“Nothing is easier than self deceit.”
-Demosthenes (circa 340 BC)
I’m borrowing that quote from Howard Marks, who borrowed it from Charlie Munger, who borrowed it from Demothesnes (Greek orator from ancient Athens). Borrowing ideas is what people in this business do.
What if I woke up every morning for the last 6 months borrowing the idea that US “growth” was “back” and that there was really nothing in this interconnected world to worry about?
Well, that idea would have been a really bad one to have borrowed. Nothing is easier than borrowing ideas – you have to do a lot less work. Nothing is going to protect your returns when those borrowed ideas turn out to be wrong either.
Howard Marks is a successful Risk Manager who runs $82 Billion (as of December 31, 2010) at Oaktree Capital Management. He borrowed that quote for his recent investment memo to Oaktree clients that was titled “How Quickly They Forget.”
Since Marks’ letter is marked “confidential”, I’ll have to stop on his ideas there, and get back to my own:
- GROWTH: US and Global Growth are slowing
- INFLATION: reported Global Inflation readings remain sticky and elevated because they are lagging indicators
- POLICY: Chinese policy (hawkish) continues to diverge from Fiat Fool policy (USA, Japan) which remains Indefinitely Dovish
Being on the road from Boston to Denver to Kansas City to New York to San Francisco in the last 4 weeks has been very interesting. The further I move in time, the more people seem to be agreeing with me on these Global Macro matters (prices going down do that). I’m in Santa Barbara, CA this morning and I’ll be in LA tonight. I don’t expect this bearish progression to lose momentum.
The #1 question Risk Managers want to know is “how do I make money with that?”
Hedgeye Risk Management’s answer remains:
- Don’t lose money (we went into yesterday’s meltdown with 10 LONGS and 12 shorts in the Hedgeye Portfolio)
- Buy Long-term US Treasuries (TLT) and a US Treasury Flattener (FLAT)
- Buy Gold (GLD)
Oh, did I borrow the only rule Buffett and Munger have signed off on before the 2011 version of buy-the-damn-dips? I think I did. Not losing money is indeed a risk management strategy worth borrowing. Try it at home – or with your client’s money.
The #2 question Risk Managers want to know is “where could your ideas be wrong?”
Hedgeye Risk Management’s answer remains:
- The Data – if our scenario analysis on growth and/or inflation change, we will
- The Market – if TREND line prices hold, we’ll cover shorts
- The Fed – if they legitimately move to QG3, we will resort to prayer
While Borrowing Deceit from the Fed on A) full employment and B) price stability can remain fashionable – it can also become, as Le Bernank likes to say, “transitory.” If the price of your homes and portfolios start going down, that is…
Of course, nothing is easier than waking up telling yourself that earnings were “good” and Le Bernank has your back. Sounds a little too much like Q2 of 2008 for me. “How Quickly They Forget.” (Howard Marks, May 25, 2011)
As for what to do in the very immediate-term, here are some key immediate-term TRADE ranges across Global Macro that we’re rolling with this morning:
- SP-1323 (bearish)
- Russell2000 801-828 (bearish)
- Nikkei 9 (bearish)
- Shanghai Composite 2 (bearish)
- FTSE 5 (bearish)
- DAX 7067-7344 (bearish)
- VIX 16.65-19.04 (bullish)
- USD 74.41-75.80 (bullish)
- Euro 1.41-1.44 (bearish)
- Oil 97.75-102.03 (bearish)
- Gold 1 (bullish)
- Copper 4.09-4.29 (bearish)
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Notable news items and price action from the restaurant space including our fundamental view on select names.
- DRI - Red Lobster is focusing on value this summer with the limited-time offer of a $15 four-course meal. The “$15 Seafood Feast” includes soup, salad, entrée, dessert and unlimited Cheddar Bay Biscuits and runs through July 25th
- SBUX signed a deal with Chinese joint-venture partner Maxim’s Caterers Ltd., which gives the coffee company full ownership of Starbucks retail outlets in six Chinese regions.
- CMG was reiterated “Buy” with the headline “CMG: A $1,000+ Stock by Decade’s End?” This is based on CMG’s strong comps and unit growth continuing to approximately 6,000 worldwide.
- YUM CEO David Novak, speaking at an investor conference, says that the company’s acquisition strategy is focused on China. The company, he says, is not interested in U.S. brands. Food costs and labor inflation were also highlighted as challenges in China.
- YUM supporting the use of food stamps in KY. Under the federal food-stamp program, states may authorize that elderly, disabled or homeless people, who often have difficulty preparing meals, can use food stamps in restaurants. Three other states — Michigan, Arizona and California — already allow such purchases.
- Also speaking yesterday was MCD CEO Jim Skinner. He said that MCD will open 175-200 stores in China this year with a focus on more drive-thrus.
- McDonald’s Issuing Coffee Apology in Australia for serving bad coffee. It should be noted that the McCafé concept originated in Australia in 1993
- A new strain of E coli is causing fears in Europe. 17 people have died due to infection and hundreds, primarily in Germany, have fallen ill due to the bacteria.
- The vast majority of restaurant names declined yesterday. JACK, AFCE, PZZA, BOBE, and MSSR traded down on strong volume.
- RRGB and DIN were the only names that we monitor to gain yesterday. DIN was up 30 bps while RRGB gained 3.2%.
Daily Trading Ranges
20 Proprietary Risk Ranges
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Conclusion: A potential record power outage looks to incrementally slow growth and marginally quicken inflation in China. Even still, we welcome these developments to the extent we may eventually be able to buy one of our favorite long ideas on sale when our models signal to us that it’s once again “safe” to significantly increase our exposure to equities in the Hedgeye Asset Allocation.
In yet another manifestation of our once out-of-consensus call that Growth Slows as Inflation Accelerates, China faces a power shortage that may incrementally slow economic growth and marginally quicken inflation. Multi-year high coal prices (+36% since Jan. ’10) driven largely by a significant pullback in Australian supply (the world’s largest producer) is causing Chinese utilities to slow electricity production, in addition to causing them to demand and receive higher prices.
Furthermore, the worst drought in a half a century is threatening to exacerbate the current reductions in aggregate power generation by limiting the capacity of China’s hydropower stations – particularly the Three Gorges Dam in the Hubei province (the world’s largest). Anecdotally, silicon makers and aluminum & copper smelters in the region are slowly suspending activity due to a lack of electricity on the margin.
The decline in hydropower output (22% of total power generation) in Hunan and Hubei is placing incremental pressure under coal prices (70% of total power generation) and exacerbating the energy supply situation across the country broadly. At an 11-month low of 8.6M metric tons, coal inventories in China are around nine days’ supply vs. a normal range of two weeks. In an attempt to incentivize utilities to reaccelerate electricity production amid rising costs, China just raised electricity prices for industrial, agricultural, and commercial users in 15 provinces for the first time in over a year by +2.2%, with further increases not being specifically ruled out. This is following a +2.7% increase to power tariffs in 12 provinces on April 10. Interestingly, in a bid to limit consumer price inflation, the National Development and Reform Commission held residential rates flat.
Still, we feel the recent hike has the potential to be passed through the supply chain to Chinese consumers and could put upward incremental upward pressure on China’s CPI – a sharp fundamental reversal (recall that we had been and continue to be bearish on the slope of Chinese inflation over the intermediate-term TREND). The NDRC believes the recent increase could indirectly add +5bps to headline CPI. Obviously any further increases in producer’s energy costs will skew the surprise risk here to the upside.
All in, the combination of lower coal-fired and lower hydropower electricity output is estimated to leave China 30-40 gigawatts short of its energy supply needs this summer (down roughly 4-5% from the full-year total) according to the State Grid Corporation of China. From a glass-half-full perspective, a government-imposed energy use reduction plan implemented last summer that helped slow YoY GDP growth -230bps from 1Q10 to 3Q10 should limit any potential YoY drop-off in economic output some. That said, however, should the current blackout target be hit or breached, this summer’s electricity shortfall will surpass the previous record set back in 2004 when YoY GDP growth slowed -130bps from 1Q to 3Q as the chart below indicates. With Chinese equities demonstrably broken from a TREND perspective, the risks to growth appear to be indeed significant. On a marginally positive note, charting the Shanghai Composite’s 2004 performance vs. 2011 YTD, we don’t see much of a difference in trajectory mid-way through the year, which suggests the magnitude of the slowdown could be similar.
All told, we prefer to continue waiting and watching before re-exercising our bullish thesis on China in the Virtual Portfolio. As the data behind the research call we made continues to play out in spades (China’s May Input Prices PMI ticked down overnight to a 10-month low of 60.3 vs. a prior reading of 66.2), we maintain our conviction that China will once again present itself as one of the best markets to invest in across the globe – particularly as consensus unwinds the incredible cognitive dissonance associated with being levered-long of US equities amid 1970’s-style Jobless Stagflation.
For now we’ll continue to ride the bullish wave in the bond market over the nearer term until our models signal to us that it’s “safe” to significantly increase our exposure to equities in the Hedgeye Asset Allocation. And as consensus slowly figures out that the US has a structural growth problem, we think the multiples paid for unlevered, elevated Chinese growth rates will expand on both an absolute and relative basis going forward.
Keith is on the road on the Left Coast (i.e. San Francisco) meeting with Hedgeye subscribers, but just called in his updated levels for the SP500. The key trend line of support is 1,324, which is currently broken with the SP500 at 1,318 (3:15pm). From the perspective of the Hedgeye quantitative models, closing prices are ultimately what matters, but this price is an important flag intraday.
In the first chart below, we’ve highlighted our current levels for the SP500. The key takeaway is that if the 1,324 trend line of support is broken then 1,214 is legitimately in play as the next stop for the SP500. This is 9% downside from current levels.
The deluge of data that we’ve received over the last two days has confirmed a thesis that we’ve been postulating for most of the year, which is that Accelerating Inflation will lead to Slowing Growth. Yesterday, Chicago PMI, housing prices, and consumer confidence were all worse than expected. Today, ISM Manufacturing hit 53.5, which was worse than the expected and a sequential decline from 60.4. In addition, the ADP employment number came in at +38K, versus an expectation of +175K. Thesis confirmed.
As a further confirmation of slowing growth, we’ve also highlighted a chart of the yield on 10-year Treasuries, which are currently yielding 2.96. This is down from 3.28% a month ago, and its year-to-date high of 3.74% on February 8th. There is a reason that one of our top ideas is the etf FLAT, which is a bet on the flattening of the yield curve. Simply put, as growth slows, the yield curve flattens.
In the Early Look today we highlighted NYSE margin debt being at an extreme of 1.5 standard deviations above its long-term mean. As another proxy for equity froth, or the potential for a froth correction, we would highlight the IPO pipeline, which currently stands at 165 companies filed. The last time the IPO pipeline was this substantial was in 2000. In the last chart below, we’ve highlighted the recent IPO of LinkedIn, which emphasizes how quickly the speculative appetite of the equity market can adjust. LinkedIn is down -20% in the last week.
The next major catalyst for the equity market will likely be the jobs report on Friday. The only potential positive ahead of that report is that expectations have been cut dramatically in the last couple of days led by Deutsche Bank, who cut their estimates for non-farm payrolls from 300,000 to 160,000 in the last two days alone.
Daryl G. Jones
R3: REQUIRED RETAIL READING
June 1, 2010
- The latest retailer to crack, JOSB not only came up shy on the top-line, but also margins with higher than expected SG&A expense driven by higher shipping costs and occupancy deleverage. The real callout here is inventories up +18% on +9% sales growth resulting in a sharp negative SIGMA turn. This isn’t the first-time JOSB has struggled with inventories and chances are it's not likely to be a one-off event with inventory compares getting even tougher next quarter.
- While we aren’t going to have the regional trends for the last week in May until tomorrow, if the first three weeks are any indication, expect the Northeast to be a common negative highlight on tomorrow’s sales calls.
OUR TAKE ON OVERNIGHT NEWS
Simpson to Take on Tweens - With an assist from her younger sister Ashlee, Jessica Simpson is tapping into the tween category. The Camuto Group, which holds the master Jessica Simpson license, has signed an agreement with The Jones Group Inc. to design, develop, produce and distribute Jessica Simpson tween apparel as part of its lifestyle offering of the Jessica Simpson Collection. This agreement expands the business the two companies are already doing with Jessica Simpson Jeanswear and Jessica Simpson Sportswear, both of which are licensed to Jones. The new collection, which will be available in stores in the fourth quarter, will be geared to the fashion-forward tween, sizes 7 to 16. According to Camuto, the tween offering will include footwear (licensed to Stride Rite) and outerwear (licensed to Fleet Street), in addition to the sportswear, jeanswear and activewear. The sportswear line will be available at about 400 doors of specialty and department stores in the fourth quarter. The company has already lined up orders with Dillard’s, Lord & Taylor, Macy’s, Belk, Von Maur, Bon-Ton and The Bay in Canada. Wholesale prices are $15.50 for core jeans; $15.75 to $18.25 for fashion bottoms; $8.50 for graphic Ts; $10.75 to $14.75 for fashion knits, and $14.75 to $20.75 for sweaters, fur vests and pleather jackets. Jones launched Simpson’s jeanswear collection last June (650 doors), and will introduce sportswear at retail this fall (450 doors). Jack Gross, chief executive officer of the Jones Jeanswear Group, projected sportswear and jeanswear combined to ring up $150 million to $200 million at retail annually by next year, evenly split between the two categories. Down the road, sportswear is forecast to outpace jeanswear. The tween line is expected to generate $20 million in retail sales in 2012, said Gross. <WWD>
Hedgeye Retail’s Take: While the tween line is projected to be only a fraction of the size of Simpson’s core lines initially, the key callouts here are 1) it’s yet another line extension (which JNY desperately needs), 2) it targets an entirely untapped consumer for Simpson and one that we’d suspect she still resonates with from her pre-fashionista music days, and 3) if done right, this segment could actually challenge if not surpass the meteoric growth rate realized in the jeanswear and sportswear businesses. Given the success of previous lines, this will be one to watch in 2012.
Hilfiger to Launch Tommy Girl - The Tommy Hilfiger Group, wholly owned by Phillips-Van Heusen Corp., will launch Tommy Girl, a sportswear collection for young women. Tommy Girl, which is licensed to RVC Enterprises LLC, will be available at 150 doors of Macy’s in the U.S., beginning in July. The collection, aimed at 12- to 18-year-olds, will be housed in its own shop environment in the junior area of Macy’s and will reflect Hilfiger’s preppy with a twist heritage. The line features oxford cloth shirts, polos, peacoats and denim jeans. “Younger audiences have shown a strong demand for the brand,” said Gary Sheinbaum, chief executive officer of Tommy Hilfiger North America. “In leveraging our relationship with Macy’s to distribute Tommy Girl, we are able to offer product to this younger consumer and in more locations than we would through our retail business model.” "I am [pleased] about the new Tommy Girl collection,” said Tommy Hilfiger. “Tommy Girl is our response to consumers wanting quality clothing at affordable prices.” Tommy Girl’s retail prices will range from $32 for T-shirts to $129 for outerwear. <WWD>
Hedgeye Retail’s Take: It appears that competition within the young girls segment is heating up with Simpson and Hilfiger both announcing their respective entries into the space. While the target consumer is decidedly different with Simpson going edgy compared to Hilfiger’s classic prep style and price points at Tommy nearly 2x, both lines will be carried at Macy’s. Following the launch of Material Girl last fall, Macy’s is proving to be a key destination for the tween’ish’ demographic.
WMT South African Deal Approved - The South African Competition Tribunal on Tuesday ruled that the Wal-Mart and Massmart merger can proceed. The tribunal accepted the conditions proposed by Wal-Mart and Massmart, including a 100 million South African rand ($15 million at current exchange) supplier development fund, no merger-related staff reductions for two years and continued recognition of the South African Commercial, Catering and Allied Workers Union for three years after the merger. The tribunal also said preference should be given to hiring 503 workers that were let go prior to the merger proposal’s announcement. Wal-Mart Stores Inc. in November acquired 51 percent of the Johannesburg-based retailer for 17 billion South African rand, or $2.36 billion. The Massmart board unanimously approved the transaction and the deal in January was approved by the necessary 75 percent of shareholders. All it needed to proceed was approval by the South African competition authorities. With the last obstacle removed, Wal-Mart said it intends to provide Massmart with increased financial stability and support to continue strengthening its presence in Africa. The combined Wal-Mart-Massmart entity is planning “significant new store openings that will create thousands of union jobs in South Africa,” Wal-Mart said. In addition, the Massmart food business is expected to grow more than 50 percent over a five-year period. <WWD>
Hedgeye Retail’s Take: Completing its biggest deal in more than a decade, Wal-Mart is now truly global penetrating the last remaining continent without the leading EDLP player. While upfront investment is considerable, we suspect it will be some time before we see this deal move the needle.
KKR Acquires Academy - Academy Sports & Outdoors is under new ownership. The Katy, Texas-based retail chain announced Tuesday it was acquired by New York private equity firm Kohlberg, Kravis, Roberts & Co. in a move that Academy President Robyn Faldyn said would accelerate growth for the athletic and outdoor-focused retailer. The current owners, the Gochman family, will retain a minority stake in the 131-door chain, which operates primarily in the southeastern U.S. and saw $2.7 billion in revenue last year. Terms of the deal were not disclosed. KKR is an international private equity firm with $61 billion in assets. As part of the agreement, Faldyn also will take on the CEO role, currently held by Chairman David Gochman, when the deal closes in six to eight weeks. Faldyn said the chain plans to open 12 stores in both new and existing markets in 2011, and he expects KKR’s involvement will facilitate even more expansion. “The transaction with KKR will give the company more flexibility and access to capital to more aggressively pursue additional store growth along with our focus on upgrading our technology and distribution infrastructure,” he said. <WWD>
Hedgeye Retail’s Take: Another sporting goods retailer falls into the hands of private-equity. With only 131 stores, 12 store growth in ’11 is on the more aggressive side relative to its peers – something we’d expect to accelerate as KKR looks to drive sales ahead of an eventual IPO. With DKS having missed the opportunity to grab the Academy when it could, it will be forced to compete with KKR over real estate out west and perhaps revisit the potential for a strategic deal down the line albeit at higher prices.
Barneys Expands e-Commerce Reach - Barneys New York says the e-commerce channel is the fastest growing part of its business and wants to keep the momentum going by playing on its international recognition. The luxury retailer has ramped up shipping online orders off barneys.com to 90 countries including Canada, South Korea, the U.K., Australia and China, from just the U.S. at the beginning of the year. “We did a phase-in process beginning at the tail end of February, with 20 countries at a time, to make sure we were up and running and could handle it,” Daniela Vitale, chief merchant and executive vice president of Barneys New York, told WWD. Asked what countries are generating the most orders, Vitale replied: “Canada is very big, and we’ve had a lot of interest from Australia due to the beneficial exchange rate.” She also cited France, Germany, Italy and Mexico, which is “quite shocking considering the huge tax issues there....There’s been pretty much a great mix, but no real activity from South America aside from a little bit from Brazil but not much else yet. We haven’t done anything yet in terms of marketing. We would partner with Google to do some search-related things that apply to Brazil” and other countries. Vitale said international tourists represent one-third of Barneys’ active customer base, and that in some flagships, like Madison Avenue and Beverly Hills, it’s closer to a 50-50 split. With the increase in foreign shipping, Barneys is building up inventories but Vitale assured it’s an increase commensurate with sales projections. <WWD>
Hedgeye Retail’s Take: At some point, it becomes more economic to establish global POD to handle volume and mitigate cost, but with well over 1/3 of its business tied to tourists, Barney’s retention cost is considerable. Strong demand out of Canada and Germany are no surprise, but Mexico? Perhaps there’s some truth to ‘if you ship it, they will come.’
AFA Introduced to Senate - The Affordable Footwear Act has been introduced in the US Senate by Senator Maria Cantwell (D-WA) and Senator Roy Blunt (R-MO) in a bid to reduce costs for outdoor industry footwear makers and their customers while supporting US production of outdoor shoes and boots. The Act would create a four-year suspension of many of the disproportionately high import tariffs, some as high as 37.5 percent, that are assessed against outdoor footwear. The bill also ensures US manufacturing that is currently underway in this area remains globally competitive by excluding any product with American production and preventing tariff engineering that undermines US footwear producers. The bill is also temporary so that domestic production can be reevaluated after four years and products removed where appropriate. It is estimated that $800 million in duties on children’s and low-cost shoes will be eliminated should the bill be passed. The goal is to ease the tax burden on families hurting in the current economy. <FashionNetAsia>
Hedgeye Retail’s Take: Back for another go attempt, but this time the Affordable Footwear Act has been introduced to the Senate – a step further than it’s ever been. This would undoubtedly help the lower end footwear retailers that are more price sensitive if passed. While unlikely to result in lower prices, we suspect that retailers will be less apt to pass increasing material costs through if cost relief in the form of lower tariffs comes to fruition.
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