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Staying Flexible

"I know a lot of people have very strong and definite plans that they've worked out on all kinds of things, but we're subject to a tremendous number of outside influences and the vast majority of them cannot be predicted. So my idea is to stay flexible."

- Henry Singleton


I have to admit, I didn’t know who Henry Singleton was when I first read the quote above – I just really liked the quote.  Then I read a little bit about Mr. Singleton and I really liked him too.  He was what I would call a great American.


Singleton graduated from the Naval Academy in 1940 and went to work as an electrical engineer.  As the United States upped its involvement in World War II, Singleton was eventually sent to Europe as a member of the Office of Strategic Services, which was the forerunner to the CIA.


After serving his country, Singleton returned to the U.S. to get a graduate degree in electrical engineering from MIT.  He would then make his way out to California where he and a former Naval Academy roommate, with the backing of legendary venture capital investor Arthur Rock, would start  Teledyne, a company that had decades of success before being acquired by Allegheny Steel.  None other than Warren Buffett once said:


“Henry Singleton of Teledyne has the best operating and capital deployment record in American business.”


Lofty praise, indeed.


One of Singleton’s keys to success was his willingness to be flexible.  Nothing could be more accurate for those of us that actively invest in the stock market.  The ability to change your mind and change your exposures on new information is a critical to succeeding as a money manager.


Yesterday, I did a brief interview on National Public Radio.  The key question they wanted answered was why August was so quiet and whether that meant things were getting better. Now perhaps I’m being a little inflexible, but my response was that they shouldn’t confuse absence of news with good news.  In fact, as we look forward there are a number of major events that we need to manage risk around, such as:

  1. The U.S. Election – As we’ve noted, this race is basically a dead heat with Romney likely doing a bit better than many polls indicate based on higher voter engagement for Republicans.  We are confident in saying, especially with the addition of Paul Ryan to the ticket, that the economic policy outcomes will be very different under a President Obama or President Romney.
  2. The U.S. Debt Ceiling – Do you remember this little critter last summer that led to a dramatic sell off in risk assets and a literal shutdown in Washington D.C.? Well, it’s going to become an issue again very soon.  According to analysis from our healthcare team, the U.S. Treasury will issue $592 billion in debt through year end, which will put them in breach of the debt ceiling of $16.4 billion sometime before 2013.
  3. Fiscal Cliff – It’s funny how we are hearing less and less about the fiscal cliff these days, since the issue hasn’t gone away.  In 2013, we have the toxic short term growth combination of higher taxes and lower government spending coming our way (less government spending will be good in the long run, of course).  Reasonably this could be a 2% plus headwind to economic growth next year.  The non-partisan CBO actually has 2013 growth pegged at an anemic +0.5% in 2013.
  4. Japanese Debt Ceiling Debate – Just because Japan is in a different time zone, doesn’t mean it doesn’t exist.  Currently,   legislation to enable the Japanese government to sell debt to finance 40% of the federal budget is stuck in the upper house as the opposition party is attempting to force Prime Minister Nodo to fix an election date.  Japan’s government could run out of money by October if this legislation is not passed. 
  5. Chinese Growth – I highlighted the Chinese flash PMIs yesterday that showed inventories building and sales declining heading.  In the Chart of the Day, we show Chinese steel prices that illustrate much the same story economically.  Rebar, in particular, is required for large scale construction and to the extent prices are declining it bodes poorly for economic activity and suggests the upcoming quarters will be replete with negative economic data.
  6. European Debt – The Eurocrats are on vacation so the news flow has been minimal and, on the margin, that’s been positive.  That said, nothing has been solved and we will likely see more “solutions” and “summits” in the coming months.  In fact, news out this morning has the German finance minister stating they will be preparing for a scenario in which Greece leaves the Eurozone.

It’s Friday, so I do want to leave you on a more cheery note heading into the weekend, so I decided to leave out my 7th potential catalyst, which would have been the potential for an Israeli strike on Iran this fall.  Certainly, oil is signaling something along these lines lately.


On a much more cheery note, my colleague Jay Van Sciver, our Industrials Sector Head, will be joining our client call this morning to discuss his sectors and one of his favorite names, PACCAR.  Van Sciver has a differentiated view on the upcoming trucking cycle, which is likely to lead to fewer truck sales and more parts sales.  Get this, truck OEMs, such as PACCAR, actually make more money selling parts.  If you can’t join us for the call this morning, ping and get on a call with Van Sciver.  His long call on PACCAR is almost as compelling as is short case on United Airlines.


Our immediate-term support and resistance ranges for Gold, Oil (Brent), US Dollar, EUR/USD, 10yr UST Yield, and the SP500 are 1, 113.96-116.21, 81.28-82.13, 1.23-1.25, 1.62-1.75% and 1.


Enjoy the weekend!


Keep your head up and stick on the ice,


Daryl G. Jones

Director of Research


Staying Flexible - Chart of the Day


Staying Flexible - Virtual Portfolio

Timing Shorts

This note was originally published at 8am on August 10, 2012 for Hedgeye subscribers.

“Observe due measure, for right timing is in all things the most important factor.”



Efficient market folks say they can’t time markets. Take their word for it. It’s our job, not theirs.


Whether you practice the art of short selling in gnomic, hymnic, or genealogical form, at some point in the decision making process we all have to do the same thing – timestamp our position.


We waited, watched, and finally re-shorted the SP500 yesterday at 10:21AM EST (1405). Given all the perma-bullish narratives I’ve had to listen to for the last few weeks, I must say I enjoyed the experience quite thoroughly.


Back to the Global Macro Grind


To timestamp or not to timestamp, remains the question. All of you who do this with real money understand the concept obviously. Timing stares at you from your P&L every day. For the Old Wall’s finest strategists, the whole accountability exercise still appears to be quite foreign.


If you’re one of the many non-timestamping strategists who had a 3% US GDP growth forecast and 1500-1600 target for the SP500 back in March, you had the entire 2012 fundamental thesis wrong. In order to remain bullish, the best move from here is to beg for bailouts and just change your thesis entirely because the “market is up year-to-date.”


Since the March 26th YTD high for the Russell2000 (+5.5% higher at 846) and the April 2nd YTD high for the SP500 (+1.2% higher at 1419) if nothing else, we’ve been consistent with both our research call (#GrowthSlowing) and our risk management process (#timestamps).


Looking back at the tapes, since February 15th this will be the 9th time we have made a risk management call on the SP500 itself without violating Rule #1 (don’t lose money). We’ve shorted it 8 times and bought it once (bought SPY on May 17th when plenty a March Perma-Bull was in the fetal position).


I’m not trying to evangelize or puff out my chest here. We haven’t killed it with all these calls. They haven’t been the worst timed calls to land in your inbox either. They aren’t meant to be anything other than immediate-term risk signals (which go both ways).


I’m just reminding you that there are some firms in this industry that have at least attempted to evolve the research and risk management process while many haven’t changed a darn thing.


Maybe this time we’ll be wrong. Maybe we’ll be right. The only thing I can tell you is that there will be no maybe when the position is closed.


Timing Matters. In some parts of this country, so does winning and losing – and being held accountable to both.


My immediate-term risk ranges (support and resistance) for Gold, Oil (Brent), US Dollar, EUR/USD, and the SP500 are now $1603-1624, $108.96-114.11, $81.95-83.01, $1.20-1.23, and 1388-1405, respectively.


Best of luck out there today and have a great weekend,



Keith R. McCullough
Chief Executive Officer


Timing Shorts - Chart of the Day


Timing Shorts - Virtual Portfolio


The Macau Metro Monitor, August 24, 2012




In June, average earnings of full-time employees in the gaming industry stood at MOP17,740 (US$2,218), up by 7.8% YoY--increasing faster than CPI (6.44%).  At the end of the first half of 2012, the gaming sector had 52,800 workers, up by 11.6%.  The figure doesn’t include junket promoters and junket associates.  Overall, there were over 1,800 job vacancies in the gaming industry.

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Takeaway: The ability of restaurant companies to manage earnings has boosted stock prices but cannot continue in perpetuity.

Now that earnings season is over, we decided to examine the trend in top- and bottom-line results versus expectations over the last couple of years.  Conclusive takeaways are difficult to make in this case, but it certainly seems that restaurant companies have succeeded in managing EPS results over the the majority of the past eight quarters of reported earnings.


The restaurant stocks we have included in this note have produced earnings results that have, in general, exceeded consensus EPS expectations by a greater margin than sales expectations over the last eight quarters.  From a price reaction perspective, it seems that sales beats/misses have possibly been more important to investors.  We would add that we are not comfortable making that assertion definitively given the arbitrary duration – three days - of the price reactions we have aggregated and the broader market and industry moves that can obscure investors’ reaction to earnings results.  That aside, we do think that the charts below make for interesting viewing. 


The stocks included are as follows: 






EPS Surprises Far-Outstripping Sales Surprises in Recent Quarters

Companies within the restaurant industry seem to have succeeded in managing the bottom line over the last eight quarters.  As the charts below illustrate, casual dining, in particular, has been able to pull levers either within operating costs or other expenses, in order to exceed EPS expectations more consistently than top-line expectations. 





QSR Earnings Callouts


CMG: Chipotle Mexican Grill reported 2Q earnings that were in line from a sales perspective and 13% above EPS expectations.  Nevertheless, due to comparable sales growth in 2Q lagging expectations, the stock traded off -21.5% over the three days following the announcement.


GMCR: Green Mountain Coffee Roasters reported EPS of $0.52 versus $0.49 consensus for 3QFY12 but missed the top-line number and struck a cautious tone on future sales trends.  The stock sold off on the news but recovered and traded sharply higher, we believe on short covering, based on comments from management on a new demand forecasting model.  We still believe that the bull case for Green Mountain’s stock is fanciful at best and will be publishing detailed work on the difficult pricing environment the company could face as its patents expire and competition intensifies in the single-serve category.



Casual Dining Earnings Callouts


BWLD: Buffalo Wild Wings missed the Street’s 2Q top- and bottom-line expectations and traded off almost 6% over the following three days.  The bottom line miss was more meaningful, in terms of magnitude, than the top line as commodity costs continued (and continue) to pressure the P&L.


TXRH: Texas Roadhouse reported a strong EPS beat of 18% ($0.28 versus $0.24) but top-line results were only in line and beef inflation commentary also likely weighed on investor sentiment.  We believe that this stock is one to stay away from on the long side given the commodity outlook and slowing industry sales.  Additionally, the company’s Return on Incremental Invested Capital is decelerating.




QSR Beat/Miss Trends







Casual Dining Beat/Miss Trends







Howard Penney

Managing Director


Rory Green




Idea Alert: BA - Decline On Cancellation

Takeaway: $BA - The Australian market for commercial aircraft is small and Qantas' cancellation has more to do with its own operating challenges.

Boeing: Hard Sell-off on Cancellation



Long-term TAIL support of 69.91 holds; immediate-term TRADE upside to 73.11 


Boeing sold off today following a cancellation by Qantas.  We note that Qantas has its own operational issues, in addition to needing a “u”.  The Australian market for commercial aircraft is about 1/10th the size of the US’s, which is only ~15% itself.  Today’s decline highlights the risk of being in consensus long names.  While it may not mean we will be wrong longer-term, it may increase downside volatility.



  • Cycle:  Boeing is in the midst of a long up cycle in commercial Aerospace, with 7 years trailing revenue in backlog.  The company also has a major product cycle in the 787.
  • Industry Structure:  Boeing has a largely unassailable competitive position in a highly consolidated industry.
  • Valuation: The valuation of Boeing is attractive at these levels on a sector relative basis, in our view, both in a DCF and on screening metrics like relative EV/S (0.5 standard deviations below the trailing 8-year mean).
  • Sector Relative: With growth slowing and estimates in the industrial sector under pressure, we believe BA remains an attractive destination for investors.
  • Sentiment:  Unfortunately, consensus seems to agree with us.  We note that consensus can be right.

Idea Alert: BA - Decline On Cancellation - 5


  • Global aircraft fleet aging has set-up robust backlogs for commercial aircraft makers
  • Strong deliveries in the late 1980s/early 1990s were partly driven by deregulation (US, UK, Japan in the 70s and 80s and, in the early 90s, Europe), which drove demand growth
  • Late 1980s/early 1990s deliveries are now retired or approaching retirement (20 to 25 year sum)
  • Boeing and Airbus have very high backlogs as deliveries have trailed orders for much of the last decade 

Fleet aging is particularly noticeable in the US.  Though only about 15% of commercial aircraft orders, the US aircraft fleet will need to be replenished over time. 


Idea Alert: BA - Decline On Cancellation - 6



Takeaway: Our outlook for US monetary policy over the TRADE and TREND durations remains counter to consensus expectations.

CONCLUSION: We shorted $GLD and bought $UUP in our Virtual Portfolio yesterday afternoon based largely on our view that Chairman Bernanke will not announce further easing at Jackson Hole.


As Shakespeare once wrote, expectations are the root of all heartache.  Next week, expectations heading into Jackson Hole by equity investors are heightened to say the least.  As incremental economic growth data continues to slow, there is really little reason left to justify the recent ramp in U.S. equity markets other than the perceived panacea of a potential monetary easing announcement in Jackson Hole.


To be fair, the FOMC minutes from yesterday certainly did leave the door open:


“A number of them indicated that additional accommodation could help foster a more rapid improvement in labor market conditions in an environment in which price pressures were likely to be subdued. Many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery.”


Nonetheless, we still believe that the next two monetary policy catalysts that are on the horizon that investors are hyper focused on (i.e. the AUG 31-1 annual central banker bonanza in Jackson Hole, WY and the SEP 13 FOMC Announcement) are likely to disappoint. While the manic media is likely to do its best to perpetuate expectations of additional “accommodation” among investors, we expect little to no change in US monetary policy out of both events. Needless to say, our outlook for US monetary policy over the TRADE and TREND durations remains counter to consensus expectations.


Looking back to Jackson Hole 2010 when the Fed overtly signaled QE2, we can safely conclude that the conditions are not in place for the Fed to pull the trigger at either of these upcoming events. Moreover, the OCT 24 FOMC meeting is far too close the election for the Fed to act, in our opinion. The caveat here is that the FOMC, a presumed-to-be-independent board of unelected bureaucrats, can do whatever they please.


That said, however, we anticipate that rising political scrutiny about the stagflationary impact of their recent policies will force them to become more, not less, prudent with regards to their decision making. As we demonstrated yesterday in our note titled, “FIRE IN THE [JACKSON] HOLE: BATTLE LINES ARE BEING DRAWN IN THE US MONETARY POLICY ARENA”, quantitative easing amounts to a highly regressive tax on the poor, begging the key political question: why is Obama such an avid Bernanke supporter?


Regarding the aforementioned conditions, we parse the Fed’s mandate into its three pillars to show just how aggressive and politically compromised the Fed would look in the event it introduces yet another LSAP over the immediate-term. For reference, Obama’s reelection odds correlate tightly with the SPX per our proprietary Hedgeye Election Indicator, as well as those provided by sources such as Intrade.


MANDATE #1: Inflate the Stock Market

The S&P 500 had completely broken down to the mid-to-low 1,000s ahead of Jackson Hole ’10. At ~1,400 on the SPX, the argument that the stock market requires additional stimulus loses a great deal of credibility.




MANDATE #2: Full Employment

Heading into Jackson Hole, we had seen two consecutive months of negative MoM Nonfarm Payroll growth and a total of four consecutive declines by SEP ’10. No such negative trend exists currently.




MANDATE #3: Price Stability

Core CPI was threatening the economy with the specter of deflation, slowing all the way to +0.9% YoY in JUL ’10 and then down to +0.6% YoY by OCT ’10. We’re at +2.1% YoY per the latest data point (JUL) – in line with the Fed’s +2% target. Additionally, the Fed’s own 5yr forward breakeven inflation rate is at 2.57% currently – well above the low of 2.17% we saw on AUG 24th, 2010.





Our quantitative levels on Gold are included in the chart below. Specifically regarding the etf GLD, we see heightening risk of forced sales over the intermediate term as John Paulson & Co., the etf’s largest owner at 5.14% of shares outstanding, may be forced to get incrementally liquid following the news that Citi Private Bank will redeem $500 million from Paulson’s flagship Advantage funds.


Daryl G. Jones

Director of Research


Darius Dale

Senior Analyst



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