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R3: JCG, KCP, WWW, Social Spend

R3: REQUIRED RETAIL READING

January 18, 2010

 

 

 

RESEARCH ANECDOTES

  • Now that Kenneth Cole has announced its closing of the company’s flagship Rockefeller Center location, speculation is about to begin on who will take over the prime retail location.  Real estate experts are suggesting the space should rent for $2000+ per foot. 
  • According to the Consumer Reports Sentiment Index, consumers are more optimistic than they have been since October 2008.  The index registered 48.7 in January, up from 45.1 in December and 44.1 one year ago.  The most optimistic consumers are age 18-34 and those with income over $100,000.
  • According to date from Nielsen, 75% of Americans already have high-speed internet access.  HDTV adoption ranks second with 46% penetration, followed by DVR’s at 35%, and handheld media devices at 20%. Tablets and 3DTV currently have just 1% penetration.   

OUR TAKE ON OVERNIGHT NEWS

 

J. Crew Go-Shop Period Expires - The deadline came and went.  The go-shop provision in TPG Capital and Leonard Green & Partners’ offer of $2.86 billion, or $43.50 a share, for J. Crew Group Inc. expired Saturday. Any new offer for the specialty retailer needed to be made before its expiration.  J. Crew chief executive officer Millard “Mickey” Drexler has indicated he’s unwilling to work for a new boss other than those at TPG, which owned the specialty retailer before taking it public in 2006. The 53-day go-shop was longer than usual, believed to allow potential buyers time to review holiday 2010 sales results. Sears Holdings Corp., Urban Outfitters Inc. and two private equity firms were reported to be considering rival bids. Even if no one ponies up with an offer, those kicking the tires might have had a once-in-a-lifetime opportunity to get a look at J. Crew’s books under the guise of “due diligence.” <WWD>

Hedgeye Retail’s Take: :  Yet another set of rumors that didn’t pan out when it came to potential suitors.  Now stay tuned for lawsuit settlement talk surrounding shareholders who feel the board did not do an adequate job “shopping” around in the first place.

 

NRF Holiday Sales Climb 5.3% - According to the National Retail Federation, retail industry sales (which exclude automobiles, gas stations, and restaurants) for December rose 5.3% unadjusted year-over-year and 0.5% seasonally adjusted from November. As a result, preliminary 2010 holiday sales, which combine the full months of November and December, rose 5.7% to $462 billion, surpassing NRF's forecast of 3.3%. This represents the best holiday sales gain since 2004 when holiday sales increased 5.9%. "In spite of weakness in employment and rising gas prices, consumers showed they still have spending power which helped retailers when it counted most," said NRF President and CEO Matthew Shay.  "Retailers did a tremendous job planning for the season by managing inventory and hitting the right price points that helped them tap into pent up demand." <SportsOneSource>

Hedgeye Retail’s Take: Definitely old news by now and optimistic by “same store sales” standards.  Perhaps this is a good reason to reflect on why sales don’t always tell the whole story.  At the end of the day, sales + discounting= better measure of holiday performance. 

 

Merrel Brand Seeking Apparel Appeal - Merrell is getting serious about clothing. The brand, which launched apparel in 2006 to mixed reviews from retailers, is gearing up to make the offering a key component of its business. “The Merrell group has pretty lofty goals,” said Mark Sandquist, president of global apparel and accessories at Wolverine World Wide Inc. “We have about 14 million consumers that, in theory, would buy Merrell apparel.” Sandquist, who joined Wolverine from Columbia in August 2009, has been charged with invigorating Merrell’s apparel and accessories division and is making moves to bring the non-footwear offerings to a broader consumer base. To do so, he said, they will boost the brand’s presence in stores and begin targeting accounts already carrying Merrell footwear. <WWD>

Hedgeye Retail’s Take: After a very slow start, we wonder if this now is truly the credible push that Merrel needs to move the brand beyond footwear and onto the body. Price points will be key to the strategy, especially given the crowded competitive space that already exists within the outdoor apparel sector. 

 

Price Hikes Top of Mind for Outdoor Players - Though economic and sourcing issues could continue to weigh heavily on the outdoor market in 2011, a large number of executives told Footwear News they were optimistic about the coming year. In the lead-up to the Outdoor Retailer show, set for Jan. 20-23 in Salt Lake City, FN polled vendors and retailers for their thoughts on the issues and trends impacting the category. They said the economy was the biggest issue facing the industry, followed by consumer spending and rising prices. In spite of the challenges, most respondents were upbeat. Roughly 46 percent of participants said they were feeling optimistic about spring ’11, while 39 percent were “somewhat optimistic” and 16 percent had a negative outlook. <WWD>

Hedgeye Retail’s Take: 2011 will be a highly competitive year in the outdoor industry with several new players entering the space and coming out with new category introductions. This all equates to innovative product at retail, which might just get customers in the door for a look.

 

Imports Increase at Slower Pace in November - Textile and apparel imports to the U.S. rose 20.1 percent in November compared with a year earlier, to 4.6 billion square meter equivalents, representing the lowest volume of shipments in five months, the Commerce Department’s Office of Textiles & Apparel said Thursday. Inventory restocking drove shipments to peak levels from June through October. Apparel imports in November increased 23.9 percent to 2.1 billion SME compared with a year earlier, while textile shipments grew 17.1 percent to 2.5 billion SME. The nation’s overall trade deficit narrowed slightly to $38.3 billion in November from $38.4 billion in October.<WWD>

Hedgeye Retail’s Take: Largely expected as retailers and ‘brands’ alike took orders earlier than usual this year driven by concerns over elevated air freight costs. Despite sales coming in better than expected over the holidays, our sense is that we aren’t likely to see demand driven by constrained supply just yet in retail.

 

Facebook Drives US Social Network Ad Spending Past $3 Billion in 2011 - US marketers will spend $3.08 billion to advertise on social networking sites this year, eMarketer predicts. Spending will be up 55% over the $1.99 billion advertisers devoted to social networks in 2010 and will rise by a further 27.7% next year to reach nearly $4 billion. This year’s dramatic growth in spending will bring social media ad dollars to 10.8% of the total spent online in the US. Worldwide, where social network ad spending will rise 71.6% to $5.97 billion, that proportion will be somewhat lower, at 8.7%. <eMarketer>

Hedgeye Retail’s Take: After proving its value last year, social media spend will be driven not only by increasing allocations from current supporters, but also new converts who were undoubtedly waiting for first mover results. Initially a low cost high impact advertising solution, we expect this spread to narrow in 2011 as the viability of social networking gains viability.   

 

R3: JCG, KCP, WWW, Social Spend - R3 1 18 11

 

Vietnam’s Garment Sector Stepping Up Hi-Value Production - Vietnam’s garment and textile industry this year should invest further in hi-value competitively priced products to maintain its position as the world’s top five exporters, according to Deputy Prime Minister Hoang Trung Hai. Hai urged the industry to focus on technological innovation, while sourcing the best raw materials and improving the quality of its human resources, including its management. The sector has set an ambitious target of US$12.7-$13 billion in export earnings this year, according to the Viet Nam National Textile and Garment Group (Vinatex). It is also aiming to source between 55 and 60 per cent of its raw materials locally to cut import costs this year. To achieve these goals, the sector planned to focus on finding new export markets, Vu Duc Giang, Vinatex chairman, said. <FashionNetAsia>

Hedgeye Retail’s Take: Now is the time for Vietnam to capitalize on the momentum its gained from a sourcing perspective and building out human capital is a key first step to further expansion – proactively selling to new export markets won’t hurt either.

 


THE M3: IM/CITI REPORT; LESS TABLES; CHINA LOAN TARGET CUT; IMPORTED WORKERS; BELLE

The Macau Metro Monitor, January 18, 2011


TRAIN TALK MISSES THE STATION Intelligence Macau

IM disagrees with Citigroup's report on the positive effects of the upcoming Guangzhou-Zhuhai intercity railway.  IM says the buses from Guangzhou to Zhuhai will continue to be the main avenue of transportation since 1) It is cheaper; 2) Direct route to Gongbei vs. the multiple stops and transfers on the railway; 3) Railway terminates 45 minutes away from the Gongbei.

 

IM also disagress with Citi's forecast that SJM will lose market share in 2011 and 2012.  IM stresses that 1) SJM has the stickiest customers in Macau, mostly because of the clan-based associations of its 3rd-party casinos; 2) Grand Lisboa is expanding space for more tables; and 3) In contrast to the 5-star rooms being developed for Galaxy Macau and Lots 5&6, SJM has some of the most affordable hotels.

 

VIP BACCARAT ACCOUNTED FOR 72% OF MACAU'S GAMING REVENUES IN 2010 macaubusiness.com

For Q4, Macau had 4,791 gaming tables, a decrease of 47 from Q3.  Slots also fell to 14,050 from 14,316.  For 2010, VIP baccarat grew 69.91% YoY to MOP135.65BN; mass market baccarat rose 36.94% YoY to MOP34.92BN; and slots jumped 32.52% YoY to MOP8.62BN.

 

CHINA CUTS LOAN TARGET; FOREIGN INVESTMENT HITS RECORD Reuters, China Daily

According to sources, China's central bank has reportedly cut its 2011 lending target by 10% to between 7.2 trillion and 7.5 trillion yuan.  New yuan‐denominated lending in China reached 7.95 trillion yuan in 2010. The figure surpassed the central bank's target of 7.5 trillion yuan. 

 

OVER 75,000 IMPORTED WORKERS IN MSAR Macau Daily Times

In November, the number of non-resident workers totaled 75,098, an increase of 318 compared to the previous month.  Mainland China continued to be the main source of imported labor; however, there was a slight decrease of 79 Mainland workers from 41,516 in October to 41,437 in November.


BELLE, LR KEEN ON PAGCOR ASSETS Philippine Daily Inquirer

On the much-anticipated Pagcor privatization, Belle's group leader Willy Ocier said: “We don’t know when that will be, but if and when they do, Belle and LR will obviously be interested in bidding for the casinos outside of Metro Manila and we are eagerly awaiting Pagcor’s terms of reference.”


WEEKLY RISK MONITOR FOR FINANCIALS: WIDELY POSITIVE ON A SHORT-TERM BASIS

Financial Risk Monitor Summary (Across 3 Durations):

  • Short-term (WoW): Positive / 8 of 10 improved / 1 out of 10 worsened / 2 of 10 unchanged
  • Intermediate-term (MoM): Neutral / 5 of 10 improved / 5 of 10 worsened / 2 of 10 unchanged
  • Long-term (150 DMA): Neutral / 3 of 10 improved / 3 of 10 worsened / 4 of 10 unchanged / 1 of 10 n/a

WEEKLY RISK MONITOR FOR FINANCIALS: WIDELY POSITIVE ON A SHORT-TERM BASIS - summary

 

1. US Financials CDS Monitor – Swaps were positive across domestic financials, tightening for 27 of the 28 reference entities and widening for only one. 

Widened the most/tightened the least vs last week: AXP, AIG, HIG

Tightened the most vs last week: MET, TRV, MBI

Widened the most vs last month: C, AXP, ACE

Tightened the most vs last month: LNC, MET, MBI

 

WEEKLY RISK MONITOR FOR FINANCIALS: WIDELY POSITIVE ON A SHORT-TERM BASIS - 1 US cds

 

2. European Financials CDS Monitor – After backing up sharply last week, banks swaps in Europe was mixed.  Swaps tightened for 24 of the 39 reference entities.

 

WEEKLY RISK MONITOR FOR FINANCIALS: WIDELY POSITIVE ON A SHORT-TERM BASIS - 2 euro cds

 

3. Sovereign CDS – Sovereign CDS fell sharply last week on the Portuguese bailout and entry of Japanese buyers before rising slightly on Monday. 

 

WEEKLY RISK MONITOR FOR FINANCIALS: WIDELY POSITIVE ON A SHORT-TERM BASIS - 3 sov cds

 

4. High Yield (YTM) Monitor – High Yield rates fell 9 bps last week, closing at 7.91 on Friday.  

 

WEEKLY RISK MONITOR FOR FINANCIALS: WIDELY POSITIVE ON A SHORT-TERM BASIS - 3 high yield

 

5. Leveraged Loan Index Monitor – The Leveraged Loan Index continued to charge higher, closing at 1598, 8 points higher than the previous week.   

 

WEEKLY RISK MONITOR FOR FINANCIALS: WIDELY POSITIVE ON A SHORT-TERM BASIS - 4 lev loan

 

6. TED Spread Monitor – The TED spread fell to 15.8 from 16.8 the prior week.

 

WEEKLY RISK MONITOR FOR FINANCIALS: WIDELY POSITIVE ON A SHORT-TERM BASIS - 5 ted spread

 

7. Journal of Commerce Commodity Price Index – Last week, the index rose 3.7 points, closing at 35.5 on Friday.

 

WEEKLY RISK MONITOR FOR FINANCIALS: WIDELY POSITIVE ON A SHORT-TERM BASIS - 7 JOC

 

8. Greek Bond Yields Monitor – We chart the 10-year yield on Greek bonds.  Last week yields fell 150 points.

 

WEEKLY RISK MONITOR FOR FINANCIALS: WIDELY POSITIVE ON A SHORT-TERM BASIS - greek bonds

 

9. Markit MCDX Index Monitor – The Markit MCDX is a measure of municipal credit default swaps.  We believe this index is a useful indicator of pressure in state and local governments.  Markit publishes index values daily on four 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. Our index is the average of their four indices.  Spreads fell last week, dropping 7 bps to 219.  

 

WEEKLY RISK MONITOR FOR FINANCIALS: WIDELY POSITIVE ON A SHORT-TERM BASIS - 8 mcdx

 

10. Baltic Dry Index – The Baltic Dry Index measures international shipping rates of dry bulk cargo, mostly commodities used for industrial production.  Higher demand for such goods, as manifested in higher shipping rates, indicates economic expansion.  The index fell to a new low of 144 amid Australian flooding. 

 

WEEKLY RISK MONITOR FOR FINANCIALS: WIDELY POSITIVE ON A SHORT-TERM BASIS - 9 baltic dry

 

11. 2-10 Spread – We track the 2-10 spread as a proxy for bank margins.  Last week the 2-10 spread held flat at 273 bps. 

 

WEEKLY RISK MONITOR FOR FINANCIALS: WIDELY POSITIVE ON A SHORT-TERM BASIS - 10 2 10 spread

 

12. XLF Macro Quantitative Setup – Our Macro team sees the setup in the XLF as follows: zero upside to TRADE resistance, 2.0% downside to TRADE support. 

 

WEEKLY RISK MONITOR FOR FINANCIALS: WIDELY POSITIVE ON A SHORT-TERM BASIS - XLF

 

 

Joshua Steiner, CFA

 

Allison Kaptur


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THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP - January 18, 2011


Equity futures are trading mixed with the Nasdaq set to open lower following yesterday's news that Steve Jobs will take a medical leave of absence as the company is set to report earnings after the close.  As we look at today’s set up for the S&P 500, the range is 22 points or -1.26% downside to 1277 and +0.45% upside to 1299.

 

 MACRO DATA POINTS:

  • 7:45 a.m.: ICSC weekly sales
  • 8:30 a.m.: Empire Manufacturing, est. 13.00, prior 10.57
  • 9 a.m.: Net long-term TIC Flows, est. $40.0b, prior $27.6b
  • 10 a.m.: NAHB Housing market index, est. 17, prior 16
  • 11 a.m.: Export inspections (grains)
  • 11:30 a.m.: U.S. to see $29b in 3-mo., $28b in 6-mo. bills
  • 5 p.m.: ABC consumer confidence

TODAY’S EARNINGS TO WATCH:

  • Delta Air Lines (DAL) 7:30 a.m., $0.24
  • TD Ameritrade Holding (AMTD) 7:30 a.m., $0.25
  • Fastenal (FAST) 7:50 a.m., $0.45
  • Citigroup (C) 8 a.m., $0.08
  • Forest Laboratories (FRX) 8 a.m., $0.98
  • McMoRan Exploration Co (MMR) 8 a.m., $(0.28)
  • Charles Schwab (SCHW) 8:45 a.m., $0.11 (tentative)
  • Cree (CREE) 4 p.m., $0.58
  • International Business Machines (IBM) 4:08 p.m., $4.08
  • Western Digital (WDC) 4:15 p.m., $0.58
  • Apple (AAPL) 4:30 p.m., $5.39
  • Fulton Financial (FULT) 4:30 a.m., $0.16
  • Linear Technology (LLTC) 5 p.m., $0.58

PERFORMANCE:

  • One day: Dow +0.47%, S&P +0.74%, Nasdaq +0.73%, Russell +0.86%
  • Last Week: Dow +0.96%, S&P +1.71%, Nasdaq 1.93%, Russell +2.51%
  • Year-to-date: Dow +1.81%, S&P +2.83%, Nasdaq +3.86%, Russell +3.05%
  • Sector Performance - (8 sectors positive and 1 flat) - Financials +1.61%, Energy +1.08%, Tech +0.89%, Consumer Discretionary +0.61%, Industrials +0.47%, Utilities +0.41%, Materials +0.23%, Healthcare +0.12% and Consumer Staples (0.00%).

  EQUITY SENTIMENT:

  • ADVANCE/DECLINE LINE: 461 (+732)  
  • VOLUME: NYSE 1059.74 (14.61%)
  • VIX:  15.46 +5.67% YTD PERFORMANCE: -12.90%
  • SPX PUT/CALL RATIO: 1.46 from 1.39 (+4.97%)

CREDIT/ECONOMIC MARKET LOOK:


Treasuries were little changed, but tempered slightly weaker as equities rose

  • TED SPREAD: 15.81
  • 3-MONTH T-BILL YIELD: 0.15%     
  • YIELD CURVE: 2.76 from 2.75

COMMODITY/GROWTH EXPECTATION:

  • CRB: 333.06 +0.02% (last week: +2.82%)  
  • Oil: 91.02 -0.57% - trading +0.56% in the AM (last week: +3.99)
  • Crude Oil Trades Near a 27-Month High After IEA Increases Demand Forecast
  • COPPER: 438.45 -0.62% - trading +1.20% in the AM (last week: +3.02%)
  • Copper rally on supply shortfall
  • GOLD: 1,360.97 +0.14% - trading +0.55% in the AM (last week: -0.65%)
  • Gold Advances as Europe Debt Concern, Price Decline Spur Investor Demand

OTHER COMMODITY NEWS:

  • Food Prices Causing Riots in Africa Stoke Record U.S. Farm Economy Growth
  • Wheat Advances, Corn Reaches 18-Month High on Rising Demand, Lower Stocks
  • Nickel Rises to Eight-Month High on Stronger Chinese Usage; Copper Gains
  • Cocoa Rises After EU Imposes Ivory Coast Sanctions; Sugar, Coffee Advance
  • Hedge-Fund Bets on Costlier Feeder Cattle Increase to Highest Since 2006
  • Soybeans, Palm Oil to Extend Rally on Tight Supply, India's Top Buyer Says
  • Coal Prices Reach Two-Year High as Flooding in Australia Curbs Production
  • Rubber Futures Decline From Record as China May Raise Rates to Cool Prices
  • Mitsui Mining to Cut Zinc Output on Maintenance Shutdown at Top Smelter
  • Coal's China-Australia Discount at 8-Month High on Floods: Energy Markets
  • Gold Sold in Tokyo Vending Machines Competes with Drinks, Sweets, Lingerie
  • Europe Commodity Day Ahead: First Gold Vending Machines Installed in Tokyo

CURRENCIES:

  • EURO: 1.3295 -0.69% - trading +0.90% in the AM
  • DOLLAR: 79.337 +0.22% - trading -0.61% in the AM

EUROPEAN MARKETS:

  • European Markets: FTSE 100: +1.08%; DAX: +0.95%; CAC 40: +0.81% (as of 07:30 ET)
  • European markets opened higher as positive corporate earnings helped sentiment.
  • The periphery remained in focus as European Finance Minister meet today with uncertainty remaining as to whether there will be any agreement to increase the EuroZone rescue fund.
  • Reports Russia may resume buying Spanish debt and a constructive Spanish bill auction lead to indices extending gains, though the UK lagged after disappointing UK inflation data pared gains.
  • All sectors other than healthcare (0.3%) trade higher led by banks +2.6%, media +2.0% and autos +1.6%.

ECONOMICS:

  • UK Dec CPI +3.7% y/y vs consensus +3.3% and prior +3.3%
  • UK Dec RPI +4.8% y/y vs consensus +4.8% and prior 4.7%
  • Germany Jan ZEW Index +15.4 vs consensus +6.8 and prior +4.3 - German Jan ZEW current situation 82.8 vs consensus 83.8 and prior 82.6

ASIAN MARKTES:

  • Asian Markets: Nikkei +0.15%; Hang Seng (0.01%); Shanghai Composite +0.09%
  • Asian stocks were mixed today, as investors waited to see Wall Street’s reaction to Apple (AAPL) CEO Steve Jobs’s taking a medical leave of absence.
  • Australia rose +0.81, with banks and retail stocks finding favor.
  • Japan erased early losses to close slightly higher.
  • China finished flat, with strong earnings from Industrial Bank and China Everbright Bank despite downward pressure resulting from a report that the country has cut banks’ lending targets 10% for the year.
  • Chalco jumped 5% in active trading on forecasting a return to profit for last year, but Hong Kong finished flat. Local property developers extended yesterday’s gains. Hutchison Whampoa fell 2% on announcing a plan to spin off its ports business.
  • Tech stocks advanced, but could not bring South Korea closed down 0.16%
  • Japan revised November industrial output +1.0% m/m, matching preliminary figure. November capacity utilization index +1.6% m/m to 86.7. December department-store sales (1.5%) y/y. Tokyo December department-store sales (0.3%) y/y..

THE HEDGEYE DAILY OUTLOOK - 1 18 2011 8 25 29 AM


MACRO ICEBERGS

This note was originally published at 8am on January 18, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“It's been 84 years, and I can still smell the fresh paint. The china had never been used. The sheets had never been slept in. Titanic was called the Ship of Dreams, and it was. It really was.”
-Old Rose

 

In the quote above from the blockbuster film “Titanic”, an elderly Rose DeWitt Bukater reminisces on the grandeur and splendor of a vessel once described as “unsinkable” – even by God. More deeply, her allusion to the Titanic’s former nickname triggers feelings of grief as she turns to the memories of a lost life that could’ve been so many years ago.

 

Unfortunately global risk managers don’t have the luxury of dwelling on the past like Old Rose here. We must constantly be playing the game in front of us; this week global markets are tuned squarely to Europe’s bond auctions and statement’s from the region’s leaders on its sovereign debt issues as a proxy for market performance.

 

Over the short term we’d expect European markets to continue to make gains on the heels of announcements from China (earlier this month) and Japan (on Tuesday) to buy European bonds and statements from EU Economic and Monetary Commissioner Olli Rehn (yesterday) that EU officials are trying to forge a “comprehensive” plan to contain the sovereign debt crisis and from German Chancellor Angela Merkel who indicated a desire to do “whatever is needed to support the euro.”  Rehn also ruled out debt restructuring for Greece or any other euro-area member state.

 

With this kind of support, it’s no surprise that investors cheered, markets boomed, and the European auctions have found plenty of demand. Yesterday saw substantial outperformance from the peripheral equity markets, with gains from: Spain’s IBEX +5.4%; Greece’s Athex+ 5.0%; Italy’s FTSE +3.8%, as credit markets have improved over the last 3 days.

 

As we head in to earnings season, MACRO seemed to return to the forefront as the high-profile upside driver to global equity prices as concerns over sovereign debt auctions diminish.  The dampened European sovereign contagion concerns fueled a pickup in risk appetite on the back of a better-than-expected Portuguese bond auction yesterday and Spain’s auction today.  This is leading to outsized gains in the financials around the world.

 

Yesterday in the US, financials extended their 2011 outperformance with the leadership coming from the banking sector, with the BKX +1.5% and the broader XLF up 1.7%.  Despite disappointing Machinery orders out of the Japan, the Japanese megabanks followed their American peers higher, leading Japan to +0.73%.  Like in the US, the potential for increased dividends is driving equity prices higher as both Sumitomo Trust & Banking and Chuo Mitsui Trust Holdings rose 5% overnight on the potential of higher dividends. 

 

Macro Icebergs

 

As we’ve seen throughout market history, it’s typically when everyone is expecting smooth sailing ahead that certain “icebergs” tend to derail things. If we’ve learned anything from the movie “Titanic”, it’s that hubris about our top ideas (the ship) and a disregard for risk (not having enough lifeboats on board) can get us into trouble.

 

Certainly a few Macro Icebergs are scattered across our domestic waters. How we navigate them individually will be the key to getting paid in 2011; currently, the collective is “full speed ahead”.

 

Below we’ll highlight one of the largest Macro Icebergs that a) has the potential to capsize our ship; and b) is out of consensus – at least for now:

 

Municipal Debt Dichotomy

 

Yesterday we published an intraday report titled: “The Municipal Bond Market: Silent But Deadly” (email sales@hedgeye.com if you want to see our work on muni bonds). In it, we took a deep dive at the headwinds affecting this sector of our financial markets and the systemic risk therein. The key takeaways from the article were:

  • Fiscal austerity at the State and Federal Government level and a strong political will in D.C. to avoid bailing out States and municipalities will perpetuate budget woes at the municipal level (together, State and Federal support account for ~34% of municipal budgets);
  • Local governments are running out of room with their accounting “tricks” and are staring at potentially 2-5 years of declining property tax receipts, which are ~26% of their budget;
  • Calls for State defaults are overblown; the real issues lie within the municipalities and municipal authorities across the nation; the States that have the most severe fiscal issues will see a disproportionate number of their municipalities go bust (though bankruptcy is not permitted in 23 States, defaulting on payments to vendors and creditors will be the more likely outcome in many cases); and
  • The equity markets are misinterpreting the recent back up in yields as “growth” and not “risk” and this risk isn’t going away any time soon.

While still largely ignored by consensus, it was certainly interesting to see some big names in our industry come out on both sides of this debate yesterday:

 

PIMCO’s Bill Gross: “Ultimately, municipal bankruptcies will be at a lower level. I don’t subscribe to the theory that there will be lots of them.” 

 

JPMorgan’s Jamie Diamond: “There have been six or seven municipal bankruptcies already. I think unfortunately you will see more… If you are an investor in municipals you should be very, very careful.”

 

“Smooth Sailing Ahead” vs. “Icebergs A’Cometh”.

 

We certainly aren’t crying wolf for the sake of attention like some analysts with ulterior motives. We don’t do ratings, banking, trading or manage assets; we only get paid for being right. Considering that we’re still in business after three of the most volatile years in the history of financial markets, we’ve been blessed to be more right than wrong over this duration.

 

For the sake of our economy (yes we are patriots), we hope we are not right on this one. The last thing America needs right now is another financial crisis on its hands perpetuated by blow-ups in the $2.9 trillion dollar muni bond market and Housing Headwinds Part II (not mentioned here; email us for more details). Unfortunately, hope is not an investment process. That’s why we’ll continue to help you navigate these murky waters as Global risk managers.

 

We’ll discuss these risks and how to play them on the long and short side on our Q1 Quarterly Themes Conference Call tomorrow at 1:00pm. Qualified prospective institutional subscribers please email sales@hedgeye.com for more details.

 

Keep your head on a swivel.

 

Howard Penney

Managing Director

 

Matthew Hedrick

Analyst

 

Darius Dale

Analyst

 

MACRO ICEBERGS - MUNI



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