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Morning Reads From Our Sector Heads

Keith McCullough (CEO):

 

Tata Faces Crisis as $20 Billion Spent on Water: Corporate India (via Bloomberg)

 

PBOC’s Zhou Says Slower Growth Needed for Restructuring (via Bloomberg)

 

Josh Steiner (Financials):

 

Wall Street betting billions on single-family homes in distressed markets (via Washington Post)

 

Cleveland Fed stress test adds housing, securitization coverage (via Housing Wire)

 

Banks pull back from risky regions (via Financial Times)

 

Jay Van Sciver (Industrials):

 

Caterpillar Reports First-Quarter Results, Revises Outlook and Announces Resumption of Stock Repurchase (via Caterpillar)

 

Brian McGough (Retail):

 

Björn Gulden Taking Reins at Puma (via WWD)

 

Teens Get Less Parental Help as Fashion Spend Dials Back (via SGI News)

 

Kevin Kaiser (Energy):

 

Halliburton Announces First Quarter Income From Continuing Operations of $0.67 Per Diluted Share, Excluding a Charge Related to the Macondo Well Incident (via Halliburton)



 

 


 


The Banker Boost

Client Talking Points

Japan's

Japan's announced a few weeks back that it would inject $1.4 trillion into the economy as a stimulus measure. In turn, stock markets ripped to the upside while the value of the Japanese Yen plummeted considerably. This morning, the tradition continues, with the Yen testing the 100 level (against the US dollar) and the Nikkei 225 hitting a fresh year-to-date high, up +1.9% to 13,568. That's the power of the Bank of Japan doing whatever it wants. In turn, the people of Japan will feel the pain when they hit the grocery store and find out that an ear of corn costs $10.

Gold Bulls

Moving on to the Federal Reserve in the United States, our central bank has made it clear there will be no QE 5 to save the day. With this being a bullish catalyst for the US dollar, gold prices continue to get whacked. Bear in mind that a dead cat bounce does not equate to a recovery. Gold can go much lower, especially as the big asset managers liquidate positions.

Asset Allocation

CASH 28% US EQUITIES 20%
INTL EQUITIES 18% COMMODITIES 0%
FIXED INCOME 6% INTL CURRENCIES 28%

Top Long Ideas

Company Ticker Sector Duration
IGT

Decent earnings visibility, stabilized market share, and aggressive share repurchases should keep a floor on the stock.  Near-term earnings, potentially big orders from Oregon and South Dakota, and news of proliferating gaming domestically could provide near term catalysts for a stock that trades at only 11x EPS.  We believe that multiple is unsustainably low – and management likely agrees given the buyback – for a company with the balance sheet and strong cash flow as IGT.  Given private equity’s interest in WMS (they lost out to SGMS) – a company similar to IGT that unlike IGT generates little free cash – we wouldn’t rule out a privatizing transaction to realize the inherent value in this company.

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

"Busiest week for $SPY earnings with one-third of the index reporting" -@CNBCMelloy

QUOTE OF THE DAY

"It is impossible to enjoy idling thoroughly unless one has plenty of work to do." -Jerome K. Jerome

STAT OF THE DAY

Caterpillar's (CAT) its first-quarter profit dropped to $880 million or $1.31 a share, from $1.59 billion or $2.37 a share, in the year-ago quarter. The company also cut its full-year outlook for 2013.


MONDAY MORNING RISK MONITOR: SHORT TERM RISK TRUMPS REWARD

Takeaway: The short-term setup for Financials is negative, but the intermediate/longer term outlook remains bullish.

Key Takeaways:

 

* XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.2% upside to TRADE resistance and 1.7% downside to TRADE support.

 

U.S. Financial CDS -  U.S. bank swaps continued to widen last week, albeit at a low-to-mid single digit basis point rate. This brings the month-over-month change to +18 bps for MS, +13 bps for BAC and +11 bps for JPM and GS. Overall, swaps widened for 18 out of 27 domestic financial institutions.

 

* Chinese Steel – Steel prices in China fell 1.4% last week, or 50 yuan/ton, to 3595 yuan/ton. Both the short-term and intermediate term trends in Chinese steel prices are negative. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.

 

Euribor-OIS Spread – The Euribor-OIS spread was essentially unchanged at 13 bps last week.

 

Sovereign CDS – European sovereign swaps were largely uneventful last week with the only notable move coming from Portugal, tightening by 17 bps. Japanese sovereign swaps tightened 4 bps to 67 bps.

 

Financial Risk Monitor Summary

 • Short-term(WoW): Negative / 1 of 12 improved / 4 out of 12 worsened / 8 of 12 unchanged

 • Intermediate-term(WoW): Negative / 3 of 12 improved / 7 out of 12 worsened / 3 of 12 unchanged

 • Long-term(WoW): Positive / 6 of 12 improved / 1 out of 12 worsened / 6 of 12 unchanged

 

MONDAY MORNING RISK MONITOR: SHORT TERM RISK TRUMPS REWARD - 15 2

 

1. U.S. Financial CDS -  U.S. bank swaps continued to widen last week, albeit at a low-to-mid single digit basis point rate. This brings the month-over-month change to +18 bps for MS, +13 bps for BAC and +11 bps for JPM and GS. Overall, swaps widened for 18 out of 27 domestic financial institutions.

 

Tightened the most WoW: XL, CB, ACE

Widened the most WoW: MBI, GNW, MS

Tightened the most WoW: GNW, AXP, XL

Widened the most MoM: MBI, MMC, SLM

 

MONDAY MORNING RISK MONITOR: SHORT TERM RISK TRUMPS REWARD - 1

 

2. European Financial CDS - European bank swaps were modestly wider last week. Societe Generale widened by 14 bps to 202 bps, while Banco Popolare widened 38 bps to 592 bps.

 

MONDAY MORNING RISK MONITOR: SHORT TERM RISK TRUMPS REWARD - 2

 

3. Asian Financial CDS - Indian bank swaps widened by 5-6 bps last week while the only notable move in China or Japan was Nomura widening by 10 bps.

 

MONDAY MORNING RISK MONITOR: SHORT TERM RISK TRUMPS REWARD - 17

 

4. Sovereign CDS – European sovereign swaps were largely uneventful last week with the only notable move coming from Portugal, tightening by 17 bps. Japanese sovereign swaps tightened 4 bps to 67 bps.

 

MONDAY MORNING RISK MONITOR: SHORT TERM RISK TRUMPS REWARD - 18

 

MONDAY MORNING RISK MONITOR: SHORT TERM RISK TRUMPS REWARD - 3

 

MONDAY MORNING RISK MONITOR: SHORT TERM RISK TRUMPS REWARD - 4

 

5. High Yield (YTM) Monitor – High yield rates rose 1.9 bps last week, ending the week at 5.67% versus 5.65% the prior week.

 

MONDAY MORNING RISK MONITOR: SHORT TERM RISK TRUMPS REWARD - 5

 

6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 1.0 points last week, ending at 1793.5.

 

MONDAY MORNING RISK MONITOR: SHORT TERM RISK TRUMPS REWARD - 6

 

7. TED Spread Monitor – The TED spread rose 1.4 basis points last week, ending the week at 22.8 bps this week versus last week’s print of 21.4 bps. The TED spread has remained relatively range bound for the past month.

 

MONDAY MORNING RISK MONITOR: SHORT TERM RISK TRUMPS REWARD - 7

 

8. Journal of Commerce Commodity Price Index – The JOC index fell -2.6 points, ending the week at 7.2 versus 9.8 the prior week.

 

MONDAY MORNING RISK MONITOR: SHORT TERM RISK TRUMPS REWARD - 8

 

9. Euribor-OIS Spread – The Euribor-OIS spread was essentially unchanged at 13 bps last week. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. 

 

MONDAY MORNING RISK MONITOR: SHORT TERM RISK TRUMPS REWARD - 9

 

10. ECB Liquidity Recourse to the Deposit Facility – Deposits were lower by 4.8bn Euros last week. The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB.  Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system.  An increase in this metric shows that banks are borrowing from the ECB.  In other words, the deposit facility measures one element of the ECB response to the crisis.  

 

MONDAY MORNING RISK MONITOR: SHORT TERM RISK TRUMPS REWARD - 10

 

11. Markit MCDX Index Monitor – Last week spreads widened 1 bp, ending the week at 65.7 bps. The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We are currently tracking the 16-V1 series. 

 

MONDAY MORNING RISK MONITOR: SHORT TERM RISK TRUMPS REWARD - 11

 

12. Chinese Steel – Steel prices in China fell 1.4% last week, or 50 yuan/ton, to 3595 yuan/ton. Both the short-term and intermediate term trends in Chinese steel prices are negative. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.

 

MONDAY MORNING RISK MONITOR: SHORT TERM RISK TRUMPS REWARD - 12

 

13. 2-10 Spread – Last week the 2-10 spread tightened another 2 bps to 150 bps. 

 

MONDAY MORNING RISK MONITOR: SHORT TERM RISK TRUMPS REWARD - 13

 

14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.2% upside to TRADE resistance and 1.7% downside to TRADE support.

 

MONDAY MORNING RISK MONITOR: SHORT TERM RISK TRUMPS REWARD - 14

 

Joshua Steiner, CFA


the macro show

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Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.

Expectations Management

This note was originally published at 8am on April 08, 2013 for Hedgeye subscribers.

Las Vegas is busy every day, so we know that not every man is rational.”

–Charles Ellis

 

Today at 11am, we are going to be joined via conference call by Dr. Richard Peterson of MarketPsych Data.  He will be giving a presentation called, “Behavioral Markets: Quantifying the Psychological Drivers of the Global Economy.”  Over the course of the past 9 years, Peterson and his team have been developing sentiment based investment models based on global news and social media sources.

 

Their underlying technology scours 1,000s of data sources (in natural languages) and then assigns scores for various indicators.  These scores are then updated by the minute to create an ongoing data feed, which can provide a real time assessment of sentiment in over 200 countries stock markets, 60 commodities, 30 currencies, and 40 industries.

 

The key reason that Peterson believes his models can highlight inflection points in markets, via blog and news sources, is based on science.  In effect, intense emotions direct attention to vivid events and catastrophic consequences.  As a result, the reasoning prefrontal cortex is taken offline and probability assessments are distorted.  To Ellis point in the quote above, men and women are not always rational.

 

In his presentation today, Peterson will walk us through his process and analysis, and then get into the outputs of his model on various time frames and over various asset classes.  Many of his investment conclusions we agree with, but others stand in contrast to our models and analysis.  This last point should make this morning’s discussion a lively one.

 

The dial-in information for the call this morning is 1-800-434-1335 and conference code is 141433. The materials can be downloaded at 10:00am following the link docs.hedgeye.com/BehavioralMarkets_04.08.13.pdfWe hope you can join us for the call to get a sense for how a true behavioral finance practitioner quantifies expectations in markets.

 

Related to gauging the market sentiment, Friday’s labor report was a bomb by almost any estimation.  Non-farm payrolls increased by a mere 88,000 in March versus 190,000 expectations and a 268,000 increase in February.  Most disconcerting was the internal participation rate, which measures the percentage of total eligible employees that are in the labor force.  We highlight this in the Chart of the Day with a look at long term labor force participation rates, which is now at its lowest level since 1979.

 

Clearly, muted employment growth is a potential risk to growth accelerating in the U.S. , so we are and will be monitoring this data closely.   The response on Friday from the SP500 was somewhat muted as the market was down -0.47% and remains up on the year just under +9%.  In terms of sector divergence on Friday, the worst performing sector was Technology -0.8% (and +3.1% on the year) and remains NEGATIVE in our quant models on the shortest duration.   The best performing sector on Friday was Utilities +0.43% on the day and +13% on the year.

 

As usual, we are seeing the interconnected follow through this morning from global markets as Taiwan is down -2.4%.  Taiwan is an important geography in the global technology food chain, so is seeing some of the follow through from U.S. technology stock weakness on Friday.  As well, having been closed since Wednesday, both the bird flu fears are being reflected in the Taiwanese market as is an increase in North Korean sabre rattling.

 

The latest from North Korea this morning is that there are signs the country is preparing for a fourth nuclear test.  This is based on South Korean intelligence that is showing increased movement of vehicles and personnel at Punggye-ri.   This is the site on North Korea’s northeast coast where the previous three nuclear tests occurred.  The prior three detonations occurred in 2006, 2009 and February 12th of this year.  Clearly, any additional detonation would be a notable acceleration of activity.

 

In terms of positives related to the North Korean situation, they received their strongest, although also most subtle rebuke, over the weekend from the Chinese.  Chinese President Xi Jinping was speaking at the three-day Boao Forum for Asia and said:

 

“No one should be allowed to throw a region and even the whole world into chaos for selfish gains.”

 

This is notable in that there is strong support for North Korean within the Chinese People’s Liberation Army, so Jinping is going out on a limb.

 

The head of the International Monetary Fund Christine Lagarde went less out on a limb when she strongly encouraged Japanese monetary actions over the weekend and called the latest move from Japan a “welcome step”.  Her statement is a precursor to newly anointed Treasury Secretary Jack Lew’s first strip to Europe where he is expected to encourage, are you ready for this, more government spending.  Keynesians of the world unite!

 

In the short run, accelerating government spending in Europe would have the likely side effect of expanding deficits.   This morning, we can actually see real time the impact of not reducing spending in Europe on government bond yields.  Portugal’s Supreme Court rejected cuts in state and pensions and cuts in public sector wages and as a result peripheral bond yields are spiking with Spain and Italy backing up 4.7% and 4.3%, respectively.

 

Given all of the negative global macro events on the horizon this morning, we have a number of potholes to seemingly avoid so that domestic equity returns can continue their upward climb.  The caveat being that the chief risk may be staring at us in the mirror.  As Benjamin Graham once said:

 

“The investor’s chief problem – and even his worst enemy – is likely to be himself.”

 

Indeed.

 

Our immediate-term Risk Range for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1548-1595, $104.18-108.31, $82.48-83.44, 94.62-98.71, 1.71-1.85%, 12.31-14.55, and 1547-1573, respectively.

 

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

Expectations Management - Chart of the Day

Expectations Management - VP

 



Inflation Trepidation

“Our trepidation about Volcker’s appointment was later justified.”

-Jimmy Carter

 

That’s what the outgoing President of the United States had to say about Paul Volcker because, “on Thursday, September 25, 1980, the Federal Reserve Board had approved by unanimous vote a one percentage-point increase in the discount rate to 11 percent.”

 

“Former Fed Chairman, William McChesney Martin led the counter attack. He termed Carter’s comments “deplorable”… a “serious and unfortunate thing”, and added … partisan politics ought not to be around the Dollar.” (Volcker: The Triumph of Persistance, pg 190)

 

Of course, by the time Carter was losing the election markets were already front-running the US shift in monetary policy. After hitting an all-time high in January of 1980 ($850/oz), Gold didn’t see those highs again for 3 decades. For Gold Bulls, that was a long-time to average down.

 

Back to the Global Macro Grind

 

To be balanced, according to the Gold Bulls of 2013, this time is different. Rather than acknowledging that the market has already discounted the greatest combination of deficit spending and money printing in US history, they’re digging in.

 

Gold isn’t trading on what they think it should trade on – it’s trading on both absolute and relative expectations vs the US Dollar:

 

1.   ABSOLUTE: On the monetary policy side, no iQe5 upgrade of Gold is coming out of Jackson Hole this year (Bernanke isn’t even going to be there). And on the fiscal side, sequestration combined with US Consumption #GrowthAccelerating, is USD bullish.

 

2.   RELATIVE: Japan is going to print to infinity and beyond and the probability of the Europeans cutting to 0% is rising. Both are bullish for the US Dollar relative to the Yen and the Euro. What’s bullish for the USD remains bearish for Gold.

 

Last week was another reminder of that:

  1. US DOLLAR = +0.9% on the week (up for the 7th week in the last 10 and +4% for 2013 YTD)
  2. CRB Commodities Index = -1.4% on the week (down for the 8th week in the last 10 and -4% for 2013 YTD)
  3. GOLD and SILVER = down -7% and -13% last week, respectively (taking Gold’s YTD decline to -16.9%)

All the while, the Gold Bulls continue to say almost the opposite of what we have been ranting about for 6 months. Paulson & Co. wrote to their investors that central bank “stimulus will eventually lead to inflation.” But that’s my point, eventually already happened.

 

We already had the greatest commodity inflation in world history. If the most asymmetric long-term move in all of Global Macro continues higher from here (#StrongDollar), this will continue to be an epic #CommodityDeflation, not inflation.

 

Don’t take my word for it – ask Mr Market, what was priced in when Bernanke said he’d go to infinity and beyond (6 months ago)?

  1. Silver is down -29% in the last 6 months
  2. Rubber is down -25% in the last 6 months
  3. Japanese Yen is down -25% in the last 6 months 

Again, if you get the US Dollar right, you’ll get a lot of other big things right. There are plenty of other ways to make money on this other than being short Gold and Copper Miners (we remain short Freeport, FCX, btw):

  1. Emerging Markets (EEM)
  2. Russian Stocks (RSX)
  3. Peruvian Stocks (EPU)

Peruvian stocks? You have to be kidding me Mucker. Who the heck do you think you are making calls on Peru – what’s next, Peruvian Par Bonds? Ha! Actually Peru just dipped inside of Russia for the world’s 2nd worse performing stock market YTD (Cyprus is the worst at -15%).

 

The reason why you shouldn’t have your 401k choking on Peru is the same as why you shouldn’t have it stuffed with Gold, Silver, or Corn. Peru a commodity economy (85% of exports) and its stock market is 37% indexed to Basic Material and Energy stocks.

 

As a point of reference, only 13% of the SP500 is in Basic Materials and Energy.  And we don’t want you to be long those S&P Sectors (XLB and XLE) either. Energy (XLE) led USA’s losers last week at -4.4%, only to be outpaced by Russian stocks (on the downside) at -4.9%!

 

How important is it for a Global Macro investor to get the world’s reserve currency right? Is it all interconnected? If you invest in Global Macro, do you have to get growth and inflation right too? We think the answers to these basic questions are self evident. That’s why we built our proprietary Growth/Inflation/Policy (GIP) Model.

 

That’s also why our views on growth and inflation have been different from consensus for a long time now. We get the #GrowthSlowing via US Dollar Debauchery inflation call (it’s a call we made consistently from 2007-2012). And when you see this week’s US preliminary GDP Growth print (Friday), sequentially in Q113 you’ll see #GrowthAccelerating as #CommodityDeflation takes hold too.

 

Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, EUR/USD, UST 10yr Yield, VIX, and the SP500 are now $1, $96.02-101.62, $82.41-83.14, 97.12-101.06, $1.29-1.31, 1.68-1.76%, 14.05-18.69, and 1, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Inflation Trepidation - Chart of the Day

 

Inflation Trepidation - Virtual Portfolio


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