Investing Ideas Updates:
- CAG: With earnings season coming to an end for consumer staples, we received an interesting data point in support of our thesis on Con Agra (CAG) in the form of Treehouse Foods’ (THS) first quarter results. THS is another publicly traded private label manufacturer and while reported sales disappointed versus consensus, gross margins improved 30 basis points year over year (60 excluding the impact of a recent acquisition that was dilutive to gross margins). We think these results may be the early signs of the gross margin tailwind that is part of our investment thesis on CAG. Lower commodities flowing through the income statement with a significant impact on margins, particularly for private label manufacturers. Further, THS management commented that 2013 looked to be a year of “modest industry volume growth”, compared to the negative results of the last two years. We see early signs of growing strength in private label, a trend which will accrue to the benefit of CAG. (Please click here to see the latest Stock Report on CAG.)
- DRI: Restaurants sector head Howard Penney writes about the casual dining sector this week. “Initial indications are that April may have been another sluggish month for casual dining. For some people this might come as disappointing news. What happened to the Easter “shift” from March to April? Knowing some chains weakness at the end of March, this had shifted to strength in early April. This suggests that balance of April was weak. Sluggish sales trends are not being borne out in the casual dining stock, which have outperformed the S&P 500 by 340bps over the past month and 1080bps year-to-date.” Darden (DRI) remains one of his favorites. (Please click here to see the latest Stock Report on DRI.)
- FDX: Shares of FedEx (FDX) moved significantly higher in the past week, with no particularly obvious catalyst for the gains, writes Industrials sector head Jay Van Sciver. While we continue to believe the shares are an excellent long-term value, we might look for a pullback before initiating a position given recent volatility. (Please click here to see the latest Stock Report on FDX.)
- HOLX: Health Care sector head Tom Tobin says this week’s earnings call confirms his bullish stance on Hologic (HOLX). Tobin wasn’t “expecting management to fumble the sales channel in China,” or to miscalculate attrition in their core business. But he thinks concerns such as unreliable management and lower than expected reimbursements may be fully priced into the stock. On the macro level, there are compelling factors to sweep HOLX to higher prices. These include acceleration in their core customer base – unlike the decline in the broad healthcare market; an accelerating growth / replacement cycle in the mammography business; and accelerating “physician utilization” (more people going to the doctor more frequently.) On the stock side, Tobin says HOLX is trading at the low end of the multiple range for its group – after a recent price decline that he thinks was overdone – and short interest has doubled in the past six months, providing a possible slingshot effect if a sudden bull rush causes a short squeeze. (Please click here to see the latest Stock Report on HOLX.)
- MPEL: Melco Crown Entertainment (MPEL) reported earnings Wednesday, and most impressive in the quarter was that the mix continued to shift towards more the profitable premium mass market. Additionally, fixed costs were controlled, leading to very good margins, despite bad luck at CoD (their largest property). As for the smoking ban at casinos in Macau, our Gaming, Lodging and Leisure team said “not a big deal.” The ban is a partial ban in roughly 50% of the casino. We initially thought that it would impact mass margins due to the fact that most Chinese like to smoke and if they need to leave the tables for a puff that may lead to a decline in play. The ban was implemented in January and we have seen no evidence of this. (Please click here to see the latest Stock Report on MPEL.)
Macro Theme of the Week: Making Up The Numbers
We are essentially rewriting economic history,
- Brent Moulton, US Bureau of Economic Analysis
The BEA, the Bureau of Economic Analysis, is the federal agency charged with creating and maintaining the nation’s economic statistics. Mr. Moulton, who manages the National Accounts, was commenting on forthcoming changes in the formula of GDP, but there are other schemes afoot to make the nation’s finances look different. Why do these changes matter?
Hedgeye senior Macro analyst Christian Drake tried to make some sense of this and points out some important policy effects.
Deflating the Inflation
Recently, there has been emergent political support for changing the way the government calculates inflation. CPI, the Consumer Price Index, is the current standard measure for calculating general price level changes of goods and services in the economy. Select lawmakers, including President Obama, have voiced support for changing the calculation of inflation from the current CPI standard, to a new methodology called “chained CPI”.
“Chaining” is a calculation that assumes consumers will substitute goods as prices rise. If beef prices rise, for example, the Chained CPI assumes the average consumer will transition to chicken, soy, canned tuna fish and – in the AARP Armageddon scenario – tins of cat food. This is an application of the economists’ notion that people operate efficiently in their own self interest. Presumably the trade-off between a fixed amount of money and an equivalent caloric and protein intake is “efficient,” where “efficiency” means that the transition takes place smoothly and predictably within an identified population group.
According to research by the Bureau of Economic Analysis (BEA) and Bureau of Labor Statistics (BLS), Chained CPI tends to report inflation around 0.25% lower than current measures of CPI. The AARP says that, under chained CPI, cost of living adjustments (COLA) for retired people would be reduced by about $3 for every $1000. While this doesn’t look like a lot of money, it makes a difference if that $1000 is all you have to live on. And it keeps compounding.
The AARP gives an example of an individual receiving a $1,250 monthly Social Security check. Chained CPI would reduce this year’s COLA $45 – and by $91.32 in 2014. For most readers of this newsletter, a difference of $91 a year might not make a meaningful difference. More to the point, by the time you are old enough to worry about retirement and the COLA, Social Security may not exist any longer. Meanwhile, Drake says Congress won’t even have to say they are reducing benefits. All they will need to do is “point at the BLS and offer up some vague, technical statistical jargon.”
It’s reassuring to know that different departments of government can work so effectively together.
If It’s July, This Must Be Belgium
Every five years, the BEA does a comprehensive revision of the National Income and Product Accounts (NIPA) based on an economic census of some 4 million US businesses. As the BEA point out, “Comprehensive NIPA revisions differ from annual NIPA revisions primarily because of the scope of the changes.” In other words, “comprehensive” is bigger than not comprehensive, because it is… uh… comprehensive. Your taxpayer dollars at work.
This year the BEA is also changing the way GDP is calculated (see this week’s Term of the Week, below, for more detail on GDP.)
GDP, which measures the value of goods and services produced in the US, was last revised in 1999, when the value of computer software produced in the US was added to the calculation of the national accounts. The BEA’s Brent Moulton – whom we quote above – explains that the new measure will include R&D expenditures, and “entertainment, literary and artistic originals” such as motion pictures, books and recordings, but also “long-lasting” television programs.
According to the Financial Times (April 21st, “Data Shift To Lift US Economy 3%”) the revision will cause the economy of the US to balloon by around half a trillion dollars – “equivalent to adding a country as big as Belgium” to the global economy. The GDP revision will cause BEA to restate the national accounts going back to 1929. Its effect will also fall unevenly on states. Says the FT, state-level GDP “will soar in small states that host a lot of military R&D,” projecting that New Mexico’s GDP could rise by 10% and Maryland’s by 6%, literally at the stroke of a pen.
Here’s another wrinkle: the new measure will record what pension plans have promised to pay out, rather than the amounts of cash they pay into the plans. This will result in a large number of pension plans showing deficits, which is realistic, if not reassuring. BEA’s Moulton notes there are plenty of underfunded pension plans in the government sector, covering (or rather, notcompletely covering) both state and federal workers.
Hedgeye’s Drake says it’s way too early to determine all the effects of this change. But he notes that “any metric in which GDP is the denominator (Debt/GDP, etc) goes down” which could have policy implications.
If you have been following the tempest in the ivory tower over Harvard’s Reinhart and Rogoff (authors of the book This Time Is Different) you know that academics and policy makers are arguing over what is a “dangerous” level of national debt. Reinhart and Rogoff tried to demonstrate, based on the first-ever compilation of hundreds of years’ worth of figures, that countries take on large amounts of public debt at their peril. Their research has been challenged recently when an error was discovered in their calculations. R & R have acknowledged the mistake, but they say their fundamental thesis remains sound: a country shouldn’t borrow more than it can handle.
How much is too much? We won’t spoil the surprise ending – because no one knows. R & R posit 90% as an upper bound. The challenge to their work, combined with a sudden inflation in reported GDP, could provide congressional cover for incremental debt and deficit spending.
So come July, the national accounts will become more robust, literally overnight. We would be speculating if we suggested that new issuance of Treasury debt – based on an economy that is all of a sudden much stronger than it was yesterday – might also convince Fed chairman Bernanke of the need to increase his bond buying spree.
How much more does GDP have to go up before Bernanke raises his ante from $85 billion a month to, say $100 billion?
As Dr. Seuss says, “I do not know. Go ask your Dad.”
Special Sector Spotlight: Is the Affordable Care Act (ACA) – Obamacare - Driving Hiring?
Financial sector head Josh Steiner addressed this question in a note to institutions earlier this week. Here’s an excerpt from his note. Steiner writes:
“Why is the labor market showing accelerating improvement? One hypothesis we've been considering is the ACA impact on low-wage, high employment industries like restaurants, hotels, etc. Under ACA, i.e., Obamacare, employers with 50+ employees must provide healthcare to employees who work 30 hours or more per week. Part-time (those under 30 hours) and temp workers are exempted from the requirement. Industries like restaurants and hotels, that employ huge numbers of relatively low-wage earners, would see their costs rise materially under ACA. Not surprisingly, many employers are quietly seeking to sidestep ACA by cutting workers to sub-30 hours and offsetting the lost hours by hiring additional part-time and temp workers.
Anecdotally, we've been reading a lot of articles about temp agencies seeing significantly higher demand of late. We ran across one that quoted an analyst at another firm saying that when Massachusetts implemented its universal healthcare plan, growth in hiring of temp workers in the state ran at six times the national average.
One thing to consider is that companies are treading very cautiously here from a public relations standpoint. No employer wants to be seen as intentionally seeking to sidestep ACA requirements. So much of this is going on under the radar. As counterintuitive as it may seem, we think ACA is actually creating jobs in significant numbers, while simultaneously reducing many workers from full-time (40 hrs+) to part-time (sub 30).”
Investment Term: GDP
Gross Domestic Product (GDP) measures the market value of all goods and services produced within a country. In 1991 the BEA replaced Gross National Product (GNP) with GDP, noting that most other countries in the world already had adopted GDP as their measure of economic activity. You might point out that the US has stubbornly refused to adopt the metric system, so why the big deal over GNP / GDP? You would be right, but things don’t always have to make sense if you’re an economist. Or a government policy maker.
The simple difference is GNP measures all the output from economic activity owned by a country, while GDP measures economic output that takes place within a country.
Since political decisions are made based on economic realities – and since economists have a very different concept of “reality” from the likes of you and me – it should not surprise you to learn that GDP is a politically charged idea.
GDP is calculated according to a simple formula:
GDP = C + I + G + (X-M)
Translation: “GDP equals private Consumption, plus private Investment, plus Government spending, plus the net of Exports minusImports.
“Gross” means the calculation doesn’t differentiate on what the outputs are used for. “Domestic” means the production takes places within a nation’s borders.
GDP covers “officially acknowledged” economic goods and services, excluding revenues from illegal activities. As states pass legislation to legalize casino gambling, their GDP goes up. The shift by states to legalize medical marijuana also boosts those states’ GDP, and the nation’s, as well as boosting the tax base.
Remember what Hedgeye’s Drake noted above: all economic measures that have GDP in the denominator suddenly get smaller when GDP is recalculated to a bigger number. As we said, the most obvious immediate policy implications are for COLA adjustments – which affect labor negotiations and retired persons – and debt issuance, which affects everyone.
The Global Standard
Updating GDP brings the US into conformity with the international United Nations System of National Accounts (SNA), whose goal is to make it possible to compare “apples to apples” when comparing global economic activity.
The SNA covers a comprehensive list of “national accounts,” such as Gross Output, Redistribution and Social Spending, Household Expenditures, Domestic Flow of Funds, and a national Balance Sheet and Balance of Payments – the record of international trade transactions.
Bringing the US GDP up to the SNA actually makes us look better in comparison to other nations, by boosting our numbers – all the way back to 1929. It remains to be seen whether the effect of the SNA will be to raise every nation’s economic profile – a meaningless gesture if it is across the board – or to provide much greater specificity (what economists call “granularity”) into comparisons.
Economics and its Discontents
But surprise, surprise – some folks are critical of the SNA, and of global economic policies in general.
Critics of the SNA point out that all it measures is money. Economists and academics reply, That’s what it’s supposed to measure. But the broader criticism – that Economics is supposed to be in service of improving people’s lives – is certainly valid. We are not the only ones troubled by the increasing trend on the part of elected policy makers to turn key policy decisions over to appointed academics.
Of all the arguments over the SNA, most criticism has been leveled at GDP because of its importance and visibility in global policy making. And perhaps the most credible argument against GDP comes from Nobel Prize-winning economist Joseph Stiglitz, who says policy makers need an equally robust measure of “wellbeing” to balance GDP – which is, after all, just a measure of how much money an economy generates. If you believe “money can’t buy happiness,” then you will understand this argument.
Stiglitz, in fact, believes that money can actually destroy happiness if that is all you focus on, and he has written extensively on the social inequality that stems from what he considers misguided economic policies.
Here are some key criticisms of GDP. You can decide what you think.
- GDP is a purely commercial measure that fails to reflect what people “experience” in a society. – This may reflect the simple reality that laws are made by people in power, and power comes from having lots of money. You can criticize that all you like. It probably won’t change.
- Women’s contribution to the economy is largely not reflected, since much of what many women do is housework and child care, enabling men to be active in the work force. – Some economists try to compensate by imputing the value of “domestic labor” to the national accounts. And what about women who drop out of college to care for younger siblings to their mothers can work? Until there is a robust scale for measuring this kind of non-remunerative work, it will be hard to judge the relative value of the contribution of family members who are not defined as being in the Labor Force.
- GDP growth in advanced economies has been weak in recent years. Thus GDP no longer measures societal change accurately, making it a poor policy tool. – This is a really Slippery Slope with frightening implications. If your Domestic economy isn’t Producing Domestically, then you have a problem. It needs lots of fixes – from “shovel-ready” projects, to overhaul of the tax code, to entitlement reform. For politicians it’s easier to come up with new ways to measure economic activity rather than admit they have utterly failed us. Needless to say, economists like this outcome too, as it provides job security.
This last point is a key example of how reliance on a single measure can lead to disastrous policy making.
When a huge number of financial stocks broke down in the early days of the Financial Crisis, FINRA, the financial services self-regulatory body, changed listing requirements so companies would not have to be de-listed, even though they were trading well below $5 a share. FINRA said the low prices did not realistically reflect the “quality” of the companies. We would argue that the low prices did accurately reflect the quality of the US economy, of the financial markets, and especially of the financial firms, which had lost their credibility. The refusal to face that reality was the regulators’ contribution to Too Big To Fail. And it worked! After all, everyone at FINRA still has a job.
Says Stiglitz, You’re not going to arrive at a right conclusion if you measure the wrong thing.