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Hedgeye Election Indicator Shows President Obama Ahead

 

Hedgeye Election Indicator Shows President Obama Ahead   - Screen Shot 2012 03 06 at 5.59.37 AM

 

The Hedgeye Election Indicator (HEI), a proprietary metric that uses real-time market and economic data to determine the probability of President Obama’s reelection chances, debuts today with a 116.9 reading, which equates to 58.4% chance that President Obama would win the US Presidential election if it were held today.

 

Hedgeye Risk Management, one of the leading independents research firms on Wall Street, developed the HEI over the past year to understand the relationship between key market and economic data and the US Presidential Election. We will release the HEI every Tuesday at 7 a.m. ET, beginning today all the way until election day Tuesday November 6.

 

After rigorous back testing, Hedgeye has determined that there are a short list of real time market-based indicators, for example, like the relative strength of the US Dollar versus a basket of selected international currencies, that move ahead of President Obama’s position in conventional polls or other measures of sentiment.  Based on our analysis, market prices will adjust in real-time ahead of economic conditions, which will ultimately shape voters’ perception of the Obama Presidency, the Republican candidates and influence the probability of an Obama reelection. 

 

 

Hedgeye Election Indicator Shows President Obama Ahead   - HEI

 

 

The model assumes that the Presidential election would be held today against any Republican candidate. Our model is indifferent toward who the Republican candidate is as the sentiment for Obama and for any Republican opponent is imputed in the market prices that determine the HEI. The Hedgeye Election Indicator is based on a scale of 0 – 200, with 100 equating to a 50% probability that President Obama would win or lose if the election were held today.


Triangulating Asia

Topics discussed this week:

  • China’s 2012 Policy Targets Bode Incrementally Poorly for Global Growth
  • Will IN-flation Become a Problem In Japan?
  • Policy Ping-Pong Sets Indian Equities Up For A Sustainable Breakout Or Breakdown

China’s 2012 Policy Targets Bode Incrementally Poorly for Global Growth

In a presentation to the National People’s Congress today, China’s Premier Wen Jiabao unveiled a bevy of key targets regarding China’s intermediate-term growth/inflation/policy dynamics. To summarize them briefly (per the National Development and Reform Commission), China will target:

  • Real GDP growth of +7.5% YoY in 2012, down from +8% in 2011 – a target that had been in place since 2005
  • CPI of +4% YoY in 2012, unchanged from 2011
  • M2 Money Supply growth of +14% in 2012, down from an actual growth rate of +14.7% in 2011
  • Fixed Asset Investment growth of +16% in 2012, down from an actual growth rate of +25% in 2011
  • A Central Government Deficit of 1.5% of GDP, down from a target of 2% in 2011
  • Budget composition:
    • Expenditures +14.1% YoY to CNY12.43 trillion
      • Social Security and Employment Spending +22% YoY
      • Education Spending +16% YoY
      • General Housing-related Expenditures +23% YoY
      • Spending on Low-Income Housing and Housing Subsides +25% YoY
      • Agriculture, Forestry and Water Conservation Expenditures +14.8% YoY
  • Tax Receipts (ex a CNY270 billion transfer from the Stabilization Fund) +9.5% YoY to CNY11.63 trillion
    • Income Tax Receipts -6.4% YoY (the number of tax-exempt citizens increased by ~60 million after the gov’t raised the minimum monthly income threshold)
    • Local Government Land Sale Receipts -18.6% YoY
      • Local governments will continue see fiscal pressure from declining land sale values and volumes, but the PBOC’s recent decision to relax lending curbs to local government financing vehicles will offset/delay a potential liquidity crunch facing the CNY10.7 trillion of debt outstanding (70% due by 2015).

The first thing we’d point out to investors is that China’s economic targets have been interpreted rather loosely by the real economy in the past. For example, Chinese GDP growth has exceeded the State Council’s +8% target every year since 2005 by an average of 294bps. Moreover, Chinese CPI came in at 5.42% last year, a full 142bps above the target.

 

That said, however, China’s setup as a State-directed economy and it’s historically air-tight model of State Capitalism do lend credence to our long-held belief that it’s very important to take Chinese bureaucrats’ words at face value – much more so than most other sovereign entities. In light of this, we think it’s very important to focus on what Wen’s speech entails for China’s long-term economic outlook.

 

During his prepared remarks, Wen stated: “[China] needs to shift to a more sustainable and efficient economic model and achieve higher-quality development over a longer period of time.” We interpret this comment as supportive of our view that the long-term outlook for Chinese economic growth is structurally lower. For more details regarding the fundamental reasoning behind this view, please refer to our OCT 18 note titled: “Putting China Into Perspective”.

 

Triangulating Asia - 1

 

The Shanghai Composite Index’s quantitative setup (demonstrably broken from a TAIL perspective) suggests to us that our view is not yet consensus on the buy side.

 

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Additionally, what bodes poorly (on the margin vs. expectations) for the intermediate-term slope of Chinese economic growth is the continued emphasis on slowing asset price appreciation in China’s property market. Given that fixed asset investment is slightly less than half of Chinese GDP, the explicit target for FAI – which calls for slowing – and the implicit target that is maintaining real estate curbs combine to suggest a slower, but more sustainable outlook for Chinese GDP growth in 2012.

 

All told, we think China’s economic policy will continue to force investors to lower their expectations for Chinese real GDP growth over the long-term TAIL. Equally as important, the composition of Chinese growth is likely to [finally] shift, on the margin, towards more household consumption and less FAI, manufacturing and exports. This is likely to slow Chinese demand for industrial commodities and energy stockpiles over the long term.

 

Will IN-flation Become a Problem In Japan?

Japan’s benchmark equity index, the Nikkei 225, is up +10.2% since the start of FEB (vs. a regional median gain of only +4.3%) on the strength of an earnings tailwind that is yen depreciation (USD/JPY down -6.4% over that duration vs. a regional median gain of +0.1%). For now, at least, Japanese equities are thoroughly enjoying their own version of the Inflation Trade.

 

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We covered our EWJ short on FEB 27 for a -2.87% loss in our Virtual Portfolio, bowing to the short-term upside risk that is rising inflation expectations within Japan that have accelerated on the margin alongside the yen’s fairly rapid decline – especially given the FX translation tailwind afforded to the 48.2% of the Nikkei 225 Index that is Japanese Industrial and Tech stocks.

 

Triangulating Asia - 5

 

From a longer-term perspective, what will rising inflation expectations mean to Japan’s low-yielding (nominal) sovereign debt market? As mentioned on our conference call last Friday, we think the JGB market will eventually become hostage to a marked acceleration in long-term inflation expectations. While the timing of this is hard to pinpoint at the current juncture, the latest developments suggest Japanese policymakers are likely to continue playing right into our view.

 

Of divine coincidence, Japan’s 5yr Breakeven Rate turned positive (+1bps) for the first time ever on the day of our conference call (securities in existence since JUN ’09) and closed at the same level today.

 

Triangulating Asia - 6

 

Again, we think the onset of long-term expectations for IN-flation (rather than DE-flation) in Japan bode poorly for the long end of the JGB curve. Again, while the timing is certainly hard to gauge at the current juncture, we’d be remiss not to signal this happening in real time, on the margin, within Japan’s equity and currency markets.

 

Going back to our point regarding Japanese policymakers playing right into our view, Prime Minister Yoshihiko Noda, whose approval rating hit an all-time low of 26.4% in FEB, said over the weekend that he remains optimistic that the DPJ and LDP can come to an understanding over his party’s proposal to hike the nation’s 5% VAT – a bill opposed by 40% of the public and which caused 9 former-DPJ lawmakers to defect from the ruling party in opposition.

 

Contrary to Noda’s [apparently groundless] optimism, LDP head Sadakazu Tanigaki reiterated his party’s long-held demand for Noda to call a snap election on top of meaningful spending cuts in exchange for acquiescing to the DPJ’s proposal. It remains to be seen whether Noda is willing to risk his party’s control over the lower house of the Diet and his own short-lived premiership (185 days) in exchange for pushing through a much-needed piece of austerity legislation. In doing so, Noda would risk becoming Japan’s seventh prime minister in just over five years!

 

Net-net, should the VAT not be raised according to Noda’s timeline, we expect the market to expect the Bank of Japan to be called upon to finance increasing shares of Japan’s sovereign debt issuance – particularly given their newfound +1% inflation target. Additionally, the DPJ is due to appoint two members to the BoJ’s nine-member board in APR ’12 and current governor Masaaki Shirakawa’s term is due in APR ’13. All three appointees are expected by us to be openly committed to increasing (to +2-3%) and achieving the bank’s inflation target by any means necessary – a view supported by accelerating political pressure emanating from lawmakers upon the central bank.

 

If this path is pursued, at risk is a loss of fiscal and monetary policy discipline that may end up stoking just what Japanese bureaucrats seek so desperately – inflation. Of course, Japanese policymakers will hold the view that they can appropriately dial back the necessary levers when the time comes, but we expect the JGB market to take the other side of this politicized view (i.e. “of course politicians will tell the market that they have all the answers – it’s their job!”).

 

Refer to slides 84-94 from our recent presentation on Japan for more details.

 

Policy Ping-Pong Sets Indian Equities Up For A Sustainable Breakout Or Breakdown

Indian equities (benchmark SENSEX Index), which have backed off hard from when/where we said they would, are now stuck between the proverbial “rock and a hard place”. The setup makes for a proactively predictable trading range and allows us to appropriately handicap the scenario analyses that are most likely to take place over the intermediate-term TREND.

 

Triangulating Asia - 7

 

Quickly delving into the past, Indian assets are generally outperforming the region on a YTD basis on the strength of capital flows that are largely predicated on the expectation that monetary policy will be incrementally eased to support growth:

  • SENSEX: +12.3%
  • INR/USD: +6.6%
  • 10yr Sovereign Yield: -35bps
  • Foreign Equity Investment: +7.4%
  • Foreign Debt Investment: +20.2%

We’ve actually seen those foreign portfolio inflows accelerate in recent weeks despite what we feel are ominous signals from India’s interest rate and currency markets. To be specific, 1yr O/S Interest Rate Swaps and 1yr Sovereign Yields continue to price in incrementally less monetary easing (a trend in place for much of the year-to-date) and the rupee is now underperforming both food and energy prices on a 1mo basis (a leading indicator for sequential inflation) to the tune of -367bps and -1,073bps, respectively.

 

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Looking forward from a TREND perspective, we expect the Reserve Bank of India to incrementally ease monetary policy at its MAR 15 meeting to help alleviate a liquidity shortage within the banking system. In FEB, Indian financial institutions borrowed an average of 1.4 trillion rupees from the RBI per day – the most since MAY ’10. And as recently as last Thursday, they borrowed a record 1.92 trillion rupees – more than three times the suggested maximum of 600 billion – from the central bank to circumvent a lack of funding. Per RBI Deputy Governor Subir Gokarn: “The RBI does not want the liquidity shortage to persist; [thus, we are] looking at ways to mitigate pressure on system.”

 

Triangulating Asia - 10

 

The liquidity shortage has served to tighten domestic monetary conditions, with O/N Interbank Rates continuing to trend higher in the YTD and commercial credit growth slowing incrementally. Interestingly, the dramatic slowing of India’s benchmark inflation readings to +6.6% in JAN has served to push India’s real sovereign yields to 2yr-plus highs. It is unlikely that the RBI will sit on its hands in the face of these hawkish trends in domestic monetary conditions.

 

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With India’s Real GDP growth slowing to a near three-year low of +6.1% YoY in 4Q11 and both Manufacturing and Services PMI readings ticking down in FEB (to 56.6 and 56.5, respectively), we think the pressure is incrementally on the RBI to lower interest rates and/or RRRs to support growth at its upcoming meeting (MAR 15).

 

Triangulating Asia - 14

 

For now, fiscal policy remains a headwind to Indian growth from an inflation perspective, and the RBI has expressed continued reluctance in easing monetary policy with such loose fiscal policy providing domestic inflationary pressures. Recall this was an issue that we correctly positioned clients ahead of via our FEB ’11 note titled: “India: Missing Where It Matters Most”.

 

From a near-term catalyst perspective, the budget for the upcoming fiscal year (staring APR 1) will be unveiled on MAR 16. Should the government adopt realistic economic growth/revenue targets and truly commit itself to reigning in public spending and narrowing the budget deficit, we expect to see market expectations of monetary easing accelerate, given that this remains the RBI’s stated largest headwind to further easing.

 

If, however, we see continued fiscal laxity, a TRADE and TREND breakdown on the SENSEX becomes an increasingly probable outcome – especially in light of the current international inflationary pressures we touched on above. Moreover, the ruling Congress party’s lackluster performance in the omnipotent Uttar Pradesh election (projected to win 38-55 of 403 seats per the latest polls) is a leading indicator for more partisan gridlock and continued lower-highs in the nation’s Investment growth.

 

Fundamental Price Data

All % moves week-over-week unless otherwise specified.

  • EQUITIES:
    • Median: +1.3%
    • High: Vietnam +6.7%
    • Low: India -0.5%
    • Callout: Vietnam +30.1% YTD on “Viet-TARP” speculation vs. a regional median of +12.3%
  • FX (vs. USD):
    • Median: -0.1%
    • High: Korean won +0.8%
    • Low: Japanese yen -1%
    • Callout: Japanese yen -5.6% YTD vs. a regional median of +2.7%
  • S/T SOVEREIGN DEBT (2YR YIELD):
    • High: India +11bps
    • Low: Vietnam -28bps
    • Callout: Vietnam -94bps YTD
  • L/T SOVEREIGN DEBT (10YR YIELD):
    • High: Philippines +9bps
    • Low: Vietnam -59bps
    • Callout: Australia +37bps YTD
  • SOVEREIGN YIELD SPREADS (10s-2s):
    • High: Philippines +13bps
    • Low: Vietnam -31bps
    • Callout: India (10s-1s) -12bps wk/wk
  • 5YR CDS:
    • Median: -5%
    • High: China flat wk/wk
    • Low: Japan -6.5%
    • Callout: Japan +7% over the last six months vs. a regional median of -8.2%
  • 1YR O/S INTEREST RATE SWAPS:
    • High: Korea +5bps
    • Low: Indonesia -45bps
    • Callout: India +40bps YTD
  • O/N INTERBANK RATES:
    • High: Australia +1bps
    • Low: China -57bps
    • Callout: India -25bps wk/wk
  • CORRELATION RISK: Indian equity investors generally like our Strong Dollar = Deflating of the Inflation view, given the positive correlation of the SENSEX to the DXY on a 15-day, 90-day, 120-day, and 3yr duration (+0.25, +0.32, +0.26, and +0.31, respectively).

Darius Dale

Senior Analyst


Decidedly Red Euro Services

No current positions in Europe


Final February Services PMI figures for select Eurozone countries were released today. As the table and chart below show, there was a notable contraction in the month-over-month figures.  In our work we’ve warned about recent unfounded optimism in Europe.

 

Decidedly Red Euro Services - 1. services pmi

 

First, our most immediate concern is that the Private Sector Involvement (PSI) deal to haircut Greek debt holders does not receive sufficient participation (especially since the ECB was exempt from taking a loss on about €50 billion of Greek bonds it exchanged for new, longer maturity securities), which will invalidate the debt reduction schedules agreed upon by Troika, the European commission, and individual country parliaments, which will leave the market back to square one on the Greek mess.

 

Second, not only may we see additional downside revisions to sovereign debt and deficit levels (last week Spain announced that its 2011 budget deficit reached 8.5% of GDP versus the original target of 6.0%), but due to austerity there may well be a longer tail of slow growth than the Street is forecasting. 

 

Finally, we keep front and center that Eurocrats will fight for their own job security in supporting the broken union of uneven countries at all costs.

 

Keith has selectively traded around European positions in the Hedgeye Virtual Portfolio based on our price sensitive macro model, however we continue to reiterate that we largely do not want to be involved in the risk imbedded in indecision of the next Eurocrat action.

 

Matthew Hedrick

Senior Analyst


real-time alerts

real edge in real-time

This indispensable trading tool is based on a risk management signaling process Hedgeye CEO Keith McCullough developed during his years as a hedge fund manager and continues to refine. Nearly every trading day, you’ll receive Keith’s latest signals - buy, sell, short or cover.

Super Dave Tuesday

Super Dave Tuesday


Conclusion:  A lengthening Republican nominating process continues to harm the Republican Party.  It is unlikely that the process ends with Super Tuesday, even though we would expect Romney to win a majority of the delegates tomorrow.

 

For those not familiar with the cultural reference in the title, Super Dave Osborne is a character that is created and played by comedian Bob Einstein.  As Wikipedia describes Osborne:

 

“He is a naïve but optimistic stuntman who is frequently injured when his stunts go spectacularly wrong.”

 

In a sense, and this may offend some die hard Republicans, but the Republican Party is becoming the Super Dave Party of U.S. politics.   We’ve noted a number of times that as the Republicans continue to extend the primary, the worse off it ultimately becomes for the presidential nominee who will have less time to focus on, strategize, and raise money for the general election.  We’ve posted President Obama’s chart from InTrade that shows his probability of reelection climbing consistently from the beginning of the Republican primary.

 

Super Dave Tuesday - intrade

 

 

We see a similar trend in more conventional polls.  On January 3rd, the day of the first Republican caucus in Iowa, Obama was at +46.6 on the Real Clear Politics poll aggregate and Romney was at +45.0, for a spread of +1.6.  Currently, Obama is at +49.1 and Romney is at +44.4, for a spread of +4.7.  Certainly, there are other factors at play, including improving economic data, but President Obama has very clearly widened his electoral advantage as the Republicans have attacked each other throughout the last two months.

 

Super Dave Tuesday - 2

 

 

A poll released this weekend from NBC / Wall Street Journal verified that the Republican nominating process is taking a toll on the Republican Party.  According to the poll, four in ten adults say the GOP nominating process has given them a less favorable view of the GOP, versus just slightly more than one in ten that say it has given them a more favorable opinion.  More critically, the poll found:

 

“Additionally, when asked to describe the GOP nominating battle in a word or phrase, nearly 70 percent of respondents – including six in ten independents and even more than half of Republicans – answered with a negative comment.”

 

Another interesting finding of the poll was that 55% of respondents, including almost 35% of Republicans polled, indicated they believe the Democrats do a better job of appealing to those who aren’t hard core supporters, which was more than double that of the Republican Party.

 

Unfortunately, Rush Limbaugh, the conservative talk show host, further injured the Republican Party’s ability to appeal more broadly heading into the 2012 election cycle with his recent comments to Georgetown law student and activist Sandra Fluke late last week.  Limbaugh called Fluke a “slut” and a “prostitute” due to her advocacy of including contraceptives in employee health plans.  Much of the Republican establishment quickly disavowed Limbaugh’s comments, but the fact remains that Limbaugh’s daily three hour radio show is the single most popular conservative talk show in the country, so, on some level, does shape perceptions of the GOP.

 

Setting aside more general perceptions, the Republican nominating process has its most critical day tomorrow (Super Tuesday) with ten states voting, including Alaska, Georgia, Idaho, Massachusetts, North Dakota, Ohio, Oklahoma, Tennessee, Vermont, and Virginia.   Based on current polls, it seems likely that Romney will win the majority of the delegates up for grabs on Super Tuesday by either solidly winning certain states, or by attaining a strong minority in states that he does not win outright.  (Including Super Delegates, there are 437 delegates being decided upon).

 

To date, Romney has won seven of the eleven primaries that have been held, with Santorum winning three, and Gingrich winning one.  In aggregate, Romney has 180 delegates, which represents well over half of the total delegates that have been awarded.  Santorum is a distant second with 90 delegates.  Assuming Romney does win a majority tomorrow, he will have 398+ delegates.  While this is a commanding lead, it is obviously still a long ways from the 1,144 delegates needed to claim the Republican nomination.  So, there does remain hope for the other candidates, albeit a distant hope.

 

In fact, Santorum already has a firm schedule that extends beyond Super Tuesday.  He has plans to visit Missouri and Mississippi a number of times over the coming week and his campaign is in the process of executing a statewide TV buy in Alabama.  Both Paul and Gingrich have campaign plans beyond Super Tuesday as well, even if slightly less formal.  It seems likely that all four candidates will stay in the race until the next major debate, which is on March 19th.

 

In the table below, we’ve outlined the key states voting on Super Tuesday, delegates at play, and results of the most recent New York Times projections based on recent polls (a proxy for consensus). If Romney does better than recent polls, it is obviously an increasingly positive indicator of the inevitability of his nomination.  That said, time will only tell whether he can come back from the damage being done in the primaries to the reputation of the GOP.

 

Super Dave Tuesday - 3

 

 

 

Daryl G. Jones

 

Director of Research

 

 

 

 

 


WEN: DEFENSIVE GROWTH IS EXPENSIVE

The bullish case for WEN, as put forward by management in the company’s 10-K published last week, is summarized by the points below:

  1. Improving the North America (USA and Canada) business by elevating the total customer experience through core menu improvement, step-change product innovation and focused execution of its brand positioning.
  2. Investing in an Image Activation program for new and remodeled restaurants.
  3. Continuing to develop the breakfast program.
  4. Growing more units internationally.

Given that the Wendy’s brand has been so poorly managed over the past five years, the initiatives the company is undertaking today are, for the most part, defensive in nature as the company is playing catch-up within an industry that kept moving while Wendy’s stood still.  Our point is certainly not that Wendy’s is beyond repair but we hold some serious concerns about the cost of recovery.  The $3.7 billion price tag, as we have been writing since the Analyst Day on 1/30, is set to be a massive drain on cash flow over the next three years.  Below, we go through several incremental thoughts pertaining to our bearish stance on Wendy’s following our perusing the 10-K filed last week.   The filing offers additional insight into cost issues facing the company. 

 

 

BREAKFAST STILL A TEST

 

2011 10-K: The newly released 2011 10-K included 438 additions to the 2010 10-K.  One of the more interesting ones to us was that Wendy’s is now seeking to encourage franchisee participation in the expanding testing of the breakfast daypart. 

 

Wendy’s will “continue to lease equipment to certain franchisees that are testing the breakfast program. At the time breakfast becomes a required program, the franchisees will be required to purchase the equipment from Wendy’s based on its then book value plus installation costs… Additionally, Wendy’s is providing loans to certain franchisees for the purchase and installation of equipment required to implement the breakfast program. The loans are expected to not exceed $25,000 per restaurant, carry no interest charge and be repayable in full 24 months after the installation is completed.” 

 

Furthermore, for the first three years of an early adopting franchisee’s participation in the breakfast program, “a portion of franchise royalties (on a sliding scale) will not be payable to Wendy’s but will be required to be reinvested in local advertising and promotions for the breakfast program.  Lastly, another addition to the annual filing states that “contributions otherwise due to The Wendy’s National Advertising Program, Inc. (“Wendy’s National Advertising Program”) based on breakfast sales will not be made but will be required to be reinvested in local advertising and promotions for the breakfast program until Wendy’s National Advertising Program begins to purchase national advertising for the breakfast program.”

 

HEDGEYE: It seems that the company has to offer substantial concessions to the franchise community to boost participation in what has been a prolonged testing period for the Wendy’s breakfast effort.  At a time when the company is likely to be cash-strapped for the next few years, these additional obligations are burdensome.  Additionally, purely by the fact that these incremental concessions seem to be necessary to convince franchisees to get in the game, is seems likely that confidence in the ability of Wendy’s to take share in the breakfast daypart is low.

 

 

INCENTIVES TO GROW UNITS IN NORTH AMERICA

 

2010 10-K: “Wendy’s has announced a program to encourage the development of new restaurants in the United States.  Under the program, provided certain conditions are met, the technical assistance fee for franchised restaurants opened from April 2011 through December 2013 will be reduced to $15,000, and royalties paid on sales from those restaurants will be reduced to 2% for the first 12 months and to 3% for the second 12 months.  After 24 months, the monthly royalty rate reverts to the prevailing 4% rate for the remaining term of the franchise agreement”

 

2011 10-K: “In order to promote new unit development, Wendy’s has established a franchisee assistance program for its North American franchisees that provides (with certain exceptions) for reduced technical assistance fees and a sliding scale of royalties for the first two years of operation for qualifying locations opened between April 1, 2011 and December 31, 2013. In addition, Wendy’s Canadian subsidiary has established a lease guarantee program to promote new franchisee unit development for up to an aggregate of C$5.0 million for periods of up to five years.”

 

HEDGEYE: That the company is now subsidizing new unit growth as well as the breakfast initiative is not a good sign.

 

 

FRANCHISEES SAYING “SHOW ME” FOR IMAGE ACTIVATION PROGRAM

 

2010 10-K: “Wendy’s has from time to time acquired the interests of and sold Wendy’s restaurants to franchisees, and it is anticipated that the company may have opportunities for such transactions in the future. Wendy’s generally retains a right of first refusal in connection with any proposed sale of a franchisee’s interest.  Wendy’s will continue to sell and acquire restaurants in the future where prudent.”

 

2011 10-K: “Wendy’s has from time to time acquired the interests of and sold Wendy’s restaurants to franchisees. Wendy’s intends to evaluate strategic acquisitions of franchised restaurants and strategic dispositions of company-owned restaurants to existing and new franchisees. Wendy’s generally retains a right of first refusal in connection with any proposed sale of a franchisee’s interest.”

 

HEDGEYE: The current leverage on the balance sheet and the cost of the remodels will limit how many stores the company can buy.   We are suspicious that some franchisees could want out at this point so the company needs to retain some dry powder to take advantage of strategic opportunities.  Part of convincing the franchisees that the image activation program is viable may involve the company owning more stores and showing concrete results. 

 

 

MORE NATIONAL AD FUND DOLLARS

 

2011 10-K: “As of January 1, 2012, the contribution rate for United States restaurants is generally 3.25% of retail sales for national advertising and .75% of retail sales for local and regional advertising. Prior to January 1, 2012, the rates were generally 3% and 1%, respectively. The contribution rate for Canadian restaurants is generally 3% of retail sales for national advertising and 1% of retail sales for local and regional advertising.”

 

HEDGEYE: Wendy’s still spends significantly less than the competition on advertising.  Shareholders will be hoping they spend the money on an advertising campaign that resonates with the consumer.

 

 

THE MOVE TO DUBLIN IS EXPENSIVE

 

2011 10-K: “We expect to incur significant costs in 2012 for the closure of the Atlanta restaurant support center and its relocation to Ohio for employee severance, retention, recruiting and relocation. In addition, we may incur redundant compensation costs for staff overlap during the relocation transition. We anticipate that our relocation activities will be substantially completed by the third quarter of 2012. During the relocation transition period, we are likely to not retain the services of some experienced corporate personnel, which could distract from and adversely impact the performance of certain corporate, control and administrative functions.  We expect to incur costs of approximately $23 million in 2012 for these costs.”

 

HEDGEYE: The move to Atlanta never made sense except to the old CEO. 

 

 

A NEW INTERESTING DEBT CALL OUT (some expensive debt in a free $ environment)

 

2010 10-K: “Wendy’s/Arby’s Restaurants and its subsidiaries have a significant amount of debt outstanding. Such indebtedness, along with the other contractual commitments of our subsidiaries, could adversely affect our business, financial condition and results of operations, as well as the ability of certain of our subsidiaries to meet payment obligations under the Senior Notes and other debt.”

 

2011 10-K: “Wendy’s Restaurants and its subsidiaries have a significant amount of debt outstanding. Such indebtedness, along with the other contractual commitments of our subsidiaries, could adversely affect our business, financial condition and results of operations, as well as the ability of certain of our subsidiaries to meet payment obligations under the Wendy’s Restaurants 10.0% Senior Notes due in 2016 (the “Senior Notes”) and other debt.”

 

HEDGEYE: The leverage the company has is manageable but is limiting the company's ability turn the system around. The Senior notes become callable July 15th this year at 107.5 and we expect the company to refinance some debt, as was hinted at last week on the earnings call.

 

 

THE BOTTOM LINE

 

As we see it, nearly all of the company’s new growth programs are going to cost the company incremental earnings for the next few years.  The company has yet to disclose how they are going to help finance the franchisees through the “image-activation” initiatives.  Given the billions of dollars needed to remodel the system, these data points from the 10-K are not incrementally positive for the company.  We believe that consensus may not be factoring in all of these issues given the current pace of same-store sales.  A slowdown in top line trends will only compound the problems facing the company; we see any top-line disappointment as likely to lead to a significant decline in the stock price.

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst


COMPLIANCE: Unreliable Narrators

Unreliable Narrators


The dotcom bust in 2000-01 should have been taken as a warning that systemic risk was unduly increasing.

OECD Yearbook 2012, “The Evolving Paradigm”

 

Hefting a silver ingot as he spoke, Ron Paul looked Fed Chairman Bernanke in the eye and asked the question the Chairman had been dreading: “Do you do your own shopping?”

 

That was but one high point in this week’s semiannual Humphrey Hawkins testimony, required under the 1978 Full Employment act.  For folks like Dr. Paul, who believe the Fed is unnecessarily opaque, the Act was designed to create sufficient transparency for Congress to fine tune policy toward the societal goals of full (read: enough to keep things quiet) employment and affordable (ditto) housing.  The Fed Chairman’s monetary policy report summarizes past policy decisions and describes their observed and projected impact on the economy, then contextualizes policy in the light of recent developments.  Some – Congressman Paul among them – believe this process fails to spread sufficiently the disinfectant of sunlight in the dingy recesses of the Fed.  It was not until Dr. Paul’s point-blank question that we learned Chairman Bernanke has first-hand knowledge of the price of tomatoes.

 

Maestro Greenspan used famously to sift through scads of prices furnished by armies of shoppers – the price of a tin of sardines in Chagrin Falls, OH; the price of a pair of nylons in Azusa, CA; the price of a tube of toothpaste in the Bronx – the Fed’s understanding of what drives America’s economy is based on a statistical edifice as massive as the Great Pyramid, and grounded in an understanding of every grain of sand that lies beneath.  What good does all this data do if we arrive at the wrong policy decisions?  You may well ask. 

 

Dr. Paul was getting at the real definition of Inflation – not, what does your regression analysis show, but a week-over-week comparison of how heavy your pocketbook is when you enter the supermarket, and how light it is when you leave.  A Princeton PhD will define Inflation with a series of algorithms derived from the data set of prices, as massively granular, as eternally shifting as desert dunes.  To the average non-PhD, Inflation is an emotional state: that feeling when the paycheck  that used to go for two tanks of gas, two weeks’ worth of groceries, movies on a Saturday night and the payment on the house, now goes for one tank of gas, two weeks’ worth of pasta and hamburger helper, a six pack and television on a Saturday night, and your younger son wearing his older sister’s sneakers for the junior high school track team.

 

The literary device of the “unreliable narrator” was first noted by Wayne Booth, professor of literature at the University of Chicago (which, it may interest you to know, does other stuff in addition to economics).  The unreliable narrator draws the reader into a narrative compromised by their own inability to see reality – or by deliberate obfuscation.  Readers of the novels of Chuck Palahniuk will recognize the phenomenon, as will fans of the movie “The Usual Suspects,” with its final-scene reversal of the central character’s identity.  Today, Unreliable Narrators dominate political discourse.  It is not clear whether the relentless pushing of fallacious policy is pure cynical manipulation, or whether our political leaders are really as stupid as they appear.

 

In his assault on the Fed, Dr. Paul made passing reference to “the old CPI” – a line of argument we wish he had followed.  Government accounts are the ultimate in unreliable narration, and the way our government measures inflation has been manipulated to an extent that even an SEC examiner would be able to detect.  It reminds us of the story the archer who shoots an arrow into the side of a barn, then paints the bull’s-eye around it.  And while it takes a Princeton PhD in economics to come up with the formula for painting the target around the arrow, anyone fourth-grader can tell you it’s wrong.

 

Two items came out this week from narrators who have a presumption of reliability.  The first was a transparent discussion of the risks of money market funds from the pen of Sallie Krawcheck, former head of wealth management at Bank of America (WSJ, 29 February, “Money-Market Funds Aren’t What You Think”).  The SEC is “finishing a proposal to increase regulation on money-market funds, the $2.7 trillion industry” whose primary purpose is to provide short-term funding for corporations.  To attain that goal, it provides investors with what has always been seen as a safe parking lot for their cash.  Krawcheck tells it like it is: money-market funds are not risk-free investments.  We hope the SEC will prevail on the matter of complete transparency, but Hope is not a regulatory oversight process.

 

Krawcheck writes that the rule as proposed would end the “convention of reporting assets at a fixed $1 net asset value – instead having it float to represent the funds’ underlying value.”  That underlying value is more diverse than it once was, and while Diversification is taught as part of Modern Portfolio Theory, your money-market fund is a case where diversification may not be a clear benefit.  The money market is a marketplace where buyers (corporations) purchase short-term cash from sellers (you), offering as inducements a rate of interest (today, nil) and the ability to sleep at night, in the form of a fixed $1 net asset value.  We were dismayed last year when we moved our retirement money out of a number of stock funds and found there is no option to hold funds in cash.  “But a money fund is cash” we were told.  No, we answered, it is an investment with a degree of risk associated with it.  Our account manager was incredulous, a situation that was only made worse when we explained that FINRA actually requires stockbrokers to be fully licensed (Series 7 registration, enabling securities professionals to sell risky investments to customers) in order to hold customer assets in a money market fund.  Even FINRA gets it right once in a while.

 

It is rare that we get such forthright disclosure of the risks facing our investments, and from such a credible source.  Krawcheck cites “hundreds of conversations” with money-fund investors, and from her professional background you may be most were with institutional money managers.  These investors – retail and professional alike – do not know “that as recently as last summer, the largest money funds averaged 45% of their investments in European bank paper, with one major player at just under 70%.”  She goes on to say that “half of the top 10 money-fund providers” are likely not well enough capitalized to guarantee the safety or liquidity of your assets.  In other words: your money market fund may hold German, French, Portuguese, Irish and Greek government debt, is not FDIC insured, and may not have enough money on hand for an overcast morning, leave alone a rainy day.  In short: it ain’t cash.  Which makes that “$1 net asset value” on your brokerage statement about as unreliable as a narrative can be.

 

Better yet, your broker is actually required to lie to you about the market value and recoverability of your holdings, because they must report the pricing as reported by the mutual fund.  Until this reported SEC proposal, no one has challenged the money fund convention of pricing all holdings at $1. 

 

We give this proposal little chance of implementation, because we think it would send a tremendous shock through the entire customer base of the US financial system.  It reveals that the value of our currency is further removed from reality than we thought: money fund valuation is a fiat on top of a fiat.  The proposal is receiving a firestorm of predictable opposition from the fund industry, but also from professional money managers – because it would demonstrate their own ignorance about the portfolio values they report to their investors and expose them to retroactive questions about levels of risk in their portfolios.  A money manager who heavily uses a less well capitalized money market fund should expect inquiries from investors and regulators alike.

 

From the corporate perspective, cutting money fund valuations loose from the one dollar benchmark would likely be disastrous.  The commercial paper market relies on the approximately $2.7 trillion money market sector for corporate liquidity.  Little did we know that the Europeans are also taking a sizeable bite out of our apple.  For all their shortcomings – perhaps because of them, if we place venality and lack of transparency atop the list – the Fortune 500 companies to whom you lend your dollars are planning to return the money in time, in order to be able to return to the world’s cheapest and most liquid trough.  Europe, in contrast, appears to be consciously steering itself into the greatest, most predictable slow-motion train wreck in modern history.  Would you lend 10% of your portfolio to the Euro zone?  How about 45% - or in some cases 70%?

 

In addition to the integrity of the commercial paper market, there is a further argument for holding firm on the one dollar valuation.  It creates a firm expectation – not a legally binding one, not even (we can hear you chortle at the term) a “moral obligation” of the fund.  But it creates a market standard that all participants must target.  It holds the managers to a level expectation and sets a clear benchmark for failure.  Indeed, we might go so far as to suggest that doing away with the $1 convention is an invitation to risky behavior.  Rather than cut the price free from its moorings, we suggest the regulators take a hard look at the composition of the portfolios of various managers, and at their risk management processes.  We recognize this is a more difficult task – but that’s what the SEC is paid to do.  Ultimately, this could even result in a two-tiered money fund marketplace: the firm one-dollar NAV funds, all managed to a conservative standard, and the speculative money funds – which would be free to float their NAV, but would have to pay a higher yield, charged to the issuers of the short-term paper.  Which raises a further question: are the money fund operators actually charging a higher rate for riskier paper, and not passing it through to the investors?  We only work here.

 

Unmentioned in this debate – and here we give particular praise to Ms. Krawcheck – is the responsibility of the consumer.  The investing world – professionals and retail alike – swing forever between panic and complacency.  Without threats looming on the horizon no one bothers to read the prospectus of their money market fund, much less to call the investor relations department and question what this stuff really means.  When things explode, everyone expresses horror at how poorly managed their investments were. 

 

Star quarterbacks are taught to shake off their shame response when they throw an interception.  The coach cannot have a quarterback feeling gloomy about his last throw: he must focus on being great in the upcoming play.  And so their egos are constantly stroked, they are trained to reinforce their awareness of their own greatness, no matter how badly they just botched that play.  Professional investors and traders are a lot like that.  We chose this week’s opening quote from the newly-issued OECD Yearbook as a classic indicator of how the system keeps failing those who rely on it.  Market participants shake off yesterday’s losses and take a fresh shot at the markets today with insouciance – and with your money.  If that didn’t work, they reason, maybe this will.  Investors must recognize that calm periods in the investment markets mask a host of sins and omissions on the part of managers, and that even the best-managed fund will have trouble if all investors rush to redeem at once.  Somebody did learn from the excesses and exposure of the dot-com collapse.  It was not the regulators, not the central bankers – and probably not the guy managing your investments – but somewhere out there are a few people who recognize that managing risk is the key to prosperity.  Michael Lewis’ book The Big Short is an example of the tremendous profits that can be earned when people focus on risk rather than return.  Finally, it appears the numbers of risk-aware investors may be growing.  There is, finally, no better means of portfolio preservation than risk management, and no better form of consumer protection than consumer education.

 

Changes in the way the markets are regulated will only come from the consumers.  The perpetual state of disaster we wake up to each morning is the direct result of leaving oversight of the marketplace in the hands of fools (the regulators) and villains (Congress).  Ms. Krawcheck has done the marketplace a tremendous service by delineating in clear and precise terms just how unrealistic the standard $1 valuation is.  Her piece is required reading for anyone who still has a dollar – a shrinking audience these days.  We would propose Sallie Krawcheck for the chairmanship of the SEC, but we would be afraid of offending her.

 

At Home With Tim And Carole


Q: When is a default not a default?

A: When it’s an ISDA.

 

Just another quiet evening by the fire in the Geithner home: that white elephant of a house in Larchmont, NY.  Tim pokes the fire lazily, unwinding after a long day of boxing with the Chinese over whose currency is bigger.  On the sofa, his wife Carole rustles the pages of the Wall Street Journal then lets out a sharp exhalation that is half surprise, half scorn in reaction to yet another story about how the Volcker Rule will cut off sovereign nations’ access to the capital markets and undermine the US’ ability to compete globally.  Despite his own very public pronouncements to the contrary, most people in the world think of Geithner as an economist and expect him to advise the President on economic issues.  We refer, of course, to Geithner’s much-parodied reply to David Gregory on “Meet the Press” (18 April 2010).  When asked whether unemployment might not rise again, Geithner replied “No, I’m not an economist, David, but if you see that happen it’ll be because you have more people come back into the work force now because there’s hope again.”  For someone who is not an economist, Geithner’s prediction is right out of Macro 101.

 

In fact, simplicity has much to recommend it, particularly in overseeing the financial markets.  Mrs. Geithner seems to share our view.  In his Opinion piece in the Wall Street Journal (2 March, “Financial Crisis Amnesia”) Secretary Geithner lays out a clear picture of what is perhaps most wrong about the regulatory process, and wrong with America’s economic and political nexus today.  Those who complain that America has allowed greed to run rampant are frequently reminded that, with all its failings – from slavery to Fannie Mae – America has created the highest standard of living for the most people in the history of humanity.  Those who keep trumpeting that factoid, though, forget that the biggest booms, the broadest creation of well-being was under a regulatory regime that included Glass Steagall, community banking, and strong labor unions.  The founders intended the political process to lurch forward through progressive points of gridlock, as a way to prevent runaway legislation by any one faction, leading to fiat government (as we go to press, Vladimir Putin looks ready for his coronation.)

 

No less than the safeguards to our democratic process, the soundness of our economic system is predicated on balancing interests: strong labor unions are a counter to the abuses of unbridled wealth, but also a productive alternative to a welfare state.  Strong bank regulation keeps a cap on bankers’ ability to grow earnings – both institutionally and personally – but protects depositors’ funds from the risks taken on by professional traders.  The community bank is analogous to the money market funds we described above.  When you deposit your $1000 in your local bank, you recognize that it may be lent to Joe’s Deli, Sam’s Shoe Town, or Bess’ Dresses, all local businesses run by people you know and trust.  The risk to your cash is the risk inherent in your community.  When you deposit that same $1000 in Banko Wanko Mundo, you may not realize that they have no interest in helping Bess expand her inventory – because they have been hypnotized to believe that they can earn more money, and pay themselves fat bonuses, if they let Wanko Mundo Securities trade your money in the European CDS market.  Well, you say, Greece is for sure going to default, so I guess I will get a return on my money.  Oops – nobody explained to you that ISDA, the private club that runs most of the world’s CDS business, can unilaterally declare that a default is not a default after all.

 

Far from being threatened by the Volcker Rule, we wonder why a private club, which is what ISDA is, can exercise a cartel-like influence on market forces by redefining the terms of the very contracts it created.  If private investors do not sue ISDA over abruptly invalidating the myriad CDS contracts that will now be violated over the Greek restructuring, perhaps the SEC and CFTC should.  Oh, we forgot – they are prohibited by Act of Congress from regulating the derivatives markets.

 

Writes Secretary Geithner, “my wife looks up from the newspaper with bewilderment at another story about people in the financial world or their lobbyists complaining about Wall Street reform.”  He has his finger on it: the conflicted structure of Wall Street is such that professionals are paid on their next transaction, not on how well they handled your money last time.  Washington, too, is caught in this windmill.  Look at the members of Congress who are charged with overseeing the financial markets.  While taking bankers and traders to task, they also must run for re-election every two years – which means they probably spend an average of about six weeks in each electoral term actually working on legislation – and will be visiting many of those same bankers to ask for campaign donations.

 

Secretary Geithner lays out a clear blow-by-blow of how we have ended up with our heads down the toilet – laced with an admonition that we are likely to remain there unless we consciously reverse course.  Geithner praises President Obama for pushing through financial reform quickly “before the memory of the crisis faded.”  But now, he writes, the weight of dialogue has shifted to criticism of the regulatory reforms and complaints that the costs are too high.  To those critics, the Secretary says the costs are “certainly not too high relative to the costs of another financial crisis.” 

 

“Amnesia,” writes Geithner, “is what causes financial crises.”  Secretary Geithner may not be much of an economist – perhaps that is why he has written a clear description of the facts, rather than a set of hazy “expectations.”  Maybe it’s time America stopped listening to economists and started listening to common sense.  Just because Tim Geithner says something, doesn’t mean it’s not true.

 


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