The World's Danger

“The world is not dangerous because of those who do harm, but because of those who look at it without doing anything.”

-Albert Einstein


One of the most influential books that I have read in the last few years has been “Einstein: His Life and Universe” by Walter Isaacson. I say most influential because it fortified something within me that the best teams I played on took to battle every day on the ice. Courage.


If you are going to play this globally interconnected game of risk management at the highest level, you need to have the confidence and courage to play it with everything you’ve learned. You have to trust yourself and your process. You have to accept its weaknesses. You have to maintain opposing thoughts in your mind and remain calm.


You also have to be able to challenge accepted dogma, groupthink, and consensus when you have an opposing point of view.


Now that America’s Almighty Central Planner has laid down the Keynesian consensus, it’s time to take this puck right to the net on him and show the crowd what’s going on in this world outside of the bubbles that Ben Bernanke admits he never realizes he’s in:


To recap, Bernanke’s conclusions in his testimony before Congress yesterday were as follows:

  1. US Monetary Policy doesn’t affect Global Inflation
  2. US Inflation is benign
  3. US Dollars are “relatively attractive”

Let’s go through these in reverse order, given that’s how I’d weight the risk implied by a man with this amount of power who looks at the world right now without doing anything:


1.  US Dollar – after a +1.3% three-day recovery ahead of Bernanke’s testimony, the US Dollar Index dropped immediately following his aforementioned comments and is now down for the 6th out of the last 7 weeks. The world’s currency market votes on credibility real-time.


With the US Dollar being bearish across all 3 of our core risk management durations (TRADE, TREND, and TAIL)… and without any respect or support from the manipulator of the world’s reserve currency, I don’t see why we shouldn’t be modeling a probable scenario analysis for another US Dollar crisis (i.e. a retest of its prior lows).



2.  US Inflation – while Bernanke did point out that central banks hold more than 60% of their foreign currency reserves in US Dollars, he forgot to remind himself that “the Dollar is used in 85% of all foreign exchange transactions worldwide.” (Barry Eichengreen, “Exorbitant Privilege”)


Furthermore, there isn’t one major asset class in the world right now that implies that inflation expectations are low. Sure, the Fed’s compromised and conflicted calculation of inflation is benign, but we’re not willing to accept that as gospel. Here’s three ways to look at inflation:


A)     Bonds – US Treasury and Emerging Market bonds have been going straight down, literally, since QG2 was introduced at the beginning of November of 2010. Inflation is bad for bonds. Bernanke is implying the entire global bond market has this wrong.


B)      Stocks – Emerging Market stocks have been getting absolutely crushed since QG2 in November, 2010 and in the US stock market there’s a huge sector performance divergence embedded in the SP500 that is also inflationary. The S&P Energy Sector (XLE) is the best sector of the 9 we track for 2011 YTD at +7.51%, while the S&P Consumer Staples Sector (XLP) is the worst at +0.75% YTD. Ben, who is taking it in the margin? Bingo, the American consumer.


C)      Corporations – Yesterday on the Coca Cola conference call (a relatively large company with a global footprint) this is what management had to say about inflation - citing bills for juice, plastics, and sweeteners, they saw a 60% ramp in cost of goods sold in the October to December period. Management went on to say that they’ll need to raise prices on beverages in the US in 2011 as it faces $300-$400M in cost increases from commodities. McDonald’s, Proctor & Gamble, and Sysco Foods have had similar comments.



3.  Global Inflation – in a shining moment for his academic dogma, Bernanke blamed the highest world food prices in the history of mankind on “emerging market demand.”


All the while, almost every single Emerging Market demand signal we measure sequentially is getting hammered as Global Inflation (which is priced primarily in US Dollars) slows last year’s cyclical economic recovery. Overnight, Indian stocks traded down another -0.74% taking the BSE Sensex to down -14.9% for the YTD as concerns of Asian growth slowing continue to spread to Thailand, Philippines, and Indonesia (down -2.1%, -2.8%, and -1.3%, respectively).


Pakistan, which is the world’s 6th largest population (so we think worthy of considering in light of The Ber-nank’s accelerating emerging market demand thesis), saw import demand DROP from +29% year-over-year growth in December to +3.7% year-over-year growth in January. Since commodity inflation was raging in January (with the USD down for 6 of the last 7 weeks), we’d have liked to have Ben’s rebuttal to that…


Now do I have courage here or common sense? Does Ben Bernanke’s new world order of the world’s reserve currency having no impact on global prices make any sense to anyone who isn’t levered long the inflation trade? How about this concept of the USA decoupling from the Rest of the World? These are important questions that, sadly, our 112th Congress didn’t have the analytical competence or courage to ask…


The World’s Danger remains a US Central Planner’s academic dogma.


My immediate term support and resistance lines for the SP500 are now 1306 and 1336, respectively. At 11AM EST, our Macro team will be hosting a conference call on one of the latest bubbles perpetuated by the Federal Reserve’s policy of zero percent interest rates in perpetuity – Munis (email if you’d like to participate).


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


The World's Danger - aa1


The World's Danger - aa2


Notable news items and price action over the past twenty-four hours.

  • BWLD reported strong earnings on Tuesday after the close and the stock gained 12.9% yesterday on strong volume.  I expect trends to decelerate in the back half of the year.  See the note published yesterday on BWLD for more details.
  • DIN reported same-store sales for the Applebee’s system at +2.9% for Q4.  Franchise same-restaurant sales increased 3.4%.  Company-operated same-restaurant sales increased 0.3%, with a decline in traffic offsetting higher average check.
  • CMG is reporting today after the close after a low-volume gain yesterday.  The stock is trading at over 18x EV/EBITDA NTM and consensus is calling for +9.9% comps for Q4, which would be a slowdown in two-year average trends from 3Q. 
  • CAKE is reporting today after the close after trading sideways yesterday. 
  • PNRA is reporting today after the close and investors will be keen to learn of their costs outlook given the level of inflation in wheat markets and almost-daily news items of inventory building and hoarding of wheat by governments.
  • COSI outperformed the QSR category yesterday after its performance moderated somewhat over the last month.  The 6.5% gain, complemented by accelerating volume, left the stock at $1.47, up 10% over the last thirty days.
  • COSI was initiated outperform yesterday by Northland Securities in what I believe to be the first of many people to hop on this bandwagon.
  • SBUX, PEET, and GMCR declined yesterday as coffee prices rose almost 2.5% in a day.  The prospect of further prices raises is clearly a concern.
  • EAT traded well yesterday, gaining 4.4% on strong volume.  The stock is up 12% YTD.  I maintain my positive outlook on the stock as margin enhancing initiatives are implemented and sales improve.



Howard Penney

Managing Director

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Empty Stomachs

This note was originally published at 8am on February 07, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“An empty stomach is not a good political adviser.”

-Albert Einstein


Economic groupthink is dangerous - particularly when its policies perpetuate social stratification. With Global Food Inflation hitting its highest price ever this past week, The People are paying attention. Real-time prices are hard to hide.


The stark contrast between Washington Groupthink and what the rest of the world thinks about the highest food prices ever (yes, ever is a long time) is easily captured by comparing what the United Nations and the Fed had to say about it last week:

  1. United Nations – The Food and Agriculture division of the UN published its Food Price Index on Thursday at an all-time high reading of 231. To put that number in context, it was up +3.4% for the month of January alone and up, sequentially, for the 7th consecutive month. According the Wall Street Journal’s Sameer Mohindru, “the UN’s Secretary of FAO's Intergovernmental Group on Food-grains, said political turmoil in some countries, the weakening dollar” … and “adverse weather conditions...” were to blame.
  2. Federal Reserve – Chairman Ben Bernanke told the National Press Club luncheon in Washington, DC on Thursday that there is no inflation in America and added that food inflation trends have nothing to do with US monetary policy. According to him, food inflation is all about “supply and demand.”

Nope – no mention of “the weakening dollar” or the fiscal and monetary policies in America that affect it - not from The Ber-nank at least...


To the high-society intellectual or ordinary person gifted with common sense, this probably stands out as somewhat odd. To the person with an Empty Stomach, this has to be downright depressing.


So how can the Chairman of the US Federal Reserve say this with a straight face?


The Fed has obviously been completely politicized. Fully loaded with that politicization comes the consummate lack of accountability that’s unique to a professional politician in the modern American Empire. But, this is the kind of thing that makes people really lose whatever trust they had left in government.


Before I go through what happened to the rest of the world’s market prices last week, let’s take a step back and think about the simplicity of a market’s pricing structure:

  1. Supply
  2. Demand
  3. Price

Sure, we agree with Bernanke on supply and demand, but what about price? Without a market price (and the currency that it’s denominated in), you obviously don’t have a market. As Barry Eichengreen writes in the introduction to his outstanding new book on the US Dollar, Exorbitant Privilege: ”The principal commodities exchanges quote prices in dollars. Oil is priced in dollars. The dollar is used in 85% of all foreign exchange transactions worldwide.”


Therefore, when you debauch the value of the world’s reserve currency, you are going to perpetuate world inflation.


If you want to take The Ber-nank’s side on this, you’ll have to ignore the math. As of this morning’s prices, here are the immediate-term TRADE correlations between the US Dollar Index and food prices:

  1. Wheat = -0.91
  2. Rice = -0.90
  3. Sugar = -0.85

*Note: these are extremely high correlations.


There are a lot of ways to prove out how US Dollar sponsored inflation is hurting bond and emerging markets worldwide too. At week’s end, here were the world’s worst performing stock markets for 2011 to-date:

  1. Egypt = -20.9%
  2. India = =12.2%
  3. Tunisia = -10.4%
  4. Philippines = -7.8%
  5. Chile = -6.4%
  6. Brazil = -5.8%

Sure, a Bernanke Bull might quickly point out that 2 of the worst 3 markets have had revolutionary social unrest – that’s the point. Is that what we need to see for governments to pay attention to people who are unemployed with an Empty Stomach?


Some people in the US are trying to say that the US Bond market is getting hammered to new intermediate-term lows because US growth “is back.” Both the Q4 US GDP and January US Employment reports missing consensus estimates notwithstanding, some of it is growth – but some of it is inflation too.


On Friday, we took fresh new lows in US Treasuries as an opportunity to cover short positions in short-term bonds (SHY) and get invested where investors fear having to compete with rising bond yields – we bought a US Treasury Curve Flattener (FLAT) and Utility stocks (XLU). Both were down on the day.


On a week-over-week basis I drew down our Cash position from 67% to 52%. Here’s the updated Hedgeye Asset Allocation Model:

  1. Cash = 52%
  2. International FX = 18% (long Chinese Yuan, CYB)
  3. Fixed Income = 12% (long Inflation Protection and a UST Flattener - TIP and FLAT)
  4. US Equities = 9% (long Healthcare and Utilities - XLV and XLU)
  5. Commodities = 6% (long Oil and Sugar – OIL and SGG)
  6. International Equities = 3% (long Sweden – EWD)

I’m still trying my best to buy things when they are on sale. Having covered my short position in the SP500 on Friday, January 28th at 1276, I’ve moved the Hedgeye Portfolio to 12 LONGS and 10 SHORTS (see all positions below). For the last week, I’ve definitely been getting longer – but that doesn’t mean I think this will end well - nor do I think it will make the 44 MILLION Americans on food stamps have less to worry about in terms of their Empty Stomachs.


My immediate term support and resistance levels for the SP500 are now 1297 and 1319, respectively.


Best of luck out there today



Keith R. McCullough
Chief Executive Officer


Empty Stomachs - vr1



TODAY’S S&P 500 SET-UP - February 10, 2011

Equity futures are trading below fair value, following equities' lower close on Wednesday, though stocks did finish off session lows. That said, the Dow closed in positive territory, which was its 8th straight gain. After the close, Cisco traded lower, following results for its January quarter, with investors expecting a bit more from results and guidance.


As we look at today’s set up for the S&P 500, the range is 30 points or -1.13% downside to 1306 and +01.14% upside to 1336.



  • 8:30 a.m. Jobless claims Feb. 5, est. 410k, prior 415k
  • 8:30 a.m. Continuing claims Jan. 29: est. 3900k, prior 3925k
  • 8:30 a.m.: Net export sales (cotton, corn, soybeans, soy meal)
  • 10 a.m. Wholesale inventories Dec. est. 0.7%, prior -0.2%
  • 10:30 a.m.: EIA natural gas storage change
  • 12:45 p.m. Fed Atlanta President Dennis Lockhart speaks as part of forum on managing public debt hosted by the Consulate General of Switzerland in Atlanta
  • 1 p.m.: U.S. sells $16b 30-yr bonds
  • 2 p.m. Monthly Budget Statement Jan. est. -$55.0b, prior -$42.6b


  • OPEC Raises Crude Demand Forecast by 400k Barrels a Day
  • President Barack Obama’s budget will include $10.7b to build a nationwide wireless network for emergency workers and $5b to help Americans get mobile access to high-speed Internet service. Obama would pay for the networks with $27.8b from auctioning airwaves relinquished by television
  • Watch Encana after PetroChina agreed yesterday after mkt close to buy 50% stake in its Cutbank Ridge gas assets in Canada for C$5.4b ($5.4b); PetroChina’s largest overseas deal
  • Verizon Wireless stores begin offering iPhone today; analysts say VZ may sell 2m or more of the devices this quarter and draw subscribers from AT&T
  • Credit Suisse falls most since Oct. after cutting ROE target to >15% from >18%. JPMorgan says concerned about CS capital positioning
  • LG Electronics gets accused in two lawsuits by Sony of infringing eight patents for technology used in LCD TVs and monitors; complaints filed in Los Angeles
  • U.S. foreclosure filings fell 17% in Jan. Y/y, fourth straight month of declines, RealtyTrac said
  • Activision Blizzard (ATVI) forecast sees 2011 adj. EPS
  • 70c vs est. 83c
  • Akamai Technologies (AKAM) forecast 1Q rev $265m-$275m vs. est. $283.8m
  • Allstate (ALL) reported 4Q oper. EPS 50c vs est. 86c, rev. $8.09b vs est. $8.04b
  • Amkor Technology (AMKR) forecast 1Q EPS 5c-14c vs est. 22c
  • Cisco Systems (CSCO) sees 3Q non-GAAP EPS 35c-38c vs est.40c
  • Idenix Pharmaceuticals (IDIX) AIDS drug licensed to GlaxoSmithKline was placed on clinical hold by FDA
  • Pacer International (PACR) forecast 2011 EPS of no more than 30c vs est. 39c
  • Questcor Pharma (QCOR) will replace Sonic Solutions on smallcap 600
  • Select Comfort (SCSS) sees 2011 EPS 68c-74c vs est. 66c
  • TriQuint Semiconductor (TQNT) sees 1Q adj. EPS 14c-16c vs est. 20c
  • Whole Foods Market (WFMI) raises FY11 EPS forecast to $1.76-$1.80 from $1.66-$1.71 (Nov. 3), est. $1.71


Fairly sluggish price action throughout much of the day seemed to fit with the lack of meaningful directional drivers.  Nevertheless, we have day 3 of perfect = 9 of 9 sectors positive on TRADE and 9 of 9 sectors positive on TREND.

  • One day: Dow +0.06%, S&P (0.28%), Nasdaq (0.29%), Russell 2000 (0.54%)
  • Month-to-date: Dow +2.93%, S&P +2.70%, Nasdaq +3.30%, Russell +3.59%
  • Quarter/Year-to-date: Dow +5.72%, S&P +5.03%, Nasdaq +5.13%, Russell +3.27%
  • Sector Performance: - Energy (1.26%), Materials (0.89%), Financials (0.70%), Tech (0.19%), Healthcare (0.22%), Utilities (0.01%), Industrials (0.01%), Consumer Spls +0.17%, Consumer Disc +0.67%


  • ADVANCE/DECLINE LINE: -721 (-1562)  
  • VOLUME: NYSE 947.16 (+6.87%)
  • VIX:  15.87 +0.38% YTD PERFORMANCE: -10.59%
  • SPX PUT/CALL RATIO: 1.46 from 1.37 (+6.15%)


Treasuries 10-year yields are within 3bps of four-day low before U.S. sells 30-yr bonds and after yesterday’s sale of 10- yr debt drew most demand on record from foreign central banks.

  • TED SPREAD: 18.42 +0.304 (1.680%)
  • 3-MONTH T-BILL YIELD: 0.15% -0.01%
  • 10-Year: 3.65 from 3.75
  • YIELD CURVE: 2.84 from 2.89


  • CRB: 339.43 +0.66%; YTD: +1.99%  
  • Oil: 86.71 -0.26%; YTD: -6.00% (trading +0.17% in the AM)
  • COPPER: 452.40 -1.09%; YTD: +1.44% (trading -0.18% in the AM)  
  • GOLD: 1,363.03 -0.35%; YTD: -4.22% ( trading -0.35% in the AM)  


  • Corn, wheat and soybean futures jumped to the highest since 2008 after a U.S. government report showed smaller crops and rising demand are eroding global inventories as food prices surge.
  • The U.S. Department of Agriculture cut its forecasts for inventories held before this year’s harvests and said world supplies of the crops will slump 2.2 percent. Droughts in Russia, Ukraine and other parts of Europe and adverse weather in the U.S., Canada and Australia slashed output as the world economy rebounded from the most-severe recession in 70 years.
  • Gasoline supplies advanced 4.66 million barrels to 240.9 million last week, the most since March 1990, the Energy Department said. Stockpiles were forecast to climb 2.6 million barrels, according to the median of 16 analyst estimates in a Bloomberg News survey.
  • LME copper stockpiles rose for the first day in four, gaining by 4,375 tons to 396,400 tons, daily exchange figures showed today. The 1.1 percent increase was the largest since Jan 26. Inventories are up 5 percent this year. Orders to draw copper from stocks, or canceled warrants, slid 4 percent to 11,875 tons.
  • Supply concerns sent Arabica coffee futures to their highest price since June 1997 on Wednesday, despite two reports this week that pointed to more coffee on the market.  Bad weather in Colombia, the world's top producer of mild washed Arabica beans, has slashed harvest output for three consecutive years, and the recent report points to a possible recovery. 


Dollar gains vs most peers while euro falls on speculation Bundesbank President Axel Weber’s exit from race to succeed Jean-Claude Trichet as head of ECB will delay rate increase.

  • EURO: 1.3709 +0.31% (trading -0.53% in the AM)
  • DOLLAR: 77.641 -0.46% (trading +0.46% in the AM) 


  • FTSE 100: (0.89%); DAX: (0.43%); CAC 40: (0.87%); IBEX: (2.13) (as of 07:00 ET)
  • European markets open lower and extended declines, currently trading near session lows led by peripheral markets, Spain and Greece down more than 2%.
  • The BOE to leave its benchmark interest rate and QE unchanged
  • Spain's bank hit by comments from Economy Minister saying some will have to raise core capital ratios above a new minimum to aid investor confidence.
  • Plant, machinery output growth in Germany may accelerate this year as Asian demand boosts export orders, VDMA association said in statement earlier today. Production may increase 10% after rising 8.8% in 2010 when adjusted for inflation
  • France Dec Industrial Production +0.3% m/m vs consensus (0.4%)
  • UK Dec Industrial Production +3.6% y/y vs consensus +3.7%; Manufacturing Production +4.4% y/y vs consensus +5.5%


  • Nikkei (0.11%); Hang Seng (1.97%); Shanghai Composite +1.59%
  • Asian markets fall on concern U.S. unemployment and inflation-curbing measures will hamper recovery.
  • Hang Seng decline of 1.97% is most since November.
  • Emerging- market stocks slid for a sixth day.
  • Property and bank shares rebounded from yesterday’s losses in China, leading the market to a gain. For no obvious reason, SAIC Motor Corp jumped by its 10% limit at the very end of the day.
  • ASX surged 5% as stock markets overseas moved to consolidate, raising hopes that Australia will approve the proposed merger with Singapore Exchange.
  • Japan opened to profit-taking ahead of a three-day weekend, though it recovered to finish flat.
  • Hong Kong Exchanges & Clearing failed to join in the regional rally for bourse shares, dropping 5% and dragging the entire market down on worries that yuan-denominated shares may not be introduced as soon as originally thought.
  • South Korea down 1.81%, Korea Gas Corp fell 3% on a report the company is considering reducing its 15% holding in the Gladstone LNG project by two thirds.
  • Japan December core machinery orders +1.7% m/m vs cons +5.3%. January domestic corporate goods price index +1.6% y/y.
  • Australia January unemployment 5.0%, unchanged m/m. January job creation +24K.

Howard Penney

Managing Director



Levi's Tells It Like It Is

Levi’s is one of the largest (privately held) apparel companies that at the same time evades many radar screens of those who solely trade equities.  Nevertheless, the company often provides interesting  and honest insights into its business trends. Last night was no exception, with Levi’s reporting it’s 4Q results.  We believe the company’s candid commentary on the cost environment provides valuable insight into the challenges facing an iconic, cotton-dependent brand such as Levi’s.

  • Despite possessing one of the world’s most recognizable trademarks, the company has launched a new global brand called dENIZEN to address emerging middle market consumers in growing markets.  The brand launched in China in 4Q with 50 doors. India and Singapore also have transitioned doors to the new
  • The company continues to view the economic environment as difficult, especially in Europe.  Southern Europe remains particularly challenged.
  • The market for cotton was described as “unpredictable”.  Increased cotton prices will work their way in the company’s COGS and as a result they’ve taken selective price increases to protect margin and mitigate inflation’s impact.  It was noted that a further increase in cotton prices could negatively impact margins and working capital in the latter part of 2011. 
  • Cotton prices in the back half will have more impact on 2012 than 2011. 
  • Management explained its relationship between Levi's, third-party manufacturers, and denim/textile manufacturers:

"We actually don’t hedge cotton where we buy finished product from our third-party manufacturers. Those manufacturers are buying denim from denim manufacturers, who are essentially buying raw cotton. So, we’re three steps or two steps removed from the actual purchasing cotton or the ability to hedge that. And so our real controls are essentially through pricing, as well as cost controls that run through our supply chain that we manage, which is primarily the third-party manufacturers."

  • When asked about the demand elasticity of their customer base, management noted that it’s too early to judge.  In three months there should be more data for which conclusions can be drawn.
  • The company has not seen customers attempt to increase purchases near-term ahead of further potential price increases. 
  • Spring deliveries which are just now arriving on retail floor are the first products carrying increased costs.
  • Japan continues to be a struggle.   Over the past three years the denim market in Japan has decreased by 40%!

Eric Levine


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