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HOUSING HEADWINDS UPDATE

The following is a republished note from our Financials vertical, led by Josh Steiner - the architect behind our long-term Housing Headwinds thesis. Josh has been and continues to remain both the axe and bear on the Street as it relates to the US housing market. If you'd like to see more of his extensive work on this subject, please email sales@hedgeye.com. 

 

Case-Shiller YoY Decline Worsens

The Case-Shiller 20-City Home Price Index increased 66 bps in April to 138.84 on a non-seasonally-adjusted basis.  On a YoY basis, however, prices fell -4.0% YoY in April versus -3.8% YoY in March.  There is a strong seasonal aspect to home prices, with the greatest increase in prices occurring in April, May, and June, as we show in the chart below. Thus, expect to see two more months of improvement (May and June) before the downtrend resumes.  As a reminder, we use the NSA YoY data instead of the seasonally adjusted series because S&P noted last year that their seasonal adjustment factor had become unreliable.  Let us know if you'd like to see a copy of the S&P report.

 

Looking at the breadth of the index,16 of the 20 cities measured accelerated their YoY declines in April while 4 slowed or improved.  Month over month, all 20 cities were sequentially better on an NSA basis (declined less or increased more MoM in April than they did in March).

 

Mortgage Interest Deduction Under Renewed Fire

The head of the Minneapolis Federal Reserve made a speech yesterday proposing that the mortgage interest deduction be scrapped in favor of a tax credit to assist homebuyers with their down payment.  While Kocherlakota was attempting to disincentivize leverage, rather than increase total government tax revenue, the mortgage interest deduction has come under fire from a number of different angles recently.  For reference, with a median home price of $170,000, a 20% down payment, and a 5% mortgage rate, the median borrower's monthly payment is $730.  Annual interest expense on this payment is $6,430 at year 4 (roughly midway through the life of a typical mortgage).  With a $50,000 median household income and an average 22% federal tax rate, the interest deduction is good for a $1,415 tax offset.  Eliminating this would represent a 2.8% tax increase on $50,000 in income, the national household median.  Needless to say, this would be a headwind for the housing market and another push from homeownership into the rental market.  

 

HOUSING HEADWINDS UPDATE - 1

 

HOUSING HEADWINDS UPDATE - 2

 

HOUSING HEADWINDS UPDATE - 3

 

HOUSING HEADWINDS UPDATE - 4

 

HOUSING HEADWINDS UPDATE - 5

 

As we've noted previously, the greatest appreciation/smallest downside each month occurs in those cities with the highest home prices.  The charts below demonstrate. Not surprisingly, Washington DC continues to be the best performing market in the country (followed by New York) based on the unprecedented growth of the Federal Government.

 

HOUSING HEADWINDS UPDATE - 6

 

HOUSING HEADWINDS UPDATE - 7

 

Joshua Steiner, CFA

 

Allison Kaptur


MACAU TIDBITS

The following are some nuggets we picked up recently.  We’re here in Macau and will try to get confirmation on a lot of this stuff. 

 

 

GALAXY

  • Galaxy Macau - drop in share may be due to weakness in VIP business
  • Galaxy Macau advertising in HK has not gotten the bang for the buck spent.  Behind target.
  • Management quietly disappointed that the property has not performed to expectations

MPEL

  • Mostly good news for the most underappreciated stock in Macau in our opinion
  • Strong volumes the last couple of weeks
  • Galaxy Macau impact on CoD has been less than expected – Street consensus was that CoD was going to get crushed
  • Macau Studio City:
    • Probably needs gazetting to start construction
    • Shouldn’t be a problem if developer sticks to original 2008 plan; otherwise, any changes to the plan will require new govt approvals
    • Earliest ramp-up in construction will be end of 2011; same time for Wynn Cotai
    • Neptune likely to open at CoD in the next couple of weeks
    • Another junket operator Lao Kung also finalizing deal to open at CoD

MGM

  • Rumor that Neptune thinking about moving home base VIP room from MGM to Galaxy Macau
  • Would be a blow to MGM since Neptune was a big part of MGM’s market share surge
  • Plausible given Galaxy’s struggles – Galaxy may be willing to offer attractive package

LVS

  • Will announce name for sites 5 & 6 soon; probably Sands Cotai
  • Hotel operator for site 5 will probably be Holiday Inn or Hilton
  • Site 5 completion date: 1Q 2012 is doable but certainly by 2Q 2012.

TALES OF THE TAPE

Notable news items and price action from the restaurant space as well as our fundamental view on select names.

 

MACRO

 

Persisting drought conditions in the southern Great Plains states are making it likely that the rebuilding of the United States’ cow herd will take four years or more. 

 

Wheat has continued to slide and could, once June is completed, be at the end of the biggest monthly slump since 2008 as harvesting accelerated thanks to the warm, dry weather.  According to the U.S. Department of Agriculture, approximately 44% of the winter crop was harvested as of yesterday, ahead of the five-year average of 37%. 

 

Restaurants have seen declining guest visits for evening meals for three years but that is now changing, according to new findings from the NPD group.  Food inflation for groceries is said to have narrowed the gap between away-from-home and in-home dining costs.  See the chart, below, for a longer term perspective of Food-at-home CPI versus Food-away-from-home

CPI.

 

TALES OF THE TAPE - cpi home away from home

 

 

QUICK SERVICE

  • MCD is to start serving Café con Leche drinks in South Florida, targeting the large Latino population.
  • CBOU continues to outperform.  The stock has gained 27% over the past month.
  • SONC declined on accelerating volume.  We are negative on this name.

 

CASUAL DINING

  • KONA, one of our favorite names in casual dining, traded up 9.3% yesterday.  Please refer to our prior notes on this.
  • RUTH and BWLD gained on accelerating volume yesterday.
  • MRT declined on accelerating volume.

TALES OF THE TAPE - stocks 628

 

 

Howard Penney

Managing Director


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The Long Run

“Avoiding danger is no safer in the long run than outright exposure.  The fearful are caught as often as the bold.”

Helen Keller

 

It is difficult to invest for the long term.  In order to do so, the key characteristic an investor must have is permanent capital.  The best example of permanent capital is Berkshire Hathaway, Warren Buffett’s investment vehicle.  Since Berkshire recently hit a 52-week low, in the short run, it has been a bad investment.  In the long run, of course, Berkshire has been a fabulous investment.

 

From December 31st, 1987 to the close yesterday, Berkshire “A” shares have returned ~3,770%+.   Over the same period, the SP500 has returned ~415%+.  In the long run, it is obviously difficult to debate Buffett’s success as an investor.  Unfortunately, very few investors can operate for the long run because of a lack of permanent capital and an unwillingness of those that provide the capital (limited partners) to suffer volatility. 

 

Naively many investors attempt to emulate Buffett’s performance by purchasing stocks that emulate his criteria.  In aggregate, studies show that cheap stocks with clean balance sheets will outperform over time if bought well.  Obviously, the challenge when emulating Buffett, though, is to assess the moats of a company and barriers to entry of an industry.

 

As Buffett wrote in his 1992 letter to Berkshire Shareholders:

 

“An economic franchise arises from a product or service that: (1) is needed or desired; (2) is thought by its customers to have no close substitute and; (3) is not subject to price regulation. The existence of all three conditions will be demonstrated by a company's ability to regularly price its product or service aggressively and thereby to earn high rates of return on capital. Moreover, franchises can tolerate mis-management.  Inept managers may diminish a franchise's profitability, but they cannot inflict mortal damage.”

 

The challenge of finding a long term economic franchise is that very few exist, or are sustainable.  At one point, the newspaper industry was a prime example of an economic franchise.  The newspaper was needed, in many markets had limited competition (think the Buffalo News), and pricing of newspapers was not regulated by the government.  While arguably the newspaper industry did represent franchise-like investments during periods, those investors that held these franchises in perpetuity are likely not happy today. 

 

The key way to “avoid danger in the long run” is to remain flexible, not duration specific.  I appeared on the Kudlow Report a few months back and one of the other guests was extolling on the virtues of being a long term investor and indicated that his firm has an average holding period of four years.  In theory, that’s fine if you have the process and team to execute on a long term holding period.  If you are investing for the long term, which for this discussion we’ll just consider beyond three years, it requires just as much work, if not more, than if you are an intraday trader.

 

The primary reason investing for the long term requires more work is because in the short term, assets will get mispriced.  Much of this can be attributed to behavioral finance and fear.  When assets get mispriced, such as in the market dislocation during the subprime debacle, it requires strong conviction in the research process to believe the fundamental story and to continue to buy, or even hold, as an investment is dramatically underwater.  While many fund managers claims to be adept at buying while there is “blood in the streets”, very few actually can effectively time purchases.  The world is replete with studies that show both professional and individual investors classically sell at the bottom and buy at the top.

 

Given the challenges with true long term investing and the reality that most cannot do it, we emphasize three investment durations in our research: TRADE (3 weeks or less), TREND (3 months or more), and TAIL (3 years or less).  In theory, at least based on how we analyze timing and risk, they are all related, so a TRADE idea can become a TREND idea and so on. Thus, a rigorous daily research process is critical to our success (hence the early mornings).

 

Shifting to the short term, there are a number of data points from the last 24 hours that I wanted to flag as fundamental to some of Hedgeye’s key investment views:

 

First, the European sovereign bond markets continue to signal that the worst is yet to come for sovereign debt on the continent.  Even as equity markets seem to be lightly cheering positive developments yesterday, bond yields have barely budged.  In fact, Greek 10-year yields are at 16.5%, Irish are at 12.1%, Portugese are at 12.1%, Spanish are at 5.7%, and finally Italian 10-year yields are at 5.0%.  Specific to Greece, civil unrest continues to accelerate as Greek trade unions are planning a 48-hour strike to protest austerity measures that will be voted on Thursday.  We remain long German equities via the etf EWG and short Spanish equities via the etf EWP.

 

Second, Premier Wen Jiabao provided us an early view on Chinese inflation for the full year yesterday.  He indicated on Hong Kong-based Cable TV that while he sees difficulties in reaching a full year inflation target of 4 percent, inflation “can still be kept below 5 percent”. This supports our view that the proactive monetary tightening that China has implemented will lead to steadily decelerating inflation in the back half of 2011 and marginal dovishness out of the People’s Bank of China.  We are long Chinese equities via CAF.

 

Finally, New Jersey officials are purportedly in negotiations to secure a temporary $2.3BN bank loan to cover a state cash shortfall.  New Jersey needs the cash to pay various bills between the start of its fiscal year on July 1st and the mid-summer bond offering.  We’ve been consistently negative on State and Local level finances and this provides incremental support to the view.  While many States are constitutionally obligated to balance budgets, it will be challenging and will likely require additional municipal bond issues as federal government support will be largely non-existent in fiscal 2012.  Further, State and Local level austerity will be a drag on economic growth more broadly.  We currently have no position in the municipal bond market.

 

Good luck “avoiding danger” out there today,

 

Daryl G. Jones

Director of Research

 

The Long Run - Chart of the Day

 

The Long Run - Virtual Portfolio

 


Keynesian Confusion

This note was originally published at 8am on June 23, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“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 $1533-1555, $91.22-95.98, and 1257-1297, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Keynesian Confusion - Chart of the Day

 

Keynesian Confusion - Virtual Portfolio


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

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