“That the earth would give way beneath his feet was a grim irony for Mickey Mantle.”
-Jane Leavy in “The Last Boy”
The end of Summer 2011 is approaching. I’m packing up my family for Thunder Bay. And I’m smack in the middle of a Twittersphere debate about arrogance, confidence, and success.
Some people think confidence and success is fleeting because, for them, it really is. Winning is hard – but great teams find a way to make it both achievable and repeatable. I wake up every morning not only accepting the Uncertainty associated with being right in this business, but swallowing the adversity that each market day and competitor brings.
Tired old processes that refuse to evolve are threatened by us. We get it. I’ve seen my fair share of Grim Irony in the arena of life. Whether accountability was my being punched square in the face in a Canadian Junior hockey barn or reality was being fired 5 days before the birth of my 1st son, I get it. No one owes me anything in life and there’s plenty of earth to give way beneath me yet.
Back to the Global Macro Grind…
Mickey Mantle was the son of a lead miner. His Dad, Mutt Mantle, died young. Before his death, as a Yankee rookie The Mick had already blown out his knee and faced plenty of adversity both on the field and from tiring veteran teammates (DiMaggio). The lesson learned from Mutt though was simple – out of sight, our of mind - play the game that’s in front of you.
And so we will this morning…
I took down my Cash position yesterday from 70% to 64% as there were some asset classes on sale that I continue to like – Corporate Bonds (LQD) and Precious Metals (SLV).
The Hedgeye Asset Allocation Model positioning is currently as follows:
- Cash = 64%
- Fixed Income = 21% (Long-term Treasuries, US Treasury Flattener, Corporate Bonds – TLT, FLAT, and LQD)
- International Currency = 6% (Canadian Dollar – FXC)
- International Equities = 6% (China and S&P Dividend ETF – CAF and DWX)
- Commodities = 3% (Silver – SLV)
- US Equities = 0%
I didn’t buy Gold yesterday (I might today – immediate-term TRADE support = $1705/oz and I’d like to see that critical risk management line of support hold before I try to play hero – for our Gold levels, see the Chart of The Day by Darius Dale attached). Instead, I bought back the Silver position that I sold on August 19th at $41.37 (SLV).
Being able to buy something that you sold higher is a wonderful feeling. A lot of people in this business call that “market timing.” And a lot of those same people say that “you can’t time markets.” Trust them on that – most of them can’t.
But if you could hit a baseball 734 feet (Mantle on May 22, 1963 at Yankee Stadium) or you could revolutionize the way people consume Apples (personal computing), why wouldn’t you try? While everyone else is whining, why wouldn’t you try it confidently?
Confidence breeds success. Success breeds confidence.
I’m certainly not suggesting Hedgeye is Mantle or Steve Jobs. But I am explicitly saying that Hedgeye is the greatest investment team I have ever had the pleasure and privilege to play on. We’re young. We’re evolving. And we have just as good an opportunity as any great Wall Street firm that has come before us to change the way this game is played. That’s exciting.
Until yesterday I had a ZERO percent asset allocation in the Hedgeye Asset Allocation Model to both US and European stocks and the entire Commodities complex. On one of those two things (Commodities), that was a good thing. On another (Stocks), it wasn’t – until China closed up big overnight (up +2.9% - we’re long Chinese Stocks) and US stock market futures are indicated down, again.
Again is as again does.
Over and over and over again, the Perma-Bulls have been buying stocks and changing their thesis as to why as they go. At the end of 2007 (the SP500 is still down -24.8% since then, fyi), it was because “stocks were cheap” and corporate America was “awash with liquidity.” Today, I guess their portfolios are still awash with US Equity exposure and stocks are getting cheaper.
But what does all of their storytelling and finger pointing really do for this country? People don’t trust this economic system or the people who manage it. If calling opacity out on the carpet is “arrogant”, I’ll happily be transparency’s child. America trusts winning and the Grim Irony of all of this back and forth about who is “perma” this and “perma” that is that very few have been Perma Right.
My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1, $81.24-89.23, and 1108-1191, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
The Macau Metro Monitor, August 25, 2011
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THE HEDGEYE DAILY OUTLOOK
TODAY’S S&P 500 SET-UP - August 25, 2011
With the exception of inflation in Vietnam being reported at +23% y/y for August (US centric stock market people will say that’s not inflationary, for them), global economic data around the world this morning is very light.
For the immediate-term TRADE, Gold down and UST Yields up is the same trade. Both are screaming that La Bernank is in a box and won’t be doing QE3 tomorrow (that’s a good thing for America). We are not short the SP500 yet, but very well could be by day’s end.
As we look at today’s set up for the S&P 500, the range is 83 points or -5.91% downside to 1108 and 1.14% upside to 1191.
SECTOR AND GLOBAL PERFORMANCE
Yesterday’s rally, put the XLU positive on TRADE and TREND.
- ADVANCE/DECLINE LINE: +1173 (-946)
- VOLUME: NYSE 1109.47 (-10.58%)
- VIX: 35.90 -1.02% YTD PERFORMANCE: +102.25%
- SPX PUT/CALL RATIO: 1.73 from 1.78 -2.99%
CREDIT/ECONOMIC MARKET LOOK:
- TED SPREAD: 31.94
- 3-MONTH T-BILL YIELD: 0.02% +0.01%
- 10-Year: 2.29 from 2.15
- YIELD CURVE: 2.06 from 1.93
MACRO DATA POINTS (Bloomberg Estimates):
- 8:30 a.m.: Initial jobless claims, est. 405k, prior 408k
- 9:30 a.m.: IMF bi-monthly press briefing
- 9:45 a.m.: Bloomberg consumer comfort index, est. -49
- 10:30 a.m.: EIA natgas storage, est. +74
- 11 a.m.: Fed to purchase $250m-$500m TIPS
- 1 p.m.: U.S. to auction $29b 7-year notes
WHAT TO WATCH:
- Greek spreads vs Bunds hit record highs on bailout concerns
- Hurricane Irene is passing over the Bahamas and may be near North Carolina this weekend and New England next week
- ECB “stands ready” to ease tensions in U.S. dollar funding of European banks if they arise, Bundesbank’s Andreas Dombret says
- Bernanke unlikely to promise new action by Fed - WSJ
- GOLD –We can look at yesterday’s move this with a fresh pair of risk management eyes; the Hedgeye immediate-term TRADE line of support has not yet been breached ($1705) and we will likely buy it there if all else remains intact.
MOST POPULAR COMMODITY HEADLINES FROM BLOOMBERG:
- Tony Hayward Gets a Life Post-BP as Investors Write Blank Check
- Hurricane Irene Strikes Bahamas on Path Toward U.S. East Coast
- Glencore First-Half Profit Rises 57%; Asian Demand ‘Strong’
- Gold Drops for Third Day After Margin Boost as Equities Advance
- Comex Increases Gold Margins After Sharpest Drop Since 2008
- Oil Trades Near Two-Day Low; Standard Chartered Cuts Forecasts
- Driver Shortage Shows Gain in U.S. Truck Cargo: Freight Markets
- Rising Potash Means Lower Debt Cost for Uralkali: Russia Credit
- Burger King Adds Mom-Friendly Food as Whopper Lovers Lose Jobs
- Gasoline Use at Nine-Year Low as Economy Falters: Energy Markets
- Irene Threatens North Carolina Prompting Evacuations From Coast
- Copper Gains for Third Day as Data Reports Boost Demand Outlook
- China Bonded Copper Stockpiles Fall About 50%, Glencore Says
- Crude Futures Advance on Fed Speculation, Supply Decline in U.S.
- EUROPE/GREECE – the country isn’t going away, but their bond and stock markets are – and what I mean by that is that no one real invests in illiquidity like this; and this is how the Fiat Fool story ends. Greece down -48.5% since FEB and hitting new lows…
- Germany Sep GfK consumer sentiment 5.2 vs consensus 5.2 and prior revised 5.3 from 5.4
- ASIA/CHINA – big short squeeze in Chinese stocks overnight of +2.9% (that’s the only equity market worldwide that we are long, and we are nervous about it), but the rest of Asia didn’t follow – Korea is still in crash mode and Indonesia, India, Thailand, and Malaysia all closed down on the session. Global growth continues to slow.
Q2 results are indeed messy, but considerably better than we expected. We thought EPS would be secondary to one of two things that had to happen, either a) the company said nothing about its strategy, or b) the board stood up like a big boy and showed the investment community that it's taking the bull by the horns and actually does have a plan. We clearly got the later.
There will be plenty more to chew on after the call, but with over 25% of the shares short this one will be up sharply.
Here are a few takeaways from the results:
- Top-line came in up +4.9%, the most robust growth the company reported since the acquisition of Stride Rite in 2007. It looks like this was largely driven by aggressive pricing in an effort to clear inventories.
- Comps came in slightly better than expected down -0.7% (vs. our -2%E) with International up +3% and Domestic down -2% reflecting sequential improvement both on a 1yr and 2yr basis.
- PLG came in strong up +25% and the company is guiding to 20% growth again in Q3.
- Gross margins (adjusted) down -360bps were worse than expected, but makes sense given that the company got even more aggressive on pricing during the quarter to reduce inventories.
- SG&A (adjusted) was down -2% excluding severance though it's not entirely clear what's in that number.
- Inventories were up +16% on 5% sales growth. While at face value this appears horrible, it's a sequential improvement from 1Q and again reflects a more aggressive posture towards clearing the balance sheet. While there is more work to be done here, the sales/inventory spread at -11% was the best it’s been in the last four quarters and significantly better than -24% posted in Q1.
Conclusion: The Japanese economy is set to undergo some meaningful political and regulatory changes. None of them are positive for Japan’s long-term economic growth.
Position: Bearish on Japanese equities (TREND; EWJ); Bullish on the Japanese yen (TREND; FXY).
Japan, the world’s third-largest single-country economy, had a busy day today. First it was announced that Moody’s downgraded Japanese sovereign debt one notch to Aa3 with a stable outlook. The JGB market hardly flinched (10yr yield up +1bps, while 2yr and 30yr yields declined), as reasons for the downgrade (“weak economic growth prospects”; “frequent changes in government that prevent long-term budget planning”; and “a build-up of debt since the 2009 global recession”) are known-knowns to market practitioners. It will be interesting to see if Moody’s follows through with a shred of intellectual honesty and downgrades the U.S., as our situation is quite similar to Japan’s:
- Weak economic growth prospects – CHECK;
- Unstable government preventing long-term budget planning – CHECK; and
- A build-up of debt since the 2009 global recession – double CHECK.
At least Japanese investors own 95% of publicly-held JGBs. That dwarfs the U.S.’s ~69% domestic investor ratio… But rather than waste time attempting to hold the lagging ratings agencies accountable, let us shift our focus back to Japan.
More Intervention; Less Growth
The second announcement came in the form of more Big Government Intervention out of the Japanese Finance Ministry via their decision to release $100 billion of Japan’s $1.07 trillion in international FX reserves into the hands of Japan’s state-run Bank for International Cooperation (JBIC). The funds will be distributed to exporters and small-to-medium-sized enterprises with the intent on spurring overseas purchases. Key potential areas for procurement are energy resources and overseas manufacturing capacity to counter the strengthening yen (more on this later).
The implications for this as it relates to the Japanese economy are large – potentially regarding future economic growth and capex spending by large Japanese corporations. Japanese officials, which are seeking to dramatically reduce the country’s reliance on nuclear energy over the next decade (by at least 20%), are contributing to major uncertainty in the boardrooms of Japanese enterprises as a result of their lack of consensus on long-term energy policy. As we wrote earlier in the month in a note titled, “THINGS ARE ABOUT TO GET A LOT WORSE IN JAPAN”:
“The uncertainty here is a negative near-to-intermediate-term catalyst because it: a) potentially delays the timeline by which Japan’s nuclear plants come back online (currently 38 of Japan’s 54 reactors are either idle or offline); and b) it casts uncertainty amid Japanese manufacturers on whether or not Japan will have enough power supply to meet their production plans over the long term. Such ambiguity is already weighing on corporate decisions to invest in Japan, as a recent Cabinet Office survey shows the percentage of goods Japanese manufacturers plan to produce outside of the Japan by 2015 jumped +340bps YoY to 21.4%.”
The secular shift in developing manufacturing capacity away from Japan being headed by major corporations (i.e. very large employers), like Toyota, Sony, and Nissan Motor – all of whom get royally squeezed when the yen appreciates beyond their forecasts:
- The stronger yen cut Toyota’s EBIT by -¥50B (-$650M) in the most recent quarter;
- The yen’s rapid ascent recently forced Sony to cut its earnings guidance by -25%; and
- Nissan Vice President Joji Tagawa officially warned of the stronger yen’s impact on job growth in Japan, citing the -¥55B ($715M) hit to their 2Q EBIT.
As we alluded to earlier, the shift away from nuclear power only exacerbates the shift away from the Japanese economy of productive economic capacity. As we outlined in our Japan’s Jugular presentation in 4Q10, Japan’s economy is highly leveraged to manufacturing and exports; as the producers go, so goes Japan’s economy (think: job growth). It will be interesting to see how the government plans to fund the country’s shift away from nuclear power over the long term with its debt/GDP ratio officially at 219% – prior to the earthquake/tsunami (OECD). Interestingly, a Japanese government report shows that a kilowatt hour of electricity is +26.4% more expensive to produce with LNG (vs. atomic power) and +101.9% more expensive to produce with crude oil. Given the current underdeveloped stage of renewable energy resources, we’d estimate the government’s official goal to grow the country’s reliance on this particular source of fuel by roughly 20x over the next decade will be incredibly costly.
If rising energy costs are indeed passed on to Japanese corporations, it will be an incremental headwind to economic growth on the island economy – in addition to negative population growth, an ageing population, eclipsing sovereign debt feeding into fiscal policy and regulatory instability, and, our personal favorite, ZIRP. Simply put, marking the risk free rate of return at ZERO percent indefinitely does five things (all of which are negative):
- DARES investors to chase yield (like forcing Japanese savers to seek higher returns off-shore in riskier securities, like emerging market high-yield corporate credit for example);
- DISGUISES financial risk (like the Japanese government seemingly being OK with a sovereign debt burden 2.2x the size of the economy);
- DELAYS balance sheet restructuring (see above);
- DEPRIVES elderly savers who rely on fixed income to fuel their consumption the means of doing so (Japan has a lot of elderly savers, FYI); and
- DOOMS the economy by frightening corporations and consumers away from either levering up or investing their “record cash pile” in productive capacity (cash on Japanese corporate balance sheets has grown to yet another record high in the most recent reporting period).
Something to keep in mind as Wall St. continues to beg the Fed for another round of Keynesian Elixir.
All told, we remain bearish on Japanese equities as economic growth is setup to slow meaningfully over the intermediate term, while long-term growth prospects are becoming dimmer on the margin.
Even beyond the intervention scheme, perhaps the most meaningful announcement of the day that current prime minister Naoto Kan is likely to step down by Friday, pending the likely passage of legislation to subsidize renewable energy and legislation to authorize the sale of deficit financing bonds that will procure funds for roughly 40% of central government expenditures for the current fiscal year, which began back on April 1st. Both bills were cleared by the more important lower house over the last few days and are expected to be ratified by the upper chamber.
The eventual passage of these bills, the final two prerequisites to the prime minister’s eventual resignation, means that Kan and his record-low 18% approval rating are finally out the door. The implications for this are great, considering that the Diet has been operating just above stall speed for quite some time now – well before the March earthquake/tsunami really put a lid their legislative productivity. We are of the view that having a less contentious leader in charge of the Japanese bureaucracy would allow the country to move forward with key policy initiatives ahead what is likely to be an meaningful FY12 (starting in April 1, 2012), specifically as it relates to Japan’s long-term fiscal health.
Currently, there are three candidates vying to replace Kan in what will be Japan’s SIXTH prime minister in the last five years. The field of potential replacements is shaping up as follows: Japan’s current finance minister Yoshihiko Noda (a deficit hawk and avid FX interventionist); the populist Seiji Maehara, former foreign minister who resigned earlier in the year over a campaign violation (a proponent of big spending and central bank stimulus); and the lesser known Banri Kaieda, who’s current post as trade minister leads us to believe that he’s also in heavy into FX intervention and monetary easing (the Toyotas, Sonys, and Nissans of the world have his ear).
The key takeaway here is that Japan is likely to have a shift, on the margin, in fiscal policy goals in the coming weeks. How that translates directly into the country’s P&L and balance sheet over a longer duration is something we will keep a close eye out for in the coming weeks. For now, let us shift to the current investment implications of this political change.
In the absence of a non-Keynesian, the marginally hawkish Noda is our preferred candidate of the three and a Noda victory would be incrementally supportive of our current bullish bias for the Japanese yen – a position supported by compressing interest rate differentials on the short end of the curve as our calls for Growth Slowing, Deflating the Inflation, Sovereign Debt Dichotomy, and Housing Headwinds force more Indefinitely Dovish policy out of the Fed. For those capable of executing directly within the forex market, we remain particularly bearish on the Aussie dollar over the intermediate-term TREND and see perhaps a bit more risk/reward to being long the JPY/AUD exchange rate (-8.2% YoY) over the JPY/USD currency pair (+9% YoY).
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