Sticky Wages, Pricey Meat

Sticky Wages, Pricey Meat - USD vs. LH and LC Chart YTD


A sign notifying customers of “conventionally raised” steak has been up for two months. Chipotle is either seeing outright supply scarcity or experiencing supply shortages at a price it’s willing to pay. Granted this is only one location, prices have recently increased +8.3% for steak and 11.1% for guacamole at New York locations… And for “conventionally raised!” 

With the exception of a -3 bps correction in front-month live cattle futures during the week ending June 20th, Livestock prices closed in positive territory every week this month:


June 6th: Live Cattle: +1.7%; Lean Hogs: +1.1%

June 13th: Live Cattle: +5.3%; Lean Hogs: +1.2%

June 20th: Live Cattle: -0.3%; Lean Hogs: +10.3%

June 27th: Live Cattle: +3.2%; Lean Hogs: +2.4%


Sticky Wages, Pricey Meat - chart 2 Performance Table


Rather than making a call on the direction of agricultural and soft commodity prices on a daily basis, we accept that the speculation of supply shortages can whip prices for a number of reasons outside our control. What we choose to dissect is the consumer and outlook for the U.S. dollar. For the first half of 2014, the consumer slowed and will continue to face similar headwinds in 2H:


  1. A Fed revision for 2014 full-year GDP from 3.0% to 2.1 - 2.3% at the last FOMC meeting will likely face a further downward revision after a -2.9% Final Q1 print last week
  2. The Fed gets more dovish with the data
  3. The bond market adjusts for growth expectations and the prospect for future dollar devaluation perpetuates the yield spread compression
  4. Commodities, which are priced in U.S. dollars, face continued pressure to the upside


Unfortunately this headline commodity inflation is not considered the kind of inflation that concerns the Federal Reserve formula. Forgive us on the repetitive call-out, but the Hedgeye Macro team felt the following article from Reuters last week was an epic interview with Yellen on the linearity of the Fed’s model.


Full Article 


Every FOMC meeting in the last several years precedes an abundance of financial media punditry that dissects the sequential change in the language of each statement. Although rare, we enjoy this direct commentary in the Reuters article for insight into the assumptions made by the fed machine:


"My own expectation is that, as the labor market begins to tighten, we will see wage growth pick up some to the point where ... nominal wages are rising more rapidly than inflation, so households are getting a real increase in their take home pay," she said last week, adding: "If we were to fail to see that, frankly, I would worry about downside risk to consumer spending."


Janet Yellen is, in this quote, referring to her belief in what is called “money neutrality” which is basically the idea that prices and wages move together without harm over the intermediate to long-term. In our opinion, she sounds rather nervous in her assessment of this “reality".


To further quote the Reuters reporter in this article:


“Over the last year Fed staff changed their main model for forecasting wage and price inflation to reflect evidence that companies were adjusting prices more slowly than in prior years. That implies the Fed has more time to allow wages to rise and employment to expand before having to be concerned about inflation accelerating.”


This seems like a convenient way to make room for an extension of accommodative policy as wage growth has stagnated against a flat dollar and skyrocketing cost of living…


Sticky Wages, Pricey Meat - chart 3 wage growth vs. livestock and USD


Income earners save less and spend more with an increase in cost-of-living:


Sticky Wages, Pricey Meat - chart 4 savings rate vs. USD and CRB


Our process points to Fed and consensus full-year growth and inflation estimates that are still too optimistic. Yellen’s comments point to the predictable FOMC policy response that we have continuously highlighted as a catalyst for further dollar devaluation. With the CRB Index up 10% in 2014, both the dollar and ten-year treasury yield remain in @Hedgeye bearish formations. 



Ben Ryan








Poll of the Day Recap: 51% Are Bullish on U.S. Equities

Takeaway: 51% voted BULLISH, 49% voted BEARISH

In today’s Morning Newsletter Keith McCullough wrote, “While it might work in disruptive technologies, devaluing history, time, and cycles rarely works in Macro…  ‘so’, let’s embrace the uncertainty born out of these measurable risk factors and get on with Q3.”


As Q2 month-end markups end today and as June stands as one of the lowest equity volume months in U.S.  we wanted to know what your thoughts were heading into the third quarter.


Today’s Poll Question Asked: Are you bullish or bearish on U.S. equities for the third quarter?


In the video below Director of Research Daryl Jones highlights the top three reasons why he is decidedly BEARISH on U.S. Equities for the third quarter.



At the time of this post, 51% voted BULLISH, 49% voted for BEARISH.


Those who would are optimistic about what the third quarter holds and are BULLISH on U.S. Equities had this to say:

  • Hard to be bearish on the equity market as a whole. There are certain sectors that are significantly outperforming. Record amount of assets under management, easing Fed, life is good when investing with other people's money. I'll buy all the stocks with VIX at 10, as long as I get paid. Greed is good.
  • Consumer spending compares get easier in 2H (the second half of the year). The worst performing stocks in the market through six months have almost all been consumer discretionary. If this group simply ceases to be putrid, it should be positive on the margin for the broader market.
  • Until the Fed stops propping up the market, I can't bet against it. I don’t want to fight the Fed.


Voters who are BEARISH on U.S. Equities for 3Q reasoned:

  • Bearish for a 10% reversion to mean without hurting major uptrend.  Reasons: XLY:XLU ratio trending sideways to downward on 1 month, 4-6 month and 1 yr period, all while JNK:TLT outperformance has slowed on those same periods.
  • Too much complacency out there, no volume, inflation cutting into consumer spending, growth forecasts being revised downward with room for consensus to continue to chase growth to the downside with future revisions...
  • Inflation creeping up, economy slowing down, jobs being created are not permanent, increasing disconnection between stock prices and economic reality... see and increasing movement of funds to commodities.
  • The third quarter contains September which historically is the worst month for the markets - so sideways trading in light volume until the tick down in Sept.


Takeaway: We lack conviction on the intermediate-term direction of the Abenomics Trade and we think investors should remain on the sidelines for now.

I know. The only thing worse than an offensive lineman who can’t block is a sell-side strategy note that lacks conviction. But don’t take our lack of conviction as the absence of conviction altogether; rather, we have conviction in the view that it makes little sense for investors to have conviction in either direction of the Abenomics Trade (SHORT Japanese yen + LONG Japanese equities) with respect to the intermediate term.


Consider the following arguments that are in favor of this investment strategy:


  1. A likely transition from Quad #3 (i.e. growth slowing as inflation accelerates) in 2Q14 to Quad #1 (i.e. growth accelerating as inflation decelerates) in 3Q14: Not exactly the hardest call to make. Japanese growth has certainly stabilized here in the back half of 2Q and that is very supportive in the context of an easier GDP compare and tougher CPI compares.
  2. A re-risking of the GPIF portfolio: Per Japanese Prime Minster Shinzo Abe, a review of GPIF’s target allocation is due anytime in the next 1-3M. He has gone on record to suggest that the portfolio rebalancing will “benefit the insured and also bring investments that foster growth”. The general consensus among the investment community is that GIPF will likely reduce its JGB holdings from 60% of its $1.2T in assets to 40% and increase its allocation to Japanese equities to 20% from 12% currently.
  3. Favorable micro tailwinds: Japanese companies have announced a record $25B in share repurchases as of the last week of JUN and are sitting on a record $3T in cash to the extent they will look to continue engineering an optical improvement in ROE over the intermediate term. Per Bloomberg, TOPIX companies posted an 8.6% ROE in the year through 1Q14, the most since the 12M ended 1Q08. That’s well in advance of the trailing 10Y average of 6.2%  – which is the 2nd lowest reading of the 24 developed markets tracked by Bloomberg and less than half that of the S&P 500.





JAPAN POLICY VACUUM PART II? - Japan High Frequency GIP Data Monitor






Now, consider the following two arguments that are particularly unsupportive of the aforementioned investment strategy:


  1. Abe’s “Third Arrow” is more talk; less walk: In an op-ed this weekend, Abe defended the “Third Arrow” of his economic reform agenda, claiming that it will “fell Japan’s economic demons”. While time will ultimately tell on that front, we do not share Abe’s bullish conviction with respect to the current plan.
    • We like that he remains committed to lowering Japan’s corporate tax rate to sub-30% “over the next several years” (after a -240bps reduction in the effective rate in FY14), but we do not think it’s particularly helpful to ensure that the measure will be “revenue neutral” in the context of long-term fiscal consolidation targets. That likely equates to even more pressure on Japanese households from a tax perspective. Moreover, it’s unclear how promoting marginal growth in corporate profits will benefit Japan; if the US experience is any indication, the only growth Japan will see from rising corporate profits is growth in socioeconomic inequality.
      • The Third Arrow is woefully short on ameliorating Japan’s core economic issue: woeful demographics. Specifically, a policy to promote mass immigration is conspicuously absent from the Third Arrow as it stands currently. Per StreetAccount:
        • Kyodo cited government data that indicated Japan's population fell 243,684 YoY to 126,434,964 as of 1-Jan. 
        • Deaths hit a record high of 1,267,838 last year while births were up modestly YoY to 1,030,388.
        • Those 65 or older increased to 31,582,754, and those under 15 hit 16,489,385, a twenty-year low.
        • 39 of 47 prefectures experienced a fall in population, with Hokkaido seeing the largest decline.
        • Elderly people accounted for 24.98% of the population, and the number of foreign residents declined 2,347 YoY to 2,003,384.
  2. Easier Fed + Japanese monetary policy vacuum = stronger JPY: We continue to be the bears on the USD because we continue to be the bears on domestic economic growth and the latter supports our contrarian view that the Fed will continue to ease monetary policy, at the margins, as we progress throughout the year. We put out a deep-dive on this topic last week; CLICK HERE to access that report. While down from the trailing 3Y reading of +0.98, the Japanese equity market remains tightly correlated to the USD/JPY cross (+0.73 over the TTM). We expect that correlation to tighten (in a manner that is negative for Japanese stocks) as consensus is forced to review its lazy expectations for US monetary policy, at the margins.


Net-net, we do not think it’s appropriate for investors to gross up their exposures here in either direction. Our call for investors to cover Abenomics shorts ~1M ago was highly appropriate, but the outlook from here is less than clear.


As such, we think it makes sense to hold tight through 3Q so that we can finally be 1-2M striking distance of a likely expansion of the BoJ’s QQE program. Again, that is the approximate timing of the next major pro-Abenomics Trade catalyst according to our Hedgeyes, as the resiliency of the Japanese economy post the consumption tax hike should continue to keep Kuroda and Co. at bay for at least the next 3-4M.


Specifically, given the large amount of “hay” that the LDP has promised to bale on the growth and inflation front, we continue to see no reason why long-term investors should bail on the Abenomics Trade (i.e. they should remain involved on the long side of Japanese equities). Policies to Inflate out of Tokyo aren’t going anywhere anytime soon; that’s more than we can say for the Japanese consumer, however.






Email us if you have any further questions and we’d be more than happy to follow up. Best of luck out there!




Darius Dale

Associate: Macro Team

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Dollar General: Our Take on the Chairman and CEO's Resignation

Takeaway: The resignation of DGs chairman and CEO likely signals either a slowdown in the growth trajectory or simply that growth is hard to come by.

(Editor's Note: Here is an excerpt from a note our Retail Team published to institutional subscribers earlier today.)

DG - Dollar General CEO Announces Retirement Plans (PRESS RELEASE)



"Dollar General Corporation announced that its chairman and chief executive officer, Rick Dreiling, 60, has informed the Board of Directors of his intent to retire as CEO effective May 30, 2015 or upon the appointment of a successor. Dreiling has agreed to serve, at the discretion of the Board, as chairman during a transition period following the appointment of a new CEO."


"Dreiling has served as CEO since January 2008 and was named chairman of the Board in December 2008. Under his leadership, the Company's annual sales have increased more than 80 percent to $17.5 billion in 2013 and store count has increased by 38 percent to more than 11,000 stores in 40 states."


Our Takeaway:

Dreiling was critical in leading DG in the two years leading up to its (re) IPO in December 2009.


Since that point, he's executed on the real estate growth strategy, but also in a meaningful shift into consumables. We've been vocal about the category shift being largely played out at DG (and FDO).


And although there is admittedly still room for the company to expand (and fill out) its footprint, we can't imagine that a CEO switch at this point does not signal either a change in the growth trajectory, or the likelihood that growth is simply harder to come by.


That's a similar theme these days in retail -- DG, TGT, JCP, KSS.

YELP: Debating TAM

Takeaway: We realize there may be some confusion regarding our US TAM estimate for YELP. Below we clarify our analysis, and reiterate our estimates.


  1. YELP's US TAM = 3.4M: We have segmented the market in terms of all US businesses by end-customer and income. Our 3.4M estimate is still generous, including two cohorts that may not be all that addressable.

  2. Peak Penetration = 170K: We've said that YELP's realistic TAM is 170K, but we realize our wording here is somewhat confusing.  We're referring to its peak quarterly penetration, not the total number of accounts that YELP will ever penetrate (we believe it has already penetrated in excess of this metric).  

  3. YP ≠ Low-Hanging Fruit: Management has suggested that YP's 575K accounts are a realistic target for YELP.  However, YP has a considerably larger TAM.  575K isn't the low-hanging fruit, it's a pipe dream.


YELP: Debating TAM - YELP US TAM 1

Consensus may argue that YELP’s total addressable market (TAM) is substantial, with a pool of 27M businesses in the US.  But after digging deeper into census data, YELP's TAM is considerably smaller.  Two things to consider 

  1. Can’t Afford: 75% of US businesses make under $100K in annual revenue.  YELP’s cheapest ad package is $3,600 annually.
  2. Wrong Audience: ~47% of US businesses are B2B, largely outside the scope of YELP’s core retail audience.

After netting out both B2B-focused businesses, and retail businesses with less than $100K in annual revenues, we estimate the total addressable US market is closer to 3.4M.  However, 3.4M is still a generous assessment.


Note the two business cohorts in the yellow boxes above.  In the first box from the left are businesses generating $100-$250K in revenue.  However, these are segmented by revenues, not profits, which means the price of YELP's ad packages may still be prohibitively expensive to this group as well.  For example, a business with $150K in revenue and a 20% operating margin generates $30K in profits; paying $3,600 for an ad package is still a prohibitive cost in this scenario.  1.4M businesses out of our 3.4M estimate lie within this cohort (40%).


In the yellow box to the right are businesses generating over $1M in revenues.  Many of these business are national businesses, which may be looking for broader reach outside of a local sponsored search results.  We're not saying that national businesses would not use local advertising, but that these businesses likely have more advertising options at their disposable, thus tougher accounts for YELP's reps to penetrate.  644K businesses out of our 3.4M estimate lie within this cohort (19%).


So while we estimate YELP's US TAM to be 3.4M, over half of that estimate may not be all that addressable.


We understand there may be some confusion here.  So below we will clarify how we arrive at this metric


YELP currently has 74K active local business accounts (ALBAs), which is only ~4.6% penetration of the 1.6M claimed business pages as of 1Q14.  YELP’s advertiser base has never exceeded 5.0% penetration of its claimed pages since at least 1Q10. 


YELP: Debating TAM - YELP   Ad penetration


But there is a more important point: YELP's recurring attrition issues will always drag on the number of accounts that it will report in any given period.  YELP can continue hiring more reps, and close more new business, but it will continue to lose more accounts as its business grows.  YELP's quarterly attrition rate has hovered in a relatively tight range since 1Q12 (18.7% average, with a standard deviation of 60bps). So unless there is a seismic shift in retention rates, penetration will always be capped by what will be a growing number of lost accounts on a quarterly basis moving forward (e.g. the 12K accounts that YELP lost in 1Q14 is roughly 1/3 of the total accounts it lost in 2013). 


So unless retention changes, which we believe will be dependent on future pricing decisions, we can't see how YELP will ever surpass its peak quarterly penetration rate of 5% by any material margin.  In turn, we estimate that YELP’s realistic peak penetration in any given quarter is 170K businesses (5% of the total 3.4M opportunity). 


YELP: Debating TAM - YELP   Attrition Q Rate ex Qype 1Q14

YELP: Debating TAM - YELP   Cum Lost Q


We understand, that 170K may sound crazy relative to the consensus narrative, especially since management has implied that YP's 575K customers are the low-hanging fruit for YELP.  But when you compare the two companies, you can see that they are not actually comparable.  The bottom line is that YP has a materially larger TAM.  Some points to consider below

  • YP has a much broader product portfolio; Not all businesses are looking to do local sponsored search results, and while YP's customer count includes fading offerings like print yellow pages and direct mailing, there is still a demand for it today and that won't change overnight.  YP's broader portfolio means it is tapping a segment of the market that YELP cannot.  That alone means it has a larger TAM.  
  • YP can penetrate the B2B market: Services such as website design/hosting, and search engine marketing & optimization are not confined to the retail market.  YELP’s users are exclusively retail, so there is no basis to assume it can penetrate the B2B market, which is 47% of all US businesses.
  • YP has lower priced products: this is extremely important since 75% of all US businesses make less than 100K in revenue.  YELP’s cheapest ad package is $3600 annually, which is prohibitively expensive for most companies in the US.  YP's lower-priced offerings means it can penetrate a much larger segment of the market that YELP can't today.

YELP: Debating TAM - YELP   vs. YP DXM


Each of these points individually means that YP has a much larger TAM; collectively they suggest that the two companies aren't comparable.  So when we say that YELP's peak quarterly penetration will not exceed 170K accounts in any given period, are we really that crazy? Or does the data raise enough red flags to cast serious doubt as to what YELP can reasonably penetrate? 



If you have any questions, or would like to discuss further, let us know.  For additional detail, let us know if you would like to see our updated deck from our call last week.


Hesham Shaaban, CFA


Cartoon of the Day: It's Different This Time

Tick, tick, tick. It’s not really different.

Cartoon of the Day: It's Different This Time - Tick tock 06.30.2014




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