TODAY’S S&P 500 SET-UP – October 22, 2014
As we look at today's setup for the S&P 500, the range is 117 points or 5.73% downside to 1830 and 0.29% upside to 1947.
CREDIT/ECONOMIC MARKET LOOK:
MACRO DATA POINTS (Bloomberg Estimates):
WHAT TO WATCH:
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
The Hedgeye Macro Team
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:
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).
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:
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”.
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?
Associate: Macro Team
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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.
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:
What We Didn't Like
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You can thank your unelected central planners for zero interest rate policy for the foreseeable future.
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:
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:
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
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