"This is more dovish than expectations," Hedgeye CEO Keith McCullough tweeted shortly following release of the FOMC statement. "You're one bad jobs report away from no September or December rate hike."
Editor's Note: This is an excerpt from a note written earlier this morning by Hedgeye CEO Keith McCullough. If you'd like more information on how you can subscribe to our services click here.
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If you ask Doctor Dollar, Janet Yellen may very well do what we think she should do. That is … stay “data dependent” with no timing on interest rates. That would mean Down Dollar, Down Rates and Up Almost Everything (similar to what I said during our live March 18th FOMC meeting call).
We think both U.S. equity futures (yesterday), and Oil again today are front-running this scenario.
Unfortunately for our friends in Europe (where I happen to be writing this morning) you get #StrongerEuro on this development. And the DAX, CAC (both down -4% in the last month) no likey Down Dollar. It means up Euro.
So we still like long U.S. Equities vs. short EuroStoxx with the Slower-For-Longer (down rates) view.
For better or (mostly) worse, all eyes are on the Fed today. We get it. Our omnipotent, un-elected, all-knowing monetary seers deserve our full and undivided attention this afternoon as they reveal their interpretation, forecasts and plans based on their reading of the economic tea leaves.
That doesn't mean we have to be happy about it!
In this free-market spirit we give you our favorite Fed cartoons from our Cartoonist-In-Chief .. the one, the only, Bob Rich.
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Takeaway: Tops are processes & “late-cycle” is not some discrete peak on a Macro sine curve. Move while the music plays but don't be willfully blind.
A CENTURY OF CYCLES: In our 2Q15 Macro Themes presentation we profiled the historical economic cycles of the last century, catalogued a selection of late-cycle indicators and contextualized the current expansion within the historical experience.
Canonical Macro cycles, left to themselves (i.e. with central banks following a largely passive policy reaction function), follow a pattern that largely resembles the circular, counter-clockwise flow captured in the inflation-output loop depicted in the chart below.
Conventional monetary policy is designed to function within the context of this naturally evolving cycle. The broader goal of current policy efforts is to both jump-start and (perhaps discordantly) smooth such a cycle in the face of persistent cyclical challenges and sectoral/secular shiftings.
“PATIENCE” - TOPS ARE PROCESSES: The halcyonic days of the late-cycle invariably birth discussion about whether it is, in fact, different this time, whether the economic cycle actually matters to stocks over protracted, investible periods of time and whether great central-bank catalyzed volatility moderations can matriculate into perma-profiteering opportunities.
The “It’s different” tag-line holds credence to the extent it refers to using the temporal pattern of typical business cycle oscillations as the appropriate anolog for the current expansion. Indeed, a defining characteristic of financial/balance sheet crises is the muted and crawling pace of the subsequent recovery. ‘Lower in Amplitude and Longer in Period’ is the periodic function speak we’ve used to describe the likely macro path over the last 2 years.
As it stands, we’re now 73-months into the current expansion – which compares to a mean of ~60 over both the last century and post-war era. What’s worth re-remembering is the fact that, on average, it takes between 6.5 and 8 years to reach pre-crisis levels of income following a financial crisis. In the current cycle - real per capita income in the U.S. reached pre-crisis levels at the end of 2013, so just about 6 years from the onset of the recession.
So, even with unprecedented intervention and global policy coordination we still fell basically right on the average. This time, in fact, was not particularly different.
PROFITS PAST-PEAK? As Keith referenced in an institutional highlight yesterday - during the 2000 and 2007 economic (and profit cycle) slow-downs, Wall St ramped M&A/IPO/Buyback activity to levels never seen before. I.e. the ramp in “everything is different” was happening to offset the cyclical slowdowns.
Corporate Profits peak mid-to-late cycle and the last few quarters of data suggest we’re probably past peak in the current cycle. Past peak profitability in combination with companies facing prospective acceleration in wage inflation, a continued dearth in aggregate global demand and the ongoing secular retreat in the worlds core consumption demographic of 35-54 year olds is not a factor cocktail supportive of a step function rise in capex.
VALUATION IS NOT A CATALYST…BUT IT IS A DECENT HARBINGER:
Valuation is not a catalyst and investor’s maintain varying proclivities for particular multiples and conceptual valuation frameworks. There is good debate to be had regarding the superiority or shortcoming of different multiples but there is a more general point to be made about current levels of valuation.
Looking across the selection of metrics below, broadly, current valuations are richer than pretty much at any point except the nose bleed tech bubble highs. Lower neutral policy rates and perma central bank interventionism may indeed be supportive of higher mean valuations but that only modestly dilutes the conclusion. When valuations are in the top decile of LT historical averages, subsequent returns over medium and longer-term periods are just not that compelling.
Solving for what drives prices higher as profits flag is trivial. But if you’re going to be paying near-peak multiples on peak margins as margins appear to be past peak and the expansion enters its twilight, you should at least be aware that that’s what you are doing.
Tops are processes and “late-cycle” is not some discrete peak on a Macro sine curve. We’re continuing to move tactically while the music plays but we won’t be willfully blind to the #LateCycle reality of it all.
Christian B. Drake
Takeaway: Best case, this discounting is a non-event. Worst case, its bad news for KSS, FL and perhaps NKE.
UNUSUAL RETAILER DISCOUNTING ACTIVITY
Takeaway: Those who know us know that we very rarely call to attention seemingly insignificant near-term datapoints like retailer emails. But a promotional email from Dick's Sporting Goods caught our eye this morning. Not the fact that the company sent one (DKS sends an email almost every day), but this was the first time we've seen the company in the past 12 months run a broad based sale on Nike product. It's not premium product -- the AUR at full price is just under $80 for the men's and women's footwear listed, but that is the segment in the marketplace that is commoditized. The key factor for us is that we subsequently saw nearly every single player in the mid-tier channel running very similar offers . Sports Authority (check), KSS (check), JCP (check), Academy Sports + Outdoor (check), and M (check) (see ads below). That tells us a few things…
- First off, it's a great example of the price transparency brought on by e-commerce. 5 years ago this bucket of retailers would have had far more opacity related to their discounting practices.
- On the plus side, the level of discounting is not particularly egregious. For many of these mid-tier players, a 25% discount is considered about as close to a full-price sale as they'll get.
- Could this be Father's Day-related? Yes, it's possible. But we checked email activity for all these retailers last year as well in the week before Father's Day, and we did not see this. The 2014 World Cup may explain away a part of that. But, our sense is that there is more at play.
- If there's anything that rubs us the wrong way on this one, it's that we've seen very strong sales for Nike in US Mid-Tier channels in recent quarters. Take Kohl's, for example...in the latest two quarters its Nike sales were up 19% and 24%, respectively or about $96mm in absolute dollar growth. The way we are running the math Nike accounts for between 3-5% of total KSS sales or about $800mm. That translates to $550mm at wholesale for NKE, or 33% of KSS' growth over the past 2 quarters.
- Nike does a great job in tiering its product by retailer, such that excessive inventory in one channel won't necessarily derail another. But still, this raises a yellow flag for us for the Foot Locker's of the world.
Nike/UnderArmour Management Age Considerations
Takeaway: One thing that we think is a constant point of controversy inside Nike is ensuring that the age of its executive management team does not run too far askew from the age of its target consumer, which is about 15-25 years old. Clearly, we don't expect to see Nike promoting recent college grads into its top ranks, but truly understanding the mindset of the key consumer is something that has been particularly important to CEO Mark Parker, who's now 58 years old.
We ran an analysis of Nike's top brass in each of the past ten years, expecting to see an aging team relative to the target market (which would be bearish). This was surprisingly not the case -- especially when we compare to UnderArmour. Though there's no smoking gun here (bullish or bearish) we thought we'd share the analysis. Consider the following…
1. The line chart below shows the average age of the management team at Nike over time. At face value, it looks ugly, but we're only talking a shift from 48 yrs to 51 yrs over a 10-year period. That's not bad by any stretch.
2. When zooming out a bit and looking at both NKE and UA in the context of the broader growth in this business, the spread relative to the core consumer (a range that could arguably have come up over time) is not alarming.
3. Comparatively speaking, the gap between Nike and UA has actually been shrinking over time -- from 9.5 years nearly a decade ago to about 3 years today. In other words, UA's team is about 49 yrs old vs Nike at 52.
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