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Men of Conformity

“I would rather be a man of conviction than a man of conformity.”

-Martin Luther King, Jr.


When I read, I flag pages and write in them. It’s my way of taking some time to get lost in thought and scribble about what lessons history might provide me in preparation for today. Last night, as I was finishing "The Autobiography of Martin Luther King, Jr.", I found that timeless leadership quote.


It’s certainly not a quote for modern day American politicians. As King goes on to say on page 342, “… there comes a time when one must take a position that is neither safe, nor politic, nor popular, but he must do it because Conscience tells him it is right.”


While I can’t imagine that Presidents George Bush or Barack Obama have a conscience that would lead them to believe that burning America’s currency at the stake is right, there are certainly many Men of Conformity who have been advising them by example of cowardice.


Whether you think Henry VIII clipping his citizenry’s coins caught up to him in the end, or whether you think that modern day American Presidents backing fiscal and monetary policies that debauch America’s dollars will equate to many globally interconnected consequences, no man, woman, or child will ultimately make the call on either. History will. And in this case, I’d rather be the man who sides with history’s lessons.


Before I dig in on the unintended consequences associated with a debasement of the world’s reserve currency, let’s look at what the US Dollar has done across multiple durations:

  1. Immediate-term TRADE (3 weeks or less): down, literally, almost every day since the President’s State of the Union Address and the Fed’s January FOMC statement.
  2. Intermediate-term TREND (3 months or more): up for 7 out of 8 weeks post US Midterm election promises, but down for 5 out of the last 6 weeks on the probability increasing that those promises are broken.
  3. Long-term TAIL (3 years or less): lower-highs and lower-lows -a national embarrassment.

Now if you can show me one man in an American position of fiscal or monetary policy setting power who shows any conviction in backing a strong US Dollar – just one man – I’ll readily accept this claim and consider why he has had no impact on the US Dollar where it matters – on the tape.


If you’ve studied economic history across long-dated cycles (yes, beyond The Ber-nank’s preferred point-in-time academic dogma of the great depression), you’ll already have learned that currency crashes and inflation are globally interconnected risks.


In fact, most modern day risk managers who have read Reinhart & Rogoff’s "This Time Is Different" have learned that there is a pattern that has repeated across 8 centuries of economic data. A simple way to consider this would be to re-read, rethink, and re-learn the lessons Reinhart & Rogoff outline in Part IV – Banking Crises, Inflation, and Currency Crashes where the sequence of chapters are as follows:

  1. Chapter 10 – Banking Crises (America has been there, done that)
  2. Chapter 11 – Default Through Debasement (America bailed some of these currencies (stock prices) out, but the national story is far from over)
  3. Chapter 12 -  Inflation and Modern Currency Crashes (America is in motion on this front – and in some cases, cheering it on)

So rather than reacting to the next country that erupts into social chaos against governments who are lying to them about real-world inflation, my advice would be for both the President of the United States and his Keynesian advisors to do the required historical reading. Remember gentlemen, conviction or not, a successful national currency landing will depend on whether your preparations meet this opportunity.


All is not yet lost. With some conviction and focus, America can arrest the social unrest associated with Global Inflation Accelerating – but this can no longer be willfully neglected. Again, for the 44 million Americans on food stamps, it’s time.


If you don’t think it’s time, take a gander at this morning’s Global Macro grind:

  1. The CRB Commodities Index (19 commodity basket) was up another +1.8% yesterday closing at its highest levels since October of 2008.
  2. Inflation, as measured by the CRB basket, is up +29% since Ben Bernanke opted for Quantitative Guessing II in Jackson Hole, WY.
  3. Dr. Copper is hitting a record high this morning at $4.48/lb (all-time records aren’t deflationary are they Mr. Ber-nank?)
  4. Oil prices are breaking out again to new intermediate-term highs with WTI Oil breaking out above our immediate term TRADE line of $90.21
  5. Food prices, measured by the UN’s basket, continue to hit all-time highs – from corn to rice, yes, this is a crisis for the world’s poor.
  6. South Korea’s inflation rate shot up to +4.1% in JAN versus 3.5% in DEC
  7. Indonesia’s inflation rate continues to rise with CPI for JAN 7.02% versus 6.96% for DEC
  8. Brazil’s CPI is now tracking up +11.5% y/y in JAN versus 11.3% in DEC
  9. Ivory Coast, which is seeing massive inflation in Cocoa prices, became the 1st country to default on their debt overnight ($2.3B in Eurobonds)

And again, for those fans of the Fiat Fools who say this has nothing to do with a humble looking bald man with a beard, that’s just a charlatan’s way of ignoring the math. Here are the refreshed inverse correlations between the US Dollar Index and major global food prices:

  1. Cocoa = -0.91
  2. Wheat = -0.90
  3. Rice = -0.88

Notwithstanding that US farmers are planning to plant the fewest acres of rice since 1989 (they make more money planting things like corn), and the global supply shortages we are seeing associated with flooding and/or countries engaging in revolutions, the simple reality here is that mostly every major food staple in the world is keying off of what the US Dollar does every day – and yes, Mssrs Obama and Bernanke, that Burning Buck stops with you.


My immediate term TRADE lines of support and resistance for the SP500 are now 1276 and 1297, respectively. I remain long of inflation and bought my Sugar (SGG) back in the Hedgeye Portfolio yesterday. Being long inflation also means being short bonds and emerging markets.


Being long inflation is an explicit conviction that the Ben Ber-nank will remain a Man of Washington Conformity.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Men of Conformity - obama

CHART OF THE DAY: Men of Conformity & Sponsors of Global Inflation



CHART OF THE DAY: Men of Conformity & Sponsors of Global Inflation -  chart of the day

Egypt and the growing problem of global inflation

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TODAY’S S&P 500 SET-UP – February 1, 2011


Equity futures are trading above fair value in a continuation of Monday's gains with geopolitical concerns more than offset by a mix of corporate earnings, ongoing M&A and positive economic data. Overnight, China's PMI data fell to a 5-month low suggesting the government's fiscal tightening policy is starting to filter into the manufacturing component.  As we look at today’s set up for the S&P 500, the range is 21 points or -0.79% downside to 1276 and +0.85% upside to 1297.



  • The ISM factory index probably grew for an 18th consecutive month, to 58 in Jan., and construction spending probably rose 0.1% in Dec., economists said. Due 10 a.m. ISM prices paid, Jan. 73.5, prior 72.5
  • 10 a.m. Construction spending, Dec., est. 0.1%, prior 0.4%
  • 11 a.m.: U.S. buys $1b-$2b TIPS
  • 11:30 a.m.: U.S. sells 4-wk bills
  • 4:30 p.m.: API inventories, Jan. 28
  • 5 p.m.: Domestic vehicle sales, Jan., est. 9.55m, prior 9.46m; total vehicle sales, Jan., est. 12.60m, prior 12.53m
  • 5 p.m.: ABC consumer confidence, Jan. 30, prior -44  


  • Anadarko (APC)4Q adj. EPS 29c vs est. 21c
  • Eastman Chemical (EMN) 4Q EPS miss, sees 1Q EPS above est.
  • Fifth Street Finance (FSC US) will sell 10m shrs
  • Hologic (HOLX) 2Q EPS forecast below est.
  • Hovnanian (HOV) will offer $150m of notes, $50m class A common stock, 3m tangible equity units
  • ICU Medical (ICUI) sees 2011 EPS $2.25 vs est. $2.22
  • Lincoln Electric (LECO) acquired Arc Products. No terms
  • McKesson (MCK) sees 2011 EPS $4.82-$5.02. Est. $4.83
  • Parexel (PRXL) sees 2011 EPS $1.24. Est. $1.27
  • Rent-A-Center (RCII) sees 2011 EPS $2.90-$3.10. Est. $3.01 



5 of 9 sectors positive on TRADE and 9 of 9 sectors positive on TREND. 

  • One day: Dow +0.58%, S&P +0.77%, Nasdaq +0.49%, Russell +0.75%
  • Month/Quarter/Year-to-date: Month/Quarter/Year-to-date: Dow +2.72%, S&P +2.26%, Nasdaq +1.78%, Russell (0.31%)
  • Sector Performance - (6 sectors up and 3 down): - Energy +2.87%, Materials +1.67%, Financials +0.92%, Industrials +1.14%, Tech +0.62%, Healthcare +0.22%, Consumer Discretionary +0.22%, Utilities +0.22%, and Consumer Staples (0.35%)


  • ADVANCE/DECLINE LINE: 1155 (+3232)  
  • VOLUME: NYSE 1198.78 (-9.42%)
  • VIX:  19.53 -2.54% YTD PERFORMANCE: +10.03%
  • SPX PUT/CALL RATIO: 3.06 from 2.32 (+32.49%)



Treasuries were weaker with slight steepening; 2s10s widened ~4bps

  • TED SPREAD: 15.33 -0.609 (-3.823%)
  • 3-MONTH T-BILL YIELD: 0.15%      
  • YIELD CURVE: 2.84 from 2.82


  • CRB: 341.42 +1.78%  
  • Oil: 92.19 +3.19% - trading -0.79% in the AM
  • COPPER: 445.85 +1.96% - trading +0.44% in the AM
  • GOLD: 1,337.07 -0.45% - trading +0.04% in the AM


  • The Thomson Reuters/Jefferies CRB Index of 19 raw materials extended a rally today to the highest since October 2008. This month, cotton and copper rose to records, while hogs climbed to a 24 year-peak. Adverse weather has slashed global crops, and the U.S. and Europe kept borrowing costs low to bolster economic.
  •  Oil surged to the highest price in more than two years and Brent crude topped $100 a barrel as a seventh day of unrest in Egypt raised concern that supplies may be disrupted. 
  • Copper rose to a record in London after metal inventories had the biggest decline in almost 11 months, signaling demand is redounding in the U.S. 
  • Wheat rose in Chicago for the first time in three sessions as North African and Middle East importers may take advantage of lower prices to build supplies in an effort to keep food prices stable amid political unrest.  Wheat fell 3.6 percent in the two sessions before today.
  • Coffee rose to the highest price since 1997 in New York and reached a 28-month high in London on signs that supplies will fail to keep up with demand.  Stockpiles monitored by the New York Board of Trade fell to 1.64 million bags for Jan. 27, the exchange said the next day.


  • EURO: 1.3738 +0.64% - trading +0.29% in the AM
  • DOLLAR: 77.737 -0.51% - trading -0.35% in the AM


  • FTSE 100: +0.47%; DAX: +0.68%; CAC 40: +0.66%
  • European markets mostly trade higher with the periphery lagging as worries over Egypt took a back seat and sentiment was helped by Wall Street's solid close, firmer markets in Asia and constructive regional economic data.
  • Major indices saw session highs early before modestly paring gains. Advancing sectors lead decliners 17-1, with oil & gas +1.8% (though BP trades lower (1.7%) post its update) and chemicals +1.3% leading gainers and financial services and retail leading laggards trading little changed. US futures trade higher
  • UK Jan house prices (1.1%) y/y vs con (1.0%)
  • Jan Manufacturing PMI, France 54.9 vs con 54.3, Germany 60.5 vs con 60.2, EuroZone 57.3 vs con 56.9, UK 62 vs con 57.9
  • Germany Jan unemployment rate +7.4% vs con +7.5%; jobless change (13k) vs con (10k)
  • UK Dec mortgage approvals 42.6k vs con 47.0k


  • Asian Markets: Nikkei +0.36%; Hang Seng +0.2%; Shanghai Composite +0.3%
  • Most Asian markets edged up to follow Wall Street this morning, as worries about Egypt took a back seat in people’s minds.
  • In Japan, Honda rose on strong earnings.
  • Technology and carmaker stocks rose, but South Korea finished flat.
  • Australia finished flat, though resource stocks gained on higher commodity prices. Australia leaves interest rates at 4.75%, as expected
  • Taiwan is closed until 8-Feb.
  • China January Purchasing Managers Index 52.9 vs December 53.9. January input prices subindex 69.3 vs December 66.7. HSBC January Purchasing Managers Index 54.5 vs December 54.4.

THE HEDGEYE DAILY OUTLOOK - 2 1 2011 6 45 14 AM 

TGT: YouTubing a Changing Tune

Back in mid-August, we published a note articulating the Bull and Bear cases on TGT.  At that time, I was admittedly in the Bullish camp with Brian centered on the other side.  So far, many of the bullish underpinnings of the Target outlook have not materialized as I expected- at least not as consistently and not as quickly.  That’s not to say that over time the company’s strategies to drive topline growth in an uncertain macro environment are a complete failure.  Instead, it is likely that these strategies will take time to materialize and will result in a choppy topline along the way.  This, in conjunction with Keith’s bearish stance on the name, leaves us far less optimistic in the near term on TGT shares.  Below we YouTube our original bullish thesis (in white) and update each point accordingly (in blue). 


Topline has more drivers now, ex-macro, than it has had in some time.  The company’s focus on rolling out the 5% rewards/loyalty program and the continued rollout of P-Fresh is accretive to sales.  Management says each could be worth 1-2 pts of comp on an annualized basis.  Clearly there is something they are seeing in the Kansas City test market (loyalty) and in the P-Fresh remodels to give them confidence.  Either way, both company led initiatives offer internally generated sales drivers that others (i.e. WMT) don’t appear to have. 

Update:  With disappointing same store sales growth of just 0.9% in December and January’s expectations racheted down (in part due to weather) we believe the topline is not likely to show a material snap back in such a short post-holiday period.  Yes, we’re aware that electronics and toys were in large part the culprit for underperformance over the holidays, but these categories don’t go away now that Christmas has passed.  With the market expecting an acceleration in sales, categories beyond food have to work. 

 Traffic is the key here, an TGT clearly has momentum.  More food and consumables=more traffic.  This also leads to opportunity, which in this case may mean a customer picks up an additional non-food item on any given trip.  Probably works.

Update:  Perhaps the consumables-driven traffic enhancing strategy will take longer to materialize.  This concerns us primarily because inflation is now here and most anecdotes suggest that WMT and others are likely to become more aggressive on price.  More food does in theory mean more visits.  However it also means more competition.  In this case, we believe the competitive environment is heating up on the margin, not good for any major player in the space let alone a growing one in TGT.


Management disciplined about opening new units in this environment, instead using capital to fund .com infrastructure and P-Fresh remodels.  We like the conservative approach and discipline in not growing for the sake of growth.  Yes international is still on the table, but we suspect that means Canada first.  There is no rush here and this is a positive for cash flow.

Update:  Canada expansion came sooner than we expected and we applaud the move.  Yes this will be the biggest use of company’s cash in many years and we think it will be worth it.  However, this really has no bearing on the intermediate or near-term as the timing of the deal makes this more noise than anything else over the next couple of quarters.  Stores are slated to open in 2013 which means we should expect 2012 to be a year in which start-up costs weigh on the P&L.  Keep in mind that the less competitive Canadian market has provided a backdrop for WMT, COST, and BBY to operate their most profitable divisions.  This will ultimately be a net positive, but for the longer term.


Aggressive pricing activity from Wal-Mart seems to be a perpetual thorn in the side of traditional grocers and now BJ’s.  However, TGT has clearly found a way to compete effectively.  The introduction of the “Up and Up” private label brand and differentiated store and merchandise assortment seems to be keeping Target relatively insulated from pricing pressure issues.  Perhaps this past quarter is the best example of this, where core retail gross margins were up 5 bps while WMT and BJ both saw pressure as they took prices down.  We don’t need to remind anyone of the trend in grocery margins.  The bottom line here is Target’s success away from commodity consumables affords better margins.

Update:   In the short run, we can’t underestimate the rhetoric and the reality of a more aggressive WMT.  Whether you believe the NY Post article from this morning, or the one from last week highlighting WMT’s fear of dollar stores, there is an increasing amount of concern for MORE aggressive pricing activity from the world’s largest retailer.  Short of a price war, lowering prices in an inflationary environment is a dangerous spot for TGT to follow, especially when they price against a spread on national brands with WMT.  


Credit card portfolio risk gradually dissipating for two reasons.  One, the overall credit environment is improving leaving opportunity to reduce reserves.  Secondly, Target is shrinking its receivables base as tighter credit restrictions and increased government restrictions no longer allow for unabated growth.  Target also discontinued its co-branded Visa program, which leaves future receivables growth entirely tied to store sales. 

Update:  In conjunction with Canadian expansion comes an announcement that TGT is looking to actively pursue a sale of its credit card receivables portfolio.  This would clearly offload a majority of the risk associated with “owning” the portfolio’s receivables and also leave the company with a slightly less complex corporate structure.  However, this is not a simple sale, as management notes that such a transaction would need to retain operational control of the financial services business.  In other words, a sale is possible but it’s not likely to be a 100% break with the retail business.  Still, selling the assets now rather than waiting for credit quality or the regulatory environment to deteriorate makes sense.  Still we think near term sales and margins trump the risk of being short if this transaction takes place.


Expense pressure from investments in dot.com will remain through 2011 as the company carries duplicative costs during the transition away from Amazon (TGT’s outsource partner).  The flip side here is we should see leverage on such investments begin to materialize in 2012, the year in which Target.com becomes fully operated in-house.

Update:  This still holds true but with a new twist.   Costs to ramp up Canada in 2012 are more than likely to trump any benefits resulting from a wholly owned and operated .com infrastructure.  Longer-term both assets are a positive.


Management has clearly articulated the benefits of adding incremental food/consumables sales into their boxes via the P-Fresh remodel.  However, the result over time will be lower gross margins and commensurately lower SG&A.  Net, net EBIT rate should remain unchanged.  While in theory this makes sense, we know that investors are not fully onboard with trading margin for expense savings.  Over time, this will become more clear.  In the nearer term, headline gross margins could remain under pressure from this mix issue alone.

Update: In the absence of an accelerating topline, we may be setting up for a situation where both gross margins AND sg&a are under pressure as the company goes up against tough 2010 comparisons in the first quarter.  Inflation should not be a surprise to anyone at this point, but the confluence of food/consumable increases and price hikes on apparel and home out of Asia (internally sourced goods) make for a challenging earnings leverage situation.


While TGT offers a more discretionary play vs. WMT, it also offers greater visibility over the intermediate term in my view.  The two strategies currently underway to drive topline results have been tested.  We already know that inventory management coupled with differentiated product helps Target to drive a higher EBIT structure than WMT.  While the Street may be excited to learn that WMT has dialed back rollbacks (after they didn’t work to drive demand elasticity), the non-consumables part of the story is still very much in limbo.  This is the single biggest wild card in the WMT story and one that in our view, has not been answered by a few mid-game personnel changes. 

Update: Target is quickly becoming a show-me story after having the benefit of the doubt on topline initiatives heading into 4Q.  We don’t disagree with management’s strategy over the longer term and believe the company’s merchandising expertise still differentiates the box from WMT and others.  However, the margin structure here is changing due to mix and the topline is beginning to show signs of volatility  at a time when then the relative outperformance and consistency was expected to take hold.  The risks outweigh the reward here in the near-term, especially with January sales being reported later this week and the company  having already pre-announced 4Q EPS.  Official results and 2011 guidance will come on February 24, long after the debate about WMT’s woes and rub-off impact on TGT become more commonplace.


TGT: YouTubing a Changing Tune - TGT sigma


Eric Levine


Brent Oil Sees Inflation . . . And Continued Upheaval in the Middle East

Conclusion: Brent oil broke the $100 barrier today, with little fanfare except to those European consumers who buy gasoline created from Brent.   Additionally, despite a strong couple of months for Brent, it continues to trade higher suggesting political upheaval in the Middle East may be poised to accelerate.


Globally, oil is up as much as 3% today on the back of accelerating tensions in Egypt.  As it relates to global production, Egypt is not a meaningful player.  The country produces ~650K barrels of oil per day, which is roughly in-line with its domestic consumption.  The key oil supply and demand factor relating to Egypt to focus on is related to transportation.


The Suez Canal links the Mediterranean and Red Seas and is considered to be one of the world’s chokepoints for energy.  It is estimated that more than 35,000 ships travel through the Suez Canal every year and that approximately 10 percent of those are petroleum tankers.  In recent years close to 2MM barrels per day of oil has been transported through the Canal, which is about 2.5% of the world’s daily oil consumption.


Given that the Suez Canal is located in Egypt, there is some risk that accessibility to the Canal could change with a less stable regime in place in Egypt.  Or, alternatively, as tensions escalate and are prolonged in Egypt, shipping companies may be less willing to utilize the Suez Canal.  As it relates to the last point, we have already seen global shipping companies begin to back out of Egypt.  Earlier today Danish shipping and oil conglomerate, A.P. Moller-Maersk, suspended its port terminal operations and closed its shipping offices located in Egypt.


Since the Middle East, via the Suez Canal, is a key supplier to European oil markets, it is no surprise that we are seeing, and have seen, the price of Brent Oil accelerate upwards.   As highlighted in the chart below, Brent recently surpassed $100 per barrel.  This is more than an $8 premium above West Texas Intermediate (WTI).  In effect, the demand for Brent Oil (it is sourced in Europe from the North Sea) increases with the perception that oil coming from the Middle East to Europe will be costlier to ship.


Interestingly, both Brent and WTI were at roughly $85 per barrel on December 1st, 2010.  Since early January, Brent has outpaced the price performance of WTI dramatically and correctly predicted the acceleration of popular upheaval in the Middle East.  Despite Brent being up more than $15 in the last two months, the price increase is still not abating, which suggests the issues in the Middle East may get worse before they get better.


Daryl G. Jones

Managing Director


Brent Oil Sees Inflation . . . And Continued Upheaval in the Middle East - 1

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