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CHART OF THE DAY: Beware of China Growth Slowdown

CHART OF THE DAY: Beware of China Growth Slowdown - 02.12.15 chart

 

Editor's note: This is an excerpt from today's Morning Newsletter written by Hedgeye Director of Research Daryl Jones. 

 

In the Chart of the Day, we show Chinese GDP growth going back 25 years. The clear takeaway from this chart is obviously that last year Chinese growth was at its lowest level in 24 years.  In part, the government is actively trying to slow growth, so this makes sense.  But even in a command economy like China, the ability of central bankers to manage a slow down in a perfectly orderly fashion is limited. 

 


Chutzpah

"It ain't what they call you, it's what you answer to."

-W.C. Fields

 

Chutzpah in English connotes courage or confidence. In Yiddish, the language from which the word originates, chutzpah means extreme arrogance.  Which describes you?

 

As stock market operators, capitalists and business builders, we are often called arrogant, when in fact we are actually just confident. We are confident in our work ethic, teammates and vision. 

 

In case you missed it, a couple of days ago the Huffington Post ran an interesting article about Hedgeye. The author, Ben Walsh, came to our office for a day and had some very thoughtful questions about our company and business.  

 

Admittedly, he also struggled with the question of confidence or arrogance.  Nonetheless, he did have some interesting insights about Hedgeye and we thought we’d share the article.

 

Click image to read. 

Chutzpah  - 88

 

The fact is, none of us will ever build anything in life if we aren't confident.

 

Speaking of chutzpah, it's clear that embattled NBC news anchor Brian Williams has some. Although now that he's sitting in the penalty box for six months, feeling shame, perhaps that will change. In the cartoon below, we actually propose an alternative job for Mr. Williams. 

 

Chutzpah  - Williams cartoon 02.11.2015

 

Back to the Global Macro Grind ...

 

Chutzpah or confidence in your analytical abilities is a truly important characteristic of being a good stock market operator. For as you all know, and as Ben Graham famously said:

 

"In the short term stocks are a weighing machine, in the long run they are a voting machine."

 

Speaking of analytical abilities, on the Hedgeye team, our Internet analyst Hesham Shabaan has been on a run of almost epic proportions with his short calls on Pandora, Yelp and Twitter.  (If you aren't currently subscribing to his research, it would be worth emailing to do so.)

 

His newest Best Idea short is the Chinese juggernaut Ali-Bubble. Sorry, Alibaba. The core of his thesis is as follows:

 

1.    GMV GROWTH TO SLOW PRECIPITOUSLY: China's upper class drives the bulk of BABA's GMV.  There is no other plausible explanation after comparing BABA's reported metrics to China consumer demographic data.  That means the next wave of user growth will come from a much weaker consumer, leading to declining GMV/Active Buyer, and slowing GMV growth.

 

2.    MODEL FACING SECULAR PRESSURE: Slowing GMV growth naturally bodes poorly for commissions.  But the bigger issue is Marketing Revenues (~60% of total), which are facing secular pricing pressure as a weaker consumer pressures ad conversions and ROI.  We were already seeing this in BABA’s financials, but the street just took notice of this last print, because...

 

3.    TMALL CAN'T SAVE THE DAY: The one thing that was keeping us on the sidelines was the migration of GMV moving over to BABA's Tmall platform (where BABA collects commissions).  That sputtered out in F3Q15, leading to a sharp slowdown in Commission revenue growth, which exposed the weakness in its Market segment (both reported in its China Retail segment).  Tmall Mix shift can't be trusted a secular growth driver moving forward, so we don't need to worry about getting run over by it longer term.

 

Yes, BABA on some level is the Chinese Internet, but if its growth is decelerating and potentially going to disappoint, does it matter?

 

The other component to the thesis on BABA is the macro economic backdrop in China.  If BABA is indeed the majority of e-commerce that occurs in China, it will be on some level hostage to economic activity in China.

 

In the Chart of the Day below, we show Chinese GDP growth going back 25 years. The clear takeaway from this chart is obviously that last year Chinese growth was at its lowest level in 24 years.  In part, the government is actively trying to slow growth, so this makes sense.  But even in a command economy like China, the ability of central bankers to manage a slow down in a perfectly orderly fashion is limited. 

 

On Sunday we received Chinese trade data, which further emphasized a Chinese economy that is slowing.   While it is always dangerous to take data in isolation, Chinese exports in January fell by -3.3% from year ago levels.  Meanwhile, imports dropped a staggering -19.9%, which was the lowest level since the financial crisis of 2009.

 

More so than the U.S., China is an economy that is largely driven by exports.  In fact, in 2014 Chinese exports totaled $2.34 trillion, which are about 50% larger than the world’s second largest exporter, the U.S.  Combined, Japan and the EU are well more than 25% of Chinese exports.

 

The implication here is pretty clear, which is that the combination of a government that is trying to at least manage growth, if not slow it, with an economy that is dependent on exports to regions in which growth is definitely decelerating, means that the Chinese economy may be set up to disappoint on the downside.

 

Frankly, if the Chinese economy is going to disappoint, we aren’t sure there is a better way to play that then a company that is levered to Chinese wealth creation and trades at almost 14x 2015 sales.  Valuation, of course, isn’t everything, but it is a good measure of expectations.  And as they say about expectations, they are the root of all heartache.

 

Our immediate-term Global Macro Risk Ranges are:

 

UST 10yr Yield 1.62-2.09%

SPX 2026-2090

VIX 15.41-20.80

USD 94.04-95.64
Oil (WTI) 46.43-53.66
Gold 1 

 

Keep your head up and stick on the ice,

 

Daryl G. Jones

Director of Research

 

Chutzpah  - 02.12.15 chart


Yen, Oil and Europe

Client Talking Points

YEN

Follow the Correlation Risk … BOJ guy says “further stimulus may be counter-productive” --> Yen bounces --> USD Down --> Oil bounces (again) --> Russian stocks rip +4% on the counter-TREND move … everyone is nailing it. 

OIL

Oil continues to trade with a hyper inverse correlation to the USD, and finally the risk range for WTIC is narrowing (not indicating a breakout, just narrowing) to $46.43-53.66 (former downside risk to our ranges was $42-43, so that’s off the table inasmuch as $57-59 is on the upside – lots to think about there). 

EUROPE

Greek stocks up +5%, down -5%, and what is going to happen next? Please central planners of the universe, tell us – because after 7 years of this...Greek unemployment is still 25.4%... oh and the poor Swedes just saw the rewards of cutting rates to -0.10%, an unemployment rate shooting up from 7.0% to 8.4% in JAN #awesome.

Asset Allocation

CASH 47% US EQUITIES 8%
INTL EQUITIES 6% COMMODITIES 0%
FIXED INCOME 32% INTL CURRENCIES 7%

Top Long Ideas

Company Ticker Sector Duration
EDV

The Vanguard Extended Duration Treasury (EDV) is an extended duration ETF (20-30yr). As our declining rates thesis proved out and picked up steam over the course of the year, we see this trend continuing into Q1.  Short of a Fed rate hike, there’s no force out there with the oomph to reverse this trend, particularly with global growth decelerating and disinflationary trends pushing capital flows into the one remaining unbreakable piggy bank, which is the U.S. Treasury debt market.

TLT

The Vanguard Extended Duration Treasury (EDV) is an extended duration ETF (20-30yr). As our declining rates thesis proved out and picked up steam over the course of the year, we see this trend continuing into Q1.  Short of a Fed rate hike, there’s no force out there with the oomph to reverse this trend, particularly with global growth decelerating and disinflationary trends pushing capital flows into the one remaining unbreakable piggy bank, which is the U.S. Treasury debt market.

HOLX

Hologic (HOLX) is a name our Healthcare Sector Head Tom Tobin has been closing monitoring for awhile. In what Tom calls his 3D TOMO Tracker Update (Institutional Research product) of U.S. facilities currently offering 3D Tomosynthesis, month-to-date December placements signaled a break-out quarter after a sharp acceleration in October and slight correction to a still very high rate in November. We believe we are seeing a sustained acceleration in placements that will likely drive upside to Breast Health throughout FY2015. Tom’s estimates are materially ahead of the Street, but importantly this upward trend in Breast Health should lead not only to earnings upside, but also multiple expansion and a significant move in the stock price.

Three for the Road

TWEET OF THE DAY

VIDEO | McCullough to Bartiromo: 'Short the Crap' https://app.hedgeye.com/insights/42305-mccullough-to-bartiromo-short-the-crap via @KeithMcCullough on @FoxBusiness 

@Hedgeye

QUOTE OF THE DAY

Do not consider painful what is good for you.

-Euripides

STAT OF THE DAY

Russian Trade Surplus Narrows for Second Month: The surplus fell 24% from a year earlier to $12.9 billion after plunging 21% the previous month, the central bank in Moscow said on its website Wednesday. 


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Lots of Questions

This note was originally published at 8am on January 29, 2015 for Hedgeye subscribers.

“The best way to get a good idea is to have a lot of ideas.”

-Linus Pauling

 

Linus Pauling was one of the most influential American scientists of the 20th century. He locked down his officialdom prize (Nobel) in chemistry in 1954 and is widely considered the forefather of molecular biology and quantum chemistry.

 

I love his creativity quote. I found it in a chapter of The Medici Effect (page 103) titled “How To Capture The Explosion – MacGyver and Boiling Potatoes.” I highly recommend you take the time to read that book.

 

I’d also suggest you take Pauling’s independent research advice one step further and apply it to your risk management #process. The best way to manage the risk in your portfolio of ideas is to ask yourself lots of macro questions.

 

Lots of Questions - Linus Pauling

 

Back to the Global Macro Grind

 

With the SP500 down for 3 of the last 4 trading days and down -2.7% for the YTD (vs. the total YTD return of our TLT up over +9%), have you asked yourself whether or not earnings season is what you thought it was going to be?

 

If you’re honest with yourself, you’ll note that the SP500 has only had 1 up week in 2015, and that had nothing to do with nothing other than the Europeans forcing yet another central plan on what used to be free-markets.

 

This leads me to asking myself lots of questions in the Global Equity sphere:

 

  1. On Europe, post the 3-day Viagra ramp, what’s next? Buy European stocks because things are that bad?
  2. On China (down -3.8% in the last 3days on #GrowthSlowing), do I buy it because it’s slowing?
  3. Do I buy #Deflation Domino markets that got crushed yesterday (Argentina -2.8%, Brazil -1.9%, Canada -1.6%)?

 

What if you can only buy US Equities?

 

  1. Energy Stocks (XLE) got smoked for another -3.9% down day yesterday as Oil/Nat Gas continue to crash
  2. Financials (XLF) underperformed a -1.3% SPY, closing -1.8% on the day at -6.2% YTD
  3. Industrials (XLI) “outperformed” at -0.9% on the day but are down the same as SPY YTD at -3.1%

 

Since all 3 of these S&P Sectors remain on our “avoid, sell, short, etc.” list (they are both late-cycle and carry explicit Global #Deflation risks), I’ll just reiterate that call this morning – because it’s easy to.

 

Back to the questions…

 

  1. Do we buy more Long Bonds (TLT, EDV, ZROZ), Munis (MUB), and low-volatility-high-return securities like them?
  2. Do we book some gains in some of those and buy more equally “expensive” stock sectors like Utes (XLU) and REITS (VNQ)?
  3. Do we own both long-duration bonds and some lower-beta, higher-return sectors like Staples (XLP) and Healthcare (XLV)?

 

Oh, and how does one justify bucking up for something that is “expensive” if one didn’t get that they should have bought it when it was less-expensive to begin with? That’s their storytelling problem. Let them deal with it.

 

Another question on valuation: what if you bought Energy stocks because you thought they were “cheap”, and the earnings just got cut in half, so now you own what’s one of the most expensive sectors in the S&P 500 anyway?

 

Two more very basic questions in risk managing the macro side of your portfolio:

 

  1. Doesn’t “expensive” get more expensive when investors seek liquidity and shelter (Long-term Treasuries)?
  2. Doesn’t “cheap” get cheaper when investors shun illiquid investments that have deteriorating fundamentals?

 

If you’ve studied macro market #history, you know the answers to these questions are not what you will find in bottom-up Value Investing books. In the intermediate-term, Mr. Macro Market doesn’t care about valuation – he cares about risk.

 

Individual stocks clearly care about their own rate of change fundamentals. If growth is accelerating and margins are expanding, they get multiple expansion. Whereas companies who show #GrowthSlowing and margin compression get multiple compression.

 

That’s why identifying bottom-up stock ideas like AAPL in an environment like this helps you crush your competition. Don’t you want to own stocks that can generate multiple expansion in a market like US Equities that has multiple compression risk? Indeed.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.71-1.82%

SPX 1983-2022

VIX 16.73-23.27

Oil (WTI) 43.69-46.44
Gold 1265-1310
Copper 2.42-2.54

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Lots of Questions - 01.29.15 Chart


McCullough to Bartiromo: 'Short the Crap'

Hedgeye CEO Keith McCullough and Eurasia Group President Ian Bremmer take a look around the globe and discuss where they see market risks and opportunities with Maria Bartiromo on Fox Business' "Closing Bell."



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