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Takeaway: China’s 3Q/SEP economic data confirms our view that global growth is slowing and will likely continue to slow through at least year-end.

Contextualizing China’s 3Q GDP Print

This we know: Chinese economic data is, at best, massaged and, at worst, fabricated (as confirmed by Chinese Premier Li Keqiang years ago). In fact, we’d argue Chinese economic data is probably about as massaged as any pre-election Jobs Report is likely to be in the US!


Still, in the context of our process of focusing primarily on slopes, inflections and deltas when analyzing economic data, we are more than happy to compare any data point to the previous data point(s), so long as the data series itself is methodologically consistent.


In that light, it doesn’t matter to us if China’s “actual” real GDP growth is +7.3% YoY (NBS for 3Q14) or the +3.9% forecasted by the Conference Board’s 2020-2025 Chinese growth outlook. All we care about is any directional deviation from trend – which is what actually matters to investors, per the preponderance of Dr. Daniel Kahneman’s work in the field of behavioral economics (e.g. anchoring, prospect theory, etc.).


From that perspective, China’s 3Q14 real GDP growth rate of +7.3% is:


  • The slowest rate of change since 1Q09;
  • Is -1.1 standard deviations from its trailing 3Y average; and
  • Is in the 5th percentile of readings on a trailing 10Y basis.


4Q Looks Dour as Well

From a forward-looking perspective, a marginally difficult base effect, slowing sequential momentum and seasonality are all supportive of continued trend-based slowing in the preponderance of China’s reported growth data here in 4Q – whatever underlying unit demand may be.






Diving deeper into the aforementioned point regarding slowing sequential momentum, our analysis of the data shows a Chinese economy continuing to lose steam without a meaningful enough change in either monetary or fiscal policy to support any semblance of a sustained inflection (i.e. 2-3 months or more).


For example:


  • As of mid-OCT, the 2M moving average of the arithmetic mean of the YoY % change in monthly average iron ore, rebar and coal prices – our favorite real-time indicator for the slope of Chinese growth – continues to crash on a YoY basis and is decelerating versus its trailing 3M, 6M and 12M trends.
  • As of SEP, China’s headline PMI data and each of its 10 sub-indices are decelerating versus their respective trailing 3M trends. China’s trade balance tells a similar tale; it too is decelerating both sequentially and versus its trailing 3M and 6M trends.
  • As of SEP, various measures of “hot money” capital flows are decelerating both sequentially and versus their respective trailing 3M, 6M and 12M trends.
  • The NBS’s Business Cycle Signal Index, Coincident Economic Indicator, Consumer Confidence Index and Leading Economic Indicator each decelerated sequentially in SEP.
  • As of SEP, growth in retail sales has decelerated both sequentially and versus its trailing 3M, 6M and 12M trends. This is especially troubling considering the fact that household consumption has overtaken investment amid structural rebalancing efforts (“C” = 48.5% of GDP in the YTD vs. 41.5% for “I”).
  • In the YTD through SEP, growth in fixed assets investment decelerated both sequentially and versus its trailing 3M, 6M and 12M trends.
  • On the positive side of the ledger, growth in exports, FDI, imports, industrial production and total social financing has accelerated both sequentially (in SEP) and versus their respective trailing 3M trends.






Looking to the Chinese property market – which accounts for ~15% of Chinese GDP directly and materially affects some 40 industries – our analysis shows continues weakness there as well:


  • As of SEP, growth in the availability of funding in the real estate sector decelerated both sequentially and versus its trailing 3M, 6M and 12M trends.
  • As of SEP, growth in both the nominal value and square footage of property purchases decelerated sequentially and versus their respective trailing 3M, 6M and 12M trends.
  • Contrast this with growth in both starts and completions having accelerated sequentially in SEP and versus their respective trailing 3M and 6M trends, and it’s easy to assume a dour outlook for Chinese property prices.
  • Speaking of, growth in Chinese property prices across all tiers of cites decelerated both sequentially in AUG and versus their respective trailing  3M, 6M and 12M trends. Data from the China Real Estate Index System confirms a continued slowdown in SEP where average home prices across the 100 largest cities decelerated to +1.2% YoY from a gain of +3.2% in AUG. The -0.9% MoM decline recorded in SEP ‘14 is the steepest drop since the survey began back in 2010.
  • All of this rhymes with the latest Real Estate Climate Index reading of 94.8 in AUG, which represented a deceleration from both a sequential perspective and versus its trailing 3M, 6M and 12M trends.




Again, it’s important to note that our daily analysis of official rhetoric via mainland press continues to suggest that no major stimulus initiatives are coming down the pike. Mortgage policy continues to ease, at the margins, but not in a material enough way to inflect the broader growth outlook; oversupply, rather than a lack of demand, is actually the key issue facing China’s housing market going forward.


For an even deeper dive into China’s Growth/Inflation/Policy outlook, please review our 9/30 note titled, “DEFCON 2.5: THE “CHINA OVERHANG” IS LIKELY TO CONTINUE”.


Parting Thoughts

All told, the inclusion of today’s growth data and its associated policy rhetoric (the NBS actually talked up the 3Q GDP figure, saying it fell within their so-called “reasonable range”) is just more of the same as Chinese policymakers attempt to gradually walk the mainland economy “down the ledge” of overcapacity and systemic indebtedness, as opposed to allowing it to “fall off a cliff”.


It’s worth noting that our views on the Chinese economy and the policy that drives it haven’t changed all that much since we correctly forecasted the aforementioned approach over three years ago. As such, we continue to think that estimates of marginal Chinese demand should continue to decline for the foreseeable future.


With #ChinaSlowing (15% of marginal global demand in 2013), #JapanSlowing (5% of marginal global demand in 2013), #EuropeSlowing (18% of marginal global demand in 2013), and #USSlowing (17% of marginal global demand in 2013) all at once, what could possibly go wrong?




Darius Dale

Associate: Macro Team

EAT: Earnings Recap

Brief Analysis: We removed EAT from our Investment Ideas list as a short on October 9th, 2014.  We thought this was a prudent move given the current sales momentum we are seeing across the restaurant industry.  To be clear, we wanted to get the 1QF15 release out of the way, and were mistaken in doing so.  Brinker's comp sales outpaced both Knapp and Black Box by notable margins and surpassed consensus expectations, but weren't strong enough to drive enough leverage through the P&L.  In addition, two-year average comps and traffic declined sequentially, suggesting that management is not doing enough to move the needle.


Brinker has prided itself over the past four years on methodically driving operating leverage in their business model, but we believe these days are abruptly coming to an end, even despite management's decision to maintain guidance for a 25-50 bps improvement in restaurant operating margin in FY15.  We believe this will be difficult to achieve and think management is (almost solely) relying on cost of sales to moderate for this to happen.


Despite covering our short a couple of weeks ago, our short thesis has not changed.  In fact, if anything, our conviction in it has strengthened.  Unfortunately, we missed today's move, but we'd be looking to short the name once again into any strength.  We think the margin story is played out here and management will be hard pressed to drive leverage moving forward.  The street is banking on the FY16 free cash flow story to come through for them as capex begins to wind down.  We suspect, however, that this will disappoint as management is forced to allocate additional dollars to reinvest in the business.


Comps: Brinker delivered system-wide comp growth of +2.4%.  Chili's company-owned comps grew +2.6%, comprised of +1.8% of pricing, +0.7% of mix-shift and +0.1% of traffic.  Traffic, while positive for the first time in the past seven quarters, saw its two-year average decline 30 bps sequentially to -1.7%.  Total revenues of $711.018 million (+3.84% y/y) beat consensus estimates by 25 bps.


EAT: Earnings Recap   - 1


EAT: Earnings Recap   - 2


EAT: Earnings Recap   - 3


Margins: Cost of sales declined 28 bps y/y driven by favorable menu pricing, menu item changes, efficiency gains from new fryers and improved waste control.  However, significant pressure from beef, cheese, avocados, and seafood resulted in significantly lower leverage than management had anticipated.  Labor costs increased 18 bps y/y driven by higher bonuses and increased wage and payroll taxes, partially offset by lower health insurance expenses.  Restaurant expenses increased 30 bps y/y driven by equipment charges associated with tabletop tablets and higher credit card fees.  As a result, restaurant margins declined approximately 30 bps in the quarter.  Management reaffirmed its guidance for a 25-50 bps improvement in this line in FY15.


Earnings: Adjusted EPS of $0.50 (+16.3% y/y) fell in-line with expectations.


What We Liked:

  • Respectable system-wide comp growth of +2.4%
  • Chili's comps outpaced Knapp and Black Box by 210 bps and 100 bps, respectively
  • Reimage program is about 90% complete
  • Installation of Kiosk tablets in all franchise restaurants will be completed next month
  • Repurchased 1.1 million shares for $53.3 million in the quarter; repurchased another 712,000 shares for $37 million since then, bringing the outstanding share authorization down to $576 million
  • Announced a 17% increase in quarterly dividend from $0.24 to $0.28

What We Didn't Like

  • Two-year average traffic declined 30 bps sequentially to -1.7% at Chili's
  • International franchise comps were down -0.5% driven by soft sales in Puerto Rico
  • Menu innovation hasn't really moved the needle on traffic
  • Restaurant level margins down despite a fairly strong comp
  • Food costs will likely continue to present a challenge for management given their unpredictable nature
  • Seemingly little to no leverage left on labor cost and other restaurant expenses lines


Call or email with questions.


Howard Penney

Managing Director


Fred Masotta


Cartoon of the Day: Absolute Zero

Cartoon of the Day: Absolute Zero - 0  cartoon 10.21.2014


You can thank your unelected central planners for zero interest rate policy for the foreseeable future.


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Selling Opportunity: SP500 Levels, Refreshed

Takeaway: There have been some fantastic selling opportunities in 2014. This looks like one of them.

I’m on the road today seeing investors in NYC and I am trying to explain what just happened in the last month in the most simple terms I can. “So” here’s the summary:


  1. Consensus chased the all-time #bubble high in SEP to > 2011 SPX
  2. Then freaked out and sold low (130-150 handles lower) last week
  3. And is now chasing a no-volume bounce to lower-highs, saying last week was the “bottom”


I for one have a harder time getting from its “it’s not a bubble”, to the fetal position, to “we’ve bottomed” (in 3 weeks) but that’s just me!


In terms of levels, here are the lines that matter to me most:


  1. Intermediate-term TREND resistance = 1967
  2. Immediate-term TRADE resistance = 1943
  3. Immediate-term TRADE support = 1830


Oh, and that’s with an immediate-term risk range for the VIX of 15-29! In other words, if the SPX were to drop over 100 points, in a day (from here), I’d consider that within the band of probable outcomes at Hedgeye.


There have been some fantastic selling opportunities in 2014. This looks like one of them.



Keith R. McCullough
Chief Executive Officer


Selling Opportunity: SP500 Levels, Refreshed  - SPX

Our Take on Existing Home Sales

Takeaway: Here's an excerpt from a note to institutional subscribers from earlier today where our analysts dove into the existing home sales report.

As we've highlighted, there's limited usefulness in the Existing Home Sales (EHS) report on the sales side since the data is well-telegraphed by the Pending Home Sales report a month earlier. We show this in the 1st chart below, where we've offset the EHS data by one month to show its correlation to PHS on a 1-month lag.  


Despite the limited real-time utility in terms of demand trends, there is value in the data on inventory and the composition of sales (first-time buyers, cash buyers, investor share). This month we flag the still-anemic level of first time homebuyers (29% vs 2001-2008 average of ~40%).


Our Take on Existing Home Sales - chart2


Our Take on Existing Home Sales - chart3


TOTAL EXISTING HOME SALES:  Total EHS resumed its uptrend in September after stumbling in August. Sales rose 2.4% MoM to 5.17mn SAAR. Meanwhile, the year-over-year rate of change slowed to a decline of 1.7%, an improvement vs the 5.3% decline in August. From a growth perspective, the YoY comps get progressively easier through the balance of the year as we lap the rising rate environment of 2H13. 


For comparison, pending home sales have advanced +11.6% since the trough in March vs +12.6% for EHS and, given the recent pattern highlighted above, its likely we see a modestly worse sequential EHS print in October.  

YELP: Thoughts into the Print (3Q14)

Takeaway: 2Q14 showed signs of deterioration, but 2015 remains the key inflection point. Till then, we need to fade the noise in between.


  1. DON’T GET BAITED: Certain metrics will be optically appealing, but largely misleading after considering the details behind them.  After the 2Q14 call, management introduced some new metrics, which are meaningless since there is no supporting detail behind them.  Expecting more of the same; be careful.
  2. 2015 IS AROUND THE CORNER: Consensus estimates are outside the realm of reason.  YELP will need an acceleration in new account growth and historically low attrition to hit consensus estimates, which are calling for 46% revenue growth.  Our bull case is calling for 31%; bear case for 23%. 



  1. Rising Customer Repeat Rate is NOT good: This is a measure of customer MIX, not retention.  We suspect this number to rise from a slowing contribution of new accounts.
  2. ARPU Should Surge for the Same Reason: Customer Repeat Rate and ARPU are directly correlated.  That is because the higher the Customer Repeat Rate, the less new customers signed intra-quarter that have paid less than a full-quarter of revenue.  In short, ARPU is a reflection of MIX as well
  3. Careful with Cohort Growth: YELP reported an acceleration across each of its 3 main cohorts last quarter, yet incurred a sharp deceleration in its remaining cohorts.  We suspect management has redeployed more of its salesforce to focus on the early cohorts, which if true, speaks volumes to its realistic TAM.
  4. “Subscription/Contract-Based Advertisers" Means Nothing: That is because management will not provide detail into what’s included in this metric; specifically the contribution from SeatMe, which management stopped providing account metrics for in 2Q14.
  5. 4Q14 Guidance Could Go Either Way: We thought its last guidance raise was an ill-advised move, and we're not expecting upside to 3Q14.  We can't say how management will approach 4Q14: it can choose to make a bet on its accelerated sales rep hires (up 63% y/y in 2Q14), or rebase expectations heading into 2015.  The latter would be the smarter move.



Our analysis has always pointed to 2H14 as the period when the model would start breaking down.  While we saw signs of deterioration in 2Q14, the 3Q14 guidance raise was much higher than we expected, and makes us wonder if we were too early in calling the inflection.  However, 2015 remains the key inflection point.  Consensus growth estimates are so aggressive that it really doesn’t matter what happens in 2014. 


Their mistake is simple: If you don’t understand the attrition element to the story, you can’t understand the excessive number of new accounts required to hit 2015 estimates.  YELP will need to produce both an acceleration in new account growth and historically low attrition to hit consensus estimates, which are calling for 46% revenue growth.  Our bull case is calling for 31%; bear case for 23%. 


For more detail, see note below.  Let us know if you have any questions, would like to discuss in more detail, or would like to see our slide deck on YELP.


Hesham Shaaban, CFA



YELP: Winter is Here 

07/31/14 07:40 AM EDT





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