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Exorbitant Privilege

“The Dollar is our currency, but it’s your problem.”

-U.S. Treasury Secretary John Connally, 1971

 

When charged with getting up early and working against the clock to produce a daily strategy missive, sometimes you throw up some duds.  You are, however, afforded the “exorbitant privilege” of serving as creator, curator and editor-in-chief of your own content. 

 

With KM in London, alongside a general dearth of domestic economic data this week, we’re afforded the opportunity to hit the Macro rand() button and survey some broader, top-down topography.

 

Exorbitant Privilege - 4

 

So, on with the binary dud or stud content creation....

 

Valéry Giscard d’Estaing, the French Finance Minister in 1960, coined the term “exorbitant privilege” in rebuking the U.S.’s ability to issue external liabilities (ie cheap treasury debt) at a discount to the global cost of capital while earning higher returns on foreign equity, debt and FDI holdings. 

 

Simply, as venture capitalist to the world and sole beneficiary of dollar hegemony – we get to borrow low and lend high. 

 

…and borrow we have. 

 

Over the last 34 years, on our way to becoming the biggest debtor nation in history, we have borrowed some $10.4T, with an average annual deficit-to-GDP ratio of ~3.2%.

 

What does that mean exactly and what are the consequences of such a massive imbalance in the global flow of goods, services, income & assets?

 

In short, it means we’ve borrowed and/or sold accumulated wealth to finance consumption in excess of income – with the tailwinds of globalization and financial integration helping us do so in unprecedented magnitude.   

 

To review: 

 

The global flow of commerce and capital can appear complex and convoluted but, in large part, the same dynamics and constraints that drive spending and borrowing decisions for the individual or household apply to sovereigns as well. 

 

If national expenditures (C+I+G) are greater than domestic output (GDP) – if spending is greater than income – that difference is financed by borrowing from abroad;  either by direct issuance of debt or via dissaving and the selling of domestic and external assets. 

 

A creditor/surplus country whose expenditures are less than its income lends that difference to a deficit country by buying the deficit country’s debt/assets.  From the opposite perspective, a debtor/deficit nation finances consumption expenditures in excess of income by selling assets or issuing debt to a surplus nation.

 

Such trade balances have important implications for national wealth because a country’s net investment position with the rest of the world (ie. how many foreign assets a country owns vs. foreign claims on domestic assets) defines a nation’s external wealth – and, in the (very) long run, it’s a country’s level of wealth plus its level of income (ie. GDP) that determines its long-run capacity to spend.    

 

Since ~1980, the U.S. has incurred a persistently negative trade balance, financing current consumption by dissaving and borrowing from abroad. 

 

Interestingly, however, U.S. external wealth has declined disproportionately less than the cumulative trade deficit.   Indeed, we have been a net exporter of assets to the tune of ~$600B per year via the trade deficit but our external net wealth has declined only modestly, even risen significantly in many years.  

 

How can a country increase its net wealth?  Again, the same as an individual or household:

 

  1. Save more (ie. the trade balance:  reduce/reverse the trade deficit)
  2. Be the beneficiary of gifts of assets (ie. the capital account: not really a factor for the U.S.)
  3. Benefit from capital gains (ie. high positive ROI on external assets)

 

For a country that is a net debtor, the singular path to earning positive net interest income is by receiving a higher rate of interest on its external assets than it pays on its liabilities. 

 

For the U.S. a few primary factors have driven this:

 

  1. The US gets to borrow low:  reserve currency, deepest/liquid market, risk-free rating, etc
  2. The US exports a significant amount of capital to foreign markets:   EM and developing market risk premiums are higher but, longer-term, returns are better also.  For the U.S., the benefit comes in the form of higher relative capital gains
  3. EM & Developing Countries borrow high and lend low:  This is an oversimplification but it's broadly true.  Cost of capital for EM and developing countries is comparably higher and, to the extent a higher proportion of investment capital flows to US/DM treasury debt (vs equity or FDI), the returns are comparably lower.

 

How do the above factors impact net external wealth and play to the benefit of the U.S.?  

 

Here’s the textbook equation for change in external wealth over a given period:  

 

Change in External Wealth = Trade balance + interest paid/received on prior period external wealth + interest rate differential + capital gains

 

It’s the two terms on the far right side of the equation that have provided an incremental net benefit to the United States and have underpinned her Exorbitant Privilege for nearly a century.

 

The data is somewhat mixed and open to debate, but the BEA estimates the US has been the beneficiary (due to the confluence of factors highlighted above) of a positive interest rate differential of ~1.5% and a positive capital gain differential of ~2% for the last 3 decades. 

 

In other words, Exorbitant Privilege has provided an  ~3.5% offset to the trade deficit. 

 

In recent years, global central bank policies aimed a lowering interest rates and inflating financial asset prices have served to further perpetuate that privilege.

 

Indeed, recall the circular flow of QE mechanics:  

 

The Treasury issues debt --> the Fed buys the debt --> the Treasury pays the Fed interest --> the Fed gives the money back to the Treasury.     

 

In addition to directly lowering the cost of U.S. external liabilities via large scale asset purchases, remittances from the Fed – at ~$80B/yr and equivalent to  ~35% of federal net interest expense – takes the effective cost of capital for the Treasury further towards 0%. 

 

#FreeLunch…for now

 

Since 1450 the mean length of dominance for a particular global reserve currency = 94 years.

 

The current duration of reign in US dollar supremacy?  Yup…94 years.

 

$USD correlation risk in markets currently is acute and for the investible future, the dollar will remain the Fx alpha male.

 

But alongside the fledgling internationalization of the renminbi and accumulating bilateral swap agreements across the BRIC and Asian axes, the anti-dollar coalition is ascendant.     

 

The dollar is our currency, and the cost of cumulative excess afforded under a century of privilege will be our problem during its descendancy. 

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.38-2.49%

SPX 1

RUT 1079-1108

VIX 14.09-17.54

USD 84.85-86.71

Brent Oil 91.18-95.16 

 

To free lunches, perpetual short-termism and blissful ignorance,

 

Christian B. Drake

Macro Analyst

 

Exorbitant Privilege - FED Remit


October 7, 2014

October 7, 2014 - Slide1

 

BULLISH TRENDS

October 7, 2014 - Slide2

October 7, 2014 - Slide3

 

BEARISH TRENDS

October 7, 2014 - Slide4

October 7, 2014 - Slide5

October 7, 2014 - Slide6 

October 7, 2014 - 7

October 7, 2014 - Slide8

October 7, 2014 - 9

October 7, 2014 - Slide10


THE HEDGEYE MACRO PLAYBOOK

Takeaway: The Hedgeye Macro Playbook is a daily 1-page summary of our core ETF recommendations, investment themes and noteworthy quantitative signals.

CLICK HERE to view the document. In today’s edition, we highlight:

 

  1.  Why a stronger US dollar is likely here to stay with respect to the intermediate term (hint: #Quad4)
  2. Why consumer discretionary stocks are not a buy on the now-consensus, but nonetheless brilliant "crude oil is breaking down" thesis

 

Best of luck out there,

 

Darius Dale

Associate: Macro Team


investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.

THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP – October 7, 2014


As we look at today's setup for the S&P 500, the range is 41 points or 1.42% downside to 1937 and 0.67% upside to 1978.                                                      

                                                                         

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: 1.88 from 1.89
  • VIX closed at 15.46 1 day percent change of 6.25%

MACRO DATA POINTS (Bloomberg Estimates):

  • 7:45am: ICSC weekly sales
  • 8:55am: Redbook weekly sales
  • 10am: JOLTs Job Openings, Aug., est. 4.7m (prior 4.673m)
  • 10am: IBD/TIPP Economic Optimism, Oct. est. 45.1 (prior 45.2)
  • 11:30am: U.S. to sell 4W bills
  • 1pm: U.S. to sell $27b 3Y notes
  • 3pm: Consumer Credit, Aug., est. $20.0b (prior $26.006b)
  • 2:30pm: Fed’s Kocherlakota speaks in Rapid City, S.D.
  • 3pm: Fed’s Dudley speaks in Troy, N.Y.
  • 4:30pm: API weekly oil inventories
  • 4:30pm: Fed’s Potter speaks in New York

 

GOVERNMENT:

    • Senate, House out of session
    • 8am: FCC Chairman Wheeler lecture at Newseum event
    • 8:45am: Treasury’s Lew speaks at Peterson Institute on global economy ahead of IMF/World Bank meetings in Washington
    • 8:45am: CFPB’s Thomas Kearney, FTC’s Malini Mithal speak at American Bar Assn conference on consumer financial svcs
    • 10am: Supreme Court hears case involving religious rights in prison
    • 1pm: Woodrow Wilson Center holds discussion on “The Politics and Process of Keystone XL”
    • U.S. ELECTION WRAP: Senate Debates in N.H., Colo.; Gay Marriage

 

WHAT TO WATCH:

  • IBM Said to Resume Talks to Offload Chip Unit to Globalfoundries
  • Time Warner’s Turner to Eliminate 10% of Jobs to Boost Profit
  • Paulson Says AIG Harsh Loan Terms Needed as Geithner to Testify
  • U.S. Banks Said to Face Another Round of Charges by DOJ: NYT
  • Banks Face 25% Loss-Absorbency Rule in FSB Too-Big-to-Fail Plan
  • Lundin Agrees to Buy Freeport Chile Copper Mine for $1.8b
  • Allergan Asks Judge to Block Ackman From Voting Stock at Meeting
  • AT&T Says Employee Gained Unauthorized Access to Customer Data
  • HP Going It Alone in PCs Faces Tough Suppliers, Shrinking Market
  • HP Seeks Judge’s Approval of Revised Autonomy Deal Settlement
  • U.S. Holiday Sales Seen Rising Most Since 2011 on Job Gains
  • Amazon Said to Face EU Antitrust Probe Over Luxembourg Tax Deal
  • German Industrial Output Drops Most Since 2009 as Risks Rise
  • Samsung Earnings Slump 60% as Galaxy Smartphones Sales Struggle
  • Bank of Japan Sees Wider Dissent on Inflation Language
  • Tesla Seen Adding All-Wheel-Drive Model S Version by Analysts
  • Sanofi Notifies U.S. Authorities on Bribery Allegations
  • Hong Kong Tensions Ease on Talks as City Weighs Cost of Protests
  • Social Finance to File for $200m-$250m IPO Next Yr: WSJ

 

EARNINGS:

    • International Speedway (ISCA), 7:30am, $0.01
    • Yum Brands (YUM) 4:15pm, $0.83

 

COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)

  • Brent Crude Falls With WTI as German Output Fans Growth Concern
  • Palm Production in Malaysia Seen Declining Most Since February
  • Gold Trades Above 2014’s Low Before China Returns From Holiday
  • Rio Tinto Jumps After Saying It Rejected Glencore Approach
  • Copper Declines Amid Concern European Demand Is Set to Weaken
  • Cotton Glut Eroding Cost for Gap as China Buys Less: Commodities
  • Soybeans Drop From Two-Week High in Chicago on Rising Reserves
  • Palm Oil Climbs a Second Day as Malaysian Output Seen Dropping
  • Indonesia’s Tin Exports Climb Most in Four Months in September
  • Iron Ore Futures Volume in Sept. Seen by TSI Overtaking Swaps
  • Chile Top Renewable Market on Sunny Desert, Windy Shores: Energy
  • EU Manufacturing Reaps $2.5 Billion Permit Win: Carbon & Climate
  • Occidental Said to Seek Buyer for $3 Billion Bakken Oil Business
  • Glasenberg’s Designs on Rio Tinto Hinge on China Inc.’s Approval

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


Retail - TIME CHANGE: Department Store Black Book

Takeaway: In this Black Book, we dive into everything from Dept Store current trends (survey) to what the group will look like in the next eco cycle.

Please note NEW DATE/TIME for our Deep Dive on Department Store Fundamentals and Stocks. Our call will be next Thursday, October 16th at 11:00 am ET. Relevant tickers: JCP, M, KSS, DDS, JWN, SHLD, TGT, WMT, TJX, and GPS.

 

Key Topics Will Include:

 

1.  What will the Department Store Landscape look like (physically and financially) when we transition into the next economic cycle?


2.  Detailed Revenue analysis for all the Department Stores – by category, consumer, and demographic.  Who has the most risk/upside based on where we are in the economic cycle?


3.  Margin Sustainability: Who has the most defendable margins and levers to pull in the event of a sales downturn?

 

4.  The importance of Financial Engineering to earnings algorithms.

 

5.  Current Business Trends: Results from our detailed 1,000 consumer survey. This is the 4th iteration of the survey that we started back in 3Q of 2013

  • Visitation statistics
  • Dot.com and Mobile trends
  • Buy Online/Pick Up in Store – does anyone really use this? Which retailers have the competitive advantage?
  • Detailed category analysis – what retailers are top of mind in each category
  • Who wins on price, sales, selection, and quality

6. Real Estate Deep Dive

  • What does the competitive matrix look like across the space
  • Winners &  losers from a demographic and spending vantage point
  • Are department stores over or under-indexed to their target customer?
  • The JCP and SHLD affect – what do more store closures mean for other names in this space

7.  E-commerce – we’ll be releasing a much more in depth look at e-commerce across the retail space in a Black Book due out in the next couple of weeks – but we will preview that work with a focused look on the department store space. Most importantly which retailers have invested the capital needed to drive growth in this channel.

 

Call details to follow

 

 

 


JCP – What JCP Needs To Say

Takeaway: There’s a gap between what JCP should say vs. what it will say on Wednesday. All it needs to say is “break even in 2016.”

Ullman & Co have a pretty easy job at this Wednesday’s JCP analyst meeting. Expectations are low, and this company has not articulated a long-term plan since Ron Johnson took center stage and then proceeded to destroy $8.6bn in shareholder value – or 87% of JCP’s market cap. Talk about easy comps. We don’t think it will take much to get people excited.

 

There’s sure to be information overload on Wednesday, but there’s only a few simple messages we want to hear.

  1. “Sales productivity of $140 by 2016”, up from $108 today. This includes Store productivity going from $98 to $120, and JCP adding another $500mm in e-commerce sales (much of which we think will come from Kohl’s).
  2. “Positive Earnings by 2016”. This would actually be a huge news event for JCP given that the consensus has JCP losing money…well…forever. We think that positive in 2017 is very likely, but 2016 is certainly possible.
  3. “Close 300 Stores”.  Our math suggests 300 stores that need to be closed. We identified each of them in an analysis in May, and outlined some of the salient points below. We’d peg a 25% or less chance in getting this announcement on Wednesday. But we don’t see how Ullman can stand up there with a straight face and say that the company is currently running the optimal fleet size. It’s too close to the holiday for him to send a message to 25% of his rank and file that they might not have jobs anymore. We expect some acknowledgement of a small number of store closures on Wednesday, with a far greater announcement coming in the new year.

 

POSITIVE JCP DATAPOINT FROM OUR CONSUMER SURVEY

We’re in the process of compiling one of our Deep Dive Black Books and will be hosting a call next week. We’ll be discussing several things, including…

a) What the Department Store landscape should look like (operationally and financially) when we enter the next economic cycle.

b) Detailed Revenue analysis for all the Department Stores – by category, consumer, and demographic.

c) Detailed Results of our latest Consumer Survey on the department stores.

d) Real estate deep dive – including overlap with stores that are likely to go away.

e) E-commerce – growth and profitability prospects for the companies and industry.

 

Here’s one chart as it relates to JCP that we thought was worth sharing. Each time we conduct our Consumer Surveys, one thing we ask the 1,000 department store shoppers is to rank which are their ‘go to’ stores in each product category. We don’t necessarily look at the results compared to one another, as Macy’s will obviously get more votes across the board than Lord & Taylor or Bon-Ton, for example. But we can gauge the incremental change for each company from one survey to the next (in this instance, 1Q14 to today).

 

There’s only one company that improved its ranking in every single product category – and that’s JCP.

 

JCP – What JCP Needs To Say - jcpgrid

 

REAL ESTATE OVERVIEW

Here are a few select highlights of the JCP Real Estate Analysis we conducted in May.   

1. Real Estate Approach: We did this analysis from the vantage point of a) optimizing JCP’s fleet, and b) seeing what the revenue impact would be for KSS. In order to properly assess the potential, we analyzed every JCP market to see where the most likely closures are, and whether or not they overlap with KSS. For starters, we did not simply map out store locations (a feat in itself) and draw a circle around each point on the map to gauge overlap by market. We mapped out a 15-minute driving radius around every store, which as you can see by the chart below is very different for every single store location in the country. This shows Tallahassee, FL, which has two locations where JCP and KSS overlap perfectly, and another location where JCP exists without KSS as a competitor. We did this in every market in the US.

 

JCP – What JCP Needs To Say - jcp2

 

2. Productivity Analysis. This next chart shows us what the implied sales per square foot range is for JCP’s 1089 stores. What we know is that in the US, JCP has 0.47% share of wallet in apparel, home furnishings and other relevant retail goods across its portfolio in aggregate – again, we’re looking at all expenditures within a 15 minute drive of its stores. If we apply that ratio to each market, we get implied sales/square foot levels ranging from $8 to nearly $1,000 (Manhattan). We know that share is likely to vary by market, so we’re not trying to say that these are the exact productivity levels of each store. But directionally, we think we’re right. And that direction tells us that 782 stores, or nearly 72% of JCP locations, are running below the system average of $98/square foot.


JCP – What JCP Needs To Say - jcp3
 

3. 300 Store Closures: We think that JCP needs to close 300 locations, at a minimum. We know that the demographic profile in the surrounding area of JCP stores in aggregate is about $66k in annual household income. We also know that JCP just identified 33 stores that it is closing. We analyzed those locations, and the demographic profile is $54k annually – that’s 18% lower than the portfolio average. So we looked throughout the system of JCP stores and looked to see how many other stores fit that profile. There are 300. If these stores are closed, the average income statistic goes up for the whole portfolio by 7% to $70k.  The 300 stores closed have implied sales/square foot of less than $38 annually. There are still almost 500 stores above $38 and yet still below the system average. 

 

JCP – What JCP Needs To Say - jcp4
 

4. Revenue Impact of Closures. Our math suggests that these stores would only result in about $550mm-$600mm in revenue loss to JCP. Importantly, KSS only overlaps in 42% of these markets. Our research shows that KSS took about 19% of the $5.4bn in sales JCP hemorrhaged over the past three years. If we apply a 20% share gain level to this analysis for KSS, it suggests about $73mm, or less than 0.4% to KSS in comp. If you want to get more aggressive and assume that KSS takes 100% of that revenue (which WMT won’t allow) you’re looking at about 1.9% in comp to KSS. We think something far below 1% is closer to reality. Here’s the sensitivity analysis below.

 

JCP – What JCP Needs To Say - jcp5

 


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Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

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