“We will all sleep as I do, in the open.”
At the end of chapter 22 of “Gates of Fire”, King Leonidas gives an epic speech to his officers about leadership.
“I am telling the Spartans what I tell you now. You are the commanders; your men will look to you and act as you do. Let no officer keep to himself or his brother officers, but circulate day long among his men. Let them see you and see you unafraid.”
Compare and contrast that sense of responsibility and selflessness versus the putrid lack of accountability we have to wake up to as modern day capitalism comes under left-leaning Keynesian assault:
“Monetary policy is not a panacea. There are certainly some areas where other policy makers could contribute.”
-Ben Bernanke (in a speech yesterday)
There is no legitimate leadership in this country’s economic policy making inasmuch as there is none in France or Italy this morning. Losers are pointing fingers and making excuses rather than bellying up to the bar like Red Sox GM Theo Epstein did last night:
“You can’t sugarcoat this. This is awful. We did it to ourselves and put ourselves in a position like this to end our season.”
The winners in this country who bleed red, white, and blue get accountability. Our academic and political policy makers, who have never had to meet a payroll in their life, do not.
Back to the Global Macro Grind…
In Monday’s Early Look I outlined this week’s calendar of Global Macro catalysts. The last 2 catalysts left for the Big Government Intervention “is the best path to long-term economic prosperity” club, were a vote for the Euro-TARP bailout in the Bundestag and month-end markups.
If the German vote was your catalyst to be long anything European or US Equities, that catalyst is now gone. What do you do now? Hope for another left-leaning central plan to suspend economic gravity? Or just say hey – this whole Keynesian thing “is not a panacea?”
Rather than lean on the losing side of this year’s Global Macro trade, it’s time to get back to winning again here this morning. From New Haven, Connecticut to St. Louis, Missouri, we’re issuing a friendly challenge to all of the winners of the 2011 game of Globally Interconnected Risk to unite.
First, let’s stick with this week’s game plan:
- Monday, I cut our asset allocation to US Equities to 0% again (sold Utilities, XLU)
- Monday, I cut our asset allocation to Commodities to 0% again (sold Gold, GLD)
- Tuesday, I moved the Hedgeye Portfolio back to net short (more shorts than longs)
This isn’t being “over-confident”, “uber bearish”, or whatever the losers and the haters out there want to call us. This is simply a reminder that we have a repeatable risk management process at this firm that has saved our clients and their clients a lot of money in both 2008 and 2011.
"Winning takes talent, to repeat takes character."
Winning doesn’t require bailing out losers. It doesn’t require extending the short-selling ban like the French are doing again this morning either. Winning requires accountability, confidence, and trust. If people don’t trust you or your economic policy making process, you should be fired.
The SP500 is down -26.5% from the October 2007 high. It’s down -15.6% from the April 2011 lower-long-term high. This is called losing. And the best way to start winning again is to end whatever it is that these people keep doing to our markets, over and over and over, again.
No more whispers, rumors, and squirreling around in the shadows of this fiat system. No more bailout money printing as the elixir of short-term political life. Stop.
“I want to see shields flashing like mirrors, for this sight strikes terror into the enemy” (Leonidas in Gates of Fire, page 226). Give me transparency, or give me a place of American mediocrity where I can sleep in.
My support and resistance ranges for Gold, Oil, the German DAX, and the SP500 are now $1, $77.91-83.69, 5, and 1113-1171, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
THE HEDGEYE DAILY OUTLOOK
TODAY’S S&P 500 SET-UP - September 29, 2011
With the Hedgeye 1182 TRADE line of support becoming resistance (again) for the S&P500, We have very little appetite to take on month-end markup or EuroPig rumor risk. Don’t forget that the average drawdown in the S&P500 in the first 6 days of the new month since April = -4.5%.
As we look at today’s set up for the S&P 500, the range is 64 points or -3.31% downside to 1113 and 1.73% upside to 1171.
SECTOR AND GLOBAL PERFORMANCE
We moved to 2/9 sectors positive on TRADE and 1/9 on TREND. XLU remains the only sector positive on both durations.
- ADVANCE/DECLINE LINE: -2079 (-4017)
- VOLUME: NYSE 1049.03 (-11.85%)
- VIX: 41.08 +8.94% YTD PERFORMANCE: +131.44%
- SPX PUT/CALL RATIO: 2.45 from 1.82 (+34.39%)
CREDIT/ECONOMIC MARKET LOOK:
Another one of the super secret surprises that the gods of Chaos Theory have imposed on Monsieur Bernank’s lap = rising rates at the short-end of the US Treasury curve with a brand new TRADE line breakout above the Hedgeye 0.20% line for 2-year yields. Long-end of the curve (yields) remain broken across durations, but rising real-rates on the short-end is not good for Gold (on the margin)
- TED SPREAD: 36.35
- 3-MONTH T-BILL YIELD: 0.02% +0.01%
- 10-Year: 2.03 from 2.00
- YIELD CURVE: 1.76 from 1.65
MACRO DATA POINTS (Bloomberg Estimates):
- 8:30 a.m.: GDP 2Q, T, est. 1.2%, prior 1.0%
- 8:30 a.m.: Personal consumption 2Q, T, est. 0.4%, prior 0.4%
- 8:30 a.m.: Jobless claims, est. 420k, prior 423k
- 8:30 a.m.: Fed’s Plosser speaks on economy in Radnor, Penn.
- 8:30 a.m.: Net export sales, commods
- 9:45 a.m.: Bloomberg consumer comfort, est. -51.0
- 10 a.m.: Pending home sales, est. M/m -2.0%
- 10 a.m.: Business Roundtable releases 3Q economic survey
- 10 a.m.: Freddie Mac Mortgage
- 10:30 a.m.: EIA natural gas storage
- 11 a.m.: Kansas City Fed. Manufacturing, est. 3
- 1 p.m.: Fed’s Lockhart speaks in Atlanta
- 1 p.m.: U.S. to sell $29b in 7-yr notes
WHAT TO WATCH:
- Germany to vote on euro rescue fund, sets stage for next steps
- Microsoft is said to add Comcast, Verizon pay TV to Xbox Live
- Basel III to hurt European companies more than U.S., S&P says
- House meets in pro-forma session, expected to pass short- term continuing resolution, which funds government through Oct. 4 by unanimous consent
- Italian, Spanish and French market regulator extend short selling ban on financial stocks
COMMODITIES: free falling Copper prices now make headline "news", should be immediate-term oversold at $3.06/lb
MOST POPULAR COMMODITY HEADLINES FROM BLOOMBERG:
- Rare Earths Fall as Toyota Develops Alternatives: Commodities
- Shell Fighting Fire at Singapore Refinery After Blaze Surges
- LME Says ‘Expressions of Interest’ Exceed 10, Board to Meet
- Saudi Crude for Fuel Oil Nearing 22-Month High: Energy Markets
- Copper, Industrial Metals Decline as European Risk Hurts Demand
- Commodities Rebound, Paring Worst Quarter Since 2008 on Germany
- Oil Fluctuates as It Heads for Biggest Quarterly Drop Since 2008
- Crude Oil Climbs Ahead of German Vote on European Bailout Fund
- Yancoal Studying More Than $1 Billion in Australian M&A
- Alumina Gains on Speculation Company May Be Takeover Target
- Singapore Middle Distillates May Rise After Shell Refinery Fire
- Denmark Creates Rescue Fund for Crisis-Hit Farming Industry
- Freeport McMoRan’s Peru Copper Miners to Strike Over Wages
- Copper Falls 5.9% to $6,824.75 a Ton in London
- Palm Oil Declines on Concern Global Slowdown May Hurt Demand
- China Seen Needing ‘Huge Effort’ to Meet Increasing Corn Demand
- Commodities Head for Biggest Quarterly Drop Since 2008 on Debt
- World Slump Seen Triggered by European Breakdown in Global Pollt
EUROPE: hope reigns into the Bundestag vote with Germany hanging tough above my immediate-term TRADE line of support (5439 DAX)
- Eurozone Sep Economic Sentiment 95.0 vs consensus 96.0 and prior revised 98.4 from 98.3
- Eurozone Sep Consumer Sentiment (19.1) vs consensus (18.9) and prior (16.5)
- Eurozone Sep Business Climate (0.06) vs consensus (0.11) and prior revised 0.06 from 0.07
DAX – bullish TRADE, bearish TREND setup continues to hold up for the Germans in the immediate-term as my 5348 TRADE line of support continues to hold. The refreshed range (immediate-term) for DAX = 5, so the squeezage from here is defined at +2% left on the upside. Rock solid unemployment report of 6.9% in Germany this morn for September (vs 7.0% AUG) notwithstanding.
Surprisingly strong session for Asian Equities last night! That doesn’t mean that China/HK/KOSPI/Japan/etc aren’t crashing anymore; it just means that bear markets bounce: Nikkei +1%, KOSPI +2.7%, India +0.9%.
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Last week, commodities continue to be pressured by a combination of the strengthening dollar and mounting concerns about economic growth.
- Declining grain prices (corn in particular) are bullish for restaurant industry margins as it is bearish for protein prices. In particular, this is a positive for TSN and SAFM
- Coffee prices have declined dramatically over the last month, perhaps indicating that further price hikes from the coffee concepts – SBUX, DNKN, PEET, GMCR, CBOU and THI – are unlikely. Higher retail prices may remain, however, as inventory acquired at high prices is worked through.
- Chicken Wing prices are heading sharply higher, which is a concern for BWLD at a time when economic growth is a concern and the company is stepping up expansion into new markets.
- Dairy prices moved marginally higher but, on a year-over-year basis, cheese prices remain down which is a positive for CAKE, DPZ YUM and PZZA, especially considering the level cheese prices were at just a few weeks ago.
Chicken wings, beef and dairy were the only items in our commodity monitor that saw price gains versus last week. The declines in our weekly monitors were far larger than the advances; as the table below shows, grains, coffee, and chicken broilers all saw significant losses in price week-over-week. In theory, this is a good thing for restaurant companies especially given the price increases that Starbucks and others have had to implement to protect margin. The reality remains, however, that much of the softness in commodities at the moment is due to concerns over the global economy. If these fears are justified, the implied softness in the sales environment would effectively offset any benefit from lower input costs.
Last week, commodities continue to be pressured by a combination of the strengthening dollar and mounting concerns about economic growth. Brent crude declined almost 6% over the last week as gasoline prices also dropped week-over-week, which is generally a positive for restaurants on the margin. That said, the chart below shows that gasoline prices plummeted in 2008 as the recession struck. Commodities are again sinking lower here in 2011 as the European sovereign-debt crisis threatens to derail the global economy.
Corn dropped 8% versus last week. This is a positive data point for the restaurant industry as a whole, not only companies with direct exposure to corn costs. As corn costs come down, that offers some relief to protein producers that can take advantage of the resulting decline in feed prices. Despite smaller supply from the U.S., demand concerns are acute enough to lead prices lower.
Below is a selection of comments from management teams pertaining to grain prices from recent earnings calls.
PNRA (7/27/11): “Just to note on the cost of wheat, in 2011 overall, the per-bushel cost will be about the same as 2010 due to our laddering purchasing strategy.”
“We are going to take price in the fourth quarter. This price will offset dollar for dollar the per-bushel inflation of wheat of approximately $3 a quarter that we're going to see in the fourth quarter of this year and then across next year”
“We do continue to expect significant inflationary pressures in 2012, 4% to 5% food inflation, $10 million of unfavorability on wheat costs, which means that we don't expect operating margin much better than flat to full-year 2011 in 2012.”
HEDGEYE: Weak global demand and a stronger dollar are currently trumping the adverse impact on supply due to weather and fires in the U.S. Slowing demand may also mean lower sales for PNRA, so it remains to be seen if margins improve from this effect, even if high wheat costs come down.
DPZ (7/26/11): “We're fairly locked in on our chicken, locked in on our wheat into – partway into next year.”
PZZA (8/4/11): “We're actually covered through Q1 from a contract standpoint. So from a supply chain disruption or even significant price impact we don't anticipate anything between now and the end of the year.”
Coffee prices declined -7.3% as the dollar gained 1% over the same period. Kraft Foods and J.M. Smucker have already cut prices as coffee prices slump but the supply and demand dynamic point to possible continuing softness in price. According to Bloomberg, farmers from Vietman to Brazil are expected to supply a record robusta crop in the marketing year that begins next month. SBUX had bought most of its coffee needs for the year ending September 2012 earlier this year, according to management commentary on its most recent earnings call in July. This could mean that retail prices take some time to adjust as inventory is processed.
Below is a selection of comments from management teams pertaining to coffee prices from recent earnings calls.
PEET (8/2/11): “As we indicated, in our first quarter call, we had to buy a small amount of our calendar 2011 coffee beans at significantly higher prices and this coffee will roll into our P&L during the third and fourth quarter.”
“Higher priced coffee resulted in gross margins this quarter being 290 basis points below prior year. In our first quarter conference call, we indicated that in addition to the overall higher price coffee market, we had to buy a small amount of coffee this year at significantly higher prices. And as a result, we expected our coffee cost to be 40% higher in fiscal 2011.”
HEDGEYE: Peet’s is a company with a very competent management team that manages coffee costs extremely well. Its higher-end, loyal customer base makes the price elasticity of demand more inelastic than for other coffee concepts’ products.
SBUX (7/28/11): “As I mentioned earlier, are absolutely a headwind for us in the full business and that's most acutely impactful on margins in CPG as it's a much more coffee intensive cost structure, as you know. I can tell you that the decline as I spoke about it earlier from about 30% operating margin in CPG this year down to the target 25% next year is really all explained by commodities. Absent commodity inflation we'd be at or improving our margin in the coming year.”
“As we had anticipated, in recent weeks, coffee prices have retreated significantly from a high of more than $3 per pound just a couple of months ago to levels now near $2.40 per pound. As prices have been falling we continue locking up our needs for fiscal '12 and now have virtually the full year price protected.”
HEDGEYE: Starbucks is aligning itself with the right partners to gain more control of its coffee costs to provide investors with more certainty going forward and to protect its margins as global coffee demand continues to rise.
GMCR (7/27/2011): “However, what we've said is that should coffee prices or other material costs spike, we will certainly consider price increases as necessary. We certainly hope that we do not have to cover one again next year. But our objective long-term is attempting to maintain our gross margin as we would see input costs come along.”
HEDGEYE: GMCR hedges out 6-9 months in advance. Strength in the dollar has helped bring coffee prices lower but whether or not dollar strength will continue or not will be a significant factor in future price action in coffee. Growing demand, globally, is bullish for coffee prices over the long term.
Chicken wings gained 4.3% after last week’s 7.2% gain in another down week for commodities. This is definitely a concern for BWLD at a time when the top-line environment is becoming more difficult and the company is expanding its footprint into new markets.
Here are some trends we are seeing from our pricing database at the end of September.
Given CCL’s Q4 guide down, analysts are expecting RCL to do the same. Q4 EPS estimates have been lowered from $0.28 to $0.23 after CCL’s conference call. We're keeping our Q4 estimate at $0.22 as we're seeing more weakness in North America pricing. Like CCL, RCL management will probably continue to bash Europe for all their problems but Europe only accounts for a small portion of RCL’s itineraries in Q4. However, Q1 2012 outlook looks pretty healthy, particularly in South America.
The good: Strong prices for close-in Caribbean bookings may give them a small boost for Q4.
The bad: Tough start to 1Q 2012 as Costa continues to cut prices sharply for its European itineraries and Mexico/South America itineraries struggle to maintain prices.
Tables and commentary
(We follow pricing trends relative to prices on the most recent earnings date)
Key: +/- 1-5%
Q4 2011 trends:
- Over the last month, there were substantial price cuts across the fleet particularly with Freedom of the Sea and Serenade of the Seas. In addition, pricing for Celebrity Millennium and Celebrity Silhouette remain weak.
- Pricing continues to improve on a fleetwide basis
- Legend of the Seas pricing has deteriorated significantly. But we think this has more to do marketing for close-in bookings as volume has improved in the past month.
- South America
- RCL brand outperforming Celebrity by a mile on pricing
- Pricing has surged since August
- Slightly weaker performance from Cunard and Costa
- Weaker across the board
Q1 2012 trends:
- Pricing remains steady as Oasis of the Seas and Allure of the Seas maintain pricing power
- No change from the few itineraries
- Stronger Legend of the Seas pricing
- South America
- RCL brand pricing remains very strong
- No change
- Not a good sign as Costa has sharply cut prices
- Mexico/South America
- A little weaker than a month ago
Reebok’s Toning settlement should be taken into context. While it never appeared to us to be a sustainable biz, it did shift share around a bit. The trend has been self-correcting for 11-months now. So we’re not concerned about it ‘going away.’ In fact, a simple look at Nike’s US order book tells us where these toning dollars are going.
Reebok’s $25mm settlement with the FTC over unsubstantiated claims on the technology behind its shoes this morning is raising questions over the ‘category’s’ sustainability. The stocks are not moving meaningfully on this, nor should they. But here’s some context to the extent that people get loud (as CNBC did – saying that there’s $1Bn at risk) on the issue. Consider the following:
- The toning trend started with Skechers Shape-Ups in early 2009. Within 6-months Reebok joined the party with its Easy Tone shoes and hefty advertising budget, which ultimately drove accelerating demand by the Fall of ’09. From late ’09 to early ’10 there were several marginal players entering the fray (Ryka, Puma, etc.), but this was really a two horse race from beginning to end with market share for SKX and Reebok at roughly 60/40 respectively. Nike stayed out of it entirely, referring to it as a gimmick. We are in print, and on TV, in saying that “selling shoes to a person who wants a shoe to get them in shape while they walk to and from the couch to the refrigerator to get bon bons and beer is hardly a sustainable model.”
- At its peak in mid-2010, we estimated toning to be just over a $1Bn category domestically and roughly $500mm internationally, at retail.
- At that time, the toning category was contributing up to 4%-6% to overall footwear sales growth in the athletic specialty channel. This benefit was fleeting. By October 2010, the category was a drag on consolidated growth in the industry as demand slowed abruptly. Meanwhile, the industry excluding toning was growing at a rate from mid-single-digit to low-double-digit.
- With Skechers and Reebok left severely over-inventoried heading into the shift in demand, the discounting began. With prices for toning shoes still now at roughly half of where they sold at the peak, the category has contracted to a what is now a ~$500mm category domestically – similar in size to categories like occupational and cold weather casual boots.
- What is perhaps the most notable callout throughout what can now be dubbed as the ‘toning fad’ is Reebok’s ability to leverage the trend to regain relevance. Take a look at the two charts below illustrating both Reebok and Skechers’ market share gains both during, but more importantly following the toning cycle. SKX gained 4 points of share in the industry only to give it all back to ‘real’ innovation leaders like Nike and Adidas. Reebok on the other hand gained 2-3 points of share initially and has continued to take share as it rolled its success directly into its latest ZigTech offering.
- Keep in mind that Skechers started from a larger base (6% share of the industry) with its stable brown shoe and growing kids business while Reebok represented an inconsequential 2% of the industry. For what it’s worth, they both now have about a 6% share.
At this point, there’s definitely a risk that Skechers is forced to pay a similar settlement to the FTC for its own advertising claims. Is it going to move the needle for the company, no.
From an industry perspective, we are a month away from the point when comping toning growth is an afterthought. In fact, over the last two quarters, footwear and sporting goods retailers alike have noted that the benefit of the latest lightweight running category has more than offset the impact of lost toning sales. The industry has moved on, so should we.
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