UK Bulls as Eurozone Inches Out of Recession

  • Bullish position on the UK (etf: EWU) and Germany (EWG) remains.
  • Eurozone fundamentals inching higher; investor sentiment improving on weak comps. On a relative basis the Eurozone is well below its historical growth average and churning only modestly higher as deep structural imbalances and the lack of credit drag on growth.
  • We underline the significance of Eurocrat and ECB resolve to lend support to the region and markets (at all costs), which, along with marginally better data, should continue to support Eurozone capital market performance.


UK’s Island Economics

In support of our fundamental bullish call on the UK economy since our June 11th European update presentation titled “Where Does Europe Go From Here”, yesterday the UK printed a strong Retail Sales figure of 3.0% in July year-over-year (exp. 2.4%) vs 1.9% JUN.


The print and the down move in the FTSE100 yesterday prompted us to add the UK via the etf EWU to our real-time portfolio positions on the long side.


UK Bulls as Eurozone Inches Out of Recession  - zzz. uk ftse


UK Bulls as Eurozone Inches Out of Recession  - z. uk retail and IP


Our outlook on the UK is data and price dependent and hasn’t changed: we expect to see outperformance from the UK economy versus many of its European peers due to its decision to issue austerity earlier in the fiscal consolidation cycle. We are now seeing stronger signs of improved consumer sentiment, and expect PMI readings to maintain their level above the 50 line (expansion) into year-end. Beyond retail sales, industrial production and housing figures have improved year-to-date, and while wage volatility and sticky stagflation persist, we view reductions in the saving rate as another indicator of improved sentiment.  Further, we’re bullish on the changing of the guard at the BOE to Mark Carney – while it’s up for argument on just how effective tying monetary policy to the unemployment rate is, we like the Bank’s move towards a more transparent state to better manage and guide expectations.


UK Bulls as Eurozone Inches Out of Recession  - z. uk cpi


UK Bulls as Eurozone Inches Out of Recession  - z. uk house prices


UK Bulls as Eurozone Inches Out of Recession  - z. uk savings rate



Eurozone Inching Higher


The big news this week was a better-than-expected first print of Q2 GDP out of the Eurozone, a follow-on to improving fundamental data out of the Eurozone in recent weeks.


The Eurozone’s +0.3% Q2 GDP rise marked the end of an 18 month recession (cheer!), and the figure beat our expectations for only modest improvement over Q1 (consensus was at +0.2%), especially in a quarter that was hampered by bad weather (including serious flooding throughout central Europe), continued misdirection in economic leadership from France’s Hollande (France has the second largest economy behind Germany in the Eurozone), and continued political strife in Italy, Spain, and Portugal.


UK Bulls as Eurozone Inches Out of Recession  - z. eurozone gdp


Clearly the data is looking better.  Germany and France also beat Q2 GDP expectations. Germany reported growth of +0.7% Q/Q (+10bps above expectations) versus 0.0% in Q1 and France rose +0.5% Q/Q (+30bps above expectations) vs -0.2% in Q1. Add to this performance PMI figures that have improved across the region over the last 3-5 months (reaching over the 50 line in the last 1-2 readings) and improvement in sentiment readings across the core and periphery.


UK Bulls as Eurozone Inches Out of Recession  - z. pmis


Risk Spreads are dropping to new lows. Also, 10YR Spanish and Italian bonds are trading at their tightest spreads over comparable German paper in more than two years at ~252bps and 235bps, respectively.


UK Bulls as Eurozone Inches Out of Recession  - z. 10 spreads



Not All Is Rosy

What’s our read?  While there’s optimism to be had on improving data, GDP was still down -0.7% year-over-year in Q2 and we expect a very slow churn higher in Eurozone GDP in the balance of 2013. Certainly GDP will remain well below the pre-crisis average of 2.1% (since 2000) as the region hits the reset button on standards of spending and lending as budgets are readjusted at the government and household levels.  We maintain our call for 2013 GDP between -0.8% and -0.6% year-over-year.

Beyond struggling to reset spending and lifestyles habits, here are some significant hurdles that we expect will continue to weigh on Eurozone GDP:

  • The slim availability of credit, in particular to the small and medium sized businesses, the core drivers of growth and employment (see chart below on ECB Loans to Non-Financial Corporations and Households as proxy—at or near all-time lows)
  • Diminished credit quality of banks, especially across the periphery, as they report increasing non-performing loans
  • Further bank write-downs of non-performing assets
  • Labor market reforms slow to enact or institute at all
  • A protracted unemployment overhang, especially youth unemployment across the periphery, that will limit consumer spending and confidence
  •  Political uncertainty, in Italy, Spain, and Portugal, to weigh on budget reforms and confidence

UK Bulls as Eurozone Inches Out of Recession  - z. ecb lending


To throw out a couple anecdotes from the media stories we’ve recently come across that paint a still subdued outlook, we include:

  • The WSJ reported that auto sales in Europe are so bad that less than half the factories in the region operate at the minimum 75% of capacity needed to break even. It said that those operating below that level are mostly located in Italy, France, and Spain whose economies have been hit by the crisis. The article noted that governments in Western Europe are worried about seeing more workers join the ranks of the unemployed and that unions are aggressively protecting jobs, while the courts have also been sympathetic. The paper said that because of this, auto makers are losing billions of euros a year by retaining workers and factories they no longer need.
  • A poll by ING-DiBa AG and the University of Hohenheim shows that only 17% of Germans believe that the worst of the Eurozone crisis is over, while 91% think that the crisis will still go on for a long time. Only 10% of Germans believe that politicians are being honest with citizens regarding Eurozone issues.


Concluding Thoughts


Our call remains that into Q4 we expect European PMIs to hover around the 50 line (ups and downs) but not to show a material breakout given the very weak structural issues that we do not see inflecting materially over the intermediate term, including weak credit conditions, high unemployment, alongside political uncertainty at the country level – Italy, Spain, and France in particular.  We continue to be fundamentally bullish on German and the UK equities, so should we see any outperformance from PMIs, we think it could come from these two countries.


As it relates to the capital markets, we think a much larger force versus marginal improvement in fundamental data is the political resolve of the Eurocrats and Draghi to lend fund if needed (back-pocket OMT ready) and prevent any country from leaving the Eurozone, which we think can continue to stabilize and push markets higher. Already we’re seeing domestic and international investors become increasingly confident in Draghi’s heavy hand and buying distressed asset, for example housing in Spain and bank debt across the periphery, as the EU banking system slowly continues to heal.      


Enjoy the weekend!


Matthew Hedrick

Senior Analyst


Hedgeye CEO Keith McCullough weighs in on the state of the markets including #EOW ("End of the World" trade) and the continuing rout of US Treasuries (yes, China holds $1.3T of those ... and they're selling).


End of the World? Get Real

Client Talking Points


Treasury yields are making higher-lows and higher-highs based on strength in the only leading indicator that matters in our employment model (non-seasonally adjusted rolling jobless claims). No, the world probably will not end on the continuing positive developments going on in US employment. 2.66-2.79% is now my 10-year risk range. It's very simple: Buy growth stocks; sell Treasuries – rinse and repeat.


It looks like someone apparently forgot to tell European markets that the world ended in the good 'ole USA yesterday (i.e. the fleeting, freak out "End of World" trade). So what is Europe doing? How about absolutely nothing except holding onto their recent gains. So no, they did not freak out. We finally had our opportunity to buy British Equities on red yesterday via (EWU). We did.


If you want to freak out about a country, pick one with A) #GrowthSlowing and B) #InflationAccelerating as their currency implodes. Yes, that there would be India. And that’s the only market that really got tagged overnight. It was down -3.3% to -2.5% year-to-date.Not a pretty market picture there.

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


TREASURIES: monster move in #RatesRising remains a pro-growth signal that growth bears missed, 2.77% 10yr last @KeithMcCullough


“Fear is static that prevents me from hearing myself.” -Samuel Butler


The Yield Spread (10-year -2-year) which is a great leading indicator for US growth is up +15 basis points this week to +243 basis points wide.

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August 16, 2013

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We are removing RRGB from the Hedgeye best ideas list as a short.


We remain cautious on the Casual Dining segment and feel RRGB is one of the weaker players in the space.  Our short thesis was predicated on the company not delivering on improving traffic (which happened) but misjudged the potential for a significant increase in average check. 


For the intermediate term, we no longer see Red Robin as one of the most attractive shorts in the space.  Improving 2-year traffic trends make it difficult to remain short the stock.  Given yesterday’s results we can no longer defend our bearish case. 




The 2Q13 numbers support the notion that RRGB’s brand transformation and new menu initiatives have impacted traffic trends sooner than anticipated.  We adopted a bearish stance on RRGB back in early June as we believed the stock had gotten ahead of the company’s fundamentals and future growth prospects. 


The bear case was led by the three main deterrents to growth that we expected the company to face in FY13.  The first was a decline in traffic.  The current casual dining environment suggests a slowing sales and traffic environment, and we viewed a second quarter uptick in traffic for RRGB as unlikely.  The second issue we had was with the near-term expectations of the brand transformation.  While we agreed RRGB was desperately in need of a brand transformation, we believed this initiative would be a negative in the short-term.  The last component of our bear case consisted of a dreadful outlook for 3Q13, a quarter which we have previously referred to as “RRGB’s Waterloo.” 


Below we break down the three main tenets of our previous bear case and explain why we have backed away from our short thesis.




While traffic did contract -0.7% in the quarter, the 2-year trend turned positive for the first time in six quarters as the company outperformed its casual dining peers by 240 bps.  This suggests that RRGB was able to gain market share during the quarter – a feat that we viewed as unlikely.  There’s no way to spin it.  A positive 2-year average trend in traffic growth, particularly in a sluggish environment, is a bright spot for the company and portends the largest hole in our thesis.



Brand Transformation

The company’s brand transformation is still in its early stages and will take time to fully materialize.  However, their efforts to-date have translated into a higher perceived value, allowing them to efficiently take +2.3% pricing in the quarter.  This, combined with menu enhancements and a renewed focus on higher margin items – alcohol, appetizers, and dessert – led to a +5% increase in average guest check during the quarter.  Whether or not this is sustainable is another question.  Price is expected to roll off in 3Q and the lift seen from menu enhancements will be difficult to match moving forward.


Several initiatives proved beneficial to 2Q13 results, but it will take time before we can determine the true, long-term impact of the brand transformation.  While early results have impressed, it is not a guaranteed success.  Moving away from the core customer always carries risk and Bar Works remains a fairly large question mark.



RRGB’s Waterloo

We previously wrote that 3Q13 is RRGB’s Waterloo for the following reasons:

  • Difficult SRS comparisons
  • Lowest revenue quarter of the year as incremental expense continues to build
  • Expenses in 2H13 likely to grow significantly thanks to new costs

Though we expect 3Q13 to be a difficult quarter for the casual dining industry in general, we now have no reason to believe it will be worse for RRGB than others. 


The company has shown it can grow sales in a slowing environment and has managed expenses, in midst of a brand transformation, better than we had anticipated.  We would heed caution, however, on a couple of counts.  First, 2Q13 restaurant-level operating profit margins of 23.3% are unsustainable, particularly when you factor in the 3Q13 roll off in price.  Second, brand transformation expenses are likely to pick up in 2H13, leading to more margin pressure than the first half of the year.


Overall, our thesis for 3Q13 has changed marginally.  The one difference is that RRGB has responded to the current environment better than we anticipated.  The street seems to have modest expectations for 3Q13, but we continue to believe the casual dining group is likely to see multiples revised lower in the current quarter.


Final Thoughts


At 8.6x EV/EBIDTA, RRGB is trading in-line with its Casual Dining peer group at 8.7x.  And while valuation is at peak levels, it is not a catalyst – and never will be.  Though we still have conviction in some of the core tenets of our short thesis, we have lost conviction in the others.  Without these, we can no longer make a compelling bearish case.  







Howard Penney

Managing Director


Picture Day

This note was originally published at 8am on August 02, 2013 for Hedgeye subscribers.

“Think of me like Yoda, but instead of being little and green, I wear suits and I’m awesome. I’m your bro — I’m Broda!”

-Keith McCullough


I’m not going to try to weave that recent #Tweetshow gem from Keith above into some sort of missive theme.  It just makes me laugh.


Let’s start somewhere else.


Back in school the bullies used to wait until Picture Day to punch a kid in the face.  Risk Management in Central CT starts early. 


Yesterday could probably be considered an investor picture day and the market delivered a bevy of black eyes to the perma #EOW contingent.


In related End of World and Recency Bias news, it’s now August and for the better part of the last 5 months, the ‘Sell in May’ mantra has been iteratively thesis drifting towards an un-convicted call to ‘Sell in September’ alongside another crescendo in congressional budgetary and debt ceiling discord. 


September, incidentally, also happens to be when the seasonal distortion present in the reported econ data flips from a headwind to a tailwind - serving to (optically) amplify any positive underlying economic trend. 


Hearing implied volatility in ‘sell in December & go away’ calls is ripping!


Back to the Global Macro Grind……

For much of 1H13, our pro-domestic growth call was buttressed by some positive redundancy.   That is, with our model signaling for the slope of U.S. growth to accelerate out of 4Q12, we had a bullish absolute call for domestic, consumer-centric equities. 


With most of Europe Bearish TRADE & TREND, an expectation for slowing EM growth, and upside to troughed out expectations for U.S. growth, we also had a relative call supporting a long bias to domestic exposure. 


In essence, even if U.S. growth turned out to be “okay” instead of very good, we were still taking a high probability swing at positive absolute performance.  


As it happened, our conviction in the strength of the relative call was tested more acutely as we transitioned out of 1Q.  A quick review of the last few months will be helpful in understanding how our view has evolved to where it is today. 


As we moved through 2Q, it become apparent that consumption growth, while remaining healthily positive, would not accelerate sequentially.  In part, this was not unexpected. 


Fiscal policy impacts generally hit on some short lag and the 1Q13 comparison was artificially difficult as consumer spending in 1Q benefited from the special dividend deluge and compensation pull-forward that occurred in December 2012 ahead of impending fiscal cliff related tax law changes. 


With the savings rate rising in 2Q and disposable personal income growth largely flat, divining the slope of sequential consumption growth just became simple math. 


Further, with federal employment growth running at approx -2% YoY and furloughs for ~700K+ federal employees beginning in July – which, in tandem, equates to ~7% reduction in income for ~2% of the workforce – upside to disposable income growth would likely be constrained in 3Q13 as well. 


Would a modest deceleration in consumption matter from a market perspective? – becomes the simple, but nontrivial investment question. 


As we highlighted yesterday, when re-evaluating positioning, it’s often helpful to start by detaching yourself from the myopia of trying to contextualize every market tick and, from a broader perspective, remember how this whole reflexive economic thing works.  Archetypically,


Rising spending drives income and employment higher which, in turn, drives consumption and confidence higher in a virtuous, self-reinforcing cycle.  Credit serves to amplify the cycle with credit expansion following pro-cyclically as loan demand and creditworthiness both increase alongside rising incomes and higher household net wealth. 


In short, if the TREND slope of improvement across the balance of key macro drivers (employment, consumption, credit, confidence) remains positive, and if the forward research view and risk management signals are still aligned, the path of least market resistance and the highest probability call is to stick with the TREND  - particularly if you don’t have a discrete catalyst for a reversal. 


So, how are the aforementioned macro metrics #TRENDing?


Labor market trends remain positive with Initial Claims continuing to register accelerating improvement while employment growth as measured by the BLS’s Establishment and Household Survey’s both remain positive. 


Confidence readings across the primary surveys continue to make new 5Y highs and are finally beginning to break out of their post recession channel.


Business and Residential Investment growth has accelerated in each of the last two quarters. 


On the credit side, banks are finally beginning to report positive loan growth, Commercial & Residential Real Estate loan demand continues to improve and credit standards across commercial and consumer loan categories continues to ease.


Consumption has shown a discrete acceleration, but faces some well advertised, nearer-term headwinds.  If labor market trends remain positive, does the market look past middling consumer spending growth over the next few months with an eye towards a diminishing fiscal drag and easy compares as we annualize the sequestration and the tax law changes in early 2014?  That’s an increasingly probable risk for the consensus #EOW bear crowd to manage.


Now, Is Congress a discrete negative catalyst?  As our Healthcare Sector Head, Tom Tobin would say; you can never underestimate congress’s ability to create a crisis so they can subsequently save us from it.  Congressional risk may rise, on the margin, but this iteration is likely to be mostly noise so long as the fundamental trends remain positive.


Is #RatesRising a catalyst?   We have a hundred page slide deck and a 60 min presentation on why we don’t think a return to interest rate normalcy is a threat to growth or market performance.  (ping if you’d like a copy)


Is today’s Employment Report a discrete catalyst?  Yes, but not really.  We don’t have any particular edge on the NFP number, but given the ongoing strength in the jobless claims data it’s more likely than not we print something close to consensus at 185K.


So, now that I’ve peppered you with bullish jabs for the last 800 words, I’ll remind you that we’re not bullish on everything at every price.   In fact, we moved to net neutral into yesterday’s close  (5 longs, 5 shorts) as almost everything pro-growth, domestic consumption (XLY, XLF, $USD) signaled immediate term overbought.  


But we’ll take our long exposure higher again on the signal so long as the TREND slope of improvement in the Macro data remains positive.  At present,….


“Your Friend, the Trend Remains”  - Broda


Our immediate-term Risk Ranges are now as follows:


UST 10yr 2.60-2.78%

SPX 1690-1712

Nikkei 14101-15095

VIX 11.96-13.74

USD 81.62-82.87

Gold 1251-1326


80o and sunny on tap for the weekend.  Enjoy. 


Christian B. Drake

Senior Analyst 


Picture Day - 10Y vs GDP  PCE  SPX


Picture Day - virtual portfolio 8 2

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