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This insight was originally published on July 8, 2010 for subscribers. RISK MANAGER SUBSCRIBERS have access to SELECT MACRO content in real-time.




Conclusion: Washington’s Economic Officialdom doesn’t understand that a ZERO percent “risk free” rate of return not only scares capital out of this country, but that it is also a tax on the fixed incomes of baby boomers with hard earned savings accounts.



MACRO: BERNANKE "GET IT OFF ZERO" - Screen shot 2010 08 17 at 9.02.04 AM



It’s no secret that we are not fans of Ben Bernanke and his Princeton crony Paul Krugman. We don’t believe in disrespecting the cost of (or access to) capital. When you socialize an economic system, you encourage bad behavior by undisciplined allocators of capital. Bad players then perpetuate existing problems.
Thankfully, there seems to be a reasonable voice at the US Federal Reserve who doesn’t wake up looking to pander to a Nobel Prize winner that has seen nothing but his 2008 theories fail. When you watch Krugman speak, you tell me if the man looks right stressed. If I were him, I would be too.
Kansas City Fed head, Thomas Hoenig, speaking with Kathleen Hays on Bloomberg Radio's "The Hays Advantage," yesterday at 11:30AM EST said he didn't think a one percent interest rate would be harmful to the economy. "I am not saying raise rates to very high levels. I am saying get it off zero," Hoenig said. (Source: Bloomberg)
Below, Darius Dale did a solid job paraphrasing the highlights from an outstanding Hays interview:

You have to be careful with resisting the inertia of “extended and exceptional”.  Just because the EU sovereign debt crisis scared investors and inflation fears subsided doesn’t mean that we should hold rates low indefinitely.

How do you incentive savings and subsequently loans when you’re giving people zero % returns on saving?

You can’t solve every problem with monetary policy. It is an allocative instrument and we need to use it carefully.
I’m not saying take rates up substantially. I’m advocating a policy towards a slow normalization of rates (i.e. what we’re seeing in Australia, etc.)

There is a time factor; the more we delay, the more difficult it will be to make a move, as uncertainties and issues build up. Slowing growth, housing, and the Bush tax cuts expiration will all be factored into the debate as we progress through the year.

There will always be risks and the more you delay in acting, the more the risks begin to pile up.

To have lived through three bubbles (housing, tech, 1970’s), not calling out the negative implications of negative real interest rates would be a derelict to my responsibility as a official of the FOMC.

It’s expensive to hire people in the U.S. That and uncertainty about the future – including burgeoning fiscal deficits – means we are going to have to wait until the confidence comes back for job creation to accelerate.

When I was elected Federal Reserve president of K.C., I was given a single reichsmark by my elderly German neighbor. He said to me, “When I was a boy, this could buy a small house. By the time I got older, it couldn’t even buy a loaf of bread. Don’t let that happen here.”

The German hyper-inflation was caused by trying to fix every single economic and political problem with monetary policy.

Keith McCullough
Chief Executive Officer
Darius Dale


The Macau Metro Monitor, August 17th, 2010



Jointly announced by the Ministry of Interior and the Ministry of Transportation and Communications, revisions include an extension of entry permit validity to three months, more flexibility with the "OK Board" expedient, and looser qualifications for mainland citizens residing in Hong Kong, Macau, and other overseas locations.


The National Immigration Agency stated the new measure is in line with the government’s policy of continuing to open Taiwan up more to mainland tourists.


Melinda Chan Mei Yi, wife of chairman David Chow Kam Fai, has bought back the 45% of Macau Legend’s capital from foreign investors for USD 125 million (MOP 1 billion) in late July.  The USD 125MM buy-out is only 32% of the USD 390 MM (MOP 3.1 billion) they put into the company back in January 2007.  The group of shareholders included Merrill Lynch, Och-Ziff, TPG-Axon, David Ross, Sean Fitzpatrick, and Siger, an investment fund connected to the King of Morocco – but Siger, which manages the Moroccan royal family’s wealth, later pulled its investment out after finding out it was linked to gaming business.


Bureau of Labor and police raided Galaxy Macau's construction site and found 13 'black' workers after inspecting over 1846 workers (1429 local/ 417 foreign).

China's Selling Treasuries… Again

Conclusion: China continues to diversify its FX holdings away from U.S. Treasuries while the rest of the world (including the Fed) continues to buy. Just as it has been for global growth over the past 18-20 months, we believe China’s selling is an important lead indicator regarding the future of U.S. Treasuries and the U.S. dollar.


Position: Short 1-3 year U.S. Treasuries via the etf SHY. Short the U.S. dollar via the etf UUP. Long the Chinese yuan via the etf CYB.


The most recent TIC data was released today and it confirms one of Hedgeye’s key long-term TAIL ideas that the U.S. Dollar will continue to make a series of lower-highs and lower-lows from a long term perspective. China, the largest holder of U.S. Treasuries, continued to be a net seller, lowering its U.S. Treasury holdings by an additional $24 billion in June to $843.7 billion. Since July 2009’s peak holdings of $939.9 billion, China has sold a cumulative $96 billion of U.S. Treasuries with a quarter of that total coming in the most recent month for which we have data (June ’10). Moreover, China has nearly liquidated its holdings of short term bills, which peaked at $210.4 billion in May ’09 and are now at $4 billion – a 98% decline!


China's Selling Treasuries… Again - 1


In contrast to China’s selling, total net foreign purchases of U.S. Treasuries increased to $45.7 billion in June vs. +$24.3 billion in May. Japan (#2 holder) and the U.K. (#3 holder) each increased their exposure to U.S. Treasuries in June, up $16.9 billion and $12.2 billion, respectively.


We continue to have conviction that the largest bubble remaining in the global marketplace is that of short-term U.S. Treasuries. At ~50bps, the yield on 2-year Treasuries is at its lowest level ever. Ever, as they say, is a long time and that represents one of the most asymmetric risk setups globally marketplace – yields can’t go down much further from here, we believe. In fact, because of the premium investors are placing in “safe” assets in light of global growth slowing, we feel the market has not priced in what we feel are substantial long term risks to U.S. Treasuries and the U.S. Dollar. We highlighted those risks two weeks ago in a note titled: China’s Stress Tests(s): Risks to the Global Economy. Excerpts below:


In a recent study done by the Congressional Budget Office, U.S. federal debt held by the public as a % of GDP is likely to eclipse 185% in just 25 years under scenarios that we consider aggressive based on assumptions of above-trend tax receipts and below-trend expenditures – which certainly hasn’t been the case of late (see Daryl Jones’ note from 7/13: The Deficit Still Looks Ugly, Normalize for TARP and It Looks Uglier). The results of the mid-term elections may prove to be a positive catalyst on the margin for reigning in the deficit, but a slowing U.S. economy may ultimately prove to trump any form of American Austerity.


On August 3rd, we put out an extensive presentation regarding the future of U.S. sovereign debt (email us if you need the replay), with the key takeaways being: 1) current demographic trends will likely beget further deficit spending; 2) a low U.S. savings rate will necessitate that an increasing amount of foreign buyers will be required to fund new debt issuance; and 3) at current and conservatively-projected near-term debt levels (+90% of GDP), U.S. economic growth will be below-trend for years to come – likely furthering the “need” for additional government spending and investment. All told, the U.S. is likely to issue a great deal more of U.S. Treasury supply in the coming decades and buyers of that supply will be increasingly foreign entities, which increasingly makes the U.S. vulnerable to external shifts in demand for U.S. sovereign debt – which is currently near all-time highs. If we’ve learned anything from Greece’s sovereign debt woes, it is that, ultimately, the market can and will re-price sovereign debt and reset the cost of government borrowing.


China's Selling Treasuries… Again - 2


It is important to note that we aren’t suggesting that U.S. Treasuries are following in the footsteps of Greek sovereign bonds. What is likely to happen based on historical precedent set by Japan is that Treasury yields stay low as a result of prolonged near-zero interest rates. From a central bank action perspective, there hasn’t been a threat to Japanese Government Bonds in decades and the United States has already started on that path. What matters to China, however, is converting those debentures into cash upon maturity. The U.S. Dollar Index continues to make as series of lower-highs and lower-lows from a intermediate and long term perspective, meaning that as time elapses, China is likely to receive less and less purchasing power from converting U.S. Treasury debt into actual currency. The U.S. dollar is still the dominant currency as a percentage of world currency reserves, but, as we say, everything that matters in Macro happens on the margin. In the last ten years alone, the dollar has declined over one thousand basis points as a percentage of world FX reserves, falling from 71.9% in 1999 to 61.5% in 2009, according to the IMF. The outlook for the U.S.’s economic growth and debt build-up over the next 20-30 years suggests the dollar will not likely regain any of its lost value any time soon.”


All told, China considers the risks to holding U.S. treasuries so great, that it favors Japanese Government Bonds over them of late. China bought more Japanese bonds than it sold for a sixth month in June (456.4 billion yen vs. 735.2 billion yen in May), heading for the biggest annual increase since at least 2005, according to a recent report by the Ministry of Finance in Tokyo. Even with a government debt-to-GDP ratio north of 200%, JGB’s still represent a more attractive investment for China’s FX reserves than U.S. Treasuries, which says a lot about what could be coming down the proverbial pike for the U.S. Dollar.


As Keith penned in today’s Early Look, capital chases yield either through growth or high interest rates and the intermediate-to-long-term outlook for the U.S. has neither. Perhaps that’s why foreign investors sold $13.5 billion in U.S. corporate bonds in June (the highest amount since January 2010), and another $4.1 billion in U.S. corporate stocks (the most since July 2008). All the while, Capital continues to pour into places like China, SE Asia, and Brazil. Just recently, ICBC Credit Suisse Asset Management Co. raised 14 billion yuan ($2.1 billion) to set up China’s largest bond fund. Expect this trend to play out over the long term as the world continues to diversify away from dollars within their FX reserves and as global investors chase yield away from a slow-growth U.S. economy.


Darius Dale



China's Selling Treasuries… Again - 3


BWLD is one the few restaurant companies that will have commodity pricing that will benefit margins thanks to lower year-over-year wing prices.  In spite of this, I remain concerned about the brand and where it is positioned with the consumer.  The concept continues to underperform other “younger” concepts that are of the same size and competing in a more differentiated part of the restaurant industry.


For certain “growth” restaurant companies, the Hedgeye “sustainability” trends are important metrics to measure how a company is using its cash flow.  With no funded debt and trading at 6.3x EV/EBITDA, BWLD has some attractive attributes.  As always, there is more to the story.        




The 20% EPS growth guidance for FY10 seems achievable.  The street’s $2.07 EPS estimate implies 22% growth and I am currently modeling $2.11 per share, or about 25% growth.  My estimate assumes 13% unit growth and two-year average comp trends that are fairly even with 2Q10 trends.   I am also assuming that restaurant-level margin growth will be positive in the back half of the year as favorable YOY cost of sales (driven largely by significantly lower wing prices) will be enough to offset the expected higher operating  and advertising costs.


I think it will be more difficult for the company to achieve 20% EPS growth in full-year 2011.  I am currently modeling 15% growth, and that assumes only a modest uptick in two-year average same-store sales trends and nearly 14% unit growth (management said it would provide more details about its plans for unit growth in FY11 on its 3Q10 earnings release date).  That being said, based on our restaurant sigma chart, it looks as though the company has a good chance of remaining in the “Nirvana” quadrant (positive same-store sales growth and positive restaurant-level margin growth) for the next several quarters if comp trends hold steady (but that is obviously a big if).  BWLD needs positive comp growth to offset the growth-related costs inherent in its P&L and comps trends definitely improved more than I was expecting during the second quarter.  It will be important to see if BWLD can maintain this top-line momentum.


Despite slowing top-line growth, the company’s FY10 capital spending is expected to increase 15% to 22% to $85 to $90 million.  Assuming the company again targets 13%-15% unit growth in FY11 (on top of the expected 13% increase in FY10) and an increased number of remodels, this number will likely move higher.  Based on my estimates, capex growth should outpace total sales growth by nearly 3% in 2010 and nearly 5% in 2011.  At the same time, net CFFO (after capex)/net income should move lower.  These two metrics are typically red flags that the company’s current growth strategy is not sustainable.  For now though, EBIT margins appear to be moving in the right direction.  And, during 2Q10, AWS growth outpaced same-store sales growth for the first time in three quarters, which implies improved new unit volumes; though the company’s decision to close a handful of low volume units also helped AWS during the quarter.


I consider return on incremental invested capital to be the best metric to look at when considering the sustainability of a company’s unit growth plans.  After declining in 2009, returns look to be recovering in 2010 to about 30%, which is impressive.  Based on my current estimates, I would expect returns, however, to fall off again in 2011 to a low double-digit range.  Although this still implies positive returns for 2011, I have found that the absolute direction of the trend in returns is the more important indicator of future trends.


BWLD – MIXED SIGNALS - bwld sigma


Howard Penney

Managing Director


WMT: Our Tone is Changing

WMT: Our Tone is Changing


Yeah, WMT is likely to beat tomorrow, but revenue visibility is likely to come up short. Mgmt is failing to execute on a plan to offset its self-deflationary model, and time is running out. If WMT can’t perform in a cyclical bounce, how can they do so in a double dip? Tack on overlap with Obama’s Housing Finance Conference tomorrow, and the headlines don’t look good.


In February (2/11) we wrote a post entitled “The Rut of Consistency” which outlined the reasons why Wal-Mart shares were likely to stay in a trading range.  In this post, we explained that even with a flurry of organizational changes and strategic initiatives underway for 2010, the ultimate reward to both earnings and share price was simply driven by the potential for increased customer traffic and pricing power resulting from merchandising improvements.  We believe both of these areas are unlikely to show any signs of improvement with tomorrow’s 2Q report. 


We went on to write:


As a result, in the near-term there is little to suggest that the company’s fundamentals and share price are anything more than still stuck in a narrow range.  To meaningfully break this cycle of monotony, we would have to see a few key things: 1) merchandising efforts actually work and drive a mix shift back towards discretionary goods, which in turn drives average ticket and margins higher, 2) a meaningful pick up in contribution from international at higher EBIT margins (unlikely as the non-U.S units collectively remain in growth mode) and 3) an acceleration in traffic (share) growth as a result of all of the above-mentioned efforts combined.  In theory, achieving this short list is what management needs to do to get out of the rut of consistency.  In reality, the hope of inflation as a savior and reliance on merchandising changes to drive margins higher are likely to be disappointing to those looking at 2010 as a breakout year for the largest company on the planet.


That brings us to today, exactly sixth months later and our thesis is very much unchanged.  Tomorrow Wal-Mart will report earnings that on the surface will be very close to the Street’s expectations.  Maybe a penny or two of upside, but all eyes will again be focused on the top line.  We have no special insight or “channel check” that tells us where exactly domestic comps will shake out, but our best guess tells us it’s slightly negative again.  After all, sales momentum slowed across the board for all types of retailers in Q2 and we don’t expect anything different from WMT.


Revenue gains remain a challenge based both on the law of large numbers that keep traffic under pressure and the fact that Wal-Mart’s pricing prowess continues to self-deflate the sales line.  We also believe recent management changes in the U.S offer the clearest signal that sales remain under pressure.  If it ain’t broke, why fix it? The bottom line here is that Wal-Mart is struggling to give the consumer a reason to shop its stores beyond price alone.  A scenario we see no signs of abating anytime soon and one which will again be made clear with tomorrow’s report.  So long as the consumer remains challenged to find higher wages and overall employment, Wal-Mart is unlikely to convince Americans that that they should be buying more “want” and less “need”.  As a result, tomorrow’s scripted call will likely be more about “opportunities” in merchandising,  maintaining price leadership, and importantly how the Wal-Mart customer remains challenged.  All of these items will come to light on a day that shares headlines with the Obama Administration Conference on the Future of Housing Finance and will likely rekindle a day of focus on the weak consumer. 


If anything has changed, it may be our bias that the shares will stay in a range.  We believe that while expectations are low enough and any rational investor knows it takes time to move a ship as big as Wal-Mart, patience is running out.  The efforts to improve the company’s apparel program have fallen short (again), as has a Sam’s Club revitalization.  There is little to grasp onto from the “story” side of things here, and the results themselves are just not good enough to keep investors interested indefinitely.  We believe the rut of consistency may be nearing an end and the “safety” factor that has kept so many investors waiting patiently for margin expansion driven by the topline is being pushed out into the future once again.  From a risk perspective, the size and complexity of the organization alone gives us comfort that we’ll have plenty of time to change our minds if some day the latest team of merchants finally gives the consumer a reason to spend more within Wal-Mart’s price-driven box.  For now, we’re looking elsewhere for investment opportunities both long and short where we can identify more meaningful catalysts.


- Eric Levine


WMT: Our Tone is Changing - WMT SIGMA


I know, we all have bigger fish to fry than to keep tabs on labor unrest in Bangladesh. But it is getting to a point where it could further crimp apparel margins in the supply chain’s of US retailers and brands.


Though not a whole lot of people care, Bangladesh carries the distinction as being the fourth largest source of finished apparel goods for US retailers – garnering about 7% of the market.  Furthermore, so far in 2010, Bangladesh has had the sharpest upward trajectory of any sourcing nation – arguably taking share from China, the 800lb gorilla (35% share).


But in response to rampant local cost inflation (nevermind $0.80/lb.+ cotton) workers in Bangladesh went on strike on June 23rd, demanding $75/month versus the prior rate of $23. The government’s National Wage Board stepped in and mandated $43 (a 72% increase), but that’s not been enough for the entire workforce to resume production.


Let’s assume that only a quarter of this capacity is still on hold. That still suggests that 1.5-2% of the global capacity for apparel is taken out temporarily (until the cost structure is fixed).


One could argue that China could step in and regain share. Perhaps they will. But let’s face facts…China outwardly stated that it wants to shift focus away from exports and towards more local consumption. The only way it will pick up slack capacity is if it will be at a meaningful price hike.


It’s all the same thing to us. It spells apparel inflation. The assumptions we need to make on the demand side of the ledger are tough enough. But on the cost side too?


And the Street STILL has the industry blowing through peak margins next year.


C’mon…It’s time for a reality check.



Bangla-who? - Appl Export Bangladesh 8 10



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