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Risk Ranger: SP500 Levels, Refreshed

POSITION: We are short the Financials (XLF)


It’s been a volatile [insert: week/month/year]. Inclusive of today’s pullback, the VIX is up nearly +150% since the start of July.


The Bernank calls this “price stability”.


We call volatility for what it is and we are quick to point out its effect on managing risk – specifically in that it adds an extra layer of complexity for larger institutions. Big Government Intervention does two things: 

  1. Shortens economic cycles
  2. Amplifies market volatility 

We are not sure the Eurocrats over at the European Securities and Markets Authority (the agency responsible for imposing short-selling bans in Europe) understand this simple concept. Furthermore, we aren’t convinced a short-selling ban is the proper remedy to the problems associated with Europe’s banking system (pull up a chart of SocGen CDS).


When volatility blows out like it has in recent weeks, investors would do better to shorten their duration and trade the range(s) appropriately – in this instance, with a bearish bias. We call this Risk Ranger and it remains one of our current Key Macro Themes.


Some call it “trading”. We call it “managing risk”. Tuh-may-toe. Tuh-mah-toe.


The bull market in price IN-stability is having a profound effect on the output of our core three-factor quant model (PRICE/VOLUME/VOLATILITY). Specifically, our immediate-term TRADE ranges are now wide enough to fit my offensive line-sized physique through: 

  1. TREND (bearish) = 1,314
  2. TAIL (bearish) = 1,257
  3. TRADE range = 1,086-1,193 

Note, our current immediate-term downside support target is within crash territory (a peak-to-trough decline of 20% or more). Moreover, the SP500 (along with most things that tick live in the Global Macro universe) remains demonstrably broken from a TREND and TAIL perspective. Manage that risk accordingly.


Darius Dale



Risk Ranger: SP500 Levels, Refreshed - SPX

LIZ: Another Catalyst


LIZ sold off some fragrance assets to Elizabeth Arden this morning for $58.4mm in cash marking the first of what we expect will be several asset sales in the coming months. One of the key factors is that despite market turmoil, LIZ has so many asymetric factors to generate an outsized longer-term term return for investors that can shoulder near-term liquidity risk.


As you can see in our sum-of-the-parts below, this sum is nearly double the value we attributed to this business. In fact, this deal represents less than half of the company's entire fragrance/ cosmetics assets with the ownership of the Juicy, Lucky, and Kate licenses still in-house. 


Only a few weeks ago, the company confirmed it was in talks to sell its Mexx business in addition to several other possible sales in an effort to reduce debt by nearly $200mm to less than $580mm by year-end. While the timing and likelihood of that eventuality is now under question in light of recent European credit concerns, the company has a stable of other brands that it's currently evaluating. With the turn underway at Mexx along with an aggressive plan in place to reduce its underperforming store base, it's less about which brand is sold just as long as one is. 


In addition, LIZ secured a distribution agreement with Li & Fung to ensure uninterrupted service as it shutters its Ohio distribution facility – a key element of its latest $25mm cost reduction initiative.


The bottom-line here is that this model has considerably better visibility than even a month ago and management is clearly driving change to improve liquidity. LIZ remains one of our top ideas.


LIZ: Another Catalyst - LIZ SOTP 8 11



Casey Flavin











Initial jobless claims came in at 395k versus expectations at 405k consensus for the week ended August 6th.  For the week ended July 28th, the number was revised to 402k versus 400k.


THE HBM: WEN & EAT EARNINGS, JACK, CHUX, CAKE - initial claims 811





Gasoline prices are coming down on an absolute basis and this is providing relief to consumers.  On a year-over-year basis, however, prices at the pump remain elevated (as the chart below illustrates).


THE HBM: WEN & EAT EARNINGS, JACK, CHUX, CAKE - gasoline prices time series





QSR stocks underperformed yesterday along with Food Retail.  The broader market dragged all categories lower.






  • WEN reported 2Q EPS of $0.05 versus consensus $0.05 this morning.  Comps exceeded expectations at +2.3% for company-owned restaurants versus consensus at 1.5%.  Margins were heavily impacted by commodity costs (180 basis points) and incremental advertising to support the new Wendy’s breakfast in additional markets (60 basis points).
  • JACK reported results for Q3FY11 last night.  Margins dragged down EPS to $0.25 ex-items versus $0.40 expectations.  Comps continue to trend higher (Jack company comps +4.7% versus +3.3% consensus and Qdoba system +5.1% versus consensus 5.0%) and the company raised the low end of FY11 comp guidance for Jack and Qdoba.



  • EAT reported a strong quarter this morning, beating consensus EPS by a penny with $0.48 in Q4FY11.  Comps came in at +2.8% blended versus 1% consensus and Chili’s comps were +2.6% versus 3.3% expectations.  Restaurant margins were 18.3% versus 17.1% expectations.  Tellingly, management raised FY12 EPS guidance to $1.80 to $1.95 versus current expectations of $1.76.  EAT remains one of our favorite names in the space and has been for some time.
  • CHUX reported 2Q EPS of ($0.08) versus consensus ($0.05) and O’Charley’s comps of +2.9% versus consensus 1.1%.  O’Charley’s management says that beef, dairy, and seafood costs are up during 3Q.  This is bearish for CAKE, given what we believe is the government’s overly conservative commodity guidance for 4Q.
  • CAKE raised to “Buy” from “Neutral” at Lazard Capital.






Howard Penney

Managing Director


Rory Green



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JCP: Life Before Johnson


JCP’s Q2 earnings out Friday are going to come in well shy of the company’s guidance, no surprise there. The bigger issue at hand is the duration mismatch between the timing of investments needed to execute on Ron Johnson’s master plan and current earnings expectations, which are too high. We firmly believe both numbers and the stock are headed lower from here.


July same-store-sales came in up 3.3% last week capping off an unimpressive quarter in which comps are likely to come in at +1.5% compared to guidance of 3-4%. This shortfall is due in part to a materially underperforming e-commerce business, which is up only LSD and running well below full-year double-digit growth expectations. With limited room for upside in gross margins as a result of the company’s competitive pricing position and limited product differentiation, SG&A will be the key lever to manage for the balance of the year. We’re shaking out at $0.07 for the quarter vs. the Street at $0.10 and management’s initial Q2 guidance of $0.20-$0.24. Given our expectation for meaningfully lower earnings, we expect JCP to take down full-year guidance for revenue, gross margins, and EPS Friday. To be clear, our thesis goes far beyond this quarter’s results.   


As we outlined in our recent JCP Black Book, here’s the setup heading into the quarter:

  1. Over the near-term (Trade = 3-weeks or less), JC Penney is one of the most poorly positioned companies in the industry as it relates to the margin compression we see ahead. We’re at $1.82 vs. the Street at $1.94 in F11.
  2. In the intermediate term (Trend = 3-months or more), we’re looking at much of the same. Numbers as the company looks today are too high in F12. Again, we’re at $1.33 vs. the Street at $2.40. 
  3. Over what we consider long-term (Tail = 3-years or less) we’ll be seeing meaningful investment back into the model, as Ullman exits either by choice or force. Then we’ll see SG&A and CapEx both go up meaningfully. Mind you, Apple lost money in retail for the first 2+ years, and fell short of its publicly stated profit goals for 2 years because Johnson opted for the benefit of long-term shareholder value, not the inability to perform. We think that this is what will take earnings down – potentially below zero based on our analysis. In F13, we’re at $1.22.
  4. Then, and only then, can JCP rise from the ashes and emerge into whatever it is that Johnson is envisioning. Heck, it might prove to be the best stock in the S&P. But that might not be until years 5-7. Johnson’s warrants get him paid – keeping in mind that he probably doesn’t need the money to feed his family in the interim.
  5. In the interim, investors have to cope with 1) the real earnings power of this company, estimates for which are too high, while keeping the Ackman’s of the world spinning their tales of value creation.

See our recently released JCP Black Book for more detail on this and other factors that have us squarely in the bear camp on JC Penney. If you are interested in receiving a copy, please contact .


JCP: Life Before Johnson - JCP S 8 11


JCP: Life Before Johnson - JCP Sent 8 11



Casey Flavin







TODAY’S S&P 500 SET-UP - August 11, 2011


The French governments (and their bankers) now, allegedly, have an edge on what independent rating agencies are going to do with their sovereign ratings. Nice!   The most important thing central planners have missed in 2011 are growth estimates – that won’t change gravity.  As we look at today’s set up for the S&P 500, the range is 50 points or -3.01% downside to 1087 and 1.45% upside to 1137.






THE HEDGEYE DAILY OUTLOOK - daily sector view


THE HEDGEYE DAILY OUTLOOK - global performance




  • ADVANCE/DECLINE LINE: -1500 (-4151)  
  • VOLUME: NYSE 2147.22 (-10.89%)
  • VIX:  42.99 +22.62% YTD PERFORMANCE: +142.20%
  • SPX PUT/CALL RATIO: 1.74 from 2.64 (-34.11%)


  • TED SPREAD: 27.09
  • 3-MONTH T-BILL YIELD: 0.02% -0.01%
  • 10-Year: 2.17 from 2.20    
  • YIELD CURVE: 1.98 from 2.01


  • 8:30 a.m.: Trade Balance, est. (-$48.0b), prior (-$50.2b)
  • 8:30 a.m.: Initial jobless claims, est. 405k, prior 400k
  • 8:30 a.m.: WASDE (corn, soybean, cotton, wheat)
  • 8:30 a.m.: Net export sales (commodities)
  • 9:45 a.m.: Bloomberg consumer comfort: est. (-48.7), prior (-47.6)
  • 10 a.m.: Freddie Mac mortgage rates
  • 10:30 a.m.: EIA Natural Gas
  • 1 p.m.: U.S. to sell $16b 30-yr bonds


  • U.S. trade deficit probably narrowed in June from the highest level in almost 3 years, helped by cheaper imported crude oil, economists said before a report today
  • Fed officials are drawing up rules for the largest U.S. banks that won’t be more stringent than global capital standards agreed to in Basel, people familiar said



THE HEDGEYE DAILY OUTLOOK - daily commodity view




  • Gold Falls From Record as Rising Equities Curb Investor Demand
  • CME Increases Gold Margins as Investors Drive Record Rally
  • Rice Is Next Japan Food Risk From Fukushima Nuclear Meltdown
  • Power Trading Set for Record on Europe Sun, Wind: Energy Markets
  • Copper Climbs Most in Two Months on Chinese Demand Speculation
  • Standard Chartered Recommends Buying Brent Oil Below $100
  • Aussie, Kiwi Rise as U.S. Stock Futures, Commodities Advance
  • Palm Oil Climbs as Malaysian Stockpiles Drop on Record Exports
  • Metals Lead Commodity Gains as Yuan Strength Buoys China Demand
  • Copper Climbs Most in Four Months, Lifted by Chinese Purchases
  • Commodities Rise for Second Day, Led by Metals on China’s Demand
  • Spot Gold Falls 0.6% After Rallying to Record Above $1,800
  • Palm Oil Imports by India Seen at Record May Halt Price Decline
  • Nestle Pakistan to Fend Off Engro by Doubling Dairy Output
  • Being Like Soros in Buying Farmland Reaps Annual Gains of 16%
  • Gold May Extend Record Rally Above $1,800 as Global Stocks Drop
  • Thai Sugar Exports May Increase to Record, Cane Board Forecasts
  • Oil Gains Most in Three Months as Supplies Fall, Demand Rises



EUR/USD – remains the most critical FX pair in all of global macro and this is really where the rubber meets the road on which European politician is telling you the truth; TREND line is now 1.44 and its bearish/broken - no bid this morn


THE HEDGEYE DAILY OUTLOOK - daily currency view




  • EUROPE: another low quality short squeeze to lower-highs in the lowest quality country markets (Italy/Spain); not good
  • FRANCE – important to acknowledge what real-time prices have been signaling in French Equities since February of 2011 when they put in another lower-long-term high – including this morning’s rally, the CAC40 has crashed (down -27% since FEB2011)


THE HEDGEYE DAILY OUTLOOK - euro performance




  • ASIA: not as bad as I thought it would act = constructive; China leads gainers (we're long) up +1.3%; Singapore day2 of neg divergence $CAF

THE HEDGEYE DAILY OUTLOOK - asia performance








Howard Penney

Managing Director

Questionable Mathematics

This note was originally published at 8am on August 08, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Common sense is not so common.”

-Voltaire (quote used at the end of David Einhorn’s Q2 2011 letter)


This morning has nothing to do with legitimate credit risk in America’s sovereign debt. US Treasuries would be collapsing if it did. Instead, stocks are as Treasuries are making new 2011 highs!


This morning has everything to do with analytical incompetence. If watching the analytically incompetent chastise the analytically incompetent yesterday didn’t remind you that both S&P and the US Government have issues, you need to replay the tapes. The People don’t trust either ratings agencies or governments’ risk management processes anymore. And they shouldn’t.


As outgoing Chairperson of President Obama’s “Council of Economic Advisers”, Austan Goolsbee, told Meet The Press yesterday that S&P had “Questionable Mathematics”, I literally started laughing out loud. This is AFTER the US government revised their Q1 2011 GDP estimate for the US by 81% to the downside to 0.36%!


With all due respect to my fellow Yalie (Goolsbee was Yale 1991), there is nothing to respect about the accuracy of either the US government’s economic forecasts in 2011 or what US Growth Slowing implies for any rating agency that has to impute a massive top line slowdown into its rating. AFTER the top line (revenues) slows, both the sell-side and ratings agencies downgrade – not before. They are THE lagging indicators.


Bloomberg Consensus (78 buy-side and sell-side institutions) forecasts for US GDP Growth in Q3 and Q4 of 2011 are still at +3.2% respectively. Our models continue to point to rates of U.S. economic growth that are HALF, or less, of those consensus estimates.


There is nothing questionable about this math: the US stock market has lost -12% of its value since the end of April for a lot of reasons – but one of the most obvious has been Growth Slowing.


Back to the Global Macro Grind


Why are US Treasuries bid to new all-time highs (all-time is a long time) on the “news” of a rating agency downgrade this morning? That’s simple. This is old news to the analysts who provide Wall Street with leading indicators.


To review the time stamps:

  1. March 5, 2010: Jim Grant issued an effective downgrade of USA’s long-term bonds
  2. May 14, 2010: Hedgeye cites Grant’s work and reiterates the conclusion using Reinhart & Rogoff data to compliment our own
  3. August 3, 2010: Hedgeye holds a conference call titled “Should US Debt Be Rated Junk?”

As recently as July 7th, 2011 in his quarterly client letter, Greenlight Capital’s David Einhorn wrote (on page 3): “Earth to S&P, if you can foresee a near-term default scenario that is plausible enough for you to warn about it, AAA cannot be the correct current rating.”


Einhorn, like Jim Grant, is one of the world’s most competent financial analysts. He has been profiting from the incompetence of ratings agencies and the governments who pay them for years. Einhorn and his clients won’t be freaking out this morning or looking for Bill Miller and Timmy Geithner to throw them some completely conflicted and compromised view of S&P’s work. They’ll be profiting from it.


Tomorrow starts today – so what’s next? Well, let’s start with what AAA not being AAA means for everyone else’s ratings.

  1. It’s now politically palatable to downgrade other AAA rated Sovereigns (France)
  2. Big Bank Ratings that rode USA’s AAA Rating Uplift need to be downgraded

After we moved to ZERO percent US Equity exposure in the Hedgeye Asset Allocation Model last Monday, our Financials guru, Josh Steiner, wrote an important note titled “New Risks For Financials” where he dug into this obvious problem of Big Bank Rating Uplifts:


“There are 8 banks that benefit directly from the United States AAA credit rating through ratings uplifts. They include: BK, STT, BAC, C, WFC, JPM, GS and MS. If the US isn’t AAA, then the implicitly backed Too Big To Fail banks can’t rely on the US’s ratings to get AAA debt themselves.”


Now Steiner has been The Bear on the moneycenter banks and US Housing since this time last year (sorry Meredith Whitney). Hedgeye has shorted Banker of America (BAC) 10x since 2010 in the face of “smart” money buying it on “valuation.”


Well, sorry “smart” money, valuation is not a catalyst.


Neither is a pending downgrade of a bank’s credit rating. Citigroup (our top short idea above and beyond BAC right now, which is saying something!) could see a 2-notch downgrade with the end of these “ratings uplifts”. This will add notably to already existing NIM pressure on Citi’s earnings (NIM = Net Interest Margin).


And when S&P or Moody’s “downgrades” Citigroup, we’ll cover the short position on that “news” too. Timing matters.


My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1638-1711, $84.02-92.03, and 1165-1219, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Questionable Mathematics - Chart of the Day


Questionable Mathematics - Virtual Portfolio

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.48%
  • SHORT SIGNALS 78.35%