“We hold these truths to be self-evident: that all men are created equal.”
A big government central planning bureaucrat got his butt whipped down in the heartland of American Constitutionalism last night. Not unlike in the 1970s, when Nixonian Republicans and Cartering Democrats all started to sound the same on economic matters, Americans voted for change.
If Eric Cantor doesn’t make your skin crawl, you and I probably won’t be having beers at the Rangers/Kings Stanley Cup tilt tonight in NYC. This guy isn’t a free-market-liberal-conservative like me. On economic matters, he is a raging Keynesian.
Bring on the self-evidence that is the Policy To Inflate crushing at least 80% of Americans via cost of living and The Dave Brat. The winner of the 7th District of Virginia is a free-market economics professor! How cool is that? On days like this, even this proud Canadian wants to be American.
Back to the Global Macro Grind…
This is not a political statement. I don’t support the Tea Party inasmuch as I don’t support either the Republican or Democrat parties. This is an economic statement that is ringing as true in the United Kingdom today as it did in the Unites States of America in 2013. Strong Currency; Stronger Country.
If you have a Policy To Inflate (weaken your currency via both monetary and fiscal policy), you get what Harvard’s Marty Feldstein finally explained (WSJ Op-Ed yesterday) to the central planning wonks at the Fed: #InflationAccelerating.
And when you get inflation accelerating the cost of living in America to all-time highs, you aren’t going to get re-elected by lying to people and telling them otherwise. The truth is self-evident.
BREAKING: World Bank Cuts US GDP Growth Forecast
Finally someone, somewhere, in the land of officialdom-nod took their US GDP forecast closer to Hedgeye Risk Management’s. While the World Bank didn’t cut its GDP outlook by enough, the point is they had the spine to do what Consensus Macro research won’t, until it’s too late.
To review our call on US GDP Growth slowing into Q3 of 2014 – it’s math:
- Top line (GDP) acceleration in US GDP growth peaked in Q3 of 2013
- Inflation (the Deflator, which you subtract from nominal GDP) bottomed in Q2/Q3 of 2013
In other words, the year-over-year comparisons put Q3’s probability of inflation slowing US consumption growth at its highest level since Q1 of 2008.
“So”, don’t ask a linear-economist who missed calling either the Q1 of 2008 or Q1 of 2011 US #InflationAccelerating calls for their Top 10 reasons why they are still using the same models that haven’t proactively predicted real-world consumption slowdowns. Ask the bond market.
At 2.64% on the 10yr US Treasury Yield (down hard from 3.03% on January 1st, 2014), the entire construct of #OldWall consensus still thinks “it’s different this time” (i.e. that they were only wrong on both rates and GDP rising in Q1 because of the weather).
Every time the bond market sells off to higher-lows, you buy it. Every time US domestic consumption growth gets bid up to no-volume-lower-highs, you sell it. That is the Hedgeye Macro Playbook for US stocks vs bonds investing in 2014, and we are sticking to it.
Another way to position for what I just wrote is as follows:
- Buy Bonds via TLT, BND, or anything equities that looks like a bond (XLU, VNQ, etc.)
- Sell US Domestic Growth like Consumer Discretionary (XLY) and Housing (ITB)
If you didn’t buy puts on Cantor’s political message, you could have bought #InflationAccelerating via Oil and Gold futures too.
In other news, the SP500 had its 38th day of not moving more (+/-) 1% yesterday. That’s the 2nd longest streak of compressed complacency in 15 years. No worries though, everyone will be able to get out, at the same time, because “this time is different.”
In case you aren’t yet convinced that it is different this time:
- Fear (VIX) has never held below 10, ever (it’s at 10.99 this morning)
- II’s Bull/Bear Spread (survey) just hit fresh YTD highs at +4540 basis points wide to the Bull side
- One legged ducks still swim in a circle
Whether you are a bond bull, US growth bear, or a Brat from Virginia this morning, we stand together fighting the tyranny of mediocre minds trying to centrally plan us into thinking we need their inflation policies to live freely. We hold these free-market truths to be self-evident. They always have been.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.44-2.65%
Brent Oil 109.10-110.96
Best of luck out there today,
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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).
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…
INTERMEDIATE-TERM TREND VIEW
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).
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.
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.
LONG-TERM TAIL VIEW
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:
- 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.
- 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.
- 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!
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!
Associate: Macro Team
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.
CREDIT/ECONOMIC MARKET LOOK:
- 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
WHAT TO WATCH:
- 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
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- 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
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.
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