June 11, 2014

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Getting 'Tipsy' Ranting About Inflation

Takeaway: Inflation is accelerating and we continue to think investors should proactively prepare their portfolios for this economic phase change.

This unlocked research note was originally published June 06, 2014 at 16:58 in Macro

The Perils of Falling Inflation.” Like clockwork, that phrase was on the cover of the November 9th – 15th issue of The Economist right after headline CPI bottomed at +1% YoY in OCT ’13. Fast forward to today, domestic consumer price inflation – on the government’s conflicted and compromised metric – is running +100% higher at +2% YoY (APR ’14).


Getting 'Tipsy' Ranting About Inflation - 10


Inflation doubled, lol!


Ok, that’s probably not very funny – especially if you’re a consumer that is feeling the pinch of rising inflation. Growth in real incomes in America has slowed from its cycle-peak of +1.3% YoY in OCT ’13 to +0.3% YoY as of APR ’14.


As a late-20s working professional living in Manhattan, I can say honestly that just about everything I buy – from rent, to clothes, to food, even down to the occasional Bud Light – has gone up in price on a YoY basis at rates well north of +2%. Some things, like taxis and train tickets, are tracking up mid-to-high single digits from a YoY rate-of-change perspective. Obviously this is all specific to my consumption basket, but when I speak to people all across the country – be it the cab driver in San Francisco or the Midwestern woman on the plane ride next to me – all everyone wants to talk about these days is how expensive everything has gotten.


Again, anecdotal data is what it is, but I challenge you to find me someone who genuinely believes inflation is running at or below +2% or decelerating. Moving along, here are a few non-anecdotal data points that have hit my inbox in recent weeks (copy/pasted directly from StreetAccount):


  • The WSJ reported that the Organization for Economic Cooperation and Development (OECD) said the annual inflation rate in its 34-member states rose to 2% in April, from 1.6% in March. It noted that in the Group of 20 leading industrial and developing nations, inflation rose for a second month to 2.8% from 2.5%.
  • The WSJ reported that rents rose at shopping centers and malls for the 12th consecutive quarter in a sign that landlords are getting a boost from the improving economy and low level of commercial real-estate construction. Data from Reis showed asking rents at strip centers rose 0.4% q/q in Q1, to $19.42 per square foot, the highest level since late 2008. Asking rents at large regional malls rose 0.5% to $40.15 per square foot, also the highest since the end of 2008.
  • Bloomberg cited a report from Trulia, which showed none of the 100 largest metro areas had increases of more than 20% in residential asking prices last month - the first time in almost two years. It compares with seven metro areas that had such y/y gains in May 2013. The report said national asking prices gained 8% y/y in May, the slowest pace in 13 months, amid slumping demand from both traditional buyers and investors. Meanwhile, rent growth is accelerating. Rents are up 5.1% nationally, with apartments climbed 5.8% and single-family homes gaining 2.1%... #InflationAccelerating AND #HousingSlowdown in the same data point(s)… #awesome!


Perhaps I’m not alone…



Luckily you, unlike the vast majority of Americans, can do something about it. In line with our #InflationAccelerating macro theme (introduced in JAN ‘14), we continue to anticipate that reported inflation will accelerate throughout 2014. There are three primary reasons we hold this view:


One: Holding current prices flat, the US dollar on a trade-weighted basis will dip into negative YoY territory in 2Q14E and will remain negative through 3Q14E, only returning to marginally positive by 4Q14E. This is a sharp deterioration from the +3-4% trend we’ve seen since the start of 1Q13. That should provide a material shock to the rate of change in import price inflation, which, at -0.3% YoY, is currently accelerating off the lows of late-2013 (-1.8% YoY in NOV).


Getting 'Tipsy' Ranting About Inflation - dale


Two: We do not, however, think it’s prudent to hold current market prices flat. While most of Wall St. continues to anticipate higher rates amid tighter policy out of the Federal Reserve, we believe rising inflation will continue to slow consumption growth at the margins – which is ~70% of US GDP. That, coupled with the precipitous decline in both activity and price appreciation in the housing market, should eventually force the Fed to pare back their guidance on eventual monetary tightening. A cessation of their existing policy to taper is not out of the question by the third quarter. Commodities, which hold a -0.70 correlation to the USD (CRB Index vs. US Dollar Index; trailing 6M), should continue to grind higher. It’s worth noting that the CRB Index is up +9% YTD, besting the sub-6% return for the S&P 500. 


Getting 'Tipsy' Ranting About Inflation - 2


Getting 'Tipsy' Ranting About Inflation - Median CPI   US  Eurozone and China


Three: If none of our market-based forecasts come to fruition, we still have confidence in CPI accelerating over the intermediate term – if for no other reason than base effects. Without getting too geeked out on differential calculus, “simple” math would suggest that as comparative base rates decline sequentially – which they do throughout the balance of the year – the probability that the rate of change accelerates from the base rate (i.e. t₀) increases substantially.


Getting 'Tipsy' Ranting About Inflation - CPI COMPS



In line with our #StructuralInflation macro theme (introduced in APR ’14), we continue to think structural inflationary pressures are building up across the US economy. While we cede the point that considerable slack remains in the labor market, we do not think investors are paying nearly enough attention to the following supply-side pressures that are likely to perpetuate cost-push inflation over the long term:


  1. S = I. Savings equals investment. That’s the most basic, underappreciated formula in all of the borderline useless economic theory we’ve all had the “great privilege” of learning at some of the world's best (i.e. overpriced) collegiate institutions. With rates being held at zero for such a long time, it should come as no surprise that real nonresidential fixed investment is up only +3.3% on a trailing 5Y CAGR basis. That’s the slowest rate of growth this far into an economic expansion over at least the last 30Y.
  2. Again, when the central bank cuts rates to zero and leaves them there for the better part of six years, savings are naturally pulled from traditional investment vehicles that encourage investment (e.g. growth stocks) and into investment vehicles that actually encourage disinvestment – such as MLPs – in search of higher yields. Duh. Moreover, corporations – which have been increasingly rewarded by investors to buy back stock and ramp dividends – have largely done so in lieu of investing in their businesses. Now, as we approach what may be the end of economic cycle, many corporations streamlining trailing peak GDP growth rates and are scrambling to ramp up production into the inevitable result of seven years worth of broad SG&A deleveraging: relatively depressed production, transportation and storage capacity.
  3. Q: What happens when company A acquires company B in industry C? A: There are fewer companies operating in industry C, effectively creating marginal headroom for company A to hike prices on its customers. This phenomenon has been happening all throughout the post-crisis era and is now accelerating to a hilt here in 2014. The total number of domestic enterprises has declined -6% since the pre-crisis peak, with larger firms leading the decline at -10%. For example, Airlines and Hotels are two obvious industries in which consumers are feeling the pricing pinch of decreased competition. Newsflash to whomever just bought the all-time high in the US equity market at 10-VIX: You can’t be long the Airlines on a tired industry consolidation thesis and say that there’s [going to be] no inflation. That’s disingenuous at best… Another newsflash: With the retail sales control group measure declining -0.1% in APR, it’s interesting to see that revolving consumer credit grew at a +12.3% SAAR pace in APR. It is likely that consumers are feeling the pinch of rising, underreported inflation and levering themselves up to keep pace!


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Buy TIPS. Protect yourself and/or your clients from a likely acceleration in CPI. Please note that we are not making a hysterical call for hyperinflation born out of serial money printing. That’s not our style. Rather, our style is to call it like it is: the US economy is likely to experience a run-of-the-mill pickup in reported inflation. A 3-handle on headline CPI – which remains a conflicted and compromised calculation – is probable over the intermediate term.


Inflation tripling, lol!


Have a great weekend. If you get hungry at the beach, grill an iPad!


Darius Dale

Associate: Macro Team


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TODAY’S S&P 500 SET-UP – June 11, 2014

As we look at today's setup for the S&P 500, the range is 24 points or 0.81% downside to 1935 and 0.42% upside to 1959.                                       













  • YIELD CURVE: 2.20 from 2.21
  • VIX closed at 10.99 1 day percent change of -1.43%


MACRO DATA POINTS (Bloomberg Estimates):

  • 7am: MBA Mortgage Applications, June 6 (prior -3.1%)  
  • 8am: Treasury Sec. Jack Lew speaks at Economic Club of NYC     
  • 10:30am: DOE Energy Inventories            
  • 2pm: Monthly Budget Statement, May, est. -$131b (prior from May 2013 -$138.7b)        



    • Shaun Donovan testifies on his nomination to lead OMB              
    • President Obama gives commencement address at Worcester Mass. Technical High School        
    • Goldman Sachs Energy summit is held in NYC, Vice President Joe Biden, Mexican Finance Sec. Luis Videgaray Caso scheduled          
    • 8:30am: House Ways and Means Chairman Dave Camp, R-Mich. Speaks at Natl Assn of Professional Employer Orgs               
    • 10am House/2pm Senate: Shaun Donovan testifies on his OMB nomination       
    • 12pm: House Budget Cmte’s Price gives Heritage Foundation economic address               
    • U.S. ELECTION WRAP: Primaries Today; Ernst Leading in Iowa     



  • AIG names Hancock CEO to rebuild co. shrunk by predecessors
  • U.S. prosecutors seek $17b for BofA settlement, NYT reports    
  • Airbus suffers worst order loss as Emirates scraps A350 buy        
  • Intel set for EU judgment day 5 yrs after $1.4b fine         
  • IBM said near deal w/Globalfoundries for chip-making unit         
  • World Bank cuts global growth forecast after 2014 bumpy start 
  • Google said to plan deeper energy push w/tools for utilities       
  • Amazon stops taking advance orders for Warner videos, NYT says           
  • EU to investigate Apple tax break in Ireland: RTE              
  • MSCI says China A-Shrs will not join Emerging Markets Index     
  • BR Towers said to join TorreSur in $4b tower sale boom
  • House Majority Leader Cantor loses in Republican primary          
  • Takata tells carmakers including Honda airbags may need fixes  
  • Toyota expands vehicle recall in Japan for Takata airbag fix          
  • Pentagon contracts slid 29% in May in extended budget slowdown         
  • U.K. unemployment falls more than forecast as recovery gains 



    • Dominion Diamond (DDC CN) 5:40pm, $0.08       
    • H&R Block (HRB) 8am, $3.23       
    • Restoration Hardware Holdings (RH) 4:05pm, $0.11         



  • OPEC Maintains Current Production Target, Person Says
  • WTI Trades Near Three-Month High on U.S. Supplies; Brent Steady
  • War on Cornfield Pest Sparks Clash Over Insecticide: Commodities
  • Saudi Oil Minister Says Supply, Demand, Prices Are Good
  • Goldman Says Keeping U.S. Oil-Export Ban to Add Value to Economy
  • OPEC Majority at Ease With Oil Markets Before Vienna Meeting
  • Gold Nears Highest in Two Weeks as Palladium Below 3-Year High
  • Palm Imports by India Tumbling as Refiners Buy Soybean Oil
  • Steel Rebar Slips to Record Low as Dalian Iron Ore Futures Slump
  • China’s Record Hoarding Seen Keeping Crude Above $100: Energy
  • Cocoa Shortage Seen by Olam as Beans Considered Poor Man’s Crop
  • Russia Sets Ukraine June 16 Deadline as Gas Talks Resume
  • Nordic Power Funds Post Losses in May Amid Narrow Trading Range
  • Nickel Declines Amid Liquidation of Wagers on Price Increases


























The Hedgeye Macro Team














Early Look

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LULU – Management on the Hot Seat

Takeaway: If mgmt blows this shot at redemption, activists should have a field day. We’re all-in on a miss. Risk/reward starting to look really good.

Conclusion: The equity value destruction and erosion in sentiment since LULU’s ‘new CEO party’ in April served as a massive ‘show me’ invitation from Wall Street to LULU management. This is a superb brand that is backed by a sub-par company and lackluster management. A good quarter on Thursday might buy the CEO time before he has to actually articulate a growth plan. But a miss, from where we sit, should trigger more management changes. No change in how this company operates, will likely result in another new CEO six months down the road. For now, we’re actually positively biased on the print. If LULU misses, we’ll likely go all-in. Yes, there are competitive margin pressures. At $75 that was a problem – at $45, not so much. There’s $3.50 in earnings power, and a call option on getting acquired. A sell-off means higher likelihood of change in the C-Suite. The risk/reward here is starting to look really attractive. 



To say that this is a critical quarter for Lululemon is an understatement. We wonder if management even knows. The Street is clearly betting against the company, as the stock is down 16% since the analyst meeting, and short interest (24% of the float) is nearly on par with levels (25%) that we saw last Spring when the ‘see thru’ Luon fiasco broke out. Laurent Potdevin has been CEO for a good six months, and although it’s too short a window for even a good manager to be a factor of change, it is certainly soon enough for the company to be articulating its go-forward growth plan. That was the biggest miss back at the analyst event. No strategy. If Potdevin didn’t get the message with how the stock has since reacted, then he shouldn’t be CEO. If he got the message and does not do anything about it, then he shouldn’t be CEO.  Shareholders deserve better. It’s pretty simple, actually. Accountability 101.


So…we’ll see on June 12th whether or not Mr. Potdevin ‘gets it’. But the punchline, we think, is that this is one of those situations where, for the most part, ‘good is good, and bad will ultimately lead to good’. Our point is that the company either…

a)  meets or beats the quarter, and buys itself more time before it has to show that it has a firm grasp on the long term growth strategy and the capital needed to achieve those plans. = Good Stock Event

b)  meets or beats the quarter AND outlines crisp long term growth strategy. = Great Stock Event

c)   Misses the quarter and outlines crisp strategy = Neutral Stock Event, depending on the size of the miss

d)   Misses the quarter and still comes across as a deer in the headlights as it relates to Strategic Plan. Initial event will be very negative. The Board will have to answer to this – either because an activist says so, or the value destruction is so obvious. = Negative Stock Event leading to a potentially very positive event/change


We’re obviously getting a bit too cute with the outcomes here.  But if we see an event that is negative enough for the stock to sell-off in spite of the 26mm shares held short, then we’ll likely go all-in on this one. The reality is that LULU is a great brand, is in a high-growth industry with global appeal and acceptance. Yes, there’s fierce competition and we think that margin expectations are way too high. At $75 that was a problem – at $45, not so much. The growth is there, and those kind of brands don’t come around too often. Even at a 19% EBIT margin (vs 24% last year) we get to $3.50 in earnings power with a call option on being acquired. The issue here is that it is a great brand backed by a sub-par company. That can be fixed.


What change? We still don’t think that the Board’s hiring process for Potdevin was anywhere near as rigorous as it should have been for a company the size of LULU. That said, we don’t think that his perceived failures to date are entirely his fault. He has extremely poor support in the C-Suite, particularly his CFO. In our opinion, John Currie was a great CFO when LULU was sub $500mm in sales 5-years ago. But he’s not the guy to be building a world class finance organization for a company that is $1.5bn in revenue that should have a plan to get to $5bn. It’s not his fault, per se, but the fact of the matter is that things like Finance, Strat Planning, and building the organizational depth of a world class company were never a priority at LULU. That’s common for many early cycle companies. But it needs to become a priority here. If Currie can’t do it, then Potdevin will be on the hook for things that are not within his skill set. Ultimately, LULU needs to turbocharge how it plans its business and match what is a limited capital budget to an unlimited number of growth opportunities. Potdevin has what is likely another six months to get this right. If not, we wouldn’t be surprised to see another new CEO.


LULU – Management on the Hot Seat - LULU financials 3


Takeaway: Credit card loan growth appears to be quietly accelerating. COF remains one of our favorite names on the long side.

What Once Was Old ...

We haven't written about the Federal Reserve's G.19 consumer credit report in ages, and that's because there's been nothing to say. U.S. credit card loan balances have been muddling sideways at a 0-1% rate of growth for the last two and a half years. But in the last two months there's been an upturn, and suddenly it looks like it might be interesting. 


One of our guiding principles is that we try and take note of inflection points in the rate of growth, i.e. the second derivative, since it's these second derivative changes that precipitate changes in the multiple.


Along those lines it's interesting to take a step back and consider whether the sleepy credit card space may have just entered such an inflection point. 


On Friday afternoon of last week the Fed released its G.19 report for the month of April and it showed that US revolving consumer credit balances rose at a month-over-month annualized rate of +12.3%, the fastest rate of growth in, well, a really long time. In fact, you'd have to go back to the early/mid 1990s to revisit that rate of growth on a sustained basis. To be fair, we've followed the G.19 data for years and, speaking from experience, it's a very choppy and often-revised data series. We wouldn't get overly excited about it but for the fact that Capital One's numbers for the month of April also reflected a sharp upturn in the rate of growth in US credit card receivable balances. 


We should know more on Monday next week when we get the May data from the various credit card companies.


In late January we issued a report arguing investors should get long Capital One following the 4Q earnings "blow-up". Our analysis showed that there was a quantifiable advantage to owning shares historically from the late January through mid-July timeframe. This owes largely to the fact that, like a clock, Capital One misses the 4Q numbers and beats the 1Q numbers every year. Our original intention was to exit the long trade ahead of reporting 2Q numbers, but now that growth is starting to show signs of life we may be interested in extending our duration. We'll know more on Monday.












On a separate note, we just couldn't resist the temptation to flag the unstoppable force that is student loan growth in this country. The chart below, also taken from the G.19 data, shows the amount of federally-backed student loans sitting on the books of the United States. Currently the figure stands at $775 billion, up $112 billion (+16.9%) in the last 12 months. For those wondering why there seems to be no recovery in the first time homebuyer market we offer the chart below as "Exhibit A".





Joshua Steiner, CFA


Jonathan Casteleyn, CFA

Foreign Policy Briefing: Professor Charles Hill

Last Friday we hosted a call with Diplomat-In-Residence at Yale, Charles Hill. A replay link is included below along with a brief summary:


Prior to his current position as professor of Grand Strategies, Charles Hill has held a number of posts including but not limited to the following:

  • Senior Adviser to George Schultz, Henry Kissinger, and Ronald Reagan
  • Deputy Assistant Secretary
  • Chief of Staff for the Middle-East at the State Department

On a high-level Professor Hill touched on four major geopolitical hotspots and painted a clear picture of a somewhat opaque interconnectedness between the four:

  1. Russia
  2. China
  3. Syria
  4. Iran

As a precursor to Professor Hill’s view of the current geopolitical reality, he described the differences in the current dynamic from the Cold War:

Throughout the Cold War, there were three main centers of influence:

  1. Western (free-world)
  2. Communism
  3. Third-World

Our current globalized society has now shifted into an entirely different but by no means antonymic world:

  1. Corporate circle of globalization:  fueled by rapidly evolving technology and social media. Those on the inside are either flourishing or sitting on the opportunity to flourish
  2. Structural Foundation: a world referred to as an “international state system” in which treaties, ambassadors, and global alliances rule. This system is being aggressively and deliberately challenged and is currently in poor shape
  3. National Identity Crisis: The West, Middle-East, Europe, and especially China are all experiencing an identity crisis currently 

Russia: Russia has suffered an identity crisis after the desecration of traditional Russian values from years of communist experimentation during the cold war. Attempts to return to a more democratized society over the last decade have been largely unsuccessful. Putin has addressed this situation by combining communism with, more traditional, pre-communism values.

Putin’s intent is to take advantage of an apparent deterioration in the power of the nations that have sat atop of the current international system. The takeover of Crimea and involvement in Eastern Ukraine is a violation in and of itself, but the fact that Russia is infiltrating into eastern Ukraine in guerilla-like fashion confirms the speculation that he believes the current structural foundation, dominated by the West and EU, is highly vulnerable.


Syria: Russia has both supplied a helped strengthen Assad's regime in Syria. A Russian intelligence agenda has taken deliberate steps to obstruct those in opposition. With this direct involvement, Russia is gaining leverage in the Middle-East. The Arab Spring movement in 2011 was suppressed with deadly violence and terrorism. A more-traditional, Islamist movement into Syria led by Al-Queda influence has succeeded with brute force and terrorism. This radical camp is gaining steam in Iraq, Iran, Lebanon, and Syria. The militarism that has signified the Assad regime is being legitimized as the international community has been largely unsuccessful in intervening.         


Iran: Iran has played the international scene perfectly by building nuclear capabilities while adhering to the minimal requirements of remaining a part of the U.N. The Iranian government has taken a revolutionary roll to help Assad remain in power and free itself of nuclear sanctions (November 2013). In a sense they are opposing the order of the structural foundation of today’s international law while still remaining a part of it.


China: China faces a severe identity crisis with the experimentation of communism and capitalism. Recent moves in the East and South China Sea prove that, like Russia, they believe the current structural foundation of a world policed by the United States and Western Europe is badly bruised. Other than the verbal disdain over Chinese strategy in the Senkaku Island dispute, Washington has been largely unresponsive to China’s direct violation of international law, especially as it pertains to the more recent moves (i.e. planting an oil rig in Vietnamese waters).  


Conclusion: The global powers in charge of the international state system are being directly challenged, and if the current trend of structural deterioration continues, we will see a shift to a much different world. The flourishing globalized economy is going to be effected if this current system is uprooted. The maintenance of an international network dominated by computers has not been kept up, and the threat of an attack in this channel is ever-increasing.


Macro Team

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