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Trade Of The Day: FXE

Today we shorted the CurrencyShares Euro Trust ETF (FXE) at $127.13 a share at 3:12 PM EDT in our Real Time Alerts. We'll continue to short the Euro when our levels and methods say we should; today was a day where we felt comfortable doing so. The Euro remains in bearish TREND formation while the US dollar bullish formation remains in tact.

 

Trade Of The Day: FXE - image001


Who is Lew?

Takeaway: Lew is most likely to replace Geithner at Treasury, which is an improvement, but will likely lead to a continuation of weak dollar policy.

President Obama kicked off negotiations on the fiscal cliff last week before heading to Asia for his first international trip since his re-election.  Interestingly, Obama indirectly made Tim Geithner, outgoing Secretary of the Treasury, as the administration’s lead negotiator.  This is somewhat surprising as it appears to displace Jack Lew, White House Chief of Staff, in his role from the prior negotiations.

 

There are likely a couple of reasons for Geither to take more of a lead role.  Firstly, Geithner has close ties to Wall Street given his time as the President of the Federal Reserve Bank of New York, so may help settle the markets (or so the argument goes).  Secondly, according to various accounts, including from Bob Woodward’s “The Price of Politics”, Lew developed an adversarial relationship with Republicans in the first round of negotiations.  Finally, and perhaps most importantly, this may well be a signal that Lew is focused on preparing for his next role as Secretary of Treasury.

 

The role of Secretary of the Treasury is defined on the Treasury department website as follows:

 

“The Secretary of the Treasury is the principal economic advisor to the President and plays a critical role in policy-making by bringing an economic and government financial policy perspective to issues facing the government. The Secretary is responsible for formulating and recommending domestic and international financial, economic, and tax policy, participating in the formulation of broad fiscal policies that have general significance for the economy, and managing the public debt.”

 

In effect, the Secretary of the Treasury manages the finances of the United States.  More importantly, as Chairman Bernanke has recently noted, the Treasury Secretary is the key spokesman on the U.S. dollar.  So assuming the rumor mill is on the correct track, and anecdotal evidence suggests it is, who is Jack Lew?

 

On an education level, Jack Lew bears a pretty similar resemblance to his predecessors at Treasury with an undergraduate degree from Harvard and law degree from Georgetown.   Conversely, unlike recent Secretaries, Geithner, Paulson, Snow and O’Neill as examples, Jack Lew is not a former prominent CEO and does not have, at least currently, the same kind of star power.  In fact, Lew has spent most of career as a numbers and operations guy within the beltway.  As Lew’s former roommate Ari Weiss noted in a National Journal article when describing one of Lew’s first jobs working as an Aid to former Speaker of the House Tip O’Neill:

 

“Budgets are places with details. Inescapably, you can’t put a budget together on slogans. It appealed to Jack and his nature and his talents because it is something that is essential.”

 

Thus, very quickly Lew’s government career became focused on the budget and he would go on to have two tours of duty as the Director of the Office of Management and Budget. The first was as President Clinton’s last OMB Director from May 1998 to January 2001.  He then succeeded former Hedgeye guest speaker Peter Orzag as President Obama’s Director of the OMB from November 2010 to January 2012.  In between these roles, Lew was the Executive Vice President of Operations at New York University and also took a spin on Wall Street as the Chief Operating Officer at Citigroup’s now defunct Alternative Investments unit.   

 

As it relates to his candidacy for Treasury Secretary, there are a few things we like about Lew:

  1. Budget knowledge – There is no question that Lew understands the federal budget and its levers better than almost anyone in Washington, if not the nation.  He has led the OMB twice and before that was a key staffer at OMB.  He understands the long term deficit issues facing the U.S., which will be critical for any incoming Treasury Secretary.
  2. Clinton era tenure – The last time the U.S. federal budget was balanced was under President Clinton, with the Balanced Budget Act of 1997 being a catalyst.  Prior to leaving for his first tour at OMB, Lew coordinated the Clinton administration’s budget and appropriations strategies.  He was also a member of the negotiating team that put together the aforementioned Balanced Budget Act by working across party lines.  In the chart below, we highlight the budget surpluses while Lew was in his role as Director of OMB.                                                               Who is Lew? - 1
  3. Not an attention seeker – Almost to a fault, Lew is known as someone who attempts to stay out of the lime light.  By most accounts, his life is balanced by work, family and faith (he is an Orthodox Jew).  He is certainly lower profile versus many of his predecessors and has a history of largely not commenting in, or on, articles that are written about him or related government negotiations.

 

By and large the attributes outlined about bode well in describing a potential Treasury Secretary that will be focused on the correct issues relating to reducing the deficit, and in turn advocating for a strong dollar. Unfortunately, there are a number of countervailing pots to consider as well, specifically:

 

  1. Long time Washington insider – Lew is what he is - a long term Washington insider. On our recent call with Neil Barofksy, a gentleman who was brought in from the outside to run TARP, he made his thoughts pretty clear on the idea that it would be difficult to change the Treasury from the inside and Lew is certainly an insider choice.
  2.  Policy continuity seems likely – On many levels, Lew is a choice that best conveys continuation of prior policy.  He’s been a mainstay in the Obama administration and is certainly not representative of a new voice, or new set of ideas.  On one hand, this will create stability, which is important for the financial markets.  On the other hand, it will also signal to the markets a continuation of a Treasury Department that is not going to adequately defend the U.S. dollar.
  3. Naïve related to markets – In his confirmation hearing to be President Obama’s Director of OMB, Lew was asked by Senator Sanders as to whether he thought de-regulation played a critical role in the to the collapse on Wall Street.  His response was as follows:

“Senator, I don’t consider myself an expert in some of these aspects of the financial industry. My experience in the financial industry has been as a manager, not as an investment adviser. My sense, as someone who has generally been familiar with these trends, is that the problems in the financial industry preceded deregulation.”

 

The primary concern with the statement above, and admittedly it is a cherry picked statement, is that it implies a somewhat superfluous understanding of Wall Street and the banking industry. 

 

We think that Lew has an experiential history that suggests that he may be a more effective Treasury Secretary than Tim Geithner.  That reality is, though, Washington, DC is rarely changed from the inside. 

 

 

 

Daryl G. Jones

Director of Research

 

 


European Banking Monitor: Risk Returns with Recession Print

Takeaway: Bank swaps widen alongside the Eurozone’s official push into recession.

Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor".  If you'd like to receive the work of the Financials team or request a trial please email .

 

Key Takeaways:


*European Bank CDS: The Eurozone officially moved into recession last week. Preliminary Q3 GDP contracted by 0.1% QoQ following a 0.2% contraction in Q2. In response, EU bank swaps widened WoW on concern around deteriorating fundamentals in Europe. Despite Draghi's pledge to do "Whatever It Takes", it seems that risk is creeping back into the markets. Along with swaps widening at the bank and sovereign levels, both Euribor-OIS and the TED spread have stopped their march downward and are now slowly pushing higher. For reference, this is the third consecutive week that the Euribor-OIS has risen WoW.   

  

On OMTs Reporting: The ECB has stated that Aggregate Outright Monetary Transaction holdings and their market values will be published on a weekly basis and the average duration of Outright Monetary Transaction holdings and the breakdown by country will take place on a monthly basis. There is no indication that the OMTs has been initiated to date.

 

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If you’d like to discuss recent developments in Europe, from the political to financial to social, please let me know and we can set up a call.

 

Matthew Hedrick

Senior Analyst

 

(o)

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European Financials CDS Monitor French banks continue to widen on the news that Europe is officially back in recession. BNP and Credit Agricole were wider WoW, bringing their MoM changes to +44 and +35 bps.  Soc Gen was flat WoW, but is up a similar +42 bps MoM. Italian banks are also notably wider MoM.

 

European Banking Monitor: Risk Returns with Recession Print - 22. banks

 

Euribor-OIS spread – The Euribor-OIS spread widened by less than a basis point to 12 bps. This series has been moving essentially sideways for the last month. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. 

 

European Banking Monitor: Risk Returns with Recession Print - 22. Euribor

 

ECB Liquidity Recourse to the Deposit Facility – In a positive sign for the stability of the EU Banking System, the ECB Liquidity Deposits continued to decline in the latest week. The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB.  Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system.  An increase in this metric shows that banks are borrowing from the ECB.  In other words, the deposit facility measures one element of the ECB response to the crisis.  

 

European Banking Monitor: Risk Returns with Recession Print - 22. facility


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Commodities Vs The Dollar

Our adage of "if you get the US dollar right, you get a lot of other things right" rings true today. With the US dollar up for 8 out of the last 9 weeks, commodities have had a rough ride. September was a particularly hard month as the CRB Commodities Index trailed lower as the dollar gained strength.

 

Commodities Vs The Dollar - image001


EARNINGS SLOWING UPDATE: HOPE SPRINGS ETERNAL

Takeaway: Relative to the latest reported data, the macroeconomic outlook and mico-level trends, NTM EPS estimates remain dramatically inflated.

SUMMARY BULLETS:

 

  • Roughly 96% of the way through the Q3 earnings season, 58.7% of S&P 500 companies have missed on the top line and 30.7% have missed on the bottom line (478 total). That compares with 57.8% and 26.8%, respectively, in 2Q12. If the season wraps up as things currently stand, 3Q12 will have reported the lowest percentage of companies beating on the top line since 1Q09.
  • 72% of companies that have issued 4Q12 EPS guidance have issued projections below the mean EPS estimate. That compares with a ratio of 80% on the negative side at this time during the previous earnings season. Despite this improvement, we continue to warn that consensus estimates for 4Q12 and 2013 remain dramatically inflated relative to any reasonable economic GROWTH scenario.
  • Bloomberg consensus still has S&P 500 constituent EPS growing an average of +7.1% YoY per quarter over the NTM vs. +0.9% YoY in 3Q12 and a trailing four quarter average of +3.1% YoY. While down from a projected quarterly average NTM EPS growth rate of +9.9% YoY when we first called out consensus’ poor modeling technique back on OCT 8, we still contend these estimates remain out to lunch with respect to any reasonably objective estimate of future corporate profit growth stemming from Bayesian logic.
  • One of the biggest proactively predictable fundamental risks to EPS growth we continue to see domestically is corporate cost cutting. Already, we’ve seen business investment contract at a -1.3% seasonally-adjusted annualized rate in 3Q12, the first sequential decline since 1Q11. Per a recent WSJ report, half of the 40 largest publically traded companies have announced plans to “curtail capital expenditures this year or next”.  
  • Equity bulls remain hopeful that this round of EPS engineering is more akin to the early 2004 and early 2011 slowdowns, rather than the early 2001 and early 2008 CapEx slowdowns, which brought forth the last two major declines the corporate profit cycle.  

 

WHERE WE STAND

Roughly 96% of the way through the Q3 earnings season, 58.7% of S&P 500 companies have missed on the top line and 30.7% have missed on the bottom line (478 total). That compares with 57.8% and 26.8%, respectively, in 2Q12. If the season wraps up as things currently stand, 3Q12 will have reported the lowest percentage of companies beating on the top line since 1Q09.

 

From a growth rate perspective, S&P 500 constituent revenue growth slowed to +2.2% YoY in 3Q12 on a median basis from +2.7% YoY in 2Q12. S&P 500 constituent operating margin growth accelerated to +16bps YoY in 3Q12 from +2bps YoY on a median basis. From a forward-looking perspective, S&P 500 constituent sales growth is projected to average +4.1% YoY on a median basis, per quarter, over the NTM, while operating margins are projected to expand an average of +97bps on a median basis, per quarter, over the NTM. Both growth rates suggest marked accelerations from the latest trends over the intermediate term.

 

EARNINGS SLOWING UPDATE: HOPE SPRINGS ETERNAL - SPX Revenues

 

EARNINGS SLOWING UPDATE: HOPE SPRINGS ETERNAL - SPX Margins

 

WHERE WE’RE HEADED

Continuing our peak into the future, 72% of companies that have issued 4Q12 EPS guidance have issued projections below the mean EPS estimate. That compares with a ratio of 80% on the negative side at this time during the previous earnings season. Despite this improvement, we continue to warn that consensus estimates for 4Q12 and 2013 remain dramatically inflated relative to any reasonable economic GROWTH scenario.

 

Bloomberg consensus still has S&P 500 constituent EPS growing an average of +7.1% YoY per quarter over the NTM vs. +0.9% YoY in 3Q12 and a trailing four quarter average of +3.1% YoY. While down from a projected quarterly average NTM EPS growth rate of +9.9% YoY when we first called out consensus’ poor modeling technique back on OCT 8, we still contend these estimates remain out to lunch with respect to any reasonably objective estimate of future corporate profit growth stemming from Bayesian logic.

 

EARNINGS SLOWING UPDATE: HOPE SPRINGS ETERNAL - 3

 

Shockingly, Bloomberg consensus is not out to lunch with their US and Global GROWTH estimates for 2013; this strongly supports our belief that bottom-up analysts are uniformly praying for a dramatic acceleration in stock buybacks, M&A and USD debauchery.

 

EARNINGS SLOWING UPDATE: HOPE SPRINGS ETERNAL - 4

 

Not that gaming sell side analysts is a new strategy, but we must never forget that the sell side is paid to hope now and blame macro later when it comes to modeling bottom up estimates. Conversely, we will continue to use a rigorous top-down approach to front-run proactively predictable fundamental risks.

 

One of the biggest proactively predictable fundamental risks to EPS growth we continue to see domestically is corporate cost cutting. Already, we’ve seen business investment contract at a -1.3% seasonally-adjusted annualized rate in 3Q12, the first sequential decline since 1Q11. Per a recent WSJ report, half of the 40 largest publically traded companies have announced plans to “curtail capital expenditures this year or next”.  Equity bulls remain hopeful that this round of EPS engineering is more akin to the early 2004 and early 2011 slowdowns, rather than the early 2001 and early 2008 CapEx slowdowns, which brought forth the last two major declines the corporate profit cycle.  

 

EARNINGS SLOWING UPDATE: HOPE SPRINGS ETERNAL - 5

 

This we know: corporate profits are, in fact, cyclical. We also know that corporate margins have been asymmetrically stretched to all-time peaks. The latter suggests to us that any further “improvements in corporate efficiency” are heavily skewed towards being a drag on future top line growth for the cost-cutting company, as well as a contemporary drag on top line growth for companies in the respective supply chain(s). As we’ve remarked in recent notes: broader economic growth suffers when corporate executives shift their focus en masse to playing “pin the tail on the EPS estimate” by embarking on aggressive cost-cutting strategies to appease shareholders (many of whom happen to be corporate executives themselves).

 

EARNINGS SLOWING UPDATE: HOPE SPRINGS ETERNAL - 6

 

EARNINGS SLOWING UPDATE: HOPE SPRINGS ETERNAL - 7

 

In the absence of robust top line growth, we submit that corporate executives can and will continue to pull various levers to get themselves and other shareholders paid. The risk, however, is that their micro-level tactics risk perpetuating a global economic slowdown initially brought on by a bleak macro environment and outlook. Keep that in mind when you press management teams on how they plan to “hit the numbers” over the intermediate term.

 

WHERE WE’VE BEEN

This is the third installment of our analysis of the 3Q12 earnings season. Please see below for the previous reports, as well as our initial #EarningsSlowing presentation as introduced as part of our 4Q12 Macro Themes:

 

  • OCT 8: Hedgeye’s Q4 Macro Themes Presentation
    • #EarningsSlowing - Corporate margins are stretched on numerous metrics. Even with financial engineering we suggest there's limited upside in the results from here.  We expect the gravity of global growth slowing and inflation accelerating to impact consumer and corporate P&Ls alike.
    • Bubble #3 - Following the tech and housing bubbles, the charts of Bernanke's Commodity Bubble could not be more crystal clear. So when does this bubble pop?  We'll continue to take our cues from the U.S. Dollar and weigh the influence of policy and fundamentals across the complex.
    • Keynesian Cliff - We wrap together an analysis of the U.S. Presidential  race with the nearing US fiscal  cliff. We discuss the impact of investors potentially shifting their attention away from  Europe and back to the U.S.'s ugly imbalances.
  • OCT 10: #EARNINGS SLOWING UPDATE: IS CORPORATE COST-CUTTING COMING BACK WITH A VENGEANCE?
    • As we have stressed in recent weeks, the 3Q12 earnings season will likely be the most dour since the Global Financial Crisis and, perhaps more importantly, consensus estimates for NTM EPS growth are simply too rich – particularly in light of aggressive margin assumptions embedded in consensus expectations.
    • As such, the direction and tone of corporate guidance will likely be as important to stock performance as it has ever been in the post-crisis period. In this regard, the next few months will definitely be a stock-picker’s environment for those seeking to meet year-end performance targets.
    • As we highlighted in recent notes, a key risk that could equate to an incremental drag on global growth over the intermediate term is an acceleration of corporate cost-cutting initiatives across both domestic and international corporations. Moreover, recent company commentary suggests this trend is already underway.
  • NOV 5: A QUICK PEAK UNDERNEATH THE HOOD OF THE US EQUITY MARKET
    • Roughly 80% though earnings season, it’s clear to see that 3Q12 has shaped up exactly as we had laid out in our #EarningsSlowing theme: very bad.
    • Consensus remains out to lunch with their forward revenue, operating margin and EPS growth estimates. When you combine the negative trend in corporate guidance with the potentially-precarious Global Macro setup (potential US recession; no Chinese stimulus; Europe continues to contract), it’s easy to anticipate a scenario whereby those estimates have to be revised down hard and fast at some point over the intermediate term.
    • Aggressive estimates for operating margin expansion puts a great deal of pressure on corporate management teams to accelerate material cost-cutting initiatives like we’ve seen at UBS, DOW, AMD, RIO, FDX and CMI (to name a few). While that may appear good for a single company’s earnings outlook in the short term, the reality is that when corporations are engaged in cost-cutting en masse, GDP growth tends to slow materially; this perpetuates top line weakness across the corporate sector in a reflexive manner.

 

Darius Dale

Senior Analyst


Getting To Know JACK

Last week, Hedgeye held its bi-annual Best Ideas call for institutional clients. On the call, we discussed our top ideas from each sector that we cover. We’re presenting each idea in a series of videos starting today with Restaurants Sector Head Howard Penney’s bullish call on Jack In The Box (JACK).

 

It’s important to note that Penney cautions against running out and buying JACK before they report on November 20. The company has several characteristics that make it attractive including stable cash flow and growth opportunity in the form of Qdoba. Jack In The Box remains the company’s mature concept while Qdoba has significant growth ahead of it. JACK also has upgraded its core asset base so capital expenditures are declining and behind the company going forward.

 

Watch the video we’ve posted for Penney’s full take on Jack In The Box.

 


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