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JAPAN: DOES THE "ABENOMICS TRADE" HAVE MORE ROOM TO RUN?

Takeaway: We’ve been dead wrong on Japan over the past month or so. With the exception of one MAJOR caveat, consensus probably has this trade right.

Where We’ve Been

On October 31st, the day of the BoJ’s surprise easing, we wrote a note titled, “WEEKEND MUST-READ: DOES THE DEATH OF JAPAN = THE DEATH OF ACTIVE MANAGEMENT?”. The key investment takeaway from that note was as follows:

 

”We’re inclined to maintain our SHORT bias on the DXJ and our LONG bias on the FXY for now. We think recent moves are exaggerated in both directions in the context of a highly likely dearth of incremental Policies to Inflate over at least the next few months.

 

That being said, however, we are actively looking for a rise in cross-asset volatility as an opportunity to exit this position in the coming weeks. In short, we are now wrong on this trade and are seeking to minimize the damage by not covering high (DXJ) and selling low (FXY).”

 

It’s worth noting that the Japanese yen tends to be positively correlated with cross-asset volatility due to the country’s status as the world’s largest supplier of capital. Japan’s net international investment surplus of ~$3T is equivalent to 68% of the country’s GDP and compares to a -$5.5T deficit for the US.

 

JAPAN: DOES THE "ABENOMICS TRADE" HAVE MORE ROOM TO RUN? - JPYUSD vs. SPX

 

With the obvious lack of cross-asset volatility since 10/31, we have been made incrementally wrong on this recommendation and are now content to just get the heck out of the way. For what it’s worth, the DXJ and FXY have moved -487bps and -787bps, respectively, against us since we introduced the thesis on September 22nd.

 

That was obviously the right call to have made by mid-October (e.g. the DXJ and FXY moved +1045bps and +253bps, respectively, in our favor from 9/22 to 10/15), but we have clearly overstayed our welcome on the short side of the “Abenomics Trade”.

 

Unlike our competitors – the vast majority of whom lack a buyside practitioner’s approach to global macro risk management – we actually get things wrong here at Hedgeye. With no banking, trading or asset management revenues to help “keep the lights on”, we don’t tend to stay wrong for long, however. Moreover, we’d like to think our customers appreciate our conviction on the LONG and SHORT side of global macro risk management.

 

The alternative would be opining with no view…

 

Where We’re Headed

In the next three sections, we attempt to coagulate all of the moving parts across Japan’s macro and political economy. Hopefully we’ll adequately distill that into an investment conclusion, but as the title of the note implies, we’ll let you be the judge of that!

 

The Snap Election: Tricky At Best

Today Prime Minster Shinzo Abe officially announced a November 21st dissolution of the Diet, effectively paving the way for snap elections on December 21st. To the extent that he secures a second mandate, it is likely that he attempts to push through a series of potentially unpopular reforms over the next four years, including but not limited to:

 

  • Lowering corporate taxes from an effective rate of ~35% to the mid-20s
  • A reduction in agriculture tariffs as part of entry into the U.S.-led Trans-Pacific Partnership
  • Deregulating the health care industry
  • Promoting women advancement in the workforce; Abe aims to have women account for 30% of management positions at Japanese companies by 2020, up from ~6% now
  • A broad restoration of Japan’s nuclear power plants
  • Potential constitutional reform to expand Japan’s military

 

Currently the LDP (Abe’s party) has 294 of 480 seats (61%) in the House of Representatives (i.e. lower house) and 114 of 242 seats (47%) in the House of Councilors (i.e. upper house). Together with partner NKP, Abe’s coalition has a 68% mandate in the lower house and a 55% mandate in the upper house.

 

Conclusion: there’s really nowhere to go but down from these levels. In fact, we consider it a highly risky proposition for Abe to pursue a snap election at the current juncture in light of recent Japanese economic data:

 

  • Overall Household Spending (i.e. “Real PCE”) crashing, down -5.6% YoY
  • Real Household Income crashing, down -6% YoY
  • Consumer Confidence on the lows
  • Small Business Confidence on the lows
  • General economic confidence (per the widely-followed Economy Watcher’s Survey) on the lows

 

JAPAN: DOES THE "ABENOMICS TRADE" HAVE MORE ROOM TO RUN? - RETAIL SALES

 

JAPAN: DOES THE "ABENOMICS TRADE" HAVE MORE ROOM TO RUN? - REAL INCOME

 

JAPAN: DOES THE "ABENOMICS TRADE" HAVE MORE ROOM TO RUN? - CONSUMER CONFIDENCE

 

JAPAN: DOES THE "ABENOMICS TRADE" HAVE MORE ROOM TO RUN? - BUSINESS CONFIDENCE

 

JAPAN: DOES THE "ABENOMICS TRADE" HAVE MORE ROOM TO RUN? - ECONOMY WATCHERS SURVEY

 

FYI, it’s worth mentioning that Japan entered its fourth recession in six years with the advent of the 3Q GDP release:

 

  • 3Q Real GDP: -1.2% YoY from -0.2% in 2Q
    • QoQ SAAR: -1.6% from -7.3%
    • Real Private Demand: -2.3% YoY from -0.3%
      • Household Consumption: -2.8% YoY from -2.7%
      • Private Residential Investment: -12.3% YoY from -2%
      • Private Nonresidential Investment: 2.8% YoY from 3.8%
    • Real Public Demand: 0.8% YoY from 0.6%
      • Government Final Consumption Expenditure: 0.3% YoY from flat
      • Public Investment: 2.9% YoY from 5.2%
  • 3Q Nominal GDP: 0.8% YoY from 1.9% in 2Q
  • 3Q GDP Deflator: 2.1% YoY from 2% in 2Q

 

Further, the Japanese economy continues to contract here in 4Q:

 

JAPAN: DOES THE "ABENOMICS TRADE" HAVE MORE ROOM TO RUN? - COMPOSITE PMI

 

To top it all off:

 

  • The approval rating for Abe’s Cabinet has fallen to 48.1%, down -6.8ppts. from the previous poll conducted in early September;
  • Abe’s economic policies were the top reason cited by respondents who did not support the Cabinet at 40.2%;
  • 84.8% of all respondents said they did not feel the economy has recovered;
  • 63.8% of the respondents expressed opposition to legalizing casinos, while only 30.3% expressed support;
  • 60.2% oppose allowing the nation’s nuclear reactors to resume operation, while only 31.9% support their reactivation;
  • 55.9% said measures to encourage the promotion of women at corporations are not effective, while a much smaller 40.8% said they are effective; and
  • Per broadcaster NTV, approximately 2/3rds of voters are against an election next month.

 

SOURCE: http://www.japantimes.co.jp/news/2014/10/19/national/politics-diplomacy/survey-finds-support-rating-abe-cabinet-48-1-6-8-points/#.VG0Wl_nF98G

 

Good luck next month, Mr. Abe; you’re going to need it!

 

In fact, the only saving grace we can find in support of a positive election surprise is the fact that:

 

  • 65.9% of respondents were opposed to raising the consumption tax rate to 10% in October 2015 (recall that Abe has just announced delaying the planned +200bps hike by 18M to April 2017); and
  • The NTV survey highlighted above found that support for Abe's LDP was at 40%, which compared to a lowly 10% approval rating for the main opposition DPJ party.

 

Abe has hinted at resigning if the election results point to an overwhelming majority of voters rise up against his Abenomics agenda. In that light, the “Abenomics Trade” will be facing a critical level of tail risk in the coming ~month.

 

Fiscal Policy: Getting Easier

With respect to Japanese fiscal policy, prepare the anchor for more stimulus. The government is currently considering a supplementary budget worth ¥2-3T full of measures aimed at “helping people cope with rising energy prices, local revitalization and reconstruction in disaster-hit areas”.

 

With unspent funds from FY13 and above-target fiscal revenues from FY14, the government should be able to secure about ~¥4T in funds for a supplementary budget. In terms of the anticipated economic impact, this figure compares to supplementary budgets of ¥10T and ¥5.5T in FY12 and FY13, respectively.

 

In the context of Abe delaying next fall’s consumption tax hike and pledging to proceed with the first iteration of cooperate tax cuts next year, Japanese fiscal policy will remain very favorable for equity investors over the next 12-18M.

 

On the flip side, much of the late-2013/early-2014 acceleration in real GDP growth was pull-forward ahead of April’s +300bps VAT hike. Without a similar need for consumers and businesses to accelerate expenditures, we anticipate Japan’s economic contraction will continue for at least the next two quarters as the country laps extremely difficult GDP compares.

 

JAPAN: DOES THE "ABENOMICS TRADE" HAVE MORE ROOM TO RUN? - JAPAN

 

In fact, the broad balance of Japan’s high-frequency economic data continues to lose sequential momentum on a trending basis. In the context of how we model Real GDP, this all but ensures a continued deceleration in the growth rate of the headline figure(s).

 

JAPAN: DOES THE "ABENOMICS TRADE" HAVE MORE ROOM TO RUN? - Japan High Frequency GIP Data Monitor

 

Monetary Policy: Getting Crazier

Japanese consumption be damned, we now know that the BoJ is completely comfortable with going “full Weimar [Republic]” with Japanese monetary policy, as most recently highlighted by today’s 8-1 vote in leaving monetary policy unchanged; recall that the board was split 5-4 when Governor Haruhiko Kuroda opted for additional easing last month.

 

What we found even more surprising is the fact that Kuroda reiterated his “upbeat” assessment of the economy. Yes, the same Japanese economy that is mired in recession and contracting -1.2% on a YoY basis!

 

What this tells us is that he is likely leaving room for a downside surprise to his targets, which would afford him scope to expand QQE sooner, rather than later. Per Bloomberg, sellside consensus expects a further expansion of QQE by June. Kuroda surprised us once; he won’t catch us off guard again!

 

Reasons for QQE expansion over the next 2-3M:

 

  • The BoJ has to increasingly provide liquidity to the JGB market in the context of the GPIF portfolio reallocation and Japan’s deteriorating BoP dynamics (CLICK HERE for more details);
  • The BoJ is seemingly hell-bent on perpetuating Japanese stock market inflation (there is speculation that the BoJ buys ETFs whenever the 1st section of the Tokyo Stock Exchange drops more than -1% in the morning session); and
  • A potentially reflexive loop of decelerating inflation and a lower-highs in Japanese inflation expectations as JPY weakness perpetuates USD strength, which continues to be a material headwind for the prices of key commodities.

 

JAPAN: DOES THE "ABENOMICS TRADE" HAVE MORE ROOM TO RUN? - CURRENT ACCOUNT BALANCE

 

JAPAN: DOES THE "ABENOMICS TRADE" HAVE MORE ROOM TO RUN? - CPI

 

JAPAN: DOES THE "ABENOMICS TRADE" HAVE MORE ROOM TO RUN? - CORE CPI

 

JAPAN: DOES THE "ABENOMICS TRADE" HAVE MORE ROOM TO RUN? - 10Y BREAKEVEN

 

JAPAN: DOES THE "ABENOMICS TRADE" HAVE MORE ROOM TO RUN? - DXY vs. Brent Crude Oil

 

JAPAN: DOES THE "ABENOMICS TRADE" HAVE MORE ROOM TO RUN? - DXY vs. CRB FOOD

 

JAPAN: DOES THE "ABENOMICS TRADE" HAVE MORE ROOM TO RUN? - CRB YoY vs. CPI YoY

 

All told, the BoJ can and will “do more” to pursue the “5% Monetary Math” agenda as originally stated with the introduction of Abenomics.

 

JAPAN: DOES THE "ABENOMICS TRADE" HAVE MORE ROOM TO RUN? - FIVE PERCENT MONETARY MATH

 

It seems crazy to us allocating capital to the “Abenomics Trade” (i.e. LONG the DXJ and SHORT the FXY) at current price levels in Japan’s equity and currency markets, but  perhaps that’s precisely the point: Japanese central planners are forcefully compelling us to join in on the craziness.

 

JAPAN: DOES THE "ABENOMICS TRADE" HAVE MORE ROOM TO RUN? - JPYUSD vs. MSCI JAPAN

 

Investment Conclusions: Doing Nothing, For Now

If there’s anything investors should glean from the U.S. midterm elections is that the state of the economy matters big time at the ballot box. We don’t want to be in the way of a potential election surprise that could potentially render the entire Abenomics agenda a thing of the past.

 

While we’re likely to miss out on further upside by not joining in on the craziness of it all, we think this is the most prudent risk management decision for an investor to make at the current juncture. At a bare minimum, those that have risk managed this trade appropriately should look to book gains in the coming days/weeks.

 

For those of you who have a desire or mandate to keep “riding the bull”, you should take some solace in the fact that with a Z-Score of +0.2x (TTM), the JPY isn’t nearly as crowded of a short now as it has been in recent months. Perhaps there’s another leg down to ~125 vs. the USD right around the corner!

 

JAPAN: DOES THE "ABENOMICS TRADE" HAVE MORE ROOM TO RUN? - CFTC NNCP

 

All told, if Abe strengthens his mandate to pursue his crazy economic agenda, we will happily go “all-in” on the long side of Japanese equities (DXJ) and on the SHORT side of the Japanese yen (FXY), while anticipating further economic deterioration in the process! We just find doing so ahead of the elections to be a risky proposition.

 

Imagine if you were forced to buy Germany’s DAX equivalent in the early 1920s?

 

JAPAN: DOES THE "ABENOMICS TRADE" HAVE MORE ROOM TO RUN? - 11 19 2014 7 27 35 PM

SOURCE: The Economics of Inflation by Costantino Bresciani-Turroni, published 1937

 

Crazy stuff indeed…

 

Feel free to ping us with any follow-up questions. Have a wonderful evening,

 

DD

 

Darius Dale

Associate: Macro Team


Jack and Qdoba

JACK continues to be on our Investment Ideas list as a long.


Key Points

  1. UPSIDE DRIVEN BY COMPS MOMENTUM: +3.1% and +7.7% system comp growth at JIB and Qdoba, respectively, drove strong restaurant operating margin expansion at both brands.  JIB outperformed the QSR sandwich segment by 330 bps due to strength in the breakfast and late-night dayparts.  Qdoba strength was driven by the conclusion of its Mango Mayo campaign, the return of Queso Diablo as a permanent menu item and double digit growth in catering.  Both concepts benefitted in the period from price increases and favorable product mix.    
  2. TRADING AT A CONGLOMERATE DISCOUNT: We believe JACK continues to trade at a conglomerate discount despite the recent success, and long-term potential, of the Qdoba brand.  JACK has transformed its business into a largely asset-light model possessing a significant growth driver.  With only 638 restaurants, the Qdoba concept has a long runway for growth ahead of it and, this time, we believe management is prepared to roll the concept out successfully.  Expect to see 50-60 new Qdoba restaurants next year and 70-110 new Qdoba restaurants annually from 2016-2018.  Trading at 11.99x EV/EBITDA, we see several turns of upside assuming the strength of the Qdoba brand persists.
  3. 2015 GUIDANCE IS ACHIEVABLE: Considering notable comp momentum, continued margin expansion and cash remaining under the share buyback program, we believe management’s guidance of $2.73 to $2.88 EPS in FY15 is conservative.  This implies a range of about 11-17% EPS growth, despite having grown EPS by over 30% in the prior two years.  Commodity inflation (beef, free sides) and labor cost pressure in some markets is a concern moving forward, but we believe management has fully accounted for this making the guidance range achievable, at the very least. 

 

The Good in 4Q14

  • Beat top line and bottom line estimates by 64 bps and 163 bps, respectively
  • +3.1% system same-store sales growth at JIB; +7.7% system same-store sales growth at Qdoba
  • JIB system same-store sales outpaced the QSR sandwich industry by 330 bps, respectively
  • JIB saw growth in both breakfast and late-night dayparts
  • Qdoba strength was driven by the conclusion of its Mango Mojo campaign, return of the Queso Diablo, double digit catering growth and less discounting
  • JIB restaurant level margins of 17.8% (+210 bps y/y) beat estimates of 17.1%
  • Qdoba restaurant level margins of 18.5% (+130 bps y/y) beat estimates of 17.7%
  • 1/3 of Qdoba restaurants generate over $1.3 million in AUVs and boast, on average, restaurant level margins of 23%
  • Continuing efforts to improve cost structure, identify efforts to cut G&A and improve restaurant profitability
  • $117 million remaining under two stock-buyback programs that expire in November 2015; additional $100 million stock-buyback program that expires in November 2016
  • Strong 2015 guidance including +6-8% comp growth at Qdoba and system-wide consolidated restaurant level margins of 18.8-19.6%
  • Management sounded clear, concise and confident in their plan moving forward, which includes better positioning the JIB brand and conscientiously growing out the Qdoba brand.

 

The Bad in 4Q14

  • JIB traffic declined -2.6%; Qdoba traffic growth of +1.7% was slightly disappointing given the strong comp

 

Jack and Qdoba - 1

 

Jack and Qdoba - 2

 

Feel free to email, or call, with questions.

 

Howard Penney

Managing Director

 

Fred Masotta

Analyst


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Hedgeye Director of Research Daryl Jones shares the top three things in Keith's macro notebook this morning.

 


Starts & Apps - More Positive Housing Data Turning the Table Greener

Takeaway: Single family starts rise to the highest level in a year while mortgage purchase apps bounce 12% w/w.

Our Hedgeye Housing Compendium table (below) aspires to present the state of the housing market in a visually-friendly format that takes about 30 seconds to consume.

 

*Note - to maintain cross-metric comparability, the purchase applications index shown in the table below represents the monthly average as opposed to the most recent weekly data point.

 

Starts & Apps - More Positive Housing Data Turning the Table Greener - Compendium 111914

 

BOTTOM LINE - THE CALL HAS BEEN WORKING BUT THE DATA'S TURNING

We'll reiterate today what we wrote yesterday when assessing the NAHB HMI data. Our bearish call on housing thus far in 2014 has been playing out as the XHB remains the worst performing sector YTD. That said, many of the negative dynamics that we flagged earlier this year have largely or completely played out and we're now seeing some signs of light at the end of the tunnel (see the volume of "green" in the compendium at the top of this note). We'll be hosting a call in early December to update our views on housing heading into 2015. 

 

 

Today's Focus: October Housing Starts & Permits & MBA Mortgage Apps

 

October Housing Starts & Permits

The Census Bureau released its monthly Housing Starts & Permits data for October this morning.

 

Total New Home Starts declined -29K (-2.8%) sequentially in October while Permits rose +49K (+4.8%) to 1.080M SAAR– the highest level since June of 2008.  In contrast to last month, the headline is less flattering than the core as single family starts showed a second month of (modest) positive mojo.

 

Single Family starts rose +28K (+4.2%) to +696K, the highest level in a year and the second month above the TTM Trend.  The September figures also saw a +22K positive revision up to +668K from +646K.  Permits, however, continue to meander with SF permits up just +9K to +640K in October, extending the flat YTD trend and diverging from starts the last two months.  The two, of course, are invariably tethered so we can expect some measure of re-coupling in the coming months. 

 

Two months do not (yet) a trend make and we’re interested to see in which direction the burgeoned divide between actual construction activity and builder confidence corrects in favor of against a 2015 backdrop of easier compares, looser regulation and ongoing improvement in the labor market (and the 20-34YOA demographic in particular). 

 

On the multi-family side, starts declined -57K MoM (-15.4%) to +313K while permits rose +40K (+10%) to +440K.   Given the volatility in the multi-family data on a month-to-month basis, we look more to the trend and with single-family starts up +4.5% YoY on average YTD vs. multi-family up 19%, the concentration in construction activity, and the predominate driver of the recovery in starts, remains well defined.

 

Starts & Apps - More Positive Housing Data Turning the Table Greener - SF Starts   permits TTM

 

Starts & Apps - More Positive Housing Data Turning the Table Greener - SF Starts   permits LT

 

Starts & Apps - More Positive Housing Data Turning the Table Greener - MF Starts   permits TTM

 

Starts & Apps - More Positive Housing Data Turning the Table Greener - MF Starts   permits LT

 

Starts & Apps - More Positive Housing Data Turning the Table Greener - Starts Lt 

 

 

MBA Mortgage Applications

The Mortgage Bankers Association today released its weekly mortgage applications survey data for the week ended November 14th. 

 

  • The Composite Index rose +4.9% in the latest week alongside a modest gain in refi activity and a remarkable pop in Purchase demand
  • Purchase demand rose +11.7% WoW – the largest weekly increase in 20 months – taking the index up to 179.8, the highest level since June. Inclusive of this weeks gain, purchase activity is tracking -1.1% QoQ and -6.7% YoY (vs. -12% YoY last week).  We continue to expect some measure of ongoing improvement in rate of change measures  as compares ease into the last weeks of the year and take a second dive into the end of 1Q15 as the collective shock from weather, QM implementation and FHFA loan limit reductions peaked.
  • Refi Activity rose for the first week in a month, gaining +0.9% sequentially as rates on the 30 FRM contract dropped a tick to 4.18%.    

 

Starts & Apps - More Positive Housing Data Turning the Table Greener - Purchase Apps 2013 v 2014

 

Starts & Apps - More Positive Housing Data Turning the Table Greener - Purchase LT w Summary

 

Starts & Apps - More Positive Housing Data Turning the Table Greener - Purchase Qtrly Ave

 

Starts & Apps - More Positive Housing Data Turning the Table Greener - Purchase   Refi YoY   

 

Starts & Apps - More Positive Housing Data Turning the Table Greener - Composite LT w Summary

 

Starts & Apps - More Positive Housing Data Turning the Table Greener - 30Y FRM

 

 

 

About Housing Starts & Permits:

The US Census Bureau records the number of new housing units that have obtained permits for construction and those that have begun construction. This data includes new buildings intended primarily as residential units. The US Census Bureau defines a start as, “Start of construction occurs when excavation begins for the footings or foundation of a building.” 

 

About MBA Mortgage Applications:

The Mortgage Bankers’ Association’s mortgage applications index covers more than 75% of mortgage applications originated through retail and consumer direct channels. It does not include loans delivered through wholesale broker and correspondent channels. The MBA mortgage purchase applications index is considered a leading indicator of single-family home sales and construction. Moreover, it is the only housing index that is released on a weekly basis. 

 

Frequency:

The MBA Purchase Apps index is released every Wednesday morning at 7 am EST.

 

  

Joshua Steiner, CFA

 

Christian B. Drake


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