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Sequestration 2014: What's the Impact Again?

Takeaway: The real economic impact of sequestration in 2014 will likely be equivocal. Positive growth will resume for the balance of the decade.

Knowing Is Half The Battle  - G.I. Joe

 

It’s been more than two years since the Budget Control Act (BCA 2011) was passed as a first step towards reigning in federal fiscal profligacy.  Subsequent legislation, principally the American Tax Payer Relief Act (ATRA 2012), modified the original provisions and adjusted the caps on discretionary budget authority.  

 

With the new fiscal year here and congressional cantankery again in crescendo, we thought it worthwhile to provide a cliff note review of the 2014 budget setup, with a focus on the projected impacts of sequestration specifically.   Unless you’ve followed the legislation closely, the details are probably fuzzy at this point and a superficial read of the headlines can be misleading in regards to both the magnitude and real economic impact of the legislated cuts.   

 

Garnering a clean read on what a fiscal policy actually proposes, how it’s being measured and scored and the mechanics of its implementation is probably more than half the battle in analyzing fiscal policy measures.  Below we offer a summary refresh on the details of sequestration and some clarity on the main points of confusion. 

 

TWO SETS OF CAPS:  There are currently two discrete sets of caps on discretionary spending in place that are independent of one another.  The Budget Control Act of 2011 placed a first set of caps on discretionary budgetary authority (see top set of numbers in table below).  Cuts legislated under sequestration are incremental to the BCA caps and work to further lower the total discretionary budget authority in each year through 2021 (middle set of numbers in CBO table below).

 

THE BUDGET CONTROL ACT:   The Budget Control Act (BCA), enacted in August 2011, put a cap on total federal discretionary spending with separate sub-caps on Defense and Non-Defense discretionary programs.  The caps were put in place for the fiscal years 2013-2021 with the goal of reducing projected deficit spending by $1.5T over that period (more on that in “Scoring Sequestration” below).

 

SEQUESTRATION:  The BCA created and charged the Joint Select Committee on Deficit Reduction (i.e. the “Supercommittee”) with finding deficit savings incremental to those achieved under the discretionary caps set forth in the BCA.  Specifically, it called for $984B in additional budget cuts, divided equally over the nine years spanning 2013-2021 ($109.4B per year, divided equally between Defense and Non-defense Discretionary).   Sequestration was the fall-back provision that automatically cut funding should the Supercommittee fail to reach agreement on an alternative source of deficit reduction.  The committee failed to reach an accord, thus triggering the Sequestration provision. 

 

BUDGET AUTHORITY vs. OUTLAYS:  The statutory caps on discretionary spending target Budget Authority.  Budget Authority represents the allocation of funds in a given year that an agency can use to make financial commitments.  Budget Authority, however, does not necessarily equal spending.  If an agency has excess funds or appropriations from prior years it can still spend those dollars – the effect being that total outlays could exceed total budget authority in a given year. 

 

SCORING THE SEQUESTRATION CUTS:  This point is simple but a key one to remember when evaluating the real economic impact of the “cuts”.  The often cited “Cuts” for a given year do not refer to incremental, year-over-year reductions in spending.  The cuts, as they are quantified and quoted, are relative to total projected spending under the 2010 funding path. 

 

To clarify, when congress was debating the Budget Control Act and the Simpson-Bowles deficit reduction committee was actively evaluating deficit reduction options, the latest available data was the official discretionary funding level for 2010 and the CBO’s forecast for discretionary spending over the 2012-2022 period.  In their baseline scenario, the CBO’s took the 2010 funding level for discretionary spending and inflation adjusted it to arrive at projected spending over the subsequent decade. 

 

To illustrate using 2014 as an example - the scheduled cut (as scored by the CBO/OMB and quoted in the press) for fiscal year 2014 is $109B.   This does not mean that discretionay outlays will be $109B less than last year – it means budget authority for 2014 will be $109B less than the CBO projected it would be back in 2010 based on the 2010 inflation adjusted spending path. 

 

EXTRA APPROPRIATIONS: Overseas Contingency Operations (i.e. war funding), Disaster relief, Emergency Designations and Program Integrity Funding all, despite being discretionary in nature, fall outside of the purview of the caps legislated under BCA.  Spending for these programs totaled $152.6B in fiscal 2013 according to the CBO (Here).  Total spending on these ‘adjustment’ items represents the chief means by which total spending could deviate from that legislated under the tight controls in place under the discretionary spending caps.  In fact, adjustments in 2013 increased total discretionary budget authority over the 2012 level. 

 

SEQUESTRATION MODIFICATIONS:   The American Tax Payer Relief Act (ATRA 2012), which served as the resolution to the fiscal cliff issue, modified the sequestration cuts for fiscal 2013 and 2014 legislated by BCA.  Specifically, it lowered the legislated cut for 2013 by $24B from $109B to $85B.  As an offset, ATRA lowered the 2014 cap by $8B (split evenly between defense and nondefense).  

 

It's worth noting that while the total cut was reduced for 2013, the final decision came in March, 5 months into the fiscal year - which, on an annualized basis, equates to ~$140B in cuts.  For any agency that hadn't already adjusted budget expectations, any adjustments had to be concentrated in order to stay below sequestration defined levels over the balance of the year.     

 

ABSOLUTE FUNDING WILL DECLINE IN 2014 BUT RISE THEREAFTER:  Total Discretionary Budget Authority is scheduled to decline $76B to $967B in fiscal 2014 from $1043B in FY2014.   From FY2015 to 2021, funding is scheduled to grow approx +2.5% per year.   

 

Sequestration 2014:  What's the Impact Again? - budget authority

 

So, unless congress reaches an accord on an alternate path to deficit reduction, total discretionary budget authority will decline by ~$76B in absolute term in 2014.  However, depending on the level of extra appropriations and the difference between actual outlays vs authorized funding, that negative difference could narrow or even turn positive. 

 

All-in, the real economic impact of sequestration in 2014 will probably be equivocal.  For the second half of the decade, discretionary budget authority (and presumably actual spending by extension) will resume positive growth. 

 

Christian B. Drake

Senior Analyst 

 

 

Resources/References:

OMB Sequestration Preview Report for FY 2014 >> HERE

CBO Sequestration update Report (Aug 2013) >> HERE

CBPP – Sequestration, Clearing Up misunderstandings >> HERE

(BCA 2011) Budget Control Act of 2011 >> HERE

(ATRA 2012) America Taxpayer Relief Act of 2012 >> HERE

 


Retail Sales: #Blah

Takeaway: Not a good start for Retail Sales data. Holiday hiring plans are both anemic and backward-looking.

Retail Sales: #Blah - ret1

 

It has not been a good week for Retail Sales data so far, as the ICSC year-over-year percentage change clocked in at +1.6%.

 

That matches the lowest reading since May.

 

While we traditionally see a strong sequential uptick in week 38, someone clearly forgot to tell the US consumer. Let’s see if the chilly start to autumn helps next week’s data. 

 

Retail Sales: #Blah - bri1

Retail Sales: #Blah - bri2

 

Editor's note: This is a brief excerpt from Hedgeye Research courtesy of Retail Sector Head Brian McGough. For more information on how you can begin receiving Hedgeye research, including "Investing Ideas" and "Real-Time Alerts" please click here


Stories on Hedgeye Radar Screen

Takeaway: Here's a quick look at some stories we're reading today.

Keith McCullough – CEO

Fisher Says White House Botched Fed Chairman Succession (via Bloomberg)

US consumer confidence dips (via Yahoo Finance)

Facebook, other banned sites to be open in China free trade zone (via Reuters)

Ex-FBI agent pleads guilty in national security leak (via BBC)

 

Stories on Hedgeye Radar Screen - sum1

 

Daryl Jones – Macro

Post Fed Hangover (via Bespoke)

 

Josh Steiner - Financials

Trader Lost $4M in Romney Bets (via NY Post)

 

Jonathan Casteleyn – Financials

Gundlach to Manage $450 Million for Prudential’s Jackson (via Bloomberg)

Applied Materials to Buy Tokyo Electron for $9.39 Billion (via Bloomberg)

 

Kevin Kaiser – Energy

Exclusive: Gulfport Energy ex-chairman received millions in free equity (via Reuters)

National Oilwell Varco (NOV) to Spin-Off Distribution Business (via StreetInsider)

 

Howard Penney – Restaurants

SEC Doesn't Like Noodles' 'Guests' (via Restaurant Finance Monitor)

 

Brian McGough – Retail

U.S. Retailers’ Holiday Hiring Seen Falling 6.9% (via Bloomberg)

Abercrombie & Fitch pays out $71,000 to settle lawsuits over hijabs (via The Guardian)

Kravis pushing to buy Jones Group (via NY Post)


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

CCL F3Q REPORT CARD

In preparation for CCL FQ3 2013 earnings release tomorrow, we’ve put together the recent pertinent forward looking company commentary.

 

 

OVERALL

  • WORSE:  While the quarter was a little better than expected, the outlook was disappointing.  1H 2014 yield guidance was substantially lower than what the Street was expecting as was Q4 EPS and yield guidance.  We continue to believe the ramifications from a tarnished Carnival brand have been underestimated.

CCL F3Q REPORT CARD - ccl

 

EX CARNIVAL NA BRANDS

  • WORSE:  North American brands' (ex Carnival) bookings volume for the next 3 quarters has been flat at higher prices in the last 12 weeks.
  • PREVIOUSLY:  "Fleet-wide bookings during the last 11 weeks from the end of March covering the next three quarters are running higher year-over-year at higher prices."
    • "North American brands' bookings and pricing during this 11-week period are higher."
      • "Caribbean itinerary booking volumes in the last 11 weeks covering the next three quarters, are slightly lower year-over-year at slightly higher prices."
      • "Alaska bookings, again excluding Carnival, are significantly higher at lower prices."
      • "European itinerary bookings for North America brands, are slightly lower at nicely higher prices."
    • "EAA brands' bookings and pricing are also higher versus the prior year."
      • "European itinerary booking volumes, and that's approximately 50% of EAA capacity, are significantly higher at higher prices."
      • "Caribbean itinerary volumes for EAA brands, which are just under 10% of EAA capacity, are running behind last year, but also at nicely higher prices."

CARNIVAL BRAND 

  • WORSE:  While management states that the Carnival brand continues to recover, F4Q pricing declines are now trending in the double digits while 1H 2014 yield guidance was a bomb mainly due to Carnival - suggesting little improvement.
  • PREVIOUSLY:  
    • "Bookings and pricing over the last 11 weeks are both lower year-over-year in a high single-digits low double-digits range respectively." 
    • "On recent surveys, consumer perception of the brand has significantly improved since the incidents back in March, and we expect this trend to continue as confidence builds back in the brand. We will need to cycle through a full year before we begin to see positive pricing comparisons, which should begin in the second half of 2014."

4Q TRENDS

  • WORSE:  Lower than expected yields due to 'geopolitical events in the Eastern Med'.  Occupancy and pricing dropped across most ships.
  • PREVIOUSLY:  
    • "On a fleet-wide basis, excluding Carnival, cumulative occupancies are slightly lower at slightly lower pricing."
    • "For North American brands, excluding Carnival again, occupancies are lower at higher prices."
      • "Carnival Cruise Lines' occupancies for the fourth quarter are also lower at slightly higher prices."
    • "For EAA brands, occupancies are flattish year-over-year at lower prices."
      • "Costa brand occupancies for the fourth quarter are nicely higher at lower prices...This is the first time during the last several quarters that Costa has been ahead of the closer-in booking curve this early in the booking process. We read this as a very positive sign are expecting Costa to have a nice increase in revenue yields in the fourth quarter."

1Q 2014 TRENDS

  • WORSE:  Ex-Carnival brands are not offsetting the bleeding from the Carnival brand by much, as revenue yield change for 1H 2014 is expected to be in the low single-digit decrease, similar to 2H 2013.
  • PREVIOUSLY:  "On a fleet-wide basis, and this includes Carnival, occupancies are lower year-over-year at higher prices. North American brands' occupancies, again including Carnival, are lower year-over-year at nicely higher prices. EAA brands' occupancies are also lower at slightly higher prices."

COSTA/EUROPE 

  • MIXED:  CCL expects Costa's performance to strengthen over 2013 and throughout 2014.  Brand perception improved in Italy and France but political uncertainties continue to pressure the European markets.
  • PREVIOUSLY:  
    • "A major challenge in Europe right now is the weakened economies, especially in Italy and Spain."
    • "Northern Europe product did have a significant capacity increase this year relative to the Med, and we do not expect that to recur in 2014."

HIGHER SPENDING COSTS

  • SAME:  Carnival expects NCC ex fuel/impairments to be roughly similar to that seen in 2H 2013.  There will be more marketing activity, ship investments and onboard products such as food and entertainment.  Dry dock costs will be higher due to vessel enhancements. 
  • PREVIOUSLY: 
    • "So beginning in the second half of the year, we are planning to increase marketing spend across all North American brands and expect this to continue into 2014."
    • "We had talked about the vessel enhancements being a multiple year process. So there will be some of that in 2014 as well."

Germany Bullish on Merkel’s Win: DAX Levels Refreshed

  • Bullish on Merkel’s Win, Coalition with the SPD likely
  • DAX is in a bullish breakout across its immediate term TRADE and intermediate term TREND durations
  • IFO German  Business Confidence pushes higher in September reading
  • EUR/USD strong on The Bernank No Taper Trade

Sunday ushered in a huge win for Chancellor Merkel, receiving a convincing 41.5% of the votes (5 seats short of an absolute majority in the Bundestag), while her former coalition partner, the Free Democrats (FDP), were bounced out of parliament having received less than the 5% minimum to retain their seats. The results portend a very likely alliance between Merkel’s CDU/CSU and the Social Democrats (SPD). For reference, this coalition, named the grand coalition, and last seen in 2005-2009, took 65 days to firm up back in 2005. How long will it take this time around?

 

Germany Bullish on Merkel’s Win: DAX Levels Refreshed - zz. poll

 

It’s tough to pin down just how negotiations will flow. Merkel has said that she hasn’t ruled out a coalition with the Greens, the party with the fourth biggest showing. However, we think a coalition with the Greens is unlikely, and may well just be a bargaining chip to play against a very likely coalition with the SPD.  We do expect a heavy level of political jockeying in the coming days and weeks as both sides look to secure key ministerial positions.

 

The SPD remains a party that has largely backed Merkel’s initiatives on EU and Eurozone policy, including the multiple bailout programs: we think the market will be bullish on this continuity.  Further, we would not expect this stance to change within a grand coalition.  Finally, we expect negotiations between to the parties to center more on domestic issues; the SPD may push for a national minimum wage and higher taxes on the wealthy, both of which have been opposed by Merkel.

 

Bullish DAX


As the politicking runs its course, we are bullish on the German equity market, a position we’ve held for much of the year.  As Keith said today on the morning call:

 

 “Respect is earned, not allocated. Over in Germany, Angela Merkel doesn’t have a bunch of Fed heads running around like chickens with their heads cut off making conflicting speeches to manic media people now does she? The DAX “correction” looked nothing like that in the S&P 500. Both DAX, the FTSE and Nikkei are all looking better now than S&P 500. Why not buy them instead?”

 

Below we highlight our key durations on the DAX that are screening a bullish breakout:

 

Germany Bullish on Merkel’s Win: DAX Levels Refreshed - zz. dax

 

German Data Grinds Higher


Below we show the IFO German Business Confidence survey. While it is but one of many surveys and data points we track, the 6-month forward Expectations figure beat consensus estimates and rose month-over-month to 104.2 versus 103.3 in August.  The positive data point is reflective of the grind higher in German data over the last 3-6 months. We maintain our bullish bias on German equities.

 

Germany Bullish on Merkel’s Win: DAX Levels Refreshed - zz. IFO

 

EUR/USD  Levels (Refreshed)


On what we shall call The Bernank No Taper Trade, the EUR/USD levels are grinding higher. Our topside trade resistance is now $1.36.

 

Germany Bullish on Merkel’s Win: DAX Levels Refreshed - zz. eur usd


CCL F3Q CONF CALL NOTES

Carnival confirmed pricing weakness suggested by our pricing survey last week.  The surprise was the release of FY2014 yield guidance early.

 

 

"During the past few months, Carnival Cruise Lines has seen a steady improvement in brand perception among U.S. consumers based on national market research data.  While some of our current challenges and cost pressures will continue well into next year, we have tremendous opportunities to enhance shareholder value over time. I have spent my initial months gaining a much deeper understanding of our people and our operations" 

 

CONF CALL

  • Impairments:  from 2 small Costa ships (one will be serviced Nov 2014), $27MM Ibero trademark
  • Accounting changes:  net cruise costs and earnings will now exclude gains/losses on ship sales and impairment charges 
  • 3Q:  
    • Fleetwide capacity:  +3.4%
      • NA:  +4%,  EAA brands: +2.5%; 
    • Ticket yield: -4.6% (NA: -5.4%, EAA: -3.0% (Northern Europe declines offset by Costa and P&O Australia)
    • Onboard yield & other:  -1% (EAA slight increase offset by NA declines)
  • 4Q:  NCC ex fuel (+4%) - low end of previous guidance
  • 2014 cost guidance:  NCC ex fuel similar to 2013 (This increase is driven by more marketing activity, investments and onboard products such as food and entertainment, hiring dry dock costs including vessel enhancements and various other costs and inflation partially offset by ongoing efforts to reduce costs).
  • (Ex Carnival brand): 
    • Covering next 3 Qs, bookings volume last 12 wks:  unchanged YoY (at higher prices)
      • NA:  higher bookings at lower prices
      • EAA:  bookings are lower at nicely higher prices
  • Carnival brand
    • Last 6 wks, bookings improving; expect prices to gradually improve over long-term
  • 4Q
    • Fleetwide (ex Carnival): occu lower, same pricing
      • NA:  occu slightly lower, slightly lower pricing
      • Carnival:  occu lower, lower pricing
      • EAA:  occu lower at slightly higher pricing
    • Yield:
      • NA ex Carnival:  down slightly
      • Carnival:  lower double-digit
      • EAA:  higher
  • 1Q 2014
    • Fleetwide: higher pricing at lower bookings
      • NA ex Carnival:  higher pricing, lower occu
      • Carnival:  lower pricing, lower occu
      • EAA:  flat pricing, lower occu
  • 1H 2014
    • Fleetwide:  pricing higher, lower occu
    • Revenue yields: low single-digit decrease similar to 2H 2013
      • NA:  lower 
      • EAA:  higher
      • Expecting yields to be higher in 2H 2014
  • Carnival perception improving faster than expected; began fall marketing program with advertising campaign yesterday
    • Carnival changes:  
      • More in-house travel - in-house call center agents new bonus commission plans, providing complimentary cabins and a variety of other changes to make it easier for travel agents to book Carnival.
      • A new and simplified cabin pricing plan also to make it easier to book Carnival is expected to be announced shortly. The response to these changes by travel agents has been very positive
    • Expect higher pricing 2H 2014
    • Recent strategy:  holding prices even at slightly lower occu
  • Costa Concordia:  take to scrapyard next spring
  • Expect Costa's performance to strengthen over 2013 and throughout 2014
    • Brand perception improved in Italy and France
  • Asia:  2 Costa in China/Southeast Asia markets, 1 Princess ship; 2 ships in Japan during Spring/Summer
  • Expected Holland America/Princess to have solid performance in 2014; Seabourn performing extremely well

Q & A

  • Wanted to give 1H 2014 guidance because "people didn't understand what is happening in the business"
    • Mainly Carnival driven; positive yields on EAA side
    • Sees Carnival not down as much and Costa not up as much
  • Quite a few dry docks in 2014 (longer in length because of vessel enchancements); more agent support costs in 2014
  • Costa:  3Q mostly occu driven recovery;  4Q:  mix of occu and pricing
  • Would not comment on NA yields ex Carnival in 1H 2014
  • Process of selling 2 Costa ships:  intention to sell off older, small, less efficient ships at very low prices given weakness in market; has already written down one of them
    • Carnival didn't build these ships; they came through acquisitions
  • Upcoming cost savings through centralization of resources?
    • Too early to say, will know in upcoming board meetings
  • Carnival:  early stages of recovery; continuing improvements in occupancy since they fell way behind earlier
  • Most people who have cruised extensively continue to cruise; not much brand overlap among repeat cruisers as people may think
  • Pressure is on 1st time cruisers
  • Carnival's hold pricing may last 1-2 quarters
  • Impact from big increase in Caribbean capacity in 2014?  No visibility at this time.
  • Carnival improvement in pricing for Q3, Q4, and Q1?  Hard to say.
  • Challenge in 1Q:  large increase in Caribbean capacity
  • % booked:  4Q: 85-95%, 1Q:  50-70%,  2Q:  30-50%
  • Have increased level of advertising for F4Q
  • Too early to say how much of the expected cost increases are permanent
  • Q1 2014 will likely be worse than Q2 2014

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