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Ask For The Truth

This note was originally published at 8am on January 02, 2014 for Hedgeye subscribers.

“If any man seeks for greatness, let him forget greatness, and ask for the truth – and he will find both.”

-Horace Mann

 

There’s a blizzard rolling in on the East Coast this morning and they’ll be legally selling pot in Colorado today. Welcome to 2014.

 

Last year I had a well known pundit tell me I wasn’t being “truthful” about US #GrowthAccelerating. The truth is US growth accelerated from +0.14% in Q412 to +4.12% by Q313. So I thought I’d start with the weather this morning. It’s tougher to obfuscate.

 

One thought I’ll share with our team in this morning’s New Year’s meeting will be to Breathe and Be Yourself. That’s a subtitle to a solid chapter in Unusually Excellent titled “Being Authentic” where John Hamm reminds us that “authenticity is the first step of leadership… because it is the basis for the kinds of trusting relationships with followers…” (pg 27). Ask yourself for the truth, every day.

 

Back to the Global Macro Grind

 

While we may not always be positioned for it, in this game last price is truth. We can argue with it, twist it, call it names – but that won’t change what it is. It’s the score.

 

Check out some of this morning’s Day 1 of 2014 scores:

  1. Thailand’s stock market -5.2%
  2. South Korea’s stock market -2.2%
  3. India’s stock market -1.3%
  4. Greece’s stock market +2.6%
  5. United Arab Emirates stock market +3.0%

#Fun. We call this a big macro day of #Divergence in Global Equities.

 

In commodity land, there are some interesting price % moves as well:

  1. Silver +3.2%
  2. Platinum +1.6%
  3. Wheat +0.8%

In other words, 3 of the commodities that experienced the biggest crashes in their 2013 prices are up more than mostly every commodity and stock market in the world today. We call this a nice bounce (to lower-highs).

 

Then alongside the #PotShops thing in Denver, you have some other social truths to consider in Japan this morning:

  1. Japan’s population growth (lack thereof) showed its largest decline on record in 2013 (-244,000)
  2. Japanese births were -6,000 y/y and deaths were -19,000 y/y in 2013, allegedly (hard for us to get to these #s)

But don’t worry, after opting for the Burning of The People’s Purchasing Power (their hard earned currency was -17% in 2013), the Japanese stock market was +59.3%. So some people crushed it in Japan; some people got crushed.

 

What do all these truths mean? And are they in fact truths? What if the birth/death calculation in Japan is as suspect as it is here in the US? However suspect the data, our working assumption here @Hedgeye is it’s apples to apples, suspect vs suspect.

 

Accepting the last market price as truth is a lot easier than taking conflicted and compromised government data at face value. The aforementioned 8 price moves in global equities and commodities, combined with what was already starting to move COUNTER-TREND in December, leads my macro craw to the same potential Global Macro Theme: Inflation Expectations Rising.

 

Stay tuned for our Q1 2014 Global Macro Themes call in the coming weeks where we’ll try our best to contextualize a developing truth (last price vs. market history) and what it could mean for your asset allocation and positioning.

 

Our immediate-term Global Macro Risk Ranges are now as follows (bullish or bearish TREND duration in brackets):

 

UST 10yr yield 2.97-3.07% (bullish)

SPX 1830-1858 (bullish)

Gold 1180-1223 (bearish)

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Ask For The Truth - Chart of the Day

 

Ask For The Truth - Virtual Portfolio


ARE YOU LONG “NEW CHINA” AND SHORT “OLD CHINA” YET?

Takeaway: Our LONG “New China” vs. SHORT “Old China” theme is working and should continue to deliver alpha over the intermediate term.

CONCLUSIONS:

 

  1. We continue to see evidence that confirms our view that China’s credit-fueled fixed-assets investment bubble is firmly in the process of popping. Furthermore, this unwind will remain a growing headwind to Chinese GDP growth for the foreseeable future (CLICK HERE for more details).
  2. Such confirming evidence underpins our long-held view that China’s growth potential and its demand curve for certain resources (namely commodities) is structurally impaired – thus necessitating a commensurate shift in the way investors should seek to allocate capital to China plays.
  3. As such, we see value in being exposed to our LONG “New China” (i.e. growth in the consumer and services sectors + broad deregulation) vs. SHORT “Old China” (i.e. the concomitant bubbles in credit and fixed assets investment + anti-pollution regulation) theme. For equity investors, this equates to being exposed to Chinese technology and consumer staples names on the LONG side and exposed to Chinese financials and industrials names on the SHORT side. We also see value in being exposed to foreign companies with “New China” exposure on the LONG side.
  4. Switching gears, we continue to think Chinese economic growth will go from slowing to stabilizing to accelerating throughout 1H14; we lack conviction in our (or any) 2H14 outlook for Chinese growth amid policy uncertainty on the economic reform front (more details below).
  5. Make no mistake, however, if China can’t “comp” ridiculously easy growth compares with clear signs of #GrowthAccelerating in 1H14, we think Chinese real GDP growth has downside to the mid-to-low 6% range by year’s end. That would represent a material delta vs. current consensus estimates of +7.4% YoY real GDP growth in 4Q14 and would obviously have broad negative implications for a variety of asset classes (particularly emerging market assets and commodities).

 

Today, China released its DEC credit data. Headline total social financing figures were solid sequentially, but all was far from well underneath the hood:

 

  • DEC Total Social Financing:flat at +1.23T CNY MoM
    • New CNY Loans:+482.5 CNY MoM vs. +624.6B prior
      • Ratio: 39.2% of the total in DEC vs. 50.7% in NOV; 51.4% in 2013 vs. 52% prior
    • Non-Traditional Credit (TSF less CNY and FX Bank Loans, Net New Corporate Bond Issuance and New Equity Capital Raised): +553.5 CNY MoM vs. +377.9 prior
      • Ratio: 45% of the total in DEC vs. 30.6% in NOV; 29.9% of the total in 2013 vs. 23% of the total in 2012
    • Total Social Financing: +9.7% YoY in 2013 vs. +22.9% YoY in 2012 vs. -8.5% in 2011
    • New Loans: +8.4% YoY in 2013 vs. +9.8% YoY in 2012 vs. -6% in 2011
    • Non-Traditional Credit: +42.8% YoY in 2013 vs. +43.2% YoY in 2012 vs. -29.7% in 2011

 

ARE YOU LONG “NEW CHINA” AND SHORT “OLD CHINA” YET? - Nominal TSF Q

 

ARE YOU LONG “NEW CHINA” AND SHORT “OLD CHINA” YET? - Nominal TSF Y

 

ARE YOU LONG “NEW CHINA” AND SHORT “OLD CHINA” YET? - TSF YoY Q

 

ARE YOU LONG “NEW CHINA” AND SHORT “OLD CHINA” YET? - TSF YoY Y

 

ARE YOU LONG “NEW CHINA” AND SHORT “OLD CHINA” YET? - TSF Ratio Q

 

ARE YOU LONG “NEW CHINA” AND SHORT “OLD CHINA” YET? - TSF Ratio Y

 

The demonstrable ramp in non-traditional (a.k.a. “shadow”) financing speaks volumes to our long-held view that perpetually rising NPLs have clogged traditional credit channels in China – forcing both corporations and lenders to find creative (and often convoluted) ways to maintain financial lubrication throughout the economy.

 

While this creativity has offset some of the downward pressure on Chinese economic growth over the past 2-3Y, it has dramatically increased system-wide financial risks and has effectively tightened monetary conditions by giving less creditworthy borrowers and institutions a seat at the table (side note: SOE and government borrowers are the only entities in China with access to cheap capital via bank loans; everyone else must scramble to find capital from whatever source at whatever cost they can find).

 

As a result, we’ve seen a demonstrable rip in borrowing costs all throughout the Chinese economy that has weighed on economic growth amid what we believe to be rising quantities of traditional financing that are coming due without the necessary cash flows to retire the debt – essentially financing debt rollovers at the expense of net new credit growth (see: “Key Problem Loan Areas” chart below). Consider the following data points:

 

  • Almost 22% of the 17.89 trillion CNY ($2.96 trillion) of local government financing vehicle debt outstanding comes due in 2014. Local government debt overdue at the end of June was 1.15 trillion CNY, or 10.6% of borrowings, according to National Audit Office data… Meanwhile, the rate on AA-rated five-year notes  jumped +146bps in the past year to a record 8.3%; that compares to a TTM rise of +104bps to 5.2% for Bloomberg’s EM USD Corporate Bond Index. Most local government financing vehicles are rated AA in China. (sources: China Daily, StreetAccount and Bloomberg News)
  • Liabilities at non-financial companies may rise to more than 150 percent of gross domestic product in 2014, raising default risks, according to Haitong Securities Co. The ratio of 139 percent at the end of 2012 was already the highest among the world’s 10 biggest economies, according to the most recent data. That compares with 108 percent in France, 103 percent in Japan and 78 percent in the U.S., figures from the Bank for International Settlements and the World Bank show. (source: Bloomberg news)
  • China Cinda Asset Management, one of the nation's four state-owned bad-loan managers, raised $2.4B in Hong Kong's biggest IPO in a year as it prepares to take on more distressed assets. The IPO will help Cinda to profit from a new round of non-performing loans following a $6.5 trillion lending spree since the end of 2008. Non-performing loans at Chinese banks increased for an eighth consecutive quarter in Q3 to 563.6B CNY ($93B), extending the longest streak in at least nine years. (source: StreetAccount)

 

ARE YOU LONG “NEW CHINA” AND SHORT “OLD CHINA” YET? - Shadow Banking

 

ARE YOU LONG “NEW CHINA” AND SHORT “OLD CHINA” YET? - Rates

 

ARE YOU LONG “NEW CHINA” AND SHORT “OLD CHINA” YET? - Key Problem Loan Areas             

 

Perhaps most importantly, it is our view that the aforementioned phenomenon will remain a structural headwind to Chinese GDP growth. The good news is that, for whatever reason – be it policy guidance or the pervasive extrapolation of recent trends – consensus is now squarely in our camp with respect to structurally depressed expectations for Chinese GDP growth.

 

ARE YOU LONG “NEW CHINA” AND SHORT “OLD CHINA” YET? - GDP Growth

 

As such, we continue to believe that investors should not be looking to passively allocate assets to China as a play on elevated rates of economic growth – especially if expectations for the second derivative of GDP are set to remain in negative territory on a structural basis. Rather, we continue to call for investors to #GetActive with their China exposure.

 

One of the ways we think investors should be actively managing their China exposure is by being LONG “New China” plays and SHORT “Old China” plays. For equity investors, this equates to being exposed to Chinese technology and consumer staples names on the LONG side and exposed to Chinese financials and industrials names on the SHORT side. It’s worth noting that on an equal-weighted basis this strategy is up +2,039bps since we introduced it on 12/4/14. This is obviously net of transaction costs and we are fully aware these aren’t investable indices; still, we think the takeaway is clear.

 

ARE YOU LONG “NEW CHINA” AND SHORT “OLD CHINA” YET? - Long New China vs. Short Old China

 

Another way investors can play our LONG “New China” vs. SHORT “Old China” theme is by being LONG foreign companies with material exposure to the growth of the Chinese consumer and service sectors. The following table is a screen of US, German, UK and Japanese equities (i.e. the four developed markets we like on the long side of equities here) above $10B in market cap that attribute > 33% of their sales to China. Obviously not all companies break out their revenues by geographic segment, but this is a good starting place for those that do. QUALCOMM Inc. looks very interesting from a valuation perspective and, to a lesser extent, so does Murata Manufacturing Co. Ltd.

 

ARE YOU LONG “NEW CHINA” AND SHORT “OLD CHINA” YET? - Equity Screen

 

Thus far, the focus of this note has been from a strategic asset allocation perspective. In adopting a more tactical purview, we continue to think Chinese economic growth is slowing and we think it is likely to continue to slow for the next 1-2M.

 

ARE YOU LONG “NEW CHINA” AND SHORT “OLD CHINA” YET? - Market Based Leading Indicators

 

ARE YOU LONG “NEW CHINA” AND SHORT “OLD CHINA” YET? - PMI Manufacturing

 

ARE YOU LONG “NEW CHINA” AND SHORT “OLD CHINA” YET? - PMI Services

 

From there, Chinese growth should stabilize and then accelerate throughout the balance of 1H14. A favorable base effect, easing money market conditions and seasonality are all supportive of an acceleration in Chinese GDP growth in 1H14.

 

ARE YOU LONG “NEW CHINA” AND SHORT “OLD CHINA” YET? - GDP Comps

 

ARE YOU LONG “NEW CHINA” AND SHORT “OLD CHINA” YET? - Money Markets Monitor

 

ARE YOU LONG “NEW CHINA” AND SHORT “OLD CHINA” YET? - GDP Seasonality

 

ARE YOU LONG “NEW CHINA” AND SHORT “OLD CHINA” YET? - CHINA

 

It’s tough to have a strong view beyond that given the continued lack of clarity on the economic reform implementation front – though the latest signs are indeed positive. Specifically, Shanghai FTZ capital account reform is likely to come as soon as 1Q14, per the latest official commentary (click HERE, HERE and HERE for detailed explanations on why that is the most important catalyst for a positive upside surprise with respect to Chinese GDP growth over the intermediate-term TREND and long-term TAIL).

 

Make no mistake, however, if China can’t “comp” ridiculously easy growth compares with clear signs of #GrowthAccelerating in 1H14, we think Chinese real GDP growth has downside to the mid-to-low 6% range by year’s end. That would represent a material delta vs. current consensus estimates of +7.4% YoY real GDP growth in 4Q14 and would obviously have broad negative implications for a variety of asset classes (particularly emerging market assets and commodities).

 

The analytical table is now set; best of luck risk managing your China exposure(s) from here. Feel free to ping us with follow up questions.

 

Have a great evening,

 

DD

 

Darius Dale

Associate: Macro Team


A Notorius Nikkei/Yen Correlation

Takeaway: Correlation matters.

We've been banging the Japanese gong a lot lately. For good reason.

 

Take a look at the -0.97 long-term TAIL correlation trending between the Yen and the Nikkei.

 

Pretty remarkable.

 

A Notorius Nikkei/Yen Correlation - If You don t know

 

The Yen had its first down day of consequence versus the US Dollar yesterday. Guess what happened?

 

Of course. The Nikkei jumped +2.5%.

 

Correlation matters.

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Questions for Kinder Morgan (Edition 2)

The Kinder Morgan complex (KMI, KMP, and EPB) is scheduled to release 4Q13 results at 4:05pm EST TODAY, closely followed by its quarterly conference call at 4:30pm EST.  Here are some questions that we hope the management team will address:


1.  What are KM's long-term distribution/dividend growth targets for KMP, EPB, and KMI?


2.  Why not amend KMP’s Partnership Agreement to include sustaining/replacement CapEx for E&P, coal royalty, G&P, and shipping businesses?  This seems appropriate given that these businesses were not in KMP when the Partnership Agreement was put in place, and it will protect the LPs from dilution.


3.  Is KMP seeing cost creep on the growth CapEx side?  KMP’s 2014 growth CapEx guidance of $3.6 billion was higher than we were expecting.  What is this attributable to?


4.  With respect to the recently acquired Jones Act tankers, how will KMP account for sustaining CapEx on those assets?  Will there be a replacement CapEx reserve to reflect the fact that the tankers will one day need to be replaced?  Why or why not?

 

5.  Discuss KM's appetite for additional shipping acquisitions/investments.


6.  In KMP’s Natural Gas segment, how much CapEx was spent on midstream (gathering and processing) in 4Q13?


7.  Over the long-term, how much capital would KMP need to spend on an annual basis to keep gathering throughput and NGL production flat (including CPNO)?


8.  Given the cost cuts (O&M expenses and maintenance CapEx) on the major El Paso systems since the acquisition, do you expect that those savings will be passed on to the consumer via rate reductions at EPNG and TGP?  When are those pipelines up for rate cases?

 

9.  Discuss contract renewal risk on KMP’s major natural gas transmission systems.


10.  How does KMP define "capacity" in its E&P operations?


11.  How much CapEx does KMP need to spend in its E&P operations in 2014 to “keep production flat” with the 2013 exit rate?


12.  How is the St. John's Dome project (CO2) going?  How much capital has been put into the project to date?  Discuss the well results.


13.  Discuss KM's intentions with respect to investing in “coal / other natural resources.”  How much capital will be dedicated to this effort?  What has been done so far?

 

14.  More importantly, how will KM define sustaining CapEx for this business?  Will there be a replacement reserve to reflect the fact that these will be depleting assets? 

 

Kevin Kaiser

Managing Director

 

 

 



Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.64%
  • SHORT SIGNALS 78.57%
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