prev

BYI 2Q 2013 REPORT CARD

In an effort to evaluate performance and as a follow up to our YouTube, we compare how the quarter measured up to previous management commentary and guidance

 

 

OVERALL:  SLIGHTLY BETTER

  • BYI beat the quarter ever so slightly but the quality was there.  Systems, BYI's highest valued cash flow stream, drove the beat.

 

SYSTEMS

  • BETTER:  Systems segment had an outstanding quarter with $72.9MM in revenues and a 79.1% gross margin.  BYI believes this will be the fastest growing segment in FY 2014.  BYI reiterated 70-75% margins and expects software and services % of mix to revert back to mid-30s. 
    • PREVIOUSLY:  "We are heading towards fiscal 2013 being a record Systems revenue year for us, beating the previous record of $218 million established in fiscal 2010 by a fair amount. We have every reason to believe fiscal 2014 will be even better."
    • [Software/hardware split] "I believe it was somewhere around 36% hardware, so not too dramatically different from the prior quarter and from the year-ago quarter. Looking into Q4, hardware might be a lower, slightly lower percentage of the overall total revenue; software might be a little bit higher...And that is reflected in the normal expectation of gross margin that we say, in the 70%s is the range our gross margin will normally be, give or take a couple of percentage points here and there."

GAMING OPERATIONS MARGIN

  • SAME: 2Q gaming operations margins came in at 69.1% - within BYI's expected range.
  • PREVIOUSLY:  "The margin on Gaming Operations was 71%, within our expected range of 68% to 73%."

WAP

  • SAME:  38% growth in the installed base of WAP games.  BYI expects WAP install base to grow in FY 2014 but not at the pace of FY 2013.
  • PREVIOUSLY:  "All things considered, we expect to see the rate of WAP unit increases to pick up during the upcoming quarters...We expect the flow of WAP and premium game titles to continue in a steady well-planned and controlled fashion."

SHARE BUYBACK/ASR

  • SAME:  Will be completed in 1Q 2014. BYI received $2.4MM in common shares.  This share count will not increase significantly due to the recent increase in weighted-average share price.
  • PREVIOUSLY:  "Just the subject alone that since November 2007, including the ASR we're doing now, we bought back $1 billion. No change in our capital allocation strategy. We think that using an ASR to basically pull in about 7.5% of our total market cap is a pretty efficient means to do that. We do have some additional powder available even during the period of the ASR, should we choose to put that to work." 

NORTH AMERICAN REPLACEMENT VOLUME

  • WORSE:  BYI thinks they might have lost a couple of % points in ship share due to disciplined pricing.
  • PREVIOUSLY:  "When I think about average order size, it's gone up a touch. I would say that's more a result of some corporate buying."

INTERNATIONAL GAME SALES

  • BETTER:  BYI  sold 1,179 international unit in F4Q, flat YoY but easily its best quarter of the year.  Buying activity picked up.  The company expects international unit sales to pick up reasonably significantly in FY 2014 from the 3,500 level in FY 2013.
  • PREVIOUSLY:  
    • "Because regardless of whether their replacement numbers increase or not, one thing is certain, we are very under-represented in those floors. So we have a lot of market share growth opportunities there, even if the overall replacement trends don't pick up. So we have a long way to go before we are worried about the overall macro (international) trends."
    • "Some of the new game content we've been working on for the past year specifically targeted towards various international regions will be released soon and should help grow this portion of our business during fiscal 2014 and beyond."

I-GAMING

  • SAME:  BYI is live on 17 different sites in Europe
  • PREVIOUSLY:  "We also made very good progress on the remote gaming server front, going live with eight Bally titles on multiple European portals this past week. We expect over a dozen such portals to launch Bally's world-class game content by the end of this fiscal year."

NASCAR

  • WORSE:  NASCAR has not had the mass market appeal that Michael Jackson did.
  • PREVIOUSLY:  "And in terms of our expectations of NASCAR, yes, it is along the lines of Michael Jackson and GREASE, if not better."

ASP

  • SAME:  ASPs of new gaming devices decreased 6% to $16,224 per unit from $17,182 a year ago, primarily as a result of a higher mix of lower-ASP VLT and VGT units sold in the quarter.  Ex Illinois/Canada, ASPs was flat QoQ.  Net net, BYI expects ASPs in FY2014 to be up a little bit. 
  • PREVIOUSLY:  "If you remove the VGTs and the VLTs our pricing is along the same lines as it has been for the last couple of quarters. In fact, pretty close to the highest levels it's been. We remain very disciplined with pricing."

CANADA & SOUTH AFRICA

  • SAME:  BYI shipped 200 VLT units to Canada in FQ4.
  • PREVIOUSLY:  "Canada and South Africa, I mean, it's a 2014 story. It's a 2015 story. It could even beyond 2015 be a story. There's still more to come on Canada, more jurisdictions that I think ultimately will come to market."

BYI 2Q 2013 CONFERENCE CALL NOTES

Systems drives a small beat

 

 

“Fiscal 2013 was a truly momentous year in Bally’s history,”  “We made enormous progress in many different ways, including continued growth in wide-area progressive (“WAP”) units, record Gaming Operations revenue, significant success in new markets like Canada, Illinois, and South Africa, establishing new revenue records in Systems while setting up Systems for further growth in the years ahead, and the launch of Bally content in regulated online jurisdictions. These achievements position us well for continued growth in fiscal 2014 and beyond.”

 

- Ramesh Srinivasan, BYI's President and Chief Executive Officer.

 

  • Reiterates FY 2014 guidance for Diluted EPS of $3.70 to $4.05. 
  • As a result of normal seasonal trends, the timing of new openings and major systems installs, the Company expects that its Diluted EPS in the second half of fiscal 2014 will exceed the first half, with the second quarter being stronger than the first quarter. 
  • Guidance anticipates continued YoY growth in each of game sales, gaming operations, and systems revenues. This guidance does not reflect the impact of the planned acquisition of SHFL entertainment or any acquisition-related costs or savings.

 

CONF CALL

  • Several legal matters from F4Q 2012 have been settled
  • With respect to HPG in Italy, both parties have agreed to waive any and all disputes and terminate all agreements and HPG has agreed to begin repayment on the loan a €15 million made in 2009 with graduating monthly payments through July 2017
  • 3,733 units in North America (2,624 replacement units)
  • Ex Canadian/IL units, ASP in F4Q would have been flat QoQ
  • Average dollar margin for each gaming unit sold was up 3% YoY
  • Cash connection 1,678 units (+265 units QoQ) - NY results were very strong
  • WAP revenues up 46% YoY; WAP yields lower QoQ due to normal seasonal trends
  • Systems:  Maintenance revenues now on annual run rate of $100MM
  • Higher mix of software and service revenues.  Continue to expect 70-75% systems margins
  • ASR:  will be completed in 1Q 2014; received $2.4MM in common shares.  Will not receive significantly more shares due to recent increase in weighted-average share price.
  • F4Q FCF:  $58MM 
  • DSO:  106 days, down from 113 days year ago
  • WAP units 2,463 
  • NASCAR:   good game but has not resonated as well as expected
  • Hot Shots:  outperforming expectations
  • New WAP titles at G2E:  Pink Lady (Grease followup)
  • G2E:  new rental/daily fee games
  • Illinois VGT:  continue to exceed expectations., Since Sept 2012, 1,943 units sold; momentum will carry in FY2014 and beyond. 
  • International game sales:  meaningful uptick in South America, customer feedback has been positive
  • Top 5 customers accounted 42% of revenues in F4Q vs 41% in F3Q
  • Systems backlog:  will establish a new annual record in FY 2014
  • Systems:  17 major implementations e.g. Macau, US, South Africa
  • 68% domestic system revenues; 32% international system revenues
  • 23% of systems revenues came from new customers, 77% came from existing customers
  • Added 9,000 gaming connections to systems products in F4Q
  • Over 450,000 gaming devices connected to BYI devices; 185k equipped with iView, 42k equipped with current generation iView units; 19k equipped with iViewDM
  • I-gaming:  BYI live on 17 different sites in Europe
  • 1H 2014 will contribute 46% of FY 2014 EPS

Q & A

  • FY 2014 35 cent guidance range: visibility has been better so tight range given 
  • Replacement market has been less of a concern for BYI.  Only 13% of gross profit.  Feel like customer are buying but they may lose a couple of % of ship share from time to time because of pricing discipline.  Remain optimistic about replacement cycle. 
  • Continue to believe they will generate at least $30MM in synergies with SHFL acquisition
  • Systems growth will be the highest.  Game sales will be 2nd highest. 
  • 39.4MM diluted share count, which had added back one month of the 2.3MM ASR or 800k shares
  • NASCAR doesn't have the common global mass appeal as Michael Jackson for example.  Already started work on NASCAR 2.
  • If you take out the 2,200 Canadian VLTs in FY 2013, ASPs in 2014 will be higher. 
    • Has at least 30% of ship share in Illinois; expect to garner a similar amount in FY 2014. So that will pressure ASPs a little bit but not substantially
    • Net net, ASPs might be up a little bit
  • There could be some of moving from class II to class III next year
  • Market is happy that the SHFL combo is happening
  • F4Q Domestic replacement share? Somewhere in the teens
  • 'Normalized' flat ASPs had some impact on replacement share
  • Good growth from Pawn Stars
  • Lottery units down?  They did some floor re-concentration.
  • International:  buying activity did pick up.  Got some sales from Argentina where importation of goods has been difficult
    • For FY2014, Argentina is one important driver of a quarter being 1,200 units or a 950-1,000 units quarter.
    • Expect units to pick up reasonably significantly in FY 2014; had 3,500 international units in FY2013
  • iView DM continues to be a terrific opportunity
  • Systems:  expect Software and services % of mix to be in the mid-30s
  • FY 2014 R&D % of revenue:  11-12%
  • Gaming equipment margins in FY2014:  may grow fractionally.  Would require higher mix of conversion kit sales to grow margins
  • MJ 2:  new music, new game mechanics, customers excited

Buyem: SP500 Levels, Refreshed

Takeaway: Evidently, #RatesRising for the right reasons is the new bear case for stocks... Still, I cover shorts and buyem here.

This note was originally published August 15, 2013 at 11:04 in Macro

POSITION: 11 LONGS, 3 SHORTS @Hedgeye

 

People are always asking me why about this and why about that – “if you are so bullish on US #GrowthAccelerating and #RatesRising, why aren’t you longer?” Well, the 1st answer is that I’m as imperfect as the rest of you at this, and the 2nd is I like to buyem when they’re really red.

 

What’s fascinating about today’s selloff (taking us -2.8% from the all-time closing high in SPY – I know, end of the world type stuff) is that it came on precisely the opposite reason 2013 stock market bears have been begging for (slowing growth).

 

In terms of how we score it (NSA rolling jobless claims) this was the best employment #GrowthAccelerating print of the year (see our Macro note on employment today for details). Rates ripped on that and now, evidently, #RatesRising for the right reasons is the new bear case for stocks.

 

Across our core risk management durations, here are the lines that matter to me most:

 

  1. Immediate-term TRADE resistance = 1691, then 1709
  2. Immediate-term TRADE support = 1659
  3. Intermediate-term TREND support = 1631

 

In other words, I cover shorts and buyem here. And I don’t know what else to tell you other than that.

 

Enjoy your summer Thursday,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Buyem: SP500 Levels, Refreshed - SPX


investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.

The Queen Mary Is Turning

(Editor's note: The article below was featured on Fortune earlier today.)

 

By Daryl G. Jones

 

FORTUNE -- Every quarter, our team here at Hedgeye gets together and boils down the turmoil in global macro markets to three neat and tidy themes for our clients. But, in the spirit of Gary Keller's new, thought-provoking book, The ONE Thing, I'm going to employ a little alchemy and distill our team's latest macro toil down to one key theme: rising rates.

 

The Queen Mary Is Turning - tut1

 

Consider the following three noteworthy items on rising interest rates:

 

The Queen Mary of macro trends has inflected. We often use the analogy of the Queen Mary turning to describe the long-term trend in interest rates. The Queen Mary, of course, was the massive ocean super liner that dominated transatlantic voyage before the jet age. As is the case with any vehicle that is more than 300 meters in length, turning the Queen Mary around was no easy task. And certainly not without wide-reaching implications and reverberations.

 

This particular analogy is especially appropriate for the current sea change in interest rates, as they have literally been in decline for the last three decades, since peaking in the early 1980s. This long-term decline has enabled virtually any business that depends on borrowing money to fund its business to have a steadily declining cost of capital. In addition, this has made bonds a compelling asset class for investors.

 

In our second-quarter models, yields inflected notably and broke out above our TRADE (three weeks or less), TREND (three months or more) and TAIL (three years or less) levels. This is nothing to sneeze at. In fact, as shown in this Chart of the Day, 10-year yields had their largest percentage increase quarter over quarter in more than a decade. Even though 10-year yields have broken out, they remain well below the mean yield since 1989 of 5.21%. In other words, despite their recent rise, yields are still around 260 basis points off the mean.

 

The market is chock full of debt. Given the generational trend in interest rates going lower, and thus providing a tailwind for bonds, it should come as no real surprise that a large percentage of investors' portfolios are full of fixed income. According to the most recent data, there is $38 trillion of bonds outstanding across all subsectors of the bond market. Moreover, bonds outstanding have increased every single year since 1990.

 

The more critical data point from an asset flow perspective is that the notional value of bonds outstanding is currently at 68/32 vs. the market capitalization of equities. This, too, is an extreme ratio based on history and is literally the highest we have seen. For comparative purposes, this ratio was at 50/50 as recently as 1999.

 

Volatility and duration across the bond market are in a setup that could lead to meaningful losses. As volatility in an asset class increases, so too does the expected loss and/or return. According to Merrill Lynch's MOVE index, bond volatility has almost doubled in the last quarter and is at two-year highs. Meanwhile, duration is at close to all-time highs. My colleague Jonathan Casteleyn of our financials team highlighted this in his recent presentation on asset managers, but based on current duration, a roughly 100 basis point move in yields equates to an 8.9% loss on the 10-year Treasury.

 

In part, we are already starting to see the sort of generational losses in bonds that we should expect from the dynamics outlined above. To put a finer point on it, the Barclays Aggregate Bond Index is set for its first loss in 14 years, and only third loss since 1990. So, while gentleman may prefer bonds, they don't prefer losses.

 

The reality in markets is that there is rarely "One Thing" that dominates. Rising interest rates may prove to be the exception. This seismic "Queen Mary" shift in interest rates will certainly be one of the most critical factors over the coming quarters and years with wide-ranging reverberations. And, as money continues to flow from the bond market to avoid losses, equities will be awaiting with wide open arms.

 

Daryl Jones is Director of Research at Hedgeye. You can follow him on Twitter @HedgeyeDJ.

 


EL – STRONG UNDERLYING PERFORMANCE

Estée Lauder’s 4QFY13 results surprised to the upside as organic sales growth came in at +8%, driving $0.24 in EPS versus $0.21 consensus. While FY14 guidance of $2.74-2.87 (inclusive of $0.10 FX headwind) falls below the Street at $2.94, organic sales growth guidance of 6-8% is reassuring. In 4QFY13, high-end brands grew 20% versus overall sales growth of 6%. Investors have clearly been reassured by the underlying top-line trends. As we wrote yesterday, the investment community was waiting for reassurance around the company’s sales growth. Concerns regarding the implementation of SMI also needed to be addressed and, judging by the results and earnings call commentary, it seems that the company is nearing the end of the “investment” phase of the initiative and is poised to reap some rewards.

 

In terms of the quantitative setup, according to our macro team’s quantitative model, the stock is breaking out above its intermediate-term TREND line.

 

EL – STRONG UNDERLYING PERFORMANCE - el levels 815.13

 

 

Below, we highlight the positives and negatives from 4QFY13 earnings, the FY14 guidance, and the earnings call this morning.

 

What we liked:  

  • EPS of $0.24 beat consensus expectations of $0.21
  • Organic sales growth of 8% came in above expectations
  • High margin luxury skincare brands growing 20%
  • Mgmt expecting to outgrow industry by at least 1%
  • Industry growth expected to be 3-4% in FY14, 4-5% thereafter
  • FY13 operating cash flow increased 9%, mgmt guiding to 14% growth in FY14
  • Performance and opportunity in emerging markets bode well for long-term growth
  • EL fundamental setup continues to be attractive with robust growth and yield

 

What we didn’t like:

  • Slow sales growth continuing in U.S., Southern Europe, Korea
  • FX continuing to be a significant headwind, FY14 impact difficult to estimate at this point
  • “Temporary softness” in the U.S. – remains to be seen if this is so
  • Gross margin decline in 4QFY13 – transient, according to mgmt

 

 

Rory Green

Senior Analyst

 


ANTI-DATA MINING IN CHINA: IS IT TIME TO RELOAD ON THE SHORT SIDE?

Takeaway: It looks like a good time to start reloading on the short side of Chinese equities, as the recent dead-cat bounce appears to be fading.

SUMMARY BULLETS:

 

  • While the anticipated dead-cat bounce in the Shanghai Composite Index off the aforementioned lows has lasted longer (i.e. in duration) than we expected, we are encouraged as short-sellers of China to see that the index failed at its intermediate-term TREND line of resistance this week.
  • That explicit quantitative signal is supportive of our fundamental research view that [largely] policy-induced banking sector headwinds will weigh on Chinese economic growth with respect to the intermediate-term TREND and the long-term TAIL (click HERE for the initial presentation of that thesis; click HERE for the latest update).
  • Simply put, while Chinese economic growth has indeed stabilized at these historically-low rates [for now], we don’t see any degree of upside that would be supportive of any long-term bullish bias in Chinese stocks; nor do we expect Chinese fiscal and monetary policy to be supportive of meaningful speculation on the long side of Chinese equities from here.
  • Lastly, in the section below titled, “WHERE TO FROM HERE”, we walk through precisely why Chinese growth data may not be as marginally healthy as it has [generally] appeared recently. In fact, our in-depth analysis of China’s financial sector lends credence to the view that China’s mini-growth rebound may be short-lived.

 

WHERE WE’VE BEEN

We’ve been on the right side of the wild cyclical swings that investors have become accustomed to in the Chinese equity market for well over a year now:

 

 

The caveat to that opening statement is that, as overt bears on China, we’ve been right squeezed by the +8% rally in the Shanghai Composite Index off of its late-JUN (6/27) lows to its 8/13 cycle peak. Hopefully you took our explicit advice to reduce your short exposure to China right around the index's YTD lows (when we openly proclaimed that our bearish thesis had been priced in on an immediate-term basis), but that’s neither here nor there.

 

What is both “here and there” is the fact that while the anticipated dead-cat bounce in the Shanghai Composite Index off the aforementioned lows has lasted longer (i.e. in duration) than we expected, we are encouraged as [rhetorical] short-sellers of China to see that the index failed at its intermediate-term TREND line of resistance this week.

 

ANTI-DATA MINING IN CHINA: IS IT TIME TO RELOAD ON THE SHORT SIDE? - China SHCOMP

 

That explicit quantitative signal is supportive of our fundamental research view that [largely] policy-induced banking sector headwinds will weigh on Chinese economic growth with respect to the intermediate-term TREND and the long-term TAIL (click HERE for the initial presentation of that thesis; click HERE for the latest update).

 

Simply put, while Chinese economic growth has indeed stabilized at these historically-low rates [for now], we don’t see any degree of upside that would be supportive of any long-term bullish bias in Chinese stocks; nor do we expect Chinese fiscal and monetary policy to be supportive of meaningful speculation on the long side of Chinese equities from here.

 

MERE STABILIZATION IS BULLISH WHEN BARRONS’ FLAGS CHINA’S “LOOMING CREDIT CRISIS”

On the same day when we were making the call that the bear case had been priced in on an immediate-term perspective, Barron’s (a publication we have a great deal of respect for) published this beauty:

 

ANTI-DATA MINING IN CHINA: IS IT TIME TO RELOAD ON THE SHORT SIDE? - Barron s China Credit Crisis JUN  13

 

Needless to say, the consensus attitude among investors had become that China was fast-approaching its much bandied about “hard landing” – a research view we’ve never bought into. Such hysteria prompted various officials to come out and affirm that Chinese growth would indeed stabilize at/around current levels:

 

  • First, Chinese Finance Minister Lou Jiwei proclaimed at the JUL US/China Summit that 6.5% real GDP growth in 2013 “may be tolerable”;
  • Then, the official state-run Xinhua News Agency subsequently proclaimed that what Jiwei really meant to say was that he has “no doubt” that +7.5% target would be achieved; and
  • Finally, Chinese Premier Li Keqiang stated plainly that +7% real GDP growth is the “bottom line” for 2013.

 

At the time, we weren’t really sure what to do with all that except to expect anything from a sequential flattening of the then-negative slopes to a modest improvement in Chinese growth data in JUL, which, for the most part (other than some noteworthy exceptions), is precisely what happened:

 

  • JUL Manufacturing PMI: 50.3 from 50.1 prior
    • The New Orders index ticked up to 50.6 from 50.4 prior
    • The New Export Orders index ticked up to 49 from 47.7 prior
    • The Employment Index ticked up to 49.1 from 48.7 prior
  • JUL HSBC Manufacturing PMI: 47.7 from 48.2 prior
    • The New Orders index fell to 46.6, which was the lowest since AUG ’12
    • The New Export Orders index contracted for a fourth-consecutive month
    • The Employment index slowed to the lowest level since MAR ’09
  • JUL Non-Manufacturing PMI: 54.1 from 53.9 prior
  • JUL HSBC Services PMI: flat at 51.3
  • JUL Industrial Production: +9.7% YoY from +8.9% prior
  • JUL Retail Sales: +13.2% YoY from +13.3% prior
  • JUL YTD Fixed Assets Investment: flat at +20.1% YoY
  • JUL M2 Money Supply: +14.5% YoY from +14% prior
  • JUL Total Social Financing: +CNY808.8B MoM from +CNY1.04T prior
    • New Loans: +CNY699.9B MoM from +CNY860.5B prior
  • JUL Electricity Consumption: +8.8% YoY from +6.3% prior
  • JUL Exports: +5.1% YoY from -3.1% prior
  • JUL Imports: +10.9% YoY from -0.7% prior
  • JUL Trade Balance: $17.8B from $27.1B prior; -$7.5B YoY from -$4.8B YoY prior
  • JUL Real Estate Climate Index: 97.4 from 97.3 prior

 

ANTI-DATA MINING IN CHINA: IS IT TIME TO RELOAD ON THE SHORT SIDE? - China PMI Table

 

WHERE TO FROM HERE?

In looking at the data, we can reasonably conclude that Chinese growth has indeed stabilized, though the sharp slowdown in credit growth (i.e. the lifeblood of the Chinese fixed-assets investment-driven economy) is cause for concern with respect to Chinese growth in 2H13. Additionally, property prices continue to accelerate and, while combating property prices is no longer a top priority for the PBoC, we are curious to see if further macroprudential tightening measures are coming down the pike – as recently hinted by Zhu Zhongyi, vice president of the China Real Estate Industry Association.

 

ANTI-DATA MINING IN CHINA: IS IT TIME TO RELOAD ON THE SHORT SIDE? - China Total Social Financing

 

ANTI-DATA MINING IN CHINA: IS IT TIME TO RELOAD ON THE SHORT SIDE? - China Real Estate Climate Index

 

On the positive side of the ledger, our favorite concurrent-to-slightly-leading (only because we get the data on a daily basis) indicators for Chinese growth auger positively for China’s AUG monthly growth data as well (they front-ran the positive inflection in JUL).

 

ANTI-DATA MINING IN CHINA: IS IT TIME TO RELOAD ON THE SHORT SIDE? - China Iron Ore  Rebar and Coal YoY

 

Additionally, money market rates on the short end of the curve continue to ease on a MoM and QoQ basis as the PBoC has become a consistent net provider of liquidity into the Chinese financial system via the issuance of reverse repos and allowing previously-issued central bank bills to expire on a net basis.

 

ANTI-DATA MINING IN CHINA: IS IT TIME TO RELOAD ON THE SHORT SIDE? - China Interbank Rates

 

ANTI-DATA MINING IN CHINA: IS IT TIME TO RELOAD ON THE SHORT SIDE? - China 7 day Repo Rate Monthly Avg

 

ANTI-DATA MINING IN CHINA: IS IT TIME TO RELOAD ON THE SHORT SIDE? - China PBoC OMO

 

But… we continue to see signs of deterioration underneath the hood. Across the maturity curve, interest rate swaps continue to trade well above the current cost of capital in China. In the past, we’ve interpreted this market signal as a sign that monetary policy tightening was increasingly probable over the intermediate term. We don’t view that scenario as likely at the current juncture; rather, we believe the market sees what we see: a prolonged erosion of financial liquidity, at the margins, will continue to apply upward pressure to money market rates over the intermediate-to-long term.

 

ANTI-DATA MINING IN CHINA: IS IT TIME TO RELOAD ON THE SHORT SIDE? - China 1Y OIS vs. PBoC Rates

 

That erosion of financial liquidity can be further identified in today’s failed bond auction by the Export-Import Bank of China – which couldn’t price 2Y or 7Y paper – and in China’s sovereign yield curve. China’s 10Y-2Y sovereign yield spread has widened modestly off its JUN mini-crisis spread lows, but it has yet to buck the trend of tightening that has been in place for just over one year now. Moreover, recent compression from the early-JUL highs is being driven by a dramatic backup in both the short end of the yield curve that is in excess of the also-noteworthy backup in the long end of the yield curve.  

 

ANTI-DATA MINING IN CHINA: IS IT TIME TO RELOAD ON THE SHORT SIDE? - China 10 2 Spread

 

The mere fact that both ends of China’s sovereign debt market is selling off should be interpreted as supportive of our view that the Chinese economy will be increasingly liquidity constrained, at the margins, as NPLs – both of the reported and unreported (i.e. debt rollovers/evergreening) genres – accelerate sustainably. A dour secular outlook for “capital” flows via the trade surplus is also supportive of our liquidity constraint thesis.

 

ANTI-DATA MINING IN CHINA: IS IT TIME TO RELOAD ON THE SHORT SIDE? - China REER

 

All told, there’s simply not enough liquidity present in the Chinese financial system currently and on a go-forward basis to consistently justify pricing bonds at yields well below what the future cost of capital will likely be for Chinese banks when the PBoC decides to liberalize deposit rates as it recently did with lending rates.

 

The aforementioned dynamic should remain a structural headwind to the overall growth rate(s) of the Chinese economy, at the margins, given the country’s overreliance on fixed assets investment as the primary engine of growth.

 

ANTI-DATA MINING IN CHINA: IS IT TIME TO RELOAD ON THE SHORT SIDE? - China GFCF   of GDP

 

Unless, of course, the Politburo plans to thread the needle with respect to their structural economic rebalancing agenda, which calls for slower overall GDP growth amid an elevation in the respective roles of the Chinese consumer and services sectors. Good luck “massaging” the data enough to get anyone to believe that!

 

Darius Dale

Senior Analyst

 

ANTI-DATA MINING IN CHINA: IS IT TIME TO RELOAD ON THE SHORT SIDE? - China GDP Expectations


Attention Students...

Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.

next