“A dog is not considered a good dog because he is a good barker.”
There are a lot of things I love about Eastern culture. One of them is the deep simplicity of their quotes. If I need to channel my inner-Buddha this morning to make a buy call, so be it.
Back to the Global Macro Grind…
So, after a 41 handle (-2.8%) drop in the SP500 from the Bernanke “Buy Everything” top, US stocks have been down for 7 out of the last 8 days. I heard more crickets than I heard bulls yesterday. Weird.
Sometimes I like to bark. And sometimes that means my cage gets kicked by my central planning overlords too. But that’s ok. I’m just that dog in your life that never goes away. I have big teeth. And when I say “Buyem!” (with a smile), I kind of look like a little bull too.
That’s what my intraday note at 11:18AM EST was titled yesterday. In addition to the list of 7 long ideas I listed in yesterday’s Early Look note, we made the following moves:
- Covered Gold (GLD) at immediate-term TRADE oversold
- Bought Taiwan (EWT) at immediate-term TRADE oversold
- Covered Discover Financial (DFS) at immediate-term TRADE oversold
- Bought Consumer Discretionary (XLY) at immediate-term TRADE oversold
- Covered Burger King (BKW) at immediate-term TRADE oversold
In other words, when I start barking buy/cover or sell/short, it’s always based on the same repeatable process. Infrequently do I get all of my Global Macro signals at the same time as I get my bottom-up (single stock) signals. But when I do, that’s when I lean long or short. The process works both ways.
This is where I can get a lot better at this game, and I will. With more reps, mistakes, and successes, I’ve learned the game by playing it. Sure, some of my lovers out there will say “he does it with a paper portfolio”, and that’s fine. I hear them barking too. But I highly doubt they’d have the guts to show the entire world every move they’ve made for the last 5 years anyway.
From the day that I started this company, I’ve believed in one very simple set of Canadian-American principles: Transparency, Accountability, and Trust. I care less about the tone of my barking than I do the results. This game can be loud and it can get messy. Anyone who wants me to hold some high level of Ivy League gravitas wants me to be someone I am not.
Back to the why…
- Immediate-term TRADE oversold is as oversold does
- Immediate-term TRADE overbought in both Bonds (UST) and the Buck (USD), complimented that equity oversold signal
- Immediate-term TRADE overbought at VIX 17.37 was another critical intraday risk management signal
US Equity Volatility’s (VIX) inverse correlation to the SP500 is as relevant (some of the time) as SPY versus USD is. Never mind the pooch metaphors, those signals were yelling at me yesterday.
With my Correlation Risk signal in hand, I then looked forward at my Global Macro Calendar Catalyst playbook, which had the following bullish catalysts:
- Q2 US GDP report (this morning) will only add fuel to the Bernanke Bailout fire
- Both month and quarter-end markups for Q3 2012 are in play in between today and Monday
- China’s Golden Week (and 18th Party Congress) is pending for the next 2 weeks
That last one only matters in terms of the manic media’s perma-perpetuating of rumors about China “stimulus.” All it takes is for Chinese stocks to stop going down and they’ll say it’s because something big is coming. The Shanghai Composite got just that overnight, having one of its biggest bounces (off the lows) in weeks (+2.6%).
We have 12 LONGS and 3 SHORTS for this morning’s open. It’s probably fair to stop calling me a bear now – just call me a dog. You can pet and feed me with bullish data points. I won’t bite.
My immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, 10yr UST Yield, and the SP500 are now $1, $106.41-111.44, $79.22-79.98, $1.28-1.30, 1.62-1.71%, and 1, respectively.
Best of luck out there today,
Keith R. McCullough
Chief Executive Officer
TODAY’S S&P 500 SET-UP – September 27, 2012
As we look at today’s set up for the S&P 500, the range is 28 points or -0.23% downside to 1430 and 1.72% upside to 1458.
SECTOR AND GLOBAL PERFORMANCE
- ADVANCE/DECLINE LINE: on 09/26 NYSE -678
- Increase versus the prior day’s trading of -1409
- VOLUME: on 09/26 NYSE 738.55
- Decrease versus prior day’s trading of -2.28%
- VIX: as of 09/26 was at 16.81
- Increase versus most recent day’s trading of 8.94%
- Year-to-date decrease of -28.16%
- SPX PUT/CALL RATIO: as of 09/26 closed at 1.84
- Up from the day prior at 1.74
CREDIT/ECONOMIC MARKET LOOK:
BONDS – Bernanke says money printing buys growth, bonds say nein! 10yr drops from 1.90% to 1.62% in a straight line as both growth and #EarningsSlowing expectations kick the Keynesians where it hurts. Bonds are immediate-term TRADE overbought here within a powerful long-term bull market; another reason to buy stocks this morning instead.
- TED SPREAD: as of this morning 26.09
- 3-MONTH T-BILL YIELD: as of this morning 0.10%
- 10-Year: as of this morning 1.65%
- Increase from prior day’s trading of 1.61%
- YIELD CURVE: as of this morning 1.39
- Up from prior day’s trading at 1.35
MACRO DATA POINTS (Bloomberg Estimates)
- 8:30am: Labor Dept. scheduled to issue preliminary benchmark revisions to annual employment data
- 8:30am: GDP (Q/q) (Annualized) 2Q T, est. 1.7% (prior 1.7%)
- 8:30am: Initial Jobless Claims, week of Sept. 22, est. 375k
- 8:30am: Continuing Claims, week of Sept. 15, est. 3.288m
- 8:30am: Durable Goods, Aug., est. -5.0% (prior 4.2%)
- 9:45am: Bloomberg Consumer Comfort, week of Sept. 23
- 10am: Pending Home Sales (M/m), Aug., est. 0.3%
- 10am: Freddie Mac mortgage rates
- 10:30am: EIA natural-gas change
- 11am: Kansas City Fed Manf. Activity, Sept., est. 5
- 11am: Fed to sell $7b-$8b notes in 9/30/2015 to 11/30/2015 range
- 1pm: U.S. to sell $29b 7-year notes
- Federal Deposit Insurance Corp. holds Consumer Research Symposium, with FDIC acting chairman Martin Gruenberg, officials from SEC, CFPB, 8am
- FDA workshop: medical countermeasures in case of radiological, nuclear, chemical attack involving mass burns, 8:30am
- Pentagon advisory panel meets to discuss uniform fomulary for TRICARE pharmaceuticals, 9am
- USTR advisory panel meets on trade practices in Iraq, Indonesia, Ukraine, Fiji, 9:30am
- Cybersecurity conf. w/ ex-NSA/CIA Director Michael Hayden, 8am
- Ford Chief Economist Ellen Hughes-Cromwick delivers remarks on state of automotive industry at National Economists Club, 12pm
WHAT TO WATCH:
- Orders for U.S. durable goods probably slumped on airplanes
- Euro-area economic confidence unexpectedly fell in September
- Madrid protesters march for second night on austerity measures
- China stocks jump most in 3 weeks on market support prospect
- Chrysler Group reaches 4yr labor deal with CAW
- German unemployment rose for 6th month in September
- VW says some carmakers may go bankrupt without state help
- Nomura said to cut as many as 30 jobs in American equities
- Comtech says CEO being probed by grand jury over sales to Israel
- ResCap bondholders pull support for Ally unit’s bankruptcy plan
- H&M 3Q profit misses estimates as margins shrink
- Starbucks to add stores in Scandinavia to spur European sales
- McCormick & Co. (MKC) 6:30am, $0.76
- Actuant (ATU) 7:30am, $0.54
- Discover Financial Services (DFS) 8:30am, $1.03 - Preview
- Accenture (ACN) 4pm, $0.88
- Micron Technology (MU) 4pm, $(0.23)
- Global Payments (GPN) 4:01pm, $0.87
- Sealy (ZZ) 4:01pm, $0.03
- Nike (NKE) 4:15pm, $1.13
- Research In Motion (RIM CN) 4:15pm, $(0.47)
COMMODITY/GROWTH EXPECTATION (HEADLINES FROM BLOOMBERG)
- Gold Gains for First Day This Week as Price Slump Spurs Buying
- Hedge Funds Bullish on Silver as Hoard Nears Record
- Sugar Imports by China Seen Falling as Harvest, Stockpiles Climb
- Oil Recovers From Eight-Week Low After U.S. Inventories Dropped
- Copper Rises as China Company Profits Fuel Stimulus Speculation
- Wheat Drops on Signs Russia Won’t Curb Shipments; Soybeans Fall
- Cocoa Falls as Ivory Coast Reform Concern Eases; Sugar Advances
- Cotton Exports From India Set to Plunge as Chinese Demand Cools
- Cosco Sees Extended Slump as Shipper Yields Surge: China Credit
- Pakistan’s Rice Sales Seen Climbing as Harvest Set to Cut Prices
- BP’s Texas Refinery Sale Shows Volatile Industry’s Decay: Energy
- Billionaires Rinehart, Bennett in New Dispute Over Pilbara Mines
- Oil Puts at 16-Month High Versus S&P 500 on Slowdown: Options
- Shrinking U.S. Corn Supply Trails Use for First Time in 16 Years
USD – get the Dollar right, and you’ll get a lot of market beta right; it has been a really nice counter-trend move for the Burning Buck off its Bernanke (SEP14) low; everything else has reacted inversely to that and now I’m getting an immediate-term TRADE overbought signal for the USD Index at $79.98, so Buyem! (stocks), for the bounce into mth/quarter end.
CHINA – nice pop off the lows for Chinese Equities of +2.6% should get the rumor mill in motion about the stimuli this morn; If Oil prices remain under pressure, we’ll be much more constructive on Equity markets built on unlevered growth (bought both Brazil and Taiwan on red this week). Interesting to see these markets diverge from USA/Europe – they should.
The Hedgeye Macro Team
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Takeaway: $GMCR could have further to fall. A "cheap" multiple does not make up for declining margins and uncertain future earnings prospects
Green Mountain is now down 62% since Starbucks announced the arrival of the Verismo home brewing system. We believe more pain could be on the way for GMCR shareholders.
Green Mountain’s brand portfolio consists largely of regional coffee brands that, even collectively, do not hold a significant share of the overall market. The brands are as follows: Barista Prima, Café Escapes, Coffee People, Diedrich Coffee, Donut House Collection, Green Mountain Coffee, Green Mountain Naturals, revvTM, Timothy’s, Tully’s, Van Houtte.
Brewer Margins Declining From Almost Zero to Virtually Zero
The management team at Green Mountain has, since beginning its quest to conquer the home brewing segment, ran its business as a razor-razor blade model. That is, the company has always sold its brewers (razors) at little margin in order to support sales of K-Cups (razor blades).
Starbucks’ new brewer is adding competitive pressure to the home brewer industry and we believe that the Verismo and any further Starbucks machines will pose a significant threat to Green Mountain’s Keurig brewer. There is a viable argument, that we happen to agree with, that consumer loyalty is more aligned with the coffee than the brewer. If this is true, it would suggest that the Keurig brewer could struggle to maintain its market share over the longer-term as customers replace their old brewers and new customers purchase their first home brewer based on its compatibility with their favorite brand of coffee.
A mere week after Starbucks began taking orders for its Verismo machine, Green Mountain announced discounting in the form of a rebate on some brewer sales. Management has adopted a defensive tone when addressing concerns about the Verismo’s impact on its business:
“…But should something like that happen we have a number of tactical responses, one of which could in fact be deciding to raise the price of the K-Cup brewing system.” – Larry Blanford, CEO of Green Mountain Coffee Roasters, Piper Jaffray Consumer Conference, June 6, 2012
How can they be now discounting their brewers?
It seems that the balance of the evidence suggests that an inventory issue may be underlying and discounting already-low-margin brewer sales will almost certainly bring about even lower margins for the company.
A Contract Manufacturer With Declining Margins
Green Mountain is a contract manufacturer for the following brands: Starbucks, Tazo, The Bigelow, Caribou Coffee, Celestial Seasonings, Dunkin’ Donuts, Emeril’s, Folgers Gourmet Selections, Gloria Jean’s, Kahlua, Millstone, Newman’s Own Organics, Swiss Miss, Twinings of London, and Wolfgang Puck.
All of these licensing partners could, at some point in the future, detach themselves from their respective agreements with Green Mountain Coffee Roasters. It is likely only a matter of time before Starbucks leads the way. The K-Cup patent expiring alone will cause margins on K-Cups to decline but the possibility of partners such as Starbucks or Dunkin’ walking away would be highly damaging to Green Mountain’s profitability. We would point to the unraveling of the Starbucks-Kraft agreement as evidence of a lack of leniency on the part of Schultz et al. when it comes to issues involving control of the Starbucks brand and consumers’ experiences of it.
Caribou Coffee offered some insight into its relationship with Green Mountain when management said:
“Additionally, in the early part of this year, the Caribou brand was repositioned within the Green Mountain portfolio to more premium pricing group. The Caribou brand can command a premium price from consumers, but the retail implementation of the Green Mountain pricing strategy is having a meaningful impact on our club volume, at least, in the near term. This channel represented a large portion of our total business and is the primary driver of our actual and forecasted volume declines.”
The apparent lack of control, on Caribou’s part, over the retail pricing of its own brand, at least in club channels, suggests that Green Mountain could be taking steps to increase the rate of sales growth of its own brands. While this may the best move in the short term, such a strategy cannot be encouraging for its licensing partners.
Getting All Done Up For Nothing
Green Mountain has been readying itself for near-parabolic growth in demand for its products, ramping up capital spending dramatically over the past two years. Unfortunately, management’s forecasting of demand has been less-than-stellar, not helped by misaligned compensation incentives, and the company has clearly invested money in anticipation of demand that is not materializing.
Rule #1: Don’t Lost Money
Many indications point to Green Mountain’s profitability continuing to decline and, we believe, there is a potential for GAAP earnings turning negative in FY13. The following points underscore our concern:
- Excess inventories including brewer inventory?
- The potential for excess K-Cup capacity
- Increased competition and the potential for lost customers
- Patent expiration leads to retail price competition
- Burning cash
- Owned brand market share losses
- Declining margins
- Management creditability
With the company’s financials almost incomprehensible from an analytical perspective, given the well-documented accounting issues, forecasting earnings for the company has become even more of an art, and even less of a science, than it was before. With the increasing competition and emerging fragility of Green Mountain’s business becoming clearer, the most significant near-term challenge will most likely be 1QFY13 as the possibility of a disappointing holiday season becomes more distinct for the company.
Takeaway: Brent crude prices move in the opposite direction of the US Dollar Index.
Below is a chart created by Hedgeye energy analyst Kevin Kaiser -- it shows the relationship between Brent oil prices and the US Dollar Index over ten-year period. As you can see, Brent crude prices move essentially in the opposite direction of the US Dollar Index.
That means that if the US Dollar strengthens, oil prices are likely to go lower. It's a very telling chart, and is consistent with Keith's adage: "If you get the US Dollar right, you get a lot of other things right."
Takeaway: High-margin slot machines are contributing a lower percentage of total gaming revenue, which is a worrying trend for the gaming industry.
Revenue from high-margin slot machines as a percentage of total gaming revenue has been declining since April 2009 on the Las Vegas strip. This is worrying given the higher margins of slots versus table games.
Additionally, the younger generation - post baby-boomers - aren't playing slots, suggesting that this overall trend will continue. MGM is particularly vulnerable to the decline in the contribution of slot machine revenues.
Here's a chart that shows this trend over the past few years.