“It is neither wealth nor splendor, but tranquility and occupation, that gives happiness.”
The first time I made the Inflation Slows Growth call (Q1 of 2008), I was a little stressed out. I was just starting a new company. I had everything to lose. Plenty of people were shooting against me.
The second time (Q1 of 2011), I had a much larger research team working alongside me and our confidence was high that consensus was way too bullish. People started to believe in our process.
This time (Q1 of 2012), from a fundamental Growth and Inflation perspective, very few factors in our risk management model suggest it’s going to be different. Growth continues to slow, globally, as inflation accelerates.
Back to the Global Macro Grind…
While the calculus associated with how inflation slows real (inflation adjusted) growth is trivial, consensus calculations addressing this very basic real-world relationship are not.
Let’s look Credit Suisse’s latest “Reasons To Be Positive On Equities”:
- “Bond yields could rise further – this might help equities”
- “The Macro environment is supportive – Economic momentum indicators suggest global and US growth is still well above consensus”
- “The dovishness of central banks and the synchronized QE as the end game”
I’ll stop with their first 3 reasons as the next 6 have to do with the run-of-the-mill bull market thesis that has had people run right over if they bought Equities at the end of Q1 2008 or Q1 2011 (‘the world is awash with liquidity… stocks are cheap… blah, blah, blah’).
First, in addressing reasons 1-3 in order, I always start debates with my analysts with questions:
- Does the thesis change if bond yields don’t rise further?
- What’s consensus GDP; what’s your outside of consensus forecast; and what track record do you have in making these GDP calls?
- What’s different this time about central bank easing that won’t perpetuate inflation and, in turn, slow growth?
So, if you are meeting with Credit Suisse or JP Morgan’s Tom Lee in the coming weeks, see if they can answer those 3 questions.
Facts about reasons 1-3:
- Bond Yields rising to their YTD highs in Q1 of 2011 were not a buy signal for stocks – they were a huge head-fake
- US GDP growth slowed hard in the face of $120 (Brent) oil in Q1/Q2 2011 to 0.36% and 1.34%, respectively
- On the margin, the only central bank of the 3 majors that can cut rates to 0% from here is the ECB
Furthermore, our risk management models suggest that reasons 1-3 need to be contextualized:
- 10-year US Treasury Yield TRADE, TREND, and TAIL lines are 2.12%, 2.03%, and 2.47%, respectively
- Our “low” and “high” scenarios for US GDP growth in Q1 and Q2 of 2012 are 0.9% and 1.7% (y/y), respectively
- The Sovereign Surprise of 2012 could be Japan, resorting to BOJ money printing, which would be US Dollar bullish (hawkish)
In other words, making a call that everyone is going to dog pile into Equities after this compressed smack-down move in Treasury Bonds is not one that is backed by anything that’s actually been happening in the world since 2008.
In theory, it makes sense. And in actuality, since Equity “fund flows” and volumes are dead, that’s what the Equity market needs (rotation out of bonds into stocks). But, to be clear, what people need in this business and what’s going to occur, can be two very different things.
Because an equity fund manager needs to chase performance or a pension fund needs to target a rate of return, doesn’t mean anything at all really. Markets do not care about what any of us need.
No matter what your successes or failures for 2012 YTD, what you need to get right from here are the slopes of Growth and Inflation. How does accelerating inflation infect growth? What pace of Deflating The Inflation could foster sustainable US Consumption Growth?
My Tranquil Occupation isn’t perma bull or perma bear – it’s perma process. In order to answer all of the aforementioned questions, you need a process that has proven to be both accurate and repeatable.
What would get me on board with some of Credit Suisse’s thoughts on US Equities:
- US Dollar Index breakout into the mid-80s (versus $79.81 this morning)
- US Treasury Yields (10-year) breaking out > 2.47% and holding there
- US Federal Reserve? Get them out of the way
My scenario is at least consistent. The Credit Suisse report wants you to believe that both bond yields and growth expectations can break-out to the upside while maintaining “synchronized QE” from central banks. By definition, all 3 of those things can’t happen at the same time. Unless, of course, the Fed is as conflicted and compromised as the world is beginning to believe it is.
My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, US Treasury 10-year Yields, and the SP500 are now $1, $124.69-127.49, $79.55-79.93, 2.12-2.38%, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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Positions in Europe: Short Greece (GREK), Short Spain (EWP)
Asset Class Performance:
- Equities: Top performers: Hungary 4.7%; Germany 4.0%; Belgium 3.7%; Italy 3.7%; Austria 3.6%. Bottom performers: Cyprus -1.7%; Portugal -1.4%; Romania -70bps.
- FX: The EUR/USD is up +0.40% week-over-week. Divergences: HUF/EUR +0.96%, GBP/EUR +0.68%; NOK/EUR -0.84%, PLN/EUR -0.76%. The HUF/EUR leads all major expanded currencies at +8.87% year-to-date.
- Fixed Income: Greek debt was re-priced this week following agreement on the PSI; the Greek 10YR yield fell a monster 1844bps to 18.12% week-over-week. Portugal’s 10YR led to the downside, falling -22bps to 13.64%, while Spain saw the largest gain at +23bps to 5.19%.
- Greece now has the highest gas price in the continent at over $9.00/gallon.
- Fitch upgraded Greece from restricted default to B-minus with a stable outlook following the completion of the country's debt swap with private investors.
- Greece’s Presidential election is to be held on April 29th or May 6th, spokesman Pantelis Kapsis.
- Spain - Finance Minister Luis de Guindos said Spain would comply with a demand by euro-zone finance ministers that it cut its deficit to 5.3% of gross domestic product in 2012, while sticking to its 2013 target of 3%.
- UK - Fitch revises UK outlook to Negative from Stable, and keeps country at AAA.
- Russia – President Medvedev’s human rights council urged him to pardon Mikhail Khodorkovsky in his last weeks in office, presenting legal advice that this doesn’t need an admission of guilt from the former Yukos Oil Co. owner. The recommendation will be discussed at the council’s meeting with Medvedev next month. [PM and President-elect Putin will take over as head of state on May 7].
This week we added two European positions to the Hedgeye Virtual Portfolio, Spain (EWP) and Greece (GREK), both on the short side.
Despite the market’s recent optimism around the two rounds of 36-month LTROs and that we “cleared” Greece’s debt restructuring, we want to temper expectations that Europe is “out and in the clear”. While the LTROs have added needed liquidity to the system, there’s no evidence (yet) that this liquidity has enter the real economy. One negative data point we do continue to observe is Overnight Bank Deposits to the ECB, which is just off its high at €727.7 Billion. Further, this injection does nothing for solvency issues of banks; Spanish, Portuguese, and Italian lenders on the metric of 5YR CDS continue to flash risk levels that are comfortably above 350bps! While a re-pricing of Greek debt saw its 10YR sovereign bond yield fall nearly 1900bps in a straight line early this week, risk is clear and present in Portugal, with the 10YR at 13.6%. And while yields in Italy and Spain have trended lower YTD, there’s nothing that concretely justifies yields maintaining this retreat short of a Monti - Draghi handshake to take care of Italia.
While “cheap” credit flows should help to spark the region’s economy, it will be off a recessionary level in 2012, as outsized debt and deficits budge little and austerity takes a firm toll not only on confidence and spending but also government tax receipts. All this spells a very long runway ahead of slow growth, alongside threats of rising inflation, most notably from energy costs.
News out this week that Spain missed its 2011 deficit target was particularly representative of the structural fiscal imbalances versus expectations across much of the region. To review, Spanish PM Mariano Rajoy, elected in December of 2011, inherited a budget that was proved to be fudged, with the 2011 budget deficit now estimated at 8.5% of GDP versus a previous target at 6%. This gap has thrown off the 2012 budget deficit reduction program, and the government unilaterally (ex-EU agreement) revised its 2012 deficit target to 5.8% versus the original 4.4% promise. The EU this week said that wasn’t enough, and mandated that additional budget cuts worth 0.5% of GDP must be carried out.
Sound a bit like Greece? Can the market really believe Troika’s report that Greece can reduce its public debt to 120% of GDP by 2020? Does Troika even (truly) believe that given the myriad of variables between now and then? We don’t think so. What governments must realize is that shaving the fat off budgets is essential, but so are the expectations around meeting those cuts. Whether the EU or the countries themselves are responsible for setting goals that are too optimistic or too lenient (in trimming fat) is for another discussion, yet what’s important is that realistic targets are set around which markets can set expectations.
We do think that taking the pain now through fiscal austerity will sacrifice growth, but this is a necessary condition given the years of excess spending by the PIIGS (and others).
The road to maintain the existing Eurozone fabric is a clouded one. However, if it’s going to work, it will come at the hand of this fiscal consolidation and further bailouts to support the Eurozone project. There are plenty of arguments to justify an exit or dissolution of the Union, however here and now we won’t discount the fortitude of Eurocrats to hold the whole together, with shoe lace and all.
CDS Risk Monitor:
Short of Portugal, we did not see huge moves in 5YR CDS on a week-over-week basis. Portugal saw the biggest gain at +82bps to 1,311bps, followed by Ireland +15bps to 635bps. France saw the biggest drop (-10bps) to 169bps.
Eurozone Economic Sentiment 11 MAR vs -8.1 FEB
Eurozone CPI 2.7% FEB Y/Y vs 2.7% JAN
Eurozone Industrial Production -1.2% JAN Y/Y (exp. -0.8%) vs -1.8% DEC
EU New Car Registrations -9.7% FEB Y/Y vs -7.1% JAN
Eurozone Trade Balance -7.6B EUR JAN (exp. -3B EUR) vs 9.1B EUR DEC
Germany Wholesale Price Index 1.9% FEB M/M (exp. 1.0%) vs 1.2% JAN [2.6% FEB Y/Y (exp. 2.6%) vs 3.0% JAN]
Germany ZEW Current Account 37.6 MAR (exp. 41.5) vs 40.3 FEB
Germany ZEW Economic Sentiment 22.3 MAR (exp. 10) vs 5.4 FEB (highest since June 2010)
Italy Q4 GDP Final -0.7% Q/Q (exp. -0.7%) vs previous -0.7% [-0.4% Y/Y (exp. -0.5%) vs previous -0.5%]
Italy CPI 3.4% FEB Final Y/Y UNCH
France CPI 2.5% FEB Y/Y (exp. +2.6%) vs 2.6% JAN [fell for 2nd month]
Spain CPI 1.9% FEB Final Y/Y UNCH
Spain House Transactions -26.3% JAN Y/Y vs -25.3% DEC
Spain House Price ToT Homes Y/Y -4.2% in Q4 Y/Y vs -2.8% in Q3
Switzerland Producers and Import Prices 0.8% FEB M/M (exp. +0.2%) vs 0.0% JAN [-1.9% FEB Y/Y (exp. -2.4%) vs -2.4% JAN]
Switzerland Credit Suisse ZEW Survey Expectations of Growth 0.0 MAR vs -21.2 FEB
UK Claimant Count Rate 5% FEB vs 5% JAN
UK Jobless Claims Chg 7.2K FEB (est. 5K) vs 7K JAN (12th straight increase)
UK ILO Unemployment Rate 8.4% JAN vs 8.4% DEC
Greece Unemployment Rate 20.7% Q4 vs 17.7% in Q3
Greece Industrial Production -5.0% JAN Y/Y vs -11.3% DEC
Sweden Unemployment Rate (SA) 6% FEB vs 6% JAN
Sweden Unemployment Rate 7.8% FEB vs 8% JAN
Ireland CPI 2.1% FEB Y/Y vs 2.2% JAN
Ireland Industrial Production -0.5% JAN Y/Y vs -3.5% DEC
Portugal CPI 3.6% FEB Y/Y vs 3.4% JAN
Interest Rate Decisions:
(3/14) Norway – Norges Bank CUT Deposit Rates 50bps to 1.75%.
(3/15) Switzerland – SNB 3M Libor Target Rate UNCH at 0.00%
The European Week Ahead:
Monday: Jan. Eurozone Current Account, Construction Output; Jan. Italy Industrial Orders and Sales
Tuesday: Greece 14.5 B Euro Bond Redemption; Feb. Germany Producer Prices; Feb. UK CPI, Retail Price Index, RPI, CBI Trends; Jan. Greece Current Account; Jan. Spain Trade Balance
Wednesday: UK BoE Minutes, Osborne Announces Budget Plans; Feb. UK Public Finances, Public Sector Net Borrowing
Thursday: Mar. Eurozone Consumer Confidence and PMI Manufacturing, Services, Composite – Advance; Jan. Eurozone Industrial New Orders; Mar. Germany PMI Manufacturing and Services – Advance; Feb. UK Retail Sales, Consumer Confidence; Mar. France PMI Manufacturing and Services – Preliminary
Friday: Feb. UK BBA Loans for House Purchases; Mar. France Production Outlook Indicator, Business Confidence Indicator, Q4 France Wages – Final; Jan. Italy Retail Sales
Extended Calendar Call-Outs:
22 April: French Elections (Round 1) begin, to conclude in May.
29 April: Potential Greek Presidential Elections.
30 June: Deadline for EU Banks to meet €106 billion capital target/the 9% Tier 1 capital ratio.
1 July: ESM to come into force.
It’s amazing how far this company has come since the early days of 2009 when you couldn’t give the stock away. Today, the investment case remains compelling. The Starbucks turnaround has been nothing but spectacular and we continue to own the stock in the Hedgeye Virtual Portfolio.
Below, we have outlined some of the attributes of Starbucks that we believe will continue to fuel this company’s progress.
- A global retail footprint with 17,000 stores around the world; 60 million customer visits a week
- Frequency of customer visits that's perhaps unmatched in all of consumer
- Strong marketing and a social media presence that is innovative and authentic
- A rapidly growing and highly profitable consumer products business, which is allows the brand to grow “across multiple channels and multiple products globally.”
Below, we run through our thoughts on some of the more important topics raised by Troy Alstead, CFO of Starbucks, during a recent conference.
ELIMINATING THE MACRO RISK?
SBUX: “Prior to 2008, any bump up or down in consumer confidence was a bump up or down in that period of time to what happened in our stores, to our traffic, and to overall comp growth … we transformed the business over the last few years to focus on creating a wedge between those two lines, to give us some degree of insulation from what's happening in the overall macro environment to what happens in our stores. And, we've done that through things like our loyalty program, through elevating the customer experience in our stores back to the extremely high levels they had been historically and frankly to new levels.”
HEDGEYE: This is very interesting commentary about how Starbucks thinks about its business. However, we would argue that the unemployment rate jumping 1-2% would slow traffic – particularly during the morning day part. The following statement should raise eyebrows; “Today, the highest correlation to comp growth in our stores is our own satisfaction, as measured by our customers, in our stores.” Paying attention to the macro indicators helps forecast that weather or operating environment and we believe that paying attention to the prevailing economic winds remains an important part of an investment thesis for Starbucks.
LOYALITY IS KEY
SBUX: “The loyalty program and our loyal customer set overall is a critical element of what we have built over time … it's given us a much more tangible way now to communicate with our customers, to give them an opportunity to engage with the brand, and to be rewarded for that. We have a very, very powerful digital presence, similar to our loyalty program itself, gives customers a chance to engage with us, to be a part of that dialog, and that's – no question – for us been an important part of our recovery in our business in the last two years and we think it gives us opportunities to engage more deeply with our customers in the years ahead.”
HEDGEYE: Technology has become a key driver of successful loyalty programs and a big driver of incremental traffic for the better-positioned restaurant companies. With an expected one billion smart phone users, globally, by 2016, digital marketing is a must for every restaurant company and Starbucks is arguably one of the best companies, globally, at driving sales through new media.
LEVERAGING THE INFRACTURE
SBUX: “Our average unit volumes in our U.S. business stand at about $1.1 million today. That's the highest they've been in history and still more than half of that volume comes in the morning day part. Now, in recent years, we have slowly but surely begun to move the needle. That statistic I just threw out was 70% in the morning not all that long ago.”
HEDGEYE: When companies in the restaurant industry focus on operating their existing assets more efficiently, it is amazing how innovative they can be. Driving same-store sales over the next few years will be based primarily upon:
- Deepening offerings at lunch
- More relevant food options for the afternoon day part (Starbucks Petites Platform)
- Focusing on building sales of “attached-to-beverage” food items in the afternoon
- Raising the ceiling on capacity during busy morning period through technology (new POS system)
- Beverage innovation and general productivity.
"With our acquisition of Evolution Fresh, just very recently, this acquisition not only gives us an opportunity to significantly elevate and reinvent the $1.6-billion super-premium juice category, it also gives us a very significant next step into the overall $50-billion health and wellness category.
Consumers expect something different and differentiated when they come into Starbucks stores. We know that with our coffee beverages, our tea beverages, our food offerings and now with Evolution Fresh, we have the opportunity to elevate that within the Starbucks store as one pillar of introducing customers to this product. Standalone Evolution Fresh stores, concept stores which we'll open soon, and leveraging that further into the CPG channels."
HEDGEYE: Part of the growth profile of the company will be new unit growth. International, especially China will be a big part of that growth. Conceptually, we think the idea of expanding into the premium juice category could be successful for Starbucks but it will take a considerable amount of time before Evolution Fresh has any meaningful impact on the growth rate of the country.
SBUX: “Last week we announced our plans to round out our portfolio in the single-cup space by launching Verismo by Starbucks later this year. Verismo fills out this offering to consumers by being a high-pressure offering – a high-pressure machine that allow – that provides that espresso opportunity in the single-cup space really for the first time for Starbucks and in a meaningful way.”
HEDGEYE: The battle between GMCR and SBUX is just beginning and we are betting on SBUX is going to be the ultimate winner. Launching Starbucks K-Cups through the Keurig platform gave the company access to the largest installed base of single-cup brewers in the United States. Starbucks continues to speak diplomatically about Green Mountain but we do not see that as a long-lasting partnership.
SBUX: “Our long-term targets for margins in the CPG segment are at 30% or somewhat higher than that, we believe, over time. We had expected and targeted about 25% this year and that's about where we're trending at this point and that's driven by really two things.
Given visibility we have into coffee costs in the next year, which we now have a tailwind coming out of 2013 as well as lapping the investments we've made in the infrastructure in that division, we expect by the time we move into 2013 to move back into the upper 20%s and over the next two years to approach that 30% margin level again in CPG."
HEDGEYE: The CPG business is poised to show accelerating sales trends and stronger margins for the next two years. Coffee costs coming down sharply this year is very helpful for the CPG business; it was the hardest-hit during the recent spikes in the spot price of the commodity.
CPI numbers released this morning for apparel appear to be moving lock-step with the change in import prices. Apparel CPI rang in at +4.17% vs. last year. Big number, but a deceleration from 4.65% in Jan. It's really a nit-pick to note that this is a 'slow down.' Though it is worth noting that the rate has stopped going up.
What is worth noting (chart 1) is that when looking at the underlying trend on a 2-yr basis, the CPI is rolling at a greater rate, while import prices are still headed up.
We know that this is backward looking, and that input cost compares get easy in 2H. But the problem is that everyone and their grandmother knows this too. Most companies are baking this into their models, and their guidance. Importantly, they are not accounting for what will happen to their plan if a competitors' plan fails.
In other words, the consumer needs to continue to pay up for apparel. We need to continue to see low single digit yy CPI growth -- even though comps start to get extremely tough mid-summer.
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