Worse Than Bad Champagne . . . The Coming Debt Hangover

Conclusion: The long term impact of debt-to-GDP over 90% is protracted periods of below average economic growth with a meaningfully negative impact on cumulative GDP.

We often write about the impact of debt-to-GDP north of 90% and its detrimental impact on growth.  This ratio and level was popularized by Carmen Reinhart and Kenneth Rogoff in their seminal work, “This Time Is Different: Eight Centuries of Financial Folly.”  In their research, Reinhart and Rogoff analyze over 200 years of data from a group of more than 60 advanced economies.  The results are summarized in the table below, but the key takeaway is that at or north 90% debt-to-GDP, of which there are 352 observations, economic growth slows to 1.7% on average versus 3.4% growth on average at lower debt levels.


Worse Than Bad Champagne . . . The Coming Debt Hangover - chart1


In a subsequent paper published last month, Reinhart and Rogoff consider the impact of longer term periods in which debt-to-GDP remains above 90%.  They define these as “debt overhangs as economic episodes where the gross public debt / GDP exceed 90% for five years or more.”  In their research, Reinhart and Rogoff identify 26 debt overhang periods in 22 countries going back to the early 1800s.  This data currently excludes the unfolding cases of Belgium, Iceland, Ireland, Portugal, and the United States.


Not surprisingly based on Reinhart and Rogoff’s prior work, periods of debt overhang lead to below trend line economic growth for extended periods.  In fact, of the 26 observations of debt overhang periods, only three observations resulted in above average growth (Belgium from 1920 – 1926, Netherlands from 1932 to 1954, and the U.K. from 1830 to 1868).  Collectively, the average growth for debt overhang periods is 2.3% per annum versus 3.5% per annum for period in which debt-to-GDP is below 90%. 


Clearly, then, economies with more debt grow at a slower pace, but the more concerning issue is the cumulative impact.  The average duration of a debt overhang period is twenty-three years.  If we extrapolate the impact of 1.2% growth per annum over twenty-three years, the cumulative impact is substantial.  In this paper, Reinhart and Rogoff use a baseline analysis and show that at the end of the average debt hangover, real GDP is 24% lower than in periods where debt-to-GDP is below 90%.


Worse Than Bad Champagne . . . The Coming Debt Hangover - chart2


Interestingly, as the chart below highlights, the current period may shortly become the most indebted period of the last century.  The chart shows gross public debt-as-a-percentage-of-GDP for 70 advanced and emerging countries.  The 22 nations considered advanced economies are, in fact, at their most indebted ever and exceed the indebtedness of the emerging markets by a ratio of greater than 2:1. Logically, then, we may be entering the most meaningful and lengthy debt hangover in modern economic history.


Worse Than Bad Champagne . . . The Coming Debt Hangover - chart3


The common refrain from many who support more aggressive government spending and higher government debt levels is that interest rates continue to allow funding.  In effect, if markets are not concerned about solvency risks, why should policy makers care?  Firstly, they should care because of the impact to long-term growth.  Secondly, in 11 of the 26 examples of debt overhang, real interest rates were lower, and therefore did not prove an adequate predictor of future economic performance, or risk.


In a typical hangover scenario, we’d recommend comfort food, vitamins and a lot of water.  The more realistic scenario for nations experiencing a debt hangover is to endure the short term economic pain of reducing government debt.  As we are seeing in Europe though, in a highly politicized world that is often easier said than done.



Daryl G. Jones

Director of Research


TJX: 1Q13 Report Card

We continue to be extremely concerned about the inventory/margin setup for retail in 2H – which plays right into the countercyclical nature of TJX. No surprise that its 1Q metrics look so good. With inventories rising at SKS, JWN and M, earnings are likely to improve from here. TJX will look expensive, and it should.



Inventory growth continues to be a key concern/theme out of 1Q12 results, which is good for off-price retailers like TJX. As we indicated in our earlier note "Retail: Complacency Today, Hope Tomorrow", while we’ve been seeing inventory growth outpacing sales in the mid-tier (KSS and Macy’s mid-tier business), we’re now seeing sharp negative sales/inventory moves out of the upper tier department store players as well; both JWN & SKS sales/inventory spreads deteriorated sequentially in Q1. TJX and ROST have been on a tear, but the reality is that as long as there are signs of inventory building out there, it will be a bullish set-up for them over the next 12 months.  In fact, TJX is at a point in its cycle where it is clearing at high margin (revs +11.3% vs inventory -3%), and we think will revert soon enough to buying higher-priced, higher quality goods that need to find a home (ie Polo and Armani in TJ Maxx). While TJX’s revised guidance remains $0.03 below consensus at the high-end, comp expectations of 2-3% appear conservative. This will likely continue to be like Chinese water torture for the bears, as both earnings, and the stock should grind higher.


What Drove the Beat?

After having originally guided 1Q13 comps to +2-4%, TJX over delivered +8% (which came out on Sales day). This additional $200m+ in sales disproportionately flowed through to gross margin with little incremental SG&A resulting in 90bps expense leverage. 1Q top line resulted from significant improvements in traffic with a slight benefit from an increase in average ticket. FX contributed a favorable 40 bps to the 220bps operating margin expansion. The remaining 180bp was driven by improved merchandise margins, and the remainder was buying and occupancy leverage off an 8% comp.  TJX ended the quarter with inventories (-3%) overall and (-7%) on a per store basis resulting in a meaningful 11 point sequential improvement in the sales/inventory spread (now +15%).


TJX: 1Q13 Report Card - TJX SIGMA


Deltas in Forward Looking Commentary?


In order to properly measure performance relative to original expectations, we look at management’s first quarter results relative to management guidance as well as any updates to previously provided full year 2013 outlook:


TJX: 1Q13 Report Card - TJX delta


Highlights from the Call:


Comps: +8% driven by significant increases in traffic with average ticket up slightly

  • Above plan sales and record flow through resulted in record profitability
  • Saw significant increases in traffic across every division
  • Warm weather boosted demand though sales remained strong in regions driven less by weather
  • International momentum remains strong

Divisional performance

US Marmaxx comp +8%

US Home goods +9%


TJX Europe: highest first quarter segment profit in history

  • Broad based strength in Europe from UK and Ireland, Germany and Poland
  • See lots of room for further improvement
  • Remain the only major off price retailer in Europe

TJX Canada: comps +6%

  • Segment profit improved significantly
  • Opened another 6 Marshalls stores in the quarter


SG&A 90bps leverage

  • Driven by expense management on above plan comp
  • Added very little incremental SG&A to 200mm+ revenue outperformance

EBIT Margin: +220bps

  • Strong flow through of above plan sales
  • 40 bps due to positive FX impact
  • 8% comps would typically drive 120 bps improvement, drove 180 bps increase ex FX
  • Merchandise margins drove 90 bps of the 180bps improvement ex FX
  • Some buying and occupancy leverage

Inventories: down 7% per store vs. 12% increase last year



  • Customer transactions have increased mid teens over the past 3 years
  • Research shows TJX attracting younger customers
  • Market penetration still well below most US department stores
  • E-Commerce remains an opportunity to draw customers in the future (E-commerce will not be top line accretive in 2012)
  • Plan to grow square footage by 4-5% annually over the next 2 years
  • More than 100 markets where there is a TJX or Marmaxx and no Homegoods creating opportunity
  • Maintaining 10-13% annual EPS growth guidance


  • May is off to a strong start


EPS: $2.27-$2.37; 14% to 19% increase over $1.99 last year (Increase do primarily to 1Q outperformance)

Comps +2-3% vs. original guidance of 1-2%

Pre tax margins 11.1%-11.5% 20-30 bps above original guidance

Share Repurchase: $1.2-$1.3bn in FY13 including $250mm in Q1


2Q guidance

EPS: $0.47-$0.50 cents ($0.01 benefit from FX)

Top line: $5.7-$5.8bn range based on comps +2-4%

May: comps planned to increase 5%,  June: flat to up 1%, July: +1-3 %

Gross Margins: 27.2%-27.4%; down 10bps to +10bps YoY, merchandise margins expected to be up, -10bps impact from FX

SG&A: 16.8%-17% range, down 10bps to +10bps YoY (reflects 30 bps of incremental growth investments)

EBIT Margin: 10%-10.4%, down 20bps to +20bps (includes 10bps negative FX impact)

Tax Rate: 38.5% (higher than last year)

Net interest 8m-9m range

Share count of 752 mm shares




Marketing and Advertising Spending in 2012:

  • Pretty flat though impressions are up leveraging corporate marketing initiatives
  • Will be more prominent in 2H
  • Have kicked it up for gift giving in Q4

Investment Spending

  • Slight increase in 2Q but investments are on plan for the full year
  • Corporate expense +$13mm in 1Q, planned to be up 20mm in 2Q with majority in investment spending
  • 1H increases in 30-33mm but back half in +10mm range
  • Able to leverage SG&A slight in 2H on flat to +1% comp to due timing of investment spending


  • Long term debt ($775mm) with nothing due near term
  • No plans at this point in time to increase leverage but remain open

Traffic Increases

  • Are seeing new customers in that average age is decreasing a bit
  • Large percent of new customers are younger (18-35 range)
  • Maintaining the older customer as well

Marmaxx segment margins:

  • Improvements coming across the board with new stores and old stores
  • Across the country in all demographics


  • High percent of sourcing done in Europe- very specific by country
  • Have learned what the mix needs to be by country
  • Adding countries to improve assortments- currently 700 people in merchandising department
  • 6 or 7 main sourcing offices around the world with additional satellite offices
  • Will be growing sourcing team through new hubs and additional buying persons in main offices
  • Sourcing team is constantly traveling


  • Only off-price vehicle in Europe
  • Europe has a long runway of opportunity
  • Merchants overall in Europe are more seasoned than a year ago which has benefitted
  • High increases in traffic patterns in Europe
  • More and more opportunity to increase store count- taking advantage of current real estate opportunity
  • Now guiding Europe to a 5.2-5.8% segment margin on a 53 week basis, 280-300 bps improvement over last year on a 4-5 comp
  • Pleased with current momentum in Europe
  • Learning from Europe E-commerce in terms of working online in the off priced sector- learning about average order, basket, communication, etc.
  • E-commerce business getting stronger and stronger
  • TJX does not perform better in a weaker macro setting

Segment margins hitting record highs

  • Planning comp conservatively, every comp is about $0.05
  • Strive to beat plan

Category Drivers

  • Apparel and Home have been terrific
  • Tremendous color changes in fashion this year
  • Mens/kids strong against the board
  • Buying structure allows team to take advantage of changes in fashion, weather, etc.

Comp Drivers

  • Planning for average ticket to be up slightly with most of comps driven by traffic 

Rural & Urban type stores

  • See more and more possibility for additional stores in rural and urban markets
  • Continue to learn and can improve on real estate targeting
  • Opportunity for home goods to have urban and rural stores as well- volume of stores is less than chain avg but margin is in line


  • Results from buying team executing on the merchandising side
  • Starting to see a younger customer with the store being a great vehicle for younger customers getting their first apartment



The Bureau of Labor Statistics released CPI data for the month of April this morning.  The spread between CPI for Food at Home and Food Away from Home continues to narrow.


We have long been calling out this trend; the advantage that restaurants enjoyed over grocers in 2011, in terms of lower price increases year-over-year, continues to fade.  Grocers were forced to raise prices in line with inflation to protect margins during 2011; we believe that restaurants benefitted from that.  Last year, restaurants’ strong top-line trends helped the industry mitigate the impact of inflation on margins.


Ahead of the next CPI report, we will be publishing some work specific to several companies in the restaurant and food retail spaces and their comparable sales growth through inflationary and deflationary cycles. 


Looking ahead, we believe that the restaurant industry’s ability to lap difficult comps during the summer months may be negatively impacted if the “food value spread” turns negative.  Management teams at McDonald’s and Jack in the Box, among others, have highlighted this metric as being instrumental in their thinking about pricing. 





Howard Penney

Managing Director


Rory Green


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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








Economic Identities - Chart of the Day


Economic Identities - Virtual Portfolio

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