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“Perfection of planned layout is achieved only by institutions on the point of collapse.”
Parkinson was a well known British scholar who specialized in naval history. Before he passed away in 1993, he authored 60 books, including “The Devil to Pay”, “Dead Reckoning”, and “So Near, So Far.” His writings recognized patterns of behavior in administrations and institutions in a way that makes we modern day chaos theorists proud. Patterns repeat.
The point of collapse is generally crystal clear in the rear-view mirror. Professional politicians in Japan have been telling stories for 20 years as to why they can prevent economic stagnation. In the US, the storytelling started in 2007. All the while, stock market and real-estate prices have every opportunity to rally to lower-highs, then collapse to lower-lows.
Despite all of the dissimilarities between Japan and the US, there is one similarity that continues to matter most in our risk management model – debt as a percentage of GDP. Now that the US can’t cut interest rates any lower, the “perfection of planned layout” to quantitatively ease, is also similar. We agree with Reinhart & Rogoff that crossing the 90% debt/GDP threshold is the equivalent of crossing the proverbial Rubicon of economic growth.
On July 2nd, as part of our Q3 Hedgeye Macro Themes presentation, we cut both our Q310 and full year 2011 GDP estimates for the US to 1.7%. At the time, these US economic growth estimates were about ∏ the Bloomberg consensus estimate. Now we’re starting to see both the sell-side and the Fed gradually cut their estimates, but not by enough. Our estimate for 2011 is still too high.
Growth slowing, both domestically and in China, is core to our bearish views on both the US Dollar and US Equities. There will be a downward bias to our US growth estimates as long as debt-financed-deficit-spending continues to remain the answer to the Fiat Fools prayers.
Markets trade on expectations. Yesterday’s setup in the SP500 was unlike most Augusts in America. That’s because the ‘government is good’ crowd leaked an idea to the Wall Street Journal that QE2 was coming, and that Ben Bernanke was going to solve for buy-and-hope begging.
To think that we have institutionalized market expectations in this great country to this degree is downright frightening. All things rallies start and end with rumors about what a humble looking man of government will represent at 215 PM EST on an August afternoon. Sadly, this kick starts thoughts of what another thoughtful European mind, Alexis De Tocqueville, warned about American style democracy in the 19th century.
So now what?
What do we do with this big Keynesian intervention that has delivered the fear-mongering national marketing message? Have we sufficiently scared the horses? While we’ve been getting paid, has this “perfectly planned layout” of telling Americans that this is a “great depression” worked?
With 40.8M Americans on food stamps (record high) and 45% of the unemployed having been seeking employment for 27 weeks or more (record high), now what?
Should we start begging for QE3? Should we cancel the bomb of an Existing Home Sales report for public release on August 24th? Or should we get back on TV after checking our I-pads and drinking our $5 mocha-frap and tell Americans to bite the bullet on ZERO percent returns-on-savings while we pay Washington to continue to lever-up our future to the point of economic collapse?
Before the Fiat Fools run out campaigning for QE3, never mind decisions made in 1997 Japan, maybe they should analyze some real time market results to yesterday’s announcement of QE Light:
1. The US Dollar is battling for resuscitation after 9 consecutive down weeks at $80.80 (down -9% since June)
2. US Treasury yields are making record lows on the short end of the curve, with 2-year yields striking 0.49%!
3. The Yield Spread (10yr minus 2yr) continues to collapse, down another 4bps day-over-day to 223bps
4. US stock market futures are diving below the beloved 200-day Moving Monkey line of 1115
5. US Volatility (VIX) is spiking from its intermediate term TREND range of support (22-23)
6. QE Specialist (Japan) got smoked overnight, closing down -2.7% to down -11.9% YTD
De Tocqueville’s answer: “The American Republic will endure until the day Congress discovers that it can bribe the public with the public's money.”
My immediate term TRADE lines of support and resistance for the SP500 are now 1099 and 1138, respectively.
Best of luck out there today,
R3: REQUIRED RETAIL READING
August 11, 2010
In preparation for Gildan’s print after the close, here are the puts and takes to help navigate the quarter.
TODAY’S CALL OUT
For Q3, we are a penny above the Street at $0.49, but starting in Q4 headwinds get considerably more challenging – we’re $0.04 below consensus at $0.42. Assuming management is looking to get paid this fiscal year, they can take down SG&A to make it happen. But, looking out into next year is when the deviation from Street estimates gets big. Our model is at $1.46 (down -5% yy) versus the Street at $1.94 (up +27%!). Here are a few assumptions to note:
Following a decent quarter that laps significant Broder related disruptions this time last year, we’d consider adding GIL to the short list in a few months one the dust settles after the quarter and as 2011 approaches.
LEVINE’S LOW DOWN
- In another sign that online and offline sales are essentially one in the same, Piperlime is opening a pop-up shop in NYC this September. The Gap-owned footwear site will represent the brand’s first ever attempt at having a physical presence. The opening coincides with Fashion Week.
- In an effort to boost its east coast image and drum up some marketing buzz, word has it that Vans is leasing a 15,000 warehouse in Brooklyn to create an indoor skate park. The site is expected to be used for promotional and marketing events and NOT for locals to use.
- Kmart gets added to the list of discounters looking to make a fashion splash, several years AFTER Target pioneered the concept. This Fall the retailer will launch Kmart Design, an apparel collection created by a team of 250 international designers. The fashion campaign will also launch with an ad campaign in Vogue.
Skechers Defends Toning Footwear - Skechers said that the two recently filed civil class actions disclosed in its Form 10-Q for the quarter ended June 30, 2010 each have only a single plaintiff and both are completely baseless. The complaints, Tamara Grabowski v. Skechers USA, Inc. and Sonia Stalker v. Skechers USA, Inc., allege that the company’s advertising for Shape-ups violates California law. The complaints, which were filed respectively on June 18 and July 2, are in the early stages and that the company will mount a vigorous defense. Skechers claims the lawsuits are inconsistent with numerous scientific studies, including studies cited in one of the lawsuits. Links to key studies, including two published in peer-reviewed journals, are available at www.ToningShoeStudies.com. The company also said that the popularity of its toning shoes provides convincing evidence that customers are pleased with the product. <sportsonesource.com>
Hedgeye Retail’s Take: Baseless or not, the volume of studies supporting and refuting the “toning” shoe claims is increasing. If anything, we expect the media attention to increase here as “consumers” begin to realize walking in a certain type of shoes may not actually be a replacement for going to the gym and eating healthy.
American Apparel Will Miss SEC Filing Deadline Due to Previous Auditor Resigning After Finding Material Weakness in Internal Control - American Apparel Inc. has informed the Securities and Exchange Commission that its numbers will neither be punctual nor profitable. Its new independent auditor, Marcum, needs more time to work through the figures for Q2, as well as Q1, which have yet to be filed. The summary of Q2 offered by American Apparel was not positive: Q2 loss against a net profit last year, net sales declines from lower retail sales only partially offset by increased wholesale, and gross margin declines from shift in business towards wholesale coupled with higher production costs. Deloitte & Touche LLP resigned the account last month after identifying “material weaknesses in internal control” with respect to the closing and reporting of its figures. Additionally, American Apparel told the SEC, Deloitte became aware of certain information “that if further investigated may materially impact the reliability of either its previously issued audit report” or the financial statements made regarding fiscal 2009. <wwd.com/business-news>
Hedgeye Retail’s Take: Maybe the clamp down on the company’s dress code was the leading indicator that things weren’t exactly as advertised.
GSI Commerce Expands to Asia; Appoints Vice President of Japan and Asia Pacific - GSI Commerce Inc. has opened its office in Tokyo, Japan and has appointed a VP of Japan and Asia Pacific. They will open the Japanese office and lead the operation of the company’s existing client commitments in Asia Pacific as well as the development of new clients. <sportsonesource.com>
Hedgeye Retail’s Take: With more and more retailers taking on their own e-commerce efforts, we wonder if the expansion is purely offensive or a bit of defense.
JCP Introduces MNG by Mango Shop in Shops - J.C. Penney juices up the contemporary side of its fashion business next Wednesday with MNG by Mango shops inside 77 of its department stores and online. By February, Penney’s intends to have Mango shops in 600 doors. MNG by Mango is one of only three brands in the store with dedicated built-out shops, including Sephora and Call It Spring footwear. The influx of goods will be speedier as Mango collections will arrive every two weeks, differing from other labels which may ship as rapidly, but in limited quantities to supplement what’s already on the selling floor. The speed to market is made possible by Mango’s superior sourcing and design capabilities coupled with Penney’s advanced logistics and planning and allocation systems. <wwd.com/retail-news>
Hedgeye Retail’s Take: One of the more exciting collaborations that we’ve seen in a long time. We do wonder how aggressive the Mango fashion will be for the JC Penney customer however.
7 For All Mankind Expands into Berlin - The premium jeans label opened a 970-square-foot store last month in Berlin’s tony Quartier 206. The store design features a slick zebra-wood interior, similar to many of its U.S. boutiques, and houses the brand’s current men’s and women’s wear collections as well as perennial best-selling items such as leather and denim jackets and skinny jeans with a low rise. The Berlin opening marks the first of several slated in Germany. A 1,938-square-foot shop will open in Düsseldorf early in September and further units are planned for Hamburg and Frankfurt. <wwd.com/retail-news>
Hedgeye Retail’s Take: While the US premium denim market appears to have peaked, it’s time to look elsewhere for growth. We wonder if Seven can be one of those American brands that was born stateside but ultimately becomes a bigger brand outside of its domestic roots.
Puma Appoints New Retail VP - Puma North America announced the appointment of John Trott as Vice President of Puma Retail, who will oversee all Puma North America retail divisions, including Puma Stores, Puma Outlet Stores, and Shop.PUMA.com. <sportsonesource.com>
Hedgeye Retail’s Take: An acceleration in growth on the horizon or perhaps a revamp of the store base that seems to have grown lockstep with popularity of low profile footwear? For those keeping track, Puma is missing the boat at the moment with the resurgence in technical/performance footwear.
Target Brings Back John Derian for Home Line - A new John Derian for Target collection will hit stores this fall, featuring more than 100 exclusive home décor and accessories. The new line will include decorative trays, wall art, coasters, stationery (mini journal sets and paper organizers), fabric-covered storage bins, ceramic mugs and melamine dinnerware.In 2008, Derian partnered with Target for a line of stationery and home décor products. <licensemag.com>
Hedgeye Retail’s Take: Given that the first collection was sold out immediately, this expanded assortment makes sense.
Perry Ellis International Launches PGA TOUR Collegiate Apparel Program - Perry Ellis International announced the launch of PGA TOUR Collegiate Apparel at retail accounts nationwide, offered through a licensing agreement with The Collegiate Licensing Company (CLC), a division of IMG Worldwide, and the PGA TOUR. <sportsonesource.com>
Hedgeye Retail’s Take: All of a sudden the college market has become a big source of growth. Long a sleeper in the world of retailing, we now see BKS, HBI, COLM, and UA tapping the college market in one way or another. After all, for every graduate there is a freshman needing new gear- year after year.
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Conclusion: Employment “growth” is anemic and looks weak going forward, which will be a negative catalyst for equities.
Today’s underwhelming Employment report was no doubt made worse by Goldman Sachs Chief Economist Jan Hatzius’ lofty forecast of +600,000 payrolls for the month of May (a +100,000 increase from his previous estimate). While being “a little low on the census contribution” was his chief reason for upping his forecast far above the median consensus estimate of a 536,000 gain, our Hedgeye estimate was that he (and consensus) was “a little too high” on the private contribution. Jan’s estimate was for an incremental 150,000 private payrolls to be added in May vs. 180,000 consensus.
Private payrolls added for the month of May was reported at an anemic 41,000 – first marginal deceleration since December of 2009. After a 9% drop in the S&P throughout the month, and a near 11% drop from the highs of April to the end of May, it was proactively predictable that the rate of job growth would slow on the margin. For clarification, the S&P 500 and Net Private Payrolls have a 0.72 positive correlation over the last three years. That’s an r-squared of 0.53, which suggests some level of statistical significance.
Interestingly, if we normalize for the birth-death adjustment, which we admit is the fodder of conspiracy theorists, and exclude the 215,000 birth-death adjustment, the economy actually lost 226,000 jobs. Even if you aren’t willing to accept that dire of a claim, those unemployed longer than 27 weeks hit a new record coincident with this report at 46%. The likelihood that people just give up hope and drop out of the workforce increases every week with that statistic.
We shorted the QQQs into the close yesterday based on the view that this payroll number was going to be worse than expected. While Hatzuis’ took the shot, and we admire him for that at least, by inflating the whisper consensus number, he actually increased the probability that we would be right on our short call and that payroll additions would be worse than expected by implicitly increasing consensus expectations.
While consensus hiring is boosting over all payroll additions and, temporarily, decreasing the unemployment rate, this payroll report should be framed for exactly what it is . . . a disaster. As we’ve highlighted in the chart below, this is a sequential decline in the addition of private sector jobs and highlights two critical points: a) this is a jobless recovery at best and b) the stimulus package has failed to stimulate any real sustainable jobs additions.
With the stimulus behind us and census hiring also primarily in the rear view mirror, it is likely that the payroll additions will continue to be anemic, and that the actual unemployment rate ticks back up. And that, as they say, is not good.
Daryl G. Jones
This insight was originally published on May 28, 2010. MACRO intra-day updates are available to RISK MANAGER SUBSCRIBERS in real-time.
MACRO: HOUSING IS STRUGGLING COMING OUT OF THE POST-EXPIRATION BLOCKS
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:
And here are the positives:
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
This insight was originally published on June 22, 2010. MACRO intra-day updates are available to RISK MANAGER SUBSCRIBERS in real-time.
MACRO: HOUSING FIZZLES EARLIER THAN EXPECTED SETTING STAGE FOR WORSE DOWNTURN
THE BOTTOM LINE
May existing home sales were much worse than expected in spite of the continued effect of the April 30 tax credit expiration pull-forward. May sales came in at 5.66 million (seasonally adjusted annualized rate) down from 5.79 million in April (revised a tad from 5.77 million). Expectations were for sales to rise north of 6.2 million units. Sales coming in 9% below expectations reflects a major incremental negative datapoint.
Remember that this May print is a lagging indicator as it reflects deals closed two to three months ago (Mar/Apr) because of the 30-60 day lag between signing and closing.
In our view, the relevant benchmark is how it compares with October 2009's print of 5.98mn. Against that measure, it's down considerably (5.66). The original tax credit expired in November, 2009, putting October 1 month ahead of that expiration. The current credit (for closing) expires June 30 (April 30 for signing), which means 1 month ahead equals May.
In other words, it's now clear that tax credit round two is having a less substantive effect on sales than round one did back in late-2009.
Inventory, on a units basis, fell a modest 3.4% to 3.89 million units from 4.04 million units in April.
Inventory, on a months supply basis, fell slightly to 8.25 months from 8.4 months last month. While inventory is down nominally on a months supply basis, this is somewhat misleading because its keying off an artificially high May 2010 sales rate. If we assume that the same dropoff in sales occurs following this tax credit expiration as followed the last tax credit expiration we can expect to see a sales rate of 4.25-4.5mn a few months from now. Meanwhile, inventory is at 3.89mn units. In other words, inventory could rise to 10-11 months or higher very shortly.
Our view is that this pull forward of activity is setting the stage for a much weaker-than-usual summer housing environment. Housing-sensitive stocks could be at risk heading into the 2H10 and 2011 time frame.
We have an extensive report coming out on this topic on Friday for subscribers and prospects of our Financials Vertical, which we will summarize on a conference call at 11am on Friday.
Joshua Steiner, CFA
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