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CHINA’S IN NO MAN’S LAND

Takeaway: China’s fundamental outlook has become increasingly convoluted in recent weeks, posing material risk to its financial markets.

SUMMARY CONCLUSIONS:

 

  • The benchmark SHCOMP index is -2.6% below its immediate-term TRADE line of resistance and +2.7% above its intermediate-term TREND line of support – making it truly stuck in between the proverbial “rock and a hard place”. With such a now-convoluted fundamental outlook, we will stick to our tried and true risk management process by deferring to our quantitative signals on what to do with our Chinese equity exposure from here:
  • BUY [more] on a breakout above TRADE resistance (2,324): A probable sequential pickup in MAR growth data and a probable sequential slowing in MAR inflation data supports this action. Moreover, continued USD strength (and, by association, CNY strength) should weigh on int’l raw materials prices and allow the pace of economic activity to creep higher in China, as China’s heavy industry needs energy and raw material deflation to produce more with less credit expansion and the Chinese consumer needs food deflation to consume more discretionary goods and services.
  • SELL/SHORT on a breakdown through TREND support (2,205): As we’ve seen since 2009, the pace of activity in the Chinese property market has become the #1 factor in determining growth rate of Chinese economy – via credit expansion – and the returns of Chinese financial markets. That quantitative signal would be a clear-cut sign that there is likely more policy-perpetuated pain to come in the months ahead – especially to the extent those linkages have not broken down as much as the CCP would’ve liked.

 

Is the Chinese Communist Party and, by extension, the PBOC too concerned about inflation – both in housing and consumer prices? That’s fast become the most critical question as it relates to navigating fundamental risk in the Chinese economy.

 

Per PBOC Governor Zhou Xiaochuan’s latest testimony at the National People’s Congress:

 

“China should be on high alert over inflation… Monetary policy is no longer relaxed and is relatively neutral as demonstrated by a 13 percent target for money-supply growth that’s tighter than expansion in the last two years… Monetary policies to cool home prices will continue or even strengthen in the future.”

 

As an extension of the CCP, Zhou’s overt hawkishness underscores a broader political agenda to quash inflationary pressures on the mainland on all fronts.

 

Interestingly, the predominance of their prudence has been our base-case scenario for many months. As early as OCT ‘11 and all throughout 2012, we have been overtly flagging a sustainable lack of resolve to reflate the Chinese economy amongst Chinese officials.

 

Moreover, as most recently outlined on our 2/27 Best Ideas presentation, consensus finally coming to grips with a structurally subdued Chinese growth outlook was one of the key reasons we have liked Chinese equities on the long side since 12/10.

 

With the Shanghai Composite Index up +8.6% since then (besting the +7.9% advance for the MSCI All-Country Asia Pacific Index), that’s been a somewhat contrarian idea that has worked in our favor.

 

More recently, however, with the SHCOMP Index down -7% from its cycle-peak on 2/6 and the Shanghai Stock Exchange Property Index down nearly -15% from its cycle-peak on 2/5, it’s very clear to us that the latest round of property market tightening – which indeed caught us off guard from a magnitude perspective – is weighting on both price and sentiment in the Chinese equity market.

 

With a Global Macro Risk Manager’s process only as good as his/her last trades (hence our never-ending focus on evolution and embracing uncertainty), the most recent performance begs the question: where to from here?

 

The benchmark SHCOMP index is -2.6% below its immediate-term TRADE line of resistance and +2.7% above its intermediate-term TREND line of support – making it truly stuck in between the proverbial “rock and a hard place”.

 

CHINA’S IN NO MAN’S LAND - 1

 

With such a now-convoluted fundamental outlook, we will stick to our tried and true risk management process by deferring to our quantitative signals on what to do with our Chinese equity exposure from here:

 

  • BUY [more] on a breakout above TRADE resistance (2,324): A probable sequential pickup in MAR growth data and a probable sequential slowing in MAR inflation data supports this action. Moreover, continued USD strength (and, by association, CNY strength) should weigh on int’l raw materials prices and allow the pace of economic activity to creep higher in China, as China’s heavy industry needs energy and raw material deflation to produce more with less credit expansion and the Chinese consumer needs food deflation to consume more discretionary goods and services.
  • SELL/SHORT on a breakdown through TREND support (2,205): As we’ve seen since 2009, the pace of activity in the Chinese property market has become the #1 factor in determining growth rate of Chinese economy – via credit expansion – and the returns of Chinese financial markets. That quantitative signal would be a clear-cut sign that there is likely more policy-perpetuated pain to come in the months ahead – especially to the extent those linkages have not broken down as much as the CCP would’ve liked.

 

All told, we are watching China like hawks here and it should be noted that we are in the process of reconsidering our bullish bias on Chinese equities.

 

Needless to say, stay tuned.

 

Darius Dale

Senior Analyst

 

CHINA’S IN NO MAN’S LAND - 2

 

CHINA’S IN NO MAN’S LAND - 3

 

CHINA’S IN NO MAN’S LAND - 4


Riding Bull: SP500 Levels, Refreshed

Takeaway: Higher-lows and higher-highs are bullish, because people have to chase them.

POSITIONS: 14 LONGS, 8 SHORTS @Hedgeye

 

After a controlled 1.5 day correction from our overbought signal, US stocks look great here. I am covering shorts and getting longer again this morning (from 20,000 feet on a GoGo connection, which is kind of cool).

 

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

 

  1. Immediate-term TRADE resistance = 1567
  2. Immediate-term TRADE support = 1540
  3. Intermediate term TREND support = 1477

 

In other words, this is the first note you are receiving from me in 2013 where I have a higher-high than the SP500’s all-time closing high (1565) signaling as probable. Higher-lows and higher-highs are bullish, because people have to chase them.

 

#StrongDollar and the Transports (IYT) lead during the red open, and you know I like that.

 

KM

 

Keith McCullough

Chief Executive Officer

 

Riding Bull: SP500 Levels, Refreshed - SPX


Is Amex Charging Ahead This Quarter?

Takeaway: American Express growth is likely to be stronger sequentially in the first quarter based on January and February SpendTrend data.

This note was originally published March 12, 2013 at 09:55 in Financials

February SpendTrend Data Shows AXP Should be in Good Shape for 1Q

First Data released its February SpendTrend data this morning, which tracks aggregate same-store sales activity in the United States. February showed modest month-over-month deceleration in credit card volume growth to +7.9% YoY vs. +9.2% YoY growth in January and +4.3% YoY growth in December. 

 

This brings the 1Q13 QTD growth rate to 8.6%, up from 6.7% in 4Q12. The correlation between the YoY growth rate in SpendTrend credit volume and AXP global volume is 0.72. The current 8.6% QTD rate of growth implies AXP global billed business will grow at 14.0% in 1Q13, up from 7.5% in 4Q12. 

 

Interestingly, the relative strength in the credit line was a divergence relative to the overall spending trend, which was negative. On an overall basis, including credit, debit and check, consumer spending volume growth in February decelerated to 4.6% YoY, which was down from 6.2% in January and slightly ahead of the 4.0% YoY growth in December.

 

FirstData flagged the following factors as notable contributors to the relative weakness of February's print: 

 

Retail dollar volume growth fell significantly in February to 2.5% compared to January’s growth of 5.7% as consumers tightened their discretionary spending budgets. This marked the slowest growth in the past twelve months. 


The combination of elevated taxes, federal tax refund delays, adverse weather and higher gasoline prices clearly curbed shoppers’ ability and willingness to shop in February. The fact that the personal savings rate significantly declined in January and consumers shifted more spending onto credit cards could be a sign that consumers may be overstretched. 

 

We like to use SpendTrend data as a proxy for American Express' intra-quarter momentum. Amex didn't provide a January update, as they normally do, on either their 4Q12 earnings call or at their recent investor meeting. 

 

It's also interesting to consider that Amex' international volume growth accelerated meaningfully in 4Q12 to 8.8%, up from 2.7% in 3Q12. With both U.S. and International now accelerating, and the benefits of cost cutting materializing, the company is in position to generate upside surprise to estimates (if they choose to let it flow through).

 

Is Amex Charging Ahead This Quarter? - spendtrend 2

 

Is Amex Charging Ahead This Quarter? - spendtrend 1

 


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Is McCormick Leaving a Bad Taste?

Takeaway: Here's why we're concerned about McCormick stock at the moment.

This note was originally published March 12, 2013 at 11:40 in Consumer Staples

Last night, YUM reported Q1 (February) China comps of down 20%, with improvement in February versus the overall quarter.  The stock is getting a well-deserved bounce today, and we mention it only because one of the names in our staples coverage has some leverage to restaurants in China - MKC.  The big difference between YUM and MKC is that MKC has been bouncing hard for about a month now, on no news and with utter disregard for the direction of earnings estimates or the company's multiple.

 

MKC’s commentary relative to continued Q1 weakness (1/24):

 

“While the Asia Pacific region had a strong sales result for the Consumer business, demand from industrial customers, primarily quick service restaurants, was weak. This was largely an outcome of less new product and promotional activity versus the year-ago period. We expect this decline to extend into the first quarter of 2013, which has a tough year-ago comparison. If you recall, we grew base business industrial sales in the Asia Pacific region 22% in local currency in the first quarter of 2012.”


We get it – shorting mid-cap staples names is tough – the companies tend to have sticky shareholder bases, multiples tend to be elevated versus the large cap peer group (and seem to matter less) and the opportunity exists for relatively small deals to move the needle on EPS pretty dramatically.  However, it isn't often that you see such a dramatic divergence between the direction of EPS estimates and the direction of the multiple in a non-cyclical name.  Full-year 2013 consensus estimates have gone from $3.36 to $3.22 since the company reported back in January, and the multiple has expanded from 18.9x (immediately post EPS) to 21.7x.

 

Is McCormick Leaving a Bad Taste? - MKC PE1

 

Perhaps you can make the case the company sandbagged 2013 EPS guidance, but even an earnings base closer to $3.50 puts this name at 20.0x '13, and we are having a difficult time coming to either that earnings base or that multiple.  It is our strong preference to deal in what is likely, and we think a more likely scenario is an EPS result for the full-year at or below current consensus.

 

Valuation is never a catalyst, but the combination of significant multiple expansion in the face of a declining EPS base confounds us, and we don't like being confounded.  MKC is fast moving up our list of names whose current price we can't justify or explain, but are inclined to short.

 


Herbalife: Math Trumps Fear

This note was originally published March 12, 2013 at 18:27 in Consumer Staples

Looking Back to Look Forward



We are taking a page from our prior experience as a dedicated tobacco analyst, recalling the days when litigation threatened the domestic tobacco business at then Altria (combined international and domestic tobacco as well as Kraft Foods).



The argument was that at some point the market was applying a negative value to the domestic business and that even in a worst case scenario (a bankrupting decision against the U.S. business), the value of the other entities would be preserved on the other side of the corporate veil.  Further, structural differences in the legal systems outside the United States made the export of any bankrupting litigation unlikely, preserving the multiple associated with the international assets.



We see the situation with Herbalife is broadly analogous, as the current share price reflects some material degradation of the earnings power of the business – with the US business being the most likely source of the decline.  We are somewhat less secure in our belief in the case of HLF that consumer protection litigation/regulation can’t be exported outside the U.S. (versus product liability litigation in the case of the tobacco industry), but we believe that the international assets are likely far more secure than the domestic assets in the case that Pershing Square’s allegations prove to have some merit (an open issue, to be sure).



Recall that it is our belief that the Herbalife debate has become too high profile to be ignored by the powers that be – the FTC, SEC any of the State Attorneys General.  We see some sort of investigation as highly likely, an event that the market will not likely treat kindly.

 

The Math

 

Consensus EBITDA estimates for 2013 EBITDA are $794 million (7.9% growth versus 2012) – of that number, we estimate that nearly $190 million in EBITDA will be generated in the United States (23.5%).  It’s a bit of a chore to get to EBITDA by region and the company’s disclosures could certainly use some improvement – we agree with Pershing Square in that regard.



The company’s average forward EV/EBITDA multiple since 2007 is 7.5x – applying that multiple to the EBITDA forecast for the company ex-U.S. ($604 million) gets us to a share price of $42.50 for HLF’s business outside of the US, implying a negative value of $1.70 per share for the US business currently imbedded in the share price.  At any multiple greater than 7.1x EV/EBITDA for the rest of the world, the U.S. business is “free” as currently reflected in the stock price.  We think a multiple closer to 8.5x EV/EBITDA is more appropriate given peers and the growth profile.

 

Herbalife: Math Trumps Fear - HLF EV.EBITDA

 

Herbalife: Math Trumps Fear - HLF Sum of the parts

 

We think replacing fear with math is always a useful exercise, and while emotions can drive stock prices beyond where the math would suggest, we think having some sort of analytical framework to look at what is currently being discounted is the best way to be right more often than not.

 

-Rob

 



 

Robert  Campagnino

 

Managing Director

 

HEDGEYE RISK MANAGEMENT, LLC

 

E: rcampo@hedgeye.com

 

P: 203.562.6500

 

 

 

Matt Hedrick

Senior Analyst


All That Giltters

Client Talking Points

China Belittles

For a while now, China has been one of Hedgeye’s top long ideas, but some of the recent data has sent some mixed signals. Specifically, industrial production, fixed asset investment and aggregate financing (a driver of money supply) were marginally below expectations and saw sequential declines. Now to be fair, many of these economic metrics are showing year-over-year growth rates, that relative to the rest of the world, are outstanding. We’ll continue to keep a close eye on China, particularly on new policy initiatives that come from the government there.

 

 

 

Gold Confirms

While China is belittling us a bit, our call on gold is playing out as we expected. The breakdown of gold has been a key asset call on the back of our view that global growth is stabilizing.  This hasn’t been a popular call as many institutional investors have been over allocated to  gold based on the idea that as growth decelerates, expectations for future QE rise, the dollar depreciates and investors flock to gold as protection against further dollar debauchery.

Asset Allocation

CASH 36% US EQUITIES 20%
INTL EQUITIES 20% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 24%

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

“That smoke out of the Vatican chimney, that mean a Darrelle Revis trade is near?” -- @Adam Schefter, ESPN NFL Insider.

QUOTE OF THE DAY

“There’s a great consumer fan base that hasn’t declined.” – Metropoulos & Company on Twinkies. Metropoulos is one of the two investment firms that has agreed to buy Hostess Brands.

STAT OF THE DAY

1.1%, the amount US retail sales rose last month, the biggest jump in five months


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