“Perhaps love is the process of my leading you gently back to yourself.”
-Antoine de Saint-Exupery
I do what I do every day because I love what I do. I love the morning’s silence. I love the research grind. And I love keeping score.
My vision for this firm isn’t to impose what I love upon you. My mission is to democratize the research process so that a real-time risk management conversation can be had. If we help you re-think any aspect of your risk management process, we’ve all won.
If a piece of research data or a point in principle leads you back to yourself, you’ve won. We can’t decide your risk tolerance. We can’t decide your investment duration either. What we can do is accept that markets are grounded in uncertainty and they do not discriminate in favor of anyone.
For me, Loving The Process means living it out loud. That’s why I’m trying my best to give you 100% transparency and accountability in every move we make each and every day. Sometimes this can be confusing – there’s a lot going on in Global Macro, so I get that. But complexity is no excuse for not delivering on the simplicity that is how I am positioned every day. So, going forward, we’re going to include the Hedgeye Portfolio at the bottom of every Early Look.
The Hedgeye Portfolio is not our Hedgeye Asset Allocation Model. These are two separate products that share many interconnected investment thoughts. The Hedgeye Portfolio is our best book of long and short ideas. They aren’t paired off. They aren’t weighted. They all have their own individual top down and bottom up thesis. They are intended to drive alpha on their own individual merits.
This is not to say that they are all driving alpha every minute of each and every day. This is not to say that we get everything right either. This is simply to say that I am going to be accountable to anything that comes out of these arthritic hockey knuckles, real-time. In the end, I think other firms will be forced by the marketplace to do the same. Opacity is dying on the vine of every industry – and there is no way to bail it out.
Enough about the process and its principles, let’s get at it and address how I am positioned (or thinking about being positioned) in the Hedgeye Portfolio after going through this morning’s grind:
1. Asia – We continue to see Asian Growth Slowing as Global Inflation Accelerates.
The Chinese and Indian governments are going to perpetuate this investment theme as they do not get paid to be willfully blind to the effects of inflation on their common people over the long term. China is raising interest rates this morning by another +25 basis points, taking its benchmark rate 300 basis points over Fed Funds, in order to address what Bernanke refuses to.
In the short-run, this is the pain that Asian central bankers are willing to impose on their stock markets. Over the long-run, seeing inflation destroy their sovereign bond markets, corporate margins, and their citizenry’s buying power is a really bad idea.
India’s stock market closed down another -1.6% overnight, taking the BSE Sensex Index down -13.4% for 2011 YTD. Bangladesh crashed yesterday, losing -10.3% of its stock market value in one day. Next to China and India at #1 and #2, Bangladesh has the world’s 8th largest population by the way. We remain short Thailand, which continues to see civil unrest on the border with Cambodia. These populations are hungry.
2. Europe – We’re not leaning bullish or bearish on Europe right now, but British Stagflation is starting to rear its ugly head.
We’ve been bullish on Germany for the last 18 months but recently sold out of that long position (EWG) as we see any price north of 7,300 on the German DAX as immediate-term TRADE overbought. Like it did in 2010, the DAX continues to outperform the SP500 and we think that Germany’s fiscal policy is amongst the most stable in all of the Western world.
We like countries with strong currencies that stand behind sober fiscal and monetary policy and Sweden fits that bill. When we say strong currencies, we don’t mean countries that say they want one – we mean countries that have one. Sweden doesn’t have Ben Bernanke. Sweden has the oldest central bank in the world and the Swedish Kroner is hitting a 10-year high this morning against the Euro. We’re long Sweden (EWD).
Despite the mean reversion rally in everything Pig Paper for 2011 YTD, we’re not preparing to buy Spanish or Greek stocks and bonds. We’re short Italy (EWI) and, as you can see in the Hedgeye Portfolio, that position is -3.82% against us. The next time someone tells you that inflating a stock market to a lower-long-term-high is bullish for a country’s long-term economic health, remind them Greece is the world’s best performer YTD.
3. USA and Latin America – We threw in the short-term towel covering our SP500 short position at 1276 on January 28th. Thank God for that.
That doesn’t mean I’m not bearish on US Equities on my long-term TAIL duration. That certainly doesn’t mean I won’t be re-shorting the SP500 again on its way up to my intermediate-term target of 1340. I’m actually as long as I have been US Equities since November and I’m downright scared about it. In the Hedgeye Portfolio, we continue to short the US Consumer stocks, trading around the positions profitably.
Whenever someone asks me about whether I am bearish or bullish on the US, I immediately have to answer them with a question – currency, stocks, or bonds? It’s a simple question, but it’s still a huge investment point when you think about generating uncorrelated returns. We remain bearish on US bonds and the US Dollar. These are major problems for the other HALF of Americans that don’t own The Ber-nank’s stock market inflation.
Latin America looks a lot like Asia – willing to accept that a debauchery of the world’s reserve currency is affecting global inflation and their citizenry. Two of the most important economies in Latin America, Brazil and Chile, are seeing their stock markets down -5.7% and -6.4% for 2011 respectively. We aren’t long of anything south of a Starbucks (SBUX) on the Mexican border.
Keep doing what you do out there, and I’ll keep doing what I do, re-thinking and re-learning how to manage Global Macro risk so that I can keep Loving The Process of being humbled by Mr. Macro Market.
My immediate term support and resistance levels for the SP500 are now 1300 and 1325, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
In preparation for the ASCA Q4 earnings release tomorrow, we’ve put together the pertinent forward looking commentary from ASCA’s Q3 earnings release/call.
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TODAY’S S&P 500 SET-UP - February 8, 2011
Equity futures are trading above fair value as investors continue to see upside potential for equities buoyed by the FED. US equities finished higher Monday on a very quiet day. Without any large negative geopolitical or economic headlines market participants focused on company specific M&A and earnings for direction. As we look at today’s set up for the S&P 500, the range is 25 points or -1.44% downside to 1300 and +0.45% upside to 1325.
MACRO DATA POINTS:
EARNINGS/WHAT TO WATCH:
The more defensive sectors – Consumer and healthcare – underperformed, while sectors more leveraged to the recovery – financials and industrials – lead the way higher. Perfect = 9 of 9 sectors positive on TRADE and 9 of 9 sectors positive on TREND.
CREDIT/ECONOMIC MARKET LOOK:
Treasuries: were weaker except for the long bond, which saw its yield decrease by ~2bps
MCD is scheduled to report its January sales results before the market open tomorrow, the 8th of January. Compared to January 2010, January 2011 had one less Friday and one additional Monday.
Below I go through my view on what sales results the Street will receive as “GOOD”, “BAD”, and “NEUTRAL” for each region. To recall, December’s results constituted a significant sequential slowdown from October in the U.S. As I detailed in my recent Black Book on MCD and the company’s prospects for 2011, specifically in the U.S., I believe that this year will see a significant slowdown in sales. While this may not spell disaster for January (there is plenty of time in 2011 for my scenario to play out), I am below the street’s estimates.
Before digging into the ranges for MCD comps, I think it important to address the key macro factors that are likely to impact results. Firstly, gas prices on a national basis were up 13.7% year-over-year in January, and up 3.3% versus December 2010. Secondly, given the importance of McDonald’s drive thru to their sales, the stormy weather that caused so much disruption may turn out to have been a factor. It is important to note, however, that Eric Levine, Hedgeye Director of Retail, wrote last week in his roundup of January’s retail same-store sales results that “the weather was barely mentioned as an excuse. Only a handful of retailers including Costco, BJ’s, JCP, and HOTT cited the impact of stormy weather on the month and actually quantified it.” There is historical precedent, however, within the restaurant space for snow storms having negatively impacted restaurant sales. The snow storms of December 1998 and January 1999 had negatively impacted the results of many QSR operators in the Midwest.
Below I go through my take on what numbers will be received by the street as GOOD, BAD, and NEUTRAL, for MCD comps by region. For comparison purposes, I have adjusted for calendar and trading day impacts. On a calendar-adjusted basis, consensus estimates are calling for two-year average trends trending roughly level with December in the U.S., down in Europe, and up in APMEA.
U.S.- Facing an easy -0.7% compare (including a calendar shift which impacted results by -0.4% to +1.0%, varying by area of the world):
GOOD: A print of roughly 4.5% or higher would be perceived as a good result, implying that the company has improved two-year average trends from December. Consensus is at 4.4% for MCD U.S. comps in January. I believe that merely meeting these expectations would be well-received by investors. I believe a print somewhere in the NEUTRAL range detailed below is most likely, but I expect a greater proportion of the slowing that I have projected for the U.S. in 2011 to take place after compares step up in difficulty from March onward. At that stage, I expect a starker divergence to emerge between my projections and those of the sell-side.
NEUTRAL: Roughly 3.5% to 4.5% implies a two-year trend approximately level with the calendar-adjusted two-year average trend in December. A print in this range may convince some investors that MCD’s top line trends are robust versus the 2.6% print in December. I would caution, however, that the compare is significantly easier in January than it was in December.
BAD: Below 3.5% would imply two-year average trends that had slowed from the calendar-adjusted two-year average trends in December which had, in turn, sharply declined from November’s results. A result this far south of expectations, obviously, would be negatively received by investors.
Europe - facing a +4.3% compare, (including a calendar shift which impacted results by -0.4% to +1.0%, varying by area of the world):
GOOD: A print of approximately 3% or higher would imply two-year average trends significantly higher than those seen in December. While two-year average trends would remain significantly below the 2010 average in the event of a +3% print, at the very least this would imply a significant bounce back from December’s disappointing result. Consensus is for a Europe comp of +3.7%.
NEUTRAL: Between roughly 2% and 3% implies a sequential increase from calendar-adjusted two-year average trends in December but would be significantly below Street expectations. Additionally, two-year average trends would be markedly lower than those seen in for the majority of 2010.
BAD: Below 2% would imply trends, at best, slightly higher than those seen in December and, of course, a one-year number far, far below Street expectations.
APMEA – facing a 4.3% compare (including a calendar shift which impacted results by -0.4% to +1.0%, varying by area of the world):
GOOD: A result of roughly 4.5% or higher would imply two-year average trends roughly in line with or better than results seen in December. Additionally, such a result would likely reassure investors that the bounce back in December from November’s result was not a head fake.
NEUTRAL: Between roughly 3.5% and 4.5% would imply two-year average trends roughly in line with, or slightly below, the strong results in December.
BAD: Below 3.5% would imply a significant slowdown from December’s result.
Nine trading sessions have passed since Coach reported its 2Q results and nothing from a fundamental perspective has changed in our view. What has changed is Keith's perspective on the shares, which were once again added to the firm's virtual portfolio on the short side.
Here's a recap of our thoughts (questions) following the handbag maker's recent report:
On an absolute basis, Coach’s F2Q was a pretty good quarter. The topline was better than expected (NA comps up 12.6% vs. a whisper of 8-9%) and quarterly EBIT margins of 35.9% by all accounts remain tops across the entire apparel, retail, and luxury sectors. Growth clearly remains the top priority for management with square footage expected to increase by 10% (vs. 8% LY) driven by aggressive expansion in China, new moves into Europe, and modest growth in the US supported by a resurgent men’s initiative. Cash generation is also a strong point as it always has been. The company ended the quarter having repurchased $388 million worth of stock, with $940 million on its balance sheet and no debt.
The “growth” story and the cash are hallmarks of Coach and factors that certainly shouldn’t be ignored. However good this may be, we come away from the quarter with more questions than answers on two fronts. First, is the Street really prepared for extremely challenging gross margin hurdles over the next three quarters after barely printing a gross margin gain of 15bps on an easy LY compare? And secondly, if SG&A growth remains high to support the company’s growth initiatives, will be there be meaningful earnings leverage in the near-term to satisfy those that are accustomed to consistent upside? Couple these unanswered questions with the fact that inventories ended the quarter up 36%, a full 17 points higher than sales growth and we believe there may be more risk than reward in the near term. While the SIGMA chart is not a perfect predictor by any means, this pattern is turning out to be a classic setup for future downside.
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