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Contemplating Canada

“Debt and deficits are not inventions of ideology. They are facts of arithmetic.”

– Paul Martin, 21st Prime Minister of Canada

 

Conclusion:  The economic outlook for Canada is quite favorable, especially vis-à-vis the United States and other developed nations.  As such, we continue have a bullish stance on the Canadian Loonie and Canadian equity markets. 

 

Keith and I spent the last couple of days visiting subscribers in Western Canada, namely Vancouver and Calgary.  The trip also gave us a chance to revisit and contemplate our thoughts on the economy there.  From an anecdotal perspective, our trip verified one key point -- free market capitalism is alive and well north of the border.

 

 As we’ve discussed in past notes, there have been a number of inflection points in the Canadian economy that are unique to anything we’ve seen in recent history.

 

The first point to highlight is unemployment.  As the chart below shows, for the first time in 30 years Canada has a lower unemployment rate than the United States.  In fact, not only does Canada have a lower unemployment rate, but there is a meaningful divergence.  Based on the most recent economic data, Canada’s unemployment rate is 7.6% and has been ticking down consistently for the last 18 months or so.  Conversely, U.S. unemployment is currently at 9.8% and has barely ticked down since the start of the most recent recession.  We view this as a real and noteworthy inflection point in comparing these economies.

 

Contemplating Canada - d1

 

In the shorter term, the relative success of the Canadian economy versus the United States, combined with the fact that the Bank of Canada has raised rates 3 times in 2010 while the U.S. Federal Reserve has continue to ease, has led to a strengthening of the Loonie over the past 12-months.  In that time period, the Loonie is up almost 5% versus the U.S. dollar.  

 

Yesterday, the Bank of Canada highlighted this increase in the value of the Loonie as a risk to the Canadian economy and a reason to keep interest rate increases on hold.  As the value of the Loonie increases versus the U.S. dollar, it inherently increases the costs of Canadian exports to the U.S. and lowers demand for Canadian goods.   Currently, more than 70% of Canadian goods are exported to the U.S and ~57% of exports are in the commodity sectors (energy, forestry, and mining).

 

Interestingly, the Bank of Canada sounded a little Hedgeye-esque as they highlighted more broad risks to the Canadian financial system yesterday, with a particular focus on interconnected risk.  Specifically, the Bank of Canada notes in their statement:

 

“Four major interconnected sources of risk emanate from the external macrofinancial environment: (i) sovereign debt concerns in several countries; (ii) financial fragility associated with the weak global economic recovery; (iii) global imbalances; and (iv) the potential for excessive risk-taking behaviour arising from a prolonged period of exceptionally low interest rates in major advanced economies.”

 

Certainly we understand these risks and also understand that Canada’s close ties to the U.S. economy will continue to be an important factor when evaluating the economic outlook for Canada.  That said, similar to out point on unemployment above, Canada has also recently seen a divergence in growth versus the United States in the last few years.

 

In the chart below, we’ve highlighted relative GDP growth rates of Canada versus the United State going back to 1980.   In the prior two periods of negative growth (the early 1980s and early 1990s), the Canadian economy contracted more than the U.S. economy.  In this most recent recession, the Canadian economy contracted less and then accelerated to a higher rate of growth post the recession.  In fact, Canada had the lowest real GDP contraction of any member of the G7 from Q2 2008 to Q3 2009.

 

Contemplating Canada - d2

 

So, what is causing this divergence and our longer-term bullish stance on Canada?  We would point to three key factors: energy independence, a strong financial system, and the government’s balance sheet.

  1. Energy independence - Amongst the G7, and really most industrialized nations, Canada has probably the best energy position.   It is, obviously, a net exporter, but has also seen its spread of production versus consumption increase over time.  From 1980 to 2007, Canada’s total energy production (mostly natural gas and oil) grew 87%, while its total consumption only increased 44%.  With the inclusion of the vast Canadian oil sands, Canada has the second largest oil reserves after Saudi Arabia.  In an increasingly short energy world, this long energy position will continue to advantage the Canadian economy.
  2. Strong banking system – In contrast to the United States, where many U.S. financial institutions underwrote loans, particularly of the mortgage variety, during the boom year leading up to 2008, the Canadian banks kept lending standards high.  As a result, unlike the major and pervasive bank failures in the U.S. over the past couple of years, there were no comparable bank failures in Canada.  (In fact, Canada’s banking system has proven to be incredibly resilient over time.  The last major bank failure in Canada was in 1923.) Prospectively, we should see this benefit in the stability of Canadian home prices and the quality of loans held on Canadian bank balance sheets.  A good proxy for this is mortgages in arrears, which are running below 1% in Canada compared to +9% in the United States.
  3. Government balance sheet – In the 1990s, Canada was the poster child for poor fiscal management.    When Paul Martin took over as Finance Minister in 1993, the Canadian government was running a deficit of 6.6% of GDP and by the following year debt as percentage of GDP eclipsed 100%.  By implementing massive spending cuts and raising certain taxes, Paul Martin got Canada’s fiscal house in order.

Currently, Canada’s debt-to-GDP is estimated to be 77% by the IMF, which is substantially lower than the U.S. at 98% and well below real problem nations, such as Italy (121%) and Japan (227%).  While Canada is expected to run ~C$50 billion deficit in 2010 – 2011, this is just over 3% of GDP, which pales in comparison to the United States, whose deficit as percentage of GDP will be closer to 10.5% in 2011.  As it stands, Canada should not eclipse the 90% debt-to-GDP ratio, which correlates with slower growth.

 

While we aren’t quite ready to say this is the Canadian century (except in hockey of course), we are seeing a number of inflection points that point to and highlight some longer term and sustainable advantages north of the border.

 

Daryl G. Jones

Managing Director


Navigating the Brazilian Terrain

Conclusion: While we remain bullish on the Brazilian Consumer sector for the long-term TAIL, the confluence of slowing growth and accelerating inflation remain a headwind over the intermediate-term TREND. As a result of inflationary pressures, we see additional tightening on the horizon in 1H11.

 

Over the past day or so, a couple of nasty economic data points have come out of Brazil: 

  • While certainly a stale number, 3Q10 GDP growth came in a full 250bps slower than 2Q10 at +6.7% YoY (after a +40bps revision to 2Q10). We expect growth to continue to slow over the next 3-6 months, a call aided by incredibly difficult comparisons starting in 4Q10 (+5%  in 4Q09, +9.3% in 1Q10).
  • CPI accelerated to a 21-month high in November, coming in at +5.63% YoY – well above the government’s 4.5% target. On a MoM basis, November’s +0.83% rise was the largest increase since April 2005! The largest contributor to the increase (0.51) was from the Food Products category, which rose +2.22% MoM.

Navigating the Brazilian Terrain - 1

 

Our call for Brazilian growth to continue slowing coupled with having already received two months of accelerating inflation readings for 4Q10 suggests Brazil’s economy could be in a state of marginal stagflation as early as… well… now:

 

Navigating the Brazilian Terrain - 2

 

From Brazil, to China, to India and elsewhere around the globe, we see that Chairman Bernanke’s experiment with Quantitative Guessing continues to have unintended consequences, due to the impact of the equation highlighted below:

 

QG = inflation [globally] = monetary policy tightening [globally] = slower growth [globally]

 

The recent surge in Brazilian inflation from the August lows has had the Brazilian bond market anticipating rate hikes in the near future, with yields rallying to higher highs over the past three-plus months. In addition to the accelerating inflation readings, the locking-out of foreign investors from the bond market coupled with concerns that President-elect Dilma Rousseff will fail to curb spending and perpetuate inflation via loose fiscal policy has certainly had Brazilian bond investors demanding higher yields to hold government paper:

 

Navigating the Brazilian Terrain - 3

 

While not much has changed regarding inflation and the de facto blockade of international investors, we will give much-deserved credit to the current regime, as well as Rousseff and her team for taking meaningful steps to combat inflation and assuage investor fears of an inflationary tsunami of late.

 

On December 3rd, the central bank raised reserve requirements on cash and time deposits to slow consumer lending – the demand for which, coincidentally hit a record high in November, growing +20% YoY. The reserve requirement on time deposits rill rise to 20% from the current 15% and the requirement for cash deposits will rise to 12% from 8% currently. The measures are expected to remove R$61 billion ($36B) from the economy.

 

Rousseff’s choice to replace current central bank Governor Henrique Meirelles with Alexandre Tombini has been well-received by those calling for prudent monetary policy going forward. The 46-year old, who was just confirmed by the Senate, has served on the central bank board since 2005 and is credited with helping design the country’s inflation-targeting regime in 1999.

 

While Tombini sees eye-to-eye with his new boss on the need to lower Brazil’s G20-high real interest rates to spur long-term investment, the governor-in-waiting has repeatedly stressed the need for “full operating autonomy” to tackle any inflationary challenges along the way. Current trading in Brazil’s interest rate futures contracts suggest market practitioners are anticipating a +50bps rate hike when he takes over in January.

 

Elsewhere on the macro-prudential front, we have seen austere steps taken by Mrs. Rousseff and her team, which, on the margin, is a meaningful shift away from her campaign stance of maintaining continuity with current President Lula’s policies by continuing to spend more on social welfare programs.

 

For example, Finance Minister Guido Mantega has announced recently that there will be a “general cut” in expenditures during the Rousseff government, sparing only priority projects such as Bolsa Familia – Brazil’s highly-regarded transfer program. Even the beloved BNDES Bank will see its budget cut by ~50% next year. This is a major step toward combating inflation and toning down domestic demand, as the bank’s main role is to provide subsidized credit for long-term projects. BNDES’ lending rate has been kept at 6% since July 2009 – a full 475bps lower than the benchmark SELIC lending rate.

 

All told, we like the direction of Brazil’s fiscal and monetary policy; we do, however, caution that because Brazil has been slightly late with its response to inflationary pressures, quickening prices will likely remain a concern over the intermediate-term. As a result, we continue to anticipate rate hike(s) in 1H11, as the government looks to quash this headwind. The one caveat here would be that if growth comes in considerably slower in 1Q11, the ability of the Brazilian government to tighten in a way they perhaps should would likely be mitigated.

 

Let’s just hope for Brazil’s sake we don’t have to say, “I told you so.”

 

Darius Dale

Analyst


Athletic Still Strong Post Holiday

Athletic apparel and footwear sales suggest that strong underlying sales have continued beyond Thanksgiving weekend. Most notably, positive sales came in despite facing the headwind of unfavorable comps for the first time since October in the case of apparel and September for footwear. Here are a few key callouts from the week:

  • Athletic specialty retailers continue to outperform both the family and mass/discount channels.
  • ASP increases decelerated considerably on a sequential basis following the holiday weekend for both footwear +1% vs. +8% in the prior week, and apparel which actually turned negative -1% vs. +8% on the week suggesting that in addition to potential mix shifts, promotional activity may in fact be picking up as well.
  • Importantly, athletic specialty retailers bucked the trend of eroding ASPs in apparel maintaining MSD price inflation offset by considerable declines in the discount/mass channel down -6% - positive for margins and DKS, HIBB, FL, and FINL.
  • New England continues to be one of the top performing regions each of the last 4-weeks.
  • Lastly, while the bifurcation in performance versus non-performance has narrowed materially over the past 2-weeks likely due to a pickup in boot sales, performance footwear continues to outperform by a wide margin.

Athletic Still Strong Post Holiday - FW App Ind 1Yr 12 9 10

 

Athletic Still Strong Post Holiday - FW App Ind 2Yr 12 9 10

 

Athletic Still Strong Post Holiday - FW Perf v NonP 12 9 10

 

Athletic Still Strong Post Holiday - FW Table 12 9 10

 

Athletic Still Strong Post Holiday - App Table 12 9 10

Casey Flavin

Director

 


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RL: RL Sucker Punched (CORRECTION)

EDITOR'S NOTE: This is a corrected version of a note published today at 11:47am. In the prior post, we included clips from YouTube, and mistakenly inserted one that is highly inapropriate, and inconsistent with our principles, research, and Brand. Please accept our appologies.

 

 

I was pretty amazed when I got this promo email from Bob's Stores this morning with a massive Polo Pony on the chest of the garment on sale.  About two seconds later I realized that it was the US Polo Association, and not Ralph Lauren.

 

The two parties have been in and out of legal battles for well over a decade. Much of it was noise, but my strong sense is that Ralph and Roger Farrah won't let this one go unanswered.

 

What's also interesting is that the consumer genuinely cares. In this YouTube society, we can now hear from the contingent that matters most. Type 'Ralph Lauren vs. USPA' into your Google machine, and you'll see about 13,000 hits. Do the same on YouTube and see consumers debating back and forth about the issue. Generally speaking, you'll see RL purists across many different age, ethnic and socioeconomic backgrounds standing behind Ralph.

 

RL: RL Sucker Punched (CORRECTION) - uspa

 

RL: RL Sucker Punched (CORRECTION) - rl

 

RL: RL Sucker Punched (CORRECTION) - rl3


European Charts of the Day

Position: Long Germany (EWG); Short Euro (FXE), Short Italy (EWI), Short Spain (EWP)

 

With the BOE on hold this morning, maintaining its benchmark (repo) rate at 0.50% and asset purchasing program of 200 Billion Pounds, while inflationary pressures loom with CPI running above the bank’s target at over 3% annually, we thought it worth charting the developing divergence among select European economies by the fundamental metrics of:  CPI, Unemployment, and GDP. We’re of the opinion that due to the ongoing Sovereign Debt “crisis” in Europe and the outcome of slower growth prospects across the region due to the issuance of austerity packages, many countries will have a difficult time arresting (or turning around) the divergences in the charts below over the intermediate term.

 

We maintain a bullish bias on Germany, yet caution that the DAX is reaching its immediate term TRADE overbought level and has sizable mean reversion risk (see yesterday’s post titled “Robust Germany”). We have a bearish bias on Europe’s fiscally bloated countries, which we think will continue to get “punished” by the market for carrying excessive public deficit and debt levels, and are short the EUR-USD with an immediate term TRADE range of $1.29-$1.34.

 

European Charts of the Day - r1

 

European Charts of the Day - r2

 

European Charts of the Day - r3

 

Matthew Hedrick

Analyst


More or Less: SP500 Levels, Refreshed...

POSITION: Short SPY

 

Being short the SP500 is 1 of the 10 SHORT positions in the Hedgeye Portfolio that is not working for me right here and now. We have 10 LONG positions that are easy to feel smarter about because everything has been straight up. I suppose the challenge is to attempt to keep feeling dumb and smart at the same time and remain employed.

 

When a market price is at its YTD high and you’re short it, it’s easy to feel things.

 

Do I have more or less conviction in my intermediate-term global macro call (Growth Slowing, Inflation Accelerating, and Interconnected Risk Compounding)?

 

More.  

 

Do I have more or less conviction in my immediate-term call to be short the SPY?

 

Less.

 

Maybe I just need to give this market another 6 or 12 hours of trading and less will feel like more. Maybe it won’t. Then I’ll feel shame.

 

My immediate-term TRADE lines of support and resistance are now 1209 and 1248, respectively.

KM

 

Keith R. McCullough
Chief Executive Officer

 

More or Less: SP500 Levels, Refreshed... - 1


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