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Misconceptions

“I believe that misconceptions play a large role in shaping history.”

-George Soros

 

That was my favorite quote from an important speech that George Soros gave at Humboldt University in Berlin on June 23, 2010, where he warned of many of the misconceptions associated with the credibility of sovereign debt. He is one of the few global macro analysts in this game who got this latest down move right. Well done, Sir Soros. Well done.

 

Like any great top-down analyst, Soros started his analysis by taking a step back, looking at the timeline of the crisis of confidence in Lehman Brothers. Then he took a step forward, using past market behavior as his guide. This is what we call proactively managing global macro risk with a behavioral bent.

 

If you wake up every morning accepting that the Officialdoms of Wall Street and Washington are all about storytelling, you put yourself in a much better position to understand that their “misconceptions play a large role in shaping history.”

 

Soros formally calls this “Reflexivity”…

 

“Reflexivity asserts that prices do in fact influence the fundamentals and that these newly-influenced set of fundamentals then proceed to change expectations, thus influencing prices; the process continues in a self-reinforcing pattern. Because the pattern is self-reinforcing, markets tend towards disequilibrium. Sooner or later they reach a point where the sentiment is reversed and negative expectations become self-reinforcing in the downward direction, thereby explaining the familiar pattern of boom and bust cycles.” (George, Soros (2008). "Reflexivity in Financial Markets". The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What it Means (1st edition ed.). PublicAffairs. p. 66).

 

Hedgeye calls this Prices Rule Risk Management. We believe that marked-to-market prices are not only leading indicators for future events; they perpetuate those events. Using this framework, our daily risk management plan is to change the plan as prices change.

 

Now that stock market prices from China to the USA are hitting lower-lows, you can bet your Madoff that the consensus storytelling on Wall Street will become bearish (this week’s II Bullish to Bearish Survey saw the Bears rise from 31% to 33%, which still isn’t Bearish Enough, but we’re getting there).

 

Eventually, Washington will follow Wall Street’s lead and start fear-mongering the citizenry into a “Third Depression” so that Professional Politicians can up government spending again. In the meantime, everyone who is long and wrong will just revert to blaming the Europeans and high-frequency traders.

 

After the 6th US market down day in the last 7 and a fresh YTD closing low of 1041, the SP500 is down -6.6% for 2010. While that’s hardly a YTD down move of consequence when you compare it to the leaders of the 2010 toilet bowl (bottom 3 countries YTD = Greece -33.2%, China -26.8% and Spain -22.6%), the SP500 is finally teetering on what our Hedgeyes call a crash relative to expectations (a peak-to-trough drop of 20% or more).

 

Since its recent bear market cycle closing high of 1217 on April 23rd, the SP500 has lost -14.5% of its value. With our immediate term TRADE target for the SP500 down at 1018, we don’t foresee a crash coming in the immediate term (1018 would imply a -16.4% correction). That said, with the intermediate and long term TREND (1144) and TAIL (1091) levels in the SP500 broken, anything can happen.

 

In the US, the biggest misconceptions that we have been hammering on are largely concerning expectations for US growth and deficit spending. Combined, lower than expected GDP growth and higher than expected deficit spending, these 2 factors will continue to play a significant role in shaping the history of markets. History, after all, gets marked-to-market as of yesterday’s closing price.

 

We’ll go through our multi-factor/multi-duration risk management model in tomorrow’s Q3 Hedgeye Macro Theme Conference Call where we’ll introduce a new quarterly theme called “Bear Market Macro” (email if you’d like to participate). The slide deck will provide you with the kind of macro analysis that market practicioners use, fully loaded with probabilities, ranges, and levels.

 

Yesterday, we took the market’s weakness as an opportunity to cover some shorts: American Express (AXP), New York Bancorp (NYB), and Consumer Staples (XLP).  On weakness, we bought Under Armour (UA) and the Brazilian Real Fund (BZF), taking our allocation to International Currencies up to 21% from 15% (and our cash position down from 70% to 64%). We like currencies where the government that houses them (China and Brazil) respects the cost of capital.

 

The US market should bounce today, and you should take that as one more opportunity to take advantage of consensus misconceptions about US growth. Remember, short term bear market bounces can often be more forceful than bull market ones. Our macro model is flashing immediate term support and resistance levels of 1018 and 1085, respectively. Manage your risk around that range.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Misconceptions - soros


US STRATEGY – FOLLOW THE LEADER

After setting off yesterday’s meltdown in the S&P500 (down 3.1% yesterday), China closed down another -1.2% overnight to new YTD lows of -26.8%.  China continues to flash a very negative leading indicator for global growth. 

 

The Conference Board issued a press release stating that due to a calculation error the originally reported April LEI for China was incorrect. The correct April LEI for China was +0.3% vs. originally reported +1.7% and March +1.2% and February +0.4%. This change raised questions about the strength of economic growth in China.

 

Copper is confirming the slowing growth story, led by China.  Yesterday, copper traded down 5% to close at $2.93 per pound.  Year-to-date, copper is down 12.5% and is broken on TRADE and TREND.   The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade ($2.84) and Sell Trade ($2.98).

 

This down move was quickly compounded when the Conference Board released the June number in the US.  After rising for the past 3 months, consumer confidence fell to 52.9 in June; much lower than consensus 62.5 and prior 62.7 (revised from 63.3). The decline was driven largely by increasing concerns related to jobs and income.  Present Situation was 25.5 vs. prior 29.8 (revised from 30.2); Expectations was 71.2 vs. prior 84.6 (revised from 85.3).

 

The Euro moved lower by 0.7%, but is rallying in early trading today.  The EURO was pressured on concerns surrounding the expiration of the ECB’s 12 month liquidity facility and the consumer uprising in Greece.  The Hedgeye Risk Management models have the following levels for the EURO – Buy Trade ($1.22) and Sell Trade ($1.24).

 

Treasuries were stronger yesterday; the yield on the 2-yr is within record territory and the yield on the 10-yr dropped below 3%. The dollar index traded up 0.4% on the day and the Hedgeye Risk Management models have the following levels for the USD – Buy Trade (85.28) and Sell Trade (86.57).  The VIX surged 17.1%, and is now up 26.2% over the past five trading days.  The Hedgeye Risk Management models have the following levels for the VIX – Buy Trade (30.87) and Sell Trade (39.90).

 

Yesterday, all sectors were down led by Energy (XLE -3.9%) and Materials (XLB -3.7%).  On a relative basis, the best performing sectors were Consumer Staples (XLP - 1.6%) and Healthcare (XLV -1.8%). 

 

The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,226) and Sell Trade (1,258). 

 

After trading down to $76 yesterday, crude is trading higher for the first time in three days.  The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (74.83) and Sell Trade (79.36).  

 

As we look at today’s set up for the S&P 500, the range is 67 points or 2.2% (1,018) downside and 4.2% (1,085) upside.   Equity futures are trading above fair value, on a light day for macro news.    

 

Howard Penney

 

US STRATEGY – FOLLOW THE LEADER - S P

 

US STRATEGY – FOLLOW THE LEADER - DOLLAR

 

US STRATEGY – FOLLOW THE LEADER - VIX

 

US STRATEGY – FOLLOW THE LEADER - OIL

 

US STRATEGY – FOLLOW THE LEADER - GOLD

 

US STRATEGY – FOLLOW THE LEADER - COPPER



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GREECE: A SIGN OF THINGS TO COME?

The headlines in Greece today suggest that social unrest is far from over.

 

Here are just a few of the headlines in Greece this morning:

“Greek Protesters Warm Up Ahead of New Nationwide 24-hour General Strike”

“Greeks Strike to Protest Pensions, Labor Law Overhaul”

“Youths Clash With Police As Greek Unions Strike Over Proposed Reforms”

 

Looking at the Greek CDS numbers, the probability of default is well above 60% and the Greek market is the worst performing equity market on the planet (China is next followed by Spain).  The citizens of Greece are speaking out loud and clear yet there is nothing the government can do; they are handcuffed by a leveraged balance sheet. 

 

The equity market in the USA is only just beginning to reflect the harsh reality of out leveraged balance sheet.  At the time of writing the S&P 500 is trading at 1,047.  If it closed below 1,051 there is no support to 1,018…

 

As I said in the Early Look today, one of the most poignant Hedgeye sayings is “austerity equals civil unrest” and civil unrest is in full force in Greece.  Spain is not far behind.  When a country is mismanaged, it can only end BADLY.

 

Howard Penney

 

GREECE: A SIGN OF THINGS TO COME? - c11

 

GREECE: A SIGN OF THINGS TO COME? - c22


Chinese Ox . . . Boxed By Leading Indicators

Conclusion:  Consistent with prior Hedgeye research, Chinese leading indicators indicate a forthcoming slowdown in economic activity in China.

 

The Conference Board’s Leading Economic Index for China was revised lower today to 0.3% from the prior report of 1.7%.  The key change in the data was the calculation of Total Floor Space Started.   Originally this data was reported to have contributed 1.3 percent, but was revised lower to negative -0.1% in April.

 

In April three of the six components that make up the LEI increased.  These positive contributors were: PMI supplier delivery index, total loans issued by financial institutions, and the raw materials supply index.  Conversely, the three components that declined in April were: consumer expectations, the PMI new export order index, and the total floor space started (as noted above).

 

With April’s gain, the six-month annual growth rate of the leading economic indicators continue to moderate, down to 3.3% (a 6.8% annual rate).  This is a marked deceleration from the prior six months period, which grew 4.9%, or 10.0% on an annualized basis.

 

Clearly, we are starting to see evidence of the Chinese government’s cooling measures, and that the second derivative of Chinese growth has peaked.  The question remains: Is this priced in?

 

On June 10th, we wrote a note that concluded, “China is starting to look interesting on the long side, as the stock market has priced in slowing economic growth.”  Based on the price action over night in China, the Shanghai Composite was down over -4%, the answer seems to be clear.

 

The combination of the downwardly revised leading indicators and the fact that the Agriculture Bank of China (the third largest lender in China) capped its IPO at a lower than expected range (signaling lower demand for Chinese equities than expected), suggests that Chinese equities are still better for sale.

 

Daryl G. Jones
Managing Director

 

Chinese Ox . . . Boxed By Leading Indicators - 1


R3: Q1 Retail Outliers

R3: REQUIRED RETAIL READING

June 29, 2010

 

A tough 2H10 for US retail is not a difficult concept to internalize. But the value for us is to increasingly pick out those companies who are showing the biggest change on the margin, and face the most positive/negative setup into 2H.

 

 

TODAY’S CALL OUT

 

Things are not looking pretty for the Softlines Industry as it relates to the back-half setup. That’s not a difficult sell for us. But the value for us is to increasingly pick out those companies who are showing the biggest change on the margin, and face the most positive/negative setup into 2H.

 

Here is a quick overview of how to read the chart: the vertical axis illustrates the difference between sales growth and inventory growth, while the horizontal axis represents the year to year change in the operating margin. We then plot the past 8 quarters of data to the trace historical trend (that’s the yellow line in the chart below). The punchline is that companies should always strive to be headed to the upper right hand quadrant (sales outpace inventories and margins up). The background to the SIGMA chart has the year to year changes in gross margin and SG&A margin, along with a line representing capex as a percent of sales on a trailing twelve month trend. This allows us to track margin and cash flow compares we’re looking at on a quarter‐to‐quarter basis.

 

R3: Q1 Retail Outliers - 1

 

Today, we are looking at 73% of the 109 companies we monitor lying in the ‘sweet spot’ (sales growth outpacing in inventory growth, and margins headed higher), which is up from a mere 50% in 3Q F09 and the 61% in 4Q F09. With favorable comps in the rear-view for most companies, it’s now time to comp against more challenging Quadrant 1 compares proving either a multi-year margin expansion process is indeed under way, or fall victim to SIGMA gravity and a round trip to Quadrant 3 – the inevitable outcome for most retailers who are more dependent on the fate of the consumer instead of proactively driving their own business.

 

Within each quadrant, here is a list of those that we think stand out as it relates to how the P&L and Balance Sheet are triangulating with expectations heading into the second half of ’10.

 

R3: Q1 Retail Outliers - 2

 

As one might imagine, the stock performance associated with moves from one quadrant to the next are meaningful. Whenever a company moves out of Quadrant 1 – or even heads to a less attractive place in that quadrant we normally see an associated negative stock move. And I’m not saying ‘sometimes it is a negative‐ish move.’ We’re talking a .90x R2 with the average move squarely in the double digits.

 

We have a SIGMA book with 109 companies, which helps our team (and our exclusive Retail vertical subscribers) focus on which companies are interesting and at what time they become actionable. Let us know if you’re interested.

 

R3: Q1 Retail Outliers - 3

 

Casey Flavin

Director

 

 

LEVINE’S LOW DOWN 

 

- After a successful collaboration with Target earlier this summer, Liberty of London has sold itself to private equity firm, BlueGem. The retailer is known best for turning itself around through successful and plentiful collaborations with numerous brands including Manolo Blahnik, Nike, and of course Target.

 

- Best Buy’s Twelpforce Twitter service received the Titanium Grand Prix award for its innovative efforts to improve customer service via technology. The jury went on to describe the Twitter effort as a “business changing idea”, something we agree with. The ability to Tweet a question to a live person, have it distributed amongst a sizable network of qualified customer service agents, and to get a credible (and non-computer generated) response truly is a new standard for which consumers can hold retailers accountable.

 

- A sneak peak of Abercrombie’s upcoming re-launch of its “Quarterly” reveals a throwback to the racy imagery of years past. Ironically, the magalog exists to sell apparel, while it appears that the models are wearing very little.

 

 

MORNING NEWS 

 

Prada Eyes IPO in Q1 2012 - While the brand has been down this road before, the company has several reasons to make it happen on the fourth attempt. First, the timing coincides with the expiration of Prada’s loan of 450 mm euros granted by a string of banks. Second, Prada’s business continues to boom. According to a spokesman, the Prada Group today is valued at 3 to 4 bn euros. While the IPO will depend, as always, on market conditions, Prada is reaping the benefits of its plan to invest in directly operated stores. The aim is to generate more than 70% of consolidated turnover from directly operated stores next year. <wwd.com/business-news>

Hedgeye Retail’s Take:   Again the timing is beginning to become suspect as macro headwinds build.  With that said, this is still one of the few iconic luxury brands in private hands.  Perhaps Mr. Armani will be watching this one real closely. 

 

Retailers Still Slow to Mobile Commerce - Nearly two-thirds of apparel, accessories and footwear retailers either don’t have a mobile-commerce strategy in place or are just getting started on one, according to a study on “The State of Online Retailing” released today by Forrester Research Inc. and Shop.org. 15% of the 26 apparel, accessories and footwear retailers included in the study said they had no mobile strategy, and another 50% said their strategy was at an early stage or just being developed. 19% said they had a strategy in place and were implementing or refining it, 12% said they had a strategy and were starting work on implementing it and 4% said they had a strategy. Overall, the study said, mobile is responsible for 2.8% of online retailers’ site traffic and 2% of their Web revenue. <wwd.com/business-news>

Hedgeye Retail’s Take:  Given retail’s track record on embracing technology, none of this is surprising.  Until there is a more defined mobile platform, it’s likely that the industry treads lightly before committing meaningful capital to mobile efforts.  With that said, mobile commerce is all about customer satisfaction, something most retailers still have an opportunity to improve upon. 

 

US Slow to Join Trade Agreements - Regional and bilateral trade agreements are proliferating worldwide without American involvement, raising industry concerns the U.S. could fall behind in the race for global trade benefits. U.S. sentiment toward trade agreements has soured in many parts of the country, making it politically challenging to move forward with new pacts. At risk for apparel companies is access to export markets and the availability of production capacity with key suppliers. Even retail sales in stores overseas could be impacted if U.S. companies were forced to compete with firms from countries with better trade benefits in a specific market, experts said. While nations around the world are rapidly signing as many agreements as they can negotiate, the U.S. has initiated one new negotiation to join the Trans-Pacific Partnership, a process that sources expect could take several years to complete. <wwd.com/business-news>

Hedgeye Retail’s Take:   It’s one thing to protect U.S jobs, but another to protect jobs in an industry that barely exists today.  The fate has been sealed for domestic apparel manufacturing and it certainly would be more useful for politicians to spend their time elsewhere. 

 

PVH to Push European Presence Through Key Show in Berlin - On July 7, Calvin Klein will stage its first multibrand presentation in Germany at Die Muenze. Lacoste, meanwhile, will launch its Legends footwear collection at Bread & Butter. The Bread & Butter is one of the most important fashion fairs in Europe, with a lot of visitors mostly from the clothing area coming from many European countries, including Germany, Holland, France, Italy, Spain and the U.K. <wwd.com/footwear-news>

Hedgeye Retail’s Take:  Don’t chalk this up to being an irrelevant European show. A coordinated effort in a forum that is as meaningful as the Vegas/MAGIC show makes sense to us.   

 

High Court Strikes Down Chicago Gun Ban, Says 2nd Amendment Applies Nationwide - In a recent development of significant relevance to the firearms community and otherwise, the United States Supreme Court has ruled to strike down the ban of private ownership of firearms in Chicago, IL, an historic decision that will have monumental implications across the nation.  <sportsonesource.com>

Hedgeye Retail’s Take:   Some are speculating that the strength in firearm’s sales could slow even further, as the rush to buy firearms ahead of potential law changes no longer exists. 

 

Former G.I. Joe's Managers Loses Lawsuit to Regain Name - Four former executives of G.I. Joe's have been thwarted in their attempt to bring back the Pacific Northwest chain. Ron Menconi, Joe's former vice president of marketing and merchandise who had served as the new company's president, told The Oregonian, "All I can say is that our project is not going forward. We're not bringing back the company, let's put it that way. We're very disappointed." <sportsonesource.com>

Hedgeye Retail’s Take:   Valiant effort, but did it really make sense to bring back a brand that failed and would now have to compete with Dick’s?

 

Adidas Aims to Keep Leadership in Golf Market With Radar Analysis of Swing - Adidas AG , the maker of TaylorMade golf clubs, said it plans to maintain its newfound position as the sport’s biggest supplier with the help of computer images and radar systems that analyze players’ swings. <bloomberg.com/news>

Hedgeye Retail’s Take:   Innovation is the only way golf will grow, so we say bring on the radar.  It will be interesting to see which retailers embrace the swing equipment.  Historically these gimmicks end of being out of service more than not, leaving the consumer disappointed and the stores cluttered with old equipment. 

 

Uniqlo Broadening Asian Presence By Entering Malaysia - Uniqlo’s corporate parent Fast Retailing Co. Ltd. said Tuesday it has formed a joint venture with DNP Clothing Sdn Bhd to open and operate stores in the Southeast Asian nation. Uniqlo is shooting to open its first store in the country this fall or winter, a spokeswoman said. She added that it is too soon to estimate how many more stores the brand will roll out in Malaysia. Fast Retailing owns 55% of the joint venture. Uniqlo is ramping up its presence in Asia. The fast-fashion brand, which is known for its affordable basics and fabric innovations, will open its first store in Taiwan sometime this fall. Its existing retail network includes stores in Hong Kong, Mainland China, South Korea and Singapore. <wwd.com/business-news>

Hedgeye Retail’s Take:  World domination continues!  Expect to see Uniqlo everywhere it makes sense, as the company heads towards its goal of being the world’s largest apparel retailer.

 

Macy's Ramps Up Destination Maternity Apparel Partnership - Macy’s Inc. on Monday revealed a deal to sell Destination Maternity Corp.’s apparel in more than 615 department stores by the end of February. The Philadelphia-based maternity clothing retailer currently has leased departments in 113 Macy’s stores. In other news, Destination Maternity is collaborating with Reebok on a collection of maternity activewear that will be available exclusively at the company’s Motherhood Maternity and A Pea in the Pod stores following a September launch. <wwd.com/business-news>

Hedgeye Retail’s Take:  Another point of differentiation, this time for expecting moms.  Clearly the partnership was already working given the partnership is expanding beyond the original arrangement.

 

KSS's Britney Spears New Candies Line - Kohls will unveil on Thursday a limited edition, co-branded collection from Candie’s, and Spears, who, over the past couple years, has rehabilitated her image from that of a head-shaving, umbrella-wielding, Kevin Federline-divorcing basket case back into a chart-topping pop star who sold out arenas in her highly successful 2009 “Circus” concert tour. Despite Spears’ checkered image, Kohl’s and Candie’s are betting she can lure her legions of fans — this summer she became the first person ever to reach five million Twitter followers — into stores to buy the new Britney for Candie’s sportswear, handbags and jewelry collections. The collection includes three deliveries, in July, September and October, with all merchandise retailing for $14 to $78. <wwd.com/retail-news>

Hedgeye Retail’s Take:    Is Britney still relevant to the core Candie’s customer?  We suspect there is a new Candie’s girl on the horizon…

 

Heely's to Role Out New Shoe - Next month will roll out a new shoe style called the Hx2, aimed at a younger market. Unlike Heelys’ current single-wheel styles, the Hx2 features two removable wheels in each shoe, making it easier for younger kids to maintain balance. It also does not require as much leg strength for heel skating. Two-wheel versions of Heelys have been popular in Japan for some time, with sales last year surpassing 300,000 pairs. However, the Hx2 marks the first two-wheel Heelys style available in the North American market. <wwd.com/footwear-news>

Hedgeye Retail’s Take:  If the original shoe was controversial at times due to safety concerns, we wonder how an even younger target audience is going to stay injury free?

 

Buy.com Adds Households Essentials to its E-commerce - Buy.com has launched a new Households Essentials section of its e-commerce site that will offer consumers such everyday items as toothpaste and laundry detergent. The goods will be sold by Alice.com, a startup that works with consumer goods manufacturers to sell their products directly to consumers via the web. Buy.com’s Households Essentials store will offer nearly 8,000 SKUs. <internetretailer.com>

Hedgeye Retail’s Take:   As long as there is free shipping we can see buying these small ticket items online.  With the CPG companies behind Alice.com, we suspect the pricing will be compelling as well.


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