“My name is Ozymandias, king of kings:
Look on my works, ye Mighty, and despair!
Nothing besides remains. Round the decay
Of that colossal wreck, boundless and bare
The long and level lands stretch far away.”
The excerpt above is from one of my favorite poems, “Ozymandias”, written by Percy Shelley. As you might have been able to decipher, the poem (well sonnet really) is about the inevitable decline of all leaders and the empires they build based on personal pretensions to greatness.
The economic and military history of the world is replete with examples of great empires that have been built and then suffered decline. The most notable to us in the west is likely the British Empire, and rightfully so. At its peak the British Empire covered more than 13,000,000 square miles, or ¼ of the earth’s surface.
The second largest empire in the history of the world was the Mongol Empire. The origins of the Mongol empire were admittedly modest and started when a young boy named Temujin vowed in his youth to bring the world to its feet. Genghis Khan, as he would later be known, did that and more. The Mongol empire, although almost impossible to manage, stretched from Vietnam to Hungary and was the largest contiguous empire in history.
In modern days, empires are more commonly measured by economic output. Currently, the top three economic empires in the world are the United States with a $16.8 trillion GDP, China with a $9.2 trillion GDP, and Japan with a $4.9 trillion GDP. Collectively, these behemoths make up almost 40% of the global economy.
If history tells us anything, to the point of Shelly’s sonnet, emperors will decline. Or as a quant might say, revert to the mean. The challenge for us as stock market operators is to find opportunities in this tectonic economic shift and to be on the right side of global economic empire building and subsequent declines.
Back to the global macro grind . . .
The mighty empire of China reported some critical economic numbers last night. My colleague Darius provided a quick summary of the results below:
- APR MNI Business Indictor: 51.1 from 53.4… G -1
- 1Q Real GDP: 7.4% YoY from 7.7% vs. a Bloomberg consensus estimate of 7.3%... G -1
- QoQ: 1.4% from 1.7% vs. a Bloomberg consensus estimate of 1.5%
- MAR FAI: 17.6% YoY from 17.9%... G -1
- MAR Retail Sales: 12.2% YoY from 13.6% in DEC (most recent release)... G -1
- MAR Industrial Production: 8.8% YoY from 9.7% in DEC (most recent release)… G -1
As you can see from his short hand notation, “G -1” (growth decelerating), broadly speaking the data was incrementally bearish for growth.
In the Chart of the Day, we take a look at year-over-year Chinese growth by quarter going back ten years. As the chart highlights, it is really no secret that Chinese growth has been declining and also no surprise that the Chinese stock market is basically shrugging off the data this morning.
Most pundits are now vocal on the fact that Chinese growth has slowed and is slowing. Meanwhile, Chinese policy makers are of the view that this is the bottom in China’s economy (in as much as an economy growing 7%+ can be considered bottomed). Given that policy makers have the ability to stimulate and an early, inside look at the data, at a minimum, we’d probably not short China here.
Or as Genghis Khan said:
“If you’re afraid – don’t do it, if you’re doing it don’t be afraid.”
Speaking of being afraid, what scares me and should scare most stock market operators are the mysterious projections that many strategists of the Old Wall come up with. As an example, yesterday we took a look at the projections for real GDP growth in the U.S. From Q2 2014 to Q2 2015 the real GDP quarterly growth rate is projected as follows:
- Q2 2014 – 3.0%
- Q3 2014 – 3.0%
- Q4 2014 – 3.1%
- Q1 2015 – 3.0%
- Q2 2015 – 3.0%
Clearly, Herding 101 was a well attended class by most of these sell side economists in PH.D. school . . .
We are not ready to call for the decline in the United States economic empire just yet, but we are wise to note that the Emperor, namely the U.S. dollar, continues to weaken and, in our view, is likely front running a more dovish tone by the Fed. In that vein, the U.S. 10-year yield is down again this morning (albeit small) as well after failing to participate in the late day, low volume exuberance in equities yesterday.
For those of you that do watch the Fed closely, Grandma Yellen, I mean Chairperson Yellen will be speaking at 12:15pm this morning in beautiful New York. Our friends at Goldman Sachs are out this morning saying it will be pertinent to interest rates, and the market seems to be agreeing with (or maybe front running) that view.
Finally this morning on the inflation front, and this is a point we highlighted in our recent themes deck, we are starting to see some tightness in the labor market. According to an article from Bloomberg, businesses in some US cities are raising wages and adding benefits to attract employees as metropolitan jobless rates have fallen below the 5.2% to 5.6% level considered full employment. The article noted that 49 of the 372 metro areas reported rates below 5% in February, while four years ago just two cities were below that level. This has the potential to build what we call #StructuralInflation and it is prudent to keep your hedgeyes on this trend.
Our immediate-term Global Macro Risk Ranges are now:
Good luck empire building today!
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
Client Talking Points
Burn baby burn. US Dollar Index continues to front-run (as rates do) what I think will be a more dovish Fed (on the margin versus tapering) come summer time. Inflation slows growth, and the Fed gets easier (i.e. devalues Dollars) when growth slows – consumer stocks (XLY) are down -6% versus slow-growth-yield-chasing Utilities (XLU) up +12% year-to-date.
Now the only thing US consumer bulls ping me on (oil not going up) is going up. Both Brent and WTIC (up +1% and +0.7%, respectively, this morning) are confirming bearish to bullish Hedgeye TREND reversals. Love those…but the consumer doesn’t. Inflation is an unlegislated tax that will continue to matter to the 80% of America getting crushed by it (see our Q2 Macro Themes slide deck for details).
The 10-year yield at 2.64% is down a beep in the last 24 hours (i.e. they might have bounced the Nasdaq and Russell off two-month lows on no-volume yesterday), but that didn’t change what the FX, Bond, and US Equity markets are pricing in – slower growth sequentially into Q314.
|FIXED INCOME||18%||INTL CURRENCIES||18%|
Top Long Ideas
Hologic is emerging from an extremely tough period which has left investors wary of further missteps. In our view, Hologic and its new management are set to show solid growth over the next several years. We have built two survey tools to track and forecast the two critical elements that will drive this acceleration. The first survey tool measures 3-D Mammography placements every month. Recently we have detected acceleration in month over month placements. When Hologic finally receives a reimbursement code from Medicare, placements will accelerate further, perhaps even sooner. With our survey, we'll see it real time. In addition to our mammography survey. We've been running a monthly survey of OB/GYNs asking them questions to help us forecast the rest of Hologic's businesses, some of which have been faced with significant headwinds. Based on our survey, we think those headwinds are fading. If the Affordable Care Act actually manages to reduce the number of uninsured, Hologic is one of the best positioned companies.
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.
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
EUROPE: 2014 YTD leaders leading this morning's rally - Italy +2% (+12% YTD), Denmark +1.3% (+12% YTD) @KeithMcCullough
QUOTE OF THE DAY
"Do not look where you fell, but where you slipped." - African Proverb
STAT OF THE DAY
President Barack Obama plans to announce an expansion of job-training and apprenticeship programs with a $600 million effort intended to equip workers with the skills sought by employers. The first initiative is a $500 million competitive grant program for community colleges linked with businesses to create programs to teach the specific skills needed for open jobs. (Bloomberg)
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This note was originally published at 8am on April 02, 2014 for Hedgeye subscribers.
“We shall not cease from exploration, and the end of our exploring will be to arrive where we started and know it for the first time.”
Yesterday we held our quarterly firm meeting in Stamford, CT. It was by all accounts a very successful day. We introduced new employees, celebrated recent wins and also contemplated strategic shifts to keep Hedgeye moving forward.
As an aside, it also coincided with my personal favorite day of the year, April Fool’s Day. Unlike those April Fool’s days of prior years, like when I fired Keith one year, this year’s joke was more benign, though we did manage to “suck” a few people in again. For those that didn’t see the faux press release about Wall Street 2.0: Hedgeye the Movie, it can be found here.
So at the company meeting, a key topic of discussion was how to generate contagious content / ideas. For those that didn’t know, the term, “content is king”, was first used in 1994 and then popularized by Bill Gates in an essay about two years later. So, as ideas go, the idea of content is king is not new, but it is certainly contagious.
Back to the Global Macro Grind...
In my mind, activist investment ideas are examples of ideas that need to become contagious before they become successful. Yesterday activist Starboard filed a presentation outlining the potential for Darden Restaurants ($DRI). A key take away from the presentation is that the Company’s EBITDA margins are at 7.4% versus the industry median of 10.3%.
As many of you know, Darden is also currently a favorite of Restaurant Sector head Howard Penney and is on our Best Ideas list. As a result, Starboard was kind enough to reference our work on Darden in their presentation. Specifically, they referenced a recent poll that we did:
“According to a recent poll conducted by sell-side research firm Hedgeye Risk Management, 84% of respondents said that they did not believe that management’s plan to spin-off Red Lobster would create value.”
We actually have created a polling product to specifically gauge sentiment and opinion in a more quantified fashion, which has, obviously, also had the derivative impact of creating contagious content.
Included in the Starboard presentation as well was this tweet from Penney:
“$DRI management shuts me out of another earnings call. Running out of time is not an excuse. @jannarone article on #CNBC was $$”
This point goes to the crux of Penney’s thesis on Darden, which is that management operates in a vacuum and is totally unwilling to listen to new ideas, especially from analysts that may disagree with them. Ignoring great ideas is the death knoll for any company. If you’d like to learn more about our thesis on Darden before it goes too viral, please email email@example.com.
While we are on the topic of contagious content, I thought it would be worth highlighting an essay that Warren Buffett wrote for Fortune in 1977 (back when periodicals like Fortune still published essays):
“There is no mystery at all about the problems of bondholders in an era of inflation. When the value of the dollar deteriorates month after month, a security with income and principal payments denominated in those dollars isn't going to be a big winner. You hardly need a Ph.D. in economics to figure that one out.
It was long assumed that stocks were something else. For many years, the conventional wisdom insisted that stocks were a hedge against inflation. The proposition was rooted in the fact that stocks are not claims against dollars, as bonds are, but represent ownership of companies with productive facilities. These, investors believed, would retain their Value in real terms, let the politicians print money as they might.
And why didn't it turn but that way? The main reason, I believe, is that stocks, in economic substance, are really very similar to bonds.”
As you can see this basic concept that we have been pounding on, which is that when a currency is devalued that devaluation naturally creates inflation in dollar denominated asset classes, is not new. Neither is the idea that at a point, this inflation begins to negatively impact economic growth, which has the potential to have a negative impact on the returns of those assets classes levered to economic growth.
Certainly, of course, we aren’t suggesting we are in the midst of 1970s style inflation. Or, frankly, on the path to that any day soon, but commodity inflation is here, is persistent and is likely to be sticky. Most notably on the inflation front is what is happening to food (you know that stuff we eat).
In the chart of the day below, we’ve compared the performance of consumer discretionary stocks in the year-to-date versus the CRB Index versus the BLS Foodstuff Index. For those that can’t read the fine print, I’ll give you the punch line. The CRB commodity index is up more than 7% in the year-to-date, the BLS Foodstuff Index is up more than 20%, and consumer discretionary stocks are down on the year.
As Warren Buffett might say, you don’t need an economics PH.D. to see that correlation!
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.66%-2.80%
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
Macau VIP vs China credit.
- In past notes we’ve discussed the statistically significant relationship between VIP Rolling Chip (RC) Volume in Macau and China’s reserve ratio requirement and discount rate which we found peaked on an 8-9 month lag. With little change in China’s monetary policy since Q2 2012 or 2013 (loosened), the softer Macau gaming revenues cannot be blamed on the China Fed.
- Here we’ve plotted and regressed VIP Rolling Chip volume against China Yuan loan growth. The correlation and significance peaks at a 1 month lag (0.37 and T-stat of 2.9).
- Could the YoY decline in loans in March explain some of the weakness in RC thus far in April?
- Probably but minor. The March/April multi year comparisons are more difficult than March/May. We’re projecting 20% YoY Macau total GGR growth in May.
- Sentiment has turned decidedly negative with VIP and credit fears running rampant. While we predicted a disappointing March/April, we’re not sure fundamentals have changed much. Look for a May rebound to catalyze the downtrodden Macau stocks.
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