Europe: Risk does not Cease to Exist

Position: Long Germany (EWG); Short Italy (EWI), Euro (FXE)


European equity indices largely closed in the red today, with negative divergence from the PIIGS; in particular Greece’s Athex fell -2.8% and Spain’s IBEX 35 declined -2.1%.


Below we refresh the charts of 10YR govt. bond yields and 5YR sovereign CDS, which show the continued heightening of risk from Europe’s periphery. Of note is Greece’s 10YR yield, which now stands at a mere 15 bps away from its previous year-to-date high of 12.449% on 5/7, a few days after Greece received a €110 Billion bailout and a few days before the EU and IMF established a €750 Billion aid package for the region to tap into.


Matthew Hedrick



Europe: Risk does not Cease to Exist - h1


Europe: Risk does not Cease to Exist - H2

Storm Clouds on the Market Horizon

“Here’s to the pilot that weathered the storm.”

-George Canning


Conclusion: Below is a summary of some of the key risks we see heading into 2011.  Please email if you would like the 40+ page presentation that supports these ideas.


The stock market year of 2010 was a solid one by many standards.  Despite some unfettered volatility, and assuming nothing dramatic happens in the next couple of days, most major U.S. stock markets will end the year solidly in the positive.  Leading the way were small cap stocks with the Russell 2000 up more than 26%.  While the broader market trailed the small cap index, the SP500, oft considered the benchmark for U.S. equity performance, was still up over 12%, coming in slightly ahead of its long run annual average.  With 2010 in the rearview mirror, it is time to start looking towards 2011.


When contemplating the outlook for the upcoming year, the best place to start is consensus expectations.   Currently, according to a Bloomberg survey of the strategists from 11 of the largest brokerage firms in the United States, the mean consensus target for the SP500 by year end 2011 is ~10.5% above current levels.   Further, every single strategist in the survey is expecting a positive performance out of the SP500 in 2011.  Suffice it to say, Hedgeye is decidedly non-consensus heading into 2011. (I’m sure none of our subscribers are surprised by this fact.)


As it stands, we see a trinity of existent, negative fundamental macro clouds on the horizon that have yet to be properly discounted by the market, and are poised to cast a potentially long shadow over domestic equities heading into next year.  The three key risks we see to these lofty consensus expectations heading into 2011 are: global growth slowing, inflation accelerating, and interconnected risk heightening.


As it relates to GDP growth in the coming year, we believe that growth, both in the U.S. and in certain major emerging market economies, will slow sequentially, though for very different reasons.  Domestically, we believe consumer spending, which is roughly 70% of GDP, will be constrained as consumer confidence erodes alongside a further slide in home prices.  This erosion in consumer confidence combined with a high structural unemployment rate will lead to what we are calling the Consumption Cannonball.  In effect, consumer spending faces tough y-o-y comparisons, which, when combined with deteriorating consumer confidence and a continued tight consumer credit environment, will likely lead to a tough consumer spending environment in 2011.


Globally, the key growth issue is related to inflation.  As we look at some of the major emerging market economies that are fueling global growth, it is obvious that inflation is accelerating.  Most recently, China reported a 28-month high in November CPI at 5.1% and Brazil reported CPI for the same month at 5.6%.  In both instances, these measures for consumer based inflation are well above the targets established by each of the country’s respective central banks. The obvious outcome if this level of inflation is sustained, as we believe it will be, is a tightening of monetary policy, and a subsequent deceleration of growth abroad.


In fact, globally, we are already seeing a number of central banks take steps to tighten monetary policy and slow inflationary pressures.   Some of the data points we’ve been focused on over the past couple weeks include: Sweden raising interest rates by 25 basis points, Chile raising interest rates by 25 basis points, China taking its reserve ratio up by 50 basis points to 18.5%, and Brazil taking its reserve ratio to 20% from 15%.  While these are somewhat muted moves in light of some of the inflationary reports we have seen, we should expect more aggressive action in 2011, especially in light of accelerating commodity prices.  As the Chinese authorities recently foreshadowed, 2011 will be a “prudent” monetary policy year and they signaled such on Christmas morning with a 25 basis point increase on key lending rates.


The final bearish factor we are focused on heading into 2011 is the increase of interconnected risk.  This factor considers rising market and asset correlations in combination with a mispricing of a number of global macro risks.  Increasingly, over the last couple of years we have seen a strengthening correlation between major markets and, really, all major asset classes.  The implication for strengthening cross-market and cross-asset class correlations, particularly in the context of an increasingly interconnected global market place, is that a major dislocation or failure or one market is increasingly likely to reverberate similarly across other major markets.  In the U.S., we saw this manifest itself via the U.S. dollar and European sovereign debt, which served as the key drivers of various major equity markets around the globe.


The key macro risk areas in 2011 that we see looming include: the domestic municipal bond market, European sovereign debt, and the continued implosion of the Japanese economy.  As it relates to the municipal bond market, broadly speaking, we think that many are missing the combination of higher projected spending with a decline in local and state tax receipts.  In terms of sovereign debts in Europe, things will get worse before they get better and we have recently seen CDS spreads in troubled countries like Greece widen to a point that implies a default is becoming somewhat imminent.  Finally, the coming year is poised to be a critical one for Japan, which is buried in a mountain of debt and an aging population that the pension system cannot support.  All this is framed with a volatility index, the VIX, which is flashing signs of complacency at its close to year-to-date lows.


We are not being non-consensus merely for the sake of being branded contrarians, but if the last few years have taught us anything it is that when consensus is solidly leaning one direction we need to seriously consider that to be a contrarian indicator.   Regardless of the consensus of views of major strategists, storm clouds loom on the economic horizon and thus we remain justifiably cautious heading into 2011.


Daryl G. Jones
Managing Director

R3: ADI, WRC, Facebook, and Snow


December 27, 2010





  • Facebook has now become the leading driver of web video traffic behind none other than Google taking over the #2 spot from Yahoo according to a recent Video and Media Industry report from Brightcove and TubeMogul. While certainly notable, so too is the gap between the top spot and Facebook’s new post, which refers 9.5% of all video traffic compared to more than 50% for Google.
  • Don’t be surprised when asked to present your driver’s license when making holiday returns this year. According to NRF’s latest return fraud survey, retailers lost nearly $4Bn to fraudulent returns last year and approximately $14Bn per annum. This added step is far from fool proof, but one thing is for certain – return lines will be longer this year as a result.
  • With 50%+ deals more rule than exception the day after Christmas, it appears that some retailers are extending offers into the week given disruptive storms along the east coast yesterday/today. In fact, some deals may get even better as retailers look to recover lost sales for those still looking for a deal.



Post Christmas Demand Strong Despite Storm - Even as concerns remain over the consumer mood in 2011, retailers have entered the last leg of the holiday season — the week between Christmas and New Year’s — expecting another wave of spirited shopping and feeling good about the outcome so far. And that’s particularly true in apparel and accessories. This past weekend, retailers and analysts concluded those categories performed the best during holiday 2010 after several years when the sector lagged in favor of electronics and toys. Skyrocketing online and mobile shopping, robust gift card sales, tax cut extensions, rebounds in luxury goods and men’s wear, and free shipping of online orders also spurred sales growth this year.  No doubt, Sunday’s storm blanketing the Northeast and mid-Atlantic regions and reaching 10 to 12 inches in some locations deterred traffic at many malls and put a dent in sales. Yet the blizzard did little to dampen the mood. The day after Christmas is traditionally one of the biggest volume days of the year, leading to a bustling retail week characterized by returns and exchanges, gift card. “The day after Christmas is a very important day,” said Brendan Hoffman, president and chief executive officer of Lord & Taylor. “It looks like today [Sunday] is starting out strong. Maybe people were getting out early to beat the snow, but the storm will certainly affect the malls. You can’t control the weather, but we’ll get through it. Up until today, we were up double digits. I don’t know what the storm will do, but the customer has been continuing to respond. This season, gains were across the board. For Lord & Taylor, it’s been the best Christmas in a number of years — five years for sure.” <WWD>

Hedgeye Retail’s Take: Largely considered a Top 5 shopping day for retailers (and #2 last year), it appears that sales early in the day were strong as usual before shopping ceased. While sales activity will be aided by increasing temps over the next few days, the storm will undoubtedly leave its mark on season ending sales, the extent to which remain unknown for now.


Adidas Outdoor to Launch Stateside at OR Next Month - Adidas is preparing to roll out its outdoor collection in the U.S. market — an initiative it first embarked on five years ago with limited success. This time around the effort is part of a worldwide push and a seven-year business strategy. Building on the outdoor category’s strength in Europe, where Adidas has been sold for the past two years, the athletic brand plans to unveil the new collection at next month’s Outdoor Retailer show. Adidas Outdoor has also made inroads in Asia and in Russia, under the guidance of Rolf Reinschmidt, senior vice president and global head of operations for Adidas Outdoor. The Stateside debut in stores is slated for July. “We knew we had to earn our way,” Reinschmidt said. “We are approaching the market from a different product focus and with a deeper integration into the outdoor community. Growth will come from doing things right and not through heavy advertising and marketing.” Adidas Outdoor is expected to be sold in 350 to 500 domestic retailers, as well as through Adidas’ seven freestanding stores and its Web site, he said. The U.S. market will have about 90 percent of what is sold in Europe. The label should face off against competitors such as The North Face, Arc’teryx and Salomon, Thomsen said. <WWD>

Hedgeye Retail’s Take: What’s notable here is Reinschmidt’s specific commentary regarding the brand’s success riding on the authenticity of the product, not the marketing spend behind it (a la Easy Tones). While the company proved successful in the later over the past year, authenticity requires a polar opposite approach and one that’s considerably slower to materialize. We’ll see what the response is out of OR (Jan 23-26).  


New Flash-Sale Jewelry Site Launching in 2011 - Ajaline, a fine jewelry flash-sale Web site set to launch on Feb. 1, wants to adapt a model crafted by online retailers such as Gilt Groupe and Rue La La. Co-founder Meeling Wong, a former president of John Hardy, said she is curating to cater to brand concerns about how items will be sold. Only three to five will be featured each week, and each flash sale will be open for three days, with a 24-hour preview. Discounts will range from 30 to 70 percent off retail, with prices from $500 to $50,000. The first sales will spotlight designs from Buccellati, Lagos and Temple St. Clair. Fine jewelry has been slow to embrace e-commerce, but Wong said she tells companies, “You guys think you can control the Internet. You can’t. You can control where you are and the way you’re presented.” <WWD>

Hedgeye Retail’s Take: A natural extension of flash-sale pioneer sites that have incorporated jewelry offerings, but not in any consistent way – this isn’t just a me-too concept. Given Wong’s experience and more importantly connections within the industry – Ajaline will likely have more popular and desirable brands than exist in this channel currently.


Cost Excerpt from Interview with WRC's CEO Joe Gromek - "I would suspect 2011 will continue to be an excellent year for intimate apparel, and consumers will continue to be back in the shopping malls. But one of the challenges in 2011 will be in terms of rising costs.…We will pass along 70 percent of rising costs through a combination of price increases and product expense reduction and margin out as good or better.…We are positioned for the first half of 2011, but we have not gone to market yet with fall 2011. We’ll do that in January. The second half will be the challenge." <WWD>

Hedgeye Retail’s Take: The fact that the company expects to absorb some portion of impending cost increases in the 1H of 2011 is more forthcoming than what we’ve heard from most in retail on the matter.


Polyester Yarn Prices on the Decline - Indian spinners have already further slashed the yarn prices by around Rs 8 per kilogram over the last few days, hoping to stop the government’s imposition of a ceiling on polyester yarn exports. Members of the textile body urged the Textile Ministry to put a ceiling on polyester yarn exports in the same way as it was done for exports of cotton yarn to make the domestic market stable, following the unprecedented hike in polyester yarn prices after November. The members also asserted that the demand for synthetic yarn, by textile manufacturers, particularly from China and Pakistan after the shortage of cotton supply, had raised the export orders from the country. <FashionNetAsia>

Hedgeye Retail’s Take: With cotton prices escalating sharply during the 2H of 2010, the halo effect across alternative materials was to be expected. Still, on a relative basis, these materials will lead to greater use of alternative materials in 2011 as producers look to mitigate cotton cost inflation.


Shoe Alliance Formed in Wenzhou - The first Chinese Footwear Cooperative Alliance has recently been established in Wenzhou, the shoe production capital of China. The alliance, which was jointly launched by Aokang Group and some 50 shoe companies, aims to build an industrial and trading chain operation model for footwear, similar to retailers Gome and Suning in the household appliance sector. Aokang Group said the alliance urges shoemakers to work together to create a franchise store brand for footwear, adding that further cooperation and investment will be needed to be discussed. Although Wenzhou is known for shoemaking, competition has been getting more intense, causing Wenzhou shoe producers to look for ways to create a new outlet channel. <FashionNetAsia>

Hedgeye Retail’s Take: It’s a start, but the beginning of a long and costly road to pull together resources in an effort to stem production outflows to inland and neighboring alternatives. While these efforts may prove successful in the long-run, the question is just how long it will take the alliance to make a meaningful impact on the decision of companies actively looking to shift resources elsewhere.


Social Media Continues to Climb - Email marketers have been warming up to social media for the past year, using social elements like “share with your network” and buttons to connect with brands on Twitter and Facebook in email campaigns. Email and social media also go together in another way: They are the top tactics marketers worldwide expect to increase budgets on in 2011. According to a November 2010 survey of business executives around the globe by StrongMail, nearly two-thirds of companies will increase spending on email marketing, and 57% will put more dollars toward social media marketing. Search took a distant third place with 41% of respondents indicating they would spend more. Budgets will be increasing, but the biggest challenge for email marketers will be a lack of resources and staff—the same problem affecting social media marketers. Email and social will continue to get closer as more marketers integrate the two channels with each other. More than a quarter of respondents said they had already formulated and implemented a strategy for making email and social work together, and another 43% plan to make efforts toward integration in 2011, though some are more prepared than others. <emarketer>

Hedgeye Retail’s Take: A clear indicator of how companies value the social media channel – it stands at #2 behind only email marketing.


R3: ADI, WRC, Facebook, and Snow - R3 1 12 27 10



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Bearish: SP500 Levels, Refreshed



It’s hard to believe, but the SP500 is vying for its 2nd consecutive down day for the 1st time in December. That said, it’s not doing so without a fight. Despite the VIX breaking out above our immediate-term TRADE line of 16.82 today, the SP500 is holding our immediate-term TRADE line of support at 1248.


In order for the SP500 to close in the red for 3 consecutive down days, we’ll likely need to see 1248 violated on the downside. If that were to occur, I don’t see any meaningful support down to the 1218 level. Ultimately, if you’re short the US stock market here, that’s what you should be playing for in the immediate term. The bulls are as complacent as they’ve been since April, and they will not sell until they have to.


In terms of upside resistance, up at 1263 I’m still registering higher-highs versus the prior YTD closing high of 1258. That’s a bullish risk management signal and so is holding 1248, until it doesn’t.




Keith R. McCullough
Chief Executive Officer


Bearish: SP500 Levels, Refreshed - spTT


Total gaming revenues for December trending between HK$17.5-18.0 billion



Macau gaming revenues decelerated a touch in the past week.  Based on the current run rate of HK$570 million in table revenue per day, down from HK$585 through the 20th, we are now projecting total gaming revenues (including slots) of HK$17.5-18.0 billion.  That level of revenues represents 59-64% growth over last year.  As always, our estimates take into account the number of weekend and weekdays and for December, only 30 days are counted.  Note that New Year’s Eve is included in the January number.


Below are the market shares.  LVS lost another half a point since our last update while SJM gained.




TODAY’S S&P 500 SET-UP - December 27, 2010

As we look at today’s set up for the S&P 500, the range is 16 points or -0.86% downside to 1246 and 0.42% upside to 1262.  Equity futures continue to trend below fair value as the rate increases out of China over the weekend are contributing to heightened tightening concerns following a similar move by Russia (only deposit rates) on the 24th.


Commodities are showing a mixed reaction to the hikes as the prospect of slower economic growth weighs against the likelihood that the rate increases will continue to pressure the dollar - gold has reversed modest early weakness and is slightly higher, while crude has given back early gains and is now slightly lower.


Little activity on the corporate and economic calendars and little is anticipated throughout the week.

  • Amkor Technology (AMKR) will redeem all $100m of its 6.25% convertible notes from Chairman James J. Kim and his family.
  • Chipotle Mexican Grill (CMG), BJ’s Restaurants (BJRI), Panera Bread (PNRA) and Red Robin Gourmet Burgers (RRGB), may be poised to decline 20% or more if “aggressive” 2011 earnings expectations aren’t met, Barron’s reported, citing analysts.
  • Cisco Systems (CSCO) may gain as demand for the equipment grows and the company initiates a dividend, Barron’s reported.
  • Dean Foods (DF) settled an antitrust lawsuit with Northeast Dairy Farmers
  • Goldman Sachs (GS) said it may grant bonuses that depend on future earnings in addition to stock performance amid pressure from regulators to design pay packages for top employees that would discourage excessive risk-taking.
  • Mylan (MYL) agreed to pay $65m to settle a lawsuit from the U.S. government and Texas related to Medicaid reimbursements
  • Netflix (NFLX) may fall as higher charges for acquiring movies hurts profitability, Barron’s reported.
  • Sierra Wireless (SWIR) may rise as growth in 4G and other mobile devices boosts demand for its technology, Barron’s said
  • WSJ is negative on MCD


  • One day: Dow +0.12%, S&P (0.16%), Nasdaq (0.22%), Russell (0.21%)
  • Last Week: Dow +0.72%, S&P +0.28%, Nasdaq +0.21%, Russell +0.34%
  • Month-to-date: Dow +5.16%, S&P +6.46%, Nasdaq +6.70%, Russell +8.52%
  • Quarter-to-date: Dow +7.28%, S&P +10.13%, Nasdaq +12.54%, Russell +16.69%
  • Year-to-date: Dow +10.98%, S&P +12.70%, Nasdaq +17.47%, Russell +26.15%
  • Sector Performance: Materials +0.36%, Energy +0.28%, Utilities +0.06%, Healthcare +0.00%, Consumer Staples +0.04%, Tech (0.17%), Industrials (0.22%), Consumer Discretionary (0.42%), and Financials (0.72%)          


  • ADVANCE/DECLINE LINE: -119 (-797)  
  • VOLUME: NYSE 615.47 (-21.52%)
  • VIX:  16.47 +6.60% YTD PERFORMANCE: -24.03%
  • SPX PUT/CALL RATIO: 2.75 from 1.54 (+78.64%)


  • TED SPREAD: 17.30 0.203 (1.187%)
  • 3-MONTH T-BILL YIELD: 0.14%  
  • YIELD CURVE: 2.74 from 2.75


  • CRB: 329.38 +0.39% (up 1.81% last week)
  • Oil: 91.51 +1.14%  (up 3.28% last week)
  • COPPER: 425.85 -0.39% (up +2.39% last week)
  • GOLD: 1,383.72 +0.32% (up +0.88% last week)


  • EURO: 1.3122 +0.10% (down -0.50% last week)
  • DOLLAR: 80.474 -0.03% ( up +0.13% last week)



  • European Markets: FTSE 100: closed; DAX: (1.28%); CAC 40: (1.11%)
  • In thin trading, Europe is weaker this morning, following declines in Asia; following the December 25th surprise rate hike in China.
  • Also on December 24th Russia’s decision to charge more on ruble deposits, another move to cool inflation, also damped market sentiment.
  • The UK is closed until 29-Dec.
  • On fears of tightening policies, car-makers are trading lower as people take profits for 2010


  • Asian Markets: Nikkei +0.75%; Hang Seng (closed); Shanghai Composite (1.9%)
  • Asian markets started higher today, as participants felt China’s raising interest rates had already been priced in, but they finished mixed.
  • Commodities fell on the rate hike, but quickly pared their losses.
  • In the lowest trading value since the first trading day of the year, export-linked shares led Japan to a modest gain up 0.75%.
  • Taiwan edged up 0.35%. Shin Kong Financial jumped 6% on expectations, leading financials higher on expectations that Taiwan’s central bank will follow China’s rate hike with one of its own.
  • South Korea fell 0.37% - car-makers fell 3-4% on Beijing’s limits for new car registrations announced last week, as well as the fear that China’s higher interest rates will reduce demand for new cars. Shippers fell 2-5% on a lower Baltic Dry Index. Banks rose, since China’s rate increase means South Korea may follow suit to combat inflation.
  • China rose in the morning on the thought that uncertainty about policymakers’ next move had now been cleared up, but dropped in afternoon trading as property, financial, and energy shares got dumped.
  • Hong Kong, Australia, and New Zealand were closed for Christmas/Boxing Day.
  • Japan November corporate services price index (1.1%) y/y, +0.1% m/m. November housing starts +6.8% y/y vs cons +4.9%.



Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.46%
  • SHORT SIGNALS 78.35%