“Evolution does not rely on narratives, humans do.”
That’s just a money quote from Taleb on page 207 of Antifragile. Apparently Jaime Dimon liked the book so much, he called his bank antifragile. I assume he wasn’t talking about the Bear Stearns part. If you’d like my review of the book, please send me a note.
Reviewing the Bullish Narrative for US and Asian stocks requires one to evaluate the bearish one. The big one our institutional clients debate with me comes from a player I respect, Francois Trahan. His Bearish Narrative is grounded in inflation concerns.
His call is a lot like mine was at the end of 2010. I get that inflation expectations rising would be bad. But our call is Strong Dollar will drive the opposite – Commodity Deflation. That’s not just a narrative; that’s precisely what we have been seeing for all of February.
Back to the Global Macro Grind…
Strong Dollar = Commodity Deflation? That’s also what we have been seeing for 2013 YTD:
- US Dollar Index +2.3%
- CRB Commodities Index -1.0%
- SP500 +6.3%
Within the SP500’s +6.3% YTD return, the worst performing Sector ETF is Basic Materials (XLB) which is down -1.54% for February and underperforming badly at +2.34% YTD. If you want to be bearish on something, be bearish on Commodities and related stocks.
There’s also a Nouveaux Bear camp that thinks Commodities falling is the leading indicator that A) Global Economic Growth is going to slow and B) the US stock market is going down in flames. I have debated Dennis Gartman on this 2x on live TV in the last week.
Finally, there’s the central planning camp (led by Ben Bernanke) that is still bullish on the stock market’s “valuation”, and never thought we had the inflation we are deflating to begin with (Bernanke said in his testimony “I have the best track record on inflation since WWII”).
So, what is the Bearish Narrative?
A) Trahan: Debauched Dollar will drive us back to the bubble highs in Oil (2008), Gold (2011), and Food Prices (2012)
B) Gartman: Strong Dollar will drive Commodity Prices down, if Oil, Gold, Corn, etc go down, stocks are going down
C) KM: I’m actually just bearish on The Taro Aso and The Bernank lying to uninformed people
I usually have a decent Bearish Narrative on something (like the Yen here), but the bear case for Asian and US stocks is all over the place right now. Maybe that’s why the only down day for stocks in the last 4 came on a catalyst that none of these bears had to begin with (Italian Election). That’s not a research call, that’s being right for the wrong reasons (otherwise known as luck).
Another Q: KM, what about The Correlation Risk (inverse correlation vs USD) call that you used to trade Macro on during 2010-2012? First, Correlation Risks are not perpetual. And, second, our intermediate-term TREND correlation model is changing, big time, right now:
- Intermediate-term TREND correlation between US Dollar and CRB Index = -0.96 (short Commodities!)
- Intermediate-term TREND correlation between US Dollar and SP500 = +0.33
- Intermediate-term TREND correlation between US Dollar and MSCI Asia (Equities) = +0.52
In other words, both the Americans and the Chinese are loving Strong Dollar in more ways than one. It’s taking down Energy and Food Inflation. And it’s a tax cut that our central planning overlords are unable to provide.
That’s great for the one thing we haven’t had, sustainably, under either the Keynesian Bush or Obama regimes – real (inflation adjusted) economic growth. Of course, the government is always my Bearish Narrative, but I think my bullish one for stocks is still intact.
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, and the SP500 are now $1, $110.67-112.68 (Oil is bearish TRADE and TREND now; a very bullish catalyst for the economy), $81.28-82.13, 91.71-94.67, 1.85-1.96%, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
This note was originally published at 8am on February 14, 2013 for Hedgeye subscribers.
“All I really need is love, but a little chocolate now and then doesn't hurt!”
-Charles M. Schulz, Peanuts.
As I set about to find an appropriate theme for the Early Look this morning, I was reminded that it is Valentine’s Day. Now just how I was reminded of Valentine’s Day is interesting in and of itself; watching the news get interrupted by yet another commercial for Kay Jewelers pitching their seemingly endless collection of heart-shaped charms and sparkling pendants. Of course TV isn’t the only place I have been inundated with a Valentine’s Day message to exercise consumerism. All I had to do was to walk into my local pharmacy or discount store where I had to snake my way around displays of candy boxes in every shape, size, and assortment. Honestly, without these less-than-subtle reminders, Valentine’s Day might sneak up on me unnoticed and Hallmark might miss the sale of one additional card.
A lot of chocolates and gifts are bought for Valentine’s Day. According to the National Retail Federation, the average male will spend $175.61 this Valentine’s Day on gifts, jewelry, roses, chocolates, dates and more. Women will spend just less than $89. It is estimated that more than 58 million pounds of chocolate will be sold in the days leading up to Valentine’s Day. All totaled, it is estimated that $13.19 Billion will be spent.
Those same commercials that last night reminded me of Valentine’s Day were also omnipresent both before and after Tuesday evening’s State of the Union message. Thinking about the marketing effectiveness surrounding Valentine’s Day, I wonder if a similarly unavoidable marketing reminder of the rising United States debt, the current Federal deficit, and pending sequestration cuts would drive more timely decision making by the male and female constituents of congress. I bet they made their respective Valentine’s decisions before today!
From candy and gifts to the State of the Union.
Tuesday evening’s address seemed to me a rambling list of the wonderful things this administration is hoping to set in place during the balance of Obama’s term in office. And whenever I hear “hope”, I am now conditioned to question the means behind the anticipated “hoped-for” event. The President spoke of expansive government involvement ranging from building roads and bridges to pre-kindergarten education for four year olds, and from Social Security and Medicare to energy independence. Very little discourse was aimed at the funding of these proposals. Like walking into displays of chocolates around Valentine’s Day, does it not make sense to discover which ones are favored by your sweetheart first? Certainly, buying every option in the store so as not to neglect that one special favorite is less than efficient, if not financially impossible.
Not knowing what chocolates are favored, would you elect to push off Valentine’s Day a couple months if you could? Would you kick the can down the road and address the decision later? What if Valentine’s Day could not be delayed or postponed? What then of your chocolate choices?
At Hedgeye, we tend to simplify our thinking wherever possible and bring complicated matters down to sporting metaphors where appropriate. In this case, I think of the Federal budget as the foundation of any game plan for our government. Pending decisions for our congressional leaders seem too easily kicked down the road. Congress has failed to pass a Federal budget since 2009! How should we expect our leaders to make decisions that potentially influence our enemies and allies alike, positively and negatively, without a game plan? I played for some Hall of Fame coaches in Herb Brooks and Bob Johnson. Like Keith and Daryl, I also played for the legendary Tim Taylor at Yale. Whether it was hockey, football, volleyball, softball, tennis, golf, or any other sport, there was always a game plan!
The Federal Debt level is fast approaching $16.5 Trillion. It is estimated that 2013 will add another $900 Billion-$1 Trillion. Rienhart and Rogoff will argue that “Countries with debt to GDP ratios above a certain level (90%) tend to experience slower economic growth.” It certainly appears that the U.S. has reached the point where our debt levels significantly dampen growth.
Of particular interest to me during the State of the Union speech were the President’s plans projecting out a decade and longer. At Hedgeye we talk about duration and believe projections longer than three years out are highly subject to forecasting error. Already the US economy is showing anemic growth. The most recent figures showed a decline of -0.1% in US GDP during the fourth quarter. The CBO office is projecting 1.4% growth for fiscal 2013. And projecting 2.6%, 4.1%, and 4.4% in ’14, ’15, and ’16 respectively. Unfortunately, much of the US expenditure projections are not as flexible or easily manipulated as the revenue and economic growth assumptions.
Just for reference, the average US GDP growth rate over the past ten years was 1.7%. What is the real plan and how does Congress make it flexible enough to adjust for the game changing and to embrace the unknowns?
And what about the sequester and Congress? Referring to Congress after the State of the Union speech by President Obama, House Speaker John Boehner stated, “None of them have ever lived under a sequester. For that matter, neither have I…This is going to be a little bleak around here when this actually happens and people actually have to make decisions.” A sobering thought during times when decisions have to be made that will affect the lives and finances of so many.
My Valentine’s wish is for Congress to develop a game plan; one with real metrics, transparent to voters, and offering accountability.
As for chocolate choices, I know yours will be easier than the decisions that face our Congressional leaders. My Valentine’s Day game plan is simple. My wife will wake to a card on the counter under a package of Reese’s Cups. And I am likely to read my card from her as I down a handful of plain M&M’s with my morning coffee.
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, and the SP500 are now $1641-1667, $116.98-118.91, $79.71-80.31, 92.78-94.46, 1.96-2.01%, and 1510-1526, respectively.
Happy Valentine’s Day!
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Takeaway: We think JCP has big support at its pre-market range of $18-$19. It’s not for the faint of heart, but we think it’s in the high $20s in a yr
Conclusion: There's a tremendous amount of emotion in this one (almost all negative), and we think that JCP has tremendous support at its pre-market range of $18-$19. As surprised as we might be to the market’s reaction, we’re not going to argue with it – the same way we didn’t argue with the 24% peak-to-trough squeeze over the past 4-weeks. What we will do is prepare for an opportunity to get heavier in an name where our conviction is growing. Regardless of what the consensus thinks, the metrics that matter (cash, internet, eps) came in at or better than our model, and we remain confident in the cadence of shop rollouts needed to make this model work. This is definitely a ‘hold your breath’ name over the near-term. But we think it is in the high $20s in 12 months.
We’ve gotta say up front that we’re surprised to see the stock trading at the same level after hours that it was when we were seeing liquidity-fueled downgrades, $12-15 price targets on supposed equity offerings, and story-telling about Icahn buying JCP bonds as a backdoor way to push Ackman’s second-largest holding into bankruptcy.
Yes, the results were bad. But the comp was right in line with the -30%+ speculation that was widespread before the quarter. The only thing that was unexpected was the atrocious -640+bp decline in gross margins during the quarter. But let’s actually give RJ some credit (we have not given him any yet). He did what he had to in order to clean inventories to be ready for what will be a very big year for the company. Being heavy on legacy product while shops are being converted would be the end for him.
Also, as an aside, we liked the element of humility that Johnson brought to the equation (“last year’s pricing mistakes were all my fault”), which is a stark contrast to the hubris we painstakingly observed last year.
As it relates to shop rollout plans, he reiterated plans for 20 Home shops in over 500 (of the 700 being converted) stores by May. He highlighted what we already knew…that Home-related dollars in JCP stores are 25% of where they used to be (10% of square footage down from 20%, and productivity down below $100/ft vs prior levels nearing $200.) We’d only been modeling 30 shops added in 2013, and still come out bullish – now we’re thinking that they probably beat that (see our shop/comp algorithm math below).
Lastly, let’s not forget about the cash. That’s the first number we looked at when JCP printed. Despite management’s original goal of $1bn, we’d have been content (based on our liquidity math) with $500-$700mm. We got $850mm. On top of that, the company built up to a liquidity cache of $3.1bn. By our math, that will fund 2013’s operating loss, working capital, and 2 years of capex.
Could This Really Happen?
While we model all our names out 3-5 years in full detail (3-years is our TAIL duration), we never make an investment case based entirely on something that is likely to happen 5-years down the road. But for a name that looks so egregiously overpriced today on a negative earnings and cash flow base, we think it’s a must to at least understand the margin trajectory.
In the end, our model (which we’re happy to provide) gets JCP up to $3.15 per share in earnings (keeping in mind that JCP lost over $2 per share in 2012). Initially, that sounds outrageous to our ears. But we assume the following…
a) JCP adds 100 shops per our models in the tables below.
b) Sales per square foot only need to hit $166
c) Revenue gets to $18.7bn, a level it saw in 2008.
d) Gross Margins stay below 37% -- despite management’s 40% target.
e) SG&A gets to 26% of revenue. It starts growing again in 2014, but is leveraged by comps in ‘14-‘17
f) No financial deleverage.
g) No NOL carryforward usage.
What kind of multiple is fair on those results – keeping in mind that it will be on a parabolic margin and earnings recovery. Perhaps 15x earnings, or maybe 6-7x EBITDA? That suggests a stock price of about $47. Yes..we know. 2017 is an eternity away. But let’s discount that back annually by 15% and we get to a price of $27 in a year, and then $31, $36, $41, and $47 for 2014-17, respectively. We know that’s trying to get real cute with price scenarios. But we want to illustrate what this company could look like if management executes on the shop rollouts and regains share that it handed off to competitors like Macy’s Kohl’s, Gap, Target, and off price apparel retailers.
Coming into this evening’s earnings release, we had concerns that the company would disappoint versus consensus – those concerns were validated. We like the category and we like the company, and we want to like the stock, but we still need to see 1H ’13 consensus come down a shade(2%). Ultimately, we continue to believe that MNST’s superior growth profile isn’t being appropriately valued, in part because of ongoing regulatory overhang and in part because of weakness in the energy drink category in the U.S.
MNST reported Q4 results this evening, falling short of consensus on both the top and bottom line. Revenue growth was 15.0% (versus 17.6% contemplated by consensus) while reported EPS of $0.39 was $0.02 light of consensus.
What we liked in the quarter (the good)
- Sequential improvement in revenue growth versus a more difficult (420 bps) one year comp
- Sequential improvement in EPS growth versus a more difficult (930 bps) one year comp
- Sequential mitigation in gross margin declines against a marginally easier comp
- Continued share gains by MNST in the energy drink category
- Sustained strength in international sales (+29.6%)
- Aggressive share repurchase by the company in the quarter
What we didn’t like in the quarter (the bad)
- Continued year over year declines in the price per case (fourth consecutive quarter)
- Weakness in the broader energy drink category
What else (the ugly)
- Very difficult one and two year comps in 1H 2013
- Pending adjustments coming out of this release, we remain below consensus for 1H ‘13
We continue to like the longer-term prospects for the energy drink category in general and MNST specifically, but this quarter’s results are precisely the reason we haven’t been as vocal as we have been in other situations – we prefer to see a clear path to EPS upside before we get excited about a name.
Call with questions,
Bank of America (BAC) has substantially cleaned up its legacy mortgage exposures and the remaining costs associated with its housing exposure are finally quantifiable . As housing improves at an accelerating rate, the bank’s credit quality will continue to improve, adding to the bottom line. Finally, risks emanating from the housing bubble and the financial crisis are largely either behind the company, or baked into the stock price. Steiner sees BAC as the best play on strong housing among the major financial institutions.
As the financials sector emerges from crisis mode, BAC stock remains highly volatile. Investors tend to use price volatility as an indicator of a company’s fundamental stability. Steiner believes observers are discounting key ratios that are standard factors in the analysis of financial companies, based on a fundamental misunderstanding of current risks.
The banks hold more tangible capital today than they have in many years – in some cases, more than they ever held. Paradoxically, the market is using historical cost-of-capital calculations at a time when the whole risk profile of the sector has changed. Banks – BAC in particular – hold lots of capital. Tangible equity capital – not “risk-weighted capital” – is hard to manipulate.
Investors remain focused on the risks of leverage – the excesses that brought down the system. But Steiner points out, capital is the inverse of leverage. High levels of capital equals low levels of risk. Steiner says the market continues to charge a high-risk cost of capital at a time when risk is lower than it has been in many years.
Steiner believes the decline in volatility will dramatically reduce BAC’s cost of capital computation. Investors should also see a significant improvement in the bank’s margins and, as volatility declines, will change the way they account for risk. Steiner thinks this Best Idea has the potential to return 100% over the next one to two years.