“It ain’t over ‘til it’s over.”
My name is Daryl Jones. I’m a former hockey player from Alberta. I practice yoga (sometimes even Bikram yoga).
Last night I was thinking what it must be like for the Greek Socialists to have to fully embrace the concept of dramatically cutting government spending. From a personal perspective, I think it is a little like me admitting that I practice Yoga. In my heart, I’m still a hockey player, but deep down I also know that practicing yoga is much better for my aging, thirty-something body. Nonetheless, it remains embarrassing to admit. (No offense to any of our Yogi readers.)
Yesterday, Greek Prime Minister George Papandreou won a confidence vote to sustain his leadership of the Greek government. The next major date for the Greek government is June 30th when the Greek parliament votes on austerity measures of EUR28 billion. Assuming these measures are passed, then the EU and IMF will extend a EUR12 billion lifeline to Greece.
Obviously, it is unlikely that these austerity measures do not pass, given the new cabinet has passed the confidence test. The reaction from the markets to the likelihood of austerity and additional bailout monies for Greece was, well, muted at best. In fact, Greek 10-year yields declined a measly 30 basis points from yesterday to 16.97%, while the periphery yields moved even less with both Spain and Italy 10-year yields effectively flat from yesterday. The markets are calling the impending extend and pretend from the EU and IMF for what it is – a short term solution to a long term issue. As we all know, being on the wrong side of a duration mismatch is never a good thing.
The other day I had an exchange with a friend that started with her asking me generally about the economy (for purposes of privacy we will call her The Diplomat). Our discussion quickly evolved into a broad discussion of economic policy. To be fair to The Diplomat, while she has a BA from Yale and law degree from Harvard, she has a limited economic background. She also willfully admitted that she gets most of her info from The New Yorker and New York Times. After I went on a bit of rant about the low return of government spending, she responded, “I thought Keynesian economics was sound.”
This, ironically, is the one key positive from the sovereign debt issues in Europe. These issues are quickening the pace towards the demise of Keynesian economics. The simple fact that a Greek Socialist had to fight to retain his government in order to have the ability to pass massive government spending cuts is about as representative of the end of Keynesian economics as it gets. In the long run, this will be a positive. In the short run, we will see more pain.
Just over a year ago, on May 18th, 2010, we gave a presentation to our subscribers entitled, “Bearish Enough on Spain?”. The presentation is posted here:
Last May, while the Greek issues were widely known, we contended that investors were not bearish enough on the peripheries, in particular Spain. Spanish CDS literally bottomed the day we gave our presentation and has been trending upwards steadily ever since. Specifically, 5-year CDS closed at 177bps on May 18th, 2010 and last traded at 279bps, which is a 56.8% return from our call.
The primary takeaway from Greece’s actions yesterday and the market’s reaction today is that sovereign debt issues are far from over and, we would submit, our call that investors are still not bearish enough on the peripheries remains intact. If Greece can rattle the world’s markets, the reaction will be amplified as fiscal and debt issues accelerate in Spain and Italy. For reference, Spain is the 8th largest economy in the world and 5th largest in Europe, or 5x the size of Greece. Spain ain’t Kansas, and I ain’t Toto.
With the excitement in Greece behind us, the focus returns to the United States today and the FOMC statement and the Bernanke presser thereafter. Our view on U.S. interest rate policy is that the Fed will remain Indefinitely Dovish. To be specific, we believe this means an interest rate increase will not occur before well into 2012. As for Quantitative Easing, recent rhetoric suggests that the Fed is done with this policy. History, on the other hand, suggests that if we get three or so months of negative payrolls, the policy will be revisited, even though Chairman Bernanke clearly appears frustrated by the limited impact of QE1 and QE2.
The reality is, though, that the ineffectiveness of QE1 didn’t stop the Fed from implementing QE2. Personally, I don’t believe I’ve seen a more apropos manifestation of Albert Einstein’s definition of insanity than Quantitative Easing. As Einstein said:
“Insanity: doing the same thing over and over again and expecting different results.”
Daryl G. Jones
TODAY’S S&P 500 SET-UP - June 22, 2011
After 11 consecutive trading days of ZERO Sectors of 9 being bullish on the Hedgeye immediate-term TRADE duration, 2 of 9 Sectors flashed green yesterday - Healthcare (XLV) and Utilities (XLU). That's the good news.
The bad news is that is a very defensive rotational signal - and the SP500 overall did not confirm bullish TRADE (1305 is TRADE line resistance). So we shorted the SPY at 1297 today, looking for a continuation of this market's bearish intermediate term TREND (1320 is TREND line resistance). Fortuitously, we covered our Basic Materials (XLB) short last week when we signaled a "Short Covering Opportunity." We also remain long Healthcare (XLV), which is now up +12.2% for the YTD.
As we look at today’s set up for the S&P 500, the range is 46 points or -2.82% downside to 1259 and 0.73% upside to 1305.
SECTOR AND GLOBAL PERFORMANCE
- ADVANCE/DECLINE LINE: +2167 (+1098)
- VOLUME: NYSE 851.16 (+8.23%)
- VIX: 18.86 -5.65% YTD PERFORMANCE: +6.25%
- SPX PUT/CALL RATIO: 1.57 from 1.65 (-4.80%)
CREDIT/ECONOMIC MARKET LOOK:
- TED SPREAD: 22.52
- 3-MONTH T-BILL YIELD: 0.03%
- 10-Year: 2.99 from 2.97
- YIELD CURVE: 2.59 from 2.59
MACRO DATA POINTS:
- 7 a.m.: MBA Mortgage Applications, prior 13.0%
- 10 a.m.: FHFA House Price Index, est. (-0.3%), prior (-0.3%)
- 10:30 a.m.: DoE inventories
- 12:30 p.m.: FOMC rate decision
- 2:15 p.m.: Bernanke press conference
WHAT TO WATCH:
- Bullish sentiment increases to 37.6% from 37.0% in the latest US Investor's Intelligence poll
- Greek Prime Minister George Papandreou won a parliamentary confidence vote
- Americans are growing more dissatisfied with Obama’s handling of the economy, Bloomberg poll shows
- FOMC completes two-day meeting with interest-rate decision at 12:30 p.m
COMMODITY HEADLINES FROM BLOOMBERG:
- Silver-Coin Sales Boom at Perth’s Mint as Mums and Dads Desert Paper Money
- Sugar Crop in Thailand Climbing to Record for Second Year May Curb Prices
- Century of Hunger Is Warning From France as Farm Ministers From G-20 Meet
- Nickel-Concentrate Imports by China Double to Record as Production Climbs
- Aluminum’s Premium Gains Being Fueled by LME Warehouse Rules, Harbor Says
- Oil Drops on U.S. Stockpiles, OPEC Output; Goldman Sees ‘Choppy’ Prices
- Copper Drops on Concern Europe’s Debt Crisis May Erode Demand for Metals
- White Sugar Rises on Speculation About Crop Losses in Top Producer Brazil
- Wheat Gains as 16% Slump Lures Buyers, Canada’s Acreage Drops on Weather
- Gold May Advance as European Sovereign-Debt Concern Stokes Investor Demand
- Oil May Rise Above $95 a Barrel After Clearing Band: Technical Analysis
- Rubber in Tokyo Declines to Four-Week Low as Supply From Thailand Expands
- Rainstorms in China Provinces Seen Raising Concerns of Reduced Rice Crop
- Europe Commodity Day Ahead: France Warns of Century of Hunger Before G-20
- EUROPE: red across the board with Greece bucking the trend but trading below TREND lines
- ASIA: green across the board, with China (which we are long) up +0.10%, Japan up 1.79% and India is sliding again down -14.53% YTD
This note was originally published at 8am on June 17, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“Measured objectively, what a man can wrest from Truth by passionate striving is utterly infinitesimal.”
What’s the truth? Greek politicians lied.
Market prices don’t lie; politicians do. We have politicians running countries and banks. Everyone but them realizes that most of them are market morons. Use that truth to your risk management advantage.
While professional politicians wouldn’t even know what Excel sheet to launch alongside a real-time market price to measure market risk, you can bet your Madoff that these people know how to manage their political career risk.
That’s what I expect to see coming out of this weekend in Europe. That’s why I think the Euro has an immediate-term bid this morning. That’s why I have looked at the 7th consecutive week of down Global Equities as a Short Covering Opportunity (moving to 12 LONGS, 7 SHORTS in the Hedgeye Portfolio).
What’s the truth?
- The US Dollar is finally stabilizing above our critical $74.41 support line
- The US Dollar going UP = Deflating The Inflation
- The Euro (and the Fiat Fools who back it) are perpetuating 1 and 2
To say that’s not the truth would imply that Mr. Macro Market is lying. There is Infinitesimal Truth in the market’s prices if you accept that A) uncertainty and B) interconnectedness can lead you to it.
What’s the truth?
- For June 2011 to-date, the SP500 is DOWN -5.8%
- For June 2011 to-date, the Russell2000 is DOWN -7.9%
- For June 2011 to-date, the CRB Commodities Index is DOWN -4.6%
At Hedgeye we’ve called this Deflating The Inflation (Q2 Macro Theme). It’s occurring in the price of your home, stocks, and commodities. And yes, in the end, Deflating The Inflation is going to be very bullish for Global Consumption (70% of US GDP).
What’s the truth?
- Week-to-date, the price of Oil (at $93, which was our target) = DOWN -6.1%
- Week-to-date, the price of Cotton = DOWN -10.1%
- Week-to-date, the price of Wheat = DOWN -9.9%
And the truth about Deflating The Inflation in commodity prices is that 99% of the free, socialist, and communist world likes it. As for the other 1% of us who are chasing monthly performance metrics to manage our own career risk, I don’t think God cares.
I’m not trying to be trite. I like God a lot – but he doesn’t owe me a return. From the day that I started this business, I have been focused on transparency, accountability, and trust. All encompassing in these principles is the truth.
Whether people who want to see me fail like it or not, the truth is that Hedgeye has been right on 16 of 17 closed positions (LONG and SHORT) in the Hedgeye Portfolio in June. The truth is that’s called alpha – and we want you to embrace the process that generated it.
We are passionately striving for Macro Market Truths. They are very different than political realities. Since the US Federal Reserve was created in 1913, the world has had to deal with the market volatility caused by Fiat Fools implementing short-term career risk policies.
I have been on the road talking about this chart for the last 10 weeks, so many of you who have given me some of your time will be familiar with it (see Chart of The Day attached). This is a Reinhart & Rogoff chart from “This Time Is Different” (by the way Mr. Greek Politician man, it’s not) that tracks the median inflation rate going back to the year 1500.
This is a Global Macro chart. And yes members of the Keynesian Kingdom, markets are now Globally Interconnected. Ever since the world allowed professional politicians to decide what the perceived “value” was for fiat currencies (the post Gold Standard period, 200 years of Global Industrialization, 1740 to WWII – see chart), we have done nothing but:
- Shorten economic cycles of inflation/deflation
- Amplify the volatility of those inflating/deflating prices
If La Bernank et La Trichet have an answer to the causality embedded in this 510 year picture, I think the 99% of us would be more than happy to hear their version of the truth.
My immediate-term support and resistance ranges for Gold (we are long), Oil (Goldman has been bullish; Hedgeye Bearish), and the SP500 (we have covered all sub-sector S&P ETF shorts), are now $1521-1554, $93.01-98.98, and 1260-1278, respectively.
Best of luck out there today and enjoy your weekend. Happy Father’s Day, Dad.
Keith R. McCullough
Chief Executive Officer
Conclusion: The case for being long Chinese equities continues to strengthen by the day and as Chinese economic data starts to come in less and less bad, we expect shorts to cover on the lack of incremental catalysts and longs to dip their toes back into the water once prices start to confirm. Additionally, we touch upon key TAIL risks and reports of corporate fraud in the report below.
Position: Long Chinese Equities (CAF).
From a price and sentiment perspective, buying Chinese equities right now feels akin to catching a falling knife. Thankfully, however, we spend countless hours modeling prices, economic data, and probability-weighting certain scenarios so that we’re prepared to catch them by the handle and not the blade. Still, the overwhelming amount of negative sentiment surrounding China is hard to ignore – even from our typically contrarian seats.
From our vantage point, there are three key issues weighing on the prices of Chinese equities:
- Growth is Slowing;
- Inflation is Accelerating; and
- Interconnected Risk is Compounding.
If this sounds familiar it’s because it is the same three-factor setup we introduced in January 2010 when we turned bearish on China via our then-contrarian Chinese Ox in a Box thesis. Since the start of last year, Chinese equities have fallen -19.2% and at one point had lost over a quarter of their value.
Now, we have been sounding the bullish siren as the data supporting each of the three aforementioned factors goes from “bad” to “less bad” on a go-forward basis. What continues to differentiate our models from our sell-side “competition” is the acute focus on slopes rather than absolutes. Understanding that price is set on the margin affords us conviction in our belief that less-negative slopes are leading indicators for positives slopes – be it for prices, economic growth, etc.
So while it’s nice to say that our models suggests China is likely to print Real GDP growth in a range of +9.2% YoY to +10% YoY in 2Q11, the reality of the situation is that we really don’t care what China’s 2Q GDP number is so long as it falls within our range of probable scenarios. A slowdown of -50bps to +9.2% YoY is less than the -160bps decline from 1Q10 to 2Q10. An acceleration to +10% YoY would imply just that – reaccelerating growth. Either way, the outlook for Chinese GDP growth in the near term looks healthy to us. Even a continued deceleration in growth in 2H would auger bullishly should growth continue to slow at a slower rate.
Bottoms, like tops, are processes – not points.
On the inflation side, we have been vocal about two events that are explicitly bearish for Chinese inflation expectations, as well as expectations of further tightening of Chinese monetary policy. The first being our contrarian Macro Theme of Deflating the Inflation, which is supportive of our second theme – the belief that Chinese YoY CPI readings peak in June (itself supported by our models). On a go-forward basis, falling prices across the commodity complex will be a headwind to Chinese inflation statistics. Sure, there will be commodities like corn that may hang in there, but the broader trend throughout this asset class is negative over the intermediate term. The quantitative setup in the CRB confirms this:
Lastly, from an interconnected risk perspective there doesn’t appear to be much else that could possibly go wrong in China without materially affecting the rest of the world. For example, Narrative Fallacies around the bursting of China’s alleged property bubble and a looming Local Government Financing Vehicle debt crisis are abound in the media.
Falling prices have a certain way of making the bears loud just as rising prices tend amplify the volume of bullish sentiment.
We have done and will continue to do the work regarding the aforementioned risks and our conclusion remains that they are unlikely to materialize over the intermediate term. That is not to say these risks are to be ignored over the long-term TAIL; we are, however, doing our best to manage the Duration Mismatch associated with the bull and bear case for Chinese equities. Simplistically speaking, any intermediate-to-long-term investor that is using the China blow-up thesis as his or her base case should also find it hard to be long anything equity or commodity related going forward. As the world’s second largest economy and greatest source of incremental demand, a material unwinding of China and/or its banking system will have a substantial negative impact on the global economy. For reference, the Chinese economy is nearly 1.5x the size of all the PIIIGS combined (Portugal, Ireland, Iceland, Italy, Greece, and Spain).
Net-net, if you’re bearish on China on blow-up risk alone, we’d reckon you rethink your entire portfolio.
Additional interconnected risks weighing on both Chinese equity prices and sentiment in recent months are horror stories of fraudulent reverse mergers and outright fraud – particularly in the highly publicized case of Sino-Forest Corporation. Prior to a peak-to-present decline of -92.4% on the Toronto Stock Exchange, Sino-Forest used to be a $6.3 billion commercial forest plantation operator in mainland China. Now, after a painful exposition by Muddy Waters LLC in which the tree operator’s reported acreage was aggressively called into question, TRE.TO is now listed as a $483 million enterprise. The Enron-like plunge certainly raises a few questions about the validity of Chinese corporate earnings broadly, and as such, we agree with the market paying a lower multiple for that.
Both anecdotal evidence and historical analysis of Chinese listed enterprises confirm that reporting fraud on a broad scale has precedent in China. From 1 when a series of profitability hurdles were implemented to curb the aggregate volume of secondary offerings, the percentage of listed enterprises demonstrating a return on equity greater than the newly required 10% over three years grew +2,140bps or 25.3x to a peak of 28.8% in 1997. A similar trend emerged (albeit to a lesser extent) in 1999 when the reporting requirement was reduced to 6%.
Net-net, it’s important to know what you own when it comes to China. The same can be said about any exposure an investor chooses to undertake, however. Doing the required due diligence is not a requirement specific to Chinese investments as some would have you believe.
All told, the case for being long Chinese equities continues to strengthen by the day and as Chinese economic data starts to come in less and less bad, we expect shorts to cover on the lack of incremental catalysts and longs to dip their toes back into the water once prices start to confirm.
Lastly, let us leave you with three legendary quotes on investing from three legendary investors. Taken in their entirety best sums up how we feel about our Year of the Chinese Bull thesis.
- “Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.” – Warren Buffett
- “Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected.” – George Soros
- “The time of maximum pessimism is the best time to buy and the time of maximum optimism is the best time to sell.” – Sir John Marks Templeton
Buy low; sell high.
Keith Shorted UA again today in the Hedgeye portfolio for a TRADE. No change here to our fundamental view. As high as our conviction is that UA is investing in all the right areas, the reality is that the stock likely won’t go up as margins and cash flow go the other way. If our analysis holds true, UA will work again as they begin to harvest, which is early 2012. Until then we’ll continue to watch closely for entry and exit points.
HERE’S OUR NOTE FOLLOWING THE COMPANY’S RECENT ANALYST MEETING:
I’m sitting on an Amtrak from UA’s analyst meeting in Baltimore back up to New Haven, and have a mixed analytical read to say the least. I’m trying to ignore the fact that I am sitting next to Ray Lewis…No joke. The dude is completely decked out in UA from head to toe…and he wears it well. (Note to self…I gotta start working out). We’re sitting here eating our Caesar Salads, and I have the screen brightness on my mac as low as possible so he can’t see what I’m typing. If he sees me write anything negative about the brand he knows and loves, I am mildly concerned that he’ll snap my left arm like a pencil. Heck, maybe I’ll roll the dice let him read this when I’m done.
The punchline out of the UA meeting was very poignant. These guys are going to grow, grow, grow. The reality is that this is not exactly a change from the plan all along. Remember that UA could have been printing an operating margin double its 10-11% over the past 8 years if it desired to do so. But instead, it has reinvested in growth. That’s why it’s growing organically today at 20-30%. It’s also why they’ll keep doing that for the next 5 years at a minimum
The only new target thrown out today was that the company would double sales in 3 years – that’s a 28% top line CAGR. What I like here is that it is not just coming from US apparel. Consumer direct going from 6% of sales, to 10% (now) to 23% by 2013 and ultimately 2030 is a massively ambitious goal. But that will help UA achieve these consumer-direct ratios that are double that of other brands.
It’s interesting to think about it, actually. Being such a young brand is a double edged sword. On one hand, they still have a lot of money to spend to get the size and scale to compete on a global cross-gender multi-sport basis with its rivals. But on the flip side, it is not hostage to the legacy processes that the traditional brands are married to as it relates to building a business from scratch. They can shake the Etch a Sketch clean, and literally start fresh. This is particularly an opportunity for Gene McCarthy in building the footwear business, which we think already has a turn time that rivals Nike, and will only get better on the margin
Despite the hyper top line, however, management made it clear that it will not be afraid to spend money to achieve its goals. That’s fine with me. This is a business where you need to spend money to make money. Also, despite what doubters may think, this company has proven to be an ardent steward of capital in recent years.
All that said, capital investment and realization of financial rewards are not simultaneous nor are they linear. Unfortunately, the former needs to come first.
We continue to contend that UA is in an investment period today – in SG&A (Tom Brady, Cam Newton – current charges plus off balance sheet liabilities), cape (building store count to 80 by end of year), and working capital (building a footwear business and filling retail stores with product.)
People focus on sales momentum and EPS growth with this name, but another key stock driver is the cadence of SG&A combined with Capex and Working Capital. When all are headed in the same direction, the stock almost always goes the other way.
Again, to say this brand is killer would be a massive understatement. To say that the management team has grown in breadth, depth and maturity is as well. My confidence level walking out of the meeting into the 100 degree Baltimore sun was quite high that this is one of those unique Consumer companies that will defy growth projections time and time again and will threaten Adidas as the #2 global athletic brand.
But we know that this is a punitive market. As working capital squeezes, our sense is that the stock will trade down on the margin.
The sentiment on the name is close to all time highs (78x), the stock is still peaky, and management stock sales have accelerated. (See our sentiment chart below).
When we put on our TAIL duration hat (3 years or less), we absolutely want to own this name. But holding true to our risk management framework, the TREND and TRADE don’t look compelling. We’ll hold on and look to buy this great company at a better price.
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