“We are comfortable missing out on potentially major rallies if they are based purely on money flows or government action; the risks of engaging in this sort of speculative activity are simply too high.”
I’ve always enjoyed reading the quarterly letters and writings of great investors. From my perspective, Baupost’s Seth Klarman fits into the category of a great investor. The quote above is from his Q1 2012 letter to investors. On some level, Klarman has earned the right to underperform in the short run as his long run track record, almost 30 years, is superior to almost any investor in that time frame.
That being said, I think what likely differentiates Klarman and many investors with superior long run track records is their process. My guess is that Klarman may have written the above quote even just a couple of years into his career before his track record was established.
The fact is great investors have a process. Sometimes the process tells them to invest aggressively, sometimes it tells them to stay on the sidelines with large cash balances, but the outcome of the process is a plan to allocate capital. Overtime, if the process is superior, the outcome will be positively differentiated returns.
If I were allocating capital to funds, the first question I would ask any potential manager would be - what is your process? That would be followed by - why will this process produce superior results over time? Undoubtedly after reviewing their historic results, I could determine whether they actually had a process and executed on their investment plan accordingly.
The famed Spanish painter Pablo Picasso said this about having a plan:
“Our goals can only be reached through the vehicle of a plan, in which we must fervently believe, and upon which we must vigorously act. There is no other route to success.”
Quoting a famed European artist about planning is somewhat appropriate given the current debacle in Europe. Now this isn’t a shot at Europeans but rather a shot at the lack of an actual long term plan emerging to solve Europe’s long run debt crisis. Not to mention, the lack of a long term plan when the common currency was established.
I’ve had a number of friends who are traders, either personally or for large institutions, email me over the last couple of days and the general consensus in the trading community seems to be that the market will remain choppy until after the Greek elections, the G20, the FOMC, and the EU Summit. Not to put words in their mouths, but the plan in the trading community seems to be to not do much until the central planners are done planning. I like that plan.
As we wait for the central planners to stop their planning, the economic data out of Europe continues to deteriorate. The key European economic data from the last 24 hours includes:
- German exports declining in April -1.2%, for the first decline this year (worse than expected);
- Bank of France cuts its forecast in Q2 for France to -0.1% (worse than expected);
- Italian industrial output for April comes in weaker at -1.9% month-over-month (worse than expected);
- Netherlands April industrial production comes in at -2.7% month-over-month (weaker than expected); and
- Greek GDP contracted -6.5% in Q1 from a year ago, versus the -6.2% projected decline on May 15th.
The most startling data point is likely the last one. Not because the Greek economy matters all that much anymore, but rather because the Greek government continues to have a difficult time getting a handle on the actual data. Personally, I’ve basically accepted that most governments make up the numbers, so revisions, either up or down, are really of no great surprise.
Speaking of government data, the Chinese government will be releasing a broad swath of data over the next 24 hours, including consumer price index, industrial production, retail sales, and producer price index. For many, the plan is to buy commodities and risk assets if a Chinese rate cutting cycle begins in earnest. In the Chart of the Day, you can see why this may not be such a good plan, at least according to the last cycle.
Specifically, on September 16th, 2008, China cut rates for the first time in the cycle. As might be expected the 19-commodity CRB index ripped +9.5% in six days. By March 2nd, 2009, the CRB index bottomed -46.4% lower. Chinese rate cutting may have been a panacea for some, though not for those investors levered long of commodities. (Thanks to my colleague Darius Dale for putting this analysis together.)
Certainly, risk assets may act differently this time around if China starts to cut interest rates aggressively. My point is simply that front running central planners, to Seth Klarman’s point above, is a dangerous plan, if it is a true investment plan at all.
Yesterday, Chairman Bernanke presented his plan to Congress and as part of that testimony he said:
“The Committee reviews the size and composition of its securities holdings regularly and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability.”
This came at the end of the paragraph in which Bernanke outlined the Fed’s current actions, namely federal funds rate at zero for an extended period and a number of rounds of quantitative easing. In effect, via error of omission perhaps, Bernanke insinuated yesterday that the Fed is basically out of bullets. This might just be the best plan I’ve heard from the Federal Reserve in years.
Our key levels are: SPX fails at 1332 resistance (no support to 1283 TAIL); VIX holds 21.41 TRADE support, resistance = 24.73; USD holds all lines of support (range = 81.98-82.62); Euro fails, again, at 1.25 resist, support = 1.22; Oil (brent) fails at 101.73 TRADE resistance, no support to 95.26 (bearish formation there); and Gold has a big breakdown through our 1596 TRADE support, now nothing to 1538.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
This note was originally published at 8am on May 25, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“China, despite the slump of 2012-2013, has recovered its growth momentum and is economically dominant.”
That’s my rumor this morning. Got one? How many more do we need from conflicted and compromised central planners of Keynesian states to keep this no-volume stock market ball in the air? This is really getting sad to watch.
Markets don’t lie; politicians do. The aforementioned quote isn’t a lie; it’s a potential long-term risk management scenario. Looking at our core Growth & Inflation macro model for China in 2013, it’s actually a very credible one.
The forecast comes from the introduction of a book I just started reading called “Eclipse – Living In The Shadow of China’s Economic Dominance.” Since it was published by the Peterson Institute, at least some of the people sleeping in Washington right now have seen it. They don’t even have to read it. The cover is red and shows Obama bowing to Premier Wen.
Back to the Global Macro Grind…
If I’ve written this 100x in the last 5 years, I’ve said it 1000x – if you lose the trust of The People, you will lose the mother’s milk of markets – inflows. The more markets depend on baseless rumors for intraday moves, the less inflows you are going to have.
Actually, never mind inflows – at this point what you should be really worried about as an asset manager are outflows. Some people are stupid with their money. Most people aren’t – at least not after you burn them 3, 4, or 5 times with the same thing.
Q: What is that thing? A: Growth.
If you don’t have growth, a government certainly can’t manufacture it. Remember Obama’s economic “advisors” (Christina Romer and Jared Bernstein) promising a government spending multiplier on $800B of 1.5x? Lol. Thank God they’re both gone.
What you need to do is what the #FairShare crowd can’t handle - let it slow. Then growth slows to a point from which it can recover. When Growth Slows at a slower rate, we start to think about getting long; really long (like we did in 2009).
When it comes to Chinese growth, genius observers of the last 2 years of reported news will tell you that it’s slower than where it was in 2009-2010. Newsflash: that’s why the Chinese stock market was down double digits for each of the last 2 years. Markets discount future expectations.
Today, we’re trying to measure the slope of Chinese growth (we model the same for 86 countries in our model) and when it’s most likely to slow at a slower rate. When running our predictive tracking algorithms, we consider Growth & Inflation on all 3 of our risk management durations:
- TRADE (3 weeks or less) = we see Chinese growth slowing at an ACCELERATING rate
- TREND (3 months or more) = we see Chinese growth slowing at a SLOWER rate
- TAIL (3 years or less) = we see Chinese growth re-ACCELERATING at some point in 2013-2014
We use real-time market signals and high-frequency economic data to make risk managed research statements. We don’t take a survey or tell you how Chinese growth “feels.” The only feel I can give you about Global Growth Expectations right now is that they still feel heavy. And they will until Hatzius and Hyman cut their growth estimates to where the growth data currently resides.
Q: What’s the only way out of this thing? A: Strong Dollar.
That’s the only thing that will Deflate The Inflation of commodity prices. That’s the only thing that matters, on the margin, to the 71% of US Consumption growth that drives US GDP. That’s also the biggest thing that will allow China to cut rates, aggressively.
So instead of begging for bailouts and whatever other rumor some Keynesian can concoct in the next 4 hours of trading, let’s keep pressuring the political elite to get out of the way. Out with the academic dogma, we want our Dollar back.
With the US Dollar Index up for 4 consecutive weeks, it’s working.
- American Purchasing Power (USD) is up +4%
- Oil prices are down -15%
- US Consumer Discretionary stocks (XLY) are now the best performing Sector in the S&P 500 (+11.1% YTD)
Get the Dollar right, and you’ll get America right. If we don’t, by 2013 we’ll be stranded on an island of hopeless growth like Japan and Europe are, begging for the Chinese to bail us out.
My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, and the SP500 are now $1533-1565, $104.48-108.43, $81.53-82.61, $1.25-1.27, and 1294-1342, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Daily Trading Ranges
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TODAY’S S&P 500 SET-UP – June 8, 2012
As we look at today’s set up for the S&P 500, the range is 49 points or -2.43% downside to 1283 and 1.29% upside to 1332.
SECTOR AND GLOBAL PERFORMANCE
- ADVANCE/DECLINE LINE: on 6/7 NYSE: -252
- Versus prior trading day +2305
- VOLUME: on 6/7 NYSE 854.61
- Versus prior trading day 711.57
- VIX: as of 6/7 was at 22.16
- Change versus prior trading day of -2%
- Year-to-date change of -7.2%
- SPX PUT/CALL RATIO: as of 6/7 1.41
- Versus prior trading day 1.74
CREDIT/ECONOMIC MARKET LOOK:
- TED SPREAD: as of this morning: 38.7
- 3-MONTH T-BILL YIELD: as of this morning 0.08%
- 10-Year yield: as of this morning 1.67
- Versus prior trading day 1.65
- YIELD CURVE: as of this morning 1.30
- Versus prior trading day 1.37
TODAY’S U.S. ECONOMIC EVENTS
- 8:30 am: Trade Balance, April, est. -$49.5b (prior -$51.8b)
- 10am: Wholesale Inventories, April, est. 0.4% (prior 0.3%)
- Fed to purchase $1b-$1.5b note in 2/15/2036 to 5/15/2042 range
- 1pm: Baker Hughes rig count
- 8pm: Fed’s Kocherlakota to speak on economic theory in Michigan
- American Bankers Association issues economic forecast. 10am
- President Obama holds bilateral meeting with Philippines President Benigno Aquino. 2pm
- House in session
- House Ways and Means subcommittee holds hearing on tax extenders. 9:30am
WHAT TO WATCH
- U.S. moves ahead with implementing global bank capital rules
- Chesapeake Energy holds annual meeting; Chesapeake shareholders seen to challenge directors’ CEO review
- Olympus to cut 2,700 jobs, ~7% of its workforce, may consider an alliance to boost capital
- Google co-founders Larry Page, Sergey Brin said to be slated for questioning by U.S. antitrust regulators
- U.S. trade deficit likely shrank in April on falling oil prices
- Morgan Stanley, other global banks undergoing credit review by Moody’s; decision expected by end of month
- NYSE opposition to Nasdaq’s proposed remedy to Facebook’s botched IPO could delay Facebook compensation plan
- Spanish Prime Minister Mariano Rajoy holds bank talks with EU leaders as Fitch cuts Spain
- CA said has begun succession planning for CEO Bill McCracken, who turns 70 this yr
- Apple’s move to block Samsung Galaxy phone placed on fast track
- Federal Housing Administration to boost sale of delinquent loans to investors: WSJ
- McDonald’s releases monthly sales
- Nomura apologizes for multiple insider trading cases
- Watch for update on GlaxoSmithKline’s $13-shr hostile bid for Human Genome; tender deadline was yday
- Russell Index rebalancing after the close
- U.S. Inflation, Apple, OPEC, Egypt Votes: Week Ahead June 9-16
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Copper Trade Most Bullish Since March as China Cuts: Commodities
- Oil Heads for Longest Run of Weekly Losses in More Than 13 Years
- Commodities Head for Longest Weekly Losing Streak in 11 Years
- Copper Falls Most in Eight Weeks Without Fed Stimulus Signal
- Gold Drops in London as Bernanke Dampens Stimulus Expectations
- Coffee Falls on Speculation Slower Growth Will Curb Consumption
- Palm Oil Set for 20-Month Low as Mistry Sees Demand Slowdown
- Jiangxi Copper Considers Halting LME Exports as Prices Decline
- Barclays, BNP Japan Commodity Sales Heads Leave as Banks Cut
- Cooking Oil Demand in India Poised to Climb 29% as Income Rises
- Palm Oil Seen Extending Drop on Falling Biofuel Appeal, Fry Says
- LNG Sellers Bet on Oil-Link Amid U.S. Shale Boom: Energy Markets
- Kingsman Raises 2012-13 World Sugar Surplus By 63% on Plantings
- Copper Trade Most Bullish Since March
- Copper Stockpiles in Shanghai Decline for Ninth Week
- Merchant Commodity Hedge Fund Said to Drop 7.5% Last Month
- Rubber Declines for Fifth Week as Bernanke Holds Off Stimulus
MIDDLE EAST (HEADLINES FROM BLOOMBERG)
- Steepest Global Slide Since Recession Pushes Central Bank Cuts
- Oil Heads for Longest Weekly Losing Streak in More Than 13 Years
- Stocks Decline With Oil as Bernanke Damps Stimulus Speculation
- Malaysia Sukuk Gain a 5th Week on 15-Year Debut: Islamic Finance
- Mizuho Ousts WestLB as Japanese Boost Lending: Turkey Credit
- LNG Sellers Bet on Oil-Link Amid U.S. Shale Boom: Energy Markets
- Oil May Climb as OPEC Meets, U.S. Supplies Shrink, Survey Shows
- Iran’s LNG Company Says Sanctions Won’t Deter Production in 2013
- GCC Sales Set for Record First Half as Costs Drop: Arab Credit
- Bernanke Anxieties Embodied as Bond Sales Tumble: Credit Markets
- Rajoy Bid to Avoid Full Bailout Risks Falling Short: Euro Credit
- U.S. Inflation, Apple, OPEC, Egypt Votes: Week Ahead June 9-16
The Hedgeye Macro Team
Dollar weakness sent corn higher over the past week which is has dampened the performance of SAFM and also drove beef prices higher for the week. There is still plenty of good news for restaurant companies with corn, wheat, cheese, rice, milk, and coffee all down double digits versus last year. Coffee and chicken breast prices were the biggest decliners on the week, of the foodstuffs that we track.
Chicken wing prices remain the standout item in our commodity monitor but a close second is the growing amount of red that we see on the table over the last few weeks. Increasing economic uncertainty and dollar strength is helping to bring down food costs for operators in the restaurant industry after a prolonged period of margin pressure in part due to rampant inflation in beef, dairy, coffee, and other items.
The chart of the CRB Foodstuffs Index versus the US Dollar Index, below, indexed from September 1stof last year, highlights the inverse relationship between the U.S. dollar and foodstuffs prices over the last nine months. As a firm, Hedgeye has been of the opinion that a Strong Dollar translates into Strong Consumption in America, which helps the top line growth of restaurant companies but it is also helping to relieve margin pressure – as the chart below shows.
Gasoline prices continue to decline. The easing of pressure at the pump is having an impact on demand. According to AAA, US retail gasoline prices are now -5.5% year-over-year and consumers are responding. Earlier this week, Mastercard reported that the gasoline consumed over the 4 weeks prior to June 1stwas -1.9% year-over-year, which is the smallest decline since 9/16/11. Gasoline consumption has been negative, on a year-over-year basis, for 40 straight weeks as lower prices spur demand but the weak economy weighs on fuel purchases.
Beef prices traded moderately higher over the last week as dollar weakness provided support. Optimistic expectations for this year’s corn crops, as well as economic concerns, had been weighing on beef prices but mounting concern that dry, hot conditions across the Corn Belt are sending prices for the grain higher. Below, we detail some thoughts on several companies’ exposures to beef prices.
JACK: Jack in the Box is one of our favorite longs. On May 17th, the company said that it expects beef costs to be up 5-6% versus prior expectations of high single-digit inflation. While prices have gone up since then, we do not think that the company will have revised its stance, yet. The company also said that, if beef prices were to continue to “stay low”, its guidance of 14.5-15% for restaurant operating margins might could have been conservative. We think expect its restaurant operating margin to come in close to that target given the recent gains in beef costs. Beef, which is 20% of the company’s spend, is the biggest wildcard in its commodity basket.
WEN: Wendy’s, like Jack in the Box, purchases fresh beef (20% of its basket) on the spot market. On May 8th, the company said that it expected beef prices “back up” by the fourth quarter and that its purchasing is pretty much “at market with a three months lag as you see the impact of market changes on beef”.
TXRH: Texas Roadhouse, as of April 30th, had pricing arrangements in place for well over 90% of its beef.
We have to highlight, once again, the resilience of chicken wing prices even as other commodities and protein costs roll over. Our conversations and analysis continue to point to undersupply in the market which, given the price action, is not being addressed by the marginal increases in egg sets that the data is showing every week. As the chart below shows, egg sets are still declining at ~4% year-over-year.
Chart of the Day
- Chinese rebar futures markets not betting on stimulus working in construction
- Rebar spot prices down about 20% Y-o-Y nominal
- Worth watching to gauge informed local market expectations for construction activity/heavy equipment demand
Navistar Miss: Navistar reported some very challenging results and the shares have sold off significantly today. The lack of clarification on the company’s engine certification was particularly troubling. Even after a period of significant underperformance relative to Paccar, Paccar still trades at a 23% discount to Navistar on an Adjusted EV/2011 EBITDA basis. While this may reflect some concerns about Paccar’s SEC inquiry, that is a less significant business headwind than not meeting *2010* emissions targets in mid-2012.
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