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The Real Test

“The real test is how you behave when the crowd is roaring the other way.”

-George Goodman


Question: from an expectations perspective, have markets really changed since George Goodman penned The Money Game in 1968? As the weak whisper and the manic chase, that question has been on my mind for the last few weeks. Just a question.


While I’m at it, here’s another question: are you #Fedup yet? This morning’s Most Read (Bloomberg) headline = “US Stocks Gain Amid Speculation of More Fed Stimulus.” That’s awesome, right?


Right, right. And so is eating yellow snow.


Back to the Global Macro Grind


Maybe Bernanke should read something from the late 1960’s and early 1970’s. Actually, wait a minute, Fred Kelly wrote in 1930 that “the crowd always loses”, so maybe Bernanke did read that. The man knows the 1930’s!


The Real Test in this game is not whether you are a student of one window of history. It’s whether or not you can beat the crowd. If Bernanke thinks he can thread the needle here into and out of next week’s FOMC meeting (June 20th), I say godspeed to him on that. He’s got the crowd right addicted to the drugs at this point, so how this all ends is anyone’s guess.


That said, I bought Gold and took my US Equity exposure up from 0% to 6% on red yesterday morning. Heck, why not roll the bones with The Bernank? This guy is a genius. Or at least that’s what the Washington crowd says.


Obviously I don’t play this game like roulette. That’s what some other people do (with other people’s money). The moves I make on red and green are based solely on my process. That investment process has 2 big parts:


A)     The Research View

B)      The Risk Management View


To be crystal clear, research and risk management are two very different things.


Quite often, as is the case with evaluating Fed Policy, what our research says Bernanke should do (nothing) and what he might do (something) are opposing thoughts.


When that happens, The Real Test is to remain sane and press the right buttons at the right time.


Timing? Yep, it matters.


In a market that’s being driven by a Correlation Risk that’s going to 1, timing matters, big time. Get the daily direction of the US Dollar right, and you’ll get a lot of other things right. With the USD down -0.35% yesterday, the best performing sector in the SP500 was the commodity heavy Basic Materials sector (XLB) at +1.9%.


Here’s an update on that (correlation risk between the US Dollar Index and everything else on a 2-month duration):

  1. SP500 = -0.92
  2. Euro Stoxx600 = -0.94
  3. CRB Commodities Index = -0.93
  4. WTI Crude Oil =  -0.95
  5. Gold = -0.78
  6. Rubber = -0.93

I really hope you haven’t been long Rubber for the last 2 months.


Hope, of course, is not a risk management process. Neither is whining about “valuation” while ignoring the Correlation Risk. When it matters, it matters – and your Real Test as a real-time Risk Manager is to solve for that.


This is why I have been so hard on Bernanke and Geithner. If we get their dogmas and policies out of the way, we’re making the 1stcritical (causal) step in getting expectations for more USD driven correlation risk out of the way.


I know, it makes simple sense. What is not simple is that short-term political career risk (admitting they’ve had this all wrong since going to Qe2) gets in the way of the truth.


The truth is that Big Government Intervention policy expectations drive market expectations. That’s not free-market capitalism. That’s just really screwed up.


Maybe I’ll be long Gold for an hour. Maybe I’ll be long it for a week. Maybe I’ll be long it to $2,000 an ounce. I have no idea. And I shouldn’t, because I have no idea what this un-elected central market planner is going to do next.


What I do know is that if Obama gives Bernanke the political weaponry to debauch the Dollar one more time before the election, Gold and Oil are going to rip, and #GrowthSlowing is going to become the Research View of 2012.


My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, and the SP500 are now $1, $96.27-99.42, $81.98-82.56, $1.24-1.26, and 1, respectively.


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


The Real Test - Chart of the Day


The Real Test - Virtual Portfolio


TODAY’S S&P 500 SET-UP – June 13, 2012

As we look at today’s set up for the S&P 500, the range is 36 points or -1.52% downside to 1304 and 1.19% upside to 1340. 












    • Up from the prior day’s trading of -1830
  • VOLUME: on 6/12 NYSE 723.91
    • Decrease versus prior day’s trading of -2.23%
  • VIX:  as of 6/12 was at 22.09
    • Decrease versus most recent day’s trading of -6.24%
    • Year-to-date decrease of -5.60%
  • SPX PUT/CALL RATIO: as of 6/12 closed at 1.47
    • Up from the day prior at 1.44 


FED – we always find it funny to watch these cracker jack market politicians blame “speculators” on commodity inflation when the causality associated with what we have to speculate on is our expectations of their policy whispers. After listening to how conflicted/compromised Evans really is yesterday, Dollar fell and Gold/Oil/BasicMatStocks ripped. It’s the game we are in, sadly. So we’re playing it. 

  • TED SPREAD: as of this morning 38
  • 3-MONTH T-BILL YIELD: as of this morning 0.09%
  • 10-Year: as of this morning 1.68
    • Increase from prior day’s trading at 1.66
  • YIELD CURVE: as of this morning 1.39
    • Up from prior day’s trading at 1.37 

MACRO DATA POINTS (Bloomberg Estimates):

  • 7am: MBA Mortgage Applications, June 8 (prior 1.3%)
  • 8:30am: PPI (M/m), May, est. -0.6% (prior -0.2%)
  • 8:30am: PPI Ex Food & Energy (M/m), May, est. 0.2% (prior 0.2%)
  • 8:30am: Advance Retail Sales, May, est. -0.2% (prior 0.1%)
  • 8:30am: Retail Sales Less Autos, May, est. 0.0% (prior 0.1%)
  • 10am: Business Inventories, April, est. 0.3% (prior 0.3%)
  • 10:30am: DoE Inventories
  • 11am: Fed to purchase $4.5b-$5.5b notes in 8/15/2020 to 5/15/2022 range
  • 1pm: U.S. to sell $21b 10-yr notes (Reopening) 


    • House in recess, Senate in session
    • Treasury Secretary Tim Geithner discusses state of economy at Council on Foreign Relations ahead of next week’s G-20 summit
    • Mitt Romney speaks to Business Roundtable at Newseum, 11:45am
    • U.S. Chamber of Commerce holds summit on jobs, growth, 12pm
    • Postal Regulatory Commission Chairman Ruth Goldway, Assn. of Postal Commerce President Gene Del Polito meet to discuss service, future of mail
    • Internet Corporation for Assigned Names and Numbers posts applications for top-level domains, first look at companies, organizations seeking “dot-brand,” other domains, 8am 


  • JPMorgan’s Dimon testifies before Senate Banking Committee, 10am
  • Morgan Stanley CEO Gorman touts differences from Dimon on risk after JPMorgan loss
  • Italy’s borrowing costs surge at 364-day bill auction
  • Philip Morris plans to buy back $18b of shrs in next 3 yrs from Aug. 1, set qtrly div. of 77c/shr
  • J&J says $19.7b Synthes deal will add to earnings; Janssen unit in $12.9b accelerated buyback pacts
  • Philipp Hildebrand, who resigned as head of the Swiss central bank in Jan., is joining BlackRock as vice chairman.
  • ICANN to give a first look at Web domain wish list
  • Nasdaq exchange immunity may limit losses from Facebook claims
  • U.S. retail sales probably fell in May for 1st time in a yr as auto demand slowed, median forecast 0.2% decline
  • Wal-Mart efforts to buy Latin American assets from Carrefour said to have slowed
  • Rajat Gupta lawyers submit e-mails, wiretaps of Goldman’s Loeb
  • Vornado expects to sell at least $1b of assets
  • CBS is said to attract $2.7b in upfront advertising sales
  • U.S. Justice begins antitrust probe of cable industry on online video limits: WSJ
  • American Express, AIG, Legg Mason among cos. presenting at Morgan Stanley Financials Conference


    • Dollarama (DOL CN) 7:30am, C$0.51
    • Evertz Technologies (ET CN) 4pm, C$0.23



GOLD – so we bought that, for a trade. The new risk range for Gold is now $1, so we’ll probably sell it if we see the high end of that range as we think this Fed iQe4 upgrade thing is more about the expectation than Bernanke actually delivering on it next week. Stay tuned. We have no idea what Bernanke is going to do vs what he should do (nothing).











GERMANY – Spain’s Rajoy idiotically wages “battle” vs the Germans this morning saying “I am waging it.” We couldn’t make that up if we tried, but these guys fighting about economic gravity is going to keep a lid on whatever is left of this European squeeze to lower highs. All European indices remain in Bearish Formations (bearish across all 3 of my risk mgt durations, TRADE/TREND/TAIL).















The Hedgeye Macro Team

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.46%
  • SHORT SIGNALS 78.35%


This is an introductory note ahead of our conference call with industry expert John Hamburger, President of the Restaurant Finance Monitor, next Tuesday, June 19, 2012 at 11am EST.  


Over the course of this call, we will discuss consensus thoughts on franchising in the restaurant industry.  Specifically, we will discuss the implications that franchising can have for the valuation of restaurant companies and the validity of the assumption that franchised business models are inherently more stable.  Historically, the steady cash flow generation, lack of exposure to variable costs, and relatively low capital spending needs of franchised systems has led investors to award premium multiples to the equity of franchised companies.  Together with John Hamburger, an expert on restaurant financing, we will discuss the valuation premium, relative to less-franchised peers, of the equity of several restaurant companies.  Below, we provide some background on the issue of franchising within the restaurant idea, as well as some thoughts on why franchising should not always been seen as a positive by investors.



The Crux of the Debate


The interests of franchisees and franchisors do not always align; in fact, in today’s environment of tight capital supply for small businesses and increasing competitiveness among restaurant companies, they can sometimes diverge.  Through franchising, franchisors gain more stable cash flow, protection from swings in variable costs, and lower expenses.  In turn, franchisees, ideally, gain operational expertise from companies and brand recognition while assuming much of the operational risk of the business.  Most of the decision-making authority pertaining to the business remains with the company and, in difficult business conditions, this can be a source of contention.


As franchisors seek to grow royalty fees, decisions made by corporate restaurant executives in the past few years have tended to focus on promotional strategies and capital-intensive store and process alterations.  Of course, as long as the consumer and financing environments cooperate, this behavior may not meaningfully impact the franchisee’s bottom line.  However, with the backdrop of a fragile economy, volatile commodity costs, tight access to capital, and increasing labor costs, there is a potential for friction.  The addition of any controversial business decisions that magnify franchisees’ difficulties all but guarantees disharmony between management and the franchise community.  Examples over the past few years are numerous, from Kentucky Grilled Chicken at KFC to bun toasters at Wendy’s to 99 cent double cheeseburgers at Burger King.



The Franchising Grenade – Sold to You!


While franchising has obvious benefits for franchisors, it seems that conventional wisdom may not appreciate the risks of companies using franchising to mask deeper flaws that exist within their business models.  The increasing ranks of activist investors within the restaurant space might offer further explanation, beyond a consumer weakness and declining margins, for the refranchising trend of the past few years.  Short term actors looking to maximize immediate-term cash flow are less likely to focus on the long term implications of business decisions than are operators.  “Deal guys” get paid to do deals but their strategies too often ignore the long term and increase the risk of a tipping point being reached where a concept is rendered uncompetitive, heavily indebted, and immobile.


Many of the concepts that make up the Quick Service Restaurant industry represent broken business models and it is little wonder that ageing properties, declining margins, and increasing economic uncertainty have moved the operators of those concepts to seek the security that franchising offers.  Generally, the refranchising trend has been driven by concepts that have been slow to adapt their facilities and offerings as consumer preferences have evolved.  The emergence of fast casual concepts has increased competitive pressures for traditional quick service restaurants in a low-growth industry. 


As weaker players fall away and large franchisees increase their holdings, the corollary is obvious in a system where management and franchisees are not seeing eye to eye.  Larger franchisees wield more power and influence in discussions with franchisors and this can lead to stand offs that impede the progress of capital reinvestment and, in turn, tie companies to practices such as discounting and promotions which, as strategies, are less and less effective over time. Ultimately, all parties suffer – especially investors.


In theory, franchising is a system that works well.  In practice, prioritizing revenues over sustainable profits can leave concepts in a downward spiral of non-competitiveness.  We believe that picking out those companies, particularly given the valuation premium that is uniformly awarded franchised businesses in the restaurant industry, is essential for investors in this space.  In discussion with Mr. Hamburger on 06/19/2012, we will discuss this issue in greater detail and answer client questions on the implications of our views for the individual companies and the broader industry.



Howard Penney

Managing Director


Rory Green






Nobody expenses ‘em like LVS.



Q2 is likely to tell us little about the ongoing cost structure of Sands Cotai Central (SCC) and LVS’s combined Macau operations.  As can be seen in the chart below, LVS has been aggressive in the past, to say the least, in terms of expensing costs into the convenient pre-opening expense line.  While some of pre-opening costs are inevitably recurring, companies and analysts exclude them from ongoing operations. 


With a very disappointing post-SCC top line, one would expect very weak margins.  However, given the flexibility with the pre-opening bucket, the only clear takeaway on future margins from the Q2 earnings release will be that there is no clear takeaway.  We are projecting only a net $45 million YoY increase in Macau property EBITDA for LVS in Q2, despite almost a full quarter contribution from the $1.5 billion SCC.  Moreover, over $30 million of that increase was at Four Seasons.  Given the additional investment, our overall Q2 Macau margin falls from 33.0% to 29.2%.  Of course, we have no idea how much LVS will allocate to pre-opening so the margin could be higher.


The chart below shows that pre-opening as a % of total capex has already exceeded Venetian and we haven’t even included the Q2 expense.  Obviously, there is precedent for an additional 3% to get to the level of Four Seasons which would imply an additional $40-45 million in pre-opening costs.



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