“Government policy is the primary cause of the financial crisis.”
That’s “fundamental theme” #1 in one of the most important post 2008 market crisis books – Chairman (and former longstanding CEO of BB&T Bank), John Allison’s The Financial Crisis and The Free Market Cure.
As I was taking a few pseudo vaca days with my kids (if you own a small business in America, there are no bailouts – no real vacations either – and real capitalists like that), I was struck by the simplicity of what hasn’t changed in this country – government price fixing.
Yep, that’s what Allison and anyone who has studied economic #history calls it too (plenty of big time capitalists like Charles Koch agree). That’s what “forward rate guidance” by the Fed really is; it’s also what Presidential executive orders on minimum wage hikes and Policies to Inflate via currency devaluation are. Inflation is an un-elected tax that politicians aren’t accountable to. That’s why they cheer it on.
Back to the Global Macro Grind…
Who needs to cheer for Latvia’s hockey team when you can wake up in America watching the Treasury Secretary (Jack Lew) whine about taxes (consumer price inflation) on European consumers being “too low.” Heck, the descendent of Geithner and Wesley Mouch is egging on the Japanese to burn its currency at the stake too.
Not to be outdone, the Congressional Budget Office is now analyzing what Obama thinks is his only way out of the tax he and Bush had the Bernanke impose on America’s poor (Down Dollar, Food/Energy Inflation) – wage inflation. My brother runs a McDonald’s franchise – ask him how many new stores he’ll be interested in opening if food costs rip and his “poor” employees cost him 10-20% more…
In other central planning news, Venezuela is “expelling” US diplomats this morning for “undermining the government.” Evidently some of these Americans aren’t yet socialist enough. Argentina and Venezuela are realizing the other side of currency devaluation, debt-rising, and #InflationAccelerating this morning – it’s called social unrest.
#InflationAccelerating? Who the heck does this Canadian think he is making that call without the government’s approval?
- US Dollar is down again this morning = down for 3 consecutive weeks, and now negative for 2014 YTD
- CRB Commodities Index (19 commodities) was up another +1.1% yesterday to a fresh 52-wk high of 302 (+7.9% YTD)
- Natural Gas is up (again!) this morning to $6.20 = +46.7% YTD (they don’t have heat or air conditioning in Washington)
I know, I know. It’s all the weather. Wages, Rents, Schooling – Facebook paying $16B for “WhatsApp”, Candy Crush going public – all of it!
But, but, the US stock market (SP500) is only down -1.1% YTD. And:
- Slow-growth Gold is +9.3% YTD
- Slow-growth-yield-chasing Utilities (XLU) are +5.9% YTD
- Lever-yourself-up-long Real Estate (REITS) are +7.5% YTD
Yep. As #InflationAccelerates, 71% of the US economy (consumption) gets A) taxed and B) slows:
- US Consumer Discretionary Stocks (XLY) are -3.2% YTD
- Consumer Staples Stocks (XLP) are -3.4% YTD
- Financials (XLF) are -2.2% YTD
But, don’t worry about it – when the weather improves, it’s all coming back – all of it.
Wait a minute. Will the spring in the Northeast change US monetary and fiscal policy? Or, as the economy slows, will Lew and Yellen quintuple down on the Down Dollar, Down Rates, House Flipping American Dream?
How’s that working out for Barney Frank and Ben Bernanke btw? US Mortgage Purchase Applications were down another -6% last week (after being down -5% in the week prior), testing post 2008 crisis lows. Imagine that, as the purchasing power of Americans falls alongside interest and savings rates, there are less lemmings this time who are going to join Than Merrill’s “Flip This House!”
John Allison’s book is a Top-10 on my shelf because he explains the basics of economics that we attempt to articulate each and every risk management morning. Two more of his “Fundamental Themes” are:
- “Government policy created a bubble in residential real estate”
- “Almost every government action taken since the crisis started (even those that may help in the short-term) will reduce the standard of living in the long-term”
And sometimes the short-term morphs into the long-term a lot faster than consensus government policy apologists think…
Our immediate-term Macro Risk Ranges are now:
Natural Gas 5.34-6.22
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
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This note was originally published at 8am on February 06, 2014 for Hedgeye subscribers.
“After the fight is over the winning animal emerges with even higher levels of testosterone.”
The thing about fighting bulls are those damn horns. No matter what the math, data, or weather, the perma ones are really stubborn too. They’ll just sit there sometimes and stare at you. So, when you’re a bear, it’s better to attack them from behind.
The aforementioned quote comes from a chapter in The Hour Between Dog and Wolf that John Coates calls The Fuel of Exuberance. “Biologists studying animals in the field had noticed that an animal winning a fight or a competition for turf was more likely to win its next fight” (pg 166).
Sounds like trending bullish and bearish price momentum to me. All our back-tests show the most powerful ramps in market emotion (fear and greed) occur when there is a reversal from bearish to bullish (or bullish to bearish) on our intermediate-term TREND duration. In other words, bear vs. bull fights matter; especially at the big TREND turns.
Back to the Global Macro Grind…
From a #behavioral market strategy perspective, does the “Winner Effect” (Coates) matter? Big time. Why? It especially matters in modern markets because, newsflash: machines chase price.
What are the most interesting bullish-to-bearish reversals in the @Hedgeye quant model right now?
- Nikkei reversing to bearish TREND
- SP500 reversing to bearish TREND
- 10yr US Treasury Yield reversing to bearish TREND
How about the most interesting bearish-to-bullish reversals in TREND?
- Commodities (CRB Commodities Index) reversing to bullish TREND
- Utilities (XLU) reversing to bullish TREND
- Fear (VIX) reversing to bullish TREND
From a Global Macro Theme perspective it’s easy to explain why all 6 of these intermediate-term TREND reversals rhyme: with #InflationAccelerating, growth expectations in Japan and the US are slowing.
These same risk management signals started to manifest in Q1 of 2008 (that’s why we got so bearish on the US consumer back then), but they also started to coagulate again in Q1 of 2011.
2011 was a very interesting year in that while US stocks (SP500) closed flat on the year:
- Fear (VIX) ripped from 15 to 24 in Q1 of 2011
- Utilities (XLU) and Treasuries (TLT) marched steadily higher (relative and absolute) throughout 2011
- Commodities (CRB Index) had a monster Q1 of 2011
Fast forward to mid-Q1 of 2014 and here’s the score:
- Nikkei -13.1% YTD
- SP500 -5.2% YTD
- US Treasuries (TLT) +5.2% YTD
- CRB Commodities Index +2.5% YTD
- Utilities (XLU) +1.1% YTD
- Fear (VIX) +45.4% YTD
Oh, and there was that “financial innovation” thing (a Policy to Inflate asset prices; especially Bonds and Commodities) that eventually caused the all-time highs in commodities like Gold in Q3 of 2011 called the quantitative easing…
So, play it forward – what do you think the Mother of All Doves (Yellen) is going to do if US growth continues to slow? Bernanke didn’t go to Jackson Hole last year, but I’m betting that she’ll strap on the cowboy pants and start printing again.
I know, Hilsenrath hasn’t leaked that probability memo to the bulls or bears yet. But Mr. Macro Market has. So keep your head on a swivel out there as these currency devaluation and money printing animals at the Federal Reserve still think they’re winning.
Our immediate-term Global Macro Risk Ranges are now:
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
Even on a luck-adjusted basis, results missed expectations. Less optimistic on VIP market than last Q.
- Korea: Jeju opportunity will meet IRR goal. Has good database of customers.
- Will start construction in 3Q 2014
- According to Jeju law, have to invest US$300MM, then can apply for gaming license. Some risk involved but it should be just a formality.
- Genting Singapore did not get gaming license until one week before they opened
- May invest more $$$ once they have more clarity on Korean market; possibly 1-2 more deals
- Jeju capex: will not provide that # at this time; need govt approval
- Why 5% stake in LIDL? Business gesture.
- CRA does have oversight over all GENT investments
- Will have real estate in the Jeju project
- Japan: believe 1st gaming bill may be passed some time in June 2014. There will be a 2nd gaming bill.
- Does not see any construction until 2017
- Tokyo/Osaka being talked about
- Adjusted EBITDA hold impact: $60-70MM
- VIP win rate: 2.5%
- GGR share: 50%
- VIP RC share: 53%
- Mass volume share: 43%
- Slot volume share: 44%
- VIP revenue as a % of net revenue: 36%
- VIP revenue as a % of gross revenue: 57%
- Mass table hold is about 22%.
- Trade receivable impairment going up: because RC volume went up
- Combined mass market in Singapore: flat growth; regional currency has depreciated vs S'pore $ - affecting casino and non-gaming.
- 4Q higher cost structure: more prudent in provisions impacted margins; everything else has been consistent with past Q. Cost structure different from MBS - payroll costs higher, operating expenses also different
- May see some growth in the mass market in 2014
- 'Cautiously optimistic' on the VIP market - many uncertain things going on in China
- RMB will be appreciating against S'pore $. RMB won't have any effect on VIP business. However, all Southeastern currencies have depreciated against S'pore $ - mostly affect very low end and very high end segments.
- 20,000 daily visitors (11,700 are to USS, rest from aquarium), average spend for USS: $83, average spend for aquarium is $30;
- VIP volume will not be impacted by currency; cautiously optimistic on volume
CAT’s 10-K is a beast to review. Below, we highlight changes and unexpected items, as well as new or broader disclosure on items relevant to earnings. We may yet have more on the filing and still have some questions, but this is our first pass and we have already had a couple of rounds with the company. It seems to us that several reserves/allowances moved to boost earnings – one time even when appropriate (benefit of ~$160 mil for loan loss and warranty). The risk language also moved to better match our view of mining equipment, as it now mentions “industry overcapacity”. Given DRC’s 2014 guide down yesterday*, we may yet see that kind of language applied to Power Systems in the 2014 10-K, a segment where order backlog declined last year.
- 2011 & 2012 Revisions: We have read in the 2013 10-Qs that Cash from Operating Activities was revised because of interest payments on Cat Financials bank borrowings being moved from the Financing section ($57 and $53 mil in 2012 and 2011, respectively). However, we got additional revisions in the 10-K:
“We have also revised previously reported balances on Statement 3 as of December 31, 2012 and 2011 to correct for customer advances invoiced but not yet paid. Receivables - trade and other decreased from the amounts previously reported by $386 million and $228 million as of December 31, 2012 and 2011, respectively. Customer advances decreased from the amounts previously reported by $340 million and $204 million as of December 31, 2012 and 2011, respectively. Other (long-term) liabilities also decreased from the amounts previously reported by $46 million and $24 million as of December 31, 2012 and 2011, respectively. Although the revision did not impact Net cash provided by (used for) operating activities on Statement 5, we have revised the impacted operating cash flow line items for the years ended December 31, 2012 and 2011.”
While not overwhelming in magnitude, it continues a trend of revisions and incorrect reporting that can attract unwanted scrutiny and suggest a lack of reporting diligence. Both interest payments and cash from customer advances seem reasonably straightforward to categorize, at least to us.
- New Risk Sounds Familiar: In discussing the risks to CAT’s sales outlook, the following text is inserted “or a weak pricing environment attributable to industry overcapacity.” That addition is consistent with our Resource Industries outlook. (See CAT & The Mining Investment Bubble from July 2012 or subsequent Black Books)
- ASR Timing: While not new, the accelerated stock repurchase is “expected to be completed in March 2014,” which coincides well with the CAT Analyst Day March 4th at ConExpo. Buying $1.7 billion (~3 days volume) in such a short time period seems like a good idea for the presenting management team, but maybe not for long-term investors.
- Warranty Liability Down: CAT’s warranty liability dropped by $110 million, while warranty payments in 2013 increased slightly. The drop may be due to the decline in new warranties vs. previous years because of reduced equipment sales. Nonetheless, it is a nonrecurring earnings benefit, all else equal.
- Loan Loss Reserve Down: While we already covered this one in a historical context here, it’s worth noting that write-offs, TDRs, and total loans and leases increased in 2013. That seems hard to reconcile with a cut in allowance for credit losses to multi-year % of assets low. Even if it is appropriate, it is a non-recurring earnings boost, all else equal. “The allowance for credit losses as of December 31, 2013 was $375 million compared with $423 million as of December 31, 2012. The overall decrease of $48 million in the allowance for credit losses during the year reflects a $55 million decrease associated with the lower allowance rate, partially offset by a $7 million increase due to an increase in Cat Financial's net finance receivables portfolio.”
- Unfriendly IRS?: Perhaps CAT did annoy the Obama administration. The company apparently does not like the preliminary results of its recent IRS field examination: “While we have not yet received a Revenue Agent's Report generally issued at the end of the field examination process, we have received Notices of Proposed Adjustment from the IRS relating to U.S. taxation of certain non-U.S. operations and foreign tax credits. We disagree with these proposed adjustments, and to the extent that adjustments are assessed upon completion of the field examination relating to these matters, we would vigorously contest the adjustments in appeals.”
- No Goodwill Impairment: While the Bucyrus goodwill was not impaired, there is an added disclosure that is a little odd “In addition, only a portion of goodwill for certain acquisitions made in 2011 or later has been allocated to segments.” Not sure on that one, but it will be interesting to see if the BUCY goodwill makes it through 2014.
- Restructuring Can Be Painful: CAT intends to finally do some restructuring this year, but this language begs the question of why one would hold the shares through the whole entire process. CAT restructured during most of the 1980s and it was ugly for shareholders for nearly half a decade. Here is the risk discussion “…we may incur additional charges, including but not limited to asset impairments, employee termination costs, charges for pension and other postretirement contractual benefits, potential additional pension funding obligations, and pension curtailments, any of which could be significant, and could adversely affect our financial condition and results of operations. In addition, we may not realize anticipated savings or benefits from past or future cost reduction actions in full or in part or within the time periods we expect. We are also subject to the risks of labor unrest, negative publicity and business disruption in connection with our cost reduction actions. Failure to realize anticipated savings or benefits from our cost reduction actions could have a material adverse effect on our business, prospects, financial condition, liquidity, results of operations and cash flows.”
- Last Year’s Cost Performance: While not exactly new, this disclosure fails to fill us with optimism on restructuring, since the LIFO liquidation looks like such a significant driver. “Manufacturing costs decreased $167 million. The decrease was primarily due to lower material costs and $115 million ($0.12 per share) of LIFO inventory decrement benefits, partially offset by unfavorable changes in cost absorption resulting from a decrease in inventory during 2013 and an increase in inventory during 2012.”
*This is worth a look just to see a company’s guide-down actually buried in pig manure discussion http://investor.dresser-rand.com/releasedetail.cfm?ReleaseID=826086
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