“It’s already Factored In”
-William Dudley, on the probable non-impact of balance sheet normalization
In case you missed it last week amidst the NFP brick, The Fed Minutes, the Syria news, the Trump-Xi meeting, the Trump Cabinet shakeup, the Gorsuch “nuclear option”, the prospective White House-Russia relations reversal, The Fed leak/Lacker Resignation update, The Kushner-Bannon rift, Dudley’s prior week comments about balance sheet normalization and Dems convening on the constitutionality of changing the locks on America while Trump is in the air to Mar-a-lago ….. on Friday, the market decided to care about Dudley saying the same thing he did a week earlier vis-à-vis probability and timeline for balance sheet normalization. The 10Y subsequently capped its +12bps intraday reversal to close +4bps on the day.
I think we all know any balance sheet unwind will be an exercise in conservatism, which means:
- A pause in interest rates hikes, at least during initial implementation
- No outright asset sales
- A gradual and well-telegraphed pace of maturity roll-off. A tapering up, if you will, in magnitude.
I suppose it may be “factored in” in the vague sense that it's been talked about recurrently and some measure of supply deluge risk (think Fed selling + fiscal stimulus funding at the same time) was baked into the epic net short spec positioning in treasuries … a position which, incidentally, got less short (again) by 34,234 contracts in the past week to a new post-election low as the market increasingly un-factor’s in stuff.
We've talked about aliens recurrently also and I'm pretty sure we’d start with a conservative approach should we encounter them but that doesn't mean aliens are “factored in”.
Anyway, I think the point is obvious. The contention that 3 years of long bond supply hitting the market is already & unequivocally priced in sits somewhere along the analytical malfeasance spectrum.
Back to the Global Macro Grind…
Was -60k in Retail Jobs in Feb/March factored in?
It had to be, right?
I mean even if you've been living under a cardboard box the last 6 months, you know half the story. After all, that box was probably built by Bezos and has a smile on the side.
Just in case, the layman’s version - which is pretty much the real, institutional version also - is this:
- Amazon is taking over the world
- Retail is uninvestible
- Brick & Mortar is dead and commercial real estate is at acute risk
And the extended, bearish macro version goes: If the retail apocalypse crescendos it could have significant multiplier effects. And if oil supply continues to ramp, demand underwhelms and commodity deflation happens to re-emerge at the same time, then all-time tights in credit spreads will be forced to take notice and equities are unlikely to sit passively and Panglossian’ly by.
Fortunately, Brian McGough and our Retail Team have been all over this Theme for months now.
In fact, their most recent blackbook, Retail 5.0, was an analytical and contextualization juggernaut, in my non-objective opinion.
This morning, I’ll supply a selection of seductive morsels on What.
For the Why, How, & Who wins/loses you’ll have to talk to Brian or tune into their follow up call on the theme later this month.
Some Background & Defining moments:
- Since 1858 and the opening of the 1st Macy's there have been four principal evolutions in retail. Broadly, the processional flow is as follows:
- Retail 1.0 (1) : The birth of Mom & Pop’s
- Retail 2.0 (1): The rise of the Chain Store
- Retail 3.0 (1): The rise of the regional mall and the 100-Year lease
- Retail 4.0 (1): The rise of the Strip Center and off-price channel
- 1972: Blue Ribbon Sports rebranded to Nike and in so doing ushered in the outsourcing/offshoring model.
- 1994: The progressive lifting of import quota’s catalyzed a multi decade period of price deflation and rising per capital consumption of apparel and served as the principal driver of department store disintermediation. (see McGough’s Early Look: Consumption Paradigm for more)
You know that period of anticipatory dread between when you drop something on your foot and when it actually starts to hurt?
The last couple quarters in Retail have been kind of like that as chapter 11 filings and announced store closures have ramped while economists/analysts have waited for signs of pain to run through the real economy.
The What: Creative Destruction and the Transition to Retail 5.0
- Past Peak: Velocity is decelerating as that multi-decade, ‘lift-all-boats’ tide of price deflation and growth in per capita consumption of apparel is now past peak and inflecting negatively.
- Sink-all-Boats: It’s not improbable that returns on net operating assets for the retail industry falls from the mid-twenties to single digits. That’s uninvestible, but not if you can short.
- Industry Idiosyncratic: Retail Bankruptcies are accelerating to all time high levels, while US GDP growth is strengthening. The problems are primarily industry specific and we expect this trend to continue accelerating.
- Minority Report: 20% of today’s companies are likely to account for 90% of tomorrow’s market cap. M&A will ramp and the-impossible-deal will become increasingly probable.
- Messin’ with Sasquatch: there’s going to be a Big (square) Footage problem. Consensus is underestimating the square footage equivalent associated with e-commerce and 13.6bn in current square footage is likely to grow to 26bn. One consequence … roughly half the existing strip malls probably go away
- Having & Eating Cake: Amazon probably emerges as the new anchor tenant in a new archetypical brick & mortar configuration … and probably gets paid to do it.
The larger reality is that no one really knows how this plays out.
But history’s lesson is that, from a research alpha perspective, you’ll have to think outside the box while consensus continues to play hopscotch. As our retail team put it, The Box Consensus Is Sitting In May Become a Coffin.
One last thing.
Somewhat drowned out in Friday’s newsflow was the late afternoon release on Consumer Credit for February.
Total consumer credit accelerated to +6.31% YoY while revolving credit growth accelerated +20bps sequentially to +6.2% YoY.
That gain has household consumption capacity (which we’re defining as aggregate private sector wages + revolving Credit, YoY) tracking at +5.5% YoY in 1Q, marking the fastest pace in 7 quarters.
For sure, household consumption has been underwhelming in Jan/Feb as a rising savings rate, weather and a higher deflator all weighed on real spending growth but it’s difficult to characterize accelerating income growth and improving household spending capacity as a negative fundamental development.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.33-2.46%
SPX 2
NASDAQ 5
Nikkei 185
DAX 12117-12356
VIX 11.00-13.31
EUR/USD 1.05-1.07
Copper 2.59-2.69
Best of luck out there this week,
Christian B. Drake
U.S. Macro analyst
