“And when it rains on your parade, look up rather than down. Without the rain, there would be no rainbow.”
-Gilbert K. Chesterton
It is a rainy day in the Northeast. And rain can be depressing if we let it get to us. The point that Chesterton makes above though is spot on. Without the disruption of rain, there would ultimately be no rainbow and subsequently the hope of a pot of gold.
The idea that we have to suffer through bad times to get to good times is of course a bit of a paradox. To Chesterton, who is often referred to as the “prince of paradox” this was fine. After all, he was an orthodox Christian who had friendly enemies. (He was also 6’4, wore a cape, and carried around a swordstick in his hand.)
In mathematical terms, we would probably characterize this concept of bad weather becoming good as reversion to the mean. Due to mathematical impossibilities, no price goes up forever and no price goes down forever. In the same vein, rain doesn’t last forever and when it stops the weather is typically very nice. Unfortunately for those hoping for good weather, the forecast is for showers through Tuesday of next week. But as Longfellow said:
“The best thing one can do when it’s raining is to let it rain.”
For the last week or so, the U.S. equity market has been raining on our growth is accelerating parade. So is this a temporary rainy spell and will the sunshine of a positive economic growth return shortly? Well, we certainly still believe this to be the case.
We had a good email discussion with one of our subscribers yesterday who asked us about an assertion Keith made that employment is continuing to improve. The distinction between our view and the view of much of consensus is that we believe that seasonally adjusting the employment number distorts the data series. Unfortunately for us, the market continues to cue off the seasonally adjusted number and those appear to be stagnating.
The impact over the last four years is that the seasonal adjustments have created a tailwind from September to February and a headwind from March through August. This is highlighted in the first chart below. This “seasonally adjusted” slowdown in employment has also been a headwind for the equity market for the last few years. Nonetheless, even on a seasonally adjusted basis, as highlighted by the purple line in the first chart, employment is decelerating at a slower pace than in the prior four years.
More instructive though is the second chart below, which highlights rolling initial unemployment claims that are non-seasonally adjusted. The trend here is clear, which is that employment is improving and somewhat decisively so. To the extent that the market continues to focus on the seasonally adjusted series, though, we are likely to have a few more months of employment rain. On that front, the May employment report is at 830am, so be wary as we are in the season of employment rain!
We would be remiss if we didn’t touch on Asia this morning where the storm clouds are creating a down pour on the global macro markets. For those that chased Japan into its Abenomic highs, they are now quite literally having a mother of a time. Specifically, the MOTHERS index closed down -11.5% over night and is now down -38% from its highs. (This index holds smaller companies so is naturally more volatile.)
The driver of this mother of a correction in Japan was the strength in the Yen versus the dollar. From our purview, the break through the 99 barrier seemingly triggered a massive stop loss program and, as they say, when it rains, it pours. As a result, the Yen / Dollar went from 99 to 96 in a straight line yesterday. (Some have speculated that one catalyst may have been a leaking of today’s jobs number, but who are we to distrust the government . . .!)
As it relates to the Yen, which remains one of our Best Ideas on the short side, we still think that relative monetary policy will inform the direction of the currency. As my colleague Darius Dale emphasized yesterday in a note to subscribers, the BOJ is already committed to monetizing ¥132 trillion through EOY ’14 (27.7% of 2012 nominal GDP) vs. the Fed’s $2.04 trillion (13% of 2012 nominal GDP) over the same time period – assuming the Fed continues at the current pace of $85 billion per month through EOY ’14 (an unlikely scenario in our opinion). So despite yesterday’s correction in the Yen, we think the structural bear case remains.
One important highlight in the recent action in U.S. equities is that our risk range on the SP500 has widened to 1,607 – 1,669. This isn’t terribly surprising given that volatility, as measured by the VIX, is up about 30% in the last month. For those that actively hedge or trade their portfolio, all this really means is that you need a bigger umbrella in the short term! Or as the popular band Blind Melon sings, “No Rain.”
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1, $100.58-104.73, $81.34-82.46, 95.66-103.34, 2.02-2.22%, 13.37-17.91, and 1, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
This note was originally published at 8am on May 24, 2013 for Hedgeye subscribers.
“To you from failing hands we throw the torch. Be yours to hold it high.”
-Lieutenant-Colonel John McCrae
Most of you probably haven’t played for the Montreal Canadiens, but if you had, you would know that the quote above is painted on the wall in the Canadiens locker room. The idea is that current players are expected to live up to traditions of the past. The line itself is taken from a poem called, “In Flanders Fields”, which was written by Dr. John McCrae in World War I.
McCrae enrolled at the age of 41 with Canadian Expeditionary Force following the outbreak of World War I. Instead of joining the medical corps, which he had the option to do based on age and training, he instead volunteered to join a fighting unit as a gunner and medical officer and was immediately sent to the German front in Belgium.
Flanders is a region in Belgium where Germany launched the first chemical attack in the war during the second battle of Ypres. At the conclusion of the battle, McCrae was inspired to write the poem after seeing the poppies grow on the graves of the dead at Ypres, thus the opening line of the poem, “In Flanders fields the poppies blow.” To this day, Canadians wear poppies on Remembrance Day in memory of those who died while serving in the Canadian military.
Back to the global macro grind . . .
This idea of transition from past to present is one we discussed in great detail on an expert call yesterday with Jim Rickards, the author of “Currency Wars: The Making of the Next Global Crisis”. The focus of our discussion of transition related to the Federal Reserve. Specifically, what will happen as Chairman Bernanke’s term ends in January 2014?
On a basic level, if Bernanke moves on, whoever comes in to lead the Fed will be burdened with unwinding the most dovish monetary policy in the history of central banking, including the longest run of zero interest rate policy and a quantitative easing program that is without parallel. Ultimately, the Fed will have to unwind the $3.4 trillion in securities on its balance sheet. That torch is passed to you Mr. or Mrs. Next Fed Head!
One area in which we would hope to see an improvement from the next Chairman of the Federal Reserve is in economic projections. In the Chart of the Day, we look at the U.S. GDP growth projections supplied by the Fed going back to the 2010. Here is the skinny:
- In 2010, the Fed’s peak GDP growth projection was 3.5%, which missed the actual number by 32%;
- In 2011, the Fed’s peak GDP growth projection was 3.7%, which missed the actual number by 51%; and
- In 2012, the Fed’s peak GDP growth projection was 2.7%, which missed the actual number by 19%.
If you didn’t know that economics isn’t a science, well, now you know.
In terms of improving their internal models, we may just send the new Chairman of the Federal Reserve a Hedgeye dart board and some darts. On a serious note, the fundamental problem with such shoddy projections is that the Federal Reserve is actually setting monetary policy based on these numbers, which currently involves purchasing $85 billion in securities monthly. It should be no surprise then that we have market volatility.
Speaking of central banking induced volatility, the Nikkei had a 7% intraday swing yesterday. What was the catalyst you ask? The Bank of Japan’s Kuroda came out midday and said that the “BOJ has announced sufficient monetary easing.” Obviously, the markets don’t believe him. Neither do we and therefore we are keeping our short Japanese Yen recommendation in our Best Ideas product. We are also negative on JGBs on the recent break out above 1% on the 10-year.
No surprise, the Keynesian economic standard bearer Paul Krugman is taking the other side of our research this morning in an op-ed in the New York Times and calling, “Japan the Model”. Like a fledgling hedge fund analyst that has to defend his position to the seasoned portfolio manager, Krugman finds the facts that best support his case. We behavioral economists call this framing.
Interestingly, on one hand Krugman is heralding the success of Japanese monetary policy because “Japanese stocks have soared”. Conversely though, he tells us not to worry about the recent sharp sell-off in Japanese equities when he writes:
“I’m old enough to remember Black Monday in 1987, when U.S. stocks suddenly fell more than 20 percent for no obvious reason, and the ongoing economic recovery suffered not at all.”
You can’t have your cake and eat it too Dr. Krugman!
Our ever savvy Healthcare sector head Tom Tobin offers an alternative thesis to the long decline of Japan’s economy, which is simply that over the last 50 years the population growth rate has been in steady decline. Not surprisingly, this decline in population growth has correlated very closely with GDP growth. That’s not our prognostication on the holy pages of the New York Times, but rather the simple math.
The fundamental problem that Keynesian economists who advocate printing to infinity and beyond have is that they can’t explain how printing leads to more jobs and higher employment. Simply put, that is because debasing a currency doesn’t incentivize companies to invest and hire. In fact, it does the opposite.
We are happy to continue to trade the market volatility induced by Keynesian economics, but at some point we do hope that the torch is passed on from these charlatans.
Our immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, USD/YEN, UST 10yr Yield, VIX, Weimar Nikkei, and the SP500 are now $1343-1424, $101.61-103.92, $83.24-84.29, 101.42-103.69, 1.95-2.05%, 13.11-15.73, 14,271-15,097, and 1634-1657, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
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THE MACAU METRO MONITOR, JUNE 7, 2013
LAS VEGAS SANDS PROBE: GRAND JURY HEARS WITNESSES WSJ
As previously reported, the government is looking into whether Las Vegas Sands employees should have alerted government authorities to potentially suspicious transactions by two high-rollers: China-born Mexican businessman Zhenli Ye Gon and former Fry's Electronics Inc. executive Ausuf Umar Siddiqui.
The company disclosed last year that it had received federal subpoenas to produce documents. The Huffington Post on Wednesday reported that a grand jury was involved in the investigation.
The people familiar with the matter said the grand jury began hearing witness testimony within the past few weeks. The company has been in discussions with the Justice Department over the past year regarding a possible settlement, people familiar with the matter said.
MACAU LEGEND PLANS HONG KONG IPO WSJ
Macau Legend Development Ltd. plans to raise up to US$788 million in an initial public offering in Hong Kong. The company, controlled by Macau tycoon David Chow Kam Fai, plans to sell 2.05 billion shares in a range of 2.30 to 2.98 Hong Kong dollars (30 to 38 U.S. cents) each and list on June 27. It will start taking orders from investors on Friday.
Cornerstone investor Dynam Hong Kong Co. Ltd. is buying US$35 million worth of the shares and has agreed to hold them for six months.
Macau Legend is looking to refurbish and expand the 133,038 square-meter Macau Fisherman's Wharf. The redevelopment is scheduled to be completed by the end of 2015, at which point Macau Legend will have 1,200 hotel rooms.
VENETIAN SENDS OUT TERM SHEETS FOR US$2.25 BLN LOAN Reuters
Venetian has sent out term sheets to relationship banks for an up to US$2.25 billion six-year financing, sources said.
Venetian was talking about a potential refinancing of its US$3.7 billion loan from September 2011. Sources said the new deal is for refinancing and a new development plot in Macau.
The financing is split into an up to US$1.5 billion revolving credit and an up to US$750 million term loan. The facility can be funded in HK$, MOP or US$. The average life is around five years.
DRAFT TAIWAN CASINO BILL DELAYED Macau Business
According to Gambling Compliance, legislative debate on Taiwan’s draft casino law is likely to be pushed back to August at the earliest. The draft casino bill, ready since last month and which oversees the development of casinos on outlying islands in the Taiwan Strait, has yet to be put up for debate.
Julia Lee, vice president of Taiwan development for Weidner Resorts, said debate is likely to take place in August, citing legislative sources close to the process.
Last week, three ruling Kuomintang legislators submitted a rival bill. It proposes the creation of foreign-passport permit based casinos in “special economic zones” located in central Taiwan.
JAPAN PARTY BREAKS RANKS TO SUBMIT CASINO BILL ON OWN Reuters
A small Japanese party plans to submit a bill legalising casinos to parliament on Friday, breaking ranks with a cross-party group that wants to delay such a move until after elections.
The move by the Japan Restoration Party (JRP) threatens to complicate efforts by the cross-party lobby, which had set its timetable in part to avoid making the controversial issue of casinos a focal point ahead of upper house elections in July.
The JRP, which has 16 lawmakers in the 140-member lobby, is keen to take the initiative on the issue in the run-up to the election, according to one of the sources, who spoke on condition of anonymity ahead of the bill's submission.
Our CEO Keith McCullough likes to frame sentiment as being bullish, bearish, or not enough of one or the other. The investment community is not bullish enough on Starbucks. The bear case does not scare us when it comes to Starbucks. We decided to run through some bull and bear points to refresh clients on our thesis.
We remain bullish on Starbucks at current levels. Despite the stock trading at the high end of its historical consensus forward earnings and cash flow multiples, we believe more upside is in store. Bullish factors we are focused on include rapid unit growth in China, expansion into new segments of the global food and beverage industry, and a commodity tailwind that only seems to be getting stronger.
Below, we go through the bear and bull cases for SBUX and offer our thoughts on each sub-point.
Starbucks has been a favorite name of ours for virtually all of the last four years. Aside from a period in 3Q12, when our research process suggested a more cautious stance was necessary, we have been bullish on the stock as it has taken share from competitors in existing businesses and grown its touch points in tangent areas of the food and beverage industries. Despite strong outperformance and plenty of bearish arguments to the contrary, we are reiterating our bullish stance today as we believe that the investment community is bullish, but not bullish enough, at this price.
As the quantitative levels, below, indicate, SBUX is in bullish formation with the immediate-term risk range at $62.63-$64.56 and TREND level support at $59.57.
Bear Case: Valuation, Sentiment, Portfolio Pitfall, Personnel Changes, EMEA, Brewer Growing Pains
Valuation is a factor we consider when formulating all investment theses but is not, in itself, a thesis. It’s impossible to know if Starbucks’ stock is cheap or expensive at current levels unless one knows the forward earnings of the company. What would make the stock cheap to us is if the future growth potential of the company was being overestimated by the investment community. We do not believe that it is.
The investment community has become more bullish on Starbucks over the past year as the stock price has risen and visibility on the company’s future growth strategies has increased. Casual dining has seen sentiment rise more than quick service as investors have sought exposure to more discretionary niches of the consumer space. We believe that the stock has further to run over the intermediate TREND and long-term TAIL durations. Our CEO Keith McCullough likes to frame sentiment as being bullish, bearish, or not enough of one or the other. The investment community is not bullish enough on Starbucks.
Portfolio Pitfalls & Growing Pains
The history of the restaurant industry is littered with anecdotes of management teams that thought they could grow forever at an ever-increasing rate. Executive compensation structures more closely tied to unit growth targets than returns typified the folly of so many quick service and casual dining companies. Many companies have reaped the negative rewards of growing too fast and/or adding too many concepts to the company’s structure.
With respect to growth, Starbucks has not been perfect throughout its history. Between 2005 and 2009, Starbucks almost doubled its number of locations, to almost 17,000. In 2007, Howard Schultz flagged changes in the consumer experience to then-CEO Jim Donald as counter-productive initiatives. Examples included “flavor-locked packaging” and complicated espresso machines that eroded the degree to which visiting Starbucks resonated with consumers.
Perhaps the most acute risk we see in Starbucks’ future trajectory is the growing number of ventures under the auspices of the current management team. We expressed this on 6/5/12 in a note titled “ONE MOVE TOO MANY?”, writing that the company seemed to be embarking on an investment phase implied added risk to the share price. Managing five concepts, we wrote, seemed to be a departure from the returns-focused strategy had added value to the company in recent years.
The best argument against the idea that Starbucks will begin to destroy value by overstretching its shareholders’ capital is the current management team’s leadership. Schultz’ emphasis on discipline and rigor in his team’s approach to making capital allocation decisions differs greatly from other, less effective, executives in the industry.
As Starbucks becomes larger, and a greater number of individuals assume leadership positions, the potential for executives to leave to pursue alternative paths could increase. Michelle Gass leaving the company for Kohl’s Corp. is a blow, with CEO Howard Schultz having praised her impact on several key areas of the business including a key role in the turnaround of 2008/2009.
What Gass’ departure means for the stock is difficult to know. The pessimist may infer that her departure represents, in part, a lack of confidence in Starbucks’ future trajectory as she had, just one month ago, been called back from her role leading the EMEA division to work in an undefined leadership role under Schultz focusing on making the “pieces” of Starbucks work together, according to The Wall Street Journal. Gass worked for Stabucks for 16 years and, in time, may have been a candidate to assume a leadership role in the company’s C-Suite.
We believe that Gass’ departure from the company is a negative but, given her focus on the EMEA division over the past couple of years, it is clear that the company has many other talented individuals that have helped drive important areas of the enterprise forward. If we were to speculate, we would guess that the incentive of almost $10 million over the next four years likely had more of an impact than unease in her role at Starbucks.
The weakness of Europe’s economies poses a risk to all global companies but we believe that Starbucks is relatively well-prepared to weather the storm. The company derives a very small proportion of its earnings, or less than 2% of total consolidated operating income, from EMEA which offers shareholders peace of mind as Europe continues to struggle to find economic momentum. Even with such a low degree of exposure, the company is taking a proactive approach to mitigating the risk of further economic turbulence in EMEA by increasing the proportion of licensed to company-owned stores.
Bull Case: Strong Dollar, Growth Runway, Commodity Costs, Mgmt Team, ROIIC
Strong Dollar, Strong America, Strong Consumption
In November 2012, our Macro team turned positive on U.S. growth, which is 71% consumption, as the strengthening U.S. Dollar gave consumers a food and energy price cut. With the U.S. economy continuing to improve, we believe that Starbucks is one of the best ways to play a strengthening consumer. Jobless Claims, in particular, are an important metric for Starbucks’ Americas business as, in the most basic terms possible, more people going to work translates very closely into more people buying coffee as part of their daily routine.
The strength of Starbucks’ Americas retail business is well-appreciated. Additional growth over the long-term TAIL will be largely driven by other segments of the business such as CPG, China, India, K-Cups, single-serve, home brewers, tea ($40 billion category), juice, and food among others. With management aiming to double the China unit count to 1,500 from 700 by the end of 2015 and viewing the CPG business as potentially becoming as large as the U.S. retail business, we believe that Starbucks is far from the end of the growth phase of its maturity curve.
Favorable coffee costs, coinciding with strong top-line growth, have resulted in strong earnings and cash flow generation. This tailwind is likely to continue through the end of the year and beyond, with management expecting a $100 million tailwind from coffee in 2014.
This is not a quantifiable factor but for anyone that has been following the restaurant space for any significant period of time, it is evident that a management team’s aptitude is often evident in their communications with the investor communities. Starbucks, over the last five or six years, has demonstrated a consistency in its message and its commitment to prudent growth that has set is apart from most of its competitors. Starbucks’ brand is one of the best-recognized in the world as the company has taken proactive steps to build an industry-leading loyalty program and an unrivalled social media presence, which has manifested in strong organic growth.
Last, but certainly not least, the ROIIC metric indicates that management is walking the walk. This chart is a key component of our process on all restaurant names – particularly those growing units – and Starbucks is better than most at sustaining a disciplined approach to expanding its business operations.
Takeaway: It didn’t take people long to get really bearish again, because consensus has been bearish for the last 6 months.
This note was originally published June 06, 2013 at 13:23 in Macro
POSITION: 12 LONGS, 5 SHORTS @Hedgeye
It didn’t take people long to get really bearish again, because consensus has been bearish for the last 6 months. Once again, the market is immediate-term TRADE oversold within a bullish intermediate-term TREND.
As both the consumption data (ISM Services PMI, New Orders, Housing, etc) and employment data (jobless claims 347,000) surprise to the bullish side, who would have thought that #GrowthAccelerating would become the latest fear? At least with Cyprus things were actually burning.
Across our core risk management durations, here are the lines that matter to me most:
- Immediate-term TRADE resistance 1624, then 1673
- Immediate-term TRADE oversold < 1601
- Intermediate-term TREND support = 1577
In other words, we snapped one of my front-runner lines (immediate-term TRADE support of 1624) and the machines chased. This isn’t new. Neither is front-month vitality (VIX) pinning another 6-month lower-high.
This is what happens when hedge fund performance is bad and consensus is forced to cover high and short low.
Keith R. McCullough
Chief Executive Officer
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