"Fear keeps you from making as much money as you ought to."
-Jesse Livermore, Reminiscence of a Stock Operator
At 3:25PM yesterday, I sent the following note to our Macro subscribers: "A close above 944 in the SP500 looks imminent and higher-highs are bullish. Away from being long REFLATION, being long short interest may be your next best bet. Squeezy is hungry."
"Squeezy" is the name of one of the Research Edge mascots - he's a shark, and he bites holes in the behinds of bears when they aren't expecting it. I have been bearish, and I have been bullish, but the Golden Rule that I discussed yesterday implies that I should never be wed to being either. I get paid to be right, not rigid.
This morning's #1 Headline on the Bloomberg box (in terms of how many people have already clicked on it) is "Stocks, U.S. Futures, Commodities Gain; Dollar, Treasuries Fall"... and that is what it is folks - it's called the #1 factor that has affected the macro side of your portfolios in the last 3.5 months - the REFLATION trade.
The US Government either A) doesn't particularly care about this US Dollar crisis or B) doesn't understand it. Having done a call with the CBO's (Congressional Budget Office) representative on US Dollar forecasting last week, we'll take B).
Obama may very well trust that the CBO's Director, Peter Orszag, does math, but someone needs to rattle his cage and wake this office up to the basic principle that forecasting the US Dollar requires a global macro investment process. If you think I am being political about this, think again. Call the office for yourself and it will take you about 3 minutes to get my point.
From the authors of Breaking The Buck, we now have the sequel - Burning It! In the short run, this is going to stoke REFLATION's fire. In the long run, the US Dollar's status as the world's reserve currency will be dead.
No, I don't mean dead as in its going away. I mean dead in terms of how the world considers the US Dollar's credibility. Three weeks ago, when I first started annoying you with this point, all I had was the world's new economic juggernaut, China, supporting my view. Today, alongside China, Russia, Germany, and even Australia, I also have the President of the World Bank, Robert Zoellick, talking about China diversifying and Lipsky at the IMF stating plainly that a "new reserve currency is possible"!
We're not being alarmist - this is a live and ticking situation that America has never had to deal with before. In decades past, we'd have a independent Federal Reserve stand up for itself (Volcker), and support America's currency with objective monetary policy (raising rates). Today, we have as highly a politicized process of monetary and fiscal policy as this country has ever seen.
So away from the "emergency" level free money policy that we have (which was prefaced by a conflicted narrative fallacy - The Great Depression, remember!), we now have a credibility crisis of generational proportions that is Burning The Buck.
If you're long commodities (or anything priced in Dollars), this is great! Again, that's in the short term. Yesterday, on the heels of Timmy Geithner being YouTubed again (bailing out his boys in De Banking Club), the Buck started to burn again intraday. As it burned lower, commodities melted higher. The CRB Commodities Index was up a sharp +2.7% on the day, and despite our British Philosopher friend's attempt to be "short of" crude oil on Monday's higher-low, the West Texas kind (priced in Dollars) has spiked another +6% in less than 48 hours.
Crude and Copper continue to make higher-highs, alongside Chinese demand. Last night, the Chinese reported a very impressive industrial production growth rate of +8.9%, rising sequentially from +7.3% last month, and putting the Panda bears to bed with a Squeezy session of their own. The Shanghai Stock Exchange was up another +1% overnight, making a higher-year-to-date-high at +54.7%. Stocks in Hong Kong closed up a full +4% on the day, taking their YTD gains to +30.6% on the Hang Sang Index. Great Depression "emergency" level of ZERO percent interest rates what??
All the while, REFLATION markets from Russia to the United Arab Emirates continue to power forward this morning, trading up another +2% and +3%, respectively. As the balance of economic power in the world shifts, make no mistake - in the end, REFLATING the almighty Petro-Dollar will have unintended consequences. Putin's Russia announced they are selling US Treasuries this morning - geopolitical risk is going to be back, in a big way.
Burning The Buck pays the Bankers, the Politicians, and the Debtors. Burning The Buck pays Putin, Ahmadinejad, and Chavez. We get it - that's why we re-invested 16% of the Assets in our Asset Allocation Model in the last few days. That's why I am back up to 22 long positions in our Virtual Portfolio. Do the said leaders of America's Financials system get it? You tell me...
My immediate term upside target for the SP500 is now 960. If you want to trade the last part of the REFLATION move (like I do), do so surgically, all the while respecting that "Fear keeps you from making as much money as you ought to."
Congratulations to our Pittsburgh subscribers and Sydney Crosby's Penguins on last night's win,
EWA - iShares Australia- EWA has a nice dividend yield of about 5% on the trailing 12-months. With RBA rate cuts showing signs of working and a commodity based economy with proximity to China's reacceleration, there are a lot of ways to win being long Australia.
FXA -CurrencyShares Australian Dollar Trust-Thanks to recovering Chinese demand for commodities, the sure handed management of RBA Governor Glenn Stevens and comparatively modest consumer debt levels -Australia's GDP continued to expand in Q1 while other industrialized economies saw double digit declines. As with Canada, we like the Australian economy as an offset to the toxic US balance sheet.
XLV - SPDR Healthcare -Healthcare looks positive from a TRADE and TREND duration. We bought XLV on 6/08 to get long the safety trade.
EWC - iShares Canada - We want to own what THE client (China) needs, namely commodities, as China builds out its infrastructure. Canada will benefit from commodity reflation, especially as the USD breaks down. We're net positive Harper's leadership, which diverges from Canada's large government recent history, and believe next year's Olympics in resource rich British Columbia should provide a positive catalyst for investors to get long the country.
XLE - SPDR Energy - We bought Energy on 6/05. We think it works higher if the Buck breaks down. Bullish TRADE and TREND remain.
CAF - Morgan Stanley China Fund - A closed-end fund providing exposure to the Shanghai A share market, we use CAF tactically to ride the wave of returning confidence among domestic Chinese investors fed by the stimulus package. To date the Chinese have shown leadership and a proactive response to the global recession, and now their number one priority is to offset contracting external demand with domestic growth.
TIP- iShares TIPS - The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield on TTM basis of 5.89%. We believe that future inflation expectations are currently mispriced and that TIPS are a compelling way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.
GLD - SPDR GOLD -We bought more gold on 5/5. The inflation protection is what we're long here looking ahead 6-9 months. In the intermediate term, we like the safety trade too.
SHY - iShares 1-3 Year Treasury Bonds - If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.
UUP - U.S. Dollar Index - We believe that the US Dollar is the leading indicator for the US stock market. In the imm.ediate term, what is bad for the US Dollar should be good for the stock market. Longer term, the burgeoning U.S. government debt balance will be negative for the greenback.
XLU - SPDR Utilities - As long term bond yields breakout to the upside, Utility investments are the relative yield loser.
EWW - iShares Mexico - We're short Mexico due in part to the repercussions of the media's manic Swine flu fear. The country's dependence on export revenues is decidedly bearish due to volatility of crude prices and when considering that the country's main oil producer, PEMEX, has substantial debt to pay down and its production capacity has declined since 2004. Additionally, the potential geo-political risks associated with the burgeoning power of regional drug lords signals that the country's economy is under serious duress.
"Fear keeps you from making as much money as you ought to."
As we move along through the trading day, one thing has happened that really matters - the US Dollar has trended lower, and everything priced in Dollars has REFLATED.
XLB (Basic Materials) and XLE (Energy) are the top 2 performing sectors out of the 9 we monitor in our Sector Views risk management system. A close above 944 in the SP500 looks imminent and higher-highs are bullish. Away from being long REFLATION, being long short interest may be your next best bet. Squeezy is hungry.
My immediate term TRADE resistance line for the SP500 is now 960.
Keith R. McCullough
Chief Executive Officer
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Position: neutral - no current position (with a positive intermediate term TREND bias)
The trifecta of negative rear-view German fundamental data points recently rolled through a dynamic landscape.
Here's what has come out over the last two days:
- The Federal Statistics Office reported that German exports declining 28.7% from a year earlier and dropped 4.8% from March, when they rose 0.3%.
- Industrial output declined 1.9% in April from March, when it rose 0.3% according to the Economy Ministry.
- Factory orders in April held steady at the March level of +3.7%, yet are down 37.1% from a year earlier, as measured by the Economy Ministry.
While the data is admittedly revisionist, April's numbers could squash our incremental German bullishness. Our better-than-bad outlook was founded on a sequential improvement in unemployment (decreasing 10 bps to 8.2% in May), a stabilization and marginal improvement in German and European business and consumer confidence numbers, a reduction in PPI and CPI numbers on a monthly basis that we believed would encourage the consumer to spend, and the month-over month improvements in the three fundamentals above from the March numbers. While we stick to our forecast that Germany will experience mild economic improvement this year with positive growth starting in early Q1 of next year, today's numbers confirm that the fundamentals are still bad.
As much as we're data dependent, three substantial changes in the German economic and political landscape have happened in the last 10 days, which we believe are important call-outs:
- On the first of the month German Chancellor Angela Merkel decided on Magna International Inc. as the buyer for GM's Opel division in Germany. The agreement was a heavily politicized event for Merkel who is running a reelection campaign in September. With thousands of jobs at Opel and from parts suppliers hanging in the balance the decision sparked much debate, from the importance of saving one of Germany's most important industries to not playing favor to one industry. Merkel had strong opposition from her newly appointed German Economics Minister Karl Theodor zu Guttenberg who believed that her approved bridge loan of 1.5 Billion EUR to prevent Opel insolvency before a buyer resumed operations was imprudent government spending. Further the choice of Magna, a Canadian-Austrian auto-parts supplier that is backed by Russian bank OAO Sberbank and carmaker OAO GAZ, created much consternation due to the historical tensions between Germany and Russia and the sizable 35% stake a Russian enterprise would have in the company.
- Over the weekend Merkel's Christian Democratic Union (CDU) beat the Social Democrats (SDP) in European Parliament elections according to preliminary results. Merkel's party (along with their Bavarian Christian Social Union-CSU sister party) received 37.9% over her incumbent Frank-Walter Steinmeier of the SPD, whose party garnered 20.8%. The victory signals German support of center-right parties. Additionally Merkel's preferred coalition partner, the pro-business Free Democrats (FDP), received 11% of the vote. Should Merkel's CDU-CSU party retain this support with the FDP as coalition partners, she'd very likely be at a margin to win a solid majority for the national vote in September.
- Today Arcandor AG, owner of Karlstadt, one of Germany's largest department-store chains, filed for insolvency after the German government decided not to come to its aid. Bloomberg cites Merkel as saying the collapse was "unavoidable after investors and banks offered too little to save the company." In any case the decision is reverberating hard throughout the media today, with many questioning if a merger with competitor Metro's Kaufhof might still be a possibility. Again, in the balance hang many jobs, and general confidence if household retail names like Karlstadt go away.
The recent political decisions help confirm German aversion to state aid, a conservative view prizing low government debt to prevent hikes in taxes. For Germany, a country considered by many Americans to be profoundly socialist, for the moment it sure looks as if the tables have turned. Despite April's poor numbers our bullish bias on Germany in the intermediate term remains. Fiscal conservatism when properly balanced will help keep the country's balance sheet at a manageable level. Such leadership can only promote investor confidence.
Now that earnings season is over, let's take a little look at earnings expectations for the remainder of the year. We've already established that the group needs positive earnings revisions to take the stocks higher - and in some cases 'run to stand still'. Like it or not, I think we get that. Let's look at two factors...
1) First is the current bottom-up eps growth rate for the Apparel/Footwear Retail Supply Chain. We're looking at expectations for a 10% decline in earnings over the next 12-months. Is this reasonable? Yes, I think it is. In fact it better be given that the market is awarding a 15x pe on these earnings expectations. I like the names where I think there are meaningful company-specific earnings levers, like RL, UA and PSS. While there will unquestionably be companies at the other end, I find it more frustrating today identifying a miss than any time over the past four months.
2) So what's so unique about the group right now? Not to sound like a broken record, but the as outlined in our 3/5 group call (I'm Getting Fundamentally Positive on Retail) we're entering a period where sales trends are stabilizing, inventories are in check, capex is coming down by over 10% (25% if we exclude Wal*Mart), and we start to go up against very easy compares on gross margins and SG&A. Tack on conservative guidance by companies who are tired of missing, and we get to a few quarters where it's tough to be bearish in aggregate. This is best illustrated by our SIGMA chart below, here the latest quarter showed a move towards the upper right - meaning that capital efficiency is improving alongside a better delta on margins. As we've been trumpeting, this will continue into holiday, at which time key companies (especially footwear) will start to really benefit from lower sourcing costs.
Men's Wearhouse reported 1Q EPS of $0.10 vs. 1Q08 EPS of $0.20 and far better than the Street which was looking for a breakeven quarter. Results were better across the board with same store sales coming in above expectations, gross margins less bad, and SG&A expenses well controlled. Perhaps the most surprising factor in the upside was the gross margin line, which was under considerable pressure in 4Q08 due to the company's decision to BOGO suits. Offsetting this margin pressure was a solid performance from the company's tuxedo business, which grew by 1.7% in the quarter and helped to offset merchandise margin declines in the core retail business. Overall, a solid performance and yet another example of "stabilization" in the marketplace.
More interesting than the 1Q results is the company's bid of $67 million for Filene's Basement (out of bankruptcy). The company actually delayed its quarterly conference call as it awaits final court approval on the offer. Remember, that only a few weeks ago (see our note: Activism Brewing?) we pointed to a new change in control clause in the proxy which essentially gave executives added compensation if the company were to be acquired - the same type of clause used to scare away activists. Now it goes ahead and bids for Filene's. Interesting narrative. The purchase price includes 17 of 20 leases, inventory from a total of 25 locations, leases on the headquarters and distribution facility, as well as the Filene's Basement trade name.
MW's strategy is historically rooted in EDLP. If you think about it, an off-price chain presents unique opportunities for the company as it diversifies the customer base with a heavier focus on women, offers a channel to clear goods from the namesake chain, and potentially gives the company a growth vehicle for the future. Additionally, with the success of off-pricers lately (take a look at a ROST or TJX chart), the severe mismanagement of Filene's Basement over the past few years, and the fact that there is still a deep heritage associated with the brand, this might end up being the type of ownership structure that can give Filene's Basement another chance.
If there is one thing to hope for (admitting that 'hope' is not an investment process), it's that MW brings back the automatic markdown system that actually made Filene's Basement an icon in the industry for so many years. Yes, it actually was 'iconic' in the retail landscape of yesteryear. This is the type of differentiator that can make this small, regional off-price retailer stand out from the rest of the pack. For those of you unfamiliar with the automatic markdown system, give us a call and we'll walk you through a quick recap in retail history. In the meantime, it's probably worth switching gears to focus on MW's plans for growth rather than who might be buying them.
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