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ECB on Hold This Thursday

Continuing with our call, we believe that Mario Draghi and the ECB will keep rates unchanged this Thursday after making a big splash cutting the main interest rate by 25bps (to +0.50%) last month.

 

Here’s how we’re sizing up our positioning:

  • Draghi has signaled that he expects a gradual recovery in growth in the back half of 2013, and therefore is monitoring the impact of the May 2nd interest rate cut and the current high-frequency data
  • Manufacturing PMIs were better in MAY vs APR (48.3 vs 46.7)
  • May Eurozone Confidence figures (Economic, Consumer, Business, Services, Industrial) all improved month-over-month
  • Sovereign yields remain largely anchored and the majority of European equity markets are positive YTD
  • The ECB needs more time to consider non-standard measures to encourage growth, including initial hints at 1.) Increased lending to small and medium-sized enterprises (SMEs) and 2.) Cutting the deposit rate to negative
  • On SME funding, it’s not clear the channel by which the funding would be carried out, ie from top-down coordination (Brussels/ECB) or bottom-up (at the individual CB/State Government level)
  • On a negative deposit rate, there is mixed discussion about the merits and benefits of such a move. Denmark provides one example of this and its government has claimed that it had no impact in boosting lending, and could negatively distort the property market. The jury is still clearly out on this option
  • Consensus is baking in no change to rates: 41 of 42 economists polled by Bloomberg agree

ECB on Hold This Thursday - yy. rates

 

Our critical TAIL line of resistance on the EUR/USD at $1.31 has not changed over recent months. We’ll be monitoring this level closely into and out of Thursday’s ECB meeting. Our immediate term TRADE range is outlined in the chart below. (The cross can be traded via the etf FXE).

 

ECB on Hold This Thursday - yy. eur usd

 

Matthew Hedrick

Senior Analyst


LINN Energy Discloses New, Critical Information

In footnote #3 on page 257 of LINN Energy's (LINE, LNCO) Form S-4/A released this morning (June 4, 2013) is a new, critical disclosure.  We highlight it below:

 

LINN Energy Discloses New, Critical Information - linn 1

 

We now know exactly how much LINN's controversial put option accounting method has contributed to "Distributable Cash Flow (DCF)" for prior periods.  In the most recent quarter (1Q13), 29% of DCF was generated by LINN's unique put options accounting method, which we believe is inappropriate and misleading, as described ad nauseum in our prior research - see slides 18 - 29).  

 

Importantly, the % of DCF generated from this accounting method has been increasing.  In 1Q12 it was 16% of DCF; for the three quarters combined 2Q12 - 4Q12 it was 24% of DCF; and in 1Q13 it was 29% of DCF.

 

Excluding premiums paid for put options settled in 1Q13, DCF/unit was only $0.46, for a coverage ratio of 0.63.  And that's saying nothing of the massively understated "maintenance CapEx" figure (which there is also some new disclosures on in today's S-4/A)...

 

LINN Energy Discloses New, Critical Information - linn 3

 

We had previously estimated that the figure would be ~$120MM per year, or $30MM per quarter, for 2013 and beyond.  It appears that we were too conservative with that estimate.  If we annualize the 1Q13 number of $43MM, that's $172MM in 2013 and 25% of guided DCF ($681MM).

 

---

 

As a reminder, this is what LINN's CFO Kolja Rockov said on this very topic when I questioned about it at the OGIS NYC break out session on 4/15/2013:

 

Kaiser: “On the 2013 hedge book, what’s the cash cost of the put options that expire in 2013?”

 

Rockov: “There is none.  Every put that we’ve ever bought we paid for with cash up front.”

 

Kaiser: “Yeah, what did that cost you, for the ones that will expire in 2013.”

 

Rockov: “Oh.  I don’t know exactly.  It’s probably $100 million-ish a year, if I had to guess.”

 

Kaiser: “$100 million?”

 

Rockov: “Yeah.  I mean, because they weren’t all bought in one time period, they were bought over the last several years, so I’d have to go back and look.  I’m not…  But somewhere in that magnitude.”

 

Compared to the new disclosure, his "guess" appears a little light...

 

Kevin Kaiser

Senior Analyst 


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.

investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.

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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