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THE BIG DAY

Client Talking Points

THE BIG DAY

Election day is finally upon us! There’s a lot of data out there and it’s essentially a dead heat between Obama and Romney. Rasmussen has Romney up a point on Obama while Battleground polls have both men tied. Our proprietary Hedgeye Election Indicator puts Obama’s chances of reelection at 62.5%, which is up 10 basis points week-over-week. While that bodes well for Obama, it’s not a landslide by any means. 

 

Remember the implications for this election: dollar up with Romney, dollar down with Obama and more Bernanke too. The outcome of this particular election will materially change the market. If Obama were to win, we’d likely short the US dollar and go long gold and vice versa if Romney wins. And with Hurricane Sandy having messed up the Northeast, it’ll be interesting to see how many people are able to get out and vote today.

Asset Allocation

CASH 52% US EQUITIES 9%
INTL EQUITIES 0% COMMODITIES 0%
FIXED INCOME 24% INTL CURRENCIES 15%

Top Long Ideas

Company Ticker Sector Duration
TCB

After a long downward slide, TCB has finally turned the corner. The margin has stabilized after the balance sheet restructuring. Loans are growing thanks to the equipment finance business. Non-interest income is more likely to go up than down going forward, a reversal from the past 18 months. Credit quality has a tailwind from a distressed housing recovery in TCB’s core markets: Minneapolis, Detroit and Chicago. On top of this, the CEO, Bill Cooper, is one of the oldest regional bank CEOs, which raises the probability that the bank will be sold. Expectations are bombed out at this point, so we think it’s time to move from bearish to bullish on TCB.

PCAR

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.

HCA

While political and reimbursement risk will remain near-term concerns, on the fundamental side we continue to expect accelerating outpatient growth alongside further strength in pricing as acuity improves thru 1Q13. Flu trends may provide an incremental benefit on the quarter and our expectation for a birth recovery should support patient surgery growth over the intermediate term. Supply costs should remain a source of topline & earnings upside going forward.

Three for the Road

TWEET OF THE DAY

“@KeithMcCullough amazing how different obama's economic policies are from clinton's. and they are in the same party” -@HedgeyeSnakeye

QUOTE OF THE DAY

“I never did give them hell. I just told the truth, and they thought it was hell.” -Harry S. Truman

STAT OF THE DAY

Final Rasmussen Poll: Romney 49% / Obama 48%


DRI: CONSENSUS REFLECTING OUR CONCERNS

Takeaway: We expect continuing softness in the broader category and continuing underperformance at Olive Garden and Red Lobster.

We remain bearish on Darden Restaurants. Yesterday, Keith added it to the short side of our Real-Time Positions. 

 

The poor same-restaurant sales trends at Olive Garden and Red Lobster are pressing the company towards an impasse. The concepts account for roughly 75% of the company's consolidated revenues. We believe that the company is on an unsustainable path.  Specifically, the company is burning cash and the stock can no longer be all things to all investors.  A rich dividend, aggressive growth profile, and sturdy balance sheet have attracted investors of all different styles to buy Darden’s stock over the past few years.  One, or more, of these attributes is likely to fall away as maintaining all three becomes unsustainable.  A proactive reorganization, including a cessation or slowing of unit growth, would be preferable to the more likely reactive lowering of margins or slashing of the dividend that we think is becoming inevitable.

 

Prior to the onslaught of the Hurricane Sandy, casual dining same-restaurant trends were slowing.  We believe that the impact of Sandy on Darden’s results have not yet been baked into consensus.  October looks to be worse than September and November, almost certainly, has gotten off to a difficult start given the company’s exposure to the northeast. 

 

Expectations, and company guidance, may be negatively revised in the coming weeks as we progress further through Darden’s second fiscal quarter of 2013.

  • Management expects total sales growth in fiscal 2013 of between 9 % and 10%; consensus is 12%

HEDGEYE: We believe that the Street may be aggressive in modeling sales growth 200 bps in excess of management’s guidance

 

  • Management expects combined same-restaurant sales growth for Red Lobster, Olive Garden, and LongHorn Steakhouse of approximately 1% to 2%; consensus is looking for 1.46%

HEDGEYE: LongHorn Steakhouse lost momentum on a two-year basis in 1QFY13 and slowing industry trends, along with the impact of Sandy, could pressure the Darden system’s sales growth.  Consensus is expecting continuing sales momentum at RL & OG in 2QFY13 with an acceleration coming in 2HFY13

 

  • Management expects that diluted net earnings per share growth from continuing operations for 2013 will be 5% to 9%; consensus 8%.

HEDGEYE: Despite consensus expecting a resounding top-line beat in 2QFY13, earnings per share growth is expected to come in 100 bps below the high end of management’s guidance.

 

The Darden management team has done a commendable job outlining the plan towards a sales recovery as the company navigates FY13.  We believe that the likelihood of the recovery playing out as planned is slim; we expect continuing softness in the broader category and continuing underperformance at Olive Garden and Red Lobster.   We are expecting FY13 guidance to be revised lower when the company announces 2QFY13 results.

 

DRI: CONSENSUS REFLECTING OUR CONCERNS - OG SRS

 

DRI: CONSENSUS REFLECTING OUR CONCERNS - RL SRS

 

DRI: CONSENSUS REFLECTING OUR CONCERNS - LH SRS

 

DRI: CONSENSUS REFLECTING OUR CONCERNS - DRI levels

 

 

Howard Penney

Managing Director

 

Rory Green

Analyst

 



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Game Day

“The Democracy will cease to exist when you take away from those who are willing to work and give to those who are not.”

-Thomas Jefferson

 

Game day is here.  In what will likely go down as the most expensive campaign season in history, it has all come down to today.  For partisans on both sides, the quote above from Thomas Jefferson is what this election has been about: should the government do less or more? Based on the current national polls, it is not clear either side really won that argument.

 

As I wrote yesterday in a note, the consensus view of the expert pollster is that President Obama has this election won.  He currently leads, albeit very slightly, in the national polls and he has a slightly higher edge in the swing state polls which should give him the Electoral College votes he needs to win.  This is all reflected in the probability markets as websites like Intrade have Obama at an almost 68% probability of winning.

 

Now, if I were content in believing the national polls, I could probably stop the note here and get on to something more interesting, like telling you that you should dial into our call with Neil Barofsky, the former Inspector General of TARP,  tomorrow morning (if you don’t have the dial-in information ping sales@hedgeye.com).  The key pushback on the story the polls are telling us is that almost all economic models suggest that President Obama should not get re-elected.  These models, like polls, also have a very strong track record predicting Presidential election results.

 

In addition, the polls generally appear to show a much higher sample of Democrats by ID than would be expected in a race this close.  This doesn’t mean the polls are wrong, of course, it may well mean there is a reason more people are indentifying as Democrats than ever before.  Currently, it is a margin of +7 for Democrats in the recent national polls that I reviewed.  It could also be a systemic error, which may give Romney the ultimate edge.

 

Regardless, by tomorrow we will know who is right and wrong in terms or predicting the outcome of the election.  We will also know who is going to be the President for the next four years.  Or will we? This year more than other, there is also a strong case for an outcome that is undecided on Election Day. 

 

Specifically, in Ohio voters that have requested ballots to vote early, can also go to the polls on Election Day and vote.  In this scenario, the Ohio voters would be given provisional ballots that could not be counted for ten days until it was determined that voter had not voted twice.  In Ohio, a recount is triggered if the vote is within 0.5% and then the recount would have to wait ten days for the provisional ballots to be legitimized.

 

In the Chart of the Day we take a look at how the market performed in the days following the 2000 tied election.  It wasn’t pretty to say the least.  There was a meaningful drawdown for most of November to the tune of some -8% in the SP500.  As my colleague Keith McCullough noted on CNBC last night, it was a market that felt like hell.  Indecision is never good for equity markets.

 

Undoubtedly, many of you will be watching the returns very closely this evening.  There are a few things that you want to focus on to get a sense for the eventual outcome of the election.  These are as follows:

 

1)      Turnout - If turnout is bigger than expected, it likely favors Obama.  If it is lower than expected, it likely favors Romney.  Potential rain in both North Carolina and Florida may help Romney.  In 2008, more than 131 million people voted.  This equated to 62.9% of eligible voters casting ballots, if the turnout percentage looks to be coming in lower it will be an edge for Romney.

 

2)      Exit polls – There are certain demographics that Romney does much better with, namely whites and males.  If the exit polls show a high turnout among these groups, this will be a positive for Romney.  The inverse is true for Obama.  A high turnout of women and ethnic minorities favors Obama.

 

3)      Virginia – The polls in Virginia close at 7pm eastern.  The path to Ohio even mattering and an eventual victory for Romney goes through Virginia.  If Romney does not win Virginia, he most certainly will not win the Presidency.

 

4)      Ohio - As I’ve written before, no Republican nominee has ever won the Presidency without winning Ohio.  While there is a path to the Presidency for Romney without Ohio, it is very unlikely.  The key counties to watch in Ohio are Hamilton (Obama won in 2004, but normally goes Republican), Wood and Ottawa.  The last two are the swing votes within the swing state and have gone with the Presidential winner every year since 1992.  North Carolina closes at 730pm, just like Ohio, and is must win for Romney.

 

5)      8pm – Three states close at 8pm, including New Hampshire and Florida.  If Romney looks to have won North Carolina, Virginia and Ohio, he will likely have also won Florida, but still needs more Electoral College votes. New Hampshire has four and would put him over the top.

 

6)      9pm – If Romney is still alive at 9pm, then we are on to 14 states, including crucial battlegrounds Colorado and Wisconsin.  Democrats have won Wisconsin for six straight elections.  If Romney can keep Wisconsin close or flip it, he will likely be the next President.

 

In closing, I will leave you with a quote from Thoreau:

 

“All voting is a sort of gaming, like checkers or back gammon, with a slight moral tinge to it, a playing with right and wrong, with moral questions; and betting naturally accompanies it. The character of the voters is not staked. I cast my vote, perchance, as I think right; but I am not vitally concerned that that right should prevail. I am willing to leave it to the majority.”

 

Indeed.

 

Our immediate-term risk range for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1, $106.03-110.12, $3.45-3.53, $80.19-80.84, $1.27-1.29, 1.67-1.75%, and 1, respectively.

 

Keep your head up, stick on the ice and put your ballot in the box,

 

Daryl G. Jones

Director of Research

 

Game Day - Chart of the Day

 

Game Day - Virtual Portfolio



Earnings Deluge

This note was originally published at 8am on October 23, 2012 for Hedgeye subscribers.

“This tends to leave us less prepared when the deluge hits.”

-Nate Silver

 

If you think about all of the corrections (2-8%), draw-downs (9-19%), and crashes (20-30%) stocks and commodities have had in the last 5 years, how many of your favorite economists nailed calling all of them?

 

Almost anyone who is overpaid on the sell-side can tell you a story about why something is going up – but why do they have such are hard time articulating real-time risk on the way down?

 

Forecasting growth (slowing in Q1/Q2 of 2012) and earnings (slowing Q3/Q4) in 2012 wasn’t easy. But it’s even more difficult to comprehend how people who missed calling both are now telling you this is the “trough” and stocks are “cheap.”

 

Back to the Global Macro Grind

 

“Forecasting something as large and complex as the American economy is a very challenging task. The gap between how well these forecasts actually do and how well they are perceived to do is substantial. Some economic forecasters wouldn’t want you to know that.” (The Signal And The Noise, page 177)

 

How $50-100 Billion in market cap companies like Caterpillar (CAT) and Intel (INTC) miss these very obvious turns in both the global growth and the corporate earnings cycle at this point shocks me.

 

Does anyone get paid to have learned anything from the cycle turning in late 2007? The Fed can’t smooth the corporate EPS cycle.

 

In our top Global Macro Theme for Q4 (#EarningsSlowing – ask sales@Hedgeye.com for the slide deck if you haven’t reviewed it), we contextualize the following:

  1. What coming off the last 5 peaks in corporate margins in the last 100 years looks like (stocks look “cheap” at the peaks)
  2. Why the risk to expectations is more in Q4 and 2013 than what’s staring CFO’s in the face in Q312
  3. Why stocks aren’t cheap if you’re using the right growth, margin, and earnings assumptions

That’s just the long-cycle data. It’s not “tail risk.” Corporate margins peaking as sales growth slows is a very high probability situation that you are seeing come across the tape with each and every Q312 earnings report. This should not be surprising you.

 

What surprises me is how disconnected the reality of this moment in the cycle has been relative to where the stock market has levitated. If you want to talk legitimate TAIL risk, that spread risk is it.

 

I often get asked what would change my view. My answer is usually a question – on what, the economy or the stock market? These have been two very different things in 2012 and all of a sudden they are colliding.

 

“Apres moi, le deluge”

 

That’s what King Louis the XV said to his mistress, meaning, en francais – ‘after me, the flood.’ And oh did he nail that one! And that’s the point of hitting the end of a long-standing narrative – everything bullish about stocks, oil, and gold at 14 VIX tends to end, fast.

 

Are the perma-bulls still serious about what they were saying in March (right as #GrowthSlowing took hold)?

  1. US GDP Growth +3-4% (US GDP = down 69% from Q411’s 4.10% to 1.26% reported most recently)
  2. Earnings are “great” (they were at the Q1 2012 top; but Q312 has been the worst in 3 years)
  3. Stocks are “cheap” (sure, if you use the wrong numbers)

Given the data, I doubt it. That would be a joke. And clients aren’t laughing. From Denver to Kansas City, Boston, Maine, and San Francisco (this morning), I have been on the road speaking with clients for the last month. They are getting very concerned about Q4 of 2012 through Q2 of 2013 – and they should be. They’ve seen this movie before.

 

The real reason stocks and commodities were straight up since June was the Fed. Since the Bernanke Top (September 14, 2012), the SP500 has had a 3% correction. What would make it a 9-19% draw-down from that “buy everything high”? Re-read the last 600 words, then factor in an Obama win, and then add a US Debt Ceiling being bonked in January, right before we hit the #FiscalCliff.

 

And remember, after stocks were up “double-digits YTD” in October of 2007, le “deluge” had a heck of a time finding its trough.

 

My immediate-term risk ranges for Gold, Oil (Brent), US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1699-1741, $108.22-110.84, $79.06-80.16, $1.29-1.31, 1.71-1.82%, and 1419-1442, respectively.

 

Best of luck out there today,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Earnings Deluge - Chart of the Day

 

Earnings Deluge - Virtual Portfolio


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