“High absolute return is much more recognizable and titillating than superior risk-adjusted performance.”

-Howard Marks (The Most Important Thing, page 57)


I wasn’t short the SP500 until 326PM EST (1290) yesterday. I’d sold all of my long-term Treasuries (TLT) on Wednesday. I wasn’t short anything Commodities and/or European Equities…


So, yesterday could have been worse.


Where I got killed was in my long US Dollar position. The US Dollar Index was down huge (-1.7%), making a fresh low for the month as US stocks completed their biggest 18 day short squeeze ever.


Ever is a long time.


Like my “Short Covering Opportunity” call on October 4th, my “Buy The US Dollar” call on October 21st has a Time Stamp. While there were plenty of risks building a US Financial Services and Media firm in the 2008-2011 period, for me at least, one of them wasn’t showing you every position I take, when I take it.


Time Stamps are cool on Wall St 2.0 because they save you from having to take my word for it.


Back to the Global Macro Grind


Get the US Dollar right and you’ll get mostly everything else right – if that’s not obvious to someone who is confusing their “high absolute returns” yesterday (everyone nailed it, right?) with what we call beta, I don’t know what is…


Using our immediate-term TRADE duration to measure Correlation Risk, here’s a real-time update on the USD’s inverse correlations:

  1. SP500 = -0.97
  2. CRB Commodities Index = -0.88
  3. 10-year US Treasury Yields = -0.81

No matter where you go this morning, there it is. If you have been bearish on the US Dollar (and bullish on the Euro) for the last 3 weeks, you have absolutely crushed it.


If you’ve been levered-long beta since April’s YTD high in the SP500 of 1363, you’re still getting crushed. Over that time span, the US Dollar Index is up +2.7% and the SP500 is down -5.8%.


But today, all of what you’ve done for 2011 doesn’t matter to the market at all. Mr Macro Market doesn’t care about who is doing the crushing or who is getting crushed. She tends to inflict the most amount of pain on the most amount of players at the same time.


So, what do I do “right here, right now?”


I was asked that yesterday at a lunch meeting in Boston. My answer: “I finish our meeting then go to my next meeting. And if I see my immediate-term TRADE overbought level in the SP500, I’ll short it, for a trade.”


Then client then asked me, “at what price?”


I said, “I don’t know. I need to fire up my machine and remodel my volatility parameters for the draw down in the VIX and melt-up in the SP500’s price. I let my process tell me what to do, not my emotions.”


So, at 326PM, I hit the button, “shorting the SP500 (SPY) as it is immediate-term TRADE overbought.” Time Stamped.


What do I do with that position today?


Same answer. The risk management process will tell me what to do. All of my decisions are risk-adjusted to the market’s last price. In other words, Prices Rule my process. Period.


The SP500’s setup is now as follows:

  1. Immediate-term TRADE overbought = 1290
  2. Intermediate-term TREND support = 1257
  3. Long-term TAIL support = 1266

In other words, on any pullback towards 1, I’ll cover that short position and get longer of US Equity exposure. If 1266 doesn’t hold, I get shorter.


Currently, in the Hedgeye Asset Allocation Model, I have a 9% position in US Equities – that’s all in Consumer Discretionary (XLY). Obviously if I stay wrong on the US Dollar, US Consumption will be adversely affected by inflation. Strong Dollar = Strong America. So with Goldman telling you to chase beta this morning, remember what that implies longer-term – Debauched Dollar = Mad America.


If my long-term bullish case for the US Dollar doesn’t convince you of that – let The People. In the face of the biggest 4-week rally ever, Bloomberg’s weekly Consumer Confidence survey dropped to minus -51.1 versus -48.4 last week. Titillating.


My immediate-term support and resistance ranges for Gold (bullish TRADE and TREND again), Oil (bullish TRADE; bearish TAIL), German DAX (bullish TRADE and TREND; bearish TAIL), and the SP500 are now $1, $89.36-93.87, 6127-6428, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Titillating - Chart of the Day


Titillating - Virtual Portfolio

CRI: Great Short into 2012


Conclusion: CRI is one of the most expensive names in retail. Valuation alone is a bad reason to sell. But growth trajectory and margin are both not sustainable. We think that once the calendar turns into 2012, CRI will be ripe for a far larger group of short and long sellers.



Sales growth of +24% was the strongest CRI has reported in the last 5-years. Looks great optically, but when taking into account the newly acquired Bonnie Togs business – which accounted for +7% and the sales pulled forward accounting for another +1% (adjusting for Q3 sales that were pulled into Q2), organic sales growth actually came in closer to +15%-16%. Good stuff, but this marks a sequential deceleration from the prior quarter at the same time CRI is about to go up against double-digit sales growth driven by accelerating sales in both Carter’s wholesale and mass businesses this time last year.


Margins continue to be under pressure with fall product costs up ~25% with mid-teen increases persistent through the 1H of F12. AURs are up anywhere from MSD to high-teens depending on the channel, but CRI is having the most success at Carter’s wholesale where units are actually up +8% on a +6% increase in pricing. In all other channels units are flat to down. We expect continued SG&A leverage to the top-line though think the opportunity for more meaningful cost reduction is modest with incremental Canadian retail expense and U.S. retail store growth investment of nearly $10mm each through the 1H of next year.


One thing to keep in mind as it relates to margins is that the sales/inventory spread has been negative for the sixth quarter in a row.


In addition, CRI pulled sales forward from Q4 while deferring the operating costs associated with those sales (when the company expected to realize the revenues) – that’s not a pretty setup for Q4. Is it enough to really derail the quarter? No. The call is bigger than that, but it certainly doesn’t help.


We’re not saying Carters isn’t a good brand, it’s actually a very good brand, but we don’t think the company is going to have the benefit of both pricing AND unit growth next year. Retailers, for the most part have taken and passed price increases along to the consumer – so far. But a major factor we can’t ignore is the real potential for a price war in the mid-tier channel in 1H12 spurred by JCP’s EDLP strategy. These companies (KSS, GPS, M) are doing their one-on-ones and telling people that they’ve got it under control and that no price war is brewing – but with all due respect, they don’t have a clue.  To intimate in any way that these companies have any certainty on pricing 2 or 3 quarters out is simply arrogant. Wal-Mart is also getting heavier in basics, which won’t help anyone. And who is to say that product costs easing in 2H will be good for Carter’s? As product costs come down, guess what happens? Competitors produce more product. And we all know that 99% of the product needs to sell at the end of each season – i.e. price will come down to accommodate that.


We’re shaking out a 10% top-line growth next year driven by retail store growth (3-4%), incremental international/Bonnie Togs (~3%), and another 1-2% each from Carter’s wholesale business and e-commerce. With the acquisition, you’re looking at a MSD-HSD top-line grower. That’s where we come out in F13 while the Street is assuming another double-digit year. Where we’re going to be most different from consensus is on gross margins. We’re modeling a -100bps decline in F12 as the company expects to pass through roughly two-thirds of future costs in the 1H. With cotton costs down sharply in recent months, we think discussions are going to be more challenging come spring for a brand like Carters that has increased prices by as much as mid-teens in some channels. With modest leverage in SG&A (-25bps) we are shaking out at $178mm in EBIT and $1.85 in EPS. Let’s not forget that Carter’s own retail stores boast an average 40% discount on day 1 for 90% of the product. Yes, it competes with itself.


The bottom-line is that execution risk is extremely high here, much is outside of CRI’s direct control, and there’s very little margin for error. With the stock now trading at 17.5x earnings and 10x EBITDA off next year’s Street estimates – and 21x and 11.5x ours – expectations are lofty to say the least. Has Carter’s all the sudden become a mid-teens grower – we don’t think so. Even if we were to give CRI the benefit of the doubt and assume a return to peak margins (~14%) some 500bps+ from where the model is today, we’d be looking at a stock trading at 11x P/E and 6.5x EBITDA F13 numbers – that’s where most of CRI’s peers are trading on current numbers. Those former margins represented a period of severe over-earning. We’ll never get back there again.


This thing appears to be trading on the Berkshire factor. This is an environment where you don’t get paid, lose your job – or both – for being short a company that’s rumored to be LBO’d and it actually happens. With 2 months left in the year, appetite for risk on small cap names like CRI is not too high on anyone’s list. So people are going along with the herd.


We think that once the calendar turns into 2012, CRI will be ripe for a far larger group of short sellers (or long sellers).


This one is right up there at the top of our short list.



Shorts: JCP, UA, HBI, CRI, GIL


CRI: Great Short into 2012 - CRI S 10 11




P.F. Chang’s reported a disappointing third quarter results before the market this morning.  Our takeaways from the numbers and the conference call that followed only confirm our cautious stance on the stock.  We believe that the acceleration of unit growth of Pei Wei restaurants with poor fundamental performance is – simply – a mistake.  The company’s answer to a question on the possibility of store closures was particularly telling in that our interpretation was that it was not a strong possibility.  Like Tennyson’s light brigade, PFCB is not reasoning why – or at least not reasoning enough.


PFCB’s stock has been beaten up badly over the last six months as concerns mounted over softening sales and then continued as the trend failed to reverse.   The two charts below show a fairly unmistakable downward trajectory in both concepts’ comparable sales trends.







From a margin perspective, the company experienced inflation in the quarter of approximately 50 basis points due to beef, broccoli, and Asian import prices offset by the benefit of a contractual price rebate on poultry.  Without the 50 basis point impact from the poultry rebate, cost of sales would have been up more than 100 basis points, but still in line with 4-5% company expectations for the quarter.  Operating costs were negatively impacted by supplies and printing costs related to Happy Hour, according to management.  Restaurant operating margins decreased 340 basis points at the Bistro and 200 basis points at Pei Wei.  The charts below show, first, the margin contraction that the company has seen in restaurant operating income and, second, that the company is in our “Deep Hole”, that is to say it is operating with negative same-store sales and declining margins.  Until we have conviction that the company is turning around one or both of these metrics, we would not consider it on the long side.







We do not subscribe to the belief that the company can continue to grow at the rate that it is with the fundamentals behind the concepts being so poor. 




  1. Management faces a struggle to drive traffic and seems to be trying many different things at once in order to do so.  Initiatives like small plates at Pei Wei for $3.95 and other lower priced menu offerings are having initial success driving some traffic while not damaging check.  It seems that progress on this front is slow as October’s trends are also soft.  The -3.7% comp at the Bistro in 3Q11 was against a +2.3% print in 3Q10.  October 2011 is trending at roughly -3% versus a +0.8% comp in October 2010. 
  2. Despite Pei Wei’s poor performance, management is opening 16-20 new Pei Wei restaurants in 2012.  Year-to-date, there have been two Pei Wei’s opened and no more are projected for the remainder of the year in domestic markets.  The company maintains that new stores are performing at-or-above system average revenue levels.  Focusing on closing underperforming stores, or unilaterally rectifying any issues the concept is having, is likely a better use of time and cash than accelerating expansion.  There is a pipeline that management is confident in but growing the store base is not a strategy that we believe will address the obvious issues being felt in many markets.  In responding to a question on closing underperforming stores, management didn’t seem to be thinking along those lines at all.
  3. SG&A was $13 million versus $23 million last year.  $8 million of the decline was due to lower share based compensation and lower incentive comp at all concepts and the Home Office. 
  4. Inflation in 2012 is expected to be level, or even higher than, what the company has been experiencing during the second half of 2011.  
  5. No doubt inspired by the success of EAT in driving the lunch day part, the Bistro will roll out a new lunch menu to an entire market.  Pending the success of this test, a system-wide rollout of the initiative will proceed in 1Q12.
  6. Sell-side sentiment has gotten more bearish of late but there is precedent for a continuation of this trade.  See chart below.




Howard Penney

Managing Director


Rory Green



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A slight beat even with lower hold in Singapore.



"We set quarterly records for both net revenue and adjusted property EBITDA during the quarter. Strong revenue growth and margin expansion at Marina Bay Sands in Singapore and our portfolio of properties in Macau and the United States contributed to excellent financial performance overall." 




  • MBS's EBITDA would have been $438MM million and when combined with $6 million of nonrecurring expenses, margins would have been of 54.1%
  • Macau would have produced $401MM on a hold adjusted basis
  • Have an aggressive plan for the Plaza beginning with the addition of two new meeting VIP operators opening in the next couple of weeks
  • Table games drop in Las Vegas has the second-largest quarter in terms in the history of their properties
  • Sands Bethlehem's outlets should open next week and should be a driver of continued growth at that property



  • At MBS, they are reserving between 3-7% of RC. This past quarter they reserved at 5.4% ($24MM reserve)
  • Having a very high end customer is driving higher commissions since their players are buying in at greater amounts at MBS
  • If anything, trends in October would suggest an acceleration of the trends seen in 3Q at MBS
  • Vegas has very heavy Asian play this past quarter at their properties - "we have never seen a third quarter or summer quarter have those kinds of drop numbers"
  • Customers from China and HK are driving the massive VIP growth at MBS
  • Non-recurring: Got property assessment from the government - so that was $3.6MM and then there was a $2.4MM entertainment charge
  • They do not think that they will cannibalize any of their properties when Sands Cotai Central opens
  • Rate structures are done in a way to avoid cannibalization
  • Feel like the new rooms at Sands Cotai will help them continue to dominate the mass market
  • Any reason why the hold so far at MBS has been lower than theo? No. They are currently tracking at 2.82% YTD
    •  We estimate October is trending at 3.3% hold MTD
  • Maintenance spend of $400MM in 2012 and $1.2BN of project spend on Sands Cotai Central
  • In Singapore, majority of their Mass customers are from non-rated players - tourists. On the slot side, it's more rated players.
  • Visitation into MBS's casino is flat QoQ but visitation to the property has growth. Think that the train stop will be a very nice driver for retail, non-gaming spend and mass play.
  • They are not really spending that much to grow the VIP business and it should have a great ROI with low capital intensity
  • Capacity constraints at MBS: No constraints on VIP side, run at 80% capacity on the slot side which is pretty constrained on Saturday nights but is rarely a problem otherwise. On the Mass side, they are hiring more dealers to get more tables opened. They are only constrained 5.5 days a week. 
  • They know that they have underperformed in VIP and can't think of a reason why things would get worse from here. They don't see a case where things get a little worse before they get better.
    • The direct play at Venetian spiked to 24% this quarter and increased to 15% at Sands, so we have to agree
  • Think that if either Korea or Japan legalize gaming, the other will legalize in short order
  • His family is in favor of dividends, which they will definitely consider next year
  • Sheldon doesn't think that their are indications that the government intends to tighten money supply
  • Sand's advantage with junkets is that they are the only new supply in town for a while with the opening of Sands Cotai
  • Macau reserves? 
    • Very consistent with what they have done historically.  



  • MBS adjusted property EBITDA: $414MM and a margin of 52.9%
  • Macau adjusted property EBITDA: $388MM and a margin of 33.3%
  • "Opening approximately five months from today in March 2012, the 13.7 million square foot Sands Cotai Central will add substantial scale to the Cotai Strip and will feature amenities and attractions designed to broaden and deepen Macau's appeal as a destination for both business and leisure traveler"
  • Las Vegas: adjusted property EBITDA of $94MM 
    • "Table games drop was up during the quarter, reflecting strong baccarat play. Cash revenues from occupied rooms increased by more than 33.5% compared to the same quarter last year. In addition, 93% of our occupied rooms during the quarter were sold to cash-paying customers, compared to just 72% in the third quarter of 2010. RevPAR increased 8.6% as our FIT, group meeting and convention businesses expanded."
  • Sands China: 
    • Net revenue $1.2BN
    • Adjusted property EBITDA: $391MM
    • NI: $278MM 

SP500 Levels, Refreshed: Shipping Up To Boston

“I'm a sailor peg, and I lost my leg
I climbed up the topsails, I lost my leg
I'm shipping up to Boston.”

-Drop Kick Murphy’s


We shipped Keith up to Boston last night to visit with Hedgeye subscribers, but he hopped out of a meeting to call us on the bat phone and give us an updated look at the market.  From a price perspective, the SP500 is shifting to a more incrementally bullish position from the TAIL perspective.


As outlined in the chart below, the SP500 is currently above the TAIL line.  While we need a three week validation to turn bullish from a TAIL perspective, this is an important inflection point.  On the shorter term TRADE duration, the SP500 is at 1,286 and beyond our overbought level of 1,279.


For those who are positioned more bearishly going into today’s action, no doubt it feels like you’ve “lost your leg”, or at least lost some relative performance.  Although we covered our short of the SP500 yesterday in the Virtual Portfolio yesterday for a gain, we are still running a tight exposure with 9 longs and 8 shorts.  Clearly, this is not ideal positioning for today.


A couple of thoughts, though, on both GDP and the European bailout:


1.   GDP growth at 2.5% quarter-over-quarter and 1.6% year-over-year  is certainly higher than we expected, though still below a level that would be needed to narrow the output gap or take the economy back to full employment in the near term.  More interesting, and perhaps disconcerting, was that personal consumption was a key driver, despite consumer confidence readings remaining abysmal.  Nonetheless, if we believe the number, the economy is on the margin improving, albeit at a tepid pace, and that is a positive.


2.   Purportedly a solution in Europe has been reached, though yields in Europe are telling us a slightly different story.  Specifically, the Italian 10-year yield is down to 5.87% today, but that is still near its highs of the year at 6.09%.  As of yet, the bond markets don’t fully believe the Eurocrats. Interestingly, while the Germans approved leveraging of the EFSF, they DID NOT approve more German capital.  In fact, the line was drawn at more German capital being contributed, which has longer term negative implications.


As Keith wrote yesterday, we’ll continue to respect what the market sees next . . . and that continues to be the case.


Daryl G. Jones

Director of Research


SP500 Levels, Refreshed: Shipping Up To Boston - 1. spx


Where the stock goes from here is largely a function of whether or not investors believe that this management team can walk the walk.  After some struggles in the past, it is natural that it will take time for the company to win back the Street’s trust.  I certainly carry plenty of baggage when it comes to certain stocks.


The 2% revenue growth in the first quarter of FY12 was the strongest in the past 10 quarters and 43% EPS growth was the strongest in the past five years.  Additionally, the EPS growth came on the back of 24% EPS growth in the prior year quarter.  Margins improved 80 basis points despite a decline in average check.  The company operated well in 1QFY12.  These figures are backward-looking and you’ll end up in a ditch if you drive looking backwards but the improvements management has made in terms of margin should not be discounted.  I think it is fair to say that they have exceeded the expectations of the Street and of management.  The conference call was dominated by a uniform line of questioning from the sell-side that anchored off one theme: can the company comp the upcoming comps?


If the company was not executing I could understand the why so many remain skeptical, but that is not the case.  At the beginning of calendar year of 2011 (six months into FY 2011), the consensus estimate for FY2012 was $1.60 it now stands at $1.85 following a significant upward revision following the most recently reports quarter.   


The tone of skepticism was set from the very beginning of the Q&A period with the following question: “I think a lot of investors wonder about this quarter in light of the entire year, basically people are wondering about whether the traffic and the margin gains that you're getting today, if you can sustain those as perhaps the margin comparisons and the sales comparisons get tougher as the year goes on. I oftentimes look at things in terms of the trend, but I think the comparison sometimes scare people with regard to Brinker and its story.”


The question is fair when thinking about sales trends but misses the point when thinking about margins.  The Bar &Grill space is hyper-competitive and there are a number of rival brands that have announced a lunch promotion with a $6 or thereabouts price point.  History has taught us that being proactive about price points within the industry is a far superior strategy than being reactive.  Chili’s is changing the category with this latest strategy and the proof is in the reaction of its competitors.  To get back to the question of margins, margin comparisons do indeed step up next quarter, from +187 basis points y/y in 1QFY11 to +212 basis points y/y in 2QFY12.  From there, however, as traffic comps step up, margin compares become easier with +152 basis points and -3 basis points in y/y restaurant operating margin growth in 3QFY11 and 4QFY11, respectively.   Chili’s 1QFY12 comparable-restaurant sales growth was less-than-expected at +1.7% with +1.9% of that coming from transaction growth.  Taking this into account makes us confident that the company is executing at a high level from a margin perspective.  Clearly, Chili’s share of market needs to grow for the more difficult compares, due to the successful rollout of the $6.99 lunch promotion, that come in the second half of 2HFY12. 


There are several reasons for our optimism relative to the Street (not that that even implies optimism) regarding Chili’s top-line as we progress through FY12.  Firstly, we contend that the remodels being carried out by the company will have a meaningful impact on brand perception and customer satisfaction.  During the McDonald’s reimaging tour, management explained a “halo effect” that has been observed in Australia, Europe and is expected in the U.S.; as the proportion of the system that has been renovated approaches 50%, there is a noticeable sales lift.  Chili’s is at least a few years away from that, given that it expects to be at 200-250 stores remodeled at the end of the year.  As yet, 65 are remodeled in different test-cities across the country.  For context, 250 restaurants is equal to 19% of the system store-base.  In terms of winning new guests, the remodel program, proactive and compelling price points, and the various consumer experience-boosting initiatives around labor and food prep are strong positives we see that the company is not comping. 


In conversation with management, we discussed the difficulty in comping an initiative like $6 lunch but came away confident that the back-of-the-house technological improvements are broadening the scope of dishes that the concept can produce for its customers.  In terms of launching new platforms, which management intends to do once per year, the new technology allows operators to do so with far greater ease than competing chains.  Additionally, consistency and quality has been improving with the rollout of the new kitchen equipment while improving efficiency.  The improvements management has proposed are not only helping EPS growth, but have also been embraced by franchisees.


Unless there is a significant step-up in discounting across the industry over the next twelve months, Brinker’s margin story, for us, remains intact.  We will be monitoring the national brands like Applebee’s and Olive Garden for any evidence of this.


Another question that we felt reeked of skepticism was the following: “My question relates to traffic.  I'm a little surprised that traffic has not improved at a greater pace, especially given the comments you provided about survey information you've collected. What do you think needs to change at Chili's to drive better traffic? I mean, is the advertising message an issue?"


When we consider that Knapp Track Casual Dining Guest Counts declined an average of -0.17% during the 3QCY11, Chili’s 1.9% growth seems impressive considering that it is a mature category.  The company also did not advertise on TV during three weeks of September, which hurt the top-line.


Yet more skepticism came from the following question: “… on kind of the longer term outlook and guidance and how you're going to get there.  As I've understood it in previous calls or meetings you've had, you've always talked about getting up to 3%, 4% comps in 2013, '14 and '15, to enable you to get to your 400 basis points of net margin expansion.  And I guess I'm still, I'm curious as to why you have the confidence that your comps are going to accelerate to that level.  Is it that you think that the broader industry is going to rebound with the economy, do you think your market share gains are going to accelerate, and why do you have such confidence in one of those two things happening that you've incorporated in your guidance?”


The preface to this question was mistaken, as management pointed out; the 3-4% growth target was actually a revenue goal and not comparable sales growth.  However, even if comparable restaurant sales was the metric, 1.7% this quarter, adjusted for weather and September’s advertising step-down would most likely not be very far away from the 3-4% range that the question was asking about (but that management was not guiding to).   


We have not seen the work behind the downgrade today by Sterne Agee, but pessimism around the company’s ability to continue to comp the comps is likely a factor.  We believe that the kitchen initiatives, remodels, and focused approach with which management is executing this turnaround bode well for the company’s prospects. 


As far as we are concerned, a company that is executing well at a time when skepticism on the stock is consensus is nothing to be afraid of on the long side. 


Until we get evidence that company is not on the right path, we remain positive on Brinker on the TRADE, TREND and TAIL durations.



Howard Penney

Managing Director


Rory Green









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