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JAPAN’S WEAK ECONOMY + CONSUMPTION TAX HIKE = BOJ EASING… OR ELSE

Takeaway: The case for incremental monetary easing amid fiscal tightening (via the consumption tax hike) grows louder in Japan.

SUMMARY BULLETS:

 

  • On both a QoQ SAAR and YoY basis, the most recently reported economic growth deltas were extremely low quality in nature as the government continues to be largely the only game in town as it relates to economic activity in Japan.
  • In the context of Japan’s private sector growth being too weak to orchestrate a smooth handoff from the government, we believe the BoJ may be forced to accelerate its balance sheet expansion over the intermediate term – especially if the consumption tax is going to be hiked as currently outlined in Japanese fiscal policy.
  • It should be noted that quantitative setup on the dollar-yen cross (i.e. Bearish TREND) is only a few days young and needs to hold below TREND for a few weeks to confirm the move. If, however, the move is subsequently confirmed, we would certainly alter our fundamental bias to a stance that is a more neutral on the Japanese yen, or perhaps even outright bullish if the US and Japanese growth data supports that conclusion.
  • If implemented, this fundamental shift would likely provide us with a ripe opportunity to short Japanese equities for the first time in a long time; the Nikkei is up +59.3% from its TTM low and the trailing 1Y and 3Y correlation coefficients between the USD/JPY spot rate and the Nikkei 225 Index are +0.96 and +0.97, respectively.
  • For now, however, we are inclined to maintain our negative bias on the Japanese yen (TREND and TAIL durations) and our positive bias on Japan’s equity market (TREND duration). The aforementioned scenario analysis is just our way of thinking out loud as we patiently wait and watch for confirming or disconfirming signals.

 

On balance, Japan’s 2Q13 GDP report was not good. Real GDP slowed to +2.6% QoQ SAAR from +3.8% in 1Q13 [revised down from +4.1%]. That headline figure was 100bps shy of the Bloomberg consensus estimate of +3.6%.

 

On a YoY basis, Japanese real GDP growth did accelerate to +0.9% from +0.3% prior, but, much like the headline QoQ SAAR figures, the YoY growth deltas were extremely low quality in nature as the government continues to be largely the only game in town as it relates to economic activity in Japan.

 

QoQ SAAR deltas:

  • C: +3.1% from +3.4% prior
  • I: -0.4% from -0.7% prior
  • G: +3.4% from +0.2% prior
  • Exports: +12.5% from +16.8% prior
  • Imports: +6.2% from +4.1% prior
  • Private Demand: +1% from +2.5% prior
  • Public Demand: +4.2% from +1% prior

 

YoY deltas:

  • C: +0.9% from +0.3% prior
  • I: -4.7% from -5.1% prior
  • G: +1.9% from +1.1% prior
  • Exports: -0.3% from -3.3% prior
  • Imports: +0.8% from +0.4% prior
  • Private Demand: +0.3% from -0.1% prior
  • Public Demand: +3.3% from +3.5% prior

 

JAPAN’S WEAK ECONOMY + CONSUMPTION TAX HIKE = BOJ EASING… OR ELSE - 1

 

JAPAN’S WEAK ECONOMY + CONSUMPTION TAX HIKE = BOJ EASING… OR ELSE - 2

 

It could be argued that the lone “bright spot” from this morning’s data release was that the GDP deflator accelerated to -0.3% YoY from -1.1% prior; that was the fastest reading since 3Q09. Indeed, Japanese policymakers are starting to get their first whiffs of the inflation they so desperately seek, but it remains well shy of their +2% target.

 

In the context of Japan’s private sector growth being too weak to orchestrate a smooth handoff from the government, we believe the BoJ may be forced to accelerate its balance sheet expansion over the intermediate term – especially if the consumption tax is going to be hiked as currently outlined in Japanese fiscal policy.

 

Recall that a pretty severe recession followed the last time Japan hiked its consumption tax back in 1997; the move cost then-prime minster Ryutaro Hashimoto his post and ultimately forced the BoJ to ease monetary policy. The USD/JPY gained 36 handles from JUN ’97 to SEP ’98 when a globally-coordinated intervention stopped the yen from crashing.

 

JAPAN’S WEAK ECONOMY + CONSUMPTION TAX HIKE = BOJ EASING… OR ELSE - 3

 

For now, all signs on that front support a status quo outcome (we’ll know for sure in late SEP/early OCT when the Cabinet Office makes its “final decision” post the final revisions to this morning’s GDP report); Finance Minister Taro Aso, Economy Minister Akira Amari and BoJ Governor Haruhiko Kuroda – all of whom will be on Prime Minster Shinzo Abe’s tax hike panel – are in favor of the move.

 

It is our view that, if the Cabinet Office proceeds as planned with respect to the consumption tax hike, the BoJ is likely to accelerate its balance sheet expansion to help make sure the economy doesn’t lose any momentum on the growth and inflation fronts. That, on the margin, would be bearish for the Japanese yen.

 

To review our negative bias on the Japanese yen (TREND and TAIL durations) and our positive bias on Japan’s equity market (TREND duration):

 

  1. While enthusiasm for the Abenomics agenda may come and go in the immediate-term, we believe investors are broadly underestimating the structural impact of imposing a +2% inflation target and +3% nominal growth target in Japan. To put that in context, the trailing 10Y averages for these metrics are -0.1% and -0.5%, respectively. Japanese policymakers have a lot of hay to bale on the monetary easing front if they are to even sniff their lofty targets within the proposed 2Y time frame.
  2. Assuming Japanese policy stays the course and our view that the US economy has finally turned the corner from a growth perspective is ultimately proven prescient, a compressing real interest rate differential will also put pressure on Japan’s currency from a capital flows perspective. Consensus expects real 2Y JGB rates to hit -2.5% by EOY 2014 (down meaningfully from -0.4% by EOY 2013); this compares to a forecast of -1.3% for real UST 2Y rates by EOY 2014 (down slightly from -1.1% by EOY 2013). More importantly, this inflection is also being confirmed in the swaps market: 2Y swap rates in Japan are now trading at -1.57% on a real basis (subtracting the 2Y breakeven rate from the swap rate); that compares to -0.88% for the US. As recently as mid-MAR, those metrics were meaningfully inverted at -0.10% and -1.98%, respectively!
  3. In the context of intermittent spikes in volatility in the bond and forex markets, we have maintained that the risk-adjusted outlook for Japanese stocks is decidedly less sanguine than consensus assumes given the reflationary tailwind of currency debasement. The caveat here is that this headwind can be offset via absolute returns that are now likely to be increasingly predicated on economic and fiscal reforms (corporate tax cuts, labor market deregulation, fiscal consolidation, etc.), as well as large-scale portfolio rebalancing by Japanese households. To that tune, only 6.8% of Japanese household financial assets are held in equities vs. 14.4% for the Eurozone and 32.8% for the US.

 

In spite of what we’ve outlined as arguably the most credible and well-articulated bull case for both the USD/JPY cross and Japanese equities, both are broken from an immediate-term TRADE perspective and flirting with breakdowns on our intermediate-term TREND duration as well. The risk management levels to watch on that front are as follows:

 

  • USD/JPY (last price = 96.55): Bearish TRADE = 97.72 and Bearish TREND = 97.13
  • Nikkei 225 (last price = 13,519): Bearish TRADE = 14,091 and Bullish TREND = 13,336

 

JAPAN’S WEAK ECONOMY + CONSUMPTION TAX HIKE = BOJ EASING… OR ELSE - 4

 

JAPAN’S WEAK ECONOMY + CONSUMPTION TAX HIKE = BOJ EASING… OR ELSE - 5

 

It should be noted that quantitative setup on the dollar-yen cross is only a few days young and needs to hold below TREND for a few weeks to confirm the move. If, however, the move is subsequently confirmed, we would certainly alter our fundamental bias to a stance that is a more neutral, or perhaps even outright bullish if the US and Japanese growth data supports that conclusion.

 

If implemented, this fundamental shift would likely provide us with a ripe opportunity to short Japanese equities for the first time in a long time; the Nikkei is up +59.3% from its TTM low and the trailing 1Y and 3Y correlation coefficients between the USD/JPY spot rate and the Nikkei 225 Index are +0.96 and +0.97, respectively.

 

Patience should pay dividends for those inclined to wait and watch here.

 

Darius Dale

Senior Analyst


[PODCAST] KEITH HEADS NORTH OF THE BORDER

 

From the outdoor ice hockey rinks of Thunder Bay, Canada, to inside the boardroom of an NHL owners' group. CBC's Lisa Laco catches up with Hedgeye CEO Keith McCullough, partner in the new NHL ownership group in Phoenix.


Morning Reads on Our Radar Screen

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

Keith McCullough – CEO

Prosecutors and F.B.I. Examine JPMorgan Over Losses (via DealB%k)

Google, Facebook among toughest interviewers: Their questions revealed (via Silicon Valley Business Journal)

Recognize the name on this building? > Moving to the Taft Mansion, a Yale Conservative Group Seeks a National Presence (via New York Times)

 

Morning Reads on Our Radar Screen - jpm

 

Daryl Jones – Macro

Gold Shorts Cover At Fastest Pace In 13 Years (via Zero Hedge)

 

Josh Steiner – Financials

Bill Miller's fund is beating the market once more (via Baltimore Sun)
U.S. Said to Plan Charges Against Ex-JPMorgan Employees (via Bloomberg)

 

Tom Tobin – Healthcare

The new normal? Shift to outpatient care, payer pressure hit hospitals (via ModernHealthcare.com)

 

Matt Hedrick - Macro

Greece will need more bailout loans by 2014, Bundesbank believes (via The Guardian)

 

Howard Penney – Restaurants

McDonald's franchisees not leaving brand despite tension (via NRN.com)


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MNST – Softness, But Energy Outperformance over Beverage and Litigation Headlines Quieter

MNST’s Q2 2013 EPS came in 2 cents lighter than consensus ($0.62 vs $0.64), while revenue increased +6.6% Y/Y and  gross profit margins expanded to 53.3% versus 51.8% in the prior-year period.   While we continue to see softness in the beverage market with CSD volumes lower in Q2 2013 vs Q2 2012 and similar softening trends in the energy drinks market, especially in Europe, energy drinks continue to outperform the beverage category.

 

We continue to like the growth in the energy category. MNST is seeing strong sales performance from Ultra -- a lighter flavor that appeals to diet drinkers and those looking for a less traditional energy drink taste profile -- but at the cost of some cannibalization to its base Monster.

 

The company said it does not forecast raw material costs going up in the back half of the year and management appears optimistic that despite the possibility of future litigation costs, it has addressed existing concerns.   On Monday and Tuesday of last week MNST sat before the  U.S. Senate Committee on Commerce, Science, and Transportation in a hearing titled “Energy Drinks: Exploring Concerns About Marketing to Youth” (Red Bull and Rock Star also testified). The company did not update any of its language in the hearing, and said it will continue to defend its products as safe for consumers.

 

The FDA has stated that available studies do not indicate any new or previously unknown risks associated with caffeine consumption, though the agency continues to explore if additional research on caffeine or energy drinks is needed.

 

MNST is in a bullish formation across our immediate term TRADE and intermediate term TREND durations, which we outline in the chart below.  

 

MNST – Softness, But Energy Outperformance over Beverage and Litigation Headlines Quieter - zz. mnst

 

Matthew Hedrick

Senior Analyst


European Banking Monitor: Eerily Quiet?

Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor".  If you'd like to receive the work of the Financials team or request a trial please email .

 

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European Financial CDS - The median European bank tightened by 6 bps last week and is tighter by 16 bps vs the previous month. 

 

ECB data showed that banks cut 5,500 branches across the EU last year, representing 2.5% of the total, after 7,200 branches were closed in 2011. The region has 20K fewer branches than it had when the financial industry was hit by the crisis in 2008.  5.7% of Greek bank branches were closed in 2012, while 4.9% were eliminated in Spain, -3.3% in Ireland, and -3.1% in Italy. The contraction was partially offset by branch increases in some eastern European countries. 

 

Overall, the EU banking system continues to slowly heal. Systemic risk measures of Europe's banking system, such as Euribor-OIS, have been benign now for almost a year having fully renormalized back in Sep/Oct 2012.

 

European Banking Monitor: Eerily Quiet? - zz.banks

 

Sovereign CDS – Sovereign credit default swaps were mixed, though largely uneventful last week. Italy and Spain tightened by 7 and 9 bps, respectively, while Portugal widened by 4 bps. Elsewhere there was very little movement. 

 

European Banking Monitor: Eerily Quiet? - zz. sov1

 

European Banking Monitor: Eerily Quiet? - zz. sov2

 

European Banking Monitor: Eerily Quiet? - zz. sov3

 

Euribor-OIS Spread – The Euribor-OIS spread was unchanged week-oer-week at 12 bps. The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States.  Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal.  By contrast, the Euribor rate is the rate offered for unsecured interbank lending.  Thus, the spread between the two isolates counterparty risk. 

 

European Banking Monitor: Eerily Quiet? - zz. euribor


MACAU WEEKLY - SOLID START

With table revenue per day over HK$900m (HK$916m, up 29% YoY), Macau is indeed off to a strong start.  Our full month projection remains in the range of +14-18% in terms of YoY growth.  Our process is to project revenues prior to the start of the month using a sequential, seasonally adjusted model and then again using a weekly model.  Both approaches are producing the same growth rate.  While the growth rate is slower than the past few months, the underlying demand fundamentals are consistent.  Hold, comparisons, and the calendar always impact YoY growth differently each month.

 

In terms of market share, the biggest takeaways (albeit early to make any definitive conclusions) are that MPEL is back on track after a couple of share loss months and MGM and LVS have resumed their upward share momentum.  We’ve been assured that MPEL’s recent VIP volume share declines are not sustainable and August’s start is certainly a first step in proving that theory out.  MGM continues to impress us with improving operations.  The ramp of SCC is mostly responsible for LVS’s ascension. 

 

In terms of stocks, we remain bullish on MGM (Trade and Trend), MPEL (Trade, Trend, and Tail), and LVS (Trade, Trend, and Tail).  Despite a slower start to August, we are warming up to Galaxy as well.

 

MACAU WEEKLY - SOLID START - macau111

 

MACAU WEEKLY - SOLID START - macau222


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 80.64%
  • SHORT SIGNALS 78.57%
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