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Lazy Conformism

This note was originally published at 8am on November 14, 2011. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“This lazy conformism is one of the big dangers of this country today…”

-Siegmund Warburg


In Niall Ferguson’s “High Financier”, that’s what Warburg had to say about British political leadership in 1957. “There is a frightening amount of mediocrity … and there should be a crusade against complacency…” (page 136).


In 2011, anytime we call Old Wall Street out on these types of structural issues, they either block us or get really upset. That means we’re being the change we all want to see in this business. Groupthink is dying on opacity’s vine.


If the American financial empire wants any chance at seizing this global debt crisis as an opportunity to change, we better start now. Post WWII Britain had to learn this lesson the hard way - time is not an entitlement.


Back to the Global Macro Grind


Pressure packed with volatility and hope, last week was exciting. While hope is not a risk management process, fading the market’s beta is – and we’ll look for direction from King Dollar on that front once again this week (we have a 12% asset allocation to the US Dollar Index in the Hedgeye Asset Allocation Model).


Week-over-week Macro moves:

  1. US Dollar Index $76.94 = flat
  2. Volatility 30.04 = flat
  3. Commodities 320 (CRB Index) = flat

That’s a lot of flat.


In US Equities, the message wasn’t as flat:

  1. SP500 = up +0.8%
  2. Nasdaq = down -0.3%
  3. Russell2000 = down -0.3%

But, this weekend, there was a Lazy Conformism in analyzing what, precisely, all of this interconnectedness might mean to Global Macro investors. I saw a lot of pundits go as far as to say things like ‘when you really think about it, US stocks are flat this year.’


If you really don’t think about anything at all, that probably sounds right. Who needs to analyze anything or charge a fee for proactive anything if we could have all just closed our eyes during a +101% rip in Volatility (VIX) since May, and gone back to bed?


Whether it’s the Nasdaq or Russell 2000 having closed down for the last 2 weeks or US Treasury Yields dropping to 6-week lows as the SP500 tries to sustain low-volume 6-week highs, there is plenty to think about. Excellence in your risk management process is required.


Being excellent is ok. So is not losing money. In fact, for my money, that’s Rule #1 in this game – and rather than subscribe to some form of centrally planned mediocrity in this business that dares people to chase yield, we’re going to stick with what’s been working since late 2007.


Since making lower long-term and intermediate-term highs:

  1. The SP500 is down -19.3% since October 2007
  2. And down -7.3% since April 2011

Lower long-term highs in stock prices with higher long-term lows in volatility is what’s crushing both the economic cycle and investment returns. The Old Wall and Washington’s analysis of as much is broken.


Change needs to happen now. And no, hiring a lifer bureaucrat and Keynesian economist to run Italy isn’t the change Americans want to see in this world. Out with the whiners - Americans want to start winning again.


My immediate-term support and resistance ranges for Gold (bullish), Oil (bullish), German DAX (bearish), French CAC (bearish), and the SP500 are now $1766-1818, $95.39-99.89, 5969-6146, 3047-3176, and 1248-1269, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Lazy Conformism - Chart of the Day


Lazy Conformism - Virtual Portfolio

Winners vs Whiners

“What is even worse is a terrifying uniformity of opinions and reasoning.”

-Siegmund Warburg


Coming out of WWII, that’s how Warburg explained the difference between his thought process and that of the American bankers he competed with (they didn’t like that). According to Niall Ferguson, “…at times Warburg could lapse into an almost blimpish anti-Americanism…” (High Financier, page 167)


I’m definitely not anti-American. In fact, at this point I think I can make the argument that I love this country as much as my own. That said, I am anti-groupthink and anti-Old Wall Street. As Warburg said, at American banks “even those who are outstandingly intelligent change their views according to the movement of the Stock Exchange.”


On that score, just fyi, the US stock market is not the US economy. A lot of people on Old Wall Street disagree with me on that – and if you can’t tell already, I really want to have this debate in the arena of American public opinion!


Strong Dollar = Strong America. Period.


That doesn’t mean that the US Dollar has to go up and the stock market down for me to be right on this. On the contrary, I think this country will only get it really right when both its currency and stock markets are going up together. That’s when the 99% get paid.


Keynesians already have their hands up in the air before the Yale-Harvard Game this weekend reading this – ‘but, but, what about exports – how do we compete with the Chinese if our currency is strong?’


Stop whining and start winning.

  1. The US Economy isn’t an export economy anymore – get over it
  2. US Consumption = 71% of US GDP - this is a service and consumption economy
  3. Strong Dollar = higher purchasing power for Americans where it matters

American winners like Ford, Microsoft, and Apple didn’t become the leaders of innovation and job creation on some cochamamy central plan for a weak currency. They did it by dealing with the globally interconnected game that they were in, and finding a way to win.


Back to the Global Macro Grind


First, let me start with what’s been winning for us here in November – our Global Macro call for King Dollar. Here’s how the Hedgeye Asset Allocation Model is positioned for this morning’s open:

  1. CASH = 52%
  2. FIXED INCOME = 24% (Long-term Treasuries, Treasury Flattener, and Corporate Bonds – TLT, FLAT, and LQD)
  3. INT’L CURRENCY = 12% (US Dollar – UUP)
  4. US EQUITIES = 6% (Utilities and Healthcare – XLU and XLV)
  5. COMMODITIES = 6% (Gold – GLD)
  6. INT’L EQUITIES = 0%

I started the week at 0% asset allocation to US Equities as I came into the week short the SP500 (SPY).


Yesterday, I did what the process told me to do: started buying Healthcare (XLV), and sold some Fixed Income exposure (which was oversized to start the week at 30%, with my max being 33% to one asset class).


By Global Macro position, here’s what I am thinking as of last price:

  1. TLT – Growth Slowing, globally, is going to continue to have an impact on US Growth Slowing. Immediate-term target for UST 10-year yields is 1.98% so that means it’s time to take my time selling some bonds and buying some stocks (see Chart of The Day).
  2. FLAT – Growth Slowing. Period. We’ve had this position on since February of 2011, so the buy-and-hold crowd can give me a golf clap for having the conviction to stay with our highest conviction idea relative to consensus in January 2011.
  3. LQD – Are Corporate balance sheets “flush with cash” – no doubt, but some of them are flush with debt too – so we want to be careful with this position as the US bankruptcy cycle accelerates (see chart of American Airlines – AMR).
  4. UUP – Domestically, we think the US Presidential cycle puts Bernanke in a box. Internationally, we think the Europeans are going to cut rates alongside most central bankers in Asia and Latin America. Strong Dollar = Strong America.
  5. XLU – next to owning the top performing major currency in November (USD), we want to continue to have exposure to American cash dividend yields. This is the highest dividend yielding S&P Sector ETF and remains in a Bullish Formation in our model.
  6. XLV – buying it right is what matters most here (yesterday was a good re-entry point), but our Healthcare Team is bullish on the intermediate-term TREND outlook for consumption oriented domestic Healthcare stocks (think dental and Strong Dollar).
  7. GLD – again, you want to buy it right and manage your risk around what looks to be a relatively predictable range ($167.21-$175.98). As long as real-interest rates on American savings accounts remain negative, Gold works for absolute return.

I know it terrifies Old Wall Street to think that we can be as bearish as we’ve been on Growth Slowing, but still find a way to make money on it on the long side. Ray Dalio has done it in both 2008 and 2011 and so have we. Winners win.


Being perma bullish or bearish isn’t a risk management process; neither is hope for the next Big Government Intervention. I think we are having a generational moment in this country where the winners can take this country’s leadership reigns back from the whiners.


That’s the long-term America I think we can all believe in.


My immediate-term support and resistance ranges for Gold, Oil, France, Germany, and the SP500 are now $1, $97.69-102.11, 3003-3089, 5, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Winners vs Whiners - Chart of the Day


Winners vs Whiners - Virtual Portfolio

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The important commodities, at least for the food and restaurant industries, were mixed in terms of price action over the last week.  Grains moved lower, as did beef and chicken broilers, but wings, dairy and coffee posted strong gains.






The supply and demand profile for beef remains highly bullish.  Despite the retracement in beef prices over the last week, the trend is straight up and to the right.  Some analysts are estimating that cattle feedlot placements in October fell 3.9% year-over-year, according to cattlenetwork.com.   The USDA Cattle on Feed report comes out on Friday and, if there is a decline of the magnitude that some are expecting, it will be signal tighter beef supplies and likely higher beef prices in 2012.  In the fourth quarter of this year, tight feed stocks and the seasonal uptick in the slaughter of cows is expected to support price.


The demand setup remains strong as emerging markets, particularly in Asia, increase beef consumption and US exports continue to grow rapidly.  In September, beef shipments were up double digits.  We believe this is a negative for WEN, TXRH, and CMG. 



Chicken – BWLD


Chicken wing prices continue to march higher as year-over-year as chicken processors cut production and the year-over-year demand dynamics also support price.  We are confident that wing price inflation is going to escalate into 1Q12 and put pressure on Buffalo Wild Wing’s margins and pricing power.  Please see our note (“BWLD: PARTY’S (ALMOST) OVER” 11/16) for further details.  Chicken wing prices are now up year-over-year for the first time since 2Q10 (chart below).





Grains’ decline over the last week is a positive for the restaurant industry.  As a word of caution, prices need to come down considerably for protein producers to feel any relief and the benefit of that to pass through to purchasers and consumers.  For PNRA and the pizza names, the decline in wheat is a positive.  AgResource is predicting that the 2012 global wheat crop will be flat while the corn crop, due to a projected increase in U.S. production, will be up year-over-year. 



Dairy – CAKE, TXRH


Dairy moved sharply higher over the last week despite concerns about soft economic trends in Europe.  The recent spike in prices is a concern for The Cheesecake Factory and Texas Roadhouse and comes as global dairy supplies have been increasing.  For CAKE, in particular, we see this as having an impact on gross margins.  Management, earlier in the year, guided to favorable dairy prices in the fourth quarter on a year-over-year basis. 
































Chicken – Whole Breast


WEEKLY COMMODITY CHARTBOOK - chicken whole breast



Chicken Wings
















Howard Penney

Managing Director


Rory Green


Apparel Strength Onward


Sports Apparel Sales continue to remain strong despite more difficult compares. We like FL and FINL into the quarter but these trends suggests a solid start to Q4 on the apparel side.


Additional Noteables:

  • Athletic Specialty Sales continue to outperform the other channels with strength in both pricing and units driving the 16% growth over 32% LY (this is the peak compare for the channel for the remainder of year)
  • Outerwear continues to ramp earlier than in years past with growth north of 20% over the last 9 weeks; a potential pullback in unit sales looms but it is a better margin event on the whole. This is also positive for COLM & TNF – the latter of which is on a tear (see chart below)
  • Basketball continues to grow LSD despite the increasing likelihood that the 2011-2012 NBA season is no more; Basketball looking more and more like a fashion play over performance
  • Adidas continues to gain share but on a base of 8-10%
  • Champion, which is about 15% of HBI’s total sales, has taken a rather dramatic turn down over the past two weeks. We initially viewed this an anomaly. Now we’re not so sure. 

Apparel Strength Onward - sports apparel tables 11 16 11


Apparel Strength Onward - outerwear 11 16 11


Apparel Strength Onward - athletic specialty 2 yr




Buffalo Wild Wings has enjoyed a tremendous tailwind thanks to the sharp decline in chicken wing prices that continued through 2010 and much of 2011.


Buffalo Wild Wings put up surprisingly strong 3Q11 results on the back of stronger-than-expected comparable restaurant sales of +5.7%, which implies a two-year average trend of +4.2% (versus +2.9% in 2Q).  While this was an impressive number, the comp was largely fueled by the unlimited wings promotion that ran through the summer months.  The year-over-year menu price increase, at +1.4%, was the lowest it had been since 2006.  Thanks to -18% deflation in chicken wing prices during the third quarter, this impact of this strategy on the company’s restaurant operating margin was immaterial. 


The chart below shows the year-over-year menu price increase trend over the last five years. We would argue that the uptick in menu price that the Street is modeling (the 4Q11 and 1Q12 points below are consensus per Consensus Analytics) are likely too low.  Please note that the price increase estimates for 4Q11 and 1Q12 (blue line) in the chart below are based on Consensus Analytics' consensus.  We believe that wing prices in 4Q and 1Q will force this line higher than the Street is forecasting.  The year-over-year trend in Chicken Wing Prices over the next couple of quarters is based upon an assumption that the upward trend will continue to $1.20 for 4Q and $1.40 for 1Q.  At the SAFM Investor Day, Joe Sanderson stated that he was expecting $1.45 per lbs chicken wings by the time the Superbowl comes around.  As processors cut production and the year-over-year demand profile points to higher prices, we believe a significant increase along the lines of what Mr. Sanderson anticipates seems reasonable. 


BWLD: PARTY’S (ALMOST) OVER - BWLD menu price vs wings


BWLD: PARTY’S (ALMOST) OVER - BWLD wing price vs margin



The reason why this is important for Buffalo Wild Wings is that it will no longer be feasible, from a margin perspective, for sales to be driven by a promotion similar to “Unlimited Wings”.  In the event of there being upside risk to the Street’s menu price increase estimates for 4Q11 and, more likely, 1Q12, we would argue that comparable restaurant sales could disappoint. 


Some may point out that one risk to our thesis is that many food service operators successfully took advantage of comparatively low chicken tenderloin prices and promoted boneless chicken wings to alter the mix.  Buffalo Wild Wings has been fairly consistent in the proportion of its revenue coming from the sale of boneless chicken wings over the past few years, despite significant moves in the price of traditional chicken wings.  As a percentage of sales, boneless wings have been running at roughly 19% of sales during 2011 and 2010.  In 2009, when chicken wing inflation peaked, that figure was 19% (versus traditional wings at ~20%).  2009’s figure was a jump from the 16% of sales that boneless wings represented in 2008 and this helped offset the commodity headwind to a degree.  Given that wing deflation did not lead to customers shifting back to traditional wings, it seems that this proportion of 20% of sales traditional and 20% of sales boneless may be difficult to shift without significant price manipulation. 


BWLD: PARTY’S (ALMOST) OVER - chicken wings 1116



One question worth thinking about at this point is whether or not, in the event of significant inflation hitting the company’s P&L in 4Q11 and in particular 1Q12, the company can adequately shift customer preference away from traditional wings (spot market pricing) to boneless wings (which are contracted for the entirety of 2012 and some of 2013).  We would doubt it.  Even in the unlikely event that management can emulate the shift that we saw from '08 to '09 , we would argue that menu prices still need to rise more than consensus is projecting for 1Q12 earnings to meet expectations and this will be detrimental to traffic trends, which the business has –over the last few quarters – become increasingly dependent upon for comp growth.


Looking at the Street’s view of Buffalo Wild Wings, it would seem that our concerns may not be shared by other analysts.  Negative sentiment around the name evaporated more or less in step with chicken wing price inflation and we believe there is a high likelihood that it will reappear as wing prices start to impact the P&L. 


BWLD: PARTY’S (ALMOST) OVER - bwld sentiment



From a valuation perspective, BWLD is richly valued.  Currently trading at 7.8x EV/EBITDA NTM versus a casual dining average of 6.8x (6.4x ex-BJRI), we believe that a negative catalyst could cause multiple contraction.  For reference, one turn in the multiple represents $7.66 of upside/downside in the stock.  All in all, we believe that the next couple of quarters could prove difficult for BWLD given that the strategy it has used to drive sales as its commodity tailwind has subsided will not be viable when the tailwind is a strong headwind.  




Howard Penney

Managing Director


Rory Green



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