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PATIENCE OR PENURY: The Jobless, Wage-less, Investment-less Recovery?

Takeaway: Below we parse the historical macro and labor market data and contemplate where we are in the current cycle.

Mania & Myopia:  Historical data investigating the strength and intertemporal dynamics of recoveries following financial crises suggests it takes ~8 years to return to pre-crisis income levels/economic activity. 

 

With the great recession officially ending in June of 2009 we are now 62 months into the current expansion and have traversed most of the expected period of subdued growth. 

 

As we’ve noted, the frustration and impatience on the pace of the recovery that pervades media reports and pundit commentary offers an interesting juxtaposition against the almost universal acknowledgement that balance sheet recessions and the back end of long-term credit cycles invariably augur protracted periods of sub-trend growth

 

Imagine if all the spurious activity, all the sunken search and opportunity costs, all the manic speculation around the monthly NFP number were, instead, diverted towards infrastructure development or figuring out how to effectively teach our kids applied math.  Anyway…..

 

The chart below remains unnerving, but not particularly surprising.

 

PATIENCE OR PENURY: The Jobless, Wage-less, Investment-less Recovery? - Post Recession GDP Progression

 

 

The Jobless, Wage-less, Investment-less Recovery?

The chart trifecta below shows earnings growth and the employment and investment level over prior economic cycles.  The fact that employment, investment and earnings have all failed to return to prior levels underpins the emergent secular stagnation and employment hysteresis theories.   

 

We won’t explore the principal demographic (population growth/LFPR), credit cycle (demand amplification), and productivity (slower output growth = slower growth in compensation for that output) arguments driving secular trends in each – here, it’s sufficient to simply re-highlight where we are currently vs cycle precedents. 

 

As can be seen, the reality isn’t particularly surprising and the collective economist concern not unfounded.  

 

PATIENCE OR PENURY: The Jobless, Wage-less, Investment-less Recovery? - Ave Hourly Earnings

 

PATIENCE OR PENURY: The Jobless, Wage-less, Investment-less Recovery? - Emp to Pop Ratio

 

PATIENCE OR PENURY: The Jobless, Wage-less, Investment-less Recovery? - NDPI   of GDP

 

 

Late Mid-Cycle Slowdown or Late Cycle Roll-over? 

The logical question born out of the dour macro realities highlighted above, together with a bond market pricing in slower growth and smaller cap/consumer facing/early cycle equities significantly underperforming is this:   

 

Does the market/macro roll-over with improvement in the chief labor and economic aggregates never materializing or is there still some runway in the current cycle?

 

We approached that question from a fundamental perspective in the table below by profiling the economic cycles of the last half century and the surrounding labor market dynamics.

 

Across each of the lead labor measures, we remain below average levels observed over the prior seven cycles.  Of the six employment measures profiled, Initial claims sits as the best leading indicator of the economy with claims troughing approximately 7 months before the official peak in the economic cycle on average (note that we are using rolling 3-month averages in the labor/market data).  With headline (& NSA) rolling claims making lower lows at present, at face value, it suggests the current cycle hasn’t fully crested.    

 

The data is always good until it isn’t, the market is not the economy and the current cycle is unique in many respects (financial crisis, magnitude of central bank intervention, demographic inflection, reversal in LT interest rate cycle, etc) but the data mosaic is suggestive: 

 

Historical financial crises analysis suggests a more subdued, but more protracted recovery (vs typical business cycle oscillations) and a parsing of the historical labor data suggests the next economic peak isn’t yet imminent.   

 

PATIENCE OR PENURY: The Jobless, Wage-less, Investment-less Recovery? - Eco labor Cycle Profile 2

 

 

#TIGHT?

Much of the debate of the last half year has centered on the underlying tightness of the labor market and read through for inflation and prospective policy.  Conventionally, wages are viewed as a lagging indicator, with wage inflationary pressure building as the labor supply declines and the economy moves towards constrained capacity.

 

This canonical view of wage inflation certainly makes conceptual sense, but the empirical data is somewhat equivocal. 

 

The best (& only) LT data set on real wage growth – which focuses on production and nonsupervisory workers - shows real wage growth has been flat/negative for most of the last 4 decades with the current post-recessionary trend in real wage growth comparing favorably with those observed over the last half century. 

 

Further, whether we can return to the historical 3-4.5% level of nominal wage growth in the face of an aging workforce, declining labor supply, lower productivity and lower credit growth remains a bigger “If” now than ever before.    

 

PATIENCE OR PENURY: The Jobless, Wage-less, Investment-less Recovery? - Real Hourly Earnings Post recession progression

 

PATIENCE OR PENURY: The Jobless, Wage-less, Investment-less Recovery? - Nominal Hourly Wage Growth 

 

 

Surveying Slack & Common Sense Q&A:  

Ultimately, whether a return to prior cycle levels in wage growth is an accurate barometer of the underlying health of the labor market is probably less important than the fact that the Fed has anchored on wage inflation as a key gauge of labor market slack and key driver in reaching/overshooting its stated inflation target. 

 

Below we survey the current trends in measures of existing labor slack. In short, all the charts look the same with the prevailing trend remaining one of ongoing, albeit painstakingly slow, improvement.    

 

Is the labor market probably tighter than the FOMC gives lip service to?  Yes. 

 

Would they rather overshoot target (particularly with ROW disinflation likely to continue prevailing) and play catch up?  Yes, probably. 

 

Is patience probably still a better prescription than panic and manic punditry with regard to the current labor market trends and the prospects for the current cycle?  It would appear so.     

 

PATIENCE OR PENURY: The Jobless, Wage-less, Investment-less Recovery? - Available Workers per Job Opening

 

PATIENCE OR PENURY: The Jobless, Wage-less, Investment-less Recovery? - ST Unemployment

 

PATIENCE OR PENURY: The Jobless, Wage-less, Investment-less Recovery? - NFIB Hard to Fill Index

 

PATIENCE OR PENURY: The Jobless, Wage-less, Investment-less Recovery? - NFIB Compensation Index

 

PATIENCE OR PENURY: The Jobless, Wage-less, Investment-less Recovery? - Quits vs Confidence

 

Christian B. Drake

@HedgeyeUSA 

 



SINGAPORE SLUNG?

Another tough quarter for Singapore gaming with a resumption of growth elusive.

THE CALL TO ACTION

Q2 2014 was another disappointing quarter for the Singapore casinos with declining hold adjusted GGR and EBITDA.  Singapore Macro isn’t helping nor are a few extraneous issues such as the Malaysian airplane disappearance.  Unfortunately, the outlook looks more challenging – at least through the end of 2015. Growth is proving elusive and we wonder if Singapore will ever be a growth market again given the casino supply growth throughout Asia.  In conclusion, the lack of Singapore growth could continue to provide an overhang on the stock of LVS and obviously, Genting Singapore. 

THE METRICS

GGR

  • Higher MBS hold boosted Singapore gross gaming revenues 5% YoY in Q2 2014 to S$1.93 billion.  Also, both MBS and RWS had easy Q2 hold comps - 2.5% and 2.6%, respectively.  On a QoQ basis, Singapore GGR declined 12% in Q2 2014.
  • MBS GGR share is in-line with 3 year average. 

 SINGAPORE SLUNG? - g1

  • Adjusting for hold (based on average since inception for both properties) for both periods, GGR fell for the 3rd consecutive quarter, -5% YoY or S$1.83 billion.  (MBS:  -10%, RWS: flat)

SINGAPORE SLUNG? - g2 

 

VIP

  • VIP Rolling chip volume tumbled for the 3rd consecutive month, falling 8% to S$32.23 billion. 
  • MBS continues to lag on VIP volume share - its 40% share is the lowest since Q4 2010.  Its S$13 billion is the lowest quarterly VIP volume since Q1 2011.
  • Q2 2014 market hold was 3.13%
  • Market historical hold since inception was 2.88%

SINGAPORE SLUNG? - g3 

 

MASS REVENUE

  • Mass revenue dropped another 3% YoY in Q2 2014, the 4th consecutive quarterly decline with volumes down 9% YoY.
  • Thanks to its success on the slots/ETGs, MBS holds a commanding 58% mass (including slots) win share. 

SINGAPORE SLUNG? - G4 

 

NON-GAMING

  • Net non-gaming revenue fell 5% YoY in Q2 2014 the 3rd consecutive quarterly decline 
  • Genting Q2 2014 REVPAR declined 3% compared with a 1% decline in the upscale hotel comp set.  Q2 is seasonally a weak quarter.
  • MBS Q2 2014 REVPAR rose 8% YoY compared with 5% growth in the luxury hotel comp set.

MACRO

  • Revisions on several Singapore macro data points in the past few weeks continue to show a weak macro picture

 SINGAPORE SLUNG? - g5

 

OUTLOOK

  • Comps will continue to be difficult on the VIP side in Q3 2014.  VIP win and rolling chip volume grew 72% and 34%, respectively in Q3 2013.
  • LVS and Genting both expressed caution with extending credit to VIPs.  Genting’s large bad debt expense in Q2 2014 indicates a shaky lending environment that will lead to greater prudence in the coming quarters.
  • Mass play is also struggling.  Even with more mass tables and greater investment in the premium mass segment from LVS, this segment has been declining to stagnant since Q1 2012.  Singapore visitation has shrunk this year, although Genting mentioned there has been a greater mix of higher spend visitors.   With many headwinds (macro, currency, travel fears stemming from the airline/ferry disasters), it would be tough for the mass market to achieve growth in 2H 2014. 

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Cartoon of the Day: Muscle vs. Russell

Takeaway: The 2014 Macro Score: Long Bond $TLT +14% vs Russell 2000 -2%

Cartoon of the Day: Muscle vs. Russell - Russell 2000 cartoon 08.14.2014


ICI Fund Flow Survey - Taxable Tantrum with Domestic Equity Funds Continuing to Struggle

Takeaway: In the most recent ICI survey, taxable bond funds experienced a substantial snap outflow joining domestic stock funds with dour trends

Investment Company Institute Mutual Fund Data and ETF Money Flow:

 

In the most recent 5 day period ending August 6th, taxable bond funds snapped 2 months of consecutive weekly inflows with a substantial $8.6 billion redemption driven by geopolitical fears and mixed domestic economic signals. The snap outflow in the category was the biggest redemption since the week of June 26th, 2013 during the Taper Tantrum where $20.4 billion in a single week was called in by investors. Despite the panic in taxable fixed income last week, the category has had inflows in 24 of the past 26 weeks, so we will be monitoring if this about face has longer standing implications. Domestic stock fund flows also continued to struggle in the most recent survey with another $3.0 billion withdrawal by investors last week, much worse than the running 2014 weekly average of a $652 million redemption, making it 15 consecutive weeks of outflows in domestic stock funds. Janus Capital (JNS) and T Rowe Price (TROW) have the most exposure to negative retail equity fund trends with 60% and 40% of assets-under-management respectively in domestic stock funds.

 

Total equity mutual funds put up a slight outflow in the most recent 5 day period ending August 6th with $422 million being redeemed from the all stock category as reported by the Investment Company Institute. The composition of the outflow continued to be weighted towards domestic stock funds with $3.0 billion being withdrawal from the category in now the 15th consecutive week of outflows. These withdrawals were again cushioned by a $2.6 billion inflow into international equity funds which have experienced subscriptions (inflows) in every week of 2014. The running year-to-date weekly average for combined equity fund flow is now a $1.5 billion inflow, which is well below the $3.0 billion weekly average inflow from 2013. 

 

Fixed income mutual funds experienced mixed trends last week with the aforementioned taxable redemption of $8.6 billion offset by a slight inflow into municipal or tax-free products of $454 million. Intermediate term bond momentum continues despite the dramatic outflow last week with inflow in 24 of the past 26 weeks in taxable bonds and municipals tallying 29 of the past 30 weeks with positive subscriptions. The 2014 weekly average for fixed income mutual funds now stands at a $1.8 billion weekly inflow, an improvement from 2013's weekly average outflow of $1.5 billion, but still a far cry from the $5.8 billion weekly average inflow from 2012 (our view of the blow off top in bond fund inflow). 

 

ETF results were volatile during the week with inflows into bond funds and substantial outflows in stock funds. Equity ETFs lost a massive $15.5 billion last week, the biggest outflow since the week of February 5th where $27.4 billion was redeemed in stock ETFs. Fixed income ETFs conversely put up a decent sized inflow with $2.7 billion flowing into bond products. The 2014 weekly averages are now a $1.2 billion weekly inflow for equity ETFs and a $883 million weekly inflow for fixed income ETFs. 

 

The net of total equity mutual fund and ETF trends against total bond mutual fund and ETF flows totaled a negative $10.4 billion spread for the week ($15.9 billion of total equity outflow versus the $5.4 billion outflow within fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52 week moving average has been $4.3 billion (more positive money flow to equities), with a 52 week high of $31.0 billion (more positive money flow to equities) and a 52 week low of -$37.5 billion (negative numbers imply more positive money flow to bonds for the week). 

 

Mutual fund flow data is collected weekly from the Investment Company Institute (ICI) and represents a survey of 95% of the investment management industry's mutual fund assets. Mutual fund data largely reflects the actions of retail investors. Exchange traded fund (ETF) information is extracted from Bloomberg and is matched to the same weekly reporting schedule as the ICI mutual fund data. According to industry leader Blackrock (BLK), U.S. ETF participation is 60% institutional investors and 40% retail investors.   

 

ICI Fund Flow Survey - Taxable Tantrum with Domestic Equity Funds Continuing to Struggle - chart1

ICI Fund Flow Survey - Taxable Tantrum with Domestic Equity Funds Continuing to Struggle - chart2

 

 

 

Most Recent 12 Week Flow in Millions by Mutual Fund Product:

 

ICI Fund Flow Survey - Taxable Tantrum with Domestic Equity Funds Continuing to Struggle - chart3

 

ICI Fund Flow Survey - Taxable Tantrum with Domestic Equity Funds Continuing to Struggle - chart4

 

ICI Fund Flow Survey - Taxable Tantrum with Domestic Equity Funds Continuing to Struggle - chart5

 

ICI Fund Flow Survey - Taxable Tantrum with Domestic Equity Funds Continuing to Struggle - chart6

 

ICI Fund Flow Survey - Taxable Tantrum with Domestic Equity Funds Continuing to Struggle - chart7

 

 

Most Recent 12 Week Flow Within Equity and Fixed Income Exchange Traded Funds:

 

ICI Fund Flow Survey - Taxable Tantrum with Domestic Equity Funds Continuing to Struggle - chart8

 

ICI Fund Flow Survey - Taxable Tantrum with Domestic Equity Funds Continuing to Struggle - chart9

 

 

Net Results:

 

The net of total equity mutual fund and ETF trends against total bond mutual fund and ETF flows totaled a negative $10.4 billion spread for the week ($15.9 billion of total equity outflow versus the $5.4 billion outflow within fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52 week moving average has been $4.3 billion (more positive money flow to equities), with a 52 week high of $31.0 billion (more positive money flow to equities) and a 52 week low of -$37.5 billion (negative numbers imply more positive money flow to bonds for the week). 

 

ICI Fund Flow Survey - Taxable Tantrum with Domestic Equity Funds Continuing to Struggle - chart10 

 

 

 

Jonathan Casteleyn, CFA, CMT 

 

 

 

Joshua Steiner, CFA


KSS - So What Makes KSS Finally Go Down?

Takeaway: KSS might never earn over $4 again. SG&A cuts and tax benefits can only obfuscate economic reality for so long. 3/1 downside/upside.

Conclusion: We fully get that KSS is the kind of stock that goes up if the company just hits the quarter – even by accident. So the reaction to today’s headline beat is no surprise, even though the quality of earnings is nothing short of horrible. Comps and Gross Margins were weak, but KSS generated $0.06 (5%) of upside by cutting SG&A, another $0.02 due to a lower tax rate, and changed up its guidance policy in a way that steps up opacity around an already cloudy model. Listening to this conference call solidified our view that KSS is one of the worst run companies in retail. There is a culture of complacency with things going wrong in the business, and a sheer lack of excellence. We hate to poke at one of KSS’ internal battle cries, but the fact management talks of its ‘Agenda of Greatness’ is a head-scratcher.  All that said, we also understand that in order for this short to work, numbers need to come down – a lot. We still believe that this will happen.

 

The company’s current guidance is $4.05-$4.45. We’re at $4.00 for the year. But the part of this story that we think people are missing is that it is likely to earn about $4.00 for the next five years straight. Consider the following assumptions.

1) Square footage: 0.5%

2) Store comp: -2-3%: That’s a 180bp-270bp hit to consolidated comp w stores at (currently  91% of total)

3) E-com: 15-20%, or 140bps to 180bps in consolidated comp

4) Total Comp: -0.4% to flat

5) Gross Margin: -25bp to -50bp. a) E-commerce is lower margin for KSS. b) needs to step up promotional cadence with JCP back in the game. c) shifts to national brands, and d) dept store industry in year 6 of what is historically a 5-yr margin cycle.

6) Gross Profit: down 1% to 3%

7) SG&A: +2.0% as KSS invests to drive e-commerce business. (incl flat depreciation – co already extended its depreciation rate so D&A = $900mm vs $950mm)

8) EBIT: down 10-12%

9) Share Repurchase: $900mm-$1bn annually, or 21mm-24mm shares on a $40-45 stock (at $56 today). Approx 10% EPS accretion.

10) When all is said and done, we’re looking at LT EPS growth flat at best.

 

 

Valuation

We are often hit with the “but it’s so cheap” argument with KSS. In certain respects, we can see that. It’s got a sub-6x EBITDA handle, and a Cash Yield of about 8%. But we think that the thing that’s most wrong is the earnings numbers, not the multiples applied to those numbers. We’re basically making the call that KSS will earn $4 (at best) in perpetuity (or at least the next five years). If we want to get academic (which we don’t) and capitalize that by a 10% cost of equity, then we get to $40. That would equate to 10x earnings, which is not a stretch at all for a department store that can’t grow earnings, and where the consensus numbers are 20% too high. $40 is 30% downside from where we are today. If the Street is right on numbers for the next two years, then we think we’ve got about 13x a $4.75 number, which is about $61 (9% higher from here). That’s about 3/1 downside/upside, which is enough to get excited.

 

 

As it relates to events that can steamroll the short side, we think they are extremely limited and unprobable.

 

1) LBO: We’re heard about this a lot lately. It seems to be the rumor du jour when a retailer gets in trouble. Based on our model, we get to an IRR of less than 10% assuming a 20% premium to the current levels.

 

2) REIT: KSS has 411 owned stores (35% of portfolio) and 12 DCs. Based on our math, there’s real estate value of about $15/share ($3bn), BUT then KSS would have to incur about $250mm in rent if it wants to stay in those stores.  It also makes the mother of all assumptions, in that there’s someone that wants to pay $3bn for a portfolio of strip-mall real estate. The reality is that if there’s any value it is in mall anchor space, which would accrue to JCP (lease buy-outs) or Dillard’s. But even DDS is encountering the biggest problem with this bull case on department stores – it’s extremely tough to find liquidity for the portfolio. No one wants to buy them.

KSS - So What Makes KSS Finally Go Down? - KSS chart2

 

A FEW IMPORTANT DETAILS FROM THE QUARTER

 

E-commerce:

1) Dot.com growth rate was up sequentially in the quarter from 12% in 1Q. Though unquantified, we’ll peg it at 15% or 300bps sequentially. That would imply 30% growth in July and 9% in May and June. The key here is that the 9% growth rate in the first two months of the quarter is organic (i.e. uninterrupted by the dot.com re-platform).

2) We’ll give the company the benefit of the doubt on the website re-platform in the third quarter. Taking the dot.com growth rate up a few percentage points in 3Q against easier compares.

3) We have a tough time understanding management's conclusions regarding the negative trends we’ve seen in this business. The re-platform explains the 15% growth rate in 3Q13, but not the 16% and 12% rate we saw in 4Q13 and 1Q14 respectively. The re-platform was at best a four month hiccup.

KSS - So What Makes KSS Finally Go Down? - KSS chart3

 

SG&A:

1) The one area of our model that was off the mark in the quarter.  This is only the 2nd time in 7 ½ years that the company has leveraged SG&A spend on a negative sales number. Initially the beat was attributed to $13mm in incremental credit revenue, that number came down to a couple million by the end of Q&A, about $0.01 of the EPS beat.

2) In order to get to the low end of guidance (+1.5% to +2.5%) we’d have to assume a 2H growth rate of 3.5%. That’s probably the type of investment this business needs going forward, but not the type of spend this management team is willing to make in light of the fact that it hasn’t taken down its FY EPS numbers despite comp numbers that are running 230bps below plan. We’re taking down our 2H SG&A assumptions from +2% to +1% - giving the company an extra $0.07 of EPS.

KSS - So What Makes KSS Finally Go Down? - KSS chart4

 

KSS - So What Makes KSS Finally Go Down? - KSS chart1


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