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IS A RATE HIKE(S) COMING DOWN THE PIKE IN CHINA?

Takeaway: No change to our dour view of China’s TREND-duration growth outlook or the pending bifurcation of FAI and consumption growth.

SUMMARY BULLETS:

 

  • Chinese home prices continue to get away from the Communist Party’s political agenda and we think we are getting close to seeing Beijing issue a new round of macroprudential tightening measures – with perhaps a better plan for local implementation this time around.
  • Additionally, if the PBOC falls behind the curve with respect to draining liquidity, we think they’ll then be forced to tighten RRRs or potentially worse – hike interest rates – in order to combat what is clearly excessive house price appreciation in the context of China’s plans to accelerate urbanization over the intermediate term (think: affordability).
  • All told, there is no change to our dour view of China’s TREND-duration growth outlook or the pending bifurcation of FAI and consumption growth. If you’re looking for a more detailed analysis of China’s pending economic trends and the risks embedded across the country’s banking system, we encourage you to review the hyperlinked research notes at the conclusion of this note.

 

Chinese home prices continue to get away from the Communist Party’s political agenda and we think we are getting close to seeing Beijing issue a new round of macroprudential tightening measures – with perhaps a better plan for local implementation this time around.

 

According to data released by the China Index Academy today, the average price of homes in 100 monitored Chinese cities increased in MAY by +0.8% MoM, in line with the SouFun Holdings data yesterday and down slightly from APR’s +1% MoM pace. Both indices registered a twelfth consecutive MoM gain.

 

From a YoY perspective, the SouFun data showed a +6.9% increase in MAY, up from a +5.3% pace in APR and good for the sixth consecutive YoY increase. Looking to the most bubbly markets, the average home price in the ten major cities including Beijing and Shanghai was CNY 17,202 per square meter in MAY, up +1.1% MoM and +9.7% YoY.

 

IS A RATE HIKE(S) COMING DOWN THE PIKE IN CHINA? - 1

 

Amid these growing asset bubble risks, the PBOC has accelerated its draining of liquidity of late,  but a total of CNY202 billion in central bank bills and repos will mature on the open market this week, representing a significant increase of CNY172 billion from the prior week, and good for the highest weekly maturity amount in the YTD.

 

IS A RATE HIKE(S) COMING DOWN THE PIKE IN CHINA? - 2

 

If the PBOC falls behind the curve with respect to draining liquidity, we think they’ll then be forced to tighten RRRs or potentially worse – hike interest rates – in order to combat what is clearly excessive house price appreciation in the context of China’s plans to accelerate urbanization over the intermediate term (think: affordability).

 

IS A RATE HIKE(S) COMING DOWN THE PIKE IN CHINA? - 4

 

Either or, we suspect that participants in the Chinese iron ore and rebar markets (down -9% and -3.4% MoM, respectively) are increasingly sniffing out what we were out front labeling as 2H13 growth headwinds for the Chinese economy.

 

IS A RATE HIKE(S) COMING DOWN THE PIKE IN CHINA? - 3

 

All told, there is no change to our dour view of China’s TREND-duration growth outlook or the pending bifurcation of FAI and consumption growth. If you’re looking for a more detailed analysis of China’s pending economic trends and the risks embedded across the country’s banking system, we encourage you to review the following research notes. As always, we are available to follow up offline as well.

 

Darius Dale

Senior Analyst

 

  • IS THE RECENT RALLY IN CHINESE EQUITIES SUSTAINABLE? (5/17): We do not think the recent strength in the Chinese equity market is sustainable, as China’s 2H13 growth outlook appears dicey at best.
  • WHY IS CHINA GOOSING ITS EXPORT FIGURES AND HOW MUCH LONGER WILL IT CONTINUE? (5/8): Chinese firms are goosing exports to drive incremental liquidity into the banking system – a phenomenon that appears set to slow from here.
  • TWO CHINAS? (5/1): Financial system headwinds continue to outweigh consumption tailwinds within the Chinese economy.
  • REPLAY: Will China Break? (4/30): The Party’s use of state owned banks to drive economic growth through fixed asset investment has left the financial system loaded with bad assets.  The bad assets mirror bad investments in the real economy.  They also can limit the ability of Chinese banks to make new loans.  Following the financial crisis, the Chinese government pushed too hard on the FAI growth lever, building infrastructure projects “for the next 10 years.” It has also left the banking sector choked with bad debts that may limit future lending.  Those factors should slow Chinese FAI growth and slower Chinese FAI growth should be negative for commodity prices and resource-related profits, all else equal.
  • CAN CHINA AVOID FINANCIAL CRISIS? (4/26): The risk of a Chinese financial crisis is heightened to the extent that financial sector reforms are not appropriately managed.
  • REPLAY: EMERGING MARKET CRISES (4/23): We currently see a pervasive level of risk across the emerging market space at the country level and have quantified which countries are most vulnerable. China is particularly vulnerable to experiencing a financial crisis.
  • 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.

Morning Reads From Our Research Team

Takeaway: A quick look at what's on the Hedgeye radar screen this morning.

Daryl Jones - Macro

DOE: U.S. Crude-Oil Stocks Highest Since May 1931 (via WSJ)

Supply shock from North American oil rippling through global market (via IEA)

 

Josh Steiner - Financials

CoreLogic Home Price Index Report (via CoreLogic)

Bank of America $8.5 billion mortgage settlement case opens (via Reuters)

 

Howard Penney - Restaurants

Reclaim Your Angus at Carl's Jr. (via YouTube)

 

Keith McCullough - CEO

A Tale of Wall St. Excess (via New York Times)

 

Kevin Kaiser - Energy

Wounded Heart (Bill Gross' new investment letter via PIMCO)

 

Matt Hedrick - Macro

EU potential for social unrest is world's highest - ILO (via Reuters)


Still Long...

Client Talking Points

S&P500

Immediate-term Risk Range is 1630-1651. We remain bullish and are time stamped buying yesterday’s dip. Key positive we see relating to growth? Expectations.  Consensus aggregate SP500 revenue growth next three quarters is 0.5%, 3.4% and 2.3%. This is an expected revenue growth rate of  just over 2.0% in the projected period, and less than half the average reported year-over-year growth rate of north of 4% in the prior three quarters.  These low expectations are very supportive. 

JAPAN

Japan bounced +2% overnight right where it should have (it was oversold yesterday). Neighbor China fell -1.2% with Honk Kong and Korea closing flat. The Weimar Nikkei is in a very interesting spot now = bearish TRADE; bullish TREND. Meanwhile, JGB 10yr Yield at 0.83%, that's still 2bps above the Hedgeye TAIL risk line. We’ll be keeping a close eye on Abe's “Yen burning” speech tomorrow.

Asset Allocation

CASH 25% US EQUITIES 28%
INTL EQUITIES 18% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 29%

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.  

WWW

WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow.

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.

Three for the Road

TWEET OF THE DAY

"Just a friendly reminder to the housing bears - you said y/y US Home prices would be up +5-6%- already running 2x that"

@KeithMcCullough

QUOTE OF THE DAY

"Failure is not fatal, but failure to change might be." - John Wooden 

STAT OF THE DAY

US Home Prices rip a new high in May up +12.5% y/y.


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Debating Growth

“All growth depends upon activity.  There is not development physically or intellectually without effort, and effort means work.”

-Calvin Coolidge

 

Former United States President Calvin Coolidge knew a thing or two about growth.  From a personal perspective, his life embodied steady growth of achievement.  His first foray into politics began in the Massachusetts House of Representatives in 1907.  He followed this up as Mayor of Northhampton, then became a member of the Massachusetts Senate, and after a couple of more stops became Governor of Massachusetts.

 

“Silent Cal”, as he was called due to his quiet demeanor, was then added to the Republican ticket as Vice President in 1920 and he and his running mate, Senator Harding of Ohio, went on to win in a landslide.   On August 2nd, 1923, President Harding died while on a speaking tour and Coolidge became President.  Coolidge then stood for election as President in 1924 and won his first official term as President.

 

From an economic perspective, largely based on a series of broad tax cuts, Coolidge oversaw a very economically prosperous time in U.S. economic history known as the “roaring 20s”. Interestingly, as well, as the top tax rates were cut from 58% in 1922 to 25% in 1929, the economy grew and the share of the tax burden of the wealthiest Americans, those making more than $100,000 per year, also grew from 35% to 63%.

 

In addition to the economic growth he oversaw, Coolidge also eventually outgrew his introverted personality.  In one his most outspoken moments, he said of his eventual successor Herbert Hoover, "for six years that man has given me unsolicited advice—all of it bad.”  Needless to say, the United States was not as economically fortunate under the stewardship of his successor President Hoover.

 

Back to the global macro grind . . .

 

Yesterday was a classic one for the ongoing debate over whether economic growth in the U.S. is accelerating or stagnating.  The Purchasing Managers Index (PMI) reading from Institute for Supply Chain Management (ISM) came in at a contraction indicating 49.0.  The internals of the report were negative across the board, as well, with new orders coming in at 48.8 and production coming in at 48.6.  The employment component of the index was still in expansion mode, albeit only marginally at 50.1.

 

The key read through from this reading is that as it relates to growth in the industrial sector in the U.S., headwinds remain.  On a relative basis, the United States is still faring better than the Eurozone where a 48.3 was reported in its latest PMI report, the latest in almost two straight years of factory output contraction in Europe.  The Chinese economy is also struggling on the industrial front as the HSBC PMI came in at 49.2 most recently.

 

Another data point that came out yesterday that supported the slowing growth case was government spending on construction.  Public construction spending dropped 1.2% in April to the lowest level since 2006 and down 5.7% from October.  This decline is obviously due to sequestration that is being implemented at the federal level.  In the short term, this may be an economic headwind, though the offset is that the deficit is declining much faster than expected.  In its most recent update the non-partisan Congressional Budget Office (CBO) projected that the deficit for fiscal year 2013 will fall to $624 billion, or about 4% of GDP, and almost $200 billion less than the CBOs estimate from three months before.

 

Our view of economic growth in the U.S. continues to be underscored by the consumer side of the economy.  On this front, the economic data released yesterday was positive as auto sales for May came in at an annualized rate of 15.3 million.  This was the fourth straight month of sales over 15.0 million and continues to show strong growth over the 14.5 million in auto sales from last year.  Certainly, auto sales are being driven by compelling financing programs, but as a proxy for consumer demand, they remain a positive indicator.

 

A key emerging American growth industry that will be a key tailwind for strong car production numbers is the U.S. energy industry.  In the Chart of the Day, we highlight this in a chart of U.S. oil production going back twenty years.  As the chart shows, largely thanks to technology advances, U.S. daily oil production is hitting 20-year highs.  This of course follows decades of production declines starting in the 1970s.

 

The International Energy Administration recently published a report that projected the North American oil supplies will grow by 3.9 million barrels by 2018.  This is almost 2/3rds of the non-OPEC production growth projected over that period.   If accurate, this will also reduce American imports by almost 40% over that period.  If the IEA is correct and this growth in production leads to a global “supply shock”, in coming years, the upside to global growth may be dramatic with declining oil prices.

 

Turning back to the shorter term and the U.S. stock market, another key positive we see relating to growth is expectations.  Currently, consensus aggregate SP500 revenue growth for the next three quarters is 0.5%, 3.4% and 2.3% respectively.  This is an expected revenue growth rate of  just over 2.0% in the projected period and less than half the average reported year-over-year growth rate of north of 4% in the prior three quarters.  For U.S. stock market bulls, these low expectations are very supportive.  For U.S. stock market bears, these expectations may well be, as Shakespeare said, “the root of all heart ache.”

 

Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1, $100.27-103.29, $82.48-83.74, 99.98-103.24, 2.07-2.23%, 14.63-16.59, and 1, respectively.

 

Daryl G. Jones

Director of Research

 

Debating Growth - Chart of the Day

 

Debating Growth - Virtual Portfolio


THE M3: GGR SHARES; GALAXY EXPANSION; TOKYO

THE MACAU METRO MONITOR, JUNE 4, 2013

 

 

SJM STILL LEADER OF CASINO MARKET SHARE Macau Business

May GGR shares:  SJM: 23%, LVS: 21%, Galaxy: 19%, MPEL: 14%, WYNN: 12%, and MGM: 11%.

 

CASINO FIRM GALAXY MULLS ACQUISITIONS, SPENDS HK$3.6 BILLION UPGRADING SCMP

Galaxy says it is looking for acquisitions in Macau.  Francis Lui Yiu-tung, the group's deputy chairman, said most of the HK$3.6 billion additional budget (HK$ 19.6 billion in total) for the second-phase expansion of Galaxy Macau was used for upgrading decor and facilities to "better cater to market demand".


Lui said the company was adding more slot machines for the mass market.  For Grand Waldo, which the group recently acquired for HK$3.25 billion, Lui said it would be positioned differently from Galaxy.  He added that the company had not yet decided whether Grand Waldo would focus on the mass market while Galaxy Macau catered to high-end gamblers. The acquisition is set to be completed in the next quarter.

 

Galaxy group is also considering other purchases.  "Land is the most difficult thing to come by. If we find any good investment opportunity around Galaxy facilities in Cotai, we will expand," said Lui.

 

TOKYO GOVERNOR REVIVES PLAN TO BUILD CASINO  ASAHI SHIMBUN

Tokyo Governor Naoki Inose said he intends to set up a casino in the capital’s waterfront district, even though operating such gambling establishments is currently illegal in Japan.  “I expect the Diet to revise the law as soon as possible,” he said at the metropolitan assembly session.


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