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Here I am addressing an article written by the respected Jacqueline Doherty of Barron’s this past weekend.


Dear Jackie,


I can appreciate the value in a non-consensus view as much as the next guy, but having read your article in Barron’s titled, “Off to the Mall” this weekend, I have a few points I’d like to make in defense of the consensus view that consumer deleveraging is due to continue for a while.  In fact, it will continue for longer than consensus expects.  The data presents a gloomy picture but I also believe that recessions such as this take a toll on the mindset of consumers in a way that less severe downturns do not.   


The crux of your argument, as I understand it, is that following “two painful years of retrenchment”, there is pent-up demand and data relating to household financial obligations are – currently – better on the margin and this points to “an end to the deleveraging process” and a boost to retail sales and the broader economy in 2011.  Respectfully, I disagree.  On the contrary, deleveraging has a ways to go.


Firstly, the Consumer Discretionary sector (XLY) is the best-performing sector so far this year and the S&P performance of late seems to suggest that positive news for the consumer is being priced in.  Corporate profits are also being well-received by the markets.  In spite of the upward trajectory of the stock market and corporate earnings, unemployment is still not improving sufficiently.  Corporations, nervous about the economic outlook, are retaining earnings in the form of liquid assets rather than hiring of investing in long-lived assets.  The Great Recession had an impact on the psychology of corporations that should not be underestimated. 


Likewise, the impact on consumers should also not be underestimated.  Job uncertainty and continuing economic weakness is imparting an unprecedented degree of frugality on today’s Americans.  The drawdown in credit card balances is one example.  Since credit card debt stands for a very small portion of total household debt outstanding, I believe that the 16% decline says more about the shift in mindset of the consumer than any completion of the deleveraging process.




The chart above illustrates an unprecedented change in consumers’ mindset.  Furthermore, private sector borrowing as a whole is dragging on the economy.  Total private sector borrowing amounted to almost 30% of GDP in 2007 and by2009 it had fallen to less than minus 15% of GDP.  That constitutes roughly a 45% of GDP swing in private sector borrowing over a two-year period.  This was a traumatic hit, to say the least.  I’m not expecting a rebound to the good old levered up days any time soon!


As the Reinhart and Reinhart study you fairly allude to in your article describes, the tectonic shifts in the financial sector, housing market, and subsequent (and ongoing) consumer deleveraging pose drastically difficult obstacles for the economy to surmount.  Unlike slowdowns that are associated with monetary policy being tweaked in order to address inflation concerns, downturns triggered by the financial sector tend to take result in longer and more sluggish recoveries. 


While the rise in equity prices over the last 18 months may help the consumer via higher 401(k) values this holiday season, inflation and the higher interest rates across the globe are causing slower growth on an international basis.  The emergency interest rate that the Federal Reserve has held for two years now may be viewed by Diane Swonk, chief economist at Mersirow Financial, as “an unqualified boon to borrowers”, but where are the lenders?  As of the most recently reported quarter, banks are tightening lending standards.  Most importantly, mortgage rates are heading higher, not lower, and that will certainly not encourage any consumer re-leveraging.






I don’t have access to James Paulsen, chief investment strategist at Wells Capital, work but I would be very interested to see how he gets to 3-4% GDP growth for next year.  Here are my main concerns with his bottom line:

  • The inventory cycle is going the wrong way in the first part of 2011; moving to net-neutrality towards impact on GDP growth.  (I recently posted that inventory accounted for 2.6%, 0.08% and 1.4% for the first three quarters 2010, respectively)  As a side note, the sequential improvement in GDP in Q3 was unintentional as some firms were caught out by the slump in demand during the summer and unintentionally built up inventories in Q3 - a trend that will reverse itself in Q4 and the early part of 2011. 
  • The Recovery Act, despite the controversy, added 2%+ to GDP in 1H10.  By design the act was to have all the money “out the door” by the end of September and succeeded in doing so.  Going forward, the cost of the Recovery Act will be net neutral and eventually as it ramps down and, eventually – in terms of cash flow – will be net negative to GDP growth.
  • The final factor is state and local deficits which are projected to be $100 to $150 billion a year for the next two tears.  Going forward, a much smaller share of which will be offset by federal subsidies, therefore a much larger share will need to be closed through tax increases and spending cuts at the state and local level.  

Taking points two and three, together that added a net 2% to GDP in 1H10 and will be a negative 2% to growth in 1H11.  If you then add the positive inventory cycle in 1H10 of 3.4% and you get the total contribution to GDP growth from the three factors of 5.4% in 1H10.  Depending on your view of the inventory cycle, we are looking at a potential year-over-year swing in GDP in 1H11 of around 5.4%, which becomes a headwind in the next 12 to 24 months.  At best, we are looking at flat to 1-2% GDP for the next 12-24 months.       


What does all this mean for the consumer and the unemployment rate?  Under a good scenario, it’s going forward it’s going to be a hard slog of 1-2% GDP growth, which will prove to be inadequate in an effort to reduce the unemployment rate.  Your article cited an improving outlook for jobs.  Is the outlook really improving enough?  If it is improving, I don’t believe that the data supports more than a miniscule improvement.  Certainly, a far greater rate of improvement will be necessary to ease concerns about the job market on a wider basis.


Last week the headline initial claims number rose 20k to 457k (23k net of revisions)!  Rolling claims came in at 456k, an increase of 2,000 over the previous week.  This wiped out last week’s improvement, and claims still remain in the same band they’ve occupied for the year. We're still a solid 50-75,000 above where we would need to be in order to see the unemployment rate fall.  


As you noted, one leading indicator of the consumer's health is the default rate on loans; it peaked in the past year in several key loan categories, and has been declining since. The S&P/Experian Consumer Credit Default Indices, a measure of changes in U.S. consumer-credit defaults, fell 3.6% in October.


We at Hedgeye have a much different point of view.  We see consumer deleveraging going on for years to come.  Here are a few key components of out thesis:

  • From 2004 to 2Q08, total household debt rose 31.6%.  From 2Q08 through 2Q10, it declined 5.1%.  There is likely more to come!
  • Looking at the year-over-year change in total household debt is even more lucid an indicator; total household debt is declining and it is declining at an accelerating rate.  The decline in 2Q10, of 3.4%, was the steepest of the recession.
  • In terms of mortgage debt, despite the decline in home values from the peak (approximately 33%), mortgage debt has only declined 5%.  Loan to value ratios are in the 80’s – expect further deleveraging, not releveraging.
  • Until LTV’s come into a more historically-normal range, it is unlikely that consumer spending will return to its former glory.  Without housing prices appreciating (highly unlikely), our financials team estimates that it would take 10-15 years for the current LTV ratio level to be worked down through amortization.  Housing is the key hurdle for stronger consumer spending in the U.S. and forms a key part of the Hedgeye view on this topic.
  • Mortgage debt matters for commercial banks; 27% of the $10.6 trillion in household mortgage debt outstanding is held by commercial banks. That’s $2.86 trillion.  
  • Credit card debt is a small piece of the picture, 6.4% of total household debt.  Year over year change in revolving credit has recently ticked up but, at this rate, would take 10 years to stop shrinking.
  • The reduction of credit card debt since 2008 (chart earlier in the post) is unprecedented; clear shift in consumer mindset.





The consumer is certainly not dead and there are segments of the consumer space that are tied to wants and not needs (or maybe less unnecessary needs) that may continue to perform well.  Starbucks may continue to sell an addictive product well, car sales may perform well also, but considering that housing is the ultimate ball around the ankle of the consumer, there is a long way to go until Americans can once again lever up and splash some cash.




Howard Penney

The Boot Heat Map 2010 Edition

Last year boots, both fashion and cold-weather, were undoubtedly one of the hottest trends of the Fall/Winter season. The combination of an early and record breaking cold selling season coupled with a women’s fashion trend favoring tapered bottoms (leggings, jeggings, skinny jeans) all contributed to what most manufacturers and retailers regard as THE best boot season ever. Fast forward one year later and we check in on the longevity of this trend.


First, the weather has not nearly been as cooperative and as a result cold-weather product has been slow to ramp against very difficult compares. With that said, early November sales have picked up for the category as the weather turned. Second, the fashion boot category remains robust even against difficult comparisons. Interestingly, the updated six year Boot Heat Map below suggests it is rare to see multiple years of strength for the category in a row. Despite the long adds, anecdotes and early data suggest that Fall/Winter 2010 is once again a good year for fashion boots.


The season is far from over, but one doesn’t need to look far to see most holiday fashion campaigns featuring boots of all heights, heels, and fabrications. While the skinny bottom trend may be drawing to close, it appears there is one final push for the boot category. Unfortunately, the ASP increases we saw last year resulting from the favorable boot mix shift is unlikely to be repeated on the same magnitude. Yes, boots are still hot, but this year’s story will have to be unit driven in order to comp last year’s extraordinary season.


The Boot Heat Map 2010 Edition - boot map


Eric Levine


Slowdown in SE Asia – A Leading Indicator For Global Growth?

Conclusion: The slowdown across SE Asia is both supportive of our bearish outlook for the global economy and a leading indicator for slower growth in advanced economies, such as the U.S.


Since early-October, we’ve been beating the drum on three themes that have us generally bearish on equities globally (not to be confused with ALL equities globally; we are bullish on Germany’s DAX, for example). Those themes are: 

  1. Growth is slowing;
  2. Inflation is accelerating; and
  3. Interconnected risk is compounding. 

We were admittedly early in calling for a correction in October; by that same token, we are not at all surprised by the recent weakness in many equity markets and commodities globally, as incremental data that supports the above theses continues to trickle in.


Over the weekend, we received 3Q10 GDP reports from SE Asia’s four largest economies that support our three-pronged bearish outlook, as growth slowed sequentially in Indonesia, Thailand, Malaysia, and Singapore – the world’s 16th, 25th, 31st, and 45th largest economies, respectively.


While it’s important to note that each economy is still growing at an enviable pace in 3Q10, the marginal deterioration is cause for alarm in our models. From an economic standpoint, the delta from “great” to “good” is equally as bearish as the delta from “good” to “bad”. Considering, we highlight sequential slowdowns like these as leading indicators for depressed growth in the coming quarters.


Using our Growth-Inflation Delta Analysis (GIDA), we are able to see quite vividly points one and two from above:


Indonesia: In 3Q10, Real YoY GDP growth slowed -38bps and Inflation (CPI YoY % Change) accelerated 75bps on a quarterly basis.


Slowdown in SE Asia – A Leading Indicator For Global Growth? - 1


Thailand: In 3Q10, Real YoY GDP growth slowed -251bps and Inflation (CPI YoY % Change) accelerated 5bps on a quarterly basis.


Slowdown in SE Asia – A Leading Indicator For Global Growth? - 2


Malaysia: In 3Q10, Real YoY GDP growth slowed -358bps and Inflation (CPI YoY % Change) accelerated 29bps on a quarterly basis.


Slowdown in SE Asia – A Leading Indicator For Global Growth? - 3


Singapore: In 3Q10, Real YoY GDP growth slowed -891bps and Inflation (CPI YoY % Change) accelerated 118bps on a quarterly basis.


Slowdown in SE Asia – A Leading Indicator For Global Growth? - 4


While most U.S.-based investors wouldn’t care to read more than a single sentence regarding SE Asian economies, we flag these as important data points you should be cognizant of – particularly in the context of the three-pronged outlook outlined above.


Further, upon considering that these four economies’ share of global exports is nearly 2x (1.78) their share of global GDP, we posit that a slowdown in this region is a leading indicator for a slowdown in the inventory cycle of advanced economies. Positive inventory adjustments have accounted for 63% of U.S. GDP growth YTD, so a slowdown across the SE Asian region may be a stealth leading indicator for inventory adjustments being a drag on U.S. GDP growth in 2011.


Slowdown in SE Asia – A Leading Indicator For Global Growth? - 5


Lastly, it’s important to keep in mind the following stats, when considering the merits of Asian trade data: 

  • 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. 

All told, the slowdown we are seeing across Asia’s export economies continue to flash bearish signals as it relates to global growth. With each passing day, it grows increasingly likely that the easy reflation money brought on by QG has been made. Now, investment professionals will have to once again “earn” their performance. Given the recent run-up in equity and commodity prices globally, we feel most of the opportunities for alpha will be found on the short side for the next 3-6 months, as growth slows globally, inflation continues to afflict economies globally, and interconnected risk (cross-asset correlation risk; Housing Headwinds; Sovereign Debt Dichotomy; U.S. State & Local Government headwinds) compounds.


Darius Dale


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Cotton Driving GIL Higher

GIL having a solid day today – up 3%, which we think is a function of the fact that Cotton is down by 4.9% today, and is off 22.3% since its Nov 12th peak.


It’s going to take a LOT more than a 22% swing in cotton in order to ease pressures building in the supply chain for GIL and its peers (a number below a buck). But nonetheless, the company reports its 4Q next week, and is likely to say and do whatever it can in order to finish off the year on a positive note. Having a recent slide in Cotton – even from what might have been a false top – adds fuel to the fire for GIL. They’ll probably leave out what most of its peers have as well…that at $1.22, Cotton is still trading 3-Standard Deviations above its 20-year mean.


Keith is short GIL in the Hedgeye portfolio, and the critical levels from a risk management perspective are TRADE = $27.79, and TREND = 28.99. 


October outperforming recent trends, adjusted for seasonality.



Given the volatility over the past two years, we believe sequential performance, adjusted for seasonality, gives a better measure of market health than simple YoY comparisons.  Assuming Mississippi reports an in-line number this week, October riverboat revs, a regional market barometer, will be 2-3% above recent trends, adjusted for seasonality, as seen in the chart below.  Easy comps in November and December set the stage for growth for the rest of the year.  Since attendance was lower than that of a year ago and hold stayed relatively steady, higher per capita spending was the catalyst for October’s outperformance.




Here are some regional market takeaways for October:


West Virginia (table revs up 94.86% YoY):  With a 1-2 punch seen below, Charles Town (PENN) recorded a new monthly high in table revs, $10.69MM.


1)      Charles Town continues to cannibalize its competition.  Ever since Charles Town opened tables on July 2, it has grown market share.    

2)      New customers propelled state table revs to 85-110% growth in the last 3 months.




Illinois (casino revs down 0.2% YoY):  Argosy (PENN) had its best YoY performance (-2%) since November 2007.  We’ll find out next month whether the better results were related to hold.


Louisiana (casino revs up 1.8% YoY):  1st YoY gain for the state since Sept 2009.  PNK had better results at Boomtown Bossier but L’Auberge lost 4.3% YoY.


Missouri (casino revs up 4.5% YoY):  Lumiere Place (PNK) was down 17.6% YoY and River City (PNK) reported $14.4MM.  However, the combination of Lumiere and River City continues to trend around $27-29MM of revenues monthly.  All of ISLE’s properties reported YoY growth.


Pennsylvania (slot revs up 11.5% YoY):  PENN National reported $20.8MM (+1.8% YoY).  Disappointing coin-in (-11.32% YoY) offset higher than average hold (+88bps).  Meanwhile, Sands Bethlehem (LVS) had the highest YoY change among the casinos; coin-in for that property has exhibited positive YoY growth since May 2010.


Florida: (same-store revs up 18.2% YoY) Pompano (ISLE) delivered a strong performance, having its highest YoY growth since February 2010.


Atlantic City:  The only disappointment.  Total revenues, table revs, and slot revs were down 14.6%, 16.2%, and 10.3% YoY, respectively.  However, Borgata (BYD) fared relatively well, with revenues only slipping 0.4% YoY.  This was due to a 4% and 4.1% YoY growth in slot win and slot drop, respectively.  By revenue market share, Borgata attained 18.7%, its highest share since January.