Editor's Note: Below is an excerpt and chart from today's Morning Newsletter written by Hedgeye CEO Keith McCullough. Click here to learn more and subscribe.
...Contextualized this way, the present (being YTD) is less than 6 months old. If you pull back your time-series #history to 1 year, obviously most of these “inflation” barometers have plummeted.
Five year breakevens is a fair way to consider inflation expectations, and while it’s true that those are +11 basis points for the current quarter, they are -32 basis points year-over-year. Newsflash: the Fed is not going to “raise rates” on that...
“I started to establish the present and the present moved on.”
I love spending long weekends with my family. I hope you had a great one with yours. Welcome back.
This weekend I took some time to review what I’ve organized as the un-read section of my library and I found a book that I’ve been wanting to read for a long time – Wallace Stegner’s 1972 Pulitzer Prize Winner, Angle of Repose.
In some ways I find Stegner to be like Hemingway. He’s of the same era; he writes from a historian’s perspective; and he keeps his short stories within a story concise and to the point. These are all writing attributes I aspire to achieve someday. Until then, I evolve.
Back to the Global Macro Grind…
When considering the non-linearity of Global Macro markets, isn’t Stegner’s aforementioned quote the truth? Just as Bloomberg writes a headline about FX “volatility expected to reverse direction”, it breaks out this morning. Again, welcome back.
Before I get into the #behavioral side of this foreign currency move (Japanese Yen -1.1% this a.m. to fresh YTD lows), it’s always critical to review the #history of market moves, so that we can attempt to establish context:
- In “front-loading” QE, Eurocrats devalued the Euro by -3.8% last week, taking it down -9% vs USD YTD
- After 6 weeks of pervasive weakness, the US Dollar Index spiked on that, closing the week +3.1% at +6.4% YTD
- The Japanese Yen, which had been doing nothing for months, finally broke down, dropping -1.8% on the week
That’s why another drop in the Yen this morning matters. Not only did it break immediate-term TRADE support last week, fortifying our long-term bearish TAIL risk view, but now it’s testing a break-down to lower-lows, -2.5% YTD.
Now, since I’m bearish on the US Dollar into this week’s GDP report (Friday) and next week’s jobs report for June (then the Fed meeting on June 17th), these Euro and Yen moves are going to present opportunities on the long side of commodities.
If you didn’t know that the USD impacts commodity #deflations and reflations (or whatever consensus is whining about right now on “inflation” coming back at sub $60 Oil and 1.68% 5yr US break-evens), now you know.
With USD having a -0.90 inverse correlation to the CRB Index (30-day duration) here’s what everything Commodities did last week:
- CRB Commodities Index -2.5% = -1.9% YTD
- Oil (WTI) -1.4% to $59.72 = +6.2% YTD
- Gold -1.7% to $1204 = +1.6% YTD
- Copper -3.9% to $2.81 = -0.5%
- Energy Stocks (XLE) -0.6% = +1.3% YTD
Contextualized this way, the present (being YTD) is less than 6 months old. If you pull back your time-series #history to 1 year, obviously most of these “inflation” barometers have plummeted.
Five year breakevens is a fair way to consider inflation expectations, and while it’s true that those are +11 basis points for the current quarter, they are -32 basis points year-over-year. Newsflash: the Fed is not going to “raise rates” on that.
Longer-term, what does the world want – a stronger or weaker Dollar?
- If you’re a European stock market bull, you want #StrongDollar, Burning Euro
- If you’re an Emerging Markets bull, you want #WeakDollar, Recovering EM Currencies
- If you’re a non-Wall St American, you want a #StrongDollar, Rising Purchasing Power
That’s what macro markets reminded you of on last week’s #StrongDollar move:
- European Stocks (EuroStoxx 600 and German DAX) +2.8% and +3.2% to +19% and +20.5% YTD, respectively
- EM Latin American Stocks (MSCI Index) -5.5% to -4.2% YTD
- Russell 2000 +0.7% to +3.9% YTD with the almighty Dow DOWN -0.2% on the week
Yep, the Russell is basically a US domestic revenue index whereas both the Dow and SP500 are increasingly proxies for international earnings. That’s why the Russell rocks during #StrongDollar periods (see our 2013 US #GrowthAccelerating theme for details).
That’s also why the US Sector Style (equities) outperformance last week was very much what it was prior to the recent US Dollar correction. US Consumer Discretionary (XLY) loves #StrongDollar whereas the global Industrials (XLI) loathe it.
Love it or loathe it, US Dollar #history has been established. And it’s my job to write about its policy risks for both the short and long-term. While it’s true that, in the long-run, Keynes is right (we’ll all be “dead”), the present moves on.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 1.97-2.24%
Oil (WTI) 57.31-61.68
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
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Takeaway: Here’s a brief summary on our Longs and Shorts. We have another dozen names on our bench, and about 20 in the vetting stage. Stay tuned.
RH: We’re comfortable owning into earnings in two weeks. We’re ahead of consensus, and the earnings algorithm should show that sales and earnings are accelerating while the broader group is slowing. We should also get some good detail on new categories/concepts, which should fuel growth along with a material square footage ramp in 2H. Still one of the biggest Consumer ideas out there today across durations. We like the fact that there are so many different angles here that are so grossly misunderstood by the investment community. The company will continually innovate, grow, while marginalizing its weaker competitors. We still think that RH being above $200 is more a question of ‘when’ than ‘if’. The story is not linear – no great stories are – and there will be puts and takes by quarter. But this quarter looks good from where we sit.
KATE: Our only concern with KATE is that it trades like something is wrong. But fundamentally, this name checks out. Comps seem to be accelerating from the (slightly weak) 9% number we saw in 1Q, and are torn as to whether the biggest surprise for people will be the sequential acceleration in the business, or the margin gain from last year. Either way, KATE is one of the few high-growth names that should work while the group faces headwinds.
NKE: We’re well ahead of the Street for the May quarter. It’s important to remember that last quarter when multinationals were dropping like flies due FX headwinds, NKE uncharacteristically came out just fine. The difference between this and prior FX cycles is that now Nike has an e-commerce offset. Dot.com should accelerate by roughly 1,000 bp to 50%+ as its solid momentum comps against an easy May14. The math here is clear – an incremental sale online not only carries a 20point margin premium to a wholesale sale, but roughly 4x the Gross Margin Dollars. The same dynamic is at play this time, and the next quarter, and the quarter after that…
WWW: We’re comfortable with this one as a sleepy name that has several levers. We think that 1) the PLG brands (40% of the company) are growing outside the US to a far greater extent than is apparent in the GAAP results. That will show to a greater degree in 2H, which should give estimates a lift. Also 2) Merrell (25% of revs) just swapped out its high-profile President, and probably has a free pass for another few quarters while it changes direction. So that’s about 65% of revenue, or 90% of rev that has any element of volatility. Estimates look extremely achievable this year. Also the Street is not accounting for what should be 500bps in financial deleverage. If we don’t see it, it is likely bc WWW goes ahead and does another deal – and it can stomach up to a $1.3bn transaction at current leverage levels. We usually don’t like deals, but in WWW’s case they usually serve as a positive catalyst.
KSS: Even after the recent drop, we still think KSS is a solid short. Expectations are too high in sales and gross margins and cash flow, and too low in SG&A. Wage pressure will build for KSS this summer (lowest paying in the industry) when it flexes its workforce for seasonal employees – then again around holiday. We also think that there’s meaningful risk to KSS’ credit card income (25% of total EBIT) – even in a very healthy credit environment – due to the flawed nature of how the new rewards program intersects with KSS Credit Card. Consensus estimates are marching to $6.00, while we think they’re headed to $3.00.
HIBB: We think that HIBB is one of the most structurally challenged retailers out there. Top line trends are decelerating, costs are accelerating, and capital requirements are going nowhere but up. Any form of growth from here on out – in existing stores, new stores, and online, will all come at an incrementally lower margin. Numbers in the current year are coming down, but we think next year’s earnings are too high by 40%. Still one of our top shorts following the 1Q print.
FL: There’s no debating the strength of the quarter on Friday, with 2% sales growth leveraging to 18% growth in EPS. But virtually every penny of the EPS upside came from lower SG&A – in fact, Gross Profit was only up 3.7%. SG&A was down 2.8% vs last year, and came in at 18% of revenue. For the record, it is almost impossible to find a small-format retailer with SG&A below 20% of sales, and FL is sitting at 18%. This is also notable in that FL recently noted that its SG&A goal is 18-19% of sales. The point is…it’s pretty much there. Remember that this company’s RNOA went from 5% to 28% over six years as it pulled capital out of the model (closing stores/repositioning banners) while boosting productivity and margins to all time highs. At the same time, it’s percent of sales from Nike (traffic driver) went up by 2,500bps to 72% of COGS – and near 80% of sales. That’s not going any higher. FL’s answer is to become a unit growth story once again and sustain a mid-single digit comp while maintaining the leanest cost structure out of any retailer around. And for all that, the stock is trading at 16x forward earnings – an all-time high. The ‘going private’ angle here is moot given its high Nike exposure. Lastly, the stock is having more muted reactions to good news.
TGT: Out of any idea on our list, this is the one we struggle with the most. On one hand, with the Canada disposal out of the way, there are no more quick and easy fixes for new CEO Cornell to improve profitability. He’s stuck with the result of an extremely poor decision making process by his predecessor that left the company in such bad shape that going to Canada actually seemed like a good idea in the first place. We think that the company needs to materially step up investment to set TGT on a growth trajectory – basically putting the brand once again on offense. That would likely take margins – and potentially sales – lower before they ultimately head much higher. But we can’t shake the Bull Case, which is that Cornell will make subtle tweaks to the model that will be enough to keep earnings slowly grinding higher – without implementing major change that will hurt the stock over the near-term. We’re going to continue to wait and see into 2H, as we think that the significant EPS deceleration in the group plus increased cost pressure (labor and margins) will step up materially. Risk to TGT in that environment is to the downside.
This note was originally published at 8am on May 11, 2015 for Hedgeye subscribers.
“A man willing to work, and unable to find work, is perhaps the saddest sight that fortune’s inequality exhibits under the sun”
How many people must run from a crowded theater before the next person decides to run?
That’s the analogy Jim Rickards uses to anchor his discussion of critical state dynamics in complex systems in the prophetic Fx apocalyptic, Currency Wars.
Rickards uses it as the metaphorical underpinning to a hypothetical example of how a repudiation of the Dollar by some relatively small number of people could propagate to a population wide repudiation and full currency collapse.
I like the theater metaphor because it’s vivid, mentally tractable and widely transferrable - if some stimulus perturbs a system such that the system reaches a critical state, the signal/perturbation gets propagated and amplified as it moves downstream.
In short: some people run from the theater --> which cause more people to run from the theater --> everyone runs from the theater.
Power laws and critical state thresholds are, conceptually, pretty simple. And in describing the fundamental nature of a complex system, the lessons apply equally well to the Labor Market, Stock Market or interconnected Global Macro Markets as they do to the Currency Market.
It’s probably generally accepted (or perhaps not) that the evolution of macro modeling should endogenize complexity. So, why hasn’t it been done?
Mostly because the math needed to model network effects and signal propagation at the scale of Macroeconomies is (really) hard.
However, for those waiting (im)patiently on the ivory tower evolution away from static equilibriums and linear macro, the direction of current research is encouraging.
At a recent conference of the National Bureau of Economic Research Daron Acemoglu (MIT) et al presented the following paper: Networks and the Macroeconomy: An Empirical Exploration
If you’re interested – and fully caffeinated – it’s worth a read. Even if you don’t understand the math and techni-speak, the Abstract/Intro provides some layman friendly intuition for understanding the conceptual framework.
Back to the Global Macro Grind….
How many central banks need divergent policy paths to effect a step function rise in the dollar? --> What is the critical threshold on the dollar to propagate reflexive price action in commodity markets(i.e for things priced in dollars)? --> What is the critical price threshold on Crude to propagate a capitulation in financial demand (i.e. futures and options) for energy products and further price volatility? --> How much does the oil price have to drop to cause a collapse in energy sector capex and employment and a state-level recession in Texas? --> What’s the critical threshold for an industry level recession to catalyze a derailment of a broader jobs recovery domestically?
That flow of questioning is, of course, easier to generate largely after the fact.
While Financial markets and social media propagate and discount newsflow and events in real-time, frictions and inefficiencies cause the impacts of those events to flow through ‘real’ markets and government statistics on a lag.
Friday’s employment report provided the latest update on the net impact of the current set of dissonant global macro crosscurrents on the domestic labor market. We reviewed the data on Friday but a few area’s are worth re-highlighting
Energy Employment: Job loss in the energy sector extended into March/April according to both the BLS and Challenger Job Cut data. Oil & Gas extraction employment, which includes data thru April, saw a employment decline for a 3rd time in four months. Broader energy sector employment, which includes data thru March, showed a 5th consecutive month of net decline, dropping by -9K sequentially with the rate of YoY growth dropping to -0.6% - the first month of negative year-over-year growth in 58 months.
The weakness in the BLS report accords with the Challenger Job Cut data for April, see the Chart of the Day below, which showed energy sector job cut announcements re-ramping to +20K in April. Notably, collective net employment gains across our basket of eight energy states was -56K in March, the first delta negative month since September 2010, with the remarkable -26K decline in Texas leading job losses at the state level. For scale, the estimated -26K decline in Texas on an employment base of 11.7M would equate to an NFP print of -305K at the national level.
We’ll find out if the weakness portended by the Challenger data and emergent angst over a prospective state-level recession in Texas finds further traction in April with the release of the state level data on May 27th .
Housing: 25-34 year old employment growth made a higher cycle high from a rate-of-change perspective, accelerating +80bps sequentially to +3.2% year-over-year. Accelerating employment growth in this key housing demand demographic should continue to flow through to rising headship rates and housing demand at a modest-to-moderate rate. Further, Residential Construction employment rose +3K in April alongside the strong rebound in broader construction employment which was up a big +45K on the month as activity rebounded alongside the thaw in the weather.
The rebound in construction employment and activity in April along with the increased pace of household spending in the March PCE data offer some support to the deferred consumption (i.e. weather/etc) storyline in 1Q15, although the ongoing weakness in the factory sector sits as a material offset.
Income/Spending: With no change in hours worked and earnings growth up small sequentially, the moderate gain in total employment and modest positive mix in high-wage/low-wage employment on the month should be enough to support continued Trend improvement in aggregate income in April.
As we’ve highlighted, with income growth accelerating alongside the rise in the savings rate in recent months, the capacity for consumption growth has increased more than actual reported household spending. That trend showed a moderate reversal last month with income gains softening, savings declining and spending rising. Whether that latent spending power re-emerges remains TBD.
Indeed, consumption has some heavy lifting to do as consensus forecasts for accelerating PCE continue to buttress full year GDP growth estimates which remain at +2.8% despite what will be another 1st quarter of negative growth following the 1st revision to 1Q15 GDP.
For investors, the labor market rubber ultimately meets the road in terms of expectations around the path of monetary policy. With the market having already pushed out rate hike expectation to September, the April employment report probably does little to shift that, although the bond market response on Friday looked to be discounting policy conservatism, at the margin.
More broadly, the return to middling employment growth – and the discrete lack of either collapse or escape velocity improvement – will mostly serve to perpetuate further policy uncertainty, and asset class volatility by extension, as another month is devoted to over-speculation and spurious investor activity in the attempt to front-run a Fed faced with equivocal data and a data-dependence mandate.
Uncertainty breeds opportunity. Profitably exploiting that opportunity stems from front-running the inflection or patiently awaiting the catharsis. Our cash position in the Hedgeye Asset Allocation model remains at 6-month highs.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 1.87-2.25%
Oil (WTI) 54.32-61.90
Best of luck out there,,
U.S. Macro Analyst
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