The Keynesian Elixir

“The lesson is clear: when we celebrate a great achievement, we are not just celebrating hard work, but also a competitive process where some have won and others have lost.”

-David Shenk


I was reading David Shenk’s new book ‘The Genius In All Of Us’ on Friday and couldn’t stop smiling. Finally, the Perceived Wisdoms associated with intelligence being endowed upon us genetically are dying on the vine of science. This is another major victory for those of us who agree with Shenk that “talent is not a thing; it’s a process.”


Risk management is a process. So is being proactively prepared for The Keynesian Elixir that has become our global economic resolve. Per our friends at Wikipedia, “an elixir is a sweet flavored liquid used in compounding medicines to be taken orally in order to mask an unpleasant taste and intended to cure one’s ills. Elixir in the noun form means a drink which makes people last forever.”


Forever is a long time. I won’t spend this morning reminding you who was bullish at SPX 1217 on April 23rd with the expectation that this bull rush was going to last forever. I don’t need to waste your time calling out who made short sales on Friday’s lows expecting that global markets would go down forever either. What we have here is a very healthy competitive process where some will win and some will lose. That’s my kind of capitalism.


I spent Thursday and Friday covering shorts and getting long. On Friday, I added a 3% position in the Nasdaq (QQQQ) to our Hedgeye Asset Allocation Model, taking our allocation to US Equities up to 6%. I started the week with a zero percent allocation to US Equities. We were short the SP500 (SPY), and now we are long that too.


How can I be bearish on US stocks and end up being long them this morning? The answer to that question is fairly straightforward  - time and price. Just because our Q2 Macro Theme for April Flowers/May Showers is playing out doesn’t mean I need to press it at every time and price. That’s what a sell-sider who has never managed money before would do. Every risk manager who has traded a market knows that, at a price, gains on the short side are meant to be taken.


We like to keep score. Some people love that. Some people love to hate it. My job isn’t to wake up and try to make friends. It’s to augment your investment process with some risk management thoughts that don’t pander to whatever it is that professional meeting organizers do.


For the month of May to-date, here’s the score for US Equities: Dow -5.7%, SP500 -6.4%, Nasdaq -8.0%, and the Russell 2000 -8.9%. This is what we call a market that’s immediate term oversold. That doesn’t mean that it’s not broken or bearish. Oversold is as oversold does.


From a risk management perspective, it’s not only critical to probability weight where we are immediate term oversold, but to also have a point of view on ranges of probabilities as to where we could bounce. For two long positions that I currently hold (SPY and QQQQ), here are those ranges:

  1. SP500: 1110-1143, with 1143 being our intermediate term TREND line of resistance, and 1172 being the line that’s in play if we close > 1143.
  2. Nasdaq: 2, with 2335 being our intermediate term TREND line of resistance, and 2425 being the line that’s in play if we close > 2335.

On the short side, we shorted the US Dollar on strength last week (on 5/6/10 at 11:29AM) as we thought the Euro was immediate term oversold and the Dollar (UUP) immediate term overbought. At Hedgeye, we define immediate term as the “TRADE” which is 3-weeks or less in terms of duration.


We remain bearish on the Euro for the intermediate term TREND (3 months or more) but, again, that doesn’t mean we are bearish on the Euro at every time and price. While our Q2 Macro Theme of Sovereign Debt Dichotomy had us short the Euro and long the US Dollar, for the immediate term TRADE both of these gains needed to be booked. Here are our refreshed lines of support/resistance for these currency markets:

  1. US Dollar: $83.06-84.59
  2. Euro: 1.26-1.31

 Altogether, all of this presents me with 2 simple macro questions this morning:

  1. Where do I sell the QQQQ and SPY?
  2. Where do I re-short the Euro and cover my trading short in the US Dollar?

We can get all caught up in the semantics of whether or not this is “too trading oriented”, but I have yet to see a legitimate risk management process that doesn’t need to execute trades in real-time. As time and prices change, we do. It’s a competitive process, not a popularity contest.


Whether we agree ideologically with The Keynesian Elixir of European governments attempting to bail out neighboring governments or not, the only thing that is going to help us all from ourselves this morning is being right. Then we can all celebrate great achievement in risk management, together.


Best of luck out there today,



The Keynesian Elixir - S PCHART


In early trading, equity futures are trading sharply above fair value after the EU and ECB unveiled a €750B rescue package to prevent the Euro zone financial system collapsing.  In addition, the EU and IMF approved the loan agreement with Greece with the first disbursement set to proceed before its May 19th bond redemption.


The European markets moved sharply higher in response to European policy makers agreeing on the rescue package.  The upward move in stocks, which saw all industry groups trade higher, was led by banks and financials with average gains of over +12%.  Also in early trading, all members of the FTSE 100 are higher.


When the US levered up its balance sheet to save the nation the market rallied 75% over the next twelve months and the Euro zone is now taking the same path as the US.  How is this all the MONETARY LUNACY going to end?  Leverage is bad, not good!  That being said, we are managing risk around what the market gives us and coming into today’s trading, we have the following positions in the Hedgeye virtual portfolio:


On 05/07/2010 (10:18 AM) LONG QQQQ - The reactive are making forced sales here in early trading, so we'll take our US Equity allocation up from 3% to 6% with this addition to our long exposure.


On 05/06/2010 11:29 AM SHORT UUP $24.75 - We have been bullish on a Buck Breakout since the beginning of the year but, for a TRADE, the buck stops here. Shorting high as US debt issues aren't going away either.


On 05/06/2010 01:25 PM LONG SPY $114.98 - May Showers it is! We'll get long some US Equity exposure now, taking our Asset Allocation in US Equities to 3% (from zero). KM


With US equities finishing substantially lower on Friday, all of the US sectors were broken on TRADE and TREND except Consumer Discretionary, which did not break TREND. 


The Hedgeye Risk Management models have the following levels for the S&P 500 the US dollar, The Euro, VIX, OIL, Copper and Gold: 

  • As we look at today’s set up the range for the S&P 500 is 33 points or 0.08% (1,110) downside and 2.9% (1,143) upside.  
  • The Dollar index is currently trading down 1.4%; the Hedgeye Risk Management models have levels for the DXY at: buy Trade (83.09) and sell Trade (84.59). 
  • The Hedgeye Risk Management models have levels for the VIX at: buy Trade (25.23) and sell Trade (40.95). 
  • The Hedgeye Risk Management models have the following levels for the EURO – Buy Trade (1.26) and Sell Trade (1.31).  
  • The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (75.01) and Sell Trade (80.40).  
  • The Hedgeye Risk Management models have the following levels for COPPER – Buy Trade (3.06) and Sell Trade (3.34). 
  • The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,180) and Sell Trade (1,212).


Howard Penney

Managing Director













JNY: The Legacy Returns

Do yourself a favor and employ a process that includes something more than looking back only 3 years in analyzing Jones Apparel Group. History is repeating itself. And history pretty much stinks.



Daryl Jones – one of the senior leaders at Hedgeye – often reminds us to “never bet against a Jones.” I’ve got to take exception to that, DJ. Here’s some historical context as to why.


I’ve been covering JNY for about 13 years. How ironic that both revenue and the stock price today are at the same levels as when I first plugged the ticker onto my stock screen. What’s different? Well…management changed a little, but the culture did not. EBIT has been cut by nearly 80%, or $400mm, as the company lost its most profitable assets (a billion+ worth of 20%+ margin Ralph Lauren biz), and no longer has the macro and industry-specific tailwinds to mask its strategy to financially engineer acquisitions while starving its existing brands.


The architect of said strategy was Peter Boneparth, a banker turned CEO of an apparel company called Norton McNaughton. And yes, Boneparth ultimately became CEO of JNY. What I’ll refer to as his ‘buy and starve’ model (starve brands of capital, but buy new ones to give the illusion of growth) worked – until it didn’t. Remember when JNY blew up in 2007? Yeah… That was the end. Or so I thought.


Wes Card was elevated to the role of CEO and has done the best he could with the mess he was left. He’s cleaned up some underperforming company retail assets, and has strengthened parts of the wholesale business. Has he benefitted at 9 West from a strong boot cycle? Yes. But overall, he seemed focused on improving the core.  Until now.

Enter JNY’s announcement to buy Stuart Weitzman.


I’ve got several thoughts on the deal.


1. Is it a good brand? Yes. JNY needs as much higher-end exposure as it can get.


2. Is the $180mm price tag for 55% of the company a good deal? On today’s cash flow stream, it probably is. How I’m doing the math, we’re looking at about 2-3% accretion in 2010 based on my assumption of 12% margins at SW (no disclosure there yet). I don’t dismiss the potential for mid-high teens margins.  If that’s where they are, then that’s super. But then, as with all companies we analyze, we’d also need to get confidence that we did not see margins shoot up recently due to unhealthy costs cuts to dress the company for sale.


3. Now here’s the kicker…The two main sellers are Mr. Weitzman and Irving Place Capital.


a) Mr. Weitzman will stay with the company, but is in print (Friday) as saying ”This is my hobby, I love it and never want to stop.” That’s actually nice to hear how passionate he is about the business. Passion is good. But the ‘hobby’ thing kinda scared me.


b) The REAL notable point here is that Peter Boneparth joined Irving Place last year as a Senior Advisor. I repeat…  Peter Boneparth joined Irving Place last year as a Senior Advisor.


So let me get this straight…If this is such a great company (I do not dispute that it is a solid brand), with margin upside and a growth trajectory that has been properly invested in over the past 2 years during the downturn, why is Irving Place selling? 


Moreover, isn’t it a little ironic that it is being placed at JNY – the place where a Senior Advisor created a culture of paying top dollar at peak margins for acquisitions just to give the illusion of growth?


Maybe we give the seller the benefit of the doubt and assume that – like many of the $550bn in levered loans out there associated with deals struck over the past 7 years – Irving Place simply needs to raise the cash, and is taking advantage of a window when it can do just that.


Regardless of the seller’s motives, I want to understand the level of diligence existing JNY management did on this deal, instead of relying on their former boss as validation. The key for me will be to see how much JNY invests to grow this brand without simply robbing capital from other areas of its portfolio. Management can say whatever it wants about its intentions, but a few quarters of action will tell the story far better.


As it relates to the stock, my sense is that JNY’s strategic shift will likely result in one of two things…


1)      Acceleration in both organic and acquisition-related growth while improving margins, or


2)      Increasing erosion in the profitability of its current core while it chases deals, and a subsequent miss/guide down/write off as the current base – as has been the case with JNY (and coincided with Mr. Boneparth’s departure in 2007).


Until I get strong evidence otherwise, I am assuming #2 -- this company's culture of shareholder is too strong to give the benefit of the doubt for anything else.  My earnings estimates for JNY are $1.30 for 2010, and $1.40 next – which are below the Street by 15% and 20%, respectively.


Let’s simply look at what a rational investor needs to believe in order to buy the stock at $20.  I’ll work under the assumption that an investor at this price needs to be looking to sell at something at least $25. JNY, and others with similar models have traded between 10-14x pe over time. I’ll assume 13x. That suggests EPS just shy of $2.00. The bottom line is that we need to get to 9.5% operating margins to support these assumptions. The last time JNY had margins over 9% it was being fueled by its Ralph Lauren licenses – which simply are no longer part of the equation.


Unless they know something pretty material that they aren’t telling us, this looks to me like JNY is reverting back to its value-destroying days of old. So…with earnings compares getting tougher, high earnings expectations, and short interest near 3-year lows, can someone tell me who the incremental buyer is of JNY here?”

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Correction or Contagion, What’s Next for Equity Markets?

As stock market operators, a strong stomach and preparedness for the unknown are critical traits.  Yesterday’s action in the U.S. equity markets tested even the most savvy of investors.  But, as Robert Frost famously said, “In three words I can sum up everything I’ve learned about life: it goes on.”  Indeed it does.


While the intraday move is quickly being dismissed by the CNBC punditry as a “fat finger”, or human error, and to some extent that is accurate, it is critical to remember that markets are interconnected.  The current catch phase in stock market parlance is contagion.  A contagion in medical terms is a contagious disease, and in this scenario, cotagion implies that the whole world is going to catch the Greek sovereign debt flu.


Esteemed investor George Soros had a more apt description for contagion, he calls it reflexivity.  Specifically, market events aren’t random, but they are influenced by other events.  Taken a step further, actual fundamentals are influenced by market events, so the market and prices in effect are leading indicators.


In isolation, yesterday’s event was an isolated event and was likely some Middle Aged White Guy, or MAWG has my colleague Howard Penney called him today, on a trading desk at a major financial institution who ran the wrong algorithm or sold shares when he should have been buying, albeit on a massive scale.  But the reality is that this event, which was the largest intraday drop for the Dow in stock market history, occurred on a day and in a period when the market and investors were incredibly skittish and schizophrenic due to accelerating sovereign debt concerns.  Even if this was a simple “error”, the timing was far from random.


In fact, this event is likely a catalyst for more market volatility in the coming weeks, rather than a return to complacency and the upward trend in the market.  This view is based on signals from a number of the key factors that we monitor in our risk management model, which include: credit spreads, volatility and sovereign debt credit default swaps, which are outline in the attached chart.  Collectively these factors had been signaling to us the potential for an equity market correction, and continue to signal further turbulence ahead.


Credit spreads widening in conjunction with a declining stock market typically indicate a dramatic shift away from any type of risk by institutional investors.  More specifically, they also signal bond investors getting increasingly concerned about fundamentals and cash flow.   Over the course of the past few days, corporate high yield yields widened dramatically from 8.2% to 8.6%.  This morning yields continue to climb.


The VIX is one of a few measures of volatility that we use, and it has been accurately called the fear index.  As investors get scared and sell assets, volatility spikes, which increases the potential intraday moves of asset classes.  Similar to credit spreads, equity volatility had been increasing over the past few weeks and is up another 14% this morning, signaling increasing fear and volatility ahead.


On the final point, credit default swap spreads widened for many European countries over night.  In fact, many are approaching all time highs, specifically Greece's five-year CDS rose 10 basis points to 950 basis points, while those of Portugal rose 60 basis points to 495 basis points, and Spanish CDS rose 17 basis points to 290 basis points.  If this market action is telling us anything, it is that any proposed bailout that is on the table is insufficient and there are more European sovereign debt issues ahead of us.


While we support the adage that the time to buy is when there is blood in the street, that strategy needs to be framed with the understanding that equity markets can stay irrational, and usually do, for longer than investors expect.  In early 2009, very few investors predicted that the market would climb over 75% in the ensuing 15-months.  Conversely, the correction, when it occurs, will likely be of longer duration than the consensus group-thinkers believe as well.  And perhaps the correction is only the beginning.


Daryl G. Jones

Managing Director


Correction or Contagion, What’s Next for Equity Markets? - 1





The Week Ahead

The Economic Data calendar for the week of the 10th of May through the 14th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - cal1

The Week Ahead - cal2

BBBY: KM Buying – Our Fundamental Backdrop

In the midst of the current correction, Keith continues to look towards quality names with stability in earnings momentum, proactively-driven top line growth, and plenty of cash to boot. In other words, Bed Bath & Beyond.


Here’s a reminder as to why we like this one…


  1. Long-term: Combine a remarkably consistent management team, steady unit growth, outsized market share gains regardless of the economic climate, and you get one of the most predictably efficient growth models in retail. We don’t buy the ‘growth is maxing out’ argument – the fact is that there’s still 85% of this industry that BBBY does not own. Sprinkle on underappreciated/undervalued non-core concepts and call option on putting $1.7bn cash hoard to work, and this is a tough story not to like at face value.
  2. Intermediate-term: Earnings guidance calls for 10-15% growth in 2010. We’re looking for 25% and that may be conservative.  Yes, expectations have risen, but 4Q was just the third quarter in a row (after 10) in which gross margins improved.  Sales are accelerating, as they should when a macro recovery is underway and the company’s biggest direct competitor is now gone for just over a year.
  3. Near-term considerations: The catalyst here should continue to be earnings. BBBY is not scheduled to report until the back half of June, but our degree of confidence in the model is high. Management finally putting the cash hoard to work would be a welcomed bonus.


Valuation: At 8x EBITDA and 15x P/E, we ‘get it’ that it is not exactly the cheapest name in retail. But its been a long time since I’ve seen a name in retail where more people say “it’s too expensive…I missed it.”  That’s a tough argument to stick to when you have a quality name that’s got growth, earnings momentum, market cap, and cash.



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