High vs. Low Society

“We took a perfectly useless psychopath like Valentine, and turned him into a successful executive. And during the same time, we turned an honest, hard-working man into a violently, deranged, would-be killer! Now, what are we going to do about taking Winthorpe back and returning Valentine to the ghetto?”

-Randolph Duke from the movie Trading Places 


When thinking about some of the topics that have been discussed in our morning meeting recently, the topic of a HIGH vs. LOW society has come up several times.  I joked that it’s like working at Hedgeye Risk Management where you have the Ivy League educated vs. everyone else.  All kidding aside, as a firm, we have some of the most talented young people working at Hedgeye, thanks to our ties with Yale University. 


That being said, the first thing I think of when talking about the HIGH vs. LOW society is the highly entertaining movie Trading Places.  (Sadly, our talented young group from Yale is too young to remember the movie.)  The storyline is that of a HIGH vs. LOW society and the movie has been called a modern take on Mark Twain's classic 19th century novel The Prince and the Pauper.


Fast forward to yesterday’s press briefing by White House Press Secretary Robert Gibbs and Treasury Secretary Tim Geithner; Mr. Gibbs commented that the market is going up because of Obama’s Administrative policies.  Mr. Gibbs is correct to a degree, and Mr. Obama gets full credit for the market’s performance under his term as president.  In fact, the President even gets credit for calling the bottom in the market when on March 3rd he offered some advice on the market saying stocks are "potentially a good deal for those willing to think long term.”  Great call!


Obama’s policies have created a V-shaped recovery and a 78% return in the market since he nearly called the bottom perfectly.  In many respects, his policies have created this HIGH vs. LOW society which might be very difficult to get out from under.


Yesterday, the S&P 500 rallied 1.1% (now up 8.6% YTD) on the back of the earnings calendar, with better-than-expected results out of the Financials (XLF - up 18.4% YTD) and Technology (XLK - up 4.4% YTD).  The Financials led the way yesterday, thanks to JP Morgan, and is the most striking example of the HIGH vs. LOW society.  


FOOD STAMPS VS PIGGY BANKERS SPREAD - The most recent statistics from the NY Times are that one in eight Americans rely on food stamps; one in four children in the United States rely on food stamps; and one in 50 Americans live on nothing but food stamps.  Contrast those disturbing facts against JPM’s reported earnings, which is a company that is printing money because of the Piggy Banker Spread.


To quote the CEO of JPM - “China’s growing, India’s growing, Japan is growing, home prices have stopped going down, consumers income is up, consumers are spending, service and manufacturing indexes are up, inventories are still low, I could go on and on.”  Yet, according to the FED, we still have the need for interest rates to stay at exceptionally low levels.     


President Obama’s campaign promised “Change” and to help the middle class.  Unfortunately, his policies that have helped drive the V shape recovery in the S&P 500 are only making the rich feel richer.


RICH vs. POOR - Back in early 2009, the spread in confidence levels, as measured by the Conference Board, between those people making more than $50,000 per year and those making less than $15,000 was 2 points.  As of the most recent reading the spread stands at 17 points.  


YOUNG vs. OLD - The Millennials were often cited as a strong political force that helped the Obama administration get elected.  It’s also the Millennials that are being hurt the most by the current recession.  Unemployment levels among the youngest demographic of our society stand at 25% versus 9.7% for the national average.    


BULLISH BEARISH SURVEY vs. CONSUMER CONFIDENCE - The most recent Institutional Investor survey shows one of the widest spreads between “bulls” and “bears” since 2007.  This, contrasted against the most recent ABC consumer confidence index, which fell to -47 in the week ending April 11, down 4 points from a week earlier, highlights the Wall Street vs. Main Street disconnect.  As an aside, today it was reported that the UK Nationwide consumer confidence fell to 72 in March vs. 81 in February.  We are not alone!


We have a chart book of MACRO data points that has only one relevant shape to describe the current economic recovery and that is a V and the signs of “over stimulation” continue.  China’s economic growth accelerated to the fastest pace in almost three years in 1Q10 - GDP rose 11.9%.  The market reaction to the news was muted as the case for continued policy tightening is clear.   


We are short the S&P 500 and "fighting the Fed" which makes us wrong, for now.  Right now, it’s more prudent to manage risk around the excessive stimulus measures that are unsustainable and inflationary.


As for Billy Ray Valentine and Louis Winthorpe III - they're not just getting rich... They're getting even!


Function in disaster; finish in style


Howard Penney

Managing Director


High vs. Low Society - ABC Piggy



Well not quite an elephant but Cosmopolitan may be IGT’s 2nd SBG property.



Finally, a positive catalyst emerges for IGT.  We think IGT may have landed a contract with Cosmopolitan to provide Server Based Gaming (SBG) across the property.  While probably not material in terms of financial contribution and it won’t hit until IGT’s FY2011, this should be considered a positive from a sentiment perspective.


IGT’s first SBG property, MGM’s Aria, opened in December.  IGT received a one-time payment of roughly $6 million for the system hardware and is essentially providing a free two year trial of its SB software.  Not bad from MGM’s perspective.  We believe the Cosmopolitan deal could be similar.  IGT should also procure a 50-55% market share at Cosmopolitan, similar to that at Aria and above its recent 35% ship share.  This is also good news for IGT.


A few other slot supplier tidbits:

  • IGT has a promising new application for SB called Random Riches whereby if a player bets X ($$'s/lines/etc) they know they will get Y (ie bonus rounds/ spins/ etc) thereby extending the time on device
  • SB Window for legacy games was a defense move against iVIEW DM (Pechanga for example)
  • WMS has submitted their operating system that would allow them to go SB at Aria.  Issue is that their games aren’t performing very well now because they have a limited library that has been approved….. since they built SB into all the games – it’s a slow process for them
  • BYI still has 5 outstanding issues to get compliant with SB but should get there by year end - moving but moving slowly.  Their games are performing well at Aria

A Tale of Two Commodities

Yesterday we added a long position in oil to our portfolio and gave a brief synopsis of the investment thesis in a follow-up research note.  The primary bullish factor in the longer term for oil, as we noted yesterday, is supply.  Global supply is constrained by almost any measure.  Some argue that Goldman Sachs manipulates the price (we heard this the other day), and maybe these pundits are correct, but the reality remains that there are serious supply issues globally for oil based on the current normalized demand picture.


Conversely, natural gas is exactly the opposite scenario.  The primary issue facing natural case pricing in the United States is natural gas supply.  Natural gas is primarily a local market, and therefore priced locally, with the swing factor being the increasing global supply of LNG (liquefied natural gas). 


Domestically in the United States, natural gas storage is well above the 5-year average.  In fact, as of the most recent report from the Energy Information Administration, natural gas in storage in the United States is 12 percent above the 5-year average.


Interestingly, the EIA expects natural gas consumption to increase 1.9% year-over-year in 2010.  In contrast, the current pace of production growth over the past six months has averaged 4.4%.  Needless to say, the combination of above average gas in storage with production growth outstripping projected demand, will be bearish for the price of natural gas.


LNG will also create a bearish overhang on the price of natural gas in 2010.  By some estimates, a 1% change in global liquefaction impacts global supplies by approximately 360 mmcf/d.  According to the IEA, from a mid-2009 report, LNG supply globally will increase by 50% between 2009 and 2013.  This will be a massive increase in supply, with the marginal amount being exported into the United States.


Below we’ve charted the price performance between oil and natural gas in the year-to-date, and the bifurcation is very clear.  We would expect the next couple of quarters to continue to be A Tale of Two Commodities.


Daryl G. Jones

Managing Director


A Tale of Two Commodities - Oil vs Nat Gas


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Nike Outperforms During Modest Slowdown in Sports Apparel Industry

Nike Outperforms During Modest Slowdown in Sports Apparel Industry    


Sports apparel sales slowed modestly after last week’s surge. NKE stands out as a clear outperformer as the only company that grew sales on a sequential basis.



This week’s industry data reflects a modest slowdown in sports apparel with total industry sales up 3.9% vs. the 5.7% increase last week. Weakness was driven by a deceleration in the Athletic Specialty channel, which slowed from 15.8% to 10.8% while both Discount/Mass and Family retailers improved on the margin. At the same time we continue to see a divergence of ASP trends in the athletic specialty and family channels.  Both Mid-Atlantic and South-Atlantic regions had a strong week backed by warmer weather while portions of Mid-West experienced more precipitation than normal hampering sales.


Nike stands out as the clear outperformer for the week as the only company that grew sales sequentially accelerating share gains from 460 bps to 560 bps y/y driven by basketball and running.  Outdoor and outerwear categories dropped off this week and significantly dropped Columbia and TNF’s sales growth rates.


Nike Outperforms During Modest Slowdown in Sports Apparel Industry     - 1


Nike Outperforms During Modest Slowdown in Sports Apparel Industry     - 2


Nike Outperforms During Modest Slowdown in Sports Apparel Industry     - 3


Nike Outperforms During Modest Slowdown in Sports Apparel Industry     - 4


Nike Outperforms During Modest Slowdown in Sports Apparel Industry     - 5


Nike Outperforms During Modest Slowdown in Sports Apparel Industry     - Weather Maps

Inflation: Reality's Illusion

The stock market bulls cannot get into my inbox fast enough this morning. Bernanke hasn’t raised rates since 2006 and they are cheering him on to keep a Japanese status quo. My inbox is usually a contrarian indicator. A hope that Americans aren’t experiencing an accelerating rate of inflation right now remains just that – a hope.


Rather than trust the data in the calculation of headline CPI (the government has numbed it down 9x since 1996), let’s look at both the absolute level of the government’s conflicted and compromised report (relative to itself) and the components of the calculation (without weighting them to the government’s benefit).


  1. Headline CPI accelerated sequentially (month over month) from +2.1% last month to +2.3% - that, on it’s own, is inflationary
  2. The Medicare and Education components were up a lot more than the Index, moving to +3.7% and +4.9% year-over-year, respectively
  3. Owner’s Equivalent Rent (which composes 40% of the Index) was down -0.1% sequentially and completely toned down the broad inflation in the report


So, what to do with in an America where the government tells you there is no inflation when there is? Assuming you live in DC and have a full medical plan and you don’t use gas in your car, eat, or have kids who go to school, you probably call this conflicted CPI report goldilocks. That’s just plain sad and that also speaks to the high-low society that this very wealthy nation is willing to continue to perpetuate. One out of every four children in America now eats off of food stamps.


There was a day when Bernanke was, in theory, “data dependent”; but that was as silly as the ideologies that Greenspan espoused. If these people didn’t see the inflation that you can see in this chart in 2008 (on their own compromised calculation), don’t expect them not to be willfully blind to it this time around.


The divergence between the Institutional Investor Survey (a contrarian indicator) and the ABC/Washington Post consumer confidence reading this morning is striking, but it makes sense. Americans aren’t stupid. Inflation is here until the Fed tones it down by raising interest rates.



Keith R. McCullough
Chief Executive Officer


Inflation: Reality's Illusion - US CPI

R3: Don’t Forget About Levi’s


April 14, 2010





Most equity analysts skip the Levi Strauss conference call in favor of letting their fixed income peers do the dirty work.  And while there’s no equity to trade here for one of the world’s largest apparel companies, there’s actually some interesting commentary.  There were two big takeaway’s from the company’s FQ1 results.  First, it is clear that a recovery is underway for the global denim maker.  This was evident with the company reporting positive sales trends across all three of its major geographic regions- the first time we’ve seen this in five quarters.   Secondly, Levi’s is extremely focused and dedicated to investing in its two major brands- core Levi’s and Dockers.  This year and likely next will be major investment years for marketing and in-store brand presentation.  This will directly impact SG&A and is a 100% offensive move to grow market share and resurrect Dockers.  Our immediate reaction here is to turn to VF Corp and its denim business.  Could this be the beginning of some sort of mass-market denim war?  Probably not, but we’re watching closely to see how VF Corp plans to defend its share in the wake of a meaningful and sustained step-up in marketing activity from the company’s primary competitor.


- For the first time in five quarters, all major regions of Levi’s business trended in positive territory.  Strength was driven by a continued improvement in the core business, coupled with incremental sales from recently acquired outlet stores.  Areas of weakness included Docker’s in the U.S (now stable but still down) and the company’s Signature brand at Wal-Mart.  Asia continues to benefit from expansion initiatives in China and India.  Management also noted that is saw domestic strength in its more fashion-forward jr’s categories.


- The company is pursuing a meaningful step up in advertising and in-store marketing for both its core Levi’s brand and Dockers.  While the effort is a global one, particular emphasis is centered in the domestic market.  This effort includes the rebranding of Docker’s with the “Wear the Pants” campaign as well as a meaningful step up in in-store display and fixturing efforts.


- Competitively, Levi’s is extremely focused on market share for its core brand and as such believes 2010 and perhaps 2011 will be heavy investment years to support brand building/reinforcement.  It was clear that this incremental spend should be expected to have an overall negative impact to the bottom line in the near-term, with future results coming in the form of international growth (primarily China & India) and market share growth in existing markets.


- Sourcing and transportation costs are on the rise, but the company is not seeing anything beyond what they would have expected with an overall global economic rebound.  Cotton costs were singled out as being on the rise, but were not specifically addressed as a major risk factor.


- Efforts to revitalize and re-position Dockers are off to a good start, but management was cautious on the length of time it would take to see meaningful results.  In the America’s the brand was still down for the quarter, but appears to be stabilizing.  The biggest marketing push (so far) for Docker’s will come with Father’s Day.  The efforts will include a meaningful step up in in-store presentation.


- The company continues to manage its business with shorter lead times and with lower absolute inventory levels.  Management believes its wholesale partners are very comfortable with operating on lower inventory levels on average and believes higher turns are more the norm going forward.


- Management noted that the Japanese market remains sluggish, especially in the department store channel.  Interestingly, the company also noted that the “fast fashion” trend continues to impact their business and the overall market.  This trend towards high volume, low priced denim was described as causing the market to recalibrate.   UNIQLO’s $29 denim is clearly having an impact here.


Eric Levine



R3:  Don’t Forget About Levi’s - Levi Strauss Segment Trends


R3:  Don’t Forget About Levi’s - Levi Strauss SIGMA





  • In a large effort to support sustainability and eco-friendliness, Puma announced it will be the first major athletic shoe maker to eliminate the use of traditional shoeboxes. Instead, the company is planning to ship its shoes in reusable bags, supported by an internal cardboard frame. The company estimates that the efforts will save 8,500 tons of paper, though the actual cost of the change may result in immediate savings. Other benefits of the change include water and energy savings as well as reduced transportation costs (due to lighter and more efficient packaging).


  • Levi Strauss indicated that sales of its Signature Brand (primarily sold through the discount channel) were down largely as a result of Wal-Mart’s efforts to de-emphasize non-apparel categories and to focus on lower priced brands in the men’s segment. Given that the Signature product retails for $18-$20 and represents the “best” product category for WMT, this is further confirmation that the world’s largest retailer continues to struggle with its apparel offering. Additionally, by way of eliminating higher priced, branded goods we expect that self inflicted deflation is still very much a large part of Wal-Mart’s topline challenges.


  • Contrary to conventional wisdom, online retailer recently indicated that the higher the return rate, the better the customer. Management claims that even with a 50% return rate for those customers that purchase the company’s highest priced products, the gross margin of the item offsets incremental (and more frequent) shipping costs. And, as result, these are the company’s best customers. While the company is known for its liberal return policy and great customer service, Zappos’ chief marketing officer went on to say, “Customer service is the new marketing”. Oddly, most retailers still don’t understand this concept.





R3:  Don’t Forget About Levi’s - Calendar





Textile and Apparel Imports Rise, Prices Remain Suppressed - Textile and apparel imports to the U.S. posted double-digit increases in February for most major suppliers, showing signs the industry could be on the road to recovery, the Commerce Department’s Office of Textiles & Apparel said Tuesday. Shipments of textiles and apparel to the U.S. rose 19.3% to 3.9 bn square meter equivalents in February compared with a year earlier. Apparel imports to the U.S. were up 15.6% to 1.8 bn SME and textile imports increased 22.6% to 2.1 bn SME. Combined shipments of textiles and apparel from China spiked 36.7% to 1.7 bn SME. <>


R3:  Don’t Forget About Levi’s - US Apparel Import Trends


Malls Still Struggle in the West - The pain of the recession is lingering at U.S. shopping centers, and the sting is worst in the once-booming Western states of California, Arizona and Nevada. Retail vacancy rates keep rising partly because unemployment remains high at 9.7%, and also because stores are having financing difficulties. The foreclosures that ravaged residential real estate in 2008 and 2009 are likely to take a toll this year on the commercial real estate market, including retail. Hardest hit may be newer properties and mid- to lower-tier malls that don’t command marquee tenants. Mall owners lowered rents about 3.6% last year. Retail vacancies in the first quarter of this year rose to their highest level in at least 10 years, despite lower rents intended to lure tenants. Vacancies at the biggest malls increased to 8.9% in the first quarter from 8.8% in the previous three months. Vacancies at smaller neighborhood and community centers rose to 10.8%, the highest percentage since 1991. <>


Fashion Brands Connect with a Clear Marketing Message - A fashion brand’s value is now defined by a clear point of view and a consistent marketing message among consumers trying to decide what to buy, according to a new study. The 10th annual Brand Keys Fashion Brand Index poll found labels with strong images, such as Ralph Lauren, Armani, Nike, Brooks Brothers and Levi’s, were “more important” or “much more important” to 28% of those surveyed, a 14% increase compared with last year. The survey in February of 3,750 men and 3,750 women, ages 21 to 65, from across the U.S. posted the highest increase in a decade and gives a real clear picture of what is resonating with consumers. Five years ago, fewer than 3% of U.S. apparel shoppers rated fashion brands and logos more important when deciding what to buy. Ralph Lauren is the “gold standard” of this new consumer attitude because of its long-standing and unwavering association with classic Americana.  <>


R3:  Don’t Forget About Levi’s - Fashion Brands Table


JD Sports Beats Expectations - Sportswear and fashion retailer JD Sports Fashion predicted a fillip to sales from the soccer World Cup as it beat forecasts with a 26% jump in full year profit and hiked its final dividend 65%. After beating estimates, JD Sports is now looking forward to the lift from the World Cup (begins June 11) that should impact all of its 530 stores. JD Sports is hopeful that a successful World Cup for England (getting to semi-finals) would spark a movement towards sports and leisurewear. Revenue increased 14.8%, benefited from store closures by struggling rival JJB Sports, which came close to administration in 2009. JD Sports was also boosted by the popularity of exclusive product from external brands such as Nike and Adidas and owned brands, such as McKenzie and Carbrini. Same store sales growth has slowed from 2009 at 2.5% to 2% for the 10 weeks to April 10.

"In our field we are the trend setters rather than the trend followers," said Cowgill. <>


WMT Says Foreign Investment Will Help Tame India's Rising Inflation - Wal-Mart Stores Inc. said India’s inflation would slow by at least two percentage points should the government agree to allow an increase in foreign investment in retail.  <>


Best Buy and Wal-Mart Gained Most of Circuit City’s Market Share - Since consumer electronics retailer Circuit City closed its doors and sold its assets to Systemax, Best Buy and Wal-Mart have taken about two-thirds of their former rival’s market share, according to a new NPD Group report. <>


Nike Sues Businessman - Nike Inc. is is suing a businessman who licenses the names and images of famous dead people and the family of Hall of Fame coach Vince Lombardi.  <>


LaCrosse Footwear Expands Workboot - LaCrosse Footwear Inc. is expanding its presence in the workboot market with launches under its LaCrosse and Danner labels. The company is introducing the Extreme Tough series of boots, made for maximum protection and durability. Available for immediate delivery, the series retails for $90 to $125. Danner’s new Corvallis series of core work product with an athletic influence includes an abrasion-resistant toe and heel, speed lacing for a more secure fit, waterproof Gore-Tex lining and Danner’s proprietary Terra Force X platform for enhanced side support. Priced at $146 to $160, the line hits stores in July. <>


 R3:  Don’t Forget About Levi’s - BOOT boot


Birkenstock Launches Steel-Toe Chef Shoes - Alpro by Birkenstock is giving chefs a new kitchen tool with the addition of a steel-toe version of its popular polyurethane clog. The slip-on also comes equipped with an oil-and slip-resistant outsole and can even be dishwasher cleaned in up to 149 degrees. For added comfort on the job, there’s an anatomically designed cork and latex footbed that can be washed in temperatures up to 86 degrees. Set to hit stores in July, the clog retails for $95.



 R3:  Don’t Forget About Levi’s - Birkentstock Boot


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