CHART OF THE DAY: Uncle Sam & Big Government Central Planning Approve this Rally



CHART OF THE DAY: Uncle Sam & Big Government Central Planning Approve this Rally -  chart

Superior Defense

“Defense is superior to opulence.”

-Adam Smith


Stock market bulls pulled out all of their guns yesterday. From the Fed’s James Bullard beating his chest on the potential for QG3, to the Saudis banging out barrels of oil, and the media professing that the Libyan nut-job had been shot – it was all out there. Central Planners of the world unite!


Yes, it’s sad – but it’s true. The other side of the Big Government Intervention trade has been price volatility. What can the Almighty Government do for us next? Price “stability” mandate of the Federal Reserve Act of 1913 be damned. This casino is open for business.


Can US stock market bulls handle three consecutive down days anymore? The Europeans were amazingly able to stomach four. After a 3-day -2.8% drop from this intermediate-term cycle’s closing high in the SP500 of 1343, the question remains – can the bulls defend their critical support lines?


Government Supports in this market are crystal clear: immediately after the St Louis Fed dove opened his mouth, the US Dollar got Bullarded (new wiki synonym for debauched). At the same time the Saudis predictably defended their Kingdom.


Quantitative Supports are less clear: with so many of Wall Street’s finest still using the 50 and 200 day moving averages as their point and click concepts of revisionist risk management, it’s become both entertaining and frightening to watch. The bulls panic when there’s such a big gap between last price the and nearest one-factor price momentum reference point (the 50-day for the SP500 is down at 1287).


I used to do that – trade on emotion. When I was in college, someone invented the internet. And I was immediately able to punch a moving average into a chart. Then I started doing it with lots of charts. Then I started trading and realized by 2001 that I needed a lot of beers to convince myself that a simple moving average was going to be the elixir of my stock picking life.


I wrote about a basic 3-factor setup that I use in my multi-factor, multi-duration, risk management model earlier this week – PRICE, VOLUME, and VOLATILITY. So rather than attempting to make any more average-at-best jokes in a Friday note, I’ll just get on with it and show you some immediate-term TRADE lines of  support and resistance.


SP500 (see attached chart)

  1. TRADE line resistance = 1326 (that’s both a lower long-term and lower immediate-term high)
  2. TRADE line support = 1295

Volatility (VIX)

  1. TRADE line resistance = 22.96
  2. TRADE line support = 18.14

The inverse correlation between the SP500 and the VIX is a critical one to consider when mapping out the probability of the US stock market holding onto its bullish intermediate-term TREND. What’s most interesting about the current setup is that when you expand your duration to 3 months-or-more (our TREND duration) as opposed to 3 weeks-or-less (our TRADE duration), both the SP500 and the VIX are bullishly positioned. One of the two has got to give.


Here are those two critical intermediate-term TREND lines of support:

  1. SP500 = 1251
  2. VIX = 18.11

For now, the better benefit of the doubt should be given to the stock market bulls. With the SP500 still up +93.2% from where we got bullish on US Equities in March of 2009, a tremendous amount of price momentum has been baked into this bullish cake.


Additionally, the immediate-term move in Big Government Sponsored Volatility (VIX) has been surreal (the VIX is UP +37% since February the 11th!). And most 3.5-4.5 standard deviation moves in price (oil just had one too) are subject to immediate-term mean reversion corrections.


All that said, the coming days will be critical to monitor from a PRICE, VOLUME, and VOLATILITY perspective. The fundamental Global Macro overlay of Growth Slowing as Inflation Accelerates will also be key to measure in real-time.


Most Asian and Emerging stock markets are already broken on both our TRADE and TREND durations. Concurrent VOLUME and VOLATILITY signals continue to support the bearish case for our short positions from Emerging Markets (EEM) to Brazil (EWZ).


Here at home, I maintain that the Superior Defense for America’s long-term prosperity is defending the US Dollar rather than debauching it. I want to stand alongside the brave men and women wearing Canadian and American jerseys who recognize that the names on the front of our jerseys mean more than the ones on our backs (Herb Brooks). It’s time to stop begging for Saudi barrels and Quantitative Guessing. It’s time to stand up and be accountable.


My immediate term support and resistance lines for the SP500 are 1295 and 1326, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Superior Defense - na1


Superior Defense - na2

Lethal To Liberty

This note was originally published at 8am on February 22, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“The natural progress of things is for liberty to yield and government to gain ground.”

-Thomas Jefferson


I went into this President’s Day weekend writing an intraday note at 3PM EST on Friday titled “Exhaustion.” I wasn’t talking about my physical state. Ex-snow shoveling, I’ve been managing with my peg leg in an air cast just fine. I was writing about the US stock market’s risk management setup.


In the most immediate-term duration (today), US stock-centric investors are going to realize that there is indeed risk to a market that’s been rallying to higher-intermediate-term highs on low-volume and negative skew. From a long-term TAIL perspective, US stocks are simply making lower-highs.


Lower-highs can be lethal to returns, particularly if confirmed by fundamentals that perpetuate lower prices. While plenty a perma-dancing-bull can tell you that the US stock market is “cheap” (if they use the wrong margin and earnings assumptions in their SP500 estimates), this type of storytelling isn’t new to your average American.


After all that we’ve been through in the last 3-years my sense is that Americans get it. Americans get leadership. Americans get liberty. Americans get transparency, accountability, and trust.


Before I take a step back recapping last week’s most important weekly moves, allow me to remind you what risks Main Street Americans see to the US economy:

  1. A 2011 US Deficit of $1,650,000,000,000
  2. A 2011 US Debt balance of $14,173,394,779,991
  3. A 2011 US Dollar Debauchery inspiring inflation

So when the S&P Futures are down 18 points like they are this morning, there are obviously more than a few relatively large risks that the “fundamentalist” might point toward.


There is also this other little risk management critter called The Rest of The World that central planning folks in Washington, DC seem to think are simply being affected by “supply and demand” as opposed to anything that’s right here in our own back yard.


Given that 85% of all foreign exchange transactions are in US Dollars, and the US Dollar continues to be debauched, we think the following week-over-week moves in Global Macro are critical correlated risks to manage around:

  1. US Dollar Index = DOWN a full -1% last week to $77.69 and down for the 6th out of the last 8 weeks.
  2. CRB Commodities Index = UP +1.2% last week to close at a new intermediate-term weekly closing high of 341.
  3. Volatility Index (VIX) = UP +4.7% last week, despite US stocks rallying to new YTD highs.

So how could US investors bid up volatility at the same time as the institutional performance chasing community bids up the price of US stocks? Maybe it wasn’t US only investors…


Maybe, just maybe, The Rest of the World remembers that deficit spending and dollar devaluation strategies don’t work out so well in the end. Maybe some Americans themselves remember what Presidents Nixon and Carter did to the US Dollar in the 1970s. Maybe history remembers The Inflation.


In terms of other important perspectives, this is what The Economist had to say this weekend in its commentary about US Leadership:


“Neither the President nor Republican leaders have had the courage to support them. In the absence of statesmanship, the chances are that only a crisis in the bond markets will provide the necessary impetus. Economic management by fiscal heart attack is not a very prudent remedy.”


This is what a massive international pension fund manager (Gerald Smith, Deputy Chief Investment Officer of Baillie Gifford, who oversees $117 Billion in assets) had to say about American monetary policy:


“If Bernanke wants inflation he’s going to get it.”


And, finally, for all of the professional politician fans who are still left out there in America, this is what Presidential candidate, Mitch Daniels, had to say about US deficit and debt spending:


“We face an enemy lethal to liberty and even more implacable than those America has defeated before.”


It’s all out there now. You don’t need this Canadian with an American family and firm to remind you of the risks. You get it too.


In the Hedgeye Asset Allocation model, last week I invested 6% of our large Cash position in a combination of Swedish stocks and soft agricultural commodities, taking the cash position down from 61% last Monday to 55% this morning.


The current exposures in the Hedgeye Asset Allocation Model are a follows:

  1. Cash = 55%
  2. International Currencies = 24% (Chinese Yuan and Canadian Dollars – CYB and FXC)
  3. Commodities = 9% (Oil and Grains – OIL and JJG)
  4. International Equities = 6% (Sweden – EWD)
  5. US Equities = 6% (US Healthcare – XLV)
  6. Fixed Income = 0%

As you can see in the Hedgeye Portfolio (see attached), I’m short both emerging markets (EEM, IFN, EWZ) and US Treasuries (SHY), so that’s one of the main reasons why I have such a large asset allocation to Cash – I don’t own any fixed income or emerging market exposure as I realize that inflation can and will continue to be lethal to these markets.


As to whether or not the Almighty Central Planners of America are infusing interconnected Global Macro market risks into our way of life … that will be an American history that writes itself on its own time… In the meantime, deficit and debt spending will remain lethal to our liberty.


My immediate term support and resistance levels for the SP500 are now 1330 and 1346, respectively. If the SP500 breaks down and closes below 1330, I have no support to 1306.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Lethal To Liberty - ted1


Lethal To Liberty - ted2

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A normalizing quarter



Now that all the public companies have released their earnings, we can take a look a slot ship share trends.  Total shipments into North America decreased 11% YoY to approximately 16k in 4Q10 from an estimated 18k in 4Q09.  We estimate that a total of 63k units were shipped in NA in 2010 compared to an estimated 71k units in 2009.  Replacements increased an estimated 3% YoY in 2010 to 47k units from approximately 45.5k units in 2009.

  • We estimate that new and expansion units decreased almost 40% YoY to 3.9k from 6.3k in 4Q09
  • Replacements in the quarter were about 12.4k, up 4% YoY and up from roughly 10.0k replacements shipped in 3Q10

Going forward, we think ship share for IGT and BYI will likely rise throughout the year while WMS and Konami will fall slightly.


Slot Ship Shares

  • IGT:  28% in 4Q up 1% from last quarter and down from 29% in 4Q09.  For 2010, IGT’s share dropped to 27% from 34% in 2009.
  • WMS:  24%, up 1% from 3Q share and flat with their 4Q09 ship share.  For 2010, WMS’s ship share was 25% compared to 22% in 2009.
  • BYI:  14% in 4Q2010 - flat sequentially and down 400bps YoY.  In 2010, BYI’s ship share fell 3% to 15%.
  • ALL:  2H2010 results were at 12%, flat YoY.  Based on company commentary on the earnings call last night, we believe that their 4Q2010 share was 13%, up from 3Q share of 11%.
  • Konami: 13% in 4Q, down from 16% in 3Q2010 and up 2% from their 4Q09 shipshare of 11%.  In 2010, Konami’s ship share stood at 13% compared to 10% in 2009

The chart below summarizes slot ship share trends:




I went through my initial take on JACK’s fiscal 1Q11 earnings yesterday (JACK – FIRST LOOK, posted yesterday).


As we knew going into the conference call, increasing commodity costs are putting significant pressure on the company’s margin relative to its prior guidance.  Fiscal 2011 commodity costs are now expected to be up 3-4% from its prior outlook of up 1-2%. Although management broke out its expected commodity cost increases by food item, they did not say how much of the company’s total costs are currently locked in for the remainder of the year.  To that end, there is still risk to the company’s current forecast.


Management would not comment on whether they are planning on taking price to help offset some of the inflationary pressures but said their approach to pricing would be cautious and if necessary, any price increases would be modest and targeted.  Given recent comp trends at Jack in the Box, the company is right to be cautious.  Although same-store sales turned positive during the quarter and improved 20 bps on a two-year average, Jack in the Box has underperformed its competitors and one quarter of positive trends does not give me confidence that the concept has real purchasing power in this environment.  Management is either being cautious on its full-year outlook or it is not yet convinced that trends have turned the corner at Jack in the Box because the low end of its full-year comp guidance assumes a slowdown in two-year average trends from first quarter levels. 


We know 2Q11 will be difficult from a top-line standpoint as the company guided to a flat to down 2% comp at Jack in the Box, which at the low end of the range implies a 50 bp decline in two-year average trends from the first quarter.  The company cited that unfavorable weather in many of its markets, particularly Texas where it has 27% of its Jack in the Box company restaurants, impacted results in the first four weeks of the second quarter.  I would expect comp trends to improve slightly on a two-year average basis in the back half of the year; though I am currently modeling a flat comp for the full-year (at the mid-point of management’s guidance).  Comparisons get much more difficult for Jack in the Box in the fourth quarter, however, so same-store sales growth could very likely turn negative again on a one-year basis.


So, 2Q11 is going to be bad from a top-line (severe weather impact), commodity cost (guided to a 5% increase, including a 20-25% increase in produce costs, versus their up 3-4% full-year outlook) and margin perspective.  I am currently modeling a 12.4% restaurant-level margin for 2Q11, which implies a 280 bp decline YOY.  Management stated that 2Q11 margin should be about even with the reported 1Q11 level of 12.6%.  In the back half of the year, restaurant-level margins should improve modestly largely as a result of the fact that the company is lapping a nearly 370 bp decline from 3Q10 and a 330 bp decline from 4Q10.  That being said, commodity costs are the biggest wild card as we move through the balance of the year!


JACK – 2QFY11 LOOKING ROUGH - jack sigma


Howard Penney

Managing Director

Show-me The Comps

Target’s earnings report and conference call still leaves us comfortable with our short bias over the near-term.  In fact, it’s probably now more clear than before that the near to intermediate term topline results are integral to this show-me story.  The expected sales ramp over the course of the year, tied almost entirely to the company’s growth in P-Fresh remodels and 5% Reward penetration, is the single biggest factor in determining if TGT can control its own destiny or if macro factors will keep the topline muted.  We remain concerned that guidance for incremental comps of 200-400bps driven by such initiatives still remains aggressive. 


As always there were a few positives (mostly longer-term) and a few negatives to contemplate following today’s official 4Q report.  First the positives:

  •  TGT’s quarter was largely as expected following the company’s January pre-announcement that indicated credit card profits and a favorable tax rate would offset modest declines in retail profitability.  In reality what we got was a much better tax rate to the tune of $0.07 per share and a flat y/y EBIT performance from retail.  All in no big surprises in the P&L.
  • Management suggested that a sale of the credit card portfolio has become increasingly likely, although the timing of such a transaction could take time and drag into early 2012.  The transaction will result in a gain on sale and a future stream of “shared economics” between the new owner and Target.  This should viewed as a win, as this takes risk off of the company’s balance sheet while maximizing the NPV of the portfolio at a time when credit seems to be stabilized. 
  •  Additional clarity was given on Canada and the impending transaction to acquire 180-200 former Zeller’s locations/leases.  The process is clearly underway and will begin to impact the P&L in the form of front-loaded investment beginning in 2Q.  This investment covers IT development, increased headcount to support the Canadian expansion, and the assumption of leases as they become property of Target.  Store openings are still slated to take place in 2013 and 2014.  Bottom line here is this will be a drag for a while until the stores actually produce revenues.  For those with a multi-year time horizon, we believe Canada will be a success and has the potential to be a key top and bottom line driver beyond the next two years.

And the negatives:

  •  The P-fresh and 5% reward programs are clearly having an impact on the topline, although not as much as originally anticipated at this early part of the roll-out.  Management noted that the rewards program added about 100bps to 4Q same store sales and P-fresh added a bit as well.  Target now expects the two efforts to contribute about 350bps combined on a run-rate basis to same store sales by the end of the year.  Keep in mind that in late fall, the expectation was for these efforts to contribute an incremental  200-400bps for the ENTIRE year.  Yes this is a subtle change in tune, but one that at best makes 2011 a year of two distinct halves.  First half comps now expected to be positive low single digits, while the second half is planned higher.
  •  The investments in Canada will result in two buckets of costs over the course of 2011.  First the actual investment in people and infrastructure to support the acquisition, which amounts to $0.10 share.  Second, the funding for Canada is now expected to put share repurchase temporarily on hold to the tune of $0.05 to $0.10 per share.  All in a $0.15 to $0.20 per share hit in the near term.  We understand these are prerequisite investments that must be made and we like the Canada acquisition.  However, we suspect that this effort may also add additional SG&A volatility over the coming year as operating a new and sizable division in a completely new country with re-purposed real estate is sure to bring some surprises.
  •  Inventories came out of the quarter a bit on the high side, up 6% against a 2.8% in total sales growth.  Management says inventories are in good shape but we can’t ignore that the reported sales/inventory spread as at its widest point in a year.  
  •  The year’s greatest same store sales increases are now expected to occur in the back half of the year at the same time costs and pricing issues are going to be at their greatest year over year increases.  We respect management’s conservatism on holding off from predictions on how the consumer will react, but we can’t ignore the fact this boils down to increased uncertainty at time when management appears to be more confident in their own sales growth.  Time will tell.

Show-me The Comps - tgt


Eric Levine


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