“If you can’t convince them, confuse them.”
On the recommendation of my good American friend whose first daughter was born on the 4thof July, I have embarked on reading what my son Jack called the “heavy book” last night – “Truman”, by David McCullough. Whether you are a Republican or Democrat (or neither), you have to love that quote - purely and professionally political.
After Truman’s 2ndterm as President of the United States, there was a French storyteller by the name of Charles de Gaulle who suckered the French people into believing that a deficit spending and currency devaluation strategy was the best way to national prosperity.
De Gaulle became the 18thPresident of France in 1959 and quickly printed a fresh new fiat currency (issued in January of 1960) that was allegedly going to control ze inflation and spur ze economic growth. Sound familiar?
Of course it does.
Professional politicians have been obfuscating facts about their policies to devalue their currency and inflate asset prices for eons. By the time the French franc was flipped for another fresh new fiat (the Euro) in 1999, De Gaulle’s Fiat Fool money was worth just north of 10% of the “value” embedded in it at prevailing market prices of 1960.
Savvy American politicians introduced this political strategy of “Confusing Them” in the 1970s. Like Bush and Obama, both Nixon and Carter had one thing in common – a modern day Ben Bernanke in Arthur Burns (good ole Art was the last US Federal Reserve Chief to attempt to “monetize” the US Debt, fyi).
So from Truman printing US Dollars to finance war (WWII, Korea), to Charles de Gaulle, Richard Nixon, and back again – what have we learned about money printing being a policy to inflate?
Obviously a lot.
And with this sad and pathetic political reality, like they used to say on my favorite Soap Opera while playing Junior Hockey in Canada, “these are the Days of Our Lives.”
Back to the Global Macro Grind…
Yesterday, the US Dollar Index got hammered for a down -1.1% move as Gold was raging to the upside. Meanwhile, La Bernank (changed from The Bernank in the spirit of his 1960s France) got put on the spot by Ron Paul when asked whether “Gold is money”?
Notwithstanding Paul’s marketing challenges in asking concise questions of the Chairman, this one was as simple as simple gets. You can check out La Bernank’s answer to the question on YouTube. Suffice to say, with Gold ripping to a new all-time high in the face of Bernanke Burning The Buck, he didn’t want to tell us he was levered long Gold futures contracts.
Rather than listening to card carrying members of the Keynesian Kingdom attempt to explain what the value of money is, I highly recommend reading Niall Ferguson’s “The Ascent of Money.” Give it 30 years and La Bernank will be remembered by the history of money about as kindly as Arthur Burns has been.
Qu’es ce qui se passe avec Le QG3?
Well, Le Quantitative Guessing Part III caught a bid yesterday as La Bernank opened the door for more of what he’s been doing since becoming the Chairman of the Federal Reserve in 2006 – compromising the credibility of American currency.
After about a 3 hour rally, US stocks got tired of the nonsense and sold off aggressively into the close. Why? The People get it – Le QG1 and Le QG2 = Le Inflation Policy, not La Employment.
Fool me once, fool me twice…
Les Fiat Fools aren’t fooling anyone this week:
- Real-time Inflation (CRB Commodities Index) = UP +1.7% for the week to-date
- Real-time Stock Market Inflation Returns = DOWN -1.9% for the week to date
Since Obama, Geithner, and Bernanke can no longer convince markets that Quantitative Guessing is the best path to long-term American prosperity, the only strategy that remains is to attempt to confuse them.
Good luck with that.
My immediate-term support and resistance ranges for Gold, Oil and the SP500 are now $1, $96.54-100.03, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Post-market, YUM is trading up 3-4% on 2Q11 earnings of $0.66 ex-items vs consensus of $0.61 and guidance of EPS growth of at least 12%, or $2.83 versus prior guidance of at least 10% growth. Without the amazing sales trends in China, and a lower-than-usual tax rate, the quality of the EPS was suspect. When it’s all said and done, I don’t believe the stock will be up much tomorrow. Below are ten quick takeaways from the quarter; with more detail to follow tomorrow after the call.
- Consolidated revenues gained +9% year-over-year, operating profit declined -2% and pre-tax income increased +1%. Net income was up 10% and EPS gained +11% y/y.
- China was strong with reported system sales growing +34% and sales excluding the impact of FX gaining +28%. Same-store sales came in at +18% versus consensus of +10.8% (SSS for KFC +17%; Pizza Hut +22% and same-store transactions +21%). On a two-year basis, same-stores accelerated 11%, up 250pbs sequentially.
- Despite these strong sales trends, China restaurant level margins were 19.7% vs 20.1% last year.
- YRI was in line with reported system sales +13% and +6% excluding FX (Emerging markets sales +11%; Developed markets +4%). Same-store sales were +2% versus consensus of +1.6%. YRI restaurant margins were 12.6% vs 10.5% last year.
- The YUM USA was an unmitigated disaster: Comps declined -4% versus consensus -1.6%. (KFC -5%; Taco Bell -5% and Pizza Hut -2%. Restaurant margin decline 4.4% to 11.8% and operating profits declined 26%. On a 2-year basis, same-store sales in the USA were -2%.
- YUM USA brands are in secular decline. EBIT growth, on a year-over-year basis, has declined 7 of the last 12 quarters.
- USA represented 28.8% of operating profits in 2Q11, down from 41.3% last year. China grew to 39.7% from 31.2% last year.
- The EPS beat was due to lower interest expense and a lower tax rate (the tax rate declined to 16.7% from 23.6%). Interest expense was down 16.7% YoY.
- Deflating the inflation in China - margin compares get easier in 2H11, while same-store sales should continue to be strong.
- Before long, it will not make sense for YUM to be headquartered in Louisville KY.
We will have more details on the quarter and how we think 2H11 will shake out after the call tomorrow.
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REPLAY PODCAST & SLIDES
This afternoon, Hedgeye's Healthcare team, led by Managing Director Tom Tobin, hosted a call with former CBO Director Douglas Holtz-Eakin on the Affordable Care Act and its implications for investing and the economy at large. Please see below to access the replay materials:
If either hyperlink fails to work, please copy & paste it into the URL of your browser.
The Hedgeye Macro Team
"Douglas Holtz-Eakin on Affordable Care Act"
Hedgeye Healthcare team, led by Managing Director Tom Tobin will be hosting a call with guest, Douglas Holtz-Eakin (former Director of the Congressional Budget Office and former Chief Economic Policy Adviser to U.S. Senator John McCain's 2008 presidential campaign) where we will discuss his recent analysis and the suggested implications of the Affordable Care Act on the private insurance market and the federal budget.
Positions in Europe: Short Italy (EWI); Long Sweden (EWD); Long Germany (EWG)
Keith shorted Italy via the etf EWI today in the Hedgeye Virtual Portfolio. There are a number of uncertain events surround Italy, most particularly that the country has now joined its PIIGS brethren in the long-awaited spotlight on its fiscal imbalances, which encourage a risk/reward profile to the downside.
Here are the main near term catalyst to get through this week:
1. Final vote on €40 Billion Austerity Package – The Italian Senate could approve the package of tax hikes and spending cuts tomorrow (Thursday) with the lower house following on Friday. PM Berlusconi has voiced support for the package, calling on short-term sacrifice for longer term stability.
2. Italy auctions a total of €3 to €5 Billion EUR in 2016 and 2026 maturing debt tomorrow —Questions remain if the offering can find demand and at what yield. Italian yields broke out this week (the 10YR rose above 6%) and we’ll have to wait and see if the ECB intervenes to support the issue.
3. Results of European Bank Stress Test Results, Part Deux on Friday (7/15) – We could see additional volatility in and out of the release. News on Monday that Italian regulators are ordering a new short-selling rule on Italian-listed securities until September 9th sent banking stocks swinging around in the last days.
4. Speculation on a tense relationship between Berlusconi and his Finance Minister Guido Tremonti –the Finance Minister admitted to graft late last week, revealing that Marco Milanese, a lawmaker accused of corruption who until early July was his political advisor, had been paying €8,500 a month on rent for his apartment in Rome. This “news” further erodes the lack of credibility in Berlusconi’s government.
Fundamentals and Fiscal Health Remain in Check:
A. GDP Drag – Even should the new austerity program pass, Italy’s GDP is expected to grow only 1% in 2011 and 1.3% in 2012. We think this number could be revised down as domestic demand wanes alongside further fiscal consolidation (austerity), unemployment rises (at 8.6% but near 30% for persons <25 years), inflation remains above the 2% target, all of which will put additional pressure on the government’s ability to generate revenue and reduce its debt and deficit levels. The government has said it will cut the deficit to 3% of GDP by 2012 from 4.5% in 2010. [Italy’s debt as a % of GDP stood at 119% in 2010—the second highest behind Greece in the Eurozone].
B. Debt Maturities—While an IMF report on Italy (July 2011) calculates that over 75% of Italian government debt is long-term debt (with average maturity at 7.2 years) and less than 12% of its total debt is at variable rates, the country is coming up against some significant payments in the coming months (see chart below). Based on the recent move in yields and auction results, there’s increased risk that Italy will have more difficulty finding demand for its paper without significantly boosting yield premiums.
C. Needy Banks—According to the IMF report, Italy’s five largest banks face large refinancing requirements of over €65 Billion and €104 Billion of bonds coming to maturity in 2H2011 and 2012, respectively. While Italy’s top five banks are estimated to have only €3 Billion of exposure to Greece, Ireland, and Portugal, across major metric the banks continue to underperform their EU peers, and declining sovereign bond prices will further worsen bank balance sheets.
D. Bleak Legacy – Over the last decade Italy has proved the relative loser on competitiveness as wages have risen faster than productivity and the gap between Italy and the major economies of Europe (Germany, France, Spain, and even the Eurozone avg) on the metrics of GDP per Capita and Productivity per Employed Person has continually widened. Additionally, Italy ranks near the top of the list across European countries for the oldest population in Europe. Look for this aging population to eat into government coffers in the form of increased spending on pensions, healthcare, and other social services.
Conclusion: To the woe of many short-sellers, the Year of the Chinese Bull is just getting started. Don’t mistake that for the Year of the [insert consensus’ top long idea] Bull. Risk will need to be acutely managed around expectations.
Position: Long Chinese Equities. Vehicle: CAF; high exposure to Financials and Consumer stocks – which are our favorite sectors within China.
“Expectation is the root of all heartache.”
As Keith pointed out in this morning’s Early Look, China’s June/2Q economic data was rock solid. The slopes of nearly every major data series came in positive on the margin, and those that didn’t slowed at a slower pace (a leading indicator for inflection points):
- Retail Sales growth accelerated in Jun: +17.7% YoY vs. a prior reading of +16.9%;
- Industrial Production growth faster in Jun: +15.1% YoY vs. a prior reading of +13.3%;
- Money Supply (M2) growth faster in Jun: +15.9% YoY vs. a prior reading of +15.1%;
- Loan Growth accelerated: +5.1% YoY vs. a prior reading of -13.7%;
- YTD Fixed Asset Investment growth slowed to +25.6% YoY vs. a prior reading of +25.8%; and
- Real GDP growth slowed to a healthy +9.5% YoY vs. a prior reading of +9.7%.
On a QoQ basis, Chinese GDP actually accelerated (albeit marginally) to +2.2% vs. the +2.1% pace recorded in 1Q11. Accepting the fact that the Chinese government makes up the number anyway (per China’s own Vice Premier Li Keqiang), we think it pays to be on the long side when they start to print data that looks increasingly better on the margin. Of course, we don’t think it will pay to be long any/all things levered to Chinese demand. As we can plainly see, consensus is back on its “global growth” horse today, using the solid Chinese economic data as a reason to be broadly bullish. We must remember that this is the same consensus that has been saying for 3-6 months that:
- Global growth was accelerating;
- US growth was accelerating;
- US housing would bottom soon;
- The US labor market would strengthen materially;
- China is careening towards a banking crisis;
Speaking to the Shakespeare quote above, one has to wonder why consensus wasn’t more bearish on the slope of global growth given that both market prices and fundamental data have been telling us that Chinese demand has been slowing since 1Q10. Consensus has a habit of ignoring data points that don’t support its top long ideas. Given this institutionalized conflict, we find it best to remain both Duration Agnostic and permanently objective. Being a perma-bear or a perma-bull isn’t profitable across market cycles.
Fully understanding that consensus lacks a Global Macro Process to properly contextualize data like what we saw from China overnight allows us to manage risk around the key trading ranges. We’ll go through this in more depth on Friday in our 3Q11 Key Macro Themes presentation. Additionally, we’ll be digging into our long-China thesis a bit more. If you have any questions on this topic ahead of the call, please email us at .
Net-net, the key takeaway from today’s Chinese economic data is that growth in China aint as bad as the shorts would have you believe. In late June we called out short-interest at an all-time high in the MSCI China Index as a classic contra-indicator. With Chinese growth nowhere in the area code of where China perma-bulls hope it is and inflation setting up to slow sustainably post June/July, we continue to expect more short-squeezing in Chinese equities – perhaps just enough to make the charts look good enough on the long side for some of the bigger players in our industry.
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