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INDONESIA’S GROWTH/INFLATION/POLICY NIGHTMARE

Takeaway: We profile Indonesia’s recent hardship as further supporting evidence of our #EmergingOutflows and #AsianContagion theses.

SUMMARY BULLETS:

 

  • It’s been an especially long ~3M for investors operating in Indonesian capital and currency markets:
    • It’s benchmark equity market, the Jakarta Composite Index, is down -16.2% over that time frame, which compares to a regional median delta of -5.7%.
    • It’s currency, the Indonesian rupiah, has fallen -8% vs. the USD over the past 3M to a ~4Y-low; this -8% decline compares to a regional median delta of -1.3% over that same duration.
    • Indonesia’s 2Y and 10Y sovereign debt yields have backed up +289bps and +277bps, respectively, over the past 3M; those fixed income [price] declines compare to regional median deltas of +24bps and +85bps on the 2Y and 10Y tenors, respectively.
  • All told, the Indonesian economy and its policymakers have not done themselves any favors as it relates to protecting investors from price declines consistent with our top-down #EmergingOutflows and #AsianContagion theses.
  • The bottom-up GROWTH/INFLATION/POLICY fundamentals in Indonesia continue to deteriorate at the margins and that alone should continue to keep “the flows” from being supportive of Indonesian assets.

 

It’s been a long 3-4 months for investors operating in EM capital and currency markets. Since we outlined our structural bearish bias on Emerging Markets in our 4/23 presentation titled: “EMERGING MARKET CRISES: IDENTIFYING, CONTEXTUALIZING AND NAVIGATING KEY RISKS IN THE NEXT CYCLE”, the MSCI EM Index has fallen -5.1%; the JPM EM FX Index has fallen -5.8%; the JPM EM USD Bond Index (EMB) has fallen -11.3%; and the Market Vectors EM Local Currency Index (EMLC) has fallen -13.4%.

 

It’s been an especially long ~3M for investors operating in Indonesian capital and currency markets:

 

  • It’s benchmark equity market, the Jakarta Composite Index, is down -16.2% over that time frame, which compares to a regional median delta of -5.7%.
  • It’s currency, the Indonesian rupiah, has fallen -8% vs. the USD over the past 3M to a ~4Y-low; this -8% decline compares to a regional median delta of -1.3% over that same duration.
  • Indonesia’s 2Y and 10Y sovereign debt yields have backed up +289bps and +277bps, respectively, over the past 3M; those fixed income [price] declines compare to regional median deltas of +24bps and +85bps on the 2Y and 10Y tenors, respectively.

 

While the flows have certainly punished Indonesia simply for being an emerging market in 2013, we’d argue that the country’s own “fundamental misbehavior” has contributed to the aforementioned underperformance:

 

GROWTH SLOWING

Indonesia’s most recently reported real GDP growth rate of +5.8% YoY (2Q13) was the slowest rate since 3Q10 and -1.5x standard deviations below the trailing 3Y mean. On this number, Bank Indonesia (the country’s central bank) revised down its 2013 GDP forecast to “the lower end” of its [new] +5.8% to +6.2% forecast range; prior to that, they had been expecting 2013 growth to come in at +6.6%.

 

INDONESIA’S GROWTH/INFLATION/POLICY NIGHTMARE - 1

 

This weekend, we received far worse news on the economic growth front: the current account deficit widened to a nominal record $9.8B in 2Q13; as a percentage of GDP, the current account deficit widened to 4.4% in 2Q13, which is also a record. In the context of capital outflows, the country will have an increasingly difficult time maintaining existing growth rates by plugging this savings/investment imbalance with outside capital. To the extent the country fails to do so, at the margins, economic growth will continue to slow.

 

INDONESIA’S GROWTH/INFLATION/POLICY NIGHTMARE - 2

 

Not ironically, Indonesia scored rather poorly (5th worst out of 29 countries) on our BOP/Currency Crisis Index, which was one of the “Four Pillars” in our EM Crisis Risk Model, so today’s current account deficit-induced issues Indonesia is experiencing across its capital and currency markets (Jakarta Composite Index tanked -5.6% DoD, while the IDR also plunged -1.9% DoD vs. the USD) comes as no surprise to us.

 

INDONESIA’S GROWTH/INFLATION/POLICY NIGHTMARE - BOP Crisis Risk

 

INDONESIA’S GROWTH/INFLATION/POLICY NIGHTMARE - Hedgeye Macro EM Crisis Risk Model Summary Table

 

INFLATION ACCELERATING

The country’s CPI rate hit a ~4.5Y-high in JUL, accelerating to +8.6% YoY from a reading of +5.9% YoY in the prior month. While currency weakness (IDR down -9.6% YoY vs. the USD) has definitely played a major factor in the recent ramp in reported inflation readings in Indonesia, President Susilo Bambang Yudhoyono raised domestic fuel prices for the first time since 2008 in JUN to help curb rampant fuel subsidy costs that is eroding the fiscal balance (more on this below).

 

INDONESIA’S GROWTH/INFLATION/POLICY NIGHTMARE - 5

 

We bold the word “help” in the previous sentence because, in reality, the recent fuel price hike is doing little to allay the aforementioned fiscal concerns: next year’s budget allocates 336.2 trillion rupiah ($32 billion) for total subsidies, which is little changed from the 346.4 trillion rupiah spent in the current fiscal year.

 

FISCAL AND MONETARY POLICY TIGHTENING

In the face of rampant inflation, Bank Indonesia has hiked interest rates by +75bps in the YTD, with 50bps of that tightening coming in the past two months alone (inclusive of the fuel price hike news). On Thursday, Bank Indonesia increased the country’s secondary reserve requirement ratio by +150bps to 4%.

 

Interestingly, there exists a divergence in the on-shore swaps market and the local currency sovereign debt market as it relates to the likelihood of further tightening over the NTM: 1Y OIS contracts are trading at a -140bps discount to the 6.5% benchmark reference rate; the 1Y sovereign debt yields are trading at a +63bps premium to the same rate.

 

We should expect to see this kind of confusion when in an environment of Growth Slowing as Inflation Accelerates. Also confused, it should be noted that Bank Indonesia held rates in its most recent meeting, opting for additional time to reassess the balance of risks facing the country’s beleaguered economy.

 

As it relates to Indonesia’s fiscal policy outlook, we’ll know more details later in the week when we receive the official 2014 budget outline. For now, investors can be assured of some meaningful degree of tightening, as the budget is expected to shrink the deficit/GDP ratio to 1.49% from a projected deficit equivalent to 2.4% of GDP in the current year.

 

All told, the Indonesian economy and its policymakers have not done themselves any favors as it relates to protecting investors from price declines consistent with our top-down #EmergingOutflows and #AsianContagion theses. The bottom-up GROWTH/INFLATION/POLICY fundamentals in Indonesia continue to deteriorate at the margins and that alone should continue to keep “the flows” from being supportive of Indonesian assets.

 

Darius Dale

Senior Analyst


Morning Reads on Our Radar Screen

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

Keith McCullough – CEO

Treasury yields mark new two-year highs (via MarketWatch)

Egyptian police killed in Sinai ambush at Rafah (via BBC)

Deadline looms for creditors to object to Detroit bankruptcy (via Reuters)

Scottish Independence Case Clouded by Oil Industry Growth Drag (via Bloomberg)

PGA’s Dustin Johnson engaged to Gretzky (via ESPN)

 

Morning Reads on Our Radar Screen - earth1

 

Daryl Jones – Macro

Repo Market Decline Raises Alarm as Regulation Strains Debt (via Bloomberg)

Caroline Baum's View on Money (via Bloomberg)

 

Howard Penney – Restaurants

Restaurants ready for football preseason (via Nation’s Restaurant News)

A Record Number Of Millennials Are Living at Home, But It’s Not What It Looks Like (via PolicyMic)

 

Jonathan Casteleyn – Financials

Obama Focuses on Risk of New Bubble Undermining Broad Recovery (JC note: Trouble in the U.S. bond market is the next big trade via Bloomberg)

Last Bernanke Years Shows No Sign of Buyer’s Remorse (JC note: Bernanke needs to present a plan to unwind the Fed's balance sheet - it started at $900 BB and now is at $3.6 TT via Bloomberg)

 

Matt Hedrick - Macro

Nestle’s Sales Slowdown Seen Leading to Fewer Brands (via Bloomberg)

 

Tom Tobin – Healthcare

Reform Update: GOP-led states raise security concerns over insurance exchanges (via ModernHealthcare.com)


MACAU: TYPHOON CAN'T STOP MOMENTUM

Macau posted another blockbuster week despite the typhoon that hit on Wednesday.  Although we think some operators played lucky this past week, volumes were still strong.  We are raising our full month projection for August to YoY growth of 16-20%, up from 14-18%.  Daily table revenue averaged HK$996 million which was actually flat with last year but up 13% over July’s strong performance.

 

In terms of market share, LVS, MGM, and MPEL remain above trend so far in August.  We like all three of those stocks.

 

MACAU: TYPHOON CAN'T STOP MOMENTUM - macau1

 

MACAU: TYPHOON CAN'T STOP MOMENTUM - MACAU2


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European Banking Monitor: Taking A Short-Term Breather

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 - British, Italian and German banks all widened last week. Sberbank of Russia widened another 6 bps last week to 239 bps. 

 

European Banking Monitor: Taking A Short-Term Breather - w. banks

 

Sovereign CDS – Italy and Spain tightened last week by 6 and 7 bps, respectively, while France and Japan both widened by 2 bps. The rest of the world's major markets were unchanged. 

 

European Banking Monitor: Taking A Short-Term Breather - w. sov1

 

European Banking Monitor: Taking A Short-Term Breather - w.sov2

 

European Banking Monitor: Taking A Short-Term Breather - w.sov3

 

Euribor-OIS Spread – The Euribor-OIS spread was unchanged at 13 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: Taking A Short-Term Breather - w.euribor

 


#RatesRising

Client Talking Points

UST 10YR

Game on. After a big +25 basis point week-over-week move to 2.83% last week, the 10-year yield is punching another new high this August morning now up at 2.85%. It's finally within a beep of an immediate-term TRADE overbought signal. Apparently, at +36 basis points month-over-month, the US Jobless Claims data is now evidently too good! 

YEN

Yen (vs USD) is still a touch weaker this morning after dropping -1.3% last week. This is a good thing, but it needs to continue in order to keep the positive Japanese and US Equity correlation TRENDs in play. The USD/YEN risk range is 97.22 - 98.16. That is relatively tight and trade-able, so it’s not an all-or-nothing trade like many think everything macro still has to be.

INDIA

Yup. India continues to get crushed. Why? A) Growth Slowing and B) Inflation Accelerating (driven by the weakening Rupee). The Sensex was down another -2.1% this morning to -5.1% year-to-date. Folks, this is why we call it #AsianContagion. Pervasive Asian currency weakness is not good for countries who catch that cold.

Asset Allocation

CASH 26% US EQUITIES 28%
INTL EQUITIES 24% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 22%

Top Long Ideas

Company Ticker Sector Duration
WWW

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.

MPEL

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. 

HCA

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

TWEET OF THE DAY

Top Global Equity Market YTD (b/c they burned their currency) = Venezuela +173% - Worst Global Equity Market YTD (b/c of mining exposure) = Peru -20% @KeithMcCullough

QUOTE OF THE DAY

"There are no shortcuts to any place worth going" - Helen Keller

STAT OF THE DAY

The S&P 500 was down -2.1% last week (still up +16.1% year-to-date); Russell was down -2.3% (still up +20.6% year-to-date).


Market Generals

This note was originally published at 8am on August 05, 2013 for Hedgeye subscribers.

“In general, our Generals were out generalled.”

-John Adams

 

While that’s what John Adams wrote to his wife, Abigail, in October of 1776, it wasn’t an entirely accurate summary of what happened. The planned escape of American forces in October was based on a British battle lost, but it also helped them win the war.

 

Per Joseph Ellis in Revolutionary Summer, on September 5th, 1776, American General, Nathanael Greene, advised George Washington that a “retreat is absolutely necessary, and that the honor and interest of America require it.” (Ellis, page 135)

 

Although it wasn’t Washington’s style to retreat, Greene was right in advising the Continental Army to do what the Continental Congress probably wouldn’t understand. Out generalling the conventional wisdom of politicians requires flexible leadership.

 

Back to the Global Macro Grind

 

With the US stock market closing at yet another all-time high on Friday (SP500 +19.9% YTD), I’m advising the US Government to retreat from Quantitative Easing and let free-market prices start to clear.

 

While Bernanke has the Congress right freaked-out about the idea of interest #RatesRising, it’s the only way out of the long-term slow-growth problem they have perpetuated under both Bush and Obama economic policy making regimes.

 

Let the US Dollar strengthen and let US interest rates rise and you’ll get two big things:

 

1.       Continued #CommodityDeflation

2.       #Debt Deflation

 

Deflation isn’t a bad word inasmuch as retreat isn’t – so don’t let your local Keynesian of the Princetonian Econ 101 Regimen sucker you into thinking so. Inflations have caused more depressions in the last 180 years than deflations have (*Atkeson/Kehoe study).

 

What’s better, filling up your gas tank 10x for $100/pop, or filling it up 10x for $50? Send that brain teaser to someone on team Bernanke that takes a tax payer funded car service to work.

 

Tapering expectations have already:

  1. Raised the value of American Purchasing Power (US Dollar) by +3% YTD
  2. Deflated the value of Commodities (CRB Index, 19 commodities) by -4% YTD
  3. Crushed the net long futures and options spec positions in everything but Crude Oil contracts

If and when the debate moves from tapering to tightening, I think that we’ll finally get after some deflation at the pump. But we’re nowhere near having an economic General in the Obama Administration stand up for the little guy on this front (yet).

 

Looking at last week’s CFTC futures and options activity, a #StrongDollar #RatesRising week had the following impact:

  1. Total CFTC net long commodities position dropped -15% wk-over-wk
  2. Gold’s net long position fell for the 1st week in 5, down -7% wk-over-wk to +65,517 contracts
  3. Crude Oil’s net long position fell for the 1st week since late June, -5% wk-over-wk, to +318,819

To put that +318,819 net long position in Crude Oil in context, that’s 1-week removed from its all-time high. If you’re telling me Obama and Bernanke couldn’t smoke the oil price via monetary policy, I’ll buy you dinner (on them) for life.

 

#CommodityDeflation has helped drive the core of US Consumption Growth for the last 2 quarters, but that’s going to be less of a tailwind if Oil prices continue to trend higher. Last week, Brent Oil was up +1.7% - and it’s up another +0.3% this morning to $109.30/barrel. Our long-term TAIL risk line (to the upside) for Oil = $107.71/barrel.

 

Put another way, after getting smoked by Bernanke’s Policies To Inflate for the last 6 years, the US Consumer just got some purchasing power back and won a few quarterly battles. But if we don’t back off (taper) and eventually tighten, it’ll be your every day American who loses the inflation war.

 

Our immediate-term Risk Ranges are now:

 

UST 10yr 2.54-2.72%

SPX 1692-1712

VIX 11.72-13.85

USD 81.53-82.48

Brent Oil 107.99-109.67

Gold 1294-1326

 

Best of luck out there this week,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Market Generals - Chart of the Day

 

Market Generals - Virtual Portfolio


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