Don’t Get Juked By Chinese Inflation Data

Conclusion: Recent price action across Chinese interest rate and fixed income markets are siding with the latest economic data that monetary easing is forthcoming. That said, however, our analysis puts any material easing in the form of rate cuts and/or large-scale fiscal stimulus at least 1-2 quarters away (assuming no new Federal Reserve policies to inflate are introduced) – a long time to wait and [potentially] a lot of downside to pay in today’s volatile markets.


Continuing recent trends, Chinese October growth and inflation data came in sequentially slower on the margin, which is in-line with our expectations. Looking to the growth data specifically, we saw retail sales slow marginally to +17.2% YoY, industrial production slow marginally to +13.2% YoY, and YTD fixed assets investment came in flat sequentially at +24.9% YoY.


Don’t Get Juked By Chinese Inflation Data - 1


Turning to the inflation data specifically, Chinese CPI came in at an attractive +5.5% YoY in October, slowing on the margin from a prior reading of +6.1%. Perhaps even more welcoming was the slowdown in producer prices, which slowed -150bps sequentially to +5% YoY in October. This confirms the dramatic easing of supply-side cost pressures we saw in the recent PMI survey(s).


Don’t Get Juked By Chinese Inflation Data - 2


Don’t Get Juked By Chinese Inflation Data - 3


Taken in aggregate, these data points inch China materially closer to cutting interest rates, insomuch that a marked slowdown in inflation must be in the books before Chinese officials can materially loosen monetary policy and ease credit conditions – a necessary catalyst for Chinese growth to rebound in our scenario analysis. To say that there is a glut in supply of anecdotal stories on China’s SME credit crunch and the resultant non-traditional lending would be an understatement at this point. Take the following Bloomberg headline for reference:


“China Credit Squeeze Prompts Suicides Amid Offer to Sever Finger” (11/7)


As always, it’s important to you know where you are in the cycle and headlines like these are helpful in the sense that they suggest to us that the apex of economic pain in China is within reach. As mentioned in previous notes, our algorithms have Chinese real GDP growth bottoming out in 1Q12E within the +8.5%-8.7% range. Nasty fourth quarter data potentially could push that bottom out 1-2 quarters and down 50-100bps, but, for now, that isn’t the most probable scenario and remains outside of our baseline assumptions. Keep in mind, there’s a lot of risk to manage in this high volatility environment, so don’t make the mistake we made this summer of buying China too early! The same message applies to industrial commodities – especially in the context of our King Dollar and Correlation Crash themes.


Again, we cannot stress how important patience will play a factor here in the short-to-intermediate term return profiles of any investments that center on Chinese monetary and/or fiscal easing at this current juncture. Based on our daily grinds through various sources of market commentary, our view is contrary to the near-consensus belief (shared by members of the sell-side and buy-side) of easing sooner-rather-than-later. The snippets below, both of which were published earlier today, frame this setup quite nicely:


“Downside risks from faltering exports and rising housing inventories are building. A broader scale easing is likely to start soon with faster new loan growth and higher budgetary spending on existing government-led investment.”

- Li Wei, a Shanghai-based economist at Standard Chartered Bank


“This is the third month of CPI easing, so investors are now more assured that the trend will continue for the rest of the year. We are now also confident there will be easing by the government.”

- Larry Wan, Beijing-based head of investment at Union Life Asset Management Co., which manages the equivalent of $2.2 billion


No doubt, selective easing has been underway for months now, including, but not limited to: investment public housing, plans to relax SME credit conditions, and supportive changes to the income tax code. This is just the tip of the iceberg. For a real buoy to Chinese [and global] growth, the PBOC needs to cut rates and lower bank reserve requirements. Our analysis of Chinese inflation data and interest rate markets suggests those actions are further out in duration (3-6 months) than consensus is likely hoping for:


Using 2008 as a proxy, when China cut its benchmark household savings deposit rate in early October, we saw five of seven flat-to-down months of annualized MoM CPI growth. In the current cycle, we have seen none. Net-net, inflationary pressure remains much too hot for the PBOC to consider material easing at the current juncture – especially given that containing property prices are to remain a key focus of policy:


"I want to especially emphasize that there will not be even the slightest faltering in the property market curbs.”

- Chinese Premier Wen Jiabao in Russia (11/5-11/6) – the third time in as many weeks he reiterated the government’s tough stance on the property market


Don’t Get Juked By Chinese Inflation Data - 4


Turning to China’s interest rate markets, we are receiving a similar signal of forthcoming monetary easing, albeit to a lesser extent. Using China’s 7day repo rate a proxy for interbank liquidity, the -134bps drop in the month-to-date rhymes with the -45bps day/day drawdown in China’s 1yr sovereign debt yields on the heels of this morning’s CPI release. Inclusive of the latter move, that puts China’s1yr fixed borrowing cost a full -99bps below the benchmark 1yr household savings deposit rate.


Again, using 2008’s first household savings deposit rate cut as a proxy, we saw the PBOC cut rates when this spread was at -77bps (not causal; merely coincidental). That’s encouraging for the “ease now” crowd, but we’d also like to see the aforementioned dramatic move into “positioning” confirmed by the interest rate swaps market as well, which is currently trading -45bps below the  1yr household savings deposit rate – a full 99bps above where it was when the PBOC cut back in 2008.


Don’t Get Juked By Chinese Inflation Data - 5


Don’t Get Juked By Chinese Inflation Data - 6


All told, the recent price action across Chinese interest rate and fixed income markets are siding with the latest economic data that monetary easing is forthcoming. That said, however, our analysis puts any material easing in the form of rate cuts and/or large-scale fiscal stimulus at least 1-2 quarters away (assuming no new Federal Reserve policies to inflate are introduced) – a long time to wait and [potentially] a lot of downside to pay in today’s volatile markets.


Per Merriam-Webster’s online dictionary, to “juke” means “to fake out of position”. As my coach used to tell me when I played defense, “Break down and make the [darn] tackle!” It will pay to acutely manage the TIME and SPACE risk associated with Chinese assets or those assets highly sensitive to Chinese growth over the next one to two quarters.


Darius Dale


Fade Beta: SP500 Levels, Refreshed

POSITION: no position


Yesterday’s head-fake was more important than the one we observed on October 31st (primarily because both VOLUME and VOLATILITY signals at 1275 were more bearish than they were at 1285).


As a reminder, my core risk management model has 3-factors – PRICE, VOLUME, and VOLATILITY.


With VOLUME signaling down -25% and down -13% moves on Monday (1261) and Tuesday (1275), respectively (versus the average VOLUME day in my immediate-term TRADE duration), today’s ramp in early morning volume is not good.


Neither is VOLATILITY making higher-lows as PRICE makes lower-highs on my intermediate-term TREND duration.


Here are the lines that matter from here: 

  1. TAIL resistance = 1268
  2. TRADE resistance = 1255
  3. TREND support = 1216 

If you take out the 2 hours of yesterday’s trading, this is pretty much the same risk management setup I gave you 24 hours ago. From here, I’m going to Fade Beta in this 1 range.




Keith R. McCullough
Chief Executive Officer


Fade Beta: SP500 Levels, Refreshed - SPX


The important commodities, at least for the food and restaurant industries, moved higher over the last week.  Despite the dollar strengthening over the past week, commodities went higher including those that typically trade with an inverse correlation to the greenback.


Please scroll down for charts detailing the trends of individual commodities.







Corn is an important for all companies in the restaurant industry, not only those I mentioned in the heading.  Corn prices gained again over the last week, even as the dollar gained, as the USDA crop progress report indicates that 87% of the harvest for the top 18 corn-producing states is complete.  The USDA also cut its corn harvest estimate by roughly 1% from its previous forecast.  The expected yields, per the USDA are now at 146.7 bushels per acre, down 1.4 bushels from the October forecast.  If this yield were to come about, it would be the lowest yield since 2003.




Texas is the state most associated with the drought that has plagued cattle farmers this year but ranchers in Arkansas are now stepping up the rate at which they are culling their herds.  The quality of the calves being sold is also down, according to market participants interviewed by  With grain too expensive to maintain herd sizes through the winter, and small rain showers having no material impact on soil conditions, farmers are downsizing their herds drastically. 


While this is boosting supply in the near-term, for FY12 it may mean even higher prices.  Consumer may expect higher retail prices in the grocery aisle but, as WFM noted in its earnings call last week, passing on inflation in meat prices has proven difficult.




Chicken wing prices have continued their march higher.  As we wrote recently, food industry experts’ commentary as well as our own analysis gives us confidence that BWLD could have year-over-year inflation in wing prices beginning in the first quarter of 2012.  Replicating the 3Q11 strategy of driving comps via a promotion will likely be difficult in 2012 if the company faces significant inflation.  Some industry experts see $1.50 wings next year and sustained year-over-year inflation versus 2011 next year.




Coffee prices moved higher over the last week after the previous seven days’ decline.  Despite the crisis in Europe and the strengthening dollar, coffee prices gained 2.3% over the last week as coffee exports from Brazil fell to 3.1 million bags in October from 3.5 million a year prior.  A University of Sao Paulo research group, Cepea, is stating that the 2012-13 harvest may still be a record, despite concern that dry weather and frosts earlier in the year could have hampered crop development.







WEEKLY COMMODITY CHARTBOOK - correlation table 119
























Chicken – Whole Breast


WEEKLY COMMODITY CHARTBOOK - chicken whole breast 119



Chicken Wings















Howard Penney

Managing Director


Rory Green


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In preparation for MPEL's Q3 earnings release Thursday morning, we’ve put together the recent pertinent forward looking company commentary.




  • According to IFR, MPEL is considering listing in Hong Kong by way of introduction, instead of selling stock, because of current market conditions.



  • [House of Dancing Water] “The show while operating at above break-even on a stand-alone basis also generates a meaningful ripple effect throughout the whole business, including higher property visitation, improved hotel and food and beverage metrics, as well as provides a significant contribution to our gaming business through, amongst other things, adding key customers to our database to drive profitability and future growth.”
  • 3Q guidance:
    • D&A: $85MM
    • Corp expense: $20MM
    • Net interest expense: $30MM
  • “On the competitive outlook side with Galaxy Cotai opening, it certainly has moved the center of gravity further into Cotai and I think we have benefited from that.”
  • [Macau Studio City] “Effectively a three-year process. And we previously said that we hope to restart construction sometime before the end of Q1 of 2012.”
  • “We’ll probably put the additional tower (Phase III of City of Dreams) on the back burner for now.
  • [Within the mass segment] “This year, the percentage on our premium mass is somewhere about 50% to 60%.”
  • “I think going into the third quarter, we plan on keeping operating expense essentially flat with what we’ve seen in the second quarter. So, we’ll fully benefit from any VIP or mass market top-line growth that we can generate.”
  • [2013 Table cap] “So I think if you read between the lines, only new builds from now until 2013 will get those tables. So, I think we’ve sensed 5 and 6 opening up next year and the year after that, that’s where the allocation of tables will be. So from our internal perspective with regards to City of Dreams and Altira, and I think Ted alluded to it early on, we are continuing to yield up the business and we are trying to operate and utilize the tables as efficiently and as profitably as we can.”
  • “We have some claims in terms of opening one to two junket operators, but due to some labor issue, we have to move those opening to the third quarter.”
  • “Unlike some of our competitors who are still waiting for their land grant, as I pointed out earlier on, the previous owners of the Studio City project had already commenced construction a few years ago and had put in significant piling and foundation work, work that was worth over U.S.$100 million. So for us right now is really a process of recommencing and getting the necessary approvals to restart construction. So, it’s a much less complex and complicated process than what others would be looking at.”

LIZ: Q3 Quick Take


No major surprises in LIZ’s numbers to note this morning before the call. Fundamentals appear largely in-line with our expectations and management’s outlook for both 2011 and 2012 adjusted EBITDA remains unchanged. That said, there was also little by way of updates regarding several items that that we expect to be discussed in more detail on the call at 10am:


These include:

  • What if any corporate expenses related to the legacy Partnered Brands now divested are expected to be carried forward. Assuming there are some, what is the plan and timeline for when we can expect these to be eliminated.
  • An update regarding debt reduction – particularly the timing of when the volatile Eurobond might be settled.
  • As a non-cash tax payer and with the Mexx deal now completed, we should also get an update re the size of NOLs. 

The bottom-line is that there is no change to our view based on this release and we continue to think the company’s 2012 EBITDA guidance looks conservative. We’ll follow up as warranted after the call.


Call at 10am (code: 22874487)



Casey Flavin



Solid quarter but “disappointing” guidance.



“Management is sandbagging”.  “Guidance is conservative”.  We’ve all heard it many times from the sell side – always when a buy rated stock provides disappointing guidance.  We, however, really mean it!  Look, we don’t have an axe to grind either way with IGT.  We’re not trying to justify a Buy rating.  Our call the last few months has been on BYI, not IGT.  However, we’ll call a spade a spade and say that IGT is sandbagging.  Guidance should’ve been 10 cents higher in our opinion.  We lay it out below.


The quarter can be summed up as having very strong top line results for both product sales and gaming operations (solidly ahead of consensus) somewhat offset by disappointing gaming operations margins and higher operating expenses.  We think management may be managing earnings a bit here.  We’ve seen it from them before.  With that level of revenues, EPS should’ve been a lot better.





Product revenues came in 19% ahead of our estimate due to better unit sales while gross margins were in-line with our estimate.

  • We estimate that IGT’s share rose to 40% in September – their best market share quarter since June 2008 (IGT would like to send out a special thanks to WMS)
  • Domestic units shipped exceeded our estimate by almost 3,000 units
    • Replacements were 1,200 units better than we estimated due to higher share (we estimate 39% share vs. high 20's share average over the last 6 quarters)
    • New units were 1,750 better than we estimated due primarily to the earlier than expected recognition of shipments to the 2 Kansas casinos opening in 1Q12 which we estimated accounted for 1,500 shipments
    • Replacement units for the quarter look like they were in-line with our original estimate of 13k for the entire market – marking an 11% YoY improvement.  We estimate that the YTD improvement in replacements is 13% with replacements tracking at 41.6k through September 30th vs. 37.7k shipped in the first 9 months of 2010.
    • International product revenues were $8MM above our estimate but gross profit was $1MM below our estimate. We suspect that this is due to the lower margins from the Entraction acquisition – which contributed to revenue but delivered no profits in the quarter.



Gaming operations revenue was $8MM above our estimate while gross profit was $6MM below our estimate, after adjusting for the $4.8MM IP settlement charge.

  • Better revenues were driven by improvements in WAP yields per day due to better game performance on fresh product.  However, WAPs do have lower margins since the games are largely licensed titles with royalty payments and jackpot funding expenses.
  • The quarter also got a boost from better than expected shipments to international markets –including shipments to CAGE
  • Adjusted for the negative impact from rates and the IP charge, ‘normalized gross profit’ margin would have been 59% - below the 62% rate where IGT had been tracking for the first 9 months of the year.  We suspect that next year’s guidance has a similarly conservative margin.

Other stuff:

  • SG&A was $13MM above our estimate – largely due to higher commissions from better product sales



IGT’s guidance for 2012 is pretty conservative in our opinion:

  • Excludes their signed contract to ship 7,200 units into Canada. If half those units ship in F2012 than that will add 5 cents to IGT's results
  • Flattish to slight uptick in the replacement environment. Unless current trends massively reverse, this is unlikely. For the TTM ended 9/30/2011 we estimate that 54k replacement units shipped in NA, a 12% YoY increase. Assuming just a 10% increase would add over 5,000 units to the market in IGT's fiscal 2012 and assuming that IGT can garner a 35% share that's another 2 cents a share.
  • Flatish new and expansion opportunities in IGT's fiscal 2012 vs. 2011.  We're not sure how that's possible, there were less then 12k new and expansion units shipped into NA for the TTM ended 9/30/11 and we estimate over 18k excluding any new units to Canada, Ohio VLTs, IL and counting 2 of 4 Ohio casino shipments. Assuming IGT get's 35-40% share of these openings we get another 3 cents
  • These 3 items account for roughly 10 cents of EPS. 

IGT’s install base and yields should show improvement YoY, however, we did take down our gross margins to 59%.  We also assumed a 30% variable component to SG&A.  All in, we get to $1.10/share for 2012. 

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