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The BOE Sees Inflation?

Hedgeye Positions in Europe: Long Germany (EWG); Short Italy (EWI), Euro (FXE)


The answer to the question, Does the Bank of England see inflation?, appears to be a qualified ‘yes’.  Today the Bank of England published the minutes from its December 8-9 meeting and one sentence stood out:


“Most of the members considered that the accumulation of news over recent months had probably shifted the balance of risks to inflation in the medium term upwards.”


We’ve highlighted inflation risk in the UK over the last months as the Bank has reported CPI above or at its target of 3% for most of the year. With CPI currently at 3.3% in November year-over-year, we’re likely to see further upside pressure on CPI in the coming quarters due to an increase in VAT to 20% (versus the current rate of 17.5%) in January 2011, a weaker Sterling versus major currencies in the 1H 2010 on the comp (see chart), and inflationary global commodities that we’re calling for next year.


The BOE Sees Inflation? - currency chart


The Bank, despite two dissenting members, maintained that the Bank Rate should remain unchanged at 0.5% and its asset purchase plan unchanged at £200 Billion. Again, we see the Bank largely handcuffed on monetary policy: the Bank can neither raise rates to quell inflation for fear of further chocking off the economy nor buy more paper (to potentially spur growth) for fear of stoking further inflation.


A sticking point remains the country’s fiscal policies, namely its austerity measures, that should threaten growth through increased taxes, job cuts, and dampen business and consumer confidence. Today, the final reading of Q3 GDP in the UK showed downward revisions. Year-over-year Q3 GDP was revised to +2.7% (versus +2.8%) and quarter-over-quarter GDP was revised down 10bps to +0.7%. 


We don’t have an investment position in the UK, but clearly we’re worried about inflationary pressures over the coming quarters given the country’s weak growth prospects next year.


Matthew Hedrick



The Macau Metro Monitor, December 22nd, 2010


Visitor arrivals to Singapore grew 15.8% YoY to reach 978,000 in October 2010, the highest number of arrivals recorded for the month of October.  Indonesia contributed the largest number of visitors with 179,000.




TODAY’S S&P 500 SET-UP - December 22, 2010


As we look at today’s set up for the S&P 500, the range is 14 points or -1.00% downside to 1242 and 0.11% upside to 1256.  Equity futures are trading mixed to fair value following Tuesday's largely uneventful session, which saw the Dow close above the 11,500 level as December's rally continues to free wheel into year end.


A heady mixture of fiscal stimuli, M&A, solid corporate earnings and year end window dressing appear to be behind the continued support for the market, although volumes remain very low.


After the close, Nike (NKE) reported Q2 earnings that broadly met analysts’ forecasts but the shares fell in after hours trading after it guided to roughly 150 bps of margin pressure over the next 2 quarters due to cost inflation. Today's macro highlights include; Q3 GDP (second revision) and Nov Existing Home Sales

  • Aeropostale (ARO) appointed Marc D. Miller as CFO
  • Humana (HUM) sees 2011 consolidated EPS $5.45-$5.65, says rev. should increase $800m from Concentra deal
  • Nike (NKE) sees 2Q brand futures orders up 11% ex-FX, vs est. up 11.6%
  • Progress Software (PRGS) sees 1Q EPS 40c-45c vs est. 36c
  • Red Hat (RHT) reported 3Q adj. EPS 20c vs est. 20c
  • Scientific Games (SGMS) got a contract to supply tickets and services to De Lotto, in the Netherlands
  • Tibco Software (TIBX) reported 4Q adj. EPS 31c vs est. 28c
  • Walter Energy (WLT) bought the assets of Mobile River Terminal; terms not disclosed
  • Xilinx (XLNX) cut Dec. Q rev. forecast to down 7%-9% Q/q, implies $563.9m-$576.3m vs est. $606.9m


  • One day: Dow +0.48%, S&P +0.60%, Nasdaq +0.68%, Russell 2000 +1.05%
  • Month-to-date: Dow +4.79%, S&P +6.27%, Nasdaq +6.78%, Russell +8.74%
  • Quarter-to-date: Dow +6.91%, S&P +9.94%, Nasdaq +12.62%, Russell +16.92%
  • Year-to-date: Dow +10.60%, S&P +12.51%, Nasdaq +17.56%, Russell +26.4%
  • Sector Performance: Financials +1.6%, Materials +1%, Energy +0.9%, Industrials +0.7%. Tech +0.6%, Consumer Disc +0.5%, Utilities (0.05%), Healthcare (0.2%), Consumer Spls (0.4%)            


  • ADVANCE/DECLINE LINE: 1156 (+1201)  
  • VOLUME: NYSE 810.52 (-2.32%)
  • VIX:  16.49 +0.49% YTD PERFORMANCE: -23.94%
  • SPX PUT/CALL RATIO: 1.54 from 1.92 (-19.67%)


  • TED SPREAD: 17.50 -0.101 (-0.576%)
  • 3-MONTH T-BILL YIELD: 0.14%  
  • YIELD CURVE: 2.72 from 2.74


  • CRB: 326.80 +0.78%
  • Oil: 89.82 +0.50%
  • COPPER: 427.60 +1.66%
  • GOLD: 1,387.97.50 +0.11%


  • EURO: 1.3120 -0.02%
  • DOLLAR: 80.718 +0.11%




  • European markets fluctuated either side of unchanged in thin trading, struggling to find any direction with limited significant news flow and ahead of US GDP.
  • In the periphery, a Portuguese newspaper reported that China is ready to buy as much as €5B in Portuguese sovereign debt and Fitch late yesterday placed Greece's BBB- sovereign debt rating on watch negative.
  • Bank of England Minutes MPC voted 7-1-1 for unchanged policy in Dec, Posen voted for £50B more QE, Sentance voted for a 25 bps rise
  • UK Q3 final GDP +0.7% q/q vs consensus +0.8%, +2.7% y/y vs consensus +2.8%


  • Most Asian markets rose slightly today.
  • South Korea’s announcement of three days of naval firing exercises to begin today did not affect the region.
  • Oil refiners rose in Hong Kong after China raised wholesale gasoline and diesel prices 4%. Property shares rose, following yesterday’s 5% jump in China.
  • In trading that only reached 60% of the average, Australia was flat, with miners up on record copper prices, and profit-taking moving banks down.
  • Japan declined slightly on profit-taking following yesterday’s gain; sentiment was also dampened when November exports increased by less than expected.
  • China fell on a liquidity crunch after yesterday’s gain. Oil issues did not react to the country’s fuel-price rise, which had been expected and therefore priced in. Bank stocks fell on continued worries that more tightening measures may be in store.
  • Japan November trade surplus ¥162.8B vs consensus ¥452.8B. November supermarket comps (0.5%) y/y. 


Howard Penney

Managing Director



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Price Matters

“The point is, in investing, price has to matter.”

-Howard Marks


That’s what Oaktree’s investment chief, Howard Marks, wrote in a recent memo to his clients where he was talking down the perception of value embedded in the price of gold. It’s a very simple market practitioner’s point, but it’s worth highlighting; especially as we traverse year-end storytelling as to why everything that’s going up in price is still “cheap.”


The price of the US stock market was cheaper 4 trading days ago than it was at last night’s closing price of 1254. That’s because the SP500 has been up for 4 consecutive days, taking it to a new YTD high. But does that make the price of the US stock market cheap?


Well, it’s definitely not cheaper than the SP500’s March 2009 closing low of 676. An arithmetically proficient 8th grader could tell you that 1254 is +85.5% more expensive. In fact, if I give him the right button to press while he is sitting on my lap at my desk, my 3-year-old son could get you a PE ratio and 200-day Moving Monkey average on that too.


Price matters.


Wall Street’s favorite way to justify higher-prices is to talk about “valuation.” Again, the opacity of the lingo is what it is, but it’s less convincing to hear a fast monkey talk about valuation today than it was, say, before the internet. Calculating “valuation” on the sell side’s consensus estimates is a trivial exercise that requires a connection, not an education.


Storytelling about “valuation”, however, requires academic degrees spanning law and social science. At the end of the day, the stories don’t change the historical reality that stocks, bonds, and commodities trade all over the place on “valuation” but, most importantly, on last price.


In the last 6 months, let’s look at what some prices have done at the same time as the storytellers talk about “the deflation”:

  1. SP500 = +23%
  2. CRB Commodities Index = +28%
  3. Copper = +47%

Now before I accuse myself of cherry-picking that all-time high price of copper of $4.27/lb this morning and what it may mean to people who make and/or sell things that include the price of copper, let me tone down my argument and look at the price of oil. Its price is up less.


The price of gasoline is hitting higher-highs this morning after a +25% move in the price of WTI crude oil since July, and the Chinese are being forced to raise consumer gas prices this morning for the 3rd time in 2010. Price fixing aside, I suppose this is Ben Bernanke’s Merry Christmas card to the world’s lower and middle class.


Inflation is a policy and Price Matters.


Ask the Bank of England. Finally it reflected some form of reality in their policy statement this morning as they opined on inflation. The minutes in the BOE’s statement read that “most of those members considered that the accumulation of news over recent months had probably shifted the balance of risks to inflation in the medium term upwards.”


Now, to be clear, don’t expect Bernanke to do what the BOE just did. If Ben Bernanke didn’t see inflation hammering America’s middle class with $150/oil in 2008, don’t expect him to see it (or Chinese or Brazilian inflation) ramping to the upside like the prices on your screen are this morning. The Heli-Ben doesn’t do global macro.


The Ber-nank’s storytelling and views about last price don’t trump what’s happening to market prices. Inflation has been hurting emerging market prices (stocks, bonds, and currencies) since November, and we don’t see what will change that direction of market prices in the new year. Inflation is a matter of prices. It’s the one thing that’s killed modern societies (and their markets) for hundreds of years.


As always, Price Matters to every long and short position we hold in the Hedgeye Portfolio. Being short the SP500 (SPY) for the last 3 weeks has been as wrong (-3.84% against me) as being long Corn (CORN), Germany (EWG), and China National Offshore (CEO) has been right.


In terms of Asset Allocation, my best “idea” going into 2011 is being long of Cash. The price of American cash (US Dollar Index) is one of the few price charts in global macro that isn’t trading at its cycle highs yet. Heck, maybe someone can tell me a story that it’s “cheap.” US Congress’ credibility on fiscal responsibility definitely trades at a discount!


And, yes, I get that in a world where you can’t buy bonds (because they are going straight down in the face of Global Inflation Accelerating) that Bernanke is daring me to chase the “yield” of the US stock market’s last price. But I also get that investing in a globally interconnected marketplace has less and less to do with the US stock market’s price than it did before 2008.


My immediate term TRADE lines of support and resistance for the SP500 are now 1242 and 1256, respectively. We’re still long the US Dollar (UUP) and short the Euro (FXE) in the Hedgeye Portfolio and the Cash position in the Hedgeye Asset Allocation Model is currently 67%.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Price Matters - USD SUPPORT

The Pain of Rain

This note was originally published at 8am on December 21, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“One can find so many pains when the rain is falling.”

-John Steinbeck


Timing is everything in life.  As it relates to my current trip to Southern California, my timing couldn’t have been worse.  I took a few hours away from the screens yesterday to finish up my Christmas shopping and a number of local business people informed me that this was one of the rainiest weeks Los Angeles had seen in, well, a really long time.   


Today Keith is off to his hometown of Thunder Bay, Ontario with his wife and little ones, Jack (already a heck of an ice skater at only three years old) and Callie.  Tomorrow I’ll head to my hometown, the small Alberta prairie outpost of Bassano, Alberta (total population of 1,200 and 75 some dogs).  I think both of us, like many of you I’m sure, will take the next week to relax and begin planning for 2011.  Much to the Steinbeck quote above, as I contemplate the future on this dark wet California morning, I do see a few pains.


While Steinbeck is most known for his literary career which culminated in the Nobel Prize for literature in 1962, he also knew a thing or two about state and local finances in California.  In fact, his father was the long serving Treasurer of Monterey County.


California has become the poster child for one of the key potential pain points heading into 2011, that of municipal debt and deficits.   We recently shorted municipal bonds in our Virtual Portfolio via the etf, MUB.  While clearly not all municipal bonds are created equally, the general short case for the municipal bond market is as follows:


1.  Rates are going higher – We’ve obviously already seen this over the last 30-days, but as the Fed is unable to keep the long end of the curve down, bonds will continue to suffer, especially as inflation expectations accelerate.   Rates, obviously, have much more room to the upside from these historically low levels.


2.  Housing prices have more downside – We are bearish on housing prices to the tune that we think home prices have 15 – 30% more downside nationally.  Since appraisals for tax purposes operate on a 2 – 3 year lag to market prices, municipalities will begin collecting taxes based on dramatically declining home prices, which should hurt their tax receipts.  Real estate taxes are the single largest revenue source for local governments.  In the Chart of the Day, we show the Case-Shiller index versus property tax receipts.


3.  State deficits set to expand – Currently, state level revenue is 12% below pre-recession levels, which is substantially worse than the revenue recovery in the past three recessions going back to the 1980 – 81 recession.  This pain is likely to intensify, with States facing a $140 billion budget gap in fiscal 2011, according to the Center of Budget and Policy Priorities.


This is obviously the cliff notes version of our body of work on the municipal market, so if are a subscriber or prospective subscriber and would like more information, or to set up a call to discuss this topic with us, please email our Head of Sales Jen Ken at sales@hedgeye.com.


While Steinbeck has become one of America’s most lauded authors, he was also, while alive, one of its most controversial.  He had left leaning politics and was long suspected to have ties to the Communist Party.  In fact, perhaps his greatest work, The Grapes of Wrath, which is considered by almost all as one of the top ten English language novels of the last century, was originally harshly critiqued because it was deemed to be too pro-worker and overly critical of capitalism.


In addition to his full-time career of writing, Steinbeck was also a very active traveler.  In 1947, he travelled to the Soviet Union with noted photographer Robert Capa.  They were two of the first Westerners to visit the Soviet Union after the Communist Revolution.   The output of this trip was A Russian Journal, which describe the harsh living conditions in the Soviet Union. 


Since Steinbeck’s visit almost 60-years ago, much has changed in the former Soviet Union.   While the transition to a fully functioning democracy in the vein of the West is still a work in progress, the introduction of capitalistic ways has certainly benefitted Russia, particularly as it relates to its vast natural resources.  Due to modern reinvestment and the opening of her oil fields, since 1999 Russian oil production has increased 62%, or 3.5MM barrels per day, while total global oil production has only increased 10.5%, or 7.6MM barrels per day. The Russians are taking market share.


Despite the pain we see in municipal debt markets headed into 2011, we do have some great long ideas.  As it relates to the Russian oil theme above, one of our favorite long ideas is Lukoil (LUKOY).  According to our Energy Sector Head Lou Gagliardi:


“Although labeled a National Oil Company (NOC), Lukoil is 100% publicly owned. But, geopolitical risk, the Russian economy, a weak global economy and energy demand, and an onerous export tax duty have all weighted heavily on Lukoil’s share price in 2010 widening its market price discount to its discounted cash flow valuation further to 50%.


Historically NOCs trade at a discount to cash flow valuations and Lukoil’s historical discount has been in the 30% range. We believe its market discount will narrow reverting to the mean in 2011 driven by several catalysts. Lukoil’s high oil production weighting of 87% levers its share price to higher crude prices; its long-lived reserves, its expanding production profile internationally, and its growing crude oil production profile of ~2% per annum will contribute to significant earnings growth in 2011.


Lukoil’s balance sheet is strong with a debt to capital ratio of ~16% and a net of cash ratio at ~12%, as the Company is living within its capital spending. At $85.00 crude oil in 2011, we expect Lukoil to easily beat consensus with a ~25% E.P.S increase from 2010 to $14.75/ADR. For 2011, NCF at $85/bbl is targeted at $8.4 billion, or $10.12/ADR. At $89.00/bbl, earnings would jump 35% from prior year to nearly $16.00/ADR, adding roughly another $1 B in NCF.”


To put it simply: Lukoil is cheap, growing, has deep reserves, and a pristine balance sheet.


While the outlook does seem a little cloudy and rainy, there are plenty of Lukoil type opportunities out on the horizon.  Moreover, as another well know American literary figure Dolly Parton once sang:


“The way I see it, if you want the rainbow, you gotta put up with the rain.”


Enjoy the holidays with your families and stay out of the rain,


Daryl G. Jones

Managing Director


The Pain of Rain - Property Tax Case Shiller

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