Takeaway: Every dollar of sovereign debt is a dollar of [future] tax. Who's going to foot the bill?



  • In the note below, we review a recent analysis put forth by the bi-partisan American Enterprise Institute titled: “A Simple Measure of the Distributional Burden of Debt Accumulation” which was co-authored by Aspen Gorry of UC Santa Cruz and Matthew Jensen of AEI.
  • One of their primary conclusions was that sovereign debt expansion implies incremental taxes and, like tax policy, these costs of servicing incremental federal debt is incredibly progressive.
  • A key takeaway we had was that, because of this highly progressive nature of debt service, the rich will bear the lion’s share of the burden in a revenue boosting scenario and the poor (i.e. households who receive a disproportionate amount of gov’t benefits) will bear the lion’s share of the burden in an expenditure reduction scenario. Moreover, if the GOP has its way, the poor will pick up the tab via regressive spending cuts; if the Democrats have their way, the rich will pay via progressive tax hikes.
  • Lastly, to the extent this continues to edge higher, the marginal propensity for politicians to pursue tax hikes (via voter preference) should also increase.


Those who’ve grown familiar with our team’s work over the last few years know that we aren’t afraid to evolve, often borrowing new ideas from risk managers, authors and academics alike. Moreover, we like to use those ideas to help develop the structural views and biases we manage immediate-to-intermediate-term risk within.


In this vein, one of the more prominent conclusions we’ve weaved into our own research process is the idea that there is a critical threshold (~90% of GDP) where the stock of sovereign debt in an economy structurally impairs economic growth. This thesis was originally demonstrated through the empirical analysis of Carmen Reinhart and Kenneth Rogoff as has since been expanded upon and cited by other scholars in the field. Their work is one of the primary reasons we continue to hold the view that economic growth is likely to remain structurally depressed across a number of developed economies for the foreseeable future.




Why sovereign debt slows economic growth at that critical threshold is still up for debate. From our vantage point, sovereign debt loads that great imply to a certain extent that the government is crowding out private investment, on the margin, due to its deficit financing needs. Another hypothesis we’ve posited is that the threat of future tax hikes and spending cuts loom large in the psyches of consumers and businesses alike, causing them to slow their rate of consumption and investment growth – two occurrences that perpetuate incremental sovereign budget deficits! A third, more simple hypothesis is that it likely takes economies some time to grow the stock of sovereign debt to 90%-plus of GDP and that is may just well be that an older, less productive society is left behind to foot the bill.


There’s likely a handful of other explanations to the aforementioned question; in the prose below, however, we focus specifically on the second hypothesis from above – particularly with regards to the costs of servicing sovereign debt imposed upon US consumers.


A few days back, the bi-partisan American Enterprise Institute published a paper titled: “A Simple Measure of the Distributional Burden of Debt Accumulation” which was co-authored by Aspen Gorry of UC Santa Cruz and Matthew Jensen of AEI. From a critique standpoint, we like that there are no major assumptions in their analysis and that it is overwhelmingly fact-based, sourcing the [presumed] bi-partisan CBO and Tax Policy Center for the bulk of their forward-looking data (though we are all aware of the fact that the CBO’s forecasts of “long run” real interest rates and GDP growth tend to be a bit aggressive). The article mostly walks through their methodologies – which we find generally sound – allowing the reader to focus extensively on the detailed tables of data analysis presented throughout the paper. They even do a good job of remaining bi-partisan, as advertised. All told, the paper is definitely a good read and the analysis is quite thought-provoking; we send our thanks to the client who initially passed it along.


The primary conclusions from the article is that incremental sovereign debt implies incremental taxes and, like tax policy, these costs of servicing incremental federal debt is incredibly progressive. Moreover, when operating under the key assumption that the revenue source for all federal expenditures (including sovereign debt service) is the government’s power to “tax” the public via outright tax hikes or lower future expenditures relative to previously-established policy, we should arrive at the conclusion that any budget outlook with persistent deficits implies equally persistent tax hikes.


One key takeaway that we had is that, because of this highly progressive nature of debt service, the rich will bear the lion’s share of the burden in a revenue boosting scenario and the poor (i.e. households who receive a disproportionate amount of gov’t benefits) will bear the lion’s share of the burden in an expenditure reduction scenario. Now we know why President Obama was so keen to focus on Governor Romney’s alleged “$5 trillion tax cut” during Wednesday night’s debate.


Lastly, the paper sheds light on exactly why both the existing stock of debt and the rate of future debt accumulation are so critical when discussing changes to fiscal policy: it’s not just about having an ideological debate about spending, taxes and the size of the government, but rather about the most important discussion of them all – who’s footing the bill? If the GOP has its way, the poor will pick up the tab via regressive spending cuts (assuming they are in conjunction with tax cuts); if the Democrats have their way, the rich will eventually pay via progressive tax hikes (though lower-income earners could still wind up “paying” via incrementally faster inflation and incrementally slower economic/employment growth).


Given that there’s 15.3x the number of US households at or below the median income than those making $200k-plus (91 million vs. 5.9 million), it’s not difficult to anticipate a future where tax hikes are increasingly favored over spending cuts – especially considering that politicians in a democratic government are generally incentivized to pursue populist means. It’s worth noting that the US’s Gini Index (a standard measure of income inequality) rose for the first time since 1993 last year (at .477 currently). To the extent this continues to edge higher, the marginal propensity for politicians to pursue tax hikes (via voter preference) should also increase.


A collection of the key tables is below; we encourage you to check out the appendix of the paper as well  - some great data. We especially enjoyed the tables highlighting the annual projected debt service costs levered upon US households as a result of the Bush and Obama presidencies.


Darius Dale

Senior Analyst









Obama Rally: SP500 Levels, Refreshed

Takeaway: The economy is not the stock market. Sometime in October though, I think they will collide.

POSITIONS: Shorting Basic Materials (XLB) and Russell (IWM)


Signals are signals. So is political noise. If you don’t think there was any irony in the US employment rate dropping to the precise rate when Obama took office (7.8%), I’ll take the other side of that trade.


I’ll also take the other side of the bullish call I made around this time yesterday. Romney Rally becomes Obama Rally (look at Intrade) – and we know what that means for our hard earned currency (US Dollar Debauchery) and commodity inflation.


The economy is not the stock market. Sometime in October though, I think they will collide.


Across risk management durations, here are the lines that matter to me most:


  1. Immediate-term TRADE overbought = 1468
  2. Immediate-term TRADE support = 1448
  3. Intermediate-term TREND support = 1419


In other words, overbought is as overbought does, so I hit the button. It’s not political. Neither is my process. The title of this note just is.


Get ready for #EarningsSlowing season next week and enjoy the weekend,



Keith R. McCullough
Chief Executive Officer


Obama Rally: SP500 Levels, Refreshed - SPX

BYI: We Have A Winner

Our Gaming, Leisure and Lodging team recently spent some time in Las Vegas speaking with executives at various gaming companies and one name that impressed us is Bally Technologies (BYI). Keith bought the name in our Real-Time Alerts yesterday.


Bally has a nice product cycle ahead of it and the announcements they made at the G2E show this week were positives in our view. Their customers are providing incontrovertible feedback. Historically, BYI is a reel spinning slot supplier and now they’re making the move to video. Approximately 80% of units shipped  in North America are video and unbeknownst to most investors, BYI’s recent video slot shipments have also been around 80% of its total.  So their video content is already driving higher share recently, and this will likely increase their high teens overall share.



BYI: We Have A Winner  - BYI2



Things are going well for Bally’s stock right now and we’re in-line with the September quarter. Looking out at 2013, however, we believe estimates may be too low. Shipments to Illinois and Canada could help exceed expectations and push earnings higher.

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Lowering Expectations







Big companies like FedEx (FDX) and Caterpillar (CAT) have already provided caution to the earnings slowdown that is occurring and it’s spreading throughout the market quickly as third-quarter earnings reports come in day after day. Just look at Zynga (ZNGA) which was down -19% pre-market. Looks like people are starting to realize that people would rather put gas in their car then buy virtual goods in Farmville. Wait and see. As we head into next week, you’re going to see weak guidance across the board, regardless of what Romney and Obama have up their sleeves.




There’s nothing wrong with a strong currency and the United States should focus on restoring confidence in the greenback. Strengthening the dollar helps strengthen America; your neighbor isn’t going to complain about commodity prices going lower, that’s for sure. The dollar and cereal boxes have a lot in common these days - they’re shrinking. Let’s see where next week takes us and remember: get the dollar right, you get a lot of other things right. 






Cash:                UP


U.S. Equities:   Flat


Int'l Equities:   DOWN   


Commodities: Flat


Fixed Income:  Flat


Int'l Currencies: Flat  








Remains our top long in casual dining as new sales layers (pizza) and strong-performing remodels (~5% comps) should maintain sales momentum. The company is continuing to enhance returns for shareholders through share buybacks . The stock trades at a discount to DIN (7.7x vs 9.3x EV/EBITDA) and in line with the group at 7.3x.

  • TAIL:      LONG            



Emissions regulations in the US focusing on greenhouse gases should end the disruptive pre-buy cycle and allow PCAR to improve margins. Improved capacity utilization, truck fleet aging, and less volatile used truck prices all should support higher long-run profitability. In the near-term, Paccar may benefit from engine certification issues at Navistar, allowing it to gain market share. Longer-term, Paccar enjos a strong position in a structurally advantaged industry and an attractive valuation.

  • TAIL:      LONG



This company’s on track to post $3Bn in revenues by ’14 – impressive given a $1.5Bn print in 2011. Perhaps more impressive is the breadth of growth drivers that will get it there – women’s, accessories, new underwear platform etc. in addition to footwear. UA is gaining share in both apparel and footwear quarter-to-date. While some may be concerned over the loss of UA’s SVP/Sourcing we’re 8% ahead of the Street in the upcoming quarter and buyers on weakness.

  • TAIL:      LONG







“If #obama can't stand up to #Romney and challenge him on facts. How do we expect him to stand up to Iran and other world leaders ? #debate” -@greenbergcap




“I don't mind what Congress does, as long as they don't do it in the streets and frighten the horses.” -Victor Hugo




US September Non-Farm Payrolls rise slightly less than expected, up by 114,000 in September; Jobless Rate falls to 7.8%


TODAY’S S&P 500 SET-UP – October 5, 2012

As we look at today’s set up for the S&P 500, the range is 20 points or -1.05% downside to 1446 and 0.31% upside to 1466. 













FLOWS – they’ve convinced me I can trade this tape w/ a bullish bias, but they haven’t convinced The People; Equity Fund Flows negative for the 3rd consecutive wk despite the US stock market at 4.5 yr highs (Lipper data had outflows of another -$2.4B wk-over-wk vs -$1.3B last); no trust = no volume.

  • ADVANCE/DECLINE LINE: on 10/04 NYSE 1384
    • Increase versus the prior day’s trading of -2
  • VOLUME: on 10/04 NYSE 674.72
    • Increase versus prior day’s trading of 1.32%
  • VIX:  as of 10/04 was at 14.55
    • Decrease versus most recent day’s trading of -5.70%
    • Year-to-date decrease of -37.82%
  • SPX PUT/CALL RATIO: as of 10/04 closed at 1.58
    • Down from the day prior at 1.93


  • TED SPREAD: as of this morning 25.09
  • 3-MONTH T-BILL YIELD: as of this morning 0.10%
  • 10-Year: as of this morning 1.68%
    • Increase from prior day’s trading of 1.67%
  • YIELD CURVE: as of this morning 1.44
    • Up from prior day’s trading at 1.43

MACRO DATA POINTS (Bloomberg Estimates)

  • 8:30 am: Non-farm Payrolls change, Sept. est. 115k (prior 96k)
  • Change in Private Payrolls, Sept. est. 130k (prior 103k)
  • Change in Manufacturing Payrolls, Sept. est. 0k (prior -15k)
  • Unemployment Rate, Sept. est. 8.2% (prior 8.1%)
  • 10:00am: Fed’s Dudley at conference in New York
  • 11:00am: Fed’s Duke speaks in New York on neighborhood stabilization
  • 1pm: Baker Hughes rig count
  • 3:00pm: Consumer credit, Aug. est. $7.5b (prior -$3.276b)


    • Most provisions of FCC rule requiring cable companies to share programming with competitors lapse on this date
    • Obama campaigns in Fairfax, Va.; Cleveland
    • Romney campaigns in Abingdon, Va.; St. Petersburg, Fla.


  • Jobless rate probably climed as US employers limited hiring
  • Jobless data seen aiding Romney if rates soars from 8.1%
  • EU doubts on deficit cutting may hinder Spain’s path to bailout
  • BOJ refrains from more stimulus as political pressure mounts
  • Zynga cuts forecast for FY adj. Ebitda and bookings
  • OCBC, CIMB said to mull bids for GE’s Bank of Ayudhya stake
  • FDA advisory panel meets on use of Optical Coherence Tomography technology for treatment of glaucoma
  • Sprint said to take fresh look at MetroPCS after Feb. talks
  • Paulson hedge funds said to further cut 2012 losses in Sept.
  • Credit Suisse sued by US regulator over faulty MBS’s
  • California refiners ration gasoline as prices soar to record
  • UnitedHealth said in talks with Brazil’s Amil Participacoes
  • Hewlett-Packard’s long-term ratings may be cut by Moody’s
  • Palo Alto Networks said to be readying secondary stock offering
  • G-7, IMF Meeting, Nobel Prizes, Sandusky: Week Ahead Oct. 6-13


    • Constellation Brands (STZ), 7:31am, $0.54



OIL – bubbles trade like this as they are popping, violently; not a shocker to see Oil meltup alongside the Euro yesterday; neither should it surprise you that Oil is back down this morn alongside the same. Our immediate-term TRADE duration correlation b/t USD and WTIC = -0.78.

  • Gold Seen Advancing After Reaching 10-Month High on Stimulus
  • Gold Traders More Bullish as Holdings Reach Record: Commodities
  • Palm Oil Stockpiles in Malaysia Set for Record on Production
  • Copper Swings Between Gains and Declines Before U.S. Jobs Report
  • Rubber Drops to Pare Fifth Weekly Gain as BOJ Holds Off Stimulus
  • Robusta Coffee Falls to One-Week Low on Stockpiles; Cocoa Climbs
  • Iron-Ore Swaps Fall 0.2% in London Trading, Clarkson Data Show
  • Oil’s Best Second Half to Hand OPEC $1 Trillion: Energy Markets
  • Soybeans Fall 0.2% to $15.4775 a Bushel, Erasing Earlier Gains
  • Oil May Fall as U.S. Crude Production Increases, Survey Shows
  • Ivory Coast Cocoa Farmers to Put Pay Raise in Crop Production
  • Silver Set to Beat Gold on QE3 in 2011 Re-Run: Chart of the Day
  • Savers Push $374 Billion U.S. Utility Industry to Shift: Energy
  • Palm Oil Climbs as Plunge to Three-Year Low Spurs Import Demand





EURO – big up move yesterday so we re-shorted the EUR/USD just inside of our long-term TAIL risk line of $1.31; Greece +3.6% this morning after telling the world they lied again (so they need more bailout moneys); Spain’s bailout is Rumor Off, for now, as the IBEX remains bearish TRADE (7903 resistance).


















The Hedgeye Macro Team






Pain & Progress

This note was originally published at 8am on September 21, 2012 for Hedgeye subscribers.

“Pain plus reflection equals progress.”

-Ray Dalio


As a hedge fund analyst, turned Portfolio Manager, turned Canadian-American Entrepreneur, there are very few quotes that resonate with me more than that one. Ray Dalio remains, The Man.


In order to really learn how to win, I need to feel the pain of my mistakes. If I’m not making mistakes, that means I’m probably not pushing myself hard enough to try something new. John Cage frames that thought about risk taking another way: “I can’t understand why people are frightened of new ideas. I’m frightened of the old ones.”


As you watch the bull market crowd cheer on 10 million iPhone5 sales this weekend but, at the same time, beg for more of what has not worked (Spain Bailouts), remember that in order to foster Apple like innovation, we can’t incubate an American culture of socializing losses.


Back to the Global Macro Grind


For me at least, last week’s pain was this week’s gain. With the US Dollar Index having its 1st up week in the last 7, the CRB Commodities Index has had its long-term TAIL spanked for a -4.4% wk-to-date move.


Within the parameters of our Multi-factor, Multi-duration Risk Management Model, we focus on 3 key durations of risk (TRADE, TREND, and TAIL). We define TAIL risk on a bi-partisan basis; it works both ways (up and down).


Across the Global Macro waterfront, here are some key TAIL duration risks (3 years or less) for long-term risk managers to consider:

  1. US Dollar Index long-term TAIL support = $78.11
  2. CRB Commodities Index long-term TAIL resistance = 309
  3. Oil (Brent) long-term TAIL resistance = $111.44/barrel
  4. US 10yr Treasury Yield long-term TAIL resistance = 1.91%
  5. EUR/USD long-term TAIL resistance = $1.31

The first and last TAIL risks are the mirrors of one another. One up, one down. That’s why I’ve been saying for a while now that if you get the US Dollar right, you get a lot of other things right. That’s where most multi-duration Correlation Risks associated with Policies To Inflate live.


The other thing that you need to get right is economic growth. Put another way, if you’ve had US and Global Growth right in 2012, you’ve had Treasury Bonds right (long). Despite all of the broken promises from Bernanke on delivering you the elixir of a centrally planned life, the bond market continues to make a series of higher-lows, as the 10yr yield’s TAIL resistance remains intact.


When you get both A) the biggest Ball Under Water Macro trade of the last decade (US Dollar) and B) US Growth (demand) right, you have a tremendous opportunity to get the holy grail of investing right – timing. Personally, I’ll always have room to improve on that.


But does Ben Bernanke? Who holds this man accountable? With a lack of progress, is America’s economy about to experience the most amount of pain yet? If we go back into the soup, what will he do next? Is he out of bullets?


If you know the answer to these critical long-term questions, tweet me.


In the meantime, here’s what you get for your Burning Bernanke Bucks:

  1. Unemployment: US Jobless Claims Rising on a 4-wk rolling average basis to 378,000 (382,000 reported for this wk)
  2. Inflation Expectations: 10yr Breakevens testing all-time highs immediately following Bernanke’s decision last Thursday
  3. Fund Flows: ex-ETFs, US Equity Fund Flows were negative (again) at -$1.9B wk-over-wk (outflows)

In other words, at 4.5 year highs in the US stock market, this is what multiple “Quantitative Easings” and countless “communication tools” about the pending Qe-upon-prior-Qe got us:

  1. Higher US unemployment than we had in 2009 (unemployment rate in January 2009 was 7.8%)
  2. The 3rd of 3 Greenspan/Bernanke Asset Bubbles (Commodities) that every money manager is dared to chase
  3. No trust and/or volume in what used to be America’s beacon of free-market capitalism (the US stock market)

Great job, dude.


Both Bush and Obama signed off on this guy. See the Chart of The Day (10yr Breakeven Inflation Expectations 2007-2012) and you tell me how much longer he can keep America’s Purchasing Power (US Dollar) down, Savings Rates on hard earned moneys at 0%, and show zero reflection on his academic dogma’s mistakes, never mind progress.


My immediate-term Risk Ranges for Gold, Oil (Brent), US Dollar, EUR/USD, 10yr UST Yield, and the SP500, are now $1756-1785, $108.03-111.44, $78.61-80.43, $1.29-1.31, 1.72-1.87%, and 1451-1474, respectively.


Best of luck out there today and enjoy your weekend,



Keith R. McCullough
Chief Executive Officer


Pain & Progress - Chart of the Day


Pain & Progress - Virtual Portfolio