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Europe’s Eye on Inflation

Position: Long British Pound (FXB)

 

Conclusion: We continue to flag our concurrent call of Inflation Accelerating with Growth Slowing across global economies. The UK remains one economy mired in this trend, with elevated levels of inflation persisting and choking off growth. Today’s UK Producer Price Index for April shows an upward acceleration in Input costs to 17.6% Y/Y (versus 14.8% in March) and Output prices slowed 30bps to 5.3% Y/Y versus the previous month. In total, we continue to note that increasing input costs should weigh to the upside on output costs, and therefore continue to hamper consumer spending, confidence, and ultimately growth.  We expect UK headline inflation, currently at 4.0% in March Y/Y, to accelerate over 2011 as we expect commodity prices to remain elevated over the medium term and due to the effect of “imported inflation”, or the impact of the weakness in the GBP-EUR over the last three years to heighten inflation pressures, especially considering that the UK imports roughly 50% of its goods from the Eurozone.

 

With no great surprise, energy and food prices were the largest inflationary components contributing to gains in input and output prices. Input crude oil gained 37.7% in April versus the 12 months ago period, and home food materials increased 15.4%.  Output prices saw the largest gain from petroleum products (up 14.9% in April Y/Y) and food products gained 7.3%. Notably, output tobacco and alcohol prices rose 5.5% Y/Y on increased tax from the government’s budget.

 

Europe’s Eye on Inflation - uk1

 

Both the ECB and BoE held benchmark interest rates unchanged on Thursday despite existing inflationary pressures (Eurozone CPI = 2.7% in March Y/Y). While we’ll have to wait for the BoE Minutes for more insight on the bank’s thinking, we remain of the camp that a hike of 25bps is prudent.  Trichet’s language in the press conference following the announcement was measured, indicating that monetary policy is “still accommodative” in an environment where there is “upward pressure on overall inflation, mainly owning to energy and commodity prices”. The market largely interpreted these statement as “dovish” for a hike next month in that he did not reiterate such phrases as “strong vigilance” or “prepared to act in a firm and timely manner”.

 

We’ve seen follow-through selling of the EUR-USD after yesterday’s announcement. In reality, the EUR-USD rose very expediently to just under $1.49 this week and was clearly disconnected with underlying fundamentals. We see immediate term support in the EUR-USD around $1.44, with upside resistance at $1.47, and expect this trade to be volatile given persistent weakness in the USD (despite a bounce yesterday) and uncertainty surrounding the sovereign debt contagion across Europe's periphery. 

 

With the unwind of the huge correlation trade to commodities this week, notably Russia’s equity market (RTSI) fell 4.4% week-over-week and Norway’s market declined 3.4%, as Greece blew up (down 4.5% w/w) on debt restructuring fears, we continue to like Germany (via the eft EWG), due to its fiscal sobriety and continued strong fundamental performance. Year-to-date the DAX is up 8.3%, within the top 10 performing global equity markets ytd. Below we highlight our support levels for the DAX. On strength, we’d short Italy (EWI) or Spain (EWP).

 

Europe’s Eye on Inflation - uk2

 

Matthew Hedrick

Analyst


EMPLOYMENT DATA REMAINS POSITIVE FOR QSR

Data from the BLS today a positive data point for restaurants. 

 

April employment data was released today by the Bureau of Labor Statistics.  As our Healthcare team pointed out this morning in their daily Healthcaster piece, the employment recovery “continues to be a barbell recovery with younger demographics, who don’t consume much healthcare, and older workers.”  The 20-24 years-of-age and the 55 years-and-higher age cohorts continue to gain while the 34-54 years-of age cohort continues to slide.  For restaurants, the recovering in employment levels among younger people is a positive for quick service restaurants, as I have written over the last number of months in these updates.  Interestingly, looking at employment trends in the full-service and limited-service sub-sectors of the food service industry also strikes a positive tone for the industry. 

 

EMPLOYMENT DATA REMAINS POSITIVE FOR QSR - employment age

 

 

I am aware that many big corporations, as the saying goes, hire at the top and fire at the bottom.  However, as long as the employment growth in the younger age cohort continues to trend in the right direction, employment will continue to be a positive driver for QSR.  The chart below also shows a sustained growth, since early 2009, in hiring by full-service restaurants.  For eating out, as a whole, it is important to pay attention to the soft employment trends in the 34-54 years-of-age bracket.  This is an important group for restaurants and the continued slide in employment levels is a negative for casual dining.

 

EMPLOYMENT DATA REMAINS POSITIVE FOR QSR - food service emplyoemtn 56

 

 

Howard Penney

Managing Director


TALES OF THE TAPE: DPZ, TXRH, CAKE, CPKI, GMCR, BWLD, BAGL, CBOU, SBUX

Notable news items and price action from the past twenty-fours along with our fundamental view on select names.

  • DPZ gained 10% yesterday on accelerating volume after posting better-than-expected earnings. 
  • TXRH gained 5.3% on accelerating volume.  I have a negative fundamental view of this stock and, over the past few months, the stock has underperformed many of its peers.
  • CAKE also gained on accelerating volume and my view of this stock is also negative.  This company is one that I believe is guiding below where inflation will ultimately be for their commodity basket this year.
  • CPKI reported earnings last night; EPS came in at $0.09 versus consensus of $0.06 but comparable restaurant sales came in at -2.1% versus consensus -1.4%.  2Q guidance is for EPS $0.20-0.21 and comparable restaurant sales flat-to-positive 1%.  Inflation guidance was raised from 2.5% for FY11 to 3% (which I still think is low).
  • GMCR announced the pricing of its common stock offering of an aggregate of 8,189,544 shares of its common stock at a price to the public of $71/share.
  • BWLD gained on accelerating volume. 
  • BAGL gained on accelerating volume and the company posted weaker-than-expected earnings after the close last night.
  • CBOU gained on accelerating volume and posted earnings above consensus with the benefit of a one-time tax benefit.
  • SBUX is hosting a half-price Frappuccino happy hour today.  Frappuccino Happy Hour will be held daily through Sunday, May 15.
  • SBUX featured in the “Heard on the Street” column in the Wall Street Journal yesterday.  The column detailed that SBUX is trading at 25x FY11 EPS and may be rich with coffee prices more than doubling in the last year. 

TALES OF THE TAPE: DPZ, TXRH, CAKE, CPKI, GMCR, BWLD, BAGL, CBOU, SBUX - stocks5.6

 

 

Howard Penney

Managing Director


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DIRTY DANCING

This note was originally published at 8am on May 03, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“I feel dirty making money on the long side in this market”

-A Hedgeye Client that has been successfully making money on the long side

 

This quote comes from a client of hedgeye, who just happens to work for one of the largest “long only” money managers on the planet.  Why does he feel dirty?  He’s probably shares many of the same views that David Einhorn has had as he’s been covering his shorts.  The music is playing and the kids are Dirty Dancing.  The Chuck Prince of 2007 would approve. The grownups, however, do not.

 

David Einhorn had this to say, in the Greenlight capital Q1 Shareholder Letter: “The broad market, which shrugged off the continued escalation of commodity prices, unrest in the Middle East, a catastrophe in Japan, tightening monetary policy outside the United States and a deceleration of domestic economic growth...this quarter we were repeatedly confuzzled when we read company news announcements that we expected to cause falling stock prices, only to see them rise instead – and sometimes sharply at that.  Nonetheless, we believe that this environment is cyclical, and that it will continue this way... until it doesn’t.”   

 

Einhorn likens the market today to Charlie Sheen, believing that “all publicity is good publicity”.  Einhorn’s past record and thorough thought process that comes through in his writing are both impressive.  He is no Bud Fox; he understands the danger of investor psychology and groupthink.  Nevertheless, he is not confident that his firm can call the turn so he has been covering. 

 

Both Einhorn and the Hedgeye Client quoted at the beginning of this Early Look are thoughtful market operators that have generated alpha in different market cycles across sectors and geographies.  Clearly by the sentiments they are expressing, they are alerting us to a real problem that exists in money management at this point in equity markets.  Capital has been pumped into the system through two rounds of quantitative easing and PM’s that want to get paid will chase yield with that capital.  The stock market rally has been self-sustaining in that regard; a rising stock market does improve consumer confidence among higher income brackets.  However, the reception of all news as good news is disturbing to say the least.  As the multitude of interconnected global macro factors continue to change in real-time, the government is handcuffed with sky-high debt, zero percent interest rates, and slowing economic growth.

 

The pension fund community, too, has been dragged into this game of pass-the-grenade.  “Assumed” rates of return are to be hit lest the funds face a significant shortfall on their obligations.  Given the fear of inflation that has rightly taken hold, pension funds cannot look to bonds for the required 7-8% returns with interest rates at 0%.  Rather, pension fund managers are chasing yield right at the top of the cycle.  In fact, I would argue – although Keith may not agree (so this is not the official Hedgeye view) – that the cycle has already topped. 

 

Jobless claims have given back all of the progress that was made from January 2010 onward.  GDP slowed sequentially and sell-side expectations for GDP growth are coming back down to earth.   What’s more, Fed-sponsored inflation and price instability is the ultimate kryptonite for the economy as we head into 2H11. 

 

Osama bin Laden’s death is a great victory for the U.S. Military and the American people, but it is important to keep that in context from a market perspective.  Many market pendants are trying to spin this as a positive for the consumer and thus the overall market.  While it may have been yesterday, for a time, consider the day-to-day realities facing Americans.  Sky high gas prices, food costs, clothing costs, healthcare costs and declining purchasing power are a constant reminder to consumers of the fragility of the economy. 

 

Even if Bin Laden’s death is to have a long-lasting impact on markets, it may be a negative one if any retaliation or escalation of extremist terrorist activity causes an increase in the global risk premium and the cost of oil.  In fact, a CNBC.com poll conducted yesterday indicated that, of just under 10,000 respondents, 72% of people responded “No” when asked if they felt safer now that U.S. forces have killed Bin Laden.

 

The Dirty Dancers out there are counting their blessings that the market, perched on a precipice, is still on two feet thanks to the maintenance of the status quo.  Quantitative Easing sponsors bubbles and I believe that while earnings have been strong of late, many markets are taking on more and more of the characteristics of a bubble.  Dr. Rich Peterson uses three main parameters to describe a bubble.  First, it’s a great story.  Secondly, it has unlimited upside and finally, it is confirmed by higher prices.  An asset class that is exhibiting these characteristics is difficult to resist.  Pension fund managers and hedge fund managers alike are following market momentum as their performance targets require them to.

 

All the while, great stories are being told as to why the market should keep going up.  Inflation is “transitory”.  Japan’s catastrophe is not a big deal.  Oil prices are still not high enough to impact the consumer, according to some.  At the end of the day, all of these stories are supportive of higher equity prices.

 

How will it end?  This debate begins on the topic of debt and deficits.  Hedgeye believes that a country’s currency is a prescient indicator of its underlying economic health and we view the USD crashing as a bearish indicator, just as it was in 2008.  Warren Buffett’s recent quote on the impossibility of a U.S. debt crisis of any kind “as long as we keep issuing our notes in our own currency” is based on several obvious assumptions that neither Mr. Buffett nor anyone in the investment or bureaucratic community can be certain of.  The unexpected is unexpected for a reason.  That the political make-up of Washington D.C. will allow the federal government to continue on this road or to involve itself with the States’ debt issues remains to be seen.  

 

Part of the timeline of the USD Currency Crash call we’ve been making has been this literal moving target on the debt ceiling limit.  It was only three weeks ago that Secretary Geithner was doing some Dirty Dancing of his own, drawing a firm line in the sand that May 16th was the debt ceiling debate’s date with destiny.  Now, after 1Q11 GDP growth sequentially slowed and the dollar maintained its downward trajectory, Geithner has decided to join the festivities by pushing out the deadline to July 8th as of a few weeks back and now to August 2nd as of yesterday. “Extend and pretend” is a phrase that comes to mind.

 

In my view, the bottom line is this; there are some terrific story-tellers out there.  Whether it’s today on Osama bin Laden’s death being bullish for confidence but not for oil, that the global currency market will tolerate this crashing of the global reserve currency, or Secretary Geithner procrastinating in the hope that the market will give the dollar a bid, story-tellers abound.     

 

Lastly, this weekend I went shopping with my daughter for her prom dress.  After trying on at least thirty different dresses, the first twenty-nine were not good enough, she found the right one.  She has assured me that there will be no Dirty Dancing at the prom.

 

Function in Disaster; finish in style,

 

Howard Penney

 

DIRTY DANCING - Chart of the Day

 

DIRTY DANCING - Virtual Portfolio



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,

KM

               

Keith R. McCullough
Chief Executive Officer

 

Employing Liberty - Chart of the Day

 

Employing Liberty - Virtual Portfolio


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