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We the People

“Government spending is taxation.   When you look at this, I’ve never heard of a poor person spending himself into prosperity; let alone I’ve never heard of a poor person taxing himself into prosperity.”

-Arthur Laffer

 

Hedgeye Early Look reader and friend Governor George Pataki officially threw his hat in the ring last night for the Republican nomination for President.   The political punditry is by and large calling him the darkest of dark horses.   And who knows, maybe they are correct – Governor Pataki has been out of public for nine years, currently is not well funded, and is centrist among Republicans.

 

The reality remains, though, that the Republican is currently ripe for a new face.  Someone that is above the fray and perhaps, on some level, embodies the “disinterested statesmen” that was originally envisioned by the Founders as a key characteristic for the Presidency.  The Republican race also needs some plain talk and who better to offer it than a candidate that has little to lose.

 

As a Canadian citizen, I can’t actually vote, so I’m no danger to any of you partisans out there, but a more centrist Republican who is trying to push the party beyond social issues and hasn’t been directly involved in the massive buildup of the federal government over the past ten years will be appealing to some.  The central tenet in Pataki’s launch video is a focus on government as the problem.

 

Certainly, a lot of politicians and political candidates pay lip service to reducing the size of the government, while few actually follow through.  If there were ever a time for follow through it is 2016, a year in which the federal government’s spending will be over $4.0 trillion and government debt will accumulate to $23.5 trillion.  Undoubtedly one point that all of us can agree on is that governments are the most ineffective allocators of capital.

We the People - z debt

 

Back to the Global Macro Grind...

 

Staying with the theme of the Presidential race this morning, there is one big challenge facing Pataki or any Republican – Hillary Clinton.   In the race for the Democratic nomination, she has a staggering lead of 51 points in poll aggregates over the second nearest candidate Elizabeth Warren. Meanwhile versus the large Republican field, Clinton outpolls the top contenders by between 8 and 10 points.

 

So, what, if anything, can stop the Clinton coronation?  Well, as we touched on it a note a few weeks ago, there are a number of legitimate headwinds to a Clinton Presidency. The top four headwinds we see are outlined below:

 

1. The Clinton Foundation - This risk is the most topical right now given the current scrutiny the Foundation is receiving thanks to Peter Schweitzer’s book, “Clinton Cash: The Untold Story of How and why Foreign Governments and Businesses Helped Make Bill and Hillary Rich.” It is also very likely an issue that will not go away.  On some level, whether the Clintons acted ethically as it relates to the Foundation is irrelevant because there is enough fodder that it will allow Republicans to continue to keep the heat on the Foundation.  To the extent the scrutiny accelerates, the Foundation has the potential to become Clinton’s “Swift Boat” moment.
  

2. Likeability (and accessibility) – Since announcing her candidacy more than 45 days ago, Hillary has limited interaction with the press.   Whether this lack of accessibility is ultimately perceived as a lack of a common touch (think Hillary going into Chipotle wearing sunglasses and not leaving a tip) remains to be seen. However, her favorability has taken a steady decline since she left office as Secretary of State in February 2013.

 

3. Bill’s Gaffes – While there is no question that Bill Clinton is one of the most talented politicians of his generation, there is also no question he is (and maybe increasingly so) prone to putting his foot in his mouth. In today’s hyper-plugged in digital world, where no one is safe from a rogue iPhone recording a candidate’s every word, this may pose a delicate challenge for the former commander in chief. 

 

4. Benghazi (and general track record) – In aggregate, Hillary Clinton’s role as Secretary of State is regarded favorably and without much controversy with one big elephant-in-the-room exception – Benghazi.  This was of course the unfortunate turn of events that led to the deaths of U.S. Ambassador J. Christopher Stevens and three other Americans when the U.S. diplomatic mission in Benghazi, Libya was attacked.

 

We are going to reserve analysis of the events, but believe this will become a major thorn in her side, especially as it gets into the nitty-gritty of the campaign post the nominating conventions.   The downside of having a track record is that it can and will be scrutinized.  With the eventual planned releases her emails as Secretary of State, her record will be subject to accelerating scrutiny.

 

Certainly, if the election were held today, it is hard to argue that Clinton would likely win in a landslide.  But whether it is the emergence of a new Republican contender or a current front runner breaking from the pack, the polls will narrow into Election Day as they always do.

 

For Clinton specifically, as touched upon above, her favorability ratings continue to decline.  Currently based on poll aggregates, 47.8% view her unfavorable and 45.9% view her favorably.   These are her worst readings since 2009.

 

Make no mistake about it: there will be a race in 2016.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.98-2.20%

SPX 2107-2130

Nikkei 20091-20688

VIX 12.76-14.42

Oil (WTI) 57.01-61.35

Gold 1180-1205 

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

We the People - z 05.29.15 chart


Ceaseless Attention

This note was originally published at 8am on May 15, 2015 for Hedgeye subscribers.

“In order to lead an army, you have to ceaselessly attend to it.”

-Napoleon Bonaparte

 

The way my typical day goes is as follows: ceaseless attention to Global Macro market moves, news, and analysis in the morning – meetings in the afternoon – and, family, hockey, and #history (in that order) in the eve.

 

The compare and contrast of the macro morning to a history book at night couldn’t be more drastic. Before bed last night I was enthralled in early 19th century European history (Napoleon, A Life). This morning I feel like I’m watching a version of it 200 years later.

 

I don’t do it because it’s cool. I do it because I love it. I do this because I’ve realized that every book I read reminds me how much I don’t know. And since I’m leading an independent army against an Old Wall guard that seems to know everything, there’s work to do.

 

Ceaseless Attention - 80

 

Back to the Global Macro Grind

 

Can you contextualize immediate-term market moves within the intermediate-term? How about the long-term? What is the long-term? Is it 3 years or 200? If you could know everything about everything, across durations, I’m betting you would.

 

Since I write every day, I spend a lot of time trying to contextualize the TRADE (3 weeks or less) within the TREND (3 months or more). But especially during times like these, it’s critical to attempt to have a view of what TRENDs are doing within long-term TAILs.

 

We define longer-term TAILs as having a duration of 3 years or less. I use that time horizon because A) I really suck at calling things 3 years out and B) unless they have permanent Buffett-like capital, mostly everyone else does too.

 

So today, to keep it simple, I just wanted to give you my TREND vs. TAIL views, across Global Macro:

 

  1. US Dollar = bearish TREND; bullish TAIL
  2. The Euro = bullish TREND; bearish TAIL
  3. Japanese Yen = bearish TREND and TAIL
  4. US 10yr Treasury = bullish TREND and TAIL
  5. US 30yr Treasury = bullish TREND and TAIL
  6. Japanese Government Bond (10 yr) = bullish TREND and TAIL
  7. SP500 = bullish TREND and TAIL
  8. Russell 2000 = bearish TREND; bullish TAIL
  9. US Equity Volatility (VIX) = bullish TREND and TAIL
  10. Nikkei = bullish TREND and TAIL
  11. German DAX = bullish TREND and TAIL
  12. BSE Sensex = bearish TREND; bullish TAIL
  13. CRB Commodities Index = bullish TREND; bearish TAIL
  14. Oil (WTI) = bullish TREND; bearish TAIL
  15. Gold = bullish TREND; bearish TAIL

 

I better stop there, or I am going to confuse you. I used to get confused by intermediate-term TREND views disagreeing with longer-term TAIL ones. But after building, breaking, and re-building my #process, I don’t dwell on the non-linearity of it all as much.

 

Most of our confusions have to deal with our own emotional baggage. We are humans, after all. And when something goes one way for a period of time that we think we understand – then it goes the other (that we don’t understand), we get frustrated.

 

That makes our collective challenge to see the macro market for what it is, as opposed to what we’d like it to be. This is not easy. And it gets a heck of a lot harder if we don’t do the longest of long-term #cycle work to contextualize the “de-couplings.”

 

I wrote about why I think USD continues lower from an intermediate-term TREND perspective yesterday (Commodities, Oil, Euro, etc. higher), but I didn’t spend any time on why it could strengthen after easier Fed policy and slower growth is baked into consensus.

 

The longer-term case for:

 

A) US Dollar Index to put in a long-term-higher-low at around 89-90 on the USD Index (EUR/USD 1.19-1.20)

B) Commodities (CRB) Index to put in a long-term-lower-high in the 248-253 range

C) Oil (WTI) to start to fade and fail at lower-long-term-highs of $69-71

 

Is as follows:

 

  1. Currency War (centrally planned FX devaluations to create growth and inflation) will see Japan, Europe, and the USA fail
  2. As each of the 3 majors sees growth and/or inflation slowing, they’ll take their turn with more of what has not worked
  3. In the end, the US has the best demographics of the 3, so they’ll have the best real growth of the 3 (and strongest currency)

 

The most important words in those 3 points are “they’ll take their turn.” In almost every macro strategist/economist piece there is either a complete disregard for that and/or a blind faith that real economic growth will be born out of these policies to begin with…

 

Look up the Wall Street Journal article this morning on US “Economist’s Expecting Recovery”:

 

  1. US economic growth to magically re-accelerate to +3.0% year-over-year in 2nd half of 2015
  2. US non-farm payrolls (NFP) to average 223,000 for the rest of 2015
  3. A “Strong Dollar” to weaken, which was the “headwind” to the US economy in Q1 2015

 

Meanwhile, the Hedgeye Predictive Tracking Algorithm has US GDP growth at +1.8% year-over-year growth in 2H 2015 and we could easily see non-farm payrolls at half of that expectation, in our most bullish case.

 

If I rattled off the Japanese and European “economist” expectations, the only ones that are in the area code of close are Japan’s. But that’s only because they have been forced to predict that none of this “growth” policy has worked for 20 years!

 

I realize this is the longest Early Look of the year. My apologies for that. If you’d like to ceaselessly stare at the S&P Futures, please refer to our risk ranges. Buy at the low-end (sell at the high-end) of the range, but please pay attention to TRENDs and TAILs too.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.95-2.31%

SPX 2098-2129
RUT 1212-1248
Nikkei 19199-20024
VIX 12.11-15.67
EUR/USD 1.10-1.14
YEN 118.77-120.58
Oil (WTI) 55.67-61.60

 

Best of luck out there today and enjoy your weekend,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Ceaseless Attention - z 05.15.15 chart


The Macro Show Replay | May 29, 2015

 

Today's show featured Financials and Housing Sector Head Josh Steiner. Below is his 18-minute segment. 


Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

May 29, 2015

May 29, 2015 - Slide1

 

BULLISH TRENDS

May 29, 2015 - Slide2

May 29, 2015 - Slide3

May 29, 2015 - Slide4

May 29, 2015 - Slide5

May 29, 2015 - Slide6

May 29, 2015 - Slide7

May 29, 2015 - Slide8

BEARISH TRENDS

 

May 29, 2015 - Slide9

May 29, 2015 - Slide10

May 29, 2015 - Slide11


LEISURE LETTER (05/29/2015)

TICKERS: MGM

EVENTS

  • June 4: CCL special press announcement in NYC

COMPANY NEWS  

MGM -  MGM's Clark Dumont confirmed that preliminary votes showed all of the casino-hotel company's 11 incumbent directors were re-elected.

Takeaway:  No surprise here

INDUSTRY NEWS 

Package tours - visitors on package tours totaled 806,000 in April 2015, down by 6.8% YoY. Package tour visitors from Mainland China (648,000) and Taiwan (45,000) dropped by 6.6% and 19.6% YoY, respectively. 

 

There were 99 hotels and guesthouses operating at the end of April 2015, providing 28,000 guest rooms, up by 1.7% year-on-year; 5-star hotels accounted for 64.8% of the total supply, with 18,000 rooms.
       
A total of 827,000 guests checked into hotels and guesthouses in April 2015, down by 7.1% YoY. Guests from Mainland China (521,000) decreased by 12.0%, while those from Hong Kong (125,000) and Taiwan (29,000) increased by 10.9% and 8.6% respectively.

 

The average length of stay of guests held stable as April 2014, at 1.4 nights. The average occupancy rate of hotels and guesthouses was 79.4%, a rebound from March (77.2%) yet still down by 5.9% YoY; the rate of 4-star hotels and 5-star hotels was 82.2% and 79.5% respectively.

 

LEISURE LETTER (05/29/2015) - occu

Takeaway: More bad news for Macau. Package tour visitors fell for the 1st time since Feb 2014. Hotel occupancy declined again in April (-6% YoY).

 

MACRO

Hedgeye Macro Team remains negative on Europe, their bottom-up, qualitative analysis (Growth/Inflation/Policy framework) indicates that the Eurozone is setting up to enter the ugly Quad4 in Q4 (equating to growth decelerates and inflation decelerates) = Europe Slowing.

Takeaway:  European pricing has been a tailwind for CCL and RCL but a negative pivot here looks increasingly likely in 2015.


KATE: The Baby vs. Bathwater

Takeaway: KATE is being thrown out with bathwater it wasn’t even bathed in. We’re fighting an uphill sentiment battle, but it’s one worth fighting.

Conclusion. We’re all-in on KATE at current levels. All along, we’ve pointed to a $70-$80 value. The stock is off 26% over the past month, due to sentiment concerns around 'the space' (KORS is off 27%), but our fundamental outlook has not changed one bit. The business remains very strong, we think that comps are accelerating into the double digits in 2Q, and we think that KATE’s margin guidance for this year will prove conservative. Ultimately we think that numbers this year are 15% too low – a delta that widens to 35% next year, and to 50%+ by 2018 when we think KATE has $3.00 in earnings power. Using decelerating multiples as growth accelerates and the P&L matures gets us 55% upside in a year and a 2-3-bagger by 2018. If we see the typical 'peak multiple on peak earnings' that retail knows so well, then a $100+ stock by year 3 is not out of the question.

 

To put this stock move in context, KORS – due to its recent implosion – is down 27% for the past month. While we think KORS is beyond cheap and has meaningful downside support here, the fact of the matter is that whether you’re bullish or bearish on KORS – the stock move can at least be explained away by the headlines. But with KATE – that’s simply not the case. As a sidenote, we turned positive on KORS on this week's implosion, but that was not a typical call for us. We think that KATE offers far better upside, has greater margin of error, and is a much more defendable growth story, by far.

 

Quick Sentiment Check

Our strong sense on the sentiment is that if you were concerned about ‘the handbag space’ (a definition that we still think is ridiculous) and wanted to short it, you had the following options…

a)      2012-14: There was pretty much one name you had for the past 3-years – Coach. The brand was beyond full market saturation, and had 30% margins that had nowhere to go but down without significant risk to the top line. But that name largely became tough to short by the fall of 2014, after it dropped by 55% at the same time the market went up by 45% (yes, 100% relative underperformance).

b)      2014-2015: About the same time Coach stopped going down, KORS became the go-to name to short. It has a fully penetrated business in the US, and Coach-like margins of 29%. Since that time (roughly a year ago) the stock traded off by 50% and underperformed the market by 60%. Then – even before this week’s blow up – the general sense we got from the investment community was that it was getting tougher to short.

c)       2015: With Coach and Kors serving as the poster twins for saturation and underperformance, people naturally look add a triplet to the group. The only other public company in this ‘space’ is KATE, which admittedly looks wildly expensive on current year earnings. As such – for better or worse -- it has turned into the go-to ‘high multiple in a troubled space’ short and source of funds in retail. The unfavorable tape might help the short case for the time being, but the supporting fundamental premises simply make no sense. Here are some considerations…

 

Why KATE ≠ KORS ≠ COH

Let’s get COH out of the way. This company is good at one thing. Creating handbags for one consumer – a 30-60 (really 40-60) year-old US consumer that shops in department stores and outlet malls. That’s all, nothing else. It has 13% share of the US handbag market. No apparel, no meaningful accessories, little presence with men (manpurses are rarely a good investment hook anyway) and consistent failure in bridging to an International audience. This coach is being drawn by a one-trick pony.

 

KORS is a different animal. KORS has an $8bn retail footprint versus COH at $5.2bn despite having 300bp lower share of the handbag market than COH (10% share vs COH at 13%). That’s due to its presence in accessories, men, and overseas (it has nearly a $1bn business alone in Europe, and that should at least double from here). Given its diversity, we’d argue that KORS has more in common with a brand like Ralph Lauren than COH. The only thing the two have in common is an EBIT margin that recently peaked at 30%, and is now trending in the high 20s.

 

KATE is also a different animal (but much smaller, and not on the endangered species list). Did anyone ever consider that one of the reasons why the incumbents are stalling out is because KATE spade is eating their lunch? Think about it this way… COH is at 13% share, KORS is 10%, and KATE is less than 3%. KATE’s (annual) brand footprint is sitting just under $1.5bn – that’s 25% less than KORS ($8bn) generates in a single quarter. Kate is even 20% smaller than Tory Burch, which isn’t (yet) public. Like KORS, KATE sells in multiple categories, with handbags accounting for about 60% of sales, apparel at 15%, footwear at 10%, accessories/other at 15%. The company also has several licenses kicking in this year, including watches (Fossil) that should boost its high-margin accessories business. KATE, unlike COH, has been accepted by consumers in Europe and across Asia – which remains a key part of the growth story.

 

KATE: The Baby vs. Bathwater - footorint

 

 

Aside from licenses, which will help KATE meaningfully effective 2H, don’t underestimate the importance of the maturation curve for its stores. So many people think that KATE’s store base is as old as the brand is. Not so. The brand hit the mainstream over a decade ago, but it really did not start to grow at retail in earnest until about 3-years ago. That’s pretty critical from where we sit because from a profitability standpoint, these stores tend to hit their stride in years 3-4. Looked at a different way, 80% of KATE’s stores are 4-years old or younger, and a whopping 44% are less than 2 years old. This is seriously bullish for the company’s margin equation.

 

KATE: The Baby vs. Bathwater - mature

 

 

The point here is that KATE is absolutely NOT either of its perceived competitors. Financially, the closest comp is probably Tory Burch. The same reason why Tory will likely go public is that same reason why KATE should be bought today – it is just hitting its stride on the top line, which will accrue disproportionately to margins.

 

Let’s be clear about something, our estimate of $3.00 in EPS in 2018 is NOT assuming KORS or COH-like margins. It’s fair to say that both of those companies have shown us the perils of over-earning in this (or any) segment of retail. We’re simply assuming that margins at KATE get to 19% -- a good healthy level that should allow the company to continually invest to drive top line growth.

 

So What’s It Worth?

Today, 41x earnings and 15x EBITDA might seem very aggressive. But consider the earnings ramp. We’re looking at a CAGR over the next three years of about 70% for both earnings and cash flow. If we hold the cash flow multiple at 15x for the next year, which we think is fair as margins head higher and KATE catches estimate revisions and upgrades, then we’re looking at a $38 stock, or a 55% return in 12 months. Then we’ll reduce the multiple by 2 points per year, as the brand gets more mature, which gets us to $50 and then $65 in year 2 and 3 (vs $25 today). All that said, we’ve almost never seen a smooth multiple transition like that in retail. A typical pattern would be a higher/peak multiple on accelerating cash flow. That’s when we start pushing a $100 stock. That’s not our call today, but it’s not out of the realm of possibility.

 

KATE: The Baby vs. Bathwater - kate fin

 

Flash Sales:

  • On the flash sale front (meaningful bc the company is trying to wean off of them, but the absence negatively impacts comps), the company ran 2 flash sales and one semi-annual sales event during 2Q14. 2Q15 to date, KATE has run one Friends and Family event (that fell in 1Q14 last year due to the late April Easter in 2014) and one flash sale. The company already indicated that it would repeat the semi-annual event at the tail end of the quarter, so there is a chance we see the elimination of one Flash Sale during the quarter. That should be more than offset by the addition of Friends in Family in the quarter.

 

e-commerce

  • Trends here matter a lot for KATE. Consider this…KORS generates 5% of its revenue online. Coach is sitting at 11%. KATE is just north of 20% -- one of the highest ratios out there for any retailer. #healthy balance
  • When we look at recent trends for each of the brands in question (the charts measure each brand versus a year ago), KATE’s numbers are unquestionably higher than KORS and COH.  The growth is lower than we saw earlier this year – but that is expected given reduced promotional activity. Overall, the trends look very healthy to us.

KATE: The Baby vs. Bathwater - reach

 

Margins:

  • On the Gross Margin line, Kate Spade Saturday alone accounted for 240bps of the 315bps of dilution on the Gross Margin line (about $6.5mm) in 2Q14. The company hasn’t addressed this benefit in its guidance, either for the fiscal year or the upcoming quarter and it is not reflected in current consensus numbers. For the quarter we assume that the company gets back 200bps of the dilution which is offset by Fx pressure and the shift of the Friends and family sale into the quarter.
  • We’re modeling 250bps of SG&A deleverage as the company continues to leverage sales growth on the fixed G&A costs and international profitability improves. 

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

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