2012 . . . Can Obama Be Beat?

Conclusion: It’s a long ways out, but President Obama looks more and more formidable heading into 2012.  The key issue is that there does not appear to be a Republican contender. Or at least anyone that is willing to be considered such.


As of yet, no Republican candidate has declared that he or she is running for President in 2012.  While the election is more than a year and a half away, the lack of decisiveness and early declaration may turn out to be an error by those candidates striving for the office.  In contrast, President Obama seems to be gaining momentum in terms of his positive standing among the electorate.


We are big fans of the Intrade markets for politics.  As we’ve witnessed in the past, they are often dead on in their ability to predict electoral outcomes and we saw this in spades with the recent midterm elections, as Intrade came very close to predicting the margin of victory in Congressional elections by the Republicans. 


The futures contract on Intrade for President Obama to win the 2012 Presidential election is currently trading at 62.  This means that if you were to buy the contract, and President Obama wins, your payout would be $38 on every $62 invested.  As outlined in the chart below, this market has trended up since its inception in December of 2010, when the futures contract was trading at 50.


2012 . . . Can Obama Be Beat? - 1


While the Presidential election is still more than a year and half away, this type of data must be disconcerting for Republican strategists, especially combined with some recent polls.  In particular, a recent NBC News / Wall Street Journal poll, with the polling period of 2/24 – 2/28 indicated Obama a +5 versus the generic Republican candidates.


More broadly, while President Obama’s approval ratings are still mired in mediocrity, he has seen some improvement from his worst approval ratings of his Presidency.  Currently, according to the Real Clear Politics Presidential Approval poll aggregate, 47.4% of respondents approve of President Obama and 48.0% disapprove.  While this rating has gone the wrong way over the last few weeks in conjunction with accelerating gasoline costs and a U.S. equity market selloff, it is still well improved from the 51% disapproval rating on September 27, 2010, which was the worst reading of the Obama Presidency.


President Obama’s ratings are far from stellar, but so far they are holding stable despite a major setback for his party in the midterms and only modest economic improvement, especially as measured by employment, in the last year.  A key benefit for Obama appears to be that there is no real frontrunner, or even a declared candidate for the Republicans yet.  In the chart below, we show the poll aggregate for the potential Republican candidates, which validates the lack of a front runner.


2012 . . . Can Obama Be Beat? - 2


In the 2008 Presidential campaign, shortly after the midterms, Presidential candidates began declaring in size.  In fact, between November 2006 and February 2007, Joe Biden, Hilary Clinton, Chris Dodd, John Edwards, Dennis Kucinich, Barack Obama, Bill Richardson, and Tom Vilsack all declared their candidacy.   In the same time period, almost as many Republicans officially declared their candidacy, including Tommy Thompson, Jim Gilmore, Sam Brownback, Mitt Romney, Ron Paul, John McCain, and Rudy Giuliani.


Currently, no Republican has officially declared his or her candidacy.  This is somewhat surprising given the large amount of cash needed to fund a campaign, and the lead time needed to raise that cash.  In addition, there is bully pulpit afforded to an official nominee.  Surprisingly, so far no potential candidate has decided to take advantage of that potential media exposure and establish his or her credentials (and, of course, attack the President).


The other challenge for the Republican Party is that they do not appear to have a strong candidate at the moment.  Currently Obama polls worse against a generic Republican than he does versus any of the perceived front runners.  According to the Real Clear Politics poll aggregates, President Obama leads a generic Republican by 2 points, but leads Huckabee by 5.5 points, Romney by 5.2 points, Ron Paul by 9 points, Gingrich by 14 points, and Palin by 15.2 points.


Clearly, the longer the Republicans wait, the more of an incumbency advantage President Obama will have in the fall of 2012.  As well, even if Republicans were to begin declaring for the Republican candidacy shortly, the other major concern from the polls is that no Republican currently seems viable.


Christie  / Walker 2012… anyone?


Daryl G. Jones

Managing Director

European Risk Monitor: Greek Bank Swaps Anticipated Positive EU Summit

Positions in Europe: Long Germany (EWG); Short Spain (EWP)


Below we include our weekly Risk Monitor for European bank CDS. Greek bank swaps were a noticeable standout week-over-week, tightening in anticipation of a favorable result to this weekend’s EU Summit. In fact, Eurozone leaders agreed to lower Greece’s bailout interest rates of about 5% by 100bps, and extend the repayment period of the loans to 7 1/2 years from 3 years.  Greek PM George Papandreou estimates the moves would save about €6 billion over the life of the loans. [See our note published today titled “The EU’s Extend and Pretend Summit Lean” for our full take on results of the EU Summit on Competitiveness over the weekend.]


Overall, bank swaps in Europe were mostly wider, widening for 32 of the 39 reference entities and tightening for 7 (see chart below).


This morning our CEO Keith McCullough summed up the policy and market implications of the EU Summit as:


“Some of the dysfunctional European equity markets are celebrating fiat socialism this morning w/ a perfect can kicking of Greek and Spanish liabilities into the long term back of the net.  Greece’s stock market is up a full +3% this morning, moving into a clean cut lead as the world’s best performing stock market for the YTD at +15%. The Federal Reserve has taught the ECB well – Central Planners of the world unite in victory.


Over the intermediate to long-term, piling more debt-upon-debt on these types of terms only increases the inevitability of another crash.”


We remain long Germany via the eft EWG in the Hedgeye Virtual Portfolio and shorted Spain via EWP last week (3/11) on a bounce. We think Spain’s banking issues are far from over despite government estimates late last week that the incremental capital needed to recapitalize its lenders is €15.1Billion, less than initial government estimates of €20 Billion in early January 2011. Our models show the EUR-USD trading in a range of $1.37-$1.40 over the immediate term (3 weeks or less).


Matthew Hedrick



European Risk Monitor: Greek Bank Swaps Anticipated Positive EU Summit  - swaps

RL: Quantifying Japan Risk

Our best shot in quantifying Japan gets us to about a $0.43 risk to Fiscal 2012(Mar) EPS. That STILL leaves us a buck above consensus.


We definitely cannot say that the devastation in Japan will not impact Ralph Lauren. There will be logistical disruptions in Japan, which probably don’t matter as much as a dried up tourist market, and what can only be a massive distaste for luxury shopping as Japanese consumers cope with the magnitude of how their Country has changed. We hate to bring this into a stock discussion, but hey… we need to manage risk. It’s what we do.

First of all, let’s focus on some numbers.


Ralph’s overall exposure to Asia is about $850million, with most of that focused on Japan and South Korea. That number sounds colossal when looking up RL’s $5.7bn GAAP revenue base. But remember that RL has wholesale, retail, and licensing revenue streams.

  • Retail is the most pure at about $2.7bn
  • Licensing’s $175mm in GAAP revenue needs to be grossed up by an average royalty rate of 7%, which gets us to global brand value of another $2,500
  • Wholesale sales of $2.8bn needs to be grossed up to a retail equivalent of about $5.5bn

All in, we’re looking at just over $10billion in global Ralph-related sales at retail.


If we conservatively assume that 80% of the existing $850mm business is Japan, Then we’re looking at 6.5% of total global brand sales.


Profitability is below company average.


Management on 3Q call: “As you can imagine, it takes a fair amount of time for us to execute our plans. Japan, South Korea and what I'll call China territories are each at different stages of development for us and it takes time to understand the varying tastes and preferences of our customers throughout this region. We are simultaneously looking for ways to maximize operational efficiencies throughout the region. This is easiest to do with our corporate shared services and creative teams, but we are also exploring synergies with inventory management and merchandising initiatives; again, recognizing there are often substantial differences between countries. We’ve made good progress in Japan in a relatively short period of time and despite extremely unfavorable market conditions, but we're still far away from where we want to be.”


All in, when we stress test the model and assume that JAPANESE REVENUE GOES AWAY,  we get to $0.33-$0.43 per share.


There are other factors to consider, including the shared services factor as it relates to implementation and integration of the Chinese and South Korean businesses. Could we see extra costs? Yes. Pushed back by 1-2 quarters? Yep.


But that would take our Fiscal 2012(Mar) estimate down to about $7.40-$7.50. Yes, that's STILL a buck above consensus.



Brian McGough

Managing Director






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The EU’s Extend and Pretend Summit Lean

Positions in Europe: Long Germany (EWG); Short Spain (EWP)


The initial report of results from the EU Summit on Competitiveness on Friday and into the weekend suggests that: (1) far more was agreed upon at the Summit than advertised, and (2) in aggregate, most of the agreements leaned dovish, meaning leaders elected to throw more monies and more generous loan terms at the region’s sovereign debt issues. Again, we contend that over the intermediate to long-term, policy that facilitates piling more debt-upon-debt only increases the inevitability of another crash.


The main Summit agreements include:


On Temporary vs Permanent Bailout Structures


-The temporary European Financial Stability Facility (EFSF) will be able to access its full funding (from the member states) of €440 Billion, versus the approximately €250 Billion previously available.


-Agreement was reached to let the EFSF buy bonds directly from governments; however, the EFSF is not authorized to buy bonds in the secondary market or finance debt buybacks by governments. Ahead of the Summit, the EFSF was only authorized to loan funds to governments. Therefore, under this agreement, credit risk for primary bond purchases will move onto the EFSF (taxpayer) balance sheet.


-Funding for the permanent bailout fund, the European Stability Mechanism, starting mid-2013, is pegged at €500 Billion.


On Existing Loans


-European leaders agreed to lower Greece’s bailout interest rates of about 5% by 100 bps, and extend the repayment period of the loans to 7 1/2 years from 3 years.  (Greek PM George Papandreou estimates the moves would save about €6 billion over the life of the loans.)


-Ireland did not receive its request to have the interest rate on its bailout loan (~5.8%) reduced by 100bps, as Irish PM Enda Kenny refused to raise the country’s 12.5% company tax rate, which compares to the EU corporate tax rate average of 23%, or Germany at 30% and France at 34%.



Overall, the agreements reached at the Summit far exceeded the syllabus, with the gravitas expected to come at the EU Summit for a Comprehensive Package on March 24-5. In particular, the more hawkish stance of Germany (via Chancellor Merkel) going into the Summit was lost over the weekend, namely that government bonds could not be bought directly by the EFSF and that funding for the facility would not be increased.  The only point that Merkel (and Sarkozy) stood strong on was maintaining that Ireland could not receive more favorable loan terms unless it raised the country’s corporate tax rate, an issue that’s very contentious and one that the Irish refuse to budge on.


In any case, the market response to the weekend is clear: bond yields from the PIIGS have come in, notably the Greek 10YR yield was down as much as -50bps d/d and the equity market (Athex) closed up a monster +5.2% today (see first chart below). The results of the weekend also alleviate the pressure that major compromise has to be met at the second Summit, which should tone down the recent return of sovereign debt fears.


We are by no means of the camp that this news is positive for the health of the region. On the contrary, we see Europe’s action as confirmation that it will choose to kick the can of debt further down the road.  In this light, the European Commission forecasts Greek public debt will reach 159% of GDP in 2012!


And while the expansion of the EFSF and talk of funding for the European Stability Mechanism will instill a level of confidence in the market and common currency, the underlying issue is not if there exists adequate funds to bail out the next overly indebted country, but should be enacting policy measures to more properly incentivize or punish countries that exceed debt and deficit levels. This will better direct the region’s future economic growth. Further, simply loosening debt payback terms sends the wrong message to countries, namely that mismanagement is permissible and the union will always be around as a backstop/crutch.


And to the point of more favorable loan terms for Ireland, we believe the island nation is going to have to play ball: it’s not going to be able to have its cake (an extremely low corporate tax rate) and eat it too (have its bailout loan more generously restructured).


What’s also clear from this weekend is that the ECB will continue to play a role as buyer of government bonds in the secondary market, currently at €77 Billion since May 2010.


We’ll get the final approval for the agreements reached this weekend at the March 24-5 Summit. While we could very well see stability in European markets and the common currency over the short run as optimism surrounds the Summit meetings, over the longer term our concern remains grounded that Europe is simply pushing its sovereign debt imbalances further out on the curve.  At the very least, we’d expect the PIIGS, some of the best equity market performers year-to-date, to mean revert over the coming weeks (see second chart below). We’ll continue to manage risk on a day-by-day basis.


Matthew Hedrick



The EU’s Extend and Pretend Summit Lean - wohl1


The EU’s Extend and Pretend Summit Lean - wohl2


The following companies are currently enjoying positive same-store sales and margin growth as of the most recently reported quarter: CMG, BJRI, PNRA, SBUX, YUM (US), DPZ, MCD, DIN, PFCB, DRI, RT, MRT, KONA.  All of these companies, with the exception of DPZ and KONA, were operating with positive same-store sales and expanding margins during their most recently reported quarter.  Also, as one can see in the chart at the bottom of this post, these stocks saw significant price gains during the fourth calendar quarter.  It is important to note that, since the end of the fourth quarter, MCD, MRT, and RT have all slowed from a price performance perspective.


Last time around, I highlighted YUM China, TXRH, MRT, CAKE, and RT as five names that I believed were “moonlighting in Nirvana”.  As it happened, YUM China, TXRH, and CAKE dropped out of the quadrant into “Trouble Brewing”, the lower-right quadrant where same-store sales remain positive but margins are contracting on a year-over-year basis.  


RT posted a strong quarter for 2QFY11 and seems well-poised for the remainder of the fiscal year.  In the immediate term, 3QFY11 could show some weather-related top-line softness.  From here, I still believe that MRT faces significant headwinds from a margin perspective and could well drop out of Nirvana.


YUM China will likely face continuing labor, food, and paper inflation throughout 2011.  On the last earnings call, management guided to 5% food and paper inflation in China with wage inflation running in the mid-teens.   As of February 2nd, the date of the most recent earnings call, management expected the modest price increase taken by the company just before Chinese New Year to cover the majority of the company’s inflation expectations (at the time) for the year.  I would expect that inflation expectations may  have changed somewhat given that many foodstuffs have increased markedly over the last five weeks.  Clearly, given the record margins YUM enjoyed last year, driven by commodity deflation, some year-over-year margin contraction is to be expected.  It will be interesting to see if comps slow in China during this year as compares step up in difficulty.


As a side note to trends in China, MCD has reported that January/February (combined) same store sales in China were up mid-to-high single digits.


MRT is not contracted on any beef prices for 2011 and that commodity has risen sharply in 2011.  Management has expressed confidence in its ability to take price as business traffic has been increasing at their restaurants.  The company has indicated its willingness to take price if necessary to offset inflation.  Obviously, margins may come under pressure as beef costs are absorbed and top-line trends may weaken if price is passed on to the customer. 


CMG is a notable constituent of Nirvana at this juncture.  The top-line growth has been nothing short of spectacular but there are definite negative factors impacting the outlook for the company.  Commodity headwinds are impacting Chipotle at least as much as any other restaurant chain given their sourcing of food ingredients from the spot market in order to abide by their “Food with Integrity” mantra.  Labor costs are also a question mark from here; federal investigations of 50 Chipotle restaurants in Minnesota resulted in the firing of 450 workers for not possessing the appropriate paperwork.  An internal review of hiring practices in Washington, D.C., has resulted in a further 40 jobs becoming vacant. 



The Deep Hole quadrant has been vacated by a large number of names over the past two quarters.  SONC, JACK, and CPKI are still languishing down there, however, as same-store sales are negative and margins are contracting on a year-over-year basis. 


SONC is a name that has received a boost recently on the back of a sell-side upgrade and a preannouncement of 2QFY11 sales of between +1% and +1.5%.  While this will mean that SONC is due out of the bottom-left quadrant when 2QFY11 results are reported a week from Tuesday.   However, as I wrote on March 8th, compares are stepping up materially from here and the preannounced same-store sales range for 2QFY11 actually implies a slowdown in two-year average trends.  Interestingly, following a strong showing in 4Q, SONC is down almost 14% year-to-date.



The lower-right quadrant, “Trouble brewing” , is where YUM China, TXRH, CAKE, and WEN are operating at present.  With the exception of WEN, which is in the midst of a turnaround, each of these names has dropped from the upper-right quadrant as a result of declining margins in 4Q10.  WEN is a name that I have a bullish outlook on; the sale of Arby’s and simplification of the menu will lead – in my view – to continued top-line growth and leverage over costs as well as labor efficiencies.  WEN’s stock gains in 4Q were somewhat muted but, for the reason I mentioned above, the stock has performed strongly since mid-January.



The upper-left quadrant, “Life-line” is currently inhabited by EAT and BWLD.  BWLD is a unique company in the restaurant industry; continuing commodity cost favorability due to declining chicken wing prices is greatly boosting margins.  The company is vulnerable to an NFL strike and, as that situation seems to be worsening, it could definitely effect traffic at BWLD if the points of contention between the players and owners is not resolved in time to save the 2011 season.   The company’s stock price declined in 4Q10 but has outperformed year-to-date, gaining over 20%.


EAT is a name I have been positive on for some time.  Operational improvements and sales-driving initiatives are greatly improving Chili’s performance.  Sell-side sentiment is only just beginning to change on this name and I believe there is significant outperformance left for this name in 2011.  Following a gain of 11% in 4Q, year-to-date the stock has risen an additional 17%.  I believe it is likely that, as EAT reports 3QFY11 results, the company will be operating in “Nirvana”, with positive same-store sales and margins.





Howard Penney

Managing Director

Drawdown: SP500 Levels, Refreshed

POSITION: no position in SPY


All 3 factors (PRICE, VOLUME, and VOLATILITY) in my core immediate-term risk management model continue to flash bearish for US Equities: 

  1. Immediate-term TRADE resistance of 1311 wasn’t overcome on Friday
  2. Immediate-term VOLUME signals continue to flash very bearish (3/11’s DOWN day = +31% VOLUME study)
  3. Immediate-term VOLATILITY (VIX) for the SP500 continues to build upward momentum > 18.52 support 

Since we’re Duration Agnostic, it’s important to expand this view to our intermediate-term duration (TREND): 

  1. Intermediate-term TREND resistance for the SP500 remains overhead at 1343
  2. Intermediate-term TREND support for the SP500 remains lower at 1271
  3. Intermediate-term VOLUME and VOLATILITY studies support a heightening probability of a 1271 test 

On a downside test of 1271, I’ll probably get longer of US Equities. I’m in a good position to do that because I’ve proactively cut my US Equity exposure (Hedgeye Asset Allocation Model) from 9% last week to 3% this morning (sold Healthcare on the open – XLV).


No one said managing drawdown risk of -5.4% is going to be easy (1). No one here was saying you should chase US Equities into their February 18th top either. Waiting and watching for risks, ranges, and spreads will be critical in the coming days.


The crowd is still too long,



Keith R. McCullough
Chief Executive Officer


Drawdown: SP500 Levels, Refreshed - 1

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