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Munis: Another Short Selling Opportunity

POSITION: Short MUB

 

If it doesn’t make you laugh, it will make you cry – but the sell-side’s probability of defending anything that starts to go down these days is as predictable as, well, US Municipalities and States running deficits. Sadly, very few risk management lessons from the 2007 MBS market seem to have been learned. And yes, there was another side to the Bush Tax cut trade!

 

We’re on the transparency/accountability tape getting bearish on Munis on February 24th, 2010 in a note we titled “Domestic Pigs.” We’re also currently on the tape with a short position in MUB in the Hedgeye Portfolio. It’s not a position we intend on covering down here because “munis are cheap.” If you’re already long them, we know why you are bullish on “cheap”. If you aren’t short them, we know why you aren’t Bearish Enough.

 

Barron’s Randall Forsyth wrote an article this weekend titled “Yields Soar on Overpunished Munis”, and I can’t help myself but to highlight a few of his lowlight reasons to be bellying up to opacity’s next sketch bar. 

  1. “Last week saw wholesale selling”
  2. “A technical situation caused by heavy liquidations”
  3. “Smart managers are buying munis, not the hysteria” 

First of all, he actually did the outflow math ($16.5B out of open-end muni funds in the last 9 weeks over a base of a $2.8T market), but failed to acknowledge that this means this selling party has barely started. This is not “wholesale” selling yet. This is not “heavy” liquidation either. This is simply the beginning.

 

It’s also the first born problem child of The Ber-nank’s 3D Risks that are associated with keeping US interest rates unsustainably low.

 

As a refresher – what the Fed staying at ground ZERO percent means in terms of 3D Risk is: 

  1. Dares investors to chase “yield” (including munis)
  2. Disguises financial risk (what will municipalities do when borrowing costs go Greek?)
  3. Delays financial restructuring 

How many of America’s Domestic Pig governments need to be restructured? What’s a revenue bond worth if the municipality can’t generate its required tax revenues? What do rising bond yields tell risk managers about default risk?

 

These are simple risk management questions that should be answered by risk managers before we let an 8th grader hit <bond yield go> on a Bloomberg terminal and analytically deduce a bond is “cheap” when it’s yield is higher than another.

 

Our refreshed TRADE and TREND lines of resistance for MUB are outlined in the chart below.

KM 

 

Keith R. McCullough
Chief Executive Officer

 

Munis: Another Short Selling Opportunity - 1


Asian Trade Data Exposes Facade of US Growth

Conclusion: The slowdowns we are seeing across Asia’s trade-heavy economies continue to flash bearish signals as it relates to the direction and amplitude of global growth.

 

Position: Short US equities via the etf SPY.

 

This morning, we saw some more negative economic data points out of Asia. Signs of a regional economic slowdown, which have largely been ignored by US investors for much of the last two months, are highlighted today by Thailand’s December trade data. Thailand’s YoY Export growth slowed sequentially by (-970bps) and YoY Import growth slowed sequentially as well, falling (-2,380bps). On the prospects of an economic slowdown, Thailand’s Commerce Minister, Porntiva Nakasai, affirmed today what we at Hedgeye have been saying since November:

 

“It is hard to replicate last year’s exceptional growth. China’s economy, which is the main growth driver in the region, is slowing, while Europe is still having financial problems.” 

 

Asian Trade Data Exposes Facade of US Growth - 1

 

Thailand’s share of world exports are roughly ~2.6x its share of global GDP, so Thailand could potentially be used as a proxy for the health of global trade. On a standalone basis, however, Thailand isn’t responsible for moving the needle on global growth or international trade. Considering, we’ve compiled an aggregated, weighted index of Asian trade data that does serve as a good proxy for the direction of global demand.

 

Asian Trade Data Exposes Facade of US Growth - 2

 

Asian Trade Data Exposes Facade of US Growth - 3

 

Further, upon considering that these ten economies’ share of global exports is nearly 25% larger than 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 in the three quarters through 3Q10, so a slowdown across Asia may be a stealth leading indicator for inventory adjustments being a drag on U.S. GDP growth in 2011.

 

Asian Trade Data Exposes Facade of US Growth - 4

 

In simple terms, consumption accounts for ~65-70% of the US economy and if factories in China and across Asia aren’t pumping out and shipping the apparel, harware, etc. that we buy with the same velocity, it means we aren’t buying it with the same velocity either. This leads to a building up of inventory and reduced demand for restocking domestically.

 

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 slowdowns we are seeing across Asia’s trade-heavy economies continue to flash bearish signals as it relates to global growth. Given the recent run-up in US equities, we feel most of the opportunities for alpha will be found on the short side throughout the next 3-6 months, as growth bulls are awoken by the pungent stench of global economic fundamentals.

 

Darius Dale

Analyst


Europe’s Smorgasbord

Position: Long Germany (EWG); Short Italy (EWI) and Euro (FXE)

 

As two days of EU meetings conclude in Brussels today it appears that nothing definitive was decided on by the 27 ministers short of renewed discussions following last week’s rumors that the region’s bailout fund could be increased, possibly from €750 billion to €1 Trillion. While the Germans continue to flip-flop on the issue (depending on who you talk to) our bet is that if the funding were to increase (very likely) you'd see a pot far greater than €1 Trillion to meet the peripheral debts, especially the bigger exposures of Italy and Spain.

 

In any event, all eyes are turned to bond auctions again this week. On a bullish note, Spain sold €4.5 Billion of 12 month bills at 2.947% today, versus 3.449% on December 14th. 

 

Tomorrow:  Portugal issues short term bills

Thursday: Spain issues long term debt maturing in 2020 and 2024, a critical gauge for investor demand and yield premium offered

 

Rumors flew around today that Russia could buy European bonds, following commitments from China and Japan earlier this month.  While Russia has impressive FX and gold reserves (3rd largest in the world at $480.7 Billion), given the economic and political instability in Russia we think this rumor could be off base. Yet over the near term the rumor (like the increased funding talks in Brussels) offers another support mechanism for European equities and the EUR. 

 

In contrast, the credit markets of the PIIGS + Belgium have seen little arrest with yields continuing to rise since last Friday (see chart). Of note is that Portugal's 10YR yield is now above 7%, a level that proved an important upward momentum line for both Greece and Ireland.

 

Europe’s Smorgasbord - t1

 

Below we give our levels for the EUR-USD.  We’d be short the EUR-USD with impunity at $1.35, its intermediate term TREND level of resistance.

 

Europe’s Smorgasbord - t2

 

 

UK Inflation Punctuating

 

UK CPI registered 3.7% in December year-over-year, versus the previous month of +3.3%.  We’ve been hitting on the risk of rising inflation in the UK for months, however with this huge jump in December there’s even more pressure on the BOE to act.  Gains came from food and fuel prices and statements out of PM Cameron today suggest just how mainstream the inflation issue has become:

 

“I tend to be a ‘now man’ because we’ve had constant reassurances that inflation will fall and it hasn’t fallen… I’d rather see them start moving up gradually than go up in a huge jump, perhaps in the autumn.”

 

Europe’s Smorgasbord - t3

 

Considering that we’ll likely see more inflation pressure in January given that VAT was increased from 17.5% to 20% into the new year, we believe the BOE will have to bite the bullet over the next few months and raise rates (despite the threat of further choking off growth) to contain inflation. 

 

A rate hike should bolster the Pound versus major currencies. As the chart below shows, and given that we think the BOE will raise rates before the ECB, we like the GBP versus the USD above its intermediate term TREND line of $1.57, which it has currently broken through.

 

Europe’s Smorgasbord - t4

 

 

German ZEW Gains

 

Germany continues to impressive regarding the majority of the fundamentals we track.  The chart below of the ZEW economic survey shows a significant gain in the Economic Sentiment survey, from 4.3 in December to 15.4 in January, with a more mild gain in the Current Situation, from 82.6 in December to 82.8 in January. (We’ve noticed that Economic Sentiment has been a much more predictive gauge than Current Situation).

 

We continue to like Germany as the sovereign debt dichotomy plays out in Europe. We're currently long Germany via the etf EWG in the Hedgeye Virtual Portfolio

 

Matthew Hedrick

Analyst

 

Europe’s Smorgasbord - t5


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IGT IN-LINE QUARTER SHOULDN’T BE THE FOCUS

The only story surrounding earnings is that they shouldn’t be an issue.

 

 

IGT is scheduled to kick off the earnings season for us next week when they report F1Q11 earnings next Thursday after close.  We don’t expect many surprises on the call and our estimate is in-line with consensus at $0.20.  The near and long-term story will be driven by the main themes of re-acceleration of replacement demand and new domestic and international markets – near-term headlines and long-term actual earnings contribution. 

 

There are other areas of interest that should be addressed on the call:

 

Top line

1. Replacement Cycle… when will things pick up?

2. Gaming Operations… can they really grow?

3. How much juice is there in the international business?

4. Will systems get a lift from SbX? We’re waiting for the killer applications.

5. Online and mobile applications… when will it become material?

 

Bottom line

6. ROI – better return on capital deployment - consolidating platforms or allocation of R&D dollars,  all of which should yield better cash flow

7. Will they take out the convert which would add over a dime in EPS?

8. Quantify the benefit from the reinstated R&D tax credit

9. Accelerated depreciation rules that recently passed should result in a decrease in deferred tax liability and provide a benefit to working capital

a. 50% retroactive to [mid-2010]

b. 100% retroactive to [September 2010]


Details on FQ1:


We are projecting revenues of $502MM and EPS of $0.20 when they report on F1Q11 results on Jan 20th. 

 

We estimate that IGT will report $237MM of product sales at 51% gross margins

  • Domestic product revenues of $134MM and gross margin of $69MM (51%)
    • Domestic box sales of $77.5MM: 5k domestic unit sales--comprised of 2,700 replacements and 2,300 new units at an ASP of $15.5k
      • December is usually and should be a better quarter for replacements for the industry since it’s the G2E quarter and many buyers must either use or lose their budgets.  However, this is usually not the case for IGT, given that their fiscal year ends in September.
      • New units should include: Cosmo units – roughly 750 units; Perryville units which were subject to a 90 day acceptance clause - ~600 units; at least part of the shipments to Gun Lake
    • ASP’s should be higher than the last few quarters with the expiration of the Dynamix promotion
    • Domestic non-box sales of $57MM, up 10% YoY
  • International product sales of $103MM and gross margin of $51MM (51%)
    • $77MM of box sales: 6.3k international unit sales at an ASP of $12.2k
    • Non-box sales of $26MM
  • Gaming operations revenue of $265MM at 59% gross margins
    • We expect the install base to stay constant from last quarter at 57k units and we expect average win per day to be $50.5

Other assumptions:

  • SG&A of $87MM
  • D&A: $20MM
  • R&D: $49MM
  • Net interest expense: $21MM
  • Tax rate: 37% (lower than guidance due to the reinstatement of the R&D tax credit)

KNAPP TRACK: CASUAL DINING IN DECEMBER

Conclusion: Knapp Track comparable restaurant sales trends in December indicate that the casual dining recovery has slowed down somewhat.  For the wider casual dining space, the fragility of the underlying economy warrants caution.

 

Knapp Track preliminary results for December suggest that the casual dining recovery seen in the third quarter has slowed over the past couple of months.  December comparable restaurant sales of -0.8% signifies the first year-over-year decline in results since June.  On a two year basis, comparable restaurant sales sequentially declined by 55 basis points.  Adjusting for bad weather, December's comparable restaurant sales number would have been +0.2%, which would imply a 5 basis point decline in two-year average trends excluding the impact of weather. Q410 saw a sequential slowdown in comparable restaurant sales to +0.5% from +0.8% in 3Q10.  On a two-year average basis, however, quarterly comparable restaurant sales trends accelerated by almost 90 basis points.

 

Comparable guest counts in the casual dining space saw a sequential decline from a revised -1.6% result in November, according to the most recent Knapp Track report.  December’s preliminary decline of -2.9% shows that the “recovery” is far from secure, especially as companies look to pare back their use of discounting as a driver of traffic.  On a two-year basis, December’s result implies a sequential deceleration of 95 basis points. 

 

In this month’s report, Malcolm Knapp highlighted several interesting factors that he believes are key to consumer behavior.  Firstly, the effects of the financial crisis persist with mortgage defaults and high levels of unemployment burdening attitudes.  Another interesting point is that increases in consumer confidence are consistently due to a view that “things will be better in 6 months” from the date of the report.  Expectations have dramatically outperformed current views. 

 

Howard Penney

Managing Director


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.

 


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