Theory vs Practice

“In theory there’s no difference between theory and practice, but in practice there is.”

-Yogi Berra


In theory, money printing and piling more debt-upon-debt was going to save the world’s biggest banks. In theory, Old Wall Street had Ben Bernanke’s back on +3-4% US GDP Growth for 2011. In theory, the Yankees should have beaten the Detroit Tigers last night too.


Then again, I’m a conflicted, compromised, and constrained Yankee fan – and with that theory, I may as well be a Keynesian this morning. In practice this is called marked-to-market risk management and the question this morning isn’t an ideological one – it’s, what do you do?


When I joined the hedge fund elite 12 years ago, I didn’t have to have a Global Macro view. Today, I do. In practice, this game of Globally Interconnected Risk is A) always on and B) always changing. Today, I have to play the game that’s in front of me.


Back to the Global Macro Grind


Immediate-term TRADE oversold is as oversold does. Today we’ll register the 3rdShort Covering Opportunity we’ll have called for in the last 2 months (the 1st call we made to cover shorts on August the 8th, 2011).


Here are the US Equity, Commodity, Currency, and Fixed Income factors that help me decide what we do now: 

  1. The SP500 is immediate-term TRADE oversold in the 1180-1197 range
  2. The Volatility Index (VIX) is immediate-term TRADE overbought at 47.11
  3. This is the first day in the last 6 trading days in US Equities where there’s more immediate-term upside vs downside
  4. The US Dollar Index is immediate-term TRADE overbought at $79.43
  5. The Euro/USD pair is immediate-term TRADE oversold at $1.31
  6. WTIC Oil is immediate-term TRADE oversold at $76.19
  7. Copper is immediate-term TRADE oversold at $2.95/lb
  8. US Treasury Yield Spread is putting in an oversold YTD low of 153 basis points wide
  9. US Treasury 2-year Yields are holding immediate-term TRADE support of 0.21%
  10. Goldman is cutting their Global Economic estimates across the board 

On top of the price/volume/volatility signals that help construct the 10 aforementioned factors in my model, we have a very newsy event on the tape with Deutsche Bank’s CEO (Ackerman) guiding Q3 down, big time.


In theory, this is all bad. In practice, a lot of what Goldman and Deutsche Bank are saying isn’t in the area code of what Hedgeye clients would consider new. Our Managing Director of Financials research, Josh Steiner, has been bearish on the banks since February.


The US Financials ETF (XLF) is down -29.3% for the YTD. That’s called a crash – and it’s readily apparent in the rear-view mirror. So is the SP500 having collapsed -29.8% and -19.4% from their October 2007 and April 2011 easy-money highs.


Today is a day to notice what no one will be focused on. In theory, your Risk Manager should have a process to impute everything that’s happening in the world as of last price. In practice, most money managers will be freaking out this morning making emotional decisions.


Capitalize on that.


What do I see that’s better than bad that people aren’t talking about this morning? 

  1. South Korean inflation (CPI) dropped sequentially to +4.3% for SEP versus +5.3% in AUG (on the margin that’s not bad)
  2. Chinese non-Manufacturing PMI rose sequentially to 59.3 for SEP versus 57.6 in AUG (China is not collapsing, yet)
  3. USA’s ISM report for SEP rose sequentially (month-over-month) to 51.6 versus 50.3 in AUG (Growth Slowing? not new) 

Again, I’m not calling for a new bull market. Neither am I saying that Growth Slowing has ended. I am simply suggesting that you see this for what it is in most things US Equities (and some things Asian and European Equities) this morning – a Short Covering Opportunity.


My immediate-term support and resistance ranges for Gold, Oil, Germany’s DAX, and the SP500 are now $1 (Gold is now bearish TRADE and TREND), $76.19-81.09 (Oil remains in a Bearish Formation – bearish on all 3 of our risk management durations), 5091-5439 (that TRADE line break in the DAX yesterday mattered), and 1080-1130, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Theory vs Practice - Chart of the Day


Theory vs Practice - Virtual Portfolio


Not as robust as earlier in the year but much higher than 2010



Market M&A Trends for Q3

  • Q3 US hotel transaction volume fell to $3BN from $4BN in Q2 and $5BN in Q1. But 2011 YTD volume is almost double that of 2010’s total.
    • Q3 US Upper Upscale Hotel Volume tumbled 65% QoQ as there were fewer transactions and a couple of fire-sales.  Average Price per Key fell to $250k in Q3.
  • REITs were not as active; JVs controlled much of the market
  • Portfolio deals picked up steam
  • The most prominent deal was the sale of W London at an average price per key of $1.6MM
  • Hotel delinquencies continue to trend around the 14% level. 
  • According to SHO CEO Kenneth Cruse, CMBS spreads have widened by 60-100bps from a rate of LIBOR+242bps a year ago

 Luxury Segment

  • Average Price per Key
    • Q3 2011
      • US average: $632,270  (2 transactions)
      • Other average: $858,612 (2 transactions)
    • Q2 2011
      • US average: $406,250 (4 transactions)
      • Other average:  $788,461 (3 transactions)

Upper Upscale Segment

  • Average Price per Key
    • Q3 2011
      • US average: $253,736 (8 transactions)
      • Other average: $338,661 (4 transactions)
    • Q2 2011
      • US average: $355,382 (13 transactions)
      • Other average: $250,152 (2 transactions)



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Bearish Formation: SP500 Levels, Refreshed

POSITION: Short Consumer Staples (XLP)


No change in my view here as there is no factor in my model that is making me change, yet.


Across risk management durations, the SP500 remains in what we call a Bearish Formation (bearish TRADE, TREND, and TAIL): 

  1. TAIL = 1266
  2. TREND = 1237
  3. TRADE = 1182 

There is an even shorter-term duration I use (almost hyper short-term to stress test for crash scenarios) that is building in a lower-high of resistance now at 1157. This is not encouraging as it puts pressure on the downward bound of my immediate-term TRADE range (1113).


At 1113 or wherever we wash out next, I’ll likely call that a Short Covering Opportunity. Nothing more. Don’t forget the US Employment Report is due out on Friday and a 50,000 payroll add (expected number) is no layup. Neither is closure on a Euro-TARP bazooka before October 17th (EU Summit).



Keith R. McCullough
Chief Executive Officer


Bearish Formation: SP500 Levels, Refreshed - SPX

European Risk Monitor: More of the Same Indecision

Positions: Short Italy (EWI)

Some things change, others stay the same. As the European sovereign debt and banking contagion crisis chugs along, the underlying current remains that despite Germany’s pledge to back the EFSF, the fund is undercapitalized to deal with the bailout/default needs of Italy or Spain, and Trichet and the ECB remain unwilling to let the Bank take on more risk via larger sovereign bond purchases.


As the powder keg of indecision on go-forward policy from Eurocrats heightens, so too does volatility across European capital markets. We’re positioning to get short a number of European economies at the right price. Currently we’re short Italy in the Hedgeye Virtual Portfolio via the etf EWI, but numerous indices are broken across immediate and intermediate TRADE and TREND durations, an explicit bearish set-up in our models. [For more on our thesis on Italy see our note titled “Shorting Italy (EWI)” on 9/30].  


From a risk perspective, we continue to take our cues from government bond yields and cds spreads. As we’ve noted in previous work, the 6% yield on 10 year government bonds has been a historically significant level for the PIIGS, meaning that a violation of the line to the upside resulted in an expeditious upward run (see chart below).  Italy, like Spain, has maintained a level below 6% since the ECB restarted the SMP on August 8th, and currently trades at 5.50%, whereas Spain is trading at 5.08%.  However, should yields rise above the 6% level, we’d expect the ECB and European policy makers to act quickly to attach another band-aid to the Union’s fiscal imbalances.


European Risk Monitor: More of the Same Indecision - A. 10


European Sovereign CDS – European sovereign swaps were mostly tighter week over week, with only the German sovereign CDS spread widening. Irish sovereign CDS spreads tightened week over week by 15%. (Please note: Greek CDS is not shown in the chart because the data was not available.  To gauge Greek credit risk, please refer to Greek bond yields below.) 


European Risk Monitor: More of the Same Indecision - A. 1


European Risk Monitor: More of the Same Indecision - A. b


We don’t have the crystal ball on the timing of the next bailout band-aid, however below we provide a calendar of catalyst around which an announcement could be made:


4th October:                            ECOFIN Council.                

6th October:                            ECB Interest rate decision. Jean Claude Trichet’s last Meeting as President.

13th October:                          Eurogroup to decide on release of 6th tranche of Greece bailout funding.

13th October:                          Italian Bond Auction.

14th October:                          G20 Finance Ministers.

Mid-October:                           Possible Italian proposals on labor market and other structural reforms.

17th October:                          Possible Slovakian vote on EFSF.                              

17th/18th October:                   EU Summit.

27th October:                          Irish Presidential Election.

28th October:                          Italian Bond Auction.

Late-October:                          Expected publication of European Commission report on Eurobonds.

1st November:                         Mario Draghi replaces Jean Claude Trichet as ECB President.

4th November:                         G20 Heads of State.

8th November:                         ECOFIN.

20th November:                       Spanish Elections.


Finally, below we present the European Financials CDS Monitor from our Financials team. Bank swaps mostly tightened in Europe last week.  Swaps tightened for 34 of the 40 reference entities, widened for 5, and was unchanged for 1. The average tightening was 6.7%, or 37 basis points, and the median tightening was 3.0%.


European Risk Monitor: More of the Same Indecision - A. Banks


Matthew Hedrick

Senior Analyst


The most important meal of the day.








Dairy price have come down dramatically over the past couple of months but it is worth noting that beef prices continue to follow a bullish trajectory.  Cheese prices have been volatile this year and we believe that another increase is possible before the quarter is out.


THE HBM: SBUX, DPZ, RT, PFCB, CAKE - cheese 103


THE HBM: SBUX, DPZ, RT, PFCB, CAKE - live cattle 103





Corn continues to slide and food processors, in turn, continue to outperform peer subsectors in the food, beverage, and restaurant space.




THE HBM: SBUX, DPZ, RT, PFCB, CAKE - subsector fbr





SBUX is kicking off its “Create Jobs for USA” campaign, accepting donations online and in some of its cafes to spur job creation among community businesses in the United States.


DPZ outperformed the space on Friday. 




RT, CAKE, and PFCB underperformed the casual dining category on accelerating volume during Friday’s trading session.


THE HBM: SBUX, DPZ, RT, PFCB, CAKE - stocks 103



Howard Penney

Managing Director


Rory Green


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