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BREAKING DOWN THE US GDP REPORT: THE ODDS OF A RECESSION JUST INCREASED

Takeaway: With a pre-election boost in government spending comes heightened odds that US GDP growth slows demonstrably in 4Q12/1Q13.

SUMMARY BULLETS:

 

  • On an industry-standard C+I+G+NX (C=consumption, I=investment, G=government and NX=net exports) basis, the 3Q12 GDP report was not good. The underlying trends suggest the odds of US recession over the intermediate term are now much higher than they were a 8:29am EST.
  • The unsustainable uptick in government spending ahead of the election portends quite negatively for 4Q12/1Q13 real GDP growth. Without Uncle Sam’s pre-election encroachment, 3Q12 US real GDP growth would have came in at +1.3% QoQ SAAR – or unchanged from 2Q12. If “G” actually came in at the trailing four quarter average of its contribution to GDP, 3Q12 US real GDP growth would have been a paltry +0.9% QoQ SAAR.
  • Imports contributed +4bps to the headline GDP figure of +2% on the strength of a sequential contraction of -0.2% (down from +2.8% QoQ in 2Q12). This is the first sequential contraction of US imports since 2Q09. Importantly, the slowdown in import growth portends somewhat negatively for domestic demand trends over the intermediate term. Imports, which themselves are led by orders, lead real final sales. We’ve highlighted this relationship in previous notes (click here for more details). Is a disappointing holiday season on the horizon?
  • Furthermore, the 3Q12 GDP report suggests weak imports may be leading a sequential slowdown in both “C” and “I”  in the upcoming quarter(s). Additionally, an demonstrable and unsustainable acceleration  in “G” was all that stood in the way of a -35% deceleration to +0.9% QoQ SAAR, allowing the headline figure to come in at +2% QoQ SAAR. This means that growth is trending along a +0.9% QoQ SAAR run rate and potentially headed lower if “C” and “I” exhibits signs of slowing.
  • Unfortunately, dual slowing of “C” and “I” is indeed a probable scenario, given the uncertainty surrounding the election, fiscal cliff and debt ceiling breach. Moreover, each catalyst may actually be contributing to a noteworthy acceleration in corporate cost-cutting initiatives (layoffs?), as highlighted on 3Q earnings calls. Recessions happen when baseline GROWTH is weak, the corporate earnings cycle slows and companies start trying to cut their way into meeting peak-cycle, peak-margin forward EPS estimates. In this respect, 4Q12 is very much like 4Q07.

 

On a SAAR basis, US real GDP growth accelerated to +2% QoQ in 3Q12 from +1.3% in 2Q12; on a YoY basis, US real GDP growth accelerated to +2.3% in 3Q12 from +2.1% in 2Q12.

 

Looking beyond the headline figures, there were some rather interesting occurrences that we think are worth highlighting:

 

  • Driven by a demonstrable acceleration in federal government spending (+9.6% QoQ in 3Q12 from -0.2% in 2Q12) the “G” in the C+I+G+NX equation contributed +71bps (or 36%) to the +2% headline figure. This was the first quarter “G” posted a positive contribution to the headline figure since 2Q10. Like the SEP Unemployment Rate and the OCT UofMich Consumer Confidence Index, the 3Q12 GDP report is just strong enough for President Obama to claim he’s got the US economy back on track just in time for the election.
  • Driven by a -1.3% QoQ decline, business investment (i.e. nonresidential fixed investment) was net drag of -13bps on the headline GDP figure of +2%; this is the first time we’ve seen US businesses retrench since 1Q11, when a -1.3% QoQ contraction then contributed to a net drag of -11bps on the then-headline +0.1% QoQ SAAR figure. Uncertainty over the domestic political situation continues to contribute to slow economic growth. More on this later.
  • Driven largely by drought-induced weakness in farm inventories, inventories overall contributed a -12bps drag on the headline GDP figure of +2%; this is up sequentially from -46bps. Nonfarm inventories contributed +30bps to the headline GDP figure, while farm inventories contributed a -42bps drag.
  • The much-celebrated recovery in the housing market continues to auger positive for domestic real GDP growth, contributing +33bps to the headline figure in 3Q12 (up from a +19bps contribution in 2Q12) on the strength of a +14.4% QoQ growth rate (accelerated from +8.5% QoQ in 2Q12).

 

BREAKING DOWN THE US GDP REPORT: THE ODDS OF A RECESSION JUST INCREASED - 1

 

Given that we’re well into 4Q12 already, we think it’s worth highlighting a few nuggets from the 3Q12 report that may offer clues as to where the rate of domestic GROWTH might end up in the current and proceeding quarters:

 

  • Imports contributed +4bps to the headline GDP figure of +2% on the strength of a sequential contraction of -0.2% (down from +2.8% QoQ in 2Q12). This is the first sequential contraction of US imports since 2Q09. Importantly, the slowdown in import growth portends somewhat negatively for domestic demand trends over the intermediate term. Imports, which themselves are led by orders, lead real final sales. We’ve highlighted this relationship in previous notes (click here for more details). Is a disappointing holiday season on the horizon?
  • The unsustainable uptick in government spending ahead of the election – as great as it may be for the Keynesian elite – actually portends quite negatively for 4Q12/1Q13 real GDP growth. Without Uncle Sam’s pre-election encroachment, 3Q12 US real GDP growth would have came in at +1.3% QoQ SAAR – or unchanged from 2Q12. If “G” actually came in at the trailing four quarter average of its contribution to GDP, 3Q12 US real GDP growth would have been a paltry +0.9% QoQ SAAR. Imagine if three months from now, US real GDP slowed from +2% QoQ SAAR in 3Q12 to +0.9% QoQ SAAR (or lower) in 4Q12. That is a real risk.

 

BREAKING DOWN THE US GDP REPORT: THE ODDS OF A RECESSION JUST INCREASED - 2

 

Net-net, the 3Q12 GDP report suggests weak imports may be leading a sequential slowdown in both “C” and “I”  in the upcoming quarter(s). Additionally, an demonstrable and unsustainable acceleration  in “G” was all that stood in the way of a -35% deceleration to +0.9% QoQ SAAR, allowing the headline figure to come in at +2% QoQ SAAR. This means that growth is trending along a +0.9% QoQ SAAR run rate and potentially headed lower if “C” and “I” exhibits signs of slowing.

 

Unfortunately, dual slowing of “C” and “I” is indeed a probable scenario, given the uncertainty surrounding the election, fiscal cliff and debt ceiling breach. Moreover, each catalyst may actually be contributing to a noteworthy acceleration in corporate cost-cutting initiatives (layoffs?), as highlighted on 3Q earnings calls. Recessions happen when baseline GROWTH is weak, the corporate earnings cycle slows and companies start trying to cut their way into meeting peak-cycle, peak-margin forward EPS estimates. In this respect, 4Q12 is very much like its 2007 counterpart.

 

Our updated US GIP model is included in the chart below.

 

Darius Dale

Senior Analyst

 

BREAKING DOWN THE US GDP REPORT: THE ODDS OF A RECESSION JUST INCREASED - US LOW


Bearish TREND: S&P 500 Levels, Refreshed

Takeaway: Our top Hedgeye Global Macro Theme for Q4 of #EarningsSlowing continues to play out at an accelerating rate.

POSITIONS: Long Utilities (XLU), Short Industrials (XLI)

 

Our top Hedgeye Global Macro Theme for Q4 of #EarningsSlowing continues to play out at an accelerating rate. Half way through Earnings Season, we see no reason to back off that fundamental research view.

 

From a quantitative perspective (different from the research view), the bearish TREND signal remains. Across our core risk management durations, here are the lines that matter to me most:

 

  1. Intermediate-term TREND resistance = 1419
  2. Immediate-term TRADE support = 1391
  3. Long-term TAIL support = 1354

 

In other words, now that the SP500 is slicing through its April 2012 highs (and there’s no Fed put), long-term TAIL support is back in play.

 

On growth, 1/3 of this morning’s GDP print came from a Government Spending (contributing +0.71% out of nowhere, after 8 consecutive quarters of declines!). That’s going to matter as the legacy media figures it out.

 

KM

 

Keith R. McCullough
Chief Executive Officer

 

Bearish TREND: S&P 500 Levels, Refreshed - SPX


The Romney USD/Energy Play

We hosted an expert call with Ken Bickers on the November election  this week and the outcome of his model shows Romney winning by a landslide. Romney says he would open up drilling on federal lands and offshore - that’s great for energy, right? Not really. A Romney win is bullish for the US dollar and when the dollar goes up, oil goes down; correlation is a beautiful thing.

 

From Hedgeye Energy Analyst Kevin Kaiser, here are the winners and losers if Romney wins the election:

 

  • Relative losers: crude oil E&Ps, refiners, oilfield services, renewables/clean.  Oil prices fall and Romney cuts subsidies to the renewable/clean energy companies.  Less regulation, more offshore drilling, Keystone XL, and a better tax environment are all well and good – but won’t move the stocks.
  • Relative winners: coal producers.  Romney is pro-coal, opposing looming EPA

The Romney USD/Energy Play  - energyUSD


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PCAR: Simply The Best

Paccar (PCAR) remains our top long idea for the Industrials sector. The company is executing well, taking market share in a cyclically depressed industry and put up a solid quarter this week. As Navistar (NAV) struggles with customer perception of its engines and financial stability, PCAR looks to benefit from NAV’s share loss.

 

PCAR: Simply The Best - PCAR chart


Shifting Expectations

Client Talking Points

Shifting Expectations

By now it’s pretty obvious that one of our big Q4 Macro themes, #EarningsSlowing, has taken effect and is widespread throughout the market. What’s interesting is that while we’ve been shouting about this since late February, the Old Wall is finally changing their stance on earnings. Consensus numbers and price targets are shifting at the banks and brokers; only took them nearly a year to get it right.

The Bernanke Top

Some people will tell you that stocks are “cheap” here. We say “they can get cheaper” because they can. Take technology for instance. Since the Bernanke Top (September 2012), the XLK ETF is down -10%, AAPL is down -14% and AMZN is down -15%. And on top of it, they’re missing on earnings. So while you might want to rush in and be a buyer, we warn that technology can get a lot cheaper. 

Asset Allocation

CASH 64% US EQUITIES 3%
INTL EQUITIES 0% COMMODITIES 0%
FIXED INCOME 18% INTL CURRENCIES 15%

Top Long Ideas

Company Ticker Sector Duration
EAT

Remains our top long in casual dining as new sales layers (pizza) and strong-performing remodels (~5% comps) should maintain sales momentum. The company is continuing to enhance returns for shareholders through share buybacks . The stock trades at a discount to DIN (7.7x vs 9.3x EV/EBITDA) and in line with the group at 7.3x.

PCAR

Emissions regulations in the US focusing on greenhouse gases should end the disruptive pre-buy cycle and allow PCAR to improve margins. Improved capacity utilization, truck fleet aging, and less volatile used truck prices all should support higher long-run profitability. In the near-term, Paccar may benefit from engine certification issues at Navistar, allowing it to gain market share. Longer-term, Paccar enjos a strong position in a structurally advantaged industry and an attractive valuation.

HCA

While political and reimbursement risk will remain near-term concerns, on the fundamental side we continue to expect accelerating outpatient growth alongside further strength in pricing as acuity improves thru 1Q13. Flu trends may provide an incremental benefit on the quarter and our expectation for a birth recovery should support patient surgery growth over the intermediate term. Supply costs should remain a source of topline & earnings upside going forward.

Three for the Road

TWEET OF THE DAY

“The problem with political jokes is they get elected.” -@Giggles270346

QUOTE OF THE DAY

“History is the version of past events that people have decided to agree upon.” -Napoleon Bonaparte

STAT OF THE DAY

Apple profit rises 24% on iPhone sales. 


BYI DELIVERS AMID THE HYPE

Takeaway: BYI delivers a beat in the face of high expectations and a challenging competitive and macro environment.

BYI DELIVERS AMID THE HYPE

 

Bally’s performance this quarter earned some stripes in justifying its premium group multiple.  Despite the higher bar set for the Company and challenging macro and competitive environment, they still managed to beat expectations.  Gross margins for all segments in of their business were better than we projected, and we were a cent ahead of the Street in terms of EPS.  Also encouraging was the continued buyback activity in the quarter and the re-upping of the buyback authorization.  Raising guidance was the clincher.

 

The biggest upside surprise in the quarter for us came from gaming operations.  We expected good growth in the Q due to strong WAP placements but actual results beat our number by 3%.  Margins were a little weaker than expected, but that did not impact EPS, as BYI benefited from the WAP link in NJ.  The results were particularly impressive given the reclassification of some low yielding centrally determined games into systems.  Assuming that Michael Jackson and Grease continue to perform well, gaming operations is poised to easily exceed $400MM in FY13.

 

Gaming equipment sales also beat our estimate by 5%, but the beat was due to earlier than expected shipments of VLTs to the Atlantic Lottery Corporate and the sale of 175 VGTs into IL which we didn’t expect to hit until next quarter.  We estimate that the VLT and VGT units boosted revenues by $11MM and EPS by $0.07-$0.08 this quarter.  However, SG&A was also likely boosted due to the sales commission component of that number.  Therefore the net affect was likely a lot lower. The one glaring negative in the quarter were international sales which are likely to continue to disappoint in the near future.

 

Systems revenue, while in-line with our estimate, generated better than expected margins.  Given the pending pickup in new system installs, which carry lower margins, we’re not going to get too excited about the high margin in the quarter.  However, as iVIEW DM continues to make traction and as more applications like NASCAR progress, margins should lift over time.  Top-line would have actually missed our number if not for the reclassification of certain centrally determined games.  To be honest, we’ve been asking BYI’s for years why those units weren’t in systems to begin with since that’s there they belong.

 

Given the results posted this quarter, the continued momentum of BYI’s WAP games, anticipation of NASCAR, continued improvement in replacement cycle, and the final opening of the VGT market in IL, coupled with visibility on their systems business, we believe that the stock can continue to work in the near-term. 


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