TODAY’S S&P 500 SET-UP - December 29, 2010
As we look at today’s set up for the S&P 500, the range is 16 points or -0.68% downside to 1250 and 0.60% upside to 1266. Equity futures remain above fair value as commodity stocks continue to benefit from investors hedging a declining dollar. In overnight news, China's central bank raised its rediscount rate 45 bps to 2.25%.
CREDIT/ECONOMIC MARKET LOOK:
Treasuries sold-off sharply on Tuesday, significantly more so following a disappointing $35B 5-yr auction which yielded 2.149%, or approximately 8bps above the prior trade. 10-yr notes added nearly 16bps, most of which in response to the auction, to yield 3.49%.
OTHER COMMODITY NEWS:
“This stubbornness in the face of clear data is right up there with the efficient market believers.”
-Jeremy Grantham (Quarterly Letter, October 2010)
Quite often I get asked whose research thoughts I try to incorporate into my global macro risk management process. In terms of risk managers who are still alive, I have a relatively short list. Jeremy Grantham, Jim Grant, and John Hussman are at the top of it. All three of these gentleman write consistently, quantitatively, and accountably.
This isn’t to say that there aren’t plenty of thoughtful people out there who are worth reading. This is to say, however, that there are plenty more opinions in the market place than there is time. Taking the time to focus on doing your own work is critical.
I’m fairly maniacal about writing down my investment thoughts. I use the same amount of space, on the same number of pages, in the same notebooks, every day. When my own work isn’t working, I shut down the noise, review my notes, and rethink my theses. Then, if I have time, I re-read some of the more pertinent intermediate-term TREND thoughts of some of the aforementioned thinkers to keep myself in check.
Yesterday, I was re-reading Jeremy Grantham’s Quarterly Letter for October titled “Night of the Living Fed” and that helped me re-think my global macro positioning heading into 2011.
Before you scroll down, don’t worry – I’m not covering my short position in the SP500 (it’s -2.81% against me). I currently hold 11 SHORT positions in the Hedgeye Portfolio (versus 10 LONGS) and my biggest loser on the short side is an unrealized loss of -4.8% in Hudson City Bancorp (HCBK). I’ve been bearish plenty enough times on US stocks in my career with performance that’s worse than that.
Being bearish on US stocks here doesn’t mean you have to be bearish on everything – that’s a US-centric stock market investor’s risk management problem, not yours. You can also be bearish on the Fed and make money being long the US Dollar (or short US Treasury bonds). Both are bets that Bernanke fails to debauch America’s currency and hold rates of return on American savings accounts unsustainably low.
Grantham, Grant, and Hussman aren’t fans of The Ber-nank either. So, while hope is not an investment process, I’m really hoping we can start a little Groupthink Club of our own ahead of Bernanke having to face both Ron Paul and more dissenting Fed Voting Members in 2011.
On the politicized US central bank, here are some valuable excerpts from Grantham in the “Night of the Living Fed”:
The “real world” is, of course, real-time… and… as Ludwig von Mises said, “For many people, the “long run” quickly becomes the short run.” There’s no better evidence of that than daily, weekly, and monthly price, sentiment, and expectations data.
On the inflation side, with the 19 component CRB Commodities Index hitting another fresh YTD high yesterday up at 331, here’s what the expectations of higher prices (inflation) have done:
For a man who preaches “price stability”, that’s nice Heli-Ben… really nice. The 45 MILLION Americans on food stamps salute you.
On the sentiment side, not surprisingly now that holiday cheer is becoming a rear-view event, this morning’s ABC Consumer Confidence reading dropped to minus -44 versus minus -41 last week. Jobless Stagflation in America perpetuated by a Fed policy to inflate isn’t cool for the 90% of Americans who aren’t levered-long the SPY.
Meanwhile, US-centric stock market bulls continue to be Stubborn Believers (like they were in late 07’ and early 08’) that stocks are “cheap” even though corporate earnings are being fueled by record low costs of capital (interest rates) and peak operating margins.
Managing risk using record low interest rates and peak margins as perpetual plugs in an earnings model is something that only a historian who has never run a business or a global macro P&L would do. Or should I say, dare you to do. Ben Bernanke, good luck with that in 2011.
My immediate term support and resistance levels for the SP500 are now 1250 and 1266, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.
This note was originally published at 8am on December 28, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”
-John Maynard Keynes
A Google search for quotes related to “inflation” produces quotes from Keynes in the first 10 spots. While his radical idea that government should spend money it doesn’t have may have saved us from the brink of a financial collapse, he might not have agreed with QG (Quantitative Guessing) and the impact it is having on global inflation.
The week in between two holidays is challenging on many fronts - personally and professionally. Typically, there is little incremental macro data in the U.S. because politicians take time off for the holidays rather than trying to force issues when there is no audience. In addition, most “big money” institutions are not going to make any big bets when there is no liquidity.
We headed into the holiday lull with a bullish sentiment, an overbought market and MACRO factors that continue to keep us on the bearish side of a tightly-wound, high-risk environment. Yesterday, on a stealth day for MACRO news, the VIX shot up 7.29%, putting a two-day move at 13.89% (but still down 18.5% YTD).
The world is interconnected and this year’s “tweener week” is filled with interesting global macro data points, especially after China used the holiday weekend to hike interest rates in an attempt to ward off mounting inflation.
The news/rumors this week do not stop with China! After the first of the year, Taiwan and South Korea will also be raising rates to battle domestic inflation. How ironic that the region of the world (Asia) that is the hot bed for “deflation” for the balance of the planet is fighting a battle against domestic inflation. If slowing growth in the emerging markets is not on your list of 10 surprises for 1Q11, it should be.
Don’t take my word for it; the Chinese equity market is now down 9 of the last 10 days, declining 1.74% last night (down over 3% at one point). The Chinese don’t mince words about where they think things are headed. Overnight China’s Premier Wen Jiabao said measures to curb the country’s property market “weren’t well implemented” and reiterated his goal for home prices to return to a “reasonable level” during his term that ends in 2012.
This is the killer statement by Wen Jiabao: “We introduced about 15 measures this year but it appears that they were not well-implemented….I believe that after some time, the home market will return to a reasonable level with our efforts.”
If China did not get it right in 2010 (even though the Shanghai Composite is down 16.6% YTD) and they implement measures to curb property prices more effectively in 2011 and demand begins to slow as a result of a heightening cycle, we could see Industrials (XLI) and Metals (XLB) quickly come under pressure. With the Chinese market as a leading indicator of growth and the market trading down 3.1% over the past month, those sectors and commodities with the biggest leverage to Chinese demand are likely headed lower, despite recent moves higher.
Over the past month:
(1) The S&P 500 is up 5.1%
(2) The XLB is up 9.6%
(3) The XLE is up 7.5%
(4) The XLI is up 6.7%
(5) The CRB is up 9.3%
(6) Copper is up 13.8%
In light of Wen Jiabao’s statement, it is interesting to note that the best performing sectors year-to-date are also those with the most leverage to Chinese demand. The four best performing sectors are:
(1) Consumer Discretionary (XLY up 26.03% YTD)
(2) Industrials (XLI up 25.51% YTD)
(3) Energy (XLE up 17.82% YTD)
(4) Materials (XLB up 15.79% YTD)
While most Asian central bankers seem to see that there is an inflation problem, in the USA we still cannot see it, despite a number of “real life” examples of real inflation hitting the U.S. consumer hard. Yes, we are going to hammer home a key theme in 2011: Jobless Stagflation (inflation accelerating, growth decelerating) is here to stay.
Of course, the components of any inflation index are up for debate. For instance, the government and most people that disagree with our view on inflation prefer to exclude staple, non-discretionary aspects of consumer spending such as food and energy from the calculation. One item I hope we can all agree to include is healthcare costs.
According to the Commonwealth Fund (a non-profit fund), U.S. health-insurance costs are rising more quickly than the ability of U.S. families to pay for it. They cited that private-insurance premiums for families rose three times faster than median household income over six years and deductibles rose almost five times faster. In 15 states, health-insurance premiums are the equivalent of at least 20% of median household income for people under 65.
While the market has rallied on the back of the Government pumping another $800 billion into the economy to prop up the ailing consumer, the average American remains liquidity-impaired and the U.S. housing market is headed lower, not higher. With these factors still in place, the now positive bias toward stronger-than-expected GDP growth in 2011 can certainly be questioned.
Inflation is a policy that, as Keynes said, confiscates part of the citizens’ wealth. The government’s most recent move, to implement payroll tax cuts while extending unemployment benefits, may go some way to stimulate the economy in the short term but runs a considerable risk of exacerbating the deficit. In this interconnected global economy, as the world’s fastest-growing economies take strong measures to curb inflation, the net effect could be icy for world growth. In the U.S. certainly, from a global and domestic perspective, the evidence is clear that inflation is here to stay on a global basis and Jobless Stagflation is going to impact the economy in 2011.
Function in disaster; finish in style.
It doesn’t come as a surprise that the biggest question we’ve been asked over the past few days relate to the magnitude and sustainability of retail sales growth.
Was it a good holiday? Relative to expectations, it probably was. But what we do not know (because retail CFOs have not said so…) is how much discounting needed to be done in order to drive the sales. We’ll find that out by mid-late Jan after everyone has all their double-secret one-on-ones with retail CFO/CEOs at the ICR conference.
We can talk about weather, deferred wardrobe building, a marginal pick-up in men’s, tax stimulus, change in unemployment, or even portfolio dressing and tax-loss selling. But the reality is that an attempt to quantify the mixture of these factors – along with rapid changes in global macro cross currents -- over such a short duration misses the bigger point.
That is – by far – when the consumption gap between spending and COGS starts to squeeze the supply chain, and therefore margins. We’ve been all over this for the past few months, but consider the milestones.
Check out our SIGMA below. If you don’t understand it, please ask us. This is a VERY important one as EVERY metric on that chart (Sales/Inventory Spread, GM%, SG&A Leverage, Capex) is heading in the wrong direction.
The punchline is that we’ve just seen a definitive turn down into the quadrant whereby retailers need to be VERY smart about planning inventory and sales campaigns, or simply hold their breath and pray that the consumer shows up.
There’s going to be plenty of pin action in the first half of 2011.
R3: REQUIRED RETAIL READING
December 28, 2010
OUR TAKE ON OVERNIGHT NEWS
P&G’s Gillette Drops Tiger - Gillette become the latest company to end its multi-million dollar sponsorship deal with Tiger Woods. Gillette had already pulled back on its use of the golfer in advertisements following revelations that Woods of extramatrial affairs. The men's grooming company will not renew its sponsorship deal with Woods as part of a plan to phase out its Gillette Champions marketing campaign in the first quarter of 2011. Other sponsors who have severed or significantly reduced their ties with Woods include AT&T, Gatorade, Accenture and Tag Heuer. Nike and Electronic Arts are the only large sponsors to have stood by Woods. <WWD>
Hedgeye Retail’s Take: After finishing either 1st or 2nd in 10 tournaments last year, Woods’ 2nd place finish in the Chevron World Challenge earlier this month is his only such success in 2010. Gillette now joins the ranks of severed endorsements including AT&T and Accenture earlier this year while Nike, EA Sports and Tag Heuer are among Woods’ eight remaining deals. It’s hard to ignore that after once ranking in the top 100 for “celebrity’s ability to influence consumers,” he now ranks below 2,500 according to the Davie Brown Index.
Continued Impact of Winter Storms - While business wasn’t bad through much of Sunday, it quickly tapered off by late afternoon as the snowfall and winds intensified and buried any hopes of a strong start to post-holiday sales. Many retailers and malls were forced to close early Sunday and delay openings on Monday or remain closed, particularly in Manhattan and outlying areas. At Scoop, “We had a great Christmas, including a massive surge last week, then the storm came and we closed eight stores in the Northeast,” said chief executive officer Susan Davidson, who was supposed to travel from Chicago to New York and then to Puerto Rico, where she has a home, but she bypassed New York and went straight south. “We will open some stores on New Year’s Day to make up for today. We’ve never done that before. I’m not sure, but I think we can make up the business. It’s been so good, I don’t want to give any of it back.” “The storm totally puts a dent into things. When you lose one of the top six days of the year you feel it,” said Marshal Cohen, chief industry analyst for The NPD Group. “The loss of post-Christmas weekend is brutal. This weekend was shortened already,” with Saturday being Christmas. <WWD>
Hedgeye Retail’s Take: Keeping stores open New Year’s Day in an effort to offset Sunday’s lost sales is not exactly a comparable exchange. Call us crazy, but our sense is that consumers hung-over from celebrating the New Year are not quite as active/productive as those the day after Christmas.
Sears Gift Card Deal Was Indeed Too Good to Be True - Sears Holdings Corp. is trying to figure out why a promotion for Christmas items turned into a 50% discount for online gift cards over the weekend. The promotion that offered half off on holiday-themed items bought online, and which was e-mailed to consumers, somehow resulted in 50% price cuts for online gift cards for a few hours Sunday, a Sears spokeswoman says. She adds that the retailer was looking into the technical reasons for the problem. The spokeswoman would not say how many consumers bought the cheaper gift cards, or how many shoppers received the original offer. Nor would she say if consumers who bought the gift cards at 50% would be able to redeem them. “We will continue to investigate the matter,” she says. <WWD>
Hedgeye Retail’s Take: Who knows, perhaps this Groupon-like deal will prove to be a positive for Sears from both a sales and marketing perspective.
Pending Raw Material Shell Game - High fiber prices are expected to create some upheaval throughout the supply chain in the coming months. Rising costs of raw materials deep in the supply chain haven’t yet made their way through to retail apparel prices, but that can’t continue indefinitely, experts said. Volatile cotton prices in the last year have soared to record highs, wool prices are higher than they have been in years and synthetic fiber prices, while not seeing upward pressure anywhere near the natural fiber industries, are also elevated. “The assumption is they’re going to have to pass some of this on at the retail level; the question is how much,” said Nate Herman, vice president of international trade for the American Apparel & Footwear Association. “It won’t be the full amount of the additional costs people are paying in the supply chain.” Retail prices for apparel are likely to register increases in the low- to midsingle digits next summer or fall given the production schedule of apparel, Herman said. Pushing costs back up the supply chain is trickier now because of a consolidation of the sourcing base following the economic crisis, when many factories were forced to close. <WWD>
Hedgeye Retail’s Take: Interestingly, it was reported in the China Daily overnight that relationships between supermarkets and suppliers are becoming increasingly strained over this same issue with parties disagreeing on price increases at retail. A likely preview of what lies ahead for U.S. retailers in 2011…
Issa Brand Coming to U.S. - Kate Middleton may have introduced the world-at-large to a small British label called Issa, but that bright, royal blue jersey dress the young royal-to-be donned on Nov. 16 is a longtime fashion favorite — with something of a dramatic past. Brazilian-born, London-based Daniella Helayel, Issa’s founder and designer, recalls that when she first introduced her now famous collection of figure-flattering, brightly colored silk jersey dresses in 2001, hardly anyone even noticed. “The first collection I ever showed was filled with leather and suede pieces and jersey dresses that were easy to pack, easy to take away on a trip. I thought it was a fabulous idea,” said the stylish and ever-smiling Helayel over lunch at an old-time Italian restaurant in London’s Chelsea. Next year, Helayel plans to relaunch her business in the U.S.; introduce e-commerce on the Issa Web site; open the first of six stand-alone stores in Brazil; begin selling a children’s collection called Baby Issa, and transform what’s now a clothing label with 200 stockists into a global brand. And contrary to British press reports, which have named her as one of the front-runners to design Middleton’s wedding gown, Helayel has not launched a stand-alone bridal collection. “I’ve done one-off designs for friends. That’s all,” she said. <WWD>
Hedgeye Retail’s Take: Think Michelle Obama and J.Crew except Issa is infantile by comparison. Let’s just hope that Helayel is well advised in regard to site infrastructure before launching her U.S. e-commerce site. Keep an eye out for this brand in 2011.
Mexico's Liverpool Looks to Expand in 2011 - Liverpool, Mexico’s largest department store chain, plans to open 40 stores by 2014 as it rushes to capitalize on the country’s booming department-store market, which is growing by 10 percent a year. Profits are expected to rise by 20 to 25 percent a year as the chain expands and works to bring new exclusive brands to its stores, general sales manager Eduardo Flores told WWD. Along those lines, the retailer recently signed a deal to exclusively carry Jones New York beginning with spring 2011. It also hopes to bring in teenage casualwear brand Alex Canon during the same period. Traded on the Mexican Stock Exchange, Liverpool operates 81 stores, after opening six units in fiscal 2010. It competes head to head with Sears Mexico, which is majority owned by billionaire Carlos Slim Helú, and smaller upmarket chain Palacio de Hierro. Unlike Palacio de Hierro, however, Liverpool caters to Mexico’s large demographic of middle-class consumers. Liverpool’s most popular apparel brands include Polo Ralph Lauren, Nautica and Levi’s. Flores said 2011 will mark a return to aggressive expansion after Liverpool virtually froze its growth plans in fiscal 2009 when the recession forced it to open only two stores, down from eight in 2008. Flores said the competition is also scrambling to become the market leader and he pointed out Coppel, a fast-growing rival chain that also targets the middle class, as a growing threat for the established players. “They [Coppel] are opening 20 to 30 stores a year so everyone’s watching what they are doing,” Flores noted. According to Flores, Mexico’s department-store sector is growing by 8 to 10 percent a year on the back of a thriving and young middle class that favors American-style shopping in big malls. <WWD>
Hedgeye Retail’s Take: With new square footage growth still tough to come by domestically, perhaps U.S.-based retailers will give more thought to expansion in Mexico given the growth outlook in the department store sector.
Consumers Remain Skeptic of Behavioral Advertising - A whopping two-thirds of internet users don’t believe advertisers should be allowed to target online ads to their interests based on the sites they have visited, according to a survey by USA Today and Gallup. Respondents were only slightly more sympathetic when asked whether free access to content made targeting worth it; 61% disagreed while 35% thought the practice was OK. Younger and wealthier internet users were less likely to be against behaviorally targeted advertising, but even among those groups only a minority tolerated the practice. Respondents were more amenable to allowing behavioral targeting from select advertisers. The youngest respondents, ages 18 to 34, were most likely to say they would be willing to allow targeting from chosen advertisers, at 57%. The most affluent users fell behind, however, and those making between $30,000 and $75,000 were more apt to say yes. The Gallup survey is hardly the first poll to show widespread antipathy toward behavioral targeting. While many marketers, led by the Interactive Advertising Bureau (IAB), still hope for the success of self-regulation, public opinion has encouraged involvement from legislative and regulatory officials. And research suggests that education about behavioral targeting—which marketers hope will assuage the concerns of web users—may actually create worse feelings. A May 2010 study from online a preference management provider PreferenceCentral found that web users’ willingness to trade off free content for targeted ads dropped by 15 percentage points after survey respondents received information about what behavioral targeting is and how it works. The fact that over time, as behavioral targeting has featured prominently in the news, Americans continue to regard it as invasive. <emarketer>
Hedgeye Retail’s Take: While the technology behind profiling based advertising as seen in the Minority Report is not far from reality, consumers’ willingness to oblige still is. Not surprisingly, younger consumers are more willing suggesting it’s only a matter of time.