June numbers should show that regionals are not out of the woods
TODAY’S S&P 500 SET-UP – July 1, 2013
As we look at today's setup for the S&P 500, the range is 60 points or 3.01% downside to 1558 and 0.73% upside to 1618.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS (Bloomberg Estimates):
WHAT TO WATCH
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
The Hedgeye Macro Team
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THE MACAU METRO MONITOR, JULY 1 2013
JUNE GGR DICJ
MOP 28.269 billion (27.44 HKD, 3.54 USD), up 21.1% YoY
AERL BUYS LE ROYAL ARC VIP ROOM Macau Business
Asia Entertainment and Resources Ltd (AERL) has completed its acquisition of Level 1 of Le Royal Arc Casino in NAPE.
The VIP gaming room has six tables and is operated under SJM Holdings Ltd’s concession. The junket operator says it now operates 40 tables in five VIP rooms.
NEW GONGBEI CHECKPOINT COMMENCED OPERATION Macau Daily News, Macau Business Daily
The east and west wings of Zhuhai Gongbei Port Joint Inspection Building have been completed and operational end of June. Waiting time for Mainland Chinese visiting Macau will be shortened.
When the building is fully operational, the reception capacity at Gongbei Port, with 80 e-channels and 98 counters, will be increased to 500,000 passengers per day. Whether or not the first floor of the expansion projects will be open throughout the day or only open to relief pressure during rush hours has not yet been decided.
Gongbei customs post supervisor and a Macau deputy at China's National People's Congress, Lao Ngai Leong, said that the additional channels currently available can already help to handle “the present daily traffic of 260,000 or 270,000 travellers a day”. "The biggest problem now” is the lack of staff on the Zhuhai side of the border, he stressed.
PANEL URGES MORE SCRUTINY OF US COMPANIES IN MACAU KHOU
A congressional advisory panel says U.S. regulators should tighten up scrutiny of casino companies operating in the top gambling market of Macau because of the risk of money laundering. Commissioner Michael Wessel said there should be stricter scrutiny of Nevada-based companies that operate in Macau. He said regulators need to "go deeper."
JUNKET OPERATORS EXPAND BUSINESS STREAMS Macau Business
Junket operators, are branching out into new businesses, establishing themselves as multinational conglomerates with the government’s blessing. Suncity Group, one of the city’s biggest junket operators, has branched out into mining, financial services, real estate, food and drink, films and media. It operates throughout Greater China and further afield. Jimei Group has expanded into wealth management and securities. There are examples of junket operators investing in financial services and pawnshops.
GAMBLING ARRIVALS CONTINUE TO SHRINK Macau Business
According to the Macau Visitor Profile Survey, the proportion of tourists reporting to come in Macau primarily for gambling shrank to 6.2% in 4Q 2012, down from 7.2% in 3Q 2012. Arrivals primarily for pleasure or holiday purposes comprised 76.5 percent of those surveyed.
Takeaway: Current Investing Ideas: FDX, HCA, HOLX, MPEL, NSM, SBUX, WWW
(Editor’s Note: We are adding Starbucks to our list of our Investing Ideas, and we will issue a full Stock report on SBUX next week.)
Investing Ideas Updates:
They will buy a cheaper house. At the margin, people looking to trade up at bargain rates will go away, but that should not be a meaningful bite out of NSM’s business. Steiner says people appear to misunderstand two key factors in NSM’s favor. First, as people rush to refinance, homeowners who are underwater on their mortgages are blocked from the conventional route. The only way open to them is the federal HARP program, which Steiner says presents a significant opportunity for NSM.
As we noted last week, HARP refinancing is much less rate sensitive – the homeowner is already paying an above-market rate on below-market equity – and NSM’s already-solid mortgage servicing business will see higher margins in a rising interest rate environment. Steiner sees plenty of volatility in the offing for the Financials (see this week’s Sector Focus, below) but remains confident in NSM’s quality and earnings power.
TRADE: In the short-term the market will trade NSM inversely to long-term interest rates. Rising rates will continue to put pressure on the stock and vice-versa. As Steiner points out, this may be the wrong reaction – but markets do what markets do.
TREND: Over the intermediate term we’ll get 2Q earnings results in just over a month. Steiner thinks this will be the early wake-up call that NSM is less exposed to rising rates than the market thinks.
TAIL: In the long-term, there is still a tremendous opportunity to roll-up the servicing business, with NSM well positioned to benefit. Steiner thinks consensus earnings estimates remain too low for 2013/2014. (Please click here to see the latest Stock Report on NSM.)
Where are the Snowdens of yesteryear?
- Joseph Heller, Catch-22
Is it just us, or is gold down 23% from its recent highs?
The Financial Times (27 June, “Gold Price Tumbles on Fears Over End to QE”) reports gold is heading for its biggest one-quarter decline since the Bretton Woods system collapsed in 1971.
This is a bit misleading: the average price of gold in 1971 was around $40 the ounce. The following year it was $58. By 1974, the year of the Arab oil embargo, gold averaged $154 the ounce. By taking the Dollar off the Gold Standard, President Nixon kicked off one of the great risk markets in history, allowing speculators to flee from the occasionally useless (currency) to the utterly useless (gold) whenever the prices of really useful things (oil, food) went up.
The dollar collapsed after Nixon took it off the gold standard. Treasury Secretary John Connally cheered, saying the US “took charge,” precipitating the dismembering of the Bretton Woods exchange rate system. Nixon went on national TV and said closing the gold window would stabilize and strengthen the Dollar. The following day – Monday – the Dow had the biggest one-day gain it had ever seen (33 points – those were the days…!) Americans took pride in their leader’s bold moves to protect them from foreigners and their currency machinations.
Fade Out, Fade In… Fade Out…
Fast forward to this week as the price of gold fades. Here are three highlights.
Brazil, the famously laid-back nation currently enjoying its lowest levels of unemployment, and highest levels of general prosperity in history, has exploded in demonstrations with over a million people marching and chanting in over 100 cities across the country. Despite her “street cred” as a former guerrilla who was herself imprisoned and tortured under the military dictatorship – and despite her winning praise for her unprecedented sacking of half a dozen cabinet ministers for corruption – Brazilian president Dilma Rousseff has not been able to co-opt the demonstrators. The current unrest doesn’t look likely to be brought under control any time soon. So why isn’t gold going up, with this unrest in our back yard?
Turkey, the “modern, secular” Moslem state – NATO member, EU aspirant and, formerly staunch friend of both the US and Israel – may be tipping into the kind of state-run violence we witnessed in Cairo’s Tahrir Square. Prime minister Erdogan has said he is at the end of his patience, an unsubtle warning to demonstrators . Turkey, where the army famously held religious fundamentalism in check for decades, is undergoing severe social friction as Erdogan has jailed senior military officers and members of the press. The recent protests were sparked by the government’s plan to dig up a popular park in the heart of Istanbul, the site of an annual celebration of the legacy of Kemal Ataturk, founder of the modern secular Turkish state. Symbolilcally it’s sort of the equivalent of offering to tear down Lambeau Field in order to beautify Green Bay, WI. Secular-minded Turks, among them many devout Moslems who support the separation of mosque and state, fear the encroachment of religion into politics as Erdogan takes steps to control his citizens’ private lives. So why isn’t gold going up, facing a situation that may degenerate into repression, if not violence?
Snowden. And where is the Snowden of this year? This week’s quote, from Joseph Heller’s masterpiece, is aimed at highly literary readers – a spoof on the most famous line from mediaeval French poet Francois Villon (died 1464), Mais ou sont les neiges d’antan? – “Where are the snows of yesteryear?” Villon’s poem describes the faded beauty of an aging Paris prostitute – perhaps a fitting metaphor for gold. In Catch-22, airman Snowden dies in the arms of the book’s hero, Captain Yossarian. When Yossarian questions the whole enterprise of war, he asks a series of seemingly random questions. (“Where are the Snowdens of yesteryear?” “Who is Spain?” “Why is Hitler?” and “Where was that stooped and mealy-colored old man I used to call ‘Poppa’ when the merry-go-round broker down?”) If you’ve never read Cath-22, it’s timeless. Ditto Villon. You may want to improve your mind while the government reads your email.
We hate the idea that a bunch of low-paid government employees might crack the security around a vast meta-data tracking system and find out where our children go to school and how much money we have in the bank. The fact of this being illegal, requiring a court to issue a warrant, and taking a fair amount of time to tease apart at the personal level makes us only slightly less uncomfortable. Still, we get the government’s argument that the alternative is a repeat of 9/11. To quote George Orwell (literary references are flying thick and fast this week – incoming!) “People sleep peaceably in their beds at night only because rough men stand ready to do violence on their behalf.” Necessary evil? Your call, Citizen.
The government is supposed to push the limits of what we find acceptable – the press is supposed to uncover and challenge. This is what makes free debate. Snowden may not have done much lasting damage to America’s intelligence capability – we suspect one knock-on effect may actually be to turn up unsuspected hiding places as Bad Actors try to burrow deeper. In the wake of Snowden’s revelations, Deep Cover risks becoming a Crowded Trade that most people can’t get out of successfully. Frankly we are far more troubled by the Administration’s positively Argentinian recent attempts to intimidate journalists.
Still, what the government does is as naught compared to what we blithely allow to be done to us for fun – and not even for profit. Or are you really comfortable with the thought that your personal information is known to Facebook? – a global company with personal information on over one billion persons, taking in over five billion dollars in annual revenues (none of which you receive, even it is generated by selling your personal information), and controlled by one person answerable to no one – and who doesn’t even need a warrant.
And note the mushrooming costs associated with the government’s domestic surveillance programs. The downfall of Communism had more to do with the cost and inherent inefficiency of maintaining the police state than with the objections of citizens who spent their lives dodging surveillance. According to some analyses, in East Germany and the Soviet Union, there were periods where half the population was on the government payroll, spying on the other half.
So Where Are The Snows of Yesteryear?
So why is gold going down? With uncertainty and instability in the air, you would expect that gold would be perhaps the single asset viewed as a safe haven.
The FT writes “Asset managers rush to dump metal,” saying demand is likely to soften further “as investors see less need to insure against QE.” Hedge funds are dumping the gold they bought because it was a smart move at the time. They knew it was smart, because they heard that hedge fund legend John Paulson bought gold. And in case you haven’t heard, “John Paulson’s Gold Fund Is Getting Absolutely Annihilated” (http://www.businessinsider.com/paulsons-gold-fund-down-54-ytd-2013-6). Renowned hedge fund genius Paulson is down 54% on his gold fund, but at least he makes his own mistakes, unlike all the me-too funds whose main research thrust is finding out What Is Paulson Buying Now?
Hedgeye’s director of research Daryl Jones has just returned from a tour of the homeland (Canada) where he founds money managers unwinding successful commodity hedges. “In the short run,” says Jones, “that means diversifying more into US equities” and looking to ride the updraft from strength in the US dollar. One Canadian manger says Canada’s major gold companies are overvalued in the market now and that their overextended hedges could hurt them if gold prices snap back from the latest plunge.
“Global markets are seemingly stabilizing,” writes Jones, noting that even Spanish 10-year bonds have backed off after peaking at over 5%. Meanwhile Jones notes that, despite prognostications and pleading, the Fed failed to hold the 2% yield line on the 10-year Treasury. “If the market truly begins to price in the end of QE,” says Jones, “the blood bath in the bond market is likely in early days.”
The other side of the Treasurys coin is fundamental strength in the US economy and a strong Dollar. Add to this other trends we have noted lately: emerging market outflows (good for investment in the US), an improving US jobs picture (Financials sector head Josh Steiner says non-seasonally adjusted unemployment claims continue to decline, improving at an accelerating rate over last year – good for US investment, both domestically and globally) and accelerated household formation. It seems the positive economic news in the US may be enough to offset overseas concerns, making gold less compelling. In an increasingly positive environment, it seems other folks’ bad news just reaffirms the Good News at home.
If you were wondering how the snows of yesteryear are faring, for the near term TRADE and TREND (see Hedgeye definitions __HERE___) our Macro work is flashing bullish signals on Treasurys, on the VIX market volatility index, and most important, on the Dollar itself. And bearish signals across the commodity group – oil, natural gas, copper, and of course gold.
Last thought, for conspiracy mongers: The FT says gold ETFs “have sold more than 500 tonnes of gold, or a fifth of their total holdings since the start of the year.” The ETFs don’t actually own all that gold. They have warehouse receipts, and while it is known that warehouses manage the quantities of physical gold to ensure levels of deliverablity, periodically an article pops up claiming they hold far less physical gold than their public records indicate. The collapse in the gold price would be a great opportunity to cover what might be a gargantuan undisclosed short position in the world’s prettiest metal.
Financials sector head Josh Steiner says his sector could be the best – and the worst – place to be in the coming months. If we are truly on the cusp of a generational shift in the interest rate picture, it will have significant implications for the sector.
Steiner reads four fundamental market environments: Bull or bear flattening, and bull or bear steepening. We are currently in a “bear/steepening” phase, with a rising yield curve in a general atmosphere of market gloom. Steiner says the really challenging environment is “bull/steepening” where, in spite of widening spreads, stock investors flee because the macroeconomic backdrop is deteriorating. Financial stocks, first and foremost, react to changes in the credit quality environment – will borrowers repay their loans – and only secondarily to changes in the yield spread environment.
Steiner says folks don’t understand the current environment and are reacting wrong. People normally view a bear/steepening, rising yield curve as an indicator of rising inflation – but inflation-adjusted Treasury bonds (TIPS) are currently the worst performing bond. The market is telling us inflation is not a threat. Steiner says the overall health of the economy is far more important to his sector than is the direction of interest rates at any given time.
Steiner says the Financials sector is largely positioned for rising interest rates, though not uniformly. Maybe it’s more accurate to say some firms are “positioned” for higher rates, while others are hunkered down in the equivalent of financial bomb shelters.
Steiner says the Fed wind-down of QE1 and QE2 were measurable factors in his sector, and he expects the tapering of QE3 to hurt, or help the same groups. Steiner says the cessation of QE1 and QE2 hurt brokers and asset management firms, specialty finance firms and money-center banks, mortgage insurers, and speculative builders – all of whom are affected by asset price deflation pressure. Steiner notes that one group that performed well in the last two periods following QE were the exchanges, as they benefit from volatility. However, large brokers like Goldman and Morgan “did terribly” in the periods following the last two QE rounds. This time around, they may have trimmed their trading operations enough to mitigate some of the damage, but Steiner still expects them to suffer if Fed stimulus cools.
On the plus side, Steiner expects a replay of positive performance from the overall homebuilder segment, mortgage REITs and title insurers, and select regional banks. The regionals outperform the money-center banks mainly because there is less uncertainty over the value of legacy assets like unpaid mortgages..
Finally, over the intermediate to long term, Steiner says there are “a lot of reasons to still like BofA.” Not the least of these, Steiner says there’s a high probability BofA will win a favorable ruling in its current $8.5 billion court case over mortgage putbacks. (For more of the history of BofA’s jousting in the courts – and other cynical observations – read the Hedgeye e-book Fixing A Broken Wall Street available HERE http://tinyurl.com/cqgter9). Note that a “win” for Bof A will allow them to close out this chapter by paying “only” $8.5 billion in a settlement.
Are you in the wrong business?
It is a fitting coincidence that this week’s Term is used in the global markets for such commodities as oil and gold – markets once dominated by Marc Rich – known to some as the maligned boy genius of the trading desk, and to others as the Lord Voldemort of the global commodities markets. Marc Rich, who died this week at age 78, who fled the US some thirty years ago to live the town of Zug, Switzerland, where he continued trading oil and currencies, while avoiding prosecution in the US on charges including evading some $50 million in taxes, and trading with Iran. President Clinton pardoned Rich, a move he clearly know would be controversial – it was close to his final official act, announced literally on his last day as president.
As Marc Rich picks up the direct line to that vast trading desk in the sky, we turn our attention to the basics of commodity pricing.
Spot – the Spot price is the immediate price at which a commodity is available for trade. The price “on the spot” that tells you what the whole world thinks the commodity is worth, given all the information available in the market right now. Think of it as similar to the Last Price of a stock during trading hours.
Forward – the Forward price is agreed between a buyer and seller and becomes the price of what is called a “nonstandard contract” for future delivery and acceptance of a quantity of commodity. Common Forward contracts are priced using the current Spot price, plus a Cost of Carry (costs to store and manage the commodity, and the foregoing of interest payments on those costs during the life of the contract, as well as a yield for risk or convenience associated with the Forward contract). The Forward contract may also have a premium for counterparty credit risk. Forward contracts do not “true up.” That is, there are no interim payments to offset increases or declines in the value of the underlying commodity. Forward contracts are executed between two parties and do not trade in standardized form, or on an exchange. For that, you go to the Futures market.
Futures – a Futures contract has much in common with the Forward contract. Futures contracts – or just Futures – are standardized as to quantity and quality of the commodity covered, price increments of trading, forms of delivery (or offset), and duration of the contract. The standardization of these parameters makes Futures suitable for trading, unlike a Forward contract. Futures exchanges establish controls to mitigate risk, and to limit opportunities for manipulation. Risk controls include requiring both parties to a contract to post margin, and to post “variation margin” to true up their position based on a daily mark-to-market of the value of the contract. Exchanges also impose price and position size limits, to prevent open-ended buying and selling. A Forward contract for an acre’s worth of Bob’s broccoli is not equivalent to a Forward contract for an acre of Barbara’s broccoli. But one contract for Hard Red Winter Wheat for July delivery traded on the Kansas City Board of Trade is exactly equivalent to any other contract of the same specifications and delivery date. Bob’s and Barbara’s broccoli Forward contracts are unique. The KCBT Hard Red Winter Wheat July contract is fungible, the concept that lies at the heart of capital markets.
Perhaps the most non-obvious aspect of the commodities market is the way prices are established – Futures prices set Spot prices, not the other way around. Yet, a moment’s reflection should suffice to clarify this for a person of above-average intelligence (which our readers surely are.)
The price of a stock at any given moment reflects all information known about the stock in the market at that moment. If you think about it, that means that future expectations – how much a company will earn, what its future revenues will be, how it will perform versus its competition, whether it will land that major contract or lose the pending lawsuit – set the current price in the market at any given moment. Stocks – and commodity futures contracts – move around in price because people have different estimates of how the vast number of factors will interact and play out, to say nothing of differences is people’s risk tolerances and investment horizons.
If this seems upside-down, should consider that all moves in the financial markets derive from Expectations. Why is the bond market in disarray? Because people expect the Bernanke Fed to withdraw the monetary methamphetamine it has been so steadily pumping into the system. (Since this is a particularly literate edition of your favorite investment newsletter, the quote “Expectation is the root of all heartache” is uniformly attributed to Shakespeare. A search through his published works reveals that he may have said it, but apparently never wrote it down.)
If you could read tomorrow’s newspaper today, you would know whether your expectation would prove profitable.
Sorry, you can’t get tomorrow’s newspaper. But you do have today’s Investing Ideas. It’s a pretty good start.
Summary & Overview
TEX can be a volatile name and we have been waiting since our March 2013 Mining & Construction Equipment call for an entry opportunity below our fair value range. We think $26 is close enough to put a toe in the water. See here for a more detailed discussion of our views on TEX and the niche construction equipment industry. In the machinery space, we think TEX is a good swap for CAT – keep construction equipment, dump mining/resources equipment.
Construction Concerns Likely Overblown: The Architectural Billings Index has moved back into positive territory, suggesting that the rebound in commercial construction is likely to regain momentum and persist well into 2014. Residential construction is also likely to continue its robust recovery, despite increases in mortgage rates. Construction equipment sales have rebounded a bit, but should retain a cyclical tailwind for some time.
Cycles Are Slow: Potential can get ahead of reality in cyclical recoveries, as we think happened to TEX in early 2013. For example, the Architectural Billings Index leads nonresidential construction by 9-12 months. The index only turned sustainably positive in 4Q 2012, indicating just the start of a rebound 2H 2013. It takes time, but disappointment at the pace of recovery can provide entry opportunities.
Already Pre-Announced: Expectations for TEX have already been reset to more reasonable levels with its mid-June preannouncement. Management may still abandon its long term goal of >$5/share/$10 billion in revenue for 2015. But, as they have said, that target is a “goal” and not “guidance”. While dropping the target is a potential negative catalyst, we do not think investors expect TEX to achieve it. For example, 2015 consensus is only at $3.80.
Great Sale of Mining Exposure: Much of TEX’s remaining “mining” exposure is from its Materials Processing business, which we believe is more exposed to construction, quarrying, and recycling than to traditional mining (copper, iron ore etc.). The unit is a small part of the TEX mix. TEX sold its traditional mining equipment business to Bucyrus, now part of CAT, in early 2010. While they may not have exactly top-ticked the mining capital spending bubble, they came very close. Management that gets cyclical businesses is a tremendous asset.
AWPs International Penetration: Over-time, increasing worker safety regulation should drive greater use of aerial work platforms (AWPs) in less developed markets. The AWP market is dominated by TEX and OSK, and both would likely benefit from higher AWP demand growth outside of North America and Europe. In developed markets, easing small business credit conditions should facilitate the acquisition of equipment by smaller rental companies. As the large rental companies are fond of pointing out, there are still lots of small equipment rental companies.
Municipal Spending Environment: Municipal finances should generally improve with rebounding home prices, Detroit aside. This key end-market for TEX and OSK has been depressed for some time.
Port Investment: Global trade growth has been unusually weak since the financial crisis. Historically, global trade has grown at a faster clip than global GDP. We expect that growth to eventually resume, with port equipment investment following. The expansion of the Panama Canal is also a potential boost for port investment.
Well Structured Markets: Many of TEX’s businesses compete in industries structured for favorable long-term returns. Cranes and AWPs are notably consolidated.
Cyclical Tailwind and Valuation Upside: We value TEX in the $26-$52 range. Given several positive cyclical tailwinds in the pipeline, we think that the recent decline provides an interesting point to consider an initial position.
(Both TEX and OSK suffered from the decline in cement mixer demand, which was pretty spectacular)
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