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European Risk Monitor: Papandreou and Berlusconi on the Precipice

Positions in Europe: Short France (EWQ)

On this Monday the 7th of November it is acutely evident how governed capital markets are to the political positioning of European leaders.


As expected, nothing concretely came out of the G20 meetings on Thursday and Friday on the big three issues: expansion of the EFSF, the terms of bank recapitalization (contingency if bank not able to meet a 9% capital ratio), and Greek haircuts. One topic that was given much attention was expansion of the IMF’s contribution to the EFSF, however here too there was no consensus or concluding statements. Finally, the Chinese remain on the sidelines as a “white horse” bailout candidate.


The political risk however has mounted over the last week. Papandreou won the confidence vote late Friday in exchange for his consent to be replaced as PM, the announcement of which could come this week. The front runner looks to be the current Finance Minister Evangelos Venizelos.  As we’ve said all along, Papandreou’s decision to call a confidence vote and referendum on the bailout package was reckless—despite his attempt to win the backing on his fellow citizens, Greece is taking its orders from Brussels to meet its nearest maturities and pay its pensioners and government workers to addressing its longer term issues of reducing its outsized deficit and debt loads. Look for an interim government to be formed, probably with the PASOK party holding a slim majority in Parliament over the next months, or as long as is needed for the country to secure its next bailout, before early elections may be held at the end of February or early March. 


Shifting westward, Italy’s political machine appears on the verge of cracking. However, this time around what’s on the line doesn’t seem that different from previous months—Berlusconi’s credibility, or the lack thereof.  The authoritarian Berlusconi this time around seems bent on intimidation as the parliament must sign-off on the 2010 budget tomorrow. This weekend saw mass rallies calling for his resignation and two Berlusconi allies defected to the opposition last week, and a third quit on Sunday.  What should be a routine measure, as this after all is the 2010 budget, did not receive a majority when it was called last month, which caused a confidence vote that Berlusconi narrowly won. This time around, we may see a different outcome. Bond yields (more below) are reflecting this risk. Ultimately, the fractured state of Italian politics bodes poorly for the international community’s expectation for budget consolidation over the coming years to bring in the country’s ballooning debt (119% of GDP).


Finally, France issued another austerity package this morning worth €18.6 Billion in spending cuts and tax hikes. While austerity is needed to reduce budget debt levels, expect this package to not cure market concerns that its AAA credit rating could be reduced. For more, see our post on 11/2 titled “Shorting France”.


Turning to the ECB, its secondary bond purchasing program, the Securities Market Program (SMP), upped its purchases in the week ended November 4th to €9.5 Billion, bring the program to €183 Billion collectively since May 2010. In his first week as ECB president, Draghi not only cut the main interest rate by 25bps, but may soon realize how necessary the Bank’s purchases are in attempts to quell Italian yields, despite the mandate that the SMP is a temporary program.


Unfortunately, what’s clear is that there are no major meetings scheduled into year-end around which we’re likely to get resolve on Europe’s big issues. This portends that Eurocrats will be held hostage by the market and will likely call short term meetings to answer big-term questions in response to ballooning risk.  While equity markets may have perversely gained today in Greece and Italy on leadership changes, we’ll continue to take our cues from bond yields and expect more downside in European capital markets than upside into year-end, as the region has yet to deliver any confidence to the market in concrete terms on further subsidizing the member states.


A look at our risk metrics below tells a clear story.


European Bond Yields – European bond yields across the PIIGS were up week-over-week, with Greek 10YR yields jumping a full 460bps from Friday’s close to today’s intraday level of 27.98%, as Italy’s 10YR jumps to a new high of 6.66% intraday!


European Risk Monitor: Papandreou and Berlusconi on the Precipice - 1. 10


European Sovereign CDS – European sovereign swaps mostly widened last week. Spanish sovereign swaps widened by 18% (+60 bps to 399) and Italian by 19% (+82bps to 516).  US CDS widened off a low base, rising from 40 bps to 48 bps.


European Risk Monitor: Papandreou and Berlusconi on the Precipice - 2. cds


European Risk Monitor: Papandreou and Berlusconi on the Precipice - 3. cds


European Financials CDS Monitor – Bank swaps were wider in Europe last week for 36 of the 40 reference entities. The average widening was 7.6% and the median widening was 14.6%. Swaps for Credit Agricole and the Deutsche Bank widened 31.7% and 31.3% respectively. The nine French and German banks we track saw swaps widen an average of 19%. 


European Risk Monitor: Papandreou and Berlusconi on the Precipice - 4. banks


Matthew Hedrick

Senior Analyst

Weekly Asia Risk Monitor: Growth Is Still An Issue

Conclusion: Both Asian economic data and financial markets are signaling to us that global growth remains under assault.


Positions in Asia: Short the Aussie dollar (FXA); Short a basket of Asian currencies (AYT).



Asian equities were generally softer over the prior week, falling -0.8% on a median basis. Declines were led by Japan, closing down -2.5% despite the Bank of Japan undertaking in a record intervention in the FX market to weaken the yen and boost exporter earnings. Asian currencies also finished generally weaker vs. the USD in the prior week, closing down -0.5% on a median basis. The Aussie dollar, a currency we’re short in the Virtual Portfolio, led declines across the region (-1.8% wk/wk).


On the short end of Asian sovereign debt yield curves (2yr), we’re seeing intra-regional divergences being created by the widening delta in monetary policy expectations based on individual growth/inflation dynamics (Australia -16bps wk/wk vs. Philippines +18bps wk/wk). Slowing growth continues to be priced into the longer dated maturities (10yr), with Australia (-24bps), Hong Kong (-16bps), and Indonesia (-11bps) leading the way to the downside wk/wk. 5yr CDS widened across the board in the last week, closing today at +7.2% wider on a percentage basis. Japan led the way to the upside, closing +15bps (+15.6%) wider.


Looser monetary policy continues to get baked into Asian interest rate swaps markets, with China closing the week down -35bps on the 1yr tenor. Australia, whose swaps have tightened the most in Asia in the YTD, closed the week down another -20bps. The Philippines, which put up a Sticky Stagflation-type inflation reading for October, saw their swaps widen +44bps wk/wk.



Rather than delineate these data points by country, given the varying size and importance of these economies, we thought we’d try something different by grouping them by theme. Ideally, this should make it easier to absorb and contextualize anything of significance. Lastly, the callouts below are from the prior seven days:


Global Growth Slowing:

  • Chinese non-manufacturing PMI ticked down in October to 57.7 vs. 59.3 prior.
  • Despite Japan’s record sales in the FX market (~¥8 trillion), the yen is essentially unchanged vs. the USD from where it closed on the day of the intervention. By not sterilizing the excess yen, the Bank of Japan is sending a key signal to the markets that economic growth remains a key issue for the world’s third-largest economy (currently mired in recession). JGBs were beneficiaries of the excess funds: 2yr, 10yr, and 30yr yields declined -9.9%, -4.9%, and -1.7% wk/wk, respectively. 
  • Thai industrial production growth slowed dramatically in September to -0.5 YoY vs. +6.8% prior. The multi-generationally large floods sweeping across the nation currently have contributed to the slowdown, shuttering  over 10,000 factories, displacing over 660k workers, and inundating roughly 15% of the homes across the country (population = 67 million).
  • Australia’s serviced PMI ticked down in October to 48.8 vs. 50.3 prior. Aussie retail sales were also weak (in Sept), slowing to +0.4% MoM vs. +0.6% prior.

King Dollar:

  • The Reserve Bank of Australia cut its growth forecast for the four quarters through 2Q12 by -50bps to 4%, citing “subdued conditions” as a result of slower private sector spending and borrowing and, of course, Europe. The markdown of growth assumptions alongside a reduction in inflation estimates as well (also -50bps), paves the way for another RBA rate cut in December – an event currently being priced into Australia’s interbank cash futures market (implied December yield of 4.235%) and into its overnight index swaps market (100% chance of a -25bps reduction being priced in; 16% chance of a -50bps reduction).

Eurocrat Bazooka:

  • Two Chinese officials reiterated our view that China is unlikely to take part in bailing out Europe as a source of uninformed, unlimited capital. Zhang Tao, director of the international department at the PBOC suggested that China needs further details regarding the options for bailing out Europe: “At present there’s no specific plan that people have clear understanding of,” he said. Zhu Guangyao, vice finance minister, had similar remarks regarding the EFSF: “There’s no concrete plans yet so it’s too early to talk about further investments in these tools.”

Deflating the Inflation:

  • In China, fixed-rate corporate debt has outperformed its floating-rate counterparts for the third consecutive month in October  (+2.9% vs. +1.1%) – the longest winning streak in over a year – as expectations for lower benchmark interest rates continue to gain traction. The PBOC injected $96 billion into the Chinese economy via open-market operations, causing the 7-day repo rate to fall a full -35bps since the start of last week.
  • Taiwanese CPI slowed in October to +1.2% YoY vs. +1.4% prior.

Sticky Stagflation:

  • Indian food inflation hit a nine-month high in the week ended 10/22: +12.2% YoY vs. +11.4% prior.
  • Philippine CPI accelerated in October to +5.2% YoY vs. +4.8% prior. Core CPI also accelerated: +3.9% YoY vs. +3.5% prior.


  • Hong Kong’s manufacturing PMI ticked up in October to 49 vs. a prior reading of 45.9. Still contracting sequentially, but a positive delta on the margin.
  • Singapore’s manufacturing PMI ticked up in October to 49.5 vs. a prior reading of 48.3. Like in Hong Kong, this measure is still contracting sequentially, but a positive delta on the margin.
  • Indonesian real GDP came in flat in 3Q at a +6.5% YoY clip – the third consecutive quarter of unchanged growth. Not bad, but not good either. Our models have Indonesian real GDP slowing 10-40bps from here in 4Q11E. Private consumption lagged other key growth drivers in 3Q, so the acceleration in consumer confidence in October (116.2 vs. 115 prior) may be supportive for consumption growth in 4Q.


  • The State Bank of India is getting a 30 billion rupee ($611 million) capital infusion from the government to bolster its capital ratios amid a rising defaults spurred by the RBI’s aggressive monetary tightening. This is part of a larger 200 billion rupee investment the government is making in state-run lenders to ensure the banks have Tier 1 capital ratios north of 8% each.
  • Thailand’s government has proposed a $26 billion fiscal package to aid flood recovery efforts. Details are still being ironed out, but, for reference, that amount is equivalent to 8.2% of Thailand’s real GDP, which is a rather sizeable stimulus package by global historic standards. This is on the heels of an October 30thAssumption University poll that showed three-quarters of Thais found the government’s relief efforts “inadequate”.

Darius Dale



Weekly Asia Risk Monitor: Growth Is Still An Issue - 1


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Weekly Asia Risk Monitor: Growth Is Still An Issue - 7


We think some investors may be waiting for the spin-off to own MAR. 



Marriott Vacation Worldwide (Ticker: “VAC”) will start trading on an as issued basis tomorrow.  As we wrote about in “It’s Not the Economy, Stupid” (08/25)”, the spin-off of Marriott’s timeshare business will be a long-term value creating transaction positive.  


Most lodging investors do not love the timeshare business - capital intensive and cash flow negative during periods of revenue and GAAP earnings growth - but as long as the business is small enough, they generally ignore it when thinking about value and multiples.  As a separate entity, VAC should grow the business with their shareholders aligned with growing the company, while MAR benefits by getting a high multiple fee revenue stream that grows with the growth of VAC’s business – which should be at a faster rate than if VAC was still under the MAR umbrella.


We think that VAC is worth about $2.10 to MAR or approximately $1BN.  Stripping out the timeshare business, MAR is trading at just 10x 2012, close to trough valuation on a business where 90% of the gross margin is fee driven.  MAR should trade well above prior trough valuation levels since the business is of much higher quality.  Incentive fees are now a smaller part of the pie and the only timeshare exposure is fee driven, and we’re at a different point in the cycle.


We think that VAC will do about $135-140MM of EBITDA in 2012 and that 7.0-7.5x EBITDA (or 17-18x P/E) is an appropriate multiple given the quality of their business.  


While management wants us to do a sum of the parts where we assign a high multiple to the fee part of their busines, we just don’t see the point since the fees that VAC collects basically equate to the royalty they pay out to MAR – so in our view it’s a wash.  What you are left with is a real estate developer, finance company and rental business - which typically trade at mid to high single digit EBITDA multiples.  There aren't many comps for this business but we would note that the Sunterra multiple included a takeout premium which occurred at the height of the market in 2007 and Bluegreen is a micro-cap stock which recently received an offer to be taken private from Diamond Resorts. 


For a vacation ownership business, there are a lot of things we like about VAC’s business:

  • Ability to grow without becoming too asset intensive
  • Seemingly competent management team and Board
  • Reasonable expectations from the outset
  • Opportunity for improvement by selling off excess land in their Luxury segment and de-emphasizing less profitable parts of their business

We are uncertain as to the near term trading, however.  On the negative side, there is a likelihood of technical selling pressure from uninterested funds inheriting this stub and the historical low multiples assigned to timeshare.  However, as we said from the outset, there appears to be a number of sideline sitters awaiting the spin-off to own the hotel company.

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.


Green Mountain Coffee is flashing bearish in Keith’s quantitative model and, as the chart below shows, is indicated to have no trade support to $59.11.  From a fundamental perspective, also, we see significant risks for the company going forward.


As we wrote in our Starbucks note on Friday, we have acute concerns about the ability of Green Mountain to generate cash.  In the Hedgeye Restaurants Sustainability model, the stock screens “UNSUSTAINABLE”.  The biggest red flags in the Hedgeye Sustainability model are Asset Turns and CFFO or, more importantly, the proportion of earnings yielding cash.


Some very pressing questions need to be answered to a satisfactory degree to change my position.  Is the company generating enough cash from its operating activities to continue without accessing new external sources of cash?  What if the capital markets dry up for GMCR?


We define CFFO as cash from operating activities less capital expenditures, less the benefits from the exercise of Employee Stock Options and adjustment for one-time gains/losses or restructuring items. 


Most of the companies we follow generate free-cash flow after significant investment in the growth of the core business, while other smaller, faster growing companies do not generate free-cash flow.  This is not necessarily a negative if the cash burn rate is within the limits of available resources.  To-date, the capital markets have been very generous to GMCR, but what happens when the music stops?   


Importantly, we are looking at the proportion of earnings yielding cash.  If GMCR reports strong revenue growth, good margins, healthy profits but those profits are accompanied by negative cash earnings yield, SBUX must be suspicious, or at least I hope they are.


GMCR: TRADE UPDATE - GMCR sustainability





Howard Penney

Managing Director


Rory Green



Banks face a triple whammy in the current quarter


Early November GGR forecast of HK$20-22 billion



Average daily table revenues for the first 6 days of November slowed to HK$639 million from HK$678 million in the last week of October.  One week of data doesn’t make a trend and we don’t know the impact of hold.  We would caution, again, that November is likely to display a sharp slowdown from October (see “An Eye on November” published on 11/02/11).  October contained Golden Week, 31 days, and a high VIP hold percentage.  Our projection for full month November Gross Gaming Revenues is HK$20-22 billion, up 19-31% YoY.  At the midpoint of that range, HK$21 billion, November would represent a 19% MoM decline.


Market shares are pretty irrelevant at this point but SJM and Galaxy had the strongest week.



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