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BBBY: Subtle Conservatism

There’s little value in rehashing the finer points of yet another solid quarter from Bed Bath and Beyond.  Let’s be upfront and recognize that the opportunities ahead have very little to do with the past.  At least that’s the sense I get after talking with numerous investors over the past week.  So putting aside the above-expectation and above-plan same-store sales, the near $1.6 billion in cash on the debt free balance sheet, and the guidance which remains unchanged (and still conservative), the market seems to have made up its mind that this is as good as it gets.  At the same time, this also appears to be the sentiment towards most retailers.  And, perhaps this is fair given the optics ahead.  There’s no question that same-store sales will slow as the company butts up against more challenging compares beginning on Q3.  The same holds true for inventory management, which showed a tick down in its spread relative to sales and is no longer being cut at the same rate.  We knew the day of tougher comparisons on the horizon would come and we’re now one quarter away.  But, what’s new?


Despite what may be a near-term disconnect between tomorrow’s expectations and those in the intermediate term, we still believe there is ample opportunity for earnings to exceed expectations over the remainder of the year and into next for BBBY.  The key here is recognizing that EBIT margins are still about 100 bps off peak in an environment that is less competitive, has far less capacity, and is not overshadowed by aggressive promotional activity (i.e couponing).  We believe the company is almost half way through the process of unwinding the heavy use of direct-mail coupons and coupon inserts that were very much a part of a three-year trend in gross margin erosion.  At the same time, square footage growth remains a healthy 5% and the likelihood for additional share repurchases remains high.


Finally, a point about the elephant in the room, a.k.a sell-side concerns about a slowing topline coming into the earnings print.  There was absolutely no evidence in our view on the conference call to  suggest that sales have slowed.  The guidance for 2Q same-store sales stands at a mid-single digit increase.  Recall that guidance has called for a mid single digit increase since the end of 3Q09.  The question will be is this the “real” expectation, or is this a case of subtle conservatism?  We believe it’s more likely the latter.


Our view remains unchanged on the opportunities that still lie ahead for the shares.  We still believe earnings will grow by at least 25% for the year.  This is now the fourth quarter in a row in which gross margins have improved, after 10 quarters of declines.  We can’t fight a growing level of bearishness permeating the retail space, but we can and do remain objective on the fundamental opportunities that still exist for the shares.


BBBY: Subtle Conservatism - 6 23 2010 6 39 07 PM


Eric Levine



The month of May was a difficult month for everything but consumer confidence.  Let’s recap the Month of May:

  1. The S&P 500 declined by 8.2%.
  2. Retail sales declined by 1.2%.
  3. The consumer sectors – Consumer Discretionary (XLY) and Consumer Staples (XLP) – declined 7.0% and 4.6%, respectively.
  4. The Housing market is collapsing.
  5. Consumer credit remains tight.
  6. Initial Jobless claims were horrible and the unemployment rate remains high.
  7. The economy is not growing as fast as the government is leading us to believe.

Today the University of Michigan is reporting that the Sentiment Index rose in June to 76.0 from 73.6 in May and up from 70.8 last year.  The Index is now at its highest level since January 2008. The Index remains 21.6% below the peak in January 2007 and up 37.4% from the low of 55.3 in November 2008.  Year-to-date, the confidence index is up 4.8%.   


The Expectations Index rose by 1 point sequentially and is only up 1.3% year-to-date.  The Expectations Index is down 20.3% from the peak in January 2007 (a year before the start of the recession and two years before it was declared by NBER).  Unfortunately, during the past 12 months the Expectations Index has not posted any further gains, signaling that consumers expect a very slow pace of growth in the year ahead.


While expectations remain muted, the consumer seems to more content with current condition.  The Current Conditions Index rose by 4.6 points sequentially and is now up 9.7% year-to-date.


With consumer assets deflating (equities and home prices) it seems unlikely that the current momentum in confidence will be sustained.



Howard Penney

Managing Director








Goldman’s downgrade last week contributed to a big drop in IGT’s stock. While we don’t disagree with their macro call, their calculator seems to be malfunctioning.



Here at Hedgeye, we aim to be 100% objective.  That becomes more difficult when we uncover data points, research, and/or analysis that may go against our established opinions.  IGT is a perfect example.  We haven’t been big fans of this name recently – we’re worried about market share on the gaming ops side – but the recent Goldman downgrade has a major hole that we feel obligated to confront.


We certainly share Goldman’s cautious outlook on 2011 for the gaming industry as a whole.  Whisper expectations have gotten way too aggressive in our opinion.  However, if you think 2011 will not be a year of recovery for gaming, why would you short IGT and keep a Buy on MGM?  One follows the other.  If you are negative on slot replacement demand, then you can’t be bullish on casino revenues.  Slot floors are old – especially at MGM – so any kind of stability or casino revenue growth will spur replacements at potentially a very accelerated rate.  Why short a company with 2x leverage and only an indirect correlation with casino revenue versus a company with over 9x leverage and huge operating leverage?  You can’t have it both ways.


So GS has IGT’s earnings increasing only $0.04 to $0.88 in 2011.  North American new/expansion unit sales should increase at least 30% (excluding Acqueduct) and IGT’s market share will probably be higher since Illinois orders are likely to contain a higher percentage of video poker machines where IGT dominates.  Margins should be better and international sales flat to up; so for IGT only to increase 4% as projected by GS, replacement demand would have to actually shrink materially.  We think this is highly unlikely.


Thus, even a relative IGT bear finds the GS 2011 estimate way too low.  We are currently projecting $1.07 in 2011 EPS and we wouldn’t call that aggressive.  Taking out the convertible would add $0.07 to our estimate alone.  Following our meetings in Las Vegas this week, we don’t think much has changed for IGT and the sector.  Replacements are still up over last year and while new casinos and expansion slot sales will be down in 2010, they should rebound in 2011.  IGT’s near term earnings visibility is as good as any other gaming company with the exception of the Macau operators.  With the stock down 23% in less than 2 months and now trading at under 15x our FY2011 estimate, we may have to revise our bearish view.

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R3: A Few Points on FINL


June 25, 2010



With the focus likely centered on a slowing comp trend, we want to make sure the company’s inventory position is not lost in the shuffle.  Sales up 9% and inventories down 18% is a solid set-up heading into back-to-school.  Good for margins and keeping promotional activity in check.





FINL reported an impressive EPS beat after the close yesterday ($0.25 vs. $0.16E), however as it typically the case there are a few notable call outs ahead of the call this morning:


  • Top-line growth of 9% was solid and relatively in-line with what we saw out of others in the space with DKS (+9%), HIBB (+17%), and FL (+5%).
  • Inventories were down 18% - the second quarter in a row of significant declines keeping the sales/inventory spread at a level well above the rest of the industry. Among the four company peer group Q1 was evenly split between those that grew inventory (HIBB +6% & DKS +3%) versus (FL -7% & FINL -18%).  This is an especially good scenario for those selling in the mall given tight inventories historically keep promotional activity in check.
  • The comp trajectory coming out of Q1 appears to be a slowdown from 1Q trends. Posting +10.9% after a March +15.5% start suggest a slowdown over the last 2-months of the quarter.  Comps so far in June (+7%) suggest that sales continue to slow.  The call just clarified the monthly comp trend, which suggests June is sequentially better than May (much like most of retail). 
  • March 18.5%, April 6.1%, Aay 5.2%, June-to-date 7%
  • Footwear comps up +12% while softgoods were +3.4% in Q1


While comps are catching our eye, it’s pretty clear that March was in fact the anomaly not June.  We’ll have additional color after the call at 8:30am EST.


R3: A Few Points on FINL - 1


R3: A Few Points on FINL - 2


R3: A Few Points on FINL - 3 





- BJ’s noted that aggressive pricing by Wal-Mart does in some cases impact their business, primarily in the form a margin hit.  The club operator often times reaches out to its vendors for additional support on items that are aggressively priced by WMT, but this is only met with mixed success.  BJ’s also indicated that some products on Wal-Mart’s rollback program have already returned to normalized pricing and they expect July 4th to be a  key weekend for which aggressive pricing may subside.


- Another sign that closeout inventory is down substantially year over year, this time from Nike.  In North America, closeout sales of apparel decreased by 50% in the quarter while footwear to the off-price channel declined by 27%.


- While still a long way off, Victoria’s Secret has finally secured a location in London to begin its UK expansion. While the company has been searching for a location for over a year, it seems that the grand opening of its first store will take place in 2012.


- Ked’s continues to plot its resurgence, this time with a special collection to be sold at Bloomingdales.  The shoes are designed in collaboration with conceptual artist, Jenny Holzer, and are known as the Whitney Collection.  All proceeds from the sale of the shoes will benefit the Whitney Museum of American Art.  Recall that Ked’s is also collaborating with The Gap, Alice + Olivia, and Steven Alan.


- Burberry continues to push the needle with its use of digital media, after becoming the first fashion house to livestream its fashion show online.  Now the company has created a fully interactive experience allowing users to click, drag, and control different views of the collection, products, and models.  The technology was released in conjunction with initial ad imagery for Fall/Winter 2010.


- The award for the most fitting rooms in a single store goes to Forever 21.  The company’s 90,000 square foot Times Square flagship contains 151 fitting rooms! 





Marks & Spencer, H&M, Zara, Wal-Mart, and Carrefour are facing the threat of delays to stock deliveries following the closure of 250 garment factories in Bangladesh.  About 250 garment factories in Bangladesh were shut Tuesday after days of violent protests by tens of thousands of workers demanding better wages.  Workers want three times the current minimum wage of $25 a month. The rate, set by the Bangladesh government, was last raised in 2006.  <fashionnetasia.com> <drapersonline.com>

Hedgeye Retail’s Take: Now in addition to wage inflation (and likely higher prices), we are starting to see supply delays here. We’re not overly concerned for now, but if this issue persists beyond a couple weeks there may be BTS implications, which will step up the urgency to resolve this situation materially. Or this will be an unconventional way to keep inventories tight at retail…


Reebok Creates Hype Around ZigTech, Signs NBA player John Wall - With its ZigTech and EasyTone franchises propelling Reebok in the fitness and training categories, the brand is ready to get back in the basketball game. Reebok officially welcomed future NBA player John Wall to its roster with an estimated 5-year $25 mm deal and unveiled the athlete’s signature basketball shoe, the ZigTech Slash, at a media event in downtown Manhattan Wednesday. Wall, formerly at the University of Kentucky, is expected to be the first-round pick at the NBA draft, to be held later on Thursday. While Reebok has dabbled in basketball in years past — Alan Iverson and Yao Ming have worn the brand — it recently positioned itself more in training and fitness with the EasyTone and ZigTech franchises, which launched this spring. Reebok will debut an ad featuring Wall and the ZigTech Slash on ESPN during Thursday’s draft. A tweaked version of the commercial will run during the major brand campaign — which includes TV, in-store and social media components — to support the shoe’s Oct. 15 launch at retail. <wwd.com/footwear-news>

Hedgeye Retail’s Take: Securing the draft’s most coveted player will provide a significant shot in the arm to Reebok’s recent brand resurgence. Give credit where it’s due – the company is doing a solid job staying front-center of the consumer.


Puma Sees Boost from World Cup - Puma Chief Executive Officer Jochen Zeitz, in an interview with Reuters, said he expects the World Cup to boost sales of the company's soccer business although he gave no projections. Business in Africa have been particularly strong. <sportsonesource.com>

Hedgeye Retail’s Take:  Is anyone surprised that the company’s soccer business picked up as a result of the World Cup?  How about saying it’s better or worse than expected? 


Renminibi's Float Will Have Minimal Impact on Hanesbrands - Hanesbrands Inc. said that China’s decision to allow fluctuation of the Renminbi/yuan currency value will not have a material effect on company performance and will not alter the company’s global supply chain advantages, including its East Asia manufacturing hub. The company said rising cotton,energy and labor costs were having a larger impact. <sportsonesource.com>

Hedgeye Retail’s Take:  More inflation chatter, which is now becoming almost universal.   


Alibaba.com to Buy U.S.-Based Vendio Sales Website for Small Businesses - Alibaba.com Ltd. , operator of China’s biggest online-commerce site, agreed to buy U.S.-based Vendio Services Inc. to expand overseas operations. <bloomberg.com/news>

Hedgeye Retail’s Take:  With U.S investors gaga over China investment and China growth, is an investment in the U.S by a Chinese company met with the opposite response?   


Retailers Win Debit-Card Swipe Fee Battle - Members of the House and Senate announced an agreement to include debit-card fee cuts in the final version of the financial-overhaul bill. Retailers have long sought to reduce the "swipe fees" that credit-card companies charge merchants for every debit-card transaction. <sportsonesource.com>

Hedgeye Retail’s Take: Any lever retailers can use to offset cost inflation is a positive and ultimately for prices and the consumer as well.


H&M Spring Sales Disappointing in Q2 - Hennes & Mauritz AB, the world’s third-largest fashion retailer, said net profits rose 24% in the second quarter, but sales of its spring garments were disappointing due to unusually cold weather in most of its markets. Same-store sales were down by 1% in the quarter, and -4% in May blaming unspecified calendar effects had a negative impact of 3 to 4 percentage units in the month. Total sales grew 6% in May and 22% during the period of June 1-22. Weaker-than-expected spring sales had left it with 2% more stock than last year which H&M acknowledged could lead to a higher price reduction level in Q3 . Gross Margin rose 490 bps, boosted by a weaker dollar, greater surplus capacity at suppliers, lower transportation costs, favorable raw material prices, and efficiencies in the buying process. H&M announced it would enter Croatia and Romania in 2011. <wwd.com/business-news>

Hedgeye Retail’s Take: Despite a reacceleration in sales so far in June, the return of discounting is concerning as western Europe continues to be soft.


China Beckons Mainstream U.S. Retailers - With the country’s middle class growing fast — projected by Euromonitor to total 700 million people in 2020 — companies such as Gap Inc., American Eagle Outfitters Inc. and Bebe Stores Inc. are making their first forays into China. Others, including Guess Inc., Iconix Brand Group Inc. and Levi Strauss & Co., are enlarging their footprints.The activity comes as China has decided to let its currency appreciate gradually against a basket of currencies, including the dollar, which could — along with rising wages for Chinese workers — boost the purchasing power of its consumers and make the world’s most populous nation an even more enticing market. <wwd.com/business-news>

Hedgeye Retail’s Take: This is not exactly new news, growing wealth and a desire for global brands in the most populous country on the planet is an attractive place for any retailer selling just about anything.


Phillips-Van Heusen Corp. Wants to Be # 1 - PVH's ultimate goal is to create the largest, most profitable branded apparel company in the world according to PVH’s chairman and chief executive officer, at the company’s annual meeting. The Tommy Hilfiger business enables PVH to reach for its goal. With PVH at $4.8 bn it surpasses other giants such as Hanesbrands Inc. ($3.89 billion in 2009 sales), Jones Apparel Group Inc. ($3.33 billion) and Liz Claiborne Inc. ($3.01 billion). While PVH hasn’t yet vaulted over Polo Ralph Lauren Corp. at $4.98 billion or VF Corp. at $7.22 billion in annual volume, that is clearly the long-term goal. <wwd.com/business-news>

Hedgeye Retail’s Take:   Don’t underestimate this goal, which more than likely will be achieved through another acquisition down the road.  Recall that just a decade ago, PVH was barely on the radar screen when it was primarily a dress shirt maker.  Interestingly, barring any major changes in strategy, the company will likely have an even more dominant market share position in men’s than it currently has. 


Sears Extends Layaway Program to Home Appliances - The nation’s largest appliance retailer already offers layaway—which allows consumers to set aside store items and pay for them in installments—on fitness equipment, home entertainment and cookware. Now it's including home appliances in the program for the first time. Sears is running in-store ads, as well as ads on its site, Sears.com. One ad, for instance, alerts consumers that layaway is available on both online and in-store purchases. “Reserve great gifts for everyone on your list & make it easy on your budget,” ads read. <brandweek.com>

Hedgeye Retail’s Take: The addition of appliances to the layaway program is another way for Sears to flush inventory that may have built as a result of high expectations following the expiration of federal tax incentives for homebuyers as well as “cash for appliance” rebates.


JCP's Billion Dollar Bet - J.C. Penney is totally overhauling its e-commerce platform, seeking to generate an additional $1 billion a year in web sales within five years. Mobile commerce is a top priority, and the fact that 126 mm (over 40% of the total population) US consumers are expected to own a smart phone by 2013 is a good reason for it. To become a $2.5 billion annual web retailing operation, J.C. Penney is building an entirely new infrastructure for JCP.com using an e-commerce platform from Art Technology Group. <internetretailer.com>

Hedgeye Retail’s Take: While none of this is really new news, the change can’t come soon enough for one of JCP’s largest businesses given its underperformance in e-commerce of late posting LSD growth rates relative to the rest of retail with growth rates well into the double-digits.

 R3: A Few Points on FINL - 4 


Iconix Strengthens Candie's Brand in China - Iconix China Limited, a 50-50 joint venture between Iconix Brand Group and Novel Fashion Brands, has partnered with Shangai La Chapelle Garment and Accessories and private equity firm Trust Bridge Partners to open free-standing specialty and franchise Candie's stores across Greater China. The first free-standing Candie's store will open this August in Shanghai, followed by a total of 50 openings by the end of the year in Shanghai. Beijing, Chongjing and other cities. Within the next five years, Iconix plans to open more than 500 Candie's stores throughout China. With this new agreement and the recent acquisition of the Peanuts brand, Iconix's presence in Greater China is predicted to grow to approximately 1,700 stores and more than 3,300 other points-of-sale in the next three years. The Peanuts brand's presence in Greater China includes 700 Snoopy Stores, Charlie Brown Cafes and Snoopy Bakeries. <licensemag.com>

Hedgeye Retail’s Take: While 0 to 500 stand-alone stores sounds like an aggressive ramp, it represents roughly a 3-4% store growth CAGR off of ICON’s already existing base in China. More importantly, the move appears to be leveraging the first of what is sure to be many relationship synergies from the Peanuts brand acquisition.


Perry Ellis Cancels Men's Accessories and Leather Goods Licensing Agreement - Perry Ellis International and Westport Corp. agreed to not renew their license agreement for men’s accessories and leather goods, including wallets, bags and gift sets under the Perry Ellis brands. The license expires on Dec. 31, after which PEI will take the category in-house. <wwd.com/business-news>

Hedgeye Retail’s Take: Accounting for nearly 50% of PERY’s EBITDA, taking the accessories business in-house will enable the company to take greater control over the international business and perhaps return growth to the top-line.


Merrell Teams Up With Vibram For a Barefoot Shoe Exclusive - Merrell plans to enter the barefoot category through an exclusive collaboration with Vibram, well known Five Fingers barefoot concept.  <sportsonesource.com>

Hedgeye Retail’s Take: Considering that Vibram Five Finger barefoot shoes are wildly successful and difficult to find in stock at any running store, this is an initially small but potentially powerful collaboration for WWW's Merrell brand.


Weby Corp Wants to Become 'Zappos' of Outdoor Inudstry - Weby Corp outdoor retailer launches its first niche category site www.Riflescopes.Webyshops.com. The site, which sells riflescopes, binoculars, spotting scopes, laser rangefinders, night vision, dog training collars, flashlights, trail cameras and other outdoor merchandise, is focused on the American market. <sportsonesource.com>

Hedgeye Retail’s Take:  For hunting enthusiasts this is good news.  For the incumbent, Cabela’s, this is not good news.   


Honda's Yellow Mizuno Boots Selling Out as Japan Advances at World Cup - Mizuno Corp. , which supplies sports gear to some members of Japan’s national soccer team, said the yellow boots worn at the World Cup by star player Keisuke Honda are proving so popular that some stores are running out. <bloomberg.com/news>

Hedgeye Retail’s Take:  Does this imply that people are actually buying the boots and wearing them around town?  Perhaps interest in soccer is picking up just so consumers have a place to wear the yellow boots! 


Hispanics Inclined to Use Mobile Phone For M-Commerce - Like many Americans, Hispanics love their mobile phones and take them everywhere, more than non-Hispanic whites and, in many cases, more than blacks. Hispanic mobile phone users are younger than the Hispanic Internet population, according to eMarketer estimates and comScore: 50.7% of mobile phone users are between 18 and 34 years of age compared with 35.6% in the same age group among Hispanic Internet users. The Hispanic mobile phone population skews even more male than the general population: 55.6% of mobile phone users are male, compared with 51% of males in the Hispanic population. <emarketer.com>

Hedgeye Retail’s Take: Knowing that PSS has been targeting Hispanic moms in its marketing, a move to mobile seems like a no-brainer.

R3: A Few Points on FINL - 5


Online Retail Sales Growth Fun Fact - FYI, online retail sales have grown every year since 2000 with the past 4 years gaining $28.3 bn. From 2000 to 2007 online retail sales grew an average of 20% each year. <internetretailer.com>

Hedgeye Retail’s Take: We question the sample set here as most of retail seems to be printing e-commerce growth rates north of 10% with laggards in the LSD range (see JCP comments above). The bottom-line here is that growth is not as easy to generate as it once was.  This is when we’ll start seeing retailers with best-in-class platforms start to really outperform compared to those that simply have an online presence.

R3: A Few Points on FINL - 6





The Macau Metro Monitor, June 25th, 2010



 IM would not be surprised if Adelson decides to scratch Lots 7&8 off and focus on other Asian opportunities such as those in India, Japan, and Korea. Focused on the higher margin mass and premium-direct businesses, the Venetian, Plaza, and Sands casinos have been steadily losing share of rolling-chip junket play in recent months due to their stubbornness in not discounting heavily enough to the junkets. However, increasing the junket discounts would also mean increasing direct VIP rebates, which would hurt margins.  IM believes Adelson may throw in the towel and give in to higher commissions if Sands China's market share falls below 20% this month.



In May, MGM Macau recorded a 30% jump in mass.  Why?  IM attributes the rise to higher hold, traffic from Encore opening (MGM's entrance sits directly across the road), easy comps, and perhaps, the mass floor reaching critical mass.  IM also believes strong mass numbers from Grand Lisboa bodes well for Wynn, MGM ,and Sands.


Statistics released by the Zhuhai government showed that the property market in Zhuahai saw average prices drop 12% in May, compared with April.  Trading volume tumbled 50% from 2,585 to 1,327 transactions.

Seeing Housing As It Is

“Some men see things as they are and say why.  I dream things that never were and say why not.”

-Robert F. Kennedy


Keith is out this morning, so I’ve been handed the pen on the Early Look.  I will start with this simple admission: getting up every morning and writing an investment strategy note every morning is not an easy thing to do.  Now you know.


Luckily, our Financials Sector Head Josh Steiner is providing ample and interesting fodder for me this morning.  He and his team are hosting a call this morning on the U.S. housing market at 11am eastern.  The title of the call is, “Housing Double Dip: A Game Changer for Financials.”  And the title basically says it all.


Suffice it to say, despite many investors “seeing housing data points as they are”, Josh and his team see the housing market “as it never was.”   In this context, “never was” means a potentially serious double dip.  If you are a qualified institutional prospect and would like to dial in to the call, please email us at .


We have started to see data points that reflect a slowing of the domestic housing market.  In fact, on Wednesday, new home sales collapsed coming in at 300K, which was down 40% month-over-month.  In terms of context, this was the worst new home sales number since 1963, which was when record keeping began.  So, this was the worst number . . . ever.  And ever, as they say, is a long time.


The housing bulls, or even those that don’t buy into the double dip call, rightfully note that this recent data has turned negative in conjunction with the expiration of tax credits.  And, ostensibly, they are correct. This expiration likely does account for the extreme negativity of the these recent data points, but let’s also keep in mind that mortgage rates, so affordability from a financing perspective, remains at near all time lows, which one would expect to continue to encourage purchasing.


In the Chart of the Day below we’ve highlighted MBA Mortgage Purchase Index Applications Indexed to 100 from the start of 2010.  For the past four weeks, mortgage applications have been down -33%, -28%, -29%, and -30% week-over-week sequentially.  Mortgage applications are, obviously, leading indicators for housing purchases.  These applications are clearly indicating it is going to be, at the very least, a long hard summer for home sales.


Without stealing his thunder, and the thunder of the 100+ page presentation he and his team have put together, I think it’s fair to say Josh’s view will be much more draconian than just a tough summer for housing.  Three key points that will be highlighted in the presentation and conference call are:


1)      Housing supply is near record highs and demand has fallen to levels of the mid-90s, which will have a direct and negative impact on housing prices given the high correlation between demand and future pricing with an r-squared of 0.80.

2)      Economics are interconnected, and the decrease in demand is being driven by tight lending standards and an abysmal employment market that shows underemployment at more than 16% currently.

3)      Supply of housing is in the top two deciles of inventory levels, and historically prices have typically fallen more than 15% over the following 15 months when at these levels.  The correlation on an r-squared basis of supply and future pricing is 0.83.


The points above are negative in and of themselves, but there is also a macro elephant in the room in the way of shadow inventory.  Based on our estimates, there are an additional almost 6 million homes of potential shadow inventory on the market.  This is based on looking at homes in foreclosure or mortgages that are seriously non-current (multiple months of being non-current).


One of the primary issues with the case outlined above is that it is likely there is another leg down in housing prices to the tune of double digits.  This creates negative equity, and negative equity changes behavior of home owners.  According to a quote from CoreLogic on 2/23/2010:


“Once negative equity exceeds 25 percent or $70,000, owners begin to default with the same propensity as investors. The aggregate dollar value of negative equity was $801 billion in 4Q09. The segment of borrowers that are 25 percent or more underwater account for over $660 billion in aggregate negative equity.”


In effect, as homeowners get dramatically underwater, their psychological perception of their home changes and they view it more as an investment in which they may have to sell to cut losses.   As negative equity increases so does the propensity to default.  This creates even more home inventory.  According to Josh’s estimates, almost 4.9 million people are underwater by more than 25%.  Not good.


After painting a completely morbid picture of housing, I’ll leave you with a slightly more inspirational quote from Robert Kennedy:


“All of us might wish at times that we lived in a more tranquil world, but we don’t.  And if our times are difficult and perplexing, so are they challenging and filled with opportunity.”


We do not live in easy times, but opportunities to make money and protect our capital remain abundant.


Keep your head up and stick on the ice,


Daryl G. Jones

Managing Director


Seeing Housing As It Is - p

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