Long Ouzo, Yogurt and Molotov Cocktails: Initial Passage of Greek Austerity in Perspective

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


The Finance Ministry in Athens is on fire, what’s next?


As we mentioned in our research earlier in the week, we believe the backing for PM Papandreou’s PASOK party in the confidence vote last Tuesday was THE critical hurdle to clear to pass the government’s newest €78 Billion austerity package. The probability of its passage was also largely confirmed by the strong performance of European equity markets over the last two days and gains in the EUR-USD cross. However, we warn that Troika’s (EU, ECB, IMF) desire to avoid a strict restructuring of Greek debt in favor of near-term bailout band-aids and debt concessions will only extend the country’s larger fiscal imbalances, and therefore downside uncertainty for those institutions and investors holding Greek debt.


Today’s vote to pass austerity opens the door widely for similar approval of a second bill tomorrow that authorizes implementation of the measures. Critically, the passage assures Greece receives its next bailout tranche of €12 Billion from the IMF on July 3rd (from its first bailout of €110 Billion in May 2010), as the Greek government has stated that it only has funds until mid-July to support government salaries, pensions, and maturing debt obligations. In the chart below we show the monthly principal and interest payments over the next months. Further, passage assures the ball will be put in motion for talks on a second bailout worth an estimated €70-120 Billion. Such discussion will take place at the next EU Finance Ministers’ Meeting on July 5-6th and 11-12th.


Long Ouzo, Yogurt and Molotov Cocktails: Initial Passage of Greek Austerity in Perspective - me1


But to what end with these bailout and austerity packages?


We’re less than optimistic that austerity will have much impact on the country’s fiscal imbalances and that the devil is in the details. Of the planned €28 Billion of spending cuts and tax hikes and €50 billion of private assets sales through 2015, Greece may be able to reach a deal that broadly agrees with Troika’s deficit reduction demands, while specific terms of the deal are back-loaded towards 2014/15.


While this is only a hypothetical, such a tactic could be used to appease both Troika and the Greek populous. But ultimately it bodes poorly for any material change in the budget debt and deficit, but then again given Greece’s poor prospects to grow any revenue with such a deflated growth profile (GDP contracted -4.4% in 2010 and is forecast to fall -3.8% this year), using smoke and mirrors by either party to reach any form of intermediate support should come as no great surprise.


Further, subsidizing Greece extends the uncertainty of all banks, central banks and private individuals, which hold nearly half a trillion dollars (or  €340 Billion) of Greek debt.  France has floated the idea of French banks reinvesting 70% of their maturing debt Greek bonds, with 50% allocated to new Greek debt that would be maturing in 5 years to be rolled over to a maturity of 30 years and another 20% directed to a zero coupon fund of “high quality securities”.  The Germans have also floated similar ideas in response (meetings being held today), yet clearly there are numerous unknowns surrounding this proposal, including interest rates on the debt, and ultimately where this Greek soap opera will take us over the next month, quarter, and years ahead.


While we worry about Greece, we’re equally concerned about rising risk premiums across the rest of the periphery, especially for Italy and Spain, two countries with outsized government debts, and much larger GDPs (and exposure to throughout European institutions) than Greece, Portugal, or Ireland.


Interestingly the spread of 10 government yields from Italy and Spain over German bunds has reached record highs over the last days, a flag to monitor as the media is focused squarely on Greece.


Long Ouzo, Yogurt and Molotov Cocktails: Initial Passage of Greek Austerity in Perspective - me2


A second chart to note is the CHF-USD cross which continues to make higher highs. Here we’ve pulled the chart back 10 years to show this serious move. We recommended a long position in the pair on 6/2/2011 and continue to support that view as the uncertainty in European sovereign debt contagion sees no end in sight.


Long Ouzo, Yogurt and Molotov Cocktails: Initial Passage of Greek Austerity in Perspective - me3


Regarding the EUR-USD cross, we expect the pair to trade in a tight band between $1.41 and $1.45, largely supported by Troika’s backstop to prevent default of any Eurozone member nations and weakness in the USD vis-à-vis political indecision on the US debt ceiling debate.


Matthew Hedrick



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




Crop conditions don’t seem to be improving in the U.S.  The States is the biggest exporter of corn and soybeans.  U.S. corn was rated 68% good or excellent as of June 26, down from 73% a year earlier.  65% of soybeans earned the good or excellent designation, down from 67% a year ago, according to USDA data. 


The federal government’s Energy Independence and Security Act has created inelasticity in corn markets.  Supply shocks are tending to push prices higher than they might be in a typical supply/demand system, according to an energy policy specialist quoted by




  • CKE reports a net loss of $2.6 million for the quarter ended May 23rd.  However, company-owned comparable restaurant sales growth was a positive; Hardee’s comps were up 9.6% - the best result in seven years – and Carl’s Jr. comps increased 2.1%. 
  • SBUX is paving the way for mainstream mobile payments, according to tech blog Mashable.  Starbucks allows customers at 9,000 of its locations to pay with their Android, Blackberry or iPhone phones.
  • SONC will serve wine and beer at a new Miami location, making it the first Sonic restaurant to do so.  A spokesperson for Sonic said that the company wishes to increase evening traffic and take advantage of the evening weather in Florida.
  • MCD should dump its “Café con Leche” beverage, announced yesterday, according to a writer at the Miami News Times.  One of the paper’s online blog calls the offering “what just might be one of the most derogatory forms of flattery I have ever seen”.
  • CMG climbed to an all-time high during yesterday’s trading session.
  • MCD climbed to an all-time high during yesterday’s trading session.



  • DRI was reiterated Buy by Stern Agee, price target is $55.
  • CBRL management said yesterday that home prices and unemployment are a drag on the industry.  Food and gas prices can be added to the list!
  • BWLD climbed to an all-time high during yesterday’s trading session.




Howard Penney

Managing Director

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The Cure That Kills

“If it ain’t broke, don’t fix it”

-Bert Lance, former OMB Director under President Carter


The current Debt Ceiling Debate ongoing in Washington, DC has largely gone unnoticed by investors.  The conventional wisdom appears to regard the daily back and forth between Democrats and Republicans with only passing interest.  As the Sector Head for Healthcare here at Hedgeye, what may be a curious side show to many, has deep implications for investment decisions today. 


Many news stories have struggled to understand Wall St.’s complacency toward the debt ceiling debate.  On the one hand, and in the face of warnings from Secretary of Treasury Geithner, who has made multiple statements regarding the “economic catastrophe” that follows if Congress fails to raise the government’s ability to borrow above $14.3T by August 2nd, there has yet to be the US equivalent of the Greek CDS chart.    Senator John Boehner, the Republican Majority Leader in the Senate, called the August 2nd deadline “an artificial date created by the Treasury secretary.”  It may just be that we’ve seen this movie before and all know the ending.


Republicans and Democrats have staked out their respective Debt Ceiling positions by centering on Medicare.  It makes sense to focus on Medicare.  Medicare spending is the fastest growing and single largest (54%) outlay within Health and Human Services (HHS), the federal department which consumes the largest percentage of federal outlays (23%).  To put this in context, Defense (16%) and Treasury (14%) are number 2 and 3, respectively.  The Congressional Budget Office (CBO), in their more reasonable ‘Alternative Fiscal Scenario’ outlined in their ‘Long Term Budget Outlook’, chart the widening gap between federal income and outlays due entirely to accelerating growth in Medicare spending.


The current Debt Ceiling debate has been decades in the making as government outlays for Medicare and Medicaid have grown substantially since 1960.  Indeed, over the life of available data (since 1960) we’ve witnessed a discrete, secular cost shift away from the individual consumer towards their employer and increasingly towards federal & state sources.    National Health Expenditure data from the Center for Medicare Studies, the agency that administers Medicare and Medicaid, show government sourced dollars have grown from ~20% of total spending to 49%, while Private sources, which include out-of-pocket and Private Health Insurance, have gradually shifted from ~75% to 51% over that same timeframe .  Moreover, Out-of-Pocket expense as a percentage of Total Private Sources has declined from 47% to 12% over the same time period. 


Despite the rapid growth in total medical spending, the Healthcare Economy in the United States by many measures and opinions is broken.  The cliché is to state that we spend far more per capita ($7,290) than any other developed nation ($3,700) yet regularly rank poorly for statistics such as life expectancy (42nd), level of health (72nd), and health system performance (37th), at least according to the World Health Organization.   The rebuttal is that the US healthcare system is better than any in the world, provided the patient carries health insurance and can pay.  But even here, Americans look unfavorably on their health insurance carriers.  According to a December 2010 Gallup survey, 56% percent of those surveyed thought the health insurers as fair or poor at providing their service.  Poor health outcomes is the routine reality for the upwards of 50M people not lucky enough to have health insurance to complain about.  For all the money spent, these statistics suggest we could do better as a country with the dollars spent.


The Affordable Care Act (ACA), also know widely as Health Reform, attempted to correct many of the issues listed above; by expanding insurance coverage, building tools to control costs, and cutting the federal deficit by $143B over ten years.  Unfortunately, the fix may actually be making the problem worse.


The ACA expands coverage by expanding Medicaid by raising the poverty limit to qualify, offering tax credits to small firms to offer health insurance, and providing subsidies to individuals and families to purchase their own insurance on an Insurance Exchange.  It saves money by encouraging the formation of Accountable Care organizations, provider groups who will share in the savings they generate while providing care audited for quality.  The ACA, according the CBO, cuts the federal deficit by lowering Medicare outlays, particularly to private insurance companies who offer Medicare Advantage.


Since President Obama signed the ACA into law many of the underlying assumptions are coming undone.  The ACA “froze” the benefit level states offered under Medicaid, but in recent months, and as states grapple with peak budget shortfalls in 2012, they are looking to cut Medicaid expenses, their second highest expense.  In the last few days, both Democrats and Republicans have publicly contemplated allowing the states to lower eligibility and provider rates under Medicaid.  ACA looks likely to expand Medicaid coverage from a much lower run rate.


Additionally, 1433 companies (representing 3.5M insured lives) have sought and received waivers from HHS to avoid complying with ACA insurance rules.  The Obama Administration has since stopped granting waivers.


Accountable Care Organizations were touted as capable of reducing costs and increasing quality, but this plan too has faltered.  After a steady stream of providers formed ACOs prior to the proposed rules offered to govern them, the concept has run up against the reality of foregoing revenue while incurring costs to comply with the rules set to govern them.  At this point, even the 5M lives estimated by the CBO to be cared for in an ACO appears aggressive.


Recently, the news has turned to a discussion of the Insurance Exchanges, slated to begin offering insurance in 2014, corporate tax credits for offering insurance and the number of people who already have insurance through their job.  McKinsey conducted a controversial survey of employers which suggests a significant percentage of employers (30%+) stop offering health insurance for their employees and pay the smaller penalty set out in the ACA.  A larger than expected coverage drop will increase the government cost of subsidizing health insurance through the planned subsidies.  The CBO currently expects 1M out of a total population of 163M to lose employer health insurance.


Douglas Holtz-Eakin went further with his estimates and calculated the penalty-insurance cost gap would induce employers to drop an additional 38M workers from employer sponsored plans and onto Insurance Exchanges.  This is in addition to the number and subsidy cost of Insurance Exchange participants the CBO estimates, 19M and $450B over 10 years.  With an additional 38M lives, the Insurance Exchange Hotltz-Eakin estimates the subsidy cost will rise to $1.4T, driving the ACA deep into the red.  We have invited Douglas Holtz-Eakin to speak on a call with our clients July 13, and I am looking forward to learning more about his analysis.


The Insurance Exchanges should not present a significant problem as long as the transfer from employer plans to the Insurance Exchanges is 100% efficient.  Similar to the corporate penalty-cost of insurance spread, the individual mandate that compels purchase of health insurance has a very low penalty that starts at $95 for individuals in 2014.  Assuming that just 5% of young healthy employees, who are high margin since they don’t incur many costs, decide to pay the penalty, this leaves a higher cost population behind.  Those that remain will have to pay higher premiums, drawing more subsidies per member, raising the deficit impact, and inducing more individuals to forego insurance, and so on.


While the Debt Ceiling debate goes largely unnoticed today, and may yet be pushed to another day, the day of reckoning approaches for the Health Economy.  Government, corporate, and individual pressures to contain costs will eventually lead to slower growth and margin pressure.  Medicare and Medicaid will need to be cut, the penalties and taxes raised to corporations and individuals, and more aggressive cost control measures put in place.  In the interconnected Health Economy, the ensuing revenue and margin pressures will pose a challenge to everyone; it’s just a question of when.


Thomas Tobin

Managing Director, Healthcare


The Cure That Kills - EL. CBO



The Cure That Kills - Debt Ceiling Intrade


The Cure That Kills - VP TT


Chinese Cowboy

This note was originally published at 8am on June 24, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“We ride and never worry about the fall – I guess that’s just the cowboy in us all.”

-Tim McGraw


My Thunder Bay Bear boys and I are big country music fans. Tim McGraw’s “The Cowboy In Me” is one of our favorite songs. I’ll be heading up to the homeland for some time with the family tomorrow. I’m looking forward to slaying the great Canadian Walleye with my buddies Luch, Gunner, and RM.


The Cowboy In Me” hit #1 on the Billboard Hot Country Singles charts immediately after McGraw’s duet with Jo Dee Messina “Bring On The Rain” did in 2001. Sometimes a bear needs a lot of rain before he gets hungry to buy.


I bought Chinese stocks (CAF) on June 16th … and I must say, not many people agreed with that. I actually don’t think I agreed with it either. But I bought them anyway.


“The things I’ve done for foolish pride

The me that’s never satisfied”


That’s a small part of the why. Most people who know me well know that I love to compete. Sometimes that’s hurt me in this business. Most of the time it’s been my greatest asset. During the sometimes that it isn’t – it’s usually because I am letting my pride get in the way of my process.


“Sometimes I’m my own worst enemy

I guess that’s just the cowboy in me”


Back to the Global Macro Grind


This morning’s bullish immediate-term TRADE action in Asia was led by the biggest rally Chinese stocks have seen in 4 months. The Shanghai Composite Index was up a big +2.2% (up for the 4th consecutive day).




The actual data was bad (the HSBC PMI print came in at 50.1, an 11 month low). But bad data in China isn’t new. The leadership call to action of Chinese Premier Wen last night was. Away from the #1 Bloomberg headline this morning being some version of European socialist hope for Greece, one of the   “Most Read” stories was about the Premier’s comments about Chinese inflation:


“I am confident prices will be firmly under control this year.”


Now I typically don’t believe a Chinese politician inasmuch as I don’t trust an American one, but the actual inflation data we’ve been modeling into our Chinese Consumer Price Inflation (CPI) forecast for the back half of 2011 is in line with Premier Wen’s forecast.


On the 2 things that really matter to Chinese stocks – Growth and Inflation – here’s Hedgeye’s call for the 2nd half of 2011:

  1. Growth Slows At A Slower Rate (+7-9% GDP growth instead of 10-12%)
  2. Inflation Starts To Deflate (4-5% CPI instead of 5.5-6.5%)

If we are right on Growth and Inflation, the only big thing left to solve for is Monetary Policy. Premier Wen’s comments also have a huge implication for Chinese interest rates – Deflating The Inflation (Hedgeye Q2 Macro Theme) means he can STOP raising rates!


On Chinese Monetary Policy, here are the facts:

  1. China has raised interest rates 4x during La Bernank’s policy to inflate cycle
  2. China has not raised interest rates in 11 weeks
  3. China’s swap spreads are already discounting an arrest of interest rate hikes

So what does The Cowboy In Me do with that?

  1. I BUY Chinese stocks (CAF)
  2. I SELL Chinese currency (CYB)

If my Macro Team continues to be right that:

  1. The US Dollar is done going down (for now)
  2. The CRB Commodities Index and Oil are going to keep going down (for now)

Then Premier Wen and I are probably going to be right. Deflating the Inflation in the CRB Commodities Index and WTI Crude Oil has been -10.8% and -19.5%, respectively since May.


Deflating The Inflation will be good for US Consumers inasmuch as it will be for Chinese consumers. Between now and then, Chinese stocks have much more upward potential to this trade than US stocks do. The SP500 is still lathered with The Inflation Trade (Financials, Energy, Basic Materials), and The Correlation Risk to US Dollar UP is much more severe to the SP500 than it is to the Shanghai Composite.


Does my craw constantly consider the time and price relationship between being long China (CAF) and short US Equities (SPY)? Of course. Managing risk in the most globally interconnected marketplace that investors have ever faced is the game that we are in.


But I won’t wake-up every morning worried about the guys who are playing this game with hope and fear as their governor. I have enough on my plate in not letting my pride get in the way of my own process.


“The face that’s in the mirror when I don’t like what I see

I guess that’s just the cowboy in me”


My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1511-1532, $90.44-95.11, and 1259-1297, respectively.


Enjoy your weekend and best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Chinese Cowboy - Chart of the Day


Chinese Cowboy - Virtual Portfolio


There is not a restaurant company that would is not worried about the current reading of consumer confidence.  


The Conference Board index of Consumer Confidence fell by 3.2 points in June to 58.5 on top of the 4.3 point decline in May.  Over all the consumer fundamentals remain soft and, at least judging by the market’s reaction, confidence missing the consensus number of 61.0 is consensus.  The two-day rally in the S&P 500 and, more pertinently, Restaurant stocks, of 1.80% and 2.82%, respectively, is indicative of that. 


Restaurant stocks continue to perform well in both and up and down tapes.  Over the past month, the QSR and FSR sectors have outperformed the S&P 500 by 5.5% and 4.1%, respectively.  The average EV/EBITDA multiple for the QSR and FSR sectors now “not cheap” at 10x and 7.4X, respectively.  Relative to other sectors that are slightly more cyclical or are driven by the wild swings in commodities, the restaurant industry as a whole is serving as somewhat of a safe haven.  The industry is not overly levered and the cash flow generation and dividend yields of some of the more mature companies are very attractive.    


Industry demand is improving, but not all concepts are created equal.  Malcolm Knapp recently reported that estimated comparable restaurant sales growth in May was 2.2%.  Final accounting period April comparable restaurant sales growth was +1.5% (versus the prior estimate of +1.6% based on weekly data).  The sequential acceleration from April to May, in terms of the two-year average trend, was +50 basis points.  Comparable guest counts for the casual dining industry, according to Knapp Track, grew +0.4% in May on a year-over-year basis.  The final April guest counts growth number was -0.1% (versus the prior estimate of +0.2%).  The sequential acceleration from April to May, in terms of the two-year trend, was +15 basis points. 


As we head into earnings season, it will be important to keep a close eye on movement in top line trends.  There appears to be a cultural shift to the fast casual segment, as younger consumer prefers the “overall” environment of the fast casual store design.  I will be exploring this theme in the coming days.    


All the good news aside, an erosion of consumer confidence is concerning and expected amidst concerns over declining asset values, inflation, rising energy costs, geopolitical flashpoints, the availability and cost of credit, and rising unemployment.  The Conference Board Consumer Confidence Index is at its lowest level since November 2010, when Knapp Track was reporting a 1.6% decline in traffic for the casual dining industry.  Even more concerning is that the expectations component once again led the decline in the overall index, falling to 72.4 from 76.7 (previously 75.2); the present situation component dipped to 37.6 from 39.3.


Declining house prices continues to be another burden for the consumer to bear (despite today’s seasonal uptick which looks to be temporary and scant consolation for homeowners).  Today, the Case-Shiller 20-City Home Price Index increased 66 bps in April to 138.84 on a non-seasonally-adjusted basis.  On a YoY basis, however, prices fell -4.0% YoY in April versus -3.8% YoY in March.  As our Financials team noted today “there is a strong seasonal aspect to home prices, with the greatest increase in prices occurring in April, May, and June … Thus, expect to see two more months of improvement (May and June) before the downtrend resumes.  As a reminder, we use the NSA YoY data instead of the seasonally adjusted series because S&P noted last year that their seasonal adjustment factor had become unreliable.”  Housing is slowly capturing more attention in the media, particularly as other bearish data points emerge and resonate with what has been playing out in housing – in line with Hedgeye Financials’ call – for some time.


Without the corporate sector adding any significant contribution to payrolls, wage income is growing at an all-too-anemic pace.  Disposable income is holding up, but only due to the temporarily reduced payroll tax withholdings, offset by the “gas tax” Gasoline prices remain a constraint, although recent trends are making life a little easier.  Over the last week, gas prices have dropped by 2.4% and 11% from the high set back in early May.  Year-over-year gas prices are now up 29%.  The consumer’s response to increasing gas prices, declining equity markets, and the disappointing trend in home prices reduced real spending in both April and May.


In today’s environment no one is immune from some sort of economic malaise:

  1. High energy prices particularly hurt “lower-income” households as they spend a disproportionate share of their income on energy needs.
  2. The decline is housing seems to hurts everyone but the “middle-income” are likely effected the most.
  3. The recent stock market weakness hurts “high-income” households


In the world of Restaurants, the Hedgeye virtual portfolio we are currently LONG COSI and SBUX and SHORT CBRL.  I’m nervous about the DRI quarter to be reported on 7/1 - it’s a consensus long and its core consumer for both Red Lobster and 

Olive Garden fall in the sweet spot of those hurting the most in the current economic environment.  Although, Long Horn is killing it! 


I am negative on CAKE and PFCB, also.





Howard Penney

Managing Director

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