“Nothing stands out so conspicuously, or remains so firmly fixed in the memory, as something you have blundered.”
-Marcus Tullius Cicero
I didn’t have a chance to watch the Republican Debate last night, but woke up to an email from a Republican operative contact intimating that Gingrich will benefit from Perry leaving the race. This particular contact has been a vociferous supporter of Perry, so I was surprised by his comment. After reviewing the transcript and key highlights this morning, I understand his point quite clearly.
In an exchange in which he was asked which three federal agencies he would do away with, Perry confidently indicated that he would do away with the Department of Education, the Department of Commerce, and a third one which he couldn’t remember. In the first attempt at trying to remember the third agency, he simply ended with “oops”. In the second attempt, he ended with this statement:
“I would do away with Education, the – Commerce and, let’s see, I can’t. The third one, I can’t”
To Cicero’s point in the quote above, Perry will certainly remember his blunder, even as he couldn’t remember the three agencies.
Normally, one bad exchange in a debate wouldn’t ring the death knoll for a candidate’s campaign. In the case of Perry, his campaign was already on life support. As we highlight in the Chart of the Day, the InTrade contract for his gaining the Republican nomination is now at 4.1%. Not only is this the worst rating since he fully launched his campaign, but Perry is now trailing the embattled Herman Cain who is at 5.6%.
In general, last night’s debate likely will not alter the overall makeup of the race for the Republican nomination. This is still Romney’s race to lose, and in a big way. On InTrade, Romney is at 71%, while his second closest rival, Newt Gingrich, is at 9.1%. In head-to-head polls amongst all the leading Republican candidates, Cain has led in some recent polls, but in aggregate since early October, Romney has either been first or second in every poll. Finally, Romney has the money and team to stay deep in the war of attrition that is the Republican primary season.
Assuming Romney does get the nomination, the question is whether he can beat President Obama in a head-to-head matchup. So far, at least, the numbers suggest that Romney will be the underdog in that matchup. Currently, according to the Real Clear Politics poll aggregate, Obama, on average, beats Romney by +1.7 points. To be sure, this is within the margin of error, though much closer than one would expect given Obama has an approval rating in the mid-40s and unemployment has a 9-handle. Ultimately, as usual, turnout and motivation will be key and if the midterms were any indication, Republican turnout could be huge.
Flipping back to the market, undoubtedly yesterday was a day most investing minds would prefer to forget. The SP500 was down -3.7% yesterday. In particular, breadth was notably negative with one stock up on the day. That stock was Bed, Bath and Beyond and the catalyst was a positive call from Cleveland Research. If Cleveland Research is moving a stock, this is probably a decent flag for another important risk factor: light volume. No surprise, to Hedgeye at least, financials were the weakest sector with the XLF down -5.4% on the day.
Coincidentally, or not, our Financials Sector Head Josh Steiner held a call with Peter Atwater (former Treasurer of Bank One) yesterday to discuss the key new risks for financials. Both Steiner and this industry veteran continue to believe that investors are underestimating the long term risks to financials, with Jeffries and MF Global potentially being canaries in the coal mine related to bank hedging. If you’d like access to our Financials sector and a replay of the call, email email@example.com.
In Europe, the news and data flow appears to be going from bad to worse. Front and center is the Italian bond market. Italy sold €5 billion of 12-month bills this morning with average yield of 6.087%. This compares to Italy’s last auction October when it sold the same duration of bills at 3.57%. Further, Italian 10-year yields remain above the 7% line. The Italian Senate is purportedly “rushing” to pass austerity measures with a vote tomorrow. The likely outcome of incremental Italian action is accelerating stagflation in Europe.
On the last point, the EU lowered its Euro-region growth forecast due to the worsening debt crisis from +1.8% growth in 2012 to 0.5% growth. Our view continues to be that European growth will likely be negative as inflation begins to accelerate alongside the eventual hum of the ECB printing presses. Our view of Europe underscores one of our top macro ideas heading into 2012, which is to be long the U.S. dollar.
We will be holding our annual best ideas call tomorrow at 11am eastern. This call will represents the best ideas, both long and short, across all seven of our coverage sectors. We will be circulating all the materials to institutional subscribers later today. For those that aren’t current Hedgeye institutional subscribers, please email for details around gaining access to the call.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
TODAY’S S&P 500 SET-UP - November 10, 2011
As we look at today’s set up for the S&P 500, the range is 31 points or -0.66% downside to 1221 and 1.86% upside to 1252.
SECTOR AND GLOBAL PERFORMANCE
If you were long King Dollar, Long-term Treasuries, and Growth Slowing yesterday, you enjoyed your day – always a bull market somewhere!
- ADVANCE/DECLINE LINE: -2517 (+1459)
- VOLUME: NYSE 1112.51 (+26.47%)
- VIX: +36.16 +8.48 YTD PERFORMANCE: +103.72%
- SPX PUT/CALL RATIO: 2.18 from 1.98 (10.1%)
CREDIT/ECONOMIC MARKET LOOK:
- TED SPREAD: 44.41
- 3-MONTH T-BILL YIELD: 0.01%
- 10-Year: 2.04 from 1.96
- YIELD CURVE: 1.81 from 1.73
MACRO DATA POINTS (Bloomberg Estimates):
- 8:30am: Import Price Index; M/m est. 0.0% (prior 0.3%)
- 8:30am: Trade balance; est. -$46.0b (prior -$45.6b)
- 8:30am: Jobless claims; est. 400k, prior 397k
- 9am: Fed’s Lockhart speaks in Washington
- 9:45am: Bloomberg consumer comfort; est. -51.0, prior -53.2
- 10:30am: EIA natural gas storage
- 10:40am: Fed’s Evans welcome remarks at Chicago banking conference
- Noon: Fed’s Bernanke speaks to soldiers in El Paso, Texas
- 1pm: ECB’s Praet Speaks in Chicago
- 1pm: U.S. to sell $16b in 30-yr bonds
- 2pm: Monthly budget statement, est. -102.5b, est. $140.4
WHAT TO WATCH:
- Svenska Cellulosa agrees to buy Georgia-Pacific’s European tissue ops for $1.8b.
- U.S. trade deficit probably little changed at $46b, economists est.
- Greek President Papoulias calls meeting with political party leaders for today:
- U.S. foreclosure filings rose 7% in October to a seven-month high
- Cisco rating boosted by Deutsche after 1Q EPS, rev. beat est.
- Deutsche Telekom 3Q Ebitda beat est.
- Credit Agricole profit trails est. after EU905m Greek writedown
- The European Commission slashed its euro-region growth forecast for next year by more than half
- WhaleShark, which distributes online discounts, said to gain funding that values it at as much as $1b
- PC shipments may fall as much as 3.4% in 4Q following floding in Thailand, IDC says
- Mitsubishi agreed to pay $5.39b for Anglo American’s Chilean copper unit
- U.S. Bancorp sued by an Oklahoma police pension fund over mortgage bonds allegations.
- Italy sells 1-yr bill as 6.087%, most since Sept. 1997
- Copper Drops to Two-Week Low as EU Cuts Euro Growth Forecast
- Gold Falls for Second Day in New York After Gain in Dollar Value
- Oil Rises Near Three-Month High on Europe Sentiment, U.S. Supply
- Solar Glut Worsens as Supply Surge Cuts Prices 93%: Commodities
- Most Refinery Cuts Since ’80s Can’t Help Profits: Energy Markets
- Noble Falls Most Since 1998, Bond Risk Doubles as CEO Quits
- IEA Cuts Oil Demand Forecast a Third Month on Weaker U.S., Japan
- Gold ETF Calls Surging Most Since U.S. Stripped of AAA: Options
- Palm Oil Jumps to 3-Month High as Stockpiles Decline in Malaysia
- Transocean Risks Junk Grade as Cash Flow Ebbs: Corporate Finance
- Soybeans, Grains Decline on Concern Euro Crisis May Slow Demand
- Gold Exchange-Traded Products Attracted $2 Billion in October
- Indonesian Tin Shipments Gain for First Time in Four Months
- Copper Declines to Two Week-Low on Europe
- Brent Oil to Drop After Failing at $116 Peak: Technical Analysis
- Asia Naphtha Crack Drops; Hin Leong Buys Fuel Oil: Oil Products
EURO – when our only line of remaining support (TRADE line support of $1.37) snapped yesterday, oh did they snap! Not only is this risk cleanly defined by The Correlation Risk, but a flailing currency perpetuates economic stagflation. European Stagflation is not consensus, yet – but it will be as long as Growth goes negative y/y and these inflation readings continue to accel sequentially.
ASIA – Growth Slowing continues to be the #1 factor that US centric investors (and European gawkers) have missed all year and will continue to miss if they don’t start modeling the day-to-day risk in both the Asian high-frequency economic data and what it’s embedding itself into Asian stocks/bonds/FX prices. Hang Seng down -5.3% last night and down -21.9% since April (crashing)
The Hedgeye Macro Team
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What’s not to like? But they’re raising the bar, and probably won’t get paid for it.
We have a very mixed read on this KSS quarter. On one hand, it was the mother of all in-line performances – something we’ve grown to know and love (and expect) out of this company. Sales were already a known entity and margins came in virtually in-line. The inventory spread improved year/year and sequentially, making KSS one of the few retailers to post this trend. In effect, it was the opposite of what we saw from Macy’s. That’s notable given that KSS represents roughly 8% of the softlines industry in aggregate – the more sane the industry is on inventories – especially in the mid-tier -- the better. KSS showed yet again, why it sets so many benchmarks for the rest of the industry.
But we’re a bit perplexed on guidance. This is a complete and total nit-pick, but why take up 4Q at a time when yy compares are getting tough? With so much uncertainty coming down the pike, why not keep the year even instead of stepping up the Street’s expectations by 5% when we’re already looking at 18 Buys, 6 Holds, and only 1 Sell? Buy-side sentiment is slightly less positive, with 6% of the float short – on the higher side for KSS. But blended together in our Sentiment Indicator, people are still bulled-up on this name. (see chart below).
We have no reason to doubt that the KSS will hit numbers in 4Q. There are a lot of factors at play, and it’s way too early to tell. But the ante chip just went up a notch and now KSS HAS TO hit estimates.
More after the call.
This note was originally published at 8am on November 07, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“Choose a job you love, and you will never have to work a day in your life.”
On this day in 2007, my first son Jack was born. Less than a week prior to that, on November 2nd, 2007, I was fired. Having recently achieved my highest ranking “title” in the vaunted hedge fund universe, this was a rather abrupt end to what was only a 10 month old affair at Carlyle’s new hedge fund.
All that ends abruptly creates opportunities for new beginnings. I’d never been cut from a team or fired by a firm before (unless I fire myself, hopefully that doesn’t happen again!). However, I firmly believe that men and women have to be able to “fail” in order to ultimately succeed. It’s the only way to learn how to rethink and rework what it is that we are here to do. Evolve.
Thank you to Laura, my family, and firm for giving me such a tremendous opportunity to help create Hedgeye. I am Loving Life.
Back to the Global Macro Grind…
With all of the October 2011 fanfare associated with the only good month stocks and commodities have had since April, last week was a reminder of what intermediate to long-term equity investors should recognize as bearish. Welcome to November.
If you’ve taken the lessons of the October 2007 US stock market top and embraced it as an opportunity to change your process to one that’s more diversified and Global Macro in scope, last week was a very good one for you. Both the US Dollar and US Treasuries outperformed, big time.
On the week, with the US Dollar Index realizing an impressive +2.5% week-over-week return, here’s how everything that’s inversely correlated to the USD moved:
- US Stocks (SP500) = down -2.5%
- Asian Stocks (MSCI Index) = down -3.6%
- Latin American Stocks (MSCI Index) = down -3.3%
- Euro/USD = down -2.1%
- Canadian Dollar (CAD/USD) = down -2.0%
- CRB Commodities Index = down -0.9%
- WTIC Oil = up +0.9%
- Gold = up +0.5%
- Copper = down -3.8%
- 10-yr US Treasury Yields = down -12.5%
Interestingly, with both Oil and Gold maintaining 0.7-0.9 inverse correlations to the US Dollar, they diverged versus just about everything else in our Global Macro Correlation model. The intermediate-term TREND between Oil and the US Dollar since May remains intact, however, with the USD Index up +5.4% and Oil down -8.7%, since.
Positively correlated with the US Dollar Index (this is the good news, if you’ve been long them since May) are:
- Long-term Treasury Bonds (TLT)
- US Treasury Flattener (FLAT)
- Corporate Bonds (LQD)
Oh, and Volatility (VIX)…
Volatility was up +23% last week alone and is up +101% since The Bernank offered us his first global press conference on what he calls “full employment and price stability” (end of April 2011).
With the so called “catalyst” of the G20 meetings gone, and another terrible 2011 US employment report behind us, “the gales of November came early.”
That line, as many locals from Thunder Bay, Ontario would recognize, comes from one of our local risk management ballads called The Wreck of the Edmund Fitzgerald:
“The legend lives on from the Chipewa on down
Of the big lake they called ‘Gitche Gumee’
The lake it is said, never gives up her dead
When the skies of November turn gloomy”
And since today is just another day for Risk Managers who have proactively prepared for the Growth Slowing storm of 2011, I’ll just end this morning’s missive here. Given the number of rants you’ve all put up with in the last 4 years of my writing these notes, I owe you all some brevity.
My immediate-term support and resistance ranges for Gold (bullish TRADE, TREND, and TAIL), Oil (bearish TAIL, bullish TRADE), German DAX (bearish TRADE, TREND, and TAIL), and the SP500 (bullish TREND; bearish TAIL) are now $1732-1778, $92.97-93.88, 5711-6068, and 1210-1267, respectively.
Happy Birthday Jack and best of luck out there today,
Keith R. McCullough
Chief Executive Officer
It wouldn’t be a LIZ call without plenty of puts and takes, but the bottom-line is that our thesis remains unchanged on the name. At this point, it’s all about execution. That will ultimately determine whether this is a $10, or closer to $20 stock 12-18 months from now. Either way, we think LIZ is headed higher.
Generally speaking we got the added color we were looking for on the conference call regarding several items that we called out earlier – we’ll hit on that in a minute. Our overall take on the quarter is that sales and segment margins are coming in better with more wood to chop on corporate overhead than expected. Coupled with uncertainty regarding the timing of debt reduction, we expect this process to be choppy near-term, but think the visibility of F12 and F13 EBITDA remains greatly improved and highly attractive on an annual basis.
We’re taking up our top line growth forecast by 2% to 14.5%, though we’re also taking up costs needed to secure the growth. Netting those two out, our numbers are down modestly (to EPS of $0.36 and $0.73 and $155mm and $215mm in EBITDA for this year and next year, respectively). We NEVER like a downward revision – but in a market like this where investors are paying up for stories that have rapid underlying growth with strong visibility, we’re going to give LIZ a bit of a pass. That’s especially when our estimates remain 2x consensus in the outer years.
Here are the key highlights from the quarter:
- Direct Brands: Kate and Lucky continue to press forward with both Q3 and October sales coming in strong. In fact, management got incrementally more bullish on both increasing the long-term outlook for Kate margins to high-teens to low-twenties (from 15%-20%) and margins at Lucky noting they expect to turn profitable for the year in Q4. In addition, the company is accelerating store growth at Kate by another 10%-20% to 20-25 in 2012. Given that Kate accounts for over 50% of EBIT this is exactly where you want to see incremental investment. Juicy came in a little lighter than expected in October. Since we aren’t expecting any real turn in sales until the 1H of next year when new product hits shelves – we’re not overly concerned.
- Partnered Brands: With assets sold rolling off and the DKNY license expiring at year-end, this segment is quickly consolidating to a base of ~$20mm in revs per quarter. It will be closer to $60mm in Q4 for the aforementioned factors, but the margin profile is coming in better than expected. Instead of the 10-12% margins we were modeling, on a go forward basis this business is going to have a margin profile in the mid-teens.
- Corporate Expenses: This was an incremental negative in the quarter. As it turns out, the corporate expense line is currently $70-$75mm, which the company intends to work down to $40-$50mm over time – more than we expected. By the end of F12, the company expects to have corporate overhead down to $55-$60mm with ~$15mm earmarked for next year. Roughly $10mm is associated with Mexx, which we expect to be cut on the front end resulting in corporate expenses of ~$60mm for F12.
- CapEx: Given the consolidation in sales, we expected CapEx to come in around $50-$60mm in F12 following ~$60-$65mm of CapEx in F11. Instead, the company is taking CapEx up to $70-$75mm next year to drive store growth as well as e-commerce and IT systems. At ~4.5%-5% of sales, this would represent the highest level of capital spending in company history. While a slight negative for F12 FCF, this has positive implications for revenue growth 2-3 years out.
- Debt Reduction: There is still uncertainty regarding the exact timing of when the company is going to settle either the Eurobond or convert. As such, we expect continued earnings volatility near-term until the Eurobond is settled, which is still the company’s first priority.
- Net Operating Losses: The updated loss carry forwards the company will have on its books by year-end is $200-$250mm, which LIZ can use as a tax shield for next few years.
All in, we’re adjusting our numbers to reflect higher sales growth of 15% in each of the next two years while also accounting for higher corporate expense. As a result, we’re reducing our EPS estimates by ~$0.10 to $0.36 and $0.73 in F12 and F13 respectively and EBITDA by ~$15mm to $155mm in F12 and $10mm to $215mm in F13. Using a blended 8x multiple, we’re still looking at a mid-teens stock. At this point, it’s all about execution. That will ultimately determine whether this is a $10, or closer to $20 stock 12-18 months from now. This remains at the top of our long list.
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