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Looking Backward

This note was originally published at 8am on November 27, 2012 for Hedgeye subscribers.

"The farther backward you can look, the farther forward you are likely to see."

-Churchill

 

If you think it’s more progressive to look forward than backward, we should take a walk in the bush together on Northern Ontario right before the black bears go into hibernation. My Dad and I recommend keeping your head on a swivel.

 

Looking back at sovereign debt cycles (Reinhart & Rogoff go back to the year 1500) helps us look forward at how ridiculous expectations are that Greece is going to be fixed.

 

I couldn’t make this up if I tried this morning, but this is what Greece Prime Minister, Antonis Samaras, had to say about the latest Greek debt deal: “A new day begins for all Greeks!”

 

Back to the Global Macro Grind

 

A new day in storytelling it is. World Equity markets initially rallied on the Greek “news”, then reversed, and quickly. Chinese stocks closed down -1.3% making fresh new lows, Greek stocks went from +1% to -1.5%, and US Equity Futures went from green to red.

 

If you’ve never played a shell game, this is how it works: now you see it, now you don’t. Here’s an abbreviated version of the Greek debt deal: €40B in debt is evaporated, then they get a fresh €44B in bailout debt within the next few months (€34.4 billion paid out in Dec and €9.3 billion in Q1 linked to MoU milestones agreed by Troika).

 

Great. Right? Yeah, just great. For those of you still looking backwards as you attempt to proactively risk manage forward, you can see what all this Greek noise has added up to over the years in Josefine Allain’s Chart of The Day:

  1. Greek stocks -1.5% on the news to 831 on the Athens Stock Exchange Index
  2. Greek stocks -7% from their lower long-term highs in October (894 on the Athex)
  3. Greek stocks -49% from the lower highs they established 2 years ago (November 2011)

To be fair, 2 years ago requires a decent look back. And, admittedly, I forget what the bailout rumors on Greece were 3 years ago. All I know is that whatever the rumors were, they were lies.

 

Martin Luther King, Jr. said “a lie cannot live.” And, if you have the risk management mandate to look forward far enough, that’s generally an accurate mean reversion assumption to make.

 

But, if you have an investment mandate to chase weekly and monthly performance bogeys, you’re probably ok to suspend disbelief and pretend the lies are realities. I read my kids fairy tales at bedtime too.

 

Reality: if you bought Greece (Athex Index) or Apple (AAPL) in November 2011 or September of 2012, you need to be up +96% and 19%, respectively, to get back to break-even. That’s just math.

 

Ultimately, betting on more of what has not worked (more debt financed government spending) is destroying the world’s long-term equity capital. That’s why I am wedded to looking back at LOWER-HIGHS in long-term prices. While this is a relatively new phenomenon to those who got plugged buying American or Greek stocks in 2007-2008, it’s been happening in Japan for 20 years.

 

Back to China (and Global #GrowthSlowing)…

 

Evidently those who were suggesting “China has bottomed” a few months ago were a little off on the timing. Last night’s -1.3% smack-down in the Shanghai Composite puts China 90 basis points away from going back into crash mode.

 

A crash, by our risk managed definition, is a price that’s made lower-highs on the order of 20% or more. Try it at home with your own money. I can promise you it will feel like what I just called it.

 

The Shanghai Composite is down -19.1% since #GrowthSlowing started, globally, in March of 2012. While it’s fun for passive Captain Stock Picker to talk about what the Dow is “up year-to-date”, real money that’s managed from a global macro perspective has been seeing lower-highs in prices in pretty much everything that matters since the March-April 2012 highs.

 

Here’s one really simple 3-factor Hedgeye Global Macro Growth Model to beam up onto your globally interconnected screens:

  1. CHINA (Shanghai Composite in a Bearish Formation = bearish TRADE, TREND, and TAIL)
  2. COPPER (Bearish Formation as well, down -11% from its Q112 lower-high)
  3. BONDS (US Treasuries in a Bullish Formation as Bond Yields are in a Bearish Formation)

Now, if my #OldWall competition wants to tell me that China, Copper, and Bond Yields are flashing a “back to growth” global economy, I’m happy to debate them live anywhere, anytime. Looking Backward, they’ll be forewarned that the Thunder Bay Bear will hold them accountable for missing the 2012 US and Global Growth slowdown just like they did in 2008.

 

Our immediate-term Risk Ranges (support and resistance) for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1728-1748, $109.91-111.48, $3.43-3.56, $80.05-80.61, $1.28-1.30, 1.54-1.68%, and 1380-1419, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Looking Backward - Athens2

 

Looking Backward - vp


CHINA CRAWLS FORWARD, WHICH IS BETTER THAN CRAWLING BACKWARDS

Takeaway: The Chinese economy continues to improve, albeit slowly. No change to our fundamental outlook.

SUMMARY BULLETS:

 

  • Inclusive of the November GROWTH and INFLATION data, we stand pat on our intermediate-term G/I/P outlook for the Chinese economy – an outlook that calls for directionally positive, but relatively muted GROWTH figures; higher-highs in reported INFLATION readings; and limited POLICY based economic reflation. We realize that’s not as sexy as some of the more aggressive “China has bottomed” claims being bandied about the Street, but our call has been and continues to closest to reality.
  • Since our 11/1 note titled: “TAKE THEIR WORD FOR IT – CHINA HAS BOTTOMED”, we continue to affirm that the Chinese economy is in the latter stages of a bottoming process and the data continues to bear this out. That said, however, China’s likely bottom doesn’t mean investors should run out and buy production-related commodities and their producers; China’s strategic economic rebalancing means the slope of Chinese demand growth for raw materials is likely to be flat-to-negative for a really long time.
  • If you are looking for a less consensus way to play the China recovery theme, we are positive on the Chinese consumer and consumption-oriented sectors and subsectors throughout the Chinese stock market, as well as international consumer companies that are taking market share in China – especially with the CNY hitting a ~20-year high vs. the USD in recent weeks. Refer to our 11/8 note titled: “HU SPEAKS; IS ANYONE LISTENING?: NOTES FROM CHINA’S 18TH PARTY CONGRESS” for more details.
  • We are also have been positive on Hong Kong’s Hang Seng Index since 11/16 for its own merits, but also see incremental upside potential stemming from institutional capital flows as sentiment regarding the mainland economy continues to improve. As a point of reference, the Heng Seng Index has appreciated +5.3% from that date.

 

Over the weekend, China reported a plethora of NOV economic statistics.  On balance, China’s GROWTH data was flat-to-up sequentially in NOV; Retail Sales and Industrial Production accelerated, while FAI came in flat and the Trade Data slowed. The country’s NOV CPI and PPI readings came in faster sequentially, underscoring previous calls by Chinese policymakers for a hawkish trend in INFLATION readings on the mainland over the intermediate term and throughout 2013. We summarize the data below:

 

  • NOV CPI: +2% YoY from +1.7%
    • Food: 3% YoY from 1.8%
    • Non-Food: +1.6% YoY from +1.7%
  • NOV PPI: -2.2% YoY from -2.8%
    • Manufacturing: -2.9%
  • NOV Industrial Production: +10.1% YoY from +9.6%
    • Cement Production: +6.9% YoY from +10.2%
    • Electricity Output: +7.9% YoY (strongest since DEC-2011) from +6.4%
  • NOV Retail Sales: +14.9% YoY from +14.5%
  • YTD through NOV Fixed Assets Investment: flat at +20.7% YoY
    • Real Estate Development: +16.7% YoY from +15.4%
    • Local Projects: +21.7% YoY from +21.8%
  • NOV Exports: +2.9% YoY from +11.6%
  • NOV Imports: flat YoY from +2.4%
  • NOV Trade Balance: $19.6B from $32.1B

 

CHINA CRAWLS FORWARD, WHICH IS BETTER THAN CRAWLING BACKWARDS - 1

 

CHINA CRAWLS FORWARD, WHICH IS BETTER THAN CRAWLING BACKWARDS - 2

 

CHINA CRAWLS FORWARD, WHICH IS BETTER THAN CRAWLING BACKWARDS - 3

 

Since our 11/1 note titled: “TAKE THEIR WORD FOR IT – CHINA HAS BOTTOMED”, we continue to affirm that the Chinese economy is in the latter stages of a bottoming process and the data continues to bear this out. That said, however, China’s likely bottom doesn’t mean investors should run out and buy production-related commodities and their producers; China’s strategic economic rebalancing means the slope of Chinese demand growth for raw materials is likely to be flat-to-negative for a really long time.

 

Additionally, we find it flat-out silly that US-centric investors are using China as a reason to be incrementally bullish on US stocks now – especially given that they were bullish on domestic equities the entire time China was slowing. We’re not sure why the Chinese economy suddenly matters to perma-bulls now, but it is indeed a sentiment nugget worth flagging:

 

CHINA CRAWLS FORWARD, WHICH IS BETTER THAN CRAWLING BACKWARDS - 4

 

If you are looking for a less consensus way to play the China recovery theme, we are positive on the Chinese consumer and consumption-oriented sectors and subsectors throughout the Chinese stock market, as well as international consumer companies that are taking market share in China – especially with the CNY hitting a ~20-year high vs. the USD in recent weeks. Refer to our 11/8 note titled: “HU SPEAKS; IS ANYONE LISTENING?: NOTES FROM CHINA’S 18TH PARTY CONGRESS” for more details.

 

We are also have been positive on Hong Kong’s Hang Seng Index since 11/16 for its own merits, but also see incremental upside potential stemming from institutional capital flows as sentiment regarding the mainland economy continues to improve. As a point of reference, the Heng Seng Index has appreciated +5.3% from that date.

 

Jumping back to China specifically, the Shanghai Composite recently recaptured its TRADE line (now support), which is the first time our quantitative signals have confirmed our updated fundamental view on the Chinese economy. We would be incrementally more positive on the situation there if the Shanghai Composite were to recapture its TREND line (just +30bps above today’s closing price). To some extent, however, the recently revised IPO rules (shelving new issues through at least Chinese New Year) might have had an immediate-term positive effect on the Chinese equity market.

 

CHINA CRAWLS FORWARD, WHICH IS BETTER THAN CRAWLING BACKWARDS - 5

 

Again, we are keen to temper our comments with respect to the intermediate term outlook for Chinese GROWTH. As recently as a couple months ago, we were in the overwhelming minority in calling for a lack of POLICY based economic reflation over the intermediate term. To some extent, our initially contrarian call has become reasonably consensus – after all, both Xi Jinping and Li Keqiang (China’s future President and Premier, respectively) have been out confirming that more-or-less in recent weeks. Another example of this is Chinese interest rate markets having completely priced out the possibility monetary easing over the NTM, replacing that with some expectations of tightening (OIS).

 

CHINA CRAWLS FORWARD, WHICH IS BETTER THAN CRAWLING BACKWARDS - 6

 

Other PRICE trends in Chinese financial markets that support our directionally positive, but relatively muted intermediate-term outlook for Chinese GROWTH are:

 

  1. Compression in the sovereign yield curve (10Y-2Y spread), largely driven by a demonstrable back up on the short end; the less aggressive back up on the long end is positive, however.
  2. Expectations for NTM weakness in the CNY and CNH vs. the USD, per the NDF market; the widening CNH premium to the CNY is a positive sign from a sentiment perspective, however.
  3. Chinese rebar prices continue to make lower-highs from an intermediate-to-long-term perspective; the mostly normal sloping curve is a recent positive phenomenon, however, after  having been inverted for quite some time.

 

CHINA CRAWLS FORWARD, WHICH IS BETTER THAN CRAWLING BACKWARDS - 7

 

CHINA CRAWLS FORWARD, WHICH IS BETTER THAN CRAWLING BACKWARDS - 8

 

CHINA CRAWLS FORWARD, WHICH IS BETTER THAN CRAWLING BACKWARDS - 9

 

CHINA CRAWLS FORWARD, WHICH IS BETTER THAN CRAWLING BACKWARDS - 10

 

All told, inclusive of the November GROWTH and INFLATION data, we stand pat on our intermediate-term G/I/P outlook for the Chinese economy – an outlook that calls for directionally positive, but relatively muted GROWTH figures; higher-highs in reported INFLATION readings; and limited POLICY based economic reflation. We realize that’s not as sexy as some of the more aggressive “China has bottomed” claims being bandied about the Street, but our call has been and continues to closest to reality.

 

Darius Dale

Senior Analyst


Where Are We Now?

With 2013 less than a month away, let's review where we're at in 2012 thus far. It's become clear that the game of printing money at the Federal Reserve (i.e. quantitative easing) isn't working the way many had hoped it would. The S&P 500 is up 13.5% on a year-to-date basis but has yet to reclaim the levels seen since the Bernanke Top (September 14). Gold continues to remain inflated courtesy of the Fed having also declined in price since September. Brent crude oil is down significantly since its February highs and we expect it to head lower into the new year. 2013 will largely be affected by the outcome of the fiscal cliff. Should Congress get its act together, we can, at least for the short-term, expect a buyer's rally across multiple asset classes.

 

Where Are We Now? - image001

 

Where Are We Now? - image002

 

Where Are We Now? - image003


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MCD NOT IN THE CLEAR

McDonald’s reported Global SSS growth of +2.4% in November versus Consensus Metrix -0.1%.  Importantly, the US posted +2.4% SSS versus consensus of -0.8%.  Europe grew SSS 1.4% in November, 130 bps ahead of consensus, and APMEA grew comps +0.6% versus consensus of -0.4%.

 

 

United States

 

The US business reported +2.5% same-store sales growth, far in excess of -0.8% consensus.  The US division was benefiting from a calendar shift and a heavy value push.  On a two-year average basis, trends improved to +4.5% from 1.5%.  October was negatively impacted by calendar shifts; the chart below, on the right, shows calendar adjusted trends which illustrate a more modest improvement in November from the previous month’s trend.

 

November was driven by a heavy focus on the Dollar Menu.  Looking forward, the McRib makes its comeback on December 17th (pushed back from original relaunch date in late October) but 4Q12 trends are still facing an uphill battle as MCD faces its toughest compares of the year in December.  Heading into 1Q13, compares will remain very difficult and the competition will also be heating up with Taco Bell ramping up its national voice.

 

MCD NOT IN THE CLEAR - mcd us coms

 

 

Europe

 

MCD Europe reported 1.4% comps in November, beating +0.1% consensus.  The calendar shift impact helped business in Europe with many previously-negative markets turning positive in November.  The UK continued to see positive organic growth in its business.  Germany, one of the most important markets in Europe, continues to act as a drag on overall results.  Margins in Europe are tracking lower-than-planned this quarter as promoting value has taken a toll. 

 

MCD NOT IN THE CLEAR - mcd eu comps

 

 

APMEA

 

The APMEA business grew same-store sales +0.6%, led by Australia, despite ongoing weakness in Japan.  A significant portion of the headline improvement in two-year average trends in APMEA was due to the calendar shift.  The value message continues to resonate in Australia but trends in China continue to decelerate with trends roughly flat in November. 

 

MCD NOT IN THE CLEAR - mcd apmea comps

 

 

Takeaway

 

November was a decent month for McDonald’s but, combining October and November to smooth out calendar-shift impacts shows a trend roughly level with September.  We believe that the business, on a global basis, did improve sequentially but by much less than the headline numbers might suggest.  The true improvement was modest, in our view, and we would need to see several months of improvement for our skepticism to reverse.  We continue to expect margin pressure in 2013 and view FY13 consensus EPS estimates of $5.80 as overly bullish.  Until expectations come in, we are not advising clients to buy this stock.

 

 

Howard Penney

Managing Director

 

Rory Green

Senior Analyst


DRI - The dividend has become a liability

This note was originally published December 08, 2012 at 08:51 in Restaurants

The recent DRI press release stating the latest disappointment stopped short of dealing with reality. 

 

A recent note we published highlighted the DRI Annual Report as an important document for investors given the primary takeaway which was: the growth ethos at Darden is an entrenched as ever.  Against a backdrop of sustained traffic declines, it is jarring to read the following sentence: “Our brands have strong individual and collective growth profiles”.   We believe that management has, and is continuing to, set itself up to miss expectations.

 

Unfortunately, the press release of December 4th did not address the most important issue that the company is facing: excessive growth.

 

Clearly, in light of the fundamentals at the company’s largest brands, the five-year growth plan outlined in the Annual Report needs to be reevaluated.  The thesis of our Darden Black Book this past summer expressed our conviction that Darden’s continuing acceleration of new unit growth over the past couple of years has masked evidence of secular decline in Olive Garden and Red Lobster.  Knowing what we now know about how FY13 to-date only adds to the need for management to address how its pace of growth can be sustained without further erosion to the financial health of the company.

 

The message from Darden’s management team highlights the economy as the biggest issue facing the company and, furthermore, sees weakness in trends at its core brands as being transitory in nature.  We have suggested that the longer-term view, as defined by the data, suggests an altogether different story. 

 

The traffic trends at Olive Garden and Red Lobster clearly are demanding significant action of management.  The economy is undoubtedly a factor but the poor performance of the “Big Two” versus the Knapp Track casual dining benchmark is a clear indication that the company’s sluggish traffic trends are not entirely attributable to the macroeconomic environment.  The data points – traffic trends – that we are pointing to as a primary reference for our thesis are indicative of, in no small part, self-inflicted wounds.

 

If the company has become dependent on growth as a drug for all ailments, management’s message is not indicating that Darden is facing up to its growth problem.  Stating that the “core brands remain highly relevant to restaurant consumers” can be supported by pointing to the average unit volumes at Red Lobster and Olive Garden as being some of the strongest in the industry.  We believe this statement to be misguided, however, when considering same-restaurant sales trends – a far more relevant metric when assessing relevance to the consumer.

 

DRI - The dividend has become a liability - red lobster comp detail

 

DRI - The dividend has become a liability - olive garden comp detail

 

DRI - The dividend has become a liability - longhorn comp detail

 

Going back to the very first conference call announcing Clarence Otis as CEO of the company, the pervading theme throughout his tenure has been “growth”.  Acquisitions of LongHorn Steakhouse and, more recently, Yard House, are testament to the unwavering loyalty Darden’s CEO has to his philosophy. 

 

Now the numbers don’t add up.   The balance sheet is levered up and margins are declining.  The company is not generating enough cash to pay the dividend given the current rate of capex growth.  The dividend has become a liability. 

 

Will management admit its past mistakes or, at least, change course and slow growth?  Or will reality continue to be ignored?  The earnings call on December 20th will be the first chance for management to face the music.  The sooner they do it, in our view, the better.

 

 

Howard Penney

Managing Director

HPenney@hedgeye.com

646.455.0992

 

Rory Green

Senior Analyst

RGreen@hedgeye.com

646.455.0992

 

 

 


Temps and Gas

The AECO spot gas price is trading at a $0.06/MMBtu premium to the Henry Hub spot (in USD). The NYMEX curve has slid since mid-November on a warmer-than-expected start to the 2012/13 winter in the US northeast, but AECO has held firm above $3.25/MMBtu (USD) on cold weather in Western Canada and a swifter fall in supply. 

 

 

Temps and Gas - canada normal

 

 

What’s interesting is that weather forecasts currently expect warmer-than-normal temps in the southern US for Jan/Feb/March. Conversely, forecasts call for normal temps on the east coast and a colder-than-normal winter in western Canada for the same time period. As such, expect the differential to remain tight; the $0.06 premium compares to the 2007-2011 average differential for the time-step of a $0.37/MMBtu discount.

 

 

Temps and Gas - temp normal


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