“My own view is that he will speak eloquently, but that words are cheap, and that the record of an individual is the basis upon which you determine whether they should continue to hold on to their job.”
-Presidential candidate Mitt Romney
Since starting Hedgeye almost four years ago, many of our readers have a hard time discerning the political leanings of the firm. At times we’ve been accused of being Democrats and in other instances we’ve been accused of being Republicans. In reality, while individuals at Hedgeye have personal political leanings, and we encourage them to get involved in the process, as analysts we are completely objective about politics. Our job is to analyze the economic policies of politicians and come up with a view of their ultimate impact on asset classes and prices.
I highlight the quote above not because I necessarily agree with Romney, but rather because I want to highlight that the political debate is going to only accelerate in the coming months heading into the nominating conventions and ultimately the general election in November. Romney’s statement above is very accurate in one sense, this election, as they usually are, will be about the performance of the incumbent and the economy under the incumbent.
Later today President Obama will be giving a speech that will be the beginning of his campaign’s attempt at taking back the economic debate. Based on early previews, Obama is likely to focus less on the last three years, a time in which he will claim he shored up the economy, and more on the future prospects for the U.S. economy. As it relates to the future, Obama will attempt to juxtapose Romney, a wealthy private equity investor, with middle class Americans. The insinuation being that Romney’s policies will only enrich the wealthy, while Obama will help the middle class.
The challenge that Obama faces, especially if he uses only rhetoric and has no new tangible plans, is that the middle class has very much struggled under his Presidency. The two statistics that the Romney camp repeatedly cites, which are largely accurate, are that no net new jobs have been created under Obama and that median household incomes have declined somewhere in the range of $4,000 per annum under Obama.
In the Chart of the Day, we highlight our proprietary Hedgeye Election Indicator (HEI). The HEI is driven by real time economic price data that correlates closely with polls and ultimately establishes a probability of an Obama re-election. In line with Romney’s statement that talk is cheap as it relates to economic performance, the HEI bears this out as it has declined to its lowest level in five months at 54%. As the economy goes, so goes Obama’s re-election chances.
In Europe this morning, we are getting increasing evidence that not only is talk cheap, but action itself is cheap. Specifically, Spanish 10-year yields touched 7.0% overnight. This is a 91 basis point increase from Monday morning’s bailout lows. It seems the attempt at containing European sovereign debt issues by adding more debt, without long term structural reform, is actually now being perceived as mere talk by the market, even if the Eurocrats see it as action.
Later today we will be publishing a note on Italy. As much of the media attention is rightfully focused on the pressure points of Spain and Greece, Italy is the third largest economy in the Eurozone , so a much bigger problem than Spain, and its yields and CDS are starting to trade in line with Spain at 6.3% on the 10-year and 554 basis points on 5-year CDS. With a 120% debt-to-GDP, it should be no surprise that adding more debt in Europe to bail out Spain is not a positive catalyst for Italy.
The unintended consequences of failed European bailouts are not only being seen in Italy’s sovereign debt markets, but also broadly in European companies. This morning the Swiss banks are getting punished. Credit Suisse is down -8.0% after the Swiss National Bank said they need a “marked increase” in capital this year to prepare for possible escalation of Euro-zone risks. The Swiss National Bank also recommended that UBS boost capital.
On a more micro level, our Restaurant team led by Howard Penney will be hosting a call on the restaurant industry’s franchise model, and its latent risks, with restaurant finance expert John Hamburger (yes, that is his real name). The crux of the debate is as follows:
“The interests of franchisees and franchisors do not always align; in fact, in today’s environment of tight capital supply for small businesses and increasing competitiveness among restaurant companies, they can sometimes diverge. Through franchising, franchisors gain more stable cash flow, protection from swings in variable costs, and lower expenses. In turn, franchisees, ideally, gain operational expertise from companies and brand recognition while assuming much of the operational risk of the business. Most of the decision-making authority pertaining to the business remains with the company and, in difficult business conditions, this can be a source of contention.
As franchisors seek to grow royalty fees, decisions made by corporate restaurant executives in the past few years have tended to focus on promotional strategies and capital-intensive store and process alterations. Of course, as long as the consumer and financing environments cooperate, this behavior may not meaningfully impact the franchisee’s bottom line. However, with the backdrop of a fragile economy, volatile commodity costs, tight access to capital, and increasing labor costs, there is a potential for friction. The addition of any controversial business decisions that magnify franchisees’ difficulties all but guarantees disharmony between management and the franchise community. Examples over the past few years are numerous, from Kentucky Grilled Chicken at KFC to bun toasters at Wendy’s to 99 cent double cheeseburgers at Burger King.”
As it relates to talk and action, I will leave you with one last quote from President Roosevelt:
“The man who really counts in the world is the doer, not the mere critic-the man who actually does the work, even if roughly and imperfectly, not the man who only talks or writes about how it ought to be done.”
Our immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, and the SP500 are now $1, $96.11-98.85, $81.91-82.46, $1.24-1.26, and 1, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
This note was originally published at 8am on May 31, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“Theory helps us to bear out ignorance of facts.”
I have a good friend whose dad is legendary for giving his sister’s suitors a difficult time. As it’s been told to me, this young lady will bring guys she is dating home and her father will take them for a little walk outside and basically warn these young lads that they don’t want to dance with the bear – the bear being him. Since he is a small town burly Canadian fire chief, the daughter’s suitors are pretty clear on the message.
As it relates to being stock market operators, I don’t think any of us enjoy dancing with bear markets. A good friend of mine, and former colleague, is one of the head traders at a major mutual fund complex. Every day I get his morning internal news summary which leads off with the ACWI etf, which is a proxy for global large cap equities. On April 2ndhis note had the ACWI up +11.9% and on May 29thhe had the ACWI up +0.76%. In effect, any investor who has a long only mandate has had to dance with the bears over the past couple of months and likely, just due to the inflexibility of their mandate, had to endure giving back performance.
But even as many of us have had to dance with U.S. and global equity bears, the Japanese have perhaps had it the worst. The most populous bear in Japan is the Asian black bear, also called the moon or white chested bear, which is medium sized and, luckily enough, largely a herbivore. While the Asian Black Bear is mostly focused on eating plants, the Japanese stock market has been focused on eating investors whole. Specifically, overnight the Nikkei close -1.1% and finished the month down -10.3%.
Our bearish thesis on Japan is, hopefully, at this point relatively well known. In late February we hosted a conference call with a 100 page presentation (email us at email@example.com if you aren’t a subscriber of our macro product and would like to trial and view the presentation) that outlined our view that Japan is facing a debt, deficit and demographic reckoning. It seems Japanese equities are agreeing with us.
One of the key catalysts we highlighted back then was the potential for a sovereign debt downgrade. Early last week this catalyst came to fruition as Fitch downgraded Japan’s long-term local-currency sovereign debt rating one notch to A+; additionally, the agency reduced the country’s long-term foreign currency debt rating two notches to the same level. As the other rating agencies follow suit and the ratings continue to tumble downwards, the larger risk is that the Japanese banking system has to do a massive capital raise in the future to keep their Tier 1 capital ratio at appropriate levels. This is an increasingly realistic risk that you may want to bear in mind.
By the time you get this missive, the U.S. will have reported GDP and jobless claims this morning. Both our predictive tracking algorithms and the stock market have been telling us that GDP is slowing and we would expect the data this morning to reflect the same. On some level, of course, slowing growth is starting to be priced into the market. Currently, in the Virtual Portfolio we are leaning slightly net long and have 8 longs and 7 shorts.
The three most recent positions that we have added to the Virtual Portfolio on the long side are as follows:
1. Apple (APPL) – As oil and commodities deflate, from a macro perspective the outlook for the iEconomy improves. Additionally, and not that I have any edge of course, Apple is cheap at 10x forward earnings but also growing the top line, based on the last quarter, at north of 30%. The simple fact is that many investors still don’t get that Apple is not a hardware company; it is a software company with long term sustainably high margins (think moat and barriers to entry).
2. Amazon (AMZN) – Amazon, much like Apple, is a play on consumption which we believe continues to improve as oil, and energy input costs generally, continue to break down. As my colleague Brian McGough wrote about Amazon yesterday:
“Let's not forget that it is the Haley’s Comet of retail. It's a retailer with $48bn in revenue growing at 40% with 2% EBIT margins that's investing on its balance sheet and p&l at a rate to make a third of retailers alive today extinct in 5+ years.”
3. Utilities (XLU) – On our quantitative model, utilities are the only sector that is bullish on both TRADE and TREND durations. This is in part due to the predictability of the cash flow streams in utilities and thus relatively safety, but also a compelling dividend yield of right around 4% which, when compared to the government bond market, is downright juicy.
So, even in the doldrums of dancing with the bear market, we’ve been able to find some compelling long ideas. Time and price will tell whether they are rentals or names that, like Starbucks, we will hold for multiple years. But the bottom line is this: if you are going to dance with the bear, be prepared to keep your hands, feet, and portfolio moving.
In fact as Wikihow instructs us, the top three tips for avoiding bear attacks are as follows:
- Avoid close encounters;
- Keep your distance; and
- Stand tall, even if the bear charges you.
For stock market operators, the last point is probably the most instructive and translates into buying high quality names when the bear market is charging away and providing a compelling entry point.
Our immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, and the SP500 are now $1546-1571, $103.27-106.97, $81.99-83.24, $1.23-1.26, and 1295-1334, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
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TODAY’S S&P 500 SET-UP – June 14, 2012
As we look at today’s set up for the S&P 500, the range is 17 points or -0.75% downside to 1305 and 0.54% upside to 1322.
SECTOR AND GLOBAL PERFORMANCE
- ADVANCE/DECLINE LINE: on 6/13 NYSE -1219
- Down from the prior day’s trading of 1640
- VOLUME: on 6/13 NYSE 707.13
- Decrease versus prior day’s trading of -2.32%
- VIX: as of 6/13 was at 24.27
- Increase versus most recent day’s trading of 9.87%
- Year-to-date increase of 3.72%%
- SPX PUT/CALL RATIO: as of 6/13 closed at 2.08
- Up from the day prior at 1.47
CREDIT/ECONOMIC MARKET LOOK:
- TED SPREAD: as of this morning 38
- 3-MONTH T-BILL YIELD: as of this morning 0.09%
- 10-Year: as of this morning 1.60
- Increase from prior day’s trading at 1.59
- YIELD CURVE: as of this morning 1.31
- Up from prior day’s trading at 1.30
MACRO DATA POINTS (Bloomberg Estimates):
- 8:30am: Current Account Balance, 1Q, est. -$131.9b (prior -124.1b)
- 8:30am: CPI (M/m), May, est. -0.2% (prior 0.0%)
- 8:30am: CPI Ex Food & Energy (M/m), May, est. 0.2% (prior 0.2%)
- 8:30am: Initial Jobless Claims, June 9, est. 375k (prior 377k)
- 9:45 am: Bloomberg Consumer Comfort, June 10
- 10am: Freddie Mac mortgage rates
- 10:30am: EIA natural-gas change
- 11am: U.S. Fed to purchase $1.5b-2.25b notes in 2/15/2036 to 5/15/2042 range
- 1pm: U.S. to sell $13b 30-yr bonds (Reopening)
- President Obama visits World Trade Center site in NYC
- Deadline set by federal judge for EPA to propose standards for soot pollution sought by environment groups
- SEC holds closed meeting on enforcement matters, 2pm
- Senate in session, House in recess
- Senate Energy and Natural Resources holds hearing on competition between U.S., China on clean energy, 9:30am
- House Oil and National Security Caucus holds discussion on gas prices, 12pm
- World Bank President Robert Zoellick speaks at a luncheon at Peterson Institute, 12pm
WHAT TO WATCH:
- Moody’s cuts Spain’s credit rating 3 steps to Baa3
- Spanish-German 10-yr. yld spread widens to euro-era record
- Italy sells EU3b of 3y bonds in first time after Spain bailout
- Nokia to cut 10,000 jobs globally by end 2013, trims outlook
- Swiss central bank pledges to defend franc cap
- Microsoft said to be in discussions to buy Yammer
- Felda Global Ventures said to raise $3.3b in IPO
- U.S. consumer prices probably fell for first time in 2yrs
- ABC, NBC, Fox said to finish ad sales orders for next season
- U.S. foreclosure filings fall 4% as lenders increase short sales
- Vector Capital raises Technicolor offer to EU2-shr
- Pier 1 Imports (PIR), 6am, $0.16
- Smithfield Foods (SFD) 6am, $0.53
- Kroger (KR) 8:15am, $0.73
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- BofA Beating JPMorgan After French Lenders Retreat: Commodities
- Gold Advances for a Fifth Day in London on Stimulus Speculation
- Oil Trades Near Eight-Month Low as OPEC Reviews Output Targets
- Copper Seen Rising on Speculation About Further U.S. Stimulus
- Cocoa at Four-Month High as Dry Weather May Reduce Next Harvest
- Ore-Ship Rates to Reach 22-Year Low as More Vessels Leave Yards
- U.K. Gas Falls as Norway Supply Rises, Work Halts Pipe Exports
- Europe Fuel Exports to Be Eclipsed by U.S. Boom: Energy Markets
- Rain, Pests Imperil India’s Wheat Crop as Warehouses Full
- Venezuela Overtakes Saudis to Hold World’s Biggest Oil Reserves
- OPEC Set to Keep Output Ceiling Unchanged Amid Europe Crisis
- Aluminum May Decline 7.3% on Topping Pattern: Technical Analysis
- Gulf Nations’ Break-Even on Oil Drops to $80: Deutsche Bank
- Japan Buys LNG From Spain, Brazil as Spot Soars Near Record
- South African Union Fight Threatens Biggest Platinum Suppliers
- Guar Futures Trading Suspension in India May End Next Month
- Indian Regulator Wants Banks Allowed in Commodity Futures
USD – get the Dollar right and you’ll get a lot of other things right; USD finally found an immediate-term TRADE oversold level in the morning yesterday; that took the immediate-term bloom off Gold’s rose; we’reregistering a lower-high of resistance for Gold at $1633 now (was at 1648 yest) and oil continues to crash (down -24% since Feb).
ITALY – plenty of jib jab about Greece and Spain, meanwhile Italy continues to crash, down another -1% this morn and down -25% since March 19th (Spain is down -26% from its YTD top). Italy has economic stagflation, and that has historically traded at 7-8x EPS, so be careful calling things “cheap” (1970s stagflation is cheap).
ASIA – sold off across the board after more US Growth Slowing data (US Retail Sales missed and Consumer Discretionary led the market lower, -1.5% yest); China continues to make fresh 3mth lows and the bailout guys keep begging for more rate cuts – maybe they should cut every other day? Indonesia led decliners -1.8%; Japan remains a mess.
The Hedgeye Macro Team
Today’s sell-off in Nike is a great example of the volatililty we should continue to see in the name for the next two months. The cards are stacked against it near-term, which is a gift for someone who wants to respect this thing we call earnings power.
From a trading perspective, NKE is bearish TRADE and TREND on our models. We rarely make ‘the sentiment trade’ on Nike, and we’re not going to start today. As such, until either a) NKE’s volatility ebbs, b) eight weeks’ time passes, or c) it’s price corrects, we’d rather be long the quality growth in UA, which is bullish TRADE and TREND – the opposite of where Nike is sitting.
There’s a very real mismatch with why we think the consensus owns Nike, versus why it SHOULD own Nike. The consensus view around Nike has been focused around near-term earnings upside and business momentum around key events and initiatives.
- Launch of the NFL deal. But that’s passed. NKE still reaps the benefits – and at an accelerating rate. But the initial splash has come and gone.
- Momentum in the North American business. Last quarter was 22% futures growth – the equivalent of adding an UnderArmour, and having $300mm left over. We can’t imagine that anyone thinks this is sustainable. But still, the rate is going down, not up.
- European Football Championships: Americans deny its existence, but this is bigger to Europeans than the Super Bowl and World Series combined. The event is halfway through.
- Launch of FlyKnit: Great new product, platform and manufacturing technology for Nike. It hits stores in full within a month. That’s great, but too many people are asking us about it. We don’t like when people get too pumped on a single initiative. Over 2-3 years, it definitely matters. But no single product can make or break this company.
- ‘The Olympic Trade’. We never could justify the rationale behind it. But it exists. No one is buying the stock now based on the event, but unfortunately those that are simply there to rent the stock rather than own the company will need to exit.
We still think that the REAL call is that Nike is going to ‘three-peat’. It’s having a great FY12. That will happen again in FY13, and again in FY14. We think it’s largely top line driven, but we’ll also see a meaningful recovery in Gross Margins due to growth in consumer direct, better pricing power, lower product costs, and fewer close outs due to a more efficient manufacturing process.
If we could craft this perfectly, it would be for long investors to wait for the ‘freak out’ event sometime over the next 8 weeks. If it doesn’t happen, then it’s probably because the company is giving the Street ammo to take up numbers in the outer years. In that event, we’d be comfortable getting in late – even at or above the current price – as the stock is trading today at less than 13x our May14 estimate. If our $8.00 number is correct, then we’ll be looking at a CAGR of about 20%. What kind of multiple do you put on that kind of growth for a quality global growth story like Nike with 25%+ return on capital? Let’s say it’s a slight discount to its PEG. Maybe 18x? $144 Stock.
With Li Ning’s preannouncement about high inventories and weak orders, it’s easy to jump to conclusions. But when you quantify one business vs. the other, it opens up the question as to whether Nike is causing Li Ning’s problems, not sharing them.
Let’s put some context around Li Ning’s (top local athletic footwear brand in China) preannouncement yesterday, and what the numbers really mean for Nike. The bottom line is that it’s definitely not a positive data point. But in really looking at the size of Nike’s business in China as well as its previously disclosed inventory position, it makes perfect sense that the little guy got crushed. In fact, we’re surprised that we have yet to see the same out of Anta.
Consider the following:
- Nike China will clock in about $2.6bn in revenue this year, double that of Li Ning.
- Nike, however, leverages that into $900mm of EBIT, compared to $70mm for Li-Ning. Even if we adjust for 15% opex infrastructure given that Li Ning is based in China and Nike carries much of its costs out of the US, it’s still churning out EBIT at 5x the rate of Li Ning.
- Nike ended last quarter with 32% growth in inventory. That’s an incremental $820mm yy. This was heavily weighted to China and Europe. China alone accounted for 13% of Nike inventory growth.
The bottom line is that Nike’s yy growth of $104mm in inventory in China is 1.5x the size of the ENTIRE profit stream generated by Li Ning. Is Nike in the same boat as it relates to Chinese growth slowing? Sure. But a) slowing to the mid-20%s ain’t half bad, and b) we have to consider that Li Ning’s preannouncement was CAUSED BY Nike, instead of being in conjunction with Nike.
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