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IS CHINA ABOUT TO GET LOOSE?

Takeaway: We are increasingly of the view that the PBoC might be setting up to ease monetary policy over the intermediate term.

CONCLUSIONS:

 

  1. Monetary conditions in China are easing dramatically.
  2. Chinese economic growth is slowing fairly dramatically.
  3. Neither the Chinese equity market nor the broader commodity complex seem to care that Chinese growth continues to slow – which, until very recently, was in stark contrast to trends across mainland credit markets.
  4. As such, we are increasingly of the view that the PBoC might be setting up to ease monetary policy over the intermediate term.
  5. All told, we aren’t yet ready to change our investment outlook for Chinese financial assets and/or consensus “China plays”. For additional color on what it means to be allocated to our LONG “New China” vs. SHORT “Old China” theme, please refer to our JAN 15 note titled, “ARE YOU LONG “NEW CHINA” AND SHORT “OLD CHINA” YET?”.

 

Monetary conditions are easing dramatically: One of the core tenets to our admittedly fickle, but decidedly positive bias on China in the YTD is our expectation that monetary conditions would ease as we progress through at least the first quarter. We’ve seen that play out in spades across money market rates and rates on fixed income securities – as evidenced by the demonstrable WoW improvement in repo rates, OIS and SHIBOR fixings. The MoM improvement in both ST and LT sovereign debt yields are also supportive.

 

IS CHINA ABOUT TO GET LOOSE? - China Money Market   Rates Monitor

 

With structural liquidity concerns remaining the biggest headwind to Chinese economic growth over the intermediate-to-long-term, any easing of monetary conditions is positive, at the margins, as the supply of incremental credit is both greater and cheaper. With almost half of Chinese GDP coming from fixed investment, the pace of credit creation and the cost of capital are arguably the two most important drivers of the marginal rate of change in Chinese economic activity.

 

IS CHINA ABOUT TO GET LOOSE? - China GFCF   of GDP

 

Growth is slowing fairly dramatically: The aforementioned factor coupled with easy compares and GDP seasonality continue to underscore our positive growth outlook for China in 1H14E and the latest credit growth, foreign trade and FDI data is supportive of that view. That being said, however, China’s PMI data for JAN and FEB leave much to be desired in the direction of #GrowthAccelerating – at least on a sequential basis. The same goes for our favorite price-based leading indicators.

 

  • FEB MNI Business Sentiment Indicator… G -1
    • Current Conditions: 50.2 from 52.2
    • Future Expectations: 50.6 from 57.9
  • JAN Total Social Financing: 2.58T CNY from 1.23T… G +1
    • New Loans: 1.32T CNY from 482.5B
    • Non-traditional Financing: 993.4B CNY from 555.6B
    • Ratio of Non-traditional Financing to Total: 38.5% from 45.1%
  • JAN M2 Money Supply: 13.2% YoY from 13.6%... G -1
  • JAN FDI: 16.1% YoY from 3.3% vs. a Bloomberg consensus estimate of 2.5%... G +1
    • Shen Danyang, spokesman for the Ministry of Commerce, said "the double-digit growth provided the most solid and convincing response to doubts such as whether China still has a favorable investment environment and whether foreign investors are confident in China's economic prospects."
    • FDI into the service sector gained 57% to a record high of $6.33B, or 58.8% of the total
    • Manufacturing sector inflows dropped 21.7% to $3.47B
    • FDI from 10 major Asian economies rose 22%
    • FDI from the US rose 34.9%
    • FDI from the EU fell 41.3%
    • JAN ODI by non-financial firms increased 47.2% y/y to $7.23B - a sign more Chinese firms are investing abroad
  • JAN Exports: 10.6% YoY from 4.3%... G +1
    • Exports to the EU increased 19.2%, while exports to the US were up 10.7%. Exports to ASEAN were up 18.4%. Exports to Japan rose 16% and exports to the rest of the world increased 17.8%.
    • The export strength was particularly surprising given softer January data from Taiwan and South Korea. While there was more discussion about over-invoicing, exports to Hong Kong did fall by more than 18%.
    • Reuters cited comments from Ma Jiantang, head of the National Bureau of Statistics, who said that China will step up efforts to investigate and punish any cases of falsified statistics. He argued that when it comes to statistics, falsification can be considered as the biggest form of corruption. The article pointed out that the statistics bureau has previously vowed zero tolerance for fake data.
  • JAN Imports: 10% YoY from 8.3%... G +1
    • The strength in imports, driven by China's commodity demand (and particularly in copper and iron ore), was also surprising given the more sluggish domestic demand backdrop in recent months.
  • JAN Trade Balance: $3.7B YoY from -$5.7B… G +1
  • JAN HSBC Services PMI: 50.7 from 50.9… G -1
  • JAN HSBC Manufacturing PMI: 49.5 from 50.5… G -1
    • First contraction on this index in six months; below the flash reading of 49.6
    • Employment sub-index below 50 for third straight month and showed quickest reduction of jobs since March 2009
    • New export orders declined for second straight month
    • Output lowest in four months
  • JAN Official Manufacturing PMI: 50.5 from 51… G -1
    • Lowest reading since JUL ‘13
  • JAN Official Non-Manufacturing PMI: 53.4 from 54.6… G -1
    • Lowest reading ever in the SA series (since MAR ’11)

 

*please note that some of the above commentary is sourced from StreetAccount

 

IS CHINA ABOUT TO GET LOOSE? - China GDP Comps

 

IS CHINA ABOUT TO GET LOOSE? - China GDP Seasonality

 

IS CHINA ABOUT TO GET LOOSE? - China Iron Ore  Rebar and Coal YoY

 

IS CHINA ABOUT TO GET LOOSE? - China PMI Table

 

IS CHINA ABOUT TO GET LOOSE? - China PMI Chart

 

Neither the Chinese equity market nor the broader commodity complex seem to care that Chinese growth continues to slow: In spite of what we’d argue is a continued deceleration in Chinese economic growth in the YTD, both the Chinese equity market and the broad commodity complex have been absolutely melting up in recent weeks (the latter in accordance with our #InflationAccelerating theme). Historically, Chinese A-shares have tracked both the slope of reported Chinese economic growth and expectations for said growth quite well and we don’t have any reason to believe otherwise in this instance. The Shanghai Composite Index is up +6.9% MoM vs. an Asia-LatAm sample mean of -0.1% and the CRB Index is up +7.6% MoM aided by broad-based reflation across the individual markets.

 

IS CHINA ABOUT TO GET LOOSE? - Equities

 

IS CHINA ABOUT TO GET LOOSE? - Commodities

 

IS CHINA ABOUT TO GET LOOSE? - CRB Index

 

IS CHINA ABOUT TO GET LOOSE? - Brent Crude Oil Levels

 

The one market that seems to have been the last hold-out is the Chinese credit market, which has been aggressively deteriorating since NOV on the back of liquidity headwinds and growth concerns. It would, however, finally appear that credit spreads have finally inflected, though it’s far too early to tell if a sustainable trend is in place given the likely cash flow pressures perpetuated by the aforementioned ramp in borrowing costs.

 

IS CHINA ABOUT TO GET LOOSE? - 17

 

As such, we think the PBoC is setting up to ease Chinese monetary policy: Tuesday’s surprise $8B repo aside, the PBoC dropping its “prudent” policy bias in favor of an easing bias would certainly seem to be an increasingly probable event over the intermediate term. That would certainly be in line with the broad economic policy loosening we’ve seen in recent weeks, including: issuing private banking licenses, relaxing capital requirements for SMEs, and loosening curbs on insurers investment portfolios among other things.

 

Moreover, the recent decision out of Beijing to accelerate capacity reductions in industries suffering from broad overcapacity might actually be a net positive in the sense that it frees up the PBoC to get looser, at the margins, without having to worry about reflating what it routinely identified as “excessive credit expansion” per its 4Q13 Report on Monetary Policy. Additionally, [purposeful] CNY strength and soft PPI trends (down YoY in JAN for a 23rd straight month – the longest period since 1997-99) should keep inflation under wraps for now, though those tailwinds are likely to be offset by increased import price pressures and easy compares by 2H14E at the very latest.

 

IS CHINA ABOUT TO GET LOOSE? - China PPI

 

IS CHINA ABOUT TO GET LOOSE? - 13

 

IS CHINA ABOUT TO GET LOOSE? - 14

 

While an outright reduction in either the benchmark lending or deposit rates is unlikely over the next 3-6M (on hold since JUL ’12), we are increasingly of the view that the PBoC might be setting up to reduce reserve requirements or implement targeted LTV ratio adjustments. Also, extending and expanding the existing de facto “cap” on money market rates might be something they wish to explore in order to support China’s [relatively] fledgling economic expansion – which the PBoC agrees is not yet on “stable footing”.

 

All told, we aren’t yet ready to change our investment outlook for Chinese financial assets and/or consensus “China plays”: For additional color on what it means to be allocated to our LONG “New China” vs. SHORT “Old China” theme, please refer to our JAN 15 note titled, “ARE YOU LONG “NEW CHINA” AND SHORT “OLD CHINA” YET?”.

 

IS CHINA ABOUT TO GET LOOSE? - 15

 

IS CHINA ABOUT TO GET LOOSE? - CHINA

 

Best of luck out there,

 

DD

 

Darius Dale

Associate: Macro Team


Inflation Deniers

Takeaway: Numbers don't lie, people do.

It was another no-bid day for the credibility of the US Dollar yesterday. The supreme Janet Yellen regime is transitioning away from being data dependent on inflation and employment and shifting towards price fixing – or rate targeting.

 

Down Dollar and Down Rates?  That simply means slowing real growth and rising Gold prices. Gold is up +10% year-to-date.

 

Inflation Deniers - Headsand


Oil joined the inflation party yesterday, ratcheting the CRB Commodities Index up another +1.8% to +6.8% year-to-date. Compare that to Consumer stocks which are down -3.5%.

 

Nat Gas? It is going completely kaboom...up a blistering +37% year-to-date.

 

That has to be “deflationary” right? Right? $110 Oil too. It just has to be. The government says so.

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Got Inflation?

Client Talking Points

US DOLLAR

Well, it was yet another no-bid day for the credibility of the US Dollar yesterday. The omnipotent Janet Yellen regime is transitioning away from being data dependent on inflation and employment and shifting towards price fixing – or rate targeting. Down Dollar and Down Rates? That simply means up Gold (+10% year-to-date!) and slowing real growth.

#InflationAccelerating

So, oil joined the raucous inflation party yesterday, taking the CRB Commodities Index up another +1.8% to +6.8% year-to-date. No small potatoes. Compare that to Consumer stocks which are down -3.5%. Nat Gas? It's going KaBoom...up a blistering +37% year-to-date. That has to be “deflationary” right? Right? $110 Oil too. It just has to be ... the government says so!

RUSSIA

Bad news for Putin as #Sochi getting slammed by bad news Ukrainian headlines this morning. The Russian Bear stock market takes another -1.8% hit to the head down to -8.5% year-to-date. Incidentally, today in 1861, the Russians abandoned serfdom. Sort of.

Asset Allocation

CASH 47% US EQUITIES 0%
INTL EQUITIES 7% COMMODITIES 16%
FIXED INCOME 16% INTL CURRENCIES 14%

Top Long Ideas

Company Ticker Sector Duration
LVS

Las Vegas Sands has transformed into that rare stock that should appeal to “Growth,” “Value”, and “Dividend/Cash Flow” investors alike.  The stock now yields higher than the S&P 500 (43% sequential quarterly dividend increase), and the company is buying back $200 million + in stock a quarter, yet still retains a pristine balance sheet.  The significant capital deployment opportunities can be funded out of annual free cash flow of nearly $4 billion. Management has indicated they are willing to raise leverage 1.5x which would still keep them well below industry average and if directed toward dividends, would result in a yield of over 6%.  And we haven’t gotten to the $10-14 billion in mall assets that could be monetized. We know of no other stocks in consumer land that provide this combination of cash flow, growth, cash return to shareholders, and value levers.

FXB

We remain bullish on the British Pound versus the US Dollar, a position supported over the intermediate term TREND by prudent management of interest rate policy from Mark Carney at the BOE (oriented towards hiking rather than cutting as conditions improve) and the Bank maintaining its existing asset purchase program (QE). UK high frequency data continues to offer evidence of emergent strength in the economy, and in many cases the data is outperforming that of its western European peers, which should provide further strength to the currency. In short, we believe a strengthening UK economy coupled with the comparative hawkishness of the BOE (vs. Yellen et al.) will further perpetuate #StrongPound over the intermediate term.

DRI

Darden is the world’s largest full service restaurant company. The company operates +2000 restaurants in the U.S. and Canada, including Olive Garden, Red Lobster, LongHorn and Capital Grille. Management has been under a firestorm of criticism for poor performance. Hedgeye's Howard Penney has been at the forefront of this activist movement since early 2013, when he first identified the potential for unleashing significant value creation for Darden shareholders. Less than a year later, it looks like Penney’s plan is coming to fruition. Penney (who thinks DRI is grossly mismanaged and in need of a major overhaul) believes activists will drive material change at Darden. This would obviously be extremely bullish for shareholders and could happen fairly soon driving shares materially higher.

Three for the Road

TWEET OF THE DAY

Natural Gas +36.7% YTD and Oil breaking out again - whatever you do, don't call it inflation @KeithMcCullough

QUOTE OF THE DAY

"The American heroes are the ones wearing camo". -T.J. Oshie

STAT OF THE DAY

Raising the U.S. federal minimum wage to $10.10, as President Obama and Democrats are proposing, could result in about 500,000 jobs being lost by late 2016, the non-partisan Congressional Budget Office (CBO) estimated.



The Olympiad

“The important thing in life is not victory but combat; it is not to have vanquished but to have fought well.”

- Pierre de Coubertin

 

We’ve been a little quiet commenting on the ongoing Winter Olympics in Sochi, Russia.  For Keith and me, it is probably nervousness over whether our native Canada can defend her Olympic gold, despite a lackluster preliminary round performance (lackluster in the sense that Canada is the first nation of hockey).  More broadly, though, the paradoxical nature of global markets has kept us busy.

 

In part, the Sochi Olympics represent this paradox.  Admittedly, from a security perspective, the games have been much more successful than anyone expected.  (As far as I can tell, the one downside is that most hotels rooms have a picture of Russia President Vladimir Putin.)  The flip side to the better than expected security (except perhaps in the Ukraine), is that many venues have been disappointing.

 

This of course goes to the heart of the paradox of the winter Olympics in Sochi, which is that Sochi is actually a beach resort.  Our partner in the Phoenix Coyotes, George Gosbee, has been in Russia since the start of the games. He took a fantastic picture that was picked up by Reuters (see below) showing the beautiful Sochi beach line that spectators walk on to get to the hockey arenas.

 

The Olympiad - g9

 

We will be doing an Olympic hockey pool later this week at Hedgeye and the odds are that our own Bob Brooke has the inside edge given his experience playing for the U.S.A. at the Sarajevo Olympics in 1984, but here are my picks:

  1. Gold – U.S.A.
  2. Silver – Canada
  3. Bronze – Russia
  4. Sweden

While it is paradoxical for a Canadian to pick the U.S. to win gold, they have looked much better, so I’m not going to let my emotions rule the day.  What are your picks?

 

Back to the Global Macro Grind . . .

 

This morning in the Chart of the Day, I wanted to continue hitting on this ongoing paradox of reported versus actual inflation.  As it relates to reported inflation, we do expect CPI to ramp and likely beat expectations in the U.S., but more importantly is the actual commodity inflation that is occurring.   The chart shows Gold Spot, Gold Miners (GDX) and the CRB Index versus the SP500, Consumer Staples (XLY) and Consumer Discretionary (XLP).

 

As the chart emphasizes, commodity inflation has been on a tear since our January 9th Q1 Themes Call.   Now, obviously, accelerating commodity inflation and input costs aren’t the reason that a number of our Best Ideas shorts, namely Weight Watchers (WTW) and Boardwalk Pipeline Partners (BWP), have underperformed so dramatically, but they are a reason that we continue to like the series of Best Idea shorts that our Restaurant team led by Howard Penney has added to the list. 

 

This list of restaurant shorts includes Cheesecake Factory (CAKE), Bloomin’ Brands (BLMN), Potbelly Corporation (PBPB), and Panera Bread (PNRA).  PNRA reported earnings least night and guided 2014 earnings estimates to $6.80 -> $7.05, which is below consensus estimates of $7.30.  Certainly not a meaningful miss, and likely weather did play a part, but when a company trades at close to 25x forward earnings, expectations are, indeed, the root of all heartache.  For more information on how to subscribe to restaurant sector research, please email .

 

Reverting back to inflation, the Congressional Budget Office released a recent report yesterday that had some rather interesting takeaways from President Obama’s proposal to raise the minimum wage (an inflationary pressure), specifically:

  • President Obama's quest to raise the minimum wage to $10.10/hour would eliminate about 500,000 jobs by 2016 but also increase pay for 16.5M workers and lift 900K out of poverty;
  • The report said benefits of an increase would be spread across a broad range of workers, with 19% of the increased wages going to Americans living below the poverty line. Close to 30% of the higher wages would go to people in families that earned more than three times the poverty level; and
  • The report added that the increased cost of labor would encourage employers to upgrade technology or hire fewer, higher-skilled workers. That effect would be partially offset by higher earnings among low-wage workers who retained their jobs.

So, a proposed government policy that slows employment growth and creates inflation . . . that sounds eerily familiar.

 

This morning and through the duration of the week we will be getting a series of macro data points that will be critical to focus on, which include:

  • Today - MBA Mortgage applications, PPI, Housing Starts and HSBC China Flash PMI.
  • Thursday - CPI, Flash PMI, Eurozone Flash PMI and BOJ Minutes; and
  • Friday - Existing home sales.

Paradoxically, the SP500 has been strong over the last two weeks or so, though it will be interesting to see how and if that strength sustains into an increased, and potentially negative, macro news flow.  Conversely, as it relates to China, our view is fairly explicit.  As my colleague Darius Dale emailed me this morning:

 

“Thus far in the YTD, the only data that has been supportive of a year-over-year acceleration in Chinese growth has been the credit data; even price-based leading indicators would suggest otherwise. All other data (i.e. PMI surveys) suggests sequential momentum is decidedly slowing. The market is clearly pricing in the expectation that the PBoC will have to ease [materially].”

 

Indeed.

 

Our immediate-term Macro Risk Ranges are now:

 

UST 10yr Yield 2.64-2.79%

SPX 1 

VIX 11.79-15.93

Gold 1

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

The Olympiad - Chart of the Day

 

The Olympiad - Virtual Portfolio


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