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Focus on Italy

Greece has been the flavor of the week for some time now, drawing the most criticism over the European financial crisis. Spain recently made its foray into headlines after accepting a €100 million bailout from the IMF, which will presumably get worse over time. It appears that the next country to make headlines will be Italy.

 

Focus on Italy - sp.ital.10yr

 

Hedgeye Director of Research Daryl Jones recently penned a piece for Toronto’s Globe and Mail that focuses on Italian debt. Italy has a €255 billion repayment schedule over the rest of the year that will force it to address its problems in an accelerated fashion. Truly, the worst is yet to come.

 

Italy, not Spain or Greece, should be on the mind at G20 meetings [Globe and Mail]


FRANCHISING: Fool's gold

Hedgeye Restaurant Sector Head Howard Penney hosted a conference call with industry expert John Hamburger on Tuesday to discuss the risks revolving around heavily franchised restaurants. The main takeaway is that franchisors are realizing that it’s easier to sit back and collect royalty payments than to own and operate a store, but areas of difficulty in the industry have arisen that plague weakly franchised companies.

 

They include, but aren’t limited to:

  • Poor asset quality: concepts that allow their asset bases to unduly deteriorate tend to fall behind and aren’t able to rectify the situation. Cash-hungry private equity firms do not help with the situation as they focus on the cash and not the subsequent consequences.
  • Franchisor/Franchisee disharmony: The disagreements between management and franchisees has been well documented over the years. Communication is more crucial than ever and when a franchisee goes “rogue” by going around corporate-directed rule sets, it raises concerns about the relationship.
  • Inconsistent unit performance: Management teams resorting to short-term, promotional strategies to “dress up” the numbers tend to produce choppy results.

 

FRANCHISING: Fool's gold - franchisors

 

The current turnaround strategy at Burger King and Wendy’s (WEN) have been particularly capital intensive as older stores remodel to comply with the new image management has created for them. To quote John Hamburger: “Half of the current restaurants operated by chains are not at the current prototype standard and it’s very capital intensive when remodeling.”

 

McDonald’s (MCD) will always be a top dog, but Burger King and Wendy’s have their work cut out for them over the next few years.


100% CASH

“Duration neglect is normal in a story, and the ending often defines its character.”

-Daniel Kahneman

 

I’m a storyteller. So are you. We tell ourselves, our families, and firms stories every day. We tend to frame each story within the framework of how we think. How we think drives our decision making. In the end, we are all accountable for those decisions.

 

I made a decision to go to 100% Cash in the Hedgeye Asset Allocation Model yesterday. That’s a first. If you’ve been reading my rants for the last 5 years, I don’t have to explain why at this point. You know where I stand. I do not think that this ends well.

 

Some people think that it will end just fine. Some people think doing more and more of what has not worked is the only way out. Many people thought the very same thing in 2008, and the moneys in their accounts are still underwater to prove it.

 

Back to the Global Macro Grind

 

You can call me short-term. You can call me the longest of long-term. You can call me whatever you want – that’s all part of the storytelling too. I was never supposed to be a name in The Game. The Old Wall was never supposed to fall.

 

The Old Wall used to get away with making up Perma characters in their storytelling. Someone was always the Perma Bull. Someone was always the Perma Bear. Some of us call that fiction. Some of us just permanently manage risk, both ways.

 

I have by no means perfected the risk management process. The day that you think you have is the day you are about to get clocked. The plan is always grounded in uncertainty. The plan is always that the plan is going to change.

 

As The Game changes, the process evolves. Sometimes the process signals that it’s time to just get out of the way.

 

To review why I am already out of the way this morning:

  1. I have no idea what our Central Market Planner in Chief is going to say
  2. If Bernanke delivers the Qe3 drugs, food/energy inflation will slow real growth further
  3. If Bernanke doesn’t deliver the drugs, a world full ofCorrelation Risk comes into play

In other words:

 

A)     You cannot beg for Qe and have Accelerating Growth at the same time – the world needs growth, not more debt

B)      If you do not get Qe, the US Dollar stops getting debauched, and Commodity Bubbles continue to pop

 

So that’s why, at this time and price, I have a 0% asset allocation to Stocks and Commodities. Why I have a 0% asset allocation to Currencies and Fixed Income is simply because I know how to manage my immediate-term risk.

 

I sold both our US Dollar (UUP) and US Treasury (TLT) positions before yesterday’s plundering. That doesn’t mean I cannot buy either of them back. There are no centrally planned rules associated with how much Cash I can be in. At least not yet.

 

Back to the #1 thing that Bernanke will not mention today that is driving both causality and correlation in real-time market pricing –The Correlation Risk. Here’s how the last 2 months of Correlation Risk between the US Dollar and everything “risk” has looked:

  1. SP500 = -0.91
  2. Euro Stoxx600 = -0.96
  3. MSCI World Index = -0.95
  4. CRB Commodities Index = -0.94
  5. WTIC Oil = -0.94
  6. Copper = -0.93

No matter what storytelling they continue to feed you (and they is all encompassing at this point, from the Old Wall to Washington, DC and Paris, France), this is all that matters right now.

 

Get policy right (causality), and you’ll get the US Dollar right. Get the US Dollar right (correlation), and you’ll get a lot of other market things right.

 

We’ve been right 32 out of 33 times since firm inception (2008) on the US Dollar. That’s probably why I haven’t spent the last 5 years trying to get back to a bull market top break-even. I may be wrong this time. If I am, I’ll at least know why.

 

European central planning storytellers have played their hands. In my own accounts, with 100% liquid Cash (and illiquid Hedgeye stock), I’m holding a hand of kings. For their last no-volume hurrah,Bernanke Beggars better hope he has 4 aces.

 

My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar Index, EUR/USD, and the SP500 are now $1589-1640, $94.84-97.59, $81.32-81.97, $1.24-1.27, and 1329-1362, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

100% CASH - COTD June20

 

100% CASH - VPjune20


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MCD – JUNE LOOKS LIKE ITS GOINGTO BE ROUGH ONE

It is tempting to say that the worst is over for McDonald’s, but we don’t think that it is.  Our view is that domestic sales trends in June are continuing to be soft and the outlook for the summer is not positive. 

 

Soft Traffic Trends

 

In early March, we wrote a note titled, “MCD – THE NEW VALUE MESSAGE”, which discussed the changes the company was making to the menu at the time and the importance of the April sales release for investors.  We wrote, “investors will be watching closely for an indication of whether or not the new menu strategy is working.” 

 

The April and May sales releases have suggested that the new menu strategy is not working as well as the company might have hoped, with management warning yesterday that “customer traffic will be difficult to grow near term”.  On the positive side, the company did highlight an emphasis on staffing to grow the peak lunch rush hour from Noon to 1 o’clock yielding an improvement in guest count growth year-to-date through May.

 

If customer traffic is flat-to-down but the core lunch business is showing some improvement, where is the slow down coming from?  Two thoughts:

  1. The core menu implemented in March has caused slower traffic as the company’s effort to force consumers to trade up from the $1 menu
  2. There is little-to-no growth in the afternoon day part  

 

Difficult Summer Comps

 

Going forward, we are concerned about the ability of the company to comp the comps.  Summer 2011 was a period of rapid growth for McDonald’s in the U.S. with beverages being a key driver.  Changes on the margin are all-important and we see the decrease in emphasis on beverages as a strategy going forward as being important.  While management said that “the U.S. also continues to strengthen its position as a as a beverage destination”, total beverage units were only up 6% versus up 20% in 4Q11, 16% in 3Q11, and 29% in 2Q11.  In fact, the word “beverage” was only mentioned twice on the 1Q12 call.  The 4Q11, 3Q11, and 2Q11 calls included 4, 8, and 18 mentions of the word “beverage”, respectively.  The word “McCafé” was mentioned twice on the 1Q12 call.  The 4Q11, 3Q11, and 2Q11 calls included zero, 7, and 11 mentions of the word “McCafé”, respectively.

 

The evidence suggests that beverages are increasingly becoming a less important part of the vocabulary from McDonald’s’ management team.  With that in mind, foremost in our thoughts is what the company’s strategy will be to maintain top-line momentum over the next few months.

 

MCD – JUNE LOOKS LIKE ITS GOINGTO BE ROUGH ONE - mcd pod 1

 

MCD – JUNE LOOKS LIKE ITS GOINGTO BE ROUGH ONE - mentions mcd

 

 

Below is our note from March 9th which described our initial concerns about the new menu strategy.

 

MCD – THE NEW VALUE MESSAGE 03/09/12 02:49PM EST

 

Some incremental changes coming to a MCD menu near you – what are the implications?

 

As first reported by Reuters, McDonald's “will be tweaking and expanding their value-priced items” at the end of March.  MCD has not discussed this with the street due to competitive reasons.

 

As we learned in conversation with the company, they are focusing the menu on four tiers (not including combo meals):

  1. Premium: $4.50-$5.50+
  2. Core: $3.50-$4.50
  3. Extra Value Menu (new): $1.20 to $3.50+
  4. Dollar menu 

In trying to understand the implications of what McDonald’s is doing, a restaurant industry consultant and associate of ours had this to say:  “I get a kick out of these corporate guys at WEN and MCD pretending they have some magical formula for value pricing. It's 100% driven by food costs and customer behavior.”  Given that MCD is seeing increasing inflation in 2012, we believe they are trying to manage check and margin by forcing consumers to trade up to the “extra value menu” from the “dollar menu.”  This makes more sense when we consider that one of the biggest changes is to remove small drinks and small fries from the dollar menu and replace those items with fresh baked cookies and ice cream cones.

 

HEDGEYE: We see this as a big risk for MCD.  If customer preference is to have the drink and fries as part of the dollar menu then there is a risk that this change negatively impacts customer satisfaction.  The company told us that a “mini-combo meal” offering may bundle the fries, burger, and drink but a decision has not been made on that yet.  Still, ordering the $1 items individually is being taken off the table.

 

 

The new "Extra Value Menu" will be advertised on March 26th.  According to Reuters, “the new menu will include 20-piece chicken McNuggets, double cheeseburgers, chicken snack wraps, Angus snack wraps, medium iced coffees and snack-sized McFlurries, plus up to four regional options, that were previously listed elsewhere on its menu.”  The idea for McDonald’s is to streamline and change what is highlighted on the menu.  The company likes to phrase this differently, saying that they are, “making it easier for customers to find them [‘Extra Value Menu’ items]”.

 

HEDGEYE:  From our perspective, the big problem is that the "Dollar Menu" has been around for a very long time.  Inflation has made it an unprofitable but necessary evil.  Customers, also pressed by inflation, have been migrating from the combo meals on the core menu, which can cost $6-7, over to the Dollar Menu where the value customers get is almost double from a price perspective.  We view this latest change as an attempt by the company to stem this flow of business from the core menu to the dollar menu.   This adds an extra emphasis on the importance of April sales; investors will be watching closely for an indication of whether or not the new menu strategy is working.

 

Howard Penney

Managing Director

 

Rory Green

Analyst


THE M3: ELAINE WYNN WANTS TO SELL SHARES; CHANGI AIRPORT DATA

The Macau Metro Monitor, June 20, 2012

 

 

WYNN RESORTS DIRECTOR PROPOSES TO SELL STAKE WSJ

Elaine Wynn, the former wife of Steve Wynn, believes she should be able to sell her 9.7% stake in WYNN now that the alliance between Mr. Wynn and Okada has been dissolved.  Mr. Wynn, who started the company in 2000 with former partner Kazuo Okada, has held control of his casino empire through a series of shareholder agreements with Okada.  Ms. Wynn signed on to a similar agreement during the divorce proceedings because she had not wanted to upset the balance Mr. Wynn had struck with Mr. Okada, she said in Tuesday's court filing.  Ms. Wynn believes the shareholder agreement should no longer apply because the business alliance that led to the restrictions is no longer in force.

 

Ms. Wynn has asked the US District Court in Nevada to declare the agreement with Mr. Wynn invalid so that she could sell her shares freely.

 

MONTHLY BREAKDOWN OF PASSENGER MOVEMENTS Changi Airport Group

4,089,894 passengers passed through Singapore's Changi Airport in May.  This is an 8.4% increase YoY.

 

THE M3:  ELAINE WYNN WANTS TO SELL SHARES;  CHANGI AIRPORT DATA - CHANGI3

 


Jelly Donuts

This note was originally published at 8am on June 06, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“A jelly donut is a yummy mid-afternoon energy boost.”

-David Einhorn

 

On a flight to Dallas, Texas yesterday, I was reviewing My Pile and re-read David Einhorn’s Op-Ed from May 3rd, 2012 in the Huffington Post titled “The Fed’s Jelly Donut Policy.” Loved it.

 

I love donuts, burgers, and beers too. What I don’t love is pretty clear – Ben Bernanke’s post 2009 Policies To Inflate rank right up there at the top of my no-love list alongside listening to Giraldo Rivera and watching figure skating.

 

What I also love is the debate. I love to argue; particularly with people that don’t. How else do we hold these charlatans accountable? How else are we going to challenge the perceived wisdoms of their economic policies? How else are we going to evolve and progress?

 

Alongside Ray Dalio (Bridgewater Associates) and Seth Klarman (Baupost Group), I consider David Einhorn (Greenlight Capital) one of the thought leaders of Wall St 2.0. Stylistically, while Einhorn is often compared to Warren Buffett (“value guys”), I think he’s currently  evolving his investment process at a much faster pace. Einhorn does macro – he shorts things too.

 

Einhorn isn’t politically polarized like Buffett has become. He is able to evaluate macro risks objectively (what the Fed should do and balance that with his opposing thoughts of what the Fed will do). He’s embraced Behavioral Finance, writing openly about fear and greed. He also understands that the stock market is not the economy, and that “valuation” is not a panacea.

 

On Bernanke’s failed policies, here’s my abbreviated version of Einhorn’s Op-Ed:

 

“The blame lies in his misunderstanding of human nature. The textbooks presume that easier money will always result in a stronger economy, but that’s a bad assumption… it is simply misguided thinking that persists among the Fed Chairman and other government ivory tower thinkers. They do not understand or relate to the prime component of capitalism and a free market: greed.”

 

“The Fed does not understand investor psychology: if you want to get people to sell bonds and buy stocks, the best way to do that is to show them that bond prices can, and do, fail… there is nothing that slows the economy faster than rising oil prices… In light of this, I cannot understand why we are even discussing let alone hoping, for Qe3.”

 

Agreed, Mr. Einhorn. Agreed. Hope is not a risk management process. Neither is doing more of what didn’t work. Enough of the yummy intraday stock market rallies on iQe4 upgrade rumors already. After 3 of these suckers, Americans have a “tummy ache.”

 

Back to the Global Macro Grind

 

Strong Dollar = Deflates The Inflation = Stronger Consumption. That remains our bull case for not only the US and Global Economy, but for their Equity market multiples.

 

Yesterday’s US Services ISM report (May) was one of the most constructive we have seen on the Prices Paid front since December:

  1. US Services ISM of 53.7 (May) vs 53.5 (April) stopped slowing – that’s better than bad
  2. Prices Paid (within the ISM Services report) dropped -7.1% month-over-month to 49.8 (vs 53.6)
  3. Employment dropped -6.2% month-over-month to 50.8 vs 54.2

So, employment is bad and getting worse. But A) you know that B) so does the bond market and C) employment is a lagging (as opposed to a leading), indicator. Real-time market prices are also leading indicators.

 

In other words, if you are begging for Bernanke’s iQe4 Upgrade this morning, you are begging for prices paid to go back up at the pump – and you are begging for the leading indicator on real (inflation adjusted) economic growth to continue to slow.

 

Begging isn’t leadership. It’s un-American.

 

Our process hasn’t changed in scoring how the real world works. Unfortunately, neither has the Washington and Old Wall Street consensus. These people don’t have a risk management process. This is what they do. So it will be very interesting to see how the political pressure for Bernanke to bailout everything from Europe to Morgan Stanley looks in the coming days and months.

 

Bailing out Europe through the Washington, DC based (and US tax payer backed) IMF? Yep, I’m thinking Einhorn will lead from the front and have a few things to say about that too.

 

In the meantime, the SP500 recapturing our long-term TAIL line of support (1283) yesterday should be as bullishly received as it was bearish when it snapped on the downside.

 

Yes, “risk” changes faster than you can bang back another Jelly Donut. That is the game we are in, so play it.

 

My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, and the SP500 are now $1597-1636, $96.21-103.11, $82.03-83.35, $1.22-1.25, and 1268-1306, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Jelly Donuts - Chart of the Day

 

Jelly Donuts - Virtual Portfolio


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