“How far is it wise to respond to a mood?”
Since yesterday’s Early Look focused on asking ourselves baseline risk management questions, I’ll roll with a good one that particle physicist Frank Oppenheimer asked his older brother in the 1930s. Here’s how Robert Oppenheimer answered it:
“… my own conviction is that one should use moods, but not be greatly deflected by them; thus one should try to use the gay times to do those things one wants to do that require gaiety, and the sober moods for the work one wants, and the low moods for giving oneself hell.” (American Prometheus, pg 95)
I’m a moody guy. So that answer spoke to me. Sober every morning, working. Giving myself hell about all my market mistakes come the afternoon. Sounds about right.
Back to the Global Macro Grind…
Markets are moody too. They rarely cooperate with all of your positions. And they don’t care whatsoever about your views. Tough relationship we have with this Mr. Market, I know. That’s why I am lobbying the Fed to call her Mrs.
Early last week I polled you asking whether you thought the latest #EOW (end of the world) correction in US stocks would be on the order of 1, 2, or 5%. Since only one client answered 1%, I figured the probability of that being the correct answer was going up.
If you answered 5%, please don’t go all caps or moody on me. Take a breath. It’s just an opinion. And we all have one or we wouldn’t be playing this game. Currently the correction (from the all-time closing high of 1709 in the SP500) is -1.4%.
Now what? Well, let’s redo the poll with some forward looking information:
- Immediate-term TRADE support is 1680 = -1.7% from the all-time high
- Intermediate-term TREND support is 1637 = -4.2% from the all-time high
- Immediate-term risk range for US Equity Volatility (VIX) = 11.62-13.71
So, what do you think?
A) 1% correction (i.e. the market closes up today and yesterday was it)
B) 2% correction (somewhere between today and early next week, that’s it)
C) 4% correction (re-testing the TREND line, which we haven’t done since late June)
I’m going with B again.
If the market closes up on the day today, that will make me and everyone else (other than anonymous client Mr. X) who answered the poll last week wrong. If that happens, we can all just give ourselves hell.
What would have been really hellish in 2013 is missing this call on US employment #GrowthAccelerating. Again, we don’t care about the line-items in the BLS data; we only care about the slope of the line in the only leading indicator we can find for the bond market: NSA (non-seasonally adjusted) rolling US jobless claims. Most of the monthly payroll data is statistically useless.
We’ll get that weekly US Jobless Claims data point this morning – and if there’s one data point that matters to both the long-end of the US Treasury curve (and the US stock market), that is it. So let’s put this morning’s number in the context of recent history:
- Last week’s NSA claims number came in -10.5% year-over-year (slight improvement vs the previous week)
- The average for the last 12 weeks is claims falling -8.8% year-over-year
- Giving exception to a single anomalous data point 3 weeks ago, avg y/y improvement over 12 weeks = -9.7%
Yes, that’s a lot better than your parroting partisan pundit would lead you to believe. It’s also our definition of not only what matters to the employment vs Fed story, but what Mr. Market trades on – the 10yr US Treasury Yield fits NSA rolling claims like a glove.
Oh, and there’s seasonal headwinds in this jobless claims series that become tailwinds in September (that can run through February). Most (other than Mr. Bond and Stock Market) don’t expect to see the jobs picture improve, so it probably will.
One other way to measure the moodiness of it all is the weekly II Bull/Bear Spread:
- Last week, Bulls dropped from 51.6 to 47.4%
- Last week, Bears rose from 18.5 to 20.6%
- Last week, Bull/Bear Spread re-tested its most bearish level since Q2 at 2680 basis points wide
Yep – everyone says everyone is bullish. But they aren’t. Less than 50% are bullish. That’s really bearish. And the last time we saw a 2600bps handle on the Bull/Bear spread was in the 1st week of July. The SP500 proceeded to move from 1631 (our new TREND support) to 1709 within a month.
So, if you are all beared up (on stocks) this morning, just remember that bullish gaiety can quickly become a mid to late month-end move. The profitable bearish mood is in bonds. We’ll see if this morning’s jobless claims print reiterates that. September is coming.
UST 10yr 2.64-2.75%
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
This note was originally published at 8am on August 01, 2013 for Hedgeye subscribers.
“We are sowing the seeds of Ignorance, Corruption, and Injustice, in the fairest field of Liberty.”
According to Joseph Ellis in Revolutionary Summer, that’s what John Adams wrote to Joseph Hawley on August 25, 1776. Adams could have said that about heavy-handed government in August of 2013 – and, in principle, he’d still be right. But betting against the prospects of American growth rising above compromised politicians has often been wrong.
Politics versus people - that’s not new. Americans generally dislike socialists and/or plutocratic pomp. On August 13, 1776, George Washington called the British out like most of us call out conflicted central planners today: “Their cause is bad; their men are conscious of it, and if opposed with firmness and coolness… victory is most assuredly ours.” (Revolutionary Summer, pg 86)
I like that, a lot.
Back to the Global Macro Grind…
I also like seeing all of the growth factors in our multi-factor model rip to the upside. It’s especially fun to watch on days like yesterday when my contra-stream (I built one on Twitter of market pundits who are wrong at least 65% of the time) starts whining.
Winning versus whining – that’s not new either. There are a lot of losers out there who whine but, over time, Americans eventually put those people on mute and roll with winners who have principles they can associate with.
There’s been a lot of whining about US GDP “dropping to 1%” in Q213 – but that didn’t happen either. US GDP has by no means had a championship season, but it’s been a heck of a lot better than Q412’s 0.38% - and it’s what happens on the margin in macro that matters to us most. Here’s the Q213 breakdown:
- Consumption (C) = +1.8% quarter-over-quarter, contributed +1.22% to Q213 GDP
- Investment (I) = +9.0% quarter-over-quarter, contributed +1.32% to Q213 GDP
- Government (G) = -0.4% quarter-over-quarter, contributed -0.1% to Q213 GDP
In other words, government spending fell as Consumption and Investment rose. Good, eh? It’s not a new story in America. It just hasn’t happened in a while – and that’s the point.
Since C + I + G + (EX-IM) is the GDP equation, whiners (particularly partisan ones) will add that:
- Net Exports (EX-IM) = +5.4% quarter-over-quarter, but contributed negatively to GDP by -0.81%
- Inventories contributed positively to GDP by +0.4%
- Inflation (PCE Deflator) was at its 2nd lowest level ever of +0.8%
But let’s get real here – who really cares about those line items when the big stuff (Consumption and Investment growth) is finally going the right way for once?
To give them some air-time, the Princeton/Yale/Harvard Keynesian Econ 101 textbooks will also whine about “net exports being down because the Dollar went up” and “disinflation is a threat to our academic dogma” – but again, who cares?
I went to Yale and, admittedly, was confused about this “inflation is good, deflation is bad” concept. My family doesn’t buy into the class warfare labeling thing, but we do buy (and invest) more when the purchasing power of our hard earned currency appreciates.
Is Bernanke’s fear-mongering about “deflation” really the hobgoblin?
We answer that on slide 36 of our current Global Macro Themes deck (ping sales@Hedgeye.com if you’d like a copy) where we outline a recent study by Atkeson & Kehoe that spans a time period of 180 years (across 17 countries) that found no relationship between deflation and depressions.
The objective study actually found a greater number of episodes of depression with economies experiencing inflation than with deflation. Over the 180 year time period:
- 65 out of 73 deflation episodes had no depression
- 21 out of 29 depressions had no deflation
So what say you President Obama? Yes, we know. We know that you know that we know.
Bernanke’s cause is no longer saving us from the end of the world. That was so 3-5 years ago. Perversely, it’s to talk down growth in order to uphold un-precedented (and un-elected) central planning power on the order that this country hasn’t seen in 237 years.
But he’s conscious of it. So is the country.
Mr. Market gets it too. That’s why all of these end of the world (#EOW) trades that were driven by an explicit Policy To Inflate (Gold, Treasury Bonds, etc.) are coming unglued. That’s also why growth investors are getting paid.
Liberty flows. She still plays to the hands of the independent minds. We don’t have to be long Bernanke Bubbles in order to get paid. We have to be right on the slopes of the lines in our model.
Growth’s slope is up; Inflation’s is down – and unlike the government, I like that, a lot.
Our immediate-term Risk Ranges are now as follows (12 big macro risk ranges are in our new Daily Trading Range product):
UST 10yr 2.52-2.71%
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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TODAY’S S&P 500 SET-UP – August 15, 2013
As we look at today's setup for the S&P 500, the range is 30 points or 0.20% downside to 1682 and 1.58% upside to 1712.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 2.40 from 2.39
- VIX closed at 13.04 1 day percent change of 5.93%
MACRO DATA POINTS (Bloomberg Estimates):
- 8:15am: Fed’s Bullard speaks on economy in Louisville, Kentucky
- 8:30am: Initial Jobless Claims, Aug. 9, est. 335k (prior 333k)
- 8:30am: Empire Manufacturing, Aug. 7, est. 10 (prior 9.46)
- 8:30am: Consumer Price Index M/m, July, est. 0.2% (prior 0.5%)
- 9am: Total Net TIC Flows, June (prior $56.4b)
- 9:15am: Industrial Production, July, est. 0.3% (prior 0.3%)
- 9:45am: Bloomberg Consumer Comfort, Aug. 11
- 10am: NAHB Housing Market Index, Aug., est. 57 (prior 57)
- 10am: Philadelphia Fed Biz Outlook, Aug., est. 15 (prior 19.8)
- 10am: Freddie Mac mortgage rates
- 10:30am: EIA natural-gas storage change
- 11am: Fed to purchase $3b-$4b notes in 2019-2020 sector
- 11am: Treasury announces offering size for auction of 5Y tips
- 11am: FDIC hosts teleconference on interim final capital rule for community banks approved by board on July 9
WHAT TO WATCH:
- Amgen talks to buy Onyx said to stall over drug trial data
- JPMorgan said to expect multiple fines as Whale traders charged
- AMR bankruptcy plan goes to judge after U.S. suit on merger
- Cisco cutting jobs as Chambers turnaround hit by sales slowdown
- Credit Cards report July Charge-Offs, delinquencies
- Gold bull Paulson cuts SPDR stake by half in 2Q amid bear market
- Cohen’s SAC reduces U.S. stock holdings by $2b in 2Q amid probe
- BP asks judge to deny investors’ bid to sue as group over spill
- Loeb’s Third Point Re raises $276m pricing IPO at low end
- U.K. July retail sales rise more than forecast amid heatwave
- Lenovo 1Q profit beats ests. on handset market share gains
- Berkshire 13F filing due today after Edgar glitch: Reuters
- Applied Materials (AMAT) 4pm, $0.19
- Aspen Technology (AZPN) 4:02pm, $0.08
- Bally Technologies (BYI) 4:01pm, $0.94
- Dell (DELL) 4:01pm, $0.24
- E-Commerce China Dangdang (DANG) Bef-mkt, $(0.15)
- Estee Lauder (EL) 7:30am, $0.21
- Kohl’s (KSS) 7am, $1.04
- Nordstrom (JWN) 4:05pm, $0.88 - Preview
- Pan American Silver (PAA CN) Bef-mkt, $0.05
- Perrigo (PRGO) 7:44am, $1.56
- Wal-Mart Stores (WMT) 7am, $1.25 – Preview
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Gold Bull Paulson Cuts SPDR Stake by Half Amid Bear Market
- Cocoa Crunch in Ivory Coast Heads for Bull Market: Commodities
- Gold Demand Fell 12% to Four-Year Low in Quarter on ETP Selling
- Brent Crude Rallies to Four-Month High on Crackdown in Egypt
- Soybeans Rise to Three-Week High on Concern About Dry Weather
- Copper Declines Amid Speculation Fed Will Reduce Debt Purchases
- Aluminum Premium Trading Rises as Regulators Focus on Warehouses
- Commerzbank’s Physical Gold Trading Is Active Amid Bear Market
- Gasoline Slumps as End of Driving Season Nears: Energy Markets
- Indonesia’s Kharisma Sells 15,000 Tons of Crude Palm Oil (Table)
- Indonesia’s July Tin Exports Seen Dropping on Low Prices: Timah
- Gold Rebound to $1,600 Seen by Fund Manager Day on Bank Stimulus
- Oil Pipeline From Kurdistan Makes Gulf Keystone Target: Energy
- Gold Gains to Three-Week High on Signs of Demand as Dollar Drops
The Hedgeye Macro Team
Takeaway: Sales under pressure, margins rolling over, increased SG&A, and higher capex. Sorry, but the ‘cheap valuation’ argument is irrelevant.
Conclusion: Macy’s has been #1 on our list of top three shorts (followed by Gap and Dick’s), and as such, the print today is not a surprise to us. We have no crystal ball as to the comp that Macy’s has been generating, so we’re not claiming to have forecasted the specific sales shortfall in this given 13-week period. But we’ve viewed the triangulation of M’s P&L, Cash Flow Statement and Balance Sheet as being like an increasingly stressed balloon under water. This event does nothing other than strengthen our confidence in our call.
Out of any name we cover (and we cover just about all of retail) there is not a single name we find ourselves more fiercely debating than Macy’s. The most common bull arguments we hear are a) the company has been so poorly run for so long, and that investments in Magic Selling, MyMacy’s, Omni-Channel, etc… are making up for years of share loss, and b) the stock is so cheap at just 12x earnings.
But we think that valuation is irrelevant, as it is not a catalyst – and never has been – especially with a levered zero-square-footage growth retailer where numbers can change so quickly.
We recognize that there are certainly ways that Macy’s can operate more efficiently and can fine-tune its approach to going after share-of-wallet. But we think that there are too many factors converging on both the P&L and balance sheet that are stacking the odds against a positive change in return on invested capital. When returns are going down, there’s no reason a 12x multiple can’t turn into a 10x multiple – and there’s no rule that says that it needs to stop there. Factors that specifically concern us are as follows…
1) Top Line
a) We can’t forget that in 2012, Macy’s grew its top line by $1.5bn, which is the same time that JC Penney lost $4.3bn in sales. Macy’s management completely discounts the idea that any of its sales gain has come at the expense of JCP. If not outright cocky, we think that at a minimum management is being intellectually dishonest. JCP will start to regain share at some point in 2H --- or lose share at a lesser rate (which is a negative change on the margin for competitors). If JCP fails, it will inflict pain while it tries. The other retailers (including Macy’s) are in denial.
b) Macy’s management did a very poor job articulating the source of the 2Q sales miss. Transaction count was down 1.6%, and they noted that consumers are more interested in buying cars, houses and spending on home improvement than they are in spending in department stores. Seriously? What’s ridiculous is that there’s no way for them to know why consumers are NOT shopping in their stores. This is particularly troubling in light of point A – in that Macy’s is blaming macro factors at the same time we’re seeing sales competition heat up in the mid tier.
c) The company noted that comps had turned up in 3QTD. That’s nice given that we’re just starting back-to-school. But there’s a long way to go in BTS. We give the company credit for trying to keep expectations somewhat grounded that its way too early to declare victory – especially when there so many unknowns as to why sales performance missed like it did throughout 2Q.
2) Gross Margins were down only 10 basis points for the quarter – which is pretty impressive given the magnitude of the sales miss. But keep in mind that the sales/inventory spread eroded by 700bp, as inventories were up 6.4% despite a 0.8% sales decline. Had the company more appropriately cleared out inventory on hand, we’d have seen more Gross Margin pressure. (Notice the swing into the third quadrant of our SIGMA chart below). Either way, management has been vocal about saying that gross margins would be tough to improve from here, and that EBIT margins would need to come from SG&A leverage…
3) …but SG&A is headed higher. In order to kick start the top line and have the proper marketing programs in place for a less-certain 2H, the company is taking up marketing costs. We’re not knocking it, as it’s the right thing to do. But the simple point is that with both the top line and gross margins under pressure, the P&L gets levered in the wrong direction with an uptick in SG&A. Let’s not forget that Macy’s has almost $400mm in interest expense as well – which is another negative leverage kicker.
4) Lastly, capex is running at $925mm this year. There hasn’t been any increase in capex guidance, which is good, but the reality is that it is still up 33% from $698mm last year.
The punchline is that we’ve got sales down, gross margins rolling over, increased SG&A spending, and higher capex. In that context, the ‘cheap valuation’ argument is simply irrelevant. We’re modeling flat operating profit over the next four years, with earnings growth only being driven by 3-4% of financial engineering (debt paydown and repo). Our earnings 3-years out are 25% below consensus (see our assumptions in financial summary below). While a 10x p/e and 5x EBITDA multiple only suggests a stock in the low $40s out that far, the reality is that those same multiples could get to a stock with a 3-handle closer in.
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