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Another Day of #InflationAccelerating

Client Talking Points

EUROPE

There is no “Candy Crush” in the Denmark index (up +1.3% this morning to +14.6% year-to-date). European stocks are having an outstanding week relative to the USA social media bubble. Just look at the DAX which is up +1% and back above its TREND line of 9377. Italy continues to rip, too. It’s up +1.2% this morning at +13% YTD.

COMMODITIES

As the 50-day moving monkeys freak out about Gold (up +7.8% year-to-date versus the Dow down -1.8%), the CRB Index (19 commodities) closed up another +0.9% yesterday to +8.5% YTD. It’s all very #InflationAccelerating.

UST 10YR

The 2.69% yield agrees with us that inflation slows US growth. While Gold may have some short-term mean reversion issues (after being up +15% year-to-date a few weeks ago) being long #GrowthSlowing in long-bond terms has been great this week. The 10-year TREND resistance of 2.81% is firmly intact. Incidentally, the SPX risk range is 1842 – 1878.

Asset Allocation

CASH 20% US EQUITIES 10%
INTL EQUITIES 12% COMMODITIES 18%
FIXED INCOME 20% INTL CURRENCIES 20%

Top Long Ideas

Company Ticker Sector Duration
OC

Construction activity remains cyclically depressed, but has likely begun the long process of recovery.  A large multi-year rebound in construction should provide a tailwind to OC shares that the market appears to be underestimating.  Both residential and nonresidential construction in the U.S. would need to roughly double to reach post-war demographic norms.  As credit returns to the market and government funded construction begins to rebound, construction markets should make steady gains in coming years, quarterly weather aside, supporting OC’s revenue and capacity utilization.

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

Utilities $XLU +7.9% remains the best sector as inflation slows growth and forces yield chasing @KeithMcCullough

QUOTE OF THE DAY

"Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man."  –  Ronald Reagan

STAT OF THE DAY

Foreign buyers are snapping up homes in London , distorting prices and forcing policymakers to levy new taxes in an attempt to control the market. Nearly 70% of newly built properties in prime areas of central London were bought by foreign nationals between 2011 and 2013, according to realtor Knight Frank. (CNN)



False Positives

“Beware of false knowledge; it is more dangerous than ignorance.”

 -George Bernard Shaw

 

Every effective stock market operator knows that investment analysis is at best an imperfect science.  The mosaic theory is an apt description because with the absence of a silver bullet (knowing the results of a drug test before everyone else as an example), an investment analyst’s best tool is his or her ability to collect more data than his or her peers and to then use that data to reach a more informed conclusion.

 

Even then, in the absence of perfect information, many outcomes are flawed.   In fact, many analysts are guilty of making what is called a Type 1 error, or a false positive.   False positives lead analysts to conclude that a relationship exists when in fact it does not.  In medicine, this might occur when a test shows a patient has a disease, when they don’t.

 

False Positives - 55

 

As Europe contemplates another round of extreme monetary policy to offset perceived deflationary pressures, it does beg the question of whether there is a relationship between a monetary policy and a tightening economy.  Certainly, many supporters of former Fed Chairman Bernanke point to the fact that the economy recovered under him as evidence that his implementation of the most extreme monetary policy in the history of central banking was the reason for this recovery.

 

Conversely, though, the question remains whether the economy has recovered at all because of QE or even commensurately with the QE that has been implemented.  As former Dallas Fed President Bob McTeer recently wrote in Forbes:

 

“The hoarding of excess reserves limited the money creation or “printing” that took place despite the Fed’s massive purchases of securities and expansion of its balance sheet. That’s why the dire consequences predicted never came to pass. However, it is also the reason that the Fed’s purchases never stimulated the economy as much as hoped.”

 

In reality if you print dollars and don’t allow them to be spent, then you are really only debauching the currency by increasing the denominator.  Certainly this a policy that is good for the inflation trade, especially relating to those commodities priced in U.S. dollars

 

Back to the Global Macro Grind...

 

As Portugal’s bonds fall below the 4% yield for the first time in almost ever, one has to wonder if there isn’t a bit of a false positive emerging in the European peripheral sovereign debt markers.   Currently the 10-year yields of Portugal, Italy and Spain stand at 3.99%, 3.27%, and 3.20%, respectively.  Certainly these yields are still wide versus German bunds, but are these yields, on absolute basis, truly reflective of the underlying creditworthiness of those economies?

 

Take Spain as an example. This morning the Spanish central bank is projecting the Spanish economy will grow by 1.2%.   Given that this is below par economic growth, it is likely that Spanish unemployment stays above 25%.   This morning consumer prices were also reported to have fallen at an annual rate of -0.2%, which is the first decline in consumer prices in four years in Spain and indicative that consumers in Spain aren’t really spending (recent retail sales data show the same).

 

Clearly, on the margin, the economies in the periphery in Europe have improved, but if you are a buyer of Italian or Spanish 10-year bonds at 3.2%-ish, you need to put on the big boy analytical pants and decide if for that yield, the risk is commensurate.  At a 10% dividend yield, Linn Energy ($LINE) might be a good relative bet . . . actually I take that back, we’d continue to stay the heck away from LINE and much of the MLP complex !!!

 

My colleague Christian Drake, our U.S. focused economic analyst, wrote a note yesterday that he titled, “INFLECTIONS OR FALSE POSITIVES? CLAIMS, CONSUMPTION & CAPEX” where he addressed some of the myriad of U.S. economic data out recently:

  • #ItsNot2013:  Growth estimates globally continue to get marked down.  Slowing topline (GDP) and compressing margins (rising inflation) is not the stuff of market multiple expansion or macro P&L dynamics to remain lazy long of.
  • RISING INEQUALITY:  Corporate Profits - measured as the % of National Income or GDP -  made another new high in 4Q13.  The other side of that, of course, is a lower low in labor’s share of income.  Latent risks can remain latent, however.
  • CAPEX RESURGENCE?  General acknowledgement that assets are aging and businesses have under-invested isn’t a catalyst.
  • PAY-ME-NOW:  Productively continues to grow at a positive spread to unit costs and investors continue to reward the ‘pay-me-now’ corporate capital strategy. 
  • DURABLE DISAPPOINTMENT:  New Orders for Capital Goods non-Defense Ex-Air have been negative on a month-over-month basis for four of the last six months.
  • INITIAL JOBLESS CLAIMS:  A positive week of data…finally.  The next few weeks of data should be important

His conclusion, which is highlighted in the Chart of the Day below, is that although the U.S. economic data is part positive and part negative, GDP estimates continue to fall.  Ultimately the direction of GDP change is what matters.

 

But that all said, as you head into the weekend I would leave you with words of Mark Twain:

 

“All generalizations are false, including this one.”

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.64-2.75%

SPX 1 

VIX 13.85-15.81 

USD 79.35-80.39 

Gold 1 

Copper 2.91-3.06 

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

False Positives - chartday

 

False Positives - Virtual Portfolio


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LEISURE LETTER (03/28/2104)

TICKERS: CZR, PNK, WYNN

 

EVENTS TO WATCH:  UPCOMING EARNINGS/CONFERENCES/RELEASES 

 Friday, March 28 

  • Nevada gaming revenues release for February 
  • Wynn Macau board meeting

Tuesday-Thursday, April 8-10

  • Mid-America Gaming Congress (Columbus, OH)

Wednesday, April 9

  • SHO Investor Day

Thursday, April 10

  • HST Investor Day

 

COMPANY NEWS

CZR – announced an offering of 7 million shares of its common stock.  Caesars expects to grant the underwriter of the offering an option to purchase up to 1.05 million additional shares of its common stock.

 

TAKEAWAY:  The equity offering seems unusual given the recently announced transaction where Caesars will sell assets to Caesars Growth Partners for cash and assumption of debt.

                                 

PNK – the Missouri Gaming Commission approved the sale of Lumiere Place to Tropicana Entertainment.  Pinnacle and Tropicana plan to complete the $260 million, all-cash transaction by the end of 1Q14.  he divestiture is structured as a 338(h)(10) transaction. The book carrying value for Lumiere Place Casino and Hotels was $401.5 million at June 30, 2013

 

TAKEAWAY:  Transaction appears on track.  We note PNK should generate a significant NOL at closing. 

 

WYNN / 1128.HK - Ltd will offer shares in the company to all 7,500 of its employees.  The company announced that it would offer each employee 1,000 shares.  Wynn Macau also said it would pay its employees two bonuses a year from this year until 2017 – one in the summer and one in winter.

TAKEAWAY:  A creative way to hand cuff workers in a tight and getting tighter labor market as the new Cotai properties begin to recruit for their 2016 and 2017 openings.

 

WYNN - Garth Brooks, the best-selling solo musician in U.S. history, ended his semi-retirement on Thursday when he announced 15 concert dates at Wynn Resorts Ltd’s Encore theater in Las Vegas. Brooks will perform on three consecutive nights beginning December 11, with another six dates in January & six in February at Wynn Resorts’ hotel, casino & performance complex, which opened late last year.

TAKEAWAY:  Given the long history between Garth Brook and Steve Wynn we are not surprised.  Bringing Garth Brooks back just prior to and just after the very busy Christmas/New Year Holidays is a creative way to create incremental room and casino business. 

  

INDUSTRY NEWS              

An Illinois Senate committee has passed a bill (SB3144) upping the number of VLTs allowed at truck stops from five to 10. 

TAKEAWAY:  A plus for the suppliers if it goes through the process. Meanwhile, the number of new VLTs approved dropped to a monthly low in February.

MACRO

Hedgeye remains negative on consumer spending and believes in more inflation.  Following  a great call on rising housing prices, the Hedgeye Macro/Financials team is turning decidedly less positive.  

TAKEAWAY:  We’ve found housing prices to be the single most significant factor in driving gaming revenues over the past 20 years in virtually all gaming markets across the US.


March 28, 2014

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BULLISH TRENDS

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BEARISH TRENDS

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China Jitters

This note was originally published at 8am on March 14, 2014 for Hedgeye subscribers.

“We fear things in proportion to our ignorance of them.”

-Christian Nestell Bovee

 

All week I’ve been putting the finishing touches on what we think will be a revolutionary dynamic asset allocation model/global macro signaling platform; as such, I haven’t had much time to consume my “fair share” of financial news media in the week-to-date.

 

When I was able to perk my head up for a brief moment, I was somewhat startled to see the SPX down ~20 handles on “China jitters” yesterday.

 

Like many other financial news media headlines, I’m not quite sure how to interpret that one. Granted, no one is paying such platforms for differentiated, cutting-edge analytical insights, but sometimes I think their need for speed and coherent storytelling in a globally-interconnected, nonlinear ecosystem can get the better of them.

 

China Jitters - china

 

HEDGEYE POLL OF THE DAY: please reply “yes” to this email if it’s news to you that Chinese economic growth is slowing.

 

It’s worth noting that in the 15 quarters since Chinese real GDP growth hit a cycle-peak of +11.9% YoY in 1Q10, Chinese economic growth has accelerated sequentially only three times. It’s basically been a straight leg down for four consecutive years – so much so that on a trailing 3Y basis, the z-score for this series is (0.6x), which is actually up from trough of (1.6x) in 2Q12. In non-statistical speak, this implies that the “surprise factor” of Chinese #GrowthSlowing is burning off.

 

That isn’t to say that Chinese economic growth is not still slowing. In fact, the broad swath of high-frequency economic data (including yesterday’s releases) points to a continued slowdown. The current risk range in our predictive tracking algorithm has probable downside to +7.3% YoY for Chinese real GDP growth here in 1Q14, which would: A) be the slowest growth rate since 1Q09; and B) imply that the Chinese economy is not taking advantage of extremely favorable base effect tailwinds – a sign that sequential momentum is indeed decelerating.

 

For those of you who do not follow China closely, below we’ve compiled the relevant data points for your review, color coding them appropriately for ease of interpretation:

  • Fixed-Assets Investment: +17.9% YoY in JAN-FEB from +19.6% in DEC; +17.9% is the slowest growth rate since DEC ‘02
  • Industrial Production: +8.6% YoY in JAN-FEB from +9.7% in DEC; +8.6% is the slowest growth rate since APR ‘09
  • Retail Sales: +11.8% YoY in JAN-FEB from +13.1% in DEC
  • Total Social Financing: +938.7B CNY in FEB from +2,584.5B in JAN
    • New CNY Loans: +644.5B CNY in FEB from +1,320B in JAN
    • Non-traditional Financing (i.e. “shadow” banking): +17.2B in FEB from +993B in JAN
    • Ratio of Non-traditional Financing to Total Social Financing: 1.8% in FEB from 38.4% in JAN
  • Official Manufacturing PMI: 50.2 in FEB from 50.5 in JAN; 50.2 marked an 8M-low for the index
    • New Orders declined 40bps to an 8M-low of 50.5
    • Export Orders declined 110bps to an 8M-low of 48.2
  • Official Non-Manufacturing PMI: 55 in FEB from 53.4 in JAN
  • HSBC Manufacturing PMI: 48.5 in FEB from 49.5 in JAN; 48.5 marked a 7M-low for the index
    • New Orders and Output both fell below 50 (i.e. contracted) for the first time in 7M
    • Employment dropped to 47.2, which is its lowest reading since MAR ‘09
  • HSBC Non-Manufacturing PMI: 51 in FEB from 50.7 in JAN
  • Exports: (18.1%) YoY in FEB from +10.6% in JAN vs. a Bloomberg consensus estimate of +7.5%
  • Imports: +10.1% YoY in FEB from +10% in JAN vs. a Bloomberg consensus estimate of +7.6%
  • Trade Balance NSA: ($23B) in FEB from $31.9B in JAN vs. a Bloomberg consensus estimate of $14.5B; ($23B) marked the largest trade deficit since FEB ‘12
  • Trade Balance YoY: ($37.8B) YoY in FEB from +$3.8B YoY in JAN

Lots of red indeed…

 

Back to the Global Macro Grind

 

So what do you do with all of this? Like we’ve been saying since the start of DEC, you should simply allocate assets to “New China” plays in lieu of “Old China” plays. Refer to the Chart of the Day below for an example of how to implement this investment strategy.

 

The worst thing you can do as a fiduciary of other people’s capital is freak out about China ~4 years into a well-telegraphed, policy-induced growth slowdown.

 

That’s not to say the Chinese economy and its banking system won’t have its day of reckoning (it will; it has twice before in the last ~20-30 years after the popping of two credit bubbles that were also policy-induced); it’s merely to suggest that it might not be tomorrow. At any rate, we’ve done a ton of work on such risks over the past 6-9M, so please ping us if you’d like our help getting up to speed.

 

One key catalyst on the horizon is a potential shift to a monetary easing bias by the PBoC. To some degree, they’ve done this already: selling CNY in the open market to lower the reference rate – as they have done in recent weeks – floods the domestic banking system with liquidity. On the surface, they’ve mopped up this liquidity by issuing repos, but money market rates falling to near 2Y-lows suggests there is ample excess liquidity in the Chinese banking system.

 

Two additional points to consider regarding this potential catalyst:

  1. The Chinese yuan’s recent decline is not because of panic selling, but rather deliberate policy adjustments after speculative capital inflows helped fuel the fastest sequential rate of credit growth ever in JAN.
  2. Yesterday, for the first time since mid-2012, the State Council rhetorically supported the prospect of policy stimulus. This is in stark contrast to the “proactive and prudent” fiscal and monetary policy bias they’ve held for much of the past 18+ months.

While we all know they cannot stimulate indefinitely, there’s little-to-no denying the short-to-intermediate term impact increased government investment or a lower WACC could have on a Chinese economy that remains levered to fixed capital formation at roughly half of GDP. It’s worth noting that real interest rates (i.e. the benchmark 1Y lending rate less headline CPI) in China have backed up from a then-3Y low of ~0% in mid-2011 to near-4Y highs just north of 4%.

 

As always, time will tell on this catalyst. For those of you who crave a higher degree of analytical color at the current juncture, please refer to our latest report titled, “IS THIS THE BEGINNING OF THE END FOR CHINA?” (3/10).

 

Our immediate-term TRADE risk ranges across Global Macro are now as follows:

 

UST 10yr Yield 2.59-2.75%
SPX 1842-1867

VIX 14.62-16.39

USD 79.31-79.94

Gold 1348-1375

 

Keep your head on a swivel,

DD

 

Darius Dale

Associate: Macro Team

 

 

China Jitters - Chart of the Day

 

China Jitters - Virtual Portfolio


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 80.28%
  • SHORT SIGNALS 78.51%
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