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Reading Between The Lines: China's Cryptic Commentary

Reading Between The Lines: China's Cryptic Commentary - China growth cartoon 11.19.2015

 

Truth out of China? 

 

If only the truth were black and white.

 

Here's analysis in a note sent to subscribers this morning in which our Macro team pieces together recent comments from the PBoC and the country's state-owned news agency Xinhua to arrive at some interesting conclusions:

 

"The Shanghai Composite Index dropped -2.3% overnight despite the PBoC injecting 250B of liquidity into the banking system, which represents the largest such injection since February 26th. Weighing on sentiment was a Xinhua report that monetary policy will likely be more prudent in 2016 than it was last year, according to sources close to the PBoC, as well as PBoC Chief Economist Ma Jun commentary about future monetary policy needing to guard against financial risks.

 

With Chinese corporate leverage high and getting higher (166% of GDP) and property prices running up 30% YoY in first tier cities, we expect the PBoC to rein in the liquidity provision meaningfully from here now that economic stabilization is in the rear view mirror."

 

More from China's state-owned news agency Xinhua:

 

"China will continue to implement a prudent monetary policy this year, and, in the context of the economic slowdown, top officials have described the prudent policy as one 'with a slight easing bias.'

 

As the economy is yet to fully restore its strength, China will not shy away from using the ample tools at its disposal to bolster the economy. But it will be more careful to prevent the easing from going too far."

 

HEADS UP!


TWTR | Covering Short

Takeaway: No catalysts + bombed-out sentiment. But it’s premature to try to call a bottom on TWTR; this story will be tough to turn around.

KEY POINTS

  1. OUT OF HARD CATALYSTS: Mgmt reset the bar on revenue growth expectations by guiding 1Q16 revenue growth 13 percentage-points below consensus.  We estimate that guidance calls for a deceleration in Ad revenue growth in excess of 11 percentage points depending on the rate of sequential growth assumed for its Data Licensing segment, which hasn't declined q/q since 3Q13.  We suspect mgmt bought itself enough breathing room on what appears to be a particularly light guide, but TWTR's push into Auto-play ads remains a wild card given the trade-off between engagements and CPE.  Further, if Auto-play winds up siphoning off engagements from its legacy CPC ad products (i.e. ad fatigue), then that breathing room could evaporate quickly.  It's a murky picture that we would rather just avoid, and given bombed out sentiment, we would rather just watch from the sidelines for now.
  2. BUT NOT OUT OF THE WOODS: Remember TWTR needs to beat on both monetization and user growth expectations to appease the street.  Those two factors have historically worked against each other with the common denominator being ad load (see 3rd note below).  It's also worth noting that TWTR's push into auto-play could exacerbate this dynamic since TWTR needs a disproportionately higher level auto-play ad load to drive revenue growth given the CPE discount.  But more importantly, user growth will be much tougher to achieve since we estimate that TWTR has churned through nearly 40% of its US user base (2nd note below).  That is shifting the dynamics of its user growth from organic growth toward reengagement, which we suspect will be tougher to achieve without giving those users a clear incentive to come back.  That said, we suspect it’s premature to call to try to call the bottom on TWTR; this story will be tough to turn around.

 

See notes below for supporting analysis and recent thoughts.  Let us know if you have any questions, or would like to discuss in more detail.

 

Hesham Shaaban, CFA
Managing Director


@HedgeyeInternet 

 

 

TWTR | Bad Guide, Better Story (4Q15)
02/11/16 08:18 AM EST
[click here]

 

TWTR: The Crossroads  (User Survey: n=7,500)
08/25/15 07:48 AM EDT
[click here

 

TWTR: What the Street is Missing
05/19/14 09:09 AM EDT
[click here]


Earnings, Euro and China

Client Talking Points

#EARNINGS

With the busiest week of Q1 Earnings for S&P 500 companies, we’ll have some concrete evidence of pending earnings deterioration. Thus far, 66 companies have reported from 7 sectors. 4 of 7 have comped down bottom line. S&P earnings have comped down -10.8% in aggregate, with materials and financials leading decliners. The trend of late cycle reporting strength in healthcare and consumer discretionary carries on, for now. Again we would ask the question, can the market continue to trade-up with the possibility of two more quarters of poor earnings? We’ll see.  

EUR/USD

The ECB holds its monetary meeting in Frankfurt tomorrow. We expect no great “waves” from President Mario Draghi as he already delivered the “Drugs” in the form of both interest rate cuts and the expansion of QE (by €20 billion to €80 billion/month) in last month’s meeting. We continue to suggest trading our immediate term TRADE risk range of $1.12 - $1.14. We have a neutral outlook on the currency cross over the intermediate term TREND.

#TIGHTCHINA

The Shanghai Composite Index dropped -2.3% overnight despite the PBoC injecting 250B of liquidity into the banking system, which represents the largest such injection since February 26th. Weighing on sentiment was a Xinhua report that monetary policy will likely be more prudent in 2016 than it was last year, according to sources close to the PBoC, as well as PBoC Chief Economist Ma Jun commentary about future monetary policy needing to guard against financial risks. With Chinese corporate leverage high and getting higher (166% of GDP) and property prices running up 30% YoY in first tier cities, we expect the PBoC to rein in the liquidity provision meaningfully from here now that economic stabilization is in the rear view mirror. 

 

*Tune into The Macro Show with Darius Dale live in the studio at 9:00AM ET - CLICK HERE

Asset Allocation

CASH 65% US EQUITIES 0%
INTL EQUITIES 0% COMMODITIES 5%
FIXED INCOME 25% INTL CURRENCIES 5%

Top Long Ideas

Company Ticker Sector Duration
MCD

McDonald's (MCD) is reporting 1Q16 results on Friday, and we will have a more thorough update following the release. Current consensus estimates are projecting system-wide same-store sales (SSS) growth to be +4.6%, and +4.6% in the United States. Given another full quarter of All Day Breakfast, and ever evolving value proposition that MCD is providing, we feel confident in their ability to perform at or above expectations.

 

MCD continues to be a great LONG stock to hold during turbulent times in the market given their attributes of being large-cap, low beta, and aligns with our macro teams view of going LONG lower to middle income food providers.

CME

With the largest Capital Markets operation reporting results last week, JP Morgan's numbers continue to relay the business-to-business (B2B) shift in both bond and equity markets. With capital hamstrung by Financial Crisis era regulation, and fixed income desks running tight as a drum, brokerage activity continues to shift over into the exchange traded derivative markets. JPM's FICC, or fixed income trading, results hit $3.5 billion in revenue in 1Q16, down 13% year-over-year.

 

Conversely, the daily reporting of CME Group's (CME) bond volumes finished at 8.2 million contracts per day in 1Q, up +9% from last year. On a revenue basis, CME's results are actually a little stronger, with fixed income rate per contract up +2% year-over-year. The shift in equities is more balanced, with JPM's equity trading revenues up +6% y-o-y according to their latest report.

 

CME's stock volumes, however, still outflank the big brokerage desk with futures and options volume up +9% y-o-y for the forthcoming quarterly report on April 28th. This activity shift is secular in our view and CME Group has a strong upward bias in earnings power which makes its stock one of the few to own in Financial Services.

TLT

We remain the bears on the U.S. economy and the corporate profit and credit cycles - we’re long growth slowing via Long Bonds (TLT) and Pimco 25+ Year Zero Coupon U.S. Treasury ETF (ZROZ) and short risky corporate credit via Junk Bonds (JNK) as the profit cycle rolls over.

 

High yield bonds have experienced meaningful relief in price terms with the move in reflationary assets. Again, we reiterate that once credit spreads move off their cycle lows, they don’t typically revert in the same cycle, which is why we are sticking with our sell recommendation on junk bonds (JNK).

 

Any time corporate profits decline for two consecutive quarters, the S&P drawdown has had a peak to trough decline of at least 20%. Dissecting the likely direction of earnings in Q1 and Q2 of this year, we could be facing 4 consecutive quarters of declining corporate profits, and we question the market's ability to slap higher earnings multiples on the S&P 500.

Three for the Road

TWEET OF THE DAY

4 Videos On Why We Remain https://app.hedgeye.com/insights/50370-4-videos-on-why-we-re-bearish… @KeithMcCullough @HedgeyeDDale @HoweGeneration $SPY #Fed

@Hedgeye

QUOTE OF THE DAY

It's about discovery.  

Scott Jurek

STAT OF THE DAY

Apple reported iPhone owners unlock their device, on average, 80 times a day.


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The Macro Show with Darius Dale Replay | April 20, 2016

CLICK HERE to access the associated slides.

 

After you've watched today's show, we invite you to read a special complimentary edition of Hedgeye's Early Look. 

 

 An audio-only replay of today's show is available here.


CHART OF THE DAY: What More Can Fed Jawboning Accomplish?

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye Senior Macro analyst Darius Dale. Click here to learn more.

 

"... With respect to Equities: Simply put, we do not think Janet Yellen can authorize QE4 without another leg down in domestic credit and equity markets – which, if prescient, calls into question the sustainability of this rally. As such, we believe the late-cycle sectors (i.e. Financials, Healthcare and Consumer Retail) are in the earlier innings of pricing in the depths of the cycle, while reflation sectors have clearly priced in some version of approaching the ninth inning; it’s not at all clear that the latter sectors will make lower-lows on the next leg down. Given our bearish outlook for the domestic equity market from here, we still want to be short the opposite of our preferred style factors on the long side – i.e. low beta, high quality, capital return stories like GIS and MCD."

 

CHART OF THE DAY: What More Can Fed Jawboning Accomplish? - Chart of the Day 4 20


Back To Basics

“It all comes back to the basics. Serve customers the best-tasting food at a good value in a clean, comfortable restaurant, and they'll keep coming back.”

-Dave Thomas

 

We can all agree to agree that Wendy’s (WEN) makes great hamburgers and that the founder of the fast-food chain, Dave Thomas, was one of the great American capitalists of the 20th century. The fact that he didn’t graduate high school until he was 61 years old speaks volumes to the importance of simply having good principles and remaining true to your core values in business.

 

Back to the Global Macro Grind

 

Amid a challenging ~6 weeks on our desk, we are keen to refocus on what we view as the core values of global macro risk management and for our team nothing is more basic than our framework for viewing the world on a rate-of-change basis across multiple factors and durations.

 

Back To Basics - sine of the times cartoon 03.03.2016

 

Our proprietary GIP Model – which produces growth, inflation and policy estimates for every noteworthy economy in the world – is our best attempt at commercializing the aforementioned framework. Below we refresh our GIP Model for each of the world’s five largest economies.

 

United States:

 

  • G: Our model has domestic economic growth decelerating sharply here in Q2 with a probable trough by the third quarter. This forecast is corroborated by the trending tightening across all segments of domestic rates markets, as well as the sharp breakdown of the USD on a trade-weighted basis in recent months – which itself has perpetuated a massive short squeeze across nearly every facet of the global reflation trade.
  • I: In line with our #Quad4 expectation for Q2, reported inflation has at least temporarily inflected from generally hawkish trends. We are projecting a resumption of trending acceleration in 2H16, but to lower-highs on a long-term basis.
  • P: Domestic and global spillover effects stemming from structural USD strength have forced the Fed’s hand to the dovish side, which is being ardently reflected throughout the short end of U.S. rates markets in the YTD. There is, however, limited room for further spread compression absent outright easing.

 

Eurozone:

 

  • G: Our model has Eurozone growth decelerating on a trending basis throughout the balance of the year. This forecast is corroborated by the fact that Eurozone economic growth continues to slow on a trending basis across every key category of high-frequency data.
  • I: Our model has Eurozone inflation decelerating through the balance of 1H16 before v-bottoming and trending higher through year-end. This forecast is corroborated by the trending breakdown in 5Y5Y EUR inflation swaps as well as the trend higher in the EUR on both a nominal and real basis.
  • P: We expect the ECB to incrementally ease monetary policy by their June meeting in order to combat: 1) the aforementioned cyclical headwinds; 2) the trend lower in both Eurozone equities and Eurozone inflation expectations; and 3) the trend higher in the EUR/USD.

 

China:

 

  • G: Our secular bear case on China remains firmly intact as evidenced by the lackluster Q1 GDP report and the fact that growth rates within the “C” + “I” + “NX” formula continue to decelerate on a trending basis across key high-frequency metrics.
  • I: Our model has Chinese inflation inflecting here in Q2 and trending lower through the balance of Q3. Corroborating this forecast is the trending deceleration in core CPI, which implies the recent trend of global commodity reflation – something we anticipate will end soon – has been artificially propping up headline inflation readings in China.
  • P: Consistent with our bullish bias on the USD from here, we anticipate the PBoC will begin to revalue the CNY lower on a trending basis over the intermediate term. This will likely force them to keep policy rates tight(er) in order to offset capital outflow pressures and it appears that is already being reflected on the short end of Chinese rates markets.

 

Japan:

 

  • G: Our model is all over the map with respect to Japanese GDP growth, forecasting a #Quad4 setup in Q1, a #Quad1 setup in Q2, a #Quad3 setup in Q3 and a #Quad2 setup in Q4. While there are indeed nascent signs of inflection, Japanese economic growth continues to trend lower across every key category of high-frequency data – as do rates on the long end of the JGB yield curve.
  • I: Our model has Japanese inflation trending lower throughout the balance of 1H16. This forecast is being corroborated by trending deceleration across headline CPI, core CPI and headline PPI, as well as the trend lower in 5Y5Y JPY inflation swaps and the trend higher in the JPY on both a nominal and real basis.
  • P: Japanese policymakers in both the Cabinet and BoJ have ratcheted up verbal intervention in the JPY, which is up ~10% YTD vs. the USD. We believe verbal intervention to be unsustainable and anticipate the BoJ will expand upon QQE and/or NIRP at its April 27-28 meeting.

 

United Kingdom:

 

  • G: Aside from a brief respite in Q3, our model has U.K. GDP growth decelerating on a trending basis throughout the balance of 2016. Corroborating this forecast is the trending deceleration seen across every key category of high-frequency growth data, as well as the trending narrowing of the Gilt 10Y-2Y spread.
  • I: Our model has U.K. inflation accelerating throughout the balance of 2016. This forecast is corroborated by trending acceleration across headline CPI, core CPI and headline PPI, as well as the trending breakdown in the GBP on both a nominal and real basis.
  • P: Naturally, we’d expect the BoE to be in a box given the aforementioned cyclical outlook for persistent #Quad3 stagflation. Complicating policy matters is the Brexit vote which is scheduled for late-June and is effectively a coin toss. The BoE is appropriately storing its ammo in the event that process weighs heavily upon consumer and business confidence in the U.K.

 

CLICK HERE to download the associated slide deck (13 slides).

 

Both our bottom-up modeling and top-down risk management systems have proven to be pretty accurate over the years, so we are effectively doubling down on our process. If we’re wrong, at least we’ll know why we’re wrong and where we need to evolve. From my vantage point, that’s a better outcome than emotionally capitulating at the top end of what we believe to be a bear-market bounce.

 

Consistent with that decision are our thematic investment conclusions, which won’t change until we traverse the depths of the domestic and global economic cycles:

 

  • With respect to Equities: Simply put, we do not think Janet Yellen can authorize QE4 without another leg down in domestic credit and equity markets – which, if prescient, calls into question the sustainability of this rally. As such, we believe the late-cycle sectors (i.e. Financials, Healthcare and Consumer Retail) are in the earlier innings of pricing in the depths of the cycle, while reflation sectors have clearly priced in some version of approaching the ninth inning; it’s not at all clear that the latter sectors will make lower-lows on the next leg down. Given our bearish outlook for the domestic equity market from here, we still want to be short the opposite of our preferred style factors on the long side – i.e. low beta, high quality, capital return stories like GIS and MCD. We continue to like Utilities on the long side as well. Internationally speaking, we remain cyclically bearish on DM equities broadly as the #BeliefSystem continues to fail on a trending basis. Moreover, we remain structurally bearish on EM equities as the #CreditCycle in many emerging market economies has yet to fully materialize – let alone capitulate.
  • With respect to Fixed Income: Consistent with our dour cyclical outlook for the U.S. economy, we remain the bulls on Treasury bonds. Moreover, we continue to remain negative of high-yield credit under the belief that the domestic #CreditCycle has yet to fully capitulate. We don’t have a view on international fixed income outside of continuing to shun EM hard and soft currency debt.
  • With respect to Currencies: Consistent with our #Quad4 outlook for the U.S. economy, we anticipate that the USD will perversely benefit from a bout of global risk aversion amid rising cross-asset volatility as it typically has during historical episodes of #Quad4. We expect a series of higher-lows versus peer currencies and a meaningful move higher versus commodity currencies as broad-based CNY devaluation fears come back online over the next few months.
  • With respect to Commodities: Consistent with the aforementioned views in the currency market, we remain bearish on reflation assets and anticipate what may be a final flush down across key commodity markets with respect to the intermediate term. Moreover, we believe the energy complex is the most likely candidate to lead any such move lower. All that being said, however, we are keen to keep any shorts in the reflation space on a short leash ahead of the Fed’s likely policy response to our economic outlook (i.e. QE4).

 

Best of luck out there risk managing these views to the extent you are generally in the same or similar camp. Consider this a heartfelt thank you to those among you who are holding the line on the bear case.

 

Our immediate-term Global Macro Risk Ranges are now:

 

UST 10yr Yield 1.69-1.82% (bearish)

SPX 2046-2112 (bearish)
RUT 1087-1153 (bearish)

USD 93.11-95.11 (bullish)
Oil (WTI) 38.08-43.99 (bearish)

Gold 1220--1268 (bullish)

Keep your head on a swivel,

 

DD

 

Darius Dale

Director

 

Back To Basics - Chart of the Day 4 20


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