Chinese Ox In A Box

“We have two classes of forecasters: those who don’t know – and those who don’t know what they don’t know.”

-John Kenneth Galbraith


This morning you are going to see a host of perpetually bullish market forecasters start to get worried about China. It’s about time. As we have been saying for the last few months, the Chinese Ox is in a Box in Q1 of 2010.


The way that this works is that China reports a better than “expected” GDP number for Q4 of 2009, CNBC cheers, but the local market reaction in both China and Hong Kong is lower stock prices. Then, all of the revisionist forecasters start asking why? And, finally, they end up knowing what they didn’t know.


In the aggregate, China’s Q4 GDP  is the equivalent of the bark on the tree. Whereas the December and January growth numbers, combined with an explicit change in Chinese monetary policy, is the forest. China is tightening monetary policy as inflation accelerates. Slowing sequential growth and accelerating sequential inflation is what is putting Chinese stocks in an intermediate term box.


Slowing growth and accelerating inflation? Yes, that’s been our forecast, and here is the data:


1.       Industrial production growth slowed in December to +18.5% year-over-year (missing expectations)

2.       Consumer Price Inflation (CPI) accelerated, big time, in December to +1.9% year-over-year (up from +0.6% last month)

3.       Money Supply growth (M2) slowed 200 basis points in December to +27.7% versus a record high of +29.7% (y/y) in November


What’s most interesting about this call for China to tone down what we have called speculative loan and money supply growth, is that the Chinese government absolutely agrees with us. They will not pander to the politics of inflating asset prices. They have learned what not to do from us.


Within China’s Q4 economic growth report, the government removed the language of “moderately loose monetary policy.” For all of the US Federal Reserve watchers out there, that would be the equivalent of Bernanke removing the “extended and exceptional” language in his currently conflicted and compromised stance.


It’s one thing to be in the political penalty box for doing something like starving your citizenry of fixed income on their savings accounts. It entirely a different thing to put yourself in the box with an explicit attempt to slow speculative borrowing. The latter is China’s strategy. The former is America’s. And for those like Goldman who came out saying “buy China” on January 1st who didn’t know that… well, now they know.


We hosted our Macro Themes conference call for our subscribers last week, and we will be presenting the case for the Chinese Ox In a Box later on today on Yale’s campus at an investor lunch. If you’d like a replay of our call and the slides, please email sales@


Now that I have issued you a shameless sales plug, here are the top 3 conclusions from our Chinese Ox In a Box presentation:


(1)    Money supply growth slowing.  Right now the central bank has not stated a 2010 target for growth in M2, but had a 17% goal last year.   The actual growth rate was more than 25% for 2009, peaking at 29.7% growth YOY in November.  We think that money supply growth could be cut by 1/3 of its current pace.

(2)    Loan growth slowing in 2010. Chinese banks extended 9.59 trillion Yuan of loans in 2009, compared with 4.15 trillion Yuan in 2008 (+131% y/y growth). We think loan growth could drop by at least 1/3 of its current pace.

(3)    Bullish on the Chinese currency. The Chinese Yuan appreciated +18.7% between 2005 and 2008, but has been basically flat for the past 18 months. This will change, when the Chinese government decides to raise both lending and currency rates again in 2010. We think that currency appreciation will be at least +3-6% in the coming 6-12 months.


Additionally, here are the key lines of resistance that have now built themselves into real-time Chinese stock market prices:


1.       China’s Shanghai Composite Exchange = 3204

2.       Hong Kong’s Hang Seng Index = 21,829


We remain bullish on China’s long term TAIL, but that’s an investment view that has 3 years in duration. When one is bullish on something for the long term, that doesn’t mean they have to be bullish on it at every price.


Our call for Q1 on China is simply that, an intermediate term call of caution. It’s what our Hedgeyes are forecasting so that you can proactively manage the risk associated with stock market prices that have stopped going up.


Best of luck out there today,






EWC – iShares Canada — We remain bullish on the intermediate term TREND for Canada. With a pullback in the ETF on 1/15/10 we bought Canada.


XLK – SPDR Technology — We bought back Tech after a healthy 2-day pullback on 1/7/10.


UUP – PowerShares US Dollar Index Fund — We bought the USD Fund on 1/4/10 as an explicit way to represent our Q1 2010 Macro Theme that we have labeled Buck Breakout (we were bearish on the USD in ’09).

VXX - iPath S&P500 Volatility — The VIX broke down to our immediate term oversold line on 1/6/10, prompting us to add to our position on VXX.


EWG - iShares Germany —Buying back the bullish intermediate term TREND thesis Matt Hedrick maintains on Germany. We are short Russia and, from a European exposure perspective, like being long the lower beta DAX against the higher beta RTSI as well.

EWZ - iShares Brazil — As Greece and Dubai were blowing up, we took our Asset Allocation on International Equities to zero.  On 12/8/09 we started buying back exposure via our favorite country, Brazil, with the etf trading down on the day. We remain bullish on Brazil's commodity complex and believe the country's management of its interest rate policy has promoted stimulus.

CYB - WisdomTree Dreyfus Chinese Yuan — The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.

TIP - iShares TIPS — The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield. We believe that future inflation expectations are mispriced and that TIPS are a efficient way to own yield on an inflation protected basis.



IEF – iShares 7-10 Year Treasury One of our Macro Themes for Q1 of 2010 is "Rate Run-up". Our bearish view on US Treasuries is implied.
RSX – Market Vectors Russia
We shorted Russia on 12/18/09 after a terrible unemployment report and an intermediate term TREND view of oil’s price that’s bearish.


EWJ - iShares JapanWhile a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership  appears, if anything, to have a less developed recovery plan than their predecessors. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.

SHY - iShares 1-3 Year Treasury BondsIf you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.


The Macau Metro Monitor. January 21rst, 2010



The Statistics and Census Service reported that consumer prices in Macau increased 0.8% y-o-y in December and 1.2% in 2009.



Resorts World Sentosa partially opened yesterday with 1,340 rooms in 4 hotels, including a Hard Rock hotel and a property designed by Michael Graves. The casino opened is scheduled to open in March following delays in getting license approval. The 7,300 seat-ballroom will host its first event at the end of this month and Universal Studies theme park is scheduled to open its doors over in several weeks.  Genting expects tourists to make up 60% of visitors to its casino with 25% of those visitors coming from China.


The S&P rolled over on Wednesday, with all of the major indexes finishing down more than 1% on the session.  Tuesday’s euphoria over the election in Massachusetts was quickly overcome by the potential for Congressional gridlock on a number of important issues.  Overall the volume was still light, but was up 1.9% day-to-day; breadth was the worst it’s been all year. 


The Hedgeye RISK Management sector models saw a breakdown yesterday in two sectors – XLY and XLU – both broke TRADE. All nine sectors declined yesterday and all nine are positive on TREND. 


On the MACRO front, the “CHINESE OX IN A BOX” and liquidity concerns were on the front burner as the focus was on Beijing's efforts to curb new bank lending.  Not surprisingly, this dynamic weighed on the RECOVERY trade as the Dollar Index continues to trade higher.  Of the three worst performing sectors two are leveraged to the RECOVERY TRADE - Materials (XLB) and Energy (XLE).  


The XLE and XLB were also hit by the strength in our “BUCK BREAKOUT” theme, which underpinned the safe haven status (i.e. better fiscal outlook now that Democrats have lost in Massachusetts and heightened risk aversion with the VIX up +6.1% on the day yesterday.  Precious metals and industrial stocks were among the biggest decliners in the XLB, while higher-beta coal and oil services stocks were underperformers in the XLE sector.  On Wednesday, crude closed down 1.9% to $77.74 a barrel.


Also on the MACRO front the MBA mortgage applications slowed to 9.1% from 14.3% and housing starts declined 4% from 8.9% last month.  On the positive side building permits were 653,000 vs. 584,000 last month. 


Also taking center stage on the downside was Technology (XLK).  The XLK underperformed yesterday despite the Q4 earnings beat from IBM. There was weakness in the software group today, with the S&P Software Index declining 1.4%, while the Semis held up better than the broader XLK. 


The best performing sector yesterday was the Financials (XLF), down only 0.3% on the day.  Within the XLF the banking group bucked the broader market selloff today with the BKX up 1.4% with the Trust names (STT, NTRS and BK) trading higher following their Q4 earnings results. Regional banking stocks are also performing wells after their Q4 earnings reports.


As we look at today’s set up the range for the S&P 500 is at 20 points or 0.43% (1,133) downside and 1.05% (1,150) upside.  At the time of writing the major market futures are trading down on the day.  


Copper imports by China, climbed for a second month in December on rising demand.  Despite this news Copper traded down 2.67% yesterday and is flattish in early trading today.  The Hedgeye Risk Management Quant models have the following levels for COPPER – buy Trade (3.32) and Sell Trade (3.46).


In early trading today Gold is declining for a second day, after falling 2.4% yesterday; the biggest decline since December 17, 2009.  The Hedgeye Risk Management models have the following levels for GOLD – buy Trade (1,101) and Sell Trade (1,134).


Yesterday crude traded down by 1.9%, and is trading slightly lower in early trading today.  The strength in the Dollar and increased inventories are putting pressure on oil.  The Hedgeye Risk Management models have the following levels for OIL – buy Trade (76.94) and Sell Trade (80.49).


Howard Penney

Managing Director














Attention Students...

Get The Macro Show and the Early Look now for only $29.95/month – a savings of 57% – with the Hedgeye Student Discount! In addition to those daily macro insights, you'll receive exclusive content tailor-made to augment what you learn in the classroom. Must be a current college or university student to qualify.


SBUX’s fiscal 1Q10 earnings came in at $0.33 per share, better than my $0.29 per share estimate and the street at $0.28 per share.


The company raised its full-year EPS guidance to 1.05-$1.08 (above the street at $1.02), or +31%-35% growth, up from its prior +15%-20% range.  Despite the better than expected same-store sales growth of +4% in the U.S. and +4% internationally, SBUX maintained its prior guidance for modestly positive comparable store sales growth.  The company did reiterate the higher end of its prior revenue guidance of mid-single digit growth.  The biggest delta to the prior guidance comes from the company’s new outlook for 400 bps of margin growth in the U.S., up from its initial expectation of 200-250 bps of growth.  SBUX maintained its expectation for 200-250 bps of margin improvement in the international segment, but reaffirmed the low end of its prior margin guidance for the CPG segment of 35%.


SBUX is now targeting $1 billion in free cash flow for the full year versus its prior outlook of $900 million.  Part of this increase may stem from the company’s lowering its capital spending expectation to $500 million (from $500M-$550M); impressive, nonetheless.

Post-Holiday State of the Industry: Sports Apparel

This week's sport’s apparel sales confirm two trends that we are currently observing across the athletic apparel industry: 1) inventories are tight, and 2) the consumer "trade down effect" has largely bypassed the industry.  These conclusions are supported by the divergence in performance between traditional Sporting Goods retailers (i.e. branded/performance), the Family channel, and the Discount/Mass channel.  Since the November lows that resulted from the sales "pull-forward" during October (yes, it was weather), sales of athletic apparel in the Sporting Goods channel have been particularly strong. Sales of similar, value-priced athletic apparel have lagged however in the Discount/Mass channel.


 Post-Holiday State of the Industry: Sports Apparel - Dollar Sales Channel


Sales in the Sporting Goods channel have been up an average of 9% y/y each week since the beginning of December, with sales in the Family channel flat-to-slightly up over the same period. In contrast, weekly results in the Discount/Mass channel have been down an average of 14% y/y since the start of December.  Furthermore, average price points in Discount/Mass have declined an average of 9% over that same period.  Contrast that with improving ASP’s in both the Sporting Goods (up an average of 2% y/y) and Family channel (up an average of 6% y/y) since the beginning of December.  It is clear that branded, performance product is key to the diverging results. 


 Post-Holiday State of the Industry: Sports Apparel - ASP Channel


The chart below illustrates how sales in the Discount/Mass channel have largely been under pressure for some time now.  Interestingly, the recent weakness comes at time when comparisons are easing and will remain so throughout much of 2010.  Further sales declines suggest market share loss to the other, higher priced channels and/or the consumers’ lukewarm appetite for value-priced athletic apparel.  Oddly, this all comes at time when we’ve seen other value-driven apparel retailers like Old Navy, Uniqlo, and Aeropostale outperform dramatically.  After some initial worry a couple of years ago with launch of Wal-Mart’s Starter and Target’s C9 brands, it appears that these opening price point offerings have yet to make a measurable impact on the branded players .  Clearly, the innovation, branding, and authenticity in the performance apparel space is helping to drive demand and differentiate the channels. Tight inventories are also a key driver behind the ASP increases.


 Post-Holiday State of the Industry: Sports Apparel - Discount Mass


We know that one week's worth of data hardly creates a trend, but there are always a few notable callouts:

  • UA was the only company in the sample to see a sequential pickup in dollar sales, improving by 100bps vs. last week to +9% y/y
  • At -3% y/y, this week marks the 11th out of the previous 12 weeks COLM sports apparel sales have declined on a y/y basis
  • Despite falling by 301bps sequentially, NKE market share still came in at +217bps y/y; Adidas was a not-too-distant second at +145bps y/y; NKE has been gaining 3-5 points of market share each week since mid-November, while Adidas has been gaining 1-4 points of market share during the same period

Post-Holiday State of the Industry: Sports Apparel - Sports Apparel Trends


Post-Holiday State of the Industry: Sports Apparel - Sports Apparel Industry by Company


Post-Holiday State of the Industry: Sports Apparel - Sports Apparel Industry by Category


Brinker’s 2Q10 earnings of $0.29 per share (includes about a $0.04 per share benefit) came in much better than the street’s and my $0.22 per share estimate.  Same-store sales growth also beat expectations with Chili’s -3.2% and blended comps -3.1% versus my estimate of -4% for both and the street’s expectations of -4.2% and -4.3%, respectively.  Based on the definite change in management’s tone on today’s earnings call relative to last quarter, results may have exceeded management’s expectations as well.


Last quarter, Brinker did not provide any updates to the guidance it provided in its 4Q09 earnings release.  Today, EAT’s press release stated, “Brinker provides annual guidance as it relates to comparable restaurant sales, earnings per diluted share, and other key line items in the income statement and will only provide updates if there is a material change versus the original guidance.”  So although management maintained the same official guidance policy this quarter, the company did make comments about the specific guidance ranges it had provided at the start of the full year whereas last quarter management seemed unwilling to even repeat the prior ranges.


Last quarter, there seemed to be a question about whether the company’s unwillingness to reiterate guidance was due to management’s not feeling comfortable with the prior guidance.  Although management said that it just did not want to get into the habit of providing quarterly guidance, it was a little unclear in its answers to investors because it seemed unwilling to repeat any prior ranges. 


From the fiscal 1Q10 earnings call:

So that means it is suspended or the $1.15 to $1.30 is still a good guidance number or we do not have any guidance except for the line by line information?


Chuck Sonsteby
I would say that the second piece would be accurate.


Today, management said it was comfortable with the higher end of guidance.  Management also said that comps during the quarter were -3%, “comfortably within the initial -2% to -4% range.”


Other management comments that signal a real shift in management tone:


“We are gaining share…we are excited about that.”


“Up is up.”


“We are seeing small bright lights in the economy.”


Echoing PFCB’s CEO Bert Vivian’s comments from last week, Brinker also stated that it is seeing improved business spending.  Specifically, management said that the banquet business at Maggiano’s was better in December, which it attributed to more expense account spending.


Although Chili’s traffic improved sequentially in the quarter and same-store sales came in 80 bps better on a 2-year average basis, it may be a little premature for the company to remove its 3 Courses for $20 promotion.  Management said that the promotion has gotten “a little stale,” but I think it could be increasingly difficult to drive traffic without it.  Management is aware that consumers are still looking for value so it will be important to watch whether the promotions currently being offered at lunch, along with the company’s upcoming value initiative, which is expected to highlight the company’s new and improved menu, will prove as successful as 3 for $20. 


The company has made a significant step in downsizing its menu (to 8 pages from 12), deemphasizing items less critical to guest loyalty.  This alone should lead to more efficient execution at Chili’s.  As I have said before, Chili’s needed to simplify its back of the house operations by reducing menu items to include only the core items that represent the bulk of the chain’s sales.  These menu changes will allow the company to increase the quality of the items left on the menu (75% of menu items now include a new recipe, new ingredient or have been replaced).  A menu that is simpler to execute will translate into better food delivered to the guest with fewer complaints, thereby allowing the concept to build increased customer loyalty.  Importantly, it will provide a better work environment for restaurant employees. 

the macro show

what smart investors watch to win

Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.