“It is gone forever.”
That’s what legendary investor, Jeremy Grantham, started off his Quarterly Letter with in November. It was titled “On the Road to Zero Growth” and was published right around the time that the Barron’s cover read “Are We Headed For A Recession” (November 12, 2012).
I have a tremendous amount of respect for Grantham’s long-term TAIL risk work, but that doesn’t mean I always agree with him; especially on timing. For the last six weeks, our Global Growth Model has explicitly disagreed with A) a global recession and/or B) anything that remotely resembles 1% US growth, never mind 0%.
Since the mid-December cover of The Economist was titled “A Rough Guide To Hell”, I think being relatively bullish on stocks (and bearish on both Bonds and Gold) here is still the contrarian call to make. I don’t make calls on forever.
Back to the Global Macro Grind…
I’ll come back to the multi-duration, multi-factor, risk management support for the aforementioned research view in a few minutes. First, let’s just take a moment to respect what yesterday was – easily the most bullish 1-day move for growth expectations in at least a year.
- After holding its 1419 line of TREND support, the SP500 ripped to within 0.8% of its September 2012 intraday high
- The Russell 2000 closed up +2.9%, making an ALL-TIME higher-high at 873 (versus 865 in April of 2011)!
- Both VOLUME and VOLATILITY signals finally confirmed the PRICE moves – and it was broad based, across sectors
In our multi-duration S&P Sector Model, all 9 sectors are bullish on all 3 of our core risk management durations (TRADE, TREND, and TAIL) for the first time since December of 2011. We call those Bullish Formations.
Yes, in spite of the Fed and Congress – global growth stabilized as expectations for future Fed Intervention came down huge (CFTC Futures and Options net long contracts dropped -49.5% from their all-time top in September to the December lows).
Rather than using Grantham’s duration (his 0% growth forecasts extend out to the years 2030-2050 – yes, you can fire me if I ever try durations like that), let’s focus on where at least 90% of money managers have to focus on these days – the intermediate-term TREND.
- Let’s start with where US GDP Growth is at – at least +2-3%, not 0 to 1%
- You can get mad about how Obama is getting to +2-3% (spending), but you also have to understand it
- Government spending is tracking +9.5% on an annualized basis – that’s a big pop
*Reminder: GDP = C + I + G + (EX-IM). So, given that Congress just yard-saled the can on spending cuts, the G (government spending), is not going to be a headwind for Q113 GDP either. It might be in Q2 or Q3 – we’ll let you know when we think we know.
And a lot can happen in between now and Q2. What if the employment report tomorrow starts getting consensus thinking about a 6% handle on the US unemployment rate?
Oh, no you didn’t Bernanke – you didn’t take your “experimentation” too far in targeting random numbers now did you? What if Bernanke is what he usually is – wrong on his growth forecasts? What if unemployment rate expectations start to fall towards 6.5% in 2013 instead of in 2017? Inquiring Bond and Gold bulls would like to know…
I have no idea what the unemployment rate is going to be tomorrow – but what I can tell you is that:
- Yesterday’s Employment component of the US manufacturing PMI reading accelerated to 52.7 in DEC vs 48.4 NOV
- Weekly US Jobless Claims have been tracking well below our critical employment growth level of 385,000
- Both Bonds and Gold have been signaling this shift in employment growth stabilizing for the last 3 weeks
Again, this doesn’t mean I am bullish on US growth forever. To the contrary, what I am really telling you is to really respect that Big Government Intervention perpetuating short-term economic cycles works both ways.
Growth scares work just as well on the upside as they do on the downside. And if the market is sniffing this one out right, wouldn’t it be ironic and deserving, all at once, for Ben Bernanke’s latest policy expectations gamble to pop the biggest bubble of them all – bonds.
Fund flows out of bonds and into stocks would come back to this market in a hurry. The US stock market perma-bulls have been waiting for that train since 2007. If #GrowthStabilizing holds, that loco market machine may have already left the station.
Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1, $110.39-112.61, $3.61-3.77, $79.49-80.14, $1.31-1.33, 1.78-1.85%, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
This note was originally published at 8am on December 20, 2012 for Hedgeye subscribers.
“You can’t expect to have war all the time.”
You can’t expect markets to keep going up or down all the time either. Especially in the middle of a Global Currency War, risk moves fast. So you have to keep moving out there. We call it managing the risk of the market’s range.
In addition to the aforementioned quote, in 1940, “Churchill told his War Cabinet that Roosevelt’s message came as near as possible to a declaration of war and probably as much as the President could do without Congress.” (The Last Lion, page 100)
After Paris fell to the Germans, that didn’t happen. Politically, Roosevelt wasn’t ready to commit. Militarily, America wasn’t yet ready either. Not unlike the FX War you are watching in markets today, timing and expectations matter. Ask the French.
Back to the Global Macro Grind…
After being on the sidelines (relative to the US and Europe) since 2006, the Japanese are going to engage in the FX War, big time. That’s what Abe’s LDP party win promised, but the timing of Japan’s engagement doesn’t happen all at once.
The Bank of Japan (BOJ) told the market that it will expand its bailout fund (asset purchase fund) to 76 TRILLION Yens last night (that’s a lot of Yens). But, from a market expectations perspective, that wasn’t enough to keep the Yen down!
All the while, Japan’s economy continues to head deep into the cesspool of Keynesian policy promises. Japanese Exports (it’s an export economy) were reported at -4.1% year-over-year for November. That’s right, despite their recent successes setting their currency on fire, “cheaper exports” are not reacting to the FX War Policy To Inflate.
Of course it does. Charles de Gaulle tried it. Failed. The British tried it in the 1960s. Failed. Nixon/Carter tried it in the 1970s. Failed. Japan tried it in the 1990s. Failed. Now they are all trying it, at the same time, and it’s failing.
And I mean failing from an economic perspective. Any buffoon with a money printing machine can inflate his stock market if he devalues the currency that market is priced in. Chavez devalued. The Venezuelan stock market is +305% YTD.
If the Japanese start to double and triple down on the 76 TRILLION Yens, just when the US and Europe feels safe from theirs, Japan may very well end up being the next sovereign credit crisis in 2013.
Follow the bouncy ball:
- Japan Real Estate and Stock Market Bubble implodes. Print “lots of money”, economy fails, stocks rally, fail, rally, fail.
- USA Real Estate and Stock Market Bubble implodes. Print “lots of money”, stocks rip, economy doesn’t; rally, fail.
- European Real Estate and Stock Market Bubble implodes. Print “lots of money”, yep – need to do more of that, rally!
This gargantuan experiment of Keynesian academic dogma (Bernanke calls it “innovation”) started with America advising Japan to “PRINT LOTS OF MONEY” in 1997 (Paul Krugman). So why can’t a lie that cannot live end where it started?
Every risk management exercise should start with a simple question that doesn’t have an answer (yet).
Back to our current positioning:
- Long US Consumption Stocks (bought Consumer Staples, XLP, on red yesterday)
- Short Commodities (re-shorted Oil yesterday on green)
- Out of the way on Fixed Income (cut our asset allocation to 0% last week)
Now maybe buying anything that’s been propped up by Policies To Inflate doesn’t make sense. Once every asset class that hasn’t been locked down (stocks, bonds, commodities) has been artificially inflated, isn’t the only risk that remains deflation?
Probably not. That’s the whole point about the FX War – you can’t have deflation all of the time. Ask the government.
Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1664-1709, $105.95-110.02, 3.57-3.62, $79.15-79.91, $1.31-1.33, 1.73-1.85%, and 1426-1447, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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We believe that there is a consensus that STZ will continue to work once the Department of Justice approves the pending transactions. To review, ABI (Anheuser-Busch InBev, ABI BB) is purchasing the 50% of Grupo Modelo that it doesn’t own while selling Modelo’s 50% stake in Crown Imports to Constellation Brands for $1.85 billion. Crown Imports is the sole importer of Corona as well as other Modelo brands in the United States (Pacifico, Modelo Especial, among others). Both STZ and ABI have guided expectations toward a Q1 2013 closing. In late August, the Department of Justice made a second request for information on the pending transactions, a not at all uncommon occurrence.
Investor concerns appear to center around the fact that ABI will, after the proposed transactions, have direct and indirect control of over 53% of the US beer market – ABI’s existing share plus the Corona brand family’s share of market. Our belief is that the indirect nature of the control over Crown is sufficient to satisfy the DOJ, as it was when InBev was forced to sell the rights to Labatt’s when the company acquired Anheuser-Busch (see below). At worst, we expect that ABI’s perpetual call option on the Crown business will have to be foregone or some similarly benign accomodation to the DOJ. From ABI’s perspective, we see this transaction as more about the global opportunity that the Modelo brand family represents, rather than the 5% share it currently enjoys in the U.S. Further, ABI has identified $600 million in acquisition synergies that we think may be too low by as much as $400 million.
There is also some concern that there is significant variance by state in terms of ABI’s market share – ranging from the low-teens to low-70s. Any increase in an already high existing state market share could throw up a red flag with the DOJ. While the DOJ may be looking for a reason to block this transaction, we don’t see the facts of the matter supporting such an action.
Risk/Reward is unfavorable, but our view is that it is highly likely the DOJ gives consent
We accept that the risk/reward profile with respect to the event is asymmetric – STZ was a $21 stock prior to the announcement of this deal, and we expect that DOJ approval will move the stock closer to our fair value in the mid-$40’s given the company’s free cash flow profile and likely continued re-rating in the face of what we see as a transformative transaction. At $37 per share, we recognize that there is a good bit of air underneath the name. For clients so inclined, protection is available – assuming a closing date toward the end of Q1, there are options strategies that could mitigate the downside risk in the case of an issue with the DOJ approving the transaction.
Consolidation has not led to pricing power
From 1945 – 1980, the total number of brewers in the United States declined by 89%. At the same time, beer production in the United States more than doubled. Meanwhile, an increasingly consolidated industry found it difficult to take pricing ahead of the broader inflation measures. Clearly, increased concentration has not led to increased market power, a fact that the DOJ must consider in its examination of ABI’s proposed acquisition of Modelo and STZ’s proposed acquisition of Crown.
Consolidation and concentration have been driven by economic factors as the industry has seen significant suboptimal brewing capacity removed over time. In fact, we believe that a compelling argument exists that consolidation and concentration have worked for the betterment of the consumer, as less efficient capacity has exited the industry, allowing the remaining brewers to pass on the benefits of economies of scale to consumers in what remains a highly competitive industry.
Since the late 1980s/early 1990s, the industry has re-fragmented as there has been a proliferation of craft brewers. In 2011, craft brewers represented 5.7% volume share and 9.1% dollar share of the industry. Importantly, craft brewers continue to garner shelf space at the expense of traditional brewers. With such a highly fragmented, aggressive segment of the market that is on trend with respect to consumers’ desire for choice and differentiation, it’s easy to see why the scale enjoyed by traditional brewers has not translated into the monopoly power that many people feared (including those that sent two beer mergers before the U.S. Supreme Court).
Importantly, craft beers make sense for wholesalers and retailers, so even if ABI wanted to, we think it unlikely that it could limit the growth of that segment of the market. Further, retailers and wholesalers should be salivating at the prospect of a highly efficient ABI running the Modelo operation down in Mexico – the production issues and glass shortages and resulting out of stocks that crop up every summer would likely go away with a management team that has a global reputation for ruthless efficiency.
Use InBev’s Acquisition of Anheuser-Busch as a template for examining the Crown deal
Anheuser-Busch held an approximate 48.5% share of market at the time it was acquired by InBev. As part of the judgment of the Department of Justice consenting to the transaction, InBev was required to divest the Labatt’s business in the United States – the business was part of Labatt Brewing Co. Ltd., which was a partially owned subsidiary of InBev based in Toronto. While Labatt’s held a less than one percent share of the total market (0.8%) in the United States, more than half its sales were in upstate New York, where the DOJ was concerned that, when combined with Anheuser-Busch’s share of market in that region, the new entity would enjoy a market share over 75%.
The solution was the mirror image of the proposed Crown transaction – InBev was required to grant an exclusive license to brew, market, sell and distribute the brands in the United States. Labatt’s Canada agreed to brew the brand during an interim period (three years). The rights in the United States were eventually sold to North American Breweries.
In the case of Constellation Brands and Crown, STZ will be purchasing the same rights (distribution, marketing, promotion, and, importantly, pricing) as those acquired by North American Breweries with two key differences. The first difference is that ABI will remain responsible for continuity of supply (brewing) as well as brand innovation. The second difference is that ABI has the right to exercise a call option on Crown and purchase the business at 13x EBIT every ten years. We suspect that the later could be a remedy if the DOJ seeks an injunction, but that it wouldn’t represent a negative for STZ.
There are other remedies that the DOJ might seek – for example, limiting the ability of ABI to introduce other imports into the U.S. for a period of time. A small brand divestiture (Michelob?) might be in play as well. At the end of the day, we think ABI would be anxious to agree to reasonable changes to the current deal structure as the global opportunity represented by the Modelo brand family is substantial.
Is “Beer” the relevant market for the DOJ to be examining?
Increasingly, we are seeing wine and spirits manufacturers talking about targeting “beer occasions” with various ready to drink (RTD) offerings. Admittedly, RTD beverages have been around for a long time, with a mixed (pun intended) history – some way too sweet and way too fruity drinks that likely skewed way too young (read - below legal drinking age) in terms of the consumer.
We look back at some comments made by Molson Coors vice chairman, Pete Coors at the time of the SABMiller and Molson Coors merger (October, 2007):
“This transaction is driven by the profound changes in the U.S. alcohol beverage industry that are confronting both of our companies with new challenges. Consumers are broadening their tastes and are increasingly looking for greater choice and differentiation; wine and spirits companies are encroaching on traditional beer occasions and global beer importers and craft brewers are both taking a larger share of volume and profit growth.”
What was true in ’07 is true today – perhaps even more so as the uncertain economic environment drove weakness in alcohol consumption on premise (in bars). For budget conscious consumers looking to imitate the cocktail taste profile of on-premise consumption, RTD offerings seemed to make perfect sense. With this as a tailwind, we have seen increased product innovation from the spirits and wine companies that likely make the growth in the segment sustainable. If frugality is the new normal, and we continue to see new product innovation and news coming from the spirits and wine companies, we think it is safe to think of beer and spirits/wine as substitute goods for at least a segment of the consuming public.
In summary, we see an opportunity for STZ to continue higher once the DOJ gives its consent for the proposed transactions to move forward, an outcome that we see as highly likely given the factors that we laid out above.
HEDGEYE RISK MANAGEMENT, LLC
Takeaway: Kicking the can down the cliff is good – for now.
This note was originally published January 02, 2013 at 12:03 in Macro
As quickly as the quantitative RISK MANAGEMENT signals told us to get defensive last Thursday, they were telling us to get offensive as of this Monday. Back in a Bullish Formation, the US equity market (SPX), likes what it sees with regards to this latest #KeynesianCliff compromise. Highlights include:
- The marginal tax rates for the wealthiest ~2% of Americans (i.e. individuals making more than $400k per year and households making more than $450k per year) have reverted back to the Clinton-era peak of 39.6%;
- These income thresholds will also be applied to an increase of the capital gains and dividend tax rates to 20% from 15%;
- The estate tax rate will rise +500bps to 40% while maintaining the existing threshold of $5 million;
- The AMT will be permanently fixed;
- Unemployment benefits will be extended by one full year; and
- The $110 billion sequester of spending cuts will be delayed for two months – just in time to be used as political leverage during pending debt ceiling “negotiations”.
Regarding the aforementioned “negotiations”, President Obama has repeatedly stated that he refuses to negotiate with Congressional Republicans on meaningful entitlement reform amid debt ceiling talks. Moreover, he continues to stress that further deficit reduction must come via his politically-compromised definition of a “balanced” approach. Having caved to some degree already, we highly doubt the GOP brass sees eye-to-eye with Obama on either stance.
As a result, you are officially invited to look forward to more political theater in t-minus ~8 weeks (on the off chance you didn’t get your fill this past holiday season). Only this time, the stakes are much, much higher – an unlikely, but potential US sovereign default.
Looking deeper into the latest fundamental RESEARCH signals, this deal to avert the full plunge of the Fiscal Cliff is positive for the US and global economy on an immediate-term TRADE and intermediate-term TREND basis – particularly relative to the now-moot fiscal doomsday scenario. This morning's sequential acceleration in the ISM Manufacturing PMI to 50.7 in DEC (from 49.5 prior) is also positive and supportive of our directionally-positive views on global growth.
On a long-term TAIL basis, however, this deal is likely to be viewed by many as explicitly bearish for the US dollar – particularly relative to expectations of meaningful fiscal reform. By some estimates, this latest deal is good for only $600 billion of deficit reduction over the next 10 years – a sharp decline from previous negotiations in the area code of $4 trillion.
As we have said time and time again, what’s bad for the US dollar is also bad for sustainable economic development, as well as the long-term prosperity of the US economy. Two critical factors that continue to register near-perfect inverse correlations to USD debauchery in our model are current POLICY volatility and uncertainty regarding future POLICY. The confluence of those factors tends to get manifested in two very distinct ways:
- Shortened economic cycles; and
- Amplified financial market volatility.
Prepare your proverbial “anchor” for both in about a couple of months. For now, enjoy the melt-up as we kick off what is sure to be an eventful 2013. Best of luck out there!