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CHART OF THE DAY: Jobs Growth Migrating South for Winter

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye U.S. Macro Analyst Christian Drake. Click here to learn more.


"...From a rate of change perspective, payroll growth will continue to slow from here. 


The why is relatively straightforward:


  1. Employment growth is hostage to the law of large numbers and as the base gets bigger, an accelerating growth rate implies an ever increasing number of jobs.  On an NFP base of 145M, the numbers get unreasonable quickly (i.e. you start needing to add 700K … 900K … >1M workers net on monthly basis to maintain the growth curve).
  2. Diminished slack and a tighter labor market.  As the expansion matures and labor supply tightens, there are simply less people to hire and more competition."

CHART OF THE DAY: Jobs Growth Migrating South for Winter - CoD NFP YoY

North vs South

“I am the object of criticism around the world. But I think that since I am being discussed, then I am on the right track.”

-Kim Jong-il



The “official” story is that North Korean Vice Premier Kim Yong Jin was executed for “not keeping his posture upright at a public event”.


Whatever the real reason is, it probably doesn’t matter – I’m sure it falls within the same broader bucket of absurdity.   


As I was reading that Reuters report yesterday, I was reminded of the famous-in-econ-circles chart below.


It shows a night image of North & South Korea.  The contrast in light output is meant to convey the relative income differences between the two countries.


Because they were once a single country, share a similar geography and have historically similar cultures and comparable resources, the two countries serve as a natural case study in growth policy.  


Institutions and ideologies matter to real growth, real standards of living, and real lives, a lot. 


North vs South - CoD N vs S Korea


Back to the Global Macro Grind ….


So, North vs South. 


That’s pretty much what macro investing distills down to.  Is the 2nd derivative of growth and inflation positive and headed north or negative and heading south.  


Let’s review the recent fundamental data before drilling into some Jobs Day, labor market specifics:


  • ISM: In confirmation of what may be the most passive aggressive top ever, the August ISM reading printed 49.4, down -3.2 pts sequentially and down for a 2nd month off the June “top” as current production, new orders, employment and backlogs all slide into contraction.  Our view has been that while stabilization in manufacturing activity after a year+ of negative growth wouldn’t be particularly surprising, we didn’t have a fundamental catalyst for a sustainable inflection.  In other words, while going from bad to less bad is good, it doesn’t really represent an investible Trend without a catalyst or expectation for a 48 --> 52 --> 58 --> 62 type progression.


  • Auto Sales:  Auto Sales fell -4.8% MoM in August, offering further confirmation that 2015 was the probable peak in demand.  The companies themselves are publically acknowledging that 2015 was the top and we’re not going back to 18M in annualized sales.  Take their word for it.


  • Retail Sales:  Auto sales represent ~20% of Headline Retail Sales so a -5% decline will sit as a -1% drag to reported growth when the data are reported on 9/15.  Recall, Retail Sales were up just 0.0% last month despite auto sales being up +6.5% sequentially.  The Retail Sales Control Group (GDP Input) and all the Ex-Auto subaggregates were negative month-over-month and decelerating on a year-over-year basis.  Some industry other than “e-commerce” will have to step up in August.


If we’re scoring yesterday, that =  3 Souths, 0 Norths


Moving on to employment.  Here’s a look at the North-to-South annual progression in the monthly NFP average:


  • 2014: 250K/mo
  • 2015: 228K/mo
  • 2016: 186K/mo


From a rate of change perspective, payroll growth will continue to slow from here. 


The why is relatively straightforward:


  1. Employment growth is hostage to the law of large numbers and as the base gets bigger, an accelerating growth rate implies an ever increasing number of jobs.  On an NFP base of 145M, the numbers get unreasonable quickly (i.e. you start needing to add 700K … 900K … >1M workers net on monthly basis to maintain the growth curve).
  2. Diminished slack and a tighter labor market.  As the expansion matures and labor supply tightens, there are simply less people to hire and more competition.


And as we reach full employment, jobs gains need only be large enough for the labor force to absorb net new entrants.  In forecasting that figure and translating it into a monthly NFP estimate, there are four primary inputs:


  1. Population Growth
  2. Labor Force participation by age
  3. Natural Unemployment Rate
  4. A conversion factor


In other words, the estimate must account for the number of working age people (the net flow of new, young entrants and older retirees), the percentage of that working age population that will generally have or be seeking employment (the Labor Force Participation Rate) and the number of labor force participants that will be unemployed in some average sense over time (Unemployment Rate).  Lastly, because the labor force participation and unemployment figures are estimated from the BLS Household Survey of employment and the NFP figures are derived from the Establishment Survey, the estimate requires an adjustment to account for systematic differences between the two surveys.  


The output is moderately sensitive to the assumptions embedded in those inputs but, across a liberal range of assumptions, the estimates of trend employment generally fall between 60-120K per month (Janet thinks it’s <100K).  


In other words, employment growth will continue migrating South for the Winter. 


Which brings us to the simple macro reality we harp on every month:


If employment growth is slowing, there are only a couple ways in which (aggregate) income growth can remain flat or accelerate:


  1. An increase in the number of hours worked per week.  It has been largely flat the last couple years.  And/or …
  2. An acceleration in wage growth.  Wage inflation has shown some fledgling mojo in recent months but wage growth needs to accelerate faster than employment growth slows, on an ongoing basis, to support any improvement in income growth.


And if income growth is slowing there are only a couple primary ways to maintain or accelerate consumption growth:


  1. Declining savings rate:  A declining savings rate, while arguably a negative fundamental development,  is supportive of consumption growth from an accounting perspective and the savings rate was down -20 bps year-over-year to 5.7% in July, providing a modest tailwind to spending growth.  With the savings rate at or above 6.0% in 2H15, if we hold the current level it will be supportive of reported consumption growth over the coming months.
  2. Accelerate credit growth:  With aggregate income growth slowing since its peak in early 2015, accelerating credit growth has helped buttress the deceleration in consumption growth.  That support may be fading.  Total Consumer Credit growth peaked in October of last year and has slowed in each of the last three months and revolving credit growth (i.e. credit cards) peaked in March and has also slowed in the subsequent 3 months.   


I have more to say around the outlook for consumption but this morning’s verbosity is marching Northward and I want to leave you with a couple parting thoughts:   


The trend in employment remains in somewhat of a Catch-22:

  • If employment growth continues to slow and wage growth can’t manage a sustainable acceleration then income and consumption growth will continue to slow.
  • If employment maintains its current pace and labor growth continues to run at a positive spread to output growth then Productivity, Corporate Margins and Profitability will all continue to head South. 


Tactically, as Keith has highlighted, bad probably = good and good probably = bad in terms of this morning’s jobs number as the implication for equities and asset prices broadly follows some version of the following.  


Strong employment report(s) = ↑ tightening expectations = Dollar ↑ = stuff priced in dollars ↓ = Deflation Risk ↑ = Yield Spread↓,Trade deficit ↑, etc


Does industrial/energy sector activity, investment or earnings inflect and inflate in that scenario?  Did it in December’s iteration of that macro factor flow?


Our immediate-term Global Macro Risk Ranges are now:


UST 10yr Yield 1.50-1.62%

SPX 2162-2188

VIX 12.07-14.41
USD 94.01-96.51
Oil (WTI) 42.13-45.55

Gold 1


Happy Labor Day.


Christian B. Drake

U.S. Macro Analyst


North vs South - CoD NFP YoY

The Macro Show with Keith McCullough Replay | September 2, 2016

CLICK HERE to access the associated slides. 

 An audio-only replay of today's show is available here.


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LULU | Rubber Hits Road, Road Hits Back

Takeaway: This print had one or two redeeming factors, but overwhelmingly reinforced our short call. There’s another $20+ downside over 12-18 months.

This quarter was not a disaster by any means, but with slightly weaker revenue and a tempered outlook, it’s certainly not what a $76 stock at a 35x multiple needs to see.  The aftermarket sell-off shows that clear as day. But the reality from where we sit is that there is much more downside from here. Our call was to press the short on the print. In hindsight, we’d have stuck with the same call from a risk management perspective. The reason is that even though the stock is selling off after market, we think there’s a good $20+ in downside left in this name. Our major concern is that numbers, and the rising capital costs to capture incrementally lower margin growth, do not synch with elevated expectations, and the company will need to guide down in 3-6 months, or flat out miss by 10% or better in 2017.


The TTM incremental margin in this quarter was under 4%, and expectations – even after weaker guidance -- are calling for that to accelerate to a whopping 24% over the next three quarters.  We think that LULU will flat-out miss this target. Even if we’re wrong, the incremental buyer needs to ask if there is any potential upside from these aggressive targets? We think No. We would love to engage in that debate, and we’re pretty sure we’d win (see note below for details).

LULU | Rubber Hits Road, Road Hits Back - 9 1 2016 LULU inc margin


To be fair, LULU put up absolute EPS growth of 12% -- which is actually good for a retailer in this day and age (though not worthy of nearly a 3x PEG ratio). In addition, it just put up the best Gross Margin improvement since 2Q 2011 on top of a downright impressive move in the SIGMA – that is nearly a lock for some level of gross margin improvement in the coming quarter. That’s the biggest, and perhaps only real positive from this print.

LULU | Rubber Hits Road, Road Hits Back - 9 1 2016 LULU sigma


But the whole thing does not sit well with us, for several reasons…

  • Management is hinging this story on a long-term comp of at least 9% -- the level needed to leverage SG&A, but it admits that customer traffic continues to be a problem (in 3Q to date as well), and is banking on higher Average Unit Retail (AUR -- i.e. price/mix per item) and Units per Transaction (UPT).  We don’t see how anyone can rely on this given the longer-term competitive pressures from solid brands with far better strategic visions, management teams and Boards.
  • Above all that, the fact (and it is a fact) that with the absence of a wholesale model – one that we think LULU is likely not capable of executing alongside its DTC business – and real estate growth outside its core markets, the company is simply not ‘fishing where the fish are’. Of COURSE traffic will be a problem in this scenario. Why should that turn around?
  • LULU took up capex slightly this quarter (2-3%) and moderated its SG&A leverage expectation to spend on the brand – but we need to see a lot more than the ~22% it is spending on the margin. We need at least an incremental $150 million in annual spend, or about another 75bps in margin – and we could even argue something closer to $250mm to meaningfully accelerate top-line growth to the levels needed to grow consistently and profitably. We heard no part of the strategy on the conference call that makes us think otherwise. Potdevin can talk about the ‘Feathered Designs and Technical Silouettes’ all he wants…the fact is that expectations are very high, growth is slowing, and the cost of growth is heading up. That means lower returns – structurally – which hardly synchs with the stratospheric multiple.


Below is our previous note from 8/30/16


08/30/16 02:33 PM EDT

LULU | The Rubber Meets The Road


Takeaway: Next year’s #'s look 10-15% too high – setting up for a big miss/guide down, just not tomorrow. We’re comfortable shorting more post-print.


Conclusion: Our LULU short call is admittedly at a polarizing point in its decision tree. On one hand, we think that this company represents one of the weakest management teams with very little brand vision and strategy that is coasting on the heels of a strong category and an unsustainable capital and margin structure. We think that earnings next year approach $2.20 vs the current consensus estimate of $2.54. In fact, the Street’s $3.00 number for 2018 might not happen for another 3-4 years. The problem is that the quarter to be released tomorrow – at least as we see it – looks fine relative to expectations. There’s very little chance we’ll get a guide down for another 13 weeks until 2017 is staring the company in the face.  Even then it might not guide down until an all-out miss becomes a reality in 1H17.  With the stock trading at 35x what we think it will earn next year, we think there’s up to 50% downside over 9-12 months as the multiple compresses on a lower earnings base (20x $2.20 = $44). That’s flat-out dangerous with the stock over $75 today. But until then, we’ve got near-term margin tailwinds, a double digit EPS/cash flow algorithm (tough to find in retail today), and short interest at 18% of the float – definitely not something we want to make a big call on the day before the quarter. But if people become even more elated by a near-term pop in growth, we’re confident enough in the eroding return and growth profile that we’d short more.


The Rubber Meets The Road:

For the first time in the better part of 2yrs, there are some serious expectations embedded in the LULU story. While there are some comparison tailwinds to consider as the company laps an investment phase primarily focused on the back of house, we think that’s more than represented in the 35x P/E and 19x EBITDA forward multiples. This quarter should – and probably will – provide the management team with all the ammunition it needs to talk up its margin expansion story Heck, the first quarter of Gross Margin expansion in over 14 quarters is worth a slap on the back. And should (assuming that the demand equation doesn’t completely fall apart) give the bulls enough to latch onto.

Then we fast forward to 2017 and we need to assume 2012-esque incremental margins – in the range of 25% – to get to current consensus numbers. We think that’s a high hurdle rate for any company at the tail end of an economic cycle, and even more ambitious for a company like LULU which… i) has some of the biggest question marks in the C-Suite out of any company that we cover and ii) continues to invest in non-core businesses in the shape of Men’s, Intl, and Ivivva in order to prop up the top line.


And It’s Not Just One Year

Past 2017, LULU’s current plan (which closely mirrors consensus expectations) assumes an incremental margin in the range strikingly similar to what it experienced in Stage 1 of its growth cycle (which we define as the years 2005-2011). During that time period, the company added nearly $1bn in sales, created a category, and scaled it across the top markets in the US and Canada. All in, that was good for an incremental margin of 30%.

LULU | Rubber Hits Road, Road Hits Back - 8 30 16 LULU inc margin

Today, LULU’s core business (which we characterize as the US and Canada) accounts for 92% of sales and 104% of EBIT. From here, the company is investing a boatload of capital into the non-core future topline growth vehicles (Men’s, Int’l, ivivva), which will take the revenue mix from 90%+ core to 75% by 2020. Don’t get us wrong, there is nothing wrong with diversifying a business model (we think LULU should do wholesale). But the problem herein lies in the expectation that LULU can get both topline reacceleration AND margin recovery as it moves the mix away from the most profitable and mature parts of the business in the US and Canada

The punchline is that as LULU shifts incremental growth away from the core businesses, we will see an offset to the margin recapture over the near and long-term. We get to steady state margins in the teens vs. the Street approaching 20%. That translates to an ultimate (4-5 year) earnings number barely hitting $3.00 vs the Street marching blindly towards $4.00.

LULU | Rubber Hits Road, Road Hits Back - 8 30 16 LULU growth algo


E-Comm, Ho-Hum

There are puts and takes by quarter, but we think the overarching trend in the e-commerce growth rates can be defined as lower lows and lower highs. The 17% reported growth rate in 1Q16 was the 2nd lowest the company has ever reported, and based on our analysis of the traffic trends it doesn’t appear that there has been a meaningful inflection through 2Q. The Street’s numbers don’t appear to be at risk as the company normalizes traffic flow after the website refresh in 1Q, but we think the company will need to re-accelerate this channel meaningfully in order to hit MSD comp expectations through the year in light of the next section.

LULU | Rubber Hits Road, Road Hits Back - 8 30 2016 LULU traffic rank


Brick and Mortar Going The Wrong Way

On a 3yr basis, constant currency store comps went flat in the quarter the company reported 3 months ago. We think that’s a meaningful metric for LULU, as there has been a lot of noise associated with the quarterly sales trends – particularly the Luon recall and Chip’s ‘our customers are fat’ comments. Comps get more difficult, going from a -1% compare in 1Q16 to +5-6% comps for the balance of the year, that’s pretty straight forward. What we think is far more important is that lack of new productive square footage coming into the sq. ft. base needed to stimulate Brick and Mortar comps. That’s glaringly obvious when you consider the following…

1) Int’l and ivivva will account for a greater percentage of new doors in 2016 (at 58% of the 40 units) than North America lululemon doors. That’s the new normal. And translates to higher investment and lower returns.

2) US growth is now centered around less productive/affluent markets. Whether you measure on athletic participation trends, income distribution, or population density the new markets LULU has entered over the last 3 years are less productive. Sq. Ft. growth opportunities in the top MSA’s are all but gone, hence the need to scale up square footage. This may be oversimplifying, but Albany, NY ≠ Houston, TX.

3) The math suggests that 2015 was the peak year of new sq. ft. comp benefits. Stores aged 0-3 years (i.e. in the key part of the maturation curve to drive comp growth) accounted for 40% of the portfolio in 2015. That ticks down in every year from here on out – to 20% of the portfolio by 2020. That means we will need to see either a) outsized category growth, or b) outsized market share gains at LULU amidst stepped up competition from copycat brands and women’s investment at NKE and UA.

As comp tailwinds from sq. footage growth dry up, we think it has encouraged return dilutive behavior, including accelerated Int’l growth and entering markets in the US where the spending and population demographics do not support the 4-wall model we have come to expect from LULU.

LULU | Rubber Hits Road, Road Hits Back - 8 30 16 LULU store comps


Still Another Quarter Of Price Benefit

Here’s a win for LULU – at least through the end of the year. The company repositioned its pants wall in September 2015 and took price at the same time. Since we’ve seen the average price of LULU bottoms SKU tick up by as much as 15%. The top of the pricing spectrum (over $110) now accounts for 30% of the total category. The company will start to anniversary those price increases in a few days but will have another two quarters of benefit.

On the tops front – there has been some press discussing the increase in price for some of the top selling SKUs. That appears to be the case on the high end, but based on our analysis, looks as if the company is building out its selection at the mid-tier price point between $52-$62. That bucket accounts for nearly 80% of the total selection on LULU’s website, taking average SKU price down by 2% in 2Q16.

What that means for the call is that the pricing bullet has already been fired, meaning LULU will have to consistently drive traffic to its doors. Given the volatility in traffic patterns for LULU historically, we’re not convinced that the company can win on traffic alone.

LULU | Rubber Hits Road, Road Hits Back - 8 30 2016 Pant SKU

LULU | Rubber Hits Road, Road Hits Back - 8 30 2016 Tanks SKU

Rousseff Is Ousted; Time to Buy Brazil?

In one word: “yes”. As widely anticipated, Brazil’s Senate voted to uphold the impeachment claims levied upon now-former President Dilma Rousseff. This clears the way for acting President Michel Temer to remain in office through 2018.


With an approval rating sub-20% and widespread allegations linking him to the “Operation Car Wash” scandal, it’s an understatement to say President Temer has his work cut out for him in convincing the PT-led Brazilian Congress to implement his proposed austerity measures. That said, however, we are keen to bet that the catalyst of structural reform may become secondary to Brazil’s cyclical recovery over at least the next 3-4 quarters.


Regarding said cyclical recovery…


Consumer spending growth appears to be breaking out of its YTD basing pattern from historically depressed levels:


Rousseff Is Ousted; Time to Buy Brazil? - HOUSEHOLD CONSUMPTION


Industrial production growth is accelerating on a sequential and trending basis off of historically depressed levels:


Rousseff Is Ousted; Time to Buy Brazil? - INDUSTRIAL PRODUCTION


Export growth is accelerating on a sequential and trending basis off of historically depressed levels:


Rousseff Is Ousted; Time to Buy Brazil? - EXPORTS


Composite PMI readings appear to be breaking out of their YTD basing pattern from historically depressed levels:


Rousseff Is Ousted; Time to Buy Brazil? - COMPOSITE PMI


Consumer and business confidence readings have each completed full-cycle bearish-to-bullish reversals… both are now accelerating on a sequential and trending basis off of historically depressed levels:


Rousseff Is Ousted; Time to Buy Brazil? - CONSUMER CONFIDENCE


Rousseff Is Ousted; Time to Buy Brazil? - BUSINESS CONFIDENCE


Headline and core inflation readings have each completed full-cycle bullish-to-bearish reversals… both are now decelerating on a sequential and trending basis off of historically elevated levels:


Rousseff Is Ousted; Time to Buy Brazil? - CPI


Rousseff Is Ousted; Time to Buy Brazil? - CORE CPI


The Brazilian real has experienced a -25% peak-to-present decline on a REER basis, which goes a long way towards mitigating the “Dutch Disease” we highlighted amid our bearish thesis on Brazil several years ago:


Rousseff Is Ousted; Time to Buy Brazil? - REER


Brazil’s current account deficit has improved +260bps off of its 1Q15 cycle-trough of -4.4% through 2Q16:


Rousseff Is Ousted; Time to Buy Brazil? - CURRENT ACCOUNT BALANCE


As a ratio to GDP, Brazil’s primary deficit finally appears to be undergoing a bottoming process; “less bad” is a great thing here:


Rousseff Is Ousted; Time to Buy Brazil? - BUDGET BALANCE


The confluence of these factors imply one of the best GIP Model setups we’ve seen in recent memory (akin to the U.S. economy when we turned bullish on domestic shares in early-2009). On top of that, BCB is setup to perpetuate this recovery with an easing bias; specifically, 1Y OIS spreads have narrowed -29bps MoM and are now pricing in five 25bps SELIC rate cuts over the NTM.


Rousseff Is Ousted; Time to Buy Brazil? - BRAZIL




Regarding Temer’s admittedly aggressive structural reform agenda, he has proposed to narrowing the primary deficit to (R$139B) in 2017 from a projected [record] (R$170.5B) in 2016. In addition to that, he’s proposed to cap the growth rate of public expenditures to CPI over the next 20Y and to raise the retirement age – both of which require amendments to the Brazilian Constitution, which itself requires a lofty three-fifths majority vote. He also proposed to implement a broad-based freeze on tax hikes – which is among the most important of his reform initiatives from our purview:


Rousseff Is Ousted; Time to Buy Brazil? - Brazil WEF DBR 2016


All told, while a lot of the easy money has already been minted on the long side of Brazil in the YTD, being late to the party doesn’t necessarily imply the party is about to end. We’re betting on a continued and prolonged cyclical recovery to perpetuate the next leg of upside in the Bovespa and the BRL from here.


Rousseff Is Ousted; Time to Buy Brazil? - YTD PERFORMANCE


As always with emerging markets, the biggest risk to investors on the long side of Brazil would be a stronger USD that perpetuates incremental commodity price deflation and a tightening of global financial conditions. As such, the EUR/USD remains the most critical top-down factor to monitor to the extent it breaks down below its ~18M trading range. The tug-of-war between #EuropeImploding and the U.S.’s #LateCycle slowdown in employment growth may keep the DXY range bound for now, however. This implies the proverbial wind may remain at the marginal EM investor’s back – for now at least.


Rousseff Is Ousted; Time to Buy Brazil? - Brent Crude Oil vs. EWZ


Rousseff Is Ousted; Time to Buy Brazil? - EUROZONE


Rousseff Is Ousted; Time to Buy Brazil? - Temps JOLTS NFP Analysis


Rousseff Is Ousted; Time to Buy Brazil? - Global Financial Stress   GFSI

Source: Bloomberg


Best of luck out there,




Darius Dale


McCullough: What One Of The World's 'Most Brilliant' Investors Told Me About Janet Yellen


In this excerpt from The Macro Show, Hedgeye CEO Keith McCullough discusses what one of the world's most brilliant investors told him about Fed chair Janet Yellen, interest rates and Friday's Jobs Report. 


Subscribe to The Macro Show today for access to this and all other episodes. 


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