Hedging The Inflation Trade: EWZ & EWA Combo Trade Update

Conclusion: Our refreshed GROWTH/INFLATION/POLICY outlook points to more downside in both Australian equities and the Aussie dollar relative to Brazilian equities and the Brazilian real over the intermediate-term TREND. Further, we continue to like Brazilian equities on their own merits over the intermediate term – irrespective of this pairing – as a deflating of the inflation provides additional headroom for growth-supportive monetary and fiscal policy amid a baseline backdrop of accelerating real GDP growth.


Virtual Portfolio Positioning: Closed our long position in Brazilian equities (EWZ); and currently short Australian equities (EWA).


Late last week, Keith initiated a long position in Brazilian equities and opened a short position in Australian equities in our Virtual Portfolio (the former has since been booked for a +2.4% gain). While both benchmark indices are fairly levered to the inflation trade, we find that Brazil’s domestic fundamentals are more supportive of equity returns and multiple expansion than Australia’s at this current juncture.


Hedging The Inflation Trade: EWZ & EWA Combo Trade Update - 1


Starting from our baseline GROWTH/INFLATION/POLICY model, Brazil’s 2Q12 outlook appears decidedly more positive than Australia’s from an equity investor’s perspective. We are comfortable adopting this baseline scenario in part due to it being confirmed by the latest high-frequency data via the slopes of both countries’ PMI, employment, and inflation statistics.


Hedging The Inflation Trade: EWZ & EWA Combo Trade Update - BRAZIL


Hedging The Inflation Trade: EWZ & EWA Combo Trade Update - AUSTRALIA


Hedging The Inflation Trade: EWZ & EWA Combo Trade Update - 4


Hedging The Inflation Trade: EWZ & EWA Combo Trade Update - 5


Hedging The Inflation Trade: EWZ & EWA Combo Trade Update - 6


From a foreign exchange risk perspective (both etfs are un-hedged), we continue to see long-term mean reversion risk in the Aussie dollar vs. the U.S. Dollar. For more details regarding this thesis, refer the following notes listed at the conclusion of this note. From an intermediate-term perspective, the Aussie dollar also looks poised to make lower-highs vs. the USD given the AUD/USD currency pair’s preponderance to trade in tandem with commodities and U.S. equities – two asset classes we are explicitly bearish on (short the SPY; ZERO percent allocation to commodities in the HAA). 

  • Trailing 3yr correlation to the CRB Index: +93%; and
  • Trailing 3yr correlation to the S&P 500: +94%. 

Looking at the Brazilian real, there appears to be less downside risk from a mean reversion perspective. The real – which is down -5.8% over the last month vs. the USD amid a politicized commitment to lower the country’s aggregate interest rate burden – is down -8.4% over the LTM and up only +38.5% since its trough financial crisis exchange rate (12/8/08). This compares rather lightly to the Aussie dollar’s +74.9% gain from its trough financial crisis exchange rate (10/27/08).


While the various interest rate markets of both countries are signaling an outlook for continued monetary easing, Australia’s are pricing in decidedly less easing over the NTM – which intuitively makes sense given RBA Governor Glenn Stevens’ reputation as the developed world’s most hawkish central bank chief, as well as Brazilian Central Bank President Alexandre Tombini’s drive to achieve and sustain mid-to-high single digit interest rates in Brazil (with political pressure from President Dilma Rousseff and Finance Minister Guido Mantega).


Hedging The Inflation Trade: EWZ & EWA Combo Trade Update - 7


Hedging The Inflation Trade: EWZ & EWA Combo Trade Update - 8


Net-net-net, our refreshed GROWTH/INFLATION/POLICY outlook points to more downside in both Australian equities and the Aussie dollar relative to Brazilian equities and the Brazilian real over the intermediate-term TREND. Our quantitative risk management levels on both countries’ benchmark equity index are included in the charts below.


Hedging The Inflation Trade: EWZ & EWA Combo Trade Update - 9


Hedging The Inflation Trade: EWZ & EWA Combo Trade Update - 10


Bearish Thesis on the Aussie Dollar:

Bullish Thesis on Brazilian Equities:

Darius Dale

Senior Analyst

PVH: Still Positive Pre & Post Qtr


Conclusion: True to form, PVH raised its outlook intra-quarter and we expect that also true to form it will come in close to a dime above Street estimates – that’s expected. We think the 2012 outlook is headed higher as a result. With our model at nearly $1 above the Street two-years out in 2013, we also expect an acceleration in revisions and expectations ahead for one of our favorite large-cap names in 2012.


TRADE (3-Weeks or Less):

We’re at $1.15 for PVH headed into Tuesday’s print after the close, which is ahead of the Street at $1.09 and guidance of $1.08-$1.10.

  • Over the last three quarters, PVH has come in above consensus by an average of +3% on revenues and +9% on EPS. We don’t think PVH results broke this cadence in Q4.
  • We expect sales to come in better than expected up +9% vs. +6.5%E in Q4 driven by CK up +14% to $284mm, Tommy up +12% to $788mm and the Heritage business essentially flat up +1% to $450mm. With sales running ahead of plan through the first two months of the quarter, we have little reason to suggest that the sales trajectory changed meaningfully in the last month based on what we’ve heard and seen across the rest of retail.
  • As a result of stronger top-line results, we are at GMs of 51.3% reflecting -150bps of contraction over 100bps better than Street expectations for -260bps. Moreover, with the inventory setup favorable heading into year-end, we don’t expect atypical seasonal promotional activity beyond elevated clearance in the Heritage segment.
  • In addition, we expect SG&A of $642mm up 5.5% yy reflecting 140bps of leverage.
  • Short interest remains very low at ~3% of the float.
  • Interestingly, sentiment as measured by our index has become more bullish over the last two-months with the stock up +26% YTD vs. the MVR up +18% and the S&P up +10%.

TREND (3-Months or More):

With the Tommy acquisition no longer artificially boosting sales in 2012, we expect top-line sales to slow on the margin in 1H and to +6.5% for the full-year reflecting uncertain demand at best in Europe and a turn in Fx to a headwind from a +2-4% tailwind in 2011. In addition, we think incremental marketing spend which has proven to be a key sales driver in 2011 and continued uncertainty leading to tighter inventory commitments from European retailers will keep earnings growth at a mid-teens rate. We’re at $6.21 vs. $6.02E in 2012.

  • At CK, we expect revenues to slow modestly next year up +10.5% from +14.5% in 2011 with +8% growth in licensing and +12% growth in apparel driven by continued growth in underwear as well as the new Power Stretch jeans line.
  • At Tommy, with most of its growth coming out of Europe (Germany and Spain top two markets by size), we expect demand to slow over in 1H of 2012 with continued weakness in Spain a key intermediate-term variable.
  • The Heritage business is unquestionably the odd man out among the three businesses over the next two quarters. It’s undergoing a transformation getting out of unprofitable/underperforming lines in 2012. Timberland accounted for ~$80mm in revs, which will account for a 4-5% reduction in sales growth while we expect the core business to stabilize. Coming in ~3pts below historical operating margins of 10% in 2011, we expect profitability to improve (+110bps) on a lower revenue base in 2012.

TAIL (3-Years or Less):

While PVH works to stabilize its cash flow business (Heritage), it’s doing what the best brands do that license out their brands in order to grow into international markets – it’s starting to take back control of its own content. Driving brand sales directly at higher margin was key to RL’s success through much of the last decade as the company bought in its licenses. We don’t expect PVH to be any different.


In fact, as we recently highlighted in our note “PVH/WRC: Understanding Licenses is Key,” we detailed how the recent CK bridge line it took back from WRC could add up to $0.75 in EPS 3-4 years out. Add on a few more of these and PVH’s earnings power could change materially higher.


We see continued upside at Tommy as well as CK resulting in EPS of $8 in 2013, a buck above consensus expectations. Following a strong end to the year, we expect an acceleration in revisions and expectations ahead for one of our favorite large-cap names along with RL and VFC in 2012.


Casey Flavin



PVH: Still Positive Pre & Post Qtr - PVH Sentiment


Management commentary from Q3 call: 

PVH: Still Positive Pre & Post Qtr - PVH Q3 Youtube


Below is a table outlining WRC's product/license portfolio as highlighted in our note “PVH/WRC: Understanding Licenses is Key”:


PVH: Still Positive Pre & Post Qtr - WRC CK Table





Priced to Perfection?: Short MUB Trade Update

Conclusion: We think any asset class that is trading just shy of all-time highs in prices without a clear outlook for continued improvement in its fundamentals is rife with asymmetric risk to the downside. 


On Friday afternoon, Keith shorted the iShares National Municipal Bond Fund (ticker: MUB) in our Virtual Portfolio. In short, the fundamental thesis behind putting on this risk exposure is twofold: 

  1. From a long-term perspective, we think muni bond yields will rise amid our belief that U.S. interest rates are poised to continue making higher-lows; and
  2. The view that municipal issuers are experiencing a structural improvement in credit quality becomes decidedly less supportive going forward, posing a risk to muni bond prices as demand from the marginal investor slows. 

Looking at muni bond prices from an average yield to maturity perspective, the Bond Buyer U.S. 40 Municipal Bond Index is currently yields 4.65%, down from a cyclical peak of 5.95% in JAN ’11. Then, the story was growing fear of default and oversupply amid an expiration of the Build America Bond program. Since then, muni issuers (particularly on the State side) have shrugged off these credit concerns and continued to strengthen their balance sheets by dramatically reducing expenditures – even amid a sharp decline in federal support.


Priced to Perfection?: Short MUB Trade Update - 1


Priced to Perfection?: Short MUB Trade Update - 2


Now the question going forward is: “How much better can it get from a credit perspective?” While that doesn’t imply an immediate reduction in issuer credit quality, it does imply that fundamentals are unlikely to continue improving from what is known/priced in.  As the chart above highlights, States’ need for fiscal consolidation (i.e. the “hurdle” they must clear from a credit quality perspective) has declined to at least a four-year low in FY13 and is only ~1/4th  the size of the “hurdle” that was cleared in FY10.


Broken TRADE and TREND on our PRICE/VOLUME/VOLATILITY model, the MUB etf is signaling to us that tough questions are, at a minimum, starting to be asked in this traditionally-opaque market. Tough questions, such as: “If Obama wins reelection and the Democrats do better-than-expected in Congressional elections, will the tax exemption of muni bond income come under increased legislative scrutiny as Obama looks to secure additional funding for his ‘fair share’ initiative(s)?” do pose risk to the muni market from a price discovery perspective given that muni bond prices are just shy of their all-time peak (+14bps from YTM perspective).


Priced to Perfection?: Short MUB Trade Update - 3


Priced to Perfection?: Short MUB Trade Update - 4


All told, we think any asset class that is trading just shy of all-time highs in prices without a clear outlook for continued improvement in its fundamentals is rife with asymmetric risk to the downside. Muni bonds fit this framework like a glove; as such, we have decided to trade around muni bonds on the short side in our Virtual Portfolio.


Darius Dale

Senior Analyst

Early Look

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European Banking Monitor: Pain in Spain

Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor".  If you'd like to receive the work of the Financials team or request a trial please email .


Key Takeaways:

* Spain and its banks are getting worse. Spanish bank default swaps were materially wider week-over-week, rising an average 74 bps, or 18%. All six of Spain's major banks, on which swaps trade, are trading well over 300 bps (the "Lehman line"). Spanish Sovereign swaps widened by 27 bps to 427 bps. While most investors are focused on the rapid deterioration taking place in Portugal, we think Spain is the one to watch more closely. Will 2012 be a redux of 2011 on the Europe front, this time with Spain playing the lead role? Looking at sovereign and bank swaps of a country in conjunction has generally been a solid cointegrated risk measure.    



Euribor-OIS spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread tightened by 3 bps to 45 bps.


 European Banking Monitor: Pain in Spain - 11. euriibor


ECB Liquidity Recourse to the Deposit Facility – The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB.  Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system.  An increase in this metric shows that banks are borrowing from the ECB.  In other words, the deposit facility measures one element of the ECB response to the crisis.  The facility reached €785.4 Billion on 3/23.


European Banking Monitor: Pain in Spain - 11.  ecb facility


European Financials CDS Monitor – Bank swaps were wider in Europe last week for 35 of the 40 reference entities. The average widening was 5.6% and the median widening was 6.0%.


European Banking Monitor: Pain in Spain - 11. banks


Security Market Program – The ECB's secondary sovereign bond purchasing program purchased no sovereign paper in the week ended 3/23, for a second straight week of zero buying. February-to-date the Bank has purchased a mere €210 Million versus €2.2 BILLION in the week ended 1/20 and €3.8 BILLION in the week 1/12. When questioned on the lack of buying over recent weeks, ECB President Draghi has only answered that the SMP is a non-standard measure that is “neither eternal nor infinite.” Clearly, with the some €1 Trillion injection of liquidity across the LTROs, the Bank is paring back buying and watching the results of sovereign bond auctions.


European Banking Monitor: Pain in Spain - 11. SMP


Matthew Hedrick

Senior Analyst


Lowering March GGR forecast to HK$23.5-24 billion.



Macau saw some deceleration this week with daily table revenues (ADTR) slowing to HK$664MM from HK$775MM last week and February’s ADTR of HK$776MM. With less than a week left in March, we are lowering our March forecast to HK$23.5-24BN, up 21% to 23% YoY.  As a reminder, March 2011 was the lowest hold month of year at just 2.66% (adjusting for direct play volume of ~6.6% or HK$4.5BN), so the comparisons are going to get tougher for the rest of the year.  While SCC should grow the market, 2011 also had the opening of Galaxy Macau, so the stimulation from new supply should be similar.  We have seen a YoY deceleration play out throughout the last 3 weeks where YoY went from 51% for the week ending 3/11, to 24% for the week ending 3/18, down to 17% this week.


The slowdown in the numbers was also reflected in lower volumes seen across the main gaming floors, so it’s unclear if all of the deceleration seen this week is simply due to changes in weekly hold rates.  Some have speculated that the slowdown could be partly due to some punters holding off their visits for the opening of Sands Cotai Central which is due to open just a few weeks from now.  However, the slowdown prior to new openings has been a little closer in historically.




In terms of market share, Galaxy was the biggest winner this week while WYNN was the biggest share donor.  We believe that the shift in market share was largely due to good luck at Galaxy and poor hold at Wynn.  MPEL’s weekly share was above its MTD trend, while LVS, MGM and SJM all were below MTD share. 








Commodity Prices




A massive beef recall in Canada has crossed the border, leading the Seattle branch of a major food distributor to recall 16,800 pounds of ground-beef patties that may be contaminated with dangerous bacteria, according to the Seattle Times.



Commentary from CEO Keith McCullough


Top 3 Most Read (on Bloomberg terminal): #1 Spain Firewall #2 Asian Stocks Fall and #3 China Soft Landing – now we’re talking:

  1. JAPAN – clients want a “catalyst” in the Japanese Sov Debt Crisis – here’s mine: gravity. The Yen kicks off the week down -0.4% vs the USD (after Goldman said buy Yen Fri) and former exec director of the BOJ (Hirano, from 2002-2006) saying that Japan has “crossed the Rubicon with really desperate measures.”
  2. SPAIN – continued selling in Spanish stocks, down -1.8% to start the week and now down -5.1% for the YTD (vs Germany +18.6%) and Super Mario Monti wants “firewall.” It ain’t over, till its over folks.
  3. COPPER – the Doctor continues to look exactly like the slope of global growth, slowing. Copper now bearish TRADE and TAIL w/ big TRADE resistance overhead at $3.85/lb.

You’d think that after the worst week for Asian and European stocks in 2012, the bull would be back this morn. Nope.







THE HBM: BEEF, WEN, BJRI - subsector 2





WEN: Wendy’s is claiming to be the first fast food company to back a new system that replaces the food processing industry standard practice of stunning chickens with electricity with a new low-atmospheric pressure system that renders the chickens unconscious before the birds are handled by plant workers.  The company says it is working with its U.S. and Canadian pork suppliers to reduce the use of crates. 




PEET: Peet’s coffee gained 5.5% on accelerating volume.  Declining coffee prices continue to help this company.





BJRI: BJ’s Restaurants was raised to Outperform from Neutral at Wedbush.




DRI: Darden declined on accelerating volume as concerns about the “choppy” macro environment and seafood inflation at Red Lobster.


THE HBM: BEEF, WEN, BJRI - stocks 2



Howard Penney

Managing Director


Rory Green



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