IF We Debauch

“We are firmly convinced that monetary and fiscal policy will continue to debase the dollar.”

-Ted Kelly (CEO of Liberty Mutual)


Liberty Mutual is an American insurance company that was founded in 1912 and currently sits at #71 on the Fortune 500 list. It has over 45,000 employees servicing global insurance products worldwide and has over $100B in consolidated assets. Their CEO made the aforementioned comment in a Bloomberg article yesterday by Noah Buhayar. No, Liberty didn’t pay me an advertising dollar for this paragraph.


Unlike The Ber-nank attempting to trade US Treasury bonds, this isn’t Ted Kelly’s first rodeo. He’s been CEO of Liberty Mutual since 1998 and his job is to manage bond market and duration risk. On the topic of real-time risk management, he went on to add that, “we are positioning our portfolio and our business to respond if inflation emerges.”


Notice Kelly didn’t say “when inflation emerges.” He said “IF” - and that’s a critical differentiator between a proactive risk manager (a portfolio manager) and a reactive one (a professional politician). Kelly isn’t alone in this line of thinking. Almost every world class risk manager in the world understands that governments that debauch their fiat currencies will impose an inflation tax on their citizenry.


The US Dollar Index backed off hard right where it should have yesterday. It closed down another -0.54%, keeping it below its intermediate-term TREND line of $78.98. Call me lucky or call me right in understanding how to manage risk around the price of the world’s reserve currency. Since starting the Hedgeye Portfolio 3 years ago, I’ve gone 18 for 18 in making profitable long/short calls on the US Dollar (UUP).


I’m not calling this out to pump my own tires. I’m calling this out so that the pundits who are out there cheering on Bernanke’s stock market inflation policy pay attention. Making calls on US Dollar declines helped predict bubbles in both US stocks (2008) and US bonds (2010). Sadly, unless President Obama starts listening to the likes of Ted Kelly, Bill Gross, and Jim Grant, it may very well take another US Dollar currency crisis to stop these Big Keynesian Central Planners in their tracks.


As a reminder, we first made our call on Global Inflation Accelerating in October of 2010, and from here on in we’ll be acutely monitoring the slope of inflation accelerating or decelerating with the following assumptions:

  1. IF we debauch the US Dollar, Global Inflation will accelerate
  2. IF we stabilize the US Dollar, Global Inflation will decelerate

That’s it. That’s the deep simplicity we’ve found in our multi-factor, multi-duration model. Remember, in principle Chaos Theory is grounded in uncertainty – so every risk management exercise starts with IF and every decision follows the THEN that’s driving correlation risk.


On our most immediate-term duration, some of the correlation risk associated with US Dollar Debauchery has burned off in the last 2 weeks. That’s primarily because the US Dollar was UP for the first week out of the last four. IF we debauch it from here, THEN that will change. Correlation risk gets fired up when the Buck Burns.


On the heels of yesterday’s US Dollar decline, here were some important Global Macro reactions to consider:

  1. Commodities – CRB Commodities Index inflated back up to its YTD weekly closing high level of 338
  2. Bond Yields – US Treasury Yields on the short-end of the curve popped back up to +0.84%
  3. Emerging Markets – Asian Equities ended their 3-day rally to lower-highs

Again, this isn’t complicated. Debauched Dollar is bullish for inflation (Commodities) and bearish for Bonds and Emerging Markets…


As you can see in the Hedgeye Portfolio (attached), alongside re-shorting the US Dollar this week, we re-shorted the following Macro positions:

  1. Indian Equities (IFN)
  2. Emerging Market Equities (EEM)
  3. Japanese Equities (EWJ)

Now as sure as the sun rises in the East, you can bet your Madoff that The Ber-nank won’t be talking about the interconnectedness that his Central Planning Policies and a Debauched Dollar have on Asian and Emerging Market currencies and/or their exports.


Let me illustrate this point (generally) with the example of how the USD is affecting South Korea:

  1. South Korean Won strength (born out of US Dollar weakness) = hurts SK Exports (50% of GDP)
  2. South Korean Import Price Inflation zoomed to +14.1% in January vs +12.7% in December = hurts SK Exporter margins
  3. South Korean Equities (KOSPI) have dropped every day this week and are now down -3.6% for 2011 YTD

South Korea’s stock market isn’t what we’d call an “emerging market.” Per capita GDP is 10x that of China and it’s an economy levered to both US Tech and Industrial demand (bearish leading indicators?). Since it’s the world’s 12th largest economy, the KOSPI recently moving to bearish TRADE and TREND in our risk management model is something worth paying attention to as you watch Bernanke and Geithner continue to erode the credibility of America’s currency today.


My immediate term support and resistance lines for the SP500 are now 1324 and 1339, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


IF We Debauch - ee1


IF We Debauch - ee2


TODAY’S S&P 500 SET-UP - February 17, 2011

Equity futures are trading just below fair value following Wednesday's bounce following positive earnings from DELL and perceived MACRO trends. Political unrest in Bahrain and Lybia are center stage.  As we look at today’s set up for the S&P 500, the range is 15 points or -0.92% downside to 1324 and 0.20% upside to 1339.



  • 8:30 a.m.: Consumer price index, Jan., M/m est. 0.3%, prior 0.4% (ex food and energy est. 0.1%, prior 0.1%)
  • 8:30 a.m.: Net export sales (cotton, corn, soybeans, soy meal), Feb. 10
  • 8:30 a.m.: Initial jobless claims, Feb. 12, est. 400k, prior 383k; continuing claims, Feb. 5, est. 3893k, prior 3888k
  • 9:45 a.m.: Bloomberg Consumer Comfort Index, est. -43.0, prior -46.0
  • 10 a.m.: Mortgage delinquencies, 4Q, prior 9.1%
  • 10 a.m.: MBA mortgage foreclosures, 4Q, prior 4.39%
  • 10 a.m.: Leading indicators, Jan., est. 0.2%, prior 1%
  • 10 a.m. Philadelphia Fed., Feb., est. 21, prior 19.3
  • 10 a.m.: Bernanke, Bair, Schapiro testify on Dodd-Frank implementation
  • 10 a.m.: Fed’s Raskin testify on debit fees
  • 10 a.m.: Treasury’s Geithner Testifies to Senate budget committee
  • 10:30 a.m.: EIA natural gas storage change
  • 12 p.m.: Fed’s Lockhart speaks on Ireland and U.S. in Atlanta
  • 12:30 p.m.: Fed’s Evans speaks on economy in Rockford, Illinois
  • 1 p.m.: U.S. sells $9b 30-yr TIPS
  • 1:10 p.m.: Fed’s Fisher speaks in Houston on Fed, economy


  • Fed ordered the 19 largest U.S. banks to test their capital levels against a scenario of renewed recession with unemployment rising above 11%, two people with knowledge of the review told Bloomberg
  • Apple’s Steve Jobs, Facebook’s Mark Zuckerberg, and Google’s Eric Schmidt are among executives meeting with President Barack Obama in San Francisco area today to discuss economy and job creation, according to person familiar with the private session
  • Bain Capital is weighing a sale or IPO of FCI, a French maker of electrical connectors valued at about EU1.6b, three people with knowledge of the matter say
  • KB Home may spend $600m-$700m on new land, mostly in Texas and California, this year as it expands its community count, CEO Jeffrey Mezger says
  • Samsung Electronics may take decision on developing TVs with Google software in 1H, Samsung’s TV unit head says
  • Aveo Pharmaceuticals (AVEO) will develop; commercialize cancer drug tivozanib with Astellas (ALPMY) outside of Asia. Aveo to get initial payment of $125m; $1.3b in milestone possible
  • Avis Budget Group (CAR) reported 4Q rev. $1.23b vs est. $1.19b
  • CBS Corp. (CBS) reported 4Q adj. EPS 46c vs est. 43c
  • Cliffs Natural Resources (CLF) reported 4Q EPS $2.82 vs est. $2.22
  • Express Scripts (ESRX) reported 4Q rev. $11.3b vs est. $11.6b
  • Itron (ITRI) forecast 2011 adj. EPS $3.95-$4.40 vs est. $4.41
  • NetApp (NTAP) forecast 4Q adj. EPS 49c-53c vs est. 54c
  • Peet’s Coffee & Tea (PEET) reported 4Q rev. $91.6m vs est. $95.2m
  • Rubicon Technology (RBCN) forecast 1Q rev. $34m-$36m vs est. $30.8m, EPS 62c-65c vs est. 50c
  • Skechers U.S.A. (SKX) reported 4Q EPS 7c vs est. 13c
  • Synopsys (SNPS) forecast 2Q adj. EPS 43c-45c vs est. 43c
  • Williams (WMB) said it plans to split infrastructure unit from exploration & production, boosts dividend by 60% to 20c


We have 8 of 9 sectors positive on TRADE and 9 of 9 sectors positive on TREND.

  • One day: Dow +0.50%, S&P +0.63%, Nasdaq +0.76%, Russell 2000 +1.02%
  • Month-to-date: Dow +3.33%, S&P +3.90%, Nasdaq +4.65%, Russell +6.03%
  • Quarter/Year-to-date: Dow +6.14%, S&P +6.26%, Nasdaq +6.51%, Russell +5.71%
  • Sector Performance: - Energy +1.33%, Materials +1.29%, Consumer Disc +0.81%, Tech +0.55%, Financials +0.54%, Healthcare +0.52%, Industrials +0.48%, Consumer Spls +0.27%, Utilities (0.22%).


  • ADVANCE/DECLINE LINE: 1503 (+2196)  
  • VOLUME: NYSE 928.97 (+0.05%)
  • VIX:  16.72 +2.14% YTD PERFORMANCE: -5.80%
  • SPX PUT/CALL RATIO: 1.88 from 1.79 (+5.05%)


Treasuries were weaker today with some of the adverse takeaways from the economic calendar offsetting continued geopolitical concerns in the Middle East.

  • TED SPREAD: 20.80 +0.101 (0.490%)
  • 3-MONTH T-BILL YIELD: 0.13%
  • 10-Year: 3.62 from 3.61
  • YIELD CURVE: 2.76 from 2.77


  • CRB: 338.21 +0.57%; YTD: +1.62%  
  • Oil: 84.54 +0.79%; YTD: -8.33% (trading -0.47% in the AM)
  • COPPER: 443.75 -1.40%; YTD: -0.05% (trading -0.99% in the AM)  
  • GOLD: 1,377.05 +0.17%; YTD: -2.89% ( trading +0.17% in the AM)  


  • Cotton Rises Above $2 for First Time as Supply Tightens on Chinese Demand
  • Copper Falls to Two-Week Low on Stockpiles; Tin Slides Most Since November
  • Brent Oil Near Two-Year High as Protests Spread Across Middle East, Africa
  • Pan Pacific, Tongling Win Copper Fee Hike in Change to Six-Month Contract
  • Drought-Hit Wheat in China to Recover Even as Some Losses `Irreversible'
  • Tin Output From Indonesia May Extend Slump on Rains, Executive Forecasts
  • Gold Demand Rose 11% in Quarter on Jewelry, Investment, Gold Council Says
  • Food Prices to Rally, Soybeans May Outperform, Standard Chartered Predicts
  • Coffee Rises on Speculation Weather to Hurt Crops in Brazil and Colombia
  • Wheat Rebounds as China Drought May Curb Output, Boost Demand for Imports
  • Gold Imports by India Advance to Record on Jewelry Demand, Price Outlook
  • Palm Oil Drops for Third Day on Speculation Prices May Have Reached a Peak
  • India Food Inflation Slows to Two-Month Low as Winter Harvest Aids Supply
  • Rusal Trails Alcoa as Oligarch Delivers $12.8 Billion Snub to Shareholdersn.


  • EURO: 1.3547 +0.21% (trading +0.06% in the AM)
  • DOLLAR: 78.223 -0.45% (trading +0.04% in the AM) 


  • FTSE 100: (0.08%); DAX: +0.04%; CAC 40: (0.03%) (as of 06:00 EST)
  • European markets trade mixed, having fluctuated either side of unchanged, with earnings in the spotlight.
  • Indices, close to 30 month highs, appear on hold with unrest in Bahrain raising the possibility of further political contagion across the region
  • The Bank of England's latest economic forecasts underestimate upside risks to inflation, and interest rates need to rise faster than markets expect to bring it back to target, according to Andrew Sentance. "My judgement is that the upside risks to inflation are understated in the published fan charts. And monetary policy would most likely need to be tightened faster and by more than the markets currently expect to bring inflation back to target," says Sentence "The value of the pound on the foreign exchanges therefore needs to be one of the key areas of focus for the MPC as we seek to steer ourselves out of the current phase of high inflation," he said.
  • Spain's treasury sells €2.47B 2020 bond, bond average yield 5.200% vs 5.446% last auction
  • There are no major MACRO data points


  • Nikkei +0.26%; Hang Seng +0.63%; Shanghai Composite +0.10%
  • Asian markets were mixed tending up today, with markets getting a boost from positive sentiment generated by US performance.
  • Financials and energy companies led the rise in Hong Kong.
  • China announced new rules to curb speculative home purchases, causing China Resources Land and China Overseas Land & Investment to fall 2% each.
  • Profit-taking limited the advance in Japan.
  • Positive earnings from Qantas and Santos allowed Australia to finish with a slight gain of 0.17%. Qantas rose 5%, and Santos rose 3%.
  • China was flat after property shares fell 2-3% on new rules restricting speculative home purchases. Higher steel prices took steelmakers like Inner Mongolian Baotou Steel Union up by the 10% daily limit.
  • Taiwan fell -0.33%, but Acer edged up on announcing a $500M contract with Suning Appliance.
  • South Korea declined -0.60% after opening gains spurred by Dell’s earnings, falling to a loss as people took profits in shipbuilders and construction companies.
  • Japan February tankan manufacturing index +14 vs +11 prior. February tankan non-manufacturing index +3 vs (2) prior. December composite index of coincident economic indicators revised to 103.5, +1.1 points m/m, vs preliminary 103.1.

Howard Penney

Managing Director




Comp trends improved on a two-year average basis during the fourth quarter at both the Bistro and Pei Wei, but fell short of the street’s expectations, particularly at the Bistro where same-store sales growth came in +0.1% versus the street’s +1.0% estimate.  At first glance, it appeared that PFCB’s reported $0.64 per share easily beat the street’s $0.57 per share estimate, but after a closer look, we learned that it was a low quality beat as a lower tax rate during the quarter added about $0.07 to $0.08 per share to earnings.


Management maintained its 10% FY11 EPS growth guidance; though off of the $1.95 per share base, which excludes the full-year tax benefit in 2010, rather than the reported $2.01 per share.  That being said, the company slightly lowered its revenue growth guidance to up 3-4% from its prior mid single-digit growth range and reduced its planned Pei Wei openings to 6-8 from 10-12 (company maintained its two-year goal to open 25-30 Pei Wei restaurants).


Management said that it expects to achieve 1-2% comp growth at both of its concepts during FY11 and seemed encouraged by the fact that comps at the Bistro and Pei Wei were running up about 1% quarter-to-date in 1Q11.  Based on recent two-year average same-store sales growth trends at the Pei Wei, I think the 1-2% full-year comp guidance is achievable and the high end of the range is likely.


I am more wary of the company’s ability to pull off +1-2% comp growth at the Bistro, however, as it implies a significant acceleration in two-year average trends throughout the year.  Although the +1% comp at the Bistro quarter-to-date signals the company is on the right track toward achieving +1-2% growth for the full year, it is important to note that the company faced its easiest monthly comparison from 2010 in January when comps declined 4.4%.  The comparisons get increasingly more difficult at the Bistro as we progress through the quarter (-1.8% in February 2010 and -1.4% in March 2010) and though the year with comps having turned positive in May 2010 and remained positive through November 2010.


PFCB’s FY11 guidance assumes a YOY improvement in restaurant level margins.  The bulk of this YOY favorability is expected to fall in 1Q11 as the company laps the nearly 220 bp decline in margin that occurred in 1Q10 as a result of inefficiencies associated with last year’s Happy Hour rollout.  Margins should be helped in FY11 from the growing contribution of PFCB’s global brands business, which is a high-margin business (management guided to a nickel more of earnings from this business alone in 2011 relative to its reported $0.01 per share earnings contribution in 2010).  Offsetting this benefit, however, is the expected inflationary headwinds which are expect to hit the COGS, labor and operating expense lines of the P&L.  Specifically, management guided to a 3-4% increase in its total commodity basket, higher wage rates and healthcare costs and increasing energy and supply costs.


In order to protect and grow restaurant-level margins in 2011 (as is assumed by management’s guidance), the company stated that it will rely on price increases at both of its concepts, improved traffic and operational efficiencies.  PFCB already took a small price increase at Pei Wei during the fourth quarter and anticipates implementing a menu price increase at the Bistro during FY11 (took its last price increase at the Bistro in May 2010).  What worries me about PFCB’s guidance is that it relies on both taking price and growing traffic to offset inflation.  Unfortunately, these two strategies do not always work in unison.  Instead, price increases often stunt traffic growth, particularly during challenging economic times.


Although management highlighted that it will only take a small price increase, they seemed confident that they have pricing power at both the Bistro and Pei Wei.  They also stated that some of the YOY price increase will result from eliminating some of the recent discounting on the fringe at the Bistro.  I would not be surprised to see a fall off in traffic when the company implements its price increase.  Regardless, the traffic comparisons get more difficult at the Bistro come 1Q11, which alone, will make it more difficult for the company to grow traffic going forward.   Traffic declined for the first time in 2010 during the fourth quarter when average check increased, not surprisingly, also for the first time in 2010.  Traffic declined 0.9% during 4Q10 and that was off of a negative YOY traffic trend in 4Q09.  Traffic turned positive in 1Q10, up 0.8% and remained positive in 2Q10 and 3Q10, up 2.6% and 2.8%, respectively.  Growing traffic on top of these more difficult comparisons, particularly with increased pricing and/or less discounting, will prove challenging and could pose a threat to the company’s full-year margin growth target.


PFCB – RISKS TO FY11 GUIDANCE - Bistro traffic vs. check






Howard Penney

Managing Director

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Is Green Mountain About to Partner With Starbucks?


Retail Sales and Use Tax receipts data from California does not paint a pretty picture for restaurants with a high level of exposure to the Golden State.


California is in the news today as home sales hit their lowest level since January 2008.  The high low society is not merely confined to the east coast – sales of luxury homes rose for the first time in five years during 2010, according to DataQuick Information Systems in San Diego.  A bearish housing market is bad for consumers, of course, and Hedgeye’s view remains bearish on housing on a national basis. 


Looking at tax receipts data, however, provides a very interesting insight into how the consumer is faring in California.  It is clear from the three charts below that California-centric restaurants are facing a possible downtick in comps, if Retail Sales and Use tax receipts trends remain on their current trajectory.  Furthermore, it seems that management teams are aware of this.  The quotes below outline management commentary on California from the most recent earnings transcripts for CAKE, CPKI and PFCB.  As you will read, there is a certain degree of hesitancy to discuss the Golden State. 





Q: Can you give us an update on California?

A: Well, California in the fourth quarter was – first of all, we saw strength in key geographies like Texas and the Midwest and Florida and the Southeast. But the impact of – it's hard to measure California in the fourth quarter because we had a period of time where it rained non-stop for like nine days in a row.





During the most recent conference call, commentary on California trends was conspicuously absent!



PFCB (from call today):

Where we saw weather, we saw negative comps.  California went back to negative because of this. 








Howard Penney

Managing Director

Japan’s Jugular Update

Conclusion: Below we revisit our intermediate and long term theses on Japanese assets – the both of which are decidedly bearish.


Position: Short Japanese equities via the etf EWJ.


Earlier this morning, we opened a short position in Japanese equities in the Hedgeye Virtual Portfolio. At current prices and overly bullish sentiment, the short idea looks much better than it did on October 5th, when we introduced our Japan’s Jugular thesis. For the sake of an easy refresher, we’ve updated the presentation and added a few more slides to reflect the current setup:'s%20Jugular.pdf


As a quick reminder, the Japan’s Jugular thesis is two-fold in duration:


Intermediate-term TREND (Bearish on Japanese equities):

  • The benefit derived from yen weakness is vastly overplayed, setting up for an asymmetric risk/reward opportunity on the short side as consensus underestimates the weak yen’s impact on corporate profitability via higher input costs;
  • Slowing growth abroad – particularly in emerging markets – will crimp Japanese export and manufacturing growth, which will result in higher unemployment;
  • Slowing consumption growth in the US creates an even higher asymmetric risk/reward setup for Japanese export growth that “no one will have seen coming”; and
  • Consumption growth in Japan (~60% of the economy) is rolling over as higher prices on the margin diminish demand and confidence remains depressed. 

Long-term TAIL (Bearish on the Japanese yen; Bullish on Japan's CDS):

  • A rapidly aging and declining population will continue to weigh on growth and Japan lacks the domestic savings and foreign capital to invest in its long term potential output;
  • Demographics, regulatory uncertainty, and a favorable cultural mindset towards entitlements will make it impossible to radically rein in entitlement spending and retirement benefits, which will render both the Japanese government and Japanese pension funds insolvent.
  • Waning domestic and global demand for JGBs will force the BOJ to do a lot more of what Paul Krugman suggested they do back in ’97: PRINT LOTS OF MONEY to finance debt issuance and keep rising borrowing costs from crushing the economy. QE2 pales in comparison to the amount of fiat money-printing the BOJ will have to do to “comprehensively ease” over the next decade. 

We intend to trade around our exposure to Japanese equities, understanding full well that the EWJ will minimize gains as the yen is likely to appreciate near-term vs. the $USD (we’re short UUP as well). That said, our research from both a fundamental and quantitative perspective suggests Japanese equities are a good short here.


Darius Dale


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