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Eye On The Obvious: Unemployment Is Bad

When jobless claims were released this morning, the typical fire engine chasing futures trader sold the lows to someone who gets it. Having CNBC give you their “up to the second” view on these macro releases has a more obvious implication than the fact that unemployment in this country is bad – they don’t have a real player taking more than “seconds” to take a breath, think, and give you a legitimate synthesis on how this jobless number fits within the game of expectations.

While it’s sad that people manage other people’s money by keying off of TV entertainers, it is what it is … and should be taken advantage of. That’s what real American Capitalists do. This morning’s jobless data was bad – we know this. After a peak to trough decline in the SP500 of -52%, the market knew this was coming too!

On both a one week and 4 week moving average basis (see chart) jobless claims hit new cycle highs. Stock markets are discounting mechanisms of the future, however, not the past. The best question you can ask yourself about this chart is what happens when it hooks down again? This is called mean reversion, and I wouldn’t be surprised to see a weekly number, within the next few weeks, coming in better on the margin.

What happens on the margin is what matters most to our macro models. We are more bullish on US Equities right now, not because the entire free world knows unemployment is bad – but because sentiment in this country is going from toxic to bad – directionally, that’s good.

YUM – Changes to the Growth Matrix in 2009

Over the past three years, YUM has not made any changes to its long-term earnings growth model. On an ongoing basis, the company still expects to generate 10% EPS growth, with China, YRI and the U.S each contributing operating profit growth of 20%, 10% and 5%, respectively. For reference, in the last 3 years, China and YRI have met and/or exceeded these targets while the U.S. has fallen short. The U.S. has not achieved 5% operating profit growth since 2002 and has been negative in four of the last six years. So, needless to say, growth in China and YRI have more than offset the weakness in the U.S. as the company has consistently grown EPS by at least 10% on an annual basis. In 2008, the U.S. accounted for about 40% of segment operating profit while China and YRI combined represented about 60% (YRI 30%, China 30%). YUM maintains that China’s operating profit contribution will continue to grow over time and should account for 40% of total company profit by 2017 (with the U.S. moving to 30%).

This is not new news and is the reason why investors have focused so much on YUM’s growth opportunities in both China and YRI, particularly as the U.S. economy has slowed. YUM’s international growth matrix has provided balance. What is new news is that in 2009, YUM expects China operating profit growth to slow to 15%-20%, YRI to decline 5% on a reported basis (up 10%, excluding foreign currency) and the U.S. to grow 15% (up 5% before expected G&A savings). YUM’s ability to achieve 10% EPS growth in 2009 will rely more heavily on the company’s growth expectations in the U.S. And, based on both the company’s track record of over promising and under delivering in the U.S. (please see post from yesterday) and YUM’s underperformance in the U.S. since 2002, this reliance on the U.S. significantly raises the risk that YUM will fail to meet its expectations.

Management stated a couple of times that its 15% operating profit goal for the U.S. in 2009 does not require heroic results out of KFC as it requires only 4% margin accretion (largely from KFC) or 5% operating profit growth from Taco Bell, Pizza Hut and KFC with the balance of the growth coming from its expected G&A savings. Although Taco Bell and Pizza Hut are expected to meet the company’s 5% operating profit target in 2008, KFC is expected to decline significantly. KFC’s same-store sales declined 4% in 3Q08 so getting to mid-single digit same-store sales growth and 5% operating profit growth in 2009 will require a dramatic turnaround even in light of the easy comparisons. As I have said numerous times before, in today’s difficult operating environment, easy comparisons no longer mean anything. Additionally, the company is still facing commodity headwinds in 2009, particularly in 1H09, which will make it even more challenging to grow margins in the U.S.

Add to the risk associated with growth in the U.S., the fact that YUM does not currently have any plans to buy back stock in 2009 so financial engineering will play less of a role in achieving targeted EPS growth than it has in the past. I cannot argue against wanting more liquidity in today’s environment. I do think management should have come to this conclusion sooner, however, rather than having levered up so significantly in 2008 to buy back nearly $1.7 billion of stock. Management highlighted that it will re-evaluate the credit markets and reconsider buying back stock and/or paying down debt in 2H09 if prudent so there could be some financial engineering to get to that 10% EPS growth after all.

Who Do You Want To Be?

“Those times when I’ve been down, when I’ve been kicked around, I hold onto those. In a way, those are the best times I’ve ever had, because that’s when I’ve found out who I am. And what I want to be.”
-Brett Favre

The most interesting reality associated with Favre’s quote is the context. After being named “Sportsman of the Year”, Sports Illustrated asked him what his favorite memory was, and that was his response…. I have kept this quote taped on the insert of one of my investment notebooks. I always re-read it when I am looking for the strength to take the shot that no one wants to take.

Being a bear for the better part of the last year has had its loneliness. This morning, you could fill a Christmas concert hall with naysayer “strategists” and television entertainers alike who are “bearish.” Taking the shot on the bullish side of China a month ago and taking it here in the USA this morning is all one and the same. It’s the one very few bears want to take. 2008 is over - and I guess they want to ride whatever it is that they are saying now out… There’s one big problem with that. This is a full contact sport, and the game is still on!

You see, the way the Street works is that “strategists” get overpaid to be stagnant. The longer they “stay with the call”, the higher the probability that they don’t ruffle any client feathers… or at least that’s what the leaders of ‘Investment Banking Inc.’ have taught them. Let’s wake up to The New Reality folks. We live in an interconnected world where global market factors interact expeditiously. The facts change daily, and when they do… Brett Favre would probably have my back in suggesting that you better have your head up.

That’s the only way that a 39-year old grey bearded man could still be marching down one of professional life’s toughest fields with a winning record. He’s a 3 time NFL MVP (1) for plenty of reasons, but I think the most relevant one is that it’s because he is a realist. He doesn’t get bogged down by his mistakes. He learns from them, and takes every snap for what it is – a new opportunity to do better.

Every day, I wake up at 4:03AM, and drive to New Haven, CT for one reason – to win. This is where the best team I have ever worked with will have the lights on. This is where the best questions are asked. This is where American Capitalism has re-found its footing.

Winning in the immediate term and the long term are two undeniably different things. And while many investors will tell you that “stylistically” they have different durations in their investment objectives, I won’t. I want to be right every single day. I am not ashamed of that fact. It is what it is. It took me a decade on Wall Street to remind myself of “who I am. And what I want to be.”

This morning, I am waking up to the most invested position I have held in 2008. I have the following Asset Allocation: US Cash 50%, US Equities 15%, Int'l Equities 19%, Commodities 16%. I am not getting invested for any other reason than to be right. Being right on Hong Kong being +41% since October or China +20% since November is not what waking up for this morning’s game was all about. Those are wins. Today is a new opportunity to add to and improve our record with our US stock market and global commodity market “Re-Flation” call.

Central Bankers around the world are going to get us all paid by doing nothing more than what Alan Greenspan did between 2001-2003. They are going to cut interest rates and devalue their currencies in order to re-flate. Taiwan cut interest rates by the most in 26-years last night taking their benchmark rate to 2%. South Korea cut rates by the most EVER, taking rates down by another 100 basis points to 3%. Don’t disregard the context of these coordinated Asian rate cuts – only 6-9 months ago (when I was bearish on Asia), these governments were raising rates!

Greenspan’s ghost has gone global folks. In Switzerland the government has effectively cut rates to zero on a real basis this morning, taking rates to 0.50%; Brazil is floating the trial balloon out to the trading community that they are ready to cut; and our Depressionista dog fighter pilot “Heli-Ben” is preparing to drop FREE moneys from the skies in t-minus a week.

This is why the US Dollar is getting smoked this morning – it is down -2.6% for the week. This is why the CRB Commodities Index is +6.3% for the week to date. This is why Russian, Middle Eastern, and Canadian equities are all rallying. Commodities are the most levered asset class bet on “Re-flation.”

I am less interested in throwing the capital allocation ball to any equity market other than the one receiver that’s wide open and staring me right in the face – she’s American, and no one thinks she can catch it, never mind running it down the field for six points. I understand the bears, because they have become me.

It takes a bear to know one. “Those times when I’ve been down, when I’ve been kicked around, I hold onto those…” I am ready for today’s 930AM game time. Ready… set… hut, hut, hut!  Let’s go get that SP500 target of 931!

Best of luck out there,

Long ETFs

DIA –DIAMONDS Trust Series – Oil is trading up to 45.93 this morning, which benefits key DIA components Chevron (6.36%) and Exxon Mobil (6.32%).

SPY-S&P 500 Depository Receipts – CME futures contracts traded below 886 before rebounding to 899 by 6:55 AM.

XLV Health Care Select Sector SPDR –Fitch Ratings issued a negative outlook for the US Healthcare sector yesterday with a bearish view on  pharmaceutical companies  and for-profit hospital operators and a stable outlook for medical device makers.

GLD -SPDR Gold Shares – Gold traded up to as much as $8.85, or 1.1%, to $819.45 an ounce and traded at $813.23 by 8:58am on the LME.

OIL iPath ETN Crude Oil – NYMEX contracts traded as high as 45.93 this morning on comments by Saudi Arabian Oil Minister Ali al-Naimi on anticipated OPEC production cuts.

EWG – iShares Germany – Germany’s Ifo Institute predicts the German economy will shrink 2.2% in 2009 and continue into 2010. The DAX is trading flat this morning, up 8.52 points, or 0.18%, at 4806.48.

EWH –iShares Hong Kong – The Hang Seng closed flat to 36.16, or 0.23%, at 15,613.90.

FXI –iShares China – The CSI300 closed down 2.39% to 2046.34. Consumer prices rose 2.4% in November from a year earlier, after gaining 4% in October.

Short ETFs

EWU – iShares United Kingdom – The FTSE100 is trading slightly up this morning, 0.57% at 4,393.46. The economy contracted 0.5% in the third quarter and the BOE predicts further contraction next year.

UUP – U.S. Dollar Index –The dollar fell to 1.3158 EUR this morning, the lowest level since October 20, while the pound rose to 1.4966 USD from 1.4785 yesterday.

FXY – CurrencyShares Japanese Yen Trust --The dollar weakened to 92.24 JPY in trading this morning while the Euro rose to 121.02.

EWY- The Bank of Korea Governor Lee Seong Tae and his board reduced the seven-day repurchase rate by one percentage point to 3% in Seoul today, the lowest since the bank began to set a policy rate in 1999.

IFN-India’s wholesale inflation rate fell to a seven-month low, suggesting further central bank rate cuts. Wholesale prices increased 8% in the week of November 29th from a year earlier after gaining 8.4% in the previous week.

GIL: Finally Shows True Colors (Lack Thereof)

GIL is finally being exposed for what it is – a moderate grower with peak margins and increased capital requirements as it grows into weak categories. Yes, it’s down. But $3-$5 is not unreasonable.

The 4Q result speaks for itself. Top line came in below plan, guide down to 7-9% average price declines in 2009, and a 38% hit to current consensus. I’m actually impressed that Gross Margin was down only 15 bps yy, but this erosion will accelerate as the level of pricing needed to sustain margins is simply failing to come through.

One factor that the bulls have latched on to is that GIL has solid pricing power with its network of US distributors – where GIL is the 900lb gorilla. But no one is considering that many of these little business are simply that – little. They are cash strapped, and some are levered and need credit. In a perverse way, my sense has been that in this environment where pricing power matters, GIL is actually losing relevance.

So now what? This company is not going away. But it also has no ’birthright’ to grow in the new competitive landscape. New guidance of $1.10-$1.30 looks reasonable. But the reality is that this is a basic underwear company with peak margins and an asset-intensive vertically-operated infrastructure. Someone ask Warren Buffet what these assets trade for. The historical bid is 3-5x EBITDA. That suggests a $3-$5 stock.

Let’s see what management says on the call. It’s tough to dig out of this hole…


Some of my colleagues are starting to get more bulled-up in their respective spaces. I really want to be part of that club, but the facts won’t let me get there as it relates to the apparel/footwear retail supply chain. The industry needs to understand where it is in its cycle, and the winners need to step up, use their liquidity, and put the competition down for the count.

1. Softline expectations for '09 have been getting better. But down 50bps still is not enough, and such a meaningful sequential uptick is not realistic unless savings rate stays at zero and better gas prices are all spent on discretionary (AND the dollar does not appreciate, AND Obama does not take rates higher).

2. I really like the cheap 5.2x cash flow multiple. But it is simply not real.

3. The industry is coming off of 6 quarters of down margins. But we have not seen the mass capitulation into the clean-up zone in our SIGMA chart yet (see definition below). Until then, there's no reason for me to believe that this group won't trade at 5x EBITDA (or 4x, or whatever) for a while.

4. The key, and obvious, strategy is to find the names where next year's numbers are real. This is Under Armour, Lululemon, Columbia, Hibbett, Bed Bath and Beyond, and Ralph Lauren. On the flip side, beware of Gildan, Philips-Van Heusen, Skechers, and VF Corp.

First off, SIGMA stands for Sales, Inventory, Gross Margin Analysis. As noisy as this chart might appear, it has everything you need in order to track the quarterly progression of how a company’s (or industry’s in this case) P&L synchs with its balance sheet. It’s part financial, part behavioral, in that you can see how a management team pulls one lever of the model when presented with challenges or opportunities elsewhere.

Here’s how to read…
1. The vertical axis is the spread between sales growth and inventory growth. The higher up, the better (and the cleaner the balance sheet of excess product).

2. Horizontal axis is yy chg in EBIT margin. Obviously, you want to be to the right side of the chart.

3. The yellow line synchs points 1 and 2, and shows you the path over the past 6 quarters.

4. Columns represent change in GM% and SG&A% over 6 quarters. Very important to see if a change in aggregate margin is driven by one vs another.

5. Lastly, the grey line is capex as a percent of sales. That shows where the industry is in its capex cycle.

The punchline with this industry, is that it had four quarters (all of ’07) where inventories and margins fell. In almost every instance, the next move would be to the upper left quadrant – where the balance sheet capitulates – even if at the expense of margins. We have not seen that yet. If there is any saving grace in ’09 it is that SG&A compares get easy, and capex is coming down. I think many companies need this to prevent from going away. Others with dominant brands and ample liquidity should be doing the exact opposite – accelerating investment spending to literally crush their competition. I’m not seeing enough of this yet.

When Biz Stinks, Stick With The Winners

Sports apparel sales trends are starting to bug me. Retailers are being very careful about which brands they reorder. They’ll stick with the winners, and so should you.

Sports apparel sales trends are starting to bug me. There’s noise around this week’s SportscanINFO numbers due to the timing of Thanksgiving, but looking at the 3-week trend (what we do anyway) suggests flattish industry wide sales. Not a disaster by any means relative to other parts of retail. But the fact that the trajectory in average price point is dropping like a stone is not comforting. Promotions are happening early, though the silver lining is that they’re working – and that unit sales are climbing at about the rate of price point declines.

Bottom line. Stick with the market share winners, and companies that are growing outside of this core sports apparel category. Under Armour’s trends remain fine in apparel. Still gaining share in its core training business (48% of total), and recent Compression category share trend has rebounded (and remains at 70% of the category). Also, expect to see running and basketball apparel step up in ’09 in conjunction with UA’s ‘year of footwear’ (when it gets into running and basketball footwear). These are two categories where I think that UA can realistically add $500mm in revenue on top of its $750mm base over 3 years while maintaining a 10-11% EBIT margin. Tough to find a 20%+ grower in any industry these days.

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