Chinese Ox Still Boxed In

Unveiled in early January, our Chinese Ox in a Box 1Q10 theme called for an economic slowdown in China. We seen just that in the equity markets, reflected by the Shanghai Composite and Hang Seng posting YTD declines of -22% and -11%, respectively. Much of the negative equity performance has been the result of government tightening to dampen inflation pressures and cool an overheating property market, which, for the most part, have been priced in. Still, concerns regarding the Eurozone’s fiscal and debt crisis, a domestic property bubble on the verge of rapid collapse, domestic wage issues, and international pressure are negatively impacting growth outlooks even beyond what we’ve seen in the numbers thus far. If yesterday’s PMI release was any indication (alongside copper breaching its long term TAIL line of support $3.03/lb), the Chinese Ox could very well be boxed in for quite some time going forward.


Below is a quick summary of recent developments from the last week which are additive to the current bear case for China. While we certainly aren’t recommending you join the “short everything China” trade now, we do think the latest developments out of China suggest further downside risk.



5/25 – More tightening in the property market:

  • Shanghai to introduce property tax trial next month
    • Estimates of an annual tax of 1.5%
    • Prices for new homes dropped 16% in Shanghai for the week ended May 23rd
  • Ronnie Chan, chairman of Hang Lung Properties said residential real estate prices in the mainland could fall by 20% - 30%  from current levels
    • Real estate investment is 12% of Chinese GDP at most recent readings

5/27 – Liquidity drying up:

  • China’s benchmark money-market rate rose 24bps to 2.4% - the highest levels since Feb. 12th
    • Prompted China to offer higher yields on short term bills @ auction (up 4bps to 1.49%)

5/28 – Domestic investors seeking returns forced to chase IPOs, which are now in a bubble:

  • Chinese IPOs beating Chinese benchmark indices by an average of 33 points in their first month of trading – best in the world YTD
    • Chinese IPOs raised $25B YTD due to many Chinese individuals being restricted from Int’l markets
    • P/E of Chinese IPOs: 46x vs. Shanghai Composite (16x) vs. Shenzhen-listed securities (23x)
    • Chinese IPOs gained an average of 32% in the first month of trading

6/1 – PMI slowing sequentially; property development and transactions eroding sequentially; domestic consumption slowing sequentially; battle over wages continue; China continues to get called out for “cheating”; and China increases its efforts to add liquidity to a financial system that has been drying on the heels of tightening in the property market and news out of the Eurozone:

  • PMI 53.9 in May vs. 55.7 in April vs. 54.5 consensus
  • HSBC PMI 52.7 in May – the lowest in a year
    • HSBC Index more weighted toward smaller, privately-owned businesses (400 manufacturing companies)
  • PMI components            
    • Output 58.2 in May vs. 59.1 in April
    • New Orders 54.8 in May vs. 59.3 in April
    • Export Orders 53.8 in May vs. 72.6 in April
    • Input Price Index 58.9 in May vs. 72.6 in April
  • Official PMI typically declines sequentially in May (3 of last  4 years) – seasonal adjustment factor off?
  • Property sales falling sequentially in May (M/M)
    • Beijing down roughly 70%
    • Shanghai around 70%
    • Shenzhen near 62%
  • Developers are postponing project launch dates and are waiting to see market developments and government policies before launching new projects
    • Shanghai – only 46 of a scheduled 96 developments were put on sale in May
  • Transactions for new homes in Shanghai fell 56% for the month through May 16 (M/M)
  • Secondhand home transactions in Beijing down 70% M/M in May
  • Hong Kong retail sales down sequentially to up 16.8% Y/Y in April vs. up 19% Y/Y in March
    • Retail sales volume down sequentially to up 12.4% in April vs. up 17.3% in March
    • Visitation up 18% Y/Y in April (1.7M)
  • Passenger car sales down sequentially - up 25% Y/Y in May vs.  Up 34% Y/Y in April
    • Has risen each month since Feb 2009 after gov’t lowered the tax on small vehicles to 5% from 10% in Jan. of ‘09
      • The tax was increased by 250bps this year to 7.5%
    • May 2010 is the most sluggish pace of growth since March 2009
    • Stockpile of vehicles up sequentially by 64,900 units in May
  • Honda Motor Co. production in China will remain halted at least through June 3rd as striking workers rejected a 24% pay increase to 1,910 yuan per month (looking for 2,000-2,500 per month)
    • Production of up to 3,000 cars per day has been lost since its auto assembly factories shut down last week
      • May 17 – plant in Foshan, Guangdong closed
      • May 24 – 2 plants closed in Guangzhou, Guangdong
      • May 26 – 2 plants in Guangzhou and Wuhau, Hubei
    • First time a strike has stopped Honda’s local auto production
    • Scuffles broke out between workers and staff from the government-backed trade union yesterday
      • Some workers sent to the hospital for treatment
  • Trade unions and employers appear to be reporting a growing number of work stoppages in China, although there are no official numbers, according to the International Labor Organization in Beijing
    • Hon Hai Group (assembler of iPhones) said last week it may raise wages 20% amidst a probe into the companies working conditions after the deaths of 10 people this year at their Shenzhen factory
      • Police treating as suicides
  • John Clarke, Head of EU delegation to WTO said today that “China uses a weak currency, export incentives, and subsidies to bolster its economy”… “the EU has seen some worrisome signals of stagnation in China’s efforts to revamp its economy”… “[EU] companies have reported a worsening of the [Chinese] business climate”
    • China March trade to EU up 25% Y/Y ($21.45B) – setting up for reported figures to slow sequentially in April and May
    • EU is largest recipient of Chinese exports in March (19.1%) vs. US (17.2%)
  • WTO judges are probing complaints by the EU, US, and Mexico against Chinese restrictions on exports of raw materials
    • Duties on coke, zinc, bauxite, magnesium, manganese, silicon carbide, yellow phosphorus
      • Used in steel, aluminum, automotive, and chemicals production
    • China claims taxes aimed at easing overproduction and pollution
    • WTO remarked that “export restraints tend to reduce export volumes of the targeted products and direct supplies to the domestic market, leading to downward pressure on the domestic prices of these products”
  • China’s Central Bank sold 1Y bills at 2.0096% vs. 1.9264% last week
    • Sold 15B yuan of 1Y bills
  • China’s Central Bank also raised rates on 3-month bills for second straight auction on May 27
  • China has added a net 145B yuan of cash into the financial system last week – the 2nd weekly injection of the last month after draining cash each week in April and March

6/2: Employers giving in to wage demands; liquidity drying up further; China may finally address restrictive residential system that has been marginally inhibiting to growth – a sign that the government may begin to pull out all the stops to avoid a full economic collapse:

  • Honda reopened a parts plant in China
    • Most of the parts factory’s 1,900 workers accepted an offer this week for a pay raise to 1,910 yuan ($280) a month (24%)
  • Hon Hai Group will raise worker salaries at least 30% after series of suicides
    • Workers with a monthly wage of 900 yuan per month will be paid 1,200 yuan effective immediately
  • 7-day repurchase rate rose 8bps to 3.28% - the highest since Oct. 2008 (19 month high) vs. 1.56% (12/31/09) vs. 0.96% (6/1/09)
  • Bank of China Ltd. (third largest lender by market value) started selling convertible bonds today
    • Plans to raise 40B yuan ($5.9B) according to a May 30 statement
  • China may gradually implement a residence permit system in 10 cities that may relax the Hukou rules, according to the South China Morning Post, which cited a State Council document

Chinese Ox Still Boxed In - SSEC



The balance of the year could prove difficult from a cost perspective.  The consumer comeback that casual dining management teams have touted may also be running on fumes.


Casual dining sales slowed in April and we are hearing that May’s numbers are not showing stronger trends.  Officially in April, the Malcolm Knapp data showed that two-year trends slowed sequentially from March. 


The trends in April and May suggest that the rate of change in improvement in sales trends is slowing just when the industry needs it most.  As you will see in the following charts, the industry benefited from declining food prices in 2009.  Labor costs were also somewhat benign as turnover rates slowed in the recession.


As we get closer to the outlook for 2011 (Q2/Q3 conference calls), higher food costs will dominate the headlines.  In addition, if the jobs picture really improves it’s only a matter of time before we hear about higher labor costs.  In an economy that is creating jobs, there is an increased incentive to quit and walk away from a lower-paying job (think restaurant server/cooks) increases and the restaurant industry will pay the price. 


There is also a case to be made that the improvement we have seen in sales trends is somewhat artificial, or said another way, it’s the SQUATTERS’ INCOME impact.  A New York Times article entitled “Owners Stop Paying Mortgages, and Stop Fretting” details just one example of unsustainable consumer spending patterns.  The article describes how for some homeowners that chose to halt mortgage payments, foreclosure has allowed them to “stabilize the family business.  Go to Outback occasionally for a steak.  Take their gas-guzzling airboat out for the weekend.  Visit the Hard Rock Casino.”  One individual stated, “instead of the house dragging us down, it’s become a life raft. It’s really been a blessing.”


Additionally, as our Hedgeye Risk Management BLACKBOOK on the consumer (released yesterday) illustrates, the consumer is facing a myriad of other headwinds.  For a copy of this BLACKBOOK, please email


From a cost perspective, restaurant companies face difficult comparisons over the next few quarters.  As the first chart below shows, average food costs as a percentage of sales for casual dining decreased significantly through the first three quarters of 2009.  While the first quarter saw further year-over-decline in food cost margin, the compares become increasingly difficult through the third quarter.  Some restaurant companies have indicated that costs have been trending higher than was expected at the outset of the year.  Two components that were cited specifically by management teams during the recent earnings calls were alcohol (MSSR) and chicken (RT).


While most companies are under long-term contracts for beef, as new contracts are negotiated, nearly every company will be paying higher prices in 2011.


Some companies that are looking vulnerable coming into the 2Q earnings season are CAKE, RT, TXRH and to a lesser extent DRI. 




In terms of labor costs, 2Q will likely bring significant labor cost year-over-year growth to the casual dining space.  Many companies saw year-over-year labor cost inflation in 1Q10.  DRI, PFCB, KONA, and RRGB had labor costs jump 95 bps, 116 bps, 133 bps, and 137 bps, respectively.  MRT saw deflation of 123 bps in labor costs.




Examining the EBIT margin trends in casual dining paints a vivid picture; the category is facing increasingly difficult margin compares for the rest of the year.  1Q10 was the last easy comp and many companies operating at peak margins will find it difficult to sustain those levels.  Those that jump out for me include CAKE, MRT, and TXRH. 




CASUAL DINING – THE SQUATTERS’ INCOME IMPACT - food cost margins cd names


Howard Penney

Managing Director


The Macau Metro Monitor, June 2nd, 2010



In an interview last week, COO Michael Leven said, "about 550,000 people visited MBS in the first 25 days of May, with ~25% of the resort open to the public."  The casino is winning “slightly more” on mass-market gambling than on VIP play since opening April 27, he said.  He believes at the current run rate, adding only improvements to the hotel, MBS will exceed the 2010 EBITDA of $329 million on the Street.  About 1/3 of MBS's visitors are Singaporeans.


Leven characterized Genting as a "very formidable casino competitor."  He said, “They know the market better than we knew the market on the mass-play side, because they operate in Malaysia and our operations in Macau are very different.”  Furthermore, Leven mentioned the lowering of food and parking prices as part of a mass market marketing plan.


According to Leven, Sands is "somewhat disappointed" at its slot win at MBS; the company has ordered popular electronic rapid roulette and mini-baccarat games to compete with Genting.



Macau gross gaming revenues soared to MOP17 billion in May (~95% YoY), the highest monthly revenue ever recorded in the territory, according to Portuguese news agency, Lusa.  From January to May, GGR totaled MOP72.2 billion, an increase of ~ 70 percent YoY.


SJM continued to be the leader with market share slightly above 32%; LVS had a 20% share; WYNN had a 16% share; MPEL had a 14% share; Galaxy had a slightly above 11% share; and MGM had a slightly above 7% share.  



Labor Secretary Marianito Roque advised Filipinos to delay finding employment in Macau because of the new imported labor law.  “Filipino workers should be wary especially against unscrupulous individuals or agencies who may entice or bring them to Macau because at the moment there is no hiring of foreign workers,’’ he added.


Based on POEA data, a total of 6,729 overseas Filipino workers (OFWs) were deployed to Macau in 2009, most of them employed in the tourism sector.






  • "The first quarter of the year is historically strong due to the seasonal impact of Chinese New Year. Surprisingly the second quarter has posted a record performance for April and the outlook for the full year remains promising."
  • GEG EBITDA increased 79% y-o-y to HK$417MM on revenue growth of 51% to HK$3.95BN
  • Starworld EBITDA increased 81% y-o-y to HK$369MM on record VIP turnover of HK$102BN (up 86% y-o-y)
    • EBITDA margin for the quarter was 11% compared to 10% in Q109 or approximately 18% compared to 16% in Q109 under the US GAAP calculation
  • City Clubs casinos contributed HK$30MM in 1Q2010
  • Construction materials earned HK$285MM of revenues and HK$68MM of EBITDA up 51% y-o-y.  The improvement in results reflects a strategic shift to a number of new Joint Ventures in Mainland China.
  • Galaxy Macau still on schedule and on budget to open early 2011.


  • Sentiment in Asia is very positive and that positive sentiment is driving spending growth
  • Had 2.9% hold compared to 3.1% in 4Q09
  • Shifted the business mix of construction business to higher margin products. Don't report revenue from minority partnerships but do report EBITDA. Hence the decline in revenue but increase in EBITDA
  • Invested a little over HK$5BN through 1Q2010 on Galaxy Macau


  • Early 2011 means 1Q2011 for the Galaxy Macau opening
  • $50-60MM corporate expense guidance going forward increasing somewhat going into the opening of Galaxy Macau
  • Increased their margins due to mix within VIP and more efficient scheduled, despite lower hold this Q
  • Had 242 tables, opened 2 more rooms this quarter and shifted more tables to VIP 130 from 110 and had 95 Mass tables from 110 last quarter.  Balance is premium direct business play. VIP only increased a little because the shift occurred mid quarter. Expect more visible benefit next quarter
  • Encore opening has actually helped the Peninsula and they haven't felt any negative impact from it
  • Feel confident that they profitable operate on Cotai given the growth in the market and the latent demand. Also infrastructure improvements coming over the next few months (increase in Guanbau gate capacity and airport, construction of high speed rail there as well)
  • Very conservative on extending working capital to their junkets.  They have increased it modestly but not relative to the volume growth
  • Anything special driving the surge in gaming revenues - especially in May?
    • Doesn't feel like there is a recession in Asia - economy is solid and improving and that's reflected in people's comfort in spending more
    • Increase in RMB flows buying the HKD

Testy Bears

“Bears get testy when they come out of hibernation.”

-John R. McCullough


Yesterday was a tough day for the bulls. After seeing a low volume Buy-And-Hope rally take the SP500 straight up to 1093 by 1030AM on the first day of a new month, the market saw a stiff -2.1% intraday reversal to the downside.  The SP500 is down -3% in the last 2 trading days and down -12.1% from its April 23rd closing high of 1217.


Correction? Yes, a big one. Crash from here? Maybe.


Markets crash when consensus expectations aren’t aligned with reality. Looking at this morning’s weekly Institutional Investor Bullish/Bearish survey, I still don’t think consensus is in the area code of being Bearish Enough. This isn’t a huge conceptual surprise, but a sniff of a fleeting market bid can get a perma-bull excited. Last Thursday’s dead cat bounce in US Equities apparently inspired some Institutional money managers to get LESS bearish.


On a week-over week basis, the Bulls climbed from 39% to 40%, while the Bears in the II Survey dropped from 29% to 28%. Having traversed my fair share of bear markets with live ammo (2000, 2001, 2002, 2008, 2010), I can tell you this – 28% of the pros admitting they are bearish is hardly Bearish Enough.


Bears on Wall Street are an interesting species. Most of them are perma-bears and, without naming names (Roubini, Rosenberg, Abelson, etc.), most of them have a tough time understanding that bottoms and tops are processes, not points. Most academic and sell-side bears have never been marked-to-market with a P&L. That poses problems that are practical in nature. Never go on a bear hunting expedition if you’ve never shot a gun.


Bears in the real world don’t have anywhere to hide. My Dad lives down at our lake house in a northern part of Ontario called Shuniah. This is what he wrote to me last Thursday when I named another name that claimed I was a Thunder Bay Bear who was going to “squirm”:


“Bears get testy when they come out of hibernation. You know they cancelled the spring bear hunt in Ontario a few years back… and the young bear population has taken to the highest levels ever. The one thing about bears is that although they are fiercely hunted… they too can become the hunter, especially when challenged on their own turf! Funny how life on the "streets" can imitate life in the wild. Keep dancing - and having fun!”


Fair enough. Sometimes I get a little testy. Mostly when someone calls me into the bull/bear faceoff circle or wants to drop the analytical mitts. I write this note in 40 minutes every morning and really don’t have time to be political or popular. The game is the game. I play it with every ounce of passion in me. What you see is what you get.


Back to market expectations…


There are three bearish US market catalysts pending in the next 3 days that kept me from chasing my own tail and covering shorts during yesterday’s hopeful morning rally:


1. Wednesday – The Financial Crisis Inquiry Commission will interview Warren Buffett on the credibility of the Ratings Agencies. Given that he is Moody’s largest shareholder, this should get interesting as the patriarch of American investing deals with this subpoena and, hopefully, the truth. The ratings agencies are conflicted, compromised, and constrained.


2. Thursday - Monthly US Retail Sales for May will be released and this is the first month in forever that the Hedgeye Retail team has been signaling to me that sales are at best in line and that EPS “beats and guide ups” are going to decelerate sequentially. All that was nirvana about being long Retail last year does need to be “comped”, indeed.


3. Friday – the US Employment report for the month of May could be the bogeyman that Mr. Macro Market saw coming yesterday – versus expectations that is. Our US Strategist,  Howard Penney sent me a note and an astute question:  “Looking ahead to Nonfarm payroll number to be reported on 6/4. The Bloomberg Survey is looking for a BIG uptick (especially relative to the latest print).  The last time the spread was this wide the Economists were missing number to the downside in 2008….  What are the chances they get it right this time?”


To be sure, there are some bullish data points this morning in global macro – there usually are:


1. Brazil’s inflation rate dropped in May to +0.21% sequentially versus +0.76% in April. This is in-line with what we are seeing in the Hedgeye Inflation Index which toned down sequentially (month-over-month) in the US in May.


2. Australian GDP was up for the 5th consecutive month to +2.7% year-over-year growth in Q110, proving that you can have interest rates greater than ZERO percent and see unemployment drop at the same time as less-cyclically oriented economic growth continues (Australia has raised rates 6 times to 4.5% and can now cut if they need to – the US and Japan can’t).


3. Japan saw another Fiat Fool Prime Minister resign. It’s hard to keep track of all these guys’ names, but the reality is that the Bernanke and Trichet fiat currency experiment has a precedent (Japan). This edition of the social system’s bureaucracy lasted less than 9 months as PM. Seeing the Bubble in Fiat Politics pop is good.


To be, or not to be, Bearish Enough – that is the question. It was also William Shakespeare who gave us one of the most important lessons in risk management – “expectations are the root of all heartache.”


My immediate term support and resistance lines for the SP500 are now 1052 and 1084, respectively.


Happy Birthday Dad, and best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Testy Bears - Day


The world’s economic recovery engine is slowing.  From the opening bell, the S&P was under pressure from the MACRO news coming from Asia and Europe.  Even the better-than- expected US economic data is not enough to pull this market out of bearish territory.  Not getting the attention that it should, the Bank of Canada raised its benchmark interest rate to 0.50% from 0.25% and the Reserve Bank of Australia left its cash rate unchanged at 4.5%.


Anyone that has been watching either the Chinese stock market or commodity prices for the last six weeks won’t be surprised that we received a couple of data points this morning that confirm economic growth is slowing incrementally in China.  Yesterday’s lower than expected reading for Chinese May manufacturing suggests that this growth has slowed more than anticipated (Chinese Ox in a Box).  China May manufacturing PMI was 53.9 vs. consensus 54.5 and prior 55.7. The official reading was reinforced by the HSBC China May PMI reading of 52.7 vs. prior 55.2. It was also reported that May property sales in several major Chinese cities had fallen significantly; providing evidence that the government’s tightening moves were impacting activity.


The Eurozone May Manufacturing PMI was 55.8 vs. consensus 55.9 and down from prior 57.6. The ECB warned that Eurozone banks are facing more losses and that write-offs could reach €195B. The ECB also commented that the financial sector and economy remain exposed to hazardous contagion effects from the sovereign debt crisis.  The Eurozone April unemployment crept up to 10.1% vs. consensus and prior 10.0%.


In reaction, the Euro traded down as low as $1.21, a four-year low, and was a leading cause for concern early in the day. The Hedgeye Risk Management models have the following levels for the EURO – Buy Trade (1.21) and Sell Trade (1.23).


In the USA, a better-than-expected increase in April construction spending provided a temporary reprieve.  April construction spending was 2.7% month-over-month vs. consensus 0.0%; March was revised to 0.4% from 0.2%.  The May ISM manufacturing number indicated a slow down, but came in better than expected; 59.7 vs. consensus 59.0 and prior 60.4. May ISM prices paid was 77.5 vs. consensus 72.0 and prior 78.0. May ISM employment was 59.8 vs. prior 58.5.


The Dollar index traded higher yesterday by 0.34%.  The Hedgeye Risk Management models have the following levels for the USD – Buy Trade (85.35) and Sell Trade (87.11).  The VIX rallied 10.8% yesterday and the Hedgeye Risk Management models have the following levels for the VIX – Buy Trade (29.36) and Sell Trade (45.11). 


For the second day in a row, the two worst performing sectors were Energy (XLE) and Materials (XLB).  The XLE is under sustained pressure from the Gulf of Mexico oil spill; BP was down 15.0%, RIG down 11.9% and HAL down 14.8%. Servicers and drillers were down significantly, with the OSX down 7.51%. 


Yesterday crude dropped 1.8% to 72.58.  The Hedgeye Risk Management models have the following levels for OIL – Buy Trade (68.01) and Sell Trade (75.34).


AAPL, MSFT and GOOG provided leadership that allowed Technology (XLK) to outperform.  AAPL reported that iPad sales have hit 2 million units. The Semis were lower on the day, with the SOX down 2.3%. 


Evidence that growth is slowing, especially in China, is dragging down the price of copper.  In early trading, copper fell for a third day to the lowest price in almost two weeks.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (2.92) and Sell Trade (3.03).    


The U.S. Mint sold 190,000 ounces of American Eagle gold bullion coins last month, the most since sales of 231,500 ounces in December.  The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,201) and Sell Trade (1,231).   


As we look at today’s set up for the S&P 500, the range is 32 points or 1.7% (1,052) downside and 1.2% (1,084) upside.  Equity futures are trading mixed to fair value, and off earlier highs. 


On the economic front to be reported today will be:

  • MBA Mortgage Applications
  • May Challenger Job Cuts
  • Apr Pending Home Sales
  • May domestic vehicle sales

Howard Penney













Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.43%
  • SHORT SIGNALS 78.34%