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FORGETFULNESS

This note was originally published at 8am on April 12, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“The name of the author is the first to go
followed obediently by the title, the plot,
the heartbreaking conclusion, the entire novel
which suddenly becomes one you have never read,
never even heard of
,”

 

-Billy Collins, Forgetfulness

 

Human beings are forgetful creatures.  Coaches the length and breadth of this country berate their players to never make the same mistake twice on the court, field, ice, or track.  In retrospect, having tried my utmost to follow this adage in my sporting – and later in my professional endeavors – I think “never make the same mistake ten times” would perhaps be a more realistic goal to set! 

 

Even with regard to that diluted standard, I am sure I have fallen short.  Nonetheless, I am going to make a bold statement to begin this Early Look in earnest: investors, being human, are forgetful.  Believing what they want to – or are paid to – believe, many commentators are pointing out the differences between “this time” and “that time”.  While there are differences; it is 2011 now and it was 2008 then, the similarities are also striking.  This earnings season could very well shape up to be the period where similarities become glaringly obvious.

 

Last night AA officially started the 1Q11 earnings season with a miss on revenues and beat on earnings; investors’ attention is turning towards the balance of the earnings season.  StreetAccount reported last week, for the fourth straight time, that negative preannouncements had outnumbered positive updates over the prior seven days. 

 

The market has been notably resilient in the face of major geopolitical unrest, natural disasters, and a veritable tsunami of freshly-printed Greenbacks originating from the epicenter of Modern-Day Keynesian Dogma: Washington, D.C.   Despite this, and besides the greasing of the market coming from the Free Money Fed policies, the outlook for the S&P 500 merits caution, if not outright divestment. 

 

Currently, in the Hedgeye Asset Allocation model, Keith has maintained near a 0% allocation to US Equities in recent weeks (though is currently at 6%) and is short the S&P 500 in the Hedgeye Virtual Portfolio.  Downward revisions to GDP numbers on a global basis are being coupled by endemic inflation in commodity markets as the US Dollar is debauched.  Hedgeye has been vocal that this current period represents a pivotal process in the market where growth slowing and inflation accelerating is being felt by corporations, citizens, and even bureaucrats alike.  The cycle of corporate earnings is peaking.  Tops are processes, not points.

 

The tone AA set is important, with a market cap of $19 billion and a business model that is tethered to the global macroeconomic climate.  AA represents a prism through which we can attempt to view part of the global economy.  The issues AA faces go beyond this quarter as the stock remains 64% below the peak set on 7/16/07.  Importantly, from a top-line perspective, we think AA will not stand as an outlier this earnings season.

 

Despite the recent optimism, much of it grounded in reality (for a change), surrounding the improving job market and the solid top-line environment evident in corporate earnings, AA’s quarter could be just the beginning of a string of corporate earnings that call the sustainability of the current trend into question.   Consistent with the past few quarters, FX tailwinds and various types of productivity gains will likely allow many companies to meet earnings expectations. 

 

Having said this, it is worth noting that the deep cost-cutting measures that were made in the midst of the Great Recession have left the majority of companies, on balance, leaner and needing less revenue growth to leverage fixed costs.  Nonetheless, with expectations high and inflation accelerating, revenue growth remains a key focus of corporate management teams.  If such a scenario plays out this quarter, it would corroborate quite neatly with Hedgeye’s view that margins – at the level of the past few quarters – are set to roll over.

 

In my view, expectations have already begun to moderate under the threat to profit margins from surging commodity and raw material costs, along with the shocks to the global supply chain from the earthquake/tsunami in Japan.  Alcoa’s management team’s statements confirmed this, as it stated, “earnings were curbed by a weaker U.S. dollar and higher energy and raw-material costs”.

 

As we proceed through this earnings season, I would argue that it is important to recognize the signs of demand destruction that is going to result from inflation.  Gas prices, thus far, do not seem to have impacted consumer spending as meaningfully as one may have thought, given that prices at the pump over the past couple of months have steadily risen. Perhaps the consumer is somewhat accustomed to high food and energy costs, having been there before, or at least has faith that prices will come down, be it by Centrally-Planned or Divine means? 

 

In the US, consumer behavior has not been as affected, as immediately as it was during the last spike in gas prices.  However, signs are starting to manifest themselves that Americans are not impervious to the effects of inflation, even if the Chairman of the Fed is.  Darden Restaurants’ Inc. CEO Clarence Otis opined on his company’s most recent earnings call that gas prices were “having a dampening effect” on Darden’s business.  Other casual dining companies have since echoed Otis’ comments, predicting that the almost-certain-to-be higher gas prices during the upcoming summer months will result in demand destruction that will hurt their profitability via the top-line.  

 

The case for inflation-induced demand destruction is playing out in the UK today. UK retail sales dropped by 1.9% (on a same-store basis sales declined 3.5%) in March as accelerating inflation squeezed households’ spending power at the fastest rate in 60 years; the decline is the biggest drop since the series began in 1995.  

 

It is not late 2007/early 2008, it is 2011, but lest we be forgetful, this is the same country that it was three years ago.  Gas prices at this level will matter on the corporate bottom line and, if one listens to the early indications from executives such as Otis, they already matter a great deal.

 

The Faithfully Forgetful may point out other differences between 2008 and 2011.  Housing was more of an issue then, someone might say.  At Hedgeye, we would argue that the housing markets of 2008 and 2011 are eerily similar in that not enough attention is being paid to the fundamental strength, or lack thereof, in the housing sector.  As our Financials Team has reiterated for months on end, housing is set to decline sharply throughout 2011.  This call is no longer a prediction; it has been playing out for months now as Corelogic, Case-Shiller, and New Home Sales data continue to highlight softness in residential real estate.   As always, feel free to reach out to sales@hedgeye.com if you would like to see the detail of Hedgeye’s Housing Headwinds thesis.

 

Rather than pointing out the obvious differences, I believe it is the similarities between this market and that of three-and-a-half years ago that are far more interesting.  A market showing resilience in an upward trend is encouraging for investors and so it should be.  However, a market barely breaking stride in the face of tectonic shifts in global geopolitics and parabolic price action in commodity markets exhibits a detachment from reality and should not be comforting to investors.  Having blind faith in the appearance of resilience, and forgetting how the story may end and has ended before, could prove a costly mistake.

 

Function in disaster; finish in style,

 

Howard Penney

 

FORGETFULNESS - EL 4.12.11 gas pump

 

FORGETFULNESS - Virtual Portfolio


THE M3: IMPORTED WORKERS; SJM; PRIVATE HOME SALES; RETAIL SALES; CHINA GDP & CPI

The Macau Metro Monitor, April 15, 2011

 

 

IMPORTED WORKERS ALMOST HIT THE 80,000 MARK macaubusiness.com

In February, the total number of non-resident workers in Macau stood at 79,500, up 2% MoM.  In September 2008, Macau had a total of 104,000 imported workers, but since then the number had continually fallen MoM until it rose back again for the first time in June 2010.

 

SJM SAYS ABUNDANT GLOBAL LIQUIDITY SHORES UP GAMING INDUSTRY Macau Daily Times

SJM CEO Ambrose So says he is upbeat about the development of Macau's gaming industry this year. So said positive factors for the gaming sector include the US QE that ‘will not tighten shortly’, the ‘very ample’ global money supply and the positive economic expectations of Asia as a whole.  SJM plans to offer more non-gambling elements if the plan for its Cotai project is approved. 

 

PRIVATE HOME SALES REBOUND AFTER 4-MONTH LOW Channel News Asia

After four months of declines, sales of private residential properties in Singapore increased in March by 25% MoM to 1,386.

 

CONSUMERS SLOW DOWN SHOPPING IN FEBRUARY Strait Times

S'pore retail sales dropped 3.6% MoM in February and 12.1% YoY.

 

CHINA ECONOMY GROWS MORE THAN FORECAST- 9.7% Bloomberg

China GDP in 1Q grew 9.7% YoY, while China CPI rose 5.4% YoY, beating expectations of 9.4% and 5.2%, respectively.  Industrial production climbed 15% YoY in March; retail sales jumped 17% YoY; and producer prices gained 7.3% YoY.

 

Meanwhile, Industrial & Commercial Bank of China Ltd., the world’s largest lender by market value, said its bad-loan ratio is dropping and ruled out a worsening of asset quality from property and local government lending.


THE HEDGEYE DAILY OUTLOOK

THE HEDGEYE DAILY OUTLOOK

 

TODAY’S S&P 500 SET-UP - April 15, 2011


Today at 11am we are hosting our 2Q11 Global MACRO Theme conference call (email if you’d like to participate). 

  1. American Sacrifice  - a scenario analysis and calendar of catalysts for the US Dollar
  2. Trashing Treasuries – long of The Bernank’s Inflation, short US Treasuries
  3. Housing Headwinds II – part deux in the Josh Steiner chronicles of the best Housing work on Wall Street

As we look at today’s set up for the S&P 500, the range is 19 points or -0.50% downside to 1308 and 0.95% upside to 1327.

 

SECTOR AND GLOBAL PERFORMANCE

 

We now have 5 of 9 sectors positive on TRADE and 8 of 9 sectors positive on TREND.    

 

THE HEDGEYE DAILY OUTLOOK - daily sector view

 

THE HEDGEYE DAILY OUTLOOK - BEST PERFORMING GLOBAL

 

THE HEDGEYE DAILY OUTLOOK - WORST PERFORMING GLOBAL

 

 

EQUITY SENTIMENT:

  • ADVANCE/DECLINE LINE: 227 (+126)  
  • VOLUME: NYSE 894.31 (-0.73%)
  • VIX:  16.27 -3.84% YTD PERFORMANCE: -8.34%
  • SPX PUT/CALL RATIO: 1.58 from 1.68 (-6.21%)

 

CREDIT/ECONOMIC MARKET LOOK:

  • TED SPREAD: 20.96
  • 3-MONTH T-BILL YIELD: 0.07% +0.01%
  • 10-Year: 3.51 from 3.49
  • YIELD CURVE: 2.74 from 2.74 

 

MACRO DATA POINTS:

  • 8:30 a.m.: Consumer Price Index, est. 0.5% M/m, prior 0.5%
  • 8:30 a.m.: Empire Manufacturing, est. 17.00, prior 17.50
  • 9 a.m.: Net long-term TIC flows, est. 40.0b, prior $51.5b
  • 9:15 a.m.: Industrial production, est. 0.6%
  • 9:15 a.m.: Capacity utilization, est. 77.4%
  • 9:55 a.m.: UMich Confidence, est. 69.0, prior 67.5
  • 10 a.m.: Fed’s Evans speaks in NYC
  • 11:15 a.m.: ECB’s Constancio speaks in New York
  • 1 p.m.: Baker Hughes Rig Count
  • 1:30 p.m.: Fed’s Hoenig to speak on economy at Purdue

 

WHAT TO WATCH:

  • Pressure for CVS Caremark to split up increasing - NYT
  • T. Rowe Price considers exiting UTI Asset Management - Economic Times
  • Fed reports balance sheet assets of $2.67T on Wednesday, +$16.8B w/w and +$326.8B y/y
  • Broadcasters ask CRTC to look at regulating Netflix - Globe & Mail
  • Dunkin' Brands planning a summer IPO, says CNBC's Kate Kelly
  • Treasuries rise as the Fed and President Barack Obama consider cutting stimulus measures for the U.S. - Bloomberg
  • Groupon may pick Goldman Sachs, Morgan Stanley as lead underwriters for planned IPO later this year, said to value company at $15b-$20b: WSJ
  • G-20 finance ministers, bankers meet this weekend in Washington.

COMMODITY/GROWTH EXPECTATION

THE HEDGEYE DAILY OUTLOOK - daily commodity view

 

 

COMMODITY HEADLINES FROM BLOOMBERG:

  • Quest for ‘Holy Grail’ of Super Corn Intensifies on Fertilizer Price Surge
  • Oil Heads for First Weekly Loss in a Month Amid Inflation, Demand Concern
  • Wheat Declines, Erasing Advance, as Russia and Ukraine May Add to Supply
  • Copper May Fall for a Fifth Day as Record Chinese Output Increases Supply
  • U.S. Probably Won’t Repeat Last Summer’s Record Heat, Forecasters Predict
  • Sugar Falls on Brazil Production, Reduced Goldman Forecast; Coffee Rises
  • Gold Is Little Changed After Reaching Record on Global Inflation Concern
  • Copper Production in China Climbs to a Record on Higher Fees After Quake
  • Orphanides Says Not Clear Price Pressures From Commodities Will Fade Soon
  • K+S Bets on Higher Potash Prices on Demand as Investments Constrain Growth
  • Toyota’s Molten Aluminum Turned Into Lump Shows Post-Quake Power Challenge
  • Commodity Trading Rules Are a Target for Worldwide Securities Regulators
  • Oil May Rise Next Week on Mideast Unrest, Saudi Output Cuts, Survey Shows  

 

CURRENCIES

 

THE HEDGEYE DAILY OUTLOOK - daily currency view

 

 

EUROPEAN MARKETS

  • Moody's downgraded Ireland to Baa3 from Baa1; outlook negative.
  • Greek government will decide today on additional measures to cut its deficit.
  • Eurozone March final CPI +2.7% y/y vs consensus +2.6% prior revised to +2.4% from +2.6%
  • Eurozone March final CPI +1.4% m/m vs consensus +1.3% and prior +0.4%

THE HEDGEYE DAILY OUTLOOK - BEST PERFORMING EURO

 

THE HEDGEYE DAILY OUTLOOK - WORST PERFORMING EURO

 

 

ASIA PACIFIC MARKTES:

  • Asian stocks were mixed as inflation and growth accelerate more than estimated in China.
  • The Chinese central bank may boost reserve requirements for lenders as early as today - Bloomberg
  •  Inflation in India also exceeds estimates at 8.98%.
  • China Q1 GDP +9.7% y/y vs cons +9.5%; March CPI +5.4% y/y vs cons +5.2%; March PPI +7.3% y/y vs cons +7.2%.
  • Japan revised February industrial output +1.8% m/m vs initial +0.9%.

THE HEDGEYE DAILY OUTLOOK - BEST PERFORMING ASIA

 

THE HEDGEYE DAILY OUTLOOK - WORST PERFORMING ASIA

 

 

MIDDLE EAST

 

THE HEDGEYE DAILY OUTLOOK - MIDEAST PERFORMANCE

 

THE HEDGEYE DAILY OUTLOOK - LEVELS 415

 

 

Howard Penney

Managing Director


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.64%
  • SHORT SIGNALS 78.57%

Currency Crash

“It would be very advantageous to allow the currency to appreciate as a way of controlling inflation.”

-George Soros, April 10th, 2011

 

That’s a very simple but critical comment Soros made last week at the Bretton Woods meetings in New Hampshire. He wasn’t talking about the US. He was talking about China.

 

He or she – whoever the overlord of policy making may be – should be thinking long and hard about what a US Currency Crash not only means for The Inflation that’s priced in US Dollars, but what they can do to fight it for the sake of their starving citizenry.

 

US Currency Crash?

 

It’s in motion folks – and if it happens, I think it happens in the next 3 months.

 

That should read as a bold statement, because it is… And the best way to put a picture with that prose and turn up some volume will be to dial into our Q2 Global Macro Theme conference call today at 11AM EST (email if you’d like to participate).

 

As is customary, Big Alberta and his Hedgeye knights have prepared the anchor with a 50 slide presentation that will lock us into making the risk management calls that we don’t think you can afford miss.

 

As a reminder, with the intermediate-term TREND overlay of Growth Slowing As Inflation Accelerates, our Q1 Global Macro Themes were:

 

1.  American Sacrifice  - a scenario analysis and calendar of catalysts for the US Dollar

2.  Trashing Treasuries – long of The Bernank’s Inflation, short US Treasuries

3.  Housing Headwinds II – part deux in the Josh Steiner chronicles of the best Housing work on Wall Street

 

This morning’s call will focus on what an expedited US Currency Crash could look like and the following Q2 Global Macro Themes:

 

1.  Year of The Chinese Bull

2.  Deflating The Inflation

3.  Indefinitely Dovish

 

While we realize we have a target on our foreheads for calling out places like The Lehman Brother, The Bear Stearn, and The Banker of America, we have grown accustomed to it and we wear it with pride.

 

Living a risk management life of consensus and strong buy versus maybe buy it after we tell our super duper clients to sell into you isn’t a life to live. At Hedgeye, the name on the front of our jerseys mean more than the ones on our backs. We don’t make contrarian calls for the sake of being contrarian. We make these calls because we think they have the highest probabilities of being right.

 

Maybe we’re a little artsy with our Soho office. Maybe we’re a little jocky with our dressing room in New Haven. But when we make a call, there is no maybe – it’s long or short – and it’s on the tape.

 

On the Currency Crash call, I’ll save the juicy details for 11AM. We didn’t need to have a super secret one-on-one in Washington with a “consultant” to the professional politicians to make this call either. Over the last 3 years we’ve made 19 long and short calls on the US Dollar – and we’ve been right 19 times – so we’re going to stick with the process on that.

 

On The Chinese Bull

 

Oh what a sexy call this one is going to be. The Hedgeyes versus the former roommate of a Yale Hockey player – Jim Chanos. We were bullish on China in 2009, bearish on China in 2010, and now we’re going to ride shotgun on this red bull before consensus does.

 

Last night’s Chinese GDP growth report beat our already above consensus estimate, coming in at +9.7%. While that’s a sequential slowdown versus the Q4 2010 China GDP report of +9.8% - that’s a deceleration in the slowdown – and on the margin, which is what matters most in making Global Macro calls, that’s what we call better than bad.

 

When better than bad is cheap (which Chinese equities are on an absolute and relative basis to both themselves and Asian Equities overall), that’s when shorts have to start covering. When better than bad is cheap and price momentum turns positive – that’s when Wall Street has to chase the asset’s price performance.

 

More on that and why we think Chinese inflation is setting up to deflate from the Elm City during our conference call. If it’s the beginning of the quarter, it’s Global Macro Theme time at Hedgeye.

 

My immediate-term support and resistance lines for oil are now $105.41 and $109.24, respectively (we bought our oil back this week at $106). My immediate-term support and resistance lines for the SP500 are now 1308 and 1325, respectively (we’re short the SP500).

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Currency Crash - Chart of the Day

 

Currency Crash - Virtual Portfolio


CBRL - demand demolition

Cracker Barrel is, in my view, the most susceptible of all restaurant concepts to the demand destruction that is caused by elevated gasoline prices.  We charted CBRL traffic trends versus miles driven in our post on 4/12.  Today, the Hedgeye Energy team produced a telling chart today showing that gasoline prices are looking a lot like 2008. 

 

If gasoline consumption trends are rolling over, the miles driven statistics will follow.   CBRL has struggled to generate significant traffic growth for some time now.  From the second quarter of this year, it should slow even further.   At the very least, it’s difficult to argue that CBRL will see the pick up in traffic that the concept needs.  A combination of inflation and slowing same-store sales is not what we are looking for in today’s environment.

 

The following come from the Hedgeye Energy team in today’s note titled, “GASOLINE CONSUMPTION SHOWING EARLY SIGNS OF A 2008 REPEAT”:

 

MasterCard Advisors reported this week that US retail gasoline stations sold 9.02MM b/d of gas in the week ending April 8th – a 3% drop year-over-year.  It was the six straight weekly year-on-year decline, indicating that demand destruction as a result of higher prices has set in, and it is eerily similar to 2008.

 

In early May of 2008, with the price of Brent crude oil near $110/bbl and the regular gasoline at $3.60, gasoline consumption went decidedly negative for 30 straight weeks.  During that time (May 2008 – Nov 2008) the price of Brent crude oil went from $108/bbl in May to its mid-July peak of $145/bbl before crashing to $60/bbl in December.  Prices did not find a bottom until February 2009, near $55/bbl.  

 

In fact, in 2008 it was not until gasoline consumption was negative year-on-year for 12 consecutive weeks that oil and gasoline prices peaked and subsequently began their rapid declines in mid-July.

 

The fact that higher gasoline prices impair demand and economic activity is obvious.  What’s not so apparent is the threshold and timing at which it does so.  Recent history reminds us of the damage that high energy prices can have on asset prices.  With gasoline consumption negative for six straight weeks and the average price of a regular gallon of gas at $3.79, the spring of 2011 is beginning to look a lot like the summer of 2008…

 

CBRL - demand demolition - gasoline energy 

 

 

Howard Penney

Managing Director

            


A Tale of Two Asias

Conclusion: From a monetary and fiscal policy perspective, we continue to see a widening divergence between developing Asia vs. developed Asia, which is contributing heavily to the divergent paths of the real economies. Net-net, we remain favorably positioned to China and Singapore and bearish on Japan and Hong Kong.

 

Positions:

Long Chinese equities (CAF);

Long Chinese yuan (CYB);

Bullish on the Singapore Dollar for the intermediate-term TREND and the long-term TAIL;

Getting constructive on Singaporean equities for the intermediate-term TREND and Bullish for the long-term TAIL;

Bearish on Japanese equities for the intermediate-term TREND and the long-term TAIL;

Bearish on Japanese yen for the intermediate-term TREND and the long-term TAIL;

Bearish on long-term JGBs for the intermediate-term TREND and the long-term TAIL; and

Bearish on Hong Kong dollar-based fixed income for the intermediate-term TREND and long-term TAIL.

 

Developing Asia: China & Singapore

 

Judging by our writing over the past three years, it’s no secret that China and Singapore continue to be our favorite investment destinations in Asia on the long side – be it equity, currency, or fixed income. That certainly doesn’t mean we’re married to these ideas, or perpetually bullish, and we have no problem managing risk around these long-term theses within narrower windows of duration. Key examples of this duration agnosticism include our decisions to put Chinese equities in the “penalty box” for the bulk of 2010 via our Chinese Ox in a Box theme and our decision to back off Singaporean equities alongside all other emerging market equities in early November.

 

As the positioning in our Virtual Portfolio would indicate, China is no longer in the penalty box, and we are getting incrementally warmer on Singaporean equities, as overly bearish consensus growth estimates are likely to be surpassed in the coming quarters.

 

From an absolute perspective, Singapore growth data lags China’s in our models by one quarter, meaning that we expect Singapore’s YoY GDP growth rate to bottom out in 2Q11 before reaccelerating in 3Q11. Tomorrow, China’s 1Q11 YoY GDP report should come in as both a sequential deceleration from 4Q10 and a cycle bottom, which sets the stage for a reacceleration over the next 3-6 months.

 

A Tale of Two Asias - 1

 

From a relative perspective, these rebounds in growth are likely to come at a time when global growth (particularly US and EU) is slowing sequentially – especially if crude oil prices stay elevated. That’s certainly not to say that China and Singapore are immune to this phenomenon and we expect high energy prices to impose a similar burden on these economies as well. That said, however, we do expect equity market investors to once again pay a premium for absolute, unlevered growth – particularly when it’s accelerating on a relative basis (i.e. we expect the “flows” to head toward China and Singapore in the coming months).

 

A Tale of Two Asias - 2

 

On a P/E basis, both China and Singapore are “cheap” relative to the last time their growth rates were accelerating on a relative basis to global growth.

 

A Tale of Two Asias - 3

 

Recapping recent economic data, we continue to see more signs of the resultant effects of sober and proactive fiscal and monetary policy in both countries. For instance, Singapore’s preliminary 1Q11 YoY GDP report showed a deceleration to +8.5% YoY vs. +12% YoY in 4Q10, largely due to a measured slowdown in manufacturing growth (+13.9% YoY vs. +25.5% YoY in 4Q).

 

This growth slowdown is a welcome event by Singaporean officials, as the county has been in a tightening cycle since mid-2010. Still, the robust QoQ SAAR growth rate (+23.5% vs. +3.9% in 4Q) was enough to strengthen their resolve to continue tightening, which they did by re-centering the currency’s trading band upwards (the Singapore central bank uses the Singapore dollar, rather than interest rates, to implement monetary policy). We welcome this proactive maneuver, as Singapore looks to continue warding off inflation, currently running at +5% YoY. This latest revaluation is a net positive for the Singapore consumer, given that we anticipate Singaporean CPI to accelerate into the early-to-mid summer months.

 

Shifting gears to Chinese economic data, we see that the main event is scheduled for later tonight (GDP, CPI, Manufacturing, and Retail Sales). This morning, however, we continued to get positive signs that the Chinese economy is responding well to the recent tightening measures. While both Money Supply (M2) and Credit growth accelerated sequentially in March (+16.6% YoY and +679.4B yuan, respectively), Total National Financing growth came in at 4.19T yuan in 1Q11 – down (-7.1%) YoY.

 

This new, encompassing metric includes bank lending, trust loans, corporate bond issuance, equity fundraising by non-financial companies, and other sources of capital accumulation, and it shows that recent PBOC efforts to combat inflation are having the desired impact. M2 and Credit growth rhymed with this reading when analyzed with a wider lens: M2 growth remains (-1,310bps) below its Nov ’09 peak growth rate and aggregate Credit growth fell (-13.3%) on a YoY basis in 1Q11. All told, we expect the Chinese equity market to welcome these depressed growth rates because they: a) give the PBOC headroom to slow the pace of tightening; and b) they provide stability for China’s long-term economic growth.

 

Developed Asia: Japan & Hong Kong

 

Insomuch as we love China and Singapore for the long term, we have an equal disdain for the Japanese economy due to its inability to grow organically – which is made worse by its massive sovereign debt load (north of one QUADRILLION yen) and the Japanese government’s heavy hand in its economy and financial markets. Hong Kong also remains in our penalty box, but for different reasons (reactive, rather than proactive monetary and fiscal policy) and to a lesser extent.

 

Take Japan for instance. In the wake of this recent string of unprecedented natural disasters, the BOJ did what it always does every time the Japanese equity market loses any meaningful amount of value – PRINT LOTS OF MONEY. Unfortunately for Paul Krugman, who advised them to do so in the late 90’s, the tactic has yet to create positive effects for Japan’s real economy. The effects of massive stimulus still remain muted in Japanese financial markets as well, with the Nikkei 225 still trading (-11.1%) below its Feb. 21 peak.

 

To their credit, however, Japanese officials (with the help of their G7 counterparts) did manage to successfully weaken the yen over the near term, as it trades (-5.4%) below its March 17th peak closing price. We continue to echo the sentiment put forth in our recent work, which effectively warns Japan’s bureaucrats to lay off attempts to weaken the yen due to the likelihood it causes a significant uptick in inflation and bond yields in Japan:

 

“History shows us that G7 intervention to weaken the yen has resulted in a significant uptick in inflation within Japan. In fact, if the G7’s plan to weaken the yen is “successful”, we expect the inflationary impact to be even greater this time around, particularly given Japan’s current staggering sovereign debt load and easy monetary policy.”

-Japanese Yen: Be Careful What You Wish For, Consensus… 3/18/11

 

In fact, we’re already seeing signs of the weak yen perpetuating inflation, as well as stirring up inflation expectations in Japan. Yesterday, Japan’s Corporate Goods Price Index accelerated for the fourth straight month, coming in at +2% YoY. Import prices accelerated to +9.4% on a YoY basis and we expect this trend to continue in the coming quarters as Japan accelerates purchases of raw materials and energy products in its rebuilding efforts.

 

A Tale of Two Asias - 4

 

A weak yen is definitely not beneficial for Japan’s rebuilding cause.  A (-29%) slide in the yen after the G7 intervened in the wake of the Kobe earthquake caused Japanese Import Price growth to peak at +15.1% a year later. This surge in raw materials costs was eventually passed through to end consumers as Japanese CPI accelerated from marginal deflation to +2.5% YoY in the ensuing months. Unlike then, however, we contend that the Japanese consumer is unable to absorb rising prices this time around – particularly after a near-decade long trend of wage deflation.

 

A Tale of Two Asias - 5

 

From an expectations perspective, we see that Japan’s short-to-intermediate-term inflation swaps are on the uptrend. In addition, expectations for a major uptick in future JGB issuance is putting a great deal of political pressure on the BOJ to fund the debt via monetization. If Shirakawa elects to go the route of former Japanese Finance Minister Korekiyo Takahashi, “look out above” is the only advice we’d offer to Japanese inflation and inflation expectations. For more details on how this is likely to end up over the long-term TAIL, please refer to our March 25 post titled “Japan: A Fiat Fool’s Game”.

 

A Tale of Two Asias - 6

 

Shifting gears to Hong Kong, we continue to see signs that inflation is a real problem in the former British colony. Hong Kong Property Prices have recently exceeded their all-time highs last seen in 1997 – shortly after the Asian Financial Crisis began. On a YTD basis (through Feb.), property prices have increased +7.2% YoY; this is on the heels of a +24% increase in 2010 and a +30% increase in 2009.

 

In waking up to this gravely concerning property bubble, Financial Secretary John Tsang had this to say:

 

“I am deeply concerned that overall property prices in February have surpassed the peak in 1997. I shall pay close attention to developments in the property market… The current abundant liquidity and low interest rates will not last forever. Neither will rising property prices.”

 

This rhymes with Bernank-style reactionary central banking strategy, whereby officials finally start to “pay close attention” to inflation when inflationary headwinds are beyond obvious and hint at tightening only after the bubble peaks. With GDP growth well above its historical average on just about any duration, it’s no secret that Hong Kong’s Monetary Authority should have tightened interest rates several quarters ago, as both Hong Kong’s main policy rate and real interest rate remain at all-time lows.

 

A Tale of Two Asias - 7

 

A Tale of Two Asias - 8

 

When Hong Kong’s property bubble pops (and it will), Indefinitely Dovish central bank policy should receive the bulk of the blame for any ensuing economic hardship. Princeton-trained economists will blame supply and demand imbalances, all the while ignoring the impact of incredibly dovish monetary policy on aggregate demand. We find this ironic, given that at the heart of Keynesian economics is a belief that monetary and fiscal policy can be used to increase or decrease said aggregate demand.

 

In Hong Kong currently, accelerating inflation (be it in housing, goods, or services) is depressing aggregate demand and causing citizens to take to the streets in protest with increasing frequency and severity. A growing imbalance in per capita income between Hong Kong’s elite and middle class is forcing the government to react to these violent demands, with the latest budget calling for the government to literally give away money to disgruntled citizens, many of whom will likely want more than the $770 handout that’s currently on the table when it’s all said and done.

 

All told, both Hong Kong and Japan show us just what happens to an economy when fiscal and monetary policy remains Indefinitely Dovish; structurally depressed growth rates (Japan), runaway inflation (Hong Kong), and civil discontent (both) are just some of the more pronounced ill-effects. Needless to say, our outlook for both Japan and Hong Kong is not positive on a long-term basis. On the flip side, however, we continue to like the proactive and sober monetary policy of China and Singapore and, thus, we remain favorability positioned to their financial markets.

 

Darius Dale

Analyst


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