The Contagion Drag

Position: Long Germany (EWG); Short France (EWQ)


As part of our Q2 theme Sovereign Debt Dichotomy, we advised that one possible play on sovereign debt risk in Europe is to be paired off long Germany and short Spain.  Our bullish thesis on Germany included a tighter fiscal balance sheet than many of its European peers, the advantage of a weaker Euro for an export-heavy economy, low inflation, and a stable rate of employment. While we’ve seen significant divergence in the underlying German and Spanish equity markets over the last weeks, including a spread as wide as 2000bps between the DAX and IBEX 35 on May 7th, the increasingly larger share of the ‘bill’ that Germany will bear for the Eurozone’s collective bailout is bearish for German capital markets (see chart 1 below).  


Since our initial conference call on the dichotomy on 4/16 we’ve traded around Spain on the short side (we are current short France in our model portfolio) and recently have seen weakness in reported German fundamentals. Further, from a tactical position, our TAIL line of support for the DAX at 5,639 could soon be tested with a close today of 5,758.02, and our TREND line of support at 5,928 is already broken (chart 2).


Today, the GfK German Consumer Confidence survey for June fell to 3.5 from 3.7 in May (chart 3). Last week German PMI contracted; services fell to 53.7 in May from 55.2 in April and manufacturing dropped to 58.3 versus 61.5 in the previous month. Also, earlier last week, the ZEW economic sentiment survey, which forecasts for 6 months ahead, fell to 45.8 in May versus 53.0 in April.


While the German unemployment rate remains positive, declining in the latest reading to 7.8% (versus the Eurozone average of 10% and 20% in Spain) and is underpinned by the government’s successful part-time labor programs, contagion from European sovereign debt risk persist despite the $1Trillion European loan/debt buy-up facility issued on 5/9. Additionally, Germany’s unilateral ban on naked short selling on 5/25 is adding fuel to the fire and enhancing market volatility.


On the margin, the fundaments we’re following in Germany and the broader stock market suggest a downward reversion to the mean, especially as risk in Europe (and globally) is pushed further out. One area to look to for confirmation of this is the bond market (chart 4), where we’re starting to see German yields rise.


Matthew Hedrick



The Contagion Drag - c1


The Contagion Drag - c2


The Contagion Drag - c3


The Contagion Drag - c4

Squeeze Me: SP500 Risk Management Levels, Refreshed

This morning, I’m the one getting squeezed. On the SPY short position I put on into yesterday’s close that is. That’s what we You Tuber’s of America call a mistake and that’s no one’s fault but my own.


When you make a short term mistake, the goal is to not immediately make another one. Over the immediate and intermediate term, compounding your mistakes gets easier if you don’t have a proactive risk management plan.


My plan in shorting the SPY yesterday was to short strength up to the two lines in the chart below: 

  1. Immediate term TRADE line resistance = 1101
  2. Intermediate term TREND line resistance = 1144 

While the long term TAIL line of support has held (1074), that doesn’t mean it can’t be broken. When markets that are broken on short and intermediate term price momentum rally to lower-highs on decelerating volume, the probability of long term support being broken increases.


Probability and scenario analysis needs to be measured dynamically if you want to have a shot at winning this game. I personally learn a lot more from my losses than I do from my wins. Today’s mistake is different than ones I’d make 3 and 5 years ago, in that time and mistakes help a man’s risk management model evolve.


If SPX 1074 breaks and VIX $26.19 holds, there will be a very high probability that we see 1048 in the SPX in the very near term. We shorted QQQQ on this morning’s opening market strength as well.


Keith R. McCullough
Chief Executive Officer


Squeeze Me: SP500 Risk Management Levels, Refreshed - S P


Sell side analysts not only follow stocks but their contrived – sorry I mean derived price targets also seem to follow stock prices.



We’ve written a little about the shaky methodology and assumptions that have been used by the sell side recently to justify hotel stock valuations.  The gaming sell side seems to be equally as momentum oriented.  Maybe it’s a function of the 2008 stock market crash followed by a huge recovery.  If it’s working, then stick with it, right?


The problem is who is paying the sell side for momentum calls?  I never did.  Anna never did.  Keith never did.  Adjusting price targets up or down following big stock moves to maintain a 25% spread to justify ratings does not seem to be much of a value-added service.  Rather, the sell side should be about providing unique fundamental research and analysis.


Case in point, GS lowered its price target on MGM and took the stock off its Conviction Buy List today.  MGM was added to the List in late April at roughly $14 after a monster move up.  The removal today at $11.95 follows a 28% three week decline.  The analyst’s price target was taken down from $17.50 to $14.00.  Some investors have made a lot of money in a momentum oriented way.  I’m fine with that but let’s call a spade a spade.

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BWS: Quick Take

Conclusion: Good number overall, with upside to EPS almost entirely driven by 16% retail comps, while finally growing wholesale sales. GM +278bps, due to better sell-through, better product with higher margins, fewer promotions and lower markdowns. Good read-through for PSS here headed into next week’s print.  



  Clean/Street/Guidance/LY:: $0.26/$0.14/-$0.14


Guidance: Raised 2010 sales growth targets to high-single/low-double from prior guidance of mid-single. Guides Q2 net sales growth to low/mid teens range.

Street $1.06. Net revenue guidance increased to high-single/low-double from prior guidance of mid-single. Lowered SG&A guidance by ~50 bps, lowered interest expense, raised taxes, and raised the lower side of Cap Ex guidance.


Sales growth: +10.9%. Sq footage -3.1%, Brown Shoe Comp 15.5%, Specialty Retail Comp 16.2%, Wholesale +3.5%. New store productivity at Famous Footwear 95% -- - improving on the margin. Revs on the higher side of guidance across all segments.


GM %: 41.4%, up 278bps yy. 1 year sequential erosion but 2 year improvement due to a slightly more difficult comp. Comps get harder going forward.  Famous Footwear GMs improved 230 bps from improved sell-through – more trend-right merchandise, and fewer promos (not sure if it’s by accident or solid proactive planning).  Wholesale GMs increased 310 bps due to lower markdowns and improved sell-through and higher margin brand growth.  Specialty Retail increased 150 bps from better product and more full priced selling.


SG&A: +5.5%, 2 year slowdown. SG&A margin -192 bps. Increase due to higher incentive compensation but offset by 62 fewer stores in operation.  


Balance sheet: Inventories up 6% on 11% sales growth. Good spread, though sequential erosion. Capex inflected, now growing as a % of sales, currently at 0.9% of sales ttm. That’s absolutely not sustainable. Average inventory on a per-store basis at Famous Footwear increased 15.9% at quarter-end, reflecting recent sales trend and near-term outlook including its investment in higher-priced categories. Inventory at its Wholesale division decreased 3%.


SIGMA: In clean up mode, negative SIGMA move. Sequentially worse sales-inventory growth ratio and margins.


BWS: Quick Take - BWS S 5 26 10



R3: AEO: Inventories Rise, Guidance on the Demise


May 26, 2010





This morning American Eagle Outfitters reported a largely inline quarter, with EPS of $0.17 coming in at the high end of the company’s guidance and on target with the Street.  By now this is old news and hardly surprising given the updates we’ve gotten along the way with each monthly sales report.  However, there are two incremental data points that stand out from the release.  First, guidance for 2Q is well-below the Street, with the new forecast of $0.12-$0.16 falling below the consensus of $0.21.  Secondly, inventories are on the rise.  On a sales increase of 8%, inventories were up 16.9%. Management chalks this increase up to a strategic initiative to have a better in-stock position on denim as well as comparisons with last year in which inventory was down 4% per foot. 


No matter how we look at it, this stands out as one of the few mall-based retailers actually committing to inventory build in advance of any potential (i.e. hopeful) acceleration in sales.  Add in the fact the company has now shed its loss producing division, Martin & Osa, and it’s a bit curious to see inventories on the rise when guidance is on the demise.  In fact, AEO is the first company we’ve seen out of earnings season to take a haircut to 2Q earnings based “margin pressure related to weaker trends early in the quarter.”  Perhaps this is a company specific issue, as much of the past year AEO has lagged its peers in the area of inventory management, but this is a data point worth keeping an eye on.  This could be a lull or the beginning of a trend.  Either way, there’s 6-8 weeks before the key back to school season kicks in and it’s fair to say some doubt should begin to enter the minds of both investors and retailers.


Eric Levine



R3: AEO: Inventories Rise, Guidance on the Demise - AEO SIGMA





- Despite some chatter suggesting post-Easter business has seen a slowdown across the mall, PVH is not seeing this from their wholesale perspective. Management noted that the company’s customers across all tiers of distribution are still pulling orders forward to meet demand.


- DSW noted that the company’s loyalty program continues to grow and now totals 14 million members. Clearly the program includes DSW’s most loyal customers as indicated by the fact that 86% of revenues are derived from those carrying loyalty cards. Efforts to mine the loyalty database and segment promotional offers are still underway.


-Fashion accessory consumption, a key consumer discretionary barometer, is on the rise as indicated by NPD data with sales up 17% in Q1 compared to a 10% decline in the same period last year. Notably, larger ticket items like women’s handbags drove the outperformance of women’s accessories up 20% during the quarter.





R3: AEO: Inventories Rise, Guidance on the Demise - Calendar





ICSC Lowers May Monthly Sales Target - The International Council of Shopping Centers said U.S. retail sales in May are so far coming in worse than originally expected. It now expects sales during the month to be up 2% to 2.5% vs. previous estimate of 3.5%. The reason for lower the estimate was inconsistent traffic trends and softer consumer spending.  Some chains said that a later Memorial Day holiday will shift some sales from May into June.  <>


Kevin Garnett Switches From Adidas to ANTA - Despite signing a "lifetime endorsement deal" with adidas in 2003, Boston Celtics star Kevin Garnett has reportedly signed an endorsement deal with the Chinese-brand ANTA for the coming season.  <>


Obama Signs Haiti Trade Bill - President Obama has signed into law a bill that almost triples the amount of apparel made in Haiti that can be shipped into the U.S. duty free. The bill is intended to help Haiti, the poorest country in the Western Hemisphere, rebuild after the devastating earthquake in January that disrupted the mainstay of its economy — the apparel and textile industry. The sector accounted for two-thirds of Haiti’s exports and almost 10% of GDP. Apparel and textile imports were $513.3 million in 2009. <>


Perry Ellis Brings Business In House - Perry Ellis International is bringing its dress shirt business in-house, ending its license with Smart Apparel (U.S.) Inc. at the end of this year. On Jan. 1, 2011 Miami-based PEI will assume all aspects of the business under the Perry Ellis and Perry Ellis Portfolio brands. Smart Apparel, which made Perry Ellis dress shirts for two years, will continue to produce Perry Ellis branded suits, suit separates and sport jackets. <>


Wal-Mart Cuts Apple's iPhone Price - Wal-Mart Stores Inc., the world’s largest retailer, cut the price of Apple Inc.’s iPhone 3GS by $100 to $97 before the possible introduction of an upgraded version of the device. The deal is available in stores and not online, Wal-Mart said on its website. It requires a two-year service contract, Melissa O’Brien, a spokeswoman for the Bentonville, Arkansas- based retailer, said in an e-mailed statement. The reduction may also be aimed at clearing unsold iPhones before Apple unveils the next iteration.  <>


84% of Women Plan to Increase Spending as the Economy Improves - Among the top items they plan to purchase are electronics, clothing and accessories, according to a new survey. <>


Burberry Group Profits for Year Fuelled by a 6.5% Sales Growth and Cost Efficiencies, Boost 2011 Capital Spending - The fastest growing category was non-apparel, which accounted for 36% of revenue. Burberry plans to build on its strong financial position by accelerating investment in growth initiatives in retail, digital, and new markets, while continuing to enhance the brand. The company added that in the current year, capital expenditures would nearly double and be spent in part on new stores and refurbishment as well as expanding key product areas including kidswear and moving into emerging markets. <>


Steve Madden to Find New Designer through MTV - Steve Madden has enlisted the help of MTV to find the newest member of his design team. On the cable network’s new show, “Hired,” tonight at 6:30 p.m., Madden chooses between five recent graduate contestants, each vying for a position at Steven Madden Ltd. The candidates each meet with a recruiter, who provides suggestions and tips, before they meet with Madden himself for an interview. The final round includes an additional interview and hands-on activities at the Long Island City, N.Y.-based headquarters. One lucky winner will be offered the job during tonight’s episode. <>


Sneaker Con in New York - The lines were out the door for last Saturday’s Sneaker Con in New York, the third edition of the celebration of all things sneaker. According to organizer Yu-Ming Wu, more than 1,000 sneaker fans flocked to Manhattan’s Sullivan Street to buy, trade and ogle some of the most sought-after kicks around. Sponsored by New York retailer Dr. Jay’s and by Adidas Originals, the meetup featured 40 vendors hawking their wares, as well as an exclusive look at rare Kaws toys from the private collection of Lev Levarek from Toy Tokyo. <>



The Macau Metro Monitor, May 26th, 2010



As the Macau Government Tourist Office (MGTO) promotes Macau to Indians, IM believes the Venetian would benefit the most.  Sources say the Indian visitors to Macau stay longer and spend more on the higher-margin, non-gaming than a typical Chinese visitor would.


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