“I love everything about investing except maybe the fact that I’m actually in the investment industry. If you see how sausage is made you probably wouldn’t eat it.” - Yours Truly, ~10 hours ago
One day back in high school my friend Michael decided to start referring to himself as “Mike Nice.” Quoting yourself to jumpstart an investment missive is about as cool as trying to give yourself your own nickname....but the message fits the theme today, I can’t think of anything else and at 4am, questionable ideas have a sneaking ability to cloak themselves as appealing.
Anyway, back to the Global Macro Grind….
It has been difficult to escape the valuation discussion the last few weeks as bubble speculation has been ubiquitous alongside higher nominal, and real, highs for domestic equities. We added our own speculative cogitations to the already teeming cauldron of valuation commentary yesterday (see BUBBLE MONGERING for more) in a note surveying a current cross-section of market valuation measures. We reprise those below, but the takeaway was fairly straightforward - across the balance of metrics, equities are, indeed, moving towards overvalued.
To recapitulate the selection of metrics we considered yesterday:
Shiller PE: The Shiller PE ratio attempts to normalize the price to earnings ratio by adjusting for economic cyclicality. It does so by dividing the price of the S&P500 by the 10Y average of inflation adjusted earnings. At its current reading of 24.9X, the CAPE ratio is moving into the top decile of its historical range. Mapping the Shiller PE by decile vs subsequent market performance suggests return expectations should move systematically lower alongside incremental increases in valuation. Historically, 1Y and 3Y returns progressively decline for each decile change in the Shiller PE (ie. average forward returns by decile decline as multiples move higher).
Tobins Q-Ratio: Longer-term valuation arguments center on the premise that returns on capital should equalize to cost of capital and market values should normalize to economic value. Tobin’s Q ratio is not a measure we use to tactically manage risk, but we can appreciate the intuition underneath its application – after all, why buy an asset when you can “re-create” it for less and compete away existing, excess profit. Currently, the q-ratio sits just below the 1.0 level and approximately 1.0 standard deviation above the long-term mean value – a level that has generally not been a harbinger of positive forward returns historically.
S&P 500 Market Cap-to-GDP: Assuming the collective output of SPX constituents credibly reflects aggregate national production (or serves as a credible proxy for it), the Market Capitalization-to-GDP ratio effectively represents a price-to-sales multiple for the economy. On a historical basis, we are certainly entering “expensive” territory as we push towards breaching 100% to the upside. At current levels we are approximately equal to the 2007 highs and well above the long-term average.
FORWARD/TRAILING P/E: On conventional P/E metrics, the market is moderately expensive currently at 17X trailing earnings and 15X forward earnings. Valuing the market on a single year of (recurrently over-optimistic) forward earnings estimates has its myopic trappings and, additionally, any perceived cheapness in current multiples should be discounted to account for mean reversion downside off peak corporate profitability (more below).
PEAK MARGINS: In the Chart of the Day below we show after-tax corporate profits as a percentage of GDP. The latest 2Q13 data marked another higher high in corporate profitability at 11% of GDP – this is some 85% above the long-term average. Unless you think peak returns to capital provide a sustainable path to aggregate demand growth in the face of negative trend growth in real earnings, trough returns to labor, middling productivity growth and secularly depressed investment spending, then the mean reversion risk for operating margins remains asymmetrically to the downside.
ESTIMATES: Topline growth estimates for the SPX (market weighted) don’t look unreasonable at +4.8% YoY for 2014. However, the slope on earnings growth (+10.9% for 2014) over the NTM continues to look overly aggressive given expectations for further, significant margin expansion (+100 to +250bps in incremental expansion over 2014) above already peak corporate profitability. Of course, iteratively ratcheting down expectations and subsequently beating deflated growth estimates over the course of the year remains the prevailing (and hereto successful) playbook strategy for higher equity prices.
So, generally speaking, we are overvalued. Practically, what do you do with that?
A chief problem for the bear camp is that that the overbought-overvalued market narrative has become a tired one as moderately elevated valuation has characterized most of 2013 and prices advancing at a premium to profits is not a new phenomenon.
Valuation-in-isolation narratives are some of the sell-sides finest sausage and sirenic when expertly crafted. But Valuation isn’t a catalyst.
At Hedgeye, we use a broad range of valuation and sentiment indicators when contemplating the direction of markets and where our view sits in the context of current prices, consensus estimates, and prevailing sentiment. From an Investment decision making perspective, valuation sits somewhere near the middle-bottom of the our consideration hierarchy.
We get that valuation matters in anchoring return expectations over the longer term. Underneath the technicals, acute policy catalysts, and reflexivity that drives immediate and intermediate term price trends sits the steady drumbeat of fundamentals and an accordion-like tether to ‘fair value’.
However, Price, not deviation from estimated intrinsic value, together with our view on marginal changes in macro fundamentals are the signals we use to risk manage immediate and intermediate term exposure.
With the Price signal bullish (SPX and all nine S&P sectors in Bullish Formation) and fund flows, decent domestic and global macro data, rising M&A activity, near universal acknowledgement of the existent ‘bubbliness’ (can you really be in the terminal stage of a bubble if everyone agrees it’s a bubble?), and the lack of a discrete negative catalyst all supporting equities in the immediate term, we’ll continue to lean long until the price signal changes.
Tops are process and we have continued to Buy The Bubble on shallow corrections within our published risk ranges while taking down our gross and net equity exposure since the No-Taper announcement in September. We’ll probably continue to run tight and #RemainActive as yesterday’s FOMC Minutes only extended the confused communication policy out of the Fed.
Raise some cash. Embrace the uncertainty and volatility of it all. Don’t eat the sausage. Eat a snickers… Don't invest like a Diva.
Our immediate-term Risk Ranges are now as follows:
UST 10yr Yield 2.67-2.83%
Christian B. Drake
THE MACAU METRO MONITOR, NOVEMBER 21, 2013
NEPTUNE MAY BUY SLICE OF JUNKET OPERATOR'S TAKINGS Macau Business
Neptune Group Ltd has agreed to buy all of Macau VIP gaming room operator Ocean Star’s profits from its junket arrangement. Neptune Group, Ocean Star and So Wai-chi have signed a memorandum of understanding to this effect. They have until the end of this year to negotiate the deal. Ocean Star runs at least 11 VIP tables in the City of Dreams, which have average monthly rolling chip turnover of HK$6.43 billion (US$ 830 million).
MACAU CPI DSEC
October 2013 CPI increased by 6.18% YoY and 0.15% MoM.
MORE VISITOR ARRIVALS TO SINGAPORE IN Q1 2013, BUT TOURISM SPENDING DROPS Strait Times
According to the Singapore Tourism Board's (STB) quarterly report, there were 3.9 million tourists in 1Q 2013, +9% YoY. But overall tourism spending dropped by 6% to $5.7billion. The report showed that visitors spent less on accommodation, shopping, and sightseeing and entertainment. They spent the same amount on food and beverage. The decline in spending was driven mainly by a 6% drop in the number of business travellers.
SINGAPORE RAISES 2013 GDP GROWTH FORECAST ON MANUFACTURING Bloomberg, Channel News Asia
Singapore trade ministry bumped up its 2013 GDP forecast to 3.5-4.0% from 2.5-3.5% earlier. GDP may expand 2%-4% in 2014. 3Q GDP grew an annualized 1.3%, beating estimates of -0.3%.
SINGAPORE CHANGI AIRPORT TRAFFIC Changi Airport Group
October passenger movement grew 3.2% YoY to 4.4 million.
DONACO SEEKS EQUITY TO FUND VIETNAM EXPANSION WSJ
Donaco International Ltd., led by two nephews of Genting Bhd.’s chairman K.T. Lim, is seeking up to 25.8 million Australian dollars (US$24.2 million) to fund the expansion of its five-star hotel and casino in Vietnam. The company said last week that Vietnam’s Ministry of Planning and Investment had provided conditional grants which allow the business to operate a maximum of 50 gaming tables. Its existing 30-year gaming license will be reset in 2014, and run through 2044.
INDIA'S LARGEST CASINO RESORT TO OPEN IN DAMAN NEXT YEAR Indiawest
India’s largest integrated casino resort, spread over 10 acres with 60,000 square feet gaming space in Daman, is likely to open early next year, according to Delta Corp. Limited Chairman Jaydev Modi. The 187-room property will open up new markets for Delta Corp. since it is near Mumbai and within convenient distance from the key cities in Gujarat. This would be the first land-based casino in Daman. The company has three offshore casino vessels in Goa.
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Takeaway: This is going to be the Q where people look back and say “yeah, that was the point where I should have realized JCP is a viable entity.”
The list of ‘what’s changed’ to our thesis on JCP in the wake of its print is a very short one. In fact, it’s nonexistent. Were there questions that emerged that we need to get answered? Of course there were. That’s what happens when a company loses $1.94 per share. But far more questions were answered than were raised. Here’s some of our thoughts.
- EPS of ($1.94) missed the Street’s ($1.70) but the reported number includes a $0.73 loss associated with a tax valuation allowance. We don’t think EPS was the most relevant statistic this quarter as share count estimates were all over the place given the mid-quarter equity offering. Nonetheless, on an adjusted basis, we’d say that they probably beat.
- By now everyone knows that JCP voluntarily repaid $200mm on its revolver. It’s worth reiterating as that’s not behavior one would expect from a company about to file Chapter 11.
- Guidance for 4Q includes; a) additional sequential improvement in top line and gross margin – and both positive vs last year, b) DOWN sg&a versus last year, and liquidity to be in excess of $2bn. We don’t think that down SG&A is sustainable for any extended period of time – nor do we want it to be. But for now, we’ll take it.
- That point on liquidity guidance is the most important. The big bears out there had estimates for year-end liquidity of $1.5bn to $1.8bn. Again, companies with stocks going to zero don’t take up liquidity expectations.
- One of the biggest factors we had to rectify is the fact that gross margins were weak at the same time the company brought back higher-margin private label. But what we did not consider is the fact that JCP is still dealing with merchandise that was ordered under Johnson’s regime – brands that the consumer simply does not want. This is product that is going out at a gross margin in the 15-20% range. That’s seriously offsetting the high-40% GM JCP realizes on private brands like Arizona, Worthington, and St. John’s Bay. We did extensive consumer survey work around these brands – and although most people reading this note might not want them, the average American definitely does.
In the end, this is going to be the quarter where people look back and say “yeah, that was the point where I realized JCP wasn’t going under”. We know that this isn’t a major bullish statement, but it certainly removes the most bearish case being throw around – and that’s the case that nearly every short is banking on (and yes, JCP remains one of the most heavily shorted stocks in the S&P). People are still going to have to buy in to the premise that this company can see an acceleration in sales/square foot to a level that can sustain a respectable earnings level. We think JCP pierces through $120/ft in 2015 – which will mark its break-even year. That might not sound too enticing – after all, we all like for companies to make money instead of simply not lose money. But the consensus is at a loss of $1.18 that year, and we think that estimates will need to come up materially.
See our note below for more details about our call, or contact us for our recent Black Book. Also look out for our updated survey the week following Black Friday.
Here are some of our recent clips from HedgeyeTV. Comments are welcome, as always.
HERE’S WHAT WE SAID WE WERE LOOKING FOR OUT OF THE QUARTER.
11/19/13 11:49 AM EST
JCP: Buy The Event
Takeaway: There are many possible outcomes from JCP’s print. But there is virtually nothing JCP can say to suggest that it is not 100% fixable.
Conclusion: One of two things will happen, either we’ll get tangible evidence of the turnaround – which will make JCP worth buying even if it’s up. Or the company will ‘pull a JCP’ and scare the Street with the print, as it has grown so accustomed to. We think that’s unlikely. But we think one thing is clear, there is virtually nothing the company can or will say to suggest that this company is not 100% fixable. We’re buyers on the event.
First off, let’s be clear about where we stand on JCP. Our positive call is based on our view that not a single thing currently ailing JCP is beyond repair. This company is not broken. Johnson bullied and bruised a few dozen critical functions at the company, and though he may have tried to break them, he failed at that too. We don’t think that Ullman is the right person to rehabilitate JCP, but he is the right guy to take it off life support and administer CPR if necessary. We expect to see a new CEO announced by Spring 2014.
Another important point..we’re not arguing that JCP is a great retailer, a great brand name, or in any way deserving of the right to exist as a go-to source for consumers.
But let’s keep an important factor in mind…it’s operating at $100 per square foot. That’s embarrassing. Kohl’s, which we think has structural issues and has been at the top of our short list – is running close to $210/sq ft. Before Johnson worked his magic, JCP peaked out at $190 per foot.
Our point here is that we don’t have to assume that JCP becomes a great retailer. We don’t have to even believe that it will be an average retailer. It can remain in the lower quartile – a notch above Sears even – and operate at $140/square foot. And it can get there by simply fixing some of the factors that Johnson damaged during his triumphant reign.
Alongside the $140/ft, our other key assumption is that Gross Margins get back to 37%, which we think is very doable – despite the severe pushback we get on this assumption. Note that Ron Johnson’s decimation of JCP’s private label brands cost the company about $1bn in gross profit – that’s what happens when you remove $2.5bn in sales at a 48% gross margin and substitute with $900mm at a 33% gross margin.
All in, those assumptions get us to $1.30 per share, which is meaningfully above the high end of where even the most vocal bulls (if there are any) are posting their estimates. Will it get there tomorrow? No. But it’s math that people will begin to run within 12-month’s time. Keep in mind that over the past few years there has always been a debate alive about what the ultimate earnings power of JCP actually is. That debate today is absolutely dead. And we’re not talking about an unachievable Ackmanist-driven Hail Mary $12-EPS power. In all our travels and phone calls, we can’t find anyone that is willing to acknowledge that JCP can actually earn money. That will change, and we think it happens within 12-months.
So, what are we looking for in the quarter?
- First off, this is literally a three-year turnaround – it won’t be fixed in a quarter. What we’re looking for this quarter is a mere two or three wins on the road to fixing several dozen problems. That might sound like a shameless hedge – perhaps it is. But there’s going to be a mix of noise and good news in this quarter. That’s upside from the past two years where it’s been all bad news.
- We’re looking for about a -5% comp. The company already reported a 0.9% store comp and 38% dot.com comp for Oct. Based on commentary by virtually all retailers, October was the best month of the quarter. -5% seems about right, but could be 2-3% +/-.
- Gross Margin change is going to move inversely to comp. We have it modeled +100bps vs. last year – which would mark the first GM improvement in about 10 quarters. Our bias is to the downside on that one, as Ullman told the whole world that he’d end the quarter with positive comps, and he did a +0.9% in Oct. Sounds like he stretched. More likely than not, he told his selling and merchandising team to drive a positive comp come hell or high water. That usually does not come alongside a healthy gross margin. Nonetheless, they’re coming off such low numbers that Gross Margins could be down 100bp and still post a 150bp sequential improvement on a 2-year run rate – which is what we’ll really be looking to see.
- We’ve got an operating loss of -$292mm, which compares to the Street at -$384mm. Our number might be on the aggressive side due to gross margin, but we’re reasonably confident that JCP won’t miss the consensus.
Usually, we don’t leave EPS for last, but the company’s print relative to expectations will be relatively meaningless due to the timing of the company’s offering and inconsistency in how people are modeling the fully-diluted share count. The Street is at -$1.70 this quarter, but the range is from -$2.36 to -$1.11. We have JCP losing a little over a buck. But again, share count is uncertain. We’ll look at the operating loss delta as the best way to gage our estimates versus consensus.
TODAY’S S&P 500 SET-UP – November 21, 2013
As we look at today's setup for the S&P 500, the range is 40 points or 1.09% downside to 1762 and 1.16% upside to 1802.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 2.51 from 2.53
- VIX closed at 13.4 1 day percent change of 0.07%
MACRO DATA POINTS (Bloomberg Estimates):
- 8:30am: Init. Jobless Claims, Nov. 16, est. 335k (prior 339k)
- 8:30am: PPI m/m, Oct., est. -0.2% (prior -0.1%)
- 8:58am: Markit US PMI Preliminary, Nov., est. 52.3
- 9:45am: Bloomberg Economic Expectations, Nov. (prior -31)
- 9:45am: Fed’s Powell speaks in N.Y.
- 10am: Philly Fed Business Outlook, Nov., est. 15 (prior 19.8)
- 10am: Freddie Mac mortgage rates
- 10:30am: EIA natural-gas storage change
- 11am: U.S. announces plans to sell 2Y, 5Y and 7Y notes
- 12:30pm: Fed’s Lacker speaks in Asheboro, N.C.
- 1pm: Fed’s Bullard speaks in Rogers, Ark.
- 1pm: U.S. to sell $13b 10Y TIPS in reopening
- Secretary of State John Kerry hosts 4th annual U.S.-China Consultation on People-to-People exchange with Chinese Vice Premier Liu Yandong
- 9am: Amtrak CEO Joseph Boardman, Rep. Tom Petri, R-Wis., speak at Bipartisan Policy Center on “Improving Passenger Rail Service in the Northeast Corridor”
- 9:30am: House Financial Svcs hearing on H.R.3482, “Restoring Main Street Investor Protection and Confidence Act,” to amend Securities Investor Protection Act
- 10am: RNC Chairman Reince Priebus holds event on Obamacare and Senate elections in 2014
- 10am: Senate Banking Cmte meets on “Housing Finance Reform: Powers and Structure of a Strong Regulator”
- 10:30am: FCC’s David Turetsky, Harris’s Dennis Martinez join panel testifying before House Energy and Commerce panel on FirstNet oversight and public safety wireless communications
- 11:45am: House Speaker John Boehner, R-Ohio, swears in Rep.-elect Vance McAllister, winner of special election Nov. 16 to succeed former Rep. Rodney Alexander
WHAT TO WATCH:
- Morgan Stanley said in discussions to sell oil unit to Rosneft
- Bain Capital said to halt talks with TI Automotive on price gap
- Goldman’s currency-trading rev. fell on options bet, WSJ says
- McKesson deadline to submit Celesio offer document to BaFin
- China manufacturing gauge declines in growth headwind
- Johnson Controls rises after boosting buyback plan by $3b
- Euro-area manufacturing expands for 5th month led by Germany
- Credit Suisse plans legal change to meet future Swiss banking regulations
- Robin Hood conference includes Loeb, Einhorn, Summers
- Abercrombie & Fitch (ANF) 7am, $0.44
- Aruba Networks (ARUN) 4:03pm, $0.14
- Autodesk (ADSK) 4:01pm, $0.39
- Berry Plastics (BERY) 5:45pm, $0.24
- Buckle (BKE) 7am, $0.89
- Dollar Tree (DLTR) 7:29am, $0.60
- Donaldson (DCI) 7am, $0.39
- Fresh Market (TFM) 4:17pm, $0.26
- GameStop (GME) 8:30am, $0.57
- Gap (GPS) 4pm, $0.71
- Gildan Activewear (GIL CN) 6:31am, $0.84
- Intuit (INTU) 4pm, $(0.09)
- Marvell Technology (MRVL) 4:03pm, $0.25
- Mentor Graphics (MENT) 4:05pm, $0.19
- Pandora Media (P) 4:01pm, $0.06
- Patterson (PDCO) 7am, $0.48
- Ross Stores (ROST) 4pm, $0.80 - Preview
- Sears Holdings (SHLD) 6am, $(3.14)
- Spectrum Brands (SPB) 6:30am, $0.88
- Splunk (SPLK) 4:02pm, $(0.01)
- Stage Stores (SSI) 6am, $(0.26)
- Target (TGT) 7:30am, $0.62 - Preview
- Wesco Aircraft (WAIR) 4:01pm, $0.32
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Goldman Predicts at Least 15% Losses for Gold, Iron Ore in 2014
- Bordeaux Grape Damage Squeezing Top French Vintners: Commodities
- WTI-Brent Link at Weakest in 9 Months on Supply: Energy Markets
- Copper Drops as Fed Signals Tapering to Stimulus: LME Preview
- Gold Rises From Four-Month Low Amid Physical Demand Speculation
- Wheat Gains as Demand Seen Rising on Shrinking Black Sea Supply
- WTI Rebounds Amid Draghi Comments, Saudi Arabia Mortar Attacks
- Indonesian Palm Oil Output Growth Slowed on Weather Effects: Fry
- Rebar Falls as China Manufacturing Data Signal Weak Demand
- South Africa’s Biggest Power Users Challenge Eskom-Cut Directive
- Morgan Stanley Said in Discussions to Sell Oil Unit to Rosneft
- Philippines Seeks Delivery of Rice Imports by December: Official
- Korea Agro-Fisheries Issues Tenders to Buy 200,000 Tons Soybeans
- Copper Little Changed as LME Stocks Decline and China Watched
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