Weekly Asia Risk Monitor: Global Bankruptcy Cycle?

Conclusion: Given the current state of emerging market external debt levels and maturities, King Dollar puts many emerging market corporations at risk of earnings erosion, balance sheet deterioration, and, at worse – bankruptcy.


Prices Rule

Asian equity markets had another soft week, closing down -1.2% wk/wk on a median basis. Losses were led by China (-4.7%) and Thailand (-4.1%), as both struggled with heightening domestic risks. Asian currencies had a slightly negative week as well, closing down -0.3% wk/wk on a median basis vs. the USD. India’s rupee led the way to the downside (-2%), while gains were led to the upside be the Japanese yen – a clear sign of regional stress based upon our analysis of the mechanics driving JPY appreciation.


Asian sovereign debt markets were fairly mixed; perhaps the most notable divergence came on the short end of India’s and Indonesia’s maturity curve. Indian 2yr yields increased +12bps wk/wk after the government affirmed that it will buck the developing trend of monetary easing across the emerging market space and maintain its hawkish bias until inflation is under control. Their commentary was taken literally in the swaps market, as India’s 1yr on-shore interest rate swaps widened +15bps wk/wk. As it relates to Indonesia, expectations of further monetary easing drove 2yr yields down -27bps wk/wk.


Sovereign credit default swaps throughout the region were fairly flat on the week. A notable decliner to the downside was Hong Kong, which saw its swaps trade -7bps (-7.4%) tighter wk/wk. 


***price tables can be found below***


The Least You Need to Know

Emerging Markets:

  • One of the themes we’ve been writing about of late is the risk of a financial crisis to sweep across the EM space driven by movements in the currency markets. Simplistically, as a country’s currency depreciates vs. the USD, both its dollar-denominated borrowing costs and its cost of servicing dollar-denominated debt increase.  Corporations in certain Asian countries, like India (INR/USD down -11% over the last 3mo), who’ve loaded up on external debt over past three  years amid FX appreciation and low dollar-funding costs are at risk of severe erosion in earnings growth. Moreover, they risk deterioration of their balance sheets as they are potentially forced to take on greater amounts to local currency debt to meet rising foreign obligations. Bankruptcy also remains a possibly for the weakest borrowers.
  • To the latter point, Bloomberg data shows that corporations in the ten largest emerging market economies have $54 billion of foreign currency bonds coming due in the NTM – the largest sum on record (dating back to 1999). This is coming at a time where the market for issuing foreign currency corporate debt has gone completely dry ($2.6 billion in Sept. vs. a record $108 billion in 1H11). Furthermore, non-investment grade issuers were completely shut out of the market in September.
  • From a borrowing costs perspective, the trend of widening credit spreads and rising interest rates continues. According JPMorgan EM bond indexes, investors now demand  a 444bps premium to holding the dollar denominated EM corporate bonds over similar maturity U.S. Treasuries – up from 256bps wide in April. And at 6.36%, rates on dollar denominated EM corporate bonds are the levels last seen since June 2010 (absent a brief stint above 7% in early October).

Net-net, we continue to flag FX risk as a reason to remain cautious on both emerging market equities and credit broadly. We are of the view that a great many EM issuers are likely un-hedged, given consensus forecasts for broad-based EM currency appreciation as recently as 2Q. We’ve done a fair amount of work on this topic in recent months and we’re happy to follow up should you like to dig in further. Simply email us for more details.



  • The key data point to flag out of China this week is the central government’s decision to allow some local governments to issue bonds independently. The move ends a 17-year ban, which forced China’s municipal governments to seek financing via arms-length entities (amassing $1.7 trillion in debt in the process). The program is rather small in both size (CNY22.9 billion) and scope (two cities; two provinces), but we would expect to see it expanded upon in the coming months as LGFV debt maturities mount.

While by no means a cure-all (the property market is still showing signs of cracking), allowing the local governments to issue bonds directly to investors will: a) diversify financial risk away from the banking system and b) smooth the systemic balance sheet mismatch that stems from issuing short-term paper to fund longer-term infrastructure initiatives.



  • The key data point to flag out of Japan this week is/are the government’s latest fiscal stimulus measures. First, it was announced that the Japan will bolster by +25% funds allocated for the recently-announced Japan Bank for International Cooperation fund to ¥10 trillion. The initiative was set up to help Japanese corporations cope with an elevated yen by aiding in overseas M&A. Secondly, Prime Minister Yoshihiko Noda approved a ¥12.1 trillion third supplementary budget to help fund both quake rebuilding and domestic capex (with the intent of preserving jobs).

As we have seen for the latter part of the past twenty years, the Japanese government continues to be the only source of incremental demand in the ailing Japanese economy. Our secular debt and demographic work on Japan suggests that this phenomenon is likely to continue as growth remains structurally depressed over the long term.



  • The key data point to flag out of India this week is the pervasive hawkishness sweeping across various levels of Indian government. This week, Chakravarthy Rangarajan, chairman of the Prime Minister’s Economic Advisory Council, affirmed the country’s need for higher interest rates, in spite of his view that inflation is being largely triggered by elevated food prices and/or supply-side constraints. His comments were supported by additional commentary out of Finance Minster Pranab Mukherjee, who said that India’s inflation “may be under pressure until December”, and that the RBI “need not follow the policy of reducing interest rates being pursued by some of its counterparts abroad.”

These comments echo RBI Governor Duvvuri Subbarao’s statement last week which read: “As much as we look at what other central banks are doing, we take into account our own domestic circumstances and the domestic context in formulating policy,” – suggesting that India is unlikely to follow suit and join the rate cutting cycle anytime soon, given that, while slowing, WPI is likely to remain elevated on an absolute basis over the intermediate term.



  • A key data point we wanted to flag out of Thailand this week was the progression of the current nation-wide flooding. Since July, these floods have spread across 61 of the country’s 77 provinces, claimed 300 lives, and forced work stoppages at over 14,000 businesses – including 930 production facilities across 28 provinces. As of the latest estimate, the flooding is anticipated to cost $3.9-$5.1 billion in damages and lost economic growth (subtracting 100-170bps from GDP) .

These floods, particularly if they breach the capital of Bangkok (Oct 29-31 projection) could have a lasting impact on Thai economic growth. As it stands currently, they are already having an impact on global supply chains. Thailand is the world’s largest producer of hard-disk drives, the largest exporter of rice and rubber, and the second-largest exporter of sugar. Companies like Apple, Toyota, Tohsiba, and Hitachi have all been forced to suspend production of key parts and/or move the assembly elsewhere.


Darius Dale



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We don’t expect BYI to report a truly impressive quarter until FQ3 but the near-term bar has been lowered too much.



As we wrote about on October 5thBYI: WE’VE GOT THAT GOOD FEELING,” we think BYI will produce an estimate-beating quarter.  Management resets expectations at significantly lower levels on their last call.  They weren’t expecting it but the stock resets much lower as well.  Since we wrote our note about 2 weeks ago, expectations have crept up by a penny to 43 cents for BYI’s F1Q12 and the stock has moved much higher (up 21%), so the quarter may not be the catalyst it was. 


More importantly, we are inching closer to a big pick-up in new openings beginning in the March quarter.  More are on the way.  Visibility on Italy and Canada should get clearer in the next few months and we expect all of the suppliers to discuss potential opportunities in MA, FL, Greece, Taiwan, Japan, Vietnam, South Korea, and other markets.  The new market thesis may come back into investor focus.


BYI should see strong flow through not only in their new unit sales but also in their systems business – an important differentiating factor for the stock in our opinion.  Their systems business is a critical lynchpin in our positive BYI thesis as visibility and growth should improve dramatically in calendar 2012.  Despite higher margins and a recurring component to systems revenue, that segment has been viewed as a bit of a black hole by investors due to the unpredictability.  We expect that to change next year.




We estimate that BYI will report $191MM of revenue and $0.45 cents of EPS after close on 10/26.

  • $62MM of gaming equipment sales at a 43% gross margin or $27MM
    • 3,250 new units
      • 2,150 units in NA with about 2k coming from replacement units.  There are very few new openings and expansions in the September quarter
      • 1,100 international units
  • ASP of $16,150
  • $9MM of parts, used and conversion sales
  • Systems revenue of $45MM at a 72% gross margin
  • Gaming operations revenue of $84.5MM, up $2MM sequentially with a 74% gross margin.  The September quarter has historically been better than the June quarter for gaming operations at BYI regarding revenues and margins
  • Other stuff:
    • SG&A: $58MM
    • R&D: $23.5MM
    • D&A: $5.5MM
    • Net interest expense: $3.4MM
    • Tax rate: 36.5%


We expect an in-line Q which may be good enough.  A refi announcement could be a big catalyst.



We are projecting break even EPS, $593MM of net revenue, and $120MM of EBITDA.  BYD reports Q3 results next Tuesday.  Our estimates are slightly below consensus, but given the negative sentiment around the name, we think actual results in-line with our numbers will be good enough, assuming a stable outlook.


Perhaps more importantly, we think there is a chance BYD announces a refinancing.  Part of BYD’s credit facility comes due in May of 2012 so it needs to be refinanced before the 2011 10k is issued to avoid a going concern letter from the accountants.  While the high yield market would not be favorable for BYD, we believe the bank market is.  Any announcement or comfort level given surrounding the prospects of a refinancing would remove a major overhang on the stock.  We do not believe that is fully priced into the stock.



Here are our estimates:


Q3 Projections

  • $150MM of net revenue in the Las Vegas locals market and $30.7MM of EBITDA
    • Assumes 2% YoY revenue growth and flat YoY expenses
    • Revenue growth in-line with the market
  • Downtown Vegas net revenue of $53MM and EBITDA of $6.3MM
    • Assumes 2% YoY and 1% increase in YoY expenses
    • Revenue growth in-line with the market
  • Midwest & South net revenue of $187MM and EBITDA of $43MM
    • Based on reported state numbers, we see net revenue decreasing 1% YoY and based on recent trends, we see total operating expenses decreasing 4% YoY
  • Borgata: $203MM of net revenue and $50MM of EBITDA
    • We assume that hotel revenues are roughly flat YoY, F&B of $55MM and promotional allowances equal to 35.3% of gaming revenues – somewhat in-line with where they have been trending
    • Flat YoY operating expenses
  • Other:
    • Corporate expense: $9.5MM
    • D&A: $32MM; $16.5MM for Borgata
    • Share based comp:  $2MM
    • Consolidated interest expense: $41MM; $19MM for Borgata

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.43%
  • SHORT SIGNALS 78.35%

Are You Bullish Enough On King Dollar?

Conclusion: Our analysis of derivative positioning and its impact on the FX spot market as a leading indicator strongly suggests that it likely won’t pay to fade consensus as it relates to being bullish on the U.S. Dollar over the intermediate-term TREND. Further, the math supports our fundamental stance of being bearish on things that are inversely correlated to the Greenback over the same duration.


Position: Long the U.S. Dollar (UUP); Short the Euro (FXE).


Themes at Play: King Dollar; Deflating the Inflation; Correlation Crash; Eurocrat Bazooka.


Much to-do is being made about how crowded the Euro-short position is and we agree that this is an acute immediate-term risk to manage. As it relates to the amount of open interest in the futures and options market, those speculators large enough to meet the minimum reporting requirements of the CFTC are net short the Euro by a total -69.8k contracts as of the latest reporting period (Oct 11). Just off of the late-September highs in short interest of -79.6k and 1.8x standard deviations below the 5yr average of +17.1 net long, it’s pretty clear that this is a fairly one-sided trade.


Are You Bullish Enough On King Dollar? - 1


Does it pay to fade the market here? The short answer is “no”. As indicated by both our fundamental outlook and the marked-to-market positioning within our Virtual Portfolio, we expect consensus to remain right on this currency play over the intermediate term TREND.


Speaking of trends, one of the reasons we rely heavily on the foreign exchange as a real-time leading indicator of both market prices and economic fundamentals is because of its sheer size ($4 trillion in daily turnover = the world’s largest mkt.) and its reflexive nature. To the former point, we are of the belief that an investor’s greatest source of conviction lies with where he plays his chips. To the latter point, the highly-levered nature of many FX market transactions (in some cases 250:1) causes the basic risk management of gains and losses to perpetuate any given pattern of trading. Moreover, currency pairs trade on their relative economic fundamentals – data that tends to be more glacial and self-sustaining in nature.


Turning to King Dollar specifically, we continue to believe strength in America’s currency will be supported over the intermediate term by a combination of three factors: 

  • Subsequent to the left-leaning Mario Draghi assuming control of the ECB next month, we expect to see a rate-cutting and/or money-printing cycle out of the Eurozone over the intermediate term as Eurozone economic growth continues to slow and exacerbate the region’s sovereign fiscal metrics (Euro = 57.6% of the DXY basket).
  • As reported inflation peaks in 3Q/4Q and trends down (albeit slowly in some cases), a cycle of monetary easing and fiscal policy relaxation is likely to sweep across emerging market economies. For early examples of this phenomenon, refer to the recent Brazilian, Indonesian, and Turkish rate cuts; Singapore’s FX adjustment; and Filipino and Malaysian stimulus measures.
  • While Obama/Bernanke/Geithner will certainly be tempted to incrementally ease both monetary and fiscal policy in the U.S., we think both mounting political pressure from the right (i.e.: voting down incremental stimulus and publicly speaking against the Fed) and sticky reported inflation (particularly “core” inflation) will keep this Keynesian trio in a box – at least for the time being. Obviously the risk of Bernanke forcefully imposing more of his academic dogma unto the markets and the U.S. economy is likely to remain a key source of both consternation and volatility in the FX markets going forward. 

We’ve been harping on each of these themes in various reports and presentations over the past couple of quarters, so we’ll leave it there for the sake of brevity. Email us if you’d like us to follow up with more details regarding any of these points.


Is a Big Appreciation in the U.S. Dollar Index Forthcoming?

Performing a similar futures + options analysis on the U.S. Dollar Index as we did with the Euro above yields a surprisingly more interesting conclusion.  Interestingly enough, open interest from large speculators reached +47k contracts net long as of the latest reporting period (Oct 11) – the highest on record, which dates back to 1995.


Are You Bullish Enough On King Dollar? - 2


Surely, we must fade this consensus positing?


A resounding “no” would be our answer here. Analyzing the open interest with the U.S. Dollar Index’s spot price provides a shocking conclusion: the derivative positioning tends to lead the action in the spot market by 2-6 months – particularly when pushed to an extreme in either direction.


Are You Bullish Enough On King Dollar? - 3


Are You Bullish Enough On King Dollar? - 4


Given that the most recent reporting shows the net long positioning at the highest on record, we would expect to see a pronounced move to the upside in the U.S. Dollar Index’s spot price over the intermediate term. The current futures + options positing registers as a +3.9x standard deviation move “off the lows”. A commensurate move in both size and historical median duration in the U.S. dollar index from April’s cycle-low of $72.93 would put the DXY at $89.30 by mid-February.


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The principles of chaos theory driving our research at the most basic level would never allow us to subscribe to the Old Wall Street model of throwing out a price target and a target date for any market (let alone the #1 factor in our Global Macro model); we do, however, think the above scenario analysis is one of many risks to at least respect as probable. Moreover, a sustained and measured breakout in the U.S. Dollar Index may prove particularly bearish for asset classes inversely correlated to the DXY (immediate-term TRADE duration regressions): 

  • Brent Crude Oil: r² = 0.90;
  • Corn: r² = 0.82;
  • CRB Index: r² = 0.87; and
  • S&P 500: r² = 0.92. 

Conversely, it may prove particularly bullish for things positively correlated to the DXY, like: 

  • CBOE SPX Volatility Index (VIX): r² = 0.75; and
  • U.S. Junk Bond Yields: r² = 0.93 (bankruptcy cycle?). 

As with all of our research, the purpose is not to fear monger or be alarmist. Rather, we hope we are equipping you with the differentiated analysis that allows you to both manage risk and preserve your client’s hard-earned capital throughout volatile times like these. As always, we’re here if you have any follow up questions.


Have a great weekend with your respective families,


Darius Dale







German business sentiment index dropped for a fourth consecutive month to 106.4 in October from a revised 107.4 in September.  French business confidence fell to 97 in October from 99 in September. 





THE HBM: MCD, CMG - subsector fbr




MCD: McDonald’s reported strong 3Q earnings this morning.   EPS came in at $1.45 versus expectations of $1.43 on the back of strong global comps with strength in France, Russia, Germany and the U.K. being particularly encouraging.  U.S. comps came in at 4.4% versus 3.8% expectations.  Europe came in at 4.9% versus 3.3% consensus and APMEA also beat, printing a 3.4% comp versus the Street at 2.7%.  The company said that October comparable sales are expected to be up 4% to 5%. 









CMG: Chipotle Mexican Grill reported $1.90 versus $1.85 on the back of 11.3% comparable restaurant sales growth.  Margins were slightly negative in the third quarter, year-over-year, as chicken, beef, cheese, and sour cream costs were higher than expected.  The company sees mid-single digit inflation in 2012.


THE HBM: MCD, CMG - stocks 1021



Howard Penney

Managing Director


Rory Green


Romney Risk

This note was originally published at 8am on October 18, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Risk means more things can happen than will happen.”

-Elroy Dimson (quote from “The Most Important Thing”)


I received a tremendous amount of feedback on my Yale Economics Department note from yesterday. Your diverse and critical thoughts have provided my team a tremendous opportunity to see plenty of perspectives. For that, we thank you.


Yale didn’t write me back, yet.


Maybe tonight in Las Vegas the dogma that is academia’s Keynesian Economics will hear some louder drums. I am probably the least connected person in American and European politics (and I’d like to keep it that way), but there is heightening probability that Mitt Romney talks more explicitly about firing Ben Bernanke at tonight’s Republican debate. That would be very bullish for the US Dollar.


Strong Dollar = Strong America. Period.


That’s my long-term call and I’m sticking to it. Like you saw yesterday, when the US Dollar strengthens, we Deflate The Inflation. That’s good for the American Consumer. This happened in September, and the Michigan Consumer Confidence reading rose.


With the US Dollar down for the 1stweek in the last 5 last week, inflation expectations at the pump rose, and that same American Consumer Confidence reading fell (57.5 OCT vs 59.4 SEP).


This may sound like a perverse relationship (stocks and commodities down make the country more confident), but the US stock market isn’t the electorate anymore. You can only plunder your people so many times.


I’m not a Republican, but this is what the Republicans are going to say about this for the next year:


Bernanke has overinflated the amount of currency that he’s created… QE2 did not work… it did not get Americans back to work.” –Mitt Romney


Whether the Keynesians want to admit this or not, monetary and fiscal policy drive the value of a country’s currency. If I’m too “young” to be “trusted” on that, ask the biggest hedge fund manager in the world who has made money for his clients during both the 2008 and 2011 Growth Slowing draw-downs. That was not Steve Cohen – it was Ray Dalio.


If you don’t want to ask any of us who have had this right what is going wrong, fine. But don’t expect The People to trust you. They aren’t as willfully blind to the academic dogma that has driven both Bush and Obama to devalue the currency in exchange for short-term asset price inflations. They may not be able to communicate it concisely yet – but I would not bet against them.


Back to the Global Macro Grind


China doesn’t trust Japanese, American, or European monetary policy. They seem keen on proving that they have better ideas to lead the next generation of global capitalists. Can communists be capitalists? If “capitalists” leading America can behave like socialists, why not? It’s all name calling anyway.


At the same time that our markets are begging the Europeans for bazookas to socialize bank losses, I hear a lot of whining in this country. It’s not the kind of whining that the Chinese in particular are used to seeing from us. It’s time to stop. Reset. And Reload. It’s time to start winning again.


Despite a lot of people in the hedge fund community fear-mongering about China falling off a cliff like Europe has, here’s how China’s Q3 GDP report looked last night:

  • Real GDP growth slowed in 3Q: 9.1% y/y vs. 9.5% prior;
  • YTD Real GDP growth slowed in 3Q: 9.4% y/y vs. 9.6% prior;
  • Industrial Production growth accelerated in September: 13.8% y/y vs. 13.5% prior;
  • Retail Sales growth accelerated in September: 17.7% y/y vs. 17% prior; consistent with our call for a shift on the margin towards consumption-led growth; and
  • YTD Fixed Assets Investment growth slowed in September: 24.9% y/y vs. 25% prior.

Not great. But not bad.


On the margin, these are still sequential decelerations so we are waiting on the sidelines to buy Chinese stocks again. Everything that really matters in Global Macro happens on the margin.


If you look at the data coming out of the rest of Asia in the last 24 hours, it’s actually quite bad:

  1. Singapore Exports for SEP down -4.5% y/y vs +3.9% AUG
  2. Australian Vehicle Sales for SEP down -1.3% y/y vs +4.6% AUG
  3. Japanese Department Store Sales for SEP -2.4% y/y vs -1.7% AUG

So, with Global Growth Slowing and the US Dollar strengthening (two of our key Macro Themes), there is a generational amount of Correlation Risk that remains in Global Macro markets.


While our American-made definition of Real-time Risk Management most certainly considers many more things that can happen than will happen, we are not trying to be alarmist. Neither are we holing up on campus with dogmas. We are standing here on the front lines of the fight trying to get to the right answers for this country before the wrong assumptions driving policy make that too late.


My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1636-1686, $84.11-89.12, and 1187-1229, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


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