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Top Emerging Market Short Ideas: Indian Equities

Conclusion: If you agree with our October call that EM assets will come under pressure and remain that way over the intermediate-term TREND, then you’re likely looking for short ideas. If so, we think Indian equities are among the top short ideas in this space, supported by the fundamental backdrop of slowing growth, accelerating inflation and interconnected risk compounding.


Position: Bearish on Indian equities and bonds.


When we last published on India (1/6 note titled: “India’s Two-Factor Squeeze”), we highlighted a two-pronged setup that leads us to be bearish on Indian equities: slowing growth and accelerating inflation. Over the last 48 hours, rhetorical, economic and price data are all contributing to that “squeeze” getting tighter.


India’s central bank, led by Governor Duvvuri Subbarao, hiked its benchmark interest rates by +25bps yesterday, increasing the Repo Rate to 6.5% and upping the Reverse Repo Rate to 5.5%. This is the first rate hike since their self-imposed moratorium starting in November.


Top Emerging Market Short Ideas: Indian Equities - 1


Despite inflation running twice the pace of the government’s target, the Reserve Bank of India (RBI) elected to purchase government securities from banks to ease a domestic liquidity shortage. Money Supply (M3) growth, though up sequentially in December and off its summer lows, remains near a five-year low. Moreover, the India National Stock Exchange Interbank Offer Rate, a measure of liquidity via interbank funding availability, averaged a full +90bps higher in 4Q10 vs. 3Q10. Relative to the 1H10, the rate averaged a full +250bps higher.


Top Emerging Market Short Ideas: Indian Equities - 2


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The cash crunch was facilitated by an elongated trend of credit growth far outpacing deposit growth, as Indian citizens elected to protect their capital from inflation by shunning bank deposits. In 2010, loan expansion (+24.4% YoY) outpaced deposit expansion (+16.5% YoY) by 790bps!


Despite this demand-side inflationary pressure, the RBI felt it both prudent and necessary to help ease the cash crunch by repurchasing government bonds on the open market and stepping up its reverse repo operations. All told, Indian banks borrowed an average of 1.2T rupees per day in December, up from 854.8B in November. January is off to a hot start as well, with lenders borrowing an average of 909.4B rupees per day from the central bank in an effort to maintain the pace of credit expansion amid weak deposit growth.


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The aforementioned inflationary pressure has become such an issue in India, we’re even starting to see bankers and asset managers (people who get paid on inflation) come out against the RBI’s Quantitative Guessing scheme:


“For the time being, inflation takes the driver’s seat… I think the time has come to stop repurchases, as it is inflationary” – Manoj Swain, CEO at Morgan Stanley India


“Inflation is becoming an increasingly huge worry at this point in time and the RBI will need to do a major part of the firefighting in containing inflation… The monetary policy needs to be much tighter than it is now, given the building up of inflationary pressures.” – Sonal Varma, Economist at HSBC Holdings Plc.


“The RBI shouldn’t do anything more to add cash to the system… There was some logic for doing it earlier because the liquidity deficit had gotten excessive, but at that time inflation looked like it was moderating.” – Prasanna Ananthasubramaniam, Chief Economist at ICICI Securities


Unfortunately, this marginal backlash leaves the RBI between a rock and a hard place. If they continue the repurchases, they risk inflation getting out of control – even more so than it already is at ~400bps higher than the target (+8.4% YoY in Dec).  Should they elect to stop the repurchases, they risk exacerbating government borrowing costs, as Indian banks, the largest buyers of Indian sovereign debt, don’t have the excess cash to make purchases right now. In fact, Indian lenders sold 288.3B rupees ($6.4B) of Indian sovereign debt last quarter – the highest sales rate since 4Q05!


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The recent backup in yields hurts the central government’s efforts to narrow its budget deficit to 5.5% of GDP by the end of FY11 (March 31), after a near doubling in three-year’s time. Currently, interest payments alone consume almost one-fifth of government expenditures. That leaves little else for developing India’s woeful infrastructure after 10% is spent on food and fertilizer subsidies, 14% on defense and an additional 25% is divvied up amongst Indian States.


One area India can look to for cost savings is the subsidies it is currently paying to hold down the prices of certain foodstuffs and fertilizers. RBI governor Subbarao is calling for the central government to remove the subsidies and allow the prices to appreciate in an effort to reduce the demand-side inflationary pressure. This morning, he reiterated his call for fiscal conservatism, saying, “Monetary policy works most efficiently while dealing with an inflationary situation when the fiscal situation is under control”.


Unfortunately, fighting inflation with more inflation doesn’t work in a country where nearly 828 million people live on less than $2 per day.


Luckily for India’s citizenry, Prime Minster Manmohan Signh is learning from the mistakes of Tunisian and Egyptian politicians and is getting marginally serious about fighting inflation, as evidence by his recent cabinet reshuffle. In the move, he appointed K.V. Thomas to head the Ministrity for Food and Consumer Affairs, a position formerly held by now-departed Agriculture Minister Sharad Pawar. Facing elections in five States over the next five months, Singh’s coalition government cannot afford to lose the ~40-42 seats predicted by a recent poll published by the India Today news magazine.


Still, the move to put in place someone who’ll be directly responsible for reeling in India’s inflation rate may be more of an empty scapegoat than it appears. Keep in mind that the Food & Beverage component of India’s benchmark Wholesale Price Index is only 14%, one of the lowest in the world by our calculations/estimates. Given that, we’ll continue to take the other side of Governor Subbarao’s claims that inflation is currently being driven by “excessive food price increases, which look to subside in coming months”.


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Even Subbarao himself is backtracking on this stance, saying recently, “The rise in food inflation in India has not only persisted for more than two years now, the increase has been rather sharp in the recent period. This cannot but have some spillover effects on generalized inflation.”


Indeed it does; recent examples of the spillover effects from higher input costs include Hero Honda Motors Ltd. (the producer of roughly half the motorcycles sold in India) recent plans to raise wages. Godrej Consumer Products Ltd. (the second-largest producer of bath soap in India) plans to increase prices for the third time in three months, citing “reduced profits from higher input costs”.


Tactical Setup


Many equity investors cheer on inflation, particularly in economies with growth profiles as robust as India’s, as rising input costs can be passed through to consumers. By all means, India had an excellent year in 2010, growing at an average +8.85 YoY rate in the three quarters through 3Q10. An easy comp in 4Q suggests that growth rate could potentially be higher when it’s all said and done:


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The problem with that is that it’s in the rear view. Many investors, particularly emerging market portfolio managers point to lagging growth data points as justification for their long positions. Given, you need a go-forward outlook to be short India here and our call is for growth to top out in 4Q10. While we’re not calling for a significant draw-down in Indian growth, we do think the confluence of tough comps, accelerating inflation, tighter monetary policy and a general erosion of financial liquidity could cause Indian GDP growth to slow sequentially by a full (-100bps) in 1H11.


Since 11/9, when we called out the aforementioned setup and turned bearish on Indian equities in a note titled “India’s Two Big Problems”, India’s SENSEX Index has declined  (-9.4%). Further, the index is the second-worst performing global equity market (down (-7.5%) YTD), so one would assume much of the juice has been squeezed already.


Not so fast. India’s SENSEX’s long-term TAIL line of support lies some (-2.4%) below at 18,511. Should we choose to get involved, we’d likely wait for a rally up to the immediate-term TRADE line of resistance at 19,462. There’s more resistance to be found at the intermediate-term TREND line of 19,991. Shorting there would be most ideal.


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Analyzing India from a global risk management lens, we see that the US dollar remains comfortably broken, trading below its intermediate-term TREND line of $78.66 for nearly three weeks on weak promises of austerity and an upward surprise to the US federal budget deficit.  While the inverse correlations between the DXY and many commodities have come down in recent months, we do anticipate them to pick up should the dollar exhibit further weakness from here. Such an event would exacerbate India’s already “desperate” inflation situation (as termed by Subbarao himself).


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Make no mistake about it, India has a major inflation problem, and, as we’ve seen time and time again throughout the history of emerging markets, inflationary spells are typically a much larger headwind than initially predicted. Indian officials are aware of this, subtlety ratcheting up their inflation expectations over the last few months. Their target for YoY WPI growth by March 2011 has increased from +5% in early 4Q10, to 6% on December 14th, to 6.5% in early January, to 7% yesterday. A +200bps jump in inflation expectations over a ~3-month period is certainly cause for alarm.


The alarm bells have been met with foreign investor redemptions, pulling $1B from Indian stocks over the last three weeks. If such redemptions were to mean revert to flat on a two-year basis, there’s $28B more redemptions waiting to be accounted for in 2011. Keep in mind that the 2008-09 crash of the SENSEX was predicated by just $14.8B in foreign investor redemptions in 2008.


While we’re not calling for a crash right here and now, we do think Indian equities will continue to experience further downside in the face of slowing growth, accelerating inflation and interconnected risk compounding.


Darius Dale


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R3: M, H&M, SKX, FitFlops


January 26, 2010





  • Check out Macy’s promotion at its Herald Square flagship which puts a live human comedian with a habit of sleepwalking in one of the company’s streetside storefronts.  The pr stunt is a collaboration between Downy and Macy’s aimed at promoting Macy’s bedding and Downy’s fabric softener.  The sleepover begins toay.
  • After a home-run collaboration with Lanvin, H&M is following up the collection with a line called “Waste”.  The extremely limited distribution, 10 piece line will be constructed entirely of leftover fabric scraps from the Lanvin production.  Unfortunately for fashionistas, the collection will only be available in one store in the US (5th Ave), which suggests there wasn’t enough “waste” to produce a larger run.
  • With Skecher’s expecting to drive a resurgence in toning momentum via its Kim Kardashian Superbowl commercial, we hope the game remains close. As it stands now, the company’s spot is slated to air after the two-minute warning in the fourth quarter.  If the game were to be a blowout, it’s fair to say the 100 million expected viewership may dwindle measurably by the final minutes.
  • It was only a matter of time until a company or brand stepped up to give Michael Vick a second chance. Unequal Technologies – a maker of shock-blocking material used in football pads amongst other products – has done just that announcing a 2-year endorsement contract. After wearing the company’s technology following a rib-injury in the playoffs, Vick is a great fit offering the company battle tested credibility. While we don’t expect the endorsement offers to come pouring in, don’t be surprised to see other small brands/companies start taking shots with one of the game’s more dynamic players.



Bloomingdale's Gives Handbags a Makeover - Bloomingdale’s has swept away the confusion and congestion that greeted customers entering its 59th Street flagship in Manhattan with a sophisticated venue for designer handbags and leather goods. The project, a 12,500-square-foot space on the Lexington Avenue side of the store, calls out European and American labels with individual shops bearing the brand’s signature touches. It also takes a top-selling business to a new level. “Designer handbags and our fine leather business was one of our strongest categories all last year, along with fine jewelry,” Michael Gould, Bloomingdale’s chairman and chief executive officer, told WWD. “We feel good about it. We keep on pushing.” <WWD>

Hedgeye Retail’s Take:   If you haven’t been to the Bloomies flagship in a while, it’s worth a visit.  This is what a modern era department store should look like with proper reinvestment over time.


Macys.com makes free shipping standard - To sum up Macy’s new attitude toward free shipping: To beat ‘em, join ‘em. Macy’s Inc. will begin shipping all online orders at Macys.com of $99 or more for free tomorrow. Most orders that fall below that threshold will be shipped for an $8 flat fee, the company says. The new free and reduced rate shipping options from Macy’s is the latest in a series of initiatives from big online and multichannel retailers to match the success of Amazon Prime, which charges subscribers a $79 annual fee for free standard shipping on all purchases made directly from Amazon.com. <InternetRetailer>

Hedgeye Retail’s Take:  It appears that free shipping is here to stay following a holiday period which was highly dependent on such a strategy.  Good for the consumer, for sure.


Ron Burkle Trims American Apparel Stake - Financier Ronald Burkle is backing away from the embattled American Apparel Inc. Burkle sold off 909,500 shares of American Apparel for $1.4 million this month, leaving him with 3.4 million shares, or 4.3 percent of those outstanding, according to a filing with the Securities and Exchange Commission Tuesday. The investor paid $5.9 million for a 6 percent stake in the company in June. So far, Burkle’s managed to make a return on his investment — having paid an average price of $1.38 a share to build the stake and selling shares at an average price of $1.55. Based on those averages, his profit on the shares just sold would be just under $155,000. <WWD>

Hedgeye Retail’s Take: Even in its fragile state, American Apparel still manages to make it into the news.  Clearly not the “turnaround” Burkle was banking on.


Coty Inc. Gets Funding from Investors - Coty Inc. may be moving plans for an initial public offering to the front burner again. Speculation about a possible IPO by the beauty firm whirled Tuesday in light of a cash infusion made into the company by two private equity firms. Berkshire Partners, based in Boston, and Rhône, which has offices in New York, London and Paris, made minority equity investments in the $3.6 billion Coty. Each of the investors will be represented on its board. Details of the transaction were not disclosed. <WWD>

Hedgeye Retail’s Take:   One to watch for sure, with a portfolio that includes the holy grail of fragrance, Calvin Klein. 


Retail Theft a Growing Issue - The cost of retail crime has skyrocketed. That’s because studies on and the reporting of retail crime have been extremely segmented. Retail loss prevention and law enforcement experts believe that if taken together, the figure would be more than $60 billion. For example, a $33.5 billion figure cited in the 2009 National Retail Security Survey from the University of Florida refers only to shrinkage, the industry term for internal theft that includes shoplifting and accounting errors. Organized retail crime involving stolen property transported across state lines accounts for $30 billion in annual losses, according to the FBI’s Web site. Neither report takes account of check kiting and credit card or gift card fraud. <WWD>

Hedgeye Retail’s Take:  So is it growing or is just being measured more effectively?  Either way, a tough economy is usually grounds for an uptick in theft.  Clearly still a huge opportunity to recoup even a small part of the $60 billion walking out of retailers each.


FitFlop Appoints CEO - FitFlop, the rocker-bottom sandal company, has appointed Suzie de Rohan Willner as chief executive officer. She was formerly director of global merchandising retail and head of international headquarters in London for Puma. She has also previously worked at Timberland, Dockers and Levi Strauss. Rohan Willner will be based at FitFlop's London headquarters. Founder and Creative Director Marcia Kilgore announced the appointment, effective immediately, late last week. The CEO is a new position for the company. <SportsOneSource>

Hedgeye Retail’s Take:  This may be the first company we’ve seen with the “CEO” position being described as a new one.  Either way, Fit Flop continues to sit on the fringe of the toning category and has yet to make a dent in the share held by Skechers and Reebok despite having an early lead.


Consumer Confidence Rises in January - Consumers began the year in an upbeat mood, sending the Conference Board’s Consumer Confidence Index up 7.3 points to 60.6, its best mark in eight months. Both components of the Index also saw gains, with the Present Situation Index rising to 31 from 24.9 last month and the Expectations Index increasing to 80.3 from 72.3. The overall figure and Expectations numbers were the highest since May, when they stood at 62.7 and 84.6, respectively, and the Present Situation measure the highest since the 42.3 registered in November 2008, two months after the financial meltdown.

Pasted from <WWD>

Hedgeye Retail’s Take: Certainly a notable positive in aggregate, but keep in mind that ICSC chain store sales reported a third straight decline down 1.2% suggesting that consumer demand is mixed at best.


Social Network Users Are Satisfied with Privacy Options - Facebook is as well known for its privacy flubs as for its massive user base, and it’s not the only social media site with this problem. But research suggests that users may be OK with how privacy works on social networks and feel comfortable dealing with the problem themselves, by using the sites’ privacy settings. Harris Interactive found in a December 2010 survey of US social media users that nearly four in five (78%) believed they could prevent “potentially negative experiences” dealing with social media activity by using their privacy settings. <eMarketer>

Hedgeye Retail’s Take: I’m surprised how many users are this positive when it comes to controlling their own privacy online – it comes down to what information is offered in one’s profile. In this case, the adage of ‘less is better’ certainly applies.


R3: M, H&M, SKX, FitFlops - R3 1 26 11



Athletic Apparel Sales Reaccelerate

Underlying trends for athletic apparel remain strong with sales reaccelerating after a meaningful slowdown last week. The rebound was less significant than we had expected, however given unprecedented weather disruptions year-to-date, the reacceleration should be viewed positively on the margin. In looking at the regional trends in greater detail, there was a notable divergence between sales in western regions (Pacific and Mountain) compared to reaccelerating trends across all other regions – particularly the South Atlantic and South Central. While the national weather data suggests more precipitation out west than average last week, we suspect year-over-year comparisons to be the cause for underperformance.  


Lastly, given disruptions over the last few weeks we expect to see continued acceleration in sales next week. With the final two weeks of the retail calendar accounting for 40%-50% more sales volume compared to the 1H of the month, January’s monthly performance will fall largely on the shoulders of next weeks’ results.


Athletic Apparel Sales Reaccelerate - FW App App Table 1 26 11


Athletic Apparel Sales Reaccelerate - FW App Reg 1 26 11


Athletic Apparel Sales Reaccelerate - Weather 1 26 11


Casey Flavin


Notable news items/price action over the past twenty-four hours.

  • Despite the continuous upward trend in wheat prices, PNRA and BAGL gained on strong volume.
  • PZZA and DPZ are up despite cheese prices gaining 8.2% week-over-week
  • GMCR declined on accelerating volume.  SBUX wants K-Cups’ 70% share of the instant coffee market.
  • A HedgeyeEdge favorite, EAT, surged 11.3% on accelerating volume after investor confidence in the turnaround story grew.
  • Other casual dining names gained on the solid results from EAT. CAKE, DIN, TXRH, BWLD and CPKI all saw a gain in share prices.  I find that interesting given that we know, via Malcolm Knapp’s casual dining sales data, that casual dining sequentially slowed during 4Q10.
  • MCD share price ticked up slightly on the day with weak volume.
  • MCD has announced that it will accept contactless payment at its 1,200 restaurants throughout the UK, making it one of the first tier-one merchants to implement the technology in the country.
  • According to adage.com, the most “checked-in” merchant last week was Starbucks with 151,000 last week, followed by McDonald's with 51,000, according to Foursquare check-in data.




Howard Penney

Managing Director

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