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Keynesian Confusion

“Confusion now hath made his masterpiece!”

-William Shakespeare

 

So… according to La Bernank in his Fed Presser yesterday, US Growth Slowing As Inflation Accelerates is “part temporary” … but “part longer lasting”… and while “we don’t have a precise read on why”… we are confident that the entire market should trust our forecasts for growth to re-accelerate.

 

Ben Bernanke’s growth forecasts haven’t been sort of wrong in 2011 - they have been wrong by almost a half! So how can a country that was founded on such fiercely independent principles put up with this level of analytical incompetence from its economic Central Planner in Chief?

 

I don’t know. But after doing a full day of meetings with major money managers in NYC yesterday, I can tell you that Keynesian Confusion is starting to breed contempt. Dollar Debauchery was all good and fine, until people stopped getting paid.

 

What we do know is that economics, never mind Keynesian economics, is a social science (Mr. Krugman, that’s different than a hard science, fyi). We also know that market-based practitioners who apply math to markets make a living off of the academic dogma of Keynesian economists.

 

This is great for my Research and Risk Management business – but really bad for the US economy. My team and I get paid to be right. These guys at the Fed get paid what they’d be worth to an asset management firm managing Globally Interconnected Risk - not much.

 

Back to this morning’s Global Macro Grind

 

USA

  1. CURRENCY – we’ve had a bullish bias towards the US Dollar since the beginning of June; now the USD Index is breaking out above its $74.41 immediate-term TRADE line of support. This is bad for asset prices that are highly correlated (inversely) to the US Dollar.
  2. TREASURIES – we’ve been bullishly positioned on the long-term Treasury (TLT) side of the bond market since May. Yes, we understand that bond yields are low – but we think they are going lower – primarily because people aren’t yet Bearish Enough on US Growth.
  3. STOCKS – we re-shorted the SP500 (SPY) at 3:14PM EST on Tuesday, June 21st ahead of the Greek confidence vote in socialism and La Bernank walking down this forecasts for US Growth. Timing matters.

EUROPE

  1. CURRENCY – having a bullish bias towards the US Dollar (with near-term catalysts that are USD bullish – QG2 ending, a mid-July Debt Ceiling compromise) is reason enough to be bearish on Euros. But the bigger bear brewing in the FX market is Europeans behaving European on go- forward monetary policy. There’s an increasing probability that the ECB considers going for a hybrid version of Quantitative Guessing II.
  2. EUROCRAT BONDS – plenty of European Sovereign bonds look like the Sovereign Debt Default Cycle is just getting started. If you think this is isolated to Greece, market prices are pricing in the other side of that thought. Major risks – and they are not going away anytime soon.
  3. STOCKS – we are long Germany (EWG) and short Spain (EWP). Germany’s PMI (Producer Manufacturing) print slowed significantly in June (54.9 versus 57.7 in April) and we’d be unaccountable to not call that data point out for what it is – Growth Slowing, globally. Across European Equities, the only major market that has not broken its intermediate-term TREND line yet is the German DAX (7103 support), but it’s close!

ASIA

  1. CURRENCY – since one of our Q2 Macro Theme remains “Deflating The Inflation”, we finally sold our 2-year (buy and hold!) long position in the Chinese Yuan (CYB) this week. We think Asian currencies will weaken as commodity inflation does. Don’t forget that most of these countries (China, Australia, India, etc.) have been vigilant in raising interest rates – now they can stop with that.
  2. CHINESE STOCKS – after being bearish on China for the last 15 months, we’ve been on the road articulating the research scenario analysis around A) Chinese Growth Slowing At A Slower Rate and B) Chinese Inflation Deflating. The research and the risk management calls are two very different things (one is research, the other timing), but we did finally buy exposure to the A-shares on June 16th and we are in the money. Despite the Keynesian Confusion, Chinese stocks were up +1.5% last night and have been up for 3 consecutive days, outperforming most of the majors in Global Equities.
  3. JAPANESE STOCKS – we remain long-term bears of the gigantic Keynesian Experiment in Japan and we remain short of Japanese Equities (EWJ) here. Yes Japanese stocks are down -6% YTD and, yes, they had a natural disaster. But the real long-term disaster in Japan is that the average annual GDP Growth rate since 1992 has been 0.85%. Bernanke would be less confused if he embraced Richard Koo’s economic ideas about “Balance Sheet Recessions” and what perpetuates them (cutting rates to the ZERO bound and scaring the hell out of your people).

COMMODTIES

  1. OIL – we remain on the other side of Goldman’s call to buy oil and see immediate-term downside in WTIC Oil to $91.22 this morning.
  2. GOLD – we remain long Gold (GLD) and think it will continue to perform as long as real-interest rates in America remain negative.
  3. COPPER – we remain respectful of Dr. Copper’s Ph.D in the antithesis of Professor Bernanke’s confusion. Bearish TREND is as bearish does. 

Otherwise, in the land of nod, it’s a pretty quiet morning. We don’t see any probability of Keynesian Confusion leading to any level of American style accountability and/or change in whatever it is that they do to come up with these embarrassingly bad forecasts.

 

My immediate-term support and resistance ranges for Gold, Oil and the SP500 are now $1, $91.22-95.98, and 1, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Keynesian Confusion - Chart of the Day

 

Keynesian Confusion - Virtual Portfolio



SONC: SOLID BEAT, BUT...

Sonic reported earnings after the close yesterday and beat expectations for both revenues and earnings.  The focus of the call was on sales trends that slowed in May and June.  Is the slowdown temporary or will hot dogs save the day?

 

Management went through a very detailed explanation as to why sales trends slowed in May and June but stopped short of saying what the magnitude was.  All they said was that the slowdown was limited to guests coming in after 8pm.  In May and June 2011 the company is lapping a buy-one-get-one-free shake promotion, which generated significant traffic; expectations are for low single same-store sales for 4Q11. 

 

For the balance of the quarter the “hope and expectation” is that the BAJA hotdog (along with a new line of shakes) at $1.99 will bring back some incremental traffic.  The irony in all this is that despite the SONC customer having been so responsive to the company’s value initiatives, management apparently feel comfortable raising menu prices.  

 

Sonic reported EPS of $0.21 excluding extraordinary items on the back of strong same-store sales growth and improved margin that management attributed to labor efficiencies that were offset by increased commodity costs and investment in product quality.

 

Company-operated same-store sales came in at +6.5%, beating expectations of +6.1%, which implied a two year average trend of +0.1% or 650 basis points higher than the two-year average trend in 2QFY11.  Management stated that the premium six-inch hot dog promotion which is driving traffic across all day parts.  The company had an effective year-over-year price increase of +1.5% on the menu in April and May which was then increased at the beginning of this month as an additional 0.5% price increase was implemented with the new menu.  The 2% price currently on the menu is not expected to begin rolling off until April of next year.

 

SONC: SOLID BEAT, BUT... - sonc pod1

 

The improvement in the company’s performance is reflected by the marked improvement in customer satisfaction scores at company and franchise stores versus the satisfaction scores that the company was reporting in fall 2008.  Over that period, company and franchise customer satisfaction scores have improved from 59% to 78% and 69% to 77%, respectively. 

 

Restaurant level operating margins expanded for the first time since 2009.  The improved top-line performance helped margins as food and packaging costs were better than expected due to less discounting and more aggressive price increases than originally planned.  Other operating expenses were favorable reflecting leverage from the company-owned same-store sales trends.

 

SONC: SOLID BEAT, BUT... - sonc pod2

 

 

Sonic is launching a new Baja hotdog in July that it hopes will, in combination with the loaded burger promotion, drive traffic and check.  In addition a new line of Real Ice Cream Shakes will be released which, in conjunction with the other products and promotions on offer, management is expecting to drive positive sales in the fourth quarter. 

 

One area management is focusing on going forward is the after 8pm day part which was slower in the third quarter than one year prior and has been a primary contributor to the slowing of SONC’s business over the last few weeks.  With respect to margins, labor costs are expected to be favorable in the fourth quarter and the other operating expense line is expected to improve again.

 

Food cost inflation in the third quarter came in lower than expected, between 5 and 6%, and management expects fourth quarter food inflation to come in below that range.

 

 

Howard Penney

Managing Director


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Right Said Fed

“I’m a model. You know what I mean. I do my little turn on the catwalk.”

                -Right Said Fred, “I’m Too Sexy”

 

Conclusion: The Fed today provided further support to our Indefinitely Dovish thesis, which postulates that interest rate policy will stay at, or below, current levels well into 2012.  In addition, the door for QE3 was opened ever so slightly based on our read.

 

The FOMC statement today continued to verify our thesis of Indefinitely Dovish.   The interesting change in this statement versus the last statement is an acknowledgement of slower than expected economic growth and a jobs recovery that is more muted than versus the last FOMC statement in late April.  The outcome of these two changes is that the Fed has, tacitly, taken down its expectations for inflation based on this statement in the release today:

 

“Inflation has moved up recently, but the Committee anticipates that inflation will subside to levels at or below those consistent with the Committee’s dual mandate as the effects of past energy other commodity price increases dissipate.”

 

He reiterated this in his press conference in which he said, “inflation remains well anchored.”

 

Our read through on this is that these statements are a shift and in contrast to Chairman Bernanke’s statement at the International Monetary Conference in early June when he said:

 

“That said, the stability of inflation expectations is ensured only as long as the commitment of the central bank to low and stable inflation remains credible. Thus, the Federal Reserve will continue to closely monitor the evolution of inflation and inflation expectations and will take whatever actions are necessary to keep inflation well controlled.”

 

Reading too much into snippets of Fed Speak is dangerous at best, but it does provide some insight into what could happen next.  The Bernank is now admitting both that the economy is getting worse and that he believes that the outlook for inflation is now likely to be at lower than normal levels going forward.  So, the door has now been cracked open for Quantitative Easing 3.

 

We continue to believe to actually implement QE3, the Fed will need sustained negative monthly payrolls.  Prior to QE1, this was 9 negative months, while prior to QE2 this was 3 negative months.  In May, non-farm payrolls came in at +54K, which was an eight month low.  The June nonfarm payrolls will be released on July 8th and will be the key measure as to the direction of monetary easing from here.  If we get a negative print, QE3 will be solidly on the table.

 

That said, the Fed will likely not implement additional easing while inflation, as measured by CPI is accelerating. While we have been of the view that reported inflation will continue to accelerate or be heightened during the summer and into the early fall, by early Q1 2012 this should reverse. Thus, heading into 2012 tougher comps on commodity inflation will potentially lead to deflationary type concerns, or at least give the Fed complete cover for incremental easing, especially as the labor market is likely to remain challenged.

 

As part of today’s Federal Reserve events, the Fed released their update economic projections based on the “models” of the Board Members.  For 2012, they are taking down growth expectations, taking up unemployment expectations, and increasing inflation expectations.  At Hedgeye, we actually call slowing growth, increasing unemployment, and increases inflation, Jobless Stagflation.

 

In the press conference, Chairman Bernanke also indicated that keeping the federal funds rate at 0 to 0.25% for an extended period means for at least 2 – 3 FOMC meetings.  This of course continues to extend Bernanke’s tenure as the most accommodative Chairman in, well, the history of the Federal Reserve.  This is outlined in the table below.

 

Right Said Fed - DJ

 

If there is anything we can take away from the Fed’s projections, it is that they are based on lagging indicators and are seemingly inaccurate as it relates to actual economic outcomes.  Collectively, this is a little disconcerting since monetary policy is set and based on these “projections”.

 

You know what I mean?

 

Daryl G. Jones

Director of Research


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