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INSTANT INSIGHT | An Update On Spain, The ECB & #EuropeImploding

Takeaway: Spanish political drama leaves investors in the dark. Meanwhile, we suggest investors continue to fade the easy yet ineffectual ECB policy.

INSTANT INSIGHT | An Update On Spain, The ECB & #EuropeImploding - Spain cartoon 06.30.2016

And the political pain continues in Spain.

 

The latest update is acting PM Rajoy has once again convoluted the road to forming a government, this time going against his word to evaluate a series of reform demands from the centrist Ciudadanos party (which if agreed to by Rajoy would increase the likelihood of Ciudadanos joining Rajoy’s party to form a coalition government). Will this political indecision continue, leaving investors in the dark? 

 

You bet!

 

It has been for some time. Take a look at the Spanish IBEX's performance below.

 

INSTANT INSIGHT | An Update On Spain, The ECB & #EuropeImploding - spain bubble peak

 

On a related note, ECB Minutes from July 21 show continued use of phrase “it [ECB] would act by using all instruments available within its mandate.” We continue to fade the ECB policy stance that QE will fix the region’s underlying growth and inflation ails. Our short bias on the EUR/USD remains intact.

#EUROPEIMPLODING.

 

***Editor's Note: The snippet above is from a note written by our Macro team and sent to subscribers this morning. Click here to learn more.


Macrocosm 2016 | Important Date Change!

We are changing the date of Macrocosm 2016 to Wednesday, November 16th in light of a religious calendar conflict. The good news is that America will have just elected a new president. Our speakers will discuss the Election Day outcome and its implications for investors around the globe.

 

In the coming weeks, we will release our full speaker roster and how to reserve your spot at this exclusive investor event.

 

The event will be held at the Yale Club of New York City.  Please mark your calendar now – November 16th!  

 

-Your Macro Team

 

Macrocosm 2016 | Important Date Change! - macrocosm2016 banner graphic email


FL | Confident in Short Across Durations

Takeaway: This short call has legs as returns get cut in half over 2 years. If FL manufactures EPS tomorrow, short more.

For over a year we have been vocal on how the changing paradigm in how shoes are designed, sourced, manufactured, and sold is radically changing up the Athletic Footwear industry as we have known it for 40+ years. To be clear, this goes far beyond the simple 'content owners (NIke, UA, Adidas, etc...)' win, and traditional distribution loses. Everyone has a license to win, or lose. All it takes is a vision, talent, a boatload of capital, and the mandate to deploy it.

 

In that context, Nike is the clear winner, which is no surprise. But we think that people grossly underestimate both the depth and duration of its share gain and boost in profitability. Foot Locker is nearly the exact inverse, characterized by declining sales, weaker margins, higher SG&A, more working capital, Capex grinding higher (but not high enough to win strategically), and RNOA going from 28% (where it is today) to something in the low-mid teens. Stocks don't go up when RNOA gets cut in half -- even if they 'look so darn cheap on consensus earnings and trailing cash flow'.

 

To be clear, this kind of call does not play out in a single quarter. That is not a 'weak conviction hedge' into tomorrow's FL print. Not by a long shot. We fully expect the print to reinforce our 'declining return' theme -- with better than 90% confidence. Could the company find a way to make the stock go up on the day? Of course. Companies always can. But either way, every bit of research in our arsenal says that this is a name we want to be short right here, and right now. 

 

DETAILS

We’ve seen some of of our call play out to date – but only some. Mostly in the stock price…off 7% YTD vs. the XRT +5%, rather than the reported earnings numbers. The call has worked, but not for all the right reasons, yet. We’ve seen multiple compression and now we think it’s time to start seeing it in the form of earnings revisions. Maybe not tomorrow, but certainly before the year is out. This is a 3 steps forward and one step back kind of short – and one that will ultimately lead to earnings closer to $3, which is significantly below where just about anyone thinks they could go.

 

Thinking about the near-term considerations, we saw the first hiccup from this company three months back in the form of a comp number that slowed by 400bps sequentially on a 2yr run rate and EPS growth of 7%, good for the lowest rate we’ve seen since 2009. It was also a watershed moment in the FL/NKE relationship as management at the former was as bearish on its key partner as we can ever remember. It hasn’t quite been a soap opera since, but there is a slew of data points that we think are particularly bearish for FL. Including…

 

a) Nike basketball growth went negative for Nike in FY16, though with Jordan the growth rate for the year was 11% down from 19% in 2015.

b) Nike readjusted the price/valuation equation at the tippity top of the pricing spectrum for its KD and Lebron shoes, taking the new model price points down 17% and 13%, respectively. That’s key given that much of the comp number is driven by ASP growth given that FL is smack dab in the middle of the negative traffic mall.

c) Nike wholesale growth went from a pretty consistent run rate between 10-15% to flat in the quarter the company closed in May.

d) Nike incremental wholesale dollars slowed to $431mm in the company’s FY16, 40% the average rate we’ve seen over the past 4 years. Assuming a 20% DTC growth rate for Nike in FY17, which we think could prove to be on the low end, means the wholesale dollars up for grabs are set to be cut in half again.

 

None of the above is a good barometer for FL. We’re short it. There’s no way FL comes out of this smelling better than it does today. Sales should weaken, gross margins should decline, SG&A and capex will BOTH head higher as FL tries to build up a more successful e-comm business to compete with its existing partners. Management is good at FL, and it will spend where it needs to – and after its Nike business went from 50% to 73% of revs over six years it really did not have to invest at all (hence unsustainably low SG&A). Now that changes.

FL | Confident in Short Across Durations - 8 18 2016 FL earn table B 

 

Near Term Considerations:

 

After 3 years of nearly bulletproof earnings prints (FL has gone 11 straight quarters meeting or exceeding street numbers), we believe FL will be hard pressed to hit current 2016 estimates. Here’s why:

 

Revenue

1. Jordan launch timing was the signaled to be the key perpetrator for the negative comp trend QTD and while we aren’t blind to the factor launch timing can have on the weekly cadence of comps, but we think the softness in Nike basketball is a bigger headwind to overcome. The latter part we think helps explain the 500bps deceleration in comps from 4Q15 to 1Q16.

2. In this last fiscal year, NKE reported Nike Basketball and the total Jordan Brand separately for the first time. Jordan Brand grew 18% for FY16 on top of +20% in 2015, while Nike Basketball was DOWN 1% on top of +18%. While we think there is some obvious shift in demand from Nike to Brand Jordan, it’s the aggregate basketball business that really matters for FL. Basketball slowed to negative mid-single digits in 1Q16 vs a tough low double digit compare, and it doesn’t get any easier up against DD growth again back in 2Q15.

3. Comps were negative QTD as of the FL call on May 20th with street expectations for a 3.8% comp in the quarter. That means we would need to see a of 500bps+ intra-quarter acceleration in the trend in order for FL to hit current estimates. If history is any indication, FL has a pretty big mountain to climb. In order to hit a 4% comp this quarter, FL would have to see the biggest acceleration in… well, ever (or at least during this economic cycle). Then, from here, comps don’t get easier.

4. Don’t be fooled by positive QTD sales commentary on the call. August of 2015 was a relatively easy compare at mid-single digits, while September and October compares jump to double digits.

FL | Confident in Short Across Durations - 8 18 2016 NKE Bball

 

Margin Considerations

Merchandise margin compares get tougher sequentially from 1Q when the company missed comp by 160bps and gross margin by 30bps. ASP resistance has been well documented, and compares aren’t getting any easier from here. That’s an important point, as FL needs a low mid-single digit comp to leverage occupancy and about the same on SG&A. The FX SG&A tailwind is now completely gone with certain investment buckets weighing on 2Q in particular. Rounding it all out, the 1Q sales to inventory spread, though still positive, hit its worst level in 9 quarters. Throw in the liquidation of ~3mm pairs of athletic footwear between TSA and Sport Chalet in 2Q, and we think margins are more likely to surprise to the downside than the up.

FL | Confident in Short Across Durations - 8 18 2016 FL Sigma


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Daily Market Data Dump: Thursday

Takeaway: A closer look at global macro market developments.

Editor's Note: Below are complimentary charts highlighting global equity market developments, S&P 500 sector performance, volume on U.S. stock exchanges, rates and bond spreads, key currency crosses, and commodities. It's on the house. For more information on how Hedgeye can help you better understand the markets and economy (and stay ahead of consensus) check out our array of investing products

 

CLICK TO ENLARGE

 

Daily Market Data Dump: Thursday - equity markets 8 18

 

Daily Market Data Dump: Thursday - sector performance 8 18

 

Daily Market Data Dump: Thursday - volume 8 18

 

Daily Market Data Dump: Thursday - rates and spreads 8 18

 

Daily Market Data Dump: Thursday - currencies 8 18

 

Daily Market Data Dump: Thursday - commodities 8 18


The Nikkei was hammered overnight...

Client Talking Points

Spain

...and so the political pain continues in Spain. The latest update is acting PM Rajoy has once again convoluted the road to forming a government, this time going against his word to evaluate a series of reform demands from the centrist Ciudadanos party (which if agreed to by Rajoy would increase the likelihood of Ciudadanos joining Rajoy’s party to form a coalition government). Will this political indecision continue, leaving investors in the dark, you bet!   #EuropeImploding.

Japan

The Nikkei was hammered overnight, closing down -1.6% as the USD/JPY cross moved back below 100 on the heels of brutal export numbers for the month of JUL. Specifically, the -14% YoY decline was the largest fall since OCT 2009 and the decline showed broad-based weakness – calling attention to slowing global growth, as well as Japan’s inability to manufacture domestic demand. We’ve been the bears on Japanese equities all year and feel it’s appropriate to reiterate that call this morning amid this incremental breakdown of the #BeliefSystem.

ECB

ECB Minutes from July 21 show continued use of phrase “it [ECB] would act by using all instruments available within its mandate”. We continue to fade the ECB policy stance that QE will fix the region’s underlying growth and inflation ails. Our short bias on the EUR/USD remains intact.

Asset Allocation

CASH US EQUITIES INTL EQUITIES COMMODITIES FIXED INCOME INTL CURRENCIES
8/17/16 54% 3% 3% 10% 18% 12%
8/18/16 54% 3% 3% 10% 18% 12%

Asset Allocation as a % of Max Preferred Exposure

CASH US EQUITIES INTL EQUITIES COMMODITIES FIXED INCOME INTL CURRENCIES
8/17/16 54% 9% 9% 30% 55% 36%
8/18/16 54% 9% 9% 30% 55% 36%
The maximum preferred exposure for cash is 100%. The maximum preferred exposure for each of the other assets classes is 33%.

Top Long Ideas

Company Ticker Sector Duration
GLD

See update on TLT below.

TLT

Eurozone GDP, reported Friday, signaled more of the same, stagnation. With that being said there were small but marginal Euro tailwinds against a U.S. retail sales report and PPI release that was likely dovish on the margin (USD -~20bps on Friday and -~60bps on the week). 

 

In line with our #EuropeSlowing theme, Q2 preliminary GDP slowed across the Eurozone to +0.3% vs. +0.6% in the prior quarter and +1.6% Y/Y for Q2 which was flat on a rate of change basis from Q1.

Looking at specific country results:

  • German (0.4% vs 0.7% sequentially) GDP accelerated to +1.8% Y/Y from +1.6% which was probably a minor Euro FX tailwind
  • Italian GDP came in at +0.7% Y/Y which was a deceleration from +1.0% in Q1
  • Greece GDP accelerated to contraction again, printing a measly -0.1% Y/Y from -1.3% in Q1

The Southern Eurozone states continue to implode.

UUP

Recall that a strong retail sales report for June, driven by a positive trend in goods consumption, was a large contributor to our GDP revision for Q2. The headline number, for June, was up +0.6% sequentially with the sequential acceleration in the control group accelerating +7.2% (annualized).

 

Friday’s retail sales report was a different story, and probably a dovish data point for the USD on the margin :

  • The control group printed flat sequentially, +0.0%
  • Retail sales ex. auto and gas printed -0.3% sequentially

Next to retail sales, July headline producer prices decelerated -0.4% vs. +0.5% in June sequentially and -0.2% Y/Y vs. +0.3% Y/Y in June. PPI ex. food and energy came in at 0.0% sequentially vs. +0.4% in June and +0.7% Y/Y from +1.3% in June. #Deflation  

Three for the Road

QUOTE OF THE DAY

“Start by doing what's necessary; then do what's possible; and suddenly you are doing the impossible”

-Francis of Assisi

STAT OF THE DAY

The first and only pair of teammates to be named co-MVPs in the NBA is John Stockton and Karl Malone. 


August 18, 2016

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  • Neutral

INDEX BUY TRADE SELL TRADE PREV. CLOSE
UST10Y
10-Year U.S. Treasury Yield
1.60 1.46 1.56
SPX
S&P 500
2,164 2,192 2,182
RUT
Russell 2000
1,210 1,241 1,227
COMPQ
NASDAQ Composite
5,130 5,255 5,228
NIKK
Nikkei 225 Index
16,033 17,158 16,745
DAX
German DAX Composite
10,204 10,898 10,537
VIX
Volatility Index
11.03 14.65 12.19
USD
U.S. Dollar Index
94.41 96.50 94.69
EURUSD
Euro
1.10 1.13 1.12
USDJPY
Japanese Yen
99.33 102.89 100.28
WTIC
Light Crude Oil Spot Price
40.26 47.53 46.79
NATGAS
Natural Gas Spot Price
2.46 2.88 2.62
GOLD
Gold Spot Price
1,330 1,370 1,348
COPPER
Copper Spot Price
2.10 2.19 2.15
AAPL
Apple Inc.
104.49 110.02 109.22
AMZN
Amazon.com Inc.
754 779 764
NFLX
Netflix Inc.
91.80 97.88 96.37
JPM
J.P. Morgan Chase & Co.
62.70 66.59 65.89
INTC
Intel Corp.
34.00 35.81 35.02
LOW
Lowe's Companies
75.78 78.95 76.88
XOP
SPDR S&P Oil & Gas Explore
34.17 37.07 36.85
RMZ
MSCI US REIT
1,224 1,261 1,232



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