Takeaway: As for the fundamental reality of #InflationAccelerating’s impact on growth, I don’t think the market cares until it has to.
Editor's note: This complimentary unlocked research note by CEO Keith McCullough was originally published February 24, 2014 at 13:02 in Macro. For more information on how you can subscribe to Hedgeye click here.
POSITIONS: 5 LONGS, 6 SHORTS @Hedgeye
Why the ramp right back to the all-time SPY highs? Surprisingly, there was a net short position (futures and options contracts) of 93,465 (Index + E-mini) in SPX on Friday’s close. Unwinding some of that happens on green, not red.
As for fundamental reasons, evidently the machines still love the smell of Burning Bucks (Dollar Down again today) as the hyper-mo-mo SPX vs USD inverse correlation (15 days) has moved to -0.94.
As for the fundamental reality of #InflationAccelerating’s impact on growth, like in Q1 of 2011 (when we made the same bearish call on US consumption), I don’t think the market cares, until it has to (which can start from today’s overbought price inasmuch as any other).
Across our core risk management durations, here are the lines that matter to me most:
- Immediate-term TRADE overbought = 1859
- Immediate-term TRADE support = 1816
- Intermediate-term TREND support = 1791
In other words, TREND support is -3.7% versus the price on your screen right now (#RealTimeAlert to short SPY = $186.11 at 12:19PM EST) , and I don’t think it will take this market much (a down day will do) to re-test that level of 1791.
If the US government burns its currency like Venezuela did, the SP500 could be up another +450% from here. But don’t worry about that. I’m sure that would be great for someone - just not for American GDP.
Keith R. McCullough
Chief Executive Officer
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“To defeat the aggressors is not enough to make peace durable. The main thing is to discard the ideology that generates war.”
- Ludwig von Mises
Von Mises is considered by many to be one of the fathers of libertarian thought in the United States. He wrote, lectured and taught broadly on many topics beyond economics, including sociology, philosophy, and engineering. As his student F.A. Hayek said, he was “one of the best educated and informed men I have ever known.”
Despite von Mises massive amount of writing and incredibly influential friends and students, such as Jacques Rueff the monetary advisor to Charles de Gaulle, Italian President Luigi Einaudi, and novelist Ayn Rand to name a few, there were periods in his career in which von Mises work was largely ignored. Nonetheless, his ideas remained durable.
The animal kingdom has some profound examples of durability as well. Three of the best examples of durability include:
- Planarian worm – Can regenerate large portions of its body and if cut in half can become two separate functioning worms;
- Cockroach – Has extreme radiation resistance (likely to survive a nuclear war), can survive for weeks with its head cut off and can live for months without food; and
- Rat – Fine swimmers, can chew through steel, can go for a couple of weeks with no food or water and can eat almost anything as a diet.
Luckily, living in the modern world doesn’t require us to go for weeks without food or chew through steel, but as stock market operators the first two months of the year have required durability. Specifically, January started with an almost 6% dive in the SP500 and February has seen more than a hundred point positive recovery. Obviously timing the markets is a much chagrined strategy, though an ability to do so would certainly have helped in the first two months of the year.
Back to the Global Macro Grind...
On the topic of durability, any investor that has put money into Brazil over the past four years has had to endure a halving (think Planarian worm) of the Brazilian stock market. In part, which is highlighted in the chart of the day, this has been driven by the dramatic decline in Petrobras (PBR), the largest single component of the Bovespa. As the chart of the day shows, from its peak PBR has lost more than 80% of its value.
This coming Thursday at 11am ET, we are going to host a conference call on Brazil with the explicit title, “Brazilian Equities Down -50% From 2011 Peak, Time to Buy?” On the call, we will review the bearish thesis, but take a more opportunistic look at getting long of Brazil. At ~ 7.0x earnings versus a peer mean of ~12x earnings, PBR may be an interesting way to play a recovery in Brazilian equities. If you aren’t currently a Macro subscriber, please email for details on how to access the call.
On the macro news flow front this morning, China is once again dominating. While most global stock markets are either up or down small, the Shanghai Composite is down just over 2%. There are three key factors that appear to be weighing on Chinese equities:
- The Shanghai Property Index closed -2.2% and hit a fresh 8 month low;
- Many of the major publicly traded developers continued to sell off, even as the major banks all said there was no change to real estate related loan policy and have not halted real estate financing operations; and
- Finally, there was a report that an Executive Director of the Bank of China was arrested in a corruption probe.
The key benefit to Chinese investors of increasingly liquid stock markets is that they can get out of the way, and remain durable, by selling, which they did in spades in the last 24 hours.
Flipping back to the U.S. for a second, it is interesting to note that the SP500, and equities generally, have recovered nicely in February, the assets and sectors that are performing the best remain those that most embody slowing growth and accelerating inflation. Specifically, while the SP500 is now down only -0.04% on the year, gold is up +10.9%, healthcare is up +6.9%, and utilities are up 6.5%. So, yes, slowing growth and accelerating inflation endures!
Interestingly, from a stock perspective, the fact that lower yielding stocks outperformed last year actually benefited a number of short calls we made in the MLP sector. Disappointing MLP fundamentals only added to the macro tailwind last year, which carried into this year when one of our Best Idea shorts Boardwalk Partners (BWP) got cut in half after reducing their distribution by 80%.
The next big short on our horizon, and on our Best Ideas list, is Kinder Morgan (KMI). Barron’s kindly quoted my colleague Kevin Kaiser and wrote this weekend:
“Kinder Morgan's valuation is crazy," says Kevin Kaiser, an energy analyst at Hedgeye, an independent Connecticut research firm and the company's most visible critic. "The distributable cash flow is overstated because the maintenance capital is understated." He thinks Kinder Morgan MLP units could drop below $50 and the GP below $20 -- both roughly 40% lower than the current quotes.”
Tomorrow, Kaiser will be discussing the durability of Kinder Morgan and MLP accounting in a conference call with energy accounting expert Julie Hannink from CFRA (email for details). It’s not clear to any of us that MLPs or their distributions are durable enough to be starved of capital expenditures.
Our immediate-term Macro Risk Ranges are now as follows:
UST 10yr Yield 2.68-2.81%
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
Takeaway: Retail sales dive again. JCP and Jones strike a good deal - RL won’t like it. Adidas kicks sand at Nike Retail. Bad break for Overstock.
EVENTS TO WATCH - Big Earnings Week
- 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
ICSC - Chain Store Sales Index
The upbeat reading we reported last week was nice while it lasted. Sales for the week ending Feb 22, dipped back down to 1.4% y/y vs +2.1% in the prior week. We had some snow here and there, but nothing out of the ordinary (and by now we think people are getting rather numb to the cold and snow -- no pun intended). By and large, weather was not a major factor last week.
ADDYY - Adidas Opens New Concept Store in China
- "Adidas this week debuted a futuristic new concept store in Beijing. The next-generation retail store is a full revamp of the brand's massive flagship in Beijing's Sanlitun Village mall complex, the largest Adidas outlet in the world opened just before the Beijing Summer Olympics in 2008."
- "The HomeCourt store, which revamps the Adidas retail outlet that opened just before the Beijing Summer Olympics in 2008, features a sports-tunnel entry where shoppers approach the floor like a field, complete with the sounds of cheering fans. Shoppers can try on products in the team room, and explore choice in a fully interactive shoe bar."
- "The HomeCourt Adidas concept store will eventually be opened in 25 locations around the world, with Rio de Janeiro and London next on the list, according to the German company."
Takeaway: Nike has got to be fuming about the layout of the concept. The whole 'enter through a tunnel that opens up into a stadium/retail store' is something Nike pioneered about four years ago. But, unfortunately for Nike, there's no such thing as a patent on a retail layout. Smart of Adidas to have chosen a basketball theme, as it's easily the #1, #2, and maybe #3 (tie with soccer) most popular sport throughout all of China. The only downside is that they don't endorse many basketball players that resonate with Chinese consumers.
JCP - J.C. Penney Unveils Evan-Picone Line
- "Black Label by Evan-Picone will be exclusive to Penney’s through a licensing agreement with the Jones Apparel Group. The collection, including dresses and related separates — more than 100 styles — officially launches March 7, though some styles have begun trickling into stores. Prices range from $35 for a blouse to $120 for a jacket, and the line will be frequently promoted at 25 percent off."
- "Evan-Picone is a well-known label, sold at Macy’s, Belk, Carson’s and Amazon, among other retailers."
- "Penney’s will go big with the new brand at the outset by launching it at 570 stores."
Takeaway: This is a win for JCP, as the Evan Picone Line has been around for decades and has a lot of brand equity with middle America. Also interesting that they're calling it 'Black Label' which is something used, of course, by none other than Ralph Lauren. While not RL's highest price point by any means, you can still find Black Label dresses and suits for up to $2,000. We can't imagine that consumers mistake the two, but definitely a smart marketing angle by Jones and JCP.
PVH - Moody's Upgrades PVH to 'Positive'
- "Moody’s Investors Service has revised PVH Corp.’s rating outlook to 'positive' from 'stable' based on the accelerated reduction of the company’s debt since its acquisition of The Warnaco Group Inc. and progress in the integration of Warnaco’s operations."
- "In lifting PVH’s outlook, Scott Tuhy, vice president and senior credit officer, stuck with the 'Ba2' corporate family rating and the 'Ba1' rating on the company’s nearly $4 billion senior credit facilities."
Takeaway: This was all in the plan, and is in response to PVH's announcement to call its 7.375% 2020 notes on February 21.
WMT - Wal-Mart’s Mexico Division to Spend $1.1 Billion to Expand Chain
- "Wal-Mart Stores Inc.’s Mexican and Central American unit plans to spend 15 billion pesos ($1.1 billion) to open stores and improve its e-commerce technology, aiming to spur growth in the region as U.S. sales slow."
- "The company expects to spend 8.4 billion pesos opening stores, adding 3.7 million square feet of space, according to a statement yesterday. Mexican floor space will grow 5 percent, with Central American stores expanding 7.6 percent."
- "Wal-Mart’s Mexican business, known as Walmex, will spend 3.5 billion pesos of its expansion budget on remodeling and maintenance. It will devote 1.2 billion pesos to logistics and 1.9 billion to e-commerce and other technology."
- "The company faces headwinds both at home and abroad. David Cheesewright, who became head of Wal-Mart’s international unit this month, said consumers around the world are stressed, with 'significant slowdowns' in numerous markets, including the faster-growing developing countries."
Takeaway: While only about 8% of Wal-Mart's total capex budget, the irony here is that WMT is spending more in Latin America than many US retailers spend in a decade in the US.
OSTK - Overstock fined $6.8 million for false advertising
- "The major issue at stake was Overstock’s apparent overstatement of customer savings. Alameda County Superior Court Wynne S. Carvill hit the web retailer with $6,828,000 in civil penalties. Overstock may also have to ante up for the costs of the suit."
- "On the site, buyers can see an item’s actual price, as well as the amount a shopper saves compared to the “MSRP,” or “suggested” retail price...the court found that the those reference prices were often created by the use of formulas not rooted in the cost of the actual product for sale, but, on similar products. Sometimes reference prices were also based on the highest possible price that could be found in the market. All this, the court said, was without adequate disclosure to consumers."
Takeaway: This is going to cost OSTK far more than $6.8mm. The company will need to revamp how it presents product and prices on its site, which could ding the perceived value proposition for consumers. The shorts are (justifiably) going to have a field day on this perennially hated stock.
JOSB, MW - Jos. A. Bank Statement on Men's Wearhouse Revised Tender Offer
- "Jos. A. Bank Clothiers, Inc. today said that its Board of Directors will review all aspects of the revised, unsolicited tender offer for the Company announced today by The Men's Wearhouse, Inc. and will make a recommendation to stockholders in due course."
- "The Company's stockholders are advised to take no action on the tender offer until the Company's Board of Directors has announced its recommendation."
JOSB , MW - Eminence Capital Enters Standstill Agreement with Men's Wearhouse (MW)
- "On February 24, 2014, Eminence Capital and certain of its affiliates entered into an agreement with the Issuer and Java Corp., a Delaware corporation wholly owned by the Issuer. Pursuant to the Agreement, the Eminence Parties agreed to, among other things, (i) cease all efforts in furtherance of the preliminary solicitation statement filed by the Eminence Parties with the SEC on November 15, 2013 and any related solicitation of the Issuer's stockholders in connection therewith, (ii) withdraw its demand to inspect the stockholder list and books and records of the Issuer and (iii) a customary standstill provision, which is described in more detail below."
Bangladesh factory collapse: big brands urged to pay into help fund
- "Only five of the 27 global clothing brands linked to the Bangladesh factory that collapsed last year with the loss of 1,138 lives have committed to paying into a compensation fund for the victims."
- "The Clean Clothes Campaign, which wants improved conditions in the industry, said only Zara-owner Inditex, Mango, Canada's Loblaw, Denmark's Mascot and El Corte of Spain had committed to the fund, which is trying to raise $40m in time for the anniversary of the Rana Plaza factory disaster in April."
- "Several big British brands, including Primark and Matalan, are among the companies that have not paid into the fund...Other big brands connected to the factory include Walmart, Benetton and JC Penney. The collapse, the deadliest disaster in the history of the clothes industry, also left more than 2,000 injured."
Takeaway: There is a legal issue, and a moral one. Legally, it is our understanding that the brands have zero obligation to compensate the victims of the collapse. That falls upon the factory owners -- many of whom are members of Parliament and have been using their political influence to shirk safety obligations. But then there's the moral issue. Our opinion on it is irrelevant. It's one that we're hearing the companies address today -- either with action or inaction.
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