“We can be blind to the obvious, and we are also blind to our blindness.”
That’s one of what I expect to be many solid risk management quotes from the book I am currently reviewing, “Thinking, Fast and Slow” by behavioral psychologist/economist Daniel Kahneman (page 24).
Are we blind to the obvious? Are we blind to our own blindness? I think we should probably ask ourselves that question both as individuals and as leaders in our society each and every day.
Last night, Daryl Jones, David Bergerson, and I hosted a dinner with 10 Portfolio Managers in mid-town Manhattan. This wasn’t an “idea dinner” like the ones the Old Wall still tries to host where people push their books. This was a legitimate Global Macro debate.
Fully loaded with the political discussion (which even if you’re not political actually has to be had – which is sad, I know), after 3 hours I concluded that we are all Playing Blind to what could ultimately happen out there each and every day.
Iran, Europe, Qe3? Romney, China, Gold? Growth, Earnings, Levels?
It’s all out there. It’s all interconnected. And the only way to even begin to attempt to absorb it all is to have a repeatable risk management process that’s Multi-Factor and Multi-Duration. Embrace Uncertainty.
Back to the Global Macro Grind…
What I didn’t expect this morning was waking up to another central planning rumor.
These central planners, like most Keynesians, fundamentally believe that they can temporarily arrest gravity. When their plans don’t work, they just make it a bigger plan.
How about a trillion?
That’s the IMF “rumor” this morning. Never mind contextualizing what a trillion dollars actually is or that any IMF sponsored trillion dollar package is implicitly backstopped by the United States of America’s tax payers – just think about it some more – think fast and slow - and watch the S&P futures whip around on this while you attempt to remain sane.
What are markets doing on that?
(hint, they are going up)
What do you do with that?
- You stay out of the way on the short EUR/USD position until it re-tests $1.31 (immediate-term TRADE resistance)
- You stay out of the way on the short German DAX position until it re-tests 6502 (long-term TAIL resistance)
- Your stay away from economists at the World Bank (another Washington based beauty) and their estimates
That 3rdpoint is more of a transition sentence to what is a Top 3 Most Read on Bloomberg today (next to Jerry Yang and Carnival Cruise lines): “World Bank Cuts Global Growth Estimates.” Gee, thanks for coming out guys.
Talk about the blind leading the blind – after looking for +3-4% US Growth (depending on when you asked them for a US GDP Growth estimate last year), the World Bank is cutting their US Growth estimate from 2.9% to 2.2% this morning.
At the same time, we’re taking our US Growth estimates up…
Rather than Playing Blind from a Growth and Inflation modeling perspective, we actually have our own models that actually work. They don’t work all of the time. But they worked in calling both turns - in both Growth and Inflation - in both 2008 and 2011.
The same models that had us turn bullish (versus consensus expectations) on Growth in early 2009, have us getting bullish, on the margin, on Growth in 2012.
- US Dollar Strength = Deflates The Inflation
- Deflating The Inflation = higher real (adjusted for inflation) Growth
I’m often blind to my own blindness. But I’m not blind to what our models are telling me. Rather than debate the obvious implied by a broken consensus source code, I’ll just call building a Washington Consensus out for what it is – it’s what group-thinkers do.
My immediate-term support and resistance ranges for Gold, Oil (Brent), EUR/USD, US Dollar Index, and the SP500 are now $1, $110.10-$112.17, $1.26-1.29, $80.24-81.77, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Credit Trends Improve in December
December monthly credit data released today showed ongoing credit quality improvement among the six big issuers. The average issuer saw delinquencies improve 11 bp in December, with 4 of the 6 issuers saw delinquencies decline by 10 basis points or more. Citigroup saw the largest sequential decrease in its delinquency rate, falling 17 bp to 3.11% On a 4Q vs. 3Q basis, all issuers improved except for Capital One, which posted a 2 bp increase in delinquencies. On the net charge-off front, the average issuer showed 21 bp of improvement in December with the 4Q vs 3Q improvement coming in at 35 bps, on average. Capital One was the only issuer to have net charge offs rise in 4Q vs. 3Q (by 15 bps).
The improvement in credit quality for the month of December is attributable to two factors. First, there was a significant denominator effect this quarter, the first in a long time. Second, the economy is providing a tailwind as jobless claims have been improving throughout 4Q11. Both of these factors could persist over the intermediate term.
The charts below show our macro team's quantitative levels for the six major issuers.
Joshua Steiner, CFA
Having trouble viewing the charts in this email? Please click the link at the bottom of the note to view in your browser.
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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.
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.
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.
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.
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.
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.
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.).
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.
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.
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:
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.
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
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