The Economic Data calendar for the week of the 1st of July through the 5th is full of critical releases and events. Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.
Takeaway: The time will come to aggressively fade the current relief rally/dead-cat bounce(s) across EM asset classes.
EM OUTFLOWS ACCELERATE… TO AN ALL-TIME HIGH!
According to data from EPFR Global, emerging market equity funds saw $5.6B of outflows in the week-ended JUN 26, good for the fifth consecutive week of outflows. The four week total for JUN-to-date came in a $19.9B, which set a new record for monthly outflows, surpassing the previous record of $18.7B in JAN ’08.
Two quick points to make in light of this data:
Regarding point #2: Even after the recent bloodbath across the EM asset allocation spectrum, EM stocks are still only roughly in line with their historical mean valuations when analyzed on a relative basis to DM equities (NOTE: we pulled the charts back as far as we can find comparable data (i.e. 1999)). Net-net, “cheap” can get a lot cheaper from here.
Regarding point #1: EM equities (using the EEM ETF as a proxy) were disgustingly oversold at the start of the week and have bounced valiantly during the current WTD relief rally. It’s interesting to note that the EEM recorded a “nice” dead-cat bounce at the end of JAN ’08 too…
PICKING THE “SLIMMEST OFFENSIVE LINEMAN”
We’re often asked by our long-only clients which emerging markets we would overweight/underweight. While our answer has been and remains “underweight all of them”, we obliged the request by initially favoring consumption-oriented economies across Asia (e.g. Philippines).
Pull up a six-week chart of the PSEi Index and you’ll know exactly how wrong that call has been. Amid broad-based capital outflows, investors have clearly been reducing their EM exposure more-or-less indiscriminately.
Analyzing our Hedgeye Macro EM Equity Market Factor Model, which contains all 21 of the countries in the MSCI EM Index (plus Argentina, for good measure), we see that low-yielding, slow-growth countries that probably had relatively tighter monetary policy (at the margin) over the trailing 18-24 months (hence the low CPI and high LTM FX performance) are precisely the markets that are outperforming on a 1M basis.
Low-yielding, slow-growth countries with relatively tight monetary policy hasn’t exactly been the “flavor of the moth” for equity investors – particularly not in the context of why people choose to invest in emerging markets in the first place. Thus, we can reasonably conclude that the countries with the worst fundamental stories are actually the ones performing the best of late.
And when you consider that Malaysia, Mexico, Hungary, Taiwan and Morocco are actually leading the charge on a 1M basis (in USD terms), you can see exactly what we mean. We don’t have a call on Hungary or Morocco specifically, but I do cover the other three countries closely and each of them has had their fair share of fundamental headwinds of late:
What’s not working? Basically everything. What’s underperforming? Countries that have recently unearthed new economic financial market headwinds due to social unrest, banking woes or commodity deflation. If you’ll recall our industry-leading work on EM Crises, that’s essentially Pillars #4, #3 and #1 in action.
Lastly, it’s important to bear in mind that in times of crisis, investors generally sell what they can – not necessarily what they should.
WHERE TO FROM HERE?
The time will come to aggressively fade the current relief rally/dead-cat bounce(s) across EM asset classes.
In our most recent globally-interconnected macroeconomic scenario analysis, our #EmergingOutflows theme should continue trending relatively unabated in three of the four most probable outcomes with respect to the TREND duration (NOTE: not all probabilities are the same):
For now, we remain the bulls on the USD and the bears on Gold. We also hold the axe on emerging markets and are inclined to keep chopping away on the short side. Specifically, there’s +2.9% upside to the EEM’s immediate-term TRADE line of resistance and +8.8% upside to the TREND line from last price. Barring scenario #4 as laid out above, we would short EM equities with impunity if they were to bounce all the way up to the latter of the two resistance levels.
Have a fantastic weekend,
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.
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.
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.
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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 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.
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.
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?
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.
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.
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.
Bullish Bias – Germany
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.
Enjoy the weekend,
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.
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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.
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.
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