• run with the bulls

    get your first month

    of hedgeye free


Excessive Storytelling

“Epidemics are sensitive to the conditions and circumstances of the times and places in which they occur.”

-Malcolm Gladwell


Epidemic might be the right word to describe the environment in the USA that has ensued since Bernanke’s speech in Jackson Hole and the 96.3% move in the S&P 500 since March 2009.  There are many corners of the world that are looking at the USA and the policies of the Federal Reserve and clearly believe that we are pouring gasoline on a blazing hot fire.


The past month’s protests in North Africa and the Middle East were partly linked to surging agriculture costs and according to the UN, countries in Latin America are most at risk of food riots as prices continue to head higher.  According to the World Bank, rising global food prices have pushed 44 million more people into “extreme” poverty in developing countries since June.  Yet the USA and the S&P 500 continue to power forward like they are impervious to these issues. 


Not so fast….  The question is when, not if, Chariman Bernanke will pull the punch bowl on the current liquidity binge.  The increased civil unrest that ensues around the world will continue to put incremental pressure on him to alter the current policy.  The scary part is he needs to do it sooner rather than later and chances are it’s going to happen at exactly the wrong time.


Just by chance, what if we get a hint of a FED exit strategy today at 2 pm just as the “storytelling” is reaching a feverish pitch?  I’m hearing people talk about stocks, saying, “This time it’s different!”  Or how about this one, “margins don’t matter!” Or better yet, “consumer companies are impervious to rising input costs!” Over the next 12-months we are going to be able to produce some serious You-Tube moments that will last a lifetime. 


Of course margins don’t matter – until they do.  Consumer companies are impervious to rising input costs – until they are not.  And we are at the tipping point! 


It seems like yesterday that Malcolm Gladwell published The Tipping Point: How Little Things Can Make a Big Difference.  Gladwell describes a tipping point as “the moment of critical mass, the threshold and the boiling point.”  In nearly every situation there is that moment in time when the world is ready to follow the leader or “the trend.”  Right now, that leader is Chairman of the Federal Reserve, Ben Bernanke and the trend is excess liquidity that is leading to higher inflation and higher stock prices.   


The critical element of the U.S. economy that is not benefitting from the Federal Reserve’s actions, in real terms, is the consumer.  I believe that the consumer is reaching a tipping point.  Accelerating demand is critical to maintaining profitability in an accelerating cost environment.  What we saw yesterday from the retail sales data was perhaps an indication that the consumer is beginning to slow down. 


In the face of non-confirming data, observers with a conflicted or biased view often look for any other metric, or any other narrative, to justify a prior perspective.  Revisionist versions of the truth are offered with adroit semantic maneuvering and frantic searching for the comfort of a confirming thesis. 


One narrative being promoted at the moment is that consumers are willing to pay above market for “green” products from “socially responsible” companies. This may be true to a degree, but deflecting the clear truth behind the data, be it Retail Sales or otherwise, with qualitative narratives that are entirely subjective, is not a practice I subscribe to.  If consumers see raising prices in the absence of a corresponding growth in personal disposable income, there is likely going to be a change in consumer behavior. 


As Gladwell wrote, "Ideas and products and messages and behaviors spread like viruses do.”  At present, it is clear that many ideas and messages have spread rapidly around investor circles.  Sectors of the market are trading at premium multiples largely because of the free-money policy of the Federal Reserve.  The confidence that this instills in investors seems to trump any concern about companies’ ability to control their input costs from now on.


For many companies, the cost of raw materials is rising at a faster pace than revenue and we have only just begun to see the impact on margins.  Rising costs take time to flow through to the bottom line.  Rhetoric from management teams, against all of their incentives, has been decidedly cautious with respect to their commodity cost outlook.   As we move through the balance of 2011, the squeeze on profit margins will be more pronounced than most analysts expect. 


The Empire Index' Prices Paid index, which climbed to a two-and-a-half-year high of 45.8, was supportive of my theory yesterday.  Quoting directly from the press release, "The prices paid index climbed to a two and-a-half-year high in February, but the measure for prices received was little changed, suggesting some pressure on profit margins."  That’s right – margins are contracting, not expanding. 


How the consumer reacts to increased inflation pressures will be the tipping point for the market.  Across a wide spectrum of the S&P 500, companies are seeing margins contract, and some are more confident than others in their ability to pass on price to customers.  A growing percentage of companies will be unable to increase price at all, or fast enough to offset margin contraction, without hurting top line trends.  The economic recovery is in its embryonic stages, unemployment remains high, and consumers are keeping a tight rein on spending.  How much inflation can they take before spending begins to suffer?


I heard some supposed experts on CNBC say that $5.00 gas will not affect consumer spending.  It’s this kind of storytelling that is sign of pure excess.


Perhaps yesterday’s Retail Sales was the first glimpse of this trend.  Retail Sales growth missed Street expectations.  The trajectory of 4Q10 sales trends cannot continue with inflation accelerating and job growth proving to be highly inadequate as an offset. 


Over the next two days we will be getting more inflation readings from the PPI and CPI.  While these two numbers are conflicted calculations, they will both point to accelerating inflation.  For proof of this trend, last night in an interview on Bloomberg, Richmond Fed President Lacker (non-voting FOMC member in 2011) said that US inflation may accelerate in H2 of 2011 as firms seek to recoup higher commodities and health care costs. 


And Joe six pack is going to roll over and say thank you very much!




Function in Disaster; finish in style


Howard Penney


Excessive Storytelling - howard11


Excessive Storytelling - howard22

The Rookie Trader

This note was originally published at 8am on February 11, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

Lorri: “So how does it feel to be the oldest rookie in the last 30 years?”
Jimmy: “I don't know... I'm tired.”

-Rachel Griffiths and Dennis Quaid in The Rookie


Alongside “Invincible” (starring Mark Wahlberg and Greg Kinnear in 2006), “The Rookie” (Dennis Quaid and Rachel Griffiths in 2002) is one of my favorite ‘true story’ Disney movies of the last decade.


I’m an athlete, so these are my confirmation biases. I get it. And I’m proud of it. While trading markets may not be a full contact sport, there’s definitely a score and the non-athletes in the game are some of the most competitive people I have ever played with and/or against.


There are plenty of Rookie Trader mistakes that people make in this business. I am certain that I have made all of them, multiple times. Most of the time, that’s the only way a risk manager can mature in this business – by learning with live ammo.


Currently, we have a Rookie Trader learning on the job as he trades America’s balance sheet. Like Jimmy Morris did, he has some of the credentials to play in the Big Leagues. He’s one of the oldest rookies we’ve put in the game. And, if you didn’t notice, on Wednesday in front of Congress, he looks tired.


Tired and old is hardly a bad thing. I’ll still put the original Thunder Bay Bear (my Dad) up against any young buck who wants to try to hold up a retaining wall (we might just have to jack him up with some coffee first!). But tired, old, and inexperienced is not the kind of trader I want at the helm of my firm or family’s future.


Every week the Federal Reserve issues its version of transparency and shows us both the size and components of the Fed’s balance sheet. In the last 2 weeks, this is what Ben Bernanke has been doing – buying bonds, aggressively:

  1. February 3rd – Fed balance sheet assets expanded +$25.9 BILLION week-over-week to $2.47 TRILLION
  2. February 10th – Fed balance sheet assets expanded $31.3 BILLION week-over-week to $2.50 TRILLION

Yes, I am capitalizing the B’s and T’s so that you can hear me now…


Over the same 2-week period, this is what the US Treasury Bond market was doing:

  1. Week of January 31st – 2-year UST yields were up +37% (week-over-week!) to 0.74% and 10-year UST yields were up +10% w/w to 3.64%
  2. Week of February 7th – 2-year UST yields are up another +10% this week to 0.81% this morning and 10s are up +5% w/w to 3.66%

So… what does this mean? drum-roll … The Rookie Trader at the helm of the US Federal Reserve is committing one of the cardinal sins of risk management – he’s getting bigger and more aggressive on the way down!


Again, remember that The Ber-nank’s promise of perpetually low interest rates and that the Quantitative Guessing II (QG2) is the elixir of Big Government Intervention life has A) never been tried before, B) no risk management scenarios in the case that the trade goes against him, and C) no one to tap him on the shoulder and stop him from trading.


When I was given my first book to trade in 2002 (at our hedge fund we called it a “carve-out”), I had 2 bosses and an entire trading desk overseeing everything I did. Stop losses, shoulder taps, personal embarrassment – there were plenty of governors managing my mellon. But this guy has none.


No real-time accountability. No modern day risk management system to stop him out. Nothing.


And this he’s betting with $25-31 BILLION DOLLARS a week!


To put those Burning Bucks in context for you… and yes I realize our entire culture and country is numb to what a US Dollar is worth anymore… pressing a one-way bet with $30 BILLION Dollars a week would be the equivalent of 3 Steve Cohens taking all of their capital and having them all buy the same security, at the same time, with no hedges and no other positions…


Welcome to Centrally Planned America 2.0. with the Rookie Trader starring as your Almighty Central Planner.


In other news this morning, as US interest rates continue to push higher (2-year yields are now up +166% since Bernanke made his QG2 promises of “low interest rates and price stability” at Jackson Hole), I see nothing but price volatility.


1.  Pepsi (PEP) – a $100 BILLION snack and beverage company cut its EPS targets for 2011, and the stock hit a fresh 3 month low on big volume. Management cited soaring commodity costs and uncertainty about when the said US economic recovery will actually be felt by consumers.


2.  Bunge (BG) – a $10 BILLION agribusiness and food service company said it would no longer issue earnings guidance because volatility in the commodity markets have made forecasting increasingly difficult.


3.  Bolivia – a country with 11 million people saw its President, Evo Morales, pull himself from all public appearances as food riots have erupted across the country and Bolivian miners, who are evidently upset, are starting to throw sticks of dynamite at government people.


I know, who cares about Egypt, India, and Bolivia? The Rookie Trader says US Monetary Policy gone bad has nothing to do with what’s happening anywhere in the world, including his home team’s bond market.


My immediate term support and resistance levels for the SP500 are now 1311 and 1334, respectively.


Best of luck out there today and have a great weekend,



Keith R. McCullough
Chief Executive Officer


The Rookie Trader - do1


The Rookie Trader - do2


Hedgeye bought IGT in the firm’s virtual portfolio yesterday.  Here’s why.



IGT is 9% below its year to date high and our macro/trading team thinks right here is a great entry point.  The stock was added into the Hedgeye virtual portfolio yesterday at $17.00.  They see short-term upside to $17.99 (TRADE line resistance) and downside to $16.61, suggesting a favorable near-term upside/downside ratio of +5.8%/-2.7%.




Our fundamental view matches up with the quantitative set up.  Earnings estimates finally look conservative as IGT maintains a number of margin levers while we wait for the long term growth picture to come into focus.  We think that could come sooner rather than later.


The inevitable acceleration of replacement demand will be the big catalyst and we may be seeing signs of that emerging.  Both PENN and MGM made positive comments regarding slot purchases on their recent earnings conference calls.  New markets will layer growth on top of the normalization of replacement demand.  While new markets (international and domestic) should provide long term growth, the news flow should be positive as state legislatures try and solve the massive budget issues.  Gaming has become a politically palatable solution as state revenues can be enhanced without raising taxes or cutting spending.


From a fundamental perspective, we think we are at the beginning of a 3-5 year bull slot cycle.  Now, the near-term quantitative trading set up matches our enthusiasm for the long-term fundamentals.

Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

China: Stuck Between a Rock and a Hard Place

Conclusion: The quantitative setup in Chinese equities reveals a lot about the current state of the Chinese economy and its lack of clarity surrounding the magnitude of any potential economic slowdown. Additionally, China’s January inflation data reveals a few incrementally bearish nuggets regarding the slope of global growth.


Position: Long Chinese yuan via the etf CYB.


Looking at a chart of Chinese equities, we see that it’s very indicative of China’s current economic backdrop: binary with a lack of clear direction. Trading between its bullish TRADE line of support and its bearish TREND line of resistance, Chinese equities are trapped in between the proverbial “rock and a hard place” and we’d like to see a decisive move beyond either of those lines to solidify our view on Chinese assets and Chinese growth:


China: Stuck Between a Rock and a Hard Place - 1


Looking at today’s inflation data, we see that today’s +30bps acceleration in headline CPI to +4.9% YoY and the +70bps acceleration in headline PPI to +6.6% YoY brings with it a slew of changes and meaningful incremental data points.


China: Stuck Between a Rock and a Hard Place - 2


China adjusted both the weightings and composition of both its CPI and PPI baskets. Thought it did not show the full updated breakout, China did provide the following re-weightings: 

  • Rent and utility costs increased +422bps;
  • Food and beverage decreased (-221bps);
  • Alcohol and tobacco decreased (-51bps);
  • Clothing decreased (-49bps);
  • Household equipment and services decreased (-36bps);
  • Health care and personal products decreased (-36bps);
  • Educational products and services decreased (-25bps); and
  • Transportation and communication decreased (-5bps). 

All told, the re-weighting ended up being largely benign (adding only +2bps to the YoY rate of +4.9% and +4bps to the MoM rate of +1%) and generally reflects current consumer sentiment around exorbitant and largely unaffordable housing prices – so much so that the central government plans to increase its development of low-cost homes over +72% YoY in 2011.


Unofficially, Chinese Property Prices posted the largest MoM gain in six months in January (+1%), according to SouFun Holdings Ltd. – the nation’s largest property website. The government’s unofficial report is due out later this month; it will be interesting to see if the slope of the YoY growth in Chinese property prices reflects this unofficial re-acceleration.


Diving more deeply into the components of China’s January CPI report, we see that: 

  • Residence-related price growth accelerated to a 29-month high of +6.8% YoY;
  • Food price growth accelerated to +10.3% YoY; and
  • Non-Food CPI accelerated to at least a six-year high of +2.6% YoY; this reading is +174bps above the average for the data series, which begins in January 2005. 

China: Stuck Between a Rock and a Hard Place - 3


The +50bps sequential change in the YoY growth rate of Chinese Consumer Prices ex-Food confirms exactly what we’d been fearing over the past few months: food and energy inflation is spilling over into the broader economy. This officially means two things: Chinese consumers will start demanding (and receiving) higher wages and the PBOC has to tighten more aggressively on the margin to bring inflation back towards the government’s +4% YoY target for 2011.


YTD, we’ve already seen signs of wage growth throughout China: 

  • Beijing plans to raise its minimum wage +20.8% by the end of this year;
  • Tianjin plans to raise its minimum wage +150 yuan per month;
  • Shanghai plans to raise its minimum wage over +10% from the current 1,120 yuan per month by April 1;
  • Jiangsu plans to raise its minimum wage +15%; and
  • Guangdong plans to raise its minimum wage +19% by March to 1,300 yuan per month – currently the country’s highest. 

Combined, these cities and provinces have a population roughly equal to 220 million people – equivalent to the fifth largest population in the world after Indonesia. While not all of their respective citizens are earning the minimum wage, we are willing to bet the slope of broader wage growth throughout these areas and the Chinese economy at large continues to trend positive, adding to already robust demand-side inflationary pressures and compounding the central bank’s fight with accelerating inflation, on both a reported and expectations basis.


Hidden beneath this trend of labor cost inflation is the margin compression by Chinese corporations who are having to deal with the ill-effects of rising input prices on the gross margins (Chinese Import growth accelerated to +51% YoY on rising raw materials costs), as well as the pinching effect of rising wages on their operating margins.


China: Stuck Between a Rock and a Hard Place - 4


China: Stuck Between a Rock and a Hard Place - 5


To compound the issues facing Chinese manufacturers, a rapidly growing labor movement in Southern China has the makings of a large cultural shift in China’s employee-to-employer relationship. According to Longguan Human Resources in Shenzhen, one of the largest recruiters of inland labor for China’s coastal factories in the Pearl and Yangtze River deltas, millions of workers are refusing to return to factories until their wage demands are met – in many cases in excess of what we detailed above.


Lui Hong, manager at Longguan had this to say regarding the recent trend: “I'm 1,000 percent sure the factories won't be able to find enough workers… there will be a shortage of millions.”


It’s worth noting that the recent costs pressures facing Chinese manufacturers will have to be passed through to global brands like COH, VFC, and JNY or they will be forced reduce production and/or move it abroad, curbing both Chinese growth and any potential near-term topline growth for such brands with a Chinese production footprint. On the topic of shifting growth to other “low(er)-cost” regions like Vietnam or India, we caution that: 

  1. Shifting production into new factories in new countries is not an overnight process and could take as many as 2-5 years to complete the desired shift (four years in COH’s case);
  2. Inflation is dragging up wages throughout the region – particularly in India, which is the only other country in the Asia with enough bodies to make up for a meaningful loss of Chinese labor headcount; and
  3. The infrastructure throughout Asia in potential “low(er) cost” regions like India is notoriously shotty and far from developed enough to prevent massive bottlenecks and delays in both production and shipping. 

The crux of this is that: 

  1. Growth is slowing: Inflation is starting to meaningfully slow unit production growth in China’s factories;
  2. Inflation is accelerating: Global brands and retailers with a Chinese production footprint will be increasingly forced to either take the price increases offered by Chinese manufacturers or reduce unit demand for new inventory; and
  3. Interconnected risk is compounding: Sneakily, rising costs and/or a declining labor pool will continue to make investment in China’s manufacturing and export sector less attractive on the margin. 

To point #2 specifically, we’re already seeing that with China’s YoY Export growth accelerating +1,980bps sequentially in January to +37.7%. China is exporting inflation. This trend will be increasingly compounded if and when the yuan appreciates meaningfully (+1-3%) in the coming quarters.


China: Stuck Between a Rock and a Hard Place - 6


It’s not uncommon for consensus to misinterpret economic data points like the jump in China’s Import/Export growth because they lack a Global Macro Process to properly contextualize the relevant changes on the margin; an example of this is was the recent bullish mosaic painted around China’s January Crude Oil Imports, which accelerated to +27.4% - a four-month high.


Careful analysis reveals that much of the demand increase is fueled by speculation that China may soon increase retail gasoline and diesel costs throughout the country, which is bullish for Chinese refiner’s margins – all things being equal (Shanghai Daily, Feb. 11). To the aforementioned trade data specifically, China’s Trade Balance contraction accelerated in Jan (-$7.71B) YoY vs. (-$5.35B) in Dec – an explicitly bearish YoY and QoQ growth data point for China’s 1Q11 GDP.


China: Stuck Between a Rock and a Hard Place - 7


Unfortunately, with the current inflationary headwinds, all things are not equal. As we have maintained since October, we see Chinese growth slowing for at least the duration of 1H11 – and perhaps more (time and data will tell).


A further look at today’s data reveals additional headwinds to China’s intermediate term growth momentum. New Loan growth accelerated in January as it typically does at the start of each year to +1.04T yuan, an increase of +559.2B yuan over December’s reading. While it fell short of consensus expectations of a +1.2T yuan increase, it was high enough to give China bulls some confirmation that China isn’t headed for a near-term crash after aggressively hiking reserve requirements and interest rates over the past 3-4 months.


Analyzing the loan growth on a YoY basis tells a more daunting tale for the slope of Chinese growth. The amount of New Loans extended in January fell (-25.4%) YoY – a large sequential deceleration from December’s +26.6% YoY growth rate and an even more precipitous drop from November’s +91.3% YoY growth rate. Money Supply (M2) growth confirmed this trend, falling to levels not seen since its July ’10 and December ’08 lows at +17.2% YoY.


China: Stuck Between a Rock and a Hard Place - 8


At the end of the day, the slope of China’s economic growth may or may not matter at all to the direction of Chinese stock prices. It’s important to remember that mainland Chinese investors have an incredibly limited selection of investment opportunities and the bulk of them have been weak in recent weeks/months: 

  • Savings deposit accounts – the returns of which are being completely eroded by inflation;
  • Gold – which just had its worst January in over 20 years;
  • Real Estate – both the Chinese premier and the PBOC leadership have pledged to crack down on property speculation in 2011, starting with the long-awaited implementation of a nationwide property tax trial;
  • Chinese equities – which are sneakily up +3.2% YTD. 

In China’s case, this time the “flows” could trump the fundamentals. For now, however, China remains stuck between a rock and a hard place.


Darius Dale


get free cartoon of the day!

Start receiving Hedgeye's Cartoon of the Day, an exclusive and humourous take on the market and the economy, delivered every morning to your inbox

By joining our email marketing list you agree to receive marketing emails from Hedgeye. You may unsubscribe at any time by clicking the unsubscribe link in one of the emails.