Retail Sales and Use Tax receipts data from California does not paint a pretty picture for restaurants with a high level of exposure to the Golden State.
California is in the news today as home sales hit their lowest level since January 2008. The high low society is not merely confined to the east coast – sales of luxury homes rose for the first time in five years during 2010, according to DataQuick Information Systems in San Diego. A bearish housing market is bad for consumers, of course, and Hedgeye’s view remains bearish on housing on a national basis.
Looking at tax receipts data, however, provides a very interesting insight into how the consumer is faring in California. It is clear from the three charts below that California-centric restaurants are facing a possible downtick in comps, if Retail Sales and Use tax receipts trends remain on their current trajectory. Furthermore, it seems that management teams are aware of this. The quotes below outline management commentary on California from the most recent earnings transcripts for CAKE, CPKI and PFCB. As you will read, there is a certain degree of hesitancy to discuss the Golden State.
Q: Can you give us an update on California?
A: Well, California in the fourth quarter was – first of all, we saw strength in key geographies like Texas and the Midwest and Florida and the Southeast. But the impact of – it's hard to measure California in the fourth quarter because we had a period of time where it rained non-stop for like nine days in a row.
During the most recent conference call, commentary on California trends was conspicuously absent!
PFCB (from call today):
Where we saw weather, we saw negative comps. California went back to negative because of this.
Conclusion: Below we revisit our intermediate and long term theses on Japanese assets – the both of which are decidedly bearish.
Position: Short Japanese equities via the etf EWJ.
Earlier this morning, we opened a short position in Japanese equities in the Hedgeye Virtual Portfolio. At current prices and overly bullish sentiment, the short idea looks much better than it did on October 5th, when we introduced our Japan’s Jugular thesis. For the sake of an easy refresher, we’ve updated the presentation and added a few more slides to reflect the current setup: http://docs.hedgeye.com/Japan's%20Jugular.pdf
As a quick reminder, the Japan’s Jugular thesis is two-fold in duration:
Intermediate-term TREND (Bearish on Japanese equities):
- The benefit derived from yen weakness is vastly overplayed, setting up for an asymmetric risk/reward opportunity on the short side as consensus underestimates the weak yen’s impact on corporate profitability via higher input costs;
- Slowing growth abroad – particularly in emerging markets – will crimp Japanese export and manufacturing growth, which will result in higher unemployment;
- Slowing consumption growth in the US creates an even higher asymmetric risk/reward setup for Japanese export growth that “no one will have seen coming”; and
- Consumption growth in Japan (~60% of the economy) is rolling over as higher prices on the margin diminish demand and confidence remains depressed.
Long-term TAIL (Bearish on the Japanese yen; Bullish on Japan's CDS):
- A rapidly aging and declining population will continue to weigh on growth and Japan lacks the domestic savings and foreign capital to invest in its long term potential output;
- Demographics, regulatory uncertainty, and a favorable cultural mindset towards entitlements will make it impossible to radically rein in entitlement spending and retirement benefits, which will render both the Japanese government and Japanese pension funds insolvent.
- Waning domestic and global demand for JGBs will force the BOJ to do a lot more of what Paul Krugman suggested they do back in ’97: PRINT LOTS OF MONEY to finance debt issuance and keep rising borrowing costs from crushing the economy. QE2 pales in comparison to the amount of fiat money-printing the BOJ will have to do to “comprehensively ease” over the next decade.
We intend to trade around our exposure to Japanese equities, understanding full well that the EWJ will minimize gains as the yen is likely to appreciate near-term vs. the $USD (we’re short UUP as well). That said, our research from both a fundamental and quantitative perspective suggests Japanese equities are a good short here.
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Today German Chancellor Angela Merkel named Jens Weidmann as the new Bundesbank President to replace Axel Weber following his formal indication late last week that he will leave his post at the end of his term on April 30th, and will not run to succeed ECB president Jean-Claude Trichet, whose term ends in October.
Weber’s decision to step down (and he was widely viewed as the top candidate to succeed Trichet), as well as the appointment of Weidmann, are significant as it relates to the shape of Germany’s and Europe’s monetary and fiscal policy. So who is Weidmann?
-Born on April 20, 1968
-Age 42 = the youngest head of the German central bank in its 54-year history and also the youngest member of the European Central Bank’s governing council
-Married with two children
-Ph.D. in economics at Bonn University
- 2006 – Present: currently Merkel’s senior economic advisor and head of the economic and financial directorate of the Federal Chancellery
- He is also German’s “Sherpa” for meeting of the G8 leading nations and G20 industrialized and developing countries
- 2003-2006: head of Bundesbank’s Monetary Policy and Analysis Group
- 1: Weidman served as secretary-general of the German Council of Economic Advisors (the 5 German wise men)
- 1997-99: worked for the IMF in Washington
- ~1987: studied economics in Aix-en-Provence, Paris, and Bonn and did internships at the Bank of France, the German economic ministry and in the central bank of Rwanda
- Weidmann worked feverishly behind the scenes to hammer out rescue plans for German banks embroiled in the global financial crisis and for carmaker Opel
- Last year, he quietly supported Economy Minister Rainer Bruederle’s right to reject aid for Opel, the European arm of U.S. carmaker General Motors, even though Merkel was in favor of providing assistance to safeguard German jobs
- He urged Merkel to resist quick aid for Greece and to involve the IMF in any European aid program, winning both arguments over the opposition of Finance Minister Wolfgang Schaeuble
What’s clear is that Weber leaves a large leadership hole with his departure, not only due to his experience, but in our opinion, due to his hawkish and conservative policy values, including dissention with Jean-Claude Trichet. Weber displayed firm opposition to the ECB’s bond repurchasing program; was proactive in addressing inflation threats to maintain price stability; and voiced opposition to blanket bailout facilities for Eurozone members.
In short, we question if Weidmann will remain true to the former Bundesbank ideals of hawkish monetary and fiscal policy. His Ph.D. professor Manfred Neumann said, “ He’s a contrast to Weber, not in terms of substance but in his manner.” Clearly the Francophone Weidmann has been shaped by Weber, who he studied under and was hand-selected by in 2003 to join the CB, and comes to his new role with great achievement, most currently as Chancellor Merkel’s main economist to direct Germany’s policy through the financial, economic and Eurozone debt crisis.
We’ll let actions speak for themselves, however we hope that Weidmann can uphold where Weber left off in influencing hawkish fiscal and monetary policy on the ECB council, and moreover helps shape the threat of rising inflation throughout the region and policy to deal with the ongoing debt and deficit imbalances of some Eurozone member states.
This week we’ll publish on the leading candidates for the ECB presidency.
Position: Long grains (via the etn JJG)
We added a long position in soft commodities via the etn JJG in the Hedgeye Virtual Portfolio. The etn was on sale yesterday due to strength in the US dollar and a strong soybean crop report out of Brazil, and we jumped on the buying opportunity. As a reminder, commodities (measured by the CRB commodity index) have a -0.80 inverse correlation to the US dollar over the last six weeks.
We have recently been playing the softies with long positions in corn (etf CORN) and sugar (etn SGG), though here and now we prefer JJG because it has a lower beta. JJG gives you a nice mix of grain exposure with positions in the futures contracts of soybeans (39%), corn (37%), and wheat (24%). Long JJG is an excellent way to be long inflation.
JJG was added into the portfolio at $55.18. From a quantitative setup, JJG has no upside resistance and TRADE line support at $54.34 and TREND line support at $51.03, suggesting a favorable near-term risk-reward setup.
Conclusion: While we continue to have a bullish view of oil based its quantitative set up, as a proxy to benefit from a weak U.S. dollar, on geopolitical risk premiums, and due to strong emerging market demand patterns, we would also be remiss not to highlight anemic U.S. demand on the negative side of the equation.
Position: Long oil via the etf OIL
We are starting to see Egyptian and Tunisian type popular tensions spread to some key oil producing states, which should provide a key support under the commodity. Specifically, both Iran and Libya have seen an increase in protests. This is relevant because, based on the most recent data, Iran is the second largest producer of crude oil in OPEC, at 3.7MM barrels of oil per day, and Libya is a sizeable producer as well at 1.6MM barrels of oil per day.
At this point, it is difficult to determine what direction the popular unrest in these major oil producing countries will take, but obviously a potential disruption of production in either of these nations is much more critical to global supply then either Tunisia or Egypt (less than 600K barrels of production per day). Egypt relevance is more related to its control of the Suez Canal, which controls more than 8% of the world’s sea trade – of which a large component is oil headed for Europe.
As a proxy for the status of the situation in the Middle East, we’ve been following the price of Brent oil, which is produced in the North Sea. As the actual or perceived threat of a supply or transportation disruption in the Middle East occurs, Brent should be bid to a premium versus its global counterparts. Currently the spread on front month futures in the U.S. is as almost as wide as it has ever been, with Brent trading at ~$102 per barrel and West Texas Intermediate trading at ~$85 per barrel, for a spread of $17.
In addition to the Middle Eastern dynamics, apparent weak demand for consumer fuels in the United States, namely gasoline, is one force that is driving the almost record divergence between WTI and Brent. As our Energy Sector Head Lou Gagliardi continues to highlight in his research, Cushing, Oklahoma is flush with supply. Cushing is the primary hub for transporting oil in the United States, and at any time stores up to 10% of North American supply. Cushing inventories are currently as high as they’ve been since 2004, and have risen 10 of the past 13 weeks.
In fact, according to data from Department of Energy, gasoline inventories in aggregate in the United States, as of the month of January, are 3.4% above the high of the normal range. In addition, distillates are 4.8% above the high end of their normal range. These inventory builds are not surprising given that retail gas prices have risen to almost $3.14 per gallon, which is comparable to the highs of October 2008.
Naturally, with rising prices comes a degradation of demand, which we are starting to see in inventory builds and actual purchases of gasoline. According to Master Card, which tracks weekly purchases of gasoline, gasoline demand was down sequentially week-over-week almost 3%, though still up 2.6% year-over-year. The real wild card for demand is of course the summer driving season and the price of gasoline at that point in the season.
To that point, according to the Department of Energy:
“There is also significant uncertainty surrounding the forecast, with the current market prices of futures and options contracts for gasoline suggesting a 35 percent probability that the national monthly average retail price for regular gasoline could exceed $3.50 per gallon during summer 2011 and about a 10 percent probability that it could exceed $4.00 per gallon.”
Clearly, given the trajectory we are on, there is some possibility that gasoline reaches a much more elevated level this summer, in which case we should expect to see a continuation of demand degradation and inventory building. This is not to say there aren’t many benefits to owning oil, but we need to be aware that the current supply factors of the world’s largest consumer of oil, the United States, are bearish.
Daryl G. Jones
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