOME INTL CURRENCIES
7/21/16 60% 0% 3% 14% 17% 6%
7/22/16 60% 0% 3% 14% 17% 6%

Asset Allocation as a % of Max Preferred Exposure

CASH US EQUITIES INTL EQUITIES COMMODITIES FIXED INCOME INTL CURRENCIES
7/21/16 60% 0% 9% 42% 52% 18%
7/22/16 60% 0% 9% 42% 52% 18%
The maximum preferred exposure for cash is 100%. The maximum preferred exposure for each of the other assets classes is 33%.

Top Long Ideas

Company Ticker Sector Duration
GLD

Gold (GLD) = Protection from global currency devaluation and inflation/down USD – You can travel anywhere on earth and get a quote in local currency.

TLT

Long Bonds (TLT) = #GrowthSlowing, yield curve compression.

TIP

Treasury Inflation-Protected Securities (TIP) = Combination of the above exposures.

Three for the Road

TWEET OF THE DAY

GOLD: consolidating in its current $1311-1365 immediate-term risk range at +25% YTD = bullish TREND @Hedgeye pic.twitter.com/jwC9UWbERt

@KeithMcCullough

QUOTE OF THE DAY

“Run from being good. Chase being great.”  

–Chip Kelly        

STAT OF THE DAY

The Washington Nationals have the best ERA in baseball at 3.23.  


CHART OF THE DAY: What Happens To S&P 500 When VIX Is Below 13

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye U.S. Macro analyst Christian Drake. Click here to learn more.

 

"... 1 Factor Model:  In the Chart of the Day below we simply show VIX vs S&P500 (S&P500 is inverted on right axis). 

 

What you’ll simply notice is how simply effective it is to take down gross exposure and tighten net exposure when VIX goes <13.   

 

Global risks haven’t “greatly moderated” so building exposure into VIX 10/11/12 embeds the assumption that those risks cumulate latently with no impact on risk premiums or prices.  That seems like a pretty heroic assumption."

 

CHART OF THE DAY: What Happens To S&P 500 When VIX Is Below 13 - 7 22 16 CoD2


Like A Glove

“How in the world can earnings go up if nominal GDP is rising by less than wages?”

-Jeffrey Gundlach

 

A few years ago @Hedgeye we took the Briggs-Myers Personality test (BMTI). 

 

I scored as a  “Thinking Introvert” which probably explains why I'm comparatively better at generating  written analysis than delivering extemporaneous verbal content on Hedgeye TV. 

 

I’m okay with that.  It’s also why we have a team … and a psychologically diverse one according to the intra company dispersion in test results. 

 

The BMTI is cool but there’s a simpler and arguably better Street version.  #Broscience, conceived by the bro’s, for the bro’s.  

 

Here it is:  Watch how someone parks their car. 

 

Style and manner of parking offers a fairly clean insight into a person’s personality.  Think about it.

 

Like A Glove - like a glove

 

Back to the Global Macro Grind

 

You can get a fairly clean insight into how a person’s positioned by the nature of the questions they ask. 

 

We ask and receive a lot of questions daily.  

 

Because our business model carries no conflicts of interest, we’ve gradually become a kind of cogitation hub and a nexus for feedback, interaction and idea generation.   

 

That was an objective, not a byproduct of the Hedgeye operational vision.  We’ll always get things wrong, but “failing fast” and the cultivation of passionate players in perpetual pursuit of collective and personal evolution is our cultural hedge against staying wrong. 

 

Anyway, I chose the Gundlach quote for a few reasons.

 

  1. It relates directly to our 3Q16 #ProfitCycle Macro theme.
  2. We have the same suspect opinion of consensus expectations for high-teens S&P500 earning growth in 2017. 
  3. It’s great when name guys make pithy, off the cuff comments like the underlying basis for the assertion is obvious even to non-institution/non-macro investors.  
  4. It captures the collective angst and questioning that currently pervades our inbox. 

 

On point #4 – while the phraseology varies, most of the more recent questions and discussion distill down to “now what?”

 

Multiple Expansion – with forward earnings multiples making new highs - has driven most of the post-Brexit retrace in prices. 

 

And with Utilities PE’s at their highest ever, performance spreads between cyclical and noncyclicals at peak, small caps trading at a discount to large caps and yields near all-time lows, late-cycle, slow growth positioning has (rightly) become as crowded as it’s ever been. 

 

And because growth is not accelerating, the chief market purveyors of Panglossianism and serial thesis drift have coalesced around the hope for a further collapse in equity risk premiums as the justification and catalyst to drive further price appreciation.  

 

Recall, the equity risk premium (ERP) represents the extra return required for holding equities over “risk-free” government bonds.  Thus, most risk premium based models are relative valuation models that value stocks relative to bonds. 

 

So, conceptually, what’s embedded in the call for a falling ERP?

 

Equity risk premiums have already come in a bit so any further decline will be the result of a move toward historic lows.  A move to all-time low spreads for equity risk premiums relative to bonds that are, themselves, already in unchartered valuation water basically equates to an expectation for peak & sustained complacency.

 

In other words, the hope that NIRP drives ERP towards NERP in some kind of clean, linear fashion is a flimsy conceptual framework on which to anchor an investment strategy and stocks need a tangible fundamental development to help them grow into those multiples and drive prices higher.

 

Which brings us back to earnings expectations.

 

Let’s break Gundlach’s comment down into discrete parts to get a better feel for the intuition and implications:

 

First, why do we care about nominal GDP?

 

Nominal GDP, by definition = aggregate national income. 

 

Subtract out personal income, depreciation, business taxes and add back government transfers/subsidies and net factor income from abroad and you have corporate profits.

 

The easier way to think about it is this:  National income can either go to labor or capital (i.e. businesses) and while accounting measures of profits and GDP can vary from quarter to quarter the larger trend in Profits is invariably tethered to Income – and particularly so when productivity growth is weak like it is now and unable support margin improvements.   

 

Indeed, since the interest rate cycle turned in 1980, Nominal GDP growth has averaged 5.5% while Corporate Profit growth has averaged 6.6%.

 

The trend in profitability is also cyclical and that’s important. 

 

  1. Profits rise faster than costs in the early-to-mid part of the cycle as businesses continue to economize on labor and growth in sales/output rises faster than payroll growth.   
  2. Historically, labor’s share of national income rises at the tail end of an expansion when the labor market tightens and after growth and profits have been strong for a protracted period.

As the chart below illustrates, Corporate Profits rarely grow above 15% on an annual basis and even more rarely at this point in the cycle. 

 

Like A Glove - 7 22 16 CoD1

 

This cycle is not proving different, which takes us to the 2nd part of Gundlach’s comment about nominal GDP rising less than wages.

 

  1. With productivity declining and employment growing at a premium to output, unit labor costs are rising as is labor’s share of nation income.
  2. Input costs are rising faster than output prices - a point we’ve made before but one that’s worth re-highlighting.   If the price to produce something (unit labor costs) is growing faster than the price at which that something can be sold (implied by the GDP deflator) then margin pressure will remain ongoing….
  3. …. This is Gundlach’s point – if aggregate wages are rising faster than aggregate income (i.e. Nominal GDP), any earnings growth becomes a challenge, let alone an expectation of earnings growth to sustainably run 5X nominal GDP.  Sure, record repo activity and an overindexing to the goods/industrial economy could provide relative support to S&P500 earnings but that doesn’t negate the underlying fundamental reality.  
  4. Further, in a situation of slack demand and waning productivity, employment gains become bittersweet.  A rising employment-to-population ratio is paid for via corporate margin compression.

 

If you’re finding this discussion too tedious for a sunny, summer (Friday) morning, I’ll leave you with this:

 

1 Factor Model:  In the Chart of the Day below we simply show VIX vs S&P500 (S&P500 is inverted on right axis). 

 

What you’ll simply notice is how simply effective it is to take down gross exposure and tighten net exposure when VIX goes <13.   

 

Global risks haven’t “greatly moderated” so building exposure into VIX 10/11/12 embeds the assumption that those risks cumulate latently with no impact on risk premiums or prices.  That seems like a pretty heroic assumption. 

 

Yes, the current expansion still has some runway but the cycle will continue its interminable negative 2nd derivative march and it won’t waive curfew just because you want to stroll home late from the pro-cyclical party. 

 

Risk manage as best you can by understanding the prevailing, underlying macro reality within the context of consensus’s expectations for it.   

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.38-1.65%

SPX 2129-2180

VIX 11.55-16.93 
USD 95.87-97.52

Gold 1311-1365

 

Have a great weekend,

 

Christian B. Drake

U.S. Macro analyst

 

Like A Glove - 7 22 16 CoD2


Early Look

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