Takeaway: The 10s/2s yield just spread hit 2007 levels.
Takeaway: Below are a selection of interesting links to stories that caught our attention (for both good reasons and bad).
At Hedgeye, we rarely mince words in assessing Old Wall and it's media. Below are a selection of interesting links to stories that caught our attention (for both good reasons and bad).
- Ben Bernanke, Brookings Blogs, "Ending "too big to fail": What's the right approach?" An interesting read, if only to get up to date on the latest central planning orthodoxy surrounding "too big to fail."
- MarketWatch, "Fed’s Yellen says negative rates would need careful consideration." NIRP! Rep. Brad Sherman (D., California) released a letter from Fed head Janet Yellen in which she writes she cannot "completely rule out the use of negative interest rates in some future very adverse scenario."
- Wall Street Journal, "WSJ Survey: Economists Divided Over Next Fed Rate Increase." This one is just silly. "About 31% of economists surveyed by WSJ this month said the Fed will raise rates in June, down from 75% in April." As we Tweeted yesterday, in other words, "Faulty forecasters are uncertain about the whims of unelected bureaucrats."
- Reuters, "BOJ will act decisively using its 'ample' tools: Kuroda." BoJ head Haruhiko Kuroda said that the "risks to [Japan's] economy are tilted to the downside" but that the central bank will act "decisively" to achieve the 2% inflation target and reiterated that it has "ample" policy octions available to expand stimulus. Nope. Macro markets disagree. Nikkei was down -1.4% today.
- Clifford Scott Asness, BloombergView, "Hedging on the Case Against Hedge Funds." A thought-provoking op-ed on how best to evaluate hedge fund returns from the founder of hedge fund and asset management firm AQR Capital Management. It's as balanced an appraisal as you'll read.
Takeaway: Complacency about the credit cycle is at YTD highs, especially in commodity-related sectors.
Editor's Note: Below is #CreditCycle analysis via our Macro team in a note sent to subscribers earlier this morning.
With renewed expectations for Fed intervention on growth slowing and the precedent of Central Bankers buying corporate bonds in Europe, bond market volatility expectations have been smashed.
The MOVE index is at a level not seen since 2014. High yield spreads have nearly returned to their 2015 averages. Energy OAS is below 2015 averages after trading +600 over that level back in Febraury, and materials and industrials spreads have nearly reverted back to 2015 levels.
What's changed? Expectations certainly have:
- Spreads being well-off 2014 cycle lows;
- Consumption rolling over; and
- Jobless claims picking up
A confluence of data suggests the cycle still cycles.
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Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye Director of Research Daryl Jones. Click here to learn more.
"... Admittedly it is somewhat ironic to have a quote about losing from Donald Trump. To the chagrin of many, Trump has literally done nothing but win over the last year. He has won primary after primary and, if the most recent polls are any indication, beating Hillary Clinton might not be as challenging as pundits once thought either. In the Chart of the Day, we highlight this narrowing gap between the two."
Takeaway: In the path to the inevitable dividend cut, all that concerns us is an activist that does not know how to do research.
Editor's Note: Today's lackluster earnings release from Kohl's (KSS) sent the shares tumbling -9%, as the company missed on just about every important metric. The stock is off almost -15% on the week, handicapped by the broader economic malaise that hit other retailers like Macy's (M).
Meanwhile, Retail analysts Brian McGough and Alexander Richards have been bearish on the stock for some time now. In a note to clients today, McGough and Richards wrote:
"One thing we want to remind everybody of, however, is our thesis that the erosion in Credit income at KSS (30% of EBIT) will take up SG&A, pressure cash flow, and cause KSS to cut its dividend.”
In other words, the worst is yet to come.
Below is an excerpt from a research note published on February 3, 2016, in which they detail the troubles ahead for KSS. To read our Retail team's institutional research email firstname.lastname@example.org.
KSS | …And This Is Only Stage 1 of 3
This is the 1st Stage of KSS EPS permanently being held below $4.00. Stage 2 goes to $3.25. Stage 3 = $2.50 and dividend cut.
All along we’ve been saying that KSS would never earn $4.00 again. While today’s rather dramatic guide-down will make this premise seem a reality for some doubters, what we find most interesting is that this is only midway through Stage 1 of what we think is a Three Stage process to KSS cutting its dividend. Here’s our thinking…
Weak sales results as a result of the fact that KSS sells less and less of what consumers want to buy. Sounds overly simple – but it’s reality. That flows through to the gross margin line as online sales cannibalize brick and mortar, and come at a gross margin 1000bps below the company average. True SG&A growth becomes apparent as credit income stops going up as newly emphasized non-credit/loyalty shoppers become a bigger mix of the pie due to launch of Yes2You rewards program.
Here’s where credit income (currently about 25% of EBIT) erodes WITHOUT a rollover in the broader credit cycle. The company’s much-touted (but ultimately fatally flawed) Yes2You rewards plan cannibalizes credit income as shoppers can move to a loyalty program that offers similar rewards to the branded credit card but gives the consumers the opportunity to get 2x the points. Once at KSS and once on a National Credit card. That takes SG&A growth, which has been artificially suppressed as credit sales grew from 50% to 60%+ of total sales over a 5 year time period, from a run rate of 1% to 3%-4%. For a company that comps 1% in a good quarter, this is incredibly meaningful.
This is the doomsday scenario, and within the realm of possibility as the credit cycle rolls. On top of the self-inflicted pain we see in Stage 2, we see consumer spending dry up (sales weaken – down 5-10%), gross profit margins are down 2-3 points due to excess inventory, SG&A grows in the high single digits due to credit income (which is booked as an offset to SG&A) eroding, and EPS falls to $2.00-$2.50.
Look at any data stream on the credit cycle and you will see that delinquencies and charge-offs are at pre-recession levels. Translate that to KSS, and it means that the credit portfolio is currently at its most profitable rate. Because the company shares in the risk/reward with its partner COF, any weakening in the consumer credit cycle exacerbates the problems brought on by Yes2You cannibalization and puts 25% of EBIT and half of the current FCF at risk. The result, cash flow dries up and by our math, cuts its dividend within 12-months.
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