TODAY’S S&P 500 SET-UP - March 7, 2011

Equity futures are holding slightly above fair value.  The price of oil is again likely to drive sentiment this week as Libya looks to be sliding into civil war and the regional civil unrest threatens to spill into Saudi Arabia. On Saturday, the Saudi authorities said they would ban all protests and marches after activists called for "a day of rage" this coming Friday.  As we look at today’s set up for the S&P 500, the range is 18 points or -0.47% downside to 1315 and 0.90% upside to 1333.



  • 7 a.m.: ECB’s Trichet speaks in Basel after global economy meeting
  • 8 a.m.: Fed’s Lockhart speaks on U.S. economic outlook
  • 9:15 a.m.: Fed’s Fisher speaks in Washington
  • 11 a.m.: Export inspections (grains)
  • 11:30 a.m.: U.S. to sell $32b 3-mo., $30b 6-mo. bills
  • 3 p.m.: Consumer credit, est. $3.4b, prior $6.1b  


  • Clashes during past two days in Libya have become more deadly as rebels moved toward Tripoli and govt. troops escalated use of force in attempts to retake rebel-held cities.
  • In deals, LVMH plans to acquire Bulgari for ~EU3.7b; agrees to buy Bulgari family’s 50.4% stake and will make tender offer for the rest.
  • Galleon trial proceedings begin this week
  • Japan’s health ministry suspends use Pfizer’s Prevenar, Sanofi-Aventis’s ActHIB after reports of four deaths following vaccinations
  • Oil prices rise to new 29-month high as violence escalates in Libya. U.S. pump prices surged to $3.51 for two weeks ended March 4 on biggest rise since 2005, Lundberg survey said
  • Moody’s downgrades Greece three steps to B1 on rising risk of default


We have 5 of 9 sectors positive on TRADE and 9 of 9 sectors positive on TREND. 

  • One day: Dow (0.72%), S&P (0.74%), Nasdaq (0.50%), Russell (0.47%)
  • Month-to-date: Dow (0.46%), S&P (0.46%), Nasdaq +0.09%, Russell +0.19%
  • Quarter/Year-to-date: Dow +5.12%, S&P +5.05%, Nasdaq +4.97%, Russell +5.28%
  • Sector Performance: - Healthcare (0.14%), Consumer Staples (0.44%), Utilities (0.61%), Energy (0.64%), Tech (0.81%), Consumer Discretionary (0.73%), Materials (0.91%), Industrials (1.16%), and Financials (1.23%)


  • ADVANCE/DECLINE LINE: -918 (-2832)  
  • VOLUME: NYSE 1038.58 (-3.3%)
  • VIX:  19.06 +2.47% YTD PERFORMANCE: +7.38%
  • SPX PUT/CALL RATIO: 1.98 from 1.60 (+23.41%)


Treasuries were stronger with the belly of the curve outperforming. 2s10s wider by nearly 2 bps

  • TED SPREAD: 20.10 +0.203 (1.020%)
  • 3-MONTH T-BILL YIELD: 0.12% -0.01%
  • 10-Year: 3.49 from 3.58
  • YIELD CURVE: 2.81 from 2.79


  • CRB: 362.88 +0.64%; YTD: +9.04%  
  • Oil: 104.42 +2.46%; YTD: +12.39% (trading +2.05% in the AM)
  • COPPER: 448.55 -0.1-%; YTD: +1.04% (trading -0.02% in the AM)  
  • GOLD: 1,428.20 +0.83%; YTD: +0.67% (trading +0.76% in the AM)  


  • Wheat Planting Falls to Four-Year Low in Russia As Export Ban Hits Farmers
  • Global Corn, Wheat Harvests to Keep Trailing Demand on La Nina, DTN Says
  • Hedge Funds Cut Bullish Rice Bets by Most Since August on U.S. Supply Gain
  • Gold Approaches Record on Mideast Violence; Spot Silver Hits 31-Year Peak
  • Cotton Advances by Daily Limit to Record on Outlook for Demand From China
  • Corn Rises on Improved Global Grain Demand; Soybeans Climb for Fifth Day
  • Palm Oil Demand to `Outpace' Supplies in 2011, TransGraph Consulting Says
  • Coffee Rises on Concern About Curbed Supply From Vietnam; Cocoa Declines
  • Goldman Heads M&A Rankings Spurred by Commodities Demand in BRIC Economies
  • Middle East Unrest Means `Every Fund' Buying Oil Futures: Energy Markets
  • Rubber in Tokyo Declines as Oil Surges, Car Sales May Slow on Fuel Costs
  • China's Jinchuan Group Looking to Buy Stakes in Copper Deposits Overseas
  • Xstrata Hires Vodafone's Bond Before Glencore's Proposed Public Offering 


  • EURO: 1.3987 +0.37% (trading +0.27% in the AM)
  • DOLLAR: 76.40 -0.11% (trading -0.25% in the AM) 


  • FTSE 100: +0.33%; DAX +0.09%; CAC 40 +0.08%; IBEX +0.48%
  • Markets have succeeded in shaking off early weakness and are currently trading in the black.
  • Most sectors are registering small gains with no real standout performances.
  • Moody's downgraded Greece's sovereign credit rating to B1. Moody’s said Greece faces considerable difficulties with revenue collection, and there is a risk that the nation may not meet criteria attached to continuing support from official sources after 2013.
  • EU leaders are scheduled to meet on Friday at an informal summit to discuss the sovereign crisis resolution ahead of the 24th/25th European Council meeting.
  • The WSJ reports that Portugal has €4B in cash according to an unnamed official at the Portuguese debt management agency.
  • In Ireland Fine Gael and the Labour Party have agreed to form a collation
  • Eurozone sentix index for Mar +17.1 vs cons 16


  • Nikkei (1.76%); Hang Seng (0.41%), Shanghai Composite +1.84%
  • Markets closed lower with the exception of China, on worries the situation in Libya could lead to oil supply issues.
  • Japan was hurt when Foreign Minister Seiji Maehara resigned, adding weight to the albatross hanging around the neck of the current government.
  • China rose after supportive economic policies were announced over the weekend.
  • Airline stocks fell 3% in Taiwan on the oil prices. Hit by the government’s new luxury tax, construction stocks lost 1-2%.
  • Australia fell as people shed miners and banks in an effort to avoid risk.
  • Japan Feb foreign exchange reserves (0.1%) m/m to $1.091T

Howard Penney

Managing Director




For the week ending March 4, 2011.




Keith McCullough – Strategy

CALLOUT OF THE WEEK: The bull/bear battle between what’s more impactful on US Consumption – unemployment or oil – is on. Since one is a leading (oil) and the other is a lagging (unemployment) indicator, I say oil. That’s not to say that I won’t get more constructive on US Equities at lower prices, especially if high-frequency and concurrent indicators (jobless claims, consumer confidence, mortgage applications) improve in unison. I highly doubt they will if oil prices stay pinned up here. 

CONTRARIAN CALLOUT:  I still don’t think consensus realizes what a US Dollar crisis will do to the American Consumer’s buying power and corporate margins. The correlation risk to just about every asset class that trades in (or relative to) US Dollars is reaching levels that I would call surreal. The Bernank is perpetuating price volatility. If he doesn’t start changing as the facts have (like virtually every other central banker in the world has), he’ll become a modern day Arthur Burns. 


Daryl Jones – Geopolitics; Commodities

CALLOUT OF THE WEEK: Regardless of the grade of oil you looking at, the commodity is melting up.  The key drivers are a weakening U.S. dollar, continued uncertainty in the Middle East, and, as well, decent demand for gasoline in the United States.  We think the U.S. dollar weakness will continue to be a key driver; look for an acceleration in the increase of the price of crude oil if the ECB starts raising rates. 

CONTRARIAN CALLOUT:  While focus has shifted to the unrest in the Middle East, unrest across the United States relating to State level budget cuts is accelerating.  This unrest could create an incremental headwind to GDP that currently isn’t in consensus numbers.  This will come from both layoffs and a decline in State and local level budget spending year-over-year.


Matt Hedrick – Europe

CALLOUT OF THE WEEK: ECB President Trichet said on Thursday that an “increase of interest rates in the next meeting is possible… but not certain.” Trichet’s tone sets him apart from Bernanke, who chooses to turn a blind eye to inflation. European markets and the EUR vs. most major currencies rose vs. the USD this week alongside a more hawkish tone. We contend that the ECB and BoE should hike rates within the next 1-3 months to address pressing inflation risk. 

CONTRARIAN CALLOUT: The March 24-25 EU Summit promises to devise a “comprehensive” package to end the region’s crisis and stabilize the Euro, however we contend that the “sailing” may not be so smooth as leaders will struggle to tie an all encompassing policy bow around the region -- increasing country competitiveness and stronger fiscal standing can be easy in theory, harder in practice. The interconnectedness of the EUR means that the instability of just one country, and Portugal looks most imminent, can severely weigh on the common currency. Gains in the EUR this week could very well pull back in the coming weeks. We’ll be monitoring political rhetoric and policy moves acutely.


Darius Dale – Asia; Latin America; State & Local Governments

CALLOUT OF THE WEEK: Both Brazil and India unveiled new fiscal policy measures this week and both failed to adequately address the key issue facing both economies – rising inflation. India’s lack of fiscal resolve (particularly relative to Brazil) contributed to the SENSEX closing up +4.5% on the week (vs. +1.9% for the Bovespa) as the market cheers on more loose policy. As we called out back in early November, Brazil’s proactive monetary policy (relative to India) will keep it outperforming in this two-legged stagflationary race: Bovespa down (-1.7%) YTD vs. SENSEX down (-9.8%) YTD.

CONTRARIAN CALLOUT: It’s clear now that consensus understands that the melt-up in commodity prices since Jackson Hole (Aug. 27) has contributed to accelerating headline inflation readings on a global basis. What consensus may fail to miss going forward is the likelihood that inflation starts to show up in “Core” CPI readings globally. The confluence of companies passing through cost pressures to end-consumers and a global acceleration in wage growth and government subsidies (particularly in key emerging economies) perpetuates this possibility.




Every morning at 8:30AM EST, we host a live conference call with clients whereby Keith’s 15 mins of prepared global macro commentary is followed by 5 mins of Q&A (if you need a live dial-in, please emails us a ; the call is also podcasted on our website each morning by 9:00AM). Below is a sample of some of the better questions we received this week (answers paraphrased).



Q: Why are you so negative on fund flows; wouldn’t it have been prudent in December to recognize that the flows would trump fundamentals for the intermediate-term TREND, rather than shorting the market? Could one argue that it’s the job of the risk manager to contextualize both fundamentals AND flows, as both have the ability to influence price?

A: We aren’t negative on fund flows per se; where we see risk is that talk of the “flows” is highly speculative in nature. You can’t quantify the dollar amounts ahead of time or even on a concurrent basis. Also, market history tells us that it’s a contrarian signal when the “flows” become consensus’ main catalyst.



Q: What would get you to put the SPY short back on; it rallied up to just under your TRADE line of support on Friday. Is there a specific level that would get you to test the waters again on the short side?

A: Waiting and watching. I’m learning from my mistakes of trading the SPY 1-3 days too early over the last decade.



Q: Much of the weakness in the US dollar has been generated by weak US monetary and fiscal policy. As we saw yesterday with Trichet’s commentary, could further US dollar weakness actually be driven now by hawkishness in the currencies in the US dollar basket? i.e. Could central bank hawkishness relative to Bernanke push the dollar down in addition to the downward pressure being applied by the Fed and D.C. politics? 

A: Outstanding multi-factor question; the answer is “yes” (currencies are priced in baskets relative to each other). As the rest of the world respects the cost of capital and their citizenry (by not infusing them with inflation), their currencies will go higher. This will have a structural negative effect for the US dollar. Don’t get carried away, however. The US Dollar Index will be immediate-term TRADE oversold in the low-$76 range and we expect to see a snap-back rally to another lower-high prior to it resuming its bearish TREND.



  • Cash: 49% vs. 58% 1wk ago vs. 58% 1mo ago
  • US Equities: 6% vs. 6% 1wk ago vs. 6% 1mo ago
  • Int’l Equities: 6% vs. 6% 1wk ago vs. 3% 1mo ago
  • Commodities: 9% vs. 6% 1wk ago vs. 6% 1mo ago
  • Int’l FX: 27% vs. 24% 1wk ago vs. 18% 1mo ago
  • Fixed Income: 3% vs. 0% 1wk ago vs. 9% 1mo ag 



3/1: Early Look: The Flows


-Our view of The Fundamentals is often 3-6 months ahead of Wall Street/Washington consensus  is what it is – since October, our Global Macro view of the fundamentals remains Global Growth Slowing as Global Inflation Accelerates.

-What happens on the margin in Global Macro matters most. And on the margin, The Flows into the stock markets of Developed Economies have been huge. The most important risk management part of that last sentence is “have been.”

-There is no but in The Flows. They are what they are until they stop. All the while, I’m most certainly not going to freeze with a strategy to short-and-hold…Not in a market where professional politicians are sponsoring a Burning Buck, The Inflation, and Price Volatility.


3/1: Could the Kingdom Fall?


-Though once unthinkable, the fall of the Saudi kingdom now seems at least in the realm of reality.  That is, popular unrest in Saudi Arabia and the Middle East could lead to a shift away from the autocratic rule in Saudi Arabia.  Keep March 11th on your calendars as Saudi youths have organized a day of protests against the monarchy called the Day of Rage.

-The Saudi stock market has been flashing some amber lights…there has been a severe correction in the Saudi stock market of more than 10% and an expansion by more than 20% in CDS spreads.

-The International Labor Organization (ILO) has put the unemployment rate for those between the ages of 20 – 25 at close to 30%.  This is particularly important given the population is young with median age of 23.4 years old.


3/3: Trichet Boosts Rate Hike Expectations, Markets Cheer


-ECB President Jean-Claude Trichet said that an “increase of interest rates in the next meeting is possible… but not certain.” Despite all attempts by Trichet to be close-lipped on future actions by the governing council, the sentence was largely interpreted by the market as proof that the ECB will hike in the near-term.

-Our position remains that both the ECB and BOE will act to address their respective inflation pressures well before Ben Bernanke does, as The Bernank chooses to ignore the looming pressures of domestic and global inflation.

-Confirming the rising tide of inflation: CPI rose 2.4% in February year-over-year versus 2.4% in January; and PPI increased 6.1% in January Y/Y versus 5.3% in December. The PPI report showed that energy prices jumped 13% from a year earlier.


3/4: Crude Oil In The US: Is the Price $103/bbl or $115/bbl?


-Refined products (gasoline and diesel) in the U.S. are tracking Brent crude oil, and not WTI.  If you are using WTI as your marker for oil’s impact on consumers in your macro model, you should reconsider.

-Interestingly, the prices of refined products in the U.S. are no longer tracking WTI.  When WTI began lagging other oils, gasoline and diesel did not hang back with it. 

-Since November 15, the correlations between a barrel of WTI crude oil and refined products since November 15th, 2010 are: Gasoline +0.83; Diesel +0.69. Over the same duration, the correlations between a barrel of Brent crude oil and refined products are: Gasoline +0.98; Diesel +0.98.


3/4: State & Local Government Finances Not Just a Problem for Muni Bonds


-Recent developments in the FY12 State & municipal government budget season reveal to us several trends that are incrementally bearish for US GDP growth and the US Dollar over the intermediate-term.

-One could make a compelling argument that the public employee protests currently impacting the Midwest region will spread throughout the country like wildfire, especially considering the relative health of Wisconsin, which just recently issued arrest warrants for its fugitive legislators.

-46 States have to balance their budgets by July 1 or risk delays in payments to vendors and creditors alike. If the US Dollar and the protests in Wisconsin et al are indicating anything, it is that this catalyst is closer on the horizon than a resolution of the budgetary debates.


Have a great weekend,


The Hedgeye Macro Team

State & Local Government Finances Not Just a Problem for Muni Bonds

Conclusion: Recent developments in the FY12 State & municipal government budget season reveal to us several trends that are incrementally bearish for US GDP growth and the US Dollar over the intermediate-term.




Given recent unrest in the Middle East, State and municipal finances have been placed on consensus’ back burner even as protestors continue to flock to the streets of Wisconsin, Indiana, and Ohio while minority legislators of these States camp out across State lines to avoid voting on controversial bills.


With States facing a collective $125-$140B budget gap in FY12 (starting on July 1 for all but four States), we expect investors to pay increasing attention to this topic as we advance further into a historic budget season, which is being delayed on the margin by the world’s largest game of “kick the can down the road” (referring specifically to the federal government’s resolve to fund itself for two weeks at a time).


One could make a compelling argument that the public employee protests currently impacting the Midwest region will spread throughout the country like wildfire, especially considering the relative health of Wisconsin, which just recently issued arrest warrants for its fugitive legislators. The chart below speaks volumes to the potential for growing civil unrest throughout the nation, given that the fiscal adjustment needed in WI, IN, and OH are fairly benign relative to States like NV, IL, NJ, TX, and CA:


State & Local Government Finances Not Just a Problem for Muni Bonds - 1


At the bare minimum, the key takeaways here are:


I: Widespread protests and delays in passing State & municipal budgets are, on the margin, bearish for GDP growth in the near term due since the outcome is likely layoffs of public employees and a delay in implementing true fiscal reform. Accordingly, the US dollar is reacting negatively to these budget battles, which are not being resolved expeditiously (refer to our Q1 theme of American Sacrifice for more details):


State & Local Government Finances Not Just a Problem for Muni Bonds - 2


II: As we outlined in our deep dive munis presentation a few weeks ago, many of the cuts, tax hikes, and union-shrinking proposals are not politically palatable. The result of widespread public backlash and legislative uproar to governors’ budget proposals is more than likely to result in some combination of declining public payrolls, accelerating retirements by public employees afraid of losing pension benefits/eligibility, and an acceleration of muni bond issuance, which, on the margin, is incrementally supportive of our case for higher interest rates throughout the US economy. (refer to our Q1 theme of Trashing Treasuries for more details):


State & Local Government Finances Not Just a Problem for Muni Bonds - 3


State & Local Government Finances Not Just a Problem for Muni Bonds - 4


State & Local Government Finances Not Just a Problem for Muni Bonds - 5


Neither of these outcomes is supportive of consensus’ current US GDP growth estimates.


As mentioned before, threats to union rights and their collective bargaining power are fueling the current demonstrations in WI, OH, and IN. Regarding State & local government employment specifically, various studies have concluded that public sector employees earn more in aggregate compensation relative to private sector employees.


Per a December report out of the BLS, wages and salaries for State & local government employees averaged $26.25 per hour vs. $19.68 per hour for private sector workers. In addition, State & local government employee benefits outpace those received by private sector employees by $5.65 per hour worked ($13.85 vs. $8.20). A recent study by USA Today found this to be true in 41 States (including D.C.).


Given the relatively healthy compensation of heavily-unionized public sector workers (36% vs. 15% in the private sector), an accelerated deterioration in labor trends in this sector will be an incremental headwind to aggregate US consumption growth over the next 3-4 quarters (in addition to consumer price inflation and housing deflation).


In aggregate, a potential reduction of over $100B from GDP by cutting State & local spending, in addition to a contraction in household consumption associated with a decline in the commensurate savings from soon-to-be-cut services provided by the government, is not bullish for growth. Moreover, tax hikes like those proposed in CA, CT, and IL (to name a few) won’t help either…  




Federal Budget Cuts: House bill 302(b) has proposed to cut non-defense discretionary spending by $63B below the original FY11 budget and 15-16% below the current continuing legislation. Aside from Medicaid, this is the category where the bulk of federal funding for States and municipalities is derived from. These cuts are on top of the well-known collapse in federal stimulus funding beginning in FY12: 

State & Local Government Finances Not Just a Problem for Muni Bonds - 6


State & Local Government Finances Not Just a Problem for Muni Bonds - 7


Inability to Adequately Pare Rising Medicaid Costs: Republican governors have met with Obama this week to ask for more flexibility in managing Medicaid implementation. Many of them, including New Jersey’s Chris Christie and Kansas’ Sam Brownback left the talks uninspired and incrementally worried about upcoming budget deadlines. Current federal mandates severely limit the amount of cost cutting States can do with regard to Medicaid (21% of total expenditures), so the focus of budget cuts will be forced to shift elsewhere.


State & Local Government Finances Not Just a Problem for Muni Bonds - 8


Changes to Federal Tax Code: Federal legislation enacted in December allows corporations to immediately deduct the entire cost of capital investments on purchases made from 9/8/10 - 12/31/11, rather than the typical depreciation schedule. Absent changes to current State tax code, 19 States stand to lose roughly $5-$6B in corporate tax revenues in the upcoming fiscal biennium.


Rising Unemployment Insurance Costs: Starting this fall, 30 States will be responsible for paying $1.3B in interest payments on $42B in loans taken out from the federal government to support depleted unemployment insurance funds. Currently, President Obama is attempting to push through legislation that will delay these interest payments for an additional two years, though Republican Congressmen refuse to support the proposal because it effectively doubles the portion of worker incomes subject to unemployment insurance taxation. Many States plan to issue bonds to fund the interest payments should the bill fail to pass the legislative process.


All told, the tea leaves provided by the standoffs in Wisconsin, Ohio, and Indiana, paint a cautious mosaic for this sector’s contribution to US GDP in 2011 and beyond. At 12.2% in 2010, State & Local government consumption was a close third in US GDP weightings; our call is for that “close” third to shift to a “distant” third and weigh on growth over the intermediate-term TREND. From a long-term prospective, however, a much-needed dose of austerity is exactly what this country needs to salvage its prosperity.


Will the professional politicians of America have the political spine to make the tough choices they’ve been called upon to make? Wisconsin Governor Scott Walker (R.) best summarizes the urgency of addressing this question with his recent comments:

 “We’re broke in this State because time and time again, politicians of both political parties ran away from the tough decisions and punted them down the road for another day. We can no longer do that.”


New Jersey Republican Governor Chris Christie’s recent comments confirm this growing sense of urgency due to States running out of “outs” themselves:


“We can’t print money. We can’t run trillion-dollar deficits.”


To his point, 46 States have to balance their budgets by July 1 or risk delays in payments to vendors and creditors alike. If the US Dollar and the protests in Wisconsin et al are indicating anything, it is that this catalyst is closer on the horizon than a resolution of the budgetary debates. Stay tuned…


Darius Dale


Early Look

daily macro intelligence

Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

The Week Ahead

The Economic Data calendar for the week of the 7th of March through the11th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - zz1

The Week Ahead - zz2


Crude Oil in the U.S. – Is the Price $103/bbl or $115/bbl?

Conclusion: Refined products (gasoline and diesel) in the U.S. are tracking Brent crude oil, and not WTI.  If you are using WTI as your marker for oil’s impact on consumers in your macro model, you should reconsider.


Beginning in November 2010, the price of WTI oil began to lag behind other light, sweet oil benchmarks.  For many weeks the market was perplexed by the widening spread between WTI and other oils.  It was not just Brent that pulled away from WTI, but ALL light, sweet crudes.


Now, the issue is understood well.  The glut of crude oil at WTI’s pricing hub – Cushing, OK – is weighing down the price.  Additional barrels coming from Canada via the Keystone pipeline and new shale oil plays in the mid-continent, namely the Bakken (ND), Niobrara (WY/CO), and Woodford (OK), are bidding for storage in Cushing.  There is no quick solution.  Only a pipeline running from Cushing, OK to the Gulf coast will allow WTI to play catch-up to other light, sweet grades, and construction of such a pipeline is nowhere in the foreseeable future.  Until then WTI will trade at a considerable discount to comparable crude oils.  Currently, the Brent-WTI differential is $12.50/bbl.


Interestingly, the prices of refined products in the U.S. are no longer tracking WTI.  When WTI began lagging other oils, gasoline and diesel did not hang back with it.  Currently, the correlations between a barrel of WTI crude oil and refined products since Nov 15th, 2010 are:


Gasoline: +0.83

Diesel: +0.69


Over the same duration, the correlations between a barrel of Brent crude oil and refined products are:


Gasoline: +0.98

Brent: +0.98


Crude Oil in the U.S. – Is the Price $103/bbl or $115/bbl? - kk brent1 wti1


What is going on here?  Well, WTI is the traditional benchmark for oil prices in the United States.  Up until a couple a months ago, this worked because all light, sweet crudes traded close to parity.  However, now that WTI is at a considerable discount to other oils, the price of WTI is not consistent with the price of oil everywhere in the U.S.


Here is the breakdown of where the U.S. holds its oil:


East Coast (PADD 1) – 3.5%

Midwest (PADD 2) – 30% (which 1/3 of which is Cushing, OK, or 11% of total U.S. stocks)

Gulf Coast (PADD 3) – 48%

Rockies (PADD 4) – 4.5%

West Coast (PADD 5) – 14%


Crude Oil in the U.S. – Is the Price $103/bbl or $115/bbl? - PADD Map


The benchmark oil price is different in each PADD.  We contend that the best light, sweet benchmark for each PADD is:


East Coast (PADD 1) – Brent, spot = $115/bbl

Midwest (PADD 2) – WTI, spot = $103/bbl

Gulf Coast (PADD 3) – Light Louisiana, spot = $120/bbl

Rockies (PADD 4) – WTI, spot = $103/bbl

West Coast (PADD 5) – Alaska North Slope (not light and sweet, but really the only crude West Coast refiners run), spot = $115/bbl


The weighted average U.S. light, sweet oil price based on location of the barrels and the benchmark price for each location is $115/bbl – exactly the current price of Brent.  This is why the prices of Brent crude oil and refined products in the U.S. have a 0.98 positive correlation.


So, if you were worried about $103 oil squeezing U.S. consumers, how does $115 oil sound?


On the micro, energy level, mid-continent refiners are benefitting from both ends of the refinery gate, with lower feedstock costs, WTI, and higher refined product prices.  Our favorites are Holly Corp. (HOC) and Frontier Oil (FTO).


From the Oil and Gas Patch,


Lou Gagliardi


Kevin Kaiser


How many people passed up buying MCD at $15 or SBUX at $10 because they were unsure of whether or not the brand can thrive and generate the revenue and profits it once did. 


You can make up 100 reasons not to buy a stock and they may all be valid.  However, finding a true turnaround story requires the ability to look past the inconsequential noise and identify positive change and value creation in a company.


Just for a minute, put aside any baggage you may carry about WEN (however justified) and take a look into what could be for a brand that has been lost for the past ten years. 

Wendy’s is traded up 7.6% yesterday on volume of almost 18m shares (+111% versus the 30-day average).  The story appears to be gaining more traction on the Street, but it is still untold with 67% of the sell-side analyst community having a hold or sell on the name.   Trading up above $5 at the time of writing, I think it could go far higher.


As a practice, we don’t set target prices but, if I were going to dream a little, I would have a $10 number in mind.  What would it take for Wendy’s to get to $10?  Such a move would almost be McDonald’s/Starbucks-esque and, while I recognize that Wendy’s is not a category leader and competes in a more competitive industry, I think it is possible.




The Wendy’s brand is very healthy and its current trends of positive comps in 1Q11 speak to the health of the concept.  Currently, management is guiding to 1-3% for 2011.  What if those expectation prove to be conservative.  Unlike a brand like Burger King, Wendy’s has a very loyal and broad customer base.  There is a possibility that the national rollout of the new cheeseburger in 2H11 resonates with the loyal customers and sparks increased usage of the brand.  The burger patty will also allow the company introduce more new product using the name of founder Dave Thomas.  


If management expectations for same-store sales prove conservative, this could provide significant upside in the stock.  The only incremental information from today’s earnings release and conference call was that comps were positive in February and will be flat-to-positive for 1Q.  The stock reacted positively to this and I believe additional improvement in comps would likely instigate another leg up in the stock price.




It’s obvious to those close to the company that the company has struggled trying to find an advertising campaign that resonates with the consumer.  As I alluded to above, the use of Dave Thomas’s name in the new hamburger could be that undiscovered marketing boost the company needs.  The Wendy’s advertising message has not resonated as strongly since Dave Thomas passed away.  Naming the new burger after him will allow the company to bring back Dave’s name and promote a message of the company going back to the basics that Dave endorsed such as high quality food and a high level of customer service.  I’m not sure how this is going to play out, but reconnecting the Wendy’s core customer to Dave Thomas could bring incremental traffic.


Initially, the company has a new advertising campaign, starring Dave Thomas daughter Wendy, which has seen a favorable response.  While this is unlikely to cure all ills for the brand, it is a start and indicates to me that management is taking a measured and targeted approach to how they drive brand awareness and image going forward.




All of management’s attention being focused on repairing Wendy’s margins over the next few years spells good news for the future.  It is important to note that the current improvement in margins has come from better operations and not leverage from increased sales trends.  Wendy’s margins have recovered from 11.6% in 2008 to 15.5% in 2010.  If the current initiatives have an out-sized impact on same-store sales, the concept is perfectly positioned to capture the flow from the increased sales volumes.  In the past cycles, Wendy’s margins peaked out at 16.5% (+/-) and the concept was never really managed with a surgical focus on operations.  Given the lessons of past business cycles and the new focus management seems to have adopted, who is to say that Wendy’s margins can’t reach 18-19%?




Investing alongside Trian could provide some upside to expectations.  In this environment (and given how troubled the brand is) just the announcement that there is actually a deal for Arby’s will be a net positive.  The Arby’s brand can benefit from being a standalone organization too.  Like Wendy’s, Arby’s needs to return to its roots and focus on operations.  This can't be accomplished as a secondary brand in a bigger organization.


Upon completion of the sale of Arby’s the WEN balance sheet will be in much better position.  The freed up capital will allow the company to buy back more stock, pay a dividend and increase the company’s domestic and overseas growth initiatives.  In the end, I would err on the side that the partners at train will come up with a deal that benefits there significant equity stake in Wendy’s.


I realize that this narrative seems far-fetched; for Wendy’s to get to $10 in two years, the company EBITDA will need to grow by 40-50%.  Yes, that seems like a big number, but if I told you two years ago that Starbucks EBITDA was going to grow by 43% by the end of fiscal 2010 you would have laughed. 


In the short run, management’s confidence in the company’s ability to grow margins next year in the face of commodity headwinds is also good news.  Again, this could prove conservative, if sales trends improve significantly in 2H 2011.  In 2011, a simply menu and investment in point-of-sale technology, coupled with sales leverage, are key to management’s optimism and I believe, having seen this strategy play out before, that the strategy will be successful.  The outline I have provided here may be fanciful and there are certainly a lot of contingencies attached to the path to $10 for Wendy’s.  Nevertheless, I see significant upside for this stock over the next two-to-three years and $10 may not seem unreasonable.


I also feel very comfortable in being out of consensus.  The sell-side community is very much not behind the Wendy’s story. 


Lastly, being bearish on MCD is bullish for WEN.  If you believe (as I do) that MCD is too focused on driving incremental sales from selling beverages not burgers, when WEN will be one of the bigger beneficiaries.


THE WEN DREAM OF $10 - qsr sell side sentiment


Howard Penney

Managing Director

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