“Fear is nothing more than a state of mind.”
Hedge Funds fear being short. Mutual Funds fear missing Santa Claus. Central planners fear-monger.
What is a Global Macro Risk Manager to do?
Last night, while the elephantine academic intellect of Larry Summers was engrossed in The Munk Debates in Toronto (I LIVE tweeted the entire debate from 700-830PM EST), at one point he paused and stated, “in a democracy, fear does the work of reason.”
Fade Larry Summers.
Last week, as the Euro was punching up against my $1.37-1.38 TRADE wall of immediate-term resistance, Goldman’s currency strategist said fear the short squeeze and buy the Euro.
Fade Thomas Stolper.
Last month, after the biggest stock market rally ever in October (ever is a long time), JP Morgan’s Thomas Lee said to stop thinking about everything else and chase beta.
Fade Thomas Lee.
With the US stocks down a full 1% yesterday, they are down for both November and 2011 YTD. Some Santa Claus rally we’re having here in mid-November…
I’m short the SP500 (SPY), long the Long-Bond (TLT), and long the US Dollar (UUP) – and relatively loud about all three of those positions. If you’ve been fading me since October 2007 or April 2011, you still have some Thanksgiving hay to bail (for November 2011 to-date, Hedgeye is 12 for 14 in the Hedgeye Portfolio).
To get back to SP500 breakeven:
- You’ll need to be up +25% (from here) to recapture the -20% from October 2007 watermark
- You’ll need to be up +8.9% (from here) to recapture the -8.2% from April 2007 watermark
Geometric math is hard to fade.
But since the Keynesians continue to attempt to ban gravity, I supposed they could move towards banning math after this morning’s drawdown in Global Equities too. If we’re fundamentally scared out of our bloody minds, there is no telling what central plan is possible.
Back to The Munk Debates - I thought David Rosenberg won last night. For those of you who missed it, the debate was between the teams of David Rosenberg/Paul Krugman and Larry Summers/Ian Bremmer.
What was crystal clear after the opening statements was that Krugman and Summers were actually on the same team. Rosie, The Canadian, was quick to figure that out and proceeded to physically poke his debate partner (Krugman), then proceeded to tell Summers he was “dropping the gloves” … reminding Larry of how bad his economic “forecasts” have been…
Fade Keynesian Economics.
Summers was literally quoting Keynes during the debate as he and Krugman agreed that the only answer to this mess is to do a lot more of what has not worked.
If you’re going to fear anything this morning, fear that.
My immediate-term support and resistance ranges for Gold, Oil, France’s CAC, Germany’s DAX, and the SP500 are now $1, $96.13-99.73, 3031-3179, 5, and 1, respectively. If 1233 in the SP500 holds, I’ll consider covering SPY there.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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We expect a solid Q3 out of FL Thursday. Despite the overhang of NBA related headline risk, the already-anemic basketball category actually improved on the margin, and overall industry sales appear to have accelerated throughout the quarter. The latest NPD data which is a component of our (statistically-valid) comp predictive model, supports our above consensus view.
We’re at $0.46 for FL on a comp assumption of +7.5% for the quarter headed into Thursday’s print, which is ahead of the Street at $0.39 and +5.3% respectively. We’re increasing our comp assumption to +7.5% from +6% based on stronger sales coming through in October. Through the first two months of the quarter, the Athletic Specialty channel was tracking up +3.1% -- well ahead of the total industry -- which had been tracking up +0.8%. With the Athletic Specialty channel tracking ~200-400bps ahead of aggregate weekly numbers we took up our estimates as October came in closer to up +2% as reflecting in the weekly data.
It’s important to note that weekly footwear numbers reflect the broader industry sample and therefore understate the underlying sales performance in the athletic specialty channel that most accurately reflects sales at athletic retailers such as FINL, DKS, HIBB, and FL in particular given its contribution to the sample set. October data out today confirms continued outperformance in the athletic specialty channel, which came in up +4.8% compared to the broader industry up +1.2% right in-line with our expectations.
In light of sales coming in stronger at quarter end, we have increased our GM estimates to 160bps over last year driven by +100bps in occupancy leverage and 60bps from merchandise margin, which may prove conservative as well a 5% increase in SG&A to support more active marketing efforts. This equates to EPS of $0.46 for the quarter up from our previous $0.42 estimate and $1.83 for the year vs. consensus at $0.39 and $1.72.
While we have been incrementally less bullish on the stock up here north of $22 given the near-term headline risk associated with the pending NBA strike, we expect the stock to maintain its underlying momentum when it reports results Thursday. With the stock currently trading at 12.5x and 11x our F11 and F12 EPS estimates respectively and below its historical average of 13x-15x, we would be looking to get more constructive on any weakness.
Conclusion: Price and issuance data out of Latin American credit markets suggest a more negative outlook for regional economic growth than do equity markets. Additionally, this week’s data analysis contains a handful of supportive nuggets for our King Dollar thesis.
Latin American equity markets were mixed last week, closing up +0.6% wk/wk on a median basis. The divergence between the three largest economies was striking: Mexico +2.4%; Brazil and Argentina down -0.2% and -0.4%, respectively. Mexico appears to have benefitted from some better-than-expected U.S. economic data last week.
The action in Latin American currency markets was a bit more muted, closing down only -0.1% wk/wk on a median basis. The Brazilian real outperformed, closing up +0.6% wk/wk.
There were a few notable moves across Latin American sovereign debt markets, headlined by the -26bps wk/wk drawdown in Brazil 2yr yields. Mexico, which got a bid largely due to the aforementioned factors, saw their longer maturities back up +18bps and +23bps on the 10yr and 30yr tenors, respectively. We saw similar divergences across Latin American interest rate swaps markets as well: Brazil -20bps tighter on the 1yr tenor; Colombia +35bps wider on the same maturity.
5yr CDS signaled a fairly dramatic heightening of risk across the region, widening +13% wk/wk on a median percentage basis. Keith has been vocal about the widening divergence between the credit markets and equity markets globally and our research, Virtual Portfolio, and Asset Allocation positioning all suggest we think the credit markets will continue to lead the equity markets down the road to perdition.
THE LEAST YOU NEED TO KNOW
Rather than delineate these data points by country, given the varying size and importance of these economies, we thought we’d try something different by grouping them by theme. Ideally, this should make it easier to absorb and contextualize anything of significance. Lastly, the callouts below are from the prior seven days:
Global Growth Slowing:
- Brazilian retail sales growth slowed in Sept on both a real (+5.3% YoY vs. +6.3% prior) and volume-weighted basis (+4.8% YoY vs. +5.4% prior).
- Even with total credit growth running 330bps higher than the central bank’s upwardly-revised 17% target in the YTD (through Sept), Brazilian policymakers are debating whether or not to remove the restrictions on credit they’ve imposed over the last year, which includes (but not limited to): increases to reserve and capital requirements and doubling a tax on consumer loans. The government may also consider implementing selective tax breaks on a per-industry basis. While a broad-based easing of regulatory policy is likely to be quite supportive for Brazilian economic growth, we think their desperation in the face of heightened inflation and heightening risk of adverse selection in credit extension speaks volumes to how sour the upcoming growth data in Brazil is likely to look. Patience will be key for those considering the long side of Brazilian equities at this juncture.
- Mexican domestic vehicle sales and vehicle production growth both slowed in Oct; the former to +2.2% YoY (vs. +12.2% prior) and the latter to +9% YoY (vs. +14.1% prior).
Deflating the Inflation:
- Brazil CPI slowed in Oct to +7% YoY vs. +7.3% prior – the first of what we expect are many sequential decelerations over the intermediate term.
- Petroleo Brasileiro SA saw its 3Q11 profit fall -26% YoY, as the real’s -17% decline in the quarter (vs. the USD) increased the company’s dollar-denominated debt service costs. Anticipating a breakout to new intermediate-term highs in the US Dollar Index, we remain bearish on emerging market equities due to many factors – not the least of which is the risk that FX translation imposes upon EM corporate earnings.
- Contra-indicator: Demand for Mexico’s shortest term bills (28-day cetes), surged to 4.15x via the bid-to-cover ratio as investors bet increasingly on a peso rally. This was the highest total since July 26 – just prior to the global beta sell-off in late July/early Aug.
- Mexican corporations are selling record amounts of peso bonds in the YTD (176.9 billion pesos), as rising dollar funding costs and global investor risk aversion contributes to a near-closure of Latin American international debt markets. The $9.33 billion in total issuance in the YTD is down -61% YoY. The rising scarcity of dollar-denominated issuance means a decreasing amount of USDs are being converted into EM currencies and an increasing amount of EM currencies being converted into USDs to meet debt service requirements (as opposed to dollar-based refinancing).
- The decline in Argentina’s FX reserves and dollar deposits is accelerating, despite an aggressive sequence of government efforts to stem record capital flight. FX reserves have fallen -2% in the month-to-date to $46.6 billion, which is the largest 2wk drop since Oct ’08. Dollar deposits have declined -5% in the YTD (vs. -0.9% through Oct 28) as the newly-imposed, strict rules preventing easy transfer of money out of the country triggered bank runs – forcing Fernandez & Co. to lower the regulatory dollar reserve requirement ratio to 20% (from 100% prior) to help banks meet rising customer demand for cash. The FX market isn’t buying into the government’s manic efforts to prevent capital flight; 6mo peso non-deliverable forwards closed the week at 5.1150 – a -16.7% discount to last week’s closing spot price!
- Chilean CPI accelerated in Oct to +3.7% YoY (vs. +3.3% prior) – the highest since Apr ’09. No surprise to see this, as the prices of crude oil (Brent) increased +6.6% during the month. Consensus calls for further dollar debasement continue to weigh on international consumers.
- Peru’s central bank, which is struggling with accelerating inflation into year-end as we had predicted, decided to keep rates on hold at 4.25% (rather than join Brazil in cutting).
- Argentina is increasing peak electricity rates by +129% for large commercial users starting next month as a part of the plan to reduce energy subsidies nationwide. We expect to see some of these added operating expenses filter through to Argentinean consumers and slow real GDP growth on the margin – irrespective of the government’s made-up statistics.
- Mexican industrial production growth accelerated in Sept to +3.6% YoY vs. +3.4% prior.
- The Brazilian central bank, which has taken some heat for cutting interest rates in the face of near six-year highs in inflation, has confirmed that it is using a largely unproven economic model to calculate its monetary policy prescriptions. Their new, 18-variable DSGE model post-dates the analytical community’s 7-variable models and grants them a higher level of forecasting confidence in slowing inflation than currently exists in the Brazilian private-sector economist community. While we have been highly critical of Tombini succumbing to political pressure to lower the nation’s debt service burden, we commend him for standing by his evolved process in the face of groupthink and analytical complacency. Moreover, we continue to expect Brazilian inflation to make lower-highs over the intermediate term – putting our forecasts in line with their own.
- Brazil is using to its worker’s compensation fund to buy up a record R$2.8 billion MBS in a plan to support homeownership by helping banks maintain funding for mortgage origination. As we detail in our Brazil Black Book, the country simply does not save enough on an aggregate basis to finance its robust portfolio of growth opportunities with domestic capital – hence the need to import capital from abroad. This makes Brazil especially vulnerable to the global risk appetite and capital markets volatility. To this point, only two Brazilian companies have issued dollar bonds since July 20; corporate and sovereign international debt sales are down -15.9% YoY in the YTD.
- As mentioned before, Mexico’s proximity and leverage to the “safe-haven” that has become the U.S. economy in 2011 is helping it outperform its emerging market peers in the equity markets. Three-month implied volatility for the iShares MSCI Mexico Index Fund dropped to 6.58 points below the iShares MSCI Emerging Markets Index last week – the widest gap since Apr ’09. “Mexico is levered play on the U.S. economy,” remarks David Spegel, head of EM strategy at ING Groep NV.
The JCP print was yet another event boosting our confidence that there is a severe duration mismatch between expectations for most institutional investors vs. Activists, vs. Management. We think that understanding the different durations is especially important with JCP given that it is a reasonably well-hated name (22.4% of the float is short) in retail with management incrementally investing capital into the model to transform the business.
In other words, the Street is beating up the company for doing the right thing. Usually, we love stories like this, as they tend to lead to share gain and margin growth on a disproportionately smaller operating asset base. This was RL, LIZ, NKE, to name a few. And yes, we think that it will ultimately be JCP as well.
But as we’ve been saying since our July 28th Black Book (JCP: What the Ackmanists are Missing), before JCP becomes the best stock in the S&P, it’s likely going to be the worst stock in the S&P. The company is investing today to make changes. But as Johnson openly states, he needs to completely overhaul this company to make it ‘America’s Favorite Place to Shop.’ JCP has bad real estate where it is captive to mall traffic, below-average brands, very little pricing power despite its clout – even at the factory level given its near-vertical positioning, and a competitor in KSS that simply has better stores in just about every way, and as of this year reached 50% overlap with JCP as it relates to footprint (stores within a 5-mile radius).
Unless you are blessed with a mandate to Outperform over a 7-year time period (like Ron Johnson is), the biggest thing to consider with valuation is that it takes a distant back seat to actually understanding what the earnings levers are, and how and when the company gets there.
Let’s look at them over several durations.
TRADE (3-Weeks or less): JCP’s 4Q guidance is absolutely not a slam dunk. With Ullman getting up there and saying that comps will be flat to positive slightly and GM% will be flat to down slightly after six quarters of inventory growing an average of 5% faster than sales – we can’t simply give this company a free pass there. Here’s another consideration, in looking at year/year discretionary spending, over the past six months we’ve had a positive influx of 4-5%spending in non-essential categories on the part of the consumer. For the next five months – barring a collapse in oil or the unemployment rate – we’re looking at -2-3% yy. That’s a -5% sequential turn, and like most retailers, there’s very little chance that JCP can avoid this. We’re still shaking out below $1 in EPS assuming a 2% decline in comp compared to the company’s guidance of $1.05-$1.15 in Q4.
In the end, it’s easy for Ullman to throw out targets to the Street…because he won’t be on the call in January to defend why he missed.
TREND (3-Months or more): Ron Johnson will be coming out of his protective shell in late January at an analyst meeting in New York. That’s where he’ll roll out his strategy for reinventing the company. We can’t imagine that people will walk away uninspired…but we also think that this is the market expectation right now. One thing that RJ cannot do is roll out his plan without telling everyone how much it will cost. That’s when we think there will be sticker shock.
Do we know the dollar amount? No. But in adding up all of what we think is deferred maintenance over time, we can get to a number anywhere between $1-3billion. I realize that’s a range wide enough to drive a truck through. But the reality is that he’s going to pick a number he thinks he needs, and then he’s going to gross it up to a number that he wants. There’s a difference. Again, his $50mm in warrants get him paid based on what happens 7-years out. He’ll has a free pass with the Board to take a whack out of CASH earnings (every $1 billion is $2.50 per share) to get the company to a best-in-class retailer.
Some will argue that people will look through any special charges. We disagree. Remember that Johnson has absolutely no problem disappointing the shorter-term agenda on the Street – as was the case in his early days at Apple – in favor of building long-term value. While we’ll be the first to admit that this is the right thing to do, the reality is that this is a MAJOR execution story, and there will be bumps and bruises along the way. Earnings will matter, and it will be tough to simply ‘look through’ such big items. All honeymoons must end at some point. Eventually, Johnson will not be viewed as ‘the guy from Apple,’ but rather ‘the guy at JCP.’
TAIL (3-Years or less): This is one where the TREND meshes with the TAIL, as the announcements will be near-term, the execution will be intermediate-term, and the results will be long-term. The problem here is that JCP’s definition of long-term is 7-years. Over ‘3-years or less’, which is our long-term duration, JCP is still likely to be in execution mode. It is unlikely too see any of the real benefits of Johnson’s actions until after 2015. In other words, it’s a long time away…