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Moscow, We Have a Problem

When your country’s central bank raises its interest rate a monster 650bps to 17% (as the Russian Central Bank did early this morning local time) and the currency still doesn’t go up, Houston, we have a problem.

 

By all accounts, we saw some of the most epic swings (ever) across Russian markets today. The whipsaw moves beg the important question:  during these desperate times in Putin’s Russia, will we witness desperate measures taken? 

 

In today’s Hedgeye Poll of the Day we asked: “Will Vladimir Putin take major military action in 2015?” The response was 65% “YES” versus 35% “NO”.  Clearly, taking a “major” action to inflect the price of oil could be seen as desperate to some, or as a necessity to others.

 

Moscow, We Have a Problem  - w. putin poll

 

We run though the current risk set-up impacting Russia below and offer accompanying charts illustrating current risks. While it remains unclear exactly how conditions will play out from here, the risk has markedly increased to the upside (over even just the last 24 hours).

 

Four factors worth considering upfront:

 

1) OPEC may have an agenda to tighten the screws on Russia and other countries with high break-even prices;

2) Currency crashes can be expedient and self-perpetuating;

3) Russia’s economic isolation and nationalism may extend the prospect of economic recovery;

4) The heavy ties of Russia’s largest companies to the State could expedite and heighten the sovereign risk profile.

 

A key news item to this entire story was released yesterday: the Russian government disclosed that state-owned Rosneft needed to raise capital, with help from the Central Bank, to cover $6.9Bn in a USD-denominated bridge term-loan due early next week. Rosneft issued $10.9Bn in new bonds at Friday’s exchange rate with large, State-owned banks buying the issue. The banks then deposit the bonds with the central bank, and Rosneft is financed with the printed Rubles.  Rosneft, due to the current sanctions, is unable to roll the term loan with western banks, and so squarely looks like it desperately needed the money from the CB to foot the bill next week.  Of note is that Rosneft CEO Igor Sechin is a close ally with President Vladimir Putin. The next unsecured USD-denominated debt from Rosneft is a $7.1Bn payment due February 2015.   

 

While we look from the outside, on the streets the purchasing power of the Ruble is evaporating, quickly. Despite Putin’s popular approval rating still in the 80s, we’d be overweight the “YES” camp that in fact a crashing Ruble will propel him to take some form of desperate action. 

 

Moscow, We Have a Problem  - w. Russia cartoon 12.15.2014 normal

 

We suggest you consider these risks to protect your portfolio during this downslide.

  • Crash Mode 1: The USD/RUB is down -27% W/W and -56% YTD
  • Crash Mode 2: The Russian Stock Market (RTSI) is down -28% W/W and -57% YTD
  • Russia’s 5YR Sovereign CDS rose to 551bps (+67bps D/D) (above 300bps = Lehman breakout line).
  • The Russian Central bank has spent ~ $80 - $100 Billion on FX interventions to strengthen the RUB – but yet to no avail. The FX reserve is now at a 5YR low. Their total FX and gold reserve base is at $416.2Bn as of 12/05 (-18.50% YTD) and we’ll get an updated number from the CB on Thursday.  They have already pumped dollars into the Russian banking system and bought Rubles (a move that would have been slightly reversed if there is any truth to the Rosneft debt bailout)
  • The Russian Central Bank has raised the main interest rate 6 times this year; today’s 650bp increase to 17% follows last week’s 100bp hike. Here too there’s been no inflection in the currency or stock market.
  • Brent Crude is down -46% YTD at $59.60. A close proxy for Russia’s Urals main export blend, according to Finance Minister Anton Siluanov the price needs to be at $90/barrel for the 2015 budget to balance (a level 51% above today’s price).
  • Russia derives about 50% of its budget revenue from oil and natural gas taxes and 25% of its GDP is linked to the energy industry.
  • The Russian Central Bank said today that 2015 GDP may shrink to 4.5% to 4.7%, the most since 2009, if oil averages $60 a barrel under a “stress scenario”. (We expect the 2015 GDP drag could be closer to -6% to -8%).
  • The Russian Central Bank said net capital outflow may reach $134 billion this year, more than double last year’s total.
  • Inflation is at a 3YR high at 9.1% while real wages are at a paltry 0.3%.
  • Lower purchasing power via a depreciating currency + some higher local prices given import sanctions = the perfect cocktail for massive declines in consumer spending (beyond buying goods to lock in the “value” of the Ruble – evidence we’ve received anecdotally).
  • Russian banking crisis risk is rising by the day: as a proxy, Sberbank, Russia's largest bank with 46% deposit share, has seen its CDS rise steadily since mid-year, up 50bps D/D to 576bps.
  • Further, the CEO of Sberbank said back on November 14th that if the Russian economy were to decline by more than 1.2% in 2015 Sberbank would need the State to bail it out.

Moscow, We Have a Problem  - a. 1

Moscow, We Have a Problem  - a. 4

Moscow, We Have a Problem  - a. 5

Moscow, We Have a Problem  - a. 6

Moscow, We Have a Problem  - a. 7

Moscow, We Have a Problem  - a 8

Moscow, We Have a Problem  - a.9

 

Matthew Hedrick

Associate

 

Ben Ryan

Analyst


REPLAY PODCAST & SLIDES | #EmergingOutflows Round II: This Time Is Actually Different

Takeaway: In today's call, we expanded upon our negative outlook for EM asset prices with respect to the intermediate-to-long term.

Amid rapidly declining asset prices, we held a conference call today to expand upon our bearish outlook for emerging markets over the intermediate-to-long term. The presentation and its conclusions were organized as follows:

 

REPLAY PODCAST & SLIDES | #EmergingOutflows Round II: This Time Is Actually Different - Thesis Summary

 

CLICK HERE to access the replay podcast.

 

CLICK HERE to access the aforementioned presentation (~75 slides).

 

As always, we’re available to field any follow-up questions you may have and are more than happy to set up a call with you to discuss these risks live; just shoot us an email as needed.

 

Have a fantastic evening,

 

DD

 

Darius Dale

Associate: Macro Team


FLASHBACK: Industrials Fishfinder: Who Is Overinvesting Now?

Editor's note: This prescient research note excerpt was originally published by Hedgeye Industrials Sector Head Jay Van Sciver on March 12, 2014. 

 

High Returns (Eventually) May Beget Low Returns

 

Looking at the recent declines in iron ore and copper prices, we are reminded of how challenging capacity additions can be in capital intensive industries.  In the commodity section of our March 2013 Mining & Construction Equipment black book, we reviewed the supply outlook for copper and iron ore.  The coming supply increases in these metals, driven by a super-cycle/bubble in mining capital investment, seems likely to keep prices under pressure for years to come.  Copper may rally here and there, but the tidal wave of capacity appears to us somewhat inescapable.  That seems the case even in a relatively strong “Old China” growth scenario, where the country continues to suffocate itself.   

 

As for iron ore, it seems absurd to dig up rocks in the Amazon, ship them by rail to the east coast of South America, load them on a boat to ship them all the way to ports in China, where they are then taken to some of the dirtiest and least efficient steel mills in the world to be processed into construction materials to building buildings that few people actually use, but are built largely just to goose regional GDP statistics or protect wealthy owners against inflation.  If that interpretation is correct, the excess capacity in seaborne iron ore one day might be quite staggering.  Looking at Vale’s share price, this is increasingly old news, and we look below at what might be next.

 

FLASHBACK: Industrials Fishfinder: Who Is Overinvesting Now? - kjh1

 

 

FLASHBACK: Industrials Fishfinder: Who Is Overinvesting Now? - kjh2

 

 

FLASHBACK: Industrials Fishfinder: Who Is Overinvesting Now? - kjh3

Note: Forecast taken from March 2013 Mining & Construction Equipment slide deck

 

FLASHBACK: Industrials Fishfinder: Who Is Overinvesting Now? - kjh4

 

 

Of course, iron ore and copper are not alone.  In many capital intensive industries, elevated investment impacts capacity on a significant lag.  What other basic industries are investing at above “trend” rates?

 

Below, we present a table of the ratio of Capital Spending to Depreciation & Amortization (Capex/D&A) for the S&P 500 and S&P 400 Industrials, Utilities, Energy and Materials sectors’ sub-industries.  In the table, a ratio of 2 would suggest that the index constituents representing that sub-industry are spending twice the level of depreciation and amortization.  While we understand that this does not adjust for historic cost accounting in D&A, certain acquisition-related items and myriad other challenges, it does provide a ruler to measure relative investment over time.  Another potential flaw is that a lack of investment may indicate a lack of opportunity, such as industries facing secular decline.  In mature industries populated by larger capitalization competitors, differentiating these situations is reasonably straightforward.

 

FLASHBACK: Industrials Fishfinder: Who Is Overinvesting Now? - kjh5

 

 

What Does The Table Imply? 

 

To us, it suggests that caution is warranted when extrapolating the current performance of CAT’s Power Systems division (or Energy & Transportation segment, but we will call it Power Systems until at least the end of 1Q because retitling is not substantive).  Nearly all of CAT’s Power Systems key end-markets are investing well above depreciation and amortization.  We have previously discussed energy sector capital spending, but it is useful to see the exposure for gas compression, locomotives and power generation, as well.  In many ways, Oil & Gas capital spending could look like mining capital spending circa mid-2012.  CAT, CMI, DRC and several others may also, eventually, see normalization energy-related capital spending impact results.

 

The table above also suggests that several construction and building products industries are not over-investing, spending at or below D&A, despite a potential significant rebound in demand.  Building products is an industry we like from the long side, not simply from a cyclical perspective, but also because of structural improvements over the past decade.


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Cartoon of the Day: Everything Good?

Cartoon of the Day: Everything Good? - Global economy cartoon 12.16.2014

"Nowhere to run to, baby ... Nowhere to hide." 

-Martha and the Vandellas


EXCLUSIVE: Keith McCullough’s 2015 Market Forecast

In this brief excerpt from today’s Morning Macro Call, Hedgeye CEO Keith McCullough finally offers his coveted 2015 market forecast in response to a viewer’s question. 

 


CALL TODAY | #EmergingOutflows Round II: This Time Is Actually Different

Takeaway: Join us on a conference call today at 1pm EST to discuss our outlook for emerging markets and the associated investment implications.

Emerging market equities, bonds and currencies are once again selling off HARD. Please join the Hedgeye Macro team for a conference call today, December 16th, at 1:00pm EST to discuss why this time actually is different:

 

  • Toll Free Number:
  • Toll Number:
  • Conference ID/Password: 13597481
  • Materials: CLICK HERE

 

Since our September 23rd [bearish] note titled, "EMERGING MARKETS: THE EM RELIEF RALLY IS LIKELY OVER", the MSCI EM Index has declined -10.5%, the JPM EM Currency Index has declined -7.1% and OAS on the Bloomberg USD EM Composite Index has widened +118bps to 425bps.

 

While it's clear to us consensus among the investment community finally understands the negative impact of a stronger U.S. dollar upon emerging market asset prices, we don't think the associated risks are even in the area code of being priced in at the current juncture. In fact, we anticipate considerable downside from current prices, citing a plethora of risks that aren't even being considered by the preponderance of investors.  

 

KEY TOPICS WILL INCLUDE

  • Where is consensus on emerging markets?: a review of recent developments to help appropriately frame the debate
  • Which countries, regions and asset classes are most risky?: using our proprietary EM Crisis Risk Model to quantify and summarize the dispersion of fundamental risks among EM economies (NOTE: we have long ideas too!)
  • What are the risks no one is talking about?: quantifying the systemic risk across the EM space and how said risk might spillover into global financial markets more broadly
  • How do you make money with this information?: providing actionable long (overweight) and short (underweight) recommendations at the asset class, regional and country levels

 

As always, there will be a live Q&A session at the end of the call. Please email to submit a question to the queue.

 

We look forward to having you join us!

 

Darius Dale

Associate: Macro Team


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