“You want a prediction about the weather? You’re asking the wrong Phil. I’ll give you a winter prediction: It’s gonna be cold, it’s gonna be grey, and it’s gonna last you for the rest of your life.”
-From the film Groundhog Day
I used the quote from Groundhog Day because as an analyst covering Europe the political and economic developments of the region continue to repeat and there appears no simple solution to solving its ails – headline risk is here to stay.
If Greece headlined the film by taking its first bailout in May of 2010, it was quickly joined by the peripheral actors of Portugal, Spain, Italy, and Ireland – and each and every time the scene repeated: a crisis deepened, Eurocrats (European politicians) responded by calling a summit, announced a solution, the solution did not have “teeth” or didn’t work, and risk expectations shifted as the movie played on.
Monday’s Greek aid deal is part of the same film. The main tenants of the “deal” include a payment of its next bailout tranches (€43.7B); approval to reduce its debt as a percentage of GDP to 124% by 2020 (versus estimates of 190% in 2013); both a reduction in interest rates on loans and extension in loan maturities and interest payments (by as much as 15 years!); a pass-along of €7B from profits on ECB Greek debt holdings to Greece; and a potential (undetermined) debt-buyback scheme.
Yet what’s most unsettling is that market participants recognize this deal for what it is: a shell game. After all there’s no prospect of this being the last bailout or concession thrown Greece’s way.
But can Eurocrats get away with playing the game? And where is the region politically and economically going now that it officially slipped into recession, with Eurozone GDP declining -0.1% in Q3 quarter-over-quarter following a -0.2% contraction in Q2? Here are some assumptions we’re working under:
- Eurocrats will do everything in their power to maintain their own job security and therefore will continue to support the region monetarily
- There’s nothing in the main constitutional treaties to allow a member state to exit the Eurozone or be expelled. Therefore we do not expect Greece et al to leave or be forced out over the next 1-3 years
- When it comes to ‘hard’ decisions or impasses, Eurocrats will chose the path of least resistance (a strong argument for keeping the region together remains the fear of a breakup), which should prolong a return to growth
- Fiscal consolidation (austerity) is needed across much of the periphery; governments have recently taken the flawed stance that they need to take their foot of the gas. Instead what’s needed is more manageable consolidation expectations and strategy to reform labor markets to improve growth prospects
- A Eurozone governed only by monetary policy is not feasible for long-term sustainability
- The path to a Fiscal Union is littered with challenges given the inability of states to relinquish their sovereignty to a European commission
- Fellow member states represent the largest trading partners for most states, therefore no one state will see a major inflection in growth until the region collectively improves
- France, the second largest economy in the Eurozone, and once a close political ally to Germany via Merkozy, has inflected alongside the election of the Socialist President Hollande. His 75% tax policy on the rich, among others, will be a headwind as the country’s sovereign debt tips past 90% of GDP and France loses its AAA status. All this bodes poorly for Eurozone bailout structures built around the credit rating of the larger economies and given that France is the second largest contributor behind Germany.
Despite the region’s challenges, one cannot forget ECB President Mario Draghi’s September announcement that “the ECB is ready to do whatever it takes to preserve the euro” via the Outright Monetary Transactions (OMT) program to buy sovereign bonds.
To date the facility has not been triggered, however sadly market operators are left to manage risk around the bubble of Big Government and Central Bank Intervention. It’s this market reality that solidifies our thinking that Eurocrats will do all that is necessary to maintain the Union; has kept the EUR/USD trading in a relatively tight band and eliminated the euro parity crowd; and caused sovereign bond yields to moderate in recent months and new issuance to be priced at lower yields versus previous auctions.
This is all positive but hinges on Draghi suspending economic reality over the long term, and is a mismatch with Eurozone fundamental indicators that continue to move in the wrong direction: PMI Services and Manufacturing figures remain grounded below 50 representing contraction; economic, business, and consumer confidence figures have been down for 7-8 straight months; Retail Sales and Industrial Production remain challenged in the core and bombed out in much of the periphery; and inflation is sticky and above the ECB’s target.
On the downside we’d caution that there is measurable risk still imbedded in Spain (the sovereign) needing a bailout, which could accompany a need for assistance in Italy. Further, a rise in foot power, namely strikes and riots, especially given outsized unemployment rates across the periphery, and push back on austerity could turn both the political and economic tide in the Eurozone.
Remember, just two weeks ago there was the first ever coordinated strike against austerity of 40 unions across 23 countries. In addition, a recent Greek popular poll showed that the anti-bailout Syriza party leading, and regional elections in Catalonia, Spain over the weekend voted in a majority of secessionist parties, all suggesting that there’s risk in reaching a tipping point should we see more concentrated popular push back on government policy and Eurozone membership.
While we don’t expect to see borders shifting in the Eurozone anytime soon, citizens have a way of viewing shell games for what they are: deception.
Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1, $107.94-111.49, $3.45-3.58, $79.95-80.61, $1.28-1.30, 1.56-1.68%, and 1, respectively.
TODAY’S S&P 500 SET-UP – November 29, 2012
As we look at today's setup for the S&P 500, the range is 13 points or 0.28% downside to 1406 and 0.64% upside to 1419.
SECTOR AND GLOBAL PERFORMANCE
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 1.38 from 1.37
MACRO DATA POINTS (Bloomberg Estimates):
- 5:30am: Bank of England’s King issues report on financial stability of Britain’s banking system
- 6am: Fed’s Fisher speaks in Frankfurt
- 8:30am: GDP Q/q, 3Q est. 2.8% (prior 2.0%)
- 8:30am: Personal Consumption, 3Q est. 1.9% (prior 2.0%)
- 8:30am: Initial Jobless Claims, Nov. 24 est. 390k (prior 410k)
- 9am: Fed’s Dudley speaks at Pace University in New York
- 9:45am: Bloomberg Consumer Comfort, Nov. 25 (prior -33.9)
- 10am: Pending Home Sales M/m, Oct. est. 1% (prior 0.3%)
- 10am: Fed’s Gibson testifies on Basel III in Washington
- 10am: Freddie Mac mortgage rates
- 10:30am: EIA natural-gas storage change
- 11am: New York Fed holds economic briefing
- 11am: Kansas City Fed Manf. Activity, Nov. est. -1 (prior -4)
- 11am: Fed to buy $4.25b-$5.25b notes due 2/15/21-11/15/22
- 1pm: U.S. to sell $29b 7Y notes
- House, Senate in session
- Treasury Secretary Tim Geithner meets w/House Speaker John Boehner, House Democratic leader Nancy Pelosi, Senate Majority Leader Harry Reid, Senate Republican leader Mitch McConnell as President Barack Obama presses for deal to avert fiscal cliff
- House Financial Services holds hearing on capital rules proposed by Basel Committee on Banking Supervision, 10am
- Commodity Futures Trading Commission meets to consider clearing requirements under the Commodity Exchange Act, 11am
- Billionaire investor T. Boone Pickens promotes government polices to support natural-gas fueled trucks, at American Trucking Association meeting, 9:30am
- Obama has lunch with Mitt Romney at White House
- Federal Housing Finance Agency will announce new loan limits for coming year for Fannie Mae, Freddie Mac
- House Transportation panel holds hearing on airport passenger security screening, 10am
- Democrats choose leadership for 113th Congress beginning in January. Minority Leader Nancy Pelosi of California, Minority Whip Steny Hoyer of Maryland, Assistant Leader James Clyburn of South Carolina are running unopposed. House Republicans, both parties in Senate already have chosen their leaders
- Senate Environment holds hearing on impact of Hurricane Sandy, 9:30am
WHAT TO WATCH
- Nov. retail sales may gain 2.5% on Black Friday demand
- World economy in best shape since ’11 as investors see rebound
- Con Edison expects to receive subpoena from Moreland Commission on utilities’ responses to Hurricane Sandy
- Citigroup chair Michael O’Neill bought $1m worth of co.’s shares after exit of former CEO Vikram Pandit
- NetJets’s new aircraft orders will avoid another aircraft glut
- LivingSocial said to cut 400 staff positions
- SAC Capital head trader named in Martoma case said to be Phillipp Villhauer
- Danfoss bids $49/share for stake in Sauer-Danfoss it doesn’t already own
- Shuster doesn’t rule out raising U.S. gasoline tax for roads
- Italy borrowing costs fall at 5.5% 2022 bond auction
- Royal Bank of Canada (RY CN) 6am, C$1.26
- Descartes (DSG CN) 6am, $0.15
- Gildan Activewear (GIL CN) 6:33am, $0.80
- Liquidity Services (LQDT) 6:55am, $0.37
- New Jersey Resources (NJR) 7am, $(0.26)
- Tiffany & Co (TIF) 7am, $0.63
- Cracker Barrel Old Country Store (CBRL) 7am, $1.06
- Beacon Roofing Supply (BECN) 7:45am, $0.60
- Kroger (KR) 8:15am, $0.43
- Barnes & Noble (BKS) 8:30am, ($0.04)
- Ship Finance (SFL) 8:45am, $0.32
- Zumiez (ZUMZ) 4pm, $0.48
- CNInsure (CISG) 4pm, NA
- Ulta Salon Cosmetics (ULTA) 4:01pm, $0.56
- Five Below (FIVE) 4:04pm, $0.01
- Splunk (SPLK) 4:05pm, $(0.02)
- Mentor Graphics (MENT) 4:15pm, $0.28
- Omnivision (OVTI) 4:18pm, $0.31
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Gold Rebounds on U.S. Budget Optimism, Record Investor Holdings
- Copper Shortage Seen Extending as China Accelerates: Commodities
- Oil Rises First Time in Four Days on Inventories, U.S. Budget
- Hong Kong Exchanges Wins Approval for $2.2 Billion LME Takeover
- Copper Climbs on China Demand Optimism, U.S. Budget Expectations
- Olam Says Studying All Legal Options as Temasek Keeps Stake
- Soybeans Rise as South America Planting Delays May Drain Stocks
- Rubber Recovers From One-Week Low as Fiscal Cliff Concerns Ease
- Shuster Doesn’t Rule Out Raising U.S. Gasoline Tax for Roads
- Chinese Rubber Imports Surge 16% to 3 Mln Tons in 11 Months
- BP’s U.S. Contract Suspension Seen as ’Black Mark’ Aiding Rivals
- China, EU Comments Suggest Reduced Scope for UN Climate Meeting
- Palladium Seen at $700 After Fibonacci Level: Technical Analysis
- Indonesia Set to Top India as World’s Largest Palm Oil Consumer
The Hedgeye Macro Team
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This note was originally published at 8am on November 15, 2012 for Hedgeye subscribers.
“We can do anything if we do it together.”
-William S. Knudsen, 1938
That’s how great business men and women think. Since its their own capital at risk, they know that the only way to win is through trust, teamwork, and collaboration. Markets didn’t see any of that from President Obama yesterday. Markets have a vote too.
The aforementioned quote comes from the beginning of Chapter 3 in Freedom’s Forge, “The World of Tomorrow.” Pre WWII, Post Depression, was arguably the greatest period of collaboration between competent US Business leaders and Washington in US history. Unfortunately, it took a crisis for politicians to cooperate with credible business sources. Maybe we need another.
From both a global growth and US earnings cycle perspective, this is not the late 1930s. “In 1939, the American steel industry was at its lowest capacity in twenty years” (page71). Today, American corporate profit margins are coming off all-time peaks. If Romney Republicans and Democrats alike are being advised by Neo-Keynesians, don’t expect them to get what I see. They haven’t all year.
Back To the Global Macro Grind…
Setting aside the money printing thing (and investors being forced to chase stocks into their April and September tops), the biggest Global Macro Research call of 2012 has to be Global Growth surprising on the downside.
Since piling more debt-upon-debt-upon-debt structurally impairs long-term economic growth (Reinhart & Rogoff 101), this really shouldn’t have surprised as many economists and strategists as it did.
Like Americans of the late 1930s, we need to evolved our risk management, modeling, and forecasting processes. We need more doers advising Washington – less talkers. They do not know what they don’t know.
Risk happens fast…
The SP500 snapped our long-term TAIL line of 1364 yesterday and then quickly drew-down another 9 handles to close the day down another -1.4%. From The Bernanke Top, that puts the SP500’s correction at -8.1% (Russell 2000 down -10.5%). That’ll leave a mark.
But what have we learned? How many more times do you want to go through this? Japan has been doing it for 20 years and is now quadrupling-down on the same monetary policy that has not worked.
The Japanese Yen is getting hammered again this morning as the leader of the LDP (Abe) is begging for “unlimited easing” going into Japan’s December 16th election. Don’t blame them – they are doing precisely what Princeton and Yale taught them to do.
So, down Yen = up Dollar… and the Correlation Risk associated with Strong Dollar is on:
- US Dollar up for the 8th of the last 9 weeks (bullish TREND – see Chart of The Day)
- Euro snaps TREND line support of $1.28 (EUR/USD)
- Yen drops back into a Bearish formation at $81.22 (USD/JPY)
I know, I know – I should be whining about the US fiscal cliff this morning. Not. With Italian GDP -2.4% y/y in Q3 and France seeing the fruits of a socialist Hollande vote (going into a recession), do not forget that the rest of the world’s fiscal and monetary risks do not cease to exist. They’re all going off the #KeynesianCliff now.
We all knew this would end badly. So don’t tell me “stocks are cheap” if you use the wrong numbers. You are better than that. Tell me you’ve learned something since the October of 2007 all-time high in US Equities and proactively prepared for this moment.
Across our core risk management durations, here’s why I am more bearish today than I was yesterday:
- CHINA – Shanghai Composite down another -1.3% overnight to a 1 month low (-17.5% since #GrowthSlowing began)
- JAPAN – Nikkei getting whipsawed by Hilsenrath like attempts to scare Equities higher, but remain -13.9% since March
- SOUTH KOREA – KOSPI down another -1.2% overnight almost back to flat YTD remains bearish TREND in our model
- GERMANY – DAX was the last holdout of the European majors; now snapping its 7118 TREND line
- SPAIN – stocks are trying to rally on another “request for bailout” rumor; that’s so Q2; IBEX is bearish TRADE and TREND
- RUSSIA – RTSI continues to crash (down -21.8% from the Global #GrowthSlowing top of March 2012)
- BRAZIL – Bovespa down another -2.1% yesterday, moves back into the red YTD (bearish TAIL remains)
- CANADA – TSX Composite cracked its TREND support of 12,131 this week, down -1.6% yesterday post Obama’s presser
Sure, that’s just a snapshot of globally interconnected risk across the majors of Global Equity markets. But guess what – if you look at what’s happening in Commodities and Currencies, from a volatility perspective, it’s even worse.
We’ve said this for a very long time, and I’ll say it again this morning – the USD arresting a 40-year decline is the most asymmetric risk that can occur, across asset classes, to what you’ve been used to for the last 10 years of your investing life.
Yes, there’s a lot going on. It’s a lot of hard and humbling analytical work to contextualize – which makes it next to impossible if the media and political elite refuse to acknowledge our voices. Rise up, and help us help them understand this together.
Our immediate-term risk ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1714-1748, $108.19-111.10, $3.41-3.47, $80.58-81.33, $1.26-1.28, 1.53-1.68%, and 1346-1364, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Investors love to focus on a single catalyst and this morning's negative New Home Sales number certainly fits the bill. Negativity aside, Hedgeye Financials Sector Head Josh Steiner notes that there are two positive data points that indicate the housing market is improving.
Firstly, household formation rates continue to accelerate, having improved meaningfully since the second quarter of 2011. September and October in particular show improvements worth mentioning; from October 2011 to October 2012 there were 2.192 million new households formed. Household growth tends to be a good economic indicator and while Americans may say they're less confident, the data says otherwise.
Focusing on New Home Sales, new homes sold in October were 368k (seasonally adjusted annual rate), down 0.3% month-over-month versus September's rate of 369k. On a year-over-year basis, October rose 12% versus September's change of 18.6% for the same time period. Over the long-term, new home sales are highly correlated with housing starts with the occasional mismatch. These starts are strong and show improvement in housing despite the New Home Sales number that came out this morning.
Takeaway: Sustained weakness in Chinese construction-related commodity prices are flashing a warning to $CAT investors. Coal & Energy are also a risk.
Bounce, Fail: Real Chinese Steel Rebar Prices Falling Again
- Real Rebar Prices: The Hedgeye Industrials team often finds local commodity price data easier to use than Chinese economic figures. Significant global industrial resources are devoted to supplying China’s fixed asset investment (FAI) boom. Tracking construction-related commodity prices, like domestic rebar prices adjusted for inflation, may provide us with timely information on Chinese activity.
- Negative Indicator for Chinese FAI: Real rebar prices are ~4% below 2009 lows, which is not a good signal for mining capital investment or Chinese construction activity, in our view.
- Currency Relationship: China pegs its currency to the USD and commodity prices are often responsive to currency moves. Chinese rebar prices show a modest negative correlation to the USD Index.
- Residual Suggests Sustained Weakness: Looking at moves in excess of those driven by currency (the residual of the regression to the USD Index), we see cause for concern in the Chinese construction related steel markets. The residual has been below its currency implied value for several months and is rising again.
- CAT Exposed: We believe Caterpillar is exposed to the potential popping of the mining capital investment bubble, which was in large part inflated by Chinese FAI. CAT has acquired mining related businesses and invested in production capacity for mining equipment at what we believe is (roughly) a cycle peak.
- Coal & Energy Capex Additional CAT Concerns: Global adoption of innovative gas extraction techniques may result in long-term weakness in coal mining capital investment. As we wrote on Monday in Overweight Capital Goods? Wrong Question, But Probably Not, growth in energy related capital investment is already elevated (chart courtesy Kevin Kaiser, Hedgeye Energy).
- CAT Risky, In Our View: We continue to think that the downside risks in CAT are not reflected in the current share price.
Jay Van Sciver, CFA
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