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SLOWING GROWTH, ACCELERATING INFLATION, & LOW VOLATILITY

Client Talking Points

JAPAN

So, what gives in Japan? Inflation! CPI in Japan accelerated +3.4% year-over-year.  This was the highest pace in 32-years for Japanese inflation. The fact of the matter is that the Japanese will tell you that once you factor out the sales tax impact, there was actually a slight drop in CPI.  That said, even the Japanese labor market is showing inflationary signs as the jobs-to-applicants hit a 22-year high at 1.09.  

VIX

Robert E. Whaley, a professor at Vanderbilt University’s business school, who is credited with developing the VIX for the Chicago Board Options Exchange in 1993, had this to say about the VIX being literally at an all-time low, “I wouldn’t be worried about it.” While Professor Whaley, aka the “Father of the VIX,” isn’t worried, that’s not necessarily a reason for us not to be worried.  The risk range for the VIX this morning is 10.61-12.94.

The U.S. FED

The Fed’s balance sheet continues inflating at an almost staggering rate. In total, the Fed’s balance sheet is at an astounding $4.4 trillion.  Certainly, tapering is slowing the growth of these assets on the Fed’s balance sheet, but what, exactly, happens when the Fed starts to sell these assets?  At over 25% of GDP, it is worth sniffing around this question.

Asset Allocation

CASH 14% US EQUITIES 6%
INTL EQUITIES 15% COMMODITIES 24%
FIXED INCOME 26% INTL CURRENCIES 15%

Top Long Ideas

Company Ticker Sector Duration
HOLX

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.

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.

LM

Legg Mason reported its month ending asset-under-management for April at the beginning of the week with a very positive result in its fixed income segment. The firm cited “significant” bond inflows for the month which we calculated to be over $2.3 billion. To contextualize this inflow amount we note that the entire U.S. mutual fund industry had total bond fund inflows of just $8.4 billion in April according to the Investment Company Institute, which provides an indication of the strong win rate for Legg alone last month. We also point out on a forward looking basis that the emerging trends in the mutual fund marketplace are starting to favor fixed income which should translate into accelerating positive trends at leading bond fund managers. Fixed income inflow is outpacing equities thus far in the second quarter of 2014 for the first time in 9 months which reflects the emerging defensive nature of global markets which is a good environment for leading fixed income houses including Legg Mason.

Three for the Road

TWEET OF THE DAY

More than a fourth of QSR users engage with at least one QSR on social media sites. pic.twitter.com/SPwRhr6VMA

@HedgeyeHWP   

QUOTE OF THE DAY

“Most of the important things in the world have been accomplished by people who have kept on trying when there seemed to be no hope at all.”

-Dale Carnegie

STAT OF THE DAY

Nike’s Gross Margins were up 169bps to 45.6%, its highest rate in 4-years.


CHART OF THE DAY: Japan Gets Its Inflation

Takeaway: CPI in Japan accelerated +3.4% year-over-year, the highest pace in 32-years. Japanese bureaucrats wanted inflation. Now they've got it.

 

CHART OF THE DAY: Japan Gets Its Inflation - Chart of the Day


Pepé Le Pew

“Keep it simple. Tell the truth.  People can smell the truth.”

-Steve Wynn, Chairman & CEO of Wynn Resorts

 

I ran over a skunk on the way to work this morning.  Accidentally, of course. But regardless it still did not smell very good.  That’s the thing with skunks; they sort of surprise you with their malodorous nature. 

 

For those of you that don’t know him, Pepé Le Pew is a French cartoon character that was first introduced in 1945.  Pepé is a French skunk who strolls around Paris looking for love.  Unfortunately, he has two big things going against him.  First of all, he’s a skunk, so he smells.  Second, he’s a tad bit aggressive and reluctant to take no for an answer.

 

Pepé Le Pew - skunk2

 

Now if that sounds a little bit like the U.S. equity market right now, it probably should. As we’ve been flagging here at Hedgeye (somewhat “aggressively” at times) volatility in the U.S. is at a level that is signaling that all is well in the world. Between you and me, that kind of stinks.

 

I read an interesting article in the Wall Street Journal (Media 1.0) yesterday discussing the volatility and the VIX.  It quoted Robert E. Whaley, a professor at Vanderbilt University’s business school, who is credited with developing the VIX for the Chicago Board Options Exchange in 1993.  Here’s what he had to say about the VIX being literally at an all-time low:

 

“I wouldn’t be worried about it.”

 

Indeed.  And if an aggressive skunk happens to be pestering you in Paris, no need to worry about that either.

 

Back to the Global Macro Grind

 

While Professor Whaley, aka the “Father of the VIX,” isn’t worried, that’s not necessarily a reason for us not to be worried,  despite the fact that this morning, the global equity markets are decidedly not worried.  China is down -0.11%, Europe is up small, and the U.S. equity futures are down small.  Frankly, the only excitement overnight is that the Nikkei in Japan is down just over a -1%.

 

So, what gives in Japan? Are you sitting down? Inflation! Yup, Japan, the home of generational deflation, is actually experiencing inflation.  In fact, CPI in Japan accelerated +3.4% year-over-year.  This was the highest pace in 32-years for Japanese inflation. The Japanese bureaucrats wanted inflation. Now they've got it.

 

The fact of the matter is that the Japanese will tell you that once you factor out the sales tax impact, there was actually a slight drop in CPI.  That said, even the Japanese labor market is showing inflationary signs as the jobs-to-applicants hit a 22-year high at 1.09.  In theory, a tight labor market should lead to increased wages and eventually more purchasing power for the consumer. Translation? Organic inflation.

 

Ultimately, the challenge with either inflation driven by a tight economy or, conversely, driven by overly dovish monetary policy is that inflation slows growth.  In the U.S., the counter argument to our view that inflation will slow grow is that even though the CRB Commodities index is up double digits on the year, commodities are a relatively small portion of the consumer’s annual spend. In part this is true, although much less so in emerging economies.

 

In fact, the WSJ this morning referenced the “fragile five” economies of Turkey, India, Indonesia, South Africa, and Brazil as economies that are particularly subject to the negative impact of commodity inflation.  The challenge with trying to fight inflation for the central banks in these countries is that growth is not at abnormal levels, so any rate hikes would slow it even more. Yes, indeed, monetary inflation stinks!

 

Speaking of inflation, the Fed’s balance sheet continues inflating at an almost staggering rate:

 

  • Holdings of US Treasury securities were $2.4T on 25-Jun, +$5.5B w/w and +$469B y/y;
  • Holdings of mortgage-backed securities were $1.7T on 25-Jun, ($4.5B) w/w and +$456B y/y; and
  • Holdings of federal agency debt securities were $43.7B on 25-Jun, unch. w/w and ($27B) y/y.

In total, the Fed’s balance sheet is at an astounding $4.4 trillion.  Certainly, tapering is slowing the growth of these assets on the Fed’s balance sheet, but what, exactly, happens when the Fed starts to sell these assets?  At over 25% of GDP, it is worth sniffing around this question.

 

As it relates to GDP, my colleague Darius Dale wrote a very thoughtful note earlier this week that again emphasized that the Fed is “always wrong on growth.”  Specifically, since 2012 the Fed has been wrong on growth by an average of 113 basis points.  No small potatoes. The takeaway from the Fed (and virtually all of Wall Street) being wrong on growth is that Fed may actually surprise us with its dovish policy.  As Darius writes:

 

“As it relates to actual macroeconomic analysis, the doves are definitely starting to cry at the Fed. In a fantastic article today, Reuters journalist Howard Schneider walks though the current debate being held amongst members of the Federal Reserve and its regional banks. Specifically, the Yellen-led institution is openly debating pushing out their forecasts for labor market tightness, citing both new and old analyses in the process.

 

The key takeaway is that the FOMC is setting up to surprise both buy-side and sell-side consensus to the downside with respect to tightening monetary policy. A less-tight labor market in the interim means the Fed can remain “accommodative” for longer – which is exactly what is being priced into the interest rate markets. Expectations for a 2015 Fed Funds Rate hike are down -27% on average, across the curve, from when we correctly introduced this bold prediction back in JAN.”

 

Slowing U.S. growth… accelerating inflation… low volatility… Yup, it might make sense to your nose right now.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.46-2.60% (bearish)

SPX 1 (bullish)

VIX 10.61-12.94 (neutral)

USD 80.01-80.45 (bearish)

Brent Oil 112.38-115.49 (bullish)

Gold 1 (bullish)

 

Keep Your Head Up,

 

Daryl G. Jones

Director of Research

 

Pepé Le Pew - Chart of the Day


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Expert Call: Geopolitical Outlook in The Energy Space

Expert Call: Geopolitical Outlook in The Energy Space - 06.25.14 Expert Call Logo

 

We will be hosting an expert call featuring Dr. Meghan O'Sullivan, Kirkpatrick Professor of the Practice of International Affairs and Director of the Geopolitics of Energy Project at Harvard University's Kennedy School. The call will be today at 1:00pm EDT.

 

CALL OBJECTIVE

To highlight the interconnectedness and progressive implications of recent geopolitical tension in the global energy space.

 

KEY WILL TOPICS INCLUDE:

  • Regional consequences of an ISIS advance in Iraq
  • Russian energy influence and its geopolitical undercurrent 
  • High level overview on the implications for the U.S. oil and gas boom

 

CALL DETAILS

  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 923285#

Ping  for more information.

 

 

ABOUT PROFESSOR MEGHAN O'SULLIVAN

Meghan served as special assistant to George W. Bush and National Security Advisor for Iraq and Afghanistan from 2004-2007. She has spent two years in Iraq, most recently in the fall of 2008 at the conclusion of the security agreement and strategic framework agreement between Washington and the government of Iraq. Prior to her current post, Meghan was a senior director for strategic planning and southwest Asia in the NSC as well as political advisor to the coalition provisional authority administrator and deputy director for governance in Baghdad.

 

She is currently an adjunct senior fellow at the Council on Foreign Relations, a consultant to the National Intelligence Council, and a strategic advisor to John Hess, the Chairman and CEO of Hess Corporation. She is also a foreign affairs columnist for Bloomberg View as well as a member of the Council of Foreign Relations, the Trilateral Commission, and the Aspen Strategy Group. O'Sullivan has published several books and articles on American Foreign Policy and has been awarded the Defense Department's highest honor for civilians, the Distinguished Public Service Medal. Esquire Magazine named her one of the most influential people of the century. 

 

Dr. O'Sullivan received a B.A. from Georgetown University, a Masters of Science in Economics and Doctorate in Politics from Oxford University.


LEISURE LETTER (06/27/2014)

Tickers: 27:HK, CZR, MPEL, PENN, WYNN

EVENTS:

  • Friday, June 27 Las Vegas May revenues

COMPANY NEWS

27:HK / Galaxy  – Lui Che Woo, founder and chairman of Galaxy, said he expects company net profits to grow in 2015 by as much as 50% YoY thanks to the opening of Phase 2 of Galaxy Macau.

Takeaway: Phase 2 will benefit Galaxy more than some investors think.  500 more tables are coming.

 

CZR – Caesars Entertainment announced (via WARN Act letters which give employees at least 60 days' notice of a planned business closure) it will close the Showboat Atlantic City hotel and casino. The closure of the property is not unexpected as CZR CEO Gary Loveman previously commented that some additional gambling facilities in Atlantic City would need to close.  

Takeaway: Atlantic City missed its opportunity to be relevant a long time ago.  The expansion of gaming across the Mid-Atlantic and Northeast has only served to exacerbate Atlantic City's woes... Unfortunately, New Jersey Governor Christie's dream for an Atlantic City turnaround might simply be too optimistic and not based on economic reality.

 

Interlot – signed a four-year contract extension with the New Hampshire Lottery Commission carrying service through June 30, 2020. Intralot will continue to provide its lottery gaming system for the operation of terminal-based games, the management of instant games and support of the retailer network. During fiscal year 2013, New Hampshire Lottery sales were more than US$280 million while also awarding more than US$174.4 million in prizes. 

Takeaway:Another win for Interlot!

 

MPEL – is selling 100% of the issued shares of Dreamworld Leisure Ltd to Ban Kea, a Cambodian citizen, for US$500,000. The purchaser is a family relative of Entertainment Gaming’s partner in Cambodia. The sale includes all assets of Dreamworld Leisure with the exception of all electronic gaming machines, and prohibits any use of the Dreamworld brand name by the buyer. The company owns and operates Dreamworld Pailin, a casino with 26 gaming tables in the Pailin province of northwestern Cambodia, near the Thailand border. It also operates Dreamworld Poipet, a standalone slot hall in an existing casino in Poipet. The move comes as the government in Cambodia is in the process of amending its gaming laws in an effort to draw major casino operators.

Takeaway: Small disposal for MPEL

 

PENN - Argosy Sioux City will be allowed to stay open through July 10, the date the Polk County District Court scheduled a hearing to consider PENN's arguments against the previous Iowa Racing and Gaming Commission order to cease operations on July 1.

Takeaway: A near term win.  Remember, PENN's guidance assumes Sioux City ceases operations on June 30. 

 

WYNN – (GGRAsia) Tokyo’s high court rejected Kazuo Okada’s appeal against a lower court’s dismissal of a defamation lawsuit he filed versus WYNN.  In a statement, the High Court reiterated the case should not be handled by a Japanese court.

Takeaway: As expected and not surprising.

INDUSTRY NEWS

Korean Tensions – North Korea fired three short-range rocket yesterday into the waters off its east coast. The launch was most likely a routine test-firing, but government officials also believe the launch/test firing could also be meant to stoke tensions with Seoul (South Korea).  News reports indicated the rockets flew about 190 kilometers (120 miles) before harmlessly landing in the water. The rockets were fired from North Korea's eastern port city of Wonsan.

Takeaway: The escalating tensions between North and South Korea as well as on going military exercises near the South Korean territorial islands may service as a near term tourism headwind.

 

Macau Traffic (Jornal Tribuna de Macau) Macau has twice as many tourist coaches as buses - 1,698 tourist coaches were on the road at the end of April, including those used as shuttles as compared to 801 city buses deployed on scheduled services. Government policy is to curb any increase in the number of tourist coaches, and to have them used more efficiently, in view of the traffic congestion they cause.

Takeaway: We witnessed the significantly worse traffic congestion during our recent trip and all the more reason to get the Light Rail Transit system operational.

LEISURE LETTER (06/27/2014) - macau coach

 

Hotel Portfolio Transaction – Katara Hospitality, the Qatar-based global owner, developer and operator of iconic hotels, announced the acquisition of five properties in key European cities from a private investor including: the InterContinental Carlton Cannes, the InterContinental Amstel Amsterdam, the InterContinental Madrid, the InterContinental Frankfurt, and the lease hold interest in the InterContinental De La Ville Rome. The acquisition brings Katara Hospitality’s global portfolio to 32 hotels operational or under development, topping its long-established goal of 30 properties by 2016. Katara now has properties or projects in 14 countries, with a total of 7,103 rooms operational or under development.

Takeaway: Continued demand for high quality lodging assets by sovereign wealth funds.

 

Sales of German agencies fall 3.6% in May (Hostelur) 

German agencies saw its sales fall 3.6% in May.  Sales of tourism products (hotels and packages) fell 8.3% in May, a stark contrast to April's gain of 14%.

Takeaway: Leisure business in Germany continues to be choppy.

 

Danube Cruises affected by low water levels (Cruise Critic)

At least 20 river cruises have ben affected by lower than normal water levels on the Danube and Elbe rivers.  Riviera Travel and Viking Cruises are two of the affected parties.

MACRO

Hedgeye remains negative on consumer spending and believes in more inflation.  Following  a great call on rising housing prices, the Hedgeye Macro & Financial teams are 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.


Giddy Up

This note was originally published at 8am on June 13, 2014 for Hedgeye subscribers.

"The responsibility of the government is to have a stable currency. This kind of stuff that you’re being taught at Princeton disturbs me."

-Paul Volcker, May 2014

 

It’s that time of year again!

 

Time to round up the buds, pony up the $2K cost of admission, saddle up and ride for downtown Baltimore.  Last week’s Triple Crown failure at Belmont was really just the warm-up for the real equine extravaganza - BronyCon 2014.   

 

BronyCon, if you are unaware,  is a now annual, multi-day conference in which thousands of grown men come to share in their passion for My Little Pony.   

 

Yep, while still in the throes of a working-class recession, thousands of men incur substantial real and opportunity costs to travel across the country with the explicit objective of hanging out with other men and basking in their collective love for the 1980’s toy designed for little girls.  

 

#BronyCon prep – if you didn’t know why there’s been fumes for market volume, now you know. 

 

Giddy Up - bronycon

 

Back to the Global Macro Grind, quickly……

 

In a research note yesterday we discussed the collective cognitive dissonance in the consensus outlook for accelerating consumption growth in the face of an emergent avalanche of disconfirming evidence (See: COGNITIVE DISSONANCE: DEATH BY A THOUSAND DATA POINTS)

 

To reprise the heart of that note:

                                                                                                                                 

After yesterday’s negative revision to 1Q14 GDP, this morning’s retail sales data should serve as another blow to forward growth expectations. 

 

While full year growth estimates continue to get clipped with regular frequency, the collective cognitive dissonance over the outlook for consumption - in the face of overtly middling data - remains very much entrenched.  

 

Indeed, looking across our Economic Summary table (Chart of the Day below), the amount of sequential Worseningcontinues to belie the “accelerating recovery” narrative and sticky, 4%’ish, consensus GDP estimates. 

 

We did see a modest, expected bounce across the breadth of manufacturing/confidence/labor data into 2Q and reported growth will accelerate sequentially but, essentially, we are what the numbers suggest. 

 

 Take the average of (soon to be revised lower) 1Q14 gdp and the (overly optimistic) 2Q14 estimate:    (-2.0%  + 3.5%) /2 = More Muddle

 

On balance, the 2Q numbers to-date have been ‘okay’ but do not reflect a material acceleration nor any significant rebound demand from deferred 1Q consumption. 

 

In their House of Debt blog yesterday, Professors Atif Mian and Amir Sufi echoed our interpretation of the May Retail Sales data in rightly highlighting the following:

 

Over the past two years, nominal spending growth has been about 3% on a year-over-year basis. But if we exclude auto sales, the numbers are much worse, especially for 2014. Spending excluding autos in the first four months of 2014 has been less then 1.5% nominal, which implies a decline in real terms. This includes March and April, so it is hard to argue that weather alone explains this weakness.

 

*Note:  Mian and Sufi are solid new school, econ researchers.  Their new book, House of Debt, should definitely be on your macro reading list.

 

In short, the current domestic macro reality is that with Inflation accelerating (food, shelter, energy), housing decelerating, the labor market middling, and tougher growth/inflation comps through 3Q14, the intermediate-term trend for consumption growth is one of deceleration.   

 

Further, with savings rates already near historical trough levels and the spread between spending growth and earnings growth having already re-expanded in the last two quarters, the upside for consumption growth remains quite constrained. 

 

How do you keep the rate of change in consumption growth increasing when spending is already growing at a positive spread to earnings…..credit growth, baby!

 

One data point we’ve highlighted recently was the marked acceleration in revolving consumer credit in April.  

 

Revolving Consumer Credit:  The Fed G.19 data for April showed US revolving consumer credit balances rose at a month-over-month annualized rate of +12.3%, the fastest rate of growth since 2001.

 

The extent to which this data point is relevant depends on your broader view of credit:    

 

Does Credit Matter?  According to the latest Fed Flow of Funds data there is ~$57T in aggregate U.S. Credit Market Debt.  This compares with a monetary base of ~$3T and nominal GDP of ~$17T – equating to dollar leverage (ie. obligations to pay dollars) of ~19.3X and a total debt-to-income ratio of ~3.4X.  Obviously, credit matters and the slope of credit growth remains the marginal driver of spending growth in a modern, developed economy.   

 

So….

 

Where are we in the credit cycle?  Household debt-to-GDP currently sits at 77.2%, down from the March 2009 peak of 95.6%.   At this point, we’ve roughly re-traced back to the debt level that existed in 2000 - before debt growth decoupled from consumption growth and went exponential - but we’re still significantly above the long-term average of ~55%.   Notably, Household debt-to-GDP ticked up in 1Q14 for the first time in 20 quarters. 

 

The Credit Edifice:  At a most basic level, household credit growth is largely a function of the rich lending to the non-rich.  An economic edifice built on lending growth at the middle and low end to drive incremental end demand faces an inherent challenge at the end of a long-term credit cycle and amidst growing inequality perpetuated by monetary policy aimed at financial asset inflation.   

 

If the lower 60%+ of households don’t own financials assets, remain over-encumbered, still haven’t recouped the wealth loss from the Great Recession, and are getting squeezed by rising commodity and shelter prices, are they really incentivized, or in a position to incur incremental debt?

 

Maybe, but it’s likely that incremental leverage is largely involuntary, non-productive in its deployment and /or hyper-transient.  The household sector certainly hasn’t delevered enough to start another ‘credit cycle’ and, critically, zero bound rates and demographic trends are antithetical to those prevailing at the start of the 30Y cycle that began in 1981.  

 

Further, the spike in credit card debt in April occurred alongside very weak consumer spending and housing data – weakness that extended into May.   Tapping credit to purchase everyday essentials because cost inflation is running at multiples of income growth is not reflective of a resurgent consumer driving an accelerating, sustainable consumption recovery. 

 

The thought train above is very “secular stagnation-y” and more of an early morning macro musing  than a refined conclusion ‘endorsed by Hedgeye’. But that’s okay – the early distillation of macro noise generally begins with an initial pass through a common sense filter, then more questions.  

 

On a less dismal note, as we head into daddy day, feel heartened that new, not-so-Ivory Tower voices like those of Mian and Sufi are finding traction and established voices like Volcker continue to stand unabashedly counter to crony conventionalist, economic thought. 

 

…..Although you may feel equally disheartened that the best seats at BronyCon are already sold out – try to enjoy the weekend anyway.  

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 2.44-2.64%

SPX 1913-1951

RUT 1140-1175

VIX 10.73-13.33

WTI Oil 103.88-106.99

Gold 1253-1286 

  

Christian B. Drake

Associate

 

Giddy Up - chartofday 


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