Known Unknowns

This note was originally published at 8am on February 04, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

"Reports that say that something hasn't happened are always interesting to me, because as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns -- the ones we don't know we don't know.”

-Donald Rumsfeld


A few nights ago, I participated in a panel on CNBC’s The Kudlow Report to discuss the outlook for the U.S. equity markets.  Interestingly, my co-panelists were an actor, Tommy Belesis, who was featured in Wall Street II and Lee Munson, who is not an actor, at least professionally, but is a veritable Jim Carey wannabe.  Larry asked all three of us about Egypt and both of my co-panelists suggested the spread of democracy would be a great thing for the markets.  Call me a nerdy hockey player from Yale, but my response was a bit more nuanced.


Stepping back for a second, I tend to agree that the proliferation of democracy is a positive force in this world.  (Hopefully that goes without saying.)  From a pure geo-political risk perspective, there are very few examples of modern democracies going to war.   Thus, the more democracies there are globally, the more likely it is that there will be less armed conflict between nation states.  This is a positive when considering a risk premium to apply to certain equity markets.


As it relates specifically to Egypt, the view I articulated the other night is that the outcome is very uncertain.  We don’t know that this is the onset of flourishing democracies in the Middle East.  Further, we don’t know what the unintended consequences of a regime change in Egypt will be.  As Former Secretary of Defense Rumsfeld notes above, the outcome of this historic last month of protests in the Middle East is, at best, a “known unknown.”


The benefit in having our headquarters at the Taft Mansion on Yale’s Campus is more than just easy access to Yale Hockey games at historic Ingalls Rink, but also easy access to Yale’s academic engine.  To the last point, we are hosting a call at 10 a.m. for institutional subscribers and prospects with Yale Professor Charles Hill.  The title of the call is “Analyzing the Geopolitical Chessboard: Is This Checkmate for American Influence in the Middle East?” If you’d like to join us for the call, please ping sales at


Rather than acting, we decided to bring in an expert to discuss the situation in the Middle East and North Africa.  Professor Hill teaches the Grand Strategy class at Yale, and is the former Chief of Staff of the State Department, an advisor to former Secretary of State George Shultz, and former Secretary-General of the United Nations Boutros Boutros-Ghali.  Needless to say, Professor Hill forgets more foreign policy strategy in a day than most of us will ever know.


Currently, the primary issue as it relates to U.S. foreign policy in the Middle East is centered on the future of Egypt, which has been a long standing ally of the United States in the region.   After the 1973 Arab-Israeli War, Egyptian foreign policy shifted under Anwar Sadat, who opted to pursue a peace process with Israel, which he believed was in the best long term interest of Egypt.  As a result, the U.S. has been a major sponsor of both military and economic aid to Egypt.  In fact, Egypt is the second largest non-NATO recipient of military aid from the United States after Israel.


From an economic perspective, Egypt is the 27th largest economy in the world and, perhaps more importantly, controls the Suez Canal, which connects the Mediterranean and Red Seas.  The key benefit of the Suez Canal from a global economic perspective is that it allows water transportation from Asia to Europe without the need to circumvent Africa.  In aggregate, the Suez Canal carries almost 8% of the world’s sea trade.


Egypt’s strategic and economic importance can obviously not be understated in global affairs, and whilst it is difficult not to support popular protests against a non-Democratic regime, such as the one run by Hosni Mubarak in Egypt, as risk managers we also need to understand the alternatives.  If Mubarak was nothing else, he was a strong American ally in the region.


The debate over the future of Egypt currently centers on the role in which the Muslim Brotherhood will play.  The Muslim Brotherhood is the world’s largest and oldest Islamic political group, and was actually founded in Egypt in 1928.  Currently, the Brotherhood is banned in Egypt, but in the post-Mubarak era, the Brotherhood will have a role which could shift Egyptian foreign policy quite dramatically.  In fact, a leading member of the Muslim Brotherhood, Muhammad Ghannem, recently said to the Arab Press, “The people should be prepared for war against Israel.”


There are some that believe the Muslim Brotherhood is an effectual organization.  This was best articulated by Scott Atran, author of "Talking to the Enemy: Faith, Brotherhood and the (Un)making of Terrorists", in the New York Times yesterday when he wrote:


“Ever since its founding in 1928 as a rival to Western-inspired nationalist movements that had failed to free Egypt from foreign powers, the Muslim Brotherhood has tried to revive Islamic power. Yet in 83 years it has botched every opportunity.”


On the other side of the debate is Dr. George Friedman from STRATFOR who recently wrote:


“The demonstrations open the door for the Muslim Brotherhood, which is stronger than others may believe. They might keep the demonstrations going after Hosni leaves, and radicalize the streets to force regime change. It could also be the Muslim Brotherhood organizing quietly. Whoever it is, they are lying low, trying to make themselves look weaker than they are — while letting the liberals undermine the regime, generate anti-Mubarak feeling in the West, and pave the way for whatever it is they are planning.”


As for where Hedgeye stands, we covered our short Egypt position yesterday (via the etf EGPT) in our Virtual Portfolio.

Keep your head up and stick on the ice,


Daryl G. Jones

Managing Director


Known Unknowns - mass

Fooling The People

“If you once forfeit the confidence of your fellow citizens, you can never regain their respect and esteem.”

-Abraham Lincoln


In the same quote Lincoln went on to point out that while “it is true that you may fool all of the people some of the time… and “you can even fool some of the people all of the time”… “but you can’t fool all of the people all of the time.”


So how is The Ber-nank doing in Fooling The People of the United States of America that the inflation of the US stock market is good?

  1. Confidence – in the week that The Inflation he is playing for in US stocks was booming (SP500 +2.7% last week), the weekly ABC US Consumer Confidence reading got hammered down to -46 versus -41 in the week prior (those are minuses).
  2. Trust – in the latest poll, when asked “who do you think the Federal Reserve Chairman Ben Bernanke cares about more, Wall Street or Main Street?”, only 20% replied Main Street (even Geithner had a higher trust reading than Bernanke on that score).
  3. Invested Position – “91% of all equity holdings in the United States held by the top 20% income group in the country. The top 1% own 38% of all the equity valuation.” (from David Rosenberg and Zero Hedge yesterday).

Now if The People of America were as stupid about what’s in their wallets as the Fed must think they are, they’d be plowing through their snow covered driveways and barging through the doors at The Lehman Brother to open a brokerage account. Oh, wait – The Lehman Brother is gone – maybe that’s why Americans aren’t investing their confidence and trust in The Ber-nank’s inflation. Maybe it’s the snow and closed for business thing?


Whatever your opinion of the Incumbent 23rd Chairman of the Federal Reserve, odds are that if you are in the business of being long the inflation (stocks), after a +93.8% rally from the March 2009 low, you’ve got to be happy. I am.


But, to be crystal clear on this, you and I are not America  - and neither is a humble looking central planner who thinks he knows exactly how this is all going to play out. Some Americans were fooled by that when the perma-bulls were cheering Bernanke on to provide the “shock and awe” of interest rate cuts in late 2007 and early 2008. But you can’t fool all of America again on this Mr. Bernanke – not this time.


Sadly, at the end of the day this is all about storytelling and the worst part about the marketing message behind the Austrian versus Keynesian economic views right now is probably that Ron Paul is the one delivering the commercials. He’s much better in print than he is on TV. What Americans really need is Robert Rubin to massage this concept of how debauching the US Dollar perpetuates American unemployment.


Unfortunately, Robert Rubin isn’t for hire anymore. Last I heard he is living large and licking his Doritos fingers, forgetting that he didn’t foresee another sovereign debt default cycle pending.


Back to Fooling The People


In a recent survey from Selzer and Co., 7 out of 10 respondents said “the US is deliberately keeping the dollar low against other currencies, while only 1 in 4 think it’s letting the market decide the value of the greenback.”


I get it. The world’s largest bond fund manager gets it (see Bill Gross’ latest monthly letter). The American People get it. The Chinese get it. And now, even 2 of The Ber-nank’s Federal Reserve Presidents came out yesterday to remind the land of the living that they get it!


Yesterday, Federal Reserve Bank of Richmond President Jeffrey Lacker and Federal Reserve Bank of Dallas President Richard Fisher came out explicitly acknowledging both The Inflation trends in the global economic system and the need for the independent Federal Reserve to address it.


“I will be at the forefront of the effort to trim back our Treasury holdings and tighten monetary policy at the earliest sign of inflationary pressures are moving beyond the commodity markets and into the general price stream.”


Well done, Mr. Fisher.


What’s most important about these dissenting Fed Head comments is the timing. Today, The Ber-nank is going to testify in front of the Congress that what is scaring the living daylights out of the US bond market (inflation) is wrong and that he, our Almighty Central Planner, is right.


This isn’t a centrally planned Russia folks. This is America  - and the next person who tells you our red, white, and blue free-market is what it used to be needs to go back and re-read the Constitution. As Steve Hanke states most succinctly, “the Constitution was designed to govern the government, not the people.”


Before you listen to Bernanke’s politicized view this morning, let me leave you with three Austrian economic thoughts (paraphrasing von Mises), because Ron Paul is going to have two thought leaders from this school lay down the opposite side of the Keynesian case today at the sub-committee meeting on Domestic Monetary Policy (that Bernanke won’t attend) in Washington, DC:

  1. Controlling Prices - “The metaphorical expression “price level” must never be used… with prices there is no such thing as a “level”… prices do not change at to the same extent at the same time” … as a central planner promises.
  2. Inflation’s Social Stratification - “When inflation starts, different groups within the population are affected by this inflation in different ways. Those groups who get the money first gain a temporary benefit.”
  3. Devaluation of a Currency - “If one devalues the currency and the workers are not clever enough to realize it, they will not offer resistance against a drop in real wages, as long as nominal wage rates remain the same.”

Sorry, Mr. Bernanke. Apparently America’s Main Street workers are clever enough. America’s small business owners aren’t hiring because they get this too. Best of luck out there in the Twitter-sphere and YouTube channels of modern day transparency in continuing to fool some of the people from here on in – the 60 Minutes gig isn’t working.


My immediate-term support and resistance lines for the SP500 are now 1303 and 1332, respectively. God Bless America.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Fooling The People - d1


Fooling The People - d2

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TODAY’S S&P 500 SET-UP - February 9, 2011

Equity futures are trading below fair value as the recent upward trend looks to be stalling amid a lack of fresh catalysts. As we look at today’s set up for the S&P 500, the range is 29 points or -1.63% downside to 1303 and +0.56% upside to 1332.


On Tuesday, indices again found the path of least resistance to be to the upside, but other than the improving economic backdrop there was little obvious justification for the performance; especially given China's interest rate move.



  • MBA mortgage applications index fell 5.5% week ended Feb. 4.; Refis down 7.7%, purchases fell 1.4%; both had gained prior week
  • Rate on 30-Yr fixed-rate mortgage rises to 5.13%, above 5% for first time since April 2010, below 5-yr avg of 5.66%
  • 8:30 a.m.: WASDE commodities
  • 10 a.m.: Fed Chair Bernanke testifies at House Budget Committee
  • 10:30 a.m.: DoE inventories
  • 1 p.m.: U.S. to sell $24b notes
  • 6:45 p.m.:  Fed’s Lockhart speaks on U.S. outlook in Atlanta


  • Bullish sentiment increases to 53.4% from 52.7% in the latest Investor's Intelligence poll; Bearish sentiment increases to 23.3% from 22.0%; those expecting a market correction decreases to 23.3% from 25.3%.
  • Morgan Stanley may turn its remaining proprietary-trading group into an electronic client-trading unit, two people with knowledge of the matter told Bloomberg
  • St. Joe hires Morgan Stanley to help it explore strategic alternatives including a merger or sale; will consider a revised business plan, operating partnerships, JVs, strategic alliances, asset sales, strategic acquisitions it says
  • News Corp.’s Fox network says it may drop some affiliates if the local TV stations are unwilling to pay a program fee sought by the broadcaster. Says it will seek direct talks with station owners after nine months of discussions with the affiliates’ board “made no progress”. Fox is demanding a share of so-called retransmission fees that stations are starting to receive from cable and satellite-TV systems for access to local signals
  • London Stock Exchange agreed to buy Toronto Stock Exchange owner TMX Group for C$3.2b
  • House Ways and Means trade subcommittee holds hearing on U.S. trade policy issues. 9 a.m.
  • House Oversight subcommittee on TARP holds hearing on the coming crisis in state and municipal debt. 9:30 a.m.
  • House Financial Services subcommittee holds hearing on job creation and the unemployment rate. 10 a.m.


There were some bright spots for stocks today, including a continued pickup in small business sentiment, another round of M&A and corporate actions activity and some heightened attention surrounding President Obama's efforts to improve the administration's relationship with the business community. 


Day 2 of perfect = 9 of 9 sectors positive on TRADE and 9 of 9 sectors positive on TREND.

  • One day: Dow +0.59%, S&P +0.42%, Nasdaq +0.47%, Russell 2000 +0.66%
  • Month-to-date: Dow +2.87%, S&P +2.99%, Nasdaq +3.59%, Russell +4.15%;
  • Quarter/Year-to-date: Dow +5.66%, S&P +5.32%, Nasdaq +5.43%, Russell +3.83%
  •  Sector Performance - (7 sectors down and 2 up): - Consumer Disc +1.19%, Industrials +0.67%, Financials +0.71%, Consumer Spls +0.48%, Tech +0.41%, Materials +0.32%, Healthcare +0.29%, Utilities (0.01%), Energy (0.34%)


  • ADVANCE/DECLINE LINE: 841 (-332)  
  • VOLUME: NYSE 886.27 (+0.75%)
  • VIX:  16.28 -2.89% YTD PERFORMANCE: -10.93%
  • SPX PUT/CALL RATIO: 1.37 from 1.85 (-25.67%)


Treasuries were weaker for a seventh straight session today. Some of the pullback was chalked up to a disappointing three-year note auction, while supply concerns are expected to remain in focus ahead of tomorrow's $24B 10-year note auction and the sale of $16B worth of 30-year bonds on Thursday.

  • TED SPREAD: 16.70 -0.507 (-2.949%)
  • 3-MONTH T-BILL YIELD: 0.15% -0.01%
  • YIELD CURVE: 2.89 from 2.90


  • CRB: 337.25 -0.06%; YTD: +1.34%  
  • Oil: 87.30 -0.62%; YTD: -5.34% (trading +0.30% in the AM)
  • COPPER: 455.30 -0.02%; YTD: +2.38% (trading +0.32% in the AM)  
  • GOLD: 1,362.58 +1.38%; YTD: -3.95% ( trading -0.35% in the AM)  


  • Natural gas futures declined to the lowest price in almost 12 weeks on forecasts of moderating temperatures that may limit demand for the heating fuel. 
  • Silver futures for March delivery gained 92.8 cents, or 3.2 percent, to settle at $30.271 an ounce on the Comex. Earlier, the price reached $30.285, the highest since Jan. 4.  Silver, which has wider industrial applications than gold, rose 84 percent last year and touched a 30-year high of $31.275 on Jan. 3, before dropping as low as $26.30 on Jan. 28.
  • After an 11-year moratorium on GMOs, Mexico had approved a small project with Monsanto and two other companies, but isn’t ready to go further into a full pilot program.  “Corn is a staple food crop in Mexico, intricately intertwined with the country’s cuisine, history, and culture,” notes Beth Buczynski at Care2. “Authorities are concerned that Monsanto’s genetically modified corn will contaminate native species, and could cause both health and environmental issues.”
  • Wheat futures rose to a 29-month high on signs that countries are boosting grain inventories after food inflation spurred unrest in North Africa.  Egypt, the world’s biggest importer, bought 55,000 metric tons from the U.S. in a tender on Feb. 5. Iraq, Turkey, Bangladesh and Algeria have issued tenders since Feb. 6, and Iran and Saudi Arabia may be in the market “soon.” 


Euro gains vs most peers while New Zealand dollar falls against all of its major counterparts after Finance Minister Bill English said it was “possible” economy slipped into recession in 2H.

  • EURO: 1.3666 +0.90% (trading -0.23% in the AM)
  • DOLLAR: 77.999 -0.04% (trading +0.03% in the AM) 


  • FTSE 100: (0.35%); DAX: (-0.04%); CAC 40: (0.15%); IBEX: (0.31%) (as of 06:45 EST)
  • European markets mainly trade lower with M&A activity and corporate results influencing individual market direction.
  • London Stock Exchange and TMX Group to merge, with LSE shareholders ending up owning 55% of the combined group, expected to be accretive to adjusted EPS for both companies
  • There are no major MACRO data points
  • Bundesbank President Axel Weber will drop out of the race to succeed Jean-Claude Trichet as head of the ECB, Reuters said


  • Nikkei; (0.17%); Hang Seng (1.36%); Shanghai Composite (0.89%)
  • Asian markets fall the most in a month, led by energy, commodities shares, after China yesterday raised one-yr deposit and lending rates.
  •  Hang Seng falls to YTD low, led by developers, while basic resources shares fall as copper retreats.
  • Commonwealth Bank of Australia rose 2% when its results beat estimates, bringing other banks up in sympathy and powering the market to a small rise.
  • Morning gains in Japan were limited by caution about China’s performance and profit-taking in banks turned the market negative in the afternoon. China-related shares fell.
  • China reopened after a long break by falling in reaction to the higher interest rates. Property, commodity, and financial firms went down on worries that higher borrowing costs will stifle consumer demand.
  • Chinese developers fell 2-4% to lead Hong Kong down.
  • China January HSBC PMI 52.0 vs prior 53.1.
  • Japan January consumer confidence +1.0 pts m/m to 41.1.
  • Tokyo January office vacancies 9.04% vs prior 8.91%.

Howard Penney

Managing DIrector




Still worried about Q2 industry RevPAR but MAR should beat Q4 and Q1 probably needs to go higher.



We project MAR will report Q4 Adjusted EBITDA and EPS of $363MM and $0.41. Our numbers are 8% and 13% ahead of consensus, respectively, and above company guidance of Adjusted EBITDA of $331-346MM and EPS of $0.33-$0.36.  At current valuations, some of the upside may be baked into these stocks.  This was evident when Starwood reported its results last week.  However, given the magnitude of the beat we are expecting, investors could move MAR higher.


We also think MAR could raise Q1 guidance.  We’re already ahead of the street for 1Q2011 but in-line for FY2011.  We continue to believe the Street is overestimating Q2 industry RevPAR.  Our research shows that the April-July period in 2010 was one of pent up demand and in terms of dollar RevPAR, was much stronger than the rest of the year.  The math shows that the comparisons during that period of 2011 will be very difficult.


For more details on our assumptions for Q4 please see below:



  • RevPAR growth of 7.4% vs. 6-8% guidance
  • Management and franchise fees of $385MM vs. guidance of $370-380MM
    • 1.5% growth in managed rooms and 6.1% growth in franchised system-wide rooms
    • 9.3% growth in base management fees to $178MM
    • 20% growth in incentive fees to $71MM
    • 14.5% growth in franchise fees
  • Owned, leased, corporate housing and other revenues of $356MM producing gross margins of $39MM compared to guidance of $40MM
    • Owned & leased room revenue up 8% to $121MM
    • 5% YoY increase in F&B & other revenues
    • $19MM of branding fees and $4MM of termination and other fees
  • $195MM of contract sales and Timeshare segment results of $48MM vs. guidance of $190-200MM of contract sales and segment results of $45-50MM
  • Other stuff:
    • $25MM of gains and other income (in-line with guidance)
    • $51MM of net interest expense (guidance of $50MM)
    • $10MM Equity loss (in-line with guidance)


The Superbowl may have been a good calendar catalyst for Pizza restaurants, but commodity costs ran straight up the middle against them over the last week.  Of the commodity costs we monitored, cheese prices led the way, gaining +6.4% on the week.  The week was more even for commodities overall, with beef, chicken, coffee, and sugar inflation notably slowing.  Below, I give my take on a couple of important items that made major moves this past week.

  • I would obviously be remiss not to elaborate on the move cheese prices made week-over-week and its implications for the restaurant space.   Especially for the Pizza concepts (DPZ, PZZA, Pizza Hut), it is obviously a concern that costs are continuing to rise.  Obviously contracts provide insulation from price volatility but, to the extent that those contracts are up for renegotiation, higher prices are a headwind.  Particularly for DPZ, facing a difficult compare in the first quarter of 2011, this is a factor to keep a close eye on.


  • Wheat prices are obviously important for many restaurant companies and they rose 4.6% week-over-week.  News of countries building grain inventories as a reaction to food inflation and possible droughts impacting wheat crops in China drove prices higher recently.  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 Wing prices declined 5.8% week-over-week.  BWLD continues to enjoy chicken wing price favorability.





Howard Penney

Managing Director

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