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IT’S NOT THE ECONOMY STUPID!

The math says RevPAR growth should reaccelerate.  Adopting a positive stance about the lodging sector is new to us this year so we hope people recognize the pivot.   

 

 

Of course the economy matters for the hotel industry.  It is cyclical after all.  Our point is that the recent RevPAR slowdown was not macro economically driven.  Rather, the math suggests that the comparisons in May, June, July, and the first half of August are much more difficult than the rest of the year.  We’ve articulated our view in the past that there was significant pent up demand in those months last year where business people caught up on travel that had been postponed from the prior 12-18 months.

 

But we’re not talking about % growth last year as the comparison as every other analyst does.  We are talking about dollar RevPAR seasonally adjusted viewed on a sequential basis.  There has been too much volatility for three years now to look at YoY % comps.  So sequentially last year (again, seasonally adjusted), dollar RevPAR accelerated beginning in May through the first half of August and then normalized in the 2nd half.  This is why RevPAR growth should reaccelerate in the 2nd half of August this year through the end of the year, likely peaking in November. 

 

The chart below shows the math we are talking about.  Note the slight pick-up in August followed by strong RevPAR growth in each remaining month of the year.  With three weeks in, August is almost in the bag.  In fact, we saw the first week of reacceleration last week with Upper Upscale RevPAR climbing 8% versus 4% for the first 2 weeks.  So far, our math is proving correct.

 

IT’S NOT THE ECONOMY STUPID! - uup2

 

The slowdown in RevPAR growth coincided with the poor economic data, worsening investor sentiment, and a stock market correction so we can forgive people for making the correlation.  However, we saw this coming even in a stronger economy and likewise, we see the reacceleration coming even in a weakening economy.  Of course, the uptick will be short-lived should we enter a double dip – this is a cyclical industry after all.  However, this industry has been battered and bruised by investors.  Look at the recent stock price performance of some of the lodging stocks we follow:

 

IT’S NOT THE ECONOMY STUPID! - ytd

 

We think the reacceleration of RevPAR will provide a much needed boost to sentiment which should inflate multiples over the near term.  Lodging stocks look much better positioned than say gaming or cruise lines because of this math.  Within lodging, MAR seems most interesting to us because of the historically low relative and absolute valuation.  We haven’t seen relative sentiment this low on MAR in a long time.  We also think the Street is underestimating MAR’s free cash flow and propensity to buy back stock.  Finally, we think the time share spin-off is a strategically smart reallocation of capital that will return MAR’s timeshare fee business to one of growth. 

 

We always worry about the economy and the Hedgeye Macro team is not the most bullish on the economy.  Should the economy continue to struggle, MAR would clearly be one of the most defensive plays in the sector due to its soon to be close to 100% fee based business model.  In fact, as noted in our 08/25/11 post “HOW LOW CAN WE GO”, MAR has the least downside to its March 2009 trough valuation.  More on MAR in some upcoming posts.  


INITIAL CLAIMS RISE 9K, ROLLING AVERAGE RISES WOW

Initial claims rose 9k to 417k WoW (+5k after the revision to the prior week).  The Labor Department noted the Verizon strike as a factor in the last two weeks of claims, accounting for "at least 12,500" claims two weeks ago and "at least 8,500" claims this week.  Net/net, the Verizon strike represented a tailwind of 4k in today's print, and the +9k print is in spite of this.  

 

We have been noting a divergence in the usually-tight correlation between the S&P and initial claims, suggesting that claims would move higher, the S&P would snap back, or some combination.  We continue to expect claims to back up further to close this gap, based primarily on Challenger job cuts as well as the layoffs that have already been announced. If all the mean reversion comes on the claims side claims will rise to ~475k. This would reflect, and cause, a significant slowdown in US economic growth expectations consistent with our Macro team's call.  

 

INITIAL CLAIMS RISE 9K, ROLLING AVERAGE RISES WOW - rolling

 

INITIAL CLAIMS RISE 9K, ROLLING AVERAGE RISES WOW - raw

 

INITIAL CLAIMS RISE 9K, ROLLING AVERAGE RISES WOW - NSA

 

INITIAL CLAIMS RISE 9K, ROLLING AVERAGE RISES WOW - s p

 

INITIAL CLAIMS RISE 9K, ROLLING AVERAGE RISES WOW - XLF

 

Margins under Pressure 

We track the 2-10 spread as a proxy for bank margin pressures.   We will have a detailed report coming out on the impact to NIM from recent yield changes, which will quantify the impact across the big banks.  Stay tuned. This week's spread level of 207 bps is 10 bps wider than the previous week. 

 

INITIAL CLAIMS RISE 9K, ROLLING AVERAGE RISES WOW - spread

 

INITIAL CLAIMS RISE 9K, ROLLING AVERAGE RISES WOW - spreads QoQ

 

The chart below shows performance by subsector.

 

INITIAL CLAIMS RISE 9K, ROLLING AVERAGE RISES WOW - perf

 

Joshua Steiner, CFA

 

Allison Kaptur

 

 


THE HBM: YUM, MCD, DNKN, SAFM, HRL, CAKE, KKD

THE HEDGEYE BREAKFAST MENU

 

Notable macro data points, news items, and price action pertaining to the restaurant space.

 

MACRO

 

This past week Cheese prices have declined 14.9%.  On the margin this is bullish for CAKE and the company ability to hit guidance in 4Q11.

 

THE HBM: YUM, MCD, DNKN, SAFM, HRL, CAKE, KKD - cheese

 

THE HBM: YUM, MCD, DNKN, SAFM, HRL, CAKE, KKD - comm

 

  • SAFM EPS - Overall market prices for poultry products were lower in 3Q11 as cash prices for corn and soybean meal increased 84.7% and 25.8%, respectively.  Management commentary - “Market prices for poultry products were significantly lower than last year’s Q3. While retail grocery store demand has remained steady, food service demand remains sluggish, and will likely remain that way until the employment market gains traction and consumers regain their confidence and return to restaurants. We also incurred significantly higher costs for corn and soybean meal, our primary feed ingredients, compared with the same period a year ago.”
  • HRL reports Q3 EPS $0.36 vs Reuters $0.35; Guidance of EPS $1.70-1.75 vs prior guidance $1.67-1.73 and Reuters $1.72

 

SUB-SECTOR PERFORMANCE

  • The QSR names continue to be the go-to group on market up days.  See below for the names that are outperforming.

 

THE HBM: YUM, MCD, DNKN, SAFM, HRL, CAKE, KKD - hfbrd

 

QUICK SERVICE

 

  • KKD announced that it has signed new development agreements with its Japanese franchisee, Krispy Kreme Doughnut Japan Co., pursuant to which the franchisee has agreed to build 73 new locations in the Kanto, Kansai and Chubu regions of Japan over the next five years.
  • YUM - The Daily Telegraph reports that KFC Australia will announce it is removing toys from its children's meals in all 600 stores Down Under.  The move comes three years after the chain committed to stop advertising or actively promoting its kids menu.
  • YUM - The Anti-monopoly Bureau of the Ministry of Commerce is looking into Nestle SA's takeover of Chinese candy maker, Hsu Fu Chi International Ltd, and Yum Brands Inc's acquisition of Chinese hotpot chain, Little Sheep Mongolian Hot Pot. 
  • DNKN and EA said they are teaming up on a six-month initiative that will feature Dunkin’ Donuts products in a version of EA’s Sims Social Facebook game.
  • MCD has launched its developmental franchise business on the Chinese mainland as it seeks to accelerate development in the world's most populous market. Kunming North Star Enterprise Co, based in southwest China's Yunnan Province, on Tuesday signed a developmental franchise agreement with McDonald's - China Daily

 

FULL SERVICE

 

  • BH is now in a war of words with CBRL management.  CBRL responds to the BH letter that we are doing nothing wrong and that you don’t know our business model very well.  CBRL’s Management views restaurant and retail operations as two related and substantially integrated product lines. Furthermore, many of the operating expenses of a store cannot be broken down between restaurant and retail operations.  Company states they have concluded that “separate segment disclosure of our restaurant and retail businesses is neither required nor appropriate.”  (Just go away!)
  • Ruth's Hospitality Group Inc. has named Cheryl J. Henry chief branding officer, replacing former chief marketing officer Jill Ramsier.

 

THE HBM: YUM, MCD, DNKN, SAFM, HRL, CAKE, KKD - qsr

 

THE HBM: YUM, MCD, DNKN, SAFM, HRL, CAKE, KKD - fsr

 

 

 

Howard Penney

Managing Director

            

 

Rory Green

Analyst


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Uncertainty and Non-Linearity

This note was originally published at 8am on August 22, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“Linearity isn’t the norm in the world around us, non-linearity is.”

-Dan Gardner

 

That’s another quote from the book I referenced last week that I am in the middle of reading – “Future Babble – Why Expert Predictions Fail and Why We Believe The Anyway.”

 

What’s interesting about both Chapter 2 (“The Unpredictable World”) and the book is that it’s really accessible for non-scientifically inclined readers. You don’t have to have a Ph.D. in fractal math or applied physics to grasp the deep simplicity of a few very important concepts – Uncertainty and Non-Linearity.

 

In Hedgeye’s Research and Risk Management Process, Uncertainty is critical to accept. Maybe that’s why our models have had very different signals than consensus during both the 2008 and 2011 Growth Slowdowns. Wall Street/Washington models tend to command some level of certainty in their baseline assumptions. Being absolutely certain about models that don’t work is a problem.

 

In the real-world of accountability, successful Buy-Side Risk Managers like Ray Dalio (Founder of $100B Bridgewater Associates) have embraced Uncertainty as a core component of what it is that they do. As Dalio says in John Cassidy’s New Yorker article (“Mastering The Machine”, July 25, 2011):

 

“I’m always trying to figure out my probability of knowing... Given that I am never sure, I don’t want to have any concentrated bets.”

 

I love that.

 

Defining Non-Linearity is a little more complex. But, essentially, that’s the point – and why we’ve built all of our models and processes on Complexity (or Chaos) Theory.

 

Clients often ask me for reading primers on Chaos Theory. Here are a few:

  1. Complexity – The Emerging Science At The Edge of Order and Chaos”, by M. Mitchell Waldrop
  2. Deep Simplicity – Bringing Order to Chaos and Complexity”, by John Gribbin

After having consumed both of these books, you’ll realize that neither contain any applied market models. And that, too, is the point. Accepting Uncertainty and Non-Linearity in your risk management process is something that you have to really come to embrace in principle before you apply it to what it is that you do.

 

In “Future Babble”, Gardner doesn’t do Chaos Theory like I do, per se, but he does simplify the difference between Linear and Non-Linear systems. “Gravity, for example, is linear in mass. Double the mass and you get twice the gravity” (page 39). “A common component of non-linear systems, feedback, involves some element of the system looping back on itself…” (page 40).

 

I like that explanation because it’s simple. To a degree, Non-Linearity also rhymes with what George Soros calls “reflexivity.” And, again, in principle, it takes a fundamental acceptance that this is what drives market prices, volumes, and volatilities before you can really apply it to what it is that you do.

 

Back to the Global Macro Grind

 

What it is that the US stock market continues to do is go down. Last week, with the SP500 closing at 1123 (its lowest weekly-closing-low of 2011), across all 3 of our core risk management durations (TRADE, TREND, and TAIL), US stocks are bearish/broken:

  1. TRADE (3 weeks or less): resistance = 1166
  2. TREND (3 months or more): resistance = 1294
  3. TAIL (3 years or less) = resistance 1256

When Perma-Bulls call this a correction, I’m not quite sure what they mean.

  1. Since its 2007 bull market cycle-high of 1565, the SP500 is down -28.2%
  2. Since its 2011 bear-market rally to a lower-long-term high of 1363, the SP500 is down -17.6%
  3. For 2011 YTD, the SP500 is down -10.7% (the Russell 2000 is down -16.8%)

Now before the bulls get to point #3 they’ll be jumping out of their seat saying, ‘but, the SP500 is still up +66.1% from its March 2009 closing low.’ OK. It really would be ok if the Perma-Bulls were in 100% Cash at the 2009 low and bought everything for their clients right then and there – but I’m pretty sure that didn’t happen.

 

In Q3 of 2008, I took the Hedgeye Asset Allocation Model to 96% Cash.

 

In Q3 of 2011, I’ve now taken the Hedgeye Asset Allocation Model to 70% Cash (versus 64% at the beginning of last week).

 

I guess that makes me relatively bullish compared to 2008!

 

Into Friday’s straight up move in Gold and Silver, I took our Commodities allocation back down to 0% (I sold our entire Silver (SLV) position). There are no rules against buying that or a long position in Gold back. Long-term returns are cumulative and gains compound. The market doesn’t particularly care what I own on any particular day.

 

Making money starts with not losing money. And while I am painfully aware of how hard it is to actually execute on that strategy at the end of bear market rallies (2007 and 2011), I’m also very respectful that long-term returns in this business are both Non-Linear and Uncertain.

 

My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1788-1866, 79.84-84.69, and 1108-1166, respectively.

 

Best of luck out there this week,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Uncertainty and Non-Linearity - Chart of the Day

 

Uncertainty and Non-Linearity - Virtual Portfolio



Grim Irony

“That the earth would give way beneath his feet was a grim irony for Mickey Mantle.”

-Jane Leavy in “The Last Boy

 

The end of Summer 2011 is approaching. I’m packing up my family for Thunder Bay. And I’m smack in the middle of a Twittersphere debate about arrogance, confidence, and success.

 

Some people think confidence and success is fleeting because, for them, it really is. Winning is hard – but great teams find a way to make it both achievable and repeatable. I wake up every morning not only accepting the Uncertainty associated with being right in this business, but swallowing the adversity that each market day and competitor brings.

 

Tired old processes that refuse to evolve are threatened by us. We get it. I’ve seen my fair share of Grim Irony in the arena of life. Whether accountability was my being punched square in the face in a Canadian Junior hockey barn or reality was being fired 5 days before the birth of my 1st son, I get it. No one owes me anything in life and there’s plenty of earth to give way beneath me yet.

 

Back to the Global Macro Grind

 

Mickey Mantle was the son of a lead miner. His Dad, Mutt Mantle, died young. Before his death, as a Yankee rookie The Mick had already blown out his knee and faced plenty of adversity both on the field and from tiring veteran teammates (DiMaggio). The lesson learned from Mutt though was simple – out of sight, our of mind - play the game that’s in front of you.

 

And so we will this morning…

 

I took down my Cash position yesterday from 70% to 64% as there were some asset classes on sale that I continue to like – Corporate Bonds (LQD) and Precious Metals (SLV).

 

The Hedgeye Asset Allocation Model positioning is currently as follows:

  1. Cash = 64%
  2. Fixed Income = 21% (Long-term Treasuries, US Treasury Flattener, Corporate Bonds – TLT, FLAT, and LQD)
  3. International Currency = 6% (Canadian Dollar – FXC)
  4. International Equities = 6% (China and S&P Dividend ETF – CAF and DWX)
  5. Commodities = 3% (Silver – SLV)
  6. US Equities = 0%

I didn’t buy Gold yesterday (I might today – immediate-term TRADE support = $1705/oz and I’d like to see that critical risk management line of support hold before I try to play hero – for our Gold levels, see the Chart of The Day by Darius Dale attached). Instead, I bought back the Silver position that I sold on August 19th at $41.37 (SLV).

 

Being able to buy something that you sold higher is a wonderful feeling. A lot of people in this business call that “market timing.” And a lot of those same people say that “you can’t time markets.” Trust them on that – most of them can’t.

 

But if you could hit a baseball 734 feet (Mantle on May 22, 1963 at Yankee Stadium) or you could revolutionize the way people consume Apples (personal computing), why wouldn’t you try? While everyone else is whining, why wouldn’t you try it confidently?

 

Confidence breeds success. Success breeds confidence.

 

I’m certainly not suggesting Hedgeye is Mantle or Steve Jobs. But I am explicitly saying that Hedgeye is the greatest investment team I have ever had the pleasure and privilege to play on. We’re young. We’re evolving. And we have just as good an opportunity as any great Wall Street firm that has come before us to change the way this game is played. That’s exciting.

 

Until yesterday I had a ZERO percent asset allocation in the Hedgeye Asset Allocation Model to both US and European stocks and the entire Commodities complex. On one of those two things (Commodities), that was a good thing. On another (Stocks), it wasn’t – until China closed up big overnight (up +2.9% - we’re long Chinese Stocks) and US stock market futures are indicated down, again.

 

Again is as again does.

 

Over and over and over again, the Perma-Bulls have been buying stocks and changing their thesis as to why as they go. At the end of 2007 (the SP500 is still down -24.8% since then, fyi), it was because “stocks were cheap” and corporate America was “awash with liquidity.” Today, I guess their portfolios are still awash with US Equity exposure and stocks are getting cheaper.

 

But what does all of their storytelling and finger pointing really do for this country? People don’t trust this economic system or the people who manage it. If calling opacity out on the carpet is “arrogant”, I’ll happily be transparency’s child. America trusts winning and the Grim Irony of all of this back and forth about who is “perma” this and “perma” that is that very few have been Perma Right.

 

My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1, $81.24-89.23, and 1108-1191, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Grim Irony - Chart of the Day

 

Grim Irony - Virtual Portfolio


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