China Is Boring

Conclusion:  While China looks to have limited downside from an economic growth perspective over the intermediate term, the same can be argued with regards to China’s upside growth potential over the long term, making the country uncharacteristically boring from a fundamental perspective.


As the world’s second-largest economy and arguably the single-most important source of global demand for raw materials (copper ~46%; aluminum ~42%; etc.), China matters a great deal to the Global Macro Universe. This is especially true on days where China is rumored to be: A) easing monetary and fiscal policy; B) bailing out the Eurozone; or C) falling off a cliff from an economic growth perspective.


On most other trading days, China has really taken on a reduced role in the calculus of the consensus fundamental outlook – which intuitively makes sense to us, given the consensus bullish bias within the U.S. financial newsmedia community and the fact that China's GROWTH/INFLATION/POLICY trends have largely been deteriorating for 2+ years now.


While almost trivial, we can’t help but remind clients that Chinese equities (via the Shanghai Composite Index) have been down quite a bit each of the past two years (2010: -14.3%; 2011: -21.7%) – underperforming U.S. equities (via the S&P 500) by a wide margin. The trend in Chinese equities is akin to the long-term decline in rates of Chinese economic growth.


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Again, while the more newsy headlines out of China and other countries have dominated the intermediate-term tops and bottoms of global equity, commodity, currency and bond markets in recent years, we always find it important to contextualize and handicap the trailing and future trends in Chinese growth, inflation and policy data. In doing so, we have created a process that helps us get ahead of the aforementioned headline risk.


China’s Multi-Duration Growth/Inflation/Policy Outlook:


TRADE: 3wks or less

At some not-yet-specified point over the next 48 hours, China will release its monthly New Loans and Money Supply data for the month of MAR. On APR 12, we’ll also receive China’s 1Q12 GDP report along with its MAR Industrial Production, Retail Sales, and Fixed Asset Investment figures. That will be followed by China’s [purposefully vague] Property Price statistics on APR 17. Most growth rates are forecasted by Bloomberg Consensus to be flat-to-down relative to the prior month/quarter.


Rather than pretend like we have any edge in modeling [likely] made-up statistics, we defer to the quant to get a real-time read on what these data points are likely to look like. Chinese equities, which recently snapped their immediate-term TRADE line, are still bullish from an intermediate-term TREND perspective. This setup tells us two things:

  1. The risk of a downside surprise in the data is much greater than the risk of an upside surprise; and
  2. The trend in reported Chinese growth data is likely to continue on its secular downtrend without a measured acceleration (to the downside) at the upcoming reporting juncture.

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In support of the latter claim, we point to the tug-of-war between China’s sequentially-improving MAR PMI reports and China’s sequentially-deteriorating MAR Trade data (particularly on the import side).


On the PMI front, China’s Manufacturing Index ticked up in MAR (alongside every subcomponent) to 53.1 from 51 prior; the new seasonally-adjusted Services Index ticked up to 58 from 57.3 prior.


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On the trade front, Chinese Export growth accelerated in MAR to +8.9% YoY from a +6.8% pace in the JAN-FEB period. Accelerating U.S. demand for Chinese goods (+14% YoY) overshadowed waning demand from the E.U. (-3.1% YoY). Chinese Import growth slowed in MAR to +5.4% YoY from an +8.2% pace in the JAN-FEB period; +5.4% YoY is the slowest pace of Chinese import demand growth since OCT ’09.


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TREND: 3mos or more

As highlighted in our recent work, we remain of the view that Chinese policymakers are unlikely to come out with any dramatic policy easing measures in the immediate-term. Rather, we expect Premier Jiabao’s to continue making good on his repeated promises of policy “fine tuning”, such as the recent increase in QFII quotas, SME bond pilot program development, RRR cuts, CNY15 billion SME credit facility, and relaxing of SME loan capital requirements.


Taken collectively, these and a growing list of other measures are supportive of Chinese growth on the margin; for example, SMEs account for 2/3rds of industrial output and employ 4/5ths of Chinese workers. That said, however, we remain convinced that China is unlikely to move the dial on its growth trajectory in a material way absent an implementation of the following two steps:

  1. Lowering interest rates; and
  2. Removing the curbs on real estate speculation.

Regarding step #1, we think China is indeed inching closer to cutting rates based on a combination of a dramatic decline in inflation/inflationary pressures, as well as a priced-in easing bias in China’s interest rate and FX markets. While the MAR CPI figure did accelerate to +3.6% YoY, our proprietary models and the Chinese yuan’s sustained outperformance of global food and energy prices (due to its now-convenient peg to the USD) both point to lower-highs in China’s reported inflation figures over the intermediate term.


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Regarding step #2, we continue to hold the belief that this China isn’t even in the area code of taking their foot off the brakes of their property market. Both rhetorically and actively – in the form of eschewing a signaling of a broader policy reversal in favor of “fine tuning” – Chinese policymakers remain committed to achieving their long-held goal of deflating the property market in an orderly fashion.


Further, it is unlikely that China will embark on such a dramatic inflection in policy so late in the leadership of the 17th  Politburo (its term concludes in MAR ’13), in our opinion. The ill-effects of the 2008-09 stimulus package haven’t yet truly come home to roost in China’s banking system – which extended CNY10.4 trillion ($1.7T) in credit in span of just 12 months through NOV ‘09. For China to move away from tight policy at the current juncture would be far from “prudent”, which both the PBOC and State Council have pledged to maintain in the policy arena as recently as last month.


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TAIL: 3yrs or less

Perhaps the most important conclusion we can stress is that if both of the aforementioned steps (#1 and #2) are not implemented largely in conjunction, we don’t see meaningful upside in China’s long-term economic growth potential. 


Much like valuation remains is not a catalyst to invest in a company, rate cuts are rarely a bullish catalyst for a country’s equity market if a positive inflection in economic growth (which, in theory, would be slowing during a rate cut cycle) is not within reach. Overlaying Chinese interest rates with the CRB Commodities Index or the Fed Funds Rate with the S&P 500 from 4Q07-1Q09 speaks volumes to this point. It remains prudent to avoid the classic consensus mistake of buying the dip the entire way down on monetary easing alone.


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Turning our attention back to China, we maintain our view that Chinese policymakers are well aware of the risk that being over-levered to investment – particularly real estate investment – poses to their economic growth potential. Specifically, at 48.6% of GDP, China’s ratio of “I” to GDP is greater now than the corresponding ratios of any of the countries that were most affected by the 1997-98 Asian Financial Crisis from a capital outflow perspective leading up to and through that event.


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To mitigate the risk of destabilizing capital outflows and a corresponding banking crisis over the long term, the State Council has called for a structural downshift in the rate of Chinese economic growth to +7.5% per annum, as well as a rebalancing towards increased household consumption in lieu of further investment. While mean reversion in the aforementioned GDP expenditure ratios seems likely over the long term, it remains to be seen whether or not Chinese policymakers have enough savvy and firepower to ensure an orderly transition over the long-term TAIL. History would suggest China’s odds of a structural “soft landing” are not favorable.


Looking to China’s property market, which is the primary beneficiary of high rates of domestic investment, the latest supply and demand data suggests real estate prices are quite likely to be headed lower on a sustained basis.


In the JAN-FEB period, the growth rate of completed supply accelerated to an all-time high of +45.2% YoY as seen in the Floor Space of Buildings Completed series. From a pending supply perspective, growth in Floor Space of Buildings Under Construction accelerated to +35.5% YoY in the JAN-FEB period – good for the second-highest rate on record. The State Council’s goal of building 36 million units of affordable housing from 2011-2015 is a key policy initiative affecting the underlying trends in supply.


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From a demand perspective, growth in Total Sales of Buildings slowed in JAN-FEB to an all-time low rate of -20.8% YoY. Moreover, growth in Floor Space of Buildings Sold and Floor Space of Residential Buildings Sold have each slowed to multi-year lows of -14% YoY and -15.9% YoY, respectively.


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Looking at the investment climate, the one positive data point we’d highlight is that growth in domestic financing for real estate investment accelerated to +16.3% YoY in JAN-FEB, which is the fastest rate of growth since NOV ’10. That said, however, China Economic Network’s Real Estate Climate Index ticked down to a 32-month low of 97.89 in the JAN-FEB period; the index’s YoY growth rate of -4.9% is the slowest rate since JUN ’09.


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With supply increasing at much higher rate than any measure of demand, continued price declines seem likely and may be poised to accelerate. Our financials team, led by Josh Steiner, has shown that demand leads U.S. housing prices by one full year. While certainly not an apples-to-apples case study, one would expect Chinese property prices to continue trending lower over the long-term TAIL given the current and [likely] future supply and demand imbalance – a setup which doesn’t look to inflect in a meaningful way absent the implementation of the aforementioned steps “#1” and “#2”.


The one bright spot we’d point to that lets us know that the Chinese property market isn’t quite falling off a cliff – at least not yet – is growth in China’s raw materials demand (consumption), which has largely trended sideways over the last 18 months. Even amid the Great Recession/Global Financial Crisis, Chinese demand for raw materials only briefly went moderately negative from a YoY perspective, suggesting to us that any sustained declines here would be quite an ominous signal for China’s Fixed Assets Investment Growth.


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All told, while China looks to have limited downside from an economic growth perspective over the intermediate term, the same can be argued with regards to China’s upside growth potential over the long term, making the country uncharacteristically boring from a fundamental perspective. Further, while not a great thesis, playing for mean reversion on the long side of Chinese equities in a strong-dollar environment is about all that an investor can hope for at the current juncture.


Darius Dale

Senior Analyst

Prepare The Pile

This note was originally published April 10, 2012 at 07:21am ET.



“The key is not to predict the future, but to be prepared for it.”



I was on a plane to Denver last night and was reviewing some of the required reading in my pile. For those of you un-familiar with my research process, my pile is part of it. I never leave home without it. I typically read my pile on a 1-3 week lag.


The Pile revealed 2 different perspectives on preparing for the future trajectory of long-term Global Economic Growth:

  1. Goldman Sachs: Global Strategy Paper No. 4 – “The Long Good Buy” (March 21, 2012)
  2. Reinhart & Rogoff: “Five Years After Crisis, No Normal Recovery” (April 2, 2012)

Goldman’s view acknowledges that “future growth may be lower than experienced over the past decade in many parts of the world”, but that equities are already pricing in “unrealistically large declines in growth.” They’re making both a growth and valuation call.


Reinhart & Rogoff suggest that “the concepts of recession and recovery need to take on new meaning” and that “financial crises leave behind deep recessions of long duration and considerable volatility.” They’re calling for debt and volatility to slow growth.


The Pile did not change my 5 year-old view on the Global Growth Cycle. Neither did it change my risk management process. From these debt and deficit levels, Big Government Interventions in our markets and economies will continue to:


A)     Shorten economic cycles

B)      Amplify market volatility


As growth slows, “cheap” markets get cheaper. Valuation isn’t a catalyst until growth re-accelerates.


Back to the Global Macro Grind


While it’s interesting to observe the emotion and Storytelling associated with why the US stocks are going down, this morning’s Global Macro research process reveals pretty much the same thing we have been flagging since February. While Growth Slowing, globally, may be new to a US stock market centric media consensus, it’s not new to the rest of the world.


Here’s a quick Global Equity market update:


1.   ASIA – context is always critical, so it’s important to acknowledge that 2 of the major leading indicators in Asia, the Hang Seng and the Nikkei, stopped going up on February 29th and March 27th, respectively. Inclusive of this week’s declines, the Hang Seng and Nikkei are down -6.1% and -7.0% from their YTD tops. India, Australia, and Singapore are all bearish TRADE.


2.   EUROPE – if Germany’s DAX is susceptible to a 6.2% correction from its YTD high (March 15th), any equity market in the world is. Germany’s employment situation is much more stable than that of the US, despite neighboring some of the most dysfunctional debt/deficit laden countries in the world. Spain is the Global Macro train wreck of the YTD, down -11%.


3.   USA – the SP500 finally broke our immediate-term TRADE line of 1391 support yesterday, but has only corrected -2.6% from its April 2nd top. The Russell 2000 stopped going up 3 weeks ago and is down -5.1% from its March 26th top (immediate-term TRADE resistance there is now 822). As for the 50-day moving averages – we only use them for behavioral observations.


The rest of the world, of course, doesn’t hinge on Dow 13,000 or the price of Apple. It’s globally interconnected, across asset classes, from countries, to currencies, bonds, and commodities.


Here are my Top 10 cross asset class callouts to make a note of this morning:

  1. US Equity Volatility (VIX) has held its long-term TAIL of 14.41 support and is now breaking out above our 16.24 TRADE line
  2. Oil Volatility (OVX) remains above its immediate-term TRADE line of 28.43 support as Oil prices break TRADE support
  3. Brent Oil (BNO) has finally broken its immediate-term TRADE support line of $124.23/barrel
  4. Copper continues to be broken from a long-term TAIL perspective and immediate-term TRADE resistance = $3.85/lb
  5. Gold is in a freshly formed Bearish Formation (bearish TRADE, TREND, and TAIL) with next support = $1616/oz
  6. Spanish and Italian 10yr bond yields remain in a Bullish Formation (bullish TRADE, TREND, and TAIL)
  7. US Treasury 10yr bond yields continue to signal Growth Slowing, under both TRADE resistance of 2.18% and TAIL 2.47%
  8. US Treasury Curve Yield Spread (10s minus 2s), which is a proxy for growth’s slope, has compressed 14bps wk/wk
  9. US Dollar Index is moving into a stealth Bullish Formation with intermediate-term TREND support = $79.55
  10. Japanese Yen is bumping up against another lower long-term high at $81.23 (vs USD) and remains in a Bearish Formation

I have a passion for my team’s process because it’s had repeatable success in revealing the deep simplicity of Growth and Inflation Accelerating or Decelerating, globally, on a real-time basis. I Prepare The Pile every day so that I am always reading the counter punches to our overall risk management conclusions, but I do not defer to The Pile’s views based on short-term market moves.


What we’ve all had the opportunity to learn in the last 5 years is that if you get the intermediate-term TRENDS in both Growth and Inflation right, and you’ll get a lot of other things right. Valuation calls with no catalysts are called opinions. If you’re using the wrong Global Economic Growth assumptions, you’re basing your “valuation” work on the wrong numbers anyway.


My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, and the SP500 are now $1616-1655, $121.31-123.84, $79.55-80.16, and 1374-1391, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Prepare The Pile - Chart of the Day


Prepare The Pile - Virtual Portfolio


Keith shorted MGM in the Hedgeye Virtual Portfolio at $13.70.  According to his model, the TRADE resistance is $14.06 and the TREND support is at $12.93.



While Q1 should be ok, we think the Street's estimates for Q2-Q4 are aggressive.  Numbers just released from Nevada for February were in line with our projections while March faces a difficult comp despite 2 extra weekend days.  The Q2 calendar is unfavorable and the US jobs picture looks a little bleaker.  As it is, we are projecting 15% company wide EBITDA growth for 2012 and we are one of the lower estimates on the Street.   




Preliminary April forecast of HK $24-25 billion, up 21-25% YoY



Average daily table revenues (ADTR) were HK$768 million for the first 9 days of April, slightly above the March run rate.  However, 4 of the 9 days were weekend days so ADTR should be higher.  We are currently projecting HK$24-25 billion in full month GGR for April, up 21-25% YoY.  Relative to the first 8 days of April last year, ADTR was up 15% but those 8 days contained only 2 weekend days which indicates there would be a little downside to our estimate.  However, the opening of SCC this week should juice the numbers into our range.  The April hold comparison is much more difficult than March (approximately 30bps of hold %).  March was the last of the easy comparisons.




In terms of market share, Galaxy is the only company significantly below trend while MGM is the only one significantly above.  With LVS opening up SCC this week, we would expect to see its shares rise, mostly at the expense of Galaxy and WYNN.



SMP Buying Stuck at Zero

Position in Europe: Long Germany (EWG)

For a fourth straight week the ECB's secondary sovereign bond purchasing program, the Securities Market Program (SMP), purchased no sovereign paper for the latest week ended 4/6, to take the total program to €214 Billion.


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 ended 1/12.


While the Bank has been in a wait and watch pattern, European capital markets are far from still.  As a risk signal, sovereign bond yields for the Spanish and Italian 10YR maturity are trading up 100bps and 84bps month-over-month to 5.95% and 5.61%, respectively.


While there are other channels to suck up sovereign bond issuance, including funding from the two 36-month LTRO programs, the SMP’s lack of buying may send a negative signal to market participants. This has perhaps been witnessed in recent weeks by sovereign auctions in which average yields were priced higher than previous auctions. This is an inflection versus February and the first half of March in which most European bond auctions went off with lower yields than previous issuance.


Europe’s response to its sovereign and banking “crisis” remains a reactive one. There's been no increase to the collective size of the EFSF and ESM, while the inability of Spain to reduce its fiscal imbalances is creating increased market nervousness. Should bonds yields continue to break out, we may see the ECB get involved again, perhaps by renewing its secondary bond purchasing.


SMP Buying Stuck at Zero - 11. smp


Matthew Hedrick

Senior Analyst








Comments: Keith closed out the PFCB position yesterday, based on quantitative factors.  We remain bullish on the intermediate term TREND from a fundamental perspective.




Comments: Keith shorted BWLD yesterday in the virtual portfolio.  We continue to like it on the short side.  20% COGS inflation after seeing zero margin flow-through in a much more benign cost environment last quarter is going to pose a problem.  At the recent Telsey Advisory Group presentation, nobody brought up commodity pressures. 




Commentary from CEO Keith McCullough


Pick your leading indicator in Global Macro – most stopped going up in late Feb/early March:

  1. HANG SENG – Hong Kong did not like the Chinese demand message for March w/ Chinese Imports only running +5.3% y/y; HK traded down another -1.1% overnight, taking the Hang Seng’s correction to -6.1% since peaking Feb 29th
  2. DAX – from an employment and stability perspective, Germany is definitely a healthier economy than the USA’s right now and the correction in German stocks is 2x that of the SP500’s; down -0.9% to start the wk (down -6.2% from the YTD high established March 16th)
  3. COMMODITIES – Dollar up days crush commodities; evidently dollar down days don’t help them now either as “weakening demand” rolls off the tongues of most who’s business is global. The CRB index is in what we call a Bearish Formation. Not good. Brent Oil broke $124.23 TRADE line support.

Growth Slowing will matter until growth slows at a slower rate.







THE HBM: MCD, DRI, CBRL - subsector




MCD: has an interesting page on the McDonald’s Political Action Committee which details its spending by election cycle and also the party split per cycle of spending.  It shows that from 1998 through 2006, 84% of the Federal McDonald’s PAC was spent supporting Republicans.  In 2008, 70% of the PAC’s spend went to Republicans.  In 2010, the GOP and Democratic party received 52% and 47% of the PAC’s spend, respectively. 


MCD: MCD Japan’s March same-store sales gained 6% year-over-year.  March 2011 performance, of course, was greatly impacted by the earthquake and tsunami of March 11th, 2011.





CMG: Chipotle gained in a down tape yesterday.  Unit level returns remain strong as this growth story sustains itself longer than many have expected along the way.


MCD: McDonald’s gained in a down tape yesterday.


DOM.LN: Domino's UK & Ireland cannot catch a bid.  The stock is down 10% since reporting disappointing comps on 3/28.





CBRL: Cracker Barrel adopted a new shareholder rights plan with a 20% triggering threshold and a qualifying offer exception.  The Board also declared a dividend distribution of one preferred share purchase right on each outstanding share of CBRL common stock.  The Board’s action, according to CEO Sandra Cochran, is “in response to Biglari Holdings’ continuing open-market acquisition program of CBRL shares”.


DRI: Darden is planning to create the world’s largest lobster farm in Malaysia, allowing it to sell the crustaceans in Asia and supply them to its chains such as Red Lobster.



RT: The market didn’t buy on the leg down.  Ruby Tuesday declined 4.1% on accelerating volume yesterday.


THE HBM: MCD, DRI, CBRL - stocks



Howard Penney

Managing Director


Rory Green



Early Look

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