CONCLUSION: Inclusive of China’s July GROWTH and INFLATION DATA, we reiterate our intermediate-term view of the Chinese economy, which remains: A) we do not expect a meaningful inflection point in Chinese economic growth and B) we do not anticipate a meaningful acceleration in fiscal stimulus, state-directed lending or deregulation in the property market. If anything, we could potentially see increased tightening in the latter if speculative activity is detected in the July/August property price data and/or the State Council’s regional surveys. Lastly, we reiterate our bearish long-term thesis on the Chinese yuan and Dim Sum bond market – a position supported by the latest data points.


Overnight China reported incrementally-dovish July GROWTH and INFLATION data – which, of course, paved the way for aggressive media coverage demanding that the PBOC cut interest rates or RRRs. Those speculative demands were no doubt emboldened by the Chinese stocks’ intraday rally from trading flat-to-down to close up +61bps on the day. The close of 2,174.1 on the Shanghai Composite Index puts it at 5 ten-thousandths of a percent higher than our immediate-term TRADE of resistance.


While we don’t expect to see a sustained follow-through, we are waiting and watching for confirmation; our fundamental case on China (as laid out above) will not change absent a meaningful shift in the data or a quantitative breakout above our TREND line as indicated in the chart below:




Below, we neatly parse the July data into the following three buckets for you:



  • JUL Industrial Production: +9.2% YoY from +9.5%
  • JUL Retail Sales: +13.1% YoY from +13.7%
  • JUL YTD Urban Fixed Assets Investment: flat at +20.4% YoY
    • YTD FAI – Real Estate Development: +15.4% YoY from +16.6%
    • YTD FAI – Construction: +19.6% YoY from +20.6%
  • JUL YTD Source of Funds for Fixed Assets Investment – Foreign Direct Investment: flat at -11.1% YoY
  • Key Takeaways: Chinese economic growth continues to slow across sectors and the continued weakness in retail sales indicates that the government isn’t “rebalancing” the Chinese economy (w/ respect to their current 5yr plan) as quickly as some might have hoped. Beyond that, we flag the -11.1% YoY rate of decline in foreign CapEx as a sign that international corporations remain particularly sour on the Chinese growth story and we continue to see longer-term negative implications here for China’s currency and cross-border capital flows. The recent occurrence of China’s sovereign Dim Sum bond yields normalizing with mainland rates is in support of our thesis, which we outline at the conclusion of this note. 



Spot prices for Rebar and Hot Rolled Sheet steel continue in free-fall, as economic growth expectations remain muted in what is arguably China’s most important domestic commodity market from a economic growth perspective (Fixed Capital Formation = 46.2% of GDP).





  • JUL CPI: +1.8% YoY from +2.2%; slowest rate since JAN ‘10
    • While falling pig prices shaved -71bps off of the YoY headline figure, the food category overall contributed +78bps to the headline figure on a net basis.
  • JUL PPI: -2.9% YoY from -2.1%;s lowest rate since OCT ‘09
  • Key Takeaways: Despite rates of headline inflation falling to new multi-year lows, Chinese interest rate markets continue to price in incrementally less easing out of the PBOC, as indicated in the chart below. We interpret this as a sign that those closest to the source are taking the PBOC’s recent hawkish warning on 2H inflation at face value. 




  • JUL YTD Source of Funds for Fixed Assets Investment – State Budget: +30.5% YoY from +26.7%
  • JUL YTD Source of Funds for Fixed Assets Investment – Domestic Loans: +6.7% YoY from 5.8%
  • Key Takeaways: Consistent with the recent pledged increases in railroad investment and low-income housing development, the State Council continues to “fine tune” its economic policy with respect to “stabilizing growth” by increasing sovereign expenditures on investment. It’s important to note, however, that stabilizing ≠ stimulating. As it relates to a state-directed lending spree, growth in domestic loans earmarked for Fixed Assets Investment accelerated to +6.7% on a YTD, which remains far, far below the +20-40% YoY clips recorded during the 2009-10 lending spree. Mid-single digit growth rates is hardly stimulatory in comparison and is consistent with Chinese policymakers’ decreased willingness to stimulate. In fact, recent statements suggest that they appear keen to avoid the recent mistakes of overinvestment and capital misallocation – both of which contributed to the current property bubble – during this growth slowdown. 




If you haven’t yet had the chance, we encourage you to check out our recent work on China – particularly our thoughts on the outlook for Chinese policy over the intermediate term. Importantly, we are increasingly of the view that aggressive expectations for Chinese stimulus and the associated rebound in Chinese economic growth are being priced into “risk assets” broadly and that Chinese policymakers are likely to disappoint those expectations. For more details please review the following notes: 

  • FLAGGING ASYMMETRIC RISK IN THE CHINESE YUAN AND DIM SUM BOND MARKETS (APR 16): Given the asymmetry of both the pricing setup and fundamental outlook, secular yuan weakness and a bearish re-pricing of the Dim Sum bond market are two long-term TAIL risks we are flagging to you at the current juncture.
  • CHINA’S INCREMENTAL GROWTH SLOWDOWN CONFIRMED (MAY 23): 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.
    • As an aside, China’s Shanghai Composite Index remains in a Bearish Formation and is down -8% since we put out this initial bearish piece on the Chinese economy in this latest cycle. That is far and away the largest decline throughout the region over that duration and is vastly underperforming the regional median gain of +6.7% (same duration).
  • 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.
  • CHINESE GROWTH: STICKING TO THE CENTRAL PLAN (JUL 13): We maintain conviction in our view that Chinese economic growth is not poised to meaningfully inflect over the intermediate term. Furthermore, we can’t stress how much the late-year transition in leadership or the growing official realization that the 2008-09 stimulus package and central plan (i.e. state-directed lending) contributed heavily to a rapid and potentially unhealthy expansion in credit (+96.6% since the end of 2008) may slow Chinese policymakers’ fiscal/regulatory response [if any] to an incremental deterioration in economic growth. Remember, Chinese banks have yet to see a material deterioration in credit quality (the industry-wide NPL ratio is at a measly 0.9%), so it’s not unreasonable to believe that Chinese policymakers could be saving their “bullets” for a potentially more worthy cause than a purposefully-engineered slowdown in Real GDP growth to +10bps above their official 2012 “target” of +7.5% (announced in MAR).
  • PONDERING CHINESE GROWTH PART II (JUL 17): Contrary to consensus speculation, we are of the view that Chinese policymakers are likely not readying a stimulus package to be announced and administered over the intermediate term that would be substantial enough to meaningfully inflect the slope of Chinese economic growth. As such, it would be prudent to fade any incremental Chinese stimulus rallies for the time being.  

Best of luck out there,


Darius Dale

Senior Analyst

FTK: Under Pressure (On Margins)

For months we have been bearish on Flotek Industries (FTK). The case we’ve made is that large oilfield services (OFS) players have seen their revenue come under pressure from lower energy prices. When cost cutting measures come into play, chemical suppliers like Flotek will be the first to undergo price renegotiations, which in turn hits their margins.


Flotek reported its second quarter results today. It missed on the top line ($78MM vs. $81MM estimate) but beat on headline EPS ($0.25 vs. $0.22 consensus).  That headline number is noisy, skewed mostly by a change in the fair value of warrant liability. Operating income (does not include unusual items) was a big miss, which was largely ignored this morning.  Operating income came in at $15.6MM vs. $17.3MM expected.



FTK: Under Pressure (On Margins)  - FTK metricsmatter



Yet after reporting second quarter results, Flotek enjoyed a +15% pop in their stock. We were not short FTK in the Hedgeye Virtual Portfolio but after this pop, we will look to short again when price and timing line up accordingly. Hedgeye Energy Analyst Kevin Kaiser outlines his two-fold bearish thesis on FTK below:


1.            Top line growth is slowing faster-than-expected as drilling activity slows onshore North America;

2.            Gross margins would contract sequentially as pricing power slips and input costs remain sticky in the Company’s Chemical and Drilling business lines.


We were spot on for the first point, but the second point we missed. Apparently the Street is willing to take the company’s word on guidance for gross margins despite our case with regard to pressure on large OFS players like Haliburton (HAL) and Baker Hughes (BHI). We think that margin guidance + the high short interest (18%) is why the stock is so strong this morning.


In essence, this quarter is being spun very well by market participants. On our quantitative model, FTK has broken out above our TREND line of $10.82, so we will wait and watch here.

CRI: Turning Point

Conclusion: The strategic implications of this CRI deal with JCP are spot-on with what we think is a very underappreciated risk in retail. It may give CRI a near-term revenue lift due to channel-fill, but it is ill-equipped to manage undifferentiated product across channels with polarized price points. This will ultimately be its undoing.


We’ve been waiting for this announcement that Carter’s is opening a shop inside JC Penney. It makes perfect sense, actually, in the context of the store that JCP is trying to build. But while these ‘partnerships’ seem equal, the reality is that they’re not, and this one favors JCP by a country mile. Ultimately, we think that this will be CRI’s swan song.

Consider the following…


1)      JCP has a bidding process for all its shops. CRI no doubt went up against Gerber, Disney, Circo, Zutano (highest unit count on Amazon) and others for this business. It is definitely a sales/margin trade off. Note that VFC’s Lee recently lost out to Levi’s in JCP as it did not chase price. Good long term for VFC. Bad short term. CRI is the opposite.


2)      CRI’s challenge is that it puts similar product into every channel of distribution. Look inside Wal-Mart, Target, Macy’s, Amazon, and Kohl’s. They all have product that is remarkably similar. That’s fine when a brand is small, but as it grows up, it gets very dangerous.


3)      Oh and by the way, the same product is in Carter’s own stores, and on its web site, and it’s almost always 40-50% off.


4)      Look at what happened when Liz Claiborne launched Liz & Co inside none other than JC Penney 6 years back. The product looked very similar to what was selling at Macy’s, but at a lower price. It didn’t take Macy’s too long to cut Liz. The market’s reaction was not pretty – the stock went from $43 to $2.


5)      How does Carter’s in-store promotional strategy synch with Johnson’s ‘Every Day Low Price’ strategy? So if a product is $14.99 list in a Carter’s store, it will be knocked down to $8.99 on day 1. On average, the whole lot will clear at about $6.00. If Johnson holds true to his Plan, then he’s going out with an initial price in the $6 range. How will Macy’s feel about that when they’re selling the same thing down the hall for $10? Wal-Mart at $9?   


6)      CRI is setting up this deal with its largest customer’s top competitor – KSS. Let’s think of how that discussion went for the CRI sales rep to Kohl’s. “Hey…Just want to let you know that we’re starting a program with JC Penney to do exclusive shops with product that is at least as good as what we’re selling to you, but will be listed at a 30% discount. You cool with that? Good. Nice knowing you.”


7)      CRI does not need to disclose how big Kohl’s is as a customer, because the reality is that as a percent of aggregate sales no one is within a stone’s throw of 10%. But that’s bc CRI’s own retail business accounts for about 55% of sales versus only 29% for Carter’s wholesale. But that’s comparing apples and oranges. We need to either gross up wholesale, or take down retail for an even comparison. Either way, looking at EBIT is a fair comparison. In the regard, both Carters US brand wholesale and retail each account for about 45-47% of EBIT. International accounts for the rest, more than making up for Osh Kosh, which is perennially in the red. KSS might only account for 3-4% of CRI’s total sales, but it is closer to 6-7% of profits.


8)      This is not just about KSS. There are going to be so many moving parts across retail in 2H. Heck, there already are. That will intensify. The dominoes that fall in footwear, housewears, underwear, fragrances, etc…will cause reverberations that are impossible to predict. For example, JC Penney’s Tourneu shop could take share from Macy’s on the margin at ridiculously low prices. Macy’s might not strike back in the jewelry category, but rather in its terms or pricing with Outerwear vendors like Columbia, Underwear like Hanesbrands, or moderate ends of the portfolio of apparel/footwear from companies like Jones Group. The cross-currents here will be fierce, and we have yet to gain conviction that anyone is really prepared for it.


Growth has come from Playwear. That’s less defendable than the core baby biz (i.e. Competes w/Old Navy)

CRI: Turning Point - category


Can’t look at the wholesale/retail split by revenue, as it grossly understates the importance of the wholesale business.

CRI: Turning Point - revebit


Company-Operated retail stores and mass retailers have grown in importance

CRI: Turning Point - channel

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We’ve always believed that slot volume is the ultimate indicator of a Vegas recovery


  • Our predictive model has been proven effective in projecting monthly slot volume on the Strip as indicated by the high correlation between the red and blue lines
  • MGM is as close to a Strip pure play as there is and its stock has closely tracked changes in slot volumes on the Strip
  • We’re not optimistic about slot trends over the near term and maintain that Vegas may be in a secular slot decline due to poor demographics and an aging core slot customer base



OH SNAP: Have Food Stamps Hit Peak Enrollment?

We’ve analyzed the latest data for the Supplemental Nutritional Assistance Program (SNAP), better known as food stamps. Since President Obama took office in 2008, the participation has shot up drastically over the last four years. Currently, about 15% of the nation or about 46 million people are enrolled in the SNAP program.  


The year-over-year growth rate is actually declining at an accelerated rate. At the current trajectory, it should go negative by October. While a positive for the American taxpayer, dollar stores like Family Dollar (FDO) and Dollar General (DG) are going to feel the pressure as more people wean themselves off food stamps. Over the last five years, the growth in the SNAP program has been a positive for dollar stores, driving new business. All good things come to an end, though. Keep an eye on names like FDO and DG as the SNAP participation rate drops.



OH SNAP: Have Food Stamps Hit Peak Enrollment?  - SNAP Aug

Short Selling Opportunity: SP500 Levels, Refreshed

POSITIONS: Short Industrials (XLI) and SPY


Since February 15th, 2012 this is the 9th time I have issued a Short Selling Opportunity note. Maybe this will be the 1st time out of 9 that I am wrong. Maybe not. That’s the game. You either buy or sell here. You don’t hide from accountability.


Across my core risk management durations, here are the lines that matter to me most: 

  1. Immediate-term TRADE resistance = 1405 (lower highs)
  2. Immediate-term TRADE support = 1388 

Every time I do this, I feel like I have to re-live the last 5 years. It’s weird. People are pressured to buy high and sell low, I guess.


Given the fundamental growth picture in the world, this one looks as clear to me as the other 8 shots were.


As Gretzky said, you’ll miss 100% of the shots you don’t take.




Keith R. McCullough
Chief Executive Officer


Short Selling Opportunity: SP500 Levels, Refreshed - 1

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