“A fool thinks himself to be wise, but a wise man knows himself to be a fool.”
Depending on your political affiliation this morning, last night was either a Shakespearean tragedy or a Shakespearean comedy. Republicans are obviously sad and Democrats are clearly quite happy. But, did anyone really win? The President was re-elected with a very small margin and Congress remains in gridlock with a Republican House and Democratic Senate.
We went into this election launching our Hedgeye Election Indicator (HEI), which attempted to assign a probability to the President getting re-elected based on real time market prices. In our Q4 themes presentation, we then flagged that all the consensus polls were pointing against Romney. The key discrepancies we saw to this consensus were the potential for a relatively higher turnout for Republicans and an economy that, based on historical standards, should not have led to a re-election for the incumbent. In the end, neither Republican turnout nor the economy mattered as much as we expected.
When the political scientists write the story of this election, it will likely come down to a few failures by the Republicans. First, they didn’t make the economic case strongly or clearly enough against Obama. Second, a number of demographic groups turned sharply against the GOP, namely women.
Obama, on the other hand, did a few things very effectively. His re-election team consistently painted Romney as unfit to be President and the characterization largely stuck -- or at least stuck enough to matter on Election Day. More importantly, Obama implemented a number of policies that aided him. Indirectly loose monetary policy aided the stock market and inflated some asset classes, which as we show in the Chart of the Day of the Hedgeye Election Indicator aided his re-election chances. The second key policy was the auto bailout, which mattered disproportionately in the key battleground states.
But now the election is behind us. To the victors go the spoils, or at least the gloating tweets and Facebook status updates, and to the stock market operators comes another day of playing the game in front of us. Some questions to consider as a result of this election are as follows:
1) How will the Fiscal Cliff ultimately play out? The timing on this step up in taxes and step down in government spending is January and no resolution is imminent.
2) Will the Republicans hold the economy hostage over the debt ceiling again? Based on our analysis, the U.S. is slated to hit the debt ceiling again in early 2013. With less of a mandate for Obama, it’s unlikely the Republicans in Congress acquiesce on this.
3) Who will replace Treasury Secretary Tim Geithner? We’ve made our stance clear on Geithner, we aren’t big fans. But based on the proverbial writing on the wall, he is on his way out and who takes his spot is very much an open ended question.
4) What will Obama’s economic policy look like in 2013 and beyond? Regardless of your partisan affiliation, you must admit this was and is a very tepid recovery. Early in his first term, the President will have pressure to do more to stimulate. How will he juxtapose this with the need to cut government spending?
5) Is this Chairman Bernanke’s last term? On some level this is irrelevant in the short term as his term doesn’t end until January 2014, so we should expect to see absurdly loose monetary policy until at least then. As always though, markets will price in a new Fed Chairman before it happens, so determining Bernanke’s replacement will be key to thinking about the future of monetary policy.
We will be digging into these questions and more this morning at 11:00am with Neil Barofsky, the former Inspector General of the Troubled Asset Relief Fund. By his own admission, Barofsky is a life-long Democrat and as a former senior official in the Treasury Department will have some keen insight into the future of policy in the Obama administration. We will be circulating dial-in information to our Macro subscribers this morning and if you are not a Macro subscriber but would like to trial the product, ping .
One of our favorite quotes from Barofsky, who wrote “Bailout: An Inside Account of How Washington Abandoned Main Street While Rescuing Wall Street”, is the following:
“We need to convince those seeking or trying to retain power that they will not get our votes unless and until they commit to meaningful change of our financial system.”
Regardless of the specific policy path, it is hard not to agree with that quote.
In terms of your portfolios, the biggest immediate term factor to focus on is the U.S. dollar. As long as Chairman Bernanke is leading the Federal Reserve, monetary policy will remain implicitly dovish. This is and remains bearish for the U.S. dollar. Conversely, this is positive for those asset classes that are inversely correlated to the dollar. Chief among these is gold, which currently has a high 90-day inverse correlation to the dollar.
Dollar down and commodities up, sound familiar? As Yogi Berra famously said, “It’s déjà vu all over again.” Unfortunately for corporations and the stock markets, dollar down means increased input costs and earnings headwinds.
As my colleague Darius Dale highlighted yesterday, for the 3Q12 earnings season to-date, 59.8% of S&P 500 companies have missed on the top line and 28.7% have missed on the bottom line (388 total). That compares with 57.8% and 26.8%, respectively, in 2Q12. Similar to the political landscape, we would expect more of the same in terms of our Q4 theme of #EarningSlowing.
Our immediate-term risk range for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1, $108.46-111.44, $3.46-3.53, $80.24-80.85, $1.27-1.29, 1.67-1.75%, and 1, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
This note was originally published at 8am on October 24, 2012 for Hedgeye subscribers.
“A tie is like kissing your sister.”
How about if America woke up on November 7th and “269 – 269” was the headline on the front of major newspapers? The implication would be that the Electoral College was effectively tied. This is actually a somewhat plausible scenario in 2012. It could occur with Obama winning all of Kerry’s states from 2004 and adding New Mexico and Ohio. Currently, both New Mexico and Ohio, albeit marginally, are in the Obama camp.
In the event of an Electoral College tie, the decision gets handed to the House of Representatives. Given that the Republicans hold a majority in the House, Romney would then become the next President. Just as many moderates think that the Tea Party has hijacked the Republican Party, they would now be arguably the key reason that the Republicans gained the Presidency. After all, if it weren’t for the Tea Party insurgency (for lack of a better word) in the midterms, the Republicans would likely not currently control the House.
Regardless of whether you believe my 269 scenario, it is beyond argument that this race is getting too close to call. The averages of the major national polls are basically within 0.5 points, favorability ratings of the candidates are basically tied, and neither candidate has a definite edge in the Electoral College.
There are some credible outliers related to predicting the outcome of the election. One of these is Professor Ken Bickers from the University of Colorado. He has done an analysis that looks at state level economics as a predictor for the Electoral College. Currently, his analysis suggests that Romney and Ryan may win up to 330 seats.
We will be joined by Professor Bickers today at 1pm today for a conference call to discuss his analysis. For institutional macro subscribers, the materials and dial-in will be circulated this morning. If you are not an institutional macro subscriber, ping email@example.com to inquire about access.
Politics matters as it relates to future economic policy, so we have been and will continue to focus closely on this election. In fact, we would postulate that some of the stock market weakness over the last few days, though largely driven by #EarningsSlowing, is being amplified by increasing uncertainty in political outcomes in the United States.
Globally, the bigger concern continues to be tepid economic growth. This morning HSBC’s flash PMI for China came in at 49.1 versus expectations of 47.9. Even if marginally better than expected, the number remains below 50. In Europe the numbers were bleaker as the Eurozone Flash PMI came in at 45.3 versus an estimate of 46.5. The German IFO business climate indicator also disappointed marginally coming in at 100.0 versus expectations of 101.6. Not surprisingly, the Euro is weak and Spanish yields are backing up this morning, as result.
It is a major policy day today in the United States with an announcement coming from the Federal Reserve. The FOMC rate decision will be held at 12:30pm today with a Bernanke press conference at 2:15pm. Even though the stock market basically peaked on the day of the last Fed announcement, it is unlikely that even Chairman Bernanke adds more fuel to the fire at this point. Although if the Fed were to signal they are going to take the money printing press up a gear, that would be the ultimate October surprise. It may even be bigger news than the October surprise that Donald Trump is purportedly going to reveal on Twitter today.
Our friends at Bespoke Investment Group actually did an interesting analysis looking at the return of the stock market on the days of Fed announcements in this period of zero interest rate policy. According to their analysis, the SP500 showed a positive return on 21 out of 31 of those days with an average gain of +0.71.
Even as history is a guidepost, we would suggest that investors are getting much better at front running the Fed. This is actually born out in the numbers as in the last year the return on a Fed day is closer to +0.30. Yes, this is still a positive return, but only marginally so. Today the setup seems more poised to disappoint as Chairman Bernanke will likely not have much new positive news on the economy, and is also unlikely to further ease. But, we’ve been surprised by the Fed before . . .
The broader issue with the Fed’s long-term zero interest rate policy is that extreme levels at which certain asset classes are getting priced. One example is the high yield market. As one high yield investor emailed me yesterday:
“Our basic premise is that there is massive technical support in the search for yield for the broader HY and leverage loan market driving yields to historically tight levels. There is such appetite in the loan market that terms are reverting back to 2007 peak levels…new issue spreads are being compressed and covenants are being pulled (45% of new issue is now ‘cov-lite’ vs. 10% last year). To a large extent this has been driven by the return of the clo…back from the dead…or at least from 2007. CLO issuance will be $40bn this year, which is more than the last 4yrs combined.”
Now we aren’t ready to make a big call on high yield market just yet, but the red flags raised above are well worth pointing out. After all, it’s not a tie if you are long high yield at the top.
Our immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1699-1741, $107.48-110.71, $79.58-80.16, $1.29-1.31, 1.71-1.82%, and 1409-1426, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
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Today, we shorted Weight Watchers International (WTW) at $55.82 a share at 11:55 AM EDT in our Real Time Alerts. With the stock trending lower over the past week, we saw an opportunity to short it on green. The company recently lowered guidance and put the blame on Superstorm Sandy as well as investment costs. We think there's more to the story as the stock fails to trade above its TAIL risk line.
"We need to convince those seeking or trying to retain power that they will not get our votes unless and until they commit to meaningful change of [our] financial system."
The Hedgeye Macro Team lead by, CEO Keith McCullough, and DOR Daryl Jones, will be hosting an Expert Conference Call with Neil Barofsky, the former Inspector General of the Troubled Asset Relief Fund (TARP). The call will be held Wednesday, November 7th at 11:00am EST, following the Presidential Election to determine the future path of fiscal, monetary and economic policy.
Barofsky is extremely familiar with the inner workings of Washington; in late 2008 he was appointed to oversee the Treasury Department's administration of the $700 billion Wall Street/TARP bailout where he remained until his resignation in February 2012. He has become known for his relentless criticism of Treasury officials, often highlighting Tim Geithner as a particular problem. Barofsky officiated as an aggressive and outspoken overseer monitoring for waste and fraud. During his time as with the U.S. Treasury more than $550 million in fraud losses were avoided and $150 million fraudulent earnings were recovered for taxpayers. Given his experience and knowledge of the treasury it will be invaluable to hear his brutally honest thoughts on the outcome of the election and his insider's perspective on how it will economically effect our country moving forward.
- Toll Free Number:
- Direct Dial Number:
- Conference Code: 345918#
Takeaway: Energy: Fuel shortage won't last long. Industrials: Near great Express & Courier entry point. Retail: Discounted goods and lower earnings.
"AFTERMATH OF HURRICANE SANDY”
Hedgeye Internal Dialogue
ENERGY: Refined Product Shortage Will Not Last Long
Takeaway: The refining, distribution, and marketing of refined product in the greater NYC metro area is clearly the segment of the energy industry most impacted by Sandy. We suspect that this “shortage” will not last much longer.
The area was ill-prepared for such a disaster. Gasoline and distillate inventories in the Atlantic Districts and New England were at the lowest level in five years heading into the storm. There are a few key reasons for this:
- Refined product demand remains weak across the entire U.S. When demand is weak, there is less chance of a “demand shock,” therefore less need to hold product in inventory.
- Futures curves are backwardated (higher prices today than in the future), dis-incentivizing storage.
- Refined product production is low in the Northeast because of poor refining margins (high Brent price, weak demand for products, excess capacity). Indeed, several Northeast refineries have closed or are running at reduced rates due to profitability issues over the last two years.
The pre-Sandy inventory figures were 48MM bbls of gasoline and 39MM bbls of diesel in the Northeast. Compare this to 3.1 MM bbls/d of demand for gasoline (15.5 days of supply) and 1.2 MM bbls/d of demand for diesel (32.5 days of supply).
The waive of the Jones Act (only U.S. flagged ships can move refined product from U.S. port to U.S. port) allows ships to take product inventory from the U.S. Gulf Coast and move it up to the New York area. At least two companies are in the process of doing that.
There is little risk of a gasoline shortage, in our view. With 15 days of inventory, refineries already coming back online and increased shipments from the Gulf via pipeline and tanker, there will be enough gasoline to support demand in the Northeast market.
The issue is that so many gas stations were without power last week (more than 50%), that the ones that had power were jammed and ran out of fuel. Now, nearly 100% of stations have power, and the ones that never lost power are waiting on the new supplies. That should come quickly. We suspect that this “shortage” will not last much longer.
INDUSTRIALS: Airfreight/Express & Courier Services Entry Point
Takeaway: We believe we are looking at a really good entry point for airfreight/express & courier services – particularly FDX.
There have been 4 huge headwinds:
- Inventories have been building
- Global trade has fallen over the past couple of quarters
- Capacity in airfreight has just started to tighten after years of slack
- Containership prices have increased relative to airfreight since 1Q after years of lost pricing.
Those have depressed margins and understated profitability and may be turning. A port disruption would be icing on that last point’s cake on relative pricing.
An estimate shows that each day of transit costs 0.6% - 2.3% of the cargo’s value in what is essentially a transport tax (lost selling days, spoilage, lost design time etc). This is an interesting data point, even if it’s only a few days of lost cargo activity, it still matters. Therefore, weeks of disruption could matter significantly. Since air cargo is basically always only at +/-50% capacity utilization, there could be some switching of more critical cargo into that transport channel. It certainly has the capacity and reliability.
People claim that improved service levels have driven air cargo to boats, we think it’s mostly that the price differential blew out. The opposite was true around 2004, when everyone figured air cargo was a huge growth business. That was relative pricing, too and largely unrelated to service. The price swings are huge over time. See the chart below from our pending Express & Courier Services Black Book (for access to this call email ).
RETAIL: Sandy Destruction; Longer Term Impact
Takeaway: Reality is going to be more discounted goods, lower earnings and less cash flow. We particularly don't like the department stores in this context (M, KSS, JCP, and we'd throw GPS in there as well).
If anyone out there thinks that Sandy will not have a meaningful impact beyond a couple of weeks worth of disruption in consumer purchasing behavior, then think again. The chart below shows the absolute containerized imports into the US for apparel and footwear products over the past two years.
Number of Twenty-Foot Equivalent Units (TEUs) Imported Into The U.S.
The data is through November 2, and the drop is startling.
The reality is that we cannot simply expect the ships to dock, unload their wares, and then the retailers are off to the races.
- The Longshoremen (already near the full capacity their strict work rules allow) will have to unload the excess containers, and then the (largely unionized) drayage drivers will need to take to either the railyard or to the hub and spoke system for an LTL trucking company (also likely unionized)
- Then the goods get unpacked, repackaged, and shipped off around the country
- It wouldn't be a problem if we were operating previously at less than 50% productivity, because then all we'd need to do is get people to work harder
- But productivity is closer to 80%, which leaves little room catching up on lost work
A simple one or two week delay in shipment could snowball into a 3-4 week delay in when product hits the shelves. This is an extremely critical period logistically for the holiday shopping season. Sandy had very bad timing.
This is when 'just in time' inventory management comes back to bite U.S. businesses. Retailers will do a great job of playing the blame game on the storm. But the reality is going to be more discounted goods, lower earnings and less cash flow. We particularly don't like the department stores in this context (M, KSS, JCP, and we'd throw GPS in there as well).
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