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Jones: What's Weighing on Mr. Market Right Now?

Editor's note: What follows below is a brief complimentary excerpt from Hedgeye's "Morning Newsletter" which is sent out weekday mornings before 9:00am. While Hedgeye CEO Keith McCullough typically writes these newsletters, periodically another member of our team jumps in and offers up our latest thoughts. This morning's note was written by Daryl Jones, Director of Research. To learn how you can subscribe please click here.)


Jones: What's Weighing on Mr. Market Right Now? - wallstreet1


Former Harvard President Larry Summers made a big decision late Sunday to withdraw his name from consideration to replace current Federal Reserve Chairman Ben Bernanke.  Now technically speaking, the fact that five Democrats intended to vote against him in committee kind of forced his hand, but nonetheless a decision was made.


In the short run, Mr. Market viewed this development as somewhat positive as stocks were up broadly with the SP500 up 0.57%.  (Strangely, the bell weather master limited partnership, Kinder Morgan Partner (KMP), underperformed and was down -1.50%.) President Obama then chose to come out and spoil the Wall Street party as Obama indicated he will not negotiate an extension of the U.S. debt ceiling as part of the budget fight. 


Slight digression, yes the debt ceiling debate is looming again.  As Yogi Berra said, this is déjà vu all over again.  You may recall, in 2011 Congress raised the debt ceiling to $16.7 trillion, an increase of over $2 trillion.  Currently, based on projections from the Treasury department, the federal government could hit the debt ceiling as soon as mid-October.


In the chart of the day, we highlight a chart from the Bipartisan Policy Center that shows that the debt ceiling is likely to be breached to between October 18th to November 5th.   Technically speaking, the United States hit its debt limit on May 19th, but as my colleague Christian Drake has written about, via a number of extraordinary measures, the ceiling has been extended, but these measures will run out at some point in the time frame noted above at which point the federal government will only have enough tax revenue to cover about 68% of its bills.


Incidentally, and for those that don’t have their calendars in front of them, the “X-date” is just over a month away.  And just think, most investors are worried about who is going to be the next Chairman / Chairperson of the Federal Reserve!  Given the uncertainty around the direction of policy, a looming fiscal crisis, and the fact that U.S. equities have performed quite well in the year-to-date, it should be no surprise that some savvy investors like Stan Druckenmiller are indicating they are largely underinvested.


We certainly get the risks, but one point that has and will continue to benefit equities, is bond outflows.  Since May we have seen $116 billion fixed income fund outflows, which is the largest absolute bond outflow in history.


Interestingly though, as our Financials team pointed out yesterday,  as a percentage of beginning fixed income assets-under-management, the current 2013 draw down is the smallest in history on a percentage basis. The 2013 running outflow has been just 2.9% of outstanding bond funds, well below the past outflows in 2003-2004 where 5.0% of outstanding bond funds were redeemed and the 14% of bond funds that were drawn down in the 1994-1995 outflow.  So while there are certainly risks looking for equities, the continuation of bond outflows will be a meaningful tailwind. 


Morning Reads on Our Radar Screen

Takeaway: Here's a quick look at stories on Hedgeye's radar screen.

Keith McCullough – CEO

S&P 500 regains 1,700, nears record (via MarketWatch)

Veteran Diplomat Fond of Cigars, Whiskey and Outfoxing U.S. (via NYT)

Syria crisis: France and Russia admit attack differences (via BBC)


Morning Reads on Our Radar Screen - bullbear

Josh Steiner – Financials

$2,472,542,000,000: Record Taxation Through August; Deficit Still $755B (via CNS News)


Todd Jordan – Healthcare

Municipalities struggle with Affordable Care Act (via KFVS)


Kevin Kaiser – Energy

Investors Increase Pressure on Barrick for Board Change (via WSJ)


Darius Dale – Macro

VIDEO: What’s Next For Emerging Markets? (via Hedgeye)


Daryl Jones – Macro

Yellen Seen as Likely Fed Nominee in Survey After Summers Exit (via Bloomberg)

What's New Today in Retail (9/17)

Takeaway: As part of our morning routine, we scour the tape and trade rags for stories that we think might be relevant to our investment process.

As part of our morning routine, we scour the tape and trade rags for stories that we think might be relevant to our investment process. 



DKS - Wednesday 9/18/2013, 8:00am. At DKS HQ in Pittsburgh.



The ICSC index, a compilation of 80 chain store retailers, came in weaker than expected this morning. While still relatively healthy at +3.2% ahead of last year, it turned down sequentially (as evidenced by the red line in the chart below). 

What's New Today in Retail (9/17) - icsc1




RH: Released its 10Q after the close last night. The biggest callout...


"Selling, general and administrative expenses for the three months ended August 3, 2013 included: (i) a $33.7 million non-cash compensation charge related to the one-time, fully vested option to Mr. Friedman upon his reappointment as Chairman and Co-Chief Executive Officer, (ii) a $26.1 million non-cash compensation charge related to the performance-based vesting of certain shares granted to Mr. Friedman in connection with the Reorganization and initial public offering, and (iii) $2.1 million of costs incurred in connection with our follow-on offerings in May 2013 and July 2013."

Translation = Good day for Gary Friedman


The Hut - The Hut prepares for IPO in early 201

The Hut Group, an online retailer selling apparel, beauty products and gifts, is considering an April or May 2014 IPO. The company is expected to be valued at 350m Pounds, about 25x EBITDA. First half 2013 profits reached 77m pounds a 30% increase YY.


JNY - More Bidders Emerge for The Jones Group
"The head of Sun Capital has joined the fray as a host of private-equity firms prepare bids for the New York-based shoe-and-apparel company, The Post has learned."
"It’s unclear which assets Sun is eyeing, but sources speculate the firm is interested in department-store staples such as Jones New York and Gloria Vanderbilt."
"As second-round bids for The Jones Group Inc. are expected to be forthcoming at the end of this month, more names of possible bidders have surfaced. According to dealReporter, Leonard Green & Partners and Golden Gate Capital are also interested in the assets of Jones Group."
"Last week, sources close to the process confirmed to WWD that KKR & Co. and Sycamore Partners are working together and had already submitted a first-round bid for Jones over the summer."


GPS -  Gap's TV Return
Gap Inc. returned to TV after a four year hiatus on Monday. The ad featured Billy Joel's daughter, Alexa Ray Joel, signing "Just the Way You Are," and George Harrison's son, Dhani Harrison, signing "For You Blue."
"Last year, Gap spent $653 million on advertising, a figure that should go up with television back in the retailer’s ad mix, although Gap has stressed its careful approach to the medium."


M - Bloomingdale’s Black Tags End Party for Next-Day Returns

"Instead of just tagging merchandise before it’s purchased to prevent theft, the Bloomingdale’s department-store chain is keeping some garments tagged after they’re sold, too. The three-inch black plastic devices are in visible places, like the front bottom hemline, so they’re hard to hide when the garment is worn. Once shoppers remove the tags, which can’t be reattached, they can’t return the item."

"Bloomingdale’s, owned by Macy’s Inc. (M), is using the tactic to combat a practice known as 'wardrobing' -- buying clothes and using them once -- a form of return fraud, which the National Retail Federation estimates cost the industry $8.8 billion last year."
"Nordstrom doesn’t use such tags, Colin Johnson, a spokesman for the Seattle-based company, said in an e-mail.


DKS - Dick's Revamps Jersey Report

"Dick's Sporting Goods announced an updated and upgraded 'Jersey Report,' with new advanced features to provide fans unparalleled insights into pro football jersey sales at Dick's Sporting Goods nationwide and online. Updated daily, the Jersey Report is the only destination offering fans a comprehensive breakdown of how the sales of their favorite players' jerseys are rising, falling and stacking up against the competition."

"In addition to football, this year's Jersey Report will also provide the same stats and analysis for hockey jersey popularity beginning in October."

What's New Today in Retail (9/17) - dks222

GIL - Gildan Named to Dow Jones Sustainability World Index 
Gildan Activewear Inc. has become one of only two North American companies to be included in the Dow Jones Sustainability World Index in the Textiles, Apparel and Luxury Goods sector, with effect from Sept. 23, 2013.

Pinterest Drives The 'Reverse Showrooming' Phenomenon, Where Shoppers Browse Online But Buy In-Store

"Recent data distributed by Vision Critical and highlighted in the Harvard Business Review found that 21% of Pinterest users had bought an item in a store after pinning, repinning, or liking the item on the site." 

"Vision Critical describes this as part of a wider phenomenon it calls 'reverse showrooming,' in which consumers search or browse products online and then enter the physical shop to make a final purchase."

What's New Today in Retail (9/17) - pinterest



US Government Looks to Boost Textile, Apparel Exports

"President Obama launched the National Export Initiative in 2010—the first government initiative of its kind—with the goal of doing more to support US companies by creating export opportunities, working to remove trade barriers and settling new trade agreements...As part of the initiative, the President plans to double US exports by the end of 2014. In the first half of 2013, US exports totaled a record-high $1.12 trillion while imports decreased by $13.1 billion over the same time, reducing the trade deficit by $36.1 billion over the last half year."
The Commerce Department’s Office of Textiles and Apparel (OTEXA) has also been working to increase domestic production and imports. 'The focus of our office has been two-pronged this year — the Made in USA database, as well as our [Trans-Pacific Partnership] and now European Union trade negotiations to help facilitate opening those markets,' Kim Glas, deputy assistant secretary for textiles and apparel at the Commerce Department told WWD."
Calendar Complicates Holiday Selling

"In its preliminary forecast for the season, Chicago-based retail traffic counter ShopperTrak projected that sales during November and December would increase 2.4 percent over 2012 levels, lower than the 3 percent increase registered during holiday 2012."
"Apparel and accessories sales are expected to come in slightly stronger for the season, rising 2.8 percent."
"ShopperTrak expects traffic to dip 1.4 percent from 2012 levels, which rose 2.5 percent from the prior year. For apparel and accessories, the traffic decrease is expected to come in at 1 percent. "
"Much of the pressure on retailers will come from an unforgiving calendar. Last year, the window between Black Friday and Christmas Day was a full 32 days, the maximum possible, and this year will swing in the opposite direction, shrinking to 25."


Turkish Industry Out to Boost U.S. Profile
The Istanbul Textile and Apparel Exporters Association, or ITKIB, is to hold its first trade mission to the U.S. on Sept. 24 and 25 at New York City’s Gotham Hall with the aim of bringing together Turkish apparel and textile manufacturers with U.S. sourcing and distribution executives.
Turkish ready-to-wear companies now operate some 3,000 stores internationally, compared with just 300 five years ago. By 2023, the goal is to have 20,000 — and the U.S. is a new priority.
Clothing and textiles are among Turkey’s biggest businesses, accounting for 6.8 percent of gross domestic product and $24 billion in exports last year. It is the world’s sixth largest apparel supplier and the second largest to the European Union after China.
According to the ITKIB chairman, the New York trade mission is but a first step. The goal is to enable Turkish firms to meet with top-tier executives in production and global sourcing of all major American brands, licensing groups and department stores. 

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[VIDEO] Dale: What Next For Emerging Markets?

Beijing, Brent & Bonds

Client Talking Points


The Shanghai Composite is down -2.1% for very good reason. The FDI (foreign direct investment) print for August was a nasty 0.6% versus +24% in July. Now that's just nasty. Look, the Chinese don’t like the Down Dollar move inasmuch as I don’t. Asian Emerging Market currencies that float freely? They do.


Without question, the most bullish economic development of the last week is removing the Syrian Oil tax. After snapping our immediate-term TRADE line of $114.97 support, Brent is in a good spot to remain under pressure now. Don’t forget that only two weeks ago, we saw the highest net long (futures/options contracts) position ever in crude. Yup... ever is a long time.


Just 24 hours ago, bond bulls were hoping, begging and wishing for Janet Yellen to bring back the easy money Fed love. Instead, all the 10-year yield registered was yet another higher-low within our Bullish Formation. Don't look now, but it is holding all lines of TRADE, TREND, TAIL support. Repeat: All lines. The immediate term risk range now is 2.80-2.98%. The Queen Mary has turned ladies and gentlemen. There's no going back now.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.


Health Care sector head Tom Tobin has identified a number of tailwinds in the near and longer term that act as tailwinds to the hospital industry, and HCA in particular. This includes: Utilization, Maternity Trends as well as Pent-Up Demand and Acuity. The demographic shift towards more health care – driven by a gradually improving economy, improving employment trends, and accelerating new household formation and births – is a meaningful Macro factor and likely to lead to improving revenue and volume trends moving forward.  Near-term market mayhem should not hamper this  trend, even if it means slightly higher borrowing costs for hospitals down the road.


Financials sector senior analyst Jonathan Casteleyn continues to carry T. Rowe Price as his highest-conviction long call, based on the long-range reallocation out of bonds with investors continuing to move into stocks.  T Rowe is one of the fastest growing equity asset managers and has consistently had the best performing stock funds over the past ten years.

Three for the Road


In the @Hedgeye S&P Sector Risk Model 7 of 9 Sectors remain bullish TRADE & TREND. 2 of 9 are bearish: Utilities $XLU & Consumer Staples $XLP



"I'm so fast that last night I turned off the light switch in my hotel room and was in bed before the room was dark." -Muhammad Ali


Got #RatesRising yet? 10-year Treasury yields climbed as high as 2.999% Sept. 5 from 1.93 percent on May 21, the day before Ben Bernanke said that the central bank could “take a step down in our pace of purchases” in the “next few meetings.”

FDX: ‘Solid but Challenged’ Or An FY1Q Beat?

“Overall, we expect earnings growth for Q1 2014 to be solid but challenged as we expect headwinds year-over-year from fuel surcharge timing lag, one less operating day and continued pressure on international yields and Freight volumes. Also the benefits of the voluntary buyout program will ramp out throughout the year with the majority of those expense reductions occurring after the first quarter. Our businesses are cyclical in nature and seasonal fluctuations will affect volumes, revenues and earnings.” - Alan Graf, June 19 2013 FY4Q 2013 Earning Call





Last quarter, FDX changed its guidance practices and ceased providing quarterly guidance.  We think consensus is a bit off for FY 1Q as a result.  We again expect the market to focus heavily on the Express division adjusted margin.  This will be only the second quarter in which we should “see” some benefit from Express restructuring and we would settle for a repeat of the YoY improvement shown last quarter.  We continue to think that FDX will prove a rewarding long-term position, as FedEx Express focuses on profitability instead of market share.  FedEx is also well positioned to benefit from signs of stronger economic growth.   



Key Items


Consensus May Be Too Pessimistic: We hate to make quarterly earnings forecasts, but it is difficult for us to get to the $1.50 consensus estimate for this quarter.  Quarterly earnings can be volatile, but we get an adjusted EPS number north of $1.58.  Forecasting may be more difficult in the absence of management guidance details.  Current consensus for the quarter is below the full year earnings growth rate guidance of 7%-13%.


Positives in Quarter:  FedEx gets the benefit of a lower pension expense in FY1Q without the headwind of the new USPS contract.  The Express margin should also benefit from additional capacity actions, continued refleeting, and the first tranche of headcount reductions.  There is little reason to expect Express to give up the benefit of shifting low yielding volume out of high cost channels, which helped the FY4Q Express margin.  There are offsets, like a higher depreciation expense and one less operating day, but they net out favorably in our scenarios.


Economic Data:  The operating environment should have been less challenging for FDX than FY4Q 2013.  For instance, IATA FTKs grew in June in July amid improving economic indicators, although certain key regions still showed weakness. ISM new orders, industrial production in Europe and Chinese export data also point to improving conditions.  Excess airfreight capacity appears likely to have kept pricing restrained, but likely less so sequentially.


Fuel Prices:  FedEx highlighted the risk of higher fuel prices, but YoY average jet fuel prices for the quarter look fairly flat.  The lag in fuel surcharge may have a relatively modest negative impact.  We do not expect FedEx Express to trot out a Syria excuse, since jet fuel costs should not be a particularly meaningful headwind.


Express Margin:  FedEx reported a 6.6% adjusted operating margin for its express division in FY4Q 2013, up 50 basis points from the FY4Q 2012 result.  Sequentially, that was a significant improvement - FY3Q 2013 margins were down 130 basis points from the year ago quarter. Continuing those gains into FY1Q, which may be be too pessimistic, gives an adjusted express margin of 3.6%.  An adjusted express margin exceeding 4% would likely be viewed as exceptionally good progress.


Capital Spending & Capacity:  Growth capital spending for FY14 is to be directed at FedEx Ground, with FedEx Express spending targeted at lowering costs (not expanding capacity).  Returns for both of those initiatives should be higher than the capacity additions to Express in recent years.  We will look for more details around the Ground spending initiatives.


Trade Down:  While there is a lot of focus on the trade down, much of FedEx Expresses recent improvements have come from ‘self-help’: adjusting capacity to meet the quantity and yield of volume.  UPS said in its more recent earnings release that trade down was still a headwind.  However, we will focus on FedEx’s adjustment to the mix shift, which should keep margins moving back toward those of competitors.  As long as margins expand on the Express division’s huge revenue base in coming quarters, we do not expect trade down to be the share price driver.


About $8.00: We still expect FDX to generate FY2014 adjusted earnings just shy of $8.00.  After all, current consensus barely secures management’s deferred compensation packages according to the recent proxy.  Fortunately, if we are wrong, FedEx senior managers will probably be able to get by without it.