Why Investors Should Short Today's Market "Bounce"

Takeaway: We think a crash is coming.

Why Investors Should Short Today's Market "Bounce" - Bull bomb cartoon 09.01.2015 large


"We need to suck every last perma bull into believing that the 'bottom is in,' then kaboom," Hedgeye CEO Keith McCullough wrote earlier this morning. 



McCullough has now advised subscribers to short eleven different stocks in Real-Time Alerts, up from two at last week's lows. 



This bounce has a suspicious air about it.



... And all today proves is that there are a lot of investors out there who have not learned this ultimate lesson... yet.



Here's another reason not to be long equities. Below is a chart from our 73-page quarterly Macro themes deck which shows when S&P 500 earnings decline for two consecutive quarters stocks fall -20% or more.


Why Investors Should Short Today's Market "Bounce" - EL profits large


Take two minutes to watch the video below with key risk management insights from McCullough in which he concludes, "Are you bearish enough?"



Here's what our subscribers are saying about us:



We're sticking with our process. Rinse & Repeat.

JWN | Time vs. Price

Takeaway: When we finally get a glance of JWN’s sales numbers–they need to be truly horrendous. We’d actually look to buy it on a sell-off tomorrow.

Conclusion: This is a multi-duration call. Bearish over the near-term as macro headwinds put earnings at risk. But, levers are there once the consumer stabilizes/recovers. The reality is that this is the only department store that really needs to exist.


We assembled a rather hefty slide deck on JWN as it emerged as a battleground stock ahead of this week’s print.  Initially, we were very bearish. The precipitous increase in short interest from 6% to recession levels of 20% over the past month means that when we finally get a glance of JWN’s sales numbers – they need to be truly horrendous. By the look of its e-commerce business, that’s precisely what we’ll get. Sometimes, the consensus is right, and this time, it probably is.


Unfortunately, it’s still the consensus. And while we think that this quarter will be terrible. The rate of change on the sales, gross margin, sg&a, and capex lines will change on the margin in JWN’s favor by mid-year. At that point, we might actually look to go long this one. After all, it’s the only department store that really needs to exist, and it’s trading at less than 7x a doable EBITDA number.


In the end, we’d actually look to buy it on a sell-off on tomorrow’s numbers – something in the low-mid $40s sounds about right. Otherwise we might be interested in buying with a $5-handle later this year when the Macro environment is de-risked and JWN emerges from ‘investment mode.’


JWN | Time vs. Price - 2 17 16 JWN earn table


Additional details…


Trade (3 weeks or less): JWN is the only name amongst its peer group that has been radio silent throughout the holiday season that saw M and KSS pre-announce earnings growth rates of -20% (-30% ex. the Brooklyn asset sale) and -15%, respectively. Management lowered the 4Q bar by 9% post the 3Q print, and then the Street came down by another 7% over the past three months. Sales expectations still look too high given the general softness in the retail space (especially at the high end) over the holiday period and the fact that JWN is up against its toughest comp since 4Q12. E-commerce traffic trends have been soft across all of JWN’s concepts as it laps the launch year of the Rack website, while Full Price and Hautelook continued to weaken into quarter close. We’re about $100mm, or 2%, below the street.


These Traffic Trends Look Terrible

JWN | Time vs. Price - JWN Traffic


On the margin side, JWN likely took the biggest hit of any of the department store players in the quarter with gross margins down 160bps in 3Q, as it proactively managed its inventory position. Warm weather and weak demand will still be an issue in 1Q, and we expect inventory growth ahead of sales for the 16th time in the past 18 quarters. Canada and Trunk dilution is starting to roll off now that the sales base North of the border is forming a critical mass and the acquisition of Trunk Club is annualized. The company pulled a few SG&A levers last quarter by cutting its investment in its loyalty program (bullish for credit income). All in we’re modeling a 200bps hit to EBIT, broken out into 110bps of deleverage in the core, another 40bps from non-core investments, and the remainder allocated to the sale of the credit card receivables.


3Q15 SIGMA Chart 

JWN | Time vs. Price - DEPT SIGMA


Trend (3 months or more): Not unlike the rest of the retail space, the street is looking for a snap back on the top line as we enter 1H16, chalking up most of the demand issues we saw in the back half of 2015 to just weather. We’re not buying it. And, after what we think will be another sales miss in the 4th quarter we expect the guide for 2016 to be conservative on the top line. Or, at least it should be given the price action on the stock over the past 3 months and the fact that short interest is at 5 year highs at 19% (up from just 6% in late November).

JWN | Time vs. Price - 2 17 16 JWN vs Retail


Here’s where we come out on each of the lines on the P&L in the first half of 2016…

  • Revenue: No comp growth in the brick and mortar side of the business with negative LSD comps at Full Line and flattish comps at Rack against easy compares last year. That’s offset by low teens growth in the company’s e-commerce business (inclusive of,, and Hautelook), about a half a point of growth from Canada and Trunk Club, and 5% square footage growth. That gets us to LSD sales growth in the first half of the year at the retail level (flat revenue growth reported due to the loss of credit revenue).
  • Gross Margin: We’re looking at another 75bps of deleverage as the company continues to invest in its roll out of Rack and Canada stores, which caused about 30bps of deleverage on the gross margin line in 2015. As noted earlier, JWN took it on the chin on the margin side to keep inventories in check headed into 4Q15, but we expect the combination of weak demand and warm weather to lead to a negative move in the sales to inventory spread. That coupled with high inventories across the space = another ‘highly promotional’ environment in 1H15.
  • SG&A: Growth in the mid to low single digit range as the company laps the Trunk Club acquisition, East Coast fulfillment center, and the profitability in the Canada business operation starts to head North. Offset by about $25mm in credit revenue from the TD Bank agreement in each quarter.
  • Earnings: Add that all up and we get to a negative DD earnings growth rate in 1H. 5% and 10% below the Street in 1Q and 2Q, respectively.

Tail (3 years or less): Over a longer duration (3 years or less), we like the setup for JWN. Yes, macro headwinds and category risk are keeping this name on the long bench rather than the core set of names as trend earnings risk still looks likely. But, once we get through the macro reset JWN has the makings of a textbook long. Here’s why…


1) For starters, we have to ask the question does JWN need to exist? We think the answer is unequivocally yes. It has arguably the best e-comm operation in all of B&M retail, premium content, a concentrated footprint in the top malls/MSAs outside of the Northeast, and can hit 300 rack doors without skipping a beat. We’re not convinced that the ‘non-core’ (Canada/Trunk) growth drivers are ROIC accretive, but expectations have come down to a level where we think the point is moot.


2) JWN is coming off a peak investment year, and while there is still $3.1bn left on the $4.3bn 5 year CapEx plan, 2015 marks the tops of capital investment. Margins are washed out as the company invests in the Rack rollout (27 doors added this year), Canadian entry, new East Coast fulfillment center, credit card receivables sale, and absorbs the Trunk Club acquisition. That should in turn fuel top line growth in the HSD range once we enter the back half of 2016 (consumer environment permitting).


3) We don’t have to make wild profitability or sales assumptions for this model to work. By 2017, we assume that Full Line EBIT margins are 100bps off 2014 levels, Rack EBIT margins are 50bps off of 2014 levels, slight improvement in e-comm margins as the business (Rack and Full Line) climbs to ~$4bil, and a profitability donut in the non-core side of the business (Canada/Trunk). At that point Canada will be around a $400mm business, with the entire full line buildout complete, and Trunk (which was break even when JWN acquired it) will have benefited from 3 years of integration. Any improvement in each of the four segments will add additional upside.


4) On that math we get to earnings of $4.13 in 2017 on a sales base just north of $16bn. 6% ahead of the street today and likely higher as numbers come down after 2016 expectations are reset. 

JT Taylor: Replacing Justice Scalia & Paul Ryan's Budgetary Balancing Act

Takeaway: Is a standstill in the Senate likely with ensuing search for Justice Scalia's replacement. Can Paul Ryan unite Republicans around a deal?

Editor's Note: Below is a brief excerpt from Potomac Research Group Senior Analyst JT Taylor's Morning Bullets sent to institutional clients each morning. 



JT Taylor: Replacing Justice Scalia & Paul Ryan's Budgetary Balancing Act - scalia


Expectations for the Senate's productivity this year were already low, but the looming nomination fight over Justice Scalia's replacement threatens to grind the chamber to a standstill. Majority Leader Mitch McConnell's decree that any Obama nominee to the Supreme Court would be stonewalled all but invites an "obstructionist" tag for the whole party in the coming election (though we're willing to bet that Harry Reid, if in his shoes, would be using the same playbook). He's caught between the stated goal of "regular order," demonstrating his party's ability to govern, and a much-less ephemeral conservative base that will not countenance a nominee from the current president, period. 


We wonder, why not just let the process work? There are several major hurdles that a nominee faces under normal circumstances -- the Judiciary Committee, a cloture vote, and finally a floor vote -- and there's opportunity throughout for Leadership to slow or block confirmation, with far less risk to the party brand. Not every Senator seems to be adopting the party's hard line -- Judiciary Chair Chuck Grassley said he would at least withhold judgment until a nominee is named, while fellow Judiciary member Thom Tillis warned about the "obstructionist trap" they risk by blocking a SCOTUS pick sight-unseen.



JT Taylor: Replacing Justice Scalia & Paul Ryan's Budgetary Balancing Act - paul ryan


Speaker Paul Ryan, facing stern opposition from conservatives to the budget caps agreed-upon by his predecessor John Boehner, laid out three options for members of his Caucus on Friday:


  1. Re-impose sequestration-level cuts for defense and domestic spending;
  2. Bump up the defense budget, to satisfy hawks, but maintain or lower caps on domestic spending; or
  3. Don't pass a budget at all -- with the budget topline already set for next year, appropriations bulls can still move forward unimpeded.


Options 1 and 2, he stated, would result in the one outcome conservatives hate even more than excess spending: a Democratic blockade in the Senate, followed by an Omnibus appropriations bill crammed down their throats at the end of the year. Option 3 would be an embarrassment for Ryan, former chair of the Budget Committee, and give Democrats yet another attack vector on the party's inability to govern -- but "the sky wouldn't fall," according to the Speaker. Partisan rancor over the SCOTUS shake-up increases the odds that House Republicans will take option 3. 

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Cartoon of the Day: The Three Little Pigs

Cartoon of the Day: The Three Little Pigs - central bank cartoon 02.17.2016


Central bankers have become concerned about recent tumult in financial markets. They should be. Macro markets continue to signal economic growth is slowing.

BREAKING: Atlanta Fed's Economic Forecast Is Out To Lunch

Takeaway: The U.S. economy is slowing, despite what the Fed says.

BREAKING: Atlanta Fed's Economic Forecast Is Out To Lunch - Fed forecast cartoon 11.13.2015


The latest Atlanta Fed GDP reading is a head-scratcher.


In case you missed it, their forecast for Q1 2016 came in at 2.6% today.




That's well above rosey Wall Street consensus estimates of 2.1% and stands in stark contrast to Hedgeye's latest (revised) forecast... 0.6%. 


BREAKING: Atlanta Fed's Economic Forecast Is Out To Lunch - gdp fed q1


For the record, our Macro team has nailed the last five GDP reports.


Then there's the Atlanta Fed's own track record... You'll recall that Q4 2015 GDP came in at 0.7%. Back in October, the Fed's estimate for Q4 2015 GDP was almost 3%. That was ratcheted way back to a final estimate of 1.0%.


BREAKING: Atlanta Fed's Economic Forecast Is Out To Lunch - gdp fed q4


Part of the inaccuracy of Atlanta Fed's model is methodological. Here's Hedgeye U.S. Macro analyst Christian Drake:  


"The GDPNow model is never accurate in the early part of a quarter  - that’s because it’s a tracking model and uses reported data for the quarter to drive the estimate. At the beginning of the quarter it is largely interpolation and estimates, which subsequently get revised as the actual data comes in.


We don’t even have January data yet across a number of material series which means the Atlanta Fed model has incorporated zero actual data across many of the expenditure types in the 1Q16 estimate so far."


Hedgeye Senior Macro analyst Darius Dale adds even if there is a "sequential acceleration by the time Q1 GDP is reported... that would not be unlike 2Q 2000 and 2Q 2008 (both #SuperLateCycle head-fakes)."


The broader point here is that our Macro team reiterates its #GrowthSlowing theme per the preponderance of economic data that is rolling over of late and in spite of the Q1 2016 GDP number.


If we're right and historical precedence (per 2Q '00 and 2Q '08) is our guidepost, stay away from equities. As Dale points out, back then "You could've bought all the stocks you wanted en route to peak-trough decline on the order of -49.1% and -56.8%, respectively (S&P 500)."


in other words ... Watch out.

INSTANT INSIGHT | Central Planning, Currency Wars, & European Stocks

Takeaway: Europe needs a strong dollar to prop up their stock markets.

INSTANT INSIGHT | Central Planning, Currency Wars, & European Stocks - draghi devalue


A few interesting insights via foreign exchange markets. As Hedgeye CEO Keith McCullough pointed out to subscribers this morning:


"The strong recovery day for the US Dollar yesterday after holding 94 @Hedgeye TREND support during the 2 week correction – rest of the world’s equities (Europe and Japan in particular need #StrongDollar as their stock markets aren’t working unless their FX weakens) – can Draghi break the Euro down to $1.05 vs USD in March? Doubt it."


That's why European markets are up today. The Euro is weakening.


here's a look at Italian stocks...



and Germany's DAX...



For the record, the DAX has tumbled -25% from it's 2015 high.


the central planning gong show continues...


INSTANT INSIGHT | Central Planning, Currency Wars, & European Stocks - Currency wars cartoon 08.12.2015

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