“I wouldn’t be doing my job if I started thinking that way.”
In one of the more riveting introductions to a book I have read in some time (Bailout – “An Inside Account of how Washington Abandoned Main Street While Rescuing Wall Street”), that’s what former Special Inspector General for TARP, Neil Barofsky, told former Assistant Secretary of the Treasury for Financial Stability, Herb Allison.
Herb was one of Hank Paulson and Timmy Geithner’s guys. He was also the former CEO of Fannie Mae and President of Merrill Lynch. While objectively analyzing the biggest taxpayer bailout in US history, Allison told Barofsky “you’re really hurting yourself” and asked him “have you thought at all about what you’ll be doing next?”
Evidently Barofsky had thought about it. He decided to tell the truth. Meanwhile, as we test 4.5 year highs, memories are short and storytelling is back. I, for one, haven’t forgotten the lessons of 2007-2008. The truth is, neither should you.
Back to the Global Macro Grind…
After 3 weeks down, US stocks had 2 up days, then a down day. After 4 months down, Chinese stocks had 3 up days, then a down day. What is the truth? With the price of Oil up +31% since late June, is economic growth going to magically appear?
- Dollar Down inflates asset prices (stocks and commodities) in the short-term
- Rising Inflation Expectations slow real (inflation adjusted) economic growth in the long-term
- As Growth Slows, begging for bailouts (and more Dollar Debauchery) is what Old Wall Street does
This is not new. In fact, what’s quite sad about it at this stage of the game is that everyone knows precisely how it works. How else would you explain the following?
- CFTC bullish futures and options contracts testing all-time highs (1.33 million contracts) as demand slows
- Gold speculative contracts up +35% and +10% wk-over-wk in the last 2 weeks, respectively (pre Fed meeting)
- Again, Oil prices up +31% in a straight line (bull contracts pushing 200,000) since mid-June as global growth has slowed
And, again… these are just questions. I wouldn’t be doing my job if I didn’t ask them that way.
Another risk management question about the current #BailoutBull rally in stocks and commodities is how does this all end? One of the easiest ways to answer that question is reversing what’s driven asset prices higher (Dollar Down). What happens when the Fed runs out of communication ammo and the largest Ball Under Water trade (Dollar Up) in US history rips to the upside again?
Sadly, at this point, Obama, Geithner, and Bernanke know the answer to that question just as well as Vladimir Putin does. President Bush understood it too. We call it the Correlation Risk. Central planners don’t call it anything because that would be an admission of the most obvious risk in the world right now. It would also make them accountable for it.
Here’s the update on that (Correlation Risk between the US Dollar and everything else on our immediate-term TRADE duration):
- Gold -0.92
- Silver -0.88
- Copper -0.89
- CRB Index -0.89
- SP500 -0.73
- Eurostoxx600 -0.77
In other words, with the US Dollar on 3-month lows, mostly everything Big Macro that moves on no-volume these days has gone straight back up to lower long-term highs. All the while, the US Dollar continues to make higher long-term lows (see chart).
As a result, the next calamity in stocks and commodities will be no different than the one we just saw from the March highs to the June lows. Every one of these centrally planned debaucheries of the currency ignites shorter-term rallies and steeper corrections.
It also perpetuates structural long-term growth slowing, globally. And why the Fed can’t figure out the why on that is very simple – they haven’t run real-time businesses that have to meet payrolls. Therefore, they don’t get expectations.
Thinking That Way, for anyone who hasn’t spent their entire life getting paid by the largesse of the US Government’s broken policy promises, isn’t tyrannical. It’s just common sense.
My immediate-term support and resistance risk range for Gold, Oil (Brent), US Dollar, EUR/USD, 10yr US Treasury Yield, Russell2000, and the SP500 are now $1, $113.47-115.48, $80.11-81.21, $1.24-1.28, 1.56-1.67%, 823-846, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Takeaway: We expect sequentially better performance for $MCD comps in August versus July but will likely remain on the sidelines for 4-5 mos
McDonald’s reports August sales results tomorrow morning before the market open. Global growth slowing is still the primary headwind for MCD but we expect sequentially better comparable store sales, at least in the United States.
We wrote on April 24th that we saw “plenty to be concerned about” regarding the outlook for McDonald’s sales trends. Macroeconomic factors remain a headwind for the company. The company’s value proposition in the U.S., relative to the competition, is less compelling in 2012 than it was in 2011 with price – at roughly 3% – in line with Food Away from Home CPI versus last year when the spread was roughly -50 basis points. We believe that MCD is closer to the bottom than the top, but are looking for catalysts before become vocal on the long side.
Macro Growth Slowing Matters
Growth continuing to slow in Asia, Europe, and the U.S. is a headwind for MCD sales growth. Europe is more difficult to calibrate since it is difficult to know which market will drive a beat or miss in any given month. China seems to be a decent proxy for APMEA which is not entirely surprising given its importance for global and regional growth.
Below we go through what we would view as good, bad, or neutral comparable restaurant sales numbers for McDonald’s three regions. For comparison purposes, we have adjusted for historical calendar and trading day impacts (but not weather).
Compared to August 2011, August 2012 had one less Monday and Tuesday and one additional Thursday and Friday. In addition, Ramadan ended on August 18th, 2012, versus August 30th, 2011. This will have a positive impact on August 2012's numbers.
U.S. – facing a compare of 3.9%, including a calendar shift of between 0.0% and -0.7%, varying by area of the world.
GOOD: A print above 3.5% would be received as good by investors as it would imply calendar-adjusted two-year average comparable store sales above the trend in July. Last month, McDonald’s traffic was negative and investors will be looking for a clear signal that this was merely a one-off and not part of a trend. We are anticipating a print of 3% for MCD U.S. in August.
NEUTRAL: Same-restaurant sales growth of between 2.5% and 3.5% would be received as neutral by investors as it would imply calendar-adjusted two-year average comparable restaurant sales growth roughly level with trends in July. This is a difficult quarter to measure on a sequential basis given the Ramadan shift but we believe that investors are not anticipating a sequentially worse headline, even excluding the benefit in August from Ramadan.
BAD: A print below 2.5% would imply calendar-adjusted two-year average comparable restaurant sales growth below the trend from July. Given the disappointment that July’s results brought for McDonald’s investors, a deceleration in underlying trends on a sequential basis would be decidedly negative for the stock.
Europe – facing a compare of 2.7%, including a calendar shift of between 0.0% and -0.7%, varying by area of the world.
GOOD: A same-restaurant sales number in excess of 4% would be considered a strong result because it would imply, on a calendar-adjusted basis, two-year average trends showing stabilization after several months of volatility. We are expecting a print of 3.6% for MCD Europe in August. We expect the Olympics to have provided a year-over-year boost to sales in some markets like the U.K., which have been driving the Europe division in recent months.
NEUTRAL: 3-4% would be a neutral result for Europe as it would imply trends roughly in line with expectations and, following a negative print in July, would provide some reassurance of MCD’s ability to take share on an ongoing basis.
BAD: A print below 3% would imply a significant sequential deceleration in calendar-adjusted, two year average trends and, possibly, negative calendar-adjusted comparable sales growth.
APMEA – facing a compare of -0.3%, including a calendar shift of between 0.0% and -0.7%, varying by area of the world.
GOOD: Same-restaurants sales growth of 5% or more would be received as a good result as it would imply calendar-adjusted two-year average trends roughly flat versus July. The trend in APMEA comps has been bearish over the last few months and any stabilization would likely be well-received. On July 23rd, management cited weakness in Japan and consumer caution in China, particularly in tier-one cities where McDonald’s stores are most heavily concentrated.
NEUTRAL: A print between 4% and 5% would be considered neutral for investors as it would be roughly in line with consensus, per Consensus Metrix.
BAD: Below 4% would imply a sequential deceleration in calendar-adjusted two-year average trends from June to July. This would be severely bearish as it would imply a sharper deceleration from July to August than there was from June to July.
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Takeaway: QE3 will likely prevent Chinese policymakers from countering their economic slowdown with further easing measures.
- On balance, Chinese GROWTH data continued to slow in AUG, while the INFLATION data (CPI) posted a hawkish inflection point.
- While we don’t currently view a breach of the State Council’s +4% target as a probable risk over the next 2-3 months, we do see risk that Chinese inflation accelerates meaningfully into and through 1H13 if the Fed goes to QE3. Furthermore, if the Fed announces QE3 on Thursday, the action would be a meaningful step forward in the Fed’s aggression towards achieving its mandates, based upon how elevated domestic inflation expectations are relative to previous iterations of QE/OpTwist.
- QE3 will likely prevent Chinese policymakers from countering their economic slowdown with further easing measures. That will equate to an incremental drag on global growth – particularly relative to consensus expectations that we believe are currently baking in some form(s) of meaningful policy accommodation in China over the intermediate term. It’s important to note that China alone has accounted for 43.9% of global real GDP growth since 2008, after only accounting for 15.9% in the five years prior.
On NOV 11, 2010, we published a note titled, “CHINESE INFLATION DATA CONFIRMS WHAT WE SHOULD ALREADY KNOW: QE2 WILL SLOW GLOBAL GROWTH”. The conclusion of that note was two-fold:
- “The latest Chinese economic data suggest China may continue with its latest round of tightening measures, as inflation and speculation continue to be a concern. Further, we are starting to see confirmation that QE2 will incrementally slow global growth.”
- “Quantitative Easing = inflation [globally] = monetary policy tightening [globally] = slower growth [globally]”
As the following chart of world Real GDP and CPI trends suggests, that call proved equally as prescient as the Growth Slows as Inflation Accelerates call our team made in 1H08.
Almost two full-years and countless data points later, we are at a similar juncture with respect to the outlook for global GROWTH and how that outlook may be impacted by POLICY decisions out of the Federal reserve. Today, Global Macro analysis remains as reflexive and proactively predictable as it was then: GROWTH and INFLATION data lead future POLICY adjustments; those POLICY adjustments lead future GROWTH and INFLATION data.
Regarding China specifically, the country’s AUG GROWTH data came in broadly weaker as the AUG INFLATION data accelerated (CPI). Below is a compendium of the reported AUG economic data (New Loans, Money Supply, FDI and Property Prices are all out later this week). The following three charts highlight the deltas in the series we think are most important to focus on at the current juncture.
- AUG CPI: 2% YoY from 1.8%
- Food: 3.4% YoY from 2.4%
- Non-Food: 1.4% YoY from 1.5%
- AUG PPI: -3.5% YoY from -2.9%
- AUG Industrial Production: 8.9% YoY from 9.2%
- Steel Products Production: 2.4% YoY from 7.3%
- Cement Production: 7.2% YoY from 4.4%
- Processing of Crude Oil: 2.6% YoY from 0.3%
- Electricity Production: 2.6% YoY from 2.3%
- AUG YTD Urban Fixed Assets Investment: 20.2% YoY from 20.4%
- Real Estate YTD: flat at 20.9% YoY
- Construction YTD: 15% YoY from 19.6%
- Local Projects YTD: 21.6% YoY from 22%
- Mining YTD: 18.6% YoY from 18.8%
- Manufacturing YTD: 23.9% YoY from 24.9%
- Sources of Funds for Fixed Assets Investment:
- State Budget YTD: 26.9% YoY from 30.5%
- Domestic Loans YTD: 7.1% YoY from 6.7%
- Domestic Loans Earmarked for Real Estate Investment YTD: 11.2% YoY from 8.8%
- AUG Retail Sales: 13.2% YoY from 13.1%
- AUG Exports: 2.7% YoY from 1%
- To US: 3% YoY from 0.6%
- To EU: -12.7% YoY from -16.2%
- AUG Imports: -2.6% YoY from 4.7%; lowest since OCT ‘09
- AUG Manufacturing PMI: 49.2 from 50.1; lowest reading since NOV ‘11
- Input Prices: 46.1 from 41
- New Orders: 48.7 from 49
- New Export Orders: flat at 46.6
- Employment: 49.1 from 49.5
- Output: 50.9 from 51.8
- Backlogs of Orders: 45.1 from 41.9
- Imports: 47 from 45
- AUG Services PMI:
- SA: 47 from 45
- NSA: 56.3 from 55.6
- AUG HSBC Manufacturing PMI: 47.6 from 49.3; lowest reading in the YTD
- AUG HSBC Services PMI: 52 from 53.1
- AUG MNI Business Sentiment Indicator: 47.5 from 49.7
- New Orders: 47.5 from 52.3
- Production: 44.7 from 49
While we don’t currently view a breach of the State Council’s +4% target as a probable risk over the next 2-3 months, we do see risk that Chinese inflation accelerates meaningfully into and through 1H13 if the Fed goes to QE3 (upcoming FOMC decisions: 9/13 and 10/24). As we penned in the conclusion our JUL 25 note titled, “CAT-CALLING CAT: GROWTH SLOWING’S SLOPE JUST GOT A BIT MORE SLIPPERY”:
“We continue to expect that global economic growth will be skewed to the downside over the intermediate term – both relative to current readings and also relative to currently-elevated expectations. Moreover, we would view the inflationary impact of any incremental LSAP program out of the Federal Reserve as a negative shock to reported growth figures globally – particularly when considering how weak the world economy is currently.”
It’s important to note that Chinese interest rate markets are pricing in LESS, NOT MORE, monetary easing amid the acceleration of QE expectations in recent weeks:
We’ve written a compendium of work outlining why we don’t think Bernanke will be able to announce QE3 before the NOV elections in the US; the two most recent notes worth reviewing are listed below:
- WILL ROMNEY AND RYAN FORCE BERNANKE INTO A BOX? (8/15): “As we’ve previously stated, political headwinds, especially from Romney and Ryan, will serve to inhibit further monetary easing out of the Fed between now and election day.”
- FIRE IN THE [JACKSON] HOLE: BATTLE LINES ARE BEING DRAWN IN THE US MONETARY POLICY ARENA (8/22): “The political rhetoric surrounding the inflationary impact of quantitative easing is poised to accelerate meaningfully from now through the general election, potentially keeping the Fed on hold with respect to that duration.”
All that being said, what we think Bernanke will/should do is often divergent from the path he has chosen to take. As such, the more wrong we are on what he does with respect to US monetary policy over the immediate-to-intermediate term, the more right we will be on global growth (slowing). $150 crude oil on the back of the Federal Reserve’s “shock and awe” interest rate cuts helped produce a global economic recession during the last US presidential election year; will Bernanke go for [black] gold this time around?
While the answer to that question remains uncertain at the current juncture, we do know that if he does pull the trigger on Thursday, the action would be a meaningful step forward in the Fed’s aggression towards achieving its mandates. The Fed’s proprietary 5yr breakeven index is currently at 2.48% (down from 2.8% in MAR) and the TIPS breakeven index is currently at 2.04% (down from 2.2% in MAR). In the past, the Fed has typically gone to QE/OpTwist around 2-2.2% on their index and following a 80-100bps cyclical decline on the more-volatile TIPS index.
Best of luck out there this week,
Takeaway: Put the focus back on the core menu and worry less about expanding it.
McDonald’s (MCD) has faced pressure from the overall global macroeconomic environment this year. It’s not like high unemployment in the US and the problems facing Europe are helping sales on a global basis. But McDonald’s faces issues other than the global macro problems out there as sales slow; companies like Five Guys and Shake Shack are slowly creeping in and taking away share from MCD.
We believe McDonald’s needs to refocus its attention to its core business. All the expansion over the years has left this segment vulnerable and management needs to make changes to its strategy in order to succeed. Simplifying the menu rather than expanding it would be one positive step in the right direction, as well as toning down the company’s overall complex strategy. Perhaps then we’ll be less bearish on the stock than we are now.
The Federal Reserve’s perpetuation of near-zero percent interest rates has been a bane for the insurance industry. With the Fed keeping rates to 0% until 2015 at Thursday’s FOMC meeting, the insurance industry is really in a bind that will be difficult to overcome.
Consider that insurance companies have investment portfolios similar to those of public pension plans around the United States. To meet their obligations, they’re expected to earn a certain rate of return per year – maybe 8%. In a normal rates environment, you’d be able to buy some Treasuries and earn 3-4% off those instruments alone, meaning you wouldn’t need to put up a lot of risk in stocks and derivatives markets to earn the difference to 8%.
Instead, Treasuries are offering little-to-no return and continue to go lower. This forces the insurance company to look elsewhere for yield and it’s tough to find these days. The portfolio manager is forced to go further out on the risk curve in order to satisfy that 8% return; maybe he needs to buy some risky junk bonds or invest in some tech IPO that just hit the market. Or maybe he can’t because it’s simply too risky and there’s a need to preserve capital.
And should this happen, the company is really in trouble. Profits go down, jobs get lost and claims risk becomes heightened all because the investment portfolio can’t maintain this set percentage it has to meet. This is just one of the many problems (and effects) with the current interest rate policy at the Federal Reserve.
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