#RatesRising - Stage 5: Acceptance?

Takeaway: Interest rate volatility is declining as investors accept economic reality and the positive implications of #RatesRising.

This note was originally published July 23, 2013 at 15:54 in Macro

What the *&%! Just Happened” headlined yesterday’s release of GMO’s quarterly investment letter.   While the title is probably accurate in capturing the prevailing, post-Taper announcement sentiment of the larger investment community, that the initial inflection in a bond bubble 30Y’s in the making occurred with some price convexity, and not a wimper, shouldn’t be particularly surprising.  


#RatesRising -  Stage 5: Acceptance? - expletive


In fact, if you have been long U.S. growth for the last 8 months, the Taper announcement itself was more a confirmation of economic reality than a prodigious central planning event.  The acceleration in the domestic macro data since late November and the slow creep higher in the 10-2 spread were heralding some measure of a policy shift.


In so much as a widening in the yield spread <--> expectations for QE Taper <--> Improving Domestic Macro, is a transitive relationship, the recent “bear steepening” in rates should be taken as positive confirmation of an improving domestic growth outlook.  This first step function move higher in yields is simply the market adjusting to the positive gravity of the domestic economic data and the implications of a sober policy response. 


In essence, the initial move in rates represents the ball under water moving towards being only half-submerged. 


From here, particularly given the Fed’s much communicated ‘data dependency’, the next 100+ bps higher should be viewed more as a growth dependent return to interest rate normalcy than a tightening in the conventional sense.  If the fundamental data is such that the controlling, dovish contingent at the fed is willing to signal a rate increase - even a small, gestural increase  -  we’d argue that pro-growth exposure should continue to outperform in the run-up to that event.


As we’ve moved past the acute response phase, the market has seemingly come to accept and price in a reduced flow of fed stimulus.   We detailed the implications of #RatesRising on our 3Q13 Macro Themes call last week.  We’d highlight a couple of incremental events of the last week:  


ACCEPTING REALITY:  Measures of implied interest rate volatility in the options markets have dropped precipitously over the last couple weeks.  Seemingly, the market has absorbed the acute impacts of the initial announcement with investor angst ebbing alongside initial portfolio re-adjustments.


#RatesRising -  Stage 5: Acceptance? - c1


TAPER TIMELINE:  Alongside lower volatility and a newly range-bound 10Y, today’s main policy related headline from Bloomberg that the consensus expectation of economists for Fed tapering (to the tune of $20B) to begin in September is further evidence that the market is getting comfortable in delineating the impacts of tapering vs. tightening.    


Given the practical aspects of implementing a tapering which, practically, means they will reduce the flow of purchases and subsequently monitor the impact before implementing incremental reductions, a September start makes sense.  With Bernanke likely stepping down come January, initiating the reversal of unprecedented policy initiatives which he captained makes sense from a continuity and (Bernanke) legacy perspective.   It also gives policy makers sufficient runway for scaling back purchases with an early eye towards a complete cessation come mid 2014. 


Also, implicit in the reduction in QE purchases is that QE was, in some manner, successful in its objective. This gives the FED and QE as a policy some credibility should they need to re-accelerate easing at some point in the future.   


SEASONALITY REMINDER:  As it relates to the expectation for tapering to begin in September - recall that the seasonal distortion present in the reported employment and economic data will build as a headwind thru August before again flipping to a tailwind over the Sept-March period.   Any prospective delay in tapering due to perceived/optical weakening in the data over the next 6 weeks should be short-lived as the impact of the distortion reverses come September.  Further, any negative drag associated with reduced stimulus may be partially masked by the positive seasonal tailwind as we move towards year-end and through 1Q14. 


(Not So) LATENT RISK:  Duration (price sensitivity to interest rate movement) on 10Y treasuries remains near peak levels while high yield and IG spreads remain near trough levels.  Despite the recent diminuendo in interest rate volatility, risk associated with another expedited back-up in yields remains very much alive across the fixed income spectrum.


#RatesRising -  Stage 5: Acceptance? - Duration   corporate Spreads


Quantitative Setup:  10Y Treasury Yields remain in Bullish Formation (Bullish across TRADE, TREND, & TAIL Durations) with immediate support and resistance at 2.45% and 2.75%, respectively. 


#RatesRising -  Stage 5: Acceptance? - 10Y levels



Christian B. Drake

Senior Analyst 



This note was originally published July 22, 2013 at 17:10 in Consumer Staples

Kimberly-Clark reported 2Q EPS of $1.41 versus consensus $1.39 despite a miss on the top line. Management reaffirmed FY13 EPS guidance of $5.60-5.75. Per management, the impact of lower predicted sales growth is expected to be offset by higher cost savings and share repurchases.


We remain bearish on the name.






We believe the stock traded off today, despite the earnings beat, because of soft volumes in the U.S. and a looming miss or guide down in the back half of 2013. Management’s reiterated FY13 EPS guidance seems much, much less stable than it was three months ago; higher cost savings and share repurchases are set to fill the void being left by slower-than expected sales growth. With inflation sequentially accelerating and FX rates acting as a top-line headwind, we see downside risk to the company’s FY13 EPS estimates and would advise clients to continue to look elsewhere for exposure to consumer staples on the short side. We do not expect the market to pay 17x for earnings increasingly driven by cost savings and share repurchases. Below are the positives and negatives we took away from the quarter.



What we liked:

  • Emerging markets have sustained strong volume growth
  • The company is finding incremental cost savings (raised annual target by $50m to $250-350m) to drive EBIT growth
  • Operating margin expanded by 90 bps to year-over-year to 15.5% despite no sales growth and commodity inflation
  • KCI produced broad-based top line growth and operating margin expansion



What we didn’t like:

  • Organic sales growth was dragged lower by negative volume growth in developed markets, particularly the U.S., Australia, South Korea
  • U.S. personal care volumes declined despite negative product mix
  • Management highlighted increasingly volatile macroeconomic environment, FX, and oil prices
  • Big K-C I markets like Australia and South Korea experienced a slowdown in 2Q
  • Negative 2Q FCF growth (-2.1%) with EBIT growth slowing to 5.8% from 15.6% in 1Q13 and 8.1% in 2Q12 (mgmt says cash flow to improve in 2H13)
  • Valuation is rich – now important with increasing risk to the downside (or limited upside, at least) in earnings estimates
  • Oil prices holding above $100 per barrel could push cost inflation above mid-point of company expectations ($150-250 million)
  • FX rates holding current levels will likely result in EPS below mid-point of guided range



Rory Green

Senior Analyst


Morning Reads on Our Radar Screen

Takeaway: A look at some stories on Hedgeye's radar screen.

Keith McCullough – CEO

Consumer Sentiment in U.S. Increases to Six-Year High July (via Bloomberg)

Pelosi Says It Would Be ‘Great’ for Woman to Be Fed Chair (via Bloomberg)

Iran Is Said to Want Direct Talks With U.S. on Nuclear Program (via NY Times)


Morning Reads on Our Radar Screen - bullbear


Howard Penney – Restaurants

Howard Schultz: I'm not losing any sleep over Dunkin' Donuts (via CNBC)


Josh Steiner – Financials

PICTURE: And the Honorable Jon Corzine roams free (via Twitter)

McCain on Watt: ‘Concerned’ (via Bloomberg)


Jonathan Casteleyn – Financials

Irrational to Slam $900 Billion Market Over Detroit (via Bloomberg)


Matt Hedrick – Macro

Greece Wins 2.5 Billion-Euro Aid Loan, Buying Time in Crisis (via Bloomberg)

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July 26, 2013

July 26, 2013 - FRIDTR


Onboard spending driving yield growth 


  • RCL posted a solid 4.5% (estimated) net onboard and other yield growth (in constant currency) in Q2.  According to management, excluding the Affinity error, net onboard and other yield would have grown 8.2%.  For comparison, CCL  reported a 0.5% net onboard and other yield (in constant currency) growth in FQ2.
  • As the chart below shows, one of the reasons why RCL could print such a high onboard number is because they have more room to grow, relative to the 2007 peak.
  • RCL’s onboard trend was seen fleetwide as US-sourced customers continue to spend well in the Caribbean and Europe.
  • For now, onboard and other yields will drive the top-line performance of both RCL and CCL as ticket yields are barely growing for RCL and significantly lower for CCL.


BBQ In Tokyo!

Client Talking Points


In case you were wondering what that smell is this morning, the Nikkei got barbequed last night. Japan down -3% as the Yen failed to breakdown this week post LDP elections. This is an interesting spot to buy the Nikkei now (we haven’t - yet). The Yen is now signaling immediate-term TRADE oversold (vs USD) in my model at 98.41 (a good spot to re-short the Yen too).


Well, what a big week it was for the Spaniards. Their alleged sky-high unemployment rate stopped going up for once (downtick from 27.2% to 26.3)%. Do we believe it? The IBEX did and is up +0.8% leading the gainers in what’s been a strong European Equity market for the last month. It will close above its 8099 TREND line too. 


Try as it may, even Down Dollar won't help the metals out this morning. "Dr. Copper" is leading the decline down -1% after failing at immediate-term TRADE resistance of $3.22 earlier in the week. On a related note, China is down for three straight days (Shanghai -10% year-to-date). That certainly doesn’t help the demand argument does it? Neither did the news from Caterpillar.

Asset Allocation


Top Long Ideas

Company Ticker Sector Duration

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.


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. 


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. 

Three for the Road


Try and stop him. @KeithMcCullough is buying the damn dip. Actually don't try. Mucker's love for a market consensus hates cannot be stopped.



"It's true that the Federal Reserve faces a lot of political pressure and is unpopular in many circles." 

- Ben Bernanke 


$885,000,000: The amount UBS has agreed to pay Fannie Mae and Freddie Mac to settle claims that it improperly sold them mortgage-backed securities during the housing bubble. 

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