“We must remember that economists are not necessarily the creatures of great thought but of circumstance.”
-John Kenneth Galbraith
As the Overlords of Keynesian Economics descend from their chalets in Davos, Switzerland this week, we must all give thanks and praise. Without doing the exact opposite of their consensus in the last 4 years, who knows what precipice we commoners would have fallen from…
Not surprisingly, Crisis-Mongering has become fashionable on Amazon. Looking at the Top 20 new hard-cover books on policy, economics, and markets, a lot of them are about debt and deficits. After all, what better time to buy Gold than after it’s gone up for 11 straight years? Right? Right.
This weekend I started reading “That Used To Be Us” by the New York Times’ Thomas Friedman and his buddy professor from John’s Hopkins University, Michael Mandelbaum. Sorry guys, but this is about as consensus as consensus gets.
The book’s preface, like most Big Government Interventionist ideas that start using the rear-view mirror, assumes the position of elephantine intellects who have found the elixir of American optimism. In reality, they are just one small part of the larger problem.
“We now live and work in the nation’s capital, where we have seen first-hand the government’s failure to come to terms with the major challenges the country faces.” –Thomas L. Friedman and Michael Mandelbaum, Bethesda, Maryland, June 2011
Really? Thanks guys. I’ve seen it first-hand without living in the nation’s capital! Telling me about your personal inconveniences commuting from Bethesda, Maryland to the epicenter of Keynesian Experimentations Failed is a much larger problem of pretense than the one you individually have to stare at each and every morning in the mirror.
We need less people with opinions born out of Washington groupthink; less Crisis-Mongering; and less commuting to get paid by DC. That’s the change I can believe in. Please, for the sake of all of us, just get out of the way.
Back to the Global Macro Grind…
Getting out of the market’s way has proven to be a great strategy for both the US and German government. While the Germans have been more explicit about their distaste for bank bailouts, American central planners haven’t been able to do much for the last 3 months. Evidently, doing nothing works.
Doing nothing probably won’t get American booksellers paid, but it’s getting the commoners paid:
- Chinese, German, and American stock markets are at 3 month highs
- Counter-party global banking risks (Euribor/OIS Spread, TED Spread, Yield Spread, etc.) are all at their best levels in 3 months
- US Growth, Employment, and Confidence readings are hitting 3-month highs
So what can they do to screw this all up this week?
- State of the Union or Republican Debate #26 (Monday-Tuesday)?
- The US Federal Reserve’s Open Market Committee meeting/decision (Wednesday)?
- Davos, Switzerland Meeting of the Crisis-Mongering minds (all week)?
What screwed this up around this time last year?
- Policies to Inflate brought us $120/oil by Q211
- Growth Slowing became reality as inflation accelerated and debt levels compounded
- Employment and Confidence followed to the downside
After seeing Global Growth slow in both 2008 and 2011, we really, really, do not want to go there again. Markets love the idea of getting Government out of the way. This is the first January since 2003 that the US Treasury market has sold off like this.
Nine years ago (2003) is a critical reference point because that came after 3 consecutive down years for US stocks (2000, 2001, and 2002), a terrorist attack on US soil, and fear-mongering from Congress like we had never seen.
Why are US Treasuries selling off as US Equity Volatility crashes (VIX down -22% YTD) and US Stocks refuse to stop going up? Because Growth Expectations are starting to recover from Crisis-Mongering lows.
Giants vs Patriots – it’s time for us all to cheer for the progressive message in this country that’s always been Red, White, and Blue.
My immediate-term support and resistance ranges for Gold, Oil (Brent), EUR/USD, US Dollar Index, and the SP500 are now $1, $109.12-111.92, $1.26-1.30, $80.01-80.86, and 1, respectively.
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
This note was originally published January 20, 2012 at 12:45 in Energy
We look to Schlumberger (SLB) as a bellwether for the oil services industry. From the Company’s 4Q11 results, and more importantly the management team’s commentary and outlook, we have more confidence in our bearish thesis on North American land-focused energy services companies. Further, we feel that the service companies with the most leverage to the rebound in deepwater drilling, as well as the nascent international shale drilling market, will be the outperformers in 2012.
Weatherford International (WFT) is heavily exposed to the North American land services market. According to the 4Q10 segment breakdown, 48% of WFT’s revenue and 66% of its operating income comes from its North America business, which makes a soft North American services market a major headwind. Further, WFT is not a major player in deepwater or an early mover in international shale exploration, which will be the pockets of strength in 2012. Given, we like WFT on the short side. If you are looking to pair it off, go with long SLB. We shorted WFT this morning in our Virtual Portfolio at $16.68.
Other reasons we like WFT on the short side are as follows:
- Slower top line growth in 2012 as company compares against increasingly difficult 2011 numbers (chart 1);
- Margins peaking and contracting (chart 2);
- North American land drilling activity slowing (chart 3);
- North American land pricing slowing (chart 4);
- The stock is 26% off its December 2011 low and is bumping up against our TRADE line resistance of $16.76. The long-term TAIL line is broken, $18.13 (chart 5).
SLB confirmed our fundamental view on the services industry in North America – that gives us incremental confidence in our short WFT thesis. BHI and HAL report earnings early next week – we see no reason for those companies to say much different.
Here are some callouts from the SLB call along with quotes from the management team:
Land activity in North America is flat and likely falling due to crashing natural gas prices. Pricing – pressure pumping, drilling, and completions – is slowing. As a result, sell side estimates are too high for 1Q12 in their assumption of 26% y-o-y revenue growth and too high for the full-year barring a recovery in the natural gas market:
“The current consensus is probably somewhat on the optimistic side or on the high side [for 1Q12]. Just a comment on how we see the quarter from this point. I think the underlying activity continues to be strong and it's driven by steady growth in the international markets and also strong activity in North America shale liquids. Like you say, we are going to see the normal seasonal slowdown in the North Sea and Russia. And I think also the sequential drop in product sales and multi-client sales. I think also there is some added uncertainty going into Q1 now in terms of the impact of the accelerating drop in North America shale gas activity. So generally I would say that the current consensus is somewhat on the optimistic.”
“In North America, land revenue grew in line with rig count while margins increased moderately driven in part by internal efficiencies and active cost management. Pricing in our wireline and drilling product lines continue to show an upward trend although slowing somewhat compared to previous quarters. In pressure pumping downward pricing pressure in the gas basins continued in the fourth quarter. Pricing in liquids-rich basins remained more or less flat excluding the impact of continued conversion to 24-hour operations.”
“In North America, we expect land rig count to remain flat with Q4 2011, combined provided the ongoing drop in gas activity will be countered by increasing activity in the liquids and liquids rich basins.”
“Well, if you look at pressure pumping pricing, as I said, we continue to see downward pressure on pricing in gas [basins] in Q4. The liquids basins we saw pricing basically being flat, some contracts being up in some context been down.”
The deepwater recovery – particularly in the GoM and off both coasts of Africa – is fully underway and will be a tailwind for the deepwater servicers in 2012:
“ This quarter I think was the first quarter where our Gulf of Mexico margins were accretive to North America.”
“We're quite optimistic in terms of the outlook for the Gulf of Mexico. Firstly in terms of our market share position and in terms of how well we can leverage our high-end technology and operational performance in this type of market. So we see steady growth in deepwater drilling rig counts during 2012, roughly about a rig a month so we would be at pre-Macondo levels for drilling rigs in the Deepwater by the latter part of 2012.”
We are in the early stages of E&P in international shale plays. That activity will continue to trend higher over 2012 and 2013; SLB and HAL are the early movers:
“We won a lot of contracts in the international market requiring fracturing capacity. So in the event that we have the opportunity or basically decide to shift capacity internationally, I think that will be welcomed by our international operations.”
“I think that international capacity is obviously one driver that's going to support pricing going forward because we don't see significant overcapacity in the international market.”
“We won a number of these contracts in all parts of the world and I would say that the increase in activity for us in international unconventionals over this year and going into next year is probably somewhat higher than where I thought it would be going back two or three quarters. So we expect to see strong growth in all the international shale plays for us in 2012. The work is still going to be around evaluation and pilot projects in general but I mean it's still going to represent very good growth for us and I think the two markets that are going to take of the fastest, I would say would be Argentina and China.”
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In preparation for IGT's FQ1 2012 earnings release Tuesday morning, we’ve put together the recent pertinent forward looking company commentary.
International Game Technology to Acquire Social Gaming Company Double Down Interactive (01/12/2012)
- IGT reached an agreement to acquire DoubleDown Casino for "$250MM in cash, $85MM in retention payments over the next 2 years and up to $165MM million in cash payable over the next 3 years subject to Double Down meeting certain financial performance targets. IGT expects to fund the transaction from cash on hand."
- "The transaction is estimated to be accretive to IGT's fiscal 2012 adjusted earnings and is projected to close within the second quarter of its current fiscal year.”
DOUBLE DOWN ACQUISITION: please see our conference call notes on 01/13/2012
IGT INVESTOR DAY: please see our conference call notes on 12/07/2011
Post Earnings Conferences: BMO Capital Markets Digital Entertainment Conference
- “So, with the acquisition of Entraction, we're now have set ourselves back from an ROI perspective appropriately and are on a three-year march with that acquisition. So, acquiring it in 2011, it will really probably be 2014, mid-fiscal '14 for us before we see that move into an ROI positive space when you think about on an isolated basis.”
- “One of the interesting reasons that we acquired Entraction that we continue to invest in our interactive business, is it is a huge defensive move for our core business, because this connected player concept where our casino operators want to embed online experiences so that their players can leave the casino and continue to gather points and continue to experience their brand and their world and come back.”
- “The interesting thing about the interactive business is that at the product margin level, it's a bit lower than my core business; but at the operating margin level it's actually much higher because it's not as capital intensive as the core business is. So we actually think that this is kind of a win-win opportunity because it's an opportunity to bolt on business to IGT, but do it without eroding operating margins. You'll probably see a bit of drag on product margins actually, because of the need for expanded quantities in content and the iterative process has to be much faster than our current iterative process is. So, the R&D spending is there. But when you get down to operating margins, you actually see it pick up because we don't have the D&A drag from capital that's associated with that business.”
- “Openings in '12 are going to look about like openings in '11 looked actually, so not a significant pick-up in new casino openings.”
- “The big move for us in revenue in the year will be in the interactive space, we'll grow in the interactive space in double-digits, and we have to take share outside the United States. Really continuing to rely on United States to fuel the growth of IGT is in the past, and we really have to be in markets that we haven't been in. And in the markets we've been in, the United States we really enjoy about 50% of the floor share; outside the United States, we're in the mid-teens, so we need to pick that up outside the United States.
- [International market share to “north of 20%”] “It probably takes us into '13, but we see it in '12.”
- “It's not likely that you go back to replacement cycles that are in single-digits, right? There was at one time a five- to seven-year replacement cycle, now, we're probably out to 16 years, that's not reasonable either. But, it probably settles in around 10-year replacement cycles; which is reasonable if you're building hardware that is good, solid, stable hardware."
YOUTUBE FROM FQ4 2011 CONFERENCE CALL
- “Given our return-oriented discipline, we expect our research and development investment to remain constant at about $200 million in 2012.”
- “The response we received from G2E exceeded our expectations. We received initial orders for over 2,000 G23 machines, from customers located all over the globe during our three days of the show.”
- “For fiscal year 2012, we would like to offer adjusted earnings guidance from continuing operations of $0.93 to $1.03 per share. This guidance assumes a 37% tax rate and a share repurchase program consistent with the last two quarters.”
- “When you think about the low end of the  guidance, it really thinks about fiscal '12 looking similar to fiscal '11 from a replacement perspective, a bit of an uptick in the install base for gaming and operations and a bit of an uptick in yields on that base, but nothing for Canada, Illinois or Ohio DLTs, the DLT portion of Ohio. So we're not counting on any of that coming in, in the year. We think that's upside to the plan but it's in not in the low end. The high end assumes that the replacements uptick a bit and install base and yields but still no Canada, Illinois or Ohio.”
- [2012 share] “I think we think about share kind of in the high 30s for us on replacement basis, closer to 50 on new openings.”
- [Entraction] “We don't anticipate that near term it's going be all that significant of a contributor. But in the same respect, it should not be a drag on the business.”
- [2012 Capex guidance] “I think it's going be very similar to what you saw in this current fiscal year…. we should be able to control within a relatively tight range this year, about $190 million this year.”
- “We have those converts coming due in 2014. And so we probably will accumulate some amount of cash on the balance sheet just so our friends the bankers don't get too concerned that we're going to use the credit facility as the sole source of repayment.”
- “We continue to think about total OpEx [including bad debt and R&D and SG&A] as a percent of revenues being in that 31% to 33% range.”
- “The fixed portion of OpEx should be pretty flat, given the guidance range we've laid out. So the things that will float will be the variable components, compensation being the biggest.”
- “The Asian market isn't at the highest margins that you would like to see always but we do expect to pick up a bit of share, probably not picking up as much share in Europe yet. In the Asian markets where we're rolling out Asian-themed games and we've been very focused on that market. Europe is running a bit behind so I would say not expecting to pick up significant share in Europe in '12.”
- “Our [international] ASPs were up about 4% or so from the prior year quarter and about 2% or so from the sequential quarter. It has been floating in that same range for quite some time, right. It floats within $1,000, $1,500 one way or the other. So not swinging wildly. We've made an assumption on ASPs in international that they hold flat about to be about the fiscal year average that we had in 2011 focused more on market share, recapture and market share gains than pure pricing increases.”
- [Domestic replacements] “So if you think about the 16,000 number-ish, it's probably more realistic going forward.”
- “I think you're going to continue to see international outpace domestic. Just given the number of opportunities that we see internationally, given that our game ops business is a relatively new business, for all intents and purposes, outside of North America. And within the North American market becoming quite mature and obviously quite competitive, it's all about maintaining the best games, too.”
- [Aqueduct share] “It was about 36%, 37% in each phase.”
- “We have about 6,500 to 7,000 games that are there [Mexico] on reoccurring basis. Currently we don't see any receivable exposure but that might change."
- “We did ship both Kansas. One of them had some deferred revenue given that it has a Tier 1 sbX associated with it. So that component and the units associated with it would have been deferred into probably Q1 or whenever the property goes live.”
Conclusion: Both Chinese and Indian equities look to test critical levels of resistance (TREND) in the coming trading days. India, in particular, will be in the spotlight next week amid various regional equity market closures. While we are long one and short the other, the data is starting to suggest both markets are potentially due for a breakout.
Virtual Portfolio Positions in Asia: Long Chinese equities (CAF); Short Indian equities (INP).
All % moves week-over-week unless otherwise specified.
- EQUITIES Median: +2.1%; High: Vietnam +5.3%; Low: Malaysia flat; Callout: India +10.3% over the past month
- FX (vs. USD) Median: +1.1%; High: Indonesian rupiah +2.6%; Low: Chinese yuan -0.2%; Indian rupee +5.6% YTD
- S/T SOVEREIGN DEBT (2YR) High: Malaysia +2bps; Low: Indonesia -47bps; Callout: Indonesia -42bps YTD
- L/T SOVEREIGN DEBT (10YR) High: Japan +4bps; Low: Indonesia -57bps; Callout: Hong Kong +19bps over the past two months
- SOVEREIGN YIELD SPREADS High: Philippines +27bps; Low: Indonesia -10bps; Callout: Hong Kong +17bps wider over the past two months vs. a regional median of -6bps
- 5YR CDS High: New Zealand -3.3%/-3bps; Low: Indonesia -6%/-13bps; Callout: Japan +17%/+20bps over the past two months vs. a regional median of -7.1%
- 1YR O/S INTEREST RATE SWAPS High: India +17bps; Low: Indonesia -25bps; Callout: China -25.2% narrower over the past six months to a price of -45bps below the PBOC’s 1yr Household Deposit Rate
- O/N INTERBANK RATES High: Australia +7bps; Low: China -116bps; Callout: China -39.1% tighter over the LTM, which is bullish, on the margin for YoY credit growth in the face of the PBOC’s continued “selective easing” measures
- CORRELATION RISK Growth expectations are a key driver of recent strength in Asian equities; the MSCI All-Country Asia Index is +92% correlated to the CRB Raw Industrials Index on a six-week basis
Full price and performance tables can be found at the conclusion of this note.
CHARTS OF THE WEEK
Inflation in India slowed well-beyond our most aggressive estimates, which forced us to reevaluate and re-weight the probabilities in our scenario analysis. The RBI’s +6-7% MAR ’11 target is definitely now in-play, which now takes them out of the “box” and gives them headroom to ease monetary policy.
A breakout in the SENSEX above its TREND line would be an explicit signal that our bearish bias on Indian equities was too long in the tooth (initiated 11/9/10).
While China’s stock market is closed all of next week, we look to the following week as an important week for economic data (PMIs released), which may bring forth a test of China’s TREND line of resistance. A breakout above would only increase our conviction in being long of Chinese equities.
On Tuesday, we published an in-depth update on China’s growth/inflation/policy outlook. The comments below pick up where that analysis left off. As always, we aim to be concise with our remarks; please email us if you’d like to follow up in more detail.
Growth Slowing’s Bottom:
- China: According to insiders, the PBOC will allow the 5 largest banks to increase lending by about +5% YoY in 1Q12 (which would be up from -13.2% YoY in 1Q11). Additionally, the regulator will delay the implementation of tighter capital standards and may also lower the risk-weighting of SME loans. That latter maneuver could potentially alleviate the SME credit crunch on the margin as banks become incentivized to hold more of those assets. Additional signs of such “policy fine-tuning” were demonstrated this week when the PBOC lowered RRR in the Guizhou province.
- China: HSBC Flash PMI accelerated slightly in DEC to 48.8 vs. 48.7 prior… slowing at a slower rate.
- Japan: Consumer Confidence ticked up marginally in DEC to 38.9 vs. 38.1 prior.
- Singapore: Non-Oil Domestic Exports growth accelerated in DEC to +9% YoY vs. +1.4% prior. Alongside Hong Kong, the manufacturing and trade data out of Singapore remains a key leading indicator for global growth.
- Thailand: Exports accelerated in DEC to -2% YoY vs. -12.4% prior.
- Australia: Westpac’s Consumer Confidence Index ticked up in JAN to 97.1 vs. 94.7 prior.
- New Zealand: ANZ’s Consumer Confidence Index ticked up in JAN to 116.1 vs. 108.4 prior.
Deflating the Inflation:
- India: In a shock to our bearish intermediate-term thesis on India, WPI slowed dramatically in DEC to +7.5% YoY vs. +9.1% prior. This reading is 80bps below the most aggressive scenario in our models and forced to reevaluate and re-weight the probabilities in our scenario analysis. The RBI’s +6-7% MAR ’11 target is definitely now in-play, which now takes them out of the “box” and gives them headroom to ease monetary policy. Expect the RBI to communicate such in next Tuesday’s monetary policy announcement. Should the RBI pander to dovish policy speculation, we would expect to see the SENSEX break out above its TREND line – an explicit signal that our bearish bias on Indian equities was too long in the tooth (initiated 11/9/10). We maintain our bearish bias on the rupee and view the recent trend of appreciation on the strength of record-setting international fixed-income flows as an eventual short-selling opportunity.
- Japan: PPI slowed in DEC to +1.3% YoY vs. +1.6% prior.
- New Zealand: CPI slowed in 4Q to +1.8% QoQ vs. +4.6% prior.
- Malaysia: CPI slowed in DEC to +3% YoY vs. +3.3% prior.
- China: We continue to see signs of capital creeping out of China on a diminished outlook for yuan appreciation, as Foreign Direct Investment growth slowed in DEC to -12.7% YoY vs. -9.8% prior. Interestingly, Chinese Premier Wen Jiabao has pledged to prevent capital from leaving the country due to speculative activity. One of the ways we believe his regime will attempt to achieve this goal is by funneling foreign investors into China’s equity market. In DEC, the China Securities Regulatory Commission granted 14 new QFII licenses – dramatically higher than the typical 1-4 per month pace we’ve seen since the start of the program.
- Philippines: Bangko Sentral ng Pilipinas lowered the country’s Benchmark Interest Rate -25bps to 4.25%. Speculation around their easing has been particularly bullish for the PSEI (up +5.3% over the last six months vs. median -8.9% loss throughout Asia) and we’re seeing all-time high international inflows in to Filipino equities ($1.1B over the past two months alone). We remain bullish on this asset class over the intermediate term. Refer to our 8/31 note titled: “Philippines: One of the Better Stories in Global Macro” for more details.
- Taiwan: Taiwanese growth continued on its established trend down in DEC. Both Industrial Production and Export Orders growth slowed to -8.2% YoY (vs. -4.7% prior) and -0.7% YoY (vs. +2.5% prior), respectively.
- South Korea: This week brought forth hawkish commentary, on the margin, out of the Bank of Korea. Per Governor Kim Shoong Soo: “Interest rates are still below policy makers’ desired level and that discrepancy cannot be left for long. We still think our monetary policy is accommodative; by that what I mean is that in the market there still exists a little excess liquidity. Our basic policy direction is to normalize our interest rates compatible with our demand pressures and pressures for inflation.” The muted wk/wk impact in the bond and interest rate markets suggests this view was already priced in.
- Australia: The Aussies reported some fairly hot (on the margin) inflation data this week: TD Securities Unofficial CPI accelerated in DEC to +2.4% YoY vs. +2.1% prior; the RBA’s Consumer Inflation Expectation Survey accelerated in DEC to +2.8% YoY vs. +2.4% prior; Import Prices accelerated in 4Q to +2.5% QoQ vs. flat prior. Our models still see Aussie inflation slowing over the intermediate term, but the obvious impact of 1Q11 natural disasters should boost growth statistics in the near-term and may limit the urgency to pursue dovish monetary policy out of Glenn Stevens and Co., which is bullish (on the margin) for the Aussie dollar. Increased bullish sentiment towards China is also supportive of the AUD as well.
- China: Home prices posted their worst performance of the year in DEC, with only two of the 70 cities posting MoM gains. Further, China’s Real Estate Climate Index ended 2011 at a 29-month low of 98.9 (-4.2% YoY). The other key real estate metrics we track (Commercial & Residential Floor Space Started, Land Area Purchased, Source of Funds for Real Estate Investing) are all at/near 2-3yr lows. We believe China’s property market will remain under official assault by policymakers; that will continue to act as a governor on Chinese (and global) growth.
- Japan: The Bank of Japan will delay by 2yrs a plan to divest its equity stakes in Japanese financial institutions (acquired in 2002 amid systematic deleveraging and capital raises). Originally scheduled for MAR ‘12, this is negative for the yen on the margin, as it maintains the size of the BOJ’s bloated balance sheet relative to expectations.
- Hong Kong: Both CPI and the Unemployment Rate were unchanged in DEC at 5.7% YoY and 3.3%, respectively.
- Australia: In 2011, the Aussies saw the slowest yearly employment growth since 1992 – a shock to the RBA’s baseline model that investment in energy and mining production will fuel labor market tightness over the long-term. In DEC, payrolls growth slowd to -29.3k MoM vs. -7.5k prior; the Unemployment Rate held flat at 5.2% as the Labor Force Participation Rate ticked down -30bps to 65.2%.
- Taiwan: Ma Ying-jeou won a second 4yr term as president of Taiwan in last Sunday’s election – a clear voter referendum for increased cross-border trade and investment flows with the mainland.
THE WEEK AHEAD
Key economic data releases and policy announcements:
- THIS WEEKEND: Australian PPI;
- MON: Reserve Bank of India Quarterly Economic Report
- TUES: Bank of Japan Monetary Policy Announcement; Japanese Trade Data; Reserve Bank of India Monetary Policy Announcement; Australian CPI
- WED: South Korean GDP; Singaporean CPI; Bank of Thailand Monetary Policy Announcement; Reserve Bank of New Zealand Monetary Policy Announcement
- THURS: Japanese CPI and Retail Sales; Hong Kong Trade Data; South Korean Business Surveys and Consumer Confidence; Singaporean Industrial Production
- FRI: Thai Industrial Production
- OTHER: The Lunar New Year will see various closures of Asian equity markets: China and Taiwan are closed all week; Hong Kong is closed Mon-Wed; South Korea is closed Mon-Tues; and Australia is closed Thursday for Australia Day.
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