The Economic Data calendar for the week of the 14th of May through the 18th is full of critical releases and events. Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.
European Positions Update: Short Italy (EWI)
Asset Class Performance:
It was yet again another week in which Europe dominated the headlines, with Greece and Spain taking most of the attention. In the mix this week the Bank of England kept its interest rate and asset purchasing program on hold, as expected, and the European Commission revised down its growth targets for much of the periphery, while boosting Germany’s (more below under Call Outs). However, it was also a week in which Russia’s Vladimir Putin and Dmitry Medvedev were confirmed, switching roles to become President and Prime Minister, respectively. For those of you that missed it, Putin put on a show in an inauguration day hockey game. Here’s a link to the video: http://www.youtube.com/watch?v=sMpR1AQmGkQ&fb_source=message. Vlady, who recently learned how to skate, propelled his team to a 3-2 victory with two assists and the game winner (surprised?).
As Keith has mentioned, the Russian stock market is down -16.6% since March 14th (when most Global Equity markets topped for the year) and is a good example of why the USD Correlation Risk matters so much – Russia is a Petro Dollar market, so with the USD up for the 8th consecutive day (and the Petro snapping his $113.87 Brent line), this is not good.
A Greek Tragedy
This week saw each of the three main Greek parties (New Democracy, Syriza, and Pasok) try to form a coalition with each another, only to come up short each time. There’s new hope from some that Pasok leader Evangelos Venizelos can put together a unity government given a shift in stance on the part of Democratic Left leader Fotis Kouvelis, who has broken ranks with Syriza, which it had backed earlier in the week. (Syriza is thoroughly against the mandates of austerity, and may be the most divisive partner in a coalition build).
As uncertainties of the prospects for a coalition persist, the calling of another general election seems a very probable event, which could come as soon as June 10th or June 17th. Here it’s important to note that despite the unknown on the future shape of the Greek government, what’s key is the strong voice from the Greek people to stay with the EUR currency and in the Eurozone. So despite all the noise from headlines discussing a Greek exit from the Eurozone (example: a Bloomberg Global Poll recorded a 50% chance Greece exits the Eurozone this year), we do not see this as a probable event for Greece in 2012. We expect the future Greek government to play ball with Brussels (and Troika for its bailouts), with more concessions likely to come from Brussels (and consent from the Germans swinging the largest bat), as Eurocrats are determined to save the existing Union. Greece will likely moderate its austerity push in favor of growth strategies (at least rhetorically), but really to appease a population pushing back at the consolidation of government spending. We think the most relevant quote of the week expressing this view came from Germany’s Finance Minister Wolfgang Schaeuble:
“If Greece decides not to stay in the Eurozone, we cannot force Greece. They will decide whether to stay in the euro zone or not.”
Spain’s Shifting Pain
After Wednesday’s announcement that Bankia, the banking group with the most real estate on its books in Spain, was nationalized, today the Spanish government rolled out a number of provisions for banks, all of which are not easily digestible in the first gulp. While the measures show directional progress, the future findings of assets as risk (which are highly tied to real estate prices that we think could have another -30% leg down) could well be considerably larger than the €184 billion of assets which the Bank of Spain terms “problematic.”
The main points, according to Economy Minister Luis de Guindos’ speech today, include:
In other news, the European Commission today estimated that Spain will have a budget deficit of 6.4% of GDP in 2012 and 6.3% in 2013 versus Spain’s pledge to bring its budget deficit down to 5.3% this year from 8.5% in 2011. It has also said that it will hit the EU-mandated 3% deficit target in 2013. The Commission also now expects Spain's economy to contract 1.8% this year versus its February estimate of a 1% contraction. While the Spanish government expects the economy will grow in 2013, the Commission forecast that it would still contract by another 0.3%.
The key point here to mention is the changing goal posts that the European Commission will have to make for Spain’s deficit consolidation, a case which may be mimicked across the periphery. All in, our point is that an additional bailout for Spain seems highly probable over the next months as we underweight the ability of the Spanish government to internally clean up its banks, create jobs for the some 24.4% unemployed (52% for youths), reduce its deficit, and grow the economy.
European Commission: forecasts 2012 Eurozone GDP to fall by -0.3% (unchanged from prior estimate) and return to growth of 1.0% in 2013. The report said Greek GDP should decline -4.7% this year and may stay unchanged in 2013; Italy will fall -1.4% this year and Portugal should contract -3.3% before both return to growth next year. It sees Spain’s economy shrinking by -1.8% this year and -0.3% in 2013. The report also Germany should grow at 0.7% this year and raised its out to1.7% next year; that France could miss its deficit target in 2013; and the Eurozone unemployment rate will probably average 11% this year, up from 10.2% in 2011.
Eurozone: Eurogroup head Jean-Claude Juncker talking to broadcaster ZDF made it clear to French president-elect Francois Hollande that fiscal compact could not be renegotiated. However, he added that the while the treaty cannot be reopened, it is possible to add growth measures, something that is already under discussion.
France: Fitch Ratings says that it will not comment on France’s AAA rating before 2013.
Germany: SEB Asset Management will liquidate its €6 Billion ImmoInvest portfolio, the largest German property mutual fund to be dissolved after failing to meet investor withdrawals. Several real-estate mutual funds, including funds owned by Credit Suisse Group AG and UBS AG, face deadlines this year to reopen or liquidate, according to Germany’s financial trade group, Bundesverband Investment and Asset Management.
IMF may limit lending to Europe: The Dow Jones, citing people familiar with the situation, reported that the IMF is drafting plans to protect it from potential lending losses, including proposals that could limit the size of loans to Eurozone countries. The article said that the proposals are being developed as the political turnover in Europe and growing austerity backlash has triggered concerns about another flare-up of the sovereign debt crisis. It added that another safeguard under consideration is the sequencing of procuring IMF funds, meaning that if Europe's recent $200B contribution is used for Eurozone loans before other countries' contributions, then Europe bears the risk if something goes wrong.
More than 50% predict euro exit: Bloomberg, citing its own global poll, reported that 57% of the 1,253 investors, analysts and traders surveyed said at least one country would exit the euro by year-end, up from 11% in January 2011. It added that 80% expected more trouble for Europe's bond markets. Highlighting contagion concerns, the article also pointed out that 47% said Spain is likely to default, the most since the survey started measuring this possibility in June 2010 and almost double the level from four months ago.
China's sovereign wealth fund says it has stopped buying European debt: Bloomberg cited comments from China Investment Corp. President Gao Xiqing, who said that the sovereign wealth fund has stopped buying European government debt given the economic crisis on the continent. However, he added that the fund still has people looking for opportunities in Europe.
CDS Risk Monitor:
Week-over-week CDS was up across the main countries we track. Portugal saw the largest gain in CDS w/w, +66bps to 1075bps, followed by Spain +39bps to 514bps, Ireland +28bps to 593bps, and Italy +19bps to 456bps.
Eurozone Sentix Investor Confidence -24.5 MAY vs -14.7 APR
Germany CPI 2.2% APR Y/Y Final (UNCH)
Germany Exports 0.9% MAR M/M (exp -0.5%) vs 1.5% FEB
Germany Imports 1.2% MAR M/M (exp. 1.0%) vs 3.6% FEB
Germany Current Acct 19.8B EUR MAR (exp.18B) vs 11.7B EUR FEB
Germany Trade Balance 17.4B EUR MAR (exp. 14.3B) vs 14.9B EUR FEB
Germany Factory Orders -1.3% MAR Y/Y (exp. -2.8%) vs -6.0% FEB [2.2% MAR M/M (exp. 0.5%) vs 0.6% FEB]
Germany Industrial Production 1.6% MAR Y/Y (exp. -1.2%) vs 0.0% FEB
Spain Industrial Output -10.4% MAR Y/Y vs -3.2% FEB [workday adjusted y/y worse than expected (-7.5% versus estimate -5.3%) ]
Spain House Transactions -22.7% MAR Y/Y vs -31.8% FEB
Spain CPI 2.0% APR Y/Y Final (UNCH)
Italy Industrial Production NSA -5.9% MAR Y/Y vs -3.3% FEB
Greece CPI 1.5% APR Y/Y (exp. 1.3%) vs 1.4% MAR
Greece Industrial Production -8.5% MAR Y/Y vs -8.3% FEB
Greece Unemployment Rate 21.7% FEB vs 21.8% JAN
France Bank of France Business Sentiment 95 APR (exp. 95) vs 95 MAR
France Industrial Production -0.9% MAR Y/Y (exp. -1.3%) vs -1.4% FEB
France Manufacturing Production -0.3% MAR Y/Y (exp. -2.8%) vs -3.2% FEB
UK Industrial Production -2.6% MAR Y/Y (exp. -2.6%) vs -2.3% FEB
UK Manufacturing Production -0.9% MAR Y/Y (exp. -1.3%) vs -1.5% FEB
UK PPI Input -1.5% APR M/M (exp -0.9%) vs 1.7% MAR [1.2% APR Y/Y (exp. 2.1%) vs 5.6% MAR]
UK PPI Output 0.7% APR M/M (exp. 0.4%) vs 0.6% MAR [3.3% APR Y/Y (exp. 2.9%) vs 3.7% MAR]
Switzerland Unemployment Rate 3.1% APR vs 3.0% MAR
Switzerland CPI -1.1% APR Y/Y vs -1.0% MAR
Netherlands CPI 2.8% APR Y/Y (exp. 2.7%) vs 2.9% MAR
Netherlands Industrial Production 0.7% MAR Y/Y vs -2.7% FEB
Sweden Industrial Production -6.5% MAR Y/Y (exp. -2.6%) vs -7.1% FEB
Sweden CPI 1.3% APR Y/Y (exp. 1.4%) vs 1.5% MAR
Norway CPI 0.3% APR Y/Y (exp. 0.5%) vs 0.8% MAR
Norway Producer Prices Incl. Oil 2.5% APR Y/Y vs 6.6% MAR
Norway Industrial Production 2.4% MAR Y/Y vs 3.1% FEB
Finland Industrial Production -5.7% MAR Y/Y (exp. -2.2%) vs -3.3% FEB
Ireland CPI 1.9% APR Y/Y (exp. 2.3%) vs 2.2% MAR
Ireland Consumer Confidence 62.5 APR vs 60.6 MAR
Portugal Industrial Sales -1.3% MAR Y/Y vs 1.1% FEB
Portugal CPI 2.9% APR Y/Y vs 3.1% MAR
Hungary Industrial Production 0.6% MAR Prelim Y/Y vs -3.5% FEB
Hungary CPI 5.7% APR Y/Y vs 5.5% MAR
Czech Republic Retail Sales -0.3% MAR (exp. 0.2%) vs 1.6% FEB
Turkey Industrial Production 2.5% MAR Y/Y vs 1.6% FEB
Romania CPI 1.8% APR Y/Y vs 2.4% MAR
Latvia Unemployment Rate 12.9% APR vs 11.7% MAR
Interest Rate Decisions:
(5/9) Poland Base Rate HIKED 25bps to 4.75%
(5/10) BOE Interest Rate Announcement UNCH 0.50% (expected)
(5/10) BOE Asset Purchase Target UNCH 325B GBP (expected)
(5/10) Norwegian Deposit Rate Announcement UNCH 1.50% (expected)
The European Week Ahead:
Monday: Mar. Eurozone Industrial Production; Apr. Germany Wholesale Price Index; Mar. France Current Account; Apr. Italy CPI - Final
Tuesday: 1Q Eurozone GDP – Advance; May Germany Zew Survey Current Situation and Economic Sentiment; 1Q Germany GDP – Preliminary; Mar. UK Trade Balance; Apr. France CPI; 1Q France GDP – Preliminary, Non-Farm Payrolls and Wages – Preliminary; 1Q Greece GDP - Preliminary
Wednesday: Apr. Eurozone 25 New Car Registrations, CPI; Mar. Eurozone Trade Balance; BoE Inflation Report; Apr. UK Claimant Count Rate, Jobless Claims Change; Mar. UK Average Weekly Earnings, ILO Unemployment; 1Q Italy GDP - Preliminary; Mar. Italy Trade Balance
Thursday: 1Q Spain GDP - Final
Friday: G8 Leaders Meet Near Washington (May 18-19); Apr. Germany Producer Prices; Mar. Spain Trade Balance; Mar. Italy Industrial Orders
Emulation is not going to get it done in the domestic QSR burger category for the same reason it did not work for Linens ‘n’ Things in retail. A thesis has been put forward over the last few days that the QSR burger industry is not a zero sum game. In this industry it is difficult to neatly delineate boundaries of competition or addressable markets but we are of the view that, if not a zero sum game, the niche of the burger industry that Burger King inhabits could possibly be shrinking. Recent commentary from Wendy’s CEO Emil Brolick supports this view.
BURGERS ‘N’ THINGS
Given the rapid growth of “better burger” category, or fast casual in general, it is easy to make blanket statements about the QSR industry because such proclamations are difficult to refute in the absence of definitive market share data. Justice Holdings took advantage of this in framing its narrative describing Burger King’s growth prospect, touting the strong expansion of the QSR industry over recent years. QSR is becoming more varied, however, both in terms of price point and product offerings. McDonald’s, Wendy’s, Burger King, and Taco Bell occupy a certain sector of the QSR industry; we think that the growth in that sector is stagnant and only differentiated concepts can achieve the level of growth that would justify the $16 per share price tag that is being attached to Burger King’s IPO. Just looking at the products Burger King is currently offering versus the McDonald’s menu highlights how little in the way of differentiation Burger King is bringing to the table. An article published last month by Advertising Age titled “Nothing Exciting About Burger King’s Menu Expansion” outlines this issue comprehensively. Discussing the “folly of emulation”, the author writes, “What was Linens ‘n’ Things’ strategy? Emulate the leader with similar stores and similar marketing strategies”. Burger King – a follower – emulating McDonald’s – a leader – is equally unwise.
There is a reason why McDonald’s has recently bought up billboards and radio air time in markets where Wendy’s tested breakfast; the competition in the segment of the market where those companies operate is fierce because of the difficult macro environment, growing ranks of competitors, and a consumer that demands not only a great product but a great overall experience too. We see it as highly unlikely that all four of the aforementioned QSR concepts are going to see positive same-store sales over the next few years absent a dramatic turnaround in the macro environment. We believe that in this small group, someone is winning and someone is losing. For that reason, making life difficult for your competitors – as McDonald’s does – is a winning strategy. Along the same lines, trying to emulate a better-positioned industry leader – as Burger King is doing – is unlikely to be effective.
This cut-throat environment is going to hamper the efforts of Wendy’s and Burger King to convince investors that their respective turnaround stories are in place. That’s bad news for two chains that need to attract billions of dollars in capital to restore severely depleted asset bases. Taco Bell’s slogan, “Think Outside the Bun”, underscores how much they compete with the burger companies. Both Yum Brands and McDonald’s have tremendous ammunition to spend. Both Taco Bell and McDonald’s have shown a willingness to lead with price and value to attract customers from other chains. McDonald’s has benefitted from the mismanagement of Wendy’s and Burger King and has recently squared up to Dunkin’ Donuts in its core geography of New England in a bid to steal some breakfast market share. Companies are hyper-competitive in their pursuit of consumers at the moment. Our view is that Burger King and, to a lesser extent Wendy’s, are facing a difficult battle to regain their prior statuses in the industry.
PICK YOUR SIDE(S)
Clearly our contention here is that a rising tide is not going to lift all boats in the domestic QSR burger industry. Burger King and Wendy’s are the two names that we would be most concerned about from an operational perspective over the next two-to-three years. Specifically, we think same-store sales growth could be weak at those concepts. This is suboptimal given that top line growth is needed to inspire confidence among investors, lenders and franchisees if the turnaround is not to turn into a protracted siege that can do long term damage to the brands.
Of course, given that “activist” investors are deeply involved with both Wendy’s and Burger King, adds another element to their stories. Weak operational performance may not lead to stock price weakness. Taking Burger King first, we believe that the $16 is a price tag that should give investors pause when considering an investment in the company. The implied valuation multiple, on an EV/EBIT basis, is 17x which makes Burger King the most expensive of the four companies (MCD, YUM, WEN, BKC). Our “Too Big To Fix” thesis contends that the issues at Burger King may be much more substantial than people realize.
Moving on to Wendy’s, the company is trading at a 26% discount to Burger King but at a 12% premium to McDonald’s. We think that represents a mispricing of the company’s fundamental outlook but investors’ expectations of Nelson Peltz’s possible next move. Given the sideways move in the stock over the past 3.5 years and the vast amount of capital needed to fix the asset base ($3.5 billion), it would not surprise us if Mr. Peltz was becoming a little anxious about Wendy’s future. Perhaps the changes that need to be brought around would be better implemented in the context of a public company, away from investor and analyst scrutiny? It would not be shocking if, in the not-too-distant future, we woke up to a rumor that Trian is shopping the company. The possibility of that happens, we believe, is helping to maintain that premium to McDonald’s which otherwise doesn’t seem to have any grounding in a fundamental comparison of the two companies.
Wendy’s CEO Emil Brolick’s recent comment on his company’s category was insightful: “we were hopeful that our February promotion of Dave's Hot 'N Juicy would help us regain our momentum, but unusually intense competitive couponing and discounting negatively impacted our sales growth.” This corroborates our view that the burger industry is, effectively, a zero sum game.
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POSITION: Long Healthcare (XLV), Short Industrials (XLI)
Same fundamental research thesis – Growth Slowing and Deflating The Inflation.
From a price, that will be good for US and Global Consumption Growth, but that (like all good sustainable things in life) will take some time.
Across our core risk management durations, here are the lines that matter most:
In other words, your new immediate-term risk range = 1. Sell on green on the way up to 1368, and buy on the way down to 1338 – but be mindful that the gravity associated with 1281’s mean reversion risk is very much new and in play over the intermediate-term; particularly with the Financials (XLF) being the lead relative performance gainer in the market YTD – plenty to give back there.
Enjoy your weekend,
Keith R. McCullough
Chief Executive Officer
HOW TO PLAY IT
TRADE (3 Weeks or Less)
JP Morgan is being punished by the market following the announcement of $2B in trading losses out of the CIO’s office. The real loss, however, is the impairment to industry credibility just as the Volcker rule is being finalized by Congress and the regulators. The apparent weakness of controls at the firm is a problematic indicator, particularly in the current regulatory environment. Additionally, the imminent downgrade of many large financials, likely including JPM, by Moody’s will add further short-term pressure.
TREND (3 Months or More)
JP Morgan is likely to suffer as we approach implementation of the Volcker rule on July 21st. While CEO Dimon was clear in his view that the trade in question was not proprietary (and thus permissible under Volcker), optics of the trade are working against him. A loss of $2B over the course of six weeks certainly gets regulators’ attention. With the trade now public, the loss is likely to grow in the coming weeks.
TAIL (3 Years or Less)
Over the long term, we expect the impact from Volcker will be less severe than the market fears. Former Citi Chairman & CEO John Reed recently noted that banking lobbyists in favor of a weaker Volcker rule outnumber and outspend consumer lobbyists by 25 to 1. We expect significant downside in the stock on both regulatory fears and macro data over the course of the next several months – but this downside could ultimately present an attractive entry point.
THE HEDGEYE EDGE
Risk will ramp back up throughout the summer months, as seasonal factors drive optical weakness in economic data. We expect this will provoke greater concern in the U.S. about Europe and other external negative factors, as the defense of “de-coupling” vanishes. Spain is the likely vector for contagion fears in 2012, just as Greece was in 2011. The global moneycenter banks and large broker-dealers (JPM, BAC, C, GS, MS) are most exposed. Until yesterday, the market was indicating that MS and C were perceived as the greatest risks among this group. This week, JPM has lost some of its “fortress” credibility, increasing the risk that they will be viewed more punitively.
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