• run with the bulls

    get your first month

    of hedgeye free


Borrowing Deceit

This note was originally published at 8am on June 02, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Nothing is easier than self deceit.”

-Demosthenes (circa 340 BC)


I’m borrowing that quote from Howard Marks, who borrowed it from Charlie Munger, who borrowed it from Demothesnes (Greek orator from ancient Athens). Borrowing ideas is what people in this business do.


What if I woke up every morning for the last 6 months borrowing the idea that US “growth” was “back” and that there was really nothing in this interconnected world to worry about?


Well, that idea would have been a really bad one to have borrowed. Nothing is easier than borrowing ideas – you have to do a lot less work. Nothing is going to protect your returns when those borrowed ideas turn out to be wrong either.


Howard Marks is a successful Risk Manager who runs $82 Billion (as of December 31, 2010) at Oaktree Capital Management. He borrowed that quote for his recent investment memo to Oaktree clients that was titled “How Quickly They Forget.”


Since Marks’ letter is marked “confidential”, I’ll have to stop on his ideas there, and get back to my own:

  1. GROWTH: US and Global Growth are slowing
  2. INFLATION: reported Global Inflation readings remain sticky and elevated because they are lagging indicators
  3. POLICY: Chinese policy (hawkish) continues to diverge from Fiat Fool policy (USA, Japan) which remains Indefinitely Dovish

Being on the road from Boston to Denver to Kansas City to New York to San Francisco in the last 4 weeks has been very interesting. The further I move in time, the more people seem to be agreeing with me on these Global Macro matters (prices going down do that). I’m in Santa Barbara, CA this morning and I’ll be in LA tonight. I don’t expect this bearish progression to lose momentum.


The #1 question Risk Managers want to know is “how do I make money with that?”


Hedgeye Risk Management’s answer remains:

  1. Don’t lose money (we went into yesterday’s meltdown with 10 LONGS and 12 shorts in the Hedgeye Portfolio)
  2. Buy Long-term US Treasuries (TLT) and a US Treasury Flattener (FLAT)
  3. Buy Gold (GLD)

Oh, did I borrow the only rule Buffett and Munger have signed off on before the 2011 version of buy-the-damn-dips? I think I did. Not losing money is indeed a risk management strategy worth borrowing. Try it at home – or with your client’s money.


The #2 question Risk Managers want to know is “where could your ideas be wrong?”


Hedgeye Risk Management’s answer remains:

  1. The Data – if our scenario analysis on growth and/or inflation change, we will
  2. The Market – if TREND line prices hold, we’ll cover shorts
  3. The Fed – if they legitimately move to QG3, we will resort to prayer

While Borrowing Deceit from the Fed on A) full employment and B) price stability can remain fashionable – it can also become, as Le Bernank likes to say, “transitory.” If the price of your homes and portfolios start going down, that is…


Of course, nothing is easier than waking up telling yourself that earnings were “good” and Le Bernank has your back. Sounds a little too much like Q2 of 2008 for me. “How Quickly They Forget.” (Howard Marks, May 25, 2011)


As for what to do in the very immediate-term, here are some key immediate-term TRADE ranges across Global Macro that we’re rolling with this morning:

  1. SP500 1305-1323 (bearish)
  2. Russell2000 801-828 (bearish)
  3. Nikkei 9257-9722 (bearish)
  4. Shanghai Composite 2669-2811 (bearish)
  5. FTSE 5801-5956 (bearish)
  6. DAX 7067-7344 (bearish)
  7. VIX 16.65-19.04 (bullish)
  8. USD 74.41-75.80 (bullish)
  9. Euro 1.41-1.44 (bearish)
  10. Oil 97.75-102.03 (bearish)
  11. Gold 1522-1549 (bullish)
  12. Copper 4.09-4.29 (bearish)

Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Borrowing Deceit - Chart of the Day


Borrowing Deceit - Virtual Portfolio

Buffett Behavior

“Human behavior, not monetary behavior, is the key…”

-Warren Buffett (May 1977)


“And when very human politicians choose between the next election and the next generation, it’s clear what usually happens.”


That’s clear, Mr. Buffett. Crystal.


I wrote my senior thesis on Warren Buffett while I was banging away on a typewriter here in New Haven, CT almost 15 years ago. Time flies. But history’s lessons don’t.


The aforementioned quotes come from a Fortune article Buffett wrote in May of 1977 titled “How Inflation Swindles The Equity Investor.” This was during the post Arthur Burns (last Fed Chief to attempt to monetize the US Debt) and Richard Nixon period, when Jimmy Carter promised to carry on the dual Fed/Presidential office mandate to attempt to inflate their way to prosperity.


The problem, of course, is that too much inflation slows growth… And Growth Slowing As Inflation Accelerates perpetuates The Jobless Stagflation… And the stock market pays a lower multiple for The Stagflation.


Back to our very human Keynesian politician …


Tonight, Le Bernank will be speaking in Atlanta where he’ll talk around A) cutting his GROWTH forecast and B) raising his INFLATION forecast (again, after the fact). While being a lagging indicator isn’t a new position for the Fed’s Chief, it’s important for Risk Managers to focus on Gaming His Almighty Policy. Across asset classes in the US, here’s how we think the market will respond:

  1. UST Bonds – Indefinitely Dovish (Q2 Macro Theme); upside in long-term bonds to 4.16% on the 30 year yield (immediate-term)
  2. US Stocks – Jobless Stagflation (1-1.5% GDP growth w/ 3.5% headline CPI; markets pay a lower multiple for The Stagflation)
  3. US Dollar – Indefinitely Dovish; should equate to further downside pressure in USD to 73.76 (a higher-low)

My lowest conviction Global Macro position is long USD into and out of this political pandering. I still like long-term bonds (TLT), UST Flattener (FLAT), and Gold (GLD).


On the short side, I covered some shorts yesterday and will look to re-short strength opportunistically today/tomorrow. So far, the best proxy product I can produce to express my risk management view of a traditional hedge fund’s NET EXPOSURE (longs minus shorts) is the LONGS minus SHORTS component of the Hedgeye Virtual Portfolio (chart below).


I know that’s not a perfect proxy, but I also know it’s a lot better than whatever the sell-side is still using to communicate their pre-2008 horse-and-buggy-whip research. With the SP500 being down now for 4 consecutive-days and 6 consecutive weeks, at Hedgeye we called yesterday a “short covering opportunity”, moving from net neutral in the Hedgeye Virtual Portfolio to 13 LONGS and 10 SHORTS.


That doesn’t make me wild and crazy long. It just means that I won’t lose an eyebrow as the machines fire up this morning’s S&P Futures. If you want to survive The Stagflation, you need to manage risk, real-time – and yes, that does include trading.


Managing risk (or trading) around the aforementioned Stock, Bond, and Currency market catalysts isn’t easy. Neither is attempting to justify being long the US Financials (XLF) with “valuation” as your backboard. Valuation isn’t a catalyst when stock prices are falling. The Financials (XLF) are down -13.1% since their YTD high on February 18th, 2011. “Cheap” stocks get cheaper.


In the same 1977 Fortune article, in asking Buffett “why does a man who is gloomy about stocks own so much stock?”… Buffett said: “Partly, it’s a habit…”


He’s partly human too. And “human behavior, not monetary behavior, is the key…”


My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1, $98.46-102.47, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Buffett Behavior - Chart of the Day


Buffett Behavior - Virtual Portfolio

investing ideas

Risk Managed Long Term Investing for Pros

Hedgeye CEO Keith McCullough handpicks the “best of the best” long and short ideas delivered to him by our team of over 30 research analysts across myriad sectors.


MCD will announce sales numbers for May on Wednesday, June 8th, before the market open.  April was a strong month for MCD, with comps comps coming in at 6% on a global basis and +4%, +6.5%, and +6.5% in the U.S, Europe and Asia, respectively.  For the U.S., this print constituted acceleration in two-year trends of approximately 30 basis points (all coming from increased pricing). 


Despite the April U.S. number far outstripping consensus, we are looking for a slowdown in two-year average trends of approximately 70-80 basis points, slightly worse that consensus at 65 basis points.  There was a slight calendar shift between the number of weekdays and weekend days in May 2011 versus May 2010.  May 2011 had one additional Tuesday, and one less Saturday, than May 2010.  I would expect a slight, negative calendar impact on May comps as a result.


Overnight, McDonald’s Japan (35% of the comp base) announced that May same-store sales we 0.9%, which was a significant slowdown from the 3.6% level in April.  I would also note that the BBC is reporting this morning that Australian butchers are reporting a drop in beef sales of 10-15% after ABC broadcast an investigation into animal cruelty in Indonesian abattoirs.  The program featured graphic footage of animals being slashed and whipped.



For the U.S., which remains the most important division for MCD, I remain cautious on the company’s ability to “comp the comps” as we head into the key selling season for beverages and lap the national roll-out of beverages last year. 


Below I go through my take on what numbers will be received by investors as GOOD, BAD, and NEUTRAL, for MCD comps by region.  For comparison purposes, I have adjusted for historical calendar and trading day impacts. 



U.S. – facing a compare of +3.4% (including a calendar shift which impacted results by +0.4% to +0.9%, varying by area of the world).  To keep the beverage sales momentum going, Frozen Strawberry Lemonade was launched in May as compared to the official National rollout of Frappes was in May 2010.  I’m looking for the USA to come in at +3%, between the “neutral” and “bad” ranges outlined below.


GOOD: A print above 4% would be perceived as a good result, implying two-year average trends roughly 20 basis points below those seen in April.  Depending on the magnitude of any negative impact that may result from the aforementioned calendar shift in May, the calendar-adjusted two-year average trend from a 4% one-year print could even accelerate from April’s level.


NEUTRAL: A print between 3% and 4% would be received as neutral by investors, given that expectations are for a softer month than in April.  However, I would weight this range to the higher end; the lower quartile of this range would likely raise some questions after the April sales results went a long way toward reassuring investors of the viability of MCD on the long side.


BAD: A print below 3% would imply a significant sequential deceleration in monthly two-year average trends.  As the economic data has shaken investor confidence of late, it will be interesting to see how MCD fares following the release of April sales.  Historically, MCD has been a value destination for consumers and I have no doubt it will remain so, but the effect could be diluted by the compelling value being offered at other concepts within quick service and casual dining.


MCD: MAY SALES PREVIEW - mcd sales chart



Europe – facing a compare of +5.7% (including a calendar shift which impacted results by +0.4% to +0.9%, varying by area of the world).  It was reported that the Eurozone April Retail sales rose +1.1% y/y vs consensus 0.0% and prior (1.7%); Eurozone April Retail sales +0.9% m/m vs consensus 0.4% and prior revised to (0.9%) from (1.0%).


GOOD:  A print of 4% or higher in Europe would be received as a good result as it would imply two-year trends that had slightly retreated from the levels seen in April, which were very robust compared to recent months. The skyward trajectory of the Icon Germany Consumer Confidence Indicator Index was arrested at the end of 2010 and has declined through April.  In addition, Germany Manufacturing PMI plummeted in April causing, along with several other factors, Hedgeye’s macro team to lose some confidence in its long position via the EWG ETF in the Hedgeye Virtual Portfolio.


NEUTRAL:  Between 3.5% and 4% would be received as a neutral result by investors.  While the result would imply a slow-down in two-year average trends, the two year trend would remain strong, continuing the departure from the softer two-year trends from the end of 2010 and maintaining the strong performance in Europe year-to-date.  Some degree of a slowdown, I think, is expected given the ongoing political and economic turmoil in the Eurozone.


BAD:  Below 3.5% would not be received well by investors as it would imply a significant sequential decline in two-year average trends.   The Europe number will likely be watched closely given the political events there of late and, it is also important to note, the E Coli situation on the continent is likely to impact consumer behavior to a degree.  Should a meaningful slowdown have taken place in May, investors may lose a degree of faith in MCD’s prospects in June with the E Coli scare taking hold.



APMEA - facing a compare of +5.7% (including a calendar shift which impacted results by +0.4% to +0.9%, varying by area of the world):


GOOD:  Above 5% will be received as a strong print despite the fact that it would imply a slowdown in two-year average trends of almost 100 basis points.  Nevertheless, the trend would be strong and it would also constitute a second consecutive month of strong growth after the disappointment of March.


NEUTRAL: Between 4% and 5% would be received as a neutral number.


BAD:  Less than 4% would imply a sharp fall off in two-year average trends and would be received poorly by investors.



Howard Penney

Managing Director


CNBC VIDEO: Hostile Takeover Bid for Temple-Inland

get free cartoon of the day!

Start receiving Hedgeye's Cartoon of the Day, an exclusive and humourous take on the market and the economy, delivered every morning to your inbox

By joining our email marketing list you agree to receive marketing emails from Hedgeye. You may unsubscribe at any time by clicking the unsubscribe link in one of the emails.