Reflexivity. Reflexivity asserts that prices do in fact influence the fundamentals and that these newly-influenced set of fundamentals then proceed to change expectations, thus influencing prices; the process continues in a self-reinforcing pattern.
Last night we celebrated another great year, our fifth, at our firm’s annual holiday party. Not thinking ahead, I agreed two days ago to write this morning’s Early Look. Keith was proactively managing risk, as usual.
Housing has been in the news a lot recently. A few days ago, Corelogic reported that home prices had risen 6.3% in October vs. the prior year, the fastest rate of growth in a long time. What’s more, Corelogic provides an early look into the following month – something they’ve been doing for the last few months – that showed November’s growth is even stronger at +7.1%. Those are some serious numbers. It’s no longer just Wall Street taking notice. Main Street is starting to pay attention too.
Housing is reflexive. I would argue it’s also a Giffen good. Giffen goods are things people buy more of when the price rises. To economists, Giffen goods are a paradox, something that should not/cannot exist. In fact, at one point in time, the only Giffen good thought to have ever existed was potatoes in Ireland during the Great Irish Potato Famine. Economists later published papers on why this wasn’t a Giffen good after all.
Why would anyone buy more of something as the price rises? The short answer is because he or she expects the price to keep rising. Consider some empirical evidence from the housing market. In 1999, the median priced home in the U.S. cost $137,000. That same year, the Mortgage Bankers Association, or MBA, showed that demand for houses, as measured by their mortgage purchase applications index, stood at 276. Fast forward six years, and by 2005 the median priced U.S. home cost $218,000, an increase of 59%. Meanwhile, demand for homes had risen to 471 on the MBA index, an increase of 70%. Apparently, when houses cost 59% more, we choose to buy 70% more of them.
Fast forward another six years, to 2011, and median price had fallen to $165,000, a decline of 24%. Demand? Demand fell to 180, a drop of 62%. So, again, when houses cost 24% less, we bought 62% less of them. It’s pretty clear that housing is, at a most basic level, a Giffen good. Rising prices stoke greater demand, which fuels rising prices. That cycle, of course, works in reverse too.
So, whether it’s reflexive or a Giffen or a potato, it’s with this dynamic in mind that we’re hosting our 11am call this morning entitled “Could Housing’s Recovery Go Parabolic in 2013?” If you’d like to listen, email .
Our contention is that housing’s positive momentum is accelerating. On the call we’ll explain the underappreciated role being played by falling rates, growing modifications, and the upside potential from credit easing. We’ll also be laying out our new home price models in the context of supply and demand across the three major markets: existing, new and distressed homes. Of course, we’ll also be flagging the stocks we see as major winners from this dynamic.
Taking a step back, it’s worth reminding investors why housing matters. My sector, Financials, is up 21.9% year-to-date. Bank of America is up 88% year-to-date and is trading at a new high for the year. While there are several reasons why, none is more important than the improvement we’ve seen in housing. Housing is still in the early stages of a secular recovery that will last for years. Similarly, Financials are in the early stages of their own recovery. 2012 has been a good year for both so far (after having endured five straight years of misery), and we expect more progress in 2013 fueled largely by housing.
Josh Steiner, CFA
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Takeaway: We are inclined to officially suspend our bearish bias until further notice.
- With the fresh passage of the multi-brand retail initiative as a catalyst for further reforms ahead, we are officially out of political catalysts on the short side Indian equities from a fundamental perspective and are inclined to officially suspend our bearish bias until further notice.
- That said however, India’s India’s GIP outlook remains particularly grim, which drastically constricts the margin for error on any slip-ups on the POLICY front over the intermediate term.
This morning we received news that Indian Prime Minister Monmohan Singh secured the “backing” of an integral party within the ruling coalition on his multi-brand retail FDI bill, which should officially be ratified in Indian parliament tomorrow by a count of 253 to 218, per the latest tally. We use quotations around “backing” as the Bahujan Samaj Party didn’t actually support the initiative with votes per se; rather, their abstention paved the way for the Congress-led ruling coalition to push through one of its hallmark economic reforms.
As an aside, the sheer nature of this “victory” is a stark reminder of the difficult road Prime Minster Singh & Co. have ahead with regards to implementing further investor-friendly initiatives over the intermediate term. Political opposition remains great as the ties binding ruling coalition together continue to be quite loose. In spite of today’s events, the retail FDI initiative still hangs in the balance, as State level governments ultimately have the final say on implementation.
Even so, we do side with the forex market’s reaction (INR up ~80bps vs. the USD on the day; at a ~1 month high) in that this event could be a catalyst to propel further reforms and/or, at the very least, positive sentiment and speculation ahead of potential future POLICY maneuvers ahead of the 2014 parliamentary elections (such as opening up the insurance and pension fund industries to FDI as well).
Moreover, this “win” comes on the heels of Singh skirting a no-confidence vote recently (rejected by Lok Sabha Speaker Meira Kumar on lack of support from members). In light of this string of positive news, we are not surprised to see that foreign investor participation in Indian capital markets continues to make new all-time highs.
On the flip side, we still maintain our view that the confluence of the reforms announced in the year-to-date do very little to correct India’s TREND and TAIL duration GROWTH concerns; nor do they adequately address rampant domestic INFLATION that the RBI has called out on multiple occasions. Refer to our 10/29 note titled: “THE TOPPING PROCESS IS UNDERWAY IN INDIA” for a detailed list of recent measures, as well as the logic behind our conclusions.
That being said, the SENSEX, which is up +6.2% since we introduced our bearish bias in a 9/20 note titled: “IS IT TIME TO GET OUT OF INDIAN EQUITIES?”, remains bullish from a TRADE and TREND perspective on our quantitative factoring. In the conspicuous absence of further political catalysts, we inclined to officially suspend our bearish bias on Indian equities and the Indian rupee until further notice.
Not to completely throw ourselves under the bus, the SENSEX is in a bull market (up +21.9%) since we told investors to cover shorts and/or get long in our 6/4 note titled: “BACKING OFF OF INDIA – AT LEAST FOR NOW” and up another +11.9% since we reiterated that call in our 8/6 note titled: “DO INDIAN EQUITIES HAVE ROOM TO RUN?”. For context, that compares to the regional median gains of +14.1% and +5.2%, respectively, over those durations. We’ve obviously paid the price for being too cute by inverting our stance over the past couple of months.
Looking ahead, India’s GIP outlook remains dour (as supported by the Services PMI hitting a 13-month low of 52.1 in NOV) , which drastically constricts the margin for error on any slip-ups on the POLICY front over the intermediate term.
As such, if we don’t see any follow through from today’s gains via PRICE and capital inflows, we would not hesitate to hop back on the short side here if this market starts to break down quantitatively. At a bare minimum, however, investors should probably be cautiously moving towards the sidelines, as the POLICY expectations remain asymmetrically skewed to the bullish side of the ledger.
Jumping ship over to Indian monetary POLICY, we will receive NOV CPI data on the 12/12 and the NOV WPI data on 12/14. As previously demonstrated, our models point to higher-highs in Indian INFLATION readings over the intermediate term, a view supported by rupee weakness (down -5% over the LTM vs. +2% for the CRB Food Index and +2.6% for Brent Crude Oil) and ultra-easy monetary POLICY (-1.6% real repo rate; RBI recently monetized $2.2B of INR debt via open market operations).
With reported INFLATION poised to diverge from the RBI’s +4-5% “comfort level” over the intermediate term, there is risk of accelerated expectations for monetary tightening in India – an event not currently being priced into the OIS market, which actually expects one 25bps cut over the NTM.
All told, with the fresh passage of the multi-brand retail initiative as a catalyst for further reforms ahead, we are officially out of political catalysts on the short side Indian equities from a fundamental perspective and are inclined to officially suspend our bearish bias until further notice. That said however, India’s India’s GIP outlook remains particularly grim, which drastically constricts the margin for error on any slip-ups on the POLICY front over the intermediate term.
Takeaway: With $3 in earnings power over the next 2yrs reflecting rev & EPS growth of 30%+ and 25%+ in '13 & '14, we can’t bet against this one here.
While not outright bullish on LULU, we came away from the print tempering the negative bias we had in prior quarters about trends in new store productivity. New store productivity is still hardly knocking the cover off the ball at a sub-50% level. But it stopped getting worse, and we think that the acceleration in the International story is a clear positive as it relates to perception in hitting LULU’s lofty growth goals over the next 3-years.
The cost of growth is still a concern. In fact, LULU fessed up that higher costs to grow its international presence to buy higher priced real estate will take-down margins from current levels. While we don’t like to see that directionally, let’s face the reality that this is still a sustainably high margin concept with anomalously high asset turns resulting in return on operating assets over 100%. If there’s a trade off between sales and margin it might matter for most companies, but we
think that LULU could sustain this hit without giving up its multiple.
This brand is in a rarified class of great global brands with great growth runway ahead. But like UA, we use ‘global’ loosely with less than 5% of sales currently generated outside of North American borders. That’s about to shift meaningfully and will be a key driver behind ~30% top-line CAGR over the next 3-years. Growth like that is tough to find in retail. At the end of three years, International should be 15% of sales for LULU, slightly ahead of what we previously assumed.
Following favorable tests, LULU is officially moving forward with plans for expansion into both Asia (Hong Kong & Singapore) and Europe (London & Germany) over the next 2-3 years. While this is likely to cost a few points of margin in the process, an investment cycle like this is what can get this brand from $1.4Bn to $3-$4Bn+ over the next 5-years as it continues to develop and create new product opportunities as only LULU can.
One of our concerns on the name recently has been eroding new store productivity trends – that reversed this quarter for the first time in the last six. While positive on the margin, it’s still something to watch closely particularly as the company looks to open larger stores overseas. Larger stores mean higher sales per store, but it’s higher sales per square foot that matters.
It helps that LULU is seeding the market by launching e-commerce and showrooms ahead of stores, but the reality is that even if these stores are targeted for higher density locations it’s simply tougher to squeeze higher productivity out of a bigger box. Given the revenue opportunity associated with this initial investment, we’re willing to give LULU a pass during the early stages as long as we see the incremental revenue growth to justify the effort (and spend).
The setup over the next two quarters – particularly on the top-line – is a tough one for LULU, but international growth should start to hit just as that gets easier next year (Q2/Q3) signaling a significant acceleration in growth over the back-end of what we call ‘intermediate-term’ (2-3 quarters). With $3 in earnings power over the next two years reflecting revenue and EPS growth of 30%+ and 25%+ in 2013 and 2014, we can’t bet against this one here.
Per Keith’s risk management levels, a close above LULU’s immediate-term TRADE level of resistance of $71.34 would suggest a bullish setup near-term.
LULU Risk Management Levels:
LULU SIGMA reflecting return to positive sales/inventory spread:
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