Buy the Market on Valuation?

Conclusion:  Based on Shiller’s CAPE P/E multiple, the market is at least one standard deviation overvalued.  Further, corporate margins are at 30-year highs, which suggest it is unlikely that earnings will grow into their multiple.


When Keith and other members of our team appear on CNBC and other major media outlets to discuss the markets and investments, it gives us a keen ability to really focus on consensus’ best ideas and the associated storytelling.  A key consensus reason often given to increase long exposure to the US equity market is valuation.


As a graduate of the Value Investing Program at the Columbia University, I’m all for value, but, as always, a valuation is only as good as its assumptions.  Attempting to value a stock is difficult enough given all the relevant assumptions needed, but attempting to project those earnings for an entire market, like say the SP500, only magnifies the complexity and, really, likelihood of error.


Regardless of our ability to actually project the earnings for a company or market accurately, valuation multiples themselves can provide an important gauge of investor sentiment.   Simply put, in extremes of serious stock investing euphoria valuations are high.  In contrast, in periods when investors are extremely concerned about the outlook for equities, stock market valuations are depressed.  Thus the power of the stock market crowd in aggregate will provide us some insightful contrarian indicators.


In the chart directly below, we’ve highlighted Professor Robert Shiller’s (our neighbor across the street at Yale’s School of Management) long term Cyclically Adjusted P/E chart for the SP500.  Over time, the valuation of the U.S. stock market has varied widely.  Based on Professor Shiller’s work, the lowest P/E multiple for the broad market was 4.8x in December 1920, while the highest P/E multiple came in December 1999 at 44.2x.


Buy the Market on Valuation? - 1


Currently, the valuation according to Shiller’s analysis is 23.6x earnings, which is well above the long run average of 16.4x.  In fact, the current valuation of SP500 composite is more than one standard deviation above its long run average.  So, while this is not necessarily an extreme overvaluation, the market is clearly not cheap on this basis.  The chart above shows this well graphically, as valuation is just starting to breakout above its historical range.


By way of background, Professor Shiller uses what is called CAPE, or Cyclically Adjusted Price to Earnings.  In terms of the numerator, or price, Shiller uses the monthly average of daily closes for the SP500.  To derive the earnings data, in this instance the denominator, Professor Shiller uses the quarterly earnings data from the SP500’s website and utilizes an interpolation to provide earnings data by month.  He then adjusts both the numerator and denominator for inflation using CPI from the Bureau of Labor Statistics.  Finally, the inflation adjusted price is divided by an average of ten years of real monthly earnings to determine the CAPE.


Obviously, market valuation is one of many factors to consider, but certainly the stock market is not cheap.   The key push back on this call out is that future earnings growth will drive the overall P/E of the market lower, so perhaps the market is not as expensive as it appears.  Our key issue with the earnings growth argument is based on slower than expected GDP growth both domestically and abroad and a limited ability of corporations to expand margins.


On the second point related to corporate margins, profit margins in the United States are at near all-time highs on various calculations.   In fact, as highlighted in the chart below, our calculations using BEA data show that both EBITDA and EBIT margins are at/near 30-year highs.   Needless to say, the margin expansion argument is somewhat difficult to make given that backdrop and the potential for mean reversion. 


Buy the Market on Valuation? - 2


In the face of near all-time high margins, a stock market that is at a stretched valuation, and sequentially slowing domestic and global growth, it is becoming increasingly difficult to make the “valuation” argument to buy equities.  That said, as long as The Bernank keeps interest rates at zero, investors are at least marginally incentivized to take some equity risk, but, to be clear, it is risky.


Daryl G. Jones

Managing Director

Greens Take Germany’s ‘Nuclear’ Elections

Positions in Europe: Long British Pound (FXB); Short EWI (Italy), Short Spain (EWP)


We continue to be constructive on German economic fundamentals, despite the backdrop of sovereign debt contagion on the continent; however, state election results in Baden-Wuerttemberg over the weekend confirm that while Chancellor Merkel’s seat may not be in threat, the ability of her CDU party (along with her junior coalition partners the Free Democrats, or FDP) to pass federal legislation will be increasingly diminished.  Below we present the recent state election shift to the Green party, and our view on utilities in Germany as nuclear power is increasingly voted down following Japan’s nuclear crisis.


Greens Capitalize on Merkel’s Flip-Flop


This weekend saw the punishment of Merkel’s conservative party at the hands of the Green party and the vote swung on one key issue: nuclear power in Germany.  According to preliminary results, the anti-nuclear Green party polled 24.2% in the Baden-Wuerttemberg state election, double the share of the last vote in 2006, effectively capitalizing on the momentum from Merkel’s recent flip-flop stance on nuclear energy following the earthquake and tsunami in Japan.


Merkel’s flip-flop came with the decision on March 15, 2011 to shut-down seven of the country’s aging reactors for three months pending a safety review, after deciding last fall to extend the lifespan of the country’s nuclear reactors from 2022 to 2036.  


The support for the Greens in Baden-Wuerttemberg over the weekend puts into play their likely coalition with the “Reds”, or the Social Democrats (SPD), which polled 23.1%, and with it the first state governor in Green Party history.  The CDU polled 39% approval, but slipped a full 5.2 percentage points, and their coalition partners, the FDP, polled a mere 5.3%, and therefore a CDU-FDP coalition will likely come up short of a majority when the final tallies are released. For context, this notable party sea change comes in a state that has been governed by the CDU for the last 58 years!


Political Messaging and Utility Implications


The lead-up to the Sunday’s election result saw more than 250,000 people protest against nuclear power across four German cities on Saturday -- a clear spike amidst years of nuclear power as a hot issue. However, the Green party’s support over the weekend proves how important it will be for Merkel and Co. to rebrand her energy message at the federal level, in particular towards renewables and away from nuclear. Not only may Merkel be losing popular support, but Sunday’s results will further reduce the number of seats the CDU and FDP have in the upper house of parliament, the Bundesrat, and therefore limit Merkel’s sway to pass national legislation.


The clear losers in the move away from nuclear power in Germany are its utility companies, in particular the major power companies of Eon and RWE (both members of the DAX), and EnBW. (Below we show a map of Germany’s reactors for reference.)


Greens Take Germany’s ‘Nuclear’ Elections - spiegel2


Leading up to the earthquake in Japan and Merkel’s flip-flop, German nuclear power companies expected to pay a new nuclear fuel rod tax, estimated to amount to €1.2 - 2.3 Billion annually until 2016, as a concession for the extension of the country’s nuclear reactors.  Now, following Merkel’s moratorium on the seven plants, recent news suggests officials at Eon, RWE, EnBW, and Sweden’s Vattenfall are preparing to file lawsuits against the German government on the decision to idle the seven power stations, and may test the legality of a nuclear fuel-rod tax.


In any case, the government’s potential shift to renewables, and the implications of the Green Party’s likely rule in the state of Baden-Wuerttemberg, could result in higher energy costs in Germany (and to its providers), including via higher energy taxes that the Greens may press for.  Clearly, any additional taxes levied on nuclear power companies will eat into profits, and negatively impact the performance of the DAX. 


Presently, our quantitative levels show that the DAX TREND line (3 months or more) is broken, and now the 7,078 line that was previously support is resistance. The DAX is flat YTD, having slid -10.4% since 2/28 to bottom at 3/16 and has now corrected +6.5%.


Greens Take Germany’s ‘Nuclear’ Elections - mh1


While there are still many unknowns about the outlook for the nuclear energy space in Germany, the results in Baden-Wuerttemberg in favor of a nuclear phase-out will have significant implications for Germany, a country that gets about 23% of its power from nuclear (vs 28% in Europe and 80% in France), as Merkel maneuvers alongside her weakening legislative hand.  


Matthew Hedrick

R3: WMT, RSH, MW, Zappos


March 28, 2011






  • A Radio Shack store in Montana is truly pushing the envelope with its latest gift-with-purchase deal – a free gun with subscription to the Dish Network. In perhaps an indication that the deal for either a specified handgun or shotgun is less outlandish than it would first appear, the store’s owner claims that sales have tripled since start of the promo back in October. In the event a customer doesn’t pass the required background check the offer translates into a $50 Pizza Hut gift card – amazing.
  • In the latest effort to tax online sales, the California State Board of Equalization is considering shifting its focus from retailers directly to consumers. According to the proposal, the state would go after residents that have purchased over $5,000 worth of goods online by paying third-party vendors to identify offenders. While there are precedents for states taking such measures like Virginia collecting taxes from residents shipping furniture from NC, we suspect the move if passed will do little to engender a positive shift in consumer sentiment within the state.
  • According a recent report by the U.S. Customs and Border Protection and U.S. Immigration and Customs Enforcement, footwear remained the top product seized for the fourth year in a row, however its share decreased meaningfully in the past year to 24% from 38%. The report attributes the 54% decline in the value of seized footwear to a decline in Chinese-based product. The categories also remaining among the Top 5 were handbags/wallets/backpacks and wearing apparel.



Wal-Mart to Reopen Half of Japanese Stores Affected by Tsunami - Wal-Mart Stores Inc., the world’s largest retailer, is resuming normal operations at half the stores hampered by Japan’s strongest earthquake as residents struggle to find water, food and other necessities. A dozen of Wal-Mart’s Seiyu stores in the quake-hit Sendai area are restarting full operations today after being limited mostly to relief efforts for two weeks, Scott Price, Wal-Mart’s Asia chief, said in an interview yesterday. Of the remaining 12 stores, 10 will be opened as soon as possible and two may take a “long time” because they’re covered in mud, he said. Retailers from Wal-Mart to 7-Eleven operator Seven & I Holdings Co. are racing to open stores and replenish shelves after the March 11 disaster left hundreds of thousands in the Tohoku region, northeast Japan, scrambling for shelter, food and water. The magnitude-9 earthquake and tsunami knocked out more than 1,000 stores in the Tohoku and Kanto regions, according to estimates at Goldman Sachs Group Inc. <Bloomberg>

Hedgeye Retail’s Take: No surprise to see WMT on the front lines of the “rebuilding” effort; however, the horrific nature of the Japanese disaster will actually drive demand for basic food and staple supplies that simply haven’t been available relative to other retail categories that have become an afterthought for most consumers in the tragedy stricken country.


Men's Wearhouse sees Competition from Jos. A Bank on Tux Rentals  - With one-third of the market, Men's Wearhouse appears to have a lock on tuxedo rentals. But even founder George Zimmer can't guarantee it.  The reason: Upscale rival Jos. A. Bank Clothiers last year entered the tuxedo-rental business, which generates some $1.2 billion in annual sales. Like Men's Wearhouse, Jos. A. Bank has a nationwide network that is convenient for groomsmen from different cities seeking matching tuxedos at local stores. That should help Jos. A. Bank take market share from the remaining competition, predominantly small, privately owned stores. Mr. Zimmer's share of the market may also be at risk. While Jos. A. Bank sells some clothing that competes directly with Men's Wearhouse, it is typically more expensive. That could mean Jos. A. Bank has a chance to win rental business from many of its own customers who have previously gone to Men's Wearhouse to rent tuxedos.  <WallstreetJournal>

Hedgeye Retail’s Take: With the number of weddings at 2.2Bn per year down from the peak of 2.5Bn in 1982 representing ~70% of MW’s tux rental business, the market appears to be constrained in terms of its long-term growth prospects. Despite its highly attractive strong cash flow generating business model, the reality is that the entry of JOSB has created added pressure on the margin for MW which has been accustomed to competing against smaller mom and pop stores. The prospect of more competitive pricing among the industries two biggest players looms like a black cloud over the balance of the highly fragmented industry's players.


Louis Vuitton Expands into Florida and DubaiLouis Vuitton is doubling up — and then some — in South Florida. The French luxury brand plans to exit Bal Harbour Shops on June 30 and establish a new location roughly double the size at the Aventura Mall, where Vuitton already operates a leased department at Bloomingdale’s. What’s more, Vuitton plans to add a unit in the burgeoning Miami Design District in the coming years, said Vuitton chief executive officer Yves Carcelle. He said details on the global store at Aventura are still being worked out and that Vuitton would open a temporary store there on July 1 to ensure a continuation of the business in a dynamic region for the brand. The size, location and concept for the design district boutique are also being fine-tuned. Vuitton decided to exit Bal Harbour upon the expiration of its lease as the complex would not allow it to expand or open a second location in the area, according to Carcelle. <WWD>

Hedgeye Retail’s Take: While exclusivity is an understandable preference, the operator at Bal Harbour may want to reconsider its policy excluding tenant expansion in the area, which typically coincides with the success and health of business. The mall is in effect forcing the hand of its best performing businesses while keeping tenants that either don’t have plans to grow locally, or simply can’t.


Zappos closes its Canadian storefront - Shoe and accessory e-retailer announced today that it will close its storefront and no longer ship to customers in Canada as of April 1. Inc.’s Canadian e-retail business encountered multiple obstacles that prevented it from delivering service that was up to the e-retailer’s standards, wrote Chris Nielsen, the retailer’s chief operating and financial officer, in a blog post. “One of our core values is to ‘deliver wow through service,’” he says. “Our Canadian customers know that we have not lived up to these service levels.” The same message appears on the home page of <InternetRetailer>

Hedgeye Retail’s Take: Customs finally gets the best of the e-retailer. That said, we tip our hat to Zappos for pulling the plug on a business that could ultimately jeopardize company’s key brand mantra – service.


CEO ups Stake in American Apparel - American Apparel Inc. chairman and chief executive officer Dov Charney has injected more of his own money into the cash-strapped company by purchasing six million shares, WWD has learned. The firm is expected to divulge the transaction in a regulatory filing with the Securities and Exchange Commission today. In the purchase, Charney spent $2 million to buy 1.8 million shares at $1.11 each. Additionally, he has converted a $4.7 million personal loan he made to the company some years ago into another 4.2 million shares, relieving American Apparel of that debt obligation. Fifty percent of those shares have been issued immediately and the remaining 50 percent will be issued if and when the company’s stock price reaches $3.50. However, the price of the conversion will also be $1.11 per share. On Friday, shares of American Apparel closed at 91 cents, down two cents. The cash infusion will be used to fund the company’s ongoing operations.  <WWD>

Hedgeye Retail’s Take:  This one continues to hang on…barely.


L.L.Bean Launches Year-Round Free Shipping - L.L.Bean said it is now offering permanent, no-strings-attached free shipping to U.S. and Canadian addresses. Only a few websites such as currently offer free shipping outside holiday selling. The free standard shipping will be effective March 25. L.L.Bean's free regular shipping includes fast delivery with customer packages arriving in 2-5 business days. The company noted that the founder and inventor of the original Maine Hunting Shoe, Mr. "L.L." Bean, introduced the concept of free shipping in 1912 by adding "post paid" in catalog copy.  "We tested free shipping offers with no minimum purchase for several months and the customer response was overwhelming," said Chris McCormick, president and CEO, L.L.Bean. "Our customers want and value free shipping. It's our opportunity to offer free shipping for all U.S. and Canadian customers with no minimum purchase, no end date, no conditions -- guaranteed." <SportsOneSource>

Hedgeye Retail’s Take: Adding to the everyday value of L.L. Bean, studies show that free shipping has proven to be a key deciding factor in consumer’s purchasing decision. Add this to the list of pressures on low-cost retailers – many of which operate e-commerce sites at a loss due to the cost of staying competitive.


Retailers Hit a High Note With Jessica Simpson -  Jessica Simpson’s teenage and twentysomething customers aren’t her only admirers. Retailers are singing Simpson’s praises as her brand prepares to launch sportswear in the fall. The singer-cum-actress-cum-designer with the disarming honesty and ability to laugh at herself is also a shrewd businesswoman. Simpson’s brand generated $750 million in retail sales in 2010 and is poised to break the $1 billion mark in 2012.  With the Camuto Group, which has made Jessica Simpson footwear since 2005, she has inked licensing partnerships for 22 other categories, ranging from jeans, sportswear, fashion accessories, swimwear and dresses to outerwear, watches and fragrance. Department and specialty stores are eager to get their hands on the next piece of the franchise — the sportswear — which is aimed at better junior areas for fall. At Belk’s, Simpson’s ready-to-wear will be sold in the young contemporary section of better sportswear departments. “The two businesses [denim and rtw] will be housed side-by-side,” said Kathryn Bufano, president and chief merchandising officer. “We see adjacencies with Kenzie Girl and Miss Me denim. <WWD>

Hedgeye Retail’s Take: With Simpson’s sportswear line launching in over 650 doors beginning fall 2011 and the exclusive partnership between the Camuto Group and Jones New York, we expect the event to get plenty of air-time on JNY’s 2H conference calls as one of the few bright spots in the business.






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No change in March estimate of HK$18-19BN.



Macau experienced another strong week and gaming revenues appear to be still on track to meet our March HK$18-19 billion (+37-40% YoY growth).  Market shares were little changed from last year with the exception of Galaxy (lower) and MGM (higher) normalizing.  The US operators continue to struggle in terms of market share with LVS, WYNN, and MGM all below trend.  Galaxy and SJM are well above trend while MPEL is in-line.  Here are the results through March 27th:



Athletic Apparel Good; Footwear Better


Sports apparel numbers showed a slight deceleration last week, but still putting up a positive trend. What’s notable is that this past week represents the toughest compare until early June. Then after a 2-3 week stint (Easter falls on the 24th this year vs. the 4th last year), the compares get ‘wickedly’ easy again until the holidays. As for brand performance, rising tide lifts all boats, but Adidas has been surprisingly strong. UnderArmour is still chugging along at a 200bp yy market share gain – which is solid to say the least. Nike’s trend is mixed. Still good, overall, but less so than peers due to lower ASPs as noted on last week’s call.


Additionally, we got our latest read on athletic footwear trends out of FINL’s results Friday that indicate sales are accelerating through the first three weeks of March. Comps are up +10% on top of toughest monthly compares of the year suggesting a substantial acceleration in the 2-year trend. Below are a few of the key highlights from the call regarding both comp trends and brand callouts:


FINL’s Q4 (Dec-Feb) Comps +4%

  • The comp store sales increase was driven by improved store metrics as conversion was up 2.1%
  • average dollars per transaction increased 2.4%
  • partially offset by a decline in store traffic of 3.1% for the quarter

Comp Trends/Callouts:

December was up +4%

January was down -2.7%

February was up +8.6%


Both sales and traffic picked up in the 2H of February with trends carrying over into March


Footwear: up +3.7%

December +4%

January -3.7%

February +8.1%

March +10%  (on top of +15.4% in first 3-weeks last year)



  • continued to lead footwear with a Q4 increase in the high teens and an increase in the mid-20s for the year
  • continues to be largest and best performing category
  • positive running trends expected to continue this fiscal year - expanding the technical running category
  • Nike's Air Max 11 as well as Nike Free were called out as key drivers in both women's and men's  along with Reebok's men's Zig Sonic


  • positive comp of the year and this trend got even better in the fourth quarter with double-digit comps for the category
  • Brand Jordan had a great quarter with strong retro releases and the very positive launch of Nike Hyperfuse
  • Reebok and Under Armour also positive callouts

Athletic Casual:

  • Down compared to last year in Q4 and slightly below plan
  • Saw positive momentum from Adidas Originals, Court styles from Nike and other retro and classic products, Canvas styles from Polo, Lotto and Levi's
  • In boot's, Polo, Nike and Timberland, were key sellers

Most notable mention in kids is the highly anticipated introduction of Nike Free and Air Max 11 which is launching in the kids category for the first time in April


Apparel: up +5.8%

  • Brand Jordan, the North Face, and UA key callouts in Q4
  • Despite more muted sales expectations in Q1, UA's charged cotton tees, Nike and Brand Jordan product expected to continue to be key drivers

 Athletic Apparel Good; Footwear Better - FW App App Table 3 23 11


Athletic Apparel Good; Footwear Better - Fw App BrandTable 3 23 11


Athletic Apparel Good; Footwear Better - FW App App 1Yr 3 23 11


Athletic Apparel Good; Footwear Better - FW App App 2Yr 3 23 11


Athletic Apparel Good; Footwear Better - NKE Apparel T3W 3 24 11


Athletic Apparel Good; Footwear Better - UA Apparel T3W 3 24 11


Athletic Apparel Good; Footwear Better - FW App Reg 3 23 11



Casey Flavin



Wait & Watch: SP500 Levels, Refreshed



While it’s very tempting to short more SPY here, it’s even more tempting to Wait & Watch for a higher price. I have immediate-term TRADE upside in the SP500 to 1323 (see chart) and there’s no reason why it can’t get there. Volume is anemic.


One of the most tempting signals to short SPY is the VIX holding its intermediate-term TREND line of support this morning. That line = 17.89. That said, a breakdown through that line could easily put the high 16s in play for the VIX and there are plenty bulls left in this marketplace who would love to see those prints into month and quarter end.


Month and quarter end is on Thursday and from a US Macro Catalyst Calendar perspective, here what’s on tap in the immediate-term (this week): 

  1. Monday – US Personal Income and Consumption (FEB)
  2. Tuesday – Conference Board Consumer Confidence (MAR) and Case-Shiller Home Prices (JAN)
  3. Wednesday – MBA Mortgage Applications (weekly) and II Bullish/Bearish Sentiment (weekly)
  4. Thursday – Month and Quarter End (MAR) and Producer Manufacturing Index (FEB)
  5. Friday – ISM Survey (FEB) and the Monthly US Employment Report (MAR) 

While the sucker trade might be waiting for Thursday to start selling aggressively again, sometimes the most obvious play is the one to make. For now, I’m giving the bulls the better benefit of the doubt, expanding the net exposure of the Hedgeye Portfolio again today (17 LONGS, 13 SHORTS). On the short side, I want to  Wait & Watch.



Keith R. McCullough
Chief Executive Officer


Wait & Watch: SP500 Levels, Refreshed - 1

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