Europe’s Inflections

Hedgeye Portfolio: Short Euro via FXE; Long Germany (EWG)


German Bulls


The ZEW survey of German investor confidence came in well above expectations today, however despite the positive print capital markets across Europe are slumped over the fate of Ireland. As an important inflection, ZEW’s 6 month forward-looking economic sentiment gauge rose for the first time in the last seven months to 13.8 in November versus a forecast of -6 and an October reading of -7.2; the current situation gauge rolled higher to 81.5 versus 72.6 in October. See yesterday’s note titled “Ireland’s River Card” for our take on Ireland and the heightening risk trade in Europe.


We continue to like Germany (EWG) from a fundamental standpoint. Germany’s fiscal conservatism continues to be a bullish catalyst and a clear positive divergence over the bloated PIIGS (Sovereign Debt Dichotomy). Export orders, especially from Asia, continue to flash bullish, and a weakening EUR versus the USD should further propel export demand on the margin.


Europe’s Inflections - m1



UK’s Inflation Juice


As we’ve highlighted in our UK posts this year, the island nation continues to suffer from inflation above its target rate of 2%.  Inflation measured by the CPI rose 10bps to 3.2% in October year-over-year versus October. The chart below shows the divergence between average Eurozone CPI. As CPI continues to trend higher in the UK, and comments from the BoE suggest a rise could be seen well into 2011, the Bank will be challenged (should it be necessary) to issue further quantitative easing for fear of boosting inflation. And should economic growth slow in the UK over the coming quarters, which we’re suggesting due to the country’s austerity programs, the country could be in a real political quarrel on go-forward economic policy.


Europe’s Inflections - m2



Das Auto


Finally, as a measure of economic health, European new car registrations (across 25 states) declined 16% in October Y/Y for the 7th straight month. Our take is that as austerity measures squeeze the consumer over the next years, we wouldn’t expect to see domestic car purchases improve materially over the intermediate to longer term. It’s worth noting the difficult compares in the chart below, in particular due to the success of the cash-for-clunkers rebate program in 2009. Bullish prospects remain for European auto manufacturers as order flow continues from the client, China, and greater Asia.


Europe’s Inflections - m3


Matthew Hedrick



TODAY’S S&P 500 SET-UP - November 16, 2010

As we look at today’s set up for the S&P 500, the range is 22 points or -0.65% downside to 1190 and 119.% upside to 1212.  Equity futures are trading below fair value as investors become increasingly skeptical about QE2's ability to address the major issues facing the US economy as evidenced by the rise in the yield curve towards the end of yesterday's session. Heavy falls in China have also hit sentiment which has seeped into European markets. Today sees several macro releases including PPI, Industrial Production, Capacity Utilization, and NAHB Housing Market Index.

  • Abraxas Petroleum (AXAS) reported 3Q adj. EPS 2c loss vs. est. 2c profit
  • Aeropostale (ARO) boosted share-repurchase program by $300m, bringing total to $1.15b
  • Bank of New York Mellon (BK): Berkshire Hathaway disclosed stake of 1.99m shrs as of Sept. 30
  • Nordstrom (JWN) sees fiscal 2010 EPS $2.60-$2.65-shr, had seen $2.50-$2.65 Aug 12, vs est. $2.65
  • RightNow Technologies (RNOW) plans offering of $125m 20-year convertible senior notes
  • TD Ameritrade Holding (AMTD) said client trades per day in Oct. were up 14% from the previous month, down 14% Y/y
  • Urban Outfitters (URBN) sees 4Q comps consistent with 3Q, reported 3Q rev. $573.6m vs est. $578.3m


  • One day: Dow +0.08%, S&P (0.12%), Nasdaq (0.17%), Russell +0.09%
  • Month-to-date: Dow +0.75%, S&P +1.22%, Nasdaq +0.26%, Russell +2.36%
  • Quarter-to-date: Dow +3.84%, S&P +4.96%, Nasdaq +6.13%, Russell +6.48%
  • Year-to-date: Dow +7.42%, S&P +7.41%, Nasdaq +10.78%, Russell +15.12%
  • Sector Performance: Financials +0.44%, Utilities +0.34%, Industrials +0.31%, Consumer Staples 0.03%, Healthcare 0.03%, Consumer Discretionary (0.19%), Tech (0.29%), Energy (0.51%), and Materials (0.79%)
  • MARKET LEADING/LAGGING STOCKS YESTERDAY: Ford +4.29%, EK +3.46% and Colgate Palmoliv +2.34%/Pulte -5.47%, Akami -5.08% and Sprint -4.96%.


  • ADVANCE/DECLINE LINE: 185 (+1792)  
  • VOLUME: NYSE: 879.52 (-13.18%)
  • VIX: 20.20 -1.99% - YTD PERFORMANCE: (-6.94%) - BEARISH TREND
  • SPX PUT/CALL RATIO: 1.46 from 1.22 +19.43%  


  • TED SPREAD: 15.05 -0.710 (-4.508%)
  • 3-MONTH T-BILL YIELD: 0.14% +0.01%
  • YIELD CURVE: 2.39 from 2.25


  • CRB: 306.02 +0.80%
  • Oil: 84.86 -0.02% - BULLISH
  • COPPER: 391.80 +0.51% - BULLISH
  • GOLD: 1,371.75 +0.48% - BULLISH


  • EURO: 1.3614 -0.56% - BEARISH
  • DOLLAR: 78.518 +0.56%  - BULLISH



European markets:

  • FTSE 100: (1.14%); DAX (0.34%); CAC 40 (1.12%)
  • Major indices are broadly lower in response to steep declines in China with Basic Resources, Construction, Industrial Goods and Banks hardest hit.
  • Pressure on Ireland to accept some form of EU bailout continues to unsettle investors with spreads on peripheral European soverign debt pushing wider again.
  • EU Finance Minister set to meet at 16:00 London time. Before that, Ireland's cabinet is set to discuss its 4-year fiscal plan. Spain and Greece tap bond markets.
  • Germany Nov ZEW current situation +81.5 vs cons +75 and prior +72.6
  • Eurozone Oct Inflation +1.9% y/y vs cons +1.9%
  • UK Oct CPI 3.2% y/y vs cons 3.1% and prior 3.1%, RPI +4.5% y/y vs cons +4.6% and prior +4.6%  

Asian markets:

  • Asian Markets: Nikkei (0.31%); Hang Seng (1.39%); Shanghai Composite (3.98%)
  • Worries about speculation of Chinese monetary policy tightening and European sovereign debt caused caution to reign in Asian markets, which mostly fell today.
  • Energy shares fell on lower crude-oil prices.
  • Banks and BHP Billiton led Australia to a small gain. Australia & New Zealand Banking Group rose on a report that someone else would buy Lone Star Funds’s 51% stake in Korea Exchange Bank , though it pared its gains to 1% when it said it is still in due diligence.
  • Japan declined slightly, having been boosted by a weaker yen, but pressured by profit-taking and heavy selling in futures contracts. All Nippon Airways fell 2% on a report that passengers to China are falling even as ticket prices plummet.
  • South Korea fell after a 25-bp interest-rate increase.
  • Hong Kong fell on China’s afternoon drop. China property stocks fell on new restrictions on foreigners’ ability to buy property in the country.  Large-cap banks and energy shares took the brunt of the hit as China dropped fairly sharply again on worries about further monetary tightening and a report that the country would unveil food price controls.
  • Coal and metal stocks fell.
  • China Oct foreign direct investment +7.9% y/y.

Howard Penney
Managing Director

THE DAILY OUTLOOK - levels and trends













DKS: Supports our Bullish View on the Space

Crusher quarter for DKS. Inventories relative to sales and margins are among the best reported yet this EPS season. Yes, there are some elements that are DKS-specific. But we think it’s a signal of more to come in this space.



Nice, clean beat for DKS, with EPS coming in at $0.22 vs. our estimate and the Street at $0.17.

  • Q3 results primarily comp driven posting +5.1% versus outlook for +1%-2% with growth in each segment:
    • Core Dick’s up +3.8%; Golf Galaxy up +2.4%; and +82% increase in e-commerce – which was the greatest driver.
    • Better than expected profitability +150bps reflecting a sequential acceleration on the 2yr margin growth rate, with an even easier comp ahead in Q4 – could be early indications of positive benefits from closing underperforming GG stores.
    • Inventories up +5% on +9% sales growth reflecting considerably more stable spread relative to retail peers. This is key, as we are seeing 9 out of 10 retailers print a meaningfully unfavorable delta in both sales/inventory spread and margins (as represented by the SIGMA chart below).
    • Better than expected results despite facing difficult compares vs. last year when unseasonably colder weather pulled forward what management estimated to be $0.03 of sales forward from Q4.
    • Raised FY outlook:
      • Comp outlook for +3-4% in Q4. But what’s notable is that the company only needs +4.5% to keep comps flat on sequential basis. They’re giving conservative guidance – especially in the face of a strengthening product cycle. They’re giving themselves a pad as it relates to consumer weakness.
      • $0.06 EPS beat in Q3 AND raising FY EPS by $0.10 suggesting continued strength through Q4.

One thing that’s worth noting is that DKS’ apparel mix is 28% of total. This compares to Foot Locker at around 9%. People seem to think that it is only the brands and those that directly procure cotton that are in trouble. Not so – by a long shot. It is a cost that will be absorbed in all critical pressure points throughout the supply chain – from Asia, to the Brands, to the Retailers, to the Consumer. To think that DKS won’t feel some pressure here is simply irresponsible.  Let’s see how they address it on the call.


DKS: Supports our Bullish View on the Space - DKS CompG 11 10


DKS: Supports our Bullish View on the Space - DKS S 11 10



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Stepping On Cocaine

“Sean: See you Monday. We'll be talking about Freud and why he did enough cocaine to kill a small horse.”

-Good Will Hunting


Yesterday, the Italian police reported intercepting 1 ton of pure cocaine inbound on 4 tractors from Brazil.  The street value was estimated at 250 MILLION Euros ($341M USD). That’s a lot of Fiat currency. That’s a lot of coke.


Since it was the largest intercepted transaction of cocaine in 15 years, I figured I’d start to analyze the matter. After all, Quantitative Guessing (QG) has many unintended consequences, not the least of which are moral.


Like creating “sugar highs” in markets for those who are levered-long of them, cocaine is a stimulant of the central nervous system. It suppresses the addict’s appetite to manage reputational risk. When it’s uncut, or “pure”, some really wild and crazy stuff starts happening post consumption.


According to one anonymous tweeter with knowledge in the crystalline tropane alkaloid space, pure cocaine “has no filters to increase the weight of the product. Dealers will usually “step on” their product to the tune of 30 or 40% of some other substance (usually Demerol, baby laxative, or B12) to increase their profits.”


As I dug deeper into my research, I couldn’t help but remember that this is exactly what 18th century Coin Clippers used to do to the their citizenry’s currency. Before we had central banking dealers clean up the messaging and delivery of the coin clipping business it was, per Wikipedia, “considered by the law to be of similar magnitude to counterfeiting, and was occasionally punishable by death.”


The good news here is that Americans are starting to figure this whole matter of feeding free money to debt addicts out. It actually didn’t take very long for consensus to come to realize that QG and Burning The Buck are bad things. This is progress.


We’re long the US Dollar (UUP) here and covering some of our US Equity short positions, not because we trust the alchemy of Alan Greenspan or Ben Bernanke, but simply because we are starting to see some of the cocaine highs of the last few weeks wear off. After all, over time, a stronger sovereign currency that isn’t being clipped by charlatans of government sponsored volatility is a good thing for America.


As risk managers, we are tasked with measuring real-time market prices, volatilities, and volumes. The output of this research results in probability-weighted market timing. As correlations and r-squares change, we start to change our positioning.


Today is November the 16th. To understand where markets can go next, we have to contextualize where they came from. So let’s look back at global macro correlation risk relative to the US Dollar on a THEN and NOW basis versus October 16th…


THEN (immediate term TRADE correlations to USD):

  1. SP500 = -0.80
  2. CRB Commodities Index = -0.88
  3. Brazil’s Bovespa Index = -0.92
  4. Oil = -0.91
  5. Gold = -0.96
  6. Copper = -0.95

NOW (immediate term TRADE correlations to USD):

  1. SP500 = -0.29
  2. CRB Commodities Index = -0.20
  3. Brazil’s Bovespa Index = -0.60
  4. Oil = -0.11
  5. Gold = -0.08
  6. Copper +0.10

The way to read this is very straightforward. Copper is undergoing the most glaring mathematical change, swinging from an INVERSE correlation of -0.95 to a POSITIVE correlation to the USD Dollar of +0.10 in only one month. This is a major new development in the risk management landscape.


While I wasn’t brave enough to buy Copper yesterday, I did buy-back my long Gold (GLD) position (email if you’d like my intraday note titled “Gold Diggers: Gold Levels, Refreshed”).


Last Tuesday, my asset allocation to Commodities was a Bernanke (ZERO percent). This morning, after seeing the CRB Commodities Index correct by -4%, the Hedgeye Asset Allocation to Commodities is back up to 6% (GLD = 3%, CORN = 3%). Managing your cash position dynamically isn’t rocket science. It’s called contrarian sobriety.


One of the most critical lessons I’ve had to learn in making global macro calls on markets is that the derivatives, correlations, and divergences embedded in the math are never perpetual. In other words, once it gets so easy that a coke-head can do it, it ends…


The SP500 is down for 5 out of the last 6 days and should test a critical level of immediate term TRADE support this morning. In the Hedgeye model, that line of support is 1190. If it holds, that’s bullish. If it breaks, that’s bearish. My immediate term TRADE line of resistance is now 1212.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Stepping On Cocaine - coke

Emergency Unemployment Insurance Benefits: Quantifying the Roll-Off

Conclusion: The unemployed face a significant headwind in expiring benefit support with the scheduled expiration of the EUC and EB programs come November 30th. With roughly 5M people on the rolls of Normal, Emergency & Extended benefits at an average weekly compensation of ~$300, government transfers via unemployment benefits provides ~$7B in support on a monthly basis. Nearly half of that government-sponsored economic demand stands to be lost in the months immediately following the expiration of EUC & EB Benefits.


Position: Bearish on U.S. Equities; Bearish on Muni Bonds.


A key caveat to our 4Q10 Macro Theme “Consumption Cannonball” is that the transfer from government-sponsored consumer demand to privately-supported consumption will be shaky at best. On November 30th,  that transfer will see its next meaningful test. According to a joint-report by the Center on Budget and Policy Priorities (CBPP) and the National Employment Law Project (NELP), roughly 2 million workers are set to lose unemployment benefits at the end of the month, with incremental monthly follow-through to the tune of “several hundred thousand workers”, barring Congressional extension of two key programs (EB and EUC) in a lame-duck session which starts today.  


The structure of unemployment benefits is often presented in an unnecessarily complicated fashion. Below we provide a coherent overview of the unemployment benefit structure along with the lead estimates for beneficiary roll-offs as we move past the November 30th program expiration date.     

  1. Within the standard Unemployment Insurance system, roughly 400,000 workers will exhaust their regular 26 weeks of benefits alongside the November expiration  with no chance of tapping additional emergency benefits for individuals in all but 10 States. 455,000 unemployed workers exhausted their 26 weeks of regular benefits in September without finding employment and several hundred thousand more are estimated to exhaust their regular benefits each month of the coming year.
  2. The Emergency Unemployment Compensation (EUC) (enacted in 2008 & expanded via ARRA2009) has provided additional weeks of support for the unemployed. Roughly 800,000 workers stand to lose benefits here come December as the program expires.
  3. The Extended Unemployment Benefits (EB) provide support beyond that provided under EUC. An additional ~800,000 workers stand to lose benefits here on December 1st, as full federal funding for the program expires.

 Emergency Unemployment Insurance Benefits: Quantifying the Roll-Off - 1


Understanding the  roll-off requires comprehension of three key benefits programs.  We explain each of these unemployment benefit buckets individually below:


1) Existing Unemployment Insurance:   Workers in every state are eligible for 26 weeks of benefits.  This compensation is fully-funded by the state.  This is an easy one.


2) Emergency Unemployment Compensation (EUC):  Benefits under EUC were provided for under the temporary Federal Emergency Unemployment Compensation program in 2008 and expanded under ARRA2009. EUC benefits vary according to the level of State Unemployment: 

  • State employment less than 6%:  Workers in States with aggregate unemployment less than 6% are eligible for 34 weeks of additional benefits under EUC.
  • State Employment greater than 6%, but less than 8.5%:    Workers in States with aggregate unemployment between 6% and 8.6% are eligible for 47 weeks of additional benefits under EUC.
  • State Employment greater than 8.5%:    Workers in States with aggregate unemployment greater than 8.5% are eligible for 53 weeks of additional benefits under EUC. 

3) Extended Benefits (EB):  Extended benefits were provided for under ARRA2009 and provide full federal funding for workers in higher unemployment states who exhaust both initial Unemployment Insurance and EUC benefits.  The duration of EB compensation is also tied to the level of state unemployment:  

  • State employment greater than 6.5%, but less than 8%:  Workers in states with unemployment between 6.5% and 8% are eligible for 13 weeks of addition benefits under EB.
  • State greater than 8%:  Workers in states with unemployment greater than 8% are eligible for 20 weeks of addition benefits under EB. 

Note:  Extended Benefits (EB) arenormally half-state, half-federally funded.  Not all states provide EB funding, although many changed state Unemployment Insurance laws to take advantage of the full federal funding provided under ARRA2009.  See CBPP information document Here for more information.


Emergency Unemployment Insurance Benefits: Quantifying the Roll-Off - 2


Again, it is the EUC and EB benefit programs that are slated to expire at the end of the month.   Workers exhausting their initial 26 weeks of unemployment insurance will no longer be eligible for extended benefits (37-53 wks depending on state employment level) under the EUC program.  Moreover, workers receiving compensation under the EB program will be cut-off immediately in states that only provide support when the program is fully Federally funded.  EB benefits will still be available in 10 states post the November 30th expiration.    


With roughly 5M people on the rolls of Normal, Emergency & Extended benefits at an average weekly compensation of ~$300, government transfers via unemployment benefits provides ~$7B in support on a monthly basis. Nearly half of that government-sponsored economic demand stands to be lost in the months immediately following the expiration of EUC & EB Benefits.


In varying proportions, States General Funds source the bulk of their revenues from income & sales tax.  With the labor market expected to remain sluggish, State tax revenues should remain  under pressure as government sponsored consumption fades, consumers continue to delever, and wage inflation remains muted alongside continued excess capacity. Such fiscal headwinds combined with a $1 trillion pension, health care  and retirement benefits shortfall, continue to have us bearish on muni bonds. We’ll follow up with a more in-depth update on state fiscal conditions tomorrow.


Christian B. Drake



Darius Dale



Emergency Unemployment Insurance Benefits: Quantifying the Roll-Off - 3

Your Greatest Victories

This note was originally published at 8am this morning, November 15, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Never forget that sometimes your greatest victories can come from your greatest defeats.”

-Drew Brees


Last week was a great week for global macro risk managers. By week’s end, with correlation risk to the US Dollar running at all-time highs (Dollar UP = stock, bonds, commodities, etc. DOWN), a gigantic global mean-reversion trade captured victory.


With the US Dollar Index recouping +1.9% of its value (week-over-week), here were some of the major correlation moves:

  1. SP500 = -2.1% (the market’s worst week in the last 3 months)
  2. Russell 2000 = -2.3% (we covered our short position last week)
  3. Euro = -2.9% (we shorted the FXE on 11/4 and remain short it)
  4. Commodities (CRB Index) = -3.2% (intra-week we moved up our asset allocation from zero to 3%)
  5. Oil = -2.3% (no position – we sold our oil on 11/3)
  6. Gold = -2.2% (no position)
  7. Copper = -1.3% (no position)
  8. Volatility = +12.9% (we sold our long VXX position on strength last week)
  9. 2-year US Treasury yields = +13 basis points or +35% to 0.50% (we remain short SHY)
  10. 10-year US Treasury yields = +26 basis points or +10% to 2.79% (we remain long PPT)

Putting price moves in context is always critical. Having been short the Burning Buck from June 7th to November 2nd, I get the bear case (DEFICITS + DEBT = CONGRESS). Inclusive of the US Dollar closing UP for the 2nd consecutive week, it’s important to acknowledge that the Debauched Dollar is still down for 19 out of the last 24 weeks and has plenty to prove before it regains any semblance of credibility.


That said, THE risk management question this morning is: Can a TRADE higher in the US Dollar become a TREND?


TRADE, in Hedgeye speak = 3 weeks or less. Whereas a TREND = 3 months or more. Global macro TRENDs back-test with much higher batting-averages in our risk management model than TRADEs. However, all TRENDs start as TRADEs, so you have to be Duration Agnostic.


I bought the US Dollar (UUP) in the Hedgeye Portfolio on November 4th and I remain long of it this morning. Consensus is still short the US Dollar and I can assure you that consensus is not comfortable with that position.


Here are the lines that matter in my model for the US Dollar Index:

  1. TRADE = $77.11
  2. TREND = $80.69

What that means is that what was immediate-term resistance for the US Dollar ($77.11) is now support and there really is no significant resistance (provided that the USD Index continues to make higher-lows) up to the TREND line of $80.69. In other words, there’s another +3.2% upside from Friday’s closing price of $78.08 and, consequently, plenty of correlation risk over the intermediate term for anything priced in US Dollars.


So what can keep an immediate-term bid to the Debauched Dollar?

  1. The Euro going down on legitimate sovereign debt risks rising (Ireland, Spain, Greece, Italy, Portugal, etc.)
  2. Fed Heads continuing to get hawkish on the margin (Jeffrey Lacker joins Kevin Warsh and Tom Hoenig this morning)
  3. US Treasury Yields continuing to breakout to the upside (2-year yields charging higher again this morning to 0.53%)

I’m not looking for bullish catalysts – these simply are bullish USD catalysts - particularly when you consider the “Bye-Bye, Bear” cover story that Barron’s was running on November the 1st. Bernanke’s QG (Quantitative Guessing) experiment has been YouTubed by the entire free and communist world at this point. If you didn’t know that QG = inflation, now you know. US inflation reports (PPI and CPI) will accelerate again sequentially when reported this week.


It’s a mathematical fact that Dollars are priced as a basket of other currencies, so I don’t think I’ll get much pushback on the Euro DOWN trade equating to US Dollar Index strength. I’ll definitely get pushback on the Fed Head thing – after all, the cornerstone of the Bull case on US Equities is built on Begging Bernanke for free moneys as insiders make their highest levels of sales since December.


On that not so little squirrel hunting signal that the world calls Mr. Bond Market however, it will be very difficult for people to ignore these immediate and intermediate-term breakouts in US Treasury Yields. This is very new. And the risks in the Treasury market are very real.


The 30-year bond has been breaking down, big time, since mid-October. Long-term interest rates breaking out in the US as sovereign yields spike in Europe were 2 of the main risk factors associated with my getting out of stocks and commodities altogether in late October. While some of my greatest 2010 defeats came in the first week of November, the greatest victories in global macro risk management are potentially on the come.


My immediate term support and resistance levels for the SP500 are now 1188 and 1211, respectively. I remain short the SP500 (SPY).


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Your Greatest Victories - USD

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