Takeaway: After a two month slide, taxable bonds rebounded posting their first subscription in 8 weeks
Investment Company Institute Mutual Fund Data and ETF Money Flow:
After an exciting month of October whereby over $36 billion alone spilled out from the taxable bond fund category, the latest ICI survey relayed some stability with a $5.0 billion inflow by investors, the first subscription since the week ending September 10th. A post-mortem of the beneficiaries of the October snap redemption shows that broadly bond ETFs hoovered up the most "money in motion," with several select Total Return Funds including the Metropolitan West Total Return Fund (a unit of TCW), BlackRock's flagship fund, and Jeff Gundlach's DoubleLine substantially improving assets-under-management in the month. Interestingly, but not a surprise to us, the Janus Uncontrained Bond Fund, had a very modest benefit and as a result we remain skeptical of the resulting market cap improvement of that company without the support of new assets-under-management (read our JNS research here).
In other survey data, U.S. equity mutual funds put up another worrisome $1.7 billion redemption making it 25 of the past 28 weeks with outflows. We continue to recommend underweight or short positions to those managers with outsized U.S. equities exposure (read our research here). Passive fund flows via ETFs continue to be substantial with a year-to-date high of $17.7 billion into total equity ETFs last week and another inflow into bond ETFs, the 6th straight week of fixed income subscriptions. The blood letting continued specifically in the Materials Sector SPDR with another 19% of assets-under-management alone coming out of that product over the past 5 days. Conversely there has been strength in Utilities (XLU) and the 20+ Treasury ETF (TLT) products with respective inflows improving AUM by 7% and 8% during the week.
In the most recent 5 day period ending November 5th, total equity mutual funds put up net outflows with $302 million coming out of the category according to the Investment Company Institute. The composition of the outflow was squarely the result of domestic stock fund redemptions as a $1.7 billion loss more than nullified the $1.4 billion which came into international stock funds. The two equity categories have been polar opposites all year with international stock funds having had inflow in 43 of the past 44 weeks, versus domestic trends which have been very soft with inflow in just 15 weeks of the 44 weeks thus far year-to-date. The running year-to-date weekly average for all equity fund flow continues to decline and now settles at a $1.1 billion inflow, now well below the $3.0 billion weekly average inflow from 2013.
Fixed income mutual funds napped their drawdown schedule of the past 5 weeks putting up inflows in both the taxable bond fund category and also in tax-free munis. Taxable fixed income netted a fresh $5.0 billion in investor money with municipal bond funds putting up a $399 million inflow, making it 42 of 44 weeks with positive subscriptions in tax-free bonds. The 2014 weekly average for fixed income mutual funds now stands at a $985 million weekly inflow, an improvement from 2013's weekly average outflow of $1.5 billion, but still a far cry from the $5.8 billion weekly average inflow from 2012 (our view of the blow off top in bond fund inflow).
ETF results were very strong during the week with substantial inflows in equity funds and decent subscriptions into passive fixed income products. Equity ETFs put up a 2014 year-to-date high subscription with a $17.7 billion inflow which made the $564 million inflow into passive bond products look very modest. The 2014 weekly averages are now a $2.1 billion weekly inflow for equity ETFs and a $1.1 billion weekly inflow for fixed income ETFs.
Mutual fund flow data is collected weekly from the Investment Company Institute (ICI) and represents a survey of 95% of the investment management industry's mutual fund assets. Mutual fund data largely reflects the actions of retail investors. Exchange traded fund (ETF) information is extracted from Bloomberg and is matched to the same weekly reporting schedule as the ICI mutual fund data. According to industry leader Blackrock (BLK), U.S. ETF participation is 60% institutional investors and 40% retail investors.
Most Recent 12 Week Flow in Millions by Mutual Fund Product: Chart data is the most recent 12 weeks from the ICI mutual fund survey and includes the running weekly year-to-date average for 2014 and the weekly quarter-to-date average for 4Q 2014:
Most Recent 12 Week Flow Within Equity and Fixed Income Exchange Traded Funds: Chart data is the most recent 12 weeks from Bloomberg's ETF database (matched to the Wednesday to Wednesday reporting format of the ICI) and the running weekly year-to-date average for 2014 and the weekly quarter-to-date average for 4Q 2014. The third table are the results of the weekly flows into and out of the major market and sector SPDRs:
Sector and Asset Class Weekly ETF and Year-to-Date Results: In specific callouts, the blood letting continued in the Materials Sector SPDR with another 19% of assets-under-management alone coming out of that product over the past 5 days. Conversely, the Utilities (XLU) and 20+ Treasury ETF (TLT) had respective inflows of 7% and 8% during the week.
The net of total equity mutual fund and ETF trends against total bond mutual fund and ETF flows totaled a positive $11.4 billion spread for the week ($17.4 billion of total equity inflow versus the $6.0 billion inflow within fixed income; positive numbers imply greater money flow to stocks; negative numbers imply greater money flow to bonds). The 52 week moving average has been $2.9 billion (more positive money flow to equities), with a 52 week high of $17.7 billion (more positive money flow to equities) and a 52 week low of -$37.5 billion (negative numbers imply more positive money flow to bonds for the week).
Exposures: The weekly data herein is important for the public asset managers with trends in mutual funds and ETFs impacting the companies with the following estimated revenue impact:
Jonathan Casteleyn, CFA, CMT
Joshua Steiner, CFA
TODAY’S S&P 500 SET-UP – November 13, 2014
As we look at today's setup for the S&P 500, the range is 59 points or 2.47% downside to 1988 and 0.43% upside to 2047.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS (Bloomberg Estimates):
WHAT TO WATCH:
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
The Hedgeye Macro Team
This note was originally published at 8am on October 30, 2014 for Hedgeye subscribers.
“How many a dispute could have been deflated into a single paragraph if the disputants had dared to define their terms?”
Are you a central planning disputant? I am, big time. So, please, allow me to define my terms:
That is all.
Back to the Global Macro Grind…
I know. So easy a Mucker can explain it.
If you’d like to have a dispute with me on these terms (or change the M in my nickname to an F like the 1997 Princeton Hockey Team did), I’m happy to have it as long as you define yours. Mr. Market has been pricing them in all year long.
When our #process signals #Quad4 deflation (growth and inflation slowing, at the same time) here’s our asset allocation:
We #timestamped that in our Q4 Macro Themes deck on October 1st (pre-Oct 14th fetal position for the levered long beta portfolios) and we’ll reiterate that again, now that the Fed has done precisely what they said they’d do (ending the Policy To Inflate).
Now that that’s over, what I think happens next is where I’ll have many disputes. Here’s what I’m thinking:
Again, think like a Fed head. Define their terms – then front-run their proactively predictable behavior.
The main problem my disputants have with me is that I don’t think like they do. I am a dynamic counter-cyclical strategist and they are pro-cyclical linear economists. The economy is non-linear. It’s also one massive cyclical. You don’t buy a cyclical at the top of a cycle – you sell it.
The #1 question you should be asking Ed & Nancy (linear economists) has two parts:
A) After 65 straight months of US economic expansion, isn’t this an early-cycle slowdown, and
B) Now that everyone has cut to zero, where are we in the worldwide easing-cycle?
We know how they think about this. They’re making the same calls that they made at the top of prior cycles (that the cycle wasn’t slowing in 2H of 2007). They have defined their surveys and their terms. Those are pro-cyclical too.
What does being pro-cyclical mean?
No, I’m not calling anyone names. I am not being “mean” either. Rather than drifting from bullish to bullish thesis on the economy (at the beginning of the year they said inflation and capex would drive the economy; now they are saying global slowing and deflation will), I am being a consistent disputant.
This morning I’ll list the Top 12 Big Macro Risk Ranges (and our TREND views in brackets) – they are in our Daily Trading Ranges product too:
UST 10yr yield 2.16-2.35% (bearish)
SPX 1871-2007 (neutral)
RUT 1071-1157 (bearish)
DAX 8709-9340 (bearish)
VIX 12.89-22.25 (bullish)
USD 85.34-86.24 (bullish)
EUR/USD 1.25-1.27 (bearish)
Yen 107.11-109.77 (bearish)
WTI Oil 79.98-83.05 (bearish)
Natural Gas 3.57-3.82 (bearish)
Gold 1194-1231 (neutral)
Copper 2.96-3.09 (bearish)
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Takeaway: After having a long bias on JCP, we now think the upside/downside is symmetric - from $15 to $0. Not the risk/reward we like on either side.
Conclusion: We’re taking JCP off of our ‘Long Bench’ and are making some meaningful downward revisions to our model. This is not all about the 3Q print, but rather our confidence in the company’s ability to drive its top line in conditions that are anything other than optimal. Modeling ‘optimal’ conditions for the next four years hardly seems realistic, and irresponsible considering JCP’s debt maturity schedule. To be clear, we’re not making a short call. But now, we think that the likelihood of the stock going to $15 is equally offset by the chance of it going to zero (something we previously assigned a very low probability). That’s hardly a palatable risk/reward with the stock at $7.50.
It’s extremely rare that a quarterly earnings print will sway our opinion meaningfully on a stock. But this is definitely one of those times. While we did not have JCP on our list of top longs we definitely had a positive bias in our view on the company’s recovery and earnings potential. Based on our view of where the department store space is headed, and where JCP’s market share and cost structure are both likely to shake out – we now don’t have JCP turning a profit on the P&L until 2019 vs our previous model of break-even by 2016. If our numbers are right, that means that JCP will have to go through another economic cycle losing money, which matters with the stock trading at 14.5x EBITDA and 6.5x an EBITDA number that’s five years out.
Liquidity is something to consider as it’s no longer a key point of the debate today (nor should it be based on current conditions). To be fair, if we’re going to assume that the economy grows at a normal clip every year for the rest of this decade, then it shouldn’t be part of the debate, as JCP will be just fine. But not having a very bad sales/margin event at some point over the next four years would make this latest expansion one for the record books. We know it’s ‘out there’ to be so focused on what could happen as far as 2018, but the company faces a very big maturity in ’18 – $2.2bn to be exact. If it had to refi that today, it would probably not have a major problem.
But what happens if the company has to do so defensively in the event of a recession/bad economic event in 2016/17? The loan is secured by JCP real estate. It would be backed into having to either a) refinance at a grossly unfavorable rate, b) issue some equity-linked security, or c) surrender the property and then pay market rents if it wants to retain the business. None of those outcomes is attractive. In fact, they’d all send the stock a lot lower from where it is today. This did not matter as much for us with the company growing sales in the mid-high single digits. But our previous assumption seems far too aggressive based on what we’re seeing right now.
Are we making the ‘bagel’ call? No. We are not. We want to be clear about that. But in stress testing the model, we think that a double from here is just as likely as the stock going to $0. That’s not a risk/reward we like to see. We’d simply stay away at this price.
Why Such A Dramatic Change?
Business Changed Very Quickly. Just five weeks ago, JCP lowered guidance to a ‘low single digit’ comp versus previous guidance of ‘mid-single’. That’s usually interpreted as a 2-3% comp, which we think the company implied. But for the quarter, comps came in flat versus a year ago. That means that October must have been an unmitigated disaster. But yet JCP said that September was the worst month of the quarter. Sounds to us like the company was missing materially a month ago, and threw out a ‘low-single’ target with its fingers crossed along with a healthy dose of hope that October would improve. That’s extremely poor risk management.
Gaining Share? JCP only comped 140bps ahead of Macy’s (and KSS based on its preannouncement). Let’s be clear, for this story to even approach something that is palatable, it needs to gain significant share on a reasonably consistent basis without buying it. The problem with this quarter is JCP did not have a merchandising miss, didn’t stumble in a specific category, or suffer anything else that is company-specific other than a 30% decrease in liquidation sales. But that was known when the company provided guidance. It was because of the same old reasons we hear from all the other mediocre retailers – weather, competition, promotional climate, and overall ‘tough retail environment’. Note: Great companies – or even mediocre ones with solid revenue plans – don’t talk about these factors.
What Happens When Things Aren’t So Good Out There? We understand that there are likely to be quarters where JCP performs closer to the peer group than others. This might be one of them. Also, the company put up a stellar 718bp improvement in Gross Margin. It could have easily forgone some of that margin in favor of a better comp. But management said flat-out that it will do mid-single digits longer term…just not this year. What we don’t understand is that this is a company that is in recovery, and is only putting up comp store sales growth (including e-commerce) of 3-4% in a decent enough economy.
What happens if the consumer cracks? What happens if the current 6-year growth and margin retail expansion cycle comes to an end, and ‘re-cycles’. It’s been known to happen from time to time (about twice a decade for the past 40 years). So basically – the company all but admitted that it can only comp msd when the economy is extremely healthy and/or the retail climate becomes ‘easy’. That’s just something that we’re not willing to put in our model for ANY company.
No Store Closures: Sounds like store closures are definitely not on the front burner. Not even close. Maybe down the road, but not now. Management admitted the same exact thing that KSS said a few weeks back – virtually all stores operating today are making money, and are cash flow positive. Furthermore, our work suggests that unlike in past cycles, retail CEOs will avoid closing stores that are otherwise considered marginal as retail stores are inextricably linked with e-commerce. Closing stores – even bad ones – risks losing e-commerce revenue. The only line item (aside from SG&A) growing for any department store is dot.com revenue, and the companies won’t risk shooting themselves in the foot by shutting down one of the biggest assets that enable e-commerce. The point is…no major store closure/cost cutting plan.
Key Assumptions In Our Model
Sales: We assume store sales grow at a 3% clip, with e-commerce growing closer to 10%. That lands us at around 4% top line growth through 2018. It also suggests that JCP gets back to $130 per square foot. That’s a far cry from its former $195 and KSS $210. But it’s better than the $108 JCP is sitting on today.
Gross Margin: We tempered our assumptions here. Assuming JCP adds 200bp over 5 years to 36.4% -- that’s down about 150bp from our previous model. On one hand, the company has been doing a great job in recovering margin, but on the flip side, a lower comp growth base will mitigate occupancy leverage.
SG&A: Growth of 1-2% per year. This is a company that used to have $5.3bn in SG&A on the same store base we have today. Today SG&A is just below $4bn. It’s probably headed higher. No changes in our modeling assumption here.
Capex: $250mm this year ramping to $400mm by year 5. Yes, the $1bn RonJon cap spending was too high. Now JCP is overshooting on the downside. If it wants to gain share, capex will need to rise. As with SG&A, we did not change anything here.
Free Cash Flow: We have FCF within about $100mm of break-even (usually positive) over the foreseeable future. The challenge is that we’ll need more than that to handle debt maturities which total $600mm over the next five years until the big $2.2bn refi in 2018.
Takeaway: The bigger issue remains: the perverse relationship b/w its user & revenue growth. The Street will not accept weakness on either front
For more detail on our short thesis, see link to our most recent note below. Let us know if you have any questions, or would like to discuss in more detail.
TWTR: The Story Has Changed
10/28/14 07:13 AM EDT
Hesham Shaaban, CFA
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