I Can't See Land!

This note was originally published at 8am on March 17, 2015 for Hedgeye subscribers.

“The problem was sight.”

-Peter Zeihan


That quote is not alluding to the Fed’s decision tomorrow. Peter Zeihan was describing what I am sure all of your FOMC day previews are writing about this morning - 14th century macro strategy.


In the world before 1400, true ocean transport was a rare thing, being neither quick nor reliable nor safe… once line of sight to the land was lost, you had to more or less guess.” (The Accidental Superpower, pg 24)


Guess? When I was first hired on the buy-side, sometimes I’d guess. Then I’d lose lots of other people’s money and my boss, Jon Dawson, would tell me not to guess. “We don’t do open-the-envelope investing.” It was a great risk management lesson.


And it’s one that has stuck with me for the 14 years since he taught it to me. That’s why I’ve been taking down my asset allocation to long-term Treasuries on the recent bounce. I can’t guess what Yellen says tomorrow. I’d rather raise cash and react to it. I Can't See Land! - Yellen cartoon 09.17.2014NEW


Back to the Global Macro Grind


This is not to suggest that what super “smart” people on the Wall Street refer to as an ‘educated guess’ can’t make you a lot of money. As I implied in my intro, the smartest of those types have figured out to bet big with other people’s money!


Will Janet Yellen remove the word “patient” from tomorrow’s Fed policy language? Will she replace it with another scrabble word score? Will she leave the word in there and be “data dependent”? Will a ramping US Dollar find its way into the language? How about the dirtiest word she’s ever whispered publicly, #deflation?


You can buy-pass the whole seeing thing if you just have answers to the aforementioned questions in advance. It’s called inside information. Some pay a lot of dough for it! If you’re a little Mucker in Stamford, CT – you’re going to have to wait and watch.




Since we said buy both stocks and bonds before they started bouncing last week, now we can sell some of what we bought, raise some cash, and sleep soundly. Chasing beta by levering up your bets after markets bounce is no way to live.


Bets? Yes, people in this profession bet. Before yesterday’s US stock and bond market ramp, here’s where consensus macro bets were leaning, from  CFTC Non-Commercial futures and options perspective:


  1. SP500 (Index + Emini) net SHORT position hit a YTD high of -39,891 contracts
  2. Russell 2000 net SHORT position hit a YTD high of -40,793 contracts
  3. Long-bond Bears ramped the net SHORT position in the 10yr Treasury to -173,194 contracts
  4. Crude Oil Bulls remained pervasive with a net LONG position of +294,609 contracts
  5. US Dollar Bulls hit YTD highs at +81,210 NET long contracts


And, guess what? Every single one of those Consensus Macro positions was wrong on the day:


  1. After 3 straight down weeks (yes people get bearish after corrections), SP500 popped +1.35%
  2. Russell 2000, which has been our favorite of the US major indexes, tested an all-time high
  3. 10yr UST Treasury Yield dropped to 2.07% (TLT was up +1% on the open)
  4. Oil continued to crash with WTI closing -2.3% on the day at -17.7% YTD
  5. US Dollar Index had one of its biggest down days of 2015, -0.76%


“So”, what does this mean?


  1. You should pay attention to modern day mind-maps like futures and options positioning
  2. Wall Street is begging for Janet to devalue Dollars and keep rates lower for longer
  3. If Yellen delivers #dovish tomorrow, you’ll see a lot more of Consensus Macro bets being wrong


I personally don’t like being wrong. That’s why, especially heading into an open-the-envelope event day like tomorrow, I lower the probability of being wrong by raising cash.


Do I have an opinion on what the Fed should do? Of course. But that and a bus ticket will get me a swift beating at a men’s league hockey game in northern Quebec. What the Fed should and could do are two very different things.


Since we’ve had a good run here in March, I’d rather cling to my cash (US Dollars) than pretend to see something I have absolutely no edge on. And I’ll let the clairvoyant vision of the Federal Reserve rule another non-free-market day.


Today we’ll be hosting a Macro Call on the US Employment Cycle at 11AM EST (ping for access). Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 2.01-2.14%

SPX 2053-2112
RUT 1222-1243

VIX 13.72-17.39
USD 98.50-101.17
Oil (WTI) 43.05-47.36
Gold 1131-1169


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


I Can't See Land! - 03.17.15 chart

Euro, Oil and Housing

Client Talking Points


The Euro is down -1% to $1.07 on neither inflation nor employment data doing anything month-over-month (the EUR/USD is down because markets expect ECB President Mario Draghi to deliver more cowbell in attempts to create inflation, which looks impossible right now). EU CPI went from -0.3% to -0.1%; unemployment rose from 11.2% to 11.3%...European stocks love Burning Euros.


Oil does not love Burning Euros because that equals #StrongDollar. Down -2.2% to -11% year-to-date for WTI Oil this morning after failing at all lines of @Hedgeye resistance – Energy and Financials (in equity land) remain our 2 favorite sector shorts/under-weights.


Our favorite sector long/over-weight remains U.S. Housing – for Pending Home Sales to be +3.1% with that weather was very bullish, because the housing data only gets more bullish with the Spring thaw. The ITB (Housing ETF) signaled overbought within a very bullish TREND yesterday (+9.1% vs SPX +1.3% year-to-date).

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

Manitowoc  (MTW) is splitting the business into two companies. Given the valuation differential between the sum-of-the-parts and the current enterprise value of the company, the break-up should be a substantial positive. Recent nonresidential and nonbuilding construction data remains firm for 2015, which suggests that MTW’s crane sales should see a pickup in the first half of the year. The Architecture Billings Index (a survey of architects) typically leads nonresidential and residential construction spending by approximately 9-12 months. More importantly, the ABI Index leads MTW Crane Orders by 2 quarters.


iShares U.S. Home Construction ETF (ITB) is a great way to play our long housing call, U.S. #HousingAccelerating remains 1 of the Top 3 Global Macro Themes in the Hedgeye Institutional Themes deck right now. Builder Confidence retreated for a 3rd consecutive month in March and New Home Starts in February saw their biggest month-over-month decline since January 2007.  We think the underlying reality is more sanguine with the preponderance of the weakness in the reported February data largely attributable to weather.


While labor supply constraints may serve as a drag to builder confidence, presumably it is rising demand trends that are driving tighter conditions in the resi employment market.  All else equal, we’d view improving demand as a net positive.  On the New Construction side, while the sharp drop in Housing Starts captured most of the headlines, we believe the real story was in the 3% gain in permits. We'd expect to see a big rebound in the next two months in housing starts as the data plays catch-up to the thaw.


Low-volatility Long Bonds (TLT) have plenty of room to run. Late-Cycle Economic Indicators are still deteriorating on a TRENDING Basis (Manufacturing, CapEX, inflation) while consumption driven numbers have improved. Most of the #Deflation trades bounced to something less-than-terrible (both absolute and relative) for 2015, whereas the real alpha trending in macro markets continues to play to the lower-rates-for-longer camp’s advantage.

Three for the Road


The Macro Show, Live and Interactive w/ @KeithMcCullough at 8:30AM ET today. Click here to watch for free:



It is good to have an end to journey toward; but it is the journey that matters, in the end.

-Ernest Hemingway


The Pending Home Sales index rose +3.1% sequentially in February, taking the index to a new 19-month high.  

CHART OF THE DAY: Does Strong #Dollar = Strong America?

CHART OF THE DAY: Does Strong #Dollar = Strong America? - Chart of the Day


Editor's Note: This is a brief excerpt from today's Morning Newsletter by CEO Keith McCullough. Click here for more information on how you can subscribe. 


Back to more local matters, like the relationship between US Dollars and American Purchasing Power, Consumption, and Savings… what Heli-Ben didn’t quite get (or blog about) was that these very important things are positively correlated.


#StrongDollar à Slowing Inflation (think cost of living) à Rising Real Consumption à Moarrr Savings


I swear, this is rocket science, eh? Don’t forget that the 1983-1989 and 1993-1999 periods of > +4% real US GDP growth was not only sustainable for more than a few quarters – but it punished those who invested in Down Dollar Inflation Expectations assets.


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Bull Fighters

“It is necessary for a bull fighter to give the appearance at least of respectability.”

-Ernest Hemingway


That’s what I was thinking about as I read Ben Bernanke’s first blog yesterday. He’s just looking for what Greenspan continues to look for – respectability (and speaking engagement fees).


The aforementioned quote comes from a beauty by Hemingway titled “The Capital of The World”, where a wanna be bull fighter dies an unceremonious death. “He died, as the Spanish phrase has it, full of illusions.”


That’s how #history remembers most ideological attempts to centrally plan things like growth, inflation, and economic gravity. Creating the illusion of growth (inflation) can only last so long. After that, c’est le #deflation.

Bull Fighters - Central banker cartoon 03.03.2015


Back to the Global Macro Grind


You don’t like my mixing of Spanish and French metaphors? Read Bernanke’s blog – and once you’re done, send me an email that tells me, in English, what he was trying to say (be forewarned, it will take you a while). Here was the highlight:


"The state of the economy, not the Fed, ultimately determines the real rate of return attainable by savers and investors.”

-Ben Bernanke




“So”, per The Bernank, the 0% rate of return on my savings account for the last half-decade was not determined by the Fed afterall! The man had nothing to do with it. It must have been the weather?




Moving along to macro markets this morning (which by the way, no buy-sider of respectability has ever given a former Fed person the reigns to successfully run real money – ever think about why?):


  1. US Dollar bounced right off immediate-term TRADE support = check
  2. US interest rates have fallen back to 1.95% on the UST 10yr = check
  3. US stocks, led by great #HousingAccelerating news, bounced into month-end = check


Backcheck, forecheck, paycheck! (I’m going all hockey blog lingo on you now)


In all seriousness, let’s go through some of the why on the these three macro moves:


  1. USD up on Burning Euros (-1% this morning post underwhelming European inflation and employment data)
  2. Global #Deflation Bulls continue to realize that the best way to get paid on their theme is lower-rates-for-longer
  3. You didn’t think they’d let the SP500 finish Q1 down for the YTD, did you?


Oh, you want some more meat on that European “data” bone?


  1. Eurozone CPI for March was -0.1% y/y vs. -0.3% in FEB
  2. Italy’s CPI for March didn’t budge, at all, at -0.1% y/y vs -0.1% in FEB
  3. Eurozone unemployment was 11.3% vs the prior 11.2% reported


In other words, much like you’ve seen in Japan for decades… in stark contrast to European stock and bond markets ramps (German DAX +23.5% YTD and German 10yr Bund Yield 0.20%), the European economy hasn’t done jack.


I guess Bernanke would tell European savers to sit on that for the next 3-5 years, and like it. If some poor bastard in Southern Italy has no savings to speak of, he needs to dial-up the Medici Bros on a rotary phone and start an online stock trading account!


Back to more local matters, like the relationship between US Dollars and American Purchasing Power, Consumption, and Savings… what Heli-Ben didn’t quite get (or blog about) was that these very important things are positively correlated.


#StrongDollar --> Slowing Inflation (think cost of living) --> Rising Real Consumption --> Moarrr Savings


I swear, this is rocket science, eh? Don’t forget that the 1 and 1 periods of > +4% real US GDP growth was not only sustainable for more than a few quarters – but it punished those who invested in Down Dollar Inflation Expectations assets.


This is not obvious to a lot of people right now because many of them would have to accept the responsibility in recommendation of maintaining a Devalued Dollar (post Nixon/Carter 40yr lows = 2011-2012) throughout Bernanke’s un-elected reign.


But I digress…


Because I am not only a Bull Fighter of Euros, Commodities, and levered expectations in Energy Stocks & Bonds, but I am a bloodied Mucker, who only gets respect for being held to account for my actions, each and every day.


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.85-2.01%
SPX 2059-2117
DAX 118
USD 96.60-99.89
EUR/USD 1.05-1.09
Oil (WTI) 43.90-50.62

Gold 1161-1208


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Bull Fighters - Chart of the Day

March 31, 2015

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Retail – Our 2015 Quarterly Playbook

Takeaway: Expect a lot of pin action in 2015. Here’s a) where we think the pins will fall b) when they'll fall, and c) what to be long/short.

Conclusion: The cadence of earnings growth in 2015 is more critical to retail than we’ve seen in a long time. We constructed a bottom-up financial model of key players in the industry to plan a quarterly playbook. The punchline is that near-term, Retail still has a quarter of opacity left which will keep names like KSS trading at seemingly ridiculous multiples -- but the clock is ticking. By quarter; 1Q is a slamdunk, 2Q should show the real (i.e. less favorable) earnings power of the group, and 3Q/4Q should show accelerating cost pressures on top of tough margin and working capital compares – which will pressure growth and returns. All in, we’re looking at mid-teens earnings growth today slowing to perhaps 300-400bp by year end (and all of that 300-400bp is driven by today’s financial engineering that will carry throughout the year).

Names To Own: RH, KATE, (and less enthusiastically) WWW. Also KORS, NKE, RL, CROX, MW, ANF, VNCE on our Bench.

Names To Short: KSS, HIBB, FL, JCP, TGT, M. Bench names include: WSM, GPS, DKS W, CRI, GES


Expectations By Quarter

There should be a meaningful bifurcation in the financial model for the softline brands and retailers as 2015 progresses – more different than we could recall in recent memory.

  • 1Q: Specifically, the growth algorithm in 1Q15 should be simply outstanding -- a tenet that few people (and a 22x multiple for retail) would debate. We’re looking at easy margin compares on top of trough working capital headed into the quarter, which is very bullish for gross margins.
  • 2Q: Growth normalizes – this should be the most ‘normal’ of all the quarters through the year. If you want to see what a company like KSS, M or RL is really capable of, this should be it (we can’t wait). It should also be a quarter where reported earnings growth decelerates by at least 500bp to the high single digits.
  • 3Q: Margins get difficult due to higher wages (thanks to WMT) and pressure to offer free shipping (or lower ‘free shipping’ spending hurdles) during back-to-school. Earnings growth falls to the mid-single digits – half of which comes from financial engineering.
  • 4Q: Tough revenue AND margin AND working capital compares at a time when retailers just had a tougher than expected back-to-school should result in a lot of itchy trigger fingers headed into holiday. In what will likely be an extremely promotional holiday – we’ll see ‘free shipping’ as the most commonly used offensive weapon. We think that retailers will opt to hold the line on market share and will view weaker margins as a customer acquisition cost while most components of the retail landscape are dropping the gloves online.   



Details Of Our Analysis

In the analysis below, we reconstructed an income statement and balance sheet based on a group of 15 companies that we consider to be representative of the US Softline retail space. Note that quarterly numbers for 2-years are represented on the left side, and the corresponding annual numbers for the past decade are on the right.  Here are some key points to consider (each numbered point refers to the corresponding chart in the Exhibit below).


  1. Sales Slowing, Margins Peaking. 2014 marked the worst top line growth rate in 7-years, and yet the group put up its highest operating margin ever.
  2. Financial Engineering Taking Place of Margin Expansion. EPS grew at 9.8% last year, the first time it was not double-digits since 2009. Maybe a more appropriate way to look at it is that we had our big earnings recovery year in 2010 (45% growth), then two very strong years of low-20s growth in ‘11/’12, and then growth was roughly cut in half again to around 10% for ‘13/’14.  The interesting thing to us is that sales grew 5.5% last year, and margins were about flat at peak levels hit in 2013, but yet earnings grew at nearly 10%. Taxes helped by about half a point, but the major delta came from financial engineering – most notably in stock buyback.  
  3. One More Quarter Left… Looking at things on more of a near-term basis…we see that the group grew at a mid-teens rate in the quarter just reported. Respectable by any stretch, but this comped against a mere 1.3% growth rate in 4Q13.  In fact, on a 2-year run-rate, this represented the second 300bp sequential decline in earnings growth. The good news for retail is that the market could probably care less about a 2-year run rate. It’s looking at one more quarter of very easy earnings compares. 1Q14 sales were up about 5%, which is fine. But margins were down 60bp y/y which is huge for such a big group of companies, and drove 1.3% growth in earnings in 1Q14. The bad news is that starting in 2Q, the group goes up against a mid-teens comp – and numbers look consistently tough throughout the year.
  4. Working Capital Looks Unusually Good. Point number 4 below shows how working capital trended down as a percent of sales so meaningfully throughout 2014. That definitely helped merchandise margins overall, and sets up 1Q to look especially good – especially in conjunction with the weak margins we saw in 1Q or last year.
  5. WC looks good for the quarter, but not much room left for the year. The point here is that working capital as a percent of sales is sitting at a 5-year trough. If it goes any lower it will need to come by way of inventories. That’s possible. But we think it’s unlikely while everyone is building out e-commerce operations. To that end, capex as a percent of sales has been climbing year after year since it washed out to 2.3% of sales in 2009. Now it’s sitting at historical peak levels of 3.9%. Our bet is that when we tabulate 2015 numbers, we’ll see that the group broke through the 4% mark – perhaps by as much as 20 or 30bps. We have to look back to 2010 to find a period where so many companies are taking up capex so materially.

Retail – Our 2015 Quarterly Playbook - chart1 3 31

Retail – Our 2015 Quarterly Playbook - chart2 3 31


Something To Keep In Mind as it Relates to Margins

Aside from the ‘tough compares’ argument (which is usually thin on its own), there are other factors that we think will temper margins in 2H. Those are a) wages and b) shipping.


a)      We all know how Wal-Mart announced that it is taking up wages by 40% for its store-level employees. Target has since increased wages, and we think other retailers will follow. So many retailers seem to have blown this off thinking that it’s really not a big deal, but rather a WMT PR stunt that won’t affect them. It may be a stunt, but when the biggest retailer in the world raises wages by $1,800 per employee, it is a big deal for everybody. We’ve heard half a dozen CEO’s say “We already pay above minimum wage, so it’s not a big deal.”  Or in Kohls’ case, “Our employees love to work, so we don’t have to pay them more.”  We understand that the companies can’t negotiate wage increases with employees through Wall-Street conference calls. But there will be an impact to almost everyone who sells to the low/mid-level consumer. The reason why we haven’t seen it yet is because we’re now at a seasonal lull for retail. By July, retailers will start beefing up temporary workforce ranks for ‘Back to School’ and then they kick it up a notch again in October as they prepare for Holiday. With the exception of grocery retailers, they ALL follow that pattern. That’s precisely when we’ll see the biggest wage pressure.


b)      The other big issue is ‘free shipping’. Target went ‘free shipping’ last holiday, and just cut its free shipping threshold in half to $25. We suspect that it will go Free again this year, and would not be surprised in the least to see several other retailers use this as an offensive weapon. Unfortunately, for almost everybody except the bullet-proof content-owners of the world (i.e. Nike) such a move will be dilutive to margins. Even worse news is that if they don’t play ball, then there’s risk to the top line (i.e. if either KSS or JCP opts-in to the free-shipping game, they both lose). We still think that by the end of FY16, all of retail will be 100% Free Shipping, 100% of the Time.  



Other Considerations On the Group


6. SIGMA Looks Outstanding. This is exactly what we’d expect to see given the easy margin compares and solid working capital trends outlined above. As a reminder, this analysis triangulates sales, inventories and margins, and has a 0.92x r-squared with stock movements of the underlying security. In this instance, the Retail Softlines group is sitting in the upper right quadrant – Quadrant 1 – which we call the Sweet Spot. Simply put, sales are growing faster than inventories, and margins are expanding. It really does not get better – unless it happens again, and again. We think we’ll get one more move higher into the upper right. After that, any possible move results in the group trading lower.


7.  The RNOA Map Is Really Peaky.  Think of this analysis as a longer-term SIGMA. Margins are on the Y Axis, and Operating Asset Turns are on the X. It’s like a SIGMA including all elements of working capital and capex instead of just inventories. When we see a stock or index trading at new highs, we expect its’ RNOA Map to look precisely like it does below. Moving up and to the right.  Could we see improvement in asset turns from here? It’s unlikely given that working capital is already troughing, and we’re seeing capex trend higher in 2015. In that case, could we at least see margins head higher? Again, we don’t think so…especially with the cost pressures emerging in the back half.


8. RNOA. The components of RNOA broken in #7 matters most to us. But the simple math is that you multiply tax adjusted margins by operating asset turns to arrive at RNOA. If a company has 6% margins and 3x asset turns, it results in 18% RNOA.  The group is sitting pretty today at about 28%. We’ll be surprised to see this group above 28% (and even above 27%) at the end of this year. We think that both margins and asset turns will start to go the wrong way.



Retail – Our 2015 Quarterly Playbook - chart3 3 31

Retail – Our 2015 Quarterly Playbook - chart5 3 31


Companies Included: CRI, DDS, DKS, FL, GPS, JWN, KSS, M, NKE, PVH, RL, ROST, TJX, VFC, WWW



Hedgeye Retail Idea Summary

Retail – Our 2015 Quarterly Playbook - idealist 3 31