Retail: Complacency Today, Hope Tomorrow

Conclusion: Macro and Micro are converging in a way that contextualizes a simple, yet powerful story about the state of retail. Hindsight positives plus deteriorating inventory spreads being led by high-end retail is not what bulls want to see. 





Let’s step back and put some of the bigger picture datapoints in retail into context. They all point to complacency today, and a good element of hope built into financial models in 2H. Consider the following…

1)      This morning’s CPI report showed that apparel/accessories CPI accelerated by 20 basis points on both a 1 and 2-year basis.  

  1. The absolute change of 5.12% is the highest reading on record since December 1990. At face value, this comes across as extremely bullish.
  2. But consider this…in 1990 roughly 70% of Apparel you put on your body was made in the US. Costs were high, elasticity of demand was a big issue, pricing was critical, ‘the era of the mall’ kept supply in check, and ultimately, competition was rational.  When costs went up, consumer prices followed. In fact, for the 30-years leading up to 1990, average price increases clocked in at 3.5%.
  3. Then we went through a massive outsourcinig wave thanks to changes in the US Government’s arcane import regulations geared toward protecting dying US textile mills. Now only 5% of what we wear is made in the US.
  4. Over this 22 year time period, per capita unit consumption of apparel went up by roughly 50% (from 40 units/yr to 60). In other words, the industry drove prices lower and stimulated additional unit purchases. This took industry margins about 500-600bps higher, despite lower prices.
  5. Today, there is almost no more room to outsource. But simply to get more efficient in how outsourcing is being handled. Retailers can’t drive increased unit demand AND margins by lowering price anymore. Finally, with 'the era of the mall' has transformed to 'the era of selling to the consumer at a transparent price  -- mall or no mall.' Translation, they NEED higher prices to stick, or simply need to be very conservative with inventory buys.

Apparel CPI (yy chg).  

Retail: Complacency Today, Hope Tomorrow - 1

Source: Bloomberg


2)      The CPI readings are definitely positive, but we can’t exactly call them bullish. Keep in mind that we’re looking at April data. This is very much a lagging indicator. It mirrors any pricing success that the industry is seeing TODAY in its reported 1Q results.

3)      But with these results, we’re also seeing inventories rise. KSS, SKS, JWM, M…all of them have an eroding sales/inventory position. This is how it starts, folks. Each retailer has a slight erosion on the margin, but assures people that it is manageable. The reality, however, is that they are powerless over what the competition will do as their respective inventories get too high.


Retail: Complacency Today, Hope Tomorrow - 2


4)      The biggest concern for us is that the two retailers with the worst sales/inventory deltas are Saks and Nordstrom. It’s way too premature to call for the death of the high end consumer – people have been calling for that for the better part of a decade. But this has been a ‘safe haven’ in the midst of KSS blindly fighting JCP in the mid-tier (collectively KSS and JCP account for about 15% of the industry). Our call all along has been that these factors would start to bleed in to 2H, and put estimates at risk.





Economic Identities

“There is, so I believe, in the essence of everything, something that we cannot call learning. There is, my friend, only a knowledge - that is everywhere.”

-Herman Hesse


Last week I was on vacation and had some time to turn off the crackberry (or iCrackberry in my case) and do some reading.  Most of my reading was centered on my day job as Director of Research at Hedgeye, but I also had a chance to read some fiction, including Hermann Hesse’s classic, “Siddhartha.”


For those of you that haven’t read Hesse’s novel, it is the classic example of a man’s search for meaning and identity.  In the story, the protagonist, Siddhartha, lives in the time of the Buddha and is in search of enlightenment.  On this path, he forsakes his family as a teen and leaves a comfortable lifestyle to the sparse life of an ascetic that is characterized by abstaining from worldly pleasures.


Siddhartha then has an awakening of sorts and leaves the ascetics to become a trader (in this day and age he would clearly have been trading CDS), and also takes on a lover.  Siddhartha then again turns his back on the materialistic world to once again return to the ascetics.  Eventually Siddhartha realizes that that his “understanding” is enhanced by the collection of his experiences.


From my purview, this short novel is the classic existential angst and search for identity story.  In people, this often occurs years immediately following college, but also manifests itself in the “midlife crisis.”  Nation states also struggle in the search for identity.  In the United States this struggle has recently been on the social side of the equation as both Republicans and Democrats have taken up the gay marriage debate with fervor, but in Europe the search for identity continues along the economic path.


This morning's GDP numbers were released for the majority of the Eurozone.  In the Chart of the Day, we’ve highlighted the y-o-y GDP growth rates for the EU-27.  While the architects of the euro may have envisioned a scenario where economic progress is shared across the region, the reality has proven to be much different.  Clearly, Germany has been, and continues to be, the key beneficiary of the common currency. This will only continue with the euro trading below the 1.30 line versus the U.S. dollar.


In aggregate, the EU27 grew 0.0% from Q4 2011 and 0.1% from Q1 2012.  This was largely driven by Germany, which grew at 0.5% sequentially and 1.2% y-o-y.   Germany has benefitted from strength in its industrial sector, in particular solid results from the automakers.  As a result, exports have been a meaningful tailwind for Germany.


On the disappointing end of the GDP report were France, Italy and Spain.  France’s growth effectively evaporated on a sequential basis to 0.0%, and Italy was -0.9% sequentially while Spain was down -0.3% sequentially.  Clearly, Europe is seeing the impact of austerity in short-term GDP growth numbers.  The open ended question remains how tolerable austerity remains, especially as Germany’s economy continues to dramatically outperform its neighbors.


To answer that question, we probably have to look no further than Francois Hollande’s first action as leader of France.  Specifically, immediately after being sworn in today Hollande is flying to Germany to discuss a growth pact with Angela Merkel.   While Merkel has been adamant that no new sovereign debt will be issued to support growth, she too is feeling the pressure to implement policies that are, at least in perception, more pro-growth by her political opposition in Germany.  The economic identity crisis in Europe continues.


The European sovereign debt markets are clearly signaling their confusion around the lack of economic identity.  While they had seemingly been reacting better to certain austerity policies, many periphery yields are now trading back near all-time highs.  The key market we watch, of course, is the Spanish 10-year yield which is now solidly above the rhetorically critical 6% line at 6.25% this morning. 


With France’s political identity resolved, at least temporarily, Greece is now in focus on the political front.  My colleague Matt Hedrick highlighted this on Friday when he noted:


“This week saw each of the three main Greek parties (New Democracy, Syriza, and Pasok) try to form a coalition with each another, only to come up short each time. There’s new hope from some that Pasok leader Evangelos Venizelos can put together a unity government given a shift in stance on the part of Democratic Left leader Fotis Kouvelis, who has broken ranks with Syriza, which it had backed earlier in the week. (Syriza is thoroughly against the mandates of austerity, and may be the most divisive partner in a coalition build).”


Clearly, the search for political identity in Greece is going to be protracted.


Changing gears for a minute, I wanted to highlight a recent note from Howard Penney and Rory Green on our restaurants team titled, “The (Coffee) Prince”.  As they wrote:


“For Howard Schultz, it is all about winning.  Even when he doesn’t want to communicate it, he does.  The word “Machiavellian” has come to represent, for many people, any human behavior that is cynical and self-interested.  While Schultz seems to have a strong social conscience – and this is meant as a compliment – we can’t help but believe that the single-serve strategy being employed by Starbucks seems to rhyme with The Prince, Machiavelli’s most famous book.  An appearance by Mr. Schultz on CNBC yesterday illustrates this perfectly.”


Their general point, and email if you want to trial their research and read the entire note, is that the identity, or search for identity, of corporate leaders can very much impact financial results.



Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research








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DKS: Quick Hit - We Still Like It


Solid quarter from DKS coming in $0.07 above the top end of its range and consensus expectations. Revenues came in strong up +15% a little better than our expectation for +14%E and the consensus of +10.5%E, but the real callout in the quarter is inventory management reflected in better than expected gross margins.

  • Inventories were up +14% on +15% sales growth resulting in an 8pt improvement in the sales/inventory spread, but more importantly a return to positive to +1%. The negative spread posted last quarter due to excess cold weather product was DKS’ first in over 3-years since Q3 ’08. The company’s ability to clean the decks headed into Q2 is impressive.      
  • Equally impressive is the gross margin improvement up +112bps on stronger sales despite clearance activity and higher equipment sales mix.
  • It’s also worth noting that both Dicks and Golf Galaxy comps accelerated on a 1yr and 2yr basis this quarter. We’ll get more color behind the drivers at Dicks, but Golf Galaxy came reflected the strength we’ve seen in the golf channel YTD.
  • The increase in full-year EPS to $2.45-$2.48 from $2.38-$2.41 reflects Q1 coming in $0.07 above the high end of Q1 outlook and comp expectations up to +3-4% from +2-3%. These expectations continue to look flat out conservative to us.

Call at 10am


Casey Flavin



DKS: Quick Hit - We Still Like It - DKS S



Back To Bed

This note was originally published at 8am on May 01, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“We are in bed too much.”

-Franklin D. Roosevelt


That classic FDR quote comes from a dramatic excerpt in Ian Toll’s latest book about WWII, The Pacific Crucible. If you are a history buff, I highly recommend it. The book is very well researched and provides a unique Japanese perspective on how they forced Americans to think differently about globally interconnected risks.


The context of the quote is important. FDR said it in the immediate aftermath of Pearl Harbor when being grilled by Senator Tom Connolly of Texas, “How did it happen that our warships were caught like tame ducks… How did they catch us with our pants down? Where were the patrols.” Roosevelt replied, “I don’t know, Tom. I don’t know.” (page 31)


Unlike most modern day Republican and Democrat “leaders”, Roosevelt didn’t point fingers. He went on to explain that it wasn’t enough not to know. It was time to take the time to re-think US strategy and understand. “They are doing things and saying things during the daytime out there, while we are all in bed.” (page 31)


Back to the Global Macro Grind


If you want to pretend it’s the 1990s or 2003-2007 bull markets, that’s cool. All you have to do is know where the 50-day moving average is and you won’t miss a thing. Just look at the US Equity futures every morning and go back to bed.


With the US Dollar being debauched (down now for 7 of the last 8 weeks), Risk Managers are starting to pick up on the idea that more QE would only inspire a weaker World Reserve Currency and higher oil prices. That, in turn, will slow growth further.


QE1 may have worked. But QE2 didn’t, and QE3 definitely won’t. Why? Because as the USA gets a short-term “pop” in stock prices, the rest of the world gets asset price inflation (i.e. in their cost of living and/or cost of goods sold) right when they need that the least. Policies To Inflate (from these prices) slows growth and compresses margins.


Global Equity markets have obviously figured this out. With the exception of Venezuela and Egypt, Global Equity prices have been making lower- highs since February-March. The slowdown in US Equities (which somehow were last to figure this out) was much more pronounced in April than it was in that February-March performance period.


Performance period? Qu’est-ce que c’est le performance chasing period? It’s been glaringly obvious that seasonal Institutional performance chasing has called the top in US Equities in Q1 of 4 of the last 5 years. Notwithstanding the no-volume rally in 4 of the last 5 days of the month, here’s how US Equities finished in April:

  1. SP500 -0.8%
  2. Nasdaq -1.5%
  3. Russell2000 -1.6%

From a S&P Sector performance perspective, the complexion of the SP500’s -0.8% loss is interesting:

  1. Top 3 Sectors = Utilities +1.8%, Consumer Discretionary +1.2%, Consumer Staples +0.3%
  2. Bottom 3 Sectors = Financials -2.3%, Industrials -1.1%, Tech -1.1%

With our only Global Equity asset allocations being US Utilities and Chinese Equities (up +1.8% and +5.9% for the month, respectively), we were quite pleased with being positioned for US Growth Slowing. The question now is what will please the monthly performance chasers for May?


Can the SP500 make higher-highs for the YTD if Financials and Tech continue to pull back? What happens to the Industrials if Growth Slowing continues? The Sector Studies tell me that the most bullish outcome for May could be Deflating The Inflation. That would be good for American Consumers (good for US Consumer and Healthcare longs).


Deflating The Inflation is already in motion, but you’ll only be able to take it out of market expectations if we stop waking up late every morning begging for Ben Bernanke to bail us out with another QE experiment.


Politicians hate the idea of Deflating The Inflation via a Strong Dollar because that would be bad (in the very short-term) for the stock market. Our Hedgeye Election Indicator has already picked this up (see Chart of The Day). President Obama just had his 1st bullish week in the last 5 (up +130bps week-over-week), primarily because the stock market was up +1.8% last week.


It’s perverse, but it’s real. That’s a big reason why neither Bush or Obama have been advised to back a Strong Dollar Policy.


Causality? Policies To Inflate cause “speculators” to bet on the inflation policies they expect from conflicted and compromised politicians at the Fed and Treasury. From an immediate-term correlation risk perspective, the writing is on the wall too:


Immediate-term TRADE correlations between the US Dollar and:

  1. SP500 = -0.83
  2. WTIC Oil = -0.86
  3. Equity Volatility = +0.93

In other words, as Colonel Jessep would have said, “You want the truth? you can’t handle the truth!” (YouTube video from A Few Good Men It’s the US Dollar, Stupid.


There should be no politics associated with the Purchasing Power of America’s Currency. Every American who championed the Strong Dollar Periods of 1983-1989 (US Dollar Index Averaged $115.18) and 1993-1999 (US Dollar Index Averaged $92.93), gets this.


At $78.69 this morning, the US Dollar Index is -32% and -15% below those 1980s and 1990s averages. The price of oil is +377% and +465% higher than those 1980s and 1990s Strong Dollar, Strong American GDP Growth Peiods of 4.3% and 3.8%, respectively.


We have a Crisis of Credibility in this country because no one wants to talk about the truth. Our currency is what we buy things with. It’s not something we can borrow respect with. Fighting for it is what should be getting you out of bed.


My immediate-term support and resistance ranges for Gold, Oil (WTIC), US Dollar Index, and the SP500 are now $1647-1667, $103.96-105.23, $78.69-79.22, and 1391-1408, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Back To Bed - Chart of the Day


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The Macau Metro Monitor, May 15, 2012




The number of new home sales in Singapore reached 2,487 in April, surpassing March's total of 2,393 units. 



As the first legal poker room in Singapore, ‘Poker World’ opened for business today and will be operating 24 hours, seven days a week for the foreseeable future.  The room has a capacity of seven tables with available stakes ranging anywhere from SGD $5/$10 to $500/$1000. 

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