Conclusion: All parties and asset classes leveraged to the RECOVERY trade (copper, oil, Brazil, Industrials globally) will come under increased pressure if China's latest round of tightening proves ineffective to contain inflation and the country is forced to implement further tightening.
In the last 48 hours, a bevy of inflationary data points out of China have been cause for concern globally and may lead to increased tightening in China, which is negative for global growth. Furthermore, we believe that the Bovespa in Brazil will continue to ride the tide of Chinese producer demand, which is already showing signs of slowing on the margin.
According to recent estimates, China accounts for nearly 13% of Brazilian exports (second only to the U.S. at ~14%). With China’s imports slowing sequentially to +49.7% Y/Y in April and the prospects of further tightening by the Chinese government, Brazil’s export-heavy economy could come under increased pressure on the margin. The chart below outlines the tight trading relationship between the two countries of late.
Furthermore, China’s shrinking trade surplus (-87% Y/Y in April) may limit the size of any perspective yuan appreciation, which is less positive for the Brazilian economy vs. a larger appreciation (FYI: Brazil, India, and Europe have backed the U.S.’s call for a stronger yuan).
Below is a summary of the most important (inflationary) Chinese economic data released in the last 48 hours which took the Shanghai Composite down another -1.9% overnight to -19.2% for 2010 YTD:
- Chinese inflation (CPI and PPI) up again sequentially to +2.8% and +6.8% y/y, respectively - the largest spikes in inflation in 18 months!
- Chinese property prices (70 cities) +12.8% year-over-year representing the largest jump since 2005;
- China's purchasing price for raw materials accelerated 50bps sequentially to +12% y/y;
- Chinese imports came in at +49.7% year-over-year growth;
- Chinese loan growth up +51% sequentially (m/m) in April to 774B Yuan (versus 511B Yuan in March);
- Chinese Industrial Production (April) +17.9% versus +18.1% y/y in March;
- China’s Money Supply (M2) for April slowed month-over-month by 100bps, but is still up +21.5% y/y, which suggest future inflation will be very difficult to avoid (The Central Bank of China has a inflation target set at +3% y/y - just 20bps away from April's reading).
All told, these inflationary data points add increased pressure for China to raise interest rates and allow the yuan to appreciate. Aside from those options, however, China has already taken measured steps to cool its economy, the most important of which are:
- Raising reserve requirement ratios three times YTD; those levels are now at 17 percent for the largest banks and 15 percent for smaller ones;
- China's Banking Regulatory Commission ordered 78 state-controlled companies to exit real estate sector;
- Chinese Banks are now asking for 40%-50% down payments for second mortgages;
- In March, Chinese officials raised deposit requirements for buyers at land auctions to 20% of the minimum price to increase costs for developers; and
- China's State Council raised down payment requirements for second homes to at least 50% and have pegged mortgage rates to no lower than 110% of the benchmark rate.
Despite the latest round of tightening measures being put in place just a few weeks prior, these steps have already had a slight, but measured impact in property prices. Beijing News reported today that property prices in the Capital fell 31% in the past month. While we must be careful to not extrapolate this decline and apply it to the entire Chinese property market, it's important to note that a systemic 20-30% decline in housing prices in China's first-tier cities will ease tightening concerns. It may, however, cause producers to substitute away from investment in property, which, on the margin, is bearish for Brazilian exports and the global industrial sector at large.
In fact, we're already seeing signs of that substitution effect, as Total Planned Investment in New Construction Projects has slowed sequentially from +34.5% y/y in the three-months ended in March to +31.3% y/y in the four-months ended in April. Furthermore, Chinese PMI slowed sequentially to 55.4 in April vs. 57 in March, which raised concerns that Chinese demand for commodities will continue to wane. These are marginal sequential changes, but they matter.
Time and data will tell the full story on Chinese housing prices and whether or not the Chinese government will continue to tighten to prevent further inflation. It is important to remember that the Chinese economy is a managed and controlled market, suggesting that incremental tightening will be at their own pace, in spite of external pressure to revalue the yuan. Regardless, all parties and asset classes leveraged to the RECOVERY trade (copper, oil, Brazil, Industrials globally) will come under increased pressure if China's latest round of tightening proves ineffective to contain inflation and the country is forced to implement further tightening.
According to the below Hedgeye RECOVERY Index, the Indices, Industries, and Asset Classes leveraged to the RECOVERY trade have suffered near-widespread declines YTD, with the notable exceptions of the S&P Building and Construction Index and the S&P Homebuilders Index.
Downgrades, unlucky play, and china stock market swoon have all pressured MPEL. It’s now relatively cheap, and strong May volumes should lead to market share gains, assuming hold, well, holds.
MPEL hit a recent high of $5.53 on April 9th. One month later, the stock is down 25% because of the China stock market decline and a few downgrades. Good enough, damage done. What now?
We think Macau is having a very good May. VIP volumes are very strong and while Mass seemed to slow down toward the end of Golden Week, May revenues should increase nicely over last year; we estimate +60%. More importantly, City of Dreams is off to a great start in May, particularly on the VIP side where we are hearing the property is generating strong volumes. Market share could be going higher for MPEL.
The sentiment on MPEL is pretty negative. This stock could experience a quick ride up if CoD posts market share gains in May. The valuation has plenty of relative upside. At 11x 2011 EBITDA, MPEL trades at a +20% discount to WYNN and LVS which assumes no share increase for MPEL.
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Less SNAP is Good
Another month of SNAP (formerly known as the Food Stamp Program) data is in, and for the third month in a row the rate of change in participation has slowed. This is hardly a victory for the American consumer or the country in general, given the absolute levels of those currently receiving benefits is still high by any measure. As of February, there are 39.7 million people on SNAP representing 18.3 million households. The USDA predicts 43 million people could be on the program by September of 2011. Let’s hope their forecasting is as “challenged” as the rest of the government.
On the plus side, we are beginning to finally see an erosion in the growth of those lining up for the government subsidy. Is this the end of the dollar stores and deep discounters as we know them? Probably not, but what has been a clear tailwind is beginning to finally subside as it pertains to low income food purchase subsidization. Unfortunately the latest data point is still two months behind, but it is now becoming clearer that the growth in those falling into the lowest income brackets (as defined by need for SNAP) is beginning to slow. Marginally good news overall for those concerned about the state of the US consumer and slightly negative news for those businesses benefitting from those needing monetary assistance to feed their families.
As the market rallies from opening on its lows this morning, we have started to make more sales (long and short) in the Virtual Portfolio.
We sold our trading long position in QQQQ and took our allocation to US Equities in the Hedgeye Asset Allocation Model back to zero percent. Our view of the market right here and now (at 1159 SPX) is implied by our positioning.
Oversold is as oversold does, and we have already seen a large percentage of the price performance associated with an overdue market bounce. The question now is simple: where does this dead cat bounce run out of energy to the upside? We think the answer to that lies in the SPX range of 1165-1187. In the chart below, we show the 1165 line as it is the most formidable line of immediate term TRADE resistance until 1187.
Altogether, the bullish part of this story is that we are in the midst of day 2 where the SP500’s intermediate term TREND line of support continues to hold. That line (thick green line in the chart below) = 1143.
The bearish part of this story is that dropping from here (1159) to 1143 would be a -1.4% correction. In terms of daily risk management, since we had relatively few daily SPX corrections of 1% or more in the months of March and April, these do have a tendency to get people’s attention. A close below 1143 reveals no support to 1105 and that’s the real risk that we want to be protecting against.
If the SPX can hold 1143 for 3 days or more, we’ll cover some shorts and get longer again.
For now, The Risk Manager’s prudent decision is to sell strength, watch levels, and wait…
Keith R. McCullough
Chief Executive Officer
Position: Long Germany (EWG); Short France (EWQ)
While the size of Europe’s loan facility, the €750 Billion Keynesian Elixir, came as a surprise to us, we’ve been vocal that the aid package will offer at best near term support to lessen contagion fears, and is far from a panacea. The European governments that have overextended their balance sheets—mainly the PIIGS—must bite the bullet and issue austerity measures to quell their debt imbalances (or restructure), else they’re simply kicking the can of debt and future inflation further down the road, which will not end well. What’s clear is the direction for Europe is still very unclear. Certainly while investors’ near-term fears have lessened (see charts 1 and 2 below of CDS and bond yields from the PIIGS), the Euro is shaking against the UDS (clearly not the outcome Trichet hoped for) and the equity markets in Europe are volatile (charts 3 and 4). We stick by our Q2 Theme of Sovereign Debt Dichotomy in which we noted that one way to play the spread is to be long Germany and short Spain. Currently the YTD spread between the German DAX and Spain’s IBEX 35 is over 1700bps.
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