“For every complex problem there is an answer that is clear, simple, and wrong.”
- H.L. Mencken
While they’re not the only ones in the business, the French are rightfully proud of their “stinky” cheeses. Yet stinky is for the consumer to judge and when it comes to pungent cheese, aroma and taste can run the spectrum from intense pleasure to pain, or alternatively as a pleasure from the pain.
A similar broad spectrum on the handling of the Eurozone’s sovereign debt and banking “crisis” is enjoyed by investors, strategists, journalists, and European citizens alike: abolish it, rescue it, or structure some hybrid of the two. So what’s the update on the region as we find ourselves in May with the stink currently in Spain?
We continue to throw the abolishment camp out the window on four main factors:
- Eurocrats will tote the line to save their job
- Fear of the contagion effect from the default of countries and banks on the rest of the continent
- Belief in the Union’s economic benefit (namely through open trade and travel)
- Belief in the formation of a European identity (including the continental strength to balance the closest geographic spheres of influence in the U.S. and Russia)
While we could argue until we’re blue in the face that Europe needs its own Lehman-like event, to let weaker countries default and/or exit the Union, and that one monetary policy for a collection of joined states growing at uneven rates will continue to compromise the Union because it handcuffs nations from manipulating currencies and interest rates to encourage competitiveness, we think the above factors will justify the maintenance of the existing Eurozone fabric over at least the next 12 months.
So the task is to play an incredibly-challenged environment ahead as Eurocrats try to find a balance between fiscal consolidation, while not obliterating future growth in the process. One key factor to monitor, which we’ll hit on later in the note, is the deterioration of Merkozy, or relations between Germany and France on Eurozone policy.
So what’s so wrong with Europe?
The existing rub in directing European policy to improve the fiscal health of countries is that European leadership is inherently compromised: on one hand they have to answer to their citizenry that is largely voting against fiscal consolidation (and rioting on the street to bout), yet on the other they must answer to the markets, and a larger Brussels “authority”. Given that the markets are pricing in slow growth across Europe in 2012 and such threats as the inability of governments to meets consolidation targets, sovereign yields should remain elevated, which in turn increases the cost to raise capital and sets the “non-virtuous” cycle of raising debt and deficits levels.
With 10YR yields trading at 20.4% in Greece; 10.5% in Portugal; 5.8% in Spain; and 5.6% in Italy; vs 1.6% in Germany, it comes with no great surprise that Germany is not interested in issuing Eurobonds.
But now the stakes in reducing risk have elevated, as Spain has taken the sovereign spotlight after a lengthy focus on Greece! (Note: Spain’s economy = 5x Greece’s.)
And while Eurocrats have set up a number of firewalls to ease investor concern that the Eurozone is going away—including funding programs such as the EFSF, ESM, and enhanced commitments to the IMF earmarked for Europe, to liquidity programs such as the two 36M- LTROs and the SMP—these programs do little to bind Europe under a growth strategy. As of recent weeks, it’s growth that has been given more attention by Eurocrats.
More Conflicts Ahead
But how do you manufacture growth? Simply by setting up more funding through the European Investment Bank or earmarking more lending from the IMF? But who’s paying for it? Importantly, Germany hasn’t put up her hand, and who’s left?
Again, the uneven and compromised nature of Europe (and the Eurozone specifically) cannot be overlooked. Simply throwing money at “problems” won’t cure structural drags like high unemployment rates, low labor productivity, vulnerable banks, and further risks from declines in housing and property prices ahead.
To highlight a few imbalances: Spain’s unemployment rate is 24.4% vs Germany’s at 6.8%, or Spain has a monster deficit reduction target of 5.3% (of GDP) for 2012 versus 8.5% last year vs the German deficit forecast to fall to 0.6%. Or consider Portugal’s average annual growth rate over the last 10 years of 0.03% vs 1.07% for Germany, or recall that we forecast house and property prices could fall another 30% from here in Spain!
It’s such structural mismatches (to name a few) that suggest that even if Europe finds a united path, it won’t come next week, next month, or next year. Uncompetitive countries like a Portugal or a Greece are going to stay uncompetitive. Europe’s stronger nations will simply have to decide how long they want to subsidize them. Is this a realistic long-term strategy? We think not, but we still must play the likelihood that Eurocrats fight to support the whole.
Of note is that in some cases expectation are just grossly misaligned. For example, the European Commission targeted all member nations to have deficits at or below 3% by 2013. That’s surely not realistic for Portugal, Ireland, Spain, or Greece! Further, the Fiscal Compact, which is really an amended version of the Stability and Growth Pact (aimed at deficit reduction to 3% and debt reduction to 60%), stands to fall short as Brussels wrongly assumes members will give up their fiscal sovereignty.
Returning to stinky cheese, the likely victory of the Socialist candidate Francois Hollande in this Sunday’s presidential elections spells the likely end of a strong working relationship between France’s Sarkozy and Germany’s Merkel. Hollande’s very socialist agenda (increase spending by €20 MM over five years, reduce the retirement age from 62 to 60, raise income tax on earners over €1 MM to 75%, capping gasoline prices for a number of months and a pledge to block corporate job cuts) along with such positions as pro Eurobonds (which Germany vehemently opposes) and opposition to the Fiscal Compact, portend great disunity at a time when the Eurozone needs its two largest economies to pull jointly on the loose strings and direct solutions to its sovereign and banking ills.
Returning to H.L. Mencken’s quote that started the note, it’s clear Europe has a very complex suite of problems. And if expectations are the root of all heartache, it’s the market’s expectation that Europe will be “fixed” tomorrow that needs amendment. While there is no simple solution, without better coordination through both appropriate targets for fiscal consolidation alongside strategies for growth, we do not see any hope for material improvement across the region over the next 12 months.
The immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, and the SP500 are now $1, $119.07-121.06, $78.55-79.32, and 1, respectively.
This note was originally published at 8am on April 18, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“To succeed, you must study the end game before everything else.”
- José Raúl Capablanca (Chess Grandmaster)
José Raúl Capablanca was one of the world’s first great Chess champions. In fact, statistical ranking systems rank him the fifth greatest player of all time. He was a Cuban national and was world champion from 1921 – 1927. His nickname was the “Human Chess Machine” which characterized the simple nature of his style combined with his total mastery over the board. To him, understanding the end game was the preeminent focus for any player.
For those of you that aren’t Chess grandmasters, the end game is the point in the game when there are a relatively limited number of pieces on the board. Many chess analysts disagree as to when exactly the end game begins, but they all agree that when the end game begins strategy is much different than the middle game. In fact, over time the world’s best chess players have always excelled at the end game and utilized a consistent strategy.
Yesterday was one of those stock market days that certainly made a few investors wonder whether the global economic growth end game is actually here yet, or close. The snap back in U.S. equities didn’t necessarily surprise us but obviously characterized the almost bi-polar sentiment that currently exists in global equities. One day bad news matters, the next day good news matters more. The global economic growth slowing end game is here, then it isn’t.
Meanwhile in Spain over night we did get more evidence of the debt end game. The nation that will continue to be the pressure point in European sovereign debt issues this year, reported that non-performing bank loans accelerated from December and now total €143.82B, which is a 18-year high. This compares to a 1% level before the correction of the real estate market that began in 2008. As we’ve noted, the key risk is that this level of non-performing loans accelerates dramatically as property prices continue to revert to the mean.
The key issue with Spain accelerating to the downside from a debt perspective is that Germany is basically on record saying that Spain is too big to save. And so is Italy. Not being able to save either Italy or Spain is certainly a European sovereign debt end game that is increasingly concerning. To be fair, though, Spanish 10-year yields have come in again over night and are now solidly below the 6% line at 5.78%, which is a positive, but the IBEX this morning is down -3.2%. Tomorrow we get the longer term Spanish bond auctions and they, too, will likely be as successful as any artificially controlled market.
The major political catalyst this week in Europe is the French elections with the first round this weekend. Since a major candidate has to garner 50% to win, it is likely there is a second round given there are major candidates competing. Currently, the most recent polls from CSA have Hollande leading Sarkozy 29% to 24% in Round 1. This is an improvement from being tied a few days ago. The polls then show Hollande mercy crushing Sarkozy in Round 2, by a margin of 58% to 42%.
The French election is critical because: A) Hollande is a Socialist, B) Hollande is a Socialist, and C) Hollande has stated that if elected he will renegotiate the EU budget compact and that he will not accept austerity as rule for countries. Things are about to get a lot more challenging politically in the great monetary union that is the Eurozone.
In the U.S. we are fully in the midst of earnings season. As part of earnings season, we our having our Sector Heads participate in our morning calls for clients ( ping firstname.lastname@example.org if you don’t have access ) and also write a brief summary of their thoughts on earnings in their sectors. Our Financials Sector Head wrote this yesterday as it related to financials:
“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.”
The remainder of his note can be found at www.hedgeye.com in unlocked content and we will be updating these summaries over the course of the next week. But if there was one take away from Josh, it is that so far his companies are beating estimates, which is a positive driver for stock prices in the financial sector in the short term.
Related to U.S. growth, we have a number of negative catalysts that will come more and more into focus in the coming months. Namely, as of January 1st, 2013, the Bush tax cuts, the temporary payroll tax cut, and the long-term unemployment benefits all expire. Then on January 15th, 2013 the automotive government spending cuts, driven by the failure of the Joint Select Committee on Deficit Reduction, go into effect. Will it be check mate for U.S. economic growth? Probably not, but Q1 2013 is certainly an end game to start contemplating.
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 $1619-1661, $117.69-120.93, $79.26-79.64, $79.96-82.30, $1.30-1.32, and 1380-1394, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
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TODAY’S S&P 500 SET-UP – May 2, 2012
As we look at today’s set up for the S&P 500, the range is 24 points or -1.05% downside to 1391 and 0.65% upside to 1415.
SECTOR AND GLOBAL PERFORMANCE
- ADVANCE/DECLINE LINE: on 5/01 NYSE 908
- Up from the prior day’s trading of -665
- VOLUME: on 5/01 NYSE 771.45
- Decrease versus prior day’s trading of -9.45%
- VIX: as of 45/01 was at 16.60
- Decrease versus most recent day’s trading of -3.21%
- Year-to-date decrease of -29.06%
- SPX PUT/CALL RATIO: as of 05/01 closed at 1.74
- Down from the day prior at 1.92
CREDIT/ECONOMIC MARKET LOOK:
- TED SPREAD: as of this morning 38
- 3-MONTH T-BILL YIELD: as of this morning 0.08%
- 10-Year: as of this morning 1.93
- Decrease from prior day’s trading of 1.94
- YIELD CURVE: as of this morning 1.68
- Unchanged from prior day’s trading
MACRO DATA POINTS (Bloomberg Estimates):
- 7am: MBA Mortgage Applications (prior -3.8%)
- 8am: Fed’s Tarullo to speak in New York at the CFR
- 8:15am: ADP Employment Change, April, est. 170k (prior 209k)
- 9:45am: ISM New York, April (prior 67.4)
- 10am: Factory Orders, March, est. -1.7% (prior 1.3%)
- 10am: U.S. Treasury makes quarterly refunding announcement
- 10:30am: DOE inventories
- 12:30pm: Fed’s Lacker speaks on economy in Norfolk, Virginia
- 6:30pm: Fed’s Evans speaks in Chicago
- NRC meets to discuss post-Fukushima recommendations on fires, flooding at power plants caused by earthquakes, 1pm
- FCC Chairman Julius Genachowski discusses broadband adoption, job creation at National Cable & Telecommunications Assoc, 3pm
- President Obama scheduled to return to the U.S. after a surprise visit to Afghanistan
- House, Senate not in session
- Commerce Dept. advisory panel meets to vote on recommendations to improve U.S. competitiveness in exporting renewable energy, energy efficiency products and services, 10am
- China, U.S. Strategic and Economic Dialogue in Beijing
WHAT TO WATCH:
- Carlyle consults buyout playbook to price IPO at 62% discount; IPO expected to price this evening
- Facebook said to begin marketing share sale as soon as next wk
- Chinese manufacturing index rose in April to 49.3 vs prelim. 49.1 reported April 23, signaling rebound
- ADP report may show U.S. added 170k jobs in April after 209k in March
- U.S. Deputy Treasury Secretary Neal Wolin said opponents of the Dodd-Frank Act will fail in efforts to roll back part of the regulatory overhaul
- Genworth Financial’s CEO resigned after an 80% stock plunge since the end of 2006
- Goldman Sachs said a proposed Fed rule seeking to limit links between banks could cut U.S. economic growth by as much as 0.4 percentage point
- News Corp.’s Rupert Murdoch may be prompted to lower or sell his 39% stake in BSkyB
- BP Gulf of Mexico spill trial shouldn’t be delayed until after a proposed hearing on a settlement of most private- party claims, U.S. tells judge
- Euro-region manufacturing shrank for a 9th month in April
- Twitter said to have considered buying mobile-photo app Camera+
- AMERIGROUP (AGP) 6am, $0.56
- Enterprise Products Partners LP (EPD) 6am, $0.57
- Macerich (MAC) 6am, $0.69
- CVS Caremark (CVS) 6:45am, $0.63. Preview
- Barrick Gold (ABX CN) 6:55am, $1.09; Preview
- Comcast (CMCSA) 7am, $0.43; Preview
- El Paso Electric (EE) 7am, $0.12
- Energizer Holdings (ENR) 7am, $1.08
- Time Warner (TWX) 7am, $0.64; Preview
- AllianceBernstein Holding (AB) 7:09am, $0.24
- Devon Energy (DVN) 7:30am, $1.43
- IAC/InterActive (IACI) 7:30am, $0.46
- IntercontinentalExchange (ICE) 7:30am, $2.02
- Och-Ziff Capital Management Group (OZM) 7:30am, $0.13
- Public Service Enterprise Group (PEG) 7:30am, $0.67
- Cooper Industries (CBE) 8am, $1.00
- Loblaw (L CN) 8am, $0.49
- Mastercard (MA) 8am, $5.30
- Magellan Midstream Partners (MMP) 8am, $0.96
- Rowan (RDC) 8:15am, $0.34
- Allete (ALE) 8:30am, $0.77
- Franklin Resources (BEN) 8:30am, $2.22
- Clorox (CLX) 8:30am, $1.03; Preview
- Marathon Oil (MRO) 8:30am, $0.87
- Allergan (AGN) 9am, $0.87; Preview
- Expeditors International of Washington (EXPD) 9am, $0.39
- PG&E (PCG) 9:04am, $0.72
- Edison International (EIX) 4pm, $0.51
- Green Mountain Coffee Roasters Inc (GMCR) 4pm, $0.64
- DreamWorks Animation SKG Inc (DWA) 4:01pm, $0.09
- Kim Realty (KIM) 4:01pm, $0.30
- Sunoco (SUN) 4:01pm, $ (0.08)
- Whole Foods Market (WFM) 4:03pm, $0.59
- Allstate (ALL) 4:05pm, $1.12
- JDS Uniphase (JDSU) 4:05pm, $0.11
- Symantec (SYMC) 4:05pm, $0.38
- Visa (V) 4:05pm, $1.51
- ValueClick (VCLK) 4:05pm, $0.34
- ON Semiconductor (ONNN) 4:05pm, $0.09
- Prudential Financial (PRU) 4:07pm, $1.72
- Lincoln National (LNC) 4:10pm, $0.98
- Boston Beer (SAM) 4:10pm, $0.41
- Continental Resources (CLR) 4:15pm, $0.85
- Concho Resources (CXO) 4:15pm, $1.13
- Hartford Financial Services Group (HIG) 4:15pm, $0.91
- Transocean (RIG) 4:15pm; Preview
- Onyx Pharmaceuticals (ONXX) 4:15pm, $ (0.78)
- RenaissanceRe Holdings (RNR) 4:22pm, $2.42
- Charles River Laboratories International (CRL) 4:30pm, $0.65
- Pioneer Natural Resources (PXD) 4:30pm, $1.20
- Hertz Global Holdings (HTZ) 4:30pm, $0.00
- First Quantum Minerals (FM CN) 5pm, $0.24
- Murphy Oil (MUR) 5pm, $1.52
- Tesoro (TSO) 5pm, $0.27
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Trafigura Follows Raffles Into Heart of Asian Trade: Commodities
- Philippines Cuts Rice Imports as Harvest Swells, Alcala Says
- Investors Dump Commodities in Longest Slide Since November
- Trafigura Hires Bankers for Commodity Trade Finance Business
- Oil Drops From Five-Week High on U.S. Supply, European Economy
- Gold Declines a Second Day on Speculation Stimulus Not Needed
- Corn Declines a Second Day as Rainfall Boosts U.S. Crop Outlook
- Cocoa Reaches Five-Week High on Supply Speculation; Sugar Falls
- Copper Falls as Euro-Area Manufacturing Shrinks for Ninth Month
- Exxon Pact Spurs Rosneft Bonds in $5 Billion Plan: Russia Credit
- YPF Bondholders Lose Faith in Takeover Clause: Argentina Credit
- Freedom From Gazprom Tempts Ukraine as Exxon Hunts Shale: Energy
- Brazil Steelmaker CSN Shares Plummet on Disruptive Rail: Freight
- Gold Rally Stalling at $1,700 Before Drop: Technical Analysis
- Congo Fighting Thwarts Plans to Export Conflict-Free Minerals
- Wien Bearish on Oil First Time as Output Swells: Energy Markets
- BHP Copper Mine Threatened by Mooted Tax Change, Citigroup Says
US DOLLAR – the Bernanke Bailout beggers can only hold this USD ball under water for so long before the Europeans and/or the Japanese start to burn their currencies at the stake – its all relative in the Currency War, so get used to it. Dollar having its 1st up day in weeks and Commodities go really red on that (immediate-term correlation USD/CRB back at 0.8).
EUROPE – apparently the European economy was not allowed to cease to exist this morning and for all the ISM fans out there, some of these European ISM’s are train wrecks (Germany 46.9, Italy 43.9, Spain 43.5!). New orders for Italy had a 3 handle at 39 and change. Ouchy
BUNDS – hot cross German Bunds; we like those as they push to new highs here this morning - #GrowthSlowing still matters and that’s why you buy Bunds and UST Bonds. We bought TLT yesterday on the associated no-volume rally in US stocks.
The Hedgeye Macro Team
The Macau Metro Monitor, May 2, 2012
MONTHLY GROSS REVENUE FROM GAMES OF FORTUNE DSEC
Macau April GGR rose 21.9% to MOP 25.0 BN (24.27HKD, 3.13USD).
WYNN MACAU RECEIVES FORMAL GAZETTE APPROVAL FOR COTAI DEVELOPMENT FROM MACAU SAR GOVERNMENT Wynn Macau
“The official transfer of real estate in Cotai makes possible the commencement of the construction phase, of what will be the single most important project in the history of Wynn Resorts," said Steve Wynn, CEO of WYNN. The Macau Special Administrative Region’s Official Gazette published its formal approval of the Cotai land concession for Wynn Macau today.
CHINA APRIL HOUSING PRICES SLIDE FOR 8TH STRAIGHT MONTH WSJ
According to the China Real Estate Index System, housing prices in 100 major cities in China were lower for the eighth consecutive month in April. The average home price in April was lower at CNY8,711 a square meter, compared with CNY8,741 in March and CNY8,767 in February. Average home prices in 10 major cities, such as Beijing and Shanghai, fell 0.4% MoM and 2.6% YoY to CNY15,391 a square meter in April.
Struggles in LV and AC were partially offset by strong regional performance.
CZR’s results (excluding one-time items) fell 3% YoY below our Property EBITDA estimate but higher corporate expense contributed to a bigger net EBITDA miss. Below are some of our observations on the quarter’s results that we believe warrant comments
- Las Vegas revenues were in-line, but EBITDA was about 11% below our estimate. We’re a little disappointed that CZR’s didn’t get more of a lift from the opening of the Octavius Tower in January.
- We estimate that operating expenses net of taxes increased 5% YoY in the quarter, largely due to the increased operating expenses from the opening of Octavius.
- There should be some sequential improvement in coming quarters as Octavius Tower will likely take a few quarters to ramp to normal gross margins
- Our understanding is that Group mix usually contributes 20% of room nights in 1Q and that shifted down to about 18% with more fill-in from FIT. Since most of the rooms at Octavius are comped, ADRs didn’t see much of a lift. Even so, net revenues should’ve been higher.
- Spend per visit fell almost 2% and we’re not confident that we’ll see major improvement going forward
- AC revenue weak even before the opening of Revel
- Excluding the $17MM tax reduction, operating expenses would have been flat YoY despite the 4% net revenue decline.
- $10MM of the tax reduction in the quarter was one-time. Without the benefit, EBITDA would have been down 10% YoY and that’s before the impact of Revel.
- LA/MS regional results were above our expectations, even excluding the $7MM insurance proceeds
- We estimate that operating expenses (ex taxes) would have been up 3.5% YoY without the insurance proceeds benefit in the Q
- Excluding the benefit of insurance proceeds, EBITDA would have still been up 16% YoY
- Managed and international performed in-line with our expectations
- $144MM of revenues with estimated EBITDA of $33MM vs. $32MM last year
- We assume that D&A remained constant at $14.2MM in order to back into our EBITDA estimate
- Corporate and other (mainly Playtika) exceeded our estimates in the quarter
- $64.7MM of net revenue and $32MM of EBITDA
- While the company refused to provide any color, Playtika revenues were an estimated $42MM in the quarter, implying almost 50% QoQ growth
- We estimate that Corporate & Other revenue were about $23MM in the quarter, up 12% YoY and $1MM higher than in 4Q.
- At current growth rates, Playtika revenues should be well in excess of $200MM this year
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