Valhalla (vahl-hah-luh): the hall of Odin into which the souls of heroes slain in battle and others who have died bravely are received.
You know those days where the slow layering of geopolitical, fundamental and market structure risks finally builds to a palpable crescendo, critical thresholds get breached amidst acute volatility clustering and a begrudging consensus finally acquiesces to a market phase transition, birthing a fevered frenzy to characterize a new investing equilibrium and Trending macro regime.
Those days where you can feel it in the air and on the tape, an amorphous but tangible energy erecting an existential bridge forever dividing time between before & after.
.… Yesterday was not one of those days.
Although with the SPX moving >1% for the 49th time this year (vs. 8 in 2017), the Nasdaq moving >3% for the 3rd time in a month and realized tech vol clocking in at the 100th-percentile on a 5Y basis, the collective angst was reverberating.
Back to the Global Macro Grind ….
When we say ‘tops are processes, not points’, the last 6 weeks is what we’re talking about. You don’t get frequent and recurrent market dynamics and a Trending breakout in volatility like the above when growth is accelerating, inflation expectations are anchored and ‘Goldilocks’ is ascendant.
Remember, simply, how this works. Slowing Growth drives negative earnings revisions. Slow growth and stagflationary environments also don’t get a multiple …. and a lower multiple on a lower earnings estimate = compound (price) compression.
It’s not particularly complicated – although pervasive factor crowding (think AMZN = tech = consumer discretionary = growth = momentum = a constituent of pretty much every factor basket of consequence) and modern market structure provide for more harrowing price reflexivity, particularly alongside a forced reversal in factor flows which have cumulated uni-directionally alongside the longest period of accelerating growth ever.
Elsewhere across Global Macro, oil continued to confound Iran supply bears, dropping for an 11th straight day, Italy is set to burn its budget bridge with Brussels with one hand while extending the other for a BTP-centric QE bailout, European sentiment fell -12pts in Germany In November and to -22 at the Eurozone level, the Yuan’s date with 7-handle destiny appears increasingly baked, and Apple led this week’s iteration of tech underperformance as November looks to one-up the worst month for growth relative performance in 10-years in October.
Filtering those same developments through the prism of our existing macro themes:
Strong Dollar + Oil/Commodity disinflation continues to deflate inflation expectations as a driver of nominal yields, Europe slowing remains an entrenched reality that should remain entrenched nearer-term, China continues to succumb to base effect gravity (slowing against uncomp’able stimulus and the associated macro fundamental and monetary policy divergence with the U.S. and the attendant implications for the currency, equities and rates) and Growth/Beta/Momentum remains a Quad 4 underweight.
Again, none of this started during yesterday’s trading:
- European GDP peaked in late 2017
- China/EM peaked in early 2018
- USA peaked in Q3 of 2018
And the Trending macro reality across all of those markets won’t end during today’s session.
In other words, the Quad 4 playbook we’ve been harping on since September 27th remains the risk management blueprint.
Another thing that did not start yesterday - and to make a hard pivot to some bottom up developments – is our short call on RDFN.
For those unfamiliar, we got bearish on the real estate services company back in August of last year, post-the IPO at ~$24/share.
The conceptual crux of the thesis isn’t overly complex – Redfin markets itself as a tech company and has thus far garnered a tech multiple. It does have legitimately impressive technology and data capabilities, but at its core it remains a discount brokerage and has increasingly evolved towards the traditional brokerage model as it has matured. This is not a simple question of semantics. The bull case is absolutely dependent on Redfin being seen and valued not as a real estate broker, which they maintain they are, but rather as a tech company where profitability is a question for another day.
Consider how we contextualized current valuation in the context of the latest results in reviewing 3Q18 earnings:
Redfin generates neither positive net income nor positive EBITDA on a full-year basis. As such, it's a bit difficult to benchmark from a valuation standpoint. One novel approach we've undertaken is to compare it on the basis of market cap relative to market share. Real estate brokerage competitors Realogy (RLGY) and Re/Max (RMAX) have market caps of $2.1bn and $570mn, respectively, while also having market shares of 16% and 10%. This equates to a valuation range of $60 - $130mn per point of market share. By contrast, Redfin has 85 bps market share and a current valuation of $1.35bn. This equates to a valuation of $1.6bn per point of market share, or roughly a multiple 12x that of Realogy and 26x that of Re/Max. While it's true that Redfin has higher growth than Realogy and Re/max, consider what's implied by these valuations. Redfin is growing market share at 14-15 bps/year and currently has 85 bps market share. This trajectory implies it will take Redfin 60 years to reach 10% market share and 100 years to reach 16% market share. So either growth needs to accelerate dramatically (revenue growth has, in fact, decelerated dramatically) or the current valuation appears unsupportable. We wouldn't go so far as to argue that $60-130mn is the right valuation. Redfin is growing, after all. But assume the company continues growing 15 bps/year for the next ten years. In 2028 they'll have 2.35% market share, which today would be worth $140-300mn vs the current valuation of $1.35bn. Email if you’d like to discuss the idea further.
It’s been a series of lower lows over the past year and suffice it to say, with slowing top-line growth, worsening margins and disappointing guidance characterizing the latest quarter, our view and outlook remains unchanged.
And from a top-down perspective, a trending breakout in volatility is not the bullish cultivator of unprofitable, story stocks.
It needn’t represent portfolio Ragnarok though either.
Vol represents the expectation for price movement and moving prices represent opportunities, provided you are on the right side of them.
The halls of Vol-halla remain open to the data-dependent souls who measure, map, and proactively risk-manage 2nd derivative inflections.
“Don’t waste your time looking back, you’re not going that way” (Ragnar Lothbrok)
Our immediate-term Global Macro Risk Ranges (with intermediate-term TREND views in brackets) are now:
UST 10yr Yield 3.05-3.25% (bullish)
SPX 2 (bearish)
RUT 1 (bearish)
NASDAQ 7111-7600 (bearish)
Utilities (XLU) 52.99-55.78 (bullish)
Consumer Staples (XLP) 54.60-57.29 (bullish)
REITS (VNQ) 77.26-81.66 (bullish)
Industrials (XLI) 68.80-73.92 (bearish)
Nikkei 219 (bearish)
DAX 111 (bearish)
VIX 15.61-24.25 (bullish)
USD 95.65-97.77 (bullish)
Oil (WTI) 57.85-64.57 (bearish)
Nat Gas 3.41-3.99 (bullish)
Gold 1191-1225 (neutral)
Copper 2.60-2.80 (bearish)
Christian B. Drake
U.S. Macro Analyst