Weekly Asia Risk Monitor


Recent trends in Asian financial markets are certainly cause for alarm over the intermediate term.



***Note: wk/wk price action is from the five trading days ending on 10/4. Additionally, we’ve moved the price tables to the end of the note to increase ease of reading.***


From a wk/wk perspective, Asian equity markets are largely in negative territory, closing today down -2.9% on a median basis and -3.4% on an average basis. Hong Kong, which we’ve been explicitly bearish on since late May, closed today down -10.4% on a wk/wk basis and is now down -29.5% for the YTD – leading all other Asian equity markets to the downside over this timeframe.


Asian currencies continued their recent string of declines vs. the USD, as the global Flight to Liquidity trade ensues.  The Aussie dollar (AUD) led the way to the downside (-4.6% wk/wk vs. the USD) largely due to the RBA’s hint that it could potentially cut interest rates at some point over the intermediate term – a view we authored in early 2Q. Australian 1yr interest rate swaps acted on the news, falling -25bps wk/wk and are now trading a full -83bps below the RBA’s 4.75% target cash rate. On three-month basis, the AUD is down nearly -12% vs. the greenback – tops amongst all Asia-Pacific currencies over this duration.


Far beyond individual currencies, we’d like to call your attention to one of the more noteworthy moves in Global Macro in a very long time. Specifically, Asian currencies, as measured by the Bloomberg-JPMorgan Asia Dollar Index, just wrapped up their worst month since December 1997 (falling -4% in Sept). This is particularly meaningful given that Dec ’97 was mid-way through the Asian Financial Crisis! In recent months, we’ve been keen to flag the risks associated with the rapid buildup in external debt we’ve seen out of various emerging market debtors over the past 2-3 years and we continue to do so now.


While we haven’t yet done enough work to feel comfortable making a call for AFC 2.0, we do have conviction in suggesting that a stronger U.S. dollar (vs. debtor currencies), a rising cost of capital for global corporations, and a contracting European banking sector will combine to create meaningful liquidity headwinds for many developing Asian debtors. Email us for more detailed analysis on this subject; we’ve been circulating a compendium of notes on the subject on a one-off basis to clients and we’d be happy to send them your way.


Looking to Asian credit markets, the key moves we’d like to flag are the backup in yields across India’s sovereign debt curve and the jump in Chinese CDS. Indian interest rates – which are being dragged higher by the combination of hawkish commentary out of the RBI and the market coming to the realization that the government is quite likely to miss its FY12 deficit reduction target (a view we authored in late February) – backed up +11bps, +22bps, and +16bps on 2s, 10s, and 30s, respectively.


China, whose banking system is coming under increasing international scrutiny, saw its 5yr CDS widen +45bps wk/wk (+29.2%) to just shy of the 200bps mark. Beyond mere Sovereign Debt Dichotomy speculation, credit investors are indeed starting to sniff out the possibility that the Chinese government may have to dramatically expand the public balance sheet to help recapitalize ailing banks at some point over the long-term TAIL.



***In an effort to make this piece more easily digestible, we’re simply going to flag key data points and our analysis in bullet point format and offer only our [brief] thoughts at the end of each country capsule. We’re always happy to follow up in greater detail; simply reply to this note to open up a dialogue on anything you see below.***



  • Dollar-denominated debt of property developers rated below investment grade fell -19.9% in 3Q11 – the steepest quarterly decline since 4Q08.
  • Unable to refinance through more traditional sources of funding, property developers have turned to private trust companies for loans costing around 16-25% per an official at Beijing National Trust. Such financing has accounted for roughly half of the total amount of credit extended to developers YTD, per a recent Credit Suisse report. In addition to being deprived of commercial bank credit, property developers have been shut out of international bond markets since May, per Bloomberg data.
  • AAA corporate credit spreads widened +46bps in 3Q11 to close the quarter at 221 bps wide – just shy of the 5yr+ high 226bps registered on 9/26.
  • Chinese corporations have issued only 494 billion yuan of bonds in 3Q11 – down -17% YoY and down -14.1% QoQ.
  • Twenty-eight percent of local government financing vehicles have negative cash flow, roughly 22% of them have debt/asset ratios north of 70%, and their average ROE is only 4.4% (vs. an average of 8% for Chinese corporations at large), making it hard for them to access new capital for refinancing, per a study published by the country’s official bond clearing house.
  • Dim-sum bonds, or yuan-denominated notes traded in Hong Kong, fell -4% MoM in September, driving yields up +105bps on average.
  • Savings deposits at Chinese banks are nearing their first quarterly decline since 1992, which threatens to exacerbate the liquidity headwinds currently squeezing the Chinese economy. Through the first half of September, deposits for China’s four largest lenders fell -420 billion yuan; through August, deposit growth for the banking system at large was running at a -98% YoY clip. Negative real interest rates (-270bps currently) are a key contributor to this issue, which may ultimately limit the scope of any monetary easing the out of the PBOC  – if any – over the short-to-intermediate term.
  • Slowing deposit growth and plunging equity prices (down -20.5% over the last six months) has forced Chinese banks to debt markets for sources of liquidity. In 3Q11, the sector issued 388 billion yuan of debt – up over +57% on a YoY basis! The glut of supply has contributed to a predictable backup in borrowing costs; 5yr commercial bank bond yields backed up +69bps in 3Q11 to 5.92% – the highest level since Sept ’07. Spreads over similar-maturity sovereign debt widened +49bps in 3Q – largest quarterly jump on record – to 216bps.
  • Manufacturing PMI ticked up in Sept to 51.2 vs. 50.9 prior.
  • Non-Manufacturing PMI ticked up in Sept to 59.3 vs. 57.6 prior.
  • The 21stCentury Business Herald reported that nearly 80% of China’s rail projects have been put on an indefinite hold as banks concerned about loan repayment have stopped extending credit to the industry. They are reported to be awaiting further clarification of the government’s updated policies for the industry in the wake of late-July’s fatal bullet train accident.
  • Senator Chuck Schumer (D-NY) and 18 of his endowed colleagues have introduced a bill designed to force the Treasury Dept. to issue a biannual report identifying currency manipulators, as well as authorizing the implementation of protectionist measures towards those countries found guilty. The bill is being vehemently opposed by over 50 U.S. business groups, including the Chamber of Commerce, the National Retail Federation, and the Financial Services Roundtable. The bill is expected by some to eventually become bottled up the House Ways and Means committee, which has authority over trade legislation.
  • In response to Schumer’s bill, the PBOC issued a stern rebuke on its website today, saying, “Passage of the legislation may lead to a trade war that we don’t want to see… The [legislation] won’t solve U.S. problems of insufficient savings, a trade deficit, and an elevated jobless rate.” The PBOC, which boasts claim to the largest currency appreciation vs. the USD of any other emerging market nation over the past five years (+24%), per Bloomberg, supports opposition claims that punitive legislation towards China won’t contribute at all to U.S. employment growth. Rather, job losses in China will likely be offset by job gains in other low-cost developing market producers.

Hedgeye’s take: In terms of having concrete numbers to crunch or floated policy recommendations to analyze, it’s too early to wrap our heads around the true size and scope of the headwinds facing the Chinese banking system as a result of property developer and local government financing vehicle credit quality. That said, however, this is an acute risk we will no doubt continue to monitor closely going forward…


Elsewhere, we see that Chuck Schumer and his political cronies are at it again attempting to infuse their dogma on the U.S. economy – despite a bevy of key business groups and actual industry players speaking out against it. Big Government Intervention continues to: a) shorten economic cycles and b) amplify market volatility. A marked and expedited yuan revaluation would spell short-term economic disaster for the U.S. economy in the form of import price inflation for a bevy of key consumer goods.


Hong Kong:

  • Export growth came in flat in Aug at +6.8% YoY.
  • Import growth accelerated in Aug to +14.1% YoY vs. +10.2% prior.
  • Trade Balance growth slowed in Aug to -HK$22.9 billion YoY vs. -HK$5.4 billion prior.
  • Retail Sales growth slowed in Aug to +20.7% YoY vs. 22.4% prior.

Hedgeye’s take: Though stale (it’s Oct), Hong Kong’s August economic data does continue to support our bearish view of the economy insomuch that growth is continuing to slow.



  • Small Business Confidence ticked up in Sept to 47.2 vs. 46.4 prior.
  • The ruling DPJ party proposed at ¥9.2 trillion ($120 bil.) “temporary” tax increase to help fund the third post-quake “stimulus” package of about ¥12 trillion. The bill, which is now being negotiated with opposition LDP lawmakers, calls for corporate tax rates to be raised in the next fiscal year (starting April 1, 2012) for three years and income tax rates to be raised in January 2013 for a full 10 years. Additionally, tobacco levies will increase in October 2012.
  • Retail Sales growth slowed in Aug to -2.6% YoY vs. +0.7% prior.
  • Overall Household Spending growth slowed in Aug to -4.1% YoY vs. -2.1% prior.
  • Japanese corporations issued ¥2.7 trillion ($28.4 bil.) worth of debt this quarter – up +17.5% QoQ after 1H11 brought on the lowest level of issuance on six-month basis in five years. The surge in supply is not being met with a commensurate backup in yields, as demand from Japanese banks (holders of ~50% of the nation’s corporate debt) increased as a result of deposits outpacing loans by ¥163.3 trillion in August – just shy of the record ¥166.7 trillion spread recorded in June.
  • Manufacturing PMI ticked down in Sept to 49.3 vs. 51.9.
  • Unemployment Rate fell in Aug to a 33-month low of 4.3% vs. 4.7% prior. We continue to point out that Japanese employment is being overstated on a relative basis to other economies, given that the Japanese labor force is shrinking aggressively and is now at lows last seen since October of 1987.
  • Industrial Production growth accelerated in Aug to +0.6% YoY vs. -3% prior. MoM growth also accelerated: +0.8% vs. +0.4% prior.
  • The Finance Ministry unveiled plans to raise the issuance limit for bills to fund intervention in the FX market by +¥15 trillion to ¥165 trillion total, as well as extending the monitoring of FX positions through year-end (from an initial plan until the end of 3Q).
  • Tankan Quarterly Business Survey came in better on the margin, but still below the pre-catastrophe levels of 1Q11: large manufacturer sentiment and outlook improved to 2 and 4, respectively (from -9 and 2); large non-manufacturer sentiment and outlook improved to 1 and 1, respectively (from -5 and -2). On a sour note, the All-Industry CapEx Guidance component dropped to +3% from +4.2% – signaling a tempering of corporate intentions to act upon the improved sentiment.
  • Japanese corporate 5yr CDS, as measured by the Markit iTraxx Japan Index widened to 209bps yesterday – the highest since July ’09.

Hedgeye’s take: It’s clear from recent data that expenditures on quake reconstruction are eating into the everyday consumption patterns of Japanese consumers. Natural disasters are, at best, a zero sum game – a point we strongly stressed in the face of consensus buying Japanese stocks on hopeful expectations for rebuilding in 2Q11... Alas, the Japanese economy – awash with corporate cash like its U.S. counterpart – remains mired in a classic liquidity trap as a result of a dim long-term outlook for the economy.


Japanese officials continue to completely miss the boat as it relates to why the yen remains at elevated levels, saying recently that, “There’s no reason for the Japanese yen to be targeted as a safe-haven currency or flight-to-safety currency.” As long as Japanese policymakers continue to fundamentally misunderstand the mechanism by which the yen trades (a mechanism imposed by the BOJ’s ZIRP, btw), expect more misguided FX intervention upon JPY exchange rates.



  • RBI governor Duvvur Subbarao unleashed a string of hawkish commentary at recent press events: “Inflation has been fairly stubborn.”… “Above a threshold, you can’t accept high inflation to have higher growth. The price limit is as much as 6% for the nation.”… “A premature change in the policy stance could harden inflation expectations, thereby diluting the impact of past policy actions (+350bps of rate hikes since March ’10 – the fastest round of tightening since the central bank was established in 1935).”
  • Manufacturing PMI ticked down to a 2.5yr low of 50.4 vs. 52.6.
  • Despite the rupee’s region-best -9.5% YTD decline vs. the USD, Subbarao stated plainly that “intervention in forex markets brings unexpected consequences”, suggesting to us that central bank aid to support the rupee might be limited going forward.

Hedgeye’s take: Subbarao’s latest statements underscore our view that Indian inflation will remain sticky enough to keep the central bank from cutting interest rates in a proactive manner to stem the tide of slowing growth – as evidenced by the PMI data.


South Korea:

  • Consumer Confidence came in unchanged in Sept from Aug at an index level of 99.
  • The Korean government, citing fiscal woes in Europe, plans to cut its fiscal deficit by ½ in the next year to 1% of GDP (~12.25 trillion won). It also will seek to balance the budget by 2013 and post a surplus of 0.3% of GDP by 2015.
  • Manufacturing Business Survey reading came in flat in Oct at 86.
  • Non-Manufacturing Business Survey reading increased in Oct to 86 vs. 83 prior.
  • Industrial Production growth accelerated in Aug to +4.8% YoY vs. 4% prior.
  • Service Industry Output growth accelerated in Aug to +4.8% YoY vs. +3.8% prior.
  • Trade Balance growth slowed in Sept to -$3 billion YoY vs. -$727 million prior.
  • CPI slowed meaningfully in Sept to +4.3% YoY vs. +5.3% prior.
  • Manufacturing PMI ticked down in Sept to an 11-month low of 47.5 vs. 49.7 prior.

Hedgeye’s take: As we’ve outlined in our work on the Korean economy in the YTD, Korean economic growth remains resilient. On balance, Korean economic growth is flat-to-down, but still hanging in there much better than most of its Asian counterparts.


While we certainly admire the Korean government for recognizing an global phenomenon and attempting to strengthen its already-pristine balance sheet (debt/GDP = 22.7%), we do question their ability to achieve next year’s target given that it relies on the aggressive assumption of +9.5% YoY revenue growth and roughly a tenth of the deficit reduction coming in the form of revenues from state asset sales. As we saw in India this year, state asset sales get canceled when capital markets are under duress – which they very well could be in 2012. 



  • HIA New Home Sales growth accelerated in Aug to +1.1% MoM vs. -8% prior.
  • Building Approvals growth accelerated in Aug to -5.5% YoY vs. -14.3% prior.
  • Manufacturing PMI ticked down to a 27-month low of 42.3 vs. 43.3 prior.
  • TD Securities unofficial CPI gauge slowed in Sept to +2.8% YoY vs. +2.9%.
  • Trade Balance growth accelerated in Aug to +A$757 million YoY vs. +A$270 million prior.
  • Corporate borrowers in Australia have cut bond issuance to the least since 4Q08 (A$16.5 billion), driven lower by reduced demand for debt capital out of Australian banks who saw term deposits surge to record A$469.5 billion as recently as July.
  • 10yr sovereign bond yields fell -15bps in September to close the quarter at 4.22%, capping the longest stretch of monthly declines on record (dating back to 1978).
  • The move in the Aussie bond market coincides with the RBA keeping the benchmark policy interest rate on hold at 4.75% for the 10th-consecutive month – the longest pause since a 13-month hiatus ended in May ’06. In accordance with the policy announcement, RBA governor Glenn Steven’s commentary came in noticeably dovish on the margin relative to recent months: “An improved inflation outlook would increase the scope for monetary policy to provide some support to demand, should that prove necessary.”Stevens also admitted to weakness in the Aussie labor market and the potential dousing impact that would have on labor costs – a key area of concern for the central bank as it relates to the long-term outlook for inflation.
  • Treasurer Wayne Swan, perhaps in response to the -600bps decline in his boss’ approval rating over the last two weeks, stated that policymakers are discussing ways to alter the tax code to address the country’s two-speed economy. Per Swan, nothing will be “off limits” at the two-day tax forum (starting today in Canberra).

Hedgeye’s take: The Aussie housing market, which remains under substantial duress, has exhibited a classic dead-cat bounce off the lows. We continue to think the trend in this market is one that is negative over the long-term TAIL – particularly if Stevens continues to remain stubbornly hawkish on interest rates. Australia’s economic growth continues to slow alongside a waning of inflation pressures out of the once-tight Aussie labor market – which is exactly why the interest rate swaps market is pricing in a full -161bps of cuts to the benchmark rate over the NTM (per a Credit Suisse index)… We don’t have any edge on this tax meeting, but any growth-negative fiscal policy in the form of higher taxes might be incrementally bearish for the Australian economy.



  • Indonesian CPI slowed in Sept to +4.6% YoY vs. +4.8% prior.
  • Thailand CPI slowed in Sept to +4% YoY vs. +4.3% prior.

Hedgeye’s take: As our theme of Deflation the Inflation continues to play out across key commodity markets, we continue to expect that reported inflation trends down on a global basis – particularly in emerging markets. At a price, this will be a very positive development for global consumer stocks. Timing, however, remains the key factor to solve for – particularly on the emerging market front, given the potential for FX headwinds to erode the profits of foreign-based investors.


Darius Dale



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Buffalo Wild Wings remains one of our favorite names on the short side. 


As detailed in the Hedgeye Restaurants Alpha, which describes our three best long and short ideas, there are several factors turning against BWLD as we move through the last few months of 2011 and into 2012.


Firstly, the fourth quarter traditionally tends to be a seasonally difficult period for the concept from a traffic perspective.  While the company is planning on implementing marketing initiatives around the football season in the back half of the year, we believe that a softening macro environment could impact BWLD’s fourth quarter comp.  The company has been successfully taking price even as wing prices have gone lower and lower; whether or not further price increases can be taken without stymieing traffic growth is the key question going forward. 





Connected to this issue of price is the fact that the relationship between restaurant operating margins and wing prices has, we believe, reached an inflection point.  Wing prices have begun to climb and the substantial tailwind that the company has enjoyed is dissipating.  Protecting margins from this point will require even more aggressive pricing than before and could prove difficult in this macro environment. 







Our conviction remains strong on this name.  Given the strong outperformance versus the S&P 500 and the XLY consumer discretionary ETF over the past three quarters, we would expect the reversal in the commodity tailwind and (possible) top-line issues to have a sizeable impact on BWLD’s stock price.





In conclusion, the valuation and sentiment set ups for BWLD are only supportive of our bearish stance.  In terms of valuation, BWLD trades at the third highest EV/EBITDA multiple of casual dining.  Some of the premium it enjoys is undoubtedly due to its growth profile and expansion into new markets.  We believe that growth is good but it does come at a price and contributed to the company’s EPS miss in 2Q.  From a sentiment perspective, as the second chart below shows, the street has not been as bullish as it is now in quite some time.


BWLD CONTINUING TO LOOK GOOD ON THE SHORT SIDE - BWLD historical sell side sentiment



Howard Penney

Managing Director


Rory Green



The markets have been melting down over the past 5 day with the S&P 500 down 5.5%, while COSI is up 11.8%.  I would argue that the stock is not reflecting the bunker mentality that management and the board has adopted, but the realization that there is a real plan in the market place that suggests COSI has a bright future.   


Yesterday, the WSJ revealed that there was a war of word between the management of COSI and Brad Blum.  It appears that management hurled the first diatribe in a memo to employee’s and Franchisees.  Which begs my first question; why did management leave out shareholders in communications about the issues its has with Mr. Blum?


What I’m asking is really a rhetorical question, because its unlikely that management has many shareholders on their side and, more importantly, their shareholder base is not naive enough to believe the rhetoric implied by the WSJ article. 


Management may be able to rally the troops internally but doing so externally is a different proposition.  I believe that COSI shareholders hold management to a high standard of accountability.  Finding the right solution will hinge on the financial performance of the company and, on that score, management gets a failing grade.  


Given current trends and management’s lack of a cohesive plan, COSI seems somewhat like Greece at this juncture: one cannot rule out the possibility of outright failure of the company.  Should the company meet that fate, it will not be entirely due to the poor economic environment; some of Cosi’s peers are managing through, and even thriving in, the current malaise.  In my view, the most significant threat to Cosi going forward is management neglecting to recognize the real issues facing the company: the need for leadership and additional capital.


The company continues to make progress on several fronts, including the new catering menu, online ordering, and a remodeling initiative but, as yet, sales have not rebounded as strongly as many had hoped. 


COSI IS LIKE GREECE - cosi comps



What is management doing to enhance shareholder value?


The Board of Directors recently engaged The Elliott Group to work with the search committee towards the goal of finding a new CEO.  I would question the wisdom of this decision.  Alice Elliot, founder and Chief Executive Officer of The Elliot Group, has extensive experience in the restaurant industry and is surely aware of the credentials of one person – Brad Blum – that is actively seeking the job and willing to work for $1.  Maybe that low salary is somewhat of a disincentive for the search firm, but irrespective of that, the company will find it very difficult to find a candidate as well-suited for the CEO position as Mr. Blum.


I would doubt that the Elliot Group can find another candidate that has done as much research on the company, has as comprehensive a plan to reinvigorate the business, will work for free and – as a bonus – has access to capital that the company desperately needs.  Additionally, Blum is a major shareholder of the company.  As things stand, the company is not facing a bright future.  This is despite the tremendous potential of the brand; I would think that a solution as offered by Blum would be a blessing for the interim CEO and the board.


Instead of this obvious solution, the company is going to pay money that it doesn’t have to a search firm to find a CEO when a highly qualified, major shareholder of the firm is willing to do the job for free.  Blum owns 6.75% of the shares out while the board (collectively) owns less than half of that percentage.  What shareholder would not want a CEO with Blum’s credentials and strong financial interest in ensuring the firm’s future success?


Time is ticking for the current management team.  If decisive actions are not taken immediately, by June 2012 the market will have determined the future of the company and it will not look good for the current management team.  Based on the assumption shown in the chart below, the company’s cash cushion will be worn thin in early 2013 unless some capital is injected into the company.  If sales soften, the process could be shortened.  Additionally, our assumption does not factor in the company’s need of $5-7mm of additional to remodel the company's restaurant base. 





Even if a quality CEO not named Bradley Blum is found in the near-term, it seems likely that the first order of business for that individual will be raising capital.  Unless the person in question has similar access to capital that Blum has, it is likely that the capital raising process will be time-consuming and costly, and perhaps extremely dilutive to current shareholders.


Yet, another conversation that management does not want to have with its shareholders!


Like Greece, Cosi needs capital fast.  The $8mm of cash on the balance sheet looks like a net positive but the company needs a significant level of reinvestment; the asset base has been starved of capital for the last three years.


COSI IS LIKE GREECE - cosi capex



If I were to the strip out the $0.16 of cash on the balance sheet, the stock price is currently valuing the company at $30.2 million.  Given that the company has no assets on the balance sheet, has not made money in years and is on schedule to lose money again in 2011, the $30.0 million would appear to represent a fair value for the goodwill in the COSI brand name. 


The company’s contention that Blum is making a low-ball offer for the company may not be entirely accurate when considering the scenario described above.  


There is no guarantee that Mr. Blum will be successful but he has a better shot than most, in my view.


One really has to wonder what the discussions are like in the COSI boardroom today.  While not an ideal scenario for management and the Board, Mr. Blum has offered multi-pronged solution to fix the company.  Any objective outside observer of this situation is surely wondering if management and the board is putting their interests ahead of employees, franchisees and shareholders.



Howard Penney

Managing Director




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The Dexia Domino & The Run On Morgan Stanley

Positions: We are currently short Citigroup (Ticker: C) in the Virtual Portfolio.


In times like these, we obviously want to be careful that we are not fear mongering, but we also want to accurately flag critical risk signals, even if portending worse news.  This morning two important events are occurring in the global banking system.  First, credit default swaps on the major U.S. brokerages are blowing out big time.  In particular, Morgan Stanley credit default swaps are now at 800/875 basis points per Zerohedge.  Second, Dexia, a Belgian bank that is two times the size of Washington Mutual appears to be on the precipice of some form of a government bailout.


Last night after the close, Morgan Stanley President and CEO James Gorman sent a memo to his firm suggesting that the rumors around the company's solvency were overdone. In the memo he wrote:


"To help you wade through the maze of numbers and information, it might be worth reading two analyst reports that were published this morning. One is from Howard Chen at Credit Suisse that examines Capital, Funding and Liquidity at Morgan Stanley and Goldman Sachs and, in some detail, highlights the dramatic improvement to our financial strength over the last three years.”


Unfortunately, this is the same Howard Chen who upgraded Morgan Stanley at north of $30 per share in early January 2010.  The point is not to denigrate Chen, as we are sure he is a great analyst, but rather to highlight that the Morgan Stanley memo reeks of desperation, which is exactly what the market is telling us this morning.


Currently, the stock price of Morgan Stanley is below $12, which, as we outline in the chart below, the lowest price for the stock since December 2008.  Even more disconcerting are the credit default swap markets on Morgan Stanley debt, which are now trading beyond 800 basis points on the one-year tenor (per Zerohedge).  As the second chart below highlights, this is well above the close of yesterday at 529 basis points on the five-year tenor. Simply, Morgan Stanley CDS at this level are not sustainable. 


The Dexia Domino & The Run On Morgan Stanley - 1 


The Dexia Domino & The Run On Morgan Stanley - 2 


Meanwhile the rest of the brokerage sector in the U.S. is showing similar stress.  Goldman 1yr CDS are now just shy of 400 basis points, Bank of America 1yr CDS are just over 500 basis points, and Citigroup’s 1yr CDS are just below 400 basis points.  Certainly the rest of the brokerage sector does not appear to be under the duress of Morgan Stanley, but swaps being prices back at levels reminiscent of 2008 are noteworthy.


As it relates to Dexia, our Financials team wrote a note this morning, which we’ve excerpted below:


"It's been a tense week at Dexia.  On Monday it was reported that the board was conducting emergency meetings.  This morning the company is facing criticism over their sovereign debt accounting, which doesn't mark Greek debt to market.  Anonymous sources told Bloomberg and other news outlets that a breakup of the company could be imminent.  Dexia could sell the healthy business units, which include asset management and a Turkish unit, in order to offset the capital hit from the sovereign debt portfolio.  


Throughout the crisis, European lenders have insisted that their capitalization levels are adequate.  Subsequent events have shown that this is transparently not the case.   


The problem with using regulatory capital ratios is a simple one.  Tier 1 Common and other regulatory ratios use as their denominator risk-weighted assets.  Under Basel II (the relevant standard for European banks), the risk-weighting for sovereign debt rated above AA-/AA3 is 0%.  That is, from a regulatory perspective, sovereign debt bears no chance of default and requires no capital.  In the current environment, looking at a capital ratio that ignores the asset class under scrutiny is quixotic.   


Thus, we revert to examining capital on the basis of tangible equity / tangible assets.  This metric removes the distortion caused by the regulatory paradigm and is less easily gamed.  We first published these charts on September 22nd in conjunction with a conference call.   


Dexia jumps out in the tables below as the least-well-capitalized of the major European lenders.  At the top of the table, for comparison, we show the US banking system in 2Q08.  European banks today look comparable to the American banks just before the crisis bore down in full force. 


These charts should be read in conjunction with the tables below showing the relative exposure to sovereign debt.  To take the Greek banks as an example, they look relatively better capitalized on a TE/TA basis.  However, their exposure to Greek and other PIIGS debt is correspondingly higher, and taking a realistic mark on the sovereign holdings would wipe out the bulk of this apparent advantage.   


On a TE/TA basis, Dexia is the weakest link.  It comes as no surprise to us to see the company wobble."


The Dexia Domino & The Run On Morgan Stanley - 3


The Dexia Domino & The Run On Morgan Stanley - 4


The Dexia Domino & The Run On Morgan Stanley - 5


The Dexia Domino & The Run On Morgan Stanley - 6


Daryl G. Jones

Director of Research


Short Covering Opportunity: SP500 Levels, Refreshed

POSITION: Long Utilities (XLU)


This is the 3rd Short Covering Opportunity note I have written in the last 2 months (August 8th and September 12th were the other two).


I mention these time stamps not to take a victory lap, but to reiterate the confidence we have in our risk management process. It’s not always right. But it’s right a lot more than it’s wrong – and it’s repeatable.


Across durations, here are the lines that matter now: 

  1. TREND resistance = 1237
  2. TRADE resistance = 1137
  3. TRADE support = 1079 

I’ve covered our short position in the Consumer Staples ETF (XLP) and have bought back the only Sector ETF we like (Utilities – XLU), moving our asset allocation in the Hedgeye Asset Allocation Model back up to 6% from 0%.



Keith R. McCullough
Chief Executive Officer


Short Covering Opportunity: SP500 Levels, Refreshed  - SPX








Cattle futures rose to a record as demand for U.S. beef is increasing as shrinking domestic herds signal tighter supplies and higher costs for restaurant companies like TXRH with exposure to beef.


The decline in gasoline prices is good for casual dining traffic but, if like in 2008 it is due to a fall in demand as economic conditions deteriorate, the benefit of cheaper gas may be offset.  The price action in casual dining stocks certainly suggests that lower gas prices are not bolstering sales significantly.


THE HBM: TXRH, SONC, YUM, CMG, SBUX, CAKE - gasoline prices



The ICSC chain store sales index rose 0.1% last week; the second week of little change. Year-over-year growth jumped to 3.7%, the fastest growth in nine weeks as sales fell in the comparable week last year.





Yesterday was a tough day for all of the food, beverage and restaurants stocks.  Casual dining got beaten up again, declining -4.9% on average.


THE HBM: TXRH, SONC, YUM, CMG, SBUX, CAKE - subsector fbr





SONC: Sonic Corp. reported sales trends of 0.4% for the fourth quarter of its fiscal year ended September.  This represents a significant slowdown in trends for the drive-in chain.  The company expects positive same-store sales in FY12 and flat restaurant level margins.





YUM:  Yum! Brands reports after the close today and we will be listening carefully for commentary around trends in China in light of softening economic data.  We like YUM on the long side, believing that the company will deliver double-digit EPS growth for 2011.  Furthermore, in the past, concerns on China have provided favorable entry points for buyers of YUM’s stock.


CMG: Chipotle Mexican Grill was initiated Outperform at Credit Suisse. 


SBUX: Starbucks is offering any breakfast sandwich for $2 when customers buy any beverage from October 4-10that participating stores.


THE HBM: TXRH, SONC, YUM, CMG, SBUX, CAKE - sbux breakfast





CAKE:  The Cheesecake Factory was rated consumers’ favorite casual-dining restaurant for the second year in succession, according to Market Force Information’s rankings of casual dining restaurants.  Texas Roadhouse and Olive Garden took silver and bronze, respectively.





Howard Penney

Managing Director


Rory Green


Early Look

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