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New Start

“If we are to build a better world, we must have the courage to make a new start.”

-F.A. Hayek


Last week I received a tremendous amount of positive feedback on my note titled “American Optimism.” So I’d like to start this week off by thanking you for inspiring me. I am very bullish on the prospects of building a better world – I am very bullish on change.


Interestingly, but not surprisingly, Hayek wrote the aforementioned quote in the concluding chapter of “The Road To Serfdom” (page 237) in 1944. His summary thought stood in the face of British-style Keynesianism that had dominated the economic theory of his time.


What was Keynes’ response to Hayek’s conclusions?


Bruce Caldwell (who edited the most recent edition of “The Road To Serfdom”) captures the moment best in his Introduction:


“John Maynard Keynes read the book on the way to the Bretton Woods conference, and delighted Hayek when he wrote him that it was “a grand book” and that “morally and philosophically I find myself in agreement with the whole of it; and not only in agreement with it, but in a deeply moved agreement.” (Letter, John Maynard Keyens to Hayek, June 28, 1944)


Alrighty then – we have a consensus!


Last week, the most bullish week-over-week moves in all of Global Macro came right where I think the prospects for change are going to be measured – in the real-time price of the US Dollar Index.


I’m not so concerned about US stocks being down for 6 consecutive weeks when it’s crystal clear that Growth Slows As Inflation Accelerates. What I need to see change (to get bullish on stocks) is a Deflating of The Inflation (Hedgeye Q2 Macro Theme).


With the US Dollar Index UP a full +2% last week to $75.60, here’s what happened to things priced in US Dollars:

  1. US Stocks = DOWN -2.3%
  2. WTI Crude Oil = DOWN -0.9%
  3. Copper = DOWN -1.4%

Le Mucker’s SERIES 66 TEST QUESTION: Which of those 3 things matters most to the US Economy?

  1. La Bernank says stocks
  2. Le Consumer says gas prices
  3. Le Industrialist says cost pressures

I’ll go with #2 and #3.


If you want a New Start in this country you have to see a Deflating of The Inflation. Otherwise you’ll continue to see a slowdown in 70% of US GDP (Consumption) and margin compression at the companies who are supposed to employ these consumers.


The Stagflation is not hard to understand (Growth Slowing below the rate of Inflation). It just isn’t palatable for the Keynesian Kingdom to accept responsibility for it. That would be called holding themselves accountable.


Until I start seeing data that implies that both of these things are occurring at the same time:

  1. Growth is slowing at a decelerating rate
  2. Inflation is accelerating at a decelerating rate

Why would I stop protecting my family’s hard-earned wealth?


Being in Cash in 2011 has obviously beaten 48 of the country stock markets in the Hedgeye Global Macro Stock Market Index for the YTD (there are 66 country indices in our Index). And, depending on where you bought them (or what index you are in – both the Nasdaq and Russell 2000 are DOWN for 2011 YTD), the +1% YTD return in the SP500 has been slim pickings!


Here’s how the Hedgeye Asset Allocation Model was positioned going into and out of Friday’s US equity market swoon:

  1. Cash = 52% (UP +3% week-over-week after selling ½ our US Equity Allocation on mid-week strength)
  2. International Currencies = 21% (Chinese Yuan and US Dollar – CYB and UUP)
  3. Fixed Income = 18% (Long-term UST Bonds and US Treasury Flattener – TLT and FLAT)
  4. Commodities = 3% (Gold – GLD)
  5. US Equities = 3% (US Healthcare – XLV)
  6. International Equities = 3% (Germany – EWG)

And no, being in 52% Cash wasn’t enough!


On a week-over-week basis, I lost money in 4 of 6 of these asset allocation positions:

  1. US Dollar (UUP) = +1.5%
  2. Long-term Treasuries (TLT) = +0.8%
  3. Chinese Yuan (CYB) = -0.4%
  4. Gold (GLD) = -0.7%
  5. Healthcare (XLV) = -1.1%
  6. Germany (EWG) = -2.7%

It’s a good thing I have shorts – and there’s plenty to be optimistic about on that front. There’s always risk to be managed somewhere.


My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1, $98.60-100.45, and 1, respectively.


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


New Start - Chart of the Day


New Start - Virtual Portfolio

The Week Ahead

The Economic Data calendar for the week of the 13th of June through the 17th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.


The Week Ahead - ca1

The Week Ahead - ca2

Gravity Weighs on Korea

Conclusion: We see more selling pressure in the Kospi’s intermediate-term future, as the balance of earnings risk is skewed to the downside alongside the gravitational pull of mean reversion. Furthermore, the Bank of Korea will likely be more hawkish than is currently anticipated by consensus.


Today, the market didn’t like the Bank of Korea’s vigilance regarding its “war on inflation” (as proclaimed by president Lee Myung Bak in January). The latest +25bps move is the third rate hike YTD and brings the country’s real benchmark interest rate to -0.85%. While the recent slope of real rates is a noteworthy positive, we can’t help but callout the fact that Korean real rates (adjusted for inflation) have been in negative territory since November ’09. And while negative real rates have indeed been stimulative to Korean economic growth over the past couple of years, we can’t help but callout their negative impact on the future slope of growth in Korea – also negative.


Gravity Weighs on Korea - 1


Both Korea’s equity and bond market agree with our stance; the Kospi Index is now broken on an immediate-term TRADE and intermediate-term TREND perspective and Korea’s sovereign bond 10Y-2Y spread has narrowed -49bps YTD:


Gravity Weighs on Korea - 2


Gravity Weighs on Korea - 3


It seems that Global Macro is akin to real life in the sense that one cannot get something for nothing. What we mean by this is that Korea’s loose monetary policy has been bullish for domestic inflation readings and we expect Korea’s CPI to continue to accelerate on a YoY basis over the next 3-6 months – particularly its core inflation index. This will force the Bank of Korea to continue to tighten monetary policy – a direct blow to economic growth in the ~70% consumption-based economy (~55% Household; ~15% Government). Moreover, higher interest rates will weigh on private consumption going forward as servicing costs for an all-time high household debt burden of 801.4 trillion won ($740 billion; equivalent to 155.4% of disposable income) creep up.


Our view that the Bank of Korea will continue to remain hawkish over the intermediate term is divergent with current consensus expectations of only one more rate hike in 2011 to 3.5% (Bloomberg). We like being contrarian here, as the Bank of Korea has recently signaled that they’re on our side of the fence insomuch that they will look past slowing growth to continue on its path of interest rate normalization:


“The committee will conduct monetary policy with a greater emphasis on ensuring that the basis for price stability is firmly anchored while the economy continues its sound growth… Despite the temporary sluggishness of domestic demand, the economy has maintained its underlying upward trend.”

-Bank of Korea Governor Kim Choong Soo; June 10, 2011


Soo also said on May 18th that the Bank of Korea will continue to boost borrowing costs at its own pace and that the nation needs to be wary of an inflation spiral.


“Inflation spiral” and “sluggishness of domestic demand” isn’t exactly what investors in Korean equities want to be hearing out of the Korean central bank chief following a 26-month doubling of the Kospi Index. While the former is much less probable at the current juncture, that doesn’t change the fact that the latter is a real and present danger to Korean corporate earnings. As such, we see more selling pressure in the Kospi’s intermediate-term future. While Korea has been a darling over the last year (up +23.9% YoY), the balance of earnings risk is skewed to the downside alongside the gravitational pull of mean reversion.


Darius Dale


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In short, David Overton’s philosophy on pricing is to take it – whether you need it or not.


Specifically, yesterday he said “We found that if we just keep going up a little bit all the time, whether you need it or not, when times like this come (read significant food inflation), you're not behind the eight ball. And you don't have to have a 3% or 4% price increase.”  So, in short, the company does not think a price hike 1%-1.5% will impact consumer behavior in today’s uncertain environment.  While I can see his point, the concept must maintain its relative value over time.


What about the cumulative effects of price hikes?  The chart below shows just how much pricing cake has taken since 2007, on a consistent basis, and we overlaid the implied traffic/mix trends implied by the reported same-stores sales trends.  Looking at the chart, it’s clear that traffic/mix has declined over the past three years.  Particularly during the latter part of 2008 and in 2009, when food costs were down year-over-year and economic woes elevated the importance of relative value, CAKE experiences a precipitous decline in traffic/mix.  Clearly, we cannot conclude that that was caused entirely by the price increase but it is possible that these persistent increases – when they are not “needed” – are hurting the traffic/mix trends.  The recurring average check problem that has hampered CAKE’s top-line is a direct message from the consumer that the continuous increases in price can take the price-point to a beyond what they are willing to pay.


The history of the Cheesecake Factory is quintessentially American, it is a great concept and – on a personal level – I’m looking forward the opening of the company’s new store in the Short Hills Mall, right in my back yard.  An important component of the bull case for the stock is the ability of the company to improve average unit volumes through increased customer counts.  Currently, CAKE is producing average unit volumes of ~$9.7 million versus $11 million a few years back.


Clearly the Great Recession has impacted the concepts guest counts, but to what degree will the company be able to win back lapsed users and potential increase frequency from the core customer base?  More importantly, when are they going to visit the store?  One sign of the health of the concept is the fact that the restaurant is busy during peak meal times and generally operates with customers waiting to be seated.  In the past, CAKE has never been a “comp story” for just that reason; it’s very difficult to push more people through the peak meal periods.  Management is focusing on “shoulder” periods in an effort through get more people through the door.  Happy hour was a factor in the recent improvement in guest traffic.


What are the long-term implications of management’s pricing philosophy and the ability to attract new consumers?  Will they only come in for the latest deal at “happy hour”, or the small plates menu, which implies that the consumer likes the concept – just at a lower price?


In the current environment, with pump prices still high, many commodities and food prices still rising, and the unemployment picture still uninspiring, economic sentiment remains stagnant and consumer spending and confidence is challenged.  The debate about menu pricing and the ongoing impact on consumer behavior will continue for some time. 


CAKE - MANAGING ATTRITION - cake price traffic mix 07



Howard Penney

Managing Director

R3: GPS, UA, FDO, & Newton



June 10, 2011



Between a capital infusion at a private player (Newton) and UA stepping up its game, expect continued innovation out of the running category.





  • While management at GPS reiterated that cost increases at Banana would be up MSD at most, they were considerably less specific regarding the increases at Old Navy and the outlet business. As the primary drivers of average AURs up over 20% in the 2H, it is concerning to hear that management is still ‘working over the business’ to  manage cost.
  • Among the new products showcased at UA’s investment day, one of the highlights was the company’s new ChargeRC lightweight running shoe. Not only is UA entering this booming sub-category, but more importantly this shoe is a solid effort in establishing the brand as a technical player instead of simply a big box discount offering. At a project $120 ASP, the ChargeRC is also likely to provide a healthy boost to gross margins. (take a look)
  • On the heels of opening its second stand alone men’s store in Boston last week, COH attempted to frame the men’s opportunity by region. In China, men’s represents 40% of the luxury spend on accessories, Japan 15%-20%, and in the U.S. only 10%-15%. By contrast, men’s accounted for only 3% of COH’s total global sales in 2010. As such, we can expect to see an increase in ‘dual gender’ stores from Coach as well as additional stand alone stores – viva la manbag!
  • Here’s a calendar shift worth noting, unique wedding dates driven demand in Q3. Management of MW noted that in years past, wedding dates such as 7/7/7 and 10/10/10 have driven a surge in wedding demand and it expects a similar effect on 9/10/11 to the tune of $0.03-$0.04 in EPS.  Who would have thought that unique/novelty wedding dates could have such an impact?





Paul Fireman Invests in Newton Running - Five years after selling Reebok to Adidas for $3.8 billion, Paul Fireman's private-equity firm is backing Newton Running Co., the Boulder, CO. maker of "natural" running shoes. Boston-based Fireman Capital Partners has invested between $10 million and $20 million in the 4-year-old company, managing general partner Dan Fireman told the Boston Herald. It's the sixth investment by the firm, whose portfolio also includes Hudson Jeans, Evolution Fresh, Serena & Lily, IdeaPaint and Pilla. "We're going to have a significant stake," Fireman told the newspaper, adding that both he and his father will be very active in Newton Running. "We'll have influence over the company, its direction and operations. It's great when you can take those skill sets that you've learned and done for years and apply them to a company that you really understand." <SportsOneSource>

Hedgeye Retail’s Take: Fireman may have been a lousy CEO – a REALLY lousy one… But he’s a much more astute investor. Remember that he’s the one who bought rights for the Reebok Brand in the US back in the 1980s in conjunction with the ‘Flashdance’ phenom as well as the NYC transit strike during which women walked to work.  The most recent investment in Newton Running is a superb investment (McGough’s opinion). Check out the product. It is revolutionary. High priced and worth it.


Old Navy Goes After Men in New Ad Push - Old Navy is looking to enlist a few good men. The retailer is launching its first campaign specifically targeting men this Thursday. It has appealed to guys in the past through its broad family-focused advertising, said Amy Curtis-McIntyre, senior-VP marketing. But now Old Navy is intent on speaking directly to "Mike," it's 25- to 35-year-old target. "We've made a lot of changes to our assortment, and we really want to ignite a conversation with that male target," Ms. Curtis-McIntyre said. "It's a big piece of business, and it's time to speak directly to Mike and not just through his girlfriend, wife or sister." Ms. Curtis-McIntyre said the men's product has gone through significant changes in recent seasons, with the addition of new denim washes and styles, as well as the addition of more tailored shirts and pants. <AdAge>

Hedgeye Retail’s Take:  Hey, you can’t blame them. The only downside for Old Navy is that they do nothing and continue to underperform the industry. They need to take more risk – or at least as much risk as the company’s sheer size can stomach.


Ackman becomes Family Dollar's Biggest Holder - Hedge fund manager William Ackman disclosed Thursday that he recently boosted his ownership of Family Dollar Stores Inc. by about 5 million shares, making his Pershing Square Capital Management the largest shareholder of the discount retailer. The move takes his stake to 10.9 million shares, or 8.9% of Family Dollar, and comes on top of a disclosure last month, when he reported the 5.8-million-share position he built during the first quarter. He made that disclosure— a day after publicly praising the stock at a hedge-fund conference—in an amended Securities and Exchange Commission filing for which he had previously requested and received permission to keep some holdings confidential. Billionaire Nelson Peltz and his Trian Fund Management LP had been the largest holder of Family Dollar, with a roughly 6.5% stake. Trian in February offered to buy the rest of Family Dollar for $55 to $60 a share. The company rejected the offer. <WallstreetJournal>

Hedgeye Retail’s Take:  Billy’s stake in FDO stands at about $571mm. A huge number in itself. But it’s still half of the $1.2bn he owns of JC Penney. Both companies would be better off without him.


Tory Burch Wins $164M in Cybersquatting Suit - Tory Burch LLC has scored another major designer victory against online counterfeiters — a $164 million one at that.  A New York federal court has awarded the fashion firm damages in that amount against hundreds of operators of Web sites selling fake Tory Burch Reva ballet flats and other footwear, handbags and accessories. While Burch has almost no chance of getting the money from the sites, the award is believed to be the largest sum of damages ever issued to a fashion firm in the ongoing battle against online counterfeiters. In addition to monetary damages, the court ordered that 232 domain names used to sell Tory Burch fakes be permanently disabled and turned over to the New York-based fashion label. The ruling, delivered last month, also allows the brand to disable any additional offending sites created by the defendants in the future without needing a new lawsuit. <WWD>

Hedgeye Retail’s Take: Even though most Wall Streeters could care less about Tory Burch (even though it is a solid brand that will be bought by a bigger company at some point), this ruling is substantive. The monetary reward, as the article points out, is immaterial. It may as well be $1trillion. Tory won’t see a dime. But the closure of distribution for knock-offs is a solid precedent for all.


LIDS Sports Group Buys Buckeye Corner Stores - LIDS Sports Group has acquired Buckeye Corner stores, which operate in the Columbus, OH area. The acquisition is made up of four store locations, the e-commerce website www.buckeyecorner.com, and a catalog business. Terms of the acquisition were not disclosed. A retailer specializing in the sale of officially licensed sports headwear, apparel, accessories, and novelties since 1980, Buckeye Corner has been the official retail partner of The Ohio State University Alumni Association, Inc. since 2004. Buckeye Corner now operates within the LIDS Clubhouse division of LIDS Sports Group. LIDS Clubhouse operates more than 20 team-specific professional sports and university athletics retail stores and e-commerce websites. "Buckeye Corner, serving one of the largest and most passionate fan bases in all of college athletics, is a marvelous addition to the LIDS Clubhouse team, and represents the latest example of LIDS Sports Group's commitment to sports fans to be the premier specialty sports retailer in the country," said Ken Kocher, president of LIDS Sports Group. Buckeye Corner store locations include Easton Town Center, Polaris Lifestyle Center and Northwest Square in Columbus, and Lane Center in Upper Arlington, Ohio. LIDS also currently operates five headwear specialty retail stores around Columbus, 32 stores across Ohio, and more than 975 stores across North America. <SportsOneSource>

Hedgeye Retail’s Take: This is the ultimate specialty specialty concept.  Not material at all. But interesting that they’d go to such a niche market.


Customs Seizes Chinese Shipment of Fake Designer Gear - Federal authorities recently seized three Chinese shipments of fake designer clothes that could have sold for $14.3 million, U.S. Customs and Border Protection officials said Wednesday.  More than 47,000 pieces of clothing violating trademark labels of designers Chanel, Polo, Gucci, Coogi and Dior were discovered inside cargo containers shipped in March, April and May to the Los Angeles/Long Beach seaports, said CBP spokesman Jaime Ruiz. <MercuryNews>

Hedgeye Retail’s Take:  Not all lbrands are as fortunate as Tory Burch.



To Be Bearish: SP500 Levels, Refreshed



To be, or not to be bearish – remains the question.


Clearly, with Growth Slowing As Reported Inflation Remains Sticky, Global Equity markets are putting a lower-multiple on The Stagflation; particularly US style Jobless Stagflation – and this morning’s y/y rise in US Import Prices is simply just another reminder of that.


In the chart below we show lower-lows of immediate-term TRADE support (1257), and no long-term support  all the way down to 1219 (our long-term TAIL of support), which would be a -10.6% drawdown from the April YTD high (1363).


While some are hoping that the 200-day moving average saves this selloff from moving to 7 consecutive weeks, we’d remind Risk Managers that hope is not a risk management process.


I remain very optimistic about the future of America – particularly as this failure of Keynesian common sense gives way to changes in leadership and economic resolve.



Keith R. McCullough
Chief Executive Officer


To Be Bearish: SP500 Levels, Refreshed - 1

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