“A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.”
Earlier this week, I appeared on BNN, which is the Canadian equivalent of CNBC to discuss some of our key recent macro thoughts (the clip can be found here: http://watch.bnn.ca/#clip491722 ). Shortly after the appearance, our COO Michael Blum emailed and said I need to smile more. I then was told by one of our top Canadian subscribers that I could use some rose colored glasses. These comments made me wonder: am I too pessimistic? Further, is Hedgeye too pessimistic?
Admittedly, our morning missives at times can come across with a pessimistic tone. This is a function of the early mornings, our legitimate concerns regarding the global economic outlook, and, candidly, some disdain for the decision making and leadership currently coming out of Washington, DC. Now some might argue we could simply ignore Washington, DC, but the reality is that we are in an economic and market environment in which Washington decision making is critical to investment decision making.
Despite our tone in the Early Look some mornings, as a firm I can ensure you we are incredibly optimistic. The simple fact that we started this firm in the middle of 2008 shortly ahead of one of the most dramatic equity sell-offs in our lifetimes is probably the best validation of our optimism. We continue to be optimistic about the future of our business, the businesses of our subscribers, and our collective ability to continue to find interesting and alpha generating investment opportunities. Moreover, we are also optimistic about our ability to help shape and inform economic policy.
We currently share our thoughts and research with decision makers within the Obama administration, with certain Presidential hopefuls, and with members of Congress on both sides of the aisle. Our goal is not to someday become rich selling research to the government, but rather to do our part to get this fine country to a better fiscal, monetary, and economic place by providing input and ideas where we can. While there are certainly economic storm clouds on the horizon, as Churchill said long ago there is “opportunity in every difficulty.”
Currently, the Hedgeye research team sees a number of interesting opportunities on the long side. Below I’ve outlined a number of our team’s top investment ideas that were circulated in May’s version of the Hedgeye Edge on May 27th 2011:
- Visa (V) – We remain strongly of the view that Durbin will be softened, and that this will remove a meaningful source of overhang on the stock. While MasterCard has already had a major run, Visa has lagged considerably behind. Update: Durbin was softened and V is up +8.5% since May 27th.
- Buffalo Wild Wings (BWLD) - The last quarter was very difficult to poke holes in and it remains one of our favorite ideas as its primary food cost, chicken wings remain suppressed. We see sales continuing to accelerate and a focus of management on deploying further cash into the business which should fuel further growth. Update: Chicken costs have remained soft and BWLD is up +5.8% since May 27th.
- Nike (NKE): Over the intermediate and longer terms this is McGough’s favorite big cap long idea. He thinks that it grows from doing $20 billion in sales to $28 billion in 3 years. Update: NKE reported strong earnings earlier this week and is up +6.1% since May 27th.
Since May 27th, the SP500 is down -1.8%, so these ideas did quite well on relative basis. Now to be fair, not all of the ideas in Hedgeye Edge fared this well (and some such as KONA fared much better), but the point is really to emphasize that even when our Macro view can sometimes be pessimistic, our research can still find interesting opportunities on the long side. If you are an institutional subscriber and would like to connect with a Sector Head on these ideas or other stock ideas, please email .
Today is both quarter end and month end for the investment management community. The SP500 as of the close yesterday is down -2.8% for the month and -1.4% for the quarter, which is depressing even for an Optimistic Pessimist like myself. The end of the quarter also signals the end of the Federal Reserve’s program of Quantitative Easing II, which is certainly a positive for anyone other than those still clinging to the ideology of Keynesian economics.
The key potential impact of the end of QEII is a strengthening U.S. dollar, which will perpetuate the continued deflation of commodity prices. Far be it for me to call out too many positives this morning, but commodity prices deflating will be positive for corporate earnings (eventually) and incrementally positive for consumer spending.
Now as for Standard & Poor’s warning this morning that it will cut the U.S. to its lowest rating of “D” if the government fails to increase the debt limit, I would recommend disregarding Standard & Poor’s with impunity. The 10-year yield for U.S. Treasury is trading at 3.097%, which means that the U.S. is not defaulting on its obligations any time soon. While we may not particularly like the debt ceiling resolution, a default is not imminent.
Our job as market operators is not to be pessimistic, optimistic, bearish, or bullish, but ultimately it is to be right. Trust me, even if we sometimes sound dour, the Hedgeye Research Team is always finding nuggets of optimism somewhere. As the famous Persian proverb goes:
“I had the blues because I had no shoes until upon the street, I met a man who had no feet.”
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
This note was originally published at 8am on June 27, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“When one door closes another door opens; but we so often look so long and so regretfully upon the closed door, that we do not see the ones which open for us.”
-Alexander Graham Bell
Keith is both back home in Canada this week. He is taking some family vacation time at his cottage on Lake Superior and I’ll be back in Alberta with my family later this week as well. For the first few days, it will be Uncle Duty for me as I apply my risk management skills to babysitting my two nieces and nephew (ages 9, 7 and 5, respectively). After that I will be headed to my hometown of Bassano, Alberta to celebrate its one hundredth birthday. That’s also a long winded way of saying I thought it was apropos to start this morning’s Early Look with a quote from one of Canada’s most famous sons, Alexander Graham Bell.
While Bell received many patents during his long career, the most famous by far was patent 174,465. This patent was issued by the U.S. Patent Office on March 7th, 1876 and covered:
“. . . the method of and apparatus for, transmitting vocal and other sounds telegraphically . . . by causing undulations, similar in form to the vibrations of the air accompanying the said vocal or other sound.”
This was, of course, the patent for the telephone. The majority of us would consider this the second most important communication related invention after the iPad (that was a joke.)
The basis of Bell’s invention was that he replicated sound waves electronically. The precursor to this was discovering the nature of sound and how it travelled. Like many discoveries related to the physical sciences, the foundation of the telephone is based on certain immutable laws of physics.
The physical sciences of course stand in stark contrast to social sciences, in particular economics. While generally agreed frameworks exist for studying economics, immutable laws are much more difficult to come by. This is an important point to consider when studying statements from preeminent economists, especially those tasked with setting monetary policy.
As the Federal Reserve provides us more transparency with press conferences and in releasing their internal projections, the fallibility of economics has become increasingly obvious.
Our research team has spent the last few weeks meeting with some of our top subscribers around North America. As usual, the discussions were lively and thoughtful. One of the key ideas that we've been floating, which has generated a significant amount of debate, is the idea that the next move by the European Central Bank could be to lower interest rates, instead of increasing them. This view is actually in contrast to the most recent statements by the ECB.
On June 9, 2011 the ECB stated the following in their monthly statement prior to Q&A with ECB President Trichet:
“On balance, risks to the outlook for price stability are on the upside. Accordingly, strong vigilance is warranted. On the basis of our assessment, we will act in a firm and timely manner. We will do all that is needed to prevent recent price developments giving rise to broad-based inflationary pressures. We remain strongly determined to secure a firm anchoring of inflation expectations in the euro area in line with our aim of maintaining inflation rates below, but close to, 2% over the medium term.”
While this is only an excerpt, the gist of the statement overall is that the main risk to the European economy is in not being diligent on inflation. Therefore, the general consensus is that the ECB will continue leading the Federal Reserve in tightening monetary policy. The Hedgeye Consensus is slightly different.
While the Federal Reserve has continued to ease in 2011 via Quantitative Easing, in contrast, the ECB has both raised its benchmark interest rates by 25 basis points in April of 2011 to 1.25% and, as outlined above, continued to talk hawkish as it relates to future policy. From our perspective, there are a number of factors that will likely cause the ECB to alter their rhetoric and potentially cut rates this year. These are:
1) Accelerating sovereign debt issues – We’ve been early on global sovereign debt issues and continue to remain pessimistic on an orderly resolution, particularly in Europe. A Greek debt restructuring seems all but a foregone conclusion. Meanwhile, Spain and Italian yields continue to widen versus benchmark rates, specifically 10-year Spanish yields are now at 5.7% versus 4.5% a year ago and Italian 10-year yields are at 5.0% versus 4.1% a year ago. As it relates to Spain, the impact of the collapse of its real estate bubble continues to be felt and El Confidencial is reporting this morning that Spanish banks may have $50BN in unrecognized problematic real estate loans.
2) Inflation in Europe may be close to peaking for the cycle - Eurozone CPI was at +2.7% in May year-over-year, which was a sequential deceleration from +2.8% in April. While certainly only one data point, this sequential decline in inflation will be increasingly driven by a Deflation of the Inflation, as evidenced by the CRB Index now being down -0.8% for the year, and tough compares in late 2011 / early 2012. Collectively, CPI should gradually decline over the next couple quarters, and perhaps even start to look like deflation.
3) Economic growth set to sequentially slow – Similar to the Federal Reserve, the ECB provides economic growth projections for the Euro area. Also similar to the Federal Reserve, those projections have proven to be inaccurate and often backward looking. Currently, the ECB’s GDP projections for the euro area are for 1.5% - 2.3% in 2011 and 0.6% - 2.8% for 2012. From our perspective, these growth projections will likely have downward bias.
Collectively, we believe these factors will make it difficult for the ECB to raise rates in the short term and, if anything, we see bias to easing emerging. Of course, this does stand in stark contrast to ECB President Trichet’s recent statements, but as it’s famously been said about economists:
“The economy depends about as much on economists as the weather does on weather forecasters.”
Daryl G. Jones
Director of Research
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The only story that matters is that MPEL is on track to blow out the Q2 and the sell side needs to get decidedly more positive.
The bears are spewing such stories as: Galaxy is going to crush CoD, the Gov’t doesn’t want Studio City, MPEL is flooding the junkets with credit. The reality is that none of these are likely true. What is probably true is that MPEL is on track to produce $180-190 million in Q2 EBITDA, just “slightly” above the Street at $135 million. We’re looking forward to seeing these analysts justify their Neutral ratings, $550 million 2011 EBITDA estimates, and $11 price targets in the face of another terrific quarter.
So why the bear stories? I guess some analysts need to grasp on to something to justify why they missed the big move in the stock. Unfortunately for them, they may miss the next big move up. Yes, the stock has done well but estimates keep going higher. But they’re still not high enough, not for Q2, 2011, or 2012 - so we haven’t seen a significant amount of multiple expansion. At 10x 2012 EBITDA of $700 million, the stock remains heavily discounted.
We’ve learned a lot while (still) here in Macau. So let’s address the bear stories:
- Macau Studio City (MSC) – a government official made the comment that MPEL has to stick to its 2008 plans for the site and people assume there is some sort of conflict. The fact is that the government asked MPEL to take over the project and MPEL intends to keep the major tenets of the original plan intact. In fact, the guys we would consider “in the know” including competitors, think that a) MSC is the best site on Cotai and b) MSC will open before Wynn Cotai.
- CoD and junket credit – this is actually old news. We believe CoD pumped some liquidity into the junkets ahead of Galaxy opening. So did other casinos. Big deal. There hasn’t been anything recently.
- Galaxy impact on CoD – CoD lost 3-5% visitation after the Galaxy opening but spend per visitor went up substantially. Visitation has come back and spend per visitor remains high. Oh and by the way, oft ignored Altira is performing well above estimates and is meaningful to MPEL.
As most of you know, President Obama gave a speech and held a subsequent press conference this afternoon. While it is likely that many CNBC viewers were disappointed that the President bumped my scheduled appearance today, more generally President Obama’s comments were noteworthy.
In both the strongest tone and most aggressive language we’ve seen, Obama challenged the Congress to “do their job” as it relates to the debt ceiling debate. He also articulated that the deficit solution would require both increased taxes and reduced expenditures. Our read-through is that the next month plus will see heated political debate and increased uncertainty as both sides attempt to negotiated for a common ground, especially given Obama’s heightened rhetoric today. The uncertainty related to the debt ceiling will continue to weigh on markets, as we can see in the sell-off intraday.
In Greece, what seemed like a solution is increasingly being viewed for what it is, an extension of the issue. While Greek equities initially rallied on the austerity news to up almost 3%, they closed on the lows for the day. Meanwhile, the credit market barely budged on the “positive” austerity news. The reality remains, European credit markets continue to signal that a restructuring of some sort will have to occur as Greek austerity will not be enough to narrow the deficit and funding gap.
We’ve outlined our revised levels for the SP500 below and took advantage of the equity strength to add to our SP500 short position today. The other key moves we made in the Virtual Portfolio today include: buying Carnival Cruise Lines (CCL), selling Gold (GLD), selling CIT (CIT), shorting Ralph Lauren (RL), and buying Ameristar Casino (ASCA). No major exposure changes per se, but just taking advantages of some good prices.
As we get closer to The Crossroad for U.S. and European debt this summer, we’ll likely continue to keep the Virtual Portfolio balanced on the long and short sides, and keep our positions moving. After all, no one’s ever lost their job for taking profits.
Daryl G. Jones
Director of Research
Conclusion: India is flirting with a bullish TREND breakout and, should prices confirm, this is an explicit sign that our nearly eight month-old call for economic stagflation in India has been fully priced into Indian stocks.
On June 7, we published a note titled, “Still Bearish on India”, the conclusion of which was:
Our call that Growth Slows as Inflation Accelerates continues to play out in spades and we see more stagflation in India’s intermediate-term future.
From the day of that report, India’s benchmark SENSEX Index exhibited a peak-to-trough decline of -5.3% (June 20). It has since rallied +6.8% (largely due to declining crude prices and marginally dovish comments out of the central bank) and, for the second day in a row, it closed above our intermediate-term TREND line of 18,467. While two days of positive TREND is hardly a trend in and of itself, it is still highly noteworthy on the margin. Further confirmation of this bullish breakout in Indian equities is an explicit sign that our nearly eight month-old call for economic stagflation has been fully priced into Indian stocks.
As we wrote in a research report on Friday afternoon titled, “Emerging vs. Developed Markets: Aggressively Framing Up the Debate”, our contrarian Deflating the Inflation thesis bodes well for strength in bombed-out equity markets across the EM universe (please email us for a copy of the full analysis). Recall that at one point in the current cycle, India was the worst performing equity market in the entire world (-16.9% from November 5th to February 10th).
India is the poster child for a market that could do well in 2H as deflating prices across the commodity complex reduce upward pressure on WPI readings. To be clear, however, we’re not necessary comfortable with getting long right here and now, as there are some key issues that we are monitoring which we’d like additional color on:
- The Federal Government raised the prices it pays farmers for raw rice, soybeans, and peanuts in a range of +8% to +17.4% to all-time highs and those increases are expected to impact food inflation readings around October when the new crops come to market;
- India is continues to rely on pollyannaish assumptions around subsidies, growth, and state asset sales to meet its current year fiscal deficit reduction goal. We’ve been bearish on their ability to hit the target since the day the budget was unveiled and nothing has changed on that front (bearish for the Indian rupee; bearish for Indian sovereign debt). Notably, Finance Minister Pranab Mukherjee came out overnight and “affirmed” his full-year growth assumption of +8.5% YoY. In actuality, this was a -75bps haircut (recall that the growth projection released alongside the budget was +9.25% YoY);
- We’re not sure if consensus is bearish enough on Indian growth yet. It’s pretty clear from our daily analysis of sell-side and buy-side commentary that our Accelerating Inflation call (and the accompanying monetary tightening) is well understood. While the Slowing Growth component of our economic stagflation thesis has been getting priced into India’s currency and its credit market to a large extent over the last 2-3 months, we’d like to see consensus GDP forecasts come down a bit from current projections that range about +70-100bps above our model’s most bullish scenarios for India’s real GDP growth (2Q11-4Q11). This morning’s data supports our contrarian view on Indian growth as the number of stalled projects and the number of new projects in the corporate sector grew and fell +18.1% YoY and -9.3% YoY, respectively; and
- As our long-term Sovereign Debt Dichotomy thesis continues to play out in Europe, it will be interesting to see if the market starts to look toward other PIIGS as Greece’s short-term fiscal woes are resolved with the “elixir” of more debt. Heightened global risk aversion is always a risk for the SENSEX due to India’s lax capital controls that encourage foreign investor participation. In the YTD, foreign investors have purchased a net +$322.3M worth of Indian stocks. In February, the net amount was closer to -$2.2B, which suggests that there is enough volatility for the current positive trend to reverse course in a meaningful way.
Net-net, the likelihood that the YTD bottom in Indian equities is in the rear-view mirror is a growing possibility that needs to risk managed. And taking a cue from our quant model, at the bare minimum, India is no longer a key short idea. Analyzing India at this critical juncture lends us a great opportunity to highlight a bit of our process as it relates to putting on and taking off exposures. Essentially there are three buckets a company, country, security, currency or asset can be in:
- Long Idea: Positive fundamentals supported by a bullish quantitative setup;
- Short Idea: Negative fundamentals supported by a bearish quantitative setup; and
- Neutral: This is the “do nothing” bucket whereby fundamentals and quantitative signals do not confirm one another. One of the key skills a risk manager must possess is the ability to know when to move his or her favorite long or short ideas into the neutral bucket – a troubling task for anyone that tends to get married to their theses.
As we say repeatedly, an investor can be bullish, bearish, or not enough/too much of either. To that point, we don’t want to risk being too bearish on India as prices signal to us our bearish thesis is largely priced in. For now, we are comfortable moving India from the “Short Idea” bucket into the “Neutral” bucket.