Less Is A Good Thing

“Less Is A Good Thing.”

-Jason Fried & Heinemeier Hansson


At our year-end Hedgeye meeting this week, this was the most valuable take-away from the aforementioned bestselling authors of “REWORK.”


My immediate term support and resistance levels for the SP500 are 1197 and 1223, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


We made a few calls to see how things are going.  It’s a small sample and definitely not reflective of the entire CMG system, but gangbuster numbers were not the order of the day.  The results were mixed with some characterizing business as steady-to-slightly slower than three months ago.  Several attributed this slowdown to seasonality.  For those stores that stated business was up YOY, the magnitude of growth for the most part was not as great as we have seen from CMG as a whole (posted +11.4% comp growth in 3Q10).  It is worth noting, however, that for those stores saying that business is flat versus 3 months ago, trends are still strong.  Flat two-year trends in 4Q10 imply, approximately, a 12% comp growth on a YOY basis.


Chipotle, CO

  • “Denver is where Chipotle started so we have a pretty big customer base and following.  Business has not slowed down with us we are generally pretty full and busy, especially during lunch and dinner.”
  • “We have gotten more customers and business compared to last year, it’s kind of hard to tell because when you’re always full at certain times to count the change.  I would say my best estimate would be maybe 2% more than last year.”
  • “Per month I can’t give you it’s just really hard to tell the difference, we are busy but it’s pretty consistent.”


Chipotle, MD

  • Stated the stores will have been open for about 3 years in a couple of months
  • Stated that compared to last year they have seen a 1 to 2 percent increase “Business has been slightly up compared to last year”


Chipotle, FL

  • Characterized business as "Up"
  • "Lunch is our most busiest, but we do get a decent amount for dinner to"
  • "I'm not sure about a percent I know we are little busier than usual"


Chipotle, NJ

  • We asked about business in general YoY.
  • He said that it is about the same.
  • We asked about 3 months ago compared to now - manager said that they were busier in the summer, but for them that is expected. Their location is always busier in the summer.
  • We asked if they are meeting the projections - manager said that the sales trends are following what they would expect. Things are pretty steady.


Chipotle, NY

  • We were transferred to the manager and asked him how business is compared to last year.
  • Manager said that they are in line with their numbers, which are about 5% growth from last year.
  • Another location opened pretty close to them a few months ago and it took a little away from them.
  • We asked how business is now compared to 3 months ago and the manager said that they are about the same, flat really.


Chipotle, IL

  • We asked about business YoY and the manager said that they are a little busier - about 3%.
  • We asked about now compared to 3 months ago - manager said that they are less busy now by a little bit.
  • We asked how much - he said 1½ or 2%.
  • We asked why - he said probably because they are downtown and it’s getting pretty cold out.

Howard Penney

Managing Director


Moderation Down Under?

Conclusion: Growth is setup to slow meaningfully in Australia over the intermediate term due to a confluence of two main factors: waning Chinese/Asian demand and a deteriorating consumer sector.


Admittedly, we don’t write about Australia much and that is a direct result of consensus understanding the Aussie trade – long the Aussie dollar as a play on growing Chinese demand for raw materials and long Australian equities as a play on the dollar-down/commodities-up reflation trade.


Looking “down under” now, we continue to receive confirmation that the two tailwinds that have supported the Aussie dollar’s +7.1% YTD gain and recent equity market strength are eroding, as: 

  1. Chinese growth looks to continue to slow into 1H10 as the government continues to aggressively fight inflation with rate hikes, reserve requirement hikes, margin hikes, price controls and supply rationing.
  2. The U.S. dollar looks to continue strengthening from here, which dampens reflationary pressure in the commodity markets. We don’t buy any of the bullish HOPE associated with EU bailouts, etc. As such, we contend Sovereign Debt Dichotomy is alive and kicking for intermediate-term TREND. 

Within the Australian economy specifically, growth appears to be moderating as both internal and external demand wanes. Australian YoY GDP growth slowed sequentially by (-47bps) from 2Q10 to 3Q10, coming in a +2.65% in the latest reading. A slight positive to the report was that inflation as measured by YoY CPI also slowed in 3Q10, which suggests the prudent rate hikes of RBA Governor Glenn Stevens have warded off the inflationary pressure that continues to plague many other Asia-Pacific nations for now.


Moderation Down Under? - 1


One side effect of slowing growth and four interest rate hikes YTD is weakness in the consumer sector, which is highlighted by Australian October Retail Sales growth exhibiting the sharpest MoM decline since July 2009 at (-1.1%). While we aren’t necessarily lamenting the Aussie consumer for refusing to lever up and spend beyond their means like we continue to do in the U.S., we are calling out slowing growth for what it is.


Moderation Down Under? - 2


The consumer spending decline is driven by a confluence of two factors: 1) weakness in the Australian labor market; and 2) higher mortgage rates constraining consumer finances.


Australia’s Unemployment Rate ticked up +24bps in October to a YTD high of 5.39%. Further, Australian Job Adds growth decelerated in the month to +29.7k from +49.6k in September; the slowdown was driven by an decrease in full-time employment (-14.1k), though that was more than offset by an increase in part-time employment (+43.8k). At any rate, replacing full-time hires with part-time labor is usually indicative of softness in the labor market and the economy at large. Further, wages and benefits for part-times employees typically lag those of full-time staff.


Moderation Down Under? - 3


Higher mortgage rates also remain a headwind for the Australian consumer going forward, which is evidenced by Australian Consumer Confidence falling in November to the lowest level since June (110.7; down -5.3% MoM). A gauge of family finances dropped (-10.2%) MoM, which is particularly supportive of the view that the rate hikes are constraining consumer spending (more than 2/3rds of Aussies own homes and ~90% of Australian homeowners have variable-rate mortgages; also, household debt is greater than 150% of pretax income). 


Moderation Down Under? - 4


Exacerbating this credit headwind is the fact that Australia’s largest mortgage lenders have been increasing mortgage rates even beyond the scope of policy rate hikes. Both ANZ Bank and Commonwealth Bank of Australia have increased variable-rate mortgage rates by an average of 168% of the latest 25bps policy rate hike. Treasury Secretary Wayne Swan recently called the moves a “cynical cash grab”, yet no official action has been taken to provide relief for the Australian consumer’s shrinking discretionary budget.


Given this setup, it’s no surprise to see that Australia’s Household Savings Rate ticked up 130bps QoQ to 10.2% of disposable income in 3Q10, which lends further support that  confidence in household finances is deteriorating.


Moving to the manufacturing sector, we see continued weakness there as well; PMI contracted for a third straight month, falling in November to 47.6 from 49.4 in October, with the employment subcomponent index falling 4.3 points to 45.9. Capacity Utilization also fell (from a two-year high, albeit) to 74.6% vs. 77.4% in October.


Moderation Down Under? - 5


These numbers are indicative of the weak external demand highlighted above from slowing growth abroad. Compounding this slowdown in mining and manufacturing is the fact that Australian budget deficit will come in wider than initially anticipated due to Aussie dollar’s strength (exporters’ revenue missed government projections). The total shortfall for FY11 will be ~A$800 million larger at A$41.5 billion and the deficit for FY12 is likely to come in at A$12.3 billion, up from the initial projection of A$10.4 billion.


This latest miss has recently-elected Prime Minster Julia Gillard weighing spending cuts in order to honor her election promise of a balanced budget within three years time. At this point, the Australian economy is on the tipping point of a meaningful slowdown in growth, so the potential for increased fiscal conservatism may exacerbate the slowdown over the intermediate term.


From a quantitative perspective, Australia’s S&P ASX All Ordinaries Index is bullish from an intermediate-term TREND perspective and ever-so-slightly bullish from an immediate-term TRADE perspective after having closed up +1.8% overnight.


Darius Dale



Moderation Down Under? - 6

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Another Day At The Carnival

This note was originally published at 8am this morning, December 02, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“If I shoot at the sun, I may hit a star.”

-P.T. Barnum


Yesterday we held our quarterly company meeting in New Haven, Connecticut.  After Keith gave the opening remarks, we spent the next five hours having various leaders from within the firm talk about their business units.  This was an opportunity for us to reflect on what went right and wrong in 2010, what we need to do in 2011 to continue to take market share, and to share best practices amongst colleagues.  As I engaged with my teammates yesterday and watched their passion, one thought struck me repeatedly -- capitalism is alive and well in America.


Ironically, while going through the daily macro grind this morning, I happened upon a quote from another Connecticut capitalist, P.T. Barnum.   Now, admittedly, P.T. wasn’t in the securities or research business, he was in the carnival business.  Specifically, he started “P.T. Barnum’s Grand Travelling Museum, Menagerie, Caravan & Hippodrome”, which would eventually be coined as the “Greatest Show on Earth”.  Barnum’s circus eventually became so successful that he purchased his own train to transport it in the late 1880s.


While we don’t have any Tom Thumb like characters walking through our offices in New Haven (who Barnum billed as the smallest person to walk alone), we do enjoy moments of levity at work as we look out at the Global Macro Three-Ring Circus every morning. 


In the Geopolitical Ring this morning, we have Secretary of State Hilary Clinton.  Just when it seemed that the news flow could get no worse for the Obama administration following the mercy crushing of the Democrats in the midterms (losing 63 seats in the House), we have one of the leaders of global transparency, WikiLeaks founder Julian Assange, taking aim at the State Department. 


The most egregious foreign affairs circus act appears to have been spying at United Nations ordered by Secretary Clinton.  According to a news report:


“Secretary of State Hillary Rodham Clinton ordered State Department employees to gather private information from high-ranking officials, including the United Nations Secretary-General Ban Ki-Moon, Security Council members’ ambassadors (including our allies, France and Britain, as well as China and Russia), prominent African military and political leaders and top UN directors.”


Obviously, this is not exactly helpful as the United States tries to rally support to contain North Korea.


In the Inflation Ring this morning, we have China front and center again.  According to reports, China’s gold imports jumped almost 5x year-over-year in just the first 10 months of 2010.  Since the Chinese central bank has to approve all gold imports, this is a direct signal as to their thoughts on inflation and the direction of the U.S. dollar.  Like many commodities, even those with a less practical use like gold, China continues to be the key driver of incremental demand.  Chinese investment gold demand is expected to reach 150 tons this year, up from 105 last year and 3 to 4 tons 10 years ago. 


The fact that the Chinese are hoarding gold as a hedge against inflation should be no surprise given some recent inflationary data points out of China. The most noteworthy of which was October CPI, which was at a two year high of 4.4% year-over-year.  Inflation and subsequent tightening of monetary policy in China continue to be the key factors that drive our view that global growth will slow into the first half of 2011.


Finally, in the Sovereign Debt Ring, the PIIGS continue to be the main act in Europe.  This morning Spain auctioned 2.5 billion Euros in notes with an average yield of 3.7% and a bid to cover of 2.3x.  While the Spanish IBEX is up 2% on this news, the act of adding more debt to the Spanish balance sheet is far from a reason to celebrate.  In fact, as of November 30th the spread of Spain’s 10-year debt over comparable German bunds climbed to an all time high.


Most pertinent, of course, are the long term and structural unemployment issues in Spain.  Yesterday, our European Analyst Matt Hedrick wrote a note to our subscribers that highlighted Spain’s unemployment rate of 20.7%.  No, that was not a typo, a full fifth of Spain’s employable adults are out of work.  The second highest unemployment rate in the Eurozone is Ireland, which is currently at 13.5%.  While the equity markets are giving Spain a golf clap this morning, to think the structural economic issues in Spain have gone away are laughable at best.


While P.T. Barnum passed away well over a century ago, his famous quote, “there’s a sucker born every minute”, continues to have relevance today . . . especially for those folks who are buying Spanish government bonds today.


Keep your head up and stick on the ice,


Daryl G. Jones

Managing Director


Another Day At The Carnival - 1spread

PSS: Closing the Gap


PSS’s Q3 results came in strong at $0.69 (less $0.06 tax benefit) vs. $0.51E and even better than our above consensus expectations at $0.60. We’re not going to rehash all the puts and takes of the quarter. But the meat of it is that comps at Payless improved on the margin. The bears will point to high inventories. As always, the company gave both side of the trade something to hang their hats on.


Comps: The directional change was something we fully expected. Keep in mind that…

a)  PSS was not on trend last year with the rapid shift towards boots in the fall of ’09. It goes without saying that boots are the highest ticket footwear units in the store.

b)  Same goes for toning. PSS sat there and watched companies like Sketchers, Reebok, New Balance and Avia jump into the category once owned by MBT. Due to the nature of PSS’ model, it will catch fashion trends after the peak in the bell curve. What’s in the stores now? Toners and boots – and at 2x the price point of PSS core.

c)  Remember last fall when PSS went in to Back-to-School with a $8.99 price point? That’s as low a price point ANY shoe retailer (incl WMT) has ever seen. The reality, however, is that the consumer did not show up regardless. The kicker is that PSS also paid up in heavy SG&A spending to support the initiative. You can complain that it was a failed initiative, but the reality is that now they’re comping that.

d)  Ultimately, the material divergence between PSS comps and peers contracted for the first time in 5 quarters. The chart below captures it all. It’s worth noting this has been one of the primary factors that bears have pointed to over the past year (and they’ve been dead on), but that trend has now turned considerably more positive on the margin.


Inventories: Margins came in up +130bps above expectations with less promotional activity and favorable Oprah compares offset in part by higher freight costs. But inventories came in high – very high.  And let’s not mince words – for a zero-square footage growth retailer, +22% inventory is ugly.  We can chalk up some of it due to…

-  Remember that the company flat-out ran out of product last year during the ‘Oprah Event.’

-  On the margin, PSS is bringing in higher priced product.

-  PLG remains exceptionally strong, and was low on inventory last year. In addition there is a slight impact from PLG store growth.

-  Rubel himself admitted that clearing inventory is not a 1-quarter process. It’s also worth noting that despite higher inventories, margins didn’t contract on a sequential basis like it did for all other footwear retailers.  Does that mean that the gross margin hit is yet to come? Perhaps. But like it or not – inventories have been too low for this company to comp on a unit basis for the better part of 3-years. Based on all the feedback and sentiment we’re hit with daily, our sense is that trading slightly lower gross margins in favor of comp would be bullish here.


PSS: Closing the Gap - PSS Q3 Peer Comp Sprd 12 10


PSS: Closing the Gap - FamChan SIGMA 12 10



Showdown Brewing on the Korean Peninsula

Conclusion: Geopolitical risk in the region remains substantially higher than U.S. consensus is aware of and the threat of full-out military conflict continues to escalate as diplomacy has taken a backseat to posturing and bravado.


Position: We remain bearish on Korean equities for the intermediate term trend, primarily due to slowing economic growth which is being exacerbated by inflationary headwinds.


With the whole world seemingly focused on Trichet’s announcement this morning, we thought we’d have your back by keeping our Global Risk Management Eye on the Korean Peninsula (among other things) for you. Markets wait for no one and risk doesn’t abate because we fail to focus on it.


Considering, it’s important to highlight some of the latest military posturing and rhetoric by political leaders regarding the situation brewing in Korea.


Earlier this week, South Korean President Lee Myung Bak vowed to make Kim Jong Il’s regime pay for additional attacks, saying, “It’s become clear that more patience and tolerance only leads to bigger provocations… North Korea will be made to pay for further provocation no matter what”.


This latest shift in tone follows a survey that shows over 80% of South Koreans believe the government should have “displayed a stronger military response” to North Korea’s recent attack on the disputed island of Yeonpyeong . Moreover, 33% of respondents said they were willing to risk war to do so going forward.


Accordingly, South Korea has doubled its’ artillery strength on the island, which coincided with the North installing surface-to-air missiles in the area. Let the arms race begin…


International Involvement


The U.S. and Japan have initiated military exercises in the region to the tune of over 44,000 combined troops, and South Korea is planning to join in on the “fun” shortly. This step heightens the risk of further military conflict when taken in the context of the North’s latest aggressive commentary:


“North Korea will deal a merciless military counter-attack at any provocative act of intruding into its territorial waters.”


It’s important to keep in mind that the North doesn’t recognize the maritime border laid out after the 1 Korean War. Additionally, the North regime has urged its Southern counterparts to call off the exercises, yet anonymous South Korean officials said today that its military may carry out further artillery drills next week – similar to the drills that started this conflict last Tuesday.


At the very least, it appears the South has been emboldened by U.S. and Japanese support, which doesn’t bode well for peace in the region.


Another headwind for conflict resolution is U.S., Japanese and South Korean reluctance to enter six-party talks with China, North Korea and Russia. Originally proposed by China on Nov. 28th, the talks have been met with steep resistance, particularly from the U.S. and Japan: 

  • U.S. Admiral Michael Mullen yesterday: “Beijing’s call for consultations will not substitute for action. I do not believe we should continue to reward North Korea’s provocative and deeply destabilizing behavior with bargaining or new incentives.”
  • Japanese Foreign Minister yesterday: “Talks can’t be held only because North Korea has run amok.”
  • South Korea’s Ministry of Foreign Affairs and Trade said it would “consider China’s call for talks very cautiously”. 

The resistance to further negotiation is born out of two key factors: 

  1. North Korea has a history of rattling its saber to force diplomatic discussions whereby they wind up exchanging promises of good behavior for additional foreign aid (email us if you’d like to receive a podcast of our May call with Charles Hill regarding North Korean tactics, etc.); and
  2. The U.S. is concerned that North Korea poses a substantial nuclear proliferation threat. Last week it confirmed it has a uranium-enrichment facility and South America intel has concluded that North Korea recently shipped Iran 19 advanced missiles. The country is already under current UN sanctions for previous nuclear tests. 

Of course, it comes as no surprise that China, a long-time ally of North Korea, is criticizing the ongoing military exercises and rejections of diplomacy as both dangerous and unproductive. Today, Chinese Foreign Ministry spokeswoman Jian Yu said, “Brandishing of force cannot solve the issue. Some are playing with knives and guns while China is criticized for calling for dialogue – isn’t that fair?”


Further, Chinese opposition has stalled UN Security Council negotiations condemning the recent attack and North Korea’s expanding nuclear program. This is noteworthy, given that the council needs to reach consensus before making accusatory statements. Earlier this year, it took roughly four months to agree on a statement that only implicitly condemned North Korea for sinking the South Korean warship Cheonan.


China’s posturing has been met with more stringent international resistance this time around, as evidenced by U.K. Ambassodor Mark Lyall Grant’s recent comments: “We are not prepared to have a weak response by the council. These are serious violations on the nuclear side and the shelling should be condemned if we are to make any statement at all.”


At any rate, the situation on the Korean peninsula is increasingly shaping up as an international game of “Us vs. Them” and the rift could be far-reaching if the conflict isn’t resolved quickly. Unfortunately for sake of conflict resolution, neither side appears willing to back down at the current moment, leaving as situation of “high alert” as the best-case scenario for the region. Worst case, the conflict could heat up if certain lines (both physical and rhetorical) are crossed.


From a quantitative perspective, Korea’s KOSPI 100 remains broken from a TRADE perspective and bullish from a TREND perspective.


Darius Dale



Showdown Brewing on the Korean Peninsula - 1

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