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THE DOUBLE PCE WHAMMY TO GAMING

I’ve updated the PCE chart from my 08/08/08 post, “SCARY MACRO CHART FRIDAY”, that showed gaming would suffer a $20bn loss just on mean reversion of gaming spend % of PCE. Gaming was more levered on the upside to housing than other consumer sectors and could be on the downside as well.

Personal consumption expenditures have been a rocket ship over the past 20 years. Gaming revenue growth has been even more impressive. Gambling spend accelerated from 0.3% of PCE in 1990 to a peak of 0.94% in December, 2006. The trend broke soon after that all the way down to 0.79% in June of 2008. As a point of reference, if gambling reverts to the mean since 1990 of 0.6%, revenues would fall by $20bn annually or over 20% of the current level. This trend could be a double whammy in a prolonged consumer slowdown.

PCE likely to fall as is gaming's share. Ouch

Going "Loonie": Buying The Canadian Dollar...

We're looking to get long another currency other than the US Dollar. The Rydex Canadian Currency Shares (FXC) is likely where we’ll make a currency investment, on a down day. The FXC has lost -13% of its value since the last week of September; it also pays a 2.6% yield. Buy low.

Below is our chart and our levels.

BUY for a "Trade" = $82.10
SELL that "Trade" = $86.28

This is simply another way for us to express our investment idea that the US Federal Reserve will de-value the US$ again by cutting interest rates to negative (on a real basis). This will be inflationary, for a "Trade", and countries (Canada) levered to commodity price strength should benefit.
KM

STATE OF THE CONSUMER II: LEISURE EDITION

The only thing I’d add to McGough’s excellent analysis (re-posted below) is that Consumer Confidence plunged to 57 this week. Consumer spending on recreational products and leisure services of almost $500bn (including almost $100bn for casinos) is under attack. For those of you expecting a v-shaped bounce in anything consumer any time soon, think again. We’ll be lucky to get a U.

Todd Jordan
Managing Director


STATE OF THE CONSUMER II: NUMBERS DON’T LIE

By my math, the year/year deficit in consumer spending in 2009 rivals the size of the US apparel/footwear industry in its entirety. Here’s how I get there…

Seems rough out there for the consumer, huh? I’m really sorry to say this, but you ain’t seen nothin’ yet. I know this seems like my typical ‘doom and gloom, margins are going away’ rant. But I spent the better part of this weekend going through the math. Many people don’t realize this, but real consumer spending is actually trending up yy. My model suggests that discretionary spending will finally turn negative in 1Q09. This would be the first time in 66 quarters consumer spending will have gone negative.

I think we’re also looking at discretionary spending down about $170bn next year. The icing on the cake is that the yy delta (prior year’s increase less current year’s decrease) is tracking close to $245bn. As a frame of reference the entire apparel and footwear retail industry is about $300bn. I have a one word answer for this. BANKRUPTCY. I outlined my list of bankruptcy candidates several times over the past few months. But that list is growing. I’ll be back with more meat on the bone there shortly.

I realize that I’m not the only person that has a detailed consumer model. So let’s take a look at some key assumptions, and you can come up with how you’d tweak it one way or another.

1. Gross personal income reflects a 7% unemployment rate, which takes total income growth down by 400-500bp sequentially over 3 quarters.

2. Zero change to the personal tax rate, which averages at 12% across the US.

3. Sub-1% savings rates is unsustainable given negative wealth effect from state of housing and equity markets. (Check out my prior post).
4. Personal interest payments head higher by 0.1% per quarter due to higher debt levels and interest rates.

5. Oil stays at $80, and gas/distillate stay at current levels. YY comps get easier in 4Q.

6. We went through all consumption categories we deem ‘Essential’ such as food, medical, housing, etc… and input growth forecasts based on my fellow analysts’ assumptions.

Tweaks to the many assumptions in our model would alter the $245bn yy delta in spending (2.5% of consumer’s wallets). But even if the geniuses at the Treasury, Fed or in the new political regime find a way to cut it in half, that would still represent 40% of the apparel/footwear retail space.

Brian McGough
President and Director of Research


Early Look

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Eye On Leadership: October 19th,"The World Turned Upside Down"

THE WORLD TURNED UPSIDE DOWN
October 19th

On October 19, 1781 the most powerful empire on earth was humbled by a ragged upstart nation. Tradition has it that when the British army marched out from the battlements of Yorktown for the surrender ceremony its band was playing “The World Turned Upside Down” –appropriate for a moment when the accepted world order suddenly and permanently changed. One of the Continental Army officers present that day was Colonel Alexander Hamilton, the future architect of the US financial system.

In 1987, 206 years later to the day, the accepted order of the capital markets suddenly and permanently changed when an unprecedented stock market crash revealed a Wall Street populated by emperors wearing no clothes. In the wake of the crash, the perception of systemic market risk had to be recalibrated and a whole new breed of financial engineers began to construct an infrastructure for the new reality. Over the next two decades they would introduce terms like “hedge fund”, “portable alpha” and “market neutral” into the lexicon of investors globally.

Today, as I reflect on the current situation –the wreckage of the markets and the failure of international financial leadership, I draw this conclusion: the rules have not changed, they no longer exist. Your models no longer work, your methodology is no longer relevant and your credit is no longer good. Welcome to the new reality.

This is not a negative. Like a temporary vacuum created by an explosion to put out an oil rig fire, this global meltdown has sucked the oxygen out of the room and created opportunities for those of us who are brave enough to step into the void. This is exhilarating stuff to consider –the opportunity to abandon broken processes and build new ones.

In the coming months the financial media will be dominated by post mortems and witch hunts; the political community will be focused on playing the blame game and the new-old order on Wall Street will try to pretend that they can return to business as usual. Ignore them all.

Reality has changed. The only correct course now is forward.

Andrew Barber
Director

Headline Of The Week:

I know, I know... we had this call 9 months ago... so I will let the media take it from here...

However, one quote comes to mind when I think about all of the pushback I got on this from the said industry savants:

"Nobody is thinking about you... unless you tell them about their faults...
Then, you can be sure that they are thinking about you...
They are thinking about killing you!"
-Roger Rosenblatt, (PBS and Time Contributor)

I, and many of you, have been overpaid to analyze industries with a fine tooth comb. Why it was contrarian to take a step back and analyze our own industry from a supply and demand perspective will remain a question in my mind for the rest of my life.
KM

Chart Of The Week: American Consumer Confidence...

As one of my favorite analysts, Sherlock Holmes, always said, "sometimes, there is nothing more deceptive than an obvious fact." There is nothing to be contrarian about when it comes to this chart.

Michigan Consumer confidence got absolutely crushed this week, coming in at 57. Finally, instead of having to endure these last 9 months of hedge fund hotel screaming in my inbox about how I am being too bearish on where the US consumer is headed next, the worst report since 1978 will remind them that the 1970's were not a good time to "buy on valuation" (stocks troughed at 8x EPS).

My World Series Consumer team of Brian McGough, Howard Penney and Todd Jordan have been doing outstanding cycle work as of late. Managing tail risk is what we do, and the US consumer spending scenarios that they have come up with for 2009 are a long long way from consensus. This ain't Kansas, and I ain't Toto. This is math.

Be careful out there if you are getting levered up long in Consumer Discretionary. Your idea is interesting, but it’s not unique, and it’s too early. Within our RE sentiment framework of “Bullish, Bearish, and Not Enough” of one or the other, I still do not think that consensus is "Bearish Enough".
KM

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