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 firstname.lastname@example.org 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,
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.
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THE HEDGEYE DAILY OUTLOOK
TODAY’S S&P 500 SET-UP - April 15, 2011
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.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS:
WHAT TO WATCH:
COMMODITY HEADLINES FROM BLOOMBERG:
ASIA PACIFIC MARKTES:
“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,
Keith R. McCullough
Chief Executive Officer
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…
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