“The first definition of victory is survival.”
Tops are processes, not points. From both an intermediate and long-term perspective, at least that’s what we have learned in the last 5 years. Big Central Planning in what used to be “free-markets” continues to A) shorten economic cycles and B) amplify price volatility.
“But, Keith, the market is up year-to-date.” Yep. And the SP500 was up double-digits for the year-to-date on October 9th, 2007 too (1565 for those of you who still remember that cost basis and the people who told you to buy there). Just think, only 18 months later you could have bought Starbucks $SBUX at $11 (i.e. 78% lower). That’s when stocks were “cheap.”
Cheap is as cheap does. People get that. How else can you explain money flowing out of Equity funds in the latest Lipper data (-$6.8B in outflows last week)? People also remember late 2007 and all the storytelling about growth recovering via centrally planned “shock and awe” rate cuts back then too. I never thought we’d get back to that same sell-side narrative. Never say never, I guess.
Back to the Global Macro Grind…
The aforementioned quote is the last one I wanted to highlight from this summer’s reading about the founding of the 19th century American West (page 469 in Blood and Thunder). It was a creed Kit Carson lived by. And it’s one I’ve embraced as a Risk Manager of my own capital too. Spending 5 years of your life trying to get your investors’ capital back to break-even is no life to live.
Getting back to break-even is another way to think about why I am constantly measuring LOWER-HIGHS across intermediate to long-term investing cycles. Those define memory, losses, and pain. If you have a friend who bought the 2007 top in the SP500, he only has another +10% higher to go (from here) to get back to his high-water mark. I hope he didn’t use leverage.
Across intermediate-term durations (since February-March 2012), here are some LOWER-HIGHS to think about (across asset classes):
- US Treasury Bond Yields (10yr) = 1.66% (down from 2.4% in March 2012)
- EUR/USD = $1.27 (down -5.2% from March 2012)
- CRB Commodities Index = 311 (down -4.4% from March 2012)
- Gold = $1736 (down -3.2% from February 2012)
- Oil (Brent) = $115 (down -9.2% from March 2012)
- Copper = $3.69 (down -7.1% from February 2012)
- Russell2000 = 842 (down from 846 on March 26th,2012)
- Chinese Stocks (Shanghai Composite) = 2134 (down -13.2% from March 2012)
- Japanese Stocks (Nikkei225) = 8869 (down -13.5% from March 2012)
- European Stocks (Eurostoxx50) = 2533 (down -2.9% from March 2012)
- Spanish Stocks (IBEX) = 7861 (down -11.9% from March 2012)
- Italian Stocks (MIB) = 16,050 (down -6.3% from March 2012)
- Russian Stocks (RTSI) = 1468 (down -16.2% from March 2012)
- Brazilian Stocks (Bovespa) = 58,321 (down -14.7% from March 2012)
In other words, if you bought any of these asset classes and went short and/or “underweight” Treasury Bonds, you are underwater since Growth Slowing began to be obvious, globally in March of 2012. That side of the research call has been dead on.
Are there any outliers?
- SP500 = 1437 (up +1.3% from March 2012)
- German Stocks (DAX) = 7217 (up +0.8% from March 2012)
- US Equity Volatility (VIX) = 14.38 (up +0.8% from March 2012)
Hoowah, what a return versus the risk you had to take! (*note: SPX and RUT had 10 and 13% draw-downs from March to June)
To be fair to the “growth is back, earnings are great, and stocks are cheap” bull crowd of economists (rewind the tapes and/or read their Feb/Mar 2012 research), Venezuelan, Egyptian, and Pakistani stocks are right ripping since March 2012. So bullish.
But let’s not fuss about the details on why “the market is up-year-to-date” (Bernanke doing Qe3 on January 25th, pushing 0% rates to 2014; and the market baking in a Qe4 or push for 0% rates to 2015 now)…
Let’s not talk about the real-time P&L impact of this little detail called timing in anything pro-cyclical since March. The very same economists and Old Wall Street strategists weren’t fussing about it in September-October of 2007 either.
This isn’t my 1st rodeo with perma-bulls. They are loud and they change their thesis to suit last market price. That’s why Surviving Tops isn’t easy. Particularly when the storytelling, groupthink, and performance chasing is coming on thick.
My immediate-term support and resistance risk ranges for Gold, Oil (Brent), US Dollar Index, EUR/USD, 10yr US Treasury Yield, and SP500 are now $1, $113.39-115.02, $80.11-81.29, $1.24-1.28, 1.56-1.70%, and 1, respectively.
Best of luck out there this week,
Keith R. McCullough
Chief Executive Officer
Takeaway: Look for $MCD's board to reassure investors of the strength of the company's cash flow by announcing a healthy dividend raise
Of all the firsts CEO Don Thompson has been facing in his new role, the September dividend announcement will be one of the more important messages he sends to the Street.
The dividend announcement is expected to come following the mid-September board meeting.
Keep the following in mind as we near the announcement:
- MCD generally tries to keep dividend growth in line with earnings growth
- EPS growth was 10%, 14% and 15% in 2009, 2010 and 2011, respectively
- Dividend growth was 15% over the last year and 12% over the last three years
- EPS growth in 2012 will likely be in the 2-3% range
- The Street is expecting 10% EPS growth in 2013
- The average of 2012 and 2013 earnings growth is likely to be roughly 6%
With all of this in mind, we would expect McDonald’s dividend growth to be in the 6-9% range with a potential upside surprise to 11%. The strength of McDonald’s cash flows is important to investors and the coming dividend announcement will likely be interpreted as a signal of the board’s confidence in that metric over the next 12 months.
Share repurchases are also a factor for investors and, while the overall pace of buy backs has slowed relative to the 2007/2008 time frame, we expect it to slow in 2013 also. If McDonald’s were to send a strong signal and raise the dividend by 10%, that would imply roughly $3 billion in dividends for 2013. On average, over the past four years, the company has returned $5.4 billion to shareholders in dividends and share repurchases. If we assume a similar level of dividends and repurchases in 2013, along with a dividend increase of ~10%, share repurchases would amount to approximately $2.4 billion, which would be the smallest dollar-amount since 2005.
We expect a sequential sales improvement for McDonald’s over the next month or two. The dividend announcement could also provide a boost to sentiment. Following that announcement, we will remain on the sidelines awaiting indication that a recovery is under way.
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TODAY’S S&P 500 SET-UP – September 10, 2012
As we look at today’s set up for the S&P 500, the range is 19 points or -1.32% downside to 1419 and 0.01% upside to 1438.
SECTOR AND GLOBAL PERFORMANCE
- ADVANCE/DECLINE LINE: on 09/07 NYSE 1083
- Decrease versus the prior day’s trading of 1763
- VOLUME: on 09/07 NYSE 679.94
- Decrease versus prior day’s trading of -7.62%
- VIX: as of 09/07 was at 14.38
- Decrease versus most recent day’s trading of -7.82%
- Year-to-date decrease of -38.55%
- SPX PUT/CALL RATIO: as of 09/07 closed at 1.82
- Up from the day prior at 1.38
CREDIT/ECONOMIC MARKET LOOK:
Qe – I for one didn’t think policy makers and the markets begging for them to do more of what has not work would get this far, but they have, sort of; “99% certainty” baked into the Bloomberg headline and 60% on another Qe from Reuters; for now, that trumps an awful US employment and growth scenario. Time to jam Americans w/ $5 at the pump, baby.
- TED SPREAD: as of this morning 30.63
- 3-MONTH T-BILL YIELD: as of this morning 0.11%
- 10-Year: as of this morning 1.68%
- Increase from prior day’s trading of 1.67%
- YIELD CURVE: as of this morning 1.43
- Up from prior day’s trading at 1.42
MACRO DATA POINTS (Bloomberg Estimates)
- 11am: Fed to buy $1b-$1.5b notes due 1/15/2019-2/15/2042
- 11:30am: U.S. sells $32b 3-mo, $28b 6-mo bills
- 3pm: Consumer Credit, July, est. $10.0b (prior $6.459b)
- 4pm: USDA crop-conditions report
- Secretary of State Clinton says U.S. “not setting deadlines” for Iran nuclear deal
- U.S. Congress returns to work following August recess
- Obama administration ordered U.S. agencies to identify three initiatives to cut paperwork required to comply with federal regulations by this date
- White House urging Senate to vote as soon as this week on expansion of govt. mortgage refinancing program
- U.S. Chamber of Commerce holds briefing on economic, workplace concerns of American businesses in election year
WHAT TO WATCH:
- Global central bankers meet in Basel to address collapse of confidence in Libor, led by BoE’s King
- Transocean agreed to sell 38 shallow water drilling rigs for $1.05b to Shelf Drilling International
- JPMorgan considering cutting 2012 bonuses for senior managers including CEO Jamie Dimon: WSJ
- Morgan Stanley, Citi face deadline to announce results of Perella Weinberg mediation over MSSB
- Smith Barney may be valued at ~$15b: N.Y. Post
- XStrata CEO Davis said ready to quit after Glencore takeover
- SEC has scheduled no action on proposal to raise standards for U.S. brokers advising retail investors
- Slowing China output augurs more stimulus before power shift
- AIG to buy up to $5b of stock in $18b Treasury offering; likely to cut U.S. stake below 50% 1st time since 2008 bailout
- A $6.4b accord for U.S. drug, medical-device reviews set to unravel 3 mos. after taking effect
- BP is said to near $6b sale of Gulf assets to Plains
- FedEx, UPS won licenses to start domestic courier business in China; aren’t allowed to operate in Beijing
- Las Vegas Sands ordered to explain to Nevada judge today how, why files from Macau ops ended up in U.S. while co. claimed Macau law prevented it from transferring them overseas
- Reinsurers including Swiss Re, Allianz said industry’s M&A appetite will be subdued this year because of financial crisis
- Oil & Natural Gas agreed to pay Hess $1b for stake in Azerbaijan’s largest oil fields, associated pipeline
- Kellogg, KKR among cos. considering bids for United Biscuits’ snacks unit
- Navistar shareholder Carl Icahn sent letter to company board, saying new management chosen without consultation
- Obama administration drafting executive order to create program protecting vital computer networks from cyber attacks
- Former UBS trader Kweku Adoboli’s trial begins
- Citigroup CEO Vikram Pandit speaks at Barclays conference
- John Wiley & Sons (JW/A) 8am, $0.73
- Casey’s General Stores (CASY) 4pm, $0.95
- Five Below (FIVE) After-mkt, $0.01
- Palo Alto Networks (PANW) After-mkt, ($0.00)
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
COPPER – big league squeeze finding her crescendo in Copper this morning at lower long-term highs; Chinese stocks down for 4mths and up for 1.5 days + a stimulus rumor will do that, I guess – but do not forget the Copper spike in late Feb early March post Bernanke pushing goal posts on 0% to 2014 – now the goal post is implying 2015 – free moneys forever.
- Hedge Funds Lift Bets to 16-Month High Before Rally: Commodities
- Gas Bears Back Shale Boom as Isaac Rally Ebbs: Energy Markets
- Oil Trades Near One-Week High on Outlook for Economic Stimulus
- Ship Magnate Uses Gut in $11 Billion Bet Worst Since ’70s Ending
- Copper Reaches 4-Month High as Chinese Data Fuel Stimulus Bets
- Gold Trades Close to Six-Month High as Stimulus Bets Increase
- Wheat Advances as U.S. Export Sales Rise, Russian Supplies Drop
- Sugar Climbs on Speculation Demand May Be Improving; Cocoa Falls
- Iron Ore Swaps for October Pass $100/Ton First Time Since August
- China to Hold Second Shale-Gas Auction Next Month, Ministry Says
- China Rebar Volumes Advance to Record on Government Spending
- Gold Fields Halts Output at Kloof-Driefontein in Second Strike
- Xstrata CEO Davis to Step Down Six Months After Planned Takeover
- Nordic Next-Quarter Power Rises Most in Two Weeks on Dry Weather
- U.K. Natural Gas Snaps Three-Day Gain as Demand Nears Record Low
- Palm Oil Snaps Four-Day Losing Streak as Malaysian Exports Jump
JAPAN – Japan’s Q2 GDP Growth of 0.7% y/y surprises on the downside (Nikkei -13.5% from March #GrowthSlowing highs as they haven’t actually done a US/ECB style Qe, yet) and Japan’s Fin. Services minister allegedly committed suicide overnight.
The Hedgeye Macro Team
Takeaway: The recent surge in the euro ($FXE) looks more like a short squeeze than a shift in the fundamental outlook for the currency.
Position: Short the euro via FXE.
As many of you know, our firm is set up like a buy side firm in order to match up better with many of our subscribers. In essence, our analysts cover a broader swath of names and try to go to where the opportunities are rather than just publishing maintenance research. As well, we encourage vigorous debate about ideas.
On the last point, this morning was no exception as we spent a good twenty minutes debating and discussing the euro. A key consideration is whether the outlook for the euro has dramatically changed with the recent policy pronouncements from the European Central Bank. To start, let’s consider the new policy.
At the press conference following the ECB monthly meeting President Mario Draghi told reporters:
“We want this to be perceived as a fully effective backstop.”
Ultimately, what that means practically is important, but from a perception perspective the markets are clearly looking at this as the ECB committing to unlimited bond purchases from the periphery. The string attached to this commitment by the ECB is that governments sign on to a euro-zone plan for budgetary discipline.
Budgetary discipline in the European Union is, of course, not a new concept. In fact, the very origin of the European Union via the Maastricht Treaty outlined some key elements of budgetary discipline. As it relates to government finance there were two key goals: 1) annual government deficit not to exceed 3% of GDP and 2) gross debt to GDP not to exceed 60% of GDP. We know how that ended.
Perhaps budgetary discipline will be different this time in Europe, although we won’t know for sure without understanding the enforcement mechanism. As a result, Europe may well be left with a situation where there is an unlimited commitment by the ECB to back stop the sovereign debt market, but the fiscal outlook never meaningfully improves. In terms of outlook for the euro currency, this scenario seems likely to lead to fundamental weakness. Ironically, in free markets the interest rate is the mechanism which penalizes countries with poor fiscal discipline.
The obvious question, then, is how we explain the current move upwards in the currency. To put it simply, it looks like a short squeeze. In the chart below we highlight the net futures positions in the euro going back to 2008. The obvious takeaway is that the early summer of 2012 was the most heavily shorted position of the euro since the European sovereign debt debacle began.
Not surprisingly, as the chart below highlights, the euro bottomed roughly around the time that short interest reached its highest point, or shortly thereafter, and the euro has been climbing as the shorts have continued to cover. The climb itself has been gradual, though the last few days highlight a fairly typical short squeeze as the shorts have scrambled to cover due to the latest policy pronouncement.
It is certainly possible that the future for the euro is now bright. On some level that may be true, as the ECB actually seems committed to at least sustaining the currency. The fundamental drivers of the currency, though, continue to paint a bearish outlook for the euro based on our analysis. For starters, money printing is bearish for any currency and the ECB has now indicated the printing press is open 24/7 for business. We highlight the balance sheet of the ECB below, which is already in a precarious position and now only set to expand further.
The other consideration for the euro is the actual economic outlook for Europe. We haven’t minced words on our view of global growth slowing and Europe has been the poster child for this as the chart below highlights. The one benefit in coming quarters may be easy comparisons for economic activity in Europe, but the PMI readings from Europe remain consistently below 50 and actually imply continued contraction in Europe.
So on one hand, the ECB’s commitment to completely backstop bond purchases is certainly a positive for those peripheral nations that are inclined to continue to issue debt with wanton abandon. On the other hand, even if it does signal a willingness to keep the euro intact, we do not see printing money as a factor that leads to a strong currency. Underscoring all of this is a European economy that continues to deteriorate. A fact that implies a return to ZIRP is likely to happen sooner rather than later. Once again, negative for the currency.
The other side of the euro is our outlook for the U.S. dollar. For purposes of this note, we won’t get into the prolonged analysis of the U.S. dollar, but a few things are positive for the dollar versus the euro. First, the outlook for economic growth in the U.S. is more positive than in Europe, even though it is somewhat tepid here as well. Second, one way or the other, government spending is set to decline in the U.S., likely via sequestration. Finally, there is a close to 50% probability that Romney becomes President and he has espoused a much more pro U.S. dollar policy (including replacing Bernanke).
As for now, we will stick with the view that short covering is the key driver of euro strength. At least until the fundamental outlook changes, or until our quantitative model supports it.
Daryl G. Jones
Director of Research
POSITIONS: Short SPY
“Here I go again on my own, like a drifter I was born to walk alone…”
But I’ve made up my mind, and shorted SPY one more time. I’m shorting it for different reasons than I would have yesterday, but the growth/earnings bulls of March 2012 change their thesis every other week, so I won’t sweat that.
Growth Slowing will continue if commodities continue higher. Burning The Buck is a market trade, not an economic solution.
Here are the lines in my model that matter to me most:
- Immediate-term TRADE overbought = 1437
- Intermediate-term TREND support = 1419
In other words, that’s your new risk range and overbought is as overbought does. If we snap 1419, that’s going to open up a whole new host of risks that I will not be exposed to. So we’ll wait, watch, and deal with that if we need to then.
What would have me become your huckleberry on the bull side of equities (bear side of bonds)? Easy answer: Growth Accelerating.
And it’s easier to see that not happening today than it was in March.
Chief Executive Officer