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Some consternation surrounding relatively weak visitation rates but GDP has mattered most.



Macau visitation grew 5.2% in February and only 1.4% in January.  Yet, Mass revenue increased 19% and 36%, respectively.  Should we even care about visitation?  Probably, but not necessarily over the near term.


We’ve run the regressions and at first blush, it appears that visitation is highly correlated with Mass gaming revenues.  Makes sense.  However, when China GDP is thrown into the equation, visitation loses its significance.  GDP and visitation are auto-correlated but GDP is by far the dominant variable.  The R Square with just GDP is 0.71 versus only 0.50 with just visitation.  With a multi-variable regression including both variables, the R Square rises to 0.77.  Moreover, the visitation coefficient is only 0.29 so a 1% increase in visitation drives only a 0.29% increase in Mass revenues – barely worth mentioning.




We do question if this relationship will hold over the long term.  It’s hard to imagine that spend per visitor can continue to grow at the current pace.  We believe long-term Mass growth will be sizable but not at current levels.  The long term pace we see is China GDP plus visitation:  7-10% GDP plus 5-10% visitation.  That would alter the current equation considerably but seems reasonable since Macau has barely tapped the provinces outside of Guangdong.  At some point, the fine people of Guangdong won’t be able to increase their gaming spend at a multiple of their wealth growth as they appear to be doing currently.


For now, however, Mass looks like it is on track for another 20% plus growth month in March, despite a 32% comparison last March.  The GDP multiplier should hold over the near term.



Consumption Cannonball Update: De-Unionizing

Conclusion: The tea leaves from early State budget battles continue to support our view that negative growth in State and local government employment and/or employee income will be a drag on the economy in 2H11 and beyond. In addition, we refresh our intermediate-term Consumption Cannonball thesis below.


The following chart comes by way of our Healthcare team, which has been closely monitoring the progression in State & municipal budget battles to ascertain their impact on consumption growth throughout the broader economy. If there is one key call-out to make, it’s that Labor Unions are growing financially weaker at an accelerating pace – meaning that their power in negotiating with the many newfound, fiscally hawkish State legislatures grows increasingly limited.


Consumption Cannonball Update: De-Unionizing - 1


The key takeaway here as it relates to the ongoing budget battles playing out across the nation is that State and local government employees, which are highly unionized relative to their private sector counterparts (36% vs. 15%), are negotiating from a position of marginal weakness. That means they’ll likely have to cave in to legislative demands to limit collective bargaining and front more of their incomes to help pay for burgeoning healthcare costs, as the threat of outright termination is as strong as it has been in many, many years.


Any threat to State and local government employee compensation is negative for aggregate household consumption growth – either through higher savings rates or lost wages resulting from layoffs – particularly given that they are generally compensated at higher rate relative to private sector employees.


Per a December report out of the BLS, wages and salaries for State & local government employees averaged $26.25 per hour vs. $19.68 per hour for private sector workers. In addition, State & local government employee benefits outpace those received by private sector employees by $5.65 per hour worked ($13.85 vs. $8.20). A recent study by USA Today found this to be true in 41 States (including D.C.).


All told, while the recent “successes” in negotiating with labor unions is positive for the financial health of States like NY and WI* (pending judge approval), successful negotiations with labor unions on a national scale will more than likely produce a drag on near-term consumption growth – particularly in the back half of the year.


Replacing this demand will have to come from a commensurate pickup in private sector employment and/or wage growth – two things we don’t see happening in an environment of slowing growth.


Consumption Cannonball Update: De-Unionizing - 2


Given that we’re at the top of another US economic cycle, we wouldn’t be surprised to see more near-term improvement in private payrolls and the unemployment rate, which is notorious for being the most lagging of all economic indicators. Over the intermediate-term, however, we don’t see domestic or global growth coming in at high enough rate for meaningful improvement in the US labor situation. GDP and PCE comparisons remain extremely difficult to surmount in the absence of this much needed improvement.


Consumption Cannonball Update: De-Unionizing - 3


Consumption Cannonball Update: De-Unionizing - 4


While consensus focuses on lagging indicators, such as Friday’s unemployment report, keep your eyes on the leading indicators of market prices, housing prices, the yield curve, and consumer and business confidence – all of which are going the wrong way for growth bulls. Alongside Housing Headwinds II, the Consumption Cannonball is alive and well…


Darius Dale



Consumption Cannonball Update: De-Unionizing - 5


Consumption Cannonball Update: De-Unionizing - 6

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Osborne’s 2011 Budget and UK Outlook

Positions in Europe: Long British Pound (FXB); Short Spain (EWP)


Below we update our outlook on the UK economy in light of Chancellor of the Exchequer George Osborne’s 2011 Budget release last week. We believe that the budget largely stays the course on deficit spending, which should be a bullish catalyst for the GBP-USD and continue to support the country’s credit market outperformance; however, we caution that the decision to raise taxes on energy producers is a competitive drag worth consideration. We continue to believe that while the UK’s austerity programs are positive for its longer term economic outlook, over the near to medium term we expect the UK economy to underperform its fiscally stronger European peers (Germany, Sweden, Poland).



Budget Direction


Last Wednesday Osborne presented the UK’s 2011 Budget; notably the budget stayed the course on deficit spending and emphasized making the UK a more competitive country by attracting investment and promoting a higher skilled and better educated work force.


Very plainly Osborne addressed the ails of the economy and its peoples, recognizing that:

  • Higher food and energy prices are squeezing consumers (unlike The Bernank) and relief must be given. He offered marginal income tax reductions (primarily for low income earners and a child tax credit) and relief at the pump by cutting the fuel tax by one penny per liter this year.
  • The UK has dropped from 4th to 12th place in the global competitiveness league, and therefore he offered:
    • Funding for 12 new University Technical Colleges
    • The creation of a new work experience program to benefit  20K young people and funding for 40K new apprenticeships to tackle youth unemployment
    • To improve competitiveness Osborne also called for a reduction in the corporate tax rate (currently the 6th highest in the world) starting this April by 2%, and by 1% in each of the following three years.  (Effectively from 28% to 23% over 4 years)

On economic fundamentals, Osborne noted:

  • Annual GDP for 2011 will be revised down to 1.7% versus the previous estimate of 2.1% and improve to 2.5% in 2012.
  • Inflation is expected to remain between 4-5% for most of 2011, before dropping to 2.5% in 2012.
  • The country stands for credibility on the global marketplace, with 10YR interest rates at 3.6%, near Germany’s rate, and far from the 12.5% in Greece or 10% in Ireland.

On taxes of oil production profits in the UK:

  • Osborne called for profits to be taxed at 62% from 50% to pay for a lower consumer tax on gas.
  • The supplementary charge levied to oil and gas production was raised from 20% to 30%.

Overall the tone of the budget was positive: Osborne sized up the country’s growth deficiencies and proposed measures to return the country to a more competitive state. However, on the point of taxing profits of oil companies invested in the UK, we caution that Osborne may be swinging the pendulum too aggressively in requiring oil companies to subsidize gas prices in the present environment of inflated energy prices. 


And the repercussion of this decision may be more than Osborne had in store. Yesterday, Statoil put on hold a $10 Billion plan to develop the Mariner and Bressay fields in the UK, with CEO Peter Mellbye saying the new taxes are “tremendously negative” and that he’ll have to reconsider the project.



Fundamental Landscape


Of the high frequency data we follow, we’ve not seen any major inflection points from trend in the UK data over the last months. The final reading of Q4 GDP was -0.5% quarter-over-quarter and the most present threat to future numbers remains inflation, which, as reflected by the CPI, continues to trend higher.  The most currently February reading is +4.4% Y/Y.  PPI input costs are running at 14.6% Y/Y, suggesting that these costs too must be passed on to the consumer.  The BoE continues to remain in the precarious situation that it needs to act to combat inflation by raising rates, however fears that a hike could stymie growth. At present, the BoE continues to lean dovish on a hike. 


UK retail Sales fell 80bps in February versus the previous month, which we think is representative for the months ahead now that we are out of the holiday period and the consumer is faced with a higher VAT (see chart below).


We’re seeing confirmation of this malaise vis-à-vis consumer confidence surveys.  According to Nationwide, consumer confidence fell to 38 in February versus 48 in January, which is the lowest reading since the survey began in 2004.


On the unemployment picture, the rate continues to tick higher, adding 10bps month-over-month in January to 8.0%, however the jobless claims figure improved remarkably, falling 10K versus expectations for a 2K gain in February.


The housing market data also fails to impress across multiple surveys.



GBP and Gilt Strength


Despite our negative outlook on the UK economy over the intermediate term, we continue to see strength in the GBP-USD and the credit market which we think is a function of the UK’s fiscal sobriety to issue austerity and cut the deficit versus, in particular, the US’s fiscal irresponsibility and USD debauchery.  We’re currently long the currency via the etf FXB. We covered our short position in Italy (EWI) today and remain long Spain (EWP) in the Hedgeye Virtual Portfolio.


Matthew Hedrick



Osborne’s 2011 Budget and UK Outlook - retail sales uk




March 29, 2011






  • The belief that ‘any press is good press’ is just not reality – case in point, ANF’s new “Ashley” bikini…a padded top for girls starting at age 7. In fact, after releasing the product on its Abercrombie Kids website over the weekend, the company removed “push-up” from its description. No stranger to controversial marketing tactics including the infamous Quarterly, which reappeared briefly last year, the company has taken its edginess down from 20s, to teens, and now to 7-year olds. 
  • Add Hot Topic to the growing list of companies that will no longer report monthly sales. Among additional changes at the corporate level, the company’s CEO Lisa Harper has taken over primary merchandising responsibilities. While reflecting on the turnaround underway relative to her experience at Gymboree, Harper highlighted the task ahead is less structural a la GYMB and more about merchandising, planning, and product with a clear focus on turnover.
  • Texas-based sporting goods retailer Academy Sports will be celebrating the grand opening of its first store in the state of Georgia with a 70,000 sq. ft. store in Atlanta this Friday, April 1st. While Hibbett Sports may prefer the date to have greater meaning, the reality is Academy has become a better competitor in recent years compared to its historical position as the industry’s low-cost player. With both DKS and HIBB both focused on expanding westward, Academy’s latest move may stifle the company’s progress as it looks to secure its core markets.



Cotton Prices Expected to Fall in 2011 - Cotton prices are expected to plunge 51% to $1 a pound by Dec. 31, according to the median in a Bloomberg survey of 14 analysts and traders. Farmers around the world are planting more cotton to profit from high prices. Cotton rose to $2.197 on March 7, the highest in 140 years of trading in New York, after flooding in Australia and Pakistan and freezes in China ruined crops. The U.S. Department of Agriculture estimates that cotton crop output may rise 11% next year (beginning August 1), compared with a 3% gain this year. Analysts are predicting that production will increase from most of the world’s major cotton producers this year, and that the U.S. will plant more than 13 million acres of cotton this season, up from 11 million acres last year.Hedge funds are already cutting bets on higher prices by the most in three years, the report indicated.<SportsOneSource>

Hedgeye Retail’s Take: As Manny Chirico of PVH noted this morning, brand manufacturers are only seeing spot rates starting to come down, but there has not been any buying actually taking place just yet. Weighted average cost could, and should, go up even as cotton retreats. Best case, we think that a better planting cycle helps 2013. Do you want to invest based on 2013 numbers? Didn’t think so…


Chinese Industry Slammed by Rising Costs - Higher labor and materials costs, and the maturing of its economy have pummeled the Chinese apparel and textile production industry in recent months, leading to mass factory closures, cost control measures and a certainty of higher prices to come for customers. Factories across the manufacturing zone in the Pearl River Delta and on the eastern seaboard have reported cutbacks and closings in the past six months, largely due to soaring cotton prices and the increased salary and benefit demands to attract workers. Factory bosses now say they expect a streamlined, more efficient and higher-end production chain to emerge, but the transition period will be difficult. In short, big changes lie ahead for the world’s largest maker and exporter of apparel.<WWD>

Hedgeye Retail’s Take: Consistent with what we heard out of Li-Ning last week suggesting labor cost increases of +10%-15% are not a near-term aberration, but rather a trend that will continue ‘in coming years.’


Central America Warming Up to CAFTAIn the five years since the Central American Free Trade Agreement was implemented, U.S. and European apparel brands and retailers have faced sourcing challenges but are now said to be looking to increase business in the region. While the recession hit Central America hard and led to a decrease in U.S. apparel import volume in 2009 and created an uncertain business climate for the seven CAFTA countries, trade has begun to bounce back in the past year and companies are now exploring new investment opportunities. Central America’s apparel and textile industry could attract significant apparel investment by 2015 as U.S. and European brands shift activities to offset deepening sourcing woes in Asia, industry experts said. <WWD>

Hedgeye Retail’s Take: There has been a clear shift in focus by many retailers that have started to look beyond China to both Central and South America as alternative export markets. Increased labor rates have closed the gap and with transportation costs also starting to weigh on margins, proximity matters. VF has had a clear relative advantage here in recent quarters as one of the few brand manufacturers with Mexican-based production. The problem is that capacity in Asia vs. Central America is 20 to 1.


Borders Liquidators Squeeze Cash From Doomed Stores - At the Borders Group Inc. store on Broadway near Wall Street, box sets of Stieg Larsson’s best- selling “Millennium” trilogy, including the “The Girl With the Dragon Tattoo,” sat on a table near the door last week on sale for $69.39 -- a liquidation markdown of 30 percent. The set costs half as much on Amazon.com Inc. (AMZN)’s website, where it was listed for $34.58 -- with free shipping. Amazon’s Kindle e-book editions were even less, priced at $27.97. At Wal-Mart Stores Inc.’s website, the three books sold for $34.96. Borders, the second-largest U.S. bookstore chain after Barnes & Noble Inc. (BKS), filed for bankruptcy last month after management shuffles, firings and debt restructuring failed to combat falling book sales and competition from Amazon and Wal-Mart. It pledged to shutter about a third of its stores. <Bloomberg>

Hedgeye Retail’s Take: Creditors have recently rallied for BGP, but the downward thrust of this business has it heading inevitably South.


Carven Opens First Store Having in four seasons resuscitated dormant French fashion house Carven, designer Guillaume Henry now holds the keys to the brand’s first women’s wear store under his tenure, at 36 Rue Saint Sulpice on the Left Bank here. Its doors open today.  The boutique, once the spot of a 19th-century brothel, has had numerous lives before becoming a Carven store. “I stumbled across this boutique by chance and thought, this is perfectly situated in the heart of Saint Germain and opposite the Saint Sulpice church,” said Henry. Eric Chevallier — who is also responsible for visual merchandising at Paris’ concept store Colette — was called in to design the Carven space. “I wanted to use all the codes that are emblematic of Paris daily life,” he explained, while standing with Henry in the pristine, home-like 800-square-foot store.  <WWD>

Hedgeye Retail’s Take: Best known stateside as one of the featured brands at Barneys’ stores this season, selling the brand’s fragrance license last year was probably the right move in hindsight enabling management to focus on continuing to build brand momentum.


EU Law Could Choke E-Commerce Startups - It's an old story in Europe: ham-fisted regulation stunting growth and innovation. This time it's new legislation that could affect the e-commerce industry. A proposed EU directive will  change online return policies, which could end up hurting ecommerce startups. The bill is not yet final, with many more steps before eventual passage in June, but here's where it stands today: Customers would get 14 days, instead of 7 days currently in most European countries, to return goods, with a further 14 days to send them back. Crucially, the merchant would have to give customers a full refund even before receiving the goods to ensure they're not damaged.  For any order over 40 euros, the merchant would have to offer free returns. Merchants would have to offer shipping and free returns across all European countries. The law would hammer e-commerce startups' margins and raise prices. <BusinessInsider>

Hedgeye Retail’s Take: Clearly an effort to maintain the highly fragmented nature of European markets – this regulation would debilitate retailer’s profitability in the e-commerce channel. In addition to the swallowing the shipping cost – a factor many domestic retailers are coping with – the full refund before receipt policy would require added staff and costs to recover returns that been damaged or used in the process.




The Sisyphean fight that is Bernanke’s refusal to acknowledge reality is becoming more and more apparent to the consumer.


The other day, Darden reported softer than expected top line numbers, especially at the Olive Garden.  While management noted some issues with promotional offerings that did not resonate with the consumer, the underlying trends for the consumer are not as healthy as they were in 4Q10.  Clarence Otis, CEO of Darden restaurant said that higher gas prices “serve as a tax” on the consumer and that it had a “dampening effect on sales trends in February.”   Is does not look like the policies in Washington are going to change and the war of attrition consumers are facing looks to be continuing for some time to come..


The strong earnings season, positive conflicted government data, and it’s looking more and more like a Bernanke recovery and not a consumer recovery.  The fourth quarter of 2010, many have said, confirmed that a consumer recovery was in the bank.  Consumer data emerging in 1Q11 is now calling that view into question.


The expectation that the consumer will lead this recovery from start to finish is unreasonable.  the support mechanism are not there.  Yesterday the government reported that excluding the effects of changes in tax payments and Social Security contributions, disposable income would have risen 0.3% in February and 0.2% in January rather than the 0.3% and 0.8% reported.  Consumer prices, as measured by the consumer spending deflator, rose 0.4%, the fastest growth since June 2009.  Inflation rising, house price depreciating, and the looming prospect of interest rates increasing are factors that do not point to the consumer staying rock-solid throughout this process.


The consumer has no purchasing power on an inflation-adjusted basis and, when excluding transfer payments, the outlook is very negative.  At best, we can expect consumer spending to remain at its current level, but that would imply no meaningful increase in the savings rate or balance sheet repair.  Regulators are also proposing a draft definition of a “qualified residential mortgage” that could, when finalized, preclude all but the most conservative mortgages from being defined as “qualified residential mortgages”.  Under the proposed rule, among other stringent conditions, buyers seeking a mortgage to buy a home will be required to put down at least 20%.  As our Financials Team wrote this morning, the current version of the definition is expected to be a headwind to the housing market.  The current downward slide in home prices and the prospect of a new era of sky-high down payments is disconcerting to say the least. 


Not surprisingly, the Conference Board reported today that consumer confidence fell significantly in March; reaching a three year high in February.  As we have been highlighting in the past few consumer posts, the expectations component is largely driving the overall index and was again instrumental in March as it fell to 81.1 from 97.5 (previously 95.1); the present situation component rose to 36.9 from 33.8 (previously 33.4).  Overall, confidence fell to 63.4 from 72 (revised from 70.4).


As Keith alluded to in this morning’s Early Look, inflation is not a positive sign for a market experiencing 30-year highs in corporate margins.  The consumer’s margins certainly aren’t at peak levels and the pain is coming through in the numbers.




THE CONSUMER'S WAR OF ATTRITION   - conconfexpmarch11


THE CONSUMER'S WAR OF ATTRITION   - conconfpresmarch11


Howard Penney

Managing Director


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