“Our support goes to those who struggle to gain those rights or keep them.”
-Franklin D. Roosevelt
Our struggle in 2013 will be no different than the struggle we’ve endured for the last 5 years. Our struggle for economic freedom is intensely personal. Both parties have violated us. That’s why it feels as real as gaining or keeping our natural rights has ever felt.
In his State of the Union Address of 1941, Franklin D. Roosevelt united America and those fighting socialism/fascism in his “Four Freedoms” speech. On page 258 of The Last Lion, Paul Reid reminded me of this epic moment in American leadership:
“We Americans are vitally concerned in your defense of freedom… This is our purpose and our pledge… We look forward to a world founded upon essential human freedoms:
- “The first is our freedom of speech and expression…”
- “The second is freedom of every person to worship God in his own way…”
- “The third is the freedom from want…”
- “The fourth is freedom from fear…”
Obviously this is not WWII. But it isn’t the time to abandon our struggle for our freedoms and liberties either. Living in fear of a cliff that politicians create and perpetuate is no way to live. With America’s balance sheet under ideological attack, I submit these principles to you for your deliberation and debate. On this #KeynesianCliff of deficits and debt, you are the last line of defense.
Back to the Global Macro Grind…
To kick-off 2013, I need to do a better job communicating our process. For those of you new to it, there are two big parts: fundamental RESEARCH and quantitative RISK MANAGEMENT. Over the years, I’ve made enough mistakes to learn that I need to respect both. They aren’t always signaling the same thing. When they are, I have more conviction.
Quantitatively speaking, our read-through on the US stock market is bullish provided that the SP500 is trading above our intermediate-term TREND line of 1419. Our call on bonds (provided that 1.70% TREND support on the 10yr holds), is now bearish. That’s why I am starting 2013 with a 0% asset allocation to Fixed Income.
From a fundamental research perspective, for over a month now our Globally Interconnected Macro Model has been signaling an important shift from global growth slowing to #GrowthStabilizing. On the margin, that matters.
So does rising volatility associated with the US government being the market’s daily catalyst. The VIX went from up +22.4% last week to down -20.7% in a day (Monday)! If you nailed both sides of those moves, congrats. No one said our daily struggle was easy.
As a reminder, our long-term thesis on Big Government Intervention is that:
- It amplifies market volatility
- It shortens economic cycles
Point #1 is trivial. Point #2 less so. On that score, I think I confuse some people when I say growth, globally, has gone from slowing to stabilizing. The point in and of itself isn’t confusing as much as how I risk manage the market on that is.
Remember, the economy is not the stock market. So you can easily see a market rip as growth slows inasmuch as you can see it collapse as growth stabilizes. There’s no rule in markets that states they have to make sense. So keep moving out there.
#GrowthStabilizing RESEARCH and RISK MANAGEMENT signals of the day:
- British Manufacturing PMI for DEC shot back above the expansion line (50) to 51.4 vs 49.1 in NOV
- India’s Manufacturing PMI hit a 6-month high of 54.7 in DEC vs 53.7 NOV
- Italy’s PMI finally stopped collapsing, sequentially, registering an uptick to 46.7 DEC vs 45.1 NOV
- Indonesian inflation (CPI) joined that of South Korea’s, slowing in DEC to 4.3%
- South Korea’s KOSPI shot to higher-highs overnight (vs SEP highs), +1.7% to 2031 (bullish TREND)
- Hong Kong’s Hang Seng Index ripped another higher-high (vs SEP), up +2.9%
- Germany’s DAX is taking out its recent highs, +1.7% this morning (bullish TREND)
- Both Brazilian and Canadian stocks markets closed at bullish TRADE and TREND levels at yr end
- CRB Commodities Index remains bearish TAIL (306 resistance) – good for consumption growth
- UST 10yr Treasury Yields are flying higher this morn to 1.82% after holding 1.70% TREND support
Of course, there’s always bearish growth data somewhere (German Manufacturing PMI slowed sequentially to 46.0 DEC vs 46.8 in NOV and Brent Oil is inflating back above its TAIL resistance of $111.58/barrel). But that’s not enough to knock me off this #GrowthStabilizing puck.
From these implied multiple expectations, the most bearish fundamental research factor affecting US Equity and Bond markets (on both a relative and absolute basis) compared to China and Germany is crystal clear: Congress.
And unless Our Struggle ends in victory versus these Keynesian quacks who get paid to lever your country up with debt and deficit spending, this short-term economic growth pop will be as short-lived as every one that’s come before it since 2008.
Our immediate-term Risk Ranges (support and resistance) for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1, $109.99-111.89, $79.21-79.98, $1.31-1.33, 1.73-1.85%, and 1, respectively.
Best of luck out there in 2013,
Keith R. McCullough
Chief Executive Officer
This note was originally published at 8am on December 19, 2012 for Hedgeye subscribers.
“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, $1685-1709, $105.95-108.94, $3.64-3.71, $79.36-79.99, $1.29-1.31, 1.69-1.80%, and 1419-1436, respectively.
Brian P. McGough
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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.”
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:
- #GrowthAccelerating = our call until January 24th when Bernanke imposed his Policy To Inflate (JAN25)
- #GrowthSlowing = our call starting in late-Feb, early March as food and oil prices ripped consumers, globally
- #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:
- We’re net short commodities and commodity related equities
- We’re net long consumption and consumer related companies profiting from commodity deflation
- 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
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.
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:
- Estimates Are Too High. We’re modeling flattish earnings in 2013, the consensus is looking for growth of about 13%.
- 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.
- 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.
- 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.
- 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 – dot.com. 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.
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