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“A plague o’ both your houses!”

-Mercutio, Romeo and Juliet


Mercutio’s immortal phrase was aimed at the houses of Montague and Capulet whose feuding led to the tragic sequence of events that make up one of Shakespeare’s most famous and timeless pieces.  The phrase has been resurrected ever since to express frustration, typically with two opposing sides of an argument. 


Franklin Delano Roosevelt, following a bloody clash between striking steel workers and the Chicago Police Department that came to be known as the Memorial Day Massacre of 1937, said that “The majority of people are saying just one thing, ‘A plague on both your houses’”.   Today, among the dearth of political leadership in Washington at such a time of crisis, many in the country are saying the same to the respective political parties.


Frustration is usually a transient feeling, sooner or later dissipated by resolution, compromise, apathy, or distraction.  As being poor became a way of life for many during the Great Depression, it seems frustration is now becoming a core component for not only the American existence, but for many people around the world. 


Conspiracy theories abound regarding the Federal Reserve and the degree of corruption that exists in America’s economic and political institutions but, Ben Bernanke’s assertion that the slow pace of economic growth is “frustrating” seems genuine to me.  I think frustration is something the country can relate to.  However, it was nearly unconscionable to me that he would used the phrase of a “bit of bad luck” when referring to the spike in oil prices and the dampening effect it had on economic growth this past year.  It was clear to us at Hedgeye that the Federal Reserve’s own policies were significant drivers of higher oil prices.       


Another political plague exists today in Europe as the never-ending saga of the sovereign debt crisis rambles on.  It has long been said by European officials that the union must be preserved and that the respective futures of the member states are inextricably linked, by both circumstance and by law.  I would view the former as being somewhat subjective and the latter as being, as was shown when Brussels consented to bailouts that may or may not be forbidden by the Maastricht Treaty, completely open to interpretation if the situation demands it.  A dramatic series of events is needed and the one certainty is that there will be pain.  Listening to politicians bending logic and essentially wasting further time with tired old solutions is becoming frustrating for Europe’s people.     


When President Obama was elected in 2008, he had successfully campaigned on a message of change.  I, like many other Americans, was taken by the message and the delivery, but it’s not possible for one person to change a compromised political system and this country is realizing now that there will be no quick fix.


This realization is all the more daunting when one considers that many of the same actors are in the same roles that they’ve been in for years.  Geithner and Bernanke are some of the most obvious examples but recent news of John Corzine possibly being culpable in the collapse of MF Global following his claim that thirteen years ago he “understood the flaws” at Long Term Capital Management better than anyone is equally disheartening.   


If repeating the same action again and again and expecting a different result is the definition of insanity, to use Einstein’s quote, then surely entrusting the same players with the same or similar responsibilities and expecting different results is also a folly.   In this respect, Wall Street and Washington D.C., are frustrating their shareholders and voters to no end.


The cast iron dogmas of the sphere of investing, as those of the policy world, are being exposed as useless.  We believe that a flexible, nimble, and data-driven investment process is essential to surviving the turbulence that is visiting the financial markets with greater and greater frequency as the unpredictable actions of governments continue to cause uncertainty.  Clearly some of the old guard in Wall Street, and Mr. Corzine is one example, have not learned to invest prudently. 


Over recent weeks, predicting whether macro factors or earnings were to be the driving force behind stock performance on any given day has been a fool’s errand.  With the wisdom of hindsight, however, I can say that macro factors have been more of a focus than earnings over the past month.  The “Greece Doesn’t Matter” television pundits have been quiet of late.  Soon the earnings season will be over and a new macro season starts.  Our “King Dollar” thesis is going to be one that we monitor closely with a minefield of catalysts heading into the holiday season.  Hedgeye has been highly accurate in calling the US Dollar over the last three years and, as Keith likes to say, “if you get the dollar right you get a lot of other things right.” 


Just as Wall Street needs a change in leadership, our policy makers need to step aside and allow new leaders to win back the confidence of the country.  The Federal Reserve’s forecast for GDP growth in 2011 is now 1.6%-1.7% versus 2.7%-2.9% prior and 2.5%-2.9% versus 3.3%-3.7% prior for 2012.  In a year, according to the Federal Reserve’s updated economic projections, the unemployment rate is scheduled to be 8.6%.  The Federal Reserve’s track record is less-than-satisfactory, so those projections certainly should not be relied upon and are likely overly-optimistic.  A mere 40 basis points of improvement in the unemployment rate is certainly frustrating.   40 basis points is of little use to the 46 million Americans now depending on food stamps for sustenance.


I can respect the experience that many of the policy makers in Washington possess and would love to someday hear or read any of their perspectives on what went wrong in the last few years.  However, given that this country is currently embroiled in a sort of economic Vietnam, I believe that the coach – President Obama – will ultimately be judged harshly for not having brought in new players in key economic policy roles.  Experience can be good but it isn’t necessarily always helpful.  As Robert Benchley said, “A boy can learn a lot from a dog: obedience, loyalty, and the importance of turning around three times before lying down”. 


Function in disaster; finish in style,


Howard Penney


FRUSTRATED - EL Chart 11.3


FRUSTRATED - Virtual Portfolio


If you thought WMS was a “show-me” stock before FQ1…



Even we were too aggressive on the numbers.  In our quarterly preview, we expressed the opinion that FQ1 was likely to be another weak quarter and that management would likely be unsuccessful in convincing investors that the story isn’t broken.  What we didn’t expect was that FQ1 would be an absolutely pitiful quarter.  On the bright side, it’s hard to imagine the quarterlies getting much worse.  CEO Brian Gamache’s characterized his company’s situation this way: “WMS has reached an inflection point."  We would say “hopefully, WMS has hit rock bottom.”


Excluding unusual charges, WMS produced $0.23 of EPS this quarter, 20% below materially reduced projections.  Not only did WMS miss for the 3rd time in a row but they once again lowered their forward numbers.  But now guidance is “conservative”.  In the penalty box, show-me stock lost all credibility; what the heck is going on?  Pick your description, they all apply, and management isn’t talking their way out of this one.


Product sales were $19MM below our estimate, although on the bright side gross profit was only $7MM below our estimate

  • New unit sales were almost 1,500 lower than we estimated with International sales just slightly more disappointing than NA sales
  • Not only were NA unit sales than our estimate, but they included 930 new units – about 700 of which came from Kansas.  We weren’t modeling the majority of those shipments for another quarter given that neither facility is opening until the March quarter and we typically assume that shipments for large openings occur one quarter in advance of an opening.  WMS must have jumped through some serious hoops to ship all their units early.  Without pulling forward Kansas, the quarter would have been even uglier.  BYI’s NA shipments only had about 150 new units – almost all from a partial shipment to Kansas Speedway - and we'll have to wait and see what IGT reports tonight. 
  • We estimate that WMS’s ship share plummeted to just 18% in the quarter.  While the F1 is normally WMS’s weakest ship share we just didn’t think that we’d see an 8% sequential drop – 5% is usually the norm.  Again, if the early shipments to Kansas were excluded or only partially shipped, share would have been even lower at roughly 13-15%.
  • Gross margins and revenues got a nice lift from the sale of an unusually high number of conversion kits which have mid to high 80’s margins. 

Gaming operations revenue and gross margin were both 6% below our estimate largely due to lower average win per day as well as more attrition in the install base than we expected.

  • Given the approval of numerous titles in the quarter, we didn’t expect an almost 280 unit sequential decline in the install base when WMS just lost 550 units in all of FY11.
  • Average win is typically flattish from the June to September quarter – we modeled a $1.50 sequential decrease which clearly underestimated the degradation in yields.

On the bright side, there was a YoY 15% decrease in R&D spend - despite management adamantly claiming they would never cut R&D -marking the first YoY decrease in R&D since March 2006.  Normalized G&A was also $2.5MM lower than we estimated decreasing 11% YoY.


TODAY’S S&P 500 SET-UP - November 8, 2011


Top 3 on Bloomberg this morning: Olympus (fraud), Berlusconi (out?), and Cain (groping?). Nice!  As we look at today’s set up for the S&P 500, the range is 13 points or -0.49% downside to 1255 and 0.55% upside to 1268. 






THE HEDGEYE DAILY OUTLOOK - daily sector view


THE HEDGEYE DAILY OUTLOOK - global performance



  • ADVANCE/DECLINE LINE: -306 (+942) 
  • VOLUME: NYSE 782.75 (-9.14%)
  • VIX:  29.85 -1.03 YTD PERFORMANCE: +68.17%
  • SPX PUT/CALL RATIO: 2.30 from 1.57 (+46.30%)




US TREASURY Yields – only up 3bps day over day to 2.03%, the long end of the US treasury market couldn’t care less about some of the lowest volume beta chasing rallies US stocks have ever seen. The 2011 call on Growth Slowing remains buy the long-bond (TLT)

  • TED SPREAD: 44.14
  • 3-MONTH T-BILL YIELD: 0.01%
  • 10-Year: 2.04 from 2.06    
  • YIELD CURVE: 1.79 from 1.84


MACRO DATA POINTS (Bloomberg Estimates):

  • 7:30 a.m.: NFIB Small Business, est. 90.0 (prior 88.9)
  • 10:00 a.m: IBD/TIPP Economic Optimism, est. 41.0 (prior 40.3)
  • 10:00 a.m: JOLTS job openings, (prior 3056)
  • 11:30 a.m: U.S. to sell $35b 4-wk bills
  • 1:00 p.m.: U.S. to sell $32b 3-yr notes
  • 1:00 p.m.: Fed’s Kocherlakota speaks in Sioux Falls, S.D.
  • 1:30 p.m.: Fed’s Plosser speaks on monetary policy in Philadelphia
  • 4:30 p.m.: API inventories


  • Election Day in the U.S. includes referendum in Ohio on collective bargaining rights
  • Jefferson County Commission will consider filing the nation’s biggest municipal bankruptcy
  • Olympus said 3 executives helped conceal decades of losses by paying higher fees to takeover advisers
  • OPEC releases estimates on global oil demand, 8:30 a.m.
  • U.S. Chamber of Commerce releases qtr economic briefing, 9 a.m.
  • President Obama travels to Philadelphia
  • New York City Mayor Michael R. Bloomberg will join the Center for American Progress and the American Action Forum for a discussion on deficit reduction in Washington. 10 a.m-11 a.m



THE HEDGEYE DAILY OUTLOOK - daily commodity view




  • Oil Rises to Three-Month High on Signs of Shrinking U.S. Stocks
  • Cargo to U.S. Dropping for First Time Since End of 2009: Freight
  • Damaged U.S. Corn Crop Pressures Global Food Supply: Commodities
  • Gold Drops After Reaching 7-Week High on European Debt Risk
  • Carbon Plan Passed by Senate as Gillard Seeks Public Support
  • Stocks Gain, Euro Pares Drop as ECB’s Stark Predicts Crisis End
  • Copper Advances First Day in Three on Strike, Inventory Drop
  • Diesel Supply Falls to 31-Month Low in Survey: Energy Markets
  • Copper May Slip Below $7,635 a Ton: Technical Analysis
  • Palm Oil Climbs to Seven-Week High as Production Poised to Slow
  • Buy Corn, Sell Wheat in 2012 as Gap Set to Narrow, Bowler Says
  • Copper May Advance on Signs of Reduced Supplies: LME Preview
  • Gold May Decline as Rally to Six-Week High Spurs Investor Sales
  • AB Foods Sees Sales, Profit Gaining as Commodity Costs Ease
  • Coca-Cola Hellenic Profit Falls on Higher Commodity Costs
  • Oil Climbs to Three-Month High on Possible New Leaders in Europe
  • Hedge Funds Curb Wagers for First Time in a Month: Commodities




THE HEDGEYE DAILY OUTLOOK - daily currency view





ITALY – oh the drama – with bond yields only down -4bps d/d to 6.62% and Italian Equities still in full crash mode (down -33% since 2011 YTD highs, despite these fun little short squeezes “off the lows”), other than having an Italian running the ECB buying everything he can that is Italian sov debt here, what else do we need? Silvio says “look into my eyes”…



THE HEDGEYE DAILY OUTLOOK - euro performance





JAPAN – on a huge fraud (Olympus) the Nikkei broke its only remaining line of TRADE support (8835) and sliced back down to -15.3% for the YTD; plenty “value” investors bought Japan on the “tsunami recovery” thesis – hearing crickets on that thesis now…



THE HEDGEYE DAILY OUTLOOK - asia performance









  • UN Report May Show Iran Is Moving Closer to Nuclear Bomb
  • Gulf Keystone Upgrades Volumes for Shaikan Discovery
  • Russia Says Timing of UN Report on Iran Nuclear Weapons ‘Wrong’
  • Gulf Keystone Revises Shaikan Resources to 8b-13.4b Barrels
  • Lavrov Says Iran Attack Would Be ‘Very Serious Mistake’: Reuters
  • Mubadala Development Owns 9.85% of Swedish Auto, Filing Shows
  • Doha Bank Considers 2012 Acquisition in Emerging Market
  • Medvedev Condemns Israel’s ‘Dangerous’ Threat of Iran Strike
  • Iran Ready And Able to Build a Nuclear Bomb, UN Watchdog Warns the Wor
  • Mol Advances Most in Week After Iraqi Oil Estimate Upgrade
  • Gulf Times (QA): Fresh clashes in Bahrain
  • Econ Times (IN): Russia warns against military strike on Iran - The Econo
  • Aramco Cuts Asia Oil Differentials, Lifts U.S.: Persian Gulf Oil
  • Zain Iraq Hires Advisers for Initial Public Offering: FT
  • Iran on Verge of Building Nuclear Weapon, Washington Post Says
  • Syrian Opposition Calls Homs ‘Disaster Area’ Amid Siege
  • Oil rallies to seven-week high ahead of IAEA report on Iran


The Hedgeye Macro Team

Howard Penney

Managing Director


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Self Indulgence

“The crisis, he came to believe, was a consequence of the self indulgence of the older generation.”

-Niall Ferguson (High Financier, page 64)


That’s what Siegmund Warburg thought about European governments coming out of the 1920s. I wonder what he’d think about them now? Top 3 headlines on Bloomberg this morning: 1. Olympus (massive Japanese corporate fraud), 2. Berlusconi (budget vote on the Italian Job) and 3. Cain (to grope or not to grope, remains the question).


Alleged or not, there is a pattern here. Self Indulgence by 21st century central planners is really wearing on The People. When I write about Old Wall Street, I don’t mean old people – I mean the mentality, opacity, and process that is what these conflicted people do. Governments, banks, and their legacy media “contacts” are all intertwined like never before. The People get that too.


Good News: Wall Street 2.0 is going to change that. The truth is very difficult to hide on Twitter. How else would sources with no real names be building higher levels of credibility than both heads of state and the manic media correspondents who are tasked with being “connected” with them? Change is good.


Back to the Global Macro Grind


On October 4th(at the US stock market’s 2011 bottom), Harvard’s Ken Rogoff wrote an Op-Ed in the Financial Times titled “Debt, Deficits, and Deadlock: Welcome to 2012.” While I think Rogoff’s “This Time Is Different” is one of the most important empirical works in recent economic history, in the belly of his article he made a statement that blew my mind:


“…it is absurd to be worrying excessively about a 1970s stagflation.”


Notwithstanding the inflammatory wording of the statement, given the data that’s emerged in both recent history (and across the longest of long-term data in his book) that piling-debt-upon-debt-upon-debt with fiat currencies produces inflation, I have no other choice this morning than to highlight something many of these academics have a hard time dealing with – real-time market prices.

  1. Brent Oil prices are pushing back toward $115 (ie up +15% from the time of Rogoff’s article)
  2. WTIC Oil prices are pushing back above our long-term TAIL line of $93.88/barrel to $96.12 (up +23% since October 1st)
  3. Gold is moving back into a Bullish Formation (bullish TRADE, TREND, and TAIL), up +10% since early October

At the same time, European economic data continues to show classic signals of Stagflation (Slowing Growth, Accelerating Inflation):

  1. British Retail Sales drop -0.6% y/y in October (a 4 month low) as British GDP is tracking at 0.5% y/y w/ +5.2% inflation
  2. France’s Services PMI report dropped to a rock bottom 44.6 in OCT, signaling a recession in French Consumption Growth
  3. Italy’s inflation for OCT was +3.8% (vs +3.6% in SEP) as unemployment hit a new highs and GDP growth is signaling recession

Never mind the “absurdity about worrying about stagflation”, if oil prices remain near generational highs (using the 2008 all-time peaks is not what a long-term investor should be normalizing), there is a very high probability that Western Europe is entering an intermediate-term period of negative GDP growth and accelerating inflation growth (ie Stagflation).


Before the Keynesians hit the roof on these calculations (accepting responsibility for their policy recommendations? how absurd!), let’s bring in another market practitioner’s view. In his most recent monthly note titled “Pennies from Heaven”, Bill Gross asks a very simple question: “Can you solve a debt crisis by creating more debt?”


Of course not.


Why? Because, as Reinhart & Rogoff empirically prove in “This Time Is Different”, once a country crosses the proverbial Rubicon of 90% debt-to-GDP (Japan, USA, Italy, etc), creating more debt structurally impairs/slows whatever economic growth that was left.


So, as we worry about the worries of the day – the crises that politicians have created so that they can now save us from the “depression” of it all – remember that the US Treasury market has had this right all year long. Growth Slowing is structural. And, as a result, I’ll Self Indulge and ask Mr. Rogoff why it is so “absurd” to be “worrying” about these very probable Global Macro risks?


My immediate-term support and resistance ranges for Gold (Bullish Formation), Oil (Bullish Formation), German DAX (bullish TRADE; bearish TREND) and the SP500 (bullish TREND; bearish TAIL) are now $1, $93.88-96.28, 5, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Self Indulgence - Chart of the Day


Self Indulgence - Virtual Portfolio


McDonald’s will announce October sales before the market open on 11/8. 


McDonald’s reported stronger-than-expected sales and EPS for 3Q which has given the stock a boost.  September sales were especially strong, with global comps coming in at +6.6% versus expectations of +3.9%.  APMEA was the largest upside surprise, with comps at +6.9% versus consensus at +2.7%.  Europe printed the same number, versus the Street at +3.3%.  The US came in at +5% versus expectations of 4.1%. 


During the third quarter earnings call management struck a positive tone and gave October-to-date global comps, as of 10/21, of between +4% and +5%.  Consensus seems to be clinging to the low end of that range at 4.1%, according to Consensus Metrix.  Judging by the Consensus Metrix data, the consensus numbers of 3.42% and 4.27% for Europe and APMEA, respectively, imply a sequential decline in two year average trends in October.  While Europe was helped in September by a calendar shift related to Ramadan which alone may make a sequential decline two-year average trends more likely, the turmoil in Europe is also a concern.  Also a concern is slowing growth in Asia, which could negatively impact APMEA comps.  However, growth was slowing in September as well and MCD posted an impressive +6.9% comp that month.  Growth in important APMEA markets such as China and Australia has been trending lower throughout the year.  We believe there could be upside risk to the consensus figures in those two divisions.


Compared to October 2010, October 2011 had one less Friday and one additional Monday.  As a result, we would expect a negative calendar shift.  In January 2011, when there was the same calendar shift versus January 2010, the impact was between -1.3% to -0.4% varying by area of the world.  For the purposes of this post we are assuming that the same calendar shift occurred in October 2011.


Below we go through our take on what numbers will be received by investors as good, bad, and neutral, for MCD comps by region.  For comparison purposes, I have adjusted for historical calendar and trading day impacts and make the aforementioned assumption for October 2011’s calendar shift.



U.S.: facing a compare of 5.6% (including a calendar shift which impacted results by -0.2% to +1.2%, varying by area of the world). 


GOOD: A print above 4.5% would be considered a good result, as it would imply a sequential acceleration in two-year average trends in October.  Following what was a strong month in September, a further acceleration would be a good indication for the strength of the domestic business.


NEUTRAL: A number between 3.5% and 4.5% would be considered neutral given that, on a calendar-adjusted basis, the midpoint of the range would imply trends that are roughly in line with September.  We are holding the domestic business to a high standard because we believe that investors are expecting MCD to continue to take share in the U.S.


BAD: A number below 3.5% would imply a sequential deceleration in two-year average trends which would be received as a bad result by investors.  Given the high standard MCD has set, a deceleration – especially after the 10/21 guidance of 4-5% global comps – would be a disappointment.





Europe: facing a difficult compare of 5.8% (including a calendar shift which impacted results by -0.2% to +1.2%, varying by area of the world). 


GOOD: A print of 4% or higher would be received as a good result by investors because, while it could imply a sequential deceleration in two-year average trends, two-year average trends would still be in line with the year-to-date average and far in excess of the poor trends in August (albeit impacted by Ramadan shift). 


NEUTRAL: A number between 3% and 4% would be interpreted as a neutral result by investors, as two-year trends would have deteriorated somewhat on a sequential basis but would still be roughly level with year-to-date trends on a calendar-adjusted two-year average basis. 


BAD: Below 3% would be received as a bad print from a headline perspective; any comp below 3% is low for MCD Europe.  August was a case of an unfavorable Ramadan-related calendar shift impacting traffic but a repeat in October could lessen investor confidence.



APMEA: facing a compare of 5.3% (including a calendar shift which impacted results by -0.2% to +1.2%, varying by area of the world). 


GOOD: A print of more than 5.5% would be received as a good result by investors.  While this result would imply a sequential decline in two-year average trends, the absolute level would be above the year-to-date average calendar-adjusted two-year average trend.  Growth has been slowing in important APMEA countries and this has been reflected in APMEA comps, therefore we feel that a calendar-adjusted two-year average trend between 5.5% and 6% (which a 5.5% print would imply) would be received well by investors.


NEUTRAL:  A result of 4.5% to 5.5% would be received as neutral by investors.


BAD: A print of less than 4.5% would be interpreted as a bad result by investors as it would imply a strong decline in two-year average trends.



Howard Penney

Managing Director


Rory Green



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