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LAND HO!: “ESCAPE VELOCITY” ON THE HORIZON?

Takeaway: A continued breakdown of investors’ perception of tail risk bodes well for domestic capital markets and economic growth.

SUMMARY CONCLUSIONS:

 

  • With spot VIX itself having broke down to new post-crisis lows in recent weeks (and still bearish-TREND on our quantitative factoring), we are encouraged to see that the rolling premium for 6M-forward VIX is also breaking down hard from its recent post-crisis peak.
  • To the extent this trend does continue as we navigate the confluence of near-term domestic fiscal policy catalysts, we could be looking at a scenario six months from now where the ever-elusive “escape velocity” becomes a probable scenario to risk manage. 
  • By “escape velocity”, we are referring to a rather bullish environment where implied volatility across domestic capital markets trades sustainably lower (a la 2003-07) amid a commensurate pickup in economic activity and the velocity of money.
  • At any rate, hope remains no investment process and we definitely need to see more data to support this narrative.

 

Shortly after our morning call yesterday, a very astute client and equally-shrewd investor asked us: “Can you explain to me what the implication of the ‘term structure of the VIX’ coming down means versus the spot VIX index coming down?”

 

Simply put, investors paying up less for perceived tail risk is a bullish indicator for US equities, as it would indicate that investors are beginning the process of closing the book on the 2008-09 financial crisis once and for all – implying that they may be increasingly comfortable with taking on more risk.

 

To the extent these signals are being driven by requests from their clients or as a result of improved corporate sentiment, the recent breakdown in the term structure of the VIX curve may turn out to be a favorable signal for the domestic economy as a whole.

 

Technically speaking, “history” (i.e. we only have data going back to 2004) shows us that the premium investors are willing to pay for 6M-forward VIX relative to spot VIX should oscillate around +20%, with any major drawdowns in that premium typically being accompanied by a melt-up in spot prices. Looking at the data through the prism of a 3M moving average (to smooth out the inevitable S/T outliers), we’ve seen that premium widen to as high as a double (i.e. +40%) in the post-crisis era.

 

With spot VIX itself having broke down to new post-crisis lows in recent weeks (and still bearish-TREND on our quantitative factoring), we are encouraged to see that the rolling premium for 6M-forward VIX is also breaking down hard from its recent post-crisis peak.

 

LAND HO!: “ESCAPE VELOCITY” ON THE HORIZON? - 1

 

LAND HO!: “ESCAPE VELOCITY” ON THE HORIZON? - 2

 

LAND HO!: “ESCAPE VELOCITY” ON THE HORIZON? - 3

 

To the extent this trend does continue as we navigate the confluence of near-term domestic fiscal policy catalysts, we could be looking at a scenario six months from now where the ever-elusive “escape velocity” becomes a probable scenario to risk manage. By “escape velocity”, we are referring to a rather bullish environment where implied volatility across domestic capital markets trades sustainably lower (a la 2003-07) amid a commensurate pickup in economic activity and the velocity of money.

 

LAND HO!: “ESCAPE VELOCITY” ON THE HORIZON? - 4

 

At any rate, hope remains no investment process and we definitely need to see more data to support this narrative. Still, it’s always fun to dream…

                                                                                                                                                                                                                   

Happy Friday,

 

Darius Dale

Senior Analyst


THE BAD NEWS IS OUT OF THE WAY IN CHINA

Takeaway: While this latest round of tightening measures is definitely impactful, they are not nearly as negative as we initially feared.

SUMMARY CONCLUSIONS:

 

  • China’s official Manufacturing PMI report was particularly bad “underneath the hood” (New Orders, New Export Orders and Purchasing of Inputs all down over 1ppt). As we have mentioned many times before, however, any sequential readings in Chinese (and, by extension, Asian) growth data from JAN to FEB will be distorted by the timing of the Lunar New Year festival, which was entirely in FEB this year after being a JAN event last year. We reiterate that the MAR growth figures will be the first true test of our Asian #GrowthStabilizing thesis (click here for the latest update).
  • Also announced overnight was the central government’s official response to the momentum of property price appreciation in China. On balance, this latest round of macroprudential tightening measures is definitely impactful, but not nearly as aggressive as the “hammer” we feared in our worst-case scenario.
  • All told, we still like Chinese equities on the long side w/ respect to the intermediate-term TREND duration. Encouragingly, our TREND and TAIL quantitative support levels are still intact after the recent round of policy-induced weakness. A recapture of the Shanghai Composite’s immediate-term TRADE line (2,385) would be an explicit signal that we’re going to continue to be right on China.
  • If you don’t want to take our word for it, that’s fine; Australia (both equities and currency) and CAT are two short ideas you can use to hedge, or to outright express any bearish view on China from here – which we obviously would be on the other side of (email us for our latest work on either).

 

PMI DATA DISAPPOINTS, BUT DOESN’T MATTER

This morning brought forth a great deal of PMI data out of Asia, obviously headlined by China’s manufacturing indices: FEB NFLP Manufacturing PMI: 50.1 from 50.4 vs. Bloomberg Consensus of 50.5; and FEB HSBC Manufacturing PMI: 50.4 from 52.3 vs. Bloomberg Consensus of 50.6.

 

China’s official Manufacturing PMI report was particularly bad “underneath the hood” (New Orders, New Export Orders and Purchasing of Inputs all down over 1ppt). As we have mentioned many times before, however, any sequential readings in Chinese (and, by extension, Asian) growth data from JAN to FEB will be distorted by the timing of the Lunar New Year festival, which was entirely in FEB this year after being a JAN event last year. We reiterate that the MAR growth figures will be the first true test of our Asian #GrowthStabilizing thesis (click here for the latest update).

 

THE BAD NEWS IS OUT OF THE WAY IN CHINA - 1

 

HOUSING’S “HAMMER”?

According to data from SouFun Holdings Ltd., the country’s largest real estate brokerage, Chinese home prices rose for the ninth consecutive month in FEB: +0.8% MoM from +1% MoM in JAN. This string of sequential  momentum is generally consistent with the property price data we track that comes out on a lag.

 

Also announced overnight was the central government’s official response to the momentum of property price appreciation in China:

 

  1. Increase down-payment requirements and interest rates for second-home mortgages in cities with “excessively fast” price gains;
  2. Ban real estate companies found to be engaged in hoarding land or collaborating to push up home prices from getting new development loans or raising funds from the capital markets;
  3. Implement a 20% capital gains tax whenever the original purchase price is available; and
  4. “Quicken” the expansion of the nationwide property-tax trials (authorities also imposed a property tax for the first time in the cities of Shanghai and Chongqing).

 

The first two measures are not particularly corrective and generally target only the obvious and unwanted speculative activity in the market. The second two measures, however, are indeed punitive in the sense that they may ultimately impact first-time homebuyers. Relative to our expectations as outlined on Wednesday’s Best Ideas call (email us for the replay info), this confluence of macroprudential tightening measures is somewhat aggressive.

 

They could’ve been far, far worse, however; any further outright restrictions on sales and purchases would’ve slowed overall construction-related activity and would have been very bearish for prices in the sense that price-insensitive buyers would’ve been incrementally forced out of the market(s).

 

Moreover, on the bright side of the property tax implementation, an expedient rollout backed by “unswerving” enforcement may help shore up local government finances to the extent they are still facing cash flow difficulties – which is among the core tenets of the stale China-bear thesis. Per the latest Ministry of Finance analysis, 53% of LGFV debt – which totaled 9.2 trillion CNY at the end of 2012 – will come due by year’s end. If 2012 was an indication, however, loans will continue to be rolled over. Trust us – Chinese state banks know exactly where their bread is buttered.

 

All told, we still like Chinese equities on the long side w/ respect to the intermediate-term TREND duration. Encouragingly, our TREND and TAIL quantitative support levels are still intact after the recent round of policy-induced weakness. A recapture of the Shanghai Composite’s immediate-term TRADE line (2,385) would be an explicit signal that we’re going to continue to be right on China. If you don’t want to take our word for it, that’s fine; Australia (both equities and currency) and CAT are two short ideas you can use to hedge or to outright express any bearish view on China from here – which we obviously would be on the other side of (email us for our latest work on either).

 

THE BAD NEWS IS OUT OF THE WAY IN CHINA - 2

 

As a reminder, the 12th National People’s Congress commences on MAR 5. Moreover, we expect to see a fair amount of positive headlines in the way of meaningful economic reforms. For the associated prep notes, please refer to our 2/26 note titled: “RISK MANAGING CHINA”.

 

Darius Dale

Senior Analyst


Financials Take Hold

Over the last year, the S&P 500 has returned +9.55%, which is impressive for anyone who had index funds in their portfolio. But the real gains can be seen in individual S&P sector ETFs. Financials (XLF) are leading the pack, up +17.16% over a one-year period, while Tech (XLK) and Energy (XLE) are up +1.24% and +2.08%, respectively. The recovery in the housing market and the uptick in mortgages and housing prices has no doubt given a boost to the banks and other financial institutions as growth continues to stabilize.

 

Financials Take Hold - SEKTORS


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The Final Countdown

Client Talking Points

Can We Fix It?

While the US stock market is looking good, America's political class is looking ugly, today. Automatic spending cuts aka The Great Sequester are set to kick in at midnight. Can Congress come to an agreement? Fat chance of that happening. So the question is, will it really hurt the stock market? In a sense: no. We may see a down day or two, but we are bullish on consumption. Consumption helps drive growth and with oil prices hitting 2013 lows this morning, we're liking the consumption game. Remember: strong dollar = strong America. 

Asset Allocation

CASH 48% US EQUITIES 20%
INTL EQUITIES 12% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 20%

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

"The one eyed man is king in the land of the blind." -@HedgeyeDJ

QUOTE OF THE DAY

"Cynicism is an unpleasant way of saying the truth." -Lillian Hellman

STAT OF THE DAY

US consumer spending edged up 0.2% in January while income fell sharply.



Feb Club

“Take the shortest route to the puck, and arrive in ill humor.”

-Fred Shero

 

At my alma mater Yale, the under graduates hold a party every day in February.  If you have ever been to New Haven, CT, you get the reason they do this - New Haven is a rainy and depressing place in February.  Naturally, in the spirit of reliving their youth, a group of Yale graduates resurrected the tradition and started Yale Club Emeritus.  In effect, Yale Club for old people.

 

Now I’m not sure if I’m officially old or not, but after stopping by the final Yale Club Emeritus last night at the infamous Dorrian’s Red Hand Bar in the Upper East Side of Manhattan, and perhaps staying a little too late, I feel old this morning.  Or to refer to Fred Shero’s quote above, I’m at the very least in ill humor.

 

Yesterday I had the pleasure of joining Mario Bartiromo on CNBC’s closing bell. The topic of the discussion was what’s next for U.S. equities. The gentleman I was debating cited the fact that most Wall Street analysts had reduced their estimates for U.S. GDP growth recently and he was therefore negative on growth and the market.  As I countered, I went to these funny critters called facts.  The three most recent data points on the U.S. economy that I’d seen which were as follows:

  • New home sales up 29% y-o-y and inventory is at the lowest level since 2005;
  • Chicago PMI new orders reading coming in at 60.1, an 11-month high; and
  • Jobless claims in the most recent week showing an 8% improvement year-over-year.

As they say, facts don’t lie, people do.  Now those are only the facts that I happened to see as I was prepping for my interview yesterday and it is certainly not to say that all is well in the world, but those facts are supportive of our growth stabilizing thesis.

 

The caveat to my points above is the Chinese economic data that came out this morning was definitely slightly disappointing. Chinese PMI came in at 50.1 versus the estimate of 50.5 and was down from January’s reading of 50.4.  Now this reading is still expansionary, but is indicative of a sequential slow down, although admittedly the February economic data from China is distorted by the Lunar New Year.

 

Even as we continue to express our bullish stance on U.S. equities, we are not bullish of all markets.  In fact, a key global market we remain bearish on is the Japanese Yen.  This morning we received more confirmatory data of that stance as Japanese CPI fell for the eighth time in the last nine months.  Since the political leadership of Japan intents to manufacture inflation, they will obviously react to this by doubling down on their policy of debauching the Yen.

 

On that note, in the Chart of the Day (titled: Japanese Consumers Are Going to Get Bag Skated) we highlight how difficult it will actually be to create inflation in Japan via monetary easing.  This chart goes back to 2004 and highlights that annual CPI has been consistently below 0%.  The point being that if the Japanese leadership is really intent on taking CPI to a 2% level, it will take a massive amount of Japanese Yen printing, which begs the question: are we bearish enough on the Yen?

 

While we are doing the around the globe macro review this morning, it is probably prudent not to forget the currency experiment gone awry – the Euro-zone. This morning European manufacturing PMIs are out and the results are mediocre at best.  The headline number for the Euro-zone is 47.9, which is slightly better than the 47.8 estimate but still suggesting of an economy in decline.  As always though, Europe is bifurcated.

 

On the positive extreme, consistent with our research, is Germany with an expansionary PMI of 50.3.  Meanwhile on the negative end of the spectrum is France with a dreadful PMI of 43.9.   To the credit of the French politicians who implemented tax rates that have motivated capital to flee France, they actually don’t have the worst PMI in the Euro-zone. That title goes to Greece at 43.0.

 

Before you head off into the weekend, let’s talk stocks for a second.  As many of you know, we are instituting a best ideas list that highlights our best ideas across our research team.  On Wednesday we did the second part of that launch and our Financials Sector Head, Josh Steiner, presented the idea Nationstar Mortgage (NSM), a company that is in the business of servicing delinquent loans and originating agency mortgages for sale.  The thesis is as follows:

  • The company operates in a oligopoly with only two true competitors;
  • We think the street is too low in 2013 and that the earnings power of the company is ultimately close to $10 per share;
  • A spin-off of its Solution Star business could unlock $6 in incremental value; and
  • NSM has a servicing acquisition pipeline of some $300BN in the foreseeable future.

So, here we have a company with a big market opportunity, operates in an oligopoly and is trading at less than 4x its ultimate earnings power.  Stock ideas like NSM, are starting to put me in a much better mood this morning.

 

Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, UST10yr, and the SP500 are now $1, $110.04-112.85, $81.45-82.46, 1.83-1.95%, and 1, respectively.

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

Feb Club - Chart of the Day

 

Feb Club - Virtual Portfolio


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