Conclusion: The latest round of Chinese economic data suggests inflation remains a headwind and that a reining in of credit expansion and additional interest rate hikes are in China’s intermediate future. Further, the data is supportive of our assertion that QE2 will incrementally slow global growth.
Position: Long Chinese Yuan (CYB); Long the U.S. Dollar (UUP); Short U.S. Equities (SPY)
Chinese November inflation data came in hot [again] over the weekend. CPI accelerated to a 28-month high of +5.1% YoY and PPI also quickened substantially to +6% YoY – a +100bps sequential uptick. In line with our call since late-August, we’re seeing more confirmation of accelerating inflation globally as a result of the Fed’s weak-dollar policy (QE2) – a term we aptly named Quantitative Guessing.
While economists continue to spend hours debating whether China’s “artificial devaluing” of the yuan is perpetuating inflation within its borders, the real truth that matters to market practitioners is that inflation is accelerating globally, across a spectrum of currency policies. Don’t take our word for it, however; pull up a chart of Brazilian or U.K. CPI, global bond yields, or the CRB Index, which just hit a new YTD high yesterday.
Turning back to China specifically, we are inclined to suspect further tightening may be on the horizon. China has been varied in its efforts to combat inflation and speculation YTD, including raising bank reserve requirements (as recently as 12/10) , restricting home loans, forcing banks to hold more FX, price controls, supply rationing and raising interest rates (10/19). Despite these measures, we feel China may be running out of room for further “cuteness” and that additional interest rate hikes are on the way in 1H11.
Looking at real 1-year deposit rates, we see that inflation is consuming Chinese savings at an accelerating rate. In November, Chinese savers effectively paid a 2.6% tax on their 1Y savings deposits - even with October’s 25bps rate hike factored in.
Considering that inflation has been, on the margin, eroding China’s high household and corporate savings (a combined 42.2% of GDP), it’s no surprise to see that China continues to struggle to rein in property prices as those savers turn to real estate investment on the margin. National Property Prices (70 cities) continued to grow in November, climbing +0.3% MoM. Although, on a YoY basis, growth in Chinese Property Prices continued to slow sequentially (+7.7% YoY in November vs. +8.6% in October).
While the pace of YoY growth has been slowing lately, the persistent MoM gains of late continue to defy China’s efforts to dampen speculation in its real estate market. Further resiliency of property prices will likely necessitate incremental rate hikes or the implementation of the oft bandied about national property tax trial.
Further compounding China’s inflation woes is the rate at which new loans are accelerating, gaining 564B yuan in November vs. advancing 587.7B yuan in October. While the second-derivative slowdown is welcomed by Chinese officials, the rate of growth in November far exceeds the average monthly growth needed throughout November and December to achieve China’s official loan growth target of +7.5 trillion yuan ($1.1 trillion) for full-year 2010 (+308.9B yuan). As a result, new loans must not exceed 53.8B yuan in December in order for the target to be met – a low not seen since October ’06!
All in all, we feel the confluence of inflation eroding savings (which causes Chinese savers to speculate with their assets on the margin) and robust loan demand will continue to put upward pressure on Chinese inflation data, absent any meaningful policy changes. The global commodity reflation brought on by Quantitative Guessing further supports our conclusion that further rate hikes may be on the horizon in China.
It’s important to keep in mind that China is not alone in its bout with inflation. As Bernanke and the Fed continue to pursue a weak-dollar policy via QG, there’s no reason to expect commodity prices to come down meaningfully in the near term, which will put upward pressure on both core and headline CPI readings globally (COGS inflation will likely get passed through to consumers).
An interesting anecdote there is that Kunming, the capital of China’s Yunan province, recently ordered five retailers including Wal-Mart to report and justify price increases two days before the changes. Should price controls accelerate on the margin, look for retailers exposed to China to suffer margin compression in 1H11 as topline growth potentially slows (vis-à-vis slowing GDP growth).
In turn, elevated inflation readings will continue to lead to further tightening globally, which will weigh on global growth in 2011. Keep the equation below in mind as you ponder the real effects of QE2 vs. what the Fed would have you believe:
QG = inflation [globally] = monetary policy tightening [globally] = slower growth [globally]
Round-up of today’s data: Berlusconi wins Confidence Vote; Bullish German ZEW survey; UK CPI accelerates; Spain’s Pain continues; Portugal bows to the client (China)
Position: Long Germany (EWG); Short Euro (FXE), Short Italy (EWI), Short Spain (EWP)
Italian Prime Minister Silvio Berlusconi won a no-confidence vote today, capturing the upper house easily, but winning by a slim majority of 314 votes to 311 in the lower house. As we noted in our post yesterday titled “Silvio’s Black Eye”, despite the victory, Berlusconi’s slim majority should only prolong Italy’s Crisis in Confidence and increase the risk that Italy struggles to finance and meet its debt obligations next year.
Position: Short Italy via the etf EWI. Current public debt projections mark Italy’s debt at ~120% of GDP. Next year, Italy is rolling up against a substantial €350 Billion in government debt maturities (principal + interest) and we’re of the opinion that the market will increasingly punish its fiscal imbalances alongside continued political uncertainty with Berlusconi at the helm. YTD we’ve seen a steady rise in the country’s risk premium via credit spreads and yields, and a more parabolic move alongside Ireland’s funding assistance over recent weeks.
Bullish German Sentiment
The German ZEW economic sentiment survey showed confirmation of a positive outlook for the next 6 months in Germany, rising to 4.3 in December from 1.8 in November, with improvement over the last two months. The current situation index also gained, registering 82.6 in December versus 81.5 in the previous month.
Position: Long Germany via EWG. We continue to like Germany’s fundamentals that present a strong dichotomy from most of its European peers. Germany’s strong exporting and industrial complex continues to get orders, especially from China. Unemployment has trended lower this year, currently at 7.5%, and the DAX has powered forward at 17.8% YTD.
UK’s Inflationary Dilemma
UK headline CPI registered 3.3% in November versus the previous year, an acceleration from October’s rate of 3.2%. With inflationary signals from November PPI (input and output) published in the last days, it came as no great surprise that headline CPI also rose. We think the UK’s inflationary issues are well documented; however the BOE still seems quite divided to make any policy changes. The dilemma remains that an additional bond purchasing program would encourage inflation, while increasing the main interest rate could threaten growth. The Bank’s consensus may well remain to do nothing for the next months.
Today we saw a similar trend in Spain’s bond auctions, namely the increased yield premium to entice investors, a trend also seen across auctions from Europe’s fiscally weaker countries. Spain issued nearly €2 Billion of 12M bonds at 3.449% versus 2.363% on November 16th. €523 Million of 18M bonds were also sold at 3.721% versus 2.664% in November. We’ll have our eyes on Spain’s auction this Thursday with maturities in 2020 and 2025 to be issued.
Portugal at China’s Hand
Portuguese Finance Minister Fernando Teixeira dos Santos completed a two-day visit to Beijing to meet with Chinese Finance Minister Xie Xuren, Chinese central bank Governor Zhou Xiaochuan, and officials of China’s state administration of external reserves to strengthen relations as Portugal hopes to get additional financial support from China.
Teixeira dos Santos said, “We took a big leap forward in terms of strengthening our relations at all levels, commercial and investment, and also in the area of financing,” however did not specify the amount of Portuguese treasury securities that Chinese institutions have already bought or will buy.
Take-away: Going to the Client (China) is an interesting move as Portugal attempts to get the media’s spotlight off its sovereign debt issues. Notwithstanding, we do not believe Portugal can escape the market forces that punish countries with excessive debt leverage and political instability.
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R3: REQUIRED RETAIL READING
December 14, 2010
- While China remains a key growth market for many western brands, there are some that actually have a disproportionate amount of doors already open. It turns out that Versace just celebrated the opening of its third jewelry boutique in Beijing, which keeps the luxury brand on track for having 67 stores in China by year end. Interestingly, this compares to just 10 locations in the U.S. Sounds like Versace is taking its cues from Yum Brands!
- While Groupon continues to be the talk of the town stateside, it’s actually growing at a furious pace outside of the U.S. In just this year alone, the company’s footprint has expanded into 35 countries from just one. Approximately 52% of Groupon’s website visitors are coming from Europe, 33% from North America, 12% Latin America, 2% in Asia, and .2% from the Middle East/Africa.
- According to new data from Comscore, holiday spending online between November 1st and December 10th has increased by 12%. Trends over the last week were up 11%. Free shipping continues to be a key driver of e-commerce and holiday growth, with a full 50% of transactions over the past three weeks including a free shipping component.
OUR TAKE ON OVERNIGHT NEWS
Supreme Court Backs Ruling on Costco Copyright Case- Discounters, beware. The Supreme Court’s narrow decision on Monday to let stand an appeals court ruling that found Costco Wholesale Corp. liable for copyright infringement when it sold Omega watches at heavily discounted prices without the Swiss company’s authorization has broad implications in the fashion world. The court’s ruling could have a significant impact on discount retailers and off-price merchants that often purchase imported goods from middlemen and distributors at lower prices, rather than buying direct from a manufacturer or its authorized U.S. distributor. These retailers then sell the products in the U.S. below the brand’s official price, legal experts said. Experts said the Supreme Court’s ruling now will make it harder for retailers to engage in this technique. It also will hit online auction sites such as eBay, they said, because gray market goods are often sold on the site and it could be held liable But while the high court’s decision was a blow to retailers, it was a victory of sorts for brands. The decision upholds a company’s right under U.S. copyright laws to regulate the distribution, price and resale of products that are made overseas and reimported to the U.S. <WWD>
Hedgeye Retail’s Take: No question that this deals a blow to those procuring goods from a third party and selling them below manufacturer’s suggested retail prices. While this likely means less “deals” for the consumer at off-pricers, discounters, and private sale operators, it also suggests that when the consumer actually sees a deal it will have been “approved” by the brand itself. Additionally, the middle man loses out on alternative distribution as they will now be under even greater scrutiny.
Neiman's Shuffles Buying Staff - Neiman Marcus, in a sweeping realignment of the responsibilities of its top merchants, has put senior vice president and general merchandise manager Jonathan Joselove in charge of designer sportswear, couture, handbags, women’s shoes and accessories. Ann Stordahl, executive vice president and general merchandise manager, will oversee precious jewelry, designer jewelry and beauty. For many years, Stordahl handled all women’s apparel, including designer sportswear and couture, intimate apparel, coats and furs, while Joselove oversaw beauty, coats, handbags, ladies shoes and accessories. In addition, Lisa Kazor, senior vice president and gmm, will be responsible for designer II, which is Neiman’s designation for bridge sportswear; St. John; contemporary sportswear; dress collections; furs; coats; intimate apparel, and children’s. Previously, she had the gift galleries, precious jewelry, designer jewelry, intimate apparel and children’s. Russ Patrick, senior vice president and gmm, will be responsible for men’s, gift galleries and the Cusp division, which operates freestanding stores and shops inside Neiman’s stores, both of which sell contemporary sportswear and accessories. Patrick previously oversaw men’s and Cusp. Neiman’s is examining Cusp to see whether it becomes a rollout strategy or not. <WWD>
Hedgeye Retail’s Take: Management changes as a precursor for an IPO? With minimal growth prospects, something will have to be different if one of the most expensive takeouts in retail history is going present well on the road.
Dillard's to Launch Cremieux Women's Line - Poised, stylish and approachable, Alexandra Dillard looks to be just the type of customer who will take to Cremieux’s new women’s collection. As brand manager, Dillard, whose father, Alex, is president of the company, is championing this collection, which she described as having “a modern fit and is a little more dressy than casual,” and should compete with labels such as Michael Kors and Kenneth Cole. While the exclusive Daniel Cremieux label has been a men’s wear top performer in the Dillard’s stable for 10 years, this spring will mark the debut of the women’s Cremieux line. Going forward, the men’s line is being marketed as Cremieux to keep everything in sync. To get shoppers excited about next month’s launch, there will be outdoor advertising, colorful in-store signage, online ads, catalogue placement and e-mail blasts. The fact that many Dillard’s shoppers are familiar with the name, which is also used for home items, should help generate interest, she said. “We are trying to trade off the base of Cremieux customers who are familiar with the label, know that it offers fashion and comfort and that it is exclusive with Dillard’s,” said Dillard, adding that luggage will be introduced this spring. <WWD>
Hedgeye Retail’s Take: Often off the radar screen of many investors, Dillard’s appears to be working harder to differentiate its merchandise. Even more interesting is that the company made a recent appearance at an investor conference after staying away from face-time with potential investors for several years.
Denim Makers Seeking Next-Generation Fabric -Sustainability was front and center at the two-day Denim by Première Vision salon held at La Halle Freyssinet. Volatile cotton prices were among the factors helping to raise the profile of sustainable alternatives such as recycled denim and cellulose-based fibers. “It’s definitely the season to add Tencel and Modal, which previously have been regarded as premium fabrics,” said Gayle Johnston, head of women’s wear fabric trends and sourcing at Marks & Spencer, which has a major sustainable program under way. Denim guru Adriano Goldschmied said a “widening of vision” will be necessary for the denim industry. “[In the future], jeans could be made out of milk, a tree or bamboo,” Goldschmied said. “Cotton can be a component of that…but there are amazing things that are giving a new look to denim.” He cited as examples Cupro, MicroModal, Tencel, viscose and rayon. <WWD>
Hedgeye Retail’s Take: Between the growing shift toward green/sustainable practices by industry pioneers and the rising cost of cotton, customers will come to expect an introduction of several new alternative materials in the coming year.
Avril Lavigne Sings New Fashion Tune - Avril Lavigne is getting ready for her solo act in fashion. Two years after launching her juniors line Abbey Dawn exclusively at Kohl’s, the entertainer is branching out on her own to sell her rock-inspired tops for men and women directly to customers on the Web and in boutiques worldwide. Working with San Diego-based manufacturer Blank Generation, Lavigne is launching Abbey Dawn’s e-commerce site on Friday, a month before she begins wholesaling to shops such as Trash and Vaudeville in New York and the 14-store Blue Banana chain in the U.K. By introducing monthly mini collections of new product throughout next year, Lavigne is ramping up for the spring 2012 debut of a full-fledged juniors fashion line with sportswear, denim, swimsuits, dresses, loungewear, activewear, shoes and handbags. “[Kohl’s] was a great way to start my line and a great home for it for two-and-a-half years,” said Lavigne, 26, curled up on a purple velvet couch before practice with her band in a San Fernando Valley recording studio. “The thing with me is…I really want my clothes to be available internationally.” <WWD>
Hedgeye Retail’s Take: A bold move by the young entrepreneur to drop the department retailer in order to pursue global reach – the reality is however, no time is like the present to take a shot on her apparel line with music still Lavigne’s primary revenue generator.
Overstock.com to Open Tech Center in 2011 – Overstock.com Inc. says it will open a software development center in early 2011 in Provo, UT. The company says it expects to hire 150 software developers to staff it. “We are expanding our tech presence in Utah and actively recruiting. We have more innovation in the pipelines than we have developers,” says Overstock.com president Jonathan Johnson. The company is offering individuals who refer qualified software developers $5,000 if Overstock hires the workers and they stay at Overstock for at least 90 days. The company says it expects to hire 100 developers within a year. The e-retailer employs more than 1,500 people in Utah through a call center and three other facilities.<InternetRetailer>
Hedgeye Retail’s Take: One of the more aggressive internal growth plans we’ve heard about over the past year, OSTK is clearly geared to ramp SG&A investment in ’11. After missing expectations in 4 of the last 5 quarters, a focus on organic growth is not the quickest path to reaccelerate top-line growth, but arguably the most sustainable.
Sen. Schumer Calls for Online Restocking Fee Investigation - A U.S. senator has called on the Federal Trade Commission to pressure retailers to disclose fees charged consumers for returning products bought online. Charles Schumer, a Democrat from New York, sent a letter to the FTC asking the agency to investigate what are commonly called restocking fees for returned goods. “I urge you to investigate whether the failure to disclose restocking fees online could constitute a deceptive trade practice, and to take swift action to crack down on it,” the letter states. “Consumers deserve to know if these charges will apply prior to a purchase.” <InternetRetailer>
Hedgeye Retail’s Take: With e-commerce accounting for a larger portion of holiday spend, this issue is sure to come into greater focus following the holidays when recipients realize the fees associated with returns. As a case in point, <$1,000 computers can generate more than $200 in return/restocking related fees alone, a material portion of ticket product value.
Conclusion: The year-to-date U.S. budget deficit is -$290BN versus -$296BN in the same period last year. Improvement, if you want to call it that.
On Friday, the U.S. government reported the federal budget deficit numbers for November of 2010. As outlined in the chart below, the deficit for November 2010, the second month in the federal government’s fiscal year, was -$150.4BN, which is the worst November deficit on record and one of the worst monthly deficit numbers ever. This was also the 26th straight monthly budget deficit.
In the year-to-date, which also includes October, we are actually running at a slightly better pace (in terms of a lower deficit) than last fiscal year. Currently, the year-to-date deficit is -$290BN versus -$296BN last year. On the positive side, the key mover has been individual income tax receipts, which are currently up $26.6BN year-over-year. On the negative side of the ledger, total outlays, or government expenditures, are up $20.2BN year-over-year, or 3.5% growth from last year.
Income tax receipts being up on a comparative basis can be attributed to two factors according to the non-partisan Congressional Budget Office:
“CBO estimates that receipts in November 2010 totaled $148 billion, $14 billion (or 11 percent) more than receipts in November 2009. Individual income and payroll taxes combined rose by $15 billion (or 13 percent), largely because of an $11 billion (or 8 percent) rise in withheld taxes, the result of both the strengthening economy and the effects of an additional working day in November this year.”
Currently, the CBO’s deficit estimate for 2011 is $1,066BN, which is an estimated ~$228BN improvement from their actual reported deficit for 2010 of a $1,294BN. Obviously for this projected number to be met, we will need a dramatic narrowing of the deficit through the remaining 10-months of the fiscal year.
Per the CBO, the deficit actually narrowed from 2009 to 2010. According to their view, the deficit was $1,416BN, or 10% of GDP in 2009, and $1,294, or 8.9% of GDP, in 2010. In our analysis, which we have outlined in the table below, we actually look at spending on a normalized basis. The primary driver of the normalized analysis is to add back TARP and payments to GSEs. Under this scenario, the deficit actually grew 16% from 2009 to 2010.
Despite seeing some marginal improvement year-to-date, the U.S. government deficit remains on an unsustainable and unprecedented path, which will eventually require dramatic policy action. The good news, as David Einhorn aptly described earlier this year, is the deficit problem is no longer our grandchildren’s problem. It is our problem.
Daryl G. Jones
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