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Imperial Ignorance

This note was originally published at 8am on March 07, 2014 for Hedgeye subscribers.

“I implore Imperial Heaven to pardon my ignorance.”

-Daoguang Emperor


Reigning over the Manchu Qing dynasty in China from 1820 to 1850, even by modern central-planning-overlord measures, this guy Daoguang was a whack job. He, like some in Big Government today, thought he was put on this earth to bend economic gravity.


But, “in 1832, Daoguang’s fears of looming crisis converged in one defeat… the government forces were not used to the mountains… many of the troops from the coastal garrisons were opium smokers, and it was difficult to get any vigorous response from them… When nature began conspiring against the Chinese empire… panic was likely to set in.” (The Opium War, pg 49)


So, don’t panic. Blame the weather.


I heard on TV that #InflationAccelerating slowing real US Growth is different this time. And the echoes of Daoguang’s ignorance has the New York Federal Reserve’s back on that: “I, the son of Heaven, am Lord of this World. Heaven looks to me that I preserve tranquility.” (pg 50)


Back to the Global Macro Grind


Yep, things are getting weird. And the President of the NY Fed, Bill Dudley, is getting weirder. You won’t remember him for being a below-average at best Keynesian economist at Goldman Sachs (1986-2007). He’s infamous for his completely out of touch with reality comment in March of 2011 that food prices ripping to all-time highs didn’t matter because iPads were cheap.


No, CRB Foodstuff’s Index fans (which is up another +1.6% this week to +14.0% YTD), you cannot eat an iPad. With US #InflationAccelerating to another fresh YTD high yesterday (CRB Index +10% YTD and the USD hitting another fresh YTD low), you can’t eat Gold (+12.1% YTD) either.


Imperial Ignorance - ipa


But Dudley, who completely missed calling for the 2008 crash, is comfy that the current growth slowdown is all about the “weather” and that US GDP is going to start tracking right back to +3%. As for the Fed’s dual mandate to raise rates when either employment recovers or inflation accelerates, yesterday Dudley called that “obsolete.”


In other dial-a-Fed guy (or gal) to Burn Your Currency news:

  1. The US Labor market data continued its deteriorating @Hedgeye TREND this past week
  2. NSA (non-seasonally adjusted) rolling y/y claims only dropped -3.5% last week
  3. The last 7 jobless claims data points (most recent data point 1st) = -3.5%, -4.4%, -5.6%, -5.1%, -5.7%, -7.3%, -7.9%, -8.5%

In other words, as our all-star-non-Keynesian US Financials analyst Josh Steiner said yesterday, “since we’re looking at the rate of change in year-over-year initial jobless claims, a more negative number is better as it implies a faster rate of improvement.”


That’s also one of the main reasons why we didn’t start to get bearish on inflation slowing real US growth until 8 weeks ago – the slope of growth, or continued improvement, in the US employment cycle. *Note: employment gains peak at the end of a cycle


Yes, we were the US employment #GrowthAccelerating bulls for all of last year, primarily because the rate of change in both weekly and monthly US employment data (leading indicators) was improving. That’s why the Fed should have started to taper in July-September 2012. They didn’t – because they act on a lag to lagging economic data.


To review how the Fed 1913 Act was supposed to work – it was a dual mandate:

  1. Full Employment
  2. Price Stability

In English, that means that the Fed is supposed to:

  1. Get looser (cut rates) when the rate of change in employment is deteriorating and inflation is slowing
  2. Get tighter (raise rates) when the rate of change in inflation is accelerating and employment is improving

Instead, the Bernanke/Yellen/Dudley Fed:

  1. Is now changing the goal posts on what was their official 6.5% employment target – Janet, we hit it too soon; change it!
  2. Will never fight inflation, so the bond market assigns 0% credibility to the Fed raising rates with #InflationAccelerating

That’s why Dudley’s March 7th, 2014 comments about the Fed Act of 1913 being “obsolete” are very much consistent with his comments about inflation in March of 2011 – eat it.


He’s un-elected and un-accountable to the American people. So, for now, like a Chinese bureaucrat posing as our god, he can say and do whatever he damn well wants. And yes, that will affect the credibility of your currency and liberty, in real-time.


So enjoy your US jobs report day in what has become the no-volume-American stock market casino. And pray that the Fed’s imperial ignorance on the impact of price-fixing rates at 0% never perpetuates a panic.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.59-2.77%

SPX 1848-1884

VIX 13.01-15.65

USD 79.49-80.22

EUR/USD 1.37-1.39

Gold 1321-1355


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Imperial Ignorance -  USD


Imperial Ignorance - rta44


Takeaway: How consumers feel about mgmt has a considerable impact on LULU. Here’s the detail on what percent care, and whether they’ll come back.

This week we explored LULU's a) customer purchase cadence, b) customer loyalty, c) competition, d) reasons for leaving the brand -- and several others.  As a reminder, we'll be looking at the incremental change in these areas as well as the following factors when we host our call on Monday 3/24 at 11am ET.


  1. Does LULU need to begin a more aggressive discounting strategy?
  2. New brands are encroaching on LULU's turf, is that rate slowing or accelerating?
  3. What is LULU's perceived price/value equation relative to other brandsand how is that changing?
  4. Growth in points of distribution for Yoga product - a key competitive threat for LULU.
  5. Insight into our store overlap analysis between Athleta and Lululemon
  6. UnderArmour scored so close to Nike in our last survey - which was a big surprise. Nike has been fighting back. Is it working?
  7. Is the 'I hate LULU Management!' factor (present in 58% of people responding last time) - still as severe? Any improvement? 


To cap off just a few of the highlights of our last survey, here are a few charts showing factors related to corporate management.  We showed this chart yesterday, but it's an important reminder that one of the most notable factors that drove people from the brand was that they dislike corporate management.




Separately, we asked people whether they are aware of the comments that Lululemon senior management made in public in November.  To be clear, we did not state who the person was, and we certainly did not say what the comments were. We did not want to lead the witness.  If we asked Wall Street about these comments, we'd get about 98% of people who heard of them. But The Lululemon customers we surveyed came in at 58%. We can all read that a different way, but our view is that this is a HUGE percentage for your everyday follower of the brand.


Then we asked that 58% if those comments impact the Lululemon brand, and 67% said Yes. We're hoping -- for LULU's sake -- that this number comes down dramatically when we crunch through our results over the next couple of days.


Lastly, we asked how these comments will impact shopper behavior.  10% of the people said that they'll never shop at Lululemon again…which is tough to overcome, 38% said that they'll spend less, and 16% indicated that they simply don't care and will likely spend more. About 36% seem neither positive or negative.


It's good that there's a big proportion of customers that are unaffected, but having 48% that are on the net negative side as it relates to spending intent is not what we want to see from a growth brand.  The update here should be interesting.






TODAY’S S&P 500 SET-UP – March 21, 2014

As we look at today's setup for the S&P 500, the range is 35 points or 1.12% downside to 1851 and 0.75% upside to 1886.                                 










THE HEDGEYE DAILY OUTLOOK - 10                                                                                                                                                                  



  • YIELD CURVE: 2.34 from 2.35
  • VIX closed at 14.52 1 day percent change of -3.97%

MACRO DATA POINTS (Bloomberg Estimates):

  • 11:45am: Fed’s Bullard speaks on panel in Washington
  • 1pm: Baker Hughes rig count
  • 1:45pm: Fed’s Fisher speaks in London
  • 4:30pm: Fed’s Kocherlakota speaks in Washington
  • 7:20pm: Fed’s Stein speaks in Washington


    • House, Senate out of session
    • 8am:  Moniz speaks with reporters, analysts at BGOV breakfast
    • 8:30am: SEC Chairman Mary Jo White, FCC Chairman Tom Wheeler speak at Consumer Federation of America assembly
    • 10am: Vice President Joe Biden speaks at National Assn of Community Health Centers’ policy forum


  • Gunvor co-founder exits ownership stake as U.S. sanctions hit
  • Sanctioned Bank Rossiya says MasterCard, Visa halt service
  • Banks’ split with Fed on stress may risk shareholder payouts
  • Volcker rule seen costing banks as much as $4.3b: OCC
  • JNJ, Takeda, Roche may receive EMA decisions
  • U.S. keeps AAA rating by Fitch as outlook raised on debt pact
  • Malaysia jet’s steady flight has Australia scouring ocean
  • No positive news yet from satellite search for jet: Malaysia
  • Families seek truth after evasive responses from airline
  • Netflix CEO calls for stronger rules on web traffic handling
  • Nike sees weaker-than-expected sales gain after profit beat
  • Macondo partner Anadarko’s e-mails seen showing role in well
  • Dow, Eastman Chem. back group airing ads to protect senators
  • Chrysler truck sales rise vs those of GM, Ford, WSJ says
  • Obama in Europe, Stress Tests, Microsoft: Week Ahead March 22-29


    • Darden Restaurants (DRI) 7am, $0.88
    • Tiffany & Co. (TIF) 6:59am, $1.52 - Preview


  • Copper Rises to Trim Weekly Decline as Price Drop Spurs Demand
  • Palm Output in Indonesia Climbing for First Time in Six Months
  • Coffee Belt in Vietnam Poised for Rains Easing Threat of Drought
  • Gold Trims Weekly Decline as Ukraine Crisis Spurs Haven Demand
  • Brent Set for Fourth Weekly Loss Amid Russia Clash; WTI Rises
  • Canada’s Grain Backlog Seen Persisting With More Oil Shipments
  • Palm Heads for Second Weekly Loss as Indonesian Output Increases
  • Global Energy Thirst Threatens to Worsen Water Scarcity, UN Says
  • Wheat Trims Weekly Advance as Dollar Rally Seen Curbing Demand
  • Hot-Rolled Coil Futures Debut in Shanghai to Complement Rebar
  • Baoshan Is Top Steel Stock on China Car Demand: Chart of the Day
  • Russia Senate Clears Crimea Annexation as EU Boosts Ukraine Ties
  • Copper Traders Are Bullish on Speculation Prices Slumped Too Far
  • Copper Advances to Trim Weekly Decline: LME Preview
  • WTI Oil Seen Dropping in Survey on Rising U.S. Crude Supplies

























The Hedgeye Macro Team














March 21, 2014

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NKE: Great Heat, No Flow

Takeaway: Tremendous ‘Brand Heat’, but if it can’t grow EPS on 12% futures, then when can it? Not an outright short, but we don’t like risk/reward.

Conclusion: We don’t have any major changes to our thesis in the wake of Nike’s 3Q14 print – we don’t think it’s an outright short, but we simply can’t get comfortable with the risk/reward here. We expected a good quarter (see prior comments below), but did not like the lack of any room for error in this financial and operating model. And that’s pretty much what we got. The top line and order book both continue to show the tremendous Brand Heat that we've grown to both expect and admire. But with 13% growth in revenue, Nike only put up 4% EPS growth, and half of that came below the line. Looking ahead, the Street is expecting a 7.3% EPS growth rate in 4Q, but even after fronting Nike the high end of its sales and gross margin forecast, we get to $360mm of incremental Gross Profit – not bad at 12% growth vs. last year. The problem is that Nike is spending an incremental $400mm in SG&A. That puts it in the hole for $40mm. Add on another $40mm in incremental FX impact, and we’re looking at a 9% decline in EPS. We ‘get it’ that there are Macroeconomic crosscurrents that are hurting everyone – not just Nike. In that context, it’s growth should be commended. But if they can’t grow EPS at a Nike-esque 20% rate when futures are six months into a double-digit growth rate, then when will it happen?  That’s a pretty good example of what we mean by minimal room for error in the model – particularly when it’s trading at 23x earnings.


NKE: Great Heat, No Flow - nke table


Here’s a few other points that stood out for us:

  1. The Portfolio: We’ve got to give big props to Nike on this one… One of our concerns was that a potential slowdown in the US would leave the top line exposed given that other regions were not carrying their weight. Well…this quarter North America futures slowed to the single digits (9% -- vs. 11%-12% over the past four quarters). That’s not the end of the world as it’s easing to a range (about 6-8%) where it should be long term. But it slowed nonetheless. The great news – and something we did not see coming – is that Western Europe futures were up 33%.  That’s the biggest number we can find on record. Western Europe is the second largest region for Nike – accounting for about 20% of cash flow. This is exactly what we want to see – when one region dips, another picks up the slack. (Though we like to see some flow-through to the bottom line as well – and that we did not see).
  2. China: China futures were down for the first time in forever (we think). The good news is that the strength in Western Europe took some of the pressure off China to perform in light of the downtick in the US. But what surprised us is that the company really did not dedicate much time to China on the call. Trevor Edwards (Nike Brand President) glossed right over it. Don Blair came to the rescue with some information about the disconnect between futures and revenue growth. But in the end it did not come across that the company has a concrete plan for reaccelerating growth in its most important country outside America.  
  3. Futures v Revenue. We’re looking at a robust 12% futures growth rate headed into Nike’s fourth quarter. That was above expectations by 1-2 points. But the problem is that the company took down revenue guidance for 4Q from ‘low double digit’ to ‘high single digit’. They chalked it up to fewer expected closeout sales, which is surprising because inventories are up 15% to $3.8bn -- the biggest inventory increase Nike has seen in almost two years. In fairness, the company took up its Gross Margin guidance, which bolsters the case for fewer low-margin closeouts. But the reduction in top line guidance absent a slowdown in futures is simply odd for Nike.
  4. 2015: The company guided to a growth rate in EPS below its ‘mid-teens’ long term model. We’re not sure how much of that we believe. Nike has its own little biorhythm, and the Street usually feels the brunt of it about this time of year. The company is about to solidify financial targets for each business over the next 1-2 months. More often than not division heads will find tangible reasons as to why they cannot grow their business, just to give that ammo to the executive team. That way, low expectations are set, which also happens to be the hurdle by which people get paid. If you run a business at Nike and manage to convince your boss that your business can only grow 5%, and yet you end up growing 15%, you’re going to have a great payday.




NKE: Great Heat, No Flow - nke sigma





NKE: Good Qtr, Bad Risk Profile

Takeaway: NKE at $70 had everything going right. Near $80 it’s all about top line. No room for error. Good Q, but we just don’t like the risk profile.



We don’t have a strong opinion on NKE headed into its print on Thursday, which is a rarity for us.  As background we turned somewhat cautious on Nike coming out of last quarter for a couple of reasons.


  1. First is that we’re still not sold on the management transition at the company. We don’t like the circumstances that led up to the changes, and we’re not convinced that the right people are in the right places. That’s a bold statement in that Nike is all about people. And it’s success over the years has been driven by consistently putting the right people in the right roles. Some recent moves are a slam dunk (like putting Eric Sprunk in charge of operations), but others are not. We fully acknowledge an important point – that our opinion on who is doing what inside Nike is not very relevant. The opinion that matters is that of the employees who have acclimated to their new bosses. And our concern is that, at least by our measure, THEY don't seem to be as sold on the new management team anywhere near the extent that they were a year ago. Another thing we acknowledge is that management transitions in a company as big and complex as Nike take years to play out – either good or bad. None of our concerns will manifest in any way as soon as this quarter. But we remain concerned about solidarity throughout the organization.
  2. The second, and more pressing (near term) reason is that the Nike story six months ago had three massive pillars of support; 1) Severe Brand heat – with futures and revenue both accelerating, 2) Improving Gross Margins, and 3) Slowing inventory growth. That’s a trifecta that makes Nike pretty much bullet proof. But today, we have a) Gross Margins turning from a tailwind to a headwind, and b) Inventories growing above the rate of sales. In effect, it lost two of its three pillars of support.  The positive is that the Brand is still on fire – both here and in Europe. That’s the most important pillar, thankfully. But there’s no question that the margin of error for Nike is dramatically tighter now than it was heading into last Fall.


So we’re looking at one longer-term concern – that won’t play out now – and a near-term concern that will likely be masked by the fact that revenue momentum remains so strong. And let’s face it, there’s not a long list of companies that are clobbering the competition like Nike is today – so on a relative basis, which is where many investors live, this one ain’t too shabby. So in the end, this will likely be a decent-enough print. But in the fall when NKE was a $70 stock it had everything going its way. Now it’s nearly an $80 stock, only one thing is going its way, and not much else can go wrong. We just don’t like the risk profile.



Here are some questions we have into the quarter:


1) North America vs. The World: Without question, the North American region has been carrying the company for the past two years. Europe kicked in to high gear last quarter and began to shoulder some of the Global Futures growth. That was great to see. That trend needs to sustain itself for Nike to maintain a 10%ish growth rate on the top line. We’d really like to see better consistency out of Emerging Markets (though we guess that once they’re consistent, they will no longer be ‘emerging’) and a meaningful step-up in China.  


2) Gross Margins: We know that the company is facing input cost pressures, but the way we see it cost pressures were easing (mostly over the past year) and at the same time the company had a great two-year run in taking up price in footwear. Can it take up price further to offset the higher raw materials, or will they have to ‘eat it’ for another three quarters while raw materials go against them? Inflation is definitely not going down.  


3)SG&A Spending: Very rarely have we EVERY questioned Nike on SG&A spend. The reality is that – despite splurges when it was in its younger days – Nike has grown up to be an extremely reliable and proficient steward of capital. But we question the recent signing of Jonny Manziel, who is taking home a reported $20mm annually. After blowups that Nike had with athletes like Lance, Kobe, and even the (once) squeaky clean Tiger Woods, we’re surprised that it is rolling the dice on someone that is not particularly likable and poses significant ‘blow-up risk’. Nike prides itself in paying up for what it calls ‘crossover athletes’ meaning that they could be on the cover of Sports Illustrated and Vogue/GQ in the same month. Not quite sure that Manziel is that kind of guy. While that might be nitpicking on one small asset in the context of a company that has $3.6bn in minimum obligations against endorsement deals in the coming 5-years, we should also note the recent deal with Manchester United. The company recently re-upped its 10-year ManU deal at a premium that stunned us. The company had been spending £23mm annually – an amount that now goes up to £60mm. We could understand if the team became meaningfully stronger in recent years, but unfortunately the reverse has happened. Nike is paying nearly 3x for a lesser team. Hopefully there are parts of this deal that we are not privy to that justifies the expense. We certainly hope that Nike will elaborate on both on the call.   


4) FlyKnit – Changing the Conversation: As cool as the FlyKnit kicks are, we want to start hearing more about a few things a) unit cost savings per pair (which they won’t provide because then they’ll tell retailers what their real cost is), b) how much Nike saves in inventory costs (raw materials) for a pair of FlyKnits vs. traditionally-manufactured footwear, and c) when the production technology will be ready to roll out at retail, so consumers could order FlyKnit NikeID product in a store, then go get a burrito at the foodcourt, and come back an hour later and the product is created, fully customized, and ready to take home. Once they nail down that capability (something they’ve quietly been working on for four years) we’ll drop every concern we have about this name and pound the table faster than you can say ‘Prefontaine’.


5) Jordan Running: Nike is launching its first running shoe for the Jordan line on May 1. It’s about time…you can buy a Jordan basketball shoe, baseball cleat, football cleat, and golf shoe. Yet not for the largest shoe category of all – running? This is one of the biggest lay-up (no pun intended) opportunities for the Jordan brand we’ve seen in a decade. We’re interested in management’s plans here.


6) Dot.Com: For one of the most powerful brands in the world, Nike has one of the lowest dot.com ratios at about 4%. Granted, part of the reason Nike’s Direct business is half the size of UnderArmour’s (as a percent of total) is that its wholesale model is so incredibly powerful. But Nike needs to do a better job articulating its dot.com strategy.



The BLS released CPI data for the month of February on Tuesday.  Despite a marginal improvement in the Restaurant Value Spread during the month, food away from home continues to be notably more expensive than food at home.  This suggests that cost sensitive consumers are more likely to frequent the grocery store and prepare their own food than they are to visit a restaurant and dine out.


The value spread did, however, narrow sequentially by 30 bps in February to -1.3% as food at home inflation accelerated at a faster rate than food away from home inflation.  Therefore, we’d surmise that eating out did become marginally more attractive over the course of the month.  Overall, we view the release as less bearish, on the margin, for the restaurant industry.


Full-service and limited-service prices grew +2.3% and +2.2% YoY, suggesting that fast casual and QSR restaurants are becoming more attractive, on the margin, than casual dining restaurants to cash-strapped consumers.


Overall, retail grocery sales and  food services sales data continue to support our thesis regarding the negative Restaurant Value Spread, as grocery sales continue to increase on a YoY basis at the expense of food services sales.





The charts below highlight the important sequential food inflation trends.

  • Core CPI growth held flat at +1.6%
  • Food at home CPI growth ticked up 50 bps sequentially to +0.9%
  • Food away from home CPI growth ticked up 20 bps sequentially to +2.2%
  • The Restaurant Value Spread, which measures the difference between food at home and food away from home, narrowed 30 bps sequentially to -1.3%





  • The spread between food at home CPI growth and core CPI growth narrowed by 50 bps sequentially to -0.7%.



  • The spread between food away from home CPI growth and core CPI growth widened by 20 bps sequentially to +0.6%



  • NSA Full-Service CPI growth accelerated 30 bps sequentially to +2.3%
  • NSA Limited-Service CPI growth accelerated 20 bps sequentially to +2.2%




Howard Penney

Managing Director


Fred Masotta


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