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Europe’s Dislocated Jaw

Positions in Europe: Short EUR-USD (FXE); European Financials (EUFN)


As Keith wrote today in this morning notes: “From a research/risk management perspective, yesterday was one of the best days we’ve had versus our sell-side competition since ‘08. It was also the biggest down day for stocks since ‘08, so that makes sense. Having 0% asset allocation to US/European Equities helps.

  1. GROWTH – is slowing… Period. The #1 headline in Europe this morning isn’t about a lying politician, it’s all about GROWTH. Slowing growth makes any leverage problem worse at an accelerating rate. IP growth down 2% y/y in Spain in June.
  2. STAGFLATION – stocks pay a lower multiple for that… Period. The #2 headline in Europe this morning isn’t about Europigs, it’s about UK input prices ripping higher to +18.5% Y/Y in July vs +17% in June. That will come down in AUG, but that’s bad for margins.
  3. LEVELS – bearish and broken… Period. Every Global Equity market in the world (other than Venezuela) is now officially broken on both my TRADE and TREND durations. In commodities, both Copper and WTIC Oil snapped TRADE and TREND lines this week. And in Fixed Income, UST bonds are hitting new highs as Growth Slowing + Deflating The Inflation is bullish for UST bonds.

Every bear market gets immediate-term TRADE oversold, and that’s what I see this morning. That said, I want to be crystal clear on this, sell all rallies in Equities/Commodities because the Street is still too long and needs to take down gross and net exposures.”



As it relates specifically to Europe, European equities took it on the chin this week. On a one week performance basis: Finland’s OMX -14.0%; Italy’s MIB -12.1%; Greece’s ATHEX -11.8%;Germany’s DAX -11.7%; Ireland’s Overall Index -10.1%; France’s CAC -9.4%; and Portugal’s PSI20 -7.9%, to name a few indices. Neither the periphery nor the heart of Europe was immune to the decline.  


The EUR-USD saw substantial day-over-day gains this week, but traded within our range of $1.40 to $1.43. Importantly, we want to stress that if both our TREND level of $1.43 and TRADE level of $1.40 on the EUR-USD pair break, we don’t see downside support until $1.28.


This week our Financials team had a call with Peter Atwater, and among his many astute comments I agree with his assessment that France is one key country to monitor as it relates to sovereign debt contagion. In particular, Atwater notes there’s a real threat that France could lose its AAA credit rating. This point is critical for the AAA rated bonds issued by the EFSF can only maintain this rating so long as the countries backing the facility maintain their AAA status. And France, behind Germany, has the second largest collateral guarantee on the facility—therefore a downgrade of France would be a huge impairment on the facility, which already looks significantly underfunded should Italy and Spain require assistance.  


This leaves us increasingly comfortable to short France and Germany on a bounce.  Below we show CDS spreads as one indicator of the building risk premium for the two countries commonly understood as Europe’s backbone. While both are far from CDS levels reached by the PIIGS, or even the 300bp line that we’ve noted as an important breakout line, both countries will be front and center on our screens.


Europe’s Dislocated Jaw - 1. CDS


Given that the EU parliament doesn’t return to session until mid September to vote on the terms of the newly crafted EFSF, we have a number of weeks of indecision ahead of us – we think this bodes poorly for a region that has struggled over the last two years to present credible plans to arrest sovereign debt contagion.  Further, comments yesterday from ECB President Trichet that the Securities Markets Program (SMP) to buy up sovereign bonds would partially resume indicates that the Bank will need to continue to support demand for future PIIGS auctions, especially until the terms of the EFSF are finalized in September. On this score, we’re particularly worried about Italy and Spain, given their steep maturity schedules into year-end and rising bond yields.


Europe’s Dislocated Jaw - 1. DEBT


Sentiment shock waves also came in the form of an announcement yesterday from Spain’s Treasury that it has suspended a bond auction originally planned for August 18th, but noted the cancellation of the auction was not a response to market turbulence (throat clear).


Below we show two charts that stood out in today’s data—UK input cost inflation, which highlights our call on the stagflation component of our sticky stagflation thesis in the UK; and slowing high frequency German data, including Industrial Production and Factory Orders.


Europe’s Dislocated Jaw - 1. UK


Europe’s Dislocated Jaw - 1. Germany


Matthew Hedrick

Senior Analyst






The DNKN visual below, (from http://www.dunkinfranchising.com) promoting Dunkin’ Donuts franchising opportunities, is a great visual that shows how truly regional the Dunkin brand is. 


THE HBM: DNKN, BAGL, SBUX, WEN, RRGB, CEC, MSSR - opportunities brewing







The U.S. Monster Employment Index fell 2 points in July to 144. The fall in labor demand is in line with other surveys which suggest the U.S. labor market failed to improve markedly in July. A stronger U.S. recovery hinges on an improving labor market.




According to the Bloomberg Weekly Consumer Comfort Index, sentiment fell from -46.8 to -47.6 for the week ending July 31st. The index has declined for two consecutive weeks and is at its lowest since May.


THE HBM: DNKN, BAGL, SBUX, WEN, RRGB, CEC, MSSR - bloomberg comfort





Yesterday was a bloodbath in the market – no subsector was “safe” – but food retail outperformed the other food, beverage and restaurants categories.  Food processors traded down -6.2%, underperforming the other categories.  The decline in the food processing stock was somewhat surprising given the significant decline in commodity costs.  







Consistent with the broader market, a number of stocks in the restaurant space fell on accelerating volume.  The names that stand out that did not see accelerating volume are also some of the strongest fundamentally (valuation aside).  In the QSR space: MCD, CMG, SONC, KKD, BAGL and GMCR.  In the casual dining space: KONA, RRGB, DRI, RT, MSSR.




  • BAGL reported Q2 EPS of $0.18 versus consensus $0.21; SSS 0.2% versus year-ago 0.8%
  • SBUX Japan reported in line numbers for the period ended June 30.
  • WEN will do business as “The Wendy’s Company” effective Tuesday and continue to trade under the ticker “WEN” following the completion of the sale of Arby’s Restaurant Group to Roark Capital.



  • RRGB initiated outperform at BMO Capital
  • CEC reported Q2 EPS $0.34 versus consensus $0.32; SSS sales were up 0.8% during H1 of 2011 and were down 7.9% during the first four weeks of Q3 of 2011.  Guidance EPS $2.75-2.95 versus prior guidance $3.00-$3.10
  • MSSR reported Q2 EPS $0.09 ex-items versus $0.09 Comparable restaurant sales -2.7% versus consensus of -2.5%; Guidance (Dec 2011): EPS $0.26-0.31 versus prior guidance $0.31-0.36.




Howard Penney

Managing Director


Rory Green



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The Macau Metro Monitor, August 5, 2011




According to a Dow Jones source, MPEL is looking to raise $400-600MM for its HK IPO.  The source also said the IPO would launch in Q4.



Sands China has signed franchise agreements with Hilton Worldwide and IHG for hotels at Sands Cotai Central.  Hilton's five-star Conrad is expected to open in 1Q 2012 with more than 600 rooms.  A four-star Holiday Inn by InterContinental should also open in 1Q 2012 with more than 1,200 rooms.



If the European Commission fight ends amicably, this would be a positive catalyst for the slot guys.



Yesterday, the Greek parliament passed an omnibus bill which included the VLT/online gaming bill.  While we expected the bill to pass in late 2011 (GREECE: DRAFT GAMING BILL SUBMITTED TO PARLIAMENT (3/21/11)), the fast-track status it obtained by clinging onto a broader legislation package was not foreseen. According to Greek finance minister Venizelos, Greece had to pass the omnibus bill before the EU/IMF audit team arrives on Aug 22.  Under the bill, OPAP will receive an exclusive license to operate all 35,000 VLTs, operating 16,500 machines itself and sub-contracting the rest.


But it’s not smooth sailing yet. Greece passed the bill despite European Gambling and Betting Association’s (EGBA) and European Commission’s (EC) protectionism and discrimination concerns which violate EU law. All eyes will be on August 8—the deadline for Greek lawmakers to reply to the objections. If Greece fails to address the Commission’s objections, the EC could launch infringement proceedings in the European Court of Justice.


However, if Greece work things out with the EC on the gambling bill, here are the next steps:

  • Bill sent to President Papoulias for promulgation and publication in the Government Gazette
  • Setup of new gaming supervising committee
  • Tender process

Repetitive Drills

This note was originally published at 8am on August 02, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Even in his repetitive drills he had a way of making the mundane seem important.”

-David Maraniss (on Vince Lombardi)


That quote comes from an inspirational excerpt on page 212 of “When Pride Still Mattered” where David Maraniss boils down the deep simplicity of Lombardi’s coaching process. If you’re trying to lead a country, company, or family this morning, I confidently submit that consuming this perspective is well worth your time. America needs you, The People, to lead us out of this mess.


Vince Lombardi was “the football variation of a masterly novelist who could take the muddle of everyday life and bring clarity and sense to it, and allow readers to see, for the first time what was in front of their eyes all along. Bart Starr was on the edge of his seat, listening – getting it for the first time. All the crap was gone; this was right to the bone, simple, yet so refreshing and exciting.”


“Everything was accounted for, labeled, identified, put in order, fundamental and sound. You could tell that the coach believed in what he was doing. His tone of voice, his posture, his manner – it all made you believe. It all made sense.”


So let’s grind. This globally interconnected marketplace all makes sense – you just need to account for “everything”:

  1. US TREASURIES – across the curve, 2s, 10s, and 30-year UST yields are making fresh YTD lows this morning in the face of a very wrong bet by some of our industry’s losing teams that suggested there was US “credit risk” coming down the pike. Not today.
  2. US DOLLARS – had a breakout day yesterday, trading right back above an important line of immediate-term support ($74.11 on the US Dollar Index) as clarity on the “Debt Deal” found her way into the market’s currency expectations.
  3. US EQUITIES – not good folks; not good – but are you surprised? With “Debt Deal” being replaced by “Growth Slowing” in this morning’s headlines, many a macro market observer has come to realize that more than just US politics makes globally interconnected risk go round.

Perversely, since La Bernank has addicted the entire Institutional Investing Community to chasing yield, what’s good for America’s currency is quite bad, in the immediate-term, for stocks and commodities.


We’ve labeled this The Correlation Risk (USD up = stocks and commodities down). Sadly, Bernanke and Geithner have been negligent in addressing this massive tail risk to the American people when under oath.


So what do you do with that?

  1. Short the Euro
  2. Short European Equities
  3. Sell US Equity and Commodity exposure

People want “clarity” in this market place. There it is.


On yesterday’s proactively predictable opening market strength, I sold down my US Equity exposure in the Hedgeye Asset Allocation Model to 0%. That’s ZERO. Like my long exposure to European Equities – ZERO.


As of yesterday’s close, here’s how the Hedgeye Asset Allocation Model is positioned:

  1. Cash = 52% (up from 43% last week)
  2. Fixed Income = 18% (Long-term Treasuries and US Treasury Flattener – TLT and FLAT)
  3. International Currencies = 12% (US Dollar and Canadian Dollar – UUP and FXC)
  4. International Equities = 12% (China, India, and S&P International Dividend ETF – CAF, INP, and DWX)
  5. Commodities = 6% (Silver – SLV)
  6. US Equities = 0%

Now the Hedgeye Portfolio (14 LONGS and 12 SHORTS) is a different product obviously than long-only asset allocation. Neither of these products are perfect. No one’s risk management process in this business ever will be. We get that – but every move we make is based on a repeatable process that changes as the math does. And, believe me, the coach over here believes in what he is doing.


My goal is simple. I want to win. And my team will stand here alongside you on the front lines of Global Macro market risk, just as we did during the thralls of 2008, so that you don’t lose your hard earned net wealth. We don’t make excuses. We make moves.


Since January 2011, we have led the debate that Global Growth Slowing was going to equate to lower than expected US Equity returns. Every morning since, we have been banging the drums with our often Repetitive Drills to remind you what we are seeing and when.


That doesn’t mean I am going to own US Treasuries (TLT), Flatteners (FLAT), or Silver (SLV) forever. I could sell them all today and nothing will have changed unless I deviate from the process in order to make those decisions. If the process changes, I better know why. And I damn well better be able to explain it to my troops.


In a world where people have no reason to believe their country’s leaders…


In a world where politics trump objectively scored performance…


That’s the best we can do as leaders. We have to be accountable. We have to make sense.


My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1611-1637, $94.11-96.21, and 1275-1316, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


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