Japan is off the hook…for now

Over the past thirty years, Japan has gone through tremendous economic headwinds beginning with the asset price bubble of the early 1990s to the financial crisis of 2008 and into the 2011 tsunami and earthquakes. The lack of growth in the country has been a bitter pill to swallow for investors and the Japanese government as the country struggles to get itself back on its feet and out of stagflation.


Japan is off the hook…for now  - JAP3 large


Despite cautious overtones related to the Japanese economy, we think there are four reasons as to why Japan is on the rebound and will not encounter a government bond-related crisis over the next few years.


1)      We see a diminished threat of future rating agency downgrades beyond critical levels. On May 22, Fitch was the first of the “Big 3” rating companies to downgrade Japan’s long-term local currency issuer rating to single-A status…


2)      On June 17, the Democratic Party of Japan agreed to double the nation’s 5% VAT tax in a two-step process ending on October 2015. While we demonstrated in our April 3 research note titled “DIGGING DEEPER INTO JAPANESE SOVEREIGN DEBT RISK” that hiking the VAT tax will do little for long term fiscal consolidation and debt reduction, positive headline risk associated with the passing of the VAT hike bill will likely buy the government a meaningful amount of time.


3)      On June 16, Prime Minister Noda agreed to restart the first two of Japan’s 50 idled nuclear reactors, implying that all political hurdles had been cleared. As a result, Japan should see a reduced need to import fossil fuels. A lack of support from Japanese voters in poll suggests that the decision was politically motivated. Noda’s decision illustrates a new confidence and willingness on the part of the Japanese government to go against popular sentiment – just last month, Japan issued projections for mandated rolling blackouts, which amount to cuts in consumer and corporate energy consumption.


4)      The slope of Japan’s 5yr breakeven inflation rate has now inflected after a long period of increasing inflation. This inflection coincides with the Bank of Japan’s unwillingness to give in to political and market pressure to ease monetary policy in pursuit of its +1% inflation target. In conjunction with a predictable compression in global interest rates differentials, this leads us to anticipate a bout of strength for the Japanese Yen in the near future.


Japan is off the hook…for now  - JAP2 large


Whether Japan will be able to shed its long-term low rates policy remains to be seen. But it’s making progress on many economic fronts that are important to keep in mind over the next one to three years. Japan also has committed a large amount of money to the International Monetary Fund ($60 billion currently) , making it one of the largest contributors to the fund. Should the European debt crisis rapidly accelerate at an unexpected rate, those commitments and associated collateral calls could prove to be costly. Japan’s economy is a lot like a game of chess. Dealing with it requires a great amount of patience and fortitude.



  • While the Macau stocks have been on a steady downward decline since late April over fears of a hard landing of Macau GGR, Junket VIP volume growth has been decelerating since September 2011
  • Using just historical seasonality trends to project future growth, the chart below illustrates projected Junket VIP volume growth for FY2012 based on the prior two months of actual data.  Using the actual results of July and August 2011, without adjusting for economic slowdown, our seasonality model would have projected a 47% increase in Junket RC volumes in 2012.  However, in each subsequent month as data came in weaker than pure seasonality factors would have implied, the forecast for 2012 continued to calibrate lower to 15% based on May results.
  • Layering in a continuation of decelerating macro factors onto our seasonality model, we are currently projecting that Junket RC volumes will come in at +10% YoY for 2012 and total GGR growth of 14% in 2012.


Leading The Pack On JACK


Howard Penney, Managing Director of Restaurants (@HedgeyeHWP)



In early May, we put out a note indicating that the time was right to get bullish on Jack in the Box (JACK). We went contrarian to the Street consensus that current sales trends would not strengthen quarter-over-quarter. Jack’s core business along with its fast growing Qdoba brand is something we found attractive at the time and still do. The company will soon wrap up its remodeling and rebranding phase which will relieve pressure on capital expenditures. This, combined with better comps going forward bodes well for top line growth. Over our long-term TAIL duration, we see as much as 50% upside in the stock.


Leading The Pack On JACK - JACK packonbull


Here is our original thesis from May 5th highlighting our durations for JACK:


TRADE (Duration = 3 weeks or less)

2QFY12 earnings are expected to be released on the 15th of May. Our view is that the Street is overly bearish on the company’s top-line trends, currently expecting a slowdown in two-year average trends.  We believe that the current sales trends at Jack in the Box strengthened quarter-over-quarter.


TREND (Duration = 3 months or more)

With the benefits of the remodel program only impacting the company’s financials now and the costs (capex) fading, we are positive on the company’s cash generation prospects.  Easier comps going forward should also help bring the top line higher.


TAIL (Duration = 3 years or less)

JACK trades at a discount to SONC (7.3x EV/EBITDA) and WEN (8.2x). We believe that JACK should trade at a premium to SONC and in line with WEN.  Over the next three years, we see as much as $8 in upside to JACK. 


So when we got bullish on May 5, 2012, the stock was trading at $23 a share. As of yesterday, the stock was at $27. That’s something to get excited about. The Street (Old Wall) is now following our lead and getting bullish as well. This company’s got legs and plenty of room (and time) to grow. 

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ENERGY: Under Pressure

In case you haven’t noticed, energy is under quite a bit of pressure lately and we are not referring to fracking here. Crude has been crashing since the $108 a barrel level in late April and continues to fall as the US dollar puts up strength and the inflation-induced commodity bubbles begin to burst.



ENERGY: Under Pressure - FTK TakeMeLower2



One of our best calls has been shorting Flotek Industries (FTK). We went short at $11 a share on June 7 with the thesis that as big name players like Baker Hughes (BHI) and Haliburton (HAL) get squeezed on costs and falling margins, they will need to cut costs somewhere and the suppliers of raw materials to the drillers are a perfect fit. It breaks down to three key factors, essentially:

  1. Top line growth slowing as drilling activity slows (strong dollar = lower oil)
  2. Margin compression due to lower chemical pricing and higher input costs
  3. Relative outperformance reversal and relative valuation call (FTK not cheap vs group)


We see FTK going lower if past performance is any indication of what the future holds (it’s not), it could happen much sooner rather than later.


The key takeaway here is that FTK isn’t the only company who stands to get squeezed from falling energy prices. Companies like CARBO Ceramics (CRR) will also capitulate to the major players as pricing agreements take to the wind and are renegotiated. Take note of CRR and as we believe it has the potential to become the next FTK as we become increasingly bearish on it.


The past week Macau GGR growth decelerated to just +2.1% YoY, generating average daily table revenues of HK$678MM. It’s unclear whether the deceleration was due to hold fluctuation or volume growth slowing.  Our full month June forecast is now for GGR of HK$22.5-23.5 billion or 12-16.5%.  While an improvement over May growth, we believe that this level of YoY growth could disappoint investors when coupled with the reduction in the UnionPay withdrawal limits and rumors of the lengthening of the IVS visa process.


Yesterday the Macau Daily News reported that UnionPay reduced its maximum daily transaction limit to on their debit cards to RMB$1MM from a prior limit of RMB$3-5MM. There is some speculation that this actually occurred back in April 2011, in which event, the tightening is likely having no impact on the recent decelerating trends we’ve been seeing. If the reduction limits are a more recent event then they are more likely to impact premium Mass business, as high rolling VIPs wager off of Junket and direct credit lines.  However, we have also heard that pawn shop business has dropped by 30% in Macau this month, which is having a negative impact on the VIP business.   


There was also an article in the Macau Daily News about rumored lengthening of the visa process for those on the IVS, which is speculated to be negatively impacting mainland visitation to Macau. We generally believe that as in the past, reaction to visa restrictions are usually overblown.




In terms of market share on a week-over-week basis, MPEL share saw a big move up from 9.5% last week to 16.1% this week while Galaxy saw the inverse move, losing 6.4% share week over week to 20.3%.  LVS’s share fell to 17.7% from 19.5% in the prior week, while Wynn gained 90bps getting its share to 12.1%.  The MTD share table is below:



Potent Weapon

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“Fear is a potent weapon in the hands of the power elite.”

-Chris Hedges


That’s an important quote in Death of The Liberal Class by Chris Hedges. If you believe, like I do, that risk management starts and ends with being empathetic to all politically polarized positions, I highly recommend this book. The first 50 pages will really make you think.


Imagine that, thinking for yourself within the context of how other people think. Instead of doing more of the same – more of what has not worked (print, bail, print), imagine a world where we aren’t centrally planned by Republican/Democrat economic policy dogma. Imagine a world where America wasn’t inching toward becoming Japanese European.


The power elite may have landlocked how Bernanke’s Fed and Geithner’s Treasury think about letting losers win, but they have not yet suffocated the rest of us free market capitalists into silence. Yesterday’s market reaction to the latest bailout scheme was a stiff reminder of that. For them.


Back to the Global Macro Grind


If you saw my market debate with the ING strategist on The Kudlow Report last night, you can see that I am pretty much #Fedup. I am tired of incompetent forecasting on both US and Global growth. I am done with letting these guys from the Old Wall change their perma-bull thesis to new ones every time they get the prior one wrong.




I think The People are done with it too. That’s why you see these outflows from stock and commodity funds. That’s why you see this American Zeitgeist of distrust in any idea that comes out of the Fed, Treasury, or IMF. That’s why you saw pretty near every pundit who was spewing about how high the market was going to go on yesterday’s bailout “news” get run right over.


“Fear is a potent weapon.” And our being right on Growth Slowing is not the fear I am talking about. That’s called being accurate. Fear is what both the Bush and Obama administrations run on. So did Nixon and Carter. Fear of Big Government Interventions and all their conflicts of political interest are what puts a confident and optimistic guy like me on hiring hold.


The Fed has a “full employment” mandate, so they think doing more of what has not worked is their job. To a degree, that’s their own problem – the inability to re-learn, re-work, re-think. But, from a bigger picture perspective, this is really a leadership problem. The Fed and Treasury take their policy making lead from the President of The United States.


Here’s what one of their chief group-thinkers (Chicago Fed Head, Charles Evans) had to say after yesterday’s market reaction:


“I’ve been in favor of pretty much any accommodative policy I’ve heard about.”


Great. Just really great, Chuck. You have got to be kidding me. If Obama created a tax shelter whereby I could hire you for free, I’d probably go for it just so that I could fire you. You and your cronies from Chicago who want Policies To Inflate commodity prices need a real life wake-up call.


I’m certainly not alone in feeling this way. And since I built this company with my own risk capital, I’ll write whatever I want. Chapter 1 of Death of The Liberal Class is called “Resistance.” That’s what I am doing. I have American kids, and I resist the institutional pressure to put short-term politics and stock/commodity market performance ahead of the long-term future of this country.


“Earnest Logan Bell, an unemployed twenty-five year old Marine Corps veteran, walks alone Route 12 in Update New York. A large American flag is strapped to the side of his green backpack… he is on a six-day, ninety mile self-styled “Liberty Walk” from Binghamton to Utica. He plans to mount a quixotic campaign…” (Death of The Liberal Class)


“Anger and a sense of betrayal: these are what Ernest Logan Bell and tens of millions of other disenfranchised workers express…” (page 6). If you don’t get that, you are completely out of touch with the real world in which central planners are forcing us to live.


So go ahead, get the US taxpayer to start back-stopping European and Japanese government losses through the IMF. Tim Geithner, I personally dare you to do that and explain it, as you like to say “deeply”, to the American people. Explain to us, with all your fear-mongerings, why we should trust you this time.


Sadly, for Bernanke and Geithner, this time is not different. The market gets that too.


In other Keynesian central planning news this morning:

  1. The IMF says the Japanese Yen is “overvalued” and that the Japanese should “stimulate”
  2. Italy’s Monti (who forecasted the European Sovereign Debt Crisis as “ending” in March) to meet with France’s Hollande
  3. India’s debt to likely lose “investment grade status” (whatever that still means)

Great. Just great. The Washington, DC based (and US tax payer backed) IMF now has market opinions on “valuation”, and Geithner is pushing Lagarde to pull a Krugman on Japan and Europe (1997 he told the Japanese to “PRINT LOTS OF MONEY”).


Great. (link to the CNBC debate


So was my 0% US Equity asset allocation yesterday. My unlevered and un-invested position Cash can be a Potent Weapon too.


My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, Spain’s IBEX, Italy’s MIB, and the SP500 are now $1588-1598, $96.59-99.98, $82.01-83.17, $1.24-1.26, 5937-6667, 12238-13661, and 1284-1326, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


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