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Is the Yuan a Yawn?

Conclusion:  The potential revaluation of the Yuan is positive for Chinese equities, but likely negative longer term for Treasuries.  It will also benefit the currencies of those nations that supply basic materials to China – Australia, New Zealand, Canada, and Brazil.

 

The global macro news of the day is, of course, the statement by the People’s Bank of China that they are going to end the two year peg of the Chinese Yuan against the U.S. dollar.  The timing is apropos as the G20 Summit is occurring this coming weekend in Ontario, and increased pressure on the Chinese to let their currency more freely float was very likely.  At the least, the Chinese have bought themselves time in that debate, though it does seem likely that this is the first step in a more freely floating currency. 

 

Per the release from the People’s Bank of China:

 

“The global economy is gradually recovering. The recovery and upturn of the Chinese economy has become more solid with the enhanced economic stability. It is desirable to proceed further with reform of the RMB exchange rate regime and increase the RMB exchange rate flexibility.”

 

While this announcement is certainly bullish for the Yuan, it must be taken with a grain of salt as it doesn’t dictate a revaluation of the Yuan or even a change in the daily trading range, but emphasizes flexibility.  So, in effective, it was the bare minimum in terms of policy to support a Yuan revaluation.  Clearly, though, with increasing signs of inflation within China, this is a way to dampen housing and consumer price increases that threaten the Chinese economy.

 

So far the reaction from the U.S. government has been muted at best.  Treasury Secretary Timmy Geithner released a statement yesterday in which he stated:

 

“This is an important step, but the test will be how far and how fast they let the currency appreciate.  Vigorous implementation would make a positive contribution to strong and balanced global growth.”

 

Translation: Timmy likes this, but he wants to see more action.  While obviously Timmy’s statement may be politically convenient within the confines of the domestic U.S., Chirping Our Creditor has implications in its own right, specifically as it relates to the appetite of the Chinese to continue to fund U.S. deficits.  Moreover, a revaluation of the Yuan will fundamentally lead to lower demand for U.S. Treasuries over the long run.

 

The longer term impact of this change in policy will likely be a decreased demand for U.S. dollars.  In order to maintain the fixed exchange rate with the U.S. dollar, the Chinese government had to get long of the U.S. dollar.  Their method for doing this was to purchase U.S. Treasury bonds in large sums.  With the decision to let the Yuan float, the need to purchase U.S. dollars decreases and with it, on the margin, Chinese demand for Treasuries, which will be negative for the price of Treasuries (and positive for yields).  The chart below outlines this point as it shows that Chinese purchased more than $450 billion in U.S. Treasuries over the last two years, while the currencies were pegged, which was almost the same as the prior eight years combined.

 

So far this morning, the movement in the Yuan has been a bit sleepy.  With no specific policy action, the Yuan is still confined to its 0.5% daily trading range.  That said, even as this announcement is somewhat rhetorical in the short term, the long term implications are positive:

 

1)      It is indicative of the Chinese showing a willingness to play by the rules of free and open markets, which will increase confidence in investing in China

 

2)      The potential of trade wars will be somewhat alleviated on the margin as the argument that China has a structural competitive advantage due to an undervalued currency is less compelling

 

3)      A stronger Yuan will combat internal inflation within China, which offsets a key potential risk for the global economy – an overheating of the Chinese economy followed by a dramatic decline (think POPPING of a bubble)

 

As it relates to global trade, a more highly valued Chinese currency will increase China’s purchasing power for commodities, which are priced in U.S. dollars.  Therefore as the Yuan appreciates, it will have positive fundamental impacts for those countries that sell commodities into China. Think Australia, New Zealand, Canada, and Brazil.  Not surprisingly, the currencies of these nations are acting accordingly and are up between 0.75% and 1.00% across the board today (with Brazil up a little less).

 

While the movement in the Yuan today may be a bit of yawn, the longer term implications of a meaningful revaluation will have a real investable impact on various asset classes globally. And positioning for this revaluation will be critical.

 

Daryl G. Jones
Managing Director

 

Is the Yuan a Yawn? - Chinese Holdings of UST


THE M3: WYNN: NO INTEREST IN MSC; ADELSON COMMENTS; YUAN/SINGAPORE... AND MORE

The Macau Metro Monitor, June 21st, 2010

 

NO LAST MINUTE SITE SWAP FOR WYNN'S COTAI PROJECT Asian Gaming Intelligence

Steve Wynn has played down any rumors on swapping his Cotai site.  According to AGI, there was speculation that Wynn may bid for Macao Studio City if the government made the MSC site available.  But Wynn said to AGI, "It seems to me if there was a good chance of switching [sites for a Cotai development], they [the government] might have said to me 'Steve if you hold off something might happen' [on plans for Cotai].  I didn't get any of that [feedback].  My site's nearly twice the size of Macao Studio City's.  I'm 51 [acres] I'm told theirs is 32.  It [the MSC site] is big enough, but I would expect that they [the government] would have told me something like that."

 

MACAU GAMING GROWTH WILL EXCEED 30%, ADELSON SAYS Bloomberg, WSJ

In its annual meeting, Adelson told reporters he expects +30% growth in second half of 2010.  The projected growth follows a YTD increase of more than 60%, he added. Adelson was confident that the foreign labor quota issue would be worked out. He also took a shot at SJM, claiming the government "shouldn't allow any more casinos to be opened where the casino is greater than 10% of the [resort's] space" because such properties aren't contributing to the diversification of Macau's economy.

 

Sands CEO Jacobs reiterated that the Cotai project will be complete by 3Q 2011, and the Four Seasons apartment sale is forthcoming.

 

SINGAPORE SAYS YUAN MOVE WON'T AFFECT CURRENCY REGIME Bloomberg

The Monetary Authority of Singapore wrote in a email that China's decision to unpeg the yuan to the dollar won’t affect Singapore’s exchange rate policy.  “The policy of a modest and gradual appreciation of the island’s currency announced on April 14 remains unchanged and is appropriate against underlying economic conditions,” it said.

 

BUDGET SURPLUS DOUBLED macaubusiness.com

Macau registered a budget surplus of MOP21.28 billion in the first five months of 2010, with direct taxes from gaming increasing 57% YoY.  Direct taxes from gaming totaled MOP24.01 billion.

 

CONSUMER PRICE INDEX FOR MAY 2010 DSEC

CPI for May 2010 increased by 2.76% YoY.  Recreation & Culture rose by 0.96%, attributable to higher charges for outbound package tours.

 

NEW RECLAIMED AREAS IN MACAU WITH 3.5 SQ KM TO BE READY IN 5 YEARS Macau News

The Macau government will reclaim 3.5 sq km of land in the next five years to provide new areas for the territory expansion, said Secretary for Transport and Public Works Lau Si Io last week.  But according to Lao Long, urban development chief of the Lands, Public Works and Transport Bureau (DSSOPT), there would be no development by the gaming sector on the newly reclaimed land.


A 10BN NUMBER BOOSTS MACAU STOCKS

An article claiming Macau revenues reached 10 billion mid-month doesn’t jive with our sources.

 

 

As we wrote about last week, our Macau sources indicated that table gaming revenues reached HK$7.5 billion through June 16th.  This weekend, an article in the Macau Daily indicated that gaming revenues were MOP10 billion (a little lower than HK$10bn) through the same date.  The Macau gaming stocks traded on the Hong Kong Stock Exchange ripped overnight, all up in the 5-6% range.  How much of that was due to the Yuan devaluation – the Hang Seng was up 3% on the news – or the Macau Daily report, we don’t know.

 

We reconfirmed with our source this morning that HK$7.5 billion remains the correct number so we stand by our report.  Our meetings last week in Macau certainly implied a level of business more consistent with the 7.5 than 10.  Obviously, the difference would be huge.  Our HK$14.0-14.5 billion full month total revenue projection yields a Y-o-Y growth rate of 74-80% versus the Macau Daily implication of a HK$19 billion month or 135% growth.


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 80.64%
  • SHORT SIGNALS 78.61%

WEEKLY RISK MONITOR FOR FINANCIALS: ONE STEP FORWARD

What a difference a week makes. After coming off new lows in high yield and leveraged loans the prior week, this past Friday showed a marked turnaround, which will surely be furthered based on China's currency news over the weekend. Overall, seven out of eight risk metrics were positive on the margin week over week.  The only outlier was Greek bond yields, which increased dramatically, indicating that risk in the Eurozone should not be considered resolved.  

 

Our risk monitor looks at the following metrics weekly:

1. CDS for all available US Financials (30 companies).

2. High Yield

3. Leveraged Loans

4. TED Spread

5. Journal of Commerce Commodity Price Index

6. Greek Bond Spreads

7. Markit Subprime Spreads

8. AAII Bulls/Bears Sentiment Survey

 

1. Financials CDS Monitor – Significant improvement across the board in credit default swaps for US financials last week.  Every US Financial we track tightened, and all but one (PGR) saw double-digit improvement on a percentage basis.  This is the best performance we've seen out of this metric in at least five weeks.  Even the worst performers, the Spanish banks, only expanded 2-3%.  Conclusion: Positive. 

Contracted the most vs last week: ACE, ALL, XL, TRV

Widened the most vs last week: BBVA-ES, POP-ES, PAS-ES, BKT-ES

Contracted the most vs last month: COF, AIG, GNW, MMC

Widened the most vs last month: SAB-ES, ACE, POP-ES, PAS-ES

 

WEEKLY RISK MONITOR FOR FINANCIALS: ONE STEP FORWARD - cds

 

2. High Yield (YTM) Monitor - High Yield rates fell 35 bp in a straight line last week last week. Rates closed the week at 8.94% down from 9.29% the week prior. Conclusion: Positive.

 

WEEKLY RISK MONITOR FOR FINANCIALS: ONE STEP FORWARD - high yield

 

3. Leveraged Loan Index Monitor - Leveraged loans rose last week, closing at 1463, up 10 bp from 1453 the week prior. Conclusion: Positive.

 

WEEKLY RISK MONITOR FOR FINANCIALS: ONE STEP FORWARD - leveraged loan index

 

4. TED Spread Monitor - The TED Spread is a great canary. It came in modestly last week, closing at 44.4 bps down from 46.8 bps in the week prior. Conclusion: Positive.

 

WEEKLY RISK MONITOR FOR FINANCIALS: ONE STEP FORWARD - ted spread

 

5. Journal of Commerce Commodity Price Index – This week the JOC smoothed commodity price index is a useful leading indicator.  A sharp sell-off in this index starting in July ’08 heralded further declines in the stock market.  This week, the index rose from 15.47 last Friday to 16.48 on Friday.  Conclusion: Positive. 

 

WEEKLY RISK MONITOR FOR FINANCIALS: ONE STEP FORWARD - joc commodity

 

6. Greek Bond Yields Monitor - The Greece situation remains in flux and so we include Greek Bond 10-Year Yields as a reflection of that dynamic. In contrast to the broadly positive signals from the rest of the risk monitor, Greek bond yields increased significantly, closing the week at 942 bps, up from 818 the week prior. Conclusion: Negative.

 

WEEKLY RISK MONITOR FOR FINANCIALS: ONE STEP FORWARD - gr bond

 

7. Markit ABX Index Monitor - We use the 2006-2 series and look at the AAA, AA, A and BBB- series. The Markit ABX Index was generally up vs the prior week. We include this measure as a reflection of what is going on in deep subprime distressed paper. Conclusion: Positive.

 

WEEKLY RISK MONITOR FOR FINANCIALS: ONE STEP FORWARD - markit

 

8. AAII Bulls/Bears Monitor - The Bulls/Bears survey grew more Bullish on the margin vs last week. Bulls increased by 8% to 42.5% while Bears fell 12.4% to 30.7%, putting the spread at 12% on the bullish side, versus 9% to the bearish side last week. (One caveat is that our interpretation of the AAII Bulls/Bears survey is that a more bearish reading is bearish. Most market observers would use this survey as a contrarian indicator, which we wouldn't disagree with from a practitioner standpoint. However, for the purposes of this risk monitor, we treat an increase in bearish sentiment as a negative.)  Conclusion: Positive.

 

WEEKLY RISK MONITOR FOR FINANCIALS: ONE STEP FORWARD - bulls bears

 

Joshua Steiner, CFA

 

Allison Kaptur


Chinese Wisdom

“They must often change who would be constant in happiness or wisdom.”

-Confucius

 

Changing your economic policies as the facts do is not easy; particularly if politics stand in your way. Unlike Western countries, China has positioned itself to make monetary and fiscal policy decisions when it wants to make them, not as the political wind of Fiat Fools blows.

 

Club Myopia  in Washington will tell you that China’s decision to allow the Chinese Yuan to appreciate this morning was driven by American political pressure. That’s obviously ridiculous. Ever since they laughed at Timmy Geithner last year, the Chinese have done nothing but smile and nod.

 

Not unlike their decisions to appreciate the Yuan between 2005 and 2008, the main drivers of China’s move this weekend were domestic growth and inflation. We’ve shown this chart many times and we’ll put it up on Hedgeye.com again today, but when you overlay the sequential rate of change in China’s consumer price inflation (CPI) with the Chinese Yuan, the catalyst for currency revaluation becomes crystal clear.

 

Ronald Reagan and Paul Volcker figured this out a long time ago. Now the Chinese are trying to apply past American Wisdoms. Whether it works or not remains to be seen, but the domestic benefits associated with having a strong national currency are huge.

 

Both inflation and politics are local. The best way to ensure political safety and benign inflation at home (at the same time) is to maintain a strong currency. This will sound very foreign to the Japanese, European, and American Fiat Fools. They believe in debasing the Yen, Euro, and Dollar anytime there is a whiff of stock market weakness. It’s sad.

 

Stock and commodity markets around the world are moving higher on this Chinese news this morning because a stronger currency for the world’s strongest sovereign balance sheet means China has more purchasing power. Gold is hitting all-time highs at the same time that prices from sugar to oil are charging convincingly above their immediate term TRADE lines of support.

 

After he is done attempting to smirk, Timmy Geithner should realize that the corollary to a strong Chinese Yuan is a weaker US Dollar. This is another reason why assets priced in US Dollars are charging higher this morning. Dollar down equals assets priced in dollars up, for a trade.

 

Unfortunately, this also means that the sovereign risk implied on America’s balance sheet goes up this morning. The US Dollar is hitting a 4-week low, and is now decidedly broken from an immediate term TRADE perspective.

 

We are long a 12% position in Chinese Yuan (CYB) in the Hedgeye Asset Allocation Model. We’re also short the US Dollar (UUP) so from a currency exposure perspective, today is going to be a good day. Unfortunately, irrespective of what US stock market futures are doing this morning, today is not a good day for modern day Rome’s Financial Empire.

 

We showed this chart in Friday’s Early Look “Guarding The Guards”, and it’s worth reminding you of its long term consequences. Since the US was endowed with the global fiduciary responsibility of managing the world’s reserve currency in 1971, with the exception of the Volcker years, it has done nothing but erode the credibility of that global currency.

 

In that chart we outlined the long term TAIL line of resistance for the US Dollar Index at $88.89. China’s decision this morning is only going to reinforce that long term level of resistance as the US Dollar continues to break down below what was immediate term support.

 

When support becomes resistance in the immediate term (3 weeks or less in our model), we call that a change on the margin worth managing risk around. On this score, risk works both ways (when resistance becomes support it’s bullish), and that’s why we covered our short position in the SP500 (SPY) earlier last week.

 

Currently, the immediate term TRADE line of resistance for the US Dollar is $86.69. Last week alone, after the Fiat Fools at the Fed ballooned the balance sheet to $2.35 TRILLION Dollars, the US Dollar Index lost -2.1% of its value on a week-over-week basis. Since its intermediate term closing highs early this month, the US Dollar Index is down -3.3%.

 

China is America’s creditor. I’m not sure whether or not the professional politicians in Washington get that or not yet. But, as we head into the G-20 meeting next week in Toronto, the Chinese are definitely going to remind the world who is wearing the pants in this financial relationship. China holds $900.2B in US Treasuries and has plenty a reason to ask Timmy what he’s thinking about Chinese Wisdoms now.

 

My immediate term support and resistance lines for the SP500 are now 1097 (immediate term TRADE line) and 1144 (intermediate term TREND line), respectively. On Friday, we took our asset allocation to US Equities up from 3% to 6% - we bought the ETF for Utilities (XLU).

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Chinese Wisdom - CHINA


US STRATEGY – MACRO MOVES

Overnight Global markets rose for a 10th day, the longest rally in 11 months, as oil and copper are higher and Treasuries are lower after China signaled it will relax the Yuan’s fixed rate to the dollar. 

 

The S&P 500 finished fairly flat on Friday, with the strength coming from only three sectors Financials (XLF), Materials (XLB) and Energy (XLE).  Volume was up 53% day-over-day, which was largely a function of quarterly options and futures expiration, as well as the quarterly S&P 500 rebalancing.

 

With no MACRO news-flow on Friday, the NASDAQ and Russell 2000 all traded in a tight range as the markets took no real direction throughout the day.  Treasuries were little changed and the dollar index was flat on the day.  The DXY declined by 0.4% yesterday and the Hedgeye Risk Management models have the following levels for the USD – Buy Trade (84.89) and Sell Trade (86.61).  The only factor in the model to make a convincing move in either direction was the VIX which was down 4.39% on Friday and 16% for the week.  The Hedgeye Risk Management models have the following levels for the VIX – Buy Trade (23.41) and Sell Trade (31.93).

 

The three best performing sectors on Friday were Financials (XLF +0.3%), Energy (XLE +0.2%) and Materials (XLB +0.1%).  The Oil Service index was up 1.8% on Friday and 5.5% for the week.  Crude traded up 0.5% to 77.18; RIG (+10.3%), APC (+2.3%) and HAL (+2.2%) were the notable gainers on the day and BP rose 0.2%.  The Hedgeye Risk Management models have the following levels for OIL – Buy Trade ($73.79) and Sell Trade ($79.56).

 

The S&P Materials Index +0.50% rallied on easing MACRO concerns. CAT +1.4% reported improved machine sales and encouraging strength in Asia, especially China, which pared some investor concerns about Asian demand, especially from the materials sector.  In early trading, Copper rose the most in a month in London on speculation a stronger Yuan may accelerate imports into China.  The Hedgeye Risk Management Quant models have the following levels for COPPER – Buy Trade (2.99) and Sell Trade (3.05).

 

Commodities continued the move to the upside, with the CRB up 1% for the week.  The Philadelphia Gold and Silver index moved up 1.8% along with a continued climb in the commodities.  Gold closed at $1,259, up 0.9% on the day.  Gold remains in a bullish formation and we are long.  The Hedgeye Risk Management models have the following levels for GOLD – Buy Trade (1,233) and Sell Trade (1,258).  

 

Rounding out the top performing sectors on Friday was Financials (XLF).  Looking ahead, financial reform will see a busy push in DC as the summer approaches.  The AMEX BioTech index rose 1.1% on the day, as AMLN was up +19.9% on Roche’s 12-18 month delay for taspoglutide.

 

Underperforming for the third day in a row was Consumer Staples (XLP -1.1%) and Consumer Discretionary (XLY -0.6%).  Leading the XLY lower was the Homebuilders, with the S&P 500 Homebuilding index (-2.2%) continued to decline on weakness following yesterday’s worries about fading demand after the homebuyer tax credit expiration.  Lennar led the group down, declining 3.7% on the day. 

 

The EURO has rallied for the past two weeks, rising 2.2% last week.  The Hedgeye Risk Management models have the following levels for the EURO – Buy Trade ($1.22) and Sell Trade ($1.24). 

 

As we look at today’s set up for the S&P 500, the range is 47 points or 1.8% (1,097) downside and 2.4% (1,144) upside.  Equity futures are trading above fair value after China announced it has effectively abandoned its dollar peg thereby allowing some flexibility in its exchange rate. There are no economic or corporate releases scheduled for today but Wednesday's FOMC Policy Announcement will take center stage in what is a busy week for data.

 

Howard Penney

 

US STRATEGY – MACRO MOVES - S P

 

US STRATEGY – MACRO MOVES - DOLLAR

 

US STRATEGY – MACRO MOVES - VIX

 

US STRATEGY – MACRO MOVES - OIL

 

US STRATEGY – MACRO MOVES - GOLD

 

US STRATEGY – MACRO MOVES - COPPER


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