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R3: Football & Fung

R3: REQUIRED RETAIL READING

July 8, 2010

 

We’re going with two call outs today…and they have nothing to do with Same Store Sales. The first is a glimpse into recent activity at Li&Fung, which is one of the best global long-term investment stories I have seen in years. The other is Italy, which has resorted to blaming €140mm on its Football team.

 

 

TODAY’S CALL OUT

 

Li & Fung Hot With Activity - Hong Kong-based sourcing giant Li & Fung said Thursday it has made three acquisitions over the past two months and struck a series of licensing deals in an effort to boost its market share and profitability. The company said it has bought the following companies for an initial cash consideration of $140 million: The Hong Kong-based Jackel Group, a player in the beauty and packaging industries; HTP Group, a Hong Kong-based denim specialist; and nearly all of the assets of Cipriani Accessories Inc. and its affiliate The Max Leather Group. Li & Fung said it has signed four additional licensing deals: a pact with celebrity stylist Rachel Zoe to launch a new contemporary collection, an expansion of its existing licensing deal with martial arts apparel maker Tapout to include men’s and junior’s sportswear, the formation of a new company with Star Branding to create new lifestyle concepts, and a new licensing deal with Sean Combs’ Sean John label for sportswear and active wear.  <wwd.com/business-news>

Hedgeye Retail’s Take: In the world of global retail, I can not find a better structural story than Li&Fung. As a 20-year trend of outsourcing and offshoring to China by US companies leveraging the US$ as the world’s reserve currency comes to an end – and reverses – LF is the only company that will win consistently. Small acquisitions into ancillary areas on which to leverage sourcing infrastructure makes a ton of sense to me. And that’s coming from someone that rips apart 9 out 10 acquisitions that comes across the retail tape.

  

Italian Retail Troubled by Economy, World Cup Woes - Local retailers in Italy are claiming to have a hard time meeting sales targets as consumer is failing to buy in the summer months due to weather, lack of confidence, and World Cup woes. The summer sales season, one of two times each year when retailers like Benetton and Prada mark down prices, normally accounts for about 12% of annual Italian revenue for the clothing and shoe industries. This year’s sales period coincides with unemployment at an 8-year high, consumer confidence slipping to a 16-month low in June and hotter-than- average temperatures in city centers from Milan to Rome. <bloomberg.com/news>

Hedgeye Retail’s Take: Italy takes the cake – twice. First by flopping out of the World Cup. Then by actually quantifying the impact on its economy of the failure of its football team to perform – 140mm Euro.  Let me get this straight…that’s 8.5% of GDP. For losing to Slovakia and drawing vs. New Zealand??? I know Americans don’t ‘get’ football. But c’mon. They can hardly quantify their unemployment rate nevermind the consumption impact of World Cup. Let’s get real.   

 

 

MORNING NEWS 

 

JJB Sports Experienced Nice Lift from World Cup - British sportswear retailer JJB Sports, which avoided administration last year, said sales have continued in line with expectations even after England's premature exit from the soccer World Cup. The company, a seller of England soccer kits as part of its World Cup range, said comps in the six weeks to July 4 jumped 22.3%, while gross margins surged. Cumulative like-for-like sales from Feb. 1, the start of the financial year, to July 4 rose 12.1%.  <reuters.com>

Hedgeye Retail’s Take: Spain/Netherlands is a dream matchup for Europe. But what’s next?

 

Uniqlo's Parent Fast Retailing Company Cuts Full Year Forecasts - Fast Retailing Co. Ltd. saw double-digit growth in the first nine months of the year but uneven sales of its spring items forced the company to cut its full-year forecasts, just months after raising estimates in April. The Japanese company’s monthly sales performance so far this year has been mixed, an outcome the company has blamed on unseasonably cool spring months and problems keeping some popular spring styles in stock. <wwd.com/business-news>

Hedgeye Retail’s Take: You know what this means? Yes, they’ll pick up the deal cadence.

  

Twitter Enters E-Commerce - Twitter is launching @earlybird, its own take on popular daily deal sites such as Rue La La or Gilt Groupe that offer limited-time sales at deep discounts. Twitter has not elaborated on the types of deals it might promote, but it did say that initially the offers will be from large, international brands or focused on the U.S. market. Participating retailers will set the terms of the offers, including the availability, amount offered and price. <internetretailer.com>

Hedgeye Retail’s Take: T’was a matter of time.

 

DKNY Opening in Singapore - DKNY Jeans International will unveil a new retail concept with today’s opening of a Singapore boutique. Located in the city’s Paragon Shopping Center, the new store will be a prototype for other DKNY Jeans freestanding units and concept shops. The company plans to unveil boutiques in Jakarta, Indonesia; Hong Kong; Beijing, and Sydney, as well as concept shops in China, Taiwan and Thailand. The company operates and distributes to 160 DKNY Jeans freestanding, shop-in-shop and multibrand stores. At this point, 11 new concept stores are expected to open by next year. <wwd.com/retail-news>

Hedgeye Retail’s Take: This makes sense. DKNY has been around for about 20 years now, which is like forever in the fashion world. All along it has maintained relevance as a global brand.

 

Target Prepares for Shaun White Shoe Line - The premiere collection of Shaun White shoes is set to hit Target stores nationwide and online at Target.com the week of July 11th. Shaun White shoes, an expansion to his line of clothing with Target, features a variety of skate and lifestyle shoes for boys and young men.  <sportsonesource.com>

Hedgeye Retail’s Take: You gotta love this kid… What’s interesting is that White’s apparel line did not sport a logo. He purposely minimized any glaring logo to maintain some form of anti-establishment status. Not quite sure if that will work with footwear. In fact, his Red Bull commercials have a very ‘big business’ slant that augers to him going more mainstream. But mark my words, this is as important a launch to watch (for Vans, Converse, Nike 6.0) as some of the Asian brands coming into the US.

 

Cornell University Drops Nike Contract Due to Honduras Labor Dispute - Without "significant progress" toward the resolution of an ongoing labor dispute in Honduras, Cornell University said last week it will follow the University of Wisconsin at Madison's lead and end its licensing agreement with Nike by the close of the year. In April, UW became the first university to cancel its contract with Nike over a contractor's treatment of workers in Honduras. <sportsonesource.com>

Hedgeye Retail’s Take: After all the progress Nike has made, this is yet another sign showing how hard these reputations are to shape. Let’s hope that these Universities don’t do any business with Gildan – who is massively overweight Honduras.

 

Who Spends Most Time on Facebook? - Age, income and ethnicity all play a role in how much internet time users spend on the social giant. And marketers may find the heaviest users the most valuable to target. <emarketer.com>

Hedgeye Retail’s Take: I have no clue what the investment significance is of this chart. But thought it was interesting from a social networking standpoint.

 

R3: Football & Fung - R3 7 8 10


TO BE OR NOT TO BE TAX FREE

As fiscal losses mount at the local level and the back to school season begins,  the discussion surrounding tax free holidays is building.   Some states view these holidays a stimulus to help local businesses and consumers while others are clearly seeing incremental sales tax as a source of revenue.  As we head into the critical back-to-school selling season, it’s important to understand what’s different this year vs. last from both a timing and magnitude perspective.   And, with June sales reported tomorrow,  we expect to hear the first indications of how tax free holidays may be expected to impact July and August results. In an effort to capture the various shifts in timing and program parameters versus last year, we present the following graphics below. Here are a few noteworthy observations:

  • There are typically 3 different types of sales tax holidays: hurricane preparedness, clothing and school supplies, and energy efficient appliances.  For the purposes of this post we are focused on the clothing and school supplies.
  • The top 5 states most exposed to teens in the 15-19 year-old demographic are CA, TX, NY, FL, IL, representing 37% of the entire domestic teen market.  However, only three offer a tax free holiday (TX, NY, & FL).
  • The two biggest teen states (CA & IL) that don’t offer the tax free holiday have some of the highest state sales taxes in the country.  CA and IL are also #1 and #4 respectively on a list for highest projected budget gaps as a percent of the state’s general fund budget.
  • So far, FL and MD are the only two states adding events vs. this time last year.  They are adding 3 and 7 day tax-free events respectively.
  • GA, Washington DC, and South Carolina have either repealed or suspended their respective tax free holidays.
  • NY just repealed it’s tax-free status on shoes and apparel under $110, however this will not take effect until October 1st.  The suspension will last until April 1st, 2011, at which point a $55 tax-free threshold will be established for a year.  Then, in 2012, the original exemption will be reinstated.

With municipalities struggling to meet budgets, we should expect continued contraction in this list of tax free events as well as growth in efforts to add or boost sales tax overall.  

 

TO BE OR NOT TO BE TAX FREE - TeenStateExp 7 10

 

TO BE OR NOT TO BE TAX FREE - TaxHoliday Sched 7 10

TO BE OR NOT TO BE TAX FREE - TaxHoliday 2 Sched 7 10

TO BE OR NOT TO BE TAX FREE - TaxHoliday 3 Sched 7 10

 

Eric Levine

Director


INITIAL JOBLESS CLAIMS FALL 21K (1K ON A ROLLING BASIS)

Initial claims this week fell 21k (18k net of the revision).  This positive print continued the volatile pattern of the last four weeks, in which the week-over-week change has been more than 15k up or down each week.  The four-week rolling average, which removes this volatility, decreased by 1k to 466k.  For another week, claims remain in the 450-470k range they've occupied for most of the year, well above the 375-400k range needed for unemployment to materially improve.  

 

INITIAL JOBLESS CLAIMS FALL 21K (1K ON A ROLLING BASIS) - rolling

 

Below we chart the raw claims data. 

 

INITIAL JOBLESS CLAIMS FALL 21K (1K ON A ROLLING BASIS) - raw

 

Below, we chart US equity correlations with Initial Claims, the Dollar Index, and US 10Y Treasury yields on a weekly basis going back 3 months, 1 year, and 3 years.Not surprisingly, Consumer Discretionary has the largest inverse correlation to Initial Claims (r-squared = 0.70) on a 1-year basis. On the flip side, it is a surprise to see that the Financials have the second lowest inverse correlation to Initial Claims (r-squared = 0.27) on a 1-year basis.

 

INITIAL JOBLESS CLAIMS FALL 21K (1K ON A ROLLING BASIS) - 1

 

As was noted in last Friday's unemployment report, May was the peak month of Census hiring, and it should be a headwind to jobs from here as the Census winds down.

 

INITIAL JOBLESS CLAIMS FALL 21K (1K ON A ROLLING BASIS) - census chart

 

 

Joshua Steiner, CFA

 

Allison Kaptur


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INITIAL JOBLESS CLAIMS FALL 21K (1K ON A ROLLING BASIS)

Initial claims this week fell 21k (18k net of the revision).  This positive print continued the volatile pattern of the last four weeks, in which the week-over-week change has been more than 15k up or down each week.  The four-week rolling average, which removes this volatility, decreased by 1k to 466k.  For another week, claims remain in the 450-470k range they've occupied for most of the year, well above the 375-400k range needed for unemployment to materially improve.  

 

INITIAL JOBLESS CLAIMS FALL 21K (1K ON A ROLLING BASIS) - rolling

 

Below the jobless claims charts, we show the correlations between initial claims and each of the 30 Financial Subsectors. To reiterate, Credit Card and Payment Processing companies show the strongest correlations to initial claims, with R-squared values of .62 and .72 over the last year, respectively.  Surprisingly, some subsectors show a positive correlation coefficient to initial claims - i.e. Financials that go up as unemployment claims go up.  These names are concentrated in the Pacific Northwest Banks and Construction Banks, though these correlations are usually not very high.  

 

In the table below, we found the correlation and R-squared of each company with initial claims, then took the average for each subsector.  For composition of the subsectors, see Chart 5 below.

 

INITIAL JOBLESS CLAIMS FALL 21K (1K ON A ROLLING BASIS) - init. claims subsector correlation analysis

 

The following table shows the most highly correlated stocks (both positively and negatively correlated) with initial claims. Note that the top 15 negatively correlated stocks have a much stronger correlation on average than the top 15 positively correlated stocks - as you would expect, given that most of the Financial space is pro-cyclical. 

 

INITIAL JOBLESS CLAIMS FALL 21K (1K ON A ROLLING BASIS) - init. claims company correlation analysis

 

As we've highlighted previously, astute investors will note that in some cases the R-squared doesn't seem to reconcile with the square of the correlation coefficient. This is a result of finding the correlation and then averaging. For example, Pacific Northwest Banks have an average correlation coefficient of .32 and an average R-squared of .52 (with CACB, CTBK, FTBK, and STSA strongly positively correlated and UMPQ strongly negatively correlated). The different directions have the effect of canceling out each other out when finding the average correlation coefficient, but do not cancel out when finding the average R-squared. 

 

Below we chart the raw claims data. 

 

INITIAL JOBLESS CLAIMS FALL 21K (1K ON A ROLLING BASIS) - raw

 

The table below shows the stock performance of each subsector over four durations. 

 

INITIAL JOBLESS CLAIMS FALL 21K (1K ON A ROLLING BASIS) - stock perf

 

As was noted in last Friday's unemployment report, May was the peak month of Census hiring, and it should be a headwind to jobs from here as the Census winds down.

 

INITIAL JOBLESS CLAIMS FALL 21K (1K ON A ROLLING BASIS) - census chart

 

Joshua Steiner, CFA

 

Allison Kaptur


US STRATEGY – HOLDING ON

Yesterday the Russell 2000, S&P 500, NASDAQ and Dow Jones were the four best performing indices globally.  For the time being, fears of a “double-dip” are being dismissed due in part to yesterday’s retail sales figure and today’s news that the IMF is raising its 2010 world growth forecast.  The retail sales data on Wednesday showed the strongest pace of growth in four years.  Despite the reported good news for the consumer, the Consumer Discretionary sector (XLY) unperformed on the day.  Yesterday’s 3.1% move in the S&P 500 came on an unconvincing 1% sequential improvement in volume.       

 

Overnight there was some follow-through in Asia; Japan was up 2.8%.  India (up 1%), Hong Kong (up 1%), and Australia (up 2.25%) also showed strength.  China declined 0.25% on the day amid speculation that China would implement a new round of property market tightening measures.  

 

In Europe, the supposed transparency and credibility surrounding the European bank stress tests also helped to underpin sentiment.  While the euro has traded higher in four of the last five days, it closed down 0.24% yesterday at 1.26.  The Hedgeye Risk Management models have the following levels for the EURO – Buy Trade (1.24) and Sell Trade (1.27).

 

Yesterday, treasuries were weaker with the dampened risk aversion in the markets.  The VIX declined 9.5% yesterday: a 22.3% decline over the past week.  The Hedgeye Risk Management models have the following levels for the VIX – Buy Trade (25.01) and Sell Trade (29.99).

 

The dollar index was down 0.31% breaking our intermediate term TREND line of $83.96. It is now down -5.5% since the Hedgeye Q3 Macro theme of American Austerity started.  The Hedgeye Risk Management models have the following levels for the USD – Buy Trade (83.35) and Sell Trade (84.96).

 

Looking at the sector performance, the Financials (XLF +4.4%), Materials (XLB +4.0%) and Energy (XLE +3.5%) were the three best performing sectors.  While Consumer Discretionary (XLY +2.8%), Healthcare (XLV +2%), Consumer Staples (XLP +1.9%) were the bottom three. 

 

Driving the XLF higher was the banking group as the BKX posted its biggest one-day gain today since May 10th.  The Trust names NTRS +6.9% and BK +6.4% were among the standouts in the group following the positive Q2 pre-announcement from STT.  Regional banks outperformed with the pickup in risk appetite; the KRE was up 4.5%.

 

Yesterday, we shorted the Industrials (XLI) into the significant outperformance.  The S&P steel index rose 6%; the industrial metals names have some of the best leverage to the risk/recovery trade.  Our GDP growth forecast remains below consensus.

 

The consumer related names underperformed as the risk aversion trade saw a move into higher beta names.  The low priced retailers and dollar stores provided the big headwind for the retail space.  With retail sales being reported today, it’s expected to be one of the more influential directional drivers for the broader market today. 

 

Commodity related equities outperformed, despite OIL and Copper being broken on TREND and TRADE.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (2.83) and Sell Trade (3.09).

 

Yesterday GOLD fell to $1,185 an ounce yesterday, the lowest price since May 24, before rebounding to close above $1,200.  The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,180) and Sell Trade (1,229). 

 

Oil continues to trade higher as the Hedgeye Risk Management models have the following levels for OIL – Buy Trade (70.51) and Sell Trade (75.28).  

 

As we look at today’s set up for the S&P 500, the range is 71 points or 5.2% (1,005) downside and 1.5% (1,076) upside.   Equity futures are trading mixed to below fair value ahead of the initial jobless claims number. 

 

Howard Penney

 

 US STRATEGY – HOLDING ON - S P

 

 US STRATEGY – HOLDING ON - DOLLAR

 

 US STRATEGY – HOLDING ON - VIX

 

 US STRATEGY – HOLDING ON - OIL

 

 US STRATEGY – HOLDING ON - GOLD

 

 US STRATEGY – HOLDING ON - COPPER


Shorting Slowly

“It does not matter how slowly you go so long as you do not stop.”

-Confucius

 

I started making short sales into yesterday’s US stock market close by re-shorting Spain (EWP) and US Industrials (XLI). During last week’s market down moves to fresh YTD lows I was on the sidelines from a short selling perspective. On market rallies, my strategy has been to start shorting slowly.

 

There is no other way to explain why I do what I do other than to tell you I have learned how to play this short selling game by doing. In my mid-20’s (the year 2000) I was tasked by a major hedge fund in Connecticut to do one thing – make money. Given that my first 3 years managing risk with real-ammo were in down markets (2000, 2001, and 2002), I learned pretty quickly that the primary path towards making money was not losing it.

 

A lot of people lose money in down markets. Then they blame a “great depression” or something that “everybody missed.” The truth is that most people aren’t experienced/competent short sellers. I have witnessed this both in analyzing the short selling processes of former colleagues and by generally observing markets. In order to make money on the short side, you have to trade.

 

From a purist “long term” investor’s perspective, “trading” is often considered a bad word. It doesn’t quite fit the storytelling in the marketing flip book that some asset managers who are too big to perform need to uphold. I use this modern day institutionalization of Duration Dogma to my advantage.

 

This isn’t to say that I am always right on the short side. I’m more focused on not losing money than anything else and that’s just how I think about risk management. As the interconnectedness of global markets continues to drive volatility in daily prices, I need to change our positioning alongside that. As far as I know, the only way to change a position in your portfolio is to “trade” it.

 

Let’s go back to the top and consider a real-time example of managing risk around what I consider a “core” Hedgeye 2010 short position – shorting Spain (EWP). For practical transparency/accountability purposes, here are the 3 most recent time stamps in the Hedgeye Virtual Portfolio:

  1. 5/18/10 re-shorted EWP at $34.74
  2. 5/24/10 covered EWP for a gain at $33.47
  3. 7/7/10 re-shorted EWP at 331PM EST at $36.93

What you should quickly notice here is that as bearish as Daryl Jones and my Macro Men were on Spain in Q2, I wasn’t able to hold onto the short position and pick the bottom (the EWP put in a YTD low at $30.14 on June 7th, a few weeks after I covered our short position).

 

What you’ll also notice is that I didn’t get squeezed for the +23% rally in the ETF from that June 7th low to yesterday’s close or the +12.5% rally we saw in the local Spain stock index (Spain’s IBEX YTD low was registered on 6/8/10 at 8869).

 

Altogether, the absolutist in me is satisfied with the outcome – we didn’t lose our clients’ money by adhering to the “this is our best idea, so we are going to let it ride because we are smarter than you” strategy. Short-And-Hold is not a long term risk management process. Shorting for absolute return is.

 

Shorting Slowly is another way to communicate how I think about getting back into short positions that I’ve recently covered with accurate, rather than emotional, timing. When you are bearish in a market that’s going up like yesterday’s did, the hardest thing to do is not hit the SHORT button.

 

I think I am sufficiently bearish (email for the slides we have on our Q3 Bear Market Macro theme). But that doesn’t mean I have to be short the SP500 (SPY) at any price. I wasn’t short the SPY for yesterday’s +3.1% melt-up and I’m not short it this morning either. I am waiting and watching.

 

What am I waiting and watching for? That’s easy – time and price. Across all 3 of the Hedgeye Risks Management durations (TRADE, TREND, and TAIL), the SP500 is broken – we call this a Bearish Formation and here are the lines that matter:

  1. TRADE = 1076
  2. TREND = 1144
  3. TAIL = 1094

So, why not wait and watch for my most immediate term line of resistance (1076) to confirm that this market is immediate term bearish from a TRADE perspective before I hit the button? I guess if you don’t have a line, it’s harder to adhere to planning your risk management process this way.

 

Most of yesterday’s melt-up in the US stock market has to do with the gravitational forces associated with chaos theory, not a Buy-And-Hope forecast by a conflicted IMF that both US and global economic growth is setting up to accelerate. Bear markets often bounce higher than bull markets do.

 

It’s mathematically impossible for us to get to this IMF 2010 GDP forecast for the US of 3.3% (upped from 3.1% last night) unless growth accelerates in the back half of the year. Don’t forget that Q1 GDP for 2010 was recently downwardly revised to 2.7% and 1.9% of that 2.7% was inventories. Our Q3 estimate for US GDP growth is 1.7% and this is why we shorted the Industrials (XLI) instead of another sector in the US into yesterday’s close.

 

On yesterday’s strength (which was the 1st up day of more than +0.54% in the last 12 - hooray) I sold all of our US Equity exposure in the Hedgeye Asset Allocation Model again taking our allocation to US stocks back to the “risk free” rate of return that the US Government is promoting – ZERO percent.

 

My immediate term support and resistance lines for the SP500 are now 1005 and 1076, respectively. If you’re looking to get short out there today, take your time and short slowly.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Shorting Slowly - bear


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