While the macro outlook is negative, there’s opportunity out there for investors who choose their vehicles carefully, says Daryl Jones. He recommends that retail investors go long in the US dollar index, as well as some benchmark index components with good fundamentals and technicals. He also shares a couple of good short candidates.
Kate Stalter: Today I’m on the phone with Daryl Jones, of Hedgeye Risk Management. Daryl, I wanted to just start out by asking you for the macro view. Obviously, with so much going on in the geopolitical world, and with so much volatility in the marketplace, investors really would like somebody to set the stage, so help us out with that.
Daryl Jones: Just stepping back, we at times want to be careful about not being too pessimistic, but we also want to be realistic about what we see out there. Right now, our macro view is not all that positive.
A couple things that we would highlight, or have people focus on: The first is global growth, which has been slowing, and we think will continue to slow sequentially into the fourth quarter and first quarter of next year.
We’ve seen some of that in the US and Canada, and in Europe, but we think that’s also going to transition over to emerging markets. So generally people should get ready for this kind of global growth slowdown that’s here and will continue to come.
The second thing we would highlight is, correlations are really heightening. From our perspective, what this does is really heighten the opportunity for a crash.
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It’s not only markets that you’d expect to be correlated—like, say, North American equities, Canada and the US—but disparate markets, like Brazil and Germany, are correlated much more than they have been historically.
Then markets within markets are very correlated. In fact, the nine subsectors of the S&P 500 are as correlated with each other as they have been in 20 years. We really have a market that’s trading on macro factors with very high correlation.
Then the other key macro theme is: We think we’re in an environment where the US dollar is strong and going to get stronger. That’s because of both the weakness in the Euro, which we think is going to get pretty ugly, but also interest rates are going to start coming down across the world and catch up to the US.
A strong US dollar—and this goes back to the correlation point—is negative for commodities and global assets that are priced in the dollar. This, we think, could lead to a correction in key commodities like oil, copper, but even potentially precious metals, where a lot of people have been hiding, like gold and silver.
Kate Stalter: So when investors are saying it seems like not too much is working, they’re not imagining that—it’s real.
Daryl Jones: Yes, it’s unfortunately very real. Not a whole lot has been working, and what’s been working is really staying under-invested, so staying in cash.
What we think will continue to work is having exposure to the US dollar. Globally, once again, markets are very correlated, and until really we get some resolution in Europe—which we think could take a long time—the best tack here is to pick your spots and/or stay on the sidelines.
Kate Stalter: Having said all that, Daryl, one of the things that Hedgeye does is publish stock ideas. I’m sure there are quite a few caveats and cautions at this point, but what are some of the names that may be catching your attention?
Daryl Jones: The way our business works for retail investors, like you said, is we have a newsletter that we publish every morning at 8 a.m., which is kind of the overview of our macro thoughts.
And then we have stock alerts or stock ideas that we effectively manage like a real-time portfolio—we call it the "virtual portfolio." So Keith, our CEO, will be trading the portfolio, which generates ideas or trade signals for our clients.
There are definitely some things that we do like. On the long side, like I mentioned, one of our favorite positions right now is the PowerShares DB US Dollar Bullish Fund (UUP).
The key reasons there, as I mentioned, we think central banks around the world are going to start cutting rates as opposed to increasing rates, which they’ve been doing for the last year, so that’s going to make the US dollar look more favorable. We think that ultimately a bailout in Europe is going to be massive—on the side of multiple trillions—which once again will make the Euro very weak, and lead a favorable strength response in the US dollar.
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Then on the margin, I think the fiscal situation is actually improving in the US, whereas in Europe it’s probably getting worse. We really like the dollar at this point.
Another interesting long idea, which is probably somewhat contrarian—but this is the time where you get an opportunity to buy great businesses at good prices—is Marriott (MAR), the hotel chain. From what our checks have been showing, business spending is actually hanging in there, so business travel and business spending is doing OK, despite the consumer struggling generally in the US.
Hotels, especially on the business side, are seeing some pricing power, so RevPAR [revenue per available room], we think, is going up sequentially in the 6% to 7% range, so you have some inherent growth.
Marriott is basically trading at, not its all-time lowest multiple, but very close to that, around 15 times forward P/E. Which doesn’t sound super cheap, but I think you have to put into context that this is a very high-return-on-margin business model, so the returns on equity of Marriott are in the 35% to 40% range and it’s trading at a low P/E multiple versus that.
Then the other key thing, a positive benefit of the credit crunch we’ve seen over the last few years: There haven’t been a whole lot of new hotels built. There’s somewhat limited capacity in the hotel industry in the US.
Kate Stalter: Daryl, before you go on to name another stock, let me just follow up on Marriott. Does Hedgeye use concepts like oversold, for example, in the case of something like a Marriott?Daryl Jones: The way our process works is, we combine what we’ll call both fundamental analysis—looking at the prospects of the actual business or the stock—then quantitative analysis.
The quantitative analysis is what some people might call technical, although it’s not technical in the traditional sense. We look at price, volume and volatility of a given security, and we have an algorithm that will spit out buy signals or sell signals, as the case may be.
So what we really try to do is marry the quantitative model we have with kind of the fundamental research and analysis. It’s sort of timing, plus a favorable fundamental outlook.
Kate Stalter: OK, great. You had some other names, too?
Daryl Jones: Yeah, a couple shorts. It’s obviously a great environment to make money on the short side.
The first one, which is a bit of a darling, is LinkedIn (LNKD). The case here is really, as much as anything, the macro environment. We just don’t think this is an environment where anyone is going to want to own a momentum stock like LinkedIn, let alone a momentum stock that is currently trading at 216 times 2012 earnings.
Not that it doesn’t have inherent growth, but a lot of that growth is already priced into the multiple. It’s also trading at ten times 2012 revenue.
The market cap is over $7 billion, and the projected revenue for 2012 is $750 million. I think it’s a valuation and expectations call, but also the macro call.
The other thing that we’re picking up on the margin is Internet advertising, which is a key part of their model, is actually slowing on the margin. You’ve seen this in recent results from Yahoo (YHOO), Google (GOOG), and InterActive Corp. (IACI).
Kate Stalter: OK, so that’s one short recommendation. Anything else out there?
Daryl Jones: You know, and this is not a contrarian call given what the stock is doing today, but we’ve been negative on US financials for a good part of the year, and Citigroup (C) is one we’re quite negative on.
The bottom line is, the consensus earnings for Citigroup in Q3 are 86 cents per share, and in Q4 they’re 94 cents per share. We think those numbers could at least get cut in half, if not by Q4 be closer to break-even or show a loss.
The key issue with financials—and in particular a financial stock like Citigroup—is that net income margin is narrowing dramatically, so their business model effectively is borrowing short and lending long. But with the yield curve compressing both naturally and because of the Fed’s Operation Twist, the margins for the banking sector in the US are effectively going away.
I think that’s starting to get priced in, but people haven’t quite realized how dramatically negative that’s going to be for earnings for financial stocks. So Citigroup is one we’d stick to on the short side.
Kate Stalter: Anything else you think investors or traders ought to be taking a look at these days?
Daryl Jones: Let’s try to spin a positive light. This is an opportunity to buy, and will become even more so an opportunity to buy, great companies at a great price.
Some more consumer-oriented names, but names that are more levered to the the global consumer, which we like, are McDonalds (MCD) and Starbucks (SBUX). These are class-A companies with incredible balance sheets, great management teams that know how to execute, and they’ve really put themselves in a position where they’re not overly dependent on the North American consumer or the European consumer.
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These have really become global brands, global companies...where even if emerging Asia slows, they still have really great inherent growth there. In these kind of market dislocations, buying world-class companies like this is a real opportunity.
Kate Stalter: Any forecast in terms of some of these companies? Because obviously some of the names you just mentioned, Starbucks, McDonalds, they are trading off their highs in this current market. Is it better to wait for some kind of buy signal, or enter now, when you can get these at a low price? What’s your take on that?
Daryl Jones: With Marriott, that’s a stock that we currently have in our virtual portfolio, and have been consistent with our clients. So we think it’s a name that they should own.
That’s consistent with both valuation, the direction of fundamentals, but also what our quantitative model is telling us. I think Marriott is at around the $25 price right now, and certainly something we would be long at that level. [Marriott is actually trading around $28 just before close on Wednesday—Editor.]
Even both Starbucks and McDonalds, once again, we think that even if there is another leg down in the markets, they’re companies that have very stable cash flows, and at these kind of price levels will hold up even if there is a further market correction.
Starbucks is trading at roughly $37, and it’s off its 52-week high, but we think earnings and return-on-capital basis is still a compelling level.