“There is only one side of the market and it is not the bull side or the bear side, but the right side.”
-Jesse Livermore
Jesse Lauriston Livermore was one of the first great stock market operators. His early profits in stocks were not actually in stocks, but came from betting in so called “bucket shops.” These were effectively gambling establishments in which one could bet on the direction of stocks without owning the stocks. Sound a little like today’s derivatives and futures markets?
Livermore was eventually banned from Boston-area bucket shops for winning too much money, so he moved to New York to trade in legitimate markets. Over the course of his career he gained and lost several fortunes but was probably most well-known for his timely short bets.
Famously, he followed a hunch and shorted the Union Pacific Railroad in 1906 ahead of the San Francisco earthquake. His first big macro call was to short the market during the Panic of 1907. This time working on more than a hunch, he had the view that there was a lack of capital to provide a bid for stocks. Therefore, as the selling forced investors to sell from margin calls, there would be no buyers to absorb the selling.
Livermore was proven correct in this thesis and walked away from the Panic of 1907 with a tidy profit of $3 million. He then subsequently lost 90% of this gain on a bad cotton trade later in 1907. Eventually, and despite declaring bankruptcy, Livermore regained his fortune during the bull market of World War I.
He noticed conditions similar to 1907 in 1929, so began short selling stocks broadly and added to them as they declined. By the end of the initial decline, Livermore had gained more than $100 million in short selling profits, which would be more than $1 billion in today’s dollars. He subsequently lost most of that fortune in untimely bets in the ensuing years.
Sadly, Livermore died an untimely death in the cloak room of the Sherry Netherland Hotel in 1940. It seems his losses and volatility got the best of him. Fortunately, for many stock market operators of the future, he left us with enduring lessons. A key one being stick to your #Process. By his own admission, Livermore mostly lost money when he violated his own rules.
Back to the Global Macro Grind…
As many of you know, the Hedgeye #Process adheres to combining macro with individual level security analysis. In our macro models, three things percolate to the surface every morning. Keith is on the road this morning, but below are the top three things in his macro notebook:
- EUROPE – the economic data continues to slow from its multi-year cycle peak with Dutch Consumer Spending slowing to +1.2% y/y (that would be very bad if we had that in the USA!) and FEB PMI readings in the red (slowing vs. JAN) across the board as Reflation Rolled Over in FEB – European Stocks and 10yr Yields Down again, diverging vs. US Treasuries again
- OIL – confirming my signal of lower highs vs. Reflation’s recent JAN peak with WTI down -0.8% this morning and am immediate-term @Hedgeye Risk Range of $58.43-62.95 so I don’t have that $65-67 level in play, for now
- UST 2YR YIELD – spikes to 2.26% this morning which is divergent from the Oil and European Bond Yield moves – part of this is headline news that consensus economists are taking their rate hike forecast to 4 in 2018 (market expects 3 – and I expect those expectations to fall if headline reflation data rolls over in FEB-MAR)
The benefit of this process for you subscribers that like to go both ways (long and short) is that in any given year we generate as many short ideas as long ideas. Three of our current top short ideas directly from our Sector Heads are as follows:
- CF Industries (Ticker: CF) – CF is a money losing produce of nitrogen fertilizers, an industry with excess capacity that continues to experience capacity growth. While some hope that demand growth will absorb this added production capacity, most vastly overestimate the rate at which demand grows. In the US, nitrogen fertilizer demand has contracted in recent years. Worse, the nitrogen fertilizer industry is highly fragmented and filled with non-economically oriented competitors. Many facilities are state controlled, and opt to produce nitrogen fertilizer rather than flare natural gas. Excess capacity should remain a persistent overhang.
- Starbucks (Ticker: SBUX) – Our top three concerns with Starbucks are:
- Leadership - For a Company like this, a retail operator would be better suited to lead the charge. As we have been saying, “technology may be the future, but they still have to get the coffee in the cup,” and Mr. Johnson has failed to do so, thus far.
- Comps are slowing - 2-year average consolidated SSS have slowed for five consecutive quarters, with consolidated traffic growth flat in the latest quarter. Management continues to tout the roasteries as a growth driver but we believe they are merely an attraction in key cities, that won’t elevate the consumer’s willingness to pay even more for a cup of coffee on a daily basis.
- ROIIC has fallen off a cliff! - With operating cash flow down ~8% YoY and capital expenditures expected to rise over 30% from $1.5B in FY18 to ~$2B in FY18, the question of SBUX’s profitability comes to the forefront.
- Hanesbrands (Ticker: HBI) - The company is obfuscating results (and share loss) by buying weak business at low teens multiples – when assets trade hands in this space historically at 4-6x. Incentives are ‘balance sheet agnostic’, which has levered the company to 4.0x. Until three weeks ago it risked a covenant breach at 4.5x – but renegotiated higher because tax bill actually went up to 15% from reported rate of 6%. Accounting is just on the legal side of unethical, and guidance is extremely aggressive for this year and next. We’re looking for either a series of cash flow guide-downs, EPS 60% below the street, and a violent re-valuation from 12x EBITDA to mid-single digits. 5x EBITDA = zero equity value.
If you’d like more detail on these short ideas, please ping .
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 2.75-2.92% (bullish)
SPX 2 (bullish)
RUT 1 (bearish)
NASDAQ 6 (bullish)
Biotech (IBB) 104-112 (bullish)
Energy (XLE) 66.20-69.37 (bearish)
Keep your head up, stick on the ice and stick to the #Process,
Daryl G. Jones
Director of Research
