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KSS - The Risk In 'KSS Rewards'

Takeaway: Decoupling KSS Credit from the Rewards Program is fine. But 57% of revs and $1.24 in EPS is dependent on Credit. KSS shouldn't disrupt this.

Yesterday KSS announced an 'official' change to its rewards program. We think this represents more of a risk than anything else.

 

Here's the Release

Kohl’s Pioneers New Approach to Customer Engagement with Launch of Yes2You Rewards Loyalty Program

(http://phx.corporate-ir.net/phoenix.zhtml?c=60706&p=irol-newsArticle&ID=1974215)

 

What It Is: Put in simple terms, this is a decoupling of KSS' credit card from its loyalty program. Previously, anyone that wanted to enroll in the 'rewards program' also had to have a KSS Credit Card. 

 

Why It's Not New: This was largely a press release to the general public -- not to Wall Street. Earlier this year KSS decoupled its rewards program from its credit card in Pittsburgh, Milwaukee, and most markets in Texas and California. The company said that it would change up the rest of the US in the back half of the year -- which it just did.

 

Why We're Concerned

  1. First off, in our recent survey, 18% of people said that they are members of KSS rewards program, which is the highest rate of any department store in our survey (ie might not go much higher). The interesting thing is that 57% of KSS Sales flow through the credit card -- up from 47% 5-years ago.
  2. This is a program with CapitalOne, switched three years ago from Chase. It's worth noting that the median credit scores for CapitalOne's portfolio range from 600-650 compared to Chase at 700-750. So it's safe to assume that the last 700bp in KSS sales bought on the store card came from a consumer with lower credit quality, and presumably is in a less enviable financial position.
  3. While it's possible that Kohl's 'Pioneered Approach to Customer Engagement' increases customer loyalty, we'd actually wonder if this gives an outlet for current rewards members to no longer use the KSS card. KSS flowed $407mm in credit card income through its P&L as an offset to SG&A last year -- that's 9.5% of total SG&A, or $1.24 per share in earnings. That's probably headed down, not up. 

KSS - The Risk In 'KSS Rewards' - 10 7 kss1

 

KSS - The Risk In 'KSS Rewards' - 10 7 kss 2


Daily Trading Ranges, Refreshed [Unlocked]

Takeaway: This is a complimentary look at our proprietary buy and sell levels on major markets, commodities and currencies for Tuesday October 7, 2014

This note was originally published October 07, 2014 at 07:45. Click here to learn more and to subscribe to Daily Trading Ranges.

Daily Trading Ranges, Refreshed [Unlocked]   - dtr

 

BULLISH TRENDS

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BEARISH TRENDS

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Dollar, UST 10YR and Russell

Client Talking Points

USD

If you didn’t know macro markets are highly correlated to USD correlation risk, now you know. USD correlations to big stuff like Gold and Oil are running -0.8-0.9 on 60-90 day correlations right now; yesterday’s up move in Gold is just the upside down of what’s been an epic EUR/USD meltdown.

UST 10YR

UST 10YR Yield dropping to 2.41% after some hoped that Friday’s jobs report was going to mean they got paid on the short side of bonds – not so much as the UST 10YR Yield moves back toward crash mode (-20% year-to-date); the Long Bond remains our best Macro Long Idea for 2014.

RUSSELL 2000

The Russell 2000 was down another -0.8% yesterday taking its draw-down to -9.4% from its all-time #bubble high established on July 7th, 2014; next support is 1079, but that’s just an immediate-term level – intermediate-term there’s no support down to 1015 ish.

Asset Allocation

CASH 60% US EQUITIES 2%
INTL EQUITIES 8% COMMODITIES 4%
FIXED INCOME 24% INTL CURRENCIES 2%

Top Long Ideas

Company Ticker Sector Duration
EDV

The Vanguard Extended Duration Treasury (EDV) is an extended duration ETF (20-30yr). Now that we have our first set of late-cycle economic indicators slowing in rate of change terms (ADP numbers and the NFP number), it's time to really think through the upcoming moves of this bond market. We are doubling down on our biggest macro call of 2014 - that U.S. growth would slow and bond yields fall in kind.

TLT

Fixed income continues to be our favorite asset class, so it should come as no surprise to see us rotate into the Shares 20+ Year Treasury Bond Fund (TLT) on the long side. In conjunction with our #Q3Slowing macro theme, we think the slope of domestic economic growth is poised to roll over here in the third quarter. In the context of what may be flat-to-decelerating reported inflation, we think the performance divergence between Treasuries, stocks and commodities may actually be set to widen over the next two to three months. This view remains counter to consensus expectations, which is additive to our already-high conviction level in this position.  Fade consensus on bonds – especially as growth slows. As it’s done for multiple generations, the 10Y Treasury Yield continues to track the slope of domestic economic growth like a glove.

RH

Restoration Hardware remains our Retail Team’s highest-conviction long idea. We think that most parts of the thesis are at least acknowledged by the market (category growth, real estate expansion), but people are absolutely missing how all the pieces are coming together to drive such outsized earnings growth over an extremely long duration. The punchline of our real estate analysis is that a) RH stores could get far bigger than even the RH bulls seem to think, b) Aside from reconfiguring 66 existing markets, there’s another 19 markets we identified where the spending rate on home furnishings by people making over $100k in income suggests that RH should expand to these markets with Design Galleries, and c) the availability and economics on large properties for all these markets are far better than people think. The consensus is looking for long-term earnings growth of 28% -- we’re looking for 45%.  

Three for the Road

TWEET OF THE DAY

Our Ace, Todd Jordan @HedgeyeSnakeye  has been making the bear call on Macau since June - reiterating SELL $LVS today

@KeithMcCullough

QUOTE OF THE DAY

The four most dangerous words in investing are: “this time it’s different.”

-Sir John Templeton

 

STAT OF THE DAY

Merger and acquisition activity has jumped this year, the total M&A volume is now $1.29 trillion in 2014 on pace for a record, according to data provider Dealogic.


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Pygmy Minds

This note was originally published at 8am on September 23, 2014 for Hedgeye subscribers.

“The government which governs the least, governs best.”

-Thomas Jefferson

 

After the election of 1800, Alexander Hamilton didn’t like the aforementioned Presidential acceptance speech from Thomas Jefferson. He called it the “symptom of a pygmy mind.” Jefferson sounded pretty darn smart to me.

 

What wasn’t smart was what Hamiltonian central planner and New York group-thinking Fed head, Bill Dudley, said about the purchasing power of the American people (the US Dollar) at a Bloomberg conference in NYC yesterday:

 

“We would have poorer trade performance, less exports… and if the Dollar were to appreciate a lot, it would dampen inflation… making it harder to achieve our objectives.” I couldn’t make that up if I tried. In stark contrast to the Reagan/Clinton administrations, who trumpeted Strong Dollar (and raised rates), this is how the Bush/Obama economic teams thought/think.

 

Pygmy Minds - dud

 

Back to the Global Macro Grind

 

Evidently, alongside his protectionist big government spenders at the US Treasury, Mr. Dudley is lost in some 18th century British time warp. And you know what, you’re going to have to deal with it. Because it’s not going away. In an economy that is 70% consumption, it’s all about the “exports”, baby!

 

To put this day in American history in context, Bloomberg’s “50 Most Influential” are mostly government guys. My partner, and Director of Research @Hedgeye, Daryl G. Jones, was at their conference yesterday (Mike, we’re a big customer – love the data product!). From raging Keynesian, Jason Furman, to Jack Lew, this was quite the central planning affair.

 

To recap yesterday’s headlines, in addition to Dudley talking down the Dollar and rates (good for our Long Bond  (TLT) position):

 

  1. Lew wants to limit inversions
  2. Jason Furman wants to spend
  3. Larry Summers wants a “major spend”

 

In other words, when all monetary policies fail to create real, sustainable, economic growth, the USA needs to move the goal posts (again) and spend, spend, spend. Isn’t that just wonderful.

 

In other news…

 

  1. The BABA #Bubble stopped inflating yesterday (Dudley, get on that)
  2. The Russell 2000 lost another -1.7% on the day, reiterating its bearish TREND for 2014
  3. The 10yr Bond Yield is falling (again) this morning to 2.54%, -16.2% YTD

 

Oh, and there are some bombs dropping in the Middle East again too, but no worries. At 55x trailing earnings, and 42% of the names in the Russell 2000 crashing (-20% or more from their 12 month peak), the US stock market is “cheap.”

 

Talk is cheap. Especially the central planning kind. Remember the narrative that 0% rates forever were going to provide Americans their housing dream? Well the news on that front sucked (again) yesterday, as Existing Home Sales for August slowed (again).

 

And what do you think US government monetary and fiscal policy is going to do as Housing and Employment gains from 2013 slow?

 

A)     Get tighter on interest rates and spend less

B)      Get tighter on rates and spend moarrr

C)      Get looser on rates and spend, spend, spend

 

Alex, I will take C).

 

As opposed to betting alongside consensus (which still thinks rates are going to rise), this Mr. Market chose C) yesterday too:

 

  1. Housing stocks (ITB) got crushed on the “news” -2.1% to -6.8% for 2014 YTD
  2. Russell 2000 diverged, big time, from the big cap Dow, -1.7% to -3.0% for 2014 YTD
  3. Consumer Discretionary (XLY) was down -1.4% yesterday, underperforming Utilities 2x

 

Yep, when US GDP growth expectations slow, you buy the Long Bond (TLT = +13.1% YTD) and anything that looks like a #YieldChasing bond (Utilities), and you like it.

 

The biggest risk to buying anything US equities (especially REITS and Commodity linked stocks) is that we are right in our US economic projections and entering what we call Quad 4 (where both inflation and growth are slowing, at the same time).

 

With that, my pygmy mind (I’m 5’9 in the 1994 hockey program, standing on pucks in my socks) agrees with Mr. Dudley, wholeheartedly. If these guys turn this place into Japan, they won’t be achieving anyone’s growth or inflation “objectives.”

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.42-2.59%

SPX 1977-2011

RUT 1115-1154

VIX 11.66-14.22

USD 83.99-84.96

Gold 1211-1256

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Pygmy Minds - Chart of the Day


CHART OF THE DAY: Exorbitant Privilege (Fed Remittances to the U.S. Treasury)

 

CHART OF THE DAY: Exorbitant Privilege (Fed Remittances to the U.S. Treasury) - FED Remit


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


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