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Déjà Vu In Japan: Has The Sun Set on Abenomics?

Takeaway: Japan just slipped into its fourth recession in five years. Abenomics is failing.

Déjà Vu In Japan: Has The Sun Set on Abenomics? - japan rising setting

 

The Bank of Japan has been purchasing 90 trillion yen worth of government bonds annually, which began in early 2013, in an effort stimulate economic growth. It's part of Abenomics, the concerted effort put forth by Prime Minister Shinzo Abe to pull Japan out of it's decades long slump.

 

It is failing. 

 

This is something we've been concerned about for a while now. Take a look below at a brief excerpt from our 73-page Q3 Macro Themes presentation released in early October:

 

"... We do not think investors are appropriately positioned for a likely trend of negative revisions to the respective growth outlooks in the U.S., Eurozone and Japan throughout the balance of the year." 

 

We could pull up any number of recent headlines that suggest as much about global growth, but the latest news out of Japan is more than just an intimation. It's a direct confirmation of our #GameOfSlowing macro theme. 

 

Déjà Vu In Japan: Has The Sun Set on Abenomics? - Japan game of slowing

 

Here's Reuters:

 

"Japan slipped into its fourth technical recession in five years between July and September - spotlighting how the government's "Abenomics" policies have struggled to drag the economy out of chronic stagnation.

 

Official data on Monday showed the world's third-largest economy shrank an annual 0.8 percent in July-September after a 0.7 percent contraction in the prior quarter, putting it firmly into recession - two consecutive quarters of declines."

 

Interestingly, Japan's Economics Minister Akira Amari blamed the recent contraction on an overhang in inventories and (wouldn't you know it) sounded a positive tone on the country's recent jobs and income data.

 

This should sound familiar. 

 

New York Fed president Bill Dudley talked up the same playbook last Thursday:

  • "... the fundamentals supporting domestic demand look quite sturdy.  For example, consumer spending has been well-supported by real income gains and rising household net worth."
  • "It is also important that the forward momentum in the jobs market persists."
  • "A large decline in the pace of inventory accumulation was the main reason why real GDP growth faltered in the third quarter."

The parallels would be comical were it not so troubling. As Hedgeye CEO Keith McCullough continues to write, "The Fed’s ‘forecast’ is wrong 70% of the time. They are the new market risk.” 

 

So too is Abenomics.

 

Déjà Vu In Japan: Has The Sun Set on Abenomics? - japan abe

 

But we digress...

 

The Nikkei index was down over 1% on the news that the economy had slid into recession. We'll have to wait and see how this changes the monetary calculus of the Bank of Japan at their rate review next week. 

 

The recent news is a confirmation of our initial take on Abenomics. So we'll reiterate:

 

Déjà Vu In Japan: Has The Sun Set on Abenomics? - abenomics


Evidence of #ConsumerSlowing Grows... Will the Fed Ignore and Hike Anyway?

Takeaway: The outlook for retailers and the manufacturing sector isn’t getting any brighter.

The consumer spending slowdown strikes again.

 

Evidence of #ConsumerSlowing Grows... Will the Fed Ignore and Hike Anyway? - consumer spent

 

Department store chain Dillard’s (DDS) opened down almost 8% after reporting declining profits and lower than expected sales. Peers like Macy’s (M), Nordstrom (JWN), and Kohl’s (KSS) have all seen their stocks clobbered of late, as shoppers were loath to open their purse strings. The stocks have lost between 6% and 24% in the past week after Friday’s retail sales data came in significantly lower than expectations.

 

Evidence of #ConsumerSlowing Grows... Will the Fed Ignore and Hike Anyway? - retailers

 

The outlook isn’t getting any brighter either. Retail inventories continue to build, which may force companies to take heavy-handed discounts into the holiday season. The latest data from the Census Bureau puts the inventory to sales ratio at U.S. retailers at 1.38, the highest reading for that month since 2001.

 

(Editor's Note: In July, our Macro team called the #ConsumerSlowing theme, while Retail analyst Brian McGough recently reiterated short calls on both Kohl's and Tiffany's (TIF). For more information, ping sales@hedgeye.com.)   

 

Here’s an excerpt from today’s Early Look written by Hedgeye CEO Keith McCullough: 

 

Since US Retailers like Macy’s (M), Nordstrom’s (JWN), and Kohl’s (KSS) had been crashing coming into this #LateCycle consumption data slowing, it was quite bearish to see both those stocks and the US Retail (XRT) sector hit new lows on the “news.”

 

Evidence of #ConsumerSlowing Grows... Will the Fed Ignore and Hike Anyway? - dillards down

 

Yet more evidence of the slowdown? Take a look at the U.S. shipping industry. During September and October, imports to key U.S. seaports in New York, L.A. and Long Beach, California — which cumulatively handle 54% of container volumes — fell for the first time in a decade.

 

For the record, the fall months are usually peak season for the shipping industry. But surprise! The Wall Street Journal reports that retail inventories were a chief concern for the recent shipping weakness.

 

Evidence of #ConsumerSlowing Grows... Will the Fed Ignore and Hike Anyway? - seaports

 

To be sure, U.S. manufacturers aren’t exactly signaling strength either. Today’s Empire State Manufacturing index, which the New York Federal Reserve uses to track the state’s business activity, contracted yet again and missed already dour expectations.

 

The reading came in at -10.74 with business conditions worsening for the fourth straight month, while the six month outlook was flat and zero sign of any labor market improvement.

 

Question: Does any of this change consensus' certainty of a December rate hike?

 

It should. 

 

Look no further than New York Fed head Bill Dudley. He has been sounding increasingly cautious of late. This, after sounding much more optimistic and calling December a “live possibility” at the beginning of the month.

 

Evidence of #ConsumerSlowing Grows... Will the Fed Ignore and Hike Anyway? - dudley 22


MCD | THE DAY MCCAFE DIED

On November 10, 2013, I wrote a note on McDonald's called “McDonald's Obsession with Starbucks”  My bearish thesis on MCD revolved around my “espresso-based conspiracy theory.”  As hard as McDonald's management tried, MCD will never be what Starbucks is: a leading destination for espresso-based beverages.  In the process of trying to be SBUX, MCD was hurting the core business of selling food! 

 

Fast forward to today and MCD is now focusing on the core business of selling food again. What interested me the most about the McDonald’s analyst day was not what was said, but what was left unsaid.  The biggest operational change appears to be a gradual shift away from beverages.  The word McCafe was never mentioned by, Steve Easterbrook, President, Chief Executive Officer & Director, McDonald's Corp., Pete Bensen, Chief Administrative Officer, McDonald's Corp., or Mike Andres President, McDonald's USA, McDonald's.

 

The first mention of McCafe came from Kevin Ozan, Chief Financial Officer & Executive Vice President, McDonald’s Corp: “We seek to balance new store investment, where we have historically earned higher rates of return, with investments in existing restaurants that has included reimaging, initiatives such as the expansion of our beverage business and McCafe, and general maintenance CapEx.”

 

At the 2013, analyst meeting “McCafe” or “coffee” was mentioned 92 times!  Do you think there has been a shift in strategy?  I place significant weight on this because I have contended since 2012 that McDonald’s, shift to over emphasizing beverages was a key contributor to poor instore execution and the biggest contributor to significantly slower drive-thru times.  

 

Correcting the mistakes of the past will be the biggest contributor to fixing the performance inside the four walls and improving same-store sales.  When I pressed this question to senior management the response I received was “Mike (Andres) is a food guy” 

 

These comments from Mike’s presentation say it best, “We are a restaurant company. We must and will win with our food. Our customers tell us that they want our food to taste great and they want to feel good about eating it. They want to know what's in their food. Where it comes from and how it's made. While we are very proud of the quality of the food that we serve today, we know we can do better. We have a committed attitude around real and fresh, specifically around the ingredients and the evolution of the menu.”

 

The rollout of McCafe was the most expensive project the company has ever undertaken!  The McCafe brand has some goodwill with customers, but the company will never be successful selling espresso based drinks.  Therefore the unwinding of the McCafe strategy is a slow process that will happen quietly.  

 

It looks like MCD has set reasonable goals for 2016.  The company is looking for constant currency financial targets of system-wide sales growth of 3% to 5%, (adjusted) operating income growth of 5% to 7%, and one year return on incremental invested capital in the high-teens.  When the company announces its longer-term targets in 2Q16, I suspect it will be close to the 2016 targets. 

OTHER IMPORTANT TAKEAWAYS

G&A SAVINGS

As expected MCD is now reducing G&A by $500 billion compared to the $300 million target announced in May the vast majority of which they expect to realize by the end of 2017.  Expectations going forward are for system sales to grow faster than G&A.  The incremental savings are primarily derived from savings coming from a more heavily franchised and less G&A intensive structure; streamlining of corporate and former Area of the World organizations and realizing greater efficiencies through the global business services platform.  The G&A savings represent roughly a 20% reduction off of the G&A 2015 base of $2.6 billion.   

 

It was interesting to note that MCD management did say, “…we analyze our G&A spend and resulting profitability on a per restaurant basis. McDonald's G&A per restaurant is currently about twice that of our QSR competitors on average. However, our profitability as measured by EBITDA per restaurant is about four times our competitor's average. Our business model, geographic diversification, franchising strategy and overall support model are some of the reasons that our restaurant averages differ from our QSR competitors. We expect to significantly reduce our G&A per restaurant as a result of our efforts.”

 

REFRANCHISING

Another big shift is that MCD is now aiming to refranchise 4,000 restaurants by the end of 2018, with mostly all of them to take place in the high-growth and foundational segments.  The refranchising target of 4,000 restaurants by 2018 implies approximately 1,000 restaurants per year and will move MCD from 81% franchise today to about 93% franchise globally.  Putting MCD well on their way to the longer term target of 95%. The refranchising strategy will help to improve MCD’s relative multiple versus its peer group.  

  1. Accretive to the company-operated margins
  2. Refranchising activity will also positively impact the franchise margin
  3. The decline in operating income will be modest when factoring in the G&A savings
  4. Refranchising will be accretive to FCF due to lower capital expenditure requirements.

MCD | THE DAY MCCAFE DIED - CHART 1

MCD | THE DAY MCCAFE DIED - CHART 2

 

DECLINING CAPITAL SPENDING

A small part of the MCD growth story will be expanding the global footprint and reinvestment into existing restaurants.  This includes the “Experience of the Future” as well as the reimaging of about half of the store base over the next several years.

 

Capital expenditures are expected to remain at about $2 billion, split evenly between new stores and investing in existing restaurants. As the business model evolves to a more heavily franchised structure, capital expenditures should decline over time.

MCD | THE DAY MCCAFE DIED - CHART 3

 

CASH

MCD significantly increased the cash return target for the three year period ending in 2016 to about $30 billion. This aggressive move is further proof in the new management teams willingness to change the MCD business model and make the appropriate adjustments when needed.  The $30 billion figure represents a $10 billion increase versus expectations.  The company will use incremental debt to fund the vast majority of this increase. The $30 billion cash return target will be nearly double the $16.4 billion for the three-year period ending 2013.

 

Importantly, MCD will now manage to rating of BBB+ at S&P and Baa1 at Moody's credit ratings. Going forward (beyond 2016) , MCD intends to return all free cash flow to shareholders over the long-term through a combination of dividends and share repurchases.

MCD USA NOTES

MCD USA

  1. Represents approximately 30% of McDonald's global revenue and 40% of consolidated operating income
  2. More than 14,000 restaurants
  3.  90% owned and operated by more than 3,100 franchisees.
  4. Traditional free-standing restaurants have AUV’s of $2.5 million and cash flow of approximately $315,000.

 

All Day Breakfast

  • All-Day Breakfast has continued to exceed managements launch volume expectations.
  • We are currently seeing more than 15% of food purchases outside the breakfast daypart that include an All-Day Breakfast menu item.
  • The lunch daypart is providing the largest impact to the All-Day Breakfast with promising results also during dinner.
  • Rest of the day average check is higher among those purchasing an All Day Breakfast entrée.
  • All Day Breakfast has helped with McDonald's brand perceptions. According to a recent YouGov survey, which indicated that MCD’s perception score stood at 17 points since the beginning of August?
  • Improving the in-store execution and success of ADB many markets have removed one or more of the McWraps, Bacon Clubhouse, Quarter Pounder Deluxe and/or Snack Wraps. In addition the menu went from 16 extra value items to nine. 
  • In addition, In July, the company rolled out the Drive-Thru Express menu board, this move took the total price point from 130 to less than half of that which of course simplifies the customer ordering process.

 

Looking forward to the next 12-18 months  

  1. Deploying indoor digital menu boards in all U.S. restaurants by fourth quarter of next year.
  2. Automate the ways they promote their food to consumers inside of our restaurants.
  3. Will install a robust content management system that will engage the customers with food show quality moving pictures, enhanced capabilities that will adjust the menu board based on time of day and product mix movement. 
  4. Based on the results in Canada the new digital menu boards and content management system will generate higher average checks and incremental sales in in-restaurant transactions.
  5. Currently MCD has about 130 restaurants that are presenting the Experience of the Future in the U.S. and advertised sales tests are scheduled to go live in six markets by the end of the year.
  6. Roughly 25% of customer visits are motivated by value.
  7. Offering a consistent, predictable and compelling national value platform is a critical component to our combined solutions plan.
  8. The MCD digital platform is evolving.

 

Please call or e-mail with any questions.

 

Howard Penney

Managing Director

 

Shayne Laidlaw

Analyst

 

 


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PRA GROUP (PRAA): NEW BEST IDEA SHORT CALL INVITATION

Takeaway: Please join us tomorrow, November 17th at 11 a.m. EST for our latest Best Ideas call on shares of PRA Group (PRAA).

PRA GROUP (PRAA): NEW BEST IDEA SHORT CALL INVITATION - PRA roller coaster

 

We will be hosting a call Tomorrow, November 17th at 11:00am EST to present a new name we've added to our Best Ideas List - PRA Group, Inc. (PRAA) - as a short

 

KEY POINTS 

  • Supply/Demand Headwinds: The market for buying defaulted receivables is especially unfavorable. Demand for paper has exceeded supply for a few years now, mirroring the environment last seen from 2005-2007 when shares of PRAA tumbled ~70%.
  • Growing Debt: Leverage at the company has risen quickly in the wake of the Activ deal.  
  • Insiders Dumping: Widespread insider selling suggests that insiders see similar intermediate/longer-term headwinds.
  • History's Guide: Our analysis of the interplay between labor markets, terminal IRRs and pre-tax margins will shed light on what to expect fundamentally from a timing standpoint.
  • Regulatory Pressure: The CFPB is expected to set new rules for debt collectors in 2016.
  • Current Value Unsustainable: The ERC less cost to collect and taxes is currently ~$400mn below the net debt of the company.

 

CALL DETAILS

  • Toll Free Number:
  • Conference Code: 13622076#
  • Materials: CLICK HERE (Materials will be available approximately one hour prior to the start of the call)

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT


Euro, Kospi and Copper

Client Talking Points

EURO

The Euro is down another -0.4% vs. the USD at $1.07 this morning with the more important line of support being the YTD low of $1.05. While Dudley’s latest comments on “inflation continues to run well below the Fed’s target” are new/dovish this morning, the FX market is obviously focused on the tragic events in France.

KOSPI

Last week was ugly for everything Global Growth Expectations and the KOSPI continued to break-down overnight down another -1%, taking it’s month-over-month decline from OCT’s counter TREND bounce to -4.3%.

COPPER

Fresh new lows (again) this morning as Copper’s #Deflation Crash continues, down -1.1% to $2.12/lb. The 6 month crash in Copper is -26% vs. WTI Oil’s at -35% - the Fed would have to back off the DEC hike to arrest the #Deflation.

Asset Allocation

CASH 61% US EQUITIES 5%
INTL EQUITIES 2% COMMODITIES 0%
FIXED INCOME 29% INTL CURRENCIES 3%

Top Long Ideas

Company Ticker Sector Duration
MCD

Restaurants Sector Head Howard Penney attended MCD's investor meeting in New York City early last week. His takeaway from the meeting was that it was "very very bullish" for investors. Expectations were high, but CEO Steve Easterbrook came to NYC with big changes which have ultimately exceeded those expectations. "The big smile on Steve Easterbrook's face when talking about the current quarter was very telling," Penney writes. "He could not hide the enthusiasm." MCD increased the dollar value returned to shareholders by $10 billion. Penney and his team still see +30% upside from here.

RH

Restoration Hardware (RH) shares got caught up in the tumultuous selloff of other high-end retailers. But we're still bullish on RH. Here's why. RH Tampa has just opened. That makes 4 new Full Line Design Galleries in 90 days. And all will be open before the start of holiday shopping season and just in time to house the new product lines RH Modern and Teen. Add up the four stores and we’re looking at about 210k square feet. That alone represents about 25% growth in square footage.

 

When all is said and done, we still think this company has $11 in earnings power 4-years out, which is nearly double the consensus. We remain convinced that the debate should not be ‘if or when’ the stock hits $115, but rather is it going to $200 or $300? We’ll be looking at an earnings CAGR of 40-50% over five years. What kind of multiple does that deserve? 20x? 25x? 30x? We’d argue the higher end.

TLT

It was a nasty end to the week for the “growth is back” bulls. It was an equally nasty end to the week in equity markets. The S&P 500 was “going to all-time highs” Tuesday before retreating over 3% from Wednesday to Friday.

 

With continued data-driven confirmation that growth is slowing:

  • PPI (producer price index) printed -1.6% Y/Y for October
  • On a m/m basis, PPI declined -0.4% 
  • Declines in the energy component certainly bring the index lower, but PPI ex. Food and energy only printed +0.1% Y/Y which is ugly

Three for the Road

TWEET OF THE DAY

Pelosky: Our Worrisome ‘Tri Polar World’ and Global Implications https://app.hedgeye.com/insights/47545-pelosky-our-worrisome-tri-polar-world-and-its-global-implications… via @jaypelosky @HedgeyeDJ

@Hedgeye

QUOTE OF THE DAY

Take calculated risks. That is quite different from being rash.

George S. Patton

STAT OF THE DAY

U.K. Prime Minister David Cameron announced that the government will hire an additional 1,900 spies for its intelligence agencies MI5, MI6 and GCHQ following the terror attacks in Paris.


MONDAY MORNING RISK MONITOR | THE DEATH STAR

Takeaway: The Fed is fulfilling its destiny as the Death Star aimed at US and Global Growth. Meanwhile, the EU put up 30 bps of growth in 3Q15.

MONDAY MORNING RISK MONITOR | THE DEATH STAR - RM11

 

Key Takeaway:

Three major stimuli drove a marked increase in risk last week: a rising expectation for a Fed rate hike into an already slowing growth environment, European GDP growth coming in at a meager 0.3%, and Portugal's government effectively falling. Most notably, concerns over credit risk ballooned last week with the high yield YTM rising by +42 bps to 7.84% and the Euribor-OIS spread widened by +4 bps to 15 bps. Beyond this, the growing conviction for a December Fed rate hike has the dollar up and commodities down 4.8% on the week and 7.4% on the month. This is further exacerbating EM weakness in places like Brazil and Russia.

 

Short-term risk measures were mostly negative last week while intermediate-term measures were more positive and long-term measures were mixed.


Current Ideas:


MONDAY MORNING RISK MONITOR | THE DEATH STAR - RM19

 

Financial Risk Monitor Summary

• Short-term(WoW): Negative / 2 of 12 improved / 5 out of 12 worsened / 5 of 12 unchanged
• Intermediate-term(WoW): Positive / 6 of 12 improved / 4 out of 12 worsened / 2 of 12 unchanged
• Long-term(WoW): Negative / 2 of 12 improved / 2 out of 12 worsened / 8 of 12 unchanged

MONDAY MORNING RISK MONITOR | THE DEATH STAR - RM15

 

 

1. U.S. Financial CDS – Swaps widened for 15 out of 27 domestic financial institutions. Bond insurers MBIA and Assured Guaranty CDS widened by 71 bps and 23 bps respectively on concerns that Puerto Rico is approaching default. Meanwhile, swaps for MGIC and Radian widened by 19 and 18 bps, respectively.

Tightened the most WoW: LNC, COF, JPM
Widened the most WoW: MBI, MTG, AGO
Tightened the most WoW: MMC, BAC, JPM
Widened the most MoM: ACE, RDN, CB

MONDAY MORNING RISK MONITOR | THE DEATH STAR - RM1

 

2. European Financial CDS – Swaps mostly widened in Europe last week as 3Q15 Eurozone GDP growth came in at only 0.3%. Portuguese and Greek CDS were outliers, as usual.

MONDAY MORNING RISK MONITOR | THE DEATH STAR - RM2

 

3. Asian Financial CDS – Swaps among Asian financials were mixed last week. Indian swaps were mostly wider on concerns over a rate hike by the U.S. Federal Reserve.

MONDAY MORNING RISK MONITOR | THE DEATH STAR - RM17

 

4. Sovereign CDS – Portuguese sovereign swaps widened by +45 bps to 215 as the country's government failed to pass its legislative program through the left-dominated parliament. Outside of Portugal, however, sovereign swaps were little changed. 

MONDAY MORNING RISK MONITOR | THE DEATH STAR - RM18

 

MONDAY MORNING RISK MONITOR | THE DEATH STAR - RM3

 

MONDAY MORNING RISK MONITOR | THE DEATH STAR - RM4


5. Emerging Market Sovereign CDS – Emerging market swaps mostly widened last week on concerns over a stronger dollar from a possible Fed rate hike. Brazilian sovereign swaps widened the most, by +29 bps to 434.
MONDAY MORNING RISK MONITOR | THE DEATH STAR - RM16

MONDAY MORNING RISK MONITOR | THE DEATH STAR - RM20

6. High Yield (YTM) Monitor – High Yield rates rose 42 bps last week, ending the week at 7.84% versus 7.42% the prior week.

MONDAY MORNING RISK MONITOR | THE DEATH STAR - RM5

7. Leveraged Loan Index Monitor  – The Leveraged Loan Index fell 8.0 points last week, ending at 1837.

MONDAY MORNING RISK MONITOR | THE DEATH STAR - RM6

8. TED Spread Monitor  – The TED spread fell 2 basis points last week, ending the week at 24 bps this week versus last week’s print of 26 bps.

MONDAY MORNING RISK MONITOR | THE DEATH STAR - RM7

9. CRB Commodity Price Index – The CRB index fell -4.8%, ending the week at 185 versus 194 the prior week. As compared with the prior month, commodity prices have decreased -7.4%. We generally regard changes in commodity prices on the margin as having meaningful consumption implications.

MONDAY MORNING RISK MONITOR | THE DEATH STAR - RM8

10. Euribor-OIS Spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread widened by 4 bps to 15 bps.

MONDAY MORNING RISK MONITOR | THE DEATH STAR - RM9

11. Chinese Interbank Rate (Shifon Index) – The Shifon Index was unchanged vs last week, ending the week at 1.79%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.

MONDAY MORNING RISK MONITOR | THE DEATH STAR - RM10

12. Chinese Steel – Steel prices in China fell 2.1% last week, or 45 yuan/ton, to 2107 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity and, by extension, the health of the Chinese economy.

MONDAY MORNING RISK MONITOR | THE DEATH STAR - RM12

13. 2-10 Spread – Last week the 2-10 spread tightened to 143 bps, -1 bps tighter than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.

MONDAY MORNING RISK MONITOR | THE DEATH STAR - RM13

14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 2.0% upside to TRADE resistance and 1.1% downside to TRADE support.

MONDAY MORNING RISK MONITOR | THE DEATH STAR - RM14


Joshua Steiner, CFA



Jonathan Casteleyn, CFA, CMT


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