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Forecasts of Doom

“Plainly, MacArthur’s bleak assessment of the situation, his forecasts of doom, had been wrong.”

-David McCullough (“Truman”, page 834)

 

We’ve all experienced getting too bearish at bottoms. Historically, when this emotional capitulation comes from the political leaders of our country, we often look back at their Forecasts of Doom as the catalysts for change. Politics are a lagging indicator.

 

While I’m not sure I’d be accused of being bullish on Keynesian Economic policies or their impacts to the US Dollar since the 2008 US stock market crash, I’m certainly not the US Dollar bears’ huckleberry on this matter right here and now.

 

Not to name names, but PIMCO’s Mohammed El-Erian has been getting plenty of air-time in recent weeks (Barrons this weekend, Bloomberg article again this morning, etc.) talking up the credit risk in US Treasury Bonds.

 

Not to callout timing, but this has been El-Erian’s view since PIMCO effectively sold almost all of their US Treasury exposure in Q1 and Q2 of 2011. While I respect Bill Gross and all of his risk management accomplishments over the years, his partner’s Forecasts of Doom for the US Treasury Bond market have not only been wrong since March, but they are wrong, again, on this morning’s Debt Ceiling “news.”

 

The “news” on anything being commandeered by central planners of the 112thCongress is that the news is going to change. This weekend’s “news” of a Debt Ceiling debate failure may have been good for the Sunday talk show ratings, but it wasn’t bad for what matters to markets – the marked-to-market rating on US Treasury Yields.

 

If you didn’t know that market prices don’t lie (politicians do) – now you know. Or at least Mr. Macro Market in US Treasuries thinks he knows. Here’s this morning’s reaction to the “news” of doom:

  1. Short-term Treasuries (2-year yields) – didn’t move 1 basis point versus where they were priced into the end of last week (0.39%)
  2. Long-term Treasuries (10-year yields) – moved a whole 2 basis points versus Friday to 2.98%

But Mr. El-Erian has a Top 10 article on Bloomberg’s most read that delivers the headline “El-Erian Says US Vulnerable To Downgrade”… Qu’est ce qui se passe avec Le Analysis if the market isn’t reacting to PIMCO’s bleak assessment?

 

I’m long US Treasuries and have been writing about why since we launched our Q2 Macro Themes at Hedgeye in April. Sure, partly because I’m bearish on US Growth (Mr. El-Erian says he’s bearish on US Growth, but evidently not Bearish Enough or he’d be long the long-bond).

 

As most of the lagging of lagging indicators (Moody’s, S&P, etc) downgrade the likes of Greece (again!) this morning, I’m moving the Hedgeye Asset Allocation Model to its most invested position of 2011.

 

Yes, we still have 40% Cash – but that’s less than the 67% Cash we held at the end of February when Wall Street/Washington expectations for growth were will too high by about a double!

 

Ahead of this Friday’s preliminary US GDP Growth Report for Q2, Hedgeye’s estimate for US GDP Growth remains 1.7%-2.1%. Since the government, to a degree, makes up this number, we make up a range of expectations around current made-up numbers.

 

Here’s where the Hedgeye Asset Allocation Model stands as of this morning:

  1. Cash = 40% (down from 46% last Monday)
  2. Fixed Income = 24% (US Treasury Flattener and Long-term Treasuries – FLAT and TLT)
  3. International Equities = 12% (China and S&P International Dividend ETF – CAF and DWX)
  4. Commodities = 9% (Gold and Silver – GLD and SLV)
  5. International Currencies = 9% (US Dollar and Canadian Dollar – UUP and FXC)
  6. US Equities = 6% (Healthcare – XLV)

Obviously as Global Economic Growth Slows and Fiat Fool Policies whip around between Europe and the US like a ping pong ball (see our Q3 Macro Theme presentation, “Policy Pong”), we don’t want to be “fully invested” – not with our own money at least.

 

As for today, what we’d like to do on this “newsy” morning is sell some Gold high and buy some US Equity and Currency exposure low. We get the bleak assessment about Congress and a President who has a hard time making hard decisions. We also get that markets discount the obvious – and we could very well be looking at “news” of a Debt Ceiling resolution by the end of the week.

 

My immediate-term support and resistance ranges for Gold (long), Oil (no position), and the SP500 (no position) are now $1, $97.72-100.24, and 1, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Forecasts of Doom - Chart of the Day

 

Forecasts of Doom - Virtual Portfolio


The Week Ahead

The Economic Data calendar for the week of the 25th of July through the 29th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.

 

The Week Ahead - ccal1

The Week Ahead - ccal2


Weekly Asia Risk Monitor: Money’s Tight in China

Conclusion: China broadly underperformed from both a financial markets and economic data perspective. We think that was due to a general lack of liquidity in China’s banking system, but one final PBOC rate-hike should not be completely ruled out.

 

This is the fourth installment of our now-weekly recap of prices, economic data, and key policy action throughout Asia. We’re aiming to keep our prose tight here, so if you’d like to dialogue more deeply regarding anything you see below, please reach out to us at .

 

PRICES

 

The key callout from an equity market perspective is China’s negative divergence (-1.8% week-over-week vs. a group median gain of +1.3%). The Shanghai Composite Index did, however, hold a key level of quantitative support and we remain long the CAF in our Virtual Portfolio. In the FX market, the New Zealand dollar (NZD) had a monster week to the upside (+2.3%) on the heels of an elevated CPI reading (21-year high). In the fixed income market, Chinese 2yr sovereign bond yields increased 23bps week-over-week. This move is confirmed by money market rates and swaps spreads breaking out to new highs. It remains to be seen whether or not this is a leading indicator for a Chinese rate hike or merely indicative of a general lack of liquidity in the financing-based economy.

 

Weekly Asia Risk Monitor: Money’s Tight in China - 1

 

Weekly Asia Risk Monitor: Money’s Tight in China - 2

 

Weekly Asia Risk Monitor: Money’s Tight in China - 3

 

Weekly Asia Risk Monitor: Money’s Tight in China - 4

 

Weekly Asia Risk Monitor: Money’s Tight in China - 5

 

Weekly Asia Risk Monitor: Money’s Tight in China - 6

 

Weekly Asia Risk Monitor: Money’s Tight in China - 7

 

Weekly Asia Risk Monitor: Money’s Tight in China - 8

 

KEY CALLOUTS

 

China: China printed a nasty preliminary July manufacturing PMI number (48.9); we think the Chinese growth continues to slow, but at slower rates. The recently announced tax reform initiative (scheduled to commence in September) should incrementally boost consumer spending in an environment of slowing inflation. We look for that to offset weakness in the manufacturing sector as external demand (US and Japan, in particular) slows.

 

Hong Kong: CPI accelerated to a 3-year high in June we remain bearish on Hong Kong equities for the intermediate-term TREND and long-term TAIL as growth continues to slow while inflation continues to accelerate. A peaking property bubble that the government is under increasing pressure to address from a policy perspective is decidedly bearish for the index’s financial and real estate developer stocks (over half the market cap of the Hang Seng Index).

 

Japan: Japan’s June trade data came in sequentially better in another sign that of the economy continuing its rebound off the March/April lows. We think it is short-lived, as Japan’s YoY economic growth data looks to materially slow in 2H. We remain bearish on Japanese equities (we’re short the EWJ in our Virtual Portfolio) for the intermediate-term TREND and long-term TAIL and are now bearish on the yen for the intermediate-term TREND ahead of a pending government shut down in Sept/October. We’ll be out with a detailed note on this topic early next week.

 

India: A weekly gauge of commodity inflation slowed and the recent move in India’s interest rate swaps market is supportive of our belief that the RBI is very close to the end of its tightening cycle. We remain cautious on Indian equities as our models have growth slowing in 3Q and inflation accelerating through August. Looking ahead to 4Q, we are quite bullish and if the Global Macro environment is favorable, the market may choose to look through the next 2-3 months of marginally negative economic data.

 

South Korea: The Bank of Korea made an important policy decision in support of long-term economic prosperity by prohibiting financial companies from buying bonds denominated in foreign currencies that have the intended use of financing domestic projects. This will limit the country’s aggregate external debt burden and may also supply upward pressure on domestic interest rates. Both are positive for the Korean won (KRW) from a long-term TAIL perspective. Our models continue to signal downside risk to Korean economic growth over the intermediate-term TREND – particularly in 4Q.

 

Australia: Per the monthly NAB survey and a quarterly Deloitte survey, business confidence continues to trend negatively amid a slowing domestic economy. Further, the RBA’s recent commentary is finally acknowledging of the domestic slowdown. Interest rate swaps, interbank rate futures, and corporate issuance of floating-rate debt (relative to fixed-rate issuance) are all signaling an RBA rate cut over the intermediate term. The 2Q CPI report (due July 27) will be critical to watch as it will likely shape the market’s perception around future RBA policy. We expect it show a sequential acceleration on a YoY basis, but it will likely slow on a QoQ basis (perhaps more important for policy). As such, we remain bearish on the Aussie dollar (AUD) for the intermediate-term TREND.

 

New Zealand: CPI accelerated to a 21-year high in 2Q alongside a sequential uptick in services PMI. The data supported a regional-best +2.3% appreciation in the New Zealand dollar (NZD/USD) on a week-over-week basis and it remains at record-highs. In spite of Prime Minister Key’s expressed concern regarding the strength of the kiwi dollar, our models would suggest further upside as inflation is set to make another high in 3Q.

 

Thailand: Trade data came in mixed in June (slower export growth; faster trade balance growth) and Bank of Thailand governor Prasarn Trairatvorakul implicitly suggested that he expects Thailand’s growth to accelerate in 2H by updating his 2011 GDP forecast (“a little more than 4%”). We are in wait-and-watch mode on Thai equities and would like to see more color on: 1) the new regime’s fiscal initiatives; and 2) the Bank of Thailand’s official response to such policies. Their bullish view of the Thai economy may lead them to continue hiking interest rates, which is bullish for the Thai baht (THB).

 

Singapore: Non-oil domestic export growth slowed materially in June and we continue to flag negative Asian trade data as a clean-cut signal that global demand is lower than where consensus believes it is – particularly in the US and Japan. Accelerating economic growth in 3Q could prove bullish for Singaporean equities for the intermediate-term TREND, while inflation continues to decelerate due to the Monetary Authority of Singapore’s proactive tightening. Further upside in the Singapore dollar (SGD) might be limited, as many of the supportive factors which kept us bullish are now in the rear-view.

 

Darius Dale

Analyst


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Athletic Apparel/FW Volatility Up, FW Down

Big switch in FW vs. Apparel this week. The key is that apparel had tough numbers to comp, FW didn’t. This is in contrast with the strong monthly data we have for June, but that’s backward looking vs. the weekly numbers. The spread between the athletic specialty and other channels is getting wider suggesting that the FLs and FINLs of the world are not getting hit nearly as hard as the weekly numbers suggest, but still down sequentially nonetheless.

 

 

Athletic Apparel/FW Volatility Up, FW Down - chart7

 

Athletic Apparel/FW Volatility Up, FW Down - chart 6

 

Athletic Apparel/FW Volatility Up, FW Down - chart 5

 

Athletic Apparel/FW Volatility Up, FW Down - chart 4

 

Athletic Apparel/FW Volatility Up, FW Down - chart3

 

Athletic Apparel/FW Volatility Up, FW Down - chart 2

 

Athletic Apparel/FW Volatility Up, FW Down - chart 1


DNKN - ANOTHER K-CUP PLAY?

If you would like a copy of our forthcoming DNKN Black Book, please contact sales@hedgeye.com.

 

It’s a great time for the Private Equity sponsors to be bringing DNKN public.  Restaurant industry performance, particularly the coffee category, has been leading the consumer space and valuations are extremely rich. 

 

We will be publishing a DNKN Black Book on Monday.  Needless to say, we think there is a bubble in the coffee market which PE sponsors are taking advantage of.

 

If you would like a copy of the Black Book, please contact sales@hedgeye.com 

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst


MCD: DOWN MARGINS DON’T MATTER WITH COMPS LIKE THAT

MCD is looking as good as the weather is hot today following extremely strong earnings that came in far above the street, and our, expectations.  The crux of our negative thesis on MCD at the outset of 2011 was based around the difficulty I foresaw for MCD to “comp the comps” versus the company’s resounding success in driving same-restaurant sales in the U.S. during summer 2010.  Following the release of April sales results, we “cried uncle” as the facts changed and sales continued to accelerate. 

 

Having seen the June results, it is clear that MCD is “comping” the comps this summer and management was eager to point out that July global same-restaurant sales are expected to be between 4-5%.  Below we offer ten takeaways and a quick recap of the sales trends by region and the markets/factors driving each.

 

 

Our ten takeaways from the quarter are as follows:

  1. MCD US is the most important division for the company from an operating income perspective and the acceleration of same-restaurant sales in June and, as guided to, in July versus extremely difficult compares from 2010 means that MCD is successfully driving traffic through its beverage initiative.  Total McCafé beverage sales grew 29% y/y in the second quarter. 
  2. On a global basis, higher commodity and, to a lesser extent, labor and occupancy costs are being offset by positive same-restaurant sales.  In China, margins are being negatively impacted by the acceleration of new restaurant openings.  New restaurants typically open with lower margins and then accelerate over time.
  3. MCD is taking share from other QSR companies.  TAST’s report of their Burger King restaurants seeing same-restaurant sales decline -5.2% in 2Q is testament to that.  Companies that fail to keep up with MCD reimaging and product initiatives are likely to continue to lose market share.  The reimaging program in the US will be implemented at 600 restaurants in the US by year-end (200 done as of 1H11).
  4. The hot weather is driving people in the US to buy beverages.  This is a positive for SBUX, SONC and other brands positioned to take advantage.  Beverages are driving traffic and are margin-accretive.
  5. The full-year outlook for the company’s U.S. grocery basket is unchanged at 4%-4.5%.  As food at home CPI continues to outstrip food away from home CPI, which gives the company some confidence in taking pricing in the current environment.
  6. Our pre-earnings assertion that top-line is all that matters this quarter seems to be correct.  Companies have made their operations far more efficient than before the recession and, despite margins declining at company-operated stores in the US from 22.2% in 2Q10 to 20.7% in 2Q11, the health of the top line is what investors are focused on.
  7. China still only represents 3% of global MCD profit.  MCD is growing rapidly in China, but the overall pie is growing also.  This is not something YUM is seeing – YUM’s US business has already shrunk to 25% of the company’s total operating profit, previously a 2015 target. 
  8. China 2Q comps were up 14.4%, the brand clearly has relevance and there seems to be enough room for MCD and YUM, which also produced double-digit comps in China during 2Q.  For MCD, breakfast is approaching 8% of sales in China.
  9. The company is growing aggressively in APMEA, and China in particular with 175-200 openings in China projected for the year.
  10. Momentum is strong heading through 3Q with July global comps expected to come in at 4-5%.

 

U.S.

Drivers: Frozen Strawberry Lemonade, classic core offerings including Chicken McNuggets and the Big Mac, and breakfast supported by the new Fruit & Maple Oatmeal.

 

MCD: DOWN MARGINS DON’T MATTER WITH COMPS LIKE THAT - mcd us jun

 

 

Europe

Strong markets: France, UK, Russia.

Drivers: Ongoing restaurant modernization efforts, focus on premium menu offerings.

 

MCD: DOWN MARGINS DON’T MATTER WITH COMPS LIKE THAT - mcd eu jun

 

 

APMEA

Strong markets: China and most other markets. 

Drivers: Affordability, drive-thru, delivery and extended hours.  Breakfast is offering a lot of growth in China and, despite the sluggish economic growth, Australia.

 

MCD: DOWN MARGINS DON’T MATTER WITH COMPS LIKE THAT - MCD APMEA Jun

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst


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