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Initial Claims

Initial Claims dropped a spectacular 32k WoW (37k after the revision to the prior week) but this improvement is too good to be true.  The Department of Labor reported that an unusual calendar caused the seasonal adjustment to break down. If you look at the NSA chart below, you can see that there's no unusual volatility in this series.  There are always big swings in the NSA series around quarter-end, and it appears that the seasonal correction generated a misleading number today.  


Unfortunately, it's not time to get excited yet.








2-10 Spread Remains Under Pressure

The current rate environment remains very difficult for bank margins. The 2-10 spread widened 7 bps in the last week to 174 bps.  






Mortgage Purchase Applications Continue to Bounce Along the Bottom

Mortgage purchase applications rose 2.6% last week, a small gain off of a low level.  For the YTD, purchase apps are running 8.6% lower than the prior year.  This is not an encouraging sign for homebuyer demand.  Refinance applications rose as mortgage rates fell, gaining 11.2% vs the prior week.  












Subsector Performance

The table below shows the performance of financial subsectors over various durations.





Joshua Steiner, CFA


Allison Kaptur


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Given that Darden preannounced its fiscal first quarter earnings earlier in the month, there were few surprises in yesterday's EPS release and nothing new to get me really excited to be long the stock.  There are, however, a lot of things to think about, not only as it relates to DRI but also the consumer environment in general. 


To me, DRI is the epitome of what is wrong with having exposure “Middle America” and the average consumer.  In the current environment, in the restaurant space, if a company/concept in not “on trend” with a unique customer appeal there is going to be traffic and spending related issues.  The easiest path to attracting more consumers for casual dining companies is through ever-better value offerings.  The Olive Garden is set to begin advertising a half Panini sandwich, unlimited soup and/or salad for $6.95 in what is clearly a move to take some traffic from Chili’s.


My belief is that the average concept serving an aging consumer is consistent with a fundamentally-weak economy.  Here, again, is my thesis for the consumer: no job growth, declining real income, Bernanke-inspired price volatility, declining stock prices, falling house prices, sticky gasoline prices, and zero confidence equals declining consumption.


The Olive Garden is the poster child for some of these issues.  The concept is generally very healthy, with very strong average unit volumes, but they are struggling to generate incremental traffic.  There are some Olive Garden-specific issues.  For instance, their asset base is weak with half of the units needing a major remodel; the fix is 6-12 months away and the advertising is somewhat stale and not driving new consumers to the concept.


Naturally, the company’s first response to immediately prop up sales is to offer lower prices to increase the value perception of the brand.  To me that is a reaction or a defensive move not a proactive step in trying to bring in new or lapsed users.


What I worry about most with DRI is the company resorting to too much discounting, as they have done in the past.  I know it’s a different management team and Clarence Otis is Joe Lee’s apprentice but I think the $15 price point offer from Red Lobster this past quarter was disconcerting.  I know management put their best foot forward with an acceptable rational for the promotion, but the memories of past Red Lobster discounting efforts are still fresh.


For 1Q12, sluggish same-store sales trends at the Olive Garden (reported -2.9%, with traffic down -2.2%), combined with higher commodity costs, resulted in lower year-over-year operating margins and earnings during the first quarter. 


Higher than anticipated “check management” during the quarter (consumers, fatigued from macro pressures are purchasing fewer appetizers, drinks and desserts) put increased pressure on margins.  Management attributed about one-third of the higher year-over-year food and beverage costs as percentage of sales to this increased “check management.” 





Darden maintained the fiscal FY12 guidance that it provided when the company preannounced first quarter earnings, including blended same-store sales growth of about 3% at Olive Garden, Red Lobster and LongHorn, operating margin growth and 12-15% earnings growth with “higher confidence at this point in the year in the low end of the range.”


Although these expectations are not out of reach, they rely on the fatigued consumer not being so fatigued.  Most notably the company needs to see improved trends at Olive Garden, a moderating level of check management and more favorable commodity costs in the back half of the year.  Not to mention the overall environment which relies on an economic recovery that Darden CEO Clarence Otis called “uneven and relatively anemic”.


Management would not provide any details about trends in September, outside of saying that they had “reason to be encouraged.”  This was not enough to outweigh investors’ concerns, as evidenced by the stock’s performance yesterday.


If consumers are focused on affordability right now as management stated on its earnings call, and we continue to see a deceleration in overall consumer spending trends, I am not as confident as management that the current level of check management will moderate.  As we have seen in the past, impacting many full-service concepts, customers tend to manage their checks lower in order to still dine out during tough economic times.  This will likely continue to be a factor until we see steady improvement in the economy.  Time will tell.  As I wrote earlier, half of The Olive Garden’s store-base needs to be remodeled and that is not going to happen in 2012.


Another financial uncertainty for Darden stems from the company’s expectation for more neutral commodity costs during the second half of the year.  Although trends will likely improve year-over-year as a result of easier comparisons, Darden’s guidance relies somewhat on declining costs from current levels.  The company has contracted 80% of its commodity costs through the end of the calendar year but only 25% of its costs through the end of its fiscal year, which leaves the company’s income statement fairly exposed during the second half of the fiscal year. 


Senior management made a bet that commodity prices will decline and it looks to be a smart move given the current trends. 





Turning the Olive Garden around is not going to be an easy and will take time.  Management is focused on doing the right things such as improving the core menu and its advertising strategy and refreshing and remodeling its store base, but these steps all take time and trends could get worse before they get better. 


The only immediate strategy to increase traffic is to offer lower priced menu options, or what management called “addressing affordability” in an effort to appeal to its customer base that includes a lot of people making less than $60K/year.  Although lower prices could drive increased traffic, it will have a negative impact on margins and could permanently push Olive Garden’s average check lower.  Given Olive Garden’s aging store base and cash-strapped customer base, I am not convinced the company will see any real improvement in same-store sales trends this year.


Relative to Darden’s full-year same-store sales guidance, if the company maintains the two-year average same-store sales growth trends at Red Lobster, Olive Garden and LongHorn that it achieved during the first quarter for the remainder of the year, it would imply same-store sales growth of about 2.7%, just shy of its 3% target. 


So reaching this 3% guidance goal assumes an improvement at Olive Garden, as stated by management, but it also assumes continued momentum at Red Lobster and LongHorn.  Given LongHorn’s consistently strong trends in the recent past, I would not be surprised to see the concept’s momentum continue at current levels. 


Same-store sales trends at Red Lobster, however, improved nearly 500 bps on a two-year average basis during the quarter and I do not think this level of improvement is necessarily sustainable for the rest of the year.  And, if Red Lobster cannot maintain +4.5% two-year average trends, Olive Garden’s performance will have to improve rather significantly on a two-year average basis to achieve 3% same-store sales growth. 









Howard Penney

Managing Director


Rory Green


Reformation Time

This note was originally published at 8am on September 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.

“There is an embarrassing lack of talent and imagination in the last generation of the technocrats.”

-Victor Davis Hanson


On August 9th, 2011, Hanson published a thought provoking article in the National Review titled “A Tottering Technocracy” that I highly recommend. If you want to stop the losing in this country, first you need to get the ball out of the losers’ hands. Winners win.


“An education-age Reformation is brewing every bit as earth-shattering as its 16th century religious counterpart… So the elites furor grows at those who seek and obtain power, exposure, and influence without the proper background, credentials, or attitude.”

-Victor Davis Hanson (National Review, August 2011)


Losers don’t want to hear this today, tomorrow, or the next day. Especially from me. But, for them, I guess that’s too bad isn’t it? I’m the one hiring and we’re going to do everything we can to be the change we all want to see in this country. We can do this.


Back to the Global Macro Grind


With global markets hanging on every whisper coming out of Eurocrats from Greece to Germany this morning, our economic freedoms remain in the balance.


What the Europeans ultimately decide to do when they pull out their multi-trillion Euro-TARP bazooka is out of our hands at this point. That said, we can make sure that the likes of Tim Geithner and his compromised and conflicted cronies don’t’ fool us the 2ndtime.


Remember, whatever bazooka took the US Financials up for the short-term remains a national banking embarrassment in this country for the long-term. Letting losers lose is an important principle of “free” markets because, in the end, they’ll lose anyway.


I can’t imagine anyone likes playing the game this way, but we have to play the game that’s in front of us. Here’s your Global Macro calendar of critical catalysts for this week: 

  1. Tuesday, Greece’s PM meets with Angela Merkel in Germany
  2. Tuesday, US Federal Reserve President Fisher discusses why he disagreed with Bernanke on implementing the Twist
  3. Wednesday, Bernanke gives a speech on “Emerging Markets” and how his policy to inflate had nothing to do with nothing
  4. Thursday, US GDP for Q211 is released (still subject to 32-81% downside revisions)
  5. Thursday, Germany’s Bundestag votes on the Euro-TARP bazooka
  6. Friday, Congress votes on another Keynesian Spending Bill (and could shut down again if they don’t pass it)
  7. Friday, is month and quarter end for all of the asset managers in our business (watch out for the customary markups) 

Why my Macro calendar of catalysts isn’t more data and fundamentally driven is a failure of our financial system’s current architecture in and of itself. If I’ve said this 1000x in the last 3 years, I have said it 10,000x - Big Government Intervention in our markets will continue to have 2 general outputs:


A)     Shortened Economic Cycles

B)      Amplified Market Volatility


And… so the “furor grows” for calling policy people out on this… the truth hurts.


The truth also reveals new horizons of opportunity. The best news we had last week was that a Strong Dollar can re-build a Strong America. The US Dollar Index was up another +2.5% week-over-week, taking its cumulative appreciation to +7.5% since the end of April.


Strong Dollar Deflates The Inflation. Period.


Week-over-week, here’s how that looked in the Commodity prices: 

  1. CRB Commodities Index down -8.5%
  2. Oil down -9.2%
  3. Copper down -16.5% 

Yes, the price of Gold and US Equities were down -9.6% and -6.6% respectively. But, that’s good for all of the astute buyers out there who knew Growth Slowing was going to be their 2011 investment theme. The winners are in cash and there’s nothing more a proactively prepared American likes than buying things on sale.


The only people who don’t want a Strong Dollar are the people who don’t get paid by a strong dollar. Follow the money and you’ll usually figure these types of things out. You’ll probably pick up some transparent and accountable friends along the way too.


To one of Washington/Wall Street’s finest central planners, it may sound upside down for me to say that seeing energy stocks and prices at the pump decline in unison is good for America. But that’s exactly what I want them to hear.


They can’t buy my vote of confidence anymore with their fleeting schemes to inflate. It’s Reformation Time in America, indeed.


My immediate-term support and resistance ranges for Gold, Oil, and the SP500 are now $1630-1782, $79.19-85.91, and 1121-1144, respectively.


Bes of luck out there today,



Keith R. McCullough
Chief Executive Officer


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The Macau Metro Monitor, September 29, 2011




Macau schools, government offices, bus and ferry services, and parts of the airport were shut down after Typhoon Nesat swept past the city.  Casinos continued to be open for business as usual.



According to the Bangkok Post, Prime Minister Yingluck Shinawatra said currently, the government has no plans to open the country to casinos.



CHART OF THE DAY: Leading From The Front


CHART OF THE DAY: Leading From The Front - Chart of the Day

Leading From The Front

“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:

  1. Monday, I cut our asset allocation to US Equities to 0% again (sold Utilities, XLU)
  2. Monday, I cut our asset allocation to Commodities to 0% again (sold Gold, GLD)
  3. 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."

-John Wooden


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


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