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QE3? Yah You Know Me

Takeaway: The Fed pulling the trigger on QE3 is bullish for gasoline and, historically, prices north of $4 per gallon have led to equity sell-offs.

It seems 99% of Wall Street was correct as QE3 was extended.  Usually fading consensus is a great strategy, although perhaps not as it relates to the Fed, at least yet.  But for starters, let’s look at the Fed’s statement from earlier today, the key points are as follows:

 

“Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.”

 

That’s actually not a key point, although it does emphasize, as we will touch on shortly, the mandate that the Fed has struggled to fulfill.

 

First on QE, the Fed effectively, as Keith would say, extended QE to infinity and beyond with this statement:

 

“If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.”

 

On a basic level, this will start with increasing purchases of longer-term securities by about $85 billion each month through the end of the year, included in this will be $40 billion of mortgage paper.  As it relates to interest rates, the Fed indicated that a zero to 0.25% federal fund rate is likely to be warranted at least through mid-2015.

 

In the chart below, we show the aggregate growth of the Federal Reserve balance sheet.  The first chart shows the massive growth in the Fed balance sheet since 2008 with close to $3 trillion dollars being printed over the course of that period.  As a ratio of nominal GDP (just shy of 20%), this is a meaningful quantity as the following chart highlights.  Unfortunately, we have not seen a corresponding increase in economic activity.

 

QE3? Yah You Know Me - 2

 

The broader issue with extending QE is that it has been largely ineffective at fulfilling the Fed’s dual mandate.  Ironically, or not, the key economic data out this morning before the Fed’s statement enforced this.  On price stability, August’s producer price index came in at +1.7%, versus last month’s +0.3%.  This is near a three year high in terms of MoM acceleration.  Jobless claims also came in higher than expected at +382K versus +370K consensus, and +367K in the prior month.

 

QE3? Yah You Know Me - PPI.claims

 

While the employment data is only marginally bearish, the PPI data point is far more critical.  At +1.7% MoM growth in producer prices, this is the largest increase in PPI since June of 2009.  Our key issue with QE / money printing is that it is bearish for the dollar, which conversely inflates key commodities that are priced in dollars.  As Keith noted in the Early Look today, the CRB index currently has a -0.94 correlation to the dollar over the past month.

 

Obviously, the most relevant commodity to the U.S. consumer is crude oil and the derivative price of gasoline.  Given that there are 254 million registered vehicles in the U.S., the relevance of gasoline costs to consumer spending and growth should not surprise anyone.  That question, as always, though, is when does increasing commodity inflation start to matter? 

 

In the chart below, we show that prices at/north of $4 per gallon at that the pump have had a definitively negative impact on growth and the stock market over the last few years. Gasoline exceeded $4 per gallon in mid-2008, mid-2011, early 2012, and now.  In each instance there was a corresponding sell off in equities.  Perhaps this time is different, though we have our doubts.

 

QE3? Yah You Know Me - 1

 

Daryl G. Jones

Director of Research


What's Next For The Manheim Index?

Takeaway: With the Manheim Index continuing to fall, it's likely the S&P 500 will follow in its footsteps based on past data.

Last month, we examined the relationship between the S&P 500 and the Manheim Index of Used Car Values. The Manheim Index is the de facto standard for determining the prices of used cars and is closely correlated with the S&P 500, meaning it can be viewed as a barometer of where the market is headed (to an extent of course). 

 

 

What's Next For The Manheim Index? - Manheim   SPX growth

 

 

Today, the Manheim Index posted its fifty consecutive month-over-month decline in August, falling 0.4% vs. July. On a year-over-year basis, the index is down 2.4%, which is an improvement vs. the July year-over-year decline of 3.7%. Suffice to say, the consecutive declines in the Manheim Index indicate that the S&P 500 will continue to fall as growth slows and the economy struggles to recover. We expect that the index will continue to decline going forward, albeit at a slower rate. 

 

 

What's Next For The Manheim Index? - Manheim   SPX

 

 

Of course, today’s announcement of QE3 by the Federal Reserve may change things in the short-term, but we’re confident that the rally will be short lived and that the market will post a correction soon enough.


CRI: Competitive Set Heating Up in Baby

Takeaway: Carter’s ~15% share of the kids apparel market is going to start feeling the heat from new(er) entrants.


The baby apparel market is getting increasingly crowded with the latest entry of Gilt Groupe. The company best known as a flash-sale pioneer is introducing Little Gilt as its first private label line highlighting a void in upscale baby essentials such as onesies, footies, and whatever else you care to swaddle your little one in.


This comes just weeks after JCP announced that it will be opening both Carter’s and Giggle shops for kids. While the Carter’s announcement was largely expected, not much was made of Giggle. We think this presents an underappreciated competitive threat to what is understood as broad channel fill for CRI at Penney's. Now we have Gilt entering the space. This isn’t exactly a direct competitor for CRI, but it’s the second announcement in the past month suggesting the Big 4 in children’s apparel (PLCE, Gymboree, Dressbarn, and Carter’s) are going to see increasing competition for their share of the market.


This is notable for a couple reasons:

  1. Gilt Groupe isn’t a start-up company/brand making yet another push into the space, but one that is quickly closing in on $1Bn in revenues with a significant online presence. The baby category is one of its largest. If we assume that it accounts for 20% of the business then were talking a retailer with nearly 2% share making a concerted effort to expand.
  2. Giggle is largely unknown due in part to the fact that it’s a smaller concept with only 13 retail stores – but not for long. At the risk of being anecdotal, we were in a Giggle store for the first time the week before the announcement and remarked at the time at what a great retail concept it was. It’s more one-stop-shop than apparel store, but as a result it’s a grandparents’ and parents’ dream for gifts or simply picking up a ‘couple’ things. It too is at the higher end compared to Carter’s, but they will compete in apparel. More importantly, Giggle will offer shoppers gift giving alternatives to basics that will likely pressure CRI’s traffic at JCP.


With much of Carter’s growth over the last decade coming from Playwear where it competes with Old Navy, the core baby business (36% of sales) has largely been considered untouchable. We won’t argue the merits of CRI’s baby  business – we think it’s great, and more importantly, so do the retailers and consumers. But increasing competition at the higher end of its pricing scale and availability of baby products both online and at retail (i.e. Giggle) provides consumers with more alternatives. At a minimum, that keeps the value proposition honest and price in check.


What this ultimately means for CRI is that it will have to spend more to protect its share of the pie. With the company also ramping less productive store growth in order to drive revenues, we see SG&A deleverage over the next three years continuing to pressure operating margins. The Street expects SG&A deleverage this year, but this year only. Based on the factors we’re seeing, we think the dynamics of the baby retail market are starting to change on the margin. As such, the rebound in CRI’s margins are likely to be less profound than expectations currently suggest.

 

CRI: Competitive Set Heating Up in Baby - Giggle SIS

 

CRI: Competitive Set Heating Up in Baby - CRI Mkt Sh 22bn

 

CRI: Competitive Set Heating Up in Baby - CRI Mix

 

 


Early Look

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CHART OF THE DAY: WILL BERNANKE GO FOR GOLD?

Takeaway: If the Fed does incrementally ease monetary policy today, it will be a meaningful step forward in the Fed’s policy to debase the US dollar.

SUMMARY BULLETS:

 

  • Long-term inflation expectations are significantly higher than they’ve been at previous iterations of QE/OpTwist.
  • As a result, if the Fed does incrementally ease monetary policy today, it will be a meaningful step forward in the Fed’s policy to debase the US dollar.

 

As we outlined in a research note Monday titled, “CHINA REMINDS US THAT GROWTH SLOWS AS INFLATION ACCELERATES”:

 

“… if the Fed announces QE3 on Thursday, the action would be a meaningful step forward in the Fed’s aggression towards achieving its mandates, based upon how elevated domestic inflation expectations are relative to previous iterations of QE/OpTwist.”

 

Looking to the charts of US 5yr and 10yr breakeven rates (TIPS), long-term domestic inflation expectations are particularly elevated – especially relative to where they’ve been at previous announcements of QE/OpTwist. As a result, any new LSAP policy announcement today out of the Federal Reserve would be a rather aggressive step forward in its pursuit of a lower USD and higher inflation. Never forget that Bernanke, a student of the Great Depression, remains quite fearful of the specter of deflation and could be ready to step up his efforts to avoid it.

 

CHART OF THE DAY: WILL BERNANKE GO FOR GOLD? - 2

 

Lastly, we’ve outlined in recent notes clear winners and losers from the Fed’s Policies To Inflate:

 

 

Best of luck out there,

 

Darius Dale

Senior Analyst


INITIAL CLAIMS: HURRICANE ISAAC PUSHES CLAIMS HIGHER, UNDERLYING TRENDS STILL POSITIVE

Takeaway: Tropical Storm Issac added 9k to this morning's claims print. Our expectations for tailwinds over the next six months is unchanged.

Isaac Headwinds

Initial jobless claims rose 17k last week, or 15k after revision. The Department of Labor blamed roughly half of the increase on Hurricane Isaac, noting that "Several states have reported increases in initial claims (approximately 9,000 in total) for the week ending September 8, 2012 , as a result of Tropical Storm Issac.".  

 

Where do claims go from here? We know that there's an embedded tailwind in the September through April data, so we would expect to see a significant improvement over the next six months of data, though week to week changes will remain random. We profiled this historical relationship in last week's jobless claims note: "Jobless Claims: Six Months of Tailwinds on Tap".

 

Stripping out the seasonal adjustment nonsense, jobless claims are still improving. The YoY change in non-seasonally adjusted initial claims was -8.5% this past week, a slight improvement from the -8.1% YoY change in the prior week. 

 

Additionally, the S&P and the rolling claims series diverged this week. These two series are cointegrated, meaning that they can diverge in the short term but mean revert over the longer term. For reference, the current level of claims implies an S&P level of ~1345. The S&P is currently trading at 1436, or roughly 6.7% higher than the level implied by our claims-driven fair value model. 

 

Claims: The Data

Initial claims rose 17k to 382k last week but after incorporating the upward revision to last week's data, claims rose 15k. On a rolling basis, claims rose 3.25k WoW to 375k. The NSA series fell 12k.  

 

INITIAL CLAIMS: HURRICANE ISAAC PUSHES CLAIMS HIGHER, UNDERLYING TRENDS STILL POSITIVE - Raw2

 

INITIAL CLAIMS: HURRICANE ISAAC PUSHES CLAIMS HIGHER, UNDERLYING TRENDS STILL POSITIVE - Rolling

 

INITIAL CLAIMS: HURRICANE ISAAC PUSHES CLAIMS HIGHER, UNDERLYING TRENDS STILL POSITIVE - NSA

 

INITIAL CLAIMS: HURRICANE ISAAC PUSHES CLAIMS HIGHER, UNDERLYING TRENDS STILL POSITIVE - Rolling NSA

 

INITIAL CLAIMS: HURRICANE ISAAC PUSHES CLAIMS HIGHER, UNDERLYING TRENDS STILL POSITIVE - S P

 

INITIAL CLAIMS: HURRICANE ISAAC PUSHES CLAIMS HIGHER, UNDERLYING TRENDS STILL POSITIVE - Fed

 

INITIAL CLAIMS: HURRICANE ISAAC PUSHES CLAIMS HIGHER, UNDERLYING TRENDS STILL POSITIVE - YoY

 

INITIAL CLAIMS: HURRICANE ISAAC PUSHES CLAIMS HIGHER, UNDERLYING TRENDS STILL POSITIVE - Recessions

 

INITIAL CLAIMS: HURRICANE ISAAC PUSHES CLAIMS HIGHER, UNDERLYING TRENDS STILL POSITIVE - Rolling Claims Linear

 

Yield Spreads

The 2-10 spread widened 13 bps WoW as the 10 yr treasury yield rose 16 bps. QTD, the 2-10 spread is averaging 1.34%, which is down 17 basis vs 2Q12. 

 

INITIAL CLAIMS: HURRICANE ISAAC PUSHES CLAIMS HIGHER, UNDERLYING TRENDS STILL POSITIVE - 2 10

 

INITIAL CLAIMS: HURRICANE ISAAC PUSHES CLAIMS HIGHER, UNDERLYING TRENDS STILL POSITIVE - 2 10 QOQ

 

Financial Subsector Performance

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

 

INITIAL CLAIMS: HURRICANE ISAAC PUSHES CLAIMS HIGHER, UNDERLYING TRENDS STILL POSITIVE - Subsector Performance

 

INITIAL CLAIMS: HURRICANE ISAAC PUSHES CLAIMS HIGHER, UNDERLYING TRENDS STILL POSITIVE - Companies

 

Joshua Steiner, CFA

 e

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.  

 


One Big Mess

ONE BIG MESS

 

 

CLIENT TALKING POINTS

 

PLEASE IGNORE THE RUMORS

Fib after lie after fib, there is always someone out there talking about China and how it has no concern for inflation (it most certainly does) and will still go into another round of easing soon, etc. This is nothing but nonsense. Six weeks of rumors have gone by and the Chinese stock market is still in the gutter. Now what do you say? Is there still hope in the form of central planner bailouts? We think not.

 

 

ONE BIG MESS

If the market goes up, it’s a mess for the economy. How? 0% rates are a bane for retirees with fixed-income portfolios, small business owners and higher commodity prices. If the market goes down, it’s a mess for the market. When stocks fall, everyone feels like a loser. Right now, growth is slowing all around us and while the market is up year-to-date still, it’s nothing to cheer about.

 

_______________________________________________________

 

ASSET ALLOCATION

 

Cash:                Down

 

U.S. Equities:   Flat

 

Int'l Equities:   Flat   

 

Commodities: Flat

 

Fixed Income:  UP

 

Int'l Currencies: Flat  

 

 

_______________________________________________________

 

TOP LONG IDEAS

 

NIKE (NKE)

Nike’s challenges are well-telegraphed. But the reality is that its top line is extremely strong, and the Olympics has just given Nike all the ammo it needs to marry product with marketing and grow in the 10% range for the next 2 years. With margin pressures easing, and Cole Haan and Umbro soon to be divested, the model is getting more focused and profitable.

  • TRADE:  LONG
  • TREND:  LONG
  • TAIL:      LONG            

 

PACCAR (PCAR)

Emissions regulations in the US focusing on greenhouse gases should end the disruptive pre-buy cycle and allow PCAR to improve margins. Improved capacity utilization, truck fleet aging, and less volatile used truck prices all should support higher long-run profitability. In the near-term, Paccar may benefit from engine certification issues at Navistar, allowing it to gain market share. Longer-term, Paccar enjos a strong position in a structurally advantaged industry and an attractive valuation.

  • TRADE:  LONG
  • TREND:  LONG
  • TAIL:      LONG

 

LAS VEGAS SANDS (LVS)

LVS finally reached and has maintained its 20% Macau gaming share, thanks to Sands Cotai Central (SCC). With SCC continuing to ramp up, we expect that level to hold and maybe, even improve. Macau sentiment has reached a yearly low but we see improvement ahead.

  • TRADE:  LONG
  • TREND:  NEUTRAL
  • TAIL:      NEUTRAL

  

_______________________________________________________

 

THREE FOR THE ROAD

 

TWEET OF THE DAY

“According to the Chinese papers today : Big stimulus will limit economic growth. They get #inflation.” -@HedgeyeDJ

 

 

QUOTE OF THE DAY

“After all is said and done, a lot more will be said than done.” –Unknown

                       

 

STAT OF THE DAY

$7.3 billion. The amount of money offered by Thai billionaire Charoen Sirivadhanabhakdi for beverage conglomerate Fraser & Neave. 

 

 

 


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