Comparing the Federal Reserve’s Balance Sheet to the European Central Bank … Negative for the Euro

Conclusion: The ECB has massively increased its balance sheet over the last six months relative to the Federal Reserve.  This trend is likely to continue, which is bearish for the Euro.


In the race to the bottom of the world’s currency markets, the actions of both the Federal Reserve and the ECB are central (no pun intended) to determining the relative value of currencies.  In the charts below, we show the increase in the balance sheets of both central banks starting from 2003 to the most recently released data from this week.


Comparing the Federal Reserve’s Balance Sheet to the European Central Bank … Negative for the Euro  - ECB


Comparing the Federal Reserve’s Balance Sheet to the European Central Bank … Negative for the Euro  - Fed Balance Sheet  3


In aggregate, both charts show the massive amount of stimulus that central banks have injected into the global economies over the past nine years with the vast majority coming in the last three years with the onset of the “Great Recession”.   In aggregate, since 2008 the two central banks have added more than $4 trillion to their balance sheets.


Over recent quarters, the Federal Reserve has halted the expansion of its balance sheet. In fact, from the start of the year to the most recent data reported on June 20th, 2012, the Federal Reserve has actually seen its balance sheet decline marginally by about $43 billion, or just under 2%. 


In the same period, the balance sheet of the ECB has expanded by an estimated $410 billion. This is an increase of just under 12% for the ECB’s own balance sheet, a dramatic relative increase versus the Federal Reserve’s decline of 2%.


The primary driver of this relative acceleration in the size of the ECB balance sheet has been the ECB’s LTRO 1 and LTRO 2.  In aggregate, these two programs have handed out more than $1.3 trillion to more than 1,000 European banks.   Collectively, this is larger than the Federal Reserve’s much ballyhooed TARP program and quantified easing (albeit QE is a different policy tool, as well).


As the ECB has taken a much more aggressive stance with its balance sheet, it should be no surprise then that the Euro has had a serious correction versus the U.S. dollar in the year-to-date.   This decline has been accelerated over the past three months as the FXE, the CurrencyShares Euro Trust etf, is down 6.3%.  (Incidentally, we’ve had some solid success trading the FXE, being correct 13 of 16 times in the Virtual Portfolio with the aggregate gains substantially larger than the aggregate losses.)


Since 2010 the relative size and relative growth of the Federal Reserve’s balance sheet versus the ECB’s has had a direct correlation with the value of the Euro versus the U.S. dollar.    Even as the Euro has weakened versus the U.S. dollar in 2012, it does seem as if some of this lock step relationship has alleviated, which may imply further downside in the Euro versus the U.S. dollar.


If we accept that the future direction of the size of the central bank’s balance sheet is a decent proxy for either more hawkish or more dovish monetary policy, then there are a couple of scenarios: 

  1. QE3 is imminent – In effect, the currency market is pricing in incremental quantitative easing from the Federal Reserve.  Based on the most recent commentary from the Federal Reserve, this seems to be an unlikely scenario in the intermediate term as they did nothing last week but extend Operation Twist.  In effect, this action is merely equivalent to not tightening.
  2. QE3 is not imminent and intervention in Europe continues – If the monetization of debt / lender of last resort continues to be an ECB led activity, the balance sheet of the ECB should continue to expand.  Given the situation in the European banking system, this seems a very likely scenario.  In fact, as we’ve highlighted, Italy and Italian banks are the next potential shoes to fall in Europe with massive pending maturities and accelerating credit default swaps.  It is highly likely that the ECB will continue to have to step up and support its banking system. 

The growth in size of the respective balance sheets of the ECB versus the Federal Reserve is a key factor in determining the direction of the currencies.  The recent expansion of the ECB balance sheet and likely continued expansion portend negatively for the Euro versus the USD.



Daryl G. Jones

Director of Research



MACAU: No one feels important

When you think of Las Vegas, you don’t just think of gambling – you think of shows, concerts, debauchery, nightclubs and a slew of other entertainment options. When you think of Macau, you strictly think in terms of gambling and numbers. Despite Macau’s meteoric rise over the last decade, it appears that the amount of VIP high rollers is tapering off and has been since last September. Growth slowing is not something new and abrupt – we have been banging our fist against the table, noting how slowing growth is a global phenomenon not limited to the US and Europe.


MACAU:  No one feels important - MACAU VIPgrowth



Based on the prior two months of data, we’ve estimated projected Junket VIP volume growth for the rest of FY2012. Decellerating macro factors combined with an sluggish global economy has led slower growth and declining volumes in Macau’s VIP market. When the VIPs begin to drop out, both the hitters and regulars will also begin to take flight. This leads to another factor that keeps investors worried: gross gaming revenue growth (GGR). If GGR goes negative, returning to growth will be a long, dragged out journey.


For active traders, names like LVS and MPEL may be attractive at lower levels, but we caution about hopping into them over a short-term TRADE duration. It will take some time for these names to appreciate and build their growth and revenue back up, so we favor the longer-term TREND and TAIL durations.


FL: We Like It Here

With FINL’s Q1 results already preannounced, quarter-to-date sales will be one of the key takeaways from Friday’s call. Weekly footwear trends, after adjusting for a typical margin of outperformance in the athletic channel, suggest that June is tracking up +10%-11%. We think this translates to comps of +8.5% at FL and +7.5% at FINL quarter-to-date – both well above current expectations. In addition to our call to be long NKE into the print, we like FL here.

Consider the following:

  • FL is back to the level where it was headed into Q1 results when European and 1H performance concerns were heightened against tougher comps and demand uncertainty. With the Q1 river card out of the way reflecting solid results highlighted by sales coming in better than expected and Europe turning positive, we’re seeing similarly favorable results thus far in Q2 after which compares only get easier.
  • May footwear sales in the Athletic Specialty channel came in up +10% following +8% in April. Given an average 4-5pt margin of outperformance in the athletic channel over aggregate industry trends, weekly industry sales suggest June-to-date is tracking up +10%-11%. When taking into account the offset of apparel underperformance (and international in the case of FL), this suggests comps are tracking at +8.5% at FL and +7.5% at FINL quarter-to-date.
  • In looking at category performance, basketball is outperforming – a trend that we think has continued through June. With greater exposure here relative to FINL, we expect FL is tracking ahead of the quarter-to-date comp update we’ll get on FINL’s call Friday.
  • Through the first three weeks of May, FL highlighted that Europe had turned positive (up +LSD vs. –MSD in Q1), which is a stark contrast to most other retailers with exposure to Europe mitigating further weakness in a region that accounts for ~24% of sales. While we admittedly don’t have great visibility into how June is shaping up, there are two factors to consider re Europe, 1) early indications suggest trends are stable if not turning positive, and 2) compares here are also getting more favorable.
  • It’s tough to ignore the fact that FL is trading at 10x our F13 EPS estimate of $2.81 – a discount last seen back in ’08. This name has typically traded at 12x-16x EPS multiple. With earnings growth in our model at 35% this year and 14% over each of the next two years, we like this entry point on a story that now has less risk than a month ago when we last saw this price.

While FINL is at a level that reflects a heavy market discount for management’s ability to execute on what we view as conservative numbers, we think FL is a more attractive play here over the intermediate-term.

Here are a couple of our prior notes on FL:

FL: 1Q12 Report Card (5/21/12)


FL: A Much Needed Beat (5/15/12)


FL: Second Act: Roadmap Intact (3/7/12)

Casey Flavin



FL: We Like It Here - FW Channel May 12


FL: We Like It Here - FW Category May 12





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HOLX: Great expectations

There has been concern in the industry about Hologic (HOLX) and the Gen-Probe (GPRO) deal for some time now.  Mainly, there is concern about the level of dilution from the debt HOLX would have to raise in order to complete the acquisition, with the emphasis on the coupon rate.  We see the line in the sand at 8% on $3 billion raise, which seems completely feasible.


Regarding the core HOLX business, the 3D tomography technology may take some time to penetrate the existing 2D customer base, but management has set low expectations for its adoption, and we see upside into 2013.  Further, HOLX’s diagnostic segment should benefit with increasing physician utilization into the second half of the year. While others are cautious about the HOLX, we are comfortable being long.


HOLX: Great expectations - hospital lobbying

HedgeyeRetail Visual: Evolve or Perish

Companies that are not targeting for better than 30% of sales to come from e-commerce risk the consumer resetting that benchmark closer to zero. Retailers need to evolve faster than consumers, not vice versa.


Industry wide e-commerce penetration has grown drastically over the past decade which we estimate now accounts for ~5% of total sales from just 1% in 2000. Despite the widespread growth trajectory of the channel as a whole, there remains a notable bifurcation between companies who have truly laid the groundwork to lead the omni channel drive relative to those who remain squarely in catch-up mode.  


Most companies are currently aiming for MSD-HSD penetration in online sales as a percent of total revenues. But these are baby steps. The companies looking to grow via baby steps will get steamrolled. The retail landscape needs to move faster than the consumer, not vice/versa.


Some companies however, like URBN are thinking long term, targeting half of its sales online as early as 2017 with penetration currently sitting at an already industry high of ~20%. Interestingly, industry data suggests URBN is one of the most exposed to the younger spending demographic with ~53% of online sales from consumers 34 and younger which lends well to the e-commerce opportunity long term. URBN is still far from the highest penetrated in the growing e-commerce channel with WSM e-commerce sales accounting for ~38% of revenues (44% including catalog) and the office superstores (which is driven largely by small business commodity-product order fulfillment) exceeding 40%.


Alternatively, there remains substantial opportunity for several retailers that currently operate a largely wholesale model like NKE, RL & VFC. It’s amazing to see that Nike’s e-commerce penetration is a third of UA and LULU. It has a much larger installed base of revenue, but it will begin to rapidly close this gap (while the others continue to grow – as they are winners as well).


Ultimately, we like companies like URBN that are targeting 50% penetration…maybe they fall short, but they’ll get close. Anyone simply targeting 10-15% has risk of getting bypassed by the consumer and having that ratio ultimately going to 0%.  (i.e. BBBY.)


HedgeyeRetail Visual: Evolve or Perish - E Commerce COTD