Delicious Privileges

This note was originally published at 8am on February 15, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“That most delicious of all privileges – spending other people’s money.”

-John Randolph


After reviewing this Disaster Deficit proposal put forth and watching the political theatre associated with delivering it from an American classroom yesterday, I re-shorted the US Dollar and sold out entirely of the 3% in US Treasury denominated Fixed Income I had left.


Since professional politicians from George Bush to Barack Obama clearly don’t have it in them to stop spending other people’s money, the only way to Govern the Government from here on in is going to have to be the old fashioned way - voting with our wallets.


The aforementioned quote came from a Congressman in Virginia (who served between 1825-1827) most commonly remembered as John Randolph of Roanoke. I am calling out his thoughts because they pertained to the constitutionality of the US government’s concentration of power. Standing up against the tyranny of central planning is not a new idea in America this morning. I’m just reminding you where we came from.


In the coming weeks I am going to focus on the history of both US monetary and fiscal policy. I’ll be drawing most specifically on a recently published book that I’m two-thirds of the way done by Barry Eichengreen titled “Exorbitant Privilege” which focuses on the history of the US Dollar, other modern day fiat currencies, and the politicization that supports them.


The idea of Delicious or “Exorbitant Privilege” shouldn’t be foreign to any human being. Depending on which part of this world that you live, you may actually call into question the US Dollar having the privilege of being the world’s most recent reserve currency. As Eichengreen reminds us,


“This has long been a sore spot for foreigners, who see themselves as supporting American living standards and subsidizing American multinationals through the operation of this asymmetric financial system.”


Why have I been so intensely focused on how modern day fiscal and monetary policies affect the US Dollar for the past 3 years? That’s simple. Staying ahead of the big draw downs in the US Dollar’s price over the course of the last 3 years has protected my clients and firm from being long massive bubbles in US Equities (2008) and US Treasuries (2010).


Until the huge correlation risk to what the US Dollar Index does every day burns off (and, God willing, it eventually will), I won’t stop weighing the US Dollar as the #1 factor in my 27-factor global macro risk management model.


Unlike whatever models Greenspan and Bernanke have been using for the last 10 years, mine has had some credibility in calling out big Global Macro risks before they become consensus. We introduced the Hedgeye Macro Theme of Global Inflation Accelerating in October of 2010 – today the #1 headline at one of the world’s key lagging economic indicators, The New York Times, is “Companies Raise Prices As Commodity Costs Jump.”


Having authored the inflation theme 5 months ago, I think we have as good a shot as the next Thunder Bay Bear to call a rollover in inflation – or to appease The Ber-nank fans, maybe we’ll call it The Deflation of The Inflation…


Just because inflation concerns are now a global consensus doesn’t mean that they can’t remain. I think the #1 factor in determining where inflation goes from here is where the US Dollar Index goes from here.


So, to keep this globally interconnected game of Chaos Theory very simple:

  1. If the US Dollar is debauched from here, I think Global Inflation will continue to accelerate
  2. If the US Dollar is resuscitated from here, I think Global Inflation readings will decelerate

As a reminder, the way we Chaos Theorists measure risks in macro markets is on the slope. Many Big Government Interventionists don’t even know what that means. Being historians and socials scientists can indeed provide impediments to understanding mathematical thoughts.


Another way to talk about slopes, sequential rates of change, and the risk management signals embedded therein is to simplify it – so Barney Frank and John Boehner please repeat after me – what happens in macro happens on the margin… what happens in macro happens on the margin…


Good. With that trivial math lesson in hand, all we need to give America’s professional politicians are some lines and charts for the US Dollar Index:

  1. TAIL (long-term) resistance = $81.66 (that’s the line you’ll need to challenge to overcome your credibility issues)
  2. TREND (intermediate-term) resistance = $78.98 (that’s the line you’ll need to watch day-to-day during the Deficit and Debt Ceiling Debates)

Now, on the topic of the US Debt Ceiling Debate, going all the way back to that prickly little critter that American folks like John Randolph were so focused on – the US Constitution – I’d be remiss not to remind the current Treasury Secretary of the United States of America that it wasn’t until 1917 that Congress gave the US Treasury discretion to issue debt…


That’s right – from 1787 to 1917 is a fairly long time. And we’re pretty sure that the decision in 1917 didn’t have anything to do with Presidents Bush and Obama giving prime time PR speeches from our children’s classrooms to justify deficit spending. The idea behind the issuance of US Treasury debt was grounded in protecting the American people during a time of war, not in protecting government from the people.


My immediate term support and resistance lines for the SP500 are now 1318 and 1337, respectively. As the implied default risks associated with US deficit spending and debt issuance continue to be reflected in higher US Treasury Yields, we now have a ZERO percent asset allocation to UST bonds.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Delicious Privileges - ja1


Delicious Privileges - ja2


Even with a new round of casino planning, Taiwan's casino future is unknown.



New markets in Asia remain a huge long term growth opportunity for WYNN and LVS but Taiwan, while still likely at some point in the future, may have to wait.


Recently, two casino development bills stalled in Taiwan's government.  The legislative session ended (Chinese New Year) without approval of the bills—1) Casino management law under the supervision of the Roads, Highways, & Railways Department and 2) Tourism project with gaming features led by the Taiwan Tourist Bureau (TTB).  But that hasn't stopped the TTB from continuing its push for casinos on Taiwan's offshore islands (IRs on Taiwan's mainland is out of the question). 


The TTB has authorized a Macau-based consultant company, Ocean Tech Group, to conduct a feasibility survey to 40 potential operators from Las Vegas, Macau, and other regions regarding location, land size, investment amount, casino size, length of license, and other logistics for an IR on one of Taiwan's 6 offshore islands: Hsiau Liouchiou, Kinmen, Lanyu, Lyudao, Matsu, and Penghu.  Ocean Tech Group will design the IR concept to include a theme park, hotel, expo, shopping mall and casino for the government.  The survey will not have any effect on the license bidding process.  Sources say TTB may receive all the surveys by the end of this week.


Kinmen has been mentioned as a front-runner given the Taiwanese government’s plan to introduce FIT travel for Chinese visitors to Kinmen in April 2011.  But that's assuming Mainland China goes through with this immigration change, which is never a certainty.  Reports also indicate that on Kinmen, a petition for a referendum has been submitted to the Executive Yuan, a process that is anticipated to take at least six months.


Meanwhile, Penghu may have a second chance as it hopes to submit another casino proposal by mid-2011.  However, Chang Jui-Tung, director-general of the Penghu County government's Civil Affairs Bureau, had said that the failed 2009 referendum means the Taiwanese government will have to wait for three years to conduct another related referendum on the island.  Recall that the citizens on the island of Penghu voted to block the construction of Taiwan's 1st casino in 2009.  A tender was held by the Tourism Agency and two foreign companies submitted bids but both were rejected because they didn't provide all the required documents.


The Ministry of Transport and Communication (MOTC) has indicated that any IR proposals should be based on a opening by the end of 2013.  But before any bill is submitted to the Legislature Yuan, it must pass through numerous public hearings and consultations, which can last many months.  The purpose of these forums is to gain the support of the local communities.  This is not an easy task.


The MOTC and TTB may be hoping for an IR.  But hope is not an investment process.  Frankly, Taiwan and its offshore islands are not in any hurry to open up an IR. They don't need the business right now as Taiwan GDP grew 10.8% and visitation soared to a record 5.6MM in 2010.   Maybe the offshore islands will follow the example set by Hainan, China's only tropical island, which earlier last year passed on becoming a gambling hub to focus on natural scenery in its quest to become a top tourist destination.


TODAY’S S&P 500 SET-UP - February 18, 2011


Equity futures are trading flat to fair value following Thursday's low key session which saw indices close modestly higher having reversed early weakness. With no major data scheduled and with Monday a holiday, trading is expected to be range bound.   As we look at today’s set up for the S&P 500, the range is 14 points or -0.93% downside to 1328 and 0.12% upside to 1342.



  • 8 a.m.: Bernanke speaks on global imbalances in Paris. Q&A
  • 1 p.m.: Baker Hughes rig count
  • G20 Finance Ministers & Central Bank Govs meet in Paris this weekend


  • Bats Global Markets is close to deal to take over Chi-X Europe, two people familiar with discussions say; Bats offered ~$300m for Chi-X, people familiar with deal said Dec.
  • Philip Falcone’s LightSquared is close to securing $585m loan to build its wireless network, as it negotiates a wholesale deal with a nationwide carrier, two people familiar with plans say
  • Time Chairman and CEO Jack Griffin is leaving co. after six months in the job; Time Warner’s magazine unit will be led by interim management committee until permanent successor found
  • U.S. House edges closer to passing bill to reduce govt. spending by at least $61b. Final vote on 2011 budget measure may come as soon as today; it then would go to the Senate, where the Democratic majority is likely to reject proposal
  • China’s central bank raises reserve requirements for lenders for second time this year to counter inflation, curb property-price gains. Ratios will increase 0.5 pct. pt. starting Feb. 24
  • Egypt’s foreign ministry says it has received and is studying a request from Iran for two military ships to pass through the Suez Canal
  • American Public Education (APEI) reported 4Q EPS 52c vs est. 47c
  • Aruba Networks (ARUN) forecast 3Q non-GAAP EPS 14c-15c vs est. 14c
  • Blue Coat Systems (BCSI) forecast 4Q adj. EPS 32c-38c vs est. 38c
  • Brocade Communications Systems (BRCD) forecast 2Q non-GAAP EPS 10c vs est. 9c
  • Clearwire (CLWR) said may sell assets and hasn’t made decision on spectrum; posted 4Q rev. $180.7m vs. est. $190.2m
  • Exelixis (EXEL) said its lead drug, XL184, reduced bone tumors in prostate cancer patients
  • Intuit (INTU) forecast 2011 adj. EPS $2.41-$2.48, vs est. $2.41
  • Newpark Resources (NR) posted 4Q EPS 15c vs est. 10c (4 est.)
  • Nordstrom (JWN) forecast 2012 adj. EPS $2.95-$3.10 vs est. $3.05
  • SunPower (SPWRA) raised 2011 adj. EPS forecast to $2-$2.20 from $1.75-$2.05 in Nov., vs est. $1.74



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

  • One day: Dow +0.24%, S&P +0.31%, Nasdaq +0.21%, Russell 2000 +0.68%
  • Month-to-date: Dow +3.58%, S&P +4.22%, Nasdaq +4.87%, Russell +6.75%
  • Quarter/Year-to-date: Dow +6.40%, S&P +6.58%, Nasdaq +6.74%, Russell +6.43%
  • Sector Performance: - Materials +0.90%, Energy +0.99%, Consumer Spls +0.68%, Healthcare +0.43%, Utilities +0.19%, Industrials +0.24%, Tech +0.19%, Consumer Disc +0.03%, Financials (0.12%)


  • ADVANCE/DECLINE LINE: 751 (-752)  
  • VOLUME: NYSE 882.14 (-5.04%)
  • VIX:  16.59 -0.78% YTD PERFORMANCE: -6.54%
  • SPX PUT/CALL RATIO: 1.22 from 1.88 (-35.13%)



Treasuries were higher today despite the move in stocks and some of the adverse headlines surrounding inflation (though this seemed to help the 30-year TIPS auction).

  • TED SPREAD: 22.43  
  • 3-MONTH T-BILL YIELD: 0.09% -0.03%
  • 10-Year: 3.58 from 3.62
  • YIELD CURVE: 2.78 from 2.76


  • CRB: 341.27 +0.90%; YTD: +2.54%  
  • Oil: 84.90 +1.61%; YTD: -6.85% (trading -0.68% in the AM)
  • COPPER: 445.50 +0.32%; YTD: +0.34% (trading -0.93% in the AM)  
  • GOLD: 1,385.18 +0.63%; YTD: -2.37% ( trading +0.21% in the AM)  


  • Gold Rises, Silver Goes to 30-Year High as Middle East Unrest Spurs Demand
  • World Feeding Itself Spurs Search for Answers Amid Global Feast and Famine
  • Crude Rises in London as Protests in Libya, Bahrain Fuel Supply Concern
  • Sugar Output in Thailand May Climb to Record on Higher Yields, Board Says
  • Copper May Decline in London on Chinese Leading Indicators: LME Preview
  • Bank of America Said to Hire Ex-JPMorgan Chase Metals Prop Trader Daniel
  • Rubber in China to Extend Record Rally, Zhongcai Says: Technical Analysis
  • Cotton Declines, Reversing Advance to Record, on Outlook For Next Harvest
  • Malaysian Palm Oil Gets Greater Access to Indian Buyers Under Trade Accord
  • Natural Gas Producer Hedging Gains as Rally Prospects Fade: Energy Markets
  • Speculators, Not Demand, Driving Surge in Food, Poland's Sawicki Tells WB
  • China $1.3 Trillion Rail Opening to Interior Aids Daqin: Freight Markets
  • Posco, Units to Cut Costs by 2.4 Trillion Won to Fight Raw-Material Prices
  • Copper May Drop Next Week as Buyers Delay Purchases, According to Survey 


  • EURO: 1.3594 +0.35% (trading -0.25% in the AM)
  • DOLLAR: 78.121 -0.29% (trading +0.16% in the AM) 


  • FTSE 100: (0.453%); DAX: (0.11%); CAC 40: (0.09%) (as of 06:15 ET)
  • European markets reversed modest early gains to trade lower.
  • Banks were pressured as elevated levels of emergency overnight borrowing from ECB leading to speculation that a EuroZone bank may be facing funding problems.
  • There was also a newspaper report that Spanish saving banks will get a six month extension to the time frame to seek private capital, when the Spanish government adopts new bank capital requirements, expected later today.
  • Finance Ministers of the G20 meet today with Fed Chairman Bernanke due to make an address at 8ET.
  • Peripheral markets lead the region lower with declines approaching (1%).
  • France Feb business climate 106 vs con 109, prior 108
  • UK Jan Retail sales +5.3% y/y vs con +4.1% vs prior revised to (0.7%) from +0.0%
  • Retail sales ex fuel +5.3% y/y vs con +4.4% vs prior revised to +0.3% from +1.0%
  • Jan impacted by VAT change, heavy snow; Dec revisions due largely to late survey returns due to snow


  • Nikkei +0.1%; Hang Seng +1.3%; Shanghai Composite (0.9%)
  • Asian markets were mixed tending up today.
  • South Korea rebounded +1.82% on foreign investors and bargain hunters.
  • Chinese financials and HSBC Holdings rose to power Hong Kong’s gain.
  • Japan ended flat as banks recovered from early losses.
  • Australia finished lower by -0.03%; Australia and New Zealand Banking Group fell 3% when it failed to beat expectations for earnings.
  • China fell as data showed that the property market remains hot, despite government efforts to cool it. Property developers, unsurprisingly, rose on the news, but other large caps were sold.
  • Thailand was closed for Makha Bucha Day.
  • Japan January department-store sales (1.1%) y/y. Tokyo January department-store sales +1.4% y/y.
  • The PBOC raised its required reserve ratio by 50 bps. The hike is effective 24-Feb


Howard Penney

Managing Director



SBUX - My take on the Starbucks memo from today….

Howard Schultz sent a very clear message today and this is my take on the memo from today….


Dear Partners,


For 40 years, Starbucks has been the world’s leading purveyor of premium coffee and premium coffee innovation. But at no point in our history has our innovation pipeline produced and introduced more successful, breakthrough products for multiple coffee occasions and in multiple form factors than it has during the past few years. Today, Starbucks provides the world’s finest coffee in virtually every format, including single-serve, to more than 50 million visitors to our stores and to millions more through nearly every retail and consumer channel in 54 counties around the world--every week.


Hedgeye - SBUX is sending a very clear message to Green Mountain “you are not in our league.”  The company is completely capable of developing its own innovative products to dominate every segment of the coffee market.

On Tuesday we announced that starting this fall we will also be bringing premium Starbucks Coffee offerings in a single-portion format to guests in 500,000 luxury and premium hotel rooms across the U.S. as part of a new partnership with Courtesy Products, the acknowledged leader in hotel room amenities. But because of the speculation swirling in the marketplace around Starbucks larger plans for single-serve in the U.S. and internationally, I wanted to take a moment to let you know what our intentions for single-serve are...because they are very bold.


Hedgeye - There are many channels of distribution and Starbucks will align itself with the partner that brings it the most economic value.


At the outset, let me share that while it is currently a $4 billion segment growing faster than any other segment of the global coffee industry, the single-serve coffee category in the U.S., and in much of the world for that matter, is in its very early stages of development.


Hedgeye – GMCR’s market cap of $5.7 billion accounts for more than 100% of its current addressable market.  There is still plenty of room within the single-serve coffee category for new market players and for product innovation.

And at this nascent stage there are numerous contenders but no demonstrated, long-term winners related to any format, geography or machine. Let me give you a few examples to illustrate this point: In Germany, where single-serve coffee has been around for some time and almost 40% of households own a single-serve brewer (compared to only 6% in the U.S.) the long-time industry leader is an open system (meaning any coffee roaster can have access to the platform) that has virtually zero presence in the U.S., the largest consumer market in the world. On the other hand, the U.S. industry leader, the Keurig K-cup, is a closed system with U.S. patents set to expire next year--and virtually no presence anywhere in the world outside of the U.S. and Canada. This global market dynamic will change.


Hedgeye - Starbucks is one of the strongest brands in the coffee segment and will shape the single-serve segment globally.  None of the single-serve brewing systems currently available to the market are good enough to be tied to the Starbucks name.

Now consider that approximately 80% of Starbucks customers do not yet own a single-serve coffee machine in their homes. This fact alone suggests that we are, again, at the very early stage of adoption and that Starbucks has a fantastic opportunity to introduce and deliver new single-serve coffee innovations to our customers. 


Hedgeye – Starbucks wants to own the category and will work to revolutionize the single-serve coffee brewing platform.  Below I outline my prediction of what the new Starbucks machine will be like (if not at first, then with later versions: 2.0, 3.0 etc.).  While some of these attributes seem fanciful, they all have founding in both Starbucks’ quest for control and the overall direction of the category (possibly run using Android):

  • The design of the machine will evoke the design and feel of the Starbucks store and experience.  I would think black and green, as well as the Siren logo. (experiences)
  • The name will also likely evoke the store.  “My Barista”, “The Siren”, or other names along those lines are likely.  (experiences)
  • The experience will be customizable, perhaps a touch screen or another user interface that allows the user to provide the machine with specific instructions as to the composition of the coffee they would like. (customization)
  • A “menu” (like a playlist in iTunes), where one can save a recipe or style of coffee for repetitive use and save it with a name like, “Jim – morning coffee”. (customization)
  • Connection to the internet via home computer system to allow the sharing of “menus” and reception of coffee ideas from Starbucks and fellow machine-owners.  This also allows a direct tap into social networking for the new machine.  (community)

We began our journey into the single-serve market with Starbucks VIA, introducing consumers to a delicious cup of coffee in an instant, soluble format. With Starbucks VIA, we also introduced them to a brand platform designed and built to facilitate an ever-evolving pipeline of new products. And Starbucks VIA’s success is undeniable: more than $180 million in system-wide sales in its first year.  This remarkable achievement for a new product was due not just to the premium quality and taste of Starbucks VIA.


It was also due to the successful implementation of a new business model where we bring the assets of the Starbucks brand--our coffee knowledge, our broad retail footprint, the passion of our store partners and our ability to reach and personally connect with millions of people--to create trial, sampling and awareness on a scale that very few, if any, retail companies can accomplish.  With Starbucks VIA, we showed how we can now migrate products through our growing presence in grocery, drug, mass, club and online channels to drive the expansion and globalization of the single-serve segment of the coffee industry.


Hedgeye - VIA was a good start, but Starbucks still needs and plans to take it to the next level.  VIA proves that the company can develop its own product and successfully market it globally.

There are many single-serve systems and solutions and even more in late-stage development. We are committed to supporting and participating in those that enable us to better and more conveniently serve our global customers, wherever they are and however and whenever they want our coffee. 


Finally, let me touch on a subject we are increasingly asked about: Green Mountain Coffee’s Keurig K-cup system. With specialty distribution arrangements and some aspects of its cartridge technology protected by patents for the next 18 months or so, Green Mountain has done a very fine job introducing single-serve brewer technology to the U.S. market.  And as a result it has emerged as an early leader. But as I have said, these are very early days, and history has demonstrated time and again that patents alone do not determine market winners--deep customer engagement, best-in-class experiences and quality do.


Hedgeye - This was the sucker punch.  CEO Howard Schultz typically uses colorful adjectives to describe the success of the Starbucks business (e.g. exceptional, unequivocal, solid).  The fact that he said GMCR has done a “fine job” was a clear signal to me that he is not a handshake away from partnering with the company.  The GMCR storytelling is getting out of hand.  GMCR’s announcement on its last conference call that it has a double secret new machine was purely a defensive move because they are desperate to work with SBUX.

The single-serve segment of the coffee industry is poised for a sea change of innovation. We will win by delivering quality in the cup, every time, and by capturing the hearts and minds of millions of loyal customers, in the U.S. and throughout the world.


Hedgeye - Take it from someone who knows firsthand - don’t bet against Howard Schultz!

Thank you for defining and delivering our Starbucks Experience to our customers, every day. I have no doubt that we will continue to reinvent this category and provide customers with yet another premium coffee experience.


Hedgeye - Our 2010 coffee strategy continues to be positive on SBUX and PEET and cautious on GMCR.


Howard Penney

Managing Director

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