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The Congressional Comb-over

“Every man's life ends the same way. It is only the details of how he lived and how he died that distinguish one man from another.

-Ernest Hemingway

 

Keith was on CNBC this morning, so as I was mulling over topics for the Early Look last night and this morning and my initial thought was to completely avoid discussion of the debt ceiling debate.  It has become the one of the most overhyped factors in global markets and it is a little depressing to analyze the political shenanigans going on in Washington.   Nonetheless, I’m at my keyboard in the Taft Mansion on Yale’s Campus this morning (more commonly known as the global headquarters of Hedgeye Risk Management) and I feel compelled to comment.

 

As many of you are now discovering, Speaker Boehner is having serious issues garnering votes for his debt and deficit plan.  The vote was scheduled yesterday and is now postponed.  It seems the Tea Party is not on his political side, despite fear mongering from the White House that Christmas will be ruined if a long term debt deal is not passed in short order.   I can’t say I agree with the Tea Party on everything, but I will give them credit for a conviction of their beliefs.

 

The debt limit deadline is August 2nd, which is now four days away.  Between now and then, how this plays out is really anyone’s guess.  It seems likely the Tea Party will acquiesce and a deal gets passed in the House, although as we saw yesterday evening, even that is uncertain.  If that does occur, Senate Majority Leader Reid and President Obama have been adamant that they will not support any bill that has a two-step process and that doesn’t extend the debt ceiling past the 2012 election.

 

Regardless of the two-step process in the Boehner bill, the Boehner and Reid bills have dramatic differences regardless.  At face value they are talking about similar numbers, the Boehner plan, in total, is looking for more than $2.7 trillion in cuts, while the Reid plan is proposing almost $2.2 trillion in deficit cuts.  While those numbers are in the same area code, the methodology for getting to the cuts is dramatically different. 

 

The Reid plan only has $710BN in real budget cuts, the remainder of the deficit reduction plan comes from the winding down of the wars in Iraq and Afghanistan.  Setting aside the differences in process, that leaves us with a $2 trillion difference in the nature of deficit cuts between the parties.  That’s one mother of a compromise for four days.

 

Stepping back to the longer term, we need to keep in mind that both of the current bills proposed are really nothing more than Congressional Comb-overs.  As a refresher, Merriam Webster describes a comb-over as follows:

 

“An arrangement of hair on a balding man in which hair from the side of the head is combed over the bald spot.”

 

As a man who sports a comb-over, I can vouch that is an apt description.  The sneaky thing about a comb-over is that while you can comb your hair over, the rest of the world can usually tell that there is a bald spot lingering beneath.

 

In the chart of the day, I’ve shown what I mean graphically by comparing proposed Reid plan discretionary spending cuts as a percentage of the estimated deficit.  Similar to many a bad business plan, the Reid plan is very back end loaded (by the way, so is the Boehner plan).  In fiscal 2012, the discretionary spending cuts as proposed by Reid ramp from 2.2% of the CBO’s projected deficit to 14.0% of the CBO’s projected deficit by 2020.

 

The other key assumption to keep in context when considering the currently proposed Congressional Comb-overs are the GDP growth assumptions proposed by CBO.  In the projection period used in my analysis in the attached chart, the federal government budget years from 2012 to 2020 at an average real GDP growth rate of 2.9% per year.  This compares to the actual real GDP growth rate over the last ten years of 1.7%.  Obviously, future deficits will be much higher if growth in the next decades tracks similar to the last decade.

 

While the political drama in Washington has been entertaining over the last few months, we need to keep in mind that even when the compromise is reached, the current bills proposed are merely covering up long term budget deficit issues that will again need to be addressed in the next 12 – 18 months.  Therefore any short term positive stock market reaction should be taken with a grain of salt in the context of continued long term issues.

 

Keep your head up and your stick on the ice,

 

Daryl G. Jones

Director of Research

 

The Congressional Comb-over - Chart of the Day

 

The Congressional Comb-over - Virtual Portfolio


American Pride

This note was originally published at 8am on July 26, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“The measure of who we are is what we do with what we have.”

-Vince Lombardi

 

This weekend I finished the “heavy book” (Truman) and opted to do what I don’t do enough of – re-read my favorite books. If “When Pride Still Mattered – A Life of Vince Lombardi” can’t get you fired up to lead people in this good life, I don’t know what can.

 

Leadership isn’t what you saw coming out of Washington yesterday. That was a joke. As Lombardi reminds us, “leaders aren’t born, they are made.” And President Obama is learning that lesson the hard way right now – unfortunately, on the job.

 

I’ve written about this for what feels like forever now, but the reality of both the Bush and Obama Administrations is that the American people don’t like either. Americans aren’t stupid. They know who these people are by watching what they do with what they have. Both Bush and Obama had/have awful economic advisors.

 

Back to the Global Macro Grind

 

Last night, after the President of the United States fear-mongered the country that we could face a “deep economic crisis”, the rest of the world’s market participants took his word for it and said ok, we’ll sell more US Dollars on that.

 

Can you imagine the leader of any great team delivering that message to the troops on the week of the one of the biggest games is US history? I can. I’ve seen plenty of losing coaches in my day, and so have you. Obama better wakeup to a winning message – and soon.

 

The good news is that market prices are already discounting political gravity. If you haven’t noticed, professional politicians chase polls and the President’s approval rating won’t be flushed out of the toilet until he makes a decision to get a deal done.

 

Here’s how I see this globally interconnected marketplace discounting Obama bellying up to the bar:

 

1.   US Dollar – yes it was down -1.2% last week and, yes, it’s down on “no deal” already for the week-to-date. But, the US Dollar Index is finally making higher-all-time-lows on selloffs. All-time is a long-time. Obama, this buck stops going down with you.

 

2.   US Treasuries – you know you have basically no stroke with markets when 3 of the “top” central planners of America (Obama, Geithner, and Daley) try to scare the living hell out of the bond market, and Treasury Yields move a beep. Or was it 2 beeps?

 

3.   US Stocks – like Braveheart, US stocks are holding every line of support that matters. Holding our TRADE line of support (1325). Holding our intermediate-term TREND line of support (1319). “Hold… hold…”

 

The People of America are like that. I’m sure Lombardi would agree that our markets are a measure of who we are. We are resilient. We are fighters. And we will not let conflicted and compromised politicians decide our future.

 

This will not be easy. This won’t change the fact that Washington/Wall Street has been wrong on their US GDP Growth estimates by about a half in 2011 either. But this definition of leadership will not continue.

 

America will do what she needs to do with what she has to make sure of that.

 

My immediate-term support and resistance ranges for Gold (sold ours yesterday), Oil (no position), and the SP500 are now $1596-1619, $97.90-100.55, and 1325-1352, respectively.

 

Best of luck out there today and God Bless America,

KM

 

Keith R. McCullough
Chief Executive Officer

 

American Pride - Chart of the Day

 

American Pride - Virtual Portfolio


SBUX: THE WORLD RUNS ON SBUX

Starbucks posted another strong quarter and the stock is up in aftermarket trading.  We have been long Starbucks since March 2009 and continue to like the long term prospects of the company.

 

We expected a strong quarter from Starbucks but not a massive beat and the quarter was largely in line with what we expected.  EPS came in at $0.36 versus expectations of $0.34.  Domestic comps were +8% versus consensus +5.3%.  International comps were +5% versus consensus +5.1%. 

 

Below are the same-store sales charts for domestic and international stores as well as our top ten takeaways from the earnings call.

 

SBUX: THE WORLD RUNS ON SBUX - SBUX US pod12

 

SBUX: THE WORLD RUNS ON SBUX - SBUX pod2

 

 

Top Ten Takeaways:

  1. Earnings growth guidance is, we believe, secure for the company in 2011 and we also feel comfortable with the FY2012 EPS growth guidance of 15-20% given the coming rollout of K-Cups in CPG channels, other sales boosting initiatives, and the company's “LEAN” principles.
  2. Same-store sales in the U.S. completely blew away expectations, coming in far above consensus expectations at 8% (against a 9% comp in the year-ago quarter).  We believe that Starbucks continues to gain traction with consumers.
  3. The strong top-line performance should continue; the company is at the cutting edge when it comes to technology and social media.  Along with Domino’s, another company taking share, Starbucks utilizes technology to improve the guest experience.  The Starbucks iPhone app is one example, allowing customers to pay via their mobile devices and, as part of a recent introduction, send e-gift cards to friends for Starbucks purchases.  Between Android and iPhone apps, the company stated that there are now 1 million devices with more than $50 million loaded for use specifically at Starbucks.
  4. The brand loyalty that Starbucks inspires is almost peerless.  The Starbucks Card and loyalty program had a record quarter in Q3 activating nearly 150,000 cards per day during the quarter and generating a 38% increase in dollars loaded on to cards over the period.  Additionally, Starbucks is the most popular brand on Facebook.
  5. Growth potential for Starbucks remains.  The CPG business, with the rollout of K-Cups is one avenue but store growth also remains a valuable revenue driver.  Next year’s initial revenue growth guidance is 10% driven by CPG, mid-single digit comps, and 800 net new stores.   200 are expected to be domestic and 600 in international markets (150 in China).  Key targets for further, longer-term unit growth include Brazil, which has less than 100 stores, and can one day have at least 1,000 stores according to management.
  6. China is a key focus for Starbucks and the company is following a very meticulous approach to its strategy there.  For instance, recently, the company formed a JV with a farming group in Yunnan, China to produce and process coffee.  As global demand rises, Starbucks is positioning itself shrewdly.
  7. Commodity cost inflation will remain a problem for the company over the remainder of the year.  Full year EPS impact from commodity inflation is expected to be $0.22 with $0.08 coming in 4Q after 3Q’s $0.07 impact. 
  8. K-Cups are expected to add $0.03-0.05 in EPS in 2012.  This is included in the company’s guidance for EPS growth of 15-20% year-over-year for the year.
  9. The company has north of a billion dollars in cash and is looking to increase its activity in the M&A markets going forward.  In 1999, Starbucks acquired Tazo Tea which is now generating more than $1 billion in system-wide sales.  According the management, tea is a $90 billion global market and the second-most consumed beverage in the world after water.
  10. Our final takeaway is that it is ludicrous to pay a higher multiple for the Dunkin’ Donuts “growth” story than the growth that Starbucks promises.  Starbucks has delivered for years as a public company and is a global brand with quantifiable and undeniable appeal for consumers, globally.  Dunkin’ Donuts is a great but regional domestic brand with no track record as a public company.  Sure, the company plans to grow into new domestic markets but growth is expensive as BWLD discussed on its earnings call.  Furthermore, if the brand doesn’t resonate as much as expected in new markets, and the ROI doesn’t meet what the current multiple implies it should be, it could pop the Dunkin’ bubble.

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 


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Will Obama Do The Two-Step?

“Say, my love, I came to you with best intentions, 

You laid down and gave to me just what I'm seeking.”

- Dave Matthews, “Two Step”

 

Conclusion: The Boehner and Reid plans are very different structurally.  We expect the Boehner plan to pass this afternoon, which will provide strategic advantage for the Republicans heading into August 2nd.

 

As Keith noted in the Early Look, the top three stories on Bloomberg this morning related to the debt ceiling.  Admittedly, this story is being over-analyzed and over-studied, but we did want to spend a few minutes highlighting the two most recent plans from Senator Reid and Speaker Boehner and the details therein.

 

As we highlighted in a note earlier this week, the primary outstanding issue relates to timing.  The Republicans, led by Boehner, are recommending a two-step process.  The first step of the process would involve extending the debt ceiling by $900BN or so, which would be matched by comparable discretionary spending cuts over ten years (duration mismatch, anyone?). The next tranche of a debt ceiling increase of $1.6 trillion would be tied to Congress passing an additional deficit reduction bill that attempts to remove an incremental $1.8 trillion in expenditures related to cuts in mandatory spending programs.  These mandatory spending cuts are to be determined by a 12-member joint leadership committee.

 

The plan from Reid has a number of noteworthy differences from the Boehner plan. First, the Reid plan is not two-step in nature.  Second, while the Reid plan proposes $2.2 trillion in deficit cuts, the bulk of the cuts in this plan actually come from an assumed winding down of the Iraq and Afghanistan military adventures.  In fact, of the total proposed cuts by the Reid plan, more than $1 trillion come from a wind down of Iraq and Afghanistan.

 

In the table below, we compare the revised Boehner plan versus the Reid plan as scored by the CBO and based on our interpretation:

 

Will Obama Do The Two-Step? - 1

 

While the primary issue between the Democrats and Republicans remains one of timing, the underlying issue, as outlined in the table above, is the exact source of cuts.  The Republicans don’t count the natural winding down of wars as a cut in spending, a stance which is consistent with CBO scoring standards.  On the other hand, Democrats are using the wind down of military spending as the primary component of the deficit reduction plan.  This debate over source of spending cuts is the primary reason that Republicans are pushing for a two-step process.   If the Republicans agreed to the Democratic plan, they would in fact be ceding away much of their long term budget cuts proposals. 

 

This is not a political statement per se, but we think Speaker Boehner characterized the current political impasse best with the following quote from yesterday:

 

“There are only three possible outcomes in this battle: President Obama gets his blank check; America defaults; or we call the president’s bluff by coming together and passing a bill that cuts spending and can pass in the United States Senate. There is no other option.”

 

The vote on the Boehner plan is scheduled for 5:45pm today, after the markets close. The House Republicans, led by the Tea Party Caucus, are adamantly opposed to giving the President any sort of blank check, and so will certainly call the White House hand on the veto threat and pass this bill.   In fact, there is risk that Boehner can’t get the votes he needs this afternoon, though the most recent information we’ve received suggests that he will.

 

If the Boehner plan does indeed pass this afternoon, the bill then goes onto the Democratic controlled Senate and then, if passed, onto the President to sign, or veto.  From a strategic perspective, the Republicans have positioned themselves well as the proverbial budget ball will be in the hands of the Democrats in the five days leading up to August 2nd. 

 

The political theater is about to get very interesting in Washington and, despite his veto threat, President Obama may be out on the dance floor doing the two-step in the next couple of days.

 

Daryl G. Jones

Director of Research


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