Part of The Game

This note was originally published at 8am on June 29, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

“… part of the Game is the anticipation of how the other players will behave.”

-George Goodman, The Money Game


It’s both fascinating and frightening that central planners will be emboldened by the market’s reaction to their latest plan. Europe is fixed again, and everything is back to being fine until people report their month and quarter end. The duration on that trade = 3 days.


Price Stability Update: At 230PM EST yesterday, the SP500 was tanking, down -1.3% on the day to 1314. An hour and a half later, it was +1.1% higher at 1329. This morning it’s trading up another 16 handles higher than that. This is really starting to rhyme with 2008.


This is one of the many reasons why I am in 94% Cash this morning (up from 91% yesterday and down from 100% last week). Part of The Game is understanding that there are times when the game becomes so volatile and arbitrary that it’s best to get out of the way.


Back to the Global Macro Grind


If I haven’t been crystal clear on this since March, let me write it one more time – I am bearish on growth. Doing more of what has not worked is only going to slow economic growth further. Central planners do not get that; markets do.


Yesterday’s rip into the close and this morning’s melt-up in the US equity futures only amplifies my greatest fear about markets that are trading purely on the anticipation of the next Big Government Intervention catalysts – government itself.


If you disagree with me, that’s fine. If you think governments do a good job creating jobs, innovation, and confidence, you’re probably thinking they are going to do a great job running our stock markets too.


That’s the long-term TAIL risk. All long-term investors need to acknowledge this and raise Cash on all rallies to lower-no-volume-highs. Since the March top, you’ve had (and, evidently, will continue to have) plenty of opportunities to get out.


Enough about the long-term implications of this market gong show. Since not many people are allowed to invest or manage risk on that long-term duration anymore, here’s how the immediate-term TRADE setup looks for US Equities:

  1. SP500 closing > 1320 keeps it bullish TRADE (1320 support); bearish TREND (1365 resistance)
  2. Russell2000 closing > 764 keeps it bullish TRADE (764 support); bearish TREND (795 resistance)
  3. US Equity VIX closing < 21.15 keeps it bearish TRADE (21.15 resistance); bullish TREND (18.22 support)

In other words, I’ll cover/buy at 1320 and short/sell at 1365, and let these government people deal with themselves everywhere in between. If 1320 snaps like it did intraday yesterday again, I’ll be recommending prayer.


In Europe, all 3 of our risk management durations (TRADE, TREND, and TAIL) were signaling bearish up until the minute of this morning’s European market open. Now, all immediate-term TRADE lines that were resistance become support:

  1. EuroStoxx50 > 2169 makes it bullish TRADE (2169 support); bearish TREND (2316 resistance)
  2. Germany’s DAX > 6251 makes it bullish TRADE (6251 support); bearish TREND (6669 resistance)
  3. Spain’s IBEX > 6698 makes it bullish TRADE (6698 support); bearish TREND (7289 resistance)

All the while, the Euro (versus the USD) is having one of its biggest short squeeze days of what was an awful Q2. Trading +1.1% this morning to $1.25, it would have to close > $1.26 to recapture its immediate-term TRADE line of support. So watch that closely.


Again, get the EUR/USD right, and you get a lot of other things right. US Dollar down hard this morning is also why everything from the price of Copper (+2.2%) to almost anything that ticks in US Equities is up. Enjoy your 4th of July tax hike at the pump.


Just don’t confuse government sponsored immediate-term TRADEs with long-term economic prosperity. It’s perverse, but what these people are doing is managing their short-term political career risk for the sake of short-term market pops, to lower highs.


Each lower-high in stock and commodity markets is met with lower and lower market volume. That’s Part of The Game. When The People no longer trust it, they just get out of the way too.


My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, Germany’s DAX, Spain’s IBEX, and the SP500 are now $1537-1586, $88.36-96.89, $82.19-83.08, $1.24-1.26, 6251-6438, 6698-6913, and 1320-1342, respectively.


Best of luck out there today and enjoy your weekend,



Keith R. McCullough
Chief Executive Officer


Part of The Game - Chart of the Day


Part of The Game - Virtual Portfolio


Yesterday, we announced that we will be doing a conference call on Thursday, July 19th at 11am EST titled "DRI: Too Big To Perform?"  Shortly after notifying clients of this, Darden announced a dilutive acquisition of Yard House USA, Inc., which in our view will only complicate the issues the company is experiencing. 


The acquisition highlights one of the issues that may be causing the recent underperformance and may represent, at least in part, an example of a company growing when perhaps focusing on the core business might better drive shareholder value.  Time will tell, but we were surprised by some of the initial details.

  • Acquiring Yard House USA, Inc. for $585 million in cash ($555 million after tax savings)
  • Yard House offers American cuisine and has grown to 39 restaurants in 13 states since its launch in 1996.  AUV’s are $8.4 million.  Implied price paid is $15 million per store or 1.8x sales
  • FY13 EPS outlook revised to account for transaction-related impact of $0.03-0.05
  • FY13 Sales growth expected to be 9-10% versus 6-7% prior guidance
  • Share repurchases now expected to be $50 million in FY13 versus $200-250 million prior guidance

We expect the company to add leverage to the balance sheet (and stop buying back stock) to finance the acquisition which appears to be at a growth premium of roughly 17x and 13x 2012 EV/EBITDA and 2013 EV/EBITDA, respectively.  


“Too Big to Perform” is a turn of phrase that our CEO, Keith McCullough, loves to use to describe the mega-banks that make up the Old Wall.  We think Darden is in danger of falling into that same category within the restaurant space.  While the company generates ample cash flow (to make expensive acquisitions like the Yard House), the reasons to own this stock, in our view, are increasingly moving away from fundamentals such as market share and toward a blinkered perspective on "hitting numbers" and the “growth” mantra of senior management.


The acquisition of the Yard House only amplifies the issues we see the company is facing over the next three years.  Yard House may be one of the country’s best positioned casual-dining concepts; its upscale position with consumers highlights one of the competitive disadvantages Olive Garden and Red Lobster are currently burdened with.  The guest counts data at Darden’s two largest brands tell a sad story; both chains require extensive changes to begin the process of growing again. 


Our conference call next Thursday will address all of this in greater detail.  Topics include, but are not limited to; 

  • Management (and executive compensation) is laser-focused on growth. We think that is a problem when the company's two largest brands are struggling to gain any sustained traction with consumers
  • Blind dedication to a "rate of growth" target independent of a changing operating environment can be a fatal mistake. Growth can mask issues, particularly of the transient variety, but the issues at Olive Garden and Red Lobster are long-standing and require significant attention.
  • Inconsistency in the company's rationale behind its top-line strategy at Olive Garden. We are not deducing a clear message from the company regarding its ability to stop the sustained traffic losses at Olive Garden.
  • Massive CapEx demands. The company is facing a prolonged period of investment into its largest chain. Getting this effort started in earnest is taking more time than many were expecting.
  • The margin gap between Darden and some competitors offers clues as to how management could seek to bring about sustainable positive momentum in their largest business.

 DRI: GROWTH AT ALL COSTS? - OG RL comps details



Howard Penney

Managing Director


Rory Green


Interesting Industrial Insights - (Also Known As Late Afternoon Alliteration)

Conclusion: Our industrials team has highlighted some key inflections in Chinese rebar pricing, real defense spending and reinvestment by mining companies.


As many of you know, Jay Van Sciver recently joined Hedgeye as our Industrials Sector Head and launched a few weeks ago with his first key call being a negative view of the U.S. Airline Industry.  This call is obviously particularly timely with Goldman’s bearish initiation on the Airlines today. 


As part of their research product mix, our industrials team is publishing a daily “Industrials Indicator” note that synthesizes and emphasizes the key data points and events in the global industrials sector.  We thought a number of their recent call outs were also particularly relevant to the global macro space, so we have highlighted them below. (If you’d like to trial our industrial team’s work and/or speak to Jay email .)


1. Chinese Rebar Prices – For those that aren’t aware, rebar is reinforcement steel that is used in concrete and masonry structures.  Rebar is a critical component of any large scale construction projects – like highway bridges, parking garages, and so on.  Demand in 2012 has been anemic for rebar in China, which is reflected in the declining prices that are reflected in the chart below.


China produces 50% of the world’s steel, so to the extent we can consider rebar a decent proxy for steel demand in China, and we believe we can, this is somewhat ominous for the global steel market as China may look to increase steel exports in order to stabilize prices.  As well, the rebar price data is negative for iron ore, as China is the world’s largest importer of iron ore, which is the key steel input.


On a much higher level of course, steel and iron ore demand by China is a reflection of economic activity in China.  As economic activity softens, naturally demand for these products will soften and lead to price declines, as we are seeing the rebar market.


Interesting Industrial Insights - (Also Known As Late Afternoon Alliteration) - 1


2.The Mining Investment Cycle – Caterpillar (CAT) is probably the best proxy for the mining investment cycle since the start of the Millennium.  Over that time period, CAT has seen a stock price increase of 393% versus mere 16.9% for the SP500.  So, the mining boom has been good for CAT and its peers.  The question of course is how sustainable is this cycle going forward.


In the chart below, our industrials team looks at the capital expenditures of large miners versus their depreciation and amortization.  A company’s cap-ex should not greatly exceed the company’s depreciation and amortization unless growth is expected.  As the chart outlines, this was the case for much of the 1990s.  This isn’t totally surprising in commodity type industries where reinvestment occurs at the marginal cost. So, in theory, increased capital investment leads to higher production, lower prices, and decreased capital investment in the future.


Conversely, in the last ten years capital expenditures in the global mining sector have dramatically outpaced D&A expenditures, and on an accelerating basis.  In fact, in 2011 cap-ex exceeded D&A by an astounding $50 billion across the sector.   Clearly, commodity prices are in some form of an easy money-induced bubble, albeit increased demand from emerging growth economies is also a factor supporting the story underpinning market prices, but as our industrials team wrote:


“Mature, cyclical industries (mining is among the most mature) do not support high levels of growth investment in the long-run.”


Interesting Industrial Insights - (Also Known As Late Afternoon Alliteration) - 2


3. Real Defense Spending – The U.S.’s federal budgetary issues are really no surprise to anyone that does macro research or focuses on the U.S. Treasury market (or actually reads a newspaper).  Currently, the United States has ~104% debt-to-GDP, is running a deficit-to-GDP of ~9%, and ~40% of all deficit spending comes from borrowing.  To narrow the budget, spending needs to decline, with defense spending being a major focus.


In the chart below, we highlight real defense spending going back to 1962.  Two key points jump out from the chart.  First, defense is a highly cyclical industry.  There are periods of high real spending, typically during wars, and then spending declines following the war or with a change in administration. Secondly, defense spending on a real basis is at an almost all time high in the United States. Given the real level of spending and massive budgetary issues in the United States, it is difficult to envision a scenario in which the defense industry sees broad top line growth.  In fact, future years of declining top line are more likely.  In effect, it is an industry in which the “value trap” risk is alive and well – i.e. cheap stocks getting cheaper.


Interesting Industrial Insights - (Also Known As Late Afternoon Alliteration) - 3


Daryl G. Jones

Director of Research

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CONCLUSION: Our analysis of recent trends across a handful of key growth economies (using China, South Korea and Brazil as proxies in this note; there are many others) lends credence to our view that growth across Asia and Latin America continue to slow. More importantly, we are of the view that economic trends across each region will continue to deteriorate over the intermediate term – a conclusion strongly supported by our quantitative risk management models.

Q: What do Chinese equities, Korean equities and Brazilian equities all have in common?


A: Bearish Formations; cheap gets cheaper when growth is slowing.








With the latest reported growth generally slowing in each of those economies – on both a high-frequency and low-frequency basis – it’s fair to say that the recent rate cut cycles we’ve seen across China (-50bps), Korea (-25bps) and Brazil (-450bps) are merely indications that policymakers in each country are cognizant of the aforementioned trends and risks to growth globally (Europe; 112th  Congress).


Chinese growth – slowing:






South Korean growth – slowing:






Brazilian growth – slowing:






We highlight the following statements from policymakers from each country as supportive of our view that the negative trend in global economic growth has not turned the corner:


“Stabilizing economic growth is not only a pressing priority for China now, it is also a long-term arduous task.”

-Chinese Premier Wen Jiabao (JUL 11, 2012)


“The South Korean economy is growing less than expected and growth will be less than potential for a considerable time.”

-JUL 12, 2012 Bank of Korea Monetary Policy Statement


“The recovery of Brazil’s economy has been slower than anticipated… The world economy will have an impact that is either neutral or disinflationary on Brazilian consumer prices.”

-JUL 11, 2012 Central Bank of Brazil Monetary Policy Statement


As an aside, the Bank of Korea’s rate cut was a surprise to us as well as the market (KOSPI closed down -2.2% on the day; KRW/USD -0.9%). We titled our JUN 28 note: “WAIT ON SOUTH KOREA” as a coherent message that it wasn’t the right time to increase one’s exposure to the KOSPI Index. Judging by the market response since then (including today’s sell-off), that appears to have been a prescient call. More importantly, the “wait” has been extended in our view, as this new monetary easing cycle takes the relatively strong KRW story – a key component of our formerly-bullish, TREND-duration fundamental bias – off of the table for now.


Looking ahead, the next major catalysts on the growth front out of each country are as follows:


  • China:
    • TONIGHT: Chinese 2Q12 Real GDP, JUN Industrial Production, JUN Fixed Assets Investment and JUN Retail Sales data will be realized. Consensus expectations for China’s 2Q Real GDP growth have come in from +8.3% at the start of MAY to +7.7%, creating ample room for headline upside surprise risk. We are inclined to fade any/all associated rallies that do not eclipse TRADE resistance on the Shanghai Composite. Chinese policymakers have been guiding towards a negative slope of domestic economic growth since 1Q10; listen to them.
    • JUL 31: JUL Manufacturing PMI
    • AUG 2: JUL Services PMI
  • Korea:
    • JUL 25: 2Q12 Real GDP
    • JUL 29: AUG Business Sentiment Survey (Manufacturing and Services)
    • JUL 31: JUL Manufacturing PMI
  • Brazil:
    • AUG 1: JUN Industrial Production, JUN Trade Data and JUL Manufacturing PMI
    • AUG 3: JUL Services PMI
    • AUG 16: JUN Retail Sales
    • AUG 31: 2Q12 Real GDP; We’ve been calling for a bottom here and will look to confirm if there’s anything in the number that will cause us to revise down our 2H12 outlook for Brazilian economic growth.


All told, our analysis of recent trends across a handful of key growth economies (using China, South Korea and Brazil as proxies in this note; there are many others) lends credence to our view that growth across Asia and Latin America continue to slow. More importantly, we are of the view that economic trends across each region will continue to deteriorate over the intermediate term – a conclusion strongly supported by our quantitative risk management models.


Anecdotally speaking, in a 30-minute call earlier this morning with one of our sharper clients on the international equity investment front, neither he nor I could come up with a solid bull case for any of the major-to-mid-major economies across Asia or Latin America – the consensus “engines of global growth” per the overwhelming majority of sell-side economists and corporate CFOs. Either we’ve become contrarian indicators or the GROWTH/INFLATION/POLICY dynamics simply aren’t there to support an incremental investment(s) in either region at the current juncture. You know where we stand on that.


Darius Dale

Senior Analyst

Vegas Sucks

Sorry, but there’s really no other way to put it. We’ve been pretty bearish on MGM Resorts (MGM) with our estimates on the company’s numbers coming in way below the Street consensus. We may need to revise downward after the latest May data on the Vegas Strip. Basically, Vegas is performing poorly (and that’s putting it lightly) and even offering one of our managing directors a $24 hotel room at Excalibur. If that doesn’t scream of desperation, then let us know what does.



Vegas Sucks - VEGAS 3mo



The Strip’s gross gaming revenue fell 18% year over year in May. That’s a huge drop. Baccarat is struggling and slots ruled in the month of May. It’s looking pitiful out there and MGM is going to have a rough quarter.


Here’s the story, by the numbers:


•             Slot handle fell 7% off of a relatively easy comp

•             Slot win lost 3% despite higher than normal hold

•             June hold may be below normal due to end of month on Saturday

•             Baccarat  (bacc) win fell 47%, on hold of 8.2% (TTM: 12.5%); baccarat volume fell 22%

•             Table win ex bacc fell 18% on below average hold of 10.3%;

•             Table volume ex bacc grew 2%

•             Hold-adjusted total win was -11%

HedgeyeRetail Visual: FNP Levels For Top Long


On our Q3 Themes earlier today, we highlighted FNP as our top long here. We think it’s a gift at this price. With the stock below $9.50, it equates to Kate Spade trading below 11x 2013 EBITDA alone.

The chief concerns weighing on the stock here is how Juicy is tracking and the slowdown in global luxury. Juicy is a 2H story and Fall product just hit shelves this week so a bit premature perhaps, but keep in mind that Juicy accounts for less than 10% of EBIT - it does not make or break this story. As for the global slowdown, it’s reality. But this is a massively underappreciated budding global growth story that can buck the Macro backdrop.

With $1 in earnings power and a sub-$10 stock, we can’t find a better risk/reward setup in retail.


HedgeyeRetail Visual: FNP Levels For Top Long - FNP TTT



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