“We want control. We need control. And bad things happen when we don’t have it.”
That’s an excellent behavioral psychology quote that I dog-eared this year after reading “Future Babble – Why Expert Predictions Fail and Why We Believe Them Anyway.” (page 134)
Why political consensus still believes the Keynesian Quacks who promise them that money printing in Japan, Europe, and the USA is the best long-term path to prosperity is officially beyond me at this point.
That said, the market can remain beyond what any of us think for longer than even a centrally planned bank can remain solvent. While the core principle of Chaos Theory that Hedgeye’s Risk Management Process adheres to (Embrace Uncertainty) is what I start my every day with, it seems that these government people want to issue you the failed hope of the opposite, daily.
Hope is not a risk management process.
Back to the Global Macro Grind…
First, let me preface this morning’s strategy thoughts with the Top 3 “Most Popular” headlines on the Bloomberg machine:
- Geithner Backs French-German Plan
- Bloomberg News Reponds to Bernanke Criticism
- Citigroup To Cut 4,500 Jobs On Slumping Revenue
Now let’s set aside Washington DC’s Hope Control messaging for 2011 that this Time Is Different, and focus on what’s actually happened since the beginning of the year on all 3 of these headline scores:
- Tim Geithner has spent 47% of his born life working on Big Government Intervention at the US Government – he is doing his very best to make said US style “free-market capitalism” look like whatever Europe is. He needs government control.
- Bernanke, like Obama, has talked a lot about “transparency, accountability, and trust” since 2006. As a functional matter, the US financial system has never looked so compromised, conflicted, and constrained. Main Street America doesn’t trust the Fed or its crony workings. Bloomberg pasted Bernanke to the boards with this article. It’s about time.
- Citigroup’s Vikram Pandit is going to cut costs so that he can get paid. That’s Old Wall Street. That’s what public financial services companies who are missing their revenue targets do. Meanwhile, as Yale’s vaunted Keynesian Economist, Irving Fisher, pleaded from 1, consensus pleads “but stocks are cheap because corporate profits are good.”
Fisher, Keynes, and all of their Big Government Intervention friends of the “Roaring 1920s”, of course, blew up most of their net worth buying on the way down well before we had a depression in this country.
Keynes, who was quite certain about the ‘devalue your currency and hope for exports model’, actually imploded early (in 1928 he was long corn, rubber – you know, the commodity trade baby!).
After this European Summit, where are we going? Where have we been? Contextualizing reality matters in mean reversion.
If you pull back the multi-duration and multi-factor curtain of what markets have actually done into and out of Big Government Interventions for the last 100 years, you’ll quickly notice that there has never been a central economic plan to debauch a citizenry’s currency that saved the world.
They’ve only saved us from what, allegedly, would have been even worse…
God Save The Geithner.
Timmy continues to take the other side of pretty much everything I think. Yesterday in Europe, this is what he said:
“This of course will take time… and a very substantial commitment and sustained commitment of political will.”
In other words, Japan and the US needed even bigger bailout and socialization bazookas. Timmy believes “deeply” in being fully “committed.”
And if we, The American People, were as “committed” to centrally planned risk taking and price volatility as Geithner and Bernanke wanted us to be, we’d all be fine. That’s what Irving Fisher and John Maynard Keynes said in 1929 too…
In other news – the rest of the world’s Growth Slowdown doesn’t cease to exist:
- Brazil reported its slowest year-over-year GDP number in 2 years (+2.1% y/y in Q311 vs +3.1% last quarter)
- China called the current slowdown in Global Export demand “under severe pressure”
- Santa’s Global Consumption Sleigh is running on $110/barrel oil
Follow the bouncing ball of hope. Piling-debt-upon-debt, bailing out banks, and money printing A) Shorten Economic Cycles and B) Amplify Market Volatility. The Hope Control’s market volume is running on empty. “And bad things happen when we don’t have it.”
My immediate-term support and resistance ranges for Gold, Brent Oil, German DAX, French CAC40, and the SP500 are now $1, $110-112-39, 5, 3104-3234, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
TODAY’S S&P 500 SET-UP - December 7, 2011
As we look at today’s set up for the S&P 500, the range is 33 points or -2.02% downside to 1233 and 0.60% upside to 1266.
SECTOR AND GLOBAL PERFORMANCE
- ADVANCE/DECLINE LINE: +17 (+1681)
- VOLUME: NYSE 801.88 (-10%)
- VIX: 28.13 +1.04% YTD PERFORMANCE: +58.48%
- SPX PUT/CALL RATIO: 1.60 from 1.46 (+9.59%)
CREDIT/ECONOMIC MARKET LOOK:
- TED SPREAD: 53.78
- 3-MONTH T-BILL YIELD: 0.00%
- 10-Year: 2.10 from 2.09
- YIELD CURVE: 1.84 from 1.84
MACRO DATA POINTS (Bloomberg Estimates):
- 7am: MBA Mortgage Applications (prior 11.7%)
- 8:30am: Fed’s Raskin speaks on data use in Baltimore
- 10:30am: DoE inventories
- 3pm: Consumer Credit, est. $7.0b (prior $7.4b)
WHAT TO WATCH:
- Treasury Secretary Geithner to hold talks with French President Nicolas Sarkozy in Paris today
- Citigroup to cut ~4,500 jobs in coming qtr, to take 4Q pretax charge of ~$400m tied to reductions
- JC Penney said to pay $38.5m for 16.6% stake in Martha Stewart Living Omnimedia in deal to be announced today: NYT
- Talbots said it would “evaluate” Sycamore Partners’s offer to buy co. for $212m
- U.S. Consumer Financial Protection Bureau planning to release simplified credit-card agreement for possible use by issuers
- Lehman Brothers said to be trying to raise ~$2.6b to buy controlling stake in Archstone as part of plan to sell or liquidate asset for $6b or more
- Expedia plans to spin off TripAdvisor unit as publicly held business around Dec. 20
- BP, Shell aim to resume drilling exploration, boost production in Libya
- Missouri Public Service Commission said they need more time to make recommendation on Energy Transfer’s $5.2b purchase of Southern Union
- ING Groep to take charge of as much as $1.5b as lower interest rates and stock markets hurt U.S. annuities
- Moelis said to be named as financial adviser for creditors committee in AMR Corp.’s bankruptcy
- AMR creditor panel risks split as unions claim three seats
- Cablevision sued Verizon on advertising campaign it claims misrepresents Cablevision’s Internet speeds
- GM said to be near completing package of proposed fixes for Chevrolet Volt battery pack: Reuters
- U.S. gets highest rating from int’l investors in more than 2 yrs on optimism economy will weather Europe’s financial crisis, avoid recession in 2012: Bloomberg poll
- Most int’l investors predict at least one nation will eventually dump the euro: Bloomberg poll
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
OIL – Santa’s sleigh better run on Dunkin’ because $110/barrel is tight! Consensus is anchored on the sequential US GDP gains we saw that came in Q3 (as oil fell to its lows in SEP); Rising Oil slows US Consumption Growth and we see US GDP falling, sequentially, from 2% to 1.4% in Q4. Not a disaster, but slower – and it’s the slope of the line that matters more than the absolute.
- Tyson to Gain as Hen Flock Falls to 15-Year Low: Commodities
- Oil Rises a Fourth Day on Concern Iran Tension May Curb Supply
- Copper Climbs as Officials May Step Up Crisis-Solving Efforts
- Palladium Climbs to Two-Month High on Car Demand; Gold Is Steady
- Corn Gains for Second Day as Europe Seen Moving to Stem Crisis
- Robusta Coffee Climbs on Warehouse Deliveries; Cocoa Advances
- Nickel Surplus to Soar as Supply Outpaces Demand, Eramet Says
- Supervalu Joins Farmers Behind U.S. Food Stamps at $71.8 Billion
- China’s Zhengzhou Exchange Halts Trading on Technical Issue
- BP, Shell Plan to Resume Exploration, Boost Production in Libya
- Lithium, Cobalt Among Minerals Facing Chronic Shortage, PwC Says
- Shanghai Futures Exchange to Widen Successive Daily Limits
- Oil-Tanker Survivor Sees Biggest Returns in Coal Ships: Freight
- Oil Near Three-Week High on Supply Concern
- Carbon Credits Turning ‘Junk’ as Ban Shuts Door: Energy Markets
- Bets Against Commodity Stocks Rise Fastest in 23 Months: Options
EURO – Le Geithner et La Sarkozy have le central plan completely figured out, right? Someone better tell whatever that means to the currency market because it’s not getting the message. Euro isn’t yet even testing its 1st line of resistance (1.35-1.36) never mind holding it. The Correlation Risk to stocks, commodities, etc. cometh on a move back down to 1.32.
CHINA – the Chinese don’t seem to be cooperating with the short-term suspension of economic gravity thing. Last night the PBOC called the global export slowdown “under severe pressure.” We know they make things up – but that’s probably not one of those things. Shanghai Comp bounced 30bps after selling off hard in the last week. Stay tuned for bad Chinese data Thursday.
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Commodities are going to be a major factor in the upcoming earnings season. Darden’s press release from yesterday morning is testament to that. On a week-over-week basis, there were more decliners than advancers among the commodities we monitor.
Chicken Wings – BWLD
It is telling that in a week where corn, wheat, beef, pork and dairy prices all declined, chicken wing prices still marched 4.2% higher. Per our notes published yesterday morning, BWLD is our favorite short idea in the casual dining space as supply and demand dynamics point to higher wing prices in 2012. If prices are up 50-60% year-over-year in the first quarter, we believe that BWLD will find it difficult to drive trends through promotion as it did in 3Q. Please see our notes from yesterday on DRI and BWLD for more details on this thesis.
Chicken prices are set to go higher in 2012 as QSR names are set to place a renewed focus on chicken, according to TSN CEO Donnie Smith. The hen flock on November 1st was 50.2 million, according to the USDA - the smallest since 1996.
Beef – WEN, JACK, CMG, TXRH
While the supply side of the beef equation points to a continuation of elevated beef prices, speculators are decreasing their net-long position according to CFTC data. For the week ended November 29th, net-long positions fell by 482 contracts, or 1%, from the week prior. From a demand perspective, many analysts are attributing the sell off over the last week to the Eurozone credit downgrade impacting the demand outlook. WEN, JACK, CMG, and TXRH are likely to face significant beef inflation through at least the first quarter of 2012. If the food service industry does shift its focus from beef to chicken, as TSN expects, it could hasten the decline in beef prices.
Dairy – CAKE, TXRH
Dairy moved sharply lower over the last week. Despite this move, prices remain up +12% year-over-year and will likely remain above 2010 prices for the remainder of the year. While the recent decline in dairy prices is good news, on the margin, for CAKE, we still believe that dairy prices will have a negative impact on gross margins during the fourth quarter. Earlier in the year, management guided to favorable dairy price comparisons, year-over-year, in the fourth quarter. We disagreed with that view from the beginning.
Chicken – Whole Breast
McDonald’s sales are to be released on Thursday, December 8th, before the market open.
McDonald’s reported stronger-than-expected sales in October after an impressive 3Q. In October, comparable restaurant sales came in at +5.5% versus consensus expectations of +4.1%, according to Consensus Metrix. Europe was encouraging, coming in at +4.8% versus consensus of +3.4% despite the escalation of the European sovereign debt crisis intra-month. The U.S. exceeded expectations by the widest margin, printing a +5.2% versus the street at +3.7%. APMEA completed the hat trick of beats for the company with a +6.1% comp versus +4.3% consensus.
We will be watching closely for any commentary on the domestic business. October was a particularly strong month with core menu items as well as beverages driving sales. According to an article on the Restaurant Finance Monitor website, the beverage segment has been leading the industry in terms of sales. A large part of McDonald’s success this year has been the successful lapping of last year’s frappes and smoothies rollout. At the outset of the year, our bearish case on the stock was predicated on the company not pulling this off, given the need for more marketing dollars to be allocated to the core business as we moved into 2011. The company did, of course, manage to successfully lap the beverage rollout of last year and strength in that category has remained even after the summer months. Other aspects of the business are also improving as the company remodels domestic stores and expanding day parts. In terms of business in Asia, and China in particular, we believe that the major QSR companies like YUM and MCD were still seeing strong trends in Asia during November.
Compared to November 2010, November 2011 had one less Wednesday and one additional Monday. As a result, we would not expect a significant calendar shift.
Below we go through our take on what numbers will be received by investors as good, bad, and neutral MCD comps numbers by region. For comparison purposes, we have adjusted for historical calendar and trading day impacts.
U.S.: facing a compare of +4.9% (including a calendar shift which impacted results by -1.8% to +0.1%, varying by area of the world):
GOOD: A print above 6% would be received as a good result, as it would imply a slight improvement in two-year average trends from October. Any improvement in two-year trends would, in our view, be encouraging because it would imply that last month’s stark improvement in trends has been sustained. September and October were exceedingly strong months in the U.S. with comps coming in at 5% and 5.2%, respectively. November faces a slightly easier year-over-year compare, but any improvement or continuation of the recent strength would be taken as a positive particularly as others in the restaurant group, like Darden, have clearly struggled recently.
NEUTRAL: A print between 5% and 6% would be considered neutral given that, on a calendar-adjusted basis, the midpoint of the range would imply trends roughly in line-to-slightly down from October. Given the outperformance in September and October, we do not believe a slight moderation would be received negatively given that comps would still be in the mid-single digit range and would still imply McDonald’s taking share from competitors.
BAD: A result below 5% would likely be received as a bad result given that it would imply that trends had decelerated from the September/October period. As strong as the company’s operational performance has been, the stock price has appreciated greatly (up over 9% QTD). It would seem that an inflection point in trends to the downside would likely bring the stock lower in short order.
Europe: facing a compare of 4.9% (including a calendar shift which impacted results by -1.8% to +0.1%, varying by area of the world):
GOOD: A print of 5% or higher would be considered a good result as it would imply two-year average trends roughly in line with October. Given all of the turmoil going on in Europe, it would seem that McDonald’s should be impacted at some point. That said, last month was an extremely strong month versus consensus so we are anticipating a print somewhere within our neutral range.
NEUTRAL: A result between 4% and 5% would be received as neutral, despite the slight deterioration in two-year average trends that the midpoint of that range implies. Given that austerity measures continue to impact consumers in Europe, a 4-5% print would still be indicative of a strong business, certainly relative to other plays on Europe.
BAD: A print of less than 4% would indicate a significant slowdown in trends for McDonald’s European business. Given the obvious concerns investors are having about Europe’s broader economy, it would likely not be difficult for sentiment around McDonald’s business in the continent to turn negative.
APMEA: facing a compare of 2.4% (including a calendar shift which impacted results by -1.8% to +0.1%, varying by area of the world):
GOOD: A print of 7% or higher would be considered good as it would imply trends slightly down from October but still at a healthy level of approximately 5%. Concerns about economic growth slowing in China are weighing on sentiment but we believe that the major US QSR chains are seeing strong trends in China at the moment.
NEUTRAL: A print of 5% to 7% would be received as neutral as, on a calendar-adjusted basis, the sequential change would be negative but the absolute level of the two-year trend would still be indicative of strong top-line trends.
BAD: A print of less than 5% would be received as a bad result as it would imply a significant slowdown in APMEA trends.
Positions in Europe: Short France (EWQ)
On Thursday the ECB convenes to announce changes to its interest rate policy and on Friday the EU Summit concludes in Brussels. We think the ECB should cut 25bps to address contracting growth forecasts and are positioned for a Summit outcome not dissimilar to previous Summits: disappointment. Here we do not expect to get definitive color on Europe’s next steps to address its sovereign and banking crisis beyond guidelines on a fiscal union to monitor budgets of member countries, which alone will not provide intermediate term support to European capital markets. It’s worth noting that Europe already has had a fiscal union of sorts, named the Stability and Growth Pact (to limit a country’s debt and deficit levels) which proved highly ineffective as its mandates were ignored by the majority of member countries (including Germany) at some point over the last ten years, and could simply spell another inefficient bureaucratic agency.
ECB Clippers Are Out
At the last interest rate decision on 11/3 ECB President Mario Draghi surprised the market with a 25bps cut to the main interest rate to 1.25%. On Thursday, we’d expect a similar cut as Europe’s macro environment continues to deteriorate, despite the move by the Fed and global central banks on 11/30 to reduce the interest rate on dollar swap liquidity swap lines by 50bps. Key statements from Draghi’s last speech highlighted the “ongoing tensions in a number of euro area sovereign debt markets” and the "impact of the still high energy prices, protectionist pressures and the possibility of a disorderly correction of global imbalances”, all of which and we think should encourage a cut.
We’re looking for $1.36 in the EUR-USD as a level to short the currency pair and expect the lack of resolve out of the EU Summit to drive EUR-USD weakness (more below).
In the chart below we show the move in the EUR-USD post the 11/3 announcement, which is 3.2% lower today. We don’t see material downside support in the cross until its previous low of $1.21.
The Summit Coming Up Short
While capital markets may see a short-term rally on any rumors (which we expect to be abundant) and initial statements around the Summit this week, ultimately we think Eurocrats will not craft solutions necessary to put medium term support in markets. Frankly, we still don’t think Eurocrats have answers in hand—the prevailing thread continues to be a willingness to keep the Eurozone intact, however without the firepower to do so on the sovereign or banking sides. We see European banks and the sovereigns needing a funding facility to the tune of $2 to 3 Trillion [$1.25 to 1.75T to recapitalize banks and $0.75 to 1.25T to fund future sovereign deficits].
The current EFSF has a mere €250 Billion left to address both fronts. Further, we do not see the Chinese riding in on a white horse with a significant loan or the IMF in a position to lend in the area code of our target. Remember, despite recent rumors that the IMF may make a €400-600 Billion loan to Italy (on 11/28) or that central banks may funnel loans through the IMF to select countries to the tune of €200B (12/1), the IMF only has €385 Billion in lending capabilities. So even in a scenario in which the IMF unloaded all of its balance sheet on Europe (which is highly improbable, and don’t forget that the USA is the largest contributor at 17%), this “max” loan would still come up short of addressing Europe’s banking and sovereign funding needs to sustain a medium-term market rally.
Central Questions Left Unanswered
In the balance lies the central question: if peripheral European countries can’t grow and can’t fund themselves with rising credit spreads, and therefore can’t balance their budgets no matter how much austerity is delivered, aren’t allowed to default (Greece), and can’t adjust monetary policy, 1.) how do weak states get out of this vortex? and 2.) what’s the benefit to weaker states to be bound in the Eurozone?
Merkozy Pact Flaws
If it wasn’t clear before, yesterday’s meeting between France’s Nicolas Sarkozy and Germany’s Angela Merkel solidified that Sarkozy is Merkel’s puppet. This unified voice supports maintaining the Eurozone fabric and Friday’s big news should center around the implementation of a fiscal union, Germany’s counter proposal to its rejection of the issuance of Eurobonds or using the ECB as the lender of last resorts.
Ultimately, a fiscal union is at best a 2.0 version of the Stability and Growth Pact, which already exists in the main treaties to limit member countries to 60% debt as a % of GDP and 3% deficit to GDP.
Here Merkel notes: “The lessons are very simple: Rules must be adhered to, adherence must be monitored, non-adherence must have consequences. Leaders have to overcome fundamental flaws in the construction of the euro area…. We are going to Brussels with the intention to change the EU treaty."
Unfortunately, since the Euro’s creation, numerous countries, including Germany, have violated one or both of the Pact’s limits. Should Eurocrats run in the direction of preserving the Eurozone’s current fabric, such a fiscal union is marginally bullish, however could well signal another bureaucratic institution that may at best have longer term benefit but contribute little to present sovereign and banking imbalances, which the market is demanding.
More Risks on the Horizon Without ECB Support
While we view the actions of ratings agencies as lagging indicators, yesterday’s move by Standard & Poor’s to place the ratings of 15 Eurozone nations on CreditWatch negative and today’s announcement that the EFSF’s AAA rating is being placed on CreditWatch negative, adds one more bee in the Eurocrats’ bonnet ahead of Friday. S&P said that ratings could be cut up to one notch for Austria, Belgium, Finland, Germany, Netherlands, Luxembourg – and by up to 2 notches for everyone else (France, Italy, Spain, Portugal, Ireland, Slovakia, Slovenia, Estonia, and Malta.) [Note: Greece was spared, and Cyprus remains on negative watch].
While S&P said it would review following the Summit, its warning portends negatively for the EFSF, a facility that is built around its AAA rating. Should downgrades come to Germany and France, its main contributors at 28% and 22%, respectively, we’d expect funding costs to rise, which negates the very purpose of this facility. In short, this will further force Eurocrat hands to meet the demand (especially by the periphery) of sovereign issuance, which we increasingly think can only be met by ECB participation. Remember, the ECB continues to state that its secondary bond purchasing program, the Securities Market Program (SMP), is only intended to be a temporary program. Last week the SMP bought another €3.7 Billion (versus €8.6 Billion in the previous week) to take its total since May 2010 to €207 Billion. Should the Eurocrats look to maintain the Eurozone’s fabric, this temporary rhetoric, and ultimately the size the ECB’s involvement, will have to change.
In our preview, we do not expect announcements on Friday to directly address the pressing sovereign and banking risks. First, we do not see an expansion/leverage of the EFSF without the ECB’s involvement, which we expect the Germans to continue to stand against. Second, we don’t expect Germany’s stance against the issuance of Eurobonds to change. Third, we see banking risk rising without more explicit funding packages. Insolvent banks in this environment will struggle to raise money on the secondary market, may well not have the sovereign backing, and it’s clear the EFSF is far undercapitalized to meet their needs. Here we think French and German banks will be critical to watch. Under these scenario we don’t see the market cheerleading post Friday’s announcement if in fact the bulk of the announcement is focused mostly around the establishment of a fiscal union. Further, there’s nothing on the calendar in terms of summits, etc. into year-end around which markets could get behind.
We remain short France via the eft EWQ in the Hedgeye Virtual Portfolio.
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