Brazilian Tug-of-War

Conclusion: Is it time to buy Brazilian equities? We think not, though we are certainly much less bearish on them than we have been in recent months.


When we when we initially turned bearish on Brazilian equities in November (alongside most other emerging markets), we were making the call within the context of our contrarian intermediate-term TREND thesis of Global Growth Slowing as Global Inflation Accelerates. Understanding full well history’s lessons of inflation eroding EM growth and asset returns augmented our conviction then.


Fast-forward nearly five months, and we have no less conviction with our fundamental call – if anything, $115 crude oil is incrementally supportive. We do, however, have less conviction in being bearish on Brazilian equities, as a lot of the scenarios we initially forecasted have already played out. Simply put, we’re running out of catalysts on the short side, so, naturally, we’re reining in our bearishness: 

  • Slowing Growth: YoY GDP growth slowed sequentially by (-170bps) in 4Q and both the Brazilian government and the sell-side have been taking down their 2011 GDP forecasts recently, currently at +4.5% YoY and +4.1% YoY, respectively.
  • Accelerating Inflation: Since bottoming in August, Brazilian CPI has crept up +150bps to the current +6% YoY reading (Feb). Consensus estimates for Brazil’s 2011 CPI are now at +5.5% YoY - up from +4.7% YoY when we initially called out Brazil’s inflationary headwinds.
  • Rate Hikes: Since our initial forecast for Brazil to resume raising interest rates (late October), the Selic Rate has been hiked +100bps and we expect an additional +50bps hike at the central bank’s next meeting (April 19-20). After that, we expect Tombini to go on hold and await more data, particularly given his dovish comments following Japan’s crisis and his reiteration that recent fiscal and monetary tightening will slow CPI to the target range by 2012. Further, the Finance Ministry recently revised down their 2011 CPI forecast (-50bps) to 4.5% – a sign that declining inflation expectations are spreading throughout the policy-making spectrum.
  • Prices: Since the start of November, the Bovespa is down (-5.7%) and are underperforming the S&P 500 and the MSCI EM Index by (-1,605bps) and (-598bps), respectively. 

Brazilian Tug-of-War - 1


Brazilian Tug-of-War - 2


Brazilian Tug-of-War - 3


Given that we’re inclined to be less bearish on Brazilian equities at current prices (relative to our entry point), the next risk management question to ask is, “Is it time to get long?”


For now, our answer is “no”, for two reasons: 

  1. The Bovespa is broken from an intermediate-term TREND perspective; and
  2. The sell-side is increasingly bullish. 

Addressing the latter point specifically, Morgan Stanley and Citigroup have come out recently recommending buying Brazilian call options (MS) and overweighting Brazilian equities (Citi). While we don’t want to dismiss their recommendations just for the sake of being contrarian, both history and our own anecdotal experience has shown sell-side recommendations tend to be lagging, if not outright contrarian, indicators.


Combining this idiosyncrasy with our quantitative context gives us a more cautious outlook. For now we’re content to wait, watch, and trade the rage. We’d need to see a sustained breakout above the TREND line or breakdown below the TRADE line before we are willing to make a new call from here, given that much of our current call has likely been priced in.


Brazilian Tug-of-War - 4


What would be incrementally bearish for Brazilian equities relative to our November forecast is if crude oil prices continue to make higher-highs over the intermediate term (incrementally accelerating inflation) and if the real weakens over the intermediate term due to (potential) Japanese repatriation, which gives Tombini more headroom to hike interest rates and escape the accompanying currency appreciation. Currently, Japan is the largest holder of real-denominated debt according to PIMCO and has some $34.3B in Japanese deposits according to HSBC.


What’s next for Brazilian equities and her currency? Stay tuned to find out.


Darius Dale


WMT: Does Someone Think They Know Something?


Keith shorted WMT this morning in the Hedgeye Virtual Portfolio at $52.90, as he continues to trade around one of our core intermediate-term ideas. 


"l assume someone thinks they have inside information somewhere in this name this morning. US Consumption will remain lower as Oil climbs higher.” -KM


Our WMT view is based on our bullish view on inflation on top of the internal challenges that the company faces to drive its domestic same store sales back into positive territory.  


The situation surrounding Wal-Mart’s internal execution in areas such as apparel and overall category management is nothing new.  Too much selection? Not enough selection?  Brands? Basics?  Management is hyper focused on turning things around, yet numerous strategy changes over the past year have yielded little in the way of tangible results. We do not see a meaningful and credible plan at this current time that suggest domestic sales can outperform an increasingly challenging backdrop for the company’s core consumer.  In fact, the company entered 2011 with total inventories up 11% against a 2.5% increase in sales.  Clearly not the “clean” start that instills confidence in the wake of rising costs and substantial volatility at the gas pump. 


We remain concerned with the following near-term challenges:

  •  Management’s message now says the US goal of positive same store sales will “take time”.  The CEO acknowledged that issues facing sales (and their customers) were bigger than they “initially expected”.  Traffic is still a drag and likely to remain so given the law of large numbers that puts 1 in 3 Americans at a Wal-Mart each week.
  • Inventories are high no matter how you slice it heading into this year.  Total inventories up 11%, total sales up 2.4% at year end.  With a negative comp headwind, inventory pressure is likely to persist through the first half of the year leaving little chance for margin expansion.  From a timing perspective, this then rolls into the second half of the year which is the most uncertain time from an inflation and price elasticity standpoint.
  • The current four point plan aimed at fixing the US business is centered on price leadership, broad assortments, improved remodels, and focus on multi-channel.  None of this is revolutionary, but rather basic blocking and tackling.  Details surrounding these plans are also scant, at least as of 4Q reporting.  The first point of the plan is most telling however.  In order to maintain price leadership in a the wake of rising costs, we suspect WMT will be as aggressive as ever to protect its market share.  At best, this caps margin improvement in the near to intermediate term.
  • The company's $1bn cut in capex is a fcf positive for the year. But a company with this magnitude of challenges on the top line and margin equation banking on to cost cutting and financial engineering to drive cash flow is a concern for us.  



The Bloomberg Weekly Consumer Comfort Index has just hit the tape and reveals some interesting takeaways on the state of the consumer for the week ended March 20.


The Bloomberg Consumer Comfort Index is not a metric that I have written about at length in the past but the granular nature in which the findings of the survey is presented allows us to gain some valuable insights into sub-trends in the economy. 


Overall, the Index declined to -48.9 for the week ended 3/20 versus -48.5 for the week prior.  Hardly a momentous decline, but a decline nonetheless.  More narrowly, respondents’ view on the state of the economy went from -80.3 to -86 week-over-week.   Personal Finances and Buying Climate were two topics that drew sequential improvements in respondents’ perception of each subject; however, both have deteriorated significantly from five weeks ago.


Segmenting the data by age, as expected, 18-34 year-olds showed the worst week-over-week decline in sentiment on the state of the nation’s economy.   Additionally, it is worth noting that over the past five weeks, 18-34 year-olds’ sentiment has declined rapidly, from -35.7 for the week ended 2/13 to -57.3 for the week ended 3/20. 


Filtering the findings of the survey by income, the only brackets that saw a week-over-week improvement in the index were the $15k to $24.9k and the $40k to $49.9k groups.  All other groups saw a decline, with the $75k to $99k seeing the sharpest decline at -35.6 versus -27.6 for the week prior.


By region, the MidWest was the only area of the country that saw a sequential improvement in the CCI on a week-over-week basis.  The NorthEast saw the steepest decline from 3/13 to 3/20, coming in at -50.5 from -45.6.


The Polarization Index, which represents the difference between Democrats and Republicans, expanded to -7.9 from -3.9 for the week prior.  The larger the absolute figure, the greater the divergence in confidence.  For Republicans and Independents, the most recent week saw a sequential improvement in the CCI, while Democrats’ reading declined.


A summary of the key takeaways from the Bloomberg Weekly Consumer Comfort Index is as follows:

  • 18-34 year olds have become far less optimistic, relative to other age groups, of late.  Joblessness continues to be an issue for this age cohort and compounding stress factors such as high personal debt levels and the general societal malaise in the United States today further drag on sentiment among young adults.
  • Overall, political sentiment has declined for GOP, Democrat, and Independent voters over the last five weeks.  Heightened concerns about government balance sheets, foreign policy, and a dearth of leaders stepping up to the plate for the GOP presidential nominations may be contributing to this trend.
  • Lastly, if you are single or divorced, you registered as being more positive for the week ended 3/20 than you did the week prior.  The married among us, however, saw their sentiment decline week-over-week!

Howard Penney

Managing Director


CONSUMER UPDATE - weekly cons comf

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Range Rover: SP500 Levels, Refreshed



I should have covered my SP500 short position on yesterday’s test of the 1 range. Should-haves are a poor hockey player’s excuse for staring down at the puck. I should not have had my head down when in Big Alberta’s trolley tracks…


With month and quarter end coming up (next week), there’s no reason why the bulls won’t do their best to defend the bottom end of this market’s newly established trading range. For both our TRADE and TREND durations, I see those ranges as follows: 

  1. Immediate-term TRADE = 1
  2. Intermediate-term TREND = 1 

One of the key reasons for the sustainability of this one-week rally from immediate-term TRADE oversold lows is that the VIX has backed off its long-term TAIL line of 22.03. The inverse relationship between the VIX and SP500 remains critical to respect. Currently, intermediate-term TREND support for the VIX holding around the 18 level keeps the intermediate-term TREND of lower-highs for the SP500 intact.


On a breakout above 1308, I’ll wait and watch to short the SP500 again at 1315-ish. Otherwise, I’m waiting for another Short Covering Opportunity at 1281. Manage your risk around the ranges.



Keith R. McCullough
Chief Executive Officer


Range Rover: SP500 Levels, Refreshed - 1


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

  • SBUX gained almost 5% on accelerating volume yesterday as investors reacted favorably to the AGM, which was held yesterday in Seattle.  Critical takeaways from the AGM include the company’s intent to expand the CPG business and growing its K-cup business, which management believes could ultimately become a $1 billion business. 
  • SBUX card mobile has become a hit already.  More than 3 million people, so far, have paid for their purchases using Starbucks Card Mobile (either the Starbucks Card Mobile iPhone or Blackberry applications).
  • SBUX said that it would expand on its previously announced relationship with Courtesy Products, the nation’s leading provider of in-room coffee service to hotels, via a new brewing system that would be priced lower than the Keurig machine.  Details of the deal are still being worked out, according to The Wall Street Journal.
  • WEN is trading well recently, gaining 3.2% on accelerating volume yesterday.  The next catalyst for the stock is the sale of Arby’s.
  • KKD is outsourcing its domestic supply chain distribution channels to Sysco Corp. KKD declined on accelerating volume yesterday.
  • SONC is facing stiff competition in its Texas market as In-N-Out and CKE Restaurants (via Carl’s Jr) expand into Texas.
  • MRT declined on accelerating volume yesterday.
  • Consumers may be more resistant to price increases than management teams are aware of.  A man in Texas fired a gun at a KFC/Taco Bell drive-thru employee after discovering the price of a burrito had risen to $1.49 from 99 cents.
  • Subway is the most loved fast food chain in the US according to Amplicate, an online opinion-collating resource.  The top 20 rankings, per the Amplicate survey, can be found here.



Howard Penney

Managing Director

CHART OF THE DAY: Short Covering in Consensus Short Ideas



CHART OF THE DAY: Short Covering in Consensus Short Ideas -  chart


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