Shifting Landscapes







Keith McCullough was hard at work yesterday updating the Hedgeye Virtual Portfolio. We covered several shorts to book gains, including Novagold (NG) and Baker-Hughes (BHI). We also shorted two huge names that we’ve been increasingly bearish on over the past year: JP Morgan (JPM) and JCPenney (JCP). We recently did a full breakdown of JCP and our bearish case for the stock on our website. Please use the URL below if you’d like to read it:


JCP: Right On The Money:



While the 10-year US Treasury yield continues to make new lows on a weekly basis, Europe is headed in the opposite direction. Yields continue to climb and set new highs all over the place, including some of the headliner countries like Spain and Italy. Spanish 10-year yields, even if marginally off their highs of the morning, are north of the 7.5% line. If you’re craving returns and don’t mind the heightened risk environment, you can find it in the Eurozone.



It appears that President Obama still has an edge in the upcoming November election. On Tuesday, we released the latest results of our Hedgeye Election Indicator (HEI – link below), showing that the President’s chances of being reelected declined by 70bp, reversing a multi-week upward trend.


A NBC News / Wall Street Journal poll out this morning shows that President Obama holds a 10-point lead on the question: who would make a better Commander in Chief? At the same point four years ago, a Pew poll showed that McCain led Obama on the same question by 15 points. Still, the race between Mitt Romney and Barack Obama remains close and spirited as the countdown until November ticks away.


Hedgeye Election Indicator Results:




Cash:  Up                   U.S. Equities: Down


Int'l Equities: Flat Commodities: Flat


Fixed Income: Flat         Int'l Currencies: Flat





This company is transitioning from cash burn to $75mm annual free cash flow generation thanks to completion of a reimaging program and refranchising of JIB units. Qdoba is the leverage; a maturing and growing store base will bring higher margins. We see 8.5% upside over the next 6-9 months.




TAIL: LONG            



SS volume accelerated in 1Q12 and employment remains a tailwind to both admissions & mix. We expect acuity to stabilize and births and outpatient utilization to accelerate out of 1Q12, while supply cost management continues as a margin driver and acquisition opportunities remain a source for upside.







We continue to expect outpatient utilization to pick up in 2H12 alongside stabilization in acuity with ortho and cardiac/ICD volumes supporting both pricing and inpatient admissions growth. Births should serve as a tailwind into year-end, recent and prospective acquisitions offer some upside to 2012/13 numbers and the in place repo offers some earnings flexibility. With European and Asian growth slowing, we like targeted domestic revenue exposure as well.









Tweet of the Day: “226 AAPL-loaded hedge funds desperate for Bernanke put to avoid margin call bonanza” -@zerohedge


Quote of the Day: “Few people can see genius in someone who has offended them.” –Robertson Davies


Stat of the Day: Caterpillar Inc (CAT) reported. The company reported a second-quarter profit of $1.67 billion, or $2.54 per share, compared with $1.02 billion, or $1.52 per share, a year earlier. Revenue rose 21 percent to $17.37 billion. Street consensus was $17.11 billion. The company also confirmed that China sales are slowing year-over-year, essentially confirming the growth slowing story in Asia.






CRI: First Chink in the Armor


Conclusion: This is the first chink in the armor for CRI. It’s still one of our top shorts.

  • CRI beat and we won’t take it away from them. Carter’s wholesale revenue and profitability looked good, but the implication of lower margins in 2H is the first chink in the armor that we’ve been concerned about.
  • They took down 2H EPS guidance to $1.58-$1.68, we were at $1.50 vs. the Street at $1.84 and we’re likely staying there.
  • While wholesale looks good, the weaker than expected retail comps are a concern and is something that management is going to have to give an answer to on the call. Particularly due to the fact that as we’ve been saying, this is a brand with little delineation, or product differentiation by channel, which will impact owned-retail in the 2H.
  • Inventories looked good on a sequential basis, but keep in mind that the Bonnie Togs acquisition closed on the last day of the quarter last year. While reported inventories were down -18%, excluding BT they were up +11%. This still suggests a 14pt improvement in sales/inventory spread to +9%, but is not as gross margin bullish as implied.

CRI: First Chink in the Armor - CRI S



    Daily Trading Ranges

    20 Proprietary Risk Ranges

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    Four Percent

    “Without continual growth and progress, such words as improvement, achievement, and success have no meaning.”

    -Benjamin Franklin


    Last night I attended a launch party for the first book to be released from the Bush Institute, which is the non-for-profit that President George W. Bush started after leaving office.  The launch was held at the Canadian Consulate in Manhattan, so I felt right at home.  The book, for those of you who haven’t read the news clippings, is called, “The 4% Solution: How Can America Regain Its Economic Strength?”


    In the Chart of the Day, we show real year-over-year GDP growth going back to 1945.  The moral of the story is that four percent GDP growth is no small task.  Since World War II, the average year-over-year GDP growth in the U.S. has been right around 3%. Over the last decade, of course, it has been significantly lower.


    In the forward to the book, the former President Bush makes no bones about the fact that growth began to slow under his tenure.  In fact, he writes:


    “While the causes of the 2008 crisis will be debated by scholars for decades to come, we can all agree that excessive risk taking by financial institutions, irresponsible decisions by lenders and borrowers and market-distorting policies all played a role.  The question now is which policies should we adopt to fix the problems, speed the recovery, and lay the foundation for another long, steady recovery.”


    Obviously, it is a worthy question, especially in the short term as we wake up to even more incremental data points that growth is and will slow both in the U.S. and globally.  Some of these include:


    1.   Company specific reports – I’d like to include Apple in this since the company “disappointed” the consensus estimates of the Old Wall, but the reality is that Apple still sold 26 million iPhones (good for 28% year-over-year growth) and iPad sales grew more than 80% year-over-year.  In aggregate, though, corporate earnings, especially on the top line where it matters, have been validating a slowing global economy.


    2.   European yields – Over the past couple of weeks, European sovereign debt yields in the periphery have gone to new highs.  Specifically, Spanish 10-year yields, even if marginally off their highs of the morning, are north of the 7.5% line.  The implication of this signal is that European governments need to do two things, both of which will slow growth in the short term, cut more spending and likely add more debt to their balance sheets to stay solvent.


    3.   Consumer confidence – The global economy is driven by consumer spending.  The latest negative data point comes from South Korea.  This morning South Korean consumer confidence fell to the lowest level in five months.  Unless consumers globally have confidence, they won’t spend and economic growth will remain anemic.


    Despite the global economic malaise that is being reinforced every morning, President Obama’s re-election chances remain relatively positive.  In fact, a NBC News / Wall Street Journal poll out this morning shows that President Obama holds a 10-point lead on the question: who would make a better Commander in Chief? At the same point four years ago, a Pew poll showed that McCain led Obama on the same question by 15 points.


    This perspective is confirmed by our Hedgeye Election Indicator that shows Obama’s re-election chances are at 57%.  This corresponds with the Presidential predictive market at InTrade that shows a similar reading with Obama having a 57.3% re-election probability.  So, what does Romney have to do to narrow this race?  According to the partisan crowd last night, he has to move the discussion away from Bain Capital, focus entirely on the economy, and introduce a differentiated economic plan to get the U.S. economy back on a growth trajectory.


    A consensus view of many of the economists last night, albeit they were more conservative leaning, is that economic policy will fail if it is thought of as a welfare policy.  On some level, it is hard not to disagree with this point.  While we harp on it daily, relying on government to be the solution is, in fact, the problem.  To wit, I received a morning note today from a friend that runs a large institutional trading firm.  His note led off by saying that European markets and U.S. futures are “holding on” in hopes of government / central bank action.  How sad is that?


    I’ll answer my own question: it is very sad.  Nonetheless, we have to play the game in front of us.  So for those of you who are looking for a government related catalyst of one kind or another, there are few dates to keep in mind:

    1. Aug 1st – Federal Reserve meetings in the U.S.;
    2. Aug 23rd – 25th – The annual central bankers confab in Jackson Hole; and/or
    3. September 13th – Federal Reserve meets again.

    You want catalysts? We got catalysts!


    Unfortunately, government induced catalysts don’t do much for inducing real and sustainable growth, even if they do at times arrest economic gravity.  Although according to some recent analysis from our own Josh Steiner, even that point is questionable.


    The most recent round of short selling bans in Europe made Josh look back at the last times governments intervened in the free markets to ban short selling.  On August 8th, 2011, France, Italy, Spain, and Belgium banned short selling.  The Euro Stoxx Bank Index went on to lose 21% over the next month.  Even more noteworthy was the SEC short selling ban on September 8th, 2008 of the financial sector, which led to subsequent 76% decline in financials over the next six months.


    So, what’s my plan for growth? For the central banks and central planning governments to do one thing: stop.


    Our immediate-term support and resistance risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, and the SP500 are now $1, $99.45-103.98, $83.36-84.17, $1.20-1.22, and 1,


    Best of luck out there today,


    Daryl G. Jones

    Director of Research


    Four Percent	 - Chart of the Day


    Four Percent	 - Virtual Portfolio


    Even the areas we thought IGT would deliver fell short.



    We had concerns going into the quarter but we’re still baffled by IGT’s FQ3 performance.  We thought international would be a bright spot and we were wrong.  Possibly even more confusing was management’s almost complete denial that there are any issues.  Maybe that denial explains why they would buy back a whopping 21 million shares ahead of a major punt.  While some for-sale units may have slipped out of this quarter and into the next, management must have known that this was not going to be a “good” quarter.  Maybe they felt they needed the 2c quarterly accretion to maintain their guidance and it was worth overpaying for the stock to get it.


    Either way, the unchanged guidance – even with the additional 2c – means that the pressure is on for FQ4.  At this point, the mid-point of their guidance looks like a big stretch.  Our 31c implies the low end of the range and even on that we feel like there is limited visibility.



    The Details:


    There was so much that was wrong with the quarter, that we’ll start with the only 2 things that weren’t bad


    The Good:

    • North American Unit sales were 1,000 better than we expected
      • 900 of the beat was due to shipments of Canadian replacement units that we didn’t expect until the September quarter
      • There were also some used units in there so it’s unclear what “new” units shipped were.  We suspect that the used unit sales may have been participation or lease units converting to sale rather than true “used” unit sales.
      • Interactive revenues were $3MM ahead of our expectations
        • We estimate that Double Down revenues were $32MM this quarter, just slightly better than the quarterized result of $24MM in F2Q for 72 days of consolidation
        • Other interactive revenue of $11MM

    The Bad (and The Ugly):

    • Core gaming operations business (excluding interactive):
      • Despite growing their install base by 3,600 units YoY, core gaming operations revenue declined 2% YoY and we estimate that gross margin declined 3% YoY
      • Yields on participation declined 7% YoY and 4% QoQ (June is usually seasonally stronger for yields)
      • Margins on the core business were down about 70bps YoY
    • International game shipments grew 3% YoY and box sales declined by $15MM YoY
      • So much for double digit growth in international and growing market share.
      • We were wrong here as we thought this would be a quarter of progress. 
    • Mix/schmix… Product ASPs were terrible 
      • NA ASPs declined 8.5% YoY
      • International ASPs were down 9% YoY
    • Non-box sales in NA were down 20% YoY
      • What happened to the Revel system deal?
    • SG&A came in at the high end of guidance despite revenues coming in at the low end 
    • Double Down
      • Memories of Server Based gaming?
      • Despite IGT telling us about how accretive this acquisition has been and how well it’s performing, the math says otherwise. 


    Big Mac

    This note was originally published at 8am on July 11, 2012. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.

    “I am the literary equivalent of a Big Mac and fries.”

    -Stephen King


    I’m not going to admit this because my brother is a McDonald’s franchisee. I am going to put it out there because this is really the key to what you really need to know this morning – I love the Big Mac!


    As are all things here in the Haven, that’s a multi-factor, risk managed, statement. Not only do I eat Big Macs (weekly), but I wear the Big Macro jersey for Hedgeye with pride.


    I am right fired up for our Big Macro Quarterly Themes Call this morning. We’ll be hosting it (49 slides in 40 mins) with the customary anonymous client Q&A at 11AM EST.


    As a reminder, last quarter my team nailed the #GrowthSlowing and #BernankeBubbles popping (Gold, Oil, etc.) calls. I’d be lying to you if I said we weren’t looking to land a few fat TAIL risked whales this morning too.


    Our Top 3 Themes are going to be as follows:

    1. Growth Slowing’s Slope – what our GDP models see in Q3 for USA, China, and Germany vs consensus.
    2. The Cliff – as in the 112th Congress kind; will #GrowthSlowing pull forward the Debt Ceiling Debate?
    3. Obama vs Romney – pickles or no pickles? You do need a risk management plan under either scenario.

    Back to the Global Macro Grind


    After 4 consecutive down days (another 33 point draw-down), the SP500 storytellers who have been telling you to buy stocks “because they are cheap” at VIX 15-16 are going to get one of the many opportunities to buy’em cheaper again this week.


    Growth Slowing matters. Most people get that by now. But the narrative of #EarningsExpectations becoming a big market liability has finally perforated the almighty media’s top headlines.


    We’ve been saying short pro-cyclical Sectors (Industrials, Basic Materials, Energy) since we made our #GrowthSlowing call in March. That’s not a victory lap – that’s just the score. These S&P Sectors are getting pounded on #EarningsExpectations in July.


    Only 10 days in, here’s the S&P Sector scoreboard for Q3 to-date:

    1. Industrials (XLI) = down -2.94%
    2. Basic Materials (XLB) = down -2.49%
    3. Energy (XLE) = down -2.12%

    But, but, the Dow is “up for the YTD.” So everything is just fine, right?


    Right. Right.


    There’s a reason why Canadian McDonald’s franchisees refuse to launch anything that resembles eating a yellow snow cone too. Whether you think the average human being on this earth is “smart” or not, there are some things people just get.


    The world’s economic growth is not fine. Neither is the perma contention of the Q1 bulls that “people are too bearish.” Maybe at 27 VIX in May (when the II Bull/Bear Spread pancaked to flat) consensus was bearish enough. Not here.


    If you bought stocks at 1374 SPX and VIX 16 last week, you certainly didn’t get that call from us. Anything in the area code of 14-16 VIX has been the closest sell signal you can find to a layup as there has been in US Equities since 2008.


    Back to the II Bull/Bear Survey, check this thing out (reported this morning):

    1. Bulls rise from 42.5% to 44.7%
    2. Bears are unchanged at 24.5%
    3. Bull/Bear Spread = 2020 basis points wide!

    Away from what I am watching and eating, that’s the super little secret of my risk management morning. The general population of investors who are telling themselves consensus is Bearish Enough are simply lying to themselves inasmuch as I would be if I told you I don’t also love the Filet O’ Fish.


    If you’d like access to this morning’s Q3 Big Macro Themes call, please email


    My immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, German DAX, and the SP500 are now $1550-1587, $97.56-103.01, 82.61-83.81, $1.21-1.24, 6267-6687, and 1331-1353, respectively.


    Best of luck out there today,



    Keith R. McCullough
    Chief Executive Officer




    Big Mac - Virtual Portfolio

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