This note was originally published at 8am on October 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.
“We can lick gravity, but sometimes the paperwork is overwhelming.”
-Werner von Braun
The only problem with last week contributing to the best month for stocks since 1974, is the 1970s. This morning, between German Retail Sales falling to flat year-over-year and Eurozone inflation (CPI) remaining at +3%, European Stagflation remains.
Most of last week’s fanfare can be boiled down to one solid gravitational factor that underpins all of the math behind what we’ve been calling The Correlation Risk – the US Dollar. If you get the US Dollar Index’s direction right, you’ll get most other things right.
The US Dollar Index is up +1.3% so far this morning. That’s a good start to my week because my being long it last week was nasty. Inclusive of a -1.7% week-over-week drawdown, the US Dollar was down for the 3rdconsecutive week, and down -4.6% since the week ended October 7th, 2011.
Since that 1stweek of October (after the Cover of Barron’s said “Watch Out, Mr. Bull” – this weekend it said “Not So Fast, Mr. Bear”?), this is what other major moves in Global Macro have looked like:
- Euro/USD = +6.1%
- CRB Commodities Index = +6.6%
- Oil = +12.5%
- Copper = +14.9%
- Volatility (VIX) = -32%
- 10-yr US Treasury Yield = +12%
So what was this all about – Growth or Gravity?
We’ve had plenty of rallies since the start of 2011 where consensus has been convinced that this has been all about growth. The only problem with that is that there is a big difference between growth and inflation. That’s why the legitimate calculations of GDP growth apply a legitimate “deflator” to the nominal growth estimate. It’s called the purchasing power of money.
Remember in Q1 of 2011 when Sell-Side and Washington “economists” had +3-4% 2011 GDP and 1450 SP500 targets? We do. We also remember that the price of oil was tracking upwards of $110/barrel – and that had a big impact on global economic growth slowing.
After it was revised -81% to the downside versus the “preliminary US government estimate”, US GDP growth in 1Q11 was only 0.36%. That was using a “deflator” that we’d consider accommodative to the Big Government Interventionist camp that it’s not Policy, Stupid.
That was then – this is now. What does this economy need from here?
A) More US Dollar Debauchery
B) Higher Oil prices
C) Stock market cheerleading based on A) and B)
Alex, I’ll take a restroom break and the other side of Jon Corzine’s long/short book for $1,000.
Obviously most people whose compensation isn’t solely tied to stock market inflations are allowed to get the point here. Not surprisingly, amidst last week’s generational squeeze, a few not so funny things happened on the way to the Europig Forum:
- European PIIG Bond Yields (Italy most specifically) hit new 3-year highs
- TED Spread (measures global banking counterparty risk) hit a new 2011 YTD high
- US Financials (XLF), The Russell 2000 (IWM), and the price of Copper (JJC) all failed at their long-term TAIL lines of resistance
Now that last point is probably the most interesting – because, essentially, it ties back to the aforementioned point about growth. It’s a question really. The Question this morning (as in what you do with your money right here and now): is Global Growth “back” OR was that just another Dollar Down reflation of asset prices?
Longer-term, I think the only way to recover real US economic growth (adjusting for inflation) is to:
1. Strengthen the US Dollar
2. Deflate The Inflation
3. Strengthen Employment
In the Chart of the Day, you’ll see this quite clearly across US Presidential terms. Someone running for President in 2012 really needs to use this picture. Going all the way back to when Richard Nixon abandoned the Gold Standard (1971) and embarked on today’s Euro-style debt monetization scheme, a Strong US Dollar = Strong America.
To be sure, looking back at the last 18 days of the biggest move ever in stock prices (ever is a long time), Licking Gravity’s short-term political resolve has its Month-End Markup perks, for some of us…
But, for most of us, the long-term TAILs of Global Growth are still broken.
My immediate-term support and resistance ranges for Gold (bullish TRADE and TREND), Oil (bullish TRADE; bearish TAIL), German DAX (bullish TRADE; bearish TAIL), and the SP500 (bullish TRADE and TREND) are now $1706-1774, $90.19-93.86, 6098-6455, and 1267-1294, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
“A plague o’ both your houses!”
-Mercutio, Romeo and Juliet
Mercutio’s immortal phrase was aimed at the houses of Montague and Capulet whose feuding led to the tragic sequence of events that make up one of Shakespeare’s most famous and timeless pieces. The phrase has been resurrected ever since to express frustration, typically with two opposing sides of an argument.
Franklin Delano Roosevelt, following a bloody clash between striking steel workers and the Chicago Police Department that came to be known as the Memorial Day Massacre of 1937, said that “The majority of people are saying just one thing, ‘A plague on both your houses’”. Today, among the dearth of political leadership in Washington at such a time of crisis, many in the country are saying the same to the respective political parties.
Frustration is usually a transient feeling, sooner or later dissipated by resolution, compromise, apathy, or distraction. As being poor became a way of life for many during the Great Depression, it seems frustration is now becoming a core component for not only the American existence, but for many people around the world.
Conspiracy theories abound regarding the Federal Reserve and the degree of corruption that exists in America’s economic and political institutions but, Ben Bernanke’s assertion that the slow pace of economic growth is “frustrating” seems genuine to me. I think frustration is something the country can relate to. However, it was nearly unconscionable to me that he would used the phrase of a “bit of bad luck” when referring to the spike in oil prices and the dampening effect it had on economic growth this past year. It was clear to us at Hedgeye that the Federal Reserve’s own policies were significant drivers of higher oil prices.
Another political plague exists today in Europe as the never-ending saga of the sovereign debt crisis rambles on. It has long been said by European officials that the union must be preserved and that the respective futures of the member states are inextricably linked, by both circumstance and by law. I would view the former as being somewhat subjective and the latter as being, as was shown when Brussels consented to bailouts that may or may not be forbidden by the Maastricht Treaty, completely open to interpretation if the situation demands it. A dramatic series of events is needed and the one certainty is that there will be pain. Listening to politicians bending logic and essentially wasting further time with tired old solutions is becoming frustrating for Europe’s people.
When President Obama was elected in 2008, he had successfully campaigned on a message of change. I, like many other Americans, was taken by the message and the delivery, but it’s not possible for one person to change a compromised political system and this country is realizing now that there will be no quick fix.
This realization is all the more daunting when one considers that many of the same actors are in the same roles that they’ve been in for years. Geithner and Bernanke are some of the most obvious examples but recent news of John Corzine possibly being culpable in the collapse of MF Global following his claim that thirteen years ago he “understood the flaws” at Long Term Capital Management better than anyone is equally disheartening.
If repeating the same action again and again and expecting a different result is the definition of insanity, to use Einstein’s quote, then surely entrusting the same players with the same or similar responsibilities and expecting different results is also a folly. In this respect, Wall Street and Washington D.C., are frustrating their shareholders and voters to no end.
The cast iron dogmas of the sphere of investing, as those of the policy world, are being exposed as useless. We believe that a flexible, nimble, and data-driven investment process is essential to surviving the turbulence that is visiting the financial markets with greater and greater frequency as the unpredictable actions of governments continue to cause uncertainty. Clearly some of the old guard in Wall Street, and Mr. Corzine is one example, have not learned to invest prudently.
Over recent weeks, predicting whether macro factors or earnings were to be the driving force behind stock performance on any given day has been a fool’s errand. With the wisdom of hindsight, however, I can say that macro factors have been more of a focus than earnings over the past month. The “Greece Doesn’t Matter” television pundits have been quiet of late. Soon the earnings season will be over and a new macro season starts. Our “King Dollar” thesis is going to be one that we monitor closely with a minefield of catalysts heading into the holiday season. Hedgeye has been highly accurate in calling the US Dollar over the last three years and, as Keith likes to say, “if you get the dollar right you get a lot of other things right.”
Just as Wall Street needs a change in leadership, our policy makers need to step aside and allow new leaders to win back the confidence of the country. The Federal Reserve’s forecast for GDP growth in 2011 is now 1.6%-1.7% versus 2.7%-2.9% prior and 2.5%-2.9% versus 3.3%-3.7% prior for 2012. In a year, according to the Federal Reserve’s updated economic projections, the unemployment rate is scheduled to be 8.6%. The Federal Reserve’s track record is less-than-satisfactory, so those projections certainly should not be relied upon and are likely overly-optimistic. A mere 40 basis points of improvement in the unemployment rate is certainly frustrating. 40 basis points is of little use to the 46 million Americans now depending on food stamps for sustenance.
I can respect the experience that many of the policy makers in Washington possess and would love to someday hear or read any of their perspectives on what went wrong in the last few years. However, given that this country is currently embroiled in a sort of economic Vietnam, I believe that the coach – President Obama – will ultimately be judged harshly for not having brought in new players in key economic policy roles. Experience can be good but it isn’t necessarily always helpful. As Robert Benchley said, “A boy can learn a lot from a dog: obedience, loyalty, and the importance of turning around three times before lying down”.
Function in disaster; finish in style,
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THE HEDGEYE DAILY OUTLOOK
TODAY’S S&P 500 SET-UP - November 3, 2011
Another day, another dislocation between stocks and bonds – bond yields have had the big moves right in 2011. As we look at today’s set up for the S&P 500, the range is 37 points or -2.09% downside to 1212 and 0.90% upside to 1249.
SECTOR AND GLOBAL PERFORMANCE
- ADVANCE/DECLINE LINE: +1998 (+4151)
- VOLUME: NYSE 957.34 (-27.98%)
- VIX: 32.74 -5.84% YTD PERFORMANCE: +84.45%
- SPX PUT/CALL RATIO: 2.29 from 2.29 (-0.28%)
CREDIT/ECONOMIC MARKET LOOK:
TREASURIES – UST 10yr yields are down -16% (39 bps) since this hour of the morning last Thursday; that’s a lot. And now we have 10s bearish on both TRADE and TREND durations again (TRADE line support was 2.11% and we’re looking at 2.02% this morning with the Yield Spread (10s minus 2s) down from 203bps wide at the start of the wk to 179bps this morn – not good).
- TED SPREAD: 43.30
- 3-MONTH T-BILL YIELD: 0.01%
- 10-Year: 2.03 from 2.01
- YIELD CURVE: 1.80 from 1.78
MACRO DATA POINTS (Bloomberg Estimates):
- 8am: RBC Consumer Outlook, prior 39.2
- 8:30am: Nonfarm Productiviity, est. 3.0%, prior -0.7%
- 8:30am: Jobless claims, est. 400k, prior 402k
- 9:45am: Bloomberg Consumer Comfort, prior 51.1
- 10am: ISM Non-Manufacturing, est. 53.5, prior 50.0
- 10am: Factory orders, est. -0.2%, prior -0.2%
- 10:30am: EIA natural gas storage, est. 70, prior 92
WHAT TO WATCH:
- American Eagle Outfitters (AEO): narrows 3Q earnings forecast to 26c-27c/shr from 22c-27c, exceeding est. by at least 3c
- Costco (COST); U.S. comp sales ex-fuel beat est.
- Whole Foods Market (WFM): fails to increase its fiscal 2012 profit forecast, still sees EPS $2.21-$2.26
- Groupon IPO expected to price this evening; yesterday, co. was said to stop taking orders for IPO because of demand
- German, French leaders withheld EU8b, warned that Greece will surrender all European aid if it votes against bailout package agreed only last week.
- MF Global’s commodity customer funds have shortfall of $633m, CFTC said
- SEC likely to file charges against more Wall Street firms in connection with sale of mortgage-linked securities: FT
- Bank of England, ECB announce interest rate decisions later today
COMMODITIES: The CRB Index remains bearish TREND and TAIL with a wall of resistance 326-335
MOST POPULAR COMMODITY HEADLINES FROM BLOOMBERG:
- Porsche Sells Malbec to Keep Autos Coming Into Argentina: Cars
- Ikea’s Paper Pallet Challenges Wood’s 50-Year Dominance: Freight
- Skunky Smells, 150-Decibel Blasts Pitched as Pirate Defenses
- Gold Drops With Commodities as European Leaders Cut Greek Aid
- China Record Corn Crop Still Failing to Meet Demand: Commodities
- World Food Prices Drop Most in 19 Months on Grain, Dairy Slump
- MF May Have Transferred Customer Money After Audit, CME Says
- Oil Drops After Europe Freezes Greek Aid, U.S. Stockpiles Rise
- U.S. Stocks Rebound, Commodities Rise as Dollar Slips After Fed
- Coal India to Quicken Search for Overseas Mines as Output Drops
- China Plans ‘Orderly’ Delivery of New Ships as Glut Hits Rates
- Midwest Refinery Upgrades Boost Canadian Crudes: Energy Markets
- Copper Declines on Concern European Debt Crisis to Damp Demand
- Copper Resumes Drop on More Signs of China Slowdown: LME Preview
- China Will Not Change Domestic Monetary Policy, Zhang Says
- Thousands March in Oakland Shutting Down Fifth Busiest U.S. Port
- Twenty-Five Indonesian Tin Producers to Extend Export Ban
- Oil Near Two-Month High as Europe Presses Greece on Rescue Deal
- U.S. Rebel’s Split Riles $6 Billion World of Ethical Commerce
- Top Gold Forecasters See Rally to Record by March: Commodities
EUROPE - "off the lows" again, this rally looks really suspect (no volume) as the CAC in particular remains bearish/broken across durations
FRANCE – interestingly, but not surprisingly, French bond yields are flagging the nasty – whether you look at the spread risk b/t German Bunds or the nominal level of French 10s, it all looks the same to me – on the stock side, the CAC40 keeps failing at my TREND zone of 3403. France’s stock market remains in crash mode (> 20% peak to trough decline for the YTD)
ASIA: ugly breakdowns in both the Hang Seng (-2.5%) and KOSPI (1.5%) overnight; both remain bearish on the Hedgeye TREND duration
The Hedgeye Macro Team
The Macau Metro Monitor, November 3, 2011
SJM LEAD NARROWS Macau Business
According to sources, October total GGR share is as follows: SJM (26%), Galaxy (21%), MPEL (15%), LVS (14%), WYNN (13%), and MGM (11%).
Conclusion: We’ve had HBI as one of our key short ideas, and after this call we like it even more. This was the weirdest print/call we’ve heard since YHOO’s Carol Bartz let loose on the investor community in ’09. HBI is shaking out to be a decelerating top line growth model with financial and operational leverage that is about to lap acquisitions, channel restocking, pricing, and now is showing signs of erosion in unit growth in the core business. Next year’s numbers hinge on continued success with pricing at a time when Wal-Mart just unexpectedly cut a major program (Just My Size) in favor of private label, which cost HBI 7 points of growth out of its core. The Street has valued HBI at egregious levels given its ‘pseudo’ growth profile over the past two years. But in the end, this quarter should give better visibility as to what the company actually is; a good, but slow and volatile grower on a heavy operating asset base with too much debt. There’s no reason why companies like GES should trade at less than 8x earnings and 5x EBITDA with HBI going out today at 10x and 8x, respectively. Even at the after-hours price of $25, it’s still 9x and 7.8x.
We’ve had HBI as one of our top three shorts for the past six months, and expected 3Q to be a bad event (see our 10/24 note “We Don’t Like It”), but what we did not expect is for the conference call to be an all out gong-show. It was simply a mess.
- First off, lets give credit where it’s due. HBI beat the quarter. They missed revenue, but completely made up for it on the gross margin line. Keep in mind that $2/lb+ cotton costs start to hit HBI in 4Q, but they’ve already taken several price increases this year. It’s been in that special place where the customer pays you without HBI having to pass it through to the back-end of its supply chain. In other words, if there was ever a quarter for HBI to crush margins, this was it. In fairness, they did. +360bps vs. last year. Congratulations.
- Organically, sales were down -2%.
- Sales missed in the quarter by ~10%, and HBI guided down the top line (and EPS) in 4Q due to weak unit demand ‘across all channels of distribution.’ Let me get this straight…
- Down in ‘all channels’ means that the channel, in aggregate, is now fully restocked. Retailers might be telling Hanes salespeople that they are simply ‘managing inventories’ but they’re probably not going to say “I loaded up six months ago before price increases went into effect.”
- If we’re right in that regard, it also suggests that the pricing discussion in 2012 is certainly not a slam dunk by any means.
- Management said that there is minimal elasticity in demand for Hanesbrands product, yet prices went up and demand went down. Huh? They noted that this is not due to elasticity, but rather inaccurate forecasting at the beginning of the year. So if we give them credit on the elasticity issue (which I won’t) then I argue that at least we need to ding the company’s forecast accuracy.
- Management noted that cotton costs are the worst in 4Q through 2Q12 – which is true. But that they’ll benefit in 2H. “The retailers want inflation next year.” Yeah…The retailers want the kind of inflation that the consumer genuinely wants to step up and pay for. Not the kind that is forced by higher costs in the supply chain. If costs ease in 2H, which they probably will, how can we have any degree of confidence that HBI will actually be able to keep that savings and flow it through as higher margins?
- How does this sound? HBI is shaking out to be a decelerating top line growth model with financial and operational leverage that is about to lap acquisitions, channel restocking, pricing, and now is showing signs of erosion in unit growth in the core business. Next year’s numbers hinge on continued success with pricing at a time when Wal-Mart just cut a major program ‘Just My Size’ in favor of private label…How does that setup sound?
- The fact that Rich Knoll ‘lost it’ in the conference call because people were not giving him and his team credit for putting up solid Gross Margins and focusing too much on elasticity and unit demand did not help one iota. If that’s how he acts when challenged on a conference call, you gotta wonder what it’s like working inside the company as one of his lieutenants.
- This might be petty but it was a bit odd when he quoted JP Morgan’s Jamie Dimon as validation that the operating environment is tough and business should be managed appropriately.
Here are our key modeling assumptions:
Revenues: We’re shaking out at +4% growth in Q4 resulting in revenues just below the lower end of the company’s guidance of $1.2-$1.3Bn with growth of +3.6% and +4.2% in F12 and F13 respectively.
Innerwear: We don’t expect weak unit demand from its department store partners that bought inventory ahead in the 1H to change near-term. In addition, while the company is getting price increases in this segment of roughly 5-8% in aggregate, units remain down just as intimates is experiencing considerable weakness resulting in anemic growth. We expect a slight sequential acceleration as September price increases take hold in addition to modest shelf space gains. While the company suggests that it’s “working with retailers to formulate a plan” as it relates to inventories and pricing, we expect a modest 1% benefit from pricing in 2012 with another 2-3% from space gains.
Outerwear: In looking at Q3 results, which were impacted by a 7point hit from WMT cutting back its Just My Size program while benefitting from a ~20% boost from incremental Gear For Sports revs, core Outerwear was actually down MSD-HSD. With GFS adding another ~6% to top-line in Q4, we are modeling no growth in core outerwear sales. In F12, Q1 will be toughest compare against the first round of pricing driving core sales up 18% in the prior year. The following three quarters we expect modest LSD-MSD growth driven primarily by GFS coupled with modest core growth resulting in a +1.5% increase in F12 revenues.
Hosiery: This segment contracts at a HSD rate perennially. We see no reason for that to change in this environment. Coming off -5% growth in F11, we expect -10% in F12.
International: HBI’s international sales base is similar in size across Canada, Europe, Mexico, Brazil and Japan with China and India much smaller. In Q3, Canada and Europe weakened slowing high double-digit growth in its other markets. With this segment about to face tough compares for the next three quarters, we expect sales to continue to decelerate in Q4 and shake out at +11% in F12.
DTC: Representing less than 10% of total sales, this segment has grown at a LSD rate over the last few years. It should be growing at a rate closer to MSD, which is where we have it next year at +4%.
Gross Margins: The highest cost cotton is about to flow through the P&L for the next three quarters at the same time other commodity costs (primarily oil) have increased as well, which will quickly reverse the benefit HBI realized in Q3. With a continued supply chain benefit of ~90bps and additional albeit more modest pricing to contribute ~700bps partially offset by higher priced cotton (-460bps) and other commodity costs (-300bps), we expect gross margins to be up slightly in Q4 before turning sharply lower in the 1H and continuing through to Q3 before improving in Q4.
SG&A: Incremental GFS costs will be a modest $5mm in Q4. In addition, we expect a slight reduction of core expenses to be offset by international investments of $8-$10mm per quarter resulting in continued expense leverage on SG&A growth of 3% in Q4 and +3% in F12.
EPS: This equates to earnings of $0.45 in Q4; $2.73 in F12 and $3.07 in 13 reflecting earnings growth of +40%, +0%, and +12% in F11, F12, and F13 respectively.
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