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Sucker Economics

This note was originally published at 8am on August 03, 2012 for Hedgeye subscribers.

“Markets are increasingly distorted by central banks’ attempts to squeeze drops of growth…”

-Louis Bacon

 

What do Louis Bacon, Stan Druckenmiller, and George Soros all have in common? They’re some of the best players in this Global Macro game, and they’re all either giving money back to their investors or getting out of the game completely.

 

They think these central planners are right nuts. So do I. But does the manic media that perpetuates this entire gong show get that? Have these pundits ever traded a macro market in their life? Or, like the worst players at a poker table, are they just the suckers trying to remain relevant until their ratings and/or credibility goes to zero % too?

 

As the old saying goes, look around the poker table; if you can’t see who the sucker is, you’re probably it.

 

Back to the Global Macro Grind

 

We got longer yesterday (cutting our Cash position to 58%) but it was still a clean cut example of what Louis Bacon coined in a recent letter (explaining why he is giving back $2B to his investors) as Disaster Economics: “where assets are valued based on their ability to withstand a lurking disaster as opposed to what they may yield or earn, is now the prism through which investors are pricing markets.”

 

Don’t think this is turning into a Q308 like disaster? Ok. What would you call this?

 

1.   745AM EST (yesterday), Spanish stocks rip to the upside, +2% on the day, after the ECB decides not to cut rates, but plenty of print, tv, and radio pundits proclaim their faith that “it’s at 830AM that we get the good stuff.”

 

2.   835AM EST (yesterday), Spanish stock stop going up, and fast, as pundits comb the release looking for “hints” that the ECB really is going to deliver the drugs, like Bernanke was supposed to in the day prior.

 

3.   1130AM EST (yesterday), Spanish stocks close down -5.2% on the day, a 7% (not a typo) intraday reversal. Pundits feel shame.

 

Or do they? 430AM EST, I get up this morning and “European stocks rally” on new news that Spain (as in the country) is going to hold a press conference about something.

 

I couldn’t make this up if I tried.

 

Notwithstanding the simple math of the matter (a market that loses 7% of its value needs to “rally” +7.5% to get whoever got suckered in at 830AM EST yesterday back to break-even), I’d say Bacon is on to something here.

 

Then you have the other running narrative of people who are in the business of markets going up saying “but the SP500 is up 10% for the year-to-date.” That one is just a beauty – it’s as if people think about their life-long net wealth on the same calendar as Old Wall Street’s bonus season.

 

Just to get the record straight – and I mean how real people with real money think about the return of their moneys:

  1. SP500 is not +10% YTD anyway, it’s up +8.5%
  2. SP500 is down -3.8% from Q1 2012 (when #GrowthSlowing started)
  3. SP500 is down -12.8% from its 2007 high, where almost everyone of the Q1 2012 bulls were the same people

So, lucky you – you only have to be up +4% and +15% to get back to your 2012 and 2007 break-evens. This better be one heck of a US Employment Report this morning.

 

Better yet, if you’ve noticed this other little thing called a broad leading indicator (the Russell 2000 has led the SP500 the entire way):

  1. RUSSELL2000 is only up +3.6% YTD
  2. RUSSELL2000 is down -9.1% from its 2012 Perma-Bull high (March 26th, where the VIX bottomed at 14.26)
  3. RUSSELL2000 is down -6.1% in the last month alone

I know, I know. Don’t be spinning that storyline on us KM, we’re still living large over here on the everything fine front. Until you aren’t. What’s happened this year at MF Global, JP Morgan, and Knight Capital is an obvious reminder of Disaster Economics too.

 

As returns (both buy and sell-side) get tougher to concoct, we’ve created a culture on Old Wall Street of cheating and corner cutting so that people A) don’t get ridiculed by their peers internally and/or B) get paid.

 

That pressure is cultural.  It’s also called causality. Much like central planning policies to suspend economic gravity, it’s only sustainable until it goes away.

 

My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, Spain’s IBEX, and the SP500 are now $1590-1605, $105.09-107.32, $82.95-84.11, $1.20-1.23, 5811-6649, and 1356-1376, respectively.

 

Best of luck out there today and enjoy your weekend,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Sucker Economics - Chart of the Day

 

Sucker Economics - Virtual Portfolio


CHART DU JOUR: MASS EXPOSURE

Takeaway: LVS's Mass exposure somewhat insulates it from the VIP volatility in Macau

Who's best positioned to weather the VIP storm?

 

 

  • LVS mainains the highest Mass exposure as measured by the percent of its total gaming revenue (GGR) in Macau derived from that high margin segment
  • VIP has been volatile and turned negative in July.  We continue to expect that segment will come under pressure.  Wynn and Galaxy are most exposed.
  • After a big VIP push - mainly through its Four Seasons property - Mass once again drives over 40% of LVS's Macau GGR following the opening of Sands Cotai Central.

 

CHART DU JOUR: MASS EXPOSURE - MASS


Time To Short The Market?

Takeaway: Keith is ready to short the S&P 500 and buy bonds. As far as Facebook goes, there's only one way to go: down. $FB $SPY

 

Hedgeye CEO Keith McCullough appeared on CNBC’s Fast Money Halftime Report today to discuss Facebook (FB) stock, which hit all time lows. Keith is bearish on the stock, noting that market momentum will continue to drag down shares. “Don’t catch a falling knife," said Keith. Wise words.

 

Also discussed was shorting the S&P 500 (SPY). We think the time is right to short stocks and buy bonds. The correlation with stocks and volatility brought the discussion back to March, when the VIX was between 14 and 15 and the time was right to short the market.. Again, with the VIX this low, a reversal in equities seems imminent. 

 


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

Knight: Throwing Up Shields

Takeaway: The market is largely ignoring several problems associated with the broker; we believe the stock can go as low as zero. $KCG

Knight Capital (KCG) has a long ways to go to recover from its near-death experience. We don’t think the event is priced into the stock properly and thus, we see further downside for KCG. Keith shorted KCG in the Hedgeye Virtual Portfolio yesterday at a price of $3.01 a share.

 

There are three factors affecting Knight that will push the stock down further. One risk of being short is that the company could be acquired at a premium to its current share price. Whether or not it’ll be sold off piecemeal style or just swallowed whole remains to be seen.  But for now, consider this:

 

-Knight took a $35 million loss on Facebook during the IPO. That debacle is still being sorted out with Nasdaq and other parties.

 

-Trading volumes have been insanely low.  Knight’s trading volume has declined sequentially over the last five quarters.

 

-Knight sold about 70% of the equity to a consortium of buyers in order to save itself. It got $400 million in 2% preferred stock convertible at a $1.50 strike. There is a mandatory conversion provision that says the preferred must be converted if the stock price stays above 2x the strike price for 60 consecutive days.

 

 

Knight: Throwing Up Shields - KCG levels

 

The stock is entirely capable of going to $1, then $0.50 then $0. CEO Tom Joyce better have an ace up his sleeve because the company is not putting enough effort into saving face. Even more concerning is whether the $400 million will be enough capital to hold the company over heading into the back half of 2012.


CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET

Takeaway: $XLF no longer bears any resemblance to jobless claims. This is a first. If you're a lender, you'd think borrowers having jobs would matter.

Trying to Improve Upon Boring

This week's claims print is boring so we've tried to make our weekly note on the subject a bit more interesting by looking at claims' relevance to both the market and the XLF over differing time intervals. That sounds boring too, but if you'll bear with us we think you'll find the conclusion at least somewhat interesting.

 

The first chart below shows the relationship between rolling initial jobless claims and the S&P 500 from the start of 2007. The relationship is strong with an R-squared of 0.8866 on a zero-lag basis. In other words, the level of jobless claims has explained 88 percent of the S&P 500's value each week over the last five and a half years. It's clear that claims are a good proxy for the health of the economy and that the market is a reflection of sentiment around the economy's health. As an aside, it's interesting to note that the strength of the relationship didn't improve much when we lagged claims. In other words, the common wisdom that the market is the leading indicator for the economy is not supported by the data in this particular case. While we saw very small increases in the R-squared value (an improvement from 0.8866 to 0.8974) by having the S&P 500 lead claims by 3 weeks rather than zero, we don't consider this difference significant. For reference, the market is overvalued, albeit slightly, based on the current level of jobless claims. This assumes that claims are in fact the x-variable (independent) and not the other way around. This model suggests a fair value for the S&P 500 of 1364, or roughly 3.3% below present levels.

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - CLAIMS VS SPX SCATTER

 

The next chart looks at the XLF vs. the same jobless claims series since 2007. Note the correlation breakdown vs. the relationship with the S&P 500. The R-squared value here is only 0.54, far less exciting. We suspect this owes to the substantial balance sheet restructurings that took place amid the large cap banks, Citi and Bank of America as glaring examples. This would partially explain the divergent path for the XLF relative to its historical relationship. 

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - CLAIMS VS XLF SCATTER

 

We actually find the next chart the most interesting. This is the relationship between the XLF and jobless claims over the past two years. Note the correlation: zero. In other words, the improvement in jobless claims in the past 104 weeks from roughly 488k to 355k has done nothing to move financials stocks higher. This is counterintuitive. For reference, that same move has driven a 302 point rise in the S&P 500 (+27.4%). Financials have been and should be more sensitive to changes in jobs than other sectors as their primary P&L driver is credit, which reflects frequency and severity of loss. Frequency of loss is driven by newly unemployed people, which is reflected in initial jobless claims.

 

Our suspicion is that the confluence of European counterparty fears, higher capital standards equating to lower returns, compressing top lines (NIM & Fee Income), and higher regulatory/litigation/personnel expenses are now large enough, on a combined basis, to completely negate the huge improvement in credit we've seen over the past two years. Looking ahead, the outlook for claims to improve further is small. Jobless claims rarely break below 300k on a sustained basis, a move from current levels roughly one-third the size of what we have seen over the last two years. This is another way of saying that the credit tailwind is coming to an end. This is troubling because the alternative interpretation of the below chart is that the only thing that's held the XLF flat (as opposed to breaking lower) over the past two years is the improvement in credit.  

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - CLAIMS VS XLF SCATTER 2yr

 

The Boring Details on This Week's Print 

Initial claims rose 5k to 366k last week, but only 2k after incorporating the 3k upward revision to the prior week's data. Meanwhile, rolling claims fell by 5.5k to 364k. 

 

We've been chirping lately about the slowdown in improvement in the year-over-year measure of rolling non-seasonally adjusted claims. We prefer this method as it gets around what are considerable seasonality distortions in the data. For the last several weeks this year-over-year change had been worsening, in that the rate of improvement was slowing. This most recent print marked a small reversal of that trend. The year-over-year change in rolling NSA claims was better by 7.9% this past week, which is an improvement from the 6.1% improvement YoY in the previous week's results. We wouldn't get too excited here as it's just one print and the prior trend had been in place for a few months. Nevertheless, we're keeping a close eye on it.

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - RAw

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - Rollinh

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - NSA

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - Rolling NSA

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - S P

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - Fed

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - YoY NSA

 

Yield Spreads

Spreads continue to widen for now, pushing the 2-10 spread out another 15 bps to 153 bps in the latest week. Much of this is coming from the long end of the curve, where 10yr yields have risen 17 bps to 182 bps. This recent rally in yields is driving a rotation out of REITs back into Financials. 

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - 2 10

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - 2 10 QoQ

 

Financial Subsector Performance

The table below shows the stock performance of each Financial subsector over multiple durations. 

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - Subsector Performance

 

CLAIMS: WHY FINANCIALS LOOK NOTHING LIKE THE REST OF THE MARKET - Companies

 

Joshua Steiner, CFA

 

Robert Belsky

 

Having trouble viewing the charts in this email?  Please click the link at the bottom of the note to view in your browser.  

 

 

 


FL: Accelerating Into 2H

 

We’re at $0.38 for FL headed into Friday’s print before the open on a +9% comp ahead of Street estimates at $0.34E and a comp of +7%.


The stock is up +18% since we published our note “FL: We Like It Here” on June 27th versus the S&P up +6% so it’s fair to say that expectations are high headed into the print, but for good reason.

  • June footwear sales in the Athletic Specialty Channel came in up +9% following +10% in May. Sales accelerated in July as expected against easing compares headed into the 2H. Given the average 400-600bps markup of weekly trends that reflect sales in aggregate (vs athletic channel), July sales appear to have come in up low-double-digits to low-teens to finish the quarter. In addition, apparel sales also picked up in July. We think this translates to comp of +9% at FL.
  • Category mix remains a key driver of outperformance and upside versus peers with strength in basketball – a trend we expect to continue following strike related disruptions last year. Take a look at the chart below, basketball has steadily improved YTD with compares getting easier through the 2H. Running also reaccelerated during the quarter. While a bigger boost for FINL (more heavily indexed to the category), these improving trends headed into the 2H are clearly favorable.
  • Europe remains an overhang. FL indicated a strong start to European sales in May with sales turning positive (up +LSD vs. –MSD in Q1), which is a stark contrast to most other retailers with exposure to Europe mitigating further weakness in a region that accounts for ~24% of sales. While we admittedly don’t have great visibility into how June is shaping up, there are two factors to consider re Europe, 1) early indications suggest trends are stable if not turning positive, and 2) compares here are also getting more favorable.
  • We’re modeling +80bps of gross margin improvement driven primarily by occupancy leverage up +90bps offset by a modest drag on merchandise margin (-10bps). We are also modeling SG&A up +3.5% reflecting 5% growth in core SG&A including $6.5mm in incremental marketing spend offset by a ~$5mm reduction in Fx.

Bottom-line is that this story in on track. The key drivers continue to be product innovation complemented by an improving apparel assortment mix, growing international store footprint (more productive that domestic base), and expanding digital platform. Given the run into earnings, we think expectation for good numbers is largely reflected in the stock here and as such don't expect a move of the same magnitude we've seen in recent quarters. But numbers are still too low for the year. We’re at $2.49 for the year above the Street at $2.38 and $2.83 for 2013 vs. $2.64E. We continue to like the earnings visibility over the intermediate-term and this name on the long side.

 

Casey Flavin

Director 


FL: Accelerating Into 2H - FL Comps

 

FL: Accelerating Into 2H - Athl Channel

 

FL: Accelerating Into 2H - Athl Cat

 


 

 


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