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BUYING CHINA ON WEAKNESS

Takeaway: We’ve used the post-Lunar New Year weakness driven by property curb speculation to increase our allocation to Chinese equities.

SUMMARY BULLETS:

 

  • All told, we’re using the weakness induced by rising speculation of incremental property curbs to increase our allocation to Chinese equities – one of our team’s top global macro investment ideas since DEC 10.
  • Specifically, we have been particularly keen on the outlook for the Chinese consumer and stocks that have exposure to that sector and the outperformance has been noteworthy: +12.7% for the MSCI China Consumer Discretionary Index since DEC 10 vs. +5.1% for the MSCI China Index over that same duration.
  • Based on our analysis of recent supply/demand/price trends in the Chinese property market and recent policy maneuvers, we think it is unlikely Chinese policymakers will pursue any draconian curbs at the current juncture. Moreover, we anticipate any developments in the way of incremental property market  curbs to be eventually overshadowed by the introduction of growth-friendly economic reforms at the 12th National People’s Congress (~MAR ’13).

 

Overnight, Chinese property stocks dropped -4.6% on speculation that the Chinese Communist Party leadership is considering additional property market curbs. That was the largest day/day % decline since early AUG and the speculation was driven by a recent trend of higher imposed LTV ratios and/or loan caps in the Zhejiang, Jiangsu and Guangdong provinces.

 

BUYING CHINA ON WEAKNESS - 1

 

Weakness in the developers – which we consider a key leading indicator of Chinese economic activity (Real Estate Development is ~20% of China’s Fixed Capital Formation and Land Sales account for ~40% of local gov’t revenues) – dragged the broader index lower to our immediate-term TRADE line of support.

 

BUYING CHINA ON WEAKNESS - 2

 

To some degree, recent weakness in the CNY has been foreshadowing this brief move lower in Chinese equities, though, to some degree, the PBOC has been combating appreciation pressures born out of Japan’s recent Currency War tactics.

 

BUYING CHINA ON WEAKNESS - 3

 

The speculation on additional property curbs also came on the heels of weak Lunar New Year Retail Sales growth figures (+14.7% YoY vs. +16.2% in 2012 and the slowest since 2009’s +13.8% YoY advance). The fact that the Finance Ministry is developing incremental curbs to be applied on local gov’t debt also continues to weigh on Chinese growth expectations.

 

A subdued Chinese growth outlook is something we’ve been calling for many months now. Specifically, we continue to see directional improvement in the Chinese economy, but not to absolute levels previously associated with peak growth rates of Chinese demand. This view remains both accurate and supportive of our bearish TAIL-duration bias on commodities.

 

You can see evidence of this real-time in the forex market having priced out expectations for structural yuan appreciation amid China’s drive to rebalance its economy away from investment, manufacturing and exports towards increased household consumption. That will obviously weigh on China’s trade and current account balances going forward.

 

BUYING CHINA ON WEAKNESS - 4

 

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With respect to this  ongoing theme of Chinese economic rebalancing, the next major catalyst to come down the pike on the policy front is the 12th National People’s Congress, which will likely convene in MAR. There, members of the new seven-man Politburo will assume their formal roles as leaders of the Chinese state and formally outline their strategies to promote domestic demand.

 

We’re hoping for meaningful advancement of social security expenditures and perhaps some degree of early hukou reform(s) that may help advance China up the urbanization curve, but we’d settle for a continued focus on tax incentives (such as expanding the VAT reform to more regions and/or industries or incremental tax cuts for SMEs) and subsidies for now. Rome wasn’t built in a day and the Chinese consumer won’t be either.

 

With respect to the aforementioned property curb speculation, we do expect the CCP to announce additional measures in line with what various officials have been hinting at for weeks. As such, we don’t think any new curbs will be as punitive as the market anticipated this morning. The recent indefinite postponement of the nationwide property tax trial is but one piece of evidence the CCP isn’t looking to get too aggressive just yet.

 

And there’s little reason for them to be aggressive right now. Per our latest monthly data (Hedgeye China 20-City Nominal Price Index), we have Chinese nationwide property prices growing at only +2.3% YoY (from +0.5% in NOV). The MoM gain of +0.5% in DEC actually slowed -10bps from NOV’s +0.6% reading. By our count – which is as good as any we can find – Chinese property prices are down -10.2% from their JAN ’10 all-time peak.

 

BUYING CHINA ON WEAKNESS - 6

 

Looking to data from Soufun Holdings Ltd., Chinese property prices rose +1% MoM in JAN – the largest gain in two years according to their index. Inclusive of the aforementioned peak-to-present decline, average square meter prices in the 100 cities tracked by SouFun are roughly five times the average Chinese consumer’s disposable income. Obviously, prices remain somewhat frothy with respect to incomes, but certainly not to the extent they once were or will be amid the CCP’s structural consumer income growth agenda. Hence, we don’t find it prudent for the CCP to authorize draconian curbs (such as meaningfully tightening credit policies for 2nd and 3rd homes or raising/implementing punitive taxes) at the current juncture.

 

As the following chart highlights, overall activity in China’s real estate sector remains incredibly subdued. Sure, it’s improving from an intermediate-term perspective, but we’d have to see a lot more activity here for us to get worried about another round of major, growth threatening curbs. There’s likely a fair amount of equity market upside between now and then – particular when factoring in China’s TREND-duration GIP outlook.

 

BUYING CHINA ON WEAKNESS - 7

 

BUYING CHINA ON WEAKNESS - CHINA

 

On balance, trends across the supply/demand/price dynamics of China’s property market continue to suggest little in the way of curb-requiring exhaustion:

 

  • YTD Land Areas Purchased: -13% YoY in DEC from -14.8% in NOV
  • YTD Starts: -6.7% YoY in DEC from -7.2% in NOV
  • YTD Construction: +12.9% YoY in DEC from +13.3% in NOV
  • YTD Completions: +11.4% YoY in DEC from +14.1% in NOV
  • YTD Floor Space of Buildings Sold: +1.2% YoY in DEC from +2.4% in NOV
  • YTD Total Sales of Buildings: +9% YoY in DEC from +9.1 in NOV
  • YTD Funds Earmarked for Real Estate Development: +16% YoY in DEC from 14.1% in NOV
  • Outstanding residential mortgage loans grew +12.9% in 2012 – the slowest pace of growth in four years
  • DEC Steel Products Production: +14.5% YoY from 15.9% in NOV
  • DEC Copper Products Production: +8.6% YoY from +0.5% in NOV
  • DEC Cement Production: +3.8% YoY from +6.9% in NOV

 

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All told, we’re using the weakness induced by rising speculation of incremental property curbs to increase our allocation to Chinese equities – one of our team’s top global macro investment ideas since DEC 10.

 

Specifically, we have been particularly keen on the outlook for the Chinese consumer and stocks that have exposure to that sector and the outperformance has been noteworthy: +12.7% for the MSCI China Consumer Discretionary Index since DEC 10 vs. +5.1% for the MSCI China Index over that same duration.

 

Based on our analysis of recent supply/demand/price trends in the Chinese property market and recent policy maneuvers, we think it is unlikely Chinese policymakers will pursue any draconian curbs at the current juncture. Moreover, we anticipate any developments in the way of incremental property market  curbs to be eventually overshadowed by the introduction of growth-friendly economic reforms at the 12th National People’s Congress (~MAR ’13).

 

Darius Dale

Senior Analyst


ISLE YOUTUBE

In preparation for ISLE's F3Q earnings release tomorrow, we’ve put together the recent pertinent forward looking company commentary.

 

 

ISLE COMPLETES SALE OF BILOXI, MISS. PROPERTY (NOV 30)

 

YOUTUBE FROM F2Q 2013 CONFERENCE CALL

  • "Cape is ramping up to our expectations."
  • [Nemacolin] "We're looking forward to an opening of the property in the summer of 2013."
  • [Lower capitalized interest] "until we ramp up in earnest in Nemacolin which will start to build up here, but, obviously with the project of less than half the size, it won't be of the magnitude that it has been."
  • [Corporate expense] "We've just had some costs that we've incurred related to a couple of disputed matters, or some legal matters that came up in the quarter. We wouldn't expect that to continue at that rate going forward."
  • [Capex] "But the balance of this year, we expect to be somewhere between $80 million and $90 million, probably $20 million to $30 million of that in Nemacolin, depending on how fast we get construction rolling. We still have a lot of settling up to do in Cape Girardeau and some stuff that wasn't paid for by the end of the quarter that's going on currently and will continue to go for the next little bit of time here until we get everything kind of wrapped up finally and then the balance of our maintenance capital for the rest of the year as well."
  • "The renovation of the Lake Charles hotel rooms will be done by the end of this calendar year."
  • [Acquisition strategy] "As our leverage gets down in a more kind of the lower fives or under five times, I think, that's probably when we would start to look at that a little bit. We're still probably somewhere between half a turn and a turn higher than ideally, I think, where we want to be leverage wise."
     

What’s Going on in Staples Today?

There are some unusually severe moves today across the sector – it strikes us as being partially driven by HF capitulation as lower multiple, lower quality names that are the usual targets for short sellers are outperforming the bulk of staples today.



Similarly, we are also seeing some modest outperformance in the higher multiple names, suggesting some additional short covering in what may be valuation shorts.

 

What’s Going on in Staples Today? - 2.19 Forward PE v perform today



However, short covering doesn’t seem to be the sole determinant of today’s stock price movements as seen below.  Nor are we seeing any meaningful disparity in performance based on beta.



What’s Going on in Staples Today? - 2.19 SI ratio v perform today

 

What’s Going on in Staples Today? - 2.19 Beta v perform today



Bottom line, it seems as if the HNZ transaction and the continued resilience of the market have caught some HFs offside, and we are seeing scrambling and associated “odd” moves as investors take down/take up exposure or reposition their books to reflect a more bullish stance.

 

Call with questions.

 

Rob

 

Robert  Campagnino

Managing Director

HEDGEYE RISK MANAGEMENT, LLC

E:

P:

 

Matt Hedrick

Senior Analyst




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MGM YOUTUBE

In preparation for MGM's 4Q earnings release tomorrow, we’ve put together the recent pertinent forward looking company commentary.

 

 

MGM RESORTS' COTAI LAND CONCESSION GAZETTED (Jan 9)

 

CITYCENTER RESIDENTIAL ANNOUNCES $119 MILLION BULK SALE OF 427 CONDOMINIUM UNITS AT VEER TOWERS (DEC 21)

  • Veer Towers 98% sold-out at deal closing

MGM RESORTS INTERNATIONAL COMPLETES LANDMARK REFINANCING TRANSACTIONS (DEC 20)

  • Entered into a $4.0 billion amended and restated credit facility, comprised of a $1.2 billion revolver, a $1.05 billion term loan A facility and a $1.75 billion term loan B facility
  • Issued $1.25 billion of 6.625% senior unsecured notes due 2021

 

YOUTUBE FROM 4Q CONFERENCE CALL

  • "We are managing our costs where we can and FTEs were down about 2% during the quarter."
  • "In Cotai, we have formally signed the land concession contract and have closed on a $2 billion credit facility, which along with our strong balance sheet and free cash flow, will give us the financial flexibility to expand in that region, strategically invest in our current resort and continue to maximize shareholder value."
  • "While our occupancy remained high at over 90%, our food, beverage, retail and entertainment were affected by the fact that we had over 100,000 less occupied room nights this year versus last year. These segments were also impacted by certain of the remodels and transitions in several of our buildings, and we expect that to turn as we bring these new amenities online in the upcoming quarters."
  • "We do expect our corporate expense to be higher here in the fourth quarter driven by the referendum expenses we're incurring and that'll be up in the fourth quarter in a range in kind of the mid $60 million level for corporate expense before our stock comp expense."
  • "We expect our stock compensation in the fourth quarter to be approximately $10 million to $11 million. Depreciation expense in the fourth quarter is estimated to be about $230 million to $235 million. Our interest expense in the third quarter was $276 million, including about $6 million from MGM China and about $17 million in non-cash amortization. And we estimate that our gross interest expense in the fourth quarter will be approximately $285 million."
  • "Viva ELVIS officially ends its run on August 31 and we're looking forward to the opening of Zarkana in November. The theater has been modified for the new show and the artists are completing their final rehearsals in anticipation of the opening November 9. We expect this new show will turn what was a loss to our business into significant profits, while also driving up ancillary business."
  • "Looking at the fourth quarter, we have some good things coming up. Great product offerings are coming online. Zarkana, the new Cirque show at ARIA opens next Friday. Blue Man Group is coming back to our family, opening up at Monte Carlo the following week. We will now have all of our rooms back at the MGM Grand and they're all online as that remodel program was completed in late September. We're still in the progress of remodeling the Bellagio Spa tower, which will be completed in mid-December, and we'll have more rooms in service in the fourth quarter. Despite having more rooms available, we are seeing a somewhat better rate environment, and expect that RevPAR in the fourth quarter will be flat to slightly up for the year. Of course, we are watching closely the impact of storm Sandy on these numbers, but we are optimistic with that forecast for the quarter."
  • "Looking out into 2013, we're very encouraged to see that convention bookings, our pace is up over 10% year-over-year with rate up. Although it's early, 2014 pace is even stronger. We're currently pacing to have about 15% more arena events between the Mandalay Event Center and the MGM Grand Garden Arena next year versus this year. We believe that the new restaurant, night club and entertainment offerings that we have underway will continue to not only enhance the customer experience, but drive increased profitability throughout our Strip properties."
  • [Macau] "The mass market continues to grow strongly. We are confident there. VIP market is consistent, but it certainly slowed up and what we're looking at is probably numbers of growth going forward more consistent with the GDP growth of China rather than some of these accelerated growth rates that we've seen over the last two or three years.... We're looking at moderating the growth rates around that 8% to 10% while that the mass market we would expect to grow somewhat faster than that."
  • "You still have a fragile consumer out there and they're continuing to kind of pick their spots. We are seeing, particularly in the third quarter, we saw more reliance on leisure customers, which is a lower spend overall type of customer that we needed to dip into a little heavier than we did last third quarter and that is a lower spending customer. Going forward, we think we'll see an increase in international travelers."
  • [Sandy impact]: "We're going to lose about 4,000 room nights. It's approximately about – close to $1 million of revenue." 
  • [Macau costs] "I guess just the general overriding market pressures that everybody's aware of labor and the potential for increases in labor cost going forward. So that would probably be the only significant issue as far as I see it....labor is 5.4% of overall costs."

#AngryBears: SP500 Levels, Refreshed

Takeaway: There is no long-term resistance in the SP500 to the prior closing all-time highs (1565).

POSITION: 10 LONGS, 6 SHORTS @Hedgeye

 

Overbought signals come and go. They are very short-term in nature. We’ll get another one > 1528 in the SP500. But Bullish Formations (bullish TRADE, TREND, and TAIL) that are making higher-highs are tough to sell until you get those signals.

 

Across our core risk management durations, here are the lines that matter to me most:

 

  1. Immediate-term TRADE overbought = 1528
  2. Immediate-term TRADE support = 1516
  3. Intermediate-term TREND support = 1458

 

In other words, higher-lows and higher-highs are bullish, until they are not – that’s why we are trying to dynamically measure exhaustion within this Bullish Formation. As volatility drops, exhaustion can get more exhausted than a classical technician thinks.

 

Long-term, as you can see in the 10yr chart there is no long-term resistance in the SP500 to the prior closing all-time highs (1565). The Russell2000 has been making higher-all-time-highs, every other day.

 

Keep moving out there,

KM

 

Keith R. McCullough
Chief Executive Officer

 

#AngryBears: SP500 Levels, Refreshed - SPX


TUESDAY MORNING RISK MONITOR: HOW LONG CAN GOLDILOCKS LAST?

Takeaway: Europe's malaise lasts two weeks while the muni market pushes to new highs. Yields widen while risk declines; a very favorable backdrop.

Key Takeaways:

 

* In spite of the sentiment asymmetry (Financials sentiment remains an 8-9 on a 10 scale based on current levels of short interest), pressing the risk side of the trade continues to work for now. While we remain cautious that the data will show signs of turning in the intermediate term, the short-term shows no red flags as yet. For now, higher-beta Financials should continue to outperform.

 

* TED Spread – The TED spread fell 3.3 basis points last week, ending the week at 19.11 bps this week versus last week’s print of 22.4 bps. For reference, this is the lowest level for the TED Spread since a brief stint in late July 2011 in the 16-19 bps range.

 

* Markit MCDX Index Monitor – Spreads on 2016 muni bonds tightened by a further 10 bps, ending the week at 90.25 bps versus 100.49 bps the prior week. This index has been rapidly declining since year-end, and has been generally trending lower since its late 2011 highs (230 bps) following a call for the conditions of the municipal finance sector to deteriorate significantly. 

 

* 2-10 Spread – While spreads tightened 3 bps in the latest week to 171 bps, the trend here has been generally higher over the last two months. Spreads are up 30-40 bps since mid-December last year. 

 

Financial Risk Monitor Summary

 • Short-term(WoW): Positive / 6 of 12 improved / 0 out of 12 worsened / 7 of 12 unchanged

 • Intermediate-term(WoW): Positive / 7 of 12 improved / 2 out of 12 worsened / 4 of 12 unchanged

 • Long-term(WoW): Positive / 9 of 12 improved / 1 out of 12 worsened / 3 of 12 unchanged

 

TUESDAY MORNING RISK MONITOR: HOW LONG CAN GOLDILOCKS LAST? - 15

 

1. American Financial CDS -  All U.S. financials tightened except for Sallie Mae (+8 bps), Aon (+2 bps) and Marsh & McLennan (+7 bps). Large-cap U.S. Financials continue to post steadily decreasing risk profiles. Swaps tightened for 24 out of 27 domestic financial institutions.

Tightened the most WoW: RDN, MET, PRU

Widened the most WoW: MMC, AON, SLM

Tightened the most WoW: AGO, RDN, MBI

Widened the most MoM: MMC, COF, SLM

 

TUESDAY MORNING RISK MONITOR: HOW LONG CAN GOLDILOCKS LAST? - 1

 

2. European Financial CDS - EU financials CDS was near universally tighter last week, with the exception of Greek banks. The largest improvements were at French, Spanish and Italian banks. British and German banks were also improved.

 

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3. Asian Financial CDS - Swaps of major Aisan Financial companies were lower across the board with the exception of Daiwa, which was wider by 8 bps. Chinese banks posted the largest improvement.

 

TUESDAY MORNING RISK MONITOR: HOW LONG CAN GOLDILOCKS LAST? - 17

 

4. Sovereign CDS – Italy, Spain and Portugal posted sharp improvements with swaps tightening 30, 29 and 13 bps, respectively. Ireland was close behind with 12 bps of tightening. Portugal remains the most risky major EU country (ex-Greece) at 382 bps. Spain is next at 255 bps. The recent run-ups in these countries have faded and they are again trading near their multi-year lows. 

 

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5. High Yield (YTM) Monitor – High Yield rates fell 3.2 bps last week, ending the week at 6.08% versus 6.11% the prior week.

 

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6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 3.6 points last week, ending at 1769.

 

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7. TED Spread Monitor – The TED spread fell 3.3 basis points last week, ending the week at 19.11 this week versus last week’s print of 22.4. For reference, this is the lowest level for the TED Spread since a brief stint in late July 2011 in the 16-19 bps range.

 

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8. Journal of Commerce Commodity Price IndexThe JOC index fell -1.2 points, ending the week at 11.54 versus 12.7 the prior week.

 

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9. Euribor-OIS Spread – The Euribor-OIS spread was unchanged at 13 bps. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. 

 

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10. ECB Liquidity Recourse to the Deposit Facility – Deposits with the ECB Liquidity Facility continue to drop. Deposits are currently 124 billion Euros, down from 400 billion Euros in mid-2012, and down from over 800 billion throughout the first half of 2012. The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB.  Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system.  An increase in this metric shows that banks are borrowing from the ECB.  In other words, the deposit facility measures one element of the ECB response to the crisis.  

 

TUESDAY MORNING RISK MONITOR: HOW LONG CAN GOLDILOCKS LAST? - 10

 

11. Markit MCDX Index Monitor – Last week spreads on 2016 muni bonds tightened by a further 10 bps, ending the week at 90.25 bps versus 100.49 bps the prior week. This index has been in total freefall since year-end, and is generally trending lower since its late 2011 highs (230 bps) following a call for the muni market to deteriorate. The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 16-V1. 

 

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12. Chinese Steel – Steel prices in China were flat last week at 3,790 yuan/ton. While there is some concern this morning about Chinese property values, the price of Chinese steel has been moving generally higher since late November of 2012. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.

 

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13. 2-10 Spread – Last week the 2-10 spread tightened to 171 bps, -3 bps tighter than a week ago. Bigger picture, however, the 2-10 yield spread has been tracking generally wider since mid-December of last year, when it was in the mid-130 bps range. We track the 2-10 spread as an indicator of bank margin pressure.

 

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14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 1.0% upside to TRADE resistance and 1.5% downside to TRADE support.

 

TUESDAY MORNING RISK MONITOR: HOW LONG CAN GOLDILOCKS LAST? - 14

 

Joshua Steiner, CFA


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