“It is the machinery of banking which makes this imbalance possible.”
-John Maynard Keynes
While I am not sure what machinery Banker of America’s Brian Moynihan uses to make his economic and risk management forecasts, I am certain that he does not use the same machines we do. We use fractal math.
I’m also confident that The Machinery of a globally interconnected marketplace of colliding risk factors is completely misunderstood by the academic source code that drives these Investment Banking Inc. estimates – classical Keynesian economics.
“The Machine” is actually what the best Global Macro Risk Manager of the 2007-2011 period (Ray Dalio, who I highlighted in yesterday’s Early Look when asking the question, What’s True?) calls economic “reality” – and sometimes it bites.
It certainly has in December.
At an “Economic Outlook” (scary) conference in Charlotte, NC yesterday, the embattled CEO of BAC channeled Hedgeye by suggesting “2012 will be another year that’s a grind in the economy.”
Notwithstanding that Moynihan is 12 months late in recognizing economic reality and its impact on Bank Of America’s cash earnings (Net Interest Margins (NIM) collapsing), we still can’t figure out how he comes up with a +2.1% US GDP estimate for 2012.
Neither can his shareholders.
On December 31, 2010, BAC’s stock price was $13.34/share. Yesterday it closed at $4.99/share. While that sounds like a weekend special on a slab of flank steak, at down -63% for the YTD, it’s even “cheaper” than that! A value meal at Mickey D’s is going to have a tough time competing with that price (even if you adjust for a black car service taking you through the drive thru, paying for gas).
As the venerable value investor Marty Whitman reminds us, “A bargain that remains a bargain, is no bargain.”
But what does this collapse of the US money-center banks mean? Isn’t this all Europe’s fault? Or this morning, should we just Blame Canada?
With the SP500 down -3.3% for December (after being down -0.6% in November and down -11.6% from the April 2011 high where the likes of Moynihan said US GDP Growth was going to be up +3-4%), how about we blame ourselves for once?
The Machinery of the globally interconnected marketplace has not changed. Unfortunately, neither has Old Wall St. It’s time we Embrace Uncertainty in our growth and inflation assumptions and stop begging for The Bernank to “smooth” the business cycle for us or our Too Big to Bail banks are going to be sitting right back where they were 23% higher in the S&P (October 2007).
In the meantime, here’s what going on in this morning’s USA Macro Grind:
- SP500 is testing its only remaining line of support in our TRADE/TREND/TAIL model (TREND = 1207)
- US Equity Volatility continues to hold its long-term bullish TAIL line of 23.11 support
- The Range (of risk) in my immediate-term probability model for the SP500 is 72 points wide (manageable)
- US Stock Market Volumes are as dead as the trust Americans have in Big Government Intervention markets
- Sector Risk: Financials (XLF) led decliners yesterday and remain in a Bearish Formation (crashing -23.2% YTD)
- Sector Signals: Consumer Discretionary (XLY) and Consumer Staples (XLP) hold up relatively well with Strong Dollar
- Strong Dollar = Strong US Consumption (try it at the pump this weekend, you’ll like it)
- US Dollar Index is busting a move into a Bullish Formation with immediate-term upside to 81.24
- US Treasury Yields continue to signal that Growth Slowing will be here through Q112 (10yr = 1.85% this morning)
- Yield Spread (proxy for growth and US bank earnings) = +161 basis points wide, and compressing
Outside of the USA, the Top 3 Risk Management items to recognize as reality today are:
- Eurocrat Bazooka is more like a pepper-gun
- China says they are not going to implement a “large stimulus”
- Greece is going away
Don’t worry SocGen vacationers, I don’t mean the Greek islands and beaches – I just mean their stock and bond markets. Greece issued 3-month piggy paper at 4.68% this morning and her stock market hit a fresh YTD low at 644 on the Athex Index (down -62.4% from Q111).
I suppose that if we give Keynes a bailout do-over on the quote about The Machinery of banking, he’d have to call the money printing and piling-debt-upon-debt solution to Greece one heck of an “imbalance!”
God Bless America and the opportunity we have here to stop what we are doing. It’s time to Re-think. Re-work. Re-build.
My immediate-term support and resistance ranges for Gold, Oil (Brent), German DAX, French CAC, and the SP500 are now $1, $101.34-106.28, 5, 2, and 1193-1213, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
The Macau Metro Monitor, December 20, 2011
FERRY TERMINAL WORK TO START IN THIRD QUARTER Macau Daily Times
The renovation work at the Outer Harbour Ferry Terminal will begin in 3Q 2012 and will last for at least one year, a Maritime Administration (CP) official said. “We will divide the work into four phases,” the official explained. The initial renovation will add luggage facilities and a baggage carousel to the east wing of the first floor. The second stage will see all the ticket offices moved into the same second floor area. During the third phase the offices of tourism and hotel businesses will be moved to a specific area in the west wing of the first floor. The final alterations will create a separate check-in and embarkation zone for vessels traveling to the Hong Kong International Airport.
There is still no decision on the future role of the Outer Harbour Ferry Terminal.
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If Nike trades down on a sentiment shift, we like it. Numbers are too low. The Street likes it, but for the wrong reasons, and will miss both the depth and duration of this stock move.
We think that we’ll see subtle changes in Nike’s posture towards the Street when it reports its F2Q12 after the bell tomorrow. Though Nike should beat handily (we’re at $1.04E vs the Street at $0.97E) and its backlog should remain in the vicinity of 10%, we think that near-term perception will turn from this being a sheer top line acceleration story, to being one of margin improvement.
The trade-off between top line and margin would ordinarily be a major yellow flag for us – especially given that Nike’s sentiment is the highest out of any name in retail (as outlined in our sentiment indicator below). It’s well loved by the sell-side (14 buys and 0 Sells) and buy-side (1% of the float short) alike. Revenue slowdown into positive sentiment is never a recipe for stocks to go up.
But few people I talk to are playing Nike for a TRADE. I don’t blame them. This is when slicing and dicing a story by duration matters most.
TAIL (3-Years or Less): We think that people like Nike, but for the wrong reasons. They under appreciate the earnings power of the company over the next 2-3 years, as well as the disproportionately smaller capital commitment Nike will need in order to incur in order to grow the P&L. Nike has already invested in the infrastructure needed to more than double the size of its direct business (which is an embarrassingly low sub-15% given that this is one of the most powerful brands in the world), as well as gain share in both Women and Apparel (these two, along with Retail, are not mutually exclusive).
That means more cash, which Nike is using increasingly to return to shareholders where it cannot invest internally or externally at 30% or better. One of the knocks we’ve had with this story has been the widening gap between ROIC and ROE. That’s finally narrowing (and it’s not bc ROIC is falling). Multiply the X axis times the Y axis on the chart below. The product is RNOA. Clearly, when both metrics head to the upper right, there is a dramatic impact on returns.
TREND: (3-Months or More): In looking at our TREND duration, it’s extremely important to keep in mind what’s changed since management updated us on its business 13 weeks ago.
1) FX: to many, it might seems like FX is the biggest factor of change here. But the reality is that it’s not. When Nike last discussed its results in September, the Euro had just crashed by 9% over twenty weeks to $1.35. Then it climbed steadily, only to crash again over the last seven weeks. When all is said and done, FX today is only about 4% off of where it was when Don Blair gave his last update. It is still a tailwind that Nike loses heading into Calendar 2012 and is a concern for us, but not as much as some might initially think.
2) Europe melted down: Nearly every brand selling across Europe is seeing a broad-based slowdown. This is Macro, and it’s big. The behavior of Draghi as new head of the ECB probably trumps any hype around near-term sell-in around the Olympics in London in ’12.
3) China continues to slow. This is no secret. But as recently as last night, Chinese officials made it clear it was willing to let economic activity moderate.
4) Generally Speaking, the sales environment for footwear and athletic apparel in the US is quite good. During the quarter, Foot Locker, Dick’s and Hibbett comped +7.4%, +4.1%, and +7.0% respectively. Inventories remain in check.
5) Nike market share in footwear continues to dominate as it relates to gains vs. last year. Apparel, on the other hand, still has some of the hottest items in the space (Nike Women’s Tempo Track Short), but has yet to meaningfully close the gap with footwear as it relates to share gain. Keep in mind that this is in the context of a space that is up solid DD so we’re less concerned about market share. But this is a key part of our broader investment theme, and we’re watching it like a hawk to see how it evolves.
It’s nice to see Nike’s US business doing so well. Because as shaky as the US Consumer might be, this is probably the most stable environment as we see it today. On the margin, we’re liking quality brands and franchises that are levered to the US consumer (think Wal-Mart), and less reliant on other economies (P&G). Nike fits somewhere in between. It comes as a surprise to many, but 55% of Nike’s sales originate OUTSIDE the US. And Yes, the vaunted US Footwear business accounts for only 24% of sales.
But when I think about the ‘where could I be wrong’ factor in 2012, it is that the dollar continues to inflate, and takes dollar-denominated commodities with it. Nike has an extremely strong hedging program, and the best relative positioning in the industry. But margins would get hit, and sentiment would get hit harder.
But the bottom line is that – with many of these factors considered -- our estimates are still ahead of the consensus for each of the next 3-years, as outlined by the chart below. That’s tough not to like. Same goes for the return profile.
TRADE: (3-Weeks or Less):
The thing that matters over the super near-term is tomorrow’s print. As noted, it will be a positive headline. But it HAS TO BE a positive headline. Our sentiment indicator below shows how little room there is for error.
Sentiment Index (Part of TRADE framework). This is the product of weighting sell-side vs buy-side sentiment. A sentiment score above 90 (overly bullish) has proven to be a good historical ‘sell’ signal, while a signal below 30 has proven to be better to Buy. Some stocks will never break out of their band, but marginal directional changes matter.
Brian P. McGough
Conclusion: We maintain our assertion that it won’t pay to be long of Chinese equities or industrial and/or energy commodities/equity plays using the prospect of China easing monetary and/or fiscal policy as the predominant catalyst. Moreover, we believe China is quite likely to disappoint growing consensus expectations for broad-based easing, absent a major deflationary shock. Chinese growth remains structurally constrained as result of past policy mistakes that are unlikely to be repeated again – just three years later.
- Equities: Asian equities closed down -2.7% wk/wk on a median basis… South Korea led decliners (down -6.5%);
- FX: Asian currencies are down -0.3% wk/wk vs. the USD on a median basis… the Korean won (KRW) and Aussie dollar (AUD) led decliners, falling -1.8% apiece… YTD callout: the Indian rupee is down -15.2% vs. the USD vs. a median decline of -2.9% for the region;
- Fixed Income: 2yr sovereign debt yields were mixed-to-slightly up wk/wk, led by Philippines (up +16bps)… 10yr sovereign debt yields broadly fell wk/wk, led by Australia (down -16bps)… 30yr sovereign debt yields all declined, led by India (down -16bps)… sovereign yield curves as measured by 10yr-2yr spreads broadly tightened wk/wk, led by Philippines (down -28bps);
- CDS: 5yr sovereign CDS traded +4.7% wider wk/wk on a median percentage basis, led by South Korea (+19bps or +12.4%);
- Rates (swaps): 1yr O/S interest rate swaps were flat wk/wk on a median percentage basis… the downside was led by an outsized move in Vietnam (down -130bps) and the upside was capped by a sizeable move in Indonesia (up +40bps); and
- Rates (interbank): O/N interbank rates were flat wk/wk on a median percentage basis a well… Australia’s S/T interbank market tightened the most (rates up +16bps).
Expanded price tables can be found at the bottom of this note.
CHARTS OF THE WEEK
Chinese equities, agree with our view that Chinese growth is: a) entering into the thralls of a 2yr-long slowdown; and b) unlikely to be meaningfully reflated via policy initiatives in 2012. We continue to wrestle with following the question internally: even if China eases, where does the additional liquidity flow through to from a growth perspective? Fixed asset investment (~half of GDP) remains under official assault by policymakers and China’s manufacturing and export base faces stiff headwinds from waning European and intra-regional demand. Unless China quickly alters its growth model away from pandering to property speculation and external demand, cutting rates and easing policy are highly unlikely to be as reflationary for the global economy as it was back in 2009. As we’ve seen domestically, central bank easing does not always equate to accelerating and sustainable growth.
Chinese stocks continue to agree with our general takeaways:
Aggressive hedging of China’s currency is also supportive of our conclusions:
The flow of hard capital in and out of China is supportive of our thoughts as well:
The following regional callouts pick up where we left off in our 12/12 note titled: A Look Under the Hood at Asia’s Trade Data and Capital Flows:
- China: New loan growth slowed in Nov to +CNY562.2B MoM vs. +CNY586.8B prior… M2 money supply growth slowed in Nov to +12.7% YoY vs. +11.9% prior – the lowest rate of growth since May ’01! China’s Shanghai Composite Index is down over -30% from the Nov ’09 cyclical peak in M2 growth rates (near +30% YoY).
- Hong Kong: Industrial production growth slowed in Oct to +0.2% YoY vs. +2% prior.
- Japan: Confidence remains bleak on the troubled island nation, which remains in recession from a YoY perspective. Consumer confidence ticked down in Nov to 38.1 vs. 38.6 prior, dragging down department store sales growth in the process (-1.9% YoY in Nov vs. -0.5% prior)… Per the omnipotent Tankan Business Survey, large manufacturers’ confidence and outlook ticked down in 4Q to -4 (vs. 2 prior) and -5 (vs. 4 prior), respectively. All-industry CapEx guidance was more than halved, falling to +1.4% in 4Q… Additionally, machine tool orders growth slowed in Nov to +15.9% YoY vs. +26% prior.
- Japan: Slowing growth, both domestically and abroad, continues to be imputed into Japan’s highly-liquid sovereign debt market. The Sharpe Ratio for 10yr JGBs has risen +52% YTD to 3.32 (vs. -87% to 0.88 for 10yr German bunds). International investors are buying JGBs at the fastest pace in four years (+$57 billion YTD vs. +$91.2 billion in ’07) as relatively low volatility in both the yen and JGB markets increases their allure as a consensus “flight to safety” trade. The Bank of Japan begins a two-day board meeting tomorrow where they are expected by some to step up liquidity provisions.
- India: A bombed-out Oct industrial production report (-5.1% YoY vs. 2% prior) exposed India’s YTD economic malaise to the financial media consensus. We view this as more of the same, having authored the bearish call across India’s various financial markets well over a year ago. India’s SENSEX Index (-25% YTD), the rupee (down -15.2% YTD vs. the USD), and 2yr sovereign yields (+74bps YTD vs. a median decline of -14bps across the region) all continue to paint a bearish outlook for the world’s 5th largest economy on a PPP basis.
- South Korea: Discount and department store sales growth slowed in Nov to -0.5% YoY each, from +5.5% and +3.1%, respectively, in the month prior.
- Australia: Westpac’s consumer confidence index dropped -8.4% MoM in Dec to 94.7.
- New Zealand: Business PMI ticked down in Nov to 45.7 vs. 46.6… Westpac’s consumer confidence index plunged -9.6% MoM in Dec to 101.3.
- China: Monetary easing speculation continues to be supportive of China’s corporate credit market. The AAA yield spread over sovereign yields has tightened -17bps MTD to a five-month low of 176bps wide. Still, China’s corporate dollar bonds remain the worst performers in Asia for the YTD (down -5.7%). To the original point re: easing speculation, 2yr sovereign debt yields, 1yr O/S interest rate swaps, and O/N interbank rates are all trading below the PBOC’s benchmark 1yr household savings deposit rate at -64bps, -79bps, and -55bps, respectively.
- China: Foreign direct investment growth slowed in Nov to -9.8% YoY vs. +8.8% prior – the lowest rate of growth since July ’09. The delta between E.U. FDI (up +0.3% YoY) vs. the U.S. (down -23% YoY) speaks volumes to which region is in greater need of tapping Chinese demand in order to supplement growth in 2012. Still, capital flight is what it is and this latest FDI data point does not help paint a rosy 2012 outlook for the global economy – very much in contrast with current Wall Street 1.0 consensus.
- China: Easing speculation and capital flight continues to weigh on the Dim Sum bond market (yields up +382bps YTD) as investors demand greater risk premiums to offset the specter of slower gains in the yuan. China’s currency continues to face pressure in FX hedging markets: 1yr O/S forwards trade at a 1.2% discount to the O/S spot rate (widest spread since Mar ’09); 1yr offshore forwards trade at a 1.1% discount to the offshore spot rate.
- India: International investors are adding to their holdings of rupee-denominated debt in Dec (another +$1.6 billion MTD to $23.8 billion). The inflows’ impact on the exchange rate is being overpowered by equity outflows and easy monetary policy out of the central bank. To that tune, the RBI has purchased $4.6 billion of sovereign debt in the secondary market since Nov 24th. Their decision to pursue Quantitative Guessing suggests to us that alleviating a liquidity crunch in the banking system appears to be the central bank’s primary objective for now – even more so than bringing down the 9%+ inflation dramatically impacting the lives of the ~828 million Indians living on less than $2 per day. In Dec, Indian banks are borrowing an average of 984 billion rupees ($18.6 billion) from the RBI’s repo facility – a 12-month high. The liquidity crunch has slowed rates of credit growth (down -680bps YTD to +17.6% YoY in Nov) and rupee-denominated corporate bond issuance (down -23% YoY to 1.49 trillion rupees YTD).
- India: Per above, the RBI kept its benchmark policy rates on hold and implemented a scheme to support the rupee in the FX market (trading just above an all-time low vs. the USD). The new regulations prevent companies from speculating on the rupee by entering into multiple forward contracts on a singular transaction. Also, previously-canceled forward contracts can no longer be reactivated. While Governor Duvuuri Subbarao did confirm that a “rate cut is an event some way ahead”, his refusal to hike rates amid a currency crash is another indication that the tightening cycle has run its course in India – an event that has recently become supportive of India’s fixed income market (2yr sovereign debt yields down -45bps over the past month; 10yr yields down -52bps over the same duration).
Deflating the Inflation:
- South Korea: Export and import prices slowed in Nov to +5.4% YoY (vs. +9.2% prior) and +11.8% YoY (vs. +16% prior), respectively.
- Australia: Consumer inflation expectations slowed in Dec to +2.4% vs. +2.5% prior… trending down right alongside the RBA’s official projections and 5yr market breakeven rates (down -926bps peak-to-trough in the YTD to 2.2%). We remain the bears on the Aussie dollar over the intermediate term.
- Hong Kong: PPI accelerated in Oct to +9.6% YoY vs. +9% prior.
- China: HSBC flash manufacturing PMI (85-90% of responses tallied) ticked up in Nov: 49 vs. 47.7.
- Singapore: Retail sales (ex autos) growth accelerated in Oct to +8.6% YoY vs. +3.5% prior… export growth accelerated in Nov to +1.6% YoY vs. -16.3% prior.
- China: Per Xinhua newspaper by way of unnamed government officials, China’s 2012 policy outlook is “progress amid stability”. The key takeaways from their statement: “policies will be fine-tuned as needed”; “… will continue to unswervingly implement real estate curbs”; “credit growth will be reasonable”; “… will step up management of local gov’t debt” (a huge step in the right direction from the current policy of willful blindness); “structural tax cuts will continue”; “… will speed-up construction of low-income housing”; and “a stable yuan exchange rate”. These statements rhyme with commentary out of Fan Gang, director of China’s National Economic Research Institute: “China is unlikely to enact a large stimulus package amid a healthy correction in economic growth.” Both [pseudo-official] outlooks are very much in line with what we’ve been telling clients to expect out of China over the past few months.
- China: Executives at Shimao Property Holdings Ltd. and Glorious Property Holdings Ltd. are taking the other side of the government’s strong stance toward the property market and tempering of easing expectations, buying as much stock in their companies since 2008 – likely expecting a redo of the ‘08/’09 rally in Chinese property shares (+62.7% trough-to-peak). Like the much-larger developer Evergrande Real Estate Group Ltd. (NOT buying), we remain skeptical of betting on such an outcome this time around. Price declines in the new homes market continue expand breadth, falling MoM in 49 of the 70 cities monitored in Nov vs. 33 in Oct.
- China: Is imposing 2yr anti-dumping and anti-subsidy duties on General Motors, Chrysler Group, Mercedes-Benz U.S. International, BMW Manufacturing LLC, Honda of America Mfg., and American Honda Motor Co. vehicles with engines over 2.5 liters ranging from 2%-12.9% with the U.S. manufacturers facing the more punitive rates. This is on top of China’s current 25% tariff on imported cars.
- China: Social unrest appears to be creeping back into the focus of the mainstream media as the government authorized a militant crackdown of Wuhan protests which had erupted after a local villager/protest organizer died in police custody.
- Hong Kong: No longer just a selling price story, Hong Kong’s bubbly property market is starting to see cracks developing in the rental market as well, with prices falling -1% MoM in Nov – the first decline since Mar ’09 per Centaline Property Agency Ltd.
- Japan: In support of Japan’s “key industry” (per Finance Minister Jan Azumi) the Diet extended tax breaks for fuel efficient vehicles through 2015 from the originally scheduled expiration date in April ’12. To help offset the lost tax revenue, lawmakers are going to impose a cap on tax deductions for taxpayers earning over ¥15 million yen ($192k) per year in addition to a new carbon tax proposal. A further “comprehensive” tax overhaul is currently being debated as the nation seeks to begin reigning in its debt and deficits amid Europe’s sovereign debt crisis.
- India: India’s legislative body passed the Food Security Bill, a new program that subsidizes grains for India’s poor (64% of the 1.2 billion population, as defined by the gov’t). The program is projected to expand current grain subsidy expenditures from 630 billion rupees annually to 950 billion. Obvious cons include: a) it’s a deficit-negative event; b) it doesn’t address the root causes of inflation (third-world infrastructure and a nationwide shortage of food storage/refrigeration facilities); and c) it showcases that populism is the only avenue whereby legislation can be enacted in India. On the flip side, it does take some heat off the wildly ineffective government, as it demonstrates that they can agree upon some new and meaningful initiative, having not done so since late last year amid staunch gridlock stemming corruption scandals and the government’s [mis]handling of the woeful inflation situation.
- Korean Peninsula: With Kim Jong Il’s sudden death, the threat of geopolitical instability looms large over the region. Several regional scholars question Kim Jon Un’s (his son and official replacement) ability to maintain the “cohesion” (if you could call it that) that his father maintained throughout the communist party. Uncertainty weighed heavily on the KOSPI index today (down -3.4%); defense contractors broadly closed limit up, however, highlighting the tense nature of the transition and the potential for heightened military activity in the coming months and years. The two countries remain technically at war since the early 1950’s.
- Australia: We flagged back in early May the contrarian indicator that was record issuance in Australia’s kangaroo bond market, as issuance tends to peak ahead of cyclical downturns in the global economy. We are starting to see that confirmed more forcefully in the data, as kangaroo bond sales in the fourth quarter to-date have fallen -88% QoQ to A$675 million.
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