“I never see what has been done; I only see what remains to be done.”
I’ll have to differ with Buddha on the first part of that thought this morning. I can definitely see what has been done out there. After a -8.1% swan dive in the SP500 (-10.9% in the Russell) and a +71% rip in the VIX since the perma-bull March top, It’s Done.
Done. As in way oversold in the immediate-term done.
Back to the Global Macro Grind…
We understand, fundamentally, why Asian, European, and US stocks have been going down since February-March. We understand, mathematically, why Commodity prices (and the Equities that track them) have been annihilated.
Instead of banging your head against the wall trying to trade Facebook this morning, call up those hash tags on Twitter, and you’ll see that we’ve been leading on these topics for at least 3 months.
Way too many people confused Ben Bernanke’s January 25thPolicy To Inflate (commodities and stocks) as growth. Short-term pops in asset price inflation is not growth. It’s precisely that food and energy price inflation that perpetuated Growth Slowing.
If you get the Slope of Growth right, you’ll get a lot of other things right. If you get the slope (sequential direction) of both Growth and the US Dollar right, at the same time, you’re done.
Done as in, done selling high – going to Cash, done.
You can have the best bottom-up “ideas” in the world, but when The Correlation Risk goes to 1.0, that’s when almost everything you are long is done too. Done, as in the bad kind of done.
As of last night’s closing prices, here’s the immediate-term TRADE correlation between the big stuff and the US Dollar Index:
- SP500 = -0.98
- Euro Stoxx600 Index = -0.99
- CRB Commodities Index = -0.94
There is no “de-coupling.” There is no risk management in the broken sources who have led you over these cliffs in Q1 2008, 2010, 2011 … and now, again in 2012, either. “Again!” (Herb Brooks)
How many times do we have to allow our profession’s consensus brain-trust miss plainly obvious forecasts of rain while the macro data was soaking wet?
The short answer is that they are done too. The People don’t trust the Old Wall anymore. And they shouldn’t. It’s going to take a long time before we, as a profession, earn The People’s trust (and inflows into Equities) back.
On a cheerier note, this morning I’ll open with our lowest Cash (64%) and highest Equity (36%) positions in the Hedgeye Asset Allocation Model since January (over the course of the Growth Slowing cycle, we’ve moved from 0% US Equities to 24%, and maintained a 0% allocation to Commodities).
To be crystal clear on duration, I’m playing this for the bounce. When markets are viciously oversold like this on our immediate-term TRADE duration, that’s just what we do. It’s no different than when I was shorting the SP500 in March-April at immediate-term TRADE overbought signals. We aren’t perma anything. Risk works both ways. The risk now is to the upside.
Looking at immediate-term ranges in the LONG positions in the Hedgeye Portfolio, here’s where I stand in terms of immediate-term upside/downside in all 14 of our current positions:
- SP500 (SPY) = 1
- Consumer Discretionary (XLY) = $42.29-43.74
- US Healthcare (XLV) = $36.32-37.07
- Apple (AAPL) = $528-560
- China (CAF) = $19.41-20.44
- Brazil (EWZ) = 50.77-55.34
- Melco (MPEL) = 11.84-13.33
- Nike (NKE) = $104.14-107.79
- Lifepoint (LPNT) = $34.93-36.66
- Hologic (HOLX) = 16.81-17.71
- HCA Holdgings (HCA) = $25.21-26.19
- Urban Outfitters (URBN) = $25.46-27.26
- Liz Claiborne (FNP) = 11.78-13.11
- Starbucks (SBUX) = 51.63-56.14
It’s Done. I bought a handful of these positions in the last 2-days. #TimeStamped like any position you have taken. I don’t run from them at the lows. I buy them on red. All the while I’m trying to understand each and every factor of each position with my Research Team so that we can handicap the probability of where prices move within our ranges, across durations.
These ranges are immediate-term TRADE durations. From an intermediate-term (TREND) to long-term (TAIL) perspective, our models generate wider ranges of risk.
Generating good “ideas” is what every good research team in this business should be doing – both long and short. But having great performance on those ideas is highly dependent on getting the timing right. You’ll need a repeatable risk management process for that.
Our Research Team, led by our Director of Research, Daryl Jones, has just published their work on Facebook. If you’d like a copy, please email . We won’t have a risk managed view of the stock until it opens and starts giving us price, volume, and volatility data.
Our immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, and the SP500 are now $1, $106.78-111.52, $80.49-81.84, $1.26-1.28, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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Conclusion: There is only one issue that matters here...and that's the trade off between operational execution and financial engineering. The latter is easy, but when you run out of net cash -- like GPS is doing -- execution is critical. We won't hang our hat there.
Before we get all excited about the GPS quarter (they were 'Congratulated' half a dozen times in the Q&A), lets consider the following. Yes, sales were up 6%.That's great for a company that has comped down for the better part of 4 US Presidential Terms. But a) it faced an easy compare vs last year, b) weather helped, c) the Easter shift was a factor, and what no one is talking about, d) JC Penney just printed a 21% decline in sales. If GPS garnered only 1/10th of that, it helped comps by over 2%.
But here's our favorite stat. Depite the boost in sales, net income was flat. But EPS was up 18%. Share count vs last year? Down 18%.
Make no mistake, this has been a financial engineering story over the past 8-years. $11bn in repo has taken down the share count by 47%. As recently as 3-years ago, GPS was sitting on a net bash position of $2.3bn. Now it is down to $400mm. In other words, this did not need to be an operational improvement story to grow earnings. Now the share repo angle is largely over. GPS absolutely NEEDS to show consistent comp and/or margin improvement.
Does it have the next quarter or two in the bag? Probably. It goes up against two very easy quarters, and JCP will continue to hemorrhage share for at least a few quarters. But GPS has already conceded that it will reinvest some of its Avg Unit Cost savings back into price and product in 2H. We think that it will have to invest much more than it plans.
We don't like this one.
Outlook: 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:
Highlights from the Call:
Domestic strength across all three concepts
In the process of making product corrections first highlighted back in Feb
Online up +18% - investing in online media, mobile tech, etc.
Believe they have a competitive advantage in online - gaining share
Franchise business added 3 new markets & 22 new stores
China added 7 new stores - on track for 30+
Athleta on track to add 25 stores
Old Navy - redesigned t-shirt business in Q1
Gap - color bottoms and color denim big driver in Q1
Five new creative platforms
Gap - Be Right received well
BR - work good execution through direct mail
New Hire: Stephan (from H&M) to run Old Navy
Joining in October
Global experience - key for expanding Old Navy's success domestically
Sales +6% on comps up +4%
Margins down only -15bps
New stores and franchise business accounted for 2pt spread
Merchandise margin down 150bps driven by higher unit cost
Occupancy costs leveraged 130bps (cautioned against extrapolating this level of leverage due to timing of openings etc)
Inventory: Inventory /store -7%
Up $62mm to $980mm due to marketing spend and store payroll
Marketing up $20mm to $139mm
CapEx = $148mm (net sq. ft. down -2%)
FCF = $216mm vs 104 yy
SRA = $1Bn (Minimal repo in Q1)
Weather was very favorable in Q1
Includes 53rd week
Modest top-line growth
Healthy merchandise margin
Expect AUC to improve yy in 2H
Saving to be offest in part by reinvestment in product
Expect leverage on positive comps
Will be investing more in domestic growth initiatives - don't expect operating leverage this year
Marketing investment step up to be similar in Q2 to Q1 = ~$20mm
With over 200mm shares repo'd in 2010-2011 at avg price of $19.60 comfortable with slower pace in 2012
Product Costs vs. Outlook:
- Feel good about AUC in 2H; It’s the AUR piece that will have to 'play out' as the year goes on
- Expect to cont. to increase store payroll and investment
- Minimal share repo will impact how EPS modeled
Avg. Unit Costs:
- Entire 2H up 20% including holiday
- Reinvesting some of those costs coming off into categories like suiting at BR, Denim at Gap
- More Gap Fit (i.e. athletic pants) are higher AUC than panties so less favorable mix shift
- Re units, as pressure on AUC eases - pulled back most units on Old Navy given AUC increases so plan to increase units this year as costs subside
- Happy with new Gap Fit business
- Kids and baby business very strong - broad based strength at Gap
- At Old Navy new t-shirt initiative - wish they had more colored bottoms
Uses of Cash:
- Share repurchase has been 'lumpy - wouldn't read too much into it'
- Quick move in stock so program didn't keep pace / catch up
- Were up +10% last yr, down -7% in Q1
- A little lean in Old Navy headed into Q2
- Seeing increased traffic and sell-through at Gap
- Ramping direct mail effort and online at BR
- More marketing behind Gap brand to showcase product (athletic fit & t-shirts)
- Expect a step up in traffic from spend
- Store growth will increase absolute rent investment
- Plan to make investments this year in the domestic business
- In 2008-2011 the expense base has stayed relatively flat despite int'l expansion
- Now that they are seeing product assortment improvements, they want to propel those initiatives
- Final changes to value proposition will be in place by end of May = sharper pricing, assortments
- Merchandising and store team element key to success from June on when chgs should be reflected
Competitive Share Gain:
- Old Navy is not JCP's #1 competitor
- Sure everyone in value business got a little piece
- Productivity /ft is very impressive
- Team has brought a leading operating example to Gap Inc.
International - Old Navy Expansion:
- Japan had a +13% sales increase in the quarter
- China committed to 30 stores - did 7 in Q1
- Franchise business up 30%+
- Modeling after successful global model for Japan intro - push model, very little localization
- Opportunity for more customer in the mid 20s-30s
- Brand hasn't been as relevant to them in recent years
- New marketing pulling in broader consumer set
Piperlime Transition to Physical Store Model:
- Taking blue print from Athleta
- Have a central design team for the stores to bring the brand to light
Product & Price:
- 2011 didn’t stay true to value proposition that they offered in 2010, they just have to get back there - 'tweak it'
Operating Margin Cadence:
- More spend in 2H?
- No real chg to view
- Expect some top-line and margin expansion in 2H as deleverage expenses
POSITIONS: Long Healthcare (XLV) and Apple (AAPL); Short Industrials (XLI)
Our core fundamental themes have not changed (#GrowthSlowing and #DeflatingTheInflation), but prices have. With the SP500 100 points lower (and AAPL $100 lower), plenty are selling low now. That’s not what we do.
Across risk management durations, here are the lines that matter most:
- Intermediate-term TREND resistance = 1369
- Immediate-term TRADE resistance = 1346
- Immediate-term TRADE oversold = 1317
In other words, we don’t get paid to freak-out and sell on moves under 1320. We get paid to book gains on the short side and, slowly, take up gross invested long positions. On the bounce to lower highs, there are no rules against re-shorting what we cover.
Keith R. McCullough
Chief Executive Officer
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