ECB and BOE likely on Hold

Positions in Europe: Short Italy (EWI)

It appears more likely that the ECB may keep interest rates on hold when it meets tomorrow (and likely choose to cut later into year-end) given the preliminary September CPI report that jumped 50bps to 3.0% year-over-year. Equally, we expect the BOE to be on hold, a position it has maintained since March 2009 despite pressing inflation—and here we’ll reiterate that policy makers are in a box with the country stuck squarely in stagflation with little room to cut interest rates to spur growth (see chart below).  We’d fade any commentary from Cameron & Co. that the economy is running in a positive direction. And today’s Final Q2 GDP report in which Q/Q was revised down 10bps to 0.1% won’t help sentiment!


ECB and BOE likely on Hold - 1. BOE


Tomorrow marks an important meeting for the ECB as it is President Trichet’s last meeting before Mario Draghi takes over on November 1.  As we’ve written about in the last months, the ECB is in the unfavorable position of being the one institution that may need to significantly contribute to Europe’s sovereign debt and banking “bazooka” bailout, while the Bank’s mandate and position (at least until now) remains to shy away from all things related to fiscal policy [short of the SMP] and focus solely on its mandate of price stability. If the last months have proven anything, it’s that there are flaws in this system, or at least to the extent that one monetary policy can govern uneven economies, especially in a slow to negative growth environment. Yet don't discount the resolve of policy makers to continue to attach fiscal "band-aids" to the Union's imbalances.


In any case, we’d expect to see the ECB cut its main rate of 1.50% sometime into year end, but wouldn’t be surprised if it didn’t come tomorrow.  The high frequency data we follow continues to trend lower as inflation remains above the Bank’s 2% target, but within a range that should come in over the coming months. Reflecting slower growth, today we received PMI Services data across the major economies. The SEPT data shows a marked slowdown month-over-month, with the Eurozone, Germany, Italy and Spain all below the 50 line, which signals contraction.


ECB and BOE likely on Hold - 1. Services


Germany, in particular, continues to remain THE country carrying the biggest stick when it comes to voicing the direction of Europe’s sovereign debt and banking contagion crisis, which may continue to take pressure off the ECB  to not only act on monetary policy, but fiscal policy as well.  However, it’s equally clear that neither Chancellor Merkel nor Brussels have any clear idea about how to get out of this mess. Yesterday the market in the US rallied on a late-session article from the FT that said EU officials are examining ways of coordinating recapitalizations of banks and agreed that additional measures are urgently needed. This news is also clearly boosting European equities today, yet again we’d warn that that such “news” will provide at best a short term rally.


Below we’ll leave you with some recent quotes from Chancellor Merkel as it relates to the sovereign debt and banking crisis in Europe. What stands out is that Merkel sounds increasingly of the opinion that performing wall sits to save the Union over the longer duration benefits both Germany and the Union. 


Merkel reaffirms anti-Eurobonds stance: issuance of shared debt by euro countries isn’t the solution to the problem spilling from Greece, even though some may long for the “big bang” to end the debt crisis… “Whoever believes that has no clue about the economy.”


Merkel on Default: A Greek default would have unpredictable consequences, lead to speculative attacks on other highly indebted euro countries and risk sending German economic growth into reverse. Letting Greece default would trigger “a gigantic loss of confidence” in euro-area sovereign bonds…”


“No one can say with 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 no path to a better future.”



Going into tomorrow’s meeting we see a bearish immediate term TRADE range in the EUR-USD of $1.31-1.34. The pair remains broken on an intermediate term TREND duration. 



Matthew Hedrick

Senior Analyst


MPEL’s special shareholder meeting tonight could provide some long overdue clarity.



MPEL’s stock has been hammered – absolutely hammered.  While all the Macau stocks have been crushed as investors replay 2008 in their heads, MPEL has underperformed even this pitiful collection of stocks.  Despite all the rumors and storytelling, the fact is that investors fear that a slowing China economy and tighter credit will pressure junket volumes similar to 2008 and that is the reason these stocks are down.


For Q3, MPEL fell 35% but that was concentrated in September when the stock fell 36%.  By comparison, the US operators with casinos in Macau fell an average of 23% and 24% in Q3 and September, respectively, while the Hong Kong listed Macau stocks dropped 30% and 41%.  In October, MPEL is down again, -4%, but this pales in comparison to the HK listed stocks which are down 19% already this month.




MPEL now trades at around 5x 2012 EV/EBITDA which seems ridiculous.  Investors clearly don’t believe that current Macau run rate revenues are sustainable but that doesn’t explain the relative valuation discount.  So why so cheap?

  • It’s MPEL, the gang that couldn’t shoot straight – 4 straight quarters of outstanding results apparently cannot overcome dreadful performance following the IPO in 2006.
  • Despite the US listing, MPEL is considered an Asian stock and US investors implicitly trust the US operators more.  As shown above, the HK stocks have underperformed, sometimes even more so than MPEL.  Similar among the HK stocks, public shareholders have little control over the entity given the concentrated ownership – for MPEL, Melco and Crown control almost 70% of the stock.
  • Shareholder dilution – as one of my smart clients has asked “do these guys really want to be known as serial diluters?” More on this later.
  • Recent performance is not sustainable – What?  MPEL has consistently grown market share and margins since the management change in the middle of 2010.  And they aren’t necessarily buying the business as EBITDA has grown faster than revenues and the company has beaten bottom line expectations (hold adjusted) for 4 straight quarters.

So what could be a catalyst to turn this thing around?  First, a rate cut or some other macro measure by the Chinese government to show it is focused on ensuring a soft landing would help all the Macau stocks.  For MPEL in particular, we are pretty sure they will beat the quarter, potentially beating Q3 EBITDA estimates by 40%.


Most immediate, MPEL will hold a special shareholder meeting tonight to discuss and vote on a listing on the Hong Kong exchange and a stock buyback.  Investors rightly fear a big dilutive equity raise.  This seems to be priced into the stock.  We are hard pressed to believe that MPEL would do a straight equity raise at 5x EV/EBITDA.  With cash trapped at the parent due to restrictions from the $600 million senior notes, MPEL eventually needs to raise cash or pay off the notes.  We opt for the latter, of course.


So the options for MPEL are as follows:

  • A big equity raise $250-300 million – probably in the stock already
  • Cancelling the HK listing – would be a huge positive for the stock
  • Going forward with the listing but buying an equal amount of stock of MPEL to offset dilution but still add the second listing – this would squeeze the shorts
  • A substantially smaller IPO – probably a positive

The prospectus is supposed to be offered sometime this month.  Hopefully , we will know more details tonight.






On yesterday’s short-covering opportunity, which yesterday’s Early Look had predicted, casual dining outperformed peer subsectors.  Food processors saw more muted gains on the day but continue to trade well as grain costs slide.


THE HBM: YUM, MCD - subsectors fbr





YUM reported earnings yesterday after the close.  EPS beat expectations by a penny, coming in at $0.83.  The stock is trading down premarket due to concerns about the quality of the beat (tax rate) and China margin pressure.  China comps accelerated to +19%, confirming our confidence in YUM's China business following a recent trip to the country.  Management is hosting the earnings call this morning.


MCD Japan SSS gained 4.8% in September.  This is the first time in three months that the monthly comp number has been positive.  The company attributed the gain to a change in lifestyle patterns after the lifting of the government-mandated electricity saving request on September 9th. 


THE HBM: YUM, MCD - stocks 1015



Howard Penney

Managing Director


Rory Green




Early Look

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Retail: Pre-Announcement Time


With companies set to report September sales on Thursday, retailers have greater visibility into not only Q3 results with two months now in the books, but also how they are tracking into year-end. If retailers are looking at the same Macro setup we are and the number of companies that have beat versus missed on the sales line over the last three months is any indication, we expect to see the first phase of pre-announcements from retailers later this week.


The key BTS August selling season was choppy at best and our sense is that many retailers, especially on the discretionary side, underestimated the percent of sales that were lost forever instead of pushed into September due to Irene. To date, there hasn’t been much from retailers suggesting slower than expected sales with perhaps the sole exception of KSS at a competitor’s conference earlier in the month. Since then, the Macro setup hasn’t changed and in fact, current economic pressures have mounted even further.


Let’s review the setup from a Macro level:

  1. Gross Personal Income was running up +3.6% and about to increase to over 4% compared to +3.3% today. (negative point)
  2. The two main levers that account for the delta between Gross Income and Personal Consumption have offset each other for the most part.
    1. The consolidated personal tax rate is now at 10.8% vs. 9.4% this time last year. (negative point)
    2. The personal savings rate is back down to +4.5% compared to +5.8%.
    3. In looking at ‘Essential Spending’ (food, energy, healthcare), the growth we’ve seen from June last year at (+2.6%) to May (+4.4%) has come in to +3.1%. (positive point)
    4. The balance of spending goes into the ‘Discretionary Spending’ line, which is considerably more volatile. This stood at +12.2% this time last year compared to +11.8% in August.
    5. In addition, consumer confidence is at 45.4 compared to 48.6 last year and unemployment is looking increasingly likely to weaken further before getting better near-term.
    6. Based on our read out of POS data (NPD & SportScan), sales in September picked up later in the month in the department store channel, but remain uninspiring. In addition, weekly ICSC retail sales continued to decelerate throughout the month.

We think that sales day and likelihood of pre-announcement activity is going to reveal a key crack as it relates to the margin weakness and unsustainable earnings expectations in retail. The tailwind in consumer income growth is shifting and relief in the form of lower taxes unlikely. A further reduction in the personal savings rate is one of the few levers left for the consumer to pull, but would in turn place the consumer on even shakier ground heading into the 1H of F12.  



Shorts: JCP, UA, HBI, SHLD

Longs: LIZ, NKE, RL, TGT



Retail: Pre-Announcement Time  - HE Consumer IS 10 4 11


Retail: Pre-Announcement Time  - SSS Beat Miss 10 11


Retail: Pre-Announcement Time  - PCE  retail sales  comps snag 10 4 11


Retail: Pre-Announcement Time  - SSI NPD 10 4 11


Retail: Pre-Announcement Time  - unemployment 10 4 11


Retail: Pre-Announcement Time  - Cotton 10 11


Retail: Pre-Announcement Time  - apparel CPI less import 10 4 11


Retail: Pre-Announcement Time  - total T E U 10 4 11


Retail: Pre-Announcement Time  - SSS 10 4 11



Nifty Adventures

“Adventure is just bad planning.
-Roald Amundsen 


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


Nifty Adventures - Chart of the Day


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