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CONCLUSION: Despite what appears to be a buying opportunity in Korean equities ahead of what is likely to be a positive inflection in the country’s domestic fundamental story, it is our view that the prudent thing for investors to do at the current juncture is wait – specifically for quantitative confirmation and increased clarity from Chinese policymakers on how they plan to address their latest bout of economic deterioration in the immediate term (if at all).


Overnight, the South Korean Finance Ministry lowered its official 2012 growth estimate by -40bps to +3.3%; additionally, it reduced its 2012 inflation estimate to +2.8% from +3.2%. While we don’t assign much weight to the economic projections of governments or their affiliated institutions in our research process (look no further than the CBO or the Fed to see just how painfully wrong such forecasts can be), we are keen to note that revisions such as these are typically leading-to-concurrent indicators of policy shifts. On that front, the South Korean Finance Ministry also introduced a KRW8.5 trillion ($7.4B or 0.7% of GDP) stimulus package designed to assist small businesses and low-income earners.


As an aside, we continue to find favorable countries who’ve protected the USD-based returns of international investors by supporting strength (relative or absolute) in their currencies. South Korea has been one of Asia’s shining stars in this regard over the past month, outperforming other Asian currencies vs. the USD by +190bps (on a regional median basis) as the table below highlights.




On the fiscal policy front, South Korea can surely afford to loosen its purse strings a bit; it’s central government budget surplus is just shy of +2% of GDP (officially at +1.8% in 2011). Their fiscal prudence has also contributed quite nicely to their strong current account position of +2.7% of GDP (2011) – giving South Korea dual surpluses where they are most supportive (in the currency market). Additionally supportive is South Korea’s relatively pristine sovereign debt/GDP ratio of 33.2% – particularly in the current Global Macro environment where consensus is literally being forced to [finally] comprehend the statistical relationship between excessive sovereign debt (beyond the Rubicon of 90%) and economic performance.




On the monetary policy front, both 1YR OIS and NDF markets continue to take the Bank of Korea’s cues of stability quite literally (they’ve been on hold for just over 1YR now), which ultimately translates into relative hawkishness in an environment where most other emerging and developed market central banks have a clear easing bias.




Furthermore, a real benchmark policy interest rate of 0.75% is supportive of cross-border capital flows into the South Korean economy – as is the government’s recent decision to exempt foreign investors from paying taxes on their foreign currency deposits as well as lowering tax rates for domestic banks that attract incremental foreign currency deposits.




As always, capital chases yield. As such, we are fundamentally inclined to [virtually] invest our “capital” in the South Korean economy at the current juncture – particularly given the country’s favorable TREND-duration GROWTH/INFLATION/POLICY outlook. On this score, Philippines and Thailand are the only other countries in Asia that currently qualify as TREND-duration fundamental long ideas based on this proprietary screening process.




As you likely focused on in the prior sentence, we can’t stress enough how important it is to our research process to have unique processes by which we derive our fundamental and risk management conclusions. In South Korea’s case, the country’s benchmark KOSPI equity index is in a Bearish Formation, which means it is quantitatively broken across all three of our risk management durations (TRADE, TREND and TAIL). We are smart enough to know that we are not smarter than Mr. Market; as such we are keen to interpret the latest economic trends out of South Korea with a grain of salt, rather than through the purview of rose colored glasses in anticipation of a positive inflection.










As we look for explanations as to why South Korean equities remain broken, the intellectually lazy answer would be to point a [fat] finger at the European sovereign debt and banking crisis. For a more quantified explanation, we instead point to recently souring trends in the global information technology sector (23.7% of the KOSPI index) and in the Chinese economy (far and away South Korea’s largest export market at 24.4% of total shipments).


As we’ve pointed out in our recent research, growth expectations for each have come down in recent weeks, with the Technology Select Sector SPDR Fund or “XLK” (bearish TRADE and TREND) underperforming the S&P 500 by -134bps since the start of MAY and the Shanghai Composite Index (also bearish TRADE and TREND) underperforming the S&P 500 by -344bps over that same duration. In the interest of keeping this analysis tight, we won’t belabor this point further; for more details, refer to the following notes/conclusions: 

  • WHAT’S ASIA SIGNALING ABOUT TRENDS IN THE TECH SECTOR? (APR 30): The relevant growth data emanating from Asia suggests the tech sector is at risk of deteriorating operating metrics over the intermediate term.
  • CHINA’S INCREMENTAL GROWTH SLOWDOWN CONFIRMED (MAY 29): While Deflating the Inflation remains a bullish catalyst for the Chinese economy, the lag between this event and the turn in both the reported growth data and growth expectations may have just increased. As such, we are of the view that waiting and watching for clarity is the best strategy in the immediate term for China.
  • CHINA’S RATE CUT IS LIKELY A BAD SIGN OF WHAT LIES AHEAD (JUN 7): We don’t see the early innings of this Chinese rate cut cycle as a signal to get bullish on China’s economy or equity market at the current juncture. Moreover, we do not find it prudent for investors to increase their asset allocation exposure to commodities here. 

All told, despite what appears to be a buying opportunity in Korean equities ahead of what is likely to be a positive inflection in the country’s domestic fundamental story, it is our view that the prudent thing for investors to do at the current juncture is wait – specifically for quantitative confirmation and increased clarity from Chinese policymakers on how they plan to address their latest bout of economic deterioration in the immediate term (if at all).


Darius Dale

Senior Analyst

HedgeyeRetail Visual: NKE Futures vs. Margins. Tough to be Bearish

When Nike's futures are up, inventories are trending down AND it's coming off the worst Gross Margin hit in 10-years, it's tough to build a bearish margin story over the next year.  


HedgeyeRetail Visual: NKE Futures vs. Margins. Tough to be Bearish - 6 28 2012 2 36 23 PM

FL: Going The Distance

SECTOR: Hedgeye Retail (@HedgeyeRetail)




Foot Locker has had its share of near-term problems as it struggled with sales and its European business. We’ve been bullish on the long-term TAIL duration of this stock as the company works its way around the European business climate and focuses on growth. We got bullish on the company before it reported Q1 earnings based on strength in domestic trends and came in above our consensus estimate.


With Q2, we expect the company to put aside any issues that have been plaguing it for some time, paving the way for a better second half of 2012. With domestic trends coming in well above expectations, we think that FL has the gusto to beat Q2 earnings estimates. Also, coming out of Q2, FL’s sales/inventory spread improved on the margin which is a positive for gross margins. Coupled with the top-line coming in ahead of expectations should result in materially higher EPS numbers this year and next. Basically, the best is yet to come for FL. Have patience with this one.



FL: Going The Distance  - FL growthchart

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SBUX: The $100 Million Question

HEDGEYE ANALYST: Howard Penney, Managing Director of Restaurants (@HedgeyeHWP)




The recent acquisition of La Boulange Bakery by Starbucks (SBUX) raises some questions. First and foremost is the price of $100 million for a bakery chain that CEO Howard Schultz justifies through a growth strategy. The goal is to expand the La Boulange footprint by distributing its goods throughout Starbucks stores and making it a nationally known name. Bringing French baked goods to the masses is a strategy that has a high likelihood of working out, similar to how Americans have embraced Italian espresso.


SBUX: The $100 Million Question - SBUX bread



But the concern we have at the moment is distribution. In a note written by Maury Rubin’s City Bakery Daily, he outlines the issues related to the logistics of shipping and distributing freshly baked goods:


Many years ago, when Starbucks first moved into New York City, they asked if City Bakery would consider being a supplier of baked goods. I was completely interested, until I learned the required delivery schedule: orders needed to ship to a central location by 6pm to be sold the next day. In our bakery, then as now, we bake every thirty minutes all morning long. The goal is to have pastry on our counter that was in the oven within the hour when bought. For Starbucks, we would need to have baked 15-18 hours before the fact.”


Howard Schultz believes that the way La Boulange handles its logistics justifies the $100 million price tag. In reality, it will probably require further capital expenditures to keep the quality associated with La Boulange products after they are shipped since it is highly unlikely existing Starbucks stores will be retrofitted with the ability to produce baked goods.


BWLD: Shorting Wings

HEDGEYE ANALYST: Howard Penney, Managing Director of Restaurants (@HedgeyeHWP)




Buffalo Wild Wings has been on our short list for two weeks now. There are many drivers behind our bearish call, but a big one is the price of chicken wings. Chicken wings are simple, cheap and have great margins for restaurants. How do you think your neighborhood bar is able to get away with 25 cent wing night?


BWLD: Shorting Wings - BWLD Chickenwing



Right now, the price of a pound of chicken wings is about $1.80 when it should be more like $1.40 a pound based on historical data. The price of corn, which is what chickens eat, has skyrocketed as of late. As the cost to feed chickens increases, so will the price of the chickens eating said corn and being sliced and diced into delicious wings. We’d like to highlight a quote from our weekly Commodity Chartbook that lays out the situation behind the scenes with the buyers and suppliers of wings.


“It seems that the peak in wing price inflation may be in but, as positive as that sounds for BWLD, it may be a slow grind lower; wing prices are stubbornly hanging in north of $1.80 and management at food processing companies that we talk to are suggesting that rebalancing the relationship between chicken wing supply and demand may take some time.”


Once upon a time someone remarked “bigger is better.” A lot of people would kindly disagree with the originator of that statement. Since 2007, the Federal Reserve and the European Central Bank (ECB) have been in a race of sorts to add as many assets to their balance sheet as humanly possible. Looking at the chart of the Federal Reserve’s balance sheet fluctuations below, you can see the original “bazooka” of $800 million that former Treasury Secretary Hank Paulson used in mid-2008. 


RACE TO THE BOTTOM: The Fed vs The ECB - FED balancesheet1



From there, when we have gone one direction: up. When things go wrong and the US doesn’t like it, we slap it on the Fed’s balance sheet. And despite constant asset sales, including the Maiden Lane portfolios that we built from the sewers of AIG, we have yet to reduce the Fed’s balance sheet in earnest.


The same goes for the ECB, save for the huge 2008 spike. It has been a gradual climb into 2011 upon which everyone else in the world realized that Greece, Spain, Italy, etc. were all corrupt, out of money and needed bailouts. So now the ECB has a bigger balance sheet from the Fed and Italy has yet to official default or come begging for a bailout yet. Expect the pain to keep coming as the balance sheet continues to rise at the ECB.



RACE TO THE BOTTOM: The Fed vs The ECB - ECB balancesheet



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.


Welcome to 2012: the year of the bailout. 

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