Our Retail Analyst's 'Killer Chart' of the Day

"Risk happens slowly at first, then all at once."


Those are the words our firm's Founder and CEO Keith McCullough is fond of reminding our subscribers. It's in that spirit of risk management that we highlight a complimentary, extended excerpt of our Early Look market newsletter. While written most mornings by McCullough, today's is by veteran retail analyst Brian McGough. He shines a light on an important issue global investors should be keeping a close eye on.




...People are talking about Trump’s anti-China move in naming Dr. Peter Navarro as Assistant to the President, and a new role of Director of Trade and Industrial Policy. Seriously, the dude wrote a book called Death by China, describing the risk that China's form of capitalism and militarism poses to the future of the US. 


Yeh…I get it, protectionism is bad for Retail margins without a corresponding offset in the form of higher wages and stimulated consumer spending. In other words, a pair of Air Jordans may cost $50 more, but the consumer can afford it so it does not matter (well, not really, but that’s the Trump argument).


But what I think people are missing is that this would – quite rapidly – undo the biggest consumption trend most of us have seen – in any industry – in our careers. Consider the following.


1) Before 1994 there was a protectionist measure in place (simply referred to as Import Quotas) that limited quantities of apparel that we could import from non-WTO countries. Yes, that meant that we could only import fixed quantities of goods from these countries (let’s simply call all of those countries ‘China’ for arguments sake).

  1. That meant that we could only import about 1mm pairs of denim, a few million pair of socks, and maybe 200k ugly holiday sweaters, etc…
  2. This measure was lobbied by Warren Buffett and others who had acquired a nice little portfolio of North Carolina-based apparel manufacturing plants, and were threatened by Chinese labor.
  3. At that point in time, the consumption norm in the US was about 30 units per capita. Plainly put, each of the 270mm Americans alive at that time purchased an average of 30 garments per year. Yes..some bought 100, and some bought 3, but you get the drift.


2) HERE’s the key..Starting in the late 1990s, we started to see apparel import quotas phased out. It took the better part of 7 years – though the factories starting jockeying in price wars to secure a customer base in a post-quota environment. That, my Macro-Loving friends, was the beginning of tsunami of apparel deflation that lasts through today.  Consider the numbers…

  1. From the 1990s, we saw the cost of apparel come down by 5-10% per year – every year for two decades.
  2. Yet the CPI for apparel only came down by only 2-4% annually. So that means that the brands, retailers and virtually everyone in the supply chain had a multi-billion dollar kitty to boost margins every year (by about 700-1,000bps in total).
  3. That allowed the industry at large to both boost margins AND pass lower costs through to consumers in order to boost per capita unit consumption.
  4. That is anomalous in every way. Most of the time, when this happens we see either consumption OR margins take off. Not both. But in this instance, we saw both.
  5. The punchline is that this trend boosted per capita unit consumption to 84 units!
  6. I’ll say that again, the average number of units purchases by US consumers on a per capita basis more than doubled over 25 years.
  7. This is a paradigm change. People bought lower quality stuff at far lower prices, and simply cycled those every 3-4 years instead of every seven years (remember the 7-year fashion cycle? That was effect, not cause).


3) This ultimately took the barriers to entry down to the point where lousy brands (by our standards) could fill the shelves at the Kohl’s and JC Pennys of the world, and actually allow the bottom of the barrel retailers to earn money, while also allowing short-sighted investors to say ‘but they’re so cheap on cash flow’.


Here’s the killer chart folks.


Our Retail Analyst's 'Killer Chart' of the Day - mcgough chart

"The World Was Gloomy Before I Won," Trump Says. Exactly!

"The World Was Gloomy Before I Won," Trump Says. Exactly! - trump sunshine


President-elect Donald Trump took a victory lap Monday night on Twitter writing, "The world was gloomy before I won - there was no hope." Trump cited stock market returns since his election and Christmas-time spending as proof that this shroud of economic anxiety has finally lifted. It would appear, he is already "Making America Great Again."


The U.S. Economic Outlook Strengthened After Trump's Win


It's true. Since Trump's Election Day victory, U.S. equity markets, bond yields and the U.S. Dollar have rallied. Consumer, Homebuilder and Business Confidence are all rising. U.S. economic growth is strengthening (though recently reported, this had nothing to with Trump since the data was recorded well before Election Day). Third quarter GDP came in at +1.7% year-over-year growth, an acceleration of 0.4 basis points versus the prior quarter.


This stands in stark contrast to a nasty slowing U.S. economy that slowed for five consecutive quarters, from the peak of 3.3% in March 2015 to the bottom of 1.3% in June 2016.


Recent macro market moves are characteristic of what we call QUAD 2 (when both economic growth and inflation are accelerating). In this environment, sector exposures like Financials, Industrials, and Tech outperform.


That's exactly what's been happening:


  • Russell 2000 (the small cap, domestic play on the U.S. economy): +0.5% last week; fourth quarter to-date gain +10.8%
  • US Dollar Index: +0.1% last week; fourth quarter to-date gain +7.9% 
  • Financials (XLF): +0.9% last week; fourth quarter to-date gain +23.8%
  • Tech (XLK): +0.8% last week; fourth quarter to-date gain +3.0%
  • Industrials (XLI) were up another +0.7% on the week; fourth quarter to-date gain +8.9% 


Stocks highly correlated to the market (otherwise known as "high beta") continue to outperform. High beta stocks are up 21% year-to-date versus 9.6% for equities less tethered to market performance (otherwise known as "low beta").

Strong Dollar Lifts U.S. Equities (Hammers Gold, Emerging Markets)


As you can see in the Chart of the Day below, the U.S. Dollar has a 90-day correlation to the S&P 500 of 0.7, which means, over the last 3 months, when the dollar rises or falls so too does the broader equity market. Conversely, Gold doesn't like #StrongDollar so much (with a correlation of -0.96 over the same period). The barbarous relic is -13.4% so far this quarter.


Meanwhile, Emerging Markets stocks have been getting shellacked. The MSCI Emerging Markets Index was down another -1.7% last week, taking its Q4 loss to -6.8%.


"The World Was Gloomy Before I Won," Trump Says. Exactly! - Strong Quad2 CoD 2

The Silver Lining For Japanese equities


The fourth quarter to-date has been especially kind to investors in Japanese equities. The Nikkei is up a monstrous +18.1% in the quarter, putting it back in the “green” at +2.1% year-to-date. The playbook is pretty simple there: Dollar Up = Yen Down = Nikkei Up. Take a look: The Japanese Yen is down -13.6% versus the dollar for the fourth quarter.


A quick recap...


It's pretty simple what you do from here: As U.S. growth continues to accelerate, expect the U.S. Dollar to rise, U.S. stocks to go up (Financials, Technology, Industrials), Japanese equities up and Emerging Markets and Gold down. 


Thanks Donald.

The U.S. Economy: Growth Accelerating

The U.S. Economy: Growth Accelerating - growth 22


There's no simpler way to say this, the U.S. economy is accelerating.


Yesterday's final revision to third quarter GDP showed a 20 basis point bump to +3.5% (on a quarter-over-quarter basis) that translated into +1.7% year-over-year growth (up 40 bps versus the prior quarter). That means, after five consecutive quarters of slowing U.S. growth (from the peak of 3.3% in March 2015 to 1.3% in June 2016) the trend finally flipped. (See the Chart of the Day below.)


The U.S. Economy: Growth Accelerating - 12.23.16 EL Chart  3


Meanwhile, Durable Goods data, reported yesterday, decelerated to -1.9% year-over-year. No surprise there. The ramp in private aircraft orders (choppy & volatile) juiced the October headline number. 


As you can see in the chart below, Durables Ex-Defense & Aircraft (a better proxy for household demand) was up +0.6% month-over-month and improved to +1.2% year-over-year. 

Where do we go from here?

Here's Hedgeye CEO Keith McCullough in today's Early Look:


"Post yesterday’s economic data, our GIP Model (predictive tracking algorithm) has GDP accelerating again in Q4 to +1.94% year-over-year = Quad2 (i.e. U.S. growth accelerating, inflation accelerating)  = Bullish for U.S. Dollar, Rates, and Stocks."


Simple as that.


The U.S. Economy: Growth Accelerating - Durable Goods

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Is The U.S. Stock Market Actually Expensive & Should You Sell It?

Is The U.S. Stock Market Actually Expensive & Should You Sell It? - expensive image

The stock market is expensive. 


No doubt about that.


But does that matter? And does the S&P 500's price-to-earnings ratio of 21 times mean the stock market is going to crash tomorrow?


Another valuation favorite: Currently the S&P 500 Index has a CAPE Ratio of 28.26. That measure is the cyclically adjusted price-to-earnings ratio, commonly known as the Shiller P/E. It's calculated by dividing price by the average of ten years of earnings (moving average) and adjusting for inflation.


It's true. Bull markets are hard to come by with a CAPE ratio this high. As Hedgeye Senior Macro analyst Darius Dale points out in today's Early Look about CAPE at 28.26:


"That’s in the 96th percentile of all readings (dating back to January 1881). If you concentrate on the trailing 30-year time period – which is arguably far more relevant than readings 100+ years ago – its 83rd percentile reading is still elevated, though not by as much."


Dale points out, over the past 30 years, "At this current extreme CAPE Ratio, the expected value of buying the S&P 500 today is +1.2%, -3.8% and -5.3% on a 1-year, 3-year and 5-year forward basis, respectively."


As the Chart of the Day below shows, these outcomes pale in comparison to lower decile (meaning CAPE Ratios in the bottom 10% of readings over the last 30-years). When the CAPE ratio is in the bottom 10%, forward 1-year, 3-year and 5-year returns are 4.2%, 9.2% and 17.2%.


This isn't a reason to sell stocks today. There is a significant amount of variability around these averages. Here's Dale again:


"Over the last 30 years, the average of the top ten 1-year forward returns of CAPE Ratio readings between the eighth and ninth decile is +31.1%. Can you afford to miss a +31% move to the upside in your benchmark?"


That's the point. As Hedgeye CEO Keith McCullough says, "Valuation is an opinion." It's the prevailing macro conditions that dictate what happens to both the P (price) and E (earnings). In short, expensive can always get more expensive and cheap can always get cheaper.


The question you should be asking yourself, is U.S. economic growth accelerating?


We think it is. That's why we told subscribers to buy stocks. 


Is The U.S. Stock Market Actually Expensive & Should You Sell It? - CoD 12 22 16

Can U.S. Stocks Continue Higher? This Volatility Measure Says Yes

Can U.S. Stocks Continue Higher? This Volatility Measure Says Yes - rollercoaster


We're within striking distance of the all-time highs in stocks. Are U.S. equities overbought? 


The short answer is ... not yet (especially if we're talking about the S&P 500).


Digging a little deeper, the longer, more comprehensive answer lies in measures of stock market volatility. This is a tricky one. But stick with us. The implications are deeply revealing.

First, some basic definitions:


  • Realized Volatility = Historical Volatility (of an asset over a given time period)
  • Implied Volatility = Future Volatility (the volatility that investors expect in the future based on current options market positioning)


In short, if investors expect volatility to rise in the future, you would see higher implied volatility than realized volatility (and vice versa). This is called the volatility premium (where implied volatility exceeds realized volatility) or discount (if implied is below realized).


Obviously, the real money in financial markets is made by selling things that are overbought and buying things that are oversold. Right now, as seen in the Chart of the Day below, S&P 500 volatility (over a 30-day period) is trading at a 25.8% premium. This means that investors are really concerned about markets near all-time highs and downside risks, like valuations, so their expectations of future volatility went up.


But this is a kneejerk reaction that is most likely overdone. Basically, when the premium stretches to these levels, it comes back to more normalized levels. Lower volatility is bullish, as formerly fearful investors capitulate and buy stocks.


Conversely, look at the discount in Energy stocks (XLE) of -26.5% (again, over a 30-day period). This suggests the recent run-up in Energy stocks (up +9.4% in the quarter-to-date) is probably overdone.


Again, this implies investors have exhuberantly piled into the Energy stocks. Volatility and downside risk is in the offing. That's also why Hedgeye CEO Keith McCullough issued an overbought signal in the Oil & Gas Exploration & Production ETF (XOP) in Real-Time Alerts yesterday.

so, What does it all mean?


It means that on a relative basis, the S&P 500 is a buy versus Energy stocks (or the Nasdaq). Add-in our positive outlook for the U.S. economy and you get a recipe for equity markets to head higher.


For more on our suite of investing products click here.


Can U.S. Stocks Continue Higher? This Volatility Measure Says Yes - 12.21.16 EL Chart

Can U.S. Stocks Make New All-Time Highs? Yes

Can U.S. Stocks Make New All-Time Highs? Yes - trump sig image


(In case you were wondering, that's Donald Trump's signature emblazoned across the bull above).


The Donald's largely unexpected Election Day victory delivered financial markets the jolt it needed to push U.S. stocks to all-time highs. We're now just shy. Is the #TrumpTrade over?


Many institutional investors think so. According to data from the CFTC, on futures and options contracts data, institutional investors are very short the S&P 500. To be exact, as you can see below in our Chart of the Day (from today's Early Look), they are as short today as they were in April of 2016.


Remember: Back then, it was just two months after the S&P 500 bottomed, a result of the Fed's pivot from hawkish (the December rate hike being the first in a decade) to dovish on deteriorating economic data. On the Fed's about-face, small cap stocks went from crashing (the Russell 2000 was down -24% from the July peak to the February lows) to a massive bull market run. The Russell 2000 is up 20.8% year-to-date. 


Once again, we think, investors are too bearish when economic data favors the bulls. 


Everything from Retail Sales to Industrial Production to Durable Goods reports are showing improvement. Meanwhile, measures of consumer, business and homebuilder confidence are hitting cycle highs. For the time being, Trump has convinced most of the country he can, in fact, "Make America Great Again. Let's call it, "Trumphoria."

What does it all mean for U.S. stocks?


In today's Early Look, Hedgeye CEO Keith McCullough writes:


"Looking at current consensus macro positioning (CFTC futures & options data), I’d bet that the current net SHORT position of -127,358 contracts in the SP500 Index burns off. And the bull will mature, no matter how many people missed making the pivot."


in other words ... The #TrumpTrade lives.


Can U.S. Stocks Make New All-Time Highs? Yes - 12.20.16 EL Chart

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