SP500 Levels Into The Close...

Buy investments down at the SPX 757 line (like we did), and sell strength up here on a low volume day into the close near the 895 line. See Chart - buy low, sell high.

MCD – Balancing Traffic and Margins

MCD’s decision to take the double cheeseburger off the dollar menu as of next week and raise the suggested retail price on the item to $1.19 is a welcomed move. Despite consistently strong same-store sales growth, MCD has faced declining U.S. restaurant margins for the last seven consecutive quarters.

The dollar menu currently accounts for about 14% of sales and the double cheeseburger has been the menu’s most popular item so a step toward increased profitability on this one menu item will help to improve U.S. margins. Although the higher price could impact traffic, I think it is more important that the company focus on margins. Additionally, maintaining the dollar price point in this environment of higher commodity costs has been the source of much friction among franchisees as they have watched their bottom lines suffer rather significantly despite continued traffic gains. At some point a decision needed to be made around traffic and margins, and MCD’s recent focus on the dollar menu had tilted the scales in favor of traffic at the expense of margins. Some franchisees, however, had clearly already chosen margins as they had already raised the price of the double cheeseburger and some are even charging more than $1.19, but MCD’s decision to follow with a system-wide price increase signals a level of support on the part of corporate.

MCD will be replacing the double cheeseburger with the McDouble on the dollar menu, which will still offer two beef patties but with only one slice of cheese (relative to the two slices of cheese on the double cheeseburger). The recent price of cheese was the primary focus of many franchisees’ argument for wanting to raise the prices of dollar menu items.

MCD’s traffic trends may experience some increased pressure from Wendy’s now that the double cheeseburger is no longer on the dollar menu as Wendy’s has been aggressively pushing its value trio promotion, which includes the Jr. Bacon Cheeseburger, the Crispy Chicken Sandwich and the Double Stack Cheeseburger, all for $0.99. As I posted back on November 5, a survey showed that the new value items are driving same-store sales but not profitability. Sound familiar? As I have said before, the restaurant industry is a zero sum game so if Wendy’s is experiencing a pick-up in traffic, it has to be coming from somewhere. Wendy’s market share gains could be accelerated by MCD’s changes to its dollar menu. That being said, I still think it was the right move by MCD from both a profitability standpoint and a franchise health perspective.


More bad news arrived for the UK this morning as new miserable economic data points emerged. GDP numbers showed that growth declined by 0.5% in Q3 while consumer spending figures declined by the most in a single period since 1995. Exports declined by 0.31% since Q2, while industrial Production was revised to a 1.1% decrease.

Gordon Brown’s government is now facing a perfect storm of rising unemployment, plummeting housing prices and a nearly completely frozen domestic credit market. It is projected that the plan that Brown and co-conspirator Darling are now proposing will leave the UK with the largest budget deficit among the G7. Academics have seriously questioned the advantages of the administration’s much ballyhooed plan to help close the gap with tax hikes for the rich, recalling the 1970’s when the highest tax rates reached over 80% and capture little or no revenues as rock stars and Duchesses alike lived abroad as “tax exiles”.

Both the FTSE and Sterling have rebounded since initially selling off this morning on this news, but we remain bearish. We are short the UK via the EWU ETF and with a committed negative bias both on a relative and absolute basis.

Andrew Barber

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The Washington Post today reported that USDA data is expected to show that more than 30 million people in the US are receiving Federal nutritional assistance. This will be the largest number since the program launched in 1969 – surpassing the previous record levels following Hurricane Katrina in 2005. Additional anecdotal evidence from food panties and other charitable organizations nationwide indicates rapidly increasing demand (coupled with an alarming drop off in donations).

An obvious strong correlation exists between unemployment and food stamp recipients (see graph below). Unemployment hit 6.5% in October and is predicted to increase in 2009. Additionally, despite the recent decline in commodity prices, increased food costs are also weighing heavily as CPI Food and Beverage jumped by 6.1% year-over-year in October.

As we enter the “New New Deal” era we expect that this data will be latched onto by members of the house and senate eager to advance their own policy agendas. Politicians love incendiary data, and what could be more compelling than 10% of the US population on food stamps?

Matthew Hedrick

Andrew Barber


The likelihood that consensus has gotten too bearish on DRI is high. The world knows that sales trends in casual dining are very tough in October and November and there is no reason that things will get better in December. However, the holiday season is upon us and more people will be coming out of their holes and shopping for family members. They might be spending significantly less this year but they will be shopping and getting hungry. Our model suggests that estimates are about 5% too low.

The consensus numbers suggest that current sales trends will continue for the balance of FY 2009 for DRI. Although I would agree that in the current fiscal quarter (2Q09) sales trends will decelerate further as September and October have proven to be more difficult than the summer from a traffic standpoint, I think casual dining companies will get some relief in early calendar 2009. It’s unclear what the Obama administration will do to help the beleaguered consumer, but help is on the way. We know the new administration is working on a plan to hopefully be in place shortly after he takes office in January.

Casual dining stocks have been in liquidation mode for the last three months. Yes, sales trends are bad but negative sentiment begets negative sentiment. Over the past three months DRI is down 49% and down 40% year to date. The stock now trades at 6x EPS with a 5% dividend yield. One of DRI’s most important competitors, EAT, is down 68% this year and trades at a 7% dividend yield. EAT trades at 5x EPS! Neither of these companies is going away, but the market seems to think otherwise.

My number one concern about DRI continues to stem from the company’s new unit growth targets and overall use of cash, which I don’t think properly reflect the current environment. Last quarter, management acknowledged the tough environment saying, “There's no question it has been a difficult quarter and given the difficult economic environment, it looks like it is going to be a challenging year. Our current sales and earnings outlook reflects that.” The analyst community does not agree with management! I think management’s EPS guidance and same-store sales target of flat to up 1% for FY09 is aggressive, but I think numbers will look better than what the street is forecasting.

Despite these challenging times when operating profit growth declined at each of the company’s core concepts, Red Lobster comparable sales declined for the third consecutive quarter with traffic down about 5.5% in 1Q and LongHorn posted a 4.9% same-store sales decline with traffic down about 7%, DRI maintained its FY09 unit growth targets (75-80 new restaurants, or 4%-5% unit growth). Total capital spending for FY09 will be north of $600 million. In addition, given where the company’s stock price is and management penchant for share repurchase, they are still buying back stock. Given the times, it’s an aggressive use of cash at a time when cash is king!

It's Time For Leadership

“He who thinketh he leadeth and hath no one following him is only taking a walk.”~ Anonymous

For whatever reason, there remains a tremendous amount of media driven hope that those who have “leadeth” us into this financial disaster are still capable of leading us out of it. After watching Vikram Pandit being interviewed by Charlie Rose last night, I can assure you that I will not be following this man anywhere. Hope is not an investment process.

After seeing the S&P500 rip the shorts for a +14% three-day move (we made the call pre-market open on 11/21 for S&P500 848, and it closed yesterday at 857.39), the Street’s perpetually bullish narrative fallacies have already swallowed the mainstream media into their groupthink. We took our ‘Hedgeye Portfolio Allocation’ in US Equities down to 6% selling into it. These networks had zero leadership to help them proactively predict this financial tsunami. They understood as little about the October 07’ top as they did last Thursday’s capitulation low. You have no reason to trust their attempt at synthesis as credible. Do so at your own risk.

I was on the road for the last 6 days, so if I am a little snarly this morning, I beg your pardon. Being away from my Bloomberg TV in the mornings and being forced to consume CNBC is as painful an exercise that I can implement into this stage of my daily life. Charlie Gasparino and Dylan Radigan are no leaders of mine. These people actually “thinketh” that they “leadeth”... for those of you who have played competitive sports, I am sure you can appreciate where I am coming from. There is nothing worse than people acting like Captains who were never voted to be by their teammates.

The Chinese are providing the real economic leadership in this interconnected global economy. Yes, this may very well be temporary… and no, this is not an un-American comment. What is un-American is what the said fiduciary “leaders” of our economic system have done to it. Pandit had to be acting last night – here’s a man who sold his hedge fund to Citigroup shareholders for over $800M, right before it blew up, and sat across from Charlie Rose telling him that weakness in Citigroup’s stock was due to “short sellers!” Clearly, “Mr. Vikram” (that’s what his new best friend Alalweed calls him) has no idea what real leaders who can hedge and make short sales in this profession do. He wouldn’t make such an embarrassing comment otherwise.

This overdose of American groupthink really has me concerned. That’s why I have moved back to 71% Cash. That said, I am more comfortable being long China today than I was yesterday, and we will be adding to that invested exposure. The Chinese “mavericks” are marching to the beat of their own drummer, and there are well over a billion people following them. This morning, China cut 1-year interest rates by over 100 basis points down to 5.8%. So now we have ourselves what most capitalists want to see – a government who is liquid long cash, cutting taxes, cutting interest rates, and creating stimulus. This is economic leadership that I can follow.

Now don’t fret, there is always hope that American Capitalism can renew her faith. I think it’s very possible, and this week’s changes to the economic leadership lineup is the first step in the right direction. This morning Obama looks like he is going to appoint The Man, Paul Volcker, to head up the Economic Recovery Advisory Board. Now we have Summers and Volcker, two players we have been championing this country to draft for the better part of the last 6-9 months, playing on the same line! This is progress. This is economic leadership that I can follow.

You see, most of the moves the Chinese Capitalists have been making in the last 3 months are being made because they proactively prepared themselves (and their balance sheet) to be in a position of strength. The scraps that remain of a failed economic Bush team are simply a function of the reality that is born out of attempting to lead a global economy reactively. Last Thursday, at S&P500 752, it felt dark in this country, because it was. Yesterday’s Federal Reserve pledge of $800B is called more leverage. We can call it the “TALF”, the “TARP”, or whatever sounds like a plan… but the plan now is that the plans are going to change. Change is good.  

We are short the US Dollar via the UUP exchange traded fund, because predicting the current American losing team’s “leadership” is easy. When in doubt, instead of a good hockey Captain saying “shoot it out”, Paulson calls for “lever it up.” This is what people who believe in themselves to a fault do. They make the capital mistake of repeating their 1st offense, over and over and over… expecting different results.

Post yesterday’s socialist call to arms, America’s balance sheet is levered almost 55x with a capital ratio of under 2%. Hank “The Market Tank” now has this fine country’s Federal Insurance Deposit Corporation (FDIC) backing his cronies bonds (Goldman Sachs) in exchange for a compromise for US homeowners. At every turn, this team’s solution has been to behave reactively and throw more debt at the problem. This is no leadership of mine.

The US Dollar has lost over 3% of its value into and out of bailing out the Pandit “Bandit’s” Citigroup, and the firm Hank levered up when he lead it. US currency weakness is a global market vote of confidence, and it’s not a good one… but for the revisionist historians, it’s probably the right one. Fixing this old boy team’s mess is going to take time and leadership. “He who thinketh he leadeth and hath no one following him” is finally going to take a walk.

Every great investment in leadership starts with a new beginning. On this American Thanksgiving, let’s be thankful for that.

Enjoy your time with your loved ones,


Long ETFs

TIP –iShares Lehman TIPS Bond --10 Year Yields dropped 11 basis points to 3.01 yesterday, near the 2.99 all time record set last week. 

OIL iPath ETN Crude Oil –Front Month Light Crude futures rose to 51.86 per barrel on Chinese rate cuts this morning.

EWA –iShares Australia – The OECD released a report estimating that Australia will emerge from recession in 2009 with a forecast GRDP rate of 1.7% due to lower rates and increased exports.

EWG – iShares Germany  --Inflation contracted in 5 states including Bavaria -where data show it at 1.5%  down from 2.7% last month. Porsche SE reported a 15% Year-over-year for the four months through November and indicated that the Volkswagen (EWG: 13.6%) ownership increase may be delayed by credit market issues.

FXI –iShares China –The People’s Bank of China lowered the benchmark one-year lending rate by 108 basis points to 5.58%, the lowest level in more than a decade. The deposit rate was also reduced to 2.52%.

VYM – Vanguard High Dividend Yield ETF –S&P data showed US equity dividend declining at the fastest pace in 50 years led by financials which accounted for 6 of 8 dividend suspensions or cuts in the S&P 500 month to date

Short ETFs

EWU – iShares United Kingdom – GDP declined by 0.5% in Q3 according to data released today, the first quarter-over-quarter decline in 16 years while consumer spending figures declined by the most in a single period since 1995.

UUP – U.S. Dollar Index – The pound declined to $1.5416 this morning on UK GDP declines.

EWJ – iShares Japan –Fitch reduced its Credit Rating for Toyota Motor Corp (EWJ: 5.61%) to AA from AAA with a negative outlook.

FXY – CurrencyShares Japanese Yen Trust – The yen rose to 95.16 USD and 123.46 EUR this morning as traders are focused on the scope of the US recession.

Keith R. McCullough
CEO & Chief Investment Officer

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