“Waves are not measured in feet or inches, they're measured in increments of fear.”
Great stock calls come and go, but rarely are there times when one can ride a Macro wave that tees up broad-based outsized returns in Retail.
History points to three distinct time periods over the past decade where this worked on the long side:
a) January-November 2003 = MVR Retail Index +60%
b) March 2009-April 2010 = +165%
c) September 2011-September 2012 = +49%
Our process is leading us to one bet from here, and it’s that 2013 will not contain one of these periods. That is, unless, we see the retail group flat-out crash first. After all, in the three periods noted above, only one happened without a preceding selloff in the group before a subsequent rally.
There are two waves leading to our summation. One is Macro, and the other is Micro.
1) Macro: One thing that is critical to measure is the spread between the price consumers are willing to pay for apparel and footwear versus the price for which the wholesalers and retailers are buying the product. Simply put, one minus the other is a major component of the margin that all members of the retail supply chain fight over at the end of the day.
The beauty is, over the past year, they have not done much fighting. Following a historic surge in raw materials costs in 2011 we saw Consumer Price increases hold in the +4-5% range despite a reduction of 2-3% in actual costs in 2012.
That resulted in a quarterly run rate of about $3bn in ‘free money’ injected into the supply chain. We’re talking about $12bn in total for an industry that only generates about $30bn in annual operating profit. Some of this is yet to be reported in 4Q with a residual in 1Q13, but the fact of the matter is that we’re on the downside of this realization. It gets harder from here. This is a wave if we ever saw one…but it’s already crested.
2) Micro: This one is all about JC Penney. So many people get so caught up in their opinions of CEO Ron Johnson and his latest and greatest ideas like giving free haircuts to every school kid in America. But they don’t keep tabs on the big picture.
First off, size-wise JCP is about 8-9% of US apparel retail. To put this into perspective, it is about 4x as big to US apparel as Greece is to the Euro zone. There’s no way that JCP can have such a major change to its operating metrics without meaningfully shaking the rest of the ecosystem.
And shake it did in 2012. We don’t think it’s appreciated exactly how much share JCP has hemorrhaged in year 1. For the first three quarters of this year we’re talking over $2.7bn. When 4Q – the seasonally strongest quarter – is released, we’ll be looking at something closer to $4bn in annual share. This is coming off a base of only $17bn in revenue. Our sense is that the M’s, GPS’, KSS’ and TJX’s of the world are underestimating how much share JCP is handing them. Is it any coincidence that these companies posted some of their best growth rates in recent history as JCP imploded? This is not a permanent share shift by any stretch.
There's nothing wrong with this if the industry both acknowledges and plans around it. But ask the average CEO of an apparel company what they think about this. They'll deny that the JCP-factor is meaningfully helping them. Check M, GPS, TJX, and KSS conference call transcripts for the words “JC Penney”. You won’t find much. The industry is in denial. That means that their process around keeping the share is nonexistent.
The key distinction is that these companies need JCP to keep comping down 25% in order to continue to feel the same competitive benefits that they have today.
We have one simple question. What if JCP comps +1 for the year? That’s a +26% positive swing.
We’ll make the call right now that the company is more likely to comp positive than negative. We think they’ll have to pay for it, but we think they’ll get it. Also remember that 33% of JCP stores will be rebranded by the end of 2013. This will not make comping easy for anyone that competes with JCP, or sells into retailers that compete with JC Penney. JCP might ultimately be a zero, but it won’t get remotely close in 2013. Check out our 12/13 report “Reasons to Reconsider Your JCP Short”.
So...where’s the next wave? We think we’re in it and the barrel is collapsing. Get out of the way otherwise it could snap your board like a toothpick. On the short side, we like names that don't have much differentiation and are at the mercy of changes in the macro climate. Financial leverage is a plus. We’re talking GPS, M, KSS, and VFC. There are others that make the cut as well, but have some company specific reasons like CRI, FDO and GES.
On the long side, be careful, but there are companies with asymmetric setups that should work. That's NKE, FNP, RH and RL.
In the end, Jon Kabat-Zinn said it best…'you can't stop the waves, but you can learn to surf.'
Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now, $1, $105.95-108.94, $3.64-3.71, $79.36-79.99, $1.29-1.31, 1.69-1.80%, and 1, respectively.
Brian P. McGough
This note was originally published at 8am on December 05, 2012 for Hedgeye subscribers.
“Buying love is as stupid as loving money.”
Off the ice, I’m a sometimes cuddly Thunder Bay bear. And since it’s the holiday season, I decided to spread some of the holiday cheer and went shopping yesterday. I love buying things on sale, so I bought some US Consumer stocks. Why some people only buy these things when they are green is still beyond me.
Clearly, buying the love here requires a suspension of disbelief. I get that. But I am also getting used to getting that. For most of 2012, the economy has not been the stock market. On global #GrowthSlowing, the bond market has been closer to the truth.
But what is the truth? That’s a question that people have been asking since Pythagoras did circa 530BC. I’m sure Christopher Columbus found some not so true truisms when he landed on the shores of Hispanolia today in 1492 too. We’re always learning something.
Back to the Global Macro Grind…
The truth is that it helps to know when someone is lying to you. For example, look at the fine folks of the Political Class in Greece. Today, the Greeks got the nod as the “most corrupt” country in the European Union. Nice. Must do more bailouts.
In other love-oriented news this morning, it turns out that France’s sperm count just dropped by 32%. Now, if you are a single French male getting taxed at 75%, that’s a problem. The good news is that this isn’t new news. The French study cited by BBC News Europe this morning goes back to 1989. Centrally planned life was not cited as causal.
On a more serious note, why would you love buying US Consumer stocks here? The reason for that is as simple as it has always been in our Global Macro Economic model – deflating the Bernanke’s Bubble (commodities) is a real-time tax cut.
I know, I know – the whole Marxist tax demagoguery thing is still a factor out there. And I’m certainly not trying to downplay the confidence interval you’ll need to have in the bottom-up research that will get you to buy something on sale (74% of companies issuing guidance so far in Q412 have guided lower ) - but tickle me with something that isn’t French this morning and humor me.
The immediate-term risk management setup for US Consumer Stocks is as follows:
- SP500 held its immediate-term TRADE support line of 1404 yesterday
- Consumer Discretionary (XLY) held its immediate-term TRADE line of $46.49
- Consumer Staples (XLP) held its immediate-term TRADE line of $35.28
From an intermediate-term TREND perspective, the Commodity Deflation setup looks equally bullish:
- CRB Commodities Index Inflation remains in a Bearish Formation (bearish TRADE, TREND, and TAIL)
- Brent and WTI Crude Oil prices remain in Bearish Formations as well ($111.58 and $92.20 TAIL resistance, respectively)
- Food Prices (Coffee, Corn – and don’t forget Wheat! “cream of wheat” –Woody Allen) are in Bearish Formations too
So, while deflation of certain asset prices may not be good for some in the Political Class, it’s really good for the Rest of Us. If they are going to tax everything and anything that isn’t locked down, we’ll take some back-pocket relief where we can find it.
What are the risks to Buying The Love in US (or Global) Consumption stocks?
- The Government
- The Government
- And, The Government
You see, it’s only the Government that can impose Policies To Inflate on its people. Bastiat and von Misses called it plundering. That’s what politicians do – they plunder you so that they get paid (that’s why they call your taxes, “revenues”).
Moving along… In other globally interconnected market news this morning:
- Chinese stocks stopped crashing (up huge overnight at +2.87% on the Shanghai Composite)
- Russian stocks = +1.75% today (out of crash mode as well, now only -17.5% from the March #GrowthSlowing top)
- Both Global Equity Volatility and Sovereign Bonds (Treasuries and German Bunds) are finally overbought
When bonds and volatility are immediate-term TRADE overbought, it’s easier to fall in love with stocks (for a day) too.
Our Risk Ranges (support and resistance) for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1694-1711, $109.12-110.69, $3.54-3.68, $79.52-80.32, $1.29-1.31, $1.59-1.66%, and 1404-1419, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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We’ve always been a fan of Chinese steel rebar as an indicator of Chinese construction activity. The spot price of Chinese rebar is now nearing 2009 lows, reflecting weak demand for the commodity. There’s now a wide spread between the price of Brent crude oil and Chinese rebar, which historically had a positive correlation. It will take a stronger US dollar and a boost in Chinese construction to bring the two commodities together again.
Wynn Resorts (WYNN) has had a tough time in Macau this year. The company is struggling to collect market share and revenues have been flat versus 2011 figures. While the Street consensus is that WYNN will see EBITDA growth of +3% over the next quarter, we see it falling 4%. Unless Wynn changes its junket commission and/or credit strategy, EBITDA growth is likely to remain flat at best until Wynn Cotai opens in 2016. Right now, the stock is under pressure with slowing market growth and hurdles like smoking restrictions and crackdowns on corruption in Beijing.
Takeaway: Performance categories returned to +HSD growth this week.
On the heels of recent volatility in athletic footwear retail names, this week’s athletic footwear sales came in better on the margin though underlying trailing 3-week figures decelerated reflecting the third consecutive week of industry sales declines.
Importantly, performance categories where FL and FINL are over-indexed were up +7.4% on the week compared to the broader industry down -3.7% reflecting a sharp rebound from last week and a return to a HSD growth trajectory.
The key brands of note continue to be Nike, Brand Jordan, and Under Armour who all gained share this week. We remain positive on NKE and FL and cautious on UA near-term.