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The Derivative Effect of Tight Liquidity in Europe

Conclusion: A lack of lending in Europe will likely lead to an incremental slowing of growth in China.


If we have learned anything in the last few years, it is that all major markets are connected.  The classic example of course, was the subprime crisis in the United States, which roiled almost all global markets across asset classes in 2007 and 2008.


The 2010 consensus global risk factor is European sovereign debt and the risk of defaults.  Our view is that consensus is still not negative enough on the potential implications of a global sovereign debt unwind, primarily because believe the issue related is still deemed to be primarily specific to Europe.  But, as ever, the global markets are interconnected with trade being a primary connector.


Specific to that, China reported an export number that was up 48.5% year-over-year in May, which exceeded most estimates.   As it related to the 27-nation European Union, exports were up 34.4%.  The European Union accounts for the largest share of Chinese imports (or exports from China as this data measured) followed closely by the United States.  In May, this number amounted to $25.9 billion in exports to the European Union, or roughly 20% of total Chinese exports.  Clearly, any slowdown in Europe will have a direct impact on European purchasing power and Chinese export growth.


At face value, the export data from May seems to suggest that sovereign debt issues had a negligible impact on global commerce and, if anything, the issues were specific to troubled countries within the European Union.   Unfortunately, exports, like many economic indicators, are backwards looking in nature.  In fact, according to the Chinese Ministry of Commerce, it typically takes Chinese companies two months or so to fulfill orders.  Therefore the May export number actually reflects orders from March, which would predate any slowdown in the European Union caused by sovereign debt turmoil.


As always, it is difficult to get a real time read of the underlying growth in an economy until after the fact.   While we can read the tea leaves from company earnings announcements and delve into economic releases from the government, neither of these are typically real time, let alone leading indicators.  One real time leading indicator though is the amount of liquidity in an economy at any time, which can be measured by the banking system’s willingness to lend.


As it relates to liquidity in Europe, we have been very focused recently on European Central Bank overnight deposit facility usage.  As outlined in the chart below, in lieu of lending to each other, banks are depositing funds with the European Central bank at record levels.   The best way to think about this chart is as a measure of banks’ willingness to lend to another bank, so their inherent trust in the counterparty’s credit worthiness.  As we can see, there is now less trust, on this basis of more money being deposited with the European Central Bank versus being lent on a short term basis to other banks, than around the time of the implosion of Lehman Brothers.


European banks are, en masse, choosing to deposit funds with European Central Bank, at rates of just 0.25%, as opposed to lending to other banks at higher rates.  The decision is primarily based on a concern over the credit worthiness of other European Banks due to their holdings of European sovereign debt.


So, what exactly does this have to do with China?  Very simply, the less banks lends to each other, the less that is lent to consumers and businesses.  As money piles up in the ECB deposit facility it is not circulated and used in the economy, therefore it is not supporting commerce.


In the attached chart we compare deposits in the ECB facility to Chinese exports.  Deposits hit an extreme of $210 billion in November of 2008, which was a dramatic increase from October 2008 of $19.9BN, so indicative of declining intra-bank lending and overall liquidity.  By February 2009, on a reported basis, exports from China to Europe were at 56% of prior levels.  Clearly, as liquidity was pulled out of the system and banks stopped lending, business slowed orders from China and this was eventually reflected in Chinese exports numbers a couple of months into the future.


Coincident with this dramatic drop off in exports to Europe of course was the decline of all things related to sustaining Chinese growth. Think oil, copper, steel, plastic, most basic materials, and the multiple on the Chinese stock market.  As orders from Europe slowed for Chinese goods, so did the demand for raw inputs.  It was not coincidence that the price of Oil bottomed in February of 2009, which was the same month, as noted above, that year-over-year declines in exports to China’s largest trading customer, the European Union, were at their worst.


It is likely that we have yet to see the worst of the sovereign debt issues in Europe, and we certainly haven’t seen the broader implications of the tightening of liquidity in Europe.  Obviously, to believe that the world is not interconnected and that European sovereign debt is an isolated issue is naïve at best.


Daryl G. Jones

Managing Director


The Derivative Effect of Tight Liquidity in Europe - ECB CHINESE EXPORTS

World Cup Chart Of The Day: Brazil

The intermediate term TREND line for the Brazil Bovespa Index remains broken at 66,687.


World Cup Chart Of The Day: Brazil - Bovespa

German Economic Sentiment Cliff Dive

Position: Short France (EWQ)


While we typically don’t give credence to any one economic survey, the latest reading from ZEW aligns with our fundamental view on Germany.  The 6 month forward-looking  economic sentiment number fell off a cliff, registering 28.7 in June versus a Bloomberg forecast of 42.0 and the previous month’s reading of 45.8, while the current situation reading improved sequentially, registering -7.9 versus a forecast of -15 and the previous month’s reading of -21.6 (see chart below).


What’s our read-through on Germany?


In the last weeks we’ve pulled back on our long call on Germany, which was part of our Q2 theme call Sovereign Debt Dichotomy, even though the DAX is in positive territory YTD with the performance spread over Spain’s IBEX at 22% YTD.


The fundamentals still look bullish for Germany: unemployment has improved over the last months, down to 7.7% (versus Eurozone average of 10.1%), a weaker Euro is benefiting the country’s export base, and inflation looks stable over the medium term. We think this is showing up in the improvement in current sentiment survey.  However, we caution that sovereign debt contagion in the region and poor go-forward prospects for Chancellor Angela Merkel’s coalition government could provide formative headwinds over the medium term, which look to be reflected in the economic sentiment survey.


While we’re not calling for new elections in Germany, the government is a real concern that we’ll have on our radar, one that would be a significant destabilizing catalyst in Europe should elections need to be called. What’s clear is that Merkel’s coalition has lost its majority in the upper house of parliament (Bundesrat) since losing a critical election in the economically important state of North Rhine Westphalia in early May. Her choice to fund the Greeks as part of the €110 Billion loan package was a main point of contention that lost her the election and has since eroded her support. Further, her recently-issued four year €80 Billion package of austerity measures, which we view as largely positive, is being met with fierce opposition at home.


The next piece of the puzzle for the government is finding a replacement as President following the resignation of Horst Koehler last month after he made an inappropriate comment related to the country’s economic interest in being involved in the Afghanistan war. While the position is largely ceremonial, the void has nevertheless added further uncertainty to Merkel’s party. The announcement of the next President is scheduled for June 30th.


The cocktail of German bank exposure to countries with sovereign debt risk combined with the future uncertainty of the government are downside risks that we’ll be monitoring acutely. Stay tuned.


Matthew Hedrick



German Economic Sentiment Cliff Dive - zew

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 80.51%
  • SHORT SIGNALS 78.32%

Squeezy: SP500 Risk Management Levels, Refreshed

This market is definitely doing its best to frustrate both bulls and bears. Yesterday was bearish. Today is bullish. Our longs (GS, BAX, and NKE, etc) feel great. Our shorts (EWQ, AXP, and SPY, etc) don’t.


We currently hold 10 longs and 9 shorts in the Hedgeye Virtual Portfolio. Only 2 of 9 short positions have positive P&L today (UUP and SHY).


As of 1PM EST we’re pushing up against yesterday’s 11:14AM intraday high of 1104. Yesterday we called it a critical immediate term TRADE line of resistance and it proved to be into the close. Today the bulls are running up against it again. A close above it would be as bullish as a close below it bearish. In our risk management model, closing prices matter most.


All the while, the intermediate and long term TREND and TAIL lines rest above and below this market’s last price (see chart). To a large extent, seeing this market rotate in between these TREND (1143) and TAIL (1082) lines perpetuates volatility.


The VIX itself is down a hefty -9% today to 26 and from an immediate term TRADE perspective that makes it broken finally as well. From an intermediate to long term perspective, the VIX remains in a very bullish position with TREND and TAIL lines converging in the 23-24 range.


Confusing short term price action on decidedly bearish volume is as confusing does.


We’re doing a whole lot of nothing for now. Watching and waiting for the close.



Keith R. McCullough
Chief Executive Officer


Squeezy: SP500 Risk Management Levels, Refreshed - S P

BBY: The TV Tell All


June 15, 2010


TV sales appear to be the culprit, directly and indirectly, in today’s BBY shortfall.  Expect the environment to heat up as inventories look bloated against lackluster sales trends. 




Embedded in today’s disappointing BBY results are a few key messages.  First, the shortfall came primarily in two areas, sales and expenses.  Domestic comps were weaker than expected, due in large part to weakness in the TV, entertainment, and media categories.  As it relates to TV’s, the negative low single digit performance was a measurable slow down from 4Q’s high single digit increases.  So why the weakness?  Management attributes the slowdown to lack of compelling promotions (thanks to Costco for pointing this out two months ago) in the category, both from a price and innovation perspective.  Of course, the benefit here is higher ASP’s than anticipated.  This quarter marked the lowest year over year decline in average selling prices for TV’s in over two years!  Good news?  Not really.  It’s clear that the consumer is highly motivated by price and without promotional activity, traffic suffers. 


As it pertains to expenses, management suggested the company’s SG&A was a bit over-budget in the first quarter at time when sales were described as being volatile.  This really leads to a question of execution and control.  Expenses and inventory are the two main areas that management should optimize in the wake of an unclear topline trend.  Unfortunately, both areas were not managed in synch with the choppiness in sales.  The balance between near term investments in SG&A (focused on store resets highlighting connectivity, development of a used video game business, and growth in mobile as well as international markets) and potential benefits to gross margins in the future is out of alignment.  With that said, we realize (and were reminded several times on the call) that the first quarter is  a) a small quarter and b) normally not a predictor of holiday upside/downside. 


Regardless of the importance of 1Q historically, it’s still worth noting that overall inventories increased 15% while sales were up 7%.  On a comp basis, US inventories increased 10% against a 1.9% increase in comp store sales. Either way we slice it, we believe a better time to buy TV’s is on the horizon.  Something has to give and it’s either a step-up in promotional activity led by BBY or a pick-up in vendor driven promotions in an effort to stimulate unit demand.   Either way, we’re likely to see the competitive environment change as efforts to boost sales and help mitigate inventory risk take place before the holiday season arrive in five short months. 


Eric Levine



BBY: The TV Tell All - BBY SIGMA





-A few weeks back we noted that Sears is looking to monetize its real estate by subleasing floor space within it’s existing (and operating) stores. It seems that Forever 21 may actually be a potential tenant, with word coming from Costa Mesa that the specialty retailer is in discussion to take a 40,000 square foot space inside a Sears store. While this is a unique arrangement for sure, being a landlord may actually be a better business than selling Craftsman tools. We do wonder however, how much control a mall-owner and its other tenants may have over what types of retailers are permitted to sublet Sears’ space.


-This year’s Best Department Store in the World award goes to U.K retailer, Selfridges. Yes, this is a real award given by the Intercontinental Group of Department Stores.


-Keep an eye on the rumor that Coach and JC Penney may be in talks to collaborate on an accessories line. Nothing is official but Coach’s CEO noted this could be a possibility. He further went on to note that the Coach brand would not be included in any such effort with JCP.





World Cup Drives More Demand for Indonesian Footwear Manufacturers - Indonesian shoe manufacturers has recently acquired additional orders worth US $360 mm from six international and important footwear brands, partly due to the forthcoming World cup held in South Africa this month, according to Aprisindo Indonesian Footwear Association for Indonesian shoe manufacturers. US-based, Nike Inc and New Balance; France-based, Lacoste, Japan’s Mizuno and Adidas Group and Puma from Germany are the six international key footwear brands, which have placed their future orders with Indonesian shoe manufacturers, owing to quality assurance. With the World Cup being held in South Africa later this month, the demand for shoes has further increased and close to 70% of the sports shoes required for the championship will be delivered by Indonesia. The new duties imposed on footwear produced in Vietnam and China has also helped the Indonesian shoe industry. <fashionnetasia.com>

Hedgeye Retail’s Take:    We’re wondering who buys shoes to sit in front of a TV to watch the World Cup.  Now, jerseys on the other hand are a no brainer.  More importantly, we see here an example of how nimble the brands can be in shifting production throughout Asia to take advantage of favorable pricing dynamics. 


India Might Overtake US in Cotton Exports this Season - The Department said India is making ongoing improvements in ginning practices and export logistics, which are enhancing its long term competitiveness. China's growth as an importer is favoring in particular Indian exporters and the dramatic shift reflects both tight American supplies and the development of India's cotton sector, it said. Demand for cotton is being driven by China, the biggest textiles producer, whose consumption will rise by 1.5m bales to 49.0m bales. <fashionnetasia.com>

Hedgeye Retail’s Take:  Hard to believe the U.S has one last stake in the ground in the apparel manufacturing process.  Quality has long been an issue with foreign cotton supply, but it appears that this is finally changing.  Overtime, this probably leads to some pricing opportunity as well as a more stable global crop given the weather dependence of the this key textile ingredient. 


Chinese Labor Hikes - A spate of suicides at the world’s largest factory has drawn international criticism of the Chinese manufacturing model, raising new questions about whether low-cost production is worth the potential consequences. The suicides have prompted the Taiwanese-owned company and others to increases salaries. But labor-rights groups say much more work is needed and low wages are only one part of the problem with China’s manufacturing industry. They argue that vast structural changes are required and that the world can no longer expect this country’s workers to work themselves to death to make consumer goods. All this has raised new questions about whether China has reached a critical juncture, moving away from being the world’s low-cost production center. Such a move is in line with the government’s ambitious but far-off goal of becoming an economy based on innovation by 2020.  <wwd.com/business-news>

Hedgeye Retail’s Take:  One word: inflation. 


Sam's Club Focused on Apparel Offerings - If there is a bright spot for apparel at Wal-Mart Stores Inc., it may be at Sam’s Club. “We’re seeing good trends in apparel, and we’re bringing in new brands that are appropriate on a seasonal level,” Brian Cornell, CEO of Sam’s Club, said after the WMT annual meeting on June 4. In contrast, vice chairman Eduardo Castro-Wright characterized Wal-Mart’s apparel business as “disappointing” and “a work in progress.” Without the constraints of Wal-Mart’s “low-price leadership” strategy, Sam’s Club can sell department and specialty store brands but still at significant savings. The approach of Sam’s Club to apparel “is generated by aspirational brands and a treasure hunt vibe,” said Linda Hefner, executive vice president of merchandising. The warehouse club still sells organic cotton apparel. In addition, Sam’s Club features Nicole Miller New York, manufactured by Delta Galil, as a club channel offering for Sam’s; along with Levi’s boot-cut jeans, Calvin Klein shorts, Speedo swimsuits, Anne Klein Sport, DKNY, Reebok, Everlast, Champion, Cole Haan, Chaus and Lizwear. <wwd.com/retail-news>

Hedgeye Retail’s Take:  Maybe the discount stores should adopt the club’s merchandising strategy.  Limited SKU’s + national brands=simplicity. 


Hat World to Expand HQ - Hat World Inc. a multichannel retailer and manufacturer of hats and sports apparel, announced it will expand its Indianapolis headquarters and distribution operations. The company, which acquired two other sports apparel retailers in May, says the facility will allow it to consolidate its manufacturing and warehouse operations that are now located in  Wisconsin. Hat World, No. 381 in the Internet Retailer Top 500 Guide, says it plans to invest up to $22 mm to lease and equip the additional space. The retailer says it plans to begin hiring manufacturing and warehouse positions later this summer as it phases in up to 571 new jobs at its headquarters by 2015. <internetretailer.com>

Hedgeye Retail’s Take:  It seemed like this business had run out of room to grow about three years ago!  Clearly there’s value and opportunity in operating the largest (and only) chain of headwear-specific stores. 


Former ARO Supplier Indicted on Fraud Charges - Douglas Dey, the owner of a former supplier of Aéropostale Inc., was arraigned on Monday in Brooklyn federal court in connection with a multimillion-dollar kickback scheme that also has ensnared Christopher Finazzo, the chain’s former chief merchandising officer. According to the U.S. Attorney’s Office in Brooklyn, the 28-count indictment — unsealed on Friday — charged the two with mail and wire fraud, money laundering conspiracy and conspiracy to violate the Travel Act. Finazzo was also charged with “causing Aéropostale to make a false statement in a report that was filed with the Securities and Exchange Commission.”  <wwd.com/business-news>

Hedgeye Retail’s Take:  Given ARO’s post-Finazzo success, it’s fair to say this probably has little relevance beyond the headlines. 


Frederick's of Hollywood Looks to Expand Product Offerings Through Licenses - Frederick’s of Hollywood Group Inc. is looking to move the brand beyond intimate apparel. After licensing Blue by Yoo to produce and market a line of Frederick’s swimwear on an international basis, the firm is looking to expand into other product categories. In addition to swimwear, the company has identified domestic and international licensing opportunities that will allow them to expand beyond intimate apparel and into a lifestyle brand, which includes product categories such as fragrance, jewelry, accessories, footwear, headwear, handbags and costumes. The company is also exploring partnerships with international distributors in countries including South Korea, Brazil, Japan, China and Canada. Frederick’s of Hollywood recently began a strategic marketing initiative with the Hard Rock Hotel & Casino in Las Vegas and launched a social media and online marketing campaign.  <wwd.com/business-news>

Hedgeye Retail’s Take:   Sounds like this strategy will need a bit of luck.  Frederick’s definitely has a brand image associated with lingerie and we wonder how easily it can be translated into other categories.



The Macau Metro Monitor, June 15th, 2010


Secretary Tam said Wynn Macau hasn’t yet presented any application for the new gaming tables the company expects to include in its Cotai project.  Tam stressed that no applications for gaming tables will be accepted before 2013; he added that any acceptance of gaming tables applications after March 2013 will depend on the development of the local gaming sector at that time.

Contacted by Macau Daily Post, a spokesperson for Wynn Macau said: “We continue to work with the Macau government and take their direction with respect to a Wynn development on Cotai, and all necessary applications will be made as and when required."


IM reported MOP 6bn for gaming revenues as of June 13, which is on track to hit MOP13.8bn for the month. IM stressed that weekly and daily revenue numbers are quite volatile and do not reflect ebitda gains very accurately (except at SJM).



The number of new private homes sold in Singapore fell ~50% sequentially in May.  According to the Urban Redevelopment Authority, home transactions declined across all segments in May.



In July, Hong Kong-based Borey Samsoun Company plans to begin building The Samsoun Casino and Resort, a new US$4 million casino in Bavet town, located 1 km from the Vietnamese border.  The proposed development is expected to take three years to complete.


As for the sector outlook, the Ministry of Economy and Finance’s chief of Casino Management Chrun Theravath said that many firms are waiting for further signs of revival before beginning construction on planned developments.  There are 27 licensed casinos presently operating in Cambodia.  Two new casinos have already opened their doors in the Kingdom this year, with $100 million Titan King Resort and Casino beginning operation in Bavet City and the Top Diamond Casino launching in Kirivong district, Takeo province.

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