European Risk Monitor: Greece at the Forefront

Positions in Europe: Long Germany (EWG); Sweden (EWD)


All eyes are back on Greece on the backdrop of increased European credit and political uncertainty over the last week.  As we continue to press, piling debt upon debt doesn’t end well – now the question remains the timing and form of a Greek debt default, restructuring, or some combination or hybrid of the two. Last week Jean-Claude Juncker candy-coated the issue and called for a possible “re-profiling” of Greek debt. What’s apparent is that EU officials will continue to extend & pretend, by delaying and/or re-allocating funds over the near to intermediate term to make concessions for Greece’s fiscal shortfalls. This should ultimately add support in the EUR-USD trade (around $1.40), but by no means reduce volatility in the pair.


Through increased pressure from EU officials, the Greek government is meeting this week to discuss a fifth austerity package, with plans to sell €50 billion of state assets to help pay down its bloated deficit. The headline risk associated with the talks continues to punish the capital markets of Greece and the rest of the periphery. Last week the Greek Athex (equity) was down -4.3%, and is down a full -25% since its ytd high in mid February. This morning we see yields of 10YR bonds from the PIIGS jumping, with Greece rising a full 44bps to just short of 17%, while Portugal rose 41bps to 9.63%!  A similar trend is seen with sovereign CDS, and the question remains just how much more likely a default of Greece is with CDS in the area code of 1400bps versus say 1300bps? After all, Lehman Brothers blew up around 600bps (see charts below).


European Risk Monitor: Greece at the Forefront - b1


European Risk Monitor: Greece at the Forefront - b2


Of the news and data causing consternation this morning (European equity indices are down 150-300 bps today):


1.)   Preliminary Services and Manufacturing PMI for May out for the Eurozone, Germany, and France, all fell considerably month-over-month (see chart below). As we’ve been highlighting over recent months, we’ve seen pockets of high frequency data slowing from the region’s largest countries. We remain bullish on Germany (currently in the Hedgeye Virtual Portfolio), but cautious as we monitor the data. Certainly Germany has not been immune to inflation (CPI stands at 2.4% Y/Y), however readings continue to come in under the EU average, and significantly below UK CPI at 4.5%.  


European Risk Monitor: Greece at the Forefront - b3


European Risk Monitor: Greece at the Forefront - b4


 2.)   Standard & Poor’s revised Italy’s credit-rating outlook to negative from stable, citing the nation’s slowing economic growth and diminished prospects for reducing government debt. If you’ve been following our work you’d know we’ve taken this tact for months on Italy (and also Spain).  S&P affirmed Italy’s A+ long-term rating. 


3.)   PM Jose Zapatero’s Socialist Party suffered a huge blow in state and municipal elections of the weekend, as expected. The opposition center-right Popular Party took share in virtually all 13 regional governments that were up for grabs. Zapatero conceded the defeat but ruled out early elections. The political fragility of his party’s rule make it all the more unlikely that the country will be able to pass further austerity measures to limit the budget deficit (9.3% of GDP).  The protests being called on the streets over unemployment should remain a permanent fixture, as a coherent strategy for growth and reduction in joblessness is nonexistent. 


4.)   German Chancellor Angela Merkel’s Christian Democratic Union Party (CDU) suffered a blow in a state election in Bremen over the weekend. Voters re-elected the Social Democrats (SPD) with 38% approval, followed by the Green Party at 23%. Merkel’s CDU fell 5pp from last election to 20%. The set-back follows two other defeats in state election ytd (Hamburg and Baden-Wuerttemberg), and highlights the cracks forming in Merkel’s foundation. Importantly, voting shows Merkel’s popularity continues to be punished based on her flip-flop on nuclear power following Fukushima.



Our European Financial CDS Monitor shows that bank swaps in Europe widened last week, with 36 of the 38 swaps wider and only two tighter. A major inflection, as expected, was Greek banks.


European Risk Monitor: Greece at the Forefront - b5

European Risk Monitor: Greece at the Forefront - b6


We’ll get a number of confidence readings from Europe this week as well as second revisions of Q1 GDP.  Today we added Sweden via the etf EWD on the long side to the Hedgeye Virtual Portfolio. Sweden remains a fiscally sober country (like Germany) with a strong growth profile of 4.5% this year. So long as the country continues to see demand for its goods from the EU, we like the country’s outlook given the Riksbank proactive rate hikes to head off inflation.


Matthew Hedrick


The Correlation Risk: SP500 Levels, Refreshed

POSITION: Covered SPY Short


It’s a big up day for the US Dollar and a big down day for US stocks. This is The Correlation Risk.


The problem now is that Growth Slowing as Reported Inflation Accelerates (emphasis on the word Reported) is going to make the US economy look a lot like The Stagflation. And The Stagflation is bad for the market multiple.


Remember, Reported Inflation is a lagging indicator, whereas the USD/CRB relationship is a leading one. For the stock market, we’ll continue to summarize this as Deflating The Inflation (Q2 Macro Theme)– and as it occurs (May-July), you want to be managing risk to US Equities with a bearish bias. Short high, Cover low.


Across our 3 core risk management durations (TRADE, TREND, and TAIL), here’s where risk is priced today: 

  1. Long-term TAIL = 1377 remains resistance – long-term lower-highs are bearish (Japan)
  2. Intermediate-term TREND = 1321 is under siege today and needs to hold this week or this market could go a lot lower
  3. Immediate-term TRADE = 1315 is oversold, setting us up for another low-volume bounce to lower-highs YTD 

Ultimately, the only way out of this mess (for the economy and country) is via a strong US Dollar. That’s why Deflating The Inflation is going to be a bullish catalyst for stocks. From what time and price remains a question that we’ll be answering day to day.



Keith R. McCullough
Chief Executive Officer


The Correlation Risk: SP500 Levels, Refreshed - 1

JCP: Storytelling Alert

Keith covered JCP in the Hedgeye virtual portfolio today. Make no mistake -- this a TRADE -- as he is managing risk ahead of storytelling at Ira Sohn Conference this week. We remain squarely bearish on JCP for the intermediate-term TREND and long-term TAIL.


JCP: Storytelling Alert - 5 23 2011 11 32 37 AM

Daily Trading Ranges

20 Proprietary Risk Ranges

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Bumping our estimate up to HK$23-24BN for May



In the first week that includes Galaxy Macau, the market generated HK$775 million in gross table revenues per day, up from HK$528 last week and HK$640 million YTD.  It’s too early to determine how much Galaxy has grown the market since we only have one week of data and don’t know what the hold percentage was.  Given the strong opening of Galaxy, we are increasing  the bottom end of our projection range for the full month of May from HK$22 billion to HK$23 billion and are now estimating a range of HK$23-24 billion.


The opening of Galaxy Macau clearly had a positive impact on Galaxy’s overall market share.  The company garnered 17.8% share in the past week, pushing Galaxy’s full share to 12.2% for May to date, versus a trailing 3 month share of 10.1%.  The big market share loser in the past week was LVS, losing 330bps from its trailing share.  Surprisingly, MPEL only lost 90bps following the opening of Galaxy despite being generally considered the biggest loser to the new property.  MPEL’s share actually recovered a bit from last week’s month to date 13.2%, which was hurt by low hold, despite the opening of Galaxy.


The figures through May 22 are shown below:




The following table compares this past week’s average table revenue per day to the average for the past three months by property.  Interestingly, despite the impact of Galaxy Macau, every company generated higher revenue per day post-Galaxy than pre-Galaxy, except for LVS.  On limited data, it appears Galaxy has grown the market.  The one caveat here is that we have heard that Galaxy has offered a lot of junket credit in conjunction with the opening and some of the other players may have followed suit.  This may not be sustainable.



The Fat Tails of VaR

Conclusion: As if risk management wasn’t difficult enough, there is a strong case that the “institutionalization” of risk management may actually be increasing risk and market inflection points.


Not only have we seen heightened volatility in financial markets over the past couple of years, but we have also witnessed accelerating volatility.  On the first point, we’ve highlighted a chart of the VIX, which is a volatility measure on the SP500, going back three years, which shows the strong relationship between an extreme in Federal Reserve Policy and this increase in volatility.  In our view, extremely loose Fed policy has both shortened the business cycle, as well as increased price volatility.


The Fat Tails of VaR - 1


To the second point, in conjunction with this broad increase in price volatility, we have also witnessed a number of accelerations in sell offs in certain markets.  The most obvious example of this is the “Flash Crash” that occurred on May 6th, 2010 and resulted in a 900 point drop in the Dow Jones Industrial Index, a 9% decline and the second largest intraday decline in history.  Just as quick as it happened, the Dow regained most of its losses within minutes on May 6th.


The Fat Tails of VaR - 3


While the “fat finger” theory has been largely disproven, the explanation given in “Findings Regarding the Market Events of May 6, 2010”, a joint report from the SEC and CFTC, still seems somewhat inadequate.  According to the report, the “Flash Crash” was likely initiated by a large and unnamed mutual fund firm that initiated a massive sell order of 75,000 E-Mini contracts, which had a value of $4.1BN.  According to the report, the algorithm the trader used was set to “target an execution rate set to 9% of the trading volume calculated over the previous minute, but without regard to price or time.”  While in “normal” markets, this execution may have gone off without a hitch, the equity markets on May 6th were more volatile and less liquid than the typical trading day.  As a result, this sell order initiated a dramatic sell off as the broad market was overwhelmed with sell orders, which was then amplified by high frequency traders.


According to the joint report:


“The combined selling pressure from the Sell Algorithm, HFTs and other traders drove the price of the E-Mini down approximately 3% in just four minutes from the beginning of 2:41 p.m. through the end of 2:44 p.m. During this same time cross-market arbitrageurs who did buy the E-Mini, simultaneously sold equivalent amounts in the equities markets, driving the price of SPY [an exchange-traded fund which represents the S&P 500 index] also down approximately 3%.

Still lacking sufficient demand from fundamental buyers or cross-market arbitrageurs, HFTs began to quickly buy and then resell contracts to each other – generating a “hot-potato” volume effect as the same positions were rapidly passed back and forth. Between 2:45:13 and 2:45:27, HFTs traded over 27,000 contracts, which accounted for about 49 percent of the total trading volume, while buying only about 200 additional contracts net.”


Another aspect to the “Flash Crash” that has been discussed less, but is perhaps just as relevant structurally, is the evolution of institutional risk management and its impact on accelerating volatility in global markets.  Specifically, most large financial institutions that commit capital utilize a number of standard measures of risk to determine their exposure and risk.  The most common of these metrics is Value at Risk, or VaR.


Like many consensus risk management measures, VaR was developed after a risk management event.  In this case, it was the stock market crash of 1987 that led many large institutions to develop and institute this measure of risk to evaluate their exposures across trading desks, groups, and geographies.  While every financial firm likely has their own tailored definition, VaR is typically defined across a probability, time horizon, and portfolio.  By way of an example, a 3-day 97% VaR of $3MM implies that the given portfolio has a 3% probability of losing $3MM in a 3-day period.


Critics of VaR, and there are many, deride the risk metric because it typically assumes normal markets and limited trading within the probability period.  Further, it doesn’t account for the potential loss period effectively.  Typically, the loss distribution is a fat tail, so the 3% in the tail potentially has massive loss potential.  Our friend David Einhorn put it most succinctly when he said VaR is, “like an airbag that works all the time, except when you have a car accident.”  Now to be fair, some of this criticism has been taken to heart and institutions continually experiment with VaR and other risk management metrics to improve them.  One of the more recent derivations is LVaR, or Liquidity Value at Risk.


According to the Bank of International Settlements the key attribute of LVaR is, “the holding periods in the risk assessment are adjusted to account for market liquidity, in particular by the length of time required to unwind positions.”  The implication of this tightened risk management metric is that it creates a feedback loop of sorts.  As liquidity decreases, the trader’s ability to take risk, according to LVaR, decreases and the trader is then forced to decrease the size of the positions.  The potential snowball effect is that across the market, traders could be forced to sell positions into increasingly illiquid and one way markets as they are forced to reduce exposure.


The recent action in the commodity futures markets appears to suggest this type of selling is occurring.  In a chart below, our Energy Sector Head Lou Gagliardi, shows that the oil futures contract spread is at a 5-year high.  Under an LVaR analysis, as liquidity in the oil futures market decreases, the exposures available to many institutional traders may decrease, which creates a snow ball effect in terms of market activity.  In the scenario of an extreme long or extreme short position, market price accelerated volatility may be particularly pronounced.


The Fat Tails of VaR - 2


In fact, we have seen this in a number of commodity markets this month. In one day in early May, oil was down more than 8% and silver was down more than 20%.  As if risk management wasn’t difficult enough, there is a strong case that the “institutionalization” of risk management may actually be increasing risk and market inflection points. Be wary of the fat tails of VaR.


Daryl G. Jones

Managing Director

R3: Fila/Acushnet, JCP, Choo, & FL



May 23, 2011






  • Calendar Watch: There are several investor conferences this week; including a ‘management access day.’ The usual characters will be participating.  We’re firm in our view that incremental margin news will be negative. The week ends with the Ira Sohn conference, where the hedge fund elite get to go and pitch their book. Do you think that Ackman just might pitch JC Penney a week after he was on the cover of Barron’s? This is a name we didn’t believe in his financial engineering at Target, and clearly don’t like it at JCP. This remains at the top of our list of shorts. See our note from Friday (JCP/TGT/GPS: Press the Call) for more details, as well as the reason for our newfound bullishness on TGT after being negative all year.
  • In a positive sign that one of management’s key initiatives is taking hold, the strongest comp gains at FL in the 1Q came in apparel up over 20%. While margins remain below footwear for now, the ramp in performance in the category is certainly notable. With little competitive distinction in footwear, the company is using apparel as a key differentiator at each of its banners such as Rocawear jeans at Footaction, technical product at Foot Locker, and licensed team apparel at Champs. While making progress here, there continues to be significant opportunity in apparel for FL that will provide an incremental boost to both top-line and margins.
  • Consistent with its peers, management of HIBB confirmed that they are beginning to see price increases coming through now in the 2Q. Footwear on the other hand, will not see increases until the 2H and then are going to be up MSD. Athletic footwear/SG retailers both expect to take pricing in select styles, typically premium product compared to broader-based increases. To date, management teams continue to be more concerned over cost inflation as it relates to 2012 than the balance of 2011.
  • Despite a sharp decline in toning sales in the 1Q, strength in running more than offset declines lead by the growing popularity of the lightweight category. Perhaps more notable is the fact that Shoe Carnival was able to post higher ASPs in the athletic footwear despite a 40%+ decline in toning shoe ASPs during the quarter. Also worth noting is the upcoming launch of SCVL’s e-commerce site in the 2H. While the company remains one of the few athletic retailers without a transactional site (HIBB is another), the company has been ramping its marketing spend to drive customers to its current platform where they can pre-shop product and print out discount coupons since BTS last year an effort that will help drive sales starting day one. While late to the party, the upside here is that the industry’s fastest growing channel will provide an incremental boost to the top-line when they’ll need it most.
  • A growing divide for product at ANN based on price is clearly evident in Q1 results. While sales below the key $50 price point at its LOFT concept accounted for 90% of sales in Q1 compared to 77% last year, the company noted that it can’t keep select novelty and suiting pieces in the store. To the extent price increases are expected to be taken in higher end items, fashion risk will elevate with less demand on mid-tier product.



Fortune Brands to Sell Titleist Golf Unit to Fila Korea - Fortune Brands Inc. (FO) agreed to sell its Titleist golf unit to a group led by the owner of the Fila sport apparel brand for $1.23 billion in cash, as part of its strategy to focus on liquor. Fortune Brands will realize proceeds of about $1.1 billion after taxes and expenses from the sale of the Acushnet business, which makes Titleist balls, according to a statement from the Deerfield, Illinois-based company. The deal is expected to close this year, it said. The sale is part of Fortune Brands Chief Executive Officer Bruce Carbonari’s plan to dispose of the company’s golf and home and security businesses by the fourth quarter. Fortune, the maker of Jim Beam and Maker’s Mark bourbon, Sauza tequila and Courvoisier cognac, said it plans to rename itself Beam. “This is obviously an important first step for Fortune,” said Jonathan Rouner, head of mergers and acquisitions for the Americas at Nomura Holdings Inc.  <Bloomberg>

Hedgeye Retail’s Take: The price came in in-line with what we expected to see for some of the best brands in golf as we highlighted in our 5/9 note (“Acushnet Bids Due Today”). The biggest callout here is that Adidas wasn’t the winning bidder – a positive for Nike – and that a Fila-lead consortium ended up victorious. Over the past year, Fila has taken material steps to becoming more relevant as a global player. The company launched its first basketball shoe in April of last year, then went public in the fall, and is now a major player in golf overnight. Given the popularity of golf in Korea, this is a great fit at what appears to be a good price for two of the most powerful brands in golf (Titleist and Foot Joy).


Labelux Group Acquires Jimmy Choo - Labelux Group, which on Sunday announced its purchase of Jimmy Choo, said the London-based brand has miles of unfulfilled potential —and nowhere more so than in Asia.The group, whose holdings including Bally, Derek Lam, Zagliani and Solange Azagury-Partridge, bought Choo from TowerBrook Capital LLP for an undisclosed price.  It beat competitors including TPG Capital and Jones Group Inc. in a deal sources say valued Choo at 549 million pounds, or $889.4 million. The sale to Labelux comes 10 years after private equity owners Equinox, under the guidance of industry investor Robert Bensoussan, first purchased Choo, valuing the company at 20 million pounds, or $32.4 million. Jimmy Choo has changed hands twice since then, its size, geographical reach and valuation spiraling each time. Labelux is Choo’s first industry, non-private equity, partner. All figures have been converted at current exchange. <WWD>

Hedgeye Retail’s Take: JNY’s shareholders should be thrilled that the company lost the bid. This was a disaster waiting to happen. Still, the fact that it likely bid something in the $700mm range is unsettling for a company with JNY’s cost structure and balance sheet.


PPR is in No Rush for Acquisitions - PPR, the parent of Puma, said it will take its time in deciding whether to buy and sell assets, with the focus being on creating value for the company. It recently reached an agreement to acquire skate and surf apparel group Volcom. Volcom will be the first brand outside Puma in PRR's new Sport & Lifestyle Group, which is being headed by former Puma CEO Jochen Zeitz.  The group is also currently selling some retail assets (catalog sales division Redcats and electronics retailer FNAC) while focusing on its luxury brands such as Gucci and and acquiring additional sports & lifestyle brands to join Puma. Speaking at PPR's annual shareholder meeting, CEO Francois-Henri Pinault noted: "We will take the time necessary to select brands to join us and to sell our retail activities under the best conditions." <SportsOneSource>

Hedgeye Retail’s Take: The first sign to suggest that PPR may actually take time to integrate its recent acquisitions. Hats off to ‘em. For shareholders’ sake, let’s hope they stick to it.


Brand Growth Key to J.C. Penney's Growth Strategy - J.C. Penney Co. Inc. thinks it can increase sales by focusing on accessories and jewelry in its stores’ “center core” and accelerating its rollout of branded shop-in-shops, said Myron “Mike” Ullman 3rd, president and chief executive officer, during the company’s annual meeting Friday at its headquarters here. “By enhancing the sense of discovery in our central core, there is a substantial upside, including increasing sales-per-square-foot and reinforcing J.C. Penney as a style destination,” he said. Call It Spring fashion footwear by Aldo Group and MNG by Mango boutiques will both extend to 500 doors by fall, Ullman said, up from 100 and 292, respectively. Sephora, with 254 locations now, will be in 305 stores by the end of January. Call It Spring and Sephora are both generating sales-per-square-foot about three times the company average of $210, a spokeswoman noted. In addition, the chain’s spring rollout of licensed Modern Bride jewelry collections to all 1,068 stores has spurred “strong gains” in the bridal business, Ullman noted. <WWD>

Hedgeye Retail’s Take: Mango and Sephora are critical initiatives for JCP, but the retailer isn’t the only one fighting for traffic. One of the key concerns here is the retailers’ ability to pass pricing through with a relatively smaller portion of premium branded product something Penney’s peers are likely to use to their advantage when it comes to drawing traffic in the 2H. More importantly, JCP’s locations and sheer box size mean that it needs to be viewed as a destination – ie incremental customers have to go out of their way to shop there. This takes real dollars to market and promote the brand. In other words, it is something that would likely make margins go down before they go up.


Macy’s Pushes Innovation Agenda - Risk-taking and retailing aren’t exactly kindred spirits. But for Macy’s Inc., the time is right to test new concepts and for “encouraging a higher level of risk-taking across all functions,” Terry Lundgren, Macy’s chairman, chief executive office and president, said. “We have to try new things — all kinds — and if one of them doesn’t work, that’s OK,” Lundgren said. During Macy’s annual meeting and press conference here Friday, Lundgren and other Macy’s executives outlined initiatives and tests in the works, in an effort to portray a culture of innovation at the $25 billion, 850-unit department store operator. Decades ago, Macy’s did have a reputation for innovation, with marketing extravaganzas like the Fourth of July fireworks and launching The Cellar in San Francisco in 1971, though the image was lost in the following years as the company got sidetracked by bankruptcy, a takeover, consolidations and management restructurings. <WWD>

Hedgeye Retail’s Take: Being in the position to take shots on new initiatives is one of the byproducts of significantly outperforming your competition. Taking risk heading into the 2H is about as counter-consensus as it gets at the moment, but to the extent Macy’s can uncover a few new successful concepts, this is exactly what will keep the company out in front in retail. That said, we want to see all companies take shots when they should – not when they can. There’s a difference. When a company ‘can’ is usually towards the peak of its cash cycle. Incremental returns rarely look good thereafter.


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