“You can’t build a railroad from nowhere to nowhere.”
While I am sure some partisan politician had a rebuttal to one of America’s most successful businessman’s thoughts on the matter at the time, that remains one of the most poignant risk management quotes from 1873.
“The Panic of 1873 began shortly before 11AM on Thursday, September 18, when the Wall Street branch of the nation’s most prestigious private banking house, Jay Cooke & Associates, unexpectedly ushered its customers out and then literally closed its doors, signaling it was bankrupt.” (John Lubetkin, in Jay Cooke’s Gamble)
Yes, I know. We have centrally planned our way to never worrying about fundamentally flawed policies and business risks again in this country. Right?
Back to the Global Macro Grind…
While the Keynesians are storytelling about needing “more time”, the fact remains that Policies To Inflate haven’t done a darn thing they were designed to do:
- Debauching the Dollar was supposed to generate “export and manufacturing growth”
- Economic growth slowing was supposed to be met with a “growth recovery” that lasted more than 3 months
- Corporate growth and earnings were supposed to remain at all-time highs; hiring would follow
Political theory versus economic reality: let’s fast forward to, well, yesterday:
- America’s ISM Manufacturing Survey for August slowed for the 3rd consecutive month to 49.6 (signaling economic contraction)
- The Prices Paid component of the ISM survey ripped higher month-over-month to 54 vs 39.5 in July (+37% sequentially)
- Fedex, a $28B US company, pre-announced another revenue and earnings miss after the market close
But no worries…
We need to beg for more of what has not worked – must do something – need more stimulus – need more time so that we can build elevated stock market prices, on no-volume, into the market’s risk matrix so that we can get from nowhere to nowhere, again.
To review what the aforementioned data points mean to real business people in this country in September 2012:
- Global Demand (yes, including Asia) slowed in August as inflation, on the margin, rose
- As inflation (prices paid by manufacturers, consumers, etc.) rises, on the margin, profits slow
- As profits slow, hiring slows – again
This isn’t a vicious cycle anymore. It’s just a sad one to watch. How definitively insane it is to watch people make the same mistakes over, and over, and over again?
I know, I know. After they are wrong on growth, and half-baked right on how bailout policies keep market prices up for 6 week intervals, perma-bulls say “the market is up and stocks are cheap.”
Well, there’s a little fibbing in that too. Since the 2007 top (1565 SPX) and lower 2012 high (1419 SPX) that followed it, stocks are down – and they’re expensive, if you don’t use the wrong growth and earnings numbers.
So where does the great Keynesian economic vision of building bridges and railway tracks to end demand that’s slowing take us? I don’t know. And, if they tell you the truth, neither do they.
My immediate-term support and resistance risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, 10yr UST Yield, and the SP500 are now $1, $111.51-115.78, $81.19-81.98, $1.24-1.26, 1.54-1.63%, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Takeaway: $UA's endorsement dollars paid off in a venue it is rarely known to frequent -- the US Open (that's right, tennis, not golf).
People often debate the efficacy of athlete endorsements. Generally speaking, we think that those that perform at the highest level in their respective sport BUT can also cross over to mainstream appeal are the only ones worth paying for. For example, just after the Olympics, Nike's Alyson Felix was featured in Sports Illustrated while also being on the cover of Teen Vogue. That's when endorsements turn commercial. Same goes for someone like LeBron James, who dominates sports headlines, but also has dominated the cover of GQ.
There are always exceptions. Sometimes those exceptions are with people, like Tom Brady, who simply can't sell due to his lack of mass appeal to most men (not our opinion -- those are simply the facts -- it's why Nike ditched him). Sometimes the exceptions are with brands, like UnderArmour, which brings us to the image below.
Enter Sloane Stephens, the youngest tennis player ranked in the top 50. While sh'e not going to win the US Open, she raised eyebrows when the 44th seed upset Francesca Schiavone -- who was ranked as high as #4 last year.
It takes all of about half a second to look at this picture and realize that something is different. No Swooshes. No Stripes (Adidas). No K Swiss Shield. No Reebok (remember them?). All you see is the edgy UA logo.
If Sloane was wearing a Swoosh, would anyone notice? No way. They'd probably expect it. But when they see the logo of a company Wall Street discounts will ever actually build a footwear business, it matters.
Remember, from a branding perspective, the US athletic market is a 2-horse race. Nike and UnderArmour. This is fairly represented in Apparel market share stats.
But Nike has about 40% share of the footwear market versus UA at 1%. We understand that this seems like a very unfair comparison. It is. But brands like Adidas, Asics, Reebok, and New Balance have between 5-7%. Brands like Saucony, Brooks and K-Swiss have another 3-4%.
Every point of share gain in footwear amounts to about $0.20 per share off of UA's $0.92 EPS base in 2011.
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Takeaway: Spain’s risk profile continues to set up to the downside. Shorting tactically.
Positions in Europe: Short Spain (EWP); Long German Bunds (BUNL); Short EUR/USD (FXE)
Today Keith shorted Spain via the etf EWP in the Hedgeye Virtual Portfolio. The etf is immediate term TRADE overbought and nearing our long-term TAIL resistance line of $27.79 (see chart below).
Our thesis on Spain hasn’t changed materially in recent months, including that the market has not fully priced in all the downside risks in the broader economy.
As a reminder, some of these risks and signals include:
- Bombed out PMI Manufacturing number, 42 in August
- Housing and Property values that have another 30% to fall
- Mortgages on Houses data at -25.2% in JUNE Y/Y
- Further credit ratings downgrades: Moody’s is expected to downgrade the sovereign to junk this month
- Rising debt levels (68% of GDP in 2011) as the future bank credit line, funneled through the FROB, adds to the debt
- Unemployment Rate at 24.6% and over 50% for youths
- The inability of PM Rajoy to reduce the country’s 8.9% deficit (as % of GDP)
- Bombed out Retail Sales: -6.9% in JULY Y/Y
- GDP in Contraction: -1.3% in Q2 Y/Y (vs an initial estimate of -1.3%) or -0.4% Q/Q
- Sticky stagflation: CPI at 2.2% in JULY Y/Y
- GDP Fudging: 2010 GDP restated to -0.3% vs -0.1% initial; 2011 restated to +0.4% vs +0.7% initial
- The spread between the Spanish 10YR yield and 2YR is at all-time wides of 350bps, as Draghi talks down the lower end of the curve via reengagement of a bond purchasing program
- The IBEX 35 is down -16% since a ytd top in early February
Takeaway: Tactically buying German bonds in a very uncertain environment.
Positions in Europe: Long German Bunds (BUNL); Short EUR/USD (FXE); Short Spain (EWP)
Keith bought German Bunds via the etf BUNL in the Hedgeye Virtual Portfolio today. The etf is in a bullish formation, meaning the current price is above its intermediate term TREND and long term TAIL levels (see chart below).
Aware that there is no “safe haven” play in Europe, we like the risk/reward set-up of German fixed income at the right price. Germany’s “messaging” has not been completely of one mind in recent months. Bundesbank President Weidmann continues to reiterate his opposition to ECB purchases of peripheral sovereign debt, warning that “central bank financing can become addictive like a drug.” He is also opposed to the sharing of risk via Eurobonds. Meanwhile, Chancellor Merkel has voiced support for Weidmann but has stopped short of endorsing his views outright, and continues to suggest that she will continue to pull out all stops to save Greece (and other peripherals as necessary) and has not completely ruled out Eurobonds.
Certainly German fundamentals in recent months have not provided a hook to hang one’s hat. Despite a marginal improvement in Manufacturing PMI for August (44.7 vs 43.0 in JULY); the unemployment rate has been locked in at 6.8%; CPI increased 30bps to 2.2% in August Y/Y; Retail Sales fell -1% in JULY Y/Y vs +3.7% JUNE; and IFO, ZEW, and GfK consumer and business confidence surveys largely continue to decelerate or show little material inflection.
Takeaway: We see no reason to back away from our long-term bearish bias on international commodity prices.
- We continue hold a counter-consensus, long-term bearish view of both international commodity prices and capital expenditures in the basic materials and energy industries.
- The key drivers we expect to perpetuate these secular outcomes are, first and foremost, a generational inflection in US monetary and fiscal policy, followed by a structural rebalancing and cooling of Chinese economic growth.
- The day-to-day noise speculating on further iterations of easing out of the Fed, ECB and/or PBOC are crowding out the fact that the aforementioned shifts are already well underway.
- While we recognize that incremental Policies to Inflate out of the Fed or ECB are likely to reflate commodity markets, we anticipate that any reflation will be to lower long-term highs and that the rallies will be shorter in duration relative to previous iterations.
In the context of our daily research output, which generally aims to help investors manage immediate-term Global Macro risks (both positive and negative), we consistently allude to several big-picture themes that we see emerging and are likely to continue over the long-term TAIL. Over the past 12-18 months, one of those themes has been our non-consensus view on global commodity markets – specifically that:
- We think the USD and the fiscal and monetary policies that back it are the key drivers of commodity prices, trumping the role of more traditional supply/demand dynamics in price formation;
- We continue to think liquid commodity markets and, subsequently, the capital expenditures of certain companies along the international commodity supply chain are poised to decline over the long term; and
- A secular reduction in investment is likely to be a meaningful headwind for rates of economic growth and balance of payment dynamics across various commodity-oriented economies (namely Australia and the bulk of Latin America’s largest countries).
To point #2, we’ve indexed the US Dollar Index, CRB All-Commodities Index, CRB Raw Industrials Index and CRB Food Index to APR 15, 2011, which is the day we initially outlined the aforementioned conclusions on our 2Q11 Macro Themes presentation via our Deflating the Inflation theme. As the chart suggests, structural deflation across various commodities markets has already commenced. Moreover, the amount of intellectual pushback we received on point #1 has receded substantially along with commodity prices over this time frame, suggesting to us that investors are broadly beginning to understand and explore the linkages between the USD and international liquid asset prices.
Below we compiled a list of recent data points from our weekly roundup of Asia and Lain America to support the conclusions laid out above regarding capital expenditures throughout the international commodity supply chain; email us if you’d like to be added to that distribution list:
9/4: Australia, China
- What Happened: With Iron Ore prices down -29.7% over the past month (mirroring price declines across the Chinese steel market), Fortescue cut its full-year CapEx spending forecast by -26%.
- Why This Matters: Fortescue’s negative CapEx guidance mirrors recent maneuvers out of other international industrial companies such as BHP Billiton, Joy Global, Komatsu, Caterpillar, Sany Heavy Industry Co. and Vale. In true interconnected fashion, we continue to highlight how slowing Chinese growth is weighing heavily on multiple points of the international industrials supply chain. Moreover, we continue to hold our counter-consensus view that a broad-based Chinese stimulus package – if any – is likely to surprise elevated expectations to the downside with respect to the intermediate-term TREND. Anything Chinese policymakers do will be far less than spectacular, merely in support of protecting the +7.5% growth target, rather than attempting to reflate the Chinese and global economy in a meaningful way (i.e. no repeat of 2009-10). Refer to our AUG 24 note titled, “IS THE CHINESE ECONOMY ABOUT TO GO DARK?” for more of our thoughts on this topic.
8/31: Japan, China
- What Happened: Hitachi Construction Machinery Co., the world’s third-biggest maker of building equipment, is shutting its Chinese plant for two weeks a month until October as the nation’s economic slowdown triggers a sales slump. (Bloomberg)
- Why This Matters: This is in-line with recent negative guidance revisions, CapEx suspensions and/or temporary plant closures at BHP Billiton, Joy Global, Komatsu, Caterpillar. With Chinese steel and global iron prices collapsing in recent months/weeks, one has to wonder how much of global GDP growth is not just Chinese demand (43.9% since ’08), but also the operations and investments of international suppliers that sell into Chinese demand. For our updated thoughts on the Chinese economy ahead of next week’s PMI data, refer to our 8/24 note titled, “IS THE CHINESE ECONOMY ABOUT TO GO DARK?”.
- What Happened: Chinese heavy excavator sales fell off a cliff in JUL, following a similar plunge in demand from China’s mining industry. Per Bloomberg: “Demand for the biggest and most expensive excavators, which weigh more than 40 tons, had largely withstood the slump because of demand from miners. A slump in coal prices has dented this sector, causing sales to tumble 53 percent in July. Total fixed- asset investment in Chinese coal mining slowed to a 3 percent growth rate from 19 percent in June.”
- Why This Matters: We continue to warn of material long-term risks to the “Weak Dollar/Long Energy, Mining, and Resource Related CapEx” trade, as we see an asymmetric setup in the market value of the US dollar. The slope of US fiscal and monetary policy could inflect materially over the next 6-24 months. In fact, a secular bull market in the USD is arguably the most asymmetric and impactful risk we can identify across global financial markets and the global economy today. For more on our thoughts here, refer to our JUN 8 note titled, “TWO SCHOOLS OF THOUGHT PART II”.
8/24: Hong Kong, China
- What Happened: Companies listed on the Hong Kong Stock Exchange are guiding down at a historic pace. Per Bloomberg: “Such warnings have been issued by 331 companies since the start of June, the most for a three-month time frame since Hong Kong Exchanges & Clearing Ltd. started compiling the data in July 2007…. Of a record 138 companies that issued such statements last month, 79 percent derive more than half their revenue from China, while 45 percent are industrial-related or commodity producers…”
- Why This Matters: We are inclined to view this as a leading indicator for broader negative revisions to corporate guidance across developed markets over the intermediate term. Corporate executives across the developed world are constantly getting their heads pumped full of expectations for economic “stimulus” out of the Fed, PBOC and/or ECB by their bankers and the manic media. If and when the stimulus A) doesn’t come or B) comes and is ineffective ($150 oil?), we would expect a material slowdown in global economic activity. Expectations remain the root of all heartache…
- What Happened: Indonesia, which accounts for 40% of world tin exports, has just announced that it will idle 70% of it tin-smelting capacity, likely to exacerbate a what they are perpetuating as a global tin shortage. Sounds eerily similar to the bull thesis on copper, which is also not working as demand growth continues to slow…
- Why This Matters: Tin, which is down over -27% from its YTD peak in early FEB, is a key ingredient in everything from cans to televisions and smart phones. The price action here continues to signal to the growth bulls that they need to wake up and smell the tin in their coffee.
8/15: Germany, Brazil, China
- What Happened: Hamburger Hafen und Logistik AG and Vale SA are taking/talking down their Chinese growth expectations with respect to the TREND and TAIL durations, respectively. Per Bloomberg: “Hamburger Hafen und Logistik AG, which handles two thirds of containers in Hamburg, cut its forecast for 2012 on July 25, saying it now sees container throughput at the same level as last year, compared with an earlier 5 percent growth estimate. Such an increase would have led to volumes exceeding the record 7.3 million standard containers handled in 2008, the year before the global financial slump prompted a 33 percent drop.” Per Vale DIR Castello Branco: “We are not going to see the spectacular growth rates of 10, 12 percent per year. The golden years are gone.”
- Why This Matters: While we continue to assign rather minimal weight to corporate guidance in our Global Macro process (companies tend to be equally as wrong as their bankers are at the turns), we do find it interesting that companies with sales exposure to China at 33% and 44%, respectively, would talk so frankly about the prospects for Chinese economic growth. More importantly, their subdued commentary is completely in-line with our TREND and TAIL expectations for the Chinese economy. Ping us for our collection of relevant notes on the subject.
Jay Van Sciver, Hedgeye’s own Managing Director of Industrials, has also been vocal in recent months about the bubble in global mining capex, as producers have chased rising prices with attempts to secure incremental supply.
We have also been vocal calling out similar trends in the US; when overlaid with a plot of the US Dollar Index, it’s easy to see why miners have been ramping up production over the last 10-plus years. In fact, the latest ramp is reminiscent of the last time US monetary policy was overtly attempting to sustainably debauch the USD (1970s).
The obvious implication here is that the spread risk here is at an asymmetric wide. Moreover, global economic growth is likely to continue being rebalanced over the long term – particularly in economies overly exposed to international commodity markets. Refer to our AUG 10 note titled, “THINKING OUT LOUD RE: GLOBAL GROWTH” for how bumpy this secular transition could potentially be. For us, Australia and Argentina have been two countries that come to mind here:
- 6/5: SLOWDOWN-UNDER: We see further weakness in the Australian economy over the intermediate-term TREND as well as a growing number of key questions regarding Australia’s long-term TAIL growth potential. As such, we are reiterating our TREND-duration bearish fundamental call on Australian equities and the Aussie dollar – barring incremental accommodation out of the Fed over the immediate term.
- 4/18: ARGENTINA, IMPLODING: Keep a small space on your white board(s) for the risk of another large-scale Argentine default over the long-term TAIL. At a bare minimum, another bout with domestic hyperinflation is an elevated risk over that duration, as the country seeks to deplete the very resources it needs to maintain stability in its currency.
Regarding Australia specifically, it’s hard to watch the following YouTube video of Fortescue’s “impressive” operations and not come away with an overwhelming feeling that you’re at/near the top of a bubble in international mining capex: http://www.youtube.com/watch?v=lA0MSsd0dvQ.
All told, with the Strong Dollar message continuing to gain political influence in the US fiscal and monetary policy arena and Chinese economic growth continuing to slow to more sustainable rates and more balanced levels of composition, we see no reason to back away from our long-term bearish bias on international commodity prices. Furthermore, while we recognize that incremental Policies to Inflate out of the Fed or ECB are likely to reflate commodity markets, we anticipate that any reflation will be to lower long-term highs and that the rallies will be shorter in duration relative to previous iterations.
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