Reverse Keynes

This note was originally published at 8am on January 22, 2015 for Hedgeye subscribers.

“If you die in the short run, there is no long run.”

-Larry Summers, offering a little reverse Keynes in discussing hysteresis & secular stagnation



If you stick your arms straight up over your head and hold them there, it’s impossible to stay angry.  Seriously, try it.


I’m not sure what you do with that nugget of empirically derived kindergarten teacher insight, but it may serve as a nice low-intensity therapeutic post this morning’s central planning event or as you puzzle further over the prospects of secular stagnation. 


Most mentions of secular stagnation in the financial press convey some vague notion of protracted ‘sub-trend’ growth due to an amorphous mix of lousy demographics and debt overhang.   


Despite the indefiniteness with which the idea is typically delivered, people find it intuitively appealing and seem willing to (at least partially) accept it simply because it plausibly characterizes our current, collective experience. 


In his 2014 address to the NABE, Larry Summers – who is credited with re-popularizing the term – presents a commonsensical and analytically tractable contextualization of the dynamics underpinning the secular stagnation thesis.   


Notably, Summers argues that the entre into economic purgatory actually began some 15+ years ago and what we had formerly viewed as “normal” growth was largely an unsustainable outcropping of overly expansive policy. 


Summers highlights recent expansionary periods across industrialized economies to illustrate the point:


  • USA 2002-2007“How satisfactory would the recovery have been with a different policy environment, in the absence of a housing bubble, and with the maintenance of strong credit standards.”
  • USA 1995-2000:  “there was very strong economic performance that in retrospect we now know was associated with the substantial stock market bubble of the late 1990s”
  • JAPAN 1994-2014:  “it is hard to make the case that over the last 20 years, Japan represents a substantial counterexample to the proposition that industrial countries are having difficulty achieving what we traditionally would have regarded as satisfactory growth with sustainable financial conditions.”
  • EUROPE 1999-2005:  “It is now clear that the strong performance of the euro in the first decade of this century was unsustainable and reliant on financial flows to the European periphery that in retrospect appear to have had the character of a bubble”


In short, Summers makes the case that the magnitude of growth in recent cycles overstated potential, was footed in a ‘sandy loam’ of loose policy, and would not have been achievable absent the associated increase in financial instability.


The fact that secular stagnation sits at the fore of the current macro discussion is simply because its realities become increasingly tangible at the lower bound in rates where policy becomes impotent in cushioning the blow of the financial instability it helped propagate in the first place. I encourage you  to read and consider Summers proposition for yourself >> HERE


Meanwhile, Super Mario’s on deck with the latest currency war announcement out of the ECB this morning.  With the alphabet soup of Eurozone stimulus programs to-date largely ineffectual in impacting the real economy, consensus sitting on an expectation for ~€600B in QE, and anything short of “unlimited” likely to be underwhelming, is the recent re-crescendo in interventionism more likely to propagate financial stability or volatility?

Reverse Keynes - Draghi cartoon 01.20.2015


…….If Florida is heaven’s waiting room, Frankfurt is fast becoming the central bank triage center for #DeflationsDominoes as the multi-decade policy to inflate reaches its terminal end. 


In other, less dismal news – we still like housing on the domestic macro front.   We don’t like it at every time and price and don’t think the industry goes full escape velocity in the intermediate term but we do think the dynamics are such that it goes from 2014 underperformer to 2015 outperformer. 


We detailed the thesis on our 12/16/14 Conference Call but understanding why we like housing in 2015 is, perhaps, most easily explained by why we didn’t like it in 2014:


  1. Taper + Tighter Credit:  2014 started with a thud as rates peaked into 2013 year-end and the twin terrors of QM (January 10, 2014) and lower FHA loan limits (January 1, 2014) constricted the underwriting box right out of the gate.
  2. Polar Vortex & Major Investor Retreat: Wicked weather capsized early-year demand while the end of the REO-to-Rental trade by private equity firms drove a substantial decline in both total volume and price uplift in select markets like Phoenix, Las Vegas, SoCal and much of Florida.
  3. Decelerating HPI: After rising at 11-12% year-over-year throughout the bulk of 2013, US home prices began to decelerate by March 2014 and continued to decelerate until just recently.


Looking forward, 2015 is essentially setting up as the obverse: 


  1. Easy Comps: 2014’s collapse is the 2015 comp
  2. HPI stabilization:  Housing related equities follow the slope of home price growth and HPI is stabilizing
  3. Expanding Credit Box:  Lower FHFA down payment requirements, lower FHA premium costs, housing as a 2015 policy focus
  4. Lower Rates:  Rates are nearly a half point lower than the 2014 avereage already.   A 1% reduction in rates equates to ~10% increase in affordability
  5. Labor Market Improvement:  Improvement remains ongoing and is picking up in key housing demand demographics. 


Yesterday’s housing data offered further confirmatory evidence of firming demand and the trend toward improving rate of change as we head into the new year. 


  • Purchase Applications:  Purchase demand registered a second week of positive year-over-year growth - the 1st weeks of positive growth since December of 2013 – accelerating to +3.7% in the latest week from +2.6% prior.  Growth is currently tracking +9.2% on a QoQ basis. 
  • Housing Starts:  Total Housing Starts rose +4.4% to 1.089MM units in December with both October and November estimates revised higher. Notably, single-family starts rose +7.2% sequentially to +782K, the highest level since March of 2008.   The Chart of the Day below shows the (improving) TTM trend in Housing Starts. 


To close, the current challenges faced by policy makers remain acute.  Investors tasked with front-running reactionary policy measures and discounting their prospective impacts and collateral damages remain equally challenged.  Neither condition is particularly amenable to a proverbial raising of the arms type remedy.  


“You don’t really know how tall you are until you have your back against the wall”


….that’s another axiomatic gem I picked up along my short stint on the kindergarten teaching circuit.  It seems fitting.


Our immediate-term Global Macro Risk Ranges are now:


SPX 1987-2040

VIX 16.66-23.07

EUR/USD 1.15-1.19

WTI Oil 44.96-49.85

Gold 1251-1312

Copper 2.48-2.64 


To (sustainable) growth,


Christian B. Drake

U.S. Macro Analyst


Reverse Keynes - Starts Total   SF TTM


Takeaway: We liked the short at $63, and after digesting the puts and takes, we love it at $67.

After stepping back and picking apart our short thesis on KSS to see where we could be wrong, we’re sticking to our guns on this one. The reality is that we thought KSS was a great short at $63, and we think it’s even a better one at $67. Was the 3.7% comp better than we expected? Yes. Would we rather have been better positioned heading into today? Absolutely. But we’re sticking by our statement that the year KSS just preannounced is likely the last time the company will ever print EPS starting with a $4. We think that the Street’s 3-year earnings ramp to nearly $6/share ($5.76) is an absolute pipe dream. Over that same time period, we have earnings hitting $3 even (and $2.75 the year after). With a -48% earnings delta, we’re willing to take the beating on a sales comp.  If our numbers prove right, which we obviously think will be the case, then we’re probably looking at about an 11-12 multiple on $3 in earnings – or about $35.


We get the whole ‘it’s got good cash flow’ argument. But even at a price in the mid-$30s, the stock would be at a 12% free cash yield. Yes, that borders on cheap, but names like Dillard’s have traded as high as 20%+. Furthermore, we’ll worry about that when the stock is in the $40s.  With the stock at $67 today, that’s about $30 downside and maybe $5 upside if KSS pulls one out of the hat this coming year and earns $4.75 ($0.25 above the consensus). To be clear, KSS hasn’t traded at this multiple since March of 2007. It’s already trading at 15x the consensus numbers. To own KSS here you NEED to believe that the company is going to crush numbers. We don’t see how anyone could argue that with any fundamental analytical support.


KSS - All IN ON THE KSS SHORT - Kss 1 2 4


There are two big points we’d hit on…one short term, and the other long term.



As it relates to shorter term considerations, we think the comparison between Macy’s and Kohl’s is overblown – or at a minimum lacks context. True, the number of times that the perennially-hated KSS puts up better numbers that the perennially-loved Macy’s are few and far between. The quick and easy conclusion on the open that all the hype around new brands (Izod, Juicy), initiatives like Beauty, and the company’s new Yes2You Rewards program have turned this company around. Could they have helped on the margin? They probably did. But consider the following…

a) This is retail, and the best companies occasionally have a bad quarter, and the worst always have their moment in the sun.  Just because the numbers were higher by 2% does not mean that earnings are going up by a dollar next year.

b) One X factor this quarter is last year's January washout. KSS comps were -8%, assuming a 14% weight for the month. To be fair, we completely knew about this, and thought we modeled it appropriately. And Macy's had an even greater impact with -10% last Jan, and it put up a 2% owned comp for the quarter which implies a 1.5% comp for January. KSS is the rare standout. But modeling the holiday hangover this year for department stores is particularly tough.

c) People are only looking at Macy’s as a comp here. But consider similarly poor quality retailers like Belk and Bon-Ton (and even Old Navy – which is in KSS comp basket) comped negative all year, and then gave holiday updates that were 500-600bp higher.  When you look at KSS’ numbers relative to those companies, it is hardly a stand out at all.

KSS - All IN ON THE KSS SHORT - kss comp table

d) By our read, KSS had a killer January in its e-commerce business. This is in large part as it comped last year’s delivery issues, which benefitted it this year. The results mirror the comp differential with Macy’s well.
KSS - All IN ON THE KSS SHORT - kss 3 2 4



We think that KSS’ target market is far more tapped than most people think. We think KSS knows this, which is why it changed up its rewards program. But how we’re doing the math, it simply will not work over the long term – and perhaps the shorter term. It offers up meaningful risk on the SG&A line of the P&L.


Keep in mind that KSS is one of the last remaining retailers that links its rewards program to the loyalty program. Or at least it did. The company decoupled late last year. Everyone knows that, but few people talk of the risks. They should given that 57% of KSS sales flow through the card.

Last year – according to Capital One – it booked $805mm in income related to the KSS Card, and then rebated $405mm to KSS (a standard practice in such partnerships). Though this is not unusual, keep in mind that it served as a 9.5% counter-expense to SG&A.

Now with the new Yes2You rewards program, KSS decoupled that card from the rewards program. As such, a customer could shop in a KSS, get full rewards, and then use Amex, Discover, or whatever card, and get those rewards too. In effect, the customer can get similar rewards but double the benefits if they DON’T use the KSS card.  So…KSS might still get the sales, but then we’d see SG&A rise simply as the counter-cost begins to deflate.


We analyzed the number of customers that KSS would need to win in order to offset this risk.  The bottom line is that for every 5% of the 57% of sales that shifts to the new rewards program, the company has to find about 395,000 new customers to fill the void. In the table below, we built up to the customer count based on KSS’ average basket and visitation statistics. So if the credit card ratio decreases by 10% (very plausible), we need about 800k people in order to offset the $0.12 per share hit in EBIT from lost credit income.


KSS - All IN ON THE KSS SHORT - kss 4 2 4


800k customers might not sound like a big deal for a company as big as KSS, but consider the share it currently has of it’s target market. We calculate it two ways, and the results are very similar (scary).

1) Household Share: There are 79,000 households within a 15 minute driving distance of the average KSS store. The company has about 58,800 customers in each market. That tells us that the company has 74% share of relevant households.

2) Customer Share: The core demo for KSS is a 30-60 year old woman, and secondly is a 61-80 year old woman. When we look at this core, we get to a total market size of 73.2mm consumers (assuming that 75% of women in the age group are potential KSS customers, and 5% of males are prospects).  Today KSS has about 64.3mm customers. In other words, it has about 88% share according to this metric.


So with extremely high consumer share penetration, KSS will largely be attracting new customers from either a) a less desirable age demo, b) a greater driving distance, or c) they’ll be looking to attract more men. We don’t want to bank on any of those. It’s no wonder that KSS has store productivity that is ahead of Macy’s. It’s not going to get much higher.  


KSS - All IN ON THE KSS SHORT - kss 5 2 4

KSS - All IN ON THE KSS SHORT - kss 6 2 4

Our Favorite Sector (on the Short Side) When the Market’s Ripping

Editor's note: This is a brief excerpt from Hedgeye research earlier this morning. Click here to learn more our options for individuals.

*  *  *  *  *  *  *

On big U.S. equity beta chases in 2015, our favorite sector to lie out on the short side when we’re at the top-end of the risk range remains the Financials (XLF).




Mainly because we think long-term rates continue to make lower-lows. Incidentally, if we get a bad jobs print this Friday, we can get you UST 10YR Yield of 1.61%, in a hurry.


Our Favorite Sector (on the Short Side) When the Market’s Ripping - br8

Cartoon of the Day: Dove Is in the Air

Cartoon of the Day: Dove Is in the Air - central planning cartoon 01.04.2015

Is anyone really surprised by the recent dovishness of central planners around the world?

CMG: Look Past the Near Term Noise

CMG remains on the Investment Ideas list as a long.


It’s unlikely for a restaurant stock to trade down after reporting same-store sales growth of +16.1% and a $0.05 (or 136 bps) bottom line beat – but that’s precisely what we have here.  With a lofty valuation (41.5x NTM P/E; 21.41x NTM EV/EBITDA) and sky high expectations, Chipotle needed to deliver an impeccable quarter to appease the market.


Alas, in the market's eyes, margin pressure and some cautious commentary regarding 2015 same-store sales and cost of sales trends trumped the best in class comp and traffic growth.  Cost of sales inflation, primarily due to beef, dairy, and avocado, pressured margins in the quarter and the guide for 2015 was well above consensus estimates (35% vs 34.3% est.) as beef and avocado prices are expected to remain elevated while dairy normalizes. 


Management dismissed the notion that cost of sales is an issue as they tend to take a more holistic view of their operating model – as long as restaurant level margins are improving, they are pleased.  As an aside, restaurant level margins improved 101 bps in 4Q14 even as cost of sales increased 108 bps.  We firmly believe Chipotle should be praised rather than condemned for investing in its food, a phenomenon that the majority of its competitors are reluctant to do.


CMG: Look Past the Near Term Noise - 1

Source: Company Filings, Consensus Metrix


In our view, there were far more positives in the quarter than negatives and the street is overlooking the strategic investments the company made this year to further improve operating performance moving forward.


Comp growth was driven by 6.3% price, 2.0% mix, and 7.8% traffic.  In addition, throughput picked up again, as CMG increased its peak hour lunch and dinner transactions by three and five, respectively.  Its restaurants are now operating at AUVs close of ~$2.5 million, a number which management intends to improve through stronger operating efficiency.  To that point, the company has decreased its field leadership ratio from 15 a few years ago to 8 today and has created its own Restaurateur diagnostic tool that helps these leaders identify weaknesses in each of the restaurants they supervise.  With these two investments (people, diagnostic and plan tool) in place, 2015 should be a year of continued growth and development in each of Chipotle’s restaurants – better food, better throughput, better experience.


Considering CMG’s bullet proof balance sheet (nearly $1 billion in cash) and improving incremental returns (even at ~1,800 restaurants), it’d be foolish to bet against this stock.  It is the best positioned growth company in our space.



While we understand the market’s initial reaction to the report, we believe it is important to look past the short-term noise and volatility that sometimes plagues this stock around earnings releases.  What’s most important to us is that Chipotle’s brand positioning and relevance has never been stronger.  This is not only evidenced by the company’s same-store sales growth, traffic growth, and all time high AUVs, but also by the ever evolving preferences of American eaters.  Chairman and Co-CEO, Steve Ells, shed light on this early on in the call:


“For example, our vision is really resonating with teens, millennials, and Generation X. According to industry research, Chipotle is one of the most popular restaurant chains among teens and has been growing in popularity among this demographic. This report from 2014 ranks Chipotle as the third most popular brand among teens, up from number eight in 2013. Gen X consumers were 33% more likely than average to choose Chipotle, with millennials Chipotle was even more popular. With customers in this group 75% more likely than average to choose Chipotle over other restaurants.


We believe that our popularity among these younger consumers is tied to our vision and the growing interest in issues related to food and how it is raised. Our own research shows that these issues are clearly becoming more relevant and important when customers choose where they will dine. Based on our ongoing tracking research, 87% of fast casual diners say they prefer to eat foods that are grown locally, up from 70% in 2011. 86% believe ingredients raised or grown in a more responsible way taste better. That’s up from 76% in 2011. 73% feels important to buy organic for certain food items, up from 61% in 2011 and 69% try to eat meat that has been raised responsibly and that’s up 53% in 2011.”


If there’s a better positioned publicly traded restaurant than Chipotle, we’d like to know about it.  


CMG: Look Past the Near Term Noise - 2


CMG: Look Past the Near Term Noise - 3

Keith's Macro Notebook 2/4: USD | Commodities | Financials


Hedgeye CEO Keith McCullough shares the top three things in his macro notebook this morning.

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