Earnings Week At Hedgeye: Spotlight On Financials


Our financials team, led by Josh Steiner, has provided their key takeaways for earnings in the financial sector this quarter, which are outlined in the bullet points below.  Based on our quantitative levels, XLF is bearish on both TRADE and bullish on TREND.



Earnings Week At Hedgeye: Spotlight On Financials  - image001



1.            Earnings Season Update. Roughly one third of financial companies have reported earnings so far. 7 of  the 8 large or mid cap companies have beaten estimates on the bottom line. Revenue trends have been more mixed, with just over 1/3 beating estimates, 1/3 in-line and just under 1/3 missing.  However, this is a bit misleading because of Debt Value Adjustment. With DVA, the big banks’ revenue lines are adversely affected by an accounting convention that requires them to recognize negative revenues when their credit default swaps tighten.  First quarter saw sizeable CDS tightening, so the headwind was significant for all the large-cap capital markets sensitive names: C, JPM, BAC, GS, MS.


Other notable trends thus far include the regional banks outperforming the Moneycenter banks on both NIM (net interest margin) and loan growth. Regional banks M&T (MTB), Commerce (CBSH) and US Bancorp (USB) have all posted positive sequential loan growth this quarter, while Wells Fargo, JPMorgan and Citigroup have all posted negative growth. On the margin front, we’ve seen the strongest results from the regional banks where NIM has been flat to up quarter over quarter vs. a mixed bag at the Moneycenters with JPMorgan down 9 bps. Market reaction to the results has been roughly evenly split between gains and losses following the reports.


2.            Looking Ahead. Financial heavyweights yet to report include Bank of America (BAC), Morgan Stanley (MS), Capital One (COF), American Express (AXP), MasterCard (MA) and Visa (V). Thus far we’ve seen strong first quarter results in both mortgage banking and consumer-related credit, i.e. credit card.  Bank of America has sizeable exposures to both these categories, and considering the kitchen sink nature of their 4Q results, we wouldn’t be surprised to see strong results when they report Thursday morning. Morgan Stanley typically mirrors Goldman and JPMorgan, where results were frankly solid, but the reaction in the stocks was lackluster. As a further headwind, Morgan Stanley has less capital markets exposure, which was the source of Goldman’s improvement this quarter.


Looking at the credit card stocks, the playbook is always to look at Discover, as they are off-cycle and so we got their first quarter results a month ago. The big surprise there was much larger than expected reserve release. (Companies release reserves when they believe that credit quality is going to be better in the future than it is today. Released reserves flow through the income statement, adding to reported earnings.) We’d expect to see the same reserve release dynamic at Capital One and American Express. On the card volume side, intra-quarter updates thus far from Amex, Visa and MasterCard have all been reasonably consistent in suggesting activity has been stable compared to strong fourth quarter trends.


3.            Sector Outlook. Financials have been among the strongest performing sectors YTD on the back of European discount reflation and an improving perception of the US economic recovery. The calendar also plays a role: distortions to the seasonal adjustment factors have caused the September through February data to look stronger than it is (and the March through August data looks worse) since the bankruptcy of Lehman Brothers. This is a contributing factor to why the XLF, the Financials sector ETF, peaked on February 21, 2011 and lost 35% of its value by October 3, 2011 and why it peaked on April 15, 2010 and lost 23% of its value by August 25th, 2010. For reference, the XLF recently put in a closing high of $15.98 on March 26, 2012. We think there’s a very good chance that this year plays out like the last two years.


Keith shorted ASCA in the Hedgeye Virtual Portfolio at $18.81.  According to his model, the TRADE resistance is $18.89 and TREND resistance is at $20.38.



Despite much better weather and a favorable calendar, ASCA may disappoint investors when they report 1Q earnings in early May.  In particular, ASCA Kansas City was impacted by the new Kansas casino opening and some of their other markets failed to capitalize on what should’ve been a very strong quarter.  While we like ASCA’s management team, ROI focus, and competitive positioning, our longer-term outlook on regional gaming is grim as demographics, the housing malaise, and other long term trends should continue to weigh on casino demand.














U.S. retail sales fell 1% for the week ended April 14th, according to the ICSC-Goldman Sachs weekly retail sales report.  This was the first decline in three weeks.


Commentary from CEO Keith McCullough


Trying to be on vaca w/ the family this wk – updates will be short:

  1. JAPAN – the Nikkei was down for the 9th of the last 10 trading sessions last night, taking its correction from the March YTD top to -7.7%; Asian equities were generally weak w/ the exception of India who reverted to the broken playbook, cutting rates.
  2. SPAIN – you learn the most about bear markets on the bounces – this morning’s in Spanish Equities on no-volume tells you all you need to know as people keep focusing on last year’s game (bond auction yields); its now all about the economic gravity of the situation and the IBEX needs to close > 7585 to recapture its 1st line of support. France and Italy don’t look much better.
  3. COPPER – we continue to see Bernanke’s Bubbles in commodities popping. On the commodities bounce this morn, Copper is down again and remains in a bearish formation alongside 10yr UST yields < 2.03% at 1.99% last.

Immediate-term risk range for SP500 = 1





THE HBM: MCD, CMG, DPZ, CBRL, CAKE - subsector





MCD: McDonald’s has appointed Tim Fenton as Chief Operating Officer, effective July 1.  Fenton is a veteran of McDonald’s since 1973 and takes over Don Thompson’s seat as Thompson transitions to his new role as Chief Executive Officer. 


CMG: Chipotle’s purchasing manager for meats and dairy, Doug George, said that beef prices will probably climb by the end of the second quarter as supplies of cattle tighten in the U.S.  


DPZ: Domino’s is featured in an article in the Wall Street Journal detailing the company’s “take me as I am” approach to emerging markets, even those markets where competition is tough and its product is not a consumer favorite.  We do not see this approach as very logical but will be looking for more commentary from management on its strategy in China, Russia, Brazil, and other markets going forward.



COSI: Cosi seems to have a problem – the stock dipped 10% on accelerating volume yesterday.


SBUX: Starbucks also dropped back below $60, declining 3.3% on accelerating volume.





CBRL: Cracker Barrel announced that it has restructured and streamlined its field organization to better align its restaurant and retail operations under central leadership.  As a result, the company has fired 20 people and is taking a charge of roughly $0.05 per share.


CBRL: Cracker Barrel named Laura Daily Senior Vice President of Retail today.  Daily will join thecompany on May 7th.  Most recently, she served as Vice President for Ballard Designs, an internet and catalog home furnishings retailer that is part of HSN, Inc.


CAKE: Today’s ICSC data point, -1% for the week ended April 14th, was a negative for Cheesecake Factory.  The chart below shows CAKE’s comps versus the ICSC Chain Store Sales year-over-year change.  The expected comp for 1Q12 could be slightly aggressive, given the drop in the ICSC Chain Store Sales Index over the same period.


THE HBM: MCD, CMG, DPZ, CBRL, CAKE - cake comps vs icsc





Howard Penney

Managing Director


Rory Green



Early Look

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The Macau Metro Monitor, April 17, 2012




Visitor arrivals in package tours surged by 41.7% YoY to 661,320 in February 2012.  Visitors from Mainland China (438,720) increased by 32.0%, with 155,036 coming from Guangdong Province; besides, those from Taiwan (68,233); Hong Kong (38,944); and the Republic of Korea (34,498) soared by 174.1%, 95.9% and 34.8% respectively.


The number of available guest rooms of the 95 hotels and guest-houses totaled 22,310 at the end of February 2012, an increase of 2,227 rooms (+11.1%) YoY, with those of the 5-star hotels accounting for 63.5% of the total.  Hotels and guest-houses received 721,036 guests in February 2012, an increase of 20.1% YoY; the average length of stay decreased by 0.12 night to 1.4 nights.



Japanese businessman Shinichi Takami was ordered to pay $2MM to Marina Bay Sands on Monday after he failed to meet the deadline to pay the cash into court.  Takami had been ordered by the High Court earlier this month to pay the sum into court, or provide a banker's guarantee if he wanted to avoid summary judgment on his gambling debts claimed by the casino.


MBS lawyers had sought such a judgment - which means the case would not have to go to a full trial - on the grounds that Takami has no real or valid defense against its claim.  MBS's successful ruling is understood to be the first against a foreigner in the many suits it has lined up to recover debts owed by defaulting patrons since the casino commenced operations in April 2010.

Damned Lies

“I am not well qualified to criticize the theory of rational expectations and the efficient market hypothesis because as a market participant I considered them so unrealistic that I never bothered to study them.”

-George Soros


Just as Keith has his pile of reading, I also have mine.  The quote above from George Soros was in a speech he gave to the Institute for New Economic Thinking Annual Plenary Conference.  The quote itself was buried somewhat deep in Soros’ comments, but it jumped off the page at me.  To me it is somewhat akin, and I hate to use another hockey analogy, to Wayne Gretzky being told he couldn’t score 90+ goals in a NHL season (which is more than one goal per game) after he did it.


Soros, of course, is in a similar situation in the realm of investing.   He has absolutely crushed it in terms of outperforming the market over long periods of time.  His performance has been so staggering, in fact, that his net worth today is estimated north of $22 billion.  Now I haven’t always admired Soros’ political positions, but it is very difficult not to admire his investment track record. 


More importantly, I’ve always admired his desire and interest in attempting to explain his investment process.  Much of what Soros has written about his investment process revolves around reflexivity.  He loosely based this way of interpreting the markets on a theory by philosopher Karl Popper that suggests that the individual’s interpretation of reality never quite correspond with reality itself.  


According to Soros, in financial markets this is taken one step further in that individuals with a flawed sense of reality actually take action based on this flawed interpretation of the future.  In turn, these collective actions often influence future events, or more likely, as Soros said, create a “divergence between the participants’ view of reality and the actual state of affairs and a divergence between the participants’ expectations and the actual outcome.”


From my seat, the pin action in Europe over the past 18-months highlights Soros’ idea that collectively market participants really have no idea what the ultimate outcome in Europe will be to resolve the intrinsic issues associate with the Maastricht Treaty. Specifically, I’m referring to the issue that a European monetary union cannot exist sustainably without a strong political union or fiscal solidarity.


This morning the first of two key Spanish debt auctions occurred for the week.  The reflexive response from the equity markets is that the auction was a success, as European equities are up across the board with beleaguered French banks leading the way.  According to reports we are receiving from some of our contacts on the ground in Europe, the Spaniards sold 3.2 billion euros of 12 – 18 month bills versus a maximum target of 3.0 billion euros at a total bid-to-cover of 3.19.  On the negative side, the bills sold yielded 2.6% on the 12-year versus 1.4% prior and 3.1% on the 18-year versus 1.7% prior.  So, yes the auction was “successful”, albeit at usury type rates.


It’s quite possible that the Spanish debt auction this Thursday is just as “successful”.  Although as always, I would recommend watching not necessarily what the government officials say, but what they actually do.  In that vein, this week European officials are headed to Washington, DC with hat in hand to ask for more money from the International Monetary Fund.  The IMF meetings occur from April 20 – 22nd.  Interestingly, the Europeans may meet at least one surprising fiscal hawk in the way of U.S. Treasury Secretary who has already ruled out additional contributions to the IMF based on the belief that the IMF already has “substantial financial resources.”


Meanwhile as the loose monetary policies in Europe appear likely to be extended in perpetuity, inflation readings came in stickier, even if marginally, across the board this morning.  Eurozone March CPI came in at +1.3% month-over-month and +2.7% on year-over-year basis, both ahead of expectations.  The acceleration in U.K. inflation was even more noteworthy coming in at +3.5% versus estimates of +3.4%.


The scary thing with inflation is that, just like George Soros’ returns, it also compounds.  So, at this rate of inflation, in 10 years someone in the U.K. who makes $50,000 now will have to make $70,000 to have the same purchasing power.  Thus we have the hidden tax of inflation. 


Switching gears briefly, I wanted to touch on U.S. politics.  Yesterday the Senate blocked the so-called Buffett Tax, which would have implemented a mandatory tax of 30% on anyone earning over $1 million in income.  The legislation was blocked basically on party lines.  In terms of true tax reform, the Buffett tax is basically meaningless and is clearly not much more than a political stunt, although perhaps an adroit one by the Obama camp as according to a recent Gallup poll 6 in 10 eligible voters supported passage of the bill. 


The Democrats are only going to continue to focus on this class warfare type issue heading into the Presidential elections this fall.  In fact, yesterday I received a blast email from Stephanie Cutter, the Deputy Campaign Manager for Obama which invited me to compare my tax rate to Romney’s.  Ultimately, this “war on the rich” is and will continue to backfire on Obama in one key way: political donations.  So far, corporate executives across almost every industry have been giving less money to Obama and the Democrats this election cycle.  (We will have a note on this up today.)


For those looking for some interesting and enlightening reading this morning, the IMF releases the world economic outlook and fiscal monitor at 9am and ECB President Draghi is delivering an intro speech at the 6thECB Statistics conference.   Thinking about an annual ECB statistics conference reminds of Mark Twain’s famous quote (who he purportedly borrowed from former U.K. Prime Minister Benjamin Disraeli):


"There are three kinds of lies: lies, damned lies, and statistics."




The immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, Japanese Yen (vs USD), Euro/USD, and the SP500 are now $1, $117.67-121.61, $79.27-79.67, $80.03-82.34, $1.30-1.32, and 1, respectively.


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


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