Takeaway: Rising commodity prices, meandering yield spreads and still-rising Euribor-OIS continue to keep us cautious, but the TED Spread is thawing.
We've been arguing in favor of a defensive posture in Financials for a few weeks now. Our main qualms with the bull case have been rising interbank systemic risk measures, rising commodity prices, which precipitate a slowing of economic growth, and a compressing yield curve. Here's the latest score on those fronts: Euribor-OIS continues to widen, albeit very modestly in the latest print. TED Spread, however, tightened a few basis points in the latest week. Commodity prices continue to rise as reflected in the CRB Index's 3.4% week-over-week increase and the now +7.2% increase on a month-over-month basis. Finally, the 2-10 yield spread was uneventful, tightening 1 bp last week to 242 bps. The notable reversal here vs recent weeks is the now tightening TED Spread, putting it at odds, from a signaling standpoint, with the widening Euribor-OIS. For now, we'll continue to err on the side of caution.
* CRB Commodity Price Index – The CRB index rose 3.4%, ending the week at 302 versus 292 the prior week. As compared with the prior month, commodity prices have increased 7.2% We generally regard changes in commodity prices on the margin as having meaningful consumption implications.
* Euribor-OIS Spread – The Euribor-OIS spread widened by half a basis point to 15.4 bps. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States. Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal. By contrast, the Euribor rate is the rate offered for unsecured interbank lending. Thus, the spread between the two isolates counterparty risk.
* High Yield (YTM) Monitor – High Yield rates fell 9.8 bps last week, ending the week at 5.77% versus 5.86% the prior week.
Financial Risk Monitor Summary
• Short-term(WoW): Positive / 6 of 13 improved / 2 out of 13 worsened / 5 of 13 unchanged
• Intermediate-term(WoW): Positive / 6 of 13 improved / 3 out of 13 worsened / 4 of 13 unchanged
• Long-term(WoW): Positive / 5 of 13 improved / 2 out of 13 worsened / 6 of 13 unchanged
1. U.S. Financial CDS - Overall, swaps tightened for 23 out of 27 domestic financial institutions. Interestingly, while the US Financials saw their median CDS tighten by 2 bps, the median stock price change was lower by 20 bps.
Tightened the most WoW: SLM, UNM, MET
Widened the most WoW: CB, ACE, AXP
Tightened the most WoW: MBI, PRU, AGO
Widened the most MoM: CB, C, ACE
2. European Financial CDS - It was a fairly uneventful week for EU bank swaps as the median change was zero basis points. #Steady as she goes.
3. Asian Financial CDS - Asian bank swaps were a mixed bag last week. The biggest improvement came from two of India's banks, ICICI and IDB, though State Bank of India widened. Results were mixed in China and generally, though modestly, tighter in Japan.
4. Sovereign CDS – Sovereign swaps were flat to tighter around the world last week. Italian and Portuguese sovereign swaps tightened by -3.6% (-6 bps to 153 ) and -2.0% (5 bps to 254 bps). Spanish and German swaps were unchanged at 135 and 25 bps, respectively.
5. High Yield (YTM) Monitor – High Yield rates fell 9.8 bps last week, ending the week at 5.77% versus 5.86% the prior week.
6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 1 point last week, ending at 1,849.
7. TED Spread Monitor – The TED spread fell 2.4 basis points last week, ending the week at 19.7 bps this week versus last week’s print of 22.1 bps.
8. CRB Commodity Price Index – The CRB index rose 3.4%, ending the week at 302 versus 292 the prior week. As compared with the prior month, commodity prices have increased 7.2% We generally regard changes in commodity prices on the margin as having meaningful consumption implications.
9. Euribor-OIS Spread – The Euribor-OIS spread widened by half a basis point to 15.4 bps. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States. Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal. By contrast, the Euribor rate is the rate offered for unsecured interbank lending. Thus, the spread between the two isolates counterparty risk.
10. Chinese Interbank Rate (Shifon Index) – The Shifon Index fell 130 basis points last week, ending the week at 1.98% versus last week’s print of 3.28%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.
11. Markit MCDX Index Monitor – Last week spreads tightened -1 bps, ending the week at 76 bps versus 77 bps the prior week. The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 16-V1.
12. Chinese Steel – Steel prices in China fell 0.4% last week, or 14 yuan/ton, to 3,334 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.
13. 2-10 Spread – Last week the 2-10 spread tightened to 242 bps, -1 bps tighter than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.
14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.1% upside to TRADE resistance of $21.51 and 1.3% downside to TREND support of $21.21.
Joshua Steiner, CFA
Jonathan Casteleyn, CFA, CMT
Despite great anticipation around the release of “news” at the annual Consumer Analyst Group of New York (CAGNY) Conference last week, the sector (XLP) was flat on the week versus the S&P500 at +0.4%.
In fact, XLP is the worst performing sector year-to-date (down -3.6% vs the broader market +1.7%), despite the slow growth and yield chasing sector of Utilizes (XLU) the top performing sector. This underperformance has also been reflected in earnings season results. As the chart below shows, the Q4 2013 Earnings Scorecard shows Consumer Staples as the worst performing sector across sales, EPS, and operating margin growth versus the prior quarter!
The Hedgeye U.S. Consumption Model is flashing predominantly red, as only 4 of the 12 metrics are flashing green.
From a quantitative set-up the sector remains broken across the immediate term TRADE and intermediate term TREND durations, our language for a bearish medium term sector outlook.
We continue to believe that the sector is facing numerous headwinds, including:
- U.S. consumption growth is slowing as inflation rises, in-line with the Macro team’s 1Q14 theme of #InflationAccelerating
- The economies and currencies of the emerging market – once the sector’s greatest growth engine – remain weak with the prospect of higher inflation in 2014 eroding real growth
- The sector is loaded with a premium valuation (P/E of 18.9x)
- Less sector Yield Chasing as Fed continues its tapering program
- The high frequency Bloomberg weekly U.S. Consumer Comfort Index has not seen any real improvement over the past 6 months, and expanded only 10bps higher week-over-week (-30.6 vs -30.7)
Food, Beverage, Tobacco, and Alcohol
In the charts below we look at the largest companies by market cap in the Consumer Staples space from both a quantitative perspective and fundamental aspect where we can offer one. As you will see over time, sometimes our fundamental view does not align with the quantitative setup (though not often).
BUD – low-volume beta bounce still hasn’t changed BUD’s developing bearish TREND – it would need to close back above $102.91 to go bullish on our model
DEO – uglier than BUD, but same setup – it had its low-volume beta bounce and failed to recapture TREND support up at $128.27
KO – our risk management model saw this breakdown coming (see prior weeks’ notes); big time bearish TREND @Hedgeye with resistance firmly intact up at $39.56
PEP – just a nasty breakdown after our risk model signaled it was in motion; TREND resistance remains overhead up at $82.11
GIS – one of the few names that deserves consideration for a bearish to bullish reversal; needs to hold $48.82 TREND support (which was resistance until the past few weeks), so let the market decide
MDLZ – Peltz’s love matters – a nice Valentine’s day v-bottom sees follow through here back above the TREND line of $32.89; if that holds, we’ll call this bullish
KMB – nothing but love for this name remains – Bullish Formation @Hedgeye with TREND support of $104.21 intact
PG – next to KO and PEP, Procter gets the nod for the next worse looking setup in this risk management note; bearish TREND remains resistance up at $79.87
MO – these smokes stocks still have dog breath; bearish TREND resistance intact ($36.16 resistance)
PM – still one of the better looking shorts in all of big cap consumer; bearish TREND @Hedgeye = $83.19 resistance
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Client Talking Points
The Shanghai Composite tried to go positive last week for the year-to-date. What happened? It got slammed -1.8% overnight (down -1.9% YTD). Ex-ramping credit (which isn’t the answer to their problems), the Chinese data is just terrible. Guess what? That matters to global growth consensus remaining too high.
Last year, we were the bulls on US #GrowthAccelerating. This year? We’re sticking with inflation’s ramp. Check out commodities with the CRB Index up another +2.8% to +7.8% YTD last week (compared to S&P 500 -0.1% to -0.7% YTD). That's a big deal that consensus is still missing. With Mario Draghi saying there is no “deflation” risk, that’s good for the Euro (bad for USD), and good for commodities. Got correlation?
Gold is up another +0.7% to +10.9% year-to-date this morning as A) 10-year yields remain bearish TREND @Hedgeye and B) US Dollar remains under pressure ahead of both Janet Yellen’s regime and Obama’s 2015 budget (#Spending). Gold loves inflation slowing growth (and Team Canada Hockey). Couldn't resist.
|FIXED INCOME||14%||INTL CURRENCIES||16%|
Top Long Ideas
We remain bullish on the British Pound versus the US Dollar, a position supported over the intermediate term TREND by prudent management of interest rate policy from Mark Carney at the BOE (oriented towards hiking rather than cutting as conditions improve) and the Bank maintaining its existing asset purchase program (QE). UK high frequency data continues to offer evidence of emergent strength in the economy, and in many cases the data is outperforming that of its western European peers, which should provide further strength to the currency. In short, we believe a strengthening UK economy coupled with the comparative hawkishness of the BOE (vs. Yellen et al.) will further perpetuate #StrongPound over the intermediate term.
Las Vegas Sands has transformed into that rare stock that should appeal to “Growth,” “Value”, and “Dividend/Cash Flow” investors alike. The stock now yields higher than the S&P 500 (43% sequential quarterly dividend increase), and the company is buying back $200 million + in stock a quarter, yet still retains a pristine balance sheet. The significant capital deployment opportunities can be funded out of annual free cash flow of nearly $4 billion. Management has indicated they are willing to raise leverage 1.5x which would still keep them well below industry average and if directed toward dividends, would result in a yield of over 6%. And we haven’t gotten to the $10-14 billion in mall assets that could be monetized. We know of no other stocks in consumer land that provide this combination of cash flow, growth, cash return to shareholders, and value levers.
Darden is the world’s largest full service restaurant company. The company operates +2000 restaurants in the U.S. and Canada, including Olive Garden, Red Lobster, LongHorn and Capital Grille. Management has been under a firestorm of criticism for poor performance. Hedgeye's Howard Penney has been at the forefront of this activist movement since early 2013, when he first identified the potential for unleashing significant value creation for Darden shareholders. Less than a year later, it looks like Penney’s plan is coming to fruition. Penney (who thinks DRI is grossly mismanaged and in need of a major overhaul) believes activists will drive material change at Darden. This would obviously be extremely bullish for shareholders and could happen fairly soon driving shares materially higher.
Three for the Road
QUOTE OF THE DAY
"What a man can be, he must be." - Abraham Maslow
STAT OF THE DAY
The G20 has pledged to install policies that will add $2 trillion to the world economy over the next five years. The world's 19 richest nations and the European Union -- said the reforms aim to lift collective GDP by more than 2%. (CNN)
Takeaway: 4,500 shoe factories close. VFC warms up TNF. Street too positive on PVH? BKS finds buyer, JJill doesn’t. WWW/Hush Pups prices go parabolic.
EVENTS TO WATCH -- BIG EARNINGS WEEK
- SHOO - Earnings Call: Tuesday 2/25, 8:30am
- HD - Earnings Call: Tuesday 2/25, 9:00am
- FNP - Earnings Call: Tuesday 2/25, 10:00am
- M - Earnings Call: Tuesday 2/25, 10:30am
- ANF - Earnings Call: Wednesday 2/26, 8:30am
- LOW - Earnings Call: Wednesday 2/26, 9:00am
- TGT - Earnings Call: Wednesday 2/26, 10:30am
- TJX - Earnings Call: Wednesday 2/26, 11:00am
- JCP - Earnings Call: Wednesday 2/26, 4:30pm
- BBY - Earnings Call: Thursday 2/27, 8:00am
- KSS - Earnings Call: Thursday 2/27, 8:30am
- DECK - Earnings Call: Thursday 2/27, 4:30pm
- GPS - Earnings Call: Thursday 2/27, 5:00pm
MW, JOSB - Men's Wearhouse Increases Cash Offer for Jos. A. Bank to $63.50 Per Share
- "The Men's Wearhouse today announced that it has increased its cash tender offer for all outstanding shares of Jos. A. Bank Clothiers, Inc. to $63.50 per share from $57.50 per share. Expiration of the amended tender offer has been moved up to 5:00 p.m., New York City time on Wednesday, March 12, 2014, unless the offer is extended."
- "Men's Wearhouse could potentially increase its offer price to $65.00 per share if it is able to conduct limited due diligence (subject to an appropriate confidentiality agreement), with access to Jos. A. Bank's management team. In addition, the amended offer is conditioned on termination of Jos. A. Bank's recently announced agreement to acquire Eddie Bauer, and Men's Wearhouse will increase the aggregate consideration to be paid to the Jos. A. Bank stockholders dollar-for-dollar to the extent Jos. A. Bank is able to terminate the Eddie Bauer purchase agreement for less than $48 million in termination fees (less any other expense or fee reimbursement paid by Jos. A. Bank in connection with such termination)."
Takeaway: We know what a rational management team and Board would do here -- take the deal. But we don't have a clue as to what JOSB will do given that they're pretty much the worst Board we've ever seen. Then again, could it be that we're the ones in the wrong, and that they've patiently executed a simply tremendous deal for JOSB shareholders -- starting with its own bid for MW? After all, JOSB is currently is sitting at an all-time high, and will make a new one by the end of business today.
VFC - North Face Introduces Workout Gear to Shake Its Wintry Image
- "...North Face is making a big push into spring and summer gear—a strategic shift that will increasingly put it toe-to-toe with Nike, Adidas, and the rest of the world’s biggest sportswear brands."
- "Next week, North Face will begin selling a line of lightweight apparel called Mountain Athletics, for training in warming temperatures. The offering will include only 16 styles, but the new line will anchor the biggest marketing campaign the company has ever produced in the first half of a year, according to North Face President Todd Spaletto."
Takeaway: At face value, it doesn't make much sense for a brand called 'The North Face' to make apparel that will be worn when it's 80 degrees. If 99 out of 100 companies tried this, we'd shrug it off. But if there is one company that we would not count out of being able to make this work, it's VF Corp. This is definitely an initiative we'll be watching.
PVH - PVH Corp. Announces Intention to Amend Its Senior Credit Facilities and Call Its 7.375% Senior Notes Due 2020 and Reaffirms Guidance for Fourth Quarter and Full Year 2013
- “The Company also announced in connection with the discussions regarding the credit facility amendment that it is reaffirming its revenue and earnings per share guidance for the fourth quarter 2013 and full year 2013 previously announced on January 10, 2014. Additionally, PVH announced that during fiscal 2013, it repaid approximately $500 million of term loans under the credit facility, above its initial expectation of approximately $400 million announced in March 2013.”
Takeaway: Overall, a good announcement from PVH. But keep one major factor in mind -- the company anniversaried the Warnaco acquisition on Feb 14th. Instead of printing 30%+ top line growth, it will be struggling to grow in the mid-single digits. The opacity of the acquisition is gone. Now we get to see what this company is really capable of. Not a single analyst out of the 19 covering the stock has a Sell rating (17 Buys). We're not nearly as bullish.
BKS - Barnes & Noble Gets Takeover Proposal From Firm Seeking Breakup
- "Barnes & Noble Inc., the struggling bookseller, received a proposal from G Asset Management LLC to acquire 51 percent of the company at $22 a share, valuing the total business at $1.32 billion."
- "G Asset also proposed buying 51 percent of Barnes & Noble’s Nook e-book division at $5 a share as an alternative deal, according to a statement yesterday from the investment firm. It said it was confident that separating the business would unlock 'substantial' shareholder value."
- "The move represents an increased bid over G Asset’s $20-a-share offer in November of last year, also for 51 percent of the business."
Takeaway: This does not sound as outrageous to us as the headline suggests. Yes, the concept is in a secular decline. But it has had some miserable initiatives over the past few years (Nook) that destroyed the P&L. There's still value at this company. We're not sure how much -- otherwise we'd be more vocal on the name. But we're not surprised to see someone drawing a line in the sand.
JJill - Women's Clothing Retailer J. Jill Considering A Sale
- "Women's retailer J. Jill...is in the process of hiring bankers to run a sales process, the people said."
- "J. Jill is owned by private-equity firms Arcapita Bank and Golden Gate Capital. Arcapita owns the majority of the retailer while Golden Gate owns about 30%."
- "San Francisco-based Golden Gate bought J. Jill in 2009 for just $63 million when the company was struggling, according to a person familiar with the matter. Today, the retailer has about $60 million in...Ebitda…"
Takeaway: We think there's value in Barnes & Noble…but JJill, we're not so sure.
WWW - Buzz: Hush Puppies, Jambu & More
- "Hush Puppies...fall ’14...collection of premium looks for men and women [is] designed to attract a younger, more trend-savvy consumer. The series of contemporary styles includes harness boots and tailored pumps for women, and chukkas and double monk straps for men."
- "Retailing from $99 to $240 for women’s and $189 to $220 for men’s, the line is aimed at new distribution channels including better independents, specialty and department stores, and e-tailers."
Takeaway: SO many people think of Hush Puppies as an old, stodgy, geriatric brand. The reality is that WWW has transformed it over the years to be much younger, trend-right and relevant. For what it's worth, the price points on the Hush Puppies boots are comparable to UGG.
LVMH - LVMH Said Investing in Marco de Vincenzo
- "LVMH Moët Hennessy Louis Vuitton is to reveal today that it has struck a joint venture with the Rome-based designer to develop his fledgling ready-to-wear brand."
- "De Vincenzo showed his fall collection here Sunday."
- "According to sources, the agreement gives LVMH a 'significant' minority holding in de Vincenzo’s company, with options to tighten the partnership and increase its stake down the road."
Shoe Factories Close on Safety Scare
- "More than 4,500 shoe factories in the eastern Chinese city of Wenling have been closed for safety violations after a fire at a local manufacturer killed 16 people in January, state-run media outlets reported."
- "The January 14th blaze at the Taizhou Dadong factory killed six men and ten women and was probably caused by faulty wiring, according to local media. Wenling produces more than a billion pair of shoes a year, many of which of which are for export."
- "The Taizhou Dadong factory owners were arrested and the local government vowed to crackdown on shoddy safety practices to prevent a similar incident."
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