The Economic Data calendar for the week of the 4th of October through the 8th is full of critical releases and events. Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.
Conclusion: The bevy of economic data out of Asia over the last 48 hours is both supportive of the bullish rally in many Asian equity markets and the relative underperformance of Japanese equities. What remains to be seen, however, is where do Asian equities go from here?
Position: Short Japanese Equities (EWJ); Short Japanese yen (FXY)
There has been a slew of economic data coming out of Asia over the last 48 hours – some good, some bad, and some ugly. Rather than belabor the point(s) with excessive prose, we’ll just highlight the meaningful deltas and inflection points in the call-outs and charts below.
The economic and company data above is both supportive of the bullish rally in many Asian equity markets, as well as the relative underperformance in Japanese equities. What remains to be seen, however, is where we go from here? With U.S. consumer demand prepared to tank in 4Q10 and 1Q11, Western European consumer demand potentially following suit, and the prospect for further strengthening in Asian currencies (Asia Dollar Index at a two-year high), do Asian equities continue to go straight up given the likelihood of sequentially deteriorating economic data over the next 3-6 months?
Consider the following stats:
Given Asia’s leverage to a weakening U.S. and European consumer, we must ask ourselves whether Asian equities could correct meaningfully in the next 3-6 months based on the confluence of declining trade and equity market mean reversion. While we are not yet ready to make a call in either direction, we’d be remiss not to call out the downside risks.
Lastly, as we see from the aforementioned China and S. Korea inflation data, Mr. Bernanke’s quantitative easing experiment continues to export commodity price inflation to the rest of the world, as dollar debasement results in appreciation of assets priced in dollars. No reason to make it any more complicated than that.
As always, time, data and more prices will guide our decision-making from here.
Have a great weekend,
“Prosperity and overconsumption was driven by asset inflation that in turn was leverage and interest rate correlated.”
-William H. Gross
From my inbox, I’ve been a long time student of Bill Gross. He is one of the most influential teachers on the buy-side. He’s a great communicator. He’s somewhat transparent about his positioning. And he’s certainly accountable to his investors’ returns.
He’s also got the US Federal Reserve in his back pocket.
I’m highlighting the aforementioned quote from Gross’ Investment Outlook missive for October titled “Stan Druckenmiller is Leaving”. It’s one of those macro sentences that you need to read slowly. Then you need to read it again. It’s solid, but it needs a little love. Subtract the qualitative word PROSPERITY and add the words DOLLAR DEVALUATION. Then you’ll see Hedgeye’s New Reality intersect PIMCO’s New Normal.
“Overconsumption was driven by asset inflation that in turn was leverage, interest rate, and Dollar devaluation correlated.”
Not that I keep track, but we introduced The New Reality before Gross went with The New Normal. The New Reality abides by the principles of chaos theory. The New Reality is that normal is grounded in uncertainty. The New Storytelling of global markets will be shaped by the math that backs it.
So let’s dig into some math…
As of last night’s Q310 closing prices, here are the top 10 inverse correlations (using our immediate term TRADE duration) versus the US Dollar Index:
The first thing you should say about anything in the area code of a 0.90 correlation is wow. The second thing you should say to the government that perpetuates this debauchery of your currency is shame on you.
As for Mr. Gross, I’m not quite sure what to say. After all, he does run the world’s largest bond fund – and that fund proved to not do so well during the DOLLAR DEVALUATION days of 2008.
That’s not a shot at Bill Gross. That’s reality. If you debauch the currency of a nation, you will ultimately get inflation. Sequentially rising inflation is bad for bonds. When oil hit $150/barrel and copper was at $4/lbs, neither Greenspan nor Bernanke saw inflation, but PIMCO’s investors did. Overlay PIMCO’s Total Return Fund with Treasury Inflation Protected securities (TIPs) for the first 9 months of 2008 and you’ll get the picture.
The New Reality is that Bill Gross gets paid to talk about the New Normal, not QE’s impact on the US Dollar. On our immediate term risk management duration, the US Dollar has an inverse correlation versus the PIMCO Total Return Fund of … drum roll for the storytellers in the Haven… -0.91!
What we’ve learned in the last few years is that DOLLAR DOWN = REFLATION until these inverse correlations get too high and REFLATION becomes INFLATION. Sure, there’s deflation in US Housing – but there’s been longstanding deflation in the price of tulips and Japanese real estate too.
The US Dollar is getting annihilated (down 15 of the last 18 weeks and down -11% since June). Those getting paid by this may not care, but the other 95% of people who live in this country do. How else could the US stock market have its best September since 1939 and US consumer confidence drop?
I bought back my inflation protection in both the Hedgeye Portfolio and Hedgeye Asset Allocation Model yesterday (TIP). My immediate term support and resistance levels for the SP500 are now 1140 and 1155, respectively.
Correlations in markets are never perpetual, but The New Storytelling of Wall Street is.
Best of luck out there today and enjoy your weekend,
Keith R. McCullough
Chief Executive Officer
This note was originally published at 8am this morning, October 01, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.
The announcement of Dick’s Chief Marketing Officer Jeff Hennion’s departure in conjunction with other moves at C-level and board positions over the last 12-months caught our attention today. Upon further digging through various moves in the company’s senior ranks over the last year, the bottom-line is that there’s been a noteworthy level of turnover. In fact, 50% of C-level management (3 of 6 positions) and 20% of the company’s Board of Directors have vacated their posts in the past year. When looked at in aggregate, the sheer volume of leadership change is certainly noteworthy.
We’d be remiss not to recall the fact that Gwen Manto (previously Dick’s Chief Merchandising Officer) left to join Sports Authority. Is it possible Mr. Hennion has also embarked on the same path? The thought certainly crossed our mind – though just to be clear, we don’t have intimate knowledge of the situation. In November 2009, TSA beefed up its team with the hiring of Jeff Schumacher as the Chief Marketing & Strategic Officer out of McKinsey & Co. While it may just be a simple case of timing, the chronology of executive moves at the two sporting goods giants suggests a shift in talent is underway. With Sports Authority’s intentions of bringing the company public in the near-term, we wonder just how many former DKS executives will be rubbing elbows at the road show.
Conclusion: The Street is mixed on BWLD, but the consensus EPS expectations seem low. I am currently modeling FY10 EPS of $2.14 versus the street at $2.08 with more of the upside falling in 4Q10.
I estimate EPS for 3Q10E and 4Q10E of $0.45 (versus the Street at $0.43) and $0.60 (versus the street at $0.56) respectively. The primary risk to my 4Q estimate is the ability of the industry to maintain the current trend of posting improved comparable-store sales results on a two-year average basis.
Reasons for upside:
Company comparable-store sales were up 2.2% in July versus +1.2% in the year-ago period, which implies a 30 bp improvement in two-year average trends since the end of 2Q10 (and trends came in much better-than-expected during 2Q10 after turning positive in June from -3.7% in April).
While this data point for July is encouraging, it obviously does not make a quarter. Industry trends, on average, have improved on a one and two-year basis since early in the summer. Comparisons become easier for BWLD for the remainder of the quarter as 3Q09 comparable-store sales came in at +0.8% (after being up 1.2% in the first four weeks of the quarter).
I am modeling +3.0% company SSS for 3Q10, which implies a nearly 60 bp acceleration in 2-year average trends from the prior quarter.
The consensus says: The chart below shows the current sentiment surrounding the stock. Positive ratings (“BUY” and “OUTPERFORM”) are at 55.6%, down from the peak of 63.2% in March, and up from the low of 44.4% in May.
COGS: Chicken wing prices were down nearly 11% in 2Q10. Based on two-month number given for 3Q10 of $1.41/lb, wing costs will be down closer to 16% in 3Q10 versus the $1.67/lb cost in 3Q09. The year-over-year benefit should be even greater in 4Q10 as the company is lapping its highest price paid in 4Q09 of $1.78/lb. This, combined with same-store sales trends that should improve on a 2-year average basis, should drive the bulk of the year-over-year restaurant-level margin growth in 2H10.
Labor: Management guided to slight year-over-year leverage in 3Q10.
Offsets: Restaurant operating expenses are moving higher in 2H10 due to additional pay-per-view TV programming costs and an expected 11% increase in media spending in 3Q and 4Q.
Preopening expenses will be higher year-over-year as the company is expected to open 13 units in 3Q10 versus 5 in 3Q09 and 14 units in 4Q10 versus 12 in 4Q09.
3Q10 EPS Growth:
Although management guided to 20% EPS growth for the full year, they said on the last earnings call that it may not achieve that target in each quarter of the year and they mentioned the expected higher level of preopening expense in 3Q10.
This, along with the fact that the company is lapping its highest quarter of YOY growth from FY09, leads me to think that the company will post its lowest year-over-year growth in 3Q10. My 3Q10 EPS estimate assumes nearly 20% EPS growth after 23% and 31% growth in 1Q and 2Q, respectively.
I think the 49% reported EPS growth in 3Q09 relative to the 24% full-year growth was partly a function of comparisons. The company’s 3Q08 EPS grew only 6% versus 24% for FY08 overall.
SSS actually slowed sharply in 3Q09 on a one-year and two-year basis and chicken wing prices were up 43% during the quarter.
Preopening expenses, however, were much lower YOY in 3Q09 and drove a bulk of the EPS growth as the company only opened 5 units in 3Q09 relative to 18 in 3Q08. If you make 3Q09 preopening expense equal to the 3Q08 level, EPS would have only been up closer to 20%.
Based on our restaurant sigma chart, it looks as though the company has a good chance of remaining in the “Nirvana” quadrant (positive same-store sales growth and positive restaurant-level margin growth) for the next several quarters if comp trends hold steady (that is obviously a big if). BWLD needs positive comp growth to offset the growth-related costs inherent in its P&L and comps trends definitely improved more than I was expecting during the second quarter. It will be important to see if BWLD can maintain this top-line momentum.
I continue to think the company is growing too fast. I consider return on incremental invested capital to be the best metric to look at when considering the sustainability of a company’s unit growth plans. After declining in 2009, returns look to be recovering in 2010 to about 30%, which is impressive. Based on my current estimates (I think it will be harder for the company to achieve 20% EPS growth in FY11), I would expect returns, however, to fall off again in 2011 to a low double-digit range. Although this still implies positive returns for 2011, I have found that the absolute direction of the trend in returns is the more important indicator of future trends and, ultimately, stock performance.
Conclusion: We continue to see weakness in the consumption trends when government spending is stripped away. Slower growth is likely going forward.
Commerce Department figures released today show that consumer spending rose in August while ISM and consumer confidence data have flashed to the downside in recent releases. See our conclusions below and a chart of ISM component shifts in the most recent months.
INCOME - Consumer spending in the U.S. rose 0.4% in August; the gain exceeded the 0.3% increase projected the Bloomberg consensus. Incomes were up 0.5%, the biggest advance this year (propelled by the incorrigible hand of Washington). Transfer payments jumped 1.6%, indicating that the government’s crutch is still a core factor in this “recovery”.
Hedgeye conclusion: there will be a rocky road transitioning from the government supporting consumer spending to the “real” economy.
ISM - The ISM print was better that feared, still growing in September, but at the slowest pace in 10 months. The I SM factory index dropped to 54.4 from 56.3 in August. Bloomberg consensus forecast a decline to 54.5.
Hedgeye conclusion: A sequentially lower ISM print in October is likely.
CONFIDENCE - The University of Michigan final index of consumer sentiment fell to 68.2 from 68.9 in August, but up significantly from the preliminary reading of 66.6 issued last month.
Hedgeye conclusion: Maybe there was a fat finger in Michigan! The bottom line is that confidence is not improving, but people are spending more thanks to gifts from Washington.
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