Conclusion: Policies designed to inflate are particularly bearish for emerging market economies like India. While the short thesis may be changing, our outlook for Indian equities remains lower over the intermediate term.
Position: Short Indian equities (INP)
Late yesterday, Keith used strength in the iPath MSCI India ETN to re-short Indian equities in our Virtual Portfolio. Since JAN 9, been caught on the wrong side of one of the largest short-squeezes across Asian equity and currency markets in the YTD (SENSEX +10.9%; INR/USD +5.8%).
Since that initial position (partially a hedge against being naked long of Chinese equities), the fundamental outlook for the Indian economy has changed direction not once, but twice. Recall that in our 1/9 note titled “Awful Fundamentals: Our Updated Thoughts on Indian and Shorting INP Trade Update”, we thought Indian monetary and fiscal policy – particularly on a relative basis to its EM peers – would remain a headwind to India’s equity market multiple and fund flows.
Specifically, we thought that inflation would not slow substantially enough relative to policymakers’ expectations to warrant a major inflection point in monetary policy, which would, in turn exacerbate India’s already-woeful debt/deficit dynamics by allowing growth to slow further.
Inflation did, however, come in far, far more dovish (in DEC) than even our most aggressive downside scenario, which dramatically pulled-forward India’s scope for monetary easing, as evidenced by the RBI’s -50bps cut to the cash reserve ratio two days ago. The prospect of further easing has been quite positive for both India’s equity and fixed-income net foreign inflows, which is the largest factor supporting rupee strength in recent weeks (equities: +306.7% YoY in the YTD; fixed income: a record +$3.9B in DEC).
Looking forward, we can glean from recent data that our long-held view that policies designed to deflate the market value of the world’s reserve currency are implicitly policies to inflate assets priced in dollars – which certainly include energy and agricultural resources, the prices of which carry large weightings in EM inflation indices.
That’s negative for Indian (and other EM) growth, particularly if today’s trading pattern (dollar DOWN; commodities UP) develops into a sustained trend. Recall that this emerging Growth Slows as Inflation Accelerates theme was exactly the same thesis that had us make the contrarian call to get aggressively bearish on emerging markets (particularly India and Brazil) in 4Q10 and hold that conviction largely through 3Q11.
Quite ironically, as EM growth slowed throughout 2011, Chairman Bernanke repeatedly attributed the sudden and dramatic ascent of commodity prices largely to “rapid emerging market demand”.
While we aren’t sure what to make of that, we are sure that we aren’t afraid to pull out the ol’ bearish playbook if the quantitative signals tell us to. For now we’ll continue to manage the immediate-term risk of Big Government Intervention.
Thinking Through the Implications of Where We Are on Jobless Claims
The headline initial claims number rose 25k WoW to 377k (up 21k after a 4k upward revision to last week’s data). Rolling claims fell 2.5k to 378k. On a non-seasonally-adjusted basis, reported claims fell 113k WoW to 414k.
Claims have been making solid progress YTD in spite of what is a seasonal-adjustment headwind tracing to the 2008/2009 move. This suggests that once we move beyond the early months of 2012, we could see claims continue to move lower as that seasonal-adjustment headwind changes to tailwind. This should happen around the end of February. It's also important to understand the ramifications of what's happening. We've noted in the past that 375-400k on initial jobless claims is a Rubicon of sorts. As you cross below that threshold, the unemployment rate starts to show steady, ongoing improvement. Why does the unemployment rate matter when it is (a) a lagging indicator and (b) a made up number (i.e. labor force participation rates)? We think it matters to the average American as a sign of confidence in the economy. If Americans hear that the unemployment rate is falling, month in, month out, we think that resonates in greater confidence. All this puts the economy on a virtuous path. Remember that the economy is very autocorrelated, so once you get the jobs engine below the 375-400k level on claims the economy will gain a level of momentum on its own. This is what seems like a growing probability at this point, based on the trend in jobless claims.
If there's a wrinkle, it's that our Macro team has, just this morning, reversed its call on the US dollar from bullish to bearish. The thinking had been that the dollar was poised to rise as the strengthening economy alleviated the need for further monetary or fiscal stimulus. However, in light of the FOMC decision to extend zero rates through YE14 and President Obama's State of the Union Address, their view has shifted towards bearish dollar. On the margin, this is negative to our call and thoughts around jobless claims, as a weak dollar stokes inflation at the pump and the grocery store, among other places - effectively, a tax on the middle class and the poor. Beyond this, there is clearly new pressure placed at the long end of the yield curve, an additional negative for the sector. It's a balancing act weighing the prospects of job improvement against the tax created by weak dollar-induced inflation.
Another thing we are calling out is the large divergence between jobless claims and the market has narrowed considerably in recent weeks with the straight-up move in the market, and today the implications of full mean reversion are a much more modest S&P index level around ~1370. Alternatively, claims would need to rise to ~397k to meet the market where the market is. Neither of these are excessively removed from where they are relative to the magnitude of the dislocation we saw roughly a month ago.
The 2-10 spread widened 10 bps versus last week to 178 bps as of yesterday. The ten-year bond yield increased 10 bps to 200 bps.
Financial Subsector Performance
The table below shows the stock performance of each Financial subsector over four durations.
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Jobless Claims came in at 377k versus 370k consensus and a revised 356k for the week prior (revised from 352k).
We called this out in our Commodity Chartbook last night but it’s worth noting again that the U.S. cattle herd is expected to show a 1.4% drop in cattle numbers from a year ago. Cattle prices could be given another boost by this data point when it is released.
Comments from CEO Keith McCullough
You can take everything I have been bullish about (Global Equities) for 6 wks and turn it as upside down as Bernanke’s policy to inflate is:
- US DOLLAR – with the back-to-back US Dollar Debauchery statements from Obama and Bernanke, the US Dollar has broken its immediate-term TRADE line of support; now the question is will it hold its $78.03 intermediate-term TREND line of support (EUR/USD TREND resist = 1.34)? Last night when I was on Kudlow, Romney said he’d fire Bernanke – I would too. Enter the debate.
- INFLATION – Bernanke fans can say whatever they want; bottom line is that market prices don’t lie; Keynesians do – Bernanke telling savers 0% is their rate-of-return until he gets fired has created an absolute 24hr meltup in both Inflation Expectations (TIPS) + Commodity Inflation –Copper and Gold just went vertical to $3.90/lb and $1720/oz en route to test bubble highs?
- 91% CASH – I obviously had very little patience for Qe2’s policy to inflate and got very bearish on this Feb-Apr of 2011 because INFLATION SLOWS GROWTH. If oil, copper, and cattle prices keep ripping like this, there is a very high probability that all of Global Growth slows, sequentially, in late JAN early FEB. Not good.
As these policies change, I have. My process has not. Before I retire, I can only hope we have a Fed that changes as the data does.
SBUX: Starbucks reports after the close today. The company needs to put up a 10% comp in the USA and 8% internationally to keep two year trends flat sequentially from 4QFY11. With McDonald’s reporting a 9.8% and weather helping, it’s not out of the realm of possibility. As we said in our MCD note the phrase “expectations are the root of all heartache” comes to mind. It’s hard to see that SBUX is going to put up numbers that are going to beat already bullish same-store sales numbers. Due to higher coffee costs and margin pressure on the CPG business, the Street is expecting 8% EPS growth on 12% revenue growth.
NOTABLE PERFORMANCE ON ACCELERATING VOLUME:
DNKN: Reporting EPS on Monday
CBOU: On the BofA M&A list for 2012
COSI: Hearing positive things about the new CEO
AFCE: Reported strong 4Q performance after the close
OTHER QSR NEWS
Better-burger segment player Smashburger Wednesday said it grew its restaurant base by 55 percent and entered 12 new markets in 2011 to end the year with 143 locations. The Denver-based chain, which is owned by Consumer Capital Partners, said its 51 new restaurants and a 3-percent increase in same-store sales at existing locations pushed annual systemwide sales to $115.7 million. - NRN
NOTABLE PERFORMANCE ON ACCELERATING VOLUME:
BWLD: Somebody does not agree with me
EAT: Recovered nicely from Tuesday’s sales miss
The Macau Metro Monitor, January 26, 2012
SHERATON MACAU TO OPEN SEPT 15 Macau Business
Sheraton Macau, at Sands Cotai Central, will open September 15. The hotel’s twin towers will feature 4,000 guestrooms, several restaurants and lounges, around 5,000 square meters of meeting space, as well as health clubs and outdoor swimming pools.
JAPAN'S UNIVERSAL ENTERTAINMENT EYES PARTNER FOR $2BN MANILA PROJECT Reuters
According to its Chairman, Kazuo Okada, Japanese arcade-game maker Universal Entertainment Corp is in talks to get a local partner for its $2BN gaming and entertainment complex in Manila set to be completed in 2014. The local partner would operate the shopping establishments outside the main casino-hotel projects set to rise on a 45-hectare site along Manila Bay, said Okada. The Philippines project has caused friction between Okada and Wynn Resorts, with the company objecting to Okada competing with it.
Cristino Naguiat, chairman of PAGCOR (Philippine Amusement and Gaming Corporation), said MPEL had initially expressed interest in the Philippine gaming business.
This note was originally published at 8am on January 23, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“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 $1646-1676, $109.12-111.92, $1.26-1.30, $80.01-80.86, and 1297-1320, respectively.
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
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