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Expert Call: Professor Steve Keen

“Economics is too important to leave to the economists.”

  • Steve Keen

 

Hedgeye’s Macro Team hosted a call today with Steve Keen, renowned professor of economics and finance. at Australia’s University of Western Sydney.  Keen calls himself a “post-Keynesian” and is critical of today’s dominant neoclassical economics, which he calls inconsistent and unscientific.  Keen was hailed as “the economist who most cogently warned of the crisis” of 2007.  Alas, this recognition came in 2011.  The Real-World Economics Review said Keen’s work “is most likely to prevent future crises.”  Professor Keen may not be at the top of the list of candidates likely to replace Tim Geithner, but he graciously made himself available to our clients in an exclusive presentation.

 

Debt: The Real Thing

Professor Keen says contemporary economic theory rests on a misunderstanding of the roles that banks, debt and money play in an economy.  Economists didn’t see the financial crisis coming because they don’t understand that banks create leverage within the economy.  Neoclassical economists view banks as intermediaries who loan deposited cash.  Superstar neoclassical economist Paul Krugman says that when banks loan out savings deposits, it does not lead to an increase in demand.  This is because he assumes increases in debt automatically are offset by increases in the assets within an economy.  

 

But the balance between assets and liabilities is an accounting definition, not an economic truth, and Keen says debt is added to income to dynamically increase the money supply, spurring demand.  Keen defines “effective demand” as income, plus the change in debt.  When this debt-inflated money supply is invested, it leads to growth in an economy.  When it is used instead for speculation, it can lead to disaster.

 

Keen says private sector debt is completely ignored in policy debates, in the press, and in the work of most academic economists.  In a healthy and growing economy, private sector debt stokes growth by fueling demand in excess of the cash income in an economy.  

 

When private sector debt flows from economic goods to speculative investments – when the capitalist stops building factories to employ workers and starts building time-share developments on abandoned farmland – it causes prices of speculative goods to inflate.  Price inflation in speculative assets attracts more investment, which creates profits that are used to leverage and create more debt, which is further re-invested in the speculative goods.  This is the bizarre economic concept of a “Giffen good,” an item that is in more demand the higher the price goes, and becomes unattractive as the price goes down.  If you think this makes no sense, you’re right: just look at the stock market, where rising prices climax in a “melt-up” of panic buying, while price drops precipitate a flush-out as investors sell their losers in despair.

 

Work by Hedgeye Financial sector head Josh Steiner indicates that housing may behave like a Giffen good.  Steiner’s analysis implies that rising house prices cause increases in demand, which meshes with Professor Keen’s observation that increases in mortgage debt have an 85% correlation to increases in house prices.  

 

Keen also finds a close positive correlation between increases in margin debt, and increases in stock prices.  The higher the price of a stock goes, the more investors can borrow against it.  The more they borrow, the more stock they buy.  It should be obvious that this is a vicious cycle that invites disaster.  

 

Keen says the economic crisis can be explained simply by comparing private sector debt with public sector debt.  Private sector debt rose steadily as a percentage of GDP from 1993, then started to decelerate after 2007.  Professor Keen’s charts show clearly that public sector debt starts to increase at an accelerated rate in 2008-2009, as private sector debt is decreasing.  The annual change of private sector debt peaked at well above $4 trillion, dropping to an annual decline of $3 trillion in two years, a huge decline that chopped some $7 trillion out of the economy.  

 

Rising private sector debt is good for the economy until it isn’t, and then it can be disastrous.  There is a very high .94 negative correlation between private sector debt and unemployment.  Meanwhile, rising unemployment is .82 positively correlated with increases in public sector debt.  In short: rising unemployment causes governments to borrow, rising government debt creates economic activity, which creates jobs.  When there are enough jobs, there is excess income in the private sector, which makes them comfortable enough to start borrowing again.  Which creates jobs.  The definition of a virtuous cycle.  I think you have the causality backwards here: Normal debt levels affect the prices of goods and services.  Abnormal debt levels spill over into the prices of speculative goods.  Left to spiral out of control, increases in debt create instability which ultimately leads asset prices to crash.  When that happens, private sector debt retrenches quickly and severely. 

 

Meanwhile, government debt expands naturally to fill the void when private sector debt retracts.  Keen says politicians who harp on debt reduction are wrong on two counts: they don’t recognize that government debt is reactive, and that the government is not so much in control of levels of debt in the economy.  Worse, says Keen, despite Professor Bernanke’s fame as a scholar of the Great Depression, politicians and economists alike have not learned the lessons of history.  Efforts in the late 1930s to control the deficit sparked massive private sector deleveraging, which caused unemployment to nearly double, to 20%.  Says Keen, the only thing that bailed out the economy was WW II.  He fears the stage has been set for a repeat of the scenario, as policy makers try to rush to deleverage our economy.  


Keen says we are in the midst of a massive private sector deleveraging which could stretch out for twenty painful years, because policy makers refuse to take bold steps.  Excess debt will not be eliminated efficiently because the ways to accomplish this are politically dicey.

 

The simple answer is for the US to admit we made a whopper of a mistake by financing massive Ponzi schemes in the housing and stock markets.  The government could neutralize those mistakes by giving large quantities of cash to people in debt.  They would then pay down their debts and spend whatever was left over.  (You may recall, this was the original intent of the TARP program, to bail out troubled mortgages.)  Keen says our economy can’t get back to sensible levels of debt because timid policies will keep us locked in for the next 20 years.

 

Keen says it is not possible to clean up excess debt with a policy of 2% inflation – inflation has to approach ten per cent in order for it to take a meaningful bite out of public sector debt.  But no one can propose such a policy because it violates government and academic economists’ theories, because people fear inflation, and because Democrats and Republicans alike are caught in the shared fallacy of deficit reduction.  

 

Keen says the only way we will avoid a “lost 20 years” of deleveraging is if we are confronted with a phenomenon that hits us the way the Second World War stimulated our economy.  Keen muses that perhaps a major climate change event could scare the bejesus out of Americans and get us moving, but he is not very sanguine on the prospects of anything radical happening.

 

Until, and unless, such a galvanizing event comes around, Keen says policy steps that could grapple head on with our economic woes are too scary – politicians perceive the risk to their own careers as greater than the risks to the nation.  The situation will not change until that perception reverses.


Missing The Point

Client Talking Points

What Me Worry?

People sure have made a lot of noise over the past two days with the market not closing in the green. It’s really funny, because the S&P 500 is still up above 1500; looks like the permabears are upset because they missed the +177 point move to the upside in the S&P 500 from the November lows. These days, people will say the craziest things just to make their position hurt a little less. We’re bullish on #GrowthStabilizing and the US dollar, which is good for consumption which helps boost stocks. We’re also bullish on US housing and US employment. As for the commodity game, that’s where our bearish stance lies. Gold, silver and food we are particularly bearish on. Perhaps the stock permabears should switch their asset class; maybe then they’d get something right.

Asset Allocation

CASH 37% US EQUITIES 24%
INTL EQUITIES 24% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 15%

Top Long Ideas

Company Ticker Sector Duration
ASCA

We believe ASCA will receive a higher bid from another gaming competitor. Our valuation puts ASCA’s worth closer to $40.

FDX

With FedEx Express margins at a 30+ year low and 4-7 percentage points behind competitors, the opportunity for effective cost reductions appears significant. FedEx Ground is using its structural advantages to take market share from UPS. FDX competes in a highly consolidated industry with rational pricing. Both the Ground and Express divisions could be separately worth more than FDX’s current market value, in our view.

HOLX

HOLX remains one of our favorite longer-term fundamental growth companies given growing penetration of its 3D Tomo platform and high leverage to the 2014 Insurance Expansion from the Affordable Care Act.

Three for the Road

TWEET OF THE DAY

“Studies show, Caffeine can cause you to be more open-minded to viewpoints that contradict your own.” -@petenajarian

 

QUOTE OF THE DAY

“The public will believe anything, so long as it is not founded on truth.” -Edith Sitwell

STAT OF THE DAY

CRB Commodities Index is down -4% for the month. Strong Dollar = Weak Commodities.


DRI STILL RIDING OUT THE STORM

In 2009, at the height of the financial crisis, the theme of the Darden Analyst Meeting was “Riding Out The Storm”.  The company could recycle that theme for this year’s Analyst Meeting but the company’s recent troubles have been self-inflicted. 

 

This morning, Darden guided to 3Q EPS of $1.00-1.02 versus the Street at $1.12.  We continue to expect EPS of $3.00 for FY13 versus $3.39 consensus.  The table below highlights the shortfall, in terms of consensus, of the pre-released same-restaurant sales results released by Darden this morning. 

 

DRI STILL RIDING OUT THE STORM - dri sss vs consensus

 

 

Capital Allocation

 

For a company of Darden’s size, following a growth mandate, it’s important for the company’s shareholders that the Return on Incremental Invested Capital metric is not declining steadily over time.  As the chart below illustrates, that has been the case.  For our position on the stock to change, we would need to see a stop to the growth of The Olive Garden and Red Lobster concepts and a slowing of the growth of LongHorn Steakhouse.  This will enable management to improve operations and restaurant-level performance.  We estimate that, since the end of 2009, Darden has spent over $2.35 billion in CapEx to generate only $198 million in incremental EBITDA.  That is not sustainable and shareholders should be seeking a change in philosophy from management: from “growth” to “prudent capital allocation”. 

 

DRI STILL RIDING OUT THE STORM - DRI ROIIC

 

 

Cutting the Fat

 

Darden has a hefty corporate structure, which is appropriate given that it manages over 2,000 restaurants within eight different concepts.  In trying to gauge whether or not the company is run efficiently, we have considered SG&A spending per store versus other operators within the industry.  While the G&A of Brinker may not be completely comparable to the SG&A line item of Darden, it is interesting to note that the aforementioned line item of Darden’s, on a per store basis, is almost twice that of Brinker, also on a per store basis.  If Darden can approach the efficiency level of Brinker in terms of its SG&A spending, we estimate that the benefit could be as much as $400 or $2.25 per share.

 

 

Whale Hunting Private Equity Firms

 

If difficult decisions are not made, it is likely that this company ends up in the hands of private equity with the company being broken into two pieces: Olive Garden and Seasons 52 (Italian) and Red Lobster, Eddie V’s and LongHorn (Steak and Seafood).  The other brands would likely be sold with Yardhouse going public.  To-date, there has been little pressure on management from shareholders to make any difficult decisions but, as the stock price goes lower, pressure is sure to follow.

 

 

The Upcoming Analyst Day

 

We are expecting management to stick with the party line during the Darden Analyst Meeting next week:

  • New Menus at Red Lobster and The Olive Garden
  • Remodel initiatives at The Olive Garden
  • Discounting
  • New leadership at the brand level
  • Inflation expectations
  • Growth initiatives
  • Supply chain efficiencies

 

We will know more about management’s vision for the future next week.  Unfortunately for those that own the shares, we don’t anticipate an increased focus on the core business and the issues therein.  We expect $3.00 in EPS for FY13 versus consensus of $3.39.  The road to recovery is not going to be easy for Darden but getting serious about fixing the core business is the sign that they are on the way.

 

 

Howard Penney

Managing Director

 

Rory Green

Senior Analyst


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GENTING SINGAPORE: BIG MOVE BUT WE STILL LIKE IT

Strong quarter drives stock price in and out of the quarter.  Improving fundamentals, strong cash flow, and potential new markets keep us excited.

 

 

We think Q4 was the first of many solid quarters from Genting Singapore.  So even though the stock is up 20% since we turned bullish following our trip there in December, we remain positive.  The company is building a warship of cash as capex subsides, earnings are stabilizing, and the promise of new Asian markets may move to the forefront in the coming months.

 

While Genting Singapore’s EBITDA missed our estimate primarily due to hold, gaming volumes were better than expected.  Mass and slot revenue exceeded estimates.  VIP RC volume grew 56% vs. our estimate of 35% growth but hold was below the company’s historical average of 3.19%, so on the margin, gross VIP revenues were only 5% ahead of our estimate.  Better GGR was offset by higher rebates, GST, gaming points, comps/MVP's & other which rose to 37% of GGR from under 34% the in 2Q and 3Q12.

 

 

4Q12 Detail:

  • Gross gaming revenue of S$998MM on net gaming revenue of S$627MM
    • Rebates, GST & mass marketing points of S$371MM; equal to 37.2% of GGR , a large increase from 3Q12 at 33.7% and 27.7% in 4Q11
    • Gross VIP revenue of S$363MM and net VIP revenue of S$190MM
      • Just to clarify, when the Company says that Net RC revenues are 28% of Net Casino revenue, they are not just referring to the rebate on VIP but ALL discounts offered on gaming play (ie, Rebates, Mass points, GST, comps, MVP’s and other).
      • 56% of GGR
      • RC turnover: S$18.6BN up 56% YoY (51% market share)
      • Hold rate: 3.0%
    • Mass win of S$285MM up 2% YoY and flat QoQ
      • Drop of S$1.19BN and hold of 24%
  • Slot & ETG win S$155MM
    • Handle up 2.5% YoY to S$2.98BN
  • Non-gaming revenues were a little better than we estimated
    • We estimate that the Marine Life Park contributed $7MM of revenues to the quarter
      • $29 ticket pricing, but the actual price is closer to $23 due to the number of package deals being sold.
  • Expenses:
    • Gaming tax: S$88.6MM
    • Bad debt charge: S$43MM or 7.7% of Gross VIP which was in-line with the 2012 average but up YoY
    • Estimated fixed costs: S$206MM up from S$169MM in 3Q12 and S$195MM in 4Q11

THE HEDGEYE DAILY OUTLOOK

TODAY’S S&P 500 SET-UP – February 22, 2013


As we look at today's setup for the S&P 500, the range is 16 points or -0.70% downside to 1513 and 1.77% upside to 1529.  

                                                                                                                             

SECTOR AND GLOBAL PERFORMANCE


THE HEDGEYE DAILY OUTLOOK - 1

 

THE HEDGEYE DAILY OUTLOOK - 2

 

THE HEDGEYE DAILY OUTLOOK - 3

 

THE HEDGEYE DAILY OUTLOOK - 4

 

EQUITY SENTIMENT:


THE HEDGEYE DAILY OUTLOOK - 10


CREDIT/ECONOMIC MARKET LOOK:

  • YIELD CURVE: 1.74 from 1.73
  • VIX  closed at 15.22 1 day percent change of 3.68%

MACRO DATA POINTS (Bloomberg Estimates):

  • 10:30am: Fed’s Powell, Rosengren speak in New York
  • 11am: Fed to buy $1.25b-$1.75b notes in 2036-2043 sector
  • 1pm: Baker Hughes rig count
  • 6:30pm: Fed’s Tarullo speaks on regulation in New York

GOVERNMENT:                                        

    • Obama hosts lunch mtg w/ Japanese Prime Minister Shinzo Abe
    • Defense Sec Leon Panetta attends NATO mtg in Brussels
    • 8am: HHS, FDA to discuss, vote on pre-mkt approval of NeuroPace Responsive Neurostimulation System
    • 3pm: Sec. of State John Kerry meets with Japanese Minister of Foreign Affairs Fumio Kishida

WHAT TO WATCH

  • Gardner Denver to release earnings, may update on sale
  • KKR said to offer ~$3.68b for Gardner Denver
  • Bernanke said to minimize asset-bubble concern at dealer meeting
  • Boeing said to present battery redesign for 787 to FAA
  • Tosoh develops material that may help solve B787’s battery issue: Nikkei
  • Bausch & Lomb owner Warburg Pincus said to seek banks for IPO
  • BOE, PBOC discussing 3yr pound/renminbi swap arrangement
  • S&P probe by Massachusetts said to extend to post-crisis ratings
  • Euro-area economy to shrink, Spain deficit widened, EU says
  • Elan plans $1b share repurchase
  • German IFO business confidence rises more than forecast
  • China’s new home prices rise for 3rd month
  • ING to name Ralph Hamers CEO
  • Alcatel-Lucent names Michel Combes CEO; France said to weigh stake
  • EMA Preview: Glaxo, Sanofi, Pfizer, J&J, Roche, Takeda
  • 85th annual Academy Awards ceremony to take place Sunday
  • Anschutz Entertainment bids are below asking price: NY Post
  • Bernanke, Italian Election, Oscars: Wk Ahead Feb. 23-March 2

EARNINGS:

    • Enerplus (ERF CN) 6am, C$0.12
    • Gardner Denver (GDI) 6:30am, $1.35
    • Barnes Group (B) 6:30am, $0.51
    • Eldorado Gold (ELD CN) 7am, $0.15
    • Cyberonics (CYBX) 7am, $0.39
    • Interpublic (IPG) 7am, $0.53
    • Selectome REIT (SIR) 7am, $0.72
    • Abercrombie & Fitch (ANF) 7am, $1.96 - Preview
    • NV Energy (NVE) 7am, $0.07
    • Mobile Mini (MINI) 7:30am, $0.30
    • HMS Holdings (HMSY) 7:30am, $0.26
    • Warner Chilcott (WCRX) 7:30am , $0.73
    • Charter Communications (CHTR) 8am, $0.06
    • Pinnacle West Capital (PNW) 8am, $0.17
    • Washington Post (WPO) 8:30am, NA

COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)

  • Nickel Narrows Biggest Drop Since 2011 as Slump Attracts Buying
  • Sugar Traders Most Bullish Since October on Ethanol: Commodities
  • Soybeans Head for Longest Rally Since April on Chinese Demand
  • Gold Cuts Third Weekly Drop as Slide to 7-Month Low Spurs Demand
  • Brent Crude Rises, Paring Biggest Weekly Decline Since December
  • Coffee Rises as Investors May Cut Bearish Bets After Price Drop
  • Soybeans Held at Brazil Ports Boost Prices in China, Wilmar Says
  • China’s Grain Supply in ‘Structrual Shortage’, Minister Says
  • Gas Curve Shows Export Profit as Obama Hosts Abe: Energy Markets
  • Crude May Fall as Weak Demand Boosts Inventories, Survey Shows
  • India Seen Raising Cooking Oil Import Taxes to Protect Growers
  • U.S. Forecasts ‘Modest Further Rise’ in Gasoline Prices at Pump
  • Gasoline Rally Seen Fueling U.S. Stock Losses: Chart of the Day
  • Record Sugar Output in India’s Top Grower Seen Curbing Imports

THE HEDGEYE DAILY OUTLOOK - 5

 

CURRENCIES


THE HEDGEYE DAILY OUTLOOK - 6

 

EUROPEAN MARKETS

 

THE HEDGEYE DAILY OUTLOOK - 7

 

ASIAN MARKETS

 

THE HEDGEYE DAILY OUTLOOK - 8

 

 

MIDDLE EAST


THE HEDGEYE DAILY OUTLOOK - 9

 

 

The Hedgeye Macro Team

 

 

 

 



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