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Employing Liberty

“Freedom and liberty are now words so worn with use and abuse that one must hesitate to employ them.”

-F.A. Hayek


Earlier this week I gave some air time to Hayek’s chapter titled “The Abandoned Road.” The aforementioned quote comes from the same book (“The Road To Serfdom”). As you think about what Big Government Intervention has done to the US Dollar and The Correlation Risk it perpetuates in markets this morning, don’t forget that the Jobless Stagflation you see emerging from the Fiat Fools finest isn’t employing a sustainable economic recovery.


Both of these Keynesian ideologies are crocks:


1. Fiat Debt - that central planning policy of printing short-term debt (beyond 90% debt/GDP) to solve long-term liabilities is the best path to prosperity

2. Dollar Debauchery - the notion that having an implied monetary policy to devalue the currency and inflate is going to end in “price stability”


What we have here folks is The Price Volatility.


We’ve seen a version of this movie before. Not unlike the Keynesians begging The Bernank to provide markets with “shock and awe” interest rate cuts to zero percent in 2008, this time our professional politicians on Wall Street and in Washington have begged for The Quantitative Guessing.


What has that done for the country?


Well, consider the order of events (causality) that drove The Correlation Risk to lead to the largest weekly decline in oil prices since, you guessed it, 2008:

  1. The Bernank panders to the political wind at the April FOMC meeting keeping all rate hikes off the table
  2. The US Dollar Index proceeds to test its all-time lows in the last week of April (same levels reached in Q2 of 2008)
  3. Energy stocks hit YTD highs on April 29th (month end)

Then, the US Dollar stops crashing (USD = UP +1.6% for this week-to-date)… and commodities start crashing…


Nice. What else happened?

  1. US stocks are down every day since April 29th…
  2. Silver prices have their biggest down week since 1975…
  3. The Volatility Index (VIX) is up +23.4% for the week-to-date…

Cool, right?


The Keynesian Kingdom calls this The Price Stability.


Let me tell you what a small business owner (me) thinks about price volatility - I am less confident to run out and hire people.


That’s why you see weekly US jobless claims breaking out to the upside again (474,000 this week versus 429,000 last week). That’s why you see the Bloomberg weekly consumer confidence reading drop to minus -46.1 this week versus -45.1 last. That’s what volatility does to real businesses with real people making real life risk management decisions.


What’s the answer to this colossal problem of common sense? Get out of the way.


That’s right, the potty trained Risk Managers in financial markets can handle the truth. We are accountable for getting run-over in our long Gold and Oil positions this week. We can handle it – Yes We Can.


As Hayek astutely observed in 1944: “Perhaps the greatest result of the unchaining of individual energies was the marvelous growth of science which followed the march of individual liberty from Italy to England and beyond.” (“The Road To Serfdom”, page 69)


He was talking about the 150 years of industrialization in this world pre WWI (see Chart of The Day below, which I think I have been using in every client presentation for 2 years). The Federal Reserve Act of 1913 doesn’t look so swell for the median global inflation rate on this chart. That’s when the Fiat Fools took over from the Gold Standard … and the financial engineering revolution began.


Fully loaded with yesterday’s drawdown in oil prices, don’t forget that the all-time high price for a barrel of oil (nominal) on an annualized basis was $101/barrel in 2008. Correcting to the all-time high yesterday isn’t called a crash – it’s called a reminder.


Yesterday was one more reminder that we have a choice in this country. We can take our “free” markets back – but first, we have to re-teach ourselves what Employing Liberty’s definition to our lives and markets really means.


What to do from here?


Well, after badgering myself about it at the YTD top, I’m still short the SP500 (SPY) but think it has every opportunity to bounce to another lower-long-term high. My immediate-term TRADE lines of support and resistance for the SP500 are now 1331 and 1351, respectively.


I took down our exposure to Commodities this week to 12% in the Hedgeye Asset Allocation Model by selling our long position in Corn (CORN) and then taking our long Oil and Gold positions to 6%, respectively. If Oil can’t hold its intermediate-term TREND line of support of $98.63 in the next three trading days, I’ll likely sell it all too. The market owes me nothing in this or any other position.


Gold looks much different than Silver or Oil at this point (lower VOLATILITY studies across durations in my models and less concerning PRICE/VOLUME factoring). My Immediate-term lines of support and resistance for Gold are now $1482 and $1523, respectively.


Happy Mother’s Day to my Mom, Mrs. Scott, and Laura, and best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Employing Liberty - Chart of the Day


Employing Liberty - Virtual Portfolio


TODAY’S S&P 500 SET-UP - May 6, 2011

In the Correlation Risk post earlier this week we called out this 73.40 USD Index level as a very immediate-term trigger line. The good news is that as of yesterday, we’re through that line and the biggest wave of guys being forced to take down exposure to the most crowded macro trade (net long and gross exposure) in hedge fund history (The Inflation trade, brought to you by The Bernank).  As we look at today’s set up for the S&P 500, the range is 20 points or -0.31% downside to 1331 and 1.19% upside to 1351.



After yesterday’s downdraft, the Hedgeye models now have 3 of 9 S&P Sectors bearish TRADE and TREND (XLF, XLE and XLB) – they were the 1st 3 sectors to crack when we made our May Showers call in 2010 too. In order of preference, the best places to hide are long Tech (XLK) and Healthcare (XLV).




THE HEDGEYE DAILY OUTLOOK - daily sector view








  • ADVANCE/DECLINE LINE: -738 (+400)  
  • VOLUME: NYSE 1113.48 (+4.11%)
  • VIX:  18.20 +6.56% YTD PERFORMANCE: +2.54%
  • SPX PUT/CALL RATIO: 1.94 from 2.08 (-6.77%)



  • TED SPREAD: 26.32 0.507 (1.964%)
  • 3-MONTH T-BILL YIELD: 0.02% -0.01%
  • 10-Year: 3.18 from 3.25
  • YIELD CURVE: 2.60 from 2.65 



  • 7:30 a.m.: Fed’s Yellen speaks on economic growth in Finland
  • 8:30 a.m.: Payroll report
  • 10 a.m.: Fed’s Dudley to speak at economic briefing in NY
  • 11 a.m.: Fed’s Bullard to speak to bankers in Little Rock, Ark.
  • 1 p.m.: Baker Hughes Rig Count, prior 1818
  • 3 p.m.: Consumer credit, est. $5b


  • US manufacturers of all sizes having trouble finding skilled workers - WSJ
  • Sen Charles Schumer leaning toward backing Deutsche Boerse bid for NYSE Euronext - WSJ
  • China is closely watching the debate over raising the U.S. debt ceiling and wants the Obama administration to do more to curb the deficit - Vice Finance Minister  Zhu Guangyao



THE HEDGEYE DAILY OUTLOOK - daily commodity view




  • Commodities Plunge for a Fifth Consecutive Day on ‘Panic’ Among Investors
  • Crude Oil Falls a Fifth Day; Poised for Biggest Weekly Decline Since 2008
  • Silver Set for Worst Weekly Drop Since 1975 Amid Rout in Commodity Prices
  • Copper Heads for Largest Drop in Eight Weeks as Central Banks Raise Rates
  • Corn, Soybeans Drop as Investors Bet Demand Will Dry Up on Higher Prices
  • Coffee Falls as Rising Robusta Stockpiles Cap Rally; Sugar, Cocoa Slide
  • Oil Bubble Pops as Bin Laden Death Triggers Four-Day Rout: Energy Markets
  • Palm Oil Futures Plunge for a Third Day, Tracking Decline in Commodities 



THE HEDGEYE DAILY OUTLOOK - daily currency view




  • European equity markets trading flat to lower
  • Germany Mar Industrial output +0.7% m/m vs consensus +0.5% and prior +1.7% revised from +1.6%
  • UK Apr PPI:  input +17.6% vs consensus +16.3%; output +5.3% vs consensus +5.1%; core output +3.4% vs consensus +3.0%
  • Spain GDP +0.2% in 1Q11, matching the 4Q10 growth rate, and +0.7% YoY - The Bank of Spain







  • Asian markets mostly lower, with commodity stocks hurt by lower oil and metals prices.
  • Australia’s dollar strengthened the most in two weeks after the Reserve Bank increased forecasts for inflation and said higher interest rates may be required “at some point.” @Bloomberg











Howard Penney

Managing Director

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Street too low, FCF yield too high



ASCA reported a blockbuster quarter this week, beating our EPS estimate by 9 cents and consensus by 12 cents.  Margins were particularly strong and management’s outlook was favorable.  But we don’t want to rehash the quarter.  To quote Larry Kudlow “the mother’s milk of stocks is earnings” and we think strong earnings going forward and an attractive free cash flow yield will propel ASCA still higher. 


We turned positive on ASCA with our 3/24/11 post “ASCA: FCF AND EARNINGS” (3/24/2011) where we stressed its attractive free cash flow yield and potential for higher than expected earnings.  While the stock has risen over 30% since then, the good news is that we’re essentially in the same situation.  Thanks to an incredibly accretive (earnings and free cash flow) refinancing and stock buyback, ASCA’s free cash flow yield remains over 20% and earnings estimates still need to go higher.  As we’ve pointed out, for ASCA that combination has historically resulted in significant share appreciation. 


Street estimates on Q2 and FY 2011 and 2012 are still too low.  We’re 10% and 23% above consensus Q2 EBITDA and EPS, respectively.  For fiscal year 2011, we’re 8% and 31% higher than consensus.  The Street seems to be underestimating the accretion from the refinancing and buyback and more importantly, continued margin improvement and revenue growth.  Remember, ASCA’s number one competitor in virtually all of its markets is Harrah’s (Caesar’s).  Have you seen a Harrah’s property lately?  When every nickel is going to pay down debt rather than buying slot machines from the current decade, it becomes tough to maintain share.


On any valuation metric, ASCA looks very cheap – yes even P/E!  On 2012, ASCA trades at 6.3x EV/EBITDA, 8.5x earnings, and carries a FCF yield of 21%.

TBL: Textbook Lesson For All

If you want a textbook example in when to buy and sell retail names, check out TBL. Sometimes the best call is to do nothing.



The Timberland quarter is such a great lesson for anyone who cares about any company touching the retail supply chain. While we love to dig into the nitty gritty details more than anyone, sometimes you simply need to look at the calendar, a stock chart, and understand the motivational drivers behind what makes the company tick.  This is one of those instances.


Specifically, recall that on the company’s 2Q conference call, CEO Schwartz altered the revenue strategy for the company. After years of pulling distribution (voluntary and involuntary) of its classic ‘yellow boot’ business, and then restricting distribution further as it tiered product to build demand under Gene McCarthy (who now heads UnderArmour’s footwear business), he said something to the tune of “our consumer wants our product, so we’re going to give them the product!!!” The triple exclaimation point there is to try to capture his tone, which was more cocky than it was aggressive.  The market liked it, and the stock popped 20% in a week.


Then when TBL printed 4Q results, it blew away  growth expectations. The stock was up another 25% in just 2 sessions.


But today’s results resulted not only in a miss, but in a flat-out horrible earnings/cash flow algorithm. Revenue growth of 10% was de-levered to operating profit decline of -29% with receivables and inventories up 13% and 37% (!), respectively. We won’t debate the company’s assertion that this is needed to hit their growth plans, but we will question the margins that will be realized to achieve such growth.


Simply put, this is just a great case of management behaving badly.


I’ll be the first to admit how I kicked myself for missing that positive move in the stock on that mid-February day. But I’d have kicked myself harder for participating in the “capital destruction gong show” that was TBL’s 1Q.  


Yes, we want to be right all the time. Every quarter, every month, and every day. But sometimes the best strategy is to sit back, stick to your guns, and do nothing.



This is the gnarliest looking SIGMA we've seen all year.Let us know if you need help interpreting.

TBL: Textbook Lesson For All - tbtb


TBL: Textbook Lesson For All - tbsshgma


1Q11 is proving to be a strong quarter for the pizza category.  DPZ reported $0.42 versus consensus $0.34.  Domestic comparable restaurant sales slowed -1.4% versus street expectations for a -4% print versus last year’s blowout first quarter.   Domestic company and franchise comparable sales slowed -2.3% and -1.3% versus consensus at -4.3% and -3.9%, respectively.   International comparable restaurant sales grew 8.3% versus consensus 6.5%. 


Management shirked away from providing guidance, reverting back to their normal practice after providing sales commentary on 1Q during the 4Q10 Earnings Call.  Management’s discussion, if a little light on forward-looking details, certainly seemed positive in tone.  The domestic and international businesses are performing well and management is “comfortable” with the +3-5% commodity cost outlook.  Given that inflation in 1Q11 was 5%, the higher end of the range seems more conservative.



Comparable-restaurant sales growth


The chart of company-operated domestic same-store sales below shows clearly that DPZ’s domestic business is trending very well.  Despite a negative comparable-restaurant sales number for the first quarter, the two-year average trend is encouraging.  On a sequential basis, from 4Q10, two-year average trends accelerated by 350 basis points.  Media spending in the quarter was in line with the one year ago and the last few quarters, and management stressed that media spend should remain at a fairly constant level for the foreseeable future. 


International markets are providing robust returns for the company with Turkey (promotions and TV) and Malaysia (new menu items) two of the standout markets.  The company began its recap of the quarter with commentary on international markets so that, according to management, it might be highlighted that Domino’s is an international company that derives one-third of its profit from international operations. 


By way of an explanation for the upside surprise in the company’s top-line performance, management reiterated its comments from a quarter ago; the company views its brand and equity as having been enhanced far past where it was pre-2010.  The U.S. business continues to perform well as the company added pizza and chicken promotions to the menu during 1Q11.  While management wouldn’t give specific numbers on the impact of chicken on average check, or what average check was during the quarter, it was explained that chicken was ordered with high frequency as an add-on, and did not cannibalize pizza sales, so we can infer, from a traffic and average check perspective, that the chicken promotion was a net positive.   Chicken was only rolled out for the last 5 weeks of the quarter so the impact on the current quarter may be more significant. 





Restaurant Operating Margins


Food costs are certainly rising for every company in the restaurant business, with the exception of BWLD, but DPZ is managing the challenge well.  The structure of the company, being 90% franchised, is a great help in this regard but DPZ feels that inflation has been managed and the company’s supply chain system has put the company in a good position in terms of negotiating contacts.  Commodities, according to the company, have been in line with their expectations.  As I wrote in my note titled “DPZ – 1Q11 INFLATION COMMENTARY”, DPZ has been maintaining a far more realistic inflation outlook than many of its peers.


Cheese prices were a huge concern for DPZ at the time of the past earnings call on March 1st.  Ten days later, cheese prices fell off a cliff and for the quarter, DPZ paid an average price of $1.60 per pound versus $1.44 last year.  Considering that cheese was trading at $2.00 before its precipitous decline in mid-March, investors are far more at east at the present time than one quarter ago.





From here, I think this name has plenty of momentum.  Some of the key reasons for my stance include: robust sales growth, a heavily franchised system, a supply chain business that benefits from higher commodity costs, and a management team that is managing investor expectations, as well as the business, very well.


Howard Penney

Managing Director

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