Takeaway: Don’t write-off outflows from EM funds as panic selling. In reality, the cycle has turned and most investors are just now figuring that out.
If you didn’t know the global macro super-cycle has turned, now you know. As most recently outlined in our latest EM strategy note titled: “NAVIGATING #EMERGINGOUTFLOWS: STRATEGY FROM THE SOURCE” (1/27/14):
“We remain broadly bearish on EM assets and continue to see them for what they are: overpriced relative to a long-term TAIL investment cycle that has clearly turned in favor of DM assets, at the margins.”
Contrast our view with that of Mark Mobius, chairman of the Templeton Emerging Markets Group (i.e. one of, if not the world’s largest EM fund umbrellas):
“People are enjoying what they see as a bull market in the U.S. As we go forward, we’re going to see a lot of overweight positions in the U.S. So, given the fact that emerging markets are still growing fast, given that they have low debt-to-gross domestic product ratios, given that they have high foreign-exchange reserves, we believe that money will be flowing back in again to emerging markets.”
We don’t write that to pick on Mr. Mobius, who has obviously had a very long and successful career managing EM assets. In fact, he probably forgets more about emerging markets on the way to lunch than I have ever learned as a quote/unquote “26-year-old-analyst” (ask @JimCramer for context).
Rather, we wrote that to juxtapose how our investment framework focuses on changes on the margin – particularly relative to expectations – versus the framework employed by many investors: i.e. a narrow focus on absolutes with a dash of consensus storytelling.
Another reason we wrote that was to show you where the quote/unquote “smart money” consensus likely still is with respect to EM assets. We know the quote/unquote “dumb money” has been pulling funds out of EM assets for 6-9M now and are doing so on an accelerated basis in the YTD. With respect to the current asset price cycle, you tell me who’s “smarter”?:
- “The MSCI Emerging Markets Index of equities is off to the worst start to a year since 2008, with about $468 billion erased from stocks this year.” – Bloomberg (1/30/14)
- “More than $7 billion flowed from ETFs investing in developing-nation assets in January, the most since the securities were created, data compiled by Bloomberg show.” – Bloomberg (1/30/14)
- “The iShares MSCI Emerging Markets ETF has seen its assets shrink by 11 percent, while the Vanguard FTSE Emerging Markets ETF is poised for the biggest monthly redemption since the fund was started in 2005.” – Bloomberg (1/30/14)
- “The WisdomTree Emerging Markets Local Debt Fund is on track for an eighth straight month of withdrawals… About $58 million has been withdrawn from the WisdomTree debt fund this month, bringing the total redemption since June to $752 million.” – Bloomberg (1/30/14)
- “Withdrawals from the iShares fund and the Vanguard ETF, the largest such products by assets for emerging markets, totaled $1.9 billion on Jan. 27, the biggest one-day redemption since 2005, data compiled by Bloomberg show.” – Bloomberg (1/30/14)
- “ETFs accounted for almost half the $2.5 billion outflows from emerging equities last week. So far this year, a net $4.12 billion has flowed out, amounting to three quarters of the total $5.7 billion that has fled, the fund tracker said.” – Reuters (1/27/14)
In the context of the sheer amount of dough plowed into EM assets over the last ~10-12 years amid Federal Reserve-style financial repression, we could see EM assets underperform by much more and for much longer than many investors currently think. This is how people get blown up buying the [perceived] bottom. Don’t buy the [perceived] bottom in EM assets – at least not until you get the green light to do so from the Fed.
- “Emerging markets have attracted about $7 trillion since 2005 through a mix of direct investment in manufacturing and services, mergers and acquisitions, and investment in stocks and bonds, the Institute for International Finance estimates.” – Reuters (1/27/14)
- “JPMorgan estimates outstanding emerging market bonds at $10 trillion compared with just $422 billion in 1993.” – Reuters (1/27/14)
- “Assets of funds benchmarked to emerging debt indices stand at $603 billion, more than double 2007 levels, it said, and over $1.3 trillion now follows MSCI's main emerging equity index.” – Reuters (1/27/14)
- “Assets of emerging equity ETFs tracked by EPFR Global ballooned to a peak of almost $300 billion, tripling since 2008 and up from next to nothing in 2004.” – Reuters (1/27/14)
- “Mutual fund data from Lipper, a ThomsonReuters service, shows that in the past 10 years net inflows into debt and equity markets was in the region of $412 billion.” – Reuters (1/27/14)
If you recall the following slide (#74) from our 4/23/13 presentation titled: “Emerging Market Crises: Identifying, Contextualizing and Navigating Key Risks in the Next Cycle”, this should all sound very familiar:
Net-net, investors have two choices when it comes to playing EM assets from here: 1) buckle up; or 2) pray to God that Janet Yellen backs away from the monetary tightening ledge. Moreover, the fact that so many institutional investors “have to be invested” in EM assets only insulates our bearish bias if things really take a turn for the worse because we haven’t actually seen any “real” selling yet…
Please feel free to ping us with any feedback or questions.
Associate: Macro Team
Takeaway: JCPenney jacks up prices for bigger discounts later.
JCPenney hikes prices for bigger discounts later
Read more at the New York Post:
- "JCPenney...is quietly jacking up prices on everything from jeans to kitchen appliances, a risky move designed to make room for steeper, more eye-catching discounts this year, sources told The Post."
- "Chief Executive Mike Ullman...hatched the stealthy strategy this month with especially lofty markups in the jewelry department, sources said."
Takeaway from Hedgeye Retail Analyst Brian McGough: The first step at JCPenney was getting things into the store that people actually want. Step two is raising prices to allow for discounting to protect gross margin. Actually, this makes sense. But the obvious risk here is that sticker shock will keep some customers away. We're going to give Mike Ullman the benefit of the doubt that he's managing this move appropriately. That said, we'd rather have someone else managing it.
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THE DEBATE: Today’s preliminary GDP estimate provides some fertile fodder for both sides of the perma-crowd. GDP slowed QoQ but accelerated YoY. Real Final Sales accelerated but Real Final Sales to Domestic Purchasers decelerated. Services consumption accelerated but residential (i.e. housing) fixed investment growth collapsed. Headline GDP slowed sequentially but with aggregate Consumption growth accelerating in 4Q, the complexion of the under-the-hood numbers are arguably better than 3Q which was juiced by inventory build and characterized by slowing household demand growth.
OUR SUMMARY TAKE & GIP (Growth/Inflation/Policy) MODEL Update:
The net impact to our GIP model from this morning’s data is a modest shift in trajectory towards quadrant #3 – Slowing Growth and Rising Inflation - in 1H14.
To reprise, in Quadrant #2 – Growth Accelerating as Inflation Accelerates – equities can certainly still work, particularly if fund flows and policy are both supportive.
As an economy moves deeper into quad #3 (think slowing topline and margins compressing), however, the case for equities gets increasingly weaker as profits slow and multiples take a hit.
Over the last month the model has been equivocal in terms of signaling a move to Quad 2 or 3 for the U.S. and we’ve moved from being explicitly bullish to carrying lower gross and tighter net exposure to domestic equities.
As we’ve highlighted, it has been trickier on the fundamental side as we’ve been listing in a macro purgatory of sorts with the balance of fundamental macro data slowing modestly from a rate of change perspective into 1Q14 while remaining largely good on an absolute and Trend basis.
In that situation we default to the price signal which has been explicitly flashing red as the SPX broke TRADE support, the VIX broke through TREND resistance (14.91) on the upside, the 10Y failed at TREND resistance (2.80%), and #InflationAccelerating signals have confirmed with breakevens up and the CRB Index outperforming most every asset class YTD.
We’ll change as the data and price signals do, but as it stands currently, we’re the least bullish we’ve been over the TTM
THE DATA: Below is a summary review of this morning’s advance estimate for 4Q13 GDP
Real GDP = +3.2 QoQ (decelerating) and +2.7% YoY (Accelerating)
C: Consumption: Accelerated to 3.3% QoQ vs. +2.0% in 3Q13…contributing +2.26 to GDP vs. +1.36 last qtr
I: Investment: Big deceleration to +3.4% QoQ vs. +17.2% in 3Q13…contributing +0.56 to GDP vs. +2.56 last qtr
G: Government Expenditures: Down -4.9% QoQ vs. +0.4% in 3Q13…contributing -0.93 to GDP vs. +0.08 last qtr
E: Exports: Net Exports contributing +1.33 to GDP vs 0.14 last quarter with Exports growing at a steep premium to imports. Exports = +11.4% QoQ, Imports, +0.9% QoQ.
Residential Investment: Down -9.8% QoQ and contributing -0.3 to GDP vs. +0.3 in 3Q13 as housing activity flags.
Inventories: Reversing a bit from a contribution perspective but still contributing positively to GDP at 0.4. While the ISM Survey data suggest vendors remain largely unconcerned with inventory levels, inventory drawdown will likely drag on domestic investment figures over the next quarter or two.
Inflation: Inflation readings falling with the GDP Price index down 0.7% sequentially to +1.3% and the Core PCE down 0.3% QoQ to 1.1%. On the margin, sequential disinflation sits as a taper cessation signal, particularly with Yellen at the helm.
Real Final Sales (GDP less Inventory Change): Solid at +2.8, accelerating 30bps sequentially
Gross Domestic Purchases (GDP less exports, including imports): Weaker sequentially at +1.8% and decelerating -210bps QoQ
Real Final Sales to Domestic Purchasers (GDP less exports less inventory change): Perhaps the cleanest read on domestic private sector demand was largely flat sequentially, decelerating -20bps to 2.0% QoQ.
Consumption: NonDurables remained strong, but most of incremental strength came on the Services side, which had been the laggard over 2H13.
- Services: Accelerating +180bps QoQ to +2.5%...contributing +1.1 to GDP
- Durables: Decelerating 200bps QoQ to 5.9%...contributing +0.4 to GDP
- NonDurables: Accelerating 150bps sequentially to +4.4% QoQ…contributing +0.7 to GDP
INITIAL CLAIMS: BENIGN
This week’s initial jobless claims data was relatively benign with the 4-wk rolling average in YoY non-seasonally adjusted claims – our preferred read on the domestic labor market – basically in-line with the YTD TREND rate of improvement at -6.6%. Headline claims increased +19K WoW to +348K with the 4-week rolling average ticking up 1K to +333K.
Normal seasonal volatility in the data will continue to ebb as we move through February while the broader "Ghost of Lehman" seasonal distortion stemming from the expedited employment loss at the onset of the great recession - which was captured, in large part, as a seasonal factor instead of a bonafide shock – will persist as a tailwind to the reported data through 1Q14. We continue to expect headline claims to track towards its historical, friction lower bound at ~300K over the next month+.
Christian B. Drake
For the past year, we have been harping on our “Espresso-Based Conspiracy Theory” as one of the reasons why McDonald’s is struggling to grow its top line. The evidence supporting this assertion continues to pile up.
In short, we believe the McCafe strategy creates additional complexity in the back of the house and diverts resources away from the core food business. We’ve always viewed McDonald’s as a food first destination and whenever management shifts their focus away from food and to beverages, the core business suffers. To that extent, we contend that the early success of the beverage strategy (cold beverages) masked a decline in the core business (selling burgers and fries).
At the most recent analyst meeting and earnings call, management finally began to “come clean” with some of the issues that are impacting sales trends. None of the issues the company addressed, however, included McCafe. In fact, part of their 2014 strategy includes increased marketing resources to “go after the coffee consumer in 2014.”
On the 4Q13 earnings call, Chief Operating Officer Tim Fenton admitted that the never-ending LTOs and menu changes in 2013 overcomplicated operations. The menu changes in 2013 included:
- Mighty Wings
- Premium McWraps
- Steak & Egg Burrito
- Fish McBites
- Steak Breakfast Sandwiches
- New Quarter Pounders
- Grilled Onion Cheddar Burger
- Hot’n Spicy McChicken
- The Dollar Menu & More (with five new burgers)
During the analyst meeting a couple of months ago, Don Thompson said: “We stumbled a bit last year with too many new products, too fast and we created a lot of complexity.” This may be true, but we contend that the issues McDonald’s faces did not start in 2013. These issues really date back to 2009/2010, when we saw the national launch of McCafe and an accelerating number of menu introductions.
Later in the note, we use a chart from Burger Business, along with management’s comments from the 4Q13 earnings call, to put our thesis in perspective.
By way of background, part of the 2003/2004 “Plan to Win” strategy included a Time & Motion analysis of the restaurants’ back of house operations. With this study, management had determined that employees’ movement in the kitchen had become inefficient. Management’s desire to fix this was a key driver in simplifying the menu and streamlining operations.
In 2014, management is now once again talking about the Time & Motion of employees in the back of the house. However, this time management does not appear to be a taking a holistic approach to fixing these issues. Rather, these moves strike us as more geared to specific menu items. To illustrate our point, we have reproduced a chart from Burger Business looking at the evolution (bloating) of the McDonald’s menu since 2004.
As you can see in the chart below, the total number of items on McDonald’s menu increased by 75% from 2004 to 2014. This means an incremental 51 items have been added to the menu over that period, making the current day menu very difficult for crews to execute.
More importantly, there are two sections that account for the bulk of the menu proliferation. Not only are the number of Burgers, Sandwiches, Wraps up by 60%, but McDonald’s also created a whole new beverage category called McCafe (espresso drinks added in 2009; smoothies and frappes added in 2010).
Knowing how important Time & Motion is to the performance of McDonald’s restaurants, we continue to believe that McCafe has played a critical role in the slowing sales trends at their restaurants. This is an issue that management continues to ignore and could very well exacerbate!
To their credit, management has addressed part of the menu proliferation with the roll out of its high density kitchen tables. As management said on the 4Q13 earnings call, “These new high density kitchen prep tables are designed to deliver enhance service capabilities and menu choice to our customers.” We believe these high density tables should address Time & Motion issues associated with burgers, sandwiches, and wraps – to an extent. Management also supported this thought: “On the capacity, any time during our peak hours, if I can keep place in place and not have their feet moving to restock or to get something else or have crossover,” they, theoretically, will be able to improve the performance of their stores.
While this may be a step in the right direction in an attempt to better execute the current menu, this will also allow for additional customization. While they may need this additional customization to remain competitive in the market place, it could mitigate some of the benefits of the high density tables.
In addition, management has failed to address the proliferation of beverages and the impact of the McCafe strategy. Is it possible to add two new pieces of equipment (needed to make McCafe beverages) and not create additional Time & Motion inefficiencies? We don’t think so, but management appears unwilling—at least at this point—to acknowledge this.
So how does this end?
The high density kitchens will be rolled out to the entire system by the end of 2Q14. Therefore, McDonald’s should begin to see better sales trends by July 2014. If, however, this doesn’t happen and weakness persists into 2H14 (meaning high density kitchen tables are not the panacea for sluggish sales trends), the focus of analysts and investors will shift to other issues the company could be facing. If and when this time comes, we’d expect management to be more upfront about the issues surrounding the McCafe strategy.
Only time will tell.
If management’s denials persist, we believe the stock will continue to underperform and may prompt Bill Ackman to dust off the old McDonald’s slide deck and step in to push for more changes at the company.
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