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EARLY LOOK: Corner Banging

This note was originally published at 8am this morning, September 3, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

 

 

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“Twenty years from now you will be more disappointed by the things that you didn't do than by the ones you did do. So throw off the bowlines. Sail away from the safe harbor. Catch the trade winds in your sails. Explore. Dream. Discover.”
-Mark Twain

 

EARLY LOOK: Corner Banging - chart1

 

 

On Tuesday, Keith comes back from vacation.  I’ll be honest, setting aside the fact that Keith and I have been friends for upwards of 15 years and I like having him around, wearing his jersey in the mornings is not easy.  I’m all about hard work, but, seriously, you try preparing for a 20-minute conference and writing a strategy note all by 8:30 am every day.  I’m starting to understand why some of his morning notes make him sound a bit a grumpy, this isn’t easy!
 
If you didn’t know, corner banging is a sailing term.  It basically means to sail all the way to one side of a race course in search of a strategic advantage.  If you bang the corner, you either win big, or you lose big.  That’s it.  For those of you who have been reading our notes for the last couple years, it is likely quite clear that we are not corner bangers.  If we’ve said it once, we’ve said it many times: we are Risk Managers.  In fact, the term is so common around our office, we even added it to the name of our company, Hedgeye Risk Management.
 
Managing risk isn’t about being short or just having a high allocation of capital to cash, but rather preparing and contemplating events that could happen and impact our portfolios.  As we look forward over the next couple of months, one specific event that jump out in our minds is the midterm elections.  There is potential that the Republicans, who are expected to do well, which could have an impact on whether the Bush tax cuts are extended.  It is our belief that the idea of the Bush tax cuts being extended is not currently priced into the market.
 
The Bush tax cuts are meaningful. To highlight this point, in the bullet points below we compare what would happen to certain tax rates if the Bush tax cuts are not extended:

  • Short term capital gains would go from 35% to 39.6%;
  • Long term capital gains would go from 15% to 20%;
  • Qualified divided taxes would go from 15% to 39.6%;
  • Non-qualified dividend taxes would go from 25% to 39.6%; and
  • Wage taxes in the top bracket would go from 35% to 39.6%.

 

On a very basic level, an increase in divided taxes should decrease the value of those companies that pay dividends, all else being equal.
 
On September 7th at 230pm, Keith and I will be hosting a call with Karl Rove to discuss the midterms with the title, “Could The Midterm Election Be A Major Stock Market Catalyst?”  Karl, as many of you know, is known as “the Architect” for putting together the successful Gubernatorial and Presidential campaigns for George W. Bush.  Now let’s be clear, we get that Mr. Rove is a Republican and that many of you may be athwartship (a sailing term that means at right angles) politically with Karl, but this is not a political call.  This is about sitting down with one of the premier political analysts in the country and having a Big Boy Talk with him. The point is to try and determine whether the midterms will indeed be a catalyst.  If you are a current subscriber or would like to trial our service and participate in the call, please email us at sales@hedgeye.com.
 
As former long time Speaker of the House famously said: “All politics is local.” Typically this is indeed true, so while we can presume to know what is going on from our perches in Manhattan, Boston, New Haven, or wherever we may be, bringing in a man who has studied elections in this country on a county by county level is sure to help make sure our sails are directed toward the wind.  Currently, the Republicans clearly have the wind behind their sails.
 
To begin with, President Obama’s approval ratings are quite low.  According to the Real Clear politics poll average, 46.4% of those polled approve of the job President Obama is doing and 47.8% of those polled disapprove.  So, in aggregate, less than half of the country approves President Obama and more disapprove than approve.  Interestingly, in the Rasmussen Daily Tracking poll (which we have highlighted below with a picture of Hedgeye’s own sailor, Zach “The Hammer” Brown), President Obama has improved over the last month or so.  His current approval index is -13 (which is the difference between Strongly Approve and Strongly Disapprove), which is an improvement off his all time low on May 26th, 2010 of -22.  Despite this improvement, the point is President Obama’s approval rating is low, which won’t bode well for the Democrats.

 

 

 

EARLY LOOK: Corner Banging - chart2

 

 
The other important point to consider is that there is substantial dissatisfaction with politicians these days.  In fact, congressional approval is as low as it’s ever been, so the concept of incumbency advantage is likely going to be less impactful than typical this election.  As I wrote back in May:
 
“As many studies note, incumbents typically win re-election 90% of the time.  These early data points are noteworthy and mark the beginning of perhaps a serious shift by voters away from incumbency. This idea is also supported in recent polls.  Specifically, a recent ABC News-Washington Post poll indicated that nearly six in 10 respondents they’re not likely to vote for their current representatives to Congress.”
 
A backlash against incumbents naturally hurts the Democrats because they hold more seats.
 
As we survey the Electoral Ocean in front of us this is what the polls looks like in terms of the shift of power according to the poll averages at Real Clear Politics:

  • Republicans to pick up 8 seats in the Senate but the Democrats will retain control at 51 to 49;
  • Republicans will win 206 seats in the House, the Democrats will win 194 seats and 35 seats are a tossup currently; and
  • The Republicans will pick up 8 governor seats to hold a 32 to 18 seat advantage.

 

The potential for major Republican victory in the fall is realistic, and we need every advantage we can get to ensure we fully understand the probabilities.  Keith and I hope you will join us on Tuesday.
 
As you head into the long weekend with your friends and family, I’ll leave you with one more quote from Mark Twain:
 
“Denial ain’t just a river in Egypt.”
 
Enjoy the weekend.
 
Yours in risk management,
 
Daryl G. Jones


THE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP - September 3, 2010

As we look at today’s set up for the S&P 500, the range is 30 points or 2.7% (1,061) downside and 0.01% (1,091) upside. 

Equity futures are trading flat to higher as the market awaits key US non-farm payroll data later. Today's macro highlights include: Aug Nonfarm Payrolls, Aug Unemployment Rate, Aug Private Nonfarm Payrolls, and Aug ISM Non-Manufacturing Index.

  • Arcsight (ARST) didn’t mention sale in 1Q earnings after WSJ last week reported co. is on the auction block
  • Esterline Technologies (ESL) boosted 2010 EPS forecast to $3.85-$3.95 from $3.45-$3.65, vs est. $3.60
  • Finisar (FNSR) forecast 2Q rev. $215m-$230m vs est. $206.1m
  • H&R Block (HRB) reported 4Q loss per share of $0.36 vs estimate of a loss of $0.41
  • Krispy Kreme Doughnuts (KKD) forecast FY11 operating income ex charges $13m-$17m, up from prev. guidance $11m-$15m
  • Quicksilver (ZQK) reported 3Q rev. $441.5m vs estimate $443.7m
  • SeaChange International (SEAC) CUTS FY rev. forecast to $215m-$220m from $225m-$235m
  • Sunoco (SUN) said former GM CEO Frederick A. Henderson has joined the company as a senior VP
  • Take-Two Interactive Software (TTWO) boosts FY adj. EPS forecast to $0.60-$0.70, from loss $0.10-$0.30, vs estimate $0.20 loss
  • Ulta Salon Cosmetics & Fragrance (ULTA) forecast 3Q adj. EPS $0.20-$0.22c vs estimate $0.17
  • U.S. Airways Group (LCC) said August passenger rev. per available seat mile increased estimate 15%

PERFORMANCE

  • One day: Dow +0.49%, S&P +0.91%, Nasdaq +1.06%, Russell 2000 +1.16%
  • Month-to-date: Dow +3.05%, S&P +3.89%, Nasdaq +4.07%, Russell +5.02%
  • Quarter-to-date: Dow +5.59%, S&P +5.76%, Nasdaq +4.30%, Russell +3.74%
  • Year-to-date: Dow (1.04%), S&P (2.24%), Nasdaq (3.05%), Russell +1.10%

EQUITY SENTIMENT:

  • ADVANCE/DECLINE LINE: 1228 (-1005)
  • VOLUME: NYSE - 960.71 (-19%) - volume drying up ahead of the jobs report
  • SECTOR PERFORMANCE: All sectors up XLU
  • MARKET LEADING/LAGGING STOCKS YESTERDAY: Nordstrom +8.05%, Goodyear Tire +6.30% and LTD Brands +6.10%/Abercrombie -3.88%, Tyson -3.32% and Total Systems -3.30%
  • VIX: 23.19 -2.93% - down 15.3% in past week - YTD PERFORMANCE - +7.0%         
  • SPX PUT/CALL RATIO: 1.32 from 1.21  

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD: 16.91 +0.249 (1.495%)
  •  3-MONTH T-BILL YIELD .14% +.01%
  • YIELD CURVE: 2.13 from 2.08

COMMODITY/GROWTH EXPECTATION:

  • CRB: 271.15 +0.98%
  • Oil: 75.02 +1.50% - a 2 day rally looks to end today
  • COPPER: 349.55 +0.52% - Dr C ragging ahead again
  • GOLD: 1,250 -0.36% - up 4 of the last 5 days

CURRENCIES:

  • EURO: 1.2808 +0.09% - looking at a 4 day rally
  • DOLLAR: 82.463 -0.07% - looking to be down for the last 3 days

OVERSEAS MARKETS:

ASIA

  • Nikkei +0.57%; Shanghai Composite (0.01%)
  • Most Asian markets ended higher or flat fuelled on the day. Technology stocks in the region outperformed tracking Nasdaq’s rise yesterday.

 

EUROPE

  • FTSE 100: +0.25%; DAX +0.31%; CAC 40: +0.40%
  • Major European indices are trading flat ahead of US non-farm payroll data later today. Technology stocks are higher in the region tracking gains by their peers in Asia earlier and on the Nasdaq yesterday. Food & Beverages and Autos are among the worst performing sectors this morning in Europe.
  • UK Aug Services PMI 51.3 vs consensus 52.9 and prior 53.1
  • EuroZone Aug Final Services PMI 55.9 vs preliminary 55.6
  • EuroZone Aug Final Composite PMI 56.2 vs preliminary 56.1
  • Germany Aug Final Services PMI 57.2 vs preliminary 58.5
  • France Aug Final Services PMI 60.4 vs preliminary 59.9
  • Eurozone July Retail Sales +1.1% y/y vs consensus +0.6% and prior revised +1.2% from +0.4% 
Howard Penney
Managing Director

THE DAILY OUTLOOK - S P

 

THE DAILY OUTLOOK - VIX

 

THE DAILY OUTLOOK - DOLLAR

 

THE DAILY OUTLOOK - OIL

 

THE DAILY OUTLOOK - GOLD

 

THE DAILY OUTLOOK - COPPER


R3: Earl, Cotton, TBL, Choo, UA, and GES

R3: REQUIRED RETAIL READING

September 3, 2010

 

Nothing like a hurricane to take the “wind” out of a retailer’s sales.  Expect those with weakness in September to blame Earl come next sales day. 

 

RESEARCH ANECDOTES

 

- Quicksilver noted that trends picked up meaningfully towards of the end of August and into early September following a weaker performance in June and July. Sales improvement coincides with the timing of back-to-school. Interestingly, similar trends are being observed in non-U.S. markets as well.

 

- As Dockers tries to reinvent the brand it has collaborated with NY based designer Steven Alan on a co-branded, higher end line. The products will be made available at Barney’s New York and at Steven Alan’s namesake boutiques, with pants priced at $128 to $148. More importantly expect a PR blitz to make its way through the fashion community. How this translates into sales of $40 khakis at Kohl’s is still unclear, but the effort is certainly noted.

 

- In one of the more rare transitions of a children’s product into the adult world, Silly Bandz may be destined for a second life. It turns out that the rubber bracelets (which come in a million shapes and colors) are now being used on the dating scene in Manhattan as a sign of flirtation. In other words, men and women are exchanging these rubber bracelets at bars as part of the dating process. Talk about a way to kill a brand (and a product).

 

 

OUR TAKE ON OVERNIGHT NEWS 

 

US Apparel Companies Turn Up the Heat on Bangladesh - U.S. retailers and apparel companies are taking a proactive stance against reports of police and government repression of garment workers and arrests of union activists in Bangladesh. The American Apparel & Footwear Association sent a letter to Bangladesh’s ambassador to the U.S., Akramul Qader, on Wednesday, expressing its concerns about the reports. The Bangladesh government moved to increase the country’s minimum wage in the garment industry in July, following months of widespread violent protests by workers and their union, but the protests have continued amidst widespread reports of worker repression and intimidation and union arrests. <wwd.com/business-news>

Hedgeye Retail’s Take:  The bottom line on rising prices out of this region and potential supply-chain disruptions in the interim are still unchanged.  It’s highly unlikely (while politically correct) that the AAFA puts this major political issue to rest for the Bangladeshis.

 

Hurricane Earl Causes Difficulties for Retailers - U.S. retailers in Hurricane Earl’s projected path were already feeling the effects of the storm before the first drop of rain or gust of wind. Retailers from the Carolinas to Massachusetts are missing out on sales this weekend especially because its the last big weekend of back-to-school. Stores noticed the first drop-off in sales on Wednesday, when recreational parks in the area were closed and travelers began to leave town.  <wwd.com/footwear-news>

Hedgeye Retail’s Take:  Take note come September sales day when retailers cite Earl as a reason for weaker sales.  As of now, this storm will likely have minimal impact on retailing as it is expected to move offshore quite quickly and is not anticipated to hover over any major metro areas.  Yes, the final summer weekend in Cape Cod, Nantucket, and Martha’s Vineyard could be impacted.  Not good for Murray’s.

 

Steve Madden Looks To Capitalize on Betsey Johnson's Credit Issues - Betsey Johnson’s credit headache could prove to be Steve Madden’s designer brand opportunity. In papers filed with the Securities and Exchange Commission late Thursday, Steven Madden Ltd. said it had taken over a $48.8 mm loan to Johnson’s firm, Betsey Johnson LLC, that is currently in default. If Johnson can’t repay the loan by Aug. 20, 2012, Madden would end up owning the brand — and could even seize the personal assets of Johnson and her chief executive officer, Chantal Bacon. There are 66 Betsey Johnson boutiques and plans call for the chain to expand to 100 stores by 2012, according to the designer’s Web site. Madden already holds a license for handbags, small leather goods, belts and umbrellas under the Betsey Johnson and Betseyville trademarks. <wwd.com/business-news>

Hedgeye Retail’s Take:  Looks like a fairly smart move as the company continues to acquire beyond the core shoe biz.  Both a real estate and brand play, this may ultimately prove to be a savvy investment.

 

More on Jimmy Choo Possible IPO - Jimmy Choo isn’t for sale at the moment, but that isn’t preventing investment banks from sniffing around. Industry sources said banks eager to drum up new business have been approaching the footwear and accessories firm, which this year is expected to post revenues of 150 million pounds, or $231 million, at current exchange. TowerBrook principals narrowed down the list and asked only Goldman Sachs and Morgan Stanley to prepare pitches with a view to becoming strategic advisers on future options for the company. <wwd.com/business-news>

Hedgeye Retail’s Take:  With momentum in the higher-end luxury retail segment hitting a pause recently, we wonder how quickly Goldman and Morgan can prepare their pitches.  If a roadshow does materialize, be prepared for a lesson in how Choo can morph into a “lifestyle” brand as well as a global retailer.

 

Timberland Steps Up Marketing on Green Products - The Timberland Company is escalating its green marketing activities with the launch of its biggest and most environmentally-focused marketing campaign yet -- Nature Needs Heroes. Launching globally over the next several weeks, the campaign showcases Timberland's Earthkeepers collection. Made with materials like recycled rubber and recycled PET (one and a half plastic bottles are used in each pair of Earthkeepers boots), Earthkeepers product is one of the company's leading and fastest growing product collections. <sportsonesource.com>

Hedgeye Retail’s Take:  While the overall business may still be under pressure, the company’s efforts in the area of sustainability and the environment clearly add credibility and authenticity to the brand.  Consumers are beginning to embrace social responsibility in a meaningful way and Timberland has been an early adopter of such efforts.

 

Under Armour Focuses on Women - Under Armour is determined to strike a chord with female athletes—many of whom have been buying the brand, but aren’t that emotionally attached to it. The company has kicked off a campaign that includes a Facebook page dedicated to women’s performance apparel. The target demographic is a female consumer who “trains in Under Armour, but doesn’t really know about the brand other than [that] it’s her boyfriend’s brand," said Adrienne Lofton, senior marketing director of Under Armour’s women’s business. The campaign, which is part the brand’s “Protect This House. I Will” campaign, includes a star-studded lineup of athletes. There is Lindsey Vonn, an Olympic gold medalist downhill skier; soccer sensation Lauren Cheney; and track and field runner Monica Hargrove. One 60-second spot (now on YouTube) takes viewers through the grueling, day-to-day training these female athletes go through to be on top of their game. Vonn lifts weights and balances herself atop a yoga ball, for instance, while Cheney collides with a player in the soccer field. <brandweek.com>

Hedgeye Retail’s Take:  Recall that UA hired a separate agency and team of marketing and merchandising execs to focus exclusively on the female consumer.  It appears that the early byproducts of these efforts are now beginning to trickle out.  Women’s continues to be a huge, untapped opportunity for the brand.

 

First Kidswear Store Signals UK Retail Assault By Guess - US denim brand and retailer Guess is to open standalone stores for its kidswear range and Guess by Marciano sub-brand as it gears up for rapid retail expansion in the UK. <drapersonline.com>

Hedgeye Retail’s Take:  Similar to the US, kids retail appears to be the concept du-jour.  Unfortunately, higher price points will put a lid on ultimate kids expansion, unless of course the concept is planning to take prices lower. 

 

Social Networking Doubles Among Boomers and Seniors - Social media usage has nearly reached saturation among younger adults, and its highest growth rates are now coming from internet users ages 65 and up, who have doubled their usage of social networking sites in the past year. The mass appeal is causing ad dollars to flow, but could it cost sites like Facebook their cool factor? <emarketer.com>

Hedgeye Retail’s Take:  While this is certainly noteworthy, we wonder if the adoption curve for social networking in the 65+ category is any different from other youth-perceived tech products.  Either way, the broader the audience online, the less relevant TV and Radio become.

 

R3: Earl, Cotton, TBL, Choo, UA, and GES - 1

 

Visa and MasterCard Show Increased Transaction Activity in E-Commerce - More than 12% of Visa's global transaction volume comes from the web, and because its growing faster than other channels Visa has stepped up their focus.  That sharper focus is evident by a series of moves in 2010 from both Visa and its main rival, MasterCard Worldwide, which does not break out its e-commerce volume. Here's what they've done this year:

— In March, Visa announced plans for an online social shopping service and electronic wallet called Rightcliq.

— MasterCard soon afterward unveiled MasterCard Marketplace, featuring discount offers from online retailers.

— Later that month, MasterCard created a new research and development unit called MasterCard Labs to speed new payment products to market. Its first initiative, announced in May and called Open APIs, is designed to make it easier for mobile and web developers to integrate MasterCard payments into their applications.

— Visa in April announced it was paying $2 billion for CyberSource Corp., a major provider of fraud prevention and payment processing services to online retailers.

— MasterCard last month announced plans to pay $520 million for U.K.-based payment processor DataCash Group plc, calling it a move to strengthen its position in e-commerce.

What all this will mean for web and mobile retailers is still coming into focus, as these initiatives are so new. But experts agree that the Visa/CyberSource combination could bring valuable new services to retailers and that MasterCard's Open APIs puts it in the thick of fast-changing developments in mobile payments.  <internetretailer.com>

Hedgeye Retail’s Take:  Fishing where the fish are.  The real innovation here however, will come when the traditional credit card is no longer needed to transact online or from a mobile device.  One click payment (like Paypal) and wireless payments seem closer to a widespread reality than ever before.  However, security and privacy concerns remain a key factor in holding back mass adoption.

 


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.28%
  • SHORT SIGNALS 78.51%

Corner Banging

“Twenty years from now you will be more disappointed by the things that you didn't do than by the ones you did do. So throw off the bowlines. Sail away from the safe harbor. Catch the trade winds in your sails. Explore. Dream. Discover.” 

-Mark Twain

 

On Tuesday, Keith comes back from vacation.  I’ll be honest, setting aside the fact that Keith and I have been friends for upwards of 15 years and I like having him around, wearing his jersey in the mornings is not easy.  I’m all about hard work, but, seriously, you try preparing for a 20-minute conference and writing a strategy note all by 8:30 am every day.  I’m starting to understand why some of his morning notes make him sound a bit a grumpy, this isn’t easy!

 

If you didn’t know, corner banging is a sailing term.  It basically means to sail all the way to one side of a race course in search of a strategic advantage.  If you bang the corner, you either win big, or you lose big.  That’s it.  For those of you who have been reading our notes for the last couple years, it is likely quite clear that we are not corner bangers.  If we’ve said it once, we’ve said it many times: we are Risk Managers.  In fact, the term is so common around our office, we even added it to the name of our company, Hedgeye Risk Management.

 

Managing risk isn’t about being short or just having a high allocation of capital to cash, but rather preparing and contemplating events that could happen and impact our portfolios.  As we look forward over the next couple of months, one specific event that jump out in our minds is the midterm elections.  There is potential that the Republicans, who are expected to do well, which could have an impact on whether the Bush tax cuts are extended.  It is our belief that the idea of the Bush tax cuts being extended is not currently priced into the market.

 

The Bush tax cuts are meaningful. To highlight this point, in the bullet points below we compare what would happen to certain tax rates if the Bush tax cuts are not extended:

  • Short term capital gains would go from 35% to 39.6%;
  • Long term capital gains would go from 15% to 20%;
  • Qualified divided taxes would go from 15% to 39.6%;
  • Non-qualified dividend taxes would go from 25% to 39.6%; and
  • Wage taxes in the top bracket would go from 35% to 39.6%.

On a very basic level, an increase in divided taxes should decrease the value of those companies that pay dividends, all else being equal.

 

On September 7th at 230pm, Keith and I will be hosting a call with Karl Rove to discuss the midterms with the title, “Could The Midterm Election Be A Major Stock Market Catalyst?”  Karl, as many of you know, is known as “the Architect” for putting together the successful Gubernatorial and Presidential campaigns for George W. Bush.  Now let’s be clear, we get that Mr. Rove is a Republican and that many of you may be athwartship (a sailing term that means at right angles) politically with Karl, but this is not a political call.  This is about sitting down with one of the premier political analysts in the country and having a Big Boy Talk with him. The point is to try and determine whether the midterms will indeed be a catalyst.  If you are a current subscriber or would like to trial our service and participate in the call, please email us at .

 

As former long time Speaker of the House famously said: “All politics is local.” Typically this is indeed true, so while we can presume to know what is going on from our perches in Manhattan, Boston, New Haven, or wherever we may be, bringing in a man who has studied elections in this country on a county by county level is sure to help make sure our sails are directed toward the wind.  Currently, the Republicans clearly have the wind behind their sails.

 

To begin with, President Obama’s approval ratings are quite low.  According to the Real Clear politics poll average, 46.4% of those polled approve of the job President Obama is doing and 47.8% of those polled disapprove.  So, in aggregate, less than half of the country approves President Obama and more disapprove than approve.  Interestingly, in the Rasmussen Daily Tracking poll (which we have highlighted below with a picture of Hedgeye’s own sailor, Zach “The Hammer” Brown), President Obama has improved over the last month or so.  His current approval index is -13 (which is the difference between Strongly Approve and Strongly Disapprove), which is an improvement off his all time low on May 26th, 2010 of -22.  Despite this improvement, the point is President Obama’s approval rating is low, which won’t bode well for the Democrats.

 

The other important point to consider is that there is substantial dissatisfaction with politicians these days.  In fact, congressional approval is as low as it’s ever been, so the concept of incumbency advantage is likely going to be less impactful than typical this election.  As I wrote back in May:

 

“As many studies note, incumbents typically win re-election 90% of the time.  These early data points are noteworthy and mark the beginning of perhaps a serious shift by voters away from incumbency. This idea is also supported in recent polls.  Specifically, a recent ABC News-Washington Post poll indicated that nearly six in 10 respondents they’re not likely to vote for their current representatives to Congress.” 

 

A backlash against incumbents naturally hurts the Democrats because they hold more seats.

 

As we survey the Electoral Ocean in front of us this is what the polls looks like in terms of the shift of power according to the poll averages at Real Clear Politics:

  • Republicans to pick up 8 seats in the Senate but the Democrats will retain control at 51 to 49;
  • Republicans will win 206 seats in the House, the Democrats will win 194 seats and 35 seats are a tossup currently; and
  • The Republicans will pick up 8 governor seats to hold a 32 to 18 seat advantage.

The potential for major Republican victory in the fall is realistic, and we need every advantage we can get to ensure we fully understand the probabilities.  Keith and I hope you will join us on Tuesday.

 

As you head into the long weekend with your friends and family, I’ll leave you with one more quote from Mark Twain:

 

“Denial ain’t just a river in Egypt.”

 

Enjoy the weekend.

 

Yours in risk management,

 

Daryl G. Jones

 

Corner Banging - hammer1


U.S. Treasury Debt... Wouldn't Touch It With a Ten Foot Pole

Conclusion: Analyzing the latest quarterly presentation of the Treasury Borrowing Advisory Committee leads to some pretty negative takeaways as it relates to the fiscal health of the U.S.

 

Position: Short the U.S. dollar (UUP); Short 1-3 year U.S. Treasuries (SHY)

 

Below is a collection of select charts we pulled from the Department of the Treasury’s latest quarterly presentation to the Treasury Borrowing Advisory Committee. Needless to say, all is not well in our Hedgeyes, which is evident in the analysis below. We continue to remain short the short end of the yield curve and the U.S. dollar to express our bearish conviction regarding the U.S. government’s fiscal health and the negative long term economic outlook domestically.

 

After having tax revenues trending well below the historical recovery average since the end of the recession, we’ve finally eclipsed the average four quarters into the recovery. Unfortunately, that’s comes just as the Bush tax cuts may be extended while employment is deteriorating and both consumer spending and housing appear to exhibit significant downside over the next 3-4 quarters.

 

 U.S. Treasury Debt... Wouldn't Touch It With a Ten Foot Pole - 1

 

Much of the growth in tax revenue have been driven by corporate tax receipts, which look to slow absent an effective tax hike in the upcoming period of slow growth and depressed top line growth. Many companies have been pulling margins levers to drive earnings growth in recent quarters so a tax hike could be disastrous for earnings going forward, as these companies don’t have much left to cut.

 

 U.S. Treasury Debt... Wouldn't Touch It With a Ten Foot Pole - 2

 

If the federal government eats the marginal loss in revenues, they will need to borrow more to fund a larger deficit on the margin. Based on the deficit projections from our Hedgeye models, their estimates for borrowing (i.e. Piling Debt Upon Debt) over the next two years are far too low.

 

 U.S. Treasury Debt... Wouldn't Touch It With a Ten Foot Pole - 3

 

With yields on the long end of the curve near historic lows, the average maturity of U.S. Treasury debt outstanding has continued to increase as the Treasury issues more long-dated paper. Currently, the average maturity is right at the 30-year average of 58 months, or 16 months above the 30-year minimum and 13 months below the 30-year maximum. Should this up-trend continue, U.S. Treasury holders in aggregate will be increasingly subject to further duration risk – which is noteworthy given the fiscal health of the country (see: PIIGS 2010).

 

 U.S. Treasury Debt... Wouldn't Touch It With a Ten Foot Pole - 4

 

The percentage of debt maturing in the near-term is at historic lows on a 20-year basis. Even still, roughly 31% of treasuries ($4.1 trillion) need to be refinanced in the next 12 months. Adding that with a consensus minimum of $950 billion in financing needs in FY11 leaves us with 38.2% of treasury debt needing to be financed in the next 16 months. Accounting for Hedgeye’s worst case scenario of $1.93 trillion in financing needs for FY11 takes the magic number up to 45.6%.  This occurs at a time when it will likely become more difficult for the United States to roll over short term debt due to burgeoning fiscal issues.

 

 U.S. Treasury Debt... Wouldn't Touch It With a Ten Foot Pole - 5

 

A chart that really jumped out to us was their interest expense projections. Under baseline OMB scenarios (which we have shown in our previous  work to assume above-trend growth and below-trend expenditures), the federal budget’s interest expense will jump to nearly 4% of GDP in just ten years – a near 275bps increase from today’s ratio of ~1.25%! This is not surprising given the upward direction of the average maturity of public debt outstanding. A domestic interest expense near 4% of GDP is well above the historic average for the previous 60 years and this rise will naturally present significant trouble for the fiscal health of the United States over the next decade – especially considering the current direction of entitlement and healthcare spending. Either taxes will have to ramp up significantly in the next 5-10 years or the U.S. will continue to have to Pile MORE Debt Upon Debt to fund its deficits. Either result is negative for future economic growth domestically.

 

 U.S. Treasury Debt... Wouldn't Touch It With a Ten Foot Pole - 6

 

The next chart highlights a pretty interesting conundrum the U.S. federal government is in regarding the direction of interest expenses. When compared to many of its Western European and Japanese counterparts, we see the weighted average maturity of U.S. Treasury debt outstanding is below the group average. This means that the Department of the Treasury has room to take advantage of depressed yields at the long end of the curve and issue more long-dated securities, further increasing the interest rate burden on the federal government P&L.  Should the U.S. remain a group laggard and/or reduce its average maturity profile, it will leave itself more exposed to market sentiment and a potential crisis of confidence in U.S. Treasury debt. China has been selling U.S. Treasuries and should any other major holder (i.e. Japan, U.S. commercial banks, U.S. pension and hedge funds, etc.) follow suit, the U.S. government could potentially face a substantial refinancing crisis if rates on the short end of the curve back up meaningfully.

 

 U.S. Treasury Debt... Wouldn't Touch It With a Ten Foot Pole - 7

 

The last chart we want to highlight shows U.S. Treasury issuance will continue to dominate the debt supply landscape over the next couple of years, further crowding out private sector investment. Not much else to say here other than the fact that we are likely to face below trend GDP growth from a lack of private investment as long as the grey bar continues to dominate the chart below.

 

 U.S. Treasury Debt... Wouldn't Touch It With a Ten Foot Pole - 8

 

All told, we continue to remain short the short end of the yield curve and the U.S. dollar to express our bearish conviction regarding the U.S. government’s fiscal health and the negative long term economic outlook. The federal government’s aggressive baseline projections highlight some pretty negative trends and the more conservative Hedgeye models suggest even more downside as it relates to the intermediate-to-long-term fiscal heath of the U.S.

 

Darius Dale

Analyst


Keeping the Same Store Sales Score

August was better month than expected for those keeping the same store sales score.  The reality of the underlying results however, is that demand doesn’t really appear to be changing, better or worse.  There are a couple of key takeaways to be mindful of.  Across the board, when given a reason to shop, the consumer appears willing to spend.  This applies to August in a couple of ways. First, as it pertains to back-to-school and back-to-college.  Retailers across the board with exposure to this event cited on plan or better results so far in this key (but drawn out) selling season.  Is this enough to propel the quarter to upside on its own? No, but it clearly demonstrates the consumer still has the propensity to spend when given an  “event” or reason to do so.  Secondly, those retailers with improved or new products are seemingly able to drive sales as well.  Case in point is Limited Brands.  The company’s focus on new product introductions at Victoria’s Secret coupled with heavy marketing were key in driving above-plan and above-expectation results for the month.  Monthly innovation in the bra space is working, hands down.

 

Unfortunately, today’s results don’t really enhance clarity or visibility as we look out towards the remaining months of the year.  The back-to-school season, while off to a solid start, is also inherently volatile given the large amount of variables impacting mom’s decision to shop.  Here’s what we know.  In areas where school is already back or close to it, demand has been stronger.  Yes, this another sign of consumers buying close to need.  In states with tax-free events response has been strong.  Keep in mind that these events inherently create volatility and pull demand forward in some cases.  Promotional activity was frequently cited as “aggressive” or “high”, which should not come as a surprise, especially when it comes to teen apparel.  Regional trends are mixed, likely influenced by the timing of when kids return to school.  California and Florida (areas with the easiest compares) were mentioned positively by several retailers, although this is a trend that has been underway for several months now.  Finally, the weather was not a help this month.  Extreme heat has in some cases put a damper on early sell-through of Fall apparel.  It has also helped those that still have some Spring/Summer goods left (i.e. shorts, tees, and sandals).  For the most part, almost every retailer at this point is hoping for a cool-down.

 

Bottom line, when we look at our monthly same store sales index, it remains stuck in a sideways trend.  The 2-year monthly industry comp did tick up sequentially to 0.3% from -1.3% in July, but the range of monthly results still hovers around flat.  With earnings reports now complete, guidance reset, and expectations generally tempered, it’s no surprise that these results appear to be optically better than one would expect.  The reality is that underlying sequential demand remains essentially unchanged, at least if you’re using same store sales as a way to keep score.

 

Keeping the Same Store Sales Score - aug sales

 

Additional company callouts:

  • Hard to believe but AEO noted a strong response to key back-to-school categories including knit caps, denim, and sweaters.  Sounds like their customers must be stocking up or are completely oblivious to the heat.
  • ARO noted that stronger results were reported in peak back-to-school regions, mostly in the South and West.  As a result, management also expressed that it believes consumers are shopping closer to need.
  • Costco noted that TV sales remain under pressure, with both unit and sales comps declining by mid single digits for the category in August.  On the positive side, softlines were a big positive divergence for the month and increased by a mid-teens percentage.  Key drivers of this business were housewares, home furnishings, domestics, jewelry, and men’s apparel.  On the inflation front, average sales prices for meat were up mid single digits and produce was flat y/y.
  •  Gap noted that the company’s current Black Pants merchandising effort in women’s was a key performer in the month.  For men, khaki’s and woven shirts were top categories.  Baby and kid’s overall outperformed adults.
  • JC Penney noted that back-to-school sales performed well during the month, led by strong double digit increases in sales of backpacks.  Similar to other retailers, JCP also noted that sales were stronger in regions with earlier back-to-school start dates indicating purchases are being made closer to need.  While still early in its turnaround process, the home category was cited as having a positive performance online in the home category.  Recall that JCP’s online biz is about 50% home related.
  • Kohl’s noted consistency within its monthly results.  All regions and product categories produced positive increases for the month.  Home was the strongest category, increasing by high single digits.  The Southeast region also outperformed, increasing by double digits.  Kohl’s also showed a notable increase in transactions, which increased by low double digits.
  • Nordstrom highlighted jewelry, dresses, and women’s shoes as leading categories for the month.  August also marked the 12th month in a row of traffic increases for the department store retailer.
  • Ross Stores continues to highlight dresses, home, and shoes as leading categories for the off price retailer.  All three categories produced sales increases in the low double digit range. 
  • Limited noted that is has been and will continue to be less promotional than last year.  The company is eliminating a Fall sale even this year and continues to see substantial merchandise margin improvement as a result of less clearance and promotional activity.
  • Target noted continued strength in its food categories, registering an increase of low double digits for the month.  Other above-average categories included health and beauty, men’s apparel and women’s apparel- all of which increased by mid single digits.  Electronics were cited as a weaker category for the month (similar to prior months).

Eric Levine

Director


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