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Eye On Asia: Things Are Getting Ugly

Conclusion: With the U.S. facing the Consumption Cannonball and Jobless Stagflation, China, India, and Australia tightening monetary policy, and Western Europe fully implementing austerity measures, we think many Asian equity markets are due for a meaningful correction over the intermediate-term TREND. Supporting this outlook are increased signs of slowing growth and accelerating inflation throughout the region.

 

Positions: Long Chinese Yuan (CYB); Short Japanese yen (FXY); Short Emerging Market Equities (FFD); Bearish on Japanese Equities; Bearish on Indian Equities

 

There has been a slew of economic data coming out of Asia over the last few days – 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 Good 

  • China’s PMI accelerated in October to 54.7 from 52.9 in September.
  • China granted the Hong Kong Monetary Authority a Qualified Foreign Institutional Investor license, which gives the city-state the right to invest Chinese stocks and bonds in an effort to diversify its $266 billion in reserves. This is yet another step in the yuan’s march up the global currency totem pole. Furthermore, today’s announcement gives rise to speculation that the HKMA will shift the Hong Kong dollar’s exchange rate peg to the yuan from the U.S. dollar in the coming years.
  • Japan’s Unemployment Rate ticked down in September to 5% from 5.1% in August.
  • Singapore’s Industrial Production growth accelerated substantially in September to +26.2% YoY from +8.1% YoY in August. We continue to be bullish on Singapore’s equity market and currency from a long-term  TAIL perspective due to reasons outlined in a July 14th report titled: The Singapore Sling – Why We Are Long of Singapore (email us if you need a copy). We, however, don’t have be bullish at every price as there is a fundamental difference between liking an investment and actually being invested in it.
  • Singapore’s PMI accelerated in October to 50.7 from 49.5 in September.
  • Singapore’s Unemployment Rate ticked down in 3Q10 to 2.1% from 2.2% in 2Q10.
  • Korea’s Export growth accelerated in October to +29.9% YoY from +16.5% YoY in September.
  • India’s Export growth accelerated in September to +23.2% YoY from +22.5% YoY in August.
  • Thailand’s CPI slowed in October to +2.8% YoY from +3% YoY in September. 

Eye On Asia: Things Are Getting Ugly - 1

 

The Bad 

  • Australia’s CPI quickened in 3Q10 to +0.7% QoQ from +0.6% in 2Q10.
  • Japan’s Personal Income growth slowed in September to +1.5% YoY from +1.8% YoY in August. Concurrently, overtime hours at manufacturers, a leading indicator for earnings, fell (-2.9%) MoM in September.
  • Japan’s Core CPI slowed in September to (-1.1%) YoY from (-1%) YoY in August. Deflation continues…
  • Thailand’s Export growth slowed in September to +21.8% YoY from +23.6% YoY in August.
  • Thailand’s Industrial Production growth slowed in September to +8.1% YoY from +8.4% YoY in August.
  • China’s Ministry of Foreign Affairs rebuffed U.S. Secretary of State Hillary Clinton’s offer to mediate a territorial dispute between China and Japan over the Diaoyu Islands, saying “[the islands] are Chinese territory, and the dispute over the islands with Japan is a matter between China and Japan… Clinton’s position is extremely wrong and the U.S. should correct its wrongful stance immediately.” This aggressive commentary out of China is the latest in a series of growing bravado towards the U.S. and Japan out of the Asian power.
  • Japan recalled its ambassador to Russia in response to a renewed territorial dispute with Russia over inhabited islands between the nations’ boarders. The islands, known as the Southern Kurils to Russia and the Northern Territories to Japan, are now in question following Dmitry Medvedev’s visit to the territory yesterday (he is the first Russian president to do so). Japan can now add another check mark next to “geopolitics” in its growing list of economic headwinds. 

Eye On Asia: Things Are Getting Ugly - 2

 

The Ugly 

  • China’s Input Price PMI accelerated meaningfully in October to 69.9 from 65.3 in September. As we have been calling out for months, QE2 = global inflation.
  • Japan’s Retail Sales growth slowed in September to +1.2% YoY from +4.3% YoY in August. Further along the consumer front, Japan’s Registered Auto Sales tanked in October, in line with our call, due to the unwinding of stimulus tailwinds: down (-26.7%) YoY from (-4.1%) in September. As we have learned for the greater part of the last two decades, this is not an economy that is able to support itself, relying exclusively on government intervention and global consumer demand to drive the paltry 80bps of average YoY GDP growth over the last 17 years.
  • Japan’s Industrial Production growth slowed in September to (-1.9%) MoM from (-0.5%) MoM in August.
  • Japan’s PMI slowed in October to 47.2 from 49.5 in September.
  • Japan’s PCE growth slowed in September to flat YoY from +1.7% YoY in August. One of the core tenants to our Japan’s Jugular thesis is that a slowdown in manufacturing and exports will resonate throughout Japan’s economy and exert downward pressure on GDP growth.
  • Japan’s Construction Orders growth slowed in September to (-15%) YoY from flat YoY in August.
  • Japan’s Prime Minister Naoto Kan’s approval rating dropped in October to 36.4% from 48.5% in September. This latest survey is a public vote of no-confidence in the face of the recently announced ¥6.6 TRILLION worth of stimulus. The Keynesian end-game seemingly draws closer with every passing day in Japan.
  • Indian companies are paying the highest short-term borrowing costs in 19 months, due to a series of rate hikes by the central bank to combat inflation, which is running at double the target rate (per the Indian Finance Ministry). Three-month funds have nearly doubled this year to 8.25%, putting pressure on corporate profitability within India. Anyone who says Indian equities are “cheap” on a NTM P/E basis relative to their 2007 peaks is likely using the wrong earnings forecast.
  • Korea’s GDP growth slowed significantly in 3Q10 to +4.5% YoY from +7.2% YoY in 2Q10. The slowdown in growth here is representative of a broader slowdown in growth we’ve seen across Asia over the last couple of months. More specifically for Korea, the 3Q10 print lapped the last of the easy YoY comps. In 4Q10 and 1Q11, Korean GDP has to comp against +6% and +8.1%, respectively.
  • Korea’s CPI quickened in October to a 20-month high of +4.1% YoY. Korea’s central bank has been reluctant to follow its Asian neighbors in aggressively combating inflation, opting for lip service regarding capital controls instead. The lip service has been unsuccessful to date, as the Korean economy is experiencing Marginal Stagflation (slowing growth; accelerating inflation). 

Eye On Asia: Things Are Getting Ugly - 3

 

Eye On Asia: Things Are Getting Ugly - 4

 

The Murky 

  • Both Australia and India raised their benchmark interest rates 25bps today in an effort to combat rising inflation brought on by global speculation that is being driven by dollar-debasement ahead of QE2 in the U.S. Furthermore, Australia’s largest home lender will raise its standard mortgage rate 45bps on Nov. 5th and India’s central bank proposed capping home loan-to-value ratios at 80% in an effort to cool domestic real estate speculation that has spread throughout the region (China, Australia, Singapore, Hong Kong, etc.). 

With the U.S. facing the Consumption Cannonball and Jobless Stagflation, China, India, and Australia tightening monetary policy, and Western Europe fully implementing austerity measures, where will global demand growth for Asia’s exports come from over the next 3-6 months? To whom will Asia ship its products? Keep in mind the following stats as you ponder the next moves in GDP growth and equity markets throughout Asia: 

  • Exports account for roughly 40-45% of Asia’s GDP;
  • The U.S. and E.U. combine for roughly a third of Asia’s export destinations; and
  • 40-50% of intra-regional trade within Asia is basic and intermediate goods meant for re-export outside of the region. 

Today we covered our short position in the U.S. Dollar (UUP) for a 14% gain, after having top-ticked it on June 7th. In that same time period, many Asian equity markets are up multiples of that, driven higher by reflationary inflows of yield-chasing capital. As evidenced by our most recent move in this globally interconnected chess match, we think the music stops here (much to Barton Bigg’s displeasure – see his bullish commentary on emerging markets from this morning).

 

Eye On Asia: Things Are Getting Ugly - 5

 

Should the dollar break out for a sustained period of time, we think the deteriorating fundamentals in Asia will be exposed, as growth in the region set to slow meaningfully over the next 3-6 months.

 

For reference, we outline below three factors we think could cause the dollar to break out: 

  • Hawkish fiscal rhetoric from the likely-to-be Republican Congress (we forecast a +65 seat gain by Republicans in the House and a potential tie in the Senate after today’s elections);
  • Mean reversion; and
  • A QE2 announcement shy of consensus expectations could trigger widespread reflexive declines in equities and commodities globally, which should support the need for increased liquidity as investors shift to cash on the margin. 

Buckle up; it’s likely to be a bumpy ride.

 

Darius Dale

Analyst


Election Day . . . Some Early Looks From The Ground

We’ve sourced some of our political contacts around the country and want to offer some early views of what we are hearing from the ground: 

  • Fond Du Lac, Wisconsin – “City of Fond du Lac Clerk Sue Strands said there’s been a steady stream of voters at the polls since they opened at 7 a.m. Strands had predicted a 63 percent turnout.” 
  • Cincinnati, Ohio – “An Enquirer analysis of early returns in Southwest Ohio shows that 43 percent of ballots mailed in were requested by Republicans, and 30 percent by Democrats. The rest were from independents or third party voters.” 
  • Portland and Bangor, Maine – “City officials in Portland and Bangor said the turnout as of midmorning was light. In Lewiston, an election official described the early turnout as steady.” 
  • St. Louis, Missouri – “It's a very heavy turnout," said Rich Chrismer, director of elections in St. Charles County, who predicted 65 to 70 percent of registered voters in the county will vote.” 
  • North Carolina – “State Board of Elections director Gary Bartlett says the two words he's been hearing from county officials so far are "steady" and "moderate." 

While it is difficult to read too much into these comments, it does appear broadly speaking that turnout will be more than the typical midterm election.  Interestingly, we have been watching the Intrade electoral markets this afternoon as well and would highlight a number of points there: 

  • The contract for the Democrats to control  the Senate has rallied well off its lows and is now registering 47.0, while the contract for the Republicans to hold 50 seats in the Senate is also rallying and is now at 38.0. 
  • The contract for Patty Murray (D) retaining her seat in Washington state is now at its highs of 69.2, which is likely leading to the increase in the Democrats chances of holding the Senate. 
  • The contract for the Republicans to gain a net 60 seats in the House is now 59.9, which is slightly off its highs of ~63, but still largely in positive territory for the Republicans.

More importantly: whatever your affiliation . . . get out there and vote! 

 

Daryl G. Jones
Managing Director


VERSIONS OF THE TRUTH

This note was originally published at 8am this morning, November 02, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

"My way of joking is to tell the truth.  It's the funniest joke in the world".

-George Bernard Shaw

 

Both the Reserve Bank of Australia and the Reserve Bank of India certainly have their version of the truth today as both raised rates on inflation fears; for India’s central bank it’s the sixth such move this year. 

 

At home we have multiple storytellers giving their versions of the truth.  George Bernard Shaw was most commonly known as an Irish playwright skilled in many spheres of literature.  As you can probably tell from this morning’s quote, his work tended to fall into the satire or black comedy categories.  The black cloud that is the political theatre unfolding in the U.S. certainly would have provided Shaw with some material, were he alive today.

 

While Shaw held some controversial views that were anathema to many of those around him, his flair for music, literary criticism, journalism and drama was widely recognized.  Reconciling the vilification Shaw endured for his stances on the World Wars and other topics with the broad acclaim he received for his work (including a Nobel Prize for Literature and an Oscar) is difficult.  The bottom line is that most people love a good story line and can appreciate the person who can tell one.

 

In the run up to today mid-term elections, the Political Partisan Playwrights have been kicking into overdrive.  Political Prose has been weaved around every political theme imaginable; government spending, taxes, and immigration, to name but a few.  The resulting narratives have been recited ad nauseam and I can’t wait until it’s over.  Political commercials seem to get worse every election cycle.

 

We can argue which political versions of the truth are more tenuously linked to fact than others but the only certainty about every politician on the soap box is this: none is as allied to the truth as they are to their prospects of being elected.

 

At Hedgeye, we prefer to examine data than listen to political sound bites (however amusing).  As my colleague and Managing Director of Macro, Daryl Jones, wrote yesterday on the election, “The turnout measures for Republicans are very positive and should drive a big Republican win to the tune of a net gain of 9 seats in the Senate and more than 65 seats in the House”.   Daryl’s mathematical reckoning anchored on a selection of political polls that he has been following closely as part of this macro process.  While the likely Republican gains have already been priced into the markets, we will continue to be confronted with political versions of the truth for some time past today’s vote. 

 

Economic versions of the truth are just as commonplace in our manic media.  The interpretation of the ISM and personal income yesterday are perfect cases in point.  George Bernard Shaw died in 1950 but even if he were alive today, despite his talent for literary criticism, I think he would struggle to follow the convoluted economic plotlines being laid out by some present day commentators – and he was a co-founder of the London School of Economics! 

 

The main question I have for the storytellers is as follows: how does the economic reality we are faced with marry the expectations imbedded in Wall Street Groupthink?  Yesterday I posted a note on the ISM and personal income print titled, “Q4 2010 THEMES UPDATE – CONSUMER CANNONBALL”, that outlined the moving parts behind a major component of the U.S. economy.  The ISM print was less-than-comforting given that the upside was primarily driven by exports (a small part of the economy) while personal income and spending weakened (pertaining to the largest part of our economy). 

 

Government support is waning and taxes are going up.  We are in the midst of Jobless Stagflation and the data is continuing to confirm that.  If you ever had any doubt that political motivations can sway departments of government to take artistic license (especially a week before elections) with economic data, take a look at the chart below.

 

The story of the 3Q10 GDP number would be a masterful piece of black comedy – and a fitting ode to Bernard Shaw – if it were funny.  The consumer services sector is growing while consumer goods are decelerating but the evidence of government propping up the respective components of GDP is obvious.  Inventory accounted for 72% of 3Q10 GDP growth and exports declined even with the Almighty Buck burning at the stake.  Whatever version of the truth you choose to believe, the trends are unsustainable given our ever-increasing deficits. 

 

One version of the truth that is front of you today is that risk is clearly building in the market and most choose to ignore the facts.  Over the past six trading days the VIX is up 15.2% and the S&P 500 is UP +0.10%.  The inverse correlation of the VIX and the S&P 500 is 0.84.  The prospects of the FED saving the anemic economy are clearly priced in.   

 

Some may find it unappealing to consider that America’s economy can be as fragile as the data suggests.  As I wrote last week in my Early Look note titled, “BEING A LADY”, “America is a great nation and I’m proud to be an American”.  As a proud American, I would pay good money to see any political party come to grips with reality and face the cold hard truth.    

 

As Shaw himself would say, “All great truths begin as blasphemies”.

 

Function in disaster; finish in style,

 

Howard Penney

 

VERSIONS OF THE TRUTH - gbschart


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HYATT YOUTUBE

In preparation for Hyatt's Q3 earnings release, we’ve put together the pertinent forward looking commentary from Hyatt’s Q2 earnings release/call.

 

 

YOUTUBE FROM Q2

  • “Strengthening group business is also important for us because it allows us to better manage yield relative to transient business as we see increased compression in hotels that have a mix of group and transient business.
  • “We also expect to see higher corporate rates coming out of negotiations this fall.”
  • “We are firm believers in the recycling of capital. This means that at any given time, we may be buying or selling hotels in order to put the capital that we have invested in hotel properties to work for us. For example, we’re currently exploring the sale of 11 properties consisting of approximately 4,500 rooms….We expect this to be a multi-month process, and we will announce completed transactions upon closing.”
  • Looking out a bit further, in the quarter bookings for all future periods were up approximately 35%, compared to the second quarter of 2009.”
  • “Visibility on group remains low as booking windows are short.”
  • “We have tightened the range on expected CapEx to 270 to 280 million. Most of that expenditure will take place in the third and fourth quarter as renovation spending at several of our larger owned hotels ramps up. These projects are currently tracking on time and on budget and will continue into next year as planned, particularly the large renovations at the Grand Hyatt properties in New York and San Francisco.”
  • “Our estimated depreciation and amortization expense remains the same at 285 to 295 million, and our interest expense range has been slightly lowered to 50 to $55 million.”
  • “With respect to growth in openings this year, we said during the last call that we expected to open more than 25 hotels, and I think that’s our current outlook. That was an increase from prior estimate that we had had, which was more than 20. Part of that has to do with some conversions, part of that has to do with some uncertainty about exactly when properties that are under construction will complete and, therefore, be able to open. So that remains our current expectation and outlook for this year.”
  • “Relative to our expense projection, we expect expenses to continue to increase, largely because we believe there will be wage inflation. We hadn’t taken merit increases last year. We restored bonuses from that perspective. So, I think you will see increase in expenses continue.”
  • [# of FTEs] “So we are going to keep that at current levels, at least in the short term.”
  • “In terms of hourly staff, that’s more of a variable expense, and we are beginning to see staffing increase for that group of colleagues, largely because the recovery so far has been demand driven. Now, the key question is going to be, relative to our profit flow-through, is how rates progress over the next six to 12 months.”
  • [Transaction environment]And with respect to the evolution of the opportunities over time, I do believe that there will be a further increase of activity and opportunities both in the latter half of this year and into 2011, and I think a lot of it has to do with people, owners and lenders alike, evaluating what their overall alternatives are. And, at least based on what we’re seeing to date, there has been more interest in trying to put a deal together to put an asset on to a different track, let’s say, or bring in a partner in order to help recapitalize. So, I think it’s very clear that, at least around our offices, we’ve got a lot more activity underway now than we did before.”
  • [Corporate negotiation rates for 2011] “Our best guess at this point is maybe somewhere in the high-single digits.  The only other thing on the corporate negotiation I’ll say, in terms of the sectors where we are negotiating-- the technology, the manufacturing and the financial segments are up; transportation is overall down.
  • [Group rates for 2011] “Tracking in the low double-digits; however, pace is still negative at this point of time, but again, that’s largely because the visibility and the lead times is fairly short at this point of time.”
  • [For 2H 2010, EBITDA impact from renovations] “From a RevPAR perspective, we think for our owned and leased segment, RevPAR is going to be impacted between 200 to 250 basis points. And, if I just take you back to what we had indicated in terms of the sensitivity on RevPAR, one point is anywhere between 10 and $15 million on an annualized basis. We think the EBITDA, in fact, is closer to $10 million or so in the second half of the year…. The renovations will continue until Q4 2011."
  • [International] So the booking curve, so to speak, or the outlook tends to be quite short.
  • “There are opportunities for capital deployment in Europe, mostly for management deals, less so for acquisitions, although we are also looking at and for acquisition opportunities in India on the JV basis and in Latin America also on a JV basis.”


ASCA YOUTUBE

In preparation for the ASCA Q3 earnings release tomorrow, we’ve put together the pertinent forward looking commentary from ASCA’s Q2 earnings release/call.

 

 

YOUTUBE FROM Q2

  • [St. Charles]Our market share there seems to have stabilized.”
  • [East Chicago] “We’ll see a $20-25 MM annualized negative impact from the bridge closure… A portion of those [road] improvements should be done later this year and the balance through the middle part of 2012.”
  • [Fixed charge coverage ratio] “We’ll see that improve starting in the third quarter now that the swaps have expired and we have substantially lower interest rates going forward.”
  • “Subsequent to the end of 2Q, we’ve retired an additional $16 million of debt. So through seven months, we’ve retired $80 million of debt. That’s created availability in our extending revolver of approximately $20 million over and above what’s required in the non-extending revolver that we have to retire in mid-November of this year. We obviously intend to continue to use free cash flow to retire debt through the balance of the year. For the rest of the quarter, we think we’ll probably end up at about 25 million in total in 3Q for debt reduction, which would be another 11 million from where we are today. And we anticipate having availability in the revolver in December of 45 to 50 million [after 1/2 of CIP] based on our current rate of debt reduction.”
  • “Our Q3 2010 estimate for non-cash stock based compensation expense: should be in the range of $3.4 to 3.9 million. And the blended federal-state tax rate should get back up to about 42.5%.”
  • “Capital spending for Q3 is expected to be between 15 and $20 million in the third quarter…. [For Q4], if we’re going to meet what we told you guys at the beginning of the year, we would have to spend a little more in the 4Q than we have so far on average this year…. Net interest expense in Q3 is expected to be near $28 million. Non-cash interest expense is expected to be between 2.5 and 3 million for Q3. Based on current LIBOR rates, we should see a reduction in the quarterly interest expense for approximately $13 million due to the expiration of the swaps in mid-July.”
  • “We currently expect to make a quarterly dividend of $0.105 per share in Q3.”
  • Pullback in Kansas City promotional spending going forward? “Yes.”
  • [Black Hawk market] “3Q should be the best quarter in that market.”

Early Look

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