“Before I went to jail, I was active in politics as a member of South Africa’s leading organization – and I was generally busy from 7 A.M. to midnight. I never had time to sit and think.”
Former South African Prime Minister Nelson Mandela had more time to sit and think then most of us will ever get. He served 27 years in prison, first on Robben Island, and later in Pollsmoor Prison and Victor Verster Prison after being convicted of sabotage and conspiracy to overthrow the South African government.
I’ve recently been reading Mandela’s biography and after reading about how he spent his nights in a damp concrete cell of 8 feet by 7 feet and his days breaking rocks into gravel, I’m not sure I would wish this type of “thinking time” on my worst enemy. But, thinking time is important for all us, and I will be taking some thinking time myself as my first two week vacation of the last decade looms in the next couple of weeks.
In a book we have cited many times, “Thinking, Fast and Slow”, Nobel laureate Daniel Kahneman describes two modes of thought. The first is System 1, which is fast, instinctive, and emotional. The second is System 2 and is slower, more deliberative, and more logical. The main purpose of his book is to describe the dichotomy between these two kinds of thought.
To illustrate how the two different systems work, answer this before you go on:
A hockey stick and puck cost $1.10 together.
If the stick costs $1.00 more than the puck, what does the puck cost?
If you are like most people, even the highly numerical, it is likely that the price of $0.10 popped into your head. The correct answer of course is that stick cost $1.05 and the puck cost $0.05, so thus the stick cost $1.00 more than the puck.
In a day and age when we are inundated with more stimuli and decision making opportunities than ever before, it is becoming even more critical to take some Thinking Time to maintain the deep logic of System 2. The fact of the matter is, the self-induced dopamine loops of constant texting, tweeting, googling and emailing diminish our performance. (Well, at least that’s how I’m justifying my vacation to my colleagues :) )
Back to the global macro grind . . .
I’m going to take this concept of short term versus long term thinking and apply it to the current battleground stock of the day, J.C. Penney (JCP). Recently Pershing Square’s Bill Ackman all but admitted defeated in his attempt to turn around the retailer as he resigned from the board of JCP and received permission for Pershing Square to sell the more than 15% of the stock it owns. This is short term capitulation.
At the same time, a number of other hedge funds have been taking sizeable positions at the stock has declined, including Kyle Bass, Soros Fund Management and Perry Capital. Bass, as reported by Bloomberg is actually buying the debt. These are long term investment positions.
Before I dig into the stock a little more, I wanted to let you know that our Retail Sectorhead Brian McGough will be doing a deep dive on the stock on August 27th at 1pm. (Ping for details.) As many of you know, Brian was in early in recommending investors short and/or sell the stock when Ackman got involved. He then tried to call the turn around and added the stock to our Best Ideas list, but ultimately removed the name at about the current price level on March 14th as there was little evidence of a turnaround and his view was that JCP was dead money (which it was).
The Chart of the Day today is a chart of JCP credit default swaps that shows that while a bankruptcy isn’t a foregone conclusion, there is certainly risk as investors are willing to pay a meaningful premium to insure JCP debt. Interestingly, while JCP debt has declined versus its peer group over the last couple years, it is not yet at extreme levels.
As examples, per Bloomberg and Forbes, the J.C. Penney 5.65% notes due 2020, yesterday traded up two points, at 73.5. While the long-tenor 6.375% bonds due 2036 traded up half a point, at 69.5, for a net gain of 3.5 points week over week. In the loan market, J.C. Penney’s covenant-lite term loan due 2018 (L+500, 1% LIBOR floor) were slightly firmer, recently quoted at 96.5/97. As a reference, the $2.25 billion loan was issued at 99.5 in May.
As McGough noted yesterday, “the fact that JCP hit the liquidity levels it guided toward at quarter-end is notable. Add on the fact that capex next year is guided to be down as far as $300mm, and the liquidity picture looks less pressured. We’d argue that these two factors are the sole reasons why the stock was up today. Why?
Let’s stress test the model. We quarter-ized our model for the next three years using the following assumptions a) JCP reaches 2012 sales per square foot levels in 2015, with a gradual comp lift throughout, b) the company generates 37% gross margins – a level we think there is no structural reason it can’t hit again relatively quickly (we know we'll get pushback on that -- but will happily entertain the debate), EBIT margins don’t turn positive until 2016, c) capex increases by $50mm each year, d) working capital patterns are similar to what we saw before 2012.
In tracking the cumulative liquidity for the next three years, there are two periods where it definitely gets dicey for JCP (the worst is 3Q15 -- in two years) – close enough such that it will likely need to find some asset sales that are not already tied to the GS secured debt offering. But even without assuming a miraculous turn at the company, we don’t get to a big liquidity event.”
So, if there is no major liquidity event for the next three years, there is decent runway for the company to turnaround and the shorter term debt, at the very least, looks reasonably safe. But what do you think?
Next Thursday at 1pm, we’ll introduce some new information and dig into more of our thoughts. If the turnaround actually happens, based on historical margin levels, JCP equity is a really cheap option at these levels.
Our immediate-term Risk Ranges are now:
Keep your head up and stick on the ice,
Daryl G. Jones
the macro show
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TODAY’S S&P 500 SET-UP – August 21, 2013
As we look at today's setup for the S&P 500, the range is 32 points or 0.63% downside to 1642 and 1.31% upside to 1674.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 2.48 from 2.48
- VIX closed at 14.91 1 day percent change of -1.26%
MACRO DATA POINTS (Bloomberg Estimates):
- 7am: MBA Mortgage Applications, Aug. 16 (prior -4.7%)
- 10am: Existing Home Sales, July, est. 5.15m (prior 5.08m)
- 10:30am: DOE Energy Inventories
- 2pm: Release of FOMC minutes from July 30-31 meeting
- SEC could vote to introduce legislation requiring cos. to disclose how much more CEOs are paid than rank-and-file workers
- 9am: Former FDIC Chairman Sheila Bair, PIMCO CEO Mohamed El-Erian discuss U.S. economy
- 2pm: FOMC releases minutes from July 30-31 meeting
- Obama meets on Egypt aid cutoff as lawmakers demand action
WHAT TO WATCH:
- Goldman said to send client requests to exchanges in error
- J&J said to weigh $3b settlement of its hip implant cases
- Disgruntled investors eyeing Falcone’s holding co., NYP says
- JPMorgan said to be near selection of 2 new directors: Reuters
- Apple said to add music videos from Vevo to expand TV content
- Office Depot and Starboard agree to settlement on board
- Kodak bankruptcy reorganization approved by N.Y. judge
- Subway targets Europe w/as many as 1,000 new outlets in 2014
- New China Trust said to withdraw ILFC bid on regulator ties
- Facebook’s Zuckerberg seeks universal Internet access
- Perry Capital said to build Herbalife stake opposed to Ackman
- Disney to shutter 10-yr-old Toontown online multiplayer game
- AT&T sued on refusal to carry Al Jazeera cable network in U.S.
- Apple iPad’s China mkt share slumps as Samsung tablets gain
- APA needs to study Envestra finances before making any new bid
- Toyota’s Lexus Marque to open luxury stores in branding push
- China Telecom posts 2nd-straight profit gain on iPhone boost
- AFC Enterprises (AFCE) 5pm, $0.31
- American Eagle Outfitters (AEO) 8am, $0.10
- Eaton Vance (EV) 9am, $0.54
- Energy XXI Bermuda (EXXI) 7am, $0.47
- Hain Celestial Group (HAIN) 4pm, $0.62
- Hewlett-Packard (HPQ) 4:04pm, $0.86 - Preview
- JM Smucker (SJM) 7am, $1.20
- L Brands (LTD) 4:30pm, $0.60
- Lowe’s (LOW) 6am, $0.79 - Preview
- Madison Square Garden (MSG) 7:30am, $0.32
- PetSmart (PETM) Bef-mkt, $0.86
- Prospect Capital (PSEC) 4:03pm, $0.30
- Sears Canada (SCC CN) 7am, C$0.23
- Semtech (SMTC) 4:03pm, $0.51
- Staples (SPLS) 6am, $0.18
- Synopsys (SNPS) 4:05pm, $0.54
- Target (TGT) 7:30am, $0.95 - Preview
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- WTI Trades Near One-Week Low on Fed Speculation, Libya Restarts
- China Gold-Mine Deals at Record After Price Plunge: Commodities
- Gold Falls as Investors Await Fed Minutes for Stimulus Outlook
- Corn Retreats for Second Day on Higher Yields; Soybeans Decline
- Copper Falls as Chinese Manufacturing Seen Continuing to Shrink
- China Copper Imports Touch 10-Month High on Premium, Arbitrage
- Japan Watchdog as Tepco Doubter Warns of More Leaks at Fukushima
- Gold in India May Climb to Record in a Month: Technical Analysis
- Sugar, Coffee Fall on Emerging Market Currencies; Cocoa Slides
- China Platinum Imports Grow 20% Yoy on Supply Concerns: BI Chart
- Cocoa Deliveries in Brazil’s Bahia Decrease 1.6%, Hartmann Says
- Kenya Fights Off Port Competition With $13 Billion Plan: Freight
- North Sea Output May Slide as Much as 22% in 2013 on Maintenance
- Rebar Declines as China Punishes Banks for Some Steel Loans
The Hedgeye Macro Team
This note was originally published at 8am on August 07, 2013 for Hedgeye subscribers.
“A coach is someone who can give correction without causing resentment.”
I’ve been blessed with great coaches and teachers in my life. They were never easy on me. Their criticisms didn’t cause any resentment either. To the contrary, they drove me to improve. Trusting your coaches is the first step toward opening your mind.
I make a lot of mistakes. And since I’m the front man for this Hedgeye show, that means every mistake I make is front-and-center in the arena of public market debate. That’s not a bad thing. That’s right where I want to be.
What I do isn’t for everyone. I get that. But the first 5 years of building this firm alongside my teammates has given me a keen appreciation for having the opportunity to make mistakes in an open and accountable forum. It speeds my learning process.
Back to the Global Macro Grind…
One of the toughest things to do in US Equities in 2013 has been to coach myself through market corrections. The new normal correction can last anywhere from 4 hours to 4 days. I know, it’s end of the world type stuff. Remember, nothing is normal.
So, from its all-time closing high of 1709 in the SP500 last week, what will the latest US stock market “correction” be?
A) -0.9% to 1693?
B) -1.9% to 1676?
C) -4.6% to 1630?
Yes, that is a Hedgeye Poll. If you have time, ping me with A, B, or C. One of the most important aspects of working in an open/transparent forum of debate is collaboration. I’m pretty sure the days of opaque #OldWall sentiment checks are dead.
Since I actually need to #timestamp an answer to this question, I’ll choose B.
That’s the highest probability choice because the S&P futures already showed me they can snap my mo mo line of 1693 support this morning. And there’s very little fundamental and/or quantitative evidence that 1630 is in play, yet.
What is the “mo mo” line?
That’s the line I use to front-run the machines. It’s home brewed. It’s my most immediate-term risk management duration. It’s especially useful for day-trading, scalping, etc. Label me long-term cycle guy or Mucker, I’m cool with both. Better to scalp, than be scalped.
Put another way, across our core risk management durations:
- SP500 immediate-term mo mo line of support = 1693; and 1714 is resistance (our Daily Risk Range)
- SP500 immediate-term TRADE support = 1676
- SP500 immediate-term TREND support = 1630
The upside down of the is US Equity front-month volatility (VIX):
- VIX mo mo risk range = 11.71-13.72
- VIX immediate-term TRADE resistance = 14.64
- VIX immediate-term TREND resistance = 18.98
In other words, the bullish TREND in US Equities (and bearish TREND in Fear) isn’t in the area code of being challenged, yet. Therefore, if contextualized within the framework of our risk management process, you woke up every morning reminding yourself to not “fight the TREND”, I’d wholeheartedly agree with that. I’d rather fight the Fed than fight things like math and/or gravity.
One of the biggest challenges I have personally is trying to communicate risk management strategies to clients who all have different risk profiles, holding periods, etc. Through consistent feedback and criticism though, I’ve learned that there’s only one answer to this challenge: keep doing what I do - be Duration Agnostic, and keep working on communicating what that process means.
In my humblest of dreams, that would be my happiest retirement: that my teammates and I were successful in not only communicating our multi-factor, multi-duration Global Macro risk management process – but that the players and peers that we coached trusted us.
Trust isn’t allocated. You have to re-learn how to earn it, every day. We have a long road of learning and teaching ahead.
Our immediate-term Risk Ranges are now as follows (*we have 12 Macro Risk Ranges in our Daily Trading Ranges tool now too – as an example, this morning I’ve attached all of them; the bracketed “bullish” or “bearish” comment is on our TREND duration (3 months or more) whereas the range itself is on our most immediate-term duration):
UST 10yr 2.56-2.73% (bullish on yield)
SPX 1676-1714 (bullish)
Nikkei 13489-14137 (bullish)
FTSE 6536-6694 (bullish)
VIX 11.71-13.72 (bearish)
USD 81.49-82.43 (bullish)
Euro 1.31-1.33 (bullish)
Yen 97.01-98.94 (bearish)
Brent 107.23-109.79 (bullish)
NatGas 3.21-3.46 (bearish)
Gold 1274-1317 (bearish)
Copper 3.05-3.18 (bearish)
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
THE MACAU METRO MONITOR, AUGUST 21, 2013
GALAXY TO ADD MORE VIP TABLES ON SURGING DEMAND Macau Business
According to deputy chairman Francis Lui Yiu Tung, Galaxy will add 12 VIP gaming tables at its Galaxy Macau casino resort by October. "I don’t see VIP spending falling dramatically for the rest of this year,” he said. Lui said the refit of the recently acquired Grand Waldo casino resort, adjacent to the Galaxy Macau, would take six to nine months to complete. Galaxy hoped to finalize details of its Hengqin Island development in the next “few months”, he said.
VERSACE, SJM TO BUILD FIVE-STAR PALAZZO VERSACE IN COTAI Macau Business
SJM and fashion house Gianni Versace SpA will open a five-star Palazzo Versace hotel at SJM’s casino resort in Cotai. The agreement will be signed at the Grand Lisboa hotel-casino on September 5. The Palazzo Versace Macau will be the first Palazzo Versace hotel in Asia.
MACAU CONSUMER PRICE INDEX FOR JULY 2013 DSEC
July 2013 increased by 5.38% YoY and 0.43% MoM. Higher charges for outbound package tours and rentals for dwellings drove up the price index of Recreation & Culture; and Housing & Fuels by 3.01% and 1.03% respectively.
MACAU CASINOS EMPLOY MORE WORKERS, SALARIES HIGHER Macau Daily Times
At the end of 2Q, the Gaming Sector had 54,554 full-time employees, up by 5.5% YoY. In June 2013, the average earnings (excluding bonuses and allowances) of full-time employees stood at MOP18,900, up by 6.5% YoY.