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MACRO: Is the Yuan a Yawn?

This insight was originally published on June 21,2010.  MACRO Intraday updates are available to RISK MANAGER SUBSCRIBERS in real-time.

 

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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.

 

MACRO: Is the Yuan a Yawn? - Chart 1

 

 

Daryl G. Jones
Managing Director


MACRO: CHINA: THE GREAT SHIFT FORWARD

This insight was originally published on July 6, 2010.  Macro select  intraday updates are available to RISK MANAGER SUBSCRIBERS in real-time.

 

 

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Conclusion: After a series of shrewd moves by the government which have centered on raising domestic consumption, China is positioning itself as a defensive play in late 2010 and heading into 2011.
 
Here’s what we know – growth in China is going to slow. After posting +11.9% Y/Y 1Q GDP, calling for a sequential erosion from here in the midst of a sovereign debt scare in Europe which has eroded the purchasing power of China’s largest export market isn’t exactly a tough call to make. The government even said on Friday that their full year growth estimate is 9.1%, explicitly implying a deceleration from 1Q. With the Shanghai Composite down 27.3% YTD as of today, prices confirm this. Using marked-to-market prices as leading indicators, however, Chinese equity prices have been telling us to expect slowing growth all year long.
 
At a price, China’s growth will become attractive on the long side irrespective of slowing growth in the U.S. and in Europe because their government is proactively preparing them to weather the storm by fueling domestic consumption. Over the past several weeks, China has taken a number of steps to increase their citizenry’s purchasing power – none arriving with more fanfare than the de-pegging of the yuan.
 
Since relaxing the fixed exchange rate on June 19th, the yuan has gain roughly 0.7% vs. the dollar and today’s 12-month non-deliverable forwards suggest an appreciation bet of roughly 1.5% in a year’s time. Despite the prospects of a stronger currency, the People’s Bank of China has ruled out any sudden large appreciations and still mandates that the currency only fluctuates 0.5% from the daily official rate. As a result, we caution that the yuan’s appreciation may not likely be the silver bullet China is looking for to stimulate domestic consumption, which has fallen from 46.4% of GDP in 2000 to 35.6% of GDP in 2009. As a percentage of GDP, personal income has had an even more dramatic decline: 53% in 1999 down to just 39.7% in 2009.
 
There have, however, been a number of positive developments regarding wage growth and government stimulus that will help move China forward towards a more consumption-oriented economy, rather than one that has been fueled by manufacturing and exports in recent years. Those developments are listed below and are by no means limited to this summary:

  • In April, Shanghai raised minimum wages 17% to 1,120 yuan per month. Guangdong (China’s largest export base) took up minimum wages in five locales within the province by an average of 21%.
  • On June 3rd, China extended its home appliance trade-in program until 2011. Sales of such appliances have reached 54B yuan and 5B yuan of subsidies were handed out since the start of the program.
  • On June 8th, a survey of Chinese employer’s hiring  plans reached a six-year high.
  • On June 11th, the IMF reported that the surplus of rural workers for labor-intensive work has fallen to about 25 million from roughly 120 million in 2007, which is bullish for wages in that sector (less supply). Conversely, research from China International Capital Corp. that suggests that 31 million Chinese will return to the labor market in 2011 after the completion of projects resulting from the government’s 4T yuan stimulus package. Net-net: supply of labor-intensive workers is still shrinking but perhaps at a slower rate, which is net bullish for wages.
  • On July 1st, Bejing increased monthly minimum wages by 20% to 960 yuan. In a similar fashion, Henan (China’s most populous province) raised its minimum wage by 33% to 600 yuan per month.

All told, more than 20 provinces and municipalities plan to increase minimum wages this year, according to the Ministry of Human Resources and Social Security. As a result, we should begin to see evidence of accelerating domestic consumption in the coming months. Furthermore, companies that are positioned to service the Chinese local economy (i.e. domestic retailers and savings deposit institutions) will see an added kick from this wave of wage inflation.
 
Currently, both the Shanghai Composite and Hang Seng are broken from a TREND perspective and last Tuesday’s 4.3% and 2.3% respective declines in both indices on the heels of a downwardly revised Conference Board Leading Index suggest that consensus still has some ground to cover on the slowing Chinese growth story. When consensus finally catches up, our Hedgeyes will be looking to buy their capitulation on sale.

 

 

MACRO: CHINA: THE GREAT SHIFT FORWARD - chart 1

 


Darius Dale
Analyst


MACRO: 2Q10 THEME: APRIL FLOWERS/MAY SHOWERS

This insight was originally published on May 4, 2010.  MACRO intra-day updates are available to RISK MANAGER SUBSCRIBERS in real-time.

 

 

 

MACRO: 2Q10 THEME - APRIL FLOWERS/MAY SHOWERS - MACRO SUSTAINABILITY?

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"The central principal of investment is to go contrary to the general opinion, on the grounds that if everyone agreed about its merits, the investment is inevitably too dear and therefore unattractive.”
  ~Warren Buffet
 
Our 2Q10 theme, APRIL FLOWERS/MAY SHOWERS, suggested that the S&P 500 could sees a 4-7% correction in 2Q10.  We did not think it would happen in a matter of days.  While Buffet took some heat over the weekend for talking up his book, he is still the ORACLE OF OMAHA.  As he suggests in the quote above, the persuasive bullishness of late is just to “dear” to the masses.   
 
Last week, the government reported that real GDP increased 3.2% annualized in the first quarter.  This print was slightly below consensus +3.3% and vs. prior +5.6%.  Personal consumption expenditures (PCE) were +3.6%; higher than consensus +3.3% and prior +1.6%.  PCE accounted for 2.5% of the reported gain and business investment accounted for 1.6% points, of which 1.5% was due to a continuing relative buildup in inventories.  The big concern with the Q1 GDP report is whether or not the trends in PCE are SUSTAINABLE.
 
As I wrote the other day, SUSTAINABLE growth in PCE requires continued growth in real disposable income.  Without growth in income consumption can only be borrowed from the future quarters through borrowing more and/or the consumer spending his/her savings.  In the current environment, neither of those sources is real or sustainable.  In 1Q10, the quarter-to-quarter trend in real disposable income was contracting.  Real consumer credit, which has been reported only for January and February, was also contracting in the first-quarter versus the fourth-quarter.  
 
If the U.S. banking system were able to function normally, it would be lending more money, not contributing to a slow downward spiral in consumer and business credit outstanding.  Needless to say, these trends show no basis for SUSTAINABLE growth in the economy or PCE.
 
The US market bulls expect the market to continue to move higher on stronger earnings.  A Bloomberg survey suggests expectations for total profit from Standard & Poor’s 500 Index companies of $88 to $90 a share this year, and close to $100 a share in 2011.
 
It seems unlikely that these strikingly bullish estimates incorporate proactive slowing of the free money trail in a number of regions around the world in 2H10 and 2011.  With the Chinese market down 13% year-to-date, worries about a slowdown in China are increasing.  The Government is proactively saying things are too hot.  The number of countries that are “proactively slowing” growth is increasing every week; it’s becoming the norm not the exception (Australia joined in last night and India has a real inflation problem to address).  Just to name a few….
 
With this trend solidly in place, and critical component to overall earnings growth, we would argue that over the next four quarters the risk/reward points to the downside in emerging economies; thereby placing much more pressure on the developed world recovery to meet the S&P 500 earnings growth numbers.  Such a recovery is not a likely event!
 
We have been very vocal about the mounting sovereign solvency issues in Europe.  In many ways, the European crisis echoes the way the U.S. banking crisis brought the global banking system to its knees.  At that time, the global monetary policy-makers allocated trillions to prevent systemic collapse.  In total, the sovereign debt crisis in Europe could also threaten systemic collapse.  As with the U.S. banking crisis, I expect that everything possible will be done to prevent that type of massive melt down.
 
As a result, U.S. fiscal stability is the key to keeping global systemic risk in check.  Unfortunately, our balance sheet issues are very much the same as those facing the PIIGS.
 
April Flowers/May Showers
 
 
Howard Penney
Managing Director


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MACRO: THE DEFICIT STILL LOOKS UGLY...

This insight was originally published on July 13, 2010.  Macro Select intraday updates are available to RISK-MANAGER SUBSCRIBERS in real-time.

 

 

 

MACRO: THE DEFICIT STILL LOOKS UGLY, NORMALIZE FOR TARP AND IT LOOKS UGLIER

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Conclusion: While June was an improvement for the deficit due to timing related to Memorial Day, the year-to-date numbers remain concerning.  On the other hand, the appointment of Jack Lew to OMB Director is a marginal positive.
 
The U.S. government reported a smaller monthly budget in June versus June 2009 with a deficit of $68.4 billion versus $94.3 billion last June.  In the year-to-date, the budget deficit is $1 trillion versus $1.1 trillion over the same period in 2009.  On a year-to-date basis, the budget deficit as a percent of GDP is 9.2% versus 10.2% in the same period in 2010.  While this high level summary suggests marginal improvement, the underlying facts still suggest dire fiscal issues in the United States on a number of fronts.
 
First, the June improvement in deficit can be attributed primarily to timing of revenues.  Due to the Memorial Day, a large amount of tax revenue was pushed into June.  In aggregate for the year-to-date, overall revenues are only up 0.5%, with corporate income tax contributing all of this increase growing 33% y-o-y.  Personal income tax, on the other hand, is down -4.4% in the year-to-date.  So despite the “economic recovery”, tax receipts from individuals are still lagging on a year-over-year basis (jobless recovery sound familiar?).
 
Second, while reported outlays were $73 billion, or 3%, lower for the first three quarters of the fiscal year, this decline included a reduction in nearly $350 billion from a combination of TARP, Treasury payments to Fannie Mae and Freddie Mac, and net outlays for FDIC insurance.  If normalized for TARP, so removing the $350 billion from last year’s numbers, then spending ex-Tarp is up 10.6% on a year-over-year basis!  Not a good trend.
 
While a large proportion of this was driven by unemployment insurance, every major line item showed a meaningful increase year-over-year.  Specifically,

  • Defense spending was up 5.8%;
  • Social security was up 6.0%;
  • Medicare was up 4.3%;
  • Medicaid was up 8.9%; and
  • And Other was up 9.1%.

Line item spending dramatically outpaced the economy vis-à-vis GDP growth and tax revenue growth.
 
In conjunction with this release, President Obama also named Jack Lew the new budget director.  While Orzag has a following amongst the paparazzis in Washington, Lew is actually an experienced hand in the budget area and has spent seven years in the OMB. He was lastly OMB director under President Clinton until 2001, and produced a budget, with the help of a healthy economy, that resulted in a surplus of $236 billion.
 
Given his prior experience, prior success, and proven ability to work across bi-partisan lines, President Obama seems to have made a solid choice in Lew.  Even though he spent some time as Chief Operating Officer at Citi Alternative Investments, we will still give him a free pass on that job choice for now.  He certainly has the wherewithal to take a tough stance on the budget, but the next few months will actually show how serious the Obama administration is about narrowing the deficit.

 

 

MACRO: THE DEFICIT STILL LOOKS UGLY... - chart 1

 

 
Daryl G. Jones
Managing Director


The Point of Collapse

“Perfection of planned layout is achieved only by institutions on the point of collapse.”

-Northcote Parkinson

 

Parkinson was a well known British scholar who specialized in naval history. Before he passed away in 1993, he authored 60 books, including “The Devil to Pay”, “Dead Reckoning”, and “So Near, So Far.” His writings recognized patterns of behavior in administrations and institutions in a way that makes we modern day chaos theorists proud. Patterns repeat.

 

The point of collapse is generally crystal clear in the rear-view mirror. Professional politicians in Japan have been telling stories for 20 years as to why they can prevent economic stagnation. In the US, the storytelling started in 2007. All the while, stock market and real-estate prices have every opportunity to rally to lower-highs, then collapse to lower-lows.

 

Despite all of the dissimilarities between Japan and the US, there is one similarity that continues to matter most in our risk management model – debt as a percentage of GDP. Now that the US can’t cut interest rates any lower, the “perfection of planned layout” to quantitatively ease, is also similar. We agree with Reinhart & Rogoff that crossing the 90% debt/GDP threshold is the equivalent of crossing the proverbial Rubicon of economic growth.

 

On July 2nd, as part of our Q3 Hedgeye Macro Themes presentation, we cut both our Q310 and full year 2011 GDP estimates for the US to 1.7%. At the time, these US economic growth estimates were about ½ the Bloomberg consensus estimate. Now we’re starting to see both the sell-side and the Fed gradually cut their estimates, but not by enough. Our estimate for 2011 is still too high.

 

Growth slowing, both domestically and in China, is core to our bearish views on both the US Dollar and US Equities. There will be a downward bias to our US growth estimates as long as debt-financed-deficit-spending continues to remain the answer to the Fiat Fools prayers.

 

Markets trade on expectations. Yesterday’s setup in the SP500 was unlike most Augusts in America. That’s because the ‘government is good’ crowd leaked an idea to the Wall Street Journal that QE2 was coming, and that Ben Bernanke was going to solve for buy-and-hope begging.

 

To think that we have institutionalized market expectations in this great country to this degree is downright frightening. All things rallies start and end with rumors about what a humble looking man of government will represent at 215 PM EST on an August afternoon. Sadly, this kick starts thoughts of what another thoughtful European mind, Alexis De Tocqueville, warned about American style democracy in the 19th century.

 

So now what?

 

What do we do with this big Keynesian intervention that has delivered the fear-mongering national marketing message? Have we sufficiently scared the horses? While we’ve been getting paid, has this “perfectly planned layout” of telling Americans that this is a “great depression” worked?

 

With 40.8M Americans on food stamps (record high) and 45% of the unemployed having been seeking employment for 27 weeks or more (record high), now what?

 

Should we start begging for QE3? Should we cancel the bomb of an Existing Home Sales report for public release on August 24th? Or should we get back on TV after checking our I-pads and drinking our $5 mocha-frap and tell Americans to bite the bullet on ZERO percent returns-on-savings while we pay Washington to continue to lever-up our future to the point of economic collapse?

 

Before the Fiat Fools run out campaigning for QE3, never mind decisions made in 1997 Japan, maybe they should analyze some real time market results to yesterday’s announcement of QE Light:

  1. The US Dollar is battling for resuscitation after 9 consecutive down weeks at $80.80 (down -9% since June)
  2. US Treasury yields are making record lows on the short end of the curve, with 2-year yields striking 0.49%!
  3. The Yield Spread (10yr minus 2yr) continues to collapse, down another 4bps day-over-day to 223bps
  4. US stock market futures are diving below the beloved 200-day Moving Monkey line of 1115
  5. US Volatility (VIX) is spiking from its intermediate term TREND range of support (22-23)
  6. QE Specialist (Japan) got smoked overnight, closing down -2.7% to down -11.9% YTD

Now what?

 

De Tocqueville’s answer: “The American Republic will endure until the day Congress discovers that it can bribe the public with the public's money.”

 

My immediate term TRADE lines of support and resistance for the SP500 are now 1099 and 1138, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

The Point of Collapse - toc2


THE M3: JULY CHINA LENDING DROPS; GSS; PAGCOR; FILIPINO TOURISTS

The Macau Metro Monitor, August 11th, 2010


CHINA'S NEW LENDING DROPS TO 532.8 BLN YUAN IN JULY Xinhua

According to the PBOC, new yuan-denominated lending in July fell to 532.8 billion (US$ 78.6 billion) from 603.4 billion yuan in June.  The first seven months brought 5.16 trillion yuan in loans, compared with 7.73 trillion yuan during the same period last year.

 

M2 supply increased 17.6% YoY to 67.41 trillion yuan by the end of July, slowing down from the 18.5% growth in June.

M1 supply climbed 22.9% in July, a decrease of 1.7% points from June's.  The Chinese government fixed this year's target for new loans at 7.5 trillion yuan. 


GSS SPENDING UP: MASTERCARD Strait Times

According to Mastercard, spending during The Great Singapore Sale (May 28-July 25) jumped 28% YoY to US$893.2 million.

 

PAGCOR CHAIR DOUBTS $10-B OFFER; KUOK DENIES REPORTS Inquirer

PAGCOR chairman Naguiat does not believe Ramon Ang's offer of $10 billion is serious.  “They’re not even industry players,” Naguiat said of Malaysia’s Robert Kuok, Ananda Krishnan and Francis Yeoh, three of the richest men in Southeast Asia.  Naguiat noted that while Kuok owned the renowned Shangri-la chain of luxury hotels, none of them had a casino. 

 

A spokesperson for Kuok in Manila, Joy Wassmer, denied reports that the Malaysian tycoon was interested in PAGCOR.  Wassmer said that Kuok had never been involved in the gaming business and had “no intention of investing in the gaming industry in the future.”


FILIPINO TOURIST ARRIVALS IN MACAU CONTINUE TO GROW Sun Star

Narzalina Lim, general manager of Macau Government Tourism Office-Philippines, said that Filipino tourists continue to visit Macau because of its accessibility and affordability with two Philippine-based airlines -- PAL and Cebu Pacific -- offering direct flights to Macau from Manila and Clark, at the same time offering cheap promotional packages.  With the implementation of the "open skies" policy, which will be announced soon by the Aquino administration, she believes more Filipinos are expected to visit Macau, particularly travelers from Davao Region and its nearby provinces.


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