“The dominance of conclusions over arguments is most pronounced where emotions are involved.”
Intraday on Friday we finally had a -1% down move in US Equities and a +1.5% up move in long-term US Bonds. So, I covered our short position in the SP500 (SPY) and sold our long position in US Treasuries (TLT) on that. Buy red, Sell green.
Buying on red and Selling on green? That’s meant to be an over-simplification of what it is that I do. I love saying it, tweeting it, and doing it – because actually finding it within me to do it when I have so many other risk management signals banging around in my head is quite difficult.
On page 103 of “Thinking, Fast and Slow” Kahneman compartmentalizes what’s happening in my little brain and reminds me that I am hostage to what his psychologist buddy, Paul Slovic, coined as “The Affect Heuristic.” It helps explain why “people let their likes and dislikes determine their beliefs about the world.”
Back to the Global Macro Grind …
At least in my own head, I’m crystal clear that I dislike Big Government Interventions, Socializations, and Regulations of free-market pricing. If all I did was trade on the Emotional Conclusions that are embedded in those thoughts, I’d be wrong a lot more than I am. Separating what should happen versus what is going to happen is critical in markets that whip around like this.
What whipped around last week?
- The US Dollar Index finally stopped going down (1stup week in the last 4) = up +0.3%
- Commodity Inflation (18 component CRB Index) stopped inflating = down -0.6%
- US Equity Volatility (VIX) ripped to 20.79 = straight up +21.6%
What’s fascinating and sad about this all at the same time is that it reminds us how sensitive market prices are to a devaluation of the US Dollar. Emotional Conclusions drive expectations too. The US Dollar currently has an immediate-term +0.7 correlation to Volatility (VIX).
Emotional? Right before they stopped inflating, CFTC (Commodities Futures Trading Commission) data showed that in the week ended February 7th, 2012, money managers ramped up their net-long positions to commodity inflation by +13% week-over-week. At 929,199 contracts (Bloomberg.com), that’s the biggest net-long position since September of 2011. Atta boy Bernank!
For those of you who still remember who and what got crushed in September 2011, the CRB Index dropped from 343 to 293 by the first week of October 2011. That was a -14.6% vertical drop as the US Dollar Index ramped +7%. Got Emotional Conclusions about causality?
Or was that Correlation Risk? Or was it expectations? Or Europe?
Whatever it was, it was the real-time score.
That’s the thing about market prices. They could not care less about what you or I think. They do what they do when they do them, rendering our immediate-term opinions about valuation, supply, and demand useless.
We’re all book smart. Or at least, technically, that’s what the diplomas say. Being market-smart will be determined many years after we leave this game – when every week, month, and year of our risk management performance has been TimeStamped.
In the meantime, we need to know what we are going to do now. As in right now. Markets wait for no one. And now that the Greek “news” is out of the way, I think this week’s focus will turn to:
- Japan: nasty Keynesian Growth Slowdown (down -2.3% GDP Growth y/y for Q411) and pending sovereign debt maturity in March
- China: growth slowing (again) as global inflation expectations rise (again)
- USA: economic data to be reported this week which should already start to show inflating import, consumer, and producer prices
I’ve dropped the Cash position in the Hedgeye Asset Allocation Model from 91% on the day of Bernanke’s Policy to Inflate (January 25th, 2012) to 64% this morning. Effectively, I’m long Inflation Expectations Rising (Energy, Gold, etc.) and I’m right worried about it. If we see the US Dollar hold last week’s gains, I’ll have no problem selling inflated prices on green.
My immediate-term support and resistance ranges for Gold, Oil (Brent), EUR/USD, and the SP500 are now $1, $114.89-120.01, $1.31-1.33, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
TODAY’S S&P 500 SET-UP – February 13, 2012
As we look at today’s set up for the S&P 500, the range is 22 points or -0.35% downside to 1338 and 1.29% upside to 1360.
SECTOR AND GLOBAL PERFORMANCE
- ADVANCE/DECLINE LINE: -1604 (-1640)
- VOLUME: NYSE 750.64 (-1.13%)
- VIX: 20.79 11.59% YTD PERFORMANCE: -11.15%
- SPX PUT/CALL RATIO: 1.40 from 1.54 (-9.09%)
CREDIT/ECONOMIC MARKET LOOK:
- TED SPREAD: 42.47
- 3-MONTH T-BILL YIELD: 0.08%
- 10-Year: 2.02 from 1.99
- YIELD CURVE: 1.75 from 1.71
MACRO DATA POINTS (Bloomberg Estimates):
- 11am: Export inspections: corn, soybeans, wheat
- 11:30am: U.S. to sell $33b 3-mo., $31b 6-mo. bills
- 9:45pm: Fed’s Williams speaks in Claremont, Calif.
- Obama delivers remarks on FY2013 budget request in speech to Northern Virginia Community College students, 11am
- Numerous departments, including transportation, HHS, energy, hold budget briefings
- House meets in pro forma session, 1pm. Senate meets 2pm
WHAT TO WATCH:
- Greek parliament approves austerity measures as rioters battled police, set fire to buildings in Athens
- European finance ministers will meet Feb. 15 to ratify Greek aid package
- Japan’s 4Q GDP fell more than expected, -0.6% on quarter vs -0.3% est.
- U.S. Budget to outline how govt. spends more than $3 trillion in next fiscal year
- Vodafone says in early stages of evaluation a potential offer for Cable & Wireless
- Weatherford cleared of Macondo disaster liability, Judge says
- Apple adds patent infringement claims against Samsung with suit
- ‘The Vow’ is No. 1 movie with $41.7m in ticket sales, second weekend on record that four movies gross more than $20m each
- Goldman to Sell 9.5m Shares in Hana Financial: Dow Jones
- EU Willing to Be Flexible on Airlines Emissions Tax: WSJ
- Regeneron Pharmaceuticals (REGN) 7 a.m., $(0.61)
- Diebold (DBD) 7:30 a.m., $0.84
- Brookfield Renewable Energy (BEP-u CN) 8 a.m., $0.07
- Regal Entertainment Group (RGC) 4 p.m., $0.04
- Rackspace Hosting (RAX) 4 p.m., $0.15
- Alexander & Baldwin (ALEX) 4:01 p.m., $0.23
- Gen-Probe (GPRO) 4:01 p.m., $0.68
- Health Management Associates (HMA) 4:01 p.m., $0.21
- Lender Processing Services (LPS) 4:05 p.m., $0.58
- Seattle Genetics (SGEN) 4:05 p.m., $(0.30)
- Fidelity National Information Services (FIS) 4:06 p.m., $0.65
- Charles River Laboratories International (CRL) 4:30 p.m., $0.56
- Masco (MAS) 5 p.m., $(0.02)
- TAL International Group (TAL) 5:48 p.m., $0.98
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
OIL – hooo-wah! Big breakout for Brent Oil to $118.28/barrel this morning with no immediate-term TRADE resistance to $120ish. If you’re looking for the #1 factor that will slow global consumption growth sequentially here in February (vs what was a big growth ramp in DEC/JAN), the black stuff in the barrel is it.
- Speculators Lift Wagers to Highest Since September: Commodities
- Gold Advances in London as Weaker Dollar Spurs Investor Demand
- Oil Rises From Three-Day Low as Greece Passes Austerity Measures
- Copper Rises as Equities, Euro Gain on Greek Austerity Approval
- Wheat Gains as Drought Threatens Ukraine, Egypt Buys From U.S.
- Robusta Coffee Rises as Vietnamese Exports Fall; Sugar Advances
- Iran Sanctions Tighten as OSG to Frontline Halt Crude Loading
- Soybean Oil Futures Rise in China to 3-Month High: Beijing Mover
- Dragon-Year Baby Boom Seen Boosting China’s Milk-Powder Imports
- Rusal Plans to Keep First-Quarter Output Stable, Sell Inventory
- Chinalco Unit Expects China Aluminum Market in Surplus This Year
- Hedge Fund Heating Oil Bets Surge on Deadly Cold: Energy Markets
- First Solar-to-Vestas Wind Profit Crash Deters New CEOs: Energy
- Crude Rises From Three-Day Low on Greece
- Russia Wheat Exports Restricted by Domestic Price, SovEcon Says
FRANCE – alongside covering our SPY short, we covered our French Equity short position on Friday as well. Typically, short-and-hold isn’t what we do. That said, we’re watching the long-term TAIL line of resistance for the CAC of 3556 very closely as we think that’s going to be a good proxy for non-German European growth/inflation for the next few quarters.
JAPAN – top 3 economy in the world drops to a -2.3% y/y GDP print in Q411 (brutal); now its full throttle game on for the Japanese as we head toward a massive sovereign debt maturity in March ($745B!). When we were getting hawked up about Italian debt in Feb of 2011, consensus didn’t have it in the area code of its map either. Stay tuned…
The Hedgeye Macro Team
The short interest data is showing a lot of capitulation on the short side in the restaurant space. Even Starbucks saw a reduction in short interest according to data released Thursday. In this post, we go through our sentiment score card and then, below that, some callouts on short interest in QSR and Casual Dining names.
For the most recent data, which was released yesterday and reflects the short interest level as of the settlement date of 1/31, short interest declined sharply in most names in the restaurant space, as the second table below illustrates. Only RUTH, CBOU, BWLD, and CBRL saw meaningful upticks in short interest during the two week period ended 1/31.
Below is our sentiment score card. The usual suspects are at the top: MCD, YUM, SBUX. EAT and PFCB languish near the bottom with other “untouchables”. As we wrote earlier in the week, we don’t see much downside to PFCB. We feel that there is a couple of outlier FY12 estimates (~$1.80) being baked into consensus that are skewing the consensus EPS number higher than true expectations. We believe that the more accurate consensus EPS number for FY12 is $1.50. Earnings are, in our view, in a bottoming period for PFCB. For investors looking for two-to-three year turnaround stories, we believe PFCB is one to consider. We like what management is doing and, clearly, the investment community has written it off. There may be a couple of difficult quarters ahead but we view the longer term risk/reward as favorable on the long side.
- PNRA saw short interest in the stock decline dramatically as it had been for some time. The stock had posted impressive gains throughout the fourth quarter only to miss on the top line (5.9% bakery comps versus 6.3% consensus)
- SBUX and MCD sentiment can’t get much better. SBUX is rated highly by the street (21 Buy ratings, 8 Hold, and 1 Sell) with only 0.9% short interest. Despite shorts covering coming into earnings on 1/26, the stock declined on the print before regaining ground and reaching a new high yesterday. MCD has traded lower since its January sales results came out on 2/8. Despite beating estimates, expectations are extremely high for MCD. The street remains extremely bullish despite the stock price appreciating by 35% since the beginning of 2011; there are 21 Buy ratings, 9 Holds, and 0 Sells on the stock and a mere 0.7% of the float is sold short. Even what would be considered as a small factor, like FX turning from a tailwind to a headwind, is enough to move the stock with the long side this crowded. We expect McDonald’s to continue to take share domestically but as investors ponder the company’s ability to outstrip the impressive top-line growth of 2011, the trajectory of the stock’s price chart will likely moderate. However, as the remodel program progresses in the U.S., we expect a benefit to same-store sales both through incremental traffic in the box and more efficient execution at the drive-through (6 seconds of time shaved off the process equals one point in same-store sales).
CASUAL DINING CALLOUTS
- CBRL short interest is building as gas prices climb higher.
- Short interest was building in BWLD ahead of its 4Q earnings release as investors were concerned about rising costs and the company’s growth prospects versus the street’s expectations. Unfortunately for those pressing the short side (we had a bearish fundamental view on the quarter), the top-line blew away expectations and 1Q12 to-date comps – although the impact of weather was not disclosed (PNRA said January comps were helped by 350 bps by weather) – were given as +12.9%. The stock responded very strongly to this and, with comps like that, it is difficult to argue that it should not. One concern that we maintain needs to be monitored by investors in this name is the fact that margins declined year-over-year despite flat wing prices (will be unfavorable in 1Q) and a surging top-line.
- CAKE is reporting on 2/21 and has seen short interest come down sharply over the last two weeks. During 4Q11 and 1Q12 to-date, the stock has traded extremely well. We will be publishing on our view ahead of CAKE’s release on 2/21 late next week.
***After receiving feedback from several clients, we’ve decided to make some fairly dramatic changes to our weekly risk monitor products. We hope you enjoy the new, more in-depth format whereby we focus solely on the three key risks we think will most impact your respective portfolios to the upside or downside. We encourage you to follow up with questions/comments/concerns and/or if you’d like to dive deeper into a theme or topic that you may or may not see below.***
Virtual Portfolio Positions in Asia: Long Chinese equities (CAF); Short Japanese equities (EWJ).
Japan’s Eroding Current Account Bodes Poorly for Long-term JGB Demand
Japan, whose local-currency sovereign credit profile cites the tailwind of a persistent current account surplus, saw the figure fall to a 15yr-low of 2% of GDP in 2011. This is a very important statistic because it directly calls into question Japan’s ability to be a net creditor nation in perpetuity.
Japan’s eroding current account is one of several key long-term tailwinds for JGB demand that look to inflect in the months ahead – putting a noteworthy level of Japanese sovereign credit risk on the table for, really, the first time ever in 2012. The others include:
- An acceleration in long-term inflation expectations as the BoJ looks to dramatically step up its share of JGB ownership (from 8.5% of total outstanding currently) by ether printing new banknotes or altering their mandate;
- A potential sovereign debt downgrade(s) to A+, which will trigger capital raises across the Japanese banking system to the tune of ~$80 billion; and
- A realization by market participants that the Diet has no credible plan for fiscal consolidation – in the face of a world-beating $3.2 trillion financing refinancing schedule for CY12. Further, staunch political gridlock will prevent any meaningful reform(s) from passing through the legislative process – per recent public statements from key policymakers in both leading parties (DPJ and LDP).
Turning back to Japan's current account dynamics, the country posted an annual trade deficit in 2011 for the first time since 1980 (-$32 billion) – with weakness not being singularly driven by the MAR '11 tragedy. Recall that both Japanese exports and industrial production growth came in flat-to-down from a YoY perspective throughout the entirety of 4Q11.
While investment income more than offset the precipitous decline in the trade balance, the dramatic slowing of foreign inflows from a trade is worrying in that there appears to be little respite on the horizon from a long-term perspective. To that tune, the trend of Japanese corporations off-shoring manufacturing production amid persistent currency strength (JPY up +56.8% vs. the USD over the previous five years) looks to continue accelerating (email us for company-specific details).
The swing into deficit territory from a trade balance perspective was also driven by an -85% decline in power generation from the country’s nuclear generators (34,417 megawatts pre-quake/tsunami vs. 5,058 in mid-JAN ‘12), which forced Japan to import energy products in size. All told, Japan lost roughly 25% of its total power-generating capacity as a result of the MAR ’11 tragedy.
Today, only three of the nation’s 54 nuclear reactors are in operation, with little political will to turn them back on as the nation shifts its energy policy towards more renewable energy generation – one of the three preconditions to convince former Prime Minister Naoto Kan to step down in AUG ’11.
Looking ahead, these growing headwinds facing Japan’s current account dynamics are unlikely to inflect in any material way, given that Japan needs a strong yen to limit the cost of energy imports. That will continue to put pressure on the country’s ability to be a manufacturing and export economy going forward, slowing domestic growth and weigh on the sovereign’s ability to tax its economy. Currently, Japan relies on debt issuance to fund nearly half (49%) of all expenditures. Expect that figure to continue to make all-time highs going forward.
***If you have not yet seen our Japan’s Jugular 2.0 presentation, please email us and we’ll get it over to you promptly.***
Chinese Inflation Data Complicates Domestic, Global Growth Outlook
Growth Slows as Inflation Accelerates – period. Only in an Ivy League introductory macroeconomics textbook is faster inflation a precondition for sustainable economic and employment growth – of course, following the chapter whereby currency devaluation strategies are professed to boost GDP via export competitiveness.
China – where Keynesian economics are far less in vogue than in Washington D.C. – saw its headline CPI reading accelerate to +4.5% YoY in JAN from +4.1% prior. While Lunar New Year distortions may have contributed to the gain, the +3.4% increase in Brent crude oil prices during the month also “fueled” a sequential uptick (+1.5% MoM vs. +0.3% prior).
As we have articulated in many notes over the past six months, China is not particularly close to cutting interest rates and the JAN inflation reading + the potential for another round of The Bernank Tax will not sit well with the PBOC. Both the data and China’s sovereign debt market + interest rate swaps markets agree with our long-held conclusion that a Chinese rate cut(s) continues to be uncomfortably out of reach – so much so that the likely acceptance of this viewpoint prompted Singaporean Prime Minister Lee Hsien Loong to say earlier this week that “China’s economy may be headed for a rough landing”.
China delaying any meaningful monetary easing takes away a key supportive catalyst for global growth in the intermediate term. In the near term, China’s JAN economic growth data was actually quite bad (again, accepting some level of Lunar New Year distortions):
- Exports: -0.5% YoY vs. +13.4% prior
- Exports To EU: -3.2% YoY vs. +7.2% prior
- Exports To US: +5.5% YoY vs. +11.9% prior
- New Loans: +738.1B MoM vs. +640.5B prior
- YoY: -29.2% vs. +33.2% prior
- Slowest pace of JAN MoM credit expansion in five years
- M2 Money Supply: +12.4% YoY vs. +13.6% prior
All told, we can’t help but take the view that consensus is continuing to dramatically misinterpret slowing Chinese economic data as a catalyst for monetary easing. Refer to our JAN 17 note titled, “China, With Context” for more details behind our conclusion.
The Bernank vs. Asia: Interest Rate Duel
We introduced the following equation back in a NOV 2010 research note to describe how the Fed’s policies inflate would impact a globally-interconnected economic system:
Quantitative Easing = accelerating inflation [globally] = monetary policy tightening [globally] = slower growth [globally]
This equation is particularly predictive for emerging markets, where the food and energy components of headline CPI readings garner more weight than their developed market counterparts.
In the second full week post the Fed’s pledge to maintain ZIRP through 2014, we’ve already seen a couple of noteworthy shifts in the scope for Asian monetary policy, most notably South Korea and Australia’s decision to hold off lowering their benchmark interest rates after dovish talk and/or previous rate cuts.
From a market signaling perspective, we see that 1yr O/S interest rate swaps are pricing in less monetary easing across various Asian economies (based on spreads relative to benchmark interest rates) – a trend that, while intact from roughly the start of the year, is only perpetuated by The Bernank Tax:
For reference, Indonesia, which the lone outlier in the previous chart, saw its equity market close down -2.6% wk/wk into and through a -25bps rate cut to 5.75%. The Jakarta Composite was only equity index in the region to close the week lower (-2.6% vs. +1.1% wk/wk on a regional median basis). Its currency also suffered amid this potentially lax monetary policy decision, closing down -1.2% wk/wk against the USD vs. a regional median of -0.8%.
Asian currencies as a whole, which are up +2.5% vs. the USD on a median basis in the YTD have been recently outperforming food and energy prices, on the margin, from a YoY perspective – a trend that has been supportive of slower CPI readings across the region. We expect this trend to reverse and re-inflate Asian CPI and PPI readings in the coming quarters if Qe3 is explicitly pursued:
The quantitative setup in the U.S. Dollar Index will continue to tell you all that you need to know regarding whether or not the risk of Qe3 is real or merely hearsay:
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