Throwing the Torch

This note was originally published at 8am on May 30, 2014 for Hedgeye subscribers.

“To you from failing hands we throw. The torch; be yours to hold it high.”

-Dr. John McCrae


On Tuesday night I had the pleasure of attending my first hockey game at the Molson Center in Montreal.  While I’m not necessarily a Habs fan, sitting in a seat on ice level next to the penalty box is definitely the right way to watch playoff hockey in Canada, especially in a 7 - 4 “Wild West” shoot out.


Last night, of course, was much different.  The New York Rangers and their all-world goalie Henrik Lundqvist bounced back and New York beat Montreal to advance on to a date with destiny and a chance to win Lord Stanley’s Cup.


Throwing the Torch - rangers canadiens


The last time the New York Rangers won the Stanley Cup was in 1994, exactly twenty years ago.  The last time a Canadian team won a Stanley Cup was actually twenty-one years ago in 1993 when Montreal won.  So if you do the math, in the last twenty years a Canadian team has won the Cup about 5% of the time. This comes despite the fact that 24% of the teams in the NHL are based in Canada.


Interestingly, statistician Nate Silver from ESPN actually ran the numbers on the probability of a Canadian winning the Cup over that period.  According to Silver:


“If a championship team was randomly chosen for each of the 19 seasons the league actually played, the odds of a Cup win for a Canadian team would have been 99.2 per cent. Taking teams’ actual competitiveness into account, Silver estimated the odds of a Canadian win during that time period were 97.5 per cent.”


So, clearly next year is Canada’s year and this unfortunate run is just bad luck. But in the meantime, let’s go Rangers!


Back to the Global Macro Grind . . .


Despite the fanfare for the Ranges in the Big Apple last night, shockingly enough, the global macro markets didn’t react.  The biggest laggard in terms of major equity markets overnight is actually Korea, which is down about 85 basis points. Even there, though, there is not much of a read through other than some profit taking ahead of the Dragon Boat Festival on Monday. (Is your dragon boat ready?)


The takeaway more broadly, of course, is that a general complacency is setting in on global markets.  Two import signals of complacency are the VIX, which measures volatility on U.S. equities, and yields on peripheral sovereign debt in Europe.  In both instances, they are literally at five year lows.


For those of you that are used to winning investing performance Stanley Cups, you get the joke.  Either things are that good and there is nothing to worry about, or they are not and it is time to throw some proverbial caution to the wind by getting shorter and/or selling exposure. 


On the risk front, a major concern we continue to have is that consensus is once again over estimating the potential for U.S. economic growth in the U.S.  For the U.S. to hit consensus GDP growth estimates for the rest of the year, economic growth will have to come in at 4% in aggregate for the next three quarters.  To state the obvious: that’s not happening folks.


My colleague Christian Drake view of Q1 GDP is as follows:


  • Bad But Not A Surprise:  The first revision to 1Q14 GDP came in at -1.0%, missing estimates of -0.5%.  The magnitude of the revision was larger than expected but the negative print and downward revisions to  inventories, exports, & Gov’t spending  was not a surprise as the actual march data came in worse than the BEA estimates embedded in the advance GDP report. 
  • Inventory Drag:  The negative revision to inventories was the biggest contributor to the total revision.  The inventory ramp, which comprised a big portion of reported nominal GDP growth in 2H13, is now reversing as end demand/income growth proved insufficient at expeditiously drawing down that burgeoning stock.  
  • Consumption:  Strength in consumption growth, particularly Services, was the conspicuous positive on the quarter.  Notably, Services consumption was supported by the significant acceleration in healthcare spending.   


Healthcare is indeed the juggernaut of GDP and something to focus on, at least in the reported numbers.  As Christian points on healthcare spending in the GDP report:


Healthcare Spending:  The strength in Healthcare Services spending stems largely from the implementation of Obamacare. The reported figures, by BEA’s own admission (see their note Here), are very much an estimate and the preliminary data are likely to be revised (significantly) over time as the Census bureau’s quarterly QSS and annual SAS survey’s provide harder data.   


With reported Hospital and Outpatient spending both accelerating materially in 1Q14, it could also be that individuals are accelerating medical consumption ahead of ACA implementation and uncertainty around coverage changes. 


Either way, in the context of the broader spending data, the takeaway is pretty straightforward – Healthcare Services represent ~17% of total household consumption expenditures and certainly impacts the direction of reported, headline consumption growth.   To the extent that deceleration is the larger trend across the balance of services, a mis-estimation of ACA related spending and/or a significant, transient pull-forward in medical consumption could be materially distorting the prevailing, underlying trend.


Unfortunately, we’ll just have to hurry up and wait to get a clearer read on the magnitude of the impact.”


So, even as the labor market is showing some tightening, in part aided by people dropping out of the work force, economic activity broadly speaking is far from robust and likely to miss consensus expectations for the remainder of the year, especially with the housing market headwind.  And at a VIX of sub 12, bad news will start to matter.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.42-2.51%

SPX 1895-1926

RUT 1089-1146

VIX 11.03-13.69

Gold 1249-1295 


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Throwing the Torch - Complacent

June 13, 2014

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Giddy Up

"The responsibility of the government is to have a stable currency. This kind of stuff that you’re being taught at Princeton disturbs me."

-Paul Volcker, May 2014


It’s that time of year again!


Time to round up the buds, pony up the $2K cost of admission, saddle up and ride for downtown Baltimore.  Last week’s Triple Crown failure at Belmont was really just the warm-up for the real equine extravaganza - BronyCon 2014.   


BronyCon, if you are unaware,  is a now annual, multi-day conference in which thousands of grown men come to share in their passion for My Little Pony.   


Yep, while still in the throes of a working-class recession, thousands of men incur substantial real and opportunity costs to travel across the country with the explicit objective of hanging out with other men and basking in their collective love for the 1980’s toy designed for little girls.  


#BronyCon prep – if you didn’t know why there’s been fumes for market volume, now you know. 


Giddy Up - bronycon


Back to the Global Macro Grind, quickly……


In a research note yesterday we discussed the collective cognitive dissonance in the consensus outlook for accelerating consumption growth in the face of an emergent avalanche of disconfirming evidence (See: COGNITIVE DISSONANCE: DEATH BY A THOUSAND DATA POINTS)


To reprise the heart of that note:


After yesterday’s negative revision to 1Q14 GDP, this morning’s retail sales data should serve as another blow to forward growth expectations. 


While full year growth estimates continue to get clipped with regular frequency, the collective cognitive dissonance over the outlook for consumption - in the face of overtly middling data - remains very much entrenched.  


Indeed, looking across our Economic Summary table (Chart of the Day below), the amount of sequential Worseningcontinues to belie the “accelerating recovery” narrative and sticky, 4%’ish, consensus GDP estimates. 


We did see a modest, expected bounce across the breadth of manufacturing/confidence/labor data into 2Q and reported growth will accelerate sequentially but, essentially, we are what the numbers suggest. 


 Take the average of (soon to be revised lower) 1Q14 gdp and the (overly optimistic) 2Q14 estimate:    (-2.0%  + 3.5%) /2 = More Muddle


On balance, the 2Q numbers to-date have been ‘okay’ but do not reflect a material acceleration nor any significant rebound demand from deferred 1Q consumption. 


In their House of Debt blog yesterday, Professors Atif Mian and Amir Sufi echoed our interpretation of the May Retail Sales data in rightly highlighting the following:


Over the past two years, nominal spending growth has been about 3% on a year-over-year basis. But if we exclude auto sales, the numbers are much worse, especially for 2014. Spending excluding autos in the first four months of 2014 has been less then 1.5% nominal, which implies a decline in real terms. This includes March and April, so it is hard to argue that weather alone explains this weakness.


*Note:  Mian and Sufi are solid new school, econ researchers.  Their new book, House of Debt, should definitely be on your macro reading list.


In short, the current domestic macro reality is that with Inflation accelerating (food, shelter, energy), housing decelerating, the labor market middling, and tougher growth/inflation comps through 3Q14, the intermediate-term trend for consumption growth is one of deceleration.   


Further, with savings rates already near historical trough levels and the spread between spending growth and earnings growth having already re-expanded in the last two quarters, the upside for consumption growth remains quite constrained. 


How do you keep the rate of change in consumption growth increasing when spending is already growing at a positive spread to earnings… growth, baby!


One data point we’ve highlighted recently was the marked acceleration in revolving consumer credit in April.  


Revolving Consumer Credit:  The Fed G.19 data for April showed US revolving consumer credit balances rose at a month-over-month annualized rate of +12.3%, the fastest rate of growth since 2001.


The extent to which this data point is relevant depends on your broader view of credit:    


Does Credit Matter?  According to the latest Fed Flow of Funds data there is ~$57T in aggregate U.S. Credit Market Debt.  This compares with a monetary base of ~$3T and nominal GDP of ~$17T – equating to dollar leverage (ie. obligations to pay dollars) of ~19.3X and a total debt-to-income ratio of ~3.4X.  Obviously, credit matters and the slope of credit growth remains the marginal driver of spending growth in a modern, developed economy.   




Where are we in the credit cycle?  Household debt-to-GDP currently sits at 77.2%, down from the March 2009 peak of 95.6%.   At this point, we’ve roughly re-traced back to the debt level that existed in 2000 - before debt growth decoupled from consumption growth and went exponential - but we’re still significantly above the long-term average of ~55%.   Notably, Household debt-to-GDP ticked up in 1Q14 for the first time in 20 quarters. 


The Credit Edifice:  At a most basic level, household credit growth is largely a function of the rich lending to the non-rich.  An economic edifice built on lending growth at the middle and low end to drive incremental end demand faces an inherent challenge at the end of a long-term credit cycle and amidst growing inequality perpetuated by monetary policy aimed at financial asset inflation.   


If the lower 60%+ of households don’t own financials assets, remain over-encumbered, still haven’t recouped the wealth loss from the Great Recession, and are getting squeezed by rising commodity and shelter prices, are they really incentivized, or in a position to incur incremental debt?


Maybe, but it’s likely that incremental leverage is largely involuntary, non-productive in its deployment and /or hyper-transient.  The household sector certainly hasn’t delevered enough to start another ‘credit cycle’ and, critically, zero bound rates and demographic trends are antithetical to those prevailing at the start of the 30Y cycle that began in 1981.  


Further, the spike in credit card debt in April occurred alongside very weak consumer spending and housing data – weakness that extended into May.   Tapping credit to purchase everyday essentials because cost inflation is running at multiples of income growth is not reflective of a resurgent consumer driving an accelerating, sustainable consumption recovery. 


The thought train above is very “secular stagnation-y” and more of an early morning macro musing  than a refined conclusion ‘endorsed by Hedgeye’. But that’s okay – the early distillation of macro noise generally begins with an initial pass through a common sense filter, then more questions.  


On a less dismal note, as we head into daddy day, feel heartened that new, not-so-Ivory Tower voices like those of Mian and Sufi are finding traction and established voices like Volcker continue to stand unabashedly counter to crony conventionalist, economic thought. 


…..Although you may feel equally disheartened that the best seats at BronyCon are already sold out – try to enjoy the weekend anyway.  


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.44-2.64%


RUT 1140-1175

VIX 10.73-13.33

WTI Oil 103.88-106.99

Gold 1 


Christian B. Drake



Giddy Up - chartofday 


TODAY’S S&P 500 SET-UP – June 13, 2014

As we look at today's setup for the S&P 500, the range is 38 points or 0.89% downside to 1913 and 1.08% upside to 1951.                                               













  • YIELD CURVE: 2.15 from 2.16
  • VIX closed at 12.56 1 day percent change of 8.28%


MACRO DATA POINTS (Bloomberg Estimates):         

  • 8:30am: PPI Final Demand, May, est. 0.1% (prior 0.6%)
  • 9:55am: UMich Confidence, June, est. 83 (prior 81.9)
  • 1pm: Baker Hughes rig count



    • House, Senate schedules TBA; No votes in either chamber
    • President Obama to visit Sioux tribe in North Dakota
    • 8:30am: U.S.-EU financial services discussion at Peterson Institute for International Economics
    • 9:30am: British Ambassador to U.S. Peter Westmacott speaks to Bloomberg reporters, editors at Bloomberg Government breakfast
    • U.S. ELECTION WRAP: Cantor Aftermath; Jockeying on Coal
    • Clinton’s popularity drops to 52% in poll as 2016 edge shrinks     



  • Intel revenue gets boost as businesses upgrade office computers
  • Express soars after Sycamore Partners says it plans to make bid
  • Obama won’t rule out airstrikes as Iraq battles militant group
  • Oil rises as extremist advance in Iraq threatens crude supply
  • Amaya to acquire Rational, owner of PokerStars, for $4.9b
  • Musk makes Tesla patents “open source” to boost battery cars
  • Tesla teams up w/Soho to add car-charging outlets in Beijing
  • BOJ sticks with easing as analysts delay extra action calls
  • Abe plans company tax cut in 2015 as Kuroda warns on budget
  • China’s May output growth signals economy is stabilizing
  • LinkedIn ordered to face claims it misused user e-mail contacts
  • Malone taking F-1 stake said to hang on $1b value gap
  • Bitcoins seized from Silk Road to be sold at auction in June
  • Cimarex Energy to replace Intl Game Technology in S&P 500
  • Apollo Global in talks to buy Encana’s Bighorn properties: WSJ
  • Relativity Media seeking close of $1b placement: N.Y. Post
  • Fed Decision, CFTC, Amazon, Oracle: Week Ahead June 14-21



    • No earnings scheduled by S&P 500 cos.



  • Oil Heads for Year’s Biggest Weekly Gain as Iraq Unrest Worsens
  • Iraq Insurgency Risks Biggest Source of New OPEC Oil, IEA Says
  • Commodities Advance to Nine-Month High as Oil Rallies on Iraq
  • Gold Poised for First Back-to-Back Weekly Increase Since April
  • Copper Advances on Indications Lower Prices Attracted Buyers
  • Naimi’s Good Times Will Last as Lost Output Lifts Prices: Energy
  • Wheat Trims Fifth Weekly Loss as Bear Market May Spur Demand
  • LBMA Gets 10 Proposals to Develop Alternative to Silver Fixing
  • Platinum Producers See Miners’ Return Next Week If Deal Accepted
  • Ukraine Ready to Pay Debt if Russia Agrees to $326 Gas: Naftogaz
  • Cocoa Farmers at Odds With Industry on Benefits of Certification
  • GrainCorp Says Shipped Grain to Brisbane From Southern Australia
  • Natural Gas Bull & Bear Pits Demand vs. Robust Supply: Outlook
  • Sunny Weather Boosts U.K. Wheat Crop Potential Before Harvest


























The Hedgeye Macro Team














LULU = Activist Candy

Takeaway: Things are getting so bad that it’s good. If no one goes activist, we might. Shareholders deserve it. Still solid acquisition candidate.

Conclusion: We think that things are getting so bad, that it’s almost good. This company is in worse shape than the quarter suggests. The good news is that every problem we see can be fixed with the right talent steering the ship. The bad news is that such talent is nowhere to be found in Vancouver. The reality is that someone will have to step up and go all activist on LULU. Valuation is at a point where we could see that happening, which could be facilitated by recent tension at the Board level.  And if it doesn’t happen, we might just lead the charge ourselves. Value needs to be unlocked. This is an amazing brand with solid global growth prospects. Management is too focused on recapturing Gross Margin that is a) lost forever, and b) something that investors won’t pay for without meaningful top line growth. If all else fails, there are no fewer than five public companies eyeing LULU, not to mention financial buyers.  



We said that the risk/reward for LULU would really shape up on a miss. We’re standing behind that statement. If we had to be long or short at this point, we’d be long. Fortunately, we don’t have to be either. But let’s make one thing abundantly clear. Our view that it is a more favorable risk/reward is not because we have confidence in management executing a sound growth strategy. Quite the opposite, actually. This is as close to a ‘no confidence’ vote as we’ve come across with a management team in a long time. If this was a weak brand with questionable growth prospects, then it’d be game over. But the fact is, this is what we’d consider one of only a small handful of truly defendable brands in retail. When there’s a great brand with bad management, it is a situation that can be easily fixed. When even the greatest of managers are in charge of marginal brands, they’re usually terminal. This is definitely the former.


If the play here is for a rebound in the business under the current regime, then it is an absolute coin toss as to whether they succeed. We don’t like flipping coins. Process = Good. Coin Flip = Bad.


That means we need major change inside the company.  John Currie (CFO) getting pushed out is a start. He was terrific for LULU in its early years (when Chip was still relevant), and sales were sub $500mm. But so many of us forget just how fast LULU grew, as sales were a mere $275mm in 2007. The skill sets throughout this company today are broadly consistent with those of an entrepreneurial early-cycle company. The problem is that LULU is going through puberty. It is sitting at $1.6bn in sales, and is in need of a completely different range of skills. Unfortunately, we’re not convinced that CEO Laurent Potdevin has them either.


WINNING VS LOSING: (LULU should look 948 miles South to see how it’s done)

We think it’s so ironic that LULU reported earnings within 14 hours of Restoration Hardware (RH – our top long idea). Some similarities are striking. Both are $1.6bn in revenue, both serve a very high end consumer in a fragmented and hyper-growth piece of the retail space, and both can conceivably achieve $4-$5bn in revenue over a 5-year time period. The big difference is that the CEO of RH (who many people hate) got on the call, played offense, took control and set the investment narrative. He conveyed top to bottom what his vision is for the company, what it will mean for long-term revenue growth, what the margin implications are, and what kind of capital is needed to achieve those goals and maximize ROI. Laurent said…well…not that.


LULU, instead, was extraordinarily defensive. Granted, weak trends will put anyone on defense. But we did not listen to the call and think “hey, these guys really understand their business.” There was no talk about long term growth targets, no crisp delineation of key growth initiatives, with the only real numbers given around share repurchase and gross margin goals.


Let’s address the gross margin issue for a minute. The fact that this company leads in with recovery of gross margins to a mid-50s level is preposterous. If the company can recapture a few points in margin over time, then great. But there’s no way we (or most others) will pay up for that now. This is a mid-cycle growth company that is growing outside of an extremely profitable core (dresses, denim, men’s – fine, but not Gross Margin Accretive). There is one thing and one thing only that most investors will pay for with LULU – top line growth.  Yet the only top line growth drivers they really address on the calls are little near-term tactical patches that are irrelevant in the context of investing in Retailers.  



What this means for us, is that the problem is still…you guessed it…Chip (Wilson, Founder). As much as everyone likes to say that Chip stepped away last year, the fact is that the guy still controls 27% of the voting stock. Voting stock aside, his influence inside the hallways of Lululemon trumps that of the CEO that he hand-picked and pushed through the Board approval process. John Currie was Chip’s CFO, and when the Board decided to push him out over the past week, we think that’s what prompted Wilson to vote against the re-election of the two Board members who caused it (one of whom replaced Chip as Chairman).


What’s nice about this is that the Board is no longer uniformly ‘Chipped’.  The more the Boardmembers band together and show Chip that he’s no longer the boss, the better chance this company has of succeeding.


The reality with all of this is that someone will have to step up and go all activist on LULU. Valuation is at a point where we could see that happening. And if it doesn’t happen, we might just lead the charge ourselves. Value needs to be unlocked.



One consideration is whether the company’s troubles put it in play. The answer there, we think , is Yes.

  1. Nike is a perennial possibility. Though its strategy is to build instead of buy (and it passed when LULU was at $8) the fact is that it has been chasing LULU for years, and LULU still is far more authentic for Yoga than Nike is. Low probability. But something to consider.
  2. Kering is in print saying that it wants to broaden its portfolio of sports brands (the owner of Gucci also owns Puma, Tretorn and Volcom). Does not hurt that it is a French company and LULU has a French speaking CEO.
  3. VFC is possible. But VFC is rumored to be buying everything. It has Lucy, which is a poor-man’s version of LULU. It’d be interested at the right price.
  4. PVH is an interesting thought. It’s business is in trouble, and what does PVH do when its core weakens? It does a HUGE acquisition. Enter LULU.
  5. Here’s a dark horse…but GPS is not completely out of the realm of possibility. Granted, it’s eating LULU’s lunch with Athleta in markets where the brands overlap. But GPS could handle it financially, and it would give the company some organic growth.

LULU = Activist Candy - LULU financials


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