prev

The Incorrigible Hand

“A government big enough to give you everything you want is a government big enough to take from you everything you have.”
-Gerald Ford [Address to a Joint Session of Congress - August 12, 1974]

 

In yesterday’s Early Look, Keith said “I haven’t considered a heightening probability of a US stock market crash in an Early Look note since 2008.”  After reading that all I could think about was 1987 and a very difficult Friday in October.  We have five Fridays in October this year and I, for one, am concerned about all of them!

 

The current backdrop:

 

First catalyst - The Incorrigible Hand:

  • A financial bubble fueled by easy money and loose credit bursts  
  • Unemployment rises and GDP growth slows 
  • The misguided in Washington blame foreigners for unfair trade practices and pass a trade bill   
  • Thus sending the country into further economic weakness

Some elder Americans have seen this movie before.  The rest of us can read about it.  The fragile state of our economy, which the data is speaking to daily, is not lost on Main Street America.  In Washington, politicians are posturing accordingly.  Schumer and friends are spitting fire about China’s “economically injurious behavior” and the need for action against the “currency manipulators” in the form of a trade tariff on Chinese imports.  Look no further than the Smoot-Hawley tariff act of 1930 for an example of what such action may result in for this country.  Despite a petition signed by over one thousand economists requesting a presidential veto, this law was signed into effect and many believe exacerbated the Great Depression.

 

Yesterday, the House of Representatives passed H.R. 2378 or the Currency Reform for Fair Trade Act.  If it becomes law this year (which is unlikely given the mid-terms and that the Senate is only in session for a few more days), the bill would give the Obama administration the power to raise tariffs on imports if the Commerce Department determines that an exporting country is manipulating its currency.

 

The refusal to yield to common sense on the part of those pushing this bill is beyond belief; you can’t make this stuff up.  The CBO released a report showing that the new tariffs would raise only $20 million versus the billions in trade we do with the Chinese.  Thinking we can legislate the YUAN higher is just lunacy.

 

Second catalyst - the Financials are at risk:

 

According to our Financials analyst Josh Steiner, certain Financials are setting up to be a great short.  In his note yesterday he said “this is the third time this year that we've written a note on high yield and its relationship/implications for the XLF. High Yield is knocking on the door of its YTD highs once again; the index peaked at 8.19% on April 29th, 8.28% on August 3rd and closed two days ago (September 27) at 8.24%. Following those first two peaks in high yield, XLF dropped 18% and 10%, respectively over durations of 64 and 23 days.“

 

Third catalyst - the cost of bailing out the European mess is on the rise:

 

Europe’s woes continue, whether the eyes of the manic media are focused on them or not.  Ireland’s government has injected 30 billion euro into Anglo Irish Bank since January 2009 and estimates that 11.4 billion euro in additional liquidity may be required.  Another lender, Allied Irish Bank, is also set to receive government funding bringing the total cost of Ireland’s bank bailout to as much as 50 billion euro ($68 billion).  In addition, the country's budget deficit will balloon to 32% of GDP this year.

 

Fourth catalyst - Fridays ISM print:

 

Once again, we are looking at a Friday in October as bonds signal trouble and stocks levitate.  I understand that the economic backdrop of the crash in October 1987 was very different, but it’s still all about interest rates, the dollar and budget deficits.  This time, the “emergency” level of rates is not helping to stimulate the economy as intended. 

 

Tomorrow the ISM manufacturing index for September will be reported.  The August reading of 56.3 posted a big upside surprise versus expectations of 52.8, setting off a 9.09% rally in the S&P 500.  Since then, Factory orders, ISM non-manufacturing, Empire Manufacturing, Philadelphia Fed, Chicago Fed and the Dallas Fed have all reported disappointing numbers relative to expectations.  All of the regional FED readings, except the Empire State manufacturing reading, are showing September numbers that imply economic contraction, not expansion. A reading below 50 on the ISM is in play for the first Friday in October.

 

We believe that the fundamentals are pointing to the downside and the catalysts outlined above highlight some key risks to be aware of.  With many close races in the November elections, pointing fingers at others is the favored position in D.C. Rest assured, government’s Incorrigible Hand will be in action.  There are historical precedents for this kind of policy.  Looking at a more contemporary cautionary tale, Japan, is also instructive.  We will be exploring the lessons to be learned from Japan’s experience next Tuesday, October 5th when the Hedgeye Macro team hosts the 4Q10 Macro Themes conference call (email if you are interested in the call).  The three themes are:

 

(1)    Japan’s Jugular  - Japan got rocked last night, down 1.99%, now down 11.6% YTD.

(2)    Krugman’s Kryptonite - comparing our Japan conclusions to academic dogma about debt financed deficit “stimulus”, and deconstructing  Paul Krugman’s math.

(3)    Consumption  Cannonball  - The Incorrigible Hand strikes again!

 

Function in disaster; finish in style

 

Howard Penney

 

The Incorrigible Hand - obama schumer


LIZ: Why We’re Liking It

It’s tough to find long ideas in retail today where the sheer force of company-specific initiatives can offset the cross currents of Macro and the Global Supply chain to take estimates above current expectations. LIZ is emerging as one of them.

 

Some points to consider. First off…look at the chart below. Former CEO Paul Charron saw what was coming down the pike. After having successfully rolled up a whole host of branded apparel companies and always looking like the good guy b/c he was perennially compared to Jones Apparel Group (JNY), Charron cashed out in 2006 with his stock in the low $40s.  Enter Bill McComb – who arguably did not know what he was getting himself into.

 

We could dedicate a few thousand words alone to what allowed Charron to build his empire, and why the environment changed after McComb took the helm. But it won’t change one major factor – that the stock is sitting at six bucks.

 

It’s easy to see why given the earnings revision chart below.

 

LIZ: Why We’re Liking It - LIZ Earnings Revisions in McComb Admin

 

The bottom line here is that we think that revisions are starting to turn positive again.

The Street’s 3Q number of break-even EPS seems about right. But in 4Q, the consensus numbers look low by about a third. For the next two years we’re commin’ in hot at $0.84 and $1.34. That compares to the Street at $0.30 and $0.80, respectively.

 

There are a few main drivers.

1)      LIZ is finally coming off a 3-year period where it…

  1. First royally crossed its largest customer and the largest department store in the world (Macy’s for those that don’t cover the space).
  2. Prepared to ramp in an exclusive arrangement to sell into JC Penney with its core LIZ Claiborne Brand – which caused additional friction in the channel.
  3. Launched a new model to sell consumer-direct on QVC.
  4. These are great ideas, as they reduce margin volatility while taking working capital out of the business at a time when the market often reverts into a mode where it thinks LIZ is going away. This deal helps both the income statement and balance sheet.  Mind you…while this transformation took place, it took away $500mm in revenue on a sales base that today stands at just $2.6bn. That’s about $3.90 per share after tax.
  5. This erosion is OVER. See earnings revision chart above once again.

2)      Mexx is another business LIZ owns that has been just awful.

  1. Once upon a time, this was a $1.2bn brand. Now it is losing money at $750mm.  One of the issues at Mexx is that the company in effect ‘fired’ their customer. They tightened the customer range, and went chic metrosexual (that’s the first and last time you’ll see that in a McGough note). They had all eggs in one basket with Li&Fung, who chinced on quality of materials. Overall, the consumer had very little reason to shop there.
  2. My Canadian friends and colleagues are gonna give me crap for bringing this up, but this got to a point where Mexx Canada asked for, and got permission to, stop sourcing from Mexx Europe. That fashion was simply too ‘out there’ for real people.
  3. Now what? New design team started early this year. Li&Fung accounts of 70% of biz – which is still big – but now there are others to keep them in check.
  4. AUR is coming down by 10%, but 2/3 of Mexx product has been selling at a discount, as opposed to peers of 1/3.  The company can offer better product 10% lower in price and probably increase traffic and conversions.
  5. Will this happen overnight? No. But this has been a BIG problem for a long time, and most US investors don’t get it bc it is all about Europe and Canada. We could see as much as a $0.30 swing in EPS next year if this gets to a 2-3% EBIT margin.

3)      There are other factors as well – such as the closure of LIZ’s perennially underperforming outlet stores – which will add another $0.12-$0.13 per share next year – and the additional cost costs at HQ.

4)      Also, did we mention the balance sheet?  We’re looking at a $200mm, or $2.15 per share swing, in operating cash flow at a time when the business is becoming less capital intensive. Interest expense should come down from $65mm last year to just under $30mm by 2012.

 

Are we concerned about cotton? Yes. But that’s not in the top 5 factors that matter here. We can’t say that for many other companies in retail.


Get Up and Strike, Europe

Hedgeye Portfolio: Short Italy (EWI); Long Germany (EWG); Long British Pound (FXB)

 

“Get up and Strike, Europe” or at least that seems to be the message today, with an estimated 50,000 people across the region standing against government-sponsored austerity measures to trim public debt and deficits. Certainly we believe it’s important to note a coordinated strike across Europe against austerity (which weighed on equity markets today and pushed up bond yields), however, we’re quick to note two points to keep this strike in perspective: 1.) you can bet this won’t be the last strike in Europe over austerity, and 2.) strikers will remain a small minority of the population = we’re not talking about economies grinding to a halt during strikes.

 

We’d direct you to our website (www.hedgeye.com) to read more of our work on the implications of austerity in Europe. In short, our position remains that we’re bullish from a top-down perspective on countries that issue austerity measures to clean up their fiscal houses. That said, fiscal trimming will not be a panacea across Europe to cure its ails. We see clear divergence among countries; we are bullish on Germany and continue to warn of further deterioration in the capital markets of countries like Portugal, Ireland, Italy, Greece, and Spain.

 

Below we show graphically the data out today from Europe, with minimal commentary included, to keep the dialogue open on our positioning in Europe.

 

Matthew Hedrick

Analyst

 

Get Up and Strike, Europe - n1

 

Get Up and Strike, Europe - n2

 

Get Up and Strike, Europe - n3

 

Get Up and Strike, Europe - n4


GET THE HEDGEYE MARKET BRIEF FREE

Enter your email address to receive our newsletter of 5 trending market topics. VIEW SAMPLE

By joining our email marketing list you agree to receive marketing emails from Hedgeye. You may unsubscribe at any time by clicking the unsubscribe link in one of the emails.

Tougher Road Ahead for Sports Apparel Near-Term

Despite what seems to be a meaningful erosion at face value, the underlying trend in sports apparel sales remains positive (+3%) on a trailing 3-week basis. While the week ending Sunday the 26th marked the greatest sequential deceleration since May 23rd, it’s important to note that at this time last year we saw the start of 3-week growth spurt brought on primarily by a nationwide cold snap through the first 3-weeks of October as well as UA’s shift into expanded fits beyond compression to fitted (non-compression) product. During that time last year, total sales accelerated from +2% this past week to +3%, +7%, and +15% while Sport Retailer sales ramped from +9% to +8%, +9%, and +19% as highlighted in the charts below.

 

The biggest anomaly for the week is that the Athletic Specialty retailers underperformed the mass, discount and channels on the margin.  Given that it’s only a week, this is not enough for us to challenge any of our models – but we’ll keep an eye on the trends to monitor any sustained channel divergence.

 

On a branded basis, sales slowed across the board sequentially. Additionally, a divergence in performance over the last two weeks has emerged with Under Armour outpacing Nike – something that we’ll be watching closely in the next few weeks but expect to moderate. Why? Recall UA introduced its expanded offering of fitted (non-compression) product in mid-October. This in turn drove sales up +56% the week ending October 18 and trailing 3-week trends materially higher. The product intro also added nearly 5% to an already strong base. At the same time Nike increased 18% driven by accelerated growth in the family channel most likely reflecting the clearance of underperforming product. Now we’ve got Nike sporting a 20%+ growth rate in its North American futures.

 

As much as we try to avoid the weather card, we can’t ignore temps hitting record highs in certain parts of the country as we start to anniversary unseasonable cooler weather. That said, October will be an important month for UA as it comps its toughest month of the entire year.

 

Casey Flavin

Director

 

Tougher Road Ahead for Sports Apparel Near-Term - App Table 9 29 10

 

Tougher Road Ahead for Sports Apparel Near-Term - FW App AppChan 1yr 9 29 10

 

Tougher Road Ahead for Sports Apparel Near-Term - FW App AppChan 2yr 9 29 10

 

Tougher Road Ahead for Sports Apparel Near-Term - App Weather 9 29 10

 

Tougher Road Ahead for Sports Apparel Near-Term - App Weather 3W 9 29 10

 

Tougher Road Ahead for Sports Apparel Near-Term - NKE Apparel T3W 9 29 10

 

Tougher Road Ahead for Sports Apparel Near-Term - UA Apparel T3W 9 29 10

 

 


EARLY LOOK: A Heavier Crash

 

“The lofty pine is oftenest shaken by the winds; high towers fall with a heavier crash; and the lightning strikes the highest mountain.” 

-Horace

 

EARLY LOOK: A Heavier Crash - Horace

 

 

 

I haven’t considered a heightening probability of a US stock market crash in an Early Look note since 2008. I’ll go there this morning.

 

Before I look forward, allow me to take a step back. To fully appreciate the risk that is getting baked into this US stock market cake, we should respect history’s lessons. If you believe that the professional politicians of the Fiat Republics of modern day America and Japan have as much to lose as those in the Roman Empire did in 49BC, you’ll find my using a quote from the leading Roman lyric poet of that era appropriate.

 

I’m not a poet. I’m a Risk Manager. In probability speak, I am registering signals in my global macro risk management model that would consider an abrupt 1-3 day US stock market crash in October probable. To be clear, I’m not saying it’s likely – but I am saying it’s probable. There is a difference.

 

Probable is proactively predictable. Likely would be a better than 50% chance. What I see here is a 33% chance this happens, so let’s strap the accountability pants on and take a walk down that path. For a Heavier Crash to occur during a compressed period of time, we still need a few more things to happen:

  1. We need to see the SP500 get squeezed one more time in the next few weeks to a price north of 1164.
  2. We need to see volatility (VIX) get oversold towards 20.
  3. We need to continue to see the world’s said “reserve currency” lose its credibility.

The bad news is that all 3 of these factors are already in motion, big time (since late August the SP500 is +10%, the VIX is down over -20%, and the US Dollar has been crushed to lower-intermediate-term-lows). If these 3 factors continue to travel the path of least resistance (SP500 up, VIX down, and US Dollar debauched), we could have a serious short term problem.

 

Measuring time and space is a critical aspect of my profession. As a chaos theorist, I don’t expect to be taken seriously by the gurus of buying cheap P/E’s, nor do I want to be. If the Ken Fishers of the world didn’t realize they were going to get smoked in 2008, I don’t see why they’d see it coming now. Evolving the risk management process is a dynamic exercise in and of itself. We all need to change as the market’s ecosystem does.

 

So what would a Heavier Crash look and feel like?

  1. The most probable scenario that the perma-bulls would consider improbable is a 1-3 day correction on the order of -5.4% to -6.9%.
  2. The least probable scenario in my model is an October 1987 type day (down -23%); I’d still consider that improbable, for now.

 

EARLY LOOK: A Heavier Crash - heute

 

Now isn’t that a correction rather than a crash? If we eliminated that one little critter that the market calls expectations, yes, it might be. But relative to the expectations in this market today (this morning’s Bullish to Bearish Survey from Institutional Investor is seeing a +2400 basis point swing to the bullish side since the week US stocks closed at their late August lows), this could feel like a Heavier Crash than it might be considered in nominal terms.

 

What immediate term bearish data and price information in the land of global interconnectedness am I staring at in my notebook?

 

EARLY LOOK: A Heavier Crash - Notebook Image Hedgeye

 

EARLY LOOK: A Heavier Crash - Notebook Bearish

 

  1. The SP500 is teetering on a critical line of support (my intermediate term TREND line of 1144); any slicing through that line on accelerating volume puts this bearish scenario back in play (again, that’s not what I would consider tail risk – it’s a probability to manage risk around)
  2. Volatility (VIX) continues to trade with an extremely high inverse correlation to the SP500 with TREND line support for the VIX at 20.96
  3. The SP500 is actually down for 4 out of the last 6 trading days and the market’s breadth is deteriorating
  4. Financials (XLF) remain the only sector in the SP500 (of the 9 we model top-down daily) that’s bearish from a TREND perspective
  5. Yield Spread (10s to 2s) continues to compress this week versus last and remains a bearish headwind for US Financial spreads and earnings
  6. High Yield is trading within 7bps of its April 2010 highs at 8.25%; this is a contrarian indicator, big time
  7. Levered Loan Index at 15.13 is 5bps away from its late April early May highs; another contrarian (bearish) indicator for equities
  8. Case-Shiller Prices (JUL) rollover again sequentially (month-over-month) and we forecast the October 26th Case-Shiller report to be a bomb
  9. US Consumer confidence comes in at a bomb, 48.5 for SEP versus 53.2 AUG, despite CNBC cheering the stock market higher
  10. “Republican House” finds its way onto the cover of Barron’s = consensus bullish catalyst now
  11. M&A rumors haven’t been this frothy since September of 2007 (we’ve counted 67 alleged “takeouts” that haven’t occurred)
  12. US Dollar Index continues to burn at the stake of QE hope; down now for the 15th of the last 18 weeks and Washington doesn’t care
  13. US Treasury Yields are in a Bearish Formation across the curve (2yr yield TRADE resist = 0.51%) = bearish signal for US economic growth
  14. Chinese stocks have closed down for 6 out of the last 8 days and the Shanghai Composite is now broken on immediate term TRADE duration
  15. Japanese stocks continue to be the armpit that is long term QE; Nikkei down 3 of last 5 days and down -10% for 2010 to-date
  16. Japanese exports (AUG) hammered sequentially down to +15.3% y/y vs +23.5% y/y in JUL; expect more Fiat Fool intervention from here
  17. Japan’s Bureaucrats calling for another 4.6 TRILLION Yen in stimulus and proposing to pay for it by raising taxes this time?
  18. Spain’s IBEX is breaking its immediate term TRADE line this morning (first time in months; support line could become resistance at 10,501)
  19. Italy’s CDS continues to push higher at 205bps and remains the country with the most downside relative to consensus (we’re short EWI)
  20. European CDS continues to push wider on the heels of Greek Equities getting smoked (down -13% since 1st week of September with SPY +9%)
  21. Russian deficit risk heightening in the face of Medvedev firing the longstanding (18 year) mayor of Moscow
  22. Romania’s Interior Minister resigns in the face of austerity implementation
  23. Sri Lanka is now issuing sovereign debt ($6B worth) and markets there are cheering it on?
  24. Dubai says “we are back”

Acknowledging that there are plenty of bullish data points on the other side of this ‘QE is going to save us all’ expectation (there better be with the SP500 up +9.6% in a straight line from its August 26th low), I can only count 15 of consequence this morning - and that’s less than what I’d need to see for me not to call for a buckling of your chinstraps.

 

Horace’s lightening has already struck some of the highest mountains of buy-side and sell-side exposures in the last 3 years, but the lofty pines of professional politicians and the highest ivory towers of academic dogma that support them are still in for their heaviest crash yet.

 

My immediate term support and resistance lines for the SP500 are now 1136 and 1155, respectively. It’s not October yet. The SP500 hasn’t touched 1164 yet. So I’m not short the SP500 yet. Measuring time, space, and probabilities matter.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

This note was originally published September 29, 2010 at 08:01am ET

 


PFCB – REAL-TIME COMMENTS

Conclusion: PFCB is facing easy comparisons in 3Q10 on many fronts.  At the same time, trends are getting better at the Bistro, which should make for a strong third quarter.  Co-CEO Bert Vivian’s modestly positive comments today increase my conviction that PFCB will have a marginally stronger back half of the year.


To that end, PFCB should move up and to the right into the “nirvana” quadrant of our restaurant sigma chart (positive same-store sales and growing YOY restaurant level margin) during the back half of the year after starting out the year in the “deep hole” quadrant (negative same-store sales and declining YOY restaurant level margin). 


Risk: Despite the company’s modestly optimistic outlook for the industry, our Hedgeye view is that the consumer will continue to face increased pressure in the back half of the year.

 

Mr. Vivian gave a broad overview of his outlook for PFCB and the industry for the balance of this year and next year at an investor conference this afternoon.  Overall, he said that the year is progressing as management had expected going into the year.  Specifically, business travel trends, or the weekday business, improved during the first half of the year while the social side of the business, primarily driven on the weekend, has caught up to-date in 2H10.  To that point, the company is seeing fairly even activity across the week on a YOY growth basis; though Mr. Vivian called the growth “modest.”

 

In August, same-store sales growth was positive for the Bistro in 36 of the 38 states in which it operates, which Mr. Vivian said signals a real change in tide of the overall health of the business relative to last year.  Trends were negative in all 38 states in the year-ago period.

 

Regional performance:  Las Vegas is currently one of PFCB’s strongest markets.  Traffic has been consistently solid this year in Las Vegas, which is a marked change from last year.  California continues to be an extremely important state for PFCB as it drives about 16-17% of sales.  Trends in California need to stay positive in order for the Bistro to be positive (California turned positive for the Bistro a few months ago).  Trends in Arizona have bounced back and forth whereas Texas and Florida have shown modest positive growth.

 

Commodities: The company is locked in on its commodity needs for the balance of 2010.

 

Share repurchase: PFCB expects to buy back about $40 million in shares in 2010.

 

4Q10: 

 

Currently, Mr. Vivian expects 4Q10 to be ok as he thinks consumers will be out and about around the Christmas season; though people will still be looking for great value.

 

2011:

 

“Unless the solar systems collide,” Mr. Vivian expects next year to be marginally better for PFCB and the industry.  For industry trends to come in better than ok, there would need to be a significant change in the jobless situation, which he views as unlikely.

 

Commodities: The company is locked in on a bulk of its commodity needs through the end of FY11, with the exception of beef (which he expects to move higher).  On balance, PFCB is locked in at prices that are fairly similar to 2010 levels.

 

Labor:  Mr. Vivian expects higher labor costs to put some pressure on margins in 2011 as a result of increased wage rates, a higher level of turnover and higher health care costs, which are expected to be up low double digits.  The company hopes to take some price next year to offset these higher costs as long as traffic trends hold up in the back half of the year.

 

New openings: Current development plans include about 4-6 new Bistros each year over the next 3-5 years and about 10-15 Pei Wei openings in 2011 (closer to the low end of that range) and 15-20 in 2012.

 

Share repurchase: PFCB expects to buy back about $60 million in shares next year.

 

Unilever and International businesses: Expected to add a small, high-margin royalty stream to PFCB’s P&L over time, which requires no capital on the part of PFCB.

 

EPS growth: Expects to achieve low double-digit EPS growth over the next 3-5 years.

 

PFCB – REAL-TIME COMMENTS - pcfb sigma

 

Howard Penney

Managing Director


Attention Students...

Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.

next