Claims Drop 13k, Remain Flat on a Rolling Basis

Initial claims fell 13k last week, dropping to 414k.  The 4-week average was unchanged, and claims remain higher than they were at the beginning of the year.  We show below initial claims with the S&P and XLF.  Over the last several years, the indices have climbed when claims are dropping, and held flat or pulled back when claims stagnate or rise.  The tight correlation between market performance and Federal Reserve purchases is ominous heading into the end of QE2.















2-10 Spread 

We track the 2-10 spread as a proxy for NIM.  Thus far the spread in 2Q is tracking 11 bps tighter than in 1Q.  This week's spread level of 259 bps compares to 257 bps last week.  






Financials Subsector Performance

The chart below shows the price performance of subsectors over four durations.




Joshua Steiner, CFA


Allison Kaptur


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

  • SBUX is broadening consumer access to mobile payment with the launch of a Starbucks for Android app.
  • SBUX is shifting its source of milk for its NYC stores from Elmhurst Dairy in Queens to a non-union plant out of the City by the end of this week.  The decision has been met with strong opposition in the City with elected officials and workers claiming that the move will cost 700 people their jobs.
  • DIN was upgraded to Overweight from Neutral at JP Morgan. 
  • The space outperformed yesterday with BAGL, SONC and WEN the standouts.  We would use this strength to pare back positions and even increase short exposure where appropriate.
  • The UN Food Price Index is 20% higher than the level it was at during the 2008 crisis levels.  The vast majority of global respondents to a survey by international aid agency Oxfam said they are no longer eating the same kind of food they did two years ago. 




Howard Penney

Managing Director

PSS: Draconian



The bottom line is that the liklihood for this company to look materially different -- in 6-12 months -- perhaps smaller, but more profitable and less levered, is quite high. Though we still have lease accretion/dilution math to crunch, in looking through the decision tree, we don't see how the recent turn of events can be viewed as anything but positive. 


After the last quarter, we expected draconian change at PSS. We simply did not think that Matt Rubel leaving would be it.


The circumstances were pretty clear to us. Matt has his plan, and wanted to make certain moves in the wake of the company's performance over the past year. But the Board felt differently. Our sense is that the Board was looking for more draconian change, rather than tweaks to the strategy. 


The last thing that Matt wants, or needs, is being at odds with the Board of his Company. Let's face it...he's a pretty strong personality.


We've been pretty adamant that at his age (53) he has at least another job left in him. We thought that he'd capitalize on that AFTER a meaningful rebound in the stock. But with a $10mm peck on the cheek on the way out, it definitely helps ease the pain.


Our strong sense is that he'll relax for a few months, and will be picked off to run a company that is not so limited in growth potential.


One thing we'll give the Board credit for is not sitting idle while the stock so grossly underperformed. We were not privy to the the precise discussions behind closed doors, but at least the Board asked the right questions. The result is clear. This happened after only 6 quarters of meaningful underperformance. Maybe I was numbed by the pain of seeing Boards like Liz Claiborne sit there with blinders on through 17 quarters of Chinese water torture.


So what does all of this mean for PSS?

  1. Yes, this is a game changer to any investment thesis. The interim CEO is a lawyer, who will bide time until either a) someone is brought in to really move the needle with changing this business model (think Crocs), or a) the company is bought by a financial buyer.
  2. Why a financial buyer today and not yesterday? The reality is that any buyer would need complete buy-in from Matt as well as the team he assembled -- who is loyal to him. That's a risky proposition given the culture that Matt instilled in this company. But with the Board doing the dirty work, the risk profile goes down for a financial buyer to come in and either break it up (think Fortune Brands) or keep PSS intact yet grossly cut the store base
  3. Some hypothetical math...
    • let’s do some simple math. Core Payless accounts for $2.5bn in revs, with PLG at about $1bn. But PLG accounts for about $70-$75mm in EBIT. Yes, that means that core Payless stores are currently churning out about $70mm/year based on our model. $70mm on $2.5bn in sales? That’s a 2.8% margin business, which is simply awful for a model with relatively low operating asset turns.
    • The Hypothetical… So, if we’ve got 4,800 stores running at an average margin of 2.8%, do you think they’re all running at that rate? No. In fact, one of the most poorly understood parts of retail (due to GAAP reporting standards) is the massive gap that exists between a given company’s better vs. poorer performing stores. Our sense is that about a third of Payless stores are dilutive to the P&L, and upwards of half that number are cash-flow dilutive. If we assume that these stores have sales productivity that are 2/3 that of the average PSS store, and that 800 are taken out, it gets us to about $275mm in revenue lost, but $25-$30mm in EBIT gained. Our math might not be spot on, but we think it’s directionally accurate. In this situation, we think the Street would look right through a special charge – even if it’s all cash.
    • Most people would argue that this math is a bit extreme, as its clearly many times what management has referred to in the past as % of stores that are cash flow negative. But we think this is the new normal -- and we think that Board is inclined to agree -- or at least seriously consider the possibilities. A consistent low growth, high inflation environment is a game changer for evaluating the quality and consistency of a portfolio.
    • We noted after the last (disastrous) quarter that this kind of math is useless if the CEO and the Board ignore it. We did not think it would be ignored at PSS. But perhaps not acted upon so soon.
  4. With a $10mm charge in the quarter, and the high probability that the company will sweep everything under the carpet this quarter certainly does not bode well for 2Q earnings. But the reality is that since the last miss, the amount of call volume I had on this name has been close to nil. Am I suggesting that this is the kind of event where Matt Rubel leaving will be a stock-popping event (ie Bill McComb at LIZ)? No. But in going through cash flow scenarios, I question how this could really be bad for shareholders unless the Board brings in someone who tries to follow Matt's plan and the shoes simply don't fit.

The bottom line is that the liklihood for this company to look materially different -- in 6-12 months -- perhaps smaller, but more profitable and less levered, is quite high. I cannot envision that with such poor sentiment on this name that this won't play out as a positive. 


We already get to meaningful support for the stock in the high-single digits for Saucony and Sperry alone. The next -- and very important -- question is 1) how many stores should be closed, 2) how many CAN be closed, 3) what is the financial cost to get out, and 4) will that be accretive or dilutive after netting it against the improved cash flow. This is not a 'back of the envelope' analysis. Stay tuned...we'll be back with more details. 




New Start

This note was originally published at 8am on June 13, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“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 $1525-1538, $98.60-100.45, and 1255-1298, respectively.


Best of luck out there this week,



Keith R. McCullough
Chief Executive Officer


New Start - Chart of the Day


New Start - Virtual Portfolio

Boston Harbor Smiles

“I'm just ready to move forward.”

-Tim Thomas


After watching a generational win for the Boston Bruins last night in Game 7 of the playoffs, I am sitting here in my hotel room watching a gorgeous sunrise in the Boston Harbor. It must be Lord Stanley’s way of smiling.


Was I smiling yesterday? Am I smiling this morning? Big time. We love winning here at Hedgeye. And we support anyone who has a transparent, accountable, and winning attitude. Our vision for American Optimism is as old as America itself.


Yesterday’s price action in markets did nothing but solidify our conviction in our Global Macro Themes:

  1. Growth Slowing (bearish on Wall Street/Washington US GDP Growth estimates) 
  2. Deflating The Inflation (bearish on housing, stocks, and commodities)
  3. Indefinitely Dovish (bullish on long-term Treasuries, UST Flattener, and Gold – TLT, FLAT, and GLD)

We’re not celebrating the other team’s losses - someone always has to lose (Goldman is bullish on commodities; JP Morgan is bullish on Equities, etc). We are championing a winning Risk Management Process that’s saving our clients from losing money in 2011.


Winning starts with not losing. It’s pretty difficult to lose if you don’t get scored on. Swedish offensive skills of the Sedin Sisters last night aside, defense won The Stanley Cup. Bruins goalie Tim Thomas was as focused as any professional athlete I have seen in a long time.


Focus, discipline, confidence – you either have it, or you don’t.


I certainly don’t have it all of the time. But the challenge isn’t to overcome my emotional capacity. The goal is to build a team and process that can pick me up when I am down. And Lord Stanley knows I’ve had my fair share of downs in life.


“I’m just ready to move forward.”


Yesterday’s wins are over with. Today we have to deal with today. It’s time to play the game that’s in front of us.


From a risk management process perspective, before we move forward, we always look back. We need to absorb what’s been priced into market expectations so that we can handicap what the probabilities are for prices to change.


From an immediate-term TRADE perspective, oversold lines in Global Equities are now as follows:

  1. SP500 = 1261
  2. Nadaq = 2613
  3. Russell2000 = 771
  4. Japan’s Nikkei = 9367
  5. China’s Shanghai Composite = 2661
  6. India’s Sensex = 18,066
  7. UK’s FTSE = 5662
  8. Germany’s DAX = 7011
  9. Spain’s IBEX = 9811
  10. Brazil’s Bovespa = 61,109

From an immediate-term TRADE perspective, oversold lines in Commodities are:

  1. WTIC Oil = $94.70
  2. Copper = $4.07
  3. Gold = $1520

From an immediate-term TRADE perspective, oversold line in US Treasury Yields are:

  1. 2-year UST Yield = 0.36%
  2. 10-year UST Yield = 2.91%
  3. 30-year UST Yield = 4.15%

The corollary to oversold bond yields, of course, is overbought bond prices – so, while it’s popular for US stock market centric pundits to trash anyone who isn’t Perma-Bullish on “stocks for the long run”, we’re quite happy that they wake up every morning thinking that way. There’s always risk to be managed somewhere. Being bullish on bonds yesterday was a big win.


There are winners and whiners in this profession. We subscribe to the principles of the former. Being Perma-Anything generally doesn’t work. In the last few years I have written a few Early Look notes about Bears and Bruins:

  1. Bullish Bruins” = April 17, 2009  (when we went bullish on US Equities – bought SBUX April 21, 2009)
  2. Ragingly Bullish Bears” = May 5, 2011 (when we pressed the short case for Growth Slowing)

What’s interesting about the timing of the “Ragingly Bullish Bear” note is how quickly sentiment has changed. In that May 5, 2011 missive I highlighted the following sentiment setup in the II Bullish-to-Bearish survey:

  1. Bulls up 100 basis points week-over-week to 55%
  2. Bears down 200 basis week-over-week to 16.5%
  3. The Spread (Bulls minus Bears) widened by 150 basis points week-over-week to +38.2% for the Bulls

Again, relative to itself, there are a few critical risk management callouts in this long-dated survey to consider:

  1. Bulls are not ragingly bullish
  2. Bears are not allowed to be bearish
  3. The Spread between Bulls and Bears is only 200-300 basis points from its all-time wides (all-time is a long time)

“All-time “wides” is risk management locker-room speak at Hedgeye for something you don’t want to mess with – kind of like being a man dressed in orange last night drinking a smoothie with your i-pod on in the bowl of the Boston Garden – it’s just a bad position to be long of.”


Back to today…


The only worse position to be “long of” was probably a Blue/Green Canucks jersey at a bar in Boston last night. This morning, the good news for Perma-Bulls (US stocks) is that this morning the II Bullish-to-Bearish Spread has narrowed to +11% for the Bulls (37% of people now admit to being Bullish and 26% being Bearish).


That’s a huge narrowing of an exceptionally wide spread. But my and the Boston Harbor’s Smiles are still beaming.

My immediate-term support and resistance ranges for the Gold, Oil, and the SP500 are now $1, $94.70-99.58, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Boston Harbor Smiles - Chart of the Day


Boston Harbor Smiles - Virtual Portfolio

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