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BEST IDEAS UPDATE: LONG CHINA (NOT); SHORT YEN

SUMMARY BULLETS:

 

China: 

  • All told, we anticipate the impact of recent and pending regulatory measures to continue weighing on both economic growth and investor sentiment across the Chinese economy (bird flu headlines don’t help either).
  • While continued CNY strength (~19-year high; trading band rumored to be widened soon) and incremental commodity deflation are supportive at the margins, the 1Q/MAR growth data (highlights below) is supportive of our view that economic rebalancing is not likely to be accelerated enough to offset the aforementioned headwinds.
  • As such, Chinese equities can no longer be considered a Best Idea at the current juncture.

 Japan:

  • As often cited in our work, a likely failure of int’l policymakers to censure and ultimately mitigate the impact of Japan’s monetary policy phase change is core to our bearish thesis on the JPY from here.
  • In that vein, Japanese Finance Minister Taro Aso confirmed that the G20 has accepted Japan's explanation that its aggressive monetary policy is aimed at beating deflation and not at a competitive devaluation of the yen.
  • Recall that in its semi-annual currency report released late last Friday, the US Treasury said that Japan should "refrain from competitive devaluation". It added that the US will continue to press Japan to adhere to the commitments agreed to with the G7 and G20.
  • In spite of these misunderstood developments, it is our view that investors would be remiss to allow the overt hypocrisy of the US government scare them out of the short yen/long Nikkei trade, which we still think has legs with respect to the intermediate term.

 

CHINESE CHICKEN INDEED

As we outlined in our recent work on China’s equity market, the Chinese economy has undergone a barrage of growth-negative regulatory reforms and macroprudential measures designed to quash speculative activity in the fixed assets investment (FAI) sector. As previously mentioned, this was not something we saw coming at the time of our 2/27 Best Ideas conference call and continues to weigh on the outlook for Chinese growth over the intermediate term.

 

  • CHINA’S IN NO MAN’S LAND (3/13): China’s fundamental outlook has become increasingly convoluted in recent weeks, posing material risk to its financial markets.
  • IS CHINA CAREENING TOWARDS FINANCIAL CRISIS? (3/28): Systemic risks are present across China’s financial sector – as is the political will and fiscal firepower needed to avert a crisis.
  • BEST IDEAS UPDATE (LONG CHINA; SHORT YEN) (4/1): That the Shanghai Composite Index closed down -0.1% on today’s positive growth figures speaks volumes to the growing concerns surrounding Chinese banking risks as regulatory overhang continues to weigh on the Chinese equity market.
  • EARLY LOOK: Chinese Chicken (4/4): In spite of fairly recent gains, the fundamental backdrop for the Chinese stock market is as convoluted as it has been in quite some time. As such, we are sticking to our process and deferring to the quant on this one.

 

Nevertheless, we were definitely wrong in the context of the Shanghai Composite’s performance since that call (-3%) and, more importantly, it’s hard to justify China on the long side outside of the beneficial impact of incremental CNY strength and commodity deflation. Given the nature of the Chinese political structure (i.e. deeply entrenched interests compounded by decentralized control), it’s tough to see the Chinese Communist Party accelerating the economic rebalancing agenda fast enough to offset the impact of slower FAI growth over the intermediate term.

 

The latest development on the FAI front was the CBRC’s dramatic tightening of credit supply to the Local Gov’t Financing Vehicle (LGFV) sector. Specifically:

 

  • For LGFVs with lower than 100% cash coverage ratio (CAR) or asset-liability ratio of above 80%, their borrowings as a percentage of banks’ total issued loans must not exceed the level in the previous year;
  • Commercial banks should gradually reduce lending to such LGFVs while looking to recover loans (i.e. clamping down on refinancing/rollovers);
  • Commercial banks and regulatory bodies at all levels are to monitor LGFV loans in all forms – which include bank loans, corporate bonds, medium-term notes, short-term financing notes, trust products, and wealth management products;
  • Commercial banks should hand over the approval authority of LGFV bonds up to their head offices; and
  • Commercial banks will no longer be allowed to provide guarantees for LGFV bonds.

 

As an aside, “Local Projects” as defined by the National Bureau of Statistics account for 94% of Total Fixed Assets Investment in China (full-year 2012 figures). If enforced properly, these measures will bite. Chinese property developers are at risk – which should not come as a surprise to anyone. According to a 2012 survey conducted by the China Banking Association, nearly 70% of Chinese bankers expressed concerns over lending to the property sector (12.1 trillion yuan in total or 9% of Chinese banks’ assets).

 

Additionally, the Chinese property market remains hot from a pricing perspective (despite the recent curbs), which may mitigate any potential outlook for monetary easing over the intermediate term; average house price appreciation across the NBS’s 70-city sample was +3.6% YoY in MAR from +2.1% in FEB. Moreover, data from the Ministry of Land and Resources (MLR) shows that the average land transaction price in major Chinese cities was CNY 3,175 per square meter in 1Q13 – up +3.9% YoY (vs. +2.6% in 4Q12).

 

All told, we anticipate the impact of recent and pending regulatory measures to continue weighing on both economic growth and investor sentiment across the Chinese economy (bird flu headlines don’t help either). While continued CNY strength (~19-year high; trading band rumored to be widened soon) and incremental commodity deflation are supportive at the margins, the 1Q/MAR growth data (highlights below) is supportive of our view that economic rebalancing is not likely to be accelerated enough to offset the aforementioned headwinds. As such, Chinese equities can no longer be considered a Best Idea at the current juncture.

 

  • 1Q Real GDP: +7.7% YoY from +7.9% vs. Bloomberg consensus estimate of +8%
    • +1.6% QoQ from +2% prior
  • MAR Industrial Production: +8.9% YoY from +10.3% YoY in DEC (no JAN-FEB figures) vs. Bloomberg consensus estimate of +10.1%
    • +9.5% YoY in 1Q from +10% in 4Q
  • MAR Retail Sales: +12.6% YoY from +15.2% YoY in DEC (no JAN-FEB figures) vs. Bloomberg consensus estimate of +12.6%
    • +12.4% YoY in 1Q from +14.5% in 4Q
  • MAR Fixed Assets Investment: +20.9% YoY from YoY +21.2% in FEB vs. Bloomberg consensus estimate of +21.3%

 

BEST IDEAS UPDATE: LONG CHINA (NOT); SHORT YEN - 4

 

TARO ASO’S POKER FACE

As often cited in our work, a likely failure of int’l policymakers to censure and ultimately mitigate the impact of Japan’s monetary policy phase change is core to our bearish thesis on the JPY from here. In that vein, Japanese Finance Minister Taro Aso confirmed that the G20 has accepted Japan's explanation that its aggressive monetary policy is aimed at beating deflation and not at a competitive devaluation of the yen.

 

Additionally, BOJ Governor Haruhiko Kuroda said that the G20 is understanding of the case for Japan's unprecedented, world-beating monetary easing. Moreover, he reiterated that the BOJ is not trying to weaken the yen, rather it is designed to achieve the Abenomics-mandated +2% inflation target as soon as possible.

 

Recall that in its semi-annual currency report released late last Friday, the US Treasury said that Japan should "refrain from competitive devaluation". It added that the US will continue to press Japan to adhere to the commitments agreed to with the G7 and G20. In spite of these misunderstood developments, it is our view that investors would be remiss to allow the overt hypocrisy of the US government scare them out of the short yen/long Nikkei trade, which we still think has legs with respect to the intermediate term.

 

In short, we think the USD/JPY cross has upside to 110 as we progress through calendar 2013 and then to 125 as we progress through calendar 2014-15. NOTE: these aren’t big, round sell-side-style forecasts; rather, they represent the long-term levels of resistance on the USD/JPY cross. 100 is the first psychological barrier to overcome; from there, the aforementioned targets come into play, in that order.

 

BEST IDEAS UPDATE: LONG CHINA (NOT); SHORT YEN - 5

 

The pace of the US recovery and investor expectations of the FOMC’s next move will also determine the pace of yen depreciation from here (thus far, it’s been mostly a Japan-driven phenomenon). Is this the mid-to-late 90s all over again, however? The USD/JPY cross ripped from 80 to ~147 over a span of four years as the respective policy paths for the Fed and BOJ diverged substantially – as we believe they are poised to do once more with respect to the long-term TAIL duration.

 

BEST IDEAS UPDATE: LONG CHINA (NOT); SHORT YEN - 6

 

That’s why US housing and labor market improvement remains so critical to the US side of our thesis. The Fed has already signaled what would get them to turn off the QE spigot and FOMC leaks. A 6-handle on the US unemployment rate would really start to make yen bulls quite nervous. As we’ve penned in recent work, neither the buy-side (via CFTC net length), the sell-side (via out-year USD/JPY targets), nor Japanese corporations (via Tankan Survey USD/JPY forecasts) is Bearish Enough on the Japanese yen – all of whom having been numbed to secular yen strength over the past ~6 years.

 

The aforementioned secular policy divergence, the lack of consensus over the yen’s outlook from here and the following cyclical reminders that Japan has barely emerged from recession all combine to point to a higher dollar-yen cross and higher Nikkei/TOPIX from here – the latter of which is being underpinned by record int’l inflows.

 

  • MAR Machine Tool Orders: -21.6% YoY from -21.5%
  • MAR Goods PPI: -0.5% YoY from -0.1%
  • MAR Consumer Confidence: 44.8 from 44.2
  • MAR Exports: +5.5% YoY from +11.9%
  • MAR Imports: +1.1% YoY from -2.9%
  • MAR Trade Balance SA: -¥922B from -¥1.09T
  • MAR Economy Watchers Survey – Outlook: 57.5 from 57.7
  • Week Ended 4/12 Net Foreign Purchases of Japanese Stocks: ¥1.57 trillion from ¥868.6 billion; highest weekly total on record

 

To the extent you may have missed them come through, we encourage you to check out our recent work on this topic if you’re looking to fully comprehend the gravity of the BOJ’s monetary policy phase change:

 

 

Have a great weekend,

 

Darius Dale

Senior Analyst


Fool's Gold

This week started off with the price of gold plummeting nearly 11% intraday on Monday, followed by a small recovery in price as the week progressed. Institutional investors, including hedge funds, banks and asset management firms, fled the precious metal, selling off gold and gold-related stocks like miners.

 

The SPDR Gold Trust ETF (GLD), by far the most popular and liquid way to trade gold, is down -5.75% since Monday and is down a whopping -14.9% over a one-year period. Pundits who said gold would go to $2000 are undoubtedly in need of a stiff drink after this week. We've made our case for long consumption/short commodities since the beginning of the year and believe that gold can fall further, especially if the US dollar continues to appreciate in value.

 

Fool's Gold - GLD 1year


JAPAN: Burn The Yen

The Japanese Yen is down another -1.0% this morning versus the US dollar, hitting a new low. Japan's de facto currency has been devalued considerably over the past month (and beyond) as the country's central bank announced monetary stimulus plans that would help artificially boost the stock market whilst destroying the Yen.

 

Finance Minister Taro Aso and Bank of Japan Governor Haruhiko Kuroda have defended their actions, stating that the G20 nations will "understand" the need for stimulus. The Japanese people will likely have a hard time understanding why their food and gas prices have shot up; McDonald's recently announced it would be hiking burger prices by 20% due to commodity inflation. 

 

JAPAN: Burn The Yen - USDJPY cross


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

2Q13 Macro Call: Employment Trends

 

Hedgeye held its second quarter of 2013 Macro Themes Call for subscribers earlier this week, which partially focused on employment trends and what it means for the markets. Employment trends have been improving considerably since early 2011, with jobless claims and non-farm payroll (NFP) and household survey employment improving significantly since then. While data might be accelerating at a lesser rate, it has yet to totally roll over and decline since then. Small business is hiring and employment growth overall is improving.

 

You can listen to Hedgeye CEO Keith McCullough discussing employment trends and view the related slides from our presentation in the video posted above.


Morning Reads From Our Sector Heads

Keith McCullough (CEO):

 

Twitter: Great Investor Tool That Won’t Make You Money (via Yahoo! Finance)

 

Rob Campagnino (Consumer Staples):

 

Herbalife Unlikely to Get Auditor Before Investor Meeting (via Bloomberg)

 

Is Pepsi better off without Pepsi? (via Quartz)

 

Matthew Hedrick (Europe):

 

Financial transaction tax contravenes G20 agreements, warn global markets bodies (via The Telegraph)

 

Kevin Kaiser (Energy):

 

Baker Hughes Announces First Quarter Results (via Baker Hughes)

 

Schlumberger Announces First-Quarter 2013 Results (via Schlumberger)

 

Howard Penney (Restaurants):

 

The McDonald’s Dollar Menu is Popular, But Can it Be Profitable? (via WSJ)


 

 

 



KMB - Tough Quarter to Poke Holes In

KMB is on the tape with Q1 EPS of $1.48, well ahead of consensus of $1.33.  The company’s better than expected result was almost entirely flowed through to full year guidance that now stands at $5.60 to $5.75 (+$0.10 at the high and low end versus prior).  The first quarter represented the toughest revenue comp on both a reported basis (+4.2%) and constant currency (+6.0%) as well as a difficult gross margin comparison (+246 bps).   Reported revenue increased +1.5% while constant currency organic revenue increased 3.0% as gross margins improved 146 bps.



What we liked:

  • Big beat and flow through on full-year guidance
  • Solid performance against difficult comparisons on revenue and gross margins
  • Superb operating leverage with +15.6% EBIT growth on 1.5% sales growth
  • Company overcame $35 million of commodity inflation in the quarter
  • Well-managed balance sheet as accounts receivables (+1.7% year over year) and inventories (+0.4%) increased in line with sales growth

What we didn’t like:

  • FCF growth (+2.1%) lagged EBIT growth (+15.6%)largely due to an increase in capital spending
  • $115 million in year over year EBIT growth continues to be primarily driven by cost savings ($85 million in the quarter)
  • Substantial portion of year over year EBIT growth driven by delta in strategic marketing spending - +$45 million in Q1 2012 and “down slightly” in Q1 2013
  • Valuation, which admittedly isn’t a catalyst and certainly matters less when estimates are going higher

Comparisons ease through the balance of 2013 on the top line as gross margin comps remain difficult for the next two quarters.  However, the company decreased strategic marketing sequentially through 2012 so the significant benefit the company saw by decreasing marketing in Q1 2013 will become less impactful as 2013 progresses.    However, the decline in the commodity complex should provide some margin benefit as we move through 2013, which is tough to fight.  In addition, we recognize that we are fighting sentiment and money flows, but we also recognize that valuation matters at some point and we will keep KMB on our least preferred list.

 

Call with questions,

 

Rob

 

Robert  Campagnino

Managing Director

HEDGEYE RISK MANAGEMENT, LLC

E:

P:

 

Matt Hedrick

Senior Analyst


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