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The Degenerative Science

This note was originally published at 8am on December 16, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Economics is too important to leave to the economists.”

 – Steve Keen

 

I graduated with a degree in Economics from Princeton University; looking back at old textbooks and syllabi, and listening to former professors debate current economic issues, I can’t help but feel like I “dropped a hundred and fifty grand on an education [I] could’ve gotten for a dollar fifty in late charges from the public library,” to quote one of my favorite movies, Good Will Hunting.   [I fully expect an angry call from my parents today.]

 

But it seems that I’m not alone.  Last month, seventy freshmen at Harvard walked out of Gregory Mankiw’s introductory Economics 10 lecture; they wrote to the well-known economist that his course “espouses a specific – and limited – view of economics that we believe perpetuates problematic and inefficient systems of economic inequality in our society today.”  And that, “As your class does not include primary sources and rarely features articles from academic journals, we have very little access to alternative approaches to economics.”

 

The quote that prologues this note is from Post-Keynesian economist Steve Keen’s book Debunking Economics.  If you’ve never heard of him it’s because he doesn’t write for the New York Times or dine in Davos, though in 2010 he did win the Revere Award for Economics for being “the economist who first and most cogently warned the world of the coming Global Financial Crisis.” 

 

He is a harsh critic of mainstream economists; while Keen warned as early as 2001 that “economic theory has been complicit in encouraging America’s investing public to once again delude itself into a crisis,” neoclassicists like Greenspan, Bernanke, and Geithner were our economic leaders that empowered the private sector to lever up to an unsustainable level (private sector debt to GDP of 300%), gave no warning of imminent danger, and today fail to apply appropriate policies to lift us out of the recession because they don’t understand what caused it.

 

Like those Harvard freshman, Keen isn’t afraid to say that today’s Emperors of Economics aren’t wearing any clothes.  Hedgeye says it every day.

 

The economists that make the world’s crucial monetary policy decisions are the same economists that I listened to in lecture halls and authored my textbooks.  While superficially appealing, their theories lack empirical evidence, are riddled with internal inconsistencies, and are based upon tenuous assumptions.  Specifically, their models are built on downward sloping demand curves, upward sloping supply curves, perfect competition, rational consumers, benevolent dictators, and general equilibrium; there is no dynamic analysis, no consideration of disequilibrium, and no role of private sector debt.

 

What real-world, market economy adheres to the principles defined by our leading economists?

 

There isn’t one.  That’s why Milton Friedman argued that a theory cannot be judged by its assumptions, but only by the accuracy of its predictions.  But that defense doesn’t hold up so well after every neoclassical economist failed to predict the financial crisis and ensuing recession.  In fact, in August 2008, Olivier Blanchard, professor at MIT and now chief economist at the IMF plainly stated that, “The state of macro is good.”  Somehow, even when groupthink’s policy resulted in turmoil the world over, economic leaders failed to judge modes of economic thought by the accuracy of their predictions.  As a result, the same actors – Geithner, Bernanke et al. – remain in systemically-important roles even after being proved wrong pre and post 2008.

 

As Keen puts it, neoclassical economists are “wedded to the belief that capitalism is inherently stable.  They cannot bring themselves to consider the alternative perspective that capitalism is inherently unstable, and that the financial sector causes its most severe breakdowns.”

 

Rather than expanding the range of phenomena that economics can explain, the leading edge of neoclassical theory focuses on defending the core beliefs from the attacks of ancillary views.  It is truly a Degenerative Science, if economics can be considered a science at all.   True sciences expand and evolve: genetics, psychology, quantum mechanics, astronomy; economics defends itself – it is an ideology.

 

On scientific progress, German physicist Max Planck said that, “Science advances one funeral at a time,” and Keen concurs: “You cannot persuade people who believe a mythical vision of reality and their whole lives are dedicated to believing that way.” 

 

As it pertains to the leadership of our globally-interconnected economy, we’re more optimistic.  The American people’s frustration demands a faster rate of change than “one funeral at a time.”  Whereas academic economists move at a glacial pace (if they are moving at all), the people are unafraid of change – they will fold a losing hand.  Public opinion polls have shown for some time the dissatisfaction of the American people with Bernanke’s performance, for instance.

 

Americans want to stop playing with perennial losers, while potential winners are left on the bench. 

 

Including concepts from complexity theory, evolutionary economics, Austrian economics, Post-Keynesian economics, and other alternative economic schools – all shunned by today’s monetary and fiscal policy leaders – would be a positive change on the margin.  What we need is an economic theory that is more relevant to a modern capitalist economy – one that embraces uncertainty and disequilibrium, is grounded upon realistic assumptions, is judged by the accuracy of its predictions, and where debt and money are implicit, important factors.

 

Like Wall Street 1.0, Economics 1.0 is broken and has to evolve.  Keen aptly states, “If economics is to become less of a religion and more of a science, then the foundations of economics should be torn down and replaced.”  We are on the way.

 

Our immediate-term support and resistance ranges for Gold (bought it on 12/14), Brent Oil (Bearish Formation), and the SP500 are now $1568-1596, $103.23-107.91, and 1206-1228, respectively. 

 

Kevin Kaiser

Analyst

 

The Degenerative Science - EL chart KK

 

The Degenerative Science - vp mh


THE M3: NOV CPI

The Macau Metro Monitor, December 21, 2011

 

 

CONSUMER PRICE INDEX FOR NOVEMBER 2011 DSEC

Macau CPI for November 2011 increased by 6.65% YoY and 0.39% MoM.


Weekly Latin America Risk Monitor: Kneeling Before the King [Dollar]

Conclusion: USD strength and the resultant knock-on effects continue to force the hands of international policymakers.

 

PRICES RULE

  • Equities: Regional equity markets closed down -0.9% wk/wk on a median basis, w/ Venezuela outperforming (up +0.6%) and Argentina underperforming (down -1.3%);
  • FX: Latin American currencies are up modestly vs. the USD wk/wk (+0.1%), w/ the Brazilian real outperforming (up +0.8%) and the Chilean peso underperforming (down -0.8%);
  • Fixed Income: Regional sovereign debt yields generally backed up across the maturity curve, w/ Brazil gaining +19bps wk/wk on both its 2yr and 9yr issues;
  • CDS: 5yr sovereign CDS closed +6.6% wider wk/wk on a median percentage basis, w/ Peru widening the most (+8.4% or +13bps) and Argentina widening the least (+2.2% or +22bps);
  • Rates (swaps): 1yr O/S interest rate swaps markets were flat wk/wk on a median percentage basis, bracketed by Mexico (+9bps wider) and Chile (-4bps tighter); and
  • Rates (interbank): O/N interbank rates backed up +0.3% wk/wk on a median percentage basis, bracketed by Mexico (+10bps wider) and Argentina (-25bps tighter).

Price tables can be found at the bottom of this note.

 

CHARTS OF THE WEEK

 

Growth in Brazil continues to be rather un-“BRIC”-like:

 

Weekly Latin America Risk Monitor: Kneeling Before the King [Dollar] - 1

 

As such, various markets continue to price in additional monetary easing measures out of Brazil’s central bank:

 

Weekly Latin America Risk Monitor: Kneeling Before the King [Dollar] - 2

 

Jumping ship, aggressive financial repression appears to have slowed capital outflows in Argentina – for now:

 

Weekly Latin America Risk Monitor: Kneeling Before the King [Dollar] - 3

 

KEY CALLOUTS

Growth Slowing:

  • Brazil: After publishing a sour 3Q real GDP report, Brazil’s economic activity index (a proxy for GDP) slowed incrementally in Oct to +0.7% YoY vs. +1.3% prior.
  • Colombia: Industrial production growth slowed in Oct to +5% YoY vs. +5.2% prior… retail sales growth slowed in Oct to +6.1% YoY vs. +8.1% prior.
  • Peru: Real GDP growth slowed in Oct to +5% YoY vs. +5.8% prior.

King Dollar:

  • Brazil: USD strength continues to force the hands of international policymakers; Brazil’s central bank became the latest country to [re]introduce ‘08/’09-esque measures to protect its currency and the supply of capital flowing into the country. Specifically, the program is structured as a 1-3 month repo that is intended to provide trade financing for Brazil’s exporters. A noteworthy takeaway here is that the central bank may view this as an effective maneuver in the short term to slow the pace of the real’s decline, thus opening the door for further rate cuts. Of course, the derivate of the latter action is indeed a weaker outlook for the currency.
  • Brazil: Regarding the slope of Brazilian interest rates, widespread political pressure continues to be applied to the country’s central bank operatives. President Dilma Rousseff had this to say over the weekend: “[Brazil] is ready to use monetary policy to stimulate growth amid a violent global crisis… Developed nations have interest rates close to zero. We have a room for maneuvers that they don’t.” Markets are taking her continued outlook for Brazilian interest rates seriously: 2yr sovereign debt yields, 1yr interest rate swaps, and O/N interbank rates are all trading below the official Selic rate at -54bps, -112bps, and -10bps, respectively.
  • Argentina: Financial repression, while successful at slowing the pace of capital flight, continues unabated in Argentina as the gov’t seeks to stave off a crash in the currency. To the former point, the central bank has now become a net buyer of FX reserves as insurers, energy and mining companies repatriate an estimated $2-4 billion into year-end per the government’s directive. Slowing capital flight, which fell to about $1 billion in Nov from $3 billion in Oct, and pressure from central bank president Mercedes Marco Del Pont are combining to drive down the cost of capital in the country (from a mid-Nov peak of 26.1% to 18.8% on the 30-day badlar). As mentioned, these near-term “successes” are not without consequence. Over the long term, we expect the country to experience incremental economic volatility and even higher [unofficial] rates of structural inflation as investors lose confidence in the country altogether and abandon peso-denominated assets. To that point, 1yr USD/ARS NDF contracts are currently pricing in a -20.2% crash from the spot rate over the NTM.
  • Chile: Less than a week after holding its benchmark policy rate at 5.25%, Chile’s central bank lowered its 2012 growth and inflation outlook by -50bps and -20bps, respectively, to 4.25%-4.7% and 2.7%, respectively. Their reduced expectations for both metrics paves the way, on the margin, for them to cut rates – an outcome currently being priced into Chile’s 1yr O/S interest rate swaps (trading -90bps below the policy rate).

Counterpoints:

  • Mexico: Who says you need a strong currency to empower domestic consumption? Mexico’s ANTAD same store sales growth ripped to the upside in Nov to +14.6 YoY vs. +5.8% prior, despite the peso falling -9.4% vs. the USD in the YTD through Nov. We don’t expect this divergence to sustain itself and remain the bears on the peso (vs. King Dollar) over the intermediate-term TREND. Mexico’s central bank remains divided on the next step(s) in monetary policy. This indecision is subtly bearish for the peso as heightened volatility forces investors to demand greater premiums to hold risky assets – a premium that is not being adequately provided by the central bank due to their Indefinitely Dovish interest rate policy.

Other:

  • Peru: Less than six months after winning the Peruvian presidency on the strength of strong populist support, it appears President Ollanta Humala is losing some of his left-most supporters in politics after he recently declared a state of emergency and authorized a military response to quash protests against a $4.8 billion gold mine being developed by Newmont Mining Corp. Two senior officials in his cabinet resigned after voicing support for the demonstrations; he then replaced his cabinet chief with a former military instructor. Former president Alejandro Toledo withdrew his party’s support for Humala in Congress, where Humala’s Gana Peru party only has 47 of 130 seats. Congressional gridlock and lower-highs in presidential approval appear to be in the cards for Peru and its now pro-business president over the intermediate and, potentially, long term. Ironically, it was Humala that led a violent uprising as a rebel solider just over ten years ago.
  • Venezuela: Another socialist leopard changing its spots? In an attempt to limit consumer goods supply shortages ahead of next year’s elections, Venezuelan president/dictator Hugo Chavez is forging strategic alliances with private international companies to entice them back to the country’s retail markets. This is a major reversal of his political M.O.; as recently as a few weeks ago, he authorized a dramatic piece of new legislation which would allow the government to impose draconian price caps on thousands of consumer goods. Moreover, since taking office in 1999, Chavez has seized the assets of 1,045 companies and is on the hook for roughly $30 billion in paid and unpaid international legal settlements. While we don’t expect Chavez to soon adopt Adam Smith-style capitalism, we do think this latest round of political short-termism might actually be marginally supportive for the economy struggling with structurally high rates of inflation – if he is to follow though, of course.

Darius Dale

Senior Analyst

 

Weekly Latin America Risk Monitor: Kneeling Before the King [Dollar] - 4

 

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Gentleman Prefer Bonds: TLT Trade Update

On a day like today where Bernanke’s mandate of “price stability” is violated to the upside on the order of ~3-4% (S&P 500, Russell 2000, crude oil), it helps to have a repeatable multi-factor, multi-duration risk management process to contextualize such moves beyond merely attributing performance to a fictional character tasked with spurring consumerism via holiday cheer.

 

To that tune, the long end of the Treasury bond market continues to suggest to us quantitatively that the global growth/inflation/interconnected risk outlook for the short-to-intermediate term has not changed. All that’s changed are market prices (to inconsequential levels) and the latest batch of consensus storytelling. As such, we’ve taken this wonderful opportunity to continue Fading Beta by purchasing long-term Treasury bonds via the TLT ETF in our Virtual Portfolio.

 

Until a) long-term Treasuries sustainably break down through any of our three risk management levels and b) the Treasury market stops being a leading indicator for U.S. equities (it has led domestic equities lower in every economic slowdown since 2007), the gentleman (and ladies) of Hedgeye will continue to prefer bonds.  

 

Buy low. Sell high. Fade Beta – for now, at least.

 

Darius Dale

Senior Analyst

 

Gentleman Prefer Bonds: TLT Trade Update - 4



CCL 4Q CONF CALL NOTES

Pricing commentary spooking investors today.

 

 

"On the whole, 2011 was an encouraging year for our global portfolio of cruise brands. Our North American brands performed well, achieving an almost four percent revenue yield increase, while our European, Australian and Asian brand yields were in line with the prior year (constant dollars) despite having been significantly impacted by the geo-political unrest in the Middle East and North Africa.  Higher revenue yields partially offset a 32 percent increase in fuel prices, which reduced earnings by $535 million or $0.68 per share for the year. Cash from operations of $3.8 billion provided more than ample funding for our $2.7 billion capital investment program and enabled the company to return excess cash to shareholders.  Earlier this year, our quarterly dividend was increased from $0.10 to $0.25 per share resulting in $670 million of dividend distributions. In addition, we purchased 14.8 million of the company's shares in the open market at a cost of $455 million."

 

- CCL CEO Micky Arison

 

 

CONF CALL

  • 4Q 2011
    • EAA brand yield grew 10% while NA brand yield grew 3%
    • Net ticket yields: NA +8%, higher yields in Caribbean, Alaska, Canada/New England, and transatlantic itineraries; EAA: -6%, from impact on MENA
    • Net onboard yield & other: +1.4%
      • Driven by our North American brands as our EAA brands were impacted from MENA itinerary changes that resulted in lower occupancies, lower short duration revenues and slightly lower spending in other areas
    • Net cruise costs ex fuel influenced by ship repair costs
    • Fuel usage savings of 15% since 2005
  • 2011
    • 4% improvement in NA brand yield; EAA brand yield in-line YoY
    • Fuel/currency shaved EPS by 41 cents
    • Ex Japan and ME, CCL would have been at the high end of their original guidance range from a year ago
    • Dividends paid and share repurchases of $1.1BN which consisted all of its FCF
    • Going forward, CCL will not include in our earnings guidance any year-to-date impact or any future estimates of the unrealized gains and losses on the fuel derivatives. Will be on non-GAAP basis going forward.
  • 2012
    • Current spot price for fuel used in our guidance is essentially in line with 2011's average price.  However, based on the current FX rates, currency is expected to have a negative impact of 17 cents
    • 10% change in the price of fuel represents a 225 million or $0.29 per share impact for the full year
    • 10% change in all relevant currencies -- relative to the U.S. dollar, would impact EPS by 25%
    • 3 ships for delivery: Costa Fascinosa scheduled for April, while AIDAmar and Carnival Breeze are scheduled for May
    • Capex: $2.6BN
    • FCF: $1.4BN
    • The $0.30 per share range for 2012 compares to the $0.20 share range we have used in recent years due to European uncertainty
    • Lower consumer confidence caused some delay in vacation decisions and resulted in a lower end booking window.
    • Fleet-wide bookings volumes have been higher year-over-year, we have achieved this volume by reducing prices for our Cruises. 
    • North America brand booking volumes over the last 13 weeks have been "rubbing higher" than a year ago at lower prices
    • EAA brand bookings are slightly higher at lower prices.  
    • Recent bookings over the last six weeks have seen stronger pickup in booking volumes for both North America and Europe brands which is encouraging 
    • In terms of our current booking status at the present time based on bookings taken to date, constant dollar ticket prices for North America and EAA brands are slightly higher than a year ago on slightly lower occupancies.
    • Capacity: +4.8%
  • 1Q 2012
    • Capacity: +4.9%
      • 4.5% for NA brands
      • 5.6% for EAA brands
    • Occupancies on the fleet-wide basis are slightly higher year-over-year, with constant dollar pricing also higher.
    • Very little inventory left
    • NA brand
      • 65% Caribbean (same as last year)--pricing is higher than a year ago at slightly higher occupancy 
      • Pricing for all other itineraries is also shootingly higher than a year ago at slightly lower occupancies
    • EAA brand
      •  22% Caribbean (vs 20% last year); 19% in Europe (vs 22% last year); 18% South America (vs 16% last year)
      • EAA constant dollar pricing in the Caribbean is higher than a year ago on lower occupancies.  EAA prices in Europe is lower year-over-year but with higher occupancies.  And EAA South America pricing is nicely higher than a year ago on higher occupancies.
    • Incremental costs for the increased number of dry dock days vs 1Q2011 is ~$0.06 per share.  This is a timing difference.  These dry dock days that will reverse during the remainder of the year as the dry dock days for the full year 2012 is approximately the same as 2011.
  • 2Q 2012
    • NA: Caribbean 56% (same YoY); pricing nicely higher on same occ; other itins are higher with lower occ
    • EAA: 53% Europe (vs 55% last year); EAA European constant currency Cruise pricing is slightly higher than a year ago on slightly lower occupancies. EAA brand pricing all taken together is slightly lower than last year also at lower occupancies.  
    • Overall basis estimate is that constant dollar revenue yields will be flattish for the second quarter by the time we close
  • 3Q 2012
    • Capacity: 4.7% (3.3% in NA, 7% in EAA)
    • Pricing higher on lower occu
    • NA
      • 39% in Caribbean (36% last ago); 24% in Alaska; (slightly higher than year ago); 25% in Europe (same YoY)
      • Pricing for Caribbean Alaska and Europe itineraries are higher than a year ago.  Occupancies for Caribbean and Alaska Cruises are running at about the same level as last year with occupancy for Europe Cruises lower than last year.
    • EAA
      • 88% in Europe (in-line YoY); pricing nicely higher on lower occu
      • But considerable amount of inventory left to be sold

 

Q&A

  • There has been "ebb and flow" in bookings
    • For last 13 weeks: less impact on 1Q, more impact on 2Q and 3Q
    • Last 6 weeks, bookings have been stronger
  • Some markets fine, some markets lower demand--more broadly so in Europe than NA
  • Southern Europe: a big challenge but still holding pricing
  • Comps for European crisis won't happen until mid-February
  • "Pleasantly surprised" by UK and Germany
  • Southern Europe--Spain, Italy and France-- wintertime is a slow time for those countries
  • Don't expect crack spread between WTI and brent to come down 
  • Costa was hit the hardest from MENA disruption--expect better occupancy to drive yields in 2012
  • MENA negatively impacted yields by 1.7%.  EAA brands was probably over double that.
  • Ships that go to dry docks depends on the ships every three years, twice every five years.
    • Relative to 2011, 2012 total # of dry dock days were in-line. Capacity went up slightly.
    • Dry dock costs will not affect cruise costs for the full year
  • FCF: 30-40% payout in dividends
  • Don't source a lot of Scandinavia passengers; Netherlands business is going well
  • Pricing will continue to be a challenge in Southern Europe; not much capacity increase in Europe
  • Booking window has come in a little bit
  • If you didn't lower price, would you see better volumes? 
    • Don't know
  • Market share vs Tour operators/Thomas Cook: Package holiday business in Europe in general is shrinking while the Cruise business is growing.  So obviously we're effectively taking share but our share is so small in number.  Compared to the overall package holiday business in Europe, it's not meaningful.
  • 2012 capacity increase is after the Pacific Sun take out
  • Wave guidance
    • In some markets, sustained pricing and good volumes
    • In other markets, lower pricing
  • But once you get post that line in the comparisons get much easier, we'll be running well ahead in terms of prices
  • More than of 50% of yield will be driven by occupancies
  • Not much change in patterns between Premium and Contemporary brands; US Premium is holding up well
  • Q2 "flattish pricing"--could still be slightly up or down but in a tight range
  • No need to worry about cost of new itineraries; they are booking well
    • Major change in deployment is shorter duration which is helping bring pricing down and delaying the booking which would benefit onboard spend

 

HIGHLIGHTS FROM THE RELEASE

  • 4Q2011 results: 
    • EPS: $0.28 (consensus $0.28)
    • Current $ net revenue yields: +2.1% (vs consensus of +2.2% and guidance of +1.5-2.5%)
    • Constant $ net revenue yields: +1.5% (guidance of +1% to 2%)
    • Gross revenue yields (in constant $): +0.3%
    • Constant dollar net cruise costs: -1.8% (guidance of -3-4%)
    • Fuel: +39% YoY to $680/metric ton (lower than guidance of $686/mt)
  • 1Q2012 guidance
    • Current dollar net revenue yields: +0.5% to 1.5% (consensus: +2%)
    • Constant dollar net revenue yields: +1.5% to 2.5% (consensus: 2.3%)
    • Current dollar net cruise costs (ex. fuel): +2.5% to 3.5%
    • Constant dollar net cruise costs (ex. fuel): +3.5% to 4.5%
    • Fuel: $652/metric ton; 860K metric tons
      • Fuel costs for Q1: $93MM or $0.12 EPS drag
    • EPS: $0.06-0.10 (consensus: $0.14)
  • FY2012 guidance:
    • Diluted EPS:$2.55-$2.85 (consensus: $2.77)
    • Constant dollar net revenue yields: +1.0% to 2.0% (consensus: +2.8%)
    • Constant dollar net cruise costs (ex. fuel): -0.5% to 0.5%
    • Fuel: $650/metric ton
    • Fuel consumption: 3,470K
  • Fuel derivatives program
    • "During the fourth quarter of 2011, the company entered into zero cost collars for approximately 10 percent of its estimated fuel consumption for the second half of fiscal 2012 through fiscal 2015.  The company will not realize any economic gain or loss upon the maturity of these zero cost collars unless the price of Brent is above the ceiling price or below the floor price." 

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