“Simple question: are we making sufficient progress to believe that our original strategic hypothesis is correct?”
I’ve been on the road for the last three days in Canada and Minnesota and had an opportunity to finish reading a book that our engineering team recommended by Eric Ries’, “The Lean Startup.” That quote comes from Chapter 8 which is titled Pivot (Or Persevere). Solid risk management read.
Solid is as solid does. Whether you are building your own company, nurturing a family, or serving as a fiduciary of other people’s money, you constantly have to Re-think, Re-work, and Re-build what isn’t working. If you are challenging yourself to evolve, you are going to break things.
What do you do when fundamental operating principles like trust break? Do you get out there and earn it back? Or do you sit there and make excuses? I thought UBS Chairman Kaspar Villager nailed it yesterday when he said this about trust:
“it cannot be tied to a far-dated founding year; trust has to be constantly won anew… reputation is the most important capital for a bank. It takes just a thoughtless action to lose it and the sweat of thousands to rebuilt it.”
If that doesn’t resonate with you, try playing on a Championship Team that sits facing one another in a 4-walled dressing room.
Back to the Global Macro Grind…
I’m not going to apologize for using sports analogies and/or team building concepts. That’s who I am – and I take great pride in working alongside teammates who think about the name on the front of their jersey before the one on their backs.
The leadership concept of Pivot (or Persevere) is a critical one in Global Macro Risk Management inasmuch as it is one in building a business. You really need to be Duration Agnostic when considering whether or not your strategic hypothesis is correct. Markets wait for no one and you’re constantly getting real-time feedback on the validity of your research views.
That’s why we’ve separated our process into two really big components:
- The Fundamental Research Process (Growth, Inflation, Policy, etc.)
- The Quantitative Risk Management Process (Price, Volume, Volatility, etc.)
Quite frequently these 2 components disagree with each-other. Usually that’s because they aren’t both speaking to you on the same duration. That’s why, contrary to popular efficient market hypothesis belief, Timing Matters.
As of 6AM EST today, here are our summary Fundamental Research Process updates:
- GROWTH: on our intermediate-term TREND duration, both globally and domestically, it’s slowing
- INFLATION: on our intermediate-term TREND duration, it’s rising
- POLICY: with the exception of very few countries (Iceland raised rates this morning), the Keynesian Bubble remains
From a Quantitative Processing perspective:
- PRICE: US and German Equities remain in Bullish Formations whereas China, India, and Hong Kong have broken TRADE lines
- VOLUME: Asian Equity volumes are ok, whereas US Equity Volumes continue to hit generational lows
- VOLATILITY: everything big beta (Inflation Policy stocks, commodities, etc.) is pseudo normal; SP500 VIX is bombed out
So what do I do with that?
Like I did in Q1 of 2008, 2010, and 2011, I sell beta (anything that’s eventually going to fall hostage to Growth Slowing, globally, in the intermediate-term). That doesn’t mean I wasn’t early in any of those prior Q1 Selling Opportunity periods. That doesn’t mean I’m not wrong right now being short the SP500 either (the position is -0.37% against me).
It just means I have plenty of room to improve my timing process.
Pivot Points (like intermediate-term tops and bottoms), are processes, not points. Every hour of every day we are offered more Fundamental Research points that can help proactively predict the changing slopes of the lines embedded in market expectations.
Market expectations, unfortunately, aren’t wrapped up in a pretty baby blue fundamental research box with a white bow. They fully factor in greed, fear, and performance chasing. They can be jubilant; they can be abrupt. And they have a not so funny way of surprising the most amount of people at the most unexpected times.
Who would have thunk that the SP500 would be down -10.2% from those topping process days of 2007 (you still need to be up over 12% from here to break-even by the way)? Are they the same people who nailed the SP500 being up +11.7% for 2012 YTD?
I don’t know. And I think that if you really want to capture the big intermediate-term Pivot Points of market prices, you really need to embrace the uncertainty of that three word statement.
My immediate-term support and resistance ranges for Gold, Oil (WTIC), US Dollar Index, and the SP500 are now $1, $105.70-108.91, $79.33-79.87, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Conclusion: We are likely to shun long exposure to Indian rupee-denominated assets for the intermediate-term TREND as bad POLICY looks to erode the country’s future GROWTH/INFLATION dynamics.
On FEB 28, 2011 we published a note titled “India: Missing Where It Matters Most”. The summary conclusion of that note was as follows:
“Finance Minister Mukherjee’s budget failed to adequately address the #1 issue facing the Indian economy – inflation. As a result, our bearish stance on Indian equities continues unabated.”
Fast forward to 1Q12, we’re seeing a similarly-precarious setup develop post the unveiling of India’s FY13 budget (APR ’12 – MAR ’13), specifically in that it: A) fails to achieve much-needed fiscal consolidation; B) like last year’s proposal, relies on aggressive growth assumptions to drive tax revenues; and C) it proposes tax hikes, which have a direct impact on India’s elevated inflation statistics.
Regarding point “A”, the budget calls for India’s deficit-to-GDP ratio to narrow to 5.1% in FY13 from a revised estimate of 5.9% in FY12. The -80bps decline seems good at face value, but recall that India’s FY12 budget proposal actually called for a -30bps narrowing of the deficit-to-GDP ratio to 4.6%. Net-net, if all goes according to plan, India will wind up with a deficit that is +50bps higher as a percentage of GDP two years after the initial investor scrutiny of the country’s fiscal position began. Not good. Other metrics worth highlighting include:
- Total Receipts ex-Debt Issuance:+22.7% YoY in FY13E vs. +2.6% in FY12E
- In FY12A (through JAN), Total Receipts ex-Debt Issuance is tracking -5.7% relative to initial expectations and -3.3.% YoY
- Total Tax & Fee Revenue:+22% YoY in FY13E vs. +0.2% in FY12E
- In FY12A (through JAN), Total Tax & Fee Revenue is tracking -2.9% relative to initial expectations and -2.7% YoY
- Public Divestment Receipts:+93.6% YoY in FY13E vs. +75.1% in FY12E
- In FY12A (through JAN), Public Divestment Receipts are tracking -61.3% relative to initial expectations and -32.2% YoY
- Total Expenditures:+13.1% YoY in FY13E vs. +5% in FY12E
- In FY12A (through JAN), Total Expenditures are tracking +4.8% relative to initial expectations and +10.1% YoY
- Expenditures on Subsidies:-12.2% YoY in FY13E vs. -17.2% in FY12E
- In FY12A (through JAN), Expenditures on Subsidies are tracking +50.7% relative to initial expectations and +24.7% YoY
- Rising global food and emerging prices specifically pressure this line item, forcing the Finance Ministry to choose between passing through higher costs to producers and end-consumers (inflationary NOW) or allowing the budget deficit to widen (inflationary LATER)
- Sovereign Debt Issuance:Down just -1.6% YoY in FY13E (from an all-time high of 5.2 trillion rupees in FY12A) vs. +10.5% in FY12E
- In FY12A (through JAN), Sovereign Debt Issuance is actually tracking +26.4% relative to initial expectations and +39.7% YoY
Regarding point “B”, it’s easier to see the risk of the Finance Ministry’s expectations of a fairly dramatic acceleration in Total Receipts ex-Debt Issuance in the context of the GDP target of +7.9% in FY13E. While down from an initial estimate of +9.25% in FY12E (which we identified as laughable then) and at a more achievable level, a +80bps acceleration in India real GDP growth from +7.1% in CY11 seems fairly aggressive in an environment where inflation is poised to reaccelerate and slow growth incrementally from already-depressed levels.
Regarding point “C”, Finance Minister Pranab Mukherjee proposes increasing both service and excise tax rates +200bps to 12% – a hike that he admits will lead to “some inflationary pressures”. Still, he says that he doesn’t expect central bank policy to be influenced by his latest budget. Ironically, members of the RBI have been very outspoken in recent weeks regarding how the [then-pending] federal budget was their #1 factor in determining their intermediate-term monetary policy outlook. Refer to the MAR 5 publication of our “Triangulating Asia” series for more details.
On this metric alone, we expect the budget letdown to support the central bank adjusting its bias away from easing back towards neutral and perhaps even towards tightening later in the coming months (our baseline model suggests Indian inflation readings start to accelerate in 2Q). In fact, in its monetary policy statement on the eve of last Friday’s budget release, the RBI stated that “upside risks to inflation have increased from the recent surge in crude oil prices, fiscal slippage, and rupee depreciation”.
Specifically regarding the latter point, the tailwind of currency strength relative to global food and energy prices is beginning to exhibit signs of erosion. We expect that to accelerate as capital inflows – which are up dramatically in the YTD – slow and/or reverse over the intermediate term. Foreign debt investors already spot trouble ahead, with holdings of rupee-denominated debt falling -2% from a cyclical peak on FEB 29; 10yr sovereign yields are up +21bps over that duration.
As we’ve flagged in recent notes, Indian interest rate markets have been well-ahead of these developments, pricing in incrementally-less monetary easing since the start of the year. Even Indian banks, who were hopeful of broad-based easing as recently as the week of MAR 8 (day of -75bps CRR cut), continue to borrow near-record amounts of cash daily from the central bank.
Net-net, from our analytical vantage point, India is at risk of going from a country with a substantial amount of monetary policy leeway to being a country with a meaningful need to tighten policy in a couple quarters or so. Don’t overlook the ruling party’s awful showing in the recent regional elections as a critical factor for monetary policy. In the absence of credible fiscal consolidation, political pressure will likely be on the central bank to shield India’s ~840 million people living on less than $2/day from incremental inflation.
An outlook of monetary tightening poses a critical risk to Indian equities, which (per the SENSEX) are up +12% in the YTD and +14.1% since the index bottomed on DEC 20 – largely due to speculation around monetary easing amid a backdrop of accelerating economic growth expectations.
As we continue to see across the macro universe, POLICY (fiscal and monetary), which itself is a function of reported GROWTH/INFLATION figures, remains a leading indicator for future GROWTH/INFLATION readings (Soros would call this relationship “reflexive”). Absent a deflationary shock to global food and energy prices, a move back into Quadrant #3 on our GIP chart likely awaits India in 2H12, begging the question: “Does the rally in the SENSEX have legs?” Our answer is unequivocally “no”.
All told, when countries consistently print sizeable fiscal deficits and monetize debt amid a global backdrop of excess liquidity and food and energy price gains (as India is doing now), inflation accelerates. Don’t make it more complicated than that. We aren’t, and thus, are likely to shun long exposure to Indian rupee-denominated assets for the intermediate-term TREND. The Trifecta is back on the table.
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It’s that time of year again. With 2011 10-Ks starting to hit the wire, we just completed our initial look at the change in average lease durations by company. While the majority of retail has yet to file, our observations reflect the 40% that has already filed.
We track these lease movements religiously, because it needs to triangulate with where a company is headed as it relates to its store size, desired locations, and how much it’s paying for rent. We particularly focus on this because these are all off-balance sheet, so naturally Wall-Street thinks that they are free of capital cost. That’s not true. There’s embedded growth in each of these contracts that needs to be included in analyzing each company. Some companies have more meaningful step-ups than others, which directly effects the sales comp hurdle needed too leverage occupancy. In addition, this is an area where – over a 2-3 year duration – we can see a material change in operating margins based on changes in lease agreements.
Our analysis reflected in the charts below calculates the weighted average lease duration. Clearly, there are differences by format. Mall-based stores will be closer to 4-6 years. Large format boxes in strip malls are closer to 10 years. Formats out in the boonies like Cabella’s and to a lesser extent, Costco, are significantly higher. Of course, there’s also the errant 100-year lease at some department stores. But all in, we’re looking at average duration of 6-7 years today.
The initial punchline is that it is a fairly even split between those companies lengthening vs. shortening duration of lease portfolios. We thought we’d see more movement here as landlords are presumably as desperate to fill space as ever. Too early to make a broad-based call, but this is an initial observation.
Here are some of the early callouts:
- On the company-specific side, DKS, JWN and JOEZ are all positive standouts, with DKS offering up enough for us to revisit our long-standing negative view on its approach too property acquisition.
- As it relates to negative divergences, we’d point out JNY, CRI, and DECK, with JNY in particular giving us yet more fuel for a structurally broken fire.
- Companies with the healthiest positioning include KCP, FDO, DLTR, CROX, VFC, SHW, and BGFV. These companies have the optionality to alter lease terms in the face of unexpected margin pressures.
- The companies with least favorable positioning include SKX, TRLG, GCO, DKS, and JNY. While not necessarily at risk per se (though it definitely bolsters the bear case on JNY), these companies simply have less flexibility to manage their costs given longer dated lease commitments. In some cases this can be viewed positively if a retailer takes on a longer commitment in exchange for more favorable lease terms. This might in fact be the case with Joe’s Jeans (JOEZ), which started to build its owned retail in recent years and has an average duration of 9.2 years.
- Among the biggest changes over the past year, BGFV (-1.5yrs) and ANN (-2.9yrs) posted the most significant improvements while WRC (+1.9yrs), KSS (+3.1yrs), and UA (+3.2yrs) logged the most aggressive shift toward longer-dated leases (or deferred payments). We’re not surprised to see UA given it’s just starting to grow retail and aggressively, or even WRC for that matter with both at an average duration of 8.1 and 6.4 years respectively within reason, but KSS shifting from 23 to 26 years on a significantly more mature portfolio is more surprising.
- Since 2007 the companies that improved the most include DKS (-4.2yrs), KCP (-3yrs), BGFV and CWTR (-2.8yrs), and MFB (-2.3yrs). As one of the companies with historically a very aggressive lease portfolio, DKS is worth highlighting given the improvement in duration from over 12 years to 8 over the last four years.
- The biggest moves towards longer dated lease portfolios include KSS (+2.7yrs), COLM (+2.6yrs), COST (+2.1yrs), CRI (+1.9yrs), and both FOSL and DECK at +1.2 years. With all but KSS and COST at an average duration less than 6.5 years, these aren’t alarming shifts, but changes on the margin do matter and is something to keep an eye on given current margin levels.
With the remaining 10-Ks coming out over the next few weeks, we will republish a complete update on the changes to lease structures across retail sometime in April. Until then, these charts are likely to raise more questions than provide answers. We are available to discuss questions and welcome any comments that this analysis might initiate.
Updated for companies that have filed a 2011 10-K reflecting change in duration since last year:
Updated for companies that have filed a 2011 10-K reflecting change in duration since 2007 (4yrs):
Complete Set as of 2010 for historical reference:
Ugly print. Raised guidance has a good element of hope on both Revenue and Margins. This is a great brand, and we want to own it at a price. But time is our friend.
Make no bones about it, this Tiffany print was not good. In fact, we’d call it flat-out bad. 1) EPS missed, 2) every single business unit decelerated on a 2-year basis, 3) the only division to NOT miss revenue expectations was Japan, 4) the Americas catalogue and internet business (6% of total) was actually down year on year (weak transaction count offsetting higher AUR), 5) the NYC flagship was up only 2% despite strength in tourist spending (they called out financial sector as driving weakness in the Northeast region), 6) this was the first time in eight quarters TIF did not leverage SG&A.
All that said, the company raised guidance for the year, but back-end-loaded it. TIF flat-out admitted that inventory will grow faster than sales throughout FY13 and any GM degradation would be offset by SG&A leverage. That makes sense – but only if the company can grow its top line as planned, though it’s worth noting that its swing in our SIGMA analysis is extremely bearish for Gross Margins.
Tiffany is one of those great global brands we’ll always be on the lookout to buy when controversy gives us a shot. In fact, the stock has been a fairly miserable performer in a space that has been lit up since the KORS IPO. It’s +10% vs. KORS +122%, COH +35%, LIZ +56%, and VRA +24% (pre-print). As such, it’s not a surprise that the stock is up on TIF’s outlook.
But the reality is that there is simply too much in question as it relates to intermediate-term trends – even for a company with as powerful a brand as Tiffany. Just dial the clock back 3 and 6 months and see how consumer spending trends have changed by region. Now, headed into FY12 we need to be patient through 2-quarters of weaker top line, inventory build and margin degradation in hopes that things recover in 2H. If anyone can pull it off, we think it’s TIF. But we don’t see why it’s worth chasing here. Let’s see where 1H earnings expectations shake out to assess the potential for capitalizing on misaligned expectations.
Brian P. McGough