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Spiking Skew

“My reading of history convinces me that most bad government results from too much government.” -Thomas Jefferson

 

Over the Thanksgiving break, I started reading “Thomas Jefferson: The Art of Power” by Jon Meacham.   For many of you Americans (like Keith I’m Canadian), undoubtedly studying the founding fathers is old hat, but for me the book has a number of revealing insights.

 

The key insight relates to the quote at the outset.  Specifically, this idea that too much government may, in fact, be too much government.  No doubt there are some pensioners in Detroit who are thinking just that as they are beginning to realize that the “government guarantee” of their pension is not as solid as they believed it to be.

 

Like most great men, Jefferson had his faults.  Regardless, the author of the Declaration of Independence was a stalwart protector of individual liberty, especially in the face of the threat of government.  Compared to the Jeffersonian era, the individual American certainly has much broader freedoms than he, and especially she, would have had in the early 1800s.

 

The one caveat to this of course is in the area of economic freedom, specifically taxation.  From the Jeffersonian period to the early 20th century, the government was both a small percentage of the economy and direct taxation was originally very limited.  On the last point, as recently as 1895 the Supreme Court of the United States actually ruled that federal income tax was unconstitutional.

 

Today as we “gladly” hand over 1/3+ of our incomes to the federal government and the government comprises 20%+ of the economy, it certainly begs the question of whether we have the personal economic freedoms that our Founding Fathers envisioned.

 

Back to the global macro grind . . .

 

Related to the topic above, one sneaky macro positive that has been emerging domestically is a shrinking of the federal budget deficit.  Over the past four years, the federal budget deficit has been cut in half from the peak level of $1.4 trillion.  Certainly, a $700-ish billion budget deficit is still too large, but in this regard the trend is definitely our friend, especially as it relates to U.S. dollar tailwinds.

 

Sadly, none of today’s current politicians have the political acumen of Thomas Jefferson, so the primary method to halt federal government spending growth has been for the Tea Party to effectively hijack the government, which most recently led to a government shutdown.

 

In 2014, we may have déjà vu all over again.  Consider the federal government catalysts we have in front of us in the next three months:

  • December 13th – The bipartisan budget committee is supposed to report back on budget / compromise progress;
  • January 15th – The Current Continuing Resolution runs out;  and
  • February 7th – The next debt ceiling deadline. . .

The threat of more negative government catalysts is actually coming at a really complacent and inopportune time for the U.S. equity markets. Specifically, the VIX’s monthly average price was just under 13 in November and at the lowest level we’ve seen in over two years.  As many of you well know, there is an inverse correlation between the VIX, a measure of volatility, and the price of the SP500.  Suffice it to say, the equity volatility ball is sufficiently under water . . .

 

In the Chart of the Day, we highlight the SKEW Index compared to the VIX index.  As the chart shows, SKEW is spiking and historically SKEW has been a decent leading indicator of volatility.  Intuitively this makes sense as investors are becoming more compelled to hedge exposure given the highs in the market and the fact that year-end is fast approaching. 

A potential spike in volatility and decline in equities also makes sense given a number of other signs of a near term top.

 

Consider a couple of headlines from the Wall Street Journal and Reuters from yesterday:

  • “More Hedge Funds Turn to Long-only Strategies”
  • “Short Sellers Trying to Cope”

No doubt, this has been a challenging year for short sellers as stocks with high short interest have outperformed meaningfully, but when more than half of hedge funds launch or plan to launch long only strategies it does reek of capitulation.  (And no, the Hedgeye Long Only ETF won’t be launching anytime soon!)

 

Before signing off, I also wanted to remind you of Hedgeye’s Energy Best Idea call on Boardwalk Partners (BWP) this Thursday at 11am.  BWP is a $6.4 billion market cap MLP primarily engaged in the transportation and storage of natural gas in the south/central US.  The diversified holding company Loews Corp. (L) owns the 2% GP interest in BWP, all IDRs (currently in the 50/50 split), and 52% of the BWP’s outstanding common units.

 

BWP is a high-conviction short idea given the Company’s deteriorating base business, aggressive accounting, high leverage, unsustainable distribution, valuation.  If this thesis sounds a little like our calls on Kinder Morgan (KMP) and Linn Energy (LINE), it should.  We think the valuation of the MLP sector is grossly overstating the intrinsic value of the underlying businesses held in these structures.  If you’d like to get access to the call, email sales@hedgeye.com.

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

Spiking Skew - SKEW

 

Spiking Skew - 12 4 2013 8 07 41 AM


December 4, 2013

December 4, 2013  - Slide1

 

BULLISH TRENDS

December 4, 2013  - 2a

December 4, 2013  - 3A

December 4, 2013  - 4A

December 4, 2013  - 5A

December 4, 2013  - 6A

December 4, 2013  - 7A

December 4, 2013  - 8A

December 4, 2013  - 9A

 

BEARISH TRENDS

December 4, 2013  - 10A

December 4, 2013  - 11A
December 4, 2013  - 12A

December 4, 2013  - 13A


THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP – December 4, 2013

 

As we look at today's setup for the S&P 500, the range is 31 points or 0.62% downside to 1784 and 1.11% upside to 1815.                                     

                                                                              

SECTOR PERFORMANCE

 

THE HEDGEYE DAILY OUTLOOK - 1

 

THE HEDGEYE DAILY OUTLOOK - 2

 

EQUITY SENTIMENT:

 

THE HEDGEYE DAILY OUTLOOK - 10                                                                                                                                                                  

 

CREDIT/ECONOMIC MARKET LOOK:

  • YIELD CURVE: 2.51 from 2.50
  • VIX  closed at 14.55 1 day percent change of 2.25%

MACRO DATA POINTS (Bloomberg Estimates):

  • 7am: MBA Mortgage Applications, Nov. 29 (prior -0.3%)
  • 8:15am: ADP Employment Change, Nov., est. 170k (prior 130k)
  • 8:30am: Trade Balance, Oct., est. -$40b (prior -$41.8b)
  • 10am: ISM Non-Manufacturing, Nov., est. 55 (prior 55.4)
  • 10am: Sept., Oct. new home sales; delayed by govt. shutdown
  • 10:30am: DOE Energy Inventories
  • 2pm: Federal Reserve releases Beige Book

GOVERNMENT:

    • Sec. of State John Kerry attends NATO mtg in Brussels
    • 9:30am: House Oversight and Govt Reform Cmte hears from Brookings, Mercatus, Cato experts on rollout of healthcare.gov
    • 9:50am: Education Sec. Arne Duncan at Federal Student Aid Training Conf., answers questions on Obama’s proposal to make college more affordable for middle-class Americans
    • 10am: House Energy and Commerce Cmte panel hears from policy institutes, think tanks on ACA, Medicare Advantage
    • 11am: Boeing CEO, Business Roundtable Chairman Jim McNerney holds conf. call to discuss CEO Economic Outlook Survey
    • 11:20am: President Obama speaks on economy at CAP event
    • 1pm: House Small Business Cmte hears from National Restaurant Assn on effects of Affordable Care Act

WHAT TO WATCH:

  • European Commission fines banks EU1.71b for rate rigging
  • JPMorgan said to snub Euribor deal
  • Deutsche Bank extends multi-party chatroom ban to fixed income
  • Merck, Lilly said to be interested in Novartis veterinary unit
  • Cyber Monday sales rise ~20%, Comscore says
  • China Mobile license paves way for world’s largest 4G network
  • Bats sees completing Direct Edge deal in 1Q
  • Ireland exits Bank of Ireland $2.4b preferred share stake
  • British probe to clear Huawei of allowing spying
  • Nokia/Microsoft: EU provisional deadline

EARNINGS:

    • Aeropostale (ARO) 4:01pm, $(0.25)
    • Avago Technologies (AVGO) 4:05pm, $0.81
    • Brown-Forman (BF/B) 7:45am, $0.91
    • Express (EXPR) 7am, $0.25
    • Guess? (GES) 4:03pm, $0.38
    • Korn/Ferry Intl (KFY) 4:01pm, $0.34
    • Mattress Firm (MFRM) 4:01pm, $0.54
    • National Bank of Canada (NA CN) 7:15am, C$2.09
    • Synopsys (SNPS) 4:05pm, $0.55
    • Verint Systems (VRNT) 4:05pm, $0.64
    • Wet Seal (WTSL) 4:05pm, $(0.12)

COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)

  • Record Rice Inventories in Thailand Jumping 17% as Exports Climb
  • Brazil Corn-to-Soy Switch Foreshadows Record Glut: Commodities
  • OPEC Seen Keeping Output Cap; Naimi Says Market in Best Shape
  • LME Is Reviewing Future of London’s Last Open-Outcry Trade Pit
  • WTI Rises on U.S. Crude Supply Drop as Discount to Brent Shrinks
  • Gold Falls to Five-Month Low as Silver Drops on Fed Taper Bets
  • Wheat Climbs on Speculation Cold Snap May Hurt U.S. Winter Crop
  • Copper Climbs Before Reports Seen Showing More Hiring in U.S.
  • Robusta Extends Gains After Biggest Rally Since 2011; Sugar Adds
  • Rebar in Shanghai Advances to Seven-Week High as Iron Ore Jumps
  • Soybean Meal Seen Falling 8.3% on Reversal: Technical Analysis
  • Ethanol Mills Face Closures as Obama Cuts Target: Energy Markets
  • Natural Gas Near $4 Makes Costly Appalachia Coal Basins Viable
  • Iran Will Meet Intl Oil Companies in March in London: Minister

THE HEDGEYE DAILY OUTLOOK - 5

 

CURRENCIES

 

THE HEDGEYE DAILY OUTLOOK - 6

 

GLOBAL PERFORMANCE

 

THE HEDGEYE DAILY OUTLOOK - 3

 

THE HEDGEYE DAILY OUTLOOK - 4

 

EUROPEAN MARKETS

 

THE HEDGEYE DAILY OUTLOOK - 7

 

ASIAN MARKETS

 

THE HEDGEYE DAILY OUTLOOK - 8

 

MIDDLE EAST

 

THE HEDGEYE DAILY OUTLOOK - 9

 

 

The Hedgeye Macro Team

 

 

 

 

 

 

 

 

 

 

 

 

 


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The Great Machine

This note was originally published at 8am on November 20, 2013 for Hedgeye subscribers.

“Unlike an inexorable, Newtonian “great machine”, the economy is not a closed system.”

-Geoger Gilder

 

That’s a quote from the end of lucky chapter 13 of one of the best markets/economics books of 2013, Knowledge and Power, by George Gilder. I like this book because it’s the precise opposite of what your central planning overlords @FederalReserve think.

 

Yesterday, at the Keynesian-economics-Club-of-Washington-D.C. event, Ben Bernanke proclaimed his mystery of faith to his head nodders: “the surest path to recovery” is for the Fed to do more (read: no taper).

 

Right, right. It’s a good thing he’s sure.

 

Back to the Global Macro Grind

 

This, of course, is the basic divide between how most of us market-practitioners think about markets/economies versus some un-elected and unaccountable academic theorist does. Core to Fed group-think is certainty whereas what we do is embrace uncertainty.

 

Markets and economies aren’t some theoretical “great machine” that behaves in “equilibrium.” Markets and economies are dynamic and non-linear. Anyone who has studied history understands that.

 

I’ve been on the road seeing clients in Los Angeles and San Francisco this week. I’ll be in Vegas tonight and Phoenix tomorrow. No matter where I go, I get the same feedback from market-practitioners about Fed policy – uncertainty.

 

At the same time, these dudes (and dudettes) backslapping one another at the Fed think that they have this completely under control. At one point yesterday, Bernanke said that his “forward rate guidance is helping the economy.”

 

Pardon?

 

Taper, no-taper, taper, no taper, maybe-taper, no taper, change goal posts on taper, don’t taper…

 

It’s a certified circus at this point.

 

The smartest investors I meet with have the humility to tell people that they have no idea how this ends. So that’s comforting, right? Not only one of the sharpest clients we have, but one of the best performers in 2013 YTD, summarized that this he-said-she-said-taper-talk thing has given him a tremendous amount of conviction in one position – cash.

 

“Keith, with all of the illiquidity and policy risk factors building out there, I really like cash.”

 

Indeed.

 

After effectively day-trading Yellen’s predictable behavior last week, I’ve gone from 48% cash in the Hedgeye Asset Allocation Model to 60% this morning. But I was at 66% cash yesterday morning, and bought-the-damn-bubble in a few things on red again yesterday.

 

Day-trading? Yep. I have no problem with that. Do you? #GetActive

 

I realize its below these uber intellectual types at the “Economics Club of Washington” to risk manage (read: trade) the market risk they are superimposing on us every day. And I kind of like that. Maybe they’ll label me a lower-class-trader, or something like that.

 

Moving along…

 

What’s my call? It’s been a fantastic year to be long US #GrowthAccelerating (from 0.14% GDP with the SP500 at 1360 in Q412 to 2.84% GDP Q313 and US stocks at all-time highs), and now, on up days, it’s time to raise cash.

 

Looking at both real-time market indicators (Russell2000 growth has been making lower highs since locking in its all-time high on October 29th) and high-frequency economic data, it appears to us that the slope of the line on US growth is peaking.

 

Since what happens on the margin matters most, if and when the US economy slows (from here) to say 2% (or 1.6%, which is now the downward bound in our GIP model for US GDP Growth in 2014), what do you think the top performing Style Factor in US Equities (GROWTH) is going to do?

 

No worries, you don’t have to guess – that style factor is already starting to do what you should expect it to do – slow. As US equity market momentum slows (on lower and lower volumes), both the Fed and its nodders are going to get lulled to sleep.

 

Moreover, I think the Fed will cheer on the #GrowthSlowing data as more reason not to taper… and, in doing so, they’ll suck in every last lemming who hasn’t been long US stocks in 2013 to buy the bubble.

 

How messed up is that? I have no idea on timing, but oh how this “great machine” of Keynesian certainty is going to fall.

 

Our immediate-term Risk Ranges are now as follows:

 

UST 10yr Yield 2.67-2.81%

SPX 1778-1809

VIX 11.85-13.88

USD 80.48-81.36

Brent 103.68-108.69

Gold 1260-1303

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

The Great Machine - Chart of the Day

 

The Great Machine - Virtual Portfolio


$JCP (and McGough) Stick It to the Bears

Takeaway: We're surprised at how many people are hanging on to the stale bear case on JCP. At least acknowledge that things are improving.

CNBC is going to have a tough time carting out a bull on JC Penney. Hedgeye retail analyst Brian McGough is the only one. And he's nailing it.

 

The stock market pinata turned the tables on JCP bears after the bell, pulling a double-digit same store sales rise out of the bag for November. The stock surged higher and was the most actively traded in the after-hours session.

 

$JCP (and McGough) Stick It to the Bears - jcp1

 

As McGough wrote in a note to clients earlier this evening, "We're surprised at how many people are hanging on to the stale bear case. At least acknowledge that things are improving." McGough says he is the first to admit that it's only a partial window into the quarter. But, as he says, "This news validates three core parts of our JCP thesis."

  1. There are so many things at JCP that are broken, but absolutely none of them are beyond repair. Consensus won't acknowledge the concept of JCP earning money, while we think that $1.50 in earnings power is within reach (that's up from our recent $1.30 estimate). Once people internalize this eventuality, we think we're looking at a $20 stock (low teens multiple, though we could argue higher).
  2. Even though Wall Streeters may not be big JC Penney shoppers, the fact of the matter is that the average American consumer genuinely wants JCP to exist. Tough for Wall Street to believe, but our work suggests that it's 100% true.
  3. JCP is absolutely gaining share -- when it comps 10% -- 3-5x its average competitor -- it's tough to argue otherwise.

The news gets worse for JCP bears.


$JCP (and McGough) Stick It to the Bears - JCP tail

Hedgeye CEO Keith McCullough points out that there's no resistance to the TAIL (mean reversion) line of $14.61. That represents 40-50% upside.

 

(Click here to subscribe to Keith McCullough's Real-Time Alerts. As of this writing, he has registered a remarkable seventeen winning trades in a row.)

 

 


JCP: The Bear Case Lacks Intellectual Integrity

Takeaway: We're surprised at how many people are hanging on to the stale bear case on JCP. Seriously, at least acknowledge that things are improving.

Great news out of JC Penney this evening, as the company reported a 10.1% comp in November.  We admit that it's only a partial window into the quarter. But, this validates three core parts of our JCP thesis.

 

  1. There are so many things at JCP that are broken, but  absolutely none of them are beyond repair. Consensus won't acknowledge the concept of JCP earning money, while we think that $1.50  in earnings power is within reach (that's up from our recent $1.30 estimate).  Once people internalize this eventuality, we think we're looking at a $20 stock (low teens multiple, though we could argue higher).
  2. Even though Wall Streeters may not be big JC Penney shoppers, the fact of the matter is that the average American consumer genuinely wants JCP to exist.  Tough for Wall Street to believe, but our work suggests that it's 100% true.
  3. JCP is absolutely gaining share -- when it comps 10% -- 3-5x its average competitor -- it's tough to argue otherwise.

 

*Our research is based in part on our survey work -- which suggested last month (before KSS missed and JCP beat 3Q) that JCP was regaining share, and that KSS was likely the biggest donor.  We've updated our survey, and will be ready to share our insight (and incremental trends from our last survey) early next week. Please contact sales@hedgeye.com if you are interested in the results.

 

BEARS ARE STILL GROWLING

 

We've gotten a lot of feedback from bears this evening -- including 1) 'they were up against an easy comp' and 2) 'we don't know inventory levels or gross margins.' The latter point is true. We don't know margins. But we have a rather strong sense that they were better than last year.  We still think that a return to the  mid-high 30s Gross Margin is likely -- from the depths of the 22% where Johnson forced them. We need to keep in mind that Gross Margin is one of the easiest lines to destroy on the P&L over a short period of time (i.e. Ron Jon eliminating $2.5bn of 48% GM private label). But unlike other industries, in retail it is also the one line where you can shake the etch-a-sketch clean and return to meaningfully higher levels over a 12-18 month time period.

 

As it relates to the bears' 'it's irrelevant -- it was an easy comp' argument, we think that's an absolutely ridiculous point. The reality is that last year JCP lost a tremendous amount of market share -- $4.3bn to be exact.  And now it's taking it back. When they take it back from KSS -- who we estimate stole $800mm in sales -- is KSS going to say…'that's ok, we took a lot of share last year, so it's ok if our sales are down.' Yes, we know how ridiculous that sounds. But the reality is that JCP is growing 3-5x ahead of its competitors. And that can't be glossed over.

 

Here's A Chart That Shows Us Who Took The Most Share From JCP. As Noted, Our Updated Survey Hits Next Week and We Will Be Able To See Incremental Trends

 

JCP: The Bear Case Lacks Intellectual Integrity - JCP

 

HERE'S ONE OF THE MOST IMPORTANT CONSIDERATIONS AS IT RELATES TO OUR BULL CASE

 

First, as a precursor, we need to reiterate that we are in no way perma bulls on JCP (we're not 'perma' on anything). We were short this name at $42 when Ackman was parading around his $12 in earnings thesis. We turned positive earlier this year when we thought perception of fundamentals as well as sentiment had overshot on the downside.

 

As it relates to earnings power, let’s keep an important factor in mind…JCP is 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 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 $140/square 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. Ron Johnson decimated JCP’s private label brands, which 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 that with $900mm at a 33% gross margin.  

  

Here are some of our recent clips from HedgeyeTV. Comments are welcome, as always.

 

http://app.hedgeye.com/media/704-video-jcp-mcgough-remains-optimistic

 

http://www.youtube.com/watch?v=nfMU0ggmJ1U&feature=share&list=UUkDxvN-bcxsKkvJ3yyiGSVQ

 

Here's Our Note After JCP Surprised on the Upside With 3Q Results Last Month

11/21/13

JCP: The Bear Case Just Shrunk

 

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.

 

  1. 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.
  2. 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.
  3. 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.
  4. 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.
  5. 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.


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