Global Shakedown

This note was originally published at 8am this morning, November 23, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“No matter what you do I'm gonna take you down.”

-Bob Seger


Bob Seger is a 65-year old American singer-songwriter from Detroit, Michigan. In 1987, he released “Shakedown.” It eventually became a #1 hit on the Billboard Hot 100. Most movie-soundtrack buffs will recall this song from Beverly Hills Cop.


This morning the Fun Cops of global risk management have apprehended the perma-bulls. Lest the bulls who don’t do mean-reversion forget that the SP500 is still up +77.1% from the March 2009 lows and, as Seger sings, “everybody wants into the crowded line.”


This morning’s headlines are multi-factor, multi-duration, multi-risk:

  1. Korea sees both civil and military casualties overnight as a 27-year old boy-king in the North makes a statement to the South.
  2. Asian stocks continue to breakdown with China closing down another -1.9% overnight, taking its cumulative decline since 11/8 to -10.5%.
  3. Sovereign yields 3-mth Spanish debt rocket to the upside in a terribly received bond auction yielding 1.74%! versus 0.95% prior.

What does this mean? What do we do? I think those of us who have seen the confluence of the following Top 3 global macro factors colliding for the last month are already positioned:

  1. Global growth is slowing
  2. Global inflation is accelerating
  3. Interconnected risk is compounding

There are plenty of other risk factors causing a Global Shakedown in the immediate term TRADE lines across our interconnected global risk management model (Quantitative Guessing, Financials freak-out, Yield Spread compressing, etc.),  but before we revisit the aforementioned Top 3, let’s look at those breakdown lines in some of the major country indices:

  1. SP500 Index = 1,997
  2. Dow Jones Industrial Avg = 11,199
  3. China’s Shanghai Composite = 3,008
  4. Hong Kong’s Hang Seng = 23,902
  5. India’s BSE Sensex = 20,386
  6. UK’s FTSE = 5,792
  7. Spain’s IBEX = 10,591
  8. Italy’s MIB = 21,181
  9. Brazil’s Bovespa = 70,929

In risk management speak, we call this Geographical Risk Factoring. Weakness in one country doesn’t always interconnected risk make in others. However, sustained weakness across geographies on our most immediate-term risk management duration (TRADE) is usually a very early signal for global risks to compound. These risk factors include: Style Factoring, Size Factoring, Liquidity Factoring, etc…


I’m not saying this market is going to crash today. I’m simply saying that the probability of a correlated and compressed-crash continue to climb. To a degree, this has already happened in Chinese and Spanish equities (down -10.5% and -9.5%, respectively, from their recent peaks in very short order). Again, these are equity market signals. But the equity bulls will have a hard case to make that the Mr. Macro Bond Market has been flashing anything bullish for the last three weeks.


Back to my Top 3 fundamental risks:

  1. Global Growth Slowing – After seeing broad based slowdowns in Asian Q3 GDP reports yesterday (Indonesia, Malaysia, Thailand), this morning South Africa reported a sequential slowdown in Q3 GDP to +2.6% (vs +2.8% last quarter).
  2. Global Inflation Accelerating – The good news here is that post Bernanke’s QG = INFLATION experiment taking plenty of commodity prices at or above all time highs, prices have come down in the last 2 weeks. The bad news is that the global inflation genie is out of the bottle and she’s hard to stop. Consider this Bloomberg News quote from a Chinese noodle shop dude this morning: “Standing near his 12-table noodle shop on Beijing’s Yonghegong Avenue, ower Liu Heliang says meat and vegetable prices have climbed 10% in a year and staff wages are up 40%.”
  3. Interconnected Risk Compounding – review all of the factoring I have gone through so far. In the US we think it all equates to Jobless Stagflation.

Now a bull could say that Germany’s GDP growth of +3.9% for Q3 was outstanding on both a relative basis to the EU (and the US) and on an absolute basis as the Germans continue to drive exports into a friendly Chinese relationship (Exports up +2.3%). I’ll agree with that. That’s why we have a 6% position in our Hedgeye Asset Allocation Model to German Equities (EWG).


While we have plenty of short positions to express the Global Shakedown risk (see my Early Look Note from November 8th titled “Tightly Squeezed” where we published our top 15 short ideas across asset classes), there are some things that we really like on the long side (alongside Germany) on a day like today:

  1. Long the US Dollar (UUP)
  2. Long the Chinese Yuan (CYB)
  3. Long Gold (GLD)

From yesterday’s price levels, I also think a 64% position in Cash is the right position to be in. Most asset managers will quibble with that for obvious reasons that are structural to their business models, but I really think the better benefit of the doubt this morning should go to the Thunder Bay Bear.


“Shakedown… Breakdown…Takedown… Everybody wants into the crowded line…”


My immediate term support and resistance lines  for the SP500 are now 1172 and 1197, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Global Shakedown - fire

Never Bet Against Oprah

Oprah is at the forefront of a major re-launch of one of Nike’s best technologies in a decade – one that will finally get t he attention it deserves. Good for Nike. Great for FL.


Even though her show starts after the market closes, I do not watch Oprah. But 7.4 million (mostly female) American consumers do. Every year, thousands of products arrive at HARPO studios around the holidays for Oprah to pick her list of ‘Ultimate Favorite Things’. Last year she downplayed higher-priced items due to the recession. But this year the list is in full force. (ie, Oprah loves the iPad. Surprised? I didn’t think so…).


Two of the items caught our attention in particular.


Lululemon: The first item is a pair of Lululemon pants that offer more flexibility (in usage) that than the standard ‘Down Dawg’ and doubles as everyday ‘around town’ pants. Also, in Oprah’s words, “I’ve got to tell you, anything that cuts your but in half should be your favorite thing too.”  It’s also notable that the model wearing the pants was wearing a pair of Nike Free. That brings to the second item…


Nike Free is made the cut and is staging a big comeback. I mean REALLY big. This is a fairly old technology in that it came out around 6-years ago as a way for elite runners to practice running as if they were barefoot on grass. But for several reasons, Nike chose to hold off from stepping the accelerator. That was in part because Reebok and Adidas were hemorrhaging share in the US, and Nike didn’t have to do a lot to see its share go from 37% to 48% (while Adibok went from 18% down to 7%). Heck, maybe the timing was not right.


Now what?

  • “Toning” has become a $1bn+ category. Nike might play down this category in public. But internally, they’re livid – as any winner would be after losing a match to a seemingly lesser opponent.
  • Has anyone read ‘Born to Run?” A truly exceptional book documenting how a Mexican tribe absolutely dominates the sport of Ultra-marathoning, and no, they don’t wear Air Max 360s. They run barefoot. A great read…I’d recommend it.
  • Let’s not forget about UnderArmour’s FW product. This is the year they hit stride.


So all of a sudden, Nike has 2 stronger large competitors, mid-and small size competitors like New Balance and Newton running, plus some Asian imports like Anta and Li-Ning, and too top it off, they missed growth in a category that could and should own. Yeah… not good for job stability if you’re in charge of Running at Nike.


But does that mean that Nike will bow to the pressure and become more mainstream? No!!!


What you should expect is that Nike will go full force with its Free technology.  Will it be the same ol’ product as 5 years ago? Nope. They will do to the same thing to the e-reader that Apple did with iPad in the wake of Kindle/Amazon’s success. You can’t even mention Kindle and iPad in the same sentence without it sounding strange. That’s what Nike will do with Free. It will hit in spring en’ masse, and should start showing up in orders in full force by holiday. Most tools and molds are already amortized, so margins will be solid.


Yes, this helps Nike. But Retailers like FL should be the biggest winners.


Never Bet Against Oprah - banner


Never Bet Against Oprah - lulu


Never Bet Against Oprah - nke


Bullish Buck Breakout



We can be as patriotic about a position we are pushing as the next firm. After being short the US Dollar from June 7th to November 3rd, we’ve been long it since November 4th.  THE question now is can a bullish TRADE become a TREND?


In Hedgeye speak, a bullish immediate-term TRADE = 3 weeks or less and a bullish intermediate-term TREND extends itself to a thesis with a duration of 3 months or more. The current global short squeeze for US Dollars is 4 weeks in the making (this is the 4th consecutive week where the US Dollar Index is up on a week-over-week basis), so the question now is do we book a nice TRADE or make the case for the TREND.


Since US Dollars are priced relatively to other dysfunctional fiat government currencies like the Euro and the Yen, the good news for US Dollar bulls is that there’s always a case to be made for continued relative weakness in the competing currency basket. Admittedly, the European Sovereign Debt news-flow is overshooting to the bearish side at this point and we’re positioned to book part of that TRADE.


We covered our short position in the Euro (FXE) today as it is finally immediate term oversold. We have not, however, closed out our US Dollar (UUP) position as we continue to think that the Pain Trade is to the upside.


The Fundamentalist’s next question on why should be what’s your catalyst? My answer = PRICE. Yes, when immediate-term price momentum starts to morph into a potential intermediate term TREND, price can be the most important catalyst. The conclusion is that simple – you just need to get the timing right.


From a pain threshold perspective, one critical PRICE line to monitor from an intermediate term TREND perspective = $79.71 (see the chart below). If the US Dollar can close above and confirm what was TREND line resistance ($79.71) as newfound support, I may be knocking  at your door in Connecticut for a Thanksgiving caroling of the Canadian version of God Bless America.


Go US Dollar!



Keith R. McCullough
Chief Executive Officer


Bullish Buck Breakout - 5

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

Positive Family Footwear Trends Mirror Athletic

With the majority of family footwear retailers reporting this morning a few things are clear, boots are working - again, traffic’s improving, and comps are rivaling what we saw in the athletic channel last week. With PSS the last to report coming out next week, the read-through is unquestionably positive. Comp trajectories suggest our prior estimate of -8% comp in Q3 is simply too low at PSS. Here are our key callouts both at the channel level as well as by retailer from this morning’s calls:


Family Channel Callouts:

   - Consistent with what we saw in the athletic channel, EPS beats across the board with upward revisions to guidance.

   - Inventory build ahead of sales growth at all 3 companies in the channel, which better positions each to capture Q4 sales 

     strength compared to chase mode several were in last year. Also embedded in inventory growth is higher toning related

     inventory that accounts for more than 50% of inventory growth at some retailers (i.e. BWS & SCVL).

   - Comps slowing more modestly on 1yr basis in 2H reflecting a substantial acceleration in the 2yr

   - Early reads for Q4 reflect accelerating trends even from Q3 levels

   - Traffic improving (up 6% at DSW; +2.5% at SCVL, and up LSD as BWS)

   - Boot comps up +10% on a +47% last year at DSW, 40%+ at SCVL confirms trend remains robust

   - Better than expected BTS sales across the board appears to have legs into Q4

   - Promotional environment has and continues to remain more benign compared to last year



DSW: EPS of $0.79 vs. $0.75E ($0.60 last year)

Sales +10%

Inv +15%

  - Better than expected sales through first 3-weeks of Q4

  - Outlook:

  • Raised EPS to $2.30-$2.40 (was $2.20-$2.30)

  - Add’l gross margin compression expected in Q4 against significantly more difficult comps (+850bps)

  - SG&A leverage largely due to lower bonus expense compared to last year

  - Inventory per sq. ft. up 13% vs. down 11% last year so up modestly on 2yr basis

  - 2yr comp (9%+ in Q3) accelerating even higher so far in November

  • Traffic up 6% in stores (.com up 22%)
  • By category: +10% in women’s; +6% men’s; +9% athletic; +19% in accessories
  • Boots posted a +10% comp on a +47% last year

  - DSW Rewards a factor in driving sales growth with 87% of sales YTD part of program – 4mm accounts added this year

  - Now have nearly 20% of stock on replenishment system helping to increase conversion rates by 4% at the store level

  - Nike assortment expanded to include men’s running in Q3 as company broadens into more athletic

  - Toning still accounts for ~2% of total sales; unit sales consistent with 1H reflecting lower ASPs

  - Bigger focus looking forward is lightweight footwear

  - Store growth:

  • plan to open 20 new stores next year
  • 3 in smaller markets that co. has previously avoided, if successful equates to additional 50+ market opportunity
  • Seeing ‘a lot of deals’ coming up for attractive real estate opportunities – positive chg on the margin

BWS:  EPS $0.45 vs. $0.30E ($0.42 last year)

Sales +14.5%

Inv +20%

 - Better than expected BTS sales driven by athletics, dress, and casual styles

 - Less promotional activity than last year (19 fewer BOGO days)

 - Stronger initial margins in mid-tier and mass channel

 - Most significant growth at wholesale up +34% in a decade

 - E-commerce up +14%

 - Comp up +10.6% on +4.7% last year at Famous Footwear

  • Traffic up LSD and AUR with double-digit increases in conversion
  • Increases across all categories and regions
  • Women’s up HSD; Men’s up MSD; Kids & Acc’s up LDD
  • Toning accounted for +4.5% of comp (most over-indexed of family channel peers)
  • Boot and dress shoe demand drove sales at Via Spiga and Vera Wang up over 50%+

  - Sales/ sq. ft. up to $184 vs. $164 last year edging closer to goal of $200+

  - Toning accounts for ~3/4 of inventory growth in Q3 with core inventory up only +5.6% excl. toning

  - 30% of customers purchasing toning product new to FF; 1/3 of which have bought other product

  - Toning category expected to represent 6%-7% of volume in Q4.

  - Comps Q4-to-date trending up HSD

  - Wholesale backlog up +25% reflecting positive forward demand

  - Strong top-line key to offsetting $17mm after tax cost ($0.25 in EPS) related to higher incentive comp and marketing

  - Net store closings continue with 14 locations vs. opening 4 in the quarter

  - Outlook:

  • FY10 EPS to $1.00-$1.05 vs. $0.90E
  • Initial outlook for FY11 - Famous Footwear same-store sales growth in the low to mid single-digit range;

GCO: EPS $0.77 vs. $0.59E ($0.49 last year)

Sales +19%

Inv +25%

  - Comp up 9% on -2% last year

  • Up +11% through first 3-weeks of November
  • By seg: Lids +13%; Journeys +9%; Johnston & Murphy +7%; Underground Station +3%
  • Johnston & Murphy one of strongest qtrs in years driven by casual business and higher full-price selling
  • Slow start to boot sales in October – accelerating in November

  - Mix shift towards casual away from dress continues


SCVL: EPS $0.70 vs. $0.66E ($0.59 last year)

Sales +6.7%

Inv +12%

  - Sales trends by category and region all positive during the quarter

  - Comp up +7.2% on +10.2% last year

  • Both traffic (+2.5%) and conversion rates increased
  • Would have still been up MSD excl. toning
  • Women’s non-athletic up MSD driven by strong sandals selling at higher rates, men’s up MSD as well
  • Adult athletic up HSD driven by running up 20%+
  • Boots up double-digit in first 2-months of Q3, trended down in October, back up 40%+ in first 2-weeks of Nov.
  • Toning $$s down in Q3 though pairs remained flat sequentially

  - More than half of inventory build due to toning (up only MSD ex toning), aged levels at all-time lows

  - Still expect to ramp store openings in FY11 to 20 stores from 10 this year – mostly in existing markets

  - Outlook:

  • Q4 EPS of $0.30-$0.32 vs. $0.25E
  • Comps +4%-6%
  • Expect strength in boots to increase throughout the holiday season (Nov & Dec strongest months)
  • Also expecting continued strength in athletic and toning categories

Positive Family Footwear Trends Mirror Athletic - Comp Table 11 10


Positive Family Footwear Trends Mirror Athletic - Comp 1yr 11 10


Positive Family Footwear Trends Mirror Athletic - Comp 2yr 11 10


Positive Family Footwear Trends Mirror Athletic - FamFW SIGMA 11 10


Casey Flavin


Voted Off the Island

Hedgeye Position: Long Germany (EWG)


Positions Covered today:  We covered the EUR-USD via the etf FXE for a gain following its sizable move since we shorted it on 11/4.


After an appropriate re-pricing of sovereign debt risk in the last week, we booked an immediate term gain on the short side of Italy (EWI). We remain bearish on Italy for the intermediate term TREND.



News out yesterday afternoon was icing on the cake in support of our conviction: don’t trust politicians, trust the markets. In a clear about-face statement from Ireland’s PM Brian Cowen late yesterday, who days before said he wasn’t going to be the scapegoat for the country’s fiscal state, he announced:


"It is my intention at the conclusion of the budgetary process, with the enactment of the necessary legislation in the new year, to then seek the dissolution of parliament.”


However, the dissolution of parliament could come far sooner than sometime next year. Here’s the political scene that’s playing out:


Having accepted an undefined bailout from the EU and IMF on Sunday (11/21) – projected at €80-95 Billion—Cowen and his party, Fianna Fáil, continue to wrestle against severe opposition to step down, especially as his narrow 3-seat parliamentary majority with his junior coalition partners, the Green Party, threatens to vote against him.


Cowen, however, continues to stress to the opposition parties of Fine Gael and Labour, as well as to defectors from his own party, that it is in the interest of the country (and markets) to first pass the scheduled 2011 budget package on December 7th, which is expected to shave €6 billion from the budget through spending cuts (~€4.5 Billion) and tax hikes of ~€1.5 Billion, to ensure a funding (bailout) agreement from the EU and IMF before a new election is called.


Yet standing in the way of his already paper-thin credibility, are calls from the opposition for a snap election and the uncertainty of a critical by-election vote this Thursday for one of the Green Party seats in parliament that could further turn sentiment against Cowen. The Green Party maintains support of the passage of the 2011 budget before elections are called.  However, they appear resolute in their wish to see elections held by mid-January.


Finally, the government is due to publish a four-year economic recovery plan on Wednesday aimed at “bringing stability to the economy”, according to Cowen. Suffice it to say, we’re expecting a lot of pin action from Ireland over the coming weeks, and the Eurozone at large.


Below we show the familiar charts of the 5YR Sovereign CDS and 10YR government bonds yields as a proxy for the risk trade we see developing in Europe, especially from its peripheral countries. As you can see, despite Ireland’s bailout, yields continue to rise for the PIIGS; if Greece is any example, and we think in this instance it is a good one, the risk premium to own peripheral debt should remain elevated at least over the intermediate term, which in and of itself will pose significant challenges as government still require debt servicing to meet their fiscal imbalances.


And today was a great example of this: Spain issued €2.09 Billion of 3-month paper at 1.743%, almost double the 0.951% commanded for a similar issue on Oct. 26th.


As we’ve made clear in our research, we see a long road ahead for Europe’s Sovereign debt “crisis”. Ireland is but one piece of the puzzle.


Matthew Hedrick



Voted Off the Island - mh1


Voted Off the Island - mh2


Conclusion: No change to our view that the pillars supporting the US economy are weakening. 


Here are some key factors to consider in the outlook for U.S. GDP growth:

  1. The boost to growth from the fiscal stimulus is fading.
  2. State and local governments will be a significant drag as they cut spending and employment. 
  3. The boost from the inventory cycle will also weaken.
  4. While exports continue to rise, imports are also increasing and the trade deficit is widening.
  5. Global growth is slowing and the sovereign debt crisis will exacerbate this weakness.

Today, the Bureau of Economic Analysis announced that the U.S. economy grew at a rate of 2.5% in the third quarter, 0.5% more than previously calculated.  The upward revision in U.S. GDP for the third quarter was due to upward revisions to consumer spending, exports, and state and local government spending.  Our view is that the trends in consumer spending and state and local spending are not sustainable.  One supporting anecdote pertaining to consumer spending is the Redbook news today that retail sales were 0.0% for November month-to-date versus October.  That compares to +0.1% month-to-date reported in the week prior.


In 2011, GDP growth will be increasingly dependent on the internal demand drivers: consumer spending and the corporate sector driving investment.  While corporate profits have returned to their pre-recession levels, confidence needs to improve.  The hoarding of cash by Corporate America underlines their reluctance to hire and invest in long-term fixed assets.  The political volatility in Washington, and the lack of predictability that goes with it, has been cited by several major CEO’s as a cause for concern. 


The most significant downside risk is the continued weakness in the labor market, which is needed to sustain continued improvement in consumer fundamentals.  Under an optimistic scenario, 1-2% GDP growth will prove to be inadequate in an effort to reduce the unemployment rate.  Add to this slowing global growth and the European sovereign debt crisis and it seems that we are far from seeing a significant acceleration in GDP.  Downside risk for the economy is still alive and well.


Howard Penney

Managing Director



Early Look

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