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CHART OF THE DAY: A Closer Look At Earnings "Beats" Vs. Earnings "Growth"

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.


"... What is American Goldilocks?


  1. Forget the 2-3-4%, we need GDP of 1% (but definitely not 0%)
  2. Earnings to “beat” beaten down expectations (and still be negative y/y)
  3. A Dovish Fed that pretends to be hawkish so they can go back to dovish
  4. The “but, but… the labor market is good” political narrative
  5. Stocks and Bonds near their highs for the YTD, at the same time


Yep. Don’t worry. We’re all in the 1% now."


CHART OF THE DAY: A Closer Look At Earnings "Beats" Vs. Earnings "Growth" - 08.08.16 EL chart

American Goldilocks

“If you want to be the best, you have to do things other people aren’t willing to do.”

-Michael Phelps


I don’t know about you, but I absolutely love watching the Olympics. As a boy (pre internet), I used to write down every medal for every country, comparing my totals to what I could find on TV. I got used to penciling in American Gold. #MaryLouRetton!


Now my 8 year-old son Jack keeps score for me on Google. After Michael Phelps won a record setting 19th Gold last night (I was in bed), that took the American medal count to 12 vs. China and Australia at 8 and 6, respectively.


I am Canadian. We’re in 18th place with 1 Silver and 1 Bronze. But somehow we beat USA’s Men’s Volleyball Team in straight sets yesterday. That was a golden moment for Team Canada. Yes, since we don’t win many golds, we’re in it for the moments!


American Goldilocks - olympic medal


Back to the Global Macro Grind


Gold itself got hammered on it, but in what seemed like a golden jobs report moment for American Goldilocks last week, both the SP500 and Nasdaq closed at all-time highs of 2182 and 5221, respectively.


I wrote those down too.


Since I’m short the Nasdaq in Real-Time Alerts right now, that sucked (for me). That said, memories can be short. If you were shorting the all-time highs in most things US Equities in July/August of last year, you were feeling golden come the February 2016 low.


What is American Goldilocks?


  1. Forget the 2-3-4%, we need GDP of 1% (but definitely not 0%)
  2. Earnings to “beat” beaten down expectations (and still be negative y/y)
  3. A Dovish Fed that pretends to be hawkish so they can go back to dovish
  4. The “but, but… the labor market is good” political narrative
  5. Stocks and Bonds near their highs for the YTD, at the same time


Yep. Don’t worry. We’re all in the 1% now.


And since our predictive tracking algo for US GDP is around 1% for Q3, why can’t this continue? Especially if the next jobs report goes from “good” to bad again, bonds (and stocks that look like bonds) are going straight back up.


From a US stock market perspective, here’s what I wrote down for last week:


  1. SP500 +0.4% last week to +6.8% YTD
  2. Nasdaq +1.1% last week to +4.3% YTD
  3. Financials (XLF) +1.6% last week to 0.8% YTD
  4. Tech (XLK) +1.3% last week to +9.9% YTD
  5. Consumer Discretionary (XLY) -0.1% last week to +4.4% YTD
  6. Utilities (XLU) -2.7% last week to +17.2% YTD


In other words, it was mostly a hopeful move higher in US interest rates that drove the Sector Style Factor performance last week. Since most macro tourists don’t do the rate of change thing, they saw a “good” jobs report as great. Bond Yields rose on that.


The US Treasury 10yr Yield was +14 basis points on the week to 1.59%. That drove the Financials out of the red, temporarily, for 2016. And it slapped a big correction on the biggest macro gold medal winners YTD (Utilities, Gold, etc.).


The other big thing that continues to manifest is a #StrongDollar move. That’s something we didn’t have wrong last week:


  1. US Dollar Index +0.7% last week and +2.6% in the last 3 months
  2. EUR/USD down -0.8% last week and -2.8% in the last 3 months
  3. British Pound -1.2% last week and -9.7% in the last 3 months


I’m using the last 3 months for our FX view as that’s when we started getting louder on both Gold and the US Dollar winning the Currency War. A big part of this view has been complimented by our Q3 Macro Theme of #EuropeImploding. While the goldilocks narrative is fun for all things American right now, both the UK and Europe are heading into a protracted recession.


I know, I know. #StrongDollar, Strong Gold (+5.2% in the last 3 months) isn’t exactly a panacea for all things “earnings”… Then again, we need to get to Q3 #EarningsSlowing before we see how sweet American Goldilocks is looking come The Fall.


With the pace of non-farm payroll growth slowing to a new cycle low of 1.72% year-over-year in JUL (vs. +2.1% JUL 2015), the probability continues to rise that jobs growth slows to 0%. And 0% isn’t 1%. That won’t even be in contention for bronze.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.45-1.60%

SPX 2148-2188

NASDAQ 5101-5228

VIX 11.29-15.16
USD 94.60-97.51
EUR/USD 1.09-1.12

Gold 1


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


American Goldilocks - 08.08.16 EL chart

Pentagon OCO Funding Taken Hostage in Washington

Takeaway: Combat ops funding has become political football in debate over increasing all federal spending or only defense spending.

Since the Budget Control Act (BCA) imposed caps on federal discretionary spending in 2013, Overseas Contingency Operations (OCO) funding has taken on greater significance than just funding combat operations.  Considered "emergency" spending, the BCA's established annual budget caps are automatically increased by the amount of funds appropriated for OCO = budget caps effectively do not apply to OCO spending.  The Pentagon received $58.6B in OCO funds in FY 2016, approximately 10.2% of total DoD spending for the year.


Last February the President requested $58.8B in OCO funds for FY 2017 in accordance with the terms of the Bipartisan Budget Act (BBA) of 2015, the two year budget deal which adjusted defense and non-defense discretionary spending caps for FY16 and 17.  However, assumptions used to justify the President's OCO request from last February have since changed, i.e., troops in Afghanistan will only be reduced from 9,800 to 8,800 not 5,500 as planned and US combat activity against ISIS is increasing in Iraq, Syria and now, Libya.  We estimate that these changes to assumptions will cost at least $4B.  


Republican Congressional leaders are clamoring to increase the FY17 OCO request by at least the estimated $4B, but the White House is sticking to the strictest interpretation of last year's budget deal and refusing to accept any additional defense funding, OCO or otherwise, unless non-defense spending is increased by the same amount.  OMB has stated that they are willing to find offsets within the overall defense request and reprogram those funds to the additional war costs. 


Given the summer doldrums and the empty capital city, this specific debate has not gotten much attention but is reflective of the larger division between the Democratic and Republican parties over non-defense spending.  Whereas there is general consensus in Congress, in the Administration and in both major political campaigns that the budget caps on defense spending have to be removed, there is a strong difference in opinion as to whether the caps on non-defense spending should also be lifted. 


While $4B is not "nothing", the amount of money is not the point.  $4B is certainly an amount that can be dealt with in a overall $583B budget (0.6%) that includes many assumptions about future inflation costs, currency exchange rates, the cost of oil, etc which can always be "adjusted" up front since they are not really known costs until after the fact anyway.   The point is that Republicans want to increase defense spending but do not want to increase the caps while the Administration and most Democrats want to raise all discretionary spending caps. 


Both Congress and the Administration have taken advantage of OCO funding's exceptional status outside of the budget caps.  OCO was supposed to be war-related spending but the line between baseline and war-related funding has become very blurry.   The FY 2016 appropriations bill language passed by Congress and signed by the President did not even attempt to maintain the fiction that OCO = war-related spending and simply listed baseline costs as an OCO line item and essentially paid $7.7B in baseline bills with "emergency" funding.  For FY17, the President requested $5.2B in OCO funds for baseline costs.  


In its version of the FY17 appropriations bill the House took the President's request for baseline spending within OCO to a new dimension by providing for the entire $59B requested for OCO but only funding war operations through April 30!   This effectively adds $32B to FY17 baseline accounts using OCO funds, six times what the President requested.  More significantly it means that there would have to be a supplemental OCO appropriation before April 30 that ostensibly would become a must pass bill.   The White House has said it would veto such a proposal and the Senate has opposed the idea.  What actually gets sent to the President will be resolved in conference this fall.


The bottom line for investors is that there continues to be strong upward pressure on the defense budget with consensus that funding must be increased but lots of political games to be played.  Although the current budget expires on September 30, we are looking for a Continuing Resolution (CR) that will maintain federal spending at FY16 levels through the election until at least early December. While there is considerable noise about extending the CR into April, we think that very unlikely unless something dramatic (and unexpected) happens in the election.  The downside to any "normal" CR is the prohibition on new starts, i.e., any changes to the FY16 program, e.g., starting construction of a new ship. We count it as highly probable that soon after inauguration either candidate will come out with a strong stimulus package to be included in the FY18 package for Congressional consideration next spring/summer. 



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The Macro Show with Keith McCullough Replay | August 8, 2016

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An audio-only replay of today's show is available here.

Nice Increase in Reimbursement for SNFs but Focus on Value-based Program ENSG, KND, DVCR, CCP

Takeaway: SNFVBP probably not a big negative in the short term but represents a challenge for providers esp less sophisticated

With no forecast error adjustment, a declining multifactor productivity adjustment and an improving market basket index, SNFs are expected to see an additional $920 million in spending in FY 2017 compared to an estimated increase of $430 million in FY 2016 or 2.4 percent.


The rate increase reflects a market basket increase of 2.7 percent less a multifactor productivity adjustment of 0.3 percent. The difference between the forecast FY 2015 market basket and the actual FY 2015 market basket (the most recent year for which there is historical data) is 0.2 percent. Because the difference is less than 0.5 percent the forecast error adjustment is not triggered. Table 1 lists the rural and urban per diem payments for SNF providers for FY 2017.


Table 1: FY 2017 Per Diem Rates for Skilled Nursing Facilities

Nice Increase in Reimbursement for SNFs but Focus on Value-based Program ENSG, KND, DVCR, CCP - FY 2017 Per Diem

Source: CMS


The big news in the final payment update is the start of the SNF Value-based Purchasing Program which was imposed by the Protecting Access to Medicare Act of 2014. PAMA required just two things for the SNFVBP program – an all-cause, all condition hospital readmission measure which is to be replaced as soon as practical by an all-condition risk-adjusted potentially preventable hospital readmission measure AND private and public reporting. Beginning in October 2018, Medicare will begin adjusting payments to SNFs based on performance on these measures.


The first of these quality measures, the 30-day All-Cause Readmission Measure (NQF#2510) was adopted in the FY 2016 final rule. The “SNF Readmission Measure” (SNFRM) assesses the risk-standardized rate for all-cause, all condition, and unplanned inpatient hospital readmissions of Medicare fee-for-service SNF patients within 30 days of discharge from an inpatient hospital.


For the second of these measures CMS proposed to use the SNF 30 day Potentially Preventable Readmission Measure (SNFPPR) as the SNF all-condition risk-adjusted potentially preventable hospital readmission measure to meet the requirements of PAMA. This proposed measure assesses the facility –level risk standardized rate of unplanned, potentially preventable hospital readmissions for SNF patients within 30 days of discharge from an inpatient hospital.


Unlike the SNFRM, the SNFPPR is a quality measure that was not developed under the auspices of the National Quality Forum. Instead, it has been developed internally by CMS. The measure is also unique in that it measures readmission within 30 days of the hospital discharge instead of within 30 days of discharge from the Post Acute Care setting as is the case with the IRF measure.


For patients readmitted to the hospital while still at a SNF, the Potentially Preventable Readmissions (PPR) will be categorized into four clinical groups:

  1. Inadequate management of chronic conditions
  2. Inadequate management of infections
  3. Inadequate management of other unplanned events
  4. Inadequate injury prevention

For patients that are readmitted after leaving the SNF, the PPR conditions will be categorized into three clinical groups:

  1. Inadequate management of chronic conditions
  2. Inadequate management of infections
  3. Inadequate management of other unplanned events

The SNFPPR measure will be calculated for each individual SNF based on the ratio of the predicted number of risk-adjusted, unplanned, potentially preventable hospital readmissions that occurred within 30 days of discharge from the prior proximal hospitalization, including the estimated facility effect to the estimated predicted number of risk-adjusted, unplanned, hospital readmission for the same individuals receiving care at the average SNF. A ratio above 1.0 indicates a higher than expected readmission rate while a ratio below 1.0 indicates a lower than expected readmission rate. The readmission ratio is referred to as the Standardization Risk Ratio (SRR). The SRR is then multiplied by the overall national raw rate of PPR for all SNF stays. The resulting rate is the risk-standardized readmission rate (RSRR) of potentially preventable readmissions.


SNFs will be evaluated in two ways; on an improvement standard and an achievement standard. The achievement standard will be the 25th percentile of national SNF performance on the quality measure during a baseline period of Jan. 1, 2015 to Dec. 31, 2015. Achievement will be measured against a benchmark of the mean of the top decile of SNF’s performance on the quality measure. The benchmark, according to CMS, will reflect observed scores for the group of the highest performing SNFs. SNFs would receive points along an achievement range, which is the scale between the achievement standard (or threshold) and the benchmark during the performance period.


SNFs will also be evaluated on an improvement standard. The improvement standard (also known as the improvement threshold) is the individual SNF’s performance on the quality measure during the baseline period. During each performance period, CMS will compare the improvement score to the baseline to measure improvement.


The numerical values of the achievement threshold and the benchmark will be published in the final SNF payment rule and in any event not later than 60 days before the beginning of the performance period. The numerical values for the achievement threshold and the benchmark for FY 2017 are listed in Table 2 below:


Table 2: FY 2017 Numerical Values for Achievement Threshold and Benchmark

Nice Increase in Reimbursement for SNFs but Focus on Value-based Program ENSG, KND, DVCR, CCP - Numerical Value

Source: CMS


Each SNF will be scored on a scale of 0 to 100 for achievement and 0 to 90 point scale for improvement. The scoring system calls for inverting the SNFRM rates so as to not confuse the public which may not associate a low rate with a positive result. A SNFRM of 0.15 would then be inverted to 0.85.


To calculate the achievement score, CMS will assign a score of 100 (the maximum) for any SNF that exceeds the benchmark. For any SNF whose score falls below the threshold, the SNF would receive a score of 0. For everyone in between, the achievement score would be calculated using this formula:


Nice Increase in Reimbursement for SNFs but Focus on Value-based Program ENSG, KND, DVCR, CCP - Achievement Scoring Method

Source: CMS


To calculate the improvement score, CMS would assign a score of 0 to 90 based on how much a SNF’s performance on the quality measure improved from its performance on the measure during the baseline period. Each SNF would be assigned an improvement range that defines the distance between the SNF’s baseline period score and  a national benchmark. The national benchmark would be defined as the top decile of SNF performance on the measure during the baseline period.


If a SNFs improvement score was equal to or lower than its improvement threshold, the SNF would receive a score of 0. If the SNFs performance period score was equal to or higher than the national benchmark, it would receive a score of 90. For all other SNFs the improvement score would be calculated using the following formula:


Nice Increase in Reimbursement for SNFs but Focus on Value-based Program ENSG, KND, DVCR, CCP - Improvement scoring

Source: CMS


In the final rule, CMs provides a few examples applying the scoring method. The example below is probably best illustrative of a real world example as most SNF’s will be scored within the achievement of improvement range.


Nice Increase in Reimbursement for SNFs but Focus on Value-based Program ENSG, KND, DVCR, CCP - Performance Scoring

Source: CMS


CMS will use the higher of the achievement and improvement score to calculate incentive payments under the SNFVBP. The SNFVBP is NOT budget neutral. The total amount of value-based incentive payments must be greater than or equal to 50 percent, but not greater than 70 percent, of the total amount of reductions to payments for that particular fiscal year. The lowest 40 percent of SNFs must receive a payment that is lower than that they would otherwise be paid under the SNFPPS.


CMS will post performance scores and ranking on the Nursing Home Compare website and such other information as determines appropriate in future rulemaking.


Although only 95 comment letters were submitted to CMS for this final rule, most focused on the VBP program. Given the content of those comments, there appears to be some trepidation on the part of SNF providers. Also, given the decentralization of the sector, we suspect that many providers are not up to speed as they should be. However, at least initially, we do not believe the SNFVBP will be that much of a negative. CMS has selected as an achievement standard the 25th percentile of all SNFs – which is a much lower bar than the 50th percentile selected for hospitals. As is becoming common whenever the subject of value-based and alternative payment models comes up, responses to the SNFVBP provisions were concerned about adjustments for socio-economic factors. CMS struggles with this argument because at this point there is no real agreement on how to adjust for socio-economic factors without perpetuating the status quo of low quality care.


The SNFVBP represents the same challenge for providers that the Home Health Value-based Purchasing Program does. It provides, for really the first time, Medicare's expectations about the care they pay for in skilled nursing facilities. Unlike other VBP programs the SNFVBP will rely on just one quality measure - hospital readmissions. This constraint specified by law will likely limit nuance in the program but will keep providers focused on the thing that has plagued the care setting for years. The SNFVBP also addresses a long standing gripe of hospitals who are also evaluated on readmissions. Patients sent to SNFs often return to the hospital because of poor care at the SNF not at the hospital. The alignment of interests between these two care settings should be a positive for the hospital sector and lead to better care coordination between the two setting.


Investing Ideas - Levels

Takeaway: Please see below Hedgeye CEO Keith McCullough's refreshed levels for our high-conviction Investing Ideas.

Investing Ideas - Levels - levels 8 5


Trade :: Trend :: Tail Process - These are three durations over which we analyze investment ideas and themes. Hedgeye has created a process as a way of characterizing our investment ideas and their risk profiles, to fit the investing strategies and preferences of our subscribers.

  • "Trade" is a duration of 3 weeks or less
  • "Trend" is a duration of 3 months or more
  • "Tail" is a duration of 3 years or less

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