“New is always bad. Never not be afraid.”
If you don’t know who Grug is, take your kids to see The Croods – the latest American computer-animated family film by Dreamworks that opened this weekend. Nicolas Cage crushes it in this one. We loved it!
The movie starts with scarier stuff than Cyprus (Croods fend it off), then Grug’s daughter introduces herself: “My name is Eep and this is my family, the Croods. We never had the chance to explore the outside world because of my Dad’s one rule: Never leave the cave.”
I know – I’m too bullish about US Equity markets, life, etc. these days. But, sometimes, it’s ok to look on the bright side. If you have a fear-mongering Cave Dweller in the office, maybe you should take him to see the movie too. Everyone needs to leave the cave.
Back to the Global Macro Grind…
There are plenty of things to worry about out there – and, from a time and price, that will include US Equities too – but for now, the most bullish TREND in America remains your friend: #StrongDollar = Stronger America. Period.
We’ll dig deeper on the Dollar on our upcoming Q2 2013 Global Macro Themes presentation, but for now it’s important to review why US Equity Markets are testing all-time highs into the end of Q1 (our Q113 Themes):
- #GrowthStabilizing – US GDP Growth bottomed, sequentially, in Q4 of 2012; upside vs consensus in Q1/Q2 2013
- #HousingsHammer – consensus is not yet Bullish Enough on US employment and housing reflexivity
- #QuadrillYen – as the US Dollar strengthens on domestic factors, it’s picking up the relative (Burning Yen) trade too
What’s good for the US Dollar is bad for Commodities:
- US Dollar Index = +0.5% last week to $82.53 (up for 6 of the last 7 weeks)
- CRB Commodities Index = -0.6% last wk to 294 (down for 6 of the last 7 weeks)
What’s good for the US Dollar is also bad for Commodities Correlation Risks:
- 30-day inverse correlation between USD and Brent Crude Oil = -0.97
- 30-day inverse correlation between USD and High Grade Copper = -0.94
- 30-day inverse correlation between USD and Rough Rice = -0.86
Rice? Grug didn’t know how to boil water, but it’s still the world’s top consumed food these days.
And that’s the other big thing going on out there this year in Global Equity markets – not all markets are going up as the US Dollar does.
A) Emerging Markets that don’t have a US Dollar peg are seeing local inflations (inflation is priced in local FX)
B) Emerging Markets whose Equity Markets are commodity-linked are losing (Brazil = down -9.4% YTD)
On that score, note the following Global Equity market divergences:
- SP500 and Russell2000 = +9.1% and +11.4% YTD, respectively
- MSCI Emerging Markets (EM) Index = -3.8% YTD
- MSCI Emerging Markets (EM) Index = -1.9% last wk vs the Dow -0.013%
If you want to freak yourself right out, there are plenty of securities and markets out there where you can do that. After all, there’s always a bear market somewhere – and the top 3 bearish TRENDs in our macro model continue to be:
- Japanese Yen
- US Treasuries
Within the Commodities Deflation trend, consensus first saw Copper imploding as a “bearish growth signal.” Now, consensus is calling it what it is this morning – the biggest build of Copper inventory on the LME (London Metals Exchange) since 2003. What if you bought SPY in 2003?
Yep, LME Copper inventory is up +76% YTD. With supply that high and the Correlation Risk in Copper to #StrongDollar ripping, who cares about anything else? It certainly doesn’t mean the world is ending either.
The End of World (#EOW) trade has great marketing programs and tends to get priced into Gold in a hurry. Last week’s net long position in Gold (per CFTC futures/options data) exploded to the upside by 63% week-over-week (to 70,193 net long contracts).
But Gold bulls have been going back to this Cave Dweller well of fear for the last 6 months. So that’s not new. Neither is Gold’s price not reacting to the fear-born expectation that it out-performs. Gold is down again this morning, testing $1605 support.
Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, USD/YEN, UST 10yr Yield, VIX, and SP500 are now $1, $106.97-108.66, $3.36-3.48, $82.15-83.25, 94.07-96.71, 1.89-1.97%, 10.78-14.92, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Takeaway: The good outweighs the bad in JCPenney’s 10K disclosure.
This note was originally published March 21, 2013 at 09:18 in Retail
Here are some key points from JC Penney's 10K disclosure.
- Commented that the letter it received from bondholders (that one the people speculated was from Icahn to back Ackman into a corner) claiming JCP had defaulted on its commitment has been rescinded. A default would have caused a chain reaction with other tranches of debt, and potentially caused a major liquidity event. That risk is now mitigated.
- Capex for 2013 is coming down to levels on par with 2012. That frees up about $200mm in our model, and of course, in JCP’s liquidity. We like this change, because quite frankly – JCP spending $1bn (even with its remodel program) borders on ridiculous.
- Pension expense (non-cash) to decline in 2013 by about 40%. On top of that, expected rate of return is down to 7% from 7.5%.
- On the negative side, JCP added risk factors of chance of non-cash asset impairment charges, and potential limited use of NOL carryforwards. Not good, and we’re curious as to why there would be a limit in the ability to use NOLs. But the end result is that this not a disaster.
- There was also a comment on change in strategy could take longer. JCP had to do that given that a) it is starting to be promotional again and does not know the full impact. And 2) the Martha Stewart trial is in limbo, and JCP might have to change to alter the scope of the product in the event of an adverse outcome.
- One credibility point is that the company noted that it ended the year at 116,000 employees, that’s 27%, or below a year ago. On one hand, that represents major progress in JCP's restructuring. On the flip side, it’s more than 2x the number of people Ron Johnson said had lost their job when he testified under oath earlier this month at the JCP/M/MSO trial. The year-ago number was likely inflated due to a higher number of seasonal employees on the books on the final day of the prior year – so the figures could likely be dissected many different ways. But either way, Johnson haters will use this as a knock on his credibility.
- There was no commentary on first quarter performance, but we caution that we still need to get past what will likely be an abysmal first quarter performance (25% of square footage will be under construction) before we start to see improved productivity from the new shops that get put in place in May.
When all is said and done, we think the good outweighs the bad. We still think anyone with an immediate-term investing horizon shouldn’t look at JCP as a long, but that it will turn in the second half of 2013.
Takeaway: Price signals and reversal of sentiment are two factors that may converge to help perpetuate a further breakdown in Thai equities.
- If you’re looking to reduce you’re international equity exposure from here, Thailand may be a good place to start as price signals and reversal of sentiment are two factors that may converge to perpetuate a further breakdown in Thai equities.
- While there’s not necessarily a high-conviction short call to be made here (the slowdown in growth from the flood comp-related acceleration in 4Q is both obvious and expected) we are monitoring the SET closely here to see if it holds or breaks down below our intermediate-term TREND line; the immediate-term TRADE line was violated to the downside just yesterday (inside baseball on the margin hike or a mere coincidence?).
- Needless to say, a confirmed TREND-line breakdown would be a clear signal for investors to dramatically reduce their Thai equity exposure. Punitive capital controls and a dramatic acceleration of political instability are two proactively predictable negative fundamental outcomes that would likely take consensus by surprise, potentially perpetuating a noteworthy reversal of international capital flows.
The Stock Exchange of Thailand announced today an increase of the cash-account rule for securities trading by brokers to 20% of a customers’ credit line, which weighed heavily on the overall SET Index (down -3.3% on the day and -7.5% wk/wk). While we expect declines specifically related to this margin hike to be short-lived, the broader question of “where to from here?” is begged by the SET’s negative delta from previously outperforming the region to now underperforming the region.
In our Asia+LatAm universe, the SET is the third-best performing index on a YoY basis at +24.2% and the second-worst performer on a MoM basis at -4%.
One has to wonder if all the good news (slowing, but very robust growth, slowing inflation and reasonably insulated from JPY debauchery as Japan is Thailand’s largest source market at 18.4% of imports and 64% of FDI) is priced in. The THB is outperforming (i.e. either #1 or #2) on all three of our core Asia+LatAm factor risk durations: +1.9% MoM, +4.5% over 3M and +5.1% YoY, indicating a high degree of foreign capital inflows.
Evidence of froth are indeed present, even as the fundamental underpinnings for further upside in Thai financial markets appears to be abating: 1M 25-delta risk reversals for the USD/THB are at -14bps, which is the lowest since mid-2008 and equity market valuations, while not dramatically overstretched, are definitely at the high ends of their respective ranges; meanwhile, Thailand’s 10Y-2Y sovereign yield spread (a key proxy for growth expectations) has pancaked in recent months.
While there’s not necessarily a high-conviction short call to be made here (the slowdown in growth from the flood comp-related acceleration in 4Q is both obvious and expected) we are monitoring the SET closely here to see if it holds or breaks down below our intermediate-term TREND line; the immediate-term TRADE line was violated to the downside just yesterday (inside baseball on the margin hike or a mere coincidence?). Needless to say, a confirmed TREND-line breakdown would be a clear signal for investors to dramatically reduce their Thai equity exposure.
Punitive capital controls, while not a near-term risk per the latest commentary out of both Finance Minister Kittiratt Na-Ranong and Bank of Thailand Governor Prasarn Trairatvorakul, could eventually be implemented if the Thai baht remains on fire. Specifically, the JAN minimum wage hike to 300 baht/day may start to weigh on the competitiveness of Thailand’s export sector (57.6% of GDP), which would increase corporate pressure upon the now heavily-scrutinized Shinawatra administration to act.
In regards to the aforementioned scrutiny, it should be noted that Prime Minster Yingluck Shinawatra is facing legal pressure for misrepresentation of familial assets and for issuing her brother, former Thai Prime Minster Thaksin Shinawatra (currently a wanted fugitive in Thailand that lives abroad to evade prosecution), a fresh Thai passport.
Her ethics are being questioned by rival parties and a full investigation by the Ombudsman’s Office is not out of the question. A revocation of her ruling mandate is a key tail risk to consider – especially given Thailand’s well-documented recent history of political instability. Recall that consternation on the political front weighed heavily on the SET Index in the Springs of 2010, 2011 and 2012 (full disclosure: we held a bearish bias heading into the 2011 correction and reinitiated appropriately bullish at the bottom the 2012 one).
All told, if you’re looking to reduce you’re international equity exposure from here, Thailand may be a good place to start as price signals and reversal of sentiment are two factors that may converge to help perpetuate a further breakdown in Thai equities. Watch that TREND line closely!
Have a great weekend,
We still see the stock setup as a win-win for investors. Management continues to fall short of the standards we believe the investment community is demanding but equity holders shouldn’t panic.
Holders of the stock can win in two ways:
- Management continues to demonstrate that it cannot effectively manage the business as it exists today, rolling out the red carpet for an activist or group of activists
- Sequential improvement in industry trends should help Darden in 4QFY13.
Conference Call Underscores the Need for Change
In our Black Book outlining our short thesis on Darden, published in July 2012, we highlighted a disconnect between management’s commentary and reality. We described a “problematic line of reasoning in Darden’s quarterly discussion of sales results”. If anything, our rating of management’s grasp on its business has deteriorated further since then. The investment community clearly sees that the strategy being employed by the company is proving ineffective. From our perspective, it seems they are attempting to limit check growth by:
- Introducing promotion to only those that need it
- Betting that there are customers willing to pay more to offset margin degradation
We believe this strategy will prove as ineffective as the majority of the company’s recent efforts. We have seen management struggle to forecast customers’ adoption rate of various promotions over time and do not buy into the “new learnings” idea that is repeated each quarter as a reason why the same strategies will yield different results.
The company is trying to manage margin without attacking the middle of the P&L. Until we hear management change course, and follow Brinker’s lead, we believe that the company will continue to underperform versus its potential. There is plenty of fat to cut at Darden but it may take an activist for shareholders to reap the rewards of it being shed.
Earnings Recap – Little Surprise Given Preannouncement
Darden delivered a slightly better-than-expected quarter this morning with same-restaurant sales for the blended “Big 3” (Olive Garden, Red Lobster, LongHorn), coming in at -4.6% in 3QFY13 versus -4.5% preannounced in February. Earnings per share for the quarter came in at $1.02 versus the Street at $1.01.
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