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“Only the wisest and stupidest of men never change.”
I’ve been on vacation for most of the last two weeks. My first child is projected to be born on June 1st , so I figured it was best to take vacation now. This was based on the sage advice from some of the more seasoned fathers at Hedgeye.
I’m not always good at unplugging on vacation, but this time I did a decent job. As I was getting caught up last night, the most interesting article I read was from Business Insider. It seems while I was gone they anointed Hedgeye the most polarizing firm in finance!
I have to admit, even though Business Insider’s journalistic standards aren’t the highest, I thought that was kind of cool. When we started the firm more than six years ago, our sole intention was to shake things up. And it seems we have done so. So far, at least, mission accomplished.
Back to the Global Macro Grind...
So, the big question now that I’m back in the proverbial saddle is: what did I miss? Based on the return of the SPY, I’d say not too much. When I left for vacation on May 5th, the S&P 500 closed at 1,884.2. Yesterday it closed at 1870.85. For those that don’t have their HP-12C handy, that is a negative return of roughly -0.7%. Nothing to write home about to be sure.
Thankfully, my colleagues were keeping busy despite the lackluster performance in U.S. equities. Over the last two weeks on the idea side, we added two longs to our Best Idea list: Bob Evans Farms (BOBE) and Och-Ziff (OZM). Both ideas, though certainly very different, are very compelling.
Bob Evans Farms, as many of you may know, is a smallish cap restaurant company. Although our Restaurant Sector Head, the sage Howard Penney, has been more cautious than not on his sector, BOBE is one company he likes on the long side.
According to Howard the thesis is as follows:
I’m not going to steal all of Howard’s thunder, but if you’d like more details, please email . Incidentally, another of Howard’s top ideas, Darden (DRI) announced this morning that they are selling one of their divisions, Red Lobster, to Golden Gate Capital for $2.1 billion. Oh snap!
More broadly though, and other than a few alpha generating idea, those of us that vacationed for the first half of May didn’t miss a whole lot from return perspective. In the Chart of the Day below, I’ve highlighted our daily U.S. quant screen and for the month-to-date the worst performing SP500 sector is the Utilities, which is down 2.78%. Meanwhile, the best performing sector is Materials, which is up +0.13%.
On some level, that is actually new. Specifically, in May the worst performing sector is actually the best performing sector on the year. Currently, Utilities are up an impressive 10.6% for the year-to-date. Who would’ve thunk it?
Switching gears, on the global macro front this morning , the United Nations released a 37-page report on the human rights situation in the eastern Ukraine. On a serious note, that is actually not news, but does exemplify the ineffectiveness of the U.N. and its ability to deal with Vladimir Putin and the gong show in the Ukraine. But, at negative -13.4% on the year, the Russian stock market seems to be dealing with him appropriately.
Meanwhile, on the bond front, the bears seemingly just won’t give up. According to Bloomberg, the ProShares Ultra 20+ Year Treasury ETF (TBT) has seen inflows of 21.6% this year. This comes despite the ETF falling almost 21.6%. In addition, there are 1.12MM short contracts of treasury futures on the Chicago Board of Trade, which compares to the five year average of 713K. Further, a recent survey of economists expects the 10-year yields to rise 75 basis points by year end. Didn’t know what consensus in Treasury land was, now you know!
And as our nemesis John Maynard Keynes famously said:
“Markets can remain irrational longer than you can remain solvent.”
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.49%-2.61%
Keep your head up and stick on the ice,
Daryl G. Jones
This note was originally published at 8am on May 02, 2014 for Hedgeye subscribers.
“He is illiterate and boorish; austere and offensive.”
-The Mercantile Agency, May 1853
In some of Americas most formative years of free market capitalism and innovation, the authorities of perceived wisdom wrote that about one of the greatest wealth creators in US history – Cornelius Vanderbilt.
“It is said that I am always in opposition, and that the same spirit of resistance which has often hitherto governed my action has influenced it now… I have only to say that this is the same spirit which founded this great Republic.” (The First Tycoon, pg 161)
And that’s all the man needed to say about that.
Back to the Global Macro Grind…
In this day and age, the more real-time market illiterate a politician is, the more offensive (to me at least) he becomes. Other than the brilliant financial market mind that is Maxine Waters, these characters are usually he’s by the way – we men think we know everything.
While I can’t comprehend how consensus economists are getting to a +3-4% US GDP ramp in the coming quarters, I guess I’ll just have to be all boorish for the next few months and reiterate how ridiculous the Old Wall’s linear forecasting process has become.
On a cheerier note, it’s jobs Friday! And while I am sure everyone wants to know what Steve Liesman has for his NFP guess, my boy, Mr. Bond Market, has already front-ran the entire circus:
NEWSFLASH (to those waiting on the next qualitative “survey” from our competitors): Bonds rip when growth is slowing.
Anything that looks like a bond is called #YieldChasing (they’re ripping too):
As for the 80% of America that is going to eat both inflation and growth slowing:
For the style-factor illiterate who gets on TV and says ‘but the market is up’ (even though both the Nasdaq and Russell are down YTD), in mathematical terms we call this risk developing underneath the US stock market’s hood SECTOR VARIANCE. In chaos theory speak, variance rises when major macro factors are undergoing the initial stage of what physics fans call a PHASE TRANSITION.
Phase transitions (like water approaching a waterfall) are really cool, because consensus doesn’t realize what’s happening a foot below the visible surface… Then kabooom! A proactively predictable point of entropy occurs. Variance, Phase Transition, Entropy – offensive terms for those who haven’t evolved their process = excellent defensive strategies for you to deploy.
If you want to consistently beat beta in this game, you have to know A) when to go on defense and B) how to rotate offensively from that defensive position. More commonly known as sector rotation, you get what I mean. Our process takes the sector rotation idea up another 10,000 feet because we go all cross-country-cross-asset-class on you.
At the beginning of Q2, on the long side here’s where we continued to rotate to (Investment Conclusions – slide 48 of our Q214 Global Macro Themes deck, which all of our Institutional Research customers can get an updated copy of anytime):
No matter what this jobs report says today, we want you to keep doing more of this because A) it’s still nowhere in the area code of consensus and B) it’s working.
Instead of calling us bearish, bullish, or boorish, I say you call us flexible. This is the opposite position our process suggested you be in at this time last year. Having resistance versus a broken consensus isn’t easy. But being a capitalist in America today isn’t either.
Our immediate-term Global Macro Risk Ranges are now (12 macro ranges with a TREND overlay are in our Daily Trading Range product):
UST 10yr Yield 2.59%-2.70%
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.
TODAY’S S&P 500 SET-UP – May 16, 2014
As we look at today's setup for the S&P 500, the range is 21 points or 0.53% downside to 1861 and 0.60% upside to 1882.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS (Bloomberg Estimates):
WHAT TO WATCH:
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
The Hedgeye Macro Team
Takeaway: Only one factor held JCP off our Best Idea long list. JCP's need for a permanent CEO. But truth be told, Ullman is getting it done.
Conclusion: The market share shift back to JCP is undeniable, which is consistent with our research. Our estimates remain far above consensus. That said, we’ve kept this name off our Best Ideas list as we've been a vocal critic of CEO Ullman, saying that he’s not the guy to unleash the $1.40+ in earnings power we see at JCP and that we need a permanent CEO. Based on the conference call it does not sound like he's going anywhere anytime soon. While that’s negative at face value, let’s give the guy credit…he’s getting it done. If he could keep this momentum going, then maybe he should stay.
We were expecting a beat out of JCP based on the research we outlined on our JCP/KSS call on Tuesday (better visitation and spending statistics in our latest Consumer survey as well as clear signs that it was taking share from KSS online), but we were definitely not expecting a top line this strong. We modeled a 4% comp, but JCP came in at 6.2%, which is 780bps better than Macy’s and 960bp better than KSS. Anyone who tries to argue that JCP is not regaining the $5.4bn in market share it gave away over the past three years is simply ignoring the cold hard facts. Our research shows that these two retailers are responsible for $1.0bn and $500+mm, respectively of that share shift. That’s a lot more meaningful for KSS in percentage terms, and we don’t think KSS sees JCP coming (or it’s simply in denial).
There was so much in this quarter to like…a) positive traffic for the first time since before Johnson trashed the place, b) 26% growth in e-commerce – the first positive 2-year comp in 3 years -- during the same quarter that KSS dot.com slowed to the point where they stopped disclosing the exact number to the Street, c) continued improvement in Gross Margin -- +224bp vs. last year, d) only 1% growth in inventories on top of 6.3% revenue growth, which bodes well for GM% headed into the second quarter, e) a 6.4% decline in SG&A, which is great, though it’s an item that has a finite runway, and f) for the people that weren’t satisfied with JCP vastly improved balance sheet situation over the past 2 quarters, the company upgraded its credit facility such that it secured an extra $500mm in unsecured liquidity. Put all this together, and this is a really tough quarter to poke holes in. Most other retailers have nothing but excuses. JCP came through with nothing but results.
We’re taking up our estimates by roughly $0.20 each year out to 2018 (see Exhibit 2 below), which is largely a function of better revenue growth. That takes our ultimate earnings power up to $1.40. We’re still of the view that it will need to be a new CEO to realize that earnings power, and truth be told, we have more questions about that than ever.
From where we sit, Ullman is looking mighty comfortable in that CEO seat. In answer to a question about his future, he seemingly dismissed that there’d be a change up top anytime soon. We’ve been his most vocal critic, so at face value, we think this is a negative development.
But let’s keep ourselves honest here. We wrote above about how well the company is executing on its turnaround plan. Is it fair then to say that on one hand, and then push him out the door with the other? Probably not. Yes, we’d rather have a CEO who is 100% committed to JCP, has more horsepower, and who is financially incentivized to hit key value-enhancing targets over a very long time period. But for now, Ullman is proving to be exactly what the company needs. What we don’t know is whether he’ll wear out his welcome with a stock at $10, 12.50, or $15. It’s highly unlikely that it will be $20 – just as it won’t be $8.
The only other semi-negative factor we could pull from the print is the fact that JCP is now back to its former capacity of private label – which is 50% of total sales. That’s important because of the 500bp GM premium this product carries relative to National Brands (some was up to 800bp). There are two primary drivers to Gross Margin 1) improving the mix of Private Brands, and 2) sheer leverage of comp above fixed components of COGS. By a country mile, #2 is the more powerful driver, and that still has a long way to go. But it’s safe for us to assume that the GM improvement from mix and mix alone will be felt for the next 3-4 quarters and then level off. This is all represented in our above consensus estimates, so we’re not worried. But it’s an important flag.
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