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Your Greatest Victories

This note was originally published at 8am this morning, November 15, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Never forget that sometimes your greatest victories can come from your greatest defeats.”

-Drew Brees

 

Last week was a great week for global macro risk managers. By week’s end, with correlation risk to the US Dollar running at all-time highs (Dollar UP = stock, bonds, commodities, etc. DOWN), a gigantic global mean-reversion trade captured victory.

 

With the US Dollar Index recouping +1.9% of its value (week-over-week), here were some of the major correlation moves:

  1. SP500 = -2.1% (the market’s worst week in the last 3 months)
  2. Russell 2000 = -2.3% (we covered our short position last week)
  3. Euro = -2.9% (we shorted the FXE on 11/4 and remain short it)
  4. Commodities (CRB Index) = -3.2% (intra-week we moved up our asset allocation from zero to 3%)
  5. Oil = -2.3% (no position – we sold our oil on 11/3)
  6. Gold = -2.2% (no position)
  7. Copper = -1.3% (no position)
  8. Volatility = +12.9% (we sold our long VXX position on strength last week)
  9. 2-year US Treasury yields = +13 basis points or +35% to 0.50% (we remain short SHY)
  10. 10-year US Treasury yields = +26 basis points or +10% to 2.79% (we remain long PPT)

Putting price moves in context is always critical. Having been short the Burning Buck from June 7th to November 2nd, I get the bear case (DEFICITS + DEBT = CONGRESS). Inclusive of the US Dollar closing UP for the 2nd consecutive week, it’s important to acknowledge that the Debauched Dollar is still down for 19 out of the last 24 weeks and has plenty to prove before it regains any semblance of credibility.

 

That said, THE risk management question this morning is: Can a TRADE higher in the US Dollar become a TREND?

 

TRADE, in Hedgeye speak = 3 weeks or less. Whereas a TREND = 3 months or more. Global macro TRENDs back-test with much higher batting-averages in our risk management model than TRADEs. However, all TRENDs start as TRADEs, so you have to be Duration Agnostic.

 

I bought the US Dollar (UUP) in the Hedgeye Portfolio on November 4th and I remain long of it this morning. Consensus is still short the US Dollar and I can assure you that consensus is not comfortable with that position.

 

Here are the lines that matter in my model for the US Dollar Index:

  1. TRADE = $77.11
  2. TREND = $80.69

What that means is that what was immediate-term resistance for the US Dollar ($77.11) is now support and there really is no significant resistance (provided that the USD Index continues to make higher-lows) up to the TREND line of $80.69. In other words, there’s another +3.2% upside from Friday’s closing price of $78.08 and, consequently, plenty of correlation risk over the intermediate term for anything priced in US Dollars.

 

So what can keep an immediate-term bid to the Debauched Dollar?

  1. The Euro going down on legitimate sovereign debt risks rising (Ireland, Spain, Greece, Italy, Portugal, etc.)
  2. Fed Heads continuing to get hawkish on the margin (Jeffrey Lacker joins Kevin Warsh and Tom Hoenig this morning)
  3. US Treasury Yields continuing to breakout to the upside (2-year yields charging higher again this morning to 0.53%)

I’m not looking for bullish catalysts – these simply are bullish USD catalysts - particularly when you consider the “Bye-Bye, Bear” cover story that Barron’s was running on November the 1st. Bernanke’s QG (Quantitative Guessing) experiment has been YouTubed by the entire free and communist world at this point. If you didn’t know that QG = inflation, now you know. US inflation reports (PPI and CPI) will accelerate again sequentially when reported this week.

 

It’s a mathematical fact that Dollars are priced as a basket of other currencies, so I don’t think I’ll get much pushback on the Euro DOWN trade equating to US Dollar Index strength. I’ll definitely get pushback on the Fed Head thing – after all, the cornerstone of the Bull case on US Equities is built on Begging Bernanke for free moneys as insiders make their highest levels of sales since December.

 

On that not so little squirrel hunting signal that the world calls Mr. Bond Market however, it will be very difficult for people to ignore these immediate and intermediate-term breakouts in US Treasury Yields. This is very new. And the risks in the Treasury market are very real.

 

The 30-year bond has been breaking down, big time, since mid-October. Long-term interest rates breaking out in the US as sovereign yields spike in Europe were 2 of the main risk factors associated with my getting out of stocks and commodities altogether in late October. While some of my greatest 2010 defeats came in the first week of November, the greatest victories in global macro risk management are potentially on the come.

 

My immediate term support and resistance levels for the SP500 are now 1188 and 1211, respectively. I remain short the SP500 (SPY).

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Your Greatest Victories - USD


SALES VS CONFIDENCE

Conclusion: Consistent with the Malcolm Knapp data we posted on earlier today, retail sales posted better that expected results.  However, it will be interesting to see if consumer confidence in November will support this trend. 

 

Some thought from today’s retail data:

  1. Retail sales posted a fourth consecutive month of top-line growth, although core sales, excluding auto dealers and gasoline stations, have decelerated for the past two months.
  2. The headline number was driven by strong auto sales; the 5% growth rate contributed more than two-thirds of the growth in top-line retail sales during the.
  3. Building supply stores, sporting goods and hobby sales posted growth of 1.9% and 1.0%, respectively.  Declines were seen in furniture stores, electronics and appliance stores, and department stores.

There are several important factors that are supporting spending in October:

  1. The S&P is down only one month in the past four, which has helped spending
  2. The headline job growth is a plus, but still remains sluggish
  3. Income has continued to rise slowly, despite less government support

On November 1st, I wrote a post titled, “Q4 THEME UPDATE – CONSUMPTION CANNONBALL” that outlined underlying trends pertaining to our thesis.  As I pointed out, transfer income is fading and taxes are on the rise.  This is clearly a negative for the consumer.  Below are the five bullet points from my 11/1 post:

  1. Both personal income and spending weakened in September.  Personal income fell 0.1%: the first decline since last September.
  2. The decline in income was driven by a $25.5 billion reduction in emergency unemployment insurance benefits.  Emergency benefits had boosted transfer income by $20.5 billion in August.
  3. Interest income (due to the Federal Reserve emergency interest rates fell 0.9% for the third straight month.
  4. Tax payments are up, driving disposable income down 0.2%.
  5. Real spending was up 0.1% driven by consumers diving into the savings rates which fell to 5.3% - matching its lowest level in over a year.

A sixth bullet point I would add to the list is illustrated in the chart below.  Despite the recent gains in Retail Sales growth, the consumer is not (as yet) getting behind it in terms of confidence.  The next release of this index, on November 30th, will be interesting to see.  The chart below suggests that this rally is unlikely to sustain itself long without a similar pickup in consumer confidence, especially with government subsidies waning and taxes increasing.   While recent jobless claims data was positive, with the rolling four-week average declining to 446k, the economy is still shedding too many jobs for any material improvement in the unemployment rate to be seen.

 

Howard Penney

Managing Director

 

SALES VS CONFIDENCE - retail sales confidence


CONFIDENT IN THE UPWARD SALES TREND? CONSUMERS AREN’T

Conclusion: Our Q4 Macro Theme, Consumption Cannonball, remains intact despite this morning’s retail sales print.  The next several quarters are setting up to be very difficult for the consumer based on very difficult year-over-year comparisons as government support diminishes.

 

Some thought from today’s retail data:

  1. Retail sales posted a fourth consecutive month of top-line growth, although core sales, excluding auto dealers and gasoline stations, have decelerated for the past two months.
  2. The headline number was driven by strong auto sales; the 5% growth rate contributed more than two-thirds of the growth in top-line retail sales during the.
  3. Building supply stores, sporting goods and hobby sales posted growth of 1.9% and 1.0%, respectively.  Declines were seen in furniture stores, electronics and appliance stores, and department stores.

There are several important factors that are supporting spending in October:

  1. The S&P is down only one month in the past four, which has helped spending
  2. The headline job growth is a plus, but still remains sluggish
  3. Income has continued to rise slowly, despite less government support

On November 1st, I wrote a post titled, “Q4 THEME UPDATE – CONSUMPTION CANNONBALL” that outlined underlying trends pertaining to our thesis.  As I pointed out, transfer income is fading and taxes are on the rise.  This is clearly a negative for the consumer.  Below are the five bullet points from my 11/1 post:

  1. Both personal income and spending weakened in September.  Personal income fell 0.1%: the first decline since last September.
  2. The decline in income was driven by a $25.5 billion reduction in emergency unemployment insurance benefits.  Emergency benefits had boosted transfer income by $20.5 billion in August.
  3. Interest income (due to the Federal Reserve emergency interest rates fell 0.9% for the third straight month.
  4. Tax payments are up, driving disposable income down 0.2%.
  5. Real spending was up 0.1% driven by consumers diving into the savings rates which fell to 5.3% - matching its lowest level in over a year.

A sixth bullet point I would add to the list is illustrated in the chart below.  Despite the recent gains in Retail Sales growth, the consumer is not (as yet) getting behind it in terms of confidence.  The next release of this index, on November 30th, will be interesting to see.  The chart below suggests that this rally is unlikely to sustain itself long without a similar pickup in consumer confidence, especially with government subsidies waning and taxes increasing.   While recent jobless claims data was positive, with the rolling four-week average declining to 446k, the economy is still shedding too many jobs for any material improvement in the unemployment rate to be seen.

 

Howard Penney

Managing Director

 

CONFIDENT IN THE UPWARD SALES TREND? CONSUMERS AREN’T - retail sales confidence


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Gold Diggers: Gold Levels, Refreshed

POSITION: Long Gold (GLD)

 

We bought back our position in Gold (GLD) this morning because: 

  1. PRICE: gold has corrected over -3% from its recent highs.
  2. CORRELATION: our immediate term TRADE correlation to the US Dollar Index has dropped to -0.10 (benign).
  3. DURATION: gold remains in what we call a Bullish Formation (bullish across all 3 of our TRADE, TREND and TAIL durations) 

Jim Grant, one of the best long-term macro analysts on Wall Street, wrote an outstanding editorial this weekend on Gold in the New York Times titled “How To Make the Dollar Sound Again. Amidst some classic Grant one-liners like, “we could not have printed it, but would have to dig for it”,  he called for the extreme bullish view on gold which would entail a return to some form of the Gold Standard that was in place from 1880 to 1914.

 

While we are very bearish on US fiscal and monetary policy, we aren’t ready to go where Grant went with his editorial, yet. That said, we are willing to subscribe to a model where gold is part of a much more diversified global currency reserve basket. The days of charlatans named Burns, Greenspan, and Bernanke Burning The Buck at the stake for the sake of their ideological beliefs about economic cycles is going by way of the horse and buggy whip.

 

Gold tested its immediate term TRADE line of support last week ($1360) and has no immediate term TRADE resistance to $1428. The extreme bullish case is very relevant to consider right now. That’s what perpetuates bubbles – the storytelling. And, oh, is this a good one.

KM

 

Keith R. McCullough
Chief Executive Officer

 

Gold Diggers: Gold Levels, Refreshed - 1


Ireland’s River Card

Hedgeye Portfolio: short Euro via FXE, short Italy (EWI)

 

Below we highlight a familiar chart of 10YR government bond yields from the PIIGS (Portugal, Ireland, Italy, Greece, Spain). Of note is the turn in Irish yields, a reflection of short covering and investor anticipation that Ireland will fall the way of Greece and receive a bailout. Beginning tomorrow, European official will meet in Brussels to discuss Ireland’s sovereign funding situation.  With an explosive deficit/GDP of 32% in 2010 (a significant share of which represent bank liabilities), the market is demanding a “fix” to the country’s outstanding fiscal imbalances.  While Ireland is pushing back on a bailout, claiming that a ~€20 Billion cash pile can cover its debt obligations into mid-2011, the market over the last three weeks is signaling that’s not enough, and that Ireland too must dip into the region’s Financial Stability Fund. Germany is particularly supportive of such a decision. This week we shall also hear from Allied Irish on its revised funding situation, which could further weigh on a bailout decision. 

 

We’ll have our eyes affixed on European meetings this week and next. Remember that European officials have seen this film before vis-à-vis Greece.  Six months ago that fire, along with the severe depreciation in the Euro versus major currencies, was quickly quelled with a €110 Billion bailout.  This time around we’re seeing the Euro weaken, down -4.3% versus the USD since 11/4 (we’re short the Euro via the etf FXE in the Hedgeye Portfolio)...the river card on Bailout Band-Aid Part Deux may not be far afield.   

 

Matthew Hedrick

Analyst

 

Ireland’s River Card - CDS15


Hedgeye Retail: 3x3x3

Here’s an update on our Three key themes, Three top longs & Three shorts.  We also include bulleted deltas that we picked up in our research over the past week that are worth noting.

 

 

THREE KEY RETAIL MACRO THEMES

 

1)      Consumption Cannonball: 4Q (i.e. now) will begin a period during which government subsidies subside, while expenses ramp creating increasing pressure on the U.S. consumer. Recent BEA data (11/4) shows that transfer income is fading and taxes are on the rise. Granted, this is September data, but the trend should continue. A few more bullets…

  1. Both personal income and spending weakened in September.  Personal income fell 0.1%: the first decline since last September.
  2. The decline in income was driven by a $25.5 billion reduction in emergency unemployment insurance benefits.  Emergency benefits had boosted transfer income by $20.5 billion in August.
  3. Interest income (due to the Federal Reserve emergency interest rates fell 0.9% for the third straight month.
  4. Tax payments are up, driving disposable income down 0.2%.
  5. Real spending was up 0.1% driven by consumers diving into the savings rates which fell to 5.3% - matching its lowest level in over a year.

2)      Raw Margins: The margin squeeze from raw materials is misunderstood given the lag between when product is ordered, raw materials are procured, and when factories set FOB prices. We’re seeing factories change the field goal in the middle of game play by simply not filling orders placed by certain customers due to raw materials/inventory/margin risk. Raw materials also head higher, and management teams we talk to are largely waiting to buy for Summer and Fall 2011 as they are ‘waiting for a pullback.’  If everyone is waiting for a pullback in prices, will the price relief ever come?

3)      3rd Derivative: The big margin killer in 2011 will not be the obvious hike in raw materials at the same time consumer trending trends down. That’s maybe good for 1-2 points in industry margins. But when we account for the unknown – which is ‘competitors and supply chain partners behaving badly’ in the face of obvious industry stress – we think that the total hit for the apparel industry in 2011 will be around 3-4 points at a mid-single digit top line growth rate. (i.e. the product is coming in…we know that. It WILL be sold, but at what price?).

 

LONGS

 

FL:

  • Continue to believe the triangulation of a step-up in the industry R&D cycle combined with Foot Locker-specific drivers including improved apparel assortments (now over 50% changed y/y), distinct banner segmentation, and inventory management will lead to a continued string of upside over the next several quarters. 
  • Weekly industry data, a recent pick-up in basketball momentum driven by key product launches, and anecdotal confirmation that the company continues to collaborate and partner with its suppliers all support our view that strategic initiatives remain on track to support near and intermediate term upside on both the top and bottom lines.  FL reports 3Q results on Friday, November 19th.
  • Our estimates remain comfortably ahead of the Street for this year at $0.93 vs. $0.86.  Expect 3Q results to show same-store sales at 5+% along with meaningful gross margin expansion.  Looking for $0.20 vs. Street at $0.16. 

LIZ:

  • 5-years of torture and pain finally coming to an end. The major issues plaguing the industry – excess inventories, cotton, and supply chain uncertainty, to name a few, do not even make the list as it relates to LIZ’s key opportunities.
  • Finally transitioned away from Macy’s and other ‘better’ department stores,  marking an end to a distracting and margin-dilutive transition. Now exclusive with JC Penney and QVC, which is a steady mid-single-digit margin, and more importantly, it is very light on asset intensity due to leverage in JCP’s sourcing organization.
  • Closing LIZ outlet stores, which were some of the least productive in all of retail.
  • Mexx (1/3 of revenue but losing money) is a massive lever that is finally swinging from negative to positive.
  • More upward revisions to come. There’s better than $1.00 in EPS power. A $6 stock could care less about that.

NKE/RL:

  • It’s a tossup at current prices which name is more attractive. RL or NKE.
  • Two things they both have in common are a) sheer organic top line momentum, and b) meaningful earnings upside in both the upcoming quarter and the next two years.
  • We think that there’s less good news in and around Nike right now. If we had to pick one, that’d be it.
  • There’s going to be a meaningful product step-up in the Spring that both the company and retailers have succeeded in keeping quiet. Note: that’s good for retailers as well.
  • Also, we like the lack of exposure to cotton with Nike.
  • People STILL don’t understand the impact and duration of its category rollout.
  • How can we ignore one of the greatest structural Yuan-appreciation stories in retail.

SHORTS

 

CRI:

  • Over-earning by at least 400bp. At peak margins and peak asset turns, but have not invested enough over the past 3 years of current CEO regime to sustain either metric without sacrificing top line.
  • CRI has not been focused enough on product and R&D, but rather on promotional cadence and inventory management. It is at a point in its own margin cycle where the top line MUST come through. Cotton prices 2x above last year, and recent turbulence with both KSS and WMT (the latter of which is completely re-building its apparel strategy) leave question marks in the mix.  The punch-line is that CRI is holding on too tight with its current productivity levels.
  • Our estimate stands at $1.85 next year versus the Street at $2.30. Street numbers have come down. But given the volatility in CRI’s retail sales and margins (retail is half of its overall sales, and 90% of the product is 40% off the first day it hits the floor) we think that the miss will not be a slow drip – but rather a meaningful event where investors are given ammo too challenge CRI ever earning over $2 again.

JCP:

  • In all the wrong spots as it relates to where you want to be at this point in the cycle – overexposed to a) middle America, b) apparel, c) private label, and d) weak management.
  • Remain unconvinced that company’s stated goal to drive $5 billion in incremental revenues over the next five years is achievable via a combination of new stores, new concepts, a same store sales CAGR of 4%, and accelerating e-commerce growth. 
  • Near-term profits being driven by expense cuts at the risk of further damage to the company’s customer experience and competitive positioning.  Gross margins likely to erode due to: peak gross margin compares, rising input costs with 50% of product exclusive or private label, and unfavorable sales/inventory spread which remains elevated entering the holiday selling season.  JCP remains one of a handful of retailers citing a highly promotional environment.
  • Distractions from both activist investor attention and formation of a “growth brands initiative” takes focus away from fundamentally improving existing store productivity and profitability.  Risk to short is that this process becomes self-fulfilling with weak management leading credence to Ackman’s pursuit.

WMT:

  • Not and LBO candidate!
  • Free-shipping initiative yet another example of how focused WMT remains on competitive pricing.  Continue to believe inflation in both consumables and discretionary items will not be entirely passed on as WMT’s remains focused on reinvesting in price.  Self-imposed deflation will remain the key factor limiting comp acceleration.
  • Still not convinced a true strategy is in place to improve high margin apparel opportunity in the near to intermediate term.  Management is focused on basics but that puts the category in the sweet spot for competition.  Without a pick-up in non-food areas, comps and profitability is destined to move sideways for yet another year.

WEEKLY DELTAS

Here is an overview of some of the more relevant research anecdotes for the industry over the past week.

  • The issue of rising cotton and sourcing costs is nothing new but JCP management noted that they are now encountering some factories which are not accepting orders due to input cost uncertainty.  While these orders primarily center around goods to be manufactured for Fall ’11 delivery, the data point is noteworthy. If this becomes a more widespread stalemate between manufacturers and suppliers, there will likely be capacity constraints come next year.
  • A quick check of Footlocker.com and UnderArmour.com reveals that UA’s flagship basketball shoe (Micro G Black Ice) is sold out in black and almost sold out in white.  While the launch was done on a small scale, the sell through is noteworthy. 
  • Wal-Mart’s  free shipping announcement essentially forces all other major retailers to match the offer.   While free-shipping has always been part of the holiday promotional calendar for most e-commerce players, the PR alone on this might leave free shipping offers in place longer than retailers would have liked.
  • Holiday marketing campaigns are creeping up earlier than ever, with most retailers launching their efforts a full two months in advance.  This year Best Buy launched its official holiday campaign on November 1st, a full 10 days earlier than last year.  By this weekend, almost all retailers will be in full on holiday marketing mode.
  • KSS and JCP both highlighted warm weather as a reason for slightly higher inventories at quarter end.  Outwear sales were substantially below last year in early October, but have since recovered.  JCP noted that category has gone from down 30-40% for a couple of weeks to up 20% as soon as cooler weather moved in.
  • While it’s clear these trends suggest the trajectory of positive footwear sales since August may now be in question in the face of more challenging comparisons looking forward – the opportunity for retailers to outperform based on portfolio mix is now greater than it has ever been over the past 2-years. The bifurcation between performance and non-performance footwear has widened since late summer with the current 40-point spread at its widest margin in 2-years. The bottom-line here is that with a favorable comp outlook for athletic footwear through November getting progressively more challenging through year-end – portfolio mix between performance and non-performance footwear will be critically important in driving near-term sales performance at retailers.
  • U.S. apparel and textile imports increased +16.7% in September. Keep in mind this is a substantial deceleration from the August rate of +29% reflecting retailers push to restock earlier than usual driven by fears over transportation cost inflation. We expect continued sequential deceleration with inventories now at higher year-over-year levels coupled with retailer interest in avoiding excess buildup.
  • We’re seeing the 13D/F filings pick up meaningfully in Retail. Since we’re at the point where average/poor CEOs are facing the music as it relates to negative organic growth due to poor planning and investment in growth during the recent downturn – why not? They’re either blowing up, buying growth, or both. With the cost of borrowing just about as close to Japan as it can get, and the M&A cycle at the lowest level in almost 2 decades, M&A activity seemingly has only one way to go. That’s higher. On a recent Cramer segment, Wes Card (JNY CEO) was asked why he’s not buying back stock? Wes answered by saying that he’d rather buy other businesses than his own. Additionally, at JCP, CRI, and SKX, we saw several examples of investors stepping in ahead of the game.
  • Steven Madden confirmed that while boots started selling earlier this year than last, the category continues to be robust again in 2010. In addition, the company is also seeing a shift into booties as well with a lace-up style one of the brands hottest selling SKUs currently. 

 


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.30%
  • SHORT SIGNALS 78.51%
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