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Unchangeable Certainty

“The only unchangeable certainty is that nothing is certain or unchangeable”

-John F. Kennedy


It was a nice long weekend. A successful May is over. Let the performance scoring for June begin.


I’m using a JFK quote to kick start the month, not only because we need some American leadership in this country, but because the last time we saw stocks get crushed like we did in May was when Kennedy was the President of the United States.


Ironically enough, the US stock market locked in a cyclical peak on the exact same day (April 23rd) of both 1962 and 2010. So far, the peak-to-closing-trough decline from April 23, 2010 has been -12.3% (1067 SP500). The question for risk managers this morning remains, are the lows for 2010 in?


The best place to start answering this question is from the top down. To understand where we are going, we better have a deep respect for where we came from. Where are we relative to our Q210 Hedgeye Macro Themes? What’s working? What’s not? Market prices don’t lie.

  1. Sovereign Debt Dichotomy: Check, check, check. We thought Greece was the first domino of sovereign debt maturities that would concern the world; then Spain; then Italy and France. Both Spain and Italy implemented austerity measures late in May and over the weekend we saw France’s Budget Minister, Francois Baroin, admit that it was a “stretch” for France to maintain an objective AAA rating. With France’s burgeoning deficit, we concur.
  2. Inflation’s V-Bottom: Across the world, inflation readings hit a series of higher-highs sequentially for the month of April. Our Hedgeye Inflation Index turned down month-over-month in May. Inflation’s V-shaped recovery is what every 12 month chart you look at looks like until the music stopped on April 23rd. Inflation’s V is now setting up to deflate in June. This will help insulate the Fed’s Japanese style monetary policy, and keep treasuries relatively safe.
  3. April Flowers/May Showers: Check. One fund of funds investor from Boston had an interesting take on what we considered proactively predictable: “Attempting to manage risk in an environment where everything that could go wrong does go wrong seems like a fruitless endeavor.” For the month of May, the SP500 was down -8.2%. One manager utilizing the Hedgeye long/short strategy was up +4.05% gross. Another was up +0.52% net. We’ll call that fruitful.

No matter where you go this morning, there market prices are. Spain, China, and France are down -21.6%, -23.7%, and -12.9%, respectively YTD. Our task isn’t to make excuses or point fingers. Our risk management goal is to see the game for what it has become. Are the lows for 2010 to-date already a rear-view event? Unlikely.


We run a multi-factor risk management model across equities, bonds, currencies, commodities, etc., globally. There are very few things that are flashing cover/buy to us yet. Simplifying our model on the US Equity side of the ledger, these are the 2 lines that are most concerning to me:

  1. SP500 intermediate term TREND line resistance of 1144
  2. Volatility Index (VIX) intermediate term TREND line support of 22.19

Provided that the SP500 can’t breakout above 1144 and the VIX can’t breakdown through 22.19, the bear market in US stocks will continue to manifest into consensus that should find another short term cyclical bottom sometime in Q2/Q3.


Another 10 intermediate term TREND lines that remain broken around the world and across asset classes that compliment this simple 2-factor US Equity bear case:

  1. Shanghai Composite Exchange = 2933
  2. Tokyo Nikkei Average = 10598
  3. Hang Seng Index = 20789
  4. London Financial Times Index (FTSE) = 5511
  5. Spain Bolsa (IBEX) = 10499
  6. French CAC 40 Index = 3794
  7. Brazilian Bovespa = 66992
  8. CRB Commodities Index = 271
  9. Copper = 3.33/lb
  10. WTI Oil = $79.11/barrel

Nothing, of course, is “certain or unchangeable” in our risk management model. It’s grounded in chaos theory and, after all, that’s grounded in uncertainty.


My immediate term TRADE lines of support and resistance for the SP500 are now 1076 and 1126, respectively. Our asset allocation to equities, globally, remains zero percent. We continue to be short both the SP500 (SPY) and Nasdaq (QQQQ).


Best of luck out there today and have a great month,



Keith R. McCullough
Chief Executive Officer


Unchangeable Certainty - May Showers

The euro won't die, but does it have any future?


Housing Datapoints Emerge Suggesting the Post-Tax Credit Expiration Decline Has Begun

We had theorized that housing would drop significantly after the tax credit expiration in April, as it did following November's tax credit expiration, and now we're getting early data to confirm that view. Yesterday, the herd drove housing-related equities modestly higher on a strong New Home sales print and Bob Toll's upbeat commentary. This was in spite of surprisingly high (and rising) existing home inventory and falling home prices (see our notes from Monday and Tuesday). The reality, however, is that since the end of April, demand in the housing market have been deteriorating.


The following chart shows MBA Mortgage Purchase applications indexed to 100 on January 1, 2010. On this basis, average applications in March were up 13.8% from the start of the year, and average applications in April were up 23.2% from the start of the year. In the first 3 weeks of May, however, applications were down 14.4% from levels in April. More striking is the fact that the most recent datapoint - May 21 - is down 25.6% from the average April level. Here's what the MBA's chief economist had to say following the release of the 5/14 data:


Purchase applications plummeted 27 percent last week and have declined almost 20 percent over the past month, despite relatively low interest rates. The data continue to suggest that the tax credit pulled sales into April at the expense of the remainder of the spring buying season. In fact, this drop occurred even as rates on 30-year fixed-rate mortgages continued to fall, and at 4.83 percent are at their lowest level since November 2009.


By the way, the week after the above comment was made - 5/21 - was the lowest weekly mortgage purchase application volume week since 1997. It's an interesting theoretical question to ask whether volume was down because of the pull-forward, the sharp stock market correction or a combination of the two.




The next chart shows Toll Brothers sequential change in buyer traffic from April to May. Bob Toll's comments in the quarterly earnings release yesterday were very positive, generating understandable investor enthusiasm towards not just TOL but the whole space. See Bob's comments below.


It appears our business has finally emerged from the tunnel and into a bit of daylight. For the third consecutive quarter, our signed contracts per community exceeded both of the previous two years' comparable-quarter totals. Deposits and traffic per community have been trending positively for the last four-, eight- and twelve-week periods. And our conversion percentage rate from traffic to deposits (non-binding reservations) was the highest second-quarter total since we began tracking this data in 1994. In the three weeks since the start of our third quarter on May 1st, which coincided with the expiration of the homebuyer tax credit, our per community deposits and traffic were up 23% and 11%, respectively, over last year's comparable period. May's activity suggests that for us the tax credit wasn't the determinative factor – rather, we believe, the past few months' activity has been driven by an increase in confidence among our buyers in their job security, their ability to sell their existing homes, and general trends in home prices.


One important fact check supplied during the Q&A portion of the call, however, revealed that year-over-year growth in buyer traffic - traffic is among the best leading indicators for housing - actually declined by two-thirds in May vs April. See the chart below. The +11% yoy May increase in buyer traffic cited in the release actually compared with a +25-30% increase in April. Suffice it to say that in spite of their claims, Toll is seeing a marked slowdown in activity following the tax credit expiration.


It's also worth pointing out that Toll Brothers houses are not representative of the country. For reference, their average ticket is in the $700,000-725,000 range, which puts them right at the cap of conforming loan limits: $729k for the highest priced markets. Considering Fannie and Freddie together accounted for over 95% of all mortgages issued last year, we would submit that the Toll Brothers addressable market does not reflect demand trends for better than 90% of the housing market.




One striking consideration is that mortgage rates are at incredibly low levels. The 30-year conforming mortgage went out at 4.86% last night, down from a recent peak of 5.25% on April 4. The following chart shows average mortgage rates by month and for quarters going back to the start of the year. The drop in mortgage rates in May is striking. May is down 19 bps, on average, vs April. While the current rate of 4.86% is down 24 bps from the average April rate. In spite of this, purchase applications just posted their lowest reading since 1997.




The bottom line is that May data is starting to trickle in and so far it is very weak. We don't think the market yet appreciates how weak this May data is, but it will figure it out soon enough. In the interim, we offer the following chart that we published recently showing lenders stacked in order of relative exposure to residential real estate by combining residential first lien mortgages, second lien mortgages, HELOCs and 1-4 Construction loans. We think that as the market shifts its focus from the EU and Financial Reform to the worsening state of the housing market this summer it will put pressure on those companies with the greatest credit exposure to housing.




To summarize, here are the negatives on housing at the moment:

  1. May purchase applications are at a record low.
  2. Toll Brothers traffic index goes from +25-30% yoy in April to +11% in May.
  3. April existing home sales data showed a ballooning of inventory (a leading indicator) in spite of a rise in sales.

And here are the positives:

  1. New home inventories are very low.

We think the negatives pretty clearly outweigh the positives here, and we would recommend caution for longs and bearishness for those with short capabilities on all companies with a high degree of sensitivity to home prices heading into the back half of this year.



Now for the silver lining

The April New Home sales data out yesterday was really exceptionally strong, as one would expect in the final month before  tax credit expiration. Sales came in at a 504k annualized rate, +22.6% from the prior month and up 46% from the year earlier, and way above consensus. There's no debating that this was an exceptionally strong result. Moreover, inventory of new homes is down a lot. From a units perspective, new home inventory is reported at 211k, down almost 8% from last month's 229k print. The equally important months supply calculation fell to 5.0 months, down from 6.7 months last month. This had more to do with the huge pickup in sales activity than it did with the decline in inventory, but nevertheless the months supply reading for April was very strong.


The catch is that unlike existing home sales, which measure contract closings, new home sales measure contract signings. In other words, while we'll continue to see existing home sales prints rise for the next two months (a lagging indicator), for new home sales April was it - the end of the good prints. We're now on the backside of the tax credit expiration. If inventories weren't so low we would be bearish on the homebuilders. We expect competitive pressure from the existing home market to weigh on new home sales volume and pricing. That said, the low inventories make the short case quite  challenging. We'll have to wait and see how the new home market evolves.


The following are several charts related to new home sales that we think tell the story of this month's data.


As mentioned before, new home sales were exceptionally strong in April.



Inventories also fell considerably.



From a longer-term perspective, inventories on a units basis are at all time lows, while on a months supply basis, they are near their lows.



We include the following chart more as a reference point. It shows the share of total home purchases represented by new homes. The chart would suggest that the new home sales share is quite depressed by historical standards, and the more likely of the two outcomes would be for some degree of mean reversion to kick in. In other words, it would seem more likely than not that new home sales would gain share from here than that they would lose share. That being said, the world has changed in the last few years and we're still unclear on the extent to which things are going to go back to business as usual. As such we're still cautious in assuming that this penetration should bounce right back to 14-16% - a common refrain from investors long the builders.




Joshua Steiner, CFA


Allison Kaptur

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The Week Ahead

The Economic Data calendar for the week of the 31st of May through the 4th of June 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 - c1

The Week Ahead - c2

Risk Management Time: SP500 Levels, Refreshed

This market continues to rally on low volume to lower-highs as volatility (VIX) continues to make higher lows. Combined, these 2 factors are bearish for US Equities. Respect yesterday’s rally from the YTD low for what it was – a rally from the YTD low.


Notwithstanding this intraday headline “North Korea says situation is so grave that war may break out at anytime—KCNA”, there remain plenty of reasons to remain short US stocks into month end. The biggest reason remains the Sovereign Debt Dichotomy. We continue to believe that the sovereign debt problems in Europe are going to manifest in the US within the next 3-6 months.


In terms of levels, the SP500 remains broken from both an immediate term TRADE and intermediate term TREND perspective. The intermediate term TREND line of resistance (1144) still leaves plenty of room for the bulls to buy-and-hope, but that also puts more downside risk to this market if our long term TAIL of support at 1074 is violated in June. Nothing makes markets go down faster than bulls having to reduce their gross long exposure.


We’ll be holding our risk management call on Korea at 1PM with renowned Yale Professor, Charlie Hill. If you’d like access to the call please email . Given the intraday headlines coming out of North Korea, the timing of this call is going to help you proactively prepare ahead of the long weekend.


About Professor Hill
Professor Charles Hill was a career minister in the U.S. Foreign Service and is a research fellow at the Hoover Institution. Hill was executive aide to former U.S. Secretary of State George P. Shultz (1985-89) and served as special consultant on policy to the Secretary-General of the United Nations from 1992 to 1996. Professor Hill has served as Chief of Staff of the State Department, a State Department political officer in Hong Kong, a cultural exchange negotiator in China, and a Chinese-language officer in Taiwan.


Keith R. McCullough
Chief Executive Officer


Risk Management Time: SP500 Levels, Refreshed - S P

R3: Really?!? With Hedgeye Retail

R3: Really?!? With Hedgeye Retail


Toys R Us is coming public – again. Really!?! Oink oink. Really?!?



As my team and I went through the news and our research form the past day, in the back of my head I kept hearing a perverse iteration of “Really? With Seth and Amy.” For those who are not SNL fans, this is part of the Weekend Update where Seth Meyers and Amy Poehler tear into current events with a super sarcastic tone. I can try to describe it here… but there are these things called You Tube and Hulu that can show it better.



- Goldman Sachs Hired for 800 mm Toys R Us IPO - KKR & Co. LP and Bain Capital Partners LLC hired Goldman Sachs Group Inc. for a $1 billion initial public offering of Toys R Us Inc., the retailer the buyout firms purchased in 2005, according to people with knowledge of the matter. The filing for the U.S. listing may come as soon as today, said the people, who declined to be named because the discussions are private.
Hedgeye Comment: Really?!? Like we really need this piggy to be public again? First Dollar General, now Toys R Us, and yes, Sports Authority next. Really?!? Oink oink…


- Add Big Lots to the list of retailers looking for “A” location real estate. Following the successful trial of eight test locations in ’09, the closeout retailer is looking to add nearly half of its new stores in “A” locations this year. While a closeout concept in higher-income demographic areas may not sound like a natural fit, management raved about the productivity of its stores with sales at $180 to $200 per square foot.
Hedgeye Comment: The sustainability of these results is a concern given that closeout inventory was both the most plentiful and arguably of the highest relative quality over the last 12-months in a very long time and perhaps ever.  You’re looking for prime real estate Big Lots? Really?!? Check out what happened when DSW went this route. How bout Circuit City? Shift to more expensive locations in a business model that in structurally not set-up to cover these rents and let’s see how you stack up.  


- Costco noted that the lack of promotional activity in televisions is one of the key drivers behind the category weakness. Management also went on to explain that increasing demand from Chinese consumers for the same products has been a key reason why manufacturers have been less aggressive on price. However, COST does expect pricing to loosen up over the summer as efforts to stimulate demand are likely to reaccelerate.
Hedgeye Comment: Price cuts just in time to buy your gazillion inch flat screen for World Cup. This price/demand trade-off actually makes a whole lot of sense to us.


- China: Demand For Luxury Unaffected by Economic Downturn - A survey from consultancy KPMG showed the economic situation had little impact on most respondents’ spending habits. The survey, which interviewed more than 900 people in 15 cities, found that 62% continued their spending on luxury goods in 2009 and 2010. Despite a tougher economic climate, respondents demonstrated their brand loyalty, as they chose to stick with existing brands rather than downgrading to less prestigious options.
Hedgeye Comment: Note that China has the world's second-highest number of dollar billionaires after the United States, and a new class of wealthy Chinese created by the country's three-decade boom has latched onto foreign luxury brands as status symbols.  Don’t underestimate the impact of the Iron Rice Bowl being broken.


- Swiss Wath Exports Growth Slows in April - Swiss watch exports continued to rise in April, albeit at a slower pace than in the first quarter, growing 11.5%. Watch exports in April returned to their 2007 level over the first four months of the year, the sector posted a rise of 16.4% versus 2009. The increase in April was driven by timepieces at both ends of price spectrum. China confirmed its position as the leading growth market, with a rise of 150.2% on the month, while the United States progressed by a modest 1.6% and Germany saw sales slide 15.2%. <wwd.com/business-news>
Hedgeye Comment: Demand for watches, TVs, other luxury goods all solid in China.


- While Tiffany reported solid sales gains across all regions and product price points, it did note that jewelry over $50,000 posted substantial increases. However, management was also quick to point out that the fine jewelry category also had the easiest comparisons with last year’s trough performance.
Hedgeye Comment: It’s easy to take a quote like “items over $50,000 are posting increases’ wildly out of context. It’s clear that ‘easy compares’ are a key driver here.


- Genesco continues to make progress with rent negotiations on its existing store base. Management noted that the company successfully renegotiated 100 leases in the first quarter, resulting in a 9% reduction in rents in those stores.
Hedgeye Comment: GCO is the ugly red-headed stepchild in footwear retail. But these guys have been managing their lease portfolio like champs.


 - When discussing the performance of discretionary vs. non-discretionary merchandise, Costco’s CFO responded with “my favorite article that I read about all of this was called, Frugality Fatigued. People were frugal last year. Some of them are a little tired of being frugal and they're buying things for the home. And whether it is door mats or housewares or coffee machines or live goods, plants, that's stuff that has been strong.”
Hedgeye Comment: Good for Bed, Bath and Beyond.


 - In an effort to expand owned retail, Australian-based Billabong acquired all but the most valuable assets of Becker Surf and Sport – its branded surfboards. The deal included the brand’s 5 brick and mortar stores in SoCal, which will double the company’s presence in CA, as well as the rights to the Becker’s online business. With only 27 stores stateside.
Hedgeye Comment: It’s too early to tell if this is the beginning of more aggressive expansion plans to roll up smaller brands in the U.S., or simply an opportunistic deal among long-time friends.  





GCO's Hat World to Acquire Sports Avenue - Genesco Inc. announced that its Hat World subsidiary has entered into an agreement to acquire the assets of Sports Avenue and related entities. Sports Avenue operates 46 retail stores across the United States and 13 ecommerce sites, selling officially licensed NFL, NCAA, MLB, NBA, NHL and NASCAR headwear, apparel and accessories, and had revenues of approximately $42 million for its most recent fiscal year.
Hedgeye Comment: Accountability check… When GCO bought Hat World, I thought it was absolutely ridiculous. It turned out to be a high ROI deal. At face value, this one looks equally ridiculous. But they’ve earned the benefit of the doubt.


FINL Cofounder and Chairman to Retire - The Finish Line, Inc. announced that Alan H. Cohen, the company's co-founder and chairman, has informed the board of his decision to retire as chairman and as a member of the board at The Finish Line's 2010 Annual Meeting of Shareholders to be held on July 22, 2010. TGlenn S. Lyon, currently chief executive officer and a member of the board, will succeed Cohen as the company's chairman <sportsonesource.com>
Hedgeye Comment: Non-event


Finish Line Finds Mobile Is A Good Fit - Finish Line says 3% of its e-commerce revenue comes from m-commerce. And 8% of its online customers access its sites though mobile devices. It’s stats like this, Finish Line says, that show a mobile strategy is important. <internetretailer.com>
Hedgeye Comment: Is it me, or is this an uphill battle? One form of distribution growing another form of distribution for content that it does not own or control. Really?!? Can anyone find me someone in their right mind that would invest in this? This is not to say that FINL can’t work. In fact, it likely will, along with the rest of the Athletic space over the next 2 years. But using an e-commerce angle is sad.


ANF Settles Stockholder Lawsuit - Abercrombie & Fitch Co. said in a Securities and Exchange Commission filing Thursday that it had agreed to settle a five-year-old stockholders’ lawsuit for $12 mm. Plaintiff Robert Ross filed the class-action suit in 2005 on behalf of investors who bought the company’s Class A shares between June 2 and Aug. 16 of that year. The suit alleged that, during the period, Abercrombie executives made misleading statements about the strength of its business and caused an inflation of the firm’s stock price. <wwd.com/business-news>
Hedgeye Comment: Really?!? ANF management make misleading statements?


CVS Caremark Says Computer Error Caused Customers to Overpay - The company says an error in data that it gave the Medicare website resulted in SilverScript Medicare prescription-drug customers' being charged higher prices than advertised since the start of the year, the WSJ reports. Generic drugs were not subject to the same problem. A Medicare spokesman says the company will refund the price difference to customers specifically requesting it, and it will also help anyone who, using the correct prices to make their comparisons, wants to switch plans.
Hedgeye Comment: Computer errors and fat fingers don’t just cost us in equity values…

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