Gas deliveries to the European Union have been disrupted since Russia cut supplies to Ukraine on January 1.

A gas disturbance is no trivial matter for Europe, considering that Russia supplies a quarter of Europe’s gas. Yet this time around (Russia cut gas supply to Ukraine in 2006), European reserves are more prepared for the intermediate supply drain.

Russia’s Gazprom and Ukraine’s Naftogaz continue to point fingers at each other to lay blame for the EU disturbance on the other. Gazprom Deputy Chief Executive Officer Alexander Medvedev told Bloomberg Television that Ukraine shut three export pipelines and said “unilateral action of the Ukrainians” caused the shortfall. Naftogaz spokesman Valentyn Zemlyanskyi said Gazprom cut shipments to Europe through Ukraine to 74 million cubic meters a day, compared with about 300 million normally.

The European Commission and the European Union presidency responded to the Russian move with a statement demanding that “gas supplies be restored immediately to the EU and that the two parties resume negotiations at once with a view to a definitive settlement of their bilateral commercial dispute.”

Gazprom chief executive, Aleksei B. Miller, said in a conversation with Prime Minister Putin—which was broadcast Monday on Russian state television—that Gazprom would reduce exports bound for Western Europe through Ukrainian pipes by the same amount that it accused Ukraine of diverting over the last days.

Russia is looking for the European community to put pressure on Ukraine to pay its gas debt and negotiate its gas price with Gazprom. With oil and natural gas both down -~75% since their summer highs and European disapproval of Russia’s attack on Georgia, Russia has lost significant weight on its balance sheet and has seen its geopolitical impact wane. We’ll be monitoring the tail risk associated with this gas disturbance and the increased tension between Russia and Ukraine.

Matt Hedrick

Bullish Global Macro Chart of The Day: European Deflation

The Euro Zone reported the most bullish macro # of this morning’s data run, printing a Consumer Price Inflation report that dropped to +1.6% y/y in December. While this deflationary “Trend” is not a new one (see chart), it definitely fits the European equity market’s newfound bullish narrative that they can join the global rate cutting party too!

From a calendar catalysts perspective, this is an important data point to consider because it provides the Bank of England the needed political ammo to drop rates big time on the Thursday – the market is begging for it. The FTSE in London closed on its highs, at +1.3% on the day, in anticipation, I think, of a BIG cut.

If they don’t cut BIG, the market’s latest “re-flation” puts itself in a position to be down BIG, on that news… we do not have edge on what the magnitude of the rate cut will be, so we will only watch the leading indicators that we always do (European stocks, currencies and bonds) and sit tight.

For now, the Euro has dropped to 1.34 vs. the USD on the day - this weakness in the Euro Zone’s 10 year old currency, alongside stock market strength has raised the bar of expectations on the British, considerably. THE QUESTION is, will they deliver?

Keith R. McCullough
CEO & Chief Investment Officer


The multi-factor approach:

TXRH—TXRH shaping up bullish; needs to hold 7.29

DRI—DRI healthy on a pull back, looking for 27.22

WEN—WEN looks strong, repo at 4.40

The fundamentals:

TXRH—I have to revisit this story as I have tended to have a negative bias toward the name in the past. The company screened positively relative to its competitors from both a balance sheet and regional store base exposure to current consumer challenges (gas prices, unemployment and housing market weakness) perspective. Please refer to my post from yesterday titled “FSR – Matrix Exposure” for more details.

DRI—I continue to think that DRI looks like one of the stronger FSR players with a strong balance sheet and proven concepts. Street estimates remain low even after the company provided significantly lower and more achievable FY09 EPS guidance. DRI’s more cautious guidance now assumes that same-store sales at the Olive Garden, Red Lobster and LongHorn Steakhouse will decelerate somewhat in the back half of the year, but Obama’s planned fiscal stimulus plans should provide some support to numbers. DRI also screened positively on the FSR Matrix.

WEN—WEN is in a strong position to right size the ship. We believe the company is on the right track with its new value initiative and will post positive MSD same-store sales in fiscal 2Q09.

the macro show

what smart investors watch to win

Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.

Chinese Generals

Chinese Generals - asset allocation010609

“All men can see these tactics whereby I conquer, but what no one can see is the strategy out of which victory is evolved.”
-The Art of War, Sun Tzu

Whether it was Team Canada earning its 5th consecutive World Junior Hockey Championship over Sweden last night or our perpetual quest to have our feet on the floor to help our clients earn a world class annual return – it’s all one in the same. This is a global “Trend” that knows no time and no bounds – it’s all about proactively preparing yourself to win.

The Art of War is a Chinese military book that has had a meaningful impact on how many of the world’s top strategists think. At Research Edge, we religiously adhere to the core strategy of changing our positioning as facts and prices change. At its core, the Chinese lesson is that within the confines of a dynamically changing battleground one requires a process to respond not rashly, but quickly, and accurately.

This is why we “Trade” around our exposures and positions. We think we understand investment “Trends” as well as anyone, but what we respect above all else is keeping our feet moving in the face of “improbable” outcomes manifesting themselves into reality. If and when those “unexpected” outcomes occur (like say a +30% 6-day “re-flation” in the price of oil like we just saw), we have already proactively positioned ourselves with a defense that can quickly turn into an offense.

Notwithstanding the wonderful history lessons written by a 6th century BC Chinese strategist, today is just another day in The New Reality of investing in 2009. After all of the nonsensical narrative fallacies of 2008, it has actually proven to be “global this time.” Quantifying the “re-flation” moves that we have seen in stock markets from Hong Kong to Brazil is not a trivial exercise. After starting 2009 off with a meltup (Brazil is +10.4% in the last 2 days), the Hang Seng and Bovespa market indices have both climbed over +40% from their October/November lows! While the manic media was focusing on the “Depression” and “what Bill Ackman likes”, the Sun Tzus of The New Reality were marching forward.

Per his friends in the media, poor Billy Ackman ended up having a down -68% year in 2008. While calling that out onto the mat may be considered “mean” by the old boy network, I’d like to hold this media maven accountable for his performance. Not unlike highlighting Sweden’s loss last night, or Peyton Manning’s loss this past weekend, that’s just the way warfare in its highest halls of competition works. There will be winners and losers. There will be transparency and accountability. Gone are the days of investing in your best “hedgie” club’s “idea dinners”. Gone are the made up Madoffs… Gone, baby, gone…

China’s stock market tacked on another +3.3% move last night, taking its 2-day rally since the New Year’s break to +6.3%. Not that I am keeping track or anything, but our Chinese long position in the FXI etf is up +24.82% now since we bought it on October 6, 2008. For the better part of October and November, no one wanted to talk about that place with all the people – but they do now… especially as the Chinese government is starting to show the world some of the “tactics whereby I conquer.”

Rather than trade their market’s future (s) on what Barney Frank is chirping at Congress, the Chinese make their announcements surgically – and almost always after the markets close. This morning they “reiterated” that they have a “moderately loose” monetary policy. In English, that means “we will cut interest rates whenever we feel like it, because we can.”

Unlike the American, Canadian, or Swedish governments, the Chinese proactively prepared for this economic tsunami. After all, Wall Street’s “Chindia” thesis of 2007 had very basic implications that the Chinese had an “edge” on… like managing their fiscal and monetary policies ahead of their foreseeable domestic slowdown. Now that the dark clouds of sentiment have lifted, whether you believe the Chinese reported numbers or not, it’s hard not to see them self-perpetuating their own economic blue skies in early 2009.

I think China can and will cut rates by another 200-300 basis points. This will both deflate the Yuan, and “re-flate” Chinese Bonds. Since bonds in China actually earn a return that isn’t ZERO, this puts the “Treasured” US Bond market in a precarious position. The largest holders of US Treasuries are China and Japan. If Obama and Volcker don’t ultimately issue these Asian governments a return, my guess is that they will go find it elsewhere – God forbid they look to the Chinese bond market! Imagine that… investing in themselves…

From the Eurozone to the Philippines, we are being issued deflating Consumer Price Inflation reports again this morning. The Europeans saw December inflation drop to a new cycle low of +1.6% y/y growth, and the Philippines saw a 200 basis point drop in month over month inflation! This, as Tim Russert would say, “IS BIG!”, as it will continue to provide the cocktail for the New Year and New Reality’s global rate cutting party.

Beware however… not all ZERO interest rate regimes are created equal… and those countries who provide their citizenry with a rate of return on their domestic savings are watching every other country’s tactics very closely…

Until this interconnected global market’s critical battles have been won and lost, what consensus may not see yet “is the strategy out of which victory is evolved.”

The US Bond market is shaking, and it is making me nervous. My SP500 support level is now 889. Wait for your prices; don’t chase them.

Best of luck out there today,

Chinese Generals - etfs010609

Got Gold?

I am getting a lot of questions today as to why I haven’t bought gold (GLD) back. I think this is a good question, given that A) gold is down today and B) gold remains in one of the most obvious bullish quantitative patterns in all of global macro.

The answer is because I am cheap. That’s it – I admit it. I am stingy here on price. I have my buying range (see chart below), and I am sticking to it.

Buy Gold between $807-826/oz, and sell it closer to where we did on 12/29 and $896/oz. This is a very trade-able range, especially suited for the patient trader. We want to own “re-flation” before oil moves up +23% in a week (like it did last week), not after.

Keith R. McCullough
CEO & Chief Investment Officer

FSR - Matrix Exposure

I have made the call that I think full-service restaurants (FSR) will outperform in early 2009 as their top-line results improve, on the margin, or become less bad, largely from Obama’s expected fiscal stimulus plans. I have also said that from a fundamental standpoint, I would expect DRI and EAT to benefit more proportionally from any economic stimulus as they both have strong balance sheets and concepts that are not going away. That being said, all FSR operators would benefit.

All full-service restaurants faced two obvious fundamental challenges in 2008: deteriorating top-line results and historically high commodity costs, which combined drove average FSR operating margins down over 250 bps on a year-over-year basis in 3Q08. The third major issue that hurt FSR stocks in 2008 (on average, down 48% in 2008) was the fact that the industry as a whole significantly increased its leverage at exactly the wrong time. On a debt (including the present value of operating leases)/EBITDAR basis, average FSR leverage increased to over 4x’s at the end of 3Q08 from about 3.3x’s at the end of FY07. Unlike the first two challenges met by the industry, not all FSR companies exposed themselves to the liquidity issues that emerged. Although we would expect all of the FSR operators to benefit from marginally better sales trends in 2009 and lower YOY increases in commodity costs, particularly in the second half of the year, only those companies with strong balance sheets heading into the year are positioned to outperform. Using the industry average debt/EBITDAR ratio as a reference, BWLD, CPKI, DRI, EAT, PFCB, RRGB and TXRH stood out as the companies in the best liquidity position.

Again, I would expect all of the FSR companies to be helped by Obama’s anticipated stimulus package, but from a macro perspective not all of the companies’ restaurant bases are created equal. As we have heard on earnings call after earnings call, dining out trends have underperformed in certain regions of the country, particularly California, Florida and Arizona to name a few. DRI commented last month on its conference call, however, that it is seeing weakness across the country and that some of the regions that had been strong, Texas in particular, did soften up in the second quarter. Using those comments as a backdrop, I set out to determine which FSR concepts are more regionally exposed to the issues currently facing the U.S. consumer, specifically gas prices, unemployment and housing market weakness. From the companies’ labor cost standpoint, I also looked at which restaurant companies are located in states least impacted by both federal and state minimum wage increases in 2009. Please refer to the matrix below for details.

Based on my more positive bias toward EAT and DRI prior to doing this analysis, I was not surprised to learn that both of these companies’ restaurant bases are well positioned from a regional standpoint. I was surprised to see that TXRH, PFCB and RT all screened relatively positive as well.

get free cartoon of the day!

Start receiving Hedgeye's Cartoon of the Day, an exclusive and humourous take on the market and the economy, delivered every morning to your inbox

By joining our email marketing list you agree to receive marketing emails from Hedgeye. You may unsubscribe at any time by clicking the unsubscribe link in one of the emails.