One of the biggest risks to financial markets right now is believing the Fed's economic forecast.
Takeaway: Tempted to nibble on shares of beaten down Chipotle? You may want to reconsider says Howard Penney.
Over the weekend, Barron's Senior Editor Vito Racanelli dug deep into Hedgeye Restaurants analyst Howard Penney's call to short Chipotle (CMG). Shares are down 45% from its all-time high.
As Racanelli writes:
"... The Denver-based chain faces a long road to regain investor trust. That’s the view of Howard Penney, an industry analyst with decades of experience at Hedgeye Risk Management, an independent research firm. He has been spot on since he turned skeptical on Oct. 19, 2015.
Is Chipotle now a cheap stock, given its heretofore 20% revenue and 30% EPS growth over the past seven years? Penney remains bearish."
In the story, Penney walks through his five stage life-cycle restaurant guide for investors tempted by Chipotle’s 45% decline.
"... Eventually, management psychology will signal a bottom in the stock price, he says. In stage No. 5, management decides to close stores, slow growth, and stop discounting to improve profitability. That’s the time to buy, says Penney, who has a $275 price target on Chipotle, down another 33%. He bases that on a still rich P/E of 27 times his estimate of $10 a share this year."
Bottom line according to Penney: We're a long ways off from Stage 5. Don't buy the dip.
Market risk is rising.
Our Financials analysts Josh Steiner and Jonathan Casteleyn highlighted this morning that the TED spread, the 3 month US Treasury Yield minus 3 month LIBOR (a proxy for risk), has nearly doubled in the past month or so.
The TED Spread is just one more market measure confirming our thinking about rising risk and volatility. Our macro team recently pointed out in our Q1 2016 Macro themes deck that a bear market for equities could be in the offing.
To be clear, the TED spread is still well below 2011 levels and pales by comparison to the jarring spike seen during the throes of the financial crisis. As Hedgeye CEO Keith McCullough points out, "Don't think about risk in terms of absolutes - rate of change is what matters most."
As Keith likes to say, "Risk happens slowly at first, then all at once."
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To read our Financials and Macro team's non-consensus institutional research ping firstname.lastname@example.org.
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Takeaway: KSS hiring a banker because it has to - not because it needs help with all the inbound requests. Selling KSS one of the hardest jobs around.
KSS - Kohl’s More Likely to Shrink Than be Sold
First of all, if anybody was wondering why KSS outperformed its peer group by 9% for the year-to-date, now you know. Presumably, the Board and the potential Bankers are the only ones who knew about this (as it should be), but it appears that someone leaked something. A lot of something.
Nonetheless, we should be clear about something. KSS is not looking for strategic alternatives because its 'Greatness Agenda' is over-delivering on value creation. Quite the opposite. We think that this business model is terminal, and just maybe management is starting to catch wind.
If KSS were to close half of its stores, and cut the size of the remaining stores in half -- we don't think that the consumer would really care. This is a business that was built upon shopping by convenience -- i.e. going to a local strip mall for mediocre brands (10-15 min drive) instead of driving to a regional mall (20-30 min drive). Unfortunately, there's a new alternative to the regional mall -- it's called the Internet. KSS can't win that battle.
This strategy, which actually worked well for about 20 years (1) is also part of the structural reason why KSS does not have real-estate optionality like Macy's or Dillard's. KSS is almost entirely based in strip malls, and they are simply a dime a dozen. 20 years ago, there were about 2,500 such strip malls. Now there's closer to 7,100. But the regional mall count, on the flip side, has remained fairly constant over time at 1,100. That means that the value per square foot of Regional Mall space has gone higher, while strip malls has been flat to lower as more properties were built. Too many people who claim that KSS has real-estate optionality simply don't understand this dynamic.
We're at $3.70 in the coming year vs the Street at $4.60, and we think that the company will never earn over $4.00 again. Ultimately, our numbers head below $3.00, while the Street's are headed above $6.00.
The biggest delta in our thesis from consensus is our view that the company has literally run out of customers (our math suggests that KSS already landed 75% of people that could be KSS customers). This is manifesting itself in declining traffic, risky promotional strategies that meaningfully put at risk the company's credit income . The key there is that this risk holds even if we don't see the credit environment roll over. If the credit environment goes bad, then we think that KSS earnings goes closer to a buck -- again, the Street is at $6.00+. For our full thesis see note link here: KSS | Here’s Why KSS Is Expensive
This company is hiring a banker because it has to -- not because it needs help with all the inbound requests. Selling this company is one of the hardest jobs around.
M - Activist Investor Starboard Urges Macy’s to Strike Real-Estate Deals
AMZN - Amazon’s full acquisition of a French package-delivery company, expected soon, would make it a direct competitor of delivery titans such as UPS and FedEx
DLTR - Family Dollar CEO Howard R. Levine is stepping down as an officer of the company following the integration of Family Dollar
UA - Under Armour is undertaking an ambitious effort to provide extremely personalized health and fitness coaching, assisted by IBM
ANF - Abercrombie & Fitch Enters Dubai With Massive Flagship Store
NKE, Adibok - The 25 Most Resold Sneakers of 2015
WMT - Wal-Mart’s Mexican Subsidiary Sees Sales Jump
So, Chinese stocks made lower-lows overnight, closing down another -5.3%. Meanwhile, the Russell 2000 is down -19.2% since July.
No worries. Right?
Earnings season starts this week with JPMorgan (JPM) reporting this Thursday. There’s no irony that the Financials (XLF) -7.3% were one of the worst S&P Sector exposures last week; with both #Deflation and a #Recession in Industrial/Cyclical terms, long-term yields fall, no matter what the omnipotent central planners at the Fed think they can do.
If you thought that cyclical "PMIs bottomed" when the employment/consumption/profit cycle peaked (at the end of Q2 2015), and you bought the Financials on that, you’re down -13.6% since the July high.
Beats being long Apple from there (down -26.5% since S&P 500 top)!
Takeaway: China raised red flags for investors, driving the risk environment last week. Beyond China, however, the US is softening on the margin.
With concern rising over both domestic growth slowing and economic weakness in China rising, global markets began the year with a bang. Even Friday's better than expected U.S. employment report was not enough to prop up markets. Notably, CDS spreads rose significantly last week across companies and sovereigns, while the TED Spread remains elevated and Euribor-OIS rose by +4 bps to 12 bps.
Our heatmap below is mostly negative across all durations.
Financial Risk Monitor Summary
• Short-term(WoW): Negative / 4 of 12 improved / 5 out of 12 worsened / 3 of 12 unchanged
• Intermediate-term(WoW): Negative / 3 of 12 improved / 7 out of 12 worsened / 2 of 12 unchanged
• Long-term(WoW): Negative / 1 of 12 improved / 4 out of 12 worsened / 7 of 12 unchanged
1. U.S. Financial CDS – Swaps widened for 16 out of 27 domestic financial institutions. With fears over weakness in China shaking markets, the median spread rose from 54 to 60 last week.
Widened the least/ tightened the most WoW: SLM, SLM, SLM
Widened the most WoW: AXP, ALL, MMC
Tightened the most WoW: AIG, JPM, CB
Widened the most MoM: ALL, COF, AXP
2. European Financial CDS – Swaps mostly widened in Europe last week. The median spread rose from 85 bps to 90 bps.
3. Asian Financial CDS – Worry over China dominated the risk environment last week and shook markets globally. Bank CDS in China rose between 4 bps and 20 bps.
4. Sovereign CDS – Sovereign swaps mostly widened over last week, led by Portuguese CDS, which widened by 11 bps to 182.
5. Emerging Market Sovereign CDS – Swaps in emerging markets reacted to the risk of waning Chinese demand, widening by 10 bps on average last week. Russian swaps widened by a significant 26 bps to 335 as oil prices continued to slide. Turkish sovereign swaps widened the most, by 29 bps to 302.
6. High Yield (YTM) Monitor – High Yield rates fell 61 bps last week, ending the week at 8.45% versus 9.06% the prior week.
7. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 3.0 points last week, ending at 1808.
8. TED Spread Monitor – The TED spread fell 3 basis points last week, ending the week at 42 bps this week versus last week’s print of 45 bps.
9. CRB Commodity Price Index – The CRB index fell -3.6%, ending the week at 169 versus 175 the prior week. As compared with the prior month, commodity prices have decreased -3.6%. We generally regard changes in commodity prices on the margin as having meaningful consumption implications.
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 12 bps.
11. Chinese Interbank Rate (Shifon Index) – The Shifon Index fell 3 basis points last week, ending the week at 1.96% versus last week’s print of 1.99%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.
12. Chinese Steel – Steel prices in China rose 2.0% last week, or 41 yuan/ton, to 2042 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity and, by extension, the health of the Chinese economy.
13. 2-10 Spread – Last week the 2-10 spread tightened to 118 bps, -4 bps tighter than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.
14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 4.1% upside to TRADE resistance and 0.1% downside to TRADE support.
Joshua Steiner, CFA
Jonathan Casteleyn, CFA, CMT
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