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Expert Call Summary

Takeaway: $NAV- Other manufacturers have yet to decide on further legal action on the EPA's NCP regime at Navistar. Decision due in about 50 days.

Emissions Call Summary


Below, we highlight some of the key topics covered on our emissions expert call with Dick Penna today.  Dick currently represents Paccar and previously represented Volvo on truck emissions issues related to the non-conformance penalties applied to Navistar’s engine.  The call was excellent and contained a number of valuable details, which can be heard by listening to a replay of the call at https://app.hedgeye.com/feed_items/23116-emissions-expert-call

 

 

       Legal Options

  • Volvo, Daimler and Paccar, among others, are meeting tomorrow to discuss litigation strategies regarding the EPA’s non-conformance penalties with respect to Navistar.
  • Further litigation could shatter the “clarity” that Navistar has said the “Final” rule provides.
  • If competing manufacturers decides they want to challenge the EPA ruling (which they must do no more than 60 days after appearance in the Federal Register, which was September 5th, 2012) they will have a good shot, but it is still very difficult to predict court cases in the DC Circuit.
  • There is a citizen suit provision in the Clean Air Act where if somebody believes the EPA is not enforcing the law, they can give the EPA 60 days notice to do so.   If the EPA does not change what it is doing, then they can be taken to court.  The odds of that happening are pretty slim, but that is another possible legal path.  The most likely groups to attempt this would be the environmental and other public interest groups.

The Landscape Created by the EPA

  • The EPA will create deterrents for companies who do not comply with their regulations, but they will also stand on their head to not put anyone out of business.
  • As for the competitors who were complying with EPA standards, you can quarrel whether or not the $3,700 fine was enough to act as a deterrent.
  • Navistar may purchase emissions credits from Cummins to gain compliance.

2014-2018 Regulations

  • To comply with the 2014-2018 emissions standards, companies will be using different tires and aerodynamics which will likely introduce additional costs.  There is not much concern here about a pre-buy mainly because despite the additional costs these new EPA regulations will align fuel efficiency incentives for both truck manufacturers and operators.
  • The manufacturers all signed on to meet the 2014-2018 regulations, so they probably think they can meet the standards at a reasonable cost.

Looking Ahead

  • The EPA has just completed the 2017-2025 emissions rules for light-duty trucks, and we can expect to start hearing about future heavy duty regulations in the next few months.
  • These post 2018 regulations will likely depend on the outcome of the presidential election.
    • If Romney is elected he will most likely not make future regulations more stringent than the 2014-2018 regulations.
    • If Obama wins the election, regulations are likely to become even more rigorous after 2018.
    • We would probably need to switch to lower sulfur fuels for further tailpipe emissions gains.  That has ripple effects because there are costs that the refiners must now pay to reduce the level of sulfur in their diesel.

Light Vehicles

  • New emissions standards for light vehicles are rigorous. The changes coming over the next 7 to 10 years are likely to be rather aggressive.
  • In the future we are also going to see a lot more “light weighting”, as manufacturers turn to lighter metals or carbon fibers. 
  • We will also see multispeed transmissions and continuously variable transmissions as well as direct injection gasoline.

CHART DU JOUR: NOT MUCH CHA-CHING IN SLOTS

Takeaway: LV Strip slot business unattractive over the near and long-term

  • Slot volumes have not grown across a 10 year span and these numbers are not even inflation adjusted
  • Weakening demographics - older and fewer slot players - play a big role in the stagnant growth.  Despite all the efforts to cultivate a younger customer base, the post baby boom generations are not playing the slots.
  • YTD, slot volumes have declined 2%, not exactly representative of a recovery

 

CHART DU JOUR: NOT MUCH CHA-CHING IN SLOTS - SLOTV


Macau: Enter The Supertables

Takeaway: Macau's table cap is approaching its limit. Casinos are moving to "Supertables" as a way to bypass the cap and cater to customers.

While Macau is dominating the gaming space compared to Las Vegas, there is a slight issue at hand involving table game limits. Currently, Macau casinos have a table cap of 5500, which is in effect until the end of March 2013. The cap isn’t a law but rather a government stipulation that can be changed at any time. So how does a savvy business overcome the cap? Easy: you build a Supertable!

 

 

Macau: Enter The Supertables  - supertablescc

 

 

These new “Supertables” seat 12 players and have two dealers as opposed to a traditional 6-8 player, single dealer setup. Las Vegas Sands (LVS) is leading the charge with 32 Supertables in place compared with the Venetian’s 20 and Starworld’s 5. Galaxy Macau has a single Supertable in place.

 

At the end of Q2 2012, the Macau government reported 5498 tables in operation. As LVS gets ready to open the second phase of its Sands Cotai Central (SCC) casino on September 20, investors are worried about the cap affecting the amount of table games in place since the SCC won’t get new table allocations until December of January. Sands China is making room for the additional 200 tables expected at SCC in late 2012/early 2013.

 

Until the table cap rises, we could see this Supertable trend quickly catching on with casinos. 


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GPS: A Cautionary Tale

Takeaway: The Gap is up against stiff competition and needs to work on improving margins - stat.

Michael Francis has joined The Gap (GPS) as their head of marketing. This is the guy who thought it’d be a good idea to give out free haircuts at JCPenney (JCP). If that doesn’t make you nervous, a few other problems with GPS will.

 

Three years ago, GPS was sitting on a net cash position of $2.3 billion. Now it is down to $400mm and shrinking. The company’s been engaged in share buybacks over the past few years and while that’s fine and dandy, it has hurt their cash position. 

 

 

GPS: A Cautionary Tale - gapchart1

 

 

The Gap also needs to work on improving its margins and retaining market share. There are plenty of competitors going head-to-head with The Gap out there: Macy’s, TJ Maxx, Ross Stores and even JCPenney. Just because the company has hit on the colored jeans trend doesn’t mean it can sustain driving existing and new trends.

 

Retail Sector Head Brian McGough makes an excellent point in a note on GPS we’ve outlined below:

 

“The consensus has GPS earning $2.40 next year. Then $2.72 the year after. We’re about 10% below next year, and 20% below the year after. We’d argue that barring a disproportionately large capital investment (which would drive returns lower) GPS will never see $2.50 again – ever. And as we say at Hedgeye, ‘ever’ is a long time.

 

That did not matter with the stock trading at $15 a year ago. But it certainly matters today at $35.  Let’s say we’re dead wrong, and the Street is spot-on. Then you’re paying 12.9x earnings for a number that GPS will earn in FY 2014. That’s right up there with AAPL, NKE and RL. Which would you rather own?


QUANTIFYING THE INFLATION TRADE ACROSS ASIA AND LATIN AMERICA

Takeaway: With expectations for QE3 now at 99% (Bloomberg), we think it's worth revisiting the post-Policy To Inflate playbook for Asia and LatAm.

***Repurposed; originally published on JUN 14, 2012.***

 

SUMMARY BULLETS:

 

  • Our analysis shows that the post-QE/OpTwist returns of USD-based investors in Asian and Latin American equity markets were neither a function of that index’s/economy’s exposure to rising commodity and/or asset prices; nor were those returns a function of performance in past iterations of Fed easing.
  • Thus, we would argue that outperformance in the next iteration of Fed easing (if any) will come down to identifying and taking advantage of idiosyncratic factors across the individual economies.

 

Dollar down; stocks, commodities and EM FX up. That’s the consensus reflation trade that has suddenly become the predominant bull case throughout the global investment community. As we have been saying since 1Q11, the reflation trade becomes the Inflation Trade as rapid commodity price gains perpetuate faster rates of reported inflation and slower growth across the global economy.

 

As completely detrimental as that is to any “long term” investment strategy, the reality of the situation is that most institutional investors have to chase short-term performance in one form or another. As such, if the Fed uses the recent string of anemic domestic employment growth and slowing [headline] inflation to signal or implement QE3-4 (it’s hard to keep track) next week, we would not be surprised to see another short-lived “risk” rally to another lower long-term high across global equity and commodity markets.

 

Turning to Asia and Latin America, we’ve taken the liberty to quantify the effects of the last three iterations of the Federal Reserve’s Policies to Inflate on their financial markets for any investors who may be looking to hit up the ol’ well once more. Our hypothesis was that those countries whose benchmark equity index was most exposed to the Inflation Trade would experience outsized returns relative to the group in both their stock market (faster earnings and economic growth) and local currency vs. the USD (capital flows; policy tightening speculation) on a S/T TREND duration (3MO). Moreover, we expected performance during these periods of reflation to be both positively and tightly correlated to the aforementioned exposure.

 

Using a simple linear regression analysis, we were able to dispel both components of our hypothesis, as outperformance of a given country’s stock market and local currency was not necessarily a function of its index’s (an admittedly loose surrogate for “economy”) exposure to the Inflation Trade; nor were returns always positively correlated across iterations.

 

QUANTIFYING THE INFLATION TRADE ACROSS ASIA AND LATIN AMERICA - 1

 

QUANTIFYING THE INFLATION TRADE ACROSS ASIA AND LATIN AMERICA - 2

 

QUANTIFYING THE INFLATION TRADE ACROSS ASIA AND LATIN AMERICA - 3

 

The key takeaway here is that there is hardly any relationship to be derived, suggesting that either A) country-specific fundamentals (i.e. GROWTH/INFLATION/POLICY) were the key determinants of performance or B) returns were more a function of performance in past iterations (i.e. “going back to the ol’ well”). To test the latter theory, we regressed returns of QE2 against those of QE1 and the returns of Operation Twist with those of QE2. In short, our findings here would suggest that this wasn’t the case.

 

QUANTIFYING THE INFLATION TRADE ACROSS ASIA AND LATIN AMERICA - 4

 

QUANTIFYING THE INFLATION TRADE ACROSS ASIA AND LATIN AMERICA - 5

 

All told, our analysis shows that the post-QE/OpTwist returns of USD-based investors in Asian and Latin American equity markets were neither a function of that index’s/economy’s exposure to rising commodity and/or asset prices; nor were those returns a function of performance in past iterations of Fed easing. Thus, we would argue that outperformance in the next iteration of Fed easing (if any) will come down to identifying and taking advantage of idiosyncratic factors across the individual economies.

 

Below is a full performance table of the countries included in our sample.

 

Darius Dale

Senior Analyst

 

QUANTIFYING THE INFLATION TRADE ACROSS ASIA AND LATIN AMERICA - 6


WE LIKE TAIWANESE EQUITIES ON THE LONG SIDE

Takeaway: We are bullish on Taiwanese equities with respect to the intermediate-term TREND duration.

SUMMARY BULLETS:

 

  • While we continue to anticipate that economic growth will continue to slow broadly across the globe over the intermediate term, there is likely to be a handful of countries that have led the slowdown and are poised to lead any potential broad-based economic recovery.
  • Taiwan is one of those economies and we are now inclined to trade Taiwanese equities with a bullish bias with respect to the intermediate-term TREND duration. 

 

Yesterday, Taiwanese Primer Sean Chen announced a series of measures designed to boost real GDP growth by +100bps over the long-term TAIL, relative to prior expectations. Those measures include:

 

  • Attracting private investments of at least NT$1 trillion ($34B) annually through relaxing restrictions on Chinese investment(s) and easing curbs on domestic companies investing in mainland China;
  • Opening industries such as chipmakers and LCD panel makers to increased Chinese investment; and
  • Promoting increased tourism and hospitality-related revenues (the government now expects to grow annual visitors from an expected 7 million in 2012 to 10 million in 2016).

 

The measures, which carry a notable pro-China theme, come in the wake of the recently-signed yuan clearing agreement that should promote the use of the Chinese currency in Taiwanese financial markets – mimicking what we are seeing today in Hong Kong’s Dim Sum and yuan-denominated deposits markets.

 

While we continue to express long-term concerns with the Chinese yuan and Dim Sum markets (introduced in a 4/16 note titled: “FLAGGING ASYMMETRIC RISK IN THE CHINESE YUAN AND DIM SUM BOND MARKET”), we do think Taiwan’s relatively small economy ($887.3B) and its financial markets could serve to benefit from an influx of Chinese capital over the intermediate term – at least in the sense that the Chinese have established a penchant for acquiring international assets in strategic industries (energy and materials specifically… is tech next?).

 

Per Chen, a specific action plan is due out by the end of this month; from a fundamental perspective, this GROWTH-positive catalyst times up quite nicely with the Taiwanese economy’s likely move into Quad #1 on our proprietary G/I/P analysis. Our models currently have Taiwanese INFLATION slowing post the 3Q time frame (the AUG CPI reading came in at +3.4% YoY, which is the fastest rate since AUG ’08), though that forecast is certainly in jeopardy pending further action out of the Federal Reserve.

 

WE LIKE TAIWANESE EQUITIES ON THE LONG SIDE - TAIWAN

 

From a POLICY perspective, the OIS market is pricing in -100bps of cuts over the NTM, while the NDF market is pricing in +1.3% of FX strength vs. the USD over that same duration, indicating a mixed/status quo outlook for Taiwanese monetary policy among market participants – a view we’d agree with at the current juncture. If, however, our forecasts prove correct on Taiwanese GROWTH, we could see the interest rate swaps market price in less monetary easing on the margin, and that could prove positive for continued gains in the Taiwanese dollar (up +2.4% YTD vs. the USD).

 

On the equity market front, Taiwan’s benchmark Taiwan Stock Exchange Weighted Index (TAIEX) closed today down -7% from its MAR 2nd YTD peak. Moreover, the TAIEX has underperformed the regional median gain across Asian equity markets on both a six-month (-4.5% vs. +2.2%) and LTM (-0.5% vs. +7.1%) basis, so we like the potential for Taiwanese stocks to play “catch-up” relative to the region over the intermediate term from  mean reversion perspective.

 

WE LIKE TAIWANESE EQUITIES ON THE LONG SIDE - 2

 

We also like that the Taiwanese government has recently cut its 2012 real GDP growth forecast by -20% to +1.66%, confirming the YTD plunge in consensus 2012 growth expectations (from +4.1% in JAN to +1.8% currently) and creating ample space for upside surprise risk in the reporting of Taiwanese economic data.

 

Why We Wouldn’t Own Taiwan

Two fundamental factors that are not in support of our bullish bias are 1) exposure to Chinese/global growth slowing and 2) a meaningful lack of economic headroom to apply fiscal stimulus to boost growth over the intermediate term.

 

To the first point, it should be noted that exports account for roughly 60% Taiwan’s real GDP, leaving the country somewhat exposed to global growth trends – trends we expect to continue deteriorating over the intermediate term. Its largest export market is China (28.1% of total shipments per CIA Factbook) – a country where economic growth has slowed significantly and looks to base at/near current historically-depressed rates over the intermediate term.

 

To the latter point, Taiwan scores quite poorly on our propriety Stimulus Space Index; in fact, it posts the third-lowest reading of our 17-country sample of Asian and Latin American economies. For more details, including our methodology, refer to the following note: WHO’S GOT SPACE FOR STIMULUS IN ASIA AND LATIN AMERICA? (8/23).

 

WE LIKE TAIWANESE EQUITIES ON THE LONG SIDE - 3

 

All told, while we continue to anticipate that economic growth will continue to slow broadly across the globe over the intermediate term, there is likely to be a handful of countries that have led the slowdown and are poised to lead any potential broad-based economic recovery. Taiwan is one of those economies and we are now inclined to trade Taiwanese equities with a bullish bias with respect to the intermediate-term TREND duration. 

 

Darius Dale

Senior Analyst


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