“The Great Recession was not an unpredictable ‘Black Swan’ event, but an almost blindingly obvious certainty.”
Yesterday was emblematic of the news flow that dominates today’s financial markets. Speaker of the House, John Boehner, published a scathing op-ed in the Wall Street Journal that criticized President Obama over the looming sequester, calling it “a product of the president’s own failed leadership.”
Hours later, the Federal Reserve released the minutes from its January 29 – 30 Federal Open Market Committee (FOMC) meeting. As soon as the robots read that “Many FOMC participants voiced concern about risks of more QE,” gold gapped down, the USD jumped, and stocks slid into the close.
These are the days of our centrally-planned lives.
Given the undeniable impact that both monetary and fiscal policies have on the disposable income in your pocket, the interest earned on your life’s savings, and the asset prices in your portfolios, it’s fair to ask some tough questions of those making the decisions:
- What caused the financial crisis and subsequent “Great Recession” which we are still mired in (as a reminder, US real GDP was -0.1% in 4Q12)?
- Why didn’t you see the crisis coming?
- What are you doing to lift us out of the current recessionary-like environment, and why do you believe these policies will work?
At 2PM EST today, the Hedgeye Macro Team will host a conference call for institutional clients with economist Steve Keen to get his views on those questions and more. Email if you would like to participate in the call.
Professor Keen predicted the financial crisis as long ago as 2005, and was recognized by his peers for his work when he received the Revere Award from the Real-World Economics Review for “being the economist who most cogently warned of the crisis, and whose work is most likely to prevent future crises” (Keen 2011). He collected twice as many votes as the runner-up, Nouriel Roubini. His book Debunking Economics and other works are super-critical of mainstream economics (“neoclassical” economics – think Bernanke and Krugman), and succinctly describe his own theories on monetary macroeconomics, which are built on the foundations of money, banks, debt, instability, and complexity.
Professor Keen quips, “Bernanke’s Essays on the Great Depression is near the top of my stack of books that indicate how poorly neoclassical economists understand capitalism,” and that “Krugman himself is unlikely to stop walking on two hind legs – he enjoys standing out in the crowd of neoclassical quadrupeds” (Keen 2011). Professor Keen likes to take shots at Bernanke and Krugman… Sounds like a Hedgeye kind of guy!
One topic that Professor Keen is an expert on that is generally absent from macroeconomic discussion is the relationship between private sector debt and growth. Debt of any kind – government, financial, mortgage, credit card – is often ignored in mainstream economics due to the argument that “one man’s liability is another man’s asset,” so that the total level of debt has no economic impact (which Keen refutes). It was really only after Carmen Reinhart and Kenneth Rogoff published their New York Times Bestseller This Time is Different, and sovereign bond yields in Europe’s periphery started to spike, that economists and market participants began speaking to the aggregate level of debt more seriously, but it was often only government debt.
The now widely-held opinion is that excessive sovereign debt will eventually impede growth. But Professor Keen has empirically demonstrated that this claim is too simplistic, and fails to explain why public debt increases in the first place.
Consider that in 2007 US public debt was less than 60% of GDP, while private sector debt was 300% of GDP, up from 110% in 1980. A massive private sector debt bubble grew for nearly 30 years while public sector debt remained fairly constant (see our Chart of the Day below). It was only after the private debt bubble burst in 2008 that public sector debt began to lever up. Why?
The correlation (2000 – present) between private debt and unemployment is -0.94. The correlation between government debt and unemployment is +0.82.
In a recession tax payers lose jobs and go on some type of welfare – for a government that equates to tax receipts down and outlays up. To fund the delta, the government borrows. In 2007, US government revenues were 18.5% of GDP; that fell to 15.1% of GDP by 2009 and only recovered to 15.8% of GDP in 2012. On the other side of the ledger, outlays were 19.7% of GDP in 2007 and jumped to 25.2% of GDP in 2009 – the majority of that increase was “mandatory” outlays. In fact, only 36% of US government spending is deemed “discretionary,” and 17% is discretionary “non-defense.”
The point is that public sector debt is reactionary. While it’s popular to deride politicians about mounting debts and deficits (and indeed politicians do this to each other), they have less control than most know. Increasing public sector debt is the symptom, not the disease. The disease is a private sector debt bubble that bursts, and is slowly deflating from a still very high level (~240% of GDP today).
The blame lies with the economists that allowed, and in fact assisted, the private sector debt bubble to grow to a dangerous, unsustainable level (because debt doesn’t matter in their models) – the same economists that are today charged with cleaning up the mess.
In describing “The Great Moderation,” Bernanke said in 2004, “Improved monetary policy has likely made an important contribution not only to the reduced volatility of inflation but to the reduced volatility of output as well.”
Does Bernanke and co. still believe their monetary policies to be a panacea? Probably. But how can they solve for the crisis if they continue to ignore its cause – a heavily-indebted, deleveraging private sector?
Professor Keen believes that we could be in for many years of a drawn out deflationary crisis, as private debt is still ignored in public policy. We hope he’s wrong about that, but are looking forward to learning more from Professor Keen on our call with him today.
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, and the SP500 are now $1 (bearish/oversold), $112.94-115.89, $80.29-80.99, 92.64-94.36, 1.97-2.05% and 1, respectively.
This note was originally published at 8am on February 07, 2013 for Hedgeye subscribers.
“We have to remember we're in a global economy. The purpose of fiscal stimulus is not simply to sustain activity in our national economies, but to help the global economy as well, and that's why it's so critical that measures in those packages avoid anything that smacks of protectionism."
-Prime Minister Stephen Harper
Next week Keith and I will be taking the show on the road to London. Our top notch sales team has set up a great schedule and we will be engaging with 20+ of the largest investment firms in London. Without a doubt, it will be interesting to get a sense for sentiment, outlook and flows from another continent. At the end of the week, we may even peak our heads into a pub. (If you are a London based fund, we still have a few slots left so email firstname.lastname@example.org if you want to set up a meeting.)
Canadian Prime Minister Stephen Harper knows a thing or two about free market capitalism. In fact, Harper went so far as to export the head of his central bank, Mark Carney, to England. As the newly anointed Governor of the Bank of England, Carney is already feeling the heat in British Parliament this morning in his first grilling. On the topic of the Bank of England independence, Carney minutes stated:
“There is no question about my independence as governor of the Bank of England. There is a governance structure that has been put in place, there is an absolutely clear structure.”
So, if the politicians of England were looking for a patsy, it would seem, at least for now, Carney is not their man.
The benefit for Carney is that the U.K. appears to be starting to see stabilizing growth, even as the rest of Europe is still struggling. The most recent British data point is December industrial trade production that was up 1.1% from November to December. Certainly that’s not a growth statistic to get overly excited about, but on the back of U.K. home prices that were up 1.3% in January and January services PMI that was reported at 51.5. Meanwhile, the Eurozone in total reported a PMI of 48.6, which signifies contraction.
Not surprisingly, the New York Times has been critical of Prime Minister David Cameron’s decision to get the fiscal house in order as a path to long term sustainable growth. In fact, in a recent article titled, “God Save The British Economy”, Adam Davidson argues that Cameron’s decision to cut government spending to eliminate crowding out of the private sector has hurt the British economy vis-à-vis the American economy.
The funny thing is that in the fourth quarter of 2012 while the British economy shrank -0.3% sequentially, the U.S. economy didn’t fare much better at a -0.1% sequential decline. Meanwhile, the U.K. has been steadily improving its fiscal situation with a debt-to-GDP of 88% versus the U.S. at 107%. Whether you are a Keynesian or not, in the long run we all likely agree that the less government money that is used to service government debt, the better an economy will fare.
While I am on the topic, today is set to be an interesting day in Europe with the beginning of the two day EU summit kicking off in Brussels. Undoubtedly, a key topic will be the recent strength of the Euro, especially versus the Japanese Yen. Perversely as both the Europeans and Japanese actively try to devalue, with both rhetoric and policy, it should be increasingly positive for the U.S. dollar and consumption in the U.S. Consumption, of course, is 70% of the U.S. economy.
In the short run, though, U.S. equities are starting to price in stabilization of economic growth. To us, this looks like a spot to reduce some equity exposure and cover bonds and gold, especially with the SP500 up a quick 5%+ on the year and the VIX at 13.4. Meanwhile, insiders, based on a report out yesterday, are selling at a level of 9.2:1, the highest level since the equity sell off in 2011.
On a company level, I wanted to highlight our short call yesterday on Gulf Port Energy, with the ticker GPOR. Energy is followed by Senior Analyst Kevin Kaiser and put together a very thoughtful presentation of some 60 pages that walks through the history of the company and a sum-of-the-parts valuation. The nut of it all is that we think GPOR is one of the better shorts in energy for the following reasons:
- Sentiment is extremely positive with 15 buys and 1 hold, and the stock is trading at literally a 52-week high;
- Former majority shareholder Wexford Capital has exited their entire position in GPOR;
- Consensus numbers appear too high for this year and next (as evidenced by yesterday’s pre-release);
- GPOR is expensive trading at $94 EV / proven reserves ($/boe) versus the peer group at $16; and
- Our NAV valuation gets us to ~$22 per share versus the current stock price of ~$40.
Obviously, when you make a short call on a stock it raises the ire of some and interest of others. The beautiful thing about being Hedgeye is that we have no banking, trading, or asset management. We get paid to simply generate compelling investment ideas and do great research. A simple enough concept, though a concept not always embodied in the hallowed halls of Wall Street 1.0.
As Sigmund Freud once said:
"Flowers are restful to look at. They have neither emotions nor conflicts."
The Hedgeye research team is many things, but wall flowers they are not. Thankfully, we are also not conflicted.
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, EUR/USD, USD/YEN, UST 10yr Yield, and the SP500 are now $1651-1686, $115.14-117.86, $79.41-79.99, $1.34-1.36, 91.93-94.31, 1.96-2.05%, and 1492-1517, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
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VIP volume growth was huge as we expected and outlook positive, but luck was just average.
"With RWS fully opened, Genting Singapore continued to look for opportunities to grow the Company. As we gradually build up capacity in the Marine Life Park, our EBITDA margins will continue to be constrained for the first half of 2013. As major capital expenditure for Singapore IR tails off in the second half of 2013 and the attractions business more settled, RWS will achieve a more steady-state profit margin. The global economic outlook appears more positive this year and we are cautiously optimistic of the performance of RWS. The Group continues to actively pursue ventures within our core expertise in the gaming, hospitality and leisure/entertainment sectors that will provide medium term growth and long term value to our shareholders."
- November: new Jurong Hotel (500 rooms, will open 2H 2015)
- Marine Life Park: since opening, it has surpassed 600,000 visitor mark;
- GGR: +25% QoQ; suggesting close to S$1BN
- VIP RC: hit highest level since Q1 2011
- 4Q VIP Hold rate: 3% vs. 3.82% last year
- VIP outlook: much more optimsitc than 4-5 months ago
- China: new leadership; more settled environment
- Non-gaming business doing very well; encouraged by MLP visitation #s
- VIP mix: a lot of new players;
- Trade receivables: aging has been the same but provision has been increased; nothing out of the ordinary (mostly on the older receivables)
- Mass win rate: 24%; win % has been creeping up due to change in table mix
- Mass revenues QoQ and YoY: up low single digit
- Chinese customers overwhelming the casino
- Did not see a significant increase in rebates/commissions
- VIP/Mass breakout:
- net gaming revenue: 42%/58%
- gross gaming revenue: 56%/44%; (51%/49% (for FY 2012))
- Marine Life Park (MLP): has priced admission fee low in the first few months to drive interest; current capacity is only 2,000 people at one time; at the end of 2013, they will raise prices and increase capacity.
- The docking area for MLP still has not opened but they hope to open it in the next few months
- EBITDA margin will stabilize in the 2nd half of 2013
- Korea will not open up to local gaming; probably won't see anything happen in the next 2 years
- Japan: optimistic on legalization; a bill will probably reach the Diet in Fall 2013
- Mass: Small decline in local business
- There will be more low cost carriers from Southeast Asia to Singapore
- Why not hike dividend?
- Still looking at couple of new/existing projects--probably will not need cash (if Japan opens) until 2 years down the road
- VIP (12-18 month basis): trend is good
- Other EBITDA of S$13MM: investments
- Non-gaming EBITDA growth: slower growth than the non-gaming revenue growth due to MLP
- Jurong hotel: should not cost more than S$150MM
- Receivables comfort zone: S$1.1-1.2 billion
- Villas are well-received by gaming customers
- International Marketing Agents (IMA) haven't been doing much business: only 2% of rolling volume.
HIGHLIGHTS FROM RELEASE
- RWS Adjusted EBITDA S$356.1MM and revenue of S$791.4MM
- Comparing to the fourth quarter of 2011, the business volume in the premium players segment improved significantly by 56%. However, this was offset by weaker win percentage in the premium players business.
- Non-gaming revenue continues to show healthy growth of 19%
- Hotel business: occupancy of 91% and ADR of S$447
- The daily average visitation to Universal Studios Singapore (“USS”) increased to 11,100 visitors with average spending of S$86.
- The much anticipated Marine Life Park (“MLP”) opened in November 2012, drawing an average daily visitation rate of 7,100 within a short period of 40 days.
- Adjusted EBITDA was affected by higher impairment loss on trade receivable and higher operating costs incurred for the opening of MLP.
- On 23 November 2012, Tamerton Pte Ltd, a wholly-owned subsidiary of Genting Singapore was awarded a hotel site at Jurong Town Hall Road, Singapore. The hotel will help to provide over 500 rooms that will contribute significantly to non-gaming revenue, and more importantly provide a source of ready visitors to the attractions and gaming facilities at RWS. Set to open in 2015, it will be the first hotel to open in the Jurong Lake precinct
- The Casino Regulatory Authority of Singapore has approved our application for the renewal of our casino licence agreement for another three years commencing 6 February 2013
- During the financial year ended 31 December 2012, the Group invested in a portfolio of quoted securities, unquoted equity investment and compounded financial instruments amounting to a net total of S$973.4 million.
- FY2012 Capex: S$503.6MM
- Introduced a tax extempt dividend of 1 cent per share, subject to shareholder approval at the next Annual General Meeting of the Company
HSH carries the day, and looking back on our assessment of Day 1 we see some similarities between KRFT and HSH, so you can see that we are looking at companies that have the ability to effect change on the margin. That lens does a disservice to a name like HSY that is simply executing very well, but aren’t doing anything “interesting” relative to the recent past.
The company is focused on four pillars of growth – global cereal, global snacks, regional frozen foods and emerging markets. Company believes that cereal can be a growth category, but needs to expand the definition of when cereal is consumed (expand in and out of the bowl). Keebler plus Pringles can be a leader in global snacking – frozen food is just a regional business at this point. Supply chain issues that have plagued the company are in the rear view mirror. 5% cost inflation versus 4% savings, very manageable and smallest gap in years actually turns to a tailwind in 2H. U.S. consumer remains under pressure, but any weakness can be offset with Pringles synergies – good visibility into 2013 numbers. The Pringles integration is going well – huge global brand, and now the second biggest brand in K portfolio. Pringles’ top line growth in ’12 exceeded company’s expectations and heavy lifting is behind the company. Good, solid, if unsexy story.
Philip Morris International (PM)
The company provided a look back at 2012 – a year that saw the company gain share in every region and deliver at the high end of expectations across multiple metrics. The company sees a “rational excise tax environment” – I am not necessarily sure such a thing exists (Philippines). The European Union proposal on tobacco products is flawed and not supported by science (according to PM) – while I agree, not sure hoping for rational behavior on the part of national or supra-national entities is a sound strategy. PM is not hopeful that EU operating environment improves meaningfully in 2013 given some of the conditions it sees as necessary for improvement. Asia has been a spectacular growth vehicle for the company – Indonesia in particular. The company is expecting a 20-25% volume decline in the Philippines due to excise tax increase, but limited operating income impact – tough to model that one right now.
Campbell Soup (CPB)
Campbell Soup – it all starts with stabilizing the core and returning soup and simple meals to profitable growth – that is the base that allows the rest of the strategic vision to be executed. I think citing some recent numbers for the soups and simple meals ignores the fact the segment has a demographic issue (soup skews older) that isn’t quickly corrected, if at all. I do have to applaud the company for some recent innovations and line extensions – that’s the cost of doing business in packaged food and the company had been trying to avoid that cost for a long time. North American beverages have now become the problem child – input cost inflation and competitor activity. The company sees input costs moderating in ’13. Arnott’s is focusing on improved execution after a difficult year. Company has in place a new innovation process (not sure it actually had an old process). Bolthouse Farms is exceeding both top line and bottom line expectations thus far – not sure chopped carrots are the wave of the future for the company.
Nestle (NESN VX)
Presentation focused on Zone Americas – very “informal” presentation (no slides) that probably could have used a little more structure and fewer personal anecdotes. The size and diversity (and success) of Nestlé’s business didn’t do Chris Johnson (Head of Zone Americas) any favors – he bounced from business to business and geography to geography. I think the intention was to provide a “clean” overview of a complex business, but it came out as a bit of a hodge-podge, without any clear sense of what makes the company best in class. Mr. Johnson did highlight the weakness of the frozen category – no real news there. He also admitted to challenges in ice cream, and has spent more time on what’s wrong (probably in an effort to seem “balanced”) than what is going right (the bulk of the portfolio). Given the quality of the “source” material, the company could have really “played a blinder” here and instead missed the mark.
Hillshire Brands (HSH)
Hillshire is the old Sara Lee, but only in the sense that the company has some of the brands – company has moved headquarters and is in the process of reinventing itself after years of neglect (sounds a little like KRFT in that regard). Most impressive slide of presentation – company was shrinking, now it is growing – testament to the fact that brands do respond to marketing. “Give the brands some attention” could have been the title of the presentation. The company still has room to grow relative to the household penetration of both its categories and its brands. The company was one of the leading innovators in the lunch meat category then “took the next few years off”. Long-term target is increasing MAP (media, advertising and promotional) spending to 5% of sales – used to be 3.5%. Brands can wither and die if you don’t feed them – advertise. The company may be limited by the category in which it competes, but management here seems to get it. I wonder if, after management does the fixer-upper thing, they just don’t sell the house?
From field to food to fuel – getting the crops from where grown to where consumed is what Bunge does, and that is a powerful long-term thesis, in my view. The company is in a growth business – leveraged to population growth, urbanization and the growth of the global middle class. All of that combined leads to growth in global agricultural trade – BG is an “expert in managing physical flows”. BG does sugar ethanol, not corn ethanol (very small) – corn ethanol assets and investments is one of our concerns with respect to ADM. The world is shifting to South America to meet demand shortfall, which should lead to high utilization of BG’s assets in that region. “As income grows, diets contain more vegetable oil and more protein” – right in BG’s wheelhouse – soybean meal. Importantly, trade will increase more rapidly than demand because of a disparity in where the crops are grown versus where the population and demand growth is located. The company will reach its cost of capital this year, with sugar being below – expect sugar to catch up in ’15.
The company has been about predictable, profitable and sustainable growth, so makes sense that the presentation leads in with those words. One thing most investors might not know is that HSY is more than just U.S chocolate – after many years of missteps, company is on pace to deliver $1 billion of sales outside the U.S and Canada by 2014. Global confectionary category has been growing at 5% per year and is fundamentally advantaged. Impulse nature of category means very high checkout conversion rate so very profitable for retailers and HSY and as category leader, HSY has been driving the category and has outpaced the growth of the category. Hershey makes it seem easy, but advertising and supporting the base and growing from a position of strength just makes sense.
Coca-Cola Enterprises (CCE)
No big surprises out of CCE – the dominant theme was growing its successful portfolio of iconic brands and returning cash to shareholders on its history of solid, balanced growth. It maintains its long-term growth targets of 4-6% net sales; 6-8% operating income; and high single digit EPS. CCE noted such risks as the macroeconomic environment, commodity cost inflation (COGS at 4% in 2013), changing consumer tastes (towards health), new and existing taxes on products and packaging, and lapping the Olympics. CCE is targeting higher volume growth over pricing in 2013 with an increased marketing spend to drive its core brands and entrance into the discount channel (Lidl and Aldi), albeit with distinctive packaging. Its target of $500MM in share repurchases by the end of 2013 and dividend boost by 25% should continue to attract investors.
HEDGEYE RISK MANAGEMENT, LLC
Today we bought the iShares Dow Jones US Home Construction ETF (ITB) at $22.17 a share at 3:08 PM EDT in our Real-Time Alerts. We thought this morning's Housing Starts were better than manic media views (single homes +0.8% sequentially) and tomorrow we have a catalyst - Existing Home Sales. Buying back Housing on the signal. #HousingsHammer is still in play.