Animal Kingdom

This note was originally published at 8am on December 18, 2012 for Hedgeye subscribers.

“In the animal kingdom, the rule is eat or be eaten; in the human kingdom, define or be defined.”

-Thomas Szasz


If 2012 has driven you right batty, I highly recommend reading the Classical Liberal work of the late psychologist, Thomas Szasz. Particularly in our profession, you have to be proactive in defining your process.


Make no mistake, on #OldWall there was a big business in being perma. There were Perma-Bulls and Perma-Bears. Now, on #WallSt2.0, there are Perma-Risk Managers who understand risk isn’t “on or off.”


Risk is always on. And it moves both up and down, fast.


Back to the Global Macro Grind


In the animal kingdom (Canadian Junior Hockey), I learned the rule of taking a punch square in the face, fast. In the human kingdom (Wall Street), I’m re-learning the rules every day. Define your process, and evolve it as the game does. The rules are always changing.


In the last week, I hope I’ve been crystal clear in both communicating and acting on what our Global Macro Process has been signaling on global growth. To review 2012:

  1. #GrowthAccelerating = our call until January 24th when Bernanke imposed his Policy To Inflate (JAN25)
  2. #GrowthSlowing = our call starting in late-Feb, early March as food and oil prices ripped consumers, globally
  3. #GrowthStabilizing = mid-Nov to early-Dec, as commodity deflation takes hold, consumption stabilizes

I use hash-tags on #Twitter to hold myself accountable to the #TimeStamps implied by both our Research and Risk Management views. If you follow the Perma-Bull and Perma-Bear guys closely, you’ll notice that they are constantly changing their thesis.


Top down, our Global Macro Process has 3 big factors (our GIP model):


The aforementioned shifts in GROWTH are happening faster right now because that’s what Big Government Intervention does:


A)     It shortens economic cycles

B)      It amplifies market volatilities


All the while, Keynesian government policy makers are trying their very best to ramp #2 (asset INFLATION) via #3 (POLICY to inflate via currency devaluation).


Japanese bureaucrats are so impressed by what Bernanke appeared to have achieved at the September 2012 highs (3% higher in the SP500 at 1474, where inflation slowed growth), that they just convinced their people to burn their currency at the stake. For that, the Nikkei is +14.6% in the last month, but real (inflation adjusted) Japanese growth is slowing.


If POLICY makers of the Keynesian Kingdom want to really get this party started, they should go full Krugman/Chavez on these markets. Then Perma-Bulls will really be right for all the wrong reasons (after torching their currency, Venezuela’s stock market is up +305% YTD).


Back to the process, the asset allocation, net exposure, and sector moves we have made in the last month are as follows:

  1. We’re net short commodities and commodity related equities
  2. We’re net long consumption and consumer related companies profiting from commodity deflation
  3. We cut out asset allocation to Fixed Income to 0% on Friday

To be clear, before I rile up pension funds, this is how I think about asset allocation with my own money. Since I can (and often do) go to cash, I have no problem selling something down to 0% if I think the asset class and/or security has a rising probability of a draw-down.


Always remember Rule #1 – don’t lose money (Buffett, pre being politicized).


From a Risk Management Process perspective, this is where my multi-duration signals play a huge role. When something signals bearish TRADE and TREND (like US Treasury Bond Yields did last week), and the Global Macro Research Process confirms it, I sell.


I also buy things when they are immediate-term TRADE oversold (bought AAPL $502.50 yesterday), but that’s a different risk management strategy, on a shorter-term duration. Our longer-term risk management decision was to sell APPL on September 28th.


In a profession where I see less and less people who actually know what it is that they do, I think there is a tremendous opportunity for all of us to evolve and attempt to explain what it is that we do. People want to trust us – and we don’t need animals eating us.


Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, AAPL, and the SP500 are now, $1685-1709, $105.95-108.94, $3.64-3.71, $79.36-79.99, $1.29-1.31, 1.69-1.80%, $501-532, and 1419-1436, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Animal Kingdom - Chart of the Day


Animal Kingdom - Virtual Portfolio


Today we covered our short position in Phillip Morris (PM) at $82.61 a share at 10:01 AM EDT in our Real-Time Alerts. We originally put on the short at 9:38 AM on December 28, 2012 at $83.69 a share. PM remains one of our best short ideas in Consumer Staples; the importance of the #timestamp continues.


TRADE OF THE DAY: PM - image001

M: Idea Alert. Shorting.

Takeaway: We’re taking the other side of today’s intraday bounce.

We added Macy’s to the short-side of our Real-Time Positions with the stock hitting lower highs today. There are a number of a reasons we don’t like M’s setup headed into 2013:

  1. Estimates Are Too High. We’re modeling flattish earnings in 2013, the consensus is looking for growth of about 13%.
  2. Can't Comp Forever. The Street is banking on another 2-3% comp for Macy’s next year. Seriously? Go back into the pages of retail history and find a time when Macy’s comped up 4-years in a row. Have fun with that research. It’ll take a while.
  3. JCP Matters Now. Is anyone considering that precisely 1-year ago JC Penney started hemorrhaging revenue, and essentially handed over $3bn in sales to anyone who wanted it? We’ll give Macy’s (and GPS) all the credit in the world…they saw the opportunity, and they took it. But JC Penney is coming on strong. What people don’t get is that even if JCP fails miserably in putting the wrong higher-end brands in front of an audience who could care less, the inventory still needs to be sold…somewhere, somehow. To think that this will not come back to haunt M is being intellectually dishonest.
  4. How big of a deal is JCP? We’re talking roughly $2.8bn over four quarters if our estimates are right. To put that into context, that equates to about 10% of Macy’s sales right there. We’re not saying that Macy’s got it all – or even half (Heck, KSS comped down during this period so we know it wasn’t them). But 2-3% comp points worth? We think so. Macy’s management won’t agree with that assessment, but the reality is that there is no way for them to know why people walk into their stores, or walk right by. One fact that is impossible to argue with is that we are just beginning to start off on a period where Macy’s needs to comp against these share gains -- whatever they are. Let’s say that they are prepared…I can promise you that all of their competitors are not. Desperate competitors equals an unhealthy environment.
  5. They'll Get It The Painful Way. In the end, we think that if Macy’s wants the comp, they’ll get the comp. But they’ll need to buy it. And we quote CFO Karen Hoguet…“We’ve consciously tried to bring more goods into the stores to help us transition to the Spring and have more newness as Christmas approaches and for a post-Christmas strategy. So this is a conscious change from what we’ve done in the past.” Much like we see with JCP, the merchandise will need to be sold.


The way we look at it, the best bull case is that even with EBIT down 5% next year (which we think will happen) we still get to earnings being about flat. Due to the debt tender and share repo activity, the financial engineering here rivals what we saw at GPS for much of the past decade. Tack on the potential success of My Macy’s and the Millennial Stores, and we’re looking at yet another year where M comps consistently higher, and add on 100bp leverage in gross margin as a result without commensurate SG&A spend. Add on some financial engineering… and you get to about $4.75 in 2013 earnings – suggesting that the stock is actually trading at 8.2x earnings and ~5x EBITDA today.

Do you REALLY want to pay 8.2x/5x for a department store under the assumption that everything goes absolutely perfect?


This a business that has no square footage growth, no ‘birthright to comp’ in its core, struggles to consistently earn its cost of capital (what happens when lease accounting rules change and M has to account for its property?), and has zero competitive advantage in the core area that will be driving incremental consumer purchases for generations to come – Try as they will with ‘The Millennial store’ and My Macy's, but the reality is that as they grow, our kids are unlikely to go en masse to Macy’s to buy their apparel at a rate greater than what we’re doing today. If they do, it will be the result of some considerable capital investment that we have yet to see (or model).

In the end, if our numbers are right, there’s no reason why this stock deserves a double digit multiple on an earnings number that people realize is shrinking. Zero growth retailers have traded at 6x forwarded earnings – several times – and there’s no reason why M can’t test that again. A 10x multiple on $4.75 suggests $8 in upside from here - that's good. But when considering a 6x-7x multiple on $3.00 in earnings, we don’t like the risk/reward here as we look out over the next 12-months.


M: Idea Alert. Shorting. - M TTT



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Stocks Around The World

Now that 2012 is coming to a close, let’s take a look at how equity indices around the globe performed. Germany’s DAX took the prize for the largest percentage gain while the Shanghai Composite in China churned out a small gain to close the year positive.


  • S&P 500: +12%
  • DAX: +29%
  • Shanghai Composite: +3%
  • Nikkei 225: +23%
  • Eurostoxx 50: +11%


Stocks Around The World - image001

Housing: Simply The Best

Housing is one sector that is enjoying a meaningful recovery after a long downturn. It seems that nearly every other day there is a new data point that supports the recovery in housing; things just keep getting better every day. The latest data we have is Pending Home Sales; November’s data was surprisingly strong with an increase of 1.7% month-over-month following October’s 5.0%. We expect future data in pending home sales to remain strong.


Housing: Simply The Best - image001


Housing: Simply The Best - image002

The Big Day

Client Talking Points

The Right Stuff

This whole cliff mess is quite funny when you look at what has occurred over time. The US government has changed how it calculates inflation nine times since 1996. This way, it looks like there’s never any real inflation to report, no matter what Bernanke does. But we’re not fools and you aren’t either. We know inflation when we see it and as well as deflation. The commodity bubble that Bernanke helped create is now deflating as growth stabilizes. If we want further recovery, we need to strengthen the US dollar in addition to deflating commodity prices. It worked for Reagan and Clinton. Why not give it a shot after our failed Keynesian efforts?

Judgment Day

Today is the last day of the 2012. It’s also the last day until we “officially” hit the debt ceiling although some economists would argue that. Can the President and Congressional Democrats and Republicans put aside their differences and actually serve the people of this great country for once? We’re about to find out. 

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

Our competitors are neutral to bearish on the name ahead of earnings, but we think they’re missing the bigger picture. We think concerns over the shoe cycle rolling over are overdone. With R&D in the mid-teens, NKE has the ability to drive the ‘sneaker cycle’ in a case of “the tail wagging the dog”. We also think $NKE is a candidate for releasing a special dividend when they report EPS next week.


Uncertainty in US from a macro perspective (jobless claims uptick) gives us pause from TRADE perspective although coffee prices will serve as a tailwind going forward. Company is becoming more complex, taking on risk as it acquires new brands. Longer-term, we view Starbucks, along with YUM, as one of the most attractive global growth stories in our space.


Margins are in a cycle trough as the USPS is on the brink. FDX is taking more share in the U.S. and following the recent $TNT news flow we think $UPS is in a tough spot.

Three for the Road


“Looks like a full trading day” -@Marketshot


“An ignorant person is one who doesn't know what you have just found out.” -Will Rogers


Shanghai Composite Index closes up +15.8% from its December low (+1.6% for the year) as global growth stabilizes. 

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.