“Milton Friedman reminded us that to spend is a tax.”
On my flight to Denver last night I finally got through half of The 4% Solution. The aforementioned quote from Prescott (Professor of Economics at Arizona State) is representative of what you’ll find in the book - historical reminders that will get you to think.
Thinking, instead of reacting to the daily-double on Spanish bank bailout rumors, matters. History is littered with short-term policy decisions that resulted in long-term structural risks. History is also a guide for those of us who want a solution for a better future.
Not all “economist” ideas are dumb. Some of the simplest ones are just too hard for politicians to swallow. As Vernon Smith (Professor of Economics at Chapman University) suggests, “cutting government spending, as opposed to cutting interest rates… could be a critical step to recovering from a financial crisis” (The 4% Solution, page 50). Try getting Bernanke or Geithner to say that.
Back to the Global Macro Grind…
Enough of the thinking already – if the Europeans print another $100-300B to bailout Spain, and Timmy backstops it with his friends from France via the IMF, the Eurocrats can blow that dough right down a rat-hole faster than you can, baby. Bull market.
After being down for 8 of the last 12 days (SPX closed up a marginal +0.09% as someone spiked AAPL into yesterday’s close) US Equity futures aren’t down yet this morning because the Europeans turned to Rumor On.
Risk off, Rumor On. That’s the political ticket. Or is it?
Tonight we’ll see if Romney can land a punch. If he can’t, I think he’s out cold. If I were him, I’d bring some music to Obama’s wide open economic chin.
Here’s where the US economy finds itself after a -69% GDP slowdown in 6 months to 1.26%. It’s a Bush/Obama Keynesian Trifecta:
- Rising Corporate Taxes (at 39.2% USA has the 2nd highest corporate tax rate (next to Japan) in the world (The 4% Solution, pg 48)
- Less than 50 days to the Fiscal Cliff (Pelosi and Geithner are going to save you from what they perpetuated, allegedly)
- Less than 1-3 months (depending on how they change the rules) on bonking the Debt Ceiling (again)
So, you can save yourself $50,000 a year sending your kid to Keynesian Economics School to come up with a solution like this:
- Cut Corporate Taxes to Canada’s levels (28%)
- Whack what it costs to employ everyone getting paid by Big Government in Washington, DC
- Fire Bernanke, replace him temporarily with Volcker, and bring back Strong Dollar
I’m not in Denver to run for office. But I think I could give Obama a good go on stage tonight if they let me. Americans are sick and tired of losing and being lied to. If you need a Canadian to be your Gladiator in this public economic Forum, I’m game.
Now that that’s off my chest, back to the market…
Last Wednesday, I said “Buyem!”, yesterday I wrote a Risk Manager note in the morning titled “Sellem!” What else do you expect me to do when watching this clown show? This is no longer about anything other than every man and woman fighting for what they have left.
Like I said on the Morning Client Call yesterday (every day at 830AM EST), “I’m just a man in a room” barking about this stuff. Whatever my ideas may be, they don’t superimpose systemic risk on the world’s consumption growth like Bernanke’s ideologies do.
Here are some multi-factor, multi-duration, risk management thoughts supporting why I sold stocks on green yesterday:
- US Dollar Index has held its long-term TAIL line of $78.11 support
- EUR/USD has failed, again, at its $1.31 TAIL risk line of resistance
- SPX vs VIX is breaking down (again) to the bear side, as VIX holds its long-term TAIL of 14-15 support
- SP500 snapped its immediate-term TRADE line of 1451; no support to 1430 on the same duration
- Russell2000 is back below its March 26th closing high of 846 (making lower long-term highs now)
- Bonds (UST 10yr 1.61%) continue to confirm that Growth and #EarningsSlowing matter more than Spanish rumors
If we don’t have the political spine to cut corporate taxes and government spending, at the same time, we’ll look more and more like Japan (or Spain). Don’t believe me? Give it 4 more years.
Sure, it will take some short-term commodity and stock market pain (like it did in the early 1980s and early 1990s) but, in return, we’ll get our hard earned currency back. That will drive oil prices lower, and US consumption higher.
Strong Dollar, Strong America – my name is Keith McCullough and I support this message.
My immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, Russell2000, and the SP500 are now $1, $109.07-112.86, $79.54-80.29, $1.27-1.29, 1.57%-1.64%, 829-846, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Takeaway: The Restaurant Value Spread is signaling a year-over-year headwind for the restaurant industry, particularly casual dining ($TXRH), in 2H12.
Internally, and within regular posts, we have been discussing the spread between the year-over-year growth rates of the Bureau of Labor Statistics’ CPI for Food at Home and CPI for Food Away from Home metrics for some time. Initially, our analysis focused on the spread as being relevant for companies’ pricing strategies but we also believe that the spread, which we call the Restaurant Value Spread, is a driver of traffic for the restaurant industry. The Restaurant Value Spread goes some way to explaining the resilience in restaurant industry sales trends in 2011. The spread effectively represents the relative rate of inflation between grocers and restaurants. In 2011, rampant food inflation was passed on to consumers by supermarket chains but not, to the same extent, by restaurants. We believe this buoyed traffic trends within the restaurant industry, particularly casual dining. Empirical data suggests that the spread turning negative may not bode well for casual dining trends from here. Additionally, the Street is expecting a positive turn in casual dining trends that we believe is looking less and less likely.
Below is a chart of a Casual Dining Same-Restaurant Sales Index, comprised of a simple average of the comps of twenty-one casual dining concepts, versus the Restaurant Value Spread. The dotted line represents what consensus expectations imply for the Index over the next four quarters. We believe that many factors are working against casual dining from here: over-supply, food inflation, energy inflation, negative traffic, employment trends, and anemic real earnings growth are several of the key headwinds we are concerned about. Relative value is another metric that we are watching closely. The chart below implies that, if relative value impacts “share of stomach” within the food industry, casual dining same-restaurant sales growth expectations from here could be overly bullish.
The Restaurant Value Spread also tracks quite closely with the Knapp Track Casual Dining Same-Restaurant Traffic Index over time. Additionally, the same-restaurant sales trends of several companies within casual dining track closely with the Restaurant Value Spread. Below, we discuss two stocks that we think are topical at the moment, within casual dining, and offer commentary on our current thoughts and what meaning, if any, we take away from charts of their respective sales trends versus the Restaurant Value Spread.
Brinker has been one of our favorite names in the restaurant space over the past 2.5 years. The stock has provided some handsome returns to shareholders over that period as investor sentiment, while investor sentiment has been dramatically improved. That sell-side bearishness peaked in April ’12, well into the stock’s rally, tells us how entrenched the negative view of Brinker was on Wall Street. That said, there are still several factors that we believe are working in the company’s favor. We like EAT on the long side versus its peers, especially TXRH, DRI, DIN, and BWLD. Some additional factors worth bearing in mind:
- The Restaurant Value Spread chart (below) indicated that same-restaurant sales expectations may be overly bullish for Chili’s. The correlation, historically, is not consistent and we believe Chili’s is taking share via its new sales layers (pizza) and strong-performing remodels (~5% comps). That said, it is likely that an erosion of the value proposition Chili's represents versus supermarkets and/or its peers will impact its same-restaurant sales numbers.
- Chili’s has invested in its kitchen technology and, in our view, should reap significant rewards relative to the competition over the coming quarters and, possibly, years. Applebee’s has been turning to non-scalable sales initiatives like 24 hour opening and “Club Applebee’s”; we are confident that Chili’s investing in technology and service initiatives has generated, and will continue to generate, strong sales versus the industry.
Texas Roadhouse is a stock that we are negative on given its position within a highly-competitive segment at a time when we expect tough top-line compares to impact the stock in the coming quarters. Additionally, aggressive discounting by a newly-public competitor is likely pressuring same-restaurant sales. We believe that earnings revisions are unlikely to rise from here, as we wrote in our 9/19 note, “TXRH: WHERE TO FROM HERE?” Sales growth lagging capex growth and beef inflation pressuring margins should, in our view, depress returns going forward. As CFO Price Cooper said on the 2Q call, “While our newer restaurants continue to open strong, as they move through the honeymoon period and their sales normalize, their base is slightly less than existing restaurants.” We believe that there is risk to the stock’s multiple if returns decline.
- We view Texas Roadhouse as being one concept that the Restaurant Value Spread is especially relevant for. To the extent that the Restaurant Value Spread being north of 300 bps wide last year may have driven consumers from Kroger to Texas Roadhouse for steak dinners, we expect the collapse in that spread to negative territory to have an adverse impact this year.
Darden is a stock that we have been negative on for some time. Please email us for a copy of our recent Blackbook detailing our thesis. The company’s recent $0.02 beat was supported by an unusually low tax rate ($0.02-0.03) as well as expanded marketing and promotional initiatives. Operating profit missed consensus expectations. Given the low quality nature of the 1QFY13 beat, our continued conviction in our thesis, and consensus continuing to show unwarranted faith in Olive Garden sales rebounding, we retain a negative view of Darden’s stock at these levels.
- Casual Dining same-restaurant sales trends were strong in 2011, benefitting in part from the relative value that the category represented for consumers versus the grocery aisle where inflation was running at 6% year-over-year. That Olive Garden was left behind by this upward surge in casual dining trends is telling. We are not in agreement with consensus that Olive Garden comps will turn sharply higher from here. As the second chart (below) indicates, traffic trends have not been moving in a positive direction.
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In preparation for MAR's 3Q earnings release tomorrow night, we’ve put together the recent pertinent forward looking company commentary.
- “We expect to share our 2013 earnings outlook with you in February after we complete our budget process. So, we will not be providing earnings guidance for 2013 this coming October.”
- “Are you seeing a slowdown in North America and the answer is no”
- “In North America, year-to-date the Marriott brand's special corporate revenue has been strong, up over 8%; group revenue rose 7% year-to-date and group bookings for the second half are even stronger.”
- “Our strong book of business in 2012 allowed us to drive REVPAR aggressively in the first quarter, but in the second quarter strong seasonal demand combined with a continuing recovery yielded an uptick in sellout nights. Looking ahead, as occupancies build, further run rate improvement should follow.”
- “In Asia and the Middle East, REVPAR growth rates for a few luxury hotels are expected to moderate in the second half, largely associated with individual market issues. In Europe, third quarter REVPAR will be helped by the Olympics in London and the Euro Cup championship. At the same time, the weak European economy will likely create headwinds.
- “We've also reduced our room opening expectations a bit for 2012. In the first quarter, we noted slippage in opening dates from 2012 to 2013 for some new hotels in Asia and the Middle East. In the second quarter, the slippage continued in these markets as well as with a few projects in Mexico. We continue to see a lot of conversion opportunities around the world but they too are taking a bit longer as some projects require more extensive renovation before flagging. As a result, today we expect to open 20,000 to 25,000 rooms in 2012. Since this reduction is largely timing, we continue to expect to add 90,000 to 105,000 rooms from 2012 through 2014.
- “DC is so meaningful that it's weak REVPAR in the quarter reduced our company-operated North American REVPAR by a point. But even here there is good news; interest in the upcoming election is starting to drive political business to the city. Group revenue bookings in DC for the Marriott brand are up 10% for the second half of 2012 and 16% for 2013. 2013 should be a good year overall in this market but we'll have to see how government demand shakes out. Next year's government per diems will be set this August and we will be watching this carefully.”
- “Looking ahead for the second half of the year, group booking pace is up 10% and 2013 booking pace is up 8%. We are very bullish about pricing in North America in 2013. For group business on the books for next year, room rates are running up 4%. On the transient side, we are targeting price increases for special corporate business at a high single-digit rate on average.”
- “For the full year, our guidance assumes approximately $9 million year-over-year lower fees due to foreign exchange.”
- [Courtyard transaction] “With this transaction, Marriot expects to recognize about $5 million in fee revenue for deferred base fees and approximately $40 million gain in the third quarter. We've already received $90 million in cash proceeds from the transaction, demonstrating once again our success in recycling capital.”
- [Drivers around of $20MM guide down ] “FX and re-licensing fees by and large are driven by the sale of existing franchised hotels and that volume has been down a bit lower than we expected, a little bit softer REVPAR with some fine-tuning around individual assets. And the sale of the ExecuStay business and with it the elimination of that is a mid single-digit number of millions of dollars on a full year basis”
- “I think we still expect in full-year 2012 that our incentive fees will be growing about 20%.”
- FY2012 WW RevPAR guidance: “Well, I think 6 to 7 is more likely than the high end of 7 to 8, but…business is good.”
- “We would think Europe will continue to tick along around of that 3% sort of number. Q3 maybe a bit better because of the Olympics and Q4 maybe a bit worse because we don't have anything like the Olympics, which is likely to help Q4, but still kind of the same rates that we've seen.”
- “China, we've been…10 or above year-to-date, I suspect the right set of expectations would be as high single-digit as opposed to a double-digit growth rate for the balance of the year reflecting a somewhat more modest growth rate there.”
- “Middle East, I think is going to be very interesting. Our team has got some optimism in places like Egypt that we could be pleased to see business coming back a little bit faster than we're planning. On the other hand, we're really wary about building in expectations from a place like Egypt, which are too bullish. Dubai, by contrast is very strong. It's a safe haven in many respects in the Middle East, and notwithstanding substantial supply growth, it is continuing to post good numbers on the books. The rest of the Middle East varies dramatically market-to-market. You've got political environments which vary from place to place and the economic environments which vary from place to place, but I think generally the Middle East ought to be performing reasonably well as the year goes along.”
- [In the Q for the Q bookings] “They're a little lower than in the first quarter, because we have a lot of full hotels, because of the booking pace we've been talking about for the last two quarters, being up so high. But for the full year, we would expect the in the quarter for the quarter, to still represent about 30% with the other two-thirds booked the previous year.”
- “We will continue to manage our leverage to 3 to 3.25 times debt-to-EBITDA. So that's what we are targeting for.”
- Q: “Are you seeing as healthy a recovery in secondary markets as you are in gateway cities”
- A: “Generally, yes”
- Q: “Hotels that's in existence today versus I guess sort of peak staffing levels in 2007, how far off are you?”
- A: “Typical hotel would be fairly close. I think the permanent reduction in head count would probably mostly be around management staff and how heavy that is and how much we've been able to do above property and do it a little bit more efficiently than used to be done on property. But that is likely to affect a relatively small number of people in a hotel, the restaurant staff and the housekeeping staff and the other key members of the team that are focused on serving our guests as occupancy has gotten back to and now beyond peak levels. So we're performing at occupancy levels which are in excess of the 2007 and 2008 levels. I suspect we have seen staffing come most of the way back to where it was before.”
Takeaway: The fiscal cliff and debt ceiling loom large in 2013. Even Romer is worried about growth!
“Tax changes have very large effects: an exogenous tax increase of 1 percent of GDP lowers real GDP by roughly 2 to 3 percent."
-National Bureau of Economic Research
We have been at times criticized for using Keynesianism in a derogatory sense as it relates to economic policy. Critics of this use suggest that current policy makers are not really true Keynesians and are misusing and misinterpreting, the tenets of Keynesian economic policy. This may well be true and we will fully admit that Keynes has become a bit of a straw man of sorts for us.
Nonetheless, there is no denying that government deficit spending has led to unsustainable debt loads globally. In the United States, the outcome of a decade of unfettered deficit spending is coming to a head in the next quarter with what we are calling the Keynesian Trifecta – increased taxes, lower government spending, and another debt ceiling.
On the first point of taxes, based on current policy we are set to undergo perhaps the most meaningful tax increases in a generation effective 2013. The quote above comes from a paper co-written by Christina Romer, formerly President Obama’s chief economic advisor entitled, “The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks.” The key takeaway is that tax increases in the short run negatively impact growth.
The key areas in which the tax increases are coming in 2013, which the Washington Post has aptly named Taxmageddon, include:
- 34% of the tax increases come from the expiration of the 2001 and 2003 Bush tax cuts (includes capital gains and dividend increases);
- 25% of the tax increase comes from an expiration of the temporary payroll tax cut (including on Social Security deductions); and
- The remainder largely comes from new taxes under the Affordable Care Act (or Obamacare).
Below, we’ve attached a graphic that looks at the scale of the coming tax increases. There are many estimates for the actual annual scale, but the range is $380 - $450 billion. On a GDP base of just north of $15 trillion, this accounts to an aggregate GDP tax of 2 – 3%.
In the current form, the tax increases look to impact a wide portion of the tax base. The key exception is the purported middle class, so those unmarried filers making less than $35K per year or married joint filers making less than $70K per year. In the table below, prepared by our Financials Sector Head Josh Steiner, we look at tax increases by both income level and also by line item. The key takeaway is that the upcoming tax increase will be broad based and comprehensive.
In fact, a report released today from the Tax Policy Center finds that 90 percent of Americans will see their taxes go up starting January 1st. The average tax increase will be $3,500 and the typical middle-income taxpayer will see his or her tax bill go up by $2,500.
In conjunction with these tax increases is the automatic cut in government spending that is going to occur under the Budget Control Act of 2011. Since the Joint Select Committee on Deficit Reduction failed to implement a $1.5 trillion deficit reduction plan, the sequestration process is triggered. Sequestration cuts are not new in the United States (three under the Gramm-Rudman-Hollings deficit targets and two under the statutory discretionary spending caps), but this round will be the largest in terms of scale.
One interesting note is that while the federal fiscal year ends in September, the first year of sequestration doesn’t begin until January 2013. As a result, a year of cuts will be squeezed into nine months. As American Progress wrote:
“On a percentage basis the cuts would have to be about a third larger than the 8.5 percent to 10 percent required for the year as a whole. Such programs would face cuts of between 11.3 percent and 13.3 percent during that nine-month period.”
Therefore at a time when we are set to see tax increases that are as large as the U.S. economy has experienced in a generation, the cuts in government spending will also be magnified.
The Budget Control Act spells out the steps that the Office of Management and Budget must take due to the lack of agreement by the Joint Committee. In 2013, sequestration cuts will be equally split between defense and non-defense for a total of $109.3 billion in total cuts. In terms of the non-defense cuts, it is expected that $16.7 billion come from mandatory programs with the bulk coming from Medicare.
In the long run, we are firm believers that taking capital away from the government and giving it back to the people to more efficiently allocate is a great thing. In the short run, though, we do need to be aware that deep cuts in government spending will be a headwind to growth. On the basis of $109.3 billion in spending cuts, this will be an incremental -0.5% detractor from GDP in 2013.
Finally, as if the cliff weren’t enough, the debt ceiling is about to be breeched again. The statutory debt limit is $16.4 trillion. As of September 28th, the total debt outstanding of the U.S. government was $16.0 trillion. The estimated required debt issuance for Q4 2012 is $316 billion. This would mean that the implied capacity going into 2013 is $50.1 billion. Therefore the debt ceiling is likely to be breached in January 2013. In reality, the ceiling can likely be extended a quarter or two based on a number of one-time items, but will most definitely be hit in the first half of 2013.
If you recall to the summer of 2011, the debt ceiling was a major catalyst for the market. In the last chart we highlight the impact to equity markets in the summer of 2011 as uncertainty around the debt ceiling accelerated. From July 1st the S&P 500 went from 1,315 to its summer trough of 1,127 on August 22nd - for an aggregate decline of some 14%.
As if Taxmagedon weren’t enough . . . the Keynesian Trifecta is looming on the horizon and will slow growth and potentially be a negative catalyst for the equity markets.
Daryl G. Jones
Director of Research
Housing is improving but still not good enough
- We’ve shown that housing prices have historically been the most statistically significant macro variable in explaining gaming revenue growth
- While better, home prices were still down YoY in Q2. The good news is that price change might be on the positive side in Q3.
- The mortgage delinquency rate continues to slope downward which is a decent economic barometer. However, that could also mean that more people are paying their mortgage or have moved out and are now paying rent. Either way, it likely means less monthly discretionary spending which could be impacting gaming spend. This phenomenon could continue to suppress locals gaming revenue.
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