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Emerging vs. Developed Markets: Aggressively Framing Up the Debate

Conclusion: As Slowing Growth gets incrementally priced into equity markets globally, we are starting to uncover some interesting opportunities across emerging markets on the long side.


As a point of clarification on how we manage Global Macro risk, we don’t typically subscribe to the convenience of lumping together random economies for storytelling purposes. That being said, however, we’re happy to step outside of our shell on a late Friday afternoon to quickly illustrate a point that you’re going to hear us make with increasing volume in the coming weeks and months:


Deflating the Inflation is especially good for those emerging markets which have underperformed on a 6-12 month basis – from both an economic and equity market perspective.


Less simplistically, we are of the view that as commodities continue to break down across the board (particularly in the food and energy complexes), downward pressure will be applied to emerging market CPI readings, which are typically more levered to food and energy prices than their developed counterparts. That provides cover for those central banks which have proactively tightened monetary policy over the last 12-18 months to become dovish on the margin. As Keith pointed out in today’s Early Look, China remains our go-to in this setup.


Be it coincidence or Chaos Theory, it’s no surprise to us that the CRB Index peaked YTD on the exact same day as the US Dollar Index found its YTD bottom (slightly above its all-time low). From a quantitative perspective, the CRB Index remains broken on our intermediate-term TREND duration, while the US Dollar remains bullish on our immediate-term TRADE perspective.


Emerging vs. Developed Markets: Aggressively Framing Up the Debate - 1


Emerging vs. Developed Markets: Aggressively Framing Up the Debate - 2


Regarding the US Dollar specifically, it remains the dominant factor in our Global Risk Management Model and we have been fortunate in making many accurate calls on the US Dollar since our firm’s inception over three years ago. Now, we are bullish on the US Dollar from a research perspective and this view is supported by the following factors: 

  • The end of QE2 means the growth of the Fed’s Balance Sheet will no longer be a headwind (positive on the margin);
  • We don’t believe QE3 is in the cards, but assuming that consensus will clamor for more “stimulus”, the timing of any hint from the Fed is likely six-plus months away (refer to our Indefinitely Dovish and What’s Next for the Fed? presentations for more details);
  • A shift on the margin towards fiscal sobriety in Washington, D.C. via a Debt Ceiling Compromise is also a bullish catalyst for America’s currency;
  • Slowing growth in the Eurozone will have the FX market pricing in less and less hawkishness out of the ECB relative to the Fed on a go-forward basis (don’t forget that the socialist Mario Draghi takes over in November and the Europeans have a full 125bps of potential interest rates to cut). EUR bearishness is USD bullish (57.6% of DXY basket). 

Emerging vs. Developed Markets: Aggressively Framing Up the Debate - 3


Emerging vs. Developed Markets: Aggressively Framing Up the Debate - 4


Net-net-net, we’re bearish on commodities and bullish on the continued unwinding of the Inflation Trade (the naming of which we appropriately authored in 4Q10).


Emerging vs. Developed Markets: Aggressively Framing Up the Debate - 5


Emerging vs. Developed Markets: Aggressively Framing Up the Debate - 6


As Slowing Global Growth continues to get priced into equity markets broadly, we expect investors to stop paying a premium for growth they hope is there (US equities) and to start paying a premium for whatever growth they can find. Hope is not an investment process. Neither is relative value from a longer-term perspective, but we agree that such a strategy can indeed work on shorter durations between cycles.


The price action we’ve seen on a global basis throughout the last week is supportive of our call. Of the 95 equity indices we track (75 countries, 9 S&P 500 large-cap sectors, the MSCI EM Index, and 10 MSCI EM sectors), China’s Shanghai Composite is leading the way at +3.9% on a week-to-date basis. In full disclosure, we are long Chinese equities in our Virtual Portfolio (since June 16). More broadly speaking, the top quartile of wk/wk performance is dominated by EM exposure at 71% of the total. We expect that number to creep higher in the months and weeks to come – particularly as bombed-out markets like India’s SENSEX and Brazil’s Bovespa (down -12.7% and -16.4%, respectively, since the start of QE2) start to recover after deceleration in their domestic growth rates is fully priced in.


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Emerging vs. Developed Markets: Aggressively Framing Up the Debate - 8


Emerging vs. Developed Markets: Aggressively Framing Up the Debate - 9


As the charts above suggest, now is not the time to cannonball into emerging markets broadly from a quantitative perspective. Each country will initiate its own bottoming process based on the slope of growth, inflation, and monetary policy within its borders. For now, we think China represents the best opportunity on the long side. We’re happy to walk through our Year of the Chinese Bull thesis and/or any other countries with you; just shoot an email to .


One final point we want to make before we wrap up is that it will likely prove prudent to stay away from those emerging markets whose economies are levered to rising commodity prices on the long side. If anything, we would be looking to short petrodollar markets like Russia. For more details on our bearish thesis on Russia, refer to Matt Hedrick’s June 23rd post titled, “Russia From 30,000 Feet”.


Best of luck out there,


Darius Dale


The Week Ahead

The Economic Data calendar for the week of the 27th of June through the 1st of July 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 - cal1

The Week Ahead - cal2

Welcome to the world of jobless stagflation

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.

Bearish: SP500 Levels, Refreshed



In the Hedgeye Portfolio, I shorted the SP500 on Tuesday at 3:14PM at 1297. We maintain that short position as 1297 remains immediate-term TRADE resistance. Across durations, within the framework of our TRADE/TREND/TAIL Risk Management Process, here’s the setup:


  1. TRADE resistance = 1297
  2. TREND resistance = 1320
  3. TAIL resistance = 1377


That’s what we call a Bearish Formation – when all 3 of our core risk management durations are bearish.


Is consensus Bearish Enough on growth yet? I’m not sure – but consensus may be too bullish on earnings expectations. Micron and Oracle certainly didn’t bode well for Tech earnings today – and I don’t think the Financials are baking upside surprises to the 1st week of earnings season in mid-July either. At least not yet.


All that said, I’m not a blind bear. Short-and-hold isn’t what I do. So I just tightened up my net exposure in the Hedgeye Portfolio (LONGS minus SHORTS) back to neutral (10 LONGS, 10 SHORTS) from net short on today’s US market open.


Enjoy your weekend,



Keith R. McCullough
Chief Executive Officer


Bearish: SP500 Levels, Refreshed - 1

Germany: High Frequency Data Slows. Period.

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


In sizing up our macro position in Germany, which we’re long in the Hedgeye Virtual Portfolio via the etf EWG, we want to emphasize that the high frequency data has slowed in recent months. While Germany continues to reflect a strong growth profile for 2011, especially when compared to many of its neighbors handcuffed by gross fiscal imbalances, high unemployment, government indecision and unruly populous’ over austerity measures,  the charts below show that German consumer and business confidence have waned over the last four months, as forward-looking Services and Manufacturing PMI surveys have also tailed off—Manufacturing has declined for the last two months as Services has been mixed and off ytd highs established in Q1 (see charts below). 


While we still like Germany’s fiscal discipline and ability to find demand for its goods and services, the risk that Germany does not meet its growth forecasts given the pressing macro climate makes us more cautious on the position. GDP forecasts include:


German Government: 2.6% in 2011. (Chancellor Merkel indicated in late May that GDP will probably be above 3% in 2011)

German-based Institute for the World Economy: 3.6% in 2011; 1.6% in 2012

Bundesbank:  3.1% in 2011; 1.8% in 2012


Contagion from the periphery remains a glaring threat. While the Troika (EU, IMF, ECB) appears poised to step in to save Greece at every step with additional funds and more favorable terms on its debt, great uncertainty exists on how long the Greek state will be subsidized by Big Brother, and the impact of similar issues for larger countries like Spain and Italy. The obvious spill-over risk could dent not only the German equity market, but also the common currency. Certainly while a weaker EUR is to Germany’s advantage, we’re certain that if a real currency crisis emerged, the advantage of “cheap” German exports wouldn’t be of note.


For now we’re managing our exposure to Germany real-time. The DAX is trading just above its intermediate term TREND support line of 7,106 (third chart below). Stay tuned.


Matthew Hedrick



Germany: High Frequency Data Slows. Period.  - g1


Germany: High Frequency Data Slows. Period.  - g2


Germany: High Frequency Data Slows. Period.  - g3


The trends at JACK are getting better “on the margin” but the company is not in the clear just yet.  As I see it, the current risk/reward is favorable.  JACK is the last QSR company with a market capitalization over a billion that is trading below 6.0x EV/EBITDA.  By comparison, the average multiple for the QSR sector is now at 9.8X EV/EBITDA.  However, excluding CMG and GMCR, the QSR average multiple drops to 8.6X EV/EBITDA. 


If JACK’s fundamental were to continue improving “on the margin” and the street were to reward the company with a higher multiple, I believe there could be over $10 of upside in the stock, or +40% from current levels. 


The case for investors to revalue the stock over the next twelve months is as follows:

  • 70% to 80% franchise mix by the end of fiscal year 2013 (just 18 months out) in line with other in the QSR space (the company needs to sell approximately 300 restaurants between now and the end of 2013.)
  • 16% restaurant level margins by 2013
  • Slowing franchise remodel incentive payments in FY2012
  • “Deflating the Inflation” into FY2012





I see FY3Q11 same-store sales growth guidance of +2-4% for Jack in the Box company units is reasonable, given the sequential improvement in two-year average trends during fiscal 2Q11 and the stable/improving QSR MACRO environment. 


The full-year guidance of +1-3%, though not completely out of reach, seems to be a bit more of a stretch given that the company would have to achieve a nearly 150 bp improvement in two-year average trends during the fourth quarter to hit the low end of the range, assuming 3Q11 same-store sales come in at 2%.  I would note that SONC showed a 645 basis point improvement in 2-yr trends at company-owned restaurants between 2QFY11 and 3QFY11 (quarters ended February and May, respectively).  For Jack in the Box, the YOY comparison gets increasingly more difficult during fiscal 4Q11 as the company is lapping a -4.0% comp from 4Q10 relative to -9.4% in 3Q10.


The Qdoba same-store sales growth target of +4-6% for both fiscal 3Q11 and the full year seem easily achievable given recent two-year average trends. 





The company’s commodity inflation guidance of up 6-7% in fiscal 3Q11 and +4.5-5.5% for the full year implies commodities are up about 5-8% during the fourth quarter, which will continue to put pressure on restaurant level margins.  There is some risk to this commodity guidance as management has been incorrect in its prior guidance of these costs, initially guiding to inflation of +1-2% and then +3-4%.   And, given recent commodity trends, I would expect the company’s commodity costs, particularly, its beef costs (guided to a 14% increase in full-year beef costs), to exceed the company’s current expectations.


JACK’s full-year restaurant level margin guidance of 12.5% to 13.5% implies the YOY margin declines moderate during the second half of the year.  It is important to remember that following the first quarter’s 170 bp decline in restaurant level margins, management guided to a significant improvement in YOY trends for the remaining three quarters. Fiscal 2Q11 margins, however, declined nearly 290 bps, largely as a result of the larger-than-expected increase in commodity costs.  Margins have also been negatively impacted YOY by the company’s investment in guest service initiatives, which at least is a high quality problem.


JACK has posted margin declines for the last seven quarters.  I would expect margins to continue to contract YOY during the second half of the year, but the magnitude of these declines should moderate significantly from fiscal 1H11, with the fourth quarter being less bad than the third on a YOY bp change basis.  Obviously, if same-store sales growth surprises to the upside, stronger margin trends could result.


JACK has not yet turned the corner, but same-store sales trends have stabilized and turned positive during 1H11.  Trends are still fairly negative on a two-year average basis but are improving nonetheless.  Margin improvements should slowly follow with margins beginning to stabilize in 2H11.  That being said, current commodity pressure will only slow this process.




  • The company is lapping its 53rd week from fiscal 2010 in fiscal 4Q11.
  • JACK increased its share repurchases during fiscal 1H11 to $75 million from $50 million during 1H10. 
  • The company’s diluted share count decreased 8.6% YOY during 2Q11.  Full-year earnings will continue to benefit from this lower YOY share count and continued share repurchases.





Howard Penney

Managing Director



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