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PSS: Domestic Drag Improves

"We've had limited blunt tools to work with…" – Michael Massey, CEO

 

It’s rare that we start off a note with a quote, but this one sums up PSS’ positioning over the 2H of 2011 pretty well. Despite this unfortunate circumstance, Q4 results suggest there are indeed signs of operational improvement underway – even if that improvement is simply getting rid of excess baggage of money-losing stores.  The offset is that while PLG blew out its revenue line, backlog slowed sharply.

 

The real question is whether these two changes on the margin are enough to impact the break-up of the company (90% of the reason why people own this thing).

 

We think it’s net neutral to positive.

  1. PLG: The key callout at PLG was the deceleration in Q1 PLG backlog up only +1% and down sharply from +17% in Q4. It’s worth noting a few items that are contributing to the decrease including 1) faster lead times so customers can order closer to need, 2) greater mix of auto-replenishment, 3) lower off-price and mid-tier bookings, and lastly 4) weather. It’s also important to recall that PLG production capacity was more constrained last year requiring a greater portion of backlog orders to secure the timing of orders, which is no longer the case. All in, it’s easy for the company to simply place blame here – as many companies do when orders slow or inventories build. They’ll need to explain this in far greater detail for someone buying the company outright. But enough of the factors at play pass the smell test for us initially.
  2. Payless Domestic: The simple fact that store count was down by 310 sequentially – or 6.5% -- at the same time we saw comps accelerate by 400bp sequentially (on a 1, 2 or 3-year basis) is proof positive for us that there’s value in the core. Check out our past research on store closure sensitivity. We’re gaining comfort with this part of the equation. We like the fact that we’re seeing some numbers work while the bankers are negotiating through the press for the highest bid. 

As we look out to 2012, we made a few adjustments to our model including a 1pt increase in comp to +3% with Q4 results turning positive, offset in part by a reduction in PLG wholesale growth to +11.5% from +12% reflecting weaker Q1 backlog trends. Offsetting these drivers is ~$120mm in lost revenue from underperforming store closures in F12, which we had previously modeled. The net result is a modest increase in our revenue growth estimate for next year to +1.6%.

 

We have gross margins expanding 106bps driven by fewer markdowns and easing product cost headwinds as well as modest SG&A leverage -30bps. The biggest delta is a lower tax rate (not exactly a high quality adjustment) accounting for the majority of the $0.10 increase to our F12 EPS estimate to $1.07 and $1.54 for F13.

 

 

PSS: Domestic Drag Improves - PSS S


THE M3: SANDS IMPORTED WORKERS QUOTA; MANILA BAY

The Macau Metro Monitor, February 29, 2012

 

 

SANDS GETS APPROVAL FOR IMPORTED WORKERS Macau Business

Sands China has been granted 2,500 new quotas to import workers.  In order to take advantage of the additional foreign labor quota, Sands also needs to hire 3,100 new local workers until March 31.  The Human Resources Office says the grant was valid between August last year and February 2012 to fill jobs at both the Venetian and Sands Cotai Central when it opens, according to media reports.

 

The Office has not said how many workers Sands has hired already, however, Sands CEO Edward Tracy says that the gaming operator expects to hire as many as 500 local workers after the mass recruitment fair held on Sunday and Monday.

 

MANILA BAY NOT ON VENETIAN'S PLANS Macau Daily Times

The Venetian has “no intention in investing in a project in Manila,” said Edward Tracy, CEO of Sands China. told Macau Daily Times, “after having spoken with Mike Leven” about the matter.  According to official sources, Manila Bay “does not fit the company investment profile”.

 

Sheraton Macao Hotel, Cotai Central is due to open September 12.  The facilities will include nine major meeting rooms, one grand ballroom, and 39 breakout rooms. The 3,863-room hotel is set to be “the premier meeting destination in the Asia Pacific."



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Demographic Reckoning

“Demography is destiny.”

-Auguste Comte

 

This Friday we are hosting a conference call for our macro subscribers on Japan titled, “Japan’s Debt, Deficit and Demographic Reckoning”.  (If you aren’t a macro subscriber and want to get access to the presentation, email  for subscription details.)  During the presentation, we will spend a fair amount of time framing up the economic history of Japan starting with the American occupation post World War II.  When contemplating economic history, I’m often reminded of George Santayana’s quote:

 

“Those who cannot learn from history are doomed to repeat it.”


Certainly, history provides a critical frame of reference for Japan.  In particular, the last twenty years of economic history in Japan, which witnessed a massive build up in Japanese sovereign debt (currently 220% debt to EBITDA) and stagnating economic growth (just +8.5% nominal growth over the last 20 years), have set the table for Japan’s future.  But as my colleagues (hat tip to Darius Dale and Josefine Allain) and I have been grinding through this 80+ page presentation, the idea that Demography is Destiny truly represents the next chapter for Japan.

 

Currently, according to estimates from the CIA fact book, 23% of the Japanese population is over 65 years old.  This compares to only 13% in the United States and approximately 8% for the rest of the world.  As one of the world’s oldest countries, the burdens of supporting this aging population are seen directly in the Japanese federal budget.  In the 2012 Japanese federal budget, social security spending will be just over 29% of the entire budget.  This compares to 17% of the federal budget in 1990.

 

Due to a low fertility rate, the Japanese death rate currently exceeds the Japanese birth rate.  In the absence of meaningful immigration, this implies that the Japanese population is in decline.  As I outline in the Chart of the Day, based on the Japanese government’s own projections, their population will decline by more than 25% by 2050.  In conjunction with said declines, the Japanese population is aging and by 2050 more than 40% of the population will be over 65. (And to think at 38 I thought I was getting old!) The demographic future of Japan will only accelerate social security entitlement spending. 

 

The other concern with an aging population is growth.  Robert Arnot and Denis Chaves recently wrote a paper for the Financial Analysts Journal called, “Demographic Changes, Financial Markets, and the Economy”, in which they attempt to quantify the relationship between demographics, growth and capital market returns based on 60 years of data.  They conclude that:

 

“ . . . senior citizens contribute to neither GDP growth nor stock and bond market returns; they divest to buy goods that they no longer produce.”


Based on their projections, the aging population will negatively impact Japanese growth over the next decade by ~-5% in aggregate. 

 

In theory an aging Japanese population, even if a major headwind for growth, could be overcome by the appropriate mechanisms and policy.  Unfortunately, after more than twenty years of deficit spending, Japan’s proverbial hands are increasingly tied by debt.  Specifically, Japan has massive non-negotiable financial burdens due to the second largest component in the proposed 2012 Japanese budget being debt service.

 

Servicing and interest on sovereign debt outstanding are projected to total 24% of Japan’s federal budget in 2012.  This line item has almost doubled since fiscal 1980, when it was at 13%.  I may not have a PHD in economics, but even I can tell you that if 1/4thof the Japanese federal budget is going towards debt service that spending is not generating an incremental return, either in the way of GDP growth or a higher standard of living, for Japanese society.

 

In a scenario analysis, we used a more normalized interest rate of 5.5%, which last occurred back in 1995, and applied that interest rate to the current debt servicing burden.  At this interest rate level, the Japanese debt servicing burden would be 100% of the current federal budget.  Clearly, increasing interest rates would squeeze out the government’s ability to more proactively invest in the nation and/or support rising social security expenditures.

 

To be sure, we are not projecting an imminent Japanese default, but in the short term with Japanese maturities accelerating in 2012, and specifically in March, there is increased concern as to Japan’s creditworthiness.  Based on the scenario I described above, the longer term question is whether Japan will be able to fund its future.  For the last twenty years, this funding has been enabled by a combination of high savings rates (both corporate and individual) and a current account surplus. Currently, we are seeing negative inflection points in both areas.

 

Ultimately, as Shakespeare wrote, “What is past is prologue”, and as it relates to Japan the past is indeed written.  Increasingly, Japan’s future is also already largely written by her Demographic Destiny.

 

Our immediate-term support and resistance ranges for Gold, Oil (Brent), USD/JPY, and the SP500 are $1, $122.01-126.19, $79.71-80.98, and 1, respectively.

 

Keep your head up and your aging stick on the ice,

 

Daryl G. Jones

Director of Research

 

Demographic Reckoning - Chart of the Day

 

Demographic Reckoning - Virtual Portfolio


Demographic Reckoning

“Demography is destiny.”

-Auguste Comte

 

This Friday we are hosting a conference call for our macro subscribers on Japan titled, “Japan’s Debt, Deficit and Demographic Reckoning”.  (If you aren’t a macro subscriber and want to get access to the presentation, email  for subscription details.)  During the presentation, we will spend a fair amount of time framing up the economic history of Japan starting with the American occupation post World War II.  When contemplating economic history, I’m often reminded of George Santayana’s quote:

 

“Those who cannot learn from history are doomed to repeat it.”


Certainly, history provides a critical frame of reference for Japan.  In particular, the last twenty years of economic history in Japan, which witnessed a massive build up in Japanese sovereign debt (currently 220% debt to EBITDA) and stagnating economic growth (just +8.5% nominal growth over the last 20 years), have set the table for Japan’s future.  But as my colleagues (hat tip to Darius Dale and Josefine Allain) and I have been grinding through this 80+ page presentation, the idea that Demography is Destiny truly represents the next chapter for Japan.

 

Currently, according to estimates from the CIA fact book, 23% of the Japanese population is over 65 years old.  This compares to only 13% in the United States and approximately 8% for the rest of the world.  As one of the world’s oldest countries, the burdens of supporting this aging population are seen directly in the Japanese federal budget.  In the 2012 Japanese federal budget, social security spending will be just over 29% of the entire budget.  This compares to 17% of the federal budget in 1990.

 

Due to a low fertility rate, the Japanese death rate currently exceeds the Japanese birth rate.  In the absence of meaningful immigration, this implies that the Japanese population is in decline.  As I outline in the Chart of the Day, based on the Japanese government’s own projections, their population will decline by more than 25% by 2050.  In conjunction with said declines, the Japanese population is aging and by 2050 more than 40% of the population will be over 65. (And to think at 38 I thought I was getting old!) The demographic future of Japan will only accelerate social security entitlement spending. 

 

The other concern with an aging population is growth.  Robert Arnot and Denis Chaves recently wrote a paper for the Financial Analysts Journal called, “Demographic Changes, Financial Markets, and the Economy”, in which they attempt to quantify the relationship between demographics, growth and capital market returns based on 60 years of data.  They conclude that:

 

“ . . . senior citizens contribute to neither GDP growth nor stock and bond market returns; they divest to buy goods that they no longer produce.”


Based on their projections, the aging population will negatively impact Japanese growth over the next decade by ~-5% in aggregate. 

 

In theory an aging Japanese population, even if a major headwind for growth, could be overcome by the appropriate mechanisms and policy.  Unfortunately, after more than twenty years of deficit spending, Japan’s proverbial hands are increasingly tied by debt.  Specifically, Japan has massive non-negotiable financial burdens due to the second largest component in the proposed 2012 Japanese budget being debt service.

 

Servicing and interest on sovereign debt outstanding are projected to total 24% of Japan’s federal budget in 2012.  This line item has almost doubled since fiscal 1980, when it was at 13%.  I may not have a PHD in economics, but even I can tell you that if 1/4thof the Japanese federal budget is going towards debt service that spending is not generating an incremental return, either in the way of GDP growth or a higher standard of living, for Japanese society.

 

In a scenario analysis, we used a more normalized interest rate of 5.5%, which last occurred back in 1995, and applied that interest rate to the current debt servicing burden.  At this interest rate level, the Japanese debt servicing burden would be 100% of the current federal budget.  Clearly, increasing interest rates would squeeze out the government’s ability to more proactively invest in the nation and/or support rising social security expenditures.

 

To be sure, we are not projecting an imminent Japanese default, but in the short term with Japanese maturities accelerating in 2012, and specifically in March, there is increased concern as to Japan’s creditworthiness.  Based on the scenario I described above, the longer term question is whether Japan will be able to fund its future.  For the last twenty years, this funding has been enabled by a combination of high savings rates (both corporate and individual) and a current account surplus. Currently, we are seeing negative inflection points in both areas.

 

Ultimately, as Shakespeare wrote, “What is past is prologue”, and as it relates to Japan the past is indeed written.  Increasingly, Japan’s future is also already largely written by her Demographic Destiny.

 

Our immediate-term support and resistance ranges for Gold, Oil (Brent), USD/JPY, and the SP500 are $1, $122.01-126.19, $79.71-80.98, and 1, respectively.

 

Keep your head up and your aging stick on the ice,

 

Daryl G. Jones

Director of Research

 

Demographic Reckoning - Chart of the Day

 

Demographic Reckoning - Virtual Portfolio


Wobbly Understanding

This note was originally published at 8am on February 15, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Even sophisticated researchers have poor intuitions and a wobbly understanding of sampling effects.”

-Daniel Kahneman

 

That quote comes from Chapter 10 of “Thinking, Fast and Slow” where Kahneman discusses both the Law of Small Numbers and what he calls a Bias of Confidence Over Doubt. After a day like yesterday, I had to re-read that.

 

Reading and re-reading my notes is what I do. I don’t read books without marking them up. I haven’t gone a market day in almost 13 years where I didn’t systematically take notes by hand on market prices. It’s not perfect. But I have yet to find a better learning process.

 

Re-think, Re-build, Re-learn. It’s not only my advice for the political leaders of this country, it’s the advice that I rinse and repeat with my team each and every risk management day. If you’re not finding a better way, you’re falling behind.

 

Back to the Global Macro Grind

 

I was almost certain that the SP500 was going to finally snap my immediate-term TRADE support line of 1345 yesterday. It did, but it didn’t close there. Closing prices matter more in my model than intraday ones.

 

Math matters. So do emotions. If you can find a way to harness both, you’ll probably make less mistakes than I did earlier in my career.

 

Dan Kahneman and his former thought partner, the late Amos Tversky, came up with what they contextualized as “strongly worded” advice for researchers like us. They suggested we consider our “statistical intuitions with proper suspicion and replace impression formation by computation whenever possible.” (Thinking, Fast and Slow, page 113)

 

Re-read that. It’s really good.

 

I can’t count the amount of investment research meetings that I have been in over the course of my career where someone just goes off with their qualitative observations. It’s probably endemic to the industry I follow most closely (Global Consumer), but I still don’t get how a billionaire can sit across the table from me talking about the deal he got on a fire-pit at Costco.

 

Over the years, after making plenty of qualitative assumptions that turned into quantified P&L mistakes, I’ve tried to cleanse myself with the “proper suspicion” of pretty much everything I think. My risk management governor is a repeatable quantitative overlay that captures real-time price, volume, and volatility signals.

 

No matter what we think we know, the market often has a not so funny way of thinking otherwise.

 

Obviously if you change the duration embedded in that thought, you come up with price disconnects that you, the great researcher, can capitalize on. But if your process aspires to be Duration Agnostic (measuring risk across different durations, all at the same time), you’ll see that you probably don’t know what you don’t know about a lot of things. That’s why I usually defer to last price.

 

Let’s isolate the SP500 and consider it across our 3 core durations (TRADE, TREND, and TAIL):

  1. Immediate-term TRADE support = 1345 and resistance = 1360 (we call this our immediate-term range)
  2. Intermediate-term TREND resistance = 1363 (April 2011’s closing high)
  3. Long-term TAIL support = 1267

Now if you are day trader or Warren Buffett, you could very well read into my risk management conclusions in completely different ways. If you are not Duration Agnostic, you probably should. Unfortunately, the market doesn’t care about our individual investment styles.

 

What happens when you overlay a fundamental Global Macro Research View

  1. US, European, and Japanese fiscal and monetary policies drive currencies
  2. Currencies drive immediate-term correlations in market inflations/deflations
  3. Inflations/Deflations drive real (inflation adjusted) Consumption Growth (71% of US GDP)

Then…

 

What if you have to think, fast – and slow, about all 3 durations (TRADE, TREND, and TAIL) and all 3 fundamental factors (Policy, Inflation, and Growth) – all at the same time?

 

I call that being Multi-Factor, Multi-Duration. I also call that Wall St 2.0.

 

Embracing Uncertainty and accepting that (unless we are trading on inside information) we all have a Wobbly Understanding about what is going to happen to our positioning next is what gets me right fired-up every morning. It’s my opportunity to improve the process.

 

My immediate-term support and resistance ranges for Gold, Oil (Brent), EUR/USD, US Dollar Index, Nikkei225, and the SP500 are now $1709-1757, $116.35-119.95, $1.30-1.33, 78.86-79.79, 8952-9397, and 1345-1360, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Wobbly Understanding - Chart of the Day

 

Wobbly Understanding - Virtual Portfolio


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