Japan: Land of the Setting Sun

Conclusion: From a secular perspective, Japan’s economy continues to implode. The acceleration of that implosion towards the Keynesian endgame is arguably the largest TAIL risk to the global economy.


Position: Bearish on Japanese Equities; Bearish on the Japanese yen; Bullish on Japanese CDS.


This morning, Standard & Poor’s came out with yet another lagging downgrade that seems to have caught the US financial media’s attention. By cutting Japan’s credit rating to AA-, Standard & Poor’s reminded us all what we already knew:


Japan’s economy is imploding in slow motion. Slowly, but surely, Japan is reaching the Keynesian endgame.


For the sake of not making too much of a deal about a late downgrade, we’ll spare you with the details on why we feel this way. Please refer to our 4Q10 Key Macro Theme of Japan’s Jugular for the work behind our implicit downgrade of Japan’s credit, currency and equity market. The presentation, originally published on October 5th, can be accessed here:


Replay Podcast (starts around 9th minute):

[To access the podcast, you may have to copy/paste the link into the URL of your browser.]

Slides (12-34):


Two alarming datapoints that hit our screens over the past couple of weeks were Japan’s widening central government budget deficit and subsequent burgeoning debt issuance. According to the Japan’s Finance Ministry, Japan’s budget deficit is forecast to grow to ¥51.8 trillion yen (~$630B) in FY13 and ¥54.2 trillion yen (~$660) in FY14. [For reference, FY13 starts April 1, 2012.]


When put into the context of a ratio, Japan could be running a PIIGS-like ~11%-12% deficit to GDP in a little over a year. Looking closer to this upcoming fiscal year, which begins on April 1st, Japan’s relentless acceleration in deficit spending has Japan’s Finance Ministry upping its projected debt burden +5.8% YoY to 997.7 trillion yen, or roughly 215-220% of GDP.


Japan bulls point to the fact 90% of Japanese government debt is financed through its domestic population of savers, making it less likely to experience a dangerous back up in yields or default. As we’ve shown in the aforementioned presentation, that tailwind is rotating on the margin towards becoming a headwind as a result of unfavorable demographics. We saw signs of this trend starting last year, with Japan’s largest pension funds selling assets and joining the global search for yield to meet payout obligations.


This will only accelerate over the next 20-30 years, with the next ten likely being a real wake up call for global investors. Currently, the ratio of retirees to working-age Japanese is equal to 35.5%. In just ten years time, that ratio will be equal to 48%. In a society notorious for luxurious pension packages, going from a 3-to-1 base in potential contributors to a near 2-to-1 base in a matter of just ten years means the domestic demand for JGBs bulls consistently refer to will decline by nearly 1/3rd.


All told, we foresee a major supply/demand imbalance for Japanese government debt and, in our opinion, this imbalance is one of the largest long-term TAIL risks to the global economy. But don’t take our word for it:


“The financial state of our nation is becoming increasingly severe. Fiscal management that depends excessively on bond issuance is becoming too difficult.” – Japan’s Finance Minister Yoshihiko Noda, January 24, 2011


 “The government must fix its finances to avoid a debt crisis that could trigger a global depression.” – Japan’s Vice Finance Minister Fumihiko Igarashi, January 2011


Obviously, we think it pays to pay attention here.


Darius Dale



Japan: Land of the Setting Sun - 1

Playing Europe’s Mismatch on Duration

Position: Short Italy (EWI); Short Euro (FXE)


Conclusion: Our current short positions in the Hedgeye Virtual Portfolio of Italy via the etf (EWI) and the Euro (FXE) are working against us as Europe gets a confidence boost from Asian debt demand, positive speculation on a future bailout package for the region, and increased sentiment from ECB President Trichet to fight inflation (ie raise rates) which is supportive for the common currency.


We see this development potentially continuing to play out in the immediate-term, however over the intermediate-term TREND our negative outlook on Europe, especially for the countries with high fiscal imbalances (Italy, Spain, and Portugal), remains intact; the credit market and recent fundaments provide supporting evidence. Our TRADE (3 weeks or less) range on the EUR-USD of $1.35-$1.37.


Don’t Fight these Forces, Near-Term


As an update on our recent work on Europe, it’s clear that European equities (especially the PIIGS) and the EUR versus major currencies (particularly the USD) are getting a sizable near-term boost. While our thesis remains intact that the region’s debt imbalances will weigh to the downside on capital market performance over the next 3-5 years, recent strength in European equities and the common currency can’t be ignored, and we think they’re primarily a function of:


1.  A pledge by Japan and China to buy European debt in the first half of January:


- And Asian investors followed through on their promises – in the first auction from the European Financial Stability Facility (rated AAA) on January 25th of €5 Billion 5-year bonds @ 2.89% the Japanese government bought 20% of the issue, with Asian investors snapping up a full 38%. The auction drew considerable demand at €44.5 Billion!


2.  Bullish speculation on a “comprehensive package” to tackle Europe’s sovereign debt crisis:


- European Ministers have said that a package to revise the EFSF and map out a permanent mechanism to replace it in 2013 and tighten fiscal rules should be decided on by late March when the European Summit convenes. 


- Proposals for this package include:

  • boosting the region’s €750 Billion EFSF rescue fund
  • helping countries buy back their bonds; and
  • lowering interest rates on bailout loans

3.  Hawkish commentary from ECB President Jean-Claude Trichet:


- Following the ECB rate decision on 1/13 and in recent interviews at Davos, Trichet is signaling to the market that he 1.) Recognizes rising inflation (particularly in commodities), and is 2.) Determined (as ever) to maintain price stability over the “medium term” to address these pressures. This position diverges greatly from Bernanke’s stance in the US!


- In a separate note we’ll be addressing the timing of an ECB rate hike, however the chart below of the 2YR German Note provides a telling inflection that a hike in the near-term is being priced in. The yield is up a full +50bps since the end of last year.


Playing Europe’s Mismatch on Duration - o1


Here’s the equity performance of the PIIGS since 1/10:


Playing Europe’s Mismatch on Duration - o2



Beware: Long-Term, Sovereign Debt Issues Persist


Over the long term we see significant headwinds from the developing sovereign debt crisis in Europe. We think this “crisis” has a tail of 3-5 years. We don’t see politicians allowing for the failure of the Eurozone member states or the Euro, however what’s clear is that the long road to tighten up the fiscal imbalance of member countries, and construct frameworks to more effectively govern the unequal economies joined under monetary policy and currency will be a great challenge.


We’re not of the opinion that governments across the region will be able to meet their debt and deficit reduction targets over the next 2-4 years. One clear signal we’ve witnessed for the last year is a trend of rising credit yields for the PIIGS despite bailouts in Greece and Ireland.  We think Portugal, Spain, and Italy are next on the block.


Playing Europe’s Mismatch on Duration - o3


As the chart above demonstrates, rising yields put increased pressure on the sovereigns as they issue new debt, and so begins the viscous cycle of nations chasing yields higher to capture demand to meet future obligations. We’ve seen, using Greece and Ireland as examples, that a yield of 7% or above is a critical inflection line -- in both cases after the line was violated to the upside, a bailout came in mere weeks. 


While we applaud the concurrent austerity programs throughout Europe to suppress spending and increase revenue vis-à-vis tax hikes, slower growth (and therefore less revenue) should follow, another headwind for fiscally imbalanced countries (and their equity markets) that have sizable debt obligations due this year and next (see chart).


Playing Europe’s Mismatch on Duration - o4


Matthew Hedrick


Shorting Thai?

Conclusion: Don’t be fooled by the “Thailand is the fourth-cheapest market in Asia” talk. Cheap can get a lot cheaper and, in Thailand’s case, we think it will.


Position: Short Thailand Equities via the etf THD.


This morning, we added Thailand to our growing list of short ideas in Asia, and quickly opened a position in the Hedgeye Virtual Portfolio. While we wait to short the next dead-cat bounce in Indian equities, we’ll use today as an opportunity to get ahead of what we think is an asymmetric risk/reward setup.


Though Thai equities are down (-2%) on the week, we’ll use today’s +0.88% up-move as an entry point on the short side. Keeping in context 2010’s +40.6% appreciation of the benchmark Stock Exchange of Thai Index, we think there is substantial mean reversion to be had to the downside based on the following catalysts: 

  1. Growth is slowing;
  2. Inflation is accelerating; and
  3. Interconnected risk is compounding. 

From a global perspective, I know we sound like a broken record here, but until the 1H11 data suggests otherwise, we’ll stick to our guns…


Moving back to Thailand specifically, we think growth is setup to slow based on the confluence of two factors: a deceleration in trade and manufacturing b/c of waning external demand (trade surplus roughly 10% of GDP) and weaker consumer spending as a result of higher inflation and interest rates (~55% of GDP).


To put it simply, Thailand’s December trade data was nasty: YoY Export growth slowed sequentially by (-970bps) and YoY Import growth slowed sequentially as well, falling (-2,380bps).  Akin to our Japan’s Jugular thesis, a measured slowdown in Thailand’s export growth will reverberate negatively throughout the Thai economy, as Thailand is a very trade-heavy nation (its share of global exports is nearly 2.6x its share of global GDP).


Shorting Thai? - 1


Concurrent with the release, Thailand’s Commerce Minister Porntiva Nakasai affirmed our call for China to lead a regional deceleration of growth:


“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.”


From a mean reversion perspective, Thailand’s GDP is bumping up against some rather difficult comparisons in the coming quarters. The 3Q10 growth rate slowed to +6.7% YoY – nearly 1/2 the rate of 1Q10 (+12% YoY). Growth in 4Q10 looks to slow even further, bumping up against the first positive comparison in five quarters: +5.9% YoY in 4Q09 vs. (-2.8%) YoY in 3Q09. The comps in 1H11 look even more overwhelming and is likely another reason Nakasai cut his forecast for 2011 GDP by nearly half to +4.5% YoY from an estimated +7.8% YoY in 2010.


Shorting Thai? - 2


Accelerating inflation lends further conviction to our belief that growth will slow over the intermediate-term TREND. CPI accelerated for the first time in five months in December, climbing +20bps to +3% YoY. While not a high nominal level, the negative real interest rates (-0.75%) are cause for alarm and we think rates are going higher as the central bank attempts to ward off speculation. The Bank of Thailand shares our hawkish view, with Governor Prasarn Trairatvorakul saying today that the bank needs to increase borrowing costs to “dampen quickening inflation”.


Shorting Thai? - 3


We share his sense of urgency, as the US dollar remains comfortably broken, trading below its intermediate-term TREND line of $78.66 for nearly three weeks on feeble 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. Currently rice, a dietary staple in the country, has among the highest inverse correlations to the dollar (r² = 0.80) on a trailing three-week basis.


Shorting Thai? - 4


A back up in food inflation could prove disastrous to Thai equities. This morning, Egypt EGX 30 Index showed the world what can happen when food inflation ails a country’s citizenry, closing down (-10.3%). There are already 2,500 protestors lining the streets of Bangkok, in an attempt to pressure the government to drop out of the United Nations’ World Heritage Committee, cancel a border-negotiation agreement and urge Cambodians to withdraw from disputed border areas. Should the rate of food inflation creep up from its current +5.6% YoY clip, we could see Thailand’s political risk discount widen, as more demonstrators lock arms in protest.


Currently, there are some in the market that believe Prime Minister Abhisit Vejjajiva can and will bring an end to this round of protests, citing generally firm support from the general public and, more importantly, the Thai military. We feel, however, that his suggestion to call an election “as early as April” might be too long a timeline for the tense political situation to die down over the immediate term. We’ll take the other side of the “trust the Thai government trade” for now:


“The political risks provide a discount, while the country’s economic fundamentals are solid… It’s not a market we want to sell.” - Masahiko Ejiri, a Tokyo-based senior fund manager at Mizuho Asset Management Co., which oversees the equivalent of $41 billion.


We think Masahiko here may be overlooking two very important facts: 

  1. Political risks provide a discount for a reason and the discount can get much deeper than (-2%) on the week; and
  2. When economic fundamentals go from “solid” to “less solid” stock market multiples typically compress. 

Don’t be fooled by the “Thailand is the fourth-cheapest market in Asia” talk. Cheap can get a lot cheaper and, in Thailand’s case, we think it will.


Darius Dale



Shorting Thai? - 5

investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.


We learned today that CMG has been awarded a US Trademark for Shophouse Southeast Asian Kitchen with the description Restaurant services, take-out restaurant services.  CMG first announced on November 3, 2010 that co-CEO Steve Ells was working on an Asian restaurant concept that follows the Chipotle model.  At that time, the company revealed its plans to open one Asian inspired concept in 2011.


Just recently, Ells stated at the ICR conference, “I would argue that different kinds of cuisine could be applied to this Chipotle model, that it’s the model that we’re best in the world at not necessarily burritos and tacos.  And so in order to prove that theory, we’re going to open an Asian concept this year. It’s very exciting. It’s completely different from the stuff that you see out there today. And we’ll open one and we’ll see how it goes and see what kind of opportunities come from that.”


CMG’s move into the Asian food segment will be interesting to watch but is certainly not a guarantee of accretion to shareholder value.  Many good operators have lost focus in the past by “diversifying” and have, ultimately, ended up failing. 


For now, they have said it will only be one restaurant in 2011, but as I have said before, there is likely so much more behind the company’s decision to move into the Asian segment.  Just ask any management team that has tried to take share in a new category; there are plenty of them.


 The key reasons usually are:

  1. More capital than they know what to do with
  2. Need another growth vehicle

Both reasons lead to management being distracted and to lower returns for shareholders - never a good combination.


Howard Penney

Managing Director


1Q guidance disappointing given high expectations


"These improved results reflect the strong reception our new ships have received along with the solid branding our different cruise brands have enjoyed. WAVE is off to a solid start and supports our earlier confidence in meaningful pricing recovery and record financial performance in 2011."

-Richard D. Fain, chairman and chief executive officer



  • "During this last quarter, extreme weather conditions impacted some of the company's voyages and impaired some of its guests' ability to make their departures. Absent these weather disruptions, Net Yields on a Constant Currency basis would have increased 4.7%, in line with previous guidance."
  • "Early "WAVE season" bookings have been encouraging and booked load factors and average per diems are ahead of same time last year."
  • "In commenting on its guidance, the company noted the potential for an increasing role of its tour operations which include Royal Celebrity Tours, Pullmantur's tour businesses and other operations on its yield and net cruise costs metrics.  Because these tour businesses have relatively low margins, this volatility has little impact on bottom line results but can cause fluctuations in the financial statistics for revenues and operating costs."
  • "Forecasted consumption is now 58% hedged for the remainder of 2011, 55% hedged in 2012, and 30% hedged in 2013."
  • "Forecasted fuel consumption per APCD is down a further 6% for 2011." 
  • Liquidity/financing update:
    • Liquidity: $1.6BN (cash and the undrawn portion revolving credit facilities)
    • "Company has $1.3 billion of committed unsecured financing on its two remaining newbuilds."
    • "During the fourth quarter of 2010 the company finalized an additional unsecured revolving credit facility in the amount of $525 million due in November, 2014. Going forward, the company anticipates maintaining two separate revolving credit facilities with staggered maturity dates to further reduce refinancing risk."
  • Capex: $1.0 billion, $1.0 billion and $350 million for 2011, 2012, and 2013 respectively. 
  • Capacity increase for 2012 of 1.2% and 2.2% for 2013
  • 1Q2011 Guidance:
    • Net Yields: 2-3% as reported, 1-2% on a constant currency; previous guidance: 2-4%
    • NCC: 1%
    • NCC (ex fuel): 2%, 1-2% on a constant currency
    • Fuel consumption: 326K metric tons; 63% hedged
    • Fuel expenses: $168MM
    • Capacity increase: 10.2%
    • D&A: 170-175MM
    • Interest expense, net: $80-85MM
    • EPS: $0.10-0.15
  • 2011 Guidance:
    • Net Yields: 4% to 6% as reported, previous guidance 4-5%
    • NCC: 2% as reported, previous guidance 0-1%
    • Fuel consumption: 1,322K metric tons; 63% hedged
    • Fuel expenses: $705MM
    • Capacity increase: 7.4%
    • D&A: 695-715MM
    • Interest expense, net: 305-325MM
    • EPS: $3.25-3.45


  • Since 3Q CC, slight "upward bias" in bookings for 2011
  • Expect more than 50% of guests will be international in 2011
  • New build application in process
  • In 2012, 55% of Celebrity will comprise of Solstice hardware; 63% of Royal Caribbean International fleet will be comprised of Oasis, Freedom and Voyager class ships.
  • Still early in WAVE season, booking demand within expectations
  • 1Q 2010 had 39 cent legal settlement
  • 1Q Net yield increase--mostly from ticket revs, on-board spending flat
  • For 2011, higher marketing/selling expenses
  •  $500MM maturity in February (no capital markets needed)
  • Europe: adding 3 ships this summer
  • Close-in bookings still healthy. Newer products still selling at premium pricing.

Q & A

  • No change in 1Q outlook from 3 months ago
  • 1Q NCC: increase in guidance due to higher marketing expenses pushed into 1Q from 4Q
  • 4Q bookings were as expected
  • Forecast for FX: do not include new building projects
  • Impact on top line as ships come out of service: schedule dry docks during softer seasons
  • Weather effect for 1Q?
    •  No cruise disruptions
  • Seasonality: Alaska operations more volatile in summer; Spanish market more volatile in 3Q.
  • Not interested in selling Azamara brand or ships.
  • WAVE is key to bookings strength for 2Q and 3Q but less of an effect compared to previous years
  • 4Q 2010 Ticket revs: exactly as expected
  • 2Q trends: should show "healthy yield improvements"
  • 3Q yields will be better than 2Q
  • APD running higher than a year ago
  • 50%of revenues booked for 2011
  • Improvements: one major change on ship at end of year
  • Mexico itineraries
    • On west coast of Mexico, Allure of the Seas is on its way
  • Customer deposits growth is mainly due to pricing

Daily Oil & Gas Perspectives

From the Global Oil and Gas Patch: January 27, 2011


Current Long Positions in Hedgeye Virtual Portfolio……


Oil (etf OIL) – Initiated 1/19/11 @ $24.82


Current Short Positions in Hedgeye Virtual Portfolio……


Canadian Natural (CNQ) – Initiated 1/26/11 @ $42.65


Chart of the Day……


Daily Oil & Gas Perspectives - murph


Key Metrics……


Daily Oil & Gas Perspectives - chart


Must Know News……


MUR Misses Quarter…….Murphy (MUR) delivered a poor quarter last night, missing on EPS but beating revenue.  EPS came in at $0.91 vs. $1.01 expected; revenue was $6.51B vs. $5.62B expected.  Production in the quarter averaged 117k b/d vs. 138k b/d in 4Q09.  For guidance, the company expects EPS in 1Q11 to be in the range of $0.55 - $0.95 vs. consensus estimate of $1.47.  The company said that this estimate includes exploration expense of between $70 million and $160 million and downstream earnings of approximately $8 million during the quarter.  (Company statements)


Hedgeye Energy’s Take: The quarter delivered from MUR was not a strong one, as higher production and exploration costs appear to have crimp margins.  The stock is down ~12% this morning.  We will have full details on MUR’s quarter after the company’s conference call today. 


TNK-BP Shareholders File to Halt BP-Rosneft Deal……Russian billionaire shareholders in TNK-BP asked a London court to halt the share swap and Arctic exploration deal between BP Plc and OAO Rosneft, according to a copy of the filing read by Bloomberg News.  The application was made to a commercial court in London yesterday and a hearing is scheduled for Feb. 1, according to the filing.  BP shares fell on concern the move will reignite the disputes between the two companies that led to current BP Chief Executive Officer Robert Dudley being ousted as head of TNK-BP in 2008. TNK-BP accounts for about a quarter of BP’s production and a fifth of reserves.  (Bloomberg)


Hedgeye Energy’s Take: TNK-BP, the Russian BP joint venture, feels left out in the cold and is playing hard ball, and they have a case. TNK-BP have an agreement with BP that any exploration by BP in Russia must be first agreed upon by TNK-BP, since the genesis of the TNK-BP arrangement was to function as an exclusive operating (E&P) unit within Russia only. BP’s agreement with Rosneft allows BP to participate in exploration deals within Russia without TNK-BP’s approval or participation. TNK-BP wants in a piece of the action and may get it. But they will have to deal with Putin who blessed the BP Rosneft deal, which is why they filed in London. We will keep our eyes on this one, always great to see Russians go at it amongst themselves.


CNOOC will Increase CapEx in 2011……Top Chinese offshore oil and gas producer CNOOC Ltd (CEO) plans to raise oil and gas output in 2011, the company said in a statement on Thursday.  State-backed CNOOC said it aimed to produce 355-365 million barrels of oil equivalent (boe), compared with estimated output for 2010 of 327-329 million boe.  CNOOC said it had targeted $8.8 billion (B) in capital expenditure for 2011, compared with $7.9 billon in 2010.  (Reuters)


Hedgeye Energy’s Take: We think CEO could hit the above production targets, growing overall boe production ~12.5% in 2011 from 2010.  At current prices and with a spending program of $8.8 B in 2011, CEO is expected to be significantly net cash flow positive after spending and dividends in 2011, possibly doubling from 2010 to ~$10/ADR and for successive years. E arnings look set to grow ~40% in 2011 to ~$22/ADR from 2010.


Lou Gagliardi


Kevin Kaiser