“Where is the edge? And how do I stay the right distance from the edge?”
That was Ray Dalio’s answer on the key to risk management success (“Mastering The Machine”, by John Cassidy, New Yorker, July 25th 2011). Like he did in 2008, Dalio is beating most of his hedge fund competition in 2011. Hedgeye calls that a repeatable process.
Where was The Edge in 2011? Global Growth Slowing. Period.
While there will be plenty of storytelling and finger pointing about how it was a pig in Europe or a politician in America, that’s pretty much it. If you got Growth Slowing right, you got a lot of other things right.
Growth won’t slow forever. But it didn’t stop slowing in the US on Friday and it doesn’t appear to be slowing in Europe this week either. When growth stops slowing, that will be a critical signal to start thinking about going the other way.
The cover of Barron’s this weekend asked “Where Do We Go From Here?” Good question. But for the answers, Barrons (like many other legacy financials media outlets) continues to use the wrong sources. Why many of these journalists are using the same sources that missed Growth Slowing in 2008 is not clear. Why they don’t use Hedgeye is simple: we are their new competition.
In my Early Look note from August 11thtitled Forecasting Dark (“Weather forecast for tonight: dark.”-George Carlin) I highlighted what Washington/Wall Street continue to use as their source for “blue chip” strategy. At the beginning of 2011 here were some of the higher profile estimates:
Forecasts for 2011 US GDP Growth:
- Bank of America = 3.2%
- Barclays = 3.1%
- Citigroup = 3.1%
Forecasts for 2011 SP500 Returns:
- Bank of America (David Bianco) = 1400 (up +11.4%)
- Barclays (Barry Knapp) = 1420 (up +13.0%)
- Citigroup (Tobias Levkovich) = 1400 (up +11.4%)
As of last week’s train wreck US unemployment report and another -31% estimate cut from the US Government on Q2 2011 GDP, here’s fact versus prior fictions:
- Q1 2011 US GDP Growth = 0.36%
- Q2 2011 US GDP Growth = 0.98%
- SP500 YTD Return = -6.7%
Now, to be fair, there are still some very contrarian views out there. Consider ISI Group’s latest sell-side hire, Bijal Shah, who proclaimed in Barron’s on August 22, 2011, “higher unemployment isn’t necessarily terrible news for equity markets.”
It just was last week.
So (drumroll), after seeing the data, here are your real-time Wall Street revisions from Barron’s this weekend:
- Deutsche Bank (Binky Chada) drops their January 2011 year-end SP500 target from 1550 to 1425
- Goldman Sachs (David Kostin) drops their January 2011 year-end SP500 target from 1450 to 1400
- Credit Suisse (Doug Cliggott) drops their January 2011 year-end SP500 target from 1250 to 1100
Whoa, hold your horses! Is that one major sell-side firm with a price target below the market’s last price? Indeed. This isn’t Doug Cliggott’s first rodeo getting a bearish move right.
So what do we do with all of this incompetence in forecasting?
- Realize that the sell-side hasn’t capitulated yet and cut their estimates to the right level (they will at the bottom)
- Accept that both the US Government and their economic advisors (the sell-side) continues to use the wrong models
- Keep doing what it is that we’ve done to call both the 2008 and 2011 Growth Slowdowns
Not that I’m still keeping track, but on February 3rd, 2011, JP Morgan’s Thomas Lee put out a note titled “Circle of Life”, raising his 2011 EPS target in the SP500 to $97.50 from $94 saying that it “smells like a secular bull market…”
While I’m not certain how to use the scratch-and-sniff model, what we can be certain of is that most of these sell-side strategists quickly revert to calling markets “cheap” when both their earnings and price targets are wrong.
Of course, anything can be deemed “cheap” if you use the wrong growth and earnings estimates…
Who has the right earnings estimates? You can drive a truck through Deutsche Bank and Credit Suisse views on the “E” in PE for 2012:
- Binky Chada says $106
- Doug Cliggott says $81
So, Chada will call the SP500 “cheap” because he is using 11x earnings (1173/$106) and Cliggott will call it more expensive at 14x (1173/$81). Who is right? What’s the right multiple? Who has The Edge?
Don’t worry, those are not the risk management question you need to answer this morning. The answer that you have to perpetually impute is “how do you stay the right distance from the edge.”
To do that, you’ll need a repeatable risk management process as well.
My immediate-term support and resistance levels for Gold, Oil, and the SP500 are now $1 (bullish but overbought), $83.87-97.34 (bearish), and 1145-1193, respectively. Europe capitulated yesterday. There’s a good chance another immediate-term low in US stocks comes at a higher-low than the prior closing low (1119) and US Treasuries are putting in immediate-term highs.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
This note was originally published at 8am on September 01, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“Willful blindness of the non-linear core nature, has led to the attempts to manipulate the markets certainly by government.”
-Martin A. Armstrong
It is the nature of a man who is in the business of being bullish to be bullish. It is in the nature of a woman who is in the business of being bearish to be bearish. Human Nature’s Manipulations of market storytelling is what it is. People push their own book.
Over the last 3 years I have been accused of being both a raging Republican and a Yale campus Democrat. In 2009 I was, allegedly, a “reckless” bull. In 2011, I am, allegedly, a Perma- Bear. All the while, across 1,377 positions that I have taken since founding Hedgeye in 2008, my long versus short positions are close to dead even (660 LONGS, 677 SHORTS). Time stamps matter.
Perma-Process? Perma-Risk Manager? Perma-Mullet? Who knows. What I do know is that if I am not more right than I am wrong on the big stuff, we don’t get paid. Despite Perma-Bulls claiming they nailed it in August, both the US and Global Equity markets got decimated.
Across our Global Macro model’s Global Equity market league tables, here was the score for August 2011:
- Greece = down -23.9%
- Germany = down -19.2%
- Italy = down -15.6%
- Russia = down -13.4%
- Austria = down -12.7%
- South Korea = down -11.9%
- France = down -11.3%
- Argentina = down -10.7%
- Sweden = down -10.6%
- Taiwan = down -10.4%
So, I guess, the US stock market bulls who were expecting 3-4% US GDP growth and SP500 returns of 15-20% in 2011 were a little off in August, but they weren’t crashing like everything else (SP500 and Russell 2000 down -6.1% and -8.7% for AUG, respectively).
That must be bullish. And I must have been too bearish.
Heck, just look at how high US stocks bounced “off the lows” in August. That’s just gotta be bullish, no? Without any economic data to back it (US consumer confidence hitting 1970s type lows; housing/mortgage demand at 14 year lows, global stock markets getting smoked, etc), the bears must be too bearish. Right? Ah to be a connoisseur of consensus…
While the answer to who called the August bottom AND actually called the April top remains unclear, what remains crystal clear is that people who are in the business of being bullish bought stocks into August month end.
In the Hedgeye Chart of The Day, Darius Dale, illuminates the simple reality of institutionalized career risk management:
LAST 6 DAYS OF THE MONTH (in the SP500):
- APRIL = +2.0%
- MAT = +2.1%
- JUNE = +2.6%
- JULY = -3.8%
- AUG = +4.9%
FIRST 6 DAYS OF THE MONTH:
- MAY = -1.3%
- JUNE = -4.9%
- JULY = +1.8%
- AUG = -13.4%
- SEP = ?
Now, if you want to roll the Bernanke Bones on this, maybe this time will be different. After all, that’s what the Keynesians and Fiat Fools have been telling us all along. But if it’s not, the US stock market could have a big problem in September. That +4.9% month-end markup into August end was the most aggressive yet and, as you can see, the higher they mark’em up, the harder they fall.
Arresting economic gravity is difficult. But Obama is scheduled to release his new bag of goodies next Thursday and, all the while, Charlie Evans can pop in from the Chicago Fed for another US Dollar Debauchery interview (not that his being paid by The Commodity Inflation or sitting on the Chicago Metropolis board with CBOT and UBS execs is a conflict of interest versus the Fed’s “independence” or anything like that).
So sit back and enjoy some price volatility in September as the Fed keeps cranking on full employment and “price stability”! We really need these guys to do a lot more of what didn’t work with QG2. Nature and the non-linear interconnectedness of Global Macro markets be damned.
Today’s risk/reward in the SP500 is dead even. I have 1203 and 1234 as immediate-term TRADE support and resistance. After moving off of my 0% asset allocation to US Equities last Friday (bought Utilities and were up +3.3% on that already) we’re long XLU (Utilities) and short Financials (XLF). Where could I be wrong? All over the place I guess. My every morning starts and ends with Uncertainty.
My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1822-1905, $85.98-89.72, and 1203-1234, respectively.
Best of luck out there in September,
Keith R. McCullough
Chief Executive Officer
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PNRA faces some big hurdles in the coming months, especially in 4Q11. While we think trends remain on track this quarter, sales have softened a bit of late. For the industry as a whole, the bar has been raised on sales trends, given the significant downturn in consumer confidence and the lack of any significant improvement in the jobs picture.
On the surface it looks like that PNRA's second half comp guidance seems achievable given that a 5% comp (guided to 4.5% to 5.5% same-store sales growth in both 3Q11 and 4Q11) during the third quarter implies a 175 bp deceleration in two-year average trends.
The biggest risk to guidance seems to come in 4Q11, as the difference in transaction growth between 3Q11 and 4Q11 is driven by the distribution of media. PNRA will print the highest year-over-year growth in media in 3Q11 as the company is rolling out the “Make Today Better” campaign. For fiscal 2011, year-over-year media spend will be up approximately 40% system-wide. Also in 4Q11, PNRA will anniversary the MY PANERA loyalty program primarily in 4Q10.
Being conservative, management’s guidance assumes a fairly significant slowdown in two-year average traffic trends during the second half of the year, which is warranted given that the company intends to raise prices in September, resulting in a 3.5% price increase during 4Q11 versus the 2.5% expected in 3Q11 and reported in 2Q11.
It was encouraging to hear management talk about the potentially negative impact on traffic as a result of the incremental price increase as companies often talk about price increases as being wholly incremental; management also attributed the expected deceleration in traffic trends to economic conditions.
The biggest risk to Panera’s second half comp targets stems from the assumed sequential improvement in mix. PNRA reported modest check compression of 50 bps during 1Q11, which worsened to 100 bps during 2Q11. Management attributed this negative mix impact to the company’s new loyalty program, which offered increased discounts and specific to 2Q11, to the later introduction of its Summer Salad Celebrations versus the year prior.
Going forward, management expects menu mix to turn positive and guided to flat to +1% mix impact on check during 3Q11 and 1-2% mix impact in 4Q11. PNRA’s comp guidance relies on this mix improvement in the back half of the year but the comparisons get much easier as the company took a big hit on mix during 4Q10 (reported +0.3% versus +3.3% in 3Q10), largely as a result of the launch of its loyalty program.
That being said, although we need to see a big improvement in mix quarter to quarter, the guidance assumes fairly even mix trends on a two-year average basis.
It will be important to watch how customers respond to Panera’s upcoming price increase and how customers fare overall in the current economic environment, but given recent trends, PNRA’s comp guidance seems reasonable in 3Q but somewhat more aggressive in 4Q11.
From a commodity perspective, Panera is expecting 4.5% inflation for the full year 2011 and roughly 4-5% for 2012. Wheat is the most important commodity for Panera, in terms of the percentage of its commodity spend that the grain accounts for. In 2008, soaring wheat prices impacted Panera’s restaurant level margins severely. A new strategy of buying at least six months out and buying in short periods of time has benefitted the company through inflationary periods but, as management said in early 2010, has allowed some benefits of commodity deflation to elude the company’s P&L.
Coming into 2010, the company had 80% of its wheat costs locked in at just over $8 per bushel and wheat costs for 2011 were locked “approximately flat” to wheat costs in 2010, according to management. As the chart below shows, wheat is currently tracking approximately flat year-over-year, at roughly $7.25 per bushel, and could be down year-over-year in early 2012. In the near term, crop damage in the U.S. caused by drought, flooding, and other events will provide support for wheat prices. Over the longer term and for 2012 overall, global demand may slow if economic growth remains stagnant. As always, the U.S. Dollar, and the factors that influence it will be a primary driver of what wheat prices restaurant companies face next year.
This note was originally published at 8am on August 31, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody”.
Markets are intimidating and they don’t wait for anyone. Nor do they owe anyone a return, as Keith likes to say.
When James Carville made the above quote, he was referencing the melt up in 10-year yields in the early stages of Bill Clinton’s first term as president. Bond investors, at the time, were concerned about federal spending. Subsequent efforts by the Clinton administration to control the deficit, which helped to strengthen the dollar, led to the bond investors’ fears being assuaged: yields trended lower and stocks surged, for the most part, during the remainder of Clinton’s stint as Commander in Chief.
Markets are at least as intimidating today as they were in the early 1990’s, when real-time prices forced the government to sober up. In the age of social media, where information is more accessible than ever, anyone can be a part of the debate. In general, I would argue, this is good for the country as it allows a broader range of views to be heard by a broader range of people. Popular consensus, in a way, is changing on a tick like real-time market prices, thanks to the democratization of information. For the political players in Washington, this is intimidating.
Although real-time communication is becoming the norm, certain members of the financial community will likely resist that move and, like others before them across industries that have resisted positive change, they will be left behind. The Federal Reserve’s inability to prop up equity prices in perpetuity has set alarm bells ringing in Washington this year as Hedgeye’s call for Jobless Stagflation, induced by ineffective Keynesian policies, has manifested itself. For now, it appears that policy-makers are sticking to their guns, but to the extent that real-time prices and economic data continue to weigh on sentiment, the time for the incumbent players to act could be limited.
Despite Charles Evans’ best attempts, yesterday on CNBC he ignored the fact that markets discount future events (like the cessation of QE), and equity markets have declined globally on expectations that the global economy is slowing. In the U.S., the primary source of pessimism (and ultimately the primary potential for renewed growth) is the consumer. Despite trillions of dollars of government spending, consumer’s expectations for an improved economy have not changed significantly over the past three years.
Yesterday’s bomb of a consumer confidence number from the Conference Board came as no surprise to anyone. In an effort to look for a positive in what was a decidedly negative report, the stat that stood out the most to me was that more than half of consumers expect the stock market to be lower in a year, the first time that has been true since March 2009. However, this is not March 2009, this is 2011.
In my view, there are four primary ailments that need to be addressed for a consumer recovery to take place.
(1) The political machine in Washington, D.C. is broken.
This one is obvious. The debt and deficit debate put the spot light on everything that is wrong with Washington politics. Dylan Ratigan recently expressed the frustration many Americans are feeling during his rant on MSNBC during which he accused legislators of being “bought”. Howard Schultz, the CEO of Starbucks, seemingly agrees as he is encouraging business leaders to just say no and stop funding the madness via political donations. Ratigan, for his part, has shown no mercy for either side of the aisle. During his now famous rant, Ratigan accused Democrats of “kicking the can down the road until 2017” and “screwing” future generations by not offering long-term solutions for extractions from the economy. Turning to Republicans, he stated that they simply want to “burn the place down” and pursue a negative agenda.
(2) Perpetually low rates is killing confidence
Easy money creates bubbles which have a severe impact on consumer confidence given that consumers are usually the last to the party.
(3) The Keynesian policies of the FED is slowing GDP growth
Quantitative Easing is inflationary! While Mr. Evans was on CNBC, refusing to admit that QE2 was inflationary, it was obvious that he was ignoring inconvenient facts while admitting only those that suited his stance. Markets are discounting mechanisms and hinge on expectations; the longer-term view of QE2 is highly conclusive; the result was a weakened dollar and a 29% surge in the CRB index over the past twelve months. Stagflation is back and it is scaring the public.
(4) The Government inflates the data to build up expectations only to be shot down with constant downward revisions
The most glaring example of this is seen in the BEA's use of "deflators." The BEA is telling us that they believe that inflation over the prior two quarters has been running at annualized rates of 2.5% and 2.7% respectively and the annualized inflation rate for the prior four quarters was just barely over 2%. You tell me!! Is it really plausible that over the last 12 months we saw net inflation of barely over 2%?
On Monday, the government reported that personal spending increased 0.8% in July. This was a 100 basis point improvement from the month prior. Consumption is accelerating despite numerous headwinds. I have become very cynical about government data and it does require a leap of faith to assume that the government has accurately captured what is happening in the real economy.
Despite a significant downturn in equity prices during August, the S&P 500 is now 10% “off the lows” into month-end. The market faces a difficult macro calendar in September including another attempt from the Obama administration to jump-start the economy. One thing Obama knows is that markets are ready-and-able to tell him if he is not doing the right thing. Coming up to the election, the incumbent president needs a win, but solutions to the problem of Jobless Stagflation and ideological dogma in Washington, D.C. are what the market of popular consensus is demanding.
Function in disaster; finish in style,
CORRECTION: The $85mm value of this morning’s deal was net of debt disposition, not gross that we previously implied. The difference is not immaterial though it does not change our call on LIZ, which is all about driving RNOA sharply higher as it sheds underperforming assets while driving EBIT higher and delevering along the way.
LIZ officially announced the sale of its Mexx business this morning removing one major drag and improving another other – its balance sheet. According to the terms of the deal, the company will receive $85mm in total cash consideration consisting of $25mm of cash in hand and $60mm of debt that will be assumed by the newly formed JV between The Gores Group (81.25% owner) and Liz (18.75%). The deal values Mexx’s ~$700mm in revenue at $105mm and marks the second asset sale in the past 30-days.
The terms are below what was rumored by the press last month, but keep in mind a few things… 1) while the market was melting down this deal was widely rumored to be falling apart, 2) The stock was off 37% during this period, and 3) at the same time, its net debt improved by almost 20% . Most importantly, the stock price is at the same level today – and the Enterprise Value 10% lower – than when the biggest pushback we got on our call was “this Board is inactive, management stinks, the balance sheet is too levered, and this company could go bankrupt.’ Anyone want to make sense of that for me?
Between this deal and the fragrance business they sold last month, the company is getting ~$83mm in cash and a $60mm reduction in debt providing added flexibility with which to manage leverage during Q3 before paying down a large portion of their debt in Q4. It’s also worth noting that this would get the company within ~$50mm of its goal of $578mm by year-end.
Looking out to next year (perhaps sooner), we suspect the company is likely to execute additional sales within its Partnered Brands business that could amount to another $100-$200mm that could be put towards deleveraging the business further.
So what’s left after these sales? We have the Partnered Brands business that we expect to generate nearly $20mm in EBIT next year and the three remaining Direct Brands (Kate, Juicy, and Lucky) that we expect to generate at least $80mm. With aggressive deleveraging underway, we are modeling approximately ~$15 in interest expense reduction generating earnings north of $0.45 next year assuming conservative operating improvement among the Direct Brands. We don’t have to drum up heroic assumptions to get earnings over $0.75.
With the company actively unlocking value through asset sales, it’s worth considering our sum-of-the-parts analysis below, which suggests a value of $12-$14 taking into account recent sales and a 10% breakup discount. That’s a double from current prices.
We think investors will get at least that on LIZ. This remains our favorite small-cap TAIL idea.
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