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GET TIGHT AND TRADE THE RANGES IN JAPAN

Takeaway: Investors would do well to reduce their gross exposure and/or tighten their net exposure to the Abenomics Trade for at least the next 2-3M.

SUMMARY BULLETS:

 

  • From our vantage point, the following three scenarios are all probable, with each ascending scenario being roughly twice as probable as the previous one on the list:
    1. The SEP and/or OCT US employment and inflation data cause the Fed to commence tapering in 4Q13;
    2. Abe’s Third Arrow platform (TBD) is well-received by the market and/or the BoJ preemptively eases monetary policy in 4Q13; or
    3. Abe’s Third Arrow platform is not well-received by the market and the BoJ refrains from preemptively easing monetary policy in 4Q13.
  • The unique nature of each of the aforementioned scenarios is supportive of developing consternation that may contribute to rising levels of implied volatility on the USD/JPY cross and in the Japanese equity market.
  • While we certainly don’t see the Abenomics Trade as being a rearview phenomenon, we do think the unsettled nature of the catalyst calendar is likely to breed contempt in the marketplace and contribute to a widening of the associated immediate-term trading ranges on a go-forward basis.
  • Thus, investors would do well to reduce their gross exposure and/or tighten their net exposure to the Abenomics Trade for at least the next 2-3M.

 

THE 30,000 FOOT VIEW

With the recent announcement that the +300bps VAT hike will proceed as scheduled come APR ‘14 and the accompanying ¥5T stimulus package now in the rearview mirror, the policy calendar in Japan becomes relatively light again.

 

The general lack of clear policy catalysts from Japan is important in the context of the developing US monetary policy situation – specifically, the Fed’s recent decision not to taper asset purchases in spite of a clear acceleration in US growth data.

 

On the margin, the aforementioned FOMC surprise was a decidedly dovish maneuver that has weighed on the US dollar (now bearish TREND) vis-à-vis the Japanese yen (the USD/JPY cross is flirting w/ a TREND-line breakdown).

 

GET TIGHT AND TRADE THE RANGES IN JAPAN - 1

 

GET TIGHT AND TRADE THE RANGES IN JAPAN - 2

 

Quantitatively speaking, what’s bullish for the Japanese yen in almost perfectly bearish for Japanese equities; the trailing 1Y and 3Y correlation between the USD/JPY cross and the Nikkei 225 Index is +0.97, respectively.

 

GET TIGHT AND TRADE THE RANGES IN JAPAN - 3

 

Perhaps more importantly, the Nikkei 225 Index remains underwater vs. it’s late-MAY YTD high and is down -6.4% since the USD/JPY cross peaked on MAY 17. The more that currency cross remains under pressure due to FOMC dogma(s), the greater the probability that market participants start to walk away from the Japanese equity reflation side of the trade.

 

IN THE WEEDS

The aforementioned playbook is something to keep in mind as you attempt to manage risk around the next couple of US Jobs Reports and any headlines surrounding Prime Minster Abe’s Third Arrow over the next 2-3M.

 

Regarding that latter point, we think any policies designed to facilitate wage increases, spur corporate CapEx and/or convince Japanese companies to believe in the sustainability of the weak yen will be most impactful as it relates to FX market participants bidding up the USD/JPY cross on [good] news:

 

  1. Wage growth remains anemic in Japan with growth in monthly cash earnings slowing to -0.6% YoY in AUG; the trailing 1Y and 3Y average growth rate is -0.4% and -0.3%, respectively.
  2. Despite the 3Q13 Tankan Survey results accelerating to the highest levels in over 5Y, the one major disappointment of the survey was the large enterprises CapEx guidance forecast slowing to +5.1% from +5.5% prior. That forecasted rate of fixed investment growth is well off prior peaks of +10-12%.
  3. We believe the primary reason Japanese multinationals are still reluctant to invest in Japan’s future is because they are not yet convinced of the sustainability of the weak yen. Per the latest Tankan Survey, the NTM forecast of Japan’s large enterprises for the USD/JPY cross is a measly 93.77. A measured shift in the direction of our ~18M view of ~125 on that cross will be highly supportive of Japanese corporations reversing the secular trend of off-shoring production and unwinding entrenched deflation expectations that have perpetually weighted on wage growth in Japan. To the former point, Japan’s overseas auto production grew +3.6% YoY in AUG, which contrasts with the -8.1% YoY decline of domestic auto production (the 12th straight month of declines).

 

GET TIGHT AND TRADE THE RANGES IN JAPAN - 4

 

GET TIGHT AND TRADE THE RANGES IN JAPAN - 5

 

GET TIGHT AND TRADE THE RANGES IN JAPAN - 6

 

As we have forecast all along, Japan’s policy prescription has done little more than contribute to rising inflation expectations in Japan, thereby adversely widening the spread between those very expectations and expectations for economic growth. The following two data points highlight this bifurcation:

 

  1. Results from a Nikkei survey released today showed that there are roughly ~4x more companies that are considering passing along the VAT hike via price increases (fully = 48%; partially = 17.1%) than those that are considering pay increases in FY14 (bonus increase = 13%; wage increase = 2.4%; both = 8.1%).
  2. Results from the BoJ’s 3Q13 consumer survey showed that the number of Japanese households that anticipate inflation will accelerate over the NTM (83%, up from 80.2% prior) is roughly 5x greater than those that anticipate growth will accelerate over the NTM (16.2%, down from 24.3% prior).

 

Indeed, in the absence of near-term tapering out of the Federal Reserve (an event that we believe would be bullish for the USD/bearish for the yen/bullish for the Nikkei), the pressure upon the LDP to hit a home run with Abe’s Third Arrow program and/or upon the BoJ to preemptively ease monetary policy ahead of the APR ‘14 VAT hike in order to maintain faith in the market that it is appropriately progressing towards its +2% inflation mandate is great.

 

Regarding that latter point, SEP 19 commentary from BoJ Board Member Takahide Kiuchi highlights the heightening risk of the BoJ being forced by the market to reengage in the Currency War: “The Fed’s decision [to not taper] shows how hard it is to end unconventional monetary policy. Market expectations may push the BoJ to ease further.”

 

THE PORTFOLIO MANAGER’S PLAYBOOK

All told, for the time being, the “Abenomics Trade” (i.e. short the Japanese yen/long Japanese equities) no longer has the policy support of a #StrongDollar. That means Japanese policymakers will become increasingly important in determining the performance of the trade – a marked shift from the last 3-6M of US growth expectations largely determining the performance of the USD/JPY cross.

 

From our vantage point, the following three scenarios are all probable, with each ascending scenario being roughly twice as probable as the previous one on the list:

 

  1. The SEP and/or OCT US employment and inflation data cause the Fed to commence tapering in 4Q13;
  2. Abe’s Third Arrow platform (TBD) is well-received by the market and/or the BoJ preemptively eases monetary policy in 4Q13; or
  3. Abe’s Third Arrow platform is not well-received by the market and the BoJ refrains from preemptively easing monetary policy in 4Q13.

 

As an aside, we put emphasis on "preemptive" because, at the moment, both growth data and inflation expectations are supportive of the BoJ standing pat.

 

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GET TIGHT AND TRADE THE RANGES IN JAPAN - 9

 

The unique nature of each of the aforementioned scenarios is supportive of developing consternation that may contribute to rising levels of implied volatility on the USD/JPY cross and in the Japanese equity market.

 

While we certainly don’t see the Abenomics Trade as being a rearview phenomenon, we do think the unsettled nature of the catalyst calendar is likely to breed contempt in the marketplace and contribute to a widening of the associated immediate-term trading ranges on a go-forward basis.

 

Thus, investors would do well to reduce their gross exposure and/or tighten their net exposure to the Abenomics Trade for at least the next 2-3M.

 

Darius Dale

Senior Analyst


How Good Is The Fed at Forecasting?

Takeaway: You be the judge.

How Good Is The Fed at Forecasting? - ddale1

Click on image to enlarge.


MCD: SIGNS OF LIFE? MAYBE (MAYBE NOT)

This note was originally published September 25, 2013 at 11:17 in Restaurants

Editor's note: This is a complimentary research report from Hedgeye Managing Director and Restaurants Sector Head Howard Penney. For more information on how you can sign up to receive our research please click here.

MCD: SIGNS OF LIFE? MAYBE (MAYBE NOT) - pen2

Clients often remind us that we’ve had a great call on MCD this year, but also prod us not to get carried away with our bearish bias.  Admittedly, this is not an easy feat – but, as the facts change, so will our call.  Our intention is always to remain flexible in our coverage.


That being said, our bearish bias has not changed.  Below we highlight four recent events and their potential implications.

  1. The stock outperformed the S&P 500 over the past month
  2. The current Mighty Wings promotion
  3. Changes in the Eurozone
  4. Personnel changes in the U.S.

Stock Price Performance – MCD is up +2.8% over the past month, outperforming the S&P 500 and its quick-service peer group by 80 bps and 200 bps, respectively.  Given that the stock had underperformed the S&P 500 by -20.9% YTD, we knew the slightest whiff of good news would push the stock higher.  So where is the good news coming from?

 

Mighty Wings – MCD hasn’t generated as much buzz around a limited-time offer (LTO) since the McRib promotion.  But, at the end of the day, it is just a LTO.  The recent buzz might create a month or so of stronger sales trends, but we don’t view this promotion as a game changer for the company.  Selling chicken wings may temporarily boost sales, but, in the long run, we fear that it will end up inflicting more harm than good.  Asking the currently disgruntled franchisee community to prepare yet another product, with a slower than normal preparation time, will only add to the service issues the company is already experiencing.  In our view, this is likely to lead to further deterioration of the MCD brand.

 

MCD: SIGNS OF LIFE? MAYBE (MAYBE NOT) - pen1

 

 

Changes in the Eurozone – MCD has been trading better since the release of August comps on September 10th.  Global trends in August were stronger due in large part to better than expected results in Europe.  The company reported Europe same-store sales growth of +3.3%, on top of +3.1% growth a year ago, as the UK, Russia, and France were strong.  Several of the MACRO indicators we monitor in Europe continue to show improvement in the region, specifically in Germany, MCD’s most important European region.  Today, the forward-looking German Consumer Confidence Indicator from the GfK Survey rose to 7.1 for October, surpassing consensus expectations.  GfK notes that, “despite a fall in income expectations, German consumers are almost euphoric when it comes to their propensity to consume.”  Investors also got some good news from Italy, another market that has given MCD considerable headaches in the past.  Today, Italy’s Consumer Confidence Index jumped to 101.1, its highest level since June 2011.

 

MCD: SIGNS OF LIFE? MAYBE (MAYBE NOT) - MCD EURO SALES

 

MCD: SIGNS OF LIFE? MAYBE (MAYBE NOT) - cons conf

 

MCD: SIGNS OF LIFE? MAYBE (MAYBE NOT) - MCD Chart4

 

MCD: SIGNS OF LIFE? MAYBE (MAYBE NOT) - germany income expect

 

 

Personnel Changes in the U.S. – Yesterday we learned that MCD’s Neil Golden plans to retire early next year.  Given the importance of MCD’s marketing message, it is clear that the company does not have its act together, particularly in its most important region, the U.S.  Despite the recent limited-time offer of Mighty Wings, McDonald’s continues to struggle in the region.

 

 

Summary

The stock is having a strong month and Europe is looking stronger, on the margin, for the company.  However, the U.S. continues to struggle and we believe it will be a while before the company returns to high-single digit EPS growth.

 

MCD: SIGNS OF LIFE? MAYBE (MAYBE NOT) - mcd chart6

 

 

 

Howard Penney

Managing Director

HPenney@hedgeye.com

 


Early Look

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Nikkei: Good Time to Buy

Editor's note: This is a brief excerpt from Hedgeye research. For more information on how you can become a subscriber click here.

 

After posting the best Japanese auto sales number in 14 months, the Yen continued its latest run higher and is finally signaling immediate-term TRADE overbought vs US Dollar.

 

No. The Nikkei definitely does not like #StrongYen. It closed down -2.1%, leading the losers in Asia overnight. Japanese stocks are oversold right now.

 

Yes. It's a good spot to buy. 

 

Nikkei: Good Time to Buy - dale22


MCD: MIGHTY DISASTER PART II

MCD remains on the Hedgeye Best Ideas list as a short.


 

To be clear, we believe MCD has a secular top line issue and not a cyclical one.  That said, we don’t believe management is willing to acknowledge this.  So far in 2013, the new product pipeline has failed to stimulate incremental customer traffic and new products, such as Mighty Wings, seem like a desperate attempt to hide from reality.

 

We posted a note a couple of weeks ago titled, “MCD: A Pending Mighty Disaster,” in which we stated that MCD’s decision to sell wings this fall could be disastrous for the company.  Given current trends, we have no reason to back off this negative bias.

 

We have three main issues with the current MCD menu strategy:

  • Mighty Wings will not enhance the McDonald’s brand (Premium Wraps have not helped either)!
  • Both new products (Mighty Wings and Premium Wraps) have slow service times.
  • Adding new products to an already complex menu is the wrong direction for the company to go.

 

We also have two main issues with the Mighty Wings promotion:

 

Mighty Wings Are Too Expensive 

For the smallest portion, you are paying a dollar per mighty wing.  

 

McDonald’s Mighty Wings are available in three portion sizes. There is a 3-piece for $2.99, a 5-piece for $4.79 and a 10-piece for $8.99.  Across the pricing spectrum, this is equivalent to paying $0.99, $0.96, and $0.90 per wing, respectively.

 

Inconsistent Product From McDonald's

We are hearing that frequent visitors of McDonald’s are not used to the bone-in chicken wings product.  While bone-in chicken wings are standard fast food options for restaurants that specialize in fried chicken – for example, KFC and Popeyes – it does not seem to fit well with the rest of McDonald’s products.

 

 

Summary

This whole situation is all too reminiscent of the period from 1, when we witnessed the sad decline of a mismanaged McDonald’s brand.  During that time, the company was focused on unit growth and cost reduction rather than driving high margin, top line sales.

 

As the image of the brand began deteriorating, management failed to invest in the brand and customer experience.  Rather, they turned to monthly promotional tactics in order to drive short-term sales at the expense of brand equity and margins.  This strategy did not end well for either the company or investors and we’d be surprised if this time was any different.

 

MCD: MIGHTY DISASTER PART II - chart1

 

 

We continue to believe there is a disconnect between investors’ expectations and the company’s fundamentals.  As long as this remains the case, we are looking for more underperformance versus both peer consumer and S&P 500 benchmarks.

 

 

 

Howard Penney

Managing Director

 

 


Draghi Leaves Door Open For Rate Cut and Liquidity Injection

Mario Draghi and the ECB’s governing council voted today to keep rates unchanged, although a cut was suggested by some members.

 

Last month’s dramatic pivot to a dovish monetary tone that interest rates should remain “at present OR lower levels for an extended period of time” was reiterated again today in remarks that monetary policy will remain accommodative for “as long as is necessary”.  Draghi described an economy that is “weak, fragile, and uneven” and left the prospect of issuing another LTRO on the table. We expect that given the continued clog in the credit channel, a liquidity package could be released into year-end (see chart below).

 

Interestingly, and despite the dovish commentary, the EUR/USD rose following the announcement, which we think is reflective of the impact of Bernanke talking down U.S. growth prospects (and the USD), as well as the Eurozone economy showing improvement on the margin.  

 

As central bankers struggle to guide expectations (hint Fed’s no-taper decision and the ECB’s and BOE’s forward guidance) we wouldn’t be surprised to see Draghi keep his cards tight on when he may issue liquidity measures or cut rates, and continue to drag his feet on any policy action until more data confirms his team’s outlook.

 

As it relates to the Eurozone, our call remains that we expect Europe’s economy to gradually improve off low levels (we’re UK and German equity bulls) and bullish on the EUR/USD, which is in a bullish breakout above its TRADE, TREND, and TAIL levels (see chart below).

 

Draghi Leaves Door Open For Rate Cut and Liquidity Injection - zz. loans

 

Draghi Leaves Door Open For Rate Cut and Liquidity Injection - zz. eur usd

 

Draghi highlights from the Press Conference:

  • Somewhat weaker growth in the beginning of Q3, but still expects a gradual recovery
  • The recovery is “weak, fragile, and uneven” and starting from very low levels
  • Unemployment, especially youth, needs to be reduced from very high levels
  • Credit dynamics remain subdued with flows “still weak, very weak” 
  • On broader developments of liquidity: ECB is ready to use all available instruments, including LTRO
  • Inflation continues to be firmly anchored, on the very low side of the 2% target (at 1.1%), but the baseline scenario has been underpinned
  • Progress is being made on political reforms:  greatest pressure should come from the inside; don’t need to be pressed by markets
  • On political instability (Italy and the rise of anti-Euro parties in Germany and Austria): while instability hampers hopes for a recovery, it doesn’t hurt the foundations of the Eurozone as it used to do a few years ago -- that suggests that the Eurozone and Euro is more stable

 

Draghi Leaves Door Open For Rate Cut and Liquidity Injection - zz. interest rates

 

 

Matthew Hedrick

Senior Analyst


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