“Any fool can know. The point is to understand.”
To truly embrace the analytical incompetence of central planners tasked with managing globally interconnected risk, one has to accept that these people are Fiat Fools. Sure, any one of them can know what happened yesterday. But can they proactively predict risk?
We introduced the term Fiat Fool during the initial stage of the European Sovereign Debt crisis (2010). To understand what the Fiat Fools are doing to economies and markets alike, all you have to do is pay attention.
Fiat Fools fundamentally believe that they can smooth economic cycles and tone down market volatility. I guess that’s what the IMF’s latest dudette in Chief, Christine Lagarde, was trying to do this morning when she proclaimed her mystery of faith that “some of the Italian numbers are excellent.”
Hedgeye’s long-term conclusion has been that the Fiat Fools do two things:
- They shorten economic cycles
- They amplify market volatility
That’s it. There is no smoothing and toning. There is no “price stability.” And there most certainly is no “full employment.” So, it’s time for La Bernank to unite with his Keynesian storytellers in Europe and admit who they are, and what they do. Greenspan did.
Not that the Obama Administration wants to be held accountable for perpetuating Keynesian Economic Ideologies, but none of these political people who support Bernanke and Trichet should forget what their idol himself admitted to Henry Waxman (under oath) during the thralls of 2008.
HENRY WAXMAN: “Do you feel that your ideology pushed you to make decisions that you wish you had not made?”
ALAN GREENSPAN: “Well, remember that what an ideology is, is a conceptual framework with the way people deal with reality. Everyone has one. You have to -- to exist, you need an ideology. The question is whether it is accurate or not. And what I'm saying to you is, yes, I found a flaw. I don't know how significant or permanent it is, but I've been very distressed by that fact.”
No. I don’t think reminding professional politicians of context and causality is going to change them this morning. Sadly, these people are more concerned with their own career risk management than that of your markets and economy. So onto the next.
Back to the Global Macro Grind…
Here’s our real-time risk management look at Global Equities:
- China was down -1.7% overnight to 2754, barely holding onto our immediate-term TRADE line of support = 2730
- India’s BSE Sensex dropped -1.8% to 18411, barely holding onto our immediate-term TRADE line of support = 18357
- Hong Kong got blasted for a -3.1% drop and remains bearish TRADE and TREND in our model (resistance = 22499)
- FTSE in London is breaking its intermediate-term TREND line of 5897
- DAX in Germany is breaking its intermediate-term TREND line of 7199
- MIB in Italy is crashing, down -22% since its February 2011 high (down another -2% this morning)
- IBEX in Spain looks awful (bearish TRADE and TREND)
- Greek stocks continue to crash (down -31% since their February 2011 lower long-term high), making lower 2011 lows today
- Russian, Norwegian, and Saudi stock markets are all breaking their intermediate-term TREND lines as Oil prices break down
- SP500 TREND line support is under attack in pre-open futures trading (Hedgeye’s line in the sand = 1317)
On the Commodity front, Deflating The Inflation remains our call:
- CRB Commodities Index (18 components) challenged TREND line resistance (349) last week and failed
- WTIC Oil’s TREND line remains at approximately $103/barrel (Goldman is the bull, Hedgeye the bear)
- Wheat and Corn prices are down another -2-3% this morning and have both broken TREND line support
- Cotton prices are getting slammed this morning (down -4%) and should alleviate some cost pressures out there
- Gold looks like a champ (as it usually does when real-interest rates are negative; UST Treasury yields plummeting again)
- Copper is the outlier on the bullish side, holding intermediate-term TREND line support of $4.20/lb
Currency and Credit Markets are all over the place:
- European Sovereign CDS in Spain and Italy are pushing toward (or above in Spain’s case) the critical Lehman Line of 300bps
- Italian Bond yield at Italy’s 12 month debt auction came in a lot higher sequentially versus last (3.67% vs 2.15%)
- EUR/USD is getting annihilated after breaking what we’ve called out as critical intermediate-term TREND support ($1.43)
- US Dollar Index is making a big bid for a TRADE and TREND breakout – this will continue to Deflate The Inflation
- US Treasury yields are all breaking down through TRADE and TREND line support (like they did in May-June)
- US Treasury Yield Spread continues to compress; 10-year minus 2-year yields = 250 basis points wide (long FLAT)
All the while, this morning’s high-frequency economic data was what I consider fine. Chinese Money Supply Growth (M2) came in at 15.9% (it’s been proactively cut in HALF by the Chinese since we got bearish on China at the end of 2009). Meanwhile German, French, and British Consumer Price Inflation (CPI) readings for June were benign enough to provoke Europe’s Fiat Fool in Chief to stop raising rates.
As for the Fiat Fools having anything in the area code of a modern day real-time risk management process, you can bet your Madoff that they don’t have one. Nor do they have any experience managing any of the aforementioned globally interconnected risk where it matters – on the tape.
My immediate-term support and resistance ranged for Gold, Oil, and the SP500 are now $1, $92.96-96.74, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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We have aggregated the Consumer sector into fourteen sub-sectors in the table below.
The table shows performance of each sub-sector and highlights moves by sub-sectors that are more than one standard deviation from the mean return of the fourteen sub-sectors. As the key at the bottom of the table describes, a number highlighted in green indicates a return greater than one standard deviation above the mean return of the fourteen sub-sectors. Red indicates one standard deviation below. Additionally, the best and worst performing stocks in each sub-sector, for each period, are highlighted in the divergence rows of the table. The consumer space has been on a tear since last year with Restaurants, Autos & Auto Parts, and Department stores leading the way.
Looking at the table below, it is clear to see that over the past six months restaurant stocks (both Quick Service and Full Service) have led the way. The laggards over the first half of 2011 have been the Food Processors ($6 corn is a problem) and Homebuilders (we continue to be very bearish of the housing market). In addition to the Restaurant sector, Footwear Apparel Specialty retail and Department Stores have been strong performers over the past six months.
Overall the performance has been very strong over the past six months; nine of the fourteen buckets shown below have returned double-digit gains.
Looking at the performance over the past three weeks Food Tobacco and the Discount stores are stand outs to the downside, while Full Service Restaurants, Auto & Auto Parts, Apparel Specialty Retail and GLL have been strong.
In terms of outliers, Hedgeye’s recent consumer ideas feature heavily. In Restaurants, KONA has outperformed over the last two, three and four weeks. KONA continues to be one of our favorite ideas. Concern around the resignation of former CEO Marc Buehler has largely been eased and the company’s reimaged stores are set to provide a boost to comps starting in 4Q. RUTH has also performed strongly over the past week and is trading at a large discount to the space.
CBRL is a favorite idea of ours on the short side. This is a company that has grown its store base by 11% since the beginning of fiscal 2007 and, over the same period, seen sales grow by 2.3% and EBIT remain essentially flat. While gasoline prices have declined sharply since May, the year-over-year increases in gasoline prices remain significant and 2Q results from CBRL will certainly be impacted by the high gasoline prices. Another of Hedgeye’s favorite ideas, EAT, has returned 74% over the last year. Our thesis one year ago was that sales would be choppy for a few quarters, but that comps would ultimately improve and margin enhancements, coupled with share buybacks, would drive EPS growth.
COSI stands out as a disappointment when looking at the performance over the past six months, but I remain convinced that the fundamentals of the company’s performance will continue to improve and reported sales trends for 2Q will be strong.
In gaming, MPEL has been a firm favorite of our GLL Team for some time now. Their conviction in MPEL’s prospects in Macau is strong and, additionally, their estimates are ahead of the Street for the second quarter. WMS has been the laggard in the space and Hedgeye GLL has expressed concern about WMS in the short-term (while favoring IGT and BYI), while remaining positive on the slot-supplier sector over the long-term.
In retail, Specialty Apparel has been performing strongly over the past one, two, three, and four weeks. Over these durations, the returns of the space have been more than one standard deviation above the average return of the sub-sectors. While Department Stores have been performing largely in line with the broader consumer space, JCP, one of our favorite ideas on the short side in the Retail space has been working well. JCP has been underperforming the category over the past one, two, and three weeks.
Thanks in no small part to continuing government support, the monthly PCE data shows, personal income, consumption and expenditure accelerated in January and have been growing robustly in 2011. More recently, we have seen a slowdown in two-year trends in April, as the slowing discretionary spending could be linked to the spike in gas prices that peaked in May.
Conclusion: We remain bullish on Chinese equities over the intermediate-term TREND and strongly believe that China represents the greatest upside potential among the world’s most liquid equity markets over that duration.
Overnight, China’s Shanghai Composite Index flashed a positive divergence relative to the other major equity markets in Asia:
- China’s Shanghai Composite: +0.2%
- Hong Kong’s Hang Seng Index: -1.7%
- Japan’s Nikkei 225 Index: -0.7%
- India’s BSE Sensex 30 Index: -0.7%
- South Korea’s Kospi Index: -1.1%
- Indonesia’s Jakarta Composite Index: -0.2%
- Australia’s All Ordinaries Index: -1.5%
- Singapore’s FTSE Straits Times Index: -1.1%
- Thailand’s Stock Exchange of Thai Index: -1%
Analyzing both inter and intra-market divergences is one of the key tools we have at our disposal to determine whether or not a particular data point(s) and/or thesis is priced in. Specifically regarding our own Year of the Chinese Bull storytelling, we believe today’s positive divergence supports our view that our bearish thesis on China (which we authored in January 2010) is fully priced in.
What isn’t priced in yet is our bullish thesis on China and we continue to favor Chinese equities over all others over the intermediate-term TREND. The research supporting this thesis can be found in the following research notes (email us for copies):
- 3/21: Buying China
- 4/18: Chinese Exposition
- 5/13: Chinese Bull Riding
- 6/9: China’s TARP
- 6/21: Freaking Out About China
- 6/24: Early Look – Chinese Cowboy
Chinese Inflation Is Peaking
Over the weekend, China reported a +90bps sequential acceleration in its June YoY CPI reading (+6.6%). This was largely driven by a pickup in the rate of Food Inflation, which accelerated to +14.4% on a YoY basis. Though the headline number exceeded analyst estimates, the measured acceleration was largely expected and, going forward, we see Chinese headline inflation on the downtrend over the intermediate term.
The slope of that line is supported by the current downtrend in China’s Input Prices PMI (less cost increases to pass through the supply chain to Chinese consumers):
Our outlook for Chinese CPI is largely a function of our once-contrarian Deflating the Inflation thesis (bullish on the USD; bearish on commodities). Simply put, as the US Dollar strengthens and puts downward pressure on food, energy, and raw materials markets, price increases on the ground in China won’t have enough velocity to surmount increasingly tough comparisons and continue their upward trend in 2H. This will allow the PBOC to relax, on the margin, its tightening bias on a go-forward basis.
We’re bullish on the US Dollar from a research perspective primarily because we’re bearish on the Euro (57.6% of the DXY basket). The following bullets summarize our bearish EURUSD thesis, which we outlined in a research note on 6/24 titled: “Emerging vs. Developed Markets: Aggressively Framing Up the Debate”:
- The end of QE2 means the growth of the Fed’s Balance Sheet will no longer be a headwind (positive on the margin);
- We don’t believe QE3 is in the cards, but assuming that consensus will clamor for more “stimulus”, the timing of any hint from the Fed is likely six-plus months away (refer to our Indefinitely Dovish and What’s Next for the Fed? presentations for more details);
- A shift on the margin towards fiscal sobriety in Washington, D.C. via a Debt Ceiling Compromise is also a bullish catalyst for America’s currency;
- Slowing growth in the Eurozone will have the FX market pricing in less and less hawkishness out of the ECB relative to the Fed on a go-forward basis (don’t forget that the socialist Mario Draghi takes over in November and that the Europeans have a full 150bps of potential interest rates to cut).
Monetary Policy Is Becoming Supportive Of Growth on the Margin
As mentioned prior, as the slope of inflation in China starts to trend down, Chinese policy makers will be able to ease off the economic brakes. Our bearish thesis on Chinese CPI leads us to believe that the PBOC is done raising interest rates in this tightening cycle, though we wouldn’t be surprised by one more hike if July CPI surprises to the upside as well. Nevertheless, we believe the go-forward outlook for Chinese monetary policy is one of marginal dovishness and we find that to be a bullish catalyst for Chinese equities – which have been struggling as a result of expectations surrounding tighter policy since early 2010. Chinese equities are down -13.1% since we introduced our Chinese Ox in a Box thesis on January 15th of last year and at one point had lost over a quarter of their value.
Recent commentary out of PBOC Governor Zhou Xiaochuan supports our outlook for Chinese monetary policy:
“China can’t adopt inflation as [its] only monetary policy target… the central bank also has to maintain economic growth and consider employment.”
- Zhou Xiaochuan, July 8, 2011
Regarding growth specifically, Governor Xiaochuan is approaching a critical juncture as it relates to the slope of both the Chinese economy and the global economy. Simply put, Chinese growth can’t go much lower from here without having a meaningful negative impact on the global economy (itself included). That is why we continue to state, “If you’re incrementally bearish on China from here, you should be going to cash.”
China’s 50.9 June Manufacturing PMI reading shows just how close one major segment of the Chinese economy is from contracting on a sequential basis. The following chart illustrates how strong the relationship is between Chinese manufacturing and global growth.
Four out of the five [reported] months YTD show negative Chinese Loan Growth on a YoY basis. That’s an explicitly bearish data point for an economy that relies on Fixed Investment for 45-50% of GDP.
All told, we don’t think Zhou and company will crash the Chinese economy. In fact, we think Chinese growth could potentially accelerate in 2H from current levels supported by a widening Trade Balance (lower import costs; more fixed export prices) and easy comparisons. We’re not necessarily making that call right here and now, but it does appear to be an upside risk we should consider. Both Chinese equities (bullish TAIL) and Dr. Copper (bullish TREND) are signaling to us to this scenario is worth considering. Interestingly, June was the first month in the last three where growth in China’s copper imports was positive on a MoM basis (+10%).
Net-net, we remain bullish on Chinese equities over the intermediate-term TREND and strongly believe that China represents the greatest upside potential among the world’s most liquid equity markets over that duration. Fear surrounding a potential housing bubble (which we do not buy into) and a potential banking crisis (Duration Mismatch at best) has made Chinese growth cheap on both a relative and absolute basis. As such, we’ll continue to heed the following advice from three legendary investors as it relates to China.
- “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.
Positions in Europe: Long Germany (EWG); Long Sweden (EWD)
Geopolitical risk is back, or did it ever leave? As we look back at last week’s market performance in Europe little has changed regarding the region’s sovereign debt soap opera. The incremental news, including Moody’s downgrade of Portuguese credit rating four notches to junk (Ba2) on Wednesday, contributed significantly to the strong underperformance from the peripheral capital markets, while the spotlight on fiscal imbalances appears to jump from one nation to the next. Of the equity markets, Italy’s FTSE was the worst performer across the region, down -7.2% last week on a week-over-week basis, followed by Spain’s IBEX (-5.3%), and Greece’s Athex (-4.4%).
Our risk metrics of bond yields and CDS spreads continue to trend up and to the right, reflecting that little has been done to address the solvency issues of the PIIGS. We’ve named the bailout packages for the PIIGS mere ‘band-aids’ for they’re just that—short term fixes to much larger fiscal imbalances. Repairing years of government overspending, oversized government sectors, and a lack of tax collection on a backdrop of weak growth prospects and under the rigid constraints of the ECB’s unilateral monetary policy, change in the fiscal standing of the PIIGS will not happen overnight—yet investor patience is short and the actions of the main ratings agencies are impactful. Expect more foot power (riots and demonstrations) on the ground. The nearest major catalyst is a mid-September date to finalize a second bailout package for Greece (est. €70-120 Billion).
As headlines sway markets, “new risks” have surfaced from Italy. We’ve long since warned of elevated debt and deficit levels of Italy and Spain, two economies that make Greece, Portugal, and Ireland, even when combined, look like small fries, with exponentially more banking counterparty exposure to the rest of Europe. News out today that Italian regulators are ordering a new short-selling rule on Italian-listed securities until September 9th, not only sent banking stocks across the region plummeting [in some cases halting the stock (Unicredit)], but took down entire indices as well. Italy’s FTSE had its largest one-day drop in more than a year! Helping the tumble was talk about Italy’s public debt—the second highest in the Eurozone behind Greece’s—at 119% of GDP at a meeting of Eurozone finance ministers today in Brussels as Italy’s parliament still needs to finalize a new three year austerity program worth €47 billion in tax hikes and spending cuts next month.
While Eurozone leaders, including Chancellor Merkel, voiced confidence in Italy’s ability to pass austerity and trim its debt, it was nevertheless a bloody Monday, with neither the equity, debt or currency markets un-phased. The worst equity performers day-over-day included:
The EUR-USD, which has largely held up in the $1.40 to $1.45 range over the last weeks, touched $1.39 intraday today (the first time since late May) and is trading at $1.4022, or down -1.70%. The EUR-USD is now squarely through our intermediate term TREND line of $1.43, an ominous signal that we’ll be looking for confirmation of before issuing a new target. We continue to maintain that Troika’s mandate to step in to bailout any Eurozone member will help support the EUR-USD, but not in perpetuity.
All-Time is a Long Time!
With yields continuing to blow out across the periphery, our focus is on Spain and Italy, both of which flashed all-time highs in spreads over German bunds today. This ominous signal was countered by the relative safety trade in the Swiss Franc, a haven as Europe works through its issues. The CHF-EUR reached its own all-time high at 0.8539 EUR today!
Banking Risks Pop
Ahead of this Wednesday’s (7/13) announcement of the European Bank Stress Tests, Part II, and with respect to Italy’s move on short sales today, risk blew out significantly week-over-week. Our European Financials CDS Monitor showed that 32 of the 38 bank swaps were wider week-over-week, and 7 were tighter, and one unchanged. Should the estimated 15-22 of 95 banks fail the test, expect more downside ahead!
We remain very cautious on owning European countries on the long or short sides. To the latter, we think there’s more downside from here for the capital markets of the periphery. We remain long Germany (via the etf EWG) in the Hedgeye Virtual Portfolio and added Sweden (EWD) on the long side on 7/8.
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