“A government’s first job should be to protect its citizens. But that should be based on informed consent, not blind trust.”
I was flying back from California last night and those few sentences in The Economist article titled “Secrets, lies and America’s spies” got me thinking about the Fed. The article, of course, had nothing to do with Bernanke. But it had everything to do with trust.
How can you trust what you cannot see? I am Canadian, so hard core Americans will have to check my work on this – but didn’t the US Constitution provide a clause for this thing called free elections?
While I hardly doubt Franklin and Jefferson envisioned an America that was hostage to an un-elected and un-accountable central planner’s qualitative views of economic gravity, that doesn’t matter right now – because that’s what you have. The blind trust this country has put in Bernanke’s ability to “smooth” the Waterfall of interconnected risk was a mistake. Now we have to deal with his mess.
Back to the Global Macro Grind…
So how did you like yesterday anyway? Feeling good yet? Want to get Bernanke whispering to Hilsenrath around 320PM EST this afternoon that he didn’t really mean it? Wouldn’t that be cool – then we could do the whole over the Waterfall thing together again!
If you are going to tell me that markets trust how Bernanke is going to manage this going forward, I am going to tell you that you are probably already hammered. It’s always 5 o’clock on a Friday somewhere.
When markets don’t trust something, the forward curve of implied volatility starts to rise. When they really don’t trust something, that volatility rises at a faster rate. It’s called convexity.
In terms of implied volatility in everything that was already crashing (Gold, Treasuries, Emerging Markets, etc), that concept has been pretty straightforward for going on 6 months now. For US Equities, it’s relatively new.
Here are front-month US Equity Volatility’s (VIX) TRADEs and TRENDs:
- Week-to-date, the VIX = +19.4%
- Month-over-month, the VIX = +57.2%
- In the last 3 months, the VIX = +61.6%
In other words, as US consumption, employment, and housing #GrowthAccelerated in the last 3 months, US Equity market expectations went right squirrel. How screwed up is that?
It makes sense though. We have a US Federal Reserve that is A) horrendous in terms of forecasting and B) compromised and conflicted in terms of timing its “communications.” Bernanke made his legacy bed – now we all have to sleep in it.
Another way to think about US growth expectations is bond yields – they love growth:
- Week-to-date UST 10yr Yield = +29 basis points to 2.42%
- Month-over-month UST 10yr Yield = +45 basis points
- In the last 6 months, UST 10yr Yield = +62 basis points
In other words, 10yr Yields ripping yesterday wasn’t new – they’ve been making higher-lows and higher-highs since the November 2012 all-time low. In the last 6 months, 10yr US Treasury Yields are up +35%!
Captain Keynesian is going to say, whoa, whoa, on that Mucker – you are using % moves instead of absolutes. Ah yes, professors, and that’s the precisely the point. Right back at ya – you created an expectation of an absolute zero bound that was reckless and un-precedented.
What else has been front-running Bernanke’s Blind Trust of 0% rates to infinity-and-beyond? Gold:
- Week-to-date Gold = -7.7%! to $1280/oz
- YTD Gold = -23.9% #crashing
- In the last 6 months, Gold = -22.5% #crashing
Gold hates growth and gold loved Bernanke’s anti-consumption growth Policies To Inflate. Period.
Now, to be fair to the community who trades on Washington “consultant” whispers, if you do have a Hilsy rumor in your back pocket this morning, the first thing you’d probably do with that is buy Gold, lever yourself up with some Oil futures, and short Treasuries.
Isn’t that just great for America!
The sad reality is that Americans don’t trust Bernanke’s Fed as far as they can throw Cramer or his buddy’s gnome. The American zeitgeist of distrust in politically driven institutions reaches far beyond the IRS. It’s in your mind each and every market day.
The best thing President Obama can do is say goodbye to Ben S. Bernanke’s concepts of “innovation and communication.” Unless you are all interested in scaling back up the bond-buying Waterfall, ripping a VIX 30 handle, and doing yesterday over and over and over again, that is.
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1, $100.80-103.96, $81.11-82.19, 96.18-97.92, 2.24-2.46%, 17.25-21.56, and 1, respectively.
Best of luck out there today and enjoy your weekend,
Keith R. McCullough
Chief Executive Officer
Takeaway: Don't read this mgmt chg as a precursor to an EPS miss. But as great as NKE is with backfilling talent, it has many roles in transition.
Conclusion: Some things surprised us about Nike's announced management changes, other things did not. Regardless, we don't think that it was timed such that there'd be a fall guy(s) for disappointing earnings to come next Thursday. We think that the company will do its best to keep guidance for FYMay14 earnings grounded -- but that has absolutely nothing to do with what we saw after the close today. The bottom line is that most of the job changes make sense and have long-term organizational benefits -- but for the next quarter or two half a dozen key roles will be in transition.
Plain and simple, Charlie Denson (COO) is retiring. We all knew back in 2006 that this day would come. Back then Bill Perez was fired from the corner office and Mark Parker got the nod to take the CEO role over Denson -- who was then his equal. Denson is 57 and Parker is 56 -- they're both still young, and Parker isn't going anywhere soon. Denson can't move any higher up the org chart. He's sticking around until January 2014 -- hardly a time frame for an executive who's running for the door (or being pushed out of it). The press release says Parker is sad to see him go, and we think it's genuine.
We're pleased to see that there are no changes to the Finance organization -- notably Don Blair or his team. With Denson transitioning out, we think that Don Blair's stock inside the company will rise given Don's ability to lend expertise to a new incoming COO. That said, it bugs us to see that Gary DeStefano is retiring. DeStefano is 54 years old, and has been at Nike for 31 years in too many roles to list. He's currently President of Global Operations, and will only be at the company for another five weeks. Last we checked, that's a pretty important role. The good news is that Denson will still be there to oversee the team while replacements are groomed. But out of the whole management change, if there was one part that we'd point to as being potentially disruptive, this would be it.
One thing that was put in place at Nike over the past few years is that all employees that have managerial responsibilities have several people identified in their HR file who could easily step into their role in the event that they move on. What this means is that if there is one higher-profile departure, then it sets off a domino-effect of other movement inside the organization. Look at past press releases. Try to find an example where only one person leaves or moves to a different role. You can't find it.
Another thing that works for Nike is that the company is not afraid to move its employees around the organization into and around different disciplines. Take for example Eric Sprunk (note: Wall Street universally loves the guy) who started his career at Price Waterhouse, and then after joining Nike in 1994 as Finance Director for the Americas, then Finance Director of Europe, Regional GM of Europe Footwear, GM Global Footwear, VP Global Product, EVP Merchandising and Product, and now COO. We could follow a similar track for almost all of the more successful Nike executives.
In the end, this is all consistent with how we expect Nike to run it's business long-term, and it's what makes it so successful at what it does. We'll keep a closer eye on a few of these areas that are in transition, but over our 15-years covering the company have never been given reason to doubt the company's ability to manage through similar leadership changes without coming out on top.
Daily Trading Ranges
20 Proprietary Risk Ranges
Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.
Takeaway: Let's not mince any words. China and Japan look nasty.
Two quick macro bullet points on the bloody mess that is Asia right now. We've been raising the red flag here for some time now. #EmergingOutflows.
Did you know that foreign investors held a combined 28% of the market cap listed on Japan’s five exchanges (up +170bps YoY) at the end of 1Q13? Clearly international investors are betting on Abenomics delivering Japan from its 20-year hole. We'll see how that one works out. For the record, we're not holding our breath.
The Liberal Democratic Party (LDP) is ready to cut the corporate tax rate to in line with international levels and also plans to implement appropriate debt management policy to maintain fiscal discipline. Specifically, the Cabinet will seek to cap spending ex-debt service at the current level of around ¥70T through FY15.
Additionally, Prime Minister Shinzo Abe said that raising the country's 5% consumption tax to 8% next April (and 10% in 2015) would “depend on the strength of the economy”, as they are concerned about the negative impact that could have to growth – which could delay consumer price hikes out of Japanese corporations and complicate the BOJ’s monetary policy agenda.
By jove, China’s banking situation is actually getting worse!
Per StreetAccount: “Bloomberg reported that China's benchmark money-market rates climbed to records as the PBoC refrained from using reverse-repos to address the cash crunch. The central bank didn't conduct open-market operations to add or drain funds today and sold 2B yuan ($326M) of three-month bills. The seven-day repo rate rose 270bp to 10.77%, the highest in data going back to March 2003. The one-day rate rose by an unprecedented 527bp to an all-time high of 12.85%. An intra-day gauge of the one-day rate touched a record 30%.”
Right in line with what we’ve been flagging for the past two months (i.e. tightening financial conditions perpetuating a slowdown in economic growth), the flash HSBC Manufacturing PMI ticked down to a 9-month low in June (48.3 from 49.2 prior). The sub-index for New Orders fell to a 10-month low of 47.1.
Stay on your toes out there.
Yesterday (6/19) we hosted a call on electronic cigarettes titled “e-Cigs: The Untapped Market for Electronic Cigarettes”, featuring John J. Wiesehan, Jr., CEO of the Charlotte based company, Ballantyne Brands. (Presentation: CLICK HERE ; Podcast: CLICK HERE)
On the call John provided an overview of his company, makers of the Mistic e-cig brand, and offered up some valuable industry insights, which we have included in summary form below.
We are very bullish on the evolving e-cig category. There has been a rapid pace of innovation, which, along with increased marketing and distribution, is bringing significant awareness to the category. We believe e-cigs offer a compelling alternative to traditional cigarettes and offer a consumer a much different experience than a nicotine patch or gum. The involvement of Big Tobacco (RAI, LO, MO) in the category should continue to lend credibility to e-cigs and accelerate growth; we expect e-cigs to be margin-enhancing to the combined cigarette category for Big Tobacco and 2014 to be a breakout year for them, having tested the waters (through acquisition and mix) through 2013.
The runway for e-cig converters is huge globally: in America alone, nearly one in five American adults smoke. We expect pending regulation from the FDA to deem e-cigs a tobacco product, and that the regulation could come down harder on online sales, and we expect that the taxation of the product will remain only at the state level. Finally, we believe e-cigs consumption will continue to benefit from its significant price point advantage over traditional cigarettes which will help to grow repeat purchase behavior.
We think e-cigs is an exciting category with investible potential. For investors looking for a publically traded pure play on e-cigs there is one option, Vapor Corp (VPCO).
On the Category, Industry’s Size, and the Players:
John J. Wiesehan, Jr. is very bullish on the industry. Some analysts have suggested that over the next decade e-cigs could be as big as tobacco is today, a $90 billion industry. He estimates that sales in the U.S. were $150MM in 2011; $500MM in 2012 ($300MM across retail channels and $200MM over the internet); and are projected to be around $1-2B in 2013.
He thinks it is very positive that Big Tobacco has entered the market because it brings credibility (and marketing support) to the category, especially to retailers that will realize the category is not going away due to the backing of Big Tobacco. He also views regulation from the Federal government (FDA) and regulation on a state-by-state basis as positive for the category.
Despite the involvement of Big Tobacco in the category, John thinks there is plenty of room for non-Big Tobacco players, like a Ballantyne Brands or NJOY.
[Note: Lorillard (LO) acquired e-cig maker Blu Ecigs in April 2012; Altria (MO) will launch its first e-cig under the MarkTen brand in August 2013; and Reynold American (RAI) has the Vuse e-cig].
On Retail Distribution, the Products, and Market Data:
Ballantyne Brands has a national footprint that distributes Mistic e-cigs across Grocery stores, Drug stores, the Mass Channel, and Convenience stores. The company notes that disposables sell well at convenience stores, whereas rechargables sell better across their other channels.
The company is focused on product quality, first and foremost the liquid that produces the vapor, insuring that it is consistent and safe. The liquid is composed of four main ingredients: water, nicotine, propylene glycol (a bonding agent), and tobacco flavoring (traditional or menthol) -- making it an attractive substitute versus the some 4,000 to 7,000 ingredients in a traditional cigarette. None of its products are patented, however, there are some Chinese patents on the hardware that they assemble for the company. [Note: given the existing pace of innovation versus the long time frame for patent approval and desire to protect IP, most e-cig brands have not patented their products].
The company offers two different variations of e-cigs under the Mistic brand, a rechargeable and disposable. For the rechargeable option, customers buy an initial starter kit, which contains 2 cartridges with a MSRP of $14.99, and then buy replacement cartridges as needed (a box of 5 cartridges has a MSRP of $14.99). John suggests each cartridge is equivalent to approximately two packs of traditional cigarettes.
Replacement cartridges come in traditional and menthol flavors, with 4 levels of nicotine respectively, including a zero percent nicotine level for both flavors. The company does not have any flavors (like coffee, vanilla, pina colada, chocolate, etc.), and markets strictly to tobacco users as an alternative product to traditional tobacco products; in John’s words, “The company is not in the business of recruiting new nicotine users.”
For the disposable e-cig, labeled under the MisticBlack brand (and available in Traditional or Menthol flavors), customers buy a pack of soft tip e-cigs that they dispose of after one use; they have the look, feel and size of traditional cigarettes. [MisticBlack has a MSRP of $5.99 and will be on the market in July in places such as Wal-Mart.]
The company’s hope is to convert a MisticBlack user to a rechargeable user. The rechargeable e-cig is in line with the razor, razor-blade model, and is a higher margin business than the disposable for the company and the retailer. John suggests the gross margin for disposables is in the 40’s (%) for the company and that rechargeable e-cigs are north of that figure, considering the consumer already purchased the battery in a starter kit.
After the consumer buys the start-up kit John thinks the conversion rate for rechargables will be high (more data supporting this claim is pending), while he thinks converting the disposable user (back to a disposable) will be at a lower rate.
Mistic brands ranks #3 behind NJOY and BLU in terms of Sales Dollars and Sales Units (according to Nielsen data ended 3/16/13 that does not include internet sales). Importanly, Mistic has been able to holds its share with an average retail price at or above most of its competitors, which John attributes to its high marks on taste and marketing campaigns.
On the FDA, Regulation, and Clinical Studies:
The company believes its products will be treated as a tobacco product in a pending FDA announcement. On regulations, John admits that it is unclear where the FDA will shake out on e-cigs. He thinks that regulation is likely to be based on nicotine level, and speculates that a cap could be put in place. Further, the sale of e-cigs could be regulated differently on such factors as internet sales versus retail sales and tobacco flavor vs menthol and other flavors.
John expected an announcement from the FDA back in April. His team now figures that an announcement could be imminent to later this summer.
He notes, today there is no talk of the Federal government issuing an excise tax on e-cigs, but rather expects any taxes will be determined on a state-by-state basis. To date, there are only two states issuing a tax, Minnesota and Oklahoma. In Minnesota, 70% of the cost of goods is taxed, which retailers pass fully onto the consumer. In Oklahoma, e-cigs are taxed at 5% based on liquid content. For Mistic, that translates to a 5 cent tax on a pack of disposables and 25 cent tax on one package of cartridge refills (5 cartridges to one pack). The company is generally comfortable with the Oklahoma tax structure, and it believes that its value proposition over traditional cigarettes will remain a huge tailwind to consumer demand.
To date, there is no clinical study that the FDA recognizes supporting that e-cigs are less harmful than traditional cigarettes. There are however many independent studies in which the results show that e-cigs are less harmful. He thinks that common sense would indicate that a product with 4 ingredients verses 4,000 that is not burned to consume is a “healthier” alternative, however it’s premature to speculate on how the FDA will rule on e-cigs. The company is pushing hard with its lobbyist in Washington, D.C. that the FDA suggests e-cigs are less harmful than traditional cigarettes.
On Value Proposition and Consumer Appeal:
An average cost of a carton of traditional cigarettes in the U.S. is $60. In comparison, a 5 cartridge replacement pack of Mistic, which is equivalent to a carton of cigarettes, has a MSRP of $14.99. [The company also has a 10pack with a MSRP of $24.99].
John argues that they are not marketing their products to stop smoking, but simply as an alternative to traditional smoking, and nothing else. However, testimonials do suggests that consumers are using the products to reduce consumption of traditional cigarettes. John believes the consumer’s appeal to an e-cig, versus a nicotine patch or gum, is that that an e-cig satisfies four main desires of smokers: hand to mouth; inhale something and get a kick in the throat; exhale something (a vapor simulates smoke); and the taste of the nicotine (without the burning sensation of a traditional cigarette).
That is to say, with other products like a nicotine patch or gum, the consumer is really not getting a cigarette substitute, just the nicotine.
On Advertising and Restrictions:
The company launched the “Easy Choice” advertising campaign back in April 2013. It is 100% all print, including USA Today and WSJ, targeting 15-20 key metropolitan areas where distribution is strong. The company has chosen to be compliant with the advertising restrictions of tobacco companies, so it does not advertise on television or on billboards.
It is also focused on age restrictions, and is a member of the WE Card Manufacturing Advisory Council, which forces anyone under the age of 18 at a retail store to be carded.
On International Involvement:
Ballantyne Brands is looking to Europe and Asia for distribution. There are, however, countries in which they are not allowed to sell into, including: China, Canada, Australia, and Brazil. John notes that some parts of Asia are “open”, while some are not.
In Europe, the UK will be a major focus. A recent decision from the UK’s version of the FDA is to regulate e-cigs as medicines by 2016. The company is broadly comfortable with the regulation because it won’t take its product off the market, ban it, and any implementation of the regulation won’t come until 2016. The company believes that the regulation will fall on the level of nicotine in e-cigs, to make sure it is consistent with traditional cigarettes, which Ballantyne Brands believes it should have no problem complying with.
Stay tuned as we continue to do work on the electronic cigarette space.