Conclusion: We’ve taken advantage of the opportunity presented via lower prices to invest in a great long-term idea.
Late yesterday afternoon, we initiated a long position in Indonesian equities in the Hedgeye Virtual Portfolio. We’ve been bullish on Indonesian equities since 3Q10 and we continue to expect the steady performance out of the Indonesian economy that we have come to know over the last few quarters. And with the world’s fourth-largest population and strong demographic tailwind (Indonesia’s labor force is set to expand +20% over the next 20 years), Indonesia’s bullish long-term TAIL story remains intact. As such, we’ve taken advantage of the opportunity presented via lower prices to invest in a great long-term idea.
Much like the Philippines, which we are also long of on the equity front in the V.P., Indonesia draws our admiration for being a relatively defensive play amid an uncertain at best Global Macro backdrop.
Indonesian economic growth is stable: real GDP growth came in flat in 2Q at +6.5% YoY and our models point to a flat-to-slightly-down outlook for 2H (vs. “down-to-down-a lot” in many other major economies). Though an absolute acceleration in GDP remains the most supportive catalyst in our models, we also like countries where economic growth is accelerating on a relative basis to vs. the rest of the world. Indonesia certainly fits the latter of those setups quite well:
Though up marginally in August, consumer price inflation has slowed to +4.8% YoY, coming in from the January peak of +7% YoY:
Core inflation, which has accelerated to a 26-month high of + 5.2% YoY in Aug, remains a key concern. Coupled with a our model’s outlook for Indonesian headline inflation (marginally higher over the next two months), we think Bank Indonesia will be forced to maintain rates on hold and perhaps introduce a hawkish lean in their statement – depending on the absolute level of inflation. Still, even adopting our model’s most inflationary estimates would leave CPI well within the central bank’s target of 5% +/- 100bps – meaning that we’re unlikely to see any tightening over the intermediate term.
For reference, Bank Indonesia’s Reference rate (currently at 6.75%) has been on hold since February; moreover, their recent commentary suggests they are perhaps more concerned about the [global] risks to Indonesian economic growth than a measured and sustained pickup in inflation:
“Bank Indonesia has room to cut its benchmark rate if inflation behaves.” – Hartadi Sarwono, Bank Indonesia Deputy Governor
“Policymakers are ready to adjust the rate and mix monetary policy toward loosening if price gains slow and the economy expands less than expected due to a global slowdown.” – Perry Warjiyo, Bank Indonesia Director of Economic Research
In addition to having an ace in the hole on the monetary policy front, Indonesia’s fiscal positioning also remains supportive should it become necessary. With a small and improving deficit/GDP ratio of -2.1% and a incredibly healthy debt/GDP ratio of 26.9%, Indonesia isn’t in a box as it relates to being able stimulate its economy should it become necessary as a function of the global growth outlook deteriorating further. Though we’re certainly not ever going to be labeled proponents of Keynesian “countercyclical” policy, even us football and hockey players can recognize the profound effects “stimulus” has on stock markets.
One key risk we see to holding Indonesian [and other emerging market] equities, is on the currency front. Should Bank Indonesia make due on their promise to “loosen” monetary policy, we could see the rupiah come under continued pressure vs. the USD (down -2.5% over the last five trading days alone). To that effect, the central bank intervened yesterday in the country’s FX and bond markets to stop the bleeding, so to speak. The meaningful backup in Indonesia’s sovereign debt yields (2yr up +47bps wk/wk; 10yr up +59bps wk/wk; and 30yr +27bps wk/wk) isn’t a result of renewed inflation/tightening speculation (1yr on-shore interest rate swaps down -90bps wk/wk). Rather, we view it as foreign investors exiting the market en masse, as both Indonesia’s equity and bond markets are subject to a great deal of Winner’s Risk as a result of their outperformance over the last year.
A hockey stick in the country’s external debt burden also remains a risk to the currency – particularly if Indonesian corporations are forced to buy USD/EUR/JPY by selling the IDR to meet debt service requirements. External debt growth, both on a public and private level, has accelerated to roughly +22% YoY and each segment is growing at the highest rate on record, which dates back to 2004:
As it currently stands we don’t see a re-do of the ’97 Asian Financial Crisis, but if the Indonesian equity market blows through its long-term TAIL of support (less than 1% below), we’d argue that the risk of a larger-scale external debt crisis is definitely in play. Still, our positioning indicates that we have confidence that this critical quantitative line will hold and, as such, we have chosen to go long the IDX in our Virtual Portfolio.
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Keith’s booking his eight gain covering JCP in the virtual portfolio since May with the sock holding its TRADE line of support at $26.13 for the first time in a while. Our thesis remains unchanged.
Ackman’s comments this morning reaffirm our bearish position over the immediate term. He’s betting on Ron Johnson to improve the retail experience, which may well play out – in 2015. In the meantime, it’s going to take both capital and time – not good for the stock over the immediate-term TRADE or intermediate-term TREND.
For more info on our thesis, see our Black Book, “JCP: What Ackmanists Are Missing.”
On a sequential basis, YoY food at home CPI inflation increased by 60 basis points to 6% versus the 10 basis point gain in food away from home CPI inflation increasing 10 basis points to 2.7%.
Food inflation is now the most important household expense, according to WMT’s commentary during its 8/16 earnings call. Food prices, according to the Bureau of Labor Statistics’ CPI data released this morning continues to accelerate higher. In August, food at home CPI increased to 6% on a year-over-year basis from 5.4% in July. We are including two charts to illustrate food costs trends and food cost trends versus core inflation. One callout we would make is that, the spread between food at home inflation and core inflation widened month-over-month while the spread between food away from home and core inflation narrowed.
Grocers like Whole Foods, where the customer is more loyal and willing to pay higher prices, are reporting no problems passing price through but other concepts where the price elasticity of demand may be higher will likely see more attrition as they look to protect margin. To the extent that grocery inflation continues to outstrip price increases in restaurants, it should be a positive for comparable sales trends at restaurant chains. Whether or not restaurant margins can withstand the pressure or not, however, remains to be seen.
Conclusion: Romney has caught Perry in the race for the Republican nomination making it a true two horse race with the support of other front runners eventually being critical. In the recent special races, the bad news builds for Democrats suggesting Republicans could gain the Presidency and Senate.
Two nights ago, the Republican candidates for President held their second debate. The message from this debate was clear: the Republican posse is not going to let the cowboy from Texas remain at the front of the pack without a fight. Indeed, Texas Governor Perry suffered shots from all of his fellow nominees and while he handled himself reasonably well, former Massachusetts Governor Mitt Romney was the clear beneficiary after the debate.
In fact, according to the most recent contracts on InTrade, Romney’s probability of becoming the Republican nominee for President now surpasses Perry’s probability. Based on the futures contracts on InTrade, Perry now has 35.4% probability of becoming President, while Romney is at 39.7%. Perry’s probability is not off dramatically from its highs, but Romeny’s, on the other hand and as shown in the chart below, has skyrocketed.
The other key take away from these InTrade contracts, and most national polls, is that this race is most definitely a two candidate race. On a combined basis, the probability of either Romney or Perry becoming the nominee is north of 75%. Interestingly, the key for either getting nomination could very likely be the endorsement of one of the other front runners, namely Gingrich, Bachmann, or Paul.
In that vein, Tim Pawlenty, who admittedly knows both candidates well, opted to publically come out and support Romney (and Romney supporters purportedly have agreed to help retire Pawlenty’s campaign debt). Since Pawlenty was a marginal national candidate at best, he likely only had a marginal impact on Romney’s standing. The next endorsements will be much more critical and will likely come much closer to Presidential primary season.
The tentative primary dates to be focused on are as follows:
- Iowa, December 5th, 2011;
- New Hampshire, December 13th, 2011;
- Nevada, December 13th, 2011; and
- South Carolina, December 17th, 2011
These dates are subject to change, but it is in this general time frame that the Republican nominee should be crowned and if the race between Perry and Romney stays tight, it will likely be determined by endorsements from the other front runners. Then, after the Republican nominee is named, the real political race begins. Or does it?
There can be no doubt that President Obama will face a tough race given the state of the economy and his own approval rating. Interestingly, many polls suggest that the race will be close and the President Obama is still the odds on favorite. In fact, a poll released by Public Policy Polling yesterday shows Obama beating Romney by 4 points, Perry by 11 points, and Bachmann by 14.
Polls, of course, are notoriously inaccurate when analyzed on a standalone basis. The recent results from Congressman Anthony Weiner’s former district, the 9thCongressional District, and other special races, are perhaps more telling than recent polls. Specifically, New York-9 has not elected a Republican in over a hundred years and has 3:1 registered Democrats versus Republicans. Not only did presumptive Congressman Bob Turner (R-NY) win the seat, he crushed the presumptive Weiner heir by a margin of almost 9 percent.
The other two recent special elections, though not as newsworthy, have had similar results. In Nevada-2 on September 13th, the Republican candidate won by 22 points and in California-36 on July 12th, the Republican only lost by 10 points. In both of these races, the Republican candidates dramatically outperformed their Partisan Voting Index (PVI), a measure of how the district voted based on the past two presidential elections, by a margin of +12 and +14 respectively. Collectively, in California-36, Nevada-2, and New York-9, the Republicans outperformed versus the PVI-expected outcome by a staggering 15 points on average.
Clearly, these are only a few races, but certainly telling. As one Queens voter told the New York Times:
“I am a registered Democrat, I have always been a registered Democrat, I come from a family of Democrats — and I hate to say this, I voted Republican. I need to send a message to the president that he’s not doing a very good job. Our economy is horrible. People are scared.”
To that end, we will be releasing our Hedgeye Election Index in coming months that takes real time economic data and provides insight into future election results. In part, the Hedgeye Election Index will be based on Yale Professor Ray Fair’s work. Professor Fair looked at more than one hundred years of national elections and found that the most consistent and relevant factors that predict elections are recent economic performance, specifically growth. Currently, based on our financial estimates, Fair’s model shows that Obama will only get 49.7%, so lose in a squeaker, but the Republicans will also gain control of the Senate.
Daryl G. Jones
Director of Research
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