“History is just one thing after another.”
I’m not sure who the attribution for the above quote goes to, but it does offer a nice little existential change of pace for the early AM global macro hombres.
The macro practitioners’ grind is just one data point and price tick after another.
If we’ve successfully employed our “communication tool” over the last six years, you’re gainfully aware that, at its core, our macro process operates as a hybrid model with our fundamental macroeconomic research dynamically informing our quantitative view of markets.
Reciprocally, as my colleague Darius Dale highlighted yesterday, we apply those top-down quantitative signals – which often front-run reported fundamental inflections - in a reflexive manner to our bottom-up qualitative analysis (e.g. our Growth/Inflation/Policy framework) in order to generate actionable investment ideas and themes.
Most of the time the fundamental and the quantitative are in accord, or harmonize on a small lag.
More rarely, the incongruency persists for an extended period. In those instances we default to the price/quantitative signal – in recognition that market prices are real-time leading indicators and that the market and the economy are not the same thing, particularly over shorter durations.
Theoretically, corporate earnings should reflect economic growth with the high end of sustainable earnings growth capped at potential GDP and the value of the stock market reflecting GDP, corporate earnings as % of that GDP, and the multiple investor’s put on those earnings. But that certainly doesn’t hold in the short run and it’s only approximately true over the long-term.
It’s the conflation of perceived fundamental trends into a convicted market call where economists turned strategists most often go awry.
Back to the Global Macro Grind…
In covering the domestic macro economy, the quasi-persistent discontinuity between the research (fundamental) and the risk management (quantitative) signals has been my reality for the last couple months.
Juxtaposing the current domestic labor market data (positive) against the prevailing price signals (bearish) provides a timely and tangible case study:
INITIAL CLAIMS: Rolling Initial Jobless Claims were just under 295K in the latest week, matching the best levels of the post-recession period. As we’ve highlighted, over the last two cycles rolling SA claims have run sub-330k for 45 and 31 months, respectively, before the corresponding market peaks in March, 2000 and October, 2007. We are currently in month seven at the sub-330K level in the present cycle. Further, over the last half century, the trough in initial claims has led the peak in equities and the peak in the economic cycle by 3 and 7 months, respectively. At present, we are still putting in the trough – with cycle precedents suggesting the economic peak is not yet imminent.
NFP: Monthly NFP gains have been solid on balance and, due to seasonal artifacts, even sequential slowdowns in net monthly payroll gains have been characterized by flat to rising employment growth on a year-over-year and 2Y average growth basis. At +1.93% YoY in September, Nonfarm Payrolls recorded their fastest rate of improvement since April 2006 and are in-line with peak growth in the last cycle. Similar to initial claims, peak monthly NFP gains lead the economic cycle by ~7 months. Whether the May-July NFP gains represented peak improvement remains to be seen.
JOLTS: Total Job Openings made a new 13 year high and the quits rate held at cycle highs in the August report released yesterday. Total hires moderated sequentially alongside the dip in NFP gains reported for August but is likely to re-accelerate to new highs in the September release. Historically, the Job Openings data leads accelerations in wage growth by about a year. The relationship has been muted vs previous cycles but with the NFIB’s compensation index making new highs, the share of short-term unemployed continuing to rise and labor supply (total available workers per job opening) tightening to pre-recession averages, wage inflationary pressures are percolating.
INCOME: The confluence of an accelerating employment base and flattish wage growth has driven an acceleration in disposable personal income growth over the last 5 months. Indeed, aggregate private sector salary & wage growth is currently running at +5.8% and holding at its best levels of the recovery outside of the peri-fiscal cliff period.
CREDIT: Consumer revolving credit declined at a -0.3% annualized pace in August according to Federal Reserve data released yesterday. The sequential decline wasn’t particularly surprising given the comps (the increase in July was the 2nd largest in 6.5 years) and the already reported retreat in spending on durable goods ex-defense and aircraft (ie. the stuff the average household buys). On a year-over-year basis, growth in credit card spending decelerated just -5bps from the 6 year high recorded in July.
In a Keynesian economy, total spending is cardinal, and income and credit is predominate. You can spend what you make (income) and you can spend what you don’t make (credit) and, with both income and credit accelerating presently, the underlying trends in both are positive.
The caveat has been that while the capacity for consumption growth has improved alongside accelerating income growth, actual household spending has not because the savings rate has shown a commensurate increase.
So, while reported consumption growth remains middling, it’s hard to characterize accelerating income growth, a rising savings rate and moderate credit growth alongside increased investment as fundamentally negative.
Transitioning to the price signals, which paint a contrasting picture for the prospects of forward growth. Keith has hit the boards hard in highlighting these, but to briefly review:
10Y Yields: 10Y bond Yields are down -69 bps YTD (-23%), the yield spread (10’s-2’s) continue to compress and inflation expectations are collapsing – all of which are discretely bearish growth signals.
Russell 2K: The Russell is down -7.5% YTD with the rotation out of growth style factors and small Cap Illiquidity accelerating over the last month+ - again, not a growth-accelerating signal . The Russell 2000 is immediate-term TRADE oversold around 1076, but remains in a Bearish Formation.
Consumer: The XLY is the worst performing sector YTD (-1.84%), underperforming the S&P500 by 6% as real median income growth continues to trend negative and the bottom 60% remain very much income constrained. Also in Bearish Formation.
Housing: The ITB is down -9.1% YTD with housing sitting as one of the worst performing asset classes globally. We have been bearish on housing since the end of 2013 and continue to believe housing related equities underperform, trading sideways-to-down, alongside ongoing deceleration in HPI trends.
ROW: The EU and Japan are in discrete deceleration, China is not an upside catalyst, EM markets are flagging alongside dollar strength and the US is already past the mean duration of expansions over the last century. The IMF marked its (still too optimistic) global growth forecast lower yesterday and growth estimate revision trends over the last quarter across both developed and EM markets have been almost universally negative. Further, the disinflationary trends prevailing globally only add to the Feds Sisyphean fight towards sustained, above target CPI and core PCE inflation.
From a Hedgeye modeling perspective we are entering Quad #4 which is characterized by both growth and inflation slowing from a 2nd derivative perspective and a generally dovish policy response. A sequential slowdown in GDP in 3Q14 from the near 5% in 2Q14 is almost as inevitable as the sequential acceleration from the worst post-war expansionary period GDP print ever in 1Q14. Whether that manifests into a protracted slowdown domestically remains TBD.
Markets are discounting an increasing probability of a more enduring deceleration and are, at the least, refuting consensus’ laughably linear straight-lining of 3% growth into perpetuity.
May the wind be always at your back.
May the sun shine warm upon your face.
May your fundamental and quantitative signals always be in accord.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.35-2.46%
WTI Oil 86.92-91.39
To cognitive dissonance, its ubiquity and successful management,
Christian B. Drake
TODAY’S S&P 500 SET-UP – October 8, 2014
As we look at today's setup for the S&P 500, the range is 30 points or 0.26% downside to 1930 and 1.29% upside to 1960.
CREDIT/ECONOMIC MARKET LOOK:
- YIELD CURVE: 1.85 from 1.83
- VIX closed at 17.2 1 day percent change of 11.25%
MACRO DATA POINTS (Bloomberg Estimates):
- 7am: MBA Mortgage Applications, Oct. 3 (prior -0.2%)
- 8:30am: Fed’s Evans speaks in Plymouth, Wis.
- 10:30am: DOE Energy Inventories
- 1pm: U.S. to sell $21b 10Y notes in reopening
- 2pm: Fed releases minutes from Sept. 16-17 FOMC meeting
- Senate, House out of session
- FCC deadline for replies on CMCSA/TWC Deal
- 10am: Supreme Court to consider arguments on whether workers at Amazon.com warehouses must be paid for time spent in security screenings after they clock out
- 2:30pm: Chinese Vice Minister of Finance Guangyao Zhu speaks at Peterson Institute talk on China-U.S. economic relations
- 4:30pm: Former Fed Chairman Ben Bernanke speaks on future of global economy at World Business Forum
- U.S. ELECTION WRAP: Kansas May Set New Trend; S.D. Crooning
WHAT TO WATCH:
- U.S. Said to Ready Charges Against Banks, Traders in FX Case
- Symantec Said to Explore Split Into Security, Storage Businesses
- Valeant Said to Plan Raising Allergan Bid Near December Vote
- Yum Cuts Profit Forecast as Chinese Food Scare Weighs on Sales
- Costco Profit Tops Estimates as Same-Store Sales Increase
- Russia Buys Rubles for a Third Day While Shifting Trading Band
- Marchionne Says He’s ‘Done’ After 2018 Plan for Fiat Chrysler
- Kurdish Protests Roil Turkey as Islamic State Attacks Kobani
- Facebook to Let Advertisers Target Users Based on Locations
- SolarCity to Finance Rooftop Systems in Shift From Leasing Model
- Chimerix’s Antiviral Drug Improved Survival in Josh Hardy Study
- Bard Said to Pay $21 Million in First Big Vaginal-Mesh Accord
- World Growth Eclipses Dollar as Concern for Lew, Manufacturers
- 18 Banks Said to Adjust Derivatives Contracts Practices: FT
- Fed Needs Plan to Sell Mortgage-Backed Assets, Lacker Says: WSJ
- San Francisco Supervisors Agree to Legalize Airbnb: SFGate
- Blackhawk (HAWK) 8:30am, $0.03
- Jean Coutu (PJC/A CN) 7am, C$0.29
- Monsanto (MON) 8am, $(0.24) - Preview
- RPM Intl (RPM) 7:30am, $0.78
- Alcoa (AA) 4:03pm, $0.22 - Preview
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- London Metal Exchange Wins Appeal Over Rusal Warehouse Ruling
- Brent Drops to 27-Month Low on IMF Growth Cut; WTI Declines
- Gold Climbs on Demand From China After Holiday; Platinum Rallies
- Corn Retreats in Chicago as U.S. Harvest Seen Exceeding Forecast
- Narrow Price Gap Opens Door for African Oil Exports to U.S. East
- Arabica Coffee Slides in New York on Speculation of Brazil Rain
- China Steel Demand May Slow as Economy Becomes More Sustainable
- OIL DAYBOOK: EIA Crude Build Fcast; OPEC Basket Drops Below $90
- Northeast U.S. Homes to Pay Higher Prices for Less Gas in Winter
- Commodity ETP Outflows Totaled $1.8 Billion in Sept: Blackrock
- Gold With Iron Ore Seen Least Preferred Metals by Morgan Stanley
- OPEC Crude Below $90 Won’t Spur Immediate Output Cut: Julian Lee
- Nickel to Aluminum Decline on Demand Concern as IMF Cuts Outlook
- Indonesia Seen Losing $20B Mining Investment on Political Risk
- Rusal Says Will Seek to Appeal U.K. Court Ruling on LME Today
The Hedgeye Macro Team
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It looks like average daily table revenues (ADTR) fell 30% YoY in the first days of October and not the 40% as some initial reports indicated. Either way, ADTR of only HK$1.17 billion vs. HK$1.68 billion for the first 6 days of October 2013 was disappointing. The 2nd half of this October will be quite volatile as there were placeholder weeks in October 2013. We are estimating full month October GGR to fall 15-20% YoY.
High rollers continue to be relatively sparse during Golden Week, affecting VIP volumes. It doesn't help that hold was below average as well; Grand Lisboa saw negative hold for a few days and WYNN/GALAXY/Four Seasons also had bad luck during Golden Week.
Some smoking tidbits we're hearing:
SCL had designated the Four Seasons Plaza entire casino Premium mass but because no smoking parlors are set up, the place is entirely non-smoking. Construction of yet to be approved smoking parlors may disrupt the small casino floor.
COD smoking rooms operational but not officially approved by Health Bureau
In terms of market share, we think low hold may have played a small role – Wynn Macau held poorly – but volumes were the main culprit overall. Wynn Macau also held low in Golden Week 2013.
We typically introduce the Hedgeye Industrials research process using the shipbuilding cycle and industry structure as an illustration. The discussion typically goes something like “after WWII, war related tonnage was converted to commercial use, but ships last for only, give or take, 30 years, so there was a replacement cycle in the mid-1970s”…and so on. But shipbuilding is not just an example of a capital equipment cycle and a flawed industry structure, it has also been, and will likely continue to be, a once in a career short opportunity.
Beyond the Fishfinder updates, we have only written on shipbuilding occasionally because not much happens that is relevant to our thesis. Basically, our view is that shorting South Korean shipbuilders should work for several years; the next move for investors is to buy Chinese shipbuilders in roughly 2030 (only partly kidding). Recently, however, there has been more action.
Industry Structure: Extremely Fragmented, Government Subsidized
We focused on Samsung Heavy in our launch deck and subsequent notes because it had fewer non-shipbuilding exposures. Samsung Heavy shares have dropped about 45% in the past year, significantly underperforming the KOSPI. Below, we provide some updates.
- Chinese Shipbuilder ‘Bailout’: Excess shipbuilding capacity has largely been of a massive ramp in Chinese capacity. To us, it has become clear that China isn’t exactly planning to layoff shipbuilding employees. For instance, the handling of China Rongsheng, a theoretically private competitor, has consisted of local government support for the company while it does a restructuring analysis due in mid-2015. Apparently, the government is looking to merge the shipbuilder with a financially stronger competitor at some point, but maybe not. This is consistent with our view that the industry is more of an employment project than a viable profit center. Excess Chinese capacity will likely continue to weigh on industry pricing.
- Pressure on Margins, Pricing: SHI’s orders have been below management expectations this year and excess capacity has pressured industry pricing. Given the intense competition in standard ship categories, Samsung Heavy and others South Korean builders have competed for complex offshore energy-related orders (drill ships, FPSOs, etc). Unfortunately, the margin on these complex ships has been poor. Costs and schedules have proved more difficult to forecast than those of more traditional products. As a result, SHI’s margins have suffered so far in 2014. We would expect that earlier orders in backlog carry better pricing than current orders, setting the stage for ongoing margin pressure.
- Not Just Samsung Heavy: Obviously, Chinese shipbuilders are experiencing stress, but other South Korean firms have also seen margin degradation.
- Last Time It Took 13 Years To Bottom: The global shipping fleet is young, having just completed a replacement cycle. Energy and bulk commodity prices have seen pressure in recent months, with customers in those end-markets driving demand. We expect pricing pressure from weak demand, excess capacity, and government subsidization to depress SHI’s profitability for years. In the last replacement cycle, deliveries peaked around 1975 and bottomed in roughly 1988.
- Low Profitability, Except During Peak Demand: Aside from the boom years of the replacement cycle, shipbuilding seems more like an employment scheme than a profit-making enterprise.
- Still Lots of Value to Lose: Given that the South Korean shipbuilding industry has lost significant ground to Chinese competitors in the last decade, we would expect valuations to compress below pre-boom norms. We also expect that Chinese shipbuilders will further develop capability in drill ships, FPSOs, and other more specialized vessels.
- Prior Valuation Range: We continue to think that our June 2012 launch deck valuation range for Samsung Heavy is still reasonable. The shares are now below our “Best” case scenario, however, but have downside to the “Optimistic Base” case.
- Over-Sold & Inheritance Tax Issue: We are not expert in the Samsung inheritance tax issue, but it seems clear that minimizing shareholder value may be a short-run priority. The shares have declined precipitously in the past year, and it might be best to wait for a bounce to press the short or initiate a position. The tax liability may be a fruitful topic for further analysis.
- Overseas Plant Addition: Samsung Heavy has announced plans to add an overseas facility in a location with lower labor costs. Vietnam, Indonesia, and Malaysia are apparently under consideration. The plant would cost $950 million and focus on lower value ships. In an industry awash in excess capacity for less complex vessels, this seems a bizarre idea at best.
- Merger with Samsung Engineering: The merger with Samsung Engineering, an engineering & construction company with exposure to the Energy sector, makes a bit more sense than the addition of overseas capacity (almost anything would). That said, it is difficult to see how the minor cost synergies would offset the customer perception problems that may result.
We continue to believe that Samsung Heavy is, well, somewhat doomed and that the shipbuilding industry is good hunting for shorts. While SHI may have a numerically substantial backlog, the margin on that backlog need not be good or even positive and a portion is pass-through. SHI’s plan to add capacity and merge with Samsung Engineering looks like a strategy developed by a flailing capital intensive enterprise caught in a long downcycle. That said, the inheritance tax issue, pressure on commodity prices, and sell-off in the shares would probably leave us looking for a bounce (like the one CAT recently completed) to press or enter a short. While we expect the shares to eventually trade much lower, we might wait for a better short-run entry point.
(Interested readers should feel free to ping us for our earlier materials.)
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