THE BIG PICTURE
|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.
|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:
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 27thremains 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.
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)
Revision Ratios Analysts get more cautious – but don’t raise the red flag yetGrowth 10 & Value 10 Growth 10 & Value 10 – November 2018US Economic Viewpoint Inflation in pictures- a contained overshoot
|What do you do when you see a Counter TREND Bounce?
It’s Macro Monday here @Hedgeye. When trying to answer this critical risk management question, the process of contextualizing weekly moves across multiple factors and durations matters more than almost anything else.
Let’s start with the global currency market:
Note that @Hedgeye TRENDs remain bearish in places like Brazil and Mexico despite their “political catalysts” and, in the case of Mexico, the grand resolution to Trump’s alleged “Trade War.”
If you watch mainstream TV, everything is always all about Trump and the “Trade War”… but how helpful has that Macro Tourism been to improving your returns or process in 2018?
Measuring and mapping the economic cycle in rate of change terms? Now that’s the stuff of championship alpha this year. If last week (the 1st up week in the last 6 for the US stock market) was counter to how you’re positioned, you’re in my camp:
This, of course, came on a nice month-end markup and some “really nice” tweeting from Trump about discussions with China’s Xi, who subsequently chirped Donald this weekend (which wasn’t nice).
Looking at the Sector and Factor Exposures within the US Equity market, the biggest losers of the past few months had the biggest bounces:
Imagine AFTER that kind of a bounce, you’re DOWN -4.7-10.9% for 2018 YTD? That’ll leave a performance and process mark. But it’s actually not as bad as the YTD score is for portfolio’s that are long things like China, Europe, and EM:
Down -11.3-19.1% YTD, post the bounce? #ouchy
With both Asian and Italian Equities resuming their crashes and declines this morning, did the @Hedgeye TREND change? Nope. Neither did our Quad 4 call in the USA.
On that front, while US Treasury Bond Yields bounced on the US Wage Inflation news on Friday, the most obvious components of headline inflation continued to break-down:
A) The CRB Commodities Index deflated another -1.6% last week to -0.8% YTD and remains Bearish @Hedgeye TREND
This ensures the INFLATION #Slowing component of our Quad 4 in Q4 call. The GROWTH part is, as always, data dependent too. Last week’s ISM #Slowing report for OCT should be the first of many that Trump may need a counter TREND tweet to offset!
If You Don’t Trade Equities, Pay Them No Mind: Trader’s Notes
(Bloomberg) — Forgive me for being mystified, but I find the juxtaposition of headlines that list the number of pipe bombs sent to prominent citizens with claims that the equity market looks oversold and is due for a bounce unsettling and distasteful. The authorities warn that more such devices may be out there, yet global markets are beginning to bounce in Europe and the U.S. as risk sentiment improves.
- And yet, traders remain confused as to why risk hedges haven’t been responding proportionately to a 9 percent sell-off in the S&P 500. If you ever needed more proof that financial markets have become disengaged from the real world, let alone the economy, here it is
- Equity markets may have to come to terms with no longer being the sacred asset class around which the entire monetary policy framework revolves. I just don’t see a single central bank changing their plans based on recent price action. Stock traders undoubtedly feel like the character Bart when facing a hostile crowd in Blazing Saddles and Reverend Johnson says, “Son, you’re on your own.” Of course, if the analogy is apt, shares will eventually see new highs. Famous last words, I realize
- Whether it was the Bank of Canada’s overtly hawkish comments when they raised rates yesterday or Norges Bank’s hawkish hold today, they are showing what they see as the way forward. The BOC was even so bold as to remove the word “gradual” from their statement. And ECB President Mario Draghi, while acknowledging the recent economic slowdown and the challenges raised by Italy, was not willing to concede any changes to well-telegraphed policies
- Investors are simply going to have to learn to live with a new reality. And we may finally get to see what they are made of. Proof positive, one way or another, whether this is all merely a financial bubble or not. The global economy may experience periodic ups and downs but what monetary policy makers are beginning to form a consensus around is things just aren’t as bad as official interest rates suggest
- The world may be having a growth spurt. Not the economic boom kind, but evolving to the point where it is normal to simultaneously have one country tightening and another adding liquidity
- All of which depends, of course, on the working assumption that those driving geopolitics don’t derail everything with their own policy mistakes and hubris. Which is a leap of faith they are forced to make, even as it gets harder all the time
- There are a few levels to watch today to see where immediate sentiment lies. Gold is the most obvious. It still doesn’t want to overcome even the lowest layer of resistance which runs from $1236 through $1250. Although, a trader told me yesterday that watching the equity meltdown, he was grateful to have bought the metal. Small consolation to the end of day P&L
- The fall in Treasury yields has felt almost grudging rather than a true change of heart. But if you see 10-year yields starting to leak through 3.08% take a very careful look at what is going on. And it didn’t take much for yields to scoot back above 3.12%. Like gold, the moves have so far stopped where they should to express concern but certainly no panic
- On another note, the dollar is making another attempt to break to the upside. It has failed here before. But don’t think it needs to wait to get past the midterms to do whatever it is going to do anyway
- NOTE: “Trader’s Notes” are authored by Richard Breslow, a former FX trader and fund manager who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice