CKR continues to stress that it will not respond to today’s environment by offering “low priced margin-impairing products,” but rather it is focus on selling “innovative, premium priced products.” At the same time, the company understands consumers are under financial pressure and that there is a critical balancing act between discounting too much (at the expense of margins) and increasing prices too much (at the expense of traffic). Management made some telling comments about just how bad QSR’s promotional landscape has gotten:

“They can’t keep this up before franchisees start filing lawsuits.”
“People this quarter were literally giving food away.”
“they can’t maintain these prices much longer

CKR also explained that adding a slice of cheese to a burger currently adds about $0.30 of costs, which puts MCD’s Dollar Menu double cheeseburger and Wendy’s $0.99 Double Stack cheeseburger into perspective from a margin standpoint.

But the reality of the situation is different that then the rhetoric. See below!

Beware October 3rd, 2008

"There is no squabbling so violent as that between people who accepted an idea yesterday and those who will accept the same idea tomorrow."
- C. Morley

Take a big red marker and circle Friday, October 3rd, 2008 on your macro calendar. For those of you who proactively prepare for market risk, this has unfortunately moved straight up on my probability chart as a potential day for the US stock market to crash.

The old boy network of Wall Street investment bankers who didn’t see this US financial crisis coming are now politically scrambling the US government to make one reactive and emotional mistake after another in order to temporarily stop gap the inevitable, marking stocks, bonds, real estate, and commodities to market. Last night, SEC chief, Chris Cox, was cajoled by the Goldman Sachs and Morgan Stanley brain-trust to ban short selling in the US Financial stocks. Let me repeat that – the US Government IS PUTTING IN PRICE FLOORS across an entire sub sector of what used to be called a free market. These guys seriously don’t get it.

It’s one thing for John Mack and Lloyd Blankfein to cry wolf and call their own prime brokerage clients (short sellers) evil doers. It’s entirely another thing for individual self serving interests to have the ability to strike regulatory and legislative change in the way that this long standing free market operates. John Mack served as Chairman of hedge fund Pequot Capital in 2005. He knows better.

There is roughly $1.5 Trillion in assets in the hedge fund community – that’s a much larger number than what Long Term Capital Management ran, fyi. Under political fire, Cox’s unprecedented and short sighted decision to lead an SEC ban on short selling in the US Financial stocks until October 2nd has massive repercussions to this market. Ahead of this, if they warned their internal prop desks to cover their shorts yesterday, that would be really bad – I hope they didn’t. Regardless, I highly doubt that they consulted Citadel’s Ken Griffin or Renaissance Capital’s Jim Simmons on this rash move, but go ask those sober and reputable risk managers what this forced SEC decision means to the structure of their hedges. The US Government is effectively going to bludgeon the risk management mechanism that prudent leaders in the investment community have proactively implemented. This is like breaking Brett Favre’s legs.

On October 19th, 1987, the Dow Jones lost 22.3% of its value. US market losses from October 10th 2007 until 1:00PM EST yesterday were approaching -27%. For 11 months, by refusing to allow a free market to mark prices to market, the US Government has chosen to enter the game, and make mistakes, at every turn. Last night’s decision may be its worst yet. They have capitulated to said “leaders” who simply do not understand how this story ends, or do, and are attempting to socialize the downside associated with their risk management mistakes. On October 3rd, 2008, this reactive decision has the potential to create selling from both the long only and short selling community in orders of volume that we have never seen.

I am not trying to be an alarmist. I do not have a self serving agenda here either. The ‘Hedgeye Portfolio’ has the transparency that these said leaders of the investment banking community still refuse to give you. In the Hedgeye Portfolio you will see that I covered my short position in Goldman Sachs a few days ago. I am not short Morgan Stanley. In fact, I am not short one name in the US Financial sector. On market weakness, I moved from 84% to 76% cash this week. The futures charging higher this morning will do nothing but enhance by YTD performance. This is not about me. This is about proactively calling out massive tail risk.

Markets across the world are raging higher this morning. Hong Kong closed +9.6%. After being halted for a few days, Russia opened up +18%, and now they are halting it again because the government cannot bear this level of volatility on the bullish side. In London, stocks are +7%, and here in the US, the reality TV sponsors of the largest global stock market mania in world history are as emotionally amped up as I have seen them since October of 2007. These people didn’t understand it then, and they certainly don’t understand it right here and now. Financial historians of this great US system of free market capitalism will remind them all that this October, fully loaded with quarter end hedge fund redemptions that are inspired by this oncoming short squeeze, may very well see history repeat.

Be careful out there,

PSS: Starting Over

I still like this name a lot. As I sit here prepping for next week’s analyst meeting, I’m staring at our sales/inventory/margin chart. It is absolutely classic retail 101. Notice the following path…

1) Business was solid in ’06 into 1Q07. Sales up, inventories down, and margins positive (and stock at $40).

2) Inventories begin to build relative to sales in 2Q and 3Q07 – both standalone PSS and resulting from Stride Rite acquisition. Margins stay positive, but hang on by a thread as inventory builds.

3) PSS can’t hold the line with margin, and by 4Q07 falls into a negative margin position – along with high inventories and low sales. Stock tests single digits.

4) 1Q08: Margins still down, but inventories clean up. Stock finds bottom.

5) 2Q08: Sales/inventory spread in perfect balance, and margins come back to year ago levels. Stock sees high teens.

6) Next stop… Sales/inventory spread goes higher, and margins trend up. As it relates to timing, we’ve got one more quarter of tough margin compares, but 3Q and 4Q are flat-out easy. Importantly, I think we’ll see top line accelerate at the same time as we start to see PSS leverage Saucony, Sperry and Keds. We’ll hear about that on Monday.

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The Race To China

With so many companies initiating or accelerating investment in China over the past quarter – I had my team dig in to when each apparel/footwear company started investing in building a Chinese consumer business (i.e. not manufacturing). It’s pretty startling when charted against the Yuan/Dollar. Some companies were ahead of the curve – such as Nike, Adidas, VF Corp, and even Jones Apparel Group (1993 – who would have thunk??). But I’m astounded by the sheer number of companies that invested in China AFTER a parabolic move in currency (bad trade) due to slowing growth in core markets. This chart shows proactive versus reactive strategic planning at its best.


The offsetting relationship between Strip table hold percentage and Strip volume appears to breaking down. If sustained that is bad for Las Vegas. Hold percentage has served as sort of a hedge when table volume dries up. Both important metrics are now in descent.

The first chart graphs Las Vegas Strip table (excluding Baccarat) hold percentage, drop, and US retail sales. As expected, US retail sales and table volume move pretty much in tandem. Surprisingly, table hold percentage actually tracks inversely to the other variables. Moreover, the relationship of all three is statistically significant (see the correlation table).

  • I have to say I was surprised and almost shocked at the correlation. Table hold percentage is not really “statistically derived” like slot hold percentage. Obviously, a slot machine is computerized and can measure exactly how much is wagered. A table game cannot. The table hold percentage is calculated dividing casino win or revenue by drop. Drop is simply the amount of chips exchanged for cash regardless of how much is actually wagered. I had posited that gamblers are less likely to wager as much when times are tough. They still may take out as many chips but would actually spend less time at the table wagering those chips. This would have the effect of lowering the hold percentage during an economic slowdown. Moreover, in order to attract more gamblers in difficult times, casinos could provide better payouts on blackjack or even offer more single deck table games. I guess I was wrong.
  • Possible explanations for the counterintuitive relationship between volume and hold %? Discounted room rates attract a lower end customer that plays less but plays stupid and plays more “house” games (lower odds). Another potential answer is more psychological. Players may be more disciplined in limiting chips to how much they are willing to lose which likely gives them the security to play longer. Volume down, hold percentage up.

  • These explanations are only possibilities. What is interesting is that there are more factors at play than just “luck”. Think about that the next time an analyst justifies a string of bad months based on low hold percentage. What is disconcerting now is that hold percentage and volume have been moving down in tandem as of late. Maybe I’ll be right after all.
Historical hedge between volume and hold % breaking down
Economy drives volume, hold % inversely correlated to both

"Evil Doers", Continued...

In what looks to be the most ridiculous comment of the day by the US Financial system's said leadership, New York's Attorney General, Andrew Cuomo, is asking the SEC to "freeze short selling" in the US Financials!

Are you kidding me Andrew? Do you have any idea what this kind of reckless political rhetoric can do to the market? If you think Long Term Capital Management blowing up was a problem, go right ahead and test your politically convenient theory here and see what happens if the entire hedge fund community has to pull their hedges.

Worse yet, consider the implications to the few money managers and individuals out there who have proactively hedged their portfolios for what has turned out to be an unmitigated disaster in risk management by the executives of our publicly held investment banks.

We cannot continue to manage this Financial Crisis reactively. Now that John McCain has thrown his thought partner, George Bush, under the bus today, I have no idea who is going to provide some sensible, calming, proactive leadership – but, boy, do we need it, fast!


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