“I thought the wind was coming more off the right, and it was off the left. That just started the problems from there. From there I hit a lot more shots, and had a lot more experiences in Ray’s Creek.”
- Tiger Woods on making a 10 on Augusta’s 12th
I was in a discussion with a friend a couple days ago about how there could be so much volatility in performance by the best golfers in the world, and how something like Tiger Woods making a 10 on a hole happens.
The friend is not a golfer and my answer was reasonably simple, there are forces in the game of golf that are impossible to measure, analyze, and predict with full certainty. Something like a misjudgment or change of the wind and the bounce on the green on a challenging hole can mean starting with two well executed swings, yet rapidly facing double bogey or worse.
I’d argue Tiger only hit one truly bad shot the whole hole (the 6th stroke, from bunker to water, which still wasn’t easy to execute).
But Tiger gets it. Making his worst professional score ever he didn’t suddenly become bad at golf, rather he made a misjudgment, committed to the wrong play, and got unlucky at the same time. He understands the uncertainty of the game and with some renewed focus and better fortune he birdied 5 of his last 6 holes.
When I exited undergrad in 2008 with a BS and a Class A PGA membership, my view of the world was more black and white. There was right and wrong, good and bad, correct and incorrect.
Over the last 12 years the world has become much more gray. Perhaps I’m getting wiser, or it was from years of grinding through the uncertainty of golf trying to improve and excel in the game, ending up far short of Tiger status.
But for me everything has become more probabilistic, less certain. You see more sides to the stories, you question assumptions, and you start to realize conclusions of studies and experts are not written in stone.
If I had to pick one Hedgeye-ism that has always rung most true to me as it relates to my analytical and decision-making process for both investing and life, it is "Embrace Uncertainty". Keith often mentions Annie Duke’s book Thinking in Bets as it relates to good, probabilistic decision making.
I didn’t read this book until 2020, but it’s a strong representation of how my thinking has evolved over the last decade. Its themes have, of course, long been a part of the Hedgeye process, but the line of thinking presented I feel is helpful beyond managing your portfolio.
Back to the Retail Macro Grind…
Retail Sector Head Brian McGough and I have been excited to bring our research to a new audience with the recent launch of Retail Pro. It is a customized array of content that provides a deeper and more democratized look into the research and thought process that we deploy on an everyday basis at Hedgeye Retail.
If you already subscribe to Retail Pro, you have probably seen us talk/write a lot about retailer credit. It’s probably the singular topic I have put the most thought and research into during my time at Hedgeye, and I don’t think there is a theme that has epitomized the concept of Uncertainty in the 2020 consumer economy more than credit.
In my 7 years of doing industry research in retail there are few things that have appeared more “certain” (translation: probable) to me than the idea that whenever the next recession came, retailers with sizeable private label credit card exposure would be sitting on a powder keg of earnings risk.
For some historical context, US retail was long built upon apparel retail and the US consumer’s appetite to wear it. Over time it became overexposed and overly dependent on massive amounts of unit inventory and the associated square footage needed to display those inventory units (the oversimplified term being "overstored").
Over the last couple decades, while the industry was building its strip malls and huge national store bases, many retailers starting bolstering the profits of customer acquisition by offering private label credit cards to the customers it found within new store markets.
The cards were either self-underwritten or offered via partnership with a major card issuer. It was great, it drove comps by extending credit to its customers that could only be used in its store, and it made more money off finances charges and late fees from the customers' desires to consume beyond their means.
In recent years, accelerating ecommerce penetration in #Retail5.0 means accelerated pressure on brick and mortar retail, while a shift to sales online brings higher costs and margin declines. Over this economic cycle the exposure to consumer credit has grown from small to massive as credit profits have flourished, and retail profits have faded.
Compared to the last recession in 2008 the private label credit card penetration in sales is 20 to 50% higher, and the percentage of EBIT generated from credit is up 100% to 300%. Several retailers even see credit as more than half of EPS. If a retailer has a private label or branded card, it most likely has direct consumer credit profit exposure. For some retailers it’s small, others it’s massive. The public disclosure is somewhere between nonexistent and poor across the board, even for those where credit is the biggest earnings driver. A few retailers with high exposure include KSS, GPS, M, DDS, JCP, but there are many others where credit matters like BBY, JWN, SIG, TGT, LOW, LB, and more.
Enter Covid-19 which accelerated the end of the cycle that Hedgeye Macro was already calling for at the end of January. Unemployment numbers skyrocket, stores are forced to close, and a doomsday scenario for retail is pretty much here. Yet, nonlinearity and uncertainty of the economy asserted itself once again, as we have seen the worst unemployment trends in history riding side by side with credit quality metrics improving to their historical bests.
If you subscribe to the The Call, you’ve probably heard Financials Sector Head Josh Steiner talk about this paradox several times. The divergence is at least in part driven by help from stimulus and enhanced unemployment, yet even as that cash flow tailwind has waned in recent months payment rates and delinquencies remain strong. Who knew it would take a global pandemic (and probably the absence of many discretionary categories) to finally make the US consumer fiscally responsible?
From here there is a high degree of uncertainty about how this will play out. Even Capital One’s executives, who built their $75bn enterprise on risk managing consumer lending appear to have no idea what the coming quarters will look like. Will a new round of stimulus provide more relief and repayment in 2021? Will the economy and unemployment rapidly recover when a vaccine is widely available? Or will real, significant underlying job losses drive rising defaults in the coming quarters?
Recent retail results have seen credit declines, but retailers are citing lower card balances and lower fees as the driver from higher pay rates and less usage. Some seem to be signaling further declines, other recovery. Despite the uncertainty on how this will play out, this week KSS’s CFO gave what we would consider overly certain commentary on its credit business, implying it will track in line with sales and hinting that sales should make a big recovery towards 2019 levels in 2021.
We’d suggest investors take that with a grain of salt and treat the credit outlook to be highly uncertain. We think the most probable outcome is the one supported by historical results and our deductive reasoning, which is that many jobs are permanently lost, and eventually that will lead to countless cardholders that can’t pay their bills, as has been the case in every prior recession. Yesterday’s jobless claims report showed we are not out of the woods and Hedgeye US Macro Analyst Christian Drake has highlighted the impending year-end income cliff.
Still, a crash in retail credit income is far from certain. If we do see recessionary levels of credit card defaults in the coming quarters, we think several credit exposed retailers like KSS and GPS will make great shorts as the market is assigning a very low probability to that scenario. And if we’re wrong, there will still be plentiful ways for us to make money on both the long and short side of retail ideas, so we can get back on the birdie train.
We’ll be keeping a close eye on retail and consumer credit data and how it might strengthen or weaken the investment call on retailers. Check out Retail Pro for a view of our work across the retail ecosystem which includes hundreds of tickers.
Immediate-term @Hedgeye Risk Range with TREND signal in brackets:
UST 10yr Yield 0.81-0.99% (neutral)
SPX 3 (bullish)
RUT 1 (bullish)
NASDAQ 11,556-12,021 (bullish)
Tech (XLK) 118.14-123.12 (bullish)
Utilities (XLU) 63.18-67.55 (bullish)
Energy (XLE) 32.23-38.03 (bullish)
Gold Miners (GDX) 34.96-38.24 (bearish)
Shanghai Comp 3 (bullish)
Nikkei 242 (bullish)
DAX 126 (bearish)
VIX 21.40-27.65 (bearish)
USD 92.04-93.16 (bearish)
Oil (WTI) 39.73-42.63 (bullish)
Nat Gas 2.54-3.15 (bullish)
Gold 1 (bearish)
Copper 3.12-3.30 (bullish)
Embrace the uncertainty, prepare and adjust accordingly,
JM
Jeremy McLean
Director – Retail Team
