“Adventure is just bad planning.”
Yesterday, in the Early Look Keith wrote the following:
“Again, I’m not calling for a new bull market. Neither am I saying that Growth Slowing has ended. I am simply suggesting that you see this for what it is in most things US Equities (and some things Asian and European Equities) this morning – a Short Covering Opportunity.”
Call us lucky or good, but with the SP500 moving 44 handles upwards in the last 45 minutes yesterday, yesterday was a short covering opportunity indeed.
A key point underscoring that call yesterday was that global macro fundamentals, on the margin, were not getting worse. Alongside that, of course, was that consensus was hyper bearish. I was reminded of that this morning when I saw an advertisement on Google that was trying to sell a list of banks that are “doomed to fail”.
Certainly, we have a bearish view on the global banking system. That said, when companies start running advertisements to sell lists of banks that are “doomed to fail”, the surest takeaway is that a lot of the bad news surrounding bank failures is priced in over the short term. In the Chart of the Day, we’ve flagged this advertisement.
The other positive catalyst for global equities today is Moody’s downgrade of Italian government debt by 3 notches. To the credit of Moody’s, the ratings agency has at least gone from being completely irrelevant and wrong to being a classic contrarian signaler. The market decides when debt is downgraded, not Moody’s, and the market downgraded Italy many months ago.
Our view of Europe is that it would require a crisis to lead to an appropriate action that would at least lead to a reprieve in the European debt crisis contagion in the short term. Yesterday, the crisis came in the form of Dexia, the largest bank in Belgium. Dexia is also a significant global banking player and is roughly twice the size of Washington Mutual for comparative purposes.
The negative rumors out on Dexia yesterday were rampant. There was speculation that an emergency board meeting had been called to discuss Dexia’s accounting for Greek debt. Rumors suggested that a breakup of the bank was imminent. To raise capital, the bank was supposedly preparing to sell its profitable Turkish and Asset Management businesses. Etc. Etc.
In the case of Dexia, we should be clear, where there is smoke there is fire. In a chart that we have flagged numerous times over the last couple quarters comparing tangible equity to tangible assets of European banks, Dexia is by far the worst capitalized of the major European lenders at 1.5%. (Incidentally, Deutsche Bank is the fourth worst capitalized bank in Europe at 2.8% tangible equity to tangible assets.)
As with any global economic crisis, though, comes a great Keynesian opportunity. Last night the Belgian Prime Minister put his Keynesian cards on the table and said the following on national radio:
“One of the possibilities to consolidate Dexia Bank Belgium is, at a certain point, to ensure that it is taken up by the government.”
To this hockey head, that sounds like an explicit back stop for Dexia and, at least, a short term reprieve for the weakest major bank in Europe.
The other marginal positive from Europe, which was a key catalyst for U.S. equities yesterday, was an article from the Financial Times that Eurozone officials are examining ways of recapitalizing banks. Like an addict, the first step in solving your problem is actually admitting you have one. After months of denial, European officials leaking that they will recapitalize bad banks is an admission of their problem and a short term positive.
In addition, German President Angela Merkel made the following statement yesterday:
“No one can say for certainty what would happen if Greece defaults. Before I make a nifty step into an adventure, I have to ask whether we can really handle this and can we oversee what we are doing? Solidarity is always cheaper than if we were to go it alone and wind up with the problem Switzerland has . . . that the currency level is so high that you can’t export any products anymore. Today, going it alone is not path to a better future.”
Not surprisingly, Merkel sums up German situations quite adroitly. On one hand, Germany has and will continue to bear the bulk of the financial responsibility of Europe’s Sovereign Debt Dichotomy. On the other hand, German has been a major economic beneficiary of a common currency in the Eurozone.
Undoubtedly Merkel has not forgotten 1992 to 1995, the last time that other European economies found their combination of demand growth and real exchange rates against the German economy unsustainable. The results were massive and abrupt depreciations against the Deutsche Mark. In turn, the appreciation of the Deutsche Mark against Germany’s key trading partners led to a collapse in German exports and competitiveness. Despite internal politicking, the Germans ultimately understand that the Euro benefits them.
And so the nifty adventure in Europe continues.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
TODAY’S S&P 500 SET-UP - October 4, 2011
Yesterday’s “Short Covering Opportunity” call was Keith’s third in the last two months (August 8th and September 12th were the other 2 time stamps).
As we look at today’s set up for the S&P 500, the range is 45 points or -2.49% downside to 1096 and 1.52% upside to 1141.
SECTOR AND GLOBAL PERFORMANCE
- ADVANCE/DECLINE LINE: 633 (-2498)
- VOLUME: NYSE 1662.1 (+18.4% )
- VIX: 40.82 -10.2% YTD PERFORMANCE: +129.97%
- SPX PUT/CALL RATIO: 2.00 from 1.97 (+1.5%)
CREDIT/ECONOMIC MARKET LOOK:
- TED SPREAD: 38.09
- 3-MONTH T-BILL YIELD: 0.00%
- 10-Year: 1.85 from 1.82
- YIELD CURVE: 1.60 from 1.57
MACRO DATA POINTS (Bloomberg Estimates):
- 7 a.m.: MBA Mortgage Applications, prior 9.3%
- 7:30 a.m.: Challenger job cuts, prior 47.0%
- 8:15 a.m.: ADP employer, est. 73k, prior 91k
- 10 a.m.: ISM Non-manufacturing, est. 52.8, prior 53.3
- 10:30 a.m.: DoE inventories
- 11 a.m.: U.S. to purchase $1b-$1.5b TIPS
WHAT TO WATCH:
- Bank of New York Mellon sued by U.S., New York for allegedly defrauding clients in FX trades
- Dexia shares rise as Belgium pledges to create a “bad bank” for assets, speculation that European policy makers mulling additional measures for region banks
- Italy downgraded three notches by Moody’s; ratings agency says more downgrades in euro-region possible
- Hewlett-Packard to decide whether to spin off its PC unit by end of month, CEO Meg Whitman said
- EMI bids, due this week, said likely to come in lower than expected, people familiar tell Bloomberg
- U.S. Trade Representative holds public meeting on China’s compliance with World Trade Organization commitments
- Cisco CEO John Chambers, Oracle CEO Larry Ellison speak at Oracle Openworld
- Bill Ackman said he may sell shares in a hedge fund to secure more permanent capital for investments as soon as next year.
- Kinetic Concepts said to host lender meeting today to discuss refinancing
GOLD – Hedgeye made a short call in Gold yesterday (before the down move) as Gold failed at the intermediate-term
TREND line of resistance ($1672); first support = $1573 and the long-term TAIL of support is all the way down at $1491; KM expects Gold to come under increasing selling pressure as 2yr UST rates hold the TRADE line of 0.21% support.
MOST POPULAR COMMODITY HEADLINES FROM BLOOMBERG:
- Commodities Climb From 10-Month Low as Bernanke May Buoy Growth
- OPEC Risks Bear Market as Libyan Output Recovers: Energy Markets
- Copper Rout Unlikely to Halt Chile $67 Billion Bet: Commodities
- Indonesia May Sell More Palm Oil to China, Hurting Prices
- Gold Declines in London as Dollar’s Rally Cuts Investor Demand
- Corn Gains on Speculation 26% Slump May Attract China Purchases
- Sugar Advances as Lower Prices May Spur Buying; Coffee Climbs
- Copper Rises on Speculation Officials Are Set to Stoke Recovery
- Commodities to Rally in ’12, Says Credit Suisse Joining Goldman
- Silver Rebound May Stall at $33.15 an Ounce: Technical Analysis
- Australian Grain Regions May Get Crop-Boosting Rain This Week
- Chile’s Richest Family Risks Golden Touch With Shipping: Freight
- Komatsu Risk at 2-Year High on Yen, Economic Slump: Japan Credit
- Oil Rises From Lowest in a Year on Supply Drop, Stimulus Hopes
- Palm Oil Drops to 1-Year Low as Malaysian Reserves Set to Climb
- Rubber May Extend Drop to Lowest Since 2009: Technical Analysis
The Russian stock market crash matters; the RTSI is flagging a negative divergence vs the rally in Europe DAX to lower highs; Russia = down -1.6% this morn and down, get this, -43% since April when the down Dollar/up inflation trade stopped! Get the USD right; you’ll get a lot more right.
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This note was originally published at 8am on September 30, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“The readiness is all.”
You have to give it to William Shakespeare, he had a way with words. Just as Canadian hockey players have a way with understatement. When it comes to the daily global macro market grind, Shakespeare’s quote above about says it all. You are either ready; or you are not ready. It is really that simple.
I’ve recently been reading, “How Markets Fail”, by John Cassidy. I wouldn’t say I agree with all of Cassidy’s observations in the book, but he does offer some interesting anecdotes regarding markets and prevailing wisdom. Near the end of the book, Cassidy takes a break from analyzing markets and describes the origin and construction of the Millennium Bridge in London.
As background, in 1996, the London Borough of Soutwark, the Royal Institute of British Architects, and the Financial Times newspaper held a competition to build a new footbridge from the Tate Modern Art Gallery to St. Paul’s Cathedral, which, of course, would cross the Thames. The winning bid ultimately came from sculptor Sir Anthony Caro, architect Sir Norman Foster, and the engineering firm of Ove Arup.
The winning entry was a spectacular design “with steel balustrades projecting out at obtuse angles from a narrow aluminum roadway.” The designers insisted that the unique looking bridge could support at least five thousand pedestrians. So, on June 10, 2000, just in time for the Millennial, the bridge was opened up by Queen Elizabeth II with much fanfare and thousands of pedestrians started to walk across the bridge.
The bridge began to immediately sway causing pedestrians to cling to the sides of the bridge and created what has been described as a sea sick feeling amongst those who traversed it. Two days later, London authorities quickly shut the bridge down for an indefinite period, concerned about the stability of the bridge and safety of pedestrians utilizing it.
After studying the issue, the engineers at Ove Arup concluded that the issue was with the pedestrians and not due to the actual design of the bridge. In part, the engineers were correct. The bridge had been designed to gently swing to and fro, but what the designers didn’t account for was that pedestrians would exaggerate these movements in unison as they walked across the bridge. Arguably, the engineers’ design was not ready.
The natural movement of walking produces a slight sideways force. Thus as hundreds, even thousands of pedestrians walked across the bridge, they unwittingly created a unified sideways force that amplified the movement of the bridge. In effect, the natural wobble of the bridge became self-reinforcing and fed on itself. The savvy engineers at Ove Arup even came up for a name for this action, called “synchronous lateral excitation”.
In preparing you for the market action in the coming quarter, one of our Q4 themes will be related to this idea of “synchronous lateral excitation”. In global markets, currently, this concept is increasingly related to heightening correlations across asset classes. In some instances, this heightened correlation applies to even seemingly unrelated asset classes. Simply put, investors are increasingly acting in unison, which is amplifying price movements across markets and amplifying future risk. We’ve termed this, the “Correlation Risk” in previous notes.
Interestingly, though, even as cross-asset correlations are heightening globally, there are seemingly outlier markets that remain less correlated. According to recent report from Bloomberg:
“The 30-day correlation coefficient between the S&P 500 Financials Index and the banking group in the Stoxx Europe 600 Index has averaged 0.65 in 2011, according to data compiled by Bloomberg. The figure for European banks and Japan's Topix Banks Index is 0.25.”
Yes, you read that correctly. Japanese banks are becoming a global safe haven. Were you ready for that?
My colleague, and Hedgeye Asian analyst, Darius Dale recently updated his thoughts on Japan in a presentation. A key takeaway is that in the last three years U.S. policy makers have been much more Japanese than the Japanese in terms of monetary policy. In fact, not only did Chairman Bernanke and his associates cut rates more aggressively from the outset of the financial crisis, they have also leaned more heavily on the balance sheet of the central bank than their Japanese counterparts.
Interestingly, and related to the topic of global banking risk, this morning credit default swaps on Morgan Stanley reached a new cycle high of 455 basis points from 275 basis points at the end of August. In effect, Morgan Stanley is now seen to be as risky a credit as the Italian banks. Are you ready for that?
Part of increasing correlation between global markets is and has been the advent of increasing economic globalization and integration. In 2011, it is truly a global economy. This morning, the Chinese HSBC manufacturing PMI came in at 49.9, which is sub 50 for the third straight month. The immediate reaction to this tepid manufacturing number from China can be seen in European equities off 1.5 – 3.0% across the board. The German Dax is leading the way to the downside as a German lawmaker spoke out against an expanded EFSF.
The Hedgeye team has certainly tried to do our best to alert our subscribers as to the dismal outlook for equities this year and this quarter. To that point, with the last trading day for Q3 2011 today, the SP500 is down -12.1% quarter-to-date. Based on the performance of the SP500 and some broad hedge fund return numbers we have seen, there is another risk to be ready for: fund redemptions. Redemptions are never fun to talk about, but they are an unfortunate reality in this business that can impact asset prices.
Hopefully this note isn’t too somber heading into the weekend, but as Shakespeare also said:
“Better three hours too soon than a minute too late.”
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
The Macau Metro Monitor, October 5, 2011
LAWMAKERS REQUEST CLEAR GAMING POLICIES Macau Daily Times
Macau lawmakers are urging the government to disclose when it will remove gaming facilities out of residential neighborhoods, a promise first made in late 2007. Secretary Tam had said at the time that the government would not grant more licences to lottery houses and slot machine venues in residential areas, explaining that it wanted to “gradually” remove gaming facilities from neighborhoods. However, almost four years have passed and the government has yet to announce a timetable.
But Tam revealed that the new legal system for the construction and location of casinos, slot machines and lottery houses will be ready in the first half of 2012. “Slot machines and lottery houses are banned in residential buildings and those that already exist will be relocated,” he reassured.
WE REMAIN COMMITTED TO HIRING SINGAPOREANS Today Online
RWS said they have a 13,000-strong workforce; about 70% are locals. They remain committed to hiring Singaporeans. MBS said out of the nearly 9,000 team members, nearly 70% are Singaporeans. In some departments such as entertainment, facilities and security, the percentage of locals is as high as 94%.
Ongoing concerns surrounding economic growth coupled with the strengthening dollar are pressuring commodity prices. Week-over-week, most of the commodities we track declined significantly.
Declining grain prices are bullish for restaurant industry margins and bearish for protein prices. This is a positive for food processors such as TSN and SAFM in particular, particularly as beef prices continue higher. Rising beef prices are a concern for WEN, TXRH and many others in the restaurant industry.
Coffee prices have continued to drop sharply, making it less likely that additional price raises from coffee retailers such as SBUX, DNKN, PEET, GMCR, CBOU and THI are imminent. As we said last week, we expect high retail prices to take some time to adjust, given the need to clear inventory purchased at elevated prices.
Chicken wing prices continue to gain, which is a concern for BWLD. See our note (10/4) for more detail on our short BWLD thesis. We believe coming margin pressure could be expedited and exacerbated by soft sales in the fourth quarter. Furthermore, from a sentiment perspective, the Street is more bullish (60% Buys) on the stock than it has been in some time.
Dairy prices have been moving sideways over the past couple of weeks, and cheese prices remain down year-over-year. This is a positive for CAKE, DPZ YUM and PZZA, especially considering the level cheese prices were at just a few weeks ago.
Lean hogs, chicken wings, live cattle and cheese were the only commodity prices in our monitor that gained versus last week. The declines in our weekly monitor were again larger than the advances. Rice, chicken broilers, sugar, coffee, milk, soybean, wheat and corn all saw sizeable declines. As we have been writing of late, declining commodity costs are generally a positive for restaurants but it is worth noting that much of the softness in commodity demand is related to softening economic conditions and this implicitly means a drop in demand for consumer goods and services.
Gasoline prices continue to toe the 2008 line, declining as the dollar continues to strengthen and economic concerns mount.
Corn has been declining sharply as demand has been slowing and stockpiles rising. This is a positive for protein producers that can enjoy much needed relief as feed prices decline. The U.S. Grain Council, according to Bloomberg, has said that China – the world’s second-largest corn consumer – won’t have enough supplies to meet rising demand even as farmers there harvest a record crop. Despite this, and concerns about a smaller U.S. crop, demand concerns seem to be catching the eye of investors as grain prices drop high-single digits week-over-week.
Below is a selection of comments from management teams pertaining to grain prices from recent earnings calls.
PNRA (7/27/11): “Just to note on the cost of wheat, in 2011 overall, the per-bushel cost will be about the same as 2010 due to our laddering purchasing strategy.”
“We are going to take price in the fourth quarter. This price will offset dollar for dollar the per-bushel inflation of wheat of approximately $3 a quarter that we're going to see in the fourth quarter of this year and then across next year”
“We do continue to expect significant inflationary pressures in 2012, 4% to 5% food inflation, $10 million of unfavorability on wheat costs, which means that we don't expect operating margin much better than flat to full-year 2011 in 2012.”
HEDGEYE: Weak global demand and a stronger dollar are currently trumping the adverse impact on supply due to weather and fires in the U.S. Slowing demand may also mean lower sales for PNRA, so it remains to be seen if margins improve from this effect, even if high wheat costs come down.
DPZ (7/26/11): “We're fairly locked in on our chicken, locked in on our wheat into – partway into next year.”
PZZA (8/4/11): “We're actually covered through Q1 from a contract standpoint. So from a supply chain disruption or even significant price impact we don't anticipate anything between now and the end of the year.”
Beef prices continue higher despite the free-fall in corn prices over the last week. Feedlot inventories shrinking and demand for meat increasing globally are two factors being cited for the continuing strength in beef prices. The U.S. cattle herd totaled 100 million heads on July 1st, the lowest for that date since at least 1973, according to the Department of Agriculture. Strong demand for U.S. beef overseas is spurring the price gains that are illustrated on the chart below.
Below is a selection of comments from management teams pertaining to beef prices from recent earnings calls.
RRGB (8/11/11): “We're still buying ground beef on the spot market… If you recall, we said 5% to 6% commodity inflation on the last call and we dropped that to 5 to 5.5. Again, that's mainly ground beef driving that.”
HEDGEYE: Live cattle prices are up 22% YoY and, we believe, will continue to be a negative for RRGB’s P&L going forward.
WEN (8/11/11): “That's one of the reasons why as we've talked about our margin guidance, we do not expect to see much relief on beef cost this year.”
Chicken wing prices continue to go higher, signaling a likely end to the massive headwind BWLD has enjoyed from a margin perspective over the last couple of years. We believe that this change is coming at a difficult time for the company as sales trends have been softer in 4Q in recent years and consumer confidence is waning.
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