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R3: Discount Rate v. Margins v. Stocks


February 22, 2010


The market seems to be suggesting that underlying fundamental strength will be there to support margins, and subsequently the stocks.  That might be the case. But it has to be the case for the group to outperform, and perhaps even to tread water.





The only thing that has moved higher and faster than margin expectations ahead of the hike in the discount rate has been the retail group itself. Here’s some recent historical context around movement in retail stocks around changes in the discount rate. Mid-04 through mid-06 is probably the best example, as that period shows the systematic rise in rates. It was textbook, actually. The consumer was healthy, industry margin tailwinds were strong, and earnings largely kept trudging higher. Over that time period, we had consensus margin expectations in retail rise by 3 points (from 10.2% to 13.2%).


What do we have now?  Margins have collapsed, and some of these reasons go beyond the simple economic climate. There are several reasons related to sourcing that should make that low-teens margin rate unattainable for a long, long time. Since the March 9 low, the MVR is up 133%, and margin expectations have accelerated by 3.3 points to 9.4%. That’s the largest 1-year boost in expectations in at least 20 years.


The point here is that the market seems to be suggesting that underlying fundamental strength will be there to support margins, and subsequently the stocks.   That might be the case. But it HAS TO be the case for the group to outperform, and perhaps even to tread water.


R3: Discount Rate v. Margins v. Stocks - 1


R3: Discount Rate v. Margins v. Stocks - 2




  • In what is sure to be viewed as a controversial merchandising move, Sears has decided to sell its coveted Craftsman tool brand outside of its own stores.  Late Friday, Ace Hardware announced it will begin selling Craftsman products in 100 doors.  By June, 4,500 Ace stores will have the opportunity to the also carry the brand.  This marks the first time that Sears is experimenting with selling its most coveted brand in a wholesale manner.  We wonder how long it will be before we see Kenmore and DieHard showing up at other retailers as well…
  • While most retailers and manufacturers have begun to note cost pressures building out of Asia for the back half of 2010, JC Penney is still expecting to see year over year declines.  As a result of the company’s extensive sourcing network, and longer lead times, management expect to see cost savings continue throughout the year, albeit a bit more muted in the back half.  Cost of goods savings coupled with tight inventory management and substantial reductions in clearance activity were the key drivers in JC Penney’s reporting of its highest gross margins in 100 years for the year just completed.
  • Good news for US Ski Team Sponsor, Under Armour.  Through February 15th, Freestyle and Downhill skiing topped the list of most watched Olympic events, ranking 1 and 2 respectively.  An average of 26.9 million viewers tuned in for the Freestyle events on opening weekend according to Neilsen.  
  • Olympic merchandise sales in Vancouver have already hit their goal of about $50 million in sales and that’s with about 50% more events to go.  In some cases, retailers have decided to stay open 24 hours in the host city to meet demand and to help alleviate long lines.  Sales of official merchandise in Torino were only about $23 million, far less than this year’s expected total. 
  • The IOC is struggling to monitor ambush marketing in Vancouver whereby companies that have not paid for sponsorship rights are tying their products to the Olympic Games. Among brands mentioned in recent articles is Canadian favorite Lululemon, which is selling red and white mittens that resemble the wildly popular “official” mittens that have now sold over 1million pair. While publicly badmouthing the company for trying to profit without supporting the Games, the Vancouver Olympic Committee (VANOC) failed to mention that the company actually lobbied to be an official sponsor, but lost out to The Hudson’s Bay Company. Oh, and they’ve also hosted over 200 athletes and their families at the “Lululemon House” near the athlete’s village over the past year during their training for the Games – sounds like athletes aren’t the only ones in need of a reminder on the merits of sportsmanship. 




EBay to Launch New Selling Formats, Boost Fashion Quotient - EBay Inc. moves more apparel online than any other company. Yet that’s simply not enough for the giant Web site. In March, eBay will launch “the fashion vault” for “flash” sales of designer goods in a format not dissimilar from that of Web sites Gilt Groupe and Ideeli. Hugo Boss, DKNY, Max Mara and Cole Haan Outerwear were tested last year and there’s a good chance they’ll be seen on the fashion vault again. Initially, there will be weekly flashes, but the frequency will increase in subsequent months. EBay also is creating an online outlet mall for the U.S. with some well-known retail and apparel brands. Lord & Taylor’s outlet division is already on board and Brooks Brothers will be added next month. More brands and stores are seen joining, as they have in Europe, where eBay operates extensive outlet sites, such as in the U.K. with 16 stores including Debenhams, House of Fraser and Schuh, and in Germany, with 24 branded apparel shops including Eastpak, Fila, Speedo and Triumph. <wwd.com>


Carrefour to Revamp Apparel Division - Carrefour SA, the world’s second-largest retailer behind Wal-Mart Stores Inc., will radically overhaul its apparel division as part of a revamp of its hypermarket operations in France, chief executive officer Lars Olofsson said Friday. “We will have to change our textile [business] quite dramatically. We will have to inverse basically what we’re doing,” Olofsson told analysts and journalists. His statements came a day after Wal-Mart revealed it was re-evaluating its entire apparel merchandising strategy after a disappointing performance. Reporting full-year 2009 results, Carrefour said net income fell 74.2 percent as it absorbed more than 1 billion euros in nonrecurring impairment and restructuring charges. Since his arrival one year ago, Olofsson has implemented measures to cut costs and improve the retailer’s price image. Last month, he appointed former Tesco executive James McCann as executive director for France, charged with tackling underperforming hypermarkets in its home market, which accounts for 40 percent of the group’s sales. Olofsson said Carrefour’s new apparel direction would start taking shape in 2011 or 2012, and likely shift from its current purchasing model toward a shorter cycle, placing Carrefour in competition with fast-fashion retailers like Sweden’s H&M and Spain’s Inditex, operator of the Zara chain. <wwd.com>


Lucy Activewear Moving HQ From Portland to San Francisco Area - Lucy Activewear is moving its headquarters from Portland to the San Francisco Bay Area to be in closer proximity to its Outdoor Coalition offices and resources. VF Corp., the parent of lucy, said approximately 82 positions will be eliminated. VF will be relocating lucy's offices to Northern California at the end of August. In addition, the brand's primary distribution facility, also located in Portland, will be merged into VF's Outdoor distribution center in Visalia, Ca. during the first quarter of 2011. In a statement, VF said one dozen of the approximately 95 Lucy associates based in Portland will be offered the opportunity to relocate to California. VF reassigned lucy from its Contemporary Coalition, which includes 7 for All Mankind, Ellas Moss and Splendid, to its Outdoor Coalition this past fall to leverage that division's expertise in technical performance. VF's Outdoor Coalition also includes The North Face, Vans, Reef, Napapijri, Kipling, JanSport, Eastpak and Eagle Creek. The offices of The North Face and Jansport, among others, are in San Leandro. The move also comes as VF took a $114.4 million after-tax impairment charge in the fourth quarter because results for lucy, Nautica, and Reef were below the company's expectations since the time each was acquired. The charge reflected the devaluation of goodwill and intangible assets since each acquisition.  <sportsonesource.com>


New CompUSA Integrates Ecommerce Site Into Retail Stores - CompUSA went out of business in 2007, but now is under new management that is experimenting with a hybrid concept dubbed Retail 2.0, which integrates their ecommerce site into their retail stores. The online shopping experience at an ecommerce site is becoming increasingly comfortable to most consumers, so CompUSA decided to enhance their retail stores with easy access to a retail site via their computers so they can research products. This new way to shop in a retail store, empowers consumers to take control and learn the product details they want quickly by using one of the touch computer screens in the shop. There are roughly 30 CompUSA stores in the U.S. which are testing this Retail 2.0 model, which now takes a lot of stress off of the staff to provide customer service.  <zippycart.com>


Burlington Coat Told to Pay Fendi $4.7M - A federal judge ordered Burlington Coat Factory Warehouse Corp. to pay Fendi $4.7 million for violating a decades-old injunction barring the off-pricer from selling the luxury brand’s trademarked goods without permission. The retailer agreed to the prohibition in 1987 to settle charges that it sold fake Fendi products. Fendi North America Inc., the brand’s U.S. unit, filed a new infringement lawsuit in 2006 accusing Burlington Coat of continuing to sell counterfeit handbags. U.S. District Court Judge Leonard Sand in Manhattan on Feb. 8 granted Fendi’s motion for summary judgment in the latest case. Sand adopted a December report and recommendation from U.S. Magistrate Judge Michael Dolinger that required the off-pricer to pay $4.7 million to Fendi for being found in contempt of the injunction. The sum includes $2.5 million in profits, $1.6 million in interest and more than $540,000 in attorneys’ fees. A Burlington Coat representative said Friday the company will appeal the decision and declined further comment. Bain Capital Partners acquired the retailer and took it private in 2006 for $2.06 billion.  <wwd.com>


Credit cards are losing some luster with online shoppers - Online shoppers have increasingly turned to prepaid, gift and debit cards, along with so-called alternative payments such as PayPal and Google Checkout, according to new research from Javelin Strategy & Research. Credit cards remain the preferred payment method for online shoppers, capturing 43.5% of the online total payments volume in 2009, Javelin says. The research firm estimates that consumers spent $205 billion online in 2009. The share of credit card payments, however, will decline to 39.4% in 2014, Javelin predicts. Debit cards also will represent a smaller share of online payments, declining to 25.6% in 2014 from 28% in 2009. Meanwhile, prepaid and gift cards will account for 10.7% of online payments by 2014, up from 6.6% in 2009, while PayPal, Google Checkout and other alternative payment methods will capture 19.2% of online purchases in 2014, up from 15.9% in 2009. The remainder, about 5%, will come from store-branded credit cards. By 2014, prepaid and gift cards will have the highest compound annual growth rate for online payment forms between 2009 and 2014—26%. “Prepaid and gift cards are hitting stride in the online payments environment,” says Javelin analyst Elizabeth Robertson. A large part of the reason for the growth of non-credit card payments is that consumers, shaken by the recession and high debt loads, have switched to more immediate methods of payments rather than credit card borrowing. <internetretailer.com>


Young and well-educated consumers are likely to go online before a purchase - 46% of consumers with a college degree say that they use a search engine before making an online purchase, and the percentage rises to 50% among consumers between the ages of 25 and 34, Opinion Research Corp. says in a recent study it conducted for digital advertising firm ARAnet. That compares to 39% of all respondents. The survey also found that adults between the ages of 25 to 34 and those with college degrees are also more likely to read an article online or consult social media before making a purchase. Following are information sources cited as important to consider before making a purchase by all respondents, adults ages 25 to 34, and those with a college degree:

  • Search engine: 39%, 50%, 46%
  • Articles read online: 28%, 39%, 36%
  • Marketing e-mail: 20%, 32%, 26%
  • Online ads: 19%, 30%, 25%,
  • Social networks: 18%, 31%, 23%

Opinion Research conducted the study of 1,029 adults in January. <internetretailer.com>  


Malcolm Knapp reported January same-store sales and traffic results of -2.3% and -2.8%, respectively.  For same-store sales, this represents a decline of 3.2% on a two-year average basis, which marks a significant improvement from December’s two-year number of -7.0%.  The traffic number shows a clear improvement in trends as well; traffic improved 330 bps from December 2009 on a two-year basis.  As Knapp points out, January trends benefited from New Year’s Eve falling in the first week, the super bowl shift into February this year, and the increased redemption rate of gift cards during the month.


January was the second month in a row where comparable store sales exceeded guest counts.  From May through November 2009, largely due to heavy discounting, guest counts had exceeded comparable store sales. 


There has been a surge in consumer confidence from January 2009; as Knapp notes, the January 2010 Consumer Conference Index is up 18.5 points compared to a year ago.   However, consumer spending is not reflecting this turnaround.  High unemployment, combined with the increasing savings rate and inflationary headwinds (especially at the pump), is taking share of wallet from consumer discretionary companies.  However, as PFCB management has noted recently, “expense account” corporate spending may be improving and providing a boost to higher-end casual dining trends.



Howard Penney

Managing Director


The Macau Metro Monitor, February 22nd, 2010


CNY PASSENGERS SLIGHTLY HIGHER YOY macaodaily.com                                                          

 2.33MM passengers, slightly higher than the 2.27MM passengers last CNY, passed through the Macau border gates from the start of the Chinese New Year to Saturday, Feb 20th. Border crossing control improvements and an increased number of ports helped deal with a larger immigration crowd.


GAMING TAX RECEIPTS SOAR macaubusiness.com

According to the Financial Services Bureau, direct gaming tax receipts for January 2010 rose 45.9% to MOP4.3BN. The receipts accounted for 85.3% of total government revenue.



Macau’s Gaming Commission recently got a makeover with the appointment of new members to the posts of  Secretary for Administration and Justice, Secretary for Transport and Public Works, the head and also a representative from the Chief Executive's Office, The Secretary for Social Affairs and Culture and the commissioner of Legal Affairs with the former Gaming Commission, Jorge Oliveira, are out are out of the new bureau.


The new commission will “do more besides grant licenses”  and become less gaming-oriented in order “to solve conflicts that have emerged with the boom of the gaming industry”.  The new commission will be more transparent around issues like land granting procedures to casino operators.

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

Learning Fast

“The ability to learn faster than your competitors may be only sustainable competitive advantage.”
-Arie de Geus


De Geus was a global macro man, of sorts. Born in Holland, he worked for Royal Dutch/Shell for his entire career (1) and was head of Shell Oil’s Strategic Planning Group. “The ability to learn faster than your competition” is a great way to think about what a global risk manager is tasked with every day.


Last week, I learned a lot about what one of our Top 3 Macro Themes for Q1 of 2010, Rate Run-up, might mean for global market risk. While my short US Treasuries (IEF), long US Dollar (UUP), position had another solid week, I ended up being way too light on my US Equity exposure.


Currently, I have only a 3% position in our Asset Allocation Model to US Equities. In a week where the SP500 was up +3.2%, and I was short the SPY (SP500 ETF) for -1.25% of that move, that made me wrong in that position.


While I was never in the camp that a Buck Breakout or a Rate Run-up were going to make the stock market crash, I was most definitely getting out of the way of what I thought would remain a credible, short term, marked-to-market fear. For now, the US stock market’s fears about the Fed raising the Discount Rate have proven to be fleeting.


The US Treasury market continues to see this differently - government bonds continue to sell off this morning. With 2-year yields trading up at 0.91%, the short end of the curve is breaking out from an intermediate term TREND perspective. Meanwhile, the long end of the yield curve continues to make a series of higher-lows and higher-highs. Intermediate term TREND line support for 10-year yields is down at 3.59%, so this morning’s yield of 3.79% is comfortably higher than that.


At +288 basis points wide, the spread between 10 and 2-year yields is within 2 basis points of its widest spread ever this morning. Ever, as we macro people like to say, is a very long time. Yes, even longer than 50 years, which is what Team USA ended last night with their respectable Olympic win against my homeland on the ice.


Our Hedgeyes affectionately refer to this 10’s to 2’s spread as the Piggy Banker Spread. That spread is the best way to measure the US Government’s choice to capitalize the profits of bankers rather than incomes for Americans with US Savings accounts. How long Washington can politicize and compromise the rate of return on your hard earned nest egg is up to the politicians, I guess. It may be sad, but it’s great for those preferred borrowers while they can get it.


This is obviously great for bankers looking to finance large M&A transactions with debt. Great, that is, until it isn’t. The ghost of the 2007 levered-loan market is back, and it will be interesting to watch corporate junk spreads trade in the coming weeks as volumes come back to the marketplace.


We’ve already seen 16 corporate bond deals and 15 IPOs pulled in the last month as interest rates have backed up. So the piggies who have been eating at the trough of a government sponsored spread are at least wavering. That said, if Bernanke panders in Washington this week (he testifies in front of Congress), there is no telling how hog wild the reflation trade can go again.


In the meantime, you don’t have to learn fast to understand this: $80/oil and $3.34/copper prices this morning are inflationary. Year-over-year US inflation growth is currently running up +3-5%, not including last week’s commodity price spike (CRB Commodities Index was +3.7% week-over-week).


Markets look forward, and maybe that’s exactly what the US stock market did after taking a good hard and long look at the SP500 futures trading down 10 handles on Thursday night. Maybe, just maybe, Mr. Macro Market is getting quite good at proactively predicting a Fed that panders to Japanese style political winds.


Markets don’t lie; people do. And I for one am not going to wake-up on this Monday morning pretending I don’t need to take up my long position in both individual US stocks and my US Equity asset allocation; particularly if we go back to a daily macro grind of politicians pretending there is no inflation in America. There remains a Bubble in US Politics that we have to manage risk around.


My intermediate term TREND line of resistance for the SP500 was eclipsed to the upside late last week. At 1099, now that’s a very important line of support. I have immediate term TRADE resistance up at 1119. Keep learning fast and manage the risks embedded in this improving stock market range.


Best of luck out there today,




XLK – SPDR Technology — We bought back Tech after a healthy 2-day pullback on 1/7/10.


UUP – PowerShares US Dollar Index Fund — We bought the USD Fund on 1/4/10 as an explicit way to represent our Q1 2010 Macro Theme that we have labeled Buck Breakout (we were bearish on the USD in ’09).

CYB - WisdomTree Dreyfus Chinese Yuan — The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.

TIP - iShares TIPS — The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield. We believe that future inflation expectations are mispriced and that TIPS are a efficient way to own yield on an inflation protected basis.



EWU – iShares United KingdomThe TREND of higher y/y inflation and stagnant growth = stagflation. For a country with the UK's balance sheet and leadership problems, that’s not good.


SPY – SPDR S&P 500We re-shorted the SP500 at an attractive re-entry point on 2/16/10. We are bearish on US Equities for the immediate term from this price. Shorting green.


XLE – SPDR EnergyWe remain bearish on Oil for the intermediate term TREND and bullish on the US Dollar on the same duration. Everything has a time and a price.


GLD – SPDR Gold We re-shorted Gold on this dead cat bounce on 2/11/10. We remain bullish on a Buck Breakout and bearish on Gold for Q1 of 2010, as a result.


RSX – Market Vectors RussiaWe shorted Russia on 2/9/10 and maintain our intermediate term TREND bearish view on the price of oil.


XLP – SPDR Consumer StaplesThe Consumer Staples sector finally broke both our TRADE and TREND lines on 2/8/10. Given how many investors own these stocks because it was a "way to play the weak US Dollar" last year, we have ourselves another way to profit from a Buck Breakout with this short position.


EWJ – iShares JapanWe re-shorted Japan on 2/2/10 after the Nikkei’s up move of +1.6%. Japan's sovereign debt problems make Greece's look benign.


IEF – iShares 7-10 Year TreasuryOne of our Macro Themes for Q1 of 2010 is "Rate Run-up". Our bearish view on US Treasuries is implied.

US STRATEGY - By the Charts

US STRATEGY - By the Charts - sp1


US STRATEGY - By the Charts - usd2


US STRATEGY - By the Charts - vix3


US STRATEGY - By the Charts - oil4


US STRATEGY - By the Charts - gold5


US STRATEGY - By the Charts - copper6

UA: Playing the Olympics Like a Champ

The Winter Olympics is traditionally a big blown-out non-event in the world of sports marketing. Yes, brands make noise about their innovations and new product. But let’s face some facts, most people don’t walk the Streets wearing those luge unitards.


Under Armour is the exception as it relates to brand impact, however. Why? Three of the many holes in its portfolio it has yet to fill are 1) International, 2) Higher-end cold weather outerwear, and 3) Women.  This event gave a lay-up opportunity to show the world that it’s not just a US football brand, and UA soared over a few defenders’ heads and jammed it.


Under Armour is taking full advantage of the 2010 Vancouver Winter Olympics through its official, unofficial, and individual sponsorships.  The ground work was laid in 2002 when UA joined the U.S. Ski Team as a supplier and has blossomed into high profile coverage through official sponsorships of the U.S. Freestyle Ski Team (aerials, moguls, and ski cross), U.S. Bobsled Team, U.S. Skeleton Team, and the Canadian Curling Teams (as an FYI, Curling in Canada is second only to Hockey as a National pastime). 


UA’s unofficial sponsorship can be seen underneath the outerwear with its performance base layers that are worn by most of the US athletes on the slopes.  If you’re watching the games, chances are that you noticed.  I’d argue that this trumps individual sponsorships in this instance. But Under Armour has also invested around cross-over athletes like Lindsey Vonn.  UA compared Vonn’s potential at the Winter Olympics of winning 5 gold medals to Michael Phelps amazing accomplishments of 8 gold medals at the 2008 Summer Games. That’s a bit of a stretch, but heck, UA endorsed Phelps last week last week, so even if they are wrong that still have the Big Man.  


Why Vonn and Phelps?  In the end, the athletes need to either win, but really, they need to capture the hearts and minds of viewers around the world. One of the more powerful ways to do this is by partnering with athletes with broad crossover appeal. By ‘crossover appeal’ I mean Vonn making it into the swimsuit issue of Sports Illustrated (see below), and Phelps endorsing UA’s product for purposes nothing having to do with water – but simply the training apparel/footwear to help him build form. This is also akin to someone like Maria Sharapova for Nike (who has been on the cover of SI and Vogue in the same month), where no one can justify the investment on tennis sales alone, but across a much broader product set.


Under Armour downplayed the impact of the Winter Olympics on their 4Q call and only mentioned it as a small opportunity to be seen as a global player. Our sense is that they fully baked this in to their SG&A guidance, but lowballed revenue opportunity as well as the longer-term brand implications.


See stats below for the market opportunity for UA in the Ski/Snowboard outerwear market. Its current share is sitting between 1-2%. Yes, that’s almost as small as its footwear market share. Big opportunity.


On a related note…Under Armour won the seventh Doc DesRoches Award (other winners include Rossignol, Spyder, and SmartWool) for recognition as an SIA member and U.S. Ski Team supplier for its promotion of the Team's brand and athletes. Under Armour was acknowledged for the national print and TV campaign around World Champion Lindsey Vonn. Check out the commercial: http://www.theskichannel.com/news/skinews/20100131/Lindsey-Vonn-Under-Armour-commercial-wins-Doc-DesRoches-Award-at-SIA.


Zach Brown


Hedgeye Retail 


UA: Playing the Olympics Like a Champ - Endorsements image 1


UA: Playing the Olympics Like a Champ - Endorsements image 2


UA: Playing the Olympics Like a Champ - Lindsey Vonn


UA: Playing the Olympics Like a Champ - Snow Market Size


UA: Playing the Olympics Like a Champ - US Winter Olympics UA Team


UA: Playing the Olympics Like a Champ - US Ski Team Website honoring UA


UA: Playing the Olympics Like a Champ - UA Webstie Image Shot