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CHART OF THE DAY: A Deep Dive Into Emerging Markets

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye Senior Macro analyst Darius Dale. Click here to learn more.

 

"For brevity’s sake, however, we’ll focus on one quick and dirty way to accomplish this, which is by regressing dollar-denominated equity market returns off of their respective YTD lows vs. the delta in composite PMI readings off of their respective YTD lows.

 

Does the market improvement match the economic improvement? If not, what is the probability the latter catches up to the former?

 

Regressing the aforementioned factors across the 16 emerging market economies we could find with available data yielded a positive correlation of +0.87. Even excluding outliers Brazil and Russia yielded a positively-sloping regression line with a correlation of +0.35 (see: Chart of the Day below for visualization)."

 

CHART OF THE DAY: A Deep Dive Into Emerging Markets - 8 18 16 Chart of the Day


Inside-Out

“When in doubt, inside-out.”

-Keith Clark

 

The quote of the day today comes from Keith Clark, current Offensive Coordinator and Head Offensive Line Coach at Dartmouth. Prior to his already-successful stint with the Big Green, Coach Clark shared those same titles for 12 years at Yale, where I played on his offensive line (left tackle to be exact).

 

It’s an understatement to say that Coach Clark is one of the best offensive line coaches in the country; he’s mentored dozens of student-athletes to All-Conference and All-American accolades (including myself) and, in addition coaching on multiple championship teams (including my own), his teams have typically enjoyed among the nation’s best success rates at both running the football and protecting the quarterback.

 

Going back to the aforementioned quote, in layman’s terms it effectively means when you’re confused by a specific blitz look in pass protection and don’t know who to block, just block the defender closest to you that possesses the shortest path to the quarterback. Simple enough, right? Right.

 

Inside-Out - yale football

 

Back to the Global Macro Grind

 

In many ways, being a global macro research analyst is a lot like being an offensive lineman. There’s way too much to know, far too little time to learn it and it always feels like the entire world is hell-bent on confusing you. The sum of it all can be quite a bit frustrating if you let it get to you.

 

As we outlined in our 8/9 Early Look titled, “Where’s China?”, my frustration with being on the wrong side of emerging market beta in the YTD eventually became too much to bear.

 

Enter fundamentals. The entire point of constantly practicing basic techniques and reviewing schematic themes is twofold:

 

  1. It slows the mental aspect of the game down, allowing one to make better decisions under pressure; and
  2. It simultaneously speeds up the physical aspect of the game, allowing one to simply react to the opponent’s movement, rather than thinking about what one’s own movement should be in response.

 

Within our global macro framework, we’ve identified three core fundamental factors that help up slow this game down by explaining away the preponderance of factor exposure performance:

 

  1. Growth
  2. Inflation
  3. Policy

 

Moreover, we’ve found that triangulating these factors in differential fashion leads to investable conclusions, across asset classes, at both the country and regional levels.

 

How I feel about the outlook for EM beta right now is a lot like how I would feel when confronted by an exotic blitz scheme – unsure of what exactly to do.

 

On the bullish side of the ledger, the U.S. successfully avoided dragging the global economy into recession (for now) and global financial stress is now making lower-highs across a variety of key volatility, flow and funding metrics – which is very positive for capital flows into EM assets (insomuch as it was negative in the ~18 months prior to JAN ’16).

 

On the bearish side of the ledger, the two factors that helped perpetuated the aforementioned catalysts – i.e. USD depreciation and a complete dissipation of “policy normalization” expectations in the U.S. – have seemingly run their course.

 

Lacking conviction in the direction of EM beta from here, I find it best to rely upon my “inside-out” technique – or in this case, GIP fundamentals. Specifically, I think country-picking is the appropriate play call until we get additional clarity on the top-down factors affecting EM beta from here.

 

As we outlined in the aforementioned note, EM assets have enjoyed fantastic run-ups throughout much of the YTD, so naturally, a good place to begin hunting is screening for countries whose markets have meaningfully underperformed their GIP fundamentals (potential longs) and those who have commensurately outperformed (potential shorts).

 

There’s a thousand ways to skin this cat and believe us – we did (we’ll present those additional findings in the days and weeks to come). For brevity’s sake, however, we’ll focus on one quick and dirty way to accomplish this, which is by regressing dollar-denominated equity market returns off of their respective YTD lows vs. the delta in composite PMI readings off of their respective YTD lows.

 

Does the market improvement match the economic improvement? If not, what is the probability the latter catches up to the former?

 

Regressing the aforementioned factors across the 16 emerging market economies we could find with available data yielded a positive correlation of +0.87. Even excluding outliers Brazil and Russia yielded a positively-sloping regression line with a correlation of +0.35 (see: Chart of the Day below for visualization).

 

The key takeaway is that investors have generally paid up for economic turnarounds in EM throughout the YTD. Assuming that holds true, which economies have outperformed and underperformed their growth trajectories?

 

  • Underperformers: China, Malaysia, South Korea, Taiwan and Turkey
  • Outperformers: Chile, Indonesia, Mexico, Russia and Thailand

 

Below we quickly profile the GIP fundamentals of each of the aforementioned economies on a trending rate-of-change basis in addition to highlighting what our Bayesian overlay implies for the upcoming 2-3 quarters in Hedgeye GIP Model “Quadrant” speak.

 

The simple risk management takeaway is to establish small long/overweight positions in the underperformers with good fundamentals and establish small short/underweight positions in the outperformers with bad fundamentals. We can build upon or reduce these exposures with the advent of incremental analysis.

 

UNDERPERFORMERS

China: DO NOTHING – the policy outlook appears to convoluted to trade

 

  • Growth: generally trending lower across the preponderance of key high-frequency data
  • Inflation: generally trending higher across the preponderance of key high-frequency data
  • Policy: getting easier at the margins
  • GIP Model Quadrant Outlook: LOL… Beijing will print whatever GDP numbers it darn well pleases; the key to trading Chinese equities is front-running the onset or withdrawal of stimulus – which itself appears to be peaking

 

Malaysia: BUY/OVERWEIGHT – as growth appears to have bottomed mid-year

 

  • Growth: generally trending mixed across the preponderance of key high-frequency data
  • Inflation: generally trending lower across the preponderance of key high-frequency data
  • Policy: getting easier at the margins
  • GIP Model Quadrant Outlook: #Quad2 throughout 2H16 and 1Q17

 

South Korea: DO NOTHING – but look to buy on a pullback within the next 4-6 weeks

 

  • Growth: generally trending higher across the preponderance of key high-frequency data
  • Inflation: generally trending lower  across the preponderance of key high-frequency data
  • Policy: getting easier at the margins
  • GIP Model Quadrant Outlook: #Quad4 in 3Q16, #Quad2 in 4Q16 and 1Q17

 

Taiwan: BUY/OVERWEIGHT – as the recovery in growth should persist through year-end

 

  • Growth: generally trending higher across the preponderance of key high-frequency data
  • Inflation: generally trending higher across the preponderance of key high-frequency data
  • Policy: getting easier at the margins
  • GIP Model Quadrant Outlook: #Quad1/2 throughout 2H16, #Quad4 in 1Q17

 

Turkey: DO NOTHING – the GIP outlook is too mixed to trade

 

  • Growth: generally trending lower across the preponderance of key high-frequency data
  • Inflation: generally trending lower across the preponderance of key high-frequency data
  • Policy: neutral
  • GIP Model Quadrant Outlook: #Quad2 in 3Q16, #Quad4 in 4Q16 and #Quad2 in 1Q17

 

OUTPERFORMERS

Chile: DO NOTHING – the good news is priced in

 

  • Growth: generally trending sideways across the preponderance of key high-frequency data
  • Inflation: generally trending lower across the preponderance of key high-frequency data
  • Policy: getting easier at the margins
  • GIP Model Quadrant Outlook: #Quad1 throughout 2H16, #Quad3 in 1Q17

 

Indonesia: DO NOTHING – but look to short on strength within the next 4-6 weeks

 

  • Growth: generally trending higher across the preponderance of key high-frequency data
  • Inflation: generally trending lower across the preponderance of key high-frequency data
  • Policy: getting easier at the margins
  • GIP Model Quadrant Outlook: #Quad1 in 3Q16, #Quad4 in 4Q16 and #Quad3 in 1Q17

 

Mexico: SHORT/UNDERWEIGHT – as tighter policy perpetuates a reversal in growth

 

  • Growth: generally trending higher across the preponderance of key high-frequency data
  • Inflation: generally trending higher across the preponderance of key high-frequency data
  • Policy: getting tighter at the margins
  • GIP Model Quadrant Outlook: #Quad4 in 3Q16, #Quad3 in 4Q16 and 1Q17

 

Russia: DO NOTHING – the good news is priced in

 

  • Growth: generally trending higher across the preponderance of key high-frequency data
  • Inflation: generally trending lower across the preponderance of key high-frequency data
  • Policy: getting easier at the margins
  • GIP Model Quadrant Outlook: #Quad4 in 3Q16, but back to #Quad1 in 4Q16 and 1Q17

 

Thailand: SHORT/UNDERWEIGHT – as tighter policy perpetuates a reversal in growth

 

  • Growth: generally trending higher across the preponderance of key high-frequency data
  • Inflation: generally trending higher across the preponderance of key high-frequency data
  • Policy: getting tighter at the margins
  • GIP Model Quadrant Outlook: #Quad3 throughout 2H16 and 1Q17

 

*NOTE: Clicking on each hyperlinked country name will download its respective economic and financial market summary table.

 

The risk management summary of the preceding exercise is as follows:

 

  • LONGS: #1. Malaysia (EWM) => #2. Taiwan (EWT) => #3. South Korea (EWY)
  • SHORTS: #1. Mexico (EWW) => #2. Thailand (THD) => #3. Indonesia (EIDO)

 

All told, there’s more to come from us in the coming days and weeks on this topic of EM country-picking, as well as where to allocate fixed income assets, at the margins (i.e. hard currency, local currency or corporate paper). Our inclination is to prefer the latter two asset classes over the former, but the sustainability of capital inflows into EM from here will be the deciding factor on whether or not they play-catch up or continue to lag.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.46-1.60% (bearish)

SPX 2164-2192 (bullish)

VIX 11.03-14.65 (bullish)
EUR/USD 1.10--1.13 (bearish)
YEN 99.33-102.89 (bullish)
Oil (WTI) 40.26-47.53 (bearish)

Gold 1 (bullish)

 

Keep your head on a swivel,

 

DD

 

Darius Dale

Director

 

Inside-Out - 8 18 16 Chart of the Day


The Macro Show with Darius Dale Replay | August 18, 2016

CLICK HERE to access the associated slides.

 

 

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


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Re-visiting Volatility's Asymmetry

Takeaway: Below we expand on our recent conversations and empirically supported evidence that investors are increasingly more bullish.

In the summer of 2014 we introduced our #volatilityasymmetry theme for our Q3 deck which turned out to be a, at minimum, a good call-out at all-time lows in cross asset volatility. Below we revisit that theme with a series of charts and tables outlining current behavioral bullishness (or lack of conviction on the short-side).

 

Highlights:

  • Total U.S. market short-interest has been cut by 13% to a new YTD low currently (Feb. 2016 was the top, and July 2015 was the most recent trip to current levels).
  • With the market at all-time highs on peak forward multiples, realized shorter-term volatility in the S&P is at a level not seen since the summer of 2014 when the CBOE skew index was signaling a much more cautious market than it is now.
  • Looking passed the VIX and S&P 500 implied volatility which is subject to ETF structuring and rebalancing ativity, implied volatility premiums over realized ranges have tightened further on a relative basis among a sample of S&P 500 constituents - this, despite realized volatility testing cycle low 2014 levels depending on the lookback window. 
  • The MOVE Index is at level not seen since 2014. Looking at high-yield credit in resource-related sectors, spreads have nearly tightened to broader indices when indexed to July 2014 (pre-USD breakout). With commodity-linked spreads tightening, net futures and options positioning among the 17 commodities we track on a weekly basis is registering a z-score >1x net long in 9 out of 17 commodities.

----------

We speak of S&P 500 net non-commercial futures and options positioning regularly. Index + e-mini positioning has been cut the last couple of weeks, but it’s still pinned near a multi-year high. Along with futures and options positioning, total U.S. market short-interest has been cut 13% since February and the CBOE skew index indicates a market that is positioned much less cautiously than it was in the summer of 2014, at least in volatility terms:

 

Re-visiting Volatility's Asymmetry  - S P CFTC Net Futures and Optons Positioning

 

Re-visiting Volatility's Asymmetry  - Total U.S. Market Short Interest

 

Re-visiting Volatility's Asymmetry  - CBOE Skew Index

 

Re-visiting Volatility's Asymmetry  - S P EV EBITDA Multiple

 

Along with equity market volatility not far off cycle-lows, implied volatility across the treasury curve (MOVE INDEX) is at a new low not seen since 2014. Looking at commodity-leveraged sectors, spreads have reverted to the broader index since breaking out with the USD in July of 2014. Following the S&P and asset price reflation in general, of the 17 commodities for which we track net futures and options positioning on a weekly basis, 9 are registering net positioning a >1x on a TTM z-score basis (and that’s with the bearish seasonality affect at this time of year in grains):

 

Re-visiting Volatility's Asymmetry  - Treasury Bond Volatility and Spreads

 

Re-visiting Volatility's Asymmetry  - HY OAS

 

Re-visiting Volatility's Asymmetry  - CFTC Table

 

And perhaps the most notable call-out, the following table looks at a random sample of 23 S&P 500 members, with a collective beta of 1.22. Short-interest has been cut over the last 6-months in 17 of those 23. Looking at Equity market skew, bombed out protection always has a bid, ESPECIALLY in the S&P. We realize it’s a more liquid and easier to trade in size. However, looking at overall levels of volatility (at-the-money implied vs. realized), realized vol. in the S&P is looking at taking out 2014 lows, and with it has gone the VIX.

 

Yet despite anemic volume and tightening ranges to all-time equity market highs, implied volatility in many of the names below has been hit harder than realized vol on a relative basis. The yellow columns furthest to the right look at the premium that implied is bid over realized ranges. Right now, despite the move to near cycle lows in realized volatility on the S&P (of course this depends on duration), 19 of 23 have implied volatility premiums that are >1x TIGHTER than 60D realized volatility. So forward-looking volatility premiums (over realized) are much tighter depsite near-cycle lows in trading ranges. We may expand the 23 to look at this more closely, but some of the offers look interesting if you’re skeptical this lasts.  

 

As we mentioned in this morning’s early look, valuation multiples, while important, can look illogical for long periods of time, but getting a grasp on consensus positioning and sentiment is a key part of our the process. Whether by capitulation or forward-looking opinion, the move to beta is becoming increasingly a reality. 

 

Re-visiting Volatility's Asymmetry  - S P Sample Dashboard

 

Re-visiting Volatility's Asymmetry  - Realized Volatility

 

Ben Ryan

Analyst

 

 

 

 

 


TGT | Losing at Defense

Takeaway: Winners find a way to win. But TGT points fingers while #failing to reinvest for growth.

The obvious place to start the conversation on TGT would be on the numbers, and the company gave us plenty of ammo to poke holes in the print this morning. But we think the far greater concern for the long-term health of this company is the lack of definable plan or any clear insight by the management team as to what actually caused the worst quarterly comp number since the data breach and subsequent guide down for 2H16. We heard a lot of excuses, everything from Apple products losing their cache, to deflation, e-commerce pressure, and soft Rx traffic. Which all may be legitimate in their own right – but we have a NEWSFLASH for Cornell and team...

 

This is something we like to call RETAIL. The environment/consumer isn’t going to throw anyone a bone, especially at the tail end of a seven year economic expansion. In this sport, only losers point fingers. Stocks that make investors money on the long side find a way to win. Target is doing the opposite.

 

All in, we think this is all very characteristic of a management team playing defense instead of offense. Need further evidence? How about 2 consecutive quarters of earnings beats generated by cost cuts and share buy-backs with the stock at or near all-time highs. We’d argue that the team in Minneapolis would be better served missing expectations and taking down numbers by 2x the rate we saw today in order to build a superior platform from which to grow.

 

That may sound harsh, but after running through the numbers and sitting through the 60-minute conference call, we were still left asking what actually happened? In the absence of a clearly articulated answer from the TGT C-Suite, here’s what we think is playing out…

1) Competitive dynamics evolving: TGT has one of the least enviable competitive sets in all of retail stuck, right smack dab in the middle of four unique competitors – 1) WalMart, 2) Department Stores, 3) Dollar Stores, and 4) Supermarkets. As a bonus, it has Amazon.com hovering over its head plucking away every last sales dollar it can. The bookends of that are the real callouts, with WMT investing its way to flat earnings growth over the next 4yrs and AMZN taking 25% of the incremental sales dollars spent by the consumer. Both have huge implications for TGT, who clearly isn’t winning or investing.

2) TGT underinvesting: That’s on a relative and absolute basis. SG&A per square foot was down 0.7% in the quarter, and that’s in the face of WMT taking SG&A/sq. ft. up 9% as it spends on e-comm/stores/labor in order to propagate positive store traffic. TGT is content with managing expenses to free up $2bn in cost savings in order to invest at a measured pace. Without a considerable step up in the investment line, we have a hard time seeing how TGT wins as the competitive dynamics continue to evolve in favor of the other guys.

3) Market share loser: Retail has been a bit fickle over the past 6 months to say the least. But we think that given the prior two points, TGT is facing the brunt of that tough environment to a greater degree than its most immediate peer group. And that’s because there isn’t a clearly articulated strategic or capital investment plan in place in order to win in any environment. We saw the company lose share for the first time since the data breach hangover, and we expect that to continue as the two points cited above compound to make TGT a net loser.

 

So what does that mean in dollars and cents? We get to $4.60 in 2018 vs. the street at $6.25. The components of that number are a 1% comp (20% e-commerce growth and flattish store comps) and margin contraction to the tune of 20-30bps per year driven by both GM deleverage and an uptick in SG&A. On that, we’d argue a generous low double digit earnings multiple for a zero square footage growth retailer positioned as a market share loser. That’s a stock in the low-50’s, good for 25%-30% downside from current levels.

 

 

Additional Details On The Quarter:

 

A Lot Promised, But No $ Allotted

We heard about a dozen or so initiatives the company is working on internally as part of the long-term plan, and the projects run the gamut from investing in people, self-checkout lanes, digital assets, to back end infrastructure. Those all fall under the overarching theme which is boiled down into the phrase, ‘initiatives to drive future growth’, that TGT management throws out when it communicates with the Street. The only problem is that there is a considerable mismatch between the number of projects the company speaks to on any given conference call and the actual dollars allocated to those projects.

 

For TGT, the numbers speak for themselves, with SG&A/Sq. Ft. still in negative town down 0.7% in the quarter on TTM basis. The company can tout its $2bn cost savings plan all it wants (we thought it was particularly strange to see that as the number two bullet point in this morning’s earnings release) but the fact of the matter is that a cost savings plan isn’t going to support top-line acceleration. Not when WMT is investing a boat load to eat TGT’s lunch supported by SG&A/sq. ft. up 9% in 1Q (a number we expect to stay elevated when we see numbers out of the company tomorrow). At the same time, AMZN steps up its marketing and fulfillment spend in order to continue to take share. For AMZN, the numbers work out to an incremental $5bn in marketing/fulfillment expense over the past 12 months to support an incremental $20.5bn in revenue, with the expense rate up 90bps.

Bottom line, TGT is not getting it done.

TGT | Losing at Defense - TGT SGA

 

Traffic Slowing, Why?

That’s a fair question, and one that we don’t think was answered during the duration of the 60 minute conference call today. We heard a lot about a tough consumer environment, weekly/regional volatility, and apples of multiple varieties (tech and food), but very little concrete detail on what the company actually has in the works to stop the bleeding. This is an important point on the TGT story from here. The benefit from the data breach is now in the rearview, much of the improvement in the ‘signature categories’ has been recognized over the past two years, 20% of its revenue base is broken and that’s food, and we think most importantly, the company is being bombarded from all sides from the competitive set which includes, WMT, AMZN, dollar stores, grocery stores, and department stores.

From here (outside of price, which has its own margin implications) we can’t point to any material initiatives the company has in the pipeline to offset a decelerating comp trend. There are a few private brands (Cat & Jack, Pillowfort), continued investment in out-of-stocks, duct-tape work on the grocery division, regionalization, and digital spend. But none of the efforts are being allocated the capital needed or the marketing dollars behind them in order for the company to play offense and take market share.

TGT | Losing at Defense - 8 17 2016 growth slowing

 

Losing Share Like Never Before

Pre-data breach, TGT was good for 2-3% points of the incremental consumer outlays in retail category per quarter. It took an obvious step back in wake of the data breach, and recognized a snap back in demand as the company restored consumer confidence and recognized part of the Cornell plan. Fast forward to where we are today and TGT in this quarter just posted its biggest market share decline we’ve seen over the past 6yrs. Some of that is due to the sale of the $4.2bn Rx business, which we don’t adjust for in the chart below. The biggest callout from where sit is the bifurcation between a relatively healthy retail sales figures (ex Auto/Food Service/Gas) which has been in the 3.5% on a TTM basis and TGT’s decelerating comp store sales into negative territory for the first time since 1Q14. We think that’s due in large part to the following…

1) AMZN: If you run the same math on AMZN as we did with TGT, you’ll see the guy’s in Seattle carving out a bigger and bigger part of the incremental retail dollars. 2x the rate from a year ago and good for 25% of the incremental retail dollars. Compare that to TGT at -1.8%. That pressure isn’t going away unless TGT implements a material capital investment plan to beef up its e-commerce operation.

2) Stores: TGT no longer has the benefit of sq. ft. growth. Not that it had a big tailwind back in 2011-12, but it’s now in sq. ft. consolidation mode with smaller format store growth offsetting some of the big box closings. That means that traffic needs to be earned organically or online. Which brings us to point 3...

3) Digital: TGT owns one of the most underfunded and underdeveloped e-commerce operations in retail. The company took the operation in house from AMZN in 2011 and since that time, sales have grown to ~4% of total. Sales in the channel grew just 16% in the quarter, 40% the rate the company promised two years ago when it spoke to a 40% e-commerce growth CAGR (the company has since talked down expectations). There is a clear divide between the e-commerce winners and TGT. Unfortunately for them, the ante chip to play the game just went up with WMT’s $3.3bn acquisition of Jet.com.

TGT | Losing at Defense - 8 17 2016 TGT   of US retail


Cartoon of the Day: Yield

Cartoon of the Day: Yield - Euro Zone cartoon 08.17.2016

 

In the past year, other than the U.K.'s FTSE, European equity market drawdowns range from the German DAX's -3% to -29% for Italy's FTSE MIB.


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