This note was originally published at 8am on May 27, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Governments everywhere are still trying to cure by public works the unemployment brought about by their own policies.”

-Henry Hazlitt (Economics In One Lesson, page 208)


I suppose it’s only fitting that Henry Hazlitt revised his million-plus copies sold of “Economics In One Lesson” in June of 1978 (originally penned in 1946). That’s when the Western world was swallowing stagflation whole. That was shortly after the French introduced the G-Fluff.


G-Fluff, formerly known as the G-6 Central Planning Board (created by France in 1975), is now affectionately referred to by professional politicians as the G-8.


The G stands for Groupthink. The G-8 currently consists of Canada, France, Germany, Italy, Japan, Russia, United Kingdom, and the United States. Not to be outdone, The EU also sends their commissioners for 3 hour lunches that serve up piping hot bs, with broccoli.


This year’s G-Fluff conference is being held in a hoity-toity town on the northwestern coastline de la belle Provence. Les Obamas et les Sarkozys (hearing there may be more than a few of them – with adjoining rooms)… La rencontre… et la culture… sans le DSK.


BREAKING HEADLINE (out of the G-8 conference this morning):




Mais, qu’est-ce que c’est Le Recovery? Que’est-ce qui se passe avec Le Downside?


(Before someone goes all French socialist on me – for the record, my Mom’s side of the family is French-Canadian, and I went to French school until the 5th grade, learning how to read, write, and count in French before the English pig stuff.)


Back to Le Recovery et Le Downside


In Spain the socialists are running a 21.3% unemployment rate, so let’s not talk about that outcome of le debt financing les deficits – Spain isn’t allowed at the G-Fluff conference anyway.


Let’s talk about le USA.

  1. Yesterdays US jobless claims report rose 15,000 week-over-week to 424,000
  2. Ze rolling claim (the 4-week moving average) held at 439,000 – a new YTD high!

When considered on 1 of the 2 key measures of le success of Le Bernank (1. Full Employment, 2. Price stability), this is not good. Actually, it’s really bad – because our math suggests that for the unemployment rate in this country to recover, we’ll need to see weekly jobless claims consistently below 385,000.


Le Bernank et L’Obama get this. That’s why Le Bernank’s key statement less than a month ago at his Presser was:


“It’s not clear that we can get substantial improvements in payrolls without some additional inflation risk.”

-Ben Bernanke, April 27, 2011


In other words, without Le Quantitative Guessing (and ze Inflation born out of it) – we do not know what to do.


May I suggest two eggs, side by each, pour ton fluffy dejeuner Madame Obama?


This entire Keynesian experiment and my mockery of it is a much more serious joke than I can muster this morning. For the last 6 months Hedgeye has been warning that a policy to inflate will structurally impair (slow) economic growth.


I’m actually getting tired of hammering my hockey knuckles into my keyboard every morning – as de French-Canadian goalie from “Slapshot”, Dennis Lemieux, might say – SLOW-z… SLOW-zzz – de Inflation slow-ZZZ de growth!


Back to the Global Macro Grind


The US Treasury Bond market is busting a move to the upside again this morning. US Treasury Bond yields are getting crushed. The 2-year is trading at 0.48% and 10’s are testing a breakdown of the 3% line. The Yield Spread (2-year yields minus 10’s) continues to compress (+258 basis points wide, down another 6 basis points week-over-week).


What does this mean?

  1. Growth expectations are slowing
  2. Inflation expectations are slowing

We call this Deflating The Inflation (Hedgeye Q2 Macro Theme), and we can send you the 50 page slide deck on how it works. The two long positions we have on to reflect this view are bullish on the long-end of the bond market (TLT) and long a US Treasury Flattener (FLAT).


Yes, we are aware that Le Bernank has to end le QG2 in 6 weeks. We are also aware that when this unprecedented Keynesian experiment ends, jobless claims in America could go a lot higher. I don’t have to wonder what Henry Hazlitt would say about that in June 2011.


My immediate-term ranges of support and resistance for Gold, Oil, and the SP500 are now $1511-1538, $96.89-101.57, and 1310-1328, respectively.


Have a great Memorial Day weekend. God Bless America. And best of luck out there today,



Keith R. McCullough
Chief Executive Officer


G-Fluff - UST Yield


G-Fluff - port2


A stock in need of a catalyst.



While most regional gaming operator stocks are sitting close to their 3 year highs, ISLE is not.  In fact, ISLE is 23% off its 2011 peak.  With concerns about flooding and gas prices, this is a stock in need of a catalyst.  A solid earnings report might just do the trick.


We’ve been a big fan of regional gaming operators for a couple of months now but have emphasized the higher quality names such as ASCA and PNK.  However, a rising tide (pun intended) lifts all boats, and ISLE should benefit from better regional gaming trends as well.  Trading at 7x forward EV/EBITDA, the ISLE boat needs a jump start.


We are projecting FQ4 (April) EPS and EBITDA of $0.29 and $63.3 million, 19% and 6% above consensus, respectively.  Q1 FY2012 will likely be messy due to flooding related property closings and business interruption insurance but underlying May fundamentals were decent.  We expect management to make that clear on the conference call.


Notable news items and price action from the restaurant space including our fundamental view on select names.

  • RRGB is to test a smaller restaurant prototype.  RRGB’s regular store size is approximately 5,600 square feet; the area of the smaller prototype will be between 2,000 and 4,000 square feet.  d CHUX gained on accelerating volume.
  • DIN has entered into an asset purchase agreement with Apple American Group LLC for the sale of 66 Applebee’s company restaurants located in Massachusetts, New Hampshire, Rhode Island, Vermont, and New York.   The transaction is expected to result in proceeds of $49 after taxes.
  • PFCB has signed an agreement with Alsea to develop 17 restaurants in Argentina, Chile and Colombia in the next 10 years.
  • The tender offer to acquire MSSR has been extended by Tilman Fertitta until July 29, 2011.
  • RT cut to “Neutral” at SunTrust Robinson.
  • TXRH raised to “Buy” at SunTrust Robinson.
  • JACK raised to “Buy” at SunTrust Robinson.
  • AFCE gained 3.9% on accelerating volume.  WEN, JACK, RUTH, BJRI, and TXRH also gained on accelerating volume.




Howard Penney

Managing Director


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Debt ceiling posturing will lead to more market volatility


Now that 1Q11 earnings are well and truly in the rear-view mirror, the resounding message from management teams is that commodity costs are set to weigh on earnings over the next couple of quarters.  While commodities took a brief pause in May overall, the direction last week was generally to the upside.  Chicken costs remain low on a year-over-year basis, with wing prices declining 1.3% week-over-week while corn prices also declined slightly over the week.







Cheese prices outperformed strongly last week as higher feed costs are squeezing dairy profitability to its worse levels since the summer of 2009, according to USDA data.  2009 was the worst year in the dairy industry since the Great Depression.  While wheat and corn did decline week-over-week, price levels remain extremely elevated versus year-ago levels.  The gain in cheese prices is a negative for DPZ, PZZA, and YUM’s Pizza Hut.  While DPZ has cheese prices has a contract that eliminates one third of the cheese market volatility, the current trajectory of cheese prices is negative for restaurant operating margins.  Below is some commentary on cheese prices from management teams:


JACK (5.19.11):  Cheese accounts for 6% of our spend and we continue to expect a 15% increase for the year.


CMG (4.20.11): As we move into 2011, we’re expanding our use of cheese and sour cream made with milk from cows


CPKI (5.5.11): I’m estimating it’ll be around $1.80 on a go-forward basis, probably for the back-end of the year.


DPZ (5.5.11): But we've got a lot of things locked in through the end of the year. And really the one to watch as always is cheese and our best bet right now is that it's going to stay relatively close to where it is right now but cheese is the one that often gives the biggest surprises either up or down and that's the one to kind of watch but assuming cheese stays relatively flat from here on out then, the absolute food costs from – through the rest of the year are probably going to stay pretty consistent with where they were in Q1 which to your point means the percentage year-over-year increase will probably ease a little bit over the course of the year.


PZZA (5.4.11):  We've got $1.70 or so built in for our full year cheese price. 


CAKE (4.20.11): We expect to have slightly lower fresh fish costs, slightly lower cheese prices, than last year.







Beef prices are front and center for QSR companies as we head into summer.  Increased traffic on the interstate should yield seasonally higher traffic for most QSR chains but, with gas prices elevated, the challenge facing management teams is meeting customers’ value demands while maintaining margins.  WEN hiked its commodity guidance for 2011 to 5% to 6% from 2% to 3% largely due to higher beef prices.  Elevated grain prices continue to point to higher meat costs as demand remains strong.  Below is some commentary on beef prices from management teams:


JACK (5.19.11):  Beef accounts for more than 20% of our spend and is the biggest factor driving the change in our guidance.  For the full year, we are now anticipating beef cost to be up nearly 14% versus our previous expectation of 9% inflation. We expect beef cost to be up approximately 14% to 15% in the third quarter. Our third quarter forecast for beef 90s, in the low $2 per pound range and for beef 50s, we expect prices to average in the $0.95 to $1.05 per pound range in Q3.


WEN (5.10.11): Beef accounts for more than 20% of our spend and is the biggest factor driving the change in our guidance.


TXRH (5.2.11): Right now, we've got just over 65% to 70% of our commodities are locked for this year and that includes some floors and ceilings on certain commodities and, within that, 90% of our beef is locked and we've also got some floor and ceiling arrangements on some of our beef tips.





Chicken Wings

Chicken wing prices declined again last week, spelling good news for BWLD.  Excluding chicken (wings and broilers), the commodities in our monitor are up almost 43% YTD.  Chicken wing costs are down 38% YTD.





Howard Penney

Managing Director

European Risk Monitor: All Eyes On Greece

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


As we’ve been calling out in our European work, headline risk has been hot and heavy in recent weeks in European capital markets as European leaders and market participants sift through solutions for and the implications of Greece’s fiscal imbalances.  Comments yesterday from Eurogroup head Jean-Claude Juncker that a total restructuring of Greece’s debt is out of the question and that EU leaders will decide on a new aid package for Greece by the end of June bulled up equity markets today (Greece’s Athex closed up +6%), boosted the EUR-USD, and depressed peripheral bond yields and CDS spreads (see charts below).


European Risk Monitor: All Eyes On Greece - b1


European Risk Monitor: All Eyes On Greece - b2


We remain grounded in our position that EU officials will continue to socialize the region’s fiscal ills in order to preserve the Eurozone, support the common currency, and limit cross-country banking exposure losses by granting additional bailout packages and potentially moderating the yield and/or maturity demanded on debt repayments to the bailout facilities by the periphery, a form of “soft” restructuring.


In any case, while we think that these support measures and subsidies could potentially bolster European markets and the common currency over the near to intermediate term, longer term fiscal health will not be attained unless a country like Greece is allowed to default and other peripherals are forced to adhere to their deficit reduction targets without concessions.


For now, given that EU leadership is content with a policy on debt of Extend and Pretend, our models suggest the EUR-USD has an immediate term TRADE range of $1.41-1.44, with a significant intermediate term TREND support level at $1.41. Should $1.41 break, we see a roughly 4% downside to $1.35 (See chart below).


European Risk Monitor: All Eyes On Greece - B3


Given Juncker’s statements yesterday and announcements last week from the Greek government of a fifth austerity package, including selling €50 billion of state assets over the next 3 years to help pay down its bloated deficit, the region could see mild respite over the next days and weeks. However, we caution on the precarious nature of headline risk. Just late last week Juncker was insinuating that Greece may not receive the IMF’s next bailout tranche, which sent markets tumbling!


As is typical for the start of the week, below we show our European Financials CDS Monitor. It shows that bank swaps in Europe widened for 34 of the 38 banks monitored week-over-week, while 4 tightened (see below). No big surprises here.


We’re currently short Spain via the etf EWP and long Germany (EWG) in the Hedgeye Virtual Portfolio. Spain’s fundamentals continue to be overshadowed by political uncertainty (Zapatero’s party lost major support in recent elections), ragingly high unemployment (20.7%), the persistent slide in housing prices, and in our assessment a high probability that Spain misses its deficit reduction target, which currently stands at 9.3% of GDP.


On the margin, and despite positive data out of Germany today (Retail Sales +3.6% in April Y/Y and Unemployment down 10bps to 7.0%), we're less bullish on Germany as the high frequency data has slowed in recent months and the Euro region remains mired in sovereign debt contagion.


Be vigil or steer clear,


Matthew Hedrick



European Risk Monitor: All Eyes On Greece - b4

European Risk Monitor: All Eyes On Greece - b5

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