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Eye On Asia: The Good, the Bad, and the Ugly

Conclusion: The bevy of economic data out of Asia over the last 48 hours is both supportive of the bullish rally in many Asian equity markets and the relative underperformance of Japanese equities. What remains to be seen, however, is where do Asian equities go from here?

 

Position: Short Japanese Equities (EWJ); Short Japanese yen (FXY)

 

There has been a slew of economic data coming out of Asia over the last 48 hours – some good, some bad, and some ugly. Rather than belabor the point(s) with excessive prose, we’ll just highlight the meaningful deltas and inflection points in the call-outs and charts below.

 

The Good 

  • China PMI accelerated in September to 53.8 from 51.7 in August. Indexes of output, New Orders, and Export Orders all climbed MoM as well.
  • Japan Tankan Survey of Business Conditions improved in September. Large Manufacturer sentiment rose sequentially in 3Q10 to 8 from 1 in 2Q10 and Large Non-Manufacturer sentiment improved QoQ to 2 from (-5) in 2Q10. Sentiment hasn’t been this high since 1Q08 and 2Q08, respectively.
  • Japan Unemployment ticked down 10bps in August to 5.1%.
  • Japan PCE accelerated in August to +1.7% YoY from +1.1% YoY in July.
  • Japan Retail Sales accelerated in August to +4.3% YoY from +3.9% YoY in July.
  • Korean Industrial Production accelerated in August to +17.1% YoY from +15.5% YoY in July.
  • India Exports accelerated in August to +22.5% YoY from +13.2% YoY in July.
  • Thailand CPI decelerated in September to +3% YoY from +3.3% YoY in August.
  • Thailand Exports accelerated in August to +23.6% YoY from +21.2% YoY in July.
  • Indonesia CPI pulled back in September to +5.8% YoY from +6.4% YoY in August.
  • Taiwan raised its benchmark policy rate to 1.5% from the prior 1.375%. 

Eye On Asia: The Good, the Bad, and the Ugly - 1

 

The Bad 

  • China stepped up efforts to cool its property market. The latest batch of measures include a ban on extending loans to buyers of third homes, extending a 30% down payment requirement to all first-home buyers, and a withdrawal of an income tax exemption on profits from the sale of real estate reinvested within one year. China may elect to announce property taxes to residential properties should they feel the latest round of tightening is not effective.
  • Japanese consumption head fake? The sequential uptick in August retail sales was supported by last-minute demand for cars ahead of the expiration of a government incentive program, as well as purchases of air conditioners during the nation’s hottest summer in over a century. In a sign that these tailwinds are wearing off, Japan Registered Auto Sales rolled over in September to (-4.1%) YoY from +46.7% YoY in August. Further, Large Retailer Sales ticked down in August to (-1.9%) YoY from (-1.2%) YoY in July. The strength in the Japanese unemployment release is also to be taken with a grain of salt, as over 90,000 Japanese citizens dropped out of the labor force in August due to their inability to find jobs.
  • Japan CPI came in flat for September, staying at (-0.9%) YoY. Deflation continues. 

Eye On Asia: The Good, the Bad, and the Ugly - 2

 

The Ugly 

  • Japan’s strong yen woes continue: Nintendo, the world’s largest maker of video-game consoles, recently cut its profit forecast by 55%; Murata Manufacturing Co., the maker of a third of the world’s ceramic capacitors (devices used in flat-panel TVs and smart phones) has planned to lay off 3,000 of its 4,500 contract employees and to move production abroad with the goal of 30% overseas production by 2012. Further, the 3Q Tankan Survey release showed a sharp divergence between the Large Manufacturer 4Q10 sentiment forecast and the 3Q print: (-1) in 4QE vs. +8 in 3QA. Automakers in particular expect an even larger decline in 4Q to (-6) from the current +32  - the widest delta in forward expectations since the Bank of Japan started tracking confidence back in 1992!
  • Japan Industrial Production fell in August to +13.7% YoY from +15.8% YoY in July. On a MoM basis, production fell (-0.3%) from July, which surprised consensus expectations of a +1.1% gain. According to the Survey of Production Forecast in Manufacturing, Industrial Production is expected to decline (-0.1%) and (-2.9%) MoM in September and October, respectively. Shipments deteriorated further in August, falling (-0.5%) MoM vs. the (-0.1%) decline in July.
  • Japan PMI (Nomura) declined in September to 49.5 from 50.1 in August.
  • China’s PMI Input Price Index rose in September to 65.3 from 60.5 in August as raw material costs climbed (think: dollar down; commodities up).
  • South Korea CPI quickened in September to the highest pace in 17 months: +3.6% YoY vs. +2.6% YoY in August. Consumer prices rose +1.1% MoM from August, the biggest monthly gain since March 2003! Food and agricultural prices grew 21.1% YoY (think: dollar down; commodities up)
  • South Korea Manufacturer Confidence fell in October to 99 from 104 in September. This is the lowest level in eight months and reflects growing concerns over the confluence of the strong won and a slowdown in W. European and U.S. consumer demand for South Korean goods. Further augmenting this point, Non-Manufacturing Confidence actually increased in October to 86 from 85 in September.
  • South Korea Exports decelerated in September to +17.2% YoY from +29.6% YoY in August. 

Eye On Asia: The Good, the Bad, and the Ugly - 3

 

The Murky

 

The economic and company data above is both supportive of the bullish rally in many Asian equity markets, as well as the relative underperformance in Japanese equities. What remains to be seen, however, is where we go from here? With U.S. consumer demand prepared to tank in 4Q10 and 1Q11, Western European consumer demand potentially following suit, and the prospect for further strengthening in Asian currencies (Asia Dollar Index at a two-year high), do Asian equities continue to go straight up given the likelihood of sequentially deteriorating economic data over the next 3-6 months?

 

Consider the following stats: 

  • Exports account for roughly 40-45% of Asia’s GDP;
  • The U.S. and the E.U. combine for roughly a third of Asia’s export destinations;
  • 40-50% of intra-regional trade within Asia is basic and intermediate goods meant for re-export outside of the region. 

Given Asia’s leverage to a weakening U.S. and European consumer, we must ask ourselves whether Asian equities could correct meaningfully in the next 3-6 months based on the confluence of declining trade and equity market mean reversion. While we are not yet ready to make a call in either direction, we’d be remiss not to call out the downside risks.

 

Eye On Asia: The Good, the Bad, and the Ugly - 4

 

Lastly, as we see from the aforementioned China and S. Korea inflation data, Mr. Bernanke’s quantitative easing experiment continues to export commodity price inflation to the rest of the world, as dollar debasement results in appreciation of assets priced in dollars. No reason to make it any more complicated than that.

 

As always, time, data and more prices will guide our decision-making from here.

 

Have a great weekend,

 

Darius Dale

Analyst

 

Eye On Asia: The Good, the Bad, and the Ugly - 5


EARLY LOOK: The New Storytelling

 

“Prosperity and overconsumption was driven by asset inflation that in turn was leverage and interest rate correlated.”

-William H. Gross

 

From my inbox, I’ve been a long time student of Bill Gross. He is one of the most influential teachers on the buy-side. He’s a great communicator. He’s somewhat transparent about his positioning. And he’s certainly accountable to his investors’ returns.

 

He’s also got the US Federal Reserve in his back pocket.

 

I’m highlighting the aforementioned quote from Gross’ Investment Outlook missive for October titled “Stan Druckenmiller is Leaving”. It’s one of those macro sentences that you need to read slowly. Then you need to read it again. It’s solid, but it needs a little love. Subtract the qualitative word PROSPERITY and add the words DOLLAR DEVALUATION. Then you’ll see Hedgeye’s New Reality intersect PIMCO’s New Normal.

 

“Overconsumption was driven by asset inflation that in turn was leverage, interest rate, and Dollar devaluation correlated.”

 

Not that I keep track, but we introduced The New Reality before Gross went with The New Normal. The New Reality abides by the principles of chaos theory. The New Reality is that normal is grounded in uncertainty. The New Storytelling of global markets will be shaped by the math that backs it.

 

So let’s dig into some math…

 

As of last night’s Q310 closing prices, here are the top 10 inverse correlations (using our immediate term TRADE duration) versus the US Dollar Index:

  1. America’s SP500 = -0.89
  2. India’s SENSEX = -0.91
  3. Brazil’s Bovespa = -0.92
  4. Reuters CBR Commodities Index = -0.96
  5. Gold = -0.96
  6. Copper = -0.89
  7. Silver = -0.97
  8. Cotton = -0.91
  9. Sugar = -0.94
  10. Rice = -0.92

The first thing you should say about anything in the area code of a 0.90 correlation is wow. The second thing you should say to the government that perpetuates this debauchery of your currency is shame on you.

 

As for Mr. Gross, I’m not quite sure what to say. After all, he does run the world’s largest bond fund – and that fund proved to not do so well during the DOLLAR DEVALUATION days of 2008.

 

 

EARLY LOOK: The New Storytelling - gross

 

 

That’s not a shot at Bill Gross. That’s reality. If you debauch the currency of a nation, you will ultimately get inflation. Sequentially rising inflation is bad for bonds. When oil hit $150/barrel and copper was at $4/lbs, neither Greenspan nor Bernanke saw inflation, but PIMCO’s investors did. Overlay PIMCO’s Total Return Fund with Treasury Inflation Protected securities (TIPs) for the first 9 months of 2008 and you’ll get the picture.

 

The New Reality is that Bill Gross gets paid to talk about the New Normal, not QE’s impact on the US Dollar. On our immediate term risk management duration, the US Dollar has an inverse correlation versus the PIMCO Total Return Fund of … drum roll for the storytellers in the Haven… -0.91!

 

What we’ve learned in the last few years is that DOLLAR DOWN = REFLATION until these inverse correlations get too high and REFLATION becomes INFLATION. Sure, there’s deflation in US Housing – but there’s been longstanding deflation in the price of tulips and Japanese real estate too.

 

The US Dollar is getting annihilated (down 15 of the last 18 weeks and down -11% since June). Those getting paid by this may not care, but the other 95% of people who live in this country do. How else could the US stock market have its best September since 1939 and US consumer confidence drop?

 

I bought back my inflation protection in both the Hedgeye Portfolio and Hedgeye Asset Allocation Model yesterday (TIP). My immediate term support and resistance levels for the SP500 are now 1140 and 1155, respectively.

 

Correlations in markets are never perpetual, but The New Storytelling of Wall Street is.

 

Best of luck out there today and enjoy your weekend,

KM

 

Keith R. McCullough
Chief Executive Officer

 

 

This note was originally published at 8am this morning, October 01, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.


DKS: C-Level Shifts

The announcement of Dick’s Chief Marketing Officer Jeff Hennion’s departure in conjunction with other moves at C-level and board positions over the last 12-months caught our attention today. Upon further digging through various moves in the company’s senior ranks over the last year, the bottom-line is that there’s been a noteworthy level of turnover.  In fact, 50% of C-level management (3 of 6 positions) and 20% of the company’s Board of Directors have vacated their posts in the past year. When looked at in aggregate, the sheer volume of leadership change is certainly noteworthy.

 

We’d be remiss not to recall the fact that Gwen Manto (previously Dick’s Chief Merchandising Officer) left to join Sports Authority. Is it possible Mr. Hennion has also embarked on the same path? The thought certainly crossed our mind – though just to be clear, we don’t have intimate knowledge of the situation. In November 2009, TSA beefed up its team with the hiring of Jeff Schumacher as the Chief Marketing & Strategic Officer out of McKinsey & Co. While it may just be a simple case of timing, the chronology of executive moves at the two sporting goods giants suggests a shift in talent is underway. With Sports Authority’s intentions of bringing the company public in the near-term, we wonder just how many former DKS executives will be rubbing elbows at the road show.

 

DKS: C-Level Shifts - DKS MgmtChgs 10 1 10

 

DKS: C-Level Shifts - DKS MgmtChgs Table 10 1 10

 

Casey Flavin

Director

 


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BWLD: SHORT TERM LOOKS GOOD BUT LONG TERM ISSUES MAKE IT A TRADE

Conclusion: The Street is mixed on BWLD, but the consensus EPS expectations seem low.  I am currently modeling FY10 EPS of $2.14 versus the street at $2.08 with more of the upside falling in 4Q10.

 

I estimate EPS for 3Q10E and 4Q10E of $0.45 (versus the Street at $0.43) and $0.60 (versus the street at $0.56) respectively.  The primary risk to my 4Q estimate is the ability of the industry to maintain the current trend of posting improved comparable-store sales results on a two-year average basis.

 

Reasons for upside:

 

Company comparable-store sales were up 2.2% in July versus +1.2% in the year-ago period, which implies a 30 bp improvement in two-year average trends since the end of 2Q10 (and trends came in much better-than-expected during 2Q10 after turning positive in June from -3.7% in April).

 

While this data point for July is encouraging, it obviously does not make a quarter.  Industry trends, on average, have improved on a one and two-year basis since early in the summer.  Comparisons become easier for BWLD for the remainder of the quarter as 3Q09 comparable-store sales came in at +0.8% (after being up 1.2% in the first four weeks of the quarter). 

 

I am modeling +3.0% company SSS for 3Q10, which implies a nearly 60 bp acceleration in 2-year average trends from the prior quarter.

 

The consensus says: The chart below shows the current sentiment surrounding the stock.  Positive ratings (“BUY” and “OUTPERFORM”) are at 55.6%, down from the peak of 63.2% in March, and up from the low of 44.4% in May.

 

BWLD: SHORT TERM LOOKS GOOD BUT LONG TERM ISSUES MAKE IT A TRADE - bwld ratings

 

COGS: Chicken wing prices were down nearly 11% in 2Q10.  Based on two-month number given for 3Q10 of $1.41/lb, wing costs will be down closer to 16% in 3Q10 versus the $1.67/lb cost in 3Q09.  The year-over-year benefit should be even greater in 4Q10 as the company is lapping its highest price paid in 4Q09 of $1.78/lb.  This, combined with same-store sales trends that should improve on a 2-year average basis, should drive the bulk of the year-over-year restaurant-level margin growth in 2H10.

 

Labor: Management guided to slight year-over-year leverage in 3Q10.

 

Offsets: Restaurant operating expenses are moving higher in 2H10 due to additional pay-per-view TV programming costs and an expected 11% increase in media spending in 3Q and 4Q.

 

Preopening expenses will be higher year-over-year as the company is expected to open 13 units in 3Q10 versus 5 in 3Q09 and 14 units in 4Q10 versus 12 in 4Q09.

 

3Q10 EPS Growth:

Although management guided to 20% EPS growth for the full year, they said on the last earnings call that it may not achieve that target in each quarter of the year and they mentioned the expected higher level of preopening expense in 3Q10. 

 

This, along with the fact that the company is lapping its highest quarter of YOY growth from FY09, leads me to think that the company will post its lowest year-over-year growth in 3Q10.  My 3Q10 EPS estimate assumes nearly 20% EPS growth after 23% and 31% growth in 1Q and 2Q, respectively.

 

I think the 49% reported EPS growth in 3Q09 relative to the 24% full-year growth was partly a function of comparisons.  The company’s 3Q08 EPS grew only 6% versus 24% for FY08 overall.

 

SSS actually slowed sharply in 3Q09 on a one-year and two-year basis and chicken wing prices were up 43% during the quarter.

 

Preopening expenses, however, were much lower YOY in 3Q09 and drove a bulk of the EPS growth as the company only opened 5 units in 3Q09 relative to 18 in 3Q08.  If you make 3Q09 preopening expense equal to the 3Q08 level, EPS would have only been up closer to 20%.

 

BWLD: SHORT TERM LOOKS GOOD BUT LONG TERM ISSUES MAKE IT A TRADE - bwld sigma

 

Summary:

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 (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.

 

Longer-term thesis:

I continue to think the company is growing too fast.  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 think it will be harder for the company to achieve 20% EPS growth in FY11), 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 and, ultimately, stock performance.

 

Howard Penney

Managing Director


FRIDAY MACRO MIXER - INCOME, ISM & SENTIMENT

Conclusion: We continue to see weakness in the consumption trends when government spending is stripped away.  Slower growth is likely going forward.

 

Commerce Department figures released today show that consumer spending rose in August while ISM and consumer confidence data have flashed to the downside in recent releases.  See our conclusions below and a chart of ISM component shifts in the most recent months.

 

INCOME - Consumer spending in the U.S. rose 0.4% in August; the gain exceeded the 0.3% increase projected the Bloomberg consensus.   Incomes were up 0.5%, the biggest advance this year (propelled by the incorrigible hand of Washington).  Transfer payments jumped 1.6%, indicating that the government’s crutch is still a core factor in this “recovery”. 

 

Hedgeye conclusion: there will be a rocky road transitioning from the government supporting consumer spending to the “real” economy.

 

 

ISM - The ISM print was better that feared, still growing in September, but at the slowest pace in 10 months.  The I SM factory index dropped to 54.4 from 56.3 in August.  Bloomberg consensus forecast a decline to 54.5.

 

Hedgeye conclusion: A sequentially lower ISM print in October is likely.

 

 

CONFIDENCE - The University of Michigan final index of consumer sentiment fell to 68.2 from 68.9 in August, but up significantly from the preliminary reading of 66.6 issued last month. 

 

Hedgeye conclusion: Maybe there was a fat finger in Michigan!  The bottom line is that confidence is not improving, but people are spending more thanks to gifts from Washington. 

 

Howard Penney

Managing Director

 

FRIDAY MACRO MIXER - INCOME, ISM & SENTIMENT - ISM COMPONENTS



CHART OF THE DAY: Deflation?

 

POSITION  

Long Treasury Inflation Protection (TIP)

Short US Dollar (UUP)

 

 

CHART OF THE DAY: Deflation? - chart1

 

 

Assuming that the man saw this morning’s inflationary spike in the PRICES PAID component of the ISM survey (70.5 SEP vs. 61.5 AUG), we’re quite sure about what Ben Bernanke is doing right now – hoping you don’t see what markets do.
 
As we like to say at Hedgeye, hope is not an investment process.

Look at the two red arrows in this chart:
 
1.      SEPTEMBER 2007

2.      SEPTEMBER 2010

Heli-Ben didn’t recognize the inflection point in 2007, so we don’t expect him to publically consider the risk management questions now… but what if this debauchery of the US Dollar continues to put upward price pressure on everything priced in dollars?
 
Don’t forget that the question mark in this chart is the risk – and the risk remains NOT that inflation is born out of currency debasement, but that the mother-load of all inflations (the dotted red line) is actually in play.
 
We’re quite certain that consensus expects “deflation”, because that’s what the Fed needs to see. What you need isn’t always what you get. Ask 1970’s Fed Head, Arthur Burns, about that.


KM


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