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Downgrade Dominoes

Conclusion: Based on the potential for negative deltas across a few rather important credit ratings in a specified order, we think it will pay to stick with our King Dollar and Eurocrat Bazooka theses throughout the intermediate term.


This morning, in our firm-wide internal research meeting, Tom Tobin, Josh Steiner, and Keith McCullough all shared various thoughts on the ratings downgrade catalyst calendar. While we do not find much value in the opinions of ratings agencies, we do accept the implications that these downgrades have on market prices and financial market risk via hardwire ratings linkages with financial institutions and the perceived creditworthiness of bailout schemes such as the EFSF.


Given, we’ve decided to take the opportunity to quickly highlight what the calendar looks like on this front, which shows serious headwind of credit downgrade risk:


Downgrade Dominoes - 1


The recent and relevant commentary from the ratings agencies is as follows: 

  • Moody’s: “Moody's Investors Service has today placed on review for downgrade all subordinated, junior subordinated and Tier 3 debt ratings of banks in those European countries where the subordinated debt still incorporates some ratings uplift from Moody's assumptions of government support, with the potential complete removal of government support in these ratings. The review will affect 88 banks in 15 countries in Europe with average potential downgrades of subordinated debt by two notches and junior subordinated debt and Tier 3 debt by one notch... The review has been caused by the rating agency's view that within Europe, systemic support for subordinated debt may no longer be sufficiently predictable or reliable to be a sound basis for incorporating uplift into Moody's ratings…The banking systems and number of banks affected by the review are in the following countries: Austria (9), Belgium (3), Cyprus (2), Finland (3), France (8), Italy (17), Luxembourg (3), Netherlands (6), Norway (5), Poland (1), Portugal (2), Slovenia (2), Spain (21), Sweden (4),Switzerland (2). A list of affected institutions is attached: http://www.moodys.com/viewresearchdoc.aspx?docid=PBS_SF268891
  • Standard & Poor’s [per French newspaper La Tribune yesterday]: "It [revision to negative outlook] could happen within a week, perhaps 10 days." La Tribune further reports that it canceled at the last minute such an announcement that was originally supposed to accompany last Friday’s downgrade of Belgium. Recall that last week Fitch reiterated France’s AAA LT/LC rating, but that it would have “limited room” to absorb new fiscal shocks without endangering that status (i.e. backstopping it’s banking system or other large European sovereigns – both things France is likely to have to commit to doing in 2012).
  • Fitch: “The rating Outlook on the Long-term [U.S. sovereign LT/LC debt] rating is revised to Negative from Stable… The Negative Outlook indicates a slightly greater than 50% chance of a downgrade over a two-year horizon. Fitch will shortly publish its revised economic and fiscal projections for the U.S. and will conduct a further review of its sovereign ratings in 2012. However, in the absence of material adverse shocks, Fitch does not expect to resolve the Negative Outlook until late 2013, taking into account any deficit-reduction strategy that emerges after Congressional and Presidential elections.” 

As you can see from the aforementioned timing setup, we think there will be an opportunity to re-short the EUR vs. the USD (among other things) throughout the intermediate term – a view supported by this singular factor of potential negative deltas across a few rather important credit ratings in a specified order. While we would never gain conviction on any long or short position using a simple one-factor model such as this one, this is an incremental factor among a myriad of supportive data points for our intermediate-term King Dollar & Eurocrat Bazooka positioning, which is manifested in our current positioning below: 

  • Long the US Dollar;
  • Long long-term U.S. Treasuries and a Treasury curve flattener;
  • Long U.S. investment-grade corporate bonds;
  • Short French equities;
  • Zero percent allocation to U.S. money center banks; and
  • Zero percent allocation to European equities or credit. 

For the sake of brevity, we’ll keep it tight here. Email our sales team at if you’d like to dialogue further regarding any of the above; Steiner’s Financials team and Tobin’s Healthcare team have done a great deal of work regarding ratings linkages, etc. and the U.S. debt/deficit outlook.


Be mindful of that Global Macro calendar!


Darius Dale



Downgrade Dominoes - 2

Trade Update: Covering Hong Kong

Conclusion: We continue have a fundamentally negative outlook for the slope of Asian economic growth over the intermediate-term TREND and trading Hong Kong with a bearish bias around our quantitative levels remains our favorite way to play that view on the equity front.


Earlier this afternoon, Keith covered our short position in Hong Kong equities in our Virtual Portfolio for a decent gain vs. our cost basis. We continue have a fundamentally negative outlook for the slope of Asian economic growth over the intermediate-term TREND and trading Hong Kong with a bearish bias around our quantitative levels remains our favorite way to play that view on the equity front.


As mentioned in prior notes, we specifically like Hong Kong on the short side (relative to other alternatives) because of the following domestic factors/catalysts: 

  1. Pronounced domestic stagflation will continue to compress corporate earnings growth over the intermediate term;
  2. An inflecting property market will weigh on credit quality across the banking sector; and
  3. Slowing global growth will weigh on Hong Kong economic growth, which is among the world’s top two trade-oriented economies.  

Trade Update: Covering Hong Kong - 2


Trade Update: Covering Hong Kong - 3


Trade Update: Covering Hong Kong - 4


We’ve been bearish on Hong Kong equities in print since May 24th and, since then, that research/risk management has produced a substantial amount of alpha (Hang Seng Index down -19.7% vs. a median decline of only -10.5% across Asia’s other benchmark equity indices).


For those of you less familiar with our thoughts here, we encourage you to review our research on this idea and the associated thematic analyses: 

Lastly, our proprietary quantitative risk management levels are included in the chart below.


Darius Dale



Trade Update: Covering Hong Kong - 5

Shorting France (EWQ): Trade Update

Positions in Europe: Short France (EWQ)

Keith shorted France via the eft EWQ in the Hedgeye Virtual Portfolio today with the etf broken on its immediate term TRADE and intermediate term TREND lines (see chart below). 


Shorting France (EWQ): Trade Update - 1. EWQ


France remains an important EU country in the crosshairs—constrained by fiscal pressures (debt and deficit) and a web of cross-country sovereign banking exposure, the two combined put pressure on the country’s AAA credit rating. Moody’s put France’s credit rating on watch back in October; last night La Tribune rumored that within 10 days Moody’s will place France's AAA rating as “negative outlook”; today Moody’s said it may cut EU subordinated bank debt (including a review of SocGen); and in late November Fitch Ratings warned that France’s AAA credit rating would be at risk if the crisis intensifies.


The likelihood of a rating cut comes as no great surprise to us. On 10/18 we penned a note titled “France is Going to Get Downgraded”, and made the important point that there exists an enormous outsized risk to the entire European bailout project for sovereigns and banks should France lose its credit rating: essentially the entire EFSF would be jeopardized, as France is the second largest contributor of collateral to the facility, at 22%, behind Germany at 29%.


Shorting France (EWQ): Trade Update - 2. efsf


From the fiscal side, France’s public debt as a % of GDP is likely to hit 88.4% this year, near the important 90% (and above) level that Reinhart and Rogoff outline in their seminal book This Time is Different as prohibitive to growth.  Through austerity, the government hopes to bring down the budget deficit, forecast to hit 5.7% of GDP this year, to 3% in 2013, or in compliance with the EU’s Growth and Stability Pact. Nevertheless, there’s been great push-back to Sarkozy’s austerity programs, including the most recent €8 Billion in additional budget cuts, and we expect growth to come in below estimates.


On the banking side, France is the largest holder of Italian public debt ($106.8B) and private debt ($309.6B) of any country according to June BIS report, which compounds risk given Italy’s own debt imbalances and investor uncertainty around leadership in the wake of Berlusconi.


Early this month Sarkozy’s government revised GDP to 1.0% in 2012 versus a previous estimate of 1.75%. Politically, Sarkozy remains faced with high unemployment, at 9.2% (vs 7% in Germany), or 22.8% among the French youth, and unlike Germany does not have the ability to cushion slowing growth through exports. 


Matthew Hedrick

Senior Analyst

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India: Shift in FDI Policy Opens Doors to Retailers


Conclusion: India is easing its policy on foreign retailers. Not huge now, but  10-years ago, no one cared about China. Those successful there today are the ones who invested when no one cared.



India is easing its policy on foreign direct investment (FDI) – a positive shift for global retailers.


For those of you who are tired of talking about Black Friday, Cyber Monday, etc., here’s a big picture point to chew on…


The Indian government has agreed to allow 51% FDI in multi-brand retail and 100% FDI in mono-brand retail in an effort to help buoy the currency. This effectively opens the door to one of Retail’s most attractive international markets to (aspiring) global retailers.


Previously, multi-brand retailing was forbidden in India and the country restricted mono-branded retailers to 51% ownership requiring a local partner. The new shift in policy no longer blocks the likes of Wal-Mart, Carrefour, or Tesco from entering the market and enables mono-brand retailers to pursue more aggressive self-funded expansion plans (ie Nike, VFC, etc…).


As a point of reference, the Indian retail sector is currently worth approximately $450-$500Bn in USD, but has been growing at a HSD-LDD digit rate over the last few years One recent study called for the market to double by 2015.


Sounds like a lot, but keep in mind that India’s per capita GDP stands at US$1,477, while China currently sits at about $4,393. So perhaps not a stretch. No, India is not China, and vice/versa. There are distinct geopgaphical, cultural and idealogical differences that make them both distinct.


Also, keep in mind that with just ~6% of India’s retail distribution organized (i.e. not via stalls, etc.), it will take years for investment from global players – especially multi-brand retailers – to establish adequate supply chains to make meaningful progress so we need to be mindful of near-term expectations.


But 10-years ago, no one cared about China. It was not every other word out of a CEO’s mouth because the core markets are too mature to grow. The companies that are successful there today are the ones who invested when no one cared.


While India accounts for roughly 1% of the global luxury market compared to China at closer to 10%, the opportunity for global retailers is clearly evident. Several companies like VFC, SHOO, and others have already established a foothold with local partners. For a company like VFC, which has clearly outlined its plan to grow sales in India from ~$50mm in 2010 to over $200mm by 2015 accounting for a mere 20bps of growth annually, this announcement could accelerate efforts in the region. Either way, we expect India to quickly become part of the expansion dialog among retailers – particularly with the reality of slowing growth across much of Europe and China.


India: Shift in FDI Policy Opens Doors to Retailers - India China GDP per capita


India: Shift in FDI Policy Opens Doors to Retailers - India China GDP








Beef Prices


An article on cattlenetwork.com today discusses the higher beef prices that the restaurant industry can expect in 2012.  We have been writing about this for some time.  Production and supplies are set to be down in 2012 with demand from emerging markets likely increasing.


THE HBM: SBUX, CAKE, DIN - beef 1129



Notes from CEO Keith McCullough


Fun and games with month-end markups on no volume. Beware of the US economic data Wednesday-Friday. Expectations are too high.

  1. INDIA – stocks decided a 1-day rally to a lower-high was enough. Inflation isn’t going away on EUR/USD up days because Oil prices aren’t going down (Brent $110/barrel last), and Indian stocks don’t like sticky stagflation – down -1% overnight, taking the Sensex to 16,002 (down -22% for 2011 YTD).
  2. ITALY - On its shortest duration (the 2014 bonds) Italy Sells another €3.5B at 7.89%; a few months ago 6% was the "critical" line, then 7%, now I guess its 8%? C’mon. Let’s get as serious as Spread Risk is telling you to be here – Italian stocks are barely up this morning – and more importantly, down -37% since FEB (crashing) – no support for the MIB Index to 13,422
  3. EURO – another day, another hope that a USD selloff and a Euro rally is real. Unfortunately, the math is getting in the way of that; EUR/USD has an important short-term line of resistance that it’s been fighting for 48 hrs at 1.34; ultimately, the bigger lines that matter are TRADE and TAIL resistance of 1.36 and 1.40, respectively.


If you want to get bulled up on something into the start of the new month, go with US Dollar (UUP) or Long-Bond (TLT) on red today.







The ICSC chain store sales index posted its largest weekly gain since April, up 1.7%.  It appears that sales the weekly sales trends benefitted from additional store hours as many chain stores opened earlier; many stores opened late Thanksgiving evening.  The implication is these sales were borrowed from sales in the coming weeks.  According to ICSC, the strength came in the face of much warmer than normal weather, which should be a drag on sales of seasonal apparel.  Year-over-year growth jumped to 4%, the strongest since late July.


As the Hedgeye Energy Team noted today – “AAA reported yesterday that the average US price of regular unleaded gasoline dipped below $3.30/gal for the first time since Feb 2011 (Libyan crisis).  Weak demand has expressed itself in the gasoline market, not in the oil market.  Our read is that the relative strength in WTI is due to the unwind of the bottleneck at Cushing; and the relative strength in the Brent market is because of Egypt/Iran/Israel geopolitical risk.”


While lower gas prices might be helping to keep consumer spending growth at a modest pace the strong Black Friday sales trends suggests that consumers remain very price sensitive, which not a good sign for the balance of the Holiday season.





THE HBM: SBUX, CAKE, DIN - subsector fbr





SBUX: The Starbucks mobile payment app is set to launch on January 5th, 2012. 





CAKE: Cheesecake Factory initiated “New Overweight” at Stephens, with a PT of $34.


DIN: Dine Equity was initiated “New Equalweight” at Stephens, with a PT of $50.



THE HBM: SBUX, CAKE, DIN - stocks 1129



Howard Penney

Managing Director


Rory Green




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