Hedgeye CEO Keith McCullough was on CNBC this afternoon discussing the market meltdown and what is next for the global financial system. You can watch the clip here:
http://www.hedgeye.com/unlocked_ideas/12292 (copy and paste the link into your web browser to view)
This evening Keith will be joining Larry Kudlow on The Kudlow Report at 7pm eastern to accost more stock market bulls with our view that inflation is accelerating and growth is slowing.
The key points Keith will be highlighting tonight include:
1. Global Stock Markets - have been giving us Global Growth Slowing signals for 6 weeks – today’s China news shouldn’t be new news to anyone paying attention (we’ve been short Emerging Markets for the better part of 2011 and making money doing it)
2. US Stock Market – casino is as casino does. The correlation risk between stocks and the USD is surreal right now – thanks go out to The Bernank. Sadly, your buy-the-dip stock promoter can’t afford what this country really needs: inflation slowing via a strong dollar (like you had today).
3. Correction or crash? - we’ve been calling for a 3-6% correction since FUND FLOWS PEAKED in the week of February 14th – be my valentine little perma bull – here’s the 1st 3.5% of that correction. Our intermediate term downside support target for the S&P500 remains 1265.
4. Oil – trade it with a bullish bias. We sold our LONG OIL position on Monday and bought it back today. We want to be long the Day of Rage and continue to think that the Middle East will be a longer term story than consensus thinks. Any oil price > $90/barrel is a significant consumption TAX on US Growth.
5. US Economic Growth – sell-side forecasts for 2011 and beyond are still too high – US GDP of sub 3% for 2011 at oil > $90/barrel.
-Your Hedgeye Risk Management Team
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Much ado about nothing.
As we mentioned in our note, GENTING SING: GOOD > BAD (3/1/11), we believe the sell side is overly concerned with Genting’s seemingly large receivable in 4Q. When looking at it within the context of high growth in VIP direct volume, Genting’s receivable doesn’t look unusual. As the charts below show, Genting’s 4Q receivable is 2.6% of direct rolling volume, which is actually lower than Marina Bay Sand’s 3.1%. When compared to some of the Macau operators, Genting’s receivables are pretty much in-line.
So, take a deep breath, sell side. For now, receivables shouldn’t be a worry, though a continuation of stagnant mass growth in Singapore may be.
Conclusion: The U.S. deficit issue continues to accelerate. February 2011 was the largest monthly deficit ever, and ever is a long time.
Position: Short the U.S. Dollar via the etf UUP
Due to seasonality, February is typically a bad month for the federal budget deficit. In fact, before February 2011, the prior worst monthly deficit on record was February 2010. According to estimates from the Congressional Budget Office (CBO), the Federal budget deficit for February was $223BN which is an increase of about 1% from February 2010.
Revenues actually grew year-over-year by 3%, which is marginally positive. This is also the 10th straight month of year-over-year revenue increases. On the flip side, and despite all of spending cut rhetoric, expenditures were up 5% from February 2010. The key driver here was a $4BN increase in interest expense, which was a function of more debt and marginally higher rates.
In the table below, we’ve outlined the year-to-date deficit numbers compared to 2010. As usual, we’ve normalized for one time expenditures, such as TARP. While revenues are showing a decent increase on a year-over-year basis, spending continues to accelerate and is up more than 5.3% in the first five months of the fiscal year. The largest gaining expenditure line item on a percentage basis year-over-year was interest expense.
Year-to-Date Deficit ($B)
To the last point on the growing expense of interest, a recent report written by Mary Meeker on behalf of Kleiner Perkins titled, “USA Inc”, highlighted the heightening threat of interest to the federal deficit. According to Meeker:
“Last year’s interest bill would have been 155% (or $290 billion) higher if rates have been at their 30-year average of 6% (vs. 2% in 2010). As debt levels rise and interest rates normalize, net interest payments could grow 20% or more annually.”
The sneaky thing about borrowing money is that the cost of borrowing increases the more you borrow.
In conjunction with writing this note, we took a look at the longer term budget history of the United States. In the chart below, we show the budget deficit going back to 1968. The chart shows a somewhat normal distribution of deficit spending and reduction and then beginning in the 2000 time frame, the deficit train wreck began.
Given this February data and the long term trend, it is no surprise that we re-shorted the U.S. dollar today in the Virtual Portfolio via the etf UUP. In God we trust, but not in debt.
Daryl G. Jones
Conclusion: A heavy load of important European policy decisions are scheduled for March. The risk is that European markets underperform as expectations for future stabilization measures diverge from the compromises leaders will have to make to appease divided opinion across countries.
Positions in Europe: Long Germany (EWG)
Tomorrow begins the EU Summit on Competitiveness, the little sister of the big brother EU Summit on March 24-5 that discusses a “Comprehensive” bailout package for the region.
The main agenda for tomorrow’s meeting with the Eurozone’s 17 heads of state and government in Brussels includes:
- Defining a “competitiveness pact”, now a watered down version from the original pressed by Germany and France, which calls for the rest of the Eurozone to show their commitment to overhauling their economies.
This current version of the pact is focused on further measures to limit public deficits; gradual increases to retirement ages; and work towards a common corporate tax base. To the last point, Ireland (including its new PM Enda Kenny) is against a common corporate tax base, as its current 12.5% rate, a clear competitive advantage compared to the EU average of 23%; Germany (30%) or France (34%).
While the agenda is a step in the right direction, the underlying issues that are plaguing Eurozone economies, especially those of the periphery, will not be addressed at tomorrow’s Summit; namely the troubled banks and leverage to them across the region and the ongoing sovereign debt and deficit imbalances of member states, despite attempts at austerity. It will be these issues that will be part of the main discussion when the 27 EU leaders meet in Brussels on March 24-5 to agree on a “Comprehensive Package”.
Ideals vs Decisions
One central topic of the “Comprehensive Package” is the size and scope of the fund to bailout troubled member nations. The current European Financial Stability Facility (EFSF), which was set up in May of last year and used to bailout Ireland, was meant to only be temporary, so a decision must be reached on the guidelines for a permanent fund, named the European Stability Mechanism, which is set to replace the EFSF from mid-2013 onwards.
Currently, the EFSF is funded with €750 Billion, composed of €440 Billion from the 16 Eurozone members; €250 from the IMF; and €60 Billion from European Commission. One pressing issue is that the entire €440 Billion is not all liquid, for guarantees against the money are needed to retain its AAA rating, which effectively leaves only €250 Billion for access. Many argue that should a country far greater than Greece or Ireland need a bailout, say a Spain or Italy, the funds are inadequate.
The German position on the size and scope of the bailout fund is largely against increasing it, for it would require even more taxpayer guarantees, which doesn’t match a largely fiscally conservative German populous that doesn’t wish to take on more leverage to countries that have exercised fiscal excess, the poster child being Greece, which for years did not properly manage its expenses and tax collection. However, most member states stand in opposition to Germany’s position, and believe increasing the bailout fund is in the interest of the all countries and the common currency.
Certainly, the size of the bailout fund is an important sticking point for German Chancellor Merkel who is fighting for a handful of state elections this year and must show a strong face against fiscal excess. Her party already lost a state election in the city-state of Hamburg late last month, and with her popularity fading and her party’s majority in the upper house of parliament lost, her voice at the Summit, and ultimately the decision of the Summit, is crucial for her future political life.
A second main point of contention at the Summit is the ability of the fund to directly purchase Eurozone member government bonds, a position Merkel and her Finance Minister Wolfgang Schaeuble are against, but many member nations are for.
Finally, discussions may also focus on the objectives of a second round of banking stress tests and a response to Ireland’s plea for more generous interest rate and payback schedules on its existing loan, the latter which Merkel is also against.
Clearly, Germany’s voice at the Summit will be loud, and important. Should Germany be the oil to the Eurozone’s water, we could get no unified decision from the Summit, which the market would largely interpret as a negative. However, should Germany’s voice prevail, or solid compromise be reached, we could see a positive interpretation. Yet, it also can’t be ruled out that should Germany get its wish to not increase the size of the bailout fund, this could be interpreted as negative for the medium-term health of the region, especially should a larger economy need a bailout, and considering that the fate of Portugal is currently weighing on investors.
This week has been packed with data and announcements that have returned the spotlight to Europe’s structural issues:
- Greek and Spanish credit ratings were downgrade by Moody’s.
- Sovereign Debt auctions from European peripheral countries showed yields backing up versus previous issuance of similar maturity, bucking a trend of lower yields we had seen year-to-date as investors were bullish on foreign buyers (China and Japan, in particular) and optimism that the EU’s comprehensive bailout package would be favorable to the periphery.
- The Bank of Spain said today that 12 lenders need to raise capital by €15.15 Billion. Of these 12 institutions, 2 are Spanish banks, 2 are subsidiaries of foreign banks, and 8 are savings banks or “cajas”. In early January, Spain’s Finance Minister said lenders need no more than €20 Billion to meet new capital levels; additionally, a government rescue fund (the Fund for Orderly Restructuring of the Banking sector, or FROB) is in place should lenders need assistance to recapitalize.
We’re of the opinion that European equity markets and the common currency could see severe pin action as the events of March unfold. Alongside the two summits, on March 16 a decision by the EU on the harmonization of tax rates will be released, and on March 18th formal parameters on the 2nd round of bank stress tests will be released.
As always, and due to the unevenness of Eurozone economies and cultures, reaching a unified decision on these important measures this month is critical to guide the region’s economic health, but won’t be easily agreed upon. We believe that the decisions and announcements in March will have impacts on the underlying markets and common currency that you’ll need to manage risk around.
Beware of March Madness in Europe.
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