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Notable news items and price action from the past twenty-four hours, as well as our fundamental view on select names.

  • JACK reported 2QFY11 earnings last night, missing EPS expectations of $0.20 with a print of $0.12.  Revenues were ahead of expectations but commodity cost guidance was raised for the year.  Jack in the Box comp guidance range midpoint was raised 200 bps and Qdoba system comp guidance was raised 100 bps.   
  • MCD this morning announced a quarterly cash dividend of $0.61 per share of common stock, payable on June 15, 2011, to shareholders of record at the close of business on June 1, 2011.
  • MCD is being called upon by a campaign group called Corporate Accountability International to bad Ronald McDonald and Happy Meals because they attract children to junk food too much.
  • SBUX is being sued by the US government for firing a barista because she is a dwarf.  The US Equal Employment Opportunity Commission said that Starbucks violated federal law by denying a reasonable accommodation to the employee.
  • JACK, SBUX, PZZA, GMCR, DPZ, CBOU and YUM all saw their stock prices gain significantly on accelerating volume yesterday.
  • BJRI, BWLD, KONA, DRI, and EAT gained on accelerating volume also.  CHUX was the only restaurant stock to decline on accelerating volume.




Howard Penney

Managing Director

Insecurity's Correlation

This note was originally published at 8am on May 16, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“The more we try to provide full security by interfering with the market system, the greater the insecurity becomes.”

-F.A. Hayek


I have been focusing my quotes for the last few weeks on the most pertinent parts of Hayek’s “The Road To Serfdom” in hopes of someone in Washington finding it within themselves to stop doing more of what got us into this mess.


The Audacity of Hope, unfortunately, is not a Global Macro risk management process. Neither is John Boehner telling Barack Obama, “let’s lock arms and jump out of the boat together”…


Boehner was talking about raising the US Debt Ceiling limit (which the US is technically in violation of today). All US Constitutional “technicalities” aside, this country hasn’t had much of a memory when it comes to the original provision to let the US Treasury print debt in 1917 (in order to finance war). When in doubt, fear monger the citizenry into believing centrally planned security is the only way out.


For the week, with the US Dollar Index closing up +1.1% at $75.78:

  1. The US Dollar Index has been up for 2 consecutive weeks for a cumulative recovery of +3.8% from its YTD lows.
  2. The US Dollar Index has been down for 14 of the last 20 weeks and remains bearish on an intermediate-term TREND basis.
  3. The US Dollar Index is down -14.4% since Obama and Geithner took over in early 2009.

From a Correlation Risk perspective, here’s the 2-week cumulative declines in stocks and commodities priced in US Dollars:

  1. US Stocks (SP500) = DOWN -1.9%
  2. US Energy Stocks (XLE) = DOWN -8.3%
  3. US Financial Stocks (XLF) = DOWN -3.7%
  4. CRB Commodities Index = DOWN -8.6%
  5. West Texas Crude Oil = DOWN -12.5%
  6. Copper = DOWN -4.6%

So, if you didn’t know that the Globally Interconnected Marketplace is highly correlated to a US Dollar UP move, now you know…


Those who interfere with the free-market system, experimenting with Fiat Fool policies that take the US Dollar to all-time lows, didn’t get The Correlation Risk they were imposing on stocks and commodities in Q208 - and they most certainly don’t get it now. The game within the hedge fund game is now called Gaming Policy – and it’s volatile.


If you disagree with me that The Bernank perpetuates The Price Volatility by promising the world to remain “Indefinitely Dovish” (Q2 Hedgeye Macro Theme), the market disagrees with you. Since pandering to the political wind at the latest FOMC presser, the VIX (volatility index) is up +15.8%.


Global Growth Slows As Inflation Accelerates – I think the world gets that now… but do the world’s Risk Managers know how to deal with the most levered long trade in hedge fund history as it unwinds?


We call this “Deflating The Inflation” (Q2 Hedgeye Macro Theme) – US Dollar UP is the only way out of creating the highest levels of US-style Stagflation since the 1970s.


Two important points on stagflation:

  1. Real-time inflation (commodities, rents, education, etc) is reported real-time…
  2. US Government reported “inflation” is reported on a lag

Last week’s US Consumer Price Index (CPI) was +3.2% for the month of April – whereas Deflating The Inflation has occurred in May. This is where it gets tricky for the stagflation bulls who don’t think they’ll ever see a 600 basis point drop in the SP500’s PE multiple (like we saw in the 1970s when reported inflation broke out above reported (lagging) US GDP growth). Sound familiar? US GDP for Q1 was +1.8%.


Two points on US Growth and Inflation:

  1. Growth Slowing (joblessness) is going to remain throughout the summer months (the 4-week rolling average of weekly jobless claims just hit a new YTD high last week of 437,000).
  2. Reported Inflation is going to remain elevated because rents continue to climb (as US Housing double dips) and The Inflation “compares” get a lot easier through August (putting an upward bias on reported y/y CPI).

So what do you do with that?


Last week I moved as aggressively to Cash in the Hedgeye Asset Allocation Model as I have since mid-February. Here’s where our allocations stand as of this morning:

  1. Cash = 52% (up from 43% last week and 34% two weeks ago)
  2. International Currencies = 18% (Chinese Yuan – CYB)
  3. Fixed Income = 15% (US Treasury Flattener and Long Term Treasuries – FLAT and TLT)
  4. Commodities = 6% (Gold – GLD)
  5. US Equities = 6% (Tech – XLK)
  6. International Equities = 3% (Germany – EWG)

Mr. Macro Market does not owe any of us a return. When The Correlation Risk hinges on insecure policy like it does today, sometimes the most secure move for my own money is to simply get out of the way.


The problem right here and now is that everyone is still long The Inflation because The Dare was to chase The Yield – so we’ll need to wait and watch for entry points (capitulation maybe closer to $93 oil) before we take up our invested position again.


My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1472-1498, $93.18-100.58, and $1331-1345, respectively.


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


Insecurity's Correlation - Chart of the Day


Insecurity's Correlation - Virtual Portfolio

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

Being Early

“As always, if you listen to my advice, be prepared to be early!”

-Jeremy Grantham, May 2011


If you have not yet read Jeremy Grantham’s most recent GMO Quarterly Letter titled “Time To Be Serious (and probably too early) Once Again”, I highly recommend it. He’s been managing Global Macro risk for a long enough time to know that the best lessons in this business are learned the hard way.


Managing interconnected Global Macro risk is hard. So is keeping up with the required risk management reading that’s readily available to you. If you read too much groupthink, you’ll miss the deep simplicity of Mr. Macro Market’s signals. If you read too little history, you’ll miss the context by which the patterns of human behavior rhyme. Your reading needs to be focused and timely.


For me, it’s taken almost 13 years to realize that I read too much garbage and too little history. So, in the last 3 years I’ve worked on changing that. The plan on this front is always that the plan is going to change, but currently my reading process falls into two buckets:

  1. My pile
  2. My books

My pile, as my teammate of many years Tanya Waite can attest, is perpetually mounting. From my desk, to my bag, to airplane pockets around the world, my pile is my Princeton hockey player. I will fight it until I knock it down. My pile is a series of print outs (Grantham, Gross, etc.), white papers, and whatever else my team sends me that refutes or augments my current thinking.


My books, like my emotional baggage, are always with me – that’s why you’ll see me cite books in the sequence that I am reading them. I just finished reviewing “The Road To Serfdom” and “Undaunted Courage.” My challenge is to read at least 1 book every 10 days. On the plane to Denver last night, I was reading “The World In 2050” – more on that book and being long Northern Rim Countries (NORCs) in the coming weeks.


Back to Grantham’s problem of Being Early

  1. Being Early to work isn’t a problem – it’s cool
  2. Being Early to mentally prepare for a game is better than being late
  3. Being Early in our institutionalized world of chasing short-term performance is also called being wrong

That’s Wall Street. In evaluating our professional competence, our process and principles can always be trumped by our short-term P&L. Are you wrong today because you are about to be right? Or are you right today because you are about to blow up?


These are fair questions. Clients shouldn’t have to pay for my pile or performance problems. We are overpaid to over-deliver over long periods of time. As Risk Managers, we are tasked with explaining to our clients what it is that we are doing and why.


As Grantham points out in his Quarterly letter, “we often arrive at the winning post with good long-term results and less absolute volatility than most, but not necessarily with the same clients that we started out with.” Isn’t that the truth? Your clients need to know your duration too.


Back to the Global Macro Morning Grind…


No matter where you go this morning, there it is – The Correlation Risk to the US Dollar Index. For the week-to-date, the US Dollar Index is down a measly -0.65%, but look at the pop you are getting in the big stuff that’s priced in those Burning Bucks:

  1. CRB Commodities Index = +1.7% week-to-date
  2. WTI Crude Oil = +1.3% week-to-date
  3. SP500 = +0.22% week-to-date

Ok, maybe a 22 basis point move in US Equities isn’t the kind of pop that would get you all fired up, but maybe that’s the point. Maybe people are starting to get the math. Since the immediate-term inverse correlation between the SP500 and the USD is -0.84% (extremely high), maybe people are starting to consider the other side of the immediate-term TRADE.


What if the US Dollar stops going down from here?


The answer to that question is a trivial one. US stocks and commodities corrected -3% and -9%, respectively, in the last 2 weeks of a USD rally. While a strong dollar is great for this country, it’s awful for stock and commodity markets in the immediate-term. Yes, Mr. Bernanke, the country and the markets are 2 very different things.


This is where all of my reading runs parallel with my risk management signals – and yes, there is also a huge difference between the research embedded in your reading and how you manage risk in your portfolio. Every once in a while a risk management signal jumps out at me that’s impossible to ignore. Currently that signal is an immediate-term TRADE breakout in the US Dollar Index.


If you were only to allow me one live market quote to manage all Global Macro risk on for the next 3 weeks, I’d take the USD Index. The line in the sand is currently $74.41. That’s my TRADE line – and my risk management process is to respect it until correlation scores tell me not too.


If $74.41 holds support, I sell stocks and commodities (that’s why I have sold all my Oil and Gold in the last 2 weeks). If $74.41 breaks, I’ll be forced to go back to speculating on what The Inflation trade can do.


Being forced to do things isn’t cool. But, like Grantham, I have learned to take a measurable level of risk to speculate in these correlation trades. On page 2 of his Quarterly Letter, Part 2 – “Time To Be Serious” – May 2011, this is how the self-effacing Grantham summed up the same:


“As readers know, driven by my increasing dislike for being early by such substantial margins, I have been experimenting recently with going with the flow. In defense of this improper behavior, rest assured that it was motivated not by chasing momentum, but by my growing recognition of the immense power – sometimes the thoroughly dangerous power – of the Fed.”


Being Early doesn’t work until it does.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Being Early - Chart of the Day


Being Early - Virtual Portfolio

Dead Cat Bounce Aside, the Sugar Market Is In Oversupply

Position: Short sugar via the etf SGG


Sugar has been leading the recent commodity sell off.  In fact, sugar prices have been on a downward slope since their 30-year highs in February of $0.36/pound, falling roughly 40% since then, and sugar is now one of the most underperforming major commodities year-to-date, down roughly -16%.  Despite this dramatic sell off, on a year-over-year basis the price of sugar is still up more than +40%, which we believe doesn’t reflect the coming supply/demand imbalance.


More recently, sugar rose for the 4th day in New York yesterday, the longest streak in more than 3 months, mostly due to -69% year-over-year lower production during spring harvest from Brazil, the top sugar producing nation.  Production fell from 2.56 million metric tons to 795,000 metric tons from mid-March to the end of April.


Setting aside the short-term supply issues in Brazil, the International Sugar Organization (ISC) estimated last week that world supply, however, would exceed demand for the 2010-2011 season by 779,000 metric tons, despite the current slower flow of product from Brazil. 


Our view, which is more bearish than the ISC, and consistent with a recent report from The Kingsman Group, a commodities market analysis and research firm, is that sugar’s excess supply level would be even greater, with a potential oversupply of north of 5.2 metric tons.  The driver of this oversupply is more tepid demand growth combined with supply growth of more than 6% on a year-over-year basis.


From a correlation perspective, our correlation analysis appears to support this increased focus on supply and demand.  While sugar has been the beneficiary of a weak dollar over the past two years, similar to the broader commodity complex, sugar has recently lost its strong negative correlation to the U.S. dollar.  In fact, over the past 6-weeks, sugar’s correlation to the U.S. dollar is a statistically insignificant +0.15, with an r-squared of 0.02.


As the Inflation continues to deflate, we like sugar on the short side.  Our levels are outlined below.


Daryl G. Jones

Managing Director


Dead Cat Bounce Aside, the Sugar Market Is In Oversupply - 1

Eye on Earnings: Growth Slows as Inflation Accelerates

Conclusion: Below we use two company-specific data points to illustrate further confirmation of the broader macro theme we authored at the start of the year: Growth Slows as Inflation Accelerates. In addition, we dive into why earnings have disappointed recently and why we expect this trend to continue.


Position: Short US Equities (SPY); Long a US Treasury Curve Flattener (FLAT); Long Long-Term Treasury Bonds (TLT).


McDonald’s: Taking Up Price on the Consumer (Accelerating Inflation)


A couple of weeks ago, MCD beat EPS estimates largely due to an acceleration of comparable store sales, which accelerated on both a one-year and two-year basis. While topline accelerations of this kind are nothing to scoff at, careful analysis by long-time industry veteran Howard Penney (Hedgeye’s Managing Director of Restaurants) shows that roughly 2/3rds of the reported comp acceleration was due to price increases. As such, we question how sustainable such topline growth is over the intermediate-term – a topic we dive into in greater detail below.


Staples: Guiding Down (Slowing Growth)


Trading down roughly (-15%) today, SPLS is the latest poster child for a) why you should never take a corporate CFO’s word for it at the peak or trough of the economic cycle; and b) why financial engineering such as share repurchases and off-balance sheet activity is not a reliable substitute for sustainable earnings growth (we’re short JCP in the Virtual Portfolio as way to express components of this thesis). The company took down its full year EPS guidance by (-10%) and revised down its comp projection to “low single digits” from “low-to-mid single digits” on a downwardly revised economic forecast of “very little improvement in the economy”.


Net-Net: Inflation Deflates Growth


While almost trivial, we think it’s important to remind everyone that Real GDP is adjusted for inflation via the GDP Price Deflator. In 1Q11, a +150bps acceleration in this index helped slow growth to a paltry +1.8% QoQ SAAR vs. +3.1% in 4Q11. Though we’ve seen some pullback in commodities prices as the Great Inflation Trade has started to unwind (Hedge Fund exposure to commodities dropped -15% wk/wk last week), we can be sure that prices on a reported basis will remain both sticky and elevated – at least for the next several months. On a real-adjusted basis, that’s not bullish for reported growth.


Eye on Earnings: Growth Slows as Inflation Accelerates - 1


But What About Earnings?


While earnings do indeed remain the mother’s milk of the stock market, one has to be concerned with the prospect of companies en masse passing through costs increases to a jobless consumer struggling to find any semblance of wage growth.


Eye on Earnings: Growth Slows as Inflation Accelerates - 2


Eye on Earnings: Growth Slows as Inflation Accelerates - 3


While it’s true the market isn’t solely consumer facing, one cannot completely rule out the impact of consumer trends on the overall economy (70% of US GDP is household consumption). Misguided talk about “manufacturing” and “exports” aside, as the consumer goes, so goes the US economy. As such, we confidently contend the consumer matters to earnings at large.


As Brian McGough, our Managing Director of Retail, has pointed out in his recent research, the recent run-up in COGS increases have yet be fully realized on corporate income statements – if at all – due to the predominance of FIFO accounting and the lag time between when raw materials are procured and when the finished product is sold. The coming quarters should make for an interesting test of whether or not corporate America can continue to squeeze the consumer’s wallet, as well as a test of the bulls’ favorite saying when things start to break down: “The US economy is very resilient.”


While the US economy has indeed proven itself quite resilient over the last 230+ years, relative to intermediate-term consensus expectations of +3.3% GDP growth for 2Q and 3Q, our Centrally Planned equity market certainly isn’t resilient enough to handle the impact of Homeless Jobless Stagflation on corporate earnings – particularly as the life support otherwise known as QE2 is removed in six weeks.


We’re short the SPY in anticipation of the equity market’s multiple eventually reflecting economic reality, as opposed to the storytelling of the CFOs of cyclical companies talking bullishly about peak earnings in the rear view at the top of the economic cycle. Interestingly, as Headline Inflation is set to breakout to the upside in the coming months, the price investors are willing to pay for said earnings should begin to breakdown (see table below).


Eye on Earnings: Growth Slows as Inflation Accelerates - 4


The recent beta-shift down into defensive sectors such as Healthcare, Utilities, and Consumer Staples, as well as long-term bonds busting a move out to the upside are not confirming the widespread optimism over the US economy on a go-forward basis.  Earnings will disappoint – perhaps materially – in the coming quarters. In fact, as measured by the spread between the Percentage of S&P 500 Companies Beating Bloomberg Consensus Estimates and those Missing Expectations, earnings have already started to disappoint and we see this trend continuing.


Eye on Earnings: Growth Slows as Inflation Accelerates - 5


Eye on Earnings: Growth Slows as Inflation Accelerates - 6


A Bespoke Investment Group analysis of earnings trends throughout the broader economy tells the same tale of deterioration, with the “beat” ratio of the 2,132 companies they track falling (-700bps) QoQ to 59.5% in 1Q11.


Eye on Earnings: Growth Slows as Inflation Accelerates - 7


Hold the line, bears.


Darius Dale