We think current RevPAR dollar levels are unsustainable. While YoY growth rates may stay strong that won’t tell the whole story.
RevPAR is at an unsustainable dollar level, in our opinion. Lodging should be in recovery mode given the depth of the recession last year. However, the macro variables do not support a continuation of these current high levels. So why is RevPAR so strong?
We believe in the pent up theory of recent lodging demand, for lack of a better phrase. Essentially, business transient travel was restricted for a long enough period that business suffered and people had to play catch up. Pent up demand was apparent in April through July. August will look stronger but in absolute dollar terms, seasonally adjusted, will mark a slowdown unless growth exceeds 13%. See our 08/10/10 post, “DOLLAR REVPAR MORE RELEVANT THAN %” to see why.
The recovery bulls are quick to point out the strong and lasting RevPAR growth during the last recovery. Indeed, from Q1 2004 to Q4 2007, quarterly RevPAR ranged from 5-11% and an average of 8%. Good stuff. Even the current high valuations would grow into those numbers. The problem is that the macro environment isn’t supportive this time. During that nearly 4 year mega recovery, quarterly nominal GDP growth YoY was 5-7% and averaged 6%. Q2 2010 YoY nominal GDP growth was only 4.0%. Looking ahead, 2H consensus expectations is for 3.3% GDP growth and only 2.8% for 2011. Hedgeye is projecting even less, 1.7% next year and our Macro team has been much better than consensus.
What else is missing this time versus last time? Housing for one. The peak of the housing bubble helped propel GDP and lodging demand. Unemployment – which we’ve proved was a more important driver of lodging demand over the last few years – does not look like it is coming down anytime soon, certainly not to the 5% average from 2004-2007.
Evidence of Pent Up Demand
Here are some charts to back up those assertions:
So if we are right about pent up demand when will it show up in the numbers? Certainly not August. The sell side cheerleaders will no doubt roll out the pompoms and dance moves to celebrate “accelerating growth”. In terms of estimates, 2H guidance and consensus look reasonable. However, whisper expectations are significantly higher. Moreover, 2011 RevPAR estimates actually look aggressive. Street consensus is 6.0-6.5%. Assuming April-July represented a period of pent up demand and the inevitable RevPAR correlation to the typical macro drivers returns, 2.5-4.0% might be the better range. Given the valuations, we don’t want to be around when numbers start coming down.
Conclusion: We like countries that have proactively prepared themselves to grow organically in light of a slowdown in global trade. China is one of those economies.
Position: Long the Chinese yuan via the etf CYB. Short the U.S. dollar via the etf UUP. Short 1-3 year U.S. Treasuries via the etf SHY.
As we pointed out a few months back, China’s organic growth story will matter more to investors when consensus finally comprehends the downside risk associated with the U.S.’s 12-18 month forward economic outlook – which we are starting to see signs of, but not nearly in the area code of bearish enough. As easy money brought on by REFLATION, accelerating trade, and industrial production slows globally, organic growth stories will move to the forefront of investment opportunities. Those economies that have proactively prepared themselves to grow organically will see their equity markets and currencies strengthen in 2H10 and 2011, and beyond. China (along with Singapore, Indonesia, Thailand, and Brazil) is one of our favorite economies in which to play this theme.
For the 12th consecutive month in July, Foreign Direct Investment (FDI) in China increased on a Y/Y basis. Though down sequentially from June’s near peak inflows, the upward trend continues – on a YTD basis, FDI accelerated in the seven months through July, up 20.7% vs. +19.6% from January through June. China, the world’s second largest recipient of foreign investment behind the U.S. ($95 billion vs. $130 billion in 2009), continues to take share amid the current global search for yield. What is important here is not just the nominal uptrend, but rather the tonal shift from investors. For years, foreign companies poured capital into China to take advantage of cheap labor to sell cheap products to American and Western European consumers. Now with both of those markets poised to slow for the foreseeable future, investor attention has turned towards China as a place where yield-seeking can and likely will be met with ample growth opportunities. Globally, companies ranging from Volkswagen AG to Tesco to Merck & Co. are increasing investments in China to take advantage of a growing Chinese consumer base.
This year, China has increased minimum wages in as many as 21 provinces and municipalities as part of a longer term trend to wean the country off of exports and real estate investment as the main drivers of growth. To be clear, however, the path towards rebalancing China’s GDP composition towards a more sustainable model is a long road that will not be trekked as quickly as things will unravel in the U.S. and W. Europe – there will be bumps along the way as a result of slowing consumer demand from those markets. With that said, however, China has made some serious headway and those gains are set to accelerate given the administration’s resolve to make its economy more defensive.
Currently, roughly 40% of China’s labor market is agricultural, which implies 40% of workers are living on subsistence incomes that do not support a meaningful increase in consumption in the near term. Moreover, the fall in agricultural employment has been modest according to the OECD, with a trend decline of less than 1.5% per year. This suggests it would take another decade at the current pace for China’s share of agricultural labor to fall to 25% – the level at which Japan’s wages of those that move from rural to urban settings began to rise substantially (OECD). As we say at Hedgeye, however, everything in macro happens on the margin. And, on the margin, the Chinese consumer’s purchasing power is growing. Moreover, further marginal shifts in China’s employment composition will continue to supply upward pressure on the price of agricultural commodities (corn, sugar, soybeans, etc.), as China produces less produce for itself.
As previously noted, the improvement is not likely to come without a bump in the road here and there. Looking back over the last 4-5 years, we’ve seen that employment growth has been largest in the coastal regions – where factories and exporters dominate the labor market. That region is also home to the greatest percentage of migrant workers, as the restrictive hukou rules are less enforced there vs. larger cities like Shanghai and Beijing. As expected, a negative shift in the external demand curve greatly disadvantages this region over any other, as evidenced in the relatively large slowdown in employment from 3Q08 to 1Q09 (see chart below). To combat future slow-downs in external demand and the negative implications that would have on migrant workers, the government is expanding its program in which unemployed migrant workers, college graduates, and laid-off workers receive subsidies to undergo vocational training. Net-net, although a slowdown in the U.S. and Western Europe economies is negative for Chinese employment in the intermediate term, China is taking steps to reduce this risk over the longer term.
What would likely allow China to expedite this risk management and beef up its consumer base more quickly is any incremental increase in policy shifts towards urbanization, which is limited by the restrictive hukou system. Further loosening of these rules will allow China to urbanize even quicker than the rapid pace at which it is currently. From 2000-2008, China’s urbanization increased to 46% from 32%. Contrast that with a similar increase in the U.S., which happended over a 25-year period from 1 (OECD). The 60% mark was not eclipsed in the U.S. for another 35 years, whereas in China, that level could be reached in less than a decade at the current rate. All told, policies directed at improving urbanization in conjunction with changing the employment composition towards a more urban profile will allow wages in China to accelerate meaningfully over the long term. We will continue to monitor the Chinese government’s sentiment towards these policies as indicators of acceleration in the growth of the Chinese consumer.
Interestingly, policy shifts bring me to our next topic – investment recommendations. In conjunction with today’s release of China’s foreign direct investment data, the People’s Bank of China announced that it will let overseas financial institutions invest their yuan holdings in the Chinese interbank market bond market. The pilot program will start with foreign central banks, clearing banks for cross-border settlement in Hong Kong and Macau, and other international lenders involved in trade settlement. By implementing this program, China sets out to accomplish two things: 1) to accelerate capital flows from abroad by opening up its domestic securities market and 2) to make its currency more attractive to foreign central banks by broadening its use globally. Traditionally, trade has been the main way for foreign holders of yuan to return money to China. By opening up its $2.1 trillion interbank market, China is now creating new avenues for foreign investors to invest in China.
Make no mistake, in ten years we’ll likely look back at today’s policy announcement as one major catalyst for the yuan gaining major share as a percentage of global FX reserves. Furthermore, we continue to have conviction that the yuan’s gain will be at the U.S. dollar’s expense and we have expressed this conviction in our Virtual Portfolio via long CYB and short UUP. Acknowledging the deep simplicity that is the chaos theory model by which we research, it’s really not a shock that this policy announcement came just one day after the world learns that China reduced its FX exposure to dollar denominated U.S. Treasuries by the most ever.
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Today we re-shorted the Consumer Discretionary (XLY) that we covered last week. Our outlook for US consumer spending and housing continues to be bearish for the intermediate term TREND.
Today the Census Bureau reported very soft July 2010 numbers for housing starts and permits. If it were not for a large downward revision to June’s number, the small monthly gain in July would have been a decline. Furthermore, the actual July number was below the 2Q10 level, suggesting slowing GDP growth in 3Q10. The expectation of a slowing GDP number is also consistent with the retail sales data released last week.
Importantly, this suggests weaker new home sales when the data is released next Wednesday.
With consumer credit continuing to contract and confidence readings trending lower, the downward sequential movement in GDP growth matches up with what the data is indicating. We estimate that personal consumption growth will slow to less than 1% in 4Q10 and that discretionary spending growth will slow to a rate close to what we experienced in 1Q09.
The market is currently bulled up over the improvement in industrial production and the weak dollar reigniting the “reflation” trade. The better-than-expected gain in industrial production came from the seasonally-adjusted auto industry, which increased 10% for the month. This seasonally-adjusted “production of motor vehicles and parts” is a “guesstimate” and is at the discretion of the FED. Not to say they are making up the numbers, but they are making up the numbers. Bernanke needed an upside surprise and he got one!
If you are looking for individual shorts (or longs) within consumer discretionary, the subsectors within the Consumer Discretionary that are the consensus longs (street is too bullish) are Internet and Catalog Retail, Hotels, Restaurant and Leisure and Diversified Consumer services.
Today has been another low-volume price rally that has not overcome any lines that matter in our macro model. Interestingly, the SP500 has been flat or down in 11 of the last 15 days, and we’ve seen this movie of a one-off price UP, volume DOWN day before.
On August 2nd, the SP500 gapped up like this and closed up +2.2% on the day on a very bearish volume study (volume didn’t confirm price). After that, the SP500 toyed with my short selling fears, but ultimately dropped 54 points (-5.2%) from that uninspiring early August Monday to its Friday the 13th of August closing low.
This is a market that pays players who take a macro view and stick with it in order to productively trade either their gross or net exposure. For me, that view remains decidedly bearish. I shorted the SPY at my immediate term TRADE line of resistance this afternoon (1099) as I see no immediate term downside support to 1063 (see chart).
If you are legitimately bearish here, you have to be able to short them when they are green.
Keith R. McCullough
Chief Executive Officer
This note was originally published at 8am this morning. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK in real-time, published by 8am every trading day.
“The US is not a superpower. The US is a financially dependent country that foreign lenders can close down at will. Washington still hasn’t learned this. American hubris can lead the administration and Congress into a bailout solution that the rest of the world, which has to finance it, might not accept.”
-Paul Craig Roberts
I read this quote just a few minutes ago from a respected American who has served his country well. As an American, it’s painful and embarrassing at the same time to get up each morning and read sentiments like this. It makes me want to move to Canada (kidding).
Valéry Giscard d’Estaing, a French Minister of Finance in the 1960’s referred to the benefits the United States had in the US Dollar being the international reserve currency as an “exorbitant privilege”.
Yesterday the S&P 500 closed flat on the day on anemic volume; it feels like everyone is on summer vacation. We learned yesterday that the Chinese are selling their holding of US Treasuries in favor of Europe and Japan. We are financially dependent on foreign lenders and our biggest creditor is saying “no mas” - on this news the S&P 500 traded flat on the day.
The dollar sent the right message yesterday, declining 0.50% and it is headed lower. The actions of the Chinese are telling the rest of the world to flee dollar-denominated paper assets. This is a problem for the dollar as the Federal Reserve appears to be a lender of last resort for the U.S. Treasury. While the selling of foreign-held dollar-denominated debt has been orderly so far, the inflow of foreign-held dollars into the U.S. will debase the dollar and lead to higher inflation. Despite what the FED sees (it’s focused on the “core” figure), the signs of inflation abound in the economy.
(1) Gold traded higher yesterday (looking to gain for a fourth day in a row) and has rallied 3.1% in the past month.
(2) Copper traded up 0.8% yesterday and is up 13.3% over the past month.
(3) Last Friday, the US CPI number crept higher and will again in August.
(4) Today’s UK inflation reading is above the BOE target rate
(5) The US PPI number will also post an upside surprise
Since the US does not have the balance sheet to execute on any creditable plan and the world has little faith in our political leaders, it’s hard to see a way out. The “Fiat Fools” in Washington have already done everything in their power to spend or to create whatever money was needed to prevent systemic collapse in 2008.
Yet, today we seem to find ourselves in a precarious position. While the situation is not overly similar to 2008 (yet); Lehman Brothers’ collapse is one important difference that shocked markets. Many facets of the economy are on a knife edge: housing is once more coming to the center of people’s attention as a concern and unemployment remains at elevated levels.
Should inflation meaningfully take hold, it would be a death knell for the margin story embedded in the current estimates for the S&P 500. The only action that will expeditiously calm the markets is more spending or creating of U.S. cash (which creates inflation). Daryl Jones has written extensively on this; our economy is addicted to foreign financing just as acutely as it is addicted to foreign oil.
The futures are rallying today on the back of China rising for the third day (up 0.4%) on signs that the Chinese economy is maintaining some momentum in June. But this is not the case in the US. The surging trade deficit and anemic retail sales (plus the Fed’s own admission) suggest that 2Q GDP will be revised downward and that 2H10 GDP will be even slower.
With consumer credit continuing to contract and confidence readings trending downward, downward sequential movement in GDP growth rhymes with what the data is indicating. We estimate that personal consumption growth will slow to less than 1% in 4Q10 and discretionary spending growth will slow to a rate close to what we experienced in 1Q09.
The unease with which Valéry Giscard d’Estaing viewed a US Dollar denominated world reserve currency is not a relic of the 1960’s. In 2009, Luo Ping, director general at China’s Banking Regulatory Commission, said in New York, “Once you start issuing $1 trillion-$2 trillion…we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do”. Yesterday, we saw this sentiment manifest itself in action. Keith highlighted Ping’s comment in real-time back in early 2009, and the selling of U.S. Treasuries by the Chinese is indicating that the turn in 10 year US Treasury yields is coming.
Function in disaster; finish in style