Positions in Europe: Short EUR-USD (FXE); Cover Italy (EWI) today
The magical European Bazooka Wand didn’t come out this weekend, and we don’t expect to see it at the EU-Summit on October 23rd either. Eurocrats have much on their plate, including bank recapitalization procedures, expanding the EFSF, and broader measures to insulate risks to the PIIGS. At odds remains the ECB’s unwillingness to take on more exposure, either directly through the EFSF or its bond purchasing program (SMP), and indecision from Eurocrats (and IMF) on Greek debt haircuts (21% vs likely reality of 50-60%), Eurobonds, higher capital standards for banks (including for future stress tests), and member nation default.
The European bag of risk continues to be directed by headlines, most particularly by the expectations that the “next” Eurocrat meeting will bring a positive solution to the region’s ills. Here we’ll repeat our bearish outlook on European capital markets. We think any relief rallies over the immediate term will be short lived, including for the EUR/USD – Europe has structural long term issues that will not be solved with the snap of a finger. We would however point to the November 4th G20 meeting as a likely date for additional direction to the banking and sovereign crisis. Quantifying last week’s bounce, European equity indices rose between +4 to 6% and the EUR-USD cross gained +3.8%.
In this light, we remain short the EUR/USD and find it prudent to be short select markets or on the sidelines until the details of Big Bazooka are revealed. The EUR/USD continues to be broken on its intermediate term TREND ($1.43) and long term TAIL ($1.39). Today Keith tactically covered our short position in Italy (EWI) in the Hedgeye Virtual Portfolio, however longer term we remain bearish on Italy. It was just Friday that Berlusconi won a narrow confidence vote, demonstrating just how fragile his rule remains, which creates huge political headwinds as the market judges the broader Italian economy on his ability to secure budget cuts in the coming 1-3 years.
Below we show our typical Monday risk monitor charts. Of note is that Italian yields (currently at 5.78%) are creeping dangerous close to the 6% level, a historically significant break-out line for Greece, Ireland, and Portugal, and the spread between German bunds and the 10YR French yield is at a decade wide of 95bps today. As we've said before, a downgrade of France's AAA credit rating is a real possibility that would have disastrous effects across the region, including undermining the EFSF.
A look at sovereign cds shows that Irish, Spanish, Italian and French spreads were slightly wider week over week, while Portuguese and German spreads tightened week over week. In particular, German CDS tightened by 8.9% (see charts below).
Finally, our European Financials CDS Monitor showed that bank swaps mostly tightened in Europe last week. Swaps tightened for 37 of the 40 reference entities. The average tightening was 7.2%, or 36 basis points, and the median tightening was 5.0%. Spanish banks saw the least tightening of the group.
POSITIONS: Long Utilities (XLU), Short Consumer Staples (XLP)
Today’s failure at our intermediate-term TREND line of resistance is very consequential.
Across durations here are my refreshed levels that matter most:
- TAIL = 1266
- TREND = 1231
- TRADE = 1189
I don’t think failing at 1231 means we crash right here and now. What I have been saying about crashing stock and commodity prices (20% declines from YTD peaks) is that the probability of crashes occurring goes up as market prices do (on low volume and negative skew).
If 1189 (TRADE support) holds, that will be a healthy signal in the immediate-term. If it doesn’t, it will be another bearish one. This is why earnings season hasn’t been this important in years.
In the very short-term, earnings should help take some of the headline burden off of European sovereign risks. The problem with that is that earnings like JPM and WFC have been negative catalysts too.
Keith R. McCullough
Chief Executive Officer
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Not a good nugget related to the strength of the global consumer.
September comps -7% showing a sequential slowdown on both a 1 and 2-year basis. With few exceptions, the trendline since August 2010 has been heading lower. The key here is that H&M is ‘comping the comp’ with relatively lousy numbers. So for all those people who think that after 1-year things must start to get better, they might want to tack on another 10 months to their ‘process’.
In typical UK fashion, disclosure is horrible, so until the mid-November report, all we know is the comp, and don’t know what countries or products are driving the business (or not, for that matter). The interesting thing we always keep in mind with H&M is that its geographic dispersion is simply massive, and sells everything from fast fashion apparel, to high-end Champagne, to cosmetics, and more. In other words, a fairly good barometer of the global consumer.
Here is H&M's sales distribution by country as well as the trends in the top 5 sales volume countries as of the September nine month report.
THE HEDGEYE BREAKFAST MONITOR
Cattle futures rallied to a record high as reduced herd sizes and strong demand for U.S. beef continues to support price.
Food processor stocks improved as the rebound in corn prices faded.
KKD: Krispy Kreme is to open 35 additional locations in the UK over the next six years.
ARCO: Arcos Dorados announced preliminary 3Q revenue of $970m to $990m and net income of $69 to $75 million. The company expects its systemwide comparable sales growth for the third quarter of 2011 to be within a range of 14.8% to 16.2%. With respect to EPS, the company expects an impact from an increase in compensation expense, certain one-time charges associated with the partial redemption of the Company’s 2019 Notes and the depreciation of certain local currencies versus the US dollar.
YUM: Taco Bell has named Brian Niccol has its Chief Marketing and Innovation Officer. Niccol has previously served as general manager at Pizza Hut and had been the brand’s CMO prior to that position.
SBUX: Starbucks features in a NY Post story this morning speculating that the company may be entering the pressed-juice bar business. The article states that CEO Howard Schultz has been “scoping out” top New York juice bars and has hired Liquiteria manager Yohana Bencosme, an 11-year veteran of the juice-bar business from Washington Heights.
BWLD: Buffalo Wild Wings was the only stock to trade on accelerating volume Friday as it underperformed peer casual dining stocks.
CDS tightened for American and European banks last week but widened slightly for most European sovereigns. The TED spread hit another new YTD high mid-week.
Financial Risk Monitor Summary (Across 3 Durations):
- Short-term (WoW): Positive / 6 of 11 improved / 1 out of 11 worsened / 4 of 11 unchanged
- Intermediate-term (MoM): Negative / 1 of 11 improved / 7 of 11 worsened / 3 of 11 unchanged
- Long-term (150 DMA): Negative / 1 of 11 improved / 7 of 11 worsened / 3 of 11 unchanged
1. US Financials CDS Monitor – Swaps tightened across all 28 major domestic financials last week.
Tightened the most vs last week: PMI, MTG, RDN
Tightened the least vs last week: GS, AXP, COF
Tightened the most vs last month: PMI, CB, MMC
Widened the most vs last month: GS, MS, AIG
2. European Financials CDS Monitor – Bank swaps mostly tightened in Europe last week. Swaps tightened for 37 of the 40 reference entities. The average tightening was 7.2%, or 36 basis points, and the median tightening was 5.0%. Spanish banks saw the least tightening of the group.
3. European Sovereign CDS – European sovereign swaps were mixed last week. Irish, Spanish, Italian, and French spreads were slightly wider, while Portuguese and German CDS spreads tightened week over week. Most notably, German sovereign CDS spreads tightened by 8.9%.
4. High Yield (YTM) Monitor – High Yield rates fell 28 bps last week. Rates ended the week at 8.49 versus 8.77 the prior week.
5. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 33 points last week, ending at 1548.
6. TED Spread Monitor – Last week the TED spread hit a new YTD high of 39.8 on Tuesday before backing off slightly to end the week at 39.5 bps.
7. Journal of Commerce Commodity Price Index – The JOC index continued its decline, falling 1.4 points to end the week at -20.0.
8. Greek Yield Monitor – Last week the 10-year yield on Greek debt rose 40 bps to end the week at 2393 bps versus 2353 bps the prior week.
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 higher. Last week, spreads fell 3 bps and closed at 173 bps.
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 index rose 173 points, ending the week at 2173 versus 1899 the prior week.
11. 2-10 Spread – We track the 2-10 spread as an indicator of bank margin pressure. Last week the 10-year yield rose to 2.25, pushing the 2-10 spread to 198 bps, 19 bps wider than a week ago.
12. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 2.8% upside to TRADE resistance and 2.6% downside to TRADE support.
Margin Debt Falls in August
We publish NYSE Margin Debt every month when it’s released.
NYSE Margin debt hit its post-2007 peak in April of this year at $320.7 billion. The chart below shows the S&P 500 overlaid against NYSE margin debt going back to 1997. In this chart both the S&P 500 and margin debt have been inflation adjusted (back to 1990 dollar levels), and we’re showing margin debt levels in standard deviations relative to the mean covering the period 1. While this may sound complicated, the message is really quite simple. First, when margin debt gets to 1.5 standard deviations or greater, as it did this past April, that has historically been a signal of extreme risk in the equity market - the last two times it did this the equity market lost half its value in the ensuing period. We flagged this for the first time back in May of this year.
The second point is that margin debt trends tend to exhibit high degrees of autocorrelation. In other words, the last few months’ change in margin debt is the best predictor of the change we’ll see in the next few months. This is important because it means that margin debt, which has retraced back to +0.64 standard deviations as of August, still has a long way to go. We would need to see it approach -0.5 to -1.0 standard deviations before the trend reversed. We’ve dropped 230 S&P handles in getting from +1.5 standard deviations to +0.64 standard deviations. There’s plenty of room for short/intermediate term reversals within this broader secular move, but overall this setup represents a material headwind for the market.
One limitation of this series is that it is reported on a lag. The chart shows data through August.
Joshua Steiner, CFA
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