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Weekly European Monitor: Cutting Growth

Takeaway: We think GDP estimates are just now getting closer to the pain the region has dragged itself into.

-- For specific questions on anything Europe, please contact me at to set up a call.

 

Asset Class Performance:

  • Equities:  The STOXX Europe 600 closed up +1.2% week-over-week vs +0.9% last week. Top performers:  Greece +3.9%; Portugal +3.4%; Cyprus +3.0%; Finland +2.8%; Russia (MICEX) +2.5%; Netherlands +1.8%; Ireland +1.7%; Ukraine +1.7%; Denmark +1.6%.  Bottom performers:  Hungary -2.6%; Spain -1.1%; Italy -0.7%; Czech Republic -0.4%; Norway -0.3%. [Other: Germany +1.5%; France +1.4%; UK +0.8%].
  • FX:  The EUR/USD is down -0.45% week-over-week vs +0.22% last week.  W/W Divergences:RUB/EUR +0.67%; GBP/EUR +0.62%; NOK/EUR +0.45%; CZK/EUR +0.22%; SEK/EUR +0.17%; DKK/EUR +0.04%; CHF/EUR -0.23%; PLN/EUR -0.40%; RON/EUR -0.40%; HUF/EUR -0.73%.
  • Fixed Income:  The 10YR yield for sovereigns were mostly flat across the region week-on-week, excluding Greece (more below on the Greek bond buyback). Greece declined -175bps to 14.46%. France -9bps to 5.46%, Germany -7bps to 1.30%, and Portugal -6bps to 7.56%. Spain gained +8bps to 2.07% and Italy was flat at 4.53%.

Weekly European Monitor: Cutting Growth - 66. yields

 

 

EUR/USD: Our TRADE range is $1.29 – 1.31 with a TREND resistance of $1.31.

  • Our call - the EUR/USD will trade within our quantitative levels and reflect much of the daily headline risk (from Spain, Greece, and Italy in particular), however ECB President Mario Draghi’s September announcement that “the ECB is ready to do whatever it takes to preserve the euro” and the resolve of Eurocrats to maintain the Union will prevent levels falling anywhere near parity.
  • We believe there is a high likelihood that no significant policy action comes in the remaining weeks of 2012, which could support the band the cross has been trading in over the last weeks.
  • We expect that the ECB and Germans will be at loggerheads over the formation of a Banking Union and Fiscal Union, which should strengthen the lid on the EUR/USD at $1.31.
  • The cross could weaken alongside the ECB showing some willingness to cut the benchmark interest rate: Draghi cited that there was wide discussion [about a rate cut] but the prevailing consensus was to leave rates unchanged when the council met on Thursday.

Weekly European Monitor: Cutting Growth - 66. eurusd

 

Weekly European Monitor: Cutting Growth - 66. cftc

 

 

Cutting Growth:

 

The week’s news-flow was dominated by Greece’s sovereign debt buyback program (more below), however our eyes were drawn to growth forecasts that were greatly cut this week. The revisions came as no great surprise – and signal to us that despite all the market intervention (Draghi “unlimited” OMT), prices will (in time) reflect the underlying health (or lack thereof) of the region.  While Greece may continue to maintain the spotlight, we’re focused on the underlying health of the region; we think estimates are just now getting closer to the pain the region has dragged itself into. Here are the notables:

 

The ECB staff’s Eurozone GDP projections fell for yet another reading for this year and next:

Eurozone 2012 GDP - DEC: -0.6% and -0.4%   SEPT: -0.6% and -0.2%   JUN: -0.5% and +0.3%

Eurozone 2013 GDP - DEC: -0.9% and +0.3%  SEPT: -0.4% and +1.4%   JUN:  0.0% and +2.0%

 

The Chancellor of the Exchequer George Osborne forecast 2012 UK GDP of -0.1% versus +0.8% in March and +1.2% in 2013 versus a previous estimate of +2.0%.

 

The German Bundesbank cut its forecast for economic expansion in Germany to +0.7% this year, down from its previous forecast of +1%, and revised 2013 projections to +0.4% versus  +1.6% predicted in June.

 


Banking Union Blues

 

This week EU finance ministers came to no conclusion on establishing the framework for a single supervisory mechanism (SSM) – aka a banking union—by 1 January 2013. Ministers are expected to reconvene on December 12th in Brussels, but we have our doubts that anything concrete will come from it. At the heart of it is an issue that was raised in the Q&A of Draghi’s press conference on Thursday, along the lines:

 

“Given that the ECB’s stance on a Banking Union remains that it should include all 6,000 banks whereas the Germans believe it should only include its largest banks, if it is decided that a Banking Union does not include all 6K does it make sense to have it at all?”. To this Draghi dodged the answer and only said that a Banking Union needs a strong supervisor where the ECB doesn’t have reputational risk.  

 

This is a clear signal to us that the ECB and Germans (in particular) will be at loggerheads over the formation of a Banking Union. Further we think there will be extensive push back on countries giving up their fiscal sovereignty to reach a Fiscal Union. 

 

For more on the ECB’s decision to keep rates on hold see Thursday’s note titled “December ECB Presser: Only Growth Cut, Happy Holidays!”

 

 

Greece Buyback, continued


Official results have not yet been released (and may not until next week) but Greece met today’s deadline to use a 10 billion EUR loan from Europe’s bailout fund (EFSF) to buy back some of the 62 billion EUR of new bonds issued when Greece restructured its privately held debt in March and unblock its next aid tranche (34.5B EUR) as part of a package approved from the European Union and International Monetary Fund to cut the nation’s debt to 124% of GDP in 2020 from a projected 190% in 2014.

 

Note: Greek banks held about 15 billion EUR of the bonds, while the country’s pension funds had 8 billion EUR, according to a Nov. 27 draft report by the troika of the European Commission, European Central Bank and IMF. According to Royal Bank of Scotland Group, hedge funds held as much as 22 billion EUR of Greek government bonds.

 

Despite uncertainty over bank participation earlier in the week, just today Greece’s three largest banks (National Bank of Greece SA, Alpha Bank SA, and Eurobank Ergasias) agreeing to participate, with Finance Minister Yannis Stournaras saying that the banks would have legal indemnity from potential shareholders who might file lawsuits against losses suffered.

 

Based on information in a statement from the Athens-based Public Debt Management Agency on Dec. 3, the prices offered for bonds maturing from 2023 to 2042 averaged 33.1% of face value, which compares with the average price of 28.1% of face value on Nov. 23.

 

We have no further comment on Greece or the buyback beyond reporting the developments. We continue to view Greece as a shell game that Eurocrats are running.

 

 

Italian Indigestion


If Italy didn’t have enough on its hands with its outsized sovereign debt, political tensions flared this week when on Thursday, former Prime Minister Berlusconi's centre-right PDL abstained from a vote in the Senate on stimulating economic growth and a vote in parliament on cutting regional spending. Despite the move, Prime Minister Monti had a quorum, and the measures still passed in both chambers. In addition, the PDL said that the abstentions were intended to signal its disapproval of Italy's economic policies and not a move to topple the Monti government.

 

While tension appear to have calmed,  speculation around Berlusconi running in next year’s election (set for early March)  remains a destabilizing force. However, it’s worth noting that Berlusconi and the PDL are trailing badly in the opinion polls. According to a poll by Demos & Pi published in La Republica today, support for the PDL has fallen to 18.2% from 23.5% in March. In addition, the centre-left PD has seen its support jump to 37.8%, the highest since its founding in 2007.

 

 

The European Week Ahead:


Sunday: Nov. UK releases Lloyds Employment Confidence

 

Monday: Dec. Eurozone Sentix Investor Confidence; Oct. Germany Exports, Imports, Trade Balance, Current Account; Nov. UK RICS House Price Balance; Nov. France BoF Business Sentiment; Oct. France Industrial Production, Manufacturing Production; Oct. Italy Industrial Production; 3Q Italy GDP – Final; Nov. Greece CPI; Oct. Italy Industrial Production\

 

Tuesday:  Dec. Eurozone ZEW Survey Economic Sentiment; Dec. Germany ZEW Survey Current Situation and Economic Sentiment; 3Q France Non-Farm Payrolls - Final

 

Wednesday: First public consultation between the Russian government, B20 Coalition and international civil society representatives on G20 agenda for 2013 (in Moscow); Oct. Eurozone Industrial Production; Nov. Germany CPI – Final; Nov. UK Jobless Claims Change, Claimant Count Rate; Oct. UK Average Weekly Earnings, ILO Unemployment Rate, Employment Change; Nov. France CPI; Oct. France Current Account; Oct. Spain House Transactions

 

Thursday: Dec. Eurozone Bloomberg Economic Survey, ECB Publishes Monthly Report; 3Q Eurozone Labour Costs; 1Q13 Germany Manpower Employment Outlook (Dec. 13-15); Dec. Germany Bloomberg Economic Survey; Dec. UK Bloomberg Economic Survey, CBI Trends Total Orders and Selling Prices; Dec. France Bloomberg Economic Survey; Dec. Spain Bloomberg Economic Survey; Nov. Spain CPI – Final; Dec. Italy Bloomberg Economic Survey; Nov. Italy CPI – Final; 3Q Greece Unemployment Rate

 

Friday: Dec. Eurozone PMI Manufacturing - Advance; Nov. EU27 New Car Registrations; Dec. Germany PMI Manufacturing and Services – Advance; Dec. France. PMI Manufacturing and Services - Preliminary; 3Q France Wages – Final; 3Q Spain House Prices, Labour Costs

 

 

Call Outs:

 

ESM - Moody’s downgrades ESM to Aa1 from Aaa. It said the decision was driven by the recent

downgrade of France to Aa1 from Aaa and the high correlation in credit risk which it believes is present

among the entities' largest financial supporters.

 

Spain - PM Rajoy says it may be “very complicated” to achieve 6.3% deficit to GDP target in 2012 given revenue problems and high financing costs. Rajoy reiterated that if an intervention request is in Spain's interest in the future, he would not have any doubts about turning to the ECB for help.

 

Greece - S&P puts Greece in “selective default” following the launch of their debt buyback.

 

Germany - Chancellor Merkel Begins Election Drive after her party nearly unanimously re-elected her as party leader.

 

Eurozone banks - The WSJ said that after borrowing more than €1T from the ECB nearly a year ago, some of Europe's biggest banks are preparing to repay the three-year loans early (they can start next month). The paper added that while the push to repay the loans highlights the partial recovery in the industry, it has also generated some concerns that banks are moving too fast and could be exposed if the crisis flares up again. According to the article, a poll conducted by Morgan Stanley found that European banks are expected to repay a total of ~€80B of the ECB loans in early 2013, with the bulk of the funds coming from the northern European banks. The Journal also discussed how repayment speeds may be influenced by the lack of opportunities to deploy the borrowed funds to businesses and individuals.

 

Italy - Italian banks held a total of €273B in funds from the ECB at the end of November, down from €276.5B in October, according to ECB data. Italian lenders took down a total of €255B in three-year funds from the ECB's LTROs in December 2011 and February 2012.

 

Eurogroup - Jean-Claude Juncker said he plans to step down at the end of the year. No replacement named.

 

 

Data Dump:

 

Weekly European Monitor: Cutting Growth - 66. pmis

 

Eurozone Prelim. Q3 GDP -0.1% Q/Q (UNCH)    [-0.6% Y/Y (UNCH)]

Eurozone PPI 2.6% OCT Y/Y vs 2.7% SEPT

Eurozone Retail Sales -3.6% OCT Y/Y (exp. -0.8%) vs -1.6% SEPT   [-1.2% OCT M/M (exp. -0.2%) vs -0.6% September]

 

Germany Factory Orders -2.4% OCT Y/Y vs -3.9% September

Germany Labor Costs 3.3% in Q3 Y/Y vs 2.7% in Q2

Germany Industrial Production -3.7% OCT Y/Y vs -0.8% September

 

France ILO Unemployment Rate 9.9% in Q3 vs 9.8% in Q2

 

UK PMI Construction 49.3 NOV vs 50.9 OCT

UK Industrial Production -3.0% OCT Y/Y vs -3.2% September

UK Manufacturing Production -2.1% OCT Y/Y vs -1.7% SEPT

UK BoE/GfK Inflation Next 12 Months 3.5% NOV vs 3.2% OCT

UK Halifax House Prices -1.3% NOV Y/Y vs -1.7% OCT

UK New Car Registrations 11.3% NOV Y/Y vs 12.1% OCT

 

Switzerland Retail Sales 2.7% OCT Y/Y vs 5.0% SEPT

Switzerland Unemployment Rate 3.1% NOV vs 2.9% OCT

Switzerland CPI -0.1% NOV Y/Y vs -0.1% OCT

 

Spain Industrial Output WDA -3.3% OCT Y/Y vs -7.5% SEPT

Portugal Final Q3 GDP -0.9% Q/Q vs initial estimate -0.8%   [-3.5% Y/Y vs initial estimate -3.4%]

 

Netherlands CPI 3.2% NOV Y/Y vs 3.3% OCT

Netherlands Industrial Production -1.7% OCT Y/Y vs -0.2% September

 

Norway Industrial Production 2.5% OCT Y/Y vs -5.0% September

Finland Q3 GDP -0.1% Q/Q (exp. 0.3%) vs -1.1% in Q2   [-1.2% Y/Y (exp. -0.8%) vs -0.3% in Q2]

 

Ireland Unemployment Rate 14.6% NOV vs 14.7% OCT

Ireland Industrial Production -16.7% OCT Y/Y vs -12.6% SEPT

 

Austria Wholesale Price Index 2.8% NOV Y/Y vs 4.2% in OCT

Iceland Q3 GDP 3.5% Q/Q vs -6.5% in Q2   [2.1% Y/Y vs 0.5% in Q2]

 

Greece Final Q3 GDP -6.9% Y/Y vs initial estimate -7.2%

Greece Unemployment Rate 26.0% SEPT Y/Y vs 25.3% AUG

 

Russia CPI 6.5% NOV Y/Y vs 6.5% OCT

Czech Republic Retail Sales 2.2% OCT Y/Y vs -2.9% SEPT

Romania Producer Prices 6.8% OCT Y/Y vs 6.6% SEPT

Romania Retail Sales 0.7% OCT Y/Y vs 5.1% September

 

Turkey Consumer Prices 6.37 NOV Y/Y vs 7.80% OCT

Turkey Producer Prices 3.60% NOV Y/Y vs 2.57% OCT

Malta Q3 GDP 4.3% Y/Y vs 3.8% in Q2

Cyprus Q3 GDP -0.4% Q/Q vs -0.5% in Q2   [-2.0% Y/Y vs -2.2% in Q2]

 

 

Interest Rate Decisions:

 

(12/5) Poland Base Rate Announcement CUT 25bps to 4.25%

(12/6) ECB Interest Rate on HOLD at 0.75%

(12/6) BOE on HOLD at 0.50% and asset purchase at 375B GBP

 

Matthew Hedrick

Senior Analyst


G19 CONSUMER CREDIT: LOPSIDED LEVERAGING CONTINUES

Takeaway: More of the same. Credit card debt growth remains virtually non-existent, while student loan growth is incredible.

Revolving Credit

Credit card debt grew 1.1% year-over-year in October. This was a slight acceleration from the 0.8% year-over-year growth posted in September, but industry growth remains extremely lackluster. On a month-over-month annualized basis the growth was 4.7%, which is an improvement over September's -3.1% month-over-month annualized change. 

 

Nonrevolving Credit

Student loan growth accelerated again in October, growing 28.4% year-over-year up from 27.8% in September. We continue to view the bubble in student lending as entirely unsustainable, but as long at it's accelerating it is way too early to call for it to pop. Total nonrevolving credit, which includes auto loans and installment lending alongside student loans, rose 6.9% month-over-month annualized in October. This is weaker than the September change of 9.2% month-over-month annualized. 

 

We normally look at consumer credit based on the trends within its individual components, but it is also worthwhile to sometimes look at what total consumer credit is doing. To that end, total non-mortgage consumer credit grew 6.0% year-over-year in October, which is up from 5.6% year-over-year growth in September. Generally speaking, consumer credit trends are pro-cyclical, as consumers tend to lever as a reflection of their own personal confidence. However, because most of the growth is being driven by student loans we are not as sure that the confidence argument holds water since student loan debt is arguably less of a reflection of economic confidence than is auto debt or credit card debt. Remember, higher education enrollment rises alongside rising unemployment. 

 

G19 CONSUMER CREDIT: LOPSIDED LEVERAGING CONTINUES - chart2

 

G19 CONSUMER CREDIT: LOPSIDED LEVERAGING CONTINUES - revolving MoM

 

G19 CONSUMER CREDIT: LOPSIDED LEVERAGING CONTINUES - CC debt LT

 

G19 CONSUMER CREDIT: LOPSIDED LEVERAGING CONTINUES - YoY Revolving Credit

 

G19 CONSUMER CREDIT: LOPSIDED LEVERAGING CONTINUES - Installment debt

 

G19 CONSUMER CREDIT: LOPSIDED LEVERAGING CONTINUES - MoM installment debt

 

G19 CONSUMER CREDIT: LOPSIDED LEVERAGING CONTINUES - YoY change in installment debt

 

G19 CONSUMER CREDIT: LOPSIDED LEVERAGING CONTINUES - Revolving   Installment

 

G19 CONSUMER CREDIT: LOPSIDED LEVERAGING CONTINUES - Government Student Loans

 

G19 CONSUMER CREDIT: LOPSIDED LEVERAGING CONTINUES - MoM NSA and SA

 

Joshua Steiner, CFA

 

Robert Belsky

 

Having trouble viewing the charts in this email?  Please click the link at the bottom of the note to view in your browser.  


AMID RECESSION FEARS, COULD GLOBAL GROWTH SURPRISE TO THE UPSIDE OVER THE INTERMEDIATE TERM?

Takeaway: Commodity deflation has provided and may continue to provide a stimulus to the still-fragile global economy.

SUMMARY BULLETS:

 

  • From the right PRICE, pending our quantitative signals, you could see a positive revision(s) to our global GROWTH  expectations with respect to the intermediate-term TREND, as further deflation of food, energy and raw materials prices provides an economic stimulus via disinflation in actual consumer and producer prices.
  • You’re seeing this potential GROWTH pickup confirmed across a large swath of PMI readings (we track 31 in total). Broadly speaking, the service sector continues to outperform manufacturing, as it has done since mid-2011. We portend this is largely a function of the decline in commodity prices over that period (consumption tailwind and commodity-related capex declines).
  • Aside from the necessary PRICE, VOLUME and VOLATILITY signals, what would get us really bullish on “risk assets” from here? More of the same. The less global financial markets have to react to the conflicted and compromised whims Bernanke, Geithner, Obama, Pelosi and Boehner, the more we are likely to see further upside in the USD and further downside across the commodities complex.
  • Additionally, “VIX-15” and an asymmetrically stretched bull/bear sentiment spread (in favor of the bulls) remain key contrarian indicators to intellectually wrestle with at the current juncture. Investors are broadly bullish and/or complacent, so it’s likely that some degree of improving global economic fundamentals is priced in.
  • In grossly uncertain times like these, it’s best to double-down on your process (assuming it is effective); in that light, we will continue to manage the risk of the ranges across a variety of securities and asset classes, with an keen eye for potential breakouts in light of the aforementioned global economic scenario.

 

Be it Deflating the Inflation (2Q11), Bernanke’s Bubbles (2Q12) or Bubble #3 (4Q11), we have been consistently and appropriately making bearish cyclical calls on the commodities complex over the past 18-24 months, with the latter theme extending our view to the TAIL duration as well. For the record, the CRB Index is down -17.7% since the start of 2Q11 and down another -4.3% quarter-to-date.

 

From the right PRICE, pending our quantitative signals, you could see a positive revision(s) to our global GROWTH  expectations with respect to the intermediate-term TREND, as further deflation of food, energy and raw materials prices provides an economic stimulus via disinflation in actual consumer and producer prices.

 

AMID RECESSION FEARS, COULD GLOBAL GROWTH SURPRISE TO THE UPSIDE OVER THE INTERMEDIATE TERM? - 1

 

Additionally, it just so happens that our baseline GIP model (driven by predictive tracking algorithms) is now pointing to a directionally positive economic environment over the intermediate term as new global GROWTH data has rolled in over the past few weeks.

 

AMID RECESSION FEARS, COULD GLOBAL GROWTH SURPRISE TO THE UPSIDE OVER THE INTERMEDIATE TERM? - 2

 

You’re seeing this potential GROWTH pickup confirmed across a large swath of PMI readings (we track 31 in total). For the month of NOV, the median PMI reading came in at 51.4, up from 50.4 in OCT; the median sequential delta for the month came in at +0.5 percentage points. Broadly speaking, the service sector continues to outperform manufacturing, as it has done since mid-2011. We portend this is largely a function of the decline in commodity prices over that period (consumption tailwind and commodity-related capex declines).

 

AMID RECESSION FEARS, COULD GLOBAL GROWTH SURPRISE TO THE UPSIDE OVER THE INTERMEDIATE TERM? - 3

 

AMID RECESSION FEARS, COULD GLOBAL GROWTH SURPRISE TO THE UPSIDE OVER THE INTERMEDIATE TERM? - 4

 

Aside from the necessary PRICE, VOLUME and VOLATILITY signals, what would get us really bullish on “risk assets” from here? More of the same. The less global financial markets have to react to the conflicted and compromised whims Bernanke, Geithner, Obama, Pelosi and Boehner, the more we are likely to see further upside in the USD and further downside across the commodities complex.

 

That’s a better, more sustainable bull case than the current one which largely consists of corporate management teams [potentially] levering up to pay “special dividends” and mass layoffs.

 

That being said, it remains to be seen whether or not an arrest of central planning is possible – especially with the Keynesian Cliff (Fiscal Cliff and Debt Ceiling domestically) hanging in the balance. For our latest deep-dive thoughts on this topic, please refer to our 11/16 note titled: “DEBT CEILING UPDATE: WILL SANTA’S SACK BE FILLED WITH COAL?”.

 

Additionally, “VIX-15” and an asymmetrically stretched bull/bear sentiment spread (in favor of the bulls) remain key contrarian indicators to intellectually wrestle with at the current juncture. Investors are broadly bullish and/or complacent, so it’s likely that some degree of improving global economic fundamentals is priced in.

 

In grossly uncertain times like these, it’s best to double-down on your process (assuming it is effective); in that light, we will continue to manage the risk of the ranges across a variety of securities and asset classes, with an keen eye for potential breakouts in light of the aforementioned global economic scenario.

 

Darius Dale

Senior Analyst


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CAT Idea Alert: It Hasn’t Started, So It Isn’t Over

Takeaway: $CAT's recent results still reflect big *increases* in mining capital investment. Investors are not looking through what they haven't seen.

CAT Idea Alert:  It Hasn’t Started, So It Isn’t Over

 


Levels:  Long-term TAIL resistance = 89.74; TRADE support = 85.79

 

We have highlighted a number of the reasons that we are bearish on CAT’s share price.   Some investors may think that the worst is over, but capital equipment cycles tend to be multi-year affairs.  The resource investment down-cycle hasn’t even started yet for CAT, in our view.

 

  • Mining Capex:  While the pending declines in mining capital investment have just started to enter guidance, they have not entered CAT’s reported results yet.  Miners like Fortescue (Capex of $3.7 billion in 1H 2012 vs. $1.2 billion in 1H 2012) and Vale (Capex of BRL 10.7 billion in 3Q 2012 vs. BRL 6.1 billion in 3Q 2011) are still reporting massive increases in capital expenditures.  Caterpillar has not reported a single quarter reflecting lower mining capital expenditures since the financial crisis, even though the miners have started to discuss the cuts.  Instead, CAT’s results still reflect big mining investment increases. 
  • Chinese Metal Demand:  Chinese fixed asset investment has been a big driver of mine expansions.  Local construction related commodity prices suggest that party is over for now.

CAT Idea Alert:  It Hasn’t Started, So It Isn’t Over - 11

 

 

  • Inventories High, Capacity High:  CAT dealers and CAT BOTH have too much inventory, and not by a small amount.  Depending on where demand shakes out, the two probably have $5-$7 billion in excess inventory.  CAT has not reported a quarter in which inventories have corrected, yet, and reducing inventories is likely to pressure results.  The company will also need to rationalize capacity, which has not happened yet, and will likely also depress results, too, in our view.
  • Coal CapEx Cuts:  We have not seen coal capital expenditures down this year, although it looks like the cuts will bite this quarter.  Coal is a major end-market for CAT and prices have been under pressure globally.

CAT Idea Alert:  It Hasn’t Started, So It Isn’t Over - 12

 

 

  • VERY Early:  We believe we are just at the beginning of the correction in resources capital investment.  CAT has yet to report a single quarter with the expected declines, so it is probably safe to assume that it isn’t “over.”  Investors extrapolating results from recent quarters (by using P/Es, for example) are making a mistake, in our view.  Investors are unlikely to “look through” what we expect to be a very long period of adjustment to inventories, capacity and end-markets with any clarity.  

 

 


Manheim Index Gets A Boost

The Manheim Index of used car values tends to closely correlate to the S&P 500 and right now we're seeing upside in both indices. The Manheim Index rose 0.6% month-over-month in November to 122.6 but declined on a year-over-year basis by 1%. 

 

Hurricane Sandy played a role in the November numbers by reducing supply and increasing demand for used cars, which is expected to continue into December and part of early 2013. Interestingly, Manheim co-integrates with the labor market. A generally improving labor market means more people need cars to get to work and most cars on the road are…wait for it….used. This is one reason why we're so interested in the decline in Manheim over the last few months. It seems to be a contradictory data point compared with what the other labor market series are telling us.

 

Manheim Index Gets A Boost - CACC vs Manheim normal

 

Manheim Index Gets A Boost - Manheim vs S P normal


JCP: Fake Estate

Takeaway: The ‘Real’ Estate angle with JC Penney is overhyped. A transaction could provide near-term relief, but may ultimately prove problematic.

Just about any development that gives the investment community ‘hope’ in JCP these days gets the stock rallying. That’s exactly what happened yesterday with a newly formed REIT structure out of Loblaw – Canada’s largest food retailer. But one consideration people should keep in mind is that if JCP creates a REIT, it may not be able to make its rent.

 

After five years of starving its store base of capital and pushing out leases to preserve cash flow, we’re left asking what levers the company has left to pull if sales and profitability growth fail to materialize. The most obvious option is to leverage the company’s real estate assets, a strategy that Bill Ackman & Co. have considerable experience with. Here’s an option JCP could consider to unlock its real estate value:


REIT Option: Back in January 2011, Dillard’s announced its intent to form a REIT in order to “enhance its liquidity” by transferring “real properties” that are currently owned and lease back the properties under triple net leases. Given an improved environment and recent transactions in the REIT sector, this strategy is likely under consideration for other retailers as well in an effort to unlock real estate value.


Loblaw’s announcement is similar to Dillards in that it is planning to spin off roughly 70% of its property assets worth more than $7Bn into a REIT. The funds from the transaction will be reinvested in the operating business. With cash flow from operations YTD down -$655mm and net debt-to-equity at historical highs at 0.67x, the probability of JCP pursuing this option is still low, but increasing on the margin.


Since the formation of a REIT provides the greatest benefit for retailers that own a substantial percent of their real estate, we’ve looked at the likely candidates (see chart below).  Both Macy’s (55%) and Nordstrom (46%) own a greater portion of their store base compared to JCP, but even with 39% of its real estate owned, this is an option for Penney’s to consider.

 

JCP: Fake Estate - JCP RE

 

JCP currently owns approximately 39% of its real estate, or 44.6 million sq. ft. Based on current rent and cap rates, we estimate JCP’s potential REIT value at $1.85Bn-$2.55Bn, or $8.25-$11.50 per share. 

 

JCP: Fake Estate - JCP REIT

 

While forming a REIT is not likely, one thing to keep in mind that Steven Roth is on JCP’s board. While Loblaw’s announcement may have roused speculation in the start of a potential trend, recall that Roth was one of the first to execute such a strategy when he bought Alexander’s out of bankruptcy in 1993 and converted it to a REIT. Roth has “been there and done that” before.


Here’s an obvious but big consideration.


Also, this 39% that is owned carries very low cost on the land. Yes, the company is depreciating the property (some of which is fully depreciated). But if it created a REIT, it would actually have to start paying market rent on this property. Funds from a transaction would provide operating cash and cushion initially, but rent expense could ultimately prove problematic for JCP over time.


In a perfect world, the 39% of JCP’s stores that are owned will be the 400 stores that are not going to be converted into the new format. After all, keeping the old format in these stores will default them to a very high cost infrastructure.  But that’s a very fat chance of perfect overlap. In fact, it makes the most sense to run a chain of only 700 stores – so they logistically and structurally only have to serve stores that are converted. Otherwise these remaining assets will do nothing but weigh down the core.


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