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European Bearish Data Roam

<revised with correct chart below>

 

Hedgeye Portfolio: Long Germany (EWG); Long British Pound (FXB); bullish on EUR-USD

 

Position: Eurozone, Germany and France Services and Manufacturing PMI numbers decline in September; UK housing loan data continues to wane; and risk heightens across the region, in particular vis-à-vis rising CDS spreads in Portugal and Ireland above the critical 400bp line (see charts below). Today’s data is in line with our call for a material downward inflection in fundamental European data across most of Europe beginning in August and continuing over the intermediate term TREND. 

 

We’re however not bearish on Europe outright. As we noted in a recent post titled “The EU’s Guiding Hand”, we’re currently bullish on Germany, with the DAX outperforming many of the equity markets of its Western European peers, and bullish on the GBP and EUR versus the USD on a relative basis, as we see substantial downside in the USD and YEN, in particular. Our bullish intermediate term TREND line for the DAX is 6089; our TREND lines for the Euro and Pound are $1.26 and $1.52, respectively.

 

Below is a short discussion of today’s charts:

 

1.  We expect Eurozone Services and Manufacturing PMI to continue to wane over the intermediate term TREND as austerity measures across the region squeeze the consumer and dampen the economic outlook out on the curve.

 

European Bearish Data Roam - h1

 

2.  The UK housing market remains a critical fundamental headwind (like in the US) that we think will continue to drag down growth prospects in the UK.  According to the British Bankers Association, loan approval for house purchase declined -7.2% M/M and fell -22.3% Y/Y.  Noteworthy is that year-over-year comps will get increasingly difficult up to a loan approval peak in Dec. ’09.

 

European Bearish Data Roam - h2

 

3.  As an important leading indicator, the risk trade in Portugal and Ireland is breaking out vis-à-vis CDS spreads, in particular.  As we noted in late ’09 and 1H10 in relation to Greece, and as history has shown in relations to the CDS spreads of Lehman Brothers and Bear Stearns, the 400bp line is a critical inflection line (Shark Line) to watch as the probably of upside risk heightens materially as you move through the line.

 

European Bearish Data Roam - h3

 

Matthew Hedrick
Analyst


INITIAL CLAIMS RISE WHILE HOUSING STARTS FORETELL NO IMPROVEMENT IN UNEMPLOYMENT

Improvement in Single Family Housing Starts Leads Improvement in Unemployment

The folks at Calculated Risk (calculatedriskblog.com) showed an interesting chart yesterday of Single Family Starts versus unemployment.  We’ve recreated this chart below.  As you can see, an improvement in single family starts typically leads an improvement in unemployment by 12-18 months.  (The 2001 recession was an exception.) Single family starts have not been improving in recent months; rather, following the expiration of the tax credit, they’ve trended sharply downward.  This suggests that we are not in for a swift improvement in unemployment from here – in fact, the downward move suggests that unemployment could increase on a reported basis (though clearly the labor force participation rate is affecting the unemployment print, as we demonstrated two weeks ago). 

 

INITIAL CLAIMS RISE WHILE HOUSING STARTS FORETELL NO IMPROVEMENT IN UNEMPLOYMENT - 2

 

Initial Claims Climb 

Initial claims rose 12k last week to 465k (rising 15k before the revision).  Rolling claims came in at 462.25k, a decline of 3.25k over the previous week. Reported claims climbed back toward the middle of the range of 450-470k that the series has occupied for all of 2010. While the rolling claims number was incrementally bullish, we are still looking for initial claims in the 375-400k range before unemployment meaningfully improves.

 

INITIAL CLAIMS RISE WHILE HOUSING STARTS FORETELL NO IMPROVEMENT IN UNEMPLOYMENT - 3

 

INITIAL CLAIMS RISE WHILE HOUSING STARTS FORETELL NO IMPROVEMENT IN UNEMPLOYMENT - 4

 

In the table below, we chart US equity correlations with Initial Claims, the Dollar Index, and US 10Y Treasury yields on a weekly basis going back 3 months, 1 year, and 3 years.

 

INITIAL CLAIMS RISE WHILE HOUSING STARTS FORETELL NO IMPROVEMENT IN UNEMPLOYMENT - 1

 

Census headwinds should abate at the end of September, as this is the last month in which Census has historically been a drag. 

 

INITIAL CLAIMS RISE WHILE HOUSING STARTS FORETELL NO IMPROVEMENT IN UNEMPLOYMENT - 5

 

Joshua Steiner, CFA

 

Allison Kaptur

 

 


CHART OF THE DAY: Real Estate Bubbles

 

 

While the United States of America in 2010 may not “precisely” be Japan of 1997, there are plenty of similarities developing in terms of Big Bureaucratic Government resolve. If you have any recovering friends from Groupthink Inc who make it past the remedial exercise above, please send them our Chart of The Day that overlays the Japanese real estate bubble with ours. *Note the duration.

 

CHART OF THE DAY: Real Estate Bubbles - Japan U.S. Real Estate normal

 

 

 

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INITIAL CLAIMS RISE WHILE HOUSING STARTS FORETELL NO IMPROVEMENT IN UNEMPLOYMENT

Improvement in Single Family Housing Starts Leads Improvement in Unemployment

The folks at Calculated Risk (calculatedriskblog.com) showed an interesting chart yesterday of Single Family Starts versus unemployment.  We’ve recreated this chart below.  As you can see, an improvement in single family starts typically leads an improvement in unemployment by 12-18 months.  (The 2001 recession was an exception.) Single family starts have not been improving in recent months; rather, following the expiration of the tax credit, they’ve trended sharply downward.  This suggests that we are not in for a swift improvement in unemployment from here – in fact, the downward move suggests that unemployment could increase on a reported basis (though clearly the labor force participation rate is affecting the unemployment print, as we demonstrated two weeks ago). 

 

INITIAL CLAIMS RISE WHILE HOUSING STARTS FORETELL NO IMPROVEMENT IN UNEMPLOYMENT - starts and unemployment

 

Initial Claims Climb 

Initial claims rose 12k last week to 465k (rising 15k before the revision).  Rolling claims came in at 462.25k, a decline of 3.25k over the previous week. Reported claims climbed back toward the middle of the range of 450-470k that the series has occupied for all of 2010. While the rolling claims number was incrementally bullish, we are still looking for initial claims in the 375-400k range before unemployment meaningfully improves.

 

 INITIAL CLAIMS RISE WHILE HOUSING STARTS FORETELL NO IMPROVEMENT IN UNEMPLOYMENT - rolling

 

INITIAL CLAIMS RISE WHILE HOUSING STARTS FORETELL NO IMPROVEMENT IN UNEMPLOYMENT - raw

 

Our firm's expectations for an ongoing economic slowdown relative to the first half of the year will keep a lid on new hiring activity as management teams focus on cost control. All of this raises the risks that a prospective slowdown in GDP will precipitate an incremental slowdown in hiring/pickup in firings, which will, in turn, further pressure growth. We continue to look to claims as the best indicator for the job market, as they are real time and inflections in the series have signaled important turning points in the market in the past.

 

Yield Curve

The following chart shows 2-10 spread by quarter while the chart below that shows the sequential change. The 2-10 spread (a proxy for NIM) has been under significant pressure in the past two quarters.  Yesterday’s closing value of 212 bps is down from 224 bps last week.

 

INITIAL CLAIMS RISE WHILE HOUSING STARTS FORETELL NO IMPROVEMENT IN UNEMPLOYMENT - spreads

 

INITIAL CLAIMS RISE WHILE HOUSING STARTS FORETELL NO IMPROVEMENT IN UNEMPLOYMENT - spreads change

 

The table below shows the stock performance of each Financial subsector over four durations. 

 

INITIAL CLAIMS RISE WHILE HOUSING STARTS FORETELL NO IMPROVEMENT IN UNEMPLOYMENT - subsector perf

 

Census headwinds should abate at the end of September, as this is the last month in which Census has historically been a drag. 

 

INITIAL CLAIMS RISE WHILE HOUSING STARTS FORETELL NO IMPROVEMENT IN UNEMPLOYMENT - census chart

 

Joshua Steiner, CFA

 

Allison Kaptur


SBUX – INFLATION FORCES STARBUCK’S HAND

Costs are too much to absorb, according to CEO Howard Schultz.

 

August 31, 2010: SBUX says it has no plans to raises prices, even though it expects higher coffee costs to weaken its profits in the upcoming fiscal year.  Management said it is able to maintain its current prices because it has long-term relationships with farmers, traders and co-ops in multiple coffee-growing regions.  Importantly, it also has bought the majority of its coffee for its upcoming fiscal year.  No change in the fiscal 2011 EPS guidance of $1.36 to $1.41, which factors in an expected $0.04 hit from higher coffee prices. 

 

September 21, 2010: At a conference in LA, CEO Howard Schultz predicted a “tough” 2011, with conditions improving the following year.  At the time I thought this was a very odd comment.  What was going to make FY2011 so tough given how strong sales are?  Or have they slowed?

 

September 22, 2010: From the SBUX press release, SBUX is raising some prices “due to the recent dramatic increases in the price of green arabica coffee, currently close to a 13-year high, as well as significant volatility in the price of other key raw ingredients, including dairy, sugar and cocoa.”

 

So what had changed between late August and now?

  • Coffee is up 1.8%
  • Milk is up 3.8%
  • Sugar is up 23.1%
  • Cocoa is up 2.4%

SBUX – INFLATION FORCES STARBUCK’S HAND - sbux eps table

 

While we think same-store sales have slowed in 4Q10 on a one-year basis, the company reiterated its comfort level with current guidance, as management affirmed its forecast for the current fiscal year.

 

SBUX – INFLATION FORCES STARBUCK’S HAND - coffee and milk

 

Going into 2011, expectations will remain high as the company’s FY11 same-store sales guidance of low-to-mid single digit growth assumes a fairly steady improvement in two-year trends.  For reference, +1% same-store sales growth in the U.S. in FY11 would imply a 350bp improvement in two-year average trends from FY10 (assuming 6.5% growth for FY10).  I think same-store sales and margin growth will continue to materialize in FY11 but the rate of growth will slow and the company’s ability to continue to surprise to the upside from both top-line and bottom-line perspectives will likely diminish. 

 

Howard Penney

Managing Director


QE Mees

“Lacking much experience with this option, we do not have very precise knowledge of the quantitative effect of changes in our holdings.”

–Ben Bernanke

 

While it’s entertaining, it’s also quite frightening to watch the same failed policy makers and the pundits that pander to them fundamentally believe that they understand exactly how this “QE” experiment is going to play out. Fortunately, Ben Bernanke is not one of those people.

 

Now that they’ve been liberated from Larry Summers assuring them that he knows exactly what he is doing, here’s a simple risk management exercise for Groupthink Inc in Washington today. Consider this part of your post Summers rehab – baby steps guys:

  1. Re-read the aforementioned quote
  2. Then count how many times you hear the media say QE today
  3. Then re-read that quote again before you go to bed tonight

Now we don’t purport to have “precise knowledge of the quantitative easing effects” on the US economy either. Einstein himself said that “if we knew what we were doing, it wouldn’t be called research, would it?” That said, our fundamental macro research does point us toward Japan’s experiment with QE as being an unsuccessful one.

 

While the United States of America in 2010 may not “precisely” be Japan of 1997, there are plenty of similarities developing in terms of Big Bureaucratic Government resolve. If you have any recovering friends from Groupthink Inc who make it past the remedial exercise above, please send them our Chart of The Day (see below) that overlays the Japanese real estate bubble with ours. *Note the duration.

 

For really advanced stage rehabilitation from the Academic Dogma that’s been driving Ben Bernanke and Larry Summers policy making decisions, you can overlay Japanese Government Bonds Yields (JGBees) with US Treasury Yields (QE Mees). While we don’t have “precise” measurements on how low the rate-of-return on America’s aging population’s hard earning savings accounts can go, we do see ZERO percent as a credible gravitational force.

 

We’ll be expanding our Japanese research effort in Q4, but if you’d like a taste of the contrarian Hedgeye cool-aid, please send an email to and we’ll get you a solid report from our Hedgeye Jedi, Darius Dale, who punched out a not yesterday titled, “Japanese Pensions: Risks to the Global Economy.”

 

Post-rehab students of objective macro-economic research have learned that the Japanese demographic curve started to age before America’s baby boomers did. Importantly, this doesn’t mean America can’t age in due course. Advanced research studies on campus here in New Haven have revealed that time, as a risk management factor, is actually quite hard to reverse.

 

All the while (alongside time), there’s this other little research critter we monitor here at Hedgeye called price. Again, this is getting into the really advanced stuff folks, so try to “dumb this down” if you attempt to explain this to anyone in Congress, but TIME and PRICE are significant factors in a modern day risk manager’s search for more “precise” knowledge about future probabilities.

 

Now let’s go to the future state - if we really want to dial up Washington’s fully loaded rehab research engine we gotta go where Heli-Ben has never gone before. As Buzz Lightyear would say, “to infinity and beyond” – the cosmic galaxy of the hedgie universe – REAL-TIME PRICES!

 

I know, I know… this is deep. But let’s suspend disbelief for a moment and take a gander into the cosmos of Hedgeye REAL-TIME PRICE research and look at what we see:

 

1.  Currencies: The US Dollar is down for the 14th week out of the last 17, breaking to lower-lows that we havn’t seen since mid-April when chaos theorists in New Haven said something about May Showers. Sounds serious, because when you Burn The Buck at the stake, it starts to become a very bad thing - importing crazy critters that Bernanke has never seen (like inflation, shhh…).

 

2.  Bond Yields: US Treasury yields are getting pulverized again this morning on the short end of the curve, with 2-year yields in America hitting their lowest levels ever. Ever, of course, is a long time… and while we can’t tell you “precisely” how poorly this ends for a lot of people in this country, we can assure you this ended poorly in Japan.

 

3.  Equities: US stocks have backed off of the line I said I was going to walk this week (1144 in the SP500), leaving our intermediate term TREND line of resistance intact. Whether or not the perma-bulls want to admit that lower-highs in everything US equities since 2007’s leverage-cycle-peak matter or not is something that Nikkei bulls in Japan have been powdered by since Gordon Gekko’s last 1980’s dance.

 

QE ain’t for me.

 

My immediate term TRADE lines of support and resistance for the SP500 are now 1127 and 1146, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

QE Mees - Japan U.S. Real Estate


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