prev

SEPARATING THE FOREST FROM THE TREES IN EMERGING MARKETS

Takeaway: Investors should avoid staring at the “trees” in lieu of the “forest” that is the fundamental bear case for emerging markets.

SUMMARY BULLETS:

 

  • We think a protracted tightening of global credit conditions driven by sustained USD appreciation and a back-up in US interest rates will weigh on growth in EM fixed investment (via an inflection(s) in portfolio and FDI flows) and growth in EM consumption (via an inflection in purchasing power as EM FX reverts to the mean).
  • We think global asset allocators in developed markets are simply running out of places to direct marginal investment flows and growth assets priced in a strengthening USD (and potentially those priced in a burning JPY) are one of the few places that remain attractive on a go-forward basis. Thus, our #EmergingOutflows thesis (click HERE and HERE for more details) should continue to play out in spades.
  • We think the impact on China’s secular economic slowdown will weigh heavily upon EM economic growth, as China’s fixed assets investment bubble has been a primary driver of marginal demand for many/most of the larger emerging market economies. In particular, the policy-induced unwind of said bubble should sustainably slow export and FDI growth across key commodity-producing countries (click HERE and HERE for more details).
  • Various EM asset classes could bounce another +5-10% from here to their respective TREND lines of resistance without signaling any shift in our interpretation of the fundamentals.

 

It’s later than I’d like it to be on a Friday in mid-July so I’ll make this one real quick: we remain the bears on emerging market economies and asset classes.

 

From a long-term perspective, investors in EM capital and currency markets have had a great run. That is, however, precisely the problem with assets that have made investors a lot of money: it’s difficult to cut ties when the underlying fundamental drivers are no longer supportive of continued outperformance.

 

SEPARATING THE FOREST FROM THE TREES IN EMERGING MARKETS - 1

 

One of the hardest things to do in trading macro markets is spotting regime/phase changes and that’s typically when justifications like “valuation” come into play and investors start to perpetuate and chase dead-cat bounces to lower long-term highs.

 

We are firm believers that valuation is more often an excuse, not a catalyst when it comes to Global Macro trading – which itself is dominated primarily by flows that are ultimately perpetuated by economic gravity. For emerging markets specifically, the “economic gravity” is as follows:

 

  • We think a protracted tightening of global credit conditions driven by sustained USD appreciation and a back-up in US interest rates will weigh on growth in EM fixed investment (via an inflection(s) in portfolio and FDI flows) and growth in EM consumption (via an inflection in purchasing power as EM FX reverts to the mean);
  • We think global asset allocators in developed markets are simply running out of places to direct marginal investment flows and growth assets priced in a strengthening USD (and potentially those priced in a burning JPY) are one of the few places that remain attractive on a go-forward basis. Thus, our #EmergingOutflows thesis (click HERE and HERE for more details) should continue to play out in spades; and
  • We think the impact on China’s secular economic slowdown will weigh heavily upon EM economic growth, as China’s fixed assets investment bubble has been a primary driver of marginal demand for many/most of the larger emerging market economies. In particular, the policy-induced unwind of said bubble should sustainably slow export and FDI growth across key commodity-producing countries (click HERE and HERE for more details).

 

SEPARATING THE FOREST FROM THE TREES IN EMERGING MARKETS - DXY

 

SEPARATING THE FOREST FROM THE TREES IN EMERGING MARKETS - UST 10Y

 

SEPARATING THE FOREST FROM THE TREES IN EMERGING MARKETS - 4

 

After gauging the pulse of the international investment community via feedback from our 3Q13 Macro Themes call earlier this week and visiting with clients and prospects all week in London, we don’t buy into the increasingly-consensus view that “EM assets are cheap”. Even if we did, there is ample room for cheap to get cheaper over the intermediate-to-long term:

 

SEPARATING THE FOREST FROM THE TREES IN EMERGING MARKETS - 5

 

Net-net-net, all of this begs the following question: are you A) positioning your portfolio to take advantage of “attractive valuations” because “consensus it too bearish on emerging markets”; OR are you B) using any immediate-term strength in EM capital and currency markets to sell into?

 

You know where we stand on that one (i.e. option “B”). If, however, you trust your process and it leads you to option “A”, just be aware of the upside/downside risks. Various EM asset classes could bounce another +5-10% from here to their respective TREND lines of resistance without signaling any shift in our interpretation of the fundamentals. Recall that market prices generally dictate our interpretation of any set of economic variables; experience has taught us to humbly accept that us football and hockey jocks will never be smarter than Mr. Market!

 

SEPARATING THE FOREST FROM THE TREES IN EMERGING MARKETS - 6

 

SEPARATING THE FOREST FROM THE TREES IN EMERGING MARKETS - 7

 

SEPARATING THE FOREST FROM THE TREES IN EMERGING MARKETS - 8

 

SEPARATING THE FOREST FROM THE TREES IN EMERGING MARKETS - 9

 

We realize that not everyone uses or is comfortable with using a proven quantitative overlay to filter and interpret immediate-term noise within the context of intermediate-to-long-term fundamental trends. That’s fine; to each his/her own. However, this proprietary research and risk management process has kept us on the right side of most of the major market moves since starting the firm ~5 years ago and we don’t intend to abandon said process now.

 

As such, we continue to warn that investors should avoid staring at the “trees” in lieu of the “forest” that is the fundamental bear case for emerging markets.

 

Have a great weekend,

 

Darius Dale

Senior Analyst


THE WEEK AHEAD

The Economic Data calendar for the week of the 22nd of July through the 26th 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.

 

THE WEEK AHEAD - WeekAhead


Stock Report: Mednax Inc. (MD)

Stock Report: Mednax Inc. (MD) - HE II MD boxes 7 19 13

 

THE HEDGEYE EDGE

We have done a deep dive on birth trends in the United States coming to the conclusion that the trend is turning positive after the worst decline in 40 years following the Great Recession.   In addition our medical consumption forecast models suggest a similar turn in medical utilization which continues to be impacted by post recessionary headwinds.  For MD, who’s doctors care for pre-term babies in their Pediatrix division, and those of MD’s American Anesthesiology division, birth trends and medical utilization  will be a key positive drivers going forward.

 

TIMESPAN

INTERMEDIATE TERM (TREND) (the next 3 months or more)

In the short term, utilization and births remain below potential, but have improved from the lows from 2009-2011.  In the first half of 2013, it appears the US Medical Economy hit a very soft patch in Q113, driving earnings misses at several companies related to MD.   While trends have improved sequentially, we have yet to see a major inflection point in growth.  While we are cautious on the slow pace of improvement to utilization and birth trends in the short term, our intermediate term analysis continues to point to recovery.   In addition, the short interest at MD remains elevated, but has been on the decline since Q412. Following the past 3 spikes in short interest, the most recent being the largest, MD shares tend to perform well as short interest declines.

 

LONG-TERM (TAIL) (the next 3 years or less)

MD has a highly defensible business model where growth is highly dependent on acquisition growth.  There are several structural changes taking place in the US Medical Economy which will continue to present an opportunity for MD to acquire growth for an extended period.  These structural changes favor large practices over sole practicioner offices.  Managed Care negotiations, medical liability insurance, and information technology, are all conspiring to raise the cost of operating a successful practice.  As a result MD continues to comment on a robust pipeline of acquisition candidates.  Consolidation in the US Medical Economy will reward those who have a successful strategy with stronger pricing power and operating efficiency, and punish those who don’t. 

 

ONE-YEAR TRAILING CHART

Stock Report: Mednax Inc. (MD) - HE II MD chart 7 19 13


GET THE HEDGEYE MARKET BRIEF FREE

Enter your email address to receive our newsletter of 5 trending market topics. VIEW SAMPLE

By joining our email marketing list you agree to receive marketing emails from Hedgeye. You may unsubscribe at any time by clicking the unsubscribe link in one of the emails.

CMG – PROVING THE NAYSAYERS WRONG

We continue to believe that Chipotle is one of the best positioned growth companies in the restaurant industry.  The company reported a very strong 2Q13 and we continue to believe that it is well positioned for the balance of 2H13.  Below are some of our thoughts on CMG’s 2Q13 results:

 

 

WHAT LOOKS GOOD

  • 2Q13 same-store sales of 5.5% beat consensus of 3.7% (as extra day adds 1%) and the two-year trend remains steady at 6.8% vs. 6.9% in 1Q13.
  • Management raised its guidance for 2013 same-store sales from “flat-to-low single-digits” to “low-to-mid single-digits.”
  • We expect 2Q13 traffic of 4.5% to continue into 3Q13.
  • $2.82 EPS was in line as a higher tax rate held back EPS by $0.04-$0.05.
  • Increased marketing appears to be driving incremental traffic.  Marketing costs increased to 1.5% of sales in 2Q13 compared to about 0.7% in 2Q12.
  • The company ended 2Q13 with $775 million in cash and cash equivalent along with no debt.
  • New restaurants are opening at (or above the high end) of the $1.5 million to $1.6 million sales target.
  • The company is expected to delay raising prices in 2H13, as management remains focused on continuing to drive traffic and take market share. 
  • Chipotle opened 44 new restaurants in 2Q13, putting year-to-date openings at 92.  It is clear to us that CMG is likely to exceed the high end of management’s targeted opening range (165-180 restaurants) for FY13.

 

POTENTIAL CAUSE FOR CONCERN

  • The majority of our concerns stem from margin pressure.
  • Restaurant level margin contracted -160bps in 2Q, primarily due to higher food costs.
  • The company reported food costs to be around 33% of sales in 2Q13 as salsa, chicken and cheese added the most pressure to margins.  We suspect that 33% may be the peak in food costs during the current cycle.
  • We continue to monitor new unit performance very closely.
  • Valuation is rich, but we believe the business model is built to stay this way. 

 

CMG – PROVING THE NAYSAYERS WRONG - CMG SSS  JULY19

CMG – PROVING THE NAYSAYERS WRONG - CMG EV EBITDA 1YR

CMG – PROVING THE NAYSAYERS WRONG - CMG EV EBITDA 3YR

 

 

 

Howard Penney

Managing Director

 


Get Out of the Way, Ben

Takeaway: Imagine what would happen to the USD and US interest rates if he took a vacation for a couple of months?

Get Out of the Way, Ben - big gov

 

We’ve said this 10,000 times before, but we’ll take this opportunity to repeat one of our favorite catch-phrases: “Big Government Intervention does two things: 1) shortens economic cycles and 2) amplifies market volatility”.  

 

Both the sell-side and buy-side are explicitly bullish on the US Dollar – for many of the right reasons. But it’s also clear that a broad swath of Foreign Exchange market participants – including banks and corporations – have yet to go all in on #StrongDollar. This is likely largely due to the mixed and convoluted messages they continue to receive from Ben Bernanke.

 

Imagine what would happen to the USD and US interest rates if he took a vacation for a couple of months?

 

For the record, our #StrongDollar, #ShortGold, stay away from Treasuries, get the Federal Reserve out of the way, strategy has been the non-consensus bull case for growth all year.

 

Get Bernanke out of the way once and for all and we will witness a rip for the ages.

 

Get Out of the Way, Ben - moo2


KO Takes It on the Chin

Takeaway: Coke takes it on the chin, but there may be room for optimism.

This note was originally published July 16, 2013 at 14:17 in Consumer Staples

KO is trading down today as volume results for Q2 2013 came in below expectations (globally +1% vs +4% last quarter) with the company citing a challenged macro environment (U.S., Europe, Asia, and Latin America), social unrest, and poor weather conditions (wet and cold across multiple regions) that impacted consumer spending and demand. North America, which is ~ 44% of sales, saw volume down a disappointing -1% in the quarter.  

 

Performance was hit by tough Q2 comps given the especially good weather in 1H last year: Pacific volumes were +2% vs +10% last year; Brazil’s volume was even cycling +6% a year ago; and India’s volume grew +1% versus a +20% comp.

 

The company cited optimism around a turnaround in 2H for its key international markets (China, Brazil, Russia, Mexico, and India) on improvement in the macro environment, continued marketing support of its brands, weather improvements (India performs historically stronger in the back half), and its systems execution.

 

While we expect many of the forces dragging on confidence and demand to remain in the back half of the year,  including  high unemployment (especially in southern Europe), social unrest, and inflation, we like that the back half quarters of 2013 are lapping much easier comparisons year-over-year.  On the top line, the Q3 2012 comp is +0.8% versus this quarter’s +2.8%. Gross margin was pretty consistent throughout last year, however the operating margin gets easier in the final two quarters of last year (+23.6% and +21.7%, respectively) versus +26.1% this quarter.

 

The stock is currently trading above its intraday lows at around $40.45. Our quantitative levels suggest that KO has an intermediate term price TREND line of support at $40.14.

 

KO Takes It on the Chin - hed

 

What we liked:

  • EPS inline with consensus at $0.63
  • Outperformance of still beverages, volume +6%  vs sparkling 0%
  • Packaged water volume up +6% and energy drinks +5%
  • Russia volume +11% with a strong marketing calendar tied to the 2014 Sochi Winter Olympics
  • COGS decreased -5%
  • Eurasia and Africa volume up 9% (benefitting from Aujan partnership)
  • New guidance on the effective tax rate of 23.0% for 2013 vs last quarter’s estimate of 23.5%

What we didn’t like:

  • Net Revenues were down -2.6%  in the quarter and missed estimates ($12.75B vs $12.96B)
  • Operating income fell -1.5% in the quarter
  • Europe volume -4% (vs -4% in Q1 2013) on colder weather and flooding in Germany and central Europe

 

Matthew Hedrick

Senior Analyst


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.32%
  • SHORT SIGNALS 78.48%
next