Business as usual
HIGHLIGHTS FROM THE RELEASE
CONF CALL NOTES
TODAY’S S&P 500 SET-UP - March 16, 2011
The Hedgeye models have all 9 sectors broken from an immediate-term TRADE perspective. The last time the the models signaled this was in May of 2010. As we look at today’s set up for the S&P 500, the range is 36 points or -0.69% downside to 1273 and 2.12% upside to 1309.
MACRO DATA POINTS:
WHAT TO WATCH:
As of the close yesterday we have 0 of 9 sectors positive on TRADE and 6 of 9 sectors positive on TREND. Utilities, Materials and Technology are broken on both TRADE and TREND.
CREDIT/ECONOMIC MARKET LOOK:
Yesterday, treasuries were mostly higher on flight-to-quality buying.
COMMODITY HEADLINES FROM BLOOMBERG:
Europe is trading mixed today, with the exception of Eastern Europe.
European inflation accelerated to the fastest in more than two years in February
Moody's downgraded Portugal's long-term debt rating to A3 from A1
Most Asian market traded higher.
Vietnam was the standout to the downside trading down 1.1%.
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There are a few datapoints out of the footwear space worth noting over the past 24 hrs. They generally point to continued health in the space, and give us added confidence in our call on Athletic Footwear overall, as well as on Collective Brands (PSS).
First off, NPD data shows that we’re ‘comping the comp’ with +5% growth this February versus +14% a year earlier. Average price point was up +1% for the second consecutive month. Not huge, but more often than not this metric tracks the Gross Margin trends in the space.
The Athletic Specialty space continues to outperform, which definitely synch with recent results out of Dick’s, Foot Locker, etc… The Family Channel looks good as well, holding steady from recent months. The channel that disappointed was the department stores, which is not a big shocker, and does not concern us. Actually, any weakness in footwear in department stores will only add to the margin pressure we should see as it relates to our call on Apparel for a 4.5pt industrywide margin decline.
Some nuggets out of Brown Shoe (BWS) and DSW:
BWS: This company is pretty much a disaster. Let’s not mistake it as a proxy for PSS – or anything else for that matter. Its wholesale business did not look good, which doesn’t shock us. Famous came in at +4.9% and sequentially unchanged on a 2-year basis, and 1Q comp guidance looks beatable at +low-msd.
DSW: This one had a rather solid quarter, but its guidance suggests a 1,000bp erosion in 1Qcomps. Are they up against some wicked y/y compares? Yes. Do they plan on beating expectations? Yes. But you can’t go guiding to comps like this and expect to walk away squeaky clean.
One thing to note is that it was about a year ago where we saw a 5-6 point negative diversion in comps at PSS vs BWS, DSW, and SCVL. Yes, this also led to PSS getting completely clocked (a painful day for us, a vindicator for the perma-bears, and an opportunity for the opportunist to buy on the capitulation). The point is that we’re about to comp up against those quarters. This is at a point where PSS’ has a better sourced-ratio, and has more boots, toning footwear, and believe it or not, higher prices. We’re not making a bull call on Payless, as we simply like the stability of its cash flow to fund growth in other brands. But let’s not be ignorant or wishful. The stock is going to trade on outsized changes in performances at Payless.
Conclusion: It’s obvious that growth will continue to slow on the island economy. What is becoming more obvious by the day is Japan’s fiscal and monetary policy ineptitude, which, for the first time in recent years is being fully exposed to global investment community. In the report below, we detail how to manage risk around this tragic event.
Position: Bearish on Japanese equities for the intermediate-term TREND. Bearish on JGB’s for the intermediate-term TREND and long-term TAIL. Bullish on the Japanese yen for the intermediate-term TREND; bearish for the long-term TAIL. Bullish on Japanese CDS for the long-term TAIL.
It goes without saying that the situation in Japan is frighteningly tragic and our thoughts and prayers go out to the victims of this crisis, both surviving and deceased.
With that said, the critical risk management task to focus on is determining what to buy and what to sell – and at what levels. To do that, one must have a proactive risk management strategy that understands full well that risk is always “on”.
As Rahm Emanuel famously said in the wake of the collapse of Lehman Bros., “You never want a serious crisis to go to waste.” In the spirit of this quote, we were marginally encouraged by the occurrences in Japanese financial markets over the past two days, as consensus finally starts to come to grips with Japan’s Keynesian Debt & Deficit Crisis:
Consensus will tell you that this price action is largely driven by hysteria surrounding Prime Minister Kan’s warnings of a possible nuclear disaster just 137 miles north of Tokyo, and, while we agree with that premise to an extent, we don’t think these moves are something to be written off as “panic selling”; nor do we think it’s wise to “buy the dips” here. Some dips are not to be bought – especially those that are broken TRADE, TREND, & TAIL. Today reminds us all that the “flows” work both ways:
We’ll need to see the prices confirm over the next three days or so before we feel comfortable shorting Japanese equities. There will be a throng of investors trying to get ahead of the Japanese recovery story, some that will buy the dip on valuation, and a few others that will buy them on the global growth story – which the data now suggests is increasingly eroding.
Of course, there will be an opportunity to get long the Japanese recovery trade eventually. As always, duration matters, however; after the January 17, 1995 Kobe earthquake, Japanese equities lost (-24.7%) before bottoming out nearly six months later on July 3. The Nikkei 225 did not break even until nearly 11 months later on December 7 of that year.
Addressing the point we made earlier, we think this most recent natural disaster serves as a wakeup call to the global investment community regarding the state of Japan’s finances. While certainly not “new news” to our Hedgeyes or to investors such as Kyle Bass and Marc Faber, we do think the broad-based weakness across Japanese asset classes exhibited today suggests that, on the margin at least, the world now understands that Japan is on the fast track to what we’ve termed the “Keynesian Endgame”.
To be clear, the Keynesian Endgame is a scenario whereby Big Government Intervention (known in academic circles as “countercyclical government stimulus”) in the form deficit spending, debt buildup, and cheap money monetary policy fail to produce the desired results. Instead, it produces depressed growth rates, which we have seen from Japan over the past two decades.
It’s important to highlight Japan’s fiscal and monetary policy response to this recent natural disaster and thus its latest contributions to its Keynesian Debt & Deficit Crisis:
Monetary Policy Response
It’s clear that Japan, much like the US, cannot afford to finance event risk – which includes things like recovery from natural disasters and war. Given, that shifts much of the burden to the central bank to print money. It’s worth noting that this concept is near the core of our bearish long-term thesis on the yen; this recent earthquake and tsunami merely inches Japan closer to a demographic fueled JGB supply/demand imbalance.
Further, one has to wonder how much the Bank of Japan can shower the financial system with yen before people stop bending over to pick them up. To this point, it comes as no surprise to us that only ¥8.9 TRILLION of the ¥42 TRILLION yen offered by the BOJ was actually met with demand from financial institutions. Japan has been in a classic liquidity trap for many years and we don’t expect the BOJ’s latest attempts at printing money to be met with a commensurate pick-up in private sector growth.
Our view is in sharp contrast to current consensus expectations, as many Japanese investors have been trained to beg for stimulus at the first sign of a market crack after many years of Big Government Intervention. Consider the commentary offered to Bloomberg by the following investment professionals as a gauge of where Japanese investor sentiment is:
“If stocks continue to drop more and the yen gains further, it will probably have an adverse effect on corporate sentiment and household consumption… So the BOJ may need to take further action.” – Norio Miyagawa, senior economist at Mizuho Securities Research and Consulting Co.
“The Bank of Japan is missing the chance of doing something more aggressive… What the BOJ should do now is to anchor investors’ sentiment with accelerated purchases in its program” – Masaaki Kano, chief Japan economist at JPMorgan Chase & Co.
“The liquidity supply was a normal response to make sure the markets function in an orderly fashion. It was nothing more than standard operating procedure.” – Richard Jerram, chief economist at Macquarie Securities Ltd. in Singapore.
Phrases like “normal response” and “standard operating procedure” are exactly why we think the recent bullish bid across the US Treasury curve is supportive of the case for QE3. That is, if UST yields continue to trade below what used to be their intermediate-term TREND lines of support, we’d contend that the bond market is forecasting another round of Quantitative Guessing here in the US.
Of course, we’d expect to see those same yields eventually back up on the inflationary impact of QE3 policy; until that occurs, however, a compressing spread between UST 2Y yields and JGB 2Y yields is bullish for the JPYUSD exchange rate – on top of any repatriation that will be done by Japanese nationals to help with relief efforts at home.
Given this setup, we can foresee a scenario whereby the yen continues to appreciate over the intermediate term even in the face of accelerated easing out of the BOJ. For this reason, we think the Japanese yen will continue to strengthen over the intermediate-term TREND. Understanding full well that consensus will likely continue using the same one-factor model of yen up/Japanese stocks down, we remain bearish on Japanese equities over that same duration.
Monitoring the slope of the aforementioned spread and QE3 expectations will be crucial to a timely exit from this position. An additional risk to highlight here is outright intervention in the FX market by the Japanese government – which will come at time when Japan can least afford a weaker currency, given its raw material needs over the intermediate term. For reference, Japanese Import Price growth continued to accelerate in Feb, advancing to +7.6% YoY.
On the other side of Japanese trade, we expect a continuation of slowing export and manufacturing growth as the damaged infrastructure and rolling blackouts delay both production and shipping – much like we saw in 1995 after the Kobe earthquake.
Currently, Japan supplies about 20% of the world’s technology products – many of them key components that cannot be done without, such as the silicon wafers used in manufacturing microchips and batteries used in the production of everything from autos to tablet PCs. The lack of Japanese supply on the margin is likely to put upward pressure on technology and industrial input prices globally – a supportive data point for our current short XLI position in the Hedgeye Virtual Portfolio. Recent commentary offered by global multinationals like Boeing Co., Korea’s Samsung Group, Germany’s BMW AG, Sweden’s Volvo AB, and Taiwan’s HTC Corp. (among many others) lend credence to this concern.
All told, it’s obvious that growth will continue to slow on the island economy and that the fiscal and monetary levers that Japan can pull in the event of further crises continues to grow increasingly inadequate by the day.
Risk is always “on”.
Positions in Europe: Long Germany (EWG); Short Spain (EWP)
We’ve been closely following the high frequency data from Europe and have warned in our research in recent weeks that PMI surveys, for both Manufacturing and Services, have come in “toppy” for many of the major economies, including Germany. Today the ZEW reported a month-over-month decline in its German Economic Sentiment survey, a 6-month forward-looking assessment, registering 14.1 in March versus 15.7 in February.
While we’ll need far more than one data point from one survey to make an investment call in the country (we’re currently long Germany via the etf EWG in the Hedgeye Virtual Portfolio), the data presents an inflection point worth calling out and is in line with our call that German PMI should mean revert over the coming months as it flirts with near all-time highs.
Although we continue to like the country longer term, we’re likely to trim our current 6% asset allocation to Germany over the near term. Currently the etf EWG is getting hammered, however not unlike most global country ETFS as investor concerns are focused on Japan.
The big news from Germany today is Chancellor Angela Merkel’s decision to shut-down 7 of the country’s aging nuclear reactors for 3 months pending a safety review in light of the events in Japan. The Swiss followed the Germans saying they will suspend the regulatory process for 3 nuclear power stations because safety remained the first priority. [For reference, Switzerland has 4 nuclear plants with 5 functioning reactors].
In opposition, France, Spain, and Italy all announced today that:
(1) They need nuclear and don’t see their stance changing in the foreseeable future, and
(2) Won’t reconsider building new nuclear plants
Germany’s 17 nuclear reactors account for ~23% of the power generated in the country last year, while atomic energy accounts for ~28% of Europe’s power generation. In 2010, Chancellor Merkel repealed a 2002 law passed by her predecessor Gerhard Schroeder and his coalition of the SPD and Green parties that would have shut down all German nuclear plants by 2022.
German leading power generators such as E.ON AG (EOAN) and RWE AG (RWE), both members of the DAX, are helping to drive the downward thrust in the DAX, both falling 6-9% over the last two days, while Q-Cells (QCE), a solar company (and not a member of the DAX), has been one strong gainer.
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