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“Knowing others is intelligence, knowing yourself is true wisdom.”

-Lao Tse


The closing of the year elicits contemplation and self-reflection. No, I’m not going to head down the road of providing a list of 10 surprises.  These lists are generally interesting to read, but – ironically – many of the forecasted “surprises” become consensus and are not particularly useful from an investment idea perspective. 


At Hedgeye, we like to think about what is going to happen in the next three month as opposed to where we are going to be 12 month from now.  As we like to say, “You’ve got to play the game that is in front of you.” Playing the game requires discipline and some self reflection to stay grounded.


Of course, as with anything, it is easiest if you have a process or methodology.  On a personal level, yoga is one thing that helps me to enjoy introspection.  In India, the method of self-reflection is called svadhyaya: Sva means “self” and adhyaya means “investigation, inquiry, or education”.  If you practice, svadhyaya it helps you observe moment-to-moment changes in your mind and pose important introspective questions. How are you feeling in your body? Is your mind present? What subject matter draws your mind away? 


When it comes to Hedgeye, we try to have a method for observing moment-to-moment changes in the market and also in our current stances on different themes and investment ideas we generate for our clients.  As we’ve said time and again, clients are a key part of this process and their feedback aids us immeasurably in our efforts to better serve them.


Heading into the New Year, it’s an appropriate time to reflect upon (1) What has transpired? (2) Where are we headed? and (3) What is left undone?   Svadhyaya is what we aspire to at Hedgeye; the ability to investigate, inquire, and educate ourselves and our processes.  Knowing oneself and obtaining true wisdom is likely a goal to be chased but never quite achieved.  If the pursuit of this goal enriches our perspective on markets and processes then that, in and of itself, makes us better on the margin.  And, as we always say, what matters happens on the margin.


Hedgeye’s take on the intermediate-term global macro outlook is three-pronged:

  1. Growth is slowing
  2. Inflation is accelerating
  3. Interconnected risk is compounding

It has been our view for some time that interest rates are going higher.  In terms of timing this call, it is extremely difficult given the scale of government interference in capital markets in recent times.  This call is, quite simply, anchored on our view that global risk is compounding.  Last week the US 10-year Treasury yield reached 3.33%, 28% higher than a month ago, compared with Germany’s borrowing costs rising +27% to 3.03%.  The trend continues today with the US Treasuries getting smoked again this morning as the world continues to see the inflation that Ben Bernanke is not allowed to see.


Yes, inflation is accelerating globally.  People are paying higher prices for what they use to feed themselves, clothe their children, and drive their cars than one year ago.  CPI in China accelerated to a 28-week high of 5.1% year-over-year in November.  Food inflation accelerated to 11.7% year-over-year.


The price of oil recently hit $90 for the first time in two years, gas prices at the pump are at $3.00 and according to Bloomberg, consumers of food made from wheat and corn should brace for higher prices, if history is any guide, after bad weather and a shortage of farmland threaten to create supply “shock waves”.


In keeping with the idea that we must play the game that is in front of us, the “growth is slowing” theme is being challenged by the “fiscal lunacy” of the politicians in Washington who will be adding another $900 billion to the deficit over the next five years.  Now the latest projections are that the USA 2011 budget deficit will hit $1.5 trillion after it was just $1.1 trillion a few months back. 


On the heels of the tax plan, consensus expects that the tax reductions will add 1% to GDP growth in 2011 (one time boost).  Side-effects of Bernanke’s monetary policy will, in my view, go some way towards offsetting this boost.  As the Federal Reserve stokes inflation through Quantitative Guessing, a run up in rates, coupled with a 15-20% decline in home prices in 2011, will mitigate the benefit of lower taxes.


The combination of inflation and ever-increasing debt levels does not encourage growth, it inhibits it!  Jobless Stagflation is a theme we’ve been highlighting for months and it will become clearer to many as 2011 proceeds.


I believe it would be beneficial for the administration to consider svadhyaya as a New Year Resolution.  The government today is an active participant in the markets.  To what end this participation?  Is there an end to this participation?  If government’s role is to protect employment levels and maintain price stability, I think the scoreboard speaks for itself on both counts. 


Projections offered by the administration in 2009 as to where unemployment would peak during this crisis have been far surpassed.  If government’s role is to somehow protect and enhance the life that its citizens lead, the almost 43 million people surviving on food stamps may have something to say about the administration’s success on that score.  It’s not that the administration it not trying; it is relentless in its pursuit of what it thinks is needed to bolster the obviously fragile economy. 


I do not believe it would take an otherworldly bout of introspection for the administration to realize that these efforts are not working and, more pointedly, they are expensive.  The public sector furor defined by massive government balance sheets has taken hold in Europe and you can bank on it coming into the fold in the U.S. in the not-too-distant future. 


David Einhorn of Greenlight Capital was interviewed by Charlie Rose on December 6th and highlighted some “unfinished business” that was left unresolved from the last crisis.  Einhorn is a thoughtful person and offered a metaphor for the economy at present of being “between two storms”.  The private sector storm was first but the public sector crisis is coming.  I don’t know David Einhorn and he may not be a yoga aficionado, but I would hazard a guess that svadhyaya would not be a completely foreign concept to him. 


Function is disaster; finish in style


Howard Penney




Looking at the recent short interest moves in the restaurant space, one can see confirmation of what we already knew; red meat costs are going to pressure earnings over the next few quarters.  Casual dining concepts with said exposure are first choice on the menu for short sellers of late (MRT, RUTH, TXRH, CHUX). 


Some other thoughts:

  • Notable that PFCB’s short interest remains at such elevated levels, and even increased over the past month’s reported data, despite overall declines in short interest in the casual dining category.  Bert Vivian’s optimism does not seem to be gaining much traction with investors
  • The Brinker story is gaining momentum and this metric also confirms it
  • Red Robin are not talking to the Street as they attempt to stimulate their brand.  I would become more and more bearish as this stock goes higher. 
  • CAKE and RT remain favored by the Street
  • CMG’s short interest has declined significantly (from ~12%) over the past month
  • Those short GMCR certainly made some money today
  • PEET also being pressed by the shorts, perhaps because of coffee prices, but this is a well-run company with one of the better management teams
  • The shorts certainly don’t seem afraid of a deal emerging for WEN!
  • CMG, PNRA, and DPZ remain the darlings of QSR
  • JACK has seen the shorts back off but I have very little confidence in that story



Howard Penney

Managing Director


For now, if the stock market is your gauge, Bernanke is seeing some success.  There are many other real time markets (commodities, global growth) that show a disconnect from U.S. equities.  The most recent consumer data point indicates that the consumer is feeling better.  I’m less-than-convinced that this will be sustainable or that Ben Bernanke has discovered any lasting solution to the problems facing the U.S. economy. 


The following are some current positives in consumerland:


1.       Income growth is getting better

2.       Job growth is still stagnating but trends are better that they were in January

3.       Retail sales are hanging in

4.       Consumer sentiment improved 5.7% and 3.6% sequentially in November and December, respectively. 

5.       The Consumer discretionary index (XLY) is up 25% YTD

6.       The S&P 500 up 8.76% and 3.69% September and October, respectively and is up 4.4% so far in December.


The University of Michigan consumer confidence reading rose to the highest level in six months, but is still registering a lower high; index of consumer sentiment rose to 74.2 from 71.6 at the end of November.  The Bloomberg consensus was for a reading of 72.5. 


The bullish consumer sentiment is not being confirmed by the more weekly ABC consumer comfort index which is at a -45, up from the low of -54 set on 12/01/08.  Year-to-date the consumer sentiment index is only up 2.3%, with the expectations component down 3%, while the current conditions is up 10%. 


The consumer is clearly responding to diminishing levels of uncertainty as corporate profits have improved to the best level since 2007.  We are reminded that not every this is turning up roses and part of the improvement increased profits is due to better efficiencies thru lower labor costs.  Just today TJX closing down the A.J. Wright division and cutting 4,400 jobs; other notable companies recently announcing layoffs in the past 30 days are the Washington Post, Express Scripts, State Street VF Corp and Apollo Group Inc.


The current trends in consumer sentiment as measured by the University Michigan are critical and continued improvements are needed to sustain the bullish sentiment running thru the market. 


1.       The Bullish to Bearish spread for the AAII sentiment index is approaching the danger zone again at 30.5.

2.       The VIX is down 48.9% over the past six months and is now down 20.99% year-to-date; another shoe dropping could see the VIX busting a serious move to the upside.


If the politicians in Washington come to some sort of compromise from the expiring Bush income tax cuts, it’s net neutral for the economy and will not likely benefit consumption.  At some time austerity will need to become a part of the conversation and a cursory glance at the television and how that is going down in Europe shows you what the consumer is going to think about that.  The continuation of the unemployment benefits helps buttress consumption.  I have described this before in the context of extended and emergency benefits.  Allowing them to expire would essentially sweep the legs from under a large portion of consumers and, whether or not one believes that this is good policy, it would initially be a negative for consumer spending and the broader U.S. economy.


On the plus-side for consumers, the one year's elimination of two percentage points in the Social Security withholding tax will directly boost disposable income of individuals currently paying those taxes.  As a result, there should be some consumption pick-up, but it is “one time” in nature and, just like the stimulus package, the impact will only be short lived.


As the facts change, we can adapt to the new trends.  For now we are sticking to our Consumer Cannonball theme (albeit on a different duration), as some of the major pillars of that thesis have not changed; primarily the outlook for housing and the labor market in 2011.  I will expound upon this point in a post next week.












Howard Penney

Managing Director

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The Week Ahead

The Economic Data calendar for the week of the 13th of December through the 17th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - f1

The Week Ahead - f2

Dr. Natty? Natural Gas and the Dollar

Conclusion:  Over the past six months, we’ve noticed a high correlation between natural gas and the dollar, though supply and demand fundamentals remain bearish.


In our internal morning meeting today, we were discussing the recent activity in natural gas.  Keith noted that as of late natural gas was moving in lock step with the dollar, so we looked at this relationship over a longer time frame.  In the chart below, we’ve charted the U.S. dollar index versus natural gas going back six months.  As the chart shows, the correlation between natural gas and the US Dollar Index is high and, in contrast to other commodities, is positive.  In fact, we’ve calculated the r squared at +0.71.


Natural gas is an interesting commodity in that it is a localized commodity and priced as such.  Specifically, natural gas is very difficult to transport across continents, so it is priced based on local supply and demand.  The read through from natural gas being positively correlated with the dollar appears to be that the dollar being strong signals a future strengthening of the U.S. economy.  Thus, the price of natural gas increasing may be based on the expectation of a pickup in demand due to accelerating economic growth.


It seems that natural gas might have its own predictive ability, not unlike our friend, Dr. Copper.  Unlike copper though, where inventories are low globally, natural gas fundamentals are somewhat bearish currently, specifically:


Supply - Currently, natural gas in storage is 9.8% above the 5-year average with 3,725 Bcf in storage.  This is obviously a bearish amount of natural gas in storage, though it is down about 1.5% on year-over-year basis, but remains well above historical norms.


Production – Our energy Sector Head Lou Gagliardi has written about this point extensively, but the growth of production in the United States continues to be one of the most overriding bearish factors for natural gas price.  With seemingly little concern for the growth of supply, major E&P companies continue to invest in the natural gas industry in the United States, especially in the various shale plays.  In fact production growth is so high, that the Department of Energy is predicting that storage by March 2011 will be 10% above 2010 levels.  According to the Department of Energy:


“This month’s STEO expects that in March 2011, inventories of working natural gas in storage will drop to 1,833 Bcf over the winter heating season, falling from its end-of-October level of 3,826 Bcf. This leaves storage levels above the five-year average (2006-2010) end-of-March inventory level of 1,576. The injection season in 2011 will begin with about 10 percent more working gas in storage that it did in March 2010.”


The most recent production data in the United States from September indicated that production was up 7.4% over September 2009, so certainly supports the DOE’s prognostication.


Demand – We’ve been quite vocal as to our expectation of slowing economic growth in the United States in H1 2011 due to tough comps, consumer headwinds, and a lack of future government stimulus.  If we are correct in our assessment, it is likely that demand for natural gas could be flat or fall in 2011 versus 2010.  In 2009, demand for natural gas was down more than 2% from 2008 levels.  Moreover, natural gas is not exactly a growth industry as overall consumption has only grown 9.1% over the 40-year period from 1969 through 2009. The Department of Energy is currently expecting demand to be flat in 2011.


Despite this bearish overhang heading into 2011, in the shorter term we have seen a bit of a bullish inflection point in demand due to the cold weather.  In the last week, consumption of natural gas was up 24% from the prior week, which has certainly supported higher prices.   The U.S. dollar will also be critical to watch due to its currently high positive correlation, but we will need to see a real pickup in economic activity to offset the looming gas surplus heading into next year.


Daryl G. Jones
Managing Director


Dr. Natty? Natural Gas and the Dollar	 - djnatty

Rich Privileges

This note was originally published at 8am this morning, December 10, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“One of the privileges of a rich man is that he can afford to be foolish much longer than a poor man.”

-Ludwig von Mises


This morning’s top global macro headline is ‘China raising rates on reserve requirements in order to fight inflation.’ This shouldn’t be new “news” to anyone who follows Chinese monetary policy closely. China is willing to give-up short-term stock market performance (the Shanghai Composite Index is down -13.3% for the YTD) for long-term price stability. Fancy that.


What is inflation? It’s when prices are breaking out to higher-highs over the intermediate-term TREND. In Ludwig von Mises 4th Lecture (“Inflation”, page 52 of Economic Policy) he reminds us that “the most important thing to remember is that inflation is not an act of God; inflation is not a catastrophe of the elements or a disease that comes like the plague. Inflation is a policy.”


The Ben Ber-nank’s inflation policy has been crystal clear. Since his decision to engage in Quantitative Guessing part deux at the Groupthink Inc. meetings in Jackson Hole in August, here are the 3-month percentage moves of real-time market prices:

  1. Crude Oil = +18.2%
  2. Natural Gas = +20.8%
  3. Heating Oil = +18.2%
  4. Gold = +10.1%
  5. Silver = +41.2%
  6. Palladium = +38.3%
  7. Copper = +17.3%
  8. Cocoa = +12.3%
  9. Cotton = +52.4%
  10. Lumber = +19.8%
  11. Orange Juice = +16.5%
  12. Sugar = +35.5%
  13. Corn = +24.2%
  14. Oats = +27.9%
  15. Rice = +20.5%
  16. Soybeans = +23.6%
  17. Wheat = +10.3%

Now to be fair to the Fear-mongering Deflationistas who want me to believe that I should accept a ZERO percent rate of return in my savings account in perpetuity, the price of pork bellies was down -1% over the same time period. Maybe, in the short run, I should have stuffed my kids with rice-less, wrap-less, pork burritos for the last 3 months and have told them to like it… no guac.


Altogether, in the long run, the Keynesians like to say don’t sweat this short run stuff, because “you’re dead.” While that’s seemingly a convenient and clever answer to starving the world’s poor for a nice year-end US stock market “pop”, as von Mises said, “the fact is that, in the not very long run, inflation does not cure unemployment” either.


As the US stock market continues to hit higher-highs on light volume and negative breadth and skew, both global and local bond yields continue to ring the alarm bells of inflation concerns. That’s why the world’s largest bond fund, Bill Gross’ PIMCO Total Return Fund ($250 BILLION in assets under management), has lost 3% of its nominal value in the last 30 days. Inflation is a policy. Inflation is bad for bonds.


Every aspect of what’s going on in global macro markets right now makes sense to us other than US stocks going higher. No, that doesn’t mean that every stock market should be going lower. We have a 9% long position in the German stock market and that makes sense to us as countries like Germany and Australia have pseudo-sober monetary and fiscal policy that’s not equating to US style Jobless Stagflation.


As a reminder, our intermediate-term global macro outlook for the next 3-6 months is as follows:

  1. Global Growth Slowing
  2. Global Inflation Accelerating
  3. Interconnected Risk Compounding

As hyped up as a US stock market bull wants to get on buying the things that China, India, and Brazil want, is as disinterested as local stock market investors in all 3 of those markets have suddenly become. Two of the three are broken on both our TRADE and TREND durations (India and Brazil) and one of the three (China) is gearing up to release very hawkish inflation data this weekend.


In the Hedgeye Chart of The Day (attached) we have outlined this point with a picture of Brazil’s Bovespa. The situation developing in Brazil’s economy is a major global macro risk:

  1. Growth Slowing – Q3 GDP released yesterday showed Brazilian growth slow materially (on a sequential basis) to +6.7% year-over-year versus the +9.2% reported growth of Q2 2010.
  2. Inflation Accelerating – this morning, Brazil’s CPI (Consumer Price Index) jumped to +5.6% for the month of November versus +5.2% reported for October.
  3. Interconnected Risk Compounding – as emerging market debt in Brazil comes off one of its worst monthly performances since the late 90’s , Brazil’s stock market has all of a sudden dropped -7% since the beginning of November.

Remember, market prices don’t lie; politicians do. And think about what Ludwig von Mises said in his 4th Lecture, “Inflation” (in Argentina 1959) when he asked us to “remember that, in the long run, we may all be dead and certainly will be dead. But we should arrange our earthly affairs for the short run in which we have to live.”


My immediate term TRADE support and resistance levels for the SP500 are now 1214 and 1249, respectively.


Best of luck out there today and enjoy your weekend,



Keith R. McCullough

Chief Executive Officer


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