Position: Long Germany (EWG); Short Euro (FXE), Short Italy (EWI)
Today European leaders announced at their two day summit in Brussels that a permanent debt-crisis mechanism will replace the current temporary package of €750 Billion that expires in mid-2013.
Importantly for German Chancellor Angela Merkel, who largely has the support of French President Nicolas Sarkozy, the EU’s constitutional Lisbon Treaty was amended to meet her demand that lending to fiscally “troubled” nations come only as a last resort. The two words added to the treaty to pacify Merkel were “if indispensable” in the clause:
“The Member States whose currency is the euro may establish a stability mechanism to be activated if indispensable to safeguard the stability of the euro area as a whole. The granting of any required financial assistance under the mechanism will be made subject to strict conditionality.”
Our read-through is that the clause accomplishes very little, given the very near to intermediate term sovereign debt risk for such countries at Portugal, Spain, and Italy. While it importantly recognizes the necessity of a “debt-crisis mechanism” for the future of this union of countries, much confusion still surrounds who will determine when financial assistance is “indispensable”, how it will be funded, and how much will be allocated, especially given the uncertainty surrounding bank liabilities throughout the region.
It’s also worth note what was NOT decided on at the summit. In particular, Luxembourg PM Jean-Claude Juncker had pressed for a joint Eurozone bond and ECB President Jean-Claude Trichet voiced support for adding additional funding to the €750 Billion fund going into the meeting. Neither were formally agreed or disagreed on.
To the former point, it’s our guess that states such as Germany and France won’t agree to take on the risk of a collective Euro area debt obligation – there’s no benefit to them, but rather downside risk to their own credit standards. To the latter point, we believe we’re likely to see further monies thrown at the Eurozone’s sovereign debt crisis before the temporary package expires.
In Europe we’re concerned about the bank liabilities in the peripheral countries that are not largely understood/quantified and the market implications should members of the “PIIGS” come up short in meeting their targeted deficit and debt reduction levels over the next three years, the probability of which we think is high. Weaker growth prospects will put pressure on incoming tax receipts, while governments continue to get pushback (strikes) over austerity to issue spending cuts. This is a dangerous equation when trying to reduce a budget.
Further, deficit reduction plans are lofty: Greece is attempting to cut from -15.4% of GDP in 2009 to -9.4% in 2010 and Portugal from -9.3% in 2009 to -4.6% in 2010. Equally, we think there’s a fair probability that any one of the PIIGS end up revealing that their previous numbers were fudged, a case we’ve already seen with Greece revising up both its debt and deficit figures for 2009. On this score, Italy could be contender.
Certainly such scenarios could require additional bailout monies over the intermediate term to arrest a plunge in a country’s capital markets. In any case, we expect government bond yields to reflect this risk. As the chart below shows, despite bailouts in Greece (May) and Ireland (December), yields across peripheral countries have remained elevated, and most recently are breaking out.
While the region ratcheted up “emergency” measures in the form of a decision yesterday by the ECB to increase its capital base by €5 Billion to €10.7 Billion over three years beginning on December 29th, the reality remains that the union of unequal states (Eurozone) will continue to be plagued by divided opinion on policy, including who’s funding its crisis. We expect underperformance from Europe’s peripheral countries that should also weigh to the downside on the Euro versus major currencies.
Today, European equity markets closed in negative territory with underperformance from the peripheral markets. Equally, the EUR-USD is taking a beating today and flirting with our TRADE line of support at $1.31. We see TREND resistance up at $1.34 (see chart below).
We sold our position in Spain (EWP) today with the immediate term TRADE oversold. We remain bearish on the intermediate term TREND.
Keep your risk management pants on,
Conclusion: Looking under the hood of the Brazilian economy and stock market, we see more confirmation of accelerating inflation and slowing growth on a global basis. Given, we expect both bonds and equities to underperform as asset classes in 1H11.
Position: Bearish on Emerging Market equities and bonds heading into 1H11.
The “accelerating growth” storytelling around rising bond yields of late gets stopped dead in its tracks once you pull up a chart of Brazilian equities. Since the U.S. dollar bottomed on 11/4 (coincidentally the day we went long UUP), Brazil’s Bovespa index has lost (-7.1%) of its value alongside the dollar’s +6.1% rise.
Of course, one would think with a rising dollar that Bovespa would come under pressure as its two largest constituents Petrobras and Vale suffer from declining crude oil and copper prices. Unfortunately for conventional wisdom’s sake, that hasn’t been the case: crude oil is up +1.4% and copper is up +5.1% over the same duration.
Given this underappreciated divergence, we posit the following explanation for the Bovespa’s underperformance:
Slowing growth perpetuated by global tightening as a result of accelerating inflation brought on by QE2. Better translated as: QG = inflation [globally] = monetary policy tightening [globally] = slower growth [globally].
The Brazilian economy is well past step one (YoY CPI accelerated to a 21-month high of +5.63% in November) and the market is pricing in steps two and three currently. Looking at Brazilian interest rate futures, we see Brazil’s bond market is anticipating a +25bps rate hike in January and an additional +175bps hike(s) by January 2012.
From a growth perspective, we recently saw 3Q10 GDP growth came in a full 250bps slower than 2Q10 at +6.7% YoY (after a +40bps revision to 2Q10). We expect growth to continue to slow over the next 3-6 months, a call aided by incredibly difficult comparisons starting in 4Q10 (+5% YoY in 4Q09, +9.3% YoY in 1Q10) and fiscal and monetary policy tightening (the central bank already hiked reserve requirements on 12/3 and set the stage for further “macro prudential” measures in the minutes of its latest meeting).
In recent reports, we’ve made note of Brazil’s late reaction to combating inflation, with the takeaway being that we’re likely to see an expedited tightening cycle in 1H11. Should growth continue to slow materially (as we expect), we could see the central bank handcuffed on the margin, which is obviously not good for Brazilian consumers, who have had to increase their financing of food expenditures through credit (~34% of supermarket sales) to keep pace with accelerating food inflation.
Looking at the Brazilian consumer from a broader lens, we see that Brazil’s Unemployment Rate hit a record low in November, ticking down (-40bps) to 5.7%. Consumer credit expansion hit a record high in November, climbing +6.2% MoM and growth in consumer delinquencies hit a five-year high in November, climbing +3.5% MoM.
In short, the Brazilian consumer is increasingly employed, levering up at record levels and not paying it back. That is a sure-fire recipe for accelerating inflation, which is why we think a meaningful tightening cycle is in Brazil’s intermediate-term future.
We aren’t the only ones who think so: the Bovespa is broken from both a TRADE and TREND perspective and it continues to make lower-highs. Further, it recently backed off its TREND line hard – an explicitly bearish quantitative signal.
From a broader perspective, Brazil’s outlook rhymes with what’s going on across much of Asia (including China and India) – the region many investors consider integral to global growth. The Ber-nank may be able to inflate U.S. real GDP growth by understating CPI, but the rest of the world isn’t buying the hoax.
Don’t be swindled; have a great weekend.
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R3: REQUIRED RETAIL READING
December 17, 2010
- While Gap is noticeably absent from this holiday’s TV commercial onslaught, it hasn’t stopped the apparel retailer from being creative. Enter Project Reindeer. The company has tagged 8 reindeer with GPS and is tracking their movements to determine which deal will be offered each day over a 5 day period. Thanks to “Bailey’s” long distance movements, customers will get 50% off sweaters today!
- According to the National Retail Federation and BigResearch, nearly 30% of consumers ranked Target's holiday commercials as their favorite, compared to 17% for Wal-mart. Additionally, more than one-quarter of consumers selected Amazon as their favorite online or email ad, while 14% chose Wal-mart. Last year consumers chose Wal-mart’s money-saving commercials as their favorite.
- Happy Free Shipping Day! Shop online today, and 1,721 merchants will send your order for free wherever it needs to go, with many including priority deliveries in their offer. 2010 marks the third year of the event.
OUR TAKE ON OVERNIGHT NEWS
Shakeup Continues at Neiman Marcus - Following this week’s shuffling of responsibilities across the senior merchant team, Neiman’s has moved on to its store organization, naming Ann Paolini senior vice president and managing director of Last Call. She was NMG’s senior vice president and director of stores. No successor was named. At Last Call, Paolini succeeds Tom Lind, who has just become senior vice president, project management. NMG said Lind will lead the newly established project management office which will “analyze and define the standards of process within the organization.” The changes show that Neiman’s new management team, led by NMG chief executive officer and president Karen Katz and Jim Gold, president of the specialty retail group, is determined to accelerate the luxury chain’s recovery and take it in new directions. In October, Katz succeeded Burt Tansky and Gold stepped into his new slot after serving as ceo of the Bergdorf Goodman division. <WWD>
Hedgeye Retail’s Take: Even with all the personnel changes, we wonder if the company’s ownership realizes that this super-luxury retailer needs help from the economy to ever get back to peak productivity?
Everlast Moves Exclusively to Sears and Kmart- Everlast apparel and footwear will be available exclusively at Sears and Kmart stores beginning next year. On Thursday, the $500 million fitness brand revealed it has signed an exclusive long-term licensing deal with Sears Holdings Corp. for apparel, footwear and accessories for men, women and children. Under the terms of the deal, the Everlast brand will be sold in 850 Sears stores, and a new diffusion brand, Everlast Sport, will be available in 1,325 Kmart locations. The product will also be available online. “Our parent company [Brands Holdings Inc.] bought this brand three years ago,” said Neil Morton, chief executive officer of Everlast. “And since then, we’ve been looking at the structure of the business and the opportunities both regionally and globally. In the U.S., we believe that a direct-to-retail partner is the best way to get the product into the consumers’ hands.” <WWD>
Hedgeye Retail’s Take: Looks like a deal out of the Iconix playbook here. Unfortunately, this will still not move the needle for stemming either retailer’s market share losses.
Coty Extends its Global Reach - Coty Inc. is on a roll with its recent rapid-fire round of acquisitions, and chief executive officer Bernd Beetz is in no mood to let up. “It is important that we broaden our footprint and build strength in color cosmetics and skin care,” he said in an interview. He was speaking just a few days after winding up a series of deals for buying Dr. Scheller Cosmetics AG in Germany; the Philosophy skin care brand and nail enamel firm OPI Products Inc. in the U.S., and Tjoy, a Chinese skin care brand. Beetz laid out his vision for the company by detailing how these acquisitions were designed to diversify and build up the separate product pillars of the company, but also make Coty more of a power in the BRIC countries. Already, the buying spree, which industry sources estimate had a combined price tag of $2 billion or more, has had an impact. According to the company, after the acquisitions, the dominant fragrance share of Coty sales shrank in influence by 7 percent to 55 percent, color cosmetics swelled by 3 percent to 26 percent of Coty volume, skin care jumped from 4 percent to 10 percent and the share of toiletries was reduced by 2 percent to 9 percent. Following the first acquisition, Dr. Scheller, which bolstered Coty’s share of the German color market with sales estimated at $70 million, the company’s total sales were nudged upward toward $4 billion. That deal was seen as paving the way for Coty to realize its ambition by hitting $7 billion in sales by 2015.<WWD>
Hedgeye Retail’s Take: One of the more aggressive rollup strategies we’ve seen in the last few years. Given the company’s recent deal pace, we should see another close before year-end.
FTC Introduces New Regulations for Jewelers - The Federal Trade Commission on Thursday released guidelines for jewelry that will impact how certain platinum products can be marketed or advertised. The issue involves the marketing of jewelry that mixes other metal alloys with platinum. The practice, according to the FTC, has made “platinum” more affordable for consumers, but necessitated a clarification of acceptable marketing for the products. The new agency rules require that for products containing between 50 and 85 percent platinum, marketers disclose the composition of the item using the full names of the alloys and metals used, not abbreviations. In addition, marketers must make it clear to consumers that the product may not have the same qualities as a product made entirely of platinum. The FTC released two new publications to help businesses and consumers understand the changes. The FTC can issue cease-and-desist orders to companies that could result in fines if ignored. <WWD>
Hedgeye Retail’s Take: Hard to believe that “platinum” wasn’t always “platinum” when it came to jewelry. Seems like a fair and reasonable crackdown, especially in light of commodity prices going through the roof.
John Hardy Launches First Store - After 20 years in business, luxury jeweler John Hardy is heralding a more mature phase with the opening of its first store on Monday in Jakarta, Indonesia. There are plans for another four units in the next three years. “We’re just getting out of the teen years,” chief executive officer Damien Dernoncourt said. “It’s probably a new chapter.…The brand grew up over 20 years, and we’re now very comfortable with who we are and what we stand for, and we know where we want to go.” Dernoncourt said John Hardy wanted its first store to be in Indonesia because the company started in Bali, and it was appropriate to start building a retail presence “in your own garden.”<WWD>
Hedgeye Retail’s Take: Brands becoming retailers is a trend that we’ve seen in apparel/footwear over the last decade and is now starting to take hold in the jewelry industry. Following the likes of fine watch brands Omega and Panerai, Hardy becomes the latest to grow direct distribution.
UK Social Network Ad Spending to Double by 2012 - The rise of social networking, and the involvement of advertisers in these channels, was one of 2010’s mega-stories—not least in the UK. Though spending in social networks is still a fraction of total online ad spending, many UK brands have leapt at the chance to engage with consumers in an environment where they spend increasing amounts of time and are highly motivated to share their thoughts. eMarketer estimates social network ad spending in the UK will rise from £130 million ($203 million) this year to £275 million ($430 million) by 2012, an increase of more than 110% in two years. This will boost social network ad spending from 3% of all online ad spending to 6% over the same time period. Facebook, the most popular social network in the UK as in the US, will take the greatest share of spending as marketers continue to follow their customers to social media. “There’s a new breed of advertisers that have recognized this shift and understand that he who adds the most value to the consumer wins,” a representative from Facebook told eMarketer. “Agencies have been quick to recognize and harness the power of social but in the last six months alone, we’ve seen marketing directors start to truly understand the opportunities in this space and build a great social experience for customers.”<eMarketer>
Hedgeye Retail’s Take: No surprise given the push and popularity domestically. Moreover, many domestically based multi-nationals that have tested the waters in 2010 will be rolling out programs across other regions if for no other reason than e-commerce sites are just now being rolled out on a global scale. Case in point, RL with extensive e-commerce expertise and experience just launched its UK site back in October – you can bet foreign social media based advertising is on the 2011 budget.
Some news items and notable stock price moves in the restaurant space.
- Starbucks gained on strong volume yesterday. The Kraft issues are, in my view, insignificant for the longer term prospects of the company. One blog, arounddublinblog.com, is running a story about Starbucks being rumored to be buying Peet’s Coffee.
- WEN down on strong volume and underperforming peers over past week.
- SONC upgraded today.
- RT up 5.6% on strong volume.
- BWLD also up on strong volume – we will have a note out on this name shortly.
- MRT continues to perform well, better than any casual dining competitors over the past week.
- Story in the WSJ about new wage and tipping rules in restaurants tells how the Department of Labor is mandating a hike in minimum wages and other procedural changes in the hospitality industry starting January 1st. The move is likely to be met with stiff legal opposition.
- If you thought fried chicken was important in Asian markets, you were right. In South Korea, Lotte Mart undercut the market for fried chicken by 60 per cent. This led to three-hour lines, street protests, a regulatory investigation, and some input from the office of the President on the issue. View the story here.
The Macau Metro Monitor, December 17th, 2010
MACAU REJECTS SJM REQUEST FOR COTAI SITES 7,8; LIKELY TO GET OTHER LAND 1ST QUARTER-SOURCE Reuters
According to a person familiar with the matter, the Macau government has rejected SJM's application for sites 7 and 8, as the two sites require a public tender. The source said SJM is likely to secure land rights for another plot of land on Cotai in the 1Q 2011. SJM CEO Ambrose So had forecasted that land rights for planned casino projects in Cotai would likely be granted to SJM, Wynn Macau and MGM Macau by the end of 2010.
SJM IN TALKS WITH COTAI'S THEME PARK Macau Daily Times
SJM is talking with Macau Theme Park and Resort Ltd, who is owned by Angela Leong, to see if they can integrate their sites on Cotai. Macau Theme Park and Resort has already acquired a 200,000 square metre site, and Leong said the park would not include gaming facilities. The integrated resort project will be developed in three phases and each of them will take about two and a half to three years to complete. In the meantime, SJM has already applied for a piece of land of some 70,000 square metres also next to the Macau Dome.
Ambrose So predicts GGR will reach MOP 190 BN this year, slightly above his first forecast of MOP 180 BN. “I am still bullish about next year. I still believe Macau’s [gaming revenues] will grow at least 15 to 20%. I think we [SJM] will keep growing together with the market and gain a few percentage points more in market [share] like we did in the past," he said.
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