TODAY’S S&P 500 SET-UP – May 15, 2014
As we look at today's setup for the S&P 500, the range is 27 points or 0.77% downside to 1874 and 0.66% upside to 1901.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS (Bloomberg Estimates):
WHAT TO WATCH:
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
The Hedgeye Macro Team
Takeaway: Both the domestic macroeconomic outlook and globally interconnected risks favor remaining long of Brazil w/ respect to the TREND duration.
Yesterday, I had a call with one of our more astute long-term customers and he asked me a version of a question that we have been receiving a lot in recent months:
“Nice call on [INSERT INTEREST RATE-SENSITIVE ASSET CLASS HERE]. But how much more upside do you see from these levels?”
I specifically say “version”, because as a true believer in our repeatable and unbiased approached to front-running asset class rotations, he understood our calls from the beginning of the year while also getting involved on the long side of some of the more bombed-out macro markets where we saw opportunity – including Brazil.
Contrast this with what has clearly become consensus across the investment community in the YTD: chalking up the domestic growth slowdown to “weather” and sticking with the outcrop of 2013’s #StrongDollar + #RatesRising = #GrowthAccelerating trade.
Indeed, Brazil has had a nice run since our FEB 27th Best Ideas conference call and we continue to anticipate further upside from here. Specifically, the iShares MSCI Brazil Index Fund (EWZ) has appreciated +19.3% since then; that compares to a +1.7% gain for the SPY and to a sample mean of +5.7% for the 24 country-level ETFs we track across the EM space. Moreover, the EWZ’s +19.3% delta ranks third in the aforementioned sample, trailing only India (EPI) at +22.1% and Turkey (TUR) at +31%; we were fortunate to have been in print liking both throughout this time frame – India as a core long idea and Turkey as a beneficiary of our EM “junk” relief rally theme.
Going back to Brazil specifically, one of the reasons we’ve liked Brazilian equities – Petrobras (PBR) in particular – is because of our anticipation of a continued rally in the Brazilian real (BRL). Specifically, that would have a number of positive effects for Brazilian capital markets, including, but not limited to:
The BRL has indeed appreciated a fair amount since FEB 27th (+5.9%, which ranks second among the 21 currencies we track across Asia and Latin America and compares to a sample mean of +1.9%). Importantly, our proprietary FX valuation models see at least +10% upside from here on both a REER and carry basis.
Valuation is not a catalyst, however. What is a catalyst is continued poor performance by Dilma Rousseff and her Workers Party (PT) in the polls leading up to OCT’s general election; her support among voters dropped again to 37% from 38% in the latest Datafolha poll, which was published MAY 9th. Both consumer and business confidence trends – each at the lows of her administration – support a continuation of the aforementioned polling trends.
She’s clearly received little boost from the backing of former Brazilian president Lula da Silva and he’s already ruled out running in this election, effectively mitigating any upside surprise to credible promises for additional Big Government Intervention that investors have now come to associate with the PT – as most recently highlighted by PT president and Dilma’s campaign coordinator Rui Falcao who suggested this week that Brazil should consider capital controls to ward off speculative capital inflows and reiterated his opposition to an independent central bank.
Newsflash Falcao: global investors are responding to opinion polls and using their capital to vote you and Rousseff “off the island” for a reason. Your economic policy flat-out sucks…
Another catalyst for staying long of Brazil is improving GIP fundamentals. Our math shows World Cup host teams tend to receive a ~190bps sequential boost to real GDP growth and a ~100bps increase in the current account/GDP balance.
Brazil has yet to see these likely tailwinds roll through the system and, as a result, we remain well above both the street and the BCB on 2014E growth and [marginally] below both on 2014E inflation. If we’re right, Brazil’s woeful fiscal situation will show optical improvement and monetary policy will remain tight (not that it wouldn’t have anyway – the BCB just sold and rolled over a cumulative ~$450M of FX swaps yesterday, signaling a renewed commitment to supporting the currency).
One last catalyst that remains non-consensus is a continuation of recent global macro asset class flow trends. We’ve spent much of the past 12-18M designing and backtesting a quantitative model that can help investors front-run said flows at both the primary and secondary asset class levels. At a bare minimum, our TACRM™ All-Weather System consistently provides investors with a real-time “look-see” on rotation-based asset class flows.
There are four primary tools our All-Weather System employs to accomplish its stated goals (please email us if you’re interested in having an in-depth discussion regarding the rigorous quantitative methods employed in each tool):
All told, both the fundamentals and TACRM™ support remaining long of Brazil, so we will – for now at least. When it is appropriate to deviate from this strategy, I promise we’ll/you’ll be among the first to know. Marrying top-down quantitative signals with bottom-up fundamentals analysis is one of the reasons we continue to add value to our institutional customer base – effectively differentiating ourselves from most other sell-side macro research providers.
Have a great night and/or wonderful Thursday morning,
Associate: Macro Team
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Takeaway: 2Q will be good, then there's risk. Street's numbers ignore the economic cycle. We're well below starting in '15. A deal might save Macy's.
Conclusion: We think Macy’s is at a critical point in its decision tree. The company printed a 1Q growth algorithm that is typical with what we’d expect from a dinosaur department store – negative comps (-1.6%), lower gross profit dollars (-1.3%), but modest growth in EBIT (+1.8%) due to lower SG&A spending. All in, about 800bps of Macy’s 9.3% EPS growth came from financial engineering via share repo. The company is going to have a better 2Q due to the timing of a major promotion and what we agree will be a little snap-back in spending from depressed winter levels. We get the whole ‘best in breed’ thing (sort of), but past a good 2Q, we think that investors should be asking themselves what they’re really in this name for. Is this a breed you need to own? Even Macy’s CFO, who we actually think is very good, used the word ‘hope’ on the conference call not once, not twice, but FIVE times when referring to recovery in different parts of Macy’s business in 2H. They’re allowed to hope. But in modeling out a cash flow trajectory, we’re not. Once 2Q earnings is past us, we’d look to short this one aggressively.
We’re coming in about 4.6% below consensus for this year – at $4.25. We think that M will beat 2Q, and then miss 2H. That’s something to keep in mind regarding near-term positioning. But it’s not the near-term that really worries us. We’re looking out across our five-year model, and we have EBIT down every single year, with stock repo and repayment of debt maturities making up the difference to keep EPS relatively flat. If we’re right, then we’re looking at an annuity of $4-$4.25 in EPS. Let’s capitalize that by a 10% cost of equity and it suggests a stock in the low $40s. If you want to use a 10x multiple instead, you get the same value (M has traded below 8x earnings in the past). This low $40s value comes out to about 5.7x EBITDA, which is hardly a trough level one might expect from a retailer with zero square footage growth.
We understand all the hype around company initiatives like My Macy’s, MAGIC, etc…these are all what makes Macy’s the leader in the space. But the reality is that we are officially in year six of an economic recovery, and the department store group has never gone more than five consecutive years of margin expansion without a material decline in margins.
The bigger concern is not a 5% EPS miss for this year, but a 50% miss in year 5. The Street’s numbers not only dismiss the potential for a near-term margin correction, but they assume we go ANOTHER five years with the business and retail cycle improving. If this actually happens, then yes, you will probably make a lot of money in Macy’s. But you’ll probably make more in high-quality growth names in the consumer space that have recently been annihilated.
One thing that we wonder about Macy’s is what it does strategically if a) this year does not pan out as planned, and b) 2015 looks even more challenging. In years past, whenever Macy’s ran into a problem, it acquired another department store chain to eventually assimilate under the Macy’s banner. It’s a strategy that worked. But with a National footprint, coverage at the high end (Bloomingdales) and in the middle/upper-middle (Macy’s), it really has no other physical retailer to buy. That’s what makes us think about the potential for Macy’s to either do a transformational dot.com merger, or gobble up smaller e-commerce business that have earned the consumer’s respect in a different segment. We’re thinking of names along the lines of GILT, Bonobos, and others (some which trade publicly). It’s unlikely that any such deal would be accretive for Macy’s given the multiple disparity, but we wouldn’t put it past M to go this route. Something to chew on.
Takeaway: 91% YES; 9% NO.
Simply put, the PPI report today showed (shocker!) that inflation is soaring – thanks in large part to food prices.
So, we asked in today’s poll: Are you feeling the impact of higher food prices at the grocery store?
At the time of this post, a revealing 91% of voters said YES; just 9% said NO.
Of the many YES voters, people explained exactly what they're seeing at the store and how it has impacted them:
Conversely, those who voted NO pointed out that “we had deflation in food prices for 7/12 months last year,” and that “professionals don't worry about the price of milk.” Another NO voted noted, “Ok, lime prices are higher -- but that's really about it. Food is still cheap in America compared to the rest of the world.”
Regional gaming is back! Well that’s a little strong but we are seeing improvement and insiders are buying.
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