“How with this rage shall beauty hold a plea?”
As our Director of Research, Daryl Jones, said on CNBC last week, “this is the most hated rally we’ve ever seen.” Hating the truth isn’t cool. But, as the late Andre Gide noted, “it’s better to be hated for who you are, than to be loved for someone you are not.”
Reality is that if you hate this market, you are raging against one of the more impressive 4-month changes in Asian and US growth prospects that we have seen in a decade. Cheering for the end of the world isn’t cool either.
A strong US currency, at the big turns (for both Reagan in the early 1980s and Clinton in the early 1990s), can be a Beautiful Rage. If sustained, it’s a pro-growth signal. So, from here, to have or not to have a #StrongDollar, remains the question.
Back to the Global Macro Grind …
One of the most obvious places we’ve been monitoring Bear-Rage is in the term-structure of US Equity Volatility (VIX). At every lower-high (and lower-low) we’ve seen in the front-month VIX, many have still held onto their future fear expectations. That’s not working.
Looking at the Front-end of Fear (where front-month VIX is trading):
- VIX was down another -8.2% yesterday to close at a fresh 5yr low of 11.56
- VIX just crashed (and quickly), down -40% from its FEB25, 2013 “Italian Election” day lower-high
- VIX has been crashing, down -49%, from its DEC28, 2012 Congress New Year’s Eve lower-high
When I say lower-highs, I mean long-term lower-highs. And this has really been our point throughout the last 2-3 months. What was long-term support for the Front-end of Fear (14-15 VIX), is now solidifying itself as intermediate-term TREND resistance.
Just to put some risk management levels around that – across our core risk management durations:
- VIX immediate-term TRADE resistance = 13.98
- VIX intermediate-term TREND resistance = 16.21
- VIX long-term TAIL resistance = 17.18
So, the Front-end of Fear is being pulverized into what we call a Bearish Formation (bearish across all 3 of our core risk management durations – TRADE, TREND, and TAIL).
And, all the while, all you’ll hear from the hedge fund community is how the “term structure” of VIX doesn’t agree. In other words, consensus doesn’t agree with higher-highs in US stocks (perpetuated by lower-lows in volatility). That’s why it keeps working.
Bridgewater’s Ray Dalio outlines what an oversupply in consensus hedge funds has meant for returns. The correlation of hedge fund returns to US stock market beta = +0.9. If you want to be freaking out about something, freak-out about that.
Why is the asset management business changing? Well that’s pretty simple. It’s called evolution. Plenty of our pension fund, mutual fund, and RIA clients are changing what it is that they do as this globally interconnected game of global macro risk changes.
That has big implications. Don’t forget that the RIA (Registered Investment Advisor) community is as large (in terms of assets under management) as the hedge fund community.
Country, Currency, Commodity, etc. ETFs and the like are allowing lower-fee structures and strategies to compete, head-to-head, with Global Macro Hedge funds. Don’t fear that – competition is a beautiful thing too.
Some other tactical points to consider (in the immediate-term) as the VIX is crashing:
- Things that are crashing tend to bounce, fast – so watch what US stocks do once VIX tests our 11.21 oversold level
- SP500’s immediate-term Risk Range of 1 is finally signaling more downside than upside in US stocks
- Immediate-term Risk Ranges change as fast as price, volume, and volatility factors do – so keep moving
We’re not suggesting that we are smarter than anyone else. We have a broad spectrum of clients we are collaborating with. We are using quantitative signals and research to highlight what we think are becoming more probable non-consensus market moves.
In order to convince you that our risk management process is both flexible and dynamic, we have to Embrace Uncertainty. Selling certainty is like selling fear; over long periods of time, you’ll get run over by being anchored to either one or the other.
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, VIX, Russell2000, and the SP500 are now $1, $109.51-110.98, $82.21-82.93, 93.56-96.81, 1.95-2.09%, 11.21-13.98, 928-951, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
The following is a brief summary of why we want to be LONG DRI at these levels. We will be hosting a black book conference call entitled "DRI: The Unthinkable Long Case" on Thursday, March 14th, at 1:00pm EST. to talk through in more detail the summary thoughts below.
By way of background, we initiated a short call, “The Unthinkable Short Case”, on DRI on July 19th, 2012. The following is a recap of our prior stance:
- Accelerated unit growth masking other issues
- Cash burn was unsustainable
- Waning ability of Darden to be all things to all people (buyback, dividend, growth, fortress balance sheet)
- Secular macro headwinds were changing the industry’s operating environment
- Leverage outlook was set to impede future growth
- Declining ROIIC
The current setup for the stock looks like this:
- Stock price depressed but dividend yield highly supportive at these levels
- Unit growth is being reined in (albeit modestly)
- Secular nature of industry change being acknowledged
- Guidance is for EPS to decline 11% in FY13 and little-to-no earnings growth in FY14
- Promotions underperforming
- Underinvestment in Olive Garden showing in results
- LongHorn no longer a jewel in the crown
- Significantly lagging peers in international expansion efforts
- Self-evident that managing portfolio is proving difficult
But on the bright side:
- The investment community has become far more bearish on the stock
- Room for improvement with the “Big 3” (Olive Garden, Red Lobster, LongHorn) same-restaurant sales growth is lagging the benchmark (Knapp Track) by 340 bps
- Management is outwardly admitting past mistakes and the reality of the environment it is operating in
- Potential changes within the C-Suite could greatly improve the company’s prospects – can current roster turn things around?
In the end the Low-Hanging, Bountiful, Fruit are too sweet not to harvest
- Tremendous cash flow potential
- Huge real estate value
- Non-core, under-utilized assets that can be sold at rich valuation
- Core assets represent a classic reorganization opportunity
- Market’s valuation of the whole is far below what we believe the sum of the parts would represent in a reorganization/breakup
- G&A rationalization opportunities
- Buying the stock today, an argument can be made that investors get Olive Garden for free!
We see the current setup as a "win-win" for the stock:
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Takeaway: DKS is entering a period where margins will tread water while asset turns back-peddle. That's not a recipe for the stock to go up.
A few people have asked us today as to whether we think that the DKS stock price reaction is overblown. If anything, we think it’s underblown (if that’s not a real word, now it is).
This has nothing to do with missing the flow of cold weather patterns or getting ‘Lanced’ by its stagnant inventory of Livestrong treadmills. But rather, it is a company in a mediocre business that is running at peak margins at a time when the outlook for comps (low single digits) is below the rate needed to leverage occupancy, deferred investments on the P&L are eating up an incremental 5% of earnings this year, and capex is trending up an incremental 20%.
Furthermore, let’s not forget that DKS falls into the bucket of names that has high risk of share loss to dot.com competitors and brands’ direct growth initiatives, and at the same time we see the company openly admit that it has underinvested in the infrastructure needed to take its ecommerce platform to the next level.
We get the whole point about DKS being a ‘best in breed’ retailer. But this is not necessarily a breed that needs to be owned.
We think that the crux of where DKS is in its cycle can be summed up in the Profitability Roadmap below, which shows the progression of margins vs. asset turns. Retailers, as we all know, can improve either one of those at any given point in time, but it’s when they improve simultaneously that real value is created and the stocks outperform materially (0.92 performance correlation). This is exactly what DKS did from 2009 through 2011, and it accounted for a 4-bagger in the stock.
But today, we think that we’re stuck at a point where margins will tread water, and it will be on an incrementally larger operating asset base. That is the ultimate recipe for a value trap.
Takeaway: The all-time highs remain in play, but so does some very short-term mean reversion (to 1532). We want to be flexible here.
This note was originally published March 11, 2013 at 10:47 in Macro
POSITIONS: 11 LONGS, 9 SHORTS @Hedgeye
I sold the open this morning (sold 2 LONGS, added 2 SHORTS) because the bottom up signals in each security told me too. The SPY didn’t register a sell signal (it usually doesn’t until after stocks do). The market has been up for 9 of the last 10 weeks; certain stocks are getting exhausted.
Exhaustion can last (think the 1995 US stock market), particularly if the research fundamentals support it (they do). So don’t expect me to get too cute here. This remains a market we want to be risk managing with a bullish bias, until something (signal or research) changes.
Across our core risk management durations, here are the lines that matter to me most:
- Immediate-term TRADE overbought = 1565
- Immediate-term TRADE support = 1532
- Intermediate-term TREND support = 1477
In other words, the all-time highs remain in play, but so does some very short-term mean reversion (to 1532). So we want to be flexible here. Keep moving and don’t get plugged buying on overbought signals.
Keith R. McCullough
Chief Executive Officer
Takeaway: On balance, this weekend’s data is unsupportive of our bullish bias on Chinese equities and very supportive of our bearish bias on the yen.
- China: Over the weekend, China put up some particularly soft FEB growth figures. If there is, however, one positive to take from these data points, it’s that they should meaningfully slow the proliferation of monetary tightening speculation, which had been weighing on Chinese equities over the past few weeks (1Y OIS 25bps premium to benchmark HH Savings Deposit Rate; up +12bps MoM).
- Bearish from an immediate-term TRADE perspective and bullish from an intermediate-term TREND and long-term TAIL perspective, the Chinese equity market is currently signaling to us exactly what the fundamental data suggests: near-term weakness that should ultimately give way to intermediate-to-long-term upside. As such, we continue to have conviction in our Asian #GrowthStabilizing theme (long China, Hong Kong and Singapore).
- Japan: Through an aggressive mix of fiscal and monetary policy, Japanese officials have managed to burn Japan’s currency by nearly -20% (-19.3% to be exact) since we started shorting it back on SEP 27. Japan has literally crashed its currency and still continues to see weakness across some key economic growth statistics – largely underpinned anemic demand for capital goods, etc.
- Consensus among sell side analysts and multinational corporations is still not even in the area code of being bearish enough on the yen – particularly relative to our expectations of a true phase change across the BOJ leadership. In this light, the buy side remains underexposed to yen downside as well.
- At a time when investors are broadly beginning to consider the merits of pulling forward expectations of Fed “tightening” (i.e. ending its open-ended asset purchase program), Japan’s intermediate-term policy outlook should continue to weigh heavily on the yen.
- That outlook is decidedly dovish – especially with Haruhiko Kuroda taking over the BOJ leadership reins from Masaaki Shirakawa. The two gentlemen are indeed polar opposites when it comes to monetary policy and willingness to ease, with the former being much, much more aggressive than the latter. For example, Kuroda was out this weekend suggesting that the central bank's new +2% inflation target can be achieved by utilizing monetary policy alone – a view the outgoing Shirakawa strongly disagrees with.
- Abe will no doubt want to maintain the current high level of popular support for himself and his LDP platform (75.8% approval rating) through the late-JUL Upper House elections, where we expect the LDP to increasingly position themselves to earn a slight majority – giving them control over both houses of Japanese parliament and free reign to pursue a much broader swath of currency-negative fiscal and monetary policies. As such, we continue to anticipate both he and Taro Aso will continue to lean heavily upon the eventually-politicized BOJ board to “do more” in the weeks and months to come.
***The note below is a follow-up to our 2/27 Best Ideas presentation, where we provided to clients detailed outlines of our bullish bias on Chinese stocks and our bearish bias on the Japanese yen. To the extent you may have missed that call, please use the following links to access the associated materials:
Over the weekend, China put up some particularly soft FEB growth figures:
- JAN-FEB Industrial Production: 9.9% YoY from 10% in DEC vs. 10.6% Bloomberg consensus estimate
- JAN-FEB Fixed Assets Investment: 21.2% YoY from 20.6% in DEC vs. 20.7% Bloomberg consensus estimate
- JAN-FEB Retail Sales: 12.3% YoY from 14.3% in DEC vs. 15% Bloomberg consensus estimate
- FEB CNY New Loans: 620B from. 1070B in JAN vs. 700B Bloomberg consensus estimate
- FEB CNY Aggregate Financing: 1070B from 2540B in JAN vs. 1500B Bloomberg consensus estimate
- FEB M2 Money Supply: 15.2% YoY from 15.9% in JAN vs. 15.9% YoY Bloomberg consensus estimate
As you would imagine, these data points are not at all a great handoff for anything that would eventually resemble a Chinese #GrowthAccelerating bull case. If there is, however, one positive to take from these weak growth figures, it’s that they should meaningfully slow the proliferation of monetary tightening speculation, which had been weighing on Chinese equities over the past few weeks (1Y OIS 25bps premium to benchmark HH Savings Deposit Rate; up +12bps MoM).
That being said, however, the hawkish FEB CPI print (Headline: 3.2% YoY from 2% in JAN vs. 3% consensus; Food: 6% YoY from 2.9%; and Non-Food: 1.9% YoY from 1.6%) may indeed limit that proposed tailwind and we need to continue to see the disinflationary impact of Strong Dollar = Strong Yuan to remain positive on the Chinese economy and China’s equity market with respect to the intermediate term. For more details on the impact of USD strength on select Asian economies, please refer to our FEB 27 note titled: “HONG KONG STILL LOOKS AWESOME”.
We also remain positive on China’s structural reform outlook as the Chinese Communist Party brass attempts to wean the Chinese economy away from an overreliance on fixed investment (“I”/GDP of ~50% is ~1,000bps too high). The latest news on this front is that the State Council plans an increase in the minimum wage to 40% of average urban salaries by 2015. That too should help underpin Chinese consumer demand and mitigate any tail risk of a destabilizing collapse in prices across the Chinese real estate market(s).
Bearish from an immediate-term TRADE perspective and bullish from an intermediate-term TREND and long-term TAIL perspective, the Chinese equity market is currently signaling to us exactly what the fundamental data suggests: near-term weakness that should ultimately give way to intermediate-to-long-term upside. As such, we continue to have conviction in our Asian #GrowthStabilizing theme (long China, Hong Kong and Singapore).
KURODA ADOPTS DRAGHI’S “WHATEVER IT TAKES” FORMAT
This weekend, weak JAN-FEB Japanese growth figures augmented our cyclical bear case for the JPY: JAN Machine Orders: -9.7% YoY from -3.4%; -13.1% MoM from 2.8%; and FEB Machine Tool Orders: -21.5% YoY from -26.4%.
Through an aggressive mix of fiscal and monetary policy, Japanese officials have managed to burn Japan’s currency by nearly -20% (-19.3% to be exact) since we started shorting it back on SEP 27. Japan has literally crashed its currency and still continues to see weakness across some key economic growth statistics – largely underpinned anemic demand for capital goods, etc.
To some degree, the lack of reflation among said growth figures in spite of aggressive currency debasement can be attributed to the fact that the overwhelming majority of multinational corporations (i.e. some of the largest actors in the forex markets) simply do not trust what they are seeing in the currency markets. The latest Cabinet Office survey showed that Japanese exporters expect the USD/JPY rate to be at 88.40 in one year’s time (USD/JPY at ~93 at the time of survey); that compares to a forecast of 80.3 one year ago (USD/JPY at ~81 at the time of survey).
This latest projection of yen strength is quite aggressive even relative to the Bloomberg consensus estimate of 96 yen per dollar at end-of 1Q14.
Clearly the key takeaway here is that consensus is not bearish enough on the yen – particularly relative to our expectations of a true phase change across the BOJ leadership. In this light, the buy side remains underexposed to yen downside as well:
In fact, the only people who seem to agree with us that the USD/JPY cross is poised to return to pre-crisis levels of ~125 over the long-term are foreign equity investors, who have been net buyers of Japanese equities every week since the week-ended NOV 16 (the Nikkei 225 Index is up +36.8% since then). If we wind up being wrong on our call for demonstrable yen weakness from here, then shorting Japanese equities will eventually become one of the best Global Macro trades in recent memory.
That is, however, not our base case scenario – especially not with Haruhiko Kuroda taking over the BOJ leadership reins from Masaaki Shirakawa. The two gentlemen are indeed polar opposites when it comes to monetary policy and willingness to ease, with the former being much, much more aggressive than the latter. For example, Kuroda was out this weekend suggesting that the central bank's new +2% inflation target can be achieved by utilizing monetary policy alone – a view the outgoing Shirakawa strongly disagrees with.
Kuroda added that he would like to quickly debate and decide on specific monetary easing measures, though he declined to provide many details. He did, however, reiterate that the BOJ needs to take bolder steps, both in terms of "quantity and quality", including increasing the duration risk of the central bank’s JGB purchases.
Kuroda also said that the BOJ has not been buying enough assets to meet its +2% inflation target and that, if appointed, he would do “whatever it takes” to achieve this goal. Recall that Kuroda has also called for speeding up the introduction of the central bank's open-ended asset purchases, which are not currently scheduled to begin until JAN ’14.
All told, Japanese officials want them some inflation and Abenomics will continue to edge Japan towards that outcome if the following is their base case scenario:
“Japan was unlikely to suffer from hyperinflation due to its aggressive monetary and fiscal stimulus measures.”
-Prime Minister Shinzo Abe, MAR ‘13
Abe would certainly not be Japan’s first bureaucrat to jump the [policy] shark in pursuit of inflation. Recall Japan’s Great Depression-era experiment that mandated the BOJ to directly monetize Japanese sovereign debt (as opposed to open-market operations), which began in 1932 and continued for the next 14 years.
During this era, the ratio of JGB issuance financed directly by the BOJ peaked at 89.6% in 1933 and remained elevated throughout the program. This monetization strategy assisted in doubling JGB issuance and boosting Japanese public expenditures by a whopping +34% in 1932 alone. Japanese CPI readings peaked at rates north of +40% YoY throughout the 1930s during the aforementioned episode of aggressive sovereign debt monetization.
For now, however, the Japanese populace remains much like frogs being boiled in water; Abe does indeed enjoy broad support, with his approval rating at 75.8% per Tokyo Broadcasting System (unchanged MoM) – good for the highest popularity of any Japanese prime minster since Junichiro Koizumi in 2006.
Abe will no doubt want to maintain this level of support for himself and his LDP platform through the late-JUL Upper House elections, where we expect the LDP to increasingly position themselves to earn a slight majority – giving them control over both houses of Japanese parliament and free reign to pursue a much broader swath of currency-negative fiscal and monetary policies. As such, we continue to anticipate both he and Taro Aso will continue to lean heavily upon the eventually-politicized BOJ board to “do more” in the weeks and months to come.
At a time when investors are broadly beginning to consider the merits of pulling forward expectations of Fed “tightening” (i.e. ending its open-ended asset purchase program), Japan’s intermediate-term policy outlook should continue to weigh heavily on the yen.