The Economic Data calendar for the week of the 25th of October through the 29th is full of critical releases and events. Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.
This note was originally published at 8am this morning, October 22, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“Being powerful is like being a lady. If you have to tell people you are, you aren't.”
America (she) is a great country and I’m proud to be an American! When are we going to behave like the powerful nation we are?
Sadly, of late, we need to keep reminding people how powerful we are. We do have tremendous power and this is a great nation, but right now we lack the backbone and the political leadership to make the tough decisions to get us on the right track. (And, no, I do not believe the Tea Party is the answer).
Case in point #1 - Treasury Secretary Tim Geithner
Mr. Geithner is in the hot seat today because he is representing the USA on the world stage in Seoul, South Korea at the G20 summit this weekend. His quotes in the WSJ yesterday are a sign of weakness, not strength. Just one example: “We would like countries to move toward a set of norms on exchange-rate policy." Seriously, the Chinese are having a field day with that comment. As issuers of the world reserve currency, it’s embarrassing that successive administrations have led us down this path.
Another embarrassing quote: "Right now, there is no established sense of what's fair". What? C’mon, Mr. Geithner, what is not fair? Given his record of paying taxes, some might find it amusing that Geithner is our guy in Seoul, making the moral case. Some might say he lacks legitimacy in such a claim. The same might be said by the international community: why is America pointing fingers when it is plainly obvious that failed economic policies and Washington DC dogma has rendered the U.S. economy and currency in their present states? The Chinese march to the beat of their own drum and look out for their interests. What part of that is not fair?
The countries with strong economic and fiscal policies are being forced to embrace capital controls to slow the inflows of speculative cash that is coming from the USA. It’s not unfair, it’s embarrassing! Nobody cares about the losing team complaining about the officiating or the lack of sportsmanship from the other team; at the end of the day, all that is remembered is who lifts the trophy.
Case in point #2 - Failed Washington policies - Stress Tests 2 is on the way
I could go in multiple directions with this one (TARP, Healthcare reform, etc….), but despite the Dodd-Frank financial regulatory act, the US financial banking system is still facing a high level of systemic risk. The foreclosure fiasco is posing systemic risks to a number of financial intuitions, and I don’t believe the first round of bank stress tests contemplated a breach of contract in securitized mortgages. This is a problem. Who knows what other omissions the stress tests made from their “analysis”?
While today is the 103rd anniversary of the Panic of 1907, which led to a run on the Knickerbocker Trust Company, we are seeing another crisis emerge at a number of large financial institutions. The 13% month-to-date decline in Bank of America is not a run on the bank, but it’s frightening nonetheless. There is no immediate threat of Bank of America being insolvent, but the damage to the bank’s reputation is immeasurable and the financial liability is uncertain.
If we have learned anything over the past two years, the downside scenario is that the losses are likely greater than the $47 billion that a few institutions want back. Importantly, the latest round of uncertainty in our financial system is not helping consumer confidence and will make most financial institutions more cautious about extending new credit, further slowing the recovery.
It would seem that it’s just a matter of time before the Stability Oversight Council created by the Financial Regulatory Act orders Stress Tests 2.
Case in point #3 - No credible plan
While Mr. Geithner can cry this weekend that things are not fair, nobody in Washington (Democrat nor Republican) has put forth a credible plan to fix the nation’s problems except for more QE.
As my colleague Daryl Jones noted in a post yesterday on Canada, for the second time in the last 30 years, the Canadian Dollar is now worth more than the US Dollar. In short, Canada cut spending and improved the corporate tax environment, which narrowed the deficit and reduced government borrowings.
Austerity, not quantitative easing, will provide Mr. Geithner the respect he needs to be powerful on the world stage. Leaders make brave decisions at difficult times; there is no evidence of strong leadership on either side of the aisle in Washington today.
The S&P 500 is up 3.4% so far this month, on the back of the FED printing more and more money. The potential headwinds for the market are seemingly being ignored (for now) but won’t go away. The headline risks from the mortgage mess, slowing GDP momentum, margin pressure from higher commodity costs and lingering worries about the backlash that could emanate from the divergent fundamentals at work in the foreign exchange market can’t be solved by the FED and QE.
Margaret Thatcher was a leader that was unafraid to take a stand. She was a divisive figure in Britain, and around the world, and remains so today. I believe that America’s leadership could learn much from her example. She allowed the gales of creative destruction to blow through the nation’s economy and many fault her for the demise of the mining industry in Britain in the 1980s.
On that same point, many applaud her confrontation of the unions and credit her with reestablishing Britain as a world power. My point here is that she made difficult decisions, perhaps made mistakes at times, but showed the leadership that was needed to boost her country.
Much like President Obama, Thatcher had a record-low approval rating during her tenure as Prime Minister. On average, it was 40%. History has been much kinder; a survey conducted by Yougov/Daily Telegraph in the United Kingdom in March 2008 rated Baroness Thatcher as the leader Britons regard as the greatest post-World War II prime minister, receiving 34% of the vote. Sir Winston Churchill came in second, with less than half of Thatcher’s support, at 15% of the vote. Politicians that make tough decisions are not always appreciated immediately.
Doing the right thing is not always easy. The administration needs to realize that instant gratification and pandering for votes is not going to set this country straight.
Function in distaster; finish in style,
VFC For TRLG? Not a Chance
The rumor mill is saying that TRLG is exploring a sale – and it absolutely should before margins collapse. Any buyer with half a due diligence process should realize this. VFC has learned its lesson with 7.
The good ‘ol rumor mill is churning this fine Friday afternoon. An interesting one is that True Religion has hired Goldman to explore a sale, and that VFC could be interested. Now… the first part of that might very well be true. After all, this is the exact time TRLG should sell – before margins erode further as the company tries to establish itself as a lifestyle brand with more of a direct-to-consumer (i.e. Retail) strategy. This will fail. Any buyer with half a due diligence process should realize this. That brings us to the second part of the rumor – that VFC is interested. Not likely… Let’s YouTube VFC on its acquisition of 7 For All Mankind.
VFC’s PREMIUM DENIM SRATEGY
VFC’s tone is changing on its premium denim line, 7 For All Mankind, as it hits a critical juncture in the contemporary brands portfolio. The original business of 7, which was purchased at the top of M&A cycle in 2007 for $775 mm, is under pressure as premium denim is no longer selling at price points it once did. Average price has now fallen from a peak $180 to $150, down 17%. Despite oversupply and weakening prices in the premium denim space overall, VFC is following its original growth plan for the brand. Such strategies include opening retail locations, expanding internationally, and extending product line offerings beyond denim and into sportswear and accessories. The challenge however lies in the fact that the wholesale channel is suffering (primarily department store distribution), the retail stores aren’t performing as well as Vans and North Face stores, and overall contemporary coalition margins are being deluted by investment spend with no near-term incremental revenue return.
Most notably, management’s tone has changed on the company’s quarterly conference calls. What was once the trio of investment spending – North Face, Vans, and 7 For All Mankind – has now become the duo with a side of everything else - 7 included. It will likely be a long time before $200 jeans return on such a widespread scale. There’s no question that there will always be a niche market for premium denim, just not one that shares distribution and price points all the way from Macy’s to Barney’s. With that said, we’re more likely to hear about efforts to diversify the product assortment from 75% denim to 66% and ultimately lower as original expectations for the “lifestyle” denim brand are paired back. 7 stores will still be opened but this is not a needle moving strategy at this point or in the near future. If one thing was clear on yesterday’s call, it’s that the company’s growth drivers remain rooted in North Face, Vans, and in Asian (China) expansion.
The 7 For All Mankind YouTube:
Conclusion: Recent moves in the Brazilian bond market have been attributed to the “currency war”, but analysis of the fundamentals suggest the moves are warranted. While we don’t currently have a position, we remain favorably disposed to the Brazilian real against the U.S. Dollar over the long term.
Yesterday, Brazilian Treasury officials walked away from a debt auction for the first time since July 22, citing bids that were deemed “unreasonable”. Why they think bids are unreasonable after effectively squeezing out half of the investor base, is beyond us. Earlier in the week, Brazilian Finance Minister Guido Mantega raised taxes on foreign inflows on fixed income investments (for the second time this month) to 6% (from prev. 4%) and to 6% on margin deposits for futures (from prev. 0.38%). A loophole that allowed Brazilian financial institutions to swap assets to foreigners was also closed.
The aggressive move to curb real appreciation brought on by inflows of dollars has triggered a bond market sell-off, with yields on Brazil’s longest fixed-rate securities increasing 60bps this week to 12.08%. Today’s failed auction highlights the lack of domestic demand needed to sustain Brazil’s “low” interest rates, causing Treasury Secretary Arno Augustin to suggest Brazil will have to accelerate international sales of real-linked bonds to counter waning domestic demand.
Brazil, like every other emerging market growth country, has been guilty of riding the yield-chasing liquidity wave brought on by expectations of QE2 in America. And while self-imposed, yesterday’s failed auction tells us exactly what direction the real is headed alongside Brazilian interest rates – up.
Mantega may be successful in slowing down the rate of real appreciation vs. the dollar in the intermediate term with taxes and regulation, but longer term, the fundamentals driving Brazilian interest rates higher will be tough for him to overcome:
Fiscal Policy: The latest polls show voter support for Lula endorsee Dilma Rousseff is growing; she currently has an 11-12% margin over rival Jose Serra and is likely to win the October 31st runoff election, barring any catastrophic campaign mistakes. This is meaningful as it relates to the direction of Brazil’s debt/deficits, as she is on record saying promoting spending cuts is a “crime”. Her fiscal policies are in stark contrast to the much more austere Serra, whose previous surge in the polls sparked a bond market rally. Currently, Brazilian government spending is growing more than twice the rate of GDP, and with Rousseff’s promise for continuity with Lula’s welfare policies, we don’t see that changing anytime soon. Further, her lax spending policies create incremental support for the next factor we outline below:
Inflation: September marked the first sequential uptick in Brazilian inflation in five months, coming in at +4.7% YoY vs. +4.5% in August. Prior to that, inflation was being tamed by the strengthening real, which is up around 3% YTD. We have been increasingly cognizant of the likelihood that the dollar finds an intermediate-term bottom around in the $78-$82 range. Should the dollar strengthen marginally over the next three months, as we expect it to, we will see downward pressure on the real over the near term, limiting Brazil’s ability to fight inflation with FX appreciation alone.
Moreover, demand from Brazilian consumers is being supported by a significant confluence of tailwinds. Brazil’s unemployment rate fell 50bps MoM to a record low in August, coming in at 6.2%. Average real incomes also increased +1.3% MoM and +6.2% YoY and the latest data (April-July) show Brazilian consumer borrowing rates are at the lowest level since 1995 (6.74% per month).
All told, the direction of fiscal policy and consumer demand will continue to put upward pressure on Brazil’s inflation rate over the intermediate-to-long term, necessitating the need for future rate hikes. While we don’t currently have a position, we remain favorably disposed to the Brazilian real against the U.S. Dollar over the long term, largely based on diverging growth prospects. As mentioned, over the intermediate term, the dollar could catch a bid from 1) hawkish fiscal rhetoric from the likely-to-be Republican Congress; 2) mean reversion; and 3) widespread reflexive declines in equities and commodities globally.
In case you missed the 15 second teaser spots on Monday Night Football this week, we remind you that Under Armour’s basketball launch hits the marketplace tomorrow. Interestingly, Foot Locker appears to have locked up THE key player in the whole marketing effort, Brandon Jennings. He’ll be appearing at a Milwaukee mall for the launch. No, not the UA flagship store in Maryland. The Foot Locker in Milwaukee. Who cares? Footlocker and UA do. This is a subtle but relevant start to a partnership that historically got off on the wrong foot (pun actually intended). Look for FL to be a key component of the basketball strategy as it moves beyond its four shoe debut.
Beyond UA, we’re also including a banner ad from today’s ESPN homepage. Yes, the NBA starts up again this weekend so it makes sense to see an increasing marketing push behind the category. However, we point out another subtlety which supports our ongoing thesis that the retailers win when R&D, marketing, and competition heat up in the space. Take a look at the co-op branding below. Can you guess who paid for this one?
Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.