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R3: Yuan Revaluation - Upping the Ante

 R3: REQUIRED RETAIL READING

 

June 21, 2010

 

A revaluation of the Yuan is sending ripples through the retail industry this morning.  As a result, we revisit one of our Top 10 Predictable Unpredictable themes from back in January,  “The Bombed Out Buck” and its impact on the supply chain.

 

 

TODAY’S CALL OUT

 

After a rally in the dollar through the 1H of 2010, a stronger Yuan serves as a reminder that the US dollar is in a longer-term decline. This trend whereby it ceases its reign as the world’s reserve currency begins to impact the sourcing economics of the apparel and footwear industry. The bottom-line here is that as China’s currency appreciates on both a cyclical and secular basis, it puts pressure on the COGS line for companies who overwhelmingly depend on Chinese labor.

 

What does this mean?  The ante for sourcing intermediaries like Li& Fung goes higher as smaller brands must pay a premium to compete. Smaller brands that choose to go at it on their own need to build the sourcing expertise, which cost P&L dollars and working capital. This trend will also accelerate the consolidation trend in the apparel/footwear industry as marginal players start to fall off the map either by choice or necessity.

 

In an effort to differentiate the companies that have proactively prepared for this shift, we updated our file highlighting the companies with meaningful exposure to China from a COGS perspective as well as the revenues derived from China. The bigger companies and those that have a Macro process and have been proactively preparing to compete in the New Reality will be the share gainers.

 

The companies that look best in this regard are Nike, Adidas, Timberland, Coach, Columbia, and Ralph Lauren. On the flip side, Brown Shoe, Payless, K Swiss, Lululemon, and many small footwear and apparel brands are at a meaningful disadvantage.

 

We don’t think that this analysis gives us much of a feel as to who the near-term longs and shorts might be, but for those that can invest with a duration of a year or more, this is an incredibly relevant issue to consider. 

 

R3: Yuan Revaluation - Upping the Ante - 1

 

 

LEVINE’S LOW DOWN 

 

- Bad news for men’s fashion out of Milan’s Spring ’11 fashion shows. Word has it that “jeggings” (jeans crossed with leggings) are being shown for men! While European trends sometimes take their time to make it stateside, we hope this is one trend that dies out before hitting the mall.

 

- According to online coupon aggregator Retailmenot, Victoria’s Secret, Kohl’s, and JC Penney were the most searched coupons for the month of May. Overall coupon traffic for the month grew 42% y/y.

 

- With Gulf oil tragedy persisting, it’s no secret that the region’s seafood industry is in danger. In Louisiana, shrimp fishing is down to just 30% of normal production levels. As a result, shrimp pricing is on the rise. Estimates suggest Gulf shrimp prices have already risen by 40% while imports are up about 13%.

 

 

MORNING NEWS 

 

  

World Cup Impact To US Geographies, Demographics - Consumer enthusiasm for the 2010 FIFA World Cup has been a boon for soccer retailers in the past few weeks, but analysts said the overall impact will depend on the outcome of the tournament. Storeowners polled last week said they are seeing a noticeable uptick in sales, particularly at stores in areas with a large Hispanic population. The Hispanic population drives the soccer market in Los Angeles because it’s a major sport embedded into the culture. In Boston, athletic footwear is also seeing a lift from the World Cup as a result of the local culture. <wwd.com/footwear-news>

Hedgeye Retail’s Take:  Measuring enthusiasm and the pulse of retailers selling World Cup gear during the event is pretty likely to come out with a positive read.  The real question is how long the excitement lasts over the next four years until the next cup. 

 

Republic Sold - Change Capital Partners LLP, the London-based private equity firm, has sold the multi-brand denim and sportswear retailer Republic to TPG Capital, formerly known as Texas Pacific Group, for an estimated 300 million pounds, or $447 million at current exchange. In a joint statement, the companies said that Republic’s management, including co-founder and chief executive Tim Whitworth, would remain in place. Republic operates 105 stores throughout the U.K. and sells brands including G-Star, Diesel and Firetrap.Change purchased a controlling stake in Republic in 2005 and has since doubled the firm's turnover to 200 million pounds, or $298 million, and trebled earnings before interest, taxes, depreciation, and amortization. <wwd.com/business-news>

Hedgeye Retail’s Take:  Another premium denim manufacturing changes hands, making this apparel sub-sector one of the most frequently traded.  This time around the assets are retail specific and European.  

 

CHRS Appoints New President to Fashion Bug Unit - MaryEllen MacDowell, most recently president of Charming Shoppes Inc.’s Lane Bryant Outlet division, has been appointed president of the company’s Fashion Bug unit. She succeeds Jay Levitt, who has left the firm after two years in the post. Additionally, Laura Johnson, previously president and chief executive officer of Zac Posen/House of Z LLC, has joined Fashion Bug as executive vice president, merchandising and product development, reporting to MacDowell.  <wwd.com/retail-news>

Hedgeye Retail’s Take:  More management changes for the plus-size retailer which is still struggling to re-energize the topline.  On paper anyway, the current team seems to be the first step towards revitalizing the specialty retailer.  

 

Under Armour Partners with IMG Soccer Academy - IMG Academies announced a deal for Under Armour to become the official apparel and shoe provider to the IMG Soccer Academy. <sportsonesource.com>

Hedgeye Retail’s Take: Add this to the already long list of grassroots efforts to get young athletes wearing the UA brand.  Also a cost effective way to build longer-term brand equity without breaking the bank via a major endorsement.

 

1000 Chinese Tanneries to Shut Down in Next 5 Years - Energy saving and emission reduction are the top concerns for China's leather industry as the drafted plan of the government's twelfth five-year plan will be announced next year. According to the secretary general of China Leather Industry Association Su Chaoying, during the twelfth five-year plan around 1,000 tanneries will be forced to shut down in order to achieve a reduction of 10% of COD and ammonia nitrogen compounds emissions. By the end of this year the Ministry of Environment Protection will reveal the list of tanneries which comply with the environmental protection standards, while the preparatory for survey conducted by the tanning self-regulation group is under way.  <fashionnetasia.com>

Hedgeye Retail’s Take:  Can’t be good for leather prices if capacity is shuttered.  Though a longer term process, it’s worth keeping an eye on footwear and accessories margins as China clamps down on environmental hazards.

 

Japanese May Department Store Sales Less Bad - Japanese department stores' May sales slid 2.1% , representing an improvement on previous months' performance. The stores registered their  27th straight month of declining sales but the drop was smaller than that of previous periods. The association said that warm weather and some holidays boosted sales of spring and summer clothing early in the month. Two stores closed their doors in the month of May, bringing the total number of department stores in the country to 265. <wwd.com/business-news>

Hedgeye Retail’s Take:  Wow, there are more Macy’s in the US than there are department stores in the entire country of Japan. 

 

Reef Expanding Products, Redifining the Brand - Reef is returning to its roots and expanding into the closed-toe business. President Jim Gerson, who has been at the VF Corp.-owned brand for a year, said his priority has been to reposition Reef as a more authentic surf player. “We spent a lot of time focusing on the brand DNA,” said Gerson. “We revamped ourselves as the exotic beach and surf brand, and we now run everything through that filter.” That includes bringing back the Reef girl ads, featuring exotic women shot from behind in remote tropical locales, and debuting shop-in-shops and fresh product. The new five-style closed-toe men’s collection, dubbed Coastal Cruisers, has canvas uppers built on the brand’s pebbled texture footbed and will retail from $43 to $55. The outsole of the shoes has a wave texture, emphasizing the brand’s connection to the beach. Gerson said he knows the category will take time to grow, but his hopes are that closed-toe footwear could make up as much as 15 percent to 20 percent of sales within five years. <wwd.com/footwear-news>

Hedgeye Retail’s Take:  It was only a matter of time before VF got traction on turning Reef into a lifestyle brand.  With sales so dependent on flip-flops, a year-round product offering (i.e closed toe) is the first logical move.  Longe-term we wonder how Reef is ultimately positioned vs. Vans.

 

Tiffany to Launch Leather Collection - Luxury retailer Tiffany not only plans to open 16 new stores within the year, but also will launch a leather goods collection to expand their merchandise offerings.  The collection will be developed by designers Richard Lambertson and John Truex and will feature wallets, key holders, business card holders, and luggage tags to sell for US$100 or US$120. Tiffany’s CEO Jim Fernandez anticipates the leather goods collection will boost sales by 6-7%.  <fashionnetasia.com>

Hedgeye Retail’s Take:  Nothing new here, except the leather-goods launch is finally drawing closer.  Recall that TIF purchased Lambertson Truex out of bankruptcy in an effort to grow it’s non-jewerly presence.

 

Big Weekend for Golf Retailers - With the U.S. Open and Father's Day, Golf retailers scrambled to make the most of the holiday. Golf retailers offered video cameras, free lessons and contests ahead of Father’s Day and the U.S. Open to spur demand as the highest sustained unemployment since 1982 deters shoppers. Golfsmith International Holdings Inc. ran another promotion to give cash back to some shoppers depending on who wins the U.S. Open this weekend. Callaway Golf Co. is giving Kodak PlaySport cameras to customers who buy new drivers. The tournament and Father’s Day usually make June the biggest sales month for golf companies, topping the Christmas season.  <bloomberg.com/news>

Hedgeye Retail’s Take:  The real question is whether Dad was actually playing golf or shopping for golf?

 

Nike's Ambush Marketing Paying off at World Cup - With its highly-popular "Write the Future" ad campaign, Nike is said to be gaining greater awareness around the World Cup than the event's official sponsor, Adidas. Two separate surveys show Nike is emerging as the most recognized company of the World Cup. <sportsonesource.com/news>

Hedgeye Retail’s Take:  Official sponsorships may be on the demise, as this is not a new trend.  Unfortunately for the sporting events themselves, this may ultimately have an impact on funding and overall success.  Clearly the better ROI for a brand is to avoid the “official” sponsorship, while thinking creatively to drive awareness. 

 

Nike's Pop-Up Stadium to Open in Selfridges - Next week, Nike will open a pop-up stadium in London's Selfridges, filled with 62 plasma screens and surround sound so that shoppers can watch World Cup matches in the store. The Nike Stadium will be on the lower ground floor in the Selfridges Ultralounge, an arts and exhibition space. Adjacent rooms will host table football and video games and an exhibition of iconic Nike football kits. The pop up coincides with the launch of a Nike concession in the department store, stocking many sportswear pieces unavailable elsewhere in London. <licensemag.com>

Hedgeye Retail’s Take:  No wonder Selfridge’s is the department store of the year!  Sounds like it could be even more exciting if Team England makes it into the elimination round. Certainly the mood for shopping would not be overshadowed by depression.

 

Puma City in New York is the Ultimate World Cup Spot - The Puma City installation, which will dominate Manhattan’s South Street Seaport until July 11, is prime World Cup territory. Insider took a walkthrough of the space on opening day of the tournament, when it was thronged with the football faithful. There are human foosball and soccer clinics on the fenced-in pitch, ping-pong tables, a beer garden run in collaboration with Red Bar and, of course, plenty of retail space. The footwear and apparel sold at Puma City crosses from soccer performance to lifestyle, with some Puma City exclusives. During the day, it’s a retail space that shows Puma’s World Cup-themed artwork and photos, but when the sun goes down, it converts into a bar/lounge, with chalkboard walls, bar games, “DJ Hero” and flatscreen TVs. “It’s soccer by day, party by night,” McCrae said with a smile. <wwd.com/footwear-news>

Hedgeye Retail’s Take:  More World Cup excitement, but this time in NYC style.  Sounds a little more dynamic than Nike’s London effort, but to be fair this is really a glorified bar.

 

Viral Marketing Top 10 Sites - Viral marketing is nothing new, but Nike raised the bar recently with its World Cup film “Write the Future,” starring a dozen marquee soccer players (plus Roger Federer, Kobe Bryant and, er, Homer Simpson). The day it hit, the ad logged 7.8 million views, a new digital record. Below are most trafficked online video sites, where you can find the Nike flick and other hot clips. 1) You Tube 101.3 mm, 2) Facebook 26.2 mm, 3) Yahoo 24.2 mm, 4) Google 18.9 mm, 5) Hulu 15.5 mm, 6) MSN/Windows Live/Bing 14.4 mm, 7) CNN Digital Network 12.4 mm, 8) Fox Interactive Media 11.5 mm, 9) The CollegeHumor Network 8.2 mm, 10) MLB.com 7.8 mm. <wwd.com/footwear-news>

Hedgeye Retail’s Take:  Expect to see more and more viral campaigns now that the reach has far surpassed traditional TV viewership. 

 

Average Value of a Facebook Fan - Many social media marketers are eager to tie a hard number to the value of their efforts. To that end, firms have attempted to analyze the worth of fans and followers on social networking sites like Facebook. Digital consulting firm Syncapse and research company Hotspex have come up with an empirical formula that puts an average value of $136.38 on the Facebook fans of the site’s 20 biggest corporate brands. Most of that value comes from how much the fans will spend on the brand’s products, with additional dollars coming from customer loyalty, recommendations and earned media.  <emarketer.com>

Hedgeye Retail’s Take:  Interesting, but this still seems like a very loose estimate.  Given the limited history with converting a “Facebook Fan” into a full on consumer of a particular brand, we suspect it will take more time to truly understand the monetary value of an individual social networker.

 

R3: Yuan Revaluation - Upping the Ante - 2


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.


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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.


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


Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

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