Taxing Onions

“Inflation is taxation without legislation.”
-Milton Friedman
Ben Bernanke got what he ordered for Christmas - global inflation.
While economic news in the US is light this morning, the rest of the world is waking up to continued signals that Global Growth is Slowing as Global Inflation Accelerates.
With Chinese Equities closing down for the 6th out of the last 7 trading days in Shanghai (China is down -12.9% YTD), here are the 3 most important inflation headlines that continued to pressure Asian Equity markets overnight:
1.       India’s weekly wholesale food inflation accelerated to +12.13% versus +9.46% last week
2.       Singapore reported another sequential acceleration in consumer prices (CPI) to +3.8% in NOV vs +3.5% in OCT.
3.       CRB Commodities Index closed at another YTD high of 328 = +15% since OCT and +29% since JUL.
Unlike in the US where the government has changed the inflation calculation 9 times since 1996 and tells you to focus on the “core” (no gas in your car, heat in your home, or food in your belly), India’s food inflation index includes the things that people eat. Things like lentils, veggies, and rice are very popular items for consumption.
Onions are a sought after food item in most parts of the world as well. It’s hard to fire up your curry without onions and the Indian government takes this practical matter quite seriously. India is calling for “emergency measures” this morning to address the onion supply imbalances due to rainfall damaged crops. Global food and water supply shocks? Heli-Ben, what are those?
Not that the people making curry for the holidays notice this (they’re probably much more focused on Quantitative Guessing and how great that is for Americans who still have 401k’s that aren’t choking on bond allocations), but the price of onions is up +34% year-over-year.
We get the year-end storytelling about “cheap” American stocks and how the world is awash with fiat currency, but we also get that inflation is a policy. Governments either fight it or perpetuate it – and there’s an Eastern versus Western view of the world emerging on this front.
Inflation is the #1 fear of emerging market economies and global bond investors alike. That’s why China, India, and Brazil’s stock markets have been going down since November. These markets apparently don’t care so much for how many 600 thread count sheets Americans are buying at Bed Bath and Beyond.
As global inflation accelerates the US Dollar Index and US Treasury yields are also rising. Again, the bulls are saying what they said on this score back in 2007 (after 64 consecutive quarters of positive US consumer spending) – everything is benign in the land of riskless nod until year-end bonuses are paid out.
We remain bullish on US Dollars and bearish on US Stocks and Bonds. Either the rest of the world won’t matter in 2011 or it will. And while hope is not an investment process, we can only hope and pray that the 45 MILLION Americans who are on food stamps this Christmas are sheltered with one of the only things left in life that the government can’t infuse with price volatility – the love of their families in times of need.
My immediate term support and resistance lines for the SP500 are now 1245 and 1259, respectively. I shorted the SP500 again yesterday.
Merry Christmas and Happy Holidays to you and your loved ones,
Keith R. McCullough
Chief Executive Officer


Taxing Onions - onions


The Macau Metro Monitor, December 23rd, 2010


November CPI rose 3.8% YoY and 0.4% MoM. This matched the Street's expectations. The latest inflation data confirmed S'pore central bank's (MAS) expectation of 4% inflation by the end of 2010.

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Price Matters

This note was originally published at 8am on December 22, 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 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

NKE: Someone Woke up the Bear

Great quarter. We still like it and have numbers that are 15-20% ahead of the Street. But a legitimate bear case arose from the quarter. We won’t ignore its existence. But rather will monitor it and point to entry/exit points on a high conviction name.


I’ve had one big multi-stage reaction to Nike’s print.

1)      Upper. Better than expected print. Nike prints $0.94 vs the Street at $0.88. We were at $0.96, but the differential was largely below the line and SG&A. Clean profit algorithm of 9.9% revenue growth, and levers it to 12% Gross Profit growth, and 24% EPS growth, respectively. North American futures accelerated AGAIN to 16%. Slight weakness in other regions on the margins, but more than made up in the US.  Remember what Nike’s stock did 13 weeks ago when US Futures went to 14%?

2)      Downer: On the flip side, as we outlined in our preview ("NKE: It's All on Nike U.S." posted 12/21) the set-up for Europe and parts of Asia is not a good one heading into ’11. Check out that note to see changes in consumer confidence, retail sales metrics, and GDP trends on the margin. Nike appears to be tracking those broader consumer trends to some degree with Western Europe, Eastern/Central Europe and China all decelerating on the margin by 300-500 basis points. Interestingly, while China decelerated, Japan turned up. Given that Japan has been a disaster for almost everyone in retail for years, this is a bit of good news. But there have been many many head fakes, and given the lack of growth in the economy in Japan, it will take well more than a quarter to establish a trend.

3)      Reality. The reality is that this company has proven time and time again that when one part of the portfolio ebbs, another will flow. That’s exactly what we have today. The difference is that in yesteryears, it was always Europe, Asia and The Americas that offset lackluster growth in the US.  Today we have the US growing at a blistering pace, and offsetting any weakness in other regions. This throws a powerful ‘what if’ into the equation.


What If???? The risk with where Nike stands today is that the US business needs to stay strong – else any weakness in Europe, Asia and Americas will be more transparent and even perhaps problematic. Remember, we have to start to deal with World Cup hangover in another two quarters.  The good news is that the US business is at the very start of a major R&D/product cycle that should last well into 2012. Our confidence level there remains very high, as outlined in our past research. Also Nike has a lot in its back pocket to mitigate gross margin pressure in its business from raw material cost inflation.


But regardless of what we think, a bear call exists, and it sounds something like this…”This company has been a solid global top line and gross margin improvement story, but now key regions have shown weakness on the margin. Inventories have built on the margin. In F3Q (Feb) we will be feeling the effects of the ‘Consumption Cannonball’ where real consumption turns negative.  Immediately thereafter Nike – and the whole industry – will have to comp World Cup. Yes, Nike has the balance sheet to buy stock on weakness, and also has recently stepped up acquisition strategy. But a story that morphs from a ‘robust top line and GM% improvement story’ into a ‘top line/acquisition and SG&A leverage story w stock repo as a kicker’ is not enough to keep its multiple in check.


With short interest near historic lows, and the sell-side universally bullish on this name, it is not a major surprise that the stock is down today.


But all that said – we’re coming out at $1.25 for 3Q, and our sense is that the Street ultimately shakes out closer to a buck. Same order of magnitude for the FY11 and FY12.


The bottom line is that we may be entering a period where Nike’s volatility kicks up a couple of notches, which we think will be a potentially good opportunity for those who have been telling us that they ‘missed it.’


NKE: Someone Woke up the Bear - NKE UTube Q2 1 12 10

NKE: Someone Woke up the Bear - NKE UTube Q2 2 12 10

NKE: Someone Woke up the Bear - NKE UTube Q2 3 12 10

NKE: Someone Woke up the Bear - NKE UTube Q2 4 12 10




Are Rising Rates Pulling Housing Demand Forward? Existing Home Sales Rise, Purchase Apps Fall

This note contains four parts:

1. Existing Homes

2. MBA Purchase Applications Fall

3. Hovnanian Comments on Housing Market

4. Campell/IMF Survey Shows Rising Rates Pull Demand Forward


1. Existing Home Sales Rise 5.6%, Less Than Expected

Expectations were high going into today's Existing Home Sales print.  After Pending Home Sales rose 10% last month, consensus was for a roughly 7% increase in Existing Homes.  Existing Homes typically lag Pending by 1-2 months.  A recent Campbell/Inside Mortgage Finance survey suggests that the immediate impact of rising rates is to pull forward demand among first-time homebuyers.  We summarize this survey at the end of this note.  


Are Rising Rates Pulling Housing Demand Forward? Existing Home Sales Rise, Purchase Apps Fall - existing


The median price of existing homes held steady MoM and eked out a slight gain YoY.  Median prices are not seasonally adjusted.  The November MoM increase of 0.1% compares to an average change for November of -0.1%.   August, September and January are historically the weakest months.


Are Rising Rates Pulling Housing Demand Forward? Existing Home Sales Rise, Purchase Apps Fall - existing median price


On a year-over-year basis, existing home sales continue to decelerate.  The YoY comparison is lapping the expiration of the first homebuyers' tax credit in November 2009, and will look much better next month. 


Are Rising Rates Pulling Housing Demand Forward? Existing Home Sales Rise, Purchase Apps Fall - existing YoY


Inventory declined sequentially to 3.71 million units from 3.86 million.  Months of supply fell to 9.5 months, a sequential improvement but still an elevated level.  


Are Rising Rates Pulling Housing Demand Forward? Existing Home Sales Rise, Purchase Apps Fall - existing inventory


Are Rising Rates Pulling Housing Demand Forward? Existing Home Sales Rise, Purchase Apps Fall - existing months supply


2. MBA Purchase Applications Fall as Refinance Applications Take Another Nose-Dive

MBA Purchase Applications fell 2.5% week-over-week on a seasonally adjusted basis, while Refinance Applications dove 24.6% in response to higher rates.  Seasonal adjustment factors tend to dominate the week-over-week fluctuations in Purchase Applications in the last few weeks of the year.


Rates remained higher for the week, but didn't rise further.  MBA mortgage rates rose 1 bp versus last week to 4.85%.  BankRate 30 year mortgage rates made a similar move, falling 3 bps versus a week ago to 4.97%. The sharp increase over the last several weeks has taken a clear toll on refinance activities, but purchase applications are much less affected thus far.  


Taking a step back as we head into year-end, mortgage application volume for 2010 is tracking approximately 24% lower than 2009 levels.


Are Rising Rates Pulling Housing Demand Forward? Existing Home Sales Rise, Purchase Apps Fall - shark chart


Are Rising Rates Pulling Housing Demand Forward? Existing Home Sales Rise, Purchase Apps Fall - mortgage rates


Are Rising Rates Pulling Housing Demand Forward? Existing Home Sales Rise, Purchase Apps Fall - refi chart


Are Rising Rates Pulling Housing Demand Forward? Existing Home Sales Rise, Purchase Apps Fall - shark chart long term


Are Rising Rates Pulling Housing Demand Forward? Existing Home Sales Rise, Purchase Apps Fall - shark YoY


3. Hovnanian Comments on 'Challenging' Environment

Hovnanian reported its 4Q results last night.  We will look for more detail in their call later this morning, but their commentary from the press release is illuminating.  


"In spite of strong long-term demographics, the current housing market remains quite challenging. The combination of a lackluster job market and high foreclosure activity is clearly having a dampening effect on the housing market. The only silver lining is that we continue to find land acquisition opportunities which we believe will yield appropriate returns at today's home prices and sales paces. Even without a general housing recovery, we are optimistic that as the percentage of deliveries from newly identified communities increases, our overall performance should continue to improve." 


4. Survey Shows Rising Rates Pull Demand Forward in the Short-term

A survey conducted by Campbell/Inside Mortgage Finance showed that the backup in mortgage rates pulled demand forward for some buyers.  Purchase share of first-time buyers rose to 37.2% in November from 34.4% in October, while fewer existing homeowners bought homes (42.9% in November versus 44.2% in October).  The remainder was investor activity, down to 19.9% in November versus 21.4% in October.  Thomas Popnick, the director of the survey, told HousingWire, "The recent surge in interest rates has made potential homebuyers nervous.  If rates go up much more, then a good percentage of them will no longer qualify for the properties they want. As a result, they're making bids on homes and quickly closing before their rate locks expire."  


This effect may explain the recent strength in Mortgage Purchase Applications and Pending Homes.  If so, the effect is likely to be temporary.  


Joshua Steiner, CFA


Allison Kaptur

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