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KEY CALLOUTS FROM CHINA’S CENTRAL ECONOMIC WORKS CONFERENCE: EXPECT MORE OF THE SAME

Takeaway: The objectives introduced in China’s Central Economic Work Conference are in line with previous POLICY objectives and our outlook for China.

SUMMARY BULLETS:

 

  • The confluence of the POLICY objectives per the latest Central Economic Work Conference are in full support of our long-held core thesis on the Chinese economy – specifically that Chinese real GDP growth is no longer going to outperform CCP targets by 200-400bps; rather, Chinese GROWTH will come in sustainably slower at +7-8% per annum (the CCP target for 2013 is +7.5%).
  • We’ve been in print confirming that Chinese GROWTH is no longer decelerating, but that any economic improvement over the intermediate-to-long term will be rather marginal and certainly nowhere near the area code of China’s trailing 5-10 year peak GROWTH rates.
  • In light of this positive, but decidedly subdued outlook for the Chinese economy, we continue to hold bearish TAIL-duration biases on worldwide mining-related capex and international raw materials prices. Plainly stated, the slope of Chinese demand for raw materials is likely to remain flat-to-negative for the foreseeable future as China accelerates its economic rebalancing by siphoning marginal GDP dollars towards consumption in lieu of fixed capital formation.
  • Sure, Chinese policymakers do indeed have a unique opportunity to accelerate urbanization and promote capital markets reform in order to sustain GROWTH, but sustaining GROWTH < demonstrably accelerating GROWTH. Don’t get ahead of your ski tips on this one!

 

Over the weekend, Chinese policymakers held their annual Central Economic Work Conference, which is used to finalize the country’s strategic macroeconomic objectives for the upcoming year. Below, we list what we thought were the key highlights of the largely uneventful event (per the State-owned Xinhua New Agency’s translation of the resulting statement):

 

  • The key points from the conference include transforming the growth pattern through expanding domestic demand, eliminating imbalances in development through structural adjustments and achieving sustainable and stable social progress through reforms in key sectors. Leaders vowed to target “sustained and healthy development” as they maintain a “prudent” monetary policy and “proactive” fiscal stance.
  • There was no mention of seeking “relatively fast” growth, a policy in place since 2006. It marks the first time that quality and efficiency, rather than speed, are center-staged in China's economic growth.
  • New growth points should be created in domestic consumption, which will serve as both a strong pulling power and foundation for the sustained and healthy development of the country's economy.
  • China will actively and steadily push forward urbanization next year, with a focus on improving quality of the efforts.
  • China has reiterated its firm stance regarding property market controls and vowed to keep tightening measures in place, including bans on third-home purchases and property tax trials that have been introduced since 2010.
  • China vowed to continue to protect foreign investors' rights and interests and their intellectual property rights.
  • While encouraging and providing better guidance to private investors, the government will increase public investment on infrastructure projects that will not cause repetitive construction but set foundations for long-term development and benefit people's well-being.

 

All told, the confluence of the aforementioned POLICY objectives are in full support of our long-held core thesis on the Chinese economy – specifically that Chinese real GDP growth is no longer going to outperform CCP targets by 200-400bps; rather, Chinese GROWTH will come in sustainably slower at +7-8% per annum (the CCP target for 2013 is +7.5%).

 

Most importantly, the government’s resolve to maintain property market curbs amid a continuation of “prudent monetary policy” and “proactive fiscal policy” confirms our view that Chinese policymakers have no interest in reflating their credit-based economic bubble – which has been identified by them as the key contributor to heightened levels of social unrest. To that tune, it’s important to note that China’s Gini coefficient (a common measure of income inequality) ripped to 0.61 in the most recent year the data was available (2010); per China’s Survey and Research Center for China Household Finance, that level is 50% higher than a risk levels for social unrest. Mass incidents, including strikes, riots and other disturbances, doubled to at least 180,000 in 2010 from 2006 levels per Tsinghua University.

 

As repeatedly stressed in outgoing CCP General Secretary Hu Jintao’s transition speech, those atop the CCP brass are keenly aware of the political risks the Party faces from social discontent, so it’s prudent for investors to maintain muted expectations with regards to Chinese POLICY going forward. We’ve been in print confirming that Chinese GROWTH is no longer decelerating, but that any economic improvement over the intermediate-to-long term will be rather marginal and certainly nowhere near the area code of China’s trailing 5-10 year peak GROWTH rates.

 

In light of this positive, but decidedly subdued outlook for the Chinese economy, we continue to hold bearish TAIL-duration biases on worldwide mining-related capex and international raw materials prices. Plainly stated, the slope of Chinese demand for raw materials is likely to remain flat-to-negative for the foreseeable future as China accelerates its economic rebalancing by siphoning marginal GDP dollars towards consumption in lieu of fixed capital formation. For more of our thoughts here, please refer to the following notes:

 

CHINESE GROWTH: STICKING TO THE [CENTRAL] PLAN (7/13);

PONDERING CHINESE GROWTH PART II (7/17);

EARLY LOOK: River Baptisms (10/4);

HOPE VS. REALITY IN THE CHINESE PROPERTY MARKET (10/4); and

HU SPEAKS; IS ANYONE LISTENING?: NOTES FROM CHINA’S 18TH PARTY CONGRESS (11/8).

 

Sure, Chinese policymakers do indeed have a unique opportunity to accelerate urbanization and promote capital markets reform in order to sustain GROWTH, but sustaining GROWTH < demonstrably accelerating GROWTH. Don’t get ahead of your ski tips on this one because China will not be lining up to bail out the global economy (see: 2009-10’s CNY4 TRILLION stimulus package and CNY17.5 TRILLION credit expansion) this time around!

 

Darius Dale

Senior Analyst


Looking at ADM below 1.0x book value

Takeaway: Since the beginning of 2009, ADM has traded at an average of 1.21x book value - the current number is 0.99x.

Within the context of our Consumer Staples Sector launch this afternoon, we highlighted ADM as one of our preferred names within the firm's broader macro call of falling commodity prices.

 

ADM has significantly lagged the overall market in 2012 (-2.9% YTD) over concerns that weakness in the company’s bioproducts (ethanol) and merchandise and handling segment will persist.  Ethanol margins suffered from higher corn costs, as well as weak domestic demand and low capacity utilization across the industry.  Merchandising and handling results were at the mercy of a smaller U.S. corn harvest.

 

Both segments could be in a position to rebound as we move into 2013 and a new crop goes into the ground.  With corn prices remaining at elevated levels, the incentive to plant corn certainly exists, and we expect that we will see corn planted fencepost to fencepost.

 

Given the valuation relative to historical norms, the risk/reward makes sense to us as we look out over the prospects for the 2013 crop year and likely planting decisions by farmers.

 

Looking at ADM below 1.0x book value - ADM price to book


CHART DU JOUR: WYNN MACAU UNDER PRESSURE

Market share in a tailspin and stagnant growth


  • In 2012, Wynn Macau will likely have generated flat net revenues and EBITDA on a normalized hold basis vs 2011
  • Our projections, as seen below, indicate similarly flat to slightly down revenue growth but EBITDA is projected to fall 4% vs the Street consensus of +3% growth.
  • Unless Wynn changes its junket commission and/or credit strategy, EBITDA growth is likely to remain flat at best until Wynn Cotai opens in 2016
  • With no positive catalysts, WYNN stock could be under pressure with slowing market growth next year (smoking restrictions, Beijing corruption crackdown, and moderating Mass hold percentage)

 

CHART DU JOUR: WYNN MACAU UNDER PRESSURE - wynn


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Replay: Consumer Staples Launch

I am very excited to be a part of the Hedgeye team and adding to the process with my launch on consumer staples this afternoon.

 

If you missed the call, or would like to review it, you will find links to the call and presentation below.

 

Call Replay: CLICK HERE

Presentation: CLICK HERE

 

I look forward to rolling up my sleeves across the space in the weeks and months ahead. More importantly, I'm excited to open up a dialogue with you all.  

 

Wishing a happy and restful Holidays!

 

-Rob

 

 

Robert  Campagnino

Managing Director

HEDGEYE RISK MANAGEMENT, LLC

 

E:

P:

 


BEST IDEAS UPDATE: IS THE USD/JPY CROSS GOING TO 100?

Takeaway: We continue to see risk that Japan experiences a currency crisis (peak-to-trough decline > 20%) over the intermediate term.

SUMMARY BULLETS:

 

  • Could the USD/JPY cross approach 100 or beyond? Most definitely, assuming a scenario in which most of our pending POLICY and PRICE catalysts materialize. As we outlined on our 11/15 firm-wide Best Ideas conference call, we think there is risk of Japan experiencing a currency crash (i.e. a peak-to-trough decline > 20%) over the intermediate term. For the record, a -20% decline in Japan’s currency from the 11/15 closing price of ¥81.17 on the USD/JPY cross puts the yen at ¥101.4625 per USD. That would be a sight to see, as the yen hasn’t traded sustainably above ¥100 per US dollar since 2008.
  • To detail the aforementioned POLICY and PRICE catalysts, we view each one of the following risks as probable over the next 12-18 months:
    • A +2-3% joint Diet-BOJ INFLATION target;
    • A stimulus package introduced by Prime Minster-elect Shinzo Abe;
    • A VAT hike delay;
    • The LDP wins a  majority in the Upper House pending elections in JUL or AUG;
    • An erosion of BOJ independence, with the BOJ governorship and two deputy governorships eventually assumed by LDP puppets;
    • Experimental monetary POLICY – particularly a foreign asset purchase program; and
    • The UST 2Y-JGB 2Y yield spread widens in any meaningful way.
  • As we explicitly stated in our 11/9 note titled, “THINKING THOUGH A POTENTIAL CURRENCY CRISIS IN JAPAN”, sustained yen depreciation and expectations for that to continue is bullish for Japanese equities until it isn’t (i.e. until the JGB market cracks in a material way). Despite the Nikkei 225 Index having appreciated +12.2% since then, our fear of a DEVALUATION and/or INFLATION-induced Japanese sovereign debt crisis will continue to keep us on the sidelines here. If you are, however, inclined to play our bearish bias on the yen via the Japanese equity market, we strongly caution against overstaying your respective welcomes. For a deeper discussion of the drivers behind such a move in the JGB market, please refer to our 7/27 note titled: “ARE JAPANESE GOVERNMENT BONDS POISED TO MAKE SOME NOISE?”.
  • One key risk to consider at the current juncture is the fact that our call has become somewhat consensus, though we counter that there is room for the market to get a lot more bearish here and that the market’s commercial players are still ragingly bullish on the yen to the tune of +3.5x standard deviations relative to the trailing 52-week average. Moreover, investors would be highly remiss to forget the #1 reason why there exists a political will to devalue the yen in the first place – Japan’s secular erosion of competitiveness. We are making an explicit call that POLICY, not sentiment/positioning will increasingly drive the boat here, leaving behind a much lower JPY in the process.

 

Over the weekend, we received confirming data to support our bearish intermediate-term bias on the Japanese yen – specifically in that the Liberal Democratic Party of Japan (LDP) is projected to capture 296 seats in the 480 seat Lower House of Japan’s parliament (Diet). Combining with the New Komeito Party’s (NKP) projected 32 seats, Japan’s new ruling coalition has garnered an omnipotent two-thirds majority needed to overturn any bills that are rejected in the Upper House, which is still controlled by the DPJ (elections likely in JUL or AUG ’13).

 

The two-thirds majority will allow LDP president and Prime Minster-elect Shinzo Abe to push forth with his reflationary campaign unabated. Per the LDP’s recently-released manifesto, he plans to pursue nominal GDP GROWTH of +3% by:

 

  1. Setting a joint INFLATION target with the BOJ of +2-3 and having the BOJ pursue “unlimited easing” until the target is sustainably reached;
  2. Implementing economic stimulus via a “large-scale” extra budget; and
  3. Delaying the 2014 VAT tax hike if necessary.

 

In addition to these steps, Abe has also supported altering Japan’s pacifist constitution to increase defense spending and the number of military personnel in order to enforce a harder stance towards China with regards to the Senkaku/Diaoyu Islands dispute. As we called out in our 9/27 note titled: “IDEA ALERT: SHORTING THE YEN AS SINO-JAPANESE TENSIONS ESCALATE”, any foreign POLICY maneuvers that exacerbate Sino-Japanese tensions will equate to lower Japanese GROWTH (China is far and away Japan’s largest export market at 19.7% of shipments). That will ultimately force Japanese policymakers to do more of steps #1-3 to shore up the Japanese economy.

 

FYI, Japan is currently mired in its 2nd recession in as many years (third in the last four), so Abe & Co. definitely have a lot of “shoring up” to do with regards to the Japanese economy. Our bearish thesis on the Japanese yen is deeply simple: the more they do, the steeper the JPY is likely to fall vs. the USD – especially in a Global Macro environment where US monetary POLICY isn’t getting incrementally dovish and US fiscal POLICY is poised to get directionally hawkish.

 

BEST IDEAS UPDATE: IS THE USD/JPY CROSS GOING TO 100? - 1

 

BEST IDEAS UPDATE: IS THE USD/JPY CROSS GOING TO 100? - 2

 

Could the USD/JPY cross approach 100 or beyond? Most definitely, assuming a scenario in which most of our pending POLICY and PRICE catalysts materialize (more on the latter later). As we outlined on our 11/15 firm-wide Best Ideas conference call, we think there is risk of Japan experiencing a currency crash (i.e. a peak-to-trough decline > 20%) over the intermediate term. For the record, a -20% decline in Japan’s currency from the 11/15 closing price of ¥81.17 on the USD/JPY cross puts the yen at ¥101.4625 per USD. That would be a sight to see, as the yen hasn’t traded sustainably above ¥100 per US dollar since 2008.

 

BEST IDEAS UPDATE: IS THE USD/JPY CROSS GOING TO 100? - 3

 

Make no mistake, Japan is likely at the cusp of experiencing a major delta in monetary POLICY – not dissimilar in magnitude to what the US experienced under the transition from Arthur Burns to Paul Volcker. Only this time, Japan is doubling down on its largely-failed Keynesian POLICY experiments, whereas the US took that opportunity to rightfully stifle the center-left leanings across its monetary POLICY landscape.

 

Jumping back to the aforementioned PRICE catalyst, we see heightening risk that the US sovereign debt market starts to make lower-highs over the intermediate term, as the yield on the 10Y UST has broken out above our 1.69% TREND line. If prices on the long end of the Treasury curve in any way start to leads the short end lower, we could see a potential widening of the UST 2Y-JGB 2Y yield spread – much to the detriment of the Japanese yen. If our Macro team is right on the US consumer (via Bubble #3 popping) and Josh Steiner is appropriately the bull on US housing, there’s little reason to believe the bond market won’t front-run any marginal changes in US monetary POLICY.

 

BEST IDEAS UPDATE: IS THE USD/JPY CROSS GOING TO 100? - 4

 

One key risk to consider at the current juncture is the fact that our call has become somewhat consensus. When we introduced our bearish TREND and TAIL bias on the JPY on 9/27, the speculators in the futures and options market were net long the yen to the tune of 21.9k contracts. Now they are over two standard deviations net short (on a trailing 52-week basis) per the latest reported data (-95.1k contracts). While sentiment/positioning do score positive for the yen from a short-term perspective, we counter that there is room for the market to get a lot more bearish here (-191.4k contracts in 2007) and that the market’s commercial players are still ragingly bullish on the yen to the tune of +3.5x standard deviations relative to the trailing 52-week average.

 

BEST IDEAS UPDATE: IS THE USD/JPY CROSS GOING TO 100? - 5

 

BEST IDEAS UPDATE: IS THE USD/JPY CROSS GOING TO 100? - 6

 

Not to mention, investors would be highly remiss to forget the #1 reason why there exists a political will to devalue the yen in the first place – Japan’s secular erosion of competitiveness. We are making an explicit call that POLICY, not sentiment/positioning will increasingly drive the boat here, leaving behind a much lower JPY in the process. It would be a gross understatement to suggest Abe is sick and tired of the Shirakawa-led BOJ consistently losing battles to Ben Bernanke amid the global “Currency War”.

 

BEST IDEAS UPDATE: IS THE USD/JPY CROSS GOING TO 100? - 7

 

All told, we continue to see risk that Japan experiences a currency crisis (peak-to-trough decline > 20%) over the intermediate term. That’s a critical Global Macro risk to manage accordingly – irrespective of your primary asset class focus. For example, anyone long domestic exporters with outsized exposure to Japan from a currency translation risk perspective would be best served stress-testing their models for meaningful USD strength over the intermediate term. Email us if you’d like to arrange a deeper discussion of our call and the implications therein.

 

Darius Dale

Senior Analyst


FINL: Knock to FINL’s Credibility

Finish Line revealed cause for recent weakness in an 8K out Friday confirming a disappointing launch of its new website platform on November 16th and has migrated back to its legacy site for the balance of the holiday shopping season. Sales disruptions are never a positive development, particularly this time of year compounding investor concerns over slowing industry sales trends in the first two weeks of December headed into year-end. But the financial implications of this change are less relevant to us as management credibility is.  FINL is already a company that lacked credibility over how it reversed course in early 2012 noting how it would all of a sudden be an ‘investment year’. And now the fact that the stock is down 12% in a flat market in the two weeks since website problems have presumably arisen is the icing on the cake. We still like so much of what FINL is doing, but at this point, we think that it is cheap and built to stay that way until earnings dictate otherwise.


Some Other Thoughts To Consider...

 

We expect the impact of these site disruptions on November sales and upcoming Q3 EPS to be modest simply due to the fact that its FINL’s seasonally lightest quarter, but near-term implications to consider for 4Q and beyond include:

  • As with most retailers, December is the most significant revenue month of the year typically accounting for more than October and November combined. As seen in the chart below, December accounts for nearly 13% of annual footwear sales.
  • FINL confirmed that it had migrated back to its legacy platform on December 6th suggesting online sales underperformance was isolated to the first week assuming no additional disruptions transitioning back. December accounts for roughly 45% of FINL’s 4Q. For perspective, if we assume ALL online sales were lost during this first week and that the first week accounts for 12-15% of FINL’s 4Q with online at ~11% of total sales at higher profitability, then we’re looking at a $4-$8mm hit to sales, or $0.01-$0.03 in EPS.
  • We also have to take the costs related to this initiative into consideration relative to FINL’s $90mm capital spending plan. Up to $30mm was spent on upgrading IT infrastructure including various supply chain and merchandise systems as well as technology to support digital growth. While it’s unclear how much was allocated to Demandware and its new website, there is no indication that the ‘plug has been pulled’ altogether on the new platform.
  • The launch of the platform just 7-days prior to the busiest shopping day of the year gave both parties little time to work through typical transition adjustments. There’s no indication of when or if FINL plans to migrate back to the new platform. However, in an 8K released by Demandware Friday the company noted that FINL “concluded that it would suspend operation of the site” suggesting the move back to the legacy platform is not permanent. As such, related investments should not be considered sunk costs unless otherwise noted.
  • Lastly, the potential impact on FINL’s recently announced partnership with Macy’s. We think the risk is modest given that this is a front-end consumer interface issue with FINL’s site and the Macy’s deal is more of a back-end inventory and assortment management agreement. The two are largely if not completely unrelated. We think the concern is more one of operational reputation risk. In all likelihood, management made the move to transition again at a less critical time to avoid any such issue. As a reminder, the deal with Macy’s is slated to start April 1st.

 

We have adjusted our estimates to reflect the loss in higher profit online sales taking FINL EPS down a penny to $0.10 in 3Q and $0.03 to $0.82 in 4Q. While FINL is trading at a modest 9x our $1.97 FY13 estimate, the absence of positive catalysts over the near-term suggests a meaningful move higher before year-end is unlikely. In fact, we’re not convinced FINL’s 3Q earnings call scheduled for January 3rd is going to be much of a catalyst given the that the name is in a ‘show me’ mode. In addition, management will be absent at ICR in mid-January due to annual board meeting scheduling conflicts. To that end, with 4Q results and the Macy’s launch slated right around the same time (April 1st), we expect FINL to be largely range-bound over the next two months.


Citing Thursday’s note, we remain positive on NKE and FL here.

 

 

FINL: Knock to FINL’s Credibility - FW Monthly Dist

 

 


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