Royal Awareness

“It’s choice not chance that determines your destiny.”

-Jean Nidetch


Interestingly this quote comes from a one-time overweight housewife with a self-confessed obsession for eating cookies—a woman who eventually kicked her weight and went on to start a peer group to support her overweight friends, which expanded and in 1963 was incorporated as the Weight Watchers organization.


The quote also seemed appropriate for it reminded me of the vaulted status of global central bankers and their choice (along with a committee vote) to act or not (in what sometimes seems like chance) to direct a country’s monetary policy, and therefore economic health. In the recent era, central bankers have attained a sort of rockstar status typically reserved for celebrities and athletes, and just this week Ben Bernanke joined the club of celebrated central bankers (notably the ECB’s Jean-Claude Trichet) with a live press conference following his policy announcement—trappings that must clearly enhance his “cult” status.


Yet, with today being the Royal wedding day, and with my role being European analyst on the Macro Team, we thought we’d give The Bernank a needed rest and focus on the actions across the pond at the Bank of England, namely the hefty choice that CB Governor Mervyn King faces with the UK stuck between stagnant growth as inflation accelerates.


In particular, we’d like to call out the strength of the British Pound versus the USD, in our opinion an out-of-consensus call that we’ve been long of via the etf FXB in the Hedgeye Virtual Portfolio since 3/23 due to the following positive factors:

  1. The BoE’s increasingly hawkish lean on inflation and evidence that suggests the positive currency impact of an interest rate hike (examples include ECB and Riksbank decisions)
  2. The announcement of austerity by the UK Government in the fall of last year to proactively cut public spending and boost revenue, versus the US’s passiveness in addressing its rising debt and deficits, a position that has perpetuating a weak USD versus most major currencies (US Dollar Index down for 14 of last 18 weeks)
  3. Bernanke’s commitment to keep rates near zero percent and his  indication that some form of QE-lite will follow QE2’s expiration in June = continued USD weakness
  4. The flight to safety of Sterling as Eurozone debt contagion remains at large (also bullish for the CHF and SEK)


The Proof is in the Pudding

While the above points have been supportive of the GBP-USD trade to some degree this year, the prospect of high inflation with slow growth in the UK is the pressing threat facing policy makers. And while there are numerous ways to spin the headline data out of the island nation, in our mind it’s hard to argue against the  inflation data, which has charged higher for the last 18-22 months. The current inflation readings include:

  • Consumer Price Index (CPI)   +4.0% in March Y/Y
  • Producer Price Index (PPI) for Input   +14.6% in March Y/Y
  • PPI Output   +5.4% in March Y/Y

While the BoE drew a sigh of relief with the March CPI number 40bps below the February reading, current levels are a full 2% higher than the BoE’s target, and 1.5-2.5% above European peers, as rising energy costs continue to fuel high readings this year.


While the BoE has maintained its 0.50% benchmark rate since March ‘09, the lowest level in over 300 years of the history of the BoE, we’re of the camp of Andrew Sentance, one of the nine voting members of the BoE’s Monetary Policy Committee, and affectionately known as the ueber inflation hawk due to his very vocal stance for an interest rate hike since June 2010. We’re now seeing in the last few BoE meetings that fellow members Spencer Dale and Martin Weale have joined ranks for a rate rise of 25bps, while Sentance has upped his rate hike call from 25bps to 50bps, leaving the committee a 6-3 vote against interest rate action, but marginally more hawkish.


Below are a few key drivers that Sentance notes to justify a rate hike, which he’s included in this speaking tours:

  1. The UK’s need to strengthen its currency with its trading partners, particularly against the EUR as the Eurozone accounts for about half of total exports and half of total imports.
  2. A stronger domestic currency will help to combat imported inflation. The renewed surge of energy and commodity prices only adds to the imported inflation driven by a weak Sterling versus the EUR since 2007. 
  3.  The squeeze on disposable income is already a factor holding back the growth of consumer spending in the short term.
  4. Ergo, a rate hike is essential to boost the Sterling versus the EUR and other major trading partners to mitigate inflation and therefore improve consumer spending.

Not so Fast – Austerity’s Bite and Growth Fears

While Sentance makes some very convincing points supportive of a rate hike, others remain convinced that excess capacity in the economy will slow/drive down prices and that a rate hike would only create a further shock to the consumer.


Rightfully, this camp also points out the negative impact of the government’s austerity program, which broadly calls public job cuts of ~500K and ~£81 Billion in public spending cuts over the next 4 years, and an increase in VAT (from 17.5% to 20%) that began in the beginning of this year. Their position is that weaker consumer and business surveys are indicative of the strain of public sector deleveraging and expectations for slower growth. Additionally, it is argued that the negative impact on the housing mortgage market from a rate hike—with the housing sector mired in an anemic state—would be an additional blow to the consumer’s wallet.


Boiling it Down

As we’ve said from the outset, there are any number of ways to interpret the data. Arguably the BoE and UK government are left in a tough spot, trying to head off inflation while not pinching growth prospects. For reference real annual GDP was +1.4% last year, with the final quarter of 2010 showing a -0.5% hit Q/Q, while 1Q2011 rebounded to +0.5% Q/Q.


While the jury is still out on whether or not Q1 can be a sustained inflection, our call is focused on the implication of the Pound versus the USD, in particular, but also the EUR. We continue to applaud PM David Cameron’s forceful strategy to reduce fiscal debt and deficits, which according to the UK statistical office were 59.6% of GDP in 2010 and 10.4%, respectively (see chart below). Notably, the chart of cumulative public sector net borrowing shows improvement across annual compares, an indication that austerity may, in fact, be working.


Further, compared to the US administration, Obama and Company are just now coming to terms with the budget ceiling debate and the great issue on shaving down the budget deficit that is expected to rise well over 10% next year, according to our calculations, with the US debt as a % of GDP expected to reach 96% this year and over 100% next.


On these metrics, we think the UK’s proactive attention to reduce fiscal imbalance, coupled with the increased likelihood of an interest rate rise, should boost the GBP versus the USD. Should we get a rate hike, it should help alleviate inflation pressures, which will improve consumer and business optimism and therefore encourage growth prospects over the intermediate to longer term.  Given the likelihood that elevated input cost pressures are here (globally) to stay over at least the medium term, we think there’s prudence in a rate hike.


Increasingly we’re seeing the bifurcation in economic performance on the basis of policy decisions to cut fiscal imbalances and increase interest rates off historical lows. So long as the US continues to fuel its monetary policy of extend and pretend and promote the fiscal printing press, we’d expect the USD to suffer versus major currencies. Getting long the GBP-USD is but one way we’ve chosen to express this bifurcation.   


Matthew Hedrick



Royal Awareness - ME1


Royal Awareness - Virtual Portfolio


6x EBITDA but what do you expect for a declining business?  Neutral to earnings but the cash position is building.


The sale of Barcrest to SGMS is only dilutive (by a penny) if one assumes that IGT just keeps the proceeds as cash.  Despite its recent struggles, IGT is really starting to accumulate cash and should be able to take out the convert next year or commence a large buyback – both would be very accretive.  By our math, IGT should generate around $300MM of excess cash per year.



Barcrest Sale Details

Purchase price:  $66MM; which includes $12M of receivables that are on extended payment terms.  The Barcrest business includes both sale and gaming operations.


Product sale impact:

  • In FY2010, 8,600 units were sold at an approximate unit price of $4k.  Margins on the for sale business are in the mid 30s%.  We estimate that in 2010, the for sale business generated $34MM of revenues and $12M of gross margin.  In FY2011 we estimate that unit sales will fall to just under 6,000 units and generate revenues of $24MM and gross margin of $8MM
  • The for-sale business has been declining for the last decade.  Before FY2003, IGT was selling over 30,000 units.  By FY09 the unit sales fell to 12,150 and continue to decline. 

 Gaming operations impact:

  • In FY2010, the install base of Barcrest units was roughly 8,000, earnings a daily yield of approx. $12.  All the Barcrest units are part of IGT’s leased install base. We estimate that gaming operation business generated revenues of $36MM in FY2010 and a gross margin of 70% or $25M
  • While the Barcrest install base has been declining, the declines are modest in nature so we assume that in FY11 gross margin contribution would have been about $24MM

 Impact on R&D, SG&A, and D&A:

  • Barcrest overhead is about $27-28MM in the form of SG&A and R&D and about $1MM of D&A

Forward multiple/ EBITDA:

  • We see EBITDA declining from $15MM in FY10 to about $11MM in FY11. Therefore, on current year EBITDA the multiple is ~6.0x


TODAY’S S&P 500 SET-UP - April 29, 2011

As we look at today’s set up for the S&P 500, the range is 34 points or -1.99% downside to 1333 and 0.51% upside to 1367.



The Financials remain the only sector broken on both TRADE and TREND.




THE HEDGEYE DAILY OUTLOOK - daily sector view








  • ADVANCE/DECLINE LINE: 691 (-141)  
  • VOLUME: NYSE 961.53 (+0.06%)
  • VIX:  14.37 -6.38% YTD PERFORMANCE: -19.04%
  • SPX PUT/CALL RATIO: 1.21 from 1.15 (+5.28%)



  • TED SPREAD: 22.25
  • 3-MONTH T-BILL YIELD: 0.06% -0.01%
  • 10-Year: 3.39 from 3.34
  • YIELD CURVE: 1.96 from 1.21 



  • 8:30 a.m.: Personal Income, est. 0.4%, prior 0.3%
  • 8:30 a.m.: Personal Spending, est. 0.5%, prior 0.7%
  • 8:40 a.m.: Fed’s Bullard to speak on community development in Virginia
  • 9:45 a.m.: Chicago Purchasing Manager, est. 68.2, prior 70.6
  • 9:55 a.m.: U Michigan Confidence, April final, est. 70.0, prior 69.6
  • 10 a.m.: NAPM-Milwaukee, est 63.0, prior 66.0
  • 12:30 p.m.: Bernanke speaks at Fed Community-Affairs Conference
  • 1 p.m.: Baker Hughes rig count, prior 1800



  • Russia Unexpectedly Raises Benchmark Interest Rate Quarter Point to 8.25%
  • PPC facing at least $500 million in higher feed costs this year
  • Berkshire Hathaway annual meeting this weekend




THE HEDGEYE DAILY OUTLOOK - daily commodity view




  • Gold-Buying Central Banks May Signal Bullion Extending Record Price Rally
  • Copper Futures in Shanghai Heading for Second Monthly Loss on China Curbs
  • Gold Heads for Best Monthly Gain Since November 2009 on Inflation, Dollar
  • Crude Oil Falls From Highest in 31 Months; Heads for Eighth Monthly Gain
  • Coffee May Climb 40% on Brazil Frost Risk as Kraft, Smucker Raise Prices
  • India Said to Consider Freeing Urea Price to Reduce Spending on Subsidies
  • Corn Demand in China to Outstrip Supplies on Livestock Feed
  • Naphtha’s Rally Not Over as Japan, Korean Demand Rebounds: Energy Markets
  • Wheat Futures Gain  as Rains in U.S. May Have Come Too Late for Harvests
  • China May Face Power Shortages in Summer as Demand Beats Growth in Supply




THE HEDGEYE DAILY OUTLOOK - daily currency view




  • U.K. markets closed for the Royal Wedding. Also closed Monday
  • Inflation Accelerates in Europe on Oil Surge as Business Confidence Wanes
  • European Stocks Are Little Changed; Yara, SSAB Rise on Earnings, YIT Sinks
  • Euro Zone April CPI 2.8% y/y vs 2.7% consensus
  • France Mar PPI +6.6% y/y vs. consensus +6.4%               







  • Asia stocks mixed as US economic growth slows
  • Yuan strengthens to post-’93 high against dollar as China fights inflation
  • Taiwan’s economy grows more-than-estimated 6.19%, adding pressure on rates
  • Japan was closed for Showa day.













Howard Penney

Managing Director

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Gaming Policy

This note was originally published at 8am on April 26, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Conditions never persist. They change. Bureaucrats really hate that.”

-Jeffrey Tucker


That’s a quote from a book I read on my family vacation last week, “Bourbon for Breakfast – Living Outside of the Status Quo” (and, no I’m not taking up sipping on Canadian Club by the pool with my morning coffee). Nor do I aspire to ever be a professional politician in America.


Never mind understanding how the interconnectedness of the Global Macro market works, most professional politicians in America don’t get how a market works. Most of them still call this game of Big Government Intervention a “free market.”  I call that a joke.


The good news is that a lot of people get the joke. Gaming Policy is the new hedge fund game in town – so game or be gamed. There are  higher prices being paid (read: trading commissions) for “one-on-one” access to private meetings with DC bureaucrats than ever before. Sad, but true.


You don’t need inside information if you have a multi-factor, multi-duration, risk management process that flags real-time pricing of these “data points.” Anyone who has traded real-time risk capital in markets knows that someone always knows something…


We’ve titled one of our Q2 Global Macro Themes, “Indefinitely Dovish” (see yesterday’s Early Look) primarily because we think the market is pricing in Bernanke remaining dovish into and out of tomorrow’s FOMC meeting.


When we say “the market”, we mean the globally interconnected one – not just US stocks:

  1. Currency Market – the US Dollar Index is trading down again this week (for the 14th out of the last 18 weeks) and the Euro is making new highs by the day ($1.46 last) because, for the 1st time since Fed head Arthur Burns was attempting to monetize the US Debt and devalue the dollar (1970s), US monetary policy is more left leaning and dovish than even what the ex-Finance Minister of France is delivering. Jean-Claude Trichet’s comments overnight were explicitly hawkish: “it is extremely important to continue to solidly anchoring inflation expectations in a period which is marked  by uncertainties and turbulence.”
  2. Bond Market – global bond yields continue to push higher as Asian and European central bankers continue to back their rhetoric with rate hike action. Meanwhile, US Treasury yields are breaking down through our intermediate-term TREND support lines of 0.71% and 3.46% for 2-year and 10-year UST yields, respectively. Indefinitely Dovish in America is as dovish does…
  3. Commodity Market – higher-highs on rallies and higher-lows on corrections for Gold, Silver, and Oil. This is where the US Dollar Devaluation driven monetary inflation is – not in GDP growth oriented commodity pricing (copper, sugar, etc.). With the Saudis trying to talk down oil prices at these levels (calling them “uncomfortable” overnight), WTI crude oil sold off a whopping 50 cents.

And Equities, well – we’re right back to where we were in mid-February where Asian Equities (growth markets) are starting to negatively diverge versus US Equities (the Gaming Policy market). China, India, and Indonesia are rightly worrying about The Inflation that will be perpetuated by a US Currency Crash.


Have no fear however – The Bernank and Groupthink Geithner are here. They have the world’s back on this Currency Crash thing. Having never seen an oil price (including $150/barrel oil) that they thought was inflationary, we don’t think they’re about to start calling $113/oil inflationary now. While Bernanke will acknowledge rising commodity prices tomorrow, he’ll offset that hawkish shift with an incrementally dovish one on US growth.


In the Chart of The Day (attached), Darius Dale calls out how super duper the sell-side has become in leading The Bernank and The Groupthinker’s Washington boys to believe that US GDP Growth was going to be all good and fine in Q1 of 2011 – then not so much.


The good news here is that Gaming The Sellside is still one of the oldest and most profitable games in town. They haven’t learned much since missing US GDP Growth Slowing in Q2 of 2008.


If you are looking for leadership on the Currency Crash thing, the President of the United States had this to say over the weekend on gas prices:


“There’s no silver bullet that can bring down gas prices right away…”


Really? If The Bernank raised rates at tomorrow’s FOMC meeting, oil prices would break $100/barrel in a day.


We’d like to remind all of our friends and foes who are still beer-bonging the Keynesian Kool-Aid that there are 3 things that burning your currency at the stake with generational levels of leverage (debt) does to an economy:

  1. It perpetuates The Inflation priced in US Dollars
  2. It structurally impairs the sustainability of long-term economic growth
  3. It dares institutional investors to chase “yield”

No, we’re not saying that these conditions will persist as a perpetually preferred dividend for those of us who are long of The Inflation. Neither are we saying this will end well. What we are saying is that playing the game in front of us right now is the game of Gaming Policy – and, as sad a state of a “free market” as this is, when this game changes, it will change abruptly.


The bureaucrats are going to really hate having to deal with that.


My immediate-term support and resistance lines for the SP500 are now 1320 and 1341, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Gaming Policy - Chart of the Day


Gaming Policy - Virtual Portfolio


Cosi announced comparable restaurant sales for the first quarter and, while not a disaster by any means, it seems that March was a soft month for a number of companies I track.


COSI released comparable restaurant sales results for the first quarter today after the close.  Company-owned comparable restaurant sales grew 3% in the quarter.  The number was comprised of 1.5% price and 1.5% average check and implied two-year average trends of -0.7% or 40 basis points below 4Q.  This is a disappointment because, as the chart below illustrates, the last three quarters had brought sharp gains in the two-year trend for company owned restaurants’ comparable sales growth. 





During the 4Q10 earnings call on March 28th, management disclosed that company comparable store sales had grown 1.6% in January and 6.2% in February.  Assuming equal weights for each of the three months would imply March comps came in at roughly 1.2%, which is a disappointing number.  However, while the market may react negatively to this print tomorrow, I think there is one important caveat to keep in mind.  March of 2010 was the first month of the year where company comparable restaurant sales growth was positive. 


Clearly March of this year had a difficult comp.  If the company can produce a one-year comp better than -3.3% for 2Q, the two-year average trend for COSI’s company comps will turn positive.  With that in mind, March 2011 comparable sales being up 1.2% versus a positive March 2010 is not quite as bad as many may initially fear.  Thus far this earnings season, a number of companies including EAT and PFCB have reported soft March comps.


I believe the sales trends in 2Q11 have accelerated from the 1Q11 level.  


Howard Penney

Managing Director

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