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Luxury Things

“Poverty wants some things, Luxury many things, Avarice all things.”

-Benjamin Franklin


Yesterday, one of our young Jedi analysts at Hedgeye, Kevin Kaiser, sent me a highlight from “The Grocer” (an industry trade rag) that inflating food prices are making ordinary breakfast items like orange and apple juice a “luxury.”


Now a Wall Street analyst at a sell side investment bank would find a way to dress this data point up with a pig’s lipstick and call it an “affordable luxury”, whereas someone working for The Ber-nank in DC probably calls something like breakfast “non-core” or “free.” But we simpleton, non-recipients of government bailout moneys, just call it what it is – inflation.


Six months ago we didn’t have Global Inflation Accelerating

  1. We had a US Dollar Index that wasn’t being debauched (+7.7% higher at $83)
  2. We had a CRB Commodities Index (19 commodity basket) that was -30% lower in price
  3. We didn’t have Quantitative Guessing Part Deux either

While I’ll be the first to admit I remained too bearish on US Equities in December of 2010 (but appropriately bearish on emerging markets and bonds), I’ll also be the first to remind the fire engine index-chasers of all the emails they were sending me on August 24th of 2010 that I was “crazy” to be covering my short positions in the SP500 (SPY), Russell2000 (IWM), and Consumer Discretionary stocks (XLY).


Back then, free markets pricing in a strong US Dollar and low inflation was a bullish signal to buy US Equities. Today, you have the latest Big Government Intervention scheme Debauching the Dollar and perpetuating higher inflation. Back then, I dropped my Cash position to 46%. Today, I’ve raised it to 67%. All the while, understanding that I’m not one of these perma-bulls who needs to be invested trying to get back to a 2007 high-water mark gone bad.


Yesterday, we saw a new high-water mark established in the real-world inflation reading. With the US Dollar getting burned at the stake (down 1% on the day, making a move towards a 6 month low), the CRB Commodities Index was hitting a freshly squeezed 6-month high. All Luxury Things considered, if you are one of the 44 MILLION Americans who lives on food stamps, how do you like them apples?


Now setting aside the inconvenient truth that there’s never been a global economic powerhouse that has devalued its way to prosperity, let’s give the ole Ber-nank a little something to bring to his dance with America’s new Chair of the US Financial Services Sub-Committee on Domestic Monetary Policy, Ron Paul, on February 9th. Here are the 6-month price percentage moves in some of the things people need to live with:

  1. Cotton = +125.7%
  2. Sugar = +82.6%
  3. Corn = +59.0%
  4. Coffee = +41.4%
  5. Rice = +40.5%
  6. Oats = +36.6%
  7. Copper = +36.1%
  8. Lumber = +33.8%
  9. Oil = +25.1%

Yeah, I guess for the sake of professional policy makers in DC who get dinner for free and a car service to work, I should stop there. To make the Top 10 things that may or may not be considered Luxury Things, you really need to have inflated on the order of +25% or more. Pork bellies are only up +10.7% in the last 6 months – so go have yourself some powdered Keynesian Kool-Aid with some sausage links for lunch and like it.


Over that same 6-month period:

  1. The Buck has Burned almost 6% lower and now has an inverse correlation to the price of rice and wheat of -0.91!
  2. The 112th Congress jacked up America’s Budget Deficit projections by 34% (CBO upward revision from August to January)
  3. The countries most affected by global inflation (Asia, Africa, and the Middle East) have started to display some fairly evident social unrest

So where does that leave the almighty American Consumer? That’s easy, pull up some charts of US Consumer stocks – and pull up some big ones like Proctor & Gamble (PG), McDonalds (MCD), and Target (TGT).


Sure, since most people in this business read points of view in terms of how it directly addresses their personal positioning, I’m sure you can find me some US Consumer stocks that used to look like Coach (before the man-purse idea didn’t fly Captain Lew to the moon), but overall, Consumer Staples (XLP) and Consumer Discretionary (XLY) are the 2 worst sectors in the entire US stock market all of a sudden for a reason, down -1.84% and -0.97% in the last 3 weeks of trading, respectively.


On a more positive note, this morning The Mu-barak turned on the internet. So now all of our Egyptian friends can start tweeting Hedgeye’s 6-month table of real-world inflation to their friends again. Social networking tools are going to continue to revolutionize the transparency and accountability standards that The People of this world hold their governments to. That’s a Luxury Thing of personal liberty that I can believe in.


My immediate term TRADE lines of support and resistance for the SP500 are now 1290 and 1308, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Luxury Things - unrest

Munis: Flurry, Blizzard or Avalanche?

This note was originally published at 8am on January 28, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“No snowflake ever falls in the wrong place.”

- Ancient Zen Proverb


Both the title of this morning’s Early Look and the quote above are very apropos for the current weather gripping New Haven, CT and much of the northeastern United States. Though the mounds of snow which line our streets are several feet high, it’s “business as usual” for those of us who refuse to blame our disappointments on things like “the weather”.


Addressing the quotation specifically, the saying above traces its origins to Zen, a school of Mahayana Buddhism. Per our friends at Wikipedia, what distinguishes Zen from other schools of Buddhism is its search for enlightenment through self-realization in Dharma practice and meditation rather than a reliance on text and intellectual reasoning.


In the asset and risk management industry, an overreliance on intellectual reasoning can get us into trouble, as we often lean towards the conviction we receive from our data analysis and channel checks versus what may or may not be blatantly obvious. In fact, we’ve all been trained to fade the obvious – even sometimes to a fault.


This brings up an interesting topic that is gathering momentum in the marketplace: Muni Bonds. The divergence in sentiment between retail investors and institutional investors seems to get wider by the day, as one group (retail) rushes to avoid what is perceived by some to be a pending crisis while the other (institutional) finds current valuations as a definite reason to “fade the obvious”:

  • Yesterday, it was reported that retail investors withdrew an additional $1.9B out of muni bond mutual funds. Though down from last week’s record $4B redemption, the trailing four-week average increased slightly to $2.3B. All told, the last eleven weeks saw a cumulative outflow of $22.5B, according to Lipper FMI. That’s ~22.5% of the roughly $100B poured into the funds from January 2009 – October 2010. Yes, there’s another side to the Bush Tax Cut extension trade…
  • Amidst the selling by retail investors, asset managers have used the latest backup in yields as a buying opportunity to lock in exceptional tax-adjusted rates, sending average yields on G.O. muni bonds down (-16bps) wk/wk, as measured by the Bond Buyer 20 Index. To a lesser extent, revenue bonds were bid up as well, with yields falling (-5bps). This was the first weekly decline in muni bond yields in four weeks.

To state it bluntly, we don’t see current prices for muni bonds as an investable opportunity to “fade the obvious”. We’re neither brave nor smart enough to get in the way of a potential wave of defaults, restructurings and credit downgrades (emphasis on potential, as we disagree with Whitney that $50-$100B worth of defaults is a foregone conclusion).  You don’t need defaults for the price of a bond to go down.


Even for those brave investors who possess the analytical firepower to find value in the muni market at current yields – including the highly-regarded Lyle Fitterer – we think many of them may actually be using faulty data in their analysis. Fitterer, the top muni bond fund manager of the last decade, remarks, “The baby has been thrown out with the bathwater”; as such, he’s using the current back up in yields as a buying opportunity for specific revenue bonds.“If a State were to file bankruptcy, I have a bond with a dedicated revenue stream,” he says.


Fitterer’s comments beg the question, “What’s a revenue bond worth when it doesn’t meet its revenue target?” Probably the same as an equity that misses estimates amid bullish sentiment: less. While we’re not yet calling for a spate of “misses” across the nation, we do think the confluence of slowing domestic growth, rising interest rates and a rapidly deteriorating housing market will weigh heavily on the finances of States, municipalities and municipal authorities alike in 2011:

  1. Consistent with our Consumption Cannonball theme, we expect consumer spending to roll over in 1H11. Sales and income tax receipts combine for ~55-60% of State and local government revenues. Deteriorating fundamentals = bad for muni bonds.
  2. Consistent with our Trashing Treasuries theme, accelerating inflation on the strength of a Debauched US Dollar continues to support rising US Treasury bond yields. The Ber-nank may not see inflation, but the global bond market sure does. A rising interest rate environment = bad for muni bonds.
  3. Consistent with our Housing Headwinds Part II theme, we think US housing prices could end up down (15-20%) by the time the July 2011 Case-Shiller data rolls in (early fall). Property tax receipts make up roughly 26% of local government revenues, though they are typically assessed on a 2-3 year lag. Regardless, municipalities across the nation are running out of headway to finagle with their accounting. US housing wasn’t exactly robust over the last 2-4 years. The oncoming wave of lower property tax receipts = bad for muni bonds.

Speaking of borderline accounting fraud, a very alarming trend has emerged over the course of the most recent economic downturn. Rather than lie about their deteriorating finances, a growing number of municipalities have opted to hide them instead.


A recent study done by DPC DATA Inc. revealed that over 56% of municipal issuers did not file a financial statement in any given year between 2005 and 2009. Over 33% of them skipped filing in three or more of the past five years. In the latest year (2009), the percentage of non-filers jumped +360bps to 40.2%. An additional 30% filed “extraordinarily late” that year, according to the analysis.


It’s tough to analyze what you can’t see. Moody’s Managing Director of Public Finance, Robert Kurtter, agrees, saying on CNBC’s Squawk Box that 2/3rds of all muni issuers are unrated (1/14). And even if they we’re “rated”, we’re not buyers in blind faith of America’s ratings agencies!


Regardless of your perception of the fundamentals, the “snow” is falling in the muni bond market and the thick coat of snow accumulating serves as a metaphor for the opacity that’s associated with issuer finances. When the ice melts in the coming months, will you be holding a bag full of “unforeseen” risk because you bought the first dip after a 30-year bull market in muni bonds? We definitely won’t be – that’s for sure.


Remember, no snowflake ever falls in the wrong place.


Darius Dale



Munis: Flurry, Blizzard or Avalanche? - red


TODAY’S S&P 500 SET-UP – February 2, 2011


Equity futures are struggling to find clear direction in the wake of yesterday's surge which saw the Dow close back above the 12K level for the first time since Jun-08.  As we look at today’s set up for the S&P 500, the range is 18 points or -1.35% downside to 1290 and +0.03% upside to 1308.



  • MBA mortgage applications index rose 11.3% week ended Jan. 28. Purchases rose 9.5%, first increase since week ended Dec. 24.  Refis jumped 11.7% Avg. 30-yr fixed rose to 4.81% from 4.80% prior week; rate hit 4.21% in Oct., lowest since group’s records began in 1990
  • Refis as % of total no. of loans fell to 69.3% from 70.3%
  • Prior week’s 12.9% drop, to lowest since Nov. 2008, wasn’t adjusted for shortened MLK Day
  • 7:30 a.m.: Challenger Job Cuts 
  • 8:15 a.m.: ADP employment change, est. 140k
  • 10:30 a.m.: DOE inventories of crude (est. 2500k), distillate (est. -1000k) and gasoline (2000k) 
  • 11: a.m.: Fed to purchase $1.5b-$2.5b bonds
  • 5:30 p.m.: Fed’s Duke speaks in N.C.  


  • Egyptian President Hosni Mubarak’s pledge to step down later this year failed to appease opposition groups demanding an end to his 30-year rule. The unrest that started in the region one month ago spread to Yemen, with President Ali Abdullah Saleh saying today he won’t seek to extend his term when it expires in 2013.
  • One Equity Partners considering options for its Duropack corrugated board unit, including a sale, according to two people with knowledge of the matter.
  • Senate to take a procedural vote as early as today on republicans’ bid to repeal the U.S. health-care overhaul



Both consumer ETF’s, XLP & XLY remain BEARISH TRADE - 7 of 9 sectors positive on TRADE and 9 of 9 sectors positive on TREND. 

  • One day: Dow +1.25%, S&P +1.67%, Nasdaq +1.89%, Russell 2000 +2.26%
  • Month-to-date: Dow +1.25%, S&P +1.67%, Nasdaq +1.89%, Russell +2.26%;
  • Quarter/Year-to-date: Dow +4.00%, S&P +3.97%, Nasdaq +3.71%, Russell +1.94%
  • Sector Performance - (All 9 sectors rose): - Materials +2.86%, Financials +2.07%, Energy +1.9%, Healthcare +1.8%, Tech +1.80%, Industrials +1.69%, Consumer Disc +1.18%, Utilities +1.01%, Consumer Spls +0.7%


  • ADVANCE/DECLINE LINE: 1962 (+807)  
  • VOLUME: NYSE 1094.59 (-8.69%)
  • VIX:  17.63 -9.73% YTD PERFORMANCE: -0.68%
  • SPX PUT/CALL RATIO: 1.21 from 3.06 (-60.53%)



Treasuries ended a two-day decline on concern over U.S. unemployment and speculation that data will show the recovery isn’t strong enough to bolster the labor market.

  • TED SPREAD: 15.33 -0.609 (-3.823%)
  • 3-MONTH T-BILL YIELD: 0.15%      
  • YIELD CURVE: 2.87 from 2.84


  • CRB: 342.17 +0.22%  
  • Oil: 90.77 -1.54% - trading +0.34% in the AM
  • COPPER: 454.70 +1.98% - trading -0.11% in the AM
  • GOLD: 1,342.03 +0.37% - trading -0.44% in the AM


  • Crude oil in New York dropped from a two-year high as concern eased that supplies through the Suez Canal may be disrupted by unrest in Egypt. Brent crude traded at more than $100 a barrel for a second day.
  • Natural gas futures declined for the first time in three days as forecasts showed milder weather later this month, reducing demand for the heating fuel. 
  • Spot gold climbed, rebounding from the biggest monthly drop since 2009, on speculation that rising food and oil prices will increase the metal’s appeal as a hedge against inflation. Protests in Egypt also boosted haven demand.
  • Copper rose to a record on signs demand will remain robust in China, the world’s biggest consumer of the metal used in cars, homes and appliances
  • Soybeans rose to a 30-month high and corn climbed as a strike by Argentina’s port workers halted grain vessels, increasing demand for supplies from the U.S., the world’s biggest exporter. 
  • Brazilian exports of crude, iron ore and coffee fell in January from December as the country posted a lower-than-expected trade surplus in the month, the trade ministry said Tuesday.


  • EURO: 1.3823 +0.91% - trading +0.01% in the AM
  • DOLLAR: 77.067 -0.86% - trading -0.10% in the AM


  • FTSE 100: +0.85%; DAX +0.09%; CAC 40 +0.21%; IBEX +0.16%
  • Europe is mostly higher for a second day led by commodities and cars.
  • FTSE100 traded above 6,000 led by commodity and bank shares.
  • Egypt remains a focus after President Mubarak said he will leave office in September.
  • Advancing sectors lead decliners 10-8 with technology +1.1% and banks +0.7% heading gainers, whilst basic resources and industrial (0.8%) lead fallers.
  • UK Jan Construction PMI 53.7 vs con 49.9, prior 49.1


  • Nikkei +1.8%; Hang Seng +1.8%; Shanghai Composite (closed)
  • Asian stocks advanced the most in two months as companies reported higher earnings amid faster economic growth.
  • Commodity stocks gained the most, with Hitachi Metals’s 5.8% increase leading the sector. Mitsubishi Materials advanced 5.6%, and Ube Industries gained 4.5%. BHP Billiton gained 2.4% and Rio Tinto gained 2.6% as metals prices climbed.
  • Toyota gained 3.3% after saying U.S. sales rebounded, Paladin Energy rose 5.8% after completing an acquisition.
  • Panasonic reported 3Q net +24% y/y on strong Japan home appliance sales, full year guidance is unchanged.
  • Hong Kong finished a shortened trading day higher, and will now be closed until 7-Feb.
  • Japan went up as investors bought large-cap stocks on positive sentiment stemming from Wall Street. 
  • Australia rose, but insurers fell as Cyclone Yasi approached the country.
  • South Korea is closed until 7-Feb, Taiwan is closed until 8-Feb, and China is closed until 9-Feb for the Lunar New Year.


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The increase of commodities continues to be fairly broad-based with most of the items we follow gaining significantly week-over-week.  With the exception of Chicken Wings, all of the foodstuffs in the table below show either flat or significantly positive week-over-week price changes.


Egypt is obviously front-and-center of the geopolitical picture at the moment and commodity investors obviously keep a keen eye on geopolitical proceedings.  There is speculation about food shortages due to a lack of access or movement of ships.  At Egyptian ports, an absence of customs officials is exacerbating the disruption. 


Rice gained 8% after trading flat last week, and relative to the other commodities at the top end of the table, its year-over-year price change is quite benign.  PFCB locks in rice and, as of most recent guidance on the item, management stated that the commodity was locked in slightly favorably for 2010 and the contract continues through September of 2011. 


Wheat narrowly missed out on the top spot this week, gaining 7.8% over a week ago.  There is speculation that Egypt unrest may delay shipments and that is why prices have come down.  However, it is unlikely that the recent pullback will persist if one shares Hedgeye’s bearish view of the dollar and if speculation that the cold snap in the central U.S. plains may adversely affect dormant crops is to be believed.   PNRA expects wheat costs for 2011 to be roughly flat versus 2010, as the company currently has nearly 75% of its wheat costs locked in for 2011, modestly below the 2010 price.   Looking at the chart below, it is clear that the company is hoping that the easier comps, from a wheat cost perspective, offer them some relief.  If prices go higher, wheat could cause some margin pressure for PNRA in 2H11. 




Chicken Wings continue to offer BWLD a nice boost here in 2011.  Following a decline of almost 5% on the week, prices are lagging those of a year ago by 36%.  The chart below shows clearly that this favorability is likely to continue for BWLD through the first half of the year if prices remain roughly stable.


WEEKLY COMMODITY MONITOR - chicken wing trend


WEEKLY COMMODITY MONITOR - commodity monitor Feb 1 2011


Howard Penney

Managing Director

Europe Is Offside

Position: Short Italy (EWI); Short Euro (FXE)


In a post on 1/27 titled “Playing Europe’s Mismatch on Duration” we noted that our short positions in Italy (via the etf EWI) and the EUR (FXE) were working against us as three catalysts were giving a boost to European equity markets (especially the PIIGS) over the immediate term:

  1. Japan and China buying European debt
  2. Bullish speculation on a “comprehensive package” to tackle Europe’s sovereign debt crisis
  3. Hawkish commentary from ECB President Jean-Claude Trichet on inflation

In the note we also cautioned that over the intermediate term TREND our negative outlook on Europe, especially for the countries with high fiscal imbalances (Italy, Spain, and Portugal), remains intact.


These positions remain unchanged, and due to recent uprisings in Tunisia and Egypt European markets have received the proverbial hall pass on headline risk, and its equity markets, especially from the PIIGS, have outperformed. The threat now is significant mean reversion risk!


After all, the top 3 global equity indices year-to-date are:

  1. Greece Athex = +17.7%
  2. Italy FTSE MIB = +11.7%
  3. Spain IBEX 35 = +11.2%

Also, some of the fundamental data we follow to gauge the region’s “health” is showing signs of slowing, a concern over the intermediate term. We’ve hit on the pressing threat of inflation in our work, but forward looking indicators such as PMI surveys are signaling a topping, particular Germany, THE country “supporting” the region and divergent from Europe’s sovereign debt issues.


Final January PMI Manufacturing figures were released today from Markit (see chart). Although we’ll be more focused on the services numbers (released on Thursday 2/3), both Manufacturing and Services are indicating a slowing on the margin (despite the majority of countries reporting Manufacturing PMI improving month-over-month).  Importantly there’s a heavy line of resistance at 60 that Germany is bumping up against, and increasing the mean reversion risk.   


Europe Is Offside - mh1


Although a lagging indicator, unemployment rates across many nations, but in particular in Spain and Ireland are moving in the wrong direction. Germany remains the exception, falling 10bps month-over-month to 7.4% in DEC. Beware that austerity programs throughout Europe, which include job strikes, wage reductions and freezes, and consumer tax hikes could further bolster these figures.


Europe Is Offside - mh2


The EUR and ECB Catalyst


On Thursday (2/3) the ECB announces its refi rate. We do not expect a hike from the current 1.0% rate, despite Trichet’s recent hawkish rhetoric, which could pare back recent gains in the EUR-USD. We’d be shorting the currency (again) at its current level of $1.38 and covering it at $1.35 for a TRADE.


Matthew Hedrick


Europe Is Offside - mh3

The Breakout: SP500 Levels, Refreshed

POSITION: no position in SPY


I said this when I covered my SPY position on Friday. I said this yesterday when I chose to do nothing. And I’ll say it again - provided that both The President and The Ber-nank and sign off on a complete debauchery of the US Dollar, this market can go higher before it blows up.


Anyone who has studied the unintended consequences associated with inflation and currency crashes knows that trading the inflation associated with it works, to a point. And when that point comes, very few are positioned for the fall. Friday’s mini-me fall, hopefully, was a mini-reminder of that.


Higher-highs and higher-lows in the SP500 will be bullish in both the immediate and intermediate terms until they aren’t. From a long-term TAIL perspective however, the SP500 continues to make lower-highs. That, combined with a monstrous amount of immediate and intermediate term price momentum, sets us up for some serious TAIL risk.


Almost every other day on our the Hedgeye Macro Morning Call, I say something like this: “If they debauch the dollar, every day and every week, from this day until that, the SP500 could easily get to 1340… and then blow up.”


What was immediate-term TRADE resistance yesterday is now support at 1289. This moves my immediate term TRADE resistance line up to 1305. The US Dollar is now down for 5 out of the last 6 weeks. It’s sad to watch.



Keith R. McCullough
Chief Executive Officer


The Breakout: SP500 Levels, Refreshed - 2

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