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Giddy Up

This note was originally published at 8am on June 13, 2014 for Hedgeye subscribers.

"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…..credit 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.   

 

So….

 

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%

SPX 1913-1951

RUT 1140-1175

VIX 10.73-13.33

WTI Oil 103.88-106.99

Gold 1253-1286 

  

Christian B. Drake

Associate

 

Giddy Up - chartofday 


THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP – June 27, 2014


As we look at today's setup for the S&P 500, the range is 37 points or 1.19% downside to 1934 and 0.70% upside to 1971.                                                          

                                                                     

SECTOR PERFORMANCE

 

THE HEDGEYE DAILY OUTLOOK - 1

 

THE HEDGEYE DAILY OUTLOOK - 2

 

EQUITY SENTIMENT:

 

THE HEDGEYE DAILY OUTLOOK - 10

 

CREDIT/ECONOMIC MARKET LOOK:

  • YIELD CURVE: 2.06 from 2.07
  • VIX closed at 11.63 1 day percent change of 0.35%

 

MACRO DATA POINTS (Bloomberg Estimates):             

  • 9:55am: U.Mich Consumer Sentiment, June fin, est. 82 (pr 81.2)
  • 1pm: Baker Hughes rig count

 

GOVERNMENT:

    • President Obama speaks on the economy in Minneapolis
    • Sec. of State John Kerry travels to Saudi Arabia to discuss situation in Iraq
    • House not in session, no more votes in Senate until after July 4th recess
    • 6am: U.S. Marshals Service start online auction of 29,656 bitcoins seized last year in illicit Silk Road marketplace

               

WHAT TO WATCH:

  • American Apparel creditor Lion Capital said to deny loan waiver
  • BPN Paribas is said to prepare to pay $8.9b penalty: NY Times
  • Netflix to come to Australia, Village Roadshow CEO says: ZDNet
  • KKR names Alex Navab sole head of private equity for Americas
  • United Technologies wins $1.3b Air Force chopper contract
  • Autoliv agrees to settle U.S. lawsuit with $22.5m payment
  • Goldman Sachs wins bid to move investor Oei suit to arbitration
  • European Medicines Agency to release drug approval, safety decisions
  • Molson CEO says craft-beer cos. “massively overvalued”
  • Russell rebalancing effective close of market today
  • U.S. Jobs, Yellen, Lew, Tankan, ECB: Wk Ahead June 28-July 5

 

EARNINGS:

    • Commercial Metals (CMC) 7am, $0.30
    • Finish Line (FINL) 7:05am, $0.21 - Preview
    • KB Home (KBH) 8:30am, $0.21 - Preview

 

COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)

  • Google’s Nordic Server Set to Get Asian Internet Imitators
  • Magnum Hunter Turns $891 Million in Debt Into 138% Gain on Shale
  • Brent Set for First Weekly Drop of Iraq Crisis as Output Spared
  • Copper Trades Near Three-Month High Before Confidence Report
  • Cocoa Rebounds in New York as Robusta Coffee Gains on Stockpiles
  • Soybeans Trim Weekly Advance as Investors Assess U.S. Weather
  • Germany’s New Coal Plants Push Power Glut to 4-Year High: Energy
  • IRAQ CRISIS WRAP: Govt Forces Advance; Brent Set for Weekly Fall
  • U.K. Audit Questions $28 Billion of Renewable Energy Deals
  • EU Would Curb Coal Use With 20-Euro Carbon Price, Iberdrola Says
  • U.S. Shale Spurs Record Foreign Chemical Investment: Commodities
  • WTI Oil Seen Rising in Survey on Iraq Supply Risk
  • Cheaper Nickel Pig Iron Production Drives China Metals Market
  • Gold Trades Near Two-Month High as Investors Weigh U.S. Economy

 

THE HEDGEYE DAILY OUTLOOK - 5

 

CURRENCIES


THE HEDGEYE DAILY OUTLOOK - 6

 

GLOBAL PERFORMANCE

 

THE HEDGEYE DAILY OUTLOOK - 3

 

THE HEDGEYE DAILY OUTLOOK - 4

 

EUROPEAN MARKETS

 

THE HEDGEYE DAILY OUTLOOK - 7

 

ASIAN MARKETS

 

THE HEDGEYE DAILY OUTLOOK - 8

 

MIDDLE EAST

 

THE HEDGEYE DAILY OUTLOOK - 9

 

 

The Hedgeye Macro Team

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


June 27, 2014

June 27, 2014 - 1

 

BULLISH TRENDS

June 27, 2014 - Slide2

June 27, 2014 - Slide3

June 27, 2014 - Slide4

June 27, 2014 - Slide5

June 27, 2014 - Slide6

June 27, 2014 - Slide7

June 27, 2014 - Slide8

 

BEARISH TRENDS

 

June 27, 2014 - Slide9

June 27, 2014 - Slide10


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NKE – Needs More Cowbell

Takeaway: Some great aspects of this print. But we need higher EPS growth than 12% to justify multiple expansion. We can’t get there, yet.

Conclusion: We said earlier this week that we’re no more or less excited about owning Nike based on the 4Q print. That statement holds true after the company’s results. Yes, Nike beat by $0.03. That’s what great companies do – they consistently beat expectations. And there is no question in our mind that Nike is one of the greatest consumer companies in the world. That’s more clear today than ever before. But that doesn’t mean it has to be one of the greatest consumer stocks. While it beat the quarter, cash flow contracted and NKE grew EPS by only 3% on 11% revenue growth.  Not a great quality quarter. Furthermore, we’re likely to see sales decelerate sequentially throughout the upcoming fiscal year, with EPS growth being fueled largely by World Cup spending simply not recurring. That’s not terrible by any stretch. After all, Nike is still in a more envious financial and operational position than most consumer companies. But at a 23x p/e, this stock is probably not going to go up due to multiple expansion. It needs outsized earnings growth. We’re currently looking at 11-12% growth for each of the next two years. If our numbers are right, then we can’t make the bet that the stock heads higher by anything more than the rate of earnings growth. But if 20% earnings growth becomes a reality, then we could argue a 25x p/e on a $3.60 EPS number and then we flirt with a $90 stock price. We don’t have the conviction top make that call today. We’re not changing any of our operating estimates, and are actually taking EPS down by about a nickel per year due to a higher tax rate. Financials are in table below.

 

Here are a few puts and takes on the results, as we see them.

  1. Brand Heat: While futures decelerated by a point, they still remain at an extremely healthy level – 11% reported and 12% in constant currency. North America was the most impressive, reaccelerating from 9% to 11% (a 150bp improvement in the 2-year trend). That’s most significant because last quarter the US market finally showed signs of ‘rolling over’. Those signs reversed course.
  2. Killer GM%: Nike’s Gross Margins were up 169bps to 45.6%, its highest rate in 4-years. Better mix and better margin close-outs accounted for the bulk of the upside. Though higher prices and strong online sales helped as well.
  3. Digital: We need to weigh-in on the company’s comments that ‘Digital is its top priority’ and it is more excited about online than ever before (growing 40% for the year). The company won’t volunteer these stats, but dot.com accounted for just about 2% of Nike’s sales in 2013, or about 12% of its total direct-to-consumer business. The reality is that Nike has the lowest e-commerce ratio of almost any company in the business.  We understand that this in part due to the fact that it has such a strong wholesale model. But keep in mind that when the company talks about growth in its e-commerce business, it is coming off an extraordinarily low base. It added about $200mm this year, compared to Nike’s $2.48bn in revenue growth.
  4. ‘Emerging’ Markets: Futures for Emerging markets were up only 2% in reported dollars, and 9% in constant currency. Maybe we’re missing something, but shouldn’t ‘Emerging Markets’ be growing faster than the two most mature markets – USA +11%, and Western Europe +25% (and even Central Europe +10%)? NKE is anniversarying the supply chain problems it had in Mexico in 1H, so sales compares should be getting easier there. This is an area we’d definitely like to see stronger.
  5. Share Repo: Nike repo’d 12.3mm shares for $912mm, an average price of $74.14. To be clear, that is a colossal amount of stock for Nike to repo in a single quarter. Interesting to hear management talk about having more growth opportunities than ever, and yet Nike is opting to also invest so much in its own stock. We're not doubting the growth opportunities, but this makes us sit back and reconsider whether we’re too conservative with our earnings estimates (i.e. what do they know that I don’t?).
  6. China Margins: Nike’s investment in a China HQ in Shanghai is a decision we absolutely won’t question. The company needs a central presence in China, and the landscape has developed enough such that they know where to be (and not to be). But, the big thing to watch is margins, which were down 521bp this quarter in China to 30.6%. China margins were once the greatest in Nike’s portfolio by a country mile (surpassing 39% just two years ago). But now they’re gravitating down closer to the US at 27% and Emerging Markets at 25%. Again, still very respectable levels by any measure, but the downward movement is a key trend to model.
  7. ROE Caught Up To ROIC: This quarter, Nike’s TTM ROIC was 24.5%. By our math, that equals ROE. That’s so important for this company. Nike always had an enviable trajectory of ROIC, but the problem is that ROE could not keep up because of all the cash on its books. The fact that Nike stepped up its repo as much as it did really had a dramatic effect this fiscal year. Nike definitely deserves a golf clap for that one – and then some.
  8. Women's – Good, Not Outstanding: Nike is really proud of its women’s business. It should be. Sales to women were up 12% last year to $5bn. That’s the size of 3 Lululemons. But on the flip side, it’s 1/3 the size of Nike’s men’s business. Perhaps it’s tough to grow relative to something that in itself is moving so fast. But as big of a focus as this is for management, we’d have thunk that women’s would grow a bit more than 12% for the year (with women’s training growing 10% to $1.1bn).

 

NKE – Needs More Cowbell - nke1

 

 

HERE'S OUR PRE-Q NOTE FROM EARLIER IN THE WEEK

06/25/14

NKE – Consider the World Cup Biorhythm

Takeaway: 23x p/e is a tough risk/reward for a company that can barely grow EPS when the brand is hotter than ever.

 

We’re no more or less excited about owning Nike into the 4Q print to be reported after the close on Thursday. A few thoughts…

  1. Revenue Looks Good: We could see a slight beat on the top line. The company guided towards a high single digit rate. The brand still has solid momentum in the US and Western Europe. In ‘Nike Speak’ high-single digit sales guidance equals 11-12%. The Street is at 9.6%.
  2. Gross Margin Expectations Appropriately High: The Street is already looking for a 44.7% Gross Margin, which is 75bps ahead of last year and represents a meaningful sequential pick-up in the 2-year trend. We’re seeing a shift toward higher GM jurisdictions (which could also help tax rate), so this is a reasonable expectation. But we’d be surprised by much more – especially given that inventories ended the last quarter +15%.
  3. Need SG&A to Shine – and It Won’t: So with a likely slight sales beat, and in-line GM, that leaves it all up to SG&A to save the day.  The problem is that in all our years covering Nike, we have never seen the company spend money at the clip (even relative to size) that we’re seeing today. Nike is one of the best steward’s of capital in this industry, so it’s earned the benefit of the doubt as it relates to its capital allocation process which will ultimately result in increased cash flow at some point down the road. But with the company spending an estimated $100mm-$150mm on World Cup, we can’t exactly bank on this being the quarter for an SG&A beat. Let’s consider that number for a minute. This coming quarter, UnderArmour will spend about $55mm in marketing on EVERYTHING. Nike will spend 3x that on one sporting event.
  4. The World Cup Factor: A few people have told us “there’s no way Nike misses during World Cup”. That’s probably true. There’s no way it will allow itself to be in the financial press as disappointing while the biggest sporting match in the world is being played out . But mind you that Nike has not beaten by more than a penny in each of the past three World Cups.
  5. Nike’s biorhythm; The problem is that the Cup is always played in conjunction with Nike reporting its fourth fiscal quarter. Aside from Nike spending huge sums of capital on this event, you need to take into account Nike’s own internal financial biorhythm.  The same factors that lead to conservative goal setting between regional GMs and the C-Suite (and subsequent EPS smoking in quarters 1 through 3 also lead to muted upside in Q4). Why? If you are a business unit head at Nike, you have to fight for a given SG&A budget in a given year. If you don’t spend every last penny, then the chance of getting a similar (or larger) budget next year is slim to none. We’ve all heard the stories about what most people would consider excessive spending at Nike (i.e. hiring rock bands to play at happy hour for your department). Most of those stories are true, and almost all happen in the fourth quarter.  The point is, if there is a quarter where you’re looking for NKE to beat on the SG&A line, 4Q probably won’t be the one – especially one where World Cup is being played in the back yard of Nike’s highest-profile National Team – Brazil.
  6. Guidance Not Headed Higher: The company already issued preliminary guidance for the May ’15 year “at or above our high-single-digit target range.“  It won’t come out and take guidance higher when the year is only four weeks old. They won’t take guidance down, either. But there’s an 80% chance it sticks with its previous comment, 15% chance it backs away, and 5% it guides higher.  

 

We’re not averse to owning Nike for someone who has an extremely long duration. But there’s no way we can justify putting money to work here for a company that is barely growing earnings when the brand is hotter than ever.  With the stock at 23x next year’s earnings, we simply think that there’s much better risk/reward elsewhere.  


Poll of the Day Recap: 54% Voted Housing Market is Heading Lower

Takeaway: 54% voted LOWER, 46% voted HIGHER

Mortgage purchase applications are down 18% year-over-year. The only recovery in housing at this point is the new and high end market ($1M+). Hedgeye's expectation remains that the back half of this year, and the first half of 2015, should see steady downward pressure on the rate of home price appreciation.

 

In the video below Housing Sector Head Josh Steiner states that various aspects of the U.S. housing market are deteriorating and describes how changes in housing prices and volumes are causing a major inflection point in this $18-19 trillion asset class.

 

 

We wanted to know what you think. Is the U.S. housing market heading higher or lower?

 

At the time of this post, 54% voted LOWER, 46% voted HIGHER.

 

Voters who forecast the U.S. housing market heads LOWER reasoned:

  • Housing is slowing and could slow for many years to come. The 2011-13 rebound in US housing "reminds" me of the summer-of-2000 bounce in the Nasdaq. Too much erosion of sequential momentum to comp the comps in the intermediate term and too many regulatory and demographic headwinds to sustain the trend over the long term. This call is as easy as it gets, IMO.
  • "At some point" price and wages have to come in line. Perpetuating rising home prices is a form of generational theft that is going to keep Millennials out of the market.  With Millennials out of the market, the marginal buyer is institutional (including public pension funds that are searching for yield).  This could turn into a battle of institutions that spike prices higher, but "at some point" the ability to collect rent from an under-employed populace will destroy the cash flow rationale.  When the yields dry up, the liquidations will start and prices will follow.
  • We won't see an across the board correction, just lower, for a slight correction, in some markets, but I also wouldn't be short housing since there are better areas to be short.

Those who voted HIGHER had this to say:

  • I would rather think of it as a bond. Home prices will go higher on the low end "shorter duration" as Millennials compete to find homes below their current rental payments. The marginal homes just below the 1%ers are doomed as higher rates erode affordability.
  • It's going higher in NY.  Real estate listings that track price changes show brokers and owners raising prices by as much as 4-5% even over the course of just 1 month.  It's probably psychological since they're getting lower offers than the original listing, so the new lower offer on the higher price ends up getting them the price they originally wanted, but there are also plenty of buyers who can afford higher prices in the city.  It'll level off at some point, but probably not anytime soon.
  • With the markets in solid shape, housing will unfortunately continue to rise, at least slightly, slightly before it drops.  Like with everything in the markets, this is a timing issue, so though I think it'll go lower eventually, it'll inch up first.
  • while there is congestion in the market now, longer term, people still want to own homes.  the market may languish for a year or so, but ultimately will recover and move higher. the economy is in better shape than gurus want to admit
  • depends on your time frame of course. Near term, 6 - 12 months, lower as incomes have not kept up with recent price rises. Longer term higher as populations rise and the need overcomes price discretion

 

 

 


Cartoon of the Day: Sleep Walking

Takeaway: No matter what anyone says, it is not different this time.

As Hedgeye CEO Keith McCullough noted earlier today, it's been 48 trading days since the S&P 500 has had a +/- 1% day. That's only happened one other time in two decades.

 

Meanwhile, Volatility (VIX) is up over +17% from its June 18th low.

 

No, it's not different this time.


Cartoon of the Day: Sleep Walking - S P walking 6.26.2014

 


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