The Enemy of Growth

This note was originally published at 8am on December 16, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Conformity is the jailer of freedom and the enemy of growth.”

-John F. Kennedy

I’ve heard a lot about “growth” in recent weeks. After a March 2009 trough to December 2010 peak rally in the SP500 of +83%, the US centric stock market bulls say “growth is back.” As a result, conforming to an institutionalized consensus weeks before our profession receives its year-end bonus check is a mounting pressure in my inbox. I’ve seen this movie before.


The Enemy of Growth isn’t going away. It’s called debt. Sovereign debt. And, no matter where you go in the new year, there will be more and more of it…


You don’t have to take my word for it on this. The longest of long-term data series we can find on sovereign debt default cycles and their correlations to fiat currency issued debts and structural inflation can be found in Reinhart & Rogoff’s “This Time Is Different.”


No, this is not a new thesis this morning. It’s a critical reminder. Because US stock market consensus is choosing to ignore it for a few more weeks doesn’t mean it ceases to exist.


The Enemy of Growth isn’t a Thunder Bay bear. It’s marked-to-market on your globally interconnected macro screens every day. While it’s convenient to assume that a +10% YTD return in the SP500 is a leading indicator for growth, one can easily argue that US style Jobless Stagflation won’t lead America to sustainable economic growth in 2011.


Remember, “inflation is a policy.” Or at least that’s what an ole school Austrian economist by the name of Ludwig von Mises said. Before your big Keynesian cheerleader of a global liquidity trap leads you to believe otherwise, don’t forget that it was von Mises who already called out Bernanke’s strategy to inflate 50 years ago when he said:


“The fact is that, in the not very long run, inflation doesn’t cure unemployment.” (Economic Policy, 4th Lecture, “Inflation”, page 53).


The Enemy of Growth is inflation. We know that, much like Jimmy Carter and then Fed Head, Arthur Burns, once tried to argue in the 1970s, some people think inflation is cool for some people. Some of those people aren’t the poor or middle-class however.


Currently, there is no more obvious threat to Global Growth Slowing than what you are seeing in emerging markets. Heck, some of these markets (like Hong Kong) might not even be considered “emerging” anymore. That’s not the point – what’s happening on the global macro scoreboard to emerging market stocks and bonds in the last 6 weeks is…


Since the beginning of November, here’s the score:

  1. Hong Kong’s Hang Seng Index has dropped -8.1% since November the 8th.
  2. India’s BSE Sensex Index has dropped -8.3% since November the 5th.
  3. Brazil’s Bovespa Index has dropped -7.1% since November the 4th.

Now, the first thing you’ll hear coming out of US-centric stock market bulls right now has nothing to do with:

  1. Spiking Sovereign Debt Yields in Spain, Italy, Portugal, Argentina, America, etc…
  2. US Treasury and Global Commodity markets flashing clean cut inflation signals.
  3. The BRIC’s (Brazil, Russia, India, and China) falling, well, like bricks.

No, no, no. It’s all about a short-term year-end bonus “pop” in US growth associated with cutting taxes so that the world worries more and more about America’s long-term sovereign debt risk. Short term political resolve perpetuating long term systemic risk. Nice trade.


Markets “pop” then “drop”… most emerging stock and bond markets are already dropping…


Like the broken European promises of reducing their deficit/GDP ratios when European bond yields started breaking out in December of last year (when Hedgeye introduced our “Sovereign Debt Dichotomy” Macro Theme), now professional US politicians are promising you this time is different. This time it’s all about “growth”…


This time, The Enemy of Growth is a government inflation policy itself.


My immediate term support and resistance levels for the SP500 are now 1232 and 1246, respectively. I continue to be a seller of bonds, reducing my asset allocation to bonds from 6% to 3% as of yesterday’s close. Inflation is bad for bonds.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


The Enemy of Growth - 1

Hard Lessons from Japan

“The world is awash with liquidity.”

-Anonymous Investor, circa late-2007


Conclusion: New proposed measures to stimulate the Japanese economy will result in nothing more than smoke, mirrors, and further economic stagnation. Further, taking a dive into Japanese corporate balance sheets and psyches reveal some interesting takeaways on where the U.S. may be headed.


Position: We remain bearish on Japanese equities for the intermediate-term TREND and are currently short the Japanese yen via the etf FXY.


Today Japan, the world’s leader in Big Government Intervention, reminded us of the long term consequences of trading away long-term, sustainable prosperity in exchange for short-term, levered growth. In addition, they reminded us just how hard it can be to wean ourselves off the fiscal and monetary stimulus drug that many investors recklessly clamor for.


This morning a panel led by Finance Minister Yoshihiko Noda unveiled a tax stimulus package that is designed to “increase hiring” and “spur economic growth”. The measures include: 

  • A to-be-determined corporate tax rate cut (latest rumor at 5%);
  • A ¥200,000 tax write-off per person for small firms that hire at least five people or increase their workforce by 10%; and
  • A 300bps tax rate reduction for compliant small businesses. 

Of course, with Japan struggling to contain the world’s largest public debt burden, there were compromises to help recoup the ¥1.4 to ¥2.1 trillion in proposed lost revenue: 

  • The government will cap income deductions for those earning in excess of ¥15 million annually;
  • Income deductions for corporate executives earning in excess of ¥40 million annually will be cut in half;
  • The minimum inheritance tax will rise +500bps to 55%; and
  • Levies on energy will increase as part of a broader environmental tax hike. 

Combined, these measures are supposed to promote growth and stimulate the economy. From our vantage point, it looks like Japan is merely robbing Peter to pay Paul – at best. As we have shown in our Japan’s Jugular slide deck, the Japanese economy has not responded well to a bevy of Keynesian stimulus measures over the years:


Hard Lessons from Japan - 1


Why has Japan not responded well? Pundits point to a multitude or reasons, including demographics, overcapacity and a weak property market. The single most important factor we highlight is the lack of business and consumer confidence resulting from nearly two decades of fear-mongering and government intervention.


In classic liquidity trap fashion, Japanese consumers have been reluctant to spend and borrow, banks have been reluctant to lend, and firms have been reluctant to invest (all on the margin, of course). Take Japanese corporation’s cash levels, for example; cash and equivalents at members of the Nikkei 225 climbed +8% this year to a record ¥1,309 ($15.60) per share. Further, companies cut bond sales 17% YoY even as corporate yields hit a five-year low earlier in the quarter.


The lack of interest in investing has been driven by weak domestic prospects for growth and a lack of favorable rates of return. Anecdotally, the comments of Kazuto Tsubouchi’s, the CFO of Japan’s largest mobile phone operator, NTT DoCoMo, should not be taken lightly:


“We have more cash than we need, but no growth investments… This is a great time to issue bonds and we would if we had no money.”


Apparently sitting on mounds of cash is not equivalent to finding and extracting an actual rate of return on that money. Keep that in mind the next time you hear the tired bullish argument that “companies are sitting on loads of cash and balance sheets are pristine”.


While we’d be remiss to refute either point (S&P 500 cash holdings have risen +10% YTD to $261.68 per share – the most since at least 1998), we are offering a contrarian view to the consensus belief that suddenly the world’s excess liquidity will magically translate into positive investment returns. If the Japanese experience is any guide, we’re likely to see more of the same cash hoarding by U.S. companies, as our burgeoning public debt north of 90%/GDP looks to structurally impair U.S. economic growth going forward.


Of course U.S. companies could follow Japan, China, and other cash rich nations into hunting for growth via emerging market acquisitions. Japan, for one, has increased its overseas investments by +18.3% over its full-year 2009 total of $22.9 billion.


As more and more corporations from slow-growth, developed economies look to buy growth via overseas transactions, expect the prices of those assets to be bid up. Emerging market assets will be overpaid for and “goodwill” will join “cash” as another bloated part of corporate balance sheets.


Lastly, we saw Japan’s Tankan Survey register its first drop since 1Q09 among large manufacturers and large non-manufacturers, coming in at 5 and 1, respectively. The 1Q11 forecasts point to outright negative sentiment in the range of (-1) to (-2).


Hard Lessons from Japan - 2


From a quantitative perspective, Japan's NIkkei 225 is bullish on both the TRADE and TREND durations, aided by recent yen weakness. We continue to caution investors that Japanese equities are setup for a sucker punch once the tide turns on equities as an asset class in early 1H11. We strongly recommend you don’t buy the storytelling associated with “Chinese acquisitions of Japanese firms” or yen weakness. Japanese exporter’s profits are likely to slow in 1H11 right alongside global growth – irrespective of the yen. 


Darius Dale



Hard Lessons from Japan - 3

No Longer Just a Hoop Dream

Another month of strong sales and unit growth for basketball footwear, marking the fourth in a row of positive increases.  This should not be too surprising given the resurgence in excitement surrounding the NBA (TNT ratings season-to-date are up 40% y/y), the launch of UA’s basketball shoe, and recent wave of new product introductions (Lebron VIII, Reebok Zig, Hyperdunk 2010, etc…).  Importantly, we remain confident that this remains the beginning of a longer term trend. 


As shown below, the category suffered declines in 14 of the prior 16 months beginning in April 2009.  While comparisons remain easy, the emergence of key product and technology launches coupled with increased marketing  keeps us especially bullish on the prospects for Foot Locker .  Importantly, year to date unit sales remain below levels recorded over the past couple of years, leaving room for further recovery.  FL is the biggest the beneficiary of the hoops recovery given its industry leading penetration of the category.  However, this is not a zero sum game and we believe the rising tide will also benefit additional retailers including DKS, HIBB, and FINL with exposure to basketball.


No Longer Just a Hoop Dream - basketball


Eric Levine


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I know food inflation is only a small part of the CPI but I’m using this as an example to make a bigger point, the current government data does not reflect reality.


We already know that the weights assigned to different components of CPI do not accurately reflect consumers’ share of wallet among those components.  On another note, recurring seasonal patterns, which are present in numerous time series data presented by the government, obscure the underlying behavior given the current economic climate.  If the 2010 data is seasonally adjusted using 2008 or 2009, you end up with one conclusion, and if seasonally adjusted using pre-2008 data – one likely has a different interpretation given the difference in volatility during these two respective periods.  These distortions are very clear in the recently reported CPI data. 


Yesterday's CPI came in below expectations, thanks partially to gasoline inflation that was reduced by seasonal adjustments. 


The issue here is that in November 2009, gasoline inflation was boosted by seasonal adjustments, but it was reduced in November 2010. Specifically, a non seasonally-adjusted 4.1% monthly gain in November 2009 gasoline prices ended up as a seasonally-adjusted gain of 6.4%. In contrast, a not-seasonally-adjusted 2.0% monthly gain in November 2010 gasoline prices ended as a seasonally-adjusted gain of 0.7%.


If you are a consumer that drove to work in the month of November 2009 and again November 2010, you paid 8% more for gas at the pump in November 2010 on a year-over-year basis.  The government CPI figure is clearly divergent from this figure.  Considering how integral a line item gasoline is for the consumer in his/her P&L, it is ridiculous that the divergence between gas prices and CPI is so stark. 


As a client of Hedgeye once said, “there is no inflation if you are an anorexic pedestrian”.  Per Wikipedia, CPI is representative of changes through time in the price level of consumer goods and services purchased by households.  Not so much.


Howard Penney

Managing Director


CPI - SMOKE AND MIRRORS - hedgeye inflation index1

R3: VFC, JNY, DG, H&M, and Tod's


December 16, 2010



  • Green Monday sales (the historical peak day for online holiday spending) reached $954 million, representing an increase of 12% year over year.  This growth rate is inline with overall e-com growth holiday-to-date.  Through December 13th, it is believed only 1/3 of consumers have completed their holiday shopping.
  • According to Google, 64% of consumers anticipate shopping  post-holiday sales.  Not surprising given the increasing emphasis on January as a “profit center” vs. a “clearance center” over the past several years.
  • According to Dollar General, the company’s price points are 38% cheaper than drug stores, 20% cheaper than grocers, and at parity with the discount stores.



Margin Concerns for H&M and Inditex grow -  Fast-fashion retailers continued to thrive in the run-up to the holiday season, but rising input costs threaten to pressure their margins heading into 2011, figures published Wednesday by market leaders Inditex SA and Hennes & Mauritz showed. Spain’s Inditex, Europe’s largest clothing retailer and owner of the Zara chain, said net profit rose 42 percent in the first nine months of its 2010 fiscal year as the group continued to rapidly expand in Asia and roll out its Zara online store across Europe. Meanwhile, H&M reported that same-store sales rose 8 percent in November, the same month its collaboration with French luxury label Lanvin was introduced, helping to fuel a 5 percent increase in sales for the financial year as a whole.  Inditex posted net profit of 1.18 billion euros, or $1.55 billion, between Feb. 1 and Oct. 31. Sales totaled 8.87 billion euros, or $11.64 billion, up 14 percent versus the same period last year. Dollar figures are converted from euros at average exchange rates for the period in question.The gross margin stood at 59.9 percent of sales, up from 57.1 percent in the first nine months of fiscal 2009. Store sales in local currencies climbed 10 percent year-on-year between Aug. 1 and Dec. 12. Analysts said the figures were broadly in line with expectations, although, based on the available data, they calculated that sales growth slowed somewhat during the first six weeks of the fiscal fourth quarter.  <WWD >

Hedgeye Retail’s Take:  Anyone get their hands on the Lanvin collab at H&M?  This has got to be one of the most successful luxury/fast fashion collaborations we’ve seen in the past 5 years.   Sold out.  Everywhere.


VF Corp. expects increase of 3B in sales for North Face by 2015 - VF Corp. plans to more than double The North Face’s volume to $3 billion in the next five years. The strategy, which would add $1.6 billion to its current sales of $1.4 billion by 2015, is built on reaching new customers by broadening category offerings, driving growth in foreign markets, expanding the direct business and investing in technology.

At an investor conference in New York Wednesday, Steve Rendle, president of North Face and VF’s Outdoor Americas unit, said, “North Face is one of a handful of brands that has the permission to extend beyond what it began as.” The business is expected to reach $1.4 billion in sales by the end of 2010, or 18.4 percent of VF’s anticipated $7.6 billion in revenue for the year.  <WWD>

Hedgeye Retail’s Take:  After moving to an Activity Based Model in early 2008, the company is focused on growing its Action Sports (skiing, snowboarding, etc.) and Performance (running, training, etc.) categories as the primary drivers of incremental growth over the intermediate-to-long-term. In turn, this categorization will help in tiering product across distribution more effectively – a necessary adjustment as the brand targets aggressive door growth plans.


Della Valle Brothers Sell 10 Percent of Tod's Shares - Christmas clearly comes more than once a year for Diego Della Valle, chairman of Tod’s SpA. Having already made a paper profit of more than $180 million on his investment in Saks Inc., Della Valle, along with his brother Andrea, has just received more than $300 million from the sale of 10 percent of Tod’s shares. The brothers had asked Italy’s merchant bank Mediobanca to place just over three million shares of the luxury goods group on the market, which amounts to about 10 percent of Tod’s capital. Italy’s Bourse said Wednesday that Mediobanca completed the operation at the price of 76 euros, or $101.90 at current exchange, a share, through an accelerated book-building offer. The operation netted the Della Valle brothers 232.5 million euros, or $311.7 million at current exchange. The Della Valle family remains the company’s largest shareholder after the placement, retaining almost 58 percent of the Italian firm, parent to the Tod’s, Hogan, Fay and Roger Vivier brands. Andrea Della Valle is vice chairman of the group. “We have been receiving indications from the market for some time to increase the liquidity of our shares in order to facilitate the investments of primary investors, who are often limited by a restricted free float,” said Diego Della Valle. “We have therefore tried to follow the investors’ requests, even if this means we have had to temporarily sacrifice the value of our investment.” <WWD>

Hedgeye Retail’s Take:  Nice gesture to cash out a $300 million equity stake to help investors increase their liquidity.  Or perhaps, the proceeds are about to be plowed into another luxury brand/retailer?


Heather Morris of 'Glee'  becomes new  Flirt Ambassador-  Flirt has signed “Glee” star Heather Morris as its Flirt ambassador. Morris, who plays cheerleader Brittany Pierce on the popular Fox TV sitcom, will hold the ambassador spot through next fall. The strategy, originated in 2004, is intended to match up-and-coming stars with the brand, which is owned by the Estée Lauder Cos. Inc.’s BeautyBank division. Past ambassadors have included Michelle Branch, Mila Kunis, Serena Williams and Vanessa Minnillo. According to Morris, the partnership works on many levels. “Brittany is the biggest flirt on “Glee,” so there’s that — not to mention I’m obsessed with the Flirt makeup,” she said, naming a lip color named Tootsie as her favorite. <WWD>

Hedgeye Retail’s Take:  What’s surprising is how long it has taken for Glee’s cast to cash in on their endorsement potential. 


Men's Tailored Clothing Industry weakened by commodity inflation -  "The industry is in turmoil.” That was the assessment of Ronny Wurtzburger, president of Peerless Clothing International, as he addressed the outlook for the tailored clothing industry next year.  Price increases on cotton, wool and polyester, coupled with a decrease in production capacity in factories overseas, is expected to add $10 to $20 to the wholesale cost of most suits by fall 2011, he said. Additionally, the economic uncertainty that still lingers in the U.S. continues to impact manufacturers and retailers seeking to boost sales. “Tailored clothing is necessary but not crucial,” said Jim Ammeen, president and chief executive officer of Neema Clothing. “It’s a postponable purchase.” Despite the challenges, manufacturers believe that by offering fresh fabrics, silhouettes and detailing, men will be stimulated to add to their wardrobes next year.  “Buying piece goods for next season is like playing the stock market,” said Wurtzburger. “You call for a price every day, and every day it’s different. If it were the stock market, we’d be happy, because it’s only going up.” <WWD>

Hedgeye Retail’s Take:   With JOSB and MW both recently reporting disappointing results, the supplier community certainly isn’t adding any hope to the industry’s outlook.  With that said, this is likely just one category where the pressure is going to be meaningful.


Sidney Kimmel moves to Non- Executive Chairman - Sidney Kimmel, founder of The Jones Group Inc., will move to the post of non-executive chairman of the company from his current post as executive chairman on Jan. 1, as Jones completes its 40th year in business. To commemorate Kimmel’s service, the company will donate $6 million to the Sidney Kimmel Comprehensive Cancer Center at Johns Hopkins in Baltimore and $2 million to establish a trust for post-secondary educational assistance for qualifying children of company personnel. The trust will be administered by an independent third party. Kimmel established the Sidney Kimmel Foundation in 1993. The philanthropic group and its cancer research subsidiary since have donated more than $550 million to cancer research.<WWD>

Hedgeye Retail’s Take:   The end of an era for one of the most tenured and pioneering apparel executives.  While Kimmel may be better known in the recent past for his investments in Hollywood productions, his roots are clearly tied to 7th Avenue.


L'Oreal to spend 26B to avoid take over , Exane Says - L’Oreal SA, the world’s largest cosmetics company, has capacity to spend as much as 20 billion euros ($26 billion) on acquisitions to help it avoid being taken over by Nestle SA, analysts at Exane BNP Paribas said. Fragrance makers Estee Lauder Cos. and Elizabeth Arden Inc. are among the possible targets for Paris-based L’Oreal, analysts Eamonn Ferry, James Bushnell and Jeff Stent wrote in a research note dated yesterday. L’Oreal will have net cash of about 2.7 billion euros by the end of 2012, and owns 9 percent of Sanofi- Aventis SA that it should sell, the analysts said. The stake is worth about 5.8 billion euros at current market values. Nestle owns about 30 percent of L’Oreal and probably wants to buy the French cosmetics company, the analysts said. Nestle Chief Executive Officer Paul Bulcke said in October that the Swiss food company is “sticking to the status quo” on L’Oreal. The French government and Bettencourt family, which owns about 31 percent of the cosmetics maker, would probably prevent a takeover by Nestle, the Exane analysts said. L’Oreal is more likely to make acquisitions than repurchase shares with its cash, because a buyback would increase Nestle’s stake, the analysts wrote.  <Bloomberg>

Hedgeye Retail’s Take:  Add to the list of takeover soap operas.  Interestingly, most of these “sagas” appear to have roots in France.


China: Retail sales of consumer goods up 18.7% in November -  China's retail sales of consumer goods grew 18.7 percent in November year on year, 0.1% higher than the same period in the previous month, said the National Bureau of Statistics (NBS).Retail sales of consumer goods stood at CNY1.39 trillion yuan (US$208.1 billion) in November, said the NBS spokesman Sheng Laiyun. Retail sales of consumer goods in the January-to-November period reached CNY13.92 trillion, up 18.4 percent from the same period last year. <FashionNetAsia>

Hedgeye Retail’s Take:  More fuel for retailers and western brands chasing China growth prospects.


China: Children’s shoe sector saw increasing growth - China's children shoemaking industry has recently been undergoing an ever-increasing growth, said industry representatives and experts from China Leather Industry Association who gathered in Quanzhou city to discuss the future of the sector.  According to the meeting report, China has 380 million children under the age of 16, with an increase of 27 million new born babies each year that accounts for one fourth of national total population and provides a market value of CNY30 billion. The report also pinpointed that in many Chinese families 40% of the household income are spent on children, and that represents a tremendous potential for business in China. Health, safety and comfort have currently become the essential factors for children’s shoemaking enterprises to take into consideration, and therefore designers should pay close attention to safety and health elements when designing, industry experts stressed. <FashionNetAsia>

Hedgeye Retail’s Take:  With Payless announcing its Stride Rite licensing agreement in China just last month, demand appears to be coming in strong at the right time.


Initial Claims Fall 1k Before Revision

The headline initial claims number fell 1k (3k after the revision) this week to 420k.  Rolling claims fell to 422.75k, 5.25k lower than the previous week and a new YTD low.  We continue to remind investors that the unemployment rate won't improve until we see claims move into the 375-400k range - this is based on our analysis of past cycles. That said, it is worth highlighting an important caveat. This recession has been different in that it has pushed the labor force participation rate down by ~200 bps, which has had a correspondingly positive improvement on the unemployment rate. In other words, the unemployment rate isn't really 9.8%, it's 11.8%. So when we say that claims of 375-400k will start to bring down the unemployment rate, we are actually referring to the 11.8% actual rate as opposed to the 9.8% reported rate. Today's data is a tiny step in the right direction. 






In the table below, we chart US equity correlations with Initial Claims, the Dollar Index, and US 10Y Treasury yields on a weekly basis going back 3 months, 1 year, and 3 years.




Joshua Steiner, CFA


Allison Kaptur

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