China, With Context

Conclusion: As of now, the data is not particularly supportive for China to meaningfully ease monetary policy (and thereby reflating import demand) in the near term. Moreover, inflation expectations need to continue trending down for Chinese assets to keep working and we anticipate that will happen as King Dollar continues to weigh on commodity prices over the intermediate-term TREND.


Virtual Portfolio Positioning: Long Chinese equities (CAF); Closed our long position in Hong Kong equities (EWH) earlier today.


Rather than react to the mania of financial media headlines and 1-day price moves, we think intermediate-to-long-term investors would be much better suited to have a process by which to properly contextualize the latest deltas in Chinese growth/inflation/policy. Our updated thoughts on each are below:


Growth: China’s 4Q/DEC economic growth data came in better than bad, which is in-line with our view that Chinese growth is slowing at a slower rate and looks to bottom-out here in 1Q12:

  • 4Q11 Real GDP: +8.9% YoY vs. +9.1% prior vs. +8.7% Bloomberg Consensus; +8.9% is the slowest pace of growth since 2Q09 and well off the 1Q10 cycle-peak of +11.9%;
  • Retail Sales: +18.1% YoY in DEC vs. +17.3% prior;
  • Industrial Production: +12.8% YoY in DEC vs. +12.4% prior;
  • YTD Urban Fixed Assets Investment: +23.8% YoY in DEC vs. +24.5% prior;
  • M2 Money Supply: +13.6% YoY in DEC vs. +12.7% prior;
  • New Loan Growth: CNY640.5B MoM in DEC vs. CNY562.2B prior;
  • Manufacturing PMI: 50.3 in DEC vs. 49 prior;
  • Non-Manufacturing PMI: 56 in DEC vs. 49.7 prior;
  • Exports: +13.4% YoY in DEC vs. +13.8% prior;
  • Imports: +11.8% YoY in DEC vs. +22.1% prior; +11.8% is the slowest rate of growth since OCT ’09 and highlights Chinese demand (or lack thereof) for things not produced in China (i.e. raw materials); and
  • Trade Balance: +26.3% YoY in DEC vs. -36.5% prior.

 China, With Context - 1


Inflation: China’s DEC inflation data was dovish, on the margin, but still not supportive of a dramatic reversal in Chinese monetary policy from either an absolute or trend-line perspective:

  • CPI: +4.1% YoY in DEC vs. +4.2% prior; though +4.1% is a 15-month low growth rate, we’d be remiss to join consensus speculation on monetary policy in the context of random 15-month intervals… instead we should focus on the fact that Chinese CPI has been above-target (+4% YoY) every month since SEP ’10; on a MoM basis, CPI accelerated +0.3% in DEC vs. -0.2% prior; sequential gains in CPI are a headwind to monetary easing;
  • PPI: +1.7% YoY in DEC vs. +2.7% prior; a surprisingly coincident indicator for Chinese consumer-price inflation (we would expect it to be a leading indicator, but it is not); and
  • Manufacturing PMI Input Prices: 47.1 in DEC vs. 44.4 prior.

 China, With Context - 2


China, With Context - 3


Policy: Rather than interpret China’s latest batch of data as a leading indicator of what we hope China will do on the policy front (see: sell-side reaction below), we think it’s critical to focus on where China has been and where it wants to go with regards to policy. Before we do that, however, it’s important to highlight the consensus reaction to the latest Chinese economic data:


“Decelerating GDP growth will provide more room for policy makers to shift towards a pro-growth bias after an extended tightening cycle.”

-Jing Ulrich, Chairman of Global Markets for China at JPMorgan Chase & Co.


“Amid a slowdown of both domestic and external economies, the government will continue to roll out stimulus policies.”

-Sylvia Chiu, an economist at SinoPac Financial


“China has a lot of room to adjust policies to simulate growth or address any kind of weaknesses in the economy.”

-K.C. Chan, Hong Kong’s Financial Services Secretary


In that light, we find it critical to remember that Slowing Growth is all part of the plan for Chinese policymakers. Ma Jiantang, Head of China’s Bureau of National Statistics, said it best overnight:


“China is prepared for a slowdown in economic growth and a mild moderation is desirable.”


To that point, we must not forget that the current growth slowdown in China is one that is: a) over two years old; and b) well within the State Council’s stated goals. Since 1Q10, Chinese policymakers have been implementing various measures ranging from property tax trials, to reserve requirement/rate hikes in order to “curb real estate prices”. In light of this, we see no reason for Chinese policymakers to panic and suddenly reverse course on monetary policy.


In fact, slowing rates of Chinese economic growth in order to combat inflation has been their focus for nearly two full years and that is highlighted by their 2011-12 and 5yr outlooks for Chinese real GDP growth (8% in 2011-12; 7% per annum in the latest 5yr plan). For reference, full-year 2011 real GDP growth came in at +9.2% – a full 120bps above the State Council’s target!


The net of it all is that the case for China to ease monetary policy in the near term is not as strong as consensus would have you believe. While we think a reserve requirement cut may be in order to alleviate interbank liquidity ahead of the Lunar New Year holiday (starting 1/23), we don’t see a strong case for a meaningful easing of monetary policy in the near term. While an RRR cut would be in line with Premier Jiabao’s monetary policy “fine-tuning”, the data just does not support consensus speculation for a dramatic reversal in China’s monetary policy stance.


China, With Context - 4


In fact, looking at the day-over-day moves in Chinese 1yr O/S interest rate swaps (+11bps), the data (DEC in particular) is actually more hawkish, on the margin, than dovish. Intuitively, that makes sense, given where the current level of Chinese economic growth fits within the State Council’s strategy and our call for Chinese growth to Slow at a Slower Rate.


Do we expect China to embark on a rate cutting cycle over the intermediate term? Most certainly, given that both market prices and our fundamental models point to a dovish outlook for Chinese monetary policy. That would, however, likely coincide with lower prices across the commodity complex, given that QE2-fueled commodity reflation was one of the primary drivers of hawkish Chinese CPI and PPI readings. For reference, the CRB All-Commodities Index is still up +16.2% since Jackson Hole 2010.


China, With Context - 6


China, With Context - 5


All told, it takes a China bull (’09; late ‘11) and China bear (’10; early ‘11) to know one, and, more importantly, to know where to poke for holes in the consensus bull/bear theses on China. We continue to question the sustainability of Chinese equities/corporate credit working at the same time as commodities.  To the former point, Chinese equities are up +7% from a near 3yr-low on 1/5 and China’s AAA/sovereign spread compressed -27bps last week to an 11-month low of 146bps wide.


China, With Context - 7


To further that point, the two major lessons from the ‘08/09 turn which are a relevant guide for today’s uncertainly are: a) commodities aren’t priced in the vacuum of Chinese demand (the rest of Asia, Europe, and the U.S. matter alongside the USD’s market value); and b) buying commodities ahead of/on the first Chinese rate cut proved to be a bad idea. To that tune, the CRB Index bottomed nearly six months and -41.3% after China’s first rate cut in early SEP ’08.


China, With Context - 8


Additionally, it’s important to understand that gross domestic capital formation is nearly half of Chinese GDP growth, which essentially means that investing in property has been the #1 driver of Chinese economic growth – not exports, consumption, nor government spending. On this front, China has pledged as recently as DEC to “unswervingly implement real estate curbs” in 2012. And as long as China’s property market is under siege, so will Chinese demand for raw materials (for construction, etc.).


China, With Context - 9


On the flip side of this view, Zhang Xiaoqiang, Vice Chairman of China’s National Development and Reform Commission, did say that Chinese policymakers plan to actively expand imports in 2012 via lowering import taxes for some raw materials and energy products. On the margin, finding clever ways of lowering the cost of such imports is bullish for Chinese demand. Moreover, Zhang said the 8-plus percent gain in CNY/USD since its de-pegging in JUN ’10 will “continue for a certain period”. That said, however, getting the timing right regarding an actual reacceleration in Chinese physical demand for raw materials will be of utmost importance here.


As of now, the data is not particularly supportive for China to meaningfully ease monetary policy in the near term. Moreover, inflation expectations need to continue trending down for Chinese assets to keep working and we anticipate that will happen as King Dollar continues to weigh on commodity prices over the intermediate-term TREND.


Darius Dale

Senior Analyst


TRADE: While the new burgers continues to help lift same-store sales trends, the combination of beef inflation and lower long-term guidance limits the current upside going into the company analyst meeting on January 30th. 


TREND:  We are cautious on this duration as rival brands continue to execute on their own remodel strategy.  CEO Emil Brolick has admitted that, while menu innovation is important, the full benefit won’t come through until the asset base is upgraded.


TAIL: We view the return of Emil Brolick as a boost to the long term prospects of the Wendy’s brand.  The company is still 6 months or so away from communicating lessons from the new remodel testing initiative. 


Grub Grade featured a story on the new Wendy’s burger being tested in select markets: a “Black Label” burger available in Bacon Portabella and Spicy Santa Fe varieties.  Here is a link to the article describing the product.


As we see the strategy from WEN unfolding, they want to keep the momentum from the new burger launch going.  The Wendy’s brand is a premium brand competing against the upstart burger chains like Smashburger and Five Guy’s.  Adding a premium burger with a higher price point will help to tier the menu and give customers another premium alternative.


The premium product has been in development prior to the Emil Brolick taking over as CEO but, we understand, the new burger was made a priority.  To us, that speaks to Brolick’s intention to focus on menu innovation to improve the image and broaden the appeal of the Wendy’s brand. 


The company’s first Investor Day since Brolick took over as CEO is scheduled for January 30th.  We believe the overall tone of the meeting will be positive but believe that the bar for EBITDA growth should be set slightly lower.  Additionally, expectations around the breakfast opportunity need to be reset lower also.  There are some difficult headwinds facing Wendy’s in the breakfast day part and we think they will take some time to resolve.




Howard Penney

Managing Director


Rory Green






Monitoring the Battleground States: Advantage Republicans

Conclusion: Given the tightness of national polls it is likely that the 2012 Presidential race occurs in a wider list of battleground states, similar to the 2004 election between Bush and Kerry.  Based on the economic performance of those states, the Republicans currently have a battleground advantage.


As the Presidential election accelerates in 2012, we are going to start closely monitoring the battleground states from an economic perspective to provide insights into the battle for the Presidency.  Battleground, or swing states, are those states in which no candidate, or party, has overwhelming support and thus the states are realistically up for grabs. 


In the electoral-college system, all but two states, Nebraska and Maine, are winner-take-all states.  In Maine and Nebraska, two electoral votes go to the candidate that wins a plurality in the state and then a candidate is allotted one additional electoral vote for each Congressional District in which they receive a plurality.   Maine is considered a Democratic state and has 4 electoral votes and Nebraska is considered a Republican state with 5 electoral votes.


Typically, candidates will limit allocating resources in the states in which they have a limited chance of winning or a very likely chance of winning.  Incremental spending in those states will not help the candidate’s chances of becoming President simply because of the winter-take-all system.  Beyond a simple majority, incremental votes do not help a Presidential candidate.


Professor Joel Bloom, a political scientist from the University of Oregon, has identified three key factors in identifying swing states: the results of previous elections, political party registration numbers, and statewide opinion polls.  For purposes of this analysis, we are going to focus exclusively on the results of previous elections as a gauge for the battleground states in 2012.  As well, given our expectation that the race for Presidency will be close, which is supported by InTrade (Obama is at 51.7%) and most national polls (the generic Republican candidate currently beats Obama), we will use 2004 as the best proxy for battleground states.  In 2004, the Republican candidate won 50.7% of the popular vote versus 48.4% of the popular vote for the Democrat and the states that were decided by margins of 5% are outlined in the table below:


Monitoring the Battleground States: Advantage Republicans - 1


In the table below, we’ve looked at the change in unemployment in these battleground states and also added in Florida, which wasn’t a battleground state in 2004 or 2008, but is likely to emerge as one again in 2012.


Monitoring the Battleground States: Advantage Republicans - 2


As outlined above, based on these key battleground states, unemployment has worsened in seven of them, improved in four of them, and stayed flat in one.  Traditionally, the incumbent gets blamed for the current state of the economy, a point we will touch on in bit more detail, so in this scenario the Republicans have an advantage in seven battleground states.  From an electoral vote perspective, the Democrats have the advantage in states with 54 electoral votes versus 84 for the Republicans.  In a tight national race, 30 electoral votes can obviously be critical when a candidate needs 270 to win.


Professor Bruno Jerome from the University of Paris presented a paper at the American Political Science Association annual meeting in September of 2011 in which he analyzed the impact of state unemployment on state level voting.  Based on his math, which looks at every Presidential election going back to 1952, he concluded the following:


“On average, a 1 point rise in the unemployment rate generates an electoral cost to the incumbent of 0.56% of the votes in a given state.”


Given the tightness of both national and local polls, even a 0.56% shift in the vote based on state level economic factors can be critical in determining the outcome of the election.  In our analysis, this suggests that Wisconsin could go Republican and Pennsylvania narrows to within a percent, so is solidly in play.


Clearly, the economic situation in the battleground states is only one factor in analyzing eventual outcomes for the election, but history suggests a very important factor.  Currently, it is advantage Republicans on this score.


Daryl G. Jones

Director of Research

Early Look

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Bullish TAIL: SP500 Levels, Refreshed

POSITION: Long Consumer Discretionary (XLY), Consumer Staples (XLP), Utilities (XLU) – Short Russell 2000 (IWM)


It’s healthy to see some European and American bank stocks struggle and, at the same time, see the market succeed. It’s about time economies (and their markets) are more about economies that the compensation mechanisms of the few.


Strong/Stable US Dollar = Stronger US Consumption, Confidence, and Employment. It also Deflates The Inflation that strangled Global Growth in 1H of 2011. That’s why I was bearish then and bullish now (from a price). Inflation adjusted growth matters in real-life.


Here are the 3 lines across my risk management model’s durations that currently matter most: 

  1. Immediate-term TRADE overbought = 1302
  2. Immediate-term TRADE support = 1287
  3. Long-term TAIL support = 1267 

While plenty of pundits and their perma-bull theses have changed over the course of the last 12 months, my process has not.


Cheers to a great start to 2012,



Keith R. McCullough
Chief Executive Officer


Bullish TAIL: SP500 Levels, Refreshed - SPX

@HedgeyeRetail #ICR (Updated)

We have updated this note to better accomodate viewing the larger images- there is no change to the content. 


@HedgeyeRetail was active on the twittersphere last week down in South Beach with notable commentary out of company presentations, management breakouts and Hedgeye sitdowns. Here’s a youtube of the team on Twitter throughout the course of the conference.


Of course, these are teasers for the masses. As Hedgeye clients, you get the full depth of our thought on any and all companies. Please ping us accordingly.


In addition to the @HedgeyeRetail Tweets, we have more detailed notes on many of the presentations and breakouts. We’ve also included a link to Brian’s Fast Money appearance on Wednesday afternoon regarding LIZ.


"Is LIZ the Best Retail Trade Today:"







@HedgeyeRetail #ICR (Updated) - TWEET image 6 

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