The Economic Data calendar for the week of the 15th of August through the 19th of August is full of critical releases and events. Here is a snapshot of some of the headline numbers that we will be focused on.
Takeaway: Current Investing Ideas: HOLX, HBI, LAZ, FL, TIF, WAB, ZBH, UUP, LMT, GLD, TLT
Below are our analysts’ new updates on our eleven 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.
Eurozone GDP, reported Friday, signaled more of the same, stagnation. With that being said there were small but marginal Euro tailwinds against a U.S. retail sales report and PPI release that was likely dovish on the margin (USD -~20bps on Friday and -~60bps on the week).
In line with our #EuropeSlowing theme, Q2 preliminary GDP slowed across the Eurozone to +0.3% vs. +0.6% in the prior quarter and +1.6% Y/Y for Q2 which was flat on a rate of change basis from Q1.
Looking at specific country results:
Recall that a strong retail sales report for June, driven by a positive trend in goods consumption, was a large contributor to our GDP revision for Q2. The headline number, for June, was up +0.6% sequentially with the sequential acceleration in the control group accelerating +7.2% (annualized).
Friday’s retail sales report was a different story, and probably a dovish data point for the USD on the margin :
Next to retail sales, July headline producer prices decelerated -0.4% vs. +0.5% in June sequentially and -0.2% Y/Y vs. +0.3% Y/Y in June. PPI ex. food and energy came in at 0.0% sequentially vs. +0.4% in June and +0.7% Y/Y from +1.3% in June. #Deflation
Overall it was a sleepy summer week for the most part. But don’t get complacent with all-time equity index market highs and a near re-testing of all-time lows in volatility. The VIX is just one-handle from its summer 2014 all-time low. Meanwhile, the Treasury bond volatility index is now at a level not seen since December of 2014. Like the set-up in Q3 2014, when we introduced our theme of #Volatility’sAsymmetry, it’s a one-way street off all-time highs in complacency.
To view our analyst's original report on Hanesbrands click here.
Hanesbrands (HBI) is facing bloated inventory levels. In 2Q, it spent an incremental $12mm on inventory reduction initiatives, but hey, the inventory clean-up plan is tracking according to plan… right?
Nah, not even close.
The sales-to-inventory spread only went from -16% to -14% after adjusting for the $51mm increase created by the closing of Champion Europe around quarter end. This high inventory level means organic growth and margins are likely to be under pressure as the level normalizes.
To view our analyst's original report on Zimmer Biomet click here.
We know at this point that hospital admissions have slowed to ~0% year-over-year. We also know that Healthcare job openings are now growing at the slowest rate in over 2 years. We know too that Nurse layoffs and discharges have spiked to growth rates not seen since the financial crisis in 2009.
Now, will this impact orthopedic surgery?
We think so, but know we have been wrong in the last year. If the relationship holds and inpatient surgeries, which are dominated by orthopedic cases and affected by the #ACATaper, drives hospital admissions into negative territory, we will see this show up in Zimmer Biomet's (ZBH) results.
At a minimum, ZBH has closed much of the multiple gap between their stock and SYK, at least taking out one leg of the long thesis. Additionally, 2Q16 earnings season was one of the worst in 5 years and the multiples investors are willing to pay for healthcare stocks and the S&P 500 Healthcare Index generally, as growth continues to deteriorate into 3Q16 and 4Q16, will continue to come in as well. That should take ZBH’s multiple lower from here.
To view our analyst's original report on Lockheed Martin click here.
Friday, Lockheed Martin (LMT) closed up $1.61 within $1 of its 52-week high spurred by news that the Pentagon is releasing nearly $1B to pay for work already performed by LMT on 57 Low Rate Incremental Production (LRIP) Lot IX F35 aircraft ordered in FY 2015 but still not yet on contract. The money comes via an Undefined Contract Action (UCA) which allows payment by the Government for ordered work that has been completed but not yet finalized in a contract.
In its Q2 earnings report, LMT announced that it had spent nearly $1B of its own funds to keep Lot 9 production on track and suppliers on board and that it was approaching its tolerable limit while negotiations drag on. Usage of UCAs and dependence on LMT’s access to cash has essentially enabled annual F35 negotiations to be perennially dragged out and has become the unfortunate norm in the F35 program. The Government and Lockheed have been negotiating ~140 Lot 9 and Lot 10 orders as a package worth nearly $14B for over a year. The first Lot 9 aircraft are due to be delivered in late 2017.
While there is no specific information as to why these particular negotiations are dragging out, the F35 program is nearing completion of development with the commencement of full rate production and the first multiyear contract planned for 2019. LRIP contracts between now and 2019 thus take on greater weight since they will form the negotiating basis for what will probably be a series of five year multiyear contracts.
To view our analyst's original report on Hologic click here. Below is an excerpt from an institutional research note written by Hedgeye Healthcare analyst Tom Tobin.
Hologic (HOLX) management described future growth available to 3D Tomo adoption as "stronger for longer" on the F3Q16 earnings call. It was a clever marketing tag line that soothed investor concerns about F2017 growth after concerns emerged with F2Q16 earnings and the "Tomo-Cliff." But "stronger for longer" will come after a diminutively termed "tough comp" for 3D Tomo in the upcoming F4Q16.
Based on our data (charts below), we'd describe management's "tough comp" as "reputation breaker," "disaster," "major fail," or any number of alternatives that capture the moment when investors realize Hologic's growth and margin prospects for 2017, as well as the truthiness of the management, are not as good as they believed. After the stock price debacle of F2Q16 driven by the weak results and the narrative of the "Tomo-Cliff," the "stronger for longer" and vigorous denials made by management over the course of F3Q17 have provided what we see as only a temporary reprieve, and what looks like a suspension of reality.
The year-over-year change in facility counts has turned negative through July 2016 and appears likely to remain negative for some time. As we described in our Black Book presentation, declines in 3D will put significant pressure on gross margins and company growth going forward. The number of facilities converted to 3D according to MQSA, which recently began disclosing 3D facility and unit placements, would further suggest HOLX is conceding market share in recent months after dominating the market for 3 years. Consensus Breast Health revenue is at $290M for F4Q16 versus $286M a year ago, and $283M last quarter. We see steep declines as far more likely.
To view our analyst's original report on Lazard click here.
Year-over-year corporate credit costs remain at elevated levels which is limiting merger and acquisition (M&A) announcements and continue to outline a short case for the boutique M&A advisors. Although credit costs have compressed slightly with 10 year Treasury yields recently, a 4-quarter moving average of corporate funding has only improved marginally, which continues to create negative comps for M&A through July.
Until funding costs decline substantially we are comfortable with our ongoing short recommendation on Lazard (LAZ) and the boutique advisory group overall. Forward earnings estimates for LAZ and the group still do not reflect the extension of negative comps into the second half of 2016.
To view our analyst's original report on Tiffany click here.
We have been watching Macy's to get a sense of TIF sales within its Americas segment. Macy's reported second quarter earnings this week and comps improved sequentially. This would appear to be good for Tiffany (TIF), but as the below chart shows, there is already the expectation of improving comps for Tiffany similar to that of M.
Macy's noted that tourist sales improved vs 1Q, but were still down double digits year-over-year, so the tourism headwind remains.
TIF may be able to hit the relatively low expectations in its upcoming quarterly earnings, but we don’t believe the back half acceleration that management and the street are looking for will ever materialize. EPS expectations for the next 12 months need to come down.
To view our analyst's original report on Foot Locker click here.
Foot Locker (FL) reports 2Q earnings on Friday, August 19th. We feel there is a high probability that FL will see a significant miss or guide down before the books are closed on 2016.
Expectations are high in the quarter with the Street looking for 3.7% comparable sales growth, when management reported May was running negative as of the 1Q conference call. To beat numbers given at the start of the quarter, FL will have to see one their biggest intra-quarter accelerations ever. The bulls have pointed to strong Jordan shoe launches as a postitive but we're not convinced they will be enough to offset declines in the rest of the business. Even if we are reading this completely wrong and the Jordan launch success creates the needed boost, how does FL replicate that in the back half and hit numbers against compares that are just as hard, if not harder?
We remain short FL on all durations.
To view our analyst's original report on Wabtec click here.
No update on Wabtec (WAB) this week but Hedgeye Industrials analyst Jay Van Sciver reiterates his short call.
Central planners have the delusional idea that they can smooth economic gravity. That #BeliefSystem is breaking down.
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In this brief excerpt from our “Healthcare Earnings Recap” call earlier this week, Hedgeye’s Tom Tobin explains why Healthcare earnings trends don’t bode well for the industry’s stocks.
Takeaway: Reported inflation is set to rise materially over the next 3 quarters. This has important implications for investors and policymakers alike.
Earlier this week Keith and I had a dialogue with some über-thoughtful macro investors regarding our outlook for inflation and how the Fed is likely to respond to it. Below is a detailed summary of the key takeaways, which we think are especially pertinent for all investors.
Q: "Do you agree with our belief that inflation is being systematically underreported in order for the Fed to remain hyper-accommodative and make rich people richer? Also, any thoughts on the GS analysis which shows a historically-elevated divergence between reported inflation and inflation expectations?"
A: The GS analysis you cite conspicuously omits commodity prices – energy prices in particular. Our analysis has shown fluctuations in commodity prices have been the primary driver of the marginal rate of change in reported headline inflation (which breakevens are designed to track) for nearly a decade now. As such, the ~15% decline in WTI from its early-JUN peak can explain away much of the -32bps decline in the 5Y breakeven rate since its late-APR peak.
Your assumption that inflation is being systematically underreported is more than likely correct, though it’s difficult to prove. Even the PriceStats aggregate inflation series is not showing much of a spread between its calculus and the official data.
I think what we intuitively feel is the systematic underreporting of big-ticket core services inflation (i.e. housing, healthcare, education, transportation, etc.) relative to core goods inflation, but because prices are sticker and less volatile in the former category, the latter category has an outsized impact on the marginal rate of change in headline CPI.
Source: Bloomberg L.P.
And yes, the Fed is well aware of where the U.S. economy’s proverbial “bread” is buttered (i.e. high-end consumer spending). This is why they aim to protect the stock market at all costs (e.g. in lieu of their policymaking credibility, bank NIMs, the active fund management industry, etc.).
Q: "At the same time we still believe in a crisis/risk premia decompression scenario with the 10Y Treasury yield going to 1%. Are we talking out of both sides of our mouths? Is it possible to believe in both scenarios and how would you reconcile that? Also, do you agree with us that demographics are the primary driver of lower yields across many advanced economies?"
A: There's no question that demographics is the tail wagging the dog here. Slides 4 and 6 of our #DemographicYields presentation cite and IMF study that empirically shows how population ageing is inversely correlated to trend rates of both GDP growth and inflation to a statistically significant degree.
Given these dynamics, I do not think you’re talking out of both sides of your mouth. Specifically, trend rates of GDP growth and inflation have continue on their secular path lower in order for the Fed to remain perpetually accommodative, which we’ve learned is bullish for the SPY until it isn’t (i.e. during recessions).
Q: "Crude oil really has to fall hard in Sept and onward to keep pace with the move last year. Our energy team sees it unlikely that prices will fall to the degree they did last fall/winter – we're thinking the price floor is in the low 40s/high 30s. If that’s the case, reported inflation will rise simply due to the mechanical effect of lapping easy compares. How are you incorporating energy price dynamics into your forecasts?"
A: We’re largely on the same page here. In terms of when we’ll see the impact of higher YoY energy prices on CPI, our models point to t-minus “now” and the effects should intensify markedly over the next 6-8 months. Specifically, the YoY rate of change in crude oil prices linearly trends from -22% in JUN ‘16 to +36% in JAN ’17.
All else being equal, we could see headline CPI more than double from here; the high end of our forecast ranges expect CPI to average +1.2% YoY in Q3, +2.1% in Q4 and +2.7% YoY in Q1.
For reference, the low end of said forecast ranges are +1.2%, +1.4% and +2.0%, respectively.
My gut feeling is that the latter set of numbers is too low, given our quantitative view on the ultimate floor in crude oil – which, at $36/bbl. is within your target range.
Q: "It's amazing that a pickup in reported inflation could have a real effect on monetary policy given we are seeing the lowest nominal GDP growth rate since the 1950s including all other recessionary periods ex GFC. Assuming the preconditions are met and NGDP does not pick up materially, then we will be in recession technically. Thoughts on this?"
A: Regarding how this will play out in recession probability and policy response terms, there are three very important things to keep in mind here:
RE: #1: The Fed did the exact opposite of what headline inflation implied they should be doing by easing in 2008, easing in 2011 and then tapering and tightening in 2014-15. Last price in the SPY is a more relevant indicator than headline CPI in terms of their propensity to adjust monetary policy.
Source: Bloomberg L.P.
RE: #2: In the face of some fairly material deltas in commodity prices, the PCE Core Price Index has been remarkably stable in the +1.3% to +1.8% range for over three years now. The U.S. government appears to have found a great deal of “stability” in [suspected] price manipulation.
RE: #3: The wild card here is that we just might start to see an acceleration in wage growth over the next 2-3 quarters. That would be consistent with previous cycles that show a consistent decoupling of employment growth and wage growth into the onset of recession.
All told, I don’t know what the catalyst is for nominal GDP to pick up materially this late in the economic cycle – absent a big run-up in energy prices that permeates throughout the manufacturing sector. That said, however, improving inflation dynamics – even if largely a function of receding base effects – is supportive of not necessarily seeing lower-lows for now.
Your point that we’ve never seen nominal GDP this low outside of recession is well-taken. This largely explains the disconnect between all-time highs in the SPY and pervasively negative sentiment among all-types of fundamentally-oriented investors who see the corporate profit cycle for what it is – recessionary with a ton of downside risk if we actually enter a real economic downturn.
Q: "Just to crystallize this, how do you think about CPI impacting Core PCE? You note Core PCE has been remarkably consistent. Should we expect it to stay consistent? Is it too difficult to predict PCE given the Fed’s apparent discretion?"
A: Core PCE is likely to move higher from here, given its historical correlation with headline inflation on both an absolute level and delta basis:
Source: Bloomberg L.P.
Source: Bloomberg L.P.
That said, however, it would be unwise to expect a material jump in the PCE Core Price Index over the next 2-3 quarters. Assuming our most aggressive scenario for upside in headline CPI (i.e. an average of +2.7% YoY in Q1) only gets you to about +1.9% on the PCE Core Price Index, assuming little change to the historical relationship. That’s only +30bps higher than the most recent print and still below the Fed's +2% "price stability" mandate – where it has been for 50 months and counting.
To your question regarding the difficulty of forecasting the PCE Core Price Index, the series is not particulalry volatile, which makes it easier to predict than headline CPI. Specifically:
Q: "It looks like “Quad 3” is going to become more pronounced given sustained weak nominal GDP and rising inflation. What sectors typically do best at “Quad 3” extremes?"
A: The sectors which have historically performed best in #Quad3 are as follows (in descending order):
The sectors which have historically performed worst in #Quad3 are (in ascending order):
We hope you found this discussion helpful to expanding upon your respective investment motifs. As always, feel free to email us with any follow-up questions.
Happy Summer Friday,
If you believe this ends well, you also have to believe the Fed’s next ease will involve buying of corporate bonds and monetization of debt.
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