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Why I Remain An Unrepentant Bear

Takeaway: Buyer beware warns market strategist Mike O'Rourke.

This is an excerpt from a special presentation Mike O’Rourke, Chief Market Strategist at Jones Trading gave to Hedgeye’s 2016 summer intern class. In this clip, O’Rourke discusses current market and economic conditions, and why he believes myriad market risks are conspiring against a continued bull market run.

 


This Week In Hedgeye Cartoons

Our cartoonist Bob Rich captures the tenor on Wall Street every weekday in Hedgeye's widely-acclaimed Cartoon of the Day. Below are his five latest cartoons. We hope you enjoy his humor and wit as filtered through Hedgeye's market insights. (Click here to receive our daily cartoon for free.)

 

Enjoy!

 

1. Vanishing (7/22/2016)

This Week In Hedgeye Cartoons - Market volume cartoon 07.22.2016

 

U.S. equity markets closed in on all-time highs this week but market volume was nowhere to be found.

 

2. A Bear Tale (7/21/2016)

This Week In Hedgeye Cartoons - Europe three bears cartoon 07.21.2016

 

Drawdowns from respective 2015 highs:

 

  • Germany, DAX: -13.7%
  • Italy, FTSE MIB: -30.3%
  • France, CAC: -16.1%
  • Spain, IBEX: -25.8%

 

3. Groovy, Man! (7/20/2016)

This Week In Hedgeye Cartoons - All time high cartoon 07.20.2016

 

What are the bulls smoking buying the all-time high in stocks?

 

4. Going Nowhere (7/19/2016)

This Week In Hedgeye Cartoons - helicopter money cartoon 07.19.2016

 

Rumors about helicopter money aside, Japan's Nikkei is still down 19.8%, inclusive of last week's 10% pop.

 

5. Extinct? (7/18/2016)

This Week In Hedgeye Cartoons - earnings cartoon 07.18.2016

 

Earnings season... hawkish or dovish?


The Week Ahead

The Economic Data calendar for the week of the 25th of July through the 29th of July is full of critical releases and events. Here is a snapshot of some of the headline numbers that we will be focused on.

 

CLICK IMAGE TO ENLARGE.

The Week Ahead - 07.22.16 Week Ahead


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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.

Investing Ideas Newsletter

Takeaway: Current Investing Ideas: DNKN, HOLX, HBI, LAZ, MDRX, FL, JNK, TIF, WAB, ZBH, TIP, LMT, GLD, TLT

Investing Ideas Newsletter - Europe three bears cartoon 07.21.2016

 

Below are our analysts’ new updates on our fourteen current high conviction long and short ideas. As a reminder, if nothing material has changed in the past week which would affect a particular idea, our analyst has noted this. We will send Hedgeye CEO Keith McCullough's refreshed levels for our high-conviction Investing Ideas in a seperate email.

IDEAS UPDATES

TIP | TLT | GLD | JNK

To view our analyst's original report on Junk Bonds click here, here for TIPs and here for Gold.

 

After a couple weeks of our long positions moving against us relative to the broader market (good thing they haven’t all year!), the good news is that the market is at all-time highs if you were long the index. The bad news? You’re still underperforming long-term Treasuries in 2016. Moreover, you’re long one of the Top-3 "most expensive" markets of the last 100 years. For the record, we remain skeptical of overly optimistic consensus expectations for an earnings rebound by Q4 of 2016.

 

Please see chart below. The most important point to make here is that the current cycle-high forward multiple is slapped on earnings expectations that are a sea of green for every sector starting in Q4 of this year and double digits in Q1 and Q2 of 2017 (see last week’s write-up for more color)  

 

Investing Ideas Newsletter - z ben II

 

So, despite a two-week period of underperformance for our Investing Ideas macro positions, here's the S&P 500 YTD scorecard against what have been our active calls for all of for 2016:

  • TLT: +15.1%
  • JNK: +7.2%
  • S&P 500: +6.4%

Of course, prospective returns are much more important than calling out what’s already happened. So we’ll dig into an important scenario analysis laid out by Senior Analyst Darius Dale in with regard to Q2 GDP which gets reported next week (Again, see last week’s note for a detailed analysis on how retail sales drives GDP). To quote Darius:

  1. “Next Friday’s Q2 GDP report is likely to come in better than expected – perhaps by a significant degree.
  2. While backward-looking in nature, any such “beat” will likely affirm the recent optimism in the domestic equity and credit markets – optimism that we’ve admittedly been on the wrong side of.
  3. That being said, however, we’re inclined to fade such optimism given our expressly dour outlook for domestic economic growth from here.”

So what does this all mean? It means that the time between the FOMC’s July 27th meeting and its September 21st meeting is likely to contain a meaningful degree of hawkish rhetoric out of various vocal Fed Heads. That may serve to catalyze incremental convergence in the factor exposures we’ve been bullish and bearish on in the YTD.

 

To sum things up on inflation expectations, we could see a brief period of a Hawkish policy pivot. However, with growth continuing to track a decelerating trend in our model in Q3 and Q4, with 1) difficult PCE comps (consumer expenditures) and 2) easy inflation comps, we want to stick with our allocations to growth slowing and inflation picking up in the latter part of 2016.   

DNKN

To view our analyst's original report on Dunkin Brands click here.

 

Dunkin Brands (DNKN) reported 2Q16 earnings this past Thursday, which showed significant weakness in the business. Coming off the 1Q16 comps at Dunkin’ U.S. of 2%, they slowed to 0.5% in 2Q16, missing consensus estimates of 1.0%. Breaking down the comp, traffic was negative 240bps, and there was slightly less than 300bps of price on the menu.

 

It was not just a problem isolated to Dunkin’ U.S. either. Their other three segments missed expectations as well. Management indicated that franchisees remain cautious, with a level of uncertainty surrounding the political picture, regulations and labor. They even noted some franchisees are sitting on sites to see who will be our next president.

 

The significant price that franchisees have been taking coupled with a slowing QSR space is having a significant effect on DNKN and we do not anticipate the weakness in the the company's business to dissipate anytime soon. We remain SHORT. 

WAB

To view our analyst's original report on Wabtec click here.

 

We expect Wabtec's (WAB) earnings report on July 25th to contain a number of unusually important elements. WAB’s report and guidance will test the sustainability of 1Q 2016’s Freight segment decremental margin, which the 10-Q indicates was driven by lower Material costs.

 

These favorable decremental margin expectations are now imbedded in 2H 2016 consensus estimates, and we expect the recent snap back in steel prices to have a significant 2H16 impact.  While Materials costs went unmentioned in both the press release and earnings call, the company has apparently subsequently claimed mix as a factor; we do not find that claim credible. 

 

Investing Ideas Newsletter - wab

HBI

To view our analyst's original report on Hanesbrands click here

 

Hanesbrands' (HBI) adjusted operating margin is at an all-time high of 16%, a level we think is clearly unsustainable.  Excessive non-gaap charges are pumping up the margin level, as well as operating its manufacturing above 90% utilization. 

 

Given the similar product assortments and the manufacturing profile, the closest comparable company to Hanesbrands is likely Fruit of the Loom, which is owned by Berkshire Hathaway.  We estimate its current margin to be in the area of 12%, which is 400bps below HBI's margin.  HBI does not have the brand strength to maintain a margin level that much higher than a large competitor.

 

We think as demand softness continues, and organic growth slows, utilization will trend downward and HBI's operating margin will move down to a level closer to that of Fruit of the Loom.

MDRX | ZBH | HOLX

 

To view our analyst's original report on Allscripts click here, here for Zimmer Biomet and here for Hologic

 

Below is a HedgeyeTV Q&A with Healthcare analysts Tom Tobin and analyst Andrew Freedman in which they discuss specific implications for Investing Ideas companies like Allscripts (MDRX)Zimmer Biomet (ZBH), and Hologic (HOLX). Other companies covered include AHS, ATHN, ILMN and MD.

 

Tom and Andrew also recap last week's Themes Presentation, which included a comprehensive overview of our #ACATaper and Healthcare Deflation themes with new datasets and analysis.

 

Investing Ideas Newsletter - healthcare Q A

Click here to access the associated slides.

 

(**Also, click here to read an unlocked institutional research note on athenahealth (ATHN) written by our Healthcare team on 5/20. "Wrong call into print, but we did flag short-term risk after ATHN CFO departure," Hedgeye Healthcare analyst Andrew Freedman wrote.)

TIF

To view our analyst's original report on Tiffany click here

  

Swiss Watch Exports numbers are one of the best indicators that we can find to gauge the global demand for luxury items - particularly jewelry. Of course, watches have their very own demand constraints and Tiffany (TIF) is underexposed to the category  -- but the iWatch, FitBit, and other connected fitness wrist wear, we'd argue, don't compete with items priced above $3,000, which  was down 19.5% for the month.

 

Looking at the trend in TIF comp sales vs. the global Swiss Watch exports numbers paints a pretty tight correlation between the two metrics, with the two most recent Swiss Watch export numbers showing a sequential deceleration in the YY trend. The only problem is that TIF Consensus estimates currently expect a reacceleration in comp trends sequentially on a 1yr and 2yr basis for 2Q16 and the balance of the year. With a positive comp bogey embedded in numbers for 4Q. We think that's a pipe dream.

 

Investing Ideas Newsletter - 7 21 2016 TIF chart1

LAZ

To view our analyst's original report on Lazard click here

 

Lazard's (LAZ) advisory business had a nice win during the week announcing the mandate to assist in the $32 billion acquisition of U.K. semiconductor ARM Holdings by Softbank. The deal was the first indication that the fallout from Brexit has been viewed as a buying opportunity as the Japanese domiciled Software has been “looking” at the U.K. based ARM for over 10 years according to the Softbank chairman.

 

The sizeable deal is the first in about 2 quarters for Lazard and is a nice respite to the vacuum of activity that has ensued throughout the first part of the year. If the deal actually gets completed, Lazard should take in between $35-45 million, a nice payday to say the least. However, we see only a ~15% bump to the quarterly advisory run rate of $250 million for the firm’s M&A business.

 

With activity trending down -40% year-over-year, it will take more than one deal to get the stock out of the current fundamental weakness caused by a moribund M&A environment. LAZ reports its 2Q16 earnings this week on Thursday the 28th and, without some serious jawboning about an improvement in sentiment and the pipeline, they will be acknowledging the soft landscape. We see more downside for the stock. 

FL 

To view our analyst's original report on Foot Locker click here.

 

Nike filed its 10-K this week. The punchline is that trends are not good for traditional wholesale partners, particularly Foot Locker (FL).

 

NKE’s North American 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 the prior two years. All in, that’s an incremental $215mm to FL, good for 4% growth in its US business. However, that’s about half the 8% average growth rate NKE wholesale has 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 on its most recent call), we think the NKE benefit gets cut in half again in 2017. This changing dynamic means that unless we see unprecedented growth/share gains from Adidas and/or Under Armour, FL sales growth expectations are way too high.

 

Investing Ideas Newsletter - nke chart3

LMT

To view our analyst's original report on Lockheed Martin click here.

 

Although Lockheed Martin (LMT) is coming off a strong Q2 report that showed sales up 11%, cash from operations up 16% and increased guidance for the rest of the year, there are two areas of caution. The first are the interminable negotiations which began 10 months ago to definitize the contract valued at ~$10B for delivery of 150 F35s from Lot 9 (FY 2015) and Lot 10 (FY 2016).  The Lot 9 aircraft are well down the construction line and the Lot 10 orders are now beginning their two year journey to delivery.  

 

LMT CEO Marilyn Hewson said the company is carrying $900M to keep supplier operations flowing efficiently but that those company cash requirements are going to increase astronomically as the aircraft move closer to completion without a contract. Even the UK Defense Minister begged the Pentagon this week to quickly close the deal as the delay begins to impact UK companies. The deal is reportedly going to close “soon” but meanwhile LMT is out the cash. 

 

The second area is Turkey. The turmoil there has resulted in the arrest or removal of over 40,000 military and civil servants to include 1/3 of the general officers and relief or removal of over 6,000 other military commanders and personnel.  There are now apparently insufficient pilots to man the country’s F16s.

 

Even after the purge passes, the remaining personnel will be focused inward and there will be questions of loyalty.  With much of the coup reprisals focused on the air force, it seems doubtful, even in the best case, that Erdogan will be enthusiastic about moving quickly on Turkey’s plan to buy 100 F35s beginning with two acft this year.

 

We believe that there will be delays.


Cartoon of the Day: Vanishing

 

Cartoon of the Day: Vanishing - Market volume cartoon 07.22.2016

 

U.S. equity markets closed in on all-time highs this week but market volume was nowhere to be found.


HEDGEYE Exchange Tracker | Back to the Futures

Takeaway: While volume was suppressed this week, futures activity maintains a slight year-over-year advance in 3Q making it the best exchange category

Weekly Activity Wrap Up

Volume was suppressed across the board this week with 3Q16TD average daily volume (ADV) falling for all exchange categories. However, the futures business is maintaining a positive year-over-year growth rate with option and cash equities volumes in retreat. Futures put up 17.1 million contracts per day this week, bringing the 3Q16TD average daily volume (ADV) to 18.8 million contracts, good enough for the only positive year-over-year activity growth rate at +1%. Options activity slumped to 14.6 million contracts per day in the past 5 days, lowering the 3Q16TD ADV to 15.7 million, -13% lower Y/Y. Cash equities came in at 6.1 billion shares per day, bringing the quarter's ADV to 6.6 billion, -10% lower than 3Q15.

 

HEDGEYE Exchange Tracker | Back to the Futures - XMon16

  

U.S. Cash Equity Detail

U.S. cash equities trading came in at 6.1 billion shares per day this week, bringing the 3Q16TD ADV to 6.6 billion, -10% lower than the year-ago quarter. In the market share battle for volume, exchanges are losing share. The New York Stock Exchange/ICE is taking a 24% share of third-quarter volume, which -18 bps lower than the year-ago quarter. NASDAQ is taking a 16% share, -243 bps lower than one year ago. Finally, BATS' 20% share is -121 bps lower Y/Y.

 

HEDGEYE Exchange Tracker | Back to the Futures - XMon2

 

HEDGEYE Exchange Tracker | Back to the Futures - XMon3

 

U.S. Options Detail

U.S. options activity came in at a 14.6 million ADV this week, bringing the 3Q16TD ADV to 15.7 million, -13% lower than the year-ago quarter. In the market share battle amongst venues, NYSE/ICE's 15% share of 3Q16 volume is -309 bps lower than one year ago. Additionally, while BATS' share grew in the first half of 2016, growth has stalled somewhat in recent weeks, and the exchange's 11% share is -27 bps lower than the year-ago quarter. Meanwhile, NASDAQ's 22% share is +141 bps higher than in 3Q15, and CBOE's 30% market share of 3Q16 is up +221 bps Y/Y. Finally, ISE/Deutsche's 13% share is -156 bps lower than 3Q15.

 

HEDGEYE Exchange Tracker | Back to the Futures - XMon4

 

HEDGEYE Exchange Tracker | Back to the Futures - XMon5

 

U.S. Futures Detail

13.2 million futures contracts per day traded through CME Group this week. That puts the 3Q16TD ADV at 14.6 million, +1% higher Y/Y. Additionally, CME open interest, the most important beacon of forward activity, currently sits at 106.7 million CME contracts pending, good for +17% growth over the 91.3 million pending at the end of 4Q15, although a contraction from the previous week's +21%.

 

Contracts traded through ICE came in at 3.9 million per day this week, lowering the 3Q16TD ADV to 4.3 million, which is flat Y/Y. ICE open interest this week tallied 64.9 million contracts, +2% higher than the 63.7 million contracts open at the end of 4Q15, although a contraction from the previous week's +3%.

 

HEDGEYE Exchange Tracker | Back to the Futures - XMon6

 

HEDGEYE Exchange Tracker | Back to the Futures - XMon8

 

HEDGEYE Exchange Tracker | Back to the Futures - XMon7

 

HEDGEYE Exchange Tracker | Back to the Futures - XMon9 

 

Monthly Historical View

Monthly activity levels give a broader perspective of exchange based trends. As volatility levels, measured by the VIX, MOVE, and FX Vol should rise to normal levels after the drastic compression this cycle, we expect all marketplaces to experience higher activity levels.

 

HEDGEYE Exchange Tracker | Back to the Futures - XMon10

 

HEDGEYE Exchange Tracker | Back to the Futures - XMon11

 

HEDGEYE Exchange Tracker | Back to the Futures - XMon12

 

HEDGEYE Exchange Tracker | Back to the Futures - XMon13

 

HEDGEYE Exchange Tracker | Back to the Futures - XMon14

HEDGEYE Exchange Tracker | Back to the Futures - XMon15

 

 

Please let us know of any questions,

 

Jonathan Casteleyn, CFA, CMT 

  

  

 

 Joshua Steiner, CFA

 

 

 

Patrick Staudt, CFA


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