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Hunting American Bear...

Much like yesterday’s Chinese PMI chart, today’s ISM non-manufacturing chart found itself a little hook higher (see chart). What happens on the margin matters most to our macro models, and this, on the margin, was another better than toxic economic report.

The bears traps are still land locked in a thesis that bottomed in November, not only locally here in the USA, but globally. In December/January, things started to get “unstuck”, and that’s why equity markets, globally, continue along this path that we have been calling for – “Re-flation”…

Keith R. McCullough
CEO & Chief Investment Officer

SP500 Levels Into The Close

With the SP500 now +25% from its deflated “Depression” lows, there are a lot of bulls out there asking themselves why they are so bearish. This is a very good thing – it’s bringing liquidity back into a market that’s earned herself lower volatility and more predictable trading ranges.

The US$ had an important intraday reversal and now higher beta assets like commodities and stocks continue to “re-flate” as a result. This is what happens after asset bubbles pop and new ones in terms of negative sentiment form. The bears have doubted this move from the start – we should be thankful for that.

My new trading ranges are outlined below. They are, on the margin, more bullish than they were prior to this morning’s open. That’s just how the math works.

Topside resistance for this market’s immediate term “Trade” moves up to the 951 line, and intermediate “Trend” resistance remains formidable at the 963 line (see chart).

On the bullish side of the “Trade”, your support line has built itself up to 896, and there is considerable support below that line at 884. Keep moving.
KM

Keith R. McCullough
CEO & Chief Investment Officer

CHUX – NEW LEADERSHIP

O’Charley’s announced today that it named Philip J. Hickey Jr., the former CEO of RARE Hospitality International, to its Board of Directors. Mr. Hickey’s appointment was recommended by Crescendo Partners, CHUX’s largest shareholder, pursuant to an agreement Crescendo Partners entered into with CHUX in December. Mr. Hickey was the CEO of RARE Hospitality when it was acquired by DRI in October 2007 for about 10x NTM EBITDA, a significant premium to the FSR group’s current average 5.9x multiple and to the group’s 5x multiple for the better part of 2008. Mr. Hickey was instrumental in selling RARE at a 39% premium to the company’s stock price prior to the announcement of the acquisition in August 2007 before FSR stock prices declined an average of 48% in 2008. Making this appointment more interesting is the fact that Crescendo Partners has engaged in discussions in the past with certain members of CHUX’s senior management regarding “various strategic alternatives to maximize shareholder value, including (i) a significant repurchase of shares, (ii) the sale-leaseback of [CHUX’s] real estate assets, (iii) a sale of [CHUX’s] Stoney River restaurant concept, (iv) the refranchising of company-owned restaurants in under-penetrated markets and (v) the outright sale of [CHUX].” Relative to these alternatives, Crescendo Partners’ choosing Mr. Hickey as its Board appointee signals that CHUX’s largest shareholder is pushing for real change, including a possible sale of the company.
Mr. Hickey’s appointment comes only two weeks after CHUX announced the retirement of its Chairman and CEO Gregory Burns. The company’s Board of Directors is currently undergoing a nationwide search for his replacement. CHUX has underperformed its FSR competitors in recent times with EBIT margins down over 560 bps since the end of FY06 to -0.3% in its most recently reported quarter. Over that same time period, the company has increased its leverage from about 3.4x to over 4.5x on a debt/EBITDAR basis (more than the FSR group’s average of about 4.2x). That being said, new leadership in both the CEO position and at the Board level should prove favorable.

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Dr. Copper is Poking Up His Head

In global macro circles, the metal copper is more commonly known as, “Dr. Copper” for its ability to predict economic cycles, much like someone with a doctorate in economics should be able to do.

The differentiating factor between Doctor Copper and the typical Doctorate in Economics is that the former has been around for millions of years, while the latter is a much more recent creation. In fact, the first Nobel Prize in economics was awarded in 1969.

Copper is known for its predictive ability due to overwhelming use in building construction and industrial production. According to copper.org, building construction is ~46% of copper use, electrical products are 23%, and transportation, consumer, and industrial product production comprising the remaining 31% of use.

Given its broad base use in many different sectors, we have had been focused on the pick-up in copper pricing over the last five weeks, which we believe is an early indicator of reaccelerating global growth and industrial production heading into Q1 2009. This pick up in pricing is shown graphically in the chart below. To be sure, bottoms are processes, not points… but this “re-flation” process continues to fortify itself.

Daryl G. Jones
Managing Director

Eye On Germany: Continuing To Add To Their Relative Positives

EYE ON GERMANY: RELATIVE STRENGTH
The German service sector is faring better than other big economies in the EU… this adds to a growing list of reasons why we still prefer Germany over the rest of the “legacy” European economies.

In addition to deflating Euro Zone CPI numbers, another big data point arrived in Europe today with the release of service industry December PMI figures. Although the data showed decline across the board, it is significant that German business conditions for the service sector registered at 46.57 vs. 42.06 for the Eurozone as a whole and significantly higher than both France and Italy –each of which levels below the aggregate (see chart below).

This clearly supports our thesis that the German economy is structurally best positioned to rebound relative to its neighbors. We will continue to watch for opportunities to buy back our position in Germany (on weakness) via the EWG etf to balance against our short positions in other parts of Europe.

Andrew Barber
Director

GAZPROM DISPUTE HITS EUROPE

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
Analyst

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