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Krugman’s Crazy Math

Takeaway: Economic history refutes Paul Krugman. Again.

“A country without a memory is a country of madmen.”  

- George Santayana


My friend Jimmy Pethokoukis wrote this morning that while he doesn’t like Paul Krugman’s tone or personal attacks, Krugman's core economic point is correct in his recent piece, Non-inflation Denial.


I respectfully disagree with Jimmy. Krugman’s argument is a crock.


Krugman’s Crazy Math - krug


The NYT’s Nobelist is saying there is no inflation now, using the highest period of food price inflation ever recorded (2003-2012). Folks, food prices hit an all-time high in 2012—deflating Bernanke’s Bubble doesn't mean there's no food inflation.


In essence, Krugman is misrepresenting (aka “cherry picking”) the economic data by using a time period that doesn't show the actual truth about food inflation. He’s using a 10-year chart, instead of a 20 or 30-year chart. Some people call this lying.


Krugman really ought to take a look at our chart below.


History refutes him.


Krugman’s Crazy Math - Chart of the Day


Why did Krugman disguise the truth?


Perhaps he hopes Americans will forget history in lieu of his latest political narrative. Perhaps he hopes Americans don’t actually pump their own gas, shop for their own groceries, pay their own heating bills, pay their own visits to the doctor, pay for their childrens’ education, etc, etc.


Facts don’t lie; political people do.

CAT: Beware EM Crisis

Takeaway: Emerging market turmoil should accelerate the downside in CAT, likely leading investors to reassess inflated 2014 expectations.

This note was originally published June 24, 2013 at 15:31 in Industrials



We have published a number of reports outlining the bear case on CAT (for example, see here, here and even here).   We do not want to rehash the whole thesis, but we do think the current issues in emerging markets will accelerate the readjustment in expectations for CAT. As a result, we are adding CAT to the Best Ideas list.


CAT: Beware EM Crisis - cat


CAT has been an underperformer over the past year as commodity prices stalled.  After a decade of being a primary beneficiary of the boom in commodity prices through increased resource-related capital spending, CAT appears very vulnerable.  Emerging-market growth, particularly the fixed asset investment bubble in China, has been a major driver of commodity demand.  


The real bite will come to 2014 expectations, we think, as investors realize that the decline in resources-related capital spending is a return to normal levels, not a decline from them



Resources-Related Capital Spending Falls Substantially When Commodity Price Flatten


The decline in mining capital spending in coming years is likely to be on the order of 60%-80% from peak, by our estimates.  Such a decline will lead to overcapacity, competitive pricing and (obviously) lower volumes for OEMs like CAT supplying mining capital equipment.  CAT has also made many peak-of-cycle acquisitions in resource-related capital equipment.



EM Crisis Accelerates Our Thesis


The recent developments in China are clearly not positive for sentiment among EM investors; nor are they supportive of EM economic fundamentals, particularly given that so much of EM growth was perpetuated by China’s fixed asset investment bubble – which we clearly view as in the process of popping.” – Darius Dale, Hedgeye Macro Team (i.e. the guy who got the current EM situation right)


China’s fixed asset investment bubble has been a major driver of physical commodity demand over the past decade.  It isn’t as though European, US or Japanese steel demand growth led the tripling of iron ore output in the last decade.  Emerging market demand has.  The financial stress currently underway is likely to crimp fixed asset investment for quite a while, and with it resources-related capital spending.   If the emerging market challenges continue, expect those CAT order delays to turn into cancellations.


CAT: Beware EM Crisis - vn2



Resources-Related Capital Investment Is Where CAT Makes Its Money


As the chart below shows, when you take out Resource Industries and Power Systems, there is not much left of CAT’s operating income.  Those two segments are dominated by energy, mining and other resource-related products, in our view. CAT dealers own much of the service and parts revenue from the existing installed base, a meaningful difference from JOY, Sandvik and other equipment suppliers.  Construction Industries competes in a more fragmented, lower margin industry that has its own emerging market exposures.   For CAT, commodity-related capital spending, and with it the emerging market growth story, are critical.   The declines that are likely to evolve from the current EM crisis are a very serious issue.


CAT: Beware EM Crisis - vn3

Refreshing the European Charts

Where are we at in Europe? We expect European equity and credit markets to trend sideways in the summer months, short of any blow-ups we could see from Italy, Portugal or spillover from Greece. We do not see any particular catalysts ahead: we’re forecasting the ECB to be on hold in wait-and-watch mode to see if economic conditions improve in the fall. Headline risk should remain a governing factor. Here we highlight Italy – both the tenuous nature of the existing coalition along with fears around its inability to establish a budget for next year. Sentiment could shift given the likelihood that the country delays a one percentage point hike (from 21% to 22%) in the VAT that was scheduled to take effect in July for at least three months.


Recent Italian sovereign bond issuance has priced debt higher versus previous auctions, a new development for the periphery versus year-to-date performance of mostly lower issuance. However, we expect both Italy and Spain, despite fluctuations, to remain grounded under 5% on the 10YR.  Draghi’s OMT put remains a force behind this call.


Another EU Summit completed—what was accomplished?   

  • EU leaders increase the funds set aside to combat youth unemployment to at least €8B from a previous target of €6B.

Hedgeye Takeaway:  While this funding is a start, the structural imbalances across the Eurozone, especially the need for labor market reform, will take years to amend, with no guarantee of success. We think the alarming rates of unemployment (Eurozone at 12.2%), especially youth unemployment that is above 50% across some peripheral states, will continue to guide long-term below-mean growth.

  • There were discussions around proposals by the European Investment Bank (EIB) and European Commission (EC) to generate €55B-€100B of new loans to small and medium sized enterprises (SMEs).

Hedgeye Takeaway: The ECB has had no success unclogging the credit channel. Loans to the SMEs are critical to restart and encourage lending; however we have our doubts on this sum given the unsuccessful LTRO packages that handed out 1 Trillion EUR in nearly free money.

  • Discussion around a framework for the Banking Union, including that bail-in agreements will exempt deposit holders of less than €100K.

Hedgeye Takeaway: Following Cyprus, Eurocrats are incentivized to ensure that deposit holders with less than €100K in deposits are not on the hook for a bail-in. We expect more guidelines on the shape of a Banking Union after German elections in September.


Data: The Haves versus the Have Nots

Continuing with our thesis on the region, the data out this week reminds us that our bullish bias on Germany versus our bearish bias on the periphery remains intact. 

  • Eurozone Confidence – figures will grind slightly higher throughout the summer, led by Germany.

Refreshing the European Charts - yy. euro econ vs consumer


Refreshing the European Charts - yy. euro manu vs service


Refreshing the European Charts - yy. euro business



Bullish Bias – Germany

  • Figures this week all looked better. The Unemployment Rate remained at 6.8% in JUN with the Unemployment Change down-12K to 2.94MM. The GfK Consumer Confidence survey rose to 6.8 JUL (exp. 6.5) vs 6.5 JUN. Retail Sales remain positive at 0.4% MAY Y/Y vs 2.7% APR and CPI rests at a healthy 1.9%  in JUN (Preliminary) Y/Y vs 1.6% MAY

Refreshing the European Charts - yy. germany cpi



Bearish Bias – The Periphery

Retail Sales fell across the periphery: Spain -4.5% MAY vs -2.6% APR; Greece -14.7% APR Y/Y vs -5.9% MAR; and Portugal -3.5% MAY Y/Y vs -2.1% APR.  Data across Italy continues to be atrocious, and Italy Economic Sentiment fell to 76.1 JUN vs 80.2 MAY. Also, Spain’s housing market continues to feel the hit, with the Total Housing Permits down -16.5% APR vs -35% MAR.


Refreshing the European Charts - yy. italy retail sales


Refreshing the European Charts - yy. spain housing


Enjoy the weekend,


Matthew Hedrick

Senior Analyst

Don't Get Blown Up

Client Talking Points


You learn a lot from bounces during crashes. What we are witnessing right now in Gold is some pathetic "bounces." It is up 20 basis points this morning. It's down 28% year-to-date. Knife catchers buying in last two weeks are down over 12%. For the record, over $62B wiped from precious metals exchange-traded product holdings this year. We have been and we remain the Gold Bears.


Japan burns its currency and still gets no inflation. Core CPI in May flat again year-over-year.  Meanwhile, Japan and India both get marked up big into quarter end up +3.5% and +2.8% respectively. Shanghai Comp and Hang Seng marked up less than Japan and India. That said, all four indices remain below Hedgeye TREND lines. For the Nikkei, our immediate-term TRADE risk ranges are now 12,815 - 13,698. Yen moves back to bearish TRADE and TREND in the Hedgeye Risk Management Model.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

Health Care sector head Tom Tobin has identified a number of tailwinds in the near and longer term that act as tailwinds to the hospital industry, and HCA in particular. This includes: Utilization, Maternity Trends as well as Pent-Up Demand and Acuity. The demographic shift towards more health care – driven by a gradually improving economy, improving employment trends, and accelerating new household formation and births – is a meaningful Macro factor and likely to lead to improving revenue and volume trends moving forward.  Near-term market mayhem should not hamper this  trend, even if it means slightly higher borrowing costs for hospitals down the road. 


Gaming, Leisure & Lodging sector head Todd Jordan says Melco International Entertainment stands to benefit from a major new European casino rollout.  An MPEL controlling entity, Melco International Development, is eyeing participation in a US$1 billion gaming project in Barcelona.  The new project, to be called “BCN World,” will start with a single resort with 1,100 hotel beds, a casino, and a theater.  Longer term, the objective is for BCN World to have six resorts.  The first property is scheduled to open for business in 2016. 


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. We think that the prevailing bearish view is very backward looking and leaves out a big piece of the WWW story, which is that integration of these brands into the WWW portfolio will allow the former PLG group to achieve what it could not under its former owner (most notably – international growth, and leverage a more diverse selling infrastructure in the US). Furthermore it will grow without needing to add the capital we’d otherwise expect as a stand-alone company – especially given WWW’s consolidation from four divisions into three -- which improves asset turns and financial returns.

Three for the Road


The main call the #OldWall missed on Gold was not being Bearish Enough - have been trying to call bottoms; its crashing



I’ve missed more than 9000 shots in my career. I’ve lost almost 300 games. 26 times I’ve been trusted to take the game winning shot and missed. I’ve failed over and over and over again in my life. And that is why I succeed. –Michael Jordan


Gold has dropped 25 percent this quarter, heading for its biggest loss since at least 1920. Gold entered a bear market in April, extending the retreat from its all-time high of $1,921.15 in September 2011.

June 28, 2013

June 28, 2013 - DTR



June 28, 2013 - 10yr

June 28, 2013 - VIX

June 28, 2013 - dxy



June 28, 2013 - dax

June 28, 2013 - euro

June 28, 2013 - yen

June 28, 2013 - oil

June 28, 2013 - natgas

June 28, 2013 - gold

June 28, 2013 - copper

Tape(r) Worms

This note was originally published at 8am on June 14, 2013 for Hedgeye subscribers.

“Shy and proud men are more liable to fall into the hands of parasites and creatures of low character.  For in the intimacies which are formed by shy men, they do not choose, they are chosen.”

-Henry Taylor


Tapeworm infestation is not something we would wish on our worst enemies.  According to Wikipedia, tapeworm infestation is the infection of the digestive tract by adult parasitic flatworms called cestodes or tapeworms.  Typically, consuming uncooked food is the way in which tapeworm larva find their way into humans.  Once inside the digestive tract, a larva can grow into a very large tapeworm.


No doubt waking up to read about tapeworms is the last thing you need.  Alas, we couldn’t think of a more appropriate analogy given the market’s recent fascination with the potential tapering of QE by the Federal Reserve.  Yesterday, the market actually rallied on this tapering rumor based on a blog by Jon Hilsenrath in the Wall Street Journal that tapering, if it is to occur, would be a more manageable version, perhaps something akin to Taper-lite.


We haven’t been stock market operators as long as many of you, but we certainly don’t remember a period in which there has been such a fascination with, and focus on, the next move of the Federal Reserve.  But until the market host rids itself of the QE parasite, this fascination and volatility associated with the next move of the Fed is likely to continue.


Back to the global macro grind . . .


Earlier this week, we reiterated our short call on emerging markets and China with a concise presentation by our Senior Asia Analyst Darius Dale. (Email sales@hedgeye.com to get a copy of the presentation.)  This short call has played out positively for us and has been backed by asset flows out of emerging markets funds.  In fact, in the most recent week the exodus from emerging market funds was $9 billion, which was the third largest weekly outflow ever (after March 2007 and January 2008).


The key new research we provided in the presentation was related to short Chinese financials.  We view this thesis as three fold:

  • Credit growth is slowing – The increasing likelihood that the People’s Bank of China tightens will provide an impediment to credit growth;
  • NIM compression is occurring – Based on the current NIM spread, we think this ratio can only tighten from current levels, which will pressure bank margins; and
  • Non-performing loans are rising – Even though the data is very opaque, NPLs of 20% are a reasonable estimate given by many experts.

In the Chart of the Day, we’ve highlighted one of the more insightful charts in the presentation, which is the Chinese 7-day repo rate monthly average, which highlights how tight money is in China currently.  This rate has gone from about 3.5% in May to 5.7% in June, which is the second highest monthly rate in the last five years and a staggering shift month-over-month.  If money sustainably tightens in China, economic growth will most certainly take a hit.


Our Senior Analyst covering Europe Matt Hedrick also gave a very lengthy and thoughtful update on Europe this week (once again email sales@hedgeye.com if you want to see this presentation).  While we don’t see the financial sector risks in Europe that we do in China, the economic outlook does remain largely bleak in Europe. Some of the key points that we highlighted in the presentation included:

  • Fundamentals in Europe remain challenged and we should expect long-term below mean growth;
  • We see limited risk to any country leaving the Eurozone or the Euro being disbanded, so another Cyprus flare-up is unlikely;
  • The bifurcation in Europe will continue and we are fundamentally bullish of Germany and the U.K. and fundamentally bearish of France, Italy and Spain; and
  • ECB is unlikely to shift policy anytime soon, which should continue to support our strong dollar call.

A structural issue that makes it inherently difficult for Europe to recover quickly is the inflexibility of the labor force.  In the United States, labor can flow freely from state to state based on employment opportunities.   So, in theory, the U.S. would be very unlikely to have states where the unemployment rate was north of 26%, such as in Spain and Greece, and other states where the unemployment rate is below 7%, such as Germany and Denmark.


Given the inability of labor to flow easily through European borders, due to differing qualification levels, work quotas and cultural barriers, it is no surprise then that a recession in Europe should be more protracted.  The bigger issue, of course, is that it creates unemployment hot spots, such as Greece, Cyprus, and Spain, that will have an inability to re-balance their economies, except over very lengthy time periods.


This dreary global growth outlook we have continues to push us back to the one economy and stock market we remain positive on – the U.S. of A.  On that front, as it relates to macro data coming out today, the big one is Michigan Consumer Confidence which is released at 9:55am to the masses, and five minutes early for those that pay up for the early look!  Regardless of who gets it ahead of you, it will still be a decent “tell” on how the consumer is feeling.


Our immediate-term Risk Ranges for Gold, Oil, US Dollar, USD/YEN, UST 10yr Yield, VIX, and the SP500 are now $1351-1418, $100.21-105.43, $80.26-80.24, 93.54-95.85, 2.07-2.27%, 15.21-1857, and 1605-1653, respectively.


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Tape(r) Worms - Chart of the Day


Tape(r) Worms - Virtual Portfolio

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