Takeaway: 2014 looks fine, but the Street is 20% too high in ‘15. Moreover, KSS might not earn $4 again until the tail end of the next economic cycle.
We’re adding KSS to our Best Idea list as a short. We have not liked this name for a while, but we think the recent strength in the stock is simply unwarranted. We’ve seen sell-side upgrades, Cramer pumping the name due to strength in Izod and Skechers (seriously?), and a general mindset that you can’t short operationally levered retailers like KSS when we’re facing 4-5 months of ‘easy’ compares for US Consumer spending – especially with KSS hosting an analyst meeting in October. For the remainder of this year, KSS’ estimates ($4.30) are probably OK.
But while the Street is looking for 10% earnings growth next year, we’re modeling a -10% decline in earnings for the year. While this is a call on next year, we also think it is a call on the ones that follow. We think that 2014 will mark the last time for at least 4-5 years -- barring a parabolic acceleration in the US economy -- that KSS will earn anything starting with a $4. That’s not good when the Street is over $5 two years out. Its operational misses should crimp its ability to buy back stock and financially engineer the P&L. We’ll be hosting a call next Wednesday with a full deck to review our thesis (including some preliminary results of the department store consumer survey that we just completed).
Takeaway: Labor gets its mojo back, reversing the weakness seen in the last two weeks.
Two Steps Back, One Giant Leap Forward
There's a reason why investors are often advised to look at 4-wk rolling averages when it comes to high-frequency economic data (i.e. weekly initial jobless claims). The last two weeks of data were conspicuously soft and we noted as much in our weekly look at the labor market, but this week was very strong. Notably, on a 4-week rolling basis, the data has been fairly steady.
Prior to a few weeks ago, the data had been running at a fairly steady rate of ~10% improvement year-over-year. That is to say, claims are lower by 10% this year vs. last. Two weeks ago, however, that rate of improvement slowed to 7% and last week claims actually rose by 2%. This week saw claims better by almost 12%, which puts them back on track with the rate of change seen throughout much of the summer.
We're still bullish on the credit card lenders (COF, DFS) as we think the combination of resurgent loan growth and stable credit quality will produce better than expected earnings and should expand the multiple on those earnings. So long as jobless claims are not flagging an inflection in the labor market trends, we're going to stick with this idea.
Prior to revision, initial jobless claims fell 35k to 280k from 315k WoW, as the prior week's number was revised up by 1k to 316k.
The headline (unrevised) number shows claims were lower by 36k WoW. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -4.75k WoW to 299.5k.
The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -7.3% lower YoY, which is a sequential improvement versus the previous week's YoY change of -7.2%
The 2-10 spread rose 8 basis points WoW to 205 bps. 3Q14TD, the 2-10 spread is averaging 199 bps, which is lower by -21 bps relative to 2Q14.
Joshua Steiner, CFA
Jonathan Casteleyn, CFA, CMT
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This note was originally published at 8am on September 04, 2014 for Hedgeye subscribers.
“If you try to fail, and succeed, which have you done?”
In theory, investing is very straightforward. You buy stocks in great companies and the stock prices goes up. You short stock in bad companies and the stock prices go down. Practically, of course, that’s never really how it happens, except in fundraising power point presentations.
A real paradox of investing is that there are periods in which the stock prices of “weaker” companies actually dramatically outperform “stronger” companies. Over the last three months, stocks in the highest quartile of short interest have outperformed low short interest stocks by 240 basis points over the last three months - +5.5% vs +3.1%. In part, this is facilitated by so called short covering.
Our lives are, of course, replete with paradoxes, so a little paradoxical market action should on some level be easy to stomach, right?
Some notable paradoxes of different genres include:
- Paradox of voting - For a rational, self-interested voter the costs of voting will normally exceed the expected benefits, so why do people keep voting?
- Fenno's paradox - This is the belief that people generally disapprove of the United States Congress as a whole, but support the Congressman from their own Congressional district.
- Hedgehog's dilemma – This is the paradox that human intimacy cannot occur without substantial mutual harm (This is maybe the best philosophical defense for long term bachelors like myself!)
- Archimedes paradox – The paradox that a massive battleship can float in a few litres of water
Lastly is one of my personal favorites - the St. Petersburg paradox.
According to the St. Petersburg paradox, a casino offers a game of chance for a single player in which a fair coin is tossed at each stage. The pot starts at $2 and is doubled every time a head appears. The first time a tail appears, the game ends and the player wins the pot.
Thus the player wins $2 dollars if a tail appears on the first toss, $4 if a head appears on the first toss and a tail on the second, $8 if a head appears on the first two tosses and a tail on the third, $16 if a head appears on the first three tosses and a tail on the fourth, and so on.
What would be a fair price to pay the casino for entering the game?
Back to the Global Macro Grind...
As it relates to recent events in Russia, the term circus comes more to mind than paradox. Yesterday Russian President Putin introduced a hastily patched together seven point peace plan at a press conference. This came shortly after President Obama upped the rhetoric in terms of the U.S.’s willingness to support Ukraine (and also NATO countries in the region) and ahead of a two day NATO summit that begins today.
By some pundits, this “ceasefire” was perceived positively. But the ever thoughtful George Friedman from Stratfor (the largest non-government intelligence agency) had a more paradoxical take and wrote the following:
“This rapid turnaround on the battlefield (in reference to the recent thwarting of a Ukrainian offensive) had two main purposes. The first was to assert Russian military power and convince the West that Moscow would not be afraid to use it in spite of the economic consequences. The second was for Moscow to use its military gains to make it appear that the West was utterly irresponsible in trying to wrest Ukraine out from Moscow's shadow. Now, by dangling an ambiguous cease-fire before the Americans, Russia is essentially telling the United States that to defeat Russia it must fight Russia directly, knowing that NATO is loath to engage directly with the Russian military.
That deal goes well beyond a cease-fire. Russia wants its buffer in Ukraine recognized and respected, along with sanctions lifted so it can get on with repairing its economy. And with winter approaching, Russia also has the means to turn the screws on Europe's natural gas supply at the same time it holds a clear military advantage on the Ukrainian battlefield.”
Of course, the real news in Europe this morning are the monetary moves from the ECB and not that geo-political move from Russia yesterday. In an announcement that was a surprise to most, the ECB cut interest rates from 0.20% to 0.05%, cut the deposit rate by 10 basis points to -20 basis points, and also cut the re-fi rate and marginal lending rate by 10 basis points.
Although this isn’t necessarily monetary shock and awe, with the Euro trading down about 80 basis points, Draghi was seemingly able to get his point across with this move on some level. Practically speaking though, it is not clear that this will necessarily be a catalyst to ignite European economic activity.
Certainly a negative deposit rate incentivizes banks to lend out their money and sovereigns such as France, with a negative short term borrowing rates, have benefitted. That said, at least based on the initial foray into a negative deposit rate early this summer, this policy move has not lead to increased lending to businesses that are willing to invest in and grow the European economy.
All eyes will now be on Draghi’s press conference where he is likely to now introduce a QE type plan that also surprises to the dovish side. But the paradox of these surprises moves from such low levels is related to the answer to the St. Petersburg paradox, which is: infinity. Unfortunately infinite monetary policy moves from zero do not grow an economy.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.33-2.43%
Shanghai Comp 2232-2316
VIX 11.34-12.95 (bullish)
WTI Oil 92.51-96.53 (bearish)
Gold 1264-1296 (neutral)
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
Client Talking Points
Plenty of foreign currency volatility out there now that the USD has had its biggest move since 1997, but we’re right where it stopped going up in July of 2013. So, for a trade we would sell that. Pound vs. USD at 2 week highs into the Scottish vote.
We heard more talking about the “dots” yesterday than we saw analysis of what Janet Yellen was actually saying – she’s saying she’ll go with the data, so watch-out below on yields if we’re right and Q3 GDP misses (and/or a jobs report does).
Gold is annoying people (as it tends to on massive USD ramps), but unless the USD Index can shoot towards 86-87 and hold up there, Gold has plenty of support here (its +2% from where it started the year); the risk range is now 1216-1266.
|FIXED INCOME||32%||INTL CURRENCIES||4%|
Top Long Ideas
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.
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.
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
INDIA: +1.7% move for BSE Sensex to +29.7% YTD (where the real perf is at)
QUOTE OF THE DAY
You don't get to choose how you're going to die, or when. You can decide how you're going to live now.
STAT OF THE DAY
The Russell 2000 (small cap Style Factor) is still down -0.9% for 2014 year-to-date versus a proxy for the #GrowthSlowing Long Bond (TLT) which is +11.1% year-to-date.
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