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Market Relationships

This note was originally published at 8am on February 05, 2013 for Hedgeye subscribers.

“Zeus ordained that only in sorrow and in suffering do we find wisdom’s way . . . by suffering we shall gain understanding.”

-AESCHYLUS, Agamemnon

 

A week ago I had memorable birthday and while I’m not quite forty, I’m getting pretty darn close.  As usual, my friends and family delivered in helping me celebrate.  Keith and his wife Laura invited me out to their house for a fine birthday dinner.  I also received a few books, including one called, “How to Be an Adult in Relationships: The Five Key Lessons to Mindful Loving.”

 

I think the person that sent me this book meant it as a gag gift, although I’m sure, as with most jest, there was some truth imbedded in the gift. Setting aside an analysis of my relationship history, I think we can all agree on the fact that relationships, and fruitful ones, are really the key to success and happiness in life.  As stock market operators, we all have a relationship with a gentleman called Mr. Market.

 

The quote at the start of this note is actually very applicable to the stock market.  The best lessons learned from investing typically come from the mistakes.  Further, as my colleague and Hedgeye restaurant Sector Head tweeted last night:

 

“$YUM is the annual reminder of how humbling this job actually is . . .”

 

In this instance, Howard Penney was referring to the results from Yum Brands, a company he had been favorably disposed to going into the quarter, which provided disappointing guidance based on worse than expected results in China.  Howard gets many more calls right than he gets wrong (see our 300%+ gain in Starbucks as evidence), but his point on $YUM is a good one – just when we are least expecting it the market humbles us. 

 

Speaking of humbling markets, the European sovereign debt market is once again becoming relevant.  In the Chart of the Day today, we look at the Spanish 10-year over the last three weeks.  On January 14th, the Spanish 10-year was yielding 4.95% and today is yielding 5.44%.  In the last three weeks, Spanish yields have spiked 10%. 

 

If I were an investor in Spanish and European sovereign debt generally, I’d probably be demanding a higher yield for the inherent acceleration in risk over the last few weeks.  First, Spanish Prime Minister Mariano Rajoy has been under attack for purportedly taking secret payments over a more than ten year period, with the evidence seemingly well documented.  Secondly, ahead of the EU Summit this week, French President Francois Hollande stated:

 

“A monetary zone must have an exchange rate policy or else it ends up subjected to an exchange rate that does not match the true state of its economy.”

 

The translation from French is simply this: Hollande does not believe the market should determine the price of the Euro.

 

The economic data out of Europe this morning will likely only serve to bolster Hollande’s arguments.  The Eurozone PMI Services numbers were reported this number and on aggregate January came in at 48.6 versus 47.8.  There were a number of positive surprises with the U.K. coming in at 51.5 and Germany at 55.7.  Unfortunately, for Hollande and his government’s policies France was a disaster at 43.6.  The other disaster in European economic data was December retail sales down -3.4% year-over-year. 

 

On one hand, Hollande is correct that with both Japan and the United States actively devaluing their currencies, Europe will be at a disadvantage in terms of exports if they don’t follow suit.  Unfortunately, like most wars, this ongoing currency is destined to end poorly.  The reality remains that no country in the history of the world has devalued its way to prosperity, though the Japanese have certainly tried.

 

On that last point, this morning the Japanese are once again upping the devaluation ante.  Bank of Japan Governor Shirakawa announced late yesterday that he would be leaving office on March 19th, a full three weeks earlier than planned.  At the same, two deputy governors will be leaving office.  It seems Prime Minister Abe realizes that political life in Japan is short, and that he needs new leadership at the Bank of Japan to aid in implementing his inflationary policies as soon as possible.  And so, the currency wars continue.

 

The question related to Japan is just how aggressive will the government get in terms of devaluing.  As my colleague Darius Dale wrote yesterday:

 

“The Japanese yen, which is down roughly -16% since we initially outlined our bearish bias back on 9/27, continues to get Taro Aso’d.

 

The latest developmental jawboning on this front has come in the form of Finance Minster Aso’s recent remarks that the Japanese government is taking a page out of its own historical playbook by pursuing strong anti-deflation policies:

 

“There is no one in the government, the bureaucracy or the BOJ who has experience in anti-deflation policy. We can only learn from history.”

 

-Taro Aso, 2/3/13

 

The history lesson Mr. Aso is referring to is Depression-era Japanese Finance Minster Korekiyo Takahashi’s mandating of the BOJ to directly monetize Japanese sovereign debt (as opposed to open-market operations), which began in 1932 and continued for the next 14 years.

 

During this era, the ratio of JGB issuance financed directly by the BOJ peaked at 89.6% in 1933 and remained elevated throughout the program. This monetization strategy assisted in doubling JGB issuance and boosting Japanese public expenditures by a whopping +34% in 1932 alone.”

 

The short answer is that Japan can get a lot more aggressive and this won’t be positive for the Yen, despite the recent sharp correction.  If you’d like to set up a time for us to do a briefing with you or your firm on the risks associated with Japan, please email sales@hedgeye.com.  Japan is a risk that you should keep front and center because in this day and age, all global markets are related.

 

Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, EUR/USD, USD/YEN, 10yr UST Yield, and the SP500 are now $1649-1686, $114.55-116.88, $79.02-79.83, $1.34-1.36, 90.77-93.22, 1.91-2.10%, and 1489-1513, respectively.

 

Best of luck out there today,

 

Daryl G. Jones

Director of Research

 

Market Relationships - Chart of the Day

 

Market Relationships - Virtual Portfolio



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Trust Mr. Market

“He knew that he had a gift: the power to make people trust him.”

-Evan Thomas

 

With the Chinese allegedly hacking US corporations and the Keynesians in an all-out currency war with the world’s savers this morning, what could possibly go wrong? The US stock market doesn’t seem to care. Do you trust it?

 

The aforementioned quote about old-school trust comes from an excellent leadership book I’m reading titled “Ike’s Bluff: President Eishenhower’s Secret Battle to Save The World.” Since I am finishing up our year-end review process, trust is a factor I thought a lot about while I was in London last week. The people you choose to work with either get it, or they don’t.

 

Americans believed in President Dwight Eisenhower, big time. He had the highest approval rating of any post WWII President, not because he gave the best speeches (he hated the teleprompter, and it showed) – it was because poll after poll revealed an endearing quality that the modern polarizing #PoliticalClass has not been able to achieve – the underlying trust of The People.

 

Back to the Global Macro Grind

 

I trust Mr. Market. I believe in his real-time signals. I trust that The People ultimately trust his scorecard too (he might be a she by the way). You don’t have to like someone in order to trust them.

 

You don’t get paid to play the market you’d like to have either. You get paid to play the game that’s in front of you.

 

That’s just too complicated for a dumb bunny like me.” –President Eisenhower (page 29)

 

Or is it?

 

At the end of the day, it’s all about your attitude. Sure, it really is hard to let Mr. Market humble you into the daily position of A) embracing uncertainty and B) accepting that risk doesn’t care about your positioning.

 

You can, however, dynamically (daily) risk adjust your positioning based on the highest probabilities that Mr. Market is giving you. Would you play any other game any other way? For us, since late November, that overall Global Macro position has been:

  1. Long US Dollar, Short Japanese Yen
  2. Long Equities (Asian and US specifically, not Europe)
  3. Short Gold and Treasury Bonds

I can be a dumb bunny too. That’s why I maintain a model that accepts dumb government policy as causal to currency moves. That’s also why we get currencies more right than wrong. Stocks, Bonds, and Commodities tend to react to big policy driven currency moves.

 

The US Dollar was up for the 2nd consecutive week last week (+1.8% over that time) and for the #1 concern my competitors are signaling as the US stock market’s greatest risk (inflation), Strong Dollar did what it should have done – it Deflated The Inflation:

  1. CRB Commodities Index = down another -0.9% last week (down -2.2% in the 2 weeks of Dollar Up)
  2. Gold = down another -3.5% last week to a fresh YTD low (down for the last 2 weeks as well)
  3. Silver = down -5.3% on the week and Food Prices deflated too (Cocoa -4.1%, Corn -1.4%, etc.)

Now a lot of people in this world (especially Americans) like it when the purchasing power of their hard earned currency appreciates. Others (like Venezuelans for example) don’t have a say in the matter. Their overlords debauch their currency whenever they please.

 

Eisenhower was lucky in that he was able to compete with British and French debaucherers of currency. These were weak governments who were addicted to debt and the cowardly messaging of #ClassWarfare. No one trusted that then – and they don’t trust it now.

 

Not all Equity markets like Commodity Deflation. Brazil’s Bovespa Index is the poster child for commodity exposure – it was down another -1% last week and is now down -5% for 2013 YTD.

 

What could really get this US and Asian Equity party started would be another blast higher in the US Dollar from here:

  1. Then Oil will eventually start to mean revert versus the rest of the CRB Commodities Index (which is breaking down)
  2. And Consumers, globally, will get a much needed TAX CUT at the pump

What’s actually quite amazing is that US Consumption hasn’t been hammered with Brent Oil trading up here at $117-118. In our GIP Model (Growth, Inflation, Policy), a Brent Oil price that is in a Bullish Formation is an explicit headwind.

 

But maybe that’s more of a headwind for those cheering on a weak currency in Europe. Enter France:

  1. France’s CAC40 snapped its immediate-term TRADE line of 3711 support in the last few weeks
  2. French Services PMI of 43.6 in JAN was god awful relative to A) itself (45.2 in DEC) or any other major country

So, the French have economic issues that, evidently, weren’t resolved with a 75% tax rate…

 

Now that their economic data really sucks again, the first thing their conflicted and compromised #PoliticalClass does is jawbones for a weaker Euro – then they tell the world they really didn’t do that at the G20 meetings, n’est-ce pas? But, with the CAC and the Euro breaking immediate-term TRADE support, who do you trust? Mr. Market doesn’t trust them.

 

Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, USD/YEN, UST 10yr Yield, and the SP500 are now $1, $116.09-118.91, $3.67-3.72, $1.31-1.33, 92.53-94.38, 1.96-2.05%, and 1, respectively.

 

Best of luck out there this week,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Trust Mr. Market - Chart of the Day

 

Trust Mr. Market - Virtual Portfolio


What is Going on with CPB?

I wrote in an earlier note that a short position in CPB would make me uneasy given some of the characteristics it shares with HNZ.  In this note, I take a look at the reasons why CPB’s operating performance doesn’t warrant the recent move up in the company’s share price.



Since December 31st, CPB’s share price has gone from $34.89 to $39.40 (as of Friday’s close), a year to date performance of nearly 13% versus the S&P’s YTD performance of 6.6%.  Admittedly, CPB has been a multi-year laggard, and so the company’s ability to exceed consensus estimates in the most recently reported two quarters has helped the share price performance, as has the HNZ deal.  However, chasing laggards solely because they have lagged doesn’t represent a compelling long-term investment process to me – I need to start seeing some improvement in the company’s business momentum.



I attribute the better than consensus results to the sell-side’s inability to model in conjunction with CPB’s acquisition of Bolthouse Farms, which has muddied the income statement a bit.  Keep in mind that buying a staples company that is in the process of integrating an acquisition usually isn’t a bad idea, in my experience.  The sell-side is generally crappy at modeling to begin with, and the top line becomes optically much more attractive, and the company has some income statement flexibility as the merger synergies start to flow through – to be honest, it’s a part of the reason I like CAG, STZ, K and BUD.  But it can’t be the only reason.

 

While reported revenue growth has been close to double-digits (against declines in the comparable quarters of 1H 2012), constant currency organic growth has been +1.1% and +1.5% in the first two quarters of 1H ’13, again against declines in 1H ’12.  The comps turn positive in 2H ’12, though the next two quarters are less seasonally important than the two reported thus far.   Keep in mind that my view is that the primary driver of multiple expansion/contraction in consumer staples is changes in top line momentum – it doesn’t appear to me that CPB has reached that type of inflection point with regard to its core business.



Importantly, EBIT growth (absent the acquisition) was only +1% in the quarter, and this result was flattered by a 14% decline in advertising and consumer promotion expense – never a good sign, in my view.  Even with the acquisition, the company posted only a 7.6% year over year increase in EPS, against a -10.1% comparable in Q2 2012 – and that is with some help from a lower tax rate year on year.  The EPS comps as we move through the remaining two quarters of the company’s fiscal 2013 don’t stiffen all that much.



Taking all that together, I don’t see a path to an EPS miss as consensus currently contemplates the pacing of the remaining two quarters, and that is central to wanting to be short a name.  As we move out closer to calendar ’14, with the HNZ transaction in the rear-view mirror and CPB moving toward more difficult comparisons, I think a short position might make more sense, but I reserve the right to change my mind in either direction or any time should the data suggest.



While I don’t do shorts purely on valuation, it appears to us that a nearly 2 turn improvement in CPB’s P/E multiple (currently 15.0x calendar 2013) to close the gap with the peer average isn’t based on the underlying strength of the company’s business – neither is it a particularly demanding multiple.  Further, I think consensus is secure for the balance of fiscal 2013 and am therefore content to watch and wait.

 

What is Going on with CPB? - CPB PE

 

Call with questions.

 

Rob

 

Robert  Campagnino

Managing Director

HEDGEYE RISK MANAGEMENT, LLC

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Matt Hedrick

Senior Analyst




MACAU: A BIG CNY DISAPPOINTMENT

We’ve got the numbers for the first half or so of the month and they’re not pretty.  Despite the favorable calendar shift of Chinese New Year (CNY) into February this year, Macau gross gaming revenues (GGR), could actually fall YoY.  With 17 days in the bag, we’re now projecting February GGR of $23.0-24.5 billion which would represent growth of -2% to +4%.  These soft results have to be a disappointment to the Macau bulls who had been calling the market as essentially impervious to the smoking ban and the junket crackdown by the Chinese government.

 

So why are the numbers so weak?  Last February was actually quite a strong month with volumes higher than January despite CNY falling in January.  We believe the smoking ban may have been more impactful on table productivity during the busy CNY period.  We’ve also heard that VIP hold may have been a little low although there is no hard evidence of that.  Finally and most importantly, we think there is a government crackdown on corruption in China which is impacting the junkets.  Some specific junkets may be targeted.  We found this article interesting and relevant:

 

http://www.bloomberg.com/news/2013-02-17/china-new-year-retail-sales-growth-slows-on-frugal-drive.html

 

MACAU: A BIG CNY DISAPPOINTMENT - m1

 

In terms of market share, Wynn is making a surprising breakout although most of it is likely hold related and comes at the expense of MPEL.  Sands China is having a strong month and we expect that trend to continue absent any hold fluctuations.  Galaxy’s market share is back up after a few disappointing months while MGM and SJM are posting shares below trend. 

 

Following the disappointing last half of January and February’s results so far, we believe Q1 estimates could be at risk.  However, while we fully expected the junket crackdown to have a material impact on Macau’s VIP numbers, we maintain our belief that the impact will be short lived, 2-3 months.  Our best guess is that the crackdown, while real, is window dressing to show the populace that the new government is serious about combating corruption.

 

MACAU: A BIG CNY DISAPPOINTMENT - m2


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