"It's the easiest thing in the world to make phony election-year promises about lower gas prices."
Markets don’t lie; politicians do. With the US Dollar getting pulverized to fresh YTD lows yesterday ($78.82 US Dollar Index), the price of oil ripped to new YTD highs.
The President of the United States said nothing about gasoline’s immediate-term -0.8 correlation to the US Dollar – he blamed “the Middle East and Wall Street Speculators.”
Storytelling can be sad.
Back to the Global Macro Grind…
This whole “clean energy” rant appeals to people. My office is on an Ivy League college campus – trust me, I get it. What I clearly don’t get is how both Bush and Obama’s economic “advisors” concluded that the best long-term path to economic prosperity is through currency devaluation. Both Carter and Nixon tried this. So did Charles de Gaulle. It doesn’t work.
“You know, there are no quick fixes to this problem.” –Obama (in Miami yesterday)
Really? There actually is a quick fix. And since our central planners love those, you’d think they’d at least be forced to debate it. A Strong Dollar Policy – in both MONETARY and FISCAL action = down oil, hard.
I know the Energy “experts” disagree, and that’s fine – all the more reason to try the one policy idea neither Bush nor Obama tried. Give one of these “experts” some inside info that Ben Bernanke is going to come out with a “surprise rate hike” on Sunday night, and you’ll see more Oil men buy puts than a Congresswoman from the 112th.
I wrote about this yesterday and had a proactively predictable responses from partisan people. The minute you credit Reagan for anything, the Democrats cringe. The second you compliment Clinton on anything fiscally conservative, the Republicans whine.
Only inside the Bubble in American Politics could partisanship make us all feel so willfully blind…
Back to the data: look at the long-term chart of Oil vs the US Dollar. It doesn’t lie.
- US Dollar Index > $90 = bearish for Oil
- US Dollar Index < $90 = bullish for Oil
Again, during the 1980s and 1990s, not only did the price of oil routinely trade in the $18-22/barrel range (using long-term decade averages here folks, not Iraqi points on the cart), markets EXPECTED it to.
- 1 = average price of oil (WTI) = $22.16/barrel
- 1 = average price of oil (WTI) = $18.63/barrel
*note, I use 1983 and 1993 to take out the 1981-82 and 1991-92 US recessions, which, ostensibly, would be your “low demand” years - if you’re asking a run-of-the-mill supply/demand Keynesian, that is…
Expectations drive markets. Period. And the entire world expects Ben Bernanke and Tim Geithner to debauch the US Dollar with the President of the United States having their backs.
How else can you explain Obama not mentioning the US Dollar once during the State of the Union address? Correlation isn’t causality. We get that. But correlations on a 30-day to 3-year basis are extremely high, and so is causality on a 40 year-basis. It was a Republican President (Nixon) who abandoned the Gold Standard in order to debauch the dollar in 1971 and proclaim “we are all Keynesians now.”
Reality 101: In an America where we try to make it ok for losers to win, I’m not going to convince someone that they are accountable for something that is very wrong in this country in 900 words or less. So now I’ll just get on with my day.
I couldn’t make this up if I tried, but Bloomberg’s #1 Economic Headline today is “STOCKS, OIL CLIMB ON GLOBAL ECONOMIC RECOVERY.”
Meanwhile, everything other than Gold, Energy, and Basic Materials stocks (inflation expectations rising), is signaling that Global Growth Slowing here sequentially in February is the case:
- The SP500 is still down -13% from its 2007 peak (tell your broker you need to be up +15% from here to get back to breakeven)
- US Treasury Yields (10-year) have dropped back below my intermediate-term TREND line of 2.03%
- The Yield Spread (10s minus 2s) is down 3bps day-over-day
- Spain, France, and Italy are all making lower-highs in the face or Economic Stagflation
- CRB Commodities Index (18 commodities) = +2% for the week vs the SP500 +0.1%
- Oil prices are up +3.4-4.8% on the week with the US Dollar down almost 1% (and the Yen is collapsing)
Japanese Yen collapsing? Yes, it’s not headline news, yet – but it will be. The Yen is down, literally, in a straight line to the tune of -6% for the month of February to-date. I think this looks eerily similar to the initial cliff dive of the Euro in April of 2011. Japan, like Europe at this time last year, is about to enter a phase of massive sovereign debt monthly maturities (57.1 TRILLION Yen in March).
Is it going to be different this time? USA and Japan have to rollover $3.0 TRILLION and $3.2 TRILLION in debt (in debauched dollars) in 2012 and oil prices over $100/barrel have never not slowed Global Economic Growth. Or are we hearing Phony Promises about an economic recovery, again, during an election year?
My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, and the SP500 are now $1, $119.81-124.61, $78.70-79.07, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
The Macau Metro Monitor, February 24, 2012
WYNN MACAU REMOVES OKADA FROM BOARD; AQUINO ORDERS PROBE BusinessWeek
Wynn Macau has kicked off Kazuo Okada from its board. Philippine President Benigno Aquino has ordered a probe into payments allegedly made to the nation’s top gaming regulator, Cristino Naguiat. Wynn Macau cited “unacceptable conduct” by Okada for the board’s decision to remove him as a non-executive director. Naguiat earlier this week said he had done “nothing inappropriate.”
Accepting free accommodations is “industry practice,” Edwin Lacierda, Aquino’s spokesman, said in a briefing on Feb. 21. “There is no conflict of interest in that sense.” Lacierda also said at the time that Aquino was satisfied with Naguiat’s explanation.
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- Does the Rally in Brazilian Equities Have Legs?
- Is It Time to Hedge Against a Pullback Across EM Asset Classes?
- Mexico’s Stagflation Problem
Does the Rally in Brazilian Equities Have Legs?
After being down just over -18% in 2011, Brazil’s benchmark equity index, the Bovespa, is off to a +16% start in the YTD. The question now, however, is: can the rally sustain itself? That is, are Brazil’s intermediate-term macro fundamentals strong enough to convince investors who may have missed the rally to participate?
Looking at how we screen for country-level opportunities, the quick answer is yes – for now. Our proprietary GROWTH/INFLATION/POLICY modeling puts Brazil in the equity-supportive Quadrants #4 and #1, in 1Q12 and 2Q12, respectively.
Using this standardized framework allows us to efficiently vet where we could be wrong, which is what we spend the majority of our time researching.
From a policy perspective, Brazil looks to continue employing growth-supportive monetary and fiscal policy. Last week, the Finance Ministry unveiled R$55 billion in cuts from the 2012 budget (R$35B from discretionary spending; R$20B from mandatory programs) to continue making room for the central bank to ease monetary policy. Per Finance Minister Guido Mantega:
“With lower rates, the country will grow more… When the state saves more and inflation is falling in the country, we’re able to open room to reduce interest rates.”
His commentary is generally in line with how we view fiscal policy’s effect on rates of inflation within an economy. Turning back to the budget specifically, we see that social expenditures such as anti-poverty programs and construction of low-income housing were spared from the cuts. Populist measures like this will continue to give President Rousseff clout with Brazilian voters and strengthen her combative stance against corruption and union demands.
The budget does, however, assume +4.5% GDP growth for the year, which is ~100bps higher than our current projection (subject to change w/ new data), imposing the risk that they come in light on the revenue front should growth come in below the official target.
Looking at monetary policy, both pressure from Rousseff/Mantega and the central bank’s latest commentary suggest that Brazilian interest rates are headed lower in 2012 – perhaps even below 10% (from 10.5% currently), according the central bank’s “high probability” scenario. Brazilian rate markets continue to take fiscal and monetary policymakers’ guidance on interest rates quite literally, pricing in roughly -120bps of cuts over the NTM.
Inflation is where we think Brazil could “miss” relative to current expectations. According to the same “high probability” scenario, Brazilian CPI is projected to fall to the mid-point of the target range of +4.5% +/- 200bps (from +6.2% YoY in JAN) by year-end. To put it simply, there is a near-Bernank (“zero percent”) chance that this will happen if global energy prices continue to make higher intermediate-term highs and remain in Bullish Formations quantitatively.
As of now, the Bovespa remains a semi-defensive play in a rising inflation environment, with 42.3% of the index’s market cap weighted to energy and basic material companies. At a point, however, rising profits at companies like Vale and Petrobras will come at the expense of the Brazilian consumer, producer, and economy at large. Additionally, we’d be remiss to forget that the Bovespa failed to participate in the 1H11 Global Inflation Trade, peaking in early NOV ’10 – just shortly after Qe2 was officially announced.
All told, we continue to like Brazil fundamentally, but certainly not at every price and level of inflation expectations. What would get us to buy Brazil is twofold: 1) stability in the U.S. dollar (i.e. a TRADE-duration breakout); and 2) a subsequent deflating of the inflation to create lower, more attractive prices (Bovespa’s trailing 30-day correlation to DXY = -0.84). Our quantitative risk management levels on the Bovespa are included in the chart below.
Is It Time to Hedge Against a Pullback Across EM Asset Classes?
Investors in emerging market assets have seen a fair amount of green on their screens in the YTD; to generalize:
- The MSCI EM Equity Index is up +16.2%;
- The Morgan Stanley EM Local Currency Debt Fund is up +18.4%; and
- The JPMorgan EM Currency Index is up +6.8%.
While the long-term growth fundamentals remain supportive of EM perma-bull storytelling, it’s fair to attribute a good deal of this performance to a relief rally of sorts stemming from the waning of systemic pressure within the Eurozone (as quantified by the Euribor-OIS spread), as well as a dramatic decline in global cross-asset volatility. To measure the latter point, we’ve created a proprietary index that uses an unequally-weighted average of the following volatility indices:
- CBOE SPX Volatility Index (VIX);
- Merrill Lynch Treasury Option Volatility Estimate Index (MOVE);
- CBOE Oil ETF Volatility Index (OVX);
- JPMorgan Global FX Volatility Index; and
- JPMorgan EM FX Volatility Index.
On this metric, global cross-asset volatility is down -18.2% in the YTD, making it easier for global investors to extend the duration of their research (obvious L/T bullish theses across the EM universe) and for EM corporates and sovereigns to raise capital. This intuitive interpretation is supported by the math: the MSCI EM Equity Index (as a rough proxy for EM assets) has a -0.88 correlation to our proprietary Global Macro Volatility Index on a trailing 3-year basis.
Importantly, our index is at levels last seen since JUL ’11. As risk managers, we should be asking ourselves if this level of cross-asset volatility is sustainable over the intermediate-term. While only a crystal ball would give us the rightful answer to this question, we can make educated guesses based on handicapping what we see as meaningful catalysts coming down the pike.
On this basis, a potential sovereign debt scare in Japan (MAR), a likely downward revision to China’s growth target (early MAR), and accelerating global stagflation on a rolling basis due to the perpetuation of Weak Dollar Policy out of the U.S. all suggest that continued lower-highs in cross-asset volatility is increasingly less likely over the intermediate term. Given, we would support being appropriately hedged against a correction across EM asset classes, which have historically been highly correlated as highlighted in the table below.
Key breakdown levels to watch across the EM debt space are included in the charts below. Gol’s (Brazil’s 2nd-largest airline by market value) recently-shelved $200M perpetual bond offer and Argentine corporates continuing to be shut out international capital markets (five consecutive months w/o a deal being priced) could be canaries in the coal mine for broader weakness over the intermediate term.
Mexico’s Stagflation Problem
Recently, Mexico reported that its Real GDP growth slowed to +3.7% YoY in 4Q11 vs. +4.5% in the prior quarter. Alongside a sequential acceleration in Headline YoY Inflation in the quarter, Mexico’s economy closed out 2011 in Quadrant #3 of our G.I.P. analysis. More importantly, adopting our model’s baseline estimates, the country looks to stay put throughout 1H12.
Flat-to-down JAN PMI data (Manufacturing flat and Services down -2.6 pts. MoM) and accelerating inflation (CPI +4.1% YoY vs. +3.8% prior) amid the worst drought on record (higher domestic food costs) suggests our baseline outlook is off to a fairly accurate start. Furthermore, from a modeling perspective, we risk not being aggressive enough to the downside and upside with our growth and inflation assumptions, respectively, in the face of what we’ve chosen to label as The Bernank Tax.
Mexican rate markets agree with our view that Mexico’s Indefinitely Dovish central bank (benchmark held at a record-low 4.5% since mid-’09) may have to, at a bare minimum, talk hawkishly in the face of CPI likely remaining above their upside target of +3-4% for the intermediate term. 1yr O/S interest rate swaps and 1yr L/C sovereign debt yields are pricing in +37bps and +1bps of tightening over the NTM and this spread has been making higher-lows since SEP – in the face of other Latin American economies’ spreads making lower-highs over the same duration.
All told, Mexico is the Latin American economy we view most at risk of experiencing stagflation over the intermediate term; as such, we are unfavorably disposed to their equity market.
Fundamental Price Data
All % moves week-over-week unless otherwise specified.
- Median: +0.8%
- High: Colombia +2.6%
- Low: Brazil, Mexico -0.5%
- Callout: Mexico +2.6% YTD vs. a regional median of +16.3%
- FX (vs. USD):
- Median: +0.2%
- High: Chilean peso +0.8%
- Low: Argentine peso, Mexican peso -0.1%
- Callout: Argentine peso -1.1% YTD vs. a regional median of +8.4%
- S/T SOVEREIGN DEBT (2YR YIELD):
- High: Colombia +22bps
- Low: Mexico +1bps
- Callout: Colombia up +32bps YTD vs. Brazil -69bps
- L/T SOVEREIGN DEBT (10YR YIELD):
- High: Mexico +4bps
- Low: Brazil -2bps
- Callout: Mexico +46bps over the last six months vs. Brazil -85bps
- SOVEREIGN YIELD SPREADS (10s-2s):
- High: Mexico +3bps
- Low: Colombia -19bps
- Callout: Mexico -7bps YTD vs. Brazil +43bps
- 5YR CDS:
- Median: -3.8%
- High: Colombia -2.9%
- Low: Chile -8.1%
- Callout: Regional posting a YTD median decline of -16.9%
- 1YR O/S INTEREST RATE SWAPS:
- High: Chile +10bps
- Low: Mexico -3bps
- Callout: Colombia +70bps YTD vs. Brazil -78bps
- O/N INTERBANK RATES:
- High: Brazil +1bps
- Low: Chile -9bps
- Callout: Colombia +18bps YTD vs. Brazil -58bps
- CORRELATION RISK: The MSCI Latin America Equity Index is trading with an inverse correlation to the U.S. Dollar Index of -0.87 on a trailing 30-day basis.
We can definitely be accused of not being a bull on CMG, but we have not been short either. Either way we have a keen eye on trying to figure out when store growth is going to slow meaningfully. Trying to guess same-store sale trends is not a reason to be short CMG. The real question is when will incremental returns on new units slow? When will the company need to slow the unit growth rate? For the time being we are not there yet, but the recently filed 10-K offers some signs that the company is maturing.
Some highlights from the 10-K:
- CMG is now looking to “fine-dining” for inspiration
- Supply problems - the numbers of store serving you basic fast food chicken and beef is growing
- Per store labor costs are increasing
- Development costs have stopped going down and could increase in 2012
- Inflation is still a concern
FROM QSR TO FINE DINING
OLD PHILOSOPHY: Chipotle began with a simple philosophy: demonstrate that food served fast doesn’t have to be a traditional “fast-food” experience. Over the years, that vision has evolved. Today, our vision is to change the way people think about and eat fast food.
NEW PHILOSOPHY: Our vision is to change the way people think about and eat fast food. We do this by avoiding a formulaic approach when creating our restaurant experience, looking to fine-dining restaurants for inspiration. We use high-quality raw ingredients, classic cooking methods and a distinctive interior design and have friendly people to take care of each customer—features that are more frequently found in the world of fine dining. Our approach is also guided by our belief in an idea we call “Food With Integrity”. Our objective is to find the highest quality ingredients we can—ingredients that are grown or raised with respect for the environment, animals and people who grow or raise the food.
HEDGEYE: CMG is now thinking in terms of a “fine dining” experience – talk about raising the bar in QSR!!
FOOD WITH INTEGRITY - BUT!!!
OLD PHILOSOPHY: Serving high quality food is what motivates us and is critical to our vision to change the way people think about and eat fast food. As part of our Food With Integrity philosophy, we believe that using fresh ingredients is not enough, so we spend time on farms and in the field to understand where our ingredients come from and how the animals are raised.
NEW PHILOSOPHY: Serving high quality food “while still charging reasonable prices” is critical to our vision to change the way people think about and eat fast food. As part of our Food With Integrity philosophy, we believe that using fresh ingredients is not enough, so we spend time on farms and in the field to understand where our food comes from and how it is raised. Because our menu is so focused, we can concentrate on where we obtain each ingredient, and this has become a cornerstone of our continuous effort to improve our food. As of December 31, 2011, we were serving exclusively naturally raised meats in all of our restaurants in the U.S. Continuing to serve naturally raised meats in all of our restaurants is one of our goals, but as discussed below, we have and will continue to face challenges in doing so. Some of our restaurants served conventionally raised chicken or steak for much of 2011, a few markets reverted to conventionally raised beef in early 2012, and more of our restaurants may periodically serve conventionally raised meats in the future due to supply constraints. We define naturally raised as coming from animals that are never given antibiotics or added hormones and that are raised responsibly—that is, in accordance with our animal welfare standards.
HEDGEYE: CMG sees the need to raise prices to execute on the current business model. It’s going to get harder for the company continue to grow at the current pace and keep is integrity with customers and that will find it harder to claim they serve naturally raised food! As of December 31, 2010, about 80% of the restaurants served naturally raised steak and about 86% of the restaurants served naturally raised chicken. These percentages, to our knowledge, are no longer disclosed.
INCREASED STORE LABOR
THE BASICS DONE RIGHT: Each restaurant typically has a restaurant manager (a position we’ve characterized as the most important in the company), an apprentice manager (in about three-quarters of our restaurants), one or two hourly service managers, one or two hourly kitchen managers and an average of 22 full and part-time crew members.
HEDGEYE: CMG took the average crew up by 2 people in 2011.
ACCELERATING UNIT DEVELOPMENT
We operated 1,230 restaurants as of December 31, 2011. We plan to increase the number of our restaurants significantly in the next three years, and plan to open between 155 and 165 new restaurants in 2012.
HEDGEYE: CMG was looking at opening between 135 and 145 new restaurants in 2011.
ACCELERTING UNIT DEVELOPMENT LEADS TO NEW CONCERN – LABOR COSTS
“One of our biggest challenges is staffing new restaurants. We seek to hire only top-performing employees and to promote restaurant managers from our crew, which may make it more difficult for us to staff all the restaurants we intend to open. Constraints on our hiring new employees are described further below under “ Our business could be adversely affected by increased labor costs or difficulties in finding the right employees for our restaurants .”
HEDGEYE: CMG added this new caveat to its 10-K this year.
DEVELOPMENT COSTS RISING?
“We also have lowered the average development cost of our new restaurants significantly in recent years, from about $916,000 in 2008 to about $800,000 in 2011, and expect development costs in 2012 to be similar to 2011. In the event we are not able to achieve the average development costs we expect for 2012 or sustain the benefits achieved in prior years, which could result from inflation, project mismanagement or other reasons, our new restaurant locations could also result in decreased profitability.”
HEDGEYE: CMG will no longer see the tail wind of declining development costs. This fact coupled with accelerated development could lead to lower returns on incremental invested capital. This point is critical to keep an eye on.
“Food prices for a number of our key ingredients escalated markedly during 2011 and we expect that there will be additional pricing pressures on some of those ingredients, including beef, chicken, rice and beans, during 2012. We could also be adversely impacted by price increases specific to naturally raised meats or other food items we buy as part of our Food With Integrity focus, the markets for which are generally smaller and more concentrated than the markets for commodity food products. Weather related issues, such as freezes or drought, may also lead to temporary spikes in the prices in some commodities.”
HEDGEYE: This was not as much of a problem in 2011 with double digit same-store sales. What about 2012?
Distortions in the Seasonal Adjustment Factor
After our claims post last week, "The Ghost of Lehman," we had a number of clients ask us if we could quantify the effect we discussed. Lehman's Ghost is a distortion in the seasonal adjustment factors that the Department of Labor is using to treat jobless claims arising from the shock in the series in late 2008 - early 2009. The Labor Department uses a five-year lookback in constructing its seasonal adjustment factor, which means that the '08-'09 shock continues to skew the data. Essentially, the seasonal adjustment sees the increase in claims in September 2008 - February 2009 and reads it as a seasonal factor rather than as a bona fide shock.
To estimate the extent of the distortion from the seasonal factor on this week's data, we examined the YoY increase in NSA claims in February 2009 (+88%) and then backed out the average YoY growth from September 2008 to February 2009 (+60%). So the February 2009 growth is 28% above trend, YoY. This should be a rough approximation of the contribution of the seasonal factor from that year. Since the overall seasonal adjustment takes a five-year average, we divide this number by five to get a 5.6% increase. The conclusion is that this week's claims data is 5.6% understated. Instead of being 351k, it should really be 372k.
This week of the year captures the maximum benefit from the distortion - i.e. claims are understated in the last weeks of February by the largest amount. From now through May, the understatement disappears. Absent an underlying trend in the series, this effect would drive claims higher by about 20k over the course of the next three months. By July, the distortion reappears, this time as an overstatement, pushing claims slightly higher still. From July through year-end, the distortion disappears, and the underlying trend will be reflected in the weekly data.
Over the last year, claims have generally moved lower YoY (NSA) by around 10%. Off of a base of 350-400k, this implies 35-40k improvement this year, or around 3-4k per month. This underlying trend is thus overwhelmed by the distortion for the next few months (as true improvement is masked by the understatement/tailwind reversing).
The headline initial claims number rose 3k WoW to 351k (staying flat after a 3k upward revision to last week’s data). Rolling claims fell 7k to 359k. On a non-seasonally-adjusted basis, reported claims fell 20k WoW to 345k.
The 2-10 spread widened 5 bps versus last week to 170 bps as of yesterday. The ten-year bond yield increased 7 bps to 201 bps.
Financial Subsector Performance
The table below shows the stock performance of each Financial subsector over four durations.
Joshua Steiner, CFA
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