Conclusion: The growing divide in monetary policy relative to the US suggests current FX trends may continue and perpetuate crude oil prices beyond their summer ’08 peak. At the bare minimum, elevated prices are here to stay over the intermediate-term TREND – irrespective of the turmoil in the Middle East and North Africa.
Position: We remain long of inflation via crude oil, gold, agricultural commodities, and energy stocks. We remain short bonds, emerging markets, and US consumer and industrial stocks.
Perhaps the most important piece of economic data to hit our screens in recent weeks is ECB President Jean-Claude Trichet’s hawkish comments following the latest ECB policy meeting last Thursday. Regarding those comments, Matt Hedrick, our European Analyst writes:
“In a Q&A session after the ECB announced no change to its key interest rates this morning, ECB President Jean-ClaudeTrichet said that an “increase of interest rates in the next meeting is possible… but not certain.” Despite all attempts by Trichet to be close-lipped on future actions by the governing council, the sentence was largely interpreted by the market as proof that the ECB will hike in the near-term.
And both the EUR and European equity markets cheered on the news. The EUR-USD rose to an intraday high of $1.3966 and European equity indices gained to close up +50 to 150bps today.
Trichet also made it clear that today’s decision was based on data taken from mid-February, and therefore did not include the recent move in crude prices, which created further speculation that greater inflationary readings next month may boost the probability of an interest rate hike.”
Regarding these rising inflation expectations, Matt writes:
“In comments today, Trichet said the range for Eurozone inflation (CPI) has shifted upwards to between 2.0% and 2.6% in 2011 and between 1.0% and 2.4% in 2012, mainly due to “the considerable rise in energy and food prices.””
It has long been our stance that Bernanke & Co. will continue to be willfully blind to inflation pressures, as neither $100-plus crude oil or world food prices at all-time highs directly manifest themselves in the Fed’s preferred “Core” CPI reading. While refraining from the debate on the analytical merits of “core” vs. “headline” inflation, the key takeaway here is that the ECB just confirmed that they’ll be quicker than the Fed to react to rising inflationary pressures resulting from commodity inflation.
The ECB now joins the Bank of England, the Bank of Canada, Sweden’s Risbank, and the Swiss National Bank as key constituents of the US dollar basket that are exhibiting hawkish monetary policy on a relative basis to the Fed. Together, these currencies make up 86.4% of the US Dollar Index.
As we often say, “everything that matters in Macro occurs on the margin”, and, on the margin, the foreign central banks most important to determining the value of the US dollar are moving away from Bernanke & Co. on monetary policy.
As a result of this collective marginal shift in monetary policy, these currencies are appreciating relative to the US dollar:
- Euro (57.6%) of DXY: +9.5% since Aug 27;
- British Pound (11.9%) of DXY: +4.3% since Aug 27;
- Canadian Dollar (9.1%) of DXY: +8.1% since Aug 27;
- Swedish Krona (4.2%) of DXY: +15.5% since Aug 27;
- Swiss Franc (3.6%) of DXY: +11% since Aug 27; and
- Weighted average appreciation since Jackson Hole: +8.5%.
Understanding that currencies can only appreciate/depreciate relative to each other, it’s no coincidence that the US Dollar Index is down (-7.7%) over the same duration. The effect of monetary and fiscal policy on currencies does not happen in a vacuum; all deltas and inflection points must be considered relative to competing currencies.
Up until last week, it can be strongly argued that the dollar’s decline has been aided by a confluence of dovish US monetary policy (QE2) and incredibly lax fiscal policy (the CBO revised up the US federal budget deficit by +46% through FY13). With this news largely baked into the cake, we argue that incremental US dollar weakness (down -2.7% since it rallied to a lower-high in mid-Feb) is being driven largely by strength in the dollar’s counterparts, rather than incrementally-weak policy home:
- Euro (57.6%) of DXY: +3.6% since Feb 14;
- British Pound (11.9%) of DXY: +1% since Feb 14;
- Canadian Dollar (9.1%) of DXY: +1.7% since Feb 14;
- Swedish Krona (4.2%) of DXY: +2% since Feb 14;
- Swiss Franc (3.6%) of DXY: +4.7% since Feb 14; and
- Weighted average appreciation since mid-Feb: +3%.
The chart below shows the inverse relationship between the US Dollar Index and strength/weakness in its constituent counterparts (ex-Japan):
It’s no coincidence that mid-Feb corresponds with the latest jump in global crude oil prices, which have an incredibly high inverse correlation to the US Dollar Index:
- Brent: +11.1% since Feb 14 with an inverse correlation of -0.90 (r² = 0.81) on an immediate-term TRADE basis; and
- WTI: +18.2% since Feb 14 with an inverse correlation of -0.93 (r² = 0.87) on an immediate-term TRADE basis.
This price action underscores a developing trend we see picking up steam over the near term: increased hawkishness relative to the Fed out of the central banks within the US dollar basket as a result of rising crude oil prices will put upward pressure on their currencies and incremental downward pressure on the US Dollar Index – in addition to the USD’s own dovish fundamentals. Perhaps the most alarming part of this trend is that it has a self-perpetuating tendency:
- Crude Oil up;
- Increased hawkishness out of the ECB, BoE, BoC, Risbank, and SNB;
- Euro, Pound, Canadian Dollar, Swedish Krona, and Swiss Franc up;
- US Dollar Index down;
- Crude Oil up;
- Rinse & repeat.
Indeed, this self-perpetuation of global FX trends vividly reminds us of early 2008, where the monetary policy backing each of these currencies was hawkish relative to the Fed (with the notable exception of Canada, which was more impacted by the US’s burgeoning recession). Even the Bank of England, which was cutting rates at the start of 2008, was more hawkish than the Fed by cutting at a significantly slower pace. The ECB and the SNB were on hold after hiking rates in mid-to-late 2007 and the Riksbank was outright raising rates until September of 2008.
This collective hawkishness relative to the Fed from mid-to-late ‘07 through mid-2008 contributed to widening interest rate differentials across the board, as the spread between German, British, Canadian, Swedish, and Swiss 2Y bonds each increased vs. 2Y US Treasury bond yields (using German bunds as a benchmark for EU yields). This widening of spreads supported the appreciation of each currency (Euro, Pound, Canadian Dollar, Swedish Krona, and Swiss Franc) vs. the USD.
Understanding full well that the Fed did its best to debauch the dollar during this period, the US dollar would not have declined much without the aid of this relative hawkishness out of competing central banks – the buck can’t truly burn without help. Thus, as each currency appreciated relative to the USD, the US Dollar Index correspondingly depreciated. Given, we argue that much of the run-up in crude oil prices from late-2007 to mid-2008 was, in fact, due to strength in the USD’s counterparts as much as it was due to Bernanke Burning the Buck.
Fast forward to 2011, and we have a very similar scenario whereby competing central banks are getting tighter on the margin relative to the Fed by a combination of hawkish rhetoric and rate hikes. This marginal hawkishness is supporting each of their currencies to varying degrees (excluding Japan, which continues to hint at additional easing, but is handcuffed by rising import prices) and keeping the selling pressure on the US dollar, which keeps buying pressure on crude oil and other commodities.
While the US Dollar Index may be oversold on an immediate-term TRADE basis, the broader intermediate-term TREND suggests that this self-perpetuating cycle is already underway and will only be alleviated by some combination of dovishness out of the aforementioned foreign central banks or hawkishness out of the Fed from a policy perspective – which is unlikely given that Bernanke was unable to see inflation at $150/bbl. crude oil; nor could he hike rates when GDP growth was at +5% on an annualized basis.
We know QE2 is ending in three months; will the Fed be tempted to step on the gas pedal some more? Reasonably strong US GDP growth forecasts of around +3.5% for 2H11 suggest that QE3 is not consensus – yet. If, however, we are correct in our call for a measured rollover in consumption growth and expedited housing deflation over the intermediate-term TREND, calls for additional monetary easing in the US will indeed become consensus – making US monetary policy incrementally dovish vs. competing central banks, as well as giving the US dollar an incremental push to the downside relative to its counterparts.
Of course, the Eurozone continues to have its sovereign debt issues, so we’ll be acutely focused on their monetary policy as well, measuring the slope of any hawkishness or dovishness on the margin. For now, their relative hawkishness combined with that of the BoE, BoC, Riksbank, and SNB is supporting the price of crude oil, which, ironically, supports additional hawkishness.
Will the cycle extend itself as it did in early 2008? As always, time and space will tell.
A confluence of thoughts this morning made me come back to one of the most hated names in retail – Liz Claiborne.
US investors didn’t pay much attention this morning to the LVMH acquisition of a majority stake in Bulgari. It’s not the $5.2bn price tag or 27x EV/EBITDA multiple that matters to us as much as the simple fact that there will always be a market for great content. LVMH would have no interest in LIZ, but it took me back to the following comments, which are more relevant.
On Feb 17th PPR’s (Gucci parent) Francois Pinault is on the tape in saying that acquisitions remain core to the story (though he did note that the luxury side of the house will grow organically). PPR is not afraid to step outside its traditional box to buy a good brand that gets them to a new luxury consumer. The best case there is Puma ($7bn) deal in April 2007.
That brings me to Liz Claiborne. I know that it’s tough to use Liz Claiborne in the same sentence as Gucci or Bulgari. Trust me, I’m not going to make the case that they compete.
But can anyone explain to me why there are so many LBOs and activist investors hitting the tape for retail-related businesses at peak margins? But no one wants to get their hands dirty on the junk?
Yes, LIZ has major problems. Not the least of which is that I can’t even get people to give 5 minutes of their calendar to discuss this name. But we get to a sum of parts between $10-$12 per-share. Interesting that we model Kate Spade to be worth $3.75 per share alone. LIZ is at $5.41 today.
I understand that ‘break up values’ never work for valuation purposes. On the same token, my handy dandy valuation textbook doesn’t tell me why ‘problem child’ stocks gap up massively when management changes are announced. Try using a p/e analysis on that one.
I noted the ‘good is good/bad is good’ call over a year ago and I proved to be flat-out wrong. Perhaps the biggest area I was wrong was in my opinion that no Board worth its salt would ever let these results continue without major management changes, or an outright breakup of the company.
Well…The environment has changed, and the Board is allowing McComb to move forward with his current plans to; a) grow JCPenney/QVC, b) close underperforming retail stores, and c) fix Mexx.
Thus far, he’s underperforming on the margin – though cash flow is still not near a level that would threaten covenants. We’ll know that within two quarters.
In the end, will the nine outside Directors (three seats turn each year) allow this ship to sink if the current initiatives don’t work? Never say never. I hope that the answer is ‘No.’ But Hope is not part of Hedgeye’s investment process. Before that question needs to be answered I’m going to bet on a) our earnings and cash flow model, and more people taking the time to analyze it over the next 3 weeks.
As an aside, LIZ is hosting a March 31st analyst meeting in NYC. This is one where they’ll have all the heads of all business units. It should be insightful, to say the least.
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MCD is scheduled to report its February sales results before the market open tomorrow, the 8th of March. There was no difference in the number of weekdays and weekend days in February 2011 versus February 2011.
Below I go through my view on what sales results the Street will receive as “GOOD”, “BAD”, and “NEUTRAL” for each region. To recall, January’s U.S. result was a mere 10 basis points above my expectation and represented a slowdown for the company’s domestic business. I expect this slowdown to continue in February. There is plenty of time for my thesis on MCD in 2011 to play out, so I will not be discouraged by an upside surprise in February. I am below the Street’s estimate and would note that a miss in February may spur the sell-side to rethink expectations ahead of 1Q results. As gas prices creep higher, putting pressure on casual dining chains, MCD may actually benefit slightly but certainly not enough to dissuade me from my bearish thesis on 2011. After all, as I noted in last month’s sales preview, drive-thru sales are important for MCD’s sales, so any share gained from casual dining may be offset, likely depending on just how high gas prices climb.
Below I go through my take on what numbers will be received by the street as GOOD, BAD, and NEUTRAL, for MCD comps by region. For comparison purposes, I have adjusted for calendar and trading day impacts.
U.S. – Facing an easy +0.6% compare (there was no calendar shift in February 2010):
GOOD: A print of roughly 3% or higher would be perceived as a good result, implying that the company has improved two-year average trends from January. I believe that any improvement in two-year average trends would be met positively by investors. I believe a result in the NEUTRAL range – closer to the lower end of roughly 2% - is most likely. To reiterate, I expect a greater proportion of the slowing in top line trends that I have projected for the U.S. business in 2011 to take place after compares step up in difficulty from March onward. At that stage, I expect a more obvious divergence to emerge between my projections and those of the sell-side. Of course, weak results tomorrow may precipitate a correction in Street expectations ahead of 1Q results but, given the darling status currently enjoyed by MCD on Wall Street, I anticipate some stickiness in current consensus.
NEUTRAL: Roughly 2% to 3% implies two-year average trends that are approximately in line with the calendar-adjusted two-year average trend in January. I would add that, in reality, a result towards the lower end of this range will not be received well and that is where I expect the U.S. comp to come in.
BAD: Below 2% would imply a significant deceleration in two-year average trends on a calendar-adjusted basis. Headline comps for the U.S. were low for December and January with similarly easy compares. A further deceleration in two-year average trends would likely call into question the direction of the U.S. business for 2011.
Europe – Facing a compare of +5.4% (there was no calendar shift in February 2010):
GOOD: A print of approximately 6% would imply two-year average trends significantly higher than those see in December and marginally better than the strong two-year average trends in January. An improvement, or even maintenance, of trends from January would be well-received given that the compare in February is significantly more difficult than that of January.
NEUTRAL: Between roughly 5% and 6% would imply a two-year average trend slightly below January’s trend. While a deceleration is usually received negatively, a slowdown is almost expected following a sharp gain in two-year average trends in January.
BAD: Below 5% would imply trends significantly below January’s and, while I believe some allowance will be made for a deceleration given the improved levels of two-year average trends on an absolute scale, the perception of January’s Europe result as being anomalous will likely drag sentiment.
APMEA – Facing a difficult 10.5% compare (there was no calendar shift in February 2010):
GOOD: Any positive same-store sales result from APMEA would be well-received by investors. Given the difficulty of the compare from February 2010, +10.5%, a same store-sales print of roughly 0.0% would imply two-year average trends approximately in line with January’s result. Additionally, a third consecutive month of strong two-year average trends flowing November’s disappointing number would bolster confidence in the APMEA business.
NEUTRAL: Between -1% and 0% would imply two-year average trends roughly in line with January.
BAD: Below -1% would obviously look bad from a headline perspective but, also, on a two-year average basis, this would imply a significant deceleration in two-year average trends from January.
Position: Long Germany (EWG); short Italy (EWI); Emerging Market Eastern Europe (ESR)
Despite the news focused on the uprisings throughout MENA, European sovereign debt concerns have not gone away. Sovereign CDS spreads continue to trend higher, with Greece just shy of an all-time high and Portugal making a formidable move since early February (see 1st chart below). Additionally, our Risk Monitor for European banks shows a widening for the Greek banks week-over-week, bucking the trend of tightening across most European banks: tightening for 31 of the 39 reference entities and widening for 8 (see 2nd chart below).
The sharp rise in Greek swaps may be attributed to a few emerging factors within the last week:
- Rising uncertainty surrounds Germany’s position on a permanent Eurozone bailout package. With numerous state elections this year, Merkel must show strong fiscal discipline regarding a permanent package for the region’s insolvent members. Currently, both Greece and Ireland are looking to receive more favorable interest rate terms and/or an extension on payback schedules. Ahead of the EU Summit on March 24-5, the suggested deadline for a new “comprehensive” bailout package, Merkel and her Finance Minister Wolfgang Schaeuble are firmly opposed to the rescue fund directly purchasing Eurozone member government bonds. Greece, like Ireland, is shaking as investors worry the country will not be able to meet its debt schedule.
- Last week further attention was given to the growing “I don’t pay” movement in which more and more Greeks are refusing to pay for road tolls, bus tickets, and other public charges.
- Today Moody’s downgraded Greece credit rating by three steps on rising default risk (Ba1 to B1).
We continue to monitor the EUR-USD closely. We’d expect to see swings in the currency pair as European leaders will be pressed to agree on an all encompassing package for a region of economically unequal and politically divided states. Based on our models, the EUR-USD is currently overbought in a TRADE (3 weeks or less) range of $1.38-$1.40.
R3: REQUIRED RETAIL READING
March 7, 2011
- A study by Luminosity suggests that Boomerangers (college educated young adults with full-time jobs who live at home with their parents) are amongst the most impulsive shoppers. One-third of Boomerangers make impulse purchases with no planning or research. Perhaps part of this behavior stems from the fact that 64% of Boomerangers said they themselves were the greatest influence on their purchasing decisions.
- Check out New Balance’s latest product intro, the “890” with REVlite. The shoe goes head to head with Nike’s LunarGlide in New Balance’s latest TV commercial in a spot reminiscent of the Pepsi Challenge. The shoe weighs 9.7oz, which is 1.6oz lighter than the competing Nike shoe, and is premium priced at $99.99. Overall, more good news for the retailers as the innovation pipeline remains robust across the athletic footwear space.
- Consistent with reports from other footwear retailers last week, Genesco’s management highlighted that February comp sales were up +10% - representing an sequential acceleration to January trends. It’s also worth noting that management teams appear to be taking a conservative approach to positive performance early in the quarter with Q1 results largely back-end loaded given the Easter shift into April this year.
OUR TAKE ON OVERNIGHT NEWS
Hedgeye Retail’s Take: If you ever wondered how Amazon knows what you want before you actually search for it on the company’s site, now you know.
Inditex Buys Space on 5th Avenue - Inditex Group, parent of fast-fashion retailer Zara, has acquired a 38,800-square-foot retail property at 666 Fifth Avenue for $324 million. The space, between 52nd and 53rd streets, was formerly the NBA Store and is part of the building’s 90,000-square-foot retail condo that includes a Hollister flagship and a Uniqlo flagship due to open this fall. Uniqlo set a retail record in Manhattan last year when it agreed to pay $300 million over the course of a 15-year lease, or about $20 million per year, surpassing Gucci’s $16.5 million in annual rent at Trump Tower. Inditex said it will use the space to open “one of the most emblematic Zara flagships worldwide.” The Spanish behemoth is clearly smitten with the location and the building, which it called “one of the most symbolic in the Big Apple.” It’s also one of the priciest, commanding some of the highest rents in the city. The NBA Store closed last month after balking at the landlord’s rent increase to more than $2,000 a square foot. <WWD>
Hedgeye Retail’s Take: In strange bit of irony, all of the major fast fashion retailers (H&M, Zara, Uniqlo, and Forever 21) now have major flagship stores on 5th Avenue within a three block radius. So much for 5th Avenue being solely a haven for luxury.
Sears Targets Youth - Sears is getting in touch with its more youthful side. According to John Goodman, EVP of apparel and home, the retailer is reaching out to a younger, trendier customer in hopes of becoming “a more aspirational place” for shoppers. To achieve this, Sears — which has been working hard to more effectively compete against rivals such as Kohl’s — has in recent weeks signed deals with contemporary fashion brands and celebrities for exclusive lines. The retailer is kicking things off next month with UK Style by French Connection. Sourced, developed and manufactured by LF USA’s Regatta division, the line will comprise contemporary clothing and accessories, including shoes, for women, men and children. <WWD>
Hedgeye Retail’s Take: We’re not sure why it’s taken so long for Sear’s to realize it has a problem with an aging customer base. Unfortunately, filling the store with youthful brands is probably not going to be a needle mover any time soon.
Best Buy Losing Market Share - Just two years after its arch rival was knocked out of the ring, Best Buy is itself on the ropes. The company revealed a problem last December that has left investors scrambling for answers. Even with bankrupt Circuit City out of the picture, the retailer was losing market share, especially in the key television and computing categories. Best Buy shares have since tumbled 21% and now trade at a mere nine times this fiscal year's consensus earnings. Investors shouldn't assume Best Buy simply needs time to recover. Rather, the threats it faces are likely only to worsen. Take Amazon.com, whose relentless growth has undercut the raison d'être of specialty retailers. That is true both in books—where Borders Group recently filed for bankruptcy protection—and in electronics. <WallStreetJournal>
Hedgeye Retail’s Take: With bookselling much more concentrated than consumer electronics, we do believe BKS has an opportunity to actually gain share from BGP’s demise.
LVMH to Take Controlling Bulgari Stake - LVMH Moet Hennessy Louis Vuitton SA is to take a controlling stake in Bulgari SpA, a person familiar with the matter said Sunday, underscoring the French group's acquisitive streak as the luxury market rebounds. The deal, expected to be announced Monday, would put the family-controlled Italian maker of jewelry and fine watches into the hands of LVMH, which owns some 50 luxury brands, including Louis Vuitton, Moët et Chandon and TAG Heuer. Bulgari has a market value of about €2.3 billion ($3.22 billion). Paolo Bulgari and Nicola Bulgari, along with Chief Executive Francesco Trapani, also a relative, own about 51% of the company. <WallStreetJournal>
Hedgeye Retail’s Take: In stark contrast to Arnault’s approach with Hermes, this deal with Bulgari appears to benefit both franchises on multiple levels, but most notably is highly amicable. Meanwhile, Hermes CEO Thomas commented at a press conference last week that the company is considering removing its listing from the London exchange to keep investors from trading shares - this one is far from over.
Michael Kors Opens Paris Flagship - Michael Kors is marking his 30th anniversary with the opening of his first freestanding store in France, a flagship here that is his largest store to date worldwide. The 7,000-square-foot unit at 279 Rue Saint-Honoré sits on the designer’s favorite retail stretch — what he calls the “stroll from Hermès to Colette.” It is the first of his stores to offer a full assortment of accessories and ready-to-wear from both his main Michael Kors collection and the Michael Michael Kors and Kors Michael Kors lifestyle lines. <wwd>
Hedgeye Retail’s Take: A substantial step forward for the designer best known for his womenswear prowess. After expanding beyond his runway collection in 2004, this is Kors’ first international full collection footprint with five such boutiques stateside – a key step in growing the brand that is perhaps best known on Main Street for its eyewear collection.
First Chinese Leather Fashion Association to be Established - The first Leather Fashion Design Association is officially founded in the beginning of March in Haining city, China, with Zhang Sifeng, a renowned fashion designer, being appointed president of the association, while Haining China Leather Marketing President Ren Youfa being the honorary president, according to the China Leather Industry Association. Ren Youfa said in the opening ceremony that there are nearly one thousand designers serving the leather sector in Haining city, and therefore the establishment of fashion association is good news to the designers as it will serve as a channel to reach out to enterprises and update their products in terms of design. <FashionNetAsia>
Hedgeye Retail’s Take: The latest from China in a move to improve the quality of its manufacturing after losing its position in the global market as the most affordable.
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