“He gave the nation the idea of American progress.”
That’s what John Meacham wrote about Thomas Jefferson in his prologue to the latest brick I tackled on a flight yesterday to San Francisco, California: Thomas Jefferson: The Art of Power.
“To his friends, who were numerous and devoted, Jefferson was among the greatest men who ever lived… to his foes, who were numerous and prolific, Jefferson was an atheist and a fanatic, a demagogue and a dreamer.” (Prologue xxiii)
Do you have a vision for your family and firm? Are you a dreamer? I am. And I’m damn proud of it too. Listening to politicians who don’t get liberty, free markets, and the purchasing power of success (#StrongDollar) has run its course. It’s a cycle. And so is American Progress.
Back to the Global Macro Grind…
At this point, the sequential progress in the US Economic data from December 2012 to March 2013 is glaringly obvious. When my signals tell me to, I have no problem fighting the Fed. But I don’t fight the data.
From US Housing to Employment (they progressed first), to more coincident economic indicators like yesterday’s ISM Services report (best since 2011), the risk management question now isn’t “where do I sell?” It’s “could growth stabilizing become #GrowthAccelerating?”
We analyze a lot of “stuff”, but some of the more forward looking “stuff” comes in the form of new order growth:
- ISM Manufacturing New Orders accelerated from 53.3 in JAN to 57.8 in FEB
- ISM Services New Orders accelerated from 54.4 in JAN to 58.2 in FEB
- PMI Manufacturing New Orders accelerated from 58.2 in JAN to 60.2 in FEB
So, if you use that “stuff” (otherwise known as economic data), you’d answer yes to the question of recent American Progress. But these are new orders, what about new consumption growth tailwinds that we didn’t have in JAN or FEB?
How about Oil prices coming down? Amidst all of the #PoliticalClass fear-mongering about the spending problem they created, could Sequestration = Strong Dollar = Down Oil = Stronger real (inflation adjusted) Consumption Growth?
I’m no atheist, and my loathers can call me fanatic about this Strong Dollar Tax Cut idea all they want, but history sides with the Canadian on this front, bros. As you can see in today’s Chart of The Day, under both Reagan (1) and Clinton (1), American Progress was built on the back of a Strong Dollar, pro growth, recovery.
How does Mr Market score our theme of being long Consumption?
- US Healthcare Stocks (very much an American Consumption story) = +11.33% YTD (XLV)
- US Consumer Staples Stocks = +10.72% YTD (XLP)
- US Consumer Discretionary Stocks = +9.66% YTD (XLY)
Yes. All of those are beating what’s been a fantastic +7.9% YTD return for the SP500. And how does Mr Market score being short (or underweight) Commodity Inflation Expectations?
- US Basic Materials Stocks = +3.41% YTD (XLB is the worst performing Sector in the S&P Sector Model)
- CRB Index (19 commodities) = -1.35% YTD (awful relative to any major asset class)
- WTI Crude Oil = -1.4% YTD (having recently broke our $93.79/barrel TREND line of support)
OK. So being long Consumption growth and short Commodity exposures is still working. How is the end of the world trade going?
- Gold = down again this morning to $1574, = down -6.02% YTD
- US Treasuries = 10yr Yield up to 1.92% this morning = up +9.09% YTD
Again, if the world was going to end: A) all US economic data wouldn’t have gone from slowing to stabilizing to accelerating (look at the slope of the line) and B) Gold and Treasuries wouldn’t be losing you money in 2013 YTD.
I know, I know. People want to bring up what happened last year, and the year before that. I know, it’s like arguing with my college girlfriend. It was painful. But I got over it.
I don’t live a regressive life. I’m writing about American Progress because we have a tremendous opportunity here. What’s not only been happening for 3 months, but what could keep happening if the #StrongDollar setup remains excites me. It should excite you too.
Look at your screens. Markets are testing all-time highs. Be a leader. Be proud. Cut government spending. Get these people you already have on mute off TV. Let’s get back to what makes this country the most progressive that the world has ever seen. This is our chance.
Our immediate-term Risk Ranges for Gold, Oil (WTIC), US Dollar, USD/YEN, UST 10yr Yield, VIX, Russell2000 and the SP500 are now $1, $89.76-91.98, $81.76-82.38, 91.79-94.68, 12.21-14.63, 910-932, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
The Macau Metro Monitor, March 6, 2013
GAMING ALERT: MORE "CASHLESS CASINO" LICENSES ALLEGEDLY ISSUED IN HAINAN Macau Daily Times
According to gaming insiders, Jester Bar owned by real estate mogul, Zhang Baoquan, wasn’t the only operator “licensed” to test the cashless casinos. Sources say “up to 10 licenses were issued or were about to be issued,” when Jester’s was shut down apparently following a Reuters’ dispatch revealing the activities of the casino bar at the Mangrove Tree Resort World.
A Shanghainese living in Sanya, surnamed Lin, confirmed the “rumors” that “they want to have a special zone for gambling in China. So Sanya officials are very willing to try gaming here.” Lin said, “There are other bars like this in Sanya. I know at least three. The first time I went to one was three years ago. Many people go there. They open and close all the time. Jesters will open again. They closed it because of troubles during a visit by government officials.”
A former Galaxy Macau executive, Eric Coskun is managing the casino operations at Jester’s and was subsequently “advised to keep a low profile”. Hainan is purported to have the most illegal gambling operations in China.
Despite the denials from Sanya’s government stating no gaming operations were ever officially sanctioned “it’s obvious that Zhang Baoquan has had the tacit approval of central government officials, even if only by turning a blind eye on the tycoon’s operations,” a gaming expert told the Times.
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This note was originally published at 8am on February 20, 2013 for Hedgeye subscribers.
“Let’s not make our mistakes in a hurry.”
-Dwight D. Eisenhower
The 34th President of the United States was a process guy. He was also a world class Risk Manager. Getting the US out of Korea, averting the French invitation to Vietnam (1953), and avoiding the ongoing threat of engaging China or Russia in nuclear war is his legacy now. If you are a Portfolio Manager in this game, your legacy is your track record – and it’ll be the mistakes you don’t make that matter most.
But what kind of team culture should you foster to ensure you aren’t missing something? Do you accept the blame for your team’s mistakes, or do you point fingers? Is there an open forum for people who report to you to disagree with your position? If they do so and have sloppy reasoning, do they expect to be taken to task in front of their peers in kind?
I’m an athlete who believes in transparency, accountability, and trust. I have biases. But they are based on experience. There are a lot of great players – and even more good teams. But only few Championship Teams can repeat. To do that, your players can’t be scared to make a mistake. At the same time, they have to be disciplined so that their mistakes don’t blow up everything the team has worked for.
Back to the Global Macro Grind…
Particularly when a market is in a Bullish Formation (Bullish on all 3 of our core risk management durations: TRADE, TREND, and TAIL), not getting squeezed (on the short side) can save the team from having a lot of losses.
If you accept that bullish and bearish formations (Gold is in a Bearish Formation, so is the Japanese Yen) can get immediate-term TRADE overbought and oversold, at a bare minimum you won’t be making the same mistakes over and over again in a hurry. You’ll wait.
It’s taken me at least 13-15 years to learn this the hard way. Getting squeezed is part of a short seller’s life. And guess what, I still have to re-learn the same lesson, weekly. This game isn’t easy. That’s why I try my best to make decisions on the signal now, instead of the noise.
To simplify what I mean by making high-probability decisions:
- Don’t be in a hurry to sell something until you get an immediate-term TRADE overbought signal
- Don’t be in a hurry to buy something until you get an immediate-term TRADE oversold signal
- Don’t eat yellow snow
Or, as President Eisenhower used to tell his brother Milton, “Never get in a pissing match with the skunk.” (Ike’s Bluff, pg 57)
Yes, I am sure there are some really smart people out there who have found a way to not have to deal with process, real-time decision making , etc. But I can almost guarantee you that what they do ends up having a higher realized level of volatility than what we do.
To put some meat on this bone, here are some immediate-term TRADE overbought signals in our models this morning:
- SP500 is immediate-term TRADE overbought at 1533
- Russell2000 is immediate-term TRADE overbought at 934
- Consumer Staples Sector ETF is immediate-term TRADE overbought at $38.06
- Kimberly Clark (KMB) is immediate-term TRADE overbought at $92.31
- Fedex (FDX) is immediate-term TRADE overbought at $107.39
First, note that I have no immediate-term TRADE overbought signals to act on in any of our long Asian Equities positions. Singapore (EWS) has immediate-term upside, and so does China (which we bought via CAF on an immediate-term TRADE oversold signal yesterday).
Second, I am agnostic on the direction of the signal. It works the same way for both my longs and shorts. Yes, we like and are long of Fedex (FDX), but A) that’s not new (we bought it when we went bullish on US Equities in late November) and B) what is new is that it gave me its first immediate-term TRADE overbought signal in at least the last few weeks.
Third, using immediate-term TRADE overbought signals is another way to hedge market (beta) risk. So, I can be bullish on US Equities on my intermediate-term TREND duration and A) realize I might get an overbought signal in SPY this morning but B) not force myself to short something consensus like SPY, and stock and sector pick on a better signal instead (shorting XLP and KMB into yesterday’s close).
I am certain that there are better ways to do this – and I assure you that before I retire, I will find better ways. But for now, this is how my team rolls because this process is both repeatable and helping us not hurry mistakes.
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, and the SP500 are now $1596-1617 (Gold remains in a Bearish Formation but is immediate-term TRADE oversold), $116.51-118.71, $80.25-80.83, 92.63-94.49, 1.97-2.05% and 1518-1533, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Takeaway: Deutsche Post reaches top end of our base case fair value range. Both near-term and long-term, DHL signals a better environment for FDX.
FDX: Deutsche Post Shows FedEx Express Can Get There
- Industry Likely Improving: In our November 2012 Express & Courier Black Book, we highlighted what we thought was an inflection point in the Express industry. Deutsche Post’s report suggests that the environment for the integrators is likely improving. FedEx reports on March 20th, so a positive read on the environment is encouraging. DHL Express reported fourth quarter organic revenue growth of 6.8% - not bad for a quarter in which the US and Eurozone were apparently in contraction.
- Americas & Asia: Deutsche Post commented that the best growth “in percentage terms” was in the Americas, where FDX has the dominant market presence. It does not appear to be a market share gains by DHL Express, but rather market growth. In addition, Deutsche Post suggested that volumes in Asia on the freight forwarding side picked up in the back end of the year, another important time definite market for FedEx. They said that airfreight was still down YoY, but less so. We have seen better Asia air cargo data, as noted here.
- Deutsche Post Was Able To Fix Its Express Margin: The Express industry is structured for good returns, in our view. The industry is increasingly consolidated with high barriers to entry and rational competitors. Deutsche Post focused on improving express margins, as described in early 2011: “On Express margins, it is our expectation that margins will continue step by step to increase over time. Our aspiration, as we talked about in the Capital Markets Day, is we get at least equal to industry leading margins ….” –Lawrence Rosen, CFO 3/10/2011. DHL Express was able to execute on this restructuring and achieve much stronger margins. DHL Express also started in a much worse state than FedEx Express is now starting, in our view.
- What FedEx Expects: Compare DHL’s management comments to those FedEx management on FedEx Express’ margin expansion prospects “ I think it will be a combination. There'll be small stair-steps, but it'll mostly be momentum that will drive this. Again, we are talking about thousands of people here. So, as we reorganize around that with a very limited backfill behind that, we have to space these folks out. So, there'll be May, then there'll be some August, and then there'll probably be some November and then there'll be some in next May, and I don't have clear visibility of that except I know where we'll be in fiscal 2015 with pretty good certainty.” – Alan Graf 12/19/12 Restructuring at FedEx Express is likely to be a multi-year process, but the leverage on a large revenue base should make it worth the wait.
- Matching Competitors: We put out our estimate for Deutsche Post’s 2012 Express margin in our Best Ideas slide deck last Wednesday. It turns out to have been about 20-30 basis points higher, with a portion of that beat driven by a stronger in the fiscal 4Q. (note: adjusted for one-time benefits)
- Asia Pacific Express Slightly More Consolidated: Deutsche Post believes that it gained about four points of market share in Asia over the past couple of years, with that gain coming from the “Other” category and potentially TNT. If TNT is losing share in Asia, it might accelerate FedEx’s decision-making on a potential transaction. If TNT is deteriorating, the rationale for buying sooner might be stronger. We would highlight that the list of countries included in the initial sample is much narrower, so Deutsche Post appears to be comparing apples and oranges, leaving it difficult to read much into the share shift.
- Is FDX Losing Share in Americas to UPS?: At first, that is the way the Deutsche Post data look. However, the 2012 DHL data includes a number of additional countries, including Brazil, Argentina and Colombia. FedEx did note that “In the U.S. Express volume share segment, we retain a clear lead over the competition. And while our volume share was down last year, on a year-over-year basis, again, that was primarily due to our yield management activities” Michael Glenn 10/10/12. We suspect any shift has been fairly small, consistent with the US share chart from the FedEx analyst day and that most of the shift in the charts has been due to the inclusion of additional countries in the Americas sample.
- Strategy in Couriers: We continue to believe that FDX offers some of the best upside in the Industrials sector, with fair value per share in our base case model between $120-$150 and a bullish model at $180. As discussed in our November 2012 Black Book, we also believed Deutsche Post itself provides excellent exposure to the improving trends in the Express & Courier industry. Our base valuation range for Deutsche Post of Eur 15-Eur 20 was achieved very quickly since then and the risk/reward appears less favorable at these levels. We would prefer FDX over DPW GY and UPS at these levels.
Takeaway: Duration matters as much today on $JCP as it did when evaluating it as a short at $40. TRADE = look elsewhere. TREND/TAIL = do the work.
Conclusion: Pick your duration. It matters -- as much today as it did when evaluating it as a short at $40. If you need to make money in a name before June, don’t look to JCP. The first quarter will be weak, 25% of square footage is unshoppable during the quarter due to construction, and EPS expectations might not be low enough. But if you can you can look to a TREND (2H) or TAIL (3 Yr) duration, we think the risk/reward favors the upside. Here’s an overview of the incremental changes in our thought process on JCP over the past week.
We were short JCP since Ackman first brought in Johnson starting in June 2011. The crux of that call was that there was a duration mismatch between the time period Johnson was incentivized to fix JCP compared to how quickly Wall Street was being led to believe (by management and Ackman alike) that a turn would take place.
That call worked quite well, but we turned positive earlier this year at $19, however, as we thought that the risk/reward was to the upside and that all the bad news was priced into the stock. That was clearly a wrong assumption. We go through the puts and takes below, but with the downward spiral since the quarter we’re left with the question as to whether we should fish or cut bait.
We’re not going to sell into the emotion-fueled debate we see out there today. Instead, we think that the real answer to the buy/sell question is different based on each of our three durations, TRADE (3 weeks or less), TREND (3 months or more), and TAIL (3-years or less).
1. TRADE: While we won’t bow to the negativity that’s currently swirling around this ticker, the fact of the matter is that there’s nothing we can point to before June that will make this stock go up. There’s a) the Martha Stewart/Macy’s trial (which could go either way), b) nearly 25% of JCP’s square footage that will be under construction (and therefore unshoppable), and c) the start of JCP’s cash burn into spring while catching up on vendor payables. Package all of this with zero guidance from management on the quarter, and the Street looking for a relatively rosy -7.8% comp in the quarter (a 500bp acceleration on a 2-year basis), and the setup into the May 1Q earnings report is nothing to write home about.
2. TREND: Once we’re past 3-months, we think that that the ‘rate of change call’ as it relates to JCP’s top line will start to unfold. Maybe that did not matter as much when the stock traded through $23 in advance of the quarter, but we think it matters at $15. Even if JCP needs to buy the comp, we think that sales trajectory will be the sole factor over a TREND duration that people will care about in answering the question as to whether it actually has connectivity to its consumer or not. As goes customer connectivity, so goes the stock.
For the year, our key modeling assumptions vs consensus are outlined in the table below. Assuming that JCP still runs at a whopping ($2.12) loss per share, we have the company using up $1.1bn of its revolver in order to maintain a cash balance of about $450mm. This assumes a very conservative -$500mm hit to working capital after cutting into too much bone last year, and also assumes no cuts to the company’s $1bn capex plan.
3. TAIL: While our TAIL duration is 3-years or less, we’re going to cheat a little bit and take this model out a full 5-years. We think we can get to earnings power starting with a $3 over that time period assuming that JCP only flirts with its former glory when it was simply a ‘bad’ instead of a ‘horrific’ retailer. Let’s be clear about one thing…we’re not parroting the Ackman earnings power of $14-$22 per share (yes, he actually said that). But our point is that we don’t need that kind of earnings power for the stock to work over a TAIL duration.
Our Updated Thoughts On Key Issues Impacting The Stock
Here’s an overview of what has changed since the print, where we think were wrong, where we’ve been challenged by investors, as well as our response.
- Expectation Mismatch: in reflecting further in the quarter, you don't have to be a genius to see that we got the near term research call wrong. Ironically, for the quarter, we modeled a -35% comp, 24.5% gross margin, and a loss of -$2.50 per share, which is pretty darn close to where JCP came in. Trade receivables were worse than we expected, but net cash on hand was still greater than the $550-$650mm we said we needed to see to prevent liquidity concerns. Our mistake was assuming that these below-consensus estimates were ‘in the stock’. Lesson learned = a large scale negative headline is rarely ‘in the stock’.
- VNO Stock Sale: The second largest shareholder selling a 10mm share block on the day Ron Johnson was on trial being grilled by Macy’s lawyers about the dispute surrounding Martha Stewart product was tough to see coming. That said the stock traded down over 5% in the session leading up to the announcement – so someone not only saw it, but unethically profited from it.
- Timing of Shop Rollouts: If the Martha Stewart trial goes against JCP, we have a very hard time believing the news headlines saying that ‘shelves will be empty’. Rather, we think it’s more likely than not that the product branding or design will need to change in a way to make it clearly not conflict with Macy’s. We don’t think that it will delay the shop opening by more than a month or so, but we think that it could delay the Martha Stewart productivity ramp by 1-2 quarters.
- Consumer Sentiment: This whole debacle has gotten so much negative press. Check out $JCP on twitter. No exaggeration that 99% of mentions are negative. The company, the management and the brand seemingly has no support – at least by this audience (we trust twitter more than Wall Street sentiment factors in this regard). Usually such negative sentiment supports a bull case, but the bear case would be that such negativity actually manifests itself in the form of backlash against shopping at the store. In other words, after firing the existing customer and being consistently in the hot seat in front of the American Consumer at large, could it actually prevent the new shop rollout plans from working? It’s a question that we need to be asking ourselves.
- How Many Shops Should There Be? We debated this one with several clients, and we think that it’s a very valid question. JCP is reconfiguring 700 of its 1,100 stores. But the question is how JCP arrived at that 700 number. Why not 500? 300? It can do all the studies it wants, but the reality is that it won’t know the appropriate number of stores for this new format until it goes too far. The solace we have from a modeling perspective is that we’ll assume that management has the common sense to start at the very top as it relates to attractiveness and potential likelihood for success. It’s going after 500 over the immediate-term, so it clearly has room to stall or alter capex plans if the data suggests that their 700 estimate is too high.
- RJ’s Job Security: Better than 50% of investors we talk to think that Ron Johnson won’t be working at JC Penney in 2014. We disagree. Simply put, JCP was a horrible retailer before he joined. Then the Board gave him a mandate to change the model. They expected disruption in sales. Did they expect first year sales to be down 25%? Probably not. Did Johnson make some serious errors? Absolutely. But the Board is getting what it asked for – a radical transformation in the business model.
What are they going to do…fire Johnson and bring in another person to return the company to its former glory? No way. In fact, we think that vendors still hold Johnson in high regard and buy into his vision as to what JCP should become. If he personally ceased to exist in his role as CEO, there’s serious risk to vendors pulling out of JCP en masse to protect their own brands.
- Real Estate Value Support: When Ackman did initial storytelling about JCP, he talked up a replacement value of $11bn, or about $50 per share. That’s fine, but there’s a pretty big flaw in that analysis – we’d argue that if JC Penney stores are so grossly underperforming, there’s no need for them to be replaced. Hence we could argue a theoretical replacement value of zero. We can, however, argue something closer to $8-$10 per share. Our assumptions are as follows.
A ) Cap Rates: While cap rates have been drifting lower, JCP would still command among the highest cap rates due to its sub-prime real estate locations. Let’s assume 8.5% vs Power Center/Strip/Regional Mall average of 7.0%.
B) Rent: Current JCP rental rate is about $4 per square foot on its leased property. It’d be tough to argue something higher than that today. Let’s assume something between $3.50 and $4.00.
C) Combining the two, we’re getting to a value of $8-$10.
The key here is not that the portfolio will be liquidated overnight. But rather that it has about $1.8bn-$2bn of near-term liquidity it can access if need be.
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