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GETTING PUNCHED IN THE FACE

This note was originally published at 8am this morning, December 07, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Everyone has a plan 'till they get punched in the mouth.”
- Mike Tyson

 

There have been a lot of interesting Mike Tyson quotes over the years, some fit for print, others less so, but this one seems apropos for the times. The Fed tells us they have a plan, and they’re implementing it. So far, the markets seem to like it. Let’s see how their plan fares once they get punched in the mouth.

 

This summer we introduced our bearish thesis on housing with our 100-page report entitled: “How Low Will Housing Go in 2H10 and 2011”. In that report we laid out our three separate home price models: our supply model, our demand model, and our combination supply & demand model. The output of those models forecast home price declines ranging from high single digits to 20%+ over the next 12-18 months. How have we fared so far? As the chart at the end of this note shows, the four major home price series that we track (Case-Shiller 20 City, Corelogic, FHFA, and Existing Home Sales Median Home Price) are all heading south. After peaking in the April/May timeframe on the strength of the tax credit, three out of four home price series are now solidly in negative year-over-year territory. The lone holdout, Case-Shiller, is a 3-month rolling average, which is why it lags the other series in reflecting the degree of slowdown. The next few months of Case-Shiller data will show a comparable negative trend.

 

For reference, the Corelogic series is the series now used by the Federal Reserve. How has the Fed’s preferred series fared? According to Corelogic, home prices have rolled from being up +4.3% YoY in May 2010 to being down -2.8% YoY in September 2010, a negative -7.1% swing in four months. Looking month-over-month, the Corelogic series was down -1.8% sequentially in September (the most recent data available), which translates to the fastest rate of decline since February 2009.

 

The supply and demand imbalances were at the root of our housing call this past summer and nothing has changed on that front. The market is more dislocated today than it was when we made the call in the summer. At the time we made our call in June there were 3.99 million homes on the market for sale and existing home sales were running at a rate of 5.37 million, which equated to 8.9 months of supply. Today, there are 3.86 million home on the market for sale (October), while existing home sales are running at a rate of 4.43 million, which equates to 10.5 months of supply. Existing home inventory peaked at 12.5 months of supply in July. Based on our conclusion that home prices take one year to fully respond to supply and demand imbalances, we would expect to see July 2011 be the low watermark for year-over-year price trends in housing. The more important takeaway, however, is that between now and July 2011 the trends should continue to get worse. While it is possible that the market’s “bad news is good news” mentality will persist and ongoing weakening in home prices will simply translate into greater and greater expectations for further quantitative easing, we continue to think that bad news is simply bad.

 

Another point to consider is the impact QE2 is having on the housing market. While recent demand statistics have been modestly upbeat (i.e. October pending home sales up 10.4% month-over-month), the reality is that mortgage rates have backed up sharply in November. The Bankrate 30-year conforming mortgage index has ballooned from 4.20% a month ago to 4.70% yesterday. For reference, a 50 bp backup in 30-year rates has a 5% negative effect on affordability.

 

It’s also worth pointing out that no amount of stimulus or quantitative easing seems to increase banks’ willingness to underwrite residential mortgage loans. In the most recent Senior Loan Officer Survey released November 8, the net percentage of lenders tightening access to prime mortgage credit rose to +9.3% from -5.5% quarter over quarter meaning that the average American is now finding it more difficult to get a mortgage than they were over the summer. The trend was similar for access to nontraditional mortgage credit: +9.5% of respondents reported tightening standards, up from +4.5% last quarter. This isn’t helped by the fact that banks are currently engaged in trench warfare with Fannie & Freddie as well as the entire private-label MBS universe over mortgage putbacks. Further, there are 8.5 million borrowers who have either been foreclosed or are currently non-performing on their loan. This is a large slice of the overall homeownership pie that has been semi-permanently eliminated from the buyer pool (7 years for most lenders to look past a mortgage default). All of this has cast a pall over banks’ willingness to underwrite new mortgages.

 

Many investors forget just how slippery the slope of negative home prices can be. Falling prices don’t happen in a vacuum: they have two insidious offshoots. First, they generate a tangible negative wealth effect. For reference, for all the excitement resulting from the upward move in equities recently, consider that as a rough rule of thumb, every 100 points of upside in the S&P is roughly equivalent to a 5-6% rise in home prices based on there being total direct equity wealth of $10.8 trillion and total residential housing wealth of $17.1 trillion. That said, the wealth associated with housing is much more broadly felt as 65% of American families are homeowners, a far higher proportion than those with material equity wealth. Second, negative home price trends increase pools of underwater borrowers. We have shown that there are presently 11.3 million borrowers (20% of all borrowers) who are underwater. 4.9 million of whom are underwater by more than 25%. A 20% decline in home prices from here would increase those who are underwater to 21.9 million (46% of all borrowers) and those underwater by 25% or more would rise to 9.4 million (20% of all borrowers). Laurie Goodman, a Senior Managing Director with Amherst Securities, one of the leading providers of mortgage data analytics, has shown that loans with LTVs greater than 120% are currently defaulting at an annualized rate of 19.1%, while those with LTVs between 100-120% are defaulting at an annualized rate of 11.3%. Those are scary statistics when one considers that there could be 22 million borrowers in a negative equity position with a 20% drop in home prices from here.

 

The real question is, what will a 20% drop in home prices feel like for the markets and for the consumer? Our guess is that it will feel a lot like getting punched in the face by Mike Tyson.

 

Josh Steiner

Managing Director

 

GETTING PUNCHED IN THE FACE - early look home price compendium


Ireland’s Tiffany Box

Position: Long Germany (EWG); Short Euro (FXE), Short Italy (EWI)

 

As the trading day winds down in the US, Ireland’s parliament is going late into the session to vote on the government’s 2011 austerity package, which aims to shave €6 Billion off the budget, and reduce the country’s 11.6% deficit/GDP in 2010 (or 32% including bank liabilities). Importantly, the passage of the austerity package is contingent on the bailout guarantee of €85 Billion from the EU/IMF. Initial live updates on the session suggest that the first of four possible votes on the budget has passed, with the possibility that the vote could spill over to tomorrow.

 

European equity indices rose today in anticipation of the passage (Ireland’s ISEQ gained +1.72% today) and the EUR-USD has given up its morning gain to currently trade at $1.3284. Our TRADE levels for the EUR-USD are $1.29-$1.33.

 

Even if the budget is passed, Cowen’s Fianna Fail party, which is carrying a very slim parliamentary majority of 2 votes going into the vote, faces reelection. Cowen has called for elections next February, however given the extreme pressure from the opposition parties of Fine Gael and Labour to immediately step down, flash elections shouldn’t be ruled out. 

 

A look at the most recent opinion poll from the Irish Sun clearly reveals how far Cowen’s party has fallen out of favor:  Fianna Fail received a mere 13% support, versus Fine Gael 32%, Labour 24%, Sinn Fein 16%, independents and others 11%, and Greens 3%.

 

Worthy of mention is that the EU has given Ireland an additional year, until 2015, to return its budget deficit below the Union’s mandate of 3% of GDP. While investors may give the country’s capital markets more short-term breathing room, if Greece is any example, and we think in this instance it is a good one, the risk premium to own its debt should remained elevated over at least the intermediate term.  Further, we believe that bloated sovereign debts of peripheral countries will pose significant challenges as these governments still require debt servicing to meet their fiscal imbalances. This will certainly have downside implications to the common currency.

 

Ireland’s Tiffany Box - cc

 

Increasingly we expect the focus to turn to Spain and Italy, countries with their own sovereign debt and deficit imbalances that represent far greater economies than Greece, Ireland, or Portugal.  Our models indicate that both Spanish and Italian equities remain broken on immediate term TRADE and intermediate term TREND durations, decidedly bearish indicators.

 

Matthew Hedrick

Analyst


SINGAPORE BOOMING

Our meetings in Singapore signal optimism.

 

 

Following meetings in Singapore, we think it’s safe to say that business levels are very high at both Marina Bay Sands and Genting.  The casinos were very busy as were the common areas of both properties.  The tone of the meetings were very bullish.  In fact, we think MBS will easily eclipse $300 million in EBITDA in Q4 versus our previous projection of $289m, which is in-line with consensus.  We also now believe there is upside to our S$412m EBITDA estimate for Genting Singapore and consensus of S$403m.

 

Given the growth profile of the market, we are not overly focused on market share but both management teams definitely were.  Genting reiterated its statements from Q3 conference call that they would maintain or gain market share.  LVS firmly believes it will continue to grow its share from Q3 levels.  Until junkets are approved, we would definitely side with LVS on this one as the property appears further from maturity.  However, Genting is currently sponsoring 24 junket applications.  We think junkets could grow the market by 10-15%.  LVS is not sponsoring any junkets currently but will piggyback the licensing process for some junkets after if and when they get approved.  The LVS wait-and-see approach is safer and lower cost but will allow Genting to own the junket market for 6-12 months upon approval from the Singapore government.  Timing of approval is a major uncertainty and our best case is in 1H 2011 but we, and the operators for that matter, have very little conviction on timing.

 

Overall, we think the market can grow 10-15% without junkets, over the next 12-18 months.  Mass is probably more mature at this point than VIP.  However, both properties have more amenities coming which should result in Mass growing at a healthy premium to GDP growth.  VIP, especially when aided by the junkets, is less tapped.  The Singapore customer base – mostly Mass – probably won’t grow much, thus inhibiting Mass versus VIP. 

 

Overall, we didn’t see/hear much negative.  On to Macau!


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R3: JCG, WMT, LIZ, RL

R3: REQUIRED RETAIL READING

December 7, 2010

 

 

 

 

RESEARCH ANECDOTES

  • Keep an eye on the resurgence of Juicy founders, Gela Nash-Taylor and Pamela Skaist-Levy.  Both are eagerly awaiting their non-compete to expire from LIZ (Juicy) before launching their next fashion endeavor.  Don’t expect a reinvention of their famous “tracksuit” however.  Word has it the line will reflect their current fashion tastes, which have matured to feature vintage and rocker looks.
  • Online promotional emails from retailers reached record levels during the week ended December 3rd, according to Responsys.  Consumers received an average of 4.4 promotional emails that week, surpassing the prior peak of 4.1 emails set the week before Christmas 2009.  Promotional email activity is expected to increase even further over the next couple weeks given the seasonality of the holiday shopping period, leaving Holiday 2010 with the highest levels of promotional email on record.
  • During a tour of RL’s New York flagship stores, management highlighted that only 30% of product available on the company’s e-commerce site overlaps with what’s available in its flagship stores. With the UK site launched in October, the company is targeting closer to 50% overlap between product available both in stores and online. Importantly, it was also noted that despite concerns of robust e-commerce sales cannibalizing retail traffic, the reality is that traffic is up both online and at retail so far through the holiday season.  
  • It's been a couple weeks since we've heard of bedbug related store closings, but they're back and at the worst possible time - the holidays! Juicy Couture is the latest retail victim. After closing its doors for nearly a week, the retailer is expected to reopen its 5th Ave store mid-week.

 

OUR TAKE ON OVERNIGHT NEWS 

 

J. Crew Acquisition Details Emerge in SEC Filing - J. Crew Group Inc. had suitors besides Texas Pacific Group and Leonard Green, but it was the belief that Millard “Mickey” Drexler would stay on in a deal with TPG that tipped the scales in its favor. According to regulatory filings with the Securities and Exchange Commission released Monday, J. Crew said that its chairman and chief executive officer told the special committee evaluating the potential sale of the retailer that “if the company were to be sold, given that he is 66 years old, he had significant reservations about the prospect of working for a new boss, but that he had a high comfort level with TPG and had a positive experience with them during the period in which TPG owned the company.” The committee concluded that Drexler would be “unwilling to work for any third party other than TPG.”The private equity fund acquired J. Crew in 1997, brought Drexler onboard in 2003, took the firm public in 2006 and sold off the final remnants of its earlier stake last year. J. Crew agreed to be acquired and taken private by TPG and Leonard Green for about $3 billion on Nov. 22.According to the SEC documents, there have been occasional overtures to J. Crew from entities interested in merging with the retailer, including one in the fourth quarter of 2008 from TPG, but none of those talks proceeded beyond the preliminary stage.r.<WWD>

Hedgeye Retail’s Take:  While JCG has been sued and criticized for its lack of transparency in the selling process, the latest details to emerge certainly offer an inside look into the inner workings of the deal, dating back to August.  We now wonder if this actually helps or hurts those looking to squeeze a few more dollars out of the offer price.

 

Golden Gate, Limited Plan Sale of Express Shares - Limited Brands Inc. and Golden Gate Private Equity plan to sell 11.5 million shares of Express Inc. common stock, reducing their aggregate holdings to 60.4 percent of the retailer’s shares outstanding from their current level of 73.3 percent. Golden Gate, which acquired a majority stake of Express from Limited in 2007, will sell 8.63 million shares to the public, reducing its total to about 40.2 million from 48.8 million and its stake to 45.3 percent from 55 percent. Limited will sell 2.88 million shares, reducing its total to 13.4 million from 16.3 million and its stake to 15.1 percent from the current level of 18.3 percent. The two companies intend to grant the underwriters options to purchase up to an additional 1.73 million shares. Express will not receive any proceeds from the sale. <WWD>

Hedgeye Retail’s Take:  Maybe a BOGO with DG shares would make sense?  With less than three weeks left in the year, the capital market’s desks across the Street appear to be flush with “holiday sales” (of retail shares).

 

Supreme Court to Hear Wal-Mart Appeal - The U.S. Supreme Court on Monday agreed to hear an appeal from Wal-Mart Stores Inc. that challenges a lower court’s class-action certification in what could be the largest gender-discrimination case in the nation’s history. The impact of the case might be far-reaching, with Wal-Mart potentially facing billions of dollars in liability. The high court will not address whether the $400 billion retailer discriminated against hundreds of thousands of female employees in pay and promotions, an allegation the company denies. It will rule on whether claims by individual employees can be combined into a single lawsuit that seeks back pay.  “We are pleased that the Supreme Court has granted review in this important case,” Wal-Mart said. “The current confusion in class action law is harmful for everyone — employers, employees, businesses of all types and sizes, and the civil justice system. These are exceedingly important issues that reach far beyond this particular case.”<WWD>

Hedgeye Retail’s Take:  This case goes far beyond WMT and discrimination, as it will likely become a monumental decision on the world of class action suits.  Oral arguments for the case are expected in the Spring with a decision expected in July.

 

Post Thanksgiving Sales Hangover Stronger than Usual - Overwhelmed by all those big Black Friday deals? Not quite. Consumers crowded the malls again last week but exhibited less readiness to spend compared with Thanksgiving weekend. The mind-set shifted — browsing became more evident amid widespread promoting that persisted aggressively, although down a notch from Black Friday’s cacophony. Still, retailers and analysts contacted Monday said volumes last week were higher than a year ago, and sufficient enough to sustain their upbeat outlook for mid-single digit holiday gains. While last week did see a decline from the end-of-November rush, it was expected, and typical for early December, retailers stressed. They also said they expect shopping to heat up again beginning online around Dec. 15 and on selling floors the week before Christmas. “We are pleased with what we saw happen last week,” said Keith Fulsher, executive vice president and chief merchandise officer of Dress Barn. “The categories that were pretty good and that we think will remain strong are special occasion, sweaters, especially longer-length tunics, jeggings, the denim business and cold weather, especially items with fur trims. We are hopeful. We think it will play out to be a good season, but there is still a lot of time ahead of us. So far, we are OK.”<WWD>

Hedgeye Retail’s Take: A sequential decline in consumer spending the week after Thanksgiving is to be expected, but this year’s appetite for spending appears slightly stronger than usual. In addition to anecdotal commentary through the rest of the month, we’ll be keeping a close eye on weekly sales data out of the athletic channel as a key indicator of consumer demand.

 

Most Marketers Shift Toward Branded Content - Marketers are recognizing the value of magnetic content over traditional disruptive forms of advertising, according to research from the Custom Content Council in partnership with branded-content newsletter ContentWise. Overall, 68% of companies said they were shifting from traditional forms of marketing to more emphasis on branded content, including 61% who reported a moderate shift and 7% who said their shift was “aggressive.” On average, spending on branded content represented 29% of respondents’ total marketing, advertising and communications budgets in 2010. That was down slightly from 32% last year. The report noted that 2010 had the fourth-highest total marketing spend recorded but the second-highest branded content spend, suggesting that branded content will continue to increase in importance among marketers. About 35% of total spending on branded content went toward electronic forms this year, according to the survey. <emarketer>

Hedgeye Retail’s Take: Think pull versus push with examples of magnetic content including anything created on behalf of a brand such as a YouTube video, Twitter promo, or online game. With magnetic content not only proving to be more effective, but also significantly more cost effective, it’s no surprise to see retailers reallocating budgets away from publications and towards these alternative channels.

 

Vietnam Plans to Further Develop Shoe Industry- Vietnam’s Ministry of Industry and Trade has approved the overall plan for developing the country’s leather shoes till 2020 and vision to 2025, sources reported. The industry targets to reach export turnover of $9 billion in 2015, $14.5 billion in 2020 and $21 billion in 2025. Total investment capital estimated for the period from 2011 to 2020 is 59.570 trillion dong, of which 43 percent will be raised domestically and remainder from international sources.<FashionNetAsia>

Hedgeye Retail’s Take: Given the country’s rapid growth in footwear exports, investment spend will have to follow if the country hopes to maintain the double-digit CAGR it expects over the next 5-years - as such an incremental positive on the margin.

 

 

 

 

 


SLOT REPLACEMENT BOOST: 100% EXPENSING

As part of the Bush tax cut compromise, it looks like Obama’s 2011 proposal for full deduction for equipment purchases will pass. 

 

 

As we wrote about in “DARE WE SAY THERE MIGHT BE  A NEAR TERM REPLACEMENT CATALYST” (09/16/10), Obama’s temporary 100% expensing proposal would allow companies to immediately deduct the full cost of equipment purchased between Sept 8, 2010 and Dec 31, 2011.  For equipment purchases, the complete write-off will lower overall effective tax rates and the cost of capital as shown below.

 

SLOT REPLACEMENT BOOST: 100% EXPENSING  - equipment

 

We believe the passage of this proposal comes at an opportune time as casino operators remain cautious about investing during the current recovery.  Accelerated depreciation could help spark the long-awaited recovery in replacement demand.

 

Appendix: Treasury Report highlights

SLOT REPLACEMENT BOOST: 100% EXPENSING  - eee33


THE M3: UNDEVELOPED PLOTS; TAM COMMENTS

The Macau Metro Monitor, December 6th, 2010

 

FIVE UNUSED PLOTS TO BE TAKEN BACK Macau Daily Times

According to secretary for Transport and Public Works, Lau Si lo, the Macau Government has decided to push forward with the recall of five undeveloped plots and two pending plots.  The process to declare that the concession of these areas has lapsed has already begun, he explained. 

 

MACAU GOVERNMENT DOESN'T COMMENT ON EVENTUAL CAP ON SLOTS macaubusiness.com

Secretary Tam refused to comment on whether the Macau government is preparing to implement a cap on slot-machines.
“Limiting the number of gaming tables is a first step to control the scale of the gaming industry, and we are reviewing other policies in order to reach a measured development of the gaming industry,” Mr Tam said.  Mr. Tam also said that the government is finalizing a by-law to regulate slot machine parlours, including location, and that the government is keen on increasing the share of the mass market in the overall casino business.


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