There’s a recent swift inflection in Eurozone peripheral yields and select Eurozone equity markets roll into crash phase! #PrepareYourself
Despite the steady improvement (decline) in sovereign periphery bond yields on a year Y/Y basis, the inflection taking place on a D/D and W/W basis is significant. Here’s a look at the 10YR yields:
- Greece 8.91% (+105bps D/D ; +229bps W/W)
- Portugal 3.67% (+38bps D/D; +71bps W/W)
- Italy 2.59% (+17bps D/D ; +28bps W/W)
- Spain 2.22% (+10bps D/D; +14bps W/W)
And Portuguese and Greek equity markets are down YTD -25.2% and -23.9%.
Why the shift? As we expressed in our Q4 Macro Themes playbook, not only is global growth getting a lot worse, but specifically in our #EuropeSlowing theme we stress that Draghi’s Drugs will not arrest deflation (currently at 0.3% Y/Y) nor produce sustainable economic growth.
A second theme we continue to hammer home is that US economy has entered #Quad4, which is characterized by slowing growth and decelerating inflation.
And our last theme, #Bubbles, demonstrates that we see a significant number of market bubbles (including the SPX). Our call is “they don’t bounce”, or said another way, we’re recommending a 0% exposure (or short position if applicable) to the equity market, and not buy-in points.
Add on in recent weeks:
- Global growth forecasts were taken down by the IMF (and by numerous individual countries/governments)
- Persistent geopolitical risks (ISIS, Ukraine, and Hong Kong)
- Ebola outbreak concerns
And there’s plenty of “juice” to send risk premiums higher. Specifically in Europe, we’re seeing a confluence of factors that are sending the risk trade (not growth trade) higher.
- Greece: Political uncertainty – Greek PM Samaras reiterated his belief that Greece would hold a general election in 2016, even though his government faces the prospect of losing the presidential vote in February
- Greece: Financial uncertainty – There’s backlash and investor uncertainty over Greece’s claim to be purely market funded. We believe the country will need to ask for another credit line from the EU when EU funds run out this year (note: Greece is still taking funding from IMF through 2016)
- Italy: Joins France on sending Austerity is Dead message with Italian PM Renzi presenting an expansionary, tax-cutting 2015 budget that ignores the concerns from the European Commission on meeting its original deficit reduction target.
If we’re right that Draghi won’t be able to bend gravity to arrest deflation and produce sustainable economic growth, we’d expect sovereign yields from the Eurozone’s weaker member states to move higher commensurate with a higher risk profile. We expect the stronger deflation in peripheral countries to persist and extend the time period to higher growth levels.
We direct you to recent work including Just Ugly Charts #EuropeSlowing and #EuropeSlowing – Austerity Is Dead? for more on our investment position, outlook on ECB policy, and country-specific commentary.
Our premium mass concerns were finally confirmed by management on the call. Lower Street estimates do not appear to be going low enough
Please see our note: http://docs.hedgeye.com/HE_LVS_10.16.14.pdf
Takeaway: Solid labor market data flies in the face of a rising risk environment. Should you buy the dip or press the shorts?
What To Do When the Stars Don't Align
Sometimes conflicting data can put you in a tough analytical position. We track labor data closely because the credit cycle trumps all for Financials investors. Labor (i.e. loss frequency) is the primary driver of the credit cycle with collateral values (i.e. loss severity) riding shotgun. We track both. This morning's claims data suggests the recovery in the labor market is ongoing. In fact, the rate of improvement accelerated to the fastest clip we've seen YTD. Rolling NSA initial claims were better by 17.2% this week vs the prior year comp. Admittedly, the comps from last year were easier, making the significance slightly less, but the conclusion is still the same. The labor data suggests all systems go.
However, every Monday morning we also publish a note called the Monday Morning Risk Monitor and the titles of that note have been increasingly bearish for the last 3 weeks, including this past Monday's note: "Danger Zone". The Risk Monitor helps us navigate the short to intermediate trends while the labor market data helps us keep perspective on the longer-term credit cycle.
At the moment, they are in conflict. The short to intermediate term outlook is decidedly bearish based on the signals from our Risk Monitor. The longer-term outlook remains constructive, for now. A word of caution, however: the longer-term outlook is dynamic, and can be altered by short to intermediate term pressures. We've learned over the years to wait for the Risk Monitor to give us the green light before getting back in the water. So, for now, we'd be pressing the shorts.
Initial jobless claims fell 23k to 264k from 287k WoW. The prior week's number was unrevised. Meanwhile, the 4-week rolling average of seasonally-adjusted claims fell -4.25k WoW to 283.5k.
The 4-week rolling average of NSA claims, which we consider a more accurate representation of the underlying labor market trend, was -17.2% lower YoY, which is a sequential improvement versus the previous week's YoY change of--13.4%
The 2-10 spread fell -4 basis points WoW to 183 bps. 4Q14TD, the 2-10 spread is averaging 186 bps, which is lower by -13 bps relative to 3Q14.
Joshua Steiner, CFA
Jonathan Casteleyn, CFA, CMT
In the Q&A portion of today's Morning Macro Call for institutional investors, Hedgeye CEO Keith McCullough explains deflation in clear terms.
Takeaway: We're getting picky with timing here, but for good reason. We're looking to re-short this name into any sustained strength.
Brief Analysis: DFRG reported an unimpressive quarter, in our view, despite the fact that the market has responded positively. We covered our short last week for this reason, as sentiment around restaurants has been improving due to strong industry sales data. What really saved the day, however, was management's decision to maintain its full-year guidance and not provide guidance on 2015. We don't think its unreasonable to expect DFRG to hit the numbers in 2014, but believe 2015 guidance on the 4Q14 earnings call will be a negative catalyst for the stock. The street currently expects 2015 EPS growth of 19%, after delivering -7% growth in 2013 and what looks to be 3% growth in 2014. Considering persistent cost of sales inflation, the ongoing struggle at Sullivan's and operational inefficiencies associated with the rollout of the Grille, we view this as highly unlikely.
Comps: DFRG delivered +3.7% system-wide comp growth in the quarter on a calendar basis. Del Frisco's Double Eagle delivered +8.4% same-store sales growth driven by a +4.6% increase in customer counts and a +3.8% increase in average check. Sullivan's delivered +0.6% same-store sales growth driven by a +7.3% increase in average check, offset by a -6.7% decline in customer counts. Per usual, management did not disclose same-store sales data for the Grille. Consolidated revenues of $61.949 million (+14.3% y/y growth) missed consensus estimates of $62.529 million by 93 bps.
Margins: DFRG suffered from margin deleverage in the quarter, primarily driven by two new Grille openings, the ongoing sales challenges in Phoenix, AZ and Palm Beach, FL, and persistent beef inflation. Cost of sales surprised to the upside (+29 bps y/y) as restaurant level margins (-118 bps y/y) and operating margins (-218 bps y/y) fell short of consensus expectations.
Earnings: Adjusted EPS of $0.08 was in-line with expectations and notably stronger than last year's $0.02 loss. Strength here was primarily driven by G&A leverage and the reduction of 165,496 shares of outstanding stock ($3.6 million in repurchases).
What We Liked:
- System-wide same-store sales increased +3.7% on a calendar basis
- Del Frisco's delivered its 19th consecutive quarter of comp growth (+8.4%)
- Del Frisco's delivered an impressive +4.6% increase in customer counts
- The natural hedge of the Grille should help mitigate food cost inflation as it becomes a larger part of the portfolio
What We Didn't Like:
- Top-line miss
- The reliance on share buybacks to hit bottom-line estimates
- Persistent beef inflation with no end in sight
- Restaurant level margin deleverage
- Operating margin deleverage
- Sullivan's rapid -6.7% decline in guest counts
- Ongoing weakness at the two Grille's in Phoenix, AZ and Palm Beach, FL
- 2013 class of Grille's continue to perform below the level of both 2011 and 2012 classes
- Sullivan's continues to be a drag on the company
- Grille continues to be an unproven growth concept
- Management approved another $25 million in share repurchases over the next three years despite no FCF generation
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