prev

BOOKING THE GAIN IN BRAZIL; ROTATING INTO TAIWAN AND BACK TO INDIA

Takeaway: We no longer consider Brazil an attractive investment destination and are content to remove the country from our Best Ideas list.

CONCLUSIONS:

 

  1. As the facts change, we do. An increasingly convoluted policy mix complicates Brazil’s intermediate-term GIP outlook. As such, we are content to book the gain and may look to potentially revisit the country on the long side as campaigning heats up into the OCT general elections.
  2. Taiwan has been a country we sort of missed not pounding the table on in the YTD (on the long side), but we now anticipate meaningful upside from current levels. For intermediate-term investors, GIP fundamentals support chasing Taiwanese equities up here – particularly amid heightened prospects for M&A activity in the global semiconductor space.
  3. Unnecessarily fearing a volatile market response, we were wrong to have booked the gain in India just ahead of the final election tally. That being said, we are now content to look through likely near-term economic softness (i.e. the “G” in our GIP model) with the intention of playing for likely structural improvement in India’s inflation and policy dynamics (i.e. the “I” and the “P” in our GIP model).

 

STEP ONE: SELL BRAZIL

Since our bullish conference call titled, “TIME TO BUY BRAZIL?” (2/27) the following has occurred in Brazilian capital and currency markets:

 

  • The BRL posted a total return of +4.7% vs. the USD, which compares to a sample mean of +2.7% of and is good for the 6th largest gain amongst the 24 EM currencies tracked by Bloomberg over that timeframe.
  • The iShares MSCI Brazil ETF (EWZ) has appreciated +11.2%, which compares to a sample mean of +6.5% and is good for the 5th largest gain over that timeframe across the 24 country-level EM ETFs we track.
  • Petrobras (PBR) – our preferred single-name exposure in the Bovespa Index (refer to slides 57-71 of the aforementioned slide deck) – has appreciated +21.4%. That more than doubles the +10.6% gain for the Bloomberg Industries Global Integrated Oils Index, for which Petrobras is a constituent.

 

While that’s obviously a fair degree of global macro alpha, we aren’t simply content to relinquish our research view simply because the trade has worked well. Rather, we see a confluence of deteriorating GIP fundamentals supporting an exodus of investors from Brazilian capital and currency markets.

 

Brazilian growth data is flat-out awful; as you can see in the table below, there is a hardly a meaningful economic indicator in Brazil that isn’t rapidly decelerating on both a sequential and trending basis. That this is coming amid accelerating headline inflation means Brazilian policymakers are now forced to choose between promoting growth or combating inflation – the latter of which we still view as the country’s key political issue.

 

BOOKING THE GAIN IN BRAZIL; ROTATING INTO TAIWAN AND BACK TO INDIA - BRAZIL GIP

 

Unfortunately for investors, the Rousseff administration is resorting to the tired Keynesian playbook of fiscal stimulus ahead of the election, choosing ramp up deficit spending ahead of what is likely to be Brazil’s most contested presidential race since 1989. Recent policy initiatives include:

 

  • A +4.5% increase in income tax exemptions starting next year;
  • A +10% increase in Bolsa Familia cash transfers starting next year worth R$9B… this latest increase takes Bolsa Familia transfers – which benefit ~25% of the Brazilian population – up +64% in real term since the Rouseff administration took office on JAN 1st, 2011; and
  • Extending a $9.7B payroll tax cut for various manufacturing industries.

 

These promises of fiscal sweetness come amid heighted pressure to raise the minimum wage, which has increased +42.2% in real terms since 2007. Both Rousseff and her runner-up in the latest polls, Aecio Neves, are on board with another hike.

 

The problem with hiking the minimum wage now is that many government salaries and pension benefits are indexed to the federal minimum wage in Brazil. In fact, roughly 80% of all federal expenditures are earmarked by law. That is obviously not helpful for a government that has promised investors fiscal retrenchment in 2014. The 1.9% primary surplus target appears to be in danger and the nominal budget balance – which is what really matters to the currency – remains bloated at -3.1% of GDP.

 

While Rousseff continues to get tagged in the latest polls (37% support as of MAY 7-8), we view the recent retreat from promises of fiscal austerity and monetary policy tightness out of the Neves camp (20% support as of MAY 7-8) limits pressure upon the Rousseff administration to tighten policy heading into the election.

 

Eduardo Campos (11% support as of MAY 7-8) is a fiscal and monetary hawk and we would view any ascent by him to 2nd place in the polls as positive for our original long idea. That remains to be seen at the current  juncture, however. As such, we are now content to take down our intermediate-term growth estimates and take up our intermediate-term inflation estimates for Brazil.

 

BOOKING THE GAIN IN BRAZIL; ROTATING INTO TAIWAN AND BACK TO INDIA - BRAZIL

 

BOOKING THE GAIN IN BRAZIL; ROTATING INTO TAIWAN AND BACK TO INDIA - BRAZIL GROWTH

 

BOOKING THE GAIN IN BRAZIL; ROTATING INTO TAIWAN AND BACK TO INDIA - BRAZIL INFLATION

 

All told, it appears increasingly likely that the Brazilian government is choosing stimulus over prudence at the current juncture and we think international capital allocators have begun to sniff this out.

 

Specifically, the BRL, Bovespa and Petrobras have all recently broken their respective immediate-term TRADE lines of support and are now flirting with TREND line breakdowns on our proprietary three-factor quant model. The latter two are in the process of confirming lower-highs from technical perspective as well. We don’t recommend buying either signal, as both tend to be leading indicators for further downside.

 

BOOKING THE GAIN IN BRAZIL; ROTATING INTO TAIWAN AND BACK TO INDIA - BZF

 

BOOKING THE GAIN IN BRAZIL; ROTATING INTO TAIWAN AND BACK TO INDIA - EWZ

 

BOOKING THE GAIN IN BRAZIL; ROTATING INTO TAIWAN AND BACK TO INDIA - PBR

 

STEP TWO: BUY TAIWAN

Let’s assume you’ve just booked your Brazil allocation for a nice profit and have some capital to put to work. You’re likely well aware of how we feel about chasing the domestic growth style factor up here in the US equity market, so naturally we are looking abroad for our preferred allocation. Taiwan passes our fundamental and quantitative screens and looks like an interesting play on the long side of global equities from current levels.

 

Up +5.9%, Taiwan’s benchmark TAIEX Index is on a slow-and-steady march higher in the YTD. While being up +590bps might not seem like that much, that compares to a sample mean of +4.7% across the 21 equity markets we track across Asia & Latin America and is besting the +4.4% YTD gain for the S&P 500.

 

While it’s hard to argue in favor of the predictability of YTD gains, Taiwan does have idiosyncratic country risk factors that support allocating capital to this market at the current juncture. Specifically, improving GIP fundamentals support chasing Taiwanese equities up here – particularly amid heightened prospects for M&A activity in the global semiconductor space. It’s worth noting that the Tech sector accounts for a whopping 46% of TAIEX market cap, with semiconductors alone accounting for 23%.

 

Contrary to Brazil, it’s particularly difficult to find a meaningful economic indicator in Taiwan that isn’t accelerating on both a sequential and trending basis. While headline inflation is indeed accelerating, it’s accelerating off of extremely low levels and does not warrant any attention from the central bank – especially with WPI trends being so subdued.

 

BOOKING THE GAIN IN BRAZIL; ROTATING INTO TAIWAN AND BACK TO INDIA - TAIWAN GIP

 

Both the sequential momentum and base effects embedded in our predictive tracking algorithm support our above-the-Street forecast for Taiwanese real GDP growth in 2014 and we see it accelerating through at least the third quarter.

 

BOOKING THE GAIN IN BRAZIL; ROTATING INTO TAIWAN AND BACK TO INDIA - TAIWAN

 

BOOKING THE GAIN IN BRAZIL; ROTATING INTO TAIWAN AND BACK TO INDIA - TAIWAN GROWTH

 

Annualized currency weakness supports a marginally hawkish CPI outlook as we progress through the year, but as previously mentioned, this catalyst is unlikely to result in monetary tightening over the intermediate term. READ: the coast is clear for Taiwanese exporters.

 

BOOKING THE GAIN IN BRAZIL; ROTATING INTO TAIWAN AND BACK TO INDIA - TWD

 

BOOKING THE GAIN IN BRAZIL; ROTATING INTO TAIWAN AND BACK TO INDIA - TAIWAN INFLATION

 

Not surprisingly, the benchmark Taiwan TAIEX Index has registered a +0.83 correlation with the MSCI World Semiconductors GICS Level 3 Index in the YTD, which is up a bit from the +0.80 correlation registered over the trailing 3Y. Indeed, it would seem that getting the semis cycle right is really all investors need to have a handle on to get market beta right for Taiwanese equities.

 

For those of you who are not yet aware, we’ve recently hired a Global Semiconductors analyst to co-head our Information Technology vertical at Hedgeye. While it would not be compliant nor appropriate for us to discuss his incubating ideas and themes at length in this note, office chatter supports our existing view that #InflationAccelerating will continue to perpetuate a robust M&A cycle across many industries globally – including semiconductors.

 

Needless to say, semiconductors is in fact an industry with far too many public companies and is ripe for M&A activity over the intermediate term. Perhaps that’s why both the semiconductor stocks and the iShares MSCI Taiwan ETF (EWT) continue to make new highs. Moreover, semiconductors aren’t levered to slowing US consumer demand, as the US accounts for only 20-25% of all consumer electronic consumption globally.

 

BOOKING THE GAIN IN BRAZIL; ROTATING INTO TAIWAN AND BACK TO INDIA - EWT

 

Another style factor we have and continue to support across global capital markets in the YTD is a reach for yield – i.e. allocating capital to long-duration fixed income and bond-like equities. As the chart below highlights, Taiwan is outclassing many of its EM peers with respect to its highly attractive real yields.

 

BOOKING THE GAIN IN BRAZIL; ROTATING INTO TAIWAN AND BACK TO INDIA - EM Real Yields

 

All told, if you’re looking for places to put money to work in global equities, then we are firmly in support of any decision to allocate capital to Taiwan on the long side.

 

STEP THREE: BUY BACK INDIA

In our 5/12 note titled, “BOOKING RESEARCH ALPHA IN INDIA”, we advocated for booking gains in what we are now dubbing the “Modi Trade” across Indian capital and currency markets. At the time, it seemed like a good call in the context of the research alpha we generated and the likelihood that much of the good news was priced in – seemingly only leaving room for election-day disappointment. From that note:

 

  • “Indian capital and currency markets have performed quite remarkably since we outlined our bullish thesis back on OCT 29th of last year.”
  • “Specifically, the EPI etf has appreciated +21.6% since then, which compares to a sample mean of -1.4% across the 24 country-level EM etfs we track and good for the second-best performance over this duration.”
  • “Moreover, the INR has appreciated +3.2% vs. the USD since then, which compares to a sample mean of -2.4% across the 21 currencies we track across Asia and Latin America and good for the third-best performance over this duration.”
  • “Going back to the EPI etf, this fund has ripped +19.2% in the last ~3M alone (note: we reiterated our bullish bias in a detailed note on JAN 22) – implying some degree of investors crowding into this trade.

 

As mentioned at the onset of this note, that was the wrong call. Specifically, the WisdomTree India Earnings Fund (EPI) has appreciated another +8.6% – on admittedly thinner volume of late. While the latter signal is cause for worry, it’s easy for investors to interpret the heavy volume amid the late-MAY melt-up as the entrance of “real money”, strategic buyers who now view a Modi-led India a core holding in an international equity portfolio. @JohnnyComeLately money aside, we do think the chase is generally warranted.

 

While the aforementioned storytelling has little to do with our fundamental process, we do think it’s worth considering in the context of what has been one of the most hyped capital and currency markets in the YTD.

 

Indeed, while Modi and his BJP Party did take care of business in last month’s elections, capturing an outright majority with 283 of 543 available seats in the lower house of Indian parliament (accounting for BJP allies, this figure jumps to an overwhelming majority of 335 seats), the BJP coalition is still on very shaking footing in the upper house where they control only 61 of 245 seats. The former ruling Congress Party, which had been in control of Indian parliament since 2004 dropped -175 seats from their 2009 election total.

 

The aforementioned consternation in the upper house consternation is critical in the context of some of the prospective economic reforms being bandied about the press, many of which require upper house consent – particularly on anything related to foreign direct investment, taxes and constitutional amendments. Such reforms include, but are not limited to:

 

  • Significant capital account/capital markets deregulation;
  • Broad-based foreign direct investment deregulation;
  • Implementing a goods and services tax in order to simplify India’s convoluted tax code that often results in double taxation at the interstate level; and
  • Deregulating the labor market in order to decrease the frictional cost of doing business in India, which we detailed in our JAN 22nd note is extremely high.

 

While it is unlikely that any of this gets done in the near term, it’s become increasingly clear that international investors are willing to propel the hope-fueled rally in Indian capital and currency markets higher.

 

Moreover, while we believe that fiscal and economic reforms are likely to disappoint intermediate-to-long-term expectations of what is likely priced into the SENSEX at its all-time highs, we do think the prospect for Indian monetary policy supporting structural improvement in India’s GIP fundamentals is a meaningful enough catalyst to warrant reallocating to India on the long side.

 

As mentioned throughout our bullish work on India over the past few quarters, RBI governor Dr. Raghuram Rajan’s monetary policy soundness has been integral to restoring the country’s credibility amongst global inventors after last year’s fiscal and monetary policy-induced currency crash. A key indication of this is India’s current account balance improving markedly from -4.4% of GDP to -2.8% in 4Q13.

 

Thus far, we’ve received little-to-no indication that his job or the RBI’s monetary policy independence is at risk under the Modi regime. Recall this was a key worry of ours a few weeks back.

 

Digging into the most recent data, the RBI’s decision to stand mostly pat on rates today was both well telegraphed (e.g. predicted by all 38 analysts surveyed by Bloomberg) and well-received given that they maintained their previous guidance of maintaining appropriately tight monetary conditions until inflation converges to their targets (i.e. +8% YoY by JAN ’15 and +6% YoY JAN ’16).

 

The board did implement some targeted easing measures, such as lowering rates in both its statutory liquidity ratio (SLR) and its export credit refinance facility (ECR), but these moves appear more administrative in nature and rhyme with the marginal trend-duration improvement we’ve seen in India’s CPI and WPI readings.

 

BOOKING THE GAIN IN BRAZIL; ROTATING INTO TAIWAN AND BACK TO INDIA - INDIA GIP

 

As the table above highlights, India’s growth data is good, but not great. Recent sequential and [marginal] trend-based improvement in PMI data is offset to some degree by waning consumer confidence, passenger car sales and money supply data. As such, we continue to maintain a choppy intermediate-term outlook for Indian growth. If it’s any consolation for investors, our model has Indian CPI converging to the aforementioned targets by EOY ’14.

 

BOOKING THE GAIN IN BRAZIL; ROTATING INTO TAIWAN AND BACK TO INDIA - INDIA

 

BOOKING THE GAIN IN BRAZIL; ROTATING INTO TAIWAN AND BACK TO INDIA - INDIA GROWTH

 

BOOKING THE GAIN IN BRAZIL; ROTATING INTO TAIWAN AND BACK TO INDIA - INDIA INFLATION

 

BOOKING THE GAIN IN BRAZIL; ROTATING INTO TAIWAN AND BACK TO INDIA - INR

 

All told, we are now content to look through likely near-term economic softness (i.e. the “G” in our GIP model) with the intention of playing for likely structural improvement in India’s inflation and policy dynamics (i.e. the “I” and the “P” in our GIP model). Giddy up!

 

BOOKING THE GAIN IN BRAZIL; ROTATING INTO TAIWAN AND BACK TO INDIA - EPI

 

Have a wonderful evening,

 

DD

 

Darius Dale

Associate: Macro Team


Real Conversations: Schwab's Liz Ann Sonders Unplugged with Hedgeye's Keith McCullough

Liz Ann Sonders, chief investment strategist at Charles Schwab, sits down with Hedgeye CEO Keith McCullough to talk markets, the economy and much more in this latest edition of HedgeyeTV's "Real Conversations."


Poll of the Day Recap: 65% Say Yes, the S&P 500 Will Cross 2,000 This Year

Takeaway: 65% said YES; 35% said NO.

As bond yields crash year-to-date and the Russell delivers negative returns, the world’s most consensus short position (SPX Index + E-mini) hit another new high on no volume yesterday.
 

Today’s poll question was: Is the S&P 500 going to cross 2,000 this year?
 

Poll of the Day Recap: 65% Say Yes, the S&P 500 Will Cross 2,000 This Year - nyse
 

At the time of this post, 65% said YES; 35% said NO.
 

(Voters sharply swung so much in one way, that we didn’t receive any comments on why people voted NO.)
 

Here’s what those who voted YES had to say:

  • “2000 is serving as a magnet, and it's only about 4 - 5% from here. Technically the chart is looking very constructive despite all the sector variances (which are not healthy). More shorts still need to be squeezed, by the time all said and done, shorts will be scared to short anything. The current pain is not severe enough for many.”
     
  • “Policy to inflate requires currency devaluation, S&P 500 only needs to rise 4% from here and it's imperative equities continue rising post Financial Crisis; so it's quite likely S&P 500 will exceed 2000 in 2014.”
     
  • “The global central banks will continue digitally printing money and artificially suppressing interest rates to push asset prices until there is a monetary crisis of some sort to force them to stop.”
     
  • “It’s already baked in. It’s a political imperative. The question is, will the S&P 2200 predictions come true, or will there be a road bump that will turn the market into road kill?”
     
  • “It will probably cross 2000, and then 1750 in the next twelve months.”
     
  • “Yes, but after summer pullback.”
     
  • “The FED cannot have the public lose confidence and stock market is harbinger of confidence.”
     
  • “The SPX will hit 2000 via the mother of all short squeezes and dovish monetary policy whereas the RUT will not revisit the March 4 high this year. I'm in Mr. McCullough's no-growth camp with the exception that I believe that if the Fed pulls out or fails then the country will find that it has actually been in a depression and the growth seen in the past 5 years was solely because of the false bottom in the economy created by the Fed.”
     
  • “Easy money pushing stocks higher.”
     
  • “The global central banks will continue digitally printing money and artificially suppressing interest rates to push asset prices until there is a monetary crisis of some sort to force them to stop.”

SUBSCRIBE TO HEDGEYE.


Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

Hedgeye Retail: Columbia Sportswear Acquisition Priced High, But May Expand Offerings | $COLM

Takeaway: Price seems a bit rich, but we have to ask if Columbia Sportswear could enter this category on its own.

 Hedgeye Retail: Columbia Sportswear Acquisition Priced High, But May Expand Offerings | $COLM - prana vendorhome

 

Columbia Sportswear Company Completes Acquisition of prAna Lifestyle Apparel Brand

  • "Columbia Sportswear Company...today announced that at midnight, May 30, 2014 it successfully completed its previously announced acquisition of prAna Living LLC for a purchase price of $190 million in cash, subject to customary post-close working capital adjustments."
     
  • "Purchase price of $190 million, subject to customary post-close working capital adjustments, equates to approximately 13 times prAna's projected 2014 EBITDA."
     
  • "PrAna will remain headquartered in Carlsbad, California as a wholly owned subsidiary of Columbia Sportswear Company and will continue to be led by current CEO Scott Kerslake, who will report directly to Columbia president and CEO Tim Boyle."
     

Hedgeye Retail: Columbia Sportswear Acquisition Priced High, But May Expand Offerings | $COLM - chart3 6 3

Takeaway From Hedgeye’s Brian McGough:

Price seems a bit rich, but we have to ask if Columbia Sportswear could enter this category on its own. We think the answer to that question is no. PrAna helps Columbia Sportswear diversify its cold weather offering and gives it instant exposure to the women's yoga market. Overall, it’s a good acquisition for Columbia Sportswear getting a brand with solid distribution but limited awareness.

 

*     *     *     *     *     *

 

Editor's Note: This is a complimentary research excerpt from Hedgeye Retail sector head Brian McGough. Follow Brian on Twitter @HedgeyeRetail

Subscribe to Hedgeye.


Video | McCullough Answers Questions on the Euro, Consumer Spending, Inflation and More

Here's the question-and-answer portion from our daily institutional Morning Call hosted by Hedgeye CEO Keith McCullough and Senior Macro Analyst Darius Dale.



Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

next