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The Perks of The Dollar

Client Talking Points

Chinese Deflation

The effects of the US dollar gaining strength week-after-week are being heard around the world. China is seeing a decrease in inflation as global food prices come down hard. Asian stocks are up this morning after Chinese CPI fell hard on a month-over-month basis to 2.1% in March vs 3.2% last month.

Confuse The Masses

The 10-year Treasury is in a nice little niche right now that can confuse the bulk of investors out there. "Which way will it go?" they'll ask. The 10-year has been making lower highs since March but is bearish on our immediate-term TRADE duration as 1.83% as resistance. If it can't break that level, expect lower yields as people think twice about Japanese and US bonds. 

Asset Allocation

CASH 26% US EQUITIES 28%
INTL EQUITIES 22% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 24%

Top Long Ideas

Company Ticker Sector Duration
DRI

Darden stands to be a beneficiary from a housing recovery and an improved employment picture, which boosts casual dining trends. The company's net income declined on its recent earnings report but beat the Street's expectations.

FDX

With FedEx Express margins at a 30+ year low and 4-7 percentage points behind competitors, the opportunity for effective cost reductions appears significant. FedEx Ground is using its structural advantages to take market share from UPS. FDX competes in a highly consolidated industry with rational pricing. Both the Ground and Express divisions could be separately worth more than FDX’s current market value, in our view.

HOLX

HOLX remains one of our favorite longer-term fundamental growth companies given growing penetration of its 3D Tomo platform and high leverage to the 2014 Insurance Expansion from the Affordable Care Act.

Three for the Road

TWEET OF THE DAY

"Fidelity Considers Scrapping Securities Lending Program [GC]" -@alea_

QUOTE OF THE DAY

"To succeed in the world it is not enough to be stupid, you must also be well-mannered." -Voltaire

STAT OF THE DAY

The March small-business optimism index of the National Federation of Independent Business fell 1.3 points to 89.5.


Sturdy Horses

This note was originally published at 8am on March 26, 2013 for Hedgeye subscribers.

“Some see private enterprise as a predatory target to be shot, others as a cow to be milked, but few are those who see it as a sturdy horse pulling the wagon.”

-Prime Minister Winston Churchill

 

Winston Churchill smoked cigars effusively, ate almost whatever was put in front of him, came under fire in armed conflicts more than 50 times, and engaged in many political battles over the course of his life.  Despite these potential health risks, Churchill lived to the ripe old age of 91.  He was, by almost any estimation, a sturdy horse.

 

As it relates to his health, many observers often commented on the generous amounts of alcohol that Churchill drank.  In fact, Sir Alexander Cadogan, head of the Foreign Office, noted at the Yalta conference in 1945 that the Prime Minister was “drinking buckets of Caucasian champagne which would undermine the health of any ordinary man.”

 

Churchill himself was not shy about acknowledging aggressive consumption of spirits and once said:

 

“Always remember that I have taken more out of alcohol than alcohol has taken out of me.”

 

For those of you that have been over served, and I will include myself in that camp, you know full well that to gain the upper hand on alcohol, and in particular hangovers, indeed requires that one have the constitution of a sturdy horse.

 

But the purpose of this note is not to delve into the fine details of Churchill’s bad habits, but rather to delve into the realm for which he is most well known – foreign policy.  Based on traditional measures of risk, like volatility, many markets are signaling a future without any major foreign policy blow ups.  In particular, U.S. equities, as highlighted in the Chart of the Day are making new lows in terms of volatility.

 

This, of course, is not to say risk has gone away, but currently equity markets are certainly discounting lower global risk in the future. As a result, it is probably a sign to be even more diligent when searching for TAIL risks.  In the realm of international security, we see a number of red lights on the horizon that are worth monitoring closely, specifically: 

 

1. North Korea – Even if Dennis Rodman has improving relations with this Communist nation, the rest of the world’s relations are deteriorating on the back of a nuclear test that coincided with President Obama’s February State of the Union address.  This followed a long range missile test in December.  In combination these two tests are an attempt by Kim Jong-un to show to the world that North Korea has, or is developing, the ability to launch long range nuclear missiles.

 

In recent history, North Korea has been more of rhetorical threat than a tangible one, but both the United Nations and United States are taking the most recent actions increasingly serious.  As well, Defense Secretary Chuck Hagel indicated he intends to re-allocate $1BN+ to build a missile shield in Alaska to bolster defenses focused on North Korean threats.  This morning the North Koreas upped the ante once more in announcing that they have placed military units tasked with targeting U.S. bases under combat ready status.

2. Iran –Iran has remained largely out of the headlines in the last few months, but this will likely change with the upcoming Presidential election in June 2013.  Current Iranian President Mahmoud Ahmadinejad is barred for running after being President for two terms and has taken to saying “long live Spring” at recent events, a cryptic phrase that is being interpreted as a call for change in the face of the Ayatollah’s attempts to manage the outcome of the election.

 

We emphasize the election because the last Iranian election is generally perceived to be the most tumultuous period of mass protests in Iran since the Iranian revolution.  Since that election in 2009, international sanctions on Iran have had their intended impact with oil subsidies falling and prices of basic foodstuffs accelerating.   So, even as the Ayatollah attempts to manage this election proactively, primarily by jailing potential reformist candidates, he can’t jail every citizen and the citizenry is much worse off now than in 2009.

3. Syria – Since the start of the Arab Spring more than two years ago, Syria has been a hot spot on the political map.  Unlike some of its neighbors in which a change in leadership was relatively swift, Syria continues to be ruled by President Assad, with the ongoing goal of the rebel forces to overthrow Assad by any means.  In fact, as recently as in the last couple of days there have been rumors that Assad had been assassinated. 

 

The reality is that Assad remains in power and the rebels remain disorganized with leadership largely in disarray since the resignation of Syrian National Coalition chief Mouaz al-Khatib. The other reality is that military activity appears to be accelerating with the worst bombing in Damascus since 2011 over the weekend.  Further, there were rumors this weekend that there was a gas attack near Aleppo.  Although even here confusion reigns as no one is sure whether it was the rebels or Syrian government that used the gas.

 

Churchill was well known for his interventionist leanings and once said about Russia that:

 

“Bolshevism must be strangled in its cradle.”

 

In contrast, the current leader of the free world, United States President Obama, has been decidedly non-interventionist. Over his first term, this has certainly not impacted the United States in the short term as the most prominent threat when Obama was first elected, Al-Queda, has been largely contained and there have not been other imminent threats to the United States or global peace.  That said, any acceleration of events in North Korea, Syria, or Iran may be cause for increased U.S. intervention abroad.

 

As we think about managing risk prospectively, especially at lower levels of implied volatility, keeping key areas of potential international conflict front and center will remain critical.  As it relates to our investment themes, accelerating international conflict is actually positive for the sturdy horse of international currencies – the U.S. dollar.

 

Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, USD/YEN, UST 10yr Yield, VIX, and SP500 are now $1582-1605, $106.76-108.64, $3.36-3.47, $82.69-83.34, 94.01-96.72, 1.89-1.97%, 10.79-14.96, and 1543-1565, respectively.

 

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research 

 

Sturdy Horses  - Dollar is a sturdy Horse EL

 

Sturdy Horses  - Virtual Portfolio



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Commodity Deflation

“We can’t afford to risk a downturn, no matter how much inflation.”

-Richard Nixon

 

Nixon’s legacy is Watergate. Trivial Pursuit presidential history doesn’t yet appreciate how horrendous he was for the US economy. On matters of economic policy, this guy was easily the most conflicted, conniving, and compromised president in the post WWII period.

 

If you’d like to re-educate yourself on the what, when and why (Nixon’s economic policies), chapter 4 “Gamble” of Volcker: The Triumph of Persistence is a beauty. The aforementioned quote came from Nixon during his 1972 re-election campaign.

 

Prior to that (1971), Nixon had already abandoned the Gold Standard and explicitly devalued the US Dollar. On the fiscal policy side, he hired a Democrat from Texas who polled well (John Connolly) to be Treasury Secretary. Connolly wrote later, “I was not an economist; I had really never studied monetary affairs. My experience with fiscal issues was limited largely to a familiarity with Congress…” (Volcker, pg 74)

 

Back to the Global Macro Grind

 

Why do we care about the context of politicized currency devaluations (and the local inflations they drive) this morning? Well, because the only opportunity the US economy has to grow (on a real inflation adjusted basis) is through pervasive Commodity Deflation. It’s a Tax Cut.

 

To be balanced, cracker jack economists who have never traded a market in their life (i.e. don’t understand price expectations) want you to believe that currency devaluation will give you the elixir of an exported life. Now that the Japanese Yen is crashing (-24% from where we made the short call in 2012), they’ll have to let us know how that is going for the Japanese consumer who isn’t levered long Nikkeis.

 

The biggest Global Macro calls for 2013 YTD have been centered squarely on understanding the causal impact central planners have on their domestic currency:

  1. Get the central plan right, you get the currency right
  2. Get the currency right, you get the correlation right
  3. Get the correlation right, you get the money

“Show me the money!” –Tom Cruise

 

To review, the US Dollar has been strengthening ever since Bernanke tried to promise to print to infinity and beyond (SEP2012):

  1. MONETARY POLICY: Since, on the margin, market expectations for an iQe5 upgrade have been crushed (see Gold chart)
  2. FISCAL POLICY: after plenty of political spending wants, the US actually implemented marginally hawkish spending cuts

Again, if you get policy (monetary and fiscal) right, you’re going to likely get the local currency move right. On the margin is what matters most in macro, and when you combine marginally hawkish domestic policy with relatively dovish competing policy (Japan), ta-dah!

 

Japan’s currency devaluation is very easy to understand (primarily because Japan’s #PoliticalClass is doing precisely what America’s did):

  1. MONETARY POLICY: hit CTRL+P (print) and step that Japanese debt monetization up to 50 TRILLION more Yens (a year)
  2. FISCAL POLICY: get the LDP to take the Upper House in this summer’s election and implement “spend your brains out 2.0”

In other words, even if we are dead wrong on the USA’s marginal policy shifts in 2013, we could be right on our #StrongDollar via the rate of change in Japanese policy. Layer on some European Marxism onto the Euro, and I have myself quite a Keynesian treat.

 

Hedgeye Playbook: how do you make money on this?

  1. Long US Dollars vs Short Yens
  2. Short Commodities (they have hyper high inverse correlations to #StrongDollar)
  3. Long Asian and US Consumption Equities

Some of our competitors can pop this in their next report. “Last night the Chinese reported more of the same on this front. #StrongDollar = Down Food Prices (globally) = Down Inflation (for countries that have a US Dollar peg).” Chinese CPI fell from 3.2% in FEB to 2.1% in MAR – and yes, that is better than a bad thing for people who don’t take government car service to work and have to eat.

 

I shorted Wheat (WEAT) on the bounce yesterday (unlike trying to call tops in the SP500, it’s always easier to short things that have already started going down – Wheat prices are down -8.4% YTD). Corn and soybean prices are down -9.3% and -2.9% YTD, respectively.

 

Brent Oil is down -5.7% YTD – but seriously? Who cares about these YTD Commodity Deflations when you can look at how epic they’ve been since Wall Street front-running Bernanke on Commodity prices ended (in food prices especially) at their all-time highs of September 2012? On a 6 month basis, Corn and Wheat are down -14.6% and -17.2%, respectively.

 

Nixon had it wrong – so did Charles de Gaulle, Jimmy Carter and George W. Bush. President Obama, like Clinton, has a choice on monetary and fiscal policy in his second term. Will he risk the Big Auto lobby for a weak currency? Folks, we need a #StrongDollar and Commodity Deflation. Oh yessir – Yes We Can.

 

Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, VIX, and SP500 are now $1, $103.19-108.02, $82.42-83.39, 95.23-99.31, 1.71-1.83%, 12.21-14.43, and 1, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Commodity Deflation - Chart of the Day

 

Commodity Deflation - Virtual Portfolio


JCP: The Board Should Resign

Takeaway: We think that firing RJ at this juncture opens JCP up to risks that were previously not part of the equation. Ullman? Seriously???

This note was originally published April 08, 2013 at 19:41 in Retail

After being short JCP from the Ackman/Johnson $40 ‘$9-$12 in earnings power’ hype, we pulled a 180 at $19 earlier this year based on our view that liquidity concerns were overblown, and that the stock would start to turn when the better productivity from the new shops rollout improved the sales delta. Without a doubt, the call was too soon and the subsequent $4/$5 drop in the stock was painful. But the reality is that the research did not change anywhere near as much as the sentiment did, so we kept this name on our Best Ideas list.  But we were vocal several times in saying that the one thing that could make us cut bait on our call is if the Board bowed to Wall Street’s bantering and fired Johnson at this juncture (see our 3/6 Note below “Why Firing Johnson Is The Fastest Way To Ch 11) . Well…Johnson is out, and we're cutting bait. There could be more downside to come.  

 

 

This Action Raises More Questions Than It Does Answers

  1. We think that this move is either six months too late, or six months too soon, but definitely ill-timed today.  The Board should fire the guy when either a) his pricing strategies are failing miserably due to botched execution (mid 2012), or b) when the shop-in-shop strategy – the real reason why you hired him – proves to be unsuccessful (end of 2013). Unless there was a dramatic negative turn of events over the past two weeks (which is possible), it is perplexing to think of why they would get rid of him today as opposed to seeing if the shop strategy works. The Board should show a little transparency into its process and personal accountability for its actions.
  2. Mike Ullman is the new CEO, again. Seriously? The stock initially traded up nearly 15% on the announcement that RJ, America’s most hated CEO, was out. That’s about what we’d expect. But once the company disclosed that that Mike Ullman was stepping in, the stock gave up nearly 20%. What does that say about the market’s confidence in Ullman?
  3. Did anyone else even want the job? Mickey Drexler? No way. Alan Questrom? Possibly. But we think he’s smart enough to pass on the job because JCP is so stuck between a rock and a hard place – not having the financial capital to change directions, and potentially lacking the human capital to stay on the existing course set by RJ. The job bank here was really thin.
  4. Lipstick on the Pig? One potential bullish signal would be whether the Board put Ullman in place for an interim period so he can calm the troops, stabilize the business, and put enough perfume and lipstick on the pig so that it can be taken private. We wouldn’t bank on this one, nor would we invest based on it. But we can’t count it out, either.
  5. Capital Considerations: Unless JCP is prepping for a sale, the likelihood of a capital raise just went up – and it went up materially. It’s pretty easy for a new CEO to step up and say “I need money to clean-up the problems caused by my predecessor.”  The reality is that if Ullman wants to go down a new path with the strategy, he will definitely need capital.

 

We think that the risks we initially highlighted (below) are still very much alive.

We’ve going to let this stock breathe for a bit. After it settles, if the quantitative factors support the call, we’ll have no problem shorting it – even if it’s at a price lower than $14. Real estate value is only $7-$8. And if Ullman can’t pull a rabbit out of his hat on this sucker, there’s no reason it can’t go lower.

 

 

 

04/08/13 05:12 PM EDT

JCP: WHY FIRING JOHNSON IS THE FASTEST PATH TO CH11

 

Conclusion: Contrary to what others are recommending today, we think that firing Ron Johnson is just about the stupidest thing that the JCP Board could do right now. If they did fire him, we think that it would be the quickest path to bankruptcy for JCP. Sentiment seems to us that the stock would go up on that news. But if we saw him ousted we’d likely short this name with impunity -- even with the sell-side capitulating at a price of $14/15. We think losing Johnson would pose significant vendor/brand risk, and would back JCP into a corner to liquidate its real estate at a discount.

 

A new CEO would be faced with a binary decision tree. Either A) Return to being the lowest-quality department store in America, or B) carry out Johnson’s shop-in-shop plan better than RJ could on his own. Johnson clearly blew himself up in 2012, but we don’t put blind faith in the ability for anyone to come in and implement this plan any better. Keep in mind that 75% of the problems JCP has had have little to do with changing up the shop format and upgrading the merchandise assortment – it was largely due to RJ getting the pricing/marketing/value proposition wrong on the existing merchandise. Letting RJ run with the current plan might carry more risk as 2013 unfolds – but doing it without him is riskier, with potentially more significant financial pain.

 
1) First off, once a cucumber becomes a pickle, you can’t reverse the process. It already has architected its square footage to new shops, chosen new partner brands, and gotten rid of hundreds of vendors to make room for what is coming down the pike. That cannot be undone, which leads us to the conclusion that a new leader would need to move forward with the current plan – or something pretty darn close to it. Unfortunately, JCP does not have the liquidity for a new CEO to shake the Etch-a-Sketch clean, start over, and create a new plan. The lack of capital deprives JCP of the oxygen needed to go down a new path.
 
2) Ron Johnson has spent easily a third of his time ensuring that the right brands/vendors are chosen, and then collectively working with the brands and his merchants to make sure that the right product is in the right place inside the store. Whether you like RJ or not, the reality is that the vendors still like him – a lot. They buy into the long term vision (even if no one on Wall Street does). We’re relatively certain that at least a few large vendors would balk at rolling out product inside JCP if leadership and strategy changed dramatically.  
 
3) If that were the case, JCP would be left half-pregnant.  It wouldn’t be able to fill the shelves quickly with legacy product (i.e. become the old, poor quality JC Penney), and the product that should ultimately drive traffic under the new plan is at risk of never becoming a reality. Then we can build to an algorithm where comps are down another 20-30%, and not only is JCP forced to use its full revolver, but to liquidate its real estate, which we estimate to be worth about $1.8bn-$2.1bn (see our note from last night “JCP: Duration Matters More Than Ever’) to fund operating losses.
 
4) Allen Questrom, the Godfather of retail (we mean that in a complimentary way), was on CNBC [on 3/8] talking about why RJ should be fired immediately. He said that the Board needs to admit its mistake and move on. At face value this carries a lot of weight given that Questrom is the only person to successfully turn around JC Penney. But let’s be real. When Johnson went down the path of ‘reinventing’ JCP, Questrom did not make the cut of people he leaned on to consult about a solution. Questrom likely viewed that as a snub, and also probably has little patience for anyone that is seemingly destroying something that he worked so hard to fix. Not really a shocker that Questrom is on the short list of people recommending that he’s ousted due to 2012’s failures. Also keep in mind that he’s on the short list of people that would be considered for the top job (though we have no reason to think that he’d want it).


JCP: Firing Johnson Is The Path To Ch11

Takeaway: Contrary to what others are recommending, we think that firing RJ is the fastest way to realizing the liquidity crunch bear case.

This note was originally published March 06, 2013 at 15:19 in Retail

Conclusion: Contrary to what others are recommending today, we think that firing Ron Johnson is just about the stupidest thing that the JCP Board could do right now. If they did fire him, we think that it would be the quickest path to bankruptcy for JCP. Sentiment seems to us that the stock would go up on that news. But if we saw him ousted we’d likely short this name with impunity -- even with the sell-side capitulating at a price of $14/15. We think losing Johnson would pose significant vendor/brand risk, and would back JCP into a corner to liquidate its real estate at a discount.

 

A new CEO would be faced with a binary decision tree. Either A) Return to being the lowest-quality department store in America, or B) carry out Johnson’s shop-in-shop plan better than RJ could on his own. Johnson clearly blew himself up in 2012, but we don’t put blind faith in the ability for anyone to come in and implement this plan any better. Keep in mind that 75% of the problems JCP has had have little to do with changing up the shop format and upgrading the merchandise assortment – it was largely due to RJ getting the pricing/marketing/value proposition wrong on the existing merchandise. Letting RJ run with the current plan might carry more risk as 2013 unfolds – but doing it without him is riskier, with potentially more significant financial pain.

 
1) First off, once a cucumber becomes a pickle, you can’t reverse the process. It already has architected its square footage to new shops, chosen new partner brands, and gotten rid of hundreds of vendors to make room for what is coming down the pike. That cannot be undone, which leads us to the conclusion that a new leader would need to move forward with the current plan – or something pretty darn close to it. Unfortunately, JCP does not have the liquidity for a new CEO to shake the Etch-a-Sketch clean, start over, and create a new plan. The lack of capital deprives JCP of the oxygen needed to go down a new path.
 
2) Ron Johnson has spent easily a third of his time ensuring that the right brands/vendors are chosen, and then collectively working with the brands and his merchants to make sure that the right product is in the right place inside the store. Whether you like RJ or not, the reality is that the vendors still like him – a lot. They buy into the long term vision (even if no one on Wall Street does). We’re relatively certain that at least a few large vendors would balk at rolling out product inside JCP if leadership and strategy changed dramatically.  
 
3) If that were the case, JCP would be left half-pregnant.  It wouldn’t be able to fill the shelves quickly with legacy product (i.e. become the old, poor quality JC Penney), and the product that should ultimately drive traffic under the new plan is at risk of never becoming a reality. Then we can build to an algorithm where comps are down another 20-30%, and not only is JCP forced to use its full revolver, but to liquidate its real estate, which we estimate to be worth about $1.8bn-$2.1bn (see our note from last night “JCP: Duration Matters More Than Ever’) to fund operating losses.
 
4) Allen Questrom, the Godfather of retail (we mean that in a complimentary way), was on CNBC today talking about why RJ should be fired immediately. He said that the Board needs to admit its mistake and move on. At face value this carries a lot of weight given that Questrom is the only person to successfully turn around JC Penney. But let’s be real. When Johnson went down the path of ‘reinventing’ JCP, Questrom did not make the cut of people he leaned on to consult about a solution. Questrom likely viewed that as a snub, and also probably has little patience for anyone that is seemingly destroying something that he worked so hard to fix. Not really a shocker that Questrom is on the short list of people recommending that he’s ousted due to 2012’s failures. Also keep in mind that he’s on the short list of people that would be considered for the top job (though we have no reason to think that he’d want it).

 


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