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European Risk Monitor: Risk On/Risk Off

Positions in Europe: Short EUR-USD (FXE); Spain (EWP); Italy (EWI); UK (EWU)


We don’t subscribe to the theory that securities or countries have “risk on” or “risk off” profiles, rather risk is always “on”. Over the last 24 months European capital markets (particularly the PIIGS) have shown a pattern of underperformance alongside sovereign debt contagion, with positive performance in the days directly preceding discussions or announcements on bailout and austerity packages followed by renewed underperformance after the event. Credit rating downgrades from the rating agencies have also done a number to drag down performance following the announcement. 

 

And Greece’s second bailout announced last Thursday (7/21) follows this mold to a “T”: buy the rumor sell the news, and sovereign debt contagion is far from over. And just today Moody’s chummed the water further by downgrading Greece’s debt from Caa1 to Ca. [For more on the terms of the bailout see our post from 7/21 titled “Framework of Greek Bailout Part II: Skepticism Abounds”].

 

Now we appear to be playing a game of semantics in determining if Greece is in default.  What’s clear is that these short term “band-aid” bailouts or obfuscating language will not solve Europe’s longer term fiscal imbalances and therefore we expect peripheral capital markets to trend lower over the intermediate term.

 

 

The Semantics of Default

The big debate is whether or not Greek debt is in default and the pricing of risk based on this rating. The International Swaps and Derivatives Association (ISDA), which governs CDS pricing, has ruled that the Greek restructuring does not constitute a credit event, which means that CDS will not be triggered. 

 

However, the credit rating agencies have said that under technical definitions, any restructuring of debt is a default, so the current plan (as defined under Greece’s second bailout) for banks to roll over shorter term Greek debt into long term debt (~ 15 to 30 year maturities) should constitute a default. In fact, the language has morphed into an “orderly” default and “partial” default, and is expected to be rated as such only during the window of late August and early September when the banks may voluntarily decide to participate in this bond swap.  Thereafter, the expectation would be that a rating above default would be returned.

 

Further, ECB President Trichet refuses to recognize any member state in default and does not see Greece’s newest package triggering a credit event (default). In fact, Trichet along with other EU officials went so far as to say they’ll rely less on the ratings from the main ratings agencies, without indicating a surrogate rating source.

 

Certainly these results leave plenty of gray areas, including how risk is priced. It appears CDS swaps will be a useless instrument for pricing default or hedging default. Conversely, bond yields may flip around in the next weeks and months depending on the “success” of the bank swap, the actions of the ratings agencies (including their language); and the general psychology of the market which over the last 18-24 months has turned violently against those peripheral countries in the spotlight.

 

 

More Kinks in the Chain

To add more fuel to the fire, amendments to the European Financial Stability Facility (EFSF), which to date has provided the bailout funding to Ireland and Portugal, must receive approval from all EU countries, which cannot happen until mid-September when the parliamentary returns from summer break.   Therefore the risk profile of the peripheral is further heightened as indecision about increasing the facility and the terms of debt could arise, and not until mid-September.

 

 

Risk Swings

Of note is that sovereign bond yields and cds across the periphery fell off a cliff last week on a week-over-week basis. Over this period 10YR government bond yields fell -323bps in Greece; -208bps in Ireland; -168bps in Portugal;-50bps in Italy; and -46bps in Spain. On Friday (7/22) alone, following Thursday’s late day announcements, 5YR CDS fell a monster -644bps in Greece; -261bps in Portugal; -249bps in Ireland; -59bps in Spain; and -55bps in Italy!!! Our call remains that despite these massive dips, the trend line will resume up and to the right.

 

European Risk Monitor: Risk On/Risk Off - 1. HHa

 

European Risk Monitor: Risk On/Risk Off - 1. HHb

 

Our European Financials CDS Monitor showed that bank swaps in Europe were mostly tighter last week, with 34 of the 38 swaps tighter and 4 wider, which rhymes with the “risk-off” trade following the announcement of Greece’s second bailout package.

 

European Risk Monitor: Risk On/Risk Off - 1. HHc

 

We remain short the EUR-USD via the etf FXE in the Hedgeye Virtual Portfolio and expect the pair to trade in a range of $1.41 to $1.43. The EUR-USD is dancing around our TREND line of $1.43, an important momentum level. We’ve position ourselves to take advantage of downside in the periphery, being short Italy (EWI) and Spain (EWP). Further, with stagflation sticky in the UK, we’re short the country via EWU.

 

Matthew Hedrick

Analyst


JCP: COVERING TRADE

 

Keith covered JCP this morning – strictly as a TRADE (3-weeks or less). Everyone reading this already knows that our fundamental view on the name and its earnings power is quite ugly and is very much out of consensus. Not an iota of our negative outlook on TREND (3-months) or TAIL (3-years) has changed. Per KM on the trade “Brian McGough remains the bear on JC Penney - Ackman the bull. The stock is immediate-term TRADE oversold here so we'll book another gain and look for re-entry on strength.”

 

JCP: COVERING TRADE - JCP VP 7 25 11


Weekly Latin America Risk Monitor: A Leopard and His Spots

Conclusion: Newly-elected Peruvian president Ollanta Humala made a key decision to central bank president Julio Velarde. Markets took this as a sign of long-term stability; we view it as a leopard attempting to hide his spots for the sake of short-term political gain.

 

This is the third installment of our now-weekly recap of prices, economic data, and key policy action throughout Latin America. 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

 

From an equity market perspective, the delta between the region’s best performer (Peru’s Lima General Index up +8.4%) and the region’s worst performer (Chile Stock Market Select down -2.1%) was over 1,000bps wide – a rather sizeable divergence from a week-over-week perspective. The Brazilian real’s (BRL) +1.4% gain led the way on the currency front. Though bond yields were little changed, Latin American credit markets had some fairly sizeable moves from a CDS perspective. Peru led the way here (-9bps or -7%), confirming the strength we saw in its equity market.

 

Weekly Latin America Risk Monitor: A Leopard and His Spots - 1

 

Weekly Latin America Risk Monitor: A Leopard and His Spots - 2

 

Weekly Latin America Risk Monitor: A Leopard and His Spots - 3

 

Weekly Latin America Risk Monitor: A Leopard and His Spots - 4

 

Weekly Latin America Risk Monitor: A Leopard and His Spots - 5

 

KEY CALLOUTS

 

Brazil: The key news out of Brazil last week was not necessarily the central bank’s decision to hike rates +25bps to 12.5%, but rather their accompanying commentary, which dropped mention of continuing to hike rates for a “sufficiently long” period. Though we see Brazilian YoY CPI peaking in August, we think consensus long-term expectations for Brazilian rates of inflation are low by ~100-200bps. As such, we believe long-term Selic Rate forecasts must also be revised up. We’ll be out with an extensive report on Brazil later this week.

 

Elsewhere in the Brazilian economy, we see that the central bank changed the formula for the way in which banks must calculate risk on payroll deductible cards. This “macro prudential” measure is designed to slow credit growth (YTD +20.6% YoY vs. central bank target of +15%) by forcing banks to raise capital provisions on loans with maturities exceeding 36 months. The previous measure to slow credit growth (an additional +3% tax on consumer credit operations) merely boosted the government’s tax receipts for such transactions (+71% YoY) rather than actually slowing the pace of credit growth. We continue to strongly believe credit is simply too cheap in Brazil (relative to historic costs) for piecemeal measures like these to be wholly effective in containing credit growth.

 

Mexico: The central bank and the central government’s forecast for economic growth diverged noticeably this week, with the central bank’s monetary policy board citing “weaker demand” as the culprit for a slowing economy and president Filipe Calderon increasing his 2011 YoY GDP forecast to +4.6% (vs. 4.3% in May). We continue to side with the Central Bank of Mexico here and remain bearish on Mexican equities and the Mexican peso (MXN). Last week, Mexico reported incremental data in support of this view: retail sales growth slowed to +1% YoY and its unemployment rate backed up +20bps to 5.4%.

 

Peru: Perhaps the most moving news out of the region last week was President Ollanta Humala’s decision to appoint Julio Velarde to another five-year term as central bank president. This sent a resounding message to the markets that Humala appears committed to providing macroeconomic policy stability and assuages fears that his socialist agenda will derail the country’s long-term growth prospects. We remain bearish on Peru from a long-term TAIL perspective and see maneuvers such as this one as mere window dressing designed to calm jittery markets. Though we do not think he’ll be able to implement his fiscal policies any better than his mentor Hugo Chavez did in Venezuela, we do see scope for Peruvian assets to continue higher in the near-term as he wins over some investors on the margin.

 

Darius Dale

Analyst


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MACAU REMAINS ON TRACK

Still +40% growth in July revenues

 

 

Through July 24th, MTD table revenues were HK$17.1 billion.  With one week left, we’ve narrowed our full month gaming revenue projection range to $22.5-23.0 billion, which includes slots.  This would represent YoY growth of 42-45%, not too shabby.  One slight negative though:  average daily revenue did slide the past week to HK$664 from HK$703 the week prior.  We don’t know if that is hold, normal seasonality, or a real slowdown.  It’s obviously too short of a period to make any real conclusions.

 

In terms of market share, WYNN took a jump up and joins MPEL and Galaxy as the only companies with higher share in July than the post Galaxy Macau opening period.  MPEL and WYNN continue to generate share in July, even above the pre-Galaxy Macau period.  MPEL looks on track already to best Q3 estimates as they will for Q2 as well.

 

MACAU REMAINS ON TRACK - MACAU


THE HBM: DPZ, PNRA, TAST, MCD, CMG, RT, EAT

THE HEDGEYE BREAKFAST MENU

 

Notable news items and price action from the restaurant space as well as our fundamental view on select names.

 

 

MACRO

 

Casual Dining

 

Malcolm Knapp released the Knapp Track Casual Dining data for June over the weekend.  Another strong month, as the estimated comparable restaurant sales change in June 2011 is 2.4% and traffic increased 0.5%.  I suspect that the strong performance of Red Lobster is helped to drive the 40 basis points sequential improvement from May to June.

 

 

Commodities

 

In terms of commodity news, corn and soybeans may rise as the hot weather of last week threatens yields.   The Japanese Food Chain is being impacted by a radiation fallout from the Fukushima nuclear plant as unsafe levels of cesium have been found in beef in supermarket shelves and in vegetables and in the ocean.

 

 

Subsectors

 

Bucking a trend that has been in place for the last 6 months or so, food processing stocks outperformed over the last couple of months.  Full service restaurants lagged their food, beverage, and restaurant peers over the same duration.

 

THE HBM: DPZ, PNRA, TAST, MCD, CMG, RT, EAT - subsector fbr

 

 

QUICK SERVICE

  • DPZ UK and Ireland SSS increased +2.4%; UK increased +3.4%; Republic of Ireland (8.4%). Management is confident the company will see SSS growth in the next 26 weeks; marketing spend will be three times the amount versus last year, combined with new products. DPZ is set to report global results for 2Q tomorrow.
  • PNRA has been reiterated Buy, with a Price Target of $134, by Sterne Agee.
  • TAST, MCD, and CMG gained on Friday on accelerating volume.  COSI declined 7.4% on accelerating volume.


FULL SERVICE

  • RT reported a disastrous quarter last week and its share price declined -14% on accelerating volume.  BJRI also declined on accelerating volume.
  • EAT gained on accelerating volume despite the nosedive in RT’s stock.  This also confirms out view that EAT is taking share from RT.

 

THE HBM: DPZ, PNRA, TAST, MCD, CMG, RT, EAT - stocks 725

 

Howard Penney

Managing Director

 

Rory Green

Analyst


MONDAY MORNING RISK MONITOR: MORTGAGE INSURANCE SWAPS CONTINUE TO WIDEN

This week's notable callouts include financial and sovereign CDS plummeting in the wake of the Greek debt deal.  While this clearly reflects increased bullishness by the market, it also appears likely that the CDS market is pricing in the loss of hedge effectiveness created by policymakers adamant about avoiding a technical credit event. Bucking the trend were the mortgage insurers, where swaps blew out further across the group. 

 

Margin Debt Continues to Fall

We publish NYSE Margin Debt every month when it’s released.  This chart shows the S&P 500, inflation adjusted back to 1997, along with the inflation-adjusted level of margin debt (expressed as standard deviations from the long-run mean).  As the chart demonstrates, higher levels of margin debt are associated with increased risk in the equity market.  Our analysis shows that more than 1.5 standard deviations above the average level is the point where things start to get dangerous.  In May, margin debt decreased $9.5B to $306B.  On a standard deviation basis, margin debt fell to 1.21 standard deviations above the long-run average.

 

One limitation of this series is that it is reported on a lag.  The chart shows data through June.

 

MONDAY MORNING RISK MONITOR: MORTGAGE INSURANCE SWAPS CONTINUE TO WIDEN - margin debt

 

Financial Risk Monitor Summary (Across 3 Durations):

  • Short-term (WoW): Positive / 5 of 11 improved / 2 out of 11 worsened / 4 of 11 unchanged
  • Intermediate-term (MoM): Negative / 6 of 11 improved / 2 of 11 worsened / 3 of 11 unchanged
  • Long-term (150 DMA): Negative / 3 of 11 improved / 5 of 11 worsened / 3 of 11 unchanged

 

MONDAY MORNING RISK MONITOR: MORTGAGE INSURANCE SWAPS CONTINUE TO WIDEN - summary

 

1. US Financials CDS Monitor – Swaps were mixed across domestic financials last week, tightening for 16 of the 28 issuers and widening for 12.  Mortgage insurers took it on the chin in the swaps market as well as in equity, as investors increasingly question their solvency.  Meanwhile, the moneycenters and large broker-dealers benefited from the Greece deal.

Tightened the most vs last week: JPM, C, WFC

Widened the most vs last week: PMI, MTG, GNW

Tightened the most vs last month: C, WFC, MBI

Widened the most vs last month: PMI, MTG, GNW

 

MONDAY MORNING RISK MONITOR: MORTGAGE INSURANCE SWAPS CONTINUE TO WIDEN - US cds

 

2. European Financials CDS Monitor – Banks swaps in Europe were mostly tighter last week.  34 of the 38 swaps were tighter and 4 widened.   

 

MONDAY MORNING RISK MONITOR: MORTGAGE INSURANCE SWAPS CONTINUE TO WIDEN - euro cds

 

3. European Sovereign CDS – European sovereign swaps collapsed following the Greece deal last weekend.  Despite the haircuts included in the deal, ISDA ruled that the restructuring does not constitute a credit event, which means that CDS will not be triggered.  As such, we expect that the CDS market is currently pricing in both improvement in sentiment around sovereign solvency and decreased hedge effectiveness.  A credit default swap is a useless hedge instrument if policymakers manage to create bailout packages designed not to trigger it.   

MONDAY MORNING RISK MONITOR: MORTGAGE INSURANCE SWAPS CONTINUE TO WIDEN - sov cds

 

4. High Yield (YTM) Monitor – High Yield rates were flat last week, ending at 7.36 versus 7.37 the prior week.

 

MONDAY MORNING RISK MONITOR: MORTGAGE INSURANCE SWAPS CONTINUE TO WIDEN - high yield

 

5. Leveraged Loan Index Monitor – The Leveraged Loan Index was close to flat last week, ending at 1610. 

 

MONDAY MORNING RISK MONITOR: MORTGAGE INSURANCE SWAPS CONTINUE TO WIDEN - lev loan

 

6. TED Spread Monitor – The TED spread fell slightly, ending the week at 22.3 versus 24.5 the prior week.

 

MONDAY MORNING RISK MONITOR: MORTGAGE INSURANCE SWAPS CONTINUE TO WIDEN - ted

 

7. Journal of Commerce Commodity Price Index – Last week, the JOC index was close to flat, falling less than one point to 7.2. 

 

MONDAY MORNING RISK MONITOR: MORTGAGE INSURANCE SWAPS CONTINUE TO WIDEN - JOC

 

8. Greek Bond Yields Monitor – We chart the 10-year yield on Greek bonds.  Last week yields fell 289 bps or 16%, ending the week at 1469.

 

MONDAY MORNING RISK MONITOR: MORTGAGE INSURANCE SWAPS CONTINUE TO WIDEN - greek bonds

 

9. Markit MCDX Index Monitor – The Markit MCDX is a measure of municipal credit default swaps.  We believe this index is a useful indicator of pressure in state and local governments.  Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 14-V1.  After bottoming in April, the index has been moving gradually higher.  Last Friday, spreads closed at 119 bps.

 

MONDAY MORNING RISK MONITOR: MORTGAGE INSURANCE SWAPS CONTINUE TO WIDEN - mcdx

 

10. Baltic Dry Index – The Baltic Dry Index measures international shipping rates of dry bulk cargo, mostly commodities used for industrial production.  Higher demand for such goods, as manifested in higher shipping rates, indicates economic expansion.  Last week the series fell 30 points to close at 1323.

 

MONDAY MORNING RISK MONITOR: MORTGAGE INSURANCE SWAPS CONTINUE TO WIDEN - Baltic dry

 

11. 2-10 Spread – We track the 2-10 spread as a proxy for bank margins.  Last week the 2-10 spread widened 2 bps to 257 bps.   

 

MONDAY MORNING RISK MONITOR: MORTGAGE INSURANCE SWAPS CONTINUE TO WIDEN - 2 10

 

12. XLF Macro Quantitative Setup – Our Macro team sees the setup in the XLF as follows:  0.7% upside to TRADE resistance, 1.6% downside to TRADE support.

 

MONDAY MORNING RISK MONITOR: MORTGAGE INSURANCE SWAPS CONTINUE TO WIDEN - XLF

 

 

Joshua Steiner, CFA

 

Allison Kaptur


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